UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q

QUARTERLY REPORT

~~Under Section 13 or 15(d) of the~~(Mark One)

~~Securities Exchange Act of 1934~~


þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the ~~Quarter~~quarterly period ended ~~September 30, 2005~~March 31, 2006


o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period fromto

Commission file number:1-12162

BORGWARNER INC.

(Exact name of registrant as specified in its charter)


Delaware		13-3404508

State or other jurisdiction of		(I.R.S. Employer
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

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.YESþ NOo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, ~~(as defined~~or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule ~~12-b2~~12b-2 of the Exchange ~~Act).~~

Act. (Check one):
~~YES~~Large Accelerated Filerþ NOAccelerated Filero Non-Accelerated Filero

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

On ~~September 30, 2005~~March 31, 2006 the registrant had ~~57,009,178~~57,240,894 shares of Common Stock outstanding.

PART I. FINANCIAL INFORMATION

BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(millions of dollars)


	September 30,			December 31,			March 31,			December 31,
	2005			2004			2006			2005
	(Unaudited)						(Unaudited)
Assets
Cash and cash equivalents	$	139.5		$	229.7		$	56.8		$	89.7
Marketable securities								65.8			40.6
Receivables, net		660.8			499.1			703.6			626.1
Inventories, net		347.8			223.4			341.3			332.0
Investment in business held for sale		—			44.2
Deferred income taxes								36.5			28.0
Prepayments and other current assets		90.2			77.9			48.8			52.3

Total current assets		1,238.3			1,074.3			1,252.8			1,168.7

Property, plant & equipment, net		1,257.0			1,077.2			1,301.5			1,294.9
Tooling, net		100.6			102.1			114.0			106.2
Investments & advances		204.6			193.7			215.9			197.7
Goodwill		1,016.6			860.8			1,036.8			1,029.8
Other non-current assets		342.7			221.0			285.2			292.1

Total assets	$	4,159.8		$	3,529.1		$	4,206.2		$	4,089.4


Total Liabilities and Stockholders’ Equity
Notes payable	$	174.0		$	16.5		$	123.1		$	160.9
Current portion of long-term debt								139.0			139.0
Accounts payable and accrued expenses		740.6			608.0			777.0			786.4
Income taxes payable		39.0			39.3			38.0			35.8

Total current liabilities		953.6			663.8			1,077.1			1,122.1

Long-term debt		626.6			568.0			510.9			440.6
Long-term retirement-related liabilities		542.9			498.0			532.8			522.1
Other long-term liabilities		281.8			242.9			218.5			224.3

Total liabilities		2,404.9			1,972.7			2,339.3			2,309.1

Minority interest		129.4			22.2			132.9			136.1

Common stock		0.6			0.6			0.6			0.6
Capital in excess of par value		824.3			797.1			837.0			828.7
Unearned compensation on restricted stock								(1.1	)		(1.1	)
Retained earnings		832.7			681.4			941.4			889.2
Accumulated other comprehensive income		(32.0	)		55.2			(43.8	)		(73.1	)
Treasury stock		(0.1	)		(0.1	)		(0.1	)		(0.1	)

Total stockholders’ equity		1,625.5			1,534.2			1,734.0			1,644.2


Total liabilities and stockholders’ equity	$	4,159.8		$	3,529.1		$	4,206.2		$	4,089.4

BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(millions of dollars, except share and per share data)


	Three Months Ended						Nine Months Ended						Three Months Ended
	September 30,						September 30,						March 31,
	2005			2004			2005			2004			2006			2005
Net sales	$	1,050.9		$	839.8		$	3,245.8		$	2,636.1		$	1,155.2		$	1,083.5
Cost of sales		842.7			694.7			2,591.5			2,148.7			928.8			869.8

Gross profit		208.2			145.1			654.3			487.4			226.4			213.7

Selling, general and administrative expenses		120.0			77.4			385.8			259.9			132.6			134.2

Other, net, including litigation settlement		(2.3	)		(0.5	)		35.7			0.4
Other income														(0.5	)		(4.1	)

Operating income		90.5			68.2			232.8			227.1			94.3			83.6

Equity in affiliates earnings, net of tax		(5.7	)		(6.2	)		(17.7	)		(21.2	)		(10.0	)		(4.0	)
Interest expense and finance charges		9.6			7.5			28.8			22.7			9.4			9.3

Earnings before income taxes		86.6			66.9			221.7			225.6
Earnings before income taxes and minority interest														94.9			78.3

Provision for income taxes		19.6			20.1			32.0			67.7
Provision (benefit) for income taxes														26.6			(0.3	)
Minority interest, net of tax		5.6			2.0			14.7			7.3			7.0			1.0

Net earnings	$	61.4		$	44.8		$	175.0		$	150.6		$	61.3		$	77.6


Earnings per share — basic	$	1.08		$	0.80		$	3.09		$	2.70		$	1.07		$	1.38


Earnings per share — diluted	$	1.07		$	0.79		$	3.05		$	2.67		$	1.06		$	1.36


Weighted average shares outstanding (thousands):

Basic		56,811			56,025			56,595			55,742			57,181			56,426
Diluted		57,483			56,650			57,287			56,354			57,758			57,153

Dividends declared per share	$	0.14		$	0.125		$	0.42		$	0.375		$	0.16		$	0.14

BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(millions of dollars)


							Three Months Ended
							March 31,
	Nine months ended						2006			2005
	September 30,									(Restated
	2005			2004						See Note 16)
Operating Activities
Net earnings	$	175.0		$	150.6		$	61.3		$	77.6
Non-cash charges to operations:
Non-cash charges (credits) to operations:
Depreciation		138.2			100.2			47.9			38.0
Amortization of tooling		29.3			30.1			10.0			9.7
Amortization of intangible assets and other		25.3			—			3.2			15.8
Deferred income tax provision		(25.7	)		—
Employee retirement benefits funded with common stock		—			25.8
Stock option compensation expense								2.9			—
Deferred income tax benefit								(2.6	)		(23.0	)
Equity in affiliate earnings, net of dividends received, minority interest and other		(3.5	)		4.0			2.5			(0.4	)

Net earnings adjusted for non-cash charges		338.6			310.7
Changes in assets and liabilities
Net earnings adjusted for non-cash charges (credits) to operations								125.2			117.7
Changes in assets and liabilities, net of effects of acquisitions and divestitures:
Receivables		(92.5	)		(83.1	)		(67.3	)		(55.7	)
Inventories		(31.4	)		(20.0	)		(4.3	)		2.4
Prepayments and other current assets		(19.0	)		(8.5	)		3.7			7.3
Accounts payable and accrued expenses		108.9			82.8			(0.3	)		19.5
Income taxes payable		(20.8	)		12.9			3.0			(11.9	)
Other long-term assets and liabilities		(31.2	)		25.9			(11.9	)		(34.3	)

Net cash provided by operating activities		252.6			320.7			48.1			45.0
Investing Activities
Capital expenditures		(150.2	)		(126.7	)		(53.1	)		(49.3	)
Tooling outlays, net of customer reimbursements		(29.5	)		(40.5	)		(17.2	)		(3.5	)
Net proceeds from asset disposals		8.0			2.9			1.1			2.9
Proceeds from sale of business		44.2			—
Investment in unconsolidated subsidiary		—			(9.0	)
Payments for business acquired, net of cash acquired		(429.4	)		—
Net (increase) decrease in marketable securities								(24.1	)		4.2
Proceeds from sale of businesses								—			44.2
Payments for business acquired, net of cash and cash equivalents acquired								—			(477.2	)

Net cash used in investing activities		(556.9	)		(173.3	)		(93.3	)		(478.7	)
Financing Activities
Net increase (decrease) in notes payable		165.1			(2.7	)		(36.8	)		215.9
Additions to long-term debt		131.2			0.3			125.6			124.8
Reductions in long-term debt		(57.2	)		(58.6	)		(54.3	)		—
Proceeds from stock options exercised		15.3			9.8			2.4			1.9
Dividends paid		(23.7	)		(20.9	)
Dividends paid, including minority shareholders								(18.2	)		(10.5	)

Net cash provided by (used in) financing activities		230.7			(72.1	)
Net cash provided by financing activities								18.7			332.1
Effect of exchange rate changes on cash and cash equivalents		(16.6	)		0.6			(6.4	)		(11.3	)

Net increase (decrease) in cash and cash equivalents		(90.2	)		75.9
Net decrease in cash and cash equivalents								(32.9	)		(112.9	)
Cash and cash equivalents at beginning of year		229.7			113.1			89.7			229.7

Cash and cash equivalents at end of period	$	139.5		$	189.0		$	56.8		$	116.8

Supplemental Cash Flow Information
Net cash paid during the period for:
Interest	$	30.8		$	23.8		$	11.0		$	10.2
Income taxes		91.4			12.6			21.9			21.7
Non-cash financing transactions:
Issuance of common stock for Executive Stock Performance Plan		2.6			2.0			2.7			2.6
Issuance of restricted common stock for non-employee directors		0.9			—
Total debt assumed from business acquired		36.0			—			—			36.0

BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(1) Basis of Presentation

The financial statements of BorgWarner Inc. and Consolidated Subsidiaries (the “Company”) have been prepared in accordance with the instructions to Form 10-Q under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The statements are unaudited but include all adjustments, consisting only of recurring items, except as noted, which the Company considers necessary for a fair presentation of the information set forth herein. The results of operations for the three ~~and nine~~ months ended ~~September 30, 2005~~March 31, 2006 are not necessarily indicative of the results to be expected for the entire year.

~~We have~~The Company has reclassified certain ~~2004~~2005 amounts to conform to the presentation of ~~our 2005~~its 2006 Condensed Consolidated Financial Statements. ~~The~~These condensed financial statements ~~and Management’s Discussion and Analysis of Financial Condition and Results of Operations~~ should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, ~~2004.~~2005.

(2) ~~Acquisition of Beru Aktiengesellschaft~~

On January 4, 2005, the Company acquired 62.2% of the outstanding shares of Beru Aktiengesellschaft (Beru), headquartered in Ludwigsburg, Germany, from the Carlyle Group and certain family shareholders. In conjunction with the acquisition, the Company launched a tender offer for the remaining outstanding shares of Beru. The tender offer period officially ended on January 24, 2005. Presently the Company holds 69.42% of the shares of Beru at a total cost of approximately€420 million. Beru is a leading global automotive supplier of diesel cold starting technology (glow plugs and instant starting systems); gasoline ignition technology (spark plugs and ignition coils); and electronic and sensor technology (tire pressure sensors, diesel cabin heaters and selected sensors). The Company’s Condensed Consolidated Financial Statements include the operating results of Beru within the Engine segment from the date of acquisition.

The impact of Beru on the Company’s future results will be affected by the allocation of the purchase price to the assets acquired and the liabilities assumed. Our preliminary allocation is based on estimated fair values as of the acquisition date as determined by third party valuation specialists. The value assigned to goodwill based on the preliminary valuation was $189.8 million. The remaining preliminary value assigned to property, plant and equipment, intangible assets and other assets and liabilities was $128.7 million, net. A final determination of required purchase accounting adjustments is expected to be made in late 2005. Amortization of the allocated costs for property, plant and equipment, intangible assets and other acquisition related costs for the nine months ended September 30, 2005 was $25.3 million.

The following pro forma information for the three and nine months ended September 30, 2005 and 2004 assumes the Beru acquisition occurred as of the beginning of each year presented. Adjustments have been made to exclude non-recurring charges directly attributable to the acquisition, including the immediate write-off of the purchase price allocation associated with Beru’s in-process research and development. The recurring adjustments reflected in the pro forma statements include the amortization of the amounts allocated to customer relationships, patents, technology, property, plant and equipment and the Company’s acquisition financing costs.

