UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 

Form 10-K

 

ANNUAL REPORT

 

(Mark One)

 

þ Annual Report Pursuant to Section 13 or 15(d) of

the Securities Exchange Act of 1934

 

For the fiscal year ended December 31, 2009

OR

o Transition Report Pursuant to Section 13 or 15(d) of

the Securities Exchange Act of 1934

For the transition period from                              to                              

 

Commission File Number: 1-12162

 

BorgWarner Inc.

(Exact name of registrant as specified in its charter)

 

 

3850 Hamlin Road,

Auburn Hills, Michigan 48326

(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code: (248) 754-9200

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered Pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

  Yes o     No  þ

 

The aggregate market value of the voting common stock of the registrant held by stockholders (not including voting common stock held by directors and executive officers of the registrant) on June 30, 2009 (the last business day of the most recently completed second fiscal quarter) was approximately $4.0 billion.

 

As of February 5, 2010, the registrant had 116,915,339 shares of voting common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the following documents are incorporated herein by reference into the Part of the Form 10-K indicated.

 

 

BORGWARNER INC.

 

Form 10-K

 

YEAR ENDED DECEMBER 31, 2009

 

INDEX

 

 

CAUTIONARY STATEMENTS FOR FORWARD-LOOKING INFORMATION

 

Statements contained in this Form 10-K (including Management’s Discussion and Analysis of Financial Condition and Results of Operations) may contain forward-looking statements as contemplated by the 1995 Private Securities Litigation Reform Act that are based on management’s current outlook, expectations, estimates and projections. Words such as “outlook,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” variations of such words and similar expressions are intended to identify such forward-looking statements. Forward-looking statements are subject to risks and uncertainties, many of which are difficult to predict and generally beyond our control, that could cause actual results to differ materially from those expressed, projected or implied in or by the forward-looking statements. Such risks and uncertainties include: fluctuations in domestic or foreign vehicle production, the continued use of outside suppliers, fluctuations in demand for vehicles containing our products, changes in general economic conditions, as well as the other risks noted under “Risk Factors.” We do not undertake any obligation to update any forward-looking statements.

 

 

BorgWarner Inc. and Consolidated Subsidiaries (the “Company”) is a Delaware corporation that was incorporated in 1987. We are a leading, global supplier of highly engineered automotive systems and components, primarily for powertrain applications. Our products help improve vehicle performance, fuel efficiency, stability and air quality. These products are manufactured and sold worldwide, primarily to original equipment manufacturers (“OEMs”) of light-vehicles (passenger cars, sport-utility vehicles, vans and light-trucks). The Company’s products are also sold to other OEMs of commercial trucks, buses and agricultural and off-highway vehicles. We also manufacture and sell our products to certain Tier One vehicle systems suppliers and into the aftermarket for light and commercial vehicles. The Company operates manufacturing facilities serving customers in the Americas, Europe and Asia, and is an original equipment supplier to every major automotive OEM in the world.

 

Financial Information About Segments

 

Refer to Note 19, “Reporting Segments and Related Information” of the Notes to the Consolidated Financial Statements in Item 8 of this report for financial information about business segments.

 

Narrative Description of Reporting Segments

 

The Company reports its results under two reporting segments: Engine and Drivetrain. Net revenues by segment for the three years ended December 31, 2009, 2008 and 2007 are as follows (in millions of dollars):

 

 

The sales information presented above excludes the sales by the Company’s unconsolidated joint ventures (See “Joint Ventures” section). Such unconsolidated sales totaled approximately $599 million in 2009, $792 million in 2008 and $720 million in 2007.

 

Engine

 

The Engine Group develops and manufactures products to manage engines for fuel efficiency, reduced emissions, and enhanced performance. Concern about fuel prices and availability, and the need to lower CO₂ emissions are driving demand for the Company’s products in smaller, more efficient gasoline and diesel engines and alternative powertrains in hybrid vehicles. Engine Group products currently fall into the following major categories: turbochargers, chain products, emissions systems, thermal systems, diesel cold start and gasoline ignition technology and cabin heaters.

 

The Engine Group provides turbochargers for light-vehicle, commercial-vehicle and off-road applications for diesel and gasoline engine manufacturers in Europe, North America, South America and Asia. The Engine Group has greatly benefited from the growth in turbocharger demand in Europe. This growth is linked to increasing demand for diesel engines in light vehicles which typically use turbochargers and for turbocharged gasoline engines. Benefits of turbochargers in both light-vehicle and commercial-vehicle applications include increased power for a given engine size, improved fuel economy and significantly reduced emissions.

 

Sales of turbochargers for light-vehicles represented approximately 27%, 24%, and 21% of the Company’s total revenues for 2009, 2008 and 2007, respectively. The Company currently supplies light-

vehicle turbochargers to many OEMs including Volkswagen, Renault, PSA, Daimler, Hyundai, Fiat, BMW, Ford and General Motors. The Company also supplies commercial-vehicle turbochargers to Caterpillar, John Deere, Daimler, International, Deutz and MAN.

 

The Company’s newest technologies are its regulated two-stage turbocharging system known as R2S^®, variable turbine geometry (“VTG”) turbochargers and turbochargers for gasoline direct injected engines. In 2008, the Company announced the start of production of its award winning R2S technology for Daimler’s new 4 cylinder diesel engine range. The Company also began shipping VTG turbochargers for VW’s new common-rail engine range and announced the launch of a VTG turbocharger for use with low-pressure exhaust gas recirculation to reduce emissions on VW’s Jetta Clean Diesel TDI. In 2009, the Company began shipping turbochargers for Ford’s 3.5 liter V6 direct-injected gasoline engines for rear-wheel drive cars and trucks. Additionally, Ford selected BorgWarner’s leading gasoline turborcharger technology for their new four-cylinder EcoBoost engine, scheduled to make its global debut early in 2010.

 

The Engine Group also designs and manufactures products to control emissions and improve fuel economy. These products include electric air pumps, turbo actuators that use integrated electronics to precisely control turbocharger speed and pressure ratio, and exhaust gas recirculation valves for gasoline and diesel applications.

 

The Engine Group’s chain and chain systems products include timing chain and timing drive systems, variable cam timing (“VCT”) systems, crankshaft and camshaft sprockets, tensioners, guides and snubbers, HY-VO ^® front-wheel drive (“FWD”) transmission chain and four-wheel drive (“4WD”) chain, and MORSE GEMINI ^® chain systems for light-vehicle and commercial-vehicle applications.

 

The Company’s timing chain systems are used in Ford’s family of overhead cam engines, including the Duratec and Modular, and in-line 4 cylinder engines, as well as on Chrysler’s 3.7 liter and 4.7 liter, overhead cam engines, and the 4 cylinder World Engine family of engines. In addition, the Company provides timing systems to a number of Asian OEMs and their North American operations, including Honda, Nissan, and Hyundai, and to several European OEMs. The Company believes that it is the world’s leading manufacturer of timing chain systems.

 

The Engine Group has successfully launched its latest VCT product; Cam Torque Actuated^tm (“CTA”) VCT. VCT is a means of precisely controlling the flow of air into and out of an engine by allowing the camshaft to be dynamically phased relative to its crankshaft. The Company’s CTA technology utilizes camshaft torque as its main actuation energy, instead of the conventional oil-pressure actuated approach. The CTA system has been launched on Ford’s 3.0 liter Duratec engine featured in the Ford Escape, Ford Fusion, Mazda 6, and Mercury Mariner.

 

The Company believes it is the world’s leading manufacturer of chain for FWD transmissions and 4WD transfer cases. HY-VO chain is used to transfer power from the engine to the drivetrain. The chain in a transfer case distributes power between a vehicle’s front and rear output shafts which, in turn, provide torque to the front and rear wheels. The Company’s MORSE GEMINI transmission chain system emits significantly less chain pitch frequency noise than conventional transmission chain systems.

 

The Engine Group believes it is a leading global provider of engine thermal solutions for truck, agricultural and off-highway applications. The group designs, manufactures and markets viscous fan drives that control fans to sense and respond to multiple cooling requirements. The Engine Group also manufactures and markets polymer fans for engine cooling systems. The Company’s thermal products provide improved vehicle fuel economy and reduced engine emissions while minimizing parasitic horsepower loss. The Company has been awarded the “standard position” (the OEM-designated preferred supplier of component systems available to the end-customer) at the major global heavy truck producers.

 

In 2005, the Company acquired approximately 69.4% of the outstanding shares of BERU Aktiengesellschaft (“BERU”), headquartered in Ludwigsburg, Germany. In 2007, the Company increased its ownership to approximately 82.2%. In the second quarter of 2008, the Company and BERU completed a Domination and Profit Transfer Agreement (“DPTA”), giving BorgWarner full control of BERU. On January 7, 2009 the Company informed BERU of its intention to purchase the remaining outstanding shares at that time

of approximately 4%, using the required German legal process referred to as a “squeeze-out” to gain 100% ownership. The “squeeze-out” became effective on September 30, 2009, making the Company the only shareholder of BERU. The Company’s corporate form and name were changed to BorgWarner BERU Systems GMBH (“BERU Systems”) in late 2009. Refer to Note 18, “Recent Transactions” of the Notes to the Consolidated Financial Statements in Item 8 of this report for further information related to the Company’s DPTA agreement with BERU.

 

BERU System’s operating results are included within the Company’s Engine Group segment. BERU Systems is a leading global automotive supplier of diesel cold starting technology (glow plugs and instant starting systems). It also designs and manufactures gasoline ignition technology (spark plugs and ignition coils); and electronic control units and sensor technology (tire pressure sensors, diesel cabin heaters and selected sensors). In 2008, BERU launched its new Pressure Sensor Glow Plug with which the combustion process of a diesel engine is monitored and enhanced, allowing the lowest CO₂ and NO_x emissions possible.

 

On June 2, 2009, the Company announced the purchase of advanced gasoline ignition technology and related intellectual property from Florida-based Etatech, Inc. The high-frequency ignition technology enables high-performing, lean burning engines to significantly improve fuel economy and reduce emissions compared with conventional combustion technologies.

 

Drivetrain

 

The Drivetrain Group leverages the Company’s expertise in clutching and control systems to enable efficient transmission of engine torque through the vehicle drivetrain and management of torque distribution to the driven wheels. The Company’s technology can improve fuel efficiency and help reduce emissions in all types of powertrains. The Drivetrain Group’s major products are transmission components and systems, and AWD torque management systems.

 

The Drivetrain Group designs and manufactures automatic transmission components and modules and is a supplier to virtually every major automatic transmission manufacturer in the world for both conventional automatic, new dual-clutch transmissions (“DCT”) and automated manual transmissions.

