博格華納 (BWA) 2009 Q2 法說會逐字稿

Good afternoon. I will be your conference facilitator today. At this time, I would like to welcome everyone to the BorgWarner second quarter results 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). Thank you.

I would now like to turn the call over to Ken Lamb, Director, Investor Relations. Sir, Mr. Lamb, you may begin your conference.

Thank you, Monica. Good afternoon, and thank you all for joining us.

We issued our release this afternoon at 1:30 p.m. Eastern. It's posted on our website, borgwarner.com, on the Investor Relations homepage. There will be a replay of today's conference call available through August 5th. The dial-in number for the replay is 800-642-1687. You'll need a conference ID, which is 12540974. The replay is also available on our website. With regard to our IR calendar, we will be presenting at a couple of conferences over the next three months. The Credit Suisse Automotive and Transportation Conference on September 9th, and the IAA Investor and Analyst Conference in Frankfurt on September 16th. Before we begin, I need to inform you that during this call, we may make forward-looking statements, which involve risks and uncertainties as detailed in our 10-K. Our actual results may differ significantly from the matters discussed today. Now, moving on to our results, Tim Manganello, Chairman and CEO, will be providing comments on the quarter and industry trends, and then Robin Adams, our CFO, will discuss operating results and the rest of the year.

With that, I'll turn it over to Tim.

Thank you, Ken, and good day, everyone.

First, let's review the highlights for from the second quarter. Our second quarter sales were $916 million, down 40% from the same period a year ago, but up versus the first quarter of this year. Our US GAAP earnings were a loss of $0.31 per share. However, on an operating basis, excluding special items, we lost $0.05 per share. Now, at the group level, our Engine Group sales were $670 million including the negative impact of currency, while Drivetrain sales were $249 million, including currency. Sales on both groups or in both groups were up versus the first quarter, which I think is a good sign for the future. Our decremental margin, a key indicator of our ability to effectively manage the business through this downturn, was about 20%. In addition, I would like to point out the significant improvement in financial performance by our Drivetrain Group from Q1 to Q2 of this year. Now, as we continue to evaluate the business climate, it was determined that further restructuring was necessary. As a result of these actions, we took a $50 million charge in the quarter. And as the market recovers, we expect that the full measure of our restructuring activities will be realized in the form of healthy returns. Now, despite depressed production levels, we generated positive cash flow in the quarter.

We remain focused on cash management with an aim of maximizing every dollar spent and we continue to invest for the long-term as evidenced by our commitment to R&D spending. Working capital management was another key contributor to our positive cash flow. However, we still have work to do in bringing down inventories to an optimal level. In the midst of the automotive industry chaos, BorgWarner made a number of exciting announcements. We purchased a new ignition technology that we expect will play a major or prominent role in the continued improvement in gasoline engines. This high-frequency ignition system enhances combustion efficiency in lean burn engines, which improves fuel economy and lowers NOx and CO2 emissions. We expect to commercialize this technology within the next three to five years. Also, two of our facilities, one in Seneca, South Carolina and the other in Ithaca, New York, were recognized by Honda as Best-in-Class for delivery and quality, respectively. And we officially opened a new turbocharger plant in Poland. We will manufacture both gasoline and diesel turbochargers at this plant and will initially supply Fiat with turbochargers for their 1.3-liter diesel engines used in various models. Now, the changes we've seen in the US auto industry over the past few months have been historic. Both GM and Chrysler filed for bankruptcy and both emerged in unprecedented speed.

And while it has been difficult for everyone involved, we are all hopeful that this marks a fresh start for both companies. A healthy group of domestic auto suppliers or auto manufacturers is in the best interest of all of us in the auto sector. BorgWarner looks forward to helping these companies, both companies, strengthen their competitiveness in the US and around the world. The EPA and NHTSA jointly proposed new CAFE standards that will accelerate fuel efficiency for cars and trucks sold in this country. We believe these rules are a step in the right direction as the US attempts to keep pace with the rest of the world's fuel economy and emissions standards. For our part, we relish the opportunity to help our customers achieve these measures. Now, recently there were high profile bankruptcies in the supply base, including both Visteon and Lear. While the supply base has seen plenty of rationalization, there is still more to be done. There is simply too much capacity and it will have to be reduced to create a healthy supply base in the auto sector. Though the rest of the automotive market continued to deal with its recession-related issues and although the dynamics were different from region to region, I'll review them. Scrappage programs in Europe have added some stability and volume to their struggling auto market. However, it is not known whether these programs have pulled ahead future demand.

And with the exception of China, Asia continues to show significant year-over-year declines, although this region by and large has helped or held up better than Europe and the US. China is the only major auto market in the world to show growth in the quarter. Our presence in this region has proven to be helpful during this challenging time. So, this brings me to the outlook for the year. The potential GM and Chrysler bankruptcies were a major source of concern for us as we attempted to deliver our outlook for the year. With these two events behind us, we now have a bit more clarity on what to expect for the remainder of 2009. However, keep in mind that the breadth and duration of the global recession is still an open question and tempers our view of the near-term. That said, we now believe that production levels for the second half of 2009 will be incrementally stronger than the first half, and since we have sized our business to be near breakeven at first half production levels, we expect to be profitable in the second half. This is consistent with our previously stated targets of positive cash flow and earnings for 2009. Now, as added information, we are moving back towards a five day work week at most of our European plants and I view this as an encouraging sign for Europe.

Longer term, we expect our technology in combination with rule changes in the US, a re-engineered GM and Chrysler and our global presence to continue to drive growth for BorgWarner. Customers continue to develop fuel efficient engines and transmissions and we continue to execute our long-term strategy to invest in R&D that will drive our growth. Now, before I turn the call over to Robin, I would like to thank our employees for their hard work, dedication and focus on cost control, so far, to help all of us weather this storm. We still have many more challenges ahead, but as we maintain our focus on continuous improvement, we will emerge as a stronger Company as industry volume recovers.

