10-K 1 a10k12312012.htm BORGWARNER INC FORM 10-K 10 K 12.31.2012
 
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, 2012
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)
Delaware
 
13-3404508
State or other jurisdiction of
Incorporation or organization
 
(I.R.S. Employer Identification No.)
 
3850 Hamlin Road,
Auburn Hills, Michigan 48326
(Address of principal executive offices) (Zip Code)
 Registrant’s telephone number, including area code: (248) 754-9200
Securities registered pursuant to Section 12(b) of the Act
Title of each class
Name of each exchange on
which registered
Common Stock, par value $0.01 per share
New York Stock Exchange
 
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  R

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):
Large accelerated filer
þ
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
o
 (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, 2012 (the last business day of the most recently completed second fiscal quarter) was approximately $7.4 billion.
 
As of February 8, 2013, the registrant had 115,639,856 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.
Document
Part of Form 10-K into which incorporated
Portions of the BorgWarner Inc. Proxy Statement for the 2013 Annual Meeting of Stockholders
Part III
 
 




BORGWARNER INC.
FORM 10-K
YEAR ENDED DECEMBER 31, 2012
INDEX
 
 
Page No.
 
 
 
 
 
 
 


2
  




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. Forward-looking statements are not guarantees of performance and the Company's actual results may differ materially from those expressed, projected or implied in or by the forward-looking statements.

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. 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.



3
  



PART I

ITEM 1. BUSINESS

BorgWarner Inc. and Consolidated Subsidiaries (the “Company”) is a Delaware corporation 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 ("SUVs"), vans and light trucks). The Company's products are also sold to other OEMs of commercial vehicles (medium-duty trucks, heavy-duty trucks and buses) and off-highway vehicles (agricultural and construction machinery and marine applications). We also manufacture and sell our products to certain Tier One vehicle systems suppliers and into the aftermarket for light, commercial and off-highway 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 17, “Reporting Segments and Related Information,” to the Consolidated Financial Statements in Item 8 of this report for financial information about the Company's reporting segments. 

Narrative Description of Reporting Segments

The Company reports its results under two reporting segments: Engine and Drivetrain. Net sales by reporting segment for the years ended December 31, 2012, 2011 and 2010 are as follows:

 
Year Ended December 31,
(millions of dollars)
2012
 
2011
 
2010
Engine
$
4,913.0

 
$
5,050.6

 
$
4,060.8

Drivetrain
2,298.7

 
2,084.5

 
1,611.4

Inter-segment eliminations
(28.5
)
 
(20.4
)
 
(19.4
)
Net sales
$
7,183.2

 
$
7,114.7

 
$
5,652.8


The sales information presented above excludes the sales by the Company's unconsolidated joint ventures (See sub-heading “Joint Ventures”). Such unconsolidated sales totaled approximately $871 million, $817 million and $779 million for the years ended December 31, 2012, 2011 and 2010, respectively.

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, as well as the need to lower CO2 emissions, are driving demand for the Company's products in gasoline and diesel engines and alternative powertrains. The Engine Group's products include: turbochargers, timing devices and chains, emissions systems, thermal systems, diesel cold start, gasoline ignition technology and cabin heaters.
 
The Engine Group provides turbochargers for light, commercial and off-highway applications for diesel and gasoline engine manufacturers in the Americas, Europe 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 light, commercial and off-highway applications include increased power for a given engine size, improved fuel economy and reduced emissions.


4
  



Sales of turbochargers for light vehicles represented approximately 26% of total net sales for the years ended December 31, 2012, 2011 and 2010, respectively. The Company currently supplies light vehicle turbochargers to many OEMs including BMW, Daimler, Fiat, Ford, General Motors, Hyundai, PSA, Renault and Volkswagen. The Company also supplies commercial vehicle turbochargers to Daimler, Deutz, MAN and Navistar and off-highway turbochargers to Caterpillar and John Deere.

The Company's newest turbocharger technologies are its regulated two-stage turbocharging system, known as R2S®, regulated 3-stage turbocharging systems ("R3S"), variable turbine geometry ("VTG") turbochargers and turbochargers for gasoline direct injected engines, all of which may be found in numerous applications around the world. For example, the Company supplies its award winning R2S® turbocharger technology to Volkswagen's 2.0 liter four-cylinder common-rail diesel engine featured in the Transporter T5 and Amarok pickup and its R3S turbocharger system, an industry first, to BMW for its new high-powered 3.0 liter diesel engine. Also, the Company supplies VTG turbochargers to Renault's 1.6 liter R9M diesel engine featured in the Mégane Scénic and to Great Wall for its 2.0 liter diesel engine. Ford selected BorgWarner's leading gasoline turbocharger technology for its new 1.6 liter and 2.0 liter four-cylinder EcoBoost engines, the latter of which launched in the U.S. in the 2012 Explorer and 2012 Edge models and in China in the Ford Mondeo.

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

The Company is a leading manufacturer of timing chain systems to OEMs around the world. BorgWarner timing chain systems are featured on Ford's family of engines, including the Duratec, Modular and in-line four-cylinder engines, Chrysler's 3.6 liter Pentastar engine, Volkswagen's EA888 family, Hyundai's Gamma, Nu and Theta families and numerous other applications around the world.

The Engine Group's newest product 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, reduce emissions and improve engine performance compared with conventional VCT systems. VCT with mid position lock made its debut on Subaru's Boxer® 2.0 liter engine. BorgWarner is currently working with a number of other OEMs interested in implementing this technology. The Company is a leading manufacturer of chain for drivetrain systems. The Company's HY-VO® chain is used to transfer power from the engine to the drivetrain in FWD transmissions and also in 4WD transfer cases, which distributes power between a vehicle's front and rear wheels.

The Engine Group also designs and manufactures products to control emissions and improve fuel economy. These products include electric air pumps, turbo actuators using integrated electronics to precisely control turbocharger speed and pressure ratio and exhaust gas recirculation ("EGR") coolers, tubes and valves for gasoline and diesel applications. In 2010, the Company acquired Dytech Ensa S.L., a leading producer of EGR coolers, EGR tubes and integrated EGR modules including valves for light, commercial and off-highway applications.

The Company is a leading global provider of engine thermal solutions for truck, agricultural and off-highway applications. The Engine 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 several major global heavy truck producers.


5
  



The Company is a leading global automotive supplier of diesel cold start technology (glow plugs and instant starting systems), including its Pressure Sensor Glow Plug which monitors and enhances the combustion process of a diesel engine, minimizing CO2 and NOx emissions. The Company also designs and manufactures gasoline ignition technology and electronic control units and sensor technology (diesel cabin heaters and selected sensors).

In 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 is expected to enable high-performing, lean burning engines to significantly improve fuel economy and reduce emissions compared with conventional combustion technologies.

In 2010, 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 Company sold its tire pressure monitoring and spark plug businesses during the fourth quarter of 2011 and third quarter of 2012, respectively. The sale of these businesses will allow the Company to continue to focus on expanding BERU Systems' core products of glow plugs, diesel cold start systems and other gasoline ignition technologies.

Drivetrain

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 conventional automatic, dual clutch transmissions (“DCT”), automated manual transmissions and continuously variable transmissions. In conventional automatic transmissions, there has been a global market trend from four and five speeds to six, seven and eight speed transmissions. Transmissions with more speeds improve fuel economy and vehicle performance and offer growth opportunities.

 Friction and mechanical products include dual clutch modules, friction clutch modules, friction and steel 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 KK ("NSK-Warner"), is a leading producer of friction plates and one-way clutches in Japan and China.

 The Company has led the globalization of today's DCT technology for over 10 years. Following the development of its DCT technology in the 1990s, the Company established its industry-leading position 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. 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 shifting a single clutch manual transmission. The result is a smooth shifting automatic transmission with the fuel efficiency and great driving experience of a manual gearbox.

In 2008, the Company entered into a joint venture agreement with China Automobile Development United Investment Company, a company owned by 12 leading Chinese automakers, to produce various DCT modules for the Chinese market. The joint venture's operations are located in Dalian, China and production is scheduled to begin in 2013. The Company owns 66% of the joint venture.

6
  




The Drivetrain Group's torque management products include rear-wheel drive (“RWD”)/all-wheel drive ("AWD") transfer case systems, FWD/AWD coupling systems and cross-axle coupling systems. The Company's focus is on developing electronically controlled torque management devices and systems that will benefit vehicle dynamics, fuel economy and stability.

 Transfer cases are installed on RWD based light trucks, SUVs, cross-over utility vehicles (“CUVs”), 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. There are many variants of the Company's transfer case technology in the market today, including Torque On-Demand (TOD®), chain-driven, gear-driven, 1-speed and 2-speed transfer cases. The Company's transfer cases are featured on the Ford F-150 and on the Dodge Ram light-duty and heavy-duty trucks.

The Company is involved in the AWD market for FWD based vehicles with couplings that use electronically-controlled clutches to distribute power to the rear wheels instantly as traction is required. The Company's latest coupling innovation, the Centrifugal Electro-Hydraulic (“CEH”) Actuator, which is utilized to engage the clutches in the coupling, produces outstanding vehicle stability and traction while promoting better fuel economy with reduced weight. The CEH Actuator is found in the AWD couplings featured in several current FWD/AWD vehicles including the Audi A3, Skoda Octavia,Volvo XC60 and VW Golf.

In 2011, the Company acquired the Traction Systems division of Haldex Group, a leading provider of innovative AWD products for the global vehicle industry headquartered in Stockholm, Sweden. This acquisition has accelerated BorgWarner's growth in the global AWD market as it continues to shift toward FWD based vehicles. The acquisition will continue to add industry leading AWD technologies for FWD based vehicles, with a strong European customer base, to BorgWarner's portfolio of front- and rear-wheel drive based products. This enables BorgWarner to offer global customers a broader range of AWD solutions to meet their vehicle needs.


7
  



Joint Ventures

As of December 31, 2012, the Company had nine joint ventures in which it had a less-than-100% ownership interest. Results from the six joint ventures in which the Company is the majority owner are consolidated as part of the Company's results. Results from the three joint 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:

Joint venture
 
Products
 
Year organized
 
Percentage
owned by the
Company
 
Location of
operation
 
Joint venture partner
 
Fiscal 2012 sales
(millions of dollars) (a)
Unconsolidated:
 
 
 
 
 
 

 
 
 
 
 
 
NSK-Warner 
 
Transmission components
 
1964
 
50
%
 
Japan/China
 
NSK Ltd.
 
$
696.7

Turbo Energy Limited (b)
 
Turbochargers
 
1987
 
32.6
%
 
India
 
Sundaram Finance Limited; Brakes India Limited
 
$
167.5

BERU Diesel Start Systems Pvt. Ltd. 
 
Glow Plugs
 
1996
 
49
%
 
India
 
Jayant Dave
 
$
6.7

Consolidated:
 
 
 
 
 
 

 
 
 
 
 
 
BorgWarner Transmission Systems Korea Ltd. (c)
 
Transmission components
 
1987
 
60
%
 
Korea
 
NSK-Warner
 
$
253.4

Divgi-Warner Private Limited 
 
Transfer cases and synchronizer rings
 
1995
 
60
%
 
India
 
Divgi Metalwares, Ltd.
 
$
23.8

Borg-Warner Shenglong (Ningbo) Co. Ltd. 
 
Fans and fan drives
 
1999
 
70
%
 
China
 
Ningbo Shenglong Automotive Powertrain Systems Co., Ltd.
 
$
33.1

BorgWarner TorqTransfer Systems Beijing Co. Ltd. 
 
Transfer cases
 
2000
 
80
%
 
China
 
Beijing Automotive Components Stock Co. Ltd.
 
$
81.7

SeohanWarner Turbo Systems Ltd. 
 
