Management’s Discussion and Analysis  of Financial Condition and Results of Operations 34 Management’s Responsibility for Consolidated Financial Statements Report of Independent Registered  Public Accounting Firm 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 beginning July 1, 2005. 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. The Company’s primary market risks include fluctuations in interest  rates and foreign currency exchange rates. We are also affected by  changes in the prices of commodities used or consumed in our manu- facturing operations. Some of our commodity purchase price risk is  covered by supply agreements with customers and suppliers. Other  commodity purchase price risk is addressed by hedging strategies,  which include forward contracts. The Company enters into derivative  instruments only with high credit quality counterparties and diversi- fies its positions across such counterparties in order to reduce its  exposure to credit losses. We do not engage in any derivative instru- ments for purposes other than hedging specific risks.  We have established policies and procedures to manage sensitivity  to interest rate, foreign currency exchange rate and commodity  purchase price risk, which include monitoring the level of exposure  to each market risk. Interest rate risk is the risk that we will incur economic losses due to  adverse changes in interest rates. The Company manages its interest  rate risk by balancing its exposure to fixed and variable rates while  attempting to minimize its interest costs. The Company selectively  uses interest rate swaps to reduce market value risk associated with  changes in interest rates (fair value hedges). At the end of 2004,  the amount of net debt with fixed interest rates was 62% of total  debt, including the impact of the interest rate swaps. Our earnings  exposure related to adverse movements in interest rates is primar- ily derived from outstanding floating rate debt instruments that are  indexed to floating money market rates. A 10% increase or decrease  in the average cost of our variable rate debt would result in a change  in pre-tax interest expense for 2004 of approximately $1.3 million,  and $1.0 million in 2003.  We also measure interest rate risk by estimating the net amount by  which the fair value of all of our interest rate sensitive assets and  liabilities would be impacted by selected hypothetical changes in  market interest rates. Fair value is estimated using a discounted cash  flow analysis. Assuming a hypothetical instantaneous 10% change in  interest rates as of December 31, 2004, the net fair value of these  instruments would increase by approximately $23.8 million if interest  rates decreased and would decrease by approximately $21.9 mil- lion if interest rates increased. Our interest rate sensitivity analysis  assumes a constant shift in interest rate yield curves. The model,  therefore, does not reflect the potential impact of changes in the  relationship between short-term and long-term interest rates. Interest  rate sensitivity at December 31, 2003, measured in a similar manner,  was slightly greater than at December 31, 2004. 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 projections. Words such as “expects,”  “anticipates,” “intends,” “plans,” “believes,” “estimates,” variations  of such words and similar expressions are intended to identify such  forward-looking statements. Forward-looking statements are subject  to risks and uncertainties, many of which are difficult to predict and  generally beyond the control of the Company, which could cause  actual results to differ materially from those projected or implied in  the forward-looking statements. Such risks and uncertainties include:  fluctuations in domestic or foreign automotive production, the contin- ued use of outside suppliers, fluctuations in demand for vehicles con- taining BorgWarner 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 the Form 10-K for the fiscal year ended December 31,  2004. The Company does not undertake any obligation to update any  forward-looking statement. Commodity price risk is the possibility that we will incur economic  losses due to adverse changes in the cost of raw materials used in  the production of our products. Commodity forward and option con- tracts are executed to offset our exposure to the potential change  in prices mainly for various non-ferrous metals and natural gas  consumption used in the manufacturing of automotive components.  As of December 31, 2004, and 2003, we had contracts with a total  notional value of $3.4 and $1.1 million, respectively. Foreign currency risk is the risk that we will incur economic losses  due to adverse changes in foreign currency exchange rates.  Currently, our most significant currency exposures relate to the Euro,  the Japanese Yen, the British Pound, the Hungarian Forint and the  South Korean Won. We mitigate our foreign currency exchange rate  risk principally by establishing local production facilities in markets  we serve, by invoicing customers in the same currency as the source  of the products and by funding some of our investments in foreign  markets through local currency loans and cross currency swaps.  Such non-U.S. Dollar debt was $324.6 million as of December 31,  2004 and $184.0 million as of December 31, 2003. We also monitor  our foreign currency exposure in each country and implement strate- gies to respond to changing economic and political environments.  