q1063008.htm
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
QUARTERLY REPORT
(Mark
One)
[ X ] Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
For the quarterly period ended June
30, 2008
OR
[ ] Transition
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
For the transition
period from ____________ to ____________
Commission file number: 1-12162
(Exact name of registrant as
specified in its charter)
Delaware 13-3404508
State or other
jurisdiction of (I.R.S.
Employer
Incorporation or
organization Identification
No.)
3850
Hamlin Road, Auburn Hills,
Michigan 48326
(Address of
principal executive
offices) (Zip
Code)
Registrant's telephone number,
including area code: (248)
754-9200
Indicate by check
mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
YES [ X ] NO
[ ]
Indicate by check
mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company. See
definition of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange
Act. (Check one):
Large Accelerated
Filer [ X ] Accelerated Filer
[ ] Non-Accelerated Filer
[ ] Smaller Reporting Company
[ ]
Indicate by check
mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
YES
[ ] NO [ X ]
On June 30, 2008,
the registrant had 116,230,266 shares of Common Stock
outstanding.
BORGWARNER INC.
FORM 10-Q
THREE AND SIX MONTHS ENDED JUNE 30,
2008
INDEX
PART I. |
Financial Information |
Page No.
|
|
|
|
Item 1. |
Financial Statements |
|
|
|
|
|
Condensed Consolidated Balance
Sheets as of June 30, 2008 (Unaudited) and December 31,
2007 |
3
|
|
|
|
|
Condensed Consolidated
Statements of Operations (Unaudited) for the three and six months ended
June 30, 2008 and 2007 |
4
|
|
|
|
|
Condensed Consolidated
Statements of Cash Flows (Unaudited) for the six months ended June 30,
2008 and 2007 |
5
|
|
|
|
|
Notes to Condensed
Consolidated Financial Statements (Unaudited) |
6 |
|
|
|
Item
2. |
Management's Discussion
and Analysis of Financial Condition and Results of
Operations |
26
|
|
|
|
Item 3. |
Quantitative and
Qualitative Disclosures About Market Risk |
37 |
|
|
|
Item
4. |
Controls
and Procedures |
37 |
|
|
|
Part II. |
Other
Information |
|
|
|
|
Item 1. |
Legal
Proceedings |
38 |
|
|
|
Item 2. |
Unregistered Sales of Equity
Securities and Use of Proceeds |
38 |
|
|
|
Item 4. |
Submission of Matters to a
Vote of Security Holders |
38 |
|
|
|
Item 5. |
Other
Information |
39 |
|
|
|
Item 6. |
Exhibits |
40 |
|
|
|
SIGNATURES |
|
41 |
PART
I. FINANCIAL INFORMATION
ITEM
1. FINANCIAL STATEMENTS
BORGWARNER
INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED
CONSOLIDATED BALANCE SHEETS
(millions
of dollars)
|
|
June
30,
|
|
|
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(Unaudited)
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
Cash
|
|
$ |
225.9 |
|
|
$ |
188.5 |
|
Marketable
securities
|
|
|
- |
|
|
|
14.6 |
|
Receivables,
net
|
|
|
951.1 |
|
|
|
802.4 |
|
Inventories,
net
|
|
|
498.3 |
|
|
|
447.6 |
|
Deferred
income taxes
|
|
|
47.5 |
|
|
|
42.8 |
|
Prepayments
and other current assets
|
|
|
89.3 |
|
|
|
84.4 |
|
Total
current assets
|
|
|
1,812.1 |
|
|
|
1,580.3 |
|
|
|
|
|
|
|
|
|
|
Property,
plant & equipment, net
|
|
|
1,701.8 |
|
|
|
1,609.1 |
|
Investments
& advances
|
|
|
253.7 |
|
|
|
255.1 |
|
Goodwill
|
|
|
1,270.7 |
|
|
|
1,168.2 |
|
Other
non-current assets
|
|
|
403.1 |
|
|
|
345.8 |
|
Total
assets
|
|
$ |
5,441.4 |
|
|
$ |
4,958.5 |
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
Notes
payable
|
|
$ |
58.1 |
|
|
$ |
63.7 |
|
Current
portion of long-term debt
|
|
|
137.7 |
|
|
|
- |
|
Accounts
payable and accrued expenses
|
|
|
1,120.2 |
|
|
|
993.0 |
|
Income taxes
payable
|
|
|
32.4 |
|
|
|
27.2 |
|
Total
current liabilities
|
|
|
1,348.4 |
|
|
|
1,083.9 |
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
|
431.1 |
|
|
|
572.6 |
|
Other
non-current liabilities:
|
|
|
|
|
|
|
|
|
Retirement-related
liabilities
|
|
|
502.8 |
|
|
|
500.4 |
|
Domination
and Profit Transfer Agreement obligation
|
|
|
181.8 |
|
|
|
- |
|
Other
|
|
|
388.3 |
|
|
|
362.6 |
|
Total
other non-current liabilities
|
|
|
1,072.9 |
|
|
|
863.0 |
|
|
|
|
|
|
|
|
|
|
Minority
interest in consolidated subsidiaries
|
|
|
34.1 |
|
|
|
117.9 |
|
|
|
|
|
|
|
|
|
|
Common
stock
|
|
|
1.2 |
|
|
|
1.2 |
|
Capital in
excess of par value
|
|
|
961.1 |
|
|
|
943.4 |
|
Retained
earnings
|
|
|
1,439.8 |
|
|
|
1,295.9 |
|
Accumulated
other comprehensive income
|
|
|
216.9 |
|
|
|
127.1 |
|
Treasury
stock
|
|
|
(64.1 |
) |
|
|
(46.5 |
) |
Total
stockholders' equity
|
|
|
2,554.9 |
|
|
|
2,321.1 |
|
Total
liabilities and stockholders' equity
|
|
$ |
5,441.4 |
|
|
$ |
4,958.5 |
|
|
|
|
|
|
|
|
|
|
See accompanying Notes to Condensed
Consolidated Financial Statements
BORGWARNER
INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(millions
of dollars, except share and per share data)
|
|
Three
Months Ended
|
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
|
June
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
1,516.6 |
|
|
$ |
1,364.3 |
|
|
$ |
3,015.5 |
|
|
$ |
2,642.1 |
|
Cost of
sales
|
|
|
1,237.8 |
|
|
|
1,116.7 |
|
|
|
2,453.2 |
|
|
|
2,178.6 |
|
Gross profit
|
|
|
278.8 |
|
|
|
247.6 |
|
|
|
562.3 |
|
|
|
463.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
159.9 |
|
|
|
135.2 |
|
|
|
315.6 |
|
|
|
261.9 |
|
Other
income
|
|
|
(2.1 |
) |
|
|
(1.2 |
) |
|
|
(1.0 |
) |
|
|
(1.9 |
) |
Operating income
|
|
|
121.0 |
|
|
|
113.6 |
|
|
|
247.7 |
|
|
|
203.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in
affiliates' earnings, net of tax
|
|
|
(11.9 |
) |
|
|
(8.8 |
) |
|
|
(21.0 |
) |
|
|
(18.0 |
) |
Interest
expense and finance charges
|
|
|
10.8 |
|
|
|
9.3 |
|
|
|
17.3 |
|
|
|
18.2 |
|
Earnings
before income taxes and minority interest
|
|
|
122.1 |
|
|
|
113.1 |
|
|
|
251.4 |
|
|
|
203.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for
income taxes
|
|
|
29.8 |
|
|
|
30.5 |
|
|
|
63.4 |
|
|
|
54.9 |
|
Minority
interest, net of tax
|
|
|
4.8 |
|
|
|
6.9 |
|
|
|
11.8 |
|
|
|
14.3 |
|
Net earnings
|
|
$ |
87.5 |
|
|
$ |
75.7 |
|
|
$ |
176.2 |
|
|
$ |
134.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per
share - basic
|
|
$ |
0.75 |
|
|
$ |
0.65 |
|
|
$ |
1.52 |
|
|
$ |
1.16 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per
share - diluted
|
|
$ |
0.74 |
|
|
$ |
0.64 |
|
|
$ |
1.49 |
|
|
$ |
1.14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding (thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
116,250 |
|
|
|
116,100 |
|
|
|
116,248 |
|
|
|
115,966 |
|
Diluted
|
|
|
118,382 |
|
|
|
117,816 |
|
|
|
118,426 |
|
|
|
117,526 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends
declared per share
|
|
$ |
0.11 |
|
|
$ |
0.09
|
* |
|
$ |
0.22 |
|
|
$ |
0.17 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
Amount has been rounded as a result of a two-for-one stock split in
December 2007
|
|
|
|
|
|
|
|
|
|
See accompanying Notes to Condensed Consolidated Financial
Statements
BORGWARNER
INC. AND CONSOLIDATED SUBSIDIARIES CONDENSED CONSOLIDATED
STATEMENTS
OF CASH FLOWS (UNAUDITED)
(millions
of dollars)
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
|
|
2008
|
|
|
2007
|
|
OPERATING
|
|
|
|
|
|
|
Net
earnings
|
|
$ |
176.2 |
|
|
$ |
134.1 |
|
Adjustments
to reconcile net earnings to net cash flows from
operations:
|
|
|
|
|
|
|
|
|
Non-cash
charges (credits) to operations:
|
|
|
|
|
|
|
|
|
Depreciation
and tooling amortization
|
|
|
135.5 |
|
|
|
117.8 |
|
Amortization
of intangible assets and other
|
|
|
17.7 |
|
|
|
8.3 |
|
Stock option
compensation expense
|
|
|
7.1 |
|
|
|
9.1 |
|
Deferred
income taxes - benefit
|
|
|
(14.9 |
) |
|
|
(5.9 |
) |
Equity in
affiliates' earnings, net of dividends received, minority interest and
other
|
|
|
28.1 |
|
|
|
11.8 |
|
Net
earnings adjusted for non-cash charges (credits) to
operations
|
|
|
349.7 |
|
|
|
275.2 |
|
Changes in
assets and liabilities:
|
|
|
|
|
|
|
|
|
Receivables
|
|
|
(110.0 |
) |
|
|
(90.1 |
) |
Inventories
|
|
|
(29.9 |
) |
|
|
(30.4 |
) |
Prepayments
and other current assets
|
|
|
(2.8 |
) |
|
|
(4.4 |
) |
Accounts
payable and accrued expenses
|
|
|
86.7 |
|
|
|
68.9 |
|
Income taxes
payable
|
|
|
(7.2 |
) |
|
|
(5.2 |
) |
Other
non-current assets and liabilities
|
|
|
(19.4 |
) |
|
|
9.4 |
|
Net
cash provided by operating activities
|
|
|
267.1 |
|
|
|
223.4 |
|
|
|
|
|
|
|
|
|
|
INVESTING
|
|
|
|
|
|
|
|
|
Capital
expenditures, including tooling outlays
|
|
|
(162.2 |
) |
|
|
(122.5 |
) |
Net proceeds
from asset disposals
|
|
|
2.0 |
|
|
|
2.3 |
|
Purchases of
marketable securities
|
|
|
- |
|
|
|
(12.6 |
) |
Proceeds from
sales of marketable securities
|
|
|
14.6 |
|
|
|
14.7 |
|
Net
cash used in investing activities
|
|
|
(145.6 |
) |
|
|
(118.1 |
) |
|
|
|
|
|
|
|
|
|
FINANCING
|
|
|
|
|
|
|
|
|
Net decrease
in notes payable
|
|
|
(7.1 |
) |
|
|
(65.9 |
) |
Additions to
long-term debt
|
|
|
- |
|
|
|
20.7 |
|
Repayments of
long-term debt
|
|
|
(7.3 |
) |
|
|
(20.0 |
) |
Payment for
purchase of treasury stock
|
|
|
(27.7 |
) |
|
|
(16.3 |
) |
Proceeds from
stock options exercised, net of tax benefit
|
|
|
7.1 |
|
|
|
17.5 |
|
Dividends
paid to BorgWarner stockholders
|
|
|
(25.8 |
) |
|
|
(19.7 |
) |
Dividends
paid to minority shareholders
|
|
|
(12.0 |
) |
|
|
(15.5 |
) |
Net
cash used in financing activities
|
|
|
(72.8 |
) |
|
|
(99.2 |
) |
Effect of
exchange rate changes on cash
|
|
|
(11.3 |
) |
|
|
(10.9 |
) |
Net increase
(decrease) in cash
|
|
|
37.4 |
|
|
|
(4.8 |
) |
Cash at
beginning of year
|
|
|
188.5 |
|
|
|
123.3 |
|
Cash at end
of period
|
|
$ |
225.9 |
|
|
$ |
118.5 |
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
|
Net cash paid
during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$ |
22.4 |
|
|
$ |
21.3 |
|
Income
taxes
|
|
|
72.8 |
|
|
|
45.1 |
|
Non-cash
investing transactions:
|
|
|
|
|
|
|
|
|
Domination
and Profit Transfer Agreement obligation
|
|
|
200.3 |
|
|
|
- |
|
Non-cash
financing transactions:
|
|
|
|
|
|
|
|
|
Stock
Performance Plans
|
|
|
2.6 |
|
|
|
2.3 |
|
See accompanying Notes to Condensed
Consolidated Financial Statements
BORGWARNER
INC. AND CONSOLIDATED SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1)
Basis of Presentation
The accompanying
unaudited consolidated financial statements of BorgWarner Inc. and Consolidated
Subsidiaries (the “Company”) have been prepared in accordance with accounting
principles generally accepted in the United States of America (“GAAP”) for
interim financial information and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes necessary for a comprehensive presentation of
financial position, results of operations and cash flow activity required by
GAAP for complete financial statements. In the opinion of management,
all normal recurring adjustments necessary for a fair presentation of results
have been included. Operating results for the three and six months ended June
30, 2008 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2008. The balance sheet as of December
31, 2007 was derived from the audited financial statements as of that
date. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company’s Annual Report on Form
10-K for the year ended December 31, 2007.
