INTRODUCTION

BorgWarner Inc. and Consolidated Subsidiaries (the "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") of light vehicles (i.e. passenger cars, sport-utility vehicles ("SUVs"), 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 for and sell our products to certain Tier One vehicle systems suppliers and into the aftermarket for light and commercial vehicles. We operate manufacturing facilities serving customers in the Americas, Europe and Asia, and are an original equipment supplier to every major automaker in the world.

The Company's products fall into two reporting segments: Engine and Drivetrain. The Engine segment's products include turbochargers, timing chain systems, air management, emissions systems, thermal systems, as well as diesel and gas ignition systems. The Drivetrain segment's products include all-wheel drive transfer cases, torque management systems, and components and systems for automated transmissions.

Stock Split

On November 14, 2007, the Company's Board of Directors approved a two-for-one stock split effected in the form of a stock dividend on its common stock. To implement this stock split, shares of common stock were issued on December 17, 2007 to stockholders of record as of the close of business on December 6, 2007. All prior year share and per share amounts disclosed in this document have been restated to reflect the two-for-one stock split.

RESULTS OF OPERATIONS

Overview

A summary of our operating results for the years ended December 31, 2008, 2007
and 2006 is as follows:


millions of dollars, except per share data
Year Ended December 31,                                    2008           2007           2006

Net sales                                                $ 5,263.9      $ 5,328.6      $ 4,585.4
Cost of sales                                              4,425.4        4,378.7        3,735.5

Gross profit                                                 838.5          949.9          849.9
Selling, general and administrative expenses                 542.9          531.9          498.1
Restructuring expense                                        127.5              -           84.7
Goodwill impairment charge                                   156.8              -              -
Other income                                                  (3.1 )         (6.8 )         (7.5 )

Operating income                                              14.4          424.8          274.6
Equity in affiliates' earnings, net of tax                   (38.4 )        (40.3 )        (35.9 )
Interest expense and finance charges                          38.8           34.7           40.2

Earnings before income taxes and minority interest            14.0          430.4          270.3
Provision for income taxes                                    33.3          113.9           32.4
Minority interest, net of tax                                 16.3           28.0           26.3

Net earnings (loss)                                      $   (35.6 )    $   288.5      $   211.6

Earnings (loss) per share - diluted                      $   (0.31 )    $    2.45      $    1.83

A summary of major factors impacting the Company's net earnings for the year ended December 31, 2008 in comparison to 2007 and 2006 is as follows:

• Global financial market and economic crisis in the second half of 2008 significantly impacted consumer demand for light vehicles and negatively impacted our sales.

• Continued demand for our products in both Engine and Drivetrain segments.

• Lower North American production of light trucks and SUVs.

• Continued benefits from our cost reduction programs, including containment of raw material and energy cost increases, health care cost inflation and the costs related to global expansion.

• Restructuring expenses in the third and fourth quarters of 2006 to adjust headcount and capacity levels, primarily in North America and primarily in the Drivetrain segment.

• Restructuring expenses in the third and fourth quarters of 2008 to adjust headcount and capacity levels, in North America, Europe and Asia.

• The write-offs of the excess purchase price allocated to in-process research and development ("IPR&D"), order backlog and beginning inventory related to the 2007 acquisition of approximately 12.8% of BERU AG ("BERU") stock and the 2008 completion of a Domination and Profit Transfer Agreement ("DPTA") between the Company and BERU.

• The write-offs of the excess purchase price allocated to IPR&D, order backlog and beginning inventory related to the 2006 acquisition of the European Transmission and Engine Controls ("ETEC") product lines from Eaton in Monaco.

• Favorable currency impact of $13.0 million, $15.2 million and $0.4 million in 2008, 2007 and 2006, respectively.

• Adjustments to tax accounts in 2008, 2007 and 2006 upon conclusion of certain tax audits and changes in circumstances, including changes in tax laws.

• An approximate $14 million provision in 2007 for a warranty-related issue surrounding a product, built during a 15-month period in 2004 and 2005, that is no longer in production.

• An approximate $23.5 million warranty-related issue associated with the company's transmission product sold in Europe, limited to mid-2007 through May 2008 production.

• An €111.5 million $(156.8 million) impairment charge in 2008 to adjust BERU's goodwill to its estimated fair value.

• Recognition in 2008 of a $4.0 million charge related to an untimely change in the level of benefits provided to BorgWarner Diversified Transmission Products Inc ("DTP") retirees.

• The establishment of a valuation allowance for foreign tax credit carryforwards in 2008 of $13.5 million.

The Company's earnings (loss) per diluted share were $(0.31), $2.45 and $1.83 for the years ended December 31, 2008, 2007 and 2006, respectively. The Company believes the following table is useful in highlighting non-recurring or non-comparable items that impacted its earnings per diluted share:

    Year Ended December 31,                            2008        2007        2006

    Non-recurring or non-comparable items:
    Goodwill impairment charge                        $ (1.35 )   $     -     $     -
    Restructuring expense                               (0.72 )         -       (0.41 )
    Transmission product related warranty charge        (0.14 )         -           -
    Tax valuation allowance                             (0.12 )         -           -
    Write-off of the excess purchase price
    allocated to IPR&D, order backlog and beginning
    inventory associated with acquisitions              (0.04 )     (0.02 )     (0.02 )
    Net gain from divestitures                              -           -        0.03
    Adjustments to tax accounts                          0.02        0.03        0.19
    Retiree healthcare litigation outcome               (0.03 )         -           -

    Total impact to earnings per share - diluted:     $ (2.38 )   $  0.01     $ (0.21 )

The Company's effective tax rate, after giving tax effect to the non-recurring or non-comparable items shown above, was 23.0%, 27.1%, and 26.0% for 2008, 2007, and 2006, respectively.

Net Sales

The table below summarizes the overall worldwide global light vehicle production percentage changes for 2008 and 2007:

Worldwide Light Vehicle Year Over Year Increase (Decrease) in Production


                                                        2008         2007

          North America*                                 (15.8 )%     (1.5 )%
          Europe*                                         (4.5 )%      5.6 %
          Asia*                                            2.4 %       7.1 %
          Total Worldwide*                                (3.7 )%      5.0 %
          BorgWarner year over year net sales change      (1.2 )%     16.2 %

* Data provided by CSM Worldwide.

Our net sales decrease in 2008 of 1.2% was slightly better than the estimated worldwide market production decrease of 3.7%. Our net sales increase in 2007 of 16.2% was strong in light of the estimated worldwide market production increase of 5.0%. The effect of changing currency rates had a positive impact on the Company's net sales and net earnings in 2008 and 2007. The effect of non-U.S. currencies, primarily the Euro, increased net sales by $191.0 million and reduced the Company's net loss by $13.0 million in 2008. In 2007, non-U.S. currencies, primarily the Euro, added $262.1 million to net sales and $15.2 million to net earnings. The year over year decrease in net sales, excluding the favorable impact of currency, was 4.8% in 2008. The year over year increase in net sales, excluding the favorable impact of currency, was 10.5% in 2007.

Consolidated net sales included sales to Volkswagen of approximately 19%, 15%, and 13%; to Ford of approximately 9%, 12%, and 13%; and to Daimler of approximately 6%, 6%, and 11% for the years ended December 31, 2008, 2007 and 2006, respectively. Daimler divested Chrysler in 2007. Both of our reporting segments had significant sales to all three 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.

Outlook

The Company is very cautious about 2009. The recent crisis in the financial sector and deteriorating global economic conditions have increased uncertainty about automotive vehicle sales in every geographic region of the world. The Company expects the unprecedented current global economic environment to continue to affect near-term results and to create difficult conditions through 2009.

The Company maintains a positive long-term outlook for its global business and is committed to new product development and strategic capital investments to enhance its product leadership strategy. The trends that are driving our long-term growth are expected to continue, including the growth of direct injection diesel and gasoline engines worldwide, the increased adoption of automated transmissions in Europe and Asia-Pacific, and the move to chain engine timing systems in both Europe and Asia-Pacific.

The impact of non-U.S. currencies is currently expected to be a decline in 2009. When the recovery from current global economic conditions occur, we expect long-term sales and net earnings growth to resume to historical rates.

Results By Reporting Segment

The Company's business is comprised of two reporting segments: Engine and Drivetrain. These segments are strategic business groups, which are managed separately as each represents a specific grouping of related automotive components and systems.

The Company allocates resources to each segment based upon the projected after-tax return on invested capital ("ROIC") of its business initiatives. The ROIC is comprised of projected earnings before interest and taxes ("EBIT") adjusted for taxes compared to the projected average capital investment required.

EBIT is considered a "non-GAAP financial measure." Generally, a non-GAAP financial measure is a numerical measure of a company's financial performance, financial position or cash flows that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. EBIT is defined as earnings before interest, taxes and minority interest. "Earnings" is intended to mean net earnings as presented in the Consolidated Statements of Operations under GAAP.

The Company believes that EBIT is useful to demonstrate the operational profitability of its segments by excluding interest and taxes, which are generally accounted for across the entire Company on a consolidated basis. EBIT is also one of the measures used by the Company to determine resource allocation within the Company. Although the Company believes that EBIT enhances understanding of its business and performance, it should not be considered an alternative to, or more meaningful than, net earnings or cash flows from operations as determined in accordance with GAAP.

The following tables present net sales and Segment EBIT by segment for the years 2008, 2007 and 2006:

Net Sales


            millions of dollars
            Year Ended December 31,        2008          2007          2006

            Engine                       $ 3,861.5     $ 3,761.3     $ 3,154.9
            Drivetrain                     1,426.4       1,598.8       1,461.4
            Inter-segment eliminations       (24.0 )       (31.5 )       (30.9 )

            Net sales                    $ 5,263.9     $ 5,328.6     $ 4,585.4

Earnings Before Interest and Taxes


millions of dollars
Year Ended December 31                                          2008         2007         2006

Engine                                                        $  394.9      $ 418.0      $ 365.8
Drivetrain                                                        (4.9 )      118.1         90.6

Segment earnings before interest and taxes ("Segment EBIT")      390.0        536.1        456.4
Restructuring expense                                           (127.5 )          -        (84.7 )
Goodwill impairment charge                                      (156.8 )          -            -
Corporate, including equity in affiliates' earnings              (52.9 )      (71.0 )      (61.2 )

Consolidated earnings before interest and taxes ("EBIT")          52.8        465.1        310.5
Interest expense and finance charges                              38.8         34.7         40.2

Earnings before income taxes and minority interest                14.0        430.4        270.3
Provision for income taxes                                        33.3        113.9         32.4
Minority interest, net of tax                                     16.3         28.0         26.3

Net earnings (loss)                                           $  (35.6 )    $ 288.5      $ 211.6

The Engine segment 2008 net sales were up 2.7% from 2007, with a 5.5% decrease in Segment EBIT over the same period. The Engine segment continued to benefit from Asian automaker demand for turbochargers and timing systems, European automaker demand for turbochargers, timing systems, exhaust gas recirculation ("EGR") valves and diesel engine ignition systems. This benefit was offset by lower North American production of light truck and sport-utility vehicles. The Segment EBIT margin was 10.2% in 2008, down from 11.1% in 2007 (which includes the one-time write-off in 2008 of the excess purchase price allocated to BERU's IPR&D, order backlog and inventory), due to the significant reduction in customer production schedules in the U.S. and European markets, and increased costs for raw materials, principally steel.

The Engine segment 2007 net sales were up 19.2% from 2006, with a 14.3% increase in Segment EBIT over the same period. The Engine segment continued to benefit from Asian automaker demand for turbochargers and timing systems, European automaker demand for turbochargers, timing systems, exhaust gas recirculation ("EGR") valves and diesel engine ignition systems, the continued roll-out of its variable cam timing systems with General Motors high-value V6 engines, stronger EGR valve sales in North America, and higher turbocharger and thermal products sales due to stronger global commercial vehicle production. The Segment EBIT margin was 11.1% in 2007 down from 11.6% in 2006 (which includes the one-time write-off in 2007 of the excess purchase price allocated to BERU's IPR&D, order backlog and inventory), due to the significant reduction in customer production schedules in the U.S. market and increased costs for raw materials, principally nickel.