 

Friction and mechanical products include dual clutch modules, friction clutch modules, friction plates, transmission bands, torque converter clutches, one-way clutches and torsional vibration dampers. Controls products feature electro-hydraulic solenoids for standard and high pressure hydraulic systems, transmission solenoid modules and dual clutch control modules.

 

The Company’s 50%-owned joint venture in Japan, NSK-Warner Kabushiki Kaisha (“NSK-Warner”), is a leading producer of friction plates and one-way clutches in Japan. NSK-Warner is also the joint venture partner with a 40% interest in the Drivetrain Group’s Korean subsidiary, BorgWarner Transmission Systems Korea, Inc.

 

The Company has led the globalization of today’s DCT technology for over ten years. Following the development of its DCT technology in the 1990s, the Company established its industry-leading position in Europe in 2003 with the production launch of its award-winning DualTronic^® innovations with VW/Audi. In 2007, the Company launched its first dual-clutch technology application in a Japanese transmission with Nissan.

 

The Company has announced DCT programs with customers that include VW, Audi, SAIC and Nissan, in addition to Getrag DCT programs with BMW, Ford and other global automakers. Also, the Company is working on several programs with OEMs around the world. BorgWarner DualTronic technology enables a conventional, manual gearbox to function as a fully automatic transmission by eliminating the interruption in power flow that occurs when a single clutch manual transmission shifts gears. The result is a smooth shifting automatic transmission with the fuel efficiency and great driving experience of a manual gearbox.

 

On November 18, 2008, we entered into a joint venture agreement with China Automobile Development United Investment Company, a company owned by leading Chinese automakers, to produce various dual clutch transmission modules. The joint venture will be located in Dalian, China and production is scheduled to begin in 2011. BorgWarner will own 66% of the joint venture.

In conventional automatic transmissions, there has been a global market trend from four and five speeds to six, seven, and even eight speed transmissions. Transmissions with more speeds improve fuel economy and vehicle performance and offer growth opportunities.

 

The Drivetrain Group’s torque management products include rear-wheel drive (“RWD”)/all-wheel drive (“AWD”) transfer case systems, FWD/AWD electromagnetic coupling systems and advanced products. The Company’s focus is on electronically controlled (active) torque management devices and systems for their vehicle dynamics, fuel economy and stability benefits.

 

Transfer cases are installed primarily on light-trucks, sport-utility vehicles (“SUV”s), rear-wheel drive based cross-over utility vehicles (“CUV”s) and passenger cars. A transfer case attaches to the transmission and distributes torque to the front and rear axles improving vehicle traction and stability in dynamic driving conditions.

 

The Company is involved in the FWD/AWD market with electromagnetic couplings that use electronically controlled clutches to distribute power to the rear wheels instantly as traction is required. The NexTrac^® AWD device is our latest product innovation that produces outstanding stability and traction while promoting better fuel economy. The NexTrac AWD device launched in 2008 on the Hyundai Santa Fe, Tucson and KIA Sportage.

 

With the trend toward vehicle electrification gaining momentum, the Company is also applying its years of expertise to deliver robust and highly efficient single and multiple speed electric gear reduction solutions for hybrids and electric vehicles. Currently, we supply our eGearDrive^tm single-speed gearbox to the all-electric Tesla Roadster, and will also supply our eGearDrive to the all-electric CODA sedan scheduled for introduction in California in 2010. Additionally, we are actively engaged with traditional and non-traditional OEMs on seven other transmission programs for plug-in hybrid and electric vehicles.

 

Joint Ventures

 

As of December 31, 2009, the Company had 11 joint ventures in which it had a less-than-100% ownership interest. Results from the seven ventures in which the Company is the majority owner are consolidated as part of the Company’s results. Results from the four ventures in which the Company’s effective ownership interest is 50% or less, were reported by the Company using the equity method of accounting.

 

Management of the unconsolidated joint ventures is shared with the Company’s respective joint venture partners. Certain information concerning the Company’s joint ventures is set forth below:

 

 

 

 

Financial Information About Geographic Areas

 

Refer to Note 19, “Reporting Segments and Related Information” of the Notes to the Consolidated Financial Statements in Item 8 of this report for financial information about geographic areas.

 

Approximately 73% of the Company’s consolidated sales for 2009 were outside the United States, including exports. However, a portion of such sales were to OEMs headquartered outside the United States that produce vehicles that are, in turn, exported to the United States.

 

Customers

 

Approximately 75% of the Company’s total sales in 2009 were for light-vehicle applications; 17% of the Company’s sales were to a diversified group of commercial truck, bus, construction and agricultural vehicle manufacturers; and the remaining 8% to distributors of aftermarket replacement parts.

 

For the most recent three-year period, the Company’s worldwide sales to the following customers (including their subsidiaries) were approximately as follows:

 

 

No other single customer accounted for more than 10% of our consolidated sales in any year of the periods presented.

 

The Company’s automotive products are generally sold directly to OEMs substantially pursuant to negotiated annual contracts, long-term supply agreements or terms and conditions as may be modified by the parties. Deliveries are subject to periodic authorizations based upon the production schedules of the OEMs. The Company typically ships its products directly from its plants to the OEMs.

 

Sales and Marketing

 

Each of the Company’s business units within its two reporting segments has its own sales function. Account executives for each of our business units are assigned to serve specific OEM customers for one or more of a business unit’s products. Our account executives spend the majority of their time in direct contact

with OEM purchasing and engineering employees and are responsible for servicing existing business and for identifying and obtaining new business. Because of their close relationship with OEMs, account executives are able to identify and meet customers’ needs based upon their knowledge of our customer’s needs and our products and design and manufacturing capabilities. Upon securing a new order, account executives participate in product launch team activities and serve as a key interface with the customers.

 

In addition, the sales and marketing employees of our Engine segment and Drivetrain segment often work together to explore cross-development opportunities for the business units. The development of DualTronic, the Company’s wet-clutch and control-system technology for a new-concept automated transmission, is an example of a successful collaboration.

 

Seasonality

 

The Company’s business is moderately seasonal because the Company’s largest North American customers typically halt vehicle production for approximately two weeks in July and one week in December. Additionally, customers in Europe and Asia typically shut down vehicle production during portions of July or August and one week in the fourth quarter. Accordingly, the Company’s third and fourth quarters may reflect those practices.

 

Research and Development

 

The Company conducts advanced engine and drivetrain research at the segment level. This advanced engineering function looks to leverage know-how and expertise across product lines to create new engine and drivetrain systems and modules that can be commercialized. A venture capital fund that was created by the Company as seed money for new innovation and collaboration across businesses is managed by this function.

 

In addition, each of the Company’s business units within its two reporting segments has its own research and development (“R&D”) organization. The Company has approximately 700 employees, including engineers, mechanics and technicians, engaged in R&D activities at facilities worldwide. The Company also operates testing facilities such as prototype, measurement and calibration, life cycle testing and dynamometer laboratories.

 

By working closely with the OEMs and anticipating their future product needs, the Company’s R&D personnel conceive, design, develop and manufacture new proprietary automotive components and systems. R&D personnel also work to improve current products and production processes. The Company believes its commitment to R&D will allow it to obtain new orders from its OEM customers.

 

The following table presents the Company’s gross and net expenditures on R&D activities:

 

 

The Company’s net R&D expenditures are included in the selling, general, and administrative expenses of the Consolidated Statements of Operations. Net R&D expenditures as a percentage of net sales were 3.9% in 2009 and 2008 and 4.0% in 2007. 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 $6.0 million in any of the years presented.

 

Patents and Licenses

 

The Company has approximately 4,200 active domestic and foreign patents and patent applications pending or under preparation, and receives royalties from licensing patent rights to others. While it considers

its patents on the whole to be important, the Company does not consider any single patent, any group of related patents or any single license essential to its operations in the aggregate or to the operations of any of the Company’s business groups individually. The expiration of the patents individually and in the aggregate is not expected to have a material effect on the Company’s financial position or future operating results. The Company owns numerous trademarks, some of which are valuable, but none of which are essential to its business in the aggregate.

 

The Company owns the “BorgWarner” and “Borg-Warner Automotive” trade names and housemarks, and variations thereof, which are material to the Company’s business.

 

Competition

 

The Company’s operating segments compete worldwide with a number of other manufacturers and distributors which produce and sell similar products. Many of these competitors are larger and have greater resources than the Company. Price, quality, delivery, technological innovation, application engineering development and program launch support are the primary elements of competition.

 

The Company’s major competitors by product type follow:

 

 

 

In addition, a number of the Company’s major OEM customers manufacture, for their own use and for others, products which compete with the Company’s products. Other current OEM customers could elect to manufacture products to meet their own requirements or to compete with the Company. There can be no assurance that the Company’s business will not be adversely affected by increased competition in the markets in which it operates.

 

For many of its products, the Company’s competitors include suppliers in other parts of the world that enjoy economic advantages such as lower labor costs, lower health care costs and, in some cases, export subsidies and/or raw materials subsidies. Also, see Item 1A. Risk Factors.

Employees

 

As of December 31, 2009, the Company and its consolidated subsidiaries had approximately 12,500 salaried and hourly employees (as compared with approximately 13,800 employees at December 31, 2008), of which approximately 4,100 were U.S. employees. The approximately 13,800 employees at December 31, 2008 included anticipated reductions, which did occur in 2009. Refer to Note 17, “Restructuring” of the Notes to the Consolidated Financial Statements in Item 8 of this report for a discussion of actions taken in 2009. Approximately 19% of the Company’s U.S. workforce is unionized. The hourly employees at certain of our international facilities are also unionized. The Company believes its present relations with employees to be satisfactory.

 

Our only domestic collective bargaining agreement is for our Ithaca and Cortland, New York facilities. This agreement expires in September 2012.

 

Raw Materials

 

The company uses a variety of raw materials in the production of its automotive products including steel, aluminum, copper, plastic resins, and certain alloying elements. Manufacturing operations for each of the Company’s operating segments are dependent upon natural gas, fuel oil, and electricity.

 

Commodity prices dropped sharply in 2009 due to falling global demands and their subsequent oversupply. Commodity prices have recovered much of their value and have returned to 2007 levels after bottoming out during the recession of 2009.

 

As developed economies recover and auto production accelerates, certain commodities may experience temporary shortages and inflated prices until production volumes again reach equilibrium with market demands. The Company uses a variety of tactics in order to limit the impact of supply shortages and inflationary pressures.

