<DOCUMENT>
<TYPE>EX-99
<SEQUENCE>4
<FILENAME>exhib99.txt
<TEXT>
Exhibit 99.1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
BorgWarner Inc. and Consolidated Subsidiaries
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 (OEM) of passenger cars, sport-utility
vehicles, trucks and commercial transportation products.
We operate manufacturing facilities serving customers in
the Americas, Europe and Asia, and are an original
equipment supplier to every major OEM in the world.
RESULTS OF OPERATIONS - 2002 vs. 2001 vs. 2000
BorgWarner reported net earnings for 2002 of $149.9 million, or
$5.58 per diluted share, before charges for the cumulative
effect of an accounting change related to goodwill.
After this charge, the Company had a net loss of $119.1 million,
or $(4.44) per diluted share. The Company's net earnings
in 2001 were $66.4 million, or $2.51 per diluted share.
Net earnings in 2000 were $94.0 million or $3.54 per
diluted share.
The following table reconciles reported earnings to earnings before
non-recurring charges and effects of change in accounting principle.
(millions of dollars)
Year ended December 31, 2002 2001 2000
----- ----- -----
Reported net earnings/(loss) $ (119.1) $ 66.4 $ 94.0
Change in accounting principle,
net of tax 269.0 - -
Goodwill amortization, net of tax - 26.5 27.3
Non-recurring charges, net of tax - 19.0 38.7
-------- -------- -----
Adjusted net earnings $ 149.9 $ 111.9 $ 160.0
======== ======== ======
The earnings comparison for 2002 to 2001, other than the items reflected in the
table above, was positively affected by increased sales, operating leverage,
lower interest expense and a lower tax rate. Overall, our sales increased
16.1% from 2001 and declined 11.1% between 2001 and 2000. The main causes
of the sales increase in 2002 were increased production in the auto
industry, increased demand for turbochargers, especially in Europe,
and new business. As a comparison, worldwide vehicle production increased
by 2.3% in 2002 and decreased by 3.8% in 2001. North American production
increased by 5.7% in 2002 and decreased by 9.7% in 2001, Japanese production
increased by 3.8% in 2002 and decreased by 2.3% in 2001 and Western European
production decreased 1.5% in 2002 and increased 1.4% in 2001.
Our 2001 results reflected weak production demand, the weak Euro and
Yen, production slowdowns and shutdowns, and further deterioration in
the heavy truck market.
Our outlook for the industry as we head into 2003 is one of caution
and uncertainty. The North American automotive market was strong in
2002, but increased incentives drove consumer sales. It is uncertain
whether these incentive levels will continue in 2003 and what impact
this will have. We anticipate global production levels of light
vehicles to be steady or slightly lower than the 2002 levels. There
is also uncertainty in the medium and heavy truck markets as these
markets continue to reflect depressed business levels. We expect
the medium and heavy truck markets to continue to be down in the first
half of 2003, and are cautiously optimistic of a recovery in the second
half of 2003. Assuming these conditions and no major negative
events, we anticipate our sales and earnings to grow due to new business
from increased penetration, new customers and new applications.
Results By Operating Segment
We announced a reorganization of the business into two operating groups
in December of 2002 to be effective January 1, 2003, which resulted
in a change to the Company's operating segments. The two segments
are Drivetrain and Engine. The Drivetrain segment is primarily the
combination of the TorqTransfer Systems and Transmissions Systems
businesses. The Engine segment is primarily the combination of
the Morse TEC, Air/Fluid Systems, and Cooling Systems businesses.
The results by operating segments are presented based on the new
operating segment structure. See Note Fourteen to the Consolidated
Financial Statements for further details on the Company's segments.
The company adopted Statement of Financial Accounting Standards (SFAS)
No. 142, "Goodwill and Other Intangible Assets," effective
January 1, 2002. Accordingly, there is no goodwill amortization
included in the 2002 results. See Note Thirteen to the Consolidated
Financial Statements for further details on the Company's
implementation of SFAS No. 142.
Net Sales
(millions of dollars)
Year ended December 31, 2002 2001 2000
------ ------- ---------
Drivetrain $1,122.1 $ 937.2 $ 980.0
Engine 1,648.2 1,426.6 1,568.3
Divested operations and
businesses held for sale - 18.0 132.9
Inter-segment eliminations (39.2) (30.2) (35.3)
------- -------- --------
Net sales $2,731.1 $2,351.6 $2,645.9
======== ========= =========
Earnings Before Interest, and Taxes (EBIT)
(millions of dollars)
Year ended December 31, 2002 2001 2000
------- ------ -----
Drivetrain $ 99.4 $ 70.1 $ 78.9
Engine 212.4 142.7 199.5
Divested operations and
businesses held for sale - (0.2) 3.2
------- ------ -------
Earnings before interest
and taxes $311.8 $212.6 $281.6
======== ====== =======
Drivetrain sales increased by 19.7% and EBIT increased by 41.8%. Sales
growth was strong in all regions for this segment, due to a combination
of market conditions and new applications, both in North America and
overseas. Higher sales in North America were due to higher volumes
for Hyundai and Kia, and the InterActive Torque Management
(ITM) system application in the Acura MDX and the recently
released Honda Pilot. Additionally, the Drivetrain segment launched
new applications for some GM vehicles, including the Hummer H2
and GMC Yukon, in mid-2002. EBIT increased due to a combination
of increased volumes and costs controls. EBIT was also positively
impacted from the elimination of goodwill amortization in 2002
versus the $6.7 million recorded in 2001, due to the adoption
of the new accounting standard on goodwill.
Sales were down 4.4% and EBIT was down 11.2% in 2001 versus 2000.
The sales reduction was due to volume decreases experienced by
major North American OEMs, driven by the general North American
automotive industry downturn as well as market share losses to
European and Asian automakers in North America. EBIT suffered
due to the volume decreases, particularly in the early part of
the year from the effects of erratic scheduling. OEMs cut
volumes on short notice in response to the market downturn,
and the Ford Explorer/Firestone tire issue had a negative
impact on the transfer case product line. Significant cost
cutting done in late 2000 and early 2001 offset the impact
on EBIT of the sales decreases.
For 2003, we expect to achieve moderate sales growth in this
segment. The growth will be driven by a full year of a new
contract to supply transfer cases to General Motors, as well
as increased transfer case business with Kia and Hyundai.
We also expect the transmissions business to increase
due to volume ramp ups in recently launched applications
as well as continued global market share increases by key
customers in Europe and Asia.
Engine sales increased by 15.5% and EBIT increased by 48.8%
in 2002. Contributing to the sales increase were strong sales
of engine timing chains, increased usage of turbochargers,
and continued strength in sales of sport-utility vehicles,
many of which utilize the Company's chain products for their
four wheel drive systems. An increase in sales of control
products to a major customer, and increased penetration of
thermal products into Asia and Europe also contributed to
the sales increase. The EBIT increase was due to higher
volumes, savings from facility rationalizations, and no goodwill
amortization in 2002 versus $35.6 million in 2001. The EBIT
increase would have been greater except for the impact of the
Honeywell International Inc. (Honeywell) agreement discussed
more fully in Note Eleven to the Consolidated Financial
Statements.
Sales decreased by 9.0% and EBIT by 28.5% from 2000 to 2001.
Sales decreased due to the North American auto downturn, but
were offset by expanded applications, particularly for engine
timing applications and turbochargers. The larger decline
in EBIT was due to the relatively larger volume decrease in
the emissions and thermal portions of the segment, where the
loss of volume and product mix issues had a large impact.
Engine revenue is expected to grow in the coming years as
turbocharger capacity is increased to meet demand on
direct-injected diesel passenger cars and as new generations
of variable geometry turbochargers for commercial diesel
applications are introduced. The introduction of additional
products, including timing systems for Chrysler overhead
cam engines, increased North American transplant business,
Ford's global four-cylinder engine program, and drive chain
for the new Toyota hybrid engine and other Japanese and
Korean applications, are expected in the coming years.
This segment also expects to benefit from the continued conversion
of engine timing systems from belts to chains in both Europe
and Japan. A rebound in the truck markets will help this
segment, particularly for cooling fans and thermal systems.
Other opportunities in the coming years include products
designed to improve fuel efficiency and reduce emissions as well
as fluid pumps for engine hydraulics supporting variable
cam timing and engine lubrication.
Below is the table for sales and EBIT for the past three
years under the old operating structure in place prior to
2003, which is being provided for informational purposes only.
Net Sales
(millions of dollars)
Year ended December 31, 2002 2001 2000
----- ------- -------
Morse TEC $1,046.9 $ 869.4 $885.8
Air/Fluid Systems 388.4 357.8 427.8
Cooling Systems 235.8 220.5 281.3
TorqTransfer Systems 630.1 500.1 526.7
Transmission Systems 495.2 428.8 437.5
Divested operations and
businesses held for sale - 18.0 132.9
Inter-segment eliminations (65.3) (43.0) (46.1)
-------- ------ --------
Net sales $2,731.1 $2,351.6 $2,645.9
======== ======== ========
Earnings Before Interest and Taxes (EBIT)
(millions of dollars)
Year ended December 31, 2002 2001 2000
----- ----- ------
Morse TEC $ 159.2 $ 119.8 $ 127.4
Air/Fluid Systems 23.4 12.9 35.7
Cooling Systems 25.1 7.5 32.1
TorqTransfer Systems 39.2 24.1 37.2
Transmission Systems 64.9 48.5 46.0
Divested operations and
businesses held for sale - (0.2) 3.2
------ ------- -------
Earnings before interest and taxes$311.8 $ 212.6 $ 281.6
======= ======== ========
Divested operations and businesses held for sale includes the
results of Fuel Systems, which was sold in 2001; and the HVAC
business, which was sold during 2000. These businesses did not
fit our strategic goals, and we believe our resources are better
spent on our core technologies in highly engineered powertrain
components and systems. The sale of the Fuel Systems business
did not result in a significant gain or loss. We adjusted our
carrying value of this business in 2000 as part of the
restructuring charge discussed below. The $5.4 million gain
on the sale of the HVAC business in 2000 is included in other
income. Divested operations and businesses held for sale contributed
sales of $18.0 million, and $132.9 million and EBIT of $(0.2)
million, and $3.2 million in 2001 and 2000, respectively.
Corporate is the difference between calculated total company
EBIT and the total from the segments and represents corporate
headquarters expenses and expenses not directly attributable to
the individual segments (see Note Fourteen to the Consolidated
Financial Statements). This expense was $40.3 million in 2002,
$26.5 million in 2001, and $4.6 million in 2000, excluding
non-recurring charges in 2001 and 2000. This amount represents
headquarters expenses and expenses not assigned to individual
segments. The main reason for the increase in the expense was
a decrease in excess of earnings from pension assets over the
costs of the U.S. pension plans of $5.3 million from 2001 to 2002
and $10.5 million from 2000 to 2001. Additionally, expenses for
post retirement benefits for sold businesses, which are captured
at the corporate level, contributed to the increase in 2002.
Also impacting this number was a $5.4 million gain on the sale
of the HVAC business in 2000. Corporate headquarters expense
was slightly higher at $24.0 million in 2002 compared to $20.5
million in 2001 and $19.2 million in 2000.
Our top ten customers accounted for approximately 78% of
consolidated sales in 2002 and 2001 compared to 77% in 2000.
Ford continues to be our largest customer with 26% of
consolidated sales in 2002, compared to 30% in 2001 and
2000. DaimlerChrysler, our second largest customer, represented
20% of consolidated net sales in 2002, 21% in 2001 and 19%
in 2000; and General Motors accounted for 12%, 12%, and 13%,
in 2002, 2001, and 2000, respectively. No other customer
accounted for more than 10% of sales in any of the periods
presented.
OTHER FACTORS AFFECTING RESULTS OF OPERATIONS
The following table details our results of operations as
a percentage of sales:
Year Ended December 31, 2002 2001 2000
----- ------ ------
Net sales 100.0% 100.0% 100.0%
Cost of sales 79.7 80.4 79.0
----- ------- ------
Gross profit 20.3 19.6 21.0
Selling, general and
administrative expenses 11.1 10.6 9.8
Goodwill amortization - 1.8 1.6
Restructuring and other non
recurring charges - 1.2 2.4
Other, net - (0.1) (0.3)
----- ------ -----
Operating income 9.2% 6.1% 7.5%
===== ====== ======
Gross profit for 2002 was 20.3%, an increase from 19.6% in 2001
and down from the 21.0% in 2000. The increase in gross profit
in 2002 is mainly due to higher sales volumes. The decrease
in 2001 compared to 2000 is attributable to lower sales volumes,
which made it more difficult to cover the fixed costs of our
manufacturing facilities. Additionally, many of our core
businesses also showed gross margin improvement in both 2001
and 2000.The decrease in margin from 2000 to 2002 is due mainly
to a shift in sales to lower margin businesses. For example, the
transfer case business had a large percentage sales gain in
2002, but has a low gross profit percentage because its products
have the highest purchased content.
The combination of price reductions to customers and cost
increases for material, labor and overhead totaled approximately
$75 million in 2002, as compared to $37 million and $16 million
in 2001 and 2000, respectively. We were able to partially offset
these impacts by actively pursuing reductions from our suppliers,
making changes in product design and by using process technology
to remove cost and/or improve manufacturing capabilities.
Selling, general and administrative expenses (SG&A) as a percentage
of sales increased to 11.1% from 10.6% and 9.8% in 2001 and 2000,
respectively. The increase in SG&A is due to several factors,
including an increase in retiree costs for both pension and
health care. Another factor is our continued commitment to
research and development (R&D) in order to capitalize on growth
opportunities. R&D spending was $109.1 million, or 4.0% of sales,
as compared with $104.5 million, or 4.4% of sales, and $112.0
million, or 4.2% of sales in 2002, 2001 and 2000, respectively.
