博格華納 (BWA) 2006 Q1 法說會逐字稿

Good morning. My name is Anissa and I will be your conference facilitator. At this time I would like to welcome everyone to the BorgWarner 2006 first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question-and-answer period. (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 you very much and good morning, and good day to all of you. Thank you for joining us. We've released copies of the earnings before the market opened. You should have those by now and weve also posted financial talking points that should help you follow the financial discussion. They are located on our website, BorgWarner.com, investor information, webcast first quarter 2006 conference call talking points. These notes will be helpful to you as we review the financials and operations. The conference call also we'll be replayed at 800-642-1687, the ID number is 7208302 and the replay is also available on our website. The schedule of conferences for the next few months is we'll be at the Bear Stearns Credit Conference on May 16 and the KeyBanc and Wachovia conferences in June.

Before we begin I need inform you that during this call we may make forward-looking statements which involve risks an uncertainties as detailed in our 10-K. Our actual results may differ significantly from the matters discussed today. Moving on to your results, Tim Manganello, our 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. With they'll turn it over to Tim.

Thank you, Mary, and good day everyone. BorgWarner delivered a solid first quarter amidst continued turmoil in our industry and we again outpaced the global industry growth. First quarter highlights include record sales of $1.2 billion, up 7% from the first quarter '05. Earnings per share was $1.06 which included a negative $0.04 per share related to the expensing of options and a negative $0.07 per share related to unfavorable currency impact, compared to the first quarter '05. On a comparable non-U.S. GAAP basis earnings increased 13% in the quarter versus the first quarter '05. Our in -- our operating income margin held at 8.2% versus Q1 '05 even after expensing options in 2006. Sales outside of the U.S. were up 21% over the first quarter of last year excluding the impact of currency. In the engine group, strong global demand for our products boosted sales 9%. Drivetrain Group sales were up 2%. Our performance should come as no surprise.

We continue to deliver good results despite uncertainties facing the industry. Our technology is targeted at improving fuel economy, improving emissions reduction, and vehicle performance, all the fastest growing parts of the market. I guess you could easily say we're in the sweet spot of the auto market right now. Our sales were up 11% excluding the impact of currency while North American and worldwide vehicle production were up only 3% and 4% respectively. Furthermore, our customer and geographic diversity along with a cost reduction focus enabled us to weather tough industry conditions, rising healthcare cost and increased commodity prices while maintaining our margins. While some of our peers are forced to make cost reductions in a crisis mode, we are trying to proactively adjust our business around the world to changing market needs and cost pressures as well as seizing growth opportunities at the same time.

During the quarter, we hosted a very successful BorgWarner technology review with both Toyota and at Nissan in Japan that drew over 1,000 of their executives and engineer -- executives, engineers and purchasing managers. Events like this are part of our continued focus to expand our global customer base. Here in the U.S. BorgWarner and the U.S. Environmental Protection Agency recently announced a partnership to del -- to develop advanced air management technologies that will enable the auto and trucking industries to utilize the EPA's clean diesel combustion and high efficiency gasoline combustion technologies. In China we opened a new op -- operation in Ningbo for the assembly of turbochargers and transmission solenoids. This manufacturing facility is the first of several operations planned for this campus. NSK Warner, our 50/50 joint mention with NSK that produces transmission products in Japan, has opened a facility in Shanghai to make friction products and one-way clutches to support the Chinese OEMs and JV automakers in China in response to increasing demand for automatic transmissions in Asia. Now our trends around the world continue to support our growth areas of fuel efficiency, emissions improvement, and vehicle stability.

Let's talk about emissions. On the emissions front in the E -- in the U.S., the EPA is relaxing some U.S. tier 2 exhaust emission standards for diesel cars. The standards have been relaxed by as much as 40% for some applications. This move should encourage the use of clean diesels and help change American customers -- or consumers perceptions of diesel vehicles. The change applies to model year vehicles from 2007 through 2009. And the emission -- the original emission standards will continue after 2009. More stringent cafe rules targeting light trucks and SUVs produced in the 2008 through 2011 model years are expected to increase fuel economy by more than 10% over the next 5 years. The rules include a provision to vary the standards according to the size of the vehicles.

Now let's talk about down-sized gasoline engines. Three new down-sized turbocharged gasoline engines in Europe for Volkswagen, PSA-BMW, and Opel, all of which are BorgWarner applications, will go into production this year. This is the first visible sign of the trend towards smaller boosted gasoline engines, to better compete with diesel engines to help decrease fuel consumption and lower CO2 emissions. China will raise consumer taxes on cars that produce higher emissions and are less energy efficient in an effort to push buyers toward choosing vehicles with smaller engines. This should also help turbocharger uses -- usage of the future

Now let's switch to alternate fuels. As we visit with investors we have gotten a number of questions about ethanol and other alternative fuels here in North America. Internal combustion engines, regardless of the fuel, can gain more efficiency with BorgWarner products. It is also interesting to note that in Europe intense discussions have started about synthetic fuels. These include biomass to liquid, gas to liquid, coal to liquid with the objective of decreased dependence on oil.

