UNITED STATES 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, 2004
Commission file number: 1-12162
BORGWARNER INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3404508
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State or other jurisdiction of (I.R.S. Employer
Incorporation or organization Identification No.)
200 South Michigan Avenue, Chicago, Illinois 60604
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(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, 2004 the registrant had 56,170,603 shares of Common Stock
outstanding.
BORGWARNER INC.
FORM 10-Q
NINE MONTHS ENDED SEPTEMBER 30, 2004
INDEX
Page No.
--------
PART I. Financial Information
Item 1. Financial Statements
Introduction .......................................................... 2
Condensed Consolidated Balance Sheets at
September 30, 2004(Unaudited) and December 31, 2003................. 3
Consolidated Statements of Operations (Unaudited) for
the three months ended September 30, 2004 and 2003.................. 4
Consolidated Statements of Operations (Unaudited) for
the nine months ended September 30, 2004 and 2003................... 5
Consolidated Statements of Cash Flows (Unaudited) for
the nine months ended September 30, 2004 and 2003................... 6
Notes to Consolidated Financial Statements(Unaudited).................. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................. 18
Item 3. Quantitative and Qualitative Disclosures
About Market Risks.............................................. 25
Item 4. Controls and Procedures............................................. 25
PART II. Other Information
Item 1. Legal Proceedings................................................... 27
Item 6. Exhibits and Reports on Form 8-K.................................... 27
SIGNATURES..................................................................... 29
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BORGWARNER INC.
FORM 10-Q
NINE MONTHS ENDED SEPTEMBER 30, 2004
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
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. Certain prior period
amounts have been reclassified to conform to current period presentation. The
results of operations for the three and nine months ended September 30, 2004 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,
2003.
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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(MILLIONS OF DOLLARS EXCEPT SHARE DATA)
September 30, December 31,
2004 2003
------------- ------------
(Unaudited)
ASSETS
Cash and cash equivalents ........................ $ 189.0 $ 113.1
Receivables ...................................... 497.1 414.9
Inventories ...................................... 221.4 201.3
Deferred income taxes ............................ 32.9 32.8
Investments in businesses held for sale .......... 40.3 32.0
Prepayments and other current assets ............. 38.7 30.5
---------- ----------
Total current assets .......................... 1,019.4 824.6
Property, plant, and equipment at cost ........... 1,766.6 1,665.7
Less accumulated depreciation .................... (759.3) (680.4)
---------- ----------
Net property, plant and equipment ............. 1,007.3 985.3
Tooling, net of amortization ..................... 101.4 90.5
Investments and advances ......................... 183.4 177.3
Goodwill ......................................... 851.9 852.0
Other non-current assets ......................... 123.3 120.7
---------- ----------
Total other assets ............................ 1,260.0 1,240.5
---------- ----------
$ 3,286.7 $ 3,050.4
========== ==========
LIABILITIES & STOCKHOLDERS' EQUITY
Notes payable and current portion of
long-term debt .................................. $ 7.3 $ 10.0
Accounts payable and accrued expenses ............ 542.4 460.3
Income taxes payable ............................. 13.2 -
---------- ----------
Total current liabilities ..................... 562.9 470.3
Long-term debt ................................... 583.0 645.5
Long-term retirement-related liabilities ......... 459.1 503.0
Other long-term liabilities ...................... 213.5 154.0
---------- ----------
Total long-term liabilities ................... 672.6 657.0
Minority interest in consolidated subsidiaries ... 19.4 17.2
Capital stock:
Preferred stock, $0.01 par value; authorized
5,000,000 shares; none issued ................... - -
Common stock, $0.01 par value; authorized
150,000,000 shares; issued shares: 2004-
56,174,587; 2003- 55,229,854; outstanding
shares: 2004-56,170,603;2003- 55,157,190 ........ 0.6 0.3
Non-voting common stock, $0.01 par value;
authorized 25,000,000 shares; none issued
and outstanding in 2004 and 2003 ................ - -
pital in excess of par value ................... 794.5 756.3
Retained earnings ................................ 620.7 491.3
Accumulated other comprehensive income ........... 33.1 14.0
Common stock held in treasury, at cost:
2004, 3,984 shares; 2003, 72,664 shares .......... (0.1) (1.5)
---------- ----------
Total stockholders' equity .................... 1,448.8 1,260.4
---------- ----------
$ 3,286.7 $ 3,050.4
========== ==========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(MILLIONS OF DOLLARS EXCEPT SHARE DATA)
Three months ended
September 30,
2004 2003
----------- ------------
Net sales .................................. $ 839.8 $ 725.2
Cost of sales .............................. 694.7 595.9
----------- -----------
Gross profit ............................... 145.1 129.3
Selling, general and administrative expenses 77.4 72.7
Other, net ................................. (0.5) 0.1
----------- -----------
Operating income ........................... 68.2 56.5
Equity in affiliate earnings, net of tax ... (6.2) (3.6)
Interest expense and finance charges ....... 7.5 8.1
----------- -----------
Earnings before income taxes ............. 66.9 52.0
Provision for income taxes ................. 20.1 14.2
Minority interest, net of tax .............. 2.0 1.9
----------- -----------
Net earnings ............................... $ 44.8 $ 35.9
=========== ===========
Net earnings per share - Basic ............. $ 0.80 $ 0.66
=========== ===========
Net earnings per share - Diluted ........... $ 0.79 $ 0.65
=========== ===========
Average shares outstanding (thousands)
Basic ...................................... 56,025 54,494
Diluted .................................... 56,650 55,064
Dividends declared per share ............... $ 0.125 $ 0.09
=========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(MILLIONS OF DOLLARS EXCEPT SHARE DATA)
Nine months ended
September 30,
2004 2003
----------- -----------
Net sales ........................................ $ 2,636.1 $ 2,270.4
Cost of sales .................................... 2,148.7 1,842.8
----------- -----------
Gross profit ..................................... 487.4 427.6
Selling, general and administrative expenses ..... 259.9 233.4
Other, net ....................................... 0.4 0.2
----------- -----------
Operating income ................................. 227.1 194.0
Equity in affiliate earnings, net of tax ......... (21.2) (15.3)
Interest expense and finance charges ............. 22.7 25.8
----------- -----------
Earnings before income taxes ................... 225.6 183.5
Provision for income taxes ....................... 67.7 52.3
Minority interest, net of tax .................... 7.3 6.3
----------- -----------
Net earnings ................................. $ 150.6 $ 124.9
=========== ===========
Net earnings per share - Basic ................... $ 2.70 $ 2.32
Net earnings per share - Diluted ................. $ 2.67 $ 2.30
Average shares outstanding (thousands)
Basic ............................................ 55,742 53,836
