testq
UNITED
STATES SECURITIES
AND EXCHANGE COMMISSION
Washington
D.C. 20549
FORM
10-Q
QUARTERLY
REPORT
(Mark
One)
_X_
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act
of 1934
For
the
quarterly period ended March
31, 2007
OR
___
Transition
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
For
the
transition period from ____________ to ____________
Commission
file number: 1-12162
BORGWARNER
INC.
(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.)
3850
Hamlin Road, Auburn Hills, Michigan
48326
(Address
of principal executive offices)
(Zip Code)
Registrant's
telephone number, including area code: (248)
754-9200
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one): Large
Accelerated Filer_X_
Accelerated Filer___ Non-Accelerated Filer___
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). YES
___ NO _X_
On
March
31, 2007, the registrant had 58,027,699 shares of Common Stock
outstanding.
BORGWARNER
INC.
FORM
10-Q
THREE
MONTHS ENDED MARCH 31, 2007
INDEX
PART
I. Financial
Information |
Page
No.
|
Item
1.
Financial Statements |
|
Condensed
Consolidated Balance Sheets as of March 31, 2007 (Unaudited) and December
31, 2006 |
3
|
Condensed
Consolidated Statements of Operations (Unaudited) for
the three months
ended
March 31, 2007 and 2006
|
4
|
Condensed
Consolidated Statements of Cash Flows (Unaudited) for
the three months ended March 31, 2007 and 2006 |
5
|
Notes to Condensed Consolidated Financial
Statements (Unaudited) |
6
|
Item
2.
Management's Discussion and Analysis of Financial Condition and
Results of Operations |
22
|
Item 3.
Quantitative and Qualitative Disclosures About Market Risk |
30
|
Item 4. Controls and Procedures |
30
|
PART
II. Other
Information
|
|
Item 1.
Legal Proceedings |
31
|
Item 5.
Other Information |
31
|
Item 6.
Exhibits |
31
|
SIGNATURES |
32
|
PART
I. FINANCIAL INFORMATION
BORGWARNER
INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED
CONSOLIDATED BALANCE SHEETS
(millions
of dollars)
|
|
March
31,
|
|
December
31,
|
|
|
|
2007
|
|
2006
|
|
|
|
|
(Unaudited)
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
Cash
|
|
$
|
118.1
|
|
$
|
123.3
|
|
Marketable
securities
|
|
|
58.0
|
|
|
59.1
|
|
Receivables
|
|
|
795.4
|
|
|
744.0
|
|
Inventories
|
|
|
425.0
|
|
|
386.9
|
|
Deferred
income taxes
|
|
|
36.9
|
|
|
33.7
|
|
Prepayments
and other current assets
|
|
|
101.1
|
|
|
90.5
|
|
Total
current assets
|
|
|
1,534.5
|
|
|
1,437.5
|
|
|
|
|
|
|
|
|
|
Property,
plant & equipment, net
|
|
|
1,460.6
|
|
|
1,460.7
|
|
|
|
|
|
|
|
|
|
Investments
& advances
|
|
|
215.8
|
|
|
198.0
|
|
Goodwill
|
|
|
1,090.5
|
|
|
1,086.5
|
|
Other
non-current assets
|
|
|
403.9
|
|
|
401.3
|
|
Total
other assets
|
|
|
1,710.2
|
|
|
1,685.8
|
|
Total
assets
|
|
$
|
4,705.3
|
|
$
|
4,584.0
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
Notes
payable
|
|
$
|
113.4
|
|
$
|
151.7
|
|
Accounts
payable and accrued expenses
|
|
|
899.5
|
|
|
843.4
|
|
Income
taxes payable
|
|
|
39.5
|
|
|
39.7
|
|
Total
current liabilities
|
|
|
1,052.4
|
|
|
1,034.8
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
|
581.6
|
|
|
569.4
|
|
Other
non-current liabilities:
|
|
|
|
|
|
|
|
Retirement-related
liabilities
|
|
|
664.8
|
|
|
660.9
|
|
Other
|
|
|
302.2
|
|
|
281.4
|
|
Total
other non-current liabilities
|
|
|
967.0
|
|
|
942.3
|
|
|
|
|
|
|
|
|
|
Minority
interest in consolidated subsidiaries
|
|
|
152.4
|
|
|
162.1
|
|
|
|
|
|
|
|
|
|
Common
stock
|
|
|
0.6
|
|
|
0.6
|
|
Capital
in excess of par value
|
|
|
895.6
|
|
|
871.1
|
|
Retained
earnings
|
|
|
1,096.1
|
|
|
1,064.1
|
|
Accumulated
other comprehensive loss
|
|
|
(40.3
|
)
|
|
(60.3
|
)
|
Treasury
stock
|
|
|
(0.1
|
)
|
|
(0.1
|
)
|
Total
stockholders' equity
|
|
|
1,951.9
|
|
|
1,875.4
|
|
Total
liabilities and stockholders' equity
|
|
$
|
4,705.3
|
|
$
|
4,584.0
|
|
See
accompanying Notes to Condensed Consolidated Financial
Statements
BORGWARNER
INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(millions
of dollars, except share and per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
March
31,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$
|
1,277.8
|
|
$
|
1,155.2
|
|
Cost
of sales
|
|
|
1,061.9
|
|
|
931.9
|
|
Gross
profit
|
|
|
215.9
|
|
|
223.3
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
126.7
|
|
|
129.5
|
|
Other
income
|
|
|
(0.7
|
)
|
|
(0.5
|
)
|
Operating
income
|
|
|
89.9
|
|
|
94.3
|
|
|
|
|
|
|
|
|
|
Equity
in affiliates' earnings, net of tax
|
|
|
(9.2
|
)
|
|
(10.0
|
)
|
Interest
expense and finance charges
|
|
|
8.9
|
|
|
9.4
|
|
Earnings
before income taxes and minority interest
|
|
|
90.2
|
|
|
94.9
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
24.4
|
|
|
26.6
|
|
Minority
interest, net of tax
|
|
|
7.4
|
|
|
7.0
|
|
Net
earnings
|
|
$
|
58.4
|
|
$
|
61.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share - basic
|
|
$
|
1.01
|
|
$
|
1.07
|
|
|
|
|
|
|
|
|
|
Earnings
per share - diluted
|
|
$
|
1.00
|
|
$
|
1.06
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding (thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
57,916
|
|
|
57,181
|
|
Diluted
|
|
|
58,619
|
|
|
57,758
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends
declared per share
|
|
$
|
0.17
|
|
$
|
0.16
|
|
See
accompanying Notes to Condensed Consolidated Financial
Statements
BORGWARNER
INC. AND CONSOLIDATED SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS (UNAUDITED)
(millions
of dollars)
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
OPERATING
|
|
|
|
|
|
|
|
Net
earnings
|
|
$
|
58.4
|
|
$
|
61.3
|
|
Adjustments
to reconcile net earnings to net cash flows from
operations:
|
|
|
|
|
|
|
|
Non-cash
charges (credits) to operations:
|
|
|
|
|
|
|
|
Depreciation
and tooling amortization
|
|
|
60.2
|
|
|
57.9
|
|
Amortization
of intangible assets and other
|
|
|
4.1
|
|
|
3.2
|
|
Stock
option compensation expense
|
|
|
4.2
|
|
|
2.9
|
|
Deferred
income tax benefit
|
|
|
(7.0
|
)
|
|
(2.6
|
)
|
Equity
in affiliates' earnings, net of dividends received, minority
interest and other
|
|
|
6.8
|
|
|
2.5
|
|
Net
earnings adjusted for non-cash charges (credits) to
operations
|
|
|
126.7
|
|
|
125.2
|
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
Receivables
|
|
|
(45.3
|
)
|
|
(67.3
|
)
|
Inventories
|
|
|
(35.3
|
)
|
|
(4.3
|
)
|
Prepayments
and other current assets
|
|
|
(12.2
|
)
|
|
3.7
|
|
Accounts
payable and accrued expenses
|
|
|
49.9
|
|
|
(0.3
|
)
|
Income
taxes payable
|
|
|
(0.5
|
)
|
|
3.0
|
|
Other
non-current assets and liabilities
|
|
|
(0.7
|
)
|
|
(11.9
|
)
|
Net
cash provided by operating activities
|
|
|
82.6
|
|
|
48.1
|
|
|
|
|
|
|
|
|
|
INVESTING
|
|
|
|
|
|
|
|
Capital
expenditures, including tooling outlays
|
|
|
(58.3
|
)
|
|
(70.3
|
)
|
Net
proceeds from asset disposals
|
|
|
2.1
|
|
|
1.1
|
|
Purchases
of marketable securities
|
|
|
(12.5
|
)
|
|
(24.1
|
)
|
Proceeds
from sales of marketable securities
|
|
|
14.4
|
|
|
-
|
|
Net
cash used in investing activities
|
|
|
(54.3
|
)
|
|
(93.3
|
)
|
|
|
|
|
|
|
|
|
FINANCING
|
|
|
|
|
|
|
|
Net
decrease in notes payable
|
|
|
(39.7
|
)
|
|
(36.8
|
)
|
Additions
to long-term debt
|
|
|
20.0
|
|
|
125.6
|
|
Repayments
of long-term debt
|
|
|
(7.5
|
)
|
|
(54.3
|
)
|
Proceeds
from stock options exercised
|
|
|
13.1
|
|
|
2.4
|
|
Dividends
paid to BorgWarner stockholders
|
|
|
(9.8
|
)
|
|
(9.1
|
)
|
Dividends
paid to minority shareholders
|
|
|
(10.9
|
)
|
|
(9.1
|
)
|
Net
cash (used in) provided by financing activities
|
|
|
(34.8
|
)
|
|
18.7
|
|
Effect
of exchange rate changes on cash
|
|
|
1.3
|
|
|
(6.4
|
)
|
Net
decrease in cash
|
|
|
(5.2
|
)
|
|
(32.9
|
)
|
Cash
at beginning of year
|
|
|
123.3
|
|
|
89.7
|
|
Cash
at end of period
|
|
$
|
118.1
|
|
$
|
56.8
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
Net
cash paid during the period for:
|
|
|
|
|
|
|
|
Interest
|
|
$
|
11.8
|
|
$
|
11.0
|
|
Income
taxes
|
|
|
27.4
|
|
|
21.9
|
|
Non-cash
financing transactions:
|
|
|
|
|
|
|
|
Issuance
of common stock for stock performance plans
|
|
|
2.3
|
|
|
2.7
|
|
See
accompanying Notes to Condensed Consolidated Financial
Statements
BORGWARNER
INC. AND CONSOLIDATED SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1)
Basis of Presentation
The
accompanying Condensed Consolidated 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 December 31, 2006 condensed consolidated balance sheet data was
derived from audited financial statements, but does not include all disclosures
required by accounting principles generally accepted in the United States of
America (“GAAP”). The results of operations for the three months ended March 31,
2007 are not necessarily indicative of the results to be expected for the entire
year.