We continue to invest in a number of cross-segment R&D
programs, as well as a number of other key programs, all of
which are necessary for short- and long-term growth. We intend
to maintain our commitment to R&D investment while continuing
to focus on controlling other SG&A costs.
Restructuring and other non-recurring charges were $28.4 million
in 2001 and $62.9 million in 2000. The 2001
non-recurring charges primarily include adjustments to
the carrying value of certain assets and liabilities related
to businesses acquired and disposed of over the past
three years. Of the $28.4 million
of pretax charges in 2001, $5.0 million represents
non-cash charges. Approximately $3.3 million was spent in 2001,
$8.4 million was spent in 2002, and $8.4 million was transferred
to environmental reserves in 2001. The remaining $3.3 million
is expected to be spent in 2003. The 2001 non-recurring charges
included $8.4 million of environmental remediation costs related
to sold businesses and $12.0 million of product quality costs for
issues with products that were sold by acquired businesses prior
to acquisition, all of which have been corrected in the currently
produced products. The Company expects to fund the total cash outlay
of these actions from operations.
Restructuring and other non-recurring charges totaling $62.9 million
were incurred in the second half of 2000 in response to deteriorating
market conditions. The charges included the rationalization and
integration of certain businesses and actions taken to bring costs
in line with vehicle production slowdowns in major customer product
lines. Of the $62.9 million in pretax charges, $47.3 million
represented non-cash charges. Approximately $4.4 million was
spent in 2000 and the remaining $11.2 million was spent in 2001.
The actions taken as part of the 2000 restructuring charges
are expected to generate approximately $19 million in annualized
savings, primarily from lower salaries and benefit costs and
reduced depreciation charges. These savings were more than offset
by lower revenue from the deterioration in the automotive and
heavy-duty truck markets.
Components of the restructuring and other non-recurring charges
are detailed in the following table and discussed further below.
(millions of dollars)
Severance and Asset write- Loss on Sale Other exit costs
Other Benefits downs of Business and non-recurring Total
charges
------------ ---------- ---------- -------------- ------
Provisions $8.9 $11.6 $35.2 $7.2 $62.9
Incurred (4.3) - - (0.1) (4.4)
Non-cash
write-offs - (11.6) (35.2) (0.5) (47.3)
----- ------ ----- ------ ------
Balance, December
31, 2000 4.6 - - 6.6 11.2
----- ------ ----- ------ ------
Provisions - 5.0 - 23.4 28.4
Incurred (4.6) - - (18.3) (22.9)
Non-cash
write-offs - (5.0) - - (5.0)
----- ------ ----- ------ ------
Balance, December
31, 2001 - - - 11.7 11.7
----- ------ ----- ------ ------
Provisions - - - - -
Incurred - - - (8.4) (8.4)
Non-cash
write-offs - - - - -
----- ------ ----- ------ ------
Balance, December
31, 2002 $ - $ - $ - $3.3 $ 3.3
===== ====== ====== ====== =======
Severance and other benefit costs relate to the reduction of
approximately 220 employees from the workforce. The reductions
affected both of our operating segments, across each of
our geographical areas, and across each major functional
area, including production and selling and administrative
positions. Approximately $8.9 million had been paid for
severance and other benefits for the terminated employees.
Asset write-downs primarily consist of the write-off of
impaired assets no longer used in production as a result
of the industry downturn and the consolidation of
certain operations. Such assets have been taken out
of productive use and have been disposed.
Loss on anticipated sale of business represents the Fuel
Systems business, which was sold to an investor group
led by TMB Industries, a private equity group,
in April 2001 for a pretax loss of $35.2 million. Fuel
Systems produced metal tanks for the heavy-duty truck market in North
America and did not fit our strategic focus on powertrain technology.
Terms of the transaction did not have a significant impact on the
Company's results of operations, financial condition or cash flows.
Other exit costs and non-recurring charges are primarily
non-employee related exit costs incurred to close certain
non-production facilities the Company has previously sold
or no longer needs and non-recurring product quality related
charges. The 2001 non-recurring charges include $8.4
million of environmental remediation costs related to
sold businesses and $12.0 million of product quality costs for issues
with products that were sold by acquired businesses prior to
acquisition, all of which have been fixed in the currently produced
products.
Goodwill amortization was zero in 2002, compared to $42.0 million in
2001 and $43.3 million in 2000. As discussed more fully in Note
Thirteen
to the Consolidated Financial Statements, the Company adopted the
provisions of SFAS No. 142, "Goodwill and Other Intangible Assets,"
which discontinued the amortization of goodwill effective January
1, 2002.
Other, net decreased to $0.9 million of income in 2002, from $2.1
million in 2001 and $8.1 million in 2000. The 2000 number included
a gain on the sale of the HVAC business of $5.4 million.
Equity in affiliate earnings, net of tax increased by $4.6 million
from 2001 and decreased by $0.8 million between 2001 and 2000. This
line item is driven by the results of our 50% owned Japanese joint
venture, NSK-Warner. Our equity in NSK-Warner's earnings of $20.4
million was $4.7 million higher than 2001, which was $1.2 million
lower than 2000.
Interest expense, net decreased by $10.1 million in 2002 and
decreased by $14.8 million between 2001 and 2000. The decreases
in 2002 and 2001 were due to lower interest rates as well as
lower debt levels, as the Company used cash generated in 2002 and
2001 to pay off debt. In 2002, the Company paid down $90.3 million
of balance sheet debt and reduced the amount of securitized accounts
receivable sold by $30.0 million. In 2001, the Company paid down
$57.8 million of balance sheet debt and reduced the amount of
securitized accounts receivable sold by $30.0 million. The Company
took advantage of lower interest rates through the use of interest
rate swap arrangements described more fully in Note Six to the
Consolidated Financial Statements. At the end of 2002, the amount
of debt with fixed interest rates was 61% of total debt,
including the impact of the interest rate swaps.
The provision for income taxes results in an effective tax rate
for 2002 of 33.0% compared with rates of 36.1% for 2001 and 36.2%
for 2000. Our effective tax rates have been lower than the
standard federal and state tax rates due to the realization of
certain R&D and foreign tax credits; foreign rates, which differ
from those in the U.S.; and offset somewhat by
non-deductible expenses. The decrease in rates is also a
result of certain changes in the Company's legal structure.
In 2003, the Company anticipates realizing a further 2% to 4%
improvement in its income tax rate.
FINANCIAL CONDITION AND LIQUIDITY
Our cash and cash equivalents increased $3.7 million at December 31, 2002
compared with December 31, 2001. Net cash provided by operating activities
of $261.4 million was primarily used to fund $138.4 million of capital
expenditures, repay $120.3 million of long-term debt, and distribute $16.0
million of dividends to our shareholders.
Operating cash flow of $261.4 million is $23.6 million more than in 2001.
The $261.4 million consists of a net loss of $119.1 million,
non-cash charges of $453.5 million and a $73.0 million decrease in
net operating assets and liabilities, net of the effects of divestitures.
Non-cash charges are primarily comprised of $137.4 million in
depreciation and amortization and the $269.0 million, net of
tax non-cash charge for a change in accounting principle.
Accounts receivable increased $67.4bmillion, however, $30.0
million of the increase was due to the reduction
in securitized accounts receivable sold.
Net cash used in investing activities totaled $130.0 million, compared
with $165.3 million in the prior year. 2001 investing activities
benefited by $14.4 million in net proceeds from the sales of
businesses, mainly non-strategic portions of our 1999 acquisitions.
Capital spending totaling $138.4 million in 2002 was $2.5 million
lower than in 2001. Approximately 60% of the 2002 spending was
related to expansion, with the remainder for cost reduction and
other purposes. Heading into 2003, we plan to keep capital spending
under control to be prepared if the industry slows down. Our
goal is to reduce spending as a percentage of sales from historical
levels of up to 6% to a target of 4.5% to 5.5%.
Stockholders' equity decreased by $122.8 million in 2002. The
decrease was caused by net loss of $119.1 million along with
adjustments for minimum pension liability of $42.3 million, dividends
of $16.0 million, and purchase of treasury stock of $18.1 million,
offset by currency translation adjustments of $40.9 million and
stock issuances to retirement plans of $20.8 million. In relation
to the dollar, the currencies in foreign countries where we conduct
business, particularly the Euro, strengthened, especially at the
end of 2002, therefore causing the currency translation component
of other comprehensive income to increase in 2002.
Our total capitalization as of December 31, 2002 of $1,628.1 million
is comprised of short-term debt of $14.4 million, long-term debt
of $632.3 million and stockholders' equity of $981.4 million.
Capitalization at December 31, 2001 was $1,841.2 million. During
the year, we reduced our balance sheet debt to capital ratio to
39.9% from 40.0% in 2001 and 42.2% in 2000. If the reduction
to equity associated with the adoption of SFAS No. 142 had taken
place in 2001, the 2001 ratio would have been 46.9%.
The Company has a $350 million revolving credit facility that
extends until July 21, 2005. Additionally, the Company also
has $300 million available under a shelf registration statement
on file with the Securities and Exchange Commission through
which a variety of debt and/or equity instruments may be issued.
The Company has access to the commercial paper market through
an accounts receivable securitization facility which is rolled
over annually. As of December 31, 2002, the facility was sized
at $90 million and has been in place with its current funding partner
since January 1994. From a credit quality perspective, the Company
has an investment grade credit rating of BBB+ from Standard & Poor's
and Baa2 from Moody's.
The Company's required debt principal amortization and payment
obligations under lease commitments at December 31, 2002, are as follows:
Total 2003 2004 2005 2006 2007+
Indebtedness $646.7 $14.4 $7.5 $39.0 $149.5 $436.3
Operating Leases 36.4 4.3 4.2 22.7 0.9 4.3
------ ----- ---- ----- ----- ------
Total $683.1 $18.7 $11.7 $61.7 $150.4 $440.6
====== ====== ==== ===== ====== ======
We believe that the combination of cash from operations and
available credit facilities will be sufficient to satisfy our
cash needs for our current level of operations and our planned
operations for the foreseeable future. We will continue to
balance our needs for internal growth, debt reduction and share
repurchase.
OTHER MATTERS
Environmental/Contingencies
The Company and certain of its current and former direct and
indirect corporate predecessors, subsidiaries and divisions
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 costs; remediation
alternatives; estimated legal fees; and other factors, the Company
has established a reserve for indicated environmental liabilities
with a balance at December 31, 2002 of approximately $20.3
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 and Kuhlman Electric to investigate
the extent of the contamination. The investigation has revealed
the presence of polychlorinated biphenyls (PCBs) in portions
The Company's lawsuit against Kuhlman Electric seeking declaration
of the scope of the Company's contractual indemnity has
been amicably resolved and dismissed. The Company believes
that the reserve for environmental liabilities is sufficient to
cover any potential liability associated with this matter.
However, due to the nature of environmental liability matters,
there can be no assurance that the actual amount of environmental
liabilities will not exceed the amount reserved.
Patent infringement actions were filed against the Company's
turbocharger unit located in Europe in late 2001 and in 2002
by Honeywell International. The Dusseldorf District Court
in Germany entered a preliminary injunction against the Company
on July 9, 2002 limiting the Company's ability to manufacture
and sell a certain variable turbine geometry (VTG) turbocharger
in Germany until a patent hearing, then scheduled for December 2002.
In order to continue uninterrupted service to its customer, the
Company paid Honeywell $25 million in July 2002 so that it
could continue to make and deliver disputed car turbochargers
through June of 2003. The agreement with Honeywell partially
settled litigation, suspended the July 2002 preliminary
injunction and provided for a license to deliver until June
2003. As part of the agreement, Honeywell agreed to not
seek damages for deliveries made before June 30, 2003. The
Company is recognizing expense of the $25 million license
payment as it ships the affected products from January 2002
to June 2003. In 2002, $14.5 million of expense was recognized.
The Company appealed the granting of the July preliminary
injunction, but Honeywell withdrew the preliminary injunction
before the Company's appeal could be heard. In January 2003,
the Dusseldorf District Court decided that the Company's
current design of the VTG turbocharger infringes the patent
asserted by Honeywell.
On June 23, 2003, the Company announced an additional agreement
with Honeywell to settle their patent dispute relating to
variable geometry turbochargers by extending their licensing
arrangement.
The new agreement covers the almost one million units and service
production expected to be produced during the period of the
agreement (July 1, 2003 through 2006). Approximately 40% of
the total consideration of $29.1 million will be paid to cover
use in 2003 and approximately 49% of the total will be paid
to cover use in 2004.
Critical Accounting Policies
The Consolidated Financial Statements are prepared in conformity
with accounting principles generally accepted in the United
States of America. The preparation of these financial statements
requires the use of estimates, judgments and assumptions that
affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of
revenues and expenses during the periods presented. In preparing
these financial statements, management has made its best
estimates and judgments of certain amounts included in the
financial statements, giving due consideration to materiality.
The significant accounting principles which management believes
are the most important to aid in fully understanding our financial
results are included below. Management also believes that
all of the accounting policies are important to investors.
Therefore, the Notes to the Consolidated Financial Statements
provide a more detailed description of these and other
accounting policies of the Company.
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. In December 2002, the Company reduced the maximum
size of the facility from $120 million to $90 million.
Product Warranty
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.