 

The Company formed a global procurement organization to accelerate: cost reductions, purchases from lower cost regions, supplier rationalization, risk mitigation efforts, and collaborative buying activities. In addition, the Company uses long-term contracts, cost sharing arrangements, design changes, customer buy programs, and limited financial instruments to help control costs. The Company intends to use similar measures in 2010 and beyond. Refer to Note 10, “Financial Instruments” of the Notes to the Consolidated Financial Statements in Item 8 of this report for information related to the Company’s hedging activities.

 

For 2010, the Company believes that its supplies of raw materials and energy are adequate and available from multiple sources to support its manufacturing requirements.

 

Environmental Regulation and Proceedings

 

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 an accrual for indicated environmental liabilities with a balance at December 31, 2009 of $21.0 million. The Company has accrued amounts that do not exceed $3.0 million related to any individual site except for the Crystal Springs site discussed below, and we do 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 relating to the alleged environmental contamination. In 2005, the Company and other defendants entered into settlements that resolved approximately 99% of those claims and the remainder of them have since been dismissed.

 

In 2007 and 2008, four additional lawsuits were filed against Kuhlman Electric and others, including the Company, on behalf of approximately 340 plaintiffs, alleging personal injury relating to the alleged environmental contamination. At this stage of the litigation, the Company cannot make any predictions as to the outcome, but it is vigorously defending against the suits.

 

Conditional Asset Retirement Obligations

 

In March 2005, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Codification (“ASC”) Topic 410, Accounting for Conditional Asset Retirement Obligations, 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 and above ground storage tanks when their use ceases, the disposal of polychlorinated biphenyl 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 31 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 $1.3 million as of December 31, 2009 and $1.4 million as of December 31, 2008.

 

Available Information

 

Through its Internet website (www.borgwarner.com), the Company makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, all amendments to those reports, and other filings with the Securities and Exchange Commission, as soon as reasonably practicable after they are filed or furnished. The Company also makes the following documents available on its Internet website: the Audit Committee Charter; the Compensation Committee Charter; the Corporate Governance Committee Charter; the Company’s Corporate Governance Guidelines; the Company’s Code of Ethical Conduct; and the Company’s Code of Ethics for CEO and Senior Financial Officers. You may also obtain a copy of any of the foregoing documents, free of charge, if you submit a written request to Investor Relations, 3850 Hamlin Road, Auburn Hills, Michigan 48326.

Executive Officers of the Registrant

 

Set forth below are the names, ages, positions and certain other information concerning the executive officers of the Company as of February 11, 2010.

 

 

Mr. Manganello has been Chairman of the Board since June 2003 and Chief Executive Officer of the Company since February 2003. Mr. Manganello is also a director of Bemis Company, Inc. and he serves as the Board Chairman of Federal Reserve Bank of Chicago, Detroit branch.

 

Mr. Adams has been Executive Vice President, Chief Financial Officer and Chief Administrative Officer since April 2004. He was Executive Vice President — Finance and Chief Financial Officer of American Axle & Manufacturing Holdings Inc. (“American Axle”) from July 1999 until April 2004. Mr. Adams also is a director of Carlisle Companies Inc.

 

Mr. Sanderson has been Executive Vice President of the Company and Group President and General Manager of the Drivetrain Group since January 2010. From February 2009 until December 2009 he was Vice President of the Company and President and General Manager of BorgWarner Transmission Systems Inc. From October 1999 until June 2008 he was Chief Executive Officer, Americas of Siemens VDO.

 

Mr. Wood has been Executive Vice President of the Company since May 2009 and Group President and General Manager of the Engine Group since January 2010. He was President and General Manager of BorgWarner Turbo Systems Inc. and BorgWarner Emissions Systems Inc. from August 2005 through December 2009. He was President and General Manager of Morse TEC from January 2001 until July 2005.

 

Ms. Bertsch has been Vice President and Treasurer of the Company since November 30, 2009. From June 2009 through November 2009 she was Senior Vice President, Treasurer, and Chief Information Officer for Chrysler Group, LLC. From July 2008 through May 2009 she was Senior Vice President, Treasurer, and Chief Information Officer of Chrysler LLC. From May 2006 through June 2008 she was Vice President and Chief Information Officer of Daimler Chrysler’s Chrysler Group and Mercedes Benz NAFTA organizations and Chrysler LLC. From July 2001 through April 2006 she was Vice President, Global Sales and Marketing Finance.

 

Mr. CasaSanta has been Vice President of the Company and President and General Manager of BorgWarner Thermal Systems Inc. (“Thermal Systems”) since January 2010. He was General Manager of Thermal Systems from June 2009 through December 2009. He was President and General Manager of BorgWarner TorqTransfer Systems Inc. (“TTS”) from June 2008 until June 2009. He was Vice President and General Manager of Thermal Systems from January 2003 until June 2008.

 

Ms. D’Aversa has been Vice President, Human Resources since October 2004. She was Acting Vice President, Human Resources from April 2004 until September 2004 and Senior Director, Management and Organization Development from April 2004 until September 2004.

Mr. Gasparovic has been Vice President, General Counsel and Secretary of the Company since January 2007. He was Senior Vice President and General Counsel of Federal-Mogul Corporation from February 2005 until December 2006.

 

Mr. Obermayer has been Vice President since December 1999 and Controller since January 2005. He was Vice President and Treasurer of the Company from December 1999 through December 2004.

 

Mr. Verrier has been Vice President of the Company and President and General Manager of BorgWarner Morse TEC Inc. (“Morse TEC”) since January 2010. He was Vice President and General Manager, Passenger Car of BorgWarner Turbo Systems Inc. from January 2006 through December 2009. He was Vice President and General Manager of BorgWarner Turbo Europe from November 2004 until January 2006.

 

Mr. Waldhier has been Vice President of the Company since November 2008 and President and General Manager of BorgWarner BERU Systems since January 2010. He was Chief Executive Officer of BERU from October 2007 through December 2009 when it ceased to be a publicly held German company. He was Executive Vice President and Chief Operating Officer of SAS Automotive from April 2004 until October 2007.

 

 

The following risk factors and other information included in this Annual Report on Form 10-K should be considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impact our business operations. If any of the following risks occur, our business including its financial performance, financial condition, operating results and cash flows could be materially adversely affected.

 

Our industry is cyclical and our results of operations will be adversely affected by industry downturns.

 

Automotive and truck production and sales are cyclical and sensitive to general economic conditions and other factors including interest rates, consumer credit, and consumer spending and preferences. Further economic decline that results in further significant reduction in automotive or truck production would have a material adverse effect on our sales to original equipment manufacturers.

 

We continue to take steps to realign and resize our production capacity and cost structure to meet current and projected operational and market requirements. Further significant declines in the automotive industry and financial declines and restructurings by our significant customers may make it necessary to take further restructuring actions and charges.

 

We are dependent on market segments that use our key products and would be affected by decreasing demand in those segments.

 

Some of our products, in particular turbochargers, are currently used primarily in diesel passenger cars and commercial vehicles. Any significant reduction in production in these market segments or loss of business in these market segments could have a material adverse effect on our sales to original equipment manufacturers.

 

We face strong competition.

 

We compete worldwide with a number of other manufacturers and distributors that produce and sell products similar to ours. Price, quality, delivery, technological innovation, application engineering development and program launch support are the primary elements of competition. Our competitors include vertically integrated units of our major original equipment manufacturer customers, as well as a large number of independent domestic and international suppliers. We are not as large as a number of these companies and do not have as many financial or other resources. The competitive environment has changed dramatically over the past few years as our traditional U.S. original equipment manufacturer customers, faced with intense international competition, have expanded their worldwide sourcing of components. As a result, we have experienced competition from suppliers in other parts of the world that enjoy economic advantages, such as

lower labor costs, lower health care costs and, in some cases, export or raw materials subsidies. Increased competition could adversely affect our businesses.

 

We are under substantial pressure from original equipment manufacturers to reduce the prices of our products.

 

There is substantial and continuing pressure on original equipment manufacturers to reduce costs, including costs of products we supply. Although original equipment manufacturers have indicated that they will continue to rely on outside suppliers, a number of our major original equipment manufacturer customers manufacture products for their own uses that directly compete with our products. These original equipment manufacturers could elect to manufacture such products for their own uses in place of the products we currently supply. We believe that our ability to develop proprietary new products and to control our costs will allow us to remain competitive. However, we cannot assure you that we will be able to improve or maintain our gross margins on product sales to original equipment manufacturers or that the recent trend by original equipment manufacturers towards increased outsourcing will continue.

 

Annual price reductions to original equipment manufacturer customers appear to have become a permanent feature of our business environment. To maintain our profit margins, we seek price reductions from our suppliers, improve production processes to increase manufacturing efficiency, update product designs to reduce costs and develop new products, the benefits of which support stable or increased prices. Our ability to pass through increased raw material costs to our original equipment manufacturer customers is limited, with cost recovery often less than 100% and often on a delayed basis. We cannot assure you that we will be able to reduce costs in an amount equal to annual price reductions and increases in raw material costs.

 

We are sensitive to the effects of our major customers’ labor relations.

 

All three of our primary North American customers, Ford, Chrysler and General Motors, have major union contracts with the United Automobile, Aerospace and Agricultural Implement Workers of America. Because of domestic original equipment manufacturers’ dependence on a single union, we are affected by labor difficulties and work stoppages at original equipment manufacturers’ facilities. Similarly, a majority of our global customers’ operations outside of North America are also represented by various unions. Any extended work stoppage could have an adverse effect on our business.

 

Part of our labor force is unionized which could subject us to work stoppages.

 

As of December 31, 2009, approximately 19% of our U.S. workforce was unionized. Our only domestic collective bargaining agreement is for our Ithaca and Cortland, New York facilities. This agreement expires in September 2012. The hourly employees at certain of our international facilities are also unionized. While we believe that our relations with our employees are satisfactory, a prolonged dispute with our employees could have an adverse effect on our business.

 

We are subject to extensive environmental regulations.

 

Our operations are subject to laws governing, among other things, emissions to air, discharges to waters and the generation, handling, storage, transportation, treatment and disposal of waste and other materials. We believe that our business, operations and activities have been and are being operated in compliance in all material respects with applicable environmental, health and safety laws. However, the operation of automotive parts manufacturing plants entails risks in these areas, and we cannot assure you that we will not incur material costs or liabilities as a result. Furthermore, through various acquisitions over the years, we have acquired a number of manufacturing facilities, and we cannot assure you that we will not incur materials costs and liabilities relating to activities that predate our ownership. In addition, potentially significant expenditures could be required in order to comply with evolving environmental, health and safety laws that may be adopted in the future.

We have contingent liabilities related to environmental, product warranties, regulatory matters, litigation and other claims.

