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, 2010

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):

 

(Do not check if a smaller reporting company)

 

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

  Yes 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, 2010 (the last business day of the most recently completed second fiscal quarter) was approximately $4.3 billion.

 

As of February 4, 2011, the registrant had 111,738,557 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, 2010

 

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 (the “Act”) that are based on management’s current outlook, expectations, estimates and projections. Words such as “anticipates,” “believes,” “continues,” “could,” “designed,” “effect,” “estimates,” “evaluates,” “expects,” “forecasts,” “goal,” “initiative,” “intends,” “outlook,” “plans,” “potential,” “project,” “pursue,” “seek,” “should,” “target,” “when,” “would,” variations of such words and similar expressions are intended to identify such forward-looking statements. All statements, other than statements of historical fact contained or incorporated by reference in this Form 10-K, that we expect or anticipate will or may occur in the future regarding our financial position, business strategy and measures to implement that strategy, including changes to operations, competitive strengths, goals, expansion and growth of our business and operations, plans, references to future success and other such matters, are forward-looking statements. Accounting estimates, such as those described under the heading “Critical Accounting Policies” in Item 7 of this Annual Report on Form 10-K, are inherently forward-looking. These statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions and expected future developments, as well as other factors we believe are appropriate in the circumstances.

 

You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report. 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 by original equipment manufacturers of outside suppliers, fluctuations in demand for vehicles containing our products, changes in general economic conditions, as well as the other risks noted under Item 1A, “Risk Factors” and in other reports that we file with the Securities and Exchange Commission. We do not undertake any obligation to update or announce publicly any updates to or revision to any of the forward-looking statements in this Form 10-K to reflect any change in our expectations or any change in events, conditions, circumstances, or assumptions underlying the statements.

 

This section and the discussions contained in Item 1A, “Risk Factors,” and in Item 7, subheading “Critical Accounting Policies” in this report, are intended to provide meaningful cautionary statements for purposes of the safe harbor provisions of the Act. This should not be construed as a complete list of all of the economic, competitive, governmental, technological and other factors that could adversely affect our expected consolidated financial position, results of operations or liquidity. Additional risks and uncertainties not currently known to us or that we currently believe are immaterial also may impair our business, operations, liquidity, financial condition and prospects.

 

 

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 Reporting 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, 2010, 2009 and 2008 are as follows :

 

 

The sales information presented above excludes the sales by the Company’s unconsolidated joint ventures (See “Joint Ventures” section). Such unconsolidated sales totaled approximately $779 million in 2010, $599 million in 2009 and $792 million in 2008.

 

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. Engine Group products currently fall into the following major categories: turbochargers, timing devices and 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 26%, 27%, and 24% of the Company’s total revenues for 2010, 2009 and 2008, 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, Navistar, 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 four-cylinder diesel engine range. The Company also began shipping VTG turbochargers for VW’s 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 2010, the Company began shipping turbochargers for Ford’s 3.5 liter V6 direct-injected gasoline EcoBoost engine for rear-wheel drive cars and trucks. Ford selected BorgWarner’s leading gasoline turbocharger technology for their new four-cylinder EcoBoost engine, which made its global debut 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 coolers, tubes and 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 on Ford’s family of engines, including the Duratec, Modular and in-line four-cylinder engines, as well as on a number of Chrysler’s engines, including its 3.7 liter and 4.7 liter engines, the four-cylinder World Engine and the new 3.6 liter Pentastar engine. In addition, the Company provides timing systems to a number of Asian OEMs, 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’s newest technology is its VCT with mid position lock, which allows a greater range of camshaft positioning thereby enabling greater control over airflow and the opportunity to improve fuel economy, function and efficiency compared with conventional VCT systems. BorgWarner is currently working with five OEMs to implement the technology.

 

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 Company also 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. Through a series of transactions and legal actions, the Company became the only shareholder of BERU effective September 30, 2009. That company’s corporate form and name was changed to BorgWarner BERU Systems GmbH (“BERU Systems”) in late 2009.