Turbochargers
 
2003
 
71
%
 
Korea
 
Korea Flange Company
 
$
123.3

BorgWarner United Transmission Systems Co. Ltd. 
 
Transmission components
 
2009
 
66
%
 
China
 
China Automobile Development United Investment Co., Ltd.
 
$
2.0

________________
(a)
All sales figures are for the year ended December 31, 2012, except NSK-Warner and Turbo Energy Limited. NSK-Warner’s sales are reported for the 12 months ended November 30, 2012. Turbo Energy Limited’s sales are reported for the 12 months ended September 30, 2012.
(b)
The Company made purchases from Turbo Energy Limited totaling $24.2 million, $22.5 million and $22.9 million for the years ended December 31, 2012, 2011 and 2010, respectively.
(c)
BorgWarner Inc. owns 50% of NSK-Warner, which has a 40% interest in BorgWarner Transmission Systems Korea Ltd. This gives the Company an additional indirect effective ownership percentage of 20%. This results in a total effective ownership interest of 80%.

Financial Information About Geographic Areas

During the year ended December 31, 2012, approximately 74% of the Company's consolidated net sales were outside the United States ("U.S."), attributing sales to the location of production rather than the location of the customer.

Refer to Note 17, “Reporting Segments and Related Information,” to the Consolidated Financial Statements in Item 8 of this report for financial information about geographic areas. 

Product Lines and Customers

During the year ended December 31, 2012, approximately 80% of the Company's net sales were for light-vehicle applications; approximately 9% were for commercial vehicle applications; approximately 6% were for off-highway vehicle applications; and approximately 5% were to distributors of aftermarket replacement parts.

8
  




The Company’s worldwide net sales to the following customers (including their subsidiaries) were approximately as follows:

 
Year Ended December 31,
Customer
2012
 
2011
 
2010
Volkswagen
17
%
 
19
%
 
19
%
Ford
13
%
 
12
%
 
11
%

No other single customer accounted for more than 10% of our consolidated net sales in any of the years 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 OEM production schedules. The Company typically ships its products directly from its plants to the OEMs.

Sales and Marketing

Each of the Company's businesses 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 customers.

In addition, the sales and marketing employees of our Engine and Drivetrain reporting segments 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

Our operations are directly related to the automotive industry. Consequently, we may experience seasonal fluctuations to the extent automotive vehicle production slows, such as in the summer months when many customer plants typically close for model year changeovers or vacations. Historically, model changeovers or vacations have generally resulted in lower sales volume in the third quarter.

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. This function manages a venture capital fund that was created by the Company as seed money for new innovation and collaboration across businesses.

In addition, each of the Company's business units within its two reporting segments has its own research and development (“R&D”) organization, including engineers 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.

9
  




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 Company's net R&D expenditures are included in selling, general and administrative expenses of the Consolidated Statements of Operations. Customer reimbursements are netted against gross R&D expenditures as they are considered a recovery of cost. Customer reimbursements for prototypes are recorded net of prototype costs based on customer contracts, typically either when the prototype is shipped or when it is accepted by the customer. Customer reimbursements for engineering services are recorded when performance obligations are satisfied in accordance with the contract and accepted by the customer. Financial risks and rewards transfer upon shipment, acceptance of a prototype component by the customer or upon completion of the performance obligation as stated in the respective customer agreement.

 
Year Ended December 31,
(millions of dollars)
2012
 
2011
 
2010
Gross R&D expenditures
$
309.3

 
$
294.7

 
$
233.2

Customer reimbursements
(43.4
)
 
(51.0
)
 
(48.2
)
Net R&D expenditures
$
265.9

 
$
243.7

 
$
185.0


Net R&D expenditures as a percentage of net sales were 3.7%, 3.4% and 3.3% in the years ended December 31, 2012, 2011 and 2010, respectively. The Company has contracts with several customers at the Company's various R&D locations. No such contract exceeded 5% of net R&D expenditures in any of the years presented.

Intellectual Property

The Company has more than 4,200 active domestic and foreign patents and patent applications pending or under preparation, and receives royalties from licensing patent rights to others. While it considers its patents on the whole to be important, the Company does not consider any single patent, any group of related patents or any single license essential to its operations in the aggregate or to the operations of any of the Company's business groups individually. The expiration of the patents individually and in the aggregate is not expected to have a material effect on the Company's financial position or future operating results. The Company owns numerous trademarks, some of which are valuable, but none of which are essential to its business in the aggregate.

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

Competition

The Company's reporting segments compete worldwide with a number of other manufacturers and distributors that 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.


10
  



The Company’s major competitors by product type follow:

Product Type: Engine
 
Names of Competitors
Turbochargers:
 
Cummins Turbo Technology
 
IHI
 
 
Honeywell
 
Mitsubishi Heavy Industries (MHI)
 
 
 
 
 
Emissions systems:
 
Behr
 
Modine
 
 
Denso
 
Pierburg
 
 
 
 
 
Timing devices and chains:
 
Denso
 
Schaeffler Group
 
 
Iwis
 
Tsubaki Group
 
 
 
 
 
Thermal systems:
 
Behr
 
Usui
 
 
Horton/Sachs
 
Xuelong
 
 
 
 
 
Diesel cold start, gasoline ignition
 
Bosch
 
Eberspacher Catem
technology and cabin heaters:
 
Delphi
 
NGK
 
Product Type: Drivetrain
 
Names of Competitors
Torque transfer:
 
American Axle
 
JTEKT
 
 
GKN Driveline
 
Magna Powertrain
 
 
 
 
 
Transmission:
 
Bosch
 
FCC
 
 
Dynax
 
Schaeffler Group

In addition, a number of the Company's major OEM customers manufacture, for their own use and for others, products that 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 is 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, lower tax rates and, in some cases, export subsidies and/or raw materials subsidies. Also, see Item 1A, "Risk Factors."

Workforce

As of December 31, 2012, the Company had a salaried and hourly workforce of approximately 19,100 (as compared with approximately 19,250 at December 31, 2011), of which approximately 5,500 were in the U.S.  Approximately 20% of the Company's U.S. workforce is unionized. The workforces at certain international facilities are also unionized. The Company believes the 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 2016.


11
  



Raw Materials

The Company uses a variety of raw materials in the production of its automotive products including steel, aluminum, copper, nickel, 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.

Commodity prices remained volatile in 2012. 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 2013 and beyond.  Refer to Note 10, “Financial Instruments,” of the Consolidated Financial Statements in Item 8 of this report for information related to the Company's hedging activities. 

For 2013, the Company believes that its supplies of raw materials 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 14, 2013.

Name
 
Age
 
Position with the Company
Timothy M. Manganello
 
63
 
Executive Chairman of the Board
Robin J. Adams
 
59
 
Vice Chairman of the Board, Executive Vice President and Chief Administrative Officer
James R. Verrier
 
50
 
President and Chief Executive Officer
Ronald T. Hundzinski
 
54
 
Vice President and Chief Financial Officer
Steven G. Carlson
 
62
 
Vice President and Controller
Stefan Demmerle

 
48
 
Vice President
Brady D. Ericson
 
41
 
Vice President
Joseph F. Fadool
 
46
 
Vice President
John J. Gasparovic
 
55
 
Vice President, General Counsel and Secretary
Robin Kendrick
 
48
 
Vice President
Pete B. Kohler
 
57
 
Vice President
Frederic B. Lissalde
 
45
 
Vice President
Janice K. McAdams
 
54
 
Vice President, Human Resources
Thomas J. McGill
 
46
 
Vice President and Treasurer

12
  




Mr. Manganello has been Executive Chairman of the Board since June 2003 and was Chief Executive Officer of the Company from February 2003 through December 2012.  Mr. Manganello also served as the Board Chairman of the Federal Reserve Bank of Chicago, Detroit branch from 2006 through 2011 and is a director of Bemis Company, Inc. and Zep Inc.

Mr. Adams has been Vice Chairman of the Board since March 2012 and Executive Vice President and Chief Administrative Officer of the Company since April 2004. From April 2004 through March 2012, he was also the Chief Financial Officer of the Company and has been a member of BorgWarner's Board of Directors since April 2005. Mr. Adams is also a director of Carlisle Companies Inc.

Mr. Verrier has been President, Chief Executive Officer and member of BorgWarner's Board of Directors since January 1, 2013. From March 2012 through December 2012, he was the President and Chief Operating Officer of the Company. From January 2010 to March 2012, he was Vice President of the Company and President and General Manager of BorgWarner Morse TEC Inc. He was Vice President and General Manager, Passenger Car of BorgWarner Turbo Systems Inc. from January 2006 to January 2010.

Mr. Hundzinski has been Vice President and Chief Financial Officer of the Company since March 2012. From August 2011 through March 2012, he was Vice President and Treasurer of the Company. From April 2010 until August 2011, he was Vice President and Controller of the Company. From June 2005 until April 2010, he was Vice President of Finance of BorgWarner Turbo Systems.

Mr. Carlson has been Vice President and Controller of the Company since May 2012. From August 2011 through April 2012, he was Vice President of Finance of BorgWarner Transmissions Systems Inc. From June 2009 until August 2011, he was Vice President of Finance of BorgWarner Morse TEC Inc. From November 2006 until June 2009, he was Group Controller of BorgWarner Thermal Systems Inc.

Dr. Demmerle has been Vice President of the Company and President and General Manager of BorgWarner TorqTransfer Systems Inc. since September 2012. From July 2010 to September 2012, he was Vice President, Engine Control Electronics at Continental Automotive Systems. From December 2007 to June 2010, he was President and CEO of Continental Diesel Systems US LLC (formerly known as Siemens Diesel Systems Technology LLC).

Mr. Ericson has been Vice President of the Company and President and General Manager of BorgWarner BERU Systems and Emissions Systems since September 2011. He was Vice President and General Manager of BorgWarner Emissions Systems from April 2010 through August 2011. From August 2009 through March 2010, he was Vice President, Global Manufacturing Strategies for BorgWarner Turbo and Emissions Systems. From January 2008 through July 2009, he was Vice President, Operations - China and Korea for BorgWarner Turbo and Emissions Systems.

Mr. Fadool has been Vice President of the Company and President and General Manager of BorgWarner Morse TEC Inc. since May 2012. He was Vice President of the Company and President and General Manager of BorgWarner TorqTransfer Systems Inc. from June 2011 until May 2012. He was Vice President and General Manager of TorqTransfer Systems Inc. from July 2010 until June 2011. From May 2009 until July 2010, he was Vice President for North American Operations for the Central Electronics Plants at Continental Automotive Systems. From July 2007 until July 2010, he was Vice President, Huntsville Operations at SiemensVDO.

Mr. Gasparovic has been Vice President, General Counsel and Secretary of the Company since January 2007.

13
  




Mr. Kendrick has been Vice President of the Company and President and General Manager of BorgWarner Transmissions Systems Inc. since September 2011. From January 2011 until September 2011, he was President and Chief Executive Officer of Ruia Global Fasteners, a spin-off of Acument Global Technologies. From September 2008 to January 2011, he was Vice President and General Manager, Europe for Acument Global Technologies. From March 1999 until September 2008, he held various positions at American Axle & Manufacturing Holdings, Inc. including Vice President & General Manager of Driveshafts & Halfshafts, Managing Director of AAM Europe, and Executive Director of Sales.

Mr. Kohler has been Vice President of the Company and President and General Manager of BorgWarner Turbo Systems Commercial Diesel Products since May 2011, President and General Manager of BorgWarner Thermal Systems since February 2013 and President Global Commercial Market Development and Strategy since March 2011. He was Acting President and General Manager of BorgWarner Turbo Systems Commercial Diesel from March 2011 to May 2011. He was Vice President and General Manager for BorgWarner Turbo Systems Commercial Vehicles from February 2006 to March 2011.