Management makes
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the financial statements and accompanying notes, as well as the amounts of
revenues and expenses reported during the periods covered by those financial
statements and accompanying notes. Actual results could differ from
these estimates.
Stock
Split
On
November 14, 2007, the Company’s Board of Directors approved a two-for-one stock
split effected in the form of a stock dividend on its common
stock. To implement this stock split, shares of common stock were
issued on December 17, 2007 to stockholders of record as of the close of
business on December 6, 2007. All prior year share and per share
amounts disclosed in this document have been restated to reflect the two-for-one
stock split.
(2)
Research and Development
The following table
presents the Company’s gross and net expenditures on research and development
(“R&D”) activities:
|
|
Three
Months Ended
|
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
|
June
30,
|
|
(millions)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross R&D
expenditures
|
|
$ |
71.7 |
|
|
$ |
65.0 |
|
|
$ |
138.7 |
|
|
$ |
125.5 |
|
Customer
reimbursements
|
|
|
(13.9 |
) |
|
|
(8.3 |
) |
|
|
(23.4 |
) |
|
|
(17.9 |
) |
Net R&D
expenditures
|
|
$ |
57.8 |
|
|
$ |
56.7 |
|
|
$ |
115.3 |
|
|
$ |
107.6 |
|
The Company’s net
R&D expenditures are included in the selling, general and administrative
expenses of the Condensed Consolidated Statements of
Operations. Customer reimbursements are netted against gross R&D
expenditures upon billing of services performed. The Company has
contracts with several customers at the
Company’s various
R&D locations. No such contract exceeded $6 million in any of the
periods presented.
(3)
Income Taxes
The Company's
provision for income taxes is based upon an estimated annual tax rate for the
year applied to federal, state and foreign income. In the first
quarter of 2008, the projected global effective tax rate was estimated to be 26%
for the full year of 2008. With a projected decrease in U.S. income,
the projected global effective tax rate for full year 2008 is
25%. This rate differs from the U.S. statutory rate primarily due to
foreign rates, which differ from those in the U.S., the realization of certain
business tax credits including R&D and foreign tax credits and favorable
permanent differences between book and tax treatment for items, including equity
in affiliates’ earnings and a Medicare prescription drug
benefit. This rate is expected to be less than the full year 2007
global effective tax rate of 26.5% primarily due to the year over year projected
decrease in U.S. income and changes in tax laws, primarily in
Europe.
The Company adopted
the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxes (“FIN 48”), on January 1, 2007. As a result of the
implementation of FIN 48, the Company recognized a $16.6 million reduction to
the January 1, 2007 balance of retained earnings. At December 31,
2007, the Company reported $71.7 million of unrecognized tax benefits;
approximately $62.5 million represent the amount that, if recognized, would
affect the Company’s global effective income tax rate in future
periods.
At
June 30, 2008, the balance of gross unrecognized tax benefits was $66.0
million. Included in the balance at June 30, 2008 are
$56.3 million of tax positions that are permanent in nature and,
if recognized, would reduce the global effective tax rate. The
reduction in the gross unrecognized tax benefits is primarily due to a $6.6
million cash payment to the Internal Revenue Service (“IRS”) to resolve agreed
upon issues of the ongoing IRS examination of the Company’s 2002-2004 tax
year. The Company is appealing an issue related to the 2002-2004 IRS
audit during 2008, which is not expected to be resolved in the next 12
months. In addition, the Company’s federal, certain state and certain
non-U.S. income tax returns are currently under various stages of audit by
applicable tax authorities and the amounts ultimately paid, if any, upon
resolution of the issues raised by the taxing authorities may differ materially
from the amounts accrued for each year. Any other possible
change in the unrecognized tax benefits within the next 12 months cannot be
reasonably estimated.
The Company
recognizes interest and penalties related to unrecognized tax benefits in income
tax expense. The Company had $9.7 million accrued at December 31,
2007 for the payment of any such interest and penalties. The Company
had approximately $10.9 million for the payment of interest and penalties
accrued at June 30, 2008.
The Company or one
of its subsidiaries files income tax returns in the U.S. federal jurisdiction,
and various states and foreign jurisdictions. The Company is no
longer subject to income tax examinations by tax authorities in its major tax
jurisdictions as follows:
|
|
Years
No Longer
|
Tax
Jurisdiction
|
|
Subject
to Audit
|
U.S.
Federal
|
|
2001
and prior
|
Brazil
|
|
2002
and prior
|
France
|
|
2006
and prior
|
Germany
|
|
2002
and prior
|
Hungary
|
|
2004
and prior
|
Italy
|
|
2002
and prior
|
Japan
|
|
2006
and prior
|
South
Korea
|
|
2004
and prior
|
United
Kingdom
|
|
2004
and prior
|
In
certain tax jurisdictions the Company may have more than one
taxpayer. The table above reflects the status of the major taxpayer
in each major tax jurisdiction.
(4)
Marketable Securities
As
of June 30, 2008 the Company had no investments in marketable
securities. At December 31, 2007, the Company held $14.6 million in
marketable securities, primarily bank notes. The securities were
carried at fair value with the unrealized gain or loss, net of tax, reported in
other comprehensive income. As of December 31, 2007, $7.3 million of
the contractual maturities were within one to five years and $7.3 million were
due beyond five years.
(5)
Sales of Receivables
The Company
securitizes and sells certain receivables through third party financial
institutions without recourse. The amount sold can vary each month
based on the amount of underlying receivables. At both June 30, 2008
and December 31, 2007, the Company had sold $50 million of receivables under a
Receivables Transfer Agreement for face value without
recourse. During both of the six-month periods ended June 30, 2008
and 2007, total cash proceeds from sales of accounts receivable were $300
million. The Company paid servicing fees related to these receivables
for the three and six months ended June 30, 2008 and 2007 of $0.4 million and
$0.7 million and $1.0 million and $1.4 million, respectively. These
amounts are recorded in interest expense and finance charges in the Condensed
Consolidated Statements of Operations.
(6)
Inventories
Inventories are
valued at the lower of cost or market. The cost of U.S. inventories
is determined by the last-in, first-out (“LIFO”) method, while the operations
outside the U.S. use the first-in, first-out (“FIFO”) or average-cost
methods. Inventories consisted of the following:
|
|
June
30,
|
|
|
December
31,
|
|
(millions)
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Raw material
and supplies
|
|
$ |
276.6 |
|
|
$ |
246.7 |
|
Work in
progress
|
|
|
111.6 |
|
|
|
99.8 |
|
Finished
goods
|
|
|
126.9 |
|
|
|
114.6 |
|
FIFO
inventories
|
|
|
515.1 |
|
|
|
461.1 |
|
LIFO
reserve
|
|
|
(16.8 |
) |
|
|
(13.5 |
) |
Inventories, net
|
|
$ |
498.3 |
|
|
$ |
447.6 |
|
(7)
Property, plant & equipment
(millions)
|
|
|
June
30,
|
|
|
December
31,
|
|
|
|
|
2008
|
|
|
2007
|
|
Land and
buildings
|
|
|
$ |
647.4 |
|
|
$ |
604.9 |
|
Machinery and
equipment
|
|
|
|
1,929.3 |
|
|
|
1,806.1 |
|
Capital
leases
|
|
|
|
3.3 |
|
|
|
1.1 |
|
Construction
in progress
|
|
|
|
154.9 |
|
|
|
143.4 |
|
Total
property, plant & equipment
|
|
|
|
2,734.9 |
|
|
|
2,555.5 |
|
Less
accumulated depreciation
|
|
|
|
(1,130.4 |
) |
|
|
(1,037.9 |
) |
|
|
|
|
1,604.5 |
|
|
|
1,517.6 |
|
Tooling, net
of amortization
|
|
|
|
97.3 |
|
|
|
91.5 |
|
Property,
plant & equipment - net
|
|
|
$ |
1,701.8 |
|
|
$ |
1,609.1 |
|
Interest costs
capitalized during the six-month periods ended June 30, 2008 and June 30, 2007
were $5.5 million and $4.4 million, respectively.
As
of June 30, 2008 and December 31, 2007, accounts payable of $31.9 million and
$30.4 million, respectively, were related to property, plant and equipment
purchases.
As
of June 30, 2008 and December 31, 2007, specific assets of $17.8 million and
$21.8 million, respectively, were pledged as collateral under certain of the
Company’s long-term debt agreements.
(8)
Product Warranty
The Company
provides warranties on some of its products. The warranty terms are
typically from one to three years. Provisions for estimated expenses
related to product warranty are made at the time products are
sold. These estimates are established using historical information
about the nature, frequency, and average cost of warranty
claims. Management actively studies trends of warranty claims and
takes action to improve product quality and minimize warranty
claims. While management believes that the warranty accrual is
appropriate, actual claims incurred could differ from the original estimates,
requiring adjustments to the
accrual. The
accrual is recorded in both long-term and short-term liabilities on the balance
sheet. The following table summarizes the activity in the warranty
accrual accounts:
|
Six
months ended
|
|
June
30,
|
(millions)
|
2008
|
|
2007
|
|
|
|
|
Beginning
balance
|
$ 70.1
|
|
$ 60.0
|
Provision
|
21.8
|
|
37.2
|
Payments
|
(16.1)
|
|
(22.5)
|
Currency
translation
|
4.3
|
|
1.5
|
Ending
balance
|
$ 80.1
|
|
$ 76.2
|
Contained within
the provision recognized in the six months ended June 30, 2007 is approximately
$14 million for a warranty-related issue surrounding a product, built during a
15-month period in 2004 and 2005, that is no longer in production.
(9)
Notes Payable and Long-Term Debt
Following is a
summary of notes payable and long-term debt, including current
portion. The weighted average interest rate on all borrowings
outstanding as of June 30, 2008 and December 31, 2007 was 5.1% and 5.4%,
respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
(millions)
|
|
June
30, 2008
|
|
|
December
31, 2007
|
|
|
|
Current
|
|
|
Long-Term
|
|
|
Current
|
|
|
Long-Term
|
|
Bank
borrowings and other
|
|
$ |
14.0 |
|
|
$ |
6.9 |
|
|
$ |
30.0 |
|
|
$ |
6.0 |
|
Term loans
due through 2013 (at an average rate of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4.9%
in 2008 and 4.0% in 2007)
|
|
|
44.1 |
|
|
|
13.8 |
|
|
|
33.7 |
|
|
|
18.8 |
|
6.50% Senior
Notes due 02/15/09, net of unamortized discount
(a)
|
|
|
136.6 |
|
|
|
- |
|
|
|
- |
|
|
|
136.5 |
|
5.75% Senior
Notes due 11/01/16, net of unamortized discount
(a)
|
|
|
- |
|
|
|
149.2 |
|
|
|
- |
|
|
|
149.1 |
|
8.00% Senior
Notes due 10/01/19, net of unamortized discount
(a)
|
|
|
- |
|
|
|
133.9 |
|
|
|
- |
|
|
|
133.9 |
|
7.125% Senior
Notes due 02/15/29, net of unamortized discount
|
|
|
- |
|
|
|
119.2 |
|
|
|
- |
|
|
|
119.2 |
|
Carrying
amount
|
|
|
194.7 |
|
|
|
423.0 |
|
|
|
63.7 |
|
|
|
563.5 |
|
Impact of
derivatives on debt
|
|
|
1.1 |
|
|
|
8.1 |
|
|
|
- |
|
|
|
9.1 |
|
Total notes
payable and long-term debt, including current portion
|
|
$ |
195.8 |
|
|
$ |
431.1 |
|
|
$ |
63.7 |
|
|
$ |
572.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) The
Company entered into several interest rate swaps, which have the effect of
converting $325.0 million of these fixed rate notes to variable rates as
of June 30, 2008 and December 31, 2007. The weighted average
effective interest rates for these borrowings, including the effects of
outstanding swaps as noted in Note 11, were 5.0% as of June 30, 2008 and
December 31, 2007, respectively.
|
|
The Company has a
multi-currency revolving credit facility, which provides for borrowings up to
$600 million through July 2009. At June 30, 2008 and December 31,
2007 there were no borrowings outstanding under the facility. The
credit agreement is subject to the usual terms and conditions applied by banks
to an investment grade company. The Company was in compliance with
all covenants at June 30, 2008 and expects to remain compliant in future
periods. The Company had outstanding letters of credit of $21.9
million at June 30, 2008 and $22.0 million at December 31, 2007. The
letters of credit typically act as a guarantee of payment to certain third
parties in accordance with specified terms and conditions.