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 start technology (glow plugs and instant starting systems). 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. 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).

 

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.

 

On April 10, 2010, the Company acquired 100% of Dytech ENSA S.L. (“Dytech”), headquartered in Vigo, Spain. Dytech is a leading producer of exhaust gas recirculation (EGR) coolers, EGR tubes, and integrated EGR modules including valves for automotive and commercial vehicle applications, both on- and off-road.

 

In anticipation of market growth expected for its electric cabin heaters, the Company completed the acquisition of BERU-Eichenauer GmbH by acquiring the shares of its former joint venture partner, Eichenauer Heizelemente GmbH & Co. KG. The former 50/50 joint venture was formed in 2000 to develop and manufacture electric cabin heaters. The acquisition formally took effect on May 1, 2010.

 

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 all-wheel drive (“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 other DCT 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’s operations will be located in Dalian, China and production is scheduled to begin in 2011. The Company owns 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”)/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 Ford Transit Connect Electric. We are actively engaged with traditional and non-traditional OEMs on a number of other transmission programs for plug-in hybrid and electric vehicles.

 

On January 31, 2011, the Company acquired the Traction Systems division of Haldex Group, a leading provider of innovative all-wheel drive (AWD) products for the global vehicle industry headquartered in Stockholm, Sweden. The purchase price was approximately $205 million (1.425 billion Swedish Krona). The operating results will be reported within the Company’s Drivetrain reporting segment from the date of acquisition.

 

This acquisition is expected to accelerate BorgWarner’s growth in the global AWD market as it continues to shift toward front-wheel drive (FWD) based vehicles. The acquisition will add industry leading FWD/AWD technologies, with a strong European customer base, to BorgWarner’s existing portfolio of front and rear-wheel drive based products. This enables BorgWarner to provide global customers a broader range of all-wheel drive solutions to meet their vehicle needs.

 

Joint Ventures

 

As of December 31, 2010, the Company had 11 joint ventures in which it had a less-than-100% ownership interest. Results from the eight ventures in which the Company is the majority owner are consolidated as part of the Company’s results. Results from the three 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 74% of the Company’s consolidated sales for 2010 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 77% of the Company’s total sales in 2010 were for light-vehicle applications; 16% of the Company’s sales were to a diversified group of commercial truck, bus, construction and agricultural vehicle manufacturers; and the remaining 7% 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 products 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. 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 reporting 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 3.3% in 2010 and 3.9% in both 2009 and 2008. 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 4,000 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. Technological innovation, application engineering development, quality, price, delivery 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 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.

 

Workforce

 

As of December 31, 2010, the Company and its consolidated subsidiaries had a salaried and hourly workforce of approximately 17,500 (as compared with approximately 12,500 at December 31, 2009), of which approximately 5,000 were in the U.S. Approximately 23% of the Company’s U.S. workforce is unionized. The hourly workforces at certain of our international facilities are also unionized. The Company believes its present relations with our workforce 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 alloy elements. Manufacturing operations for each of the Company’s operating segments are dependent upon natural gas, fuel oil, and electricity.

 

Due to a global economic recovery in 2010, commodity prices increased after dropping sharply in 2009. The 2009 decline in commodity prices was due to falling global demand and oversupply.

 

As developed economies continue to 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’s global procurement organization works 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 2011 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 2011, the Company believes that its supplies of raw materials and energy are adequate and available from multiple sources to support its manufacturing requirements.

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 10, 2011.

 

 

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 Zep 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. Mr. Adams serves as a member of BorgWarner’s Board of Directors. 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 of the Engine Group since January 2010. He was President of BorgWarner Turbo Systems Inc. and BorgWarner Emissions Systems Inc. from August 2005 through December 2009.