Goodwill and Other Intangible Assets
The Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," effective January 1, 2002. Under SFAS
No. 142, goodwill is no longer amortized; however, it must
be tested for impairment at least annually. Amortization
continues to be recorded for other intangible assets with
definite lives. The Company is subject to financial statement
risk to the extent that goodwill and indefinite-lived intangible
assets become impaired. See Note Thirteen to the Consolidated
Financial Statements for more information regarding goodwill
and the adoption of SFAS No. 142.
Pension and Other Postretirement Benefits
The Company's employee pension and other postretirement benefit
(i.e., health care) costs and obligations are dependent on
management's assumptions used by actuaries in calculating such
amounts. These assumptions include discount rates, health care
cost trend rates, inflation, long-term return on plan assets,
retirement rates, mortality rates and other factors.
Management bases the discount rate assumption on investment
yields available at year-end on AA-rated corporate
long-term bond yields. Health care cost trend assumptions are
developed based on historical cost data, the near-term outlook,
and an assessment of likely long-term trends. The inflation
assumption is based on an evaluation of external market indicators.
Retirement and mortality rates are based primarily on actual
plan experience. Actual results that differ from the
assumptions are accumulated and amortized over future periods
and, therefore, generally affect the recognized expense and
recorded obligation in such future periods. While management
believes that the assumptions used are appropriate,
significant differences in actual experience or significant
changes in assumptions would affect pension and other
postretirement benefit costs and obligations. See Note Eight
to the Consolidated Financial Statements for more information
regarding costs and assumptions for employee retirement benefits.
Impairment of Long-Lived Assets
The Company periodically reviews the carrying value of its
long-lived assets held and used and assets to be disposed
of, including other intangible assets, when events and
circumstances warrant such a review. This review is performed
using estimates of future cash flows. If the carrying value
of a long-lived asset is considered impaired, an impairment
charge is recorded for the amount by which the carrying
value of the long-lived asset exceeds its fair value.
Management believes that the estimates of future cash flows
and fair value are reasonable; however, changes in estimates
of such cash flows and fair value could affect the evaluations.
New Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board (FASB)
issued SFAS No. 142 "Goodwill and Other Intangible Assets."
SFAS No. 142, effective January 1, 2002, specifies that
goodwill and certain intangible assets will no longer be
amortized but instead will be subject to periodic impairment
testing. SFAS No. 142 also requires that, upon adoption,
goodwill be allocated to the Company's reporting units
and a two-step impairment analysis be performed.
The Company adopted SFAS No. 142 effective January 1, 2002.
Under the transitional provisions of the SFAS, the Company
allocated goodwill to its reporting units and performed the
two-step impairment analysis. The fair value of the Company's
businesses used to determine the goodwill impairment was
computed using the expected present value of associated future
cash flows. As a result of this analysis, the Company
determined that goodwill associated with its Cooling Systems
and Air/Fluid Systems businesses within the Engine operating
segment was impaired due to fundamental changes in their
served markets, particularly the medium- and
heavy-truck markets, and weakness at a major customer. As a
result a charge of $269 million, net of taxes of $76 million, was
recorded. The impairment loss was recorded in the first
quarter of 2002 as a cumulative effect of change in accounting
principle.
In August 2001, the FASB issued SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which
addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. The Company
adopted SFAS No. 144 effective January 1, 2002. The adoption
of SFAS No. 144 had no impact on the Company's results
of operations, financial position or cash flows.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections." This statement eliminates
the automatic classification of gain or loss on extinguishment
of debt as an extraordinary component of income and requires
that such gain or loss be evaluated for extraordinary
classification under the guidelines of Accounting Principles
Board Opinion No. 30, "Reporting Results of Operations."
This statement also requires sales-leaseback accounting for
certain lease modifications that have economic effects that
are similar to sales-leaseback transactions and makes
various other technical corrections to the existing
pronouncements mentioned above. The adoption of SFAS
No. 145 had no impact on the Company's results of operations,
financial position or cash flows.
In June 2002, the FASB issued Statement No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities." This
standard requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the standard include lease
termination costs and certain employee severance costs that
are associated with a restructuring, discontinued operation,
plant closing, or other exit or disposal activity. SFAS No.
146 is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. The Company
does not expect that the adoption of SFAS No. 146 will have
a material impact on the Company's results of operations,
financial position or cash flows.
In November 2002, the FASB issued Interpretation No. 45
"Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness
to Others" (FIN 45), which expands previously issued
accounting guidance and disclosure requirements for certain
guarantees. FIN 45 requires the Company to recognize an
initial liability for fair value of an obligation assumed
by issuing a guarantee. The provision for initial recognition
and measurement of the liability will be applied on a
prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 will not have
a material impact on the Company's financial position,
operating results or liquidity and resulted in additional
disclosures in the Company's Consolidated Financial Statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting
for Stock-Based Compensation -Transition and Disclosure
- an amendment of FASB Statement No. 123." This Statement
amends FASB Statement No. 123 to provide alternative
methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee
compensation and amends the disclosure requirements to
require prominent disclosures in both annual and interim
financial statements about the method of accounting for
stock-based employee compensation and the effect of the
method used on reported results. The Company is required
to adopt SFAS No. 148 January 1, 2003. The Company is
currently assessing the impact of the adoption of SFAS
No. 148.
In January 2003, the FASB issued Interpretation No. 46,
"Consolidation of Variable Interest Entities," (FIN 46).
FIN 46 requires that the assets, liabilities and
results of the activity of variable interest entities
be consolidated into the financial statements of the
entity that has the controlling financial interest.
FIN 46 also provides the framework for determining
whether a variable interest entity should be consolidated
based on voting interest or significant financial support
provided to it. For the Company, this Interpretation
is effective immediately for variable interest entities
created after January 31, 2003 and effective July 1,
2003, for variable interest entities acquired before
February 1, 2003. The Company does not expect the
adoption of FIN 46 to have any impact on its fiscal
2003 Consolidated Financial Statements.
Qualitative and Quantitative Disclosure About Market Risk
The Company's primary market risks include fluctuations
in interest rates and foreign currency exchange rates.
We are also affected by changes in the prices of
commodities used or consumed in our manufacturing
operations. Some of our commodity purchase price
risk is covered by supply agreements with customers
and suppliers. Other commodity purchase price risk
is addressed by hedging strategies, which include forward
contracts. We do not engage in any derivative
instruments for purposes other than hedging specific
risk.
We have established policies and procedures to manage
sensitivity to interest rate, foreign currency exchange
rate market, and commodity purchase price risk, which
include monitoring the level of exposure to each market
risk.
Interest rate risk is the risk that we will incur
economic losses due to adverse changes in interest
rates. Our earnings exposure related to adverse
movements in interest rates is primarily derived from
outstanding floating rate debt instruments that are
indexed to floating money market rates. A 10% increase
or decrease in the average cost of our variable rate
debt would result in a change in pre-tax interest
expense of approximately $0.5 million.
We also measure interest rate risk by estimating the
net amount by which the fair value of all of our
interest rate sensitive assets and liabilities would
be impacted by selected hypothetical changes in market
interest rates. Fair value is estimated using a discount
cash flow analysis. Assuming a hypothetical instantaneous
10% change in interest rates as of December 31, 2002, the
net fair value of these instruments would increase by
approximately $29.2 million if interest rates decreased
and would decrease by approximately $26.6 million if
interest rates increased. Our interest rate sensitivity
analysis assumes a parallel shift in interest rate
yield curves. The model, therefore, does not reflect
the potential impact of changes in the relationship
between short-term and long-term interest rates.
Interest rate sensitivity at December 31, 2001, measured
in a similar manner, was slightly greater than at
December 31, 2002.
Foreign currency risk is the risk that we will incur economic
losses due to adverse changes in foreign currency exchange
rates. We mitigate our foreign currency exchange rate risk
principally by establishing local production facilities in
markets we serve, by invoicing customers in the same currency
as the source of the products and by funding some of our
investments in foreign markets through local currency loans.
Such non-U.S. dollar debt was $152.0 million as of December
31, 2002 and $116.3 million as of December 31, 2001. We also
monitor our foreign currency exposure in each country and
implement strategies to respond to changing economic and
political environments. In addition, the Company periodically
enters into forward contracts in order to reduce exposure
to exchange rate risk related to transactions denominated
in currencies other than the functional currency. In the
aggregate, our exposure related to such transactions was
not material to our financial position, results of operations
or cash flows in both 2002 and 2001.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Statements contained in this Management's Discussion and
Analysis of Financial Condition and Results of Operations
may contain forward-looking statements as contemplated
by the 1995 Private Securities Litigation Reform Act
that are based on management's current expectations,
estimates and projections. Words such as "expects,"
"anticipates," "intends," "plans," "believes," "estimates,"
variations of such words and similar expressions are
intended to identify such forward-looking statements.
Forward-looking statements are subject to risks and
uncertainties, which could cause actual results to
differ materially from those projected or implied
in the forward-looking statements. Such risks and
uncertainties include: fluctuations in domestic or
foreign automotive production, the continued use of
outside suppliers, fluctuations in demand for vehicles
containing BorgWarner products, general economic conditions,
as well as other risks detailed in the Company's filings
with the Securities and Exchange Commission, including
the Cautionary Statements filed as Exhibit 99.1 to the
Form 10-K for the fiscal year ended December 31, 2002.
INDEPENDENT AUDITORS' REPORT
To The Board of Directors and Stockholders of BorgWarner Inc.:
We have audited the consolidated balance sheets of BorgWarner Inc. and
Consolidated Subsidiaries (the "Company") as of December 31, 2002 and
2001, and the related consolidated statements of operations, cash
flows, and stockholders' equity for each of the three years in the
period ended December 31, 2002. These financial statements are
the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements based on our
audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present
fairly, in all material respects, the financial position of
BorgWarner Inc. and Consolidated Subsidiaries at December 31,
2002 and 2001, and the results of their operations and their
cash flows for each of the three years in the period ended
December 31, 2002 in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note Thirteen to the Consolidated
Financial Statements, effective January 1, 2002, the
Company adopted Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangibles," and
accordingly, discontinued the amortization of goodwill to
conform to the provisions of this standard. Note Thirteen
provides transitional disclosures regarding the impact of
the adoption of SFAS No. 142.
DELOITTE & TOUCHE LLP
Chicago, Illinois
February 6, 2003
(June 24, 2003 as to the last paragraph of Note Eleven
and to Note Fourteen)
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
millions of dollars, except per share amounts
For the Year Ended December 31, 2002 2001 2000
------------ --------- -----
<S> <C> <C> <C>
Net sales ................................. $2,731.1 $2,351.6 $2,645.9
Cost of sales .............................. 2,176.5 1,890.8 2,090.7
-------- ------ -------
Gross profit ............................. 554.6 460.8 555.2
Selling, general and administrative expenses 303.5 249.7 258.7
Goodwill amortization ....................... -- 42.0 43.3
Other, net ................................. (0.9) (2.1) (8.1)
Restructuring and other non-recurring charges -- 28.4 62.9
------ ------- -----
Operating income ........................ 252.0 142.8 198.4
Equity in affiliate earnings, net of tax .. (19.5) (14.9) (15.7)
Interest expense and finance charges ....... 37.7 47.8 62.6
--------- --------- -------
Earnings before income taxes ..............233.8 109.9 151.5
Provision for income taxes ................. 77.2 39.7 54.8
Minority interest, net of tax .............. 6.7 3.8 2.7
-------- ---------- -------
Net earnings before cumulative effect of
accounting change .............. 149.9 66.4 94.0
Cumulative effect of change in accounting
principle, net of tax ........... (269.0) -- --
-------- --------- -----
Net earnings/(loss) .....................$(119.1) $ 66.4 $ 94.0
========== ========= ======
Net earnings/(loss) per share - Basic
Net earnings per share before cumulative
effect of accounting change ...... $ 5.63 $ 2.52 $ 3.56
Cumulative effect of accounting change ... (10.10) -- --
--------- --------- ------
Net earnings/(loss) per share ..........$ (4.47) $ 2.52 $ 3.56
Net earnings/(loss) per share - Diluted
Net earnings per share before cumulative
effect of accounting change ...... $ 5.58 $ 2.51 $ 3.54
Cumulative effect of accounting change .... (10.02) -- --
------------ -------- -------
Net earnings/(loss) per share ........... $ (4.44) $ 2.51 $ 3.54
Average shares outstanding (thousands)
Basic .................................. 26,625 26,315 26,391
========= ======== =========
Diluted ................................. 26,854 26,463 26,487
========= ======== ========
</Table>
See accompanying Notes to Consolidated Financial Statements.