As
of June 30, 2008 and December 31, 2007, the estimated fair values of the
Company’s senior unsecured notes totaled $580.2 million and $572.4 million,
respectively. The estimated fair values were $41.3 million
higher at June 30,
2008 and $33.7 million higher at December 31, 2007 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 quarter-end and year-end. The fair value
estimates do not necessarily reflect the values the Company could realize in the
current markets.
(10)
Fair Value Measurements
On
January 1, 2008, the Company partially adopted as required, Statement of
Financial Accounting Standards No. 157 – “Fair Value Measurements” (“SFAS 157”)
which expands the disclosure of fair value measurements and its impact on the
Company’s financial statements. In February 2008, the FASB issued FSP
157-2, which delayed the effective date of adoption with respect to certain
non-financial assets and liabilities until 2009. We intend to defer
the adoption of SFAS 157 with respect to certain non-financial assets and
liabilities as permitted.
Statement No. 157
emphasizes that fair value is a market-based measurement, not an entity specific
measurement. Therefore, a fair value measurement should be determined
based on assumptions that market participants would use in pricing an asset or
liability. As a basis for considering market participant assumptions
in fair value measurements, SFAS 157 establishes a fair value hierarchy, which
prioritizes the inputs used in measuring fair values as follows:
Level
1: Observable
inputs such as quoted prices in active markets;
|
Level
2:
|
Inputs, other
than quoted prices in active markets, that are observable either directly
or indirectly; and
|
|
Level
3:
|
Unobservable
inputs in which there is little or no market data, which require the
reporting entity to develop its own
assumptions.
|
Assets and
liabilities measured at fair value are based on one or more of the following
three valuation techniques noted in
SFAS 157:
Market
approach:
|
Prices and
other relevant information generated by market transactions involving
identical or comparable assets or
liabilities.
|
|
Cost
approach:
|
Amount that
would be required to replace the service capacity of an asset (replacement
cost).
|
Income
approach:
|
Techniques to
convert future amounts to a single present amount based upon market
expectations (including present value techniques, option-pricing and
excess earnings models).
|
The following table
classifies the assets and liabilities measured at fair value on a recurring
basis during the period ended June 30, 2008:
|
|
|
|
|
|
|
Basis of Fair Value Measurements
|
|
|
|
|
|
|
|
|
Quoted
|
|
|
Significant
|
|
|
Significant
|
|
|
|
|
|
|
|
|
Prices in
|
|
|
Other
|
|
|
Unobservable
|
|
|
|
|
|
|
|
|
Active
|
|
|
Observable
|
|
|
Inputs
|
|
|
|
Balance at
|
|
|
Markets for
|
|
|
Inputs
|
|
|
|
|
(millions)
|
|
June 30,
|
|
|
Identical
Items
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
(Level
1)
|
|
|
(Level
2)
|
|
|
(Level
3)
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate
swap contracts
|
|
$ |
|
|
9.2 |
|
|
$ |
- |
|
|
$ |
|
|
9.2 |
|
|
$ |
- |
|
Commodity
contracts
|
|
|
|
|
2.4 |
|
|
|
- |
|
|
|
|
|
2.4 |
|
|
|
- |
|
Foreign
exchange contracts
|
|
|
|
|
4.7 |
|
|
|
- |
|
|
|
|
|
4.7 |
|
|
|
- |
|
|
|
$ |
|
|
16.3 |
|
|
$ |
- |
|
|
$ |
|
|
16.3 |
|
|
$ |
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity
contracts
|
|
$ |
|
|
15.8 |
|
|
$ |
- |
|
|
$ |
|
|
15.8 |
|
|
$ |
- |
|
Foreign
exchange contracts
|
|
|
|
|
31.2 |
|
|
|
- |
|
|
|
|
|
31.2 |
|
|
|
- |
|
Net
investment hedge contracts
|
|
|
|
|
57.3 |
|
|
|
- |
|
|
|
|
|
57.3 |
|
|
|
- |
|
|
|
$ |
|
|
104.3 |
|
|
$ |
- |
|
|
$ |
|
|
104.3 |
|
|
$ |
- |
|
(11)
Financial Instruments
The Company’s
financial instruments include cash, marketable securities, trade receivables,
trade payables, and notes payable. Due to the short-term nature of these
instruments, the book value approximates fair value. The Company’s financial
instruments also include long-term debt, interest rate and currency swaps,
commodity swap contracts, and foreign currency forward contracts. All
derivative contracts are placed with counterparties that have an S&P, or
equivalent, credit rating of “A-“ or better.
The Company manages
its interest rate risk by balancing its exposure to fixed and variable rates
while attempting to minimize its interest costs. The Company
selectively uses interest rate swaps to reduce market value risk associated with
changes in interest rates (fair value hedges). The Company also
selectively uses cross-currency swaps to hedge the foreign currency exposure
associated with our net investment in certain foreign operations (net investment
hedges).
A
summary of these instruments outstanding at June 30, 2008 follows: (in
millions)
|
|
|
Notional
|
|
|
|
Hedge
Type
|
Amount
|
Maturity
(a)
|
Interest
rate swaps
|
|
|
|
|
Fixed to
floating
|
|
Fair
value
|
$100
|
February 15,
2009
|
Fixed to
floating
|
|
Fair
value
|
$150
|
November 1,
2016
|
Fixed to
floating
|
|
Fair
value
|
$75
|
October 1,
2019
|
|
|
|
|
|
Cross
currency swap
|
|
|
|
|
Floating $ to
floating €
|
|
Net
Investment
|
$100
|
February 15,
2009
|
Floating $ to floating ¥
|
|
Net
Investment
|
$150
|
November 1,
2016
|
Floating $ to
floating €
|
|
Net
Investment
|
$75
|
October 1,
2019
|
|
|
|
|
|
(a) The
maturity of the swaps corresponds with the maturity of the hedged item as
noted in the debt summary, unless otherwise
indicated.
|
Effectiveness for
fair value and net investment hedges is assessed at the inception of the hedging
relationship. If specified criteria for the assumption of effectiveness are not
met at hedge inception, effectiveness is assessed quarterly. Ineffectiveness is
measured quarterly and results are recognized in earnings.
Fair values of
fixed to floating interest rate swaps are based on observable inputs, such as
interest rates, yield curves, credit risks, and other external valuation
methodology (Level 2 inputs under SFAS 157). See Note 10 for further
discussion of fair value measurements. As of June 30, 2008, the fair
values of the fixed to floating interest rate swaps were recorded as a current
asset of $1.1 million and a non-current asset of $8.1 million, with a
corresponding increase in current portion of long-term debt of $1.1 million and
in long-term debt of $8.1 million. As of December 31, 2007, the fair
values of the fixed to floating interest rate swaps were recorded as a
non-current asset of $9.1 million, with a corresponding increase in long-term
debt of $9.1 million. No hedge ineffectiveness was recognized in
relation to fixed to floating swaps.
Fair values of
cross currency swaps are based on observable inputs, such as interest rates,
yield curves, credit risks, currency exchange rates and other external valuation
methodology (Level 2 inputs under SFAS 157). See Note 10 for further
discussion of fair value measurements. As of June 30, 2008, the fair
values of the cross currency swaps were recorded as a current liability of $22.9
million and a non-current liability of $34.4 million. As of December
31, 2007, the fair values of the cross currency swaps were recorded as a
non-current liability of $33.7 million. Hedge ineffectiveness related
to cross currency swaps was unfavorable $1.7 million as of June 30, 2008 and
unfavorable $1.6 million as of December 31, 2007. As of June 30,
2008, there were no foreign currency forward contracts designated as a net
investment hedge. As of December 31, 2007, the fair value of foreign
currency forward contracts designated as a net investment hedge
was
negligible.
The Company also
entered into certain commodity derivative instruments to protect against
commodity price changes related to forecasted raw material and supplies
purchases. The primary purpose of the commodity price hedging
activities is to manage the volatility associated with these forecasted
purchases. The Company primarily utilizes forward and option
contracts, which are designated as cash flow hedges. As of June 30,
2008, the Company had forward and option commodity contracts with a total
notional value of $39.5 million. The fair values for certain commodity
derivative instruments are based on Level 2 evidence (for example, future prices
reported on commodity exchanges) under SFAS 157. See Note 10 for
further discussion of fair value measurements. As of June 30, 2008,
the Company was holding commodity derivatives with positive and negative fair
market values of $2.4 million and ($15.8) million, respectively, all of which
mature in less than one year. To the extent that derivative
instruments are deemed to be effective as defined by FAS 133, gains and losses
arising from these contracts are deferred in other comprehensive
income. Such gains and losses will be reclassified into income as the
underlying operating transactions are realized. Gains and losses not
qualifying for deferral treatment have been credited/charged to income as they
are recognized. As of December 31, 2007, the Company had forward and option
commodity contracts with a total notional value of $67.3 million. As
of December 31, 2007, the Company was holding commodity derivatives with
positive and negative fair market values of $0.1 million and ($18.4) million,
respectively, of which $0.1 million in gains and ($14.5) million in losses
mature in less than one year. Losses not qualifying for deferral
associated with these contracts for June 30, 2008 were negligible. At
December 31, 2007, losses not qualifying for deferral were ($0.1)
million.
The Company uses
foreign exchange forward and option contracts to protect against exchange rate
movements for forecasted cash flows for purchases, operating expenses or sales
transactions designated in currencies other than the functional currency of the
operating unit. Most contracts mature in less than one year, however,
certain long-term commitments are covered by forward currency arrangements to
protect against currency risk through 2011. Foreign currency contracts require
the Company, at a future date, to either buy or sell foreign currency in
exchange for the operating units’ local currency. At June 30, 2008,
contracts were outstanding to buy or sell British Pounds Sterling, Euros,
Hungarian Forints, Indian Rupee, Japanese Yen, Mexican Pesos, South Korean Won
and U.S. Dollars. To the extent that derivative instruments are
deemed to be effective as defined by FAS 133, gains and losses arising from
these contracts are deferred in other comprehensive income. Such
gains and losses will be reclassified into income as the underlying operating
transactions are realized. Any gains or losses not qualifying for deferral are
credited/charged to income as they are recognized. The fair values of
foreign exchange forward and option contracts are based on Level 2 inputs under
SFAS 157, such as quoted exchange rates by various exchanges. See Note 10 for
further discussion of fair value measurements. As of June 30, 2008,
the Company was holding foreign exchange derivatives with a positive market
value of $4.7 million, of which $3.0 million matures in less than one year.
Derivative contracts with negative value amounted to ($31.2) million, of which
($17.2) million matures in less than one year. As of December 31, 2007, the
Company was holding foreign exchange derivatives with a positive market value of
$1.9 million, all maturing in less than one year. Derivatives
contracts with negative value amounted to ($9.9) million, of which ($5.9)
million matures in less than one year. As of June 30, 2008 and
December 31, 2007, there were no gains or losses which did not qualify for
deferral.
(12)
Retirement Benefit Plans
The Company has a
number of defined benefit pension plans and other post employment benefit plans
covering eligible salaried and hourly employees. The other post employment
benefits plans, which provide
medical and life
insurance benefits, are unfunded plans. The estimated contributions to the
Company’s defined benefit pension plans for 2008 range from $10 to $20 million,
of which $6.0 million has been contributed through the first six months of the
year.
In
September 2007, the Company made changes to its U.S. retiree medical program
that impact certain non-union active employees with a future retiree benefit and
current retirees participating in a health care plan. These changes
will become effective on January 1, 2009. The effect of the changes
to both groups is that most members will pay a higher percentage of the annual
premium for Company-sponsored retiree medical coverage between ages 60 to 64,
and neither group will receive Company-sponsored Medicare Supplemental coverage
once entitled to Medicare. Instead, certain active employees will
receive a lump sum credit into a non-contributory cash balance pension plan
earning interest each year. Current retirees will receive an annual
per member allowance toward the purchase of individual Medicare Supplemental
coverage and for reimbursement of medical out-of-pocket expenses.