Diluted .......................................... 56,354 54,382
Dividends declared per share ..................... $ 0.375 $ 0.27
=========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(MILLIONS OF DOLLARS)
Nine months ended
September 30,
2004 2003
------ ------
OPERATING
Net earnings ....................................................... $150.6 $124.9
Non-cash charges to operations:
Depreciation .................................................... 100.2 90.5
Amortization of tooling ......................................... 30.1 25.6
Employee retirement benefits funded with common stock ........... 27.7 9.9
Equity in affiliate earnings, net of dividends received,
minority interest and other ................................... 4.0 (2.0)
------ ------
Net earnings adjusted for non-cash charges ................... 312.6 248.9
Changes in assets and liabilities:
(Increase) in receivables ....................................... (83.1) (72.0)
(Increase) in inventories ....................................... (20.0) (12.0)
(Increase) decrease in prepayments and other current assets ..... (8.5) 9.6
Increase (decrease) in accounts payable and accrued expenses .... 82.8 (0.5)
Increase in income taxes payable ................................ 12.9 24.3
Net change in other long-term assets and liabilities ............ 24.0 22.1
------ ------
Net cash provided by operating activities ..................... 320.7 220.4
INVESTING
Capital expenditures ............................................... (126.7) (104.1)
Tooling outlays, net of customer reimbursements .................... (40.5) (28.8)
Net proceeds from asset disposals .................................. 2.9 1.8
Proceeds from sale of business ..................................... - 5.4
Investment in unconsolidated subsidiary ............................ (9.0) (14.4)
Contingent valuation payment on acquired business .................. - (12.8)
------ ------
Net cash used in investing activities ......................... (173.3) (152.9)
FINANCING
Net decrease in notes payable ...................................... (2.7) (2.5)
Additions to long-term debt ........................................ 0.3 0.4
Reductions in long-term debt ....................................... (58.6) (7.9)
Payments for purchases of treasury stock ........................... - (2.5)
Proceeds from stock options exercised .............................. 9.8 28.1
Dividends paid ..................................................... (20.9) (14.5)
------ ------
Net cash (used in) provided by financing activities ........... (72.1) 1.1
Effect of exchange rate changes on cash and cash equivalents ....... 0.6 1.6
------ ------
Net increase in cash and cash equivalents .......................... 75.9 70.2
Cash and cash equivalents at beginning of period ................... 113.1 36.6
------ ------
Cash and cash equivalents at end of period ......................... $189.0 $106.8
====== ======
SUPPLEMENTAL CASH FLOW INFORMATION
Net cash paid during the period for:
Interest ........................................................ $ 23.8 $ 27.4
Income taxes .................................................... 12.6 16.6
Non-cash financing transactions:
Issuance of common stock for Executive Stock
Performance Plan ............................................ 2.0 3.3
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-7-
BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) Research and development costs charged to expense for the three and nine
months ended September 30, 2004 were $33.6 million and $94.0 million. 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.
(2) Inventories consisted of the following (millions of dollars):
September 30, December 31,
2004 2003
------------- ------------
Raw materials .............. $ 91.0 $ 95.5
Work in progress ........... 88.0 65.1
Finished goods ............. 42.4 40.7
------ ------
Total inventories ..... $221.4 $201.3
====== ======
(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 provision of 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,
---------------------
2004 2003
------ -------
Net earnings, as reported $ 44.8 $ 35.9
Add:
Stock-based employee compensation expense
included in net income, net of income tax 0.4 0.6
Deduct:
Total stock-based employee compensation
expense determined under fair value based
methods for all awards, net of tax effects (2.9) (2.3)
------ ------
Pro forma net earnings $ 42.3 $ 34.2
====== ======
Net earnings per share
Basic - as reported $ 0.80 $ 0.66
Basic - pro forma 0.76 0.63
Diluted - as reported 0.79 0.65
Diluted - pro forma 0.75 0.62
-8-
Nine Months Ended
September 30,
--------------------------
2004 2003
---------- ---------
Net earnings, as reported $ 150.6 $ 124.9
Add:
Stock-based employee compensation expense
included in net income, net of income tax 1.1 3.2
Deduct:
Total stock-based employee compensation
expense determined under fair value
based methods for all awards, net of tax effects (5.7) (7.0)
---------- ----------
Pro forma net earnings $ 146.0 $ 121.1
========== ==========
Net earnings per share
Basic - as reported $ 2.70 $ 2.32
Basic - pro forma 2.62 2.25
Diluted - as reported 2.67 2.30
Diluted - pro forma 2.59 2.23
On May 17, 2004 the Company announced a two-for-one stock split of common stock
for stockholders of record on May 3, 2004. All share and per share amounts for
prior periods were restated to account for the effect of the stock split.
In calculating earnings per share, earnings are the same for the basic and
diluted calculations. Shares increased for diluted earnings per share by 625,000
and 570,000 for the three months ended, and 612,000 and 546,000 for the nine
months ended September 30, 2004 and 2003, 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 2004 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. The Company expects its effective tax rate for
2004 to be approximately 30.0%. This rate is about 1.5% higher than the prior
year due to changes in tax laws in some of the countries where the Company does
business.
(5) Following is a summary of notes payable and long-term debt:
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September 30, 2004 December 31, 2003
----------------------- ----------------------
Current Long-Term Current Long-Term
-------- --------- -------- ---------
(millions of dollars)
DEBT
Bank borrowings and other ............................ $ 0.6 $ 16.7 $ 2.9 $ 42.5
Term loans due through 2011
(at an average rate of 3.2% at
September 30, 2004 and 3.4% at
December 31, 2003) ................................. 6.7 27.8 7.1 31.4
7% Senior Notes due 2006,
net of unamortized discount ........................ - 139.0 - 139.4
($139 million converted to floating
rate of 3.9% by interest rate swap
at September 30, 2004)
6.5% Senior Notes due 2009,
net of unamortized discount ........................ - 136.1 - 164.7
($100 million converted to floating
rate of 4.6% by interest rate swap
at September 30, 2004)
8% Senior Notes due 2019,
net of unamortized discount($75
million converted to floating rate of
4.8% by interest rate swap at September 30, 2004)... - 133.8 - 133.9
7.125% Senior Notes due 2029,
net of unamortized discount ........................ - 119.1 - 122.1
-------- -------- -------- --------
Carrying amount of notes
payable and long-term debt ................. 7.3 572.5 10.0 634.0
Fair value adjustment for interest
rate swaps (a) .................................. - 10.5 - 11.5
-------- -------- -------- --------
Total notes payable and
long-term debt ......................... $ 7.3 $ 583.0 $ 10.0 $ 645.5
======== ======== ======== ========
(a) The fair value adjustment for interest rate swaps has been reclassified to
long-term debt for all periods presented.
