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## RESULTS OF OPERATIONS Net Sales 

The table below summarizes the overall worldwide global light vehicle production percentage changes for 2004 and 2003: 

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Our net sales increase in 2004 and 2003 was strong compared to the estimated worldwide market production increase of approximately 5.2% in 2004 and decrease of (1.6)% in 2003. The Company’s net sales increased 14.9% from 2003 and increased 12.4% from 2002 to 2003. The increase in 2004 was driven by both of our operating seg- ments from higher demand for turbochargers, especially in Europe; new DualTronic™ transmissions; all-wheel drive systems; and timing chain systems in Asia and Europe. The effect of changing currency rates also had a positive impact on net sales and net earnings in 2004. The effect of non-U.S. currencies, primarily the Euro, U.K. Pound, Japanese Yen and Korean Won, added $114.0 million to net sales in 2004 and $161.9 million in 2003. The year over year increase in net sales excluding the favorable impact of currency was 11.1% in 2004 and 6.5% in 2003. 

Consolidated net sales included sales to Ford Motor Company of approximately 21%, 23%, and 26%; to DaimlerChrysler of approxi- mately 14%, 17%, and 20%; and to General Motors Corporation of approximately 10%, 12%, and 12% for the years ended December 31, 2004, 2003 and 2002, respectively. Sales to Volkswagen were approximately 10% in 2004. Both of our operating segments had significant sales to all four of the customers listed above. Such sales consisted of a variety of products to a variety of customer locations and regions. No other single customer accounted for more than 10% of consolidated sales in any year of the periods presented. 

Over the past several years as our major customers have continued to consolidate, we have increased our sales to several other global OEMs, bringing us more in line with our customers’ share of the global vehicle market. As a result, sales to Ford, DaimlerChrysler and General Motors have become a smaller percentage of total sales. 

Our overall outlook for 2005 is positive. Sales are expected to grow in excess of a projected flat to slightly positive global production rate and we expect to benefit from the continuation of several trends: change in Europe to diesel engines, which utilize turbochargers and certain Beru products; shift in Europe to automatic transmissions; and the switch from timing belts to timing chains in Asia and Europe. Each of these trends is positive for the Company. Assuming no major changes to the above assumptions, the Company expects continued long-term sales and net earnings growth. 

## Results By Operating Segment 

The following tables present net sales and earnings before interest and income taxes (EBIT) by segment for the years 2004, 2003 and 2002. 

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## EARNINGS BEFORE INTEREST AND TAXES (EBIT) 

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The Drivetrain  segment net sales increased 9.1% from 2003 to 2004; EBIT increased 8.6% for the same period. The sales increase was the result of strong global demand for transmission compo- nents and all-wheel drive systems. The Company’s new DualTronic™ transmission product continues to ramp-up volume in Europe. The increase in EBIT was due to increased volume and continued focus on cost reductions in our operations. These positive trends were offset by commodity price increases of approximately $20 million, which is primarily steel, and start up costs. 

The Drivetrain segment net sales increased 11.0% from 2002 to 2003, but EBIT declined 1.5% for the same period. The sales gains were due to all-wheel drive transfer case programs with General Motors, increased sales of the Company’s Interactive Torque Management ™ all-wheel drive systems to Honda and Hyundai, and steady demand for transmission components and systems, especially with increased automatic transmission adoption in Europe. These sales gains were offset by declines in North American automotive production. The decrease in EBIT was due to start-up costs for the Company’s new DualTronic™ transmission product, including the opening of a new assembly facility in Europe. Profitability also suffered from a less favorable product mix and an increase in pension and retiree health care costs over the previous year. 

In 2005, growth in the Drivetrain segment is expected to be flat as demand for traditional light-trucks will be about the same as in 2004. Sport-utility vehicles are expected to decline, while sales of front- wheel-drive based all-wheel-drive systems are expected to increase. Transmission products will benefit from increased penetration of auto- matic transmissions in Europe and Asia, and the continued ramp-up of DualTronic™ transmission modules in Europe. 

The Engine  segment 2004 net sales increased 18.6% over 2003 and EBIT increased 17.6% over the same period. This segment benefited from strong demand for the Company’s turbochargers for European passenger cars and commercial vehicles. The segment EBIT was impacted by increased volume, productivity and positive currency impact, which offset commodity price increases of approximately $20 million and start up costs in Korea and China. 