 

Ms. Bertsch has been Vice President and Treasurer of the Company since November 30, 2009. From July 2008 through November 2009 she was Senior Vice President, Treasurer, and Chief Information Officer for Chrysler Group, LLC and 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 for Chrysler LLC.

 

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.

 

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. Hundzinski has been Vice President and Controller of the Company since April 2010. He was Vice President of Finance of BorgWarner Turbo Systems from June 2005 to April 2010.

 

Ms. McAdams has been Vice President, Human Resources since March 2010. She was Director of Compensation and Benefits from May 2005 to March 2010. She was Vice President of Human Resources at Metaldyne from January 2004 until 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 and Emissions 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. Economic declines that result in 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. Significant declines in the automotive industry and financial declines and restructurings by our significant customers may make it necessary to take restructuring actions and charges.

 

We are dependent on market segments that use our key products. Decreased demand in those segments could adversely affect our business.

 

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 trend by original equipment manufacturers towards 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, increases in raw material costs, and increases in employee wages and benefits.

 

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, 2010, approximately 23% 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 material 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, 2010, we may be liable for the cost of clean-up and other remedial activities at 38 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 2010 is between approximately $27 million and $42 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 of $29.2 million, which includes our conditional asset retirement obligation under ASC Topic 410 of $1.2 million at December 31, 2010. 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 $66.8 million at December 31, 2010.

 

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 2010,

approximately 74% 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 2010 to Volkswagen and Ford constituted approximately 19% and 11%, respectively, of our 2010 consolidated sales.

 

Suppliers’ economic distress could result in the disruption of our operations and could adversely affect our business.

 

Rapidly changing industry conditions such as volatile 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 cannot 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 ability 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 could become restricted.

 

Additionally, our revolving credit agreement includes an increase in interest rates if the ratings for our debt are downgraded. The interest costs on our revolving credit agreement are based on a rating grid agreed to in our credit agreement. 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 manufacturers 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 may adversely affect 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. Insolvency of one or more of these service providers could adversely affect our business.

 

Our business success depends on attracting and retaining qualified personnel.

 

Our ability to sustain and grow our business requires us to hire, retain and develop a highly skilled and diverse management team and workforce worldwide. Any unplanned turnover or inability to attract and retain key employees in numbers sufficient for our needs could adversely affect our business.

 

We are subject to business continuity risks associated with increasing centralization of our information technology systems.

 

To improve efficiency and reduce costs, we have regionally centralized the information systems that support our business processes such as invoicing, payroll and general management operations. If the centralized systems are disrupted or disabled, key business processes could be interrupted, which could adversely affect our business.

 

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 2010 fiscal year that remain unresolved.

 

As of December 31, 2010, the Company had 57 manufacturing, assembly, and technical locations worldwide. In addition to its 14 U.S. locations, the Company has nine locations in Germany; six locations in Korea; five locations in India; four locations in China; three locations in Japan and Mexico; two locations in United Kingdom, France and Spain and one location in each of Brazil, Hungary, Ireland, Italy, Monaco, Poland and Portugal. 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 (ERISA) 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 considered 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 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 and in the discovery phase. The Company is vigorously defending against the suit. This contingency is subject to many uncertainties, therefore based on the information available to date, the Company cannot estimate the amount or the range of potential loss, if any.

 

Environmental, Conditional Asset Retirement Obligations and Product Liability

 

Refer to Note 14, “Contingencies” in the Notes to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K.

 

 

 

The Company’s Common Stock is listed for trading on the New York Stock Exchange under the symbol BWA. As of February 4, 2011, there were 2,511 holders of record of Common Stock.

 

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

 

 

On March 5, 2009, the Company announced the 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 2009 and 2010 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.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among BorgWarner Inc., the S&P 500 Index,
SIC 3714 Motor Vehicle Parts and a Peer Group

 

 

*$100 invested on 12/31/05 in stock or index, including reinvestment of dividends.
Fiscal year ending December 31.

 

Copyright^© 2011 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved.