The pro forma results for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that actually would have been obtained had the acquisition been in effect for the period presented or that may be obtained in the future. The

Company expects to finalize the accounting for the acquisition of Beru in late 2005. Accordingly, this pro forma information does not include all costs related to the acquisition. When the costs are finalized, they will either change the amount of goodwill recorded and/or change net earnings, depending on the nature of the costs.

Three months ended Nine months ended
September 30, September 30,
(Pro forma, unaudited, in millions, except per share amounts) 2005 2004 2005 2004
Net sales $ 1,050.9 $ 955.2 $ 3,245.8 $ 2,986.7

Net earnings $ 61.4 $ 43.3 $ 182.3 $ 154.8

Earnings per share — basic $ 1.08 $ 0.77 $ 3.22 $ 2.78

Earnings per share — diluted $ 1.07 $ 0.76 $ 3.18 $ 2.75

~~(3) Sale of Aktiengesellschaft Kühnle, Kopp & Kausch~~

~~On March 11, 2005, the Company completed the sale of its holdings in Aktiengesellschaft Kühnle, Kopp & Kausch (AGK) for~~€42 million to Turbo Group Gmbh, a private equity group. BorgWarner Europe Inc. acquired the stake in AGK, a turbomachinery company, from Penske Transportation International Corporation, a subsidiary of Penske Corporation in 1997. Since that time AGK was treated as an unconsolidated subsidiary of the Company and recorded as an “Investment in business held for sale” in the Condensed Consolidated Balance Sheets. The investment was carried on a cost basis, with dividends received from AGK applied against the carrying value of the asset. The proceeds, net of closing costs, were approximately€~~40.3 million.~~

~~(4)~~ Research and Development

Research and development (R&D) costs charged to expense were ~~$39.9~~$46.0 million and ~~$32.8~~$41.1 million for the three months ended March 31, 2006 and ~~$121.0 million and $90.7 million for the nine months ended September 30,~~ 2005, ~~and 2004,~~ respectively. R&D costs are included primarily in the selling, general, and administrative expenses of the Condensed Consolidated Statements of Operations. Not included in these amounts were customer sponsored R&D activities of approximately $7.5 million and $9.0 million for the three months ended March 31, 2006 and 2005, respectively.

(3) Income Taxes

The Company’s provision for income taxes is based upon estimated annual tax rates for the year applied to federal, state and foreign income. The projected effective tax rate of 28.0% for 2006 differs from the U.S. statutory rate primarily due to a) foreign rates, which differ from those in the US, and b) favorable permanent items including equity in affiliate earnings and Medicare prescription drug benefits. This rate is expected to be greater than the full year 2005 effective tax rate of 17.5% because the 2005 rate included a) the release of tax accrual accounts upon conclusion of certain tax audits and b) the tax effects of dispositions. The 2006 projected effective tax rate of 28.0% compares to the Company’s full year 2005 effective tax rate associated with its on-going business operations of 27.8%.

(4) Stock-Based Compensation

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised 2004) – “Share-Based Payment” (“SFAS 123R”), which

required the Company to measure all employee stock-based compensation awards using a fair value method and record the related expense in the financial statements. The Company elected to use the modified prospective transition method, which requires that compensation cost be recognized in the financial statements for all awards granted after the date of adoption as well as for existing rewards for which the requisite service has not been rendered as of the date of adoption and requires that prior periods not be restated. All periods presented prior to January 1, 2006 were accounted for in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). Accordingly, no compensation cost was recognized for fixed stock options prior to January 1, 2006 because the exercise price of the stock options exceeded or equaled the market value of the Company’s common stock at the date of grant, which is the measurement date.

In October 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. 123R-2, “Practical Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123R” (“FSP 123R-2”), to provide guidance on determining the grant date for an award as defined in SFAS 123R. FSP 123R-2 stipulates that assuming all other criteria in the grant date definition are met, a mutual understanding of the key terms and conditions of an award to an individual employee is presumed to exist upon the award’s approval in accordance with the relevant corporate governance requirements, provided that the key terms and conditions of an award (a) cannot be negotiated by the recipient with the employer because the award is a unilateral grant, and (b) are expected to be communicated to an individual recipient within a relatively short time period from the date of approval. The Company has applied the principles set forth in FSP 123R-2 upon its adoption of SFAS 123R on January 1, 2006.

Paragraph 81 of SFAS 123R requires an entity to calculate the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to adopting Statement 123R (termed the “APIC Pool”). In November 2005, the FASB issued FSP No. 123R-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” (“FSP 123R-3”), to provide an alternative transition election related to accounting for the tax effects of share-based payment awards to employees to the guidance provided in Paragraph 81 of SFAS 123R. The Company elected to adopt the transition method described in FSP 123R-3. Utilizing the calculation method described in FSP 123R-3, the Company calculated its APIC pool as of January 1, 2006 associated with stock options that were fully vested as of December 31, 2005. The impact on the APIC Pool for stock options that are partially vested at, or granted subsequent to, December 31, 2005 will be determined in accordance with SFAS 123R.

Under the Company’s 1993 Stock Incentive Plan, the Company granted options to purchase shares of the Company’s common stock at the fair market value on the date of grant. The options vest over periods up to three years and have a term of ten years from date of grant. As of December 31, 2003, there were no options available for future grants under the 1993 plan. The 1993 plan expired at the end of 2003 and was replaced by the Company’s 2004 Stock Incentive Plan. Under the 2004 Stock Incentive Plan, the number of shares originally authorized for grant was 2,700,000. As of March 31, 2006, there were a total of 3,138,272 outstanding options under the 1993 and 2004 Stock Incentive Plans.

The adoption of SFAS 123R reduced income before income taxes and net earnings for the first quarter of 2006 by $2.9 million and $2.1 million ($0.04 per basic and diluted share), respectively. The adoption affected both operating activities ($2.9 million non-cash charge back) and financing activities ($0.8 million tax benefit) of the Statement of Cash Flows for the three months ended March 31, 2006.

The following table illustrates the effect on the Company’s net earnings and net earnings per share if the Company had applied the fair value recognition provision of SFAS No. 123, “Accounting for Stock-Based Compensation,” for the prior period presented:


	Three months ended
(Millions, except per share amounts)	March 31, 2005
Net earnings as reported	$	77.6
Add: Stock-based employee compensation expense included in net earnings, net of income tax		0.4
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of tax effects		(1.7	)


Pro forma net earnings	$	76.3


Earnings per share
Basic — as reported	$	1.38

Basic — pro forma	$	1.35


Diluted — as reported	$	1.36

Diluted — pro forma	$	1.33

Total unrecognized compensation cost related to nonvested share-based compensation on arrangements at March 31, 2006 is approximately $16.4 million. This cost is expected to be recognized over the next 2.25 years. A summary of the plans’ shares under option as of and for the three months ended March 31, 2006 is as follows:


	Shares			Weighted-average
	(thousands)			exercise price

Outstanding at December 31, 2005		3,209		$	42.41
Exercised		(59	)		27.00
Forfeited		(12	)		31.97

Outstanding at March 31, 2006		3,138		$	42.74


Options exerciseable at March 31, 2006		825		$	25.97
Options available for future grants		569

In calculating earnings per share, earnings are the same for the basic and diluted calculations. Shares increased for diluted earnings per share by 577,000 and 727,000 for the three months ended March 31, 2006 and 2005, respectively, due to the effects of stock options and shares issuable under the Executive Stock Performance Plan.

The Company did not grant any options during the three months ended March 31, 2006. The weighted average fair value at date of grant for options granted during 2005 was $14.63 and was estimated using the Black-Scholes options pricing model with the following weighted average assumptions:


	2005
Risk-free interest rate		4.07	%
Dividend yield		1.09	%
Volatility factor		27.02	%
Weighted average expected life	4.0 years

The expected lives of the awards are based on historical exercise patterns and the terms of the options. The assumption for weighted average expected lives was based on a third-party evaluation of the Company’s historical exercise patterns. The risk-free interest rate is based on zero coupon treasury bond rates corresponding to the expected life of the awards. The expected volatility assumption was derived by referring to changes in the Company’s historical common stock prices over the same timeframe as the expected life of the awards. The expected dividend yield of stock is based on the Company’s historical dividend yield. The Company has no reason to believe that the expected dividend yield or the future stock volatility is likely to differ materially from historical patterns.

(5) Marketable Securities

As of March 31, 2006 and December 31, 2005, the Company had $65.8 million and $40.6 million, respectively, of highly liquid investments in marketable securities, primarily bank notes. The securities are carried at fair value with the unrealized gain or loss, net of tax, reported in other comprehensive income. As of March 31, 2006 and December 31, 2005, $52.6 million and $27.7 million of the contractual maturities are within one to five years and $13.2 million and $12.9 million are due beyond five years, respectively. The Company does not intend to hold these investments until maturity; rather they are available to support current operations if needed. There were no sales of marketable securities in the three months ended March 31, 2006. Net realized gains of $0.3 million, based on specific identification of securities sold, have been reported in other income for the three months ended March 31, 2005. See Note 16 regarding the restatement of marketable securities in the Company’s 2005 interim financial statements.

(6) Sales of Receivables

Transfer Agreement for face value without recourse. During both of the three-month periods ended March 31, 2006 and 2005, total cash proceeds from sales of accounts receivable were $150 million. The Company paid servicing fees related to these receivables of $0.6 million and $0.4 million for the three months ended March 31, 2006 and 2005, respectively. These amounts are recorded in interest expense and finance charges in the Condensed Consolidated Statements of Operations.

(7) Inventories

Inventories are valued at the lower of cost or market. The cost of U.S. inventories is determined by the last-in, first-out (LIFO) method, while the foreign operations use the first-in, first-out (FIFO) or average-cost methods. Inventories consisted of the following:


	September 30,		December 31,		March 31,			December 31,
(Millions)	2005		2004		2006			2005
Raw materials	$	152.4	$	104.6
Raw material and supplies					$	160.1		$	163.9
Work in progress		88.0		69.8		94.2			84.9
Finished goods		107.4		49.0		92.7			92.3

Total inventories, net	$	347.8	$	223.4
FIFO inventories						347.0			341.1
LIFO reserve						(5.7	)		(9.1	)

Net inventories					$	341.3		$	332.0

In calculating earnings per share, earnings are the same for the basic and diluted calculations. Shares increased for diluted earnings per share by 672,000 and 625,000 for the three months ended September 30, 2005 and 2004 respectively, and 692,000 and 612,000 for the nine months ended September 30, 2005 and 2004, respectively, due to the effects of stock options and shares issuable under the Executive Stock Performance Plan.

~~(7) Income Taxes~~(9) Product Warranty

The Company’s provision for income taxes is based upon estimated annual tax rates for the year applied to federal, state and foreign income. The projected effective tax rate of 19.3% for 2005 differs from the U.S. statutory rate primarily due to a) the release of tax accrual accounts upon conclusion of certain tax audits, b) the tax effects of the disposition of AGK and other miscellaneous dispositions, c) foreign rates which differ from those in the US and d) realization of certain business tax credits including R&D and foreign tax credits. If the effects of the tax accrual release, the disposition of AGK and other miscellaneous dispositions are not taken into account, the Company’s effective tax rate associated with its on-going business operations is approximately 28.0%. This rate is lower than the 2004 tax rate for on-going operations of 30.0% due to changes in the mix of global pre-tax income among taxing jurisdictions as well as an increase in favorable permanent items.

In December 2004, the FASB issued FSP 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (AJCA),and FSP 109-2 “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the AJCA.” These two FSPs provide guidance on the application of the new provisions of the AJCA, which was signed into law on October 22, 2004.

