博格華納 (BWA) 2007 Q1 法說會逐字稿

Good morning. My name is Jennifer and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2007 first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers 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, Jennifer. Welcome to everyone, thank you for joining us. Copies of our press release went out today before the market opened. We have posted financial talking points that should help you follow the financial discussion today. They are located at Borgwarner.Com, investor information, webcasts, first quarter 2007 conference call talking points. Should be right there -- it's easier to find than it sounds. These notes will be helpful to you as we review the financials and operations.

This conference call will also be replayed today through May 2nd. The call in number for the U.S. Is 800-642-1687. The international number is 706-645-9291, and the conference ID is 3379165. And the replay is also available on our website. Want to let you know that we're scheduled to attend a number of conferences in the next few months. The KeyBanc Automotive and Industrial Conference in Boston on June 6th, and the Wachovia Global Equity conference in Massachusetts on June 28th.

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

Thank you, Mary, and good day, everyone. Today we reported solid results for the quarter. On the positive side, we delivered record sales as our European and Asian operations continued to drive growth, and we have seen a noticeable improvements from our restructuring efforts here in North America. I would also like to emphasize from an operational perspective, everything in the quarter went according to our plan. But there is a $0.17 per share warranty related charge from a product that was built in 2004 and 2005 which is no longer in production.

We did lower our guidance as a result of this charge. We now expect earnings in the range of $4.53 to $4.73 per share , $0.17 per share lower than our previous range. We still expect sales growth of 7 to 9% and operating margins near the low end of our historical range of 8.5 to 9%. First quarter highlights include record sales of $1.3 billion, up 11% from first quarter 2006. Our sales outside of the U.S. Were up 13%, excluding the impact of currency, compared with vehicle production outside of the U.S. That was up only 2%.

Sales in the U.S. Were down 5% primarily due to lower U.S. vehicle production, which was down 8%. We improved our margins based on the restructuring actions we took in our North American operations in the second half of 2006 and these actions were taken in response to customer restructuring and significantly lower customer production schedules. Earnings were $1 per share, including the related charge of $0.17 per share. Without this charge, our earnings would have been up 10% over the third quarter of 2006.

On an operational basis, our operating margin of 8.1% was nearly flat compared to the first quarter of '06 and a marked improvement over the second half of 2006. So let's discuss the group highlights. Sales in both our engine and drivetrain group were up with sales in both groups the strongest outside of the U.S. Region. Operating margins in the drivetrain group were up 22% showing the biggest impact from our restructuring.

During the quarter, our European drivetrain business opened a new technical center in Ketch, Germany, that will also function as its European headquarters. We announced that the 2008 Dodge Avenger will offer our interactive torque management or ITM system that debuted last year in the 2007 Chrysler Pacifica. And the 2007 Toyota Tundra six speed transmission is built with shift quality components supplied by BorgWarner transmission systems and NSK Warner, our joint venture based in Japan.

Before I turn this meeting over to Robin, I want to focus your attention on our continued strong fundamentals, which are the trends that are driving our business and our $1.7 billion of new business backlog. These trends include fuel prices that are rising again, and governments around the world are focusing on climate change and CO-2 reduction and our technologies are aimed at improving these issues. We continue to win new business. 40% of that business is in new turbochargers for light vehicles and we have variable geometry and regulated 2-stage units for both gasoline and diesel engines.

Another 15% of our new business is in our dual clutch transmission technology. Our geographic region and customer diversity are unmatched. Last week, we were awarded two Automotive News pace collaboration for our work with Porsche for leading edge turbocharger and hollow drive technologies on the new Porsche 911. These same projects were honored with innovation awards also. No supplier is better positioned than we are to benefit from the demand for better, cleaner powertrains. We continue to demonstrate the viability of our technology driven growth strategy, and the benefits of building one of the most diverse customer profiles, which is combined with an environmentally friendly green product portfolio. Thank you, and now I'll turn the meeting over to

Thank you, Tim and good morning, everyone.

Before I get into the financials, let's review the industry environment during the first quarter. Which pretty much was a continuation of the second half of 2006, with production in the first quarter in the U.S. down 8% and global production in the quarter kind of flat year-over-year , and as in the prior few quarters, the growth is coming outside the U.S. Predominantly Asia, which was up 2% in the quarter, Europe was up a tad about 1%. Now given that industry background, let's look at our first quarter financials. As Tim said our sales growth in the quarter was 11%, or if you exclude the impact of currency 6%, and that 6% again compares to a flat global production environment. Our regional sales performance continued to reflect these regional conditions.

