博格華納 (BWA) 2006 Q3 法說會逐字稿

Good morning. My name is Courtney and I will be your conference facilitator. At this time I would like to welcome everyone to the BorgWarner 2006 Third Quarter Earnings Conference Call. All lines have an placed on mute to prevent any background noise. [OPERATOR INSTRUCTIONS] After the speakers remarked there will be a question and answer period. If you'd like to ask a question during this time simply press star then the number one on your telephone key pad. If you'd like to withdraw your question, please press star then the number two. If you are using a speaker phone, please pick up the hand set before asking your question. I would now like to turn the call over to Mary Brevard, Vice President of Investor Relations and Communications. Ms. Brevard, you may begin your conference.

Thank you Courtney. I'd like to thank all of you for joining us today. You should have copies of the releases on the earnings that were sent out for when the market opened today. You should have also received copies of our announcement of our new 1.7 billion in new business for 2007 through 2009. Good news for our backlog. We posted financial talking points to help you follow the financial discussions, they are located on our website, BorgWarner.com on to investor information page, webcast, third quarter 2006 conference call talking points.

These notes will be helpful to you as we review the financials. There is also a replay of this conference call at 800-642-168, the I.D. number 6528818 and replay is also available on the website. I want to remind you that we have an active schedule of conferences in the next few months or at the [Cabellie] conference on October 31, Baird conference November 7, the Bank of America event in November and also the Automotive analyst event at the auto show here in Detroit in January.

Before we begin, I need to inform you that during this call we may make forward-looking statements which involves risks and uncertainties as details in our 10-K. Our actual results may differ significantly from the matters discussed today. Tim Manganello, Chairman and CEO will provide comments on the quarter and the new business backlog. Robin will be discussing the operating results for the rest of the year. I'll turn it over to Tim.

Thank you Mary. Good day everyone. We have three key areas to talk about today. First, as we expected the quarter was a challenge. Sales of about $1.1 billion were up 1 % in the quarter, all reported earnings per share was $0.68, a decline of 36 %. This excluded nonrecurring items and FAS expenses earnings declined 20 % in the quarter. Second, we reiterated our guidance for the full year of $3.95 to $4.10 per share. We are on track and managing our business to match market conditions. We have taken structural costs out of our North American operations and will continue to manage this regions business while we build infrastructures in those regions of the world where we are continuing our rapid growth. As evidence of this, we acquired the European controls business of Eaton during the quarter. This transmission and engine controls operation specializes in high pressure, solenoid for automated transmissions, common rail diesel and gas engines and other solenoid applications that compliment BorgWarner's expertise in engine and drive train electronics. Our presence in emerging markets such as Korea, India and China as well as our relationships with growing global OEM's under pins our expectations of continued growth that will outpace the industry.

Operating margins are now expected to decline slightly in 2006, but are anticipated to return to historical levels in 2007. Our third, this morning we released our new business outlook for the next three years. We continue to expect solid, profitable growth that outpaces that of the auto industry, with $1.7 billion of net new business for the period of 2007 through 2009.

We released this information today, because we thought it was important to assure you that despite a difficult second half, the trends around fuel economy, emissions and performance, along with vehicle stability continued to provide a strong foundation for our growth. While we have seen some degradation in new business volumes and launch timing in 2006, the 2007 through 2009 list of programs is a testament to our balance product portfolio and continued growth outside of North America. Now, I will break down the $1.7 billion in net new business. For engine, engines represent 73 % of the '07 to '09 backlog. Drive train represents 27 %. Engines 73, Drive Train 27.

Geographically, once again, same numbers 73 % of our new business is outside of North America. That includes Europe at 46 %. Asia at 27 %, which is Korea at 15 and China at 9 % of the total. Just like Asia at 27 %, North America is also 27 % of the backlog. Now, the product break down includes for engines, turbo chargers at 40%, this is made up mainly of regulated two-stage and variable turbo geometry turbo chargers. Engine timing and variable cam timing represents 11 % of the total. In other engine products represents 23 %, which includes Baru and the thermal systems products.

Within the Drivetrain, all wheel drive products represent 6 % in dual clutch transmissions remains at 15 % as compared to 15 % last year. Now over the next three year period, about $530 million will be sales in 2007 and the same number $530 million for 2008 and the remainder of the backlog falls in 2009. BorgWarner is uniquely positioned among all suppliers to deliver a broad range of power train technology for fuel economy, reduced emissions and enhanced vehicle stability. Over the next three years we believe that our technologies will be a strong growth catalyst as we continue to serve the needs of our growing and diverse global customer base. In a brutal industry environment, like we have today, we continue to challenge ourselves to deliver steady, profitable growth. This book of new business in the face of these difficult industry conditions, is evidence of our determination to deliver that growth. Now, I'll turn the meeting over to Robin.