The Company has a new revolving credit facility that provides for borrowings up
to $600 million through July 2009. This new facility effective July 22, 2004
replaced the Company's existing facility of $350 million. At September 30, 2004
and December 31, 2003, there were no borrowings outstanding and no obligations
under standby letters of credit under either facility. The line of credit is
subject to the usual terms and conditions applied by banks to an investment
grade company. The Company is in compliance with its credit agreement covenants
as of September 30, 2004 and expects to be compliant in future periods.
(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, 2004 follows (currency in millions):
-10-
Interest rates
Notional -------------- Floating interest
Hedge Type Amount Receive Pay Rate basis
---------- ------ ------- --- -----------------
(Millions)
Interest Rate Swaps
(a)
Fixed to floating Fair value $ 139 7.0% 3.9% 6 month LIBOR+1.7%
Fixed to floating Fair value $ 100 6.5% 4.6% 6 month LIBOR+2.4%
Fixed to floating Fair Value $ 75 8.0% 4.8% 6 month LIBOR+2.6%
Cross Currency Swaps
(Matures in 2006)
Floating $ Investment $ 125 3.6% - 6 mo. USD LIBOR+1.4%
To floating Y Y 14,930 - 1.7% 6 mo. JPY LIBOR+1.6%
(Matures in 2019)
Floating $ Investment $ 25 5.2% - 6 mo. USD LIBOR+3.0%
To floating (euro) (euro)20 - 5.2% 6 mo. Euribor+3.0%
a) The maturity of the swaps corresponds with the maturity of the hedged item as
noted in the debt summary.
The ineffective portion of the swaps was not material. As of September 30, 2004
and December 31, 2003, the fair value of the fixed to floating interest rate
swaps was $10.5 and $11.5 million, respectively. The cross currency swaps were
recorded at their fair value of $(11.1) and $(13.6) million at September 30,
2004 and December 31, 2003, respectively. 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.
These instruments are intended to offset the effect of changes
in commodity prices on forecasted purchases. As of September
30, 2004 the Company had forward and option commodity contracts
with a total notional value of $4.7 million and a market value $5.2
million, resulting in a favorable fair value of $0.5 million,
which is deferred in other comprehensive income and will
be reclassified and matched into income as the underlying
operating transactions are realized. At December 31, 2003,
the Company had forward and option commodity contracts with
a total notional value of $1.1 million and a market value
of $1.2 million, resulting in a favorable fair value of $0.1
million. During the nine months ended September 30, 2004
and 2003, hedge ineffectiveness of these contracts was not
material.
The Company uses foreign exchange forward contracts to protect
against exchange rate movements for forecasted cash flows for
purchases 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
sales contracts are covered by forward currency arrangements to
protect against currency risk through the second quarter of
2009. Foreign currency contracts require the Company, at a future
date, to either buy or sell foreign currency in exchange for
primarily U.S. Dollars, Euro, Japanese Yen and British Pounds
Sterling. Contracts outstanding as of September 30, 2004 had
a total notional value of $91.7 million and a market value of $94.3
million, resulting in a favorable fair value of $2.7 million,
which is deferred in other comprehensive income and will be
reclassified and matched into income as the underlying operating
transactions are realized. Contracts outstanding as of December
31, 2003 had a total notional value of $25.5 million and a market value
of $26.6 million, resulting in a favorable fair value of $1.1 million.
(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 41 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, 2004 of approximately
$21.3 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 and remediate
the contamination. The investigation revealed the presence of Polychlorinated
Biphenyls (PCBs) in portions of the soil at the plant and neighboring areas.
Clean up began in 2000 and is continuing. Kuhlman Electric and others, including
the Company, have been sued in numerous related lawsuits, in which multiple
claimants allege personal injury and property damage. The first of these
lawsuits
-12-
is scheduled to go to trial in March 2005.
The Company believes that the reserve for environmental liabilities and any
insurance recoveries are adequate to cover any potential liability associated
with environmental matters. However, due to the nature of environmental
remediation, there can be no assurance that the actual amount of environmental
liabilities will not exceed the amount reserved.
The Company has guaranteed the residual values of certain leased machinery and
equipment at one of its facilities. The guarantees extend through the maturity
of the underlying lease, which is in 2005. In the event the Company exercises
its option not to purchase the machinery and equipment, the Company has
guaranteed a residual value of $16.3 million. The Company does not believe it
has any loss exposure due to this guarantee.
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 $2.4 million in the third
quarter 2004 and $5.7 million in the third quarter 2003. The royalty costs
incurred for the nine months ended September 30, 2004 and 2003 were $12.0
million and $17.2, respectively. These costs were all recognized as part of cost
of goods sold. These costs will continue to decrease in 2004 and be at minimal
levels in 2005 and 2006 as the Company's primary customers have converted most
of their requirements to the next generation VTG turbocharger.
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 represented in both long-term and short-term
liabilities on the balance sheet. The following table summarizes the activity in
the warranty accrual accounts (in millions):
For the nine months
ended September 30,
-------------------
2004
-------------------
Beginning balance $ 28.7
Provision 10.6
Incurred (7.4)
------
Ending balance $ 31.9
======
(8) Comprehensive income is a measurement of all changes in stockholders' equity
-13-
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 market
value changes in certain hedge instruments. The amounts presented as other
comprehensive income, net of related taxes, are added to net income resulting in
comprehensive income.