Our sales in the U.S. Were down 5% compared to that 8% production decline, and outside of the U.S, we posted solid growth excluding the impact of currency, of 13% compared so 1.5% market growth. If you look at our sales in the U.S, It represented about 36% of our quarterly sales versus 42% a year ago, and it's a continuing shift, if you look back at the third quarter, the U.S. was 38% of our sales, the fourth quarter was 37 and again, the first quarter of 2007 is now 36, as we continue to out pace the growth in other parts of the world.

In the quarter, gross margin and operating margin were 16.9 and 7% respectively on a reported basis, versus 19.3 and 8.2 respectively during the first quarter a year ago. Now let me give you some details of how our operations were impacted by the growth around the world, lack of growth and to get you to understand our operating income. If you look in the U.S, our U.S.- based core operations declined approximately $50 million in the quarter which was as expected, and also consistent with what we saw in the third and fourth quarter last year. If you remember, in the third quarter our sales, base U.S. sales declined $65 million year-over-year and the fourth quarter, $55 million and as we told you last year, we expected another 100 to $120 million decline in the first half of 2007 until we get some good comparison towards the back half of the year and that's what the first quarter was.

It was a decline of $50 million. If you remember, as well, the decline in sales in the U.S. In the third quarter, we lost $0.45 on the dollar. In the fourth quarter, we lost $0.31 in the dollar, and as we said before, we expected the 2006 restructuring of our North American operations to improve these detrimental margins and based on our financials it is clearly yielding results. The lost income in the quarter on the $50 million U.S. sales decline was $10 million, which translates into about $0.20 on the dollar and again a significant improvement from the $03.8 on the dollar average we experienced in the last half of 2006.

Now offsetting the decline in our base U.S. operations was approximately $175 million, or over 20% of growth elsewhere in the quarter. This was primarily outside of the U.S, but also included the continued growth of a new turbocharger program we have in the U.S. And also the impact of stronger currencies, primarily the Euro. These higher sales translated into about $20 million of incremental income, or $0.11 on the dollar after absorbing much higher raw material costs primarily nickel.

On a net basis, or after contractual customer passthroughs and hedging activities, raw material costs were higher by approximately $23 million year-over-year, or first quarter 2007 versus first quarter 2006. Of that $23 million, $13 million was related to nickel, and again, the 13 related to nickel is a net nickel amount on a gross basis, or before customer pass throughs and hedging, nickel was up about $28 million in the quarter versus first quarter 2006 and also was up, remember we had expected nickel prices to be higher in 2007 versus 2006, and also was up, remember, we had expected nickel prices to be higher in 2007 versus 2006, so in the first quarter, nickel prices were about $11 million higher than our first quarter 2007 expectations. Finally, we continue to tightly control our overall SG&A expense which was at ten percent of sales in the quarter versus 11% last year, while still investing in our future growth as R & D spending remained at the 4% of sales target level in the quarter.

Now, the net results of these items was record operating income in the quarter and operating margin of 8.1% and that 8.1% operating income margin was essentially flat with last year's margin of 8.2%. And as Tim mentioned, this is a significant improvement over the third and fourth quarter 2006margins, which if of you remember, third quarter 2006 operating income margin was 6.3 %, fourth quarter was 7.4, and now we're at 8.1%, and this is pretty much in line with our expectations to bring margins in 2007 back to the low end of our historical 8.5 to 9 percentage range, as a result of the restructuring actions we took in the last half of 2006.

As Tim also mentioned, our reported earnings and margins included the impact of a $14 million warranty related charge surrounding a product which was built during a 15 month period in 2004 and 2005 that is no longer in production. The warranty related charge was $14 million pre-tax as I said, and as a result, our reported operating income margin in the quarter was 7%. Below the operating income line, equity and affiliate earnings was slightly lower due to a weaker Japanese Yen. Interest expense was lower as lower debt levels more than offset the effect of slightly higher interest rates and the effective tax rate in the quarter was 27%, down from 28 in the first quarter 2006, and up from the full year 2006 rate of 26%, but in line with our previous expectations of guidance of 27%.