Now, with that, I will turn the business over or turn the call over to Robin.

Thank you, Tim, and good afternoon, everyone.

Before I get into the details behind the financials, let's review again the industry environment in the quarter, which continues to be burdened by the global economic recession. Global production was down 26%, significantly lower than the same period a year ago, but actually up about 14% from the dismal first quarter 2009 production levels. And US industry production was down about 50%, our sales were down 41%. We outperformed in the sector. Our sales in Europe, excluding the impact of currency, were down about 30%. Industry production down about 27%. Japan and Korea down about 36%. Our sales down only 30%. Again, excluding currency. Overall, our sales, excluding currency, were down 33%. Global production was down 26%. If you look at the makeup of our sales, it helps explain a little bit of the difference. Our sales in the US represented only 27% of our total consolidated sales in the quarter, which from a diversification perspective, is a good thing. However, if you look at US industry production from a global perspective, it represents just 9% of the global market in the quarter, and China industry production made up 18% of total global production and grew at a 20% rate year-over-year, and that's a flip from a year ago where US was 13% of global production and China was 11%. Now, it's 9% and 18%, respectively.

Our sales in Europe made up 58% of our second quarter sales while European industry production represents about a third of the global market. So you can see, there's still a little bit of a mismatch with respect to our sales, global production, and when you think about our product technology, I think you could expect that some of the more developed parts of the world are using more leading technology today. That will change in the future. As Tim said, our sales in the quarter were approximately $916 million, down 40%, or $600 million from the second quarter of 2008. Again, down 33% without currency. For a discussion on earnings, we provided, as we usually do, a table on page 3 in this press release that we issued this afternoon, to help everyone understand our US GAAP reported earnings and also the non-recurring or non-operational items that occurred in the quarter. And this chart is intended to help reconcile our financial performance to both prior and current periods and also for assessing future expectations. And we think this is an important part of the release, an part of your understanding of BorgWarner's performance and future expectations. We also intend to file our 10-Q by the end of the day, which will provide all on the details on the quarter from a financial perspective and all the footnotes. I'm just going to hit the highlights today in this call.

For the quarter, US GAAP earnings were a loss of $0.31 a share compared with a gain of $0.74 a share in the second quarter of 2008. The second quarter 2009 loss included two items, which we, again, laid out in our press release. A $0.29 per share restructuring charge or about $50 million pretax, and that restructuring charge includes about $41 million related to asset impairments and other costs and $9 million related to employee termination costs. We have reduced our global workforce by another approximately 750 people in the first six months of the year and since June a year ago, approximately 5,000, or about 28% of the workforce. The asset impairment in the quarter includes the final cleanup of closing our Muncie, Indiana transfer case facility and some European assets. The other unique non-operational item in the quarter that we identified in the press release was a $0.04 per share gain, or $6.6 million pretax, from interest rate derivative agreements and those are reflected in the interest expense line of the income statement. And for those of you with a particular interest in derivative accounting, there are four pages of detailed disclosure in our 10-Q on the subject that I encourage you all to read. Second quarter 2008 earnings include purchase accounting adjustments related to the BERU acquisition a year ago, $4.5 million net of tax, or $0.04 a share. So, if you exclude the restructuring and the derivative item for 2009, and then exclude the BERU acquisition adjustment from 2008, you get a comparable loss in the quarter of 2009 of $5.1 million or $0.05 a share, compared to $92 million or $0.78 per share earnings in the same period a year ago.

Looking at the six months numbers, earnings were a loss of $0.37 a share on a GAAP basis compared with a gain of $1.49 in the first six months of last year. The first six months of 2009 included the $0.29 a share restructuring charge we talked about, a $0.03 per share net loss or $4.8 million pretax related to interest rate swaps. We had a loss in the first quarter, a gain in the second quarter, it nets out again to about $4.8 million pretax loss and again, that loss is reflected in the interest expense line item on the income statement on a year-to-date basis. We did have a loss in the first quarter as well, approximately $0.03 a share, due to the adoption of FAS 141R. It's in the SG&A line item, and we talked about that with the release of our first quarter earnings. And finally, in the first quarter of 2009, we did have a $0.15 per share net gain or $27.9 million pretax related to retiree obligations resulting from the closure of the Muncie facility, and this is also found in the SG&A line item of the income statement. When you look at the first six months of 2008 from a comparative perspective, the only non-operational item that occurred was, again, the purchase accounting adjustment related to the BERU acquisition that we just mentioned. Stripping out all these items, our net loss for the first six months of 2009 was $20 million or $0.17 a share compared with $181 million earnings or $1.53 a share during the same period last year.

Gross profit in the quarter as a percent of sales was just under 13% in the second quarter, down from approximately 18% in the second quarter last year, but up sequentially from 9.7% we reported in the first quarter of 2009. The year-over-year decline in gross margin is related to sharply lower production levels around the globe. Raw material costs were inconsequential in the quarter as far as increases and decreases relative to last year. For the year, as we've said before, we still expect nickel to provide about a $25 million benefit for us, relative to 2008, and nearly all of that in the second half of the year as existing hedges roll off in the second quarter of 2009 and as lower prices relative to last year, net of customer reimbursements, run through our income statement and just as a barometer, nickel is currently at about $7.50 a pound. Last year, it was running $11.16 a pound average for the quarter. The second quarter SG&A costs were reported at $115 million or 12.6% of sales compared with $157 million or 10.3% of sales a year ago and again, a year ago we excluded special items. Operating income on a reported basis was $49.5 million negative in the quarter versus about $119 million in the same period a year ago and again, operating income included that $50 million restructuring charge and if you put the operating income on a comparable basis, operating income running the business was about $800,000 positive in the quarter, essentially breakeven, versus $124 million of operating income in the second quarter of 2008.