40
BorgWarner
<PAGE>
2002
CONSOLIDATED BALANCE SHEETS
BorgWarner Inc. and Consolidated Subsidiaries
<Table>
<Caption>
millions of dollars
December 2002 2001
--------- ---------
<S> <C> <C>
ASSETS
Cash and cash equivalents .................................$ 36.6 $ 32.9
Receivables ............................................... 292.1 203.7
Inventories ............................................... 180.3 143.8
Deferred income taxes ..................................... 11.4 23.6
Investments in businesses held for sale ................... 14.2 12.2
Prepayments and other current assets ...................... 31.9 25.1
------- ---------
Total current assets .................................. 566.5 441.3
Land ...................................................... 40.6 29.6
Buildings ................................................. 288.0 246.1
Machinery and equipment ...................................1,060.0 940.9
Capital leases ............................................ 2.7 2.7
Construction in progress .................................. 76.5 128.4
--------- ---------
1,467.8 1,347.7
Less accumulated depreciation ............................. 572.9 509.5
--------- ---------
Net property, plant and equipment ..................... 894.9 838.2
Tooling, net of amortization .............................. 82.0 84.1
Investments and advances .................................. 153.1 137.4
Goodwill .................................................. 827.0 1,160.6
Deferred income taxes ..................................... 51.2 5.7
Other noncurrent assets ................................... 108.2 103.6
-------- ---------
Total other assets ......................................1,221.5 1,491.4
-------- ---------
Total assets ........................................$ 2,682.9 $ 2,770.9
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable and current portion of long-term debt .....$ 14.4 $ 35.6
Accounts payable and accrued expenses ................... 435.6 410.6
Income taxes payable .................................... 1.2 8.8
--------- ---------
Total current liabilities ........................... 451.2 455.0
Long-term debt .......................................... 632.3 701.4
Long-term liabilities:
Retirement-related liabilities .......................... 478.3 393.0
Other ................................................. 125.2 105.9
-------- ---------
Total long-term liabilities ......................... 603.5 498.9
Minority interest in consolidated subsidiaries ........... 14.5 11.4
Commitments and contingencies .............................. -- --
Capital stock:
Preferred stock, $.01 par value; authorized shares: 5,000,000;
none issued ................................................-- --
Common stock, $.01 par value; authorized shares: 50,000,000;
issued shares: 2002, 27,398,891 and 2001, 27,039,968;
outstanding shares: 2002, 26,580,004; 2001, 26,365,169. 0.3 0.3
Non-voting common stock, $.01 par value; authorized shares:
25,000,000; none issued and outstanding ................ -- --
Capital in excess of par value ........................... 737.7 715.7
Retained earnings ........................................ 335.8 470.9
Management shareholder note .............................. (2.0) (2.0)
Accumulated other comprehensive income/(loss) ............ (54.5) (53.1)
Common stock held in treasury, at cost: 2002, 818,887 shares; 2001,
674,799 shares ........................................... (35.9) (27.6)
--------- ---------
Total stockholders' equity .............................. 981.4 1,104.2
--------- ---------
Total liabilities and stockholders' equity ............$2,682.9 $ 2,770.9
========= =========
</Table>
See accompanying Notes to Consolidated Financial Statements.
41
BorgWarner
<PAGE>
2002
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
millions of dollars
For the Year Ended December 31, 2002 2001 2000
-------- -------- --------
<S> <C> <C> <C>
OPERATING
Net earnings/(loss) ......................................$ (119.1) $ 66.4 $ 94.0
Adjustments to reconcile net earnings/(loss) to net cash flows from operations:
Non-cash charges (credits) to operations:
Depreciation ........................................... 108.1 104.2 102.2
Goodwill amortization .................................. -- 42.0 43.3
Amortization of tooling ................................ 29.3 23.7 24.9
Non-cash restructuring and other non-recurring charges ... -- 5.0 47.3
Cumulative effect of change in accounting principle,
net of tax .............................................. 269.0 -- --
Employee retirement benefits ............................. 20.8 19.8 --
Deferred income tax provision ............................ 30.4 3.1 (8.5)
Other, principally equity in affiliate earnings .......... (4.1) (25.9) 6.9
-------- -------- --------
Net earnings adjusted for non-cash charges ............. 334.4 238.3 310.1
Changes in assets and liabilities, net of effects of acquisitions and divestitures:
(Increase) decrease in receivables ....................... (67.4) (48.6) 18.6
(Increase) decrease in inventories ....................... (29.3) 10.1 (14.7)
(Increase) decrease in prepayments and deferred income taxes(3.4) 0.1 11.6
Increase (decrease) in accounts payable and accrued expenses(14.7) 23.0 7.0
Increase (decrease) in income taxes payable ................ 14.1 (12.7) (25.9)
Net change in other long-term assets and liabilities ....... 27.7 27.6 14.5
------ -------- --------
Net cash provided by operating activities ................261.4 237.8 321.2
INVESTING
Capital expenditures .........................................(138.4) (140.9) (167.1)
Tooling outlays, net of customer reimbursements .............. (27.7) (42.0) (29.7)
Net proceeds from asset disposals ............................ 12.3 6.5 16.2
Proceeds from sale of businesses ............................. 3.3 14.4 131.9
Tax refunds/(payments) related to businesses sold ............ 20.5 -- (43.0)
Payments for businesses acquired, net of cash acquired ....... -- (3.3) --
-------- -------- --------
Net cash used in investing activities ....................(130.0) (165.3) (91.7)
FINANCING
Net decrease in notes payable ................................ (22.8) (16.5) (74.5)
Additions to long-term debt ................................... 2.3 34.0 86.9
Reductions in long-term debt ..................................(85.3) (64.3) (192.3)
Payments for purchase of treasury stock ...................... (18.1) (0.7) (22.1)
Proceeds from stock options exercised ........................ 9.8 2.8 1.1
Dividends paid ............................................... (16.0) (15.8) (15.9)
------- -------- --------
Net cash used in financing activities ....................(130.1) (60.5) (216.8)
Effect of exchange rate changes on cash and cash equivalents . 2.4 (0.5) (13.0)
------- -------- --------
Net increase (decrease) in cash and cash equivalents ......... 3.7 11.5 (0.3)
Cash and cash equivalents at beginning of year ................ 32.9 21.4 21.7
------- -------- --------
Cash and cash equivalents at end of year ......................$36.6 $ 32.9 $ 21.4
======== ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Net cash paid/(refunded) during the year for:
Interest ....................................................$39.5 $ 50.2 $ 65.4
Income taxes ................................................(11.0) 28.1 107.7
Non-cash financing transactions:
Issuance of common stock for management notes ...............$ -- $ -- $ 0.5
Issuance of common stock for Executive Stock Performance Plan 1.2 1.0 0.8
</Table>
See accompanying Notes to Consolidated Financial Statements.
42
BorgWarner
<PAGE>
2002
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
BorgWarner Inc. and Consolidated Subsidiaries
<Table>
<Caption>
millions of dollars
Number of Shares Stockholders' Equity
------------------------ -------------------
Issued Common Issued Capital in
common stock in common excess of Treasury
stock treasury stock par value stock
------ --------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 2000 27,040,492 (316,300) $ 0.3 $ 715.7 $(15.2)
Purchase of treasury stock -- (589,700) -- -- (22.1)
Dividends declared -- -- -- --
shareholder note -- 15,223 -- -- 0.7
Shares issued under stock
option plans -- 53,750 -- -- 2.2
Shares issued under executive
stock plan -- 21,818 -- -- 1.1
Net income -- -- -- -- --
Adjustment for minimum
pension liability -- -- -- -- --
Currency translation adjustment -- -- -- -- --
--------- --------- ------ ----- --------
Balance, December 31, 2000 27,040,492 (815,209) $0.3 $ 715.7 $(33.3)
Purchase of treasury stock -- (15,000) -- -- (0.7)
Dividends declared -- -- -- -- --
Management shareholder notes -- -- -- -- --
Shares issued under stock
option plans -- 129,550 -- -- 5.3
Shares issued under executive
stock plan -- 25,860 -- -- 1.1
Kuhlman shares retired (524) -- -- -- --
Net income -- -- -- -- --
Adjustment for minimum pension
liability -- -- -- -- --
Currency translation adjustment -- -- -- -- --
------- --------- ------ ----- ------
Balance, December 31, 2001 27,039,968 (674,799) $0.3 $715.7 $(27.6)
Purchase of treasury stock -- (385,000) -- -- (18.1)
Dividends declared -- -- -- -- --
Shares issued under stock
option plans -- 217,632 -- 0.9 8.9
Shares issued under executive
stock plan -- 23,280 -- 0.3 0.9
Shares issued under retirement
savings plans 358,923 -- -- 20.8 --
Net loss -- -- -- -- --
Adjustment for minimum pension
liability -- -- -- -- --
Currency translation adjustment -- -- -- -- --
-------- --------- ------ ------ -------
BALANCE, DECEMBER 31, 2002 27,398,891 (818,887) $0.3 $737.7 $ 35.9)
========== ========== ===== ====== ======
millions of dollars
Comprehensive
Stockholders' Equity income/(loss)
---------------------------- -------------
Accumulated
Management other
shareholder Retained comprehensive
notes earnings income/(loss)
--------- --------- ---------- -------
<S> <C> <C> <C> <C>
Balance, January 1, 2000 $ (2.0) $ 346.4 $ 12.3
Purchase of treasury stock -- -- -- --
Dividends declared -- (15.9) -- --
Shares issued for management
shareholder note (0.5) (0.2) -- --
Shares issued under stock
option plans -- (1.1) -- --
Shares issued under executive
stock plan -- (0.3) -- --
Net income -- 94.0 -- $94.0
Adjustment for minimum pension
liability -- -- (0.1) (0.1)
Currency translation adjustment -- -- (28.2) (28.2)
-------- -------- ------ -------
Balance, December 31, 2000 $ (2.5) $ 422.9 $(16.0) $65.7
-------- ------- ------ -------
Purchase of treasury stock -- -- -- --
Dividends declared -- (15.8) -- --
Management shareholder notes 0.5 -- -- --
Shares issued under stock
option plans -- (2.5) -- --
Shares issued under executive
stock plan -- (0.1) -- --
Kuhlman shares retired -- -- -- --
Net income -- 66.4 -- $ 66.4
Adjustment for minimum pension
liability -- -- (18.7) (18.7)
Currency translation adjustment -- -- (18.4) (18.4)
----- -------- -------- -------
Balance, December 31, 2001 $(2.0) $ 470.9 $(53.1) $ 29.3
------ -------- ------- -------
Purchase of treasury stock -- -- -- --
Dividends declared -- (16.0) -- --
Shares issued under stock
option plans -- -- -- --
Shares issued under executive
stock plan -- -- -- --
Shares issued under retirement
savings plans -- -- -- --
Net loss -- (119.1) -- $(119.1)
Adjustment for minimum pension
liability -- -- (42.3) (42.3)
Currency translation adjustment -- -- 40.9 40.9
------- ------ ------- ------
BALANCE, DECEMBER 31, 2002 $(2.0) $ 335.8 $(54.5) $(120.5)
======= ====== ======= =======
</Table>
See accompanying Notes to Consolidated Financial Statements.
43
BorgWarner
<PAGE>
2002
FINANCIAL STATEMENTS
INTRODUCTION
BorgWarner Inc. and Consolidated Subsidiaries (the "Company") is a leading
global supplier of highly engineered systems and components primarily for
powertrain applications. These products are manufactured and sold worldwide,
primarily to original equipment manufacturers of passenger cars,
sport-utility
vehicles, trucks, commercial transportation products and industrial equipment.
Effective January 1, 2003, the Company will be reporting its results under its
reorganized structure of two reportable operating segments: Drivetrain and
Engine.The Drivetrain segment is primarily the combination of the
TorqTransfer Systems and Transmission Systems businesses. The
Engine segment is primarily the combination of the Morse TEC,
Air/Fluid Systems, and Cooling Systems businesses.
1
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following paragraphs briefly describe significant accounting policies.
USE OF ESTIMATES The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions. These estimates and
assumptions affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results
could differ from those estimates.
PRINCIPLES OF CONSOLIDATION The consolidated financial statements include all
significant majority-owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation. Certain prior amounts
have been reclassified to conform to the current year presentation.
CASH AND CASH EQUIVALENTS Cash and cash equivalents are valued at cost, which
approximates market. It is the Company's policy to classify investments with
original maturities of three months or less as cash and cash equivalents.
ACCOUNTS RECEIVABLE The Company securitizes and sells certain receivables
through third party financial institutions without recourse. The amount sold can
vary each month based on the amount of underlying receivables. In December 2002,
the Company reduced the maximum size of the facility from $120 million to $90
million. During the year ended December 31, 2002, total cash proceeds from sales
of accounts receivable were $1,389.2 million, and the amount of receivables sold
ranged from $90 to $120 million at any time during the year. In 2002, the
Company paid a servicing fee of $2.5 million related to these receivables, which
is included in interest expense and finance charges. At December 31, 2002, the
Company had sold $90 million of receivables under a Receivables Transfer
Agreement for face value without recourse. At December 31, 2001, the amount sold
was $120 million.
INVENTORIES Inventories are valued at the lower of cost or market. Cost of U.S.
inventories is determined by the last-in, first-out (LIFO) method, while the
foreign operations use the first-in, first-out (FIFO) method. Inventories held
by U.S. operations was $96.0 million in 2002 and $81.1 million in 2001. Such
inventories, if valued at current cost instead of LIFO, would have been greater
by $3.6 million and $3.9 million, respectively.
PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION Property, plant and equipment are
valued at cost less accumulated depreciation. Expenditures for maintenance,
repairs and renewals of relatively minor items are generally charged to expense
as incurred. Renewals of significant items are capitalized. Depreciation is
computed generally on a straight-line basis over the estimated useful lives of
the assets. Useful lives for buildings range from 15 to 40 years and useful
lives for machinery and equipment range from 3 to 12 years. For income tax
purposes, accelerated methods of depreciation are generally used.
GOODWILL AND OTHER INTANGIBLE ASSETS The Company adopted SFAS No. 142, "Goodwill
and Other Intangible Assets," effective January 1, 2002. Under SFAS No. 142,
goodwill is no longer amortized; however, it must be tested for impairment at
least annually. Amortization continues to be recorded for other intangible
assets with definite lives. See Note Thirteen for further details on the
adoption of SFAS No. 142.