The Engine segment 2003 net sales increased 13.4% over 2002 and EBIT increased 11.0% over the same period. This segment benefited from continued demand for the Company’s turbochargers for European passenger cars and commercial vehicles as well as continued growth of our timing chain and emissions products. The EBIT was impacted by increased productivity and production in the turbocharger business, which translated into higher profitability. This was partially offset by start up costs for Variable Cam Timing systems, which will launch in 2004 and for new Korean operations. 

For 2005, the Engine Group expects to deliver continued growth from further penetration of diesel engines in Europe, which will continue to boost demand for turbochargers and Beru technologies, and the launch of our first high-volume variable cam timing (VCT) system. Investments in Korea and China are expected to begin to contribute to results. This growth is expected to help offset anticipated weak- ness in North American light vehicle production. 

Corporate  is the difference between calculated total Company EBIT and the total from the segments and represents corporate headquar- ters expenses and expenses not directly attributable to the individual segments and includes equity in affiliate earnings. This net expense was $50.3 million in 2004, $48.0 million in 2003, and $44.3 million in 2002. The main reasons for the increase from 2003 to 2004 was an increase in our environmental spending related to the Crystal Springs, Mississippi site and the $3.7 million write down of a note relating to the sale of Kuhlman Electric Corporation, which were mostly offset by stron- ger equity earnings from NSK-Warner. The increase from 2002 to 2003 was due to higher pension and post retirement health care costs for discontinued operations, which are recorded at the corporate level. 

## Other Factors Affecting Results of Operations 

The following table details our results of operations as a percentage of sales: 

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Gross Profit  for 2004 was 18.5% down from 19.1% in 2003 and down from 20.3% in 2002. The decrease in gross profit in 2004 was due to several factors, including significant commodity price increases, including steel, a change in sales mix and geographic expansion. The geographic expansion includes new facilities in Europe and Asia for both operating segments. We anticipate 2005 margins to be impacted by the leveling off of commodity price increases, the con- tinued shift from components to systems sales and continued results from our cost reduction initiatives. 

Also impacting gross margins in 2004, 2003 and 2002 is the effect of a royalty agreement the Company entered into with Honeywell International for certain variable turbine geometry (VTG) turbocharg- ers after a German court ruled in favor of Honeywell in a patent infringement action. In order to continue shipping to its OEM custom- ers, the Company and Honeywell entered into two separate royalty agreements, signed in July 2002 and June 2003, respectively. The June 2003 agreement runs 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 agreement costs recognized under the agreements were $14.2 million in 2004, $23.2 million in 2003 and $13.5 million in 2002. These costs were based on units shipped and were recorded in cost of goods sold. It is anticipated that these costs will be at minimal levels in 2005 and 2006 as the Company’s primary custom- ers have converted most of their requirements to the next generation VTG turbocharger. 

Selling, general and administrative  expenses (SG&A) as a per- centage of net sales decreased to 9.6% from 10.3% in 2003 and 11.1% in 2002. While SG&A spending in dollars increased slightly, we were able to slow that growth to a level below the growth in sales through continued focus on cost controls, and leveraging the existing infrastructure to support the increased sales. 

Research and development (R&D) is a major component of the Company’s SG&A expenses. R&D spending was $123.1 million, or 3.5% of sales in 2004, compared to $118.2 million, or 3.9% of sales in 2003, and $109.1 million, or 4.0% of sales in 2002. We continue to increase our spending in R&D, although the growth rate has been somewhat lower than our sales growth rate. We also continue to invest in a number of cross-business R&D programs, as well as a number of other key programs, all of which are necessary for short- and long- term growth. Our long-term target for R&D spending is approximately 4% of sales. We intend to maintain our commitment to R&D spending while continuing to focus on controlling other SG&A costs. 

Other, net  decreased to $(3.0) million of loss in 2004, from $0.1 mil- lion of income in 2003 and $0.9 million of income in 2002. The major item was losses from capital asset disposals of $3.5 million in 2004. 

Equity in affiliates earnings, net of tax  increased by $9.1 million from 2003, and by $0.6 million between 2003 and 2002. This line item is primarily driven by the results of our 50% owned Japanese joint venture, NSK-Warner. For more discussion of NSK-Warner, see Note 5 of the Consolidated Financial Statements. 