Now, if you look at the decline in operating income relative to sales year-over-year, as Tim mentioned, it was about 20%. You're looking at $123 million of operating income change decline on $600 million of sales in the second quarter, and that's pretty much consistent with our 21% decremental margin performance in the first quarter and at the low end of our targeted 20% to 25% decremental margin range. When you think about it, our sales in the first six months of 2009 are down almost $1.3 billion or 42% from the first six months of last year, and I don't think anyone could have even imagined such a devastating sales decline a year ago. Despite this environment, we've been able to make significant changes in our cost structure to minimize the lost operating income associated with that $1.3 billion sales decline and we've minimized that to only $265 million, again, approximately $0.20 on the dollar. This is at the lowest or best end of our targeted 20% to 25% decremental margin performance again. What has made it a little bit more challenging for BorgWarner, and we've talked about this with some of the investors and the analysts, is the significant amount of our sales that are generated in Europe and in the quarter, it was over 55%, and the general stickiness of labor costs in that region of the world compared to the US market. So this performance, this 20% decremental margin performance year-over-year for the first quarter, the second quarter and the first six months, required implementation of some -- of many tough measures and sacrifices by all of our employees in the past 12 months. Close to 5,000 employees have been reduced or approximately 28% of our workforce from a year ago.

We've incurred extended shutdown weeks with no pay at most of our facilities around the world. We are at four and three day work weeks in our European operations, or have been. As Tim said, that's changing gradually. We've taken 10% across the board salary reductions with a 15% reduction at the senior executive level. Tough measures enacted swiftly and embraced by our employees around the world as what is required in these unique economic times and suffice it to say that we are generally very pleased with the results we see. The only operating income line for the quarter, equity and affiliates earnings were down -- I mean, were $4.8 million, down from almost $12 million in the second quarter a year ago. Predominantly, this is our NSK-Warner joint venture in Japan, which is our transmission components business to the Japanese customers and we continue to see the production cuts from our Japanese customers, as well, in this global marketplace. On the positive side, if you look at affiliate earnings in the second quarter, that $4.8 million is quite a bit better than first quarter which was essentially zero, so the trends are positive in that line item as well. Interest expense and finance charges, $9 million in the quarter. Again, included a $6.6 million gain related to interest rate swap ineffectiveness. Excluding that gain, interest expense was $15.6 million on a run rate basis compared to $10.8 million in the second quarter 2008. Included in that $15.6 million is approximately $7.4 million related to the convertible notes we issued in April and $1.1 million in amortization of financing fees.

While the convertible notes provided much needed liquidity insurance for the Company in these difficult financial markets and put excess cash on the balance sheet, they are a very expensive form of liquidity compared to the undrawn revolving credit facility we used a year ago as liquidity backdrop for this Company. The US GAAP effective tax rate in the quarter reflects a 39% year-to-date rate or 48% excluding non-recurring and non-operational items. After considering tax expense recorded in the first quarter, the rate for the second quarter falls out at 36% on a GAAP basis, 55% excluding the non-recurring non-operational items, and all that gets you, again, back to $0.05 a share loss in the quarter that we reported excluding unique items. Let's look at the operating performance in the quarter by segment. Reduced global vehicle production cut demand for all of our products and that included the Engine Group. Engine segment sales decreased $439 million, down 33% excluding the impact of currency. Earnings before interest and taxes were about $44 million in the quarter, down considerably, $82 million year-over-year. That translates to a decremental margin of $0.19 on the dollar, so when you look at that, it's good year-over-year cost containment on the Engine side of the business despite some of the challenges in the European market for them.

On the Drivetrain side, second quarter sales were just under $250 million, versus $414 million in the second quarter of 2008. That's down about 34% excluding currency. If you look at earnings before interest and taxes, the Drivetrain segment actually had a loss in the quarter, $8 million to $9 million, which is a decline of over $30 million compared to the second quarter last year. On a decremental margin basis, that's about $0.18 on the dollar. Very good performance from Drivetrain and, as Tim mentioned, a marked improvement over first quarter.

If you remember from our first quarter earnings call, Tim told you that Drivetrain performance would improve to the rest of 2009 with the closure of our Muncie facility and continuing actions in Europe, and I think the second quarter performance you're seeing is evidence of Tim's statement relative to that improvement. Both Drivetrain and Engine segments achieved decremental margins at the low end or again best end of our 20% to 25% range. And as I pointed out earlier, an excellent job of implementing tough but necessary cost structure adjustments in response to the unprecedented decline in sales. While we are generally very pleased with these results, we're not fully satisfied. As you know, Tim and I are a tough couple to make happy here. And despite taking all the right actions and seeing results at the best end of our expectation range, we still report a small net loss for the quarter, but an improvement from first. Now, many of you are not only looking at year-over-year decremental margins, but also incremental margins on a quarterly sequential basis and let me assure you we're doing the same thing. We are, as well. It's an important part of our look at the business. On a sequential basis compared with the first quarter, our incremental operating income margin is calculates to around 20%. Again, the top end of our 15% to 20% incremental operating income margin, and that's our expectation in a normal growth environment, but a little light from where we want to it be in this environment. And if you look at the income statement changes Q1 to Q2 sequentially, gross profit margin improved from 9.7% to 12.7%, as I said before, or about $37 million on $97 million of increased sales.