Mr. Lissalde has been Vice President of the Company and President and General Manager of BorgWarner Turbo Systems Passenger Car Products since May 2011. He was Acting President and General Manager of BorgWarner Turbo Systems Passenger Car Products from March 2011 until May 2011. He was Vice President and General Manager for Turbo Systems Passenger Car from January 2010 until March 2011. He was Vice President and General Manager, DualTronic and Clutch Systems, BorgWarner Transmission Systems Inc. from January 2008 to January 2010. He was the Vice President of Global Sales of that entity from May 2007 to January 2008.

Ms. McAdams has been Vice President, Human Resources of the Company since March 2010. She was Director of Compensation and Benefits from May 2005 to March 2010.

Mr. McGill has been Vice President and Treasurer of the Company since May 2012. He was Vice President of Finance of BorgWarner Turbo Systems from April 2010 until May 2012. He was Vice President of Finance of BorgWarner Thermal Systems Inc. from June 2009 to April 2010. He was Vice President of Finance TorqTransfer Systems Inc. from February 2009 to June 2009. He was Director of Audit & Analysis of the Company from December 2006 to February 2009.

Item 1A.    Risk Factors    

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.

Risks related to our industry

Conditions in the automotive industry may adversely affect our business.

Our financial performance depends on conditions in the global automotive industry. 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 affect on our sales to OEMs.


14
  



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 OEM 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. Although OEMs have indicated that they will continue to rely on outside suppliers, a number of our major OEM customers manufacture products for their own uses that directly compete with our products. These OEMs could elect to manufacture such products for their own uses in place of the products we currently supply. The competitive environment has changed dramatically over the past few years as our traditional U.S. OEM 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, lower tax rates and, in some cases, export or raw materials subsidies. Increased competition could adversely affect our business.

Risks related to our business

We are under substantial pressure from OEMs to reduce the prices of our products.

There is substantial and continuing pressure on OEMs to reduce costs, including costs of products we supply. Annual price reductions to OEM customers 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 OEM customers is limited, with cost recovery often less than 100% and often on a delayed basis. Inability to reduce costs in an amount equal to annual price reductions, increases in raw material costs, and increases in employee wages and benefits could have an adverse effect on our business.

We continue to face highly volatile costs of commodities 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 and by selectively hedging certain commodity exposures. Customers frequently challenge these contractual provisions and rarely pay the full cost of any material increases. The discontinuation of our ability to pass-through or hedge increasing commodity costs could 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. If these supply interruptions occur, it could adversely affect our business.


15
  



We use important intellectual property in our business. If we are unable to protect our intellectual property or if a third party makes assertions against us or our customers relating to intellectual property rights, our business could be adversely affected.

We own important intellectual property, including patents, trademarks, copyrights and trade secrets, and are involved in numerous licensing arrangements. Our intellectual property plays an important role in maintaining our competitive position in a number of the markets that we serve. Our competitors may develop technologies that are similar or superior to our proprietary technologies or design around the patents we own or license. Further, as we expand our operations in jurisdictions where the protection of intellectual property rights is less robust, the risk of others duplicating our proprietary technologies increases, despite efforts we undertake to protect them. Developments or assertions by or against us relating to intellectual property rights, and any inability to protect these rights, could materially adversely impact our business and our competitive position.

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.

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.

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

As of December 31, 2012, approximately 20% 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 2016. The workforce at certain of our international facilities is also unionized. A prolonged dispute with our employees could have an adverse effect on our business.

We are impacted by the rising cost of providing retirement benefits and certain retirement benefit plans we sponsor are currently unfunded or underfunded.

We sponsor certain retirement benefit plans worldwide that are unfunded or underfunded and will require cash payments. If the performance of the assets in our funded pension plans do not meet our expectations, if medical costs continue to increase or actuarial assumptions are modified, our required cash payments may be higher than we expect.   


16
  



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. 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. 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. Costs associated with failure to comply with environmental regulations could have an adverse effect on our business.

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.

We provide product warranties to our customers for some of our products. Under these product 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 product warranties in our financial statements.

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, personal injury, product liability, environmental and employment claims. There is a possibility that such claims may have an adverse impact on our business that is greater than we anticipate.

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, which are inherently uncertain. Negative or unexpected results from one or more such tax audits or changes to tax laws governing the jurisdictions in which we operate could adversely affect our business.


17
  



Our growth strategy may prove unsuccessful.

We have a stated goal of increasing sales 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 that 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 affectively. Failure to execute our growth strategy could adversely affect our business.

We are subject to risks related to our international operations.

We have manufacturing and technical facilities in many regions including the Americas, Europe and Asia. For 2012, approximately 74% of our sales were outside the U.S. Consequently, our results could be affected by changes in trade, monetary and fiscal policies, trade restrictions or prohibitions, import or other charges or taxes, fluctuations in foreign currency exchange rates, limitations on the repatriation of funds, changing economic conditions, unreliable intellectual property protection and legal systems, insufficient infrastructures, 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.

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.

Risks related to our customers

We rely on sales to major customers.

We rely on sales to OEMs around the world of varying credit quality. Supply to several of these customers requires significant investment by the Company. 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 due to any of a variety of factors including non-renewal of purchase orders, the customer's financial hardship or other unforeseen reasons, it could adversely affect our business.

Furthermore, some of our sales are concentrated. Our worldwide sales in 2012 to Volkswagen and Ford constituted approximately 17% and 13%, respectively, of our 2012 consolidated net sales.   


18
  



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 OEMs' dependence on a single union, we are affected by labor difficulties and work stoppages at OEMs' 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 affect on our business.

Risks related to our suppliers

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.

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 other factors 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 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.

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.


19
  



Other risks

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, utilization 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; global excess capacity and vehicle platform proliferation; and the impact of natural disasters.

Item 1B.
Unresolved Staff Comments
 
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 2012 fiscal year that remain unresolved.  


20
  



Item 2.
Properties

As of December 31, 2012, the Company had 57 manufacturing, assembly, and technical locations worldwide. In addition to its 14 U.S. locations, the Company has seven locations in Germany; six locations in each of China and South Korea; five locations in India; three locations in each of Japan and Mexico; two locations in Hungary and one location in each of Brazil, France, Ireland, Italy, Monaco, Poland, Portugal, Spain, Sweden, Thailand and the United Kingdom. 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 principal manufacturing, assembly, and technical facilities operated by the Company, its subsidiaries, and affiliates.

ENGINE(a) 
 
Americas:
Europe:
Asia:
Asheville, North Carolina
Arcore, Italy
Aoyama, Japan
Auburn Hills, Michigan
Bradford, England
Changwon, South Korea (b)
Cadillac, Michigan
Kirchheimbolanden, Germany
Chennai, India
Campinas, Brazil
Ludwigsburg, Germany
Chonburi, Thailand
Cortland, New York
Markdorf, Germany
Chungju-City, South Korea
Dixon, Illinois
Muggendorf, Germany
Kakkalur, India
El Salto Jalisco, Mexico
Oroszlany, Hungary
Manesar, India (b)
Fletcher, North Carolina
Rzeszow, Poland
Nabari City, Japan
Ithaca, New York
Tralee, Ireland
Ningbo, China (b) (c)
Marshall, Michigan
Valenca, Portugal (b)
Pyongtaek, South Korea (b) (c)
Ramos, Mexico
Vigo, Spain
 

DRIVETRAIN(a) 
 
Americas:
Europe:
Asia:
Addison, Illinois (b)
Arnstadt, Germany
Beijing, China (b)
Auburn Hills, Michigan
Heidelberg, Germany
Dalian, China (b)
Bellwood, Illinois
Ketsch, Germany
Eumsung, South Korea
Frankfort, Illinois
Landskrona, Sweden
Fukuroi City, Japan
Irapuato, Mexico
Monte Carlo, Monaco
Ochang, South Korea (b)
Livonia, Michigan
Szentlorinchata, Hungary
Pune, India
Longview, Texas (b)
Tulle, France
Shanghai, China (b)
Seneca, South Carolina
 
Sirsi, India
Water Valley, Mississippi
 
 
________________

(a)
The table excludes joint ventures owned less than 50% and administrative offices.
(b)
Indicates leased land rights or a leased facility.
(c)
City has 2 locations: a wholly owned subsidiary and a joint venture.

21
  



Item 3.
Legal Proceedings    

The Company is subject to a number of claims and judicial and administrative proceedings (some of which involve substantial amounts) arising out of the Company’s business or relating to matters for which the Company may have a contractual indemnity obligation. See Note 13, "Contingencies," to the Consolidated Financial Statements for a discussion of environmental, product liability and other litigation, which is incorporated herein by reference.

Item 4.
Mine Safety Disclosures

Not applicable.

PART II

Item 5.
Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company's common stock is listed for trading on the New York Stock Exchange under the symbol BWA. As of February 8, 2013, there were 2,196 holders of record of Common Stock.
 
On March 5, 2009, the Company announced the suspension of the Company's quarterly dividend of $0.12 per share. The dividend policy is subject to review and change at the discretion of the Board of Directors.    

High and low prices (as reported on the New York Stock Exchange composite tape) for the Company's common stock for each quarter in 2011 and 2012 were:

Quarter Ended
High
 
Low
March 31, 2011
$
81.07

 
$
64.22

June 30, 2011
$
82.28

 
$
65.78

September 30, 2011
$
81.98

 
$
57.39

December 31, 2011
$
77.70

 
$
54.59

March 31, 2012
$
87.45

 
$
64.28

June 30, 2012
$
87.00

 
$
62.62

September 30, 2012
$
78.18

 
$
60.17

December 31, 2012
$
74.88

 
$
60.53



22
  



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 our 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 12/31/2007 in stock or index, including reinvestment of dividends. Fiscal year ending December 31.
Copyright © 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
 
2007
2008
2009
2010
2011
2012
BorgWarner Inc.(1)
100.00
45.53

69.95

152.36

134.21

150.80

S&P 500(2)
100.00
63.00

79.67

91.67

93.61

108.59

SIC Code Index(3)
100.00
41.02

74.87

126.38

94.34

109.28

Peer Group(4)
100.00
49.25

73.41

114.58

103.92

127.13

________________
(1)BorgWarner Inc.
(2)S&P 500 — Standard & Poor’s 500 Total Return Index
(3)Standard Industrial Code (“SIC”) 3714-Motor Vehicle Parts
(4)Peer Group Companies — Consists of the following companies:
American Axle & Manufacturing Holdings, Inc., Autoliv, Inc., Gentex Corporation, Johnson Controls, Inc., Lear Corporation (pre-2009 bankruptcy), Magna International Inc., Meritor, Inc., Modine Manufacturing Company, Tenneco Inc., TRW Automotive Holdings Corp. and Visteon Corporation (pre-2009 bankruptcy)
 
Repurchase of Equity Securities

The Company's Board of Directors has authorized the purchase of up to 24.8 million shares of the Company's common stock. As of December 31, 2012, the Company had repurchased 21,669,252 shares under the Common Stock Repurchase Program. 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 common stock held in treasury and may subsequently be reissued for general corporate purposes.


23
  



Employee transactions include restricted shares withheld to offset statutory minimum tax withholding that occurs upon vesting of restricted shares. The BorgWarner Inc. Amended and Restated 2004 Stock Incentive Plan provides that the withholding obligations be settled by the Company retaining stock that is part of the Award. Withheld shares will be deemed common stock held in treasury and may subsequently be reissued for general corporate purposes.

