UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

QUARTERLY REPORT

Under Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the Quarter ended March 31, 2005

Commission file number: 1-12162

BORGWARNER INC.

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12-b2 of the Exchange Act).
YES þ NO o

On March 31, 2005 the registrant had 56,489,020 shares of Common Stock outstanding.

BORGWARNER INC.

INDEX

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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES

See accompanying Notes to Condensed Consolidated Financial Statements

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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES

See accompanying Notes to Condensed Consolidated Financial Statements

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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES

See accompanying Notes to Condensed Consolidated Financial Statements

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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES

(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 months ended March 31, 2005 are not necessarily indicative of the results to be expected for the entire year.

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

(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 excess purchase price over the net book value of assets acquired between intangible assets and goodwill. The purchase price has been allocated based on estimated fair values as of the acquisition date as determined by third party valuation specialists. The purchase price allocation is preliminary and a final determination of required purchase accounting adjustments is expected to be made in late 2005.

The following pro forma information for the three months ended March 31, 2004 assumes the Beru acquisition occurred as of the beginning of that year and includes adjustments for the amortization of the estimated excess purchase price allocation, the immediate write-off of the excess purchase price associated with Beru’s in-process research and development and the Company’s acquisition financing costs in a manner consistent with the current period financial statements. The pro forma results for the three months ended March 31, 2004 are not necessarily indicative of the results that actually would have been obtained had the acquisition been in effect for the period

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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 income, depending on the nature of the costs.

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 Corp., 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 for the three months ended March 31, 2005 and 2004 were $41.1 million and $29.4 million, 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 $9.0 million and $2.9 million for the three months ended March 31, 2005 and 2004, respectively.

(5) 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:

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(6) Stock-Based Compensation

SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” encourage, but do not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation in accordance with Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no compensation cost has been recognized for fixed stock options because the exercise prices of the stock options equal the market value of the Company’s common stock at the date of grant, which is the measurement date. 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.

In calculating earnings per share, earnings are the same for the basic and diluted calculations. Shares increased for diluted earnings per share by 727,000 and 600,000 for the three months ended, March 31, 2005 and 2004, respectively, due to the effects of stock options and shares issuable under the Executive Stock Performance Plan.

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(7) Stock Split

On May 17, 2004 the Company announced a two-for-one stock split of common stock for stockholders of record on May 3, 2004. All share and per share amounts for prior periods have been restated to account for the effect of the stock split.

(8) 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 21.8% for 2005 differs from the US 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 research 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 29%. This rate is lower than the 2004 tax rate for on-going operations of 30% due to the tax benefits of increased interest expense associated with the Beru acquisition.

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 to qualifying earnings repatriations in 2005. Under the guidance set forth in FSP 109-2, the Company is allowed time beyond the financial reporting period of enactment to evaluate the effect of the AJCA on its plan for reinvestment or repatriation of foreign earnings. The Company has started an evaluation of the effects of the repatriation provision; however, the Company does not expect to be able to complete this evaluation until after the U.S. Congress or the Treasury Department provides additional clarifying language on key elements of the provision. The Company expects to complete its evaluation of the effects of

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the repatriation provision within a reasonable period of time following the publication of the additional clarifying language. The range of possible amounts that the Company is considering for repatriation under this provision is between zero and $74 million. The related range of income tax effects of such repatriation cannot be reasonably estimated until guidance is issued by Congress or the Treasury Department.

(9) Notes Payable and Long-Term Debt

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

The Company has a revolving credit facility, which provides for committed borrowings up to $600 million through July 2009. At March 31, 2005, $90.0 million of borrowings under the facility were outstanding in addition to $0.5 million of obligations under standby letters of credit. At December 31, 2004 the facility was unused. 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 March 31, 2005 and December 31, 2004 and expects to be compliant in future periods.

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(10) Financial Instruments

The Company’s financial instruments include cash and cash equivalents, 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). We also selectively use cross-currency swaps to hedge the foreign currency exposure associated with our net investment in certain foreign operations (net investment hedges). A summary of these instruments outstanding at March 31, 2005 follows (currency in millions):

As of March 31, 2005, the fair value of the fixed to floating interest rate swaps were recorded as a long-term asset of $5.8 million and a long-term liability of $(3.7) million. As of December 31, 2004, the fair value of the fixed to floating interest rate swaps were recorded as a long-term asset of $6.9 million.

The cross currency swaps were recorded at their fair values of $2.5 million included in other long-term assets, and $(19.5) million included in other long-term liabilities at March 31, 2005 and $(33.1) million in other long-term liabilities at December 31, 2004. Fair value is based on quoted market prices for contracts with similar maturities.