The AJCA provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010. In return, the AJCA provides for a two-year phase-out of the existing extra-territorial income exclusion (ETI) for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. Under the guidance in FSP 109-1, the deduction will be treated as a “special deduction” as described in SFAS 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this deduction will be reported in the period in which the deduction is claimed on our tax return. The Company does not expect the net effect of the phase out of the ETI and the phase in of this new deduction to have a material impact on its effective tax rate.

FSP 109-2 provides guidance on the accounting for the deduction of 85% of certain foreign earnings that are repatriated, as defined in the AJCA. The Company may elect to apply this provision (“the election”) to qualifying earnings repatriations in 2005.

The Company ~~has decided~~provides warranties on ~~a plan~~some of its products. The warranty terms are typically from one to three years. Provisions for ~~reinvestment~~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 ~~repatriation~~warranty claims. Management actively studies trends of ~~foreign earnings (as a result of~~warranty claims and takes action to improve product quality and minimize warranty claims. Management believes that the ~~repatriation provision) and obtained approval for the repatriation plan~~warranty accrual is appropriate, however, actual claims incurred could differ from the ~~Board of Directors~~original estimates, requiring adjustments to the accrual. The accrual is recorded in both long-term and short-term liabilities on ~~July 26, 2005.~~the balance sheet. The ~~Company intends to repatriate foreign earnings of approximately $71.4 million~~following table summarizes the activity in the warranty accrual accounts:


	Three months ended
	March 31,
(Millions)	2006			2005
Beginning balance	$	44.0		$	26.4
Beru acquisition		—			7.3
Provision		5.6			3.2
Payments		(6.8	)		(0.5	)
Currency translation		1.7			(0.4	)

Ending balance	$	44.5		$	36.0

911

from its non-US subsidiaries during 2005. Of the approximately $71.4 million, the Company intends to make an election under the AJCA with respect to approximately $18.5 million. The Company intends to use this $18.5 million to pay down its US debt obligations and invest in R&D. The Company is estimating a de minimis effect from the election on income tax expense for 2005.

~~(8)~~(10) Notes Payable and Long-Term Debt

Following is a summary of notes payable and long-term debt:


	September 30, 2005				December 31, 2004				March 31, 2006					December 31, 2005
(Millions)	Current		Long-Term		Current		Long-Term		Current		Long-Term			Current		Long-Term
Bank borrowings and other	$	158.0	$	46.4	$	9.2	$	6.1	$	90.6	$	94.7		$	136.2	$	21.0

Term loans due through 2013 (at an average rate of 3.1% in 2005 and 3.3% in 2004)		16.0		49.0		7.3		26.9
Term loans due through 2013 (at an average rate of 2.2% in 2006 and 3.2% in 2005)										32.5		30.9			24.3		30.4

7% Senior Notes due 11/01/06, net of unamortized discount ($139 million converted to floating rate of 5.9% by interest rate swap at 09/30/05)		—		139.0		—		139.0
7% Senior Notes due 11/01/06, net of unamortized discount ($139 million converted to floating rate of 6.8% by interest rate swap at 03/31/06)										139.0		—			139.0		—

6.5% Senior Notes due 02/15/09, net of unamortized discount ($100 million converted to floating rate of 6.6% by interest rate swap at 09/30/05)		—		136.2		—		136.1
6.5% Senior Notes due 02/15/09, net of unamortized discount($100 million converted to floating rate of 7.5% by interest rate swap at 03/31/06)										—		136.3			—		136.2

8% Senior Notes due 10/01/19, net of unamortized discount ($75 million converted to floating rate of 6.8% by interest rate swap at 09/30/05)		—		133.9		—		133.9
8% Senior Notes due 10/01/19, net of unamortized discount ($75 million converted to floating rate of 7.7% by interest rate swap at 03/31/06)										—		133.9			—		133.9

7.125% Senior Notes due 02/15/29, net of unamortized discount		—		119.1		—		119.1		—		119.1			—		119.1

Carrying amount of notes payable and long-term debt		174.0		623.6		16.5		561.1		262.1		514.9			299.5		440.6

Impact of derivatives on debt		—		3.0		—		6.9		—		(4.0	)		0.4		—

Total notes payable and long-term debt	$	174.0	$	626.6	$	16.5	$	568.0	$	262.1	$	510.9		$	299.9	$	440.6

The Company has a multi-currency revolving credit facility, which provides for ~~committed~~ borrowings up to $600 million through July 2009. At ~~September 30, 2005, $40.0~~March 31, 2006, $90.0 million of borrowings under the facility were ~~outstanding in addition to $1.0 million of obligations under standby letters of credit. At December 31, 2004 the facility was unused.~~outstanding. The credit agreement is subject to the usual terms and conditions applied by banks to an investment grade company. The Company was in compliance with all covenants at ~~September 30, 2005~~March 31, 2006 and expects to be compliant in future periods. The 7% Senior Notes with a face value of $139.0 million mature in November 2006. Management plans to refinance this amount at that time. The Company had outstanding letters of credit of $26.7 million at March 31, 2006 and $25.7 million at December 31, 2005. The letters of credit typically act as a guarantee of payment to certain third parties in accordance with specified terms and conditions.

Fair market values are developed by the use of estimates obtained from brokers and other appropriate valuation techniques based on information available as of year-end. The fair value estimates do not necessarily reflect the values the Company could realize in the current markets.

~~(9)~~(11) Financial Instruments

The Company’s financial instruments include cash and cash equivalents, marketable securities, trade receivables, trade payables, and notes payable. Due to the short-term nature of these instruments, the book value approximates fair value. The Company’s financial instruments also include long-term debt, interest rate and currency swaps, commodity swap contracts, and foreign currency forward contracts.

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). WeThe Company also selectively ~~use~~uses cross-currency swaps to hedge the foreign currency exposure associated with ~~our~~its net investment in certain foreign operations (net investment hedges).

A summary of these instruments outstanding at ~~September 30, 2005~~March 31, 2006 follows (currency in millions):


													Notional		Interest Rates^(b)
		Notional Interest Rates^(b)										Hedge Type	Amount		Receive			Pay			Floating Interest Rate Basis
	Hedge Type	Amount		Receive			Pay			Floating Interest Rate Basis
Interest rate swaps^(a)											Interest rate swaps^(a)
Fixed to floating	Fair value	$	139		7.0	%		5.9	%	6 month LIBOR + 1.7%		Fair value	$	139		7.0	%		6.8	%	6 mo. USD LIBOR + 1.7%
Fixed to floating	Fair value	$	100		6.5	%		6.6	%	6 month LIBOR + 2.4%		Fair value	$	100		6.5	%		7.5	%	6 mo. USD LIBOR + 2.4%
Fixed to floating	Fair value	$	75		8.0	%		6.8	%	6 month LIBOR + 2.6%		Fair value	$	75		8.0	%		7.7	%	6 mo. USD LIBOR + 2.6%

Cross currency swap (matures 11/01/06)											Cross currency swap (matures 11/01/06)
Floating $	Net investment	$	125		5.6	%		—		6 month USD LIBOR + 1.4%		Net investment	$	125		6.5	%				6 mo. USD LIBOR + 1.4%
to floating ¥		¥	14,930		—			1.7	%	6 month JPY LIBOR + 1.6%			¥	14,930					1.8	%	6 mo. JPY LIBOR + 1.6%

Cross currency swap (matures 02/15/09)											Cross currency swap (matures 02/15/09)
Floating $	Net investment	$	100		6.6	%		—		6 month USD LIBOR + 2.4%		Net investment	$	100		7.5	%				6 mo. USD LIBOR + 2.4%
to floating€		€	75		—			4.6	%	6 month EURIBOR + 2.4%			€	75					5.4	%	6 mo. EURIBOR + 2.4%

Cross currency swap (matures 10/01/19)											Cross currency swap (matures 10/01/19)
Floating $	Net investment	$	75		6.8	%		—		6 month USD LIBOR + 2.6%		Net investment	$	75		7.7	%				6 mo. USD LIBOR + 2.6%
to floating€		€	61		—			4.8	%	6 month EURIBOR + 2.6%			€	61					5.6	%	6 mo. EURIBOR + 2.6%

ineffectiveness was recognized in relation to fixed to floating ~~interest rate swaps were recorded as a long-term asset of $6.9 million.~~swaps.

The cross currency swaps were recorded at their fair values of ~~$14.0~~$4.5 million included in other ~~long-term~~current assets, $10.3 million included in non-current assets and ~~$(7.4)~~$(4.3) million included in other ~~long-term~~current liabilities at ~~September 30, 2005~~March 31, 2006 and ~~$(33.1)~~$3.9 million included in other ~~long-term~~current assets, $14.9 million included in non-current assets and $(5.1) million included in other current liabilities at December 31, ~~2004.~~2005. Hedge ineffectiveness of $0.2 million was recognized as of March 31, 2006 in relation to cross currency swaps. Fair value is based on quoted market prices for contracts with similar maturities.

The Company also entered into certain commodity derivative instruments to protect against commodity price changes related to ~~forecast~~forecasted raw material and

~~supply~~ supplies purchases. The primary purpose of the commodity price hedging activities is to manage the volatility associated with these forecasted purchases. The Company primarily utilizes forward and option contracts, which are designated as cash flow hedges. ~~These instruments are intended to offset the effect of changes in commodity prices on forecasted purchases.~~ As of ~~September 30, 2005~~March 31, 2006, the Company had forward ~~and option~~ commodity contracts with a total notional value of ~~$6.4~~$8.2 million. The fair market value of the ~~swap~~commodity forward contracts showing gains to the Company as of March 31, 2006 was ~~$0.9~~$3.2 million ($~~0.8~~3.2 million maturing in less than one year) ~~as of September 30, 2005, which is~~and ($0.3) million for those showing losses (($0.3) million maturing in less than one year). These amounts are deferred in other comprehensive income and will be reclassified and matched into income as the underlying operating transactions are realized. As of December 31, 2005, the Company had commodity forward contracts with a total notional value of $5.8 million. The fair market value of the forward contracts was $2.1 million ($2.0 million maturing in less than one year) as of December 31, 2005, which was deferred in other comprehensive income. During the ~~nine~~three and twelve months ended ~~September 30,~~March 31, 2006 and December 31, 2005, ~~and 2004,~~respectively, hedge ineffectiveness associated with these contracts was not significant.

The Company uses foreign exchange forward and option contracts to protect against exchange rate movements for forecasted cash flows for purchases, operating expenses or sales transactions designated in currencies other than the functional currency of the operating unit. Most contracts mature in less than one year, however certain long-term commitments are covered by forward currency arrangements to protect against currency risk through the ~~third~~second quarter of 2009. Foreign currency contracts require the Company, at a future date, to either buy or sell foreign currency in exchange for the operating units local currency. At ~~September 30, 2005~~March 31, 2006, contracts were outstanding to buy or sell U.S. Dollars, Euros, British Pounds Sterling, ~~Canadian Dollars~~South Korean Won, Japanese Yen and Hungarian Forints. Gains and losses arising from these contracts are deferred in other comprehensive income and will be reclassified and matched into income as the underlying operating transactions are realized. As of ~~September 30, 2005~~March 31, 2006, deferred gains amounted to ~~$4.5~~$1.4 million, ($~~2.8~~1.4 million maturing in less than one year) and ~~unrealized~~deferred losses amounted to ~~$(0.5)~~$(1.2) million ($~~(0.4)~~(0.8) million maturing in less than one year). As of December 31, ~~2004 unrealized~~2005, deferred gains amounted to ~~$8.8~~$3.0 million, ($1.6 million maturing in less than one year) and ~~unrealized~~deferred losses amounted to ~~$(4.1)~~$(1.6) million ($(1.4) million maturing in less than one year). Hedge ineffectiveness associated with open contracts as of March 31, 2006 amounted to a loss of $ (0.1) million. Hedge ineffectiveness associated with ~~these~~open contracts ~~for the nine months ended September 30,~~at December 31 2005 amounted to a loss of $(0.5) million. ~~Hedge~~Gains and losses arising from ineffectiveness, ~~associated~~as defined by FAS 133, are charged or credited to income as they arise.