SG&A, as I said earlier, is at 12.6% versus 11.9% in the first quarter, or up $18 million sequentially in spending. Now, as we look at that $18 million, half of that increase actually was expected. There's a $5 million run rate increase, second quarter versus first quarter, in PRB and pension expense and that increase is associated with the closure of the Muncie facility and again, was expected. And there's also a $4 million increase in R&D expenses, second quarter from first quarter. Not expected in the second quarter in SG&A, part of that $18 million, and part of the drag on sequential incremental margins is what I'll call the BorgWarner stock effect. A portion of our employees incentive compensation and employee benefits are linked to the performance of BorgWarner stock, and after being relatively flat from year end, and to the end of the first quarter, BorgWarner stock rose from about $20 a share to $34 a share in the second quarter, or 68%. And I hope no one is going to complain about a 68% increase in BorgWarner stock value in the quarter but, however, this did result in about a $5 million increase in SG&A expense in quarter two versus quarter one and cost a little over 5 percentage points in sequential incremental operating income margin. Without the so-called VW stock effect, again, which we're all very pleased with, the sequential incremental margin was 25% and SG&A as a percent of sales was about 12% in Q2 versus 11.9% in Q1, essentially flat. Also, as you look at sequential performance, Q2 versus Q1, about 10% of the increase in sales Q2 versus Q1 was a function of foreign currency.

The dollar Euro was $1.34 at the end of the second quarter, $1.32 at the end of the first quarter, which is generating about 10% of those incremental sales and given the breakeven level we're at from an operating income perspective, that sales increase is not generating any operating income. So looking at the sequential operating income improvement, Q1 versus Q2, Q2 versus Q1, we're actually about $0.27, $0.28 on the dollar, significantly more than that $0.15 to $0.20 that we see in normal times and closer to our expectation of incremental margin improvement as we bring sales back, growth into the Company. If you look at segments, Drivetrain was 47% sequential incremental margin, Engine was about 18% and, as Tim mentioned, there's still room for improvement in both of these segments. Drivetrain was coming from a very poor first quarter operating loss and still has a little bit more work to do to generate positive operating income in that segment, but it's a tremendous improvement in performance. The Engine segment reflects, as I said earlier, our sticky European labor costs, which are not only sticky on the way down but also sticky on the way up and they need some further fine-tuning. As Tim mentioned previously, we are seeing increasing customer schedules in Europe and about two thirds of our facilities in Europe are actually currently back to five day work weeks.

And when you look at the stickiness or the cost structure when you go from a four day to five day work week, you're in theory increasing capacity 25% and your incremental costs. When sales increase over previous activity levels but less than the 25% increase in labor capacity on, let's say, 15% as an example, your incremental margins suffer a bit. So, if European volumes in the future increase closer to match that 25% increase in labor cost capacity, the overall incremental margins in our business will get stronger. Let's talk about the balance sheet and cash flow for a few minutes. Net cash provided by operating activities was $174 million in the first six months of 2009. Capital spending including tooling was around $88 million, significantly down from $162 million in the prior year, but pretty much in line with our full year expectation of about $200 million for the full year. After deducting the capital spending and tooling investment for the first six months from that net cash provided by our operating activities, operating cash flow was approximately $86 million in the first half of 2009. This is very strong cash flow generation in what is still a dismal global auto industry environment. As we've said many times, this is a business that generates cash. Another point of reference relative to the strong cash generating capabilities of BorgWarner, our EBITDA margin or EBITDA as a percent of sales for the second quarter was 7.5%.

Many of our peers strive to hit that 7.5% level of performance in the best of times and we're running at that level in what is arguably the worst of times we've seen in this industry. You'll note on the consolidated statements of cash flow provided in the press release the changes in asset liabilities was a source of cash over the first six months of the year. Tim has mentioned before that reducing inventory has been a focus of his and the Company and that's the primary factor for improvement. We've lowered inventory by almost $140 million throughout the first six months of this year or approximately 31%. The other major working capital change in the balance sheet is a $50 million increase in receivables resulting from the second quarter maturity of our off balance sheet receivables facility. One side of the transaction is increasing receivables, but the other side of the transaction is a $50 million increase in balance sheet debt. There's no real economic change here in the Company, just a movement of $50 million of financing from off balance sheet to on balance sheet. Balance sheet debt in the first six months of the year increased by $82 million or $32 million without the receivables debt.

We issued, as we noticed, $374 million in convertible notes during the year, retired $137 million in senior notes with those proceeds and repaid other short-term debt obligations. During the same period, cash increased by $154 million, resulting again in a decrease in net debt of $72 million, or if you exclude the receivables facility going on the balance sheet, it's really $22 million decrease in net debt. And when you look at this and put it all together, we further strengthened our balance sheet in a very difficult industry environment. Net debt-to-capital at the end of the quarter was 23% versus 25% at the beginning of the year. Let me talk about the rest of 2009 and pretty much reiterate Tim's comments. Clearly, there's a bit of optimism as volumes appear to have stabilized and inventory levels for our domestic automakers have returned to somewhat normal levels, and I'll leave that definition of normal up to the analyst experts. Also, the uncertainty around the fate of GM and Chrysler and how that would impact the supply base and, to some extent, the US economy, really restricted visibility into the near term and that's behind us. And so, as we look beyond the first six months of the year, we recognize we're still in a global recession that continues to disrupt auto markets around the world and there are market distortions, again, as Tim mentioned, as a result of these scrappage programs that are starting up and ending in different parts of the world. This causes us, again, to approach the next several months with caution.

Since our last earnings call, we polled the experts again and they really have made no substantive changes to their volume forecasts for Europe or North America for the year. The low end of the range for North America production is still about 8 million vehicles and for Europe, it's about 15 million. And even using those numbers, that would imply a stronger recovery in North America in the second half of the year and basically no falloff in Europe. While those low end of the range scenarios imply good things for BorgWarner, we continue to stay prudent and alert and keep our expectations in check. Tim mentioned we provided guidance, continued guidance, positive net cash flow and earnings for the quarter -- for the year, I'm sorry, and this implies that our continued cost cutting efforts in combination with at least a mild recovery in production volumes will generate positive earnings for us on the second half to more than offset the small year-to-date losses. While we remain cautious about the rest of the year, we've not forgotten again the criticalness of leading powertrain technology as the importance with respect to our continued long-term success. And again, we remain focused on executing our technology driven growth strategy. You can see that in our increased investment in R&D. We have a strong, dedicated workforce that's worked with us through these tough times and continues to ensure that we make the right decisions and maintain BorgWarner's reputation and position as the global leader in powertrain technology. And with that, when the global economy turns around, which it will at some point, we are currently well positioned both financially and technologically to remain at the forefront of the growth curve in this automotive industry.