Thank you, Tim. Good morning everyone. You know as Tim said this past quarter was a challenging one for the industry for and BorgWarner, as well.

Global production was up 3 % but the growth or lack of growth was pretty diverse geographically. Vehicle production in North America was down 8 % while Europe was up slightly at about 2 %. The real growth in the quarter occurred in China, Japan and Korea, which when combined were up other 10 %. In North America, specifically the decline was in the light truck SUV segment with past cars relatively flat and light truck SUV's down 14 % in the quarter. Our financial performance in the quarter pretty much reflects the impact of the industry's global diversity.

Our sales growth in the quarter was 1 % as Tim mentioned and just like the industry our growth was made up of geographical divestiture, a challenging U.S. market environment resulted in a sales decline of 14 % and continued growth outside of the U.S. resulted in the sales increase of about 13 %. As a result, our sales in the U.S. dropped from 45 % of total sales to 38 %. Last year third quarter to this year's third quarter and outside of the U.S. our sales represent 62 % of total, up considerably from the 55 % last year.

Rather than get in the details of the individual income statement line items I'd like to step back and look at the quarter from a more macro perspective. I hope this will make it easier for everyone to understand what happened. Before I do that I do want to remind of rule of thumb information we've given you in the past about our cost structure and how that relates to this quarter. We've said that on average our material costs represent about $0.50 per sales dollar. We have also told you that total compensation cost, wages plus fringes averages 20 to 25 % of sales.

Those relationships are still in the ballpark today. We have also said we would expect on lost sales a decremental margin in the 30 to 35 % range and increase sales incremental margin of 15 to 20 %.

Now, with that background behind you, let's talk about the quarter and what happened. There are three really major item that is explain the bulk of the third quarter's financial performance. First is the 14% sales decline in the U.S. or the reduction of our total percentage of sales going from 45 % U.S. to 38 % of total. That decline impacted our third quarter financial performance.

It translates to about $65 million in sales. Our decremental margin on those sales was on a company average about 45 %, which is obviously is disappointing to us. The reason it was higher hasn't our 30 to 35 % range is that we did not react fast enough in adjusting our U.S. work force to the dramatic reduction in customer production schedules. We recognize this in the third quarter as it was progressing, and that lead to the restructuring we announced on September 22. So the 65 million decline of sales in the U.S. translated to approximately $29 million reduction in operating income versus third quarter 2005. The second major item for the quarter is the 13 % increase in sales we saw outside of the U.S., that translates to about $75 million in sales and on those sale dollar increases, we saw incremental margin excluding the cost of nickel increases, of about 15 %.

Or again, about $11 million increase in operating income versus last year. The third major item that impacted our financial performance in the quarter was increased material cost, particularly nickel. When we started the year we said we expected material price increases of 25 million for the year versus 2005, that translates to $6 million a quarter. We experienced increases of approximately $6 million per quarter in both the first and second quarter of this year. In our September 22 press release and conference call that day, we pointed out that nickel had moved from $6 a pound to approximately $13 a pound in a last few months, resulting in a year-over-year increase expected of $15 million for the last half of the year. Or, looking at our total material costs, $40 million increase versus 2005 instead of the $25 million we had been expecting earlier. As we look at the third quarter material cost increase approximately $13 million of which approximately $6 million was our previously expected run rate number. $6 million a quarter is about 25.

Approximately $7 million of the 13 reflects the impact of rising nickel costs. Now, if you net those three items, the decrease of $29 million in operating income from the lost sales in the U.S., the increase of $11 million of operating income on the increased sales outside of the U.S. and the $7 million I'll call it surprise increase in nickel, it comes to about a $25 million negative impact on the quarter or $0.31 a share.

Now, just a word of caution, the incremental margins I talked about both up and down differ between the engine and Drive train segments for various reasons.

On the average for the Company in total, these relationships hold true. Now these three items were really the bulk of the story operationally for the quarter. Add to that the $11.5 million in restructuring charge, which was $0.15 a share, we told you about this in September, we had a finalization of outstanding contingencies related to a previous asset disposal that resulted in a $4.9 million pre-tax gain or $0.06 a share, then the quarterly run rate $3.2 million, related to FAS 123R, which we didn't expenses last year, that's $0.04 a share, add those to the other three items and you get $34.8 million, which is a little more than the $30 million change in operating income in the quarter year-over-year and net EPS impact of about $0.44 a share.