On the drivetrain side of our business the trend towards 6-speed automatic transmissions continues to gain momentum. Industry six-seed -- six-speed programs include those launched by Ford and General Motors that began last year. We expect DaimlerChrysler to launch a six-speed program in North America later this year. Toyota's new Tundra gets a 6 speed automatic that will be built in the U.S. And Toyota in Japan is also launching a six-speed in the Camry, Avalon and Lexus ES series this summer. Now in Korea, Hyundai and Kia is developing a new six-speed automatic transmission and on the engine front a new diesel engine to meet Euro 5 emission standards. Back to transmissions, GM has a new mid-sized passenger car with a new six-speed automatic transmission for Korea also. While we cannot comment on specific customer programs, you can see the emerging opportunities for BorgWarner.

Let's talk about dual clutch transmissions as usual. Dual clutch lines continue to ramp-up as expected in Europe. We continue to work on strong opportunities for this technology in Asia and we have seen more interest among traditional North America OEMs as well.

Let me conclude by reminding you that we reiter -- re -- reiterate our guidance for 2006. We expect 2006 earnings per share on a U.S. GAAP basis to be within a range of $4.22 to $4.57. With the help of everyone in this Company, we also expect to maintain our operating margins despite continued raw material and energy cost increases, rising healthcare costs and the cost related to our global expansion. We believe our growth strategy is solid, and the market needs should prove and provide long-term growth opportunities for BorgWarner. Thank you very much and with that I'll now turn the meeting over to Robin for his financials.

Thank you, Tim, and good day to everyone. As Tim said this past quarter was another outstanding quarter for BorgWarner. Sales were up 7% and non-GAAP comparable earnings up 13% in the quarter. That compares, as Tim said, to North American vehicle production of up about 3% and worldwide production up 4%. With 58% of our sales in the quarter outside the U.S., the strength of the dollar compared to first quarter last year muted the strong results of our foreign operations. The dollar was up strengthened 8.5% versus the Euro in the quarter last year 12.5% versus the yen. So on a same currency basis sales grew 11% in the quarter and earning 21%, and we continue to execute our growth strategy despite what Tim laid out as a difficult industry environment.

On a U.S. GAAP basis our net income in the quarter was $1.06 per share compared with $1.36 per share in the first quarter 2005. First quarter 2006 included $0.04 a share related to the implementation of option expensing or FAS-123R, and if you remember, first quarter 2005 included $0.38 a share related to special items and we've detailed those special items in our press release this morning. Excluding those items in the first quarter 2006 -- 6 impact of FAS-123R earnings per share were up 13% from first quarter 2005. The impact of foreign currency reduced earnings per share by $0.07 in the quarter, so excluding currency earnings were up 21% year-over-year. We believe that our earnings excluding these items are a more appropriate comparison to prior period and future period earnings. Or in other words better represent how the business runs on an ongoing basis. The impact of foreign currency reduced sales by approximately $48 million in the quarter. Excluding currency our consolidated sales grew 11% while our sales outside the U.S. grew 21%, complare -- compared with global light vehicle production outside of the U.S. up 6%.

Sales outside of the U.S. as I mentioned represented 58% of our consolidated sales in the first quarter, versus 55% in the same period a year ago. Our sales in the U.S. continue to be negatively impacted by our 4-wheel drive torque transfer products and hence we're down 1% in the quarter versus last year compared with North American vehicle production up 3%. We continue to see solid growth, however, in every one of our major product areas around the globe in the quarter, except for those torque transfer products.

Gross margin for the first quarter was 19.6% compared with 19.7 in the first quarter of 2005. The impact of higher raw material and energy costs, higher healthcare costs, as well as the incremental margin related to lower North American SUV and light truck related product sales continue to pressure gross margins. Part of the expense of FAS-123R was reported in gross margin and excluding net charge gross margin was actually 19.8 versus 19.7 last year. A slight improvement. SG&A as a percentage of sales was reported at 11.5% in the quarter. That compares to reported SG&A of 12.5% in the first quarter of 2005 or again excluding those special items but SG&A as a percent of sales last year was 11.5%. Again, excluding FAS-123R with respect to SG&A in the first quarter, SG&A as a percent of sales was actually 11.2% on a comparable basis to that 11.5% last year. R&D as a percent of sales in the quarter increased to 4% of sales versus 3.8% in the first quarter last year.

Operating income, as Tim mentioned, was reported at 8.2% in the first quarter, however, excluding the impact of FAS-123R, operating income margin was 8.4% compared to first quarter last year excluding all the special items of 8.2%. So we improved excluding FAS 123R and special items last year, we improved margins at the gross margin level, at the SG&A level and at the operating income level on the quarter. Affiliate earnings for first quarter 2006 were up versus last year due to the combined effect of improved operating as a results of our affiliates as well as some adjustments we made to carrying values in the first quarter of last year in those investments. Interest expense was flat year-over-year. Our effective tax rate in the quarter was 28%, in line with our full year 2005 normalized effective rate. Looking at the income statement you can tell the first quarter at 2005 basically no effective taxes, was impacted, again, by I non-unique items primarily the release of tax accruals and actually 2005 on a normalize basis in the first quarter was about 29%.

