博格華納 (BWA) 2009 Q3 法說會逐字稿

Good morning. My name is Darlene, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner third 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)

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

Thank you, Darlene. Good morning, and thank you all for joining us. We issued our release this morning at approximately 8:00 a.m. Eastern Time. It's posted on our Web site at BorgWarner.com on the Investor Relations home page.

There will be a replay of today's conference call available through November 4. The dial-in number is 800-642-1687. You will need the conference ID which is 33375379. The replay will also be available on our Web site.

With regard to our IR calendar, we will be attending the following conferences over the next three months, the Gabelli Conference in Las Vegas on November 3; the Baird Industrial Conference in Chicago on November 10; and the 2010 Detroit Auto Show analyst conference January 12 and 13. Also we will be announcing our net new business for the years 2010 through 2012 on November 9 at 10:00 a.m. We will be sending out a separate notice tomorrow to give you the details.

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 highlights on the quarter and sharing his perspective on recent industry trends, and then Robin Adams, our CFO, will discuss our operating results and his thoughts on the rest of the year. With that, I'll turn it over to Tim.

Thank you, Ken, and good day, everyone. I'm pleased to review our third quarter performance and comment on the state of the industry today. I'll begin by briefly highlighting our third quarter results. We reported third quarter sales of just over $1 billion and while this was lower than the same period last year, it is important to note that BorgWarner achieved an improvement for the second consecutive quarter in both sales and operating profits.

Our earnings were $0.15 per share. Our earnings performance in the third quarter has lifted us close to break even year-to-date despite incurring losses in each of the fist two quarters of 2009. This is a direct result of resizing our business for profitability at today's sales levels.

As a result of actions taken over the last 12 months, BorgWarner is a leaner Company with a renewed commitment to operational efficiency. This is combined with our continued focus on profitable growth.

At the group level our Engine group sales were $731 million, including the unfavorable impact of currency while Drivetrain sales were $297 million, also including currency. Sales and EBIT in both groups were higher versus the second quarter which we regard as a positive sign as we enter the final quarter for 2009.

Drivetrain's improvement in EBIT for the same period a year ago provided a real lift for the Company. This group posted a quarterly profit for the first time since the second quarter of 2008, and we are encouraged by the turnaround and the future potential for this business. Cash management remained a high priority in the third quarter and we were efficient in both our CapEx and working capital spending.

As a result, we once again generated positive free cash flow at about $14 million. However, and most importantly, we continue to invest for the long term as evidenced by our commitment to maintaining our spending for R&D and new program launches. In addition to our improved financial performance, we also announced several exciting developments during the quarter.

These include important new business wins in the fast growing Chinese market, the advanced automatic transmission area and with electric vehicle products. These programs are representative of how BorgWarner is leading the way in important drivetrain development around the world.

Specifically, BorgWarner will be supplying First Automotive, Chinese largest domestic OEM, with turbochargers on their 1.3 liter and 2-liter gasoline engines and EGR valves on their new 3-liter diesel engine. Also BorgWarner has been selected to supply friction plates for the new ZF 8-speed automatic transmission debuting on the 2010 BMW 760i.

We are also supplying clutch packs and one-way clutches plates for Hyundai-Kia's next generation 6-speed automatic transmissions. The new transmission family will ultimately drive 16 Hyundai and Kia vehicles including Hyundai 's new Tucson, the Sonata and the Santa Fe as well as Kia's new Sorento. And the all-electric Coda vehicle scheduled to launch in California next year will be equipped with our new eGear single-speed transmission.

Shifting gears, I would like to make a few comments on the broader auto industry as we saw some interesting developments during the last quarter. In Europe, industry production volumes in the third quarter were down slightly compared with the second quarter with most of the decline occurring in the A and B segments. We believe the decline in small cars was due to scrappage program fatigue while flat volumes in mid-sized and large cars indicate stable conditions with some limited growth in the European market.

In the U.S., the "Cash For Clunkers" program boosted volumes in August and industry watchers estimate that the program was directly responsible for about 700,000 sold vehicles. There were also claims that the program generated sales simply because it increased showroom traffic. But volumes in September were down suggesting that "Cash For Clunkers" did not necessarily generate demand but rather pulled it ahead.

However, recent announcements from GM and Ford regarding production increases indicate that demand is on the rise and our orders from the Detroit Three support this. The commercial vehicle market remains near trough levels in the third quarter, but began to show early signs of recovery.

We saw incremental schedule improvements in North America that may be the beginning of a trend or at the very least a shift to higher production rates than we saw in the first half of 2009. In Europe, however, volumes were flat and our view is that there will not be much change in the commercial vehicle market in the near-term for Europe.

Now that brings me to the outlook for the remainder of the year. In some respects, the fourth quarter will be a continuation of positive trends that occurred in the third quarter. In Europe, we expect that vehicle mix will continue to move towards mid-size and large size vehicles, but are nervous that volumes may soften a little bit in December from the peak third quarter levels.

In the U.S., we expect that volumes will improve quarter-on-quarter and possibly into 2010. I would say probably into 2010. Now increasing fourth quarter 2009 schedules in the North American light vehicle and commercial truck markets combined with reasonable European volumes indicate that BorgWarner will be profitable in the fourth quarter of this year.

Most importantly, this allows BorgWarner to reaffirm our previously stated expectations of positive cash flow and positive earnings for the full year 2009. Longer term we expect to leverage our industry leading technology, our global presence and our focus on operational right sizing to continue to drive our growth.