 

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 authorized the purchase of up to 14.8 million shares of the Company’s common stock. As of December 31, 2010, the Company had repurchased 12,563,528 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.

 

The following table provides information about Company purchases of its equity securities that are registered pursuant to Section 12 of the Exchange Act during the quarter ended December 31, 2010, at a total cost of $132.2 million:

 

ISSUER REPURCHASES OF EQUITY SECURITIES

 

 

 

NOTE: All purchases were made on the open market.

 

Equity Compensation Plan Information

 

As of December 31, 2010, 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,

 

 

 

 

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, 2010, 2009 and 2008 is as follows:

 

A summary of major factors impacting the Company’s net earnings for the year ended December 31, 2010 in comparison to 2009 and 2008 is as follows:

 

 

The Company’s earnings (loss) per diluted share were $3.07, $0.23 and $(0.31) for the years ended December 31, 2010, 2009 and 2008, 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 21.7%, (12.0)%, and 23.0% for 2010, 2009, and 2008, respectively.

 

Net Sales

 

The table below summarizes the overall worldwide light vehicle production percentage changes for 2010 and 2009:

 

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

 

 

 

 

Our net sales increase in 2010 of 42.7% was better than the estimated worldwide market production increase of 23.5%. Our net sales decrease in 2009 of 24.7% was worse than the estimated worldwide market production decrease of 13.7%. The effect of changing currency rates had a negative impact on the Company’s net sales and net earnings in 2010 and in 2009. The effect of non-U.S. currencies, primarily the Euro, decreased net sales by approximately $90 million in 2010. Non-US currencies had a negligible impact on the Company’s net earnings in 2010. In 2009, non-U.S. currencies, primarily the Euro, decreased net sales by approximately $169 million and reduced the Company’s net earnings by approximately $4 million.

The year over year increase in net sales, excluding the unfavorable impact of currency, was 45% in 2010. The year over year decrease in net sales, excluding the unfavorable impact of currency, was 21.5% in 2009.

 

Consolidated net sales to a single customer (including their subsidiaries), which exceeded 10% of our total sales, were to Volkswagen of approximately 19%, 22%, and 19%; and to Ford of approximately 11%, 12%, and 9% for the years ended December 31, 2010, 2009 and 2008, 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

 

Our overall outlook for 2011 is positive. The Company expects global production volumes to be higher in 2011 compared with 2010. Furthermore, we expect that higher adoption rates of BorgWarner products around the world will result in sales growth for the Company above global production growth in 2011.

 

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.

 

Results By Reporting Segment

 

The Company’s business is comprised of two reporting segments: Engine and Drivetrain. These 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 restructuring, goodwill impairment charges, affiliates’ earnings and other items not reflective of on-going operating profit or loss (“Adjusted EBIT”) compared to the projected average capital investment required.

 

Adjusted EBIT is the measure of segment profit or loss used by the Company. The Company believes Adjusted EBIT is most reflective of the operational profitability or loss of our reporting segments.

 

The following tables present net sales and Segment Adjusted EBIT for the years 2010, 2009 and 2008:

 

Net Sales

 

Adjusted Earnings (Loss) Before Interest, Income Taxes and Noncontrolling Interest (“Adjusted EBIT”)

 

 

The Engine segment 2010 net sales increased $1,177.6 million, or 40.8%, and segment EBIT increased $318.1 million, or 144.7%, from the year ended December 31, 2009. Excluding the impact of weaker foreign currencies, primarily the Euro, sales increased approximately 44%. The sales increase was primarily driven by strong global growth in all major product groups as well as the second quarter 2010 acquisition of Dytech ENSA SL. The Segment EBIT margin was 13.2% in 2010, up from 7.6% in 2009, due to a significant increase in customer production schedules in the U.S. and European market and continued cost management.