The components of
net periodic benefit cost recorded in the Company’s Condensed Consolidated
Statements of Operations, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
post
|
|
(millions)
|
|
Pension
benefits
|
|
|
employment
|
|
Three
months ended June 30,
|
|
2008
|
|
|
2007
|
|
|
benefits
|
|
|
|
US
|
|
|
Non-US
|
|
|
US
|
|
|
Non-US
|
|
|
2008
|
|
|
2007
|
|
Components
of net periodic benefit cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$ |
0.5 |
|
|
$ |
2.4 |
|
|
$ |
0.5 |
|
|
$ |
2.3 |
|
|
$ |
0.7 |
|
|
$ |
1.7 |
|
Interest
cost
|
|
|
5.1 |
|
|
|
4.8 |
|
|
|
4.3 |
|
|
|
3.9 |
|
|
|
5.8 |
|
|
|
7.4 |
|
Expected
return on plan assets
|
|
|
(7.1 |
) |
|
|
(3.4 |
) |
|
|
(7.4 |
) |
|
|
(3.1 |
) |
|
|
- |
|
|
|
- |
|
Amortization
of unrecognized
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
prior
service benefit
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(5.4 |
) |
|
|
(3.9 |
) |
Amortization
of unrecognized loss
|
|
|
0.5 |
|
|
|
- |
|
|
|
0.5 |
|
|
|
0.3 |
|
|
|
2.7 |
|
|
|
3.8 |
|
Other
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
0.3 |
|
|
|
- |
|
|
|
- |
|
Net periodic
benefit cost (benefit)
|
|
$ |
(1.0 |
) |
|
$ |
3.8 |
|
|
$ |
(2.1 |
) |
|
$ |
3.7 |
|
|
$ |
3.8 |
|
|
$ |
9.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
post
|
|
(millions)
|
|
Pension
benefits
|
|
|
employment
|
|
Six months ended June
30,
|
|
2008
|
|
|
2007
|
|
|
benefits
|
|
|
|
US
|
|
|
Non-US
|
|
|
US
|
|
|
Non-US
|
|
|
2008
|
|
|
2007
|
|
Components
of net periodic benefit cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$ |
1.0 |
|
|
$ |
4.8 |
|
|
$ |
1.0 |
|
|
$ |
5.3 |
|
|
$ |
1.3 |
|
|
$ |
3.3 |
|
Interest
cost
|
|
|
10.2 |
|
|
|
9.6 |
|
|
|
8.7 |
|
|
|
7.9 |
|
|
|
11.6 |
|
|
|
14.9 |
|
Expected
return on plan assets
|
|
|
(14.2 |
) |
|
|
(6.9 |
) |
|
|
(14.8 |
) |
|
|
(6.2 |
) |
|
|
- |
|
|
|
- |
|
Amortization
of unrecognized
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
prior
service benefit
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(10.7 |
) |
|
|
(7.9 |
) |
Amortization
of unrecognized loss
|
|
|
1.0 |
|
|
|
- |
|
|
|
1.0 |
|
|
|
0.7 |
|
|
|
5.4 |
|
|
|
7.6 |
|
Other
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
0.3 |
|
|
|
- |
|
|
|
- |
|
Net periodic
benefit cost (benefit)
|
|
$ |
(2.0 |
) |
|
$ |
7.5 |
|
|
$ |
(4.1 |
) |
|
$ |
8.0 |
|
|
$ |
7.6 |
|
|
$ |
17.9 |
|
(13)
Stock-Based Compensation
Under the Company's
1993 Stock Incentive Plan (“1993 Plan”), the Company granted options to purchase
shares of the Company's common stock at the fair market value on the date of
grant. The options vest over periods up to three years and have a
term of ten years from date of grant. As of December 31, 2003, there
were no options available for future grants under the 1993 Plan. The
1993 Plan expired at the end of 2003 and was replaced by the Company's 2004
Stock Incentive Plan, which was amended at the Company’s 2006 Annual
Stockholders Meeting, among other things, to increase the number of shares
available for issuance under the plan. Under the BorgWarner Inc.
Amended and Restated 2004 Stock Incentive Plan (“2004 Stock Incentive Plan”),
the number of shares authorized for grant was 10,000,000, of which approximately
1,550,000 shares are available for future issuance. As of June 30,
2008, there were a total of 6,017,949 outstanding options under the 1993 and
2004 Stock Incentive Plans.
Stock option
compensation expense reduced income before income taxes and net earnings for the
three months ended June 30, 2008 and 2007 by $3.5 million and $2.7 million
($0.02 per basic and diluted share) and by $4.9 million and $3.6 million ($0.03
per basic and diluted share), respectively. Stock option compensation
expense reduced income before income taxes and net earnings for the six months
ended June 30, 2008 and 2007 by $7.1 million and $5.3 million ($0.05 and $0.04
per basic and diluted shares, respectively) and by $9.1 million and $6.7 million
($0.06 per basic and diluted share), respectively. Stock option
compensation expense affected both operating activities ($7.1 million and $9.1
million non-cash charge backs) and financing activities ($1.8 million and $2.4
million tax benefits) of the Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 2008 and 2007, respectively.
Total unrecognized
compensation cost related to nonvested stock options at June 30, 2008 is
approximately $13.8 million. This cost is expected to be recognized
over the next 1.6 years. On a weighted average basis, this cost is
expected to be recognized over 0.7 years.
A
summary of the plans’ shares under option as of and for the six months ended
June 30, 2008 is as follows:
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Shares
|
|
|
Weighted
|
|
|
Average
|
|
|
Aggregate
|
|
|
|
Under
|
|
|
Average
|
|
|
Remaining
|
|
|
Intrinsic
|
|
|
|
Option
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Value
|
|
|
|
(thousands)
|
|
|
Price
|
|
|
Life
(in years)
|
|
|
(in
millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2007
|
|
|
6,331 |
|
|
$ |
27.75 |
|
|
|
|
|
|
|
Granted
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
Exercised
|
|
|
(96 |
) |
|
|
23.15 |
|
|
|
|
|
|
|
Forfeited
|
|
|
(59 |
) |
|
|
32.53 |
|
|
|
|
|
|
|
Outstanding
at March 31, 2008
|
|
|
6,176 |
|
|
$ |
27.78 |
|
|
|
7.4 |
|
|
$ |
94.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(150 |
) |
|
|
23.35 |
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(8 |
) |
|
|
31.29 |
|
|
|
|
|
|
|
|
|
Outstanding
at June 30, 2008
|
|
|
6,018 |
|
|
$ |
27.88 |
|
|
|
7.2 |
|
|
$ |
99.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
exerciseable at June 30, 2008
|
|
|
2,060 |
|
|
$ |
20.80 |
|
|
|
5.5 |
|
|
$ |
48.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In calculating
earnings per share, earnings are the same for the basic and diluted
calculations. Shares increased for diluted earnings per share by
2,132,000 and 1,716,000 for the three months ended June 30,
2008 and 2007,
respectively, and 2,178,000 and 1,560,000 for the six months ended June 30, 2008
and 2007, respectively, due to the effects of stock options and shares issued
and issuable under the 1993 Plan and 2004 Stock Incentive
Plan.
The fair value for
options granted in February 2007 was $10.52 per option. The fair
value at date of grant was estimated using the Black-Scholes options pricing
model with the following assumptions:
|
|
2007
|
|
|
|
Risk-free
interest rate
|
|
4.82%
|
Dividend
yield
|
|
0.97%
|
Volatility
factor
|
|
28.64%
|
Expected
life
|
|
4.7
years
|
The expected lives
of the awards are based on historical exercise patterns and the terms of the
options. The risk-free interest rate is based on zero coupon Treasury
bond rates corresponding to the expected life of the awards. The
expected volatility assumption was derived by referring to changes in the
Company’s historical common stock prices over the same timeframe as the expected
life of the awards. The expected dividend yield of stock is based on
the Company’s historical dividend yield. The Company has no reason to
believe that the expected dividend yield or the future stock volatility is
likely to differ from historical patterns.
At
its November 2007 meeting, our Compensation Committee decided that restricted
common stock would be awarded in place of stock options for the 2008 long-term
incentive award grants to employees. These restricted shares for
employees vest fifty percent after two years and the remainder after three years
from the date of grant. The Company also grants restricted common stock to its
non-employee directors. For non-employee directors restricted shares
vest ratably on the anniversary of the date of the grant over a period of three
years. The market value of the Company’s restricted common stock at
the date of grant determines the value of the restricted common
stock. In February 2008, a grant of 390,873 restricted shares was
awarded to employees under the 2004 Stock Incentive Plan. The value of the
awards is recorded as unearned compensation within capital in excess of par
value in stockholders’ equity, and is amortized as compensation expense over the
restriction periods. The Company recognized compensation expense
related to restricted common stock of $2.6 million and $0.2 million for the
three months ended June 30, 2008 and 2007, respectively and $4.6 million and
$0.3 million for the six months ended June 30, 2008 and 2007,
respectively.
A
summary of the status of the Company’s nonvested restricted stock as of and for
the six months ended June 30, 2008 is as follows:
|
|
Shares
|
|
|
|
|
Subject
to
|
|
Weighted
|
|
|
Restriction
|
|
Average
|
|
|
(thousands)
|
|
Price
|
|
|
|
|
|
Nonvested at
December 31, 2007
|
27.5
|
|
$31.95
|
Granted
|
|
390.9
|
|
46.34
|
Vested
|
|
-
|
|
-
|
Nonvested at
March 31, 2008
|
418.4
|
|
$45.39
|
Granted
|
|
10.2
|
|
49.55
|
Vested
|
|
(1.4)
|
|
38.24
|
Nonvested at
June 30, 2008
|
|
427.2
|
|
$45.52
|
(14)
Comprehensive Income
The amounts
presented as changes in accumulated other comprehensive income, net of related
taxes, are added to (deducted from) net earnings resulting in comprehensive
income. The following table summarizes the components of
comprehensive income on an after-tax basis for the three and six-month periods
ended June 30, 2008 and 2007.
|
|
Three
months ended
|
|
|
Six
months ended
|
|
|
|
June
30,
|
|
|
June
30,
|
|
(millions)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments, net
|
|
$ |
(5.8 |
) |
|
$ |
20.3 |
|
|
$ |
113.1 |
|
|
$ |
39.3 |
|
Market value
change in hedge instruments, net
|
|
|
9.6 |
|
|
|
(3.9 |
) |
|
|
(23.3 |
) |
|
|
(2.7 |
) |
Minimum
pension liability adjustment, net
|
|
|
- |
|
|
|
(3.5 |
) |
|
|
- |
|
|
|
(3.5 |
) |
Unrealized
(loss) gain on available-for-sale securities, net
|
|
|
(0.1 |
) |
|
|
0.2 |
|
|
|
- |
|
|
|
- |
|
Change in accumulated other comprehensive income
|
|
|
3.7 |
|
|
|
13.1 |
|
|
|
89.8 |
|
|
|
33.1 |
|
Net earnings
as reported
|
|
|
87.5 |
|
|
|
75.7 |
|
|
|
176.2 |
|
|
|
134.1 |
|
Total comprehensive income
|
|
$ |
91.2 |
|
|
$ |
88.8 |
|
|
$ |
266.0 |
|
|
$ |
167.2 |
|
(15)
Contingencies
In
the normal course of business the Company and its subsidiaries are parties to
various commercial and legal claims, actions and complaints, including matters
involving warranty claims, intellectual property claims, general liability and
various other risks. It is not possible to predict with certainty
whether or not the Company and its subsidiaries will ultimately be successful in
any of these commercial and legal matters or, if not, what the impact might
be. The Company’s environmental and product liability contingencies
are discussed separately below. The Company’s management does not
expect that the results in any of these commercial and legal claims, actions and
complaints will have a material adverse effect on the Company’s results of
operations, financial position or cash flows.
Environmental
The Company and
certain of its current and former direct and indirect corporate predecessors,
subsidiaries and divisions have been identified by the United States
Environmental Protection Agency and certain state environmental agencies and
private parties as potentially responsible parties (“PRPs”) at various hazardous
waste disposal sites under the Comprehensive Environmental Response,
Compensation and Liability Act (“Superfund”) and equivalent state laws and, as
such, may presently be liable for the cost of clean-up and other remedial
activities at 35 such sites. Responsibility for clean-up and other
remedial activities at a Superfund site is typically shared among PRPs based on
an allocation formula.
The Company
believes that none of these matters, individually or in the aggregate, will have
a material adverse effect on its results of operations, financial position, or
cash flows. Generally, this is because either the estimates of the
maximum potential liability at a site are not large or the liability will be
shared with other PRPs, although no assurance can be given with respect to the
ultimate outcome of any such matter.
Based on
information available to the Company (which in most cases includes: an estimate
of allocation of liability among PRPs; the probability that other PRPs, many of
whom are large, solvent public companies, will fully pay the cost apportioned to
them; currently available information from PRPs and/or federal or state
environmental agencies concerning the scope of contamination and estimated
remediation and consulting costs; remediation alternatives; and estimated legal
fees), the Company has established an accrual for indicated environmental
liabilities with a balance at June 30, 2008 of $10.5 million. The
Company has accrued amounts that do not exceed $3.0 million related to any
individual site and management does not believe that the costs related to any of
these sites will have a material adverse effect on the Company’s results of
operations, cash flows or financial condition. The Company expects to
pay out substantially all of the amounts accrued for environmental liability
over the next three to five years.
In
connection with the sale of Kuhlman Electric Corporation, the Company agreed to
indemnify the buyer and Kuhlman Electric for certain environmental liabilities,
then unknown to the Company, relating to certain operations of Kuhlman Electric
that pre-date the Company’s 1999 acquisition 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 is continuing to work with the Mississippi Department of Environmental
Quality and Kuhlman Electric to investigate and remediate to the extent
necessary, historical contamination at the plant and surrounding
area. Kuhlman Electric and others, including the Company, were sued
in numerous related lawsuits, in which multiple claimants alleged personal
injury and property damage. In 2005, the Company and other defendants
entered into settlements that resolved approximately 99% of the then known
personal injury and property damage claims relating to the alleged environmental
contamination. Those settlements involved payments by the Company of
$28.5 million in the second half of 2005 and $15.7 million in the first quarter
of 2006, in exchange for, among other things, dismissal with prejudice of these
lawsuits.