(2)
Research and Development
The
following table presents the Company’s gross and net expenditures on research
and development (“R&D”) activities:
(Millions) |
Three
months ended March 31, |
|
2007
|
|
2006
|
|
Gross
R&D expenditures
|
$
|
60.5
|
|
$
|
53.5
|
|
Customer
reimbursements
|
|
(9.6
|
)
|
|
(7.5
|
)
|
Net
R&D expenditures
|
$
|
50.9
|
|
$
|
46.0
|
|
|
The
Company’s net R&D expenditures are included in the selling, general and
administrative expenses of the Condensed Consolidated Statements of Operations.
Customer reimbursements are netted against gross R&D expenditures upon
billing of services performed. The Company has contracts with several customers
at the Company’s various R&D locations. No such contract exceeded $6 million
in any of the periods presented.
(3)
Income Taxes
The
Company's provision for income taxes is based upon an estimated annual tax
rate
for the year applied to federal, state and foreign income. The projected
effective tax rate of 27.0% for 2007 differs from the U.S. statutory rate
primarily due to foreign rates, which differ from those in the U.S., the
realization of certain business tax credits including R&D and foreign tax
credits and favorable permanent differences between book and tax treatment
for
items, including equity in affiliates’ earnings and a Medicare prescription drug
benefit. This rate is expected to be greater than the full year 2006 effective
tax rate of 12.0% because the 2006 rate included the release of tax accrual
accounts upon conclusion of certain tax audits, the tax effects of dispositions
and adjustments to various tax accounts, including changes in tax laws.
The
Company adopted the provisions of FASB Interpretation No. 48, Accounting
for Uncertainty in Income Taxes
(“FIN
48”), on January 1, 2007. As a result of the implementation of FIN 48, the
Company recognized a $16.6 million reduction to the January 1, 2007 balance
of
retained earnings.
At
January 1, 2007, the balance of gross unrecognized tax benefits is $50.5
million. Included in the balance at January 1, 2007 are $43.1 million of tax
positions that are permanent in nature and, if recognized, would reduce the
effective tax rate. However, the Company’s federal, certain state and certain
non-U.S. income tax returns are currently under various stages of audit by
applicable tax authorities and the amounts ultimately paid, if any, upon
resolution of the issues raised by the taxing authorities may differ materially
from the amounts accrued for each year. It is not possible to reasonably
estimate any possible change in the unrecognized tax benefits within the next
12
months.
The
Company or one of its subsidiaries files income tax returns in the U.S. federal
jurisdiction, and various states and foreign jurisdictions. The Company is
no
longer subject to income tax examinations by tax authorities in its major tax
jurisdictions as follows:
Tax
Jurisdiction |
Years
No Longer Subject to Audit |
U.S. federal |
2001 and prior |
Brazil |
2000 and prior |
France |
2002 and prior |
Germany |
2002 and prior |
Hungary |
2004 and prior |
Italy |
2000 and prior |
Japan |
2002 and prior |
South Korea |
2004 and prior |
United Kingdom |
2003 and
prior |
In
certain tax jurisdictions the Company may have more than one taxpayer. The
table
above reflects the status of the major taxpayers in each major tax
jurisdiction.
The
Company recognizes interest and penalties related to unrecognized tax benefits
in income tax expense. The Company had $5.3 million accrued at January 1, 2007
for the payment of any such interest and penalties.
(4)
Marketable Securities
As
of
March 31, 2007 and December 31, 2006, the Company held $58.0 million and $59.1
million, respectively, of highly liquid investments in marketable securities,
primarily bank notes. The securities are carried at fair value with the
unrealized gain or loss, net of tax, reported in other comprehensive income.
As
of March 31, 2007 and December 31, 2006, $44.2 million and $45.5 million of
the
contractual maturities are within one to five years and $13.8 million and $13.6
million are due beyond five years, respectively. The Company does not intend
to
hold these investments until maturity; rather, they are available to support
current operations if needed.
(5)
Sales of Receivables
The
Company securitizes and sells certain receivables through third party financial
institutions without recourse. The amount sold can vary each month based on the
amount of underlying receivables. At both March 31, 2007 and 2006, the Company
had sold $50 million of receivables under a Receivables Transfer Agreement
for
face value without recourse. During both of the three-month periods ended March
31, 2007 and 2006, total cash proceeds from sales of accounts receivable were
$150 million. The Company paid servicing fees related to these receivables
of
$0.7 million and $0.6 million for the three months ended March 31, 2007 and
2006, respectively. These amounts are recorded in interest expense and finance
charges in the Condensed Consolidated Statements of Operations.
(6)
Inventories
Inventories
are valued at the lower of cost or market. The cost of U.S. inventories is
determined by the last-in, first-out (“LIFO”) method, while the operations
outside the U.S. use the first-in, first-out (“FIFO”) or average-cost methods.
Inventories
consisted of the following:
|
|
March
31,
|
|
December
31,
|
|
(Millions)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
Raw
material and supplies
|
|
$
|
215.2
|
|
$
|
207.4
|
|
Work
in progress
|
|
|
108.1
|
|
|
100.0
|
|
Finished
goods
|
|
|
115.3
|
|
|
91.9
|
|
FIFO
inventories
|
|
|
438.6
|
|
|
399.3
|
|
LIFO
reserve
|
|
|
(13.6
|
)
|
|
(12.4
|
)
|
Net
inventories
|
|
$
|
425.0
|
|
$
|
386.9
|
|
(7)
Property, plant & equipment
(Millions)
|
March
31,
|
|
December
31,
|
|
|
2007
|
|
2006
|
|
Land
and buildings
|
$
|
551.3
|
|
|
$
|
552.3
|
|
Machinery
and equipment
|
|
1,695.0
|
|
|
|
1,687.8
|
|
Capital
leases
|
|
1.1
|
|
|
|
1.1
|
|
Construction
in progress
|
|
125.8
|
|
|
|
112.8
|
|
Total
property, plant & equipment
|
|
2,373.2
|
|
|
|
2,354.0
|
|
Less
accumulated depreciation
|
|
(1,006.2
|
)
|
|
|
(988.4
|
)
|
|
|
1,367.0
|
|
|
|
1,365.6
|
|
Tooling,
net of amortization
|
|
93.6
|
|
|
|
95.1
|
|
Property,
plant
& equipment - net
|
$
|
1,460.6
|
|
|
$
|
1,460.7
|
|
Interest
costs capitalized during the three-month periods ended March 31, 2007 and March
31, 2006 were $2.0 million and $1.7 million, respectively.
As
of
March 31, 2007 and December 31, 2006, accounts payable of $28.4 million and
$36.0 million, respectively, were related to property, plant and equipment
purchases.
As
of
March 31, 2007 and December 31, 2006, specific assets of $21.5 million and
$21.3
million, respectively, were pledged as collateral under certain of the Company’s
long-term debt agreements.
(8)
Product Warranty
The
Company provides warranties on some of its products. The warranty terms are
typically from one to three years. Provisions for estimated expenses related
to
product warranty are made at the time products are sold. These estimates are
established using historical information about the nature, frequency, and
average cost of warranty claims. Management actively studies trends of warranty
claims and takes action to improve product quality and minimize warranty claims.
While management believes that the warranty accrual is appropriate, actual
claims incurred could differ from the original estimates, requiring adjustments
to the accrual. The accrual is recorded in both long-term and short-term
liabilities on the balance sheet. The following table summarizes the activity
in
the warranty accrual accounts:
|
|
Three
months ended
|
|
|
|
|
March
31,
|
|
(Millions) |
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
Beginning
balance
|
|
$
|
60.0
|
|
$
|
44.0
|
|
Provision
|
|
|
24.9
|
|
|
5.6
|
|
Payments
|
|
|
(5.6
|
)
|
|
(6.8
|
)
|
Currency
translation
|
|
|
0.5
|
|
|
1.7
|
|
Ending
balance
|
|
$
|
79.8
|
|
$
|
44.5
|
|
Contained
within the provision recognized in the three months ended March 31, 2007 is
approximately $14 million for a warranty-related issue surrounding a product,
built during a 15-month period in 2004 and 2005, that is no longer in
production.
(9)
Notes Payable and Long-Term Debt
Following
is a summary of notes payable and long-term debt. The weighted average interest
rate on all borrowings outstanding as of March 31, 2007 and December 31, 2006
was 4.9%.