Currency translated added $0.04 a share to earnings versus last year, however relative to our earnings guidance, the currency movement is about $0.02 a share in the quarter. On a U.S. GAAP basis, net earnings were $1 a share, down $0.06 from first quarter 2006, and again the warranty related charge was about $0.17 a share after-tax, and without that charge, our earnings would have been up 10%, in line with the 10% top line growth we had in the quarter with the 10% top line growth we had in the quarter and also record first quarter earnings to go with our record first quarter sales.

Now let's move on to our operating segment performance. The drivetrain group's first quarter 2007 consolidated sales were up 4%. Solid performance for a group that has been under a great deal of production, volume-related pressure in the United States in recent quarters and as we alluded to earlier when discussing our consolidated operating results, our operating segments' regional performance again reflects regional conditions. In the U.S, drivetrain group sales were down 11% as lower domestic vehicle production primarily equipped with TorqTransfer products and lower sales of traditional transmission products weighed on the group.

Drivetrain sales were up 8% outside of the U.S. excluding the impact of currency, and also the Eaton European Controls business acquisition we made late in the third quarter. The group continued to benefit from increased demand for dual clutch transmissions in Europe and TorqTransfer products in both Europe and Asia and if you look at the EBIT margin in the quarter again, you can see the impact of the restructuring, which as we said in the fourth quarter, the majority of that restructuring activity was in the drivetrain business, as our EBIT margin for the quarter was 7.1%, up over 1% from the 6% EBIT margin for drivetrain in the first quarter 2006.

Moving to the engine side, first quarter consolidated sales were up 14% versus first quarter last year, and the U.S, the engine group sales were flat as growth in that new turbocharger program launch offset production volume-related sales declines from our customers. Outside of the U.S, excluding currency, sales were up 11% and in the engine group segment, EBIT margin for the quarter was 9.5% compared with 12.3 in the first quarter last year as the impact of the warranty related charge and sharply higher raw material costs, primarily nickel, weighed on the group.

Let's talk about the balance sheet and cash flow at the quarter. Our investment grade capital structure continues to be strong. Our debt-to-capital was at 26% at the end of the quarter versus 28% at the end of the year. Net cash provided by operating activities, we had a strong first quarter at $83 million, it's up $35 million from the first quarter last year. Capital spending including tooling was $58 million compared to $70 million last year, and these investments continue to support our $1.7 billion book of new business, as well as the continued focus on cost reduction and productivity improvements we're driving in our business to help offset some of the raw material price increases. Our after-tax return on invested capital at the end of the first quarter on a rolling four quarter basis was still strong at approximately 12%.

Now, let's talk about nickel and the rest of 2007. I want to take a minute to talk specifically about nickel prices for you. We've had a lot of questions about nickel, and the impact nickel is having on our 2007 financials. Let me give you some relative numbers. Average prices in the first quarter for nickel were up approximately $12 a pound from first quarter 2006, and on average, were up about $4 a pound higher than the fourth quarter of 2006, so from a year ago $12 a pound and from the previous quarter about $4, and as we said before we buy anywhere from 9.5 to 10 million pounds of nickel in our product throughout the year so first quarter we use about 2.3 million pounds.

It gives you a sense of the size. We do have in place today contractual rights to pass through nickel price increases with some of our customers, and we also have hedged a portion of our nickel purchases. Together, these cover about 50% of our gross nickel exposure. However, because of these higher nickel prices and our inability to pass through the full 100%, our expectations regarding the net impact, which is the gross cost plus pass through and hedging, the net impact of higher raw material costs on our Company this year has changed. Our original guidance for the year for raw material price increases was 40 to $45 million. If nickel were to stay at current levels, which is about $22 a pound, we would see net raw material price increases in the range of 75 to 80 million this year.

Now, as I say that, please keep in mind that we've always absorbed $23 million of that 75 to $80 million expectation in the first quarter, and we've absorbed that $23 million while improving margins from the last half of 2006 levels and let me tell you, we fully intend to continue to manage through these potential future cost increases. The market for nickel has been highly volatile, and we continue to implement a full compliment of solutions aimed at mitigating the impact of our nickel exposure, including additional market hedges, product redesign to reduce the amount of nickel we use on our products, and looking for more customer pass throughs. We also continue to work on the other parts of our cost structure to help offset rising nickel costs and you notice again the tight control we had on SG&A in the first quarter.