In
December 2007, a lawsuit was filed against Kuhlman Electric and others,
including the Company, on behalf of approximately 209 plaintiffs, alleging
personal injury relating to the alleged environmental
contamination. Given the early stage of the litigation, the Company
cannot make any predictions as to the outcome, but its current intent is to
vigorously defend against the suit.
Conditional
Asset Retirement Obligations
In
March 2005, the FASB issued Interpretation No. 47, Accounting
for Conditional Asset Retirement Obligations - an interpretation of FASB
Statement No.
143 (“FIN 47”), which requires the Company to
recognize legal
obligations to perform asset retirements in which the timing and/or method of
settlement are conditional on a future event that may or may not be within the
control of the entity. Certain government regulations require the
removal and disposal of asbestos from an existing facility at the time the
facility undergoes major renovations or is demolished. The liability
exists because the facility will not last forever, but it is conditional on
future renovations (even if there are no immediate plans to remove the
materials, which pose no health or safety hazard in their current
condition). Similarly, government regulations require the removal or
closure of underground storage tanks (“USTs”) when their use ceases, the
disposal of polychlorinated biphenyl (“PCB”) transformers and capacitors when
their use ceases, and the disposal of used furnace bricks and liners, and
lead-based paint in conjunction with facility renovations or
demolition. The Company currently has 17 manufacturing locations that
have been identified as containing these items. The fair value to remove and
dispose of this material has been estimated and recorded at $1.0 million as of
June 30, 2008 and December 31, 2007.
Product
Liability
Like many other
industrial companies who have historically operated in the U.S., the Company (or
parties the Company is obligated to indemnify) continues to be named as one of
many defendants in asbestos-related personal injury
actions. Management believes that the Company’s involvement is
limited because, in general, these claims relate to a few types of automotive
friction products that were manufactured many years ago and contained
encapsulated asbestos. The nature of the fibers, the encapsulation and the
manner of use lead the Company to believe that these products are highly
unlikely to cause harm. As of June 30, 2008, the Company had
approximately 37,000 pending asbestos-related product liability
claims. Of these outstanding claims, approximately 27,000 are pending
in just three jurisdictions, where significant tort reform activities are
underway.
The Company’s
policy is to aggressively defend against these lawsuits and the Company has been
successful in obtaining dismissal of many claims without any payment. The
Company expects that the vast majority of the pending asbestos-related product
liability claims where it is a defendant (or has an obligation to indemnify a
defendant) will result in no payment being made by the Company or its
insurers. In the first six months of 2008, of the approximately 5,400
claims resolved, only 97 (1.8%) resulted in any payment being made to a claimant
by or on behalf of the Company. In 2007, of the approximately 4,400
claims resolved, only 194 (4.4%) resulted in any payment being made to a
claimant by or on behalf of the Company.
Prior to June 2004,
the settlement and defense costs associated with all claims were covered by the
Company’s primary layer insurance coverage, and these carriers administered,
defended, settled and paid all claims under a funding arrangement. In
June 2004, primary layer insurance carriers notified the Company of the alleged
exhaustion of their policy limits. This led the Company to access the next
available layer of insurance coverage. Since June 2004, secondary
layer insurers have paid asbestos-related litigation defense and settlement
expenses pursuant to a funding arrangement. To date, the Company has
paid $36.7 million in defense and indemnity in advance of insurers’
reimbursement and has received $12.1 million in cash from insurers. The
outstanding balance of $24.6 million is expected to be fully recovered.
Timing of the recovery is dependent on final resolution of the declaratory
judgment action referred to below. At December 31, 2007, insurers owed
$20.6 million in association with these claims.
At
June 30, 2008, the Company has an estimated liability of $39.2 million for
future claims resolutions, with a related asset of $39.2 million to recognize
the insurance proceeds receivable by the Company for estimated losses related to
claims that have yet to be resolved. Insurance carrier reimbursement of 100% is
expected based on the Company’s experience, its insurance contracts and
decisions received to date in the declaratory judgment action referred to below.
At December 31, 2007, the comparable value of the insurance
receivable
and accrued
liability was $39.6 million.
The amounts
recorded in the Condensed Consolidated Balance Sheets related to the estimated
future settlement of existing claims are as follows:
|
|
June
30,
|
|
|
December
31,
|
|
(millions)
|
|
2008
|
|
|
2007
|
|
Assets:
|
|
|
|
|
|
|
Prepayments
and other current assets
|
|
$ |
21.9 |
|
|
$ |
20.1 |
|
Other
non-current assets
|
|
|
17.3 |
|
|
|
19.5 |
|
Total
insurance receivable
|
|
$ |
39.2 |
|
|
$ |
39.6 |
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
$ |
21.9 |
|
|
$ |
20.1 |
|
Other
non-current liabilities
|
|
|
17.3 |
|
|
|
19.5 |
|
Total
accrued liability
|
|
$ |
39.2 |
|
|
$ |
39.6 |
|
The Company cannot
reasonably estimate possible losses, if any, in excess of those for which it has
accrued, because it cannot predict how many additional claims may be brought
against the Company (or parties the Company has an obligation to indemnify) in
the future, the allegations in such claims, the possible outcomes, or the impact
of tort reform legislation that may be enacted at the State or Federal
levels.
A
declaratory judgment action was filed in January 2004 in the Circuit Court of
Cook County, Illinois by Continental Casualty Company and related companies
(“CNA”) against the Company and certain of its other historical general
liability insurers. CNA provided the Company with both primary and
additional layer insurance, and, in conjunction with other insurers, is
currently defending and indemnifying the Company in its pending asbestos-related
product liability claims. The lawsuit seeks to determine the extent
of insurance coverage available to the Company including whether the available
limits exhaust on a “per occurrence” or an “aggregate” basis, and to determine
how the applicable coverage responsibilities should be
apportioned. On August 15, 2005, the Court issued an interim order
regarding the apportionment matter. The interim order has the effect
of making insurers responsible for all defense and settlement costs pro rata to
time-on-the-risk, with the pro-ration method to hold the insured harmless for
periods of bankrupt or unavailable coverage. Appeals of the interim
order were denied. However, the issue is reserved for appellate
review at the end of the action. In addition to the primary insurance
available for asbestos-related claims, the Company has substantial additional
layers of insurance available for potential future asbestos-related product
claims. As such, the Company continues to believe that its coverage
is sufficient to meet foreseeable liabilities.
Although it is
impossible to predict the outcome of pending or future claims or the impact of
tort reform legislation that may be enacted at the State or Federal levels, due
to the encapsulated nature of the products, the Company’s experiences in
aggressively defending and resolving claims in the past, and the Company’s
significant insurance coverage with solvent carriers as of the date of this
filing, management does not believe that asbestos-related product liability
claims are likely to have a material adverse effect on the Company’s results of
operations, cash flows or financial condition.
(16)
Leases and Commitments
The Company has
guaranteed the residual values of certain leased machinery and equipment at one
of its facilities. The guarantees extend through the maturity of the
underlying lease, which is in September 2009. In the event the
Company exercises its option not to purchase the machinery and equipment, the
Company has guaranteed a residual value of $10.0 million. The Company
has accrued $4.1 million as a loss on this guarantee, which is expected to
be paid in 2009.
(17)
Restructuring
Estimates of
restructuring expense are based on information available at the time such
charges are recorded. Due to the inherent uncertainty involved in estimating
restructuring expenses, actual amounts paid for such activities may differ from
amounts initially recorded. Accordingly, the Company may record revisions of
previous estimates by adjusting previously established reserves.
The table below
summarizes accrual activity for employee related costs related to the Company’s
previously announced restructuring actions for the three months ended June 30,
2008 (in millions):
|
|
Employee
|
|
|
|
Related
Costs
|
|
Balance at
December 31, 2007
|
|
$ |
9.1 |
|
Cash
payments
|
|
|
- |
|
Balance at
March 31, 2008
|
|
|
9.1 |
|
Cash
payments
|
|
|
(0.8 |
) |
Balance at
June 30, 2008
|
|
$ |
8.3 |
|
|
|
|
|
|
Future cash
payments for these restructuring activities are expected to be complete by the
end of 2009.
(18)
Reporting Segments
The Company’s
business is comprised of two reporting segments: Engine and
Drivetrain. These reporting segments are strategic business groups,
which are managed separately as each represents a specific grouping of related
automotive components and systems.
The Company
allocates resources to each segment based upon the projected after-tax return on
invested capital (“ROIC”) of its business initiatives. The ROIC is
comprised of projected earnings before interest and income taxes (“EBIT”)
adjusted for income taxes compared to the projected average capital investment
required.
EBIT is considered
a “non-GAAP financial measure.” Generally, a non-GAAP financial
measure is a numerical measure of a company’s financial performance, financial
position or cash flows that excludes (or includes) amounts that are included in
(or excluded from) the most directly comparable measure calculated and presented
in accordance with GAAP. EBIT is defined as earnings before interest,
income taxes and minority interest. “Earnings” is intended to mean
net earnings as presented in the Condensed Consolidated Statements of Operations
under GAAP.
The Company
believes that EBIT is useful to demonstrate the operational profitability of our
segments by excluding interest and income taxes, which are generally accounted
for across the entire Company on a consolidated basis. EBIT is also
one of the measures used by the Company to determine resource
allocation
within the
Company. Although the Company believes that EBIT enhances
understanding of our business and performance, it should not be considered an
alternative to, or more meaningful than, net earnings or cash flows from
operations as determined in accordance with GAAP.
The following
tables present net sales, segment EBIT and total assets for the Company’s
reporting segments.
Net
Sales by Reporting Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
(millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
months ended
|
|
|
Six
months ended
|
|
|
|
June
30,
|
|
|
June
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Engine
|
|
$ |
1,109.0 |
|
|
$ |
955.4 |
|
|
$ |
2,207.1 |
|
|
$ |
1,849.5 |
|
Drivetrain
|
|
|
414.4 |
|
|
|
417.7 |
|
|
|
824.2 |
|
|
|
809.7 |
|
Inter-segment
eliminations
|
|
|
(6.8 |
) |
|
|
(8.8 |
) |
|
|
(15.8 |
) |
|
|
(17.1 |
) |
Net
sales
|
|
$ |
1,516.6 |
|
|
$ |
1,364.3 |
|
|
$ |
3,015.5 |
|
|
$ |
2,642.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment
Earnings Before Interest and Income Taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
months ended
|
|
|
Six
months ended
|
|
|
|
June
30,
|
|
|
June
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Engine
|
|
$ |
126.4 |
|
|
$ |
108.3 |
|
|
$ |
264.3 |
|
|
$ |
193.6 |
|
Drivetrain
|
|
|
21.8 |
|
|
|
33.3 |
|
|
|
40.1 |
|
|
|
61.0 |
|
Segment
earnings before interest and income taxes ("Segment EBIT")
|
|
|
148.2 |
|
|
|
141.6 |
|
|
|
304.4 |
|
|
|
254.6 |
|
Corporate,
including equity in affiliates' earnings and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
stock-based
compensation
|
|
|
15.3 |
|
|
|
19.2 |
|
|
|
35.7 |
|
|
|
33.1 |
|
Consolidated
earnings before interest and taxes ("EBIT")
|
|
|
132.9 |
|
|
|
122.4 |
|
|
|
268.7 |
|
|
|
221.5 |
|
Interest
expense and finance charges
|
|
|
10.8 |
|
|
|
9.3 |
|
|
|
17.3 |
|
|
|
18.2 |
|
Earnings
before income taxes and minority interest
|
|
|
122.1 |
|
|
|
113.1 |
|
|
|
251.4 |
|
|
|
203.3 |
|
Provision for
income taxes
|
|
|
29.8 |
|
|
|
30.5 |
|
|
|
63.4 |
|
|
|
54.9 |
|
Minority
interest, net of tax
|
|
|
4.8 |
|
|
|
6.9 |
|
|
|
11.8 |
|
|
|
14.3 |
|
Net
earnings
|
|
$ |
87.5 |
|
|
$ |
75.7 |
|
|
$ |
176.2 |
|
|
$ |
134.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June
30,
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
Engine
|
|
|
|
|
|
|
|
|
|
$ |
3,691.0 |
|
|
$ |
3,357.9 |
|
Drivetrain
|
|
|
|
|
|
|
|
|
|
|
1,358.7 |
|
|
|
1,294.2 |
|
Total
|
|
|
|
|
|
|
|
|
|
|
5,049.7 |
|
|
|
4,652.1 |
|
Corporate, including equity in
affiliates(a)
|
|
|
|
|
|
|
|
|
|
|
391.7 |
|
|
|
306.4 |
|
Total assets
|
|
|
|
|
|
|
|
|
|
$ |
5,441.4 |
|
|
$ |
4,958.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
Corporate assets, including equity in affiliates, are net of trade
receivables securitized and sold to third parties, and include cash,
deferred income
|
|
taxes
and investments & advances.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(19)
New Accounting Pronouncements
In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141 (Revised 2007), Business Combinations (“FAS 141(R)”). FAS 141(R)
establishes principles and requirements for recognizing identifiable assets
acquired, liabilities assumed, noncontrolling interest in the acquiree, goodwill
acquired in the combination or the gain from a bargain purchase, and disclosure
requirements. Under this revised statement, all costs incurred to
effect an acquisition will be recognized separately from the
acquisition. Also, restructuring costs that are expected but the
acquirer is not obligated to incur will be recognized separately from the
acquisition. FAS 141(R) is effective for the Company beginning with
its
quarter ending
March 31, 2009. The Company is currently assessing the potential
impacts, if any, on its consolidated financial statements.