 

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 Drivetrain segment 2010 net sales increased $517.9 million, or 47.4%, and segment EBIT increased $150.5 million from the year ended December 31, 2009. Excluding the impact of weaker foreign currencies, primarily the Euro, sales increased approximately 49%. The sales increase was primarily driven by strong growth of transmission components and torque management devices in Europe, Asia and the U.S. Segment EBIT margin was 8.5% in 2010, up from (1.2)% in 2009, primarily due to higher global production of light trucks and sport-utility vehicles equipped with its torque transfer products and continued cost management.

 

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.

Corporate 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 $111.0 million in 2010, $111.3 million in 2009 and $60.0 million in 2008. The increase in Corporate expenses in 2009 from 2008 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 19.3%, 14.2% and 15.9% in 2010, 2009 and 2008, respectively. The gross margin percentage increase is primarily due to higher sales in 2010 and successful cost reduction actions taken in 2009 and 2008, offset by higher raw material costs. Cost reduction actions taken in 2009 and 2008 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 10.0%, 11.6% and 10.3% in 2010, 2009 and 2008 respectively. 2010 SG&A expenses increased $106.8 million or 23.2% compared to 2009. The 2010 decrease in SG&A as a percentage of net sales was primarily due to a significant year over year increase in sales, offset by an increase in performance related compensation.

 

Research and development (“R&D”) is a major component of our SG&A expenses. R&D spending, net of customer reimbursements, was $185.0 million or 3.3% of sales in 2010, compared to $155.2 million, or 3.9% of sales in 2009, and $205.7 million, or 3.9% of sales in 2008. 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.

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 2008 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.

 

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.

 

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 $39.6 million, $21.8 million and $38.4 million in 2010, 2009 and 2008, 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 increase in equity in affiliates’ earnings in 2010 is primarily due to higher vehicle production in Asia. For more discussion of NSK-Warner, see Note 5 of the Consolidated Financial Statements.

 

Interest expense and finance charges were $68.8 million, $57.2 million and $38.8 million in 2010, 2009 and 2008, respectively. The increase in 2010 over 2009 and 2009 over 2008 was primarily due to accretion of the discounted carrying value of our $373.8 million convertible senior notes and higher debt levels.

 

The provision for income taxes The provision for income taxes resulted in an effective tax rate for 2010 of 17.1% compared with rates of (103.4)% in 2009 and 237.9% in 2008. The 2010 tax rate differs from the U.S. statutory rate primarily due to foreign rates, which differ from those in the U.S., the realization of certain business tax credits including foreign tax credits and favorable permanent differences between book and tax treatment for items, including equity in affiliates’ earnings. Excluding the impacts of the reversal of the valuation allowance on U.S. based foreign tax credits, the change in tax treatment for Medicare Part D subsidies, the BERU-Eichenauer equity investment gain and the Company’s environmental litigation settlement, the Company’s annual effective tax rate associated with on-going business operations was 21.7%.

 

The effective tax rate of (103.4%) for 2009 differs from the U.S. statutory rate primarily due 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 $18.8 million increased by $9.4 million from 2009 and $2.5 million from 2008. The increase between 2010 and 2009 is primarily related to higher sales and earnings by the Company’s joint ventures. The increase between 2010 and 2008 is primarily related to higher sales by the Company’s joint ventures, offset by the Company’s increased ownership to 100% of BERU.

LIQUIDITY AND CAPITAL RESOURCES

 

     Capitalization

 

 

 

Total equity increased by $87.1 million in 2010 as follows:

 

 

The currency translation component of other comprehensive income decreased in 2010 primarily due to the weakening of the Euro and British Pound in relation to the U.S. Dollar.

 

Operating Activities

 

Net cash provided by operating activities was $538.9 million, $351.0 million and $400.8 million in 2010, 2009 and 2008, respectively. The $187.9 million increase in 2010 from 2009 primarily reflects higher earnings, offset by higher working capital needs as compared to 2009. The $538.9 million of net cash provided by operating activities in 2010 consists of net earnings of $396.2 million, increased for non-cash charges of $249.5 million and a $106.8 million decrease in net operating assets and liabilities. Non-cash charges are primarily comprised of $252.9 million in depreciation and amortization.