 

We and certain of our 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 at various hazardous waste disposal sites under the Comprehensive Environmental Response, Compensation and Liability Act and equivalent state laws. As a result, as of December 31, 2009, we may be liable for the cost of clean-up and other remedial activities at 35 of these sites.

 

We work with outside experts to determine a range of potential liability for environmental sites. The ranges for each individual site are then aggregated into a loss range for the total accrued liability. Management’s estimate of the loss range for environmental liability, including conditional asset retirement obligations, for 2009 is between approximately $20 million and $40 million. We record an accrual at the most probable amount within the range unless one cannot be determined; in which case we record the accrual at the low end of the range. Based on information available to us, we have established an accrual in our financial statements for indicated environmental liabilities, including our conditional asset retirement obligation under ASC Topic 410, with a balance of $1.3 million at December 31, 2009. We currently expect the substantial portion of this amount to be expended over the next three to five years.

 

We provide warranties to our customers for some of our products. Under these warranties, we may be required to bear costs and expenses for the repair or replacement of these products. We cannot assure you that costs and expenses associated with these product warranties will not be material, or that those costs will not exceed any amounts accrued for such warranties in our financial statement. Based upon information available to us, we have established an accrual in our financial statements for product warranties of $61.7 million at December 31, 2009.

 

We are also party to, or have an obligation to defend a party to, various legal proceedings, including those described in Note 14 to the Notes to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K.

 

We are currently, and may in the future become, subject to legal proceedings and commercial or contractual disputes. These claims typically arise in the normal course of business and may include, but not be limited to, commercial or contractual disputes with our suppliers, intellectual property matters and employment claims. There is a possibility that such claims may have an adverse impact on our business that is greater than we anticipate.

 

Our growth strategy may prove unsuccessful.

 

We have a stated goal of increasing revenues and operating income at a rate greater than global vehicle production by increasing content per vehicle with innovative new components and through select acquisitions. We may not meet our goal because of any of the following: (a) the failure to develop new products which will be purchased by our customers; (b) technology changes rendering our products obsolete; (c) a reversal of the trend of supplying systems (which allows us to increase content per vehicle) instead of components; and (d) the failure to find suitable acquisition targets or the failure to integrate operations of acquired businesses quickly and cost effectively.

 

We are subject to risks related to our international operations.

 

We have manufacturing and technical facilities in many regions and countries, including North America, Europe, China, India, South Korea, Japan, and Brazil and sell our products worldwide. For 2009, approximately 72% of our sales were outside North America. Consequently, our results could be affected by changes in trade, monetary and fiscal policies, trade restrictions or prohibitions, import or other charges or taxes, and fluctuations in foreign currency exchange rates, limitations on the repatriation of funds changing economic conditions, social unrest, political instability and disputes, and international terrorism. Compliance with multiple and potentially conflicting laws and regulations of various countries is burdensome and

expensive. See Note 19, “Reporting Segments and Related Information” to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K, regarding the size of our international operations.

 

We may not realize sales represented by awarded business.

 

We base our growth projections, in part, on commitments made by our customers. These commitments generally renew yearly during a program life cycle. If actual production orders from our customers do not approximate such commitments, it could adversely affect our business.

 

We are impacted by the rising cost of providing pension and other post employment benefits.

 

The automotive industry, like other industries, continues to be impacted by the rising cost of providing pension and other post employment benefits. To partially address this impact, we continue to make adjustments to certain retiree medical and pension plans. See Note 11, “Retirement Benefit Plans” to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K.

 

Certain defined benefit pension plans we sponsor are currently underfunded.

 

We sponsor certain defined benefit pension plans worldwide that are underfunded and will require cash payments. Additionally, if the performance of the assets in our pension plans does not meet our expectations, or if other actuarial assumptions are modified, our required contributions may be higher than we expect. See Note 11, “Retirement Benefit Plans” to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K.

 

Negative or unexpected tax consequences could adversely affect our business.

 

Adverse changes in the underlying profitability and financial outlook of our operations in several jurisdictions could lead to changes in our valuation allowances against deferred tax assets and other tax accruals that could adversely affect our financial performance.

 

Additionally, we are subject to tax audits by governmental authorities in the U.S. and numerous non-U.S. jurisdictions. Because the results of tax audits are inherently uncertain, negative or unexpected results from one or more such tax audits could adversely affect our business.

 

We rely on sales to major customers.

 

We rely on sales to original equipment manufacturers around the world. Supply to several of these customers requires significant investment by the Company in working capital, plant and equipment. Some of our customers are rated by the credit rating agencies as below investment grade. The loss of sales to a major customer, due to any of a variety of factors including non-renewal of purchase orders, the customer’s financial hardship or other unforeseen reasons, could adversely affect our business.

 

Furthermore, some of our sales are concentrated. Our worldwide sales in 2009 to Volkswagen and Ford constituted approximately 22% and 12%, respectively, of our 2009 consolidated sales.

 

Suppliers’ economic distress could result in the disruption of our operations and have a material effect on our business.

 

Unfavorable industry conditions such as lower production volumes; credit tightness; changes in foreign currencies; raw material, commodity, transportation, and energy price escalation; drastic changes in consumer preferences; and others could adversely affect our supply chain, and sometimes with little advanced notice. These conditions could also result in increased commercial disputes and supply interruption risks. In certain instances, it would be difficult and expensive for us to change suppliers that are critical to our business. On occasion, we must provide financial support to distressed suppliers or take other measures to protect our supply lines. While we have taken definite actions to mitigate these factors, we can not predict with certainty the potential adverse effects these costs might have on our business.

We continue to face highly volatile commodity costs used in the production of our products.

 

The Company uses a variety of commodities (including steel, nickel, copper, aluminum, plastic resins, other raw materials and energy) and materials purchased in various forms such as castings, powder metal, forgings, stampings, and bar stock. Increasing commodity costs will have an impact on our results. We have sought to alleviate the impact of increasing costs by including a material pass-through provision in our customer contracts wherever possible or by selectively hedging certain commodity exposures. Customers frequently challenge these contractual provisions and rarely pay the full cost of any materials increases. The discontinuation of being able to pass-through or hedge increasing commodity costs would adversely affect our business.

 

From time to time, commodity prices may also fall rapidly. When this happens, suppliers may withdraw capacity from the market until prices improve which may cause periodic supply interruptions. The same may be true of our transportation carriers and energy providers.

 

We could be adversely affected by supply shortages of components from our suppliers.

 

In an effort to manage and reduce the cost of purchased goods and services, we have been rationalizing our supply base. As a result, we are dependent on fewer sources of supply for certain components used in the manufacture of our products. The Company selects suppliers based on total value (including total landed price, quality, delivery, and technology), taking into consideration their production capacities and financial condition. We expect that they will deliver to our stated written expectations.

 

However, there can be no assurance that capacity limitations, labor unrest, weather emergencies, commercial disputes, government actions, riots, wars, sabotage, non-conforming parts, acts of terrorism, “Acts of God”, or other problems experienced by our suppliers will not result in occasional shortages or delays in their supply of components to us. If we were to experience a significant or prolonged shortage of critical components from any of our suppliers and could not procure the components from other sources, we would be unable to meet the production schedules for some of our key products and could miss customer delivery expectations. This would adversely affect our customer relations and business.

 

A downgrade in the ratings of our debt could restrict our ability to access the debt capital markets.

 

Changes in the ratings that rating agencies assign to our debt may ultimately impact our access to the debt capital markets and the costs we incur to borrow funds. If ratings for our debt fall below investment grade, our access to the debt capital markets would become restricted.

 

Additionally, our revolving credit agreement includes an increase in interest rates if the ratings for our debt are downgraded. Further, an increase in the level of our indebtedness and related interest costs may increase our vulnerability to adverse general economic and industry conditions and may affect our ability to obtain additional financing.

 

Conditions in the automotive industry may adversely affect our business.

 

Our financial performance depends on conditions in the global automotive industry. Original equipment manufactures have experienced difficulties from a weakened economy and tightened credit markets. If our customers reduce their orders to us, it would adversely affect our results of operations. A prolonged downturn in the automotive industry or a significant product mix shift due to consumer demand could require us to shut down plants or incur impairment charges. Continued uncertainty relating to the financial condition of automakers would have a negative impact on our business.

 

We are subject to possible insolvency of financial counterparties.

 

The Company engages in numerous financial transactions and contracts including insurance policies, letters of credit, credit line agreements, financial derivatives, and investment management agreements involving various counterparties. The Company is subject to the risk that one or more of these counterparties may become insolvent and therefore be unable to discharge its obligations under such contracts.

We are subject to possible insolvency of outsourced service providers.

 

The Company relies on third party service providers for administration of workers’ compensation claims, health care benefits, pension benefits, stockholder and bondholder registration and similar services. These service providers contribute to the efficient conduct of the Company’s business, so the Company could be adversely affected in the event of insolvency of one or more of these service providers.

 

A variety of other factors could adversely affect our business.

 

Any of the following could materially and adversely affect our business: the loss of or changes in supply contracts or sourcing strategies of our major customers or suppliers; start — up expenses associated with new vehicle programs or delays or cancellation of such programs, underutilization of our manufacturing facilities, which can be dependent on a single product line or customer; inability to recover engineering and tooling costs; market and financial consequences of recalls that may be required on products we supplied; delays or difficulties in new product development; the possible introduction of similar or superior technologies by others; and global excess capacity and vehicle platform proliferation.

 

 

The Company has received no written comments regarding its periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of its 2009 fiscal year that remain unresolved.

 

 

As of December 31, 2009, the Company had 59 manufacturing, assembly, and technical locations worldwide. In addition to its 15 U.S. locations, the Company has 10 locations in Germany; five locations in Korea; four locations in India and China; three locations in each of the United Kingdom, France, Japan, and Mexico and one location in each of Brazil, Canada, Hungary, Ireland, Italy, Monaco, Poland, Spain, and Taiwan. The Company also has several sales offices, warehouses and technical centers. The Company’s worldwide headquarters are located in a leased facility in Auburn Hills, Michigan. In general, the Company believes its facilities to be suitable and adequate to meet its current and reasonably anticipated needs.

The following is additional information concerning the principal manufacturing, assembly, and technical facilities operated by the Company, its subsidiaries, and affiliates.(a)

 

ENGINE

 

 

DRIVETRAIN

 

 

 

 

 

The Company is subject to a number of claims and judicial and administrative proceedings (some of which involve substantial amounts) arising out of the Company’s business or relating to matters for which the Company may have a contractual indemnity obligation. Refer to Note 14, “Contingencies” of the Notes to the Consolidated Financial Statements in Item 8 of this report for a discussion of environmental, asbestos and other litigation.