Before we review our segment performance in the quarter, I -- I would like to point that effective January 1st, of this year, the Company assigned an operating facility previously reported in the engine segment to the drivetrain segment and this was due to changes in the facility's product mix more towards drivetrain than engine. So prior period segment amounts have been reclassified in engine and drivetrain to conform to the current year's presentation. Now if you look at drivetrain segment performance in the quarter, consolidated sales were up 2% despite lower light truck sales in North America which were down 2%. The group continued to benefit from sales growth outside of North America including increased sales of dual clutch transmission products in Europe to help offset the continued decline of 4-wheel drive torque transfer products here in North America. Segment EBIT was down 12% in the quarter as the newer North American production of light truck and sport utility vehicles with our 4-wheel drive products and higher healthcare costs more than offset the incremental margin from the higher DCT sales. Segment EBIT margin declined to 6% in the quarter compared to 7% last year.

On the engine side of the business our sales increased 9% in the quarter, the group continues to benefit from Europe, Asian auto maker demand for turbochargers, timing systems and emission products, European demand for diesel engine ignition systems and stronger commercial vehicle production in both Europe and North America. The engine group EBIT margin was 12.3% in the quarter compared with 10.2 reported in the first quarter last year but excluding special items again, in the first quarter last year engine group EBIT margin was 11.6%. So we improved margins on a comparable basis in the quarter to 12.3 versus 11.6. Incremental engine -- incremental income on incremental sales in the engine group was $0.19 on the dollar.

Let's talk a little bit about the balance sheet and our cash flow our investment rate capital structure continues to be strong. Our debt to capital ratio was 31% at the end of the first quarter. In line with 31% at then of 2005. Netting out cash and cash equivalents, net debt to capital at the end of the quarter was about 29%. Net cash provide by operating activities for the quarter was 48 million, up slightly from 45 million last year. Of the first quarter this year also included a $16 million payment representing the final amount due under the $45 million of Crystal Spring's settlement that we recorded in earnings in the second quarter of last year.

Regarding working capital levels, our net operating position at the end of the quarter, which we define as receivables and inventories less payables and accruals, increased by $94 million since year end as is typical in the first quarter, and it's a result of increased business activity levels in the month of March versus December. Our sales were up over $100 million in March versus December last year. Capital spending was 53 million during the quarter, and together with net tooling outlays of 17 million totaled $70 million compared with 53 million for the first quarter last year. Inventory turns were 13.5 versus 12.5 at the end of last year and 12.5 at then of the quarter in 2005. So an improvement from a turn's perspective as well. The investment we've made in this business, particularly on the capital spy -- side continues to support our book to new business as well as our cost reduction and productivity improvements. If you look at net cash provided by operating activities less the investment in capital and tooling in the quarter, I was a negative of 22 million versus a negative 8 million in the first quarter last year. And if you exclude those Crystal Springs settlement in the first quarter this year cash provided by operating activities less capital spending and tooling was relatively flat year-over-year. Our after tax return on invested capital continues to remain at the top end of our peer group and at then of the first quarter on a rolling four-quarter basis basically remained unchanged from year end at approximately 13%.

Now let's talk and our outlook for 2006. The Company continues to remain cautious on it's outlook for the year, but we have reiterated our 2006 full year earnings expectations of $4.22 to $4.57 on a U.S. GAAP reported basis. Remember this includes $0.16 to $0.18 a share negative impact from the implementation of FAS-123R and as you can see we experienced $0.04 of that $0.16 to $0.18 annual, we experienced $0.04 of that in the first quarter. And this guidance also includes $0.12 to $0.25 a share diluted negative impact from weaker foreign currencies, and again, if you think of the first quarter we experienced $0.07 a share in the first quarter related to the weaker foreign currencies. Excluding FAS-123R and the impact of currency, we are expecting 2006 full year earnings on a comparable basis with last year to 4,65 to 4.85 a share compared again with a run rate of 4.33 last year, 2005. Equivalent to year-over-year earnings growth anywhere from 7& to 12% in line with your historical earnings growth rates and our future expectations.

In addition, our outlook for the -- the year, the Company expects sales growth of 5% to 7% on a U.S. GAAP reported basis, 9 to 11, excluding the impact of currency. And you saw that impact in the first quarter already. We also expect to maintain our operating margins, as Tim pointed out, despite continued raw material and enery cost increases, rising healthcare costs and the costs related to global expansion. We expect net cash provided by operating activities of approximately $450 million. Capital spending together with net tooling outlays of around 300 million. R&D continued to spend at the rate of 4% of sales. A tax rate continuing to be at about 28% of sales, and again, an after tax return on invested capitol of over 13%. You know, as expected the industry environment was very challenging in the first quarter, with little evidence from our perspective that it will improve in the ner -- in the near term. In spite of this, BorgWarner was able to execute its growth strategy, show strong financial performance in the quarter and expect to continue to do so for the remainder of 2006. With that I'll turn the call back over to Mary. Mary?

Thank you very much, Robin. We'll turn to the question-and-answer portion of this call. I will ask Anissa to please give everyone the call -- question-and-answer procedures. Anissa?

(OPERATOR INSTRUCTIONS) Your first question comes from John Murphy with Merrill Lynch Research.

Good morning, guys.

Hi, John.

Just a quick question on the Ningbo operations, I mean where are these turbochargers going? Are they going into the China market or are they potentially being shipped to Europe and the U.S.?

John, mainly they're going into the China market, so -- and we'll see what happens, but there's tremendous growth opportunities in China for turbochargers because of the change in emissions regulations to accept diesel -- European standards which lend itself towards diesel engines.

John, we've announced that VW-Audi is making one of their world engines over there and some of these will go for that.

Okay. So they'll be going into those engines that might end up in different markets.