In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
160, Noncontrolling Interests in Consolidated Financial Statements (“FAS
160”). FAS 160 requires that ownership interests in subsidiaries held
by parties other than the parent are clearly identified. In addition,
it requires that the amount of consolidated net income attributable to the
parent and to the noncontrolling interest be clearly identified and presented on
the face of the statement of operations. FAS 160 is effective for the
Company beginning with its quarter ending March 31, 2009. The
adoption of FAS 160 is not expected to have a material impact on the Company’s
consolidated financial position, results of operations or cash
flows.
In
March 2008, the FASB issued Statement of Financial Accounting Standards No.
161, Disclosures about Derivative Instruments and Hedging Activities
(“FAS 161”). FAS 161 requires entities to provide enhanced
disclosures about how and why an entity uses derivative instruments, how
derivative instruments and related hedged items are accounted for under
Statement 133 and its related interpretations, and how derivative instruments
and related hedged items affect an entity’s financial position, financial
performance, and cash flows. FAS 161 is effective for the Company
beginning with its quarter ending March 31, 2009.
(20)
Recent Transaction
In
the second quarter of 2008, the Company and BERU AG (“BERU”) completed a
Domination and Profit Transfer Agreement (“DPTA”), giving BorgWarner full
control of BERU. Under this agreement BERU is obligated to transfer
100% of its profits or losses to the Company. Upon request of BERU
minority shareholders, the Company is obligated to purchase their shares for a
cash payment of €71.32 per share. Those BERU minority shareholders
who do not sell their shares are entitled to receive an annual compensatory
payment (perpetual dividend) of €4.73 (gross) per share, less certain taxes,
from the Company. The total obligation associated with the DPTA is
approximately €127.2 ($200.3) million, based upon the present value of the
perpetual dividend and approximates the cost if all remaining shares were
purchased by the Company at €71.32 per share. The DPTA obligation is
presented in the Condensed Consolidated Balance Sheet as $18.5 million in
current liabilities and $181.8 million in other non-current
liabilities.
In connection with
the DPTA, the Company recorded the remaining 17.8% of the fair value of BERU as
follows (in millions):
Elimination
of Minority Interest
|
|
|
$ |
86.6 |
|
Goodwill
|
|
|
|
71.2 |
|
Tangible and
Intangible Assets
|
|
|
|
61.7 |
|
Liabilities
|
|
|
|
(19.2 |
) |
Domination and Profit Transfer Agreement Obligation
|
|
|
$ |
200.3 |
|
The $71.2 million
of goodwill represents the excess of the DPTA obligation over the fair value of
assets acquired and liabilities assumed. Goodwill is reflected in the
Engine segment.
Of
the total tangible and intangible fair value write up of $61.7 million, $3.3
million of in process R&D and order backlog were immediately written off in
the selling, general, and administrative line and $1.8 million of beginning
inventory was immediately written off in the cost of sales line in the Condensed
Consolidated
Statement of
Operations. The combined pre-tax effect of both items is $5.1
million, $4.5 million net of tax or $0.04 per diluted share.
As
of June 30, 2008, the portion of the acquisition related to the DPTA represents
a non-cash transaction. The cost related to the annual perpetual dividend
arrangement will be reflected as interest and income tax expense in the
Consolidated Statement of Operations. The annual payment of the
perpetual dividend will be reflected as a financing activity and the acquisition
of shares purchased by the Company will be reflected as an investing activity in
the Consolidated Statement of Cash Flows. The payment of the annual
perpetual dividend is expected to occur in the second quarter of each year,
beginning in 2009.
The DPTA is a
binding agreement. However, minority shareholders of BERU initiated
an appraisal proceeding in the German court system that challenges the
€71.32
purchase price and €4.73 annual
compensatory payment (perpetual dividend). If a higher price is
determined, the excess purchase price would be recorded as additional goodwill
with a corresponding increase to the Company’s total DPTA
obligation.
For a description
of our earlier acquisition of 82.2% of BERU, see Note 19 to the Notes
to Consolidated Financial Statements in our most recently filed Annual
Report on Form 10-K.
(21)
Subsequent Event
On July
31, we announced a restructuring of our operations to align ongoing operations
with what we believe is a continuing, fundamental market shift in the U.S. auto
industry. The Company expects to reduce its North American workforce in
the third quarter by approximately 1,000 people, or 16% of our North American
employee base, spread across its operations in the U.S., Canada and
Mexico. Although not all aspects of the restructuring actions have been
finalized, the Company currently expects to incur pretax costs estimated in the
range of $10 million to $12 million in connection with the restructuring
actions. Other incremental costs, if any, resulting from the restructuring
actions are under evaluation. Benefits from the restructuring are expected
to be realized in the second half of 2008.
Item 2. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
INTRODUCTION
BorgWarner Inc. and
Consolidated Subsidiaries (the “Company”) is a leading global supplier of highly
engineered systems and components primarily for powertrain
applications. Our products help improve vehicle performance, fuel
efficiency, air quality and vehicle stability. They are manufactured
and sold worldwide, primarily to original equipment manufacturers (“OEMs”) of
light vehicles (i.e., passenger cars, sport-utility vehicles (“SUVs”),
cross-over vehicles, vans and light-trucks). Our products are also
manufactured and sold to OEMs of commercial trucks, buses and agricultural and
off-highway vehicles. We also manufacture and sell our products into the
aftermarket for light and commercial vehicles. We operate
manufacturing facilities serving customers in the Americas, Europe and Asia, and
are an original equipment supplier to every major automaker in the
world.
The Company’s
products fall into two reporting segments: Engine and
Drivetrain. The Engine segment’s products include turbochargers,
timing chain systems, air management, emissions systems, thermal systems, as
well as diesel and gas ignition systems. The Drivetrain segment’s
products are all-wheel drive transfer cases, torque management systems, and
components and systems for automated transmissions.
Stock
Split
On
November 14, 2007, the Company’s Board of Directors approved a two-for-one stock
split effected in the form of a stock dividend on its common
stock. To implement this stock split, shares of common stock were
issued on December 17, 2007 to stockholders of record as of the close of
business on December 6, 2007. All prior year share and per share
amounts disclosed in this document have been restated to reflect the two-for-one
stock split.
RESULTS
OF OPERATIONS
Three
months ended June 30, 2008 vs. Three months ended June 30, 2007
Consolidated net
sales for the second quarter ended June 30, 2008 totaled $1,516.6 million, an
11.2% increase over second quarter 2007. This increase occurred while
light-vehicle production was up 2% worldwide and down 14% in North America from
the previous year’s quarter. Light-vehicle production increased 6% in
Asia-Pacific and 5% in Europe. The net sales increase included the
effect of stronger foreign currencies, primarily the Euro, of approximately $125
million. Currency fluctuations impacted all of the Company’s product
lines. Without the currency impact, the increase in global net sales
was 2.0%, due to strong demand for the Company’s products in Europe and
Asia-Pacific, offset by weakness in North America.
Gross profit and
gross margin were $278.8 million and 18.4% for second quarter 2008 as compared
to $247.6 million and 18.1% for second quarter 2007. The gross margin
percentage increase is due to favorable product mix, offset by higher raw
material costs, including steel, copper, aluminum and plastic resin, and lower
vehicle production in North America. Raw material costs, net of
recoveries, increased approximately $1 million as compared to the second quarter
2007, of which steel was the single largest contributor. The Company
benefited in the quarter from lower nickel prices as compared to the second
quarter of 2007.
Second quarter
selling, general and administrative (“SG&A”) costs increased $24.7 million
to $159.9 million from $135.2 million, and increased as a percentage of net
sales to 10.5% from 9.9%. The impact of foreign exchange increased
SG&A by $11.9 million. Also, $3.3 million of amortization
for the immediate write off of in process R&D and order backlog related to
the Domination and Profit Transfer Agreement between the Company and BERU AG
(“BERU”) was incurred in the second quarter of 2008. R&D costs
increased $1.1 million to $57.8 million from $56.7 million as compared to second
quarter 2007.
Other income of
$(2.1) million and $(1.2) million for second quarter 2008 and 2007,
respectively, are comprised primarily of interest income.
Equity in
affiliates’ earnings of $11.9 million increased $3.1 million as compared to
second quarter 2007 due to increased sales and improved operating performance at
our joint ventures.
Second quarter
interest expense and finance charges of $10.8 million increased $1.5 million as
compared with second quarter 2007, primarily due to the June 30, 2008
measurement of ineffectiveness of a cross currency interest rate
swap.
The Company's
provision for income taxes is based upon an estimated annual tax rate for the
year applied to federal, state and foreign income. In the first
quarter of 2008, the projected global effective tax rate was estimated to be 26%
for the full year of 2008. With a projected decrease in U.S. income,
the projected global effective tax rate for full year 2008 is
25%. This rate differs from the U.S. statutory rate primarily due to
foreign rates, which differ from those in the U.S., the realization of certain
business tax credits including R&D and foreign tax credits and favorable
permanent differences between book and tax treatment for items, including equity
in affiliates’ earnings and a Medicare prescription drug
benefit. This rate is expected to be less than the full year 2007
global effective tax rate of 26.5% primarily due to the year over year projected
decrease in U.S. income and changes in tax laws, primarily in
Europe.
Net earnings were
$87.5 million for the second quarter, or $0.74 per diluted share, an increase of
$0.10 per diluted share over the previous year’s second
quarter. This increase included a one-time write off in process
R&D and order backlog related to the Domination and Profit Transfer
Agreement between the Company and BERU of $4.5 million, net of tax, or $0.04 per
diluted share.
Six
months ended June 30, 2008 vs. Six months ended June 30, 2007
Consolidated net
sales for the six months ended June 30, 2008 totaled $3,015.5 million, a 14.1%
increase over the six months ended June 30, 2007. This increase
occurred while light-vehicle production was up 3% worldwide and down 11% in
North America from the previous year’s first six
months. Light-vehicle production increased 8% in Asia-Pacific and 4%
in Europe. The net sales increase included the effect of stronger
foreign currencies, primarily the Euro, of approximately $241
million. Currency fluctuations impacted all of the Company’s product
lines. Without the currency impact, the increase in global net sales
would have been 5.0% due to strong demand for the Company’s products in Europe
and Asia-Pacific, offset by weakness in North America.
Gross profit and
gross margin were $562.3 million and 18.6% for the first six months of 2008 as
compared to $463.5 million and 17.5% for the first six months of
2007. The gross margin percentage increase is due to favorable
product mix, offset by higher raw material costs, including steel, copper,
aluminum, and plastic resin, and lower vehicle production in North
America. Raw material costs, net of recoveries, increased
approximately $6 million as compared to the first six months of 2007, of which
steel was the single largest contributor. Our focused cost reduction
programs in our operations partially offset these higher raw material
costs. Gross
margin for the six months ended June 30, 2007 contained a charge for
approximately $14 million, for a warranty-related issue surrounding a product,
built during a 15-month period in 2004 and 2005, that is no longer in
production.
Selling, general
and administrative (“SG&A”) costs for the first six months of 2008 increased
$53.7 million to $315.6 million from $261.9 million, and increased as a
percentage of net sales to 10.5% from 9.9%. The impact of foreign
exchange increased SG&A by $22.5 million. Also, $3.3 million
of amortization for the immediate write off of in process R&D and order
backlog related to the Domination and Profit Transfer Agreement between the
Company and BERU was incurred in the second quarter of 2008. R&D costs
increased $7.7 million to $115.3 million from $107.6 million as compared to the
first six months of 2007.
Other income of
$(1.0) million for the first six months of 2008 is comprised primarily of
interest income, offset by the realization of a loss on the sale of a product
line. Other income of $(1.9) million for the first six months of 2007
is comprised primarily of interest income.
Equity in
affiliates’ earnings of $21.0 million increased $3.0 million as compared to the
first six months of 2007 due to increased sales and improved operating
performance at our joint ventures.
Interest expense
and finance charges for the first six months of 2008 were $17.3 compared with
$18.2 million in the first six months of 2007, primarily due to reduced debt
levels.