 

In January 2006, BorgWarner Diversified Transmission Products Inc (“DTP”), a subsidiary of the Company, filed a declaratory judgment action in United States District Court, Southern District of Indiana

(Indianapolis Division) against the United Automobile, Aerospace, and Agricultural Implements Workers of America (“UAW”) Local No. 287 and Gerald Poor, individually and as the representative of a defendant class. DTP sought the Court’s affirmation that DTP did not violate the Labor-Management Relations Act or the Employee Retirement Income Security Act by unilaterally amending certain medical plans effective April 1, 2006 and October 1, 2006, prior to the expiration of the then-current collective bargaining agreements. On September 10, 2008, the Court found that DTP’s reservation of the right to make such amendments reducing the level of benefits provided to retirees was limited by its collectively bargained health insurance agreement with the UAW, which did not expire until April 24, 2009. Thus, the amendments were untimely. In 2008 the Company recorded a charge of $4.0 million as a result of the Court’s decision.

 

DTP filed a declaratory judgment action in the United States District Court, Southern District of Indiana (Indianapolis Division) against the UAW Local No. 287 and Jim Barrett and others, individually and as representatives of a defendant class, on February 26, 2009 again seeking the Court’s affirmation that DTP will not violate the Labor — Management Relations Act or the Employment Retirement Income Security Act (ERISA) by modifying the level of benefits provided retirees to make them comparable to other Company retiree benefit plans after April 24, 2009. Certain retirees, on behalf of themselves and others, filed a mirror-image action in the United States District Court, Eastern District of Michigan (Southern Division) on March 11, 2009, for which a class has been certified. During the last quarter of 2009 the action pending in Indiana was dismissed, while the action in Michigan is continuing. At this stage of the litigation, the Company cannot make any predictions as to the outcome, but it is vigorously defending against the suit.

 

 

There were no matters submitted to the Company’s security holders during the fourth quarter of 2009.

 

 

The Company’s Common Stock is listed for trading on the New York Stock Exchange under the symbol BWA. As of February 5, 2010, there were 2,397 holders of record of Common Stock.

 

Cash dividends declared and paid per share, adjusted for stock splits in 2004 and 2007, were as follows:

 

 

On March 5, 2009, the Company announced the temporary suspension of the Company’s quarterly dividend of $0.12 per share until global economic conditions improve. The dividend policy is subject to review and change at the discretion of the Board of Directors.

 

High and low sales prices (as reported on the New York Stock Exchange composite tape) for the Common Stock for each quarter in 2008 and 2009 were:

 

The line graph below compares the cumulative total shareholder return on our Common Stock with the cumulative total return of companies on the Standard & Poor’s (S&P’s) 500 Stock Index, companies within BorgWarner’s peer group, and companies within Standard Industrial Code (“SIC”) 3714 — Motor Vehicle Parts.

 

This graph assumes the investment of $100 on September 1, 2004 and the reinvestment of all dividends since that date.

 

 

BWA, S&P 500 and Peer Group data gleaned from Capital IQ; SIC Code Index gleaned from Research Data Group

 

 

 

 

Repurchase of Equity Securities

 

The Company’s Board of Directors previously authorized the purchase of up to 9.8 million shares (adjusted for the Company’s 2007 two-for-one stock split) of the Company’s common stock. As of December 31, 2009, the Company had repurchased 5,422,428 shares.

 

All shares purchased under this authorization have been and will continue to be repurchased in the open market at prevailing prices and at times and in amounts to be determined by management as market conditions and the Company’s capital position warrant. The Company may use Rule 10b5-1 plans to facilitate share repurchase. Repurchased shares will be deemed treasury shares and may subsequently be reissued for general corporate purposes.

Equity Compensation Plan Information

 

As of December 31, 2009, the number of stock options and restricted common stock outstanding under our equity compensation plans, the weighted average exercise price of outstanding options and restricted common stock, and the number of securities remaining available for issuance were as follows:

 

 

 

millions of dollars, except share and per share data For the Year Ended December 31,

 

 

 

See the material in response to Item 7 of this report for a discussion of the factors that materially affect the comparability of the information contained in such data.

 

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 for and sell our products to certain Tier One vehicle systems suppliers and 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 include all-wheel drive transfer cases, torque management systems, and components and systems for automated transmissions.

 

RESULTS OF OPERATIONS

 

Overview

 

A summary of our operating results for the years ended December 31, 2009, 2008 and 2007 is as follows:

 

A summary of major factors impacting the Company’s net earnings for the year ended December 31, 2009 in comparison to 2008 and 2007 is as follows:

 

 

The Company’s earnings (loss) per diluted share were $0.23, $(0.31) and $2.45 for the years ended December 31, 2009, 2008 and 2007, respectively. The Company believes the following table is useful in highlighting non-recurring or non-comparable items that impacted its earnings per diluted share:

 

 

The company’s effective tax rate, after giving tax effect to the non-recurring or non-comparable items shown above, was (12.0%), 23.0%, and 27.1% for 2009, 2008, and 2007, respectively.

 

Net Sales

 

The table below summarizes the overall worldwide global light vehicle production percentage changes for 2009 and 2008:

 

Worldwide Light Vehicle Year Over Year Increase (Decrease) in Production

 

 

 

 

Our net sales decrease in 2009 of 24.7% was worse than the estimated worldwide market production decrease of 13.7%. This is due to the Company’s relative higher percentage of business in Europe and North America versus Asia; and certain product mix changes due to scrappage incentives. Our net sales decrease in 2008 of 1.2% was slightly better than the estimated worldwide market production decrease of 3.7%. The effect of changing currency rates had a negative impact on the Company’s net sales and net earnings in 2009, but had a positive impact on the Company’s net sales and net earnings in 2008. The effect of non-U.S. currencies, primarily the Euro, decreased net sales by approximately $169 million and decreased the Company’s net earnings by approximately $4 million in 2009. In 2008, non-U.S. currencies, primarily the Euro, increased net sales by approximately $191 million and reduced the Company’s net loss by approximately $13 million. The year over year decrease in net sales, excluding the unfavorable impact of currency, was 21.5% in 2009. The year over year decrease in net sales, excluding the favorable impact of currency, was 4.8% in 2008.

Consolidated net sales to a single customer (including their subsidiaries), which exceeded 10% of our total sales, were to Volkswagen of approximately 22%, 19%, and 15%; and to Ford of approximately 12%, 9%, and 12% for the years ended December 31, 2009, 2008 and 2007, respectively. Both of our reporting segments had significant sales to the customers listed above. Such sales consisted of a variety of products to a variety of customer locations and regions. No other single customer accounted for more than 10% of consolidated sales in any year of the periods presented.

 

Outlook

 

The Company is cautiously optimistic about 2010. The Company expects global production volumes to be higher in 2010 compared with 2009. However, visibility is limited in Europe due to uncertainty surrounding consumer demand, the impact of expiring government-sponsored incentive programs and other market dynamics.

 

The Company maintains a positive long-term outlook for its global business and is committed to new product development and strategic capital investments to enhance its product leadership strategy. The trends that are driving our long-term growth are expected to continue, including the growth of direct injection diesel and gasoline engines worldwide, the increased adoption of automated transmissions in Europe and Asia-Pacific, and the move to variable cam and chain engine timing systems in both Europe and Asia-Pacific. As the recovery from current global economic conditions occurs, we expect long-term sales and net earnings growth to resume to historical rates.

 

Results By Reporting Segment

 

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, income taxes and noncontrolling interest (“EBIT”) adjusted for 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 restructuring expense, goodwill impairment charge, interest, income taxes and noncontrolling 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 its segments by excluding restructuring expense, goodwill impairment charge, interest, income taxes and noncontrolling interest, 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 its business and performance, it should not be considered an alternative to, or more meaningful than, net earnings or cash flows from operations as determined in accordance with GAAP.

The following tables present net sales and Segment EBIT by segment for the years 2009, 2008 and 2007:

 

Net Sales

 

 

Earnings (Loss) Before Interest and Taxes

 

 

The Engine segment 2009 net sales were down 25.3% from 2008, with a 44.3% decrease in Segment EBIT over the same period. The Engine segment decrease was primarily driven by reduced global vehicle production and depressed demand for engine products. The Segment EBIT margin was 7.6% in 2009, down from 10.2% in 2008, due to the significant reduction in customer production schedules in the U.S. and European markets.

 

The Engine segment 2008 net sales were up 2.7% from 2007, with a 5.5% decrease in Segment EBIT over the same period. The Engine segment continued to benefit from Asian automaker demand for turbochargers and timing systems, European automaker demand for turbochargers, timing systems, exhaust gas recirculation (“EGR”) valves and diesel engine ignition systems. This benefit was offset by lower North American production of light truck and sport-utility vehicles. The Segment EBIT margin was 10.2% in 2008, down from 11.1% in 2007 (which includes the one-time write-off in 2008 of the excess purchase price allocated to BERU’s IPR&D, order backlog and inventory), due to the significant reduction in customer production schedules in the U.S. and European markets, and increased costs for raw materials, principally steel.

The Drivetrain segment 2009 net sales decreased 23.3% from 2008 with a 175.5% decrease in Segment EBIT over the same period. The group was negatively impacted by lower global production of light trucks and SUVs equipped with its torque transfer products and lower sales of its traditional transmission products. Segment EBIT margin was (1.2)% in 2009, down from (0.3)% in the prior year, primarily due to lower global production of light trucks and sport-utility vehicles equipped with its torque transfer products.

 

The Drivetrain segment 2008 net sales decreased 10.8% from 2007 with a 104.1% decrease in Segment EBIT over the same period. The group was negatively impacted by lower U.S. production of light trucks and SUVs equipped with its torque transfer products and lower sales of its traditional transmission products. Segment EBIT margin was (0.3)% in 2008, down from 7.4% in the prior year, due to the combined effect of DCT product start-up cost pressures and lower North American production of light trucks and sport-utility vehicles equipped with its torque transfer products.

 

Corporate is the difference between calculated total consolidated EBIT and the total of the Segments’ EBIT. It represents corporate headquarters’ expenses, expenses not directly attributable to the individual segments, expenses associated with divested operations and equity in affiliates’ earnings. This net expense was $111.3 million in 2009, $60.0 million in 2008 and $77.7 million in 2007. The increase in Corporate expenses in 2009 is primarily related to a decline in affiliate earnings, an increase in pension and other postemployment expenses and an increase in performance related compensation.