The following summarizes the components of other comprehensive income on a
pretax and after-tax basis for the periods ended September 30,
(in millions)
Three Months Ended
------------------------------------------------------
2004 2003
------------------------- --------------------------
Income Income
Tax After- Tax After-
Pretax Effect tax Pretax Effect tax
------ ------ ------ ------ ------ ------
Foreign currency
translation adjustments.................... $ 18.6 $ 1.9 $ 20.5 $ 3.3 $ (4.0) $ (0.7)
Market value change in
hedge instruments.......................... ( 0.9) - ( 0.9) - - -
Net earnings as reported.................... 44.8 35.9
------ ------
Total comprehensive income $ 64.4 $ 35.2
====== ======
(in millions)
Nine Months Ended
------------------------------------------------------
2004 2003
------------------------- --------------------------
Income Income
Tax After- Tax After-
Pretax Effect tax Pretax Effect tax
------ ------ ------ ------ ------ ------
Foreign currency
translation adjustments................... $ 12.3 $ 1.1 $ 13.4 $ 50.8 $ (4.0) $ 46.8
Market value change in
hedge instruments........................ 2.0 - 2.0 - - -
Net earnings as reported.................... 150.6 124.9
------ ------
Total comprehensive income $166.0 $171.7
====== ======
The components of accumulated other comprehensive income, net of tax, in the
Condensed Consolidated Balance Sheets are as follows:
(in millions)
September 30, December 31,
2004 2003
------------- ------------
Foreign currency translation adjustments.................. $ 86.7 $ 73.3
Market value change in hedge instruments.................. 3.2 1.2
Minimum pension liability adjustment...................... (56.8) (60.5)
-------- ------
Total accumulated other comprehensive income.............. $ 33.1 $ 14.0
======== ======
(9) The following tables show net sales, earnings before interest and taxes and
total assets for the Company's reportable operating segments (millions of
dollars).
-14-
NET SALES
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------
2004 2003
------------------------------ ---------------------------------
Inter- Inter-
Customer segment Net Customer segment Net
-------- ------- ------ -------- ------- -------
Drivetrain $ 318.7 $ - $318.7 $ 284.3 $ - $ 284.3
Engine 521.1 11.6 532.7 440.9 10.5 451.4
Inter-segment eliminations - (11.6) (11.6) - (10.5) (10.5)
-------- ------- ------ -------- ------- -------
Consolidated $ 839.8 $ - $839.8 $ 725.2 $ - $ 725.2
======== ======= ====== ======== ======= =======
NET SALES
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------
2004 2003
-------------------------------- ----------------------------------
Inter- Inter-
Customer segment Net Customer segment Net
-------- ------- -------- -------- ------- --------
Drivetrain $1,025.7 $ - $1,025.7 $ 915.3 $ - $ 915.3
Engine 1,610.4 39.0 1,649.4 1,355.1 33.7 1,388.8
Inter-segment eliminations - (39.0) (39.0) - (33.7) (33.7)
-------- ------- -------- -------- ------- --------
Consolidated $2,636.1 $ - $2,636.1 $2,270.4 $ - $2,270.4
======== ======= ======== ======== ======= ========
EARNINGS BEFORE EARNINGS BEFORE
INTEREST & TAXES INTEREST & TAXES
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ------------------------
2004 2003 2004 2003
-------- -------- --------- --------
Drivetrain $ 24.4 $ 16.7 $ 78.9 $ 66.5
Engine 65.2 55.6 208.8 178.3
-------- -------- -------- --------
Total segments 89.6 72.3 287.7 244.8
Corporate, including
equity in affiliates (15.2) (12.2) (39.4) (35.5)
-------- -------- -------- --------
Earnings before interest and taxes
Interest expense and finance charges 74.4 60.1 248.3 209.3
Earnings before income taxes (7.5) (8.1) (22.7) (25.8)
-------- -------- -------- --------
$ 66.9 $ 52.0 $ 225.6 $ 183.5
======== ======== ======== ========
TOTAL ASSETS
SEPTEMBER 30 DECEMBER 31
2004 2003
------------ --------------
Drivetrain $ 824.1 $ 778.8
Engine 2,063.9 1,925.1
-------- --------
Total segments 2,888.0 2,703.9
Corporate, including
investment in affiliates 398.7 346.5
-------- --------
Consolidated $3,286.7 $3,050.4
======== ========
-15-
(10) 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 $50 million.
During the nine months ended September 30, 2004, the amount of receivables sold
remained constant at $50 million and total cash proceeds from sales of accounts
receivable were $450.0 million. For the nine months ended September 30, 2004,
the Company paid a servicing fee of $0.6 million related to these receivables,
which is included in interest expense and finance charges.
(11) The changes in the carrying amount of goodwill (in millions of dollars) for
the nine months ended September 30, 2004, are as follows:
Drivetrain Engine Total
---------- ------ ------
Balance at December 31, 2003 $134.3 $717.7 $852.0
Translation adjustment - (0.1) (0.1)
------ ------ ------
Balance at September 30, 2004 $134.3 $717.6 $851.9
====== ====== ======
(12) The Company has a number of defined benefit pension plans and other
postretirement benefit plans covering eligible salaried and hourly employees.
The other postretirement benefits plans, which provide medical and life
insurance benefits, are unfunded plans. The estimated contributions for 2004
range from $34 to $36 million, of which about $34 million has been contributed
through the first nine months of the year. The components of net periodic
benefit cost recorded in the Company's Consolidated Statement of Operations, are
as follows:
Other
Pension Postretirement
Benefits Benefits
Three months Ended September 30
----------------------------------------
2004 2003 2004 2003
----- ----- ----- -----
Service cost $ 3.4 $ 2.5 $ 1.5 $ 1.3
Interest cost 11.4 7.0 6.8 7.4
Expected return on plan assets (14.7) (6.6) - -
Amortization of unrecognized
transition asset - - - -
Amortization of unrecognized 0.8 0.4 -
Prior service cost (0.1)
Amortization of unrecognized loss 2.1 2.4 2.5 1.5
----- ----- ----- -----
Net periodic benefit cost $ 3.0 $ 5.7 $10.8 $10.1
===== ===== ===== =====
Other
Pension Postretirement
Benefits Benefits
Nine months Ended September 30
----------------------------------------
2004 2003 2004 2003
----- ------ ------ -----
Service cost $ 9.9 $ 7.5 $ 4.5 $ 3.9
Interest cost 27.5 21.0 21.6 22.3
Expected return on plan assets (30.5) (19.8) - -
-16-
Amortization of unrecognized
transition asset - 0.2 - -
Amortization of unrecognized 1.7 1.1 - (0.1)
Prior service cost
Amortization of unrecognized loss 6.3 7.2 6.3 4.5
----- ------ ------ -----
Net periodic benefit cost $14.9 $ 17.2 $ 32.4 $30.6
===== ====== ====== =====
(13) In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation (FIN) No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51,"which was revised in December 2003. FIN No. 46R
requires that the assets, liabilities and results of the activity of variable
interest entities be consolidated into the financial statements of the entity
that has the controlling financial interest. FIN No. 46R also provides the
framework for determining whether a variable interest entity should be
consolidated based on voting interest or significant financial support provided
to it. For the Company, this Interpretation, as revised, was effective January
1, 2004. The Company has no variable interest entities required to be
consolidated as a result of adopting FIN No. 46R, therefore, there was no impact
on our Consolidated Financial Statements.