 

The $49.8 million decrease in 2009 from 2008 was primarily due to lower operational earnings, somewhat offset by lower working capital needs.

 

Inventory increased in 2010 by $79.0 million excluding the impact of currency due to higher business levels in all regions of the world. Inventory management continues to remain an area of focus for the Company as sales volumes continue to stabilize.

Investing Activities

 

Net cash used in investing activities was $429.5 million, $154.8 million and $343.9 million in 2010, 2009 and 2008, respectively. This increase is primarily due to the $147.6 million acquisition of Dytech, the $9.6 million acquisition of the Company’s 50/50 BERU-Eichenauer joint venture, and the final $7.5 million payment for the June 2009 purchase of Etatech, Inc. Capital expenditures, including tooling outlays (“capital spending”) of $276.6 million in 2010, or 4.9% of sales, increased $104.6 million over the 2009 level of $172.0 million, or 4.3% 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 2011, 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 $449.9 million of cash on hand at December 31, 2010. On March 31, 2010, the Company replaced its $250 million multi-currency revolving credit facility with a new $550 million multi-currency revolving credit facility, which includes a feature that allows the Company to increase its borrowings to $600 million. The new facility provides for borrowings through March 31, 2013, and is guaranteed by the Company’s domestic subsidiaries. The Company has three key financial covenants as part of the credit agreement. These covenants 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, 2010 and expects to remain compliant in future periods. At December 31, 2010 and December 31, 2009 there were no outstanding borrowings under these facilities. In addition to the credit facility, as of December 31, 2010, the Company had approximately $126 million available under a universal shelf registration statement on file with the Securities and Exchange Commission (“SEC”) under which a variety of debt and equity instruments could be issued. The Company’s Board of Directors has authorized the filing of a new universal shelf registration with the SEC.

 

From a credit quality perspective, the Company has a credit rating of BBB from both Standard & Poor’s and Fitch Ratings and Baa3 from Moody’s (on September 2, 2010 the Company received its first credit rating from Fitch Ratings). On October 27, 2010, Moody’s upgraded the Company’s credit rating from Ba1 to Baa3. The current outlook from Standard & Poor’s, Moody’s and Fitch Ratings is stable. None of the Company’s debt agreements require accelerated repayment in the event of a downgrade 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.

 

On September 8, 2010 the Company amended the December 21, 2009 Receivable Purchase Agreement, which increased the accounts receivable securitization facility from $50 million to $80 million. This facility matures on December 21, 2012.

The Company’s significant contractual obligation payments at December 31, 2010 are as follows:

 

 

 

 

We believe that the combination of cash from operations, cash balances, available credit facilities and our 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 $256.3 million, $102.4 million and $107.5 million in 2010, 2009 and 2008, respectively. The change is mostly due to the Company’s September 16, 2010 issuance of $250 million in 4.625% senior notes, offset by the repurchasing of approximately 7.1 million shares of its common stock in 2010. Proceeds from stock options exercised, net of tax benefit were $67.1 million, $8.7 million and $17.1 million in 2010, 2009 and 2008, respectively. The Company paid dividends to BorgWarner stockholders of $13.8 million and $51.1 million in 2009 and 2008, respectively. The Company had treasury stock purchases of $331.2 million in 2010, of which $325.7 million has been paid for as of December 31, 2010. The Company had treasury stock purchases of $55.9 million in 2008.

 

The Company purchased approximately 0.4 million and 1.34 million BERU shares in 2009 and 2008, respectively. The cost for these shares was $46.6 million and $136.8 million for 2009 and 2008, 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

 

The Company securitizes certain receivables through third party financial institutions without recourse. The amount can vary each month based on the amount of underlying receivables. The Company continues to administer the collection of these receivables on behalf of the third party.