The Company had intangible assets with a cost of $14.7 million, less accumulated
amortization of $7.6 million and $6.5 million at December 31, 2002 and 2001,
respectively. The intangible assets are being amortized on a straight-line basis
over their legal lives, which range from 10 to 15 years. Annual amortization
expense recognized was $1.1 million in each of the years 2002, 2001 and 2000.
The estimated future annual amortization expense for each of the successive
years 2003 through 2007 is $1.1 million.
44
BorgWarner
<PAGE>
BorgWarner Inc. and Consolidated Subsidiaries
REVENUE RECOGNITION The Company recognizes revenue upon shipment of product when
title and risk of loss pass to the customer. Although the Company may enter into
long-term supply agreements with its major customers, each shipment of goods is
treated as a separate sale and the price is not fixed over the life of the
agreements.
FINANCIAL INSTRUMENTS Financial instruments consist primarily of investments in
cash, short-term securities, receivables and debt securities, and obligations
under accounts payable, accrued expenses and debt instruments. The Company
believes that the fair value of the financial instruments approximates the
carrying value, except as noted in Note Six.
The Company received corporate bonds with a face value of $30.3 million as
partial consideration for the sales of Kuhlman Electric and Coleman Cable in
1999. These bonds were recorded at their fair market value of $12.9 million
using valuation techniques that considered cash flows discounted at current
market rates and management's best estimates of credit quality. In 2001, the
sale agreement with Coleman Cable was finalized, resulting in the exchange of
the corporate bonds along with a purchase price receivable, for $3 million in
cash and a $2 million note, which was collected in 2002. The fair value of these
instruments was estimated to be $8.8 million at December 31, 2002 and $10.9
million at December 31, 2001. They have been classified as investments
available-for-sale in the other current assets section of the Consolidated
Balance Sheets. The contractual maturities of these bonds are beyond five years.
FOREIGN CURRENCY The financial statements of foreign subsidiaries are translated
to U.S. dollars using the period-end exchange rate for assets and liabilities
and an average exchange rate for each period for revenues and expenses. The
local currency is the functional currency for substantially all the Company's
foreign subsidiaries. Translation adjustments for foreign subsidiaries are
recorded as a component of accumulated other comprehensive income in
stockholders' equity.
PRODUCT WARRANTIES 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.
Below is a table that shows the activity in the warranty accrual accounts:
<Table>
<Caption>
millions of dollars
2002 2001 2000
-------- -------- --------
<S> <C> <C> <C>
Beginning balance $ 19.5 $ 16.5 $ 22.8
Provisions 14.2 18.3 7.4
Incurred (10.0) (15.3) (13.7)
-------- -------- --------
Ending balance $ 23.7 $ 19.5 $ 16.5
======== ======== ========
</Table>
DERIVATIVE FINANCIAL INSTRUMENTS The Company recognizes that certain normal
business transactions generate risk. Examples of risks include exposure to
exchange rate risk related to transactions denominated in currencies other than
the functional currency, changes in cost of major raw materials and supplies,
and changes in interest rates. It is the objective and responsibility of the
Company to assess the impact of these transaction risks, and offer protection
from selected risks through various methods including financial derivatives. All
derivative instruments held by the Company are designated as hedges, have high
correlation with the underlying exposure and are highly effective in offsetting
underlying price movements. Accordingly, gains and losses from changes in
derivative fair values are deferred until the underlying transaction occurs. The
Company does not engage in any derivative instruments for purposes other than
hedging specific risk.
NEW ACCOUNTING PRONOUNCEMENTS In August 2001, the Financial Accounting Standards
Board (FASB) issued SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. The Company adopted SFAS No. 144
effective January 1, 2002. The adoption of SFAS No. 144 had no impact on the
Company's results of operations, financial position or cash flows.
45
BorgWarner
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
This statement eliminates the automatic classification of gain or loss on
extinguishment of debt as an extraordinary component of income and requires that
such gain or loss be evaluated for extraordinary classification under the
guidelines of Accounting Principles Board Opinion No. 30 "Reporting the Results
of Operations." This statement also requires sales-leaseback accounting for
certain lease modifications that have economic effects that are similar to
sales-leaseback transactions and makes various other technical corrections to
the existing pronouncements mentioned above. The adoption of SFAS No. 145 had no
impact on the Company's results of operations, financial position or cash flows.
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." The standard requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the standard include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity. SFAS
No. 146 is to be applied prospectively to exit or disposal activities initiated
after December 31, 2002. The Company does not expect that the adoption of SFAS
No. 146 will have a material impact on the Company's results of operations,
financial position or cash flows.
In November 2002, the FASB issued Interpretation No. 45 "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others" (FIN 45), which expands previously issued accounting
guidance and disclosure requirements for certain guarantees. FIN 45 requires the
Company to recognize an initial liability for the fair value of an obligation
assumed by issuing a guarantee. The provision for initial recognition and
measurement of the liability will be applied on a prospective basis to
guarantees issued or modified after December 31, 2002. The adoption of FIN 45
will not have a material impact on the Company's financial position, operating
results or liquidity and resulted in additional disclosures in the Company's
Consolidated Financial Statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123." This Statement amends FASB Statement No. 123 to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation and amends the disclosure
requirements to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
is required to adopt SFAS No. 148 on January 1, 2003. The Company is currently
assessing the impact of the adoption of SFAS No. 148.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," (FIN 46). FIN 46 requires that the assets,
liabilities and results of the activity of variable interest entities be
consolidated into the financial statements of the entity that has the
controlling financial interest. FIN 46 also provides the framework for
determining whether a variable interest entity should be consolidated based on
voting interest or significant financial support provided to it. For the
Company, this Interpretation is effective immediately for variable interest
entities created after January 31, 2003 and effective July 1, 2003, for variable
interest entities acquired before February 1, 2003. The Company does not expect
the adoption of FIN 46 to have any impact on its fiscal 2003 Consolidated
Financial Statements.
2
RESEARCH AND DEVELOPMENT COSTS
The Company spent approximately $109.1 million, $104.5 million and $112.0
million in 2002, 2001 and 2000, respectively, on research and development (R&D)
activities. Not included in these amounts were customer-sponsored R&D activities
of approximately $14.2 million, $20.0 million and $12.5 million in 2002, 2001
and 2000, respectively.
3
OTHER INCOME
Items included in other income consist of:
<Table>
<Caption>
millions of dollars
Year Ended December 31, 2002 2001 2000
------ ------ ------
<S> <C> <C> <C>
Gains on sales of business $ -- $ -- $ 5.4
Interest income 1.7 1.4 0.8
Loss on asset disposals, net (1.5) (0.2) (0.4)
Other 0.7 0.9 2.3
------ ------ ------
Total other income $ 0.9 $ 2.1 $ 8.1
====== ====== ======
</Table>
46
BorgWarner
<PAGE>
BorgWarner Inc. and Consolidated Subsidiaries
4
INCOME TAXES
Earnings before taxes and provision for taxes consist of:
<Table>
<Caption>
millions of dollars
2002 2001 2000
------------------- ------------------ ------------------
U.S. Non-U.S.Total U.S. Non-U.S.Total U.S. Non-U.S. Total
---- ------ ---- ---- ------ ----- ---- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Earnings before
taxes $ 150.7 $83.1 $233.8 $23.3 $86.6 $109.9 $74.8 $76.7 $151.5
---- --- ----- ---- ---- ----- ---- ----- -----
Income taxes:
Current :
Federal/
foreign $11.1 $10.6 $ 21.7 $ 9.8 $24.7 $ 34.5 $26.8 $24.9 $ 51.7
State 3.1 -- 3.1 2.1 -- 2.1 11.6 -- 11.6
----- ---- ---- --- ---- ----- ---- ----- ------
14.2 10.6 24.8 11.9 24.7 36.6 38.4 24.9 63.3
Deferred 44.8 7.6 52.4 2.0 1.1 3.1 (13.7) 5.2 (8.5)
----- ---- ---- ---- ----- ----- ----- ----- ----
Total income
taxes $59.0 $18.2 $77.2 $13.9 $25.8 $39.7 $24.7 $30.1 $54.8
===== ===== ==== ==== ===== ==== ==== ==== ====
</Table>
The analysis of the variance of income taxes as reported from income taxes
computed at the U.S. statutory rate for consolidated operations is as follows:
<Table>
<Caption>
millions of dollars
2002 2001 2000
------- ------- -------
<S> <C> <C> <C>
Income taxes at U.S. statutory rate of 35% $ 81.8 $ 38.5 $ 53.0
Increases (decreases) resulting from:
Income from non-U.S. sources (6.8) (0.1) (0.3)
State taxes, net of federal benefit 2.0 1.4 7.5
Business tax credits, net (4.7) (7.2) (10.3)
Affiliate earnings (6.8) (5.2) (5.5)
Nontemporary differences and other 11.7 12.3 10.4
------- ------- -------
Income taxes as reported $ 77.2 $ 39.7 $ 54.8
======= ======= =======
</Table>
At December 31, 2002, the Company had $8.4 million of foreign tax credit
carryforwards, $3.0 million of R&D tax credit carryforwards, and $1.9 million of
net foreign operating loss carryforwards available to offset future taxable
income. The foreign tax credits and net operating loss carryforwards will expire
in 2007. The R&D tax credit carryforward will expire in 2022.
Following are the gross components of deferred tax assets and liabilities as of
December 31, 2002 and 2001:
<Table>
<Caption>
millions of dollars
2002 2001
---------- ----------
<S> <C> <C>
Deferred tax assets - current:
Capital loss carryover $ -- $ 22.2
Accrued costs related to divested operations -- 1.4
Foreign tax credits 8.4 --
Research and development credits 3.0 --
---------- ----------
Net deferred tax asset - current $ 11.4 $ 23.6
========== ==========
Deferred tax assets - noncurrent:
Postretirement benefits $ 121.2 $ 116.2
Pension 52.5 18.6
Other long-term liabilities and reserves 32.3 29.6
Goodwill 26.0 --
Other 14.7 20.6
---------- ----------
246.7 185.0
Deferred tax liabilities - noncurrent:
Fixed assets 135.9 98.0
Pension 35.0 32.3
Goodwill -- 28.9
Other 24.6 20.1
---------- ----------
195.5 179.3
---------- ----------
Net deferred tax asset - noncurrent $ 51.2 $ 5.7
========== ==========
</Table>
No deferred income taxes have been provided on undistributed earnings of foreign
subsidiaries totaling $59.2 million and $47.8 million in 2002 and 2001,
respectively, as the amounts are essentially permanent in nature. Any such
potential liability would be substantially offset by foreign tax credits with
respect to such undistributed foreign earnings.
47
BorgWarner
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
BALANCE SHEET INFORMATION
Detailed balance sheet data are as follows:
<Table>
<Caption>
millions of dollars
December 31, 2002 2001
-------- --------
<S> <C> <C>
Receivables:
Customers $ 247.9 $ 170.5
Other 49.3 37.1
-------- --------
Gross receivables 297.2 207.6
Less allowance for losses 5.1 3.9
-------- --------
Net receivables $ 292.1 $ 203.7
======== ========
Inventories:
Raw material $ 85.3 $ 69.7
Work in progress 57.6 41.5
Finished goods 37.4 32.6
-------- --------
Total inventories $ 180.3 $ 143.8
======== ========
Investments and advances:
NSK-Warner $ 148.3 $ 128.8
Other 4.8 8.6
-------- --------
Total investments and advances $ 153.1 $ 137.4
======== ========
Other noncurrent assets:
Deferred pension assets $ 91.0 $ 83.4
Other 17.2 20.2
-------- --------
Total other noncurrent assets $ 108.2 $ 103.6
======== ========
Accounts payable and accrued expenses:
Trade payables $ 257.0 $ 236.7
Payroll and related 70.9 42.1
Insurance 26.1 20.7
Warranties and claims 16.3 17.1
Restructuring and other non-recurring charges 3.3 11.7
Other 62.0 82.3
-------- --------
Total accounts payable and accrued expenses $ 435.6 $ 410.6
======== ========
Other long-term liabilities:
Environmental reserves $ 20.3 $ 25.5
Other 104.9 80.4
-------- --------
Total other long-term liabilities $ 125.2 $ 105.9
======== ========
</Table>
Dividends and other payments received from affiliates accounted for under the
equity method totaled $8.4 million in 2002, $8.9 million in 2001 and $25.5
million in 2000.
The Company has a 50% interest in NSK-Warner, a joint venture based in Japan
that manufactures automatic transmission components. The Company's share of the
earnings or losses reported by NSK-Warner is accounted for using the equity
method of accounting. NSK-Warner has a fiscal year-end of March 31. The
Company's equity in the earnings of NSK-Warner consists of the 12 months ended
November 30 so as to reflect earnings on as current a basis as is reasonably
feasible.
Following are summarized financial data for NSK-Warner, translated using the
ending or periodic rates as of and for the fiscal years ended March 31, 2002,
2001 and 2000:
<Table>
<Caption>
millions of dollars
2002 2001 2000
-------- -------- --------
<S> <C> <C> <C>
Balance sheets:
Current assets $ 147.2 $ 147.6 $ 196.0
Noncurrent assets 133.8 151.7 157.8
Current liabilities 83.1 94.3 96.2
Noncurrent liabilities 4.4 5.5 8.5
Statements of operations:
Net sales $ 285.2 $ 333.6 $ 303.8
Gross profit 59.6 72.8 64.7
Net income 27.9 29.6 27.7
</Table>
The equity of NSK-Warner as of March 31, 2002, was $193.5 million.