In December 2003, the FASB issued a revised SFAS No. 132, "Employer's
Disclosures About Pensions and Other Postretirement Benefits." SFAS No. 132
changes employers' disclosures about pension plans and other postretirement
benefits and requires additional disclosures about assets, obligations, cash
flows and net periodic benefit cost. The Statement is effective for annual and
interim periods ended after December 15, 2003. The Company adopted SFAS No. 132
as of December 31, 2003, resulting in additional disclosures in the Company's
annual and interim Consolidated Financial Statements.
In December 2003, the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 ("the Act") was enacted in the United States. The Act provides,
among other things, expanded existing Medicare healthcare benefits to include an
outpatient prescription drug benefit to Medicare eligible residents of the U.S.
(Medicare Part D) beginning in 2006. Prescription drug coverage will be
available to eligible individuals who enroll under the Part D plan. As an
alternative, employers may provide drug coverage at least "actuarially
equivalent to standard coverage" and receive-free federal subsidy equal to 28%
of a portion of a Medicare beneficiary's drug costs for covered retirees who do
not enroll in a Part D plan.
In May 2004, the FASB issued Staff Position FAS No. 106-2, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003," to provide guidance on accounting for effects of
the Act. The Staff Position requires treating the effect of the employer subsidy
on the accumulated post retirement benefit obligation (APBO) as an actuarial
gain. The effect of the subsidy is to be reflected in the estimate of service
cost in measuring the cost of benefits attributable to current service. The
effects of plan amendments adopted subsequent to the Act to qualify plans as
actuarially equivalent are to be treated as actuarial gains if the effect of the
amendments reduces the APBO. The net effect on the APBO of any plan amendments
that (a) reduce benefits under the plan and thus disqualify the benefits as
actuarially equivalent and (b) eliminate the subsidy are to be accounted for as
prior service cost. The effect of the adoption was a $6.8 million reduction of
the Company's 2004 post-retirement benefits expense.
-17-
(14) On November 1, 2004, the Company announced that its wholly-owned German
subsidiary, BorgWarner Germany GmbH ("BorgWarner Germany"), entered into a Sale
and Purchase Agreement, dated October 30, 2004 (the "Sale and Purchase
Agreement"), with CEP BE 00 Beteiligungs GmbH, Frau Ingelore Ruprecht, Wolfram
Birkel, Elsa Birkel, Annegret Birkel, Christoph Birkel, Catharina Birkel,
Klosterfeld Beteiligungen GmbH + Co. KG, and Meier-Birkel GmbH & Co. KG to
purchase an aggregate of 6,221,170 shares or 62.21% of the outstanding shares of
Beru AG, a German publicly-traded company ("Beru"), for Euro 59 per share.
BorgWarner Germany also entered into an option agreement (the "Option
Agreement") to acquire an additional 81,500 shares of Beru for Euro 59 per share
from Annegret Birkel at any time after January 3, 2005 and prior to March 31,
2005. The completion of the transactions contemplated by the agreements is
conditioned on obtaining regulatory approval and other customary conditions.
Assuming regulatory approval, the closing is anticipated to occur around
year-end.
On November 1, 2004, the Company also announced that BorgWarner Germany intends,
as required by German law, to commence a tender offer in Germany (the "Tender
Offer") to acquire the remaining shares of approximately 37% (or approximately
3.7 million shares) of the outstanding stock of Beru at a price of Euro 67.50
per share.
The total transaction, assuming purchase of all the remaining outstanding shares
of Beru in the Tender Offer, is valued at Euro 621 million (or approximately
$764 million). The Company intends to initially fund the transaction with cash
and funds available under its existing revolving credit facility. The Company
intends to ultimately fund the transaction in a manner consistent with
maintaining the Company's current investment grade capital structure.
Beru is a leading global automotive supplier and manufacturer 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 company's major customers include, among others, BMW, DCX, GM/Fiat, VW/
Audi, Ford, Porsche, PSA, Renault, Isuzu, Siemens VDO, Valeo, Deutz, and MAN.
The company employs approximately 2,700 employees and reported 2004 fiscal year
(ended March 31) revenues of (euro)354.5 million.
-18-
Item 2. 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 vehicle
powertrain applications. Our products help improve vehicle performance, fuel
efficiency, handling, and air quality. They 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
THREE MONTHS ENDED SEPTEMBER 30, 2004 VS. THREE MONTHS ENDED SEPTEMBER 30, 2003
Consolidated net sales for the third quarter ended September 30, 2004 totaled
$839.8 million, a 15.8% increase over the third quarter of 2003. This increase
occurred in a market where production was up slightly from the previous year's
quarter. Production in North America was down 1.5%. Light vehicle production was
up in both Europe and Asia. Net sales increased $24.2 million due to stronger
currencies, primarily the Euro. Turbochargers and automatic transmissions are
the products most affected by currency fluctuations in Europe and Asia. Without
the currency impact, the increase in net sales would have been 12.5% due to
strong demand for the Company's products in Europe and Asia.
Gross profit and gross margin were $145.1 million and 17.3% for the third
quarter 2004 as compared to $129.3 million and 17.8% for the third quarter 2003.
Gross profit margins were impacted negatively by higher prices for commodities,
including steel, copper and aluminum. The increase in commodity costs was
approximately $12 million for the third quarter, of which steel was the single
largest contributor. These higher commodity costs were offset by improved
productivity on greater sales volume and by cost reductions in our operations.
For the third quarter selling, general and administrative costs increased $4.7
million from $72.7 million to $77.4 million, but decreased as a percentage of
sales from 10.0% to 9.2% of net sales. The majority of the increase $4.6 million
was for research and development costs, which are included in selling, general
and administrative expenses. Spending on research and development totaled $33.6
million, or 4.0% of net sales versus $29.0 million, or 4.0% of net sales for the
third quarter of 2003.
Third quarter interest expense and finance charges decreased $0.6 million from
third quarter 2003 as a result of reduced debt levels, which more than offset
year-over-year interest rate increases.