And finally, the contribution margins on our continued strong sales growth around the world will help to minimize the negative impact of rising nickel costs on overall earnings for 2007. So there has been no change in our operating performance expectations for the year. We have adjusted our guidance today to $4.53 to $4.73 a share range solely to reflect the impact of that first quarter warranty related charge. Our 2007 guidance remains based on expectations of 7 to 9% sales growth and operating income margin in that is near the low end of our historical 8.5 to 9% range and a 27% tax rate.

The business environment in the first quarter of the U.S. was a continuation of what we saw in the second half of 2006 , sharply lower production volumes in the U.S. market, pressuring OEMs and suppliers alike; however this was in line with our expectations and our North American restructuring activities in 2006 have left us much better equipped to deal with the challenges of the U.S. market and that shows in our financial performance in the first quarter.

Net restructuring, combined with our technology leadership and geographic and customer diversity, enabled us to absorb higher nickel prices and achieve strong operational performance in the first quarter. We continue to believe that we are well positioned to continue to profitably exploit the powertrain trends around the world that will drive our long term growth and future success. And with that, I'd like to turn the call back over

Thank you very much, Robin. I'll now ask our call coordinator, Jennifer, if you'd please go through the Q & A procedure, please.

(OPERATOR INSTRUCTIONS). We'll pause for just a moment to compile the Q & A roster. Your first question comes from Rich Kwas with Wachovia.

Hi, everyone.

Good morning, Rich.

Good morning. Wanted to just ask kind of a bit of a longer term question on DCT and kind of the potential growth there. What are you seeing in the emerging markets, particularly given that as a percentage of your revenue is coming out of the U.S. is lower and will continue to get lower, what are you seeing with DCT and some of the other products where the growth is going to come from particularly as you look over the next three years and as the backlog starts to build?

Rich, I just came back from a trip to Korea and China in March and I can tell you that DCT or DCT related transmission programs within BorgWarner are just starting to sky rocket in terms of the number of projects. Once we announced the Shanghai Automotive DCT program, a huge number of Chinese companies have now jumped on the band wagon in terms of development programs and investigations on how they can best utilize this technology. We're working, we're continuing to work with the Japanese. We're continuing to work with the Koreans, so and because we're working on low cost versions of dual clutch transmissions, it takes us into emerging Markets like China and even India.

So if your question is focused on the emerging Markets or the Asian Markets, tremendous, tremendous growth opportunity. Most of it obviously will be outside of the three year backlog period, but there will be some of it, some of the beginning of these programs will be at the tail end of that backlog period. I don't know if that answers your question. That's on top of we're seeing growth opportunities in North America now and all the growth opportunities we've discussed over all of these years in Europe that continue to run the plan.

Okay, great. Is that low cost version in the DCT production ready?

No. It's moving from the prototype stage to the production development stage.

Okay. And then Robin, with the debt to the balance sheet in very good shape here, I know you continue to look at acquisitions, bolt-ons. Any, when you look at the opportunities out there, have they gotten more plentiful, less plentiful or kind of the same as it was three or six months ago?

You know, we haven't seen a significant increase of assets available from what we were looking at six to nine months ago. As we've said before, most of the companies we're looking at are not things that just come on the market as part of a book that Investment Bankers shopping. These are mostly companies that we spend a lot of time getting to know, getting comfortable with and waiting maybe for a change in ownership structure or things along those lines, so the deal flow in the market per se really wouldn't be an indication of the activity we would have in the M & A side. It would be more what we can find by ourselves and the timing of some of the companies we have an interest in, their timing on when they're willing to change their ownership structure.

Rich, I'd like to go back and clarify one thing. We kind of have three levels of DCT now. We have the current production DCT. We also have a lower cost DCT that's ready for production now that we're talking to people about, and then over our cost reduced version of the current production and then what I was referring to that's going into the development stage is a, what I'll call an emerging market type transmission that's off of a DCT type platform.

Okay, great. Thanks for the clarification.

Rich, again, on the acquisition side as far as the activity, the activity hasn't changed but we do have a sizeable number of potential that we continue to monitor and work on and try and track down. So it's not like there's nothing out there that interests us. There are a number of things that interest us. It's just trying to get something that makes sense for everyone and move forward with a deal.