As a result of the declining U.S. operating income, we also reduced our compensation expense in the quarter by about $4 million. So that should tie out pretty much the operating income side of the statement for you. Affiliate earnings were up $2.1 million in the quarter, $0.03 a share base on continued growth of our Japanese drivetrain customers and interest expense was relatively flat in the quarter.

The tax rate in the quarter was approximately 24 %, higher than the approximate 23 % in last year's quarter. The 24 % rate this year reflects the year to date impact of lowering our full year tax rate expectation to 27 % from the previous 28 %. That's really a direct result of the decline in U.S. income we saw this the third quarter and obviously U.S. income is taxed at a higher rate than our average 27 to 28%, so that's the reason for the decline from 28 to 27.

Getting to reported earnings on a U.S. GAAP basis as Tim mentioned it was $0.68 a share down $0.39 a share from third quarter last year. As Tim also mentioned earlier eliminating nonrecurring items, and FAS 123R which you can find in the table in our earnings release, earnings per share were down $0.21 for 20 %.

We believe our that our earnings, excluding these items are a more appropriate comparison to prior and future period earnings or said another way, better represents how the business is runs on an on going basis. Despite the difficult conditions in the U.S. market we continue to invest for the future as well. To support the $1.7 billion of new business Tim announced this morning and other product technology initiatives we spent $46.2 in R&D in the quarter an increase of 16 % versus third quarter last year, this represents about $0.08 a share of the $0. 21 a share decline in the quarter.

For the first nine months of 2006 sales were up 4.3 % in net income on a U.S. GAAP basis was $2.95 a share down from $3.05 a share in 2005. The first nine months of 2006, included the $0.06 per share impact and the divetures and $0.15 per share impact of the North American restructuring activity that we mentioned in the third quarter as well as $0.12 a share related to implementation of FAS 123 R. The first nine months of 2005 including a net charge of about $0.07 a share related to a number of special items.

Again, all of these are detailed in our press release this morning. Excluding the impact of special item and FAS 123 R, earnings per share on a comparable non-U.S. GAAP basis were up 1 %. The decline in the euro and Japanese yen in first nine months of 2006 more than offset gains from other currency and reduced net income by about 0.04 a share versus first nine months of 2005. Let's move on to our segment operating performance. Drivetrains consolidated sales were down 8 % in the third quarter versus 2005.

Performance, which again reflects two separate parts of the business, a 21% sales decline in the U.S. and 21 % sales growth outside of the U.S. Outside of the U.S. the continued ramp up of dual clutch transmission and torque transfer product sales in Europe under pin the group solid performance.

In the U.S. the group was again negatively impacted by sharply lower production of light trucks and sport utility vehicles equipped with torque transfer products as well as lower sales of its traditional transmission products. If you remember, fourth quarter declines in North America I said light trucks and SUV's were down 14 %. Drivetrain segment EBIT margin declined to 4 % in the quarter compared to 6.6 % margin in the third quarter 2005 and this is due primarily again to the incremental margin on lost sales in the U.S. On the engine side of the business sales increased 5 % in the third quarter. Similar to Drivetrain the groups results were different in the U.S. and non-U.S. markets. Outside of the U.S. sales increased 11 % including 28 % growth in Asia, while sales in the U.S. declined 7 %. The group continued to benefited from both Asian and European demand for its products but was impact by the dramatic production decline that occurred in the U.S. The Engine Group EBIT margin was 10.3 % in the quarter compared to 13.4 % in the third quarter 2005.

Segment earnings in the quarter were negatively impacted by sharply higher commodity cost primarily related to nickel and all our nickle exposure falls in the engine side of the group. The incremental margin on lost sales in the U.S. and the Engine Group was also impacted negatively by infrastructure cost to support sales growth in Asia, including the 27 % or approximately $460 million of new growth in Asia projected over the next three years that Tim discussed earlier. Let's talk a little bit about the balance sheet and cash flow. Our investment grade capital structure continues to be strong. Our debt to capital ratio was 29 % at the end of third quarter versus 31 % at the year end of 2005. Netting out cash and cash equivalence and marketable securities, net debt to capital at the end of the quarter was 25 %, a very strong position.

Net cash provided by operating activities for the first nine months of 2006 was $270 million up from $261 million last year. Capital expenditures including tooling outpace were $192 million during the first nine months compared to $180 million last year. These investments continue to support our $1.7 billion book and new business as well as cost reduction and productivity improvements.

Net cash provided by operating activities was more than enough to the fund capital spending including tooling as well as finance the approximately $65 million acquisition cost of the engine and transmission controls business, European engine transmission control businesses from Eaton, which occurred right at the end of the quarter. Our after tax return on investment capital at the end of the quarter on a rolling fourth quarter basis was still strong at 12.3 %.