No. They're -- they're going into basically VW type vehicles for the Chinese market.

Okay. Is there -- is there an opportunity of potentially to -- I mean, the quality -- and I'm sure the specs that you're building over there are the same that you're building every place else. Is there every -- is there going to be an opportunity to potentially ship from China?

Well, not-- that's not the plan initially. Right now the -- the-- the -- the business in Ningbo for turbochargers is sized for the market size in China as of today, which is small but growing. Over time we'll see what happens, but at this point in time, we're competitive in Europe. We're competitive in other parts of the world for turbochargers and we plan to keep it that way for local consumption.

Then, if we could just shift gears and look at the -- the torque transfer business. I mean that -- that seems like that's getting -- coming under pressure because of Fords volumes. Are the margins there similar to what they're are on the other business or is is as that top-line fades -- I mean what kind of impact is that having on the operating margins or the EBIT level?

John, that's-- that's been a continuing issue for us for probably the last -- the last year and a half, quarter after quarter we see the decline there. As you look at it from a margin perspective it's not so much what the OM margin for that business is it's what the incremental margin on those lost sales and it is relatively high. As we've said before, from a lost sales perspective, we're typically seeing $0.30 on the dollar incremental loss income on the loss dollar of sales, and -- and that's pretty much where that business is running. And also getting impacted, again, in North America by -- by higher healthcare costs as all our north American operations which doesn't help the -- the equation.

That 30% is very much contribution margin. Is that what you would say?

Yes.

Okay. Then can you remind us what your commercial mix is -- what portion of your business is going to commercial vehicles?

Yeah. Hold on I have got that right here. On the commercial side, if you call it truck --light truck-- I'm sorry, medium truck and heavy truck, it's about 13% of our business.

Okay. Then just one last question, you often highlight your business to the Japanese and maybe not so much your business as going to the Koreans. I was just wondering if you could characterize the relationship and the bidding process and how those two sets of customers act in the initial process and further down the line in their relationship?

Well, I think-- first of all let me start by saying the relationship that BorgWarner has with both our Japanese customers, whether they're Japanese or transplants or our Korean customers in Korea are -- are good and healthy, and very positive. There's slightly different approaches between the Koreans and the Japanese in general. The Japanese are maybe a little bit more collaborative, and a little bit more partnership oriented. The Koreseans -- Koreans are more -- what I'll call a weather style where they're -- they're pretty good negotiators.

Okay. And then just one last question on pass throughs, how are you -- how are you seeing the raw material pass throughs going to -- to your customers? Has there been any change recently in acceptance of absorption?

Well we have -- we do have some pass through. What we're seeing on commodities right now is the biggest one is -- -- is -- is aluminum, and that's the one that's kind of like the hot spot for this year, and we've got more pass through on aluminum than we do typically on some of the other commodities we have, but I -- I would -- I'm hoping for the day when commodities stop going up and start going down, but we just done see that happening right now.

We're hoping for it too. Thanks a lot, guys.

Thanks, John.

Thanks, John.

Your next question comes from Darren Kimball with Lehman Brothers.

Hi, good morning, guys.

Good morning, Bill.

Couple things. First of all can you put some kind of range on the turbocharger growth that you saw in the quarter?

The-- we saw obviously growth on the engine side of the business north -- 9% on a reported basis. Obviously it's stronger than that when you get into local currency. And as I said we had good strong growth in our all of product areas, and turbo didn't represent all the growth and the rest of engine products not growing at all. There's good solid growth in all of our business cells. so if you look at our -- our growth, excluding currency on the engine side of the business it was north of 10% and I think you can assume that -- that was also the case for the turbocharger business.

We typically don't break down growth for individual product line.

Yes, that's why I have to keep asking the questions in creative ways. Secondly, I'm just wondering in terms of the 4-wheel drive torque transfer business I think Expedition, Navigator which is an important program for you probably bottomed in terms of volumes in the -- in the first quarter and should improve with a change over. Is it your sense this bottom -- or that this segment is bottoming and may flatten out? I know the prospects aren't great from here, but --

Well, let's just say that we've continued -- continued to see downward pressures on the -- the mid-sized SUV portion of the market. The larger size portion of the SUV market has been a little bit more stable and General Motors we -- we -- are participated on some of the vehicle's stability systems which have seen -- have started to see some growth. On the pickup truck side, we have a fair amount of obviously Ford pickup truck business, and that's been somewhat stable for us and we're holding in there, and on the Ford side with the pickup trucks and we're happy to see that they're kind of holding in there. So I don't know if it's the bottom or not, John. It depends on -- I mean Darrell -- it depends on what slice of the market. But right now I'm not so sure we've seen the bottom of the -- of the mid--sized SUV market but the rate of -- the rate of decline is probably slowing.

Okay. And let me ask just a third and then I'll jump off the queue. Could you provide some further granularity on the growth in the JV income, which I assume is predominantly NSK-Warner?

Darren, it's -- it's a couple of pieces. It's NSK-Warner, which is one piece, good strong growth there. It is -- we have a joint venture -- turbocharger business, both in India and -- and in Asia -- in other parts of Asia, as well as the growth in our consolidated transmission business in Korea, which a portion of that is owned by NSK-Warner and flows through on the affiliate line. So it -- it's -- it's our transmission systems business in Asia, which is both NSK-Warner and our Korean operation -- a portion of our Korean operations as well as our turbocharger business in India and Asia. Good -- ver -- excellent-- excellent growth in the quarter there. And again, if you look at our core business and you look at where your sales were, again, sales were down 1% in the -- in the U.S. market, and high digit growth outside the U.S. in our consolidated businesses, you would expect the same type of growth in our joint ventures as well.

Is this a new run rate? You've had like a $10 million quarter two -- two quarters back to back.

We've been running, you know, 9 to 10 million I think the last few quarters. So, somewhere in that range is certainly an expectation.

That's great. Thank you.

Okay.

Your next question comes from Rod Lache with Deutsche Bank.

Good morning, everyone.

Hi, Rod.

A couple of things, just to follow up on this torque transfer, can you give us any color at all on the magnitude of the decline, and you know, what -- maybe directionally would you expect the rate of decline to moderate going forward?

I think that's the best way to answer it is that it is moderating, but you know, let's just say the Ford Explorer hasn't -- has not --just is not holding up so we're seeing -- we're seeing the results of that.

I guess if -- if that seems to be the -- the really big headwind for you guys in terms of the operating performance, which obviously is looking very good despite that, but I'm just wonder why you're suggesting that the earnings growth for the Company is going to moderate in the next couple of quarters. You're talk about -- like 7 to 12% for the year ex the FAS-123, and you did over 13% this quarter and the headwinds kind of moderates.

Well, 13% versus 7 to 12? I mean I -- I don't know how much moderation that is, but I think we're still expecting good solid growth in the last three quarters of this year.

Uh-huh.

I -- I -- you know I can't -- we are not expecting any quarter to have a year-over-year decline in earnings. We're expecting earnings growth in every quarter of the year and -- and it varies by program launches and we've got currency that, again, impacts us that we pointed out before. There's a wide range of -- of possible answers from a currency perspective that as you can see impacts our earnings and impacted us $0.07 a share in the quarter.

Right.

You compound that times 40that's almost $0.30 a share. Now obviously as you look at our guidance we're not expecting as much of an impact but -- as we saw in the first quarter, but still that -- that impacts us and that's a variable that we just at this point in time it's difficult for us to forecast.

Right.

But we certainly -- I -- I certainly wouldn't -- wouldn't take the fact that the quarter was up 13% and our -- our guidance is 7 to 12% is any indication that wee see troubles in the back half of the year.

Okay. What -- why was D&A -- why was D&A declining? It looks like your CapEx has been pretty strong.

That's -- that's -- that's a great question. We should have pointed that out. Some of the -- the one-time items in the first quarter last year, about $10 million worth of D&A was related to the initial capitalization and immediate write-off of excess purchase price related to BERU, and again, you've got a little bit of currency impact.

Okay. And just lastly, what was the commodity headwind in the quarter? And can you give us any color on your expectation for the year?

We've said previously that we expect the year to be about $25 million plus or minus and in the first quarter we are running a little north of 6 million.

Great. Thank you.

We're still putting the data together but it's a little north of 6 million.

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

Hi, this is Brandon Farrell I'm on for Brett this morning. We were -- we were wondering how the integration of BERU's going and how successful has the Company been in potentially leveraging some of those European relationships and the diesel product portfolio there into other parts of the globe?

First of all BERU is going quite well. The -- the results we're seeing so far this year are equal to or -- or slightly better than our original forecast and our -- the model we used when we ran the financials on the -- based on the -- to basically drive the acquisition. As far as integration, we don't -- we don't really have a -- a plan that's based on integration of BERU into BorgWarner in terms of redundancies and synergies and all of this other stuff. Basically, they are a standalone company we have a 70% equity ownership, roughly 70%, and we're happy with that percentage. They -- they run the business and their -- basically we -- everything we do for BERU is to basically increase the value of BERU for all of the shareholders of the Company. Both us and the minority shareholders and we -- what we give them help in buying power and we also give them help in coverage -- customer exposure in Europe and so forth to help them launch or leverage their sales and maybe lower their costs based on some of the -- the cost benefits that we can bring to the party on cost leveraging with some of our other buying powers.

Okay. So you -- you haven't necessarily seen any potential sales synergies in North America or maybe Asia from that relationship?

Yes. As -- as diesel engines are starting to gain momentum in North America and in Asia, we bring -- we bring BERU to the party, and BERU has their own strong reputation and presence in Europe and somewhat in other parts of the world and all we're -- and we're -- we're basically bringing them to the party on diesels, let's say, with a much stronger presence and a much -- and-- and much more robust discussion in terms of technical opportunities between BERU and their customers and BorgWarner and -- and -- and the same customers.

Okay. And then as a follow-up to the Ford transfer case we had kind of talked about the contribution margins on that business, when -- when we think about the heavy duty exposure and that set of products how -- how do you guys think about the contribution margins there and the potential impact as we move into 2007?

You talk about the heavy-duty truck-related products?

Yes.

Yes. Same thing as we look at incremental margins on those products they're 30% -- north of 30%. Having said that, and Tim's pointed this out before, we do have growth for some of those products in a couple of different areas that we expect to offset some of the general decline in -- in volume demand in the overall industry, such that we won't have significant declines in sales. In fact we -- we expect to be able to maintain sales or maybe have a little bit of growth.

Right. Let me -- let me answer the question that nobody's asked yet, but I want to make sure it gets answered. It's related to this. We answered it in the last conference call -- earnings call, and that is everybody expects that the commercial truck market will see a decline because of a buy ahead and when the emissions laws change. Our forecasts indicate -- in the two products that are effected for BorgWarner, our turbochargers and our cooling systems products -- or thermo systems products. We expect to grow our way through that decline so we will not see a decline even if -- and I'll just say if the commercial truck market declines, which everybody expects it too, BorgWarner does not expect to see a decline in sales we expect to see -- continue to see an increase in sales on the commercial truck side of our market, both on the turbocharger side and the thermo systems side.

Okay. Thank you very much.

Sure.

Your next question comes from Chris Ceraso with Credit Suisse.

Thanks, good morning, everyone.

Hi, Chris.

A few items, first, can you give us an update on the all-wheel drive business? Any new awards for the ITM I or the ITM II that are coming on later this year or next year? Is there any new technology here or maybe some stepped up efforts on your part to go out and win more all-wheel drive business to help offset the -- the transfer case business that's going away?

Chris, I think you have seen recently the introduction of our complete family of all-wheel drive products called I-Track both for the -- sort of mass market and for high performance, so there's certainly greater variety and price points for product offerings and there's been a lot of effort put on working on new business there, and we do have a couple of programs coming on stream this year, that's in the backlog, we just haven't been able to announce to customers.

And we -- we did announce that we have a program coming on, a small program in China. But we -- we also have a program that we haven't announced the customer for that we'll be launching, that's a -- let's say a premium product for a -- a high value or high performance, I should say, European manufacturer. And that will bring on some technology. We're working on other applications in -- both -- mainly with Europeans and some -- some North Americans for all-wheel drive-based products.

Okay. And then maybe you -- you can just revisit quickly, sort of the -- the business case for dual clutches. You go out and talk to global automakers, how are they weighing the -- the cost versus the fuel savings versus the -- the features that they can -- they can explain to customers, and then where do you see this going in the longer term in Europe, U.S., or Asia?

I'm writing down all of our parts here. Dual -- dual clutch transmissions. First of all the technology is -- is -- is proven now to be a market-winning technology. There are a number of OEMs are coming on -- on board besides Volkswagen and Audi families you now heard Ford of Europe. We've got another European OEM that's been -- hasn't -- is -- will be launching but nobody's got official approval to use their name yet, but they -- we have con -- contracts coming on board now -- lower volume at first to try it out with the European OEM -- I'm sorry an Asian OEM, a number of projects going on now with Asians and -- and Americans. It just continues to gain momentum. The -- the fuel economy benefits are all plus. The price benefits are actually reasonably -- it's -- it's -- it's a lower-priced product than what would be a traditional automatic transmission especially as you start to get into 6, 7, and 8-speed transmissions. So it's got fuel economy is the big plus along with the fact that it's fun to drive. The cost -- the cost factor is a benefit, and it's -- it's gathering momentum every day.

Do you see this catching on broadly in the U.S. Tim or do you think it will be kind of a niche enthusiast performance type product?

Well, here's what I think. I think that Fords going to have it in the production in Europe so it's not beyond the stretch of imagination that Ford will eventually see that technology as an opportunity to use in North America. We do know that that there are -- there's at least one other -- what we would call traditional big three that's working on similar technology and considering it very strongly as they try to upgrade their transmission product line. Automatic product line. So I see quite a lot of activity and interest in North America, and it's -- it's not a matter of if it's only a matter of when and I could say that about North America, Asia and more opportunities with -- with Europe.

And then just lastly, you mentioned a little bit about the diesel, can you just give us a feel for, sort of where we are now in the U.S. or North America in terms of diesel penetration, where do you think that goes in -- in one year or three years? What's the -- what's BorgWarner's outlook for diesel penetration here?

Let me -- let me just start by qualifying my answer. First of all BorgWarner has products that work very well with hybrids. We participate in hybrid growth, so we are -- we're -- we're equally interested in hybrids, but we've said all along, that diesels will gain traction in North America. You're starting to see some kind of a push towards more diesels. We announced a joint partnership with EPA two weeks ago. You're seeing -- you're now seeing articles in the press that's kind of been categorized -- these are not my words or BorgWarners words, but words in the press like hybrid backlash that are basically saying hybrids don't deliver the full impact -- the fuel economy that everybody expected. Diesels do deliver what's promised on fuel economy. The fact that the EPA is lowering some standards temporarily for '07 to '09 to help diesels, the fact that there's a big push on North Am -- within the United States to become oil independent, the fact there's low sulfer -- sulfur fuel coming on board in the third or fourth quarter of this year for North America. You're seeing a tremendous groundswell of -- of positive momentum gaining for diesels in the United States. And let's just say this, back when everybody was pushing CVTs, and wasn't saying any -- much positive about dual clutch transmissions, we are riding a dual clutch transmission horse in terms of future opportunities, even though we are selling products for CVT's. Okay? I still -- I feel the same way about diesels. In the end diesels will probably prevail to a much sig -- for -- to a large -- a larger and more significant volume than what people expect to see today or, last year let's say, where people expected to see in North America for the future.

Okay. Great. Thanks a lot.

Your next question comes from Rob Hinchliffe with UBS.

Thanks. Good morning..

Hello.

Good morning.

Good morning.

I guess a few questions largely follow-ons to what we've had. But, transfer cases as volumes are going down, are you seeing any pricing pressure start to -- to come in as the automakers profits on these vehicles are also going down?

Well, we don't see -- let's put it this way, we always see pricing pressure. Pricing pressure is a given for this industry. I can't say it's any more or any less than last year or the year before or the year before that. At -- at then of the day, we have so much capacity we're going to sell our capacity and -- and basically we -- we will try to -- we'll do everything we can to maintain margins or improve margins even in the face of a declining market.

Okay.

But, you know, I can't say -- it's no tougher now than it was a year ago even though every -- everybody -- it's a tougher sit -- it's a tougher industry. You can only beat a horse so hard.

You were talking about the three engines or automakers, I guess, in Europe that are coming up with small turbo gas motors. The -- the technologies on those turbos, from your perspective, are you indifferent to small diesel turbo, the turbo itself or turbo on the gas motor?

Yes.

Okay.

We have -- we have the turbochargers for the gasoline engines. We've been the market leader on technology for turbo charged gas -- for turbo's for gas engines and it's not exactly an easy application because the temperature range on a turbocharger and a gas engine runs at about 1,050 C whereas the turbocharger on a turbocharged diesel engine runs at like I think it's 700 -- or 850 to 900 C. So and that -- those couple hundred degrees make a big difference.

Okay. The -- the Volkswagen this twin charger as they're calling it, what -- is that -- is that something that's that kind of technology turbo and supercharger in conjunction is that the wave of something new or is that more of a niche do you think?

Well, it's -- it's a different approach. I don't know if that approach will last. It's similar to our two-staged -- regulated two-staged turbocharger. The -- the -- the goal of that is to basically reduce or eliminate turbo lag when you first start and do kick on a vehicle and before the turbocharger kicks in. So you -- you want want the kicker a turbocharger kicks in the less turbo lag you have. We have a technology called twin scroll which basically has two passage ways, one's a -- one's a small passageway, one's a large passaway which -- which also can improve turbo lag. So between the twin scroll technology and between our two-stage -- regulated two-stage it does similar approach. We're also working on other technologies, some of which fall under the umbrella that this technology partnership with the EPA that also -- that -- that use -- I can't say what it is, but it's a technology that -- that we are working on and we had internal to BorgWarner, and simultaneously they're working on and they had inside the EPA, we decided -- and we're actually supplying them components as a -- more of a customer supplier relationship, we decided put -- go together on a collaborative arrangement, that's what caused this partnership and one of the prime benefits is to eliminate turbo lag which that's exactly what the supercharger combined with a turbocharger does on the Volkswagen engine. I think that that's just a temporary approach, though.

Rob, and it's a pretty expensive op -- more high performance niche answer.

Uh-huh. Okay. And I guess just one last one. It looks like Honda maybe sort of insourcing their 4-wheel drive business, looking at the RDX and maybe even the next MDX. Any thought on that and how about the rest of your ITM? Any losses maybe?

Well, let's just say this, Honda's always done -- Howie -- Honda's always done their 4-wheel drive business until we came along and helped -- and you -- and so it was somewhat unusual for Honda to source outside the Honda for their 4-wheel drive or all wheel drive technology. That's the historical facts. The RAV 4 which I think is one of the ones that -- that you -- which was replaced by one of the vehicles you were talking about was a tech -- a tech -- an all-wheel drive technology that they've always made inside their own shaft. So it's not un -- unual -- unusual. We -- we have the Pilot. We have the -- the -- the Ridge Line. And those volumes are greater now than they were in the past, and the MDX will probably be a product line that they will consider going inside.

Okay. Thank you, Tim.

Sure.

Your next question comes from Jonathan Steinmetz with Morgan Stanley.

Thanks, good morning, everyone.

Jonathan.

Good morning.

A few questions first on the -- on the engine side you listed a number of factors contributing to the increase on the -- on the press release, turbos, timing, diesel engine ignition, commercial vehicle. Is there any way on the 22 million EBIT walk that you would just rank order those in terms of -- of -- of their magnitude?

No.

All right. Figured it was worth a shot. You talked a lot at the beginning about all of the new business opportunities and throughout the call on some new business opportunities. I know you don't give a formal backlog number until November type time frame but any reason to think it would be materially different from sort of the high single digit low double digit type range we've seen?

No, I think the backlog will probably continue to be what -- what you've seen from us in the past -- path -- past. It'll be hopefully a normal rate of positive progression forward, and we don't have the numbers so any -- anything I say right now is purely speculation on my part but we see plenty of growth ahead. We see plenty of opportunities ahead that -- that -- that -- that could turn into growth, more solid growth than we even know of. So we're pretty pos -- we're very positive and we're very bullish about the future growth prospects of BorgWarner and I don't see any reason why anything should be going backwards in the future.

Okay. And lastly --

In terms of our book to new business.

Thank you. And -- and last question, you gave a-- you gave 13% of revenue from the commercial vehicle business for a first quarter of this year, do you have a comparable figure first quarter last year?

It's very similar. I don't have the exact number, but it -- it's -- there's not much movement in it.

Okay. Thank you very much.

Your next question comes from Joe Amaturo with Calyon Securities.

Good morning, everyone.

Hi, Joe.

I was wondering if -- you touched on how the -- there's increased interest for turbo diesels in North America, I was just wondering if you could touch on what type of vehicles the OEMs are looking to power the -- power -- power up with turbo diesels?