(12) Retirement Benefit Plans

The Company has a number of defined benefit pension plans and other postretirement benefit plans covering eligible salaried and hourly employees. The other postretirement benefits plans, which provide medical and life insurance benefits, are unfunded plans. The estimated contributions to pension plans for 2006 range from $25.0 to $30.0 million, of which about $8.0 million has been contributed through the first three months of the year. The components of net periodic benefit cost recorded in the Company’s Condensed Consolidated Statements of Operations, are as follows:


													Other post
(Millions)	Pension benefits												retirement benefits
Three months ended March 31,	2006						2005						2006			2005
	U.S.			Non-U.S.			U.S.			Non-U.S.
Service cost	$	0.7		$	3.2		$	0.6		$	2.6		$	3.2		$	2.1
Interest cost		4.2			3.5			4.3			3.2			8.9			8.5
Expected return on plan assets		(7.2	)		(2.8	)		(7.0	)		(2.1	)		—			—
Amortization of unrecognized transition obligation		—			0.1			—			—			—			—
Amortization of unrecognized prior service cost		0.2			—			0.4			—			(1.0	)		(0.1	)
Amortization of unrecognized loss		1.6			0.6			1.2			0.7			5.8			3.3

Net periodic cost/(benefit)	$	(0.5	)	$	4.6		$	(0.5	)	$	4.4		$	16.9		$	13.8

(13) Comprehensive Income

Comprehensive income is a measurement of all changes in stockholders’ equity that result from transactions and other economic events other than transactions with ~~these contracts was not significant~~stockholders. The amounts presented as other comprehensive income/(loss), net of related taxes, are added to net earnings resulting in ~~2004.~~comprehensive income. The following table summarizes the components of comprehensive income on an after-tax basis for the three-month periods ended March 31, 2006 and 2005.


	Three months ended
	March 31,
(Millions)	2006			2005
Foreign currency translation adjustments, net	$	30.0		$	(27.1	)
Market value change in hedge instruments, net		(0.9	)		(1.7	)
Unrealized gain/(loss) on available-for-sale securities, net		0.2			0.2
Minimum pension liability adjustment, net		—			(2.6	)

Accumulated other comprehensive income/(loss)		29.3			(31.2	)
Net earnings as reported		61.3			77.6

Total comprehensive income	$	90.6		$	46.4

~~(10)~~(14) Contingencies

In the normal course of business the Company and its subsidiaries are parties to various legal claims, actions and complaints, including matters involving intellectual property claims, general liability and various other risks. It is not possible to predict with certainty whether or not the Company and its subsidiaries will ultimately be successful in any of these 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 legal proceedings will have a material adverse effect on the Company’s results of operations, financial position or cash flows. ~~It is not possible to predict with certainty whether or not the Company and its subsidiaries will ultimately be successful in any of these legal matters or, if not, what the impact might be.~~

Environmental

environmental agencies and private parties as potentially responsible parties ~~(PRPs)~~(“PRPs”) at various hazardous waste disposal sites under the Comprehensive Environmental Response, Compensation and Liability Act ~~(Superfund)~~(“Superfund”) and equivalent state laws and, as such, may presently be liable for the cost of clean-up and other remedial activities at 3736 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 ~~condition~~position, or ~~future operating results,~~cash flows, generally either because estimates of the maximum potential liability at a site are not large or because liability will be shared with other PRPs, although no assurance can be given with respect to the ultimate outcome of any such matter.

Based on information available to the Company, which in most cases, includes: an estimate of allocation of liability among PRPs; the probability that other PRPs, many of whom are large, solvent public companies, will fully pay the cost apportioned to them; currently available information from PRPs and/or federal or state environmental agencies concerning the scope of contamination and estimated remediation and consulting costs; remediation alternatives; estimated legal fees; and other ~~factors;~~factors, the Company has established an accrual for indicated environmental liabilities with a balance at ~~September 30, 2005~~March 31, 2006 of approximately ~~$54.9~~$17.6 million. Included in the total accrued liability is the ~~$31.7~~$0.3 million anticipated cost to settle all outstanding claims related to Crystal Springs described below, which was recorded in the second quarter of 2005. For the other 35 sites, the Company has accrued amounts that do not exceed $3.0 million related to any individual site and management does not believe that the costs related to any of these other individual sites will have a material adverse effect on the Company’s results of operations, cash flows or financial condition. The Company expects to expend substantially all of the ~~$54.9~~$17.6 million environmental accrued liability over the next three to five years.

In connection with the sale of Kuhlman Electric Corporation, the Company agreed to indemnify the buyer and Kuhlman Electric for certain environmental

liabilities relating to the past operations of Kuhlman Electric. The liabilities at issue result from operations of Kuhlman Electric that pre-date the Company’s acquisition of Kuhlman Electric’s parent company, Kuhlman Corporation, ~~during~~in 1999. During 2000, Kuhlman Electric notified the Company that it discovered potential environmental contamination at its Crystal Springs, Mississippi plant while undertaking an expansion of the plant. Kuhlman Electric and others, including the Company, ~~have been~~were sued in numerous related lawsuits, in which multiple claimants ~~allege~~alleged personal injury and property damage.

The Company and other defendants, including the Company’s subsidiary, Kuhlman Corporation, entered into a settlement in July 2005 regarding approximately 90% of personal injury and property damage claims relating to the alleged environmental contamination. In exchange for, among other things, the dismissal with prejudice of these lawsuits, the defendants agreed to pay a total sum of up to $39.0 million in settlement funds. The ~~actual amount paid in~~ settlement ~~will depend upon the number of plaintiffs who opt-out of the settlement. The settlement will be~~was paid in three approximately equal installments. The first ~~payment~~two payments of $12.9 million ~~was~~were made in the third ~~quarter~~and fourth quarters of 2005 and ~~the remaining installments will be~~$13.0 million was paid in ~~the fourth quarter of 2005 and~~ the first quarter of 2006.

The same group of defendants entered into a settlement in October 2005

regarding approximately 9% of personal injury and property damage claims relating to the alleged environmental contamination. In exchange for, among other things, the dismissal with prejudice of these lawsuits, the defendants agreed to pay a total sum of up to $5.4 million in settlement funds. The ~~actual amount paid in~~ settlement ~~will depend upon the number of plaintiffs who opt-out of the settlement. The settlement will be~~was paid in two approximately equal installments in the fourth quarter of 2005 and the first quarter of 2006. With this settlement, the Company and ~~the~~ other defendants have resolved about ~~98%~~99% of the known personal injury and property damage claims relating to the alleged environmental contamination. The cost of this settlement has been recorded in other income in the Consolidated Statements of Operations.

Conditional Asset Retirement Obligations

In 2005, the FASB issued Interpretation (“FIN”) No. 47, “Accounting for Conditional Asset Retirement Obligations” an interpretation of Statement of Financial Accounting Standards (“SFAS”) 143, which requires the Company to recognize legal obligations to perform asset retirements in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Certain government regulations require the removal and disposal of asbestos from an existing facility at the time the facility undergoes major renovations or is demolished. The liability exists because the facility will not last forever, but it is conditional on future renovations, even if there are no immediate plans to remove the materials, which pose no health or safety hazard in their current condition. Similarly, government regulations require the removal or closure of underground storage tanks (“USTs”) when their use ceases, the disposal of polychlorinated biphenyl (“PCB”) transformers and capacitors when their use ceases, and the disposal of lead-based paint in conjunction with facility renovations or demolition. The Company currently has 11 manufacturing locations that have been identified as containing asbestos-related building materials, USTs, PCB transformers or capacitors, or lead-based paint. The fair value to remove and dispose of this material has been estimated and recorded at $0.8 million as of March 31, 2006 and December 31, 2005.

Product Liability

Like many other industrial companies who have historically operated in the United States, the Company (or parties the Company indemnifies) continues to be named as one of many defendants in asbestos-related personal injury actions. Management believes that the Company’s involvement is limited because, in general, these claims relate to a few types of automotive friction products, manufactured many years ago that 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 ~~September 30, 2005,~~March 31, 2006, the Company had approximately ~~83,000~~67,800 pending asbestos-related product liability claims. Of these outstanding claims, approximately ~~76,000~~58,000 are pending in just three jurisdictions, where significant tort reform activities are underway.

The Company’s policy is to aggressively defend against these lawsuits and the Company has been successful in obtaining dismissal of many claims without any payment. The Company expects that the vast majority of the pending asbestos-related product liability claims where it is a defendant (or has an obligation to indemnify a defendant) will result in no payment being made by the Company or its ~~insurer.~~insurers. In the first ~~nine months of 2005,~~quarter 2006, of the approximately ~~11,700~~2,425 claims resolved, only ~~229 (2.0%~~46 (1.9%) resulted in any payment being made to a claimant by or on behalf of the Company. In ~~2004~~2005, of the ~~4,062~~approximately 38,000 claims resolved, only ~~255 (6.3%~~295 (0.8%) resulted in any payment being made to a claimant by or on behalf of the Company. ~~In 2003 of~~

Prior to June 2004, the ~~4,664 claims resolved, only 273 (5.9%) resulted in any payment being made to claimants. The~~ settlement and defense costs of these claims were paid by the insurance carriers, except for $3.4 million paid in the first nine months of 2005 and $1.0 million for the full year in 2004 as described in the paragraph below. Based upon the encapsulated nature of the products, our experiences in aggressively defending and resolving claims in the past, and our significant insurance coverageassociated with solvent carriers as of the date of this filing, management does not believe that asbestos-related product liability claims are likely to have a material adverse effect on the Company’s results of operations, cash flows or financial condition.

~~agreement. The~~ arrangement. As of March 31, 2006, the Company has ~~paid $3.4~~a receivable of $3.5 million ~~in the first nine months of 2005 and $1.0 million in the fourth quarter of 2004 as a result~~due to funding settlements before reimbursement by some of the ~~funding agreement.~~secondary layer insurers under this arrangement. The Company is expecting to fully recover these amounts. ~~Recovery~~At March 31, 2006, the Company has an estimated liability of $37.8 million for future claims resolutions, with a related asset of $37.8 million to recognize the insurance proceeds receivable by the Company for estimated losses related to claims that have yet to be resolved. Insurance carrier reimbursement of 100% is ~~dependent~~expected based on the ~~completion of an audit proving the exhaustion of primary~~Company’s experience, its insurance ~~coverage~~contracts and ~~the successful resolution of~~decisions received to date in the declaratory judgment action referred to below.

The Company’s contractual relationship with the secondary layer carriers provides a change in circumstances and allows the Company to take a more direct role in defending and settling claims than with the primary carriers. Previously, the Company’s arrangement utilized the primary layer insurance carriers’ positions to defend and negotiate the settlements with input from the Company.

~~At September 30, 2005, the Company has a liability of $41.2 million; with a related asset of $41.2 million to recognize the insurance proceeds receivable to the Company for estimated claim losses.~~ At December 31, ~~2004,~~2005, the comparable value of the insurance receivable and accrued liability was ~~$40.8~~$41.0 million.

apportioned. On August 15, 2005, the Court issued an interim order regarding the apportionment matter. The interim order has the effect of making insurers responsible for all defense and settlement costs pro rata to time-on-the-risk, with the pro-ration method to hold the insured harmless for periods of bankrupt or unavailable coverage. ~~This~~Appeals of the interim order were denied. However, the issue is ~~under appeal.~~reserved for appellate review at the end of the action. In addition to the primary insurance available for asbestos-related claims, the Company has substantial additional layers of insurance available for potential future asbestos-related product claims. As such, the Company continues to believe that its coverage is sufficient to meet foreseeable liabilities.