48
BorgWarner
<PAGE>
BorgWarner Inc. and Consolidated Subsidiaries
6
NOTES PAYABLE AND LONG-TERM DEBT
Following is a summary of notes payable and long-term debt. The weighted average
interest rate on all borrowings for 2002 and 2001 was 5.2% and 5.8%,
respectively.
<Table>
<Caption>
millions of dollars
December 31, 2002 2001
--------------------- ---------------------
Current Long-Term Current Long-Term
------- --------- ------- ---------
<S> <C> <C> <C> <C>
Bank borrowings and other $ 8.0 $ 40.4 $ 30.6 $ 69.6
Term loans due through 2011
(at an average rate of 3.1% in
2002 and 3.3% in 2001; and
3.2% at December 31, 2002) 6.4 31.5 5.0 31.2
7% Senior Notes due 2006,
net of unamortized discount -- 139.3 -- 141.8
6.5% Senior Notes due 2009,
net of unamortized discount -- 164.9 -- 164.7
8% Senior Notes due 2019,
net of unamortized discount -- 134.2 -- 134.2
7.125% Senior Notes due 2029,
net of unamortized discount -- 122.0 -- 159.9
------- --------- ------- ---------
Total notes payable
and long-term debt $ 14.4 $ 632.3 $ 35.6 $ 701.4
======= ========= ======= =========
</Table>
Annual principal payments required as of December 31, 2002 are as follows (in
millions of dollars):
<Table>
<Caption>
<S> <C>
2003 $ 14.4
2004 7.5
2005 39.0
2006 149.5
2007 5.2
After 2007 434.1
Less: Unamortized discounts (3.0)
------
Total $646.7
======
</Table>
The Company has a revolving credit facility which provides for borrowings up to
$350 million through July, 2005. At December 31, 2002, there were no borrowings
outstanding under the facility and the Company had $7.1 million of obligations
under standby letters of credit. At December 31, 2001, $20.0 million of
borrowings under the facility were outstanding in addition to $6.5 million of
obligations under standby letters of credit. The credit agreement contains
numerous financial and operating covenants including, among others, covenants
requiring the Company to maintain certain financial ratios and restricting its
ability to incur additional indebtedness.
The Company has entered into interest rate and currency swaps to manage interest
rate and foreign currency risk. A summary of these instruments outstanding at
December 31, 2002 follows (currency in millions):
<Table>
<Caption>
INTEREST RATES (b)
Hedge Notional ------------- Floating Interest
Type Amount Receive Pay Rate Basis
----- ------ ----- ----- -------------
<S> <C> <C> <C> <C> <C>
INTEREST RATE SWAPS (a)
Fixed to floating Fair value $125 7.0% 2.8% 6 month LIBOR+1.43%
Fixed to floating Fair value $ 25 6.5% 1.8% 6 month LIBOR+.45%
CROSS CURRENCY SWAPS
(MATURE IN 2006)
Floating $ Cash Flow $70 2.8% -- 6 mo. USD LIBOR+1.43%
to floating Y. Investment Y.8,871 -- 1.3% 6 mo. JPY LIBOR+1.21%
</Table>
(a) The maturity of the swaps corresponds with the maturity of the hedged item
as noted in the debt summary, unless otherwise indicated.
(b) Interest rates are as of December 31, 2002.
The ineffective portion of the swaps was not material. As of December 31, 2002,
the fair value of the fixed to floating interest rate swaps was $14.9 million.
Cross currency swaps were recorded at their fair value of $(4.8) million. Fair
value is based on quoted market prices for contracts with similar maturities.
As of December 31, 2002 and 2001, the estimated fair values of the Company's
senior unsecured notes totaled $610.7 million and $579.6 million, respectively.
The estimated fair values were $50.3 million higher in 2002, and $21.0 million
lower in 2001, 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.
49
BorgWarner
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7
RESTRUCTURING AND OTHER NON-RECURRING CHARGES
Other non-recurring charges of $28.4 million were incurred in the fourth quarter
of 2001. The charges primarily include adjustments to the carrying value of
certain assets and liabilities related to businesses acquired and disposed of
over the past three years. Of the $28.4 million of pretax charges, $5.0 million
represents non-cash charges. Approximately $3.3 million was spent in 2001, $8.4
million in 2002, and $8.4 million was transferred to environmental reserves in
2001. The remaining $3.3 million is expected to be spent in 2003. The Company
expects to fund the total cash outlay of these actions with cash flow from
operations.
Restructuring and other non-recurring charges totaling $62.9 million were
incurred in 2000 in response to deteriorating market conditions. The charges
included the rationalization and integration of certain businesses and actions
taken to bring costs in line with vehicle production slowdowns in major customer
product lines. Of the $62.9 million pretax charges in 2000, $47.3 million
represented non-cash charges. Approximately $4.4 million was spent in 2000 and
$11.2 million was spent in 2001.
Components of the restructuring and other non-recurring charges are detailed in
the following table and discussed further below.
<Table>
<Caption>
millions of dollars
Severance Loss on Other Exit Costs
and Other Asset Sale of and Non-Recurring
Benefits Write-down Business Charges Total
-------- --------- ------- ------- -----
<S> <C> <C> <C> <C> <C>
Provisions $ 8.9 $ 11.6 $ 35.2 $7.2 $ 62.9
Incurred (4.3) -- -- (0.1) (4.4)
Non-cash write-offs -- (11.6) (35.2) (0.5) (47.3)
------ ----- ------ ------- ------
Balance,
December 31, 2000 ------ ----- ------ ------- -----
$ 4.6 $ -- $ -- $6.6 $ 11.2
Provisions -- 5.0 -- 23.4 28.4
Incurred (4.6) -- -- (18.3) (22.9)
Non-cash write-offs -- (5.0) -- -- (5.0)
---- ----- ----- ------ -----
Balance,
December 31, 2001 $ -- $ -- $ -- $ 11.7 $ 11.7
------ ----- ------- ----- ------
Provisions -- -- -- -- --
Incurred -- -- -- (8.4) (8.4)
Non-cash write-offs -- -- -- -- --
----- ----- ------- ---- ------
Balance,
December 31, 2002 $ -- $ -- $ -- $ 3.3 $ 3.3
====== ====== ====== ====== ======
</Table>
Severance and other benefit costs relate to the reduction of approximately 220
employees from the workforce. The reductions affected both of the Company's
operating segments across each of the Company's geographical areas, and across
each major functional area, including production and selling and administrative
positions. Approximately $8.9 million had been paid for severance and other
benefits for the terminated employees.
Asset write-downs primarily consist of the write-off of impaired assets no
longer used in production as a result of the industry downturn and the
consolidation of certain operations. Such assets have been taken out of
productive use and have been disposed.
Loss on anticipated sale of business represents the Fuel Systems business, which
was sold in April 2001 to an investor group led by TMB Industries, a private
equity group, for a pretax loss of $35.2 million. Fuel Systems produced metal
tanks for the heavy-duty truck market in North America and did not fit the
Company's strategic focus on powertrain technology. Terms of the transaction did
not have a significant impact on the Company's results of operations, financial
condition or cash flows.
Other exit costs and non-recurring charges are primarily non-employee related
exit costs for certain non-production facilities the Company has previously sold
or no longer needs and non-recurring product quality related charges. The 2001
non-recurring charges include $8.4 million of environmental remediation costs
related to sold businesses and $12.0 million of product quality costs for issues
with products that were sold by acquired businesses prior to acquisition, all of
which have been fixed in the currently produced products.
8
RETIREMENT BENEFIT PLANS
The Company has a number of defined benefit pension plans and other
postretirement benefit plans covering eligible salaried and hourly employees.
The other postretirement benefit plans, which provide medical and life insurance
benefits, are unfunded plans. The following provides a reconciliation of the
plans' benefit obligations, plan assets, funded status and recognition in the
Consolidated Balance Sheets.
50
BorgWarner
<PAGE>
BorgWarner Inc. and Consolidated Subsidiaries
<Table>
<Caption>
millions of dollars
Pension Postretirement
Benefits Benefits
------- -------------
2002 2001 2002 2001
---- ---- ---- -----
<S> <C> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of year$385.7 $350.3 $407.1 $341.6
Service cost 7.6 7.1 5.0 4.4
Interest cost 26.3 25.0 28.8 25.0
Plan participants' contributions 0.2 0.2 -- --
Amendments -- 7.5 (2.3) --
Net actuarial loss 32.7 23.6 37.9 64.2
Currency translation adjustment 17.3 (1.4) -- --
Settlements -- (0.2) -- (1.4)
Curtailments -- -- (0.5) --
Benefits paid (26.7) (26.4) (29.5)(26.7)
-------- ------- ------ ------
Benefit obligation at end of year $ 443.1 $385.7 $446.5 $407.1
======== ===== ====== ======
CHANGE IN PLAN ASSETS:
Fair value of plan assets at
beginning of year $ 358.2 $ 385.1
Actual return on plan assets (27.7) (2.3)
Employer and other contributions 11.7 3.1
Plan participants' contributions 0.2 0.2
Currency translation adjustment 7.8 (1.2)
Settlements -- (0.3)
Benefits paid (26.7) (26.4)
-------- --------
Fair value of plan assets at end of year $ 323.5 $ 358.2
======== ========
RECONCILIATION OF FUNDED STATUS:
Funded status $ (119.6) $(27.5) $ (446.5) $(407.1)
Unrecognized net actuarial loss 142.9 50.8 131.4 98.2
Unrecognized transition asset (0.1) (0.3) -- --
Unrecognized prior service cost 11.1 12.7 (2.6) (0.6)
------- ------- ------- -------
Net amount recognized $ 34.3 $ 35.7 $ (317.7)$ (309.5)
======== ====== ======== ========
AMOUNTS RECOGNIZED IN THE
CONSOLIDATED BALANCE SHEETS:
Prepaid benefit cost $ 80.3 $ 71.1 $ -- $ --
Accrued benefit liability (46.0) (35.4) (317.7) (309.5)
Additional minimum liability (106.0) (42.2) -- --
comprehensive income 95.3 29.9 -- --
-------- ------ ------ -------
Net amount recognized $ 34.3 $ 35.7 $ (317.7) $ (309.5)
======== ======= ======== =======
</Table>
The funded status of pension plans included above with accumulated benefit
obligations in excess of plan assets at December 31 is as follows:
<Table>
<Caption>
millions of dollars
2002 2001
-------- --------
<S> <C> <C>
Accumulated benefit obligation $ 343.8 $ 295.2
Plan assets 216.7 238.1
-------- --------
Deficiency $ 127.1 $ 57.1
======== ========
</Table>
The $127.1 million deficiency in 2002 consists of $60.7 million related to U.S.
plans, $25.0 million related to UK plans, and $41.4 million related to German
plans. The 2001 deficiency of $57.1 million consists of $19.2 million related to
U.S. plans, $5.1 million related to UK plans, and $32.8 million related to
German plans.
<Table>
<Caption>
millions of dollars
Pension Benefits Other Postretirement Benefits
For the Year Ended ----------------- --------------------------------
December 31, 2002 2001 2000 2002 2001 2000
------ ---- ----- ---- ---- -------
<S> <C> <C> <C> <C> <C> <C>
COMPONENTS OF NET
PERIODIC BENEFIT COST:
Service cost $ 7.6 $ 7.1 $ 6.8 $ 5.0 $ 4.4 $ 3.8
Interest cost 26.3 25.0 23.4 28.8 25.0 23.4
Expected return
on plan assets (30.7) (32.1) (36.8) -- -- --
Amortization of
unrecognized
transition asset(0.2) (0.1) (0.1) -- -- --
Amortization of
unrecognized
prior service cost1.6 2.2 1.5 (0.1) (0.1) (0.1)
Amortization of
unrecognized
(gain)/loss 2.2 -- (2.7) 4.0 -- --
Settlement loss -- 0.1 1.8 -- -- --
------ ------ ------- ----- ------ ------
Net periodic benefit
cost (income) $6.8 $2.2 $(6.1) $37.7 $ 29.3 $ 27.1
====== ======= ====== ===== ====== =======
</Table>
51
BorgWarner
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's weighted-average assumptions used as of December 31,
in determining the net periodic benefit cost and the benefit
obligation liabilities shown above were as follows:
<Table>
<Caption>
percent
Other
Pension Benefits Postretirement Benefits
-------------------------- -------------------
2002 2001 2000 2002 2001 2000
-------- ------- ----- ----- ----- ------
<S> <C> <C> <C> <C> <C> <C>
U.S. plans:
Discount rate 6.75 7.25 7.5 6.75 7.25 7.5
Rate of compensation
increase 4.5 4.5 4.5
Expected return
on plan assets 8.75 9.5 9.5
Foreign plans:
Discount rate 5.5-6.0 5.5-6.0 5.5-6.0
Rate of compensation
increase 2.5-4.0 2.5-4.0 2.5-4.0
Expected return
on plan assets 7.0 6.5 6.0
</Table>
The weighted-average rate of increase in the per capita cost of covered health
care benefits is projected to be 8% in 2003 grading down 1% per year until the
ultimate rate of 4.5% is reached in 2007. A one-percentage point change in the
assumed health care cost trend would have the following effects:
<Table>
<Caption>
millions of dollars
One Percentage Point
Increase Decrease
-------- --------
<S> <C> <C>
Effect on postretirement benefit obligation $ 53.3 $ (44.7)
Effect on total service and interest cost components $ 5.0 $ (4.1)
</Table>
9
STOCK INCENTIVE PLANS
STOCK OPTION PLANS Under the Company's 1993 Stock Incentive Plan, the Company
may grant options to purchase shares of the Company's common stock at the fair
market value on the date of grant. In 2000, the Company increased the number of
shares available for grant by 1,200,000 to 2,700,000 shares. The options vest
over periods up to three years and have a term of ten years from date of grant.