(Millions)
|
|
March
31, 2007
|
|
December
31, 2006
|
|
December
31,
|
|
Current
|
|
Long-Term
|
|
Current
|
|
Long-Term
|
|
Bank
borrowings and other
|
|
$
|
70.0
|
|
$
|
15.6
|
|
$
|
131.8
|
|
$
|
5.9
|
|
Term
loans due through 2013 (at an average rate of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.6%
in 2007 and 3.0% in 2006)
|
|
|
43.4
|
|
|
25.8
|
|
|
19.9
|
|
|
23.1
|
|
5.75%
Senior Notes due 11/01/16, net of unamortized discount (a)
|
|
|
-
|
|
|
149.1
|
|
|
-
|
|
|
149.0
|
|
6.50%
Senior Notes due 02/15/09, net of unamortized discount (a)
|
|
|
-
|
|
|
136.4
|
|
|
-
|
|
|
136.4
|
|
8.00%
Senior Notes due 10/01/19, net of unamortized discount (a)
|
|
|
-
|
|
|
133.9
|
|
|
-
|
|
|
133.9
|
|
7.125%
Senior Notes due 02/15/29, net of unamortized discount
|
|
|
-
|
|
|
119.2
|
|
|
-
|
|
|
119.2
|
|
Carrying
amount of notes payable and long-term debt
|
|
|
113.4
|
|
|
580.0
|
|
|
151.7
|
|
|
567.5
|
|
Impact
of derivatives on debt
|
|
|
-
|
|
|
1.6
|
|
|
-
|
|
|
1.9
|
|
Total
notes payable and long-term debt
|
|
$
|
113.4
|
|
$
|
581.6
|
|
$
|
151.7
|
|
$
|
569.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
The Company entered into several interest rate swaps, which have
the
effect of converting $325.0 million of these fixed rate notes to
variable rates as of March 31, 2007 and December 31, 2006. The
weighted
average effective inerest rates for these borrowings, including
the
effects of outstanding swaps as noted in Note 10, were 4.6% and
4.5% as of
March 31, 2007 and December 31, 2006,
respectively.
|
The
Company has a multi-currency revolving credit facility, which provides for
borrowings up to $600 million through July 2009. At March 31, 2007, $10.0
million of borrowings under the facility were outstanding. At December 31,
2006,
there were no borrowings outstanding under the facility. The credit agreement
is
subject to the usual terms and conditions applied by banks to an investment
grade company. The Company was in compliance with all covenants at March 31,
2007 and expects to be compliant in future periods. The Company had outstanding
letters of credit of $25.8 million at March 31, 2007 and $27.0 million at
December 31, 2006. The letters of credit typically act as a guarantee of payment
to certain third parties in accordance with specified terms and
conditions.
As
of
March 31, 2007 and December 31, 2006, the estimated fair values of the Company’s
senior unsecured notes totaled $572.8 million and $572.7 million, respectively.
The estimated fair values were $34.2 million higher at March 31, 2007 and
December 31, 2006 than their respective carrying values. Fair market values
are
developed by the use of estimates obtained from brokers and other appropriate
valuation techniques based on information available as of year-end. The fair
value estimates do not necessarily reflect the values the Company could realize
in the current markets.
(10)
Financial Instruments
The
Company’s financial instruments include cash, marketable securities, trade
receivables, trade payables, and notes payable. Due to the short-term nature
of
these instruments, the book value approximates fair value. The Company’s
financial instruments also include long-term debt, interest rate and currency
swaps, commodity swap contracts, and foreign currency forward contracts. All
derivative contracts are placed with counterparties that have a credit rating
of
“A-“ or better.
The
Company manages its interest rate risk by balancing its exposure to fixed and
variable rates while attempting to minimize its interest costs. The Company
selectively uses interest rate swaps to reduce market value risk associated
with
changes in interest rates (fair value hedges). The Company also selectively
uses
cross-currency swaps to hedge the foreign currency exposure associated with
our
net investment in certain foreign operations (net investment hedges).
A
summary
of these instruments outstanding at March 31, 2007 follows (currency in
millions):
|
|
|
|
Notional
|
|
|
|
|
|
Hedge
Type
|
|
Amount
|
|
Maturity
(a)
|
|
Interest
rate swaps
|
|
|
|
|
|
|
|
|
|
|
Fixed
to floating
|
|
|
Fair
value
|
|
$
|
100
|
|
|
February
15, 2009
|
|
Fixed
to floating
|
|
|
Fair
value
|
|
$
|
150
|
|
|
November
1, 2016
|
|
Fixed
to floating
|
|
|
Fair
value
|
|
$
|
75
|
|
|
October
1, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
Cross
currency swap
|
|
|
|
|
|
|
|
|
|
|
Floating
$ to floating €
|
|
|
Net
Investment
|
|
$
|
100
|
|
|
February
15, 2009
|
|
Floating
$ to floating ¥
|
|
|
Net
Investment
|
|
$
|
150
|
|
|
November
1, 2016
|
|
Floating
$ to floating €
|
|
|
Net
Investment
|
|
$
|
75
|
|
|
October
1, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
The maturity of the swaps corresponds with the maturity of the
hedged item
as noted in the debt summary, unless otherwise
indicated.
|
Effectiveness
for interest rate and cross currency swaps is assessed at the inception of
the
hedging relationship. If specified criteria for the assumption of effectiveness
are not met at hedge inception, effectiveness is assessed quarterly.
Ineffectiveness is measured quarterly and results are recognized in
earnings.
As
of
March 31, 2007, the fair values of the fixed to floating interest rate swaps
were recorded as a current asset of $1.7 million and a current liability of
$(0.1) million. As of December 31, 2006, the fair values of the fixed to
floating interest rate swaps were recorded as a non-current asset of $1.9
million. No hedge ineffectiveness was recognized in relation to fixed to
floating swaps. Fair values are based on quoted market prices for contracts
with
similar maturities.
As
of
March 31, 2007, the fair values of the cross currency swaps were recorded as
a
non-current asset of $0.3 million and a non-current liability of $(7.8) million.
As of December 31, 2006, the fair values of the cross currency swaps were
recorded as a non-current asset of $1.7 million and a non-current liability
of
$(5.5) million. Hedge ineffectiveness of $0.9 million was recognized as of
March
31, 2007 in relation to cross currency swaps. Fair values are based on quoted
market prices for contracts with similar maturities.
The
Company also entered into certain commodity derivative instruments to protect
against commodity price changes related to forecasted raw material and supplies
purchases. The primary purpose of the commodity price hedging activities is
to
manage the volatility associated with these forecasted purchases. The Company
primarily utilizes forward and option contracts, which are designated as cash
flow hedges. As of March 31, 2007, the Company had forward and option commodity
contracts with a total notional value of $41.0 million. As of March 31, 2007,
the Company was holding commodity derivatives with positive and negative fair
market values of $3.2 million and $(0.5) million, respectively ($3.0 million
gains and ($0.2) million losses mature in less than one year). To the extent
that derivative instruments are deemed to be effective as defined by FAS 133,
gains and losses arising from these contracts are deferred in other
comprehensive income. Such gains and losses will be reclassified into income
as
the underlying operating transactions are realized. Gains and losses not
qualifying for deferral treatment have been credited/charged to income as they
are recognized. As of December 31, 2006, the Company had forward and option
commodity contracts with a total notional value of $19.1 million. The fair
market values of the forward contracts were negative ($2.0) million ($(1.9)
million losses maturing in less than one year). Losses not qualifying for
deferral associated with these contracts for March 31, 2007 were negligible.
At
December 31, 2006, losses not qualifying for deferral were $(0.1)
million.
The
Company uses foreign exchange forward and option contracts to protect against
exchange rate movements for forecasted cash flows for purchases, operating
expenses or sales transactions designated in currencies other than the
functional currency of the operating unit. Most contracts mature in less than
one year, however certain long-term commitments are covered by forward currency
arrangements to protect against currency risk through 2009. Foreign currency
contracts require the Company, at a future date, to either buy or sell foreign
currency in exchange for the operating units’ local currency. At March 31, 2007,
contracts were outstanding to buy or sell U.S. Dollars, Euros, British Pounds
Sterling, South Korean Won,
Japanese
Yen and Hungarian Forints. To the extent that derivative instruments are deemed
to be effective as defined by FAS 133, gains and losses arising from these
contracts are deferred in other comprehensive income. Such gains and losses
will
be reclassified into income as the underlying operating transactions are
realized. Any gains or losses not qualifying for deferral are credited/charged
to income as they are recognized. As of March 31, 2007, the Company was holding
foreign exchange derivatives with a positive market value of $4.4 million ($3.1
million maturing in less than one year). Derivative contracts with negative
value amounted to $(0.6) million ($(0.5) million maturing in less than one
year). As of December 31, 2006, the Company was holding foreign exchange
derivatives with a positive market value of $5.1 million ($4.5 million maturing
in less than one year). Derivatives contracts with negative value amounted
to
$(0.1) million (all maturing in less than one year). Losses not qualifying
for
deferral associated with these contracts as of March 31, 2007 were negligible.
As of December 31, 2006, gains not qualifying for deferral amounted to $0.7
million.