And with that, I'd like to turn the call back over to Ken. Ken?

Thanks, Robin. We'll now turn to the Q&A portion of the call. I would ask Monica to please announce the Q&A procedure.

(Operator Instructions). We'll pause for just a moment to compile the Q&A roster. And your first question comes from the line of Itay Michaeli with CitiGroup.

Robin and Tim, could you just talk a little bit more about what impacted you from a mix perspective in Europe in the quarter specifically and how you view and model your performance in the second half of the year versus the industry?

Itay, I can give you a little bit of insight. We saw some declines in diesel sales, obviously, in Europe and there's an extremely high penetration rate for BorgWarner on diesels, both with glow plugs for starting systems and turbochargers. Now, some of that was picked up with gas engines, but the penetration rate for turbochargers on gas engines, although it's increasing in Europe on turbo charged gas engines, it's still not 100% like the penetration rate for diesel engines and turbochargers. We're still seeing really weak demand on commercial trucks in Europe and North America. Europe was down, like, in the air range of like 50% in commercial trucks, and I don't know if it's due to the scrappage program or whatever, but the aftermarket in BERU has some depressed sales, which has an impact on our margins. We do pretty well in the aftermarket. And because -- and I don't know if it's because of the scrappage program or what, but we're seeing depressed aftermarket sales out of BERU. So, that coupled with continued focus on heavy duty spending or heavy spending on R&D to continue the growth curve for the future and the launch of all our new technology and all our new programs we have, those all add up to be a little bit of a drag. What was the second part of your question?

No. Actually, that took care of it. Just moving on, a couple more follow-ups. Robin, can you quantify the impact of nickel in the quarter? I know you had mentioned the projections for the year.

As I said, when you look at the commodities in the quarter, it pretty much netted out to no impact whatsoever, nickel, steel and all the other pieces. We're expecting, again, about a $25 million improvement in nickel costs for the year and all of that's back-ended, third and fourth quarter.

Okay. Great. And then just finally, Robin, looks like you're doing a pretty good job of controlling CapEx. I know you're still tracking for about $200 million for the year. Could you talk about the next couple of years as production ramps up, do you think you kind of get back to the $400 million level or are you at a point where you feel comfortable you can kind of keep it at lower levels for a couple more years?

I think we're far away from a $400 million level. And as we said earlier, there's still quite a bit of uncertainty just from the last six months of this year and we continue to remain cautious on capital spending. We certainly are aware that when volumes start to pick up and the economies start to reverse flow here, it will be a significant amount of demand for our product. But how much additional capital will be required and when will really be dependent on the timing of that recovery and the size of it.

Also, I would add for the time being, we still have excess capacity and we'll use that and convert that as required to new programs before we start continued buying new CapEx for new programs if we can convert something else. The other thing is we've done a very good job of keeping our capital spending in that 5% to 6% of sales range and I think we're going to be able to continue to do that for the future and still manage this growth. That coupled with the excess capacity allows me to feel comfortable to stay in those percentages.

Great. Thank you. That's helpful.

Your next question comes from the line of Rich Kwas of Wells Fargo Securities.

Can you hear me?

Yes, hi, Rick. How you doing?

How you doing? Robin, I just wanted to ask about corporate expense within the segment reporting. That was a little bit higher than Q1, but running much higher than the year-ago period. I assume that there's a lot of -- there's some of that pension stuff and stock-based comp in there, but is that kind of the level we should be thinking about for the rest of this year?

The first thing that when you look at that segment reporting, it says corporate including equity and affiliate earnings. So, when you look at that, it looks like a $12 million increase year-over-year in the quarter, about $7 million of that is related to reduced equity earnings from the equity affiliate line items, so it's NSK-Warner. And then the remaining $5 million, yes, is the -- couple items that actually pension PRB expense, year-over-year is about $5 million in the quarter and then again the BWA stock effect relative to second quarter last year is still about a $4 million to $5 million item, which means basically we had some improvement in the cost structure in the rest of our corporate items and those are the three items that are really driving the 2008 versus 2009 quarterly comparison.

Okay. So, do we think about going forward with the stock, who knows where the stock goes right now, but where do we -- how do we think about that impact on, sequentially speaking, for the rest of year? Is it more likely to come down?

I'm voting for another 68% increase in stock price, so stick another $5 million of expense to the third quarter. No, seriously, pension PRB expense is a true run rate increase for us in SG&A. That is -- and maybe shame on us, we didn't do a good job of explaining that in the first quarter, but that was kind of built into our $0.20 of decremental margin management as is a lot of other factors, but basically the accounting in the first quarter with respect to closing Muncie does result in a $4 million to $5 million run rate increase in PRB and pension expense going forward, so we'll see that -- we saw it second quarter, we'll see it third and fourth quarter. We talked about the stock effect. I'd love to see that every quarter, and then really the other piece is NSK-Warner, the affiliate earnings. And again, second quarter was improved from first quarter. With all the uncertainty in the market, it's difficult for us to say how much better NSK-Warner earnings can get in the third quarter but, as Tim said, there's little bit of improvement expected in different regions of the world. That could be a little bit better in the third and fourth quarter. Our core corporate spending, though, we intend to try to keep a good, tight clamp on that for a little bit longer with business levels remaining as they are today.