 

Other Factors Affecting Results of Operations

 

The following table details our results of operations as a percentage of sales:

 

 

Gross profit as a percentage of net sales was 14.2%, 15.9% and 17.8% in 2009, 2008 and 2007, respectively. Our gross profit decrease in 2009 was due to sales volumes declining faster than our ability to reduce our cost structure. Cost reduction actions taken in 2009 to reduce our cost structure included headcount reductions, global pay cuts, selected plant shutdowns and reduced work weeks outside of the U.S.

 

Selling, general and administrative expenses (“SG&A”) as a percentage of net sales were 11.6%, 10.3% and 10.0% in 2009, 2008 and 2007 respectively. 2009 SG&A expenses decreased $83.1 million or 15.3% compared to 2008. The 2009 increase in SG&A as a percentage of net sales was primarily due to a

significant year over year reduction in sales with increased pension and other postemployment expenses and performance related compensation, net of salary wage reductions.

 

Research and development (“R&D”) is a major component of our SG&A expenses. R&D spending, net of customer reimbursements, was $155.2 million or 3.9% of sales in 2009, compared to $205.7 million, or 3.9% of sales in 2008, and $210.8 million, or 4.0% of sales in 2007. We currently intend to continue to increase our spending in R&D, although the growth rate in the future may not necessarily match the rate of our sales growth. We also intend to continue to invest in a number of cross-business R&D programs, as well as a number of other key programs, all of which are necessary for short and long-term growth. Our current long-term expectation for R&D spending is approximately 4.0% of sales. We intend to maintain our commitment to R&D spending while continuing to focus on controlling other SG&A costs.

 

Restructuring expense of $50.3 million in 2009 and $127.5 million in 2008 was in response to declines in global customer production levels, customer restructurings and a subsequent evaluation of our headcount levels in North America, Europe and Asia and our long-term capacity needs.

 

In the second quarter of 2009, the Company took additional restructuring actions. The Company reduced its North American workforce by approximately 550 people, or 12%; its European workforce by approximately 150 people, or 2%; and its Asian workforce by approximately 60 people, or 3% in the second quarter. The net restructuring expense recognized in the second quarter was $9.0 million for employee termination benefits. In addition to employee termination costs, the Company recorded $36.3 million of asset impairment and $5.0 million of other charges in the second quarter of 2009 related to the North American and European restructuring. The combined 2009 restructuring expenses of $50.3 million are broken out by segment as follows: Engine $27.2 million, Drivetrain $19.7 million and Corporate $3.4 million.

 

Included in the second quarter of 2009 asset impairment charge is $22.3 million related to one of the Company’s European locations. During the second quarter of 2009 circumstances caused the Company to evaluate the long range outlook of the facility using an undiscounted and discounted cash flow model, both of which indicated that assets were impaired. The Company then used a replacement cost technique to determine the fair value of the assets at the facility. This reduction of asset value was included in the Engine segment.

 

On July 31, 2008, the Company announced a restructuring of its operations to align ongoing operations with a continuing, fundamental market shift in the auto industry. As a continuation of the Company’s third quarter restructuring, on December 11, 2008, the Company announced plans for additional restructuring actions. As a result of these third and fourth quarter 2008 restructuring actions, the Company had reduced its North American workforce by approximately 2,400 people, or 33%; its European workforce by approximately 1,600 people, or 18%; and its Asian workforce by approximately 400 people, or 17%. The restructuring expense recognized for employee termination benefits was $54.6 million. In addition to employee termination costs, the Company recorded $72.9 million of asset impairment charges related to the North American and European restructuring. The combined restructuring expenses of $127.5 million are broken out by segment as follows: Engine $85.3 million, Drivetrain $40.9 million and Corporate $1.3 million.

 

Refer to Note 17, “Restructuring” of the Notes to the Consolidated Financial Statements in Item 8 of this report for further discussion.

 

Equity in affiliates’ earnings, net of tax was $21.8 million, $38.4 million and $40.3 million in 2009, 2008 and 2007, respectively. This line item is primarily driven by the results of our 50% owned Japanese joint venture, NSK-Warner, and our 32.6% owned Indian joint venture, Turbo Energy Limited (“TEL”). The significant reduction to equity in affiliates’ earnings in 2009 is primarily due to lower vehicle production in Asia. For more discussion of NSK-Warner, see Note 5 of the Consolidated Financial Statements.

 

Interest expense and finance charges were $57.2 million, $38.8 million and $34.7 million in 2009, 2008 and 2007, respectively. The increase in 2009 expense over 2008 was primarily due to increased debt levels, resulting from the Company’s $373.8 million convertible debt offering, which provided the Company increased liquidity. The increase in 2008 expense over 2007 expense was primarily due to costs related to acquiring 100% of BERU.

The provision for income taxes The provision for income taxes resulted in an effective tax rate for 2009 of (103.4%) compared with rates of 237.9% in 2008 and 26.5% in 2007. The effective tax rate of (103.4%) for 2009 differs from the U.S. statutory rate primarily due to a reduction in U.S. income; foreign rates, which differ from those in the U.S.; the realization of certain business tax credits including R&D and U.S. based foreign tax credits; and favorable permanent differences between book and tax treatment for items, including equity in affiliates’ earnings.

 

Noncontrolling interest, net of tax of $9.4 million decreased by $6.9 million from 2008 and by $18.6 million from 2007. The decrease is primarily related to the Company’s increased ownership to 100% of BERU.

 

LIQUIDITY AND CAPITAL RESOURCES

 

     Capitalization

 

 

 

Stockholders’ equity increased by $185.2 million in 2009 as follows:

 

 

The currency translation component of other comprehensive income increased in 2009 primarily due to the strengthening of the Euro, Korean Won and British Pound in relation to the U.S. Dollar.

 

Operating Activities

 

Net cash provided by operating activities was $351.0 million, $400.8 million and $603.5 million in 2009, 2008 and 2007, respectively. The $49.8 million decrease in 2009 from 2008 was primarily due to lower operational earnings, somewhat offset by lower working capital needs. The $202.7 million decrease in 2008 from 2007 was primarily due to lower earnings and increased working capital. The $351.0 million of net cash provided by operating activities in 2009 consists of net earnings of $36.4 million, increased for non-cash

charges of $297.6 million and a $17.0 million increase in net operating assets and liabilities. Non-cash charges are primarily comprised of $260.9 million in depreciation and amortization.

 

Inventory decreased in 2009 by $143.0 million excluding the impact of currency due to lower business levels, particularly in North America and Europe.

 

Investing Activities

 

Net cash used in investing activities was $154.8 million, $343.9 million and $229.2 million in 2009, 2008 and 2007, respectively. Capital expenditures, including tooling outlays (“capital spending”) of $172.0 million in 2009, or 4.3% of sales and decreased $197.7 million over the 2008 level of $369.7 million, or 7.0% of sales. Selective capital spending remains an area of focus for us, both in order to support our book of new business and for cost reduction and other purposes. Heading into 2010, we plan to continue to spend capital to support the launch of our new applications and for cost reductions and productivity improvement projects.

 

Financing Activities and Liquidity

 

Liquidity: The Company had $357.4 million of cash on hand at December 31, 2009. The Company has a multi-currency revolving credit facility, which provides for borrowings up to $250 million through January 22, 2011. The facility is secured by unperfected pledges of the Company’s equity interests in its subsidiaries and certain assets. No secured party is entitled to perfect its lien on any of the collateral until the long term unsecured senior, non-credit enhanced debt rating of the Company is rated less than or equal to BB+ by Standard & Poor’s and less than or equal to Ba1 by Moody’s. The three key covenants of the credit agreement are a net worth test, a debt compared to EBITDA (“Earnings Before Interest, Taxes, Depreciation and Amortization”) test, and an interest coverage test. The Company was in compliance with all covenants at December 31, 2009 and expects to be compliant in future periods. At December 31, 2009 and 2008 there were no outstanding borrowings under the facility. In addition to the credit facility, as of December 31, 2009, the Company had approximately $376 million available under a universal shelf registration statement on file with the Securities and Exchange Commission under which a variety of debt and equity instruments could be issued. From a credit quality perspective, the Company has a credit rating of BBB from Standard & Poor’s and Ba1 from Moody’s. On March 18, 2009, Moody’s downgraded the Company’s credit rating from Baa3 to Ba1. The current outlook from Standard & Poor’s and Moody’s is negative. None of the Company’s debt agreements require accelerated repayment in the event of a decrease in credit ratings.

 

On April 24, 2009 the Company’s $50 million accounts receivable securitization facility matured and was repaid. On December 21, 2009 the Company entered into a new $50 million accounts receivable securitization facility. This facility matures on December 21, 2012, subject to extension or replacement of the revolving credit facility by January 2011. Both the maturity and repayment; as well as the subsequent renewal of our accounts receivable securitization facility are reflected as Financing activities in the Consolidated Statements of Cash Flows.

The Company’s significant contractual obligation payments at December 31, 2009 are as follows:

 

 

 

 

We believe that the combination of cash from operations, cash balances, available credit facilities, and the remaining shelf registration capacity will be sufficient to satisfy our cash needs for our current level of operations and our planned operations for the foreseeable future. We will continue to balance our needs for internal growth, external growth, debt reduction and cash conservation.

 

Financing Activities: Net debt increases, excluding the impact of currency translation, were $102.4 million and $107.5 million in 2009 and 2008 respectively. Net debt decreases were $101.7 million in 2007 excluding the impact of currency translation. Proceeds from stock options exercised, net of tax benefit were $8.7 million, $17.1 million and $46.3 million in 2009, 2008 and 2007, respectively. The Company paid dividends to BorgWarner stockholders of $13.8 million, $51.1 million and $39.4 million in 2009, 2008 and 2007, respectively. The Company had treasury stock purchases of $55.9 million and $47.0 million in 2008 and 2007, respectively.

The Company purchased approximately 0.4 million, 1.34 million and 1.28 million BERU shares in 2009, 2008 and 2007, respectively. The cost for these shares was $46.6 million, $136.8 million and $138.8 million for 2009, 2008 and 2007 respectively and has been reflected as “payments for noncontrolling interest acquired” in the Financing section of the Consolidated Statements of Cash Flows. See Note 18, “Recent Transactions” for further information.

 

Off Balance Sheet Arrangements

 

On April 24, 2009 the Company’s $50 million accounts receivable securitization facility matured and was repaid. On December 21, 2009 the Company entered into a new $50 million accounts receivable securitization facility. This facility matures on December 21, 2012, subject to extension or replacement of the revolving credit facility by January 2011. Both the maturity and repayment; as well as the subsequent renewal of our accounts receivable securitization facility are reflected as Financing activities in the Consolidated Statements of Cash Flows.