The following table provides information about the Company's purchases of its equity securities that are registered pursuant to Section 12 of the Exchange Act during the quarter ended December 31, 2012:

Issuer Repurchases of Equity Securities
Period
 
Total number of shares repurchased
 
Average price per share
 
Total number of shares purchased as part of publicly announced plans or programs
 
Maximum number of shares that may yet be purchased
Month Ended October 31, 2012
 
 
 
 
 
 
 
 
Common Stock Repurchase Program
 

 
$

 

 
4,630,748

Employee transactions
 
657

 
$
65.82

 

 
 
Month Ended November 30, 2012
 
 
 
 
 
 
 
 
Common Stock Repurchase Program
 
1,188,100

 
$
63.14

 
1,188,100

 
3,442,648

Employee transactions
 

 
$

 

 
 
Month Ended December 31, 2012
 
 
 
 
 
 
 
 
Common Stock Repurchase Program
 
311,900

 
$
66.05

 
311,900

 
3,130,748

Employee transactions
 

 
$

 

 
 
____________
NOTE: All purchases made on the open market.

Equity Compensation Plan Information

As of December 31, 2012, the number of stock options and restricted common stock outstanding under our equity compensation plans, the weighted average exercise price of outstanding stock options and restricted common stock and the number of securities remaining available for issuance were as follows:
 
 
Number of securities to be issued upon exercise of outstanding options, restricted common stock, warrants and rights
 
Weighted average exercise price of outstanding options, restricted common stock, warrants and rights
 
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Plan category
(a)
 
(b)
 
(c)
Equity compensation plans approved by security holders
2,467,429

 
$
42.46

 
1,935,283

Equity compensation plans not approved by security holders

 
$

 

Total
2,467,429

 
$
42.46

 
1,935,283

 

24
  



Item 6.
Selected Financial Data
 
 
Year Ended December 31,
(millions of dollars, except share and per share data)
 
2012 (a)
 
2011 (a)
 
2010 (a)
 
2009 (a)
 
2008 (b)
Operating results
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
7,183.2

 
$
7,114.7

 
$
5,652.8

 
$
3,961.8

 
$
5,263.9

Operating income (c)
 
$
752.9

 
$
797.5

 
$
504.3

 
$
50.8

 
$
7.3

Net earnings (loss) attributable to BorgWarner Inc. (c)
 
$
500.9

 
$
550.1

 
$
377.4

 
$
27.0

 
$
(35.6
)
 
 
 
 
 
 
 
 
 
 
 
Earnings (loss) per share — basic
 
$
4.45

 
$
5.04

 
$
3.31

 
$
0.23

 
$
(0.31
)
Earnings (loss) per share — diluted
 
$
4.17

 
$
4.45

 
$
3.07

 
$
0.23

 
$
(0.31
)
 
 
 
 
 
 
 
 
 
 
 
Net R&D expenditures
 
$
265.9

 
$
243.7

 
$
185.0

 
$
155.2

 
$
205.7

 
 
 
 
 
 
 
 
 
 
 
Capital expenditures, including tooling outlays
 
$
407.4

 
$
393.7

 
$
276.6

 
$
172.0

 
$
369.7

Depreciation and tooling amortization
 
$
260.2

 
$
252.2

 
$
224.5

 
$
234.6

 
$
259.7

 
 
 
 
 
 
 
 
 
 
 
Number of employees
 
19,100

 
19,250

 
17,500

 
12,500

 
13,800

 
 
 
 
 
 
 
 
 
 
 
Financial position
 
 
 
 

 
 

 
 

 
 

Cash
 
$
715.7

 
$
359.6

 
$
449.9

 
$
357.4

 
$
103.4

Total assets
 
$
6,400.8

 
$
5,958.6

 
$
5,555.0

 
$
4,811.4

 
$
4,644.0

Total debt
 
$
1,067.2

 
$
1,329.1

 
$
1,180.4

 
$
842.3

 
$
780.3

 
 
 
 
 
 
 
 
 
 
 
Common share information
 
 
 
 
 
 
 
 
 
 
Cash dividend declared and paid per share
 
$

 
$

 
$

 
$
0.12

 
$
0.44

 
 
 
 
 
 
 
 
 
 
 
Market prices of the Company's common stock
 
 
 
 
 
 
 
 
 
 
High
 
$
87.45

 
$
82.28

 
$
73.43

 
$
36.78

 
$
55.99

Low
 
$
60.17

 
$
54.59

 
$
33.43

 
$
14.62

 
$
15.00

 
 
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding (thousands)
 
 
 
 
 
 
 
 
 
 
Basic
 
112,652

 
109,229

 
114,155

 
116,522

 
116,007

Diluted
 
121,377

 
128,468

 
129,575

 
116,939

 
116,007

________________
(a)
Refer to Note 15, "Earnings per Share," in Item 8 of this report regarding the impact of the Company's 3.50% convertible senior notes and associated call options and warrants on the Company's earnings per share for the years ended December 31, 2012, 2011 and 2010. For the year ending December 31, 2009, the impact of the Company's 3.50% convertible senior notes and associated warrants were not included in the calculation of diluted earnings per share because including them, under the if-converted method, would have increased earnings per share.

(b)
The Company had a net loss for the year ended December 31, 2008. As a result, diluted loss per share is the same as basic loss per share in the period, as any dilutive securities would reduce the loss per share.

(c)
Refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for discussion of non-comparable items impacting the years ending December 31, 2012, 2011 and 2010. The Company's operating income and net earnings attributable to BorgWarner Inc. for the year ended December 31, 2009 includes $50.3 million of restructuring expense. The Company's operating income and net loss attributable to BorgWarner Inc. for the year ended December 31, 2008 includes $127.5 million of restructuring expense and a goodwill impairment charge of $156.8 million.


25
  




Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION
 
BorgWarner Inc. and Consolidated Subsidiaries (the “Company”) is a leading global supplier of highly engineered 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 ("SUVs"), vans and light trucks). The Company's products are also sold to other OEMs of commercial vehicles (medium-duty trucks, heavy-duty trucks and buses) and off-highway vehicles (agricultural and construction machinery and marine applications). We also manufacture and sell our products to certain Tier One vehicle systems suppliers and into the aftermarket for light, commercial and off-highway 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.

The Company's products fall into two reporting segments: Engine and Drivetrain. The Engine segment's products include turbochargers, timing devices and chain products, emissions systems, thermal systems, diesel coldstart, gasoline ignition technology and cabin heaters. The Drivetrain segment's products include transmission components and systems and all-wheel drive torque management systems.

RESULTS OF OPERATIONS

A summary of our operating results for the years ended December 31, 2012, 2011 and 2010 is as follows:

 
Year Ended December 31,
(millions of dollars, except per share data)
2012
 
2011
 
2010
Net sales
$
7,183.2

 
$
7,114.7

 
$
5,652.8

Cost of sales
5,716.3

 
5,704.3

 
4,559.5

Gross profit
1,466.9

 
1,410.4

 
1,093.3

Selling, general and administrative expenses
629.3

 
621.0

 
566.6

Other (income) expense
84.7

 
(8.1
)
 
22.4

Operating income
752.9

 
797.5

 
504.3

Equity in affiliates’ earnings, net of tax
(42.8
)
 
(38.2
)
 
(39.6
)
Interest income
(4.7
)
 
(4.8
)
 
(2.8
)
Interest expense and finance charges
39.4

 
74.6

 
68.8

Earnings before income taxes and noncontrolling interest
761.0

 
765.9

 
477.9

Provision for income taxes
238.6

 
195.3

 
81.7

Net earnings
522.4

 
570.6

 
396.2

Net earnings attributable to the noncontrolling interest, net of tax
21.5

 
20.5

 
18.8

Net earnings attributable to BorgWarner Inc. 
$
500.9

 
$
550.1

 
$
377.4

Earnings per share — diluted
$
4.17

 
$
4.45

 
$
3.07


26
  



Non-comparable items impacting the Company's earnings per diluted share and net earnings

The Company's earnings per diluted share were $4.17, $4.45 and $3.07 for the years ended December 31, 2012, 2011 and 2010, respectively. The Company believes the following table is useful in highlighting non-comparable items that impacted its earnings per diluted share:

 
Year Ended December 31,
Non-comparable items:
2012
 
2011
 
2010
Loss from disposal activities
$
(0.37
)
 
$
(0.19
)
 
$

Restructuring expense
(0.17
)
 

 

Retirement related obligations

(0.10
)
 

 

Tax adjustments
(0.16
)
 
0.05

 
 
Patent infringement settlement, net of legal costs incurred

 
0.14

 

Environmental litigation settlement

 

 
(0.14
)
Medicare Part D tax law change

 

 
(0.02
)
Reversal of foreign tax credit valuation allowance

 

 
0.17

BERU - Eichenauer equity investment gain

 

 
0.04

Total impact of non-comparable items per share — diluted:
$
(0.80
)
 
$

 
$
0.05


A summary of non-comparable items impacting the Company’s net earnings for the years ended December 31, 2012, 2011 and 2010 is as follows:

Year ended December 31, 2012:
The Company incurred $39.7 million of expense and $5.7 million of tax expense associated with the loss on sale of the spark plug business, primarily related to the write-down of prior purchase price accounting adjustments included within the disposal group. The Company also recorded restructuring expense of $27.4 million, primarily associated with the disposal and future requirements of BERU's on-going business, which was partially offset by a tax benefit of $7.7 million.
Retirement related obligations of $17.3 million are comprised of a $5.7 million loss resulting from the settlement of a portion of the Muncie Plant's pension obligation and an $11.6 million expense associated with the retirement of certain Named Executive Officers.These obligations were partially offset by a $6.1 million tax benefit.
The Company incurred $19.8 million of tax expense resulting from other tax adjustments. These other tax adjustments primarily include tax expense resulting from the settlement of certain tax audits, the Company's second quarter 2012 decision to change its cash repatriation assertion for some of its foreign subsidiaries and a correction of the income taxes payable balance, partially offset by a tax benefit related to certain countries enacting changes to their respective statutory income tax rates.
Year ended December 31, 2011:
The Company incurred $21.5 million in expense associated with the loss on sale of the tire pressure monitoring business, including costs related to the divestiture, and a write-down of a portion of the ignitor and electronic business. In addition, the Company recorded $1.4 million of tax benefit associated with the disposals and $4.1 million of tax expense related to an intercompany disposal transaction.
The Company recorded a $29.1 million patent infringement settlement gain, net of legal costs incurred, which was partially offset by $11.0 million of tax expense.
The Company recorded a $6.2 million benefit related to tax adjustments resulting from a change in state corporate income tax legislation as well as an adjustment of the Company's tax accounts as a result of the closure of certain tax audits.

27
  



Year ended December 31, 2010:
The Company recorded a $28.0 million charge for alleged personal injury relating to environmental contamination.
The Company recorded $2.5 million in expense associated with the Medicare Part D tax adjustment.
The Company reversed $21.2 million of the valuation allowance on U.S. based foreign tax credit carryforwards.
The Company recorded an $8.0 million gain on the acquisition of BERU-Eichenauer GmbH related to adjusting the Company's 50% investment to fair value under ASC Topic 805.

The Company's effective tax rate, after giving tax effect to the non-comparable items shown above, was 26.8%, 24.8% and 21.7% for the years ended December 31, 2012, 2011 and 2010, respectively.

Net Sales

The table below summarizes the overall worldwide light vehicle production year over year percentage increases/(decreases) for the years ended December 31, 2012 and 2011:
 
 
Years Ended December 31,
 
2012
 
2011
North America*
17
 %
 
9
 %
Europe*
(6
)%
 
5
 %
Asia*
11
 %
 
 %
Total Worldwide*
6
 %
 
3
 %
BorgWarner year over year net sales change
1
 %
 
26
 %
BorgWarner year over year net sales change, excluding the impact of acquisitions, divestitures and foreign currencies
6
 %
 
17
 %
________________
*
Estimated data provided by IHS Automotive.