Although it is impossible to predict the outcome of pending or future ~~claims;~~claims or the impact of tort reform legislation being considered at the State and Federal levels, due to the encapsulated nature of the products, ~~our~~the Company’s experiences in aggressively defending and resolving claims in the past, and ~~our~~the Company’s significant insurance coverage with solvent carriers as of the date of this filing, management does not believe that asbestos-related product liability claims are likely to have a material adverse effect on the Company’s results of operations, cash flows or financial condition.

~~(11)~~(15) Leases and Commitments

The Company has guaranteed the residual values of certain leased machinery and equipment at one of its facilities. The guarantees extend through the maturity of the underlying lease, which is in September 2006. In the event the Company exercises its option not to purchase the machinery and equipment, the Company has guaranteed a residual value of $16.6 million. The Company does not believe it has any loss exposure due to this guarantee.

(16) Restatement of Marketable Securities

On January 4, 2005, the Company acquired 62.2% of the outstanding shares of Beru AG (“Beru”), headquartered in Ludwigsburg, Germany, from the Carlyle Group and certain family shareholders. In conjunction with the acquisition, the Company launched a tender offer for the remaining outstanding shares of Beru, which ended in February 2005. Presently, the Company holds 69.4% of the shares of Beru. In the preparation of the Company’s 2005 annual financial statements, the Company determined that marketable securities, which were part of the Beru acquisition and which amounted to $46.4 million as of March 31, 2005, had previously been reported as cash and cash equivalents in the Company’s March 31, 2005 quarterly filing, and should have been reported as marketable securities. The Company ~~entered into two separate royalty agreements with Honeywell International for certain variable turbine geometry (VTG) turbochargers~~has restated its March 31, 2005 financial statements contained in ~~order~~this quarterly filing to ~~continue shipping to its OEM customers after a German court ruled in favor~~properly present these marketable securities.

This restatement has no impact on current assets or total assets, but does impact the presentation of Honeywell in a patent infringement action. The two separate royalty agreements were signed in July 2002 and June 2003, respectively. The July 2002 agreement was effective immediately and expired in June 2003. The June 2003 agreement was effective July 2003 and covers the ~~period through 2006 with a minimum royalty for shipments up to certain volume levels and a per unit royalty for any units sold above these stated amounts.~~

~~The royalty costs recognized under the agreements~~Consolidated Statement of Cash Flow for the three ~~and nine~~ months ended ~~September 30~~March 31, 2005. The effects of this restatement on the previously reported March 31, 2005 Consolidated Statements of Cash Flows were ~~$0.5 million and $1.5 million in 2005 and $2.4 million and $12.0 million in 2004, respectively. These costs were all recognized as part of cost of goods sold. These costs will continue~~ to change (a) the net (increase)/decrease in ~~2005~~marketable securities’ from $0.0 to $4.2 million; (b) payments for business acquired, net of cash acquired from $(429.4) million to $(477.2) million; (c) net cash used in investing activities from $(435.1) million to $(478.7) million; (d) effect of exchange rate changes on cash and becash equivalents from $(8.5) million to $(11.3) million; and (e) cash and cash equivalents at ~~minimal levels~~end of period from $163.2 million to $116.8 million.

(17) Operating Segments

Effective January 1, 2006, the Company assigned an operating facility previously reported in ~~2006 as~~ the ~~Company’s primary customers have converted most of their requirements~~Engine segment to the ~~next generation VTG turbocharger.~~

~~(12) Warranties~~

~~The Company provides warranties on some of its products. The warranty terms are typically from one~~Drivetrain segment due to three years. Provisions for estimated expenses related to product warranty are made at the time products are sold. These estimates are established using historical information about the nature, frequency, and average cost of warranty claims. Management actively studies trends of warranty claims and takes action to

improve product quality and minimize warranty claims. Management believes that the warranty accrual is appropriate; however, actual claims incurred could differ from the original estimates, requiring adjustments to the accrual. The accrual is recorded in both long-term and short-term liabilities on the balance sheet. The following table summarizes the activity in the warranty accrual accounts:

Nine months ended
September 30,
(Millions) 2005 2004
Beginning balance $ 26.4 $ 28.7
Beru acquisition 7.6 —
Provision 17.9 10.6
Payments (12.0 ) (7.3 )
Currency translation (2.3 ) (0.1 )

Ending balance $ 37.6 $ 31.9

~~(13) Comprehensive Income / (Loss)~~

Comprehensive income/(loss) is a measurement of all changes in stockholders’ equity that result from transactions and other economic events other than transactions with stockholders. For the Company, this includes foreign currency translation adjustments, changes in the ~~minimum pension liability adjustment and market value changes in certain hedge instruments. The~~facility’s product mix. Prior period segment amounts ~~presented as other comprehensive income/(loss), net of related taxes, are added~~have been re-classified to ~~net earnings resulting in comprehensive income/(loss). The following table summarizes~~conform to the ~~components of comprehensive income/(loss) on an after-tax basis for the three and nine-month periods ended September 30, 2005 and 2004.~~

Three months ended Nine months ended
September 30, September 30,
(Millions) 2005 2004 2005 2004
Foreign currency translation adjustments $ (13.5 ) $ 20.5 $ (83.0 ) $ 13.4
Market value change in hedge instruments (0.3 ) (0.9 ) (0.2 ) 2.0
Minimum pension liability adjustment — — (4.0 ) 3.7

Change in accumulated other comprehensive income (13.8 ) 19.6 (87.2 ) 19.1
Net earnings as reported 61.4 44.8 175.0 150.6

Total comprehensive income $ 47.6 $ 64.4 $ 87.8 $ 169.7

~~(14) Operating Segments~~

current year’s presentation. The following tables show net sales, segment earnings before interest and income taxes and total assets for the Company’s reportable operating segments.

(Millions) Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
Net Sales

Drivetrain $ 324.4 $ 318.7 $ 1,007.5 $ 1,025.7
Engine 736.7 532.7 2,273.0 1,649.4
Inter-segment eliminations (10.2 ) (11.6 ) (34.7 ) (39.0 )

Net sales $ 1,050.9 $ 839.8 $ 3,245.8 $ 2,636.1

Earnings before income taxes

Drivetrain $ 22.5 $ 24.4 $ 73.1 $ 78.9
Engine 95.4 65.2 265.0 208.8

Segment earnings before interest and income taxes 117.9 89.6 338.1 287.7

Corporate, including litigation settlement and equity in affiliates earnings (21.7 ) (15.2 ) (87.6 ) (39.4 )
Interest expense and finance charges (9.6 ) (7.5 ) (28.8 ) (22.7 )

Earnings before income taxes $ 86.6 $ 66.9 $ 221.7 $ 225.6

Total Assets
September 30, December 31,
(Millions) 2005 2004
Drivetrain $ 928.8 $ 810.0
Engine 3,067.2 2,208.4

Total 3,996.0 3,018.4
Corporate, including equity in affiliates 163.8 510.7

Total assets $ 4,159.8 $ 3,529.1

a) Corporate assets, including equity in affiliates, are net of trade receivables securitized and sold to third parties, and include cash, marketable securities, deferred income taxes and investments and advances.

~~(15) Sales of Receivables~~

The Company securitizes and sells certain receivables through third party financial institutions without recourse. The amount sold can vary each month based on the amount of underlying receivables. At both September 30, 2005 and 2004, the Company had sold $50 million of receivables under a Receivables Transfer Agreement for face value without recourse. During both of the nine-month periods ended September 30, 2005 and 2004, total cash proceeds from sales of accounts receivable were $450 million. The Company paid servicing fees related to these receivables of $1.3 million and $0.6 million for the nine months ended September 30, 2005 and 2004, respectively. These amounts are recorded in interest expense and finance charges in the Condensed Consolidated Statements of Operations.

~~(16) Goodwill~~

~~The changes in the carrying amount of goodwill for the nine months ended September 30, 2005, are as follows:~~

(Millions) Drivetrain Engine Total
Balance at December 31, 2004 $ 134.6 $ 726.2 $ 860.8
Beru acquisition — 189.8 189.8
Translation adjustment (0.5 ) (33.5 ) (34.0 )

Balance at September 30, 2005 $ 134.1 $ 882.5 $ 1,016.6

~~(17) Retirement Benefit Plans~~

The Company has a number of defined benefit pension plans and other postretirement benefit plans covering eligible salaried and hourly employees. The other postretirement benefits plans, which provide medical and life insurance benefits, are unfunded plans. The estimated contributions to pension plans for 2005 range from $22 to $25 million, of which about $22 million has been contributed through the first nine months of the year. The components of net periodic benefit cost recorded in the Company’s Condensed Consolidated Statements of Operations, are as follows:

Other post
(Millions) Pension benefits retirement benefits
Three months ended September 30, 2005 2004 2005 2004
U.S. Non-U.S. U.S. Non-U.S.

Service cost $ 0.7 $ 2.5 $ 0.5 $ 2.9 $ 2.0 $ 1.5
Interest cost 4.2 3.3 7.7 3.7 7.7 6.8
Expected return on plan assets (6.8 ) (2.0 ) (11.6 ) (3.1 ) — —
Amortization of unrecognized transition obligation — — — — — —
Amortization of unrecognized prior service cost 0.3 0.1 0.6 0.2 (0.5 ) —
Amortization of unrecognized loss 1.2 0.4 1.0 1.1 3.2 2.5

Net periodic cost/(benefit) $ (0.4 ) $ 4.3 $ (1.8 ) $ 4.8 $ 12.4 $ 10.8

Other post
(Millions) Pension benefits retirement benefits
Nine months ended September 30, 2005 2004 2005 2004
U.S. Non-U.S. U.S. Non-U.S.

Service cost $ 1.9 $ 7.9 $ 2.0 $ 7.9 $ 6.1 $ 4.5
Interest cost 12.8 10.0 17.0 10.5 23.5 21.6
Expected return on plan assets (21.0 ) (6.2 ) (24.5 ) (6.0 ) — —
Amortization of unrecognized transition obligation — — — 0.2 — —
Amortization of unrecognized prior service cost 1.1 0.1 1.3 0.2 (0.9 ) —
Amortization of unrecognized loss 3.6 1.9 4.5 1.8 9.6 6.3

Net periodic cost/(benefit) $ (1.6 ) $ 13.7 $ 0.3 $ 14.6 $ 38.3 $ 32.4


Net Sales by Operating Segment	Three months ended March 31
(Millions)
	2006			2005


Engine	$	785.9		$	722.0
Drivetrain		377.0			370.6
Inter-segment eliminations		(7.7	)		(9.1	)

Net sales	$	1,155.2		$	1,083.5


Segment Earnings Before Interest and Income Taxes	Three months ended March 31
(Millions)
	2006			2005


Engine	$	96.3		$	74.0
Drivetrain		22.7			25.8

Segment earnings before interest and income taxes (“Segment EBIT”)		119.0			99.8
Corporate, including equity in affiliates earnings and FAS 123(R)		(14.7	)		(12.2	)

Consolidated earnings before interest and taxes (“EBIT”)		104.3			87.6
Interest expense and finance charges		9.4			9.3

Earnings before income taxes & minority interest		94.9			78.3
Provision for income taxes		26.6			(0.3	)
Minority interest, net of tax		7.0			1.0

Net earnings	$	61.3		$	77.6

Total Assets
(Millions)


	March 31,		December 31,
	2006		2005
Engine	$	2,819.6	$	2,925.5
Drivetrain		1,142.0		1,081.8

Total		3,961.6		4,007.3
Corporate, including equity in affiliates^(a)		244.6		82.1

Total assets	$	4,206.2	$	4,089.4


^(a)		Corporate assets, including equity in affiliates, are net of trade receivables securitized and sold to third parties, and include cash, cash equivalents, deferred income taxes and investments and advances.