Okay. That's helpful. Thanks. And then on restructuring, I think you mentioned $9 million of the $50 million was related to kind of headcount reduction. If I recall in the past you've been -- you were pretty comfortable, say, a quarter ago with the business where it was with the manufacturing footprint and the headcount. What's kind of changed in the quarter? Would you expect any further action here needed as we get into the back half of the year?

Well, some of it, Rich, was we had had stickiness in the -- in Europe, but -- and Robin talked about that. But as we looked ahead, we started to see that schedules looked like they were going to start to pick up, so where we thought we were going to go after some restructuring and a little bit more restructuring, we didn't see the need to reduce heads and then just bring them back in Europe as sales came back because it's so costly to reduce the heads, so we just kept some of the extra employees on the payroll because it was cheaper to keep them on the payroll and then, as orders picked up, we put them back to work full-time versus letting them go, paying them and then bringing somebody back to fill the increased demand. So, we had a little bit of that extra cost on a labor cost as we looked through the second quarter.

Okay.

Rick, I think if you remember on the first quarter call, we talked a little bit that we weren't happy that we were exactly where we wanted to be on the cost structure. We were close. We liked the decremental margin performance. We thought it could require a little bit more tweaking, and we were going to look at that in the second quarter. And that's really what the employee-related charge in the second quarter is more tweaking than some large movements of people out the door.

As we talked in the past, it's much easier to flex your labor costs in North America than it is in Europe.

Okay.

Very expensive when you start flexing it, especially if you flex it and then you have to bring some back.

Okay. And last question on sequential -- you talked about sequential contribution margin. With the increase to the five day work week, how do we think about the impact on sequential contribution margins with expected higher revenues in the back half?

That's a great question, Rick, and we're struggling with that ourselves. It's this stickiness issue that we're trying to manage through from an expectation perspective ourselves. As Tim said, we've got about two-thirds of our European operations back to five days, and we're trying to match up, as I said earlier, actual revenue increases to going from a three to four day or four to a five day is very difficult. So, we're looking. The $0.20 on the dollar, which was the high end we would expect in normal markets, certainly will achieve that. How much better than that we'll get, again, is dependent on how well we match up that going to five days with the increase in sales and I can tell you that I think early on in the first -- in the back six months of the year, we're going to have a little bit of fine-tuning required to match those things up, so you're not going to see a perfect correlation in incremental income on those sales early in this process, but we'll shake it out and get there.

One thing we are focused on, Rich, is that we're not going to let increased labor costs get in the way of generating or optimizing our margins the best we can as sales start to pick up. We're going to be very -- we acted as quickly as we could to reduce labor costs and we're going to be very slow to increase labor costs as volume picks up.

All right. Okay. Thanks so much.

At least do the best we can.

Your next question comes from the line of Brian Johnson with Barclays Capital.

Since most of the housekeeping questions are behind us, thought I'd ask a couple strategic questions. First, vis-a-vis DCT in China, can you give us any better estimate of when we can expect that to hit revenue and when we can expect to see it in backlog and maybe the magnitude, rough cut magnitude of what you're looking forward to?

Yes, sure. As typical of Chinese programs, they don't come as quickly as we like. I think you're going to start to see it in the 2011 to 2012 time frame, which is exactly I think what I said in the first quarter. Nothing's changed. We're continuing to have intense focus with the Chinese, especially with the customers, the two customers we're going to launch with. Their sense of urgency is quite high and probably picking up to higher levels of intensity, so -- but I still thing that there's going to be a big push to do it in 2011 as much as they can. I can tell you right now the Chinese auto market's the only hot market there is right now and I said that in my presentation. We're well positioned in China with DCT and all of our other products and the higher their demand goes, the better off we're going to be. It's going to take a little while to launch DCT because everything is coming from a green field plant, this joint venture that we announced at the end of last year where we're going to do module assembly, that's going to be a green field plant. We've got to get that up and running. We already have a component plant set to go, which is part of our wholly owned Company in China, so -- but the transmission plant that we're going to be selling to or at least two transmissions plants, they've got to get up and running too and we're waiting for them.

And secondly, with Fiat taking over the equity interest in Chrysler and Fiat also being well-known for its small displacement turbo charged engines in Europe, are you, A, what's your current relationship with Fiat and, B, where could that go as they bring their European product over to Chrysler?

For almost all our product lines, that's a great question, for almost all our product lines, Fiat is growing into a very strategic customer of ours. Almost all of our business units are doing business with Fiat. All our businesses are trending upward in a growth mode. We're actually doing more business with Chrysler or with Fiat right now than Chrysler. That's for the quarter. I think for the six months, it's about the same. Our Fiat business and our Chrysler business for the full six months this year is about equal. The combination of Fiat and Chrysler together, as I look at it, it's going to be plus or minus around 5% of our total sales, so they will be a strategic customer. BorgWarner will do much better with -- in the future with Fiat as the owner and just probably keeping Chrysler the way it was under the old Chrysler ownership.

And I think --

Perfect. Okay. Thanks.

If you look at what new business we've announced in the past few months, we saw a major participation in Fiat's new DCT transmission and I think in the last week, we've announced the turbocharger for their new 1.8-liter GDI engine, as well.

Just picked up the 1.3.

That was going to my question, between Engine and Drivetrain where are you on, say, the DCT programs --

They're working on some dual clutch transmission technology, actually, dry clutch. We're going to be a supplier to them on the control module for the dry clutch even though the dry clutch tends to compete with us on the wet clutch side. So, we've got our wet clutch technology that's growing and I think that there's a lost interest in that technology, including with Fiat, and there's going to be on the competing technology, we're going to probably pick up half the content there.

Okay. Thanks.

Thank you.

And your next question comes from the line of Rod Lache with Deutsche Bank.

Good afternoon, everybody.

Morning, Rod.