Net sales for the year ended December 31, 2012 totaled $7,183.2 million, a 1.0% increase from the year ended December 31, 2011. Excluding the impact of the first quarter 2011 acquisition of Haldex Traction Holding AB, fourth quarter of 2011 and third quarter of 2012 dispositions and the impact of weaker foreign currencies, primarily the Euro, net sales increased approximately 6%. This increase occurred while estimated light vehicle production was up 6% worldwide, primarily driven by a 17% increase in North America and a 19% increase in Japan, partially offset by a 6% decrease in Europe from the year ended December 31, 2011.

Net sales for the year ended December 31, 2011 totaled $7,114.7 million, a 25.9% increase from the year ended December 31, 2010 and better than the then estimated worldwide market production increase of 3%. Excluding the impact of strengthening foreign currencies, primarily the Euro, the second quarter 2010 purchase of Dytech Ensa S.L. and the first quarter 2011 purchase of Haldex Traction AB, net sales increased by approximately 17% during the year ended December 31, 2011. The above-market growth for the Company was driven by the industry's focus on fuel economy and lower emissions.



28
  



The following table details our results of operations as a percentage of net sales:
 
 
Year Ended December 31,
(percentage of net sales)
2012
 
2011
 
2010
Net sales
100.0
 %
 
100.0
 %
 
100.0
 %
Cost of sales
79.6

 
80.2

 
80.7

Gross profit
20.4

 
19.8

 
19.3

Selling, general and administrative expenses
8.8

 
8.7

 
10.0

Other (income) expense
1.2

 
(0.1
)
 
0.4

Operating income
10.4

 
11.2

 
8.9

Equity in affiliates’ earnings, net of tax
(0.6
)
 
(0.5
)
 
(0.7
)
Interest income
(0.1
)
 
(0.1
)
 

Interest expense and finance charges
0.5

 
1.0

 
1.2

Earnings before income taxes and noncontrolling interest
10.6

 
10.8

 
8.4

Provision for income taxes
3.3

 
2.8

 
1.4

Net earnings
7.3

 
8.0

 
7.0

Net earnings attributable to the noncontrolling interest, net of tax
0.3

 
0.3

 
0.3

Net earnings attributable to BorgWarner Inc. 
7.0
 %
 
7.7
 %
 
6.7
 %

Cost of sales as a percentage of net sales was 79.6%, 80.2% and 80.7% in the years ended December 31, 2012, 2011 and 2010, respectively. The Company's material cost of sales was approximately 50% of net sales in the years ended December 31, 2012, 2011 and 2010. The Company's remaining cost to convert raw material to finished product, which includes direct labor and manufacturing overhead, has continued to improve during the years ended December 31, 2012 and December 31, 2011 compared to December 31, 2010 as a result of increased net sales and successful cost reduction actions. Gross profit as a percentage of net sales was 20.4%, 19.8% and 19.3% in the years ended December 31, 2012, 2011 and 2010, respectively.

Selling, general and administrative expenses (“SG&A”) was $629.3 million, $621.0 million and $566.6 million or 8.8%, 8.7% and 10.0% of net sales for the years ended December 31, 2012, 2011 and 2010, respectively. SG&A remained relatively flat during the year ended December 31, 2012 compared to the year ended December 31, 2011 as a result of increased research and development ("R&D") costs included in SG&A, offset by continued cost management. The increase in SG&A for the year ended December 31, 2011 compared with the year ended December 31, 2010 of $54.4 million was primarily due to the $58.7 million, or 31.7%, increase in R&D costs. The SG&A decrease as a percentage of net sales was primarily driven by the significant year over year increase in net sales.

R&D costs, net of customer reimbursements, was $265.9 million, or 3.7% of net sales, in the year ended December 31, 2012, compared to $243.7 million, or 3.4% of net sales, and $185.0 million, or 3.3% of net sales, in the years ended December 31, 2011 and 2010, respectively. We will 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% of net sales.

Other (income) expense was $84.7 million, $(8.1) million and $22.4 million for the years ended December 31, 2012, 2011 and 2010, respectively. This line item is primarily comprised of transactions discussed within the subtitle "Non-comparable items impacting the Company's earnings per diluted share and net earnings" above.

29
  




Equity in affiliates' earnings, net of tax was $42.8 million, $38.2 million and $39.6 million in the years ended December 31, 2012, 2011 and 2010, 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 increase in equity in affiliates' earnings for the year ended December 31, 2012 compared with the year ended December 31, 2011 is primarily due to year over year growth in the Japanese auto market resulting in improved earnings from the Company's interest in NSK-Warner. The decrease in equity in affiliates' earnings for the year ended December 31, 2011 compared to the year ended December 31, 2010 is primarily due to lower production volumes in Japan as a result of natural disasters. Refer to Note 5 to the Consolidated Financial Statements in Item 8 of this report for further discussion of NSK-Warner.

Interest expense and finance charges were $39.4 million, $74.6 million and $68.8 million in the years ended December 31, 2012, 2011 and 2010, respectively. The decrease in interest expense for the year ended December 31, 2012 compared with the year ended December 31, 2011 was primarily due to the April 2012 settlement of the Company's convertible senior notes, the ineffectiveness of cross-currency swaps and higher capitalized interest associated with increased long-term capital projects. The increase in interest expense for the year ended December 31, 2011 compared with the year ended December 31, 2010 was primarily due to higher debt levels.

Provision for income taxes The provision for income taxes resulted in an effective tax rate of 31.4% for the year ended December 31, 2012, compared with rates of 25.5% and 17.1% for the years ended December 31, 2011 and 2010, respectively.

The Company's provision for income taxes for the year ended December 31, 2012 includes a net tax benefit of $2.0 million associated with the loss from disposal activities and restructuring expense. The $2.0 million net benefit is comprised of a tax benefit of $7.7 million associated with restructuring expense, partially offset by tax expense of $5.7 million resulting from the sale of the spark plug business. Additionally, the provision includes a tax benefit of $6.1 million related to retirement related obligations and additional tax expense of $19.8 million resulting from other tax adjustments. These other tax adjustments include $5.9 million of tax expense primarily resulting from the settlement of certain tax audits, $7.5 million of tax expense associated with the Company's second quarter 2012 decision to change its cash repatriation assertion for some of its foreign subsidiaries, $4.7 million of tax benefit related to certain countries enacting changes to their respective statutory income tax rates and $11.1 million of U.S. tax expense to correct the income taxes payable balance. Excluding the impact of these non-comparable items, the Company's annual effective tax rate associated with ongoing operations for 2012 was 26.8%.

In January 2013, the United States Congress passed an extension of the federal research and development tax credit and other international tax provisions through December 31, 2013. As a result, we expect that our tax provision for the first quarter of fiscal year 2013 will include a discrete tax benefit which will reduce our effective tax rate for the quarter and, to a lesser extent, the full year.

The effective tax rate of 25.5% for the year ended December 31, 2011 includes $11.0 million of tax expense associated with the Company's patent infringement settlement, $2.7 million of tax expense associated with the loss on disposals and a tax benefit of $6.2 million resulting from other tax adjustments. These other tax adjustments related to a change in state corporate income tax legislation as well as an adjustment of the Company's tax accounts as a result of the closure of certain tax audits. This rate differs from the U.S. statutory rate primarily due to foreign rates, which differ from those in the U.S., the realization of certain business tax credits including foreign tax credits and favorable permanent differences between book and tax treatment for items, including equity in affiliates' earnings. Excluding the impact of these non-comparable items, the Company's annual effective tax rate associated with ongoing operations for 2011 was 24.8%.

30
  



The effective tax rate of 17.1% for the year ended December 31, 2010 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 impact of the items mentioned above, the Company's annual effective tax rate associated with ongoing business operations was 21.7%.

Net earnings attributable to the noncontrolling interest, net of tax of $21.5 million for the year ended December 31, 2012 increased by $1.0 million and $2.7 million compared to 2012 for the years ended December 31, 2011 and 2010, respectively. The increases during the years ended December 31, 2012 and December 31, 2011 compared to the year ended December 31, 2010 are primarily related to higher sales and earnings by the Company's joint ventures.

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. ROIC is comprised of Adjusted EBIT after deducting notional taxes compared to the projected average capital investment required. Adjusted EBIT is comprised of earnings before interest, income taxes and noncontrolling interest (“EBIT") adjusted for restructuring, goodwill impairment charges, affiliates' earnings and other items not reflective of ongoing operating income or loss.

Adjusted EBIT is the measure of segment income 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 show segment information and Adjusted EBIT for the Company's reporting segments.

Net Sales

 
Year Ended December 31,
(millions of dollars)
2012
 
2011
 
2010
Engine
$
4,913.0

 
$
5,050.6

 
$
4,060.8

Drivetrain
2,298.7

 
2,084.5

 
1,611.4

Inter-segment eliminations
(28.5
)
 
(20.4
)
 
(19.4
)
Net sales
$
7,183.2

 
$
7,114.7

 
$
5,652.8



31
  



Adjusted Earnings Before Interest, Income Taxes and Noncontrolling Interest ("Adjusted EBIT")
 
 
Year Ended December 31,
(millions of dollars)
2012
 
2011
 
2010
Engine
$
786.4

 
$
774.3

 
$
537.9

Drivetrain
209.1

 
161.2

 
137.0

Adjusted EBIT
995.5

 
935.5

 
674.9

Loss from disposal activities
39.7

 
21.5

 

Restructuring expense
27.4

 

 

Retirement related obligations
17.3

 

 

Patent infringement settlement, net of legal costs incurred

 
(29.1
)
 

Environmental litigation settlement

 

 
28.0

BERU - Eichenauer equity investment gain

 

 
(8.0
)
Corporate, including equity in affiliates' earnings and stock-based compensation
115.4

 
107.4

 
111.0

Interest income
(4.7
)
 
(4.8
)
 
(2.8
)
Interest expense and finance charges
39.4

 
74.6

 
68.8

Earnings before income taxes and noncontrolling interest
761.0

 
765.9

 
477.9

Provision for income taxes
238.6

 
195.3

 
81.7

Net earnings
522.4

 
570.6

 
396.2

Net earnings attributable to the noncontrolling interest, net of tax
21.5

 
20.5

 
18.8

Net earnings attributable to BorgWarner Inc. 
$
500.9

 
$
550.1

 
$
377.4


The Engine segment's net sales for the year ended December 31, 2012 decreased $137.6 million, or 2.7%, and segment Adjusted EBIT increased $12.1 million, or 1.6%, from the year ended December 31, 2011. Excluding the impact of the fourth quarter 2011 and third quarter 2012 dispositions and weaker foreign currencies, primarily the Euro, net sales increased approximately 4% from the year ended December 31, 2011. This increase was primarily driven by global growth in most major product groups. The segment Adjusted EBIT margin was 16.0% for the year ended December 31, 2012, up from 15.3% in the year ended December 31, 2011. The Adjusted EBIT margin increase was primarily driven by continued cost management.

The Engine segment's net sales for the year ended December 31, 2011 increased $989.8 million, or 24.4%, and segment Adjusted EBIT increased $236.4 million, or 43.9%, from the year ended December 31, 2010. Excluding the impact of strengthening foreign currencies, primarily the Euro, and the second quarter 2010 acquisition of Dytech ENSA S.L., net sales increased approximately 18%. The segment Adjusted EBIT margin was 15.3% for the year ended December 31, 2011, up from 13.2% in the year ended December 31, 2010. The net sales and Adjusted EBIT margin increases were primarily driven by strong global growth in all major product groups and continued cost management.