(11)
Retirement Benefit Plans
The
Company has a number of defined benefit pension plans and other post employment
benefit plans covering eligible salaried and hourly employees. The other post
employment benefits plans, which provide medical and life insurance benefits,
are unfunded plans. The estimated contributions to pension plans for 2007 range
from $10 to $20 million, of which $2.6 million has been contributed through
the
first three months of the year. The components of net periodic benefit cost
recorded in the Company’s Condensed Consolidated Statements of Operations, are
as follows:
|
|
Pension
benefits
|
|
Other
post
|
(Millions) |
|
2007
|
|
2006
|
|
employment
benefits
|
Three
months ended March 31,
|
|
US
|
|
Non-US
|
|
US
|
|
Non-US
|
|
2007
|
|
2006
|
|
Components
of net periodic benefit cost: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Service cost |
|
$
|
0.5
|
|
$
|
3.0
|
|
$
|
0.7
|
|
$
|
3.2
|
|
$
|
1.6
|
|
$
|
3.2
|
|
Interest cost |
|
|
4.4
|
|
|
4.0
|
|
|
4.2
|
|
|
3.5
|
|
|
7.5
|
|
|
8.9
|
|
Expected return on plan assets |
|
|
(7.4
|
)
|
|
(3.1
|
)
|
|
(7.2
|
)
|
|
(2.8
|
)
|
|
-
|
|
|
-
|
|
Amortization of unrecognized
transition obligation
|
|
|
- |
|
|
- |
|
|
- |
|
|
0.1 |
|
|
- |
|
|
- |
|
Amortization
of unrecognized prior service cost (benefit)
|
|
|
- |
|
|
-
|
|
|
0.2
|
|
|
-
|
|
|
(4.0
|
) |
|
(1.0
|
) |
Amortization
of unrecognized
loss |
|
|
0.5
|
|
|
0.4
|
|
|
1.6
|
|
|
0.6
|
|
|
3.8
|
|
|
5.8
|
|
Net periodic benefit cost (benefit) |
|
$
|
(2.0
|
)
|
$
|
4.3
|
|
$
|
(0.5
|
)
|
$
|
4.6
|
|
$
|
8.9
|
|
$
|
16.9
|
|
(12)
Stock-Based Compensation
Under
the
Company's 1993 Stock Incentive Plan, the Company granted options to purchase
shares of the Company's common stock at the fair market value on the date of
grant. The options vest over periods up to three years and have a term of
ten years from date of grant. As of December 31, 2003, there were no
options available for future grants under the 1993 plan. The 1993 plan expired
at the end of 2003 and was replaced by the Company's 2004 Stock Incentive Plan,
which was amended at the Company’s 2006 Annual Stockholders Meeting, among other
things, to increase the number of shares available for issuance under the
plan. Under the BorgWarner Inc. Amended and Restated 2004 Stock Incentive
Plan (“2004 Stock Incentive Plan”), the number of shares authorized for grant is
5,000,000. As of March 31, 2007, there were a total of 3,915,280
outstanding options under the 1993 and 2004 Stock Incentive Plans.
Employee
stock-based compensation
reduced
income before income taxes and net earnings by $4.2 million and $3.1 million
($0.05 per basic and diluted share) and by $2.9 million and $2.1 million ($0.04
per basic and diluted share) for the three months ended March 31, 2007 and
2006,
respectively. The adoption of FAS 123R affected both operating activities ($4.2
million and $2.9 million non-cash charge backs) and financing activities ($1.1
million and $0.8 million tax benefits) of the Condensed Consolidated Statements
of Cash Flows for the three months ended March 31, 2007 and 2006,
respectively.
Total
unrecognized compensation cost related to nonvested stock options at March
31,
2007 is approximately $33.1 million. This cost is expected to be recognized
over
the next three years. On a weighted average basis, this cost is expected to
be
recognized over 1.2 years.
A
summary
of the plans’ shares under option as of and for the three months ended March 31,
2007 is as follows:
|
|
Shares
|
|
Weighted-average
|
|
|
|
(thousands)
|
|
exercise
price
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2006
|
|
|
3,471
|
|
$
|
47.48
|
|
Granted
|
|
|
908
|
|
|
69.89
|
|
Exercised
|
|
|
(295
|
)
|
|
35.12
|
|
Forfeited
|
|
|
(169
|
)
|
|
41.04
|
|
Outstanding
at March 31, 2007
|
|
|
3,915
|
|
$
|
53.88
|
|
|
|
|
|
|
|
|
|
Options
exerciseable at March 31, 2007
|
|
|
825
|
|
$
|
32.61
|
|
Options
available for future grants
|
|
|
1,275
|
|
|
|
|
In
calculating earnings per share, earnings are the same for the basic and diluted
calculations. Shares increased for diluted earnings per share by 703,000 and
577,000 for the three months ended March 31, 2007 and 2006, respectively, due
to
the effects of stock options and shares issuable under the Performance Stock
Plan.
The
fair
value for options granted in February 2007 was $21.04 per option. The Company
did not grant any options during the three months ended March 31, 2006, as
2006
options were granted in July. The fair value at date of grant was estimated
using the Black-Scholes options pricing model with the following
assumptions:
|
2007
|
|
|
Risk-free
interest rate
|
4.82% |
Dividend
yield
|
0.97% |
Volatility
factor
|
28.64% |
Expected
life
|
4.7
years |
The
expected lives of the awards are based on historical exercise patterns and
the
terms of the options. The risk-free interest rate is based on zero coupon
Treasury bond rates corresponding to the expected life of the awards. The
expected volatility assumption was derived by referring to changes in the
Company’s historical common stock prices over the same timeframe as the expected
life of the awards. The expected dividend yield of stock is based on the
Company’s historical dividend yield. The Company has no reason to believe that
the expected dividend yield or the future stock volatility is likely to differ
from historical patterns.
(13)
Comprehensive Income (Loss)
The
amounts presented as changes in accumulated other comprehensive income (loss),
net of related taxes, are added to (deducted from) net earnings resulting in
comprehensive income (loss). The following table summarizes the components
of
comprehensive income (loss) on an after-tax basis for the three-month periods
ended March 31, 2007 and 2006.
|
|
Three
months ended
|
|
|
|
March
31,
|
|
(Millions)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments, net
|
|
$
|
19.0
|
|
$
|
30.0
|
|
Market
value change in hedge instruments, net
|
|
|
1.2
|
|
|
(0.9
|
)
|
Unrealized
(loss) gain on available-for-sale securities, net
|
|
|
(0.2
|
)
|
|
0.2
|
|
Change
in accumulated other comprehensive loss
|
|
|
20.0
|
|
|
29.3
|
|
Net
earnings as reported
|
|
|
58.4
|
|
|
61.3
|
|
Total
comprehensive income
|
|
$
|
78.4
|
|
$
|
90.6
|
|
(14)
Contingencies
In
the
normal course of business the Company and its subsidiaries are parties to
various commercial and legal claims, actions and complaints, including matters
involving warranty claims, intellectual property claims, general liability
and
various other risks. It is not possible to predict with certainty whether or
not
the Company and its subsidiaries will ultimately be successful in any of these
commercial and legal matters or, if not, what the impact might be. The Company’s
environmental and product liability contingencies are discussed separately
below. The Company’s management does not expect that the results in any of these
legal proceedings will have a material adverse effect on the Company’s results
of operations, financial position or cash flows.
Environmental
The
Company and certain of its current and former direct and indirect corporate
predecessors, subsidiaries and divisions have been identified by the United
States Environmental Protection Agency and certain state environmental agencies
and private parties as potentially responsible parties (“PRPs”) at various
hazardous waste disposal sites under the Comprehensive Environmental Response,
Compensation and Liability Act (“Superfund”) and equivalent state laws and, as
such, may presently be liable for the cost of clean-up and other remedial
activities at 35 such sites. Responsibility for clean-up and other remedial
activities at a Superfund site is typically shared among PRPs based on an
allocation formula.
The
Company believes that none of these matters, individually or in the aggregate,
will have a material adverse effect on its results of operations, financial
position, or cash flows. Generally, this is because either the estimates of
the
maximum potential liability at a site are not large or the liability will be
shared with other PRPs, although no assurance can be given with respect to
the
ultimate outcome of any such matter.
Based
on
information available to the Company (which in most cases, includes: an estimate
of allocation of liability among PRPs; the probability that other PRPs, many
of
whom are large, solvent public companies, will fully pay the cost apportioned
to
them; currently available information from PRPs and/or federal or state
environmental agencies concerning the scope of contamination and estimated
remediation and consulting costs; remediation alternatives; estimated legal
fees; and other factors), the Company has established an accrual for indicated
environmental liabilities with a balance at March 31, 2007 of $15.8
million. Excluding the Crystal Springs site discussed below for which $7.4
million has been accrued, the Company has accrued amounts that do not exceed
$3.0 million related to any individual site and management does not believe
that
the costs related to any of these other individual sites will have a material
adverse effect on the Company’s results of operations, cash flows or financial
condition. The Company expects to pay out substantially all of the $15.8 million
accrued environmental liability over the next three to five years.
In
connection with the sale of Kuhlman Electric Corporation, the Company agreed
to
indemnify the buyer and Kuhlman Electric for certain environmental liabilities,
then unknown to the Company, relating to the past operations of Kuhlman
Electric. The liabilities at issue result from operations of Kuhlman Electric
that pre-date the Company’s acquisition of Kuhlman Electric’s parent company,
Kuhlman Corporation, in 1999. During 2000, Kuhlman Electric notified the Company
that it discovered potential environmental contamination at its Crystal Springs,
Mississippi plant while undertaking an expansion of the plant. The Company
is
continuing to work with the Mississippi Department of Environmental Quality
and
Kuhlman Electric to investigate and remediate to the extent necessary, if any,
historical contamination at the plant and surrounding area. Kuhlman Electric
and
others, including the Company, were sued in numerous related lawsuits, in which
multiple claimants alleged personal injury and property damage. In 2005, the
Company and other defendants, including the Company’s subsidiary Kuhlman
Corporation, entered into settlements that resolved approximately 99% of the
known personal injury and property damage claims relating to the alleged
environmental contamination. Those settlements involved payments by the
defendants of $28.5 million in the second half of 2005 and $15.7 million in
the
first quarter of 2006, in exchange for, among other things, dismissal with
prejudice of these lawsuits.
Conditional
Asset Retirement Obligations
In
March
2005, the FASB issued Interpretation No. 47, Accounting
for Conditional Asset Retirement Obligations - an interpretation of FASB
Statement No.
143
(“FIN
47”), which requires the Company to recognize legal obligations to perform asset
retirements in which the timing and/or method of settlement are conditional
on a
future event that may or may not be within the control of the entity. Certain
government regulations require the removal and disposal of asbestos from an
existing facility at the time the facility undergoes major renovations or is
demolished. The liability exists because the facility will not last forever,
but
it is conditional on future renovations (even if there are no immediate plans
to
remove the materials, which pose no health or safety hazard in their current
condition). Similarly, government regulations require the removal or closure
of
underground storage tanks (“USTs”) when their use ceases, the disposal of
polychlorinated biphenyl (“PCB”) transformers and capacitors when their use
ceases, and the disposal of used furnace bricks and liners, and lead-based
paint
in conjunction with facility renovations or demolition. The Company currently
has 17 manufacturing locations that have been identified as containing these
items. The fair value to remove and dispose of this material has been estimated
and recorded at $1.0 million as of March 31, 2007 and December 31,
2006.