Equity in affiliate earnings, which consist primarily of the Company's 50% share
of NSK-Warner in Japan, was up $2.6 million in the third quarter of 2004 as
compared to the third quarter of 2003. NSK-Warner realized both strong sales and
profits in the third quarter from its operations.
-19-
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 2004 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. The Company expects its effective tax rate for 2004 to be
approximately 30.0%. This represents a 1.5% increase over last year due to
changes in tax laws in some of the countries where the Company does business.
Net income was $44.8 million for the third quarter, or $0.79 per diluted share,
an increase of $0.14 over the previous year's third quarter. The increase from
prior years third quarter was due to operations of $0.15 per share, favorable
currency of $0.04 per share offset by an increase in effective tax rate change
of $(0.03) per share and by a share dilution impact of $(0.02) per share. Shares
outstanding increased due to shares issuable under the Executive Stock
Performance Plan and contributions of Company stock to benefit plans.
NINE MONTHS ENDED SEPTEMBER 30, 2004 VS. NINE MONTHS ENDED SEPTEMBER 30, 2003
Consolidated net sales in the first nine months of 2004 were $2,636.1 million as
compared to $2,270.4 million in the first nine months of 2003, an increase of
$365.7 million or 16.1%. This increase occurred in a market where production was
up 4% from the previous year's nine months. Light vehicle production in North
America and Europe was relatively flat. Light vehicle production was up in Asia.
Net sales increased $85.8 million due to stronger currencies, primarily the
Euro. Turbochargers and automatic transmissions are the products most affected
by currency fluctuations in Europe and Asia. Without the currency impact, the
increase in net sales would have been 12.3% due to the growing demand for our
products in Europe and Asia.
Gross profit and gross margin were $487.4 million and 18.5% in the first nine
months of 2004 as compared to $427.6 million and 18.8% in the first nine months
of 2003. Gross profit margins were impacted negatively by higher prices for
commodities, including steel, copper and aluminum. The increases in commodity
costs were approximately $20 million in the first nine months of 2004, of which
steel was the single largest contributor. These higher commodity costs were
offset by productivity gains due to higher sales volumes and cost reductions in
our operations.
Selling, general and administrative costs, including research and development
costs, increased $26.5 million from $233.4 million to $259.9 million, but
decreased as a percentage of sales from 10.3% to 9.9% of net sales. Spending on
research and development, totaled $94.0 million, or 3.6% of net sales in the
first nine months of 2004 as compared to $87.4 million, or 3.9% of net sales in
the first nine months of 2003.
Interest expense and finance charges decreased by $3.1 million from $25.8
million to $22.7 million in the first nine months of 2004 as compared to the
first nine months of 2003. The interest expense decrease was a result of reduced
debt levels which more than offset interest rate increases during the first nine
months of 2004. At September 30, 2004, the amount of net debt with fixed
interest rates was 55% of total net debt.
-20-
Equity in affiliate earnings, which consist primarily of the Company's 50% share
of NSK-Warner in Japan, increased by $5.9 million from $15.3 million to $21.2
million. NSK-Warner realized both strong sales volume and profit gains from
operations in the first nine months of 2004.
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 2004 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. The Company expects its effective tax rate for 2004 to be
approximately 30.0%. This represents a 1.5% increase over last year due to
changes in tax laws in some of the countries where the Company does business.
Net income was $150.6 million, or $2.67 per diluted share, in the first nine
months of 2004 as compared to $124.9 million, or $2.30 per diluted share in the
first nine months of 2003, an increase of $0.37 per diluted share. The increase
from the first nine months of 2003 was due to operations of $0.39 per share,
favorable currency of $0.14 per share offset by an increase in effective tax
rate change of $(0.06) per share and by a share dilution impact of $(0.10) per
share. Shares outstanding increased due to shares issuable under the Executive
Stock Performance Plan and contributions of Company stock to benefit plans.
REPORTABLE OPERATING SEGMENTS
The Company's products fall into two reportable operating segments: Drivetrain
and Engine. The following tables present net sales and earnings before interest
and income taxes (EBIT) by segment for the three and nine months ended September
30, 2004 and 2003 in millions of dollars.
Three Months Nine Months
September 30, September 30,
Net Sales 2004 2003 2004 2003
- ------------- -------- -------- -------- --------
Drivetrain $ 318.7 $ 284.3 $1,025.7 $ 915.3
Engine 532.7 451.4 1,649.4 1,388.8
Inter-segment
eliminations (11.6) (10.5) (39.0) (33.7)
-------- -------- -------- --------
Net sales $ 839.8 $ 725.2 $2,636.1 $2,270.4
======== ======== ======== ========
Three Months Nine Months
September 30, September 30,
EBIT 2004 2003 2004 2003
- ------------ ------ ------ ------ ------
Drivetrain $ 24.4 $ 16.7 $ 78.9 $ 66.5
Engine 65.2 55.6 208.8 178.3
------ ------ ------ ------
Segment EBIT $ 89.6 $ 72.3 $287.7 $244.8
====== ====== ====== ======
THREE MONTHS ENDED SEPTEMBER 30, 2004 VS. THREE MONTHS ENDED SEPTEMBER 30, 2003
The Drivetrain segment sales increased $34.4 million, or 12.1% and EBIT
increased $7.7 million, or 46.1% from the third quarter of 2003. The strong
sales gain was a result of four-wheel drive transfer case programs with General
Motors and Ford and steady demand for transmission components and systems,
especially with
-21-
increased automatic transmission penetration in Europe. The EBIT margin increase
was due primarily to the increase in sales and improved productivity, lower
pension expense from increased pension funding in 2004 and a reduction of start
up costs for new products that were expensed in the third quarter of 2003.
The Engine segment sales increased $81.3 million, or 18.0% and EBIT increased
$9.6 million, or 17.3% from third quarter of 2003. This business benefited from
continued demand for the Company's turbochargers for European passenger cars and
commercial vehicles. Sales of timing chains increased as well, particularly to
our Asian customers. The EBIT margin was flat as the incremental profits of the
increased sales volumes were offset by higher commodity prices, primarily steel.
NINE MONTHS ENDED SEPTEMBER 30, 2004 VS. NINE MONTHS ENDED SEPTEMBER 30, 2003
The Drivetrain segment sales increased $110.4 million, or 12.1% and EBIT
increased $12.4 million, or 18.8% from the first nine months of 2003. The strong
sales gain was a result continued demand of four-wheel drive transfer case
programs with General Motors and Ford and steady demand for transmission
components and systems, especially with increased automatic transmission
penetration in Europe. The EBIT margin increase was due primarily to the
increase in sales and improved productivity, which offset higher commodity
costs.
