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Interest expense, net  decreased by $3.6 million in 2004 and decreased by $4.4 million between 2003 and 2002. The decreases in 2004 and 2003 were due to lower debt levels, as we used cash gen- erated from operations to pay off debt. In 2004, our balance sheet debt decreased by $71.0 million. In 2003, our balance sheet debt decreased $2.7 million excluding the fair value adjustment for inter- est rate swaps, and we reduced the amount of securitized accounts receivable sold by $40.0 million. We took advantage of lower inter- est rates through the use of interest rate and cross-currency swap arrangements described more fully in Note 7 to the Consolidated Financial Statements. 

The provision for income taxes  resulted in an effective tax rate for 2004 of 26.3% compared with rates of 28.5% in 2003 and 33.0% for 2002. Our effective tax rates have been lower than the standard federal and state tax rates due to the realization of certain R&D and foreign tax credits; foreign rates, which differ from those in the U.S.; and offset by non-deductible expenses. In addition, the Company made an $11.4 million year-end adjustment to various tax accounts due to changes in circumstances related to various tax items, includ- ing changes in tax laws. The year-end adjustment resulted in a reduc- tion in the U.S. effective tax rate for 2004. In 2005, we anticipate our tax rate to be approximately 30% to 31% based on our current mix of business. 

## LIQUIDITY AND CAPITAL RESOURCES 

Net cash provided by operating activities of $426.6 million was pri- marily used to fund $204.9 million of capital expenditures, $47.5 mil- lion of tooling, net of customer reimbursements, pay down long-term debt of $61.8 million, pay $27.9 million of dividends to our sharehold- ers, and increase cash and cash equivalents by $116.6 million. 

## Operating Activities 

Net cash provided by operating activities of $426.6 million is $119.7 million more than in 2003. The $426.6 million consists of net income of $218.3 million, increased for non-cash charges of $222.4 million and offset by a $17.3 million increase in net operating assets and liabilities. Non-cash charges are primarily comprised of $177.0 million in depreciation and amortization expense. 

Accounts receivable increased a total of $84.2 million, of which $23.8 was due to currency. The remaining increase was due to higher busi- ness levels, particularly in Europe. Certain of our European custom- ers tend to pay slower than our North American customers. Inventory increased by $22.1 million, but our inventory turns improved to 12.9 times from 12.3 times in 2003. 

## Investing Activities 

Net cash used in investing activities totaled $257.2 million, compared with $228.2 million in the prior year. Capital spending totaling $204.9 million in 2004 was $32.9 million higher than in 2003. Approximately 60% of the 2004 capital spending was related to expansion, with the remainder for cost reduction and other purposes. Heading into 2005, we plan to continue to spend on capital to support the launch of our 

new applications and for cost reductions and productivity improve- ment projects. Our target for capital spending is to be approximately 5.5% of sales. 

The 2003 investing uses of cash includes $12.8 million of payments to resolve a valuation dispute regarding the value of the turbocharger business of Aktiengesellschaft Kühnle, Kopp & Kausch (AGK). The valuation payment resulted from the settlement in 2003 of a lawsuit brought by certain minority shareholders of AGK related to the auto- motive turbocharger business of AGK, which the Company purchased from AGK in 1998. 

Since the settlement of the dispute, the Company extended a formal tender offer to purchase all of the outstanding common and preferred shares of AGK from the remaining shareholders. The Company spent $9.0 million in 2004 and $14.4 million in 2003 to purchase additional shares of AGK, an unconsolidated subsidiary of the Company, which has been recorded as an “Investment in business held for sale” in the Consolidated Balance Sheets. Effective February 17, 2005, the Company signed a Share Transfer Agreement (STA) with Turbo Group GmbH for the sale of its 95.42% interest in AGK. The STA will become effective no later than seven banking days after receipt of approval from both the German Federal Cartel Office and the Austrian Merger Control Authority. The transaction is anticipated to close before March 31, 2005. The estimated proceeds from the pending sale, net of closing costs are approximately €39.8 million. 

## Financing Activities and Liquidity 

Stockholders’ equity increased by $273.8 million in 2004. The increase was primarily caused by net income of $218.3 million, along with currency translation and hedge instruments adjustments of $28.4 million, stock option exercises of $14.4 million and stock issuances to retirement plans of $25.8 million. These factors were somewhat offset by dividend payments of $27.9 million. In relation to the U.S. Dollar, the currencies in foreign countries where we conduct business, particularly the Euro and Yen, strengthened, causing the currency translation component of other comprehensive income to increase in both 2004 and 2003. 