(18) ~~Property, plant & equipment~~

September 30, December 31,
(Millions) 2005 2004
Land and buildings $ 496.7 $ 403.2
Machinery and equipment 1,691.9 1,352.3
Capital leases 1.2 1.1
Construction in progress 131.2 103.0

Total property, plant & equipment 2,321.0 1,859.6
Less accumulated depreciation 1,064.0 782.4

Property, plant & equipment — net $ 1,257.0 $ 1,077.2

~~Interest costs capitalized during the nine-month periods ended September 30, 2005 and September 30, 2004 were $3.8 million and $3.2 million, respectively.~~

~~As of September 30, 2005 and December 31, 2004, accounts payable of $20.7 million and $24.4 million, respectively, were related to property, plant and equipment purchases.~~

As of September 30, 2005 and December 31, 2004, there were specific assets of $34.3 million and $38.7 million, respectively, pledged as collateral under certain of the Company’s long-term debt agreements.

~~(19)~~ New Accounting Pronouncements

In November 2004, the ~~FASB~~Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards ~~(SFAS)~~(“SFAS”) No. 151, “Inventory Costs” which is an amendment of ARB ~~No. 43,~~No.43, Chapter 4. This statement provides clarification of accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. Generally, this statement requires that those items be recognized as current period charges. SFAS 151 ~~will be~~became effective for the Company on January 1, 2006. The ~~Company does not expect that this pronouncement will have a material impact on its consolidated financial position, results of operations and cash flows.~~

In December 2004, the FASB issued SFAS No. 123R, “Shared-Based Payment” which requires companies to measure and recognize compensation expense for all share-based payments at fair value. Share-based payments include stock option grants and certain transactions under other Company stock plans. The Company grants options to purchase common stock of the Company to some of its employees and directors under various plans at prices equal to the market value of the stock on the dates the options are granted. SFAS 123R will be effective for the Company on January 1, 2006. The Company is currently evaluating the impact that the adoption of SFAS ~~123R will have on its consolidated financial position, results of operations and cash flows.~~

In March 2005, the FASB issued Interpretation (FIN) No. 47, “Accounting for Conditional Asset Retirement Obligations” an interpretation of SFAS 143. FIN 47 clarifies the manner in which uncertainties concerning the timing and the method of settlement of an asset retirement obligation should be accounted for. In addition, the Interpretation clarifies the circumstances under which fair value of an asset retirement obligation is considered subject to reasonable estimation. The Interpretation is effective no later than the end of fiscal years ending after December 15, 2005. The Company does151 did not ~~expect~~

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION

BorgWarner Inc. and Consolidated Subsidiaries (the ~~Company)~~“Company”) is a leading global supplier of highly engineered systems and components primarily for powertrain applications. Our products help improve vehicle performance, fuel efficiency, air quality and vehicle stability. They are manufactured and sold worldwide, primarily to original equipment manufacturers ~~(OEMs)~~(“OEMs”) of ~~light-vehicles~~light vehicles (i.e. passenger cars, sport-utility vehicles, cross-over vehicles, vans and light-trucks). Our products are also manufactured and sold to OEMs of commercial trucks, buses and agricultural and off-highway vehicles. We also manufacture and sell our products into the aftermarket for light and commercial vehicles. We operate manufacturing facilities serving customers in the Americas, Europe and ~~Asia-Pacific,~~Asia, and are an original equipment supplier to every major ~~OEM~~automaker in the world.

The Company’s products fall into two reportable operating segments: Engine and Drivetrain. Effective January 1, 2006, the Company assigned an operating facility previously reported in the Engine segment to the Drivetrain segment due to changes in the facility’s product mix. Prior period segment amounts have been re-classified to conform to the current year’s presentation. The Engine segment’s products include turbochargers, timing chain systems, air management, emissions systems, thermal systems, as well as diesel and ~~Engine.~~gas ignition systems. The Drivetrain segment is comprised of all-wheel drive transfer cases, torque management systems, and components and systems for ~~automatic~~automated transmissions.

RESTATEMENT

As discussed more fully in Note 16 in Item 1 of Part I, we have restated our Condensed Consolidated Statement of Cash Flows for the three months ended March 31, 2005. This discussion and ~~automated transmissions. The Engine segment’s products include turbochargers, timing chain systems, air management, emissions~~analysis should be read in conjunction with the consolidated financial statements and ~~thermal systems as well as diesel~~notes appearing elsewhere in this report and ~~gas ignition systems.~~in the 2005 Form 10-K.

RESULTS OF OPERATIONS

Three months ended ~~September 30, 2005~~March 31, 2006 vs. Three months ended ~~September 30, 2004~~March 31, 2005

Consolidated net sales for the ~~third~~first quarter ended ~~September 30, 2005~~March 31, 2006 totaled ~~$1,050.9~~$1,155.2 million, a ~~25.1%~~6.6% increase over the ~~third~~first quarter of ~~2004 including Beru, and were up 10.6% excluding Beru.~~2005. This increase occurred ~~in a market where global~~while light-vehicle production was up about 5%4% worldwide and 3% in North America from the previous year’s quarter. Light-vehicle production ~~in North America was up nearly 2%. Light-vehicle production was up~~increased approximately ~~13%~~4% in Asia-Pacific and ~~down slightly~~4% in Europe. ~~Approximately $3.1 million of the~~The net sales increase was ~~due to stronger~~partially offset by the effect of weaker currencies, primarily the ~~Euro.~~Euro, by approximately $48 million. Turbochargers, timing chain systems, ignition systems and automatic transmission components and systems are the products most affected by currency fluctuations in Europe and Asia-Pacific. Without the currency impact, the increase in net sales would have been ~~24.8%~~11.1% due to strong demand for the Company’s products in Europe and ~~Asia-Pacific; and the acquisition of Beru.~~Asia-Pacific.

~~Third~~First quarter selling, general and administrative (SG&A) costs ~~increased $42.6~~decreased $1.6 million to $132.6 million from ~~$77.4 million to $120.0~~$134.2 million, and ~~increased~~decreased as a percentage of net sales to 11.5% from 9.2% to 11.4% of net sales. Included in the increase was $4.2 million of depreciation and amortization of the allocated purchase price related to the acquisition of our majority stake in Beru. The inclusion of Beru in the Company’s operating results is responsible for $31.7 million of the increase in SG&A costs.12.4%. R&D costs, which are included in SG&A expenses, ~~also~~ increased ~~$7.1~~$4.9 million to $46.0 million from ~~$32.8 million to $39.9~~$41.1 million as compared to the ~~third~~first quarter of ~~2004.~~2005. The increase is primarily driven by our continued investment in a number of cross-business R&D programs, as well as other key programs, all of which are necessary for short and long term growth. As a percentage of sales, R&D costs ~~decreased~~increased to 4.0% from ~~3.9% to~~ 3.8% ~~versus~~in the ~~third~~first quarter of ~~2004.~~2005.

Other ~~net includes~~income for the first quarter of 2006 of $0.5 million is comprised primarily of interest income. First quarter 2005 other income of $4.1 million is comprised mainly of a ~~$2.1 million~~ gain ~~related to~~on the sale of a ~~fixed asset disposal in our Drivetrain~~ business.

Equity in affiliate earnings ~~was $0.5~~of $10.0 million ~~lower in the third quarter of 2005~~increased $6.0 million as compared to the ~~third~~first quarter of ~~2004.~~2005 due to the combined effect of improved operating results of affiliates and adjustments made in 2005 to the carrying values of the equity investments.

~~Third~~First quarter interest expense and finance charges of $9.4 million increased ~~$2.1~~$0.1 million as compared to the ~~third~~first quarter ~~2004~~of 2005, primarily due ~~primarily~~ to ~~increased debt levels from funding our Beru acquisition.~~higher short-term interest rates.

The Company’s provision for income taxes is based upon estimated annual tax rates for the year applied to federal, state and foreign income. The projected effective tax rate of ~~19.3%~~28.0% for ~~2005~~2006 differs from the U.S. statutory rate primarily due to a) foreign rates, which differ from those in the US, and b) favorable permanent items including equity in affiliate earnings and Medicare prescription drug benefits. This rate is higher than the full year 2005 effective tax rate of 17.5% because the 2005 rate included a) the release of tax accrual accounts upon conclusion of certain tax audits and b) the tax effects of ~~the disposition~~dispositions. The 2006 projected effective tax rate of AGK and other miscellaneous dispositions, c) foreign rates which differ from those in the US and d) realization of certain business tax credits including R&D and foreign tax credits. If the effects of the tax accrual release, the disposition of AGK and other miscellaneous dispositions are not taken into account,28.0% compares to the Company’s full year 2005 effective tax rate associated with its on-going business operations ~~is approximately 28.0%. This rate is lower than the 2004 tax rate for on-going operations~~ of ~~30.0% due to changes in the mix of global pre-tax income among taxing jurisdictions as well as an increase in favorable permanent items.~~27.8%.

Net earnings were ~~$61.4~~$61.3 million for the ~~third~~first quarter, or ~~$1.07~~$1.06 per diluted share, ~~an increase~~a decrease of ~~$0.28~~$0.30 per diluted share over the previous year’s ~~third~~first quarter. ~~The increase from the prior year third quarter was due to favorable~~Improved operating results in the first quarter of ~~$0.20~~2006 provided an incremental $0.13 per share ~~including Beru, favorable tax adjustment of $0.08 per share, favorable currency impact of $0.01 per share and a $(0.01) per share decrease due to an increase in shares outstanding.~~

~~Nine months ended September 30, 2005 vs. Nine months ended September 30, 2004~~

~~Consolidated net sales for the first nine months ended September 30, 2005 totaled $3,245.8 million, a 23.1% increase~~ over the ~~first nine months of 2004 including Beru, and~~same period a year ago but, on a reporting basis, were ~~up 8.6% excluding Beru. This increase occurred in a market where global light-vehicle production was up about 3% from~~more than offset by the previous year’s first nine months. Light-vehicle production in North America was down approximately 1%. Light-vehicle production increased approximately 9% in Asia-Pacific and flat in Europe. Net sales increased $45.4 million due to stronger currencies, primarily the Euro. Turbochargers, ignition systemsfollowing factors:

	•		An unfavorable currency impact of $(0.07) per share

	•		The impact of the implementation of FAS 123(R) of $(0.04) per share

	•		A $(0.01) per share decrease due to the higher number of shares outstanding

	•		The release of tax accruals in 2005 of $0.40 per share

~~and automatic transmission components and systems are~~

	•		Net gains from divestitures in 2005 of $0.11 per diluted share

	•		The write-off in 2005 of the excess purchase price associated with Beru’s in-process R&D of $(0.13) per diluted share

Reportable Operating Segments

Effective January 1, 2006, the products most affected by currency fluctuations in Europe and Asia-Pacific. Without the currency impact, the increase in net sales would have been 21.4% due to strong demand for the Company’s products in Europe and Asia-Pacific; and the acquisition of Beru.

Gross profit and gross margin were $654.3 million and 20.2% for the first nine months of 2005 including the impact of Beru, as compared to $487.4 million and 18.5% for the third quarter 2004. Excluding Beru, our gross margin was 18.1%. Gross profit margins were impacted negatively by higher costs for commodity purchases, including steel, copper, aluminum, plastic resin and natural gas. The increase in commodity costs from the first nine months of 2004 was approximately $34 million. Our focused cost reduction programs in our operations partially offset these higher commodity costs.