As of December 31, 2002, there are 1,825,105 outstanding options under the 1993
Stock Incentive Plan.
The Company accounts for stock options in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly,
no compensation cost has been recognized for fixed stock options because the
exercise price of the stock options exceeded or equaled the market value of the
Company's common stock at the date of grant.
A summary of the plan's shares under option at December 31, 2002, 2001 and 2000
follows:
<Table>
<Caption>
2002 2001 2000
------------------- -------------------- --------------------
Weighted- Weighted- Weighted-
Average Average Average
Shares Exercise Shares Exercise Shares Exercise
(thousands) Price (thousands) Price (thousands) Price
---------- --------- --------- ------ ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning
of year 1,493 $ 44.67 1,248 $41.22 861 $ 43.37
Granted 616 50.67 442 47.99 506 36.11
Exercised (217) 45.22 (129) 22.51 (54) 19.59
Forfeited (67) 46.26 (68) 45.18 (65) 47.77
------ --------- ---------- -------- ------- -------
Outstanding at
end of year 1,825 $ 46.57 1,493 $44.67 1,248 $ 41.22
------ --------- --------- -------- ------- -------
Options exercisable
at year-end 594 $ 45.21 423 $46.81 431 $ 38.12
------ --------- ---------- ------- ------ -------
Options available
for future
grants 345
------
</Table>
52
BorgWarner
<PAGE>
BorgWarner Inc. and Consolidated Subsidiaries
The following table summarizes information about stock options outstanding at
December 31, 2002:
<Table>
<Caption>
Options Outstanding Options Exercisable
------------------------------ -------------------
Weighted- Weighted- Weighted
Number Average Average Number -Average
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices (thousands) Contractual Life Price (thousands) Price
---------- ------------ --------- ---------- -----
<S> <C> <C> <C> <C> <C>
$22.50 - 44.19 491 6.7 $35.54 258 $ 34.66
$48.28 - 53.44 1,149 8.4 50.05 151 52.32
$53.88 - 57.31 185 5.9 54.17 185 54.17
------ ---- ------ ---- --------
$22.50 - 57.31 1,825 7.7 $46.57 594 $ 45.21
===== ==== ====== ==== ========
</Table>
Pro-forma information regarding net income and earnings per share is required by
SFAS No. 123, "Accounting for Stock-Based Compensation," and has been determined
as if the Company had accounted for its employee stock options under the fair
value method of that Statement. The fair value for the Company's options was
estimated at the date of grant using a Black-Scholes options pricing model with
the following weighted average assumptions:
<Table>
<Caption>
2002 2001 2000
--------- --------- ---------
<S> <C> <C> <C>
Risk-free interest rate 4.34% 5.02% 6.50%
Dividend yield 1.32% 1.49% 1.52%
Volatility factor 33.66% 32.73% 32.54%
Weighted-average expected life 6.5 years 6.5 years 6.5 years
</Table>/
For purposes of pro-forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's
pro-forma net earnings/(loss) and earnings/(loss) per share, adjusted to include
pro-forma expense related to stock options, are as follows:
<Table>
<Caption>
millions of dollars,
except per share and option amounts
2002 2001 2000
---------- ---------- ----------
<S> <C> <C> <C>
Net earnings/(loss) - as reported $ (119.1) $ 66.4 $ 94.0
Net earnings/(loss) - pro-forma (121.8) 64.8 92.5
Earnings/(loss) per share - as reported
(basic) (4.47) 2.52 3.56
Earnings/(loss) per share - as reported
(diluted) (4.44) 2.51 3.54
Earnings/(loss) per share - pro-forma
(basic) (4.57) 2.46 3.50
Earnings/(loss) per share - pro-forma
(diluted) (4.54) 2.45 3.48
Weighted-average fair value of options
granted during the year 20.26 17.28 13.63
</Table>
EXECUTIVE STOCK PERFORMANCE PLAN The Company has an executive stock performance
plan which provides payouts at the end of successive three-year periods based on
the Company's performance in terms of total stockholder return relative to a
peer group of automotive companies. Payouts earned are payable 40% in cash and
60% in the Company's common stock. For the three-year measurement periods ended
December 31, 2002, 2001 and 2000, the amounts earned and expensed under the plan
were $4.5 million, $3.6 million and $1.7 million, respectively. Under this plan,
23,280 shares, 25,860 shares and 21,818 shares were issued in 2002, 2001 and
2000, respectively. Estimated shares issuable under the plan are included in the
computation of diluted earnings per share as earned.
EARNINGS PER SHARE In calculating earnings per share, earnings are the same for
the basic and diluted calculations. Shares increased for diluted earnings per
share by 229,000, 148,000 and 96,000 for 2002, 2001 and 2000, respectively, due
to the effects of stock options and shares issuable under the executive stock
performance plan.
10
OTHER COMPREHENSIVE INCOME
The tax effects of the components of other comprehensive income/(loss) in the
Consolidated Statements of Stockholders' Equity are as follows:
<Table>
<Caption>
millions of dollars
For the Year Ended December 31, 2002 2001 2000
-------- -------- --------
<S> <C> <C> <C>
Foreign currency translation adjustment $ 55.9 $ (14.6) $ (28.0)
Income taxes (15.0) (3.8) (0.2)
-------- -------- --------
Net foreign currency translation adjustment 40.9 (18.4) (28.2)
-------- -------- --------
Minimum pension liability adjustment (65.4) (29.7) (0.1)
Income taxes 23.1 11.0 --
-------- -------- --------
Net minimum pension liability adjustment (42.3) (18.7) (0.1)
-------- -------- --------
Other comprehensive loss $ (1.4) $ (37.1) $ (28.3)
======== ======== ========
</Table>
53
BorgWarner
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of accumulated other comprehensive loss, net of tax, in the
Consolidated Balance Sheets are as follows:
<Table>
<Caption>
millions of dollars
December 31, 2002 2001
-------- --------
<S> <C> <C>
Foreign currency translation adjustment $ 6.7 $ (34.2)
Minimum pension liability adjustment (61.2) (18.9)
-------- --------
Accumulated other comprehensive loss $ (54.5) $ (53.1)
======== ========
</Table>
11
COMMITMENTS AND CONTINGENCIES
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 44 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 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 December 31, 2002 of approximately $20.3 million.
The Company expects this amount to be expended over the next three to five
years.
BorgWarner 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 and Kuhlman Electric to investigate the extent of the contamination. The
investigation has revealed the presence of polychlorinated biphenyls (PCBs) in
portions of the soil at the plant and neighboring areas. Kuhlman Electric and
others, including the Company, have been sued in several related lawsuits which
claim personal and property damage. The Company has moved to be dismissed from
some of these lawsuits.
The Company's lawsuit against Kuhlman Electric seeking declaration of the scope
of the Company's contractual indemnity has been amicably resolved and dismissed.
The Company believes that the reserve for environmental liabilities is
sufficient to cover any potential liability associated with this matter.
However, due to the nature of environmental liability matters, there can be no
assurance that the actual amount of environmental liabilities will not exceed
the amount reserved.
Patent infringement actions were filed against the Company's turbocharger unit
located in Europe in late 2001 and in 2002 by Honeywell International. The
Dusseldorf District Court in Germany entered a preliminary injunction against
the Company on July 9, 2002 limiting the Company's ability to manufacture and
sell a certain variable turbine geometry (VTG) turbocharger in Germany until a
patent hearing, then scheduled for December 2002.
In order to continue uninterrupted service to its customer, the Company paid
Honeywell $25 million in July 2002 so that it could continue to make and deliver
disputed car turbochargers through June of 2003. The agreement with Honeywell
partially settled litigation, suspended the July 2002 preliminary injunction and
provided for a license to deliver until June 2003. As part of the agreement,
Honeywell agreed to not seek damages for deliveries made before June 30, 2003.
The Company is recognizing expense of the $25 million license payment as it
ships the affected products from January 2002 to June 2003. In 2002, $14.5
million of expense was recognized.The Company appealed the granting of the
July
preliminary injunction, but Honeywell withdrew the preliminary injunction before
the Company's appeal could be heard. In January 2003, the Dusseldorf District
Court decided that the Company's current design of the VTG turbocharger
infringes the patent asserted by Honeywell.
54
BorgWarner
<PAGE>
BorgWarner Inc. and Consolidated Subsidiaries
On June 23, 2003, the Company announced an additional agreement
with Honeywell to settle their patent dispute relating to variable
geometry turbochargers by extending their licensing arrangement.
The new agreement covers the
almost one million units and service production expected to be
produced during the period of the agreement (July 1, 2003
through 2006). Approximately 40% of the total consideration of $29.1
million will be paid to cover use in 2003 and approximately 49% of the total
will be paid to cover use in 2004.
12
LEASES
Certain assets are leased under long-term operating leases. These include
machinery and equipment at one plant, rent for the corporate headquarters, and a
leased plane. Most leases contain renewal options for various periods. Leases
generally require the Company to pay for insurance, taxes and maintenance of the
leased property. Total rent expense was $11.4 million in 2002, $8.3 million in
2001, and $10.1 million in 2000. The Company does not have any material capital
leases.
The Company has guaranteed the residual values of the leased machinery and
equipment. The guarantees extend through the maturity of the underlying lease,
which is in 2005. In the event the Company exercised its option not to purchase
the machinery and equipment, the Company has guaranteed a residual value of
$16.3 million.
Future minimum operating lease payments at December 31, 2002 were as follows:
<Table>
<Caption>
millions of dollars
<S> <C>
2003 $ 4.3
2004 4.2
2005 22.7
2006 0.9
2007 0.9
After 2007 3.4
-------
Total minimum lease payments $ 36.4
=======
</Table>
13
GOODWILL
In July 2001, the Financial Accounting Standards Board issued SFAS No. 142,
"Goodwill and Other Intangible Assets." SFAS No. 142, effective January 1, 2002,
specifies that goodwill and certain intangible assets will no longer be
amortized but instead will be subject to periodic impairment testing. SFAS No.
142 also requires that, upon adoption, goodwill be allocated to the Company's
reporting units and a two-step impairment analysis be performed.
The Company adopted SFAS No. 142 effective January 1, 2002. Under the
transitional provisions of the SFAS, the Company allocated goodwill to its
reporting units and performed the two-step impairment analysis. The fair value
of the Company's businesses used in determination of the goodwill impairment was
computed using the expected present value of associated future cash flows. As a
result of this analysis, the Company determined that goodwill associated with
its Cooling Systems and Air/Fluid Systems businesses within its Engine operating
segment was impaired due to fundamental changes in their served markets,
particularly the medium and heavy truck markets, and weakness at a major
customer. As a result a charge of $269 million, net of taxes of $76 million,
was recorded.
The impairment loss was recorded in the first quarter of 2002 as a cumulative
effect of change in accounting principle. The changes in the carrying amount of
goodwill (in millions of dollars) for the twelve months ended December 31, 2002,
are as follows:
<Table>
<Caption>
Drivetrain Engine Total
------------ --------- ---------
<S> <C> <C> <C>
Balance at
12/31/2001 $ 131.8 $ 1,028.8 $ 1,160.6
Translation
adjustments 0.5 10.9 11.4
Change in accounting
principle -- (345.0) (345.0)
--------- --------- ---------
Balance at
12/31/2002 $ 132.3 $ 694.7 $ 827.0
========= ========= =========
</Table>
55
BorgWarner
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Also as a result of the adoption of SFAS No. 142, the Company did not amortize
goodwill in 2002. The following table provides adjusted net earnings/(loss) and
earnings per share data for the years ended December 31, 2002, 2001, and 2000 as
if goodwill had not been amortized during these periods:
<Table>
<Caption>
millions of dollars
For the Twelve Months Ended December 31, 2002 2001 2000
------- ------ --------
<S> <C> <C> <C>
Reported net earnings before cumulative
effect of change in accounting
principle $ 149.9 $ 66.4 $ 94.0
Goodwill amortization, net of tax -- 26.5 27.3
------- ------ --------
Adjusted net earnings before cumulative
effect of change in accounting
principle 149.9 92.9 121.3
Cumulative effect of change in
accounting principle, net of tax (269.0) -- --
-------- ------ -------
Adjusted net earnings/(loss) $(119.1) $ 92.9 $ 121.3
======= ====== =======
BASIC EARNINGS (LOSS) PER SHARE:
Reported net earnings before cumulative
effect of change in accounting
principle $ 5.63 $ 2.52 $ 3.56
Goodwill amortization -- 1.00 1.03
------- ------ -------
Adjusted net earnings before cumulative
effect of change in accounting
principle 5.63 3.52 4.59
Cumulative effect of change in accounting
principle, net of tax (10.10) -- --
-------- ------ -------
Adjusted net earnings/(loss) $ (4.47) $ 3.52 $ 4.59
======== ====== =======
DILUTED EARNINGS (LOSS) PER SHARE:
Reported net earnings before cumulative
effect of change in accounting
principle $ 5.58 $ 2.51 $ 3.54
Goodwill amortization -- 1.00 1.03
------- ------ --------
Adjusted net earnings before cumulative
effect of change in accounting
principle 5.58 3.51 4.57
Cumulative effect of change in accounting
principle, net of tax (10.02) -- --
-------- ----- ------
Adjusted net earnings/(loss) $ (4.44) $ 3.51 $ 4.57
======== ===== ======
</Table>
14
OPERATING SEGMENTS
GEOGRAPHIC INFORMATION No country outside the U.S., other than Germany, accounts
for as much as 5% of consolidated net sales, attributing sales to the sources of
the product rather than the location of the customer. For this purpose, the
Company's 50% equity investment in NSK-Warner (Note Five) amounting to $148.3
million at December 31, 2002 is excluded from the definition of long-lived
assets, as are goodwill and certain other noncurrent assets.