Now lets talk about the outlook for 2006. First let me say that judging by first call estimates, many of you had different expectations about our third quarter financial performance. It looks like you also have different expectations about our fourth quarter financial performance. Let me assure you that our third quarter was right in line with the expectations we had on September 22, when we adjusted our 2006 full year earnings guidance to $3.95 to $4.10 a share. That is the reason therefore that we have reiterated that full year guidance today. Remember, our guidance reflects continued difficult conditions in the U.S. market.

Particularly in the light truck SUV segments as well as the expected impact of sharply higher nickel cost at about $13 a pound. The guidance does exclude the $0.15 a share restructuring charge and the third quarter's $0.06 a share divestiture related gain. We also expect operating income margins to be better than third quarter levels in the fourth quarter but still behind fourth quarter 2005 levels and we also continue to expect net cash provide by operating activities of approximately $425 million for the year. That's the end of the financial section. With that I'd like to turn the call back over to Tim for some closing comments.

Thank you, Robin. I want this opportunity to make some concluding remarks because I need to reiterate the important message I started with. We had a difficult quarter, but our fundamental growth drivers remain strong as evidence by our book of new business. The industry environment, particularly here in the U.S., was very challenging in the third quarter, and there is little evidence that it will improve in the near term. Robin went through the numbers with you and believe me, no one here at BorgWarner is satisfied with our third quarter financial performance. As a result of these conditions, we made the tough decision in September to restructure our operations in the U.S. and better align our cost structure with the lower volumes.

We believe we will start to see some of the benefits of these actions in the fourth quarter and the full benefits in the first quarter of next year. However, we also understand that this industry is dynamic. We are prepared and committed to make additional changes to our cost structure to maintain our above-average margins. Despite the current issues in the U.S. market, BorgWarner expects to continue to successfully execute our growth strategy and I believe we are on target do so as demonstrated by this morning's announcement of our three-year $1.7 billion backlog of business. The applied growth rate from this announcement is in line with our historical growth rates of 8 to 10 %. It is evidence that BorgWarner remains on track and in closing we look forward to, and are excited about the future of BorgWarner. With that I thank you and we'll open the table for questions.

Courtney, I'll ask you to give the instructions for the question an answers, please.

[OPERATOR INSTRUCTIONS] Absolutely. At this time I would like to remind everyone if you would like to ask a question please press star and number one on your telephone key pad. If you are using a speaker phone please pick up the hand set before asking your questions. We'll pause far moment to compile the Q&A roster. Your first question comes from Jon Rogers with Citigroup.

Hi good morning.

Good morning, John.

Robin, as I look at the balance sheet, the net cash position at 25 %, you've made kind of a bolt on acquisition with Eden, can you tell us again, how you feel about that number being down there? I mean, has the macro conditions in North America made you get a little bit more conservative or are you still looking at an optimal capital structure at 35 %? If you are, what are you going to do between now and the end of the year to change that?

Yes, that's a good question, John. As we have said before we feel comfort of capital in that 30 to 40 % range. We are at the low end of the range, slightly below it. We have three major priorities for the cash use. First of all to maintain our dividends, which we expect to do. We review that annually and try to have that reflecting the growth in our business. Second, we continue to look at strategic growth opportunities from an acquisition perspective. Obviously we made one acquisition this year, just at the end of the third quarter and we continue to look. We still believe there are some very good opportunities out there for BorgWarner in the technology area. I think the Eaton European controls business is a great example of that. So acquisitions are important. Then third, what we said before, we have a current authorization to repurchase share from our board of directors and borrowing all opportunities, we'd look to get in the market and repurchase some stock Okay. We strongly believe there are other opportunity in the marketplace out there for us from an acquisition perspective.

Tim, on the backlog, I guess it is maybe a little surprising that DCT, is as a percentage of the backlog is flat. As you have given the growth rate there, is most of the growth that you are talking about or a good portion beyond 2009? Then, can you give us an idea of where your split by say traditional Detroit three and other manufactures in the backlog?

Yes, let me just take DCT first. You got to remember it is DCT's holding as a percentage but it is an increasing number at $1.7 versus $1.6 billion. Yes, there will be a tremendous amount of DCT that falls out of the time period 2007 to 2009. I can tell you, we have active programs that are serious programs that, I'm sure will result in growth business for BorgWarner, with seven different OEM's. I'm including Volkswagen and Audi as one of the seven. So there is a significant amount of opportunity with us right now for DCT. We are working with Chinese OEM's, we are working with Japanese OEM's, we are working with more European OEM's and we are working with American OEM's. All as it relates to DCT. Like I said, some of these guys will sit on the sidelines and see what the market acceptance will be. The market acceptance by far as been overwhelmingly positive and people now are going off the side lines and jumping into the game. Because of the length of the transmission programs, transmission programs have a gestation period of three to four years at least. That pushes some of the stuff now toward the back end. So we have some in the back end and there is going to be more that falls out of the 2009. Regarding the backlog, I think the total backlog the Detroit 3 represents about 12% of the total backlog.

Thank you.

Thanks, John

Your next question comes from the line of Rob Hinchliffe with UBS.

Thanks very much. Good morning. Can you talk about what kind of industry assumptions you have over the next three years. A lot of people with trying to figure out is if economy going to soften or hold up and wondering what you baked in there.

In general, the industry assumption are probably flat. Declining in North America some growth in the emerging markets and maybe slight growth in Europe. But that doesn't necessarily mean anything for our product or our platforms because we tend to be on platforms in most of the cases, that are on the higher end of the growth rates, so we may see platforms that have growth rates are above industry standard or industry norms.

Tim, you mentioned all wheel drive is 6 % of the backlog, is that disappointing one? And two is there assumption for Ford business in there being weak that offsets what all wheel drive is doing in reality?

Yes, there are assumption Ford being business somewhat weak and offsetting it. Two, Robin, in all honesty it is somewhat disappointing, I would like to have faster growth rate on all wheel drive. We have great technology and a lot of active l programs going on with customers. But it just seems to be, most of these programs now seem to be pushed out past the 2009 time frame, but we are growing. It is just that some of the volumes are coming in lower than we would expect or lower than we'd like. So, all in all we are growing on the all wheel drive side. Unfortunately we are not growing as fast as I would like.

Last one. Medium and heavy duty truck revenue, Robin, in the quarter round numbers and then thoughts on how that might impact you in '07?

I can grab that one.

Okay

Heavy duty for the quarter was around 14 %. That doesn't include AG equipment. AG equipment jumps in at about 4 % on top of that. That's basically third quarter sales.

Looking into '07. Growth offset, what looks like a decline in the heavy duty or --

Well the market is going to decline, that's for sure. We said because of our--for us we are going to bridge ourself across the decline or across the valley. If you see a valley of sales decline for the industry in 2007, because we are growing in applications on the cooling system side or the thermal system side for fan and fan drive applications where we are going from an optional situation to the standard position on many of these North American and European truck manufacturers, and I also should say that this commercial truck decline is more U.S. oriented than European oriented we are also strong on Europe on commercial truck. We are also growing on turbo charges for light truck and commercial truck side of our business out of our Asheville plant. We think we'll be at least even and bridge across the decline for 2007 and stay even on sales.

Okay. Thanks a lot.

Thanks, Rob.

Your next question comes from the line of Robert Barry with Goldman Sachs.

Good morning everybody.

Good morning Rob.

Any new color on the outlook for diesel in North America now that the backlog looks another year our.

Diesel in North America continues to be a more positive story. You have Honda saying they are coming on board with diesel engines in North America and they showed the first engine over at the Paris auto show. You have growth in diesels for light truck and SUV's. You are starting to see more activity on, EPA and some of the regulations that will help diesels. You have the low sulfur fuel coming, that's here now. Not even station has it. You have guys like me driving diesels now, I'm driving a new diesel and I have to tell you it is a lot of fun. So, it is a slow, but positive story for North America on diesels.

I would say that the--in the backlog we are probably seeing more influence from imports from Europe that are diesels in this wave of backlog as the domestics begin to build their fleets here.

I see. Are you on the Honda ?

No.

Okay.

Well, they haven't announced whose on it, but we are not involved on that one.

I see. Have you ever talked about the margins of the DCT or could you at least say if they are at, above or below the average operating margin for the company?

We have not talked about the margins of DCT, we stay away from discussing margins on all our products.

Okay.

But I can say over time, we expect a program. When a product is introduced and over the life of the product we expect it to return 15 % cost of capital.

The other thing, we have said is we expect to be able to maintain our overall company margins in that 8.5 to 9% range so that would infer that as we grow with new programs they'll help us be able to maintain the margins.

Got you. Anything you can do about the nickel head winds? Sounds like it might of cost you a little bit by surprise.

Robert, that is a great question. Were working on that right now. Tim and I have a meeting once a week with the executives in the turbo organization. The president that runs that business a head of their sale organization, the head of their purchasing organization and their finance team and review once a week opportunities action items for trying to turn that situation around for us. There is a lot of activity going on both on the purchasing side as well as on the customer side and then in the engineering side, which is probable just important. Looking at ways to reduce the amount of nickle content in some of the products that we use.

Okay, just one house keeping item. Did you mention that the R&D increase year over year was $0.08 a share?

Yes.

Okay. Thank you.