The Drivetrain segment's net sales for the year ended December 31, 2012 increased $214.2 million, or 10.3%, and segment Adjusted EBIT increased $47.9 million, or 29.7%, from the year ended December 31, 2011. Excluding the acquisition of Haldex Traction AB and the impact of weaker foreign currencies, primarily the Euro, net sales increased approximately 13% from the year ended December 31, 2011. This increase was primarily driven by strong global growth in all major product groups. The segment Adjusted EBIT margin was 9.1% in the year ended December 31, 2012, up from 7.7% in the year ended December 31, 2011. The Adjusted EBIT margin increase was primarily driven by strong global growth in all major product groups, operational improvements and continued cost management.


32
  



The Drivetrain segment's net sales for the year ended December 31, 2011 increased $473.1 million, or 29.4%, and segment Adjusted EBIT increased $24.2 million, or 17.7%, from the year ended December 31, 2010. Excluding the impact of strengthening foreign currencies, primarily the Euro, and the first quarter 2011 acquisition of Haldex Traction AB, net sales increased approximately 14%. The net sales increase was a result of strong four-wheel drive system and traditional transmission component sales in South Korea and higher dual clutch transmission module sales in Europe. The segment Adjusted EBIT margin was 7.7% in the year ended December 31, 2011, down from 8.5% in the year ended December 31, 2010, primarily due to operational inefficiencies in its European operations and Traction Systems acquisition related expenses.

Corporate represents headquarters' expenses not directly attributable to the individual segments, expenses associated with divested operations and equity in affiliates' earnings. This net expense was $115.4 million, $107.4 million and $111.0 million for the years ended December 31, 2012, 2011 and 2010, respectively.

Outlook

Based on weakening global economic conditions, particularly in Europe, our overall outlook for 2013 is cautious. The Company expects global production volumes to be slightly higher in 2013 compared with 2012. In Europe, our largest market, we expect production volumes to decline in 2013 compared with 2012. However, we expect that higher adoption rates of BorgWarner products around the world will result in sales growth for the Company in 2013.

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 Europe and Asia-Pacific.

LIQUIDITY AND CAPITAL RESOURCES

The Company maintains various liquidity sources including cash and cash equivalents and the unused portion of our multi-currency revolving credit agreement. At December 31, 2012, the Company had $715.7 million of cash, including $712.1 million of cash held by our subsidiaries outside of the United States. Cash held by these subsidiaries is used to fund foreign operational activities and future investments, including acquisitions. The vast majority of cash held outside the United States is available for repatriation, however, doing so could result in increased foreign and U.S. federal, state and local income taxes. A deferred tax liability has been recorded for the portion of these funds anticipated to be repatriated to the United States.

The Company's $650 million multi-currency revolving credit facility, which includes a feature that allows the Company's borrowings to be increased to $1 billion, provides for borrowings through June 30, 2016 and is guaranteed by the Company's material domestic subsidiaries. The Company has two key financial covenants as part of the credit agreement. These covenants are 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, 2012 and expects to remain compliant in future periods. At December 31, 2012 and 2011, the Company had outstanding borrowings of $140.0 million and $70.0 million, respectively, under this facility.

On April 9, 2009, the Company issued $373.8 million in convertible senior notes, which were settled in April 2012 by delivering approximately 11.4 million shares of common stock held in treasury to the note holders. The settlement resulted in a reduction in the current portion of long-term debt of $373.8 million, a reduction in common stock held in treasury of $617.3 million and a reduction in capital in excess of par value of $243.5 million.


33
  



In conjunction with the convertible senior note offering, the Company entered into a bond hedge overlay, including both call options and warrants, at a net pre-tax cost of $25.2 million, effectively raising the conversion premium to 50%, or approximately $38.61 per share. On April 16, 2012, the Company settled the call option portion of the bond hedge overlay, receiving approximately 6.5 million shares of its common stock. The settlement resulted in an increase to common stock held in treasury of $503.9 million offset by an increase to capital in excess of par value of $503.9 million.

During the third and fourth quarters of 2012, the Company settled the warrants included in the bond hedge overlay, delivering approximately 4.9 million shares of its common stock held in treasury, resulting in a reduction in common stock held in treasury of $338.5 million offset by a reduction to capital in excess of par value of $338.5 million.

In addition to the credit facility, the Company's universal shelf registration with the Securities and Exchange Commission has an unlimited amount of various debt and equity instruments that could be issued.

From a credit quality perspective, the Company has a credit rating of Baa2 from Moody's. In April 2012, the Company's credit rating was raised to BBB+ from BBB by both Standard & Poor’s and Fitch Ratings. The current outlook from Moody's, Standard & Poor’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.

    Capitalization

 
December 31,
(millions of dollars)
2012
 
2011
Notes payable and short-term debt
$
239.1

 
$
196.3

Current portion of long-term debt
4.3

 
381.5

Long-term debt
823.8

 
751.3

Total debt
1,067.2

 
1,329.1

Less: cash
715.7

 
359.6

Total debt, net of cash
351.5

 
969.5

Total equity
3,146.1

 
2,453.0

Total capitalization
$
3,497.6

 
$
3,422.5

Total debt, net of cash, to capital ratio
10.0
%
 
28.3
%

Balance sheet debt decreased by $261.9 million and cash on hand increased by $356.1 million compared to December 31, 2011 primarily due to net cash provided by operating activities, net of capital expenditures, and the Company's settlement of its 3.50% convertible senior notes, which was partially offset by share repurchases.


34
  



Total equity increased by $693.1 million in the year ended December 31, 2012 as follows:

(millions of dollars)
 
Balance, January 1, 2012
$
2,453.0

Net earnings
522.4

Convertible bond settlement
373.8

Purchase of treasury stock
(295.9
)
Stock-based compensation
94.4

Other comprehensive income
32.3

Dividends declared to noncontrolling stockholders
(18.9
)
BorgWarner BERU Systems Korea Co., Ltd. acquisition
(15.0
)
Balance, December 31, 2012
$
3,146.1


Operating Activities

Net cash provided by operating activities was $878.7 million, $708.2 million and $538.9 million in the years ended December 31, 2012, 2011 and 2010, respectively. The increase for the year ended December 31, 2012 compared with the year ended December 31, 2011 primarily reflects improved working capital management. The increase in the year ended December 31, 2011 compared to the year ended December 31, 2010 primarily reflects higher earnings.

Investing Activities

Net cash used in investing activities was $345.2 million, $564.5 million and $429.5 million in the years ended December 31, 2012, 2011 and 2010, respectively. The decrease in the year ended December 31, 2012 compared with the year ended December 31, 2011 primarily reflects the cash payment of $203.7 million made during the first quarter of 2011 for the acquisition of Haldex Traction AB and the cash proceeds of $55.2 million received during the third quarter of 2012 from the sale of the spark plug business, which was partially offset by increased capital expenditures. The increase in cash used in investing activities in the year ended December 31, 2011 compared to the year ended December 31, 2010 was primarily due to increased capital spending and higher payments for businesses acquired, net of cash acquired. Year over year capital spending increases of $13.7 million and $117.1 million during the years ended December 31, 2012 and December 31, 2011, respectively, were primarily due to higher spending levels required to meet increased program launches worldwide.

Financing Activities

Net cash used in financing activities was $188.6 million, $219.7 million and $13.2 million for the years ended December 31, 2012, 2011 and 2010, respectively. The $31.1 million decrease in the year ended December 31, 2012 compared with the year ended December 31, 2011 was primarily driven by decreased purchases of treasury stock partially offset by an increase in dividends paid to noncontrolling stockholders.

The $206.5 million increase in cash used in financing activities during the year ended December 31, 2011 compared to the year ended December 31, 2010 reflects lower net borrowings of $133.2 million, an increase in the Company's purchases of treasury stock of $31.9 million and the purchase of the noncontrolling interest's 40% share of BorgWarner Vikas Emissions Systems India Private Limited of $29.4 million.


35
  



The Company's significant contractual obligation payments at December 31, 2012 are as follows:

(millions of dollars)
Total
 
2013
 
2014-2015
 
2016-2017
 
After 2017
Other postretirement benefits, excluding pensions (a)
$
297.3

 
$
21.1

 
$
40.3

 
$
37.6

 
$
198.3

Defined benefit pension plans (b)
101.0

 
7.1

 
19.0

 
18.3

 
56.6

Notes payable and long-term debt
1,071.0

 
243.4

 
12.8

 
290.0

 
524.8

Projected interest payments (c)
339.4

 
38.4

 
73.7

 
66.1

 
161.2

Non-cancelable operating leases
68.7

 
18.1

 
27.2

 
20.0

 
3.4

Capital spending obligations
39.8

 
39.8

 

 

 

Income tax payments (d)
201.1

 
201.1

 

 

 

Total
$
2,118.3

 
$
569.0

 
$
173.0

 
$
432.0

 
$
944.3

________________
(a)
Other postretirement benefits, excluding pensions, include anticipated future payments to cover retiree medical and life insurance benefits. See Note 11 to the Consolidated Financial Statements for disclosures related to the Company’s other postretirement benefits.
(b)
Since the timing and amount of payments for funded defined benefit pension plans are usually not certain for future years such potential payments are not shown in this table. Amount contained in “After 2017” column is for unfunded plans and includes estimated payments through 2022. See Note 11 to the Consolidated Financial Statements for disclosures related to the Company’s pension benefits.
(c)
Projection is based upon actual fixed rates where appropriate, and a projected floating rate for the variable rate portion of the total debt portfolio. The floating rate projection is based upon current market conditions and rounded to the nearest 50th basis point (0.50%), which is 4.0% for this purpose. Projection is also based upon debt being redeemed upon maturity.
(d)
See Note 4 to the Consolidated Financial Statements for disclosures related to the Company’s income taxes.

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

Off Balance Sheet Arrangements

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 non-cancelable operating lease obligations at December 31, 2012 is $68.7 million. See Note 14 to the Consolidated Financial Statements for more information on operating leases, including future minimum payments.

Pension and Other Postretirement 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, 2012, all legal funding requirements had been met. The Company contributed $18.0 million, $37.0 million and $25.1 million to its defined benefit pension plans in the years ended December 31, 2012, 2011 and 2010, respectively. The Company expects to contribute a total of $15 million to $25 million into its defined benefit pension plans during 2013. Of the $15 million to $25 million in projected 2013 contributions, $7.1 million are contractual obligations, while the remaining payments are discretionary.

The funded status of all pension plans was a net unfunded position of $317.1 million and $236.4 million at December 31, 2012 and 2011, respectively. Of these amounts, $192.4 million and $128.7 million at December 31, 2012 and 2011, 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 to make contributions as benefit payments become due.


36
  



Other postretirement benefits primarily consist of postretirement 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 postretirement benefits had an unfunded status of $220.5 million and $251.0 million at December 31, 2012 and 2011, respectively.

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 is party to various commercial and legal claims, actions and complaints, including matters involving warranty claims, intellectual property claims, general liability and various other risks. It is not possible to predict with certainty whether or not the Company 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, 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 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 did 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. 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 reasonably estimate the amount or the range of potential loss, if any. A decision on the merits of the suit could be rendered sometime in 2013.


37
  



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 32 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; and remediation alternatives), the Company has an accrual for indicated environmental liabilities of $3.9 million at December 31, 2012. The Company expects to pay out substantially all of the amounts accrued for environmental liability over the next 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. In 2007 and 2008, lawsuits were filed against Kuhlman Electric and others, including the Company, on behalf of approximately 340 plaintiffs alleging personal injury relating to alleged environmental contamination at its Crystal Springs, Mississippi plant. The Company entered into a settlement in July 2010 regarding the personal injury claims of the plaintiffs 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. The Company paid $13.9 million in November 2010 and made the final payment of $13.9 million in February 2011. Litigation concerning indemnification is pending and the Company may in the future become subject to further legal proceedings.