The Company also entered into certain commodity derivative instruments to

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protect against commodity price changes related to forecasted raw material and supplies purchases. The primary purpose of the commodity price hedging activities is to manage the volatility associated with these forecasted purchases. The Company primarily utilizes forward and option contracts, which are designated as cash flow hedges. These instruments are intended to offset the effect of changes in commodity prices on forecasted purchases. As of March 31, 2005 the Company had forward and option commodity contracts with a total notional value of $1.7 million. The fair market value of the swap contracts was $0.5 million as of March 31, 2005, which is deferred in other comprehensive income and will be reclassified and matched into income as the underlying operating transactions are realized. During the three months ended March 31, 2005 and 2004, hedge ineffectiveness associated with these contracts was not significant.

The Company uses foreign exchange forward 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 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 March 31, 2005 contracts were outstanding to buy or sell U.S. Dollars, Euros, British Pounds Sterling, Canadian Dollars 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 March 31, 2005 deferred gains amounted to $4.8 million ($3.8 million maturing in less than one year) and unrealized losses amounted to $(2.2) million ($(2.0) million maturing in less than one year). As of December 31, 2004 unrealized gains amounted to $8.8 million and unrealized losses amounted to $(4.1) million. Hedge ineffectiveness associated with these contracts for the quarter ended March 31, 2005 amounted to a loss of $(0.2) million. Hedge ineffectiveness associated with these contracts was not significant in 2004.

(11) 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. 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

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) at various hazardous waste disposal sites under the Comprehensive

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Environmental Response, Compensation and Liability Act (Superfund) and equivalent state laws and, as such, may presently be liable for the cost of clean-up and other remedial activities at 38 such sites. Responsibility for clean-up and other remedial activities at a Superfund site is typically shared among PRPs based on an allocation formula.

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, the Company has established an accrual for indicated environmental liabilities with a balance at March 31, 2005 of approximately $29.3 million. The Company expects this amount to be expended over the next three to five years.

The Company believes that none of these matters, individually or in the aggregate, will have a material adverse effect on its financial condition or future operating results, 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.

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 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.

The Company has been working with the Mississippi Department of Environmental Quality and Kuhlman Electric to investigate the extent of and remediate the contamination. The investigation revealed the presence of polychlorinated biphenyls (PCBs) in portions of the soil at the plant and neighboring areas. Clean up began in 2000 and is continuing. Kuhlman Electric and others, including the Company, have been sued in numerous related lawsuits, in which multiple claimants allege personal injury and property damage. The Company has moved to be dismissed from some of these lawsuits. The first trial in these lawsuits is currently scheduled to begin in May 2005, although settlement discussions are in process.

The Company believes that the accrual for environmental liabilities and any insurance recoveries are sufficient to cover any potential liability associated with this matter. However, due to the nature of environmental liability matters, there can be no assurance that the actual amount of environmental liabilities will not exceed the amount accrued.

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

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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 March 31, 2005, the Company had approximately 98,000 pending asbestos-related product liability claims. Of these outstanding claims, approximately 90,000 are pending in just three jurisdictions, where significant tort reform activities are underway.

The Company’s policy is to aggressively defend against these lawsuits and the Company has been successful in obtaining dismissal of many claims without any payment. The Company expects that the vast majority of the pending asbestos-related product liability claims where it is a defendant (or has an obligation to indemnify a defendant) will result in no payment being made by the Company or its insurers. In the first quarter of 2005, of the approximately 4,500 claims resolved, only 74 (1.6%) resulted in any payment being made to a claimant by or on behalf of the Company. In 2004 of the 4,062 claims settled, only 255 (6.3%) resulted in any payment being made to a claimant by or on behalf of the Company. In 2003 of the 4,664 claims settled, only 273 (5.9%) resulted in any payment being made to claimants. The settlement costs of these claims were paid by the insurance carriers, except for $1.0 million paid in the first quarter 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 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.

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. In June 2004, the Company was notified by primary layer insurance carriers of the 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. Two secondary layer insurers are currently not participating in this arrangement, until they are satisfied through an audit process, that the primary level of insurance is exhausted. The Company therefore paid defense and settlement costs of $1.0 million in the first quarter of 2005 and $1.0 million in the fourth quarter of 2004 and expects to recover those amounts from either these insurers, or the primary layer insurers if the exhaustion audit shows that primary layer insurance is still available.

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 periodic input from the Company.

At March 31, 2005, the Company recorded a liability of $37.9 million; with a

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related asset of $37.9 million to recognize the insurance proceeds receivable to the Company for estimated claim losses. At December 31, 2004, the comparable value of the insurance receivable and accrued liability was $40.8 million.

The amounts recorded in the Condensed Consolidated Balance Sheets are as follows: