博格華納 (BWA) 2005 Q3 法說會逐字稿

I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner, 2005 third quarter earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the call over to Mary Brevard, Vice President Investor Relations and Communications. Ms. Brevard, you may begin your conference.

Thank all of you for joining us today. The release went out before the market opened today. You should have all received copies of it. We have also posted financial talking points that should help you follow the financial discussions. They are located at borgwarner.com on the Investor Relations page Webcast, 2005 third quarter results.

These notes will be helpful to you as we review the financials and the operations. Our next conference appearances. Gabelli next week, November 2, we will be announcing our pipeline and new business. Robert W. Baird in Chicago on November 8. And the Bank of America 1 on 1 Venue on December 7 in New York City. And of course, the Auto Analysts Meeting in Detroit in conjunction with the January Auto Show.

Before we begin, I need to inform you that during this call, we may make forward-looking statements, which involve risks and uncertainties as detailed in our 10 K. Our actual results may differ significantly from the matters discussed today. Moving on to our results Tim Manganello, Chairman and CEO will be providing comments on the quarter and industry trends. Robin Adams, CFO, will discuss operating results and the rest of the year. Tim?

Thank you, Mary and good day, everyone. BorgWarner had another solid quarter despite a challenging environment. Third quarter sales for BorgWarner plus Beru grew 25% to $1.1 billion. Now, without Beru, base BorgWarner sales were up 11%. excluding Beru and the impact of currency. Sales outside of the U.S., without Beru, grew 25% over last year's third quarter.

Earnings were $1.07 per share on a reported basis, and $0.99 per share on operating basis, up 25% excluding a reduction in the tax rate. Strong demand for our fuel efficient technology around the world along with continued cost improvements in a diverse customer base helped boost our results. These results compare to a 2% growth in North American production, declines in European production, and a 6% increase in Japan and Korea. And overall, worldwide production was up 5%.

Our engine business reported strong sales growth of 38%, versus the third quarter 2004. Driven by the demand for our fuel efficient technology and the Beru contribution. During the quarter, we entered into a collaborative relationship with Modine Manufacturing to develop thermal management solutions for truck and off-highway applications worldwide. We are also providing the turbo charger for the new Audi 1.4 litre twin charger engine that marries the BorgWarner turbo with a super charger to improve response time in small engine displacements. The result is an exceptionally agile engine that combines driveability, fuel economy, and reduced emissions.

Now, the drivetrain group reported sales up 2% versus a third quarter 2004. Despite lower production of light trucks and sport utility vehicles by some of our larger North American customers. It was a very exciting quarter for us in terms of our DualTronic transmission technology. We announced three new European programs, including two new European customers for this industry-first technology. Total BorgWarner DualTronic programs announced today represent an expected 1.5 million transmissions per year at their full run - - full production run rates. Or approximately about a 10% market share in Europe. On the all wheel drive front, we announced that we will supply the all-wheel drive transfer case to the new Ssangyong Kyron sport utility vehicle and the all-wheel drive trance case to the new Audi Q7. A luxury performance SUV, on which the BorgWarner transfer case will be standard.

Now, looking at the remainder of the year, we continue to face difficult market conditions. These conditions include the decline of the traditional SUV and light truck market, and rising commodity prices. In addition, we face the cost challenges of rapid growth in our turbocharger business and the upfront costs of international sales expansion for all of our other products. Despite this industry environment, we intend to hold our 2005 full year's earnings expectation within the lower end of our previous guidance. And Robin will go over the details later. During the next few years, we expect our growth to continue to outpace the industry. And next week, we will release our news business backlog for the 2006 through 2008 period.

Now, the the trends that drive our growth continue. During the third quarter, you saw world oil prices rise to over $60 a barrel. This hurts us in the short term, but should drive our long-term growth. Average gasoline prices in the U.S. are up about 30% over last year at this time. And fuel prices in Europe are up about 15%. And Japan up about 25%.

Now, in addition to the direct and indirect impact of fuel prices on the auto industry, there have been developments during the last quarter on the regulator front. In the U.S., an Energy Bill was passioned that offers incentives for drivers up to $3,400 for those who buy hybrids, or diesel - - or clean diesels. There are also incentives to retrofit buses and other commercial vehicles with clean diesels. These incentives should be a long term benefit for BorgWarner. Also in the U.S., a new CAFE proposal would raise overall CAFE standards for light trucks by about 2% a year. Each auto maker would have a truck fleet standard based on their own product mix.

Now in Europe, new NOx limits were set to allow most diesel cars to meet requirements without expensive after treatment. Because of market pressures, a particulate limit was set that in effect allows for the use of diesel particulate traps that are already available. Now, China, India and South Korea will follow the European emission standards.

In terms of fuel economy standards, China already also has implemented a rather moderate but well structured program. A proposal for developing diesel passenger cars was released at the China Energy Savings Conference in September in Beijing. The proposal strengthens the importance of developing diesel passenger cars in China due to the increasing demand for oil and concerns for their environment.

As fuel prices continue to rise, BorgWarner is in a unique position to offer fuel economy solutions to the global industry. As a powertrain leader, week benefit from technology changes whether they are in hybrids, clean diesels or direct injected gas engines. Several new hybrid programs were announced this quarter. Now, just how many of those programs are public relations versus engineering logic is debatable. But clearly, hybrids will be part of the future mix for the vehicle market.

Diesels will have a clear place in most of the world markets also. In terms of the U.S., my personal opinion is that once drivers experience diesels, diesel vehicles will be a higher market share than hybrids in the U.S. BorgWarner has a major stake in the success of diesels. And we are very well positioned to maximize the abundant global opportunities that we see in this area. In spite of today's challenging macroenvironment, BorgWarner is clearly demonstrating the viability of the BorgWarner difference. That is; our technology driven growth strategy, our focus on managing costs, and the benefits of global customer diversity. With that, I'll turn the meeting over to Robin.

Thank you Tim. Good morning everyone. As Tim said, this past quarter was another solid one in the continuing string of solid quarterly performances for BorgWarner. Our sales and earnings growth was achieved while the industry continued to experience modest growth around the world. In the third quarter, worldwide production was up about 5%. However, Europe was down and North America was up only slightly. And despite that environment our base business sales grew 11% and our base business earnings per share grew 22%.

Our earnings about share growth of our base business plus the contribution of Beru was up 25% in the quarter versus last year. So, we continue to execute our growth strategy despite what, as Tim described, is a continuing difficult industry environment. Looking at the quarter, our net income was $1.07 a share, which included favorable tax adjustments of approximately $0.08 a share. Looking at the favorable tax adjustments, about $0.03 a share is related to reducing our estimated effective tax rate for the full year, up to 28%. And basically reflects the first six months adjustment for that effective tax rate, which we had originally projected at 29%. The remaining $0.05 a share, of the $0.08 tax related, is an adjustment to other tax accounts. Excluding the favorable tax adjustment, earnings were $0.99 a share in the quarter, which we believe is a more comparable number to use with prior periods than the $1.07 a share we reported on a U.S. GAAP basis.

For the first nine months of 2005, net income on an U.S. GAAP basis was $3.05 a share. Now, going back to some of the transactions earlier in the year, if we exclude the $0.05 adjustment to the tax accounts reported in third quarter I just talked about; the $0.50 a share Crystal Springs charge in the second quarter; and the first quarter $0.38 a share positive impact to earnings associated with divestitures, release of tax accruals, and net of the immediate write off of excess purchase price associated with Beru's in process R&D. Again, adjusting all those non-routine items out, our earnings for the first nine months were $3.12 a share, versus 2.67 a share last year, or a 17% increase. Again, these non-U.S. GAAP earnings metrics that we use, which exclude these unique items I just went through are provided for comparisons of our base business. Plus the contribution of Beru with other periods and other reported earnings. Which we feel is a more fair comparison.

Our consolidated sales were up 25% in the quarter, including Beru, looking at our base business growth, we were up 11%. Excluding currency and Beru, sales were up about 10%, again, versus global production of 5%, production down in Europe, and slight growth in the North American market. Our sales in the U.S. were up 1% in the quarter, roughly in line with North American production. And as we have throughout the year, we continued to experience strong levels of growth outside of the U.S. in Europe and in Asia. With growth rates of over 20% in the quarter on a comparable currency basis. For the first nine months of 2005, sales were up 23%. Excluding Beru sales were up 9%. Or put it another way, our internal growth rate in what continues to be a difficult environment was 9% for the first nine months of this year.

Gross margin for the quarter was 19.8%, but included the impact of Beru. Excluding Beru to get a comparison to last year, our gross margin would have been 17.8% in the quarter, compared with 17.3% in the third quarter of last year. The impact of higher commodity prices, and Tim talked about that a little bit, as well as the incremental margin related to lower North American SUV and light truck sales continue to pressure our gross margins on our base business. But our continued focus on managing costs resulted in improvements in gross margin in the quarter over third quarter last year.

SG&A as a percent of sales increased to 11.4% in the quarter, from 9.2% last year, primary as a result of Beru. Excluding Beru, our SG&A was about 9.5% of sales, up slightly from last year's 9.2. Affiliate earnings for the quarter were essentially flat with last year. Interest expense in the quarter was higher. Primary due to increased debt levels related to the acquisition of the majority stake in Beru. And to a lesser extent, higher short term interest rates, which we are starting to see in the market.

Our effective tax rate in the quarter, as I mentioned, on a GAAP basis was about 22.6% compared with 30% in the third quarter last year. The effective tax rate change in the quarter, again, is due to an adjustment of our provision is for income taxes for the first half of 2005 to reflect our current estimated full year tax rate of 28% for the year. And additional adjustments to tax accounts in the quarter.

Looking at our segments drivetrain consolidated sales were up 2% in the quarter. However, all of that growth came outside the U.S. The group continued to benefit from sales growth outside of North America. Including increased sale of dual-clutch transmission products in Europe. But segment EBIT was down 8% and negatively impacted by the activity in North American market. That continued lower production of light trucks and sport utility vehicles equipped with our torque transfer products. This resulted in a margin decline in the quarter for our drivetrain business to 6.9% from 7.6% last year.

On the engine side of the business, our sales increased 38% in the quarter, including Beru. 15% excluding Beru. And we had good solid growth in each one of our product areas on the engine side of the business. The group continues to benefit from European Asian automaker demand for turbochargers, timing systems, thermal and emission products. And from stronger commercial vehicle production in both Europe and North America. The group's consolidated EBIT grew 46% in the quarter. The engine group's EBIT margin was 12.9% with Beru. And excluding Beru was 13.3%, comparable to last year's 12.2%, which reflects a margin improvement for the engine group.

On a Companywide basis, including Beru, our operating income margin improved to 8 .6% from 8.1% last year. Again, excluding Beru, and providing some good year-over-year comparison, our operating income margin improved by 30 basis points per year, in the quarter to 8.4%. Again, compared to last year's 8.1%. And for the entire Company, sales outside of the Americas represented 52% of our sales in the quarter versus 42% in the third quarter last year.

Let's talk a little bit about the balance sheet and our cash flow in the quarter. Our investment grade capital structure continues to be strong. Our debt to capital ratio was 33% at the end of the third quarter, versus 28% at year end. And we all know we've made a major acquisition since that time. Netting out cash and cash equivalents, net debt to capital at the end of the quarter was 29%. Balance sheet debt increased 216 million since year end. And our cash balance has decreased by 90 million. And again, that's a $300 million swing. But all to do to the funding the Beru acquisition in the first quarter, which was in excess of $500 million.

Net cash provided by operating activities for the first nine month of this year was $253 million, versus 321 million for the same period last year. The $70 million reduction from the nine months in 2004 is primarily due to the 2004 funding of employee retirement benefits; With $26 million of common stock, refunded that with cash in 2005. Approximately $80 million of increased foreign tax payments in 2005 versus 2004, including approximately $30 million tax payments by Beru. And also payments related to the Crystal Springs settlement in the second quarter of this year. All of that being offset by approximately $50 million of improvements from operations related cash flow year over year.

Regarding working capital levels, our net operating position, which we define at receivables and inventories less payable and accruals, increased by $154 million since the end of 2004. Again, primarily reflecting the consolidation or addition of Beru's working capital into our financial statements this year. Excluding Beru, our net operating position increased by approximately $31 million. And that increase was a result of significant increased business activity in the third quarter of 2005 relative to activity the year end 2004. And we all know there's a two week shut down at the end of 2000 - - at the end of the year, and lower activity levels. It's just a natural increase in working capital.

Capital expenditures and tooling outlays were up slightly for the first nine month of this year to about 180 million from 167 million during the same period last year. This level of investment continues to support our book of new business as well as our cost reduction and productivity improvement programs. Our trailing 12 month after tax return on invested capital at 12.7% was relatively flat with year end 2004. Our overall strong financial performance in the quarter continues to support our contention that BorgWarner is completely different from most other auto suppliers around the world.

Now, let's talk about the outlook for the year. As Tim said, despise an increasingly difficult market environment, we refined our 2005 full year earnings guidance expectations by tightening our estimates within the range of previous guidance. We tightened the range to $4.20 to $4.25 per diluted share on an U.S. GAAP basis from previous guidance of $4.15 to $4.31. We took a $0.16 spread, and tightened it down to $0.05 as we get close to year end. That range - - the U.S. GAAP range again includes the $0.05 per share diluted impact related to favorable tax adjustments that we reported in the third quarter. That reflects the $0.50 per diluted share charge related to the cost of settling Crystal Springs related alleged environmental contamination, personal injury and personal property damage claims, which we reported in the second quarter. And $0.38 per diluted share associated with the activity reported in the first quarter, divestiture, favorable tax adjustment, net of the immediate write-off of the excess purchase price associated with Beru's in process R&D.

Excluding all these non-GAAP - - U.S. GAAP items, which approximates about $0.07 a share in total, we are tightening our 2005 full year earnings guidance on our base business plus Beru to be in a range of $4.27 to $4.32 per diluted share. This guidance would result on these non-GAAP numbers, comparable EPS growth rate of 15% to 20% for the fourth quarter of this year. Continued strong growth for BorgWarner, consistent with what we've seen for the first nine months. And 16% to 18% growth for the full year.

As expected, the industry environment continued to be challenging in the third quarter. And in spite of this BorgWarner was able to continue to execute its growth strategy. We expect as Tim mentioned the fourth quarter environment to be just as tough if not tougher. And despite the difficult industry environment, we remain focused on trying to successfully execute our long term plan. And with that, I'll turn the call back over to Mary. Mary?

Thank you, Robin. I will ask the call coordinator, if you would please announce the Q&A procedures.

[OPERATOR INSTRUCTIONS] Your first question comes from Jon Rogers, with Citigroup.

Yes, good morning, guys.

Good morning, Jon.

Just a couple of questions. Tim, sort of a big picture question. You mentioned that you believe diesels are going to be more of the market than hybrids. Have you - - are you actually seeing increased quoting activity for North American based diesels, or do you think that's still a couple of years out?

There's many active programs in development stages right now, among, not just the Europeans, but also the Asians, and north Americans. The North Americans may not be doing their diesel development work over in the United States because they are focused on hybrid development. But their European arms or their Asian affiliates are doing the diesel work - - diesel engine development work for them, including in preparation for possible entry into the North American market. There was an article in the Automotive News just this week, I think, about Honda's diesel - - work on diesel. So there's a lot of activity going on, we can't get into any specifics. But I drive diesels, I go to Europe and I drive diesels. And I've driven some hybrids that are name brand hybrids. And, yes, the hybrids deliver good fuel economy, but diesels deliver equal to or better and they don't have some of the hangover effects - - long term hangover effects like battery replacements and so forth.

And Robin, is this - - the 28% tax rate, is that sustainable going forward as we look into '06 and '07?

Jon, a lot of our tax rate is driven by activities outside of the U.S. markets. At this point in time, 28% is a fair estimate, but we actually look at at it in a range of 28% to 29% right now.

Okay. And then, I guess just lastly, I think that post the Beru acquisition, Robin, net debt to capital is coming down in the 29% range, which I think is fairly close, if not on the low end of what you view as optimal. Can you just rank uses of cash, dividends, acquisitions or share buybacks going forward over the next couple of years?

Certainly. We, as we've said before, our first focus has been to get the capital structure back in line. And as you point out, we are getting close to having that accomplished. Our second priority is maintaining the dividend level we have as a Corporation. And again, we review that on an annual basis, and we'll review that again before year end. We've had - - that's our second priority. We still believe there may be opportunities in the marketplace for us. Selective acquisitions that can further enhance our product technology or strengthen our geographic presence. And so that's a priority for us, obviously, always focused on creating value. And then finally, we have a, have been active previously in the market repurchasing stock. We have an existing authorization available. And that's also part of the activity that we look at when trying to consider what to do with our excess cash flow.

Thank you very much.

One thing I would like to add, one thing you have with diesel, they save fuel all the time. Whereas hybrids save more fuel or less fuel, depending on the driving cycle. And another thing that you'll notice as you - - I know you've driven diesels, they are fun to drive. So, those are part of the reasons why I think that they have a very good chance of success in North America.

Your next question comes from Darren Kimball with Lehman Brothers.

Can you talk a little bit about what's going on in the turbocharger market? There have been some reports that diesels are maturing a bit, and there's been a shift towards smaller engine displacements. You guys sounded like you had a good quarter in the third quarter?

Yes, we did have a good quarter in the third quarter in general. And we're - - our diesel business continues to grow, our diesel business will continue to, will grow worldwide. But I will say that the diesels are starting to see some impact with the scheduled cuts in Europe and so forth. But - - so where our projections for growth in the fourth quarter in diesels may have been higher four months ago, they are a little lower now because there is a little bit of softness. But there is still year in year comparisons, they're still increasing year on year compared to the fourth quarter of last year. We are seeing growth in small - - in diesel - - let's just say turbochargers for small diesels or diesels with small engine displacements. You are also seeing growth on turbochargers for gasoline engines. So, if diesels switch back to gas, we are in a market leading position on turbochargers for gas engines.

Darren, I think the latest JD Power estimates on diesel penetration in Europe show maybe a couple of percentage points growth this year to 50% of the market up about 57%, by 2009. So there's clearly growth there but at a slower pace.

How would you characterize the 2006 growth opportunity for turbos?

I believe that the penetration is expected to increase another couple percentage points, maybe to 52%.

And it will continue to grow within BorgWarner.

But, so - - but this is a single digit growth opportunity now? No longer double digit? Is that fair?

Darren, you have to remember that as we've talked about a long term growth in the turbocharger business, a lot of that growth is outside of the European market in the long term.

So, where we see the biggest growth opportunities for the future, you are talking about tremendous growth in turbochargers or diesels for the Korean market, the Chinese market, and some of the Indian market. and that doesn't even include potential growth or de-growth for diesel engines for the truck market in North America

Remember what Tim said. It's on the turbocharger side of our business, it's also gasoline engines that pick up an applications with turbochargers. These direct injected gasoline engines that require turbochargers is also providing good part of our growth there.

And just to add to - - to hitchhike on Jon's original question, there's a significant number of gas engine projects with turbochargers in development also right now for North America. And I think you will see turbocharger gas engines penetrating North America first, while momentum continues to grow for turbocharged diesel engines in North America .

I don't want to put words in your mouth, but it sound likes it's a business that could slow to a single digit growth rate in the short term. But then has the potential of being a double digit growth business again. Is that fair?

Depends on the market. I'd say worldwide, it still has for us, it probably still has - - I'd have to look at the numbers, but probably high single or low double digit growth for us worldwide.

Okay, listen, I just wanted to ask one other question, which relates to sort of the mix shift we're seeing in the marketplace, can you give us some sense of the ratio of your sales right now from in terms of transfer cases, product for traditional SUV's and pickups; versus sort of new ITM type products for the crossovers? And sort of when in the future you might see those two, those revenue bases crossing over to where you are more evenly matched?

Well, let's just say right now it's probably 2/3 transfer cases, 1/3 ITM type devices and that's probably in terms of sales dollars. You need to understand that typically, the price - - the market price for an ITM device is lower, maybe even by half, than it is for a transfer case. Now, on an ITM type devices it depends on whether it's an ITM-1 device where it's - - it has one clutch and just goes front to rear. Or if it's an ITM-2 type device, where it has two clutches in it and goes front to rear, and also goes left to right on the rear differential in the rear axle. So - - but in general, ITM devices have a lower price - - average price point than a transfer case. So that's - - it takes more units to make up the difference of a transfer case.

As far as the shift, one thing I think we all need to remember, Darren, while in the short term we are seeing some impact from our traditional transfer case products in the marketplace. As we've said before, we're adding new programs and gaining share. That still is a solid part of our sales business. We are not expecting over the long term a significant decline in that portion of our product area. So what we will do is, as the ITM sales grow, they will be growing on o top of that existing base of transfer case sales.

And what you're seeing is we're growing some transfer case business with the Europeans. And we're growing some transfer case business with the Asians.

That's great, guys, thanks a lot.

Your next question come from Rod Lache with Deutsche Bank Securities.

Hi. It's Mike Heifler for Rod. Just a few questions,. Robin, did you quantify what the raw material hit was in the quarter?

No, I didn't. We've talked about this before. I don't know. We'll tell you the number, but we are getting to the point where it's absorbed in our cost structure. It's about $10 million in the quarter.

It sounds like it's going to be an increasing headwind for you guys going forward from the comments.

Well, I think one of the things that you got from Tim's comment is the raw material environment is still difficult. It is still difficult and so in the short term, we are not seeing any relief.

What we are seeing is energy costs are hitting us, high resin costs are hitting us, steel isn't as big an impact as it was in 2004, but it still, we are seeing steel prices that aren't going down as expected. Maybe even kind of dithering upward a little. So, raw materials is continuing to impact us including things like titanium and [maui] and copper. But the mix is changing from last year it was mostly steel to this year it's steel plus a bunch of others.

Despite higher raw materials, the shift in mix away from the traditional trucks and SUV's, you guys have been able to improve operating margins. Do you see that ability remaining, when we look into 2006, will you be able to offset the headwinds?

Mike, we've said consistently for some time now, our objective in the type of environment we're in and expect to continue to be in, is to try and maintain margins. And that is despite mix changes, that's despite increased raw materials prices, which sometimes we make it look a little bit too easy. But our challenge for the foreseeable future in the environment we are in is to continue to maintain our margins. So, we don't anticipate, we would love to see it, but our future expectations are not built around significant improvements in our operating margins. In this environment, it would be just difficult to be able to get comfortable that there's some certain think that's going to be able to occur.

Is it the mix of business that you see coming on line in the next 12 months or is it additional cost reduction efforts that are going to allow you to maintain the margins or improve them?

It's a little bit of both. What the dynamics we have in this Company, because we are growing so much faster in the industry, we are consistently in a start-up mode. So, we are consistently incurring costs with respect to start up and it's a challenge of these costs. It is the incremental margin on the incremental sales, as well as the significant focus on cost reduction. This Company has an intense focus on cost reduction. Trying to offset, as you point out, when we have a decline in a product area like products sold in North America, light truck and transfer cases, the incremental margin loss on that business is significantly higher than what we are going for new programs we're bringing onstream. Just because of the fixed cost nature of this business. So, it's just not one factor, it's four or five different things that as a Company we spend a lot of time trying to focus on and manage. So the end result is nice strong financial performance going forward for the Company. Mike, I'll give you an example of like a cost that we try to manage. As we expand globally, we all knew but we are finding and reinforcing the fact that global expansion costs are pretty high. Because you start from scratch globally. So what we are trying to do as a way to manage that, is we are going to BorgWarner campuses where we are putting multiple products in the same building to start off with. And as the business businesses grow, they will grow into maybe - - if they can justify it, their own building always in the same campus. We'll use - - utilize the concept of shared services so we can use a common infrastructure to support multiple locations in China or Korea or something like that. But I can tell you, global expansion doesn't come cheap.

Just one last question on the DualTronic business. The volumes today, what are they for '05, and what's the outlook for '06?

Hold on, I've got that. Right now, we have running, here it is. We've got that, we're running about 1,150 a day. By the beginning of next year, we will be running just a little less than 1,300 units a day. And then by 2007, roughly, we will be at about 1,400 units per day. Now, all these - - it's plus or minus on all of these, but those are roughly the target numbers we are trying to utilize. So we are going from 1,150 to roughly a little less than 1,300 for '06 to 1,400 a day for '07.

Thanks.

And then, there will be other, as other programs kick in, there will be ramp-ups from there.

Thank you.

Your next question comes from Brett Hoselton with KeyBanc Capital Markets.

Good morning.

Hey, Brett.

Let's see here, couple of different brief questions. First of all, when are you going to present your sales backlog? Is it going to be in Vegas again?

Next week at the Gabelli conference.

And I'm not going to ask you what you are going to do there. So, obviously. Acquisitions.

We'll be there.

And acquisitions would you say as you look forward that you think you have your plate reasonably full in terms of major technologies, major growth drivers. And therefor, your acquisitions will be more in the area of smaller bolt-on acquisitions that would add to your current technology base? Or would you say that there's a possibility that you might go out and brio buy let's a new turbocharger type technology here you have nothing and you built it?

I would say right now the probable path would be smaller bolt-on acquisitions. That would improve our technology, create - - fill the gap in either customer or geographic location. Or something that is supplementary or complimentary to our existing technology. And/or give us - - in areas where we have a pretty good leadership position, we may go a little bit more vertical in part of, due to an acquisition in order to reinforce that technology. Yes, if there is an opportunity that came along that was a game-breaking opportunity on a new product, we would look at it. We have the financial wherewithal to look at at most things. But it would have to be pretty compelling. That would be a lower probability.

And then Robin, just as you look at your guidance for the year, you are obviously not changing it but you're using the lower end of the range. What was the primary one or two factors that are moving you towards the lower end of the range as opposed to the higher end? Is it primarily Beru or what else, what is it?

From our perspective Beru continues to perform as we expect it, since we first provided guidance. Tim talked about the challenges in the environment and the slowing, on the sales side in some of our product. It's just we had a wide range there that represented an outlook 12 months ago that has a lot of risks in it and a lot of opportunities. As we get closer to year end, the opportunities become a little bit tighter. And we've been through nine months of the year. We've benefited from whatever risks and opportunities were in that original range. And all we have left is a quarter now. And so now we are down to the last quarter. And it was a challenging year. So, the potential range had some opportunities that we used up in the first nine months, getting to where we are at. So I think that there's not one item to the point to whatsoever. It's just a passage of time, and where we are for the fourth quarter. And it's - - if you look at what that guidance relates to, debt will translate to very strong growth here in the fourth quarter for us. And so it's 15% to 20% growth in the fourth quarter will be, again, one of our stronger quarters for the year. So the guidance really reflected a full year of opportunities. We're through nine months. We've had good strong performance. Some of those opportunities are behind us. And so we are still looking for a very strong fourth quarter with that guidance but it had to be tightened up.

Very good, thank you very much, gentlemen.

Your next question comes from Robert Barry with Goldman Sachs.

Good morning. I was curious if in the past couple of months you've noticed any change in the conversation, the tone of the conversations with the OEM's in terms of a pricing or getting recoveries on raw materials?

Well, let's talk about - - you have to look at that in terms of regions. I'd say that - - and I've said this throughout most of the year so for us, it hasn't really changed much. In Europe on the OEM side, they tend to have a pretty rationale approach and they work with their suppliers on recovery. More so than we see on the North American side. There's not a lot of forgiveness, nor is there a lot of, how should I say it, sympathy for pricing increases from our suppliers to us. Nor is there any, a lot of tolerance for pricing recovery from us to our North American customers. That being said, we do get some recovery on the commercial side globally. Most of the global commercial customers tend to understand what's going on and are more cooperative in terms of pricing recovery. So, it's like, as usual, there's always negotiations and there's always different points of view. And there's the people that have and the people that have nots. And there's not as much understanding.

Okay. So no real delta then in North America, even again some stresses we've seen recently? Maybe it's your more distressed peers who are noticing a change in tone?

At the OEM level, there's a tremendous amount of stress. So you don't - - there's not a lot of tolerance for - -. We'll go in and talk about it and we'll negotiate it, but I can't guarantee you what the expectations are in terms of being very positive.

Okay. And a question on the tax rate. Clearly, it does depend on the mix of the earnings. If we expected over time the growth is going to come more from outside of North America, should we expect the tax rate to inch up?

Yes, that is a fair assessment. Over time, we would expect more of our earnings outside the U.S. market, as has been the trend. Some of those regions have higher tax rates in the U.S. Some are lower. But on average, I think they are slightly higher than the effective tax rate here in the U.S. So, you will see that inch up but it's not going to - - we don't expect it to grow 2 and 3 percentage points a year. As I said, right now, we are looking at from a long term perspective for the next couple of years 28% to 29% range as being a reasonable assessment, at least in the near term.

Okay. And then last question, you mentioned that the return on capital was flattish, is that the earnings growth being offset by some of the higher capital spending that you talked about?

Primarily, the challenge there was the acquisition of Beru. As with any acquisitions, the purchase price relative to the value is a relative over a longer period of time versus a first year value. So, being able to generate the return on capital for an acquisition on that, in addition to our exists business, of 12.7%, it's pretty good performance. Typically you have an acquisition and you get some dilution in your return on capital in the first year or two.

So, do you think adjusting for Beru, the return on capital would have been up?

Yes.

Okay. Great, thank you.

Your next question come from Chris Ceraso with Credit Suisse First Boston.

Good morning. A few items. One, affected the question about the mix between transfer case ITM business. If it's 2/3 - 1/3 on the sales line, is it a similar ratio in terms of operating profit between those two kind of products?

We don't get into that kind of discussion.

I tried to grab him before he said anything.

I know.

He gave the right answer.

We don't get into those discussions.

You can't fault a guy for trying though, right? I guess next question, the - - maybe if you can frame for us the size and timing of the diesel opportunity in places like China and India and South Korea?

The size and the timing of the diesel opportunity in Korea and China, is that what the full question was?

Yes.

Well, the diesel opportunity is right in our face really. We, in terms of Korea, we are putting in operations. We're launching product, I can't remember what our units per day are. But I think we've assembled and shipped about 8,000 units up to now in Korea. And we are going rapidly. We are supplying turbochargers to the major Korean OEM's and that's a tremendous growth opportunity. We have a joint venture over there, and I can't remember the percentage, I think it's 70% or 80% ownership of the joint venture. And so the Korean diesel turbocharger opportunity is right now and growing. In China, we are localizing turbo production in China. As we speak, we've got a plant that's in process of being built. We are moving over there with turbocharger production and then things will start that ramp up in the next few years. So I don't know if that fully answered your question but the timing is now.

Okay. And the in China, is it a - -?

Ramping up.

Is it a passenger car opportunity or is it more on the truck side for the diesel?

It will probably - - it will be a mix. It was mainly commercial now, but it will eventually be a mix. Because the Chinese are basically changing the laws just like the Koreans have changed the laws that basically favor European emissions standards. And the European emissions standards, obviously as you know, are very high in terms of diesel penetration. Like we talked about on one of the earlier questions, it's over the 50% mark now. And I think you'll see similar types of penetration rates over time in Korea and in China. And like I said, they are following the European standards, which will be a benefit for people that are in the diesel business.

Chris, that new facility and expansion that's going up right now in China, is not only there to support commercial programs, but as Tim mentioned, there's also a passenger car program that will be part of that initial capacity.

Okay. Last question, on the dual-clutch technology. In Frankfort, we heard from at least one other supplier, maybe two, that they are also working on dual-clutch transmissions. So I guess two points to the question; One, are you seeing more competitors when you go in and bid for this business? And then two, maybe as a positive, do you think we'll get to the point where OEM's globally start to tip toward dual-clutch transmission in favor of automatic on a much larger scale?

Well, let me get some clarity on your question. You alluded to one specific company in Frankfort. Which company are you alluding to?

That's a good question. I'd have to go back and look at my notes. It was at least one, I thought maybe two, that said they had - - it was a dry clutch, dual-clutch program not a wet clutch program.