<Table>
<Caption>
millions of dollars
Net Sales Long-Lived Assets
2002 2001 2000 2002 2001 2000
----- ----------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
United States $ 1,859.1 $ 1,687.4 $ 1,960.2 $ 643.0 $ 638.5 $591.9
-------- ----------- -------- ------ ------ -----
Europe:
Germany 453.4 347.5 350.0 182.3 148.5 132.3
Other Europe 236.0 162.2 183.2 72.4 64.4 60.6
---------- -------- ---------- -------- ------ --------
Total Europe 689.4 509.7 533.2 254.7 212.9 192.9
Other foreign 182.6 154.5 152.5 80.8 75.5 88.6
--------- --------- ---------- -------- -------- -------
Total $2,731.1 $ 2,351.6 $2,645.9 $978.5 $926.9 $ 873.4
======== ========== ========= ====== ======== =======
</Table>
SALES TO MAJOR CUSTOMERS Consolidated sales included sales to Ford Motor Company
of approximately 26%, 30% and 30%; to DaimlerChrysler of approximately 20%, 21%
and 19%; and to General Motors Corporation of approximately 12%, 12% and 13% for
the years ended December 31, 2002, 2001 and 2000, respectively. No other single
customer accounted for more than 10% of consolidated sales in any year between
2000 and 2002. Such sales consisted of a variety of products to a variety of
customer locations worldwide. Each of the two operating segments had
significant sales to all three of the customers listed above.
For purposes of this footnote, the Company's business was comprised of two
operating segments: Engine and Drivetrain. These reportable segments are stra-
tegic business units which are managed separately because each represents a
specific grouping of automotive components and systems. The Company evaluates
performance based on earnings before interest and taxes, which emphasizes
realization of a satisfactory return on the total capital invested in each
operating unit. Intersegment sales, which are not significant, are
recorded at market prices.
This footnote presents summary segment information.
56
BorgWarner
<PAGE>
BorgWarner Inc. and Consolidated Subsidiaries
OPERATING SEGMENTS
<Table>
<Caption>
millions of dollars
Sales
-----------------------
Earnings
Before Depre- Long-Lived
Inter- Interest Year End ciation/ Assets
Customers segment Net and Taxes Assets Amorti- Expen-
zation ditures(c)
------- ------- ---- -------- ------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
2002
Drivetrain $ 1,122.1 $ - $1,122.1 $ 99.4 $ 706.7 $ 50.4 $ 54.4
Engine 1,609.0 39.2 1,648.2 212.4 1,711.3 84.9 91.8
Inter-segment
eliminations - (39.2) (39.2) - - - -
---------- ------- ------ ----- ------- ------ ------
Total 2,731.1 - 2,731.1 311.8 2,418.0 135.3 146.2
Corporate - - - (40.3) 264.9(b) 2.1 19.9
---------- ------- ------ ----- ------- ------- ------
Consolidated $ 2,731.1 $ - $2,731.1 $271.5(d)$2,682.9 $137.4 $ 166.1
========= ====== ======= ===== ======== ====== =======
2001
Drivetrain $ 937.2 $ - $ 937.2 $70.1 $ 647.8 $ 52.1 $ 66.0
Engine 1,396.4 30.2 1,426.6 142.7 1,937.0 115.4 106.5
Divested operations and
businesses held
for sale (a) 18.0 - 18.0 (0.2) - 0.2 -
Inter-segment
eliminations - (30.2) (30.2) - - - -
--------- -------- -------- ------- ------ ------ ------
Total 2,351.6 - 2,351.6 212.6 2,584.8 167.7 172.5
Corporate - - (26.5) 186.1(b) 2.2 10.4 -
Restructuring and
other non-
recurring charges - - - (28.4) - - -
---------- ------ --------- ------ ------ ------- -----
Consolidated $ 2,351.6 $ - $ 2,351.6 $157.7(d)$2,770.9 $ 169.9 $182.9
========== ======= ========= ======= ====== ======= =======
2000
Drivetrain $ 979.9 $ 0.1 $ 980.0 $ 78.9 $ 628.9 $ 54.3 $56.8
Engine 1,533.3 35.0 1,568.3 199.5 1,932.2 110.0 121.5
Divested operations and
businesses held
for sale (a) 132.7 0.2 132.9 3.2 73.6 3.0 4.6
Inter-segment
eliminations - (35.3) (35.3) - - - -
---------- ------- ------- ------ ------ ------ ------
Total 2,645.9 - 2,645.9 281.6 2,634.7 167.3 182.9
Corporate - - - (4.6) 104.9(b) 3.1 13.9
Restructuring and
other non-
recurring charges - - - (62.9) - - -
---------- ------- ------- ------- ------- -------- ------
Consolidated $ 2,645.9 $ - $ 2,645.9 $214.1(d)$2,739.6 $ 170.4 $196.8
========== ======== ======= ======== ======== ======= ======
(a) Fuel Systems was sold in 2001. The HVAC business was sold in 2000.
(b) Corporate assets, including equity in affiliates, are net of trade
receivables sold to third parties, and include cash, marketable
securities, deferred taxes and investments and advances.
(c) Long-lived asset expenditures includes capital spending and
additions to non-perishable tooling, net of customer reimbursements.
(d) Earnings before interest and taxes above is net of interest expense
and finance charges of $37.7, $47.8, and $62.6 million in 2002, 2001,
and 2000, respectively. Had these amounts been included in the
table above, earnings before taxes for the years 2002, 2001,
and 2000 would be $233.8, $109.9, and $151.5 million, respectively.
57
BorgWarner
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interim Financial Information (Unaudited)
The following information includes all adjustments, as well as normal recurring
items, that the Company considers necessary for a fair presentation of 2002 and
2001 interim results of operations. Certain 2002 and 2001 quarterly amounts have
been reclassified to conform to the annual presentation.
millions of dollars, except per share amounts
2002
Quarter Ended, March 31 June 30 Sept. 30 Dec. 31 Year 2002
--------- --------- --------- --------- ---------
Net sales $ 633.9 $ 712.4 $ 684.0 $ 700.8 $ 2,731.1
Cost of sales 504.2 561.4 556.1 554.8 2,176.5
--------- --------- --------- --------- ---------
Gross profit 129.7 151.0 127.9 146.0 554.6
Selling, general and administrative
expenses 74.5 76.5 73.2 79.3 303.5
Goodwill amortization -- -- -- -- --
Other, net (0.5) 0.1 (0.2) (0.3) (0.9)
Restructuring and other non-recurring
charges -- -- -- -- --
--------- --------- --------- --------- ---------
Operating income 55.7 74.4 54.9 67.0 252.0
Equity in affiliate earnings, net
of tax (3.4) (6.0) (4.5) (5.6) (19.5)
Interest expense, net 9.8 9.5 9.3 9.1 37.7
--------- --------- --------- --------- ---------
Income before income taxes 49.3 70.9 50.1 63.5 233.8
Provision for income taxes 16.3 23.6 16.4 20.9 77.2
Minority interest, net of tax 1.5 1.6 1.8 1.8 6.7
--------- --------- --------- --------- ---------
Net earnings before cumulative
effect
of accounting change $ 31.5 $ 45.7 $ 31.9 $ 40.8 $ 149.9
========= ========= ========= ========= =========
Cumulative effect of accounting
change(a) (269.0) -- -- -- (269.0)
--------- --------- --------- --------- ---------
Net earnings/(loss) $ (237.5) $ 45.7 $ 31.9 $ 40.8 $ (119.1)
========= ========= ========= ========= =========
Net earnings/(loss) per share -
basic $ (8.98) $ 1.72 $ 1.19 $ 1.52 $ (4.47)
========= ========= ========= ========= =========
Net earnings/(loss) per share -
diluted $ (8.90) $ 1.70 $ 1.18 $ 1.52 $ (4.44)
========= ========= ========= ========= =========
millions of dollars, except per share amounts
2001
Quarter Ended, March 31 June 30 Sept. 30 Dec. 31 Year 2001
--------- --------- --------- --------- ---------
Net sales $ 606.8 $ 602.0 $ 559.9 $ 582.9 $ 2,351.6
Cost of sales 494.3 480.4 451.5 464.6 1,890.8
--------- --------- --------- --------- ---------
Gross profit 112.5 121.6 108.4 118.3 460.8
Selling, general and
administrative expenses 59.4 63.0 59.2 68.1 249.7
Goodwill amortization 10.6 10.3 10.4 10.7 42.0
Other, net (0.6) 0.2 (0.6) (1.1) (2.1)
Restructuring and other non-
recurring charges -- -- -- 28.4 28.4
--------- --------- --------- --------- ---------
Operating income 43.1 48.1 39.4 12.2 142.8
Equity in affiliate earnings,
net of tax (3.9) (4.8) (3.3) (2.9) (14.9)
Interest expense, net 12.8 12.4 12.3 10.3 47.8
--------- --------- --------- --------- ---------
Income before income taxes 34.2 40.5 30.4 4.8 109.9
Provision for income taxes 12.4 15.1 10.9 1.3 39.7
Minority interest, net of tax 0.7 0.7 1.1 1.3 3.8
-------- --------- --------- --------- ---------
Net earnings/(loss) $ 21.1 $ 24.7 $ 18.4 $ 2.2 $ 66.4
======= ========= ========= ========= =========
Net earnings/(loss) per share
- basic $ 0.80 $ 0.94 $ 0.70 $ 0.08 $ 2.52
======== ========= ========= ========= =========
Net earnings/(loss) per share
- diluted $ 0.80 $ 0.93 $ 0.70 $ 0.08(b)$ 2.51(b)
========= ========= ========= ========= =========
(a) In 2002, the Company recorded a $269.0 million charge for cumulative effect
of change in accounting principle, net of tax. This charge was $10.02 per
diluted share. Earnings before cumulative effect of change in accounting
principle were $149.9 million or $5.58 per diluted share.
(b) In the fourth quarter of 2001, the Company recorded $28.4 million in non-
recurring charges. Net of tax, this totaled $19.0 million or $0.72 per diluted
share.
58
BorgWarner
<PAGE>
2002
SELECTED FINANCIAL DATA BorgWarner Inc. and Consolidated Subsidiaries
millions of dollars, except per share data
For the Year Ended December 31, 2002 2001 2000 1999 1998
------ ------ ----- ------ ----------
STATEMENT OF OPERATIONS DATA
Net sales $2,731.1 $2,351.6 $2,645.9 $2,458.6 $1,836.8
Cost of sales 2,176.5 1,890.8 2,090.7 1,968.3 1,518.0
--------- --------- -------- ------- ------
Gross profit 554.6 460.8 555.2 490.3 318.8
Selling, general and
administrative expenses 303.5 249.7 258.7 214.8 142.6
Goodwill amortization -- 42.0 43.3 32.1 16.8
Other, net (0.9) (2.1) (8.1) (2.4) (4.8)
Restructuring and other non-
recurring charges -- 28.4(b) 62.9(c) -- --
------- ------- ------- ------- -----
Operating income 252.0 142.8 198.4 245.8 164.2
Equity in affiliate earnings,
net of tax (19.5) (14.9) (15.7) (11.7) (5.5)
Interest expense, net 37.7 47.8 62.6 49.2 26.9
-------- ------ ------ ------- -----
Income before income taxes 233.8 109.9 151.5 208.3 142.8
Provision for income taxes 77.2 39.7 54.8 74.7 46.0
Minority interest, net of tax 6.7 3.8 2.7 1.3 2.1
--------- ------ ------ ------ -------
Net earnings before cumulative effect of
accounting change 149.9 66.4 94.0 132.3 94.7
Cumulative effect of change in accounting
principle, net of tax (269.0)(a) -- -- -- --
---------- ------ ----- ------ ----
Net earnings/(loss) $ (119.1) $66.4 $94.0 $132.3 $94.7
========= ====== ===== ====== =====
Net earnings/(loss) per share
- basic $ (4.47)(a)$2.52(b) $3.56(c) $5.10 $4.03
========== ======= ======= ====== =====
Average shares outstanding
(thousands) - basic 26,625 26,315 26,391 25,948 23,479
Net earnings/(loss) per share
- diluted $(4.44)(a) $2.51(b) $3.54(c) $5.07 $ 4.00
========= ======= ====== ===== ======
Average shares outstanding
(thousands) - diluted 26,854 26,463 26,487 26,078 23,676
Cash dividend declared per share $0.63 $ 0.60 $0.60 $0.60 $ 0.60
BALANCE SHEET DATA (at end of period)
Total assets $ 2,682.9 $2,770.9 $2,739.6 $2,970.7 $ 1,846.1
Total debt 646.7 737.0 794.8 980.3 393.5
</Table>
(a) In 2002, upon the adoption of SFAS No. 142, the Company recorded a $269.0
million charge for cumulative effect of accounting principle, net of tax.
This charge was $10.02 per diluted share. Earnings before cumulative effect
of change in accounting principle were $149.9 million or $5.58 per diluted
share.
(b) In 2001, the Company recorded $28.4 million in non-recurring charges. Net
of tax, this totaled $19.0 million or $0.72 per diluted share.
(c) In 2000, the Company recorded $62.9 million in restructuring and other
non-recurring charges. Net of tax, this totaled $38.7 million or $1.47 per
diluted share.
</TEXT>
</DOCUMENT>