The Company's
provision for income taxes is based upon an estimated annual tax rate for the
year applied to federal, state and foreign income. In the first
quarter of 2008, the projected global effective tax rate was estimated to be 26%
for the full year of 2008. With a projected decrease in U.S. income,
the projected global effective tax rate for full year 2008 is
25%. This rate differs from the U.S. statutory rate primarily due to
foreign rates, which differ from those in the U.S., the realization of certain
business tax credits including R&D and foreign tax credits and favorable
permanent differences between book and tax treatment for items, including equity
in affiliates’ earnings and a Medicare prescription drug
benefit. This rate is expected to be less than the full year 2007
global effective tax rate of 26.5% primarily due to the year over year projected
decrease in U.S. income and changes in tax laws, primarily in
Europe.
Net earnings for
the first six months of 2008 were $176.2 million, or $1.49 per diluted share, an
increase of $0.35 per diluted share over the previous year’s first six
months. This increase included a one-time write off in process
R&D and order backlog related to the Domination and Profit Transfer
Agreement between the Company and BERU of $4.5 million, net of tax, or $0.04 per
diluted share.
Reporting
Segments
The Company’s
business is comprised of two reporting segments: Engine and
Drivetrain. These reporting segments are strategic business groups,
which are managed separately as each represents a specific grouping of related
automotive components and systems.
The Company
allocates resources to each segment based upon the projected after-tax return on
invested capital (“ROIC”) of its business initiatives. The ROIC is
comprised of projected earnings before interest and income taxes (“EBIT”)
adjusted for income taxes compared to the projected average capital investment
required.
EBIT is considered
a “non-GAAP financial measure.” Generally, a non-GAAP financial
measure is a numerical measure of a company’s financial performance, financial
position or cash flows that excludes (or includes) amounts that are included in
(or excluded from) the most directly comparable measure calculated and presented
in accordance with GAAP. EBIT is defined as earnings before interest,
income taxes and minority interest. “Earnings” is intended to mean
net earnings as presented in the Consolidated Statements of Operations under
GAAP.
The Company
believes that EBIT is useful to demonstrate the operational profitability of our
segments by excluding interest and income taxes, which are generally accounted
for across the entire Company on a consolidated basis. EBIT is also
one of the measures used by the Company to determine resource allocation within
the Company. Although the Company believes that EBIT enhances
understanding of our business and performance, it should not be considered an
alternative to, or more meaningful than, net earnings or cash flows from
operations as determined in accordance with GAAP.
The following
tables present net sales, segment EBIT and total assets for the Company’s
reporting segments.
Net
Sales by Reporting Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
(millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
months ended
|
|
|
Six
months ended
|
|
|
|
June
30,
|
|
|
June
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Engine
|
|
$ |
1,109.0 |
|
|
$ |
955.4 |
|
|
$ |
2,207.1 |
|
|
$ |
1,849.5 |
|
Drivetrain
|
|
|
414.4 |
|
|
|
417.7 |
|
|
|
824.2 |
|
|
|
809.7 |
|
Inter-segment
eliminations
|
|
|
(6.8 |
) |
|
|
(8.8 |
) |
|
|
(15.8 |
) |
|
|
(17.1 |
) |
Net
sales
|
|
$ |
1,516.6 |
|
|
$ |
1,364.3 |
|
|
$ |
3,015.5 |
|
|
$ |
2,642.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment
Earnings Before Interest and Income Taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
months ended
|
|
|
Six
months ended
|
|
|
|
June
30,
|
|
|
June
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Engine
|
|
$ |
126.4 |
|
|
$ |
108.3 |
|
|
$ |
264.3 |
|
|
$ |
193.6 |
|
Drivetrain
|
|
|
21.8 |
|
|
|
33.3 |
|
|
|
40.1 |
|
|
|
61.0 |
|
Segment
earnings before interest and income taxes ("Segment EBIT")
|
|
|
148.2 |
|
|
|
141.6 |
|
|
|
304.4 |
|
|
|
254.6 |
|
Corporate,
including equity in affiliates' earnings and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
stock-based
compensation
|
|
|
15.3 |
|
|
|
19.2 |
|
|
|
35.7 |
|
|
|
33.1 |
|
Consolidated
earnings before interest and taxes ("EBIT")
|
|
|
132.9 |
|
|
|
122.4 |
|
|
|
268.7 |
|
|
|
221.5 |
|
Interest
expense and finance charges
|
|
|
10.8 |
|
|
|
9.3 |
|
|
|
17.3 |
|
|
|
18.2 |
|
Earnings
before income taxes and minority interest
|
|
|
122.1 |
|
|
|
113.1 |
|
|
|
251.4 |
|
|
|
203.3 |
|
Provision for
income taxes
|
|
|
29.8 |
|
|
|
30.5 |
|
|
|
63.4 |
|
|
|
54.9 |
|
Minority
interest, net of tax
|
|
|
4.8 |
|
|
|
6.9 |
|
|
|
11.8 |
|
|
|
14.3 |
|
Net
earnings
|
|
$ |
87.5 |
|
|
$ |
75.7 |
|
|
$ |
176.2 |
|
|
$ |
134.1 |
|
Three
months ended June 30, 2008 vs. Three months ended June 30, 2007
The Engine segment
net sales increased $153.6 million, or 16.1%, and Segment EBIT increased $18.1
million, or 16.7%, from second quarter 2007. Excluding the impact of
stronger foreign currencies, primarily the Euro, sales increased
4.9%. The Engine segment continued to benefit from European and Asian
automaker demand for turbochargers, timing systems and emissions products, and
European demand for diesel engine ignition systems. The segment EBIT
margin was negatively impacted by higher commodity costs, primarily
steel.
The Drivetrain
segment net sales decreased $3.3 million, or 0.8%, and Segment EBIT decreased
$11.5 million, or 34.5%, from second quarter 2007. Excluding the
impact of stronger foreign currencies, primarily the Euro, sales decreased
5.3%. The sales decrease was driven by lower North America production
of light trucks and sport-utility vehicles. The Drivetrain segment’s
EBIT decreased due to the combined effect of start-up cost pressures and lower
North American production of light trucks and sport-utility vehicles equipped
with its torque transfer products.
Six
months ended June 30, 2008 vs. Six months ended June 30, 2007
The Engine segment
net sales increased $357.6 million, or 19.3%, and Segment EBIT increased $70.7
million, or 36.5%, from the first six months of 2007. Excluding the
impact of stronger foreign currencies, primarily the Euro, sales increased
8.4%. The Engine segment continued to benefit from European and Asian
automaker demand for turbochargers, timing systems and emissions products, and
European demand for diesel engine ignition systems. The segment EBIT
margin was negatively impacted by sharply higher commodity costs, primarily
steel. The segment EBIT margin was negatively impacted in 2007 by
approximately $14 million for a warranty-related issue surrounding a product,
built during a 15-month period in 2004 and 2005, that is no longer in
production.
The Drivetrain
segment net sales increased $14.5 million, or 1.8%, and Segment EBIT decreased
$20.9 million, or 34.3%, from the first six months of 2007. Excluding
the impact of stronger foreign currencies, primarily the Euro, sales decreased
2.9%. The sales decrease was driven by lower North America production
of light trucks and sport-utility vehicles. The Drivetrain segment’s
EBIT decreased due to the combined effect of start-up cost pressures and lower
North American production of light trucks and sport-utility vehicles equipped
with its torque transfer products.
Outlook
for the remainder of 2008
Our overall outlook
for 2008 remains generally positive. We expect our sales to grow in excess
of a projected moderate global vehicle production growth rate with growth in
Europe and Asia expected to offset declines in North America. The impact
of raw materials, including steel, copper, aluminum and plastic resin, is
expected to continue to pressure gross profit.
We
remain concerned about the state of the North American automotive
market. On July
31, we announced a restructuring of our operations to align ongoing operations
with what we believe is a continuing, fundamental market shift in the U.S. auto
industry. The Company expects to reduce its North American workforce in
the third quarter by approximately 1,000 people, or 16% of our North American
employee base, spread across its operations in the U.S., Canada and
Mexico. Although not all aspects of the restructuring actions have been
finalized, the Company currently expects to incur pretax costs estimated in the
range of $10 million to $12 million in connection with the restructuring
actions. Other incremental costs, if any,
resulting from the restructuring actions are under evaluation.
Benefits from the restructuring are expected to be realized in the second half
of 2008.
We
anticipate that the European automotive market will experience a moderate slow
down in the second half of 2008, but that anticipated demand for our
technologies in down-sized turbocharged gas and diesel engines and more
efficient dual-clutch transmissions will continue to drive our above-average
growth. In Asia, we expect to continue to benefit from regional industry
growth and demand for our entire range of engine and drivetrain
products.
Assuming no major
departures from our assumptions, we expect continued long-term sales and net
earnings growth. The Company is committed to new product development and
strategic capital investments to enhance its product leadership strategy.
We believe that the global need for improved fuel economy and reduced emissions
without sacrificing vehicle performance will continue to drive our continued,
longer-term growth. Our products are key technologies used worldwide in
downsized, advanced gasoline and diesel engines, and in fuel-efficient automatic
transmissions, all-wheel drive systems and hybrid
powertrains.
FINANCIAL
CONDITION AND LIQUIDITY
Net cash provided
by operating activities increased $43.7 million to $267.1 million for the first
six months of 2008 from $223.4 million in the first six months of 2007. The
increase reflects higher earnings in the first six months of 2008 as compared to
the first six months of 2007. Capital spending, including tooling outlays, was
$162.2 million in the first six months of 2008, compared with $122.5 million in
2007. Selective capital spending remains an area of focus for the
Company, both in order to support our book of new business, and for cost
reductions and productivity improvements. The Company expects to
spend approximately $400 million on capital and tooling expenditures in 2008,
but this expectation is subject to ongoing review based on market
conditions.
As
of June 30, 2008, the portion of the acquisition related to the DPTA represents
a non-cash transaction. Future payments related to the annual dividend
arrangement will be reflected as financing activities and the acquisition of
shares tendered will be reflected as investing activities in the Condensed
Consolidated Statement of Cash Flows, consistent with the underlying
transaction.
As
of June 30, 2008, debt decreased from year-end 2007 by $9.4 million, cash
increased by $37.4 million and marketable securities decreased by $14.6
million. Our debt to capital ratio was 19.5% at the end of the second
quarter versus 20.7% at the end of 2007. The Company paid dividends to
BorgWarner stockholders of $25.8 million and $19.7 million in the first six
months of 2008 and 2007, respectively. The Company repurchased
618,095 shares of its common stock for $27.7 million in the first six months of
2008.
The Company
securitizes and sells certain receivables through third party financial
institutions without recourse. The amount sold can vary each month
based on the amount of underlying receivables. At both June 30, 2008
and December 31, 2007, the Company had sold $50 million of receivables under a
Receivables Transfer Agreement for face value without
recourse. During both of the six-month periods ended June 30, 2008
and 2007, total cash proceeds from sales of accounts receivable were $300
million. The Company paid servicing fees related to these receivables
for the three and six months ended June 30, 2008 and 2007 of $0.4 million and
$0.7 million and $1.0 million and $1.4 million, respectively. These
amounts are recorded in interest expense and finance charges in the Condensed
Consolidated Statements of Operations.
The Company has a
multi-currency revolving credit facility, which provides for borrowings up to
$600 million through July 2009. At June 30, 2008 and December 31,
2007 there were no borrowings outstanding
under the
facility. The credit agreement is subject to the usual terms and
conditions applied by banks to an investment grade company. The
Company was in compliance with all covenants at June 30, 2008 and expects to
remain compliant in future periods. The Company had outstanding
letters of credit of $21.9 million at June 30, 2008 and $22.0 million at
December 31, 2007. The letters of credit typically act as a guarantee
of payment to certain third parties in accordance with specified terms and
conditions.
From a credit
quality perspective, we have an investment grade credit rating of A- from
Standard & Poor’s and Baa1 from Moody’s, upgraded from Baa2 on February 11,
2008. The outlook from both agencies is stable.
The Company
believes that the combination of cash balances, cash flow from operations,
available credit facilities and $750 million available under a universal shelf
registration statement filed with the Securities and Exchange Commission on
March 4, 2008, under which a variety of debt and equity instruments could be
issued, will be sufficient to satisfy its cash needs for the current level of
operations and planned operations for the remainder of 2008. The
Company expects that net cash provided by operating activities will be
approximately $550 million in 2008.
Recent
Transaction
In
the second quarter of 2008, the Company and BERU AG (“BERU”) completed a
Domination and Profit Transfer Agreement (“DPTA”), giving BorgWarner full
control of BERU. Under this agreement BERU is obligated to transfer
100% of its profits or losses to the Company. Upon request of BERU
minority shareholders, the Company is obligated to purchase their shares for a
cash payment of €71.32 per share. Those BERU minority shareholders
who do not sell their shares are entitled to receive an annual compensatory
payment (perpetual dividend) of €4.73 (gross) per share, less certain taxes,
from the Company. The total obligation associated with the DPTA is
approximately €127.2 ($200.3) million, based upon the present value of the
perpetual dividend and approximates the cost if all remaining shares were
purchased by the Company at €71.32 per share. The DPTA obligation is
presented in the Condensed Consolidated Balance Sheet as $18.5 million in
current liabilities and $181.8 million in other non-current
liabilities.