Great. Thanks for the update.

Your next question comes from Brett Hoselton with KeyBanc capital.

Good morning.

Hi, Brett.

A couple things here. First of all, the warranty charge, as we go forward here, is there any reason to believe that that may, we may see another impact there, either positively or negatively? In other words is there any other potential for charges associated with this or recovery of this charge?

Brett, as we said, this product has not been in production for over a year, so the relative exposure is fairly well known and we reflected in the quarter what we believe fully believe to be the amount required to take care of this issue and so at this point in time, we would have to change our financials if we thought anything different.

Okay. And then the outlook for nickel prices, 75 to $80 million, well that's not just nickel but that's total raw material, does that include the 50% recovery/hedging you have in nickel? Yes, that is net of it. That's right.

So apples-to-apples versus 40 to 45?

Exactly right. If you were looking at gross, that number would be a lot higher.

And the primary portion of that increase, is that due to nickel?

Yes. It's almost 100% due to nickel.

Okay and as we think about the trends we saw in the first quarter, in the different groups, the engine group, the drivetrain group, do you think that those trends are going to be fairly consistent going forward and by that I mean this, the engine we saw some very strong sales increases but we saw margin decline primarily due to nickel, on the drivetrain we saw slow sales due to production, but margin improvement due to restructuring, is that a consistent pattern for the remainder of this year?

Yeah. It will be a consistent pattern and I think that we'll continue to, what you saw in terms of the run rate for the performance of this quarter I think will be indicative of what we expect to see for the year. Like Robin will tell you, the comparables will get better in the second half of the year.

Brett, as far as the drivetrain versus engine goes, if you remember, most of the restructuring activity that took place last year was in the drivetrain part of the business, where the biggest exposure was, so the improvement from the restructuring as we said before that we're seeing and expect to see to Tim's point, the majority of that is occurring in the drivetrain business so the year-over-year improvement in margin that we're seeing a result of restructuring is predominantly in that part of the business and then as you point out, on the engine side, tremendous growth outside the U.S. market and we've got the nickel issue that we're dealing with. But as we've said before, we're not going to use nickel as an excuse for the Company's performance. It's just something we have to work through.

Thank you very much.

Thanks, Brett.

Your next question comes from Robert Barry with Goldman Sachs.

Hi. This is actually [Tyler]. I'm just calling in for Rob, but just two quick questions. I guess one on the nickel side. Obviously that came a little bit above your expectations and I guess I'm just trying to get a better understanding going forward. What specific areas do you really see a lot of those offsets coming from that pretty much allows you guys to keep your guidance on track, ex the $0.17 charge this quarter?

Well, regarding the nickel offsets, like I think Robin emphasized, we're going strongly going after pass throughs with our customers and we're in a number of negotiations. We're working on plans that reduces the amount of nickel in our product. That's something that you can't do overnight because it requires validation. We're working with our suppliers to basically have, how should I say it, get them to absorb and share in some of this pain, and then we're doing, we're hedging as much as we can when the time is right.

Okay.

And on the hedging, you still are subject to correlation issues.

And I guess just one last question. Do you think, I think we actually talked about it on the last call, but if you could just maybe give a little color on the heavy truck part of the business and just your expectations there?

Well, the truck, we're still doing well. We look at the numbers that I think the truck business in Europe is continuing to do well. We, like I said earlier, we've gone from an optional position to a standard position. You'll see that's kicking in now, but it's ramping up. You'll see the biggest impact probably in the second half of the year, so and on the commercial side which is mainly turbochargers and chain and fan drives, we're growing on the turbocharger side on the commercial side with the medium duty and the heavier duty are off highway, both in North America and we're doing well in Europe. So we don't feel that much pain or any pain on the commercial side now, and we expect things will just get better as we continue to get more and more penetration throughout the year.

Okay, great. Thanks a lot, guys.

(OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q & A roster. There are no further questions at this time. I will now turn the call back over to our host for closing comments.

Thank you, Jennifer. We will conclude our call today. Please direct any follow-up questions to Ken Lamm or to me. Thank you for joining us. We'll talk to you next quarter.

That does conclude the BorgWarner 2007 first quarter earnings conference call. Thank you for joining. You may now disconnect.