The Engine segment sales increased $260.6 million, or 18.8% and EBIT increased
$30.5 million, or 17.1% from the first nine months of 2003. This business
benefited from continued demand for the Company's turbochargers for European
passenger cars and commercial vehicles. Sales of timing chains increased as
well, particularly to our Asian customers. The EBIT margin was flat as the
incremental profits of the increased sales volumes were offset by higher
commodity prices, primarily steel.
OUTLOOK FOR THE REMAINDER OF 2004
For the remainder of 2004, the trends that are driving our growth are expected
to continue. These trends include the growth of diesel engines in Europe, the
popularity of cross-over vehicles in North America and the move to chain engine
timing systems in both Europe and Asia. North American vehicle production is
expected to be down year-over-year for the remainder of 2004 and into 2005. The
Company continues to focus on its cost reduction efforts to offset the effects
of commodity price increases. We anticipate commodity price increases will
approach $40 million for 2004, of which we estimate steel to be $25 million.
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
Net cash provided by operating activities increased $100.3 million from $220.4
million in 2003 to $320.7 million in 2004. The main factors driving this
increase were higher net income and improved working capital management. The
Company made a scheduled royalty payment of $14.2 million in the first quarter
of 2004. Dividend receipts, net of withheld taxes from non-consolidated
affiliates were $15.6 million in the first nine months of 2004 compared to $3.7
million for the
-22-
first nine months of 2003.
Capital spending for the nine months was $126.7 million compared with $104.1
million last year. Selective capital spending remains an area of focus for the
Company, both in order to support new business and for cost reductions and
productivity improvements. The Company expects to spend $180 million to $190
million on capital in 2004, but this expectation is subject to ongoing review
based on market conditions.
As of September 30, 2004, debt decreased from year-end 2003 by $65.2 million,
while cash and cash equivalents increased by $75.9 million. The debt reduction
includes $61.0 million in principal payments, $1.0 million reduction in the
value of our interest rate swaps and $3.2 million in foreign exchange
translation adjustments. The Company paid dividends of $7.0 million and $4.9
million in the third quarter of 2004 and 2003, respectively.
As of September 30, 2004 and December 31, 2003, the Company had sold $50.0
million of receivables under a Receivables Transfer Agreement for face value
without recourse.
From a credit quality perspective, we have an investment grade credit rating of
A- from Standard & Poor's and Baa2 from Moody's. On August 30, 2004 Moody's
placed its rating for the Company under review for potential upgrade. See Recent
Developments section of Management's Discussion and Analysis of Financial
Condition and Results of Operations for a discussion of recent actions taken by
each credit rating agency.
Effective July 22, 2004 the Company established a new credit facility that
provides for borrowings up to $600 million through July 2009. The new credit
facility replaced the Company's existing $350 million facility.
The Company believes that the combination of cash balances, cash flow from
operations, available credit facilities and universal shelf registration will be
sufficient to satisfy its cash needs for the current level of operations and
planned operations for the remainder of 2004. The Company expects net cash flow
to exceed $150 million in 2004.
OTHER MATTERS
LITIGATION
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 41 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
-23-
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, 2004 of approximately $21.3 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 and remediate
the contamination. The investigation revealed the presence of Polychlorinated
Biphenyls (PCBs) in portions of the soil at the plant and neighboring areas.
Clean up began in 2000 and is continuing. Kuhlman Electric and others, including
the Company, have been sued in numerous related lawsuits, in which multiple
claimants allege personal injury and property damage. The first trial in these
lawsuits is scheduled to begin in March 2005.
The Company believes that the reserve for environmental liabilities and any
insurance recoveries are adequate to cover any potential liability associated
with environmental matters. However, due to the nature of environmental
remediation, there can be no assurance that the actual amount of environmental
liabilities will not exceed the amount reserved.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation (FIN) No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51", which was revised in December 2003. FIN No. 46R
requires that the assets, liabilities and results of the activity of variable
interest entities be consolidated into the financial statements of the entity
that has the controlling financial interest. FIN No. 46R also provides the
framework for determining whether a variable interest entity should be
consolidated based on voting interest or significant financial support provided
to it. For the Company, this Interpretation, as revised, was effective January
1, 2004. The Company has no variable interest entities required to be
consolidated as a result of adopting FIN No. 46R, therefore, there was no impact
on our Consolidated Financial Statements.
In December 2003, the FASB issued a revised Statement of Financial Accounting
Standards, (SFAS) No. 132, "Employer's Disclosures About Pensions and Other
-24-
Postretirement Benefits." SFAS No. 132 changes employers' disclosures about
pension plans and other postretirement benefits and requires additional
disclosures about assets, obligations, cash flows and net periodic benefit cost.
The Statement is effective for annual and interim periods ended after December
15, 2003. The Company adopted SFAS No. 132 as of December 31, 2003, resulting in
additional disclosures in the Company's annual and interim Consolidated
Financial Statements.
In December 2003, the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 ("the Act") was enacted in the United States. The Act provides,
among other things, expanded existing Medicare healthcare benefits to include an
outpatient prescription drug benefit to Medicare eligible residents of the U.S.
(Medicare Part D) beginning in 2006. Prescription drug coverage will be
available to eligible individuals who enroll under the Part D plan. As an
alternative, employers may provide drug coverage at least "actuarially
equivalent to standard coverage" and receive-free federal subsidy equal to 28%
of a portion of a Medicare beneficiary's drug costs for covered retirees who do
not enroll in a Part D plan.
In May 2004, the FASB issued Staff Position FAS No. 106-2, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003," to provide guidance on accounting for effects of
the Act. The Staff Position requires treating the effect of the employer subsidy
on the accumulated post retirement benefit obligation (APBO) as an actuarial
gain. The effect of the subsidy is to be reflected in the estimate of service
cost in measuring the cost of benefits attributable to current service. The
effects of plan amendments adopted subsequent to the Act to qualify plans as
actuarially equivalent are to be treated as actuarial gains if the effect of the
amendments reduces the APBO. The net effect on the APBO of any plan amendments
that (a) reduce benefits under the plan and thus disqualify the benefits as
actuarially equivalent and (b) eliminate the subsidy are to be accounted for as
prior service cost. The effect of the adoption was a $6.8 million reduction of
the Company's 2004 post-retirement benefits expense.