There is a company. And I didn't mean to you the on the spot. But there are some companies - - I just wanted to know if you wanted to target any particular company. But there is a company that's focused on dry clutch. It tends to be for the low, small displacement engines. Ours is for vehicles with larger displacement engines. Theirs is probably 1.5 liters and below. We're 1.5 liters and above. We have competing technology that's probably equally cost effective to go after the dry clutch market. Time will tell how well the dry clutch can compete against the wet clutch in a lower end. But in the midsized to large sizes end of the market, dual wet clutch seems to be the way to go. We are of the supplier to like we said, Volkswagen, Audi direct for their transmissions. Because they manufacturer their own transmissions. There are transmission manufacturers in Europe that will manufacture transmissions that are dual-clutch transmissions. But we will be - - in the area of dual-clutch componentry, we will be a tier 2 supplier to them for their dual-clutch transmissions. So, you'll see some confusion in there as the BorgWarner being the - - promoting our dual-clutch as the supplier of dual-clutch technology. But we supply - - we manufacture clutch housings, and clutch modules and control modules. But somebody has to put that into a complete transmission. And at this point in time, we are not in the complete transmission business.

Chris, I think you will see that dual-clutch transmissions are a viable alternative to automatic transmissions. And as more manual transmission market moves into automatics, we expect them to be the DualTronic type of transmission.

But the only caveat I'd add to that, and everything Mary said is right, except that the dual-clutch technology starts at a manual transmission. So you have to be in a part of the world that has a manual transmission capacity and infrastructure. So Europe is a good hot bed for dual-clutch. Obviously, in the long run, China, Korea, and India, which have a lot of manual transmission capacity, are good opportunities for dual-clutch. In North America, dual-clutch transmissions will have to basically replace existing automatic transmission capacity. Which over time probably will happen. But nobody in North America has got the money to go in and completely tool up a whole new transmission plant. Unless you are a transplant and coming in with a new transmission plant and you've got to start with a greenfield. And those are the opportunities for us in North America.

Great, thank you very much.

Your next question come from Scott Merlis with Thomas Weisel Partners.

Big picture question. When you look at squeezing fuel efficiency out of your traditional gasoline engine, given your smart bed on diesels and turbos. If you exclude turbos from the discussion for a second; does it make sense to put more resources into squeezing fuel efficiency out of the traditional gasoline engines? It seems like you could get some growth on VVT and 6-speed. Would you get into adjacent technologies? Where are you, for example, in cylinder deactivation? And the more general question is, how important of a growth driver will be non-turbo gasoline efficiency?

Could you repeat the last part? I was writing down that first part.

How important will be squeezing fuel efficiency out of a gasoline engine as a growth driver for BorgWarner? Clearly turbo gas is - - you'll have more turbos than gasoline. What is your VVT, 6-speed, can you do cylinder deactivation, et cetera?

Let me address that. We have a chart that we - - that you have probably seen in the past. I don't know if it's on our Website or not. But it shows our leading technology that has impact for fuel economy, emissions, performance, and vehicle stability. And it kind of uses three pluses at the max, and two pluses is slightly less. and so forth, in terms of benefits. It's on our Website. But I don't have them in front of me. But the bottom line is, obviously, you know all about the benefits of turbochargers.

Next on the list is variable cam timing. Variable cam timing can, as you said, can be very productive and very effective in reducing fuel economy - - improving fuel economy, reducing fuel usage for gas engines. And BorgWarner has the generation 2 technology, this technology is just in production now on the GM push rod engine. It works on both push rod engines and was developed for overhead cam engines. I don't think we've announced it but it will be launched in Europe on an overhead cam engine for one of the premiere vehicles in Europe. And it's actually sold globally. But - - and there's a huge opportunity for fuel economy and emissions improvements with variable cam timing. So much so that people, both BorgWarner and OEM engine developers are just now trying to understand how much opportunity and how deep the value is for that technology.

In addition to that, we have cooling systems that basically can improve fuel economy with on-demand. Or basically electronically controlled cooling systems that can reduce fuel economy - - or improve fuel economy. And obviously, the Beru technologies improve fuel economy and also improve emissions. Then you have a transmission technologies like dual-clutch. You have improvement in friction material for our traditional automatics that improve fuel economy. So, we have a lot of products that are aimed at fuel economy for either gas or diesels.

So, in the big picture of things, VVT, variable cam timing, is that seen as a major growth source or just one of the many?

It will be a - - in the future, it will be one of the other growth drivers with tremendous growth opportunity within BorgWarner. And there are - - I probably couldn't count on two hands the number of people or engine developers - - car companies and engine developers that we're working with to actually optimize the benefit of that technology. And it's a huge - - I think it's going to be a great product for us and I think the market opportunity is going to be real nice.

That's interesting. There's a lot more improvement you can make with the traditional gas engine.

I think anybody in the engine business will tell you there's more to be squeezed out of gas engines. Just like there's more to be squeezed out of a diesel engine. And that's what is going to make it tough for all these technologies to compete head to head. Gas, diesel, and they are going to converge to similar technologies over time I think. And then hybrids - - and what the benefits are with hybrids.

Interesting times. I'll save my other seven questions for later given the late hour. And thank you very much.

Thanks. Your next question come from David Leiker with Robert Robert W. Baird.

Good morning. A handful and a number of questions, I missed the beginning of the call, so you might have gone through this. What did currency and Beru add to the revenue line?