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 both December 31, 2012 and December 31, 2011, the Company had approximately 16,000 pending asbestos-related product liability claims, respectively. Of the approximately 16,000 outstanding claims at December 31, 2012, approximately half were pending in jurisdictions that have undergone significant tort and judicial reform activities subsequent to the filing of these claims.


38
  



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 2012, of the approximately 2,400 claims resolved, 308 (13%) resulted in payment being made to a claimant by or on behalf of the Company. In the full year of 2011, of the approximately 1,800 claims resolved, 288 (16%) 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 paid by the Company's primary layer insurance carriers under a series of funding arrangements. In addition to the primary insurance available for asbestos-related claims, the Company has substantial excess insurance coverage available for potential future asbestos-related product claims. In June 2004, primary layer insurance carriers notified the Company of the alleged exhaustion of their policy limits.

A declaratory judgment action was filed in January 2004 in the Circuit Court of Cook County, Illinois by Continental Casualty Company and related companies against the Company and certain of its historical general liability insurers. The court has issued a number of interim rulings and discovery is continuing. The Company has entered into settlement agreements with some of its insurance carriers, resolving their coverage disputes by agreeing to pay specified amounts to the Company. The Company is vigorously pursuing the litigation against the remaining insurers.

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.

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 experience 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, financial position or cash flows.

To date, the Company has paid and accrued $235.8 million in defense and indemnity in advance of insurers' reimbursement and has received $124.8 million in cash and notes from insurers. The net balance of $111.0 million, is expected to be fully recovered, of which approximately $20 million is expected to be recovered within one year. Timing of recovery is dependent on final resolution of the declaratory judgment action referred to above or additional negotiated settlements. At December 31, 2011, insurers owed $109.8 million in association with these claims.

In addition to the $111.0 million net balance relating to past settlements and defense costs, the Company has estimated a liability of $85.6 million for claims asserted, but not yet resolved and their related defense costs at December 31, 2012. The Company also has a related asset of $85.6 million to recognize proceeds from the insurance carriers, which is expected to be fully recovered. Receipt of these proceeds is not expected prior to the resolution of the declaratory judgment action referred to above, which, more-likely-than-not, will occur subsequent to December 31, 2013. At December 31, 2011, the comparable value of the accrued liability and associated insurance asset was $61.7 million.


39
  



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

 
December 31,
(millions of dollars)
2012
 
2011
Assets:
 

 
 

Prepayments and other current assets
$

 
$
28.8

Other non-current assets
85.6

 
32.9

Total insurance assets
$
85.6

 
$
61.7

Liabilities:


 
 

Accounts payable and accrued expenses
$
36.5

 
$
28.8

Other non-current liabilities
49.1

 
32.9

Total accrued liabilities
$
85.6

 
$
61.7


The 2012 increase in the accrued liability and associated insurance asset is primarily due to an expected higher rate of claim settlement based on recent litigation claim activity.

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. Some of 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 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 as of the date of the financial statements and the accompanying notes, as well as, the amounts of revenues and expenses reported during the periods covered by these financial statements and accompanying notes. Actual results could differ from those estimates.

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.

Cost of sales The Company includes materials, direct labor and manufacturing overhead within cost of sales. Manufacturing overhead is comprised of indirect materials, indirect labor, factory operating costs and other such costs associated with manufacturing products for sale.

40
  




Impairment of long-lived assets, including definite-lived intangible assets The Company reviews the carrying value of its long-lived assets, whether held for use or disposal, including other amortizing intangible assets, when events and circumstances warrant such a review under Accounting Standards Codification ("ASC") Topic 360. A recoverability review is performed using the undiscounted cash flows if there is a triggering event. 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. If the carrying value of a long-lived asset is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value.

Management believes that the estimates of future cash flows and fair value assumptions are reasonable; however, changes in assumptions underlying these estimates could affect the valuations. Long-lived assets held for sale are recorded at the lower of their carrying amount or fair value less cost to sell. Significant judgments and estimates used by management when evaluating long-lived assets for impairment include: (i) an assessment as to whether an adverse event or circumstance has triggered the need for an impairment review; (ii) undiscounted future cash flows generated by the asset; and (iii) fair valuation of the asset.

Goodwill and other indefinite-lived intangible assets During the fourth quarter of each year, the Company qualitatively assesses its goodwill and indefinite-lived intangible assets assigned to each of its reporting units. This qualitative assessment evaluates various events and circumstances, such as macro economic conditions, industry and market conditions, cost factors, relevant events and financial trends, that may impact a reporting unit's fair value. Using this qualitative assessment, the Company determines whether it is more-likely-than not the reporting unit's fair value exceeds its carrying value. If it is determined that it is not more-likely-than-not the reporting unit's fair value exceeds the carrying value, or upon a triggering event, including recent acquisition or divestiture activity, the Company performs a quantitative, "step one," goodwill impairment analysis.

During the fourth quarter of 2012, the Company performed a qualitative analysis on each reporting unit and determined it was more-likely-than-not the fair value exceeded the carrying value of these reporting units. For the reporting unit with recent divestiture activity, the Company performed a quantitative, "step one," goodwill impairment analysis, which 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 this goodwill impairment analysis is the Company's annual budget and long-range plan (“LRP”). The annual budget and LRP includes a five year projection of future cash flows based on actual new products and customer commitments and assumes the last year of the LRP data is a fair indication of the future performance. Because the LRP is estimated over a significant future period of time, those estimates and assumptions are subject to a high degree of uncertainty. Further, the market valuation models and other financial ratios used by the Company require certain assumptions and estimates regarding the applicability of those models to the Company's facts and circumstances.

The Company believes the assumptions and estimates used to determine its estimated fair value are reasonable. Different assumptions could materially affect the estimated fair value. The primary assumptions affecting the Company's December 31, 2012 goodwill quantitative, "step one," impairment review are as follows:

Discount rate: The Company used a 10% weighted average cost of capital (“WACC”) as the discount rate for future cash flows. The WACC is intended to represent a rate of return that would be expected by a market participant.

Operating income margin: The Company used historical and expected operating income margins, which may vary based on the projections the reporting unit being evaluated.


41
  



In addition to the above primary assumptions, the Company notes the following risks to volume and operating income assumptions that could have an impact on the discounted cash flow model:

The automotive industry is cyclical and the Company's results of operations would be adversely affected by industry downturns.
The Company is dependent on market segments that use our key products and would be affected by decreasing demand in those segments.
The Company is subject to risks related to international operations.

Based on the assumptions outlined above, the impairment testing conducted in the fourth quarter of 2012 indicated the Company's goodwill assigned to the reporting unit that was quantitatively assessed was not impaired. Additionally, a sensitivity analysis was completed indicating a 1% increase in the discount rate or a 1% decrease in the operating margin assumptions would not result in the carrying value exceeding the fair value of the reporting unit quantitatively assessed.

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

Product warranties The Company provides warranties on some, but not all, of its products. The warranty terms are typically from one to three years. Provisions for estimated expenses related to product warranty are made at the time products are sold. These estimates are established using historical information about the nature, frequency and average cost of warranty claim settlements as well as product manufacturing and industry developments and recoveries from third parties. Management actively studies trends of warranty claims and takes action to improve product quality and minimize warranty claims. Management believes that the warranty accrual is appropriate; however, actual claims incurred could differ from the original estimates, requiring adjustments to the accrual. Our warranty provision over the last three years, and as a percentage of net sales, has continued to decrease in conjunction with Company's improved quality efforts and has trended as follows:

 
Year Ended December 31,
(millions of dollars)
2012
 
2011
 
2010
Net sales
$
7,183.2

 
$
7,114.7

 
$
5,652.8

Warranty provision
$
33.7

 
$
47.5

 
$
39.3

Warranty provision as a percentage of net sales
0.5
%
 
0.7
%
 
0.7
%

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

 
December 31,
(millions of dollars)
2012
 
2011
 
2010
25 basis point decrease (income)/expense
$
(18.0
)
 
$
(17.8
)
 
$
(14.1
)
25 basis point increase (income)/expense
$
18.0

 
$
17.8

 
$
14.1


At December 31, 2012, the total accrued warranty liability was $64.9 million. The accrual is represented as $33.1 million in current liabilities and $31.8 million in non-current liabilities on our Consolidated Balance Sheet.

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


42
  



Other loss accruals and valuation allowances The Company has numerous other loss exposures, such as customer claims, workers' compensation claims, litigation and recoverability of assets. Establishing loss accruals or valuation allowances for these matters requires the use of estimates and judgment in regard to the risk exposure and ultimate realization. The Company estimates losses under the programs using consistent and appropriate methods; however, changes to its assumptions could materially affect the recorded accrued liabilities for loss or asset valuation allowances.

Environmental contingencies The Company works 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. 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. Management's estimate of the loss for environmental liability was $3.9 million at December 31, 2012.

See Note 13 to the Consolidated Financial Statements for more information regarding environmental accrual.

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

The Company's defined benefit pension and other postretirement plans are accounted for in accordance with ASC Topic 715. The determination of the Company's obligation and expense for its pension and other postretirement benefits, such as retiree health care, is dependent on certain assumptions used by actuaries in calculating such amounts. Certain assumptions, including the expected long-term rate of return on plan assets, discount rate, rates of increase in compensation and health care costs trends are described in Note 11, “Retirement Benefit Plans,” to the Consolidated Financial Statements. The effects of any modification to those assumptions are either recognized immediately or amortized over future periods in accordance with GAAP.

In accordance with GAAP, actual results that differ from assumptions used are accumulated and generally amortized over future periods. The primary assumptions affecting the Company's accounting for employee benefits under ASC Topics 712 and 715 as of December 31, 2012 are as follows:

Expected long-term rate of return on plan assets: The expected long-term rate of return is used in the calculation of net periodic benefit cost. The required use of the expected long-term rate of return on plan assets may result in recognized returns that are greater or less than the actual returns on those plan assets in any given year. Over time, however, the expected long-term rate of return on plan assets is designed to approximate actual earned long-term returns. The expected long-term rate of return for pension assets has been determined based on various inputs, including historical returns for the different asset classes held by the Company's trusts and its asset allocation, as well as inputs from internal and external sources regarding expected capital market return, inflation and other variables. The Company also considers the impact of active management of the plans' invested assets. In determining its pension expense for the year ended December 31, 2012, the Company used long-term rates of return on plan assets ranging from 1.75% to 6.75% outside of the U.S. and 6.75% in the U.S.

43
  




Actual returns on U.S. pension assets were 11.0%, 3.7% and 14.6% for the years ended December 31, 2012, 2011 and 2010, respectively, compared to the expected rate of return assumption of 6.75% for the year ended December 31, 2012 and 7.50% for the years ended December 31, 2011 and 2010, respectively.

Actual returns on U.K. pension assets were 10.0%, 3.3% and 13.3% for the years ended December 31, 2012, 2011 and 2010, respectively, compared to the expected rate of return assumption of 6.75% for the year ended December 31, 2012 and 7.50% for the years ended December 31, 2011 and 2010, respectively.

Discount rate: The discount rate is used to calculate pension and postretirement employee benefit obligations (“OPEB”). The discount rate assumption is based on a constant effective yield from matching projected plan cash flows to high quality (Aa) bond yields of corresponding maturities as of the measurement date. The Company used discount rates ranging from 1.75% to 6.75% to determine its pension and other benefit obligations as of December 31, 2012, including weighted average discount rates of 3.67% in the U.S., 3.86% outside of the U.S., and 3.25% for U.S. other postretirement health care plans. The U.S. discount rate reflects the fact that our U.S. pension plan has been closed for new participants since 1989 (1999 for our U.S. health care plan), and with the closing of our Muncie facility in 2009, there will be negligible service cost going forward.