Just a couple things still. Can we use the $50,000 per person savings that you talked about last quarter, so you would be at roughly a $250 million run rate and how much have you achieved so far and then how would that break down between SG&A and your operating expenses?

Let me answer the macro piece. I think that the $50,000 per person average is still a relatively good number. Relative to quarter by quarter, that's a tough one. I don't have that in front of me. I can tell you that second quarter versus fourth quarter is about -- on a quarterly basis, about a $20 million improvement and sequentially that continues to improve throughout the year, so we're -- through the second quarter, we're $80 million annualized versus fourth quarter but, as we said, we expect that to grow throughout the year.

Okay. And is it like 75/25 with SG&A being roughly 25% of that? Does that sound right?

Probably. We tend to look at it from an operating income perspective, but looking at the cost structure and where the dollars lie, that's probably a fair assessment.

I guess I'm just trying to get a sense of what your run rate would be for SG&A, excluding, obviously, the stock effect. Is R&D likely to stay close to this level? Would SG&A be at this run rate over the longer term?

I think that as a percent of sales, R&D will at least maintain its level, maybe slightly increase. So, you'll see -- with the expectation that there's some growth, you'll see some increase in R&D spending, but as a percent of sales, we've traditionally been at about 4%, a little bit shy of 4% right now, but you could expect a good 4% spending level.

Okay. And just two more. If you can just talk a little bit about this new ignition system and what your expectations are for deployment and then just lastly, I guess I'm being a little thick on the understanding of the incremental margins. I thought you said earlier that you could get to 25% initially, but had some offsets from the move to a five day work week and then I heard the 20% that you had commented on previously. Could you just maybe clarify that for us?

Sure. That's great. First, let me start with the decremental margins. Back in December last year and January this year, we said that we were going to try and manage the business to 20% decremental margins. We've lost $1.3 billion of sales versus the first half of last year, in effect, have managed to that 20% decremental margin and I think that that in and of itself is a strong sign of our will and ability to execute and manage the cost structure of this business because frankly, I don't know of any other supplier that gets close to that. Having said that, the next issue is as sales increase, what's the incremental profit look like? As I said, if you look on a reported basis, stripping out the unique items, the one-timers, the incremental income from second quarter versus first quarter is about $0.19, $0.20 on the dollar, it's about $0.19 on the dollar.

But if you look at the incremental income second quarter versus first quarter, again, we've got the so-called VW stock effect. It's $5 million on $97 million of incremental sales, and if you take that out of the equation, you're close to 24%, 25% incremental margin and then, again, if you recognize that the sales increase second quarter versus first quarter, about $10 million of that is nothing more than currency. It's not new operational sales. And with the business running at about breakeven and you just changing the exchange rate, you're not generating any additional income. So, you take that out of the equation. You relook at the calculation and you're running about $0.27 on the dollar incremental income.

Now, as far as the new technology, let me just say this about it. We've -- it's in development right now. It's probably three to five years out in terms of commercialization. We are actively engaged with the development program with at least one European OEM and we're just starting now with an American OEM, but we're working on it with the European side of their house. And there's extremely high interest and what it does, it basically gives you, without going into the technology, it kind of acts like a lightning bolt and that basically gives you a very fast flame propagation front or flame ball, and so you have quick burn rate that's three or four times faster than the spark ignition. Plus, not only is it faster, but it basically is more homogeneous, so it burns in all directions at almost an equal rate. So, it helps you improve your fuel economy and lower your emissions because you're getting a more complete burn and you're doing it quicker.

It is best combined with a lean burn type of an engine, which is the technology of the future engines is going more and more towards a lean burn engine, which is more air than fuel mixture, higher air/fuel ratio, gives you a lean mixture, and it's very much compatible, the direction engines are going for down-sizing with the direct injection and turbo charging. So it has -- we still have a few development issues, not so much to prove out the technology, but to work out the packaging and the size of some of the products. So, as it replaces the current ignition system, it doesn't take up much more space or no more space than the existing ignition system. So, that's really the challenge right now.

Thanks. That's helpful. And just to clarify, Robin, how long can you sustain this 25% plus incremental until you -- things costs start to get feathered back in?

Again, as we've looked at this, given the environment we're in, we think that we're going to run north of $0.20 incremental for a good six to nine months, at least. Again, we've got the stickiness in Europe. We're not sure where volumes go. But these short-term movements, certainly we would expect to get some good leverage off the cost structure. Again, we're looking at this thing from two perspectives. We're looking at the year-over-year decrements where the dollars are bigger and I think the comparison is a little bit more valid and real because you're talking about looking at a $1.3 billion change of sales. We're talking about real dollars here. Calculation based off of 1.3 is a little bit more relevant than, again, Q2 to Q1, we're talking about $97 million, you take out the currency, it's about $87 million. A couple million dollar movement here or there can make a big difference in the percentages. So, while we're looking at incremental margins and we look at relative sequential performance and that's part of our review to see that we're on track, I think in the interim, the larger piece of the dollars to analyze is the year over year change in sales and we're more intensely focused on managing the decremental margin relative to those sales because they're a lot bigger numbers and have a lot bigger impact in the long term.

Great. Thank you.

Sure.

And we have time for one final question and that question comes from the line of Brett Hoselton with KeyBanc Capital.

Tim, Robin, Ken.

How you doing, Brett?

Okay. Let's see. Probably going to ask some similar questions here because I'm still trying to kind of wrap this up or understand it myself. So, what I heard you say, Robin, was that if I just -- okay, first of all, I'm thinking about sequential earnings. What I heard you say was that if I adjust for the stock hit and FX, going from the first quarter to the second quarter, your incremental margins were 27%.

Yes, about 27%, yes.

Yes. And it sounds like going forward, you're thinking you can run north of 20%?

Definitely in the short term.

Yes. Why wouldn't it be closer to 27% as you go into the third quarter or fourth quarter?