Product
Liability
Like
many
other industrial companies who have historically operated in the U.S., the
Company (or parties the Company is obligated to indemnify) continues to be
named
as one of many defendants in asbestos-related personal injury actions.
Management believes that the Company’s involvement is limited because, in
general, these claims relate to a few types of automotive friction products
that
were manufactured many years ago and contained encapsulated asbestos. The nature
of the fibers, the encapsulation and the manner of use lead the Company to
believe that these products are highly unlikely to cause harm. As of March
31,
2007, the Company had approximately 44,000 pending asbestos-related product
liability claims. Of these outstanding claims, approximately 34,000 are pending
in just three jurisdictions, where significant tort reform activities are
underway.
The
Company’s policy is to aggressively defend against these lawsuits and the
Company has been successful in obtaining dismissal of many claims without any
payment. The Company expects that the vast majority of the pending
asbestos-related product liability claims where it is a defendant (or has an
obligation to indemnify a defendant) will result in no payment being made by
the
Company or its insurers. In the first quarter 2007, of the approximately 600
claims resolved, only 44 (7.3%) resulted in any payment being made to a claimant
by or on behalf of the Company. In 2006, of the approximately 27,000 claims
resolved, only 169 (0.6%) resulted in any payment being made to a claimant
by or
on behalf of the Company.
Prior
to
June 2004, the settlement and defense costs associated with all claims were
covered by the Company’s primary layer insurance coverage, and these carriers
administered, defended, settled and paid all claims under a funding arrangement.
In June 2004, primary layer insurance carriers notified the Company of the
alleged exhaustion of their policy limits. This led the Company to access the
next available layer of insurance coverage. Since June 2004, secondary layer
insurers have paid asbestos-related litigation defense and settlement expenses
pursuant to a funding arrangement. To
date,
the Company has paid $18.8 million in defense and indemnity in advance of
insurers’ reimbursement and has received $5.9 million in cash from
insurers. The outstanding balance of $12.9 million is expected to be fully
recovered. Timing of the recovery is dependent on final resolution of the
declaratory judgment action referred to below. At December 31, 2006,
insurers owed $11.7 million in association with these claims.
At
March
31, 2007, the Company has an estimated liability of $42.1 million for future
claims resolutions, with a related asset of $42.1 million to recognize the
insurance proceeds receivable by the Company for estimated losses related to
claims that have yet to be resolved. Insurance carrier reimbursement of 100%
is
expected based on the Company’s experience, its insurance contracts and
decisions received to date in the declaratory judgment action referred to below.
At December 31, 2006, the comparable value of the insurance receivable and
accrued liability was $39.9 million.
The
amounts recorded in the Condensed Consolidated Balance Sheets related to the
estimated future settlement of existing claims are as follows:
|
|
March
31,
|
|
December
31,
|
|
(Millions)
|
|
2007
|
|
2006
|
|
Assets:
|
|
|
|
|
|
|
|
Prepayments and other current assets
|
|
$
|
23.6
|
|
$
|
23.3
|
|
Other non-current assets
|
|
|
18.5
|
|
|
16.6
|
|
Total
insurance receivable
|
|
$
|
42.1
|
|
$
|
39.9
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses
|
|
$
|
23.6
|
|
$
|
23.3
|
|
Other non-current liabilities
|
|
|
18.5
|
|
|
16.6
|
|
Total
accrued liability
|
|
$
|
42.1
|
|
$
|
39.9
|
|
The
Company cannot reasonably estimate possible losses, if any, in excess of those
for which it has accrued, because it cannot predict how many additional claims
may be brought against the Company (or parties the Company has an obligation
to
indemnify) in the future, the allegations in such claims, the possible outcomes,
or the impact of tort reform legislation that may be enacted at the State
or Federal levels.
A
declaratory judgment action was filed in January 2004 in the Circuit Court
of
Cook County, Illinois by Continental Casualty Company and related companies
(“CNA”) against the Company and certain of its other historical general
liability insurers. CNA provided the Company with both primary and additional
layer insurance, and, in conjunction with other insurers, is currently defending
and indemnifying the Company in its pending asbestos-related product liability
claims. The lawsuit seeks to determine the extent of insurance coverage
available to the Company including whether the available limits exhaust on
a
“per occurrence” or an “aggregate” basis, and to determine how the applicable
coverage responsibilities should be apportioned. On August 15, 2005, the Court
issued an interim order regarding the apportionment matter. The interim order
has the effect of making insurers responsible for all defense and settlement
costs pro rata to time-on-the-risk, with the pro-ration method to hold the
insured harmless for periods of bankrupt or unavailable coverage. Appeals of
the
interim order were denied. However, the issue is reserved for appellate review
at the end of the action. In addition to the primary insurance available for
asbestos-related claims, the Company has substantial additional layers of
insurance available for potential future asbestos-related product claims. As
such, the Company continues to believe that its coverage is sufficient to meet
foreseeable liabilities.
Although
it is impossible to predict the outcome of pending or future claims or the
impact of tort reform legislation that may be enacted at the State or
Federal levels, due to the encapsulated nature of the products, the Company’s
experiences in aggressively defending and resolving claims in the past, and
the
Company’s significant insurance coverage with solvent carriers as of the date of
this filing, management does not believe that asbestos-related product liability
claims are likely to have a material adverse effect on the Company’s results of
operations, cash flows or financial condition.
(15)
Leases and Commitments
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 September 2007. In the event the Company
exercises its option not to purchase the machinery and equipment, the Company
has guaranteed a residual value of $14.4 million. The
Company has accrued $6.0 million as a loss on this guarantee, which
is expected to be paid in 2008.
(16)
Restructuring
On
September 22, 2006, the Company announced the reduction of its North American
workforce by approximately 850 people, or 13%, spread across its 19 operations
in the U.S., Canada and Mexico. In addition to employee related costs of $6.7
million, the Company recorded $4.8 million of asset impairment charges related
to the North American restructuring. The restructuring expenses broken out
by
segment were as follows: Engine $7.3 million, Drivetrain $3.6 million and
Corporate $0.6 million.
During
the fourth quarter of 2006, the Company recorded restructuring expense
associated with closing its Drivetrain plant in Muncie, Indiana and adjusted
the
carrying values of other assets primarily related to its four-wheel drive
transfer case product line. Production activity at the Muncie facility is
scheduled to cease no later than the expiration of the current labor contract
in
2009. The Company recorded employee related costs of $14.8 million, asset
impairments of $51.6 million and pension curtailment expense of $6.8 million
in
the fourth quarter of 2006. The expenses broken out by segment were as follows:
Engine $5.9 million and Drivetrain $67.3 million.
Estimates
of restructuring expense are based on information available at the time such
charges are recorded. Due to the inherent uncertainty involved in estimating
restructuring expenses, actual amounts paid for such activities may differ
from
amounts initially recorded. Accordingly, the Company may record revisions of
previous estimates by adjusting previously established reserves.
The
table
below summarizes accrual activity for employee related costs related to the
Company’s previously announced restructuring actions for the three months ended
March 31, 2007 (in millions):
|
|
|
Employee
Related
Costs
|
|
Balance
at December 31, 2006
|
|
$
|
16.2
|
|
Cash
payments
|
|
|
(6.1
|
)
|
Balance
at March 31, 2007
|
|
$
|
10.1
|
|
Future
cash payments for these restructuring activities are expected to be complete
by
the end of 2009.
(17)
Operating Segments
The
Company’s business is comprised of two operating segments: Engine and
Drivetrain. These reportable segments are strategic business groups, which
are
managed separately as each represents a specific grouping of related automotive
components and systems.
The
Company allocates resources to each segment based upon the projected after-tax
return on invested capital (“ROIC”) of its business initiatives. The ROIC is
comprised of projected earnings before interest and income taxes (“EBIT”)
adjusted for income taxes compared to the projected average capital investment
required.
EBIT
is
considered a “non-GAAP financial measure.” Generally, a non-GAAP financial
measure is a numerical measure of a company’s financial performance, financial
position or cash flows that excludes (or includes) amounts that are included
in
(or excluded from) the most directly comparable measure calculated and presented
in accordance with GAAP. EBIT is defined as earnings before interest, income
taxes and minority interest. “Earnings” is intended to mean net earnings as
presented in the Consolidated Statements of Operations under GAAP.
The
Company believes that EBIT is useful to demonstrate the operational
profitability of our segments by excluding interest and income taxes, which
are
generally accounted for across the entire Company on a consolidated basis.
EBIT
is also one of the measures used by the Company to determine resource allocation
within the Company. Although the Company believes that EBIT enhances
understanding of our business and performance, it should not be considered
an
alternative to, or more meaningful than, net earnings or cash flows from
operations as determined in accordance with GAAP.
The
following tables show net sales, segment EBIT and total assets for the Company’s
reportable operating segments.