Health care cost trend: For postretirement employee health care plan accounting, the Company reviews external data and Company specific historical trends for health care cost to determine the health care cost trend rate assumptions. In determining the projected benefit obligation for postretirement employee health care plans as of December 31, 2012, the Company used health care cost trend rates of 7.50%, declining to an ultimate trend rate of 5% by the year 2019.

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

The following table illustrates the sensitivity to a change in certain assumptions for Company sponsored U.S. and non-U.S. pension plans on its 2013 pre-tax pension expense:

(millions of dollars)
Impact on U.S. 2013 pre-tax pension (expense)/income
 
 
Impact on Non-U.S. 2013 pre-tax pension (expense)/income
1 percentage point decrease in discount rate
$

*
 
$
(4.9
)
1 percentage point increase in discount rate
$

*
 
$
4.9

1 percentage point decrease in expected return on assets
$
(2.7
)
 
 
$
(1.8
)
1 percentage point increase in expected return on assets
$
2.7

 
 
$
1.8

________________
* A 1 percentage point increase or decrease in the discount rate would have a negligible impact on the Company’s U.S. 2013 pre-tax pension expense.

The following table illustrates the sensitivity to a change in the discount rate assumption related to the Company’s U.S. OPEB interest expense:
 
(millions of dollars)
Impact on 2013 pre-tax OPEB interest (expense)/income
1 percentage point decrease in discount rate
$
(2.4
)
1 percentage point increase in discount rate
$
2.4


44
  




The sensitivity to a change in the discount rate assumption related to the Company's total 2013 U.S. OPEB expense is expected to be negligible, as any increase in interest expense will be offset by net actuarial gains.

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

 
One Percentage Point
(millions of dollars)
Increase
 
Decrease
Effect on other postretirement benefit obligation
$
16.2

 
$
(14.3
)
Effect on total service and interest cost components
$
0.5

 
$
(0.5
)

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

Income taxes  The Company accounts for income taxes in accordance with ASC Topic 740. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

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

The Company is subject to income taxes in the U.S. at the federal and state level and numerous non-U.S. jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and recording the related assets and liabilities. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is less than certain. Accruals for income tax contingencies are provided for in accordance with the requirements of ASC Topic 605. The Company’s U.S. federal and certain state income tax returns and certain non-U.S. income tax returns are currently under various stages of audit by applicable tax authorities. Although the outcome of ongoing tax audits is always uncertain, management believes that it has appropriate support for the positions taken on its tax returns and that its annual tax provisions included amounts sufficient to pay assessments, if any, which may be proposed by the taxing authorities. At December 31, 2012, the Company has recorded a liability for its best estimate of the more likely than not loss on certain of its tax positions, which is included in other non-current liabilities. Nonetheless, the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year.

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

45
  




New Accounting Pronouncements

In November 2012, the Financial Accounting Standards Board ("FASB") amended ASC Topic 220, "Comprehensive Income," requiring companies to disclose the income statement line items impacted by the reclassification of comprehensive income (loss) into net earnings. This guidance is effective retrospectively for interim and annual periods beginning on or after December 15, 2012. The Company anticipates the adoption of this guidance will not have a material impact on its Consolidated Financial Statements.

In December 2011, the FASB amended ASC Topic 210, "Balance Sheet," requiring companies to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position as well as instruments and transactions subject to an agreement similar to a master netting arrangement. This guidance is effective retrospectively for interim and annual periods beginning on or after January 1, 2013. The Company anticipates the adoption of this guidance will not have a material impact on its Consolidated Financial Statements.

QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The Company's primary market risks include fluctuations in interest rates and foreign currency exchange rates. We are also affected by changes in the prices of commodities used or consumed in our manufacturing operations. Some of our commodity purchase price risk is covered by supply agreements with customers and suppliers. Other commodity purchase price risk is addressed by hedging strategies, which include forward contracts. The Company enters into derivative instruments only with high credit quality counterparties and diversifies its positions across such counterparties in order to reduce its exposure to credit losses. We do not engage in any derivative instruments for purposes other than hedging specific operating risks.

We have established policies and procedures to manage sensitivity to interest rate, foreign currency exchange rate and commodity purchase price risk, which include monitoring the level of exposure to each market risk. For quantitative disclosures about market risk, please refer to Note 10, "Financial Instruments," to the Consolidated Financial Statements in Item 8 of this report for information with respect to interest rate risk and foreign currency exchange rate risk.

Interest Rate Risk

Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. The Company manages its interest rate risk by balancing its exposure to fixed and variable rates while attempting to minimize its interest costs. The Company selectively uses interest rate swaps to reduce market value risk associated with changes in interest rates (fair value hedges). At December 31, 2012, the amount of debt with fixed interest rates was 43.5% of total debt, including the impact of the interest rate swaps. Our earnings exposure related to adverse movements in interest rates is primarily derived from outstanding floating rate debt instruments that are indexed to floating money market rates. A 10% increase or decrease in the average cost of our variable rate debt would result in a change in pre-tax interest expense of approximately $1.6 million, $1.8 million and $1.6 million in the years ended December 31, 2012, 2011 and 2010, respectively.


46
  



Foreign Currency Exchange Rate Risk

Foreign currency exchange rate risk is the risk that we will incur economic losses due to adverse changes in foreign currency exchange rates. Currently, our most significant currency exposures relate to the British Pound, the Chinese Yuan, the Euro, the Hungarian Forint, the Japanese Yen, the Swedish Krona and the South Korean Won. We mitigate our foreign currency exchange rate risk by establishing local production facilities and related supply chain participants in the markets we serve, by invoicing customers in the same currency as the source of the products and by funding some of our investments in foreign markets through local currency loans and cross currency swaps. Such non-U.S. Dollar debt was $258.3 million and $280.4 million as of December 31, 2012 and 2011, respectively. We also monitor our foreign currency exposure in each country and implement strategies to respond to changing economic and political environments. In addition, the Company periodically enters into forward currency contracts in order to reduce exposure to exchange rate risk related to transactions denominated in currencies other than the functional currency. As of December 31, 2012, the Company was holding foreign exchange derivatives with positive and negative fair market values of $5.9 million and $9.8 million, respectively, of which $5.2 million in gains and $9.8 million in losses mature in less than one year.

Commodity Price Risk

Commodity price risk is the possibility that we will incur economic losses due to adverse changes in the cost of raw materials used in the production of our products. Commodity forward and option contracts are executed to offset our exposure to the potential change in prices mainly for various non-ferrous metals and natural gas consumption used in the manufacturing of vehicle components. As of December 31, 2012, the Company had no forward and option commodity contracts outstanding.

Disclosure Regarding Forward-Looking Statements

The matters discussed in this Item 7 include forward looking statements. See "Forward Looking Statements" at the beginning of this Annual Report on Form 10-K.

47
  



REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The information in this report is the responsibility of management. BorgWarner Inc. and Consolidated Subsidiaries (the “Company”) has in place reporting guidelines and policies designed to ensure that the statements and other information contained in this report present a fair and accurate financial picture of the Company. In fulfilling this management responsibility, we make informed judgments and estimates conforming with accounting principles generally accepted in the United States of America.

The accompanying Consolidated Financial Statements have been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm.

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting.

The Company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. The internal control process includes those policies and procedures that:
Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.

Any system of internal control, no matter how well designed, has inherent limitations. Therefore, even those systems determined to be effective may not prevent or detect misstatements and can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2012. In making this assessment, the Company's management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control - Integrated Framework.

Based on management's assessment and those criteria, we believe that, as of December 31, 2012, the Company's internal control over financial reporting is effective.

PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the Company's consolidated financial statements and the effectiveness of internal controls over financial reporting as of December 31, 2012 as stated in their report.

The Company's Audit Committee, composed entirely of directors of the Company who are not employees, meets periodically with the Company's management and independent registered public accounting firm to review financial results and procedures, internal financial controls and internal and external audit plans and recommendations. In carrying out these responsibilities, the Audit Committee and the independent registered public accounting firm have unrestricted access to each other with or without the presence of management representatives.

/s/ James R. Verrier
President and Chief Executive Officer

/s/ Ronald T. Hundzinski
Vice President and Chief Financial Officer


February 14, 2013




48
  



Item 7A.
Quantitative and Qualitative Disclosures About Market Risk

For quantitative and qualitative information regarding market risk, please refer to the discussion in Item 7 of this report under the caption "Quantitative and Qualitative Disclosure about Market Risk."

For information regarding interest rate risk and foreign currency exchange risk, refer to Note 10, “Financial Instruments,” to the Consolidated Financial Statements in Item 8 of this report. For information regarding the levels of indebtedness subject to interest rate fluctuation, refer to Note 8, “Notes Payable and Long-Term Debt,” to the Consolidated Financial Statements in Item 8 of this report. For information regarding the level of business outside the United States, which is subject to foreign currency exchange rate market risk, refer to Note 17, “Reporting Segments and Related Information,” to the Consolidated Financial Statements in Item 8 of this report.

Item 8.
Financial Statements and Supplementary Data



49
  



Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of BorgWarner Inc.

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of BorgWarner Inc. and its subsidiaries at December 31, 2012 and December 31, 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP
Detroit, Michigan
February 14, 2013


50
  



BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 
December 31,
(millions of dollars)
2012
 
2011
ASSETS
 

 
 

Cash
$
715.7

 
$
359.6

Receivables, net
1,147.3

 
1,183.0

Inventories, net
447.6

 
454.3

Deferred income taxes
94.7

 
58.5

Prepayments and other current assets
67.5

 
82.4

Total current assets
2,472.8

 
2,137.8

 
 
 
 
Property, plant and equipment, net
1,788.0

 
1,664.3

Investments and advances
382.7

 
345.3

Goodwill
1,181.4

 
1,186.2

Other non-current assets
575.9

 
625.0

Total assets
$
6,400.8

 
$
5,958.6

 
 
 
 
LIABILITIES AND EQUITY
 

 
 

Notes payable and other short-term debt
$
239.1

 
$
196.3

Current portion of long-term debt
4.3

 
381.5

Accounts payable and accrued expenses
1,287.2

 
1,297.8

Income taxes payable
72.5

 
29.8

Total current liabilities
1,603.1

 
1,905.4

 
 
 
 
Long-term debt
823.8

 
751.3

 
 
 
 
Other non-current liabilities:
 

 
 

Retirement-related liabilities
509.7

 
457.0

Other
318.1

 
391.9

Total other non-current liabilities
827.8

 
848.9

 
 
 
 
Capital stock:
 

 
 

Preferred stock, $0.01 par value; authorized shares: 5,000,000; none issued and outstanding

 

Common stock, $0.01 par value; authorized shares: 390,000,000; issued shares: (2012- 123,023,159; 2011- 121,315,705); outstanding shares: (2012 - 115,572,699; 2011 - 108,514,462)
1.2

 
1.2

Non-voting common stock, $0.01 par value; authorized shares: 25,000,000; none issued and outstanding

 

Capital in excess of par value
1,160.7

 
1,134.3

Retained earnings
2,611.2

 
2,110.3

Accumulated other comprehensive loss
(121.3
)
 
(150.8
)
Common stock held in treasury, at cost: (2012 - 7,450,460 shares; 2011 - 12,801,243 shares)
(569.2
)
 
(707.1
)
Total BorgWarner Inc. stockholders’ equity
3,082.6

 
2,387.9

Noncontrolling interest
63.5

 
65.1

Total equity
3,146.1

 
2,453.0

Total liabilities and equity
$
6,400.8

 
$
5,958.6

 
See Accompanying Notes to Consolidated Financial Statements.

51
  



BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
 
 
Year Ended December 31,
(in millions, except per share amounts)
2012
 
2011
 
2010
Net sales
$
7,183.2

 
$
7,114.7

 
$
5,652.8

Cost of sales
5,716.3

 
5,704.3

 
4,559.5

Gross profit
1,466.9