Well, let me just give you my opinion. Well first of all it's fact that -- that diesel engines in North American vehicles right now are typically in pickup trucks and will move towards SUVs. I'm pretty sure you're going to see more turbocharged diesel gas engines in North America. And I know the Europeans and the -- the Asians along with the -- the European businesses tied to the -- to the big three or the Detroit three I should say, have turbochargers that are being worked on for the North American market. But before you see turbo charged -- at the same time -- you you see turbocharged diesel engines penetrating North America for passenger cars you're also going to see turbocharged gas engines penetrating North America. That may actually come first, Joe, because we have -- obviously we're predominantly gas engines and turbocharging a gas engine is a more natural sequence than bringing in a new diesel engine. So you'll probably see that first in North America followed by more. A steady stream of turbocharged diesels for passenger cars over time. And I -- I think that -- I would have said, and maybe I did say, a coup -- a year or two ago, it was maybe five years out, I'm saying -- I'm thinking now that things are moving much -- at a much faster pace. It's like everything in technology, once technology is somewhat developed it gets -- and it's valuable, it gets pulled ahead. I wouldn't be surprised if you see a lot more diesels. Let's just say this, when we had this discussion three years from now we'll probably have a lot more diesel applications to talk about, Joe.

And do you think the infrastructure in North America is there to support increased diesel penetration?

Well, we'll have the right fuel at then end of this year. About 47% of the gas stations, or fueling stations, in North America have diesel as an option now. I've talked to a number of people that are in the gas or fuel distribution business and it's a very easy conversion for them to convert a gas pump to a diesel pump. No big deal. It's just the old supply and demand. And the -- the big -- the issue is distribution -- the production and distribution of -- of fuel through the pipelines. And I -- I -- don't -- there;s nothing technical, there's no technical challenges there.

Okay. And then the next one's for Robin. Just directionally, with respect to drivetrain, how should we think about the segment income margin going - [LINE WENT DEAD]

I -- I -- I -- you broke up at the end of it. I think I know your question, you wanted to know about the segment income margin for drivetrain. And I think it's going to continue to be under pressure for the rest of the year. I hope you heard that Joe.

Hey, Joe, you're cutting out.

Either you're cutting out or we're cutting out. But --

If there's any way you can pick up the handset, that would be great, sir.

Hello?

That's better.

It was on your side, good. I thought it was us.

Okay. Sorry.

As far as your question on the margin, the first quarter, 6% margin is -- is one of the lower levels we've seen in this business for the last -- last couple of years. but we're not expecting significant increases in those margins either over the -- it's going to be a tough year for that segment of the business.

So year-on-year we should expect comparable declines?

Yes.

As we roll through each quarter?

Yes.

And then lastly, what -- what assumption are you -- are you baking into your guidance with respect to Ford-like truck for '06?

Down slightly.

Down slightly. Okay. That's it. Thank you.

We have time for one final question. And that question comes from Michael Bruynesteyn with Prudential Equity Group.

Morning, folks. Apologize if you addressed this as I'm jumping on late. Could you talk about the working capital? I think was saw a big jump in receivables, payables actually fell despite higher sales. And then there was also a large jump in tooling outlays and I'd like to understand those impacts on cash please.

Yes, ex -- as -- as we look at overall working capital, receivables and inventory net of payables, it was up about $90 million in the quarter and if you look at our -- our business activity in the quarter, our sales in -- towards the end of the quarter like a March versus sales in end of the year December were up over $100 million period over period. So when you look at working capital what really drives that increase typically is the increase in receivables. And it's just a result of -- of when we ship and when we get paid by our customers. There's no deterioration in the quality of our receivables. Inventory actually is relatively flat in the quarter if you look at inventory turns as I said earlier it's 3.5 at the end of the quarter versus 12.5 last year at the end of the first quarter and 12.5 at the end of the year.

As far as the payables and tooling it was -- cash outflows in the quarter related to tooling and that's just timing of some of our growth overseas, A good portion of that is in Europe and in Asia that -- when we look at the year, as I said earlier, we're still looking at about $300 million of fixed capital investment plus tooling which is where we -- we've said we expected the year to be previously. But compared to last year there's a lot more activity going on in the first quarter with getting ready for new launches this year.

Does that tooling unwind fairly quickly on reimbursements or is that something that's going to be there for awhile or it continue to grow?

That -- that tooling is not reimbursable. That's -- that's investment for us. That -- 17 million or so reported in the quarter that -- that -- that's our tooling, our investments and we'll amortize that over it's useful life. If you look at cash flow in the quarter, again, I think cash from -- from operations was about 48 million this year versus 45 last year. And this year, and maybe you missed this, we made the final payment on our settlement related to the Crystal Spring litigation that we recorded from an income statement perspecting in the second quarter last year. We made about a $16 million payment in the quarter. So, compared to first quarter last year, actually, cash from operations was almost 20 million stronger. The first quarter is always a tough quarter from a cash perspective simply because of the timing of business activity in December versus March.

Okay. Super. Thanks for your help.

Okay.

Oh. I guess that will conclude our call today. Thank you all for joining us. If you have any follow-up call -- questions please direct them to Ken Lamb or to me. Thank you very much for joining us.

That does conclude the BorgWarner 2006 first quarter earnings conference call. Thank you for joining and you may now disconnect..