~~SG&A costs increased $125.9 million from $259.9 million to $385.8 million, and increased as a percentage of sales from 9.9% to 11.9% of net sales. Included~~Company assigned an operating facility previously reported in the ~~increase was $25.3 million of depreciation and amortization of the allocated purchase price related~~Engine segment to the acquisition of our majority stake in Beru. The inclusion of Beru in the Company’s operating results is responsible for $106.2 million of the increase in SG&A costs. R&D costs, which are included in SG&A expenses, also increased $30.3 million from $90.7 million to $121.0 million as compared to the third quarter of 2004. As a percentage of sales, R&D costs increased from 3.4% to 3.7% versus the third quarter of 2004.

Other, net includes a $45.5 million charge related to the anticipated cost of settling all Crystal Springs-related alleged environmental contamination personal injury and property damage claims. Equity in affiliate earnings was $3.5 million lower in the first nine months of 2005 as compared to the first nine months of 2004 due to adjustments to the carrying values of our equity investments in the first quarter.

~~Interest expense and finance charges in 2005 increased $6.1 million compared with the first nine months of 2004 due primarily to increased debt levels from funding our Beru acquisition.~~

The Company’s provision for income taxes is based upon estimated annual tax rates for the year applied to federal, state and foreign income. The projected effective tax rate of 19.3% for 2005 differs from the U.S. statutory rate primarily due to a) the release of tax accrual accounts upon conclusion of certain tax audits, b) the tax effects of the disposition of AGK and other miscellaneous dispositions, c) foreign rates which differ from those in the US and d) realization of certain business tax credits including R&D and foreign tax credits. If the effects of the tax accrual release, the disposition of AGK and other miscellaneous dispositions are not taken into account, the Company’s effective tax rate associated with its on-going business operations is approximately 28.0%. This rate is lower than the 2004 tax rate for on-going operations of 30.0%Drivetrain segment due to changes in the ~~mix of global pre-tax income among taxing jurisdictions as well as an increase in favorable permanent items.~~

~~Reportable Operating Segments~~

presentation. The following tables present net sales and segment earnings before interest and income taxes by segment for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2006 and 2005 ~~and 2004~~ and total assets as of ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004.~~2005.

(Millions) Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
Net Sales

Drivetrain $ 324.4 $ 318.7 $ 1,007.5 $ 1,025.7
Engine 736.7 532.7 2,273.0 1,649.4
Inter-segment eliminations (10.2 ) (11.6 ) (34.7 ) (39.0 )

Net sales $ 1,050.9 $ 839.8 $ 3,245.8 $ 2,636.1

Earnings before income taxes

Drivetrain $ 22.5 $ 24.4 $ 73.1 $ 78.9
Engine 95.4 65.2 265.0 208.8

Segment earnings before interest and income taxes 117.9 89.6 338.1 287.7

Corporate, including litigation settlement and equity in affiliates earnings (21.7 ) (15.2 ) (87.6 ) (39.4 )

Interest expense and finance charges (9.6 ) (7.5 ) (28.8 ) (22.7 )

Earnings before income taxes $ 86.6 $ 66.9 $ 221.7 $ 225.6

Net Sales by Operating Segment
(Millions)


	Three months ended
	March 31,
	2006			2005
Engine	$	785.9		$	722.0
Drivetrain		377.0			370.6
Inter-segment eliminations		(7.7	)		(9.1	)

Net sales	$	1,155.2		$	1,083.5

Segment Earnings Before Interest and Income Taxes
(Millions)


	Three months ended
	March 31,
	2006			2005
Engine	$	96.3		$	74.0
Drivetrain		22.7			25.8

Segment earnings before interest and income taxes (“Segment EBIT”)		119.0			99.8
Corporate, including equity in affiliates earnings and FAS 123(R)		(14.7	)		(12.2	)

Consolidated earnings before interest and taxes (“EBIT”)		104.3			87.6
Interest expense and finance charges		9.4			9.3

Earnings before income taxes & minority interest		94.9			78.3
Provision for income taxes		26.6			(0.3	)
Minority interest, net of tax		7.0			1.0

Net earnings	$	61.3		$	77.6

2725

Three months ended ~~September 30, 2005~~March 31, 2006 vs. Three months ended ~~September 30, 2004~~March 31, 2005

The Drivetrain segment net sales increased $5.7 million, or 1.8% and segment earnings before interest and taxes decreased $1.9 million, or 7.8% from the third quarter of 2004. The sales increase was driven by growth outside of North America including higher sales of DualTronic^TM transmission modules. The Drivetrain segment’s earnings before interest and taxes decreased 7.8% for the quarter due to lower domestic production of light trucks and sport-utility vehicles equipped with its torque transfer products.

The Engine segment net sales increased ~~$204.0~~$63.9 million, or ~~38.3%~~8.9%, and segment earnings before interest and taxes increased ~~$30.2~~$22.3 million, or ~~46.3%~~30.1%, from the ~~third~~first quarter of ~~2004. The increase in net sales was partially due to the acquisition of our majority stake in Beru whose operating results are now included in this segment.~~2005. Excluding the ~~impact~~one-time write-off in the first quarter of 2005 of the ~~Beru acquisition,~~excess purchase price associated with Beru’s in-process R&D, the Engine segment ~~net sales were 15.3% higher than~~earnings before interest and taxes increased $12.3 million, or 14.6%, over the prior year. The Engine segment continues to benefit from strong demand for turbochargers for European passenger cars and commercial vehicle applications. Sales of timing chains increased as well, particularly to our Asian customers. The EBIT margin increased from ~~2004~~2005 due to the combined effect of increased sales across all Engine segment product ~~lines which offset commodity cost increases~~families and the ~~amortization~~unfavorable impact of ~~Beru related acquisition costs.~~

~~Nine months ended September 30,~~special items on the first quarter 2005 ~~vs. Nine months ended September 30, 2004~~EBIT margin.

The Drivetrain segment net sales ~~decreased $18.2~~increased $6.4 million, or ~~1.8%~~1.7%, and segment earnings before interest and taxes decreased ~~$5.8~~$3.1 million, or ~~7.4%~~12.0%, from the first ~~nine months~~quarter of ~~2004.~~2005. The ~~net~~ sales ~~decrease~~increase was ~~a result~~driven by growth outside of ~~weaker sport-utility and light truck production in~~ North America ~~partially offset by increased~~including higher sales of DualTronic^TM transmission modules. The ~~segment~~Drivetrain segment’s earnings before interest and taxes ~~margin decrease was due primarily to the incremental profit loss on the lower sales volumes and the negative impact of commodity and health care cost increases incurred during the first nine months.~~

The Engine segment net sales increased $623.6 million, or 37.8% and segment earnings before interest and taxes increased $56.2 million, or 26.9% from the first nine months of 2004. The increase in net sales was partiallydecreased due to the ~~acquisition~~combined effect of ~~our majority stake in Beru whose operating results are now included in this segment. Excluding the impact~~higher health costs, continued raw material and energy cost pressures and lower North American production of ~~the Beru acquisition, Engine segment net sales were 14.7% higher than the prior year. The Engine segment continues to benefit from strong demand for turbochargers for European passenger cars~~light trucks and commercial vehicle applications. Sales of timing chains increased as well, particularly to our Asian customers. The EBIT margin decreased from 2004 due to the unfavorable product mix and the amortization of Beru related acquisition costs.sport-utility vehicles equipped with its torque transfer products.

Outlook for the remainder of ~~2005~~2006

The Company is cautious about the remainder of ~~2005~~2006 as the industry environment remains difficult. The recent increases in fuel prices and customer incentive sales programs have made near term vehicle production levels more uncertain. North American sport-utility vehicle sales are expected to continue to show weakness induring the ~~fourth quarter~~rest of ~~2005.~~2006. We anticipate commodity cost increases will be approximately ~~$45~~$25 million for ~~2005,~~2006 including steel, copper, aluminum, plastic resin and natural gas. The Company continues to focus on its cost reduction efforts to help offset this market weakness and the effects of commodity cost increases.

The Company maintains a positive long-term outlook for its business and is committed to ~~ongoing strategic investments in capital and~~ new product development and strategic capital investments to enhance its product leadership strategy. The trends that are driving our longer-term growth are expected to continue, including the growth of diesel engines worldwide, the increased adoption of automatic transmissions in Europe and Asia-Pacific, the popularity of cross-over vehicles in North America and the move to chain engine timing systems in both Europe and Asia-Pacific.

FINANCIAL CONDITION AND LIQUIDITY

Net cash provided by operating activities ~~decreased $68.1~~increased $3.1 million to $48.1 million for the first three months of 2006 from ~~$320.7~~$45.0 million in the first ~~nine months of 2004 to $252.6 million for the first nine~~three months of 2005. The decrease in operating cash flow from 2004 was primarily due to tax payments made by our non-U.S. entities, including $30.4 million by Beru of which approximately $19.0 million related to a recently completed statutory tax audit. In addition, in 2004 the Company funded its U.S. employee retirement benefit plans with $25.8 million of the Company’s common stock.

Capital spending, including tooling outlays, was ~~$179.7~~$70.3 million in the first ~~nine~~three months of ~~2005,~~2006, compared with ~~$167.2~~$52.8 million in ~~2004.~~2005. Selective capital spending remains an area of focus for the Company, both in order to support our book of new business, and for cost reductions

and productivity improvements. The Company expects to spend $285 million to ~~$305~~$325 million on capital and tooling expenditures in ~~2005,~~2006, but this expectation is subject to ongoing review based on market conditions.

As of ~~September 30, 2005,~~March 31, 2006, debt increased from year-end ~~2004~~2005 by ~~$216.1~~$32.5 million, ~~and~~ cash and cash equivalents decreased by ~~$90.2~~$32.9 million and marketable securities increased by $25.2 million. ~~The debt increase was primarily due to the funding of our Beru acquisition.~~ Our debt to capital ratio was ~~33.0%~~30.8% at the end of the ~~third~~first quarter versus ~~27.6%~~31.1% at the end of ~~2004.~~2005. The Company paid dividends, including those to minority shareholders, of ~~$23.7~~$18.2 million and ~~$20.9~~$10.5 million in the first ~~nine~~three months of ~~2005~~2006 and ~~2004,~~2005, respectively.

The Company securitizes and sells certain receivables through third party financial institutions without recourse. The amount sold can vary each month based on the amount of underlying receivables. At both ~~September 30,~~March 31, 2006 and 2005, ~~and 2004,~~ the Company had sold $50 million of receivables under a Receivables Transfer Agreement for face value without recourse. During both of the ~~nine-month~~three-month periods ended ~~September 30,~~March 31, 2006 and 2005, ~~and 2004,~~ total cash proceeds from sales of accounts receivable were ~~$450~~$150 million. The Company paid servicing fees related to these receivables of ~~$1.3~~$0.6 million and ~~$0.6~~$0.4 million for the ~~nine~~three months ended ~~September 30,~~March 31, 2006 and 2005, ~~and 2004,~~ respectively. These amounts are recorded in interest expense and finance charges in the Condensed Consolidated Statements of Operations.

The Company has a revolving credit facility, which provides for committed borrowings up to $600 million through July 2009. At ~~September 30, 2005, $40.0~~March 31, 2006, $90.0 million of borrowings under the facility were outstanding in addition to ~~$1.0~~$26.7 million of obligations under standby letters of credit. At December 31, ~~2004~~

2005, $15.0 million of borrowings under the facility ~~was unused.~~were outstanding in addition to $25.7 million of obligations under standby letters of credit. The credit agreement is subject to the usual terms and conditions applied by banks to an investment grade company. The Company was in compliance with all covenants at ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004~~2005 and expects to remain compliant in future periods.