Your next question comes from the line of David Leiker with Robert W. Baird.

Good morning all . There is a couple things I want to follow up on. You said you business, commercial vehicle business is like 15% today. How is that split between U.S. and Europe?

David, it is about 50/50 between the two.

Okay. When you look at the DCT launch, that's a program that's been in launch mode and hasn't really been a contributor to the bottom line, has that cross that threshold here this year for you or is that still a 2007 issue.

That has crossed a threshold for us. We are getting incremental earnings out of those sales, all that product line is now generating profit for us.

With that being said we are continuing to put infrastructure in other parts of the world for dual clutch transmissions. It is kind of give and take on that one

Do you think you reached your normal operating profitability on that or is there still room to go?

As Tim pointed out we are still put anything infrastructure in certain locations. We will be as we pointed out. These programs will continue to grow, Tim mentioned we've got a lot of business sitting behind the 2009 number, 2010, 2011. That will require infrastructure investment as well. Gradually it will be moving in the right direction. It is profitable today, it will continue to grow incrementally but there will be a number of years of growth pains from investment perspective and infrastructure perspective in the business.

David, if your talking about the Volkswagen and Audi business that's starting to grow and--in its incremental profits. I wouldn't say it has reached where we think it will end up.

That's great. When you look at your new business, that you come out with each year, we typically see something from a technology side that is a little bit new , whether it is DCT or next generation turbo or variable cam timing. It didn't seem like there was much of that in this book of business when you look out to the '09 or is there something I'm missing?

David, one of the significant pieces is in the turbocharger business you have a lot more of the new generation technologies around VTG and R 2S. Some of that is being driven by the applications in gasoline-direct inject engines.

Another thing I would add is we have some new engine technology that's not in that time frame and we have new transmission technology that basically could be viewed as the low-cost transmission technology for the emerging markets. None of which is in that backlog either. So we have got plenty of ideas and plenty of products that is we are working on to keep our pipeline of new technology full or reasonably full, so that we can continue to have this growth in our pipeline of new business.

You have done a good job of handling that in there.

To be honest with you we developed the technology to meet the market needs. Sometime was codeveloped with customers, sometimes we don't. But sometimes you just need that spark. You have the technologies you just need that spark to ignite it. We have some product or technology these just on the verge of waiting for that spark to ignite it.

Okay. Robin, I missed part of this t call and I don't know if you detailed this but this gain that you have got divestitures, is there a pretax number you can give us.

Yes, it is 4.9.

4.9 is pre-tax?

Yes.

Did you list what were?

It is sitting in other income. That's a divestiture that occur in 2005. There are potential contingent liabilities associated with the the transaction. They have gone away so we have taken the rest of that gain to income.

Okay. Then the last thing here as we look at the new business when you try to model it out year by year by year, I'm trying to figure out if there is a step down in the volume in '09 or is there smoothing we need to do with '07 or '08 of business that may have pushed in '09? Does that make sense?

No. Try it another way. Sorry.

What I--take the $1.7 billion and role in '09 for where our '07 and '08 estimates are, '09 new business numbers are actually lower than '08. I'm wondering if there is smoothing there?

No, let me give you the numbers. It is 530 for '07. 530 million for '08 and 640 million for '09.

David, I think the difference is there's been volume assumption changes in the '07 and '08 numbers plus some delays in launching. Some timing delays.

Okay. It looks like there is some '08 business got moved into '09.

That's very possible.

Could be.

That's great. Thank you very much.

Thanks David.

Your next question comes from the line of Richard Kwas with Wachovia Securities.

Good morning everyone.

Good morning.

Tim or Robin, I wanted to ask about with 530 million of business coming on-line next year are you still sticking by your 7 to 9 % topline growth rate for '07 because that seems to imply a little bit higher growth rate?

Well, Rick a couple things you need to look at. One is the amount of money each year that we so happily give back to our customers in price reductions, which will average between 1.5 to 2 % a year. So start January 1 of 2007 and you can reduce our numbers by a healthy amount there. In the growth we see 530 backlog. Year-over-year we do expect to see the type of levels in the U.S. market that we are seeing today. As we said before we believe we've made some permanent changes in our cost structure in the U.S. in preparation for what we think the future to be. What we are experiencing here in the third and fourth quarter in volume levels from the light truck SUV product levels we are not expecting that to some back next year. The first half of 2007 you'll continue to see some negative comparisons in some of the segments from a sales perspective. Does that help you?

Yes, it does, sounds like you are still looking for 7 and 9 next year rather than higher than that.

Yes.

And then, I guess on that transmission technology, that you were referencing earlier is that the DCT light?

Well, it's got a lot of code names inside the company but that would be one of them.