Net
Sales by Operating Segment
|
|
|
|
|
|
(Millions)
|
|
|
|
|
|
|
|
Three
months ended
March
31,
|
|
|
|
|
2007
|
|
|
2006
|
|
Engine
|
|
$
|
894.1
|
|
$
|
785.9
|
|
Drivetrain
|
|
|
392.0
|
|
|
377.0
|
|
Inter-segment
eliminations
|
|
|
(8.3
|
)
|
|
(7.7
|
)
|
Net
sales
|
|
$
|
1,277.8
|
|
$
|
1,155.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment
Earnings Before Interest and Income Taxes
|
|
|
|
|
|
|
|
(Millions)
|
|
|
|
|
|
|
|
|
|
|
Three
months ended
March
31,
|
|
|
|
|
2007
|
|
|
2006
|
|
Engine
|
|
$
|
85.3
|
|
$
|
96.3
|
|
Drivetrain
|
|
|
27.7
|
|
|
22.7
|
|
Segment
earnings before interest and income taxes ("Segment
EBIT")
|
|
|
113.0
|
|
|
119.0
|
|
Corporate,
including equity in affiliates' earnings and stock-based
compensation
|
|
|
(13.9
|
)
|
|
(14.7
|
)
|
Consolidated
earnings before interest and taxes ("EBIT")
|
|
|
99.1
|
|
|
104.3
|
|
Interest
expense and finance charges
|
|
|
8.9
|
|
|
9.4
|
|
Earnings
before income taxes and minority interest
|
|
|
90.2
|
|
|
94.9
|
|
Provision
for income taxes
|
|
|
24.4
|
|
|
26.6
|
|
Minority
interest, net of tax
|
|
|
7.4
|
|
|
7.0
|
|
Net
earnings
|
|
$
|
58.4
|
|
$
|
61.3
|
|
|
|
|
|
|
|
|
|
Total
Assets
|
|
|
|
|
|
|
|
(Millions)
|
|
|
|
|
|
|
|
|
|
|
March
31,
|
|
|
December
31,
|
|
|
|
|
2007
|
|
|
2006
|
|
Engine
|
|
$
|
3,245.0
|
|
$
|
3,103.1
|
|
Drivetrain
|
|
|
1,224.6
|
|
|
1,191.0
|
|
Total
|
|
|
4,469.6
|
|
|
4,294.1
|
|
Corporate,
including equity in affiliates (a)
|
|
|
235.7
|
|
|
289.9
|
|
Total
assets
|
|
$
|
4,705.3
|
|
$
|
4,584.0
|
|
|
|
|
|
|
|
|
|
(a)
Corporate assets, including equity in affiliates, are net of trade
receivables securitized and sold to third parties, and include
cash, deferred income taxes and investments &
advances.
|
(18)
New Accounting Pronouncements
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157,
Fair
Value Measurements
(“FAS
157”). FAS 157 defines fair value, establishes a framework for measuring fair
value in GAAP and expands disclosures about fair value measurements. FAS 157
is
effective for the Company beginning with its quarter ending March 31, 2008.
The adoption of FAS 157 is not expected to have a material impact on the
Company’s consolidated financial position, results of operations or cash
flows.
In
February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159, The Fair Value Option for Financial Assets and Financial
Liabilities (“FAS 159”). FAS 159 allows entities to irrevocably elect to
recognize most financial assets and financial liabilities at fair value on
an
instrument-by-instrument basis. The stated objective of FAS 159 is to improve
financial reporting by giving entities the opportunity to elect to measure
certain financial assets and liabilities at fair value in order to mitigate
earnings volatility caused when related assets and liabilities are measured
differently. FAS 159 is effective for the Company beginning with its quarter
ending March 31, 2008. The Company is currently assessing the potential
impact, if any, on its financial statements.
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 primarily for powertrain
applications. Our products help improve vehicle performance, fuel efficiency,
air quality and vehicle stability. They are manufactured and sold worldwide,
primarily to original equipment manufacturers (“OEMs”) of light vehicles (i.e.,
passenger cars, sport-utility vehicles (“SUVs”), cross-over vehicles, vans and
light-trucks). Our products are also manufactured and sold to OEMs of commercial
trucks, buses and agricultural and off-highway vehicles. We also manufacture
and
sell our products into the aftermarket for light and commercial vehicles. We
operate manufacturing facilities serving customers in the Americas, Europe
and
Asia, and are an original equipment supplier to every major automaker in the
world.
The
Company’s products fall into two reportable operating segments: Engine and
Drivetrain. The Engine segment’s products include turbochargers, timing chain
systems, air management, emissions systems, thermal systems, as well as diesel
and gas ignition systems. The Drivetrain segment’s products are all-wheel drive
transfer cases, torque management systems, and components and systems for
automated transmissions.
RESULTS
OF OPERATIONS
Three
months ended March 31, 2007 vs. Three months ended March 31,
2006
Consolidated
net sales for the first quarter ended March 31, 2007 totaled $1,277.8 million,
a
10.6% increase over the first quarter of 2006. This increase occurred while
light-vehicle production was flat worldwide and down 7% in North America from
the previous year’s quarter. Light-vehicle production increased approximately 2%
in Asia-Pacific and 1% in Europe. The net sales increase included the effect
of
stronger foreign currencies, primarily the Euro, of approximately $60 million.
Turbochargers,
timing
chain systems,
ignition systems and automatic transmission components and systems are the
products most affected by currency fluctuations in Europe and Asia-Pacific.
Without the currency impact, the increase in net sales would have been 5.4%
due
to strong demand for the Company’s products in Europe and
Asia-Pacific.
Gross
profit and gross margin were $215.9 million and 16.9% for first quarter 2007
as
compared to $223.3 million and 19.3% for first quarter 2006. Our gross margin
percentage was negatively impacted by a warranty-related issue; higher raw
material costs, including nickel, steel, copper, aluminum and plastic resin;
and
lower vehicle production in North America. The warranty-related issue surrounded
a product, built during a 15-month period in 2004 and 2005, that is no longer
in
production. This resulted in a pre-tax charge of approximately $14 million.
Raw
material costs, net of recoveries, increased approximately $23
million
as compared to the first quarter 2006, of which nickel was the single largest
contributor. Our focused cost reduction programs in our operations partially
offset these higher raw material costs.
First
quarter selling, general and administrative (“SG&A”) costs decreased $2.8
million to $126.7 million from $129.5 million, and decreased as a percentage
of
net sales to 9.9% from 11.2%. R&D costs, which are included in SG&A
expenses, increased $4.9 million to $50.9 million from $46.0 million as compared
to the first quarter of 2006. The increase is primarily driven by our continued
investment in a number of cross-business R&D programs, as well as other key
programs, all of which are necessary for short and long-term growth. As a
percentage of sales, R&D costs remained constant at 4.0% in the first
quarter of 2007 and 2006.
Other
income of $(0.7) million and $(0.5) million for first quarter 2007 and 2006,
respectively, are comprised primarily of interest income.
Equity
in
affiliates’ earnings of $9.2 million decreased $0.8 million as compared to the
first quarter of 2006 primarily due to a weaker Japanese Yen.
First
quarter interest expense and finance charges of $8.9 million decreased $0.5
million as compared to the first quarter of 2006, primarily due to reduced
debt
levels, partially offset by higher short-term interest rates.
The
Company's provision for income taxes is based upon an estimated annual tax
rate
for the year applied to federal, state and foreign income. The projected
effective tax rate of 27.0% for 2007 differs from the U.S. statutory rate
primarily due to foreign rates, which differ from those in the U.S., and
favorable permanent differences between book and tax treatment for items,
including equity in affiliates’ earnings and Medicare prescription drug benefit.
This rate is expected to be greater than the full year 2006 effective tax rate
of 12.0% because the 2006 rate included the release of tax accrual accounts
upon
conclusion of certain tax audits, the tax effects of dispositions and
adjustments to various tax accounts, including changes in tax laws.
Net
earnings were $58.4 million for the first quarter, or $1.00 per diluted share,
a
decrease of $0.06 per diluted share over the previous year’s first quarter.
Excluding the $(0.17) per diluted share impact of the warranty-related issue
and
the $0.04 per diluted share impact of stronger foreign currencies, primarily
the
Euro, net earnings were $1.13 per diluted share, an increase of $0.07 per
diluted share over the previous year’s first quarter.
Reportable
Operating Segments
The
Company’s business is comprised of two operating segments: Engine and
Drivetrain. These reportable segments are strategic business groups, which
are
managed separately as each represents a specific grouping of related automotive
components and systems.
The
Company allocates resources to each segment based upon the projected after-tax
return on invested capital (“ROIC”) of its business initiatives. The ROIC is
comprised of projected earnings before interest and income taxes (“EBIT”)
adjusted for income taxes compared to the projected average capital investment
required.
EBIT
is
considered a “non-GAAP financial measure.” Generally, a non-GAAP financial
measure is a numerical measure of a company’s financial performance, financial
position or cash flows that excludes (or includes) amounts that are included
in
(or excluded from) the most directly comparable measure calculated and presented
in accordance with GAAP. EBIT is defined as earnings before interest, income
taxes and minority interest. “Earnings” is intended to mean net earnings as
presented in the Consolidated Statements of Operations under GAAP.
The
Company believes that EBIT is useful to demonstrate the operational
profitability of our segments by excluding interest and income taxes, which
are
generally accounted for across the entire Company on a consolidated basis.
EBIT
is also one of the measures used by the Company to determine resource allocation
within the Company. Although the Company believes that EBIT enhances
understanding of our business and performance, it should not be considered
an
alternative to, or more meaningful than, net earnings or cash flows from
operations as determined in accordance with GAAP.
The
following tables present net sales and segment EBIT by segment for the three
months ended March 31, 2007 and 2006.