Our total capitalization as of December 31, 2004 of $2,140.9 million is comprised of short-term debt of $16.5 million, long-term debt of $568.0 million, minority interest of $22.2 million and stockholders’ equity of $1,534.2 million. Capitalization at December 31, 2003 was $1,934.2 million. During the year, we reduced our balance sheet debt to debt plus equity ratio to 27.3% from 34.2% in 2003. 

The Company has a new revolving credit facility, which provides for borrowings up to $600 million through July 2009. The new facility effective July 22, 2004, replaced the Company’s previous facility of $350 million. Additionally, we have $300 million available under a universal shelf registration statement on file with the Securities and Exchange Commission through which a variety of debt and/or equity instruments may be issued. The Company also has access to the commercial paper market through a $50 million accounts receivable securitization facility, which is rolled over annually. From a credit qual- ity perspective, we have an investment grade credit rating of A- from Standard & Poor’s and Baa2 from Moody’s. 

The Company’s significant contractual obligation payments at December 31, 2004, are as follows: 

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(a) Other post retirement benefits (excluding pensions) include anticipated future payments to cover retiree medical and life insurance benefits. Since the timing and amount of payments for pension plans is not certain for future years, such payments have been excluded from this table. The Company expects to contribute a total of $20 million to $25 million into all pension plans during 2005. See Note 8 to the Consolidated Financial Statements for disclosures related to the Company’s pension and other post retire- ment benefits. 

(b) Projection is based upon an average debt portfolio interest rate of 5.00%. The calculation excludes the impact of the Beru transaction. 

(c) The minimum royalty payments are related to the Honeywell royalty agreement discussed more fully in Note 12 to the Consolidated Financial Statements. The Company has other royalty agreements that are based on sales volumes. These royalty agreements do not have minimum royalty payments and are typically cancellable and have been excluded from the amounts in the table. 

The Company does not have any long-term or fixed purchase obliga- tions for inventories. 

The Company has a credit agreement that 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 December 31, 2004. 

We believe that the combination of cash from operations, cash bal- ances, available credit facilities and the universal shelf registration will be sufficient to satisfy our cash needs for our current level of operations and our planned operations, including the acquisition of Beru, for the foreseeable future. We will continue to balance our needs for internal growth, external growth, debt reduction, dividends and share repurchase. 

## Off Balance Sheet Arrangements 

As of December 31, 2004, the accounts receivable securitization facility was sized at $50 million and has been in place with its cur- rent funding partner since January 1994. This facility sells accounts receivable without recourse. 

The Company has certain leases that are recorded as operating leases. Types of operating leases include leases on the headquar- ters facility, an airplane, vehicles, and certain office equipment. The Company also has a lease obligation for production equipment at one of it facilities. The total expected future cash outlays for all lease obligations at the end of 2004 is $58.0 million. See Note 12 to the Consolidated Financial Statements for more information on operating leases, including future minimum payments. 

The Company has guaranteed the residual values of the leased production equipment. The guarantees extend through the maturity of the underlying lease, which is in 2005. In the event the Company exercises its option not to purchase the production equipment, the Company has guaranteed a residual value of $16.3 million. We do not believe we have any potential loss due to this guarantee. 

## Pension and Other Post Retirement Benefits 

The Company’s policy is to fund its defined benefit pension plans in accordance with applicable U.S., U.K., German and Japanese govern- ment regulations and to make additional contributions when manage- ment deems it appropriate. At December 31, 2004, all legal funding requirements had been met. The Company contributed $36.3 million to its pension plans in 2004 and $17.1 million in 2003. The Company expects to contribute a total of $20 million to $25 million in 2005. 

The funded status of pension plans with accumulated benefit obliga- tions in excess of plan assets improved from $(148.1) million at the end of 2003 to $(127.8) million at the end of 2004. The improvement was primarily due to positive returns on plan assets of $43.6 million and company contributions of $36.3 million, which were partially off- set by interest costs of $28.8 million, service costs of $11.7 million and foreign currency translation of $9.7 million. 

Other post retirement benefits primarily consist of post retirement health care benefits. The Company funds these benefits as retiree claims are incurred. Other post retirement benefits had an unfunded status of $(537.2) million at the end of 2004, and $(537.4) million at the end of 2003. The unfunded levels were relatively stable as increases in the liabilities related to a decline in the interest rate assumptions used to calculate the ending liabilities for each of the plans were offset by benefits of the new Medicare Part D plan enacted during 2004. 

The Company believes it will be able to fund the requirements of these plans through cash generated from operations or other sources for the foreseeable future. 