As we - - on the revenue perspective, we said that our sales in the quarter were up what 25%? 25% with Beru, 11% without Beru.

Currency?

Currency, provided about 1% of growth.

Okay. Do you have a cash from operations number?

I'm not sure how you define it. There was a financials statement, capital statement attached to the press release. Cash provided by operating activities was $253 million, if that's your definition.

I missed that. Sorry about that.

Okay. That's all right, some people have different nomenclature for cash and use different metrics. That's why I wanted to double check with you.

I was using the FASB number. And then when you look at your 427 to 432 guidance number, non-GAAP guidance number, what's the equivalent nine month number that goes against that? Is it 317?

Yes, let me grab that for you. That would be 315.

And did you exclude any impact from of tax issues here in the third quarter from that number?

I'm sorry David, ask that again.

You had unusual items you had pulled out of Q1 and Q2, are there any in third quarter that you pulled out of the GAAP number?

Yes, $0.05 a share.

And that's for the tax?

Yes.

Okay.

We have time for one final question and that question comes from Rich Kwas with Wachovia Securities.

It looks like you've got relatively easy comps when you head into first part of next year. You've got your launching. You are on several platforms that are changing over. Is it right to kind of read into this that - - it sounds like you are still a little cautious on it, going forward. How do we read into that? Is that kind of related to the current environment with fuel prices? Or are you expecting that production launch won't be as aggressive from the OE's that are changing over their product? How do we read into that?

Rich, we missed the first half of your question. I don't know what happened but there was no sound.

Can you hear me now?

Yes, we can hear you fine now, but we don't know what the second half applies to.

We heard the question what happened. We didn't hear the rest of it.

I apologize. I was just talking about transfer cases. As you head into the first half of next year, you've got relatively easy comps, just on the platforms that - - the key platforms that you are on. At least according to the numbers I'm looking at. You have product that is changing over. So, I would expect that those OE's that are changing over the product are going to relatively aggressive launching the new product in terms of production schedules. How do we read into that? Should transfer cases as we head into the first half of '06 just be - - and I know it's new products. So their margin may be a little lower. But how do we read into that? It sounds like you are a still a little cautious. Is that in relation to your view on fuel prices and maybe there's not as much upside with some of the new launches coming out because of the macro environment?

Yes, we're cautious for a couple of reasons. Nobody quite knows what's going to happen with fuel. We are seeing - - we've seen just global basis, but mainly North America some tough schedules on sport utility and even pickup trucks to some degree. Pickup trucks have been relatively more stable but sport utilities have been really tough. And we are going to be launching with some new products like the - - we've got - - we've launched some just recent - - not - - within the last year, some GM products. They will be ramping up. And we'll be launching on the Audi Q7. But all of that is overshadowed by significant schedule cuts in some our traditional North American customers for transfer cases. So, those - - going into 2006, we don't see anything that's really promising or robust in terms of improvements. In fact, it may even get worse as we head into 2006 for the, let's just say the SUV market.

So even with the Explorer changing over and the 900 coming online, in North America, you are not seeing - - you're not expecting an easy comparison? You are not expecting much of a benefit?

We have the Explorer now, we'll have the Explorer next year. So, we don't do that on the GMT 900. So, that doesn't really have much impact on us. It only has impact on us if it possibly takes sales from somebody else. So that is kind of like the macro view on those two questions - - or those two programs.

Lastly, just bigger picture quickly on hybrids versus diesels. If hybrids really - - it looks like hybrids is the popular trend right now. If that keeps going and diesel really doesn't take hold here in North America. What's the incremental content difference on a hybrid vehicle for you, and say, versus a diesel vehicle including a turbocharger?

The hybrid - - in general, probably a diesel would have more content, because the turbochargers are pretty nice products for us. But don't underestimate the value of a hybrid for BorgWarner. Because if hybrids continue to refine themselves, you are going to see, you're going to see turbocharged gas engines for hybrids. You're going to see - - we have some products that will add value to some of the clutching technologies that are required for hybrid. And the also, hybrids, because of the nature of the drivetrain, or the powertrain with the electric motor, they have the ability to offer what I'll call - - if it starts as a front wheel drive platform, they, we have the ability to offer electronically driven rear axle as part of it. And so we have technology and we actually have development programs in process with some key OEM's to work on electronic axle technology that would be very complimentary for hybrids. That's in addition to all the clutches we have in our traditional transmission for hybrids and all the engine content we have on the traditional gas engines that are in a hybrid. So, hybrids are somewhat of an opportunity for us, an enabler for us. And they're certainly not anything that is, at least what I'll call the mild hybrids, or the current series hybrids that are definitely a benefit, neutral - - a neutral to a beneficial to BorgWarner.

And then Robin, I wanted to make shower on the first the quarters for the guidance now, David's question regarding what your basing that off of. Where is it - - I have 309 for the first three quarters of the year - - first nine months. And you said it's - - that the guidance is based off 315 for the first nine months?

Well, first of all, we are adjusting our first full nine months year to date for the tax rate.

Okay. So you are at the lower tax rate for the first two quarters of the year, including this quarter?

Yes.

Okay. Thanks.

I think our time is up. Thank you all for joining us. This call will be replayed through the 31. The number is 800-841-1687. The conference ID is 9874934. And the Web - - the replay is also available on our Investor Website on the Internet. If you have any follow-up calls, you can direct them to either Ken Lamb or me. And thank you all for joining us.

Thank you. That does conclude the BorgWarner 2005 third quarter earnings conference call. Thank you for joining and you may now disconnect.