Net
Sales by Operating Segment
|
|
|
|
|
|
(Millions)
|
|
|
|
|
|
|
|
Three
months ended
March
31,
|
|
|
|
|
2007
|
|
|
2006
|
|
Engine
|
|
$
|
894.1
|
|
$
|
785.9
|
|
Drivetrain
|
|
|
392.0
|
|
|
377.0
|
|
Inter-segment
eliminations
|
|
|
(8.3
|
)
|
|
(7.7
|
)
|
Net
sales
|
|
$
|
1,277.8
|
|
$
|
1,155.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment
Earnings Before Interest and Income Taxes
|
|
|
|
|
|
|
|
(Millions)
|
|
|
|
|
|
|
|
|
|
|
Three
months ended
March
31,
|
|
|
|
|
2007
|
|
|
2006
|
|
Engine
|
|
$
|
85.3
|
|
$
|
96.3
|
|
Drivetrain
|
|
|
27.7
|
|
|
22.7
|
|
Segment
earnings before interest and income taxes ("Segment
EBIT")
|
|
|
113.0
|
|
|
119.0
|
|
Corporate,
including equity in affiliates' earnings and stock-based
compensation
|
|
|
(13.9
|
)
|
|
(14.7
|
)
|
Consolidated
earnings before interest and taxes ("EBIT")
|
|
|
99.1
|
|
|
104.3
|
|
Interest
expense and finance charges
|
|
|
8.9
|
|
|
9.4
|
|
Earnings
before income taxes and minority
interest
|
|
|
90.2
|
|
|
94.9
|
|
Provision
for income taxes
|
|
|
24.4
|
|
|
26.6
|
|
Minority
interest, net of tax
|
|
|
7.4
|
|
|
7.0
|
|
Net
earnings
|
|
$
|
58.4
|
|
$
|
61.3
|
|
|
Three
months ended March 31, 2007 vs. Three months ended March 31,
2006
The
Engine segment net sales increased $108.2 million, or 13.8%, and segment EBIT
decreased $11.0 million, or 11.4%, from first quarter 2006. Excluding the impact
of stronger foreign currencies, primarily the Euro, sales increased 7.8%. The
Engine segment continued to benefit from European and Asian automaker demand
for
turbochargers, timing systems and emissions products, and European demand for
diesel engine ignition systems. In North America, higher turbocharger sales
offset lower sales of other Engine segment products, which were lower primarily
due to lower domestic vehicle production. The segment EBIT margin was negatively
impacted by the approximate $14 million warranty-related charge and by sharply
higher commodity costs, primarily nickel.
The
Drivetrain segment net sales increased $15.0 million, or 4.0%, and segment
EBIT
increased $5.0 million, or 22.0%, from first quarter 2006. Excluding the impact
of stronger foreign currencies, primarily the Euro, sales increased 0.5%. The
sales increase was driven by growth outside of North America including higher
sales of DualTronic®
transmission modules and torque transfer products.
Outlook
for the remainder of 2007
Our
overall outlook for 2007 remains positive, as we expect our sales to grow in
excess of a projected moderate global vehicle production growth rate. The
outlook for global vehicle production by region is for moderate declines in
North America, moderate increases in Europe, and solid growth in Asia. While
expecting only moderate overall growth in global vehicle production, we expect
to benefit from strong European and Asian automaker demand for our engine
products, including turbochargers, timing systems, ignition systems and
emissions products. Growing demand for our drivetrain products outside of North
America, including increased sales of dual-clutch transmission products, is
also
a positive trend for the Company. The impact of non-U.S. currencies is currently
planned to be negligible in 2007. The impact of raw materials, including
nickel, steel, copper, aluminum and plastic resin, is expected to continue
to
pressure gross profit. Assuming no major departures from these
assumptions, we expect continued long-term sales and net earnings
growth.
The
Company maintains a positive long-term outlook for its business and is committed
to new product development and strategic capital investments to enhance its
product leadership strategy. The trends that are driving our longer-term growth
are expected to continue, including the growth of diesel engines worldwide,
the
increased adoption of automatic transmissions in Europe and Asia-Pacific, the
popularity of cross-over vehicles in North America and the move to chain engine
timing systems in both Europe and Asia-Pacific.
FINANCIAL
CONDITION AND LIQUIDITY
Net
cash
provided by operating activities increased $34.5 million to $82.6 million for
the first three months of 2007 from $48.1 million in the first three months
of
2006. Capital spending, including tooling outlays, was $58.3 million in the
first three months of 2007, compared with $70.3 million in 2006. Selective
capital spending remains an area of focus for the Company, both in order to
support our book of new business, and for cost reductions and productivity
improvements. The Company expects to spend approximately $325 million on capital
and tooling expenditures in 2007, but this expectation is subject to ongoing
review based on market conditions.
As
of
March 31, 2007, debt decreased from year-end 2006 by $26.1 million,
cash decreased by $5.2 million and marketable securities decreased by $1.1
million. Our debt to capital ratio was 24.8% at the end of the first quarter
versus 26.1% at the end of 2006. The Company paid dividends to BorgWarner
stockholders of $9.8 million and $9.1 million in the first three months of
2007
and 2006, respectively.
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. At both March 31, 2007 and 2006, the Company
had sold $50 million of receivables under a Receivables Transfer Agreement
for
face value without recourse. During both of the three-month periods ended March
31, 2007 and 2006, total cash proceeds from sales of accounts receivable were
$150 million. The Company paid servicing fees related to these receivables
of
$0.7 million and $0.6 million for the three months ended March 31, 2007 and
2006, respectively. These amounts are recorded in interest expense and finance
charges in the Condensed Consolidated Statements of Operations.
The
Company has a revolving credit facility, which provides for committed borrowings
up to $600 million through July 2009. At March 31, 2007, $10.0 million of
borrowings under the facility were outstanding in addition to $25.8 million
of
obligations under standby letters of credit. At December 31, 2006, there
were no borrowings outstanding under the facility.
The
credit agreement is subject to the usual terms and conditions
applied
by banks to an investment grade company. The Company was in compliance with
all
covenants at March 31, 2007 and December 31, 2006 and expects to remain
compliant in future periods.
From
a
credit quality perspective, we have an investment grade credit rating of A-
from
Standard & Poor’s and Baa2 from Moody’s.
The
Company believes that the combination of cash balances, cash flow from
operations, available credit facilities and $50 million available under a shelf
registration statement on file with the Securities and Exchange Commission,
under which a variety of debt instruments could be issued, will be sufficient
to
satisfy its cash needs for the current level of operations and planned
operations for the remainder of 2007. The Company expects that net cash provided
by operating activities will be approximately $500 million in 2007.
OTHER
MATTERS
Contingencies
In
the
normal course of business the Company and its subsidiaries are parties to
various commercial and legal claims, actions and complaints, including matters
involving warranty claims, intellectual property claims, general liability
and
various other risks. It is not possible to predict with certainty whether or
not
the Company and its subsidiaries will ultimately be successful in any of these
commercial and legal matters or, if not, what the impact might be. The Company’s
environmental and product liability contingencies are discussed separately
below. The Company’s management does not expect that the results in any of these
legal proceedings will have a material adverse effect on the Company’s results
of operations, financial position or cash flows.
Environmental
The
Company and certain of its current and former direct and indirect corporate
predecessors, subsidiaries and divisions have been identified by the United
States Environmental Protection Agency and certain state environmental agencies
and private parties as potentially responsible parties (“PRPs”) at various
hazardous waste disposal sites under the Comprehensive Environmental Response,
Compensation and Liability Act (“Superfund”) and equivalent state laws and, as
such, may presently be liable for the cost of clean-up and other remedial
activities at 35 such sites. Responsibility for clean-up and other remedial
activities at a Superfund site is typically shared among PRPs based on an
allocation formula.
The
Company believes that none of these matters, individually or in the aggregate,
will have a material adverse effect on its results of operations, financial
position, or cash flows. Generally, this is because either the estimates of
the
maximum potential liability at a site are not large or the liability will be
shared with other PRPs, although no assurance can be given with respect to
the
ultimate outcome of any such matter.
Based
on
information available to the Company (which in most cases, includes: an estimate
of allocation of liability among PRPs; the probability that other PRPs, many
of
whom are large, solvent public companies, will fully pay the cost apportioned
to
them; currently available information from PRPs and/or federal or state
environmental agencies concerning the scope of contamination and estimated
remediation and consulting costs; remediation alternatives; estimated legal
fees; and other factors), the Company has established an accrual for indicated
environmental liabilities with a balance at March 31, 2007 of $15.8
million. Excluding the Crystal Springs site discussed below for which $7.4
million has been accrued, the Company has accrued
amounts
that do not exceed $3.0 million related to any individual site and management
does not believe that the costs related to any of these other individual sites
will have a material adverse effect on the Company’s results of operations, cash
flows or financial condition. The Company expects to pay out substantially
all
of the $15.8 million accrued environmental liability over the next three to
five
years.
In
connection with the sale of Kuhlman Electric Corporation, the Company agreed
to
indemnify the buyer and Kuhlman Electric for certain environmental liabilities,
then unknown to the Company, relating to the past operations of Kuhlman
Electric. The liabilities at issue result from operations of Kuhlman Electric
that pre-date the Company’s acquisition of Kuhlman Electric’s parent company,
Kuhlman Corporation, in 1999. During 2000, Kuhlman Electric notified the Company
that it discovered potential environmental contamination at its Crystal Springs,
Mississippi plant while undertaking an expansion of the plant. The Company
is
continuing to work with the Mississippi Department of Environmental Quality
and
Kuhlman Electric to investigate and remediate to the extent necessary, if any,
historical contamination at the plant and surrounding area. Kuhlman Electric
and
others, including the Company, were sued in numerous related lawsuits, in which
multiple claimants alleged personal injury and property damage. In 2005, the
Company and other defendants, including the Company’s subsidiary Kuhlman
Corporation, entered into settlements that resolved approximately 99% of the
known personal injury and property damage claims relating to the alleged
environmental contamination. Those settlements involved payments by the
defendants of $28.5 million in the second half of 2005 and $15.7 million in
the
first quarter of 2006, in exchange for, among other things, dismissal with
prejudice of these lawsuits.
Conditional
Asset Retirement Obligations
In
March
2005, the FASB issued Interpretation No. 47, Accounting
for Conditional Asset Retirement Obligations - an interpretation of FASB
Statement No. 143
(“FIN
47”), which requires the Company to recognize legal obligations to perform asset
retirements in which the timing and/or method of settlement are conditional
on a
future event that may or may not be within the control of the entity. Certain
government regulations require the removal and disposal of asbestos from an
existing facility at the time the facility undergoes major renovations or is
demolished. The liability exists because the facility will not last forever,
but
it is conditional on future renovations (even if there are no immediate plans
to
remove the materials, which pose no health or safety hazard in their current
condition). Similarly, government regulations require the removal or closure
of
underground storage tanks (“USTs”) when their use ceases, the disposal of
polychlorinated biphenyl (“PCB”) transformers and capacitors when their use
ceases, and the disposal of used furnace bricks and liners, and lead-based
paint
in conjunction with facility renovations or demolition. The Company currently
has 17 manufacturing locations that have been identified as containing these
items. The fair value to remove and dispose of this material has been estimated
and recorded at $1.0 million as of March 31, 2007 and December 31,
2006.