 

The Company is required to adopt Statement of Financial Accounting Standards No. 166, Accounting for Transfer of Financial Assets — an amendment of ASC Topic 860 (“FAS 166”) and Statement of Financial Accounting Standards No. 167, Amendments to ASC Topic 810 (“FAS 167”) on January 1, 2010. This adoption requires the Company to reflect its receivable securitization facility in its financial statements. Accounting rules prior to January 1, 2010 allowed off-balance sheet treatment. The first quarter 2010 impact of this adoption is expected to be an increase in receivables of $50 million and an increase in debt of $50 million in the Company’s December 31, 2009 and March 31, 2010 Condensed Consolidated Balance Sheets.

 

The Company has certain leases that are recorded as operating leases. Types of operating leases include leases on the headquarters facility, an airplane, vehicles, and certain office equipment. The Company also has a lease obligation for production equipment at one of its facilities. The total expected future cash outlays for all lease obligations at the end of 2009 is $62.0 million. See Note 15 to the Consolidated Financial Statements for more information on operating leases, including future minimum payments.

 

The Company has guaranteed the residual values of certain leased machinery and equipment at its facilities. The guarantees extend through the maturity of the underlying lease, which is in September 2010. In the event the Company exercises its option not to purchase the remaining machinery and equipment, the Company has guaranteed a residual value of $6.0 million at September 30, 2010.

 

Pension and Other Post Employment Benefits

 

The Company’s policy is to fund its defined benefit pension plans in accordance with applicable government regulations and to make additional contributions when appropriate. At December 31, 2009, all legal funding requirements had been met. The Company contributed $39.3 million to its defined benefit pension plans in 2009 and $13.3 million in 2008. The Company expects to contribute a total of $10 million to $20 million in 2010.

 

The funded status of all pension plans was a net unfunded position of $(229.9) million and $(253.5) million at the end of 2009 and 2008, respectively. Of these amounts, $(131.1) million and $(110.9) at the end of 2009 and 2008, respectively, were related to plans in Germany, where there is not a tax deduction allowed under the applicable regulations to fund the plans; hence the common practice is that they are unfunded plans.

 

Other post employment benefits primarily consist of post employment health care benefits for certain employees and retirees of the Company’s U.S. operations. The Company funds these benefits as retiree claims are incurred. Other post employment benefits had an unfunded status of $(278.5) million at the end of 2009 and $(328.5) million at the end of 2008. The unfunded levels decreased due to the closure of the Company’s Muncie, Indiana automotive components plant and changes in certain plan designs.

 

The Company believes it will be able to fund the requirements of these plans through cash generated from operations or other available sources of financing for the foreseeable future.

See Note 11 to the Consolidated Financial Statements for more information regarding costs and assumptions for employee retirement benefits.

 

OTHER MATTERS

 

Contingencies

 

In the normal course of business the Company and its subsidiaries are parties to various commercial and legal claims, actions and complaints, including matters involving warranty claims, intellectual property claims, general liability and various other risks. See Notes 7 and 14 to the Consolidated Financial Statements. 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.

 

Litigation Outcome

 

In January 2006, DTP, a subsidiary of the Company, filed a declaratory judgment action in United States District Court, Southern District of Indiana (Indianapolis Division) against the United Automobile, Aerospace, and Agricultural Implements Workers of America (“UAW”) Local No. 287 and Gerald Poor, individually and as the representative of a defendant class. DTP sought the Court’s affirmation that DTP did not violate the Labor-Management Relations Act or the Employee Retirement Income Security Act by unilaterally amending certain medical plans effective April 1, 2006 and October 1, 2006, prior to the expiration of the then-current collective bargaining agreements. On September 10, 2008, the Court found that DTP’s reservation of the right to make such amendments reducing the level of benefits provided to retirees was limited by its collectively bargained health insurance agreement with the UAW, which did not expire until April 24, 2009. Thus, the amendments were untimely. In 2008 the Company recorded a charge of $4.0 million as a result of the Court’s decision.

 

DTP filed a declaratory judgment action in the United States District Court, Southern District of Indiana (Indianapolis Division) against the UAW Local No. 287 and Jim Barrett and others, individually and as representatives of a defendant class, on February 26, 2009 again seeking the Court’s affirmation that DTP will not violate the Labor — Management Relations Act or the Employment Retirement Income Security Act (ERISA) by modifying the level of benefits provided retirees to make them comparable to other Company retiree benefit plans after April 24, 2009. Certain retirees, on behalf of themselves and others, filed a mirror-image action in the United States District Court, Eastern District of Michigan (Southern Division) on March 11, 2009, for which a class has been certified. During the last quarter of 2009 the action pending in Indiana was dismissed, while the action in Michigan is continuing. At this stage of the litigation, the Company cannot make any predictions as to the outcome, but it is vigorously defending against the suit.

 

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 an accrual for indicated environmental liabilities with a balance at December 31, 2009 of $21.0 million. The Company has accrued amounts that do not exceed $3.0 million related to any individual site except for the Crystal Springs site discussed below, and we do 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 relating to the alleged environmental contamination. In 2005, the Company and other defendants entered into settlements that resolved approximately 99% of those claims and the remainder of them have since been dismissed.

 

In 2007 and 2008, four additional lawsuits were filed against Kuhlman Electric and others, including the Company, on behalf of approximately 340 plaintiffs, alleging personal injury relating to the alleged environmental contamination. At this stage of the litigation, the Company cannot make any predictions as to the outcome, but it is vigorously defending against the suits.

 

Conditional Asset Retirement Obligations

 

In March 2005, the FASB issued ASC Topic 410, Accounting for Conditional Asset Retirement Obligations, 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 and above ground storage tanks when their use ceases, the disposal of polychlorinated biphenyl 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 31 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 $1.3 million as of December 31, 2009 and $1.4 million as of December 31, 2008.

 

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. We believe 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 December 31, 2009 and December 31, 2008 the Company had approximately 23,000 and 27,000 pending asbestos-related product liability claims, respectively. Of the 23,000 outstanding claims at December 31, 2009, approximately 12,000 were pending in just three jurisdictions, where significant tort and judicial reform activities are underway.

The Company’s policy is to vigorously 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 2009, of the approximately 5,300 claims resolved, only 223 (4.2%) resulted in any payment being made to a claimant by or on behalf of the Company. In 2008, of the approximately 17,500 claims resolved, only 210 (1.2%) 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 $79.8 million in defense and indemnity in advance of insurers’ reimbursement and has received $21.2 million in cash from insurers. The net outstanding balance of $58.6 million is expected to be fully recovered, of which $23.0 million is expected to be recovered in 2010. Timing of the recovery is dependent on final resolution of the declaratory judgment action referred to below. At December 31, 2008, insurers owed $35.9 million in association with these claims.

 

In addition, at December 31, 2009, the Company has estimated a liability of $49.9 million for claims asserted, but not yet resolved and their related defense costs. The Company also has a related asset of $49.9 million to recognize the proceeds receivable from the insurance carriers. 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, 2008, the comparable value of the insurance receivable and accrued liability was $34.7 million.

 

The amounts recorded in the Consolidated Balance Sheets related to the estimated future settlement of existing claims are as follows:

 

 

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 vigorously 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.

 

CRITICAL ACCOUNTING POLICIES

 

The consolidated financial statements are prepared in conformity with GAAP. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. Critical accounting policies are those that are most important to the portrayal of the Company’s financial condition and results of operations. These policies require management’s most difficult, subjective or complex judgments in the preparation of the financial statements and accompanying notes. Management makes estimates and assumptions about the effect of matters that are inherently uncertain, relating to the reporting of assets, liabilities, revenues, expenses and the disclosure of contingent assets and liabilities. Our most critical accounting policies are discussed below.

 

Revenue Recognition

 

The Company recognizes revenue when title and risk of loss pass to the customer, which is usually upon shipment of product. Although the Company may enter into long-term supply agreements with its major customers, each shipment of goods is treated as a separate sale and the price is not fixed over the life of the agreements.

 

Impairment of Long-Lived Assets

 

In accordance with ASC Topic 360, the Company periodically reviews the carrying value of its long-lived assets, whether held for use or disposal, including other intangible assets, when events and circumstances warrant such a review. Such events and circumstances include, but are not limited to, a significant decrease in market volumes, or project life, or a loss of a major customer application (i.e., a “triggering event”). The Company’s impairment review is performed at each manufacturing, assembly, and technical site by local and business unit management, using data that is the basis for the Company’s annual budget (or forecast on an interim basis) and long-range plan (“LRP”). The annual budget and LRP include a five year projection of future cash flows based on actual new products and customer commitments. If the operating site review reflects that a triggering event has occurred, the assets identified by the operating location as potentially impaired will be reviewed by management. The review will determine if a current or future alternative use exists for additional customer applications or if redeployment of the assets to any of the Company’s other operating sites around the world is justified. If a future alternative use can not be identified, a test for recoverability is performed at the lowest level for which cash flows can be identified. The test compares projected undiscounted future cash flows to the carrying value of a product line or a specific customer application or asset grouping, as applicable. If the undiscounted cash flow test for recoverability identifies a possible impairment, management will perform a test based on the discounted future cash flows. (The discount rate used for impairment testing is the same for both long-lived assets and goodwill). If the carrying value of the long-lived assets is considered impaired based on the discounted future cash flow analysis, an impairment charge is recorded for the amount by which the carrying value of the long-lived assets exceeds their fair value. In certain cases, management will consider estimates obtained from third parties as evidence of the assets’ fair value, including among other factors, the assets’ orderly liquidation value. Management believes that the

estimates of future cash flows and fair value assumptions are reasonable. However, changes in assumptions with respect to future volumes, program project life or future asset use, in addition to future cash flows underlying these estimates could affect the Company’s fair value evaluations.

 

Due to the sudden decline in the global automotive markets in 2008 and 2009, the Company reviewed the carrying value of its long-lived assets. As a result of these reviews, the Company recognized $36.3 million and $72.9 million in impairment of long-lived assets (i.e., plant and equipment) as part of restructuring expenses in 2009 and 2008, respectively. The 2009 and 2008 impairment charges are broken out by segment as follows:

 

 

Further declines in the industry could result in additional impairment charges on the Company’s remaining property, plant and equipment balance of $1,490.3 million and amortized intangible assets balance of $111.2 million at December 31, 2009.

 

See Note 17, “Restructuring” and Note 9 “Fair Value Measurements”, to the Consolidated Financial Statements for more information regarding the Company’s 2009 and 2008 impairment of long-lived assets and a discussion of market-based measurements.