You have other stuff?

No, that's one of the code names for that technology. We are working on -- Rich, let me clarify it a letter bit better. When it comes to DCT we are working on multiple generations of DCT to improve cost structures for our customers because you continually have to improve your technology for emerging markets that want a lower cost automatic transmission. So we are doing that. So that's what you may have referring to as D CT light.

Really, none of that's in the current backlog?

No, like I said, gestation period for transmission programs is three to four years.

All right. Thanks.

Thanks,Rich.

Thanks, Rich.

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

Good morning.

Good morning Bret.

It seems like you are so happy to share the money with your customers, you might want to spread it around and consider the analyst community, as well.

I don't think that's allowed.

There you go. The 14 % number you gave for the medium heavy duty half sound like it is in U.S., can you give me a rough slit of what the medium heavy duty is on the U.S. portion?

I would probably says the a little more slanted towards medium than heavy duty. I don't have the exact break down, but know what programs it is attached to it is probably more slanted 2-1 towards medium duty.

Okay. That's perfect. As far as your sales backlog, going 535,36,40. As we think about the '09 number, my question is as we think about '10, 11 and so forth, should we think about this acceleration as something that should continue going forward or is '09 just happens to be a big year? I mean is there any particular one or two product that is are really starting to see an acceleration in growth?

Well, to be honest with you I can't answer that question directly because we only captures it for three years the fourth and fifth year get a little bit foggy for all of us in the industry. But my expectation is that we have some pretty good products that are going to generate some continue--continue to generate good growth. Turbo charges and dual clutch transmissions. All I can tell you is hang tight because you'll--we're going--we'll be talking more about dual clutch transmissions shortly. We also are starting to see, in addition to continued interest we've seen in dual clutch transmissions, we are starting to see-sorry not dual clutch, variable cam timing, more interest because of the extreme interest and push towards a better emissions and better fuel economy and the interest in using variable cam timing on diesel engines, in addition to gas engines. So we have continue to have sleepers out there that I this will give us a continued good growth rate. The way I like it at. Long answer to a short question, the way I look at 1.7 million and the growth rate we have had over the last four or five year, just continue on with that kind of a growth rate. I think that'd be a fair way to look at it.

Let me ask that question a slightly different way. That was a thorough answer, thank you. As we think of the 640 relative to 530's in '07 and '08 is there a particular, notable increase in any particular product or region in the $640 million versus the previous two years?

I think it is a lot of programs all catch them.

Okay.

It is an even distribution, I'd say.

Robin, as you think about the fourth quarter, is it fair to assume that decremental margins on declining sales you see getting closer to the 30 to 35 % range?

That's exactly right Bret. We made the changes as we said earlier, from a restructuring perspective towards the end of the third quarter. We didn't react quickly enough. Frankly you can say that the customers dropped schedules quickly but none the less. So we are not seeing any benefit in the third quarter from the restructuring activities. We expect to see that in the fourth quarter, that will help move that in the U.S. down close to our 30 to 35 % target range.

Tim, on the acquisition front, couple thoughts there. One, can you talk a little about your focus in terms of product or regions of the world? Where would you like to see I some growth there? Secondly, are you thinking primarily small acquisition or is there a potential to do something larger? Third, simply is there anything you see taking place within the next six months?

Hole on a second. I got--you had so many parts I have to write them down so I can remember all of them. In the regions--basically I think we're going to look at acquisitions that grow where the world is grow ing the auto sector.

That bring said we're going to look at acquisition that probably continue to grow in the eastern European or western European markets. You're going to see acquisition--I'd like to do acquisitions in the Asian markets. It is tougher over there, both in Korea and in Japan. Japan, because of the network and the culture, Korea because of the cable network and there is mainly one or two big OEM's over there. They actually want to integrate technology inside their own company and that doesn't lend itself very well to acquisition or to divestitures. Them doing divestitures.So we'd like to grow in Asia, we'll see us doing acquisitions in Europe, for sure. North America it'd have to be a real sweet technology opportunity or a certain play on a key customer. In general, I don't see us doing a lot of acquisitions in North America, for a lot of reason we have a lot of infrastructure in North America already that I'm restructuring.

As far as small versus large, yes, we have the where with all, the financial with where with all to do a large one, if there is a compelling, strategic, large acquisition, we'd look at it. That being said, our primary driver will be smaller, more strategic acquisition that are in the bolt on size, much like what you saw with the transmission solenoid acquisition we just did with Eaton. That's a very strategic acquisition for us, in terms of technology, customer presence and actually they had some good trade secret manufacturing that will also help us as we take low volume manufacturing technology for high pressure solenoids into China and the rest of Asia. What was the third part of your question?