 

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.

 

The Company was required to adopt amended ASC Topic 860, “Accounting for Transfer of Financial Assets”, on January 1, 2010. This adoption required the Company to reflect its receivable securitization facility in its financial statements in the current year of change. Accounting rules prior to January 1, 2010 allowed qualifying special-purpose entities off-balance sheet treatment. The impact of this adoption was an increase in receivables, net of $80 million and an increase in notes payable and other short-term debt of $80 million in the Company’s December 31, 2010 Consolidated Balance Sheet.

 

On September 8, 2010 the Company amended the December 21, 2009 Receivable Purchase Agreement, which increased the accounts receivable securitization facility from $50 million to $80 million. This facility matures on December 21, 2012. 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 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 total expected future cash outlays for all lease obligations at the end of 2010 is $43.0 million. See Note 15 to the Consolidated Financial Statements for more information on operating leases, including future minimum payments.

 

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, 2010, all legal funding requirements had been met. The Company contributed $25.1 million, $39.3 million and $13.3 million to its defined benefit pension plans in 2010, 2009 and 2008, respectively. The Company expects to contribute a total of $30 million to $40 million in 2011. $23.2 million of the $30 million to $40 million in 2011 contributions are contractually obligated, as shown in the table above, while the remaining payments are discretionary.

 

The funded status of all pension plans was a net unfunded position of $(210.4) million and $(229.9) million at the end of 2010 and 2009, respectively. Of these amounts, $(128.0) million and $(131.1) at the end of 2010 and 2009, 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 $(261.9) million at the end of 2010 and $(278.5) million at the end of 2009.

 

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

 

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 (ERISA) 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 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 and in the discovery phase. The Company is vigorously defending against the suit. This contingency is subject to many uncertainties, therefore based on the information available to date, the Company cannot estimate the amount or the range of potential loss, if any.

 

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 38 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 material 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, 2010 of $28.0 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. One of the lawsuits, involving a single plaintiff, was dismissed by the trial court in April 2010 and the plaintiff’s appeal of that decision was dismissed by the appellate court in August 2010. The Company entered into a settlement in July 2010 regarding the personal injury claims of the plaintiffs in the other three lawsuits and those of approximately 2,700 unfiled claimants represented by those plaintiffs’ attorneys. In exchange for, among other things, the dismissal with prejudice of these lawsuits and the release of claims by the unfiled claimants, the Company agreed to pay up to $28 million in settlement funds, which was expensed in the second quarter of 2010. In November 2010 the Company paid $13.9 million related to this settlement. The remaining payment of approximately $14 million is expected to be paid in February 2011.

 

Conditional Asset Retirement Obligations

 

In March 2005, 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 45 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 $1.2 million as of December 31, 2010 and $1.3 million at December 31, 2009.

 

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, 2010 and December 31, 2009 the Company had approximately 17,000 and 23,000 pending asbestos-related product liability claims, respectively. Of the 17,000 outstanding claims at December 31, 2010, approximately 8,000 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 2010, of the approximately 7,700 claims resolved, 245 (3.2%) resulted in any payment being made to a claimant by or on behalf of the Company. In the full year of 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.

 

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 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.

 

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 been responsible for asbestos-related litigation defense and settlement expenses pursuant to a funding arrangement.

 

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.

 

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.

 

To date, the Company has paid and accrued $153.1 million in defense and indemnity in advance of insurers’ reimbursement, which includes the $40.7 million referred to below, and has received $32.5 million in cash from insurers. The net outstanding balance of $120.6 million is expected to be fully recovered, of which approximately $43 million is expected to be recovered within one year. Timing of the recovery is dependent on final resolution of the declaratory judgment action referred to above. At December 31, 2009, insurers owed $58.6 million in association with these claims.