 

Goodwill

 

The Company annually reviews its goodwill for impairment in the fourth quarter of each year for all of its reporting units, or more often when events and circumstances warrant such a review.

 

The Company’s goodwill impairment review utilizes the “two-step impairment test” required under ASC Topic 350, which requires us to make significant assumptions and estimates about the extent and timing of future cash flows, discount rates and growth rates. The basis of our goodwill impairment analysis is the Company’s annual budget and long-range plan (“LRP”). The annual budget and LRP include a five year projection of future cash flows based on actual new products and customer commitments. As part of the projection, we assumed the last year of the LRP data is a fair indication, on average, including fundamental industry growth, of the future performance of the business beyond the five year period into perpetuity. As the LRP is estimated over a significant future period of time, those estimates and assumptions are subject to a high degree of uncertainty. We also utilize market valuation models and other financial ratios, which require us to make certain assumptions and estimates regarding the applicability of those models to our assets and businesses. We believe that the assumptions and estimates used to determine the estimated fair values of each of our business units are reasonable. Different assumptions could materially affect the estimated fair value. The primary assumptions affecting the Company’s December 31, 2009 goodwill impairment review are as follows:

 

 

While the Company believes that these assumptions are appropriate, significant changes in these assumptions may materially affect the Company’s analysis. The following table illustrates the sensitivity to an

increase in our discount rate and decrease in our operating income margin assumptions; as it would have reduced the Company’s goodwill of $1,061.4 million as of December 31, 2009:

 

 

See Note 6 to the Consolidated Financial Statements for more information regarding goodwill.

 

Environmental Accrual

 

We work with outside experts to determine a range of potential liability for environmental sites. The ranges for each individual site are then aggregated into a loss range for the total accrued liability. Management’s estimate of the loss range for environmental liability, including conditional asset retirement obligations, for 2009 is between approximately $20 million and $40 million. We record an accrual at the most probable amount within the range unless one cannot be determined; in which case we record the accrual at the low end of the range. At the end of 2009, our total accrued environmental liability was $22.3 million, which includes our conditional asset retirement obligation under ASC Topic 410 of $1.3 million.

 

See Note 14 to the Consolidated Financial Statements for more information regarding environmental accrual.

 

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 claim settlements; as well as product manufacturing and industry developments and recoveries from third parties. Management actively studies trends of warranty claims and takes action to improve product quality and minimize warranty claims. Management believes that the warranty accrual is appropriate; however, actual claims incurred could differ from the original estimates, requiring adjustments to the accrual. Our warranty provision over the last three years, and as a percentage of net sales, has trended as follows:

 

 

The following table illustrates the sensitivity of a 25 basis point change (as a percentage of sales) in the assumed warranty trend on the Company’s accrued warranty liability:

 

 

At the end of 2009, our total accrued warranty liability was $61.7 million. The accrual is represented as $32.5 million in current liabilities and $29.2 million in non-current liabilities on our balance sheet.

 

See Note 7 to the Consolidated Financial Statements for more information regarding product warranty.

 

Other Loss Accruals and Valuation Allowances

 

The Company has numerous other loss exposures, such as customer claims, workers’ compensation claims, litigation, and recoverability of assets. Establishing loss accruals or valuation allowances for these matters requires the use of estimates and judgment in regard to the risk exposure and ultimate realization. We

estimate losses under the programs using consistent and appropriate methods; however, changes to our assumptions could materially affect our recorded accrued liabilities for loss or asset valuation allowances.

 

Pension and Other Post Employment Defined Benefits

 

The Company provides post employment defined benefits to a number of its current and former employees. Costs associated with post employment defined benefits include pension and post employment health care expenses for employees, retirees and surviving spouses and dependents.

 

Using appropriate actuarial methods and assumptions, the Company’s defined benefit pension and non-pension postretirement employee benefit plans are accounted for in accordance with ASC Topic 715. Disability, early retirement and other postretirement employee benefits are accounted for in accordance with ASC Topic 712.

 

The determination of the Company’s obligation and expense for its pension and other postretirement employee benefits, such as retiree health care, is dependent on certain assumptions used by actuaries in calculating such amounts. Certain of the more important assumptions are described in Note 11 “Retirement Benefit Plans” to the Company’s consolidated financial statements included in Item 8 “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K and include the discount rate, expected long-term rate of return on plan assets, rates of increase in compensation and health care costs, retirement rates, mortality rates and other factors. The effects of any modification to those assumptions are either recognized immediately or amortized over future periods in accordance with accounting principles generally accepted in the United States (“GAAP”).

 

In accordance with GAAP, actual results that differ from assumptions used are accumulated and generally amortized over future periods. The primary assumptions affecting the Company’s accounting for employee benefits under ASC Topics 712 and 715 as of December 31, 2009 are as follows:

 

 

Actual return on U.S. pension assets for 2009, 2008 and 2007 were 25.3%, (25.7%) and 3.9%, respectively, compared to the expected rate of return assumption of 7.50% in 2009 and 8.75% for 2008 and 2007.

 

Actual return on U.K. pension assets for 2009, 2008 and 2007 were 15.1%, (18.7%) and 6.4%, respectively, compared to the expected rate of return assumption of 7.50% in 2009 and 7.25% for 2008 and 2007.

 

 

 

While the Company believes that these assumptions are appropriate, significant differences in actual experience or significant changes in these assumptions may materially affect the Company’s pension and other postretirement employee benefit obligations and its future expense.

 

The following table illustrates the sensitivity to a change in certain assumptions for Company sponsored U.S. and non-U.S. pension plans on its 2010 pre-tax pension expense:

 

 

 

 

The following table illustrates the sensitivity to a change in the discount rate assumption related to the Company’s U.S. OPEB interest expense:

 

 

The sensitivity to a change in the discount rate assumption related to the Company’s total 2010 U.S. OPEB expense is expected to be negligible, as any increase in interest expense will be offset by net actuarial gains.

 

The following table illustrates the sensitivity to a one-percentage point change in the assumed health care cost trend related to the Company’s OPEB obligation and service and interest cost:

 

 

See Note 11 to the Consolidated Financial Statements for more information regarding the Company’s retirement benefit plans.

 

Income Taxes

 

The Company accounts for income taxes in accordance with ASC Topic 740. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company records a valuation allowance that primarily represents foreign net operating losses and U.S. based foreign tax credits for which utilization is uncertain. Management judgment

is required in determining the Company’s provision for income taxes, deferred tax assets and liabilities and the valuation allowance recorded against the Company’s net deferred tax assets. In calculating the provision for income taxes on an interim basis, the Company uses an estimate of the annual effective tax rate based upon the facts and circumstances known at each interim period. In determining the need for a valuation allowance, the historical and projected financial performance of the operation recording the net deferred tax asset is considered along with any other pertinent information. Since future financial results may differ from previous estimates, periodic adjustments to the Company’s valuation allowance may be necessary.

 

The Company is subject to income taxes in the U.S. at the federal and state level and numerous non-U.S. jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and recording the related assets and liabilities. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is less than certain. Accruals for income tax contingencies are provided for in accordance with the requirements of ASC Topic 605. The Company’s U.S. federal and certain state income tax returns and certain non-U.S. income tax returns are currently under various stages of audit by applicable tax authorities. Although the outcome of ongoing tax audits is always uncertain, management believes that it has appropriate support for the positions taken on its tax returns and that its annual tax provisions included amounts sufficient to pay assessments, if any, which may be proposed by the taxing authorities. At December 31, 2009, the Company has recorded a liability for its best estimate of the more likely than not loss on certain of its tax positions, which is included in other non-current liabilities. Nonetheless, 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.

 

See Note 4 to the Consolidated Financial Statements for more information regarding income taxes.

 

New Accounting Pronouncements

 

In June 2006, FASB ASC amended Topic 740, Income Taxes. The interpretation prescribes a consistent recognition threshold and measurement attribute, as well as clear criteria for subsequently recognizing, derecognizing and measuring such tax positions for financial statement purposes. ASC Topic 740 also requires expanded disclosure with respect to the uncertainty in income taxes. The Company adopted the provisions of ASC Topic 740 on January 1, 2007. As a result of the implementation of ASC Topic 740, the Company recognized a $16.6 million reduction to its January 1, 2007 retained earnings balance.

 

In September 2006, the FASB ASC amended Topic 820, Fair Value Measurements and Disclosures. ASC Topic 820 defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. On January 1, 2009, the Company fully adopted as required, ASC Topic 820. See Note 9 to the Consolidated Financial Statements for more information regarding the implementation of ASC Topic 820.

 

In February 2007, the FASB ASC amended Topic 825, Financial Instruments. ASC Topic 825 allows entities to irrevocably elect to recognize most financial assets and financial liabilities at fair value on an instrument-by-instrument basis. The stated objective of ASC Topic 825 is to improve financial reporting by giving entities the opportunity to elect to measure certain financial assets and liabilities at fair value in order to mitigate earnings volatility caused when related assets and liabilities are measured differently. ASC Topic 825 was effective for the Company beginning with its quarter ending March 31, 2008. The Company chose to not make the election to adopt.

 

In December 2007, the FASB ASC amended Topic 805, Business Combinations. ASC Topic 805 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 are recognized separately from the acquisition. Also, restructuring costs that are expected but the acquirer is not obligated to incur are recognized separately from the acquisition. On January 1, 2009, the Company adopted ASC Topic 805. In the first quarter of 2009, the Company expensed $4.8 million related to on-going acquisition related activity.

In December 2007, the FASB ASC amended Topic 810, Consolidation. For consolidated subsidiaries that are less than wholly owned, the third party holdings of equity interests are referred to as noncontrolling interests. The portion of net income (loss) attributable to noncontrolling interests for such subsidiaries is presented as net income (loss) applicable to noncontrolling interest on the consolidated statement of operation, and the portion of stockholders’ equity of such subsidiaries is presented as noncontrolling interest on the consolidated balance sheet. Effective January 1, 2009, the Company adopted ASC Topic 810.

 

The adoption of ASC Topic 810 did not have a material impact on the Company’s financial condition, results of operations or cash flows. However, it did impact the presentation and disclosure of noncontrolling (minority) interests in our consolidated financial statements and notes to the consolidated financial statements. As a result of the retrospective presentation and disclosure requirements of ASC Topic 810, the Company was required to reflect the change in presentation and disclosure for the period ending March 31, 2009 and all periods presented in future filings.

 

The principal effect on the prior year balance sheets related to the adoption of ASC Topic 810 is summarized as follows:

 

 

The principal effect on the prior year statement of operations related to the adoption of ASC Topic 810 is summarized as follows: