Management's Discussion and Analysis of
Financial Condition and Results of Operations

Results of Operations

Net Revenues

The Company's physical security services unit is the nation's largest provider of contract security personnel with approximately 73,000 employees serving 14,000 customers in the United States, Canada, United Kingdom and South America. Physical security business revenue was flat versus 1995 primarily due to management's decision to prune low margin and higher risk business during the year. Revenue growth in 1995 was principally due to higher billing rates and new business growth.

The Company's electronic security services unit is a leading full service provider of integrated electronic security systems, including intrusion and fire detection, closed circuit television, and access control. The unit has approximately 126,000 customers and 2,200 employees. In 1995 this unit began recognizing certain long-term alarm service contracts as sales-type leases rather than operating leases. Excluding the impact of sales-type lease accounting, 1996 alarm revenues were up modestly from 1995. Revenue in 1995, excluding the impact of sales-type leases, increased 5 percent primarily due to higher direct sales of commercial installations and higher service revenue on residential operations.

The Company's armored security services unit is a leading provider of armored transportation, automated teller machine and cash handling services to financial institutions and commercial businesses nationwide. Revenue in 1996 increased principally due to higher volume in ATM services. 1995 revenue increased due to better pricing and higher volume in the Wells Fargo Armored Express and ATM service operations.

In January, 1997, Wells Fargo Armored entered into a business combination with Loomis Armored. The combined company, known as Loomis, Fargo & Co., is owned 51 percent by the former Loomis shareholders and 49 percent by Borg-Warner Security. The combination created a leading armored transportation and ATM services company with broad geographic coverage. This transaction has allowed Borg-Warner Security to reduce its debt by $105 million from the 1996 year-end level.

As of September 30, 1996, the Company's Pony Express Courier unit has been treated as a discontinued operation. In connection with this, a non-cash charge of $25 million, an earnings per share equivalent of $1.06, was incurred to recognize the future realizable value of this business. These two events enable Borg-Warner Security to focus its resources on the core electronic and physical security businesses.

The Company believes the security industry will experience significant changes in the future. Increased outsourcing of security management needs, customer demand for single point responsibility, improved quality and reliability of services, and financial stability of security providers are factors driving the trend toward "total security solutions."

Through its ability to offer both physical and electronic security services, and its 49 percent ownership in Loomis, Fargo & Co., the Company is uniquely positioned to effectively and profitably provide customers with the total security solution they require.

Total Costs and Expenses

Depreciation expenses were $47.0 million in 1996, down from $52.1 million in 1995 and $52.8 million in 1994. Reduced electronic security equipment under operating leases was the principal factor.

Selling, general and administrative (SG&A) expenses were $210.6 million, $212.5 million and $220.2 million in 1996, 1995 and 1994, respectively. As a percent of net sales, SG&A costs were 12.3 percent, 12.4 percent and 13.5 percent in 1996, 1995 and 1994, respectively. The decrease since 1994 is due primarily to continued cost reduction efforts, partially offset by increased investments in training and recruitment of employees and in information systems. Additionally, SG&A in 1994 included $14.0 million in non-recurring, non-cash accruals for self-insurance reserves and other corporate allowances.

Operating profit increased to $93.1 million in 1996 from $85.9 million in 1995 and $76.1 million in 1994. Operating profit margin increased to 5.4 percent in 1996 from 5.0 percent in 1995 and 4.0 percent in 1994. Physical security services operating profit increased to $62.1 million in 1996 from $56.4 million in 1995 and $54.5 million in 1994. Electronic security services operating profit increased to $18.9 million in 1996 from $15.8 million in 1995 and $14.9 million in 1994. Armored security services operating profit was $12.1 million in 1996 compared with $13.7 million in 1995 and $6.7 million in 1994.

Other income in 1994 included a gain of $9.9 million related to the sale of trademarks and other rights to Borg-Warner Automotive.

Interest expense, including the amortization of financing costs, increased to $56.6 million in 1996 from $55.9 million in 1995 as a result of higher costs associated with the issuance and renegotiation of certain bank lines of credit and borrowing facilities. This was partially offset by the benefits of lower short-term market rates of interest and lower average debt levels outstanding. The increase in 1995 from $48.8 million in 1994 was due to higher market interest rates combined with increased rates under the 1995 credit agreement amendments and refinancing.

Income taxes were $9.5 million and $6.9 million in 1996 and 1995, respectively. The Company's effective tax rate in 1996 was 40.6 percent, down from 45.1 percent in 1995. The effective tax rate generally exceeds the statutory rate because of non-deductible excess purchase price amortization. The Company recorded a net income tax benefit in 1994 primarily because of adjustments to deferred income taxes of $7.0 million related to changes in the tax basis of certain liabilities as a result of sales and settlements.

Earnings from continuing operations for 1996 were $13.9 million, up 65.5 percent from $8.4 million in 1995. Earnings from continuing operations were $13.8 million in 1994. Including the impact of the discontinued Pony Express Courier business, the Company incurred a net loss of $14.6 million in 1996, compared with net earnings of $1.2 million in 1995, and $13.1 million in 1994. Net earnings in 1995 included a charge of $4.7 million, net of tax, from the early extinguishment of debt in connection with the amendment of the Company's credit facilities.

International Operations

Financial Position, Capital Resources and Liquidity

Cash Flow

Capital expenditures of $40.7 million in 1996 were down from 1995 and 1994 levels of $47.8 million and $59.4 million, respectively. This reduction reflects a more selective investment process, primarily within the electronic security services segment.

The Company also implemented a program in 1995 to securitize certain lease contracts within the electronic security services segment. This program reduced the internal capital requirements necessary to maintain and grow this line of business.

Leverage/Capitalization

In 1996, the Company repaid $100 million of 8% senior notes with $100 million in proceeds from a bank term loan due December 31, 1998.

The Company uses selective financial derivative instruments to limit exposure to fluctuations in short term interest rates.

At year-end 1996, the Company maintained bank lines of credit and borrowing facilities totalling $332.2 million of which $283.6 million was utilized and outstanding. Of the total, $41.6 million is available through June 1999 and $248 million matures at various dates through 1998, with the remainder maturing at various dates in 1997. The bank credit lines and facilities provide for funds at market rates of interest throughout the availability periods. The Company's term loan facility requires partial prepayment if, at the end of each quarter beginning with the quarter ended March 31, 1997, the Company has not achieved required covenants for the four consecutive quarters ending on such date. The Company has commitments, subject to certain customary conditions, from banks to provide debt financing that would replace the existing term loan facility.

The Company also maintained a $155 million letter of credit facility that is available through 1998. The Company utilizes letters of credit to secure certain of its obligations under various casualty insurance programs. At year-end 1996, letters of credit totalling $136.3 million were issued and outstanding.

As discussed more fully in Note 6 of the Notes to Consolidated Financial Statements, various complaints seeking substantial dollar amounts have been filed against the Company. The Company believes that it has established adequate provisions for litigation liabilities in its financial statements in accordance with generally accepted accounting principles. The Company believes that none of these matters individually or in the aggregate will have a material adverse effect on its financial position or future operating results, although no assurance can be given with respect to the ultimate outcome of any such proceeding.