In addition, the Company periodically enters into forward currency  contracts in order to reduce exposure to exchange rate risk related  to transactions denominated in currencies other than the functional  currency. In the aggregate, our exposure related to such transactions  was not material to our financial position, results of operations or  cash flows in both 2004 and 2003. The information in this report is the responsibility of management.  BorgWarner Inc. and Consolidated Subsidiaries (the “Company”) has  in place reporting guidelines and policies designed to ensure that  the statements and other information contained in this report pres- ent a fair and accurate financial picture of the Company. In fulfilling  this management responsibility, we make informed judgments and  estimates conforming with accounting principles generally accepted  in the United States of America. The accompanying Consolidated Financial Statements have been  audited by Deloitte & Touche LLP, independent auditors. Management  has made available all the Company’s financial records and related  information deemed necessary by Deloitte & Touche LLP. Furthermore,  management believes that all representations made by it to Deloitte &  Touche LLP during its audit were valid and appropriate. Management is responsible for maintaining a comprehensive system  of internal control through its operations that provides reasonable  assurance that assets are protected from improper use, that mate- rial errors are prevented or detected within a timely period and  that records are sufficient to produce reliable financial reports. The  system of internal control is supported by written policies and proce- dures that are updated by management as necessary. The system is  reviewed and evaluated regularly by the Company’s internal auditors  as well as by the independent auditors in connection with their annual  audit of the financial statements. The independent auditors conduct  their evaluation in accordance with auditing standards generally  accepted in the United States of America and perform such tests  of transactions and balances as they deem necessary. Management  considers the recommendations of its internal auditors and indepen- dent auditors concerning the Company’s system of internal control  and takes the necessary actions that are cost-effective in the circum- stances. Management believes that, as of December 31, 2004, the  Company’s system of internal control was effective to accomplish the  objectives set forth in the first sentence of this paragraph. The Company’s Finance and Audit Committee, composed entirely of  directors of the Company who are not employees, meets periodically  with the Company’s management and independent auditors to review  financial results and procedures, internal financial controls and  internal and external audit plans and recommendations. In carrying  out these responsibilities, the Finance and Audit Committee and the  independent auditors have unrestricted access to each other with or  without the presence of management representatives. We have also audited, in accordance with the standards of the  Public Company Accounting Oversight Board (United States), the  effectiveness of the Company’s internal control over financial report- ing as of December 31, 2004, based on the criteria established in  Internal Control—Integrated Framework  issued by the Committee  of Sponsoring Organizations of the Treadway Commission and our  report dated March 7, 2005 expressed an unqualified opinion on  management’s assessment of the effectiveness of the Company’s  internal control over financial reporting and an unqualified opin- ion on the effectiveness of the Company’s internal control over  financial reporting. In our opinion, such consolidated financial statements present fairly,  in all material respects, the financial position of BorgWarner Inc. and  Consolidated Subsidiaries at December 31, 2004 and 2003, and  the results of their operations and their cash flows for each of the  three years in the period ended December 31, 2004 in conformity  with accounting principles generally accepted in the United States  of America. We conducted our audits in accordance with the standards of the  Public Company Accounting Oversight Board (United States). Those  standards require that we plan and perform the audit to obtain rea- sonable assurance about whether the financial statements are free of  material misstatement. An audit includes examining, on a test basis,  evidence supporting the amounts and disclosures in the financial  statements. An audit also includes assessing the accounting prin- ciples used and significant estimates made by management, as well  as evaluating the overall financial statement presentation. We believe  that our audits provide a reasonable basis for our opinion. We have audited the consolidated balance sheets of BorgWarner  Inc. and Consolidated Subsidiaries (the Company) as of December  31, 2004 and 2003, and the related consolidated statements of  operations, cash flows, and stockholders’ equity and comprehensive  income for each of the three years in the period ended December  31, 2004. These financial statements are the responsibility of the  Company’s management. Our responsibility is to express an opinion  on these financial statements based on our audits. To The Board of Directors and Stockholders of BorgWarner Inc.:  35 Robin J. Adams Executive Vice President, Chief Financial Officer &  Chief Administrative Officer Timothy M. Manganello  Chairman and Chief Executive Officer  Detroit, Michigan March 7, 2005 March 7, 2005 Commodity Price Risk Disclosure Regarding Forward-Looking Statements Foreign Currency Exchange Rate Risk Qualitative and Quantitative Disclosure  About Market Risk Interest Rate Risk