The Drivetrain segment 2008 net sales decreased 10.8% from 2007 with a 104.1% decrease in Segment EBIT over the same period. The group was negatively impacted by lower U.S. production of light trucks and SUVs equipped with its torque transfer products and lower sales of its traditional transmission products. Segment EBIT margin was (0.3)% in 2008, down from 7.4% in the prior year, due to the combined effect of DCT product start-up cost pressures and lower North American production of light trucks and sport-utility vehicles equipped with its torque transfer products.

The Drivetrain segment 2007 net sales increased 9.4% from 2006 with a 30.4% increase in Segment EBIT over the same period. The segment continued to benefit from growth outside of North America including the continued ramp up of dual-clutch transmission and torque transfer product sales in Europe. In the U.S., the group was negatively impacted by lower production of light trucks and SUVs equipped with its torque transfer products and lower sales of its traditional transmission products. Segment EBIT margin was 7.4% in 2007, up from 6.2% in the prior year, due to the benefits of restructuring in its North American operations and growth outside of the U.S.

Corporate is the difference between calculated total Company EBIT and the total of the Segments' EBIT. It represents corporate headquarters' expenses, expenses not directly attributable to the individual segments and

equity in affiliates' earnings. This net expense was $52.9 million in 2008, $71.0 million in 2007 and $61.2 million in 2006.

Other Factors Affecting Results of Operations

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


  Year Ended December 31,                               2008         2007        2006

  Net sales                                              100.0 %      100.0 %     100.0 %
  Cost of sales                                           84.1         82.2        81.5

  Gross profit                                            15.9         17.8        18.5
  Selling, general and administrative expenses            10.3         10.0        10.9
  Restructuring expense                                    2.4            -         1.8
  Goodwill impairment charge                               3.0            -           -
  Other income                                            (0.1 )       (0.2 )      (0.2 )

  Operating income                                         0.3          8.0         6.0
  Equity in affiliates' earnings, net of tax              (0.7 )       (0.8 )      (0.8 )
  Interest expense and finance charges                     0.7          0.7         0.9

  Earnings before income taxes and minority interest       0.3          8.1         5.9
  Provision for income taxes                               0.7          2.2         0.7
  Minority interest, net of tax                            0.3          0.5         0.6

  Net earnings (loss)                                     (0.7 )%       5.4 %       4.6 %

Gross profit as a percentage of net sales was 15.9%, 17.8% and 18.5% in 2008, 2007 and 2006, respectively. Our gross profit decrease in 2008 is due to unfavorable product mix as a result of the sudden decline in the North American and European automotive markets, including a 15.8% decrease in light truck and SUV production in North America. The Company has restructured its North American and European operations in the third and fourth quarters of 2008 to align the Company's workforce with forecasted production.

Selling, general and administrative expenses ("SG&A") as a percentage of net sales were 10.3%, 10.0% and 10.9% in 2008, 2007 and 2006 respectively. The 2008 increase in SG&A as a percentage of net sales was primarily due to $8.0 million of amortization for the recognition of the remaining 17.8% of the fair value of BERU. $3.3 million of the amortization recognized in the second quarter of 2008 is for the immediate write off of in process R&D and order backlog, the remaining $4.7 million increase is amortization on other intangible assets. The Company also recorded an increase in bad debt expense of $2.7 million in 2008 related to a decline in the financial condition of certain customers.

Research and development ("R&D") is a major component of our SG&A expenses. R&D spending, net of customer reimbursements, was $205.7 million, or 3.9% of sales in 2008, compared to $210.8 million, or 4.0% of sales in 2007, and $187.7 million, or 4.1% of sales in 2006. We currently intend to continue to increase our spending in R&D, although the growth rate in the future may not necessarily match the rate of our sales growth. We also intend to 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 current long-term expectation for R&D spending is approximately 4.0% of sales. We intend to maintain our commitment to R&D spending while continuing to focus on controlling other SG&A costs.

Restructuring expense of $127.5 million in 2008 and $84.7 million in 2006 was in response to declines in global customer production levels, customer restructurings and a subsequent evaluation of our headcount levels in North America, Europe and Asia (in 2008 only) and our long-term capacity needs.