In connection with
the DPTA, the Company recorded the remaining 17.8% of the fair value of BERU as
follows (in millions):
Elimination
of Minority Interest
|
|
|
$ |
86.6 |
|
Goodwill
|
|
|
|
71.2 |
|
Tangible and
Intangible Assets
|
|
|
|
61.7 |
|
Liabilities
|
|
|
|
(19.2 |
) |
Domination and Profit Transfer Agreement Obligation
|
|
|
$ |
200.3 |
|
The $71.2 million
of goodwill represents the excess of the DPTA obligation over the fair value of
assets acquired and liabilities assumed. Goodwill is reflected in the
Engine segment.
Of
the total tangible and intangible fair value write up of $61.7 million, $3.3
million of in process R&D and order backlog were immediately written off in
the selling, general, and administrative line and $1.8 million of beginning
inventory was immediately written off in the cost of sales line in the Condensed
Consolidated Statement of Operations. The combined pre-tax effect of
both items is $5.1 million, $4.5 million net of tax
or
$0.04 per diluted share.
As
of June 30, 2008, the portion of the acquisition related to the DPTA represents
a non-cash transaction. The cost related to the annual perpetual dividend
arrangement will be reflected as interest and income tax expense in the
Consolidated Statement of Operations. The annual payment of the
perpetual dividend will be reflected as a financing activity and the acquisition
of shares purchased by the Company will be reflected as an investing activity in
the Consolidated Statement of Cash Flows. The payment of the annual
perpetual dividend is expected to occur in the second quarter of each year,
beginning in 2009.
The DPTA is a
binding agreement. However, minority shareholders of BERU initiated
an appraisal proceeding in the German court system that challenges the
€71.32
purchase price and €4.73 annual
compensatory payment (perpetual dividend). If a higher price is
determined, the excess purchase price would be recorded as additional goodwill
with a corresponding increase to the Company’s total DPTA
obligation.
For a description
of our earlier acquisition of 82.2% of BERU, see Note 19 to the Notes
to Consolidated Financial Statements in our most recently filed Annual
Report on Form 10-K.
OTHER
MATTERS
In
the normal course of business the Company and its subsidiaries are parties to
various commercial and legal claims, actions and complaints, including matters
involving warranty claims, intellectual property claims, general liability and
various other risks. It is not possible to predict with certainty
whether or not the Company and its subsidiaries will ultimately be successful in
any of these commercial and legal matters or, if not, what the impact might
be. The Company’s environmental and product liability contingencies
are discussed separately below. The Company’s management does not
expect that the results in any of these commercial and legal claims, actions and
complaints will have a material adverse effect on the Company’s results of
operations, financial position or cash flows.
Environmental
The Company and
certain of its current and former direct and indirect corporate predecessors,
subsidiaries and divisions have been identified by the United States
Environmental Protection Agency and certain state environmental agencies and
private parties as potentially responsible parties (“PRPs”) at various hazardous
waste disposal sites under the Comprehensive Environmental Response,
Compensation and Liability Act (“Superfund”) and equivalent state laws and, as
such, may presently be liable for the cost of clean-up and other remedial
activities at 35 such sites. Responsibility for clean-up and other
remedial activities at a Superfund site is typically shared among PRPs based on
an allocation formula.
The Company
believes that none of these matters, individually or in the aggregate, will have
a material adverse effect on its results of operations, financial position, or
cash flows. Generally, this is because either the estimates of the
maximum potential liability at a site are not large or the liability will be
shared with other PRPs, although no assurance can be given with respect to the
ultimate outcome of any such matter.
Based on
information available to the Company (which in most cases includes: an estimate
of allocation of liability among PRPs; the probability that other PRPs, many of
whom are large, solvent public companies, will fully pay the cost apportioned to
them; currently available information from PRPs and/or federal or state
environmental agencies concerning the scope of contamination and estimated
remediation and consulting costs; remediation alternatives; and estimated legal
fees), the Company has established an accrual for
indicated
environmental liabilities with a balance at June 30, 2008 of $10.5
million. The Company has accrued amounts that do not exceed $3.0
million related to any individual site and management does not believe that the
costs related to any of these sites will have a material adverse effect on the
Company’s results of operations, cash flows or financial
condition. The Company expects to pay out substantially all of the
amounts accrued for environmental liability over the next three to five
years.
In
connection with the sale of Kuhlman Electric Corporation, the Company agreed to
indemnify the buyer and Kuhlman Electric for certain environmental liabilities,
then unknown to the Company, relating to certain operations of Kuhlman Electric
that pre-date the Company’s 1999 acquisition 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 is continuing to work with the Mississippi Department of Environmental
Quality and Kuhlman Electric to investigate and remediate to the extent
necessary, historical contamination at the plant and surrounding
area. Kuhlman Electric and others, including the Company, were sued
in numerous related lawsuits, in which multiple claimants alleged personal
injury and property damage. In 2005, the Company and other defendants
entered into settlements that resolved approximately 99% of the then known
personal injury and property damage claims relating to the alleged environmental
contamination. Those settlements involved payments by the Company of
$28.5 million in the second half of 2005 and $15.7 million in the first quarter
of 2006, in exchange for, among other things, dismissal with prejudice of these
lawsuits.
In
December 2007, a lawsuit was filed against Kuhlman Electric and others,
including the Company, on behalf of approximately 209 plaintiffs, alleging
personal injury relating to the alleged environmental
contamination. Given the early stage of the litigation, the Company
cannot make any predictions as to the outcome, but its current intent is to
vigorously defend against the suit.
Conditional
Asset Retirement Obligations
In
March 2005, the FASB issued Interpretation No. 47, Accounting
for Conditional Asset Retirement Obligations - an interpretation of FASB
Statement No.
143 (“FIN 47”), which requires the Company to recognize legal obligations
to perform asset retirements in which the timing and/or method of settlement are
conditional on a future event that may or may not be within the control of the
entity. Certain government regulations require the removal and
disposal of asbestos from an existing facility at the time the facility
undergoes major renovations or is demolished. The liability exists
because the facility will not last forever, but it is conditional on future
renovations (even if there are no immediate plans to remove the materials, which
pose no health or safety hazard in their current
condition). Similarly, government regulations require the removal or
closure of underground storage tanks (“USTs”) when their use ceases, the
disposal of polychlorinated biphenyl (“PCB”) transformers and capacitors when
their use ceases, and the disposal of used furnace bricks and liners, and
lead-based paint in conjunction with facility renovations or
demolition. The Company currently has 17 manufacturing locations that
have been identified as containing these items. The fair value to remove and
dispose of this material has been estimated and recorded at $1.0 million as of
June 30, 2008 and December 31, 2007.
Product
Liability
Like many other
industrial companies who have historically operated in the U.S., the Company (or
parties the Company is obligated to indemnify) continues to be named as one of
many defendants in asbestos-related personal injury
actions. Management believes that the Company’s involvement is
limited because, in general, these claims relate to a few types of automotive
friction products that were manufactured many years ago and contained
encapsulated asbestos. The nature of the fibers, the encapsulation and the
manner of use
lead the Company to
believe that these products are highly unlikely to cause harm. As of
June 30, 2008, the Company had approximately 37,000 pending asbestos-related
product liability claims. Of these outstanding claims, approximately
27,000 are pending in just three jurisdictions, where significant tort reform
activities are underway.
The Company’s
policy is to aggressively defend against these lawsuits and the Company has been
successful in obtaining dismissal of many claims without any payment. The
Company expects that the vast majority of the pending asbestos-related product
liability claims where it is a defendant (or has an obligation to indemnify a
defendant) will result in no payment being made by the Company or its
insurers. In the first six months of 2008, of the approximately 5,400
claims resolved, only 97 (1.8%) resulted in any payment being made to a claimant
by or on behalf of the Company. In 2007, of the approximately 4,400
claims resolved, only 194 (4.4%) resulted in any payment being made to a
claimant by or on behalf of the Company.
Prior to June 2004,
the settlement and defense costs associated with all claims were covered by the
Company’s primary layer insurance coverage, and these carriers administered,
defended, settled and paid all claims under a funding arrangement. In
June 2004, primary layer insurance carriers notified the Company of the alleged
exhaustion of their policy limits. This led the Company to access the next
available layer of insurance coverage. Since June 2004, secondary
layer insurers have paid asbestos-related litigation defense and settlement
expenses pursuant to a funding arrangement. To date, the Company has
paid $36.7 million in defense and indemnity in advance of insurers’
reimbursement and has received $12.1 million in cash from insurers. The
outstanding balance of $24.6 million is expected to be fully recovered.
Timing of the recovery is dependent on final resolution of the declaratory
judgment action referred to below. At December 31, 2007, insurers owed
$20.6 million in association with these claims.
At
June 30, 2008, the Company has an estimated liability of $39.2 million for
future claims resolutions, with a related asset of $39.2 million to recognize
the insurance proceeds receivable by the Company for estimated losses related to
claims that have yet to be resolved. Insurance carrier reimbursement of 100% is
expected based on the Company’s experience, its insurance contracts and
decisions received to date in the declaratory judgment action referred to below.
At December 31, 2007, the comparable value of the insurance receivable and
accrued liability was $39.6 million.
The amounts
recorded in the Condensed Consolidated Balance Sheets related to the estimated
future settlement of existing claims are as follows:
|
|
June
30,
|
|
|
December
31,
|
|
(millions)
|
|
2008
|
|
|
2007
|
|
Assets:
|
|
|
|
|
|
|
Prepayments
and other current assets
|
|
$ |
21.9 |
|
|
$ |
20.1 |
|
Other
non-current assets
|
|
|
17.3 |
|
|
|
19.5 |
|
Total
insurance receivable
|
|
$ |
39.2 |
|
|
$ |
39.6 |
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
$ |
21.9 |
|
|
$ |
20.1 |
|
Other
non-current liabilities
|
|
|
17.3 |
|
|
|
19.5 |
|
Total
accrued liability
|
|
$ |
39.2 |
|
|
$ |
39.6 |
|
The Company cannot
reasonably estimate possible losses, if any, in excess of those for which it has
accrued, because it cannot predict how many additional claims may be brought
against the Company (or parties the Company has an obligation to indemnify) in
the future, the allegations in such claims, the possible outcomes, or the impact
of tort reform legislation that may be enacted at the State or Federal
levels.
A
declaratory judgment action was filed in January 2004 in the Circuit Court of
Cook County, Illinois by Continental Casualty Company and related companies
(“CNA”) against the Company and certain of its other historical general
liability insurers. CNA provided the Company with both primary and
additional layer insurance, and, in conjunction with other insurers, is
currently defending and indemnifying the Company in its pending asbestos-related
product liability claims. The lawsuit seeks to determine the extent
of insurance coverage available to the Company including whether the available
limits exhaust on a “per occurrence” or an “aggregate” basis, and to determine
how the applicable coverage responsibilities should be
apportioned. On August 15, 2005, the Court issued an interim order
regarding the apportionment matter. The interim order has the effect
of making insurers responsible for all defense and settlement costs pro rata to
time-on-the-risk, with the pro-ration method to hold the insured harmless for
periods of bankrupt or unavailable coverage. Appeals of the interim
order were denied. However, the issue is reserved for appellate
review at the end of the action. In addition to the primary insurance
available for asbestos-related claims, the Company has substantial additional
layers of insurance available for potential future asbestos-related product
claims. As such, the Company continues to believe that its coverage
is sufficient to meet foreseeable liabilities.
Although it is
impossible to predict the outcome of pending or future claims or the impact of
tort reform legislation that may be enacted at the State or Federal levels, due
to the encapsulated nature of the products, the Company’s experiences in
aggressively defending and resolving claims in the past, and the Company’s
significant insurance coverage with solvent carriers as of the date of this
filing, management does not believe that asbestos-related product liability
claims are likely to have a material adverse effect on the Company’s results of
operations, cash flows or financial condition.
New
Accounting Pronouncements
In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141 (Revised 2007), Business Combinations (“FAS 141(R)”). FAS 141(R)
establishes principles and requirements for recognizing identifiable assets
acquired, liabilities assumed, noncontrolling interest in the acquiree, goodwill
acquired in the combination or the gain from a bargain purchase, and disclosure
requirements. Under this revised statement, all costs incurred to
effect an acquisition will be recognized separately from the
acquisition. Also, restructuring costs that are expected but the
acquirer is not obligated to incur will be recognized separately from the
acquisition. FAS 141(R) is effective for the Company beginning with
its quarter ending March 31, 2009. The Company is currently
assessing the potential impacts, if any, on its consolidated financial
statements.
In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
160, Noncontrolling Interests in Consolidated Financial Statements (“FAS
160”). FAS 160 requires that ownership interests in subsidiaries held
by parties other than the parent are clearly identified. In addition,
it requires that the amount of consolidated net income attributable to the
parent and to the noncontrolling interest be clearly identified and presented on
the face of the statement of operations. FAS 160 is effective for the
Company beginning with its quarter ending March 31, 2009. The
adoption of FAS 160 is not expected to have a material impact on the Company’s
consolidated financial position, results of operations or cash
flows.