RECENT DEVELOPMENTS
A. PROPOSED ACQUISITION OF MAJORITY STAKE IN BERU AG
On November 1, 2004, the Company announced that its wholly-owned German
subsidiary, BorgWarner Germany GmbH ("BorgWarner Germany"), entered into a Sale
and Purchase Agreement, dated October 30, 2004 (the "Sale and Purchase
Agreement"), with CEP BE 00 Beteiligungs GmbH, Frau Ingelore Ruprecht, Wolfram
Birkel, Elsa Birkel, Annegret Birkel, Christoph Birkel, Catharina Birkel,
Klosterfeld Beteiligungen GmbH + Co. KG, and Meier-Birkel GmbH & Co. KG to
purchase an aggregate of 6,221,170 shares or 62.21% of the outstanding shares of
Beru AG, a German publicly-traded company ("Beru"), for Euro 59 per share.
BorgWarner Germany also entered into an option agreement (the "Option
Agreement") to acquire an additional 81,500 shares of Beru for Euro 59 per share
from Annegret Birkel at any time after January 3, 2005 and prior to March 31,
2005. The completion of the transactions contemplated by the agreements is
conditioned on obtaining regulatory approval and other customary conditions.
Assuming regulatory approval, the closing is anticipated to occur around
year-
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end.
On November 1, 2004, the Company also announced that BorgWarner Germany intends,
as required by German law, to commence a tender offer in Germany (the "Tender
Offer") to acquire the remaining shares of approximately 37% (or approximately
3.7 million shares) of the outstanding stock of Beru at a price of Euro 67.50
per share.
The total transaction, assuming purchase of all the remaining outstanding shares
of Beru in the Tender Offer, is valued at Euro 621 million (or approximately
$764 million). The Company intends to initially fund the transaction with cash
and funds available under its existing revolving credit facility. The Company
intends to ultimately fund the transaction in a manner consistent with
maintaining the Company's current investment grade capital structure.
Beru is a leading global automotive supplier and manufacturer 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 company's major customers include, among others, BMW, DCX, GM/Fiat, VW/
Audi, Ford, Porsche, PSA, Renault, Isuzu, Siemens VDO, Valeo, Deutz, and MAN.
The company employs approximately 2,700 employees and reported 2004 fiscal year
(ended March 31) revenues of (euro)354.5 million.
B. ACTIONS OF CREDIT RATING AGENCIES
Based on the proposed acquisition of a majority stake in Beru AG and the related
tender offer for their remaining shares, on November 1, 2004 Standard & Poor's
placed their long-term credit rating of A- for the Company on credit watch with
negative implications. Standard & Poor's has committed to meet with Company
management to review the Beru financing and integration plans and the near-term
outlook for the Company before making a ratings decision. Standard & Poor's
indicated that the impact on the ratings could be modest, depending on how the
deal is financed.
On November 2, 2004 Moody's reiterated their long-term credit rating of Baa2 on
the Company and will continue to review the Company for potential upgrade.
C. DIVIDENDS
On October 20, 2004, the Company declared a $0.125 per share dividend to be paid
on November 15, 2004 to stockholders of record as of November 1, 2004.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Statements contained in this Management's Discussion and Analysis of Financial
Condition and Results of Operations may contain forward-looking statements as
contemplated by the 1995 Private Securities Litigation Reform Act that are based
on management's current expectations, estimates and projections. Words such as
"expects," "anticipates," "intends," "plans," "believes," "estimates,"
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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, that 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 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, 2003. The
Company does not undertake any obligation to update any forward-looking
statements.
Item 3. Quantitative and Qualitative Disclosure About Market Risks
There have been no material changes to our exposures to market risk since
December 31, 2003.
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
the Company 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.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is party to various judicial and administrative
proceedings, which are considered to be routine and incidental to its business
including those described in the MD&A under Other Matters Litigation. 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.
Like many other industrial companies, the Company continues to be
named as one of the defendants in asbestos-related personal injury actions.
Management believes that the Company's involvement is limited to claims that
relate to a few types of automotive friction products, manufactured many years
ago, that contained encapsulated asbestos. The Company aggressively defends
against these lawsuits and has been successful in obtaining dismissal of many
cases without any payment whatsoever, or in many cases, for nominal or minimal
settlement payments. The Company has significant insurance coverage with solvent
carriers. During the quarter, the Company and its first layer of excess insurers
negotiated a cost sharing agreement among themselves pursuant to which asbestos
related litigation continues to be funded.
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 primary and
excess insurance, and, in conjunction with another primary insurer, is currently
defending and indemnifying the Company in all of its pending asbestos-related
claims. The lawsuit seeks to determine the extent of insurance coverage
available to the Company including whether the available limits exhaust on a
"per occurrence" or an aggregate basis, and to determine how the applicable
coverage responsibilities should be apportioned. In addition to the primary
insurance available for these claims, the Company has substantial historical
excess and umbrella insurance available for any anticipated asbestos-related
liabilities.
Although it is impossible to predict the outcome of pending or future
claims, in light of the nature of the products, our experience in defending and
resolving claims in the past, our insurance coverage and existing reserves,
management does not believe that asbestos-related claims will 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
(a) Exhibits
Exhibit 10.1 Credit Agreement dated as of July 22, 2004
among BorgWarner Inc., as Borrower, the Lenders
Party Hereto, JPMorgan Chase Bank, Administrative
Agent, Bank of America, N.A. as Syndication Agent
and Calyon New York Branch
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Citibank, N.A. Deutsche Bank Securities Inc., as
Documentation Agents.
Exhibit 10.2 BorgWarner Inc. 2004 Deferred Compensation Plan
Exhibit 10.3 Form of BorgWarner Inc. 2004 Stock Incentive Plan,
Non-Qualified Stock Option Award Agreement
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
(b) Reports on Form 8-K
On July 23, 2004, the Company filed a report on Form 8-K, attaching a copy
of a press release announcing the appointment of Cynthia Niekamp as
President and General Manager of BorgWarner TorqTransfer Systems,
Drivetrain Group and Vice President of BorgWarner Inc.
On July 29, 2004 the Company filed a report on Form 8-K, furnishing a copy
of a news release relating to earnings expectations for the second quarter
of 2004 and full year 2004.
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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
(Signature)
William C. Cline
Vice President and Controller
(Principal Accounting Officer)
Date: November 9, 2004
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