 

On April 5, 2010 the Superior Court of New Jersey Appellate Division affirmed a lower court judgment in an asbestos-related action against the Company and others. The Company filed its Notice of Petition to the Supreme Court of New Jersey in late April, seeking to appeal the decisions of the lower courts. On July 8, 2010 the Supreme Court of New Jersey denied the Company’s Notice of Petition appealing the decision of the lower courts. The total claim of $40.7 million was paid by the Company in July 2010.

In addition to the $120.6 million net outstanding balance relating to past settlements and defense costs, the Company has estimated a liability of $50.6 million for claims asserted, but not yet resolved and their related defense costs at December 31, 2010. The Company also has a related asset of $50.6 million to recognize proceeds 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, 2009, the comparable value of the insurance asset and accrued liability was $49.9 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.

 

CRITICAL ACCOUNTING POLICIES

 

The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (“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.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Depreciation

 

The automotive industry experienced unprecedented declines in production in the fourth quarter of 2008 and projected continued declines for the full year of 2009. According to Accounting Standards Codification (“ASC”) 250, future depreciation expense should be revised due to a change in the estimated future benefits inherent in an asset, the pattern of consumption of those benefits, or the information available to the entity about those benefits. As a result of the 2008 and 2009 unprecedented declines in production activity, the

Company determined that its usage pattern for certain assets had changed significantly and revised the useful lives of certain equipment starting in 2009. This adjustment was considered to be a change in an accounting estimate.

 

The impact to the Company in 2010 and 2009 were as follows (unaudited):

 

 

 

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 prices are 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 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 a triggering event has occurred, the assets are identified by the operating location and management as potentially impaired and a recoverability review is performed 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. The recoverability 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 fair value analysis. Management determines fair value under ASC Topic 820 using the appropriate valuation technique of market, income or cost approach. Management believes that the estimates and 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:

 

 

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, under ASC Topic 350, requires the Company 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 of the future performance, including fundamental industry growth for 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 reporting units are reasonable. Different assumptions could materially affect the estimated fair value. The primary assumptions affecting the Company’s December 31, 2010 goodwill impairment review are as follows:

 

 

In addition to the above significant assumptions, the Company notes the following risk to volume assumptions that could have an impact on the discounted cash flow model:

 

 

While the Company believes that these assumptions are appropriate, significant changes in these assumptions may materially affect the Company’s analysis related to one of its reporting units in the Engine operating segment, whose estimated fair value is 112% of its carrying value.

 

Based on our sensitivity analysis, a 1% increase in the discount rate or a 1% decrease in the operating margin assumptions would result in the carrying value exceeding the estimated fair value of one reporting unit tested within the Engine operating segment. This would require further evaluation of the reporting unit’s

goodwill, under a step two impairment test. The following table illustrates the sensitivity to the estimated fair value of that reporting unit.

 

 

In 2008 the company recorded impairment charges totaling €111.5 ($156.8) million to adjust BERU’s goodwill to its estimated fair value. The impairment charge is attributable to a decrease in the operating unit’s estimated fair value based primarily upon the effect of the decline in European market conditions on current and projected operating results. The impairment charge was also impacted by the recognition of additional goodwill in the second quarter of 2008, which was based on the court determined buy out value of €71.32 per share related to the Domination and Profit Transfer Agreement. Any differences in future results compared to management’s estimates could result in fair values different from estimated fair values, which could materially impact the Company’s future results of operations and financial condition.

 

See Note 18, “Recent Transactions”, for further discussion on the BERU Domination and Profit Transfer Agreement.

 

The impairment tests completed in the fourth quarter of 2010 and 2009 indicated no impairment for either year, and estimated fair value to be approximately 360% and 220% for the Company’s carrying value in 2010 and 2009, respectively.

 

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 2010 is between approximately $26 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 2010, our total accrued environmental liability was $29.2 million, which includes our conditional asset retirement obligation under ASC Topic 410 of $1.2 million.

 

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

 

Product Warranty