Anything in the next six months?

Oh, never say never.

Okay. Thank you very much.

Thanks Bret

Your next question comes from the line of Scott Merlis with Thomas Weisel Partners.

How are you?

Good Scott.

I actually had a question on the transmission solenoid technology. You had already had a fair amount of solenoid technology, I think I remember you acquiring with Coltec in the early to mid 90's. How is this transmission solenoid technology new, complimentary? And if the manufacturing technology is not a total secret, what's really going on there?

Okay. Our current technology that we have is more low pressure focused in the world because of a transmissions are look for faster. Transmission shift points and crisper transmission shift points and more accuracy in the way transmissions operate. People are high expectations for the way their transmissions operate in terms of smooth shifting and how fast they shift. Consequently you need higher pressure transmission solenoid to do that. Our technology, with this latest acquisition we now cover the full range of low pressure and high pressure technology and solenoid, so from a compatibility it is complimentary to our current technology and it gives us kind of a leapfrog of technology we are developing internally, so this basically speeds up with our development of higher pressure transmission solenoid technology. As far as manufacturing, I had said this earlier, But, I give it a more simple answer, that is our technology for manufacturing tends to be higher volume, longer runs, less variety of solenoid okay? On the acquisition they are used to more variety, shorter runs and they have very low volume manufacturing technology which will be very helpful for us as we go into new markets where they start out with lower volumes we have have a very cost competitive transmission solenoid or any solenoid, whether it is engine or transmission. They have a lower cost to start off with low volume and move into our technology for lower cost high volume technology on the manufacturing side. I don't know if that answer you question, Scott.

These interest. [inaudible]

I want to compliment meant you on your memory. That's pretty darn good.

There are very few people that remember that started with Coltec

I think I found one of your solenoids on my desk. As long as it doesn't have any nickel in it I'm okay. In the final question goes back to the backlog, can you discuss the cash flow intensity of this backlog? How much more infrastructure, a lot of the products in there seems like they could go into existing plants. This does cause your cash flow to grow because you can fill existing plants? Obviously you are going to build more plants in Asia.

That's a good question Scott, we have been in the expanding capacity in Asia and our capital spending as a percent of sales runs around that range plus or minus a half of a percent. We expect to continue to have capital spending at that level. We don't anticipate a significant increase in capital spending relative to where we have to be able to support this growth.

Okay. That's important. Thanks.

We have time for one final question. That question comes from Chris Ceraso with Credit Suisse.

Thanks. Good morning. Couple left on the backlog. On the turbo still robust growth there. Can you give us a feel of how much of that is within diesel and within that is it Europe, Asia, North America and how much is gas direct injection?

I can give you the geographic pretty easy. As the combination of Europe and Asia. I know gas is growing in--I don't know about diesel--it is almost all diesel according to my experts here.

Okay. So. Still mostly diesel.

Yes.

Okay. Then the other one, maybe this gets to what your comment about you would have liked to have seen better growth in the all-wheel drive area. What's your assumption for the transfer case business on the T-900?

Well, there is a debate. We were with a customer last week as a matter of fact, the customer thought it was going to be stable and or maybe slight growth. Our view is it is going to be--probably won't be stable and probably decline slightly. We have seen a huge decline already, there will probably be more to come. I don't know how much is left. But, there will be stabilization on the pick up truck side what you are seeing now is some of the rare wheel drive passenger cars are going to all wheel drive. We are picking up some of that business, like the Audi 27 that I'm driving. We have the Cadillac rear wheel drive cars. So we are pick up a lot of the--these are lower volume applications. There is more business out there we'll be picking up and probably other people in the market will pick up some. I think that the decline in the--the decline in SUV's will be greater than the increase in transfer cases for passenger cars with all wheel drive.

But Tim, isn't there something incremental here for the trucks that have the stability control? Aren't they looking for a bigger penetration rate?

Well, there are regulation in terms of stable control going wide-spread across the board in North America. There's--yes you may see more stability control systems going on, which means you have to have that active transfer case. Doesn't necessarily mean you have to add a transfer case, you just have to convert, what right now is a passive shifting or engaging transfer case to an active transfer case.

Right, but those are yours instead of the other guys so fit has stability control it is your transfer case.

We do a lot of stability control systems like a GM and 900. Okay? I wish I was the only one out there with active transfer cases, but we're not. We're the first, but we're not the only at this point in time.

Okay. Thanks a lot.

Sure.

Thanks, Chris.

With that we will conclude today's call. I will ask if you have any follow up questions you can direct them to me or Ken, thank you all for joining us.

That does conclude the BorgWarner 2006 Third Quarter Earnings Conference Call. Thank you so much for joining and you may now disconnect.