Well, 27% is north of 20%.

Okay. So, conceivably, it could be 25% or even higher or something like that?

Exactly right. As I said, we're working with small numbers here on these increments from quarter-to-quarter. We do have a little bit of stickiness on the upside in Europe. And so, whether it's 23%, 27%, 30%, you're talking about a couple million dollars here in the scheme of things that could drive that percentage. As I said, I wouldn't get upset between 27% and 30% or 25% because it's a couple million dollars quarter-over-quarter. To me, again, the more meaningful number -- I'm not saying incremental margins aren't meaningful because we are watching them and we're working along with them. But a couple million move here or there can really make a change from a percentage perspective. When you look at the decrementals year-over-year, you've really got to have a large amount of expense and/or lack of expense to move that $0.20 on the dollar, and I think from our perspective as we look at how well we're managing the cost structure, it's a more meaningful number with respect to our confidence that we're doing the right thing. And so, as we continue to be in an environment where there's these dramatic declines in sales and, again, we hope that at the back half of the year, the declines are not as dramatic, but as we get into these $1.3 billion decline in sales, that 20% decremental margin is a very meaningful number and there's takes a lot of dollars to move that, and I think that's the important part of the equation for us. On the increment quarter-to-quarter, as I said, a couple million dollars can move that plus or minus 3 or 4 percentage points and I'm not going to get too excited whether it's 22%, 27%, 30% or 25%. It's heading in the right direction on an incremental basis and that's probably the more important thing for us.

Okay. My wife would tell you a couple million would buy a lot of shoes.

Yes, that's true.

Yes. Hey, nickel --

Yes, what do you --

Yes, nickel, it sounds like -- when we think about the $25 million, should we think about that as a $25 million sequential improvement from the first half to the second half?

I'm sorry, 25 -- are you saying 25% or --

No, no, you were talking about nickel being down $25 million in the back half of the year and I think that's a year-over-year decline of $25 million as opposed to a --

Yes, that's exactly right. It's a year-over-year improvement. Part of that improvement, again, is nickel prices now are at about $7 a pound. Last year, they were at about $11. And we've had those hedges roll off that were at prices, frankly, that were higher than current spot, so --

As you think of -- as you think about that sequentially, is there any particular improvement as you move from the second to the third to the fourth quarter as a result of lower nickel prices?

I think it's split fairly evenly. There's going to be a little bit of variation depending on relative volume, but it's split pretty evenly.

No, no, what I mean is, like, as I go from the second quarter of this year to the third quarter of this year, so as I move into next quarter, am I to expect that my operating income improves by $12.5 million because of lower nickel prices?

Not quite $12.5 million, no, but there will be some improvement.

Okay. And then, it sounds like the stock hit, I mean assuming the price -- if the price remains the same, $5 million would not occur again as we move into the third quarter; correct?

That's exactly right. That's one of these unique things. We've got employee-related benefits that sit on the balance sheet that need to get marked to market. When you have a 68% increase in the value, it becomes meaningful. I would love to plan for a 68% increase every quarter in the value of BorgWarner stock. I think realistically I'm going to be disappointed.

How does the -- now, the $50 million charge, I thought I heard, and I got a little bit distracted, $41 million asset impairment, $9 million employee; is that correct?

$41 million in asset and asset related, yes.

Yes. How do you think about the impact of the $41 million asset impairment on your operating income as you move from the second quarter to the third quarter?

A portion of that was cleanup from the closure of Muncie. We actually -- if you remember, we took that impairment at year end 2006, estimating realizable values from disposal of excess assets and we went through the experience now of being in 2009, the used machinery market is terrible, the value of scrap steel is down, and so some of that was just recognizing actual proceeds quite a bit less than what we had had estimated at year end 2006. So, there's not much of an income statement benefit there. That is more of a cleanup from the closure. We will see a slight run rate improvement on a portion of that fixed asset, but from an annual perspective, it's not meaningful.

And then finally, as you think about the restructuring that you've done thus far and how much is accounted for here in the second quarter results, plus the $9 million of employees, I mean, how would you think about the incremental improvement in earnings as you move from the second to the third quarter? Is it just -- I think about the $9 million employee, I think about a one year payback or something along those lines, but obviously you had some restructuring that you did as you moved from the first or the second quarter that didn't get completed entirely in the first quarter. I mean, is it just a small impact or is there a more meaningful impact?

I think, from our perspective, Brett, as we continue to look at this business, our focus is more on what's the change in sales, what's the change in operating income, and we're trying to adjust the cost structure to get to that $0.20 on the dollar level and from our perspective, that's the easiest way for us to think about it because you've got pieces moving all over the place.

And then -- I'm sorry, Robin, I didn't mean to cut you off.

No, I'm finished. That's all right.

Assuming you start making money in the back half of the year as you expect, tax rate?

That's another mystery for us, believe me. That's why, if you look at our disclosure, we've calculated the estimated tax rate, we haven't calculated an estimated tax rate, we normally would calculate an estimated tax rate for the year and apply it to our six months performance. We actually calculated what we believe the true rate is for the first six months of the year. I think of it this way. In the U.S., the effective tax rate statutory is about $0.35, $0.36 on the dollar. And outside the US, it's going to be a little bit less than that.

Okay. Very good. Well, you've helped me build my model exactly. So, thanks, Robin, I certainly do appreciate it and if you could send me that check for $2 million, my wife would be happy to go shopping.

She's got to get in line behind my wife.

See you guys. Thanks.

Thanks.

I'd like to thank you all for joining us. As Robin said, we expect to file the Q before the end of the day, which should provide details of our results. But, of course, if you have follow-up questions, please give me a call and I'll get them answered for you. Monica, you can go ahead and close it out now.

That does conclude the BorgWarner second quarter results conference call. Thank you for joining and you may now disconnect.