Product
Liability
Like
many
other industrial companies who have historically operated in the U.S., the
Company (or parties the Company is obligated to indemnify) continues to be
named
as one of many defendants in asbestos-related personal injury actions.
Management believes that the Company’s involvement is limited because, in
general, these claims relate to a few types of automotive friction products
that
were manufactured many years ago and contained encapsulated asbestos. The nature
of the fibers, the encapsulation and the manner of use lead the Company to
believe that these products are highly unlikely to cause harm. As of March
31,
2007, the Company had approximately 44,000 pending asbestos-related product
liability claims. Of these outstanding claims, approximately 34,000 are pending
in just three jurisdictions, where significant tort reform activities are
underway.
The
Company’s policy is to aggressively defend against these lawsuits and the
Company has been successful in obtaining dismissal of many claims without any
payment. The Company expects that the vast majority of the pending
asbestos-related product liability claims where it is a defendant (or has an
obligation to indemnify a defendant) will result in no payment being made by
the
Company or its insurers. In the first quarter 2007, of the approximately 600
claims resolved, only 44 (7.3%) resulted in any payment being made to a claimant
by or on behalf of the Company. In 2006, of the approximately 27,000 claims
resolved, only 169 (0.6%) resulted in any payment being made to a claimant
by or
on behalf of the Company.
Prior
to
June 2004, the settlement and defense costs associated with all claims were
covered by the Company’s primary layer insurance coverage, and these carriers
administered, defended, settled and paid all claims under a funding arrangement.
In June 2004, primary layer insurance carriers notified the Company of the
alleged exhaustion of their policy limits. This led the Company to access the
next available layer of insurance coverage. Since June 2004, secondary layer
insurers have paid asbestos-related litigation defense and settlement expenses
pursuant to a funding arrangement. To
date,
the Company has paid $18.8 million in defense and indemnity in advance of
insurers’ reimbursement and has received $5.9 million in cash from
insurers. The outstanding balance of $12.9 million is expected to be fully
recovered. Timing of the recovery is dependent on final resolution of the
declaratory judgment action referred to below. At December 31, 2006,
insurers owed $11.7 million in association with these claims.
At
March
31, 2007, the Company has an estimated liability of $42.1 million for future
claims resolutions, with a related asset of $42.1 million to recognize the
insurance proceeds receivable by the Company for estimated losses related to
claims that have yet to be resolved. Insurance carrier reimbursement of 100%
is
expected based on the Company’s experience, its insurance contracts and
decisions received to date in the declaratory judgment action referred to below.
At December 31, 2006, the comparable value of the insurance receivable and
accrued liability was $39.9 million.
The
amounts recorded in the Condensed Consolidated Balance Sheets related to the
estimated future settlement of existing claims are as follows:
|
|
March
31,
|
|
December
31,
|
|
(Millions)
|
|
2007
|
|
2006
|
|
Assets:
|
|
|
|
|
|
|
|
Prepayments
and other current assets
|
|
$
|
23.6
|
|
$
|
23.3
|
|
Other
non-current assets
|
|
|
18.5
|
|
|
16.6
|
|
Total
insurance receivable
|
|
$
|
42.1
|
|
$
|
39.9
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
$
|
23.6
|
|
$
|
23.3
|
|
Other
non-current liabilities
|
|
|
18.5
|
|
|
16.6
|
|
Total
accrued liability
|
|
$
|
42.1
|
|
$
|
39.9
|
|
The
Company cannot reasonably estimate possible losses, if any, in excess of those
for which it has accrued, because it cannot predict how many additional claims
may be brought against the Company (or parties the Company has an obligation
to
indemnify) in the future, the allegations in such claims, the possible outcomes,
or the impact of tort reform legislation that may be enacted at the State or
Federal levels.
A
declaratory judgment action was filed in January 2004 in the Circuit Court
of
Cook County, Illinois by Continental Casualty Company and related companies
(“CNA”) against the Company and certain of its other historical general
liability insurers. CNA provided the Company with both primary and additional
layer insurance, and, in conjunction with other insurers, is currently defending
and indemnifying the Company in its pending asbestos-related product liability
claims. The lawsuit seeks to determine the extent of insurance coverage
available to the Company including whether the available limits exhaust on
a
“per occurrence” or an “aggregate” basis, and to determine how the applicable
coverage responsibilities should be apportioned. On August 15, 2005, the Court
issued an interim order regarding the apportionment matter. The interim order
has the effect of making insurers responsible for all defense and settlement
costs pro rata to time-on-the-risk, with the pro-ration method to hold the
insured harmless for periods of bankrupt or unavailable coverage. Appeals of
the
interim order were denied. However, the issue is reserved for appellate review
at the end of the action. In addition to the primary insurance available for
asbestos-related claims, the Company has substantial additional layers of
insurance available for potential future asbestos-related product claims. As
such, the Company continues to believe that its coverage is sufficient to meet
foreseeable liabilities.
Although
it is impossible to predict the outcome of pending or future claims or the
impact of tort reform legislation that may be enacted at the State or Federal
levels, due to the encapsulated nature of the products, the Company’s
experiences in aggressively defending and resolving claims in the past, and
the
Company’s significant insurance coverage with solvent carriers as of the date of
this filing, management does not believe that asbestos-related product liability
claims are likely to have a material adverse effect on the Company’s results of
operations, cash flows or financial condition.
New
Accounting Pronouncements
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157,
Fair
Value Measurements
(“FAS
157”). FAS 157 defines fair value, establishes a framework for measuring fair
value in GAAP and expands disclosures about fair value measurements. FAS 157
is
effective for the Company beginning with its quarter ending March 31, 2008.
The adoption of FAS 157 is not expected to have a material impact on the
Company’s consolidated financial position, results of operations or cash
flows.
In
February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159,
The
Fair Value Option for Financial Assets and Financial
Liabilities
(“FAS
159”). FAS 159 allows entities to irrevocably elect to recognize most financial
assets and financial liabilities at fair value on an instrument-by-instrument
basis. The stated objective of FAS 159 is to improve financial reporting
by
giving entities the opportunity to elect to measure certain financial assets
and
liabilities at fair value in order to mitigate earnings volatility caused
when
related assets and liabilities are measured differently. FAS 159 is effective
for the Company beginning with its quarter ending March 31, 2008. The
Company is currently assessing the potential impact, if any, on its financial
statements.
Recent
Development
On
April
20, 2007, the Company announced a $0.17 per share dividend to be paid on May
15,
2007 to stockholders of record on May 1, 2007.
DISCLOSURE
REGARDING FORWARD-LOOKING STATEMENTS
Statements
contained in this Management’s Discussion and Analysis of Financial Condition
and Results of Operations may contain forward-looking statements as contemplated
by the 1995 Private Securities Litigation Reform Act that are based on
management’s current expectations, estimates and projections. Words such as
"expects," "anticipates," "intends," "plans," "believes," "estimates,"
variations of such words and similar expressions are intended to identify such
forward-looking statements. Forward-looking statements are subject to risks
and
uncertainties, many of which are difficult to predict and generally beyond
the
control of the Company, 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 Risk Factors, identified
in
the Form 10-K for the fiscal year ended December 31, 2006. The Company does
not
undertake any obligation to update any forward-looking statements.
Item
3.
Quantitative
and Qualitative Disclosure About Market Risk
There
have been no material changes to our exposures related to market risk as stated
in the Company’s Annual Report on Form 10-K for the year ended December 31,
2006.
Item
4.
Controls
and Procedures
The
Company maintains disclosure controls and procedures (as defined in Exchange
Act
Rules 13a-15(e) and 15d-15(e)) that are designed to provide reasonable assurance
that the information required to be disclosed in the reports it files with
the
Securities and Exchange Commission is collected and then processed, summarized
and disclosed within the time periods specified in the rules of the Securities
and Exchange Commission. Under the supervision and with the participation of
the
Company’s management, including the Company’s Chief Executive Officer and Chief
Financial Officer, the Company has evaluated the effectiveness of the design
and
operation of its disclosure controls and procedures as of the end of the period
covered by this report. Based on such evaluation, the Company’s Chief Executive
Officer and Chief Financial Officer have concluded that these procedures are
effective. There have been no changes in internal control over financial
reporting that occurred during the period covered by this report that have
materially affected, or are likely to materially affect, the Company’s internal
control over financial reporting.
PART
II. OTHER INFORMATION
Item
1.
Legal
Proceedings
The
Company is subject to a number of claims and judicial and administrative
proceedings (some of which involve substantial amounts) arising out of the
Company’s business or relating to matters for which the Company may have a
contractual indemnity obligation. See Note 14 - Contingencies to the condensed
consolidated financial statements for a discussion of environmental, product
liability and other litigation, which is incorporated herein by reference.
Item
5.
Other
Information
At
the
Annual Meeting of Stockholders held April 25, 2007, non-employee Directors
Drummond and Novak were elected to three year terms on the Company's Board
of
Directors, and were each granted 2,158 shares
of
restricted stock as equity compensation. Restrictions on the shares of stock
will expire over their three year terms, one third in each year, as more fully
described in the Company's proxy statement filed for its 2007 Annual
Meeting of Stockholders.
Item
6.
Exhibits
Exhibit 10.1
|
Form
of BorgWarner Inc. Amended and Restated 2004 Stock Incentive
Plan
Restricted
Stock Agreement for Non-Employee
Directors
|
Exhibit
31.1
|
Rule 13a-14(a)/15d-14(a) Certification
of the Principal
Executive Officer |
Exhibit
31.2
|
Rule
13a-14(a)/15d-14(a) Certification of the Principal
Financial Officer |
Exhibit
32
|
Section
1350 Certifications |
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/
Jeffrey L. Obermayer
(Signature)
Jeffrey
L. Obermayer
Vice
President and Controller
(Principal
Accounting Officer)
Date:
April 26, 2007