From a credit quality perspective, we have an investment grade credit rating of A- (stable outlook) from Standard & Poors and Baa2 (positive outlook) from Moodys.

The Company believes that the combination of cash balances, cash flow from operations, available credit facilities and universal shelf registration will be sufficient to satisfy its cash needs for the current level of operations and planned operations for the remainder of ~~2005.~~2006. The Company expects that net cash provided by operating activities will ~~exceed $350~~be approximately $450 million in ~~2005.~~2006.

OTHER MATTERS

Contingencies

~~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 ~~(EPA)~~ and certain state environmental agencies and private parties as potentially responsible parties ~~(PRPs)~~(“PRPs”) at various hazardous waste disposal sites under the Comprehensive Environmental

Response, Compensation and Liability Act ~~(Superfund)~~(“Superfund”) and equivalent state laws and, as such, may presently be liable for the cost of clean-up and other remedial activities at 3736 such sites. Responsibility for clean-up and other remedial activities at a Superfund site is typically shared among PRPs based on an allocation formula.

federal or state environmental agencies concerning the scope of contamination and estimated remediation and consulting costs; remediation alternatives; estimated legal fees; and other ~~factors;~~factors, the Company has established an accrual for indicated environmental liabilities with a balance at ~~September 30, 2005~~March 31, 2006 of approximately ~~$54.9~~$17.6 million. Included in the total accrued liability is the ~~$31.7~~$0.3 million anticipated cost to settle all outstanding claims related to Crystal Springs described below, which was recorded in the second quarter of 2005. For the other 35 sites, the Company has accrued amounts that do not exceed $3.0 million related to any individual site and management does not believe that the costs related to any of these other individual sites will have a material adverse effect on the Company’s results of operations, cash flows or financial condition. The Company expects to expend substantially all of the ~~$54.9~~$17.6 million environmental accrued liability over the next three to five years.

In connection with the sale of Kuhlman Electric Corporation, the Company agreed to indemnify the buyer and Kuhlman Electric for certain environmental liabilities relating to the past operations of Kuhlman Electric. The liabilities at issue result from operations of Kuhlman Electric that pre-date the Company’s acquisition of Kuhlman Electric’s parent company, Kuhlman Corporation, ~~during~~in 1999. During 2000, Kuhlman Electric notified the Company that it discovered potential environmental contamination at its Crystal Springs, Mississippi plant while undertaking an expansion of the plant. Kuhlman Electric and others, including the Company, ~~have been~~were sued in numerous related lawsuits, in which multiple claimants ~~allege~~alleged personal injury and property damage.

The same group of defendants entered into a settlement in October 2005

Conditional Asset Retirement Obligations

Product Liability

the Company or its ~~insurer.~~insurers. In the first ~~nine months of 2005,~~quarter 2006, of the approximately ~~11,700~~2,425 claims resolved, only ~~229 (2.0%~~46 (1.9%) resulted in any payment being made to a claimant by or on behalf of the Company. In ~~2004~~2005, of the ~~4,062~~approximately 38,000 claims resolved, only ~~255 (6.3%~~295 (0.8%) resulted in any payment being made to a claimant by or on behalf of the Company. ~~In 2003 of~~

~~Prior to June 2004,~~ all claims were covered by the Company’s primary layer insurance coverage, and these carriers administered, defended, settled and paid all claims under a funding ~~agreement.~~arrangement. In June 2004, primary layer insurance carriers notified the Company of the alleged exhaustion of their policy limits. This led the Company to access the next available layer of insurance coverage. Since June 2004, secondary layer insurers have paid asbestos-related litigation defense and settlement expenses pursuant to a funding ~~agreement. The~~arrangement. As of March 31, 2006, the Company has ~~paid $3.4~~a receivable of $3.5 million ~~in the first nine months of 2005 and $1.0 million in the fourth quarter of 2004 as a result~~due to funding settlements before reimbursement by some of the ~~funding agreement.~~secondary layer insurers under this arrangement. The Company is expecting to fully recover these amounts. ~~Recovery~~At March 31, 2006, the Company has an estimated liability of $37.8 million for future claims resolutions, with a related asset of $37.8 million to recognize the insurance proceeds receivable by the Company for estimated losses related to claims that have yet to be resolved. Insurance carrier reimbursement of 100% is ~~dependent~~expected based on the ~~completion of an audit proving the exhaustion of primary~~Company’s experience, its insurance ~~coverage~~contracts and ~~the successful resolution of~~decisions received to date in the declaratory judgment action referred to below.

additional layer insurance, and, in conjunction with other insurers, is currently defending and indemnifying the Company in its pending asbestos-related product liability claims. The lawsuit seeks to determine the extent of insurance coverage available to the Company including whether the available limits exhaust on a “per occurrence” or an “aggregate” basis, and to determine how the applicable coverage responsibilities should be apportioned. On August 15, 2005, the Court issued an interim order regarding the apportionment matter. The interim order has the effect of making insurers responsible for all defense and settlement costs pro rata to ~~time-on-the-risk,~~time- on-the-risk, with the pro-ration method to hold the insured harmless for periods of bankrupt or unavailable coverage. ~~This~~Appeals of the interim order were denied. However, the issue is ~~under appeal.~~reserved for appellate review at the end of the action. In addition to the primary insurance available for asbestos-related claims, the Company has substantial additional layers of insurance available for potential future asbestos-related product claims. As such, the Company continues to believe that its coverage is sufficient to meet foreseeable liabilities.

New Accounting Pronouncements

In November 2004, the ~~FASB~~Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards ~~(SFAS)~~(“SFAS”) No. 151, “Inventory Costs” which is an amendment of ARB No.43, Chapter 4. This statement provides clarification of accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. Generally, this statement requires that those items be recognized as current period charges. SFAS 151 ~~will be~~became effective for the Company on January 1, 2006. The ~~Company does not expect that this pronouncement will have a material impact on its consolidated financial position, results of operations and cash flows.~~

Recent Development

On ~~October~~April 21, ~~2005,~~2006, the Company announced a ~~$0.14~~$0.16 per share dividend to be paid on ~~November~~May 15, ~~2005~~2006 to stockholders of record on ~~November~~May 1, ~~2005.~~2006.

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

Statements contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations may contain forward-looking statements as contemplated by the 1995 Private Securities Litigation Reform Act that are based on management’s current expectations, estimates and

production, the continued use of outside suppliers, fluctuations in demand for vehicles containing the Company’s products, general economic conditions, as well as other risks detailed in the Company’s filings with the Securities and Exchange Commission, including the ~~Cautionary Statements filed as Exhibit 99.1 to~~Risk Factors, identified in the Form 10-K for the fiscal year ended December 31, ~~2004.~~2005. The Company does not undertake any obligation to update any forward-looking statements.

Item 3.Quantitative and Qualitative Disclosure About Market Risk

There have been no material changes to our exposures related to market risk since December 31, ~~2004.~~2005.

Item 4.Controls and Procedures

The Company’s management, including the Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that information required to be disclosed in reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There have been no changes in internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are likely to materially affect, our internal control over financial reporting.

The Company completed the acquisition of its majority stake in Beru during the first quarter of 2005 and has not yet completed its documentation and testing of Beru’s internal controls over financial reporting. The Company is in the process of evaluating Beru’s internal controls.

3532

PART II. OTHER INFORMATION

Item 1.Legal Proceedings

On July 8, 2005, the Company announced that it and other defendants, including its subsidiary Kuhlman Corporation, had entered into a settlement regarding approximately 90% of the claims pending in Mississippi state court related to previously alleged environmental contamination from a KEC plant-site in Crystal Springs, Mississippi. The Company and other defendants agreed to pay up to $39 million in three equal installments ending on January 2, 2006.

The same group of defendants entered into a settlement in October 2005 regarding approximately 9% of personal injury and property damage claims relating to the alleged environmental contamination. In exchange for, among other things, the dismissal with prejudice of these lawsuits, the defendants agreed to pay a total sum of up to $5.4 million in settlement funds. The actual amount paid in settlement will depend upon the number of plaintiffs who opt-out of the settlement. The settlement will be paid in two approximately equal installments in the fourth quarter of 2005 and the first quarter of 2006. With this settlement, the Company and the other defendants have resolved about 98% of the personal injury and property damage claims relating to the alleged environmental contamination.

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 ~~10 —~~14 – Contingencies to the condensed consolidated financial statements for a discussion of environmental, product liability and other litigation, which is incorporated herein by reference.

A declaratory judgment action was filed by a subsidiary of the Company, BorgWarner Diversified Transmission Products Inc. (“DTP”), in January 2006 in the United States District Court, Southern District of Indiana, Indianapolis Division, against the United Automobile, Aerospace, and Agricultural Implements Workers of America, Local No. 287 and Gerald Poor, individually and as the representative of a defendant class. DTP is seeking the Court’s affirmation that DTP will not violate the Labor-Management Relations Act of 1947 (“LMRA”) or the Employee Retirement Income Security Act (“ERISA”) by amending certain retirees’ medical plans, effective March 12, 2006. In February 2006, four retirees filed a parallel retiree health benefits case in the United States District Court, Eastern District of Michigan, Southern Division, and sought certification of the case as a class action. Motions concerning the appropriate venue for these cases are expected to be heard in the second quarter. DTP believes that it is within its rights to amend the plans and that it will be successful on the merits of the lawsuits, although there can be no guarantee of success in any litigation.

Item 6.Exhibits


		Exhibit 31.1		Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer

		Exhibit 31.2		Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer

		Exhibit 32		Section 1350 Certifications

3633


	Page No.
PART I. Financial Information		3

Item 1. Financial Statements

Condensed Consolidated Balance Sheets ~~at September 30, 2005~~as of March 31, 2006 (Unaudited) and December 31, ~~2004~~2005		3

Condensed Consolidated Statements of Operations (Unaudited) for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2006 and 2005 ~~and 2004~~		4

Condensed Consolidated Statements of Cash Flows (Unaudited) for the ~~nine~~three months ended ~~September 30,~~March 31, 2006 and 2005 ~~and 2004~~(Restated)		5

Notes to Condensed Consolidated Financial Statements (Unaudited)		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		23

Item 3. Quantitative and Qualitative Disclosures About Market Risk		3532

Item 4. Controls and Procedures		3532

PART II. Other Information

Item 1. Legal Proceedings		3633

Item 6. Exhibits		3633

SIGNATURES		3734
Certification by Chief Executive Officer
Certification of Chief Financial Officer
~~Certification~~Section 1350 Certifications


(Net earnings per share — diluted, unaudited)
BorgWarner base business	$	0.32
Beru’s contribution to net earnings		0.10
Impact of changes in foreign currencies		0.08
Dilution from increase in shares outstanding		(0.05	)
Gain from divestitures		0.11
Immediate write-off of the excess purchase price associated with Beru’s in-process R&D		(0.13	)
Release of tax accruals and adjustments		0.45
Estimated settlement of all Crystal Springs related claims		(0.50	)

Total increase	$	0.38


			BorgWarner Inc.	(Registrant)

	~~(Registrant)~~

By	/s/ Jeffrey L. Obermayer
			(Signature)
		~~(Signature)~~	Jeffrey L. Obermayer Vice President and Controller (Principal Accounting Officer)

	~~Jeffrey L. Obermayer~~

	~~Vice President and Controller~~

	~~(Principal Accounting Officer)~~


a)		The maturity of the swaps corresponds with the maturity of the hedged item as noted in the debt summary.

b)		Interest rates are as of ~~September 30, 2005.~~March 31, 2006.