On July 31, 2008, the Company announced a restructuring of its operations to align ongoing operations with a continuing, fundamental market shift in the auto industry. As a continuation of the Company's third quarter restructuring, on December 11, 2008, the Company announced plans for additional restructuring actions. As a

result of these third and fourth quarter restructuring actions, the Company has reduced its North American workforce by approximately 2,400 people, or 33%; its European workforce by approximately 1,600 people, or 18%; and its Asian workforce by approximately 400 people, or 17%. The restructuring expense recognized for employee termination benefits is $54.6 million, of which $10.3 million was paid out in the third and fourth quarters of 2008. The remaining liability will be paid out by the middle of 2010. In addition to employee termination costs, the Company recorded $72.9 million of asset impairment charges related to the North American and European restructuring. The combined restructuring expenses of $127.5 million are broken out by segment as follows: Engine $85.3 million, Drivetrain $40.9 million and Corporate $1.3 million. Refer to Note 19, "Restructuring" of the Notes to the Consolidated Financial Statements in Item 8 of this report for further discussion.

On September 22, 2006, the Company announced the reduction of its North American workforce by approximately 850 people, or 13%, spread across its 19 operations in the U.S., Canada and Mexico. This third quarter reduction of the North American workforce addressed an immediate need to adjust employment levels to meet customer restructurings and significantly lower production schedules going forward. In addition to employee related costs of $6.7 million, the Company recorded $4.8 million of asset impairment charges related to the North American restructuring. The third quarter restructuring expenses of $11.5 million broken out by segment were as follows: Engine $7.3 million, Drivetrain $3.6 million and Corporate $0.6 million.

During the fourth quarter 2006, the Company evaluated the competitiveness of its North American facilities, as well as its long-term capacity needs. As a result, the Company will be closing the drivetrain plant in Muncie, Indiana and has adjusted the carrying values of other assets, primarily related to its four-wheel drive transfer case product line. Production activity at the Muncie facility is scheduled to cease no later than the expiration of the current labor contract in April 24, 2009. As a result of the fourth quarter restructuring, the Company recorded employee related costs of $14.8 million, asset impairments of $51.6 million and pension curtailment expense of $6.8 million. The fourth quarter restructuring expenses of $73.2 million broken out by segment were as follows: Engine $5.9 million and Drivetrain $67.3 million.

Other income was $(3.1) million, $(6.8) million and $(7.5) million in 2008, 2007 and 2006, respectively. The 2008 income was comprised primarily of interest income, offset by the realization of a loss on the sale of a product line and other asset disposals. The 2007 income was comprised primarily of interest income. The 2006 income was comprised primarily of a $(4.8) million gain from a previous divestiture and $(3.2) million of interest income.

Equity in affiliates' earnings, net of tax was $38.4 million, $40.3 million and $35.9 million in 2008, 2007 and 2006, respectively. This line item is primarily driven by the results of our 50% owned Japanese joint venture, NSK-Warner, and our 32.6% owned Indian joint venture, Turbo Energy Limited ("TEL"). For more discussion of NSK-Warner, see Note 6 of the Consolidated Financial Statements.

Interest expense and finance charges were $38.8 million, $34.7 million and $40.2 million in 2008, 2007 and 2006, respectively. The increase in 2008 expense over 2007 expense was primarily due to costs related to BERU's DPTA. The decrease in 2007 expense over 2006 expense was primarily due to reduced debt levels.

The provision for income taxes resulted in an effective tax rate for 2008 of 237.9% compared with rates of 26.5% in 2007 and 12.0% in 2006. The effective tax rate of 237.9% for 2008 differs from the U.S. statutory rate primarily due to the non-deductibility of the $156.8 million impairment charge in 2008 related to BERU goodwill; a reduction in U.S. income; foreign rates, which differ from those in the U.S.; the realization of certain business tax credits including R&D and foreign tax credits and favorable permanent differences between book and tax treatment for items, including equity in affiliates' earnings. If the effects of tax accrual changes and the Company's third quarter $13.5 million valuation allowance are not taken into account, the Company's effective tax rate associated with its on-going business operations was 23.0%. This rate was lower than the 2007 tax rate for on-going operations of 27.1% primarily due to the decline in U.S. earnings.

Minority interest, net of tax of $16.3 million decreased by $11.7 million from 2007 and by $10.0 million from 2006. The decrease is primarily related to the Company's DPTA with BERU, giving BorgWarner full control of BERU.