We are continually adjusting our cost structure to reflect the current economic landscape and at the same time we continue to focus on new product launches and global growth. Lastly, customer interest in our fuel efficient engine and transmissions has only grown stronger and this will be a major growth driver for years to come due to more stringent government regulations. With that, I will turn the meeting over to Robin.

Thank you, Tim, and good morning, everyone. Before I give you the financials in detail, let's go over the industry environment in the third quarter which was weak from a historical perspective but did show encouraging signs of recovery from the dismal first half we experienced earlier this year.

In the third quarter, global production was down 9%. A weak quarter considering third quarter 2008 was an easy comparison, but on a volume perspective a marked improvement from the past few quarters of the year. If you look at the data it appears the worst seems to be over.

Let me give you some of the data points. The global vehicle production fourth quarter 2008 was 14 million units, first quarter was 11.6 million. Second quarter was 13.6 million, third quarter was 14.2 million. So you can see we climbed back to that fourth quarter of 2008 level and the trend certainly looks to be in the right direction.

I will give you the same data for North America. In the fourth quarter last year they produced 2.7 million vehicles in North America. First quarter was 1.7 million, a quarter I would like to forget. Second quarter was1.8 million, not much better. And the third quarter was 2.4 million.

In Europe, fourth quarter was 4 million units last year. First quarter was 3.4 million, second quarter an improvement at 4.3 million, and as Tim mentioned, the third quarter was about 4.1 million, basically flat or down slightly from the second quarter. That gives you perspective of where the market's been and where it is in the quarter.

If you look at our sales in the quarter we were down 22% versus last year, 18% excluding currency. But relative to second quarter levels we were actually up 8 percentage points excluding currency compared to a global vehicle market that was up about 4% quarter-over-quarter. So if you look at the sequential growth in this business the strength is starting to show and the signs are pretty encouraging with respect to where we were in the first half of the year and where we are today.

For the quarter, as Tim mentioned, earnings were $0.15 a share compared with a GAAP loss of $1.12 in the third quarter of last year. And if you look at the third quarter last year there were a number of non-recurring items and we've detailed those in a table in the press release. If you look at that table hopefully it helps you reconcile the financial performance to both prior and current periods and also gives you some sense of how to look at future projections.

We think this is an important part of the release, and I'm going to leave a lot of those details to the release and just talk about the summary number. For the third quarter excluding all those items in 2008 earnings were about $0.44 a share. While sales and earnings in the quarter declined from year-ago levels, they are marked improvement from the previous few quarters in 2009.

By the way, we also intend to file our 10-Q by the end of the day which should also provide a lot more details on the quarter for you. Looking at the first nine months, U.S. GAAP earnings were a loss of $0.22 a share compared with a gain of $0.39 per share in the first nine months of 2008.

Again, our press release provides the details of a number of non-recurring items both the first nine months of 2009 and 2008 for your review. If you exclude these items from both periods, our net loss year-to-date was $3.1 million, as Tim said. Virtually break even or $0.03 a share loss compared with income of $232 million or $1.97 a share for the first nine months of last year.

And as I said, the year-over-year comparisons don't look, pretty obviously, driven by a significant decline in sales, but the encouraging signs are the sequential quarterly performance that we just talked about. If you look at the income statement, gross profit in the quarter as a percent of sales was 14.8%. Not too bad compared to 15.4% in the third quarter of a year ago. But actually up from 12.7% in the second quarter.

And this improvement relative to the second quarter and the relative tightness versus the third quarter last year reflects the effectiveness of the restructuring activities and other cost containment actions that we've taken as a Company over the past 12 months. Third quarter SG&A costs were $126 million or 12.3% of sales which is down $5 million compared with the third quarter of last year excluding special items, and as a percent of sales it was about 10%.

Included in SG&A, as you know, are R&D costs, which were 4% in the third quarter this year versus 3.8% during the same period a year ago. On an absolute dollar basis that equates to about $41 million, down about $9 million from about $50 million in the third quarter last year. And about a third of that change year-over-year relates to the salary/wage reductions that we implemented in early 2009 and our total work force took as a way to try and improve the performance of this Company and share the sacrifice.

We are also looking at, when you look at third quarter 2009 versus 2008, SG&A, we are experiencing about an $8 million increase in pension and OPEB expense versus last year resulting from primarily the closure of the Muncie facility earlier in the year. And relative to the second quarter of this year, now looking at third quarter 2009 versus second quarter 2009, SG&A is up sequentially $9 million, with $5 million of that related to increased R&D spending, as Tim said, we continue to ratchet up the spending there.

And $4 million really related to the impact of currency reported in the third quarter this year versus the second quarter this year. That's primarily driven by the dollar/euro. In the second quarter, we talked about SG&A being negatively impacted by stock-related compensation of about $5 million.

Obviously, in the third quarter, unfortunately, we didn't have that $5 million burden. We wish we would have had it. So there was a benefit relative to third quarter in SG&A, but that was offset in the quarter by the start of the -- incurring some incentive comp in the Company.

Operating income on reported basis was $27.5 million in the quarter versus a loss of $103.9 million in the same period a year ago. Again, excluding the non-recurring certain items operating income in the third quarter really came in $175 million. I'm sorry $72 million. The adjustment was $175 million excluding the adjustment in items third quarter 2008 was $72 million. So $27 million third quarter this year, $72 million third quarter last year.

If you compare the decline in operating income that $72 million to $27.5 million, relative to the decline in sales year-over-year, it provides a decremental margin of 15%. We talked last year and early this year about our focus on trying to maintain that decline in operating income to the 20% to 25% level and coming in at 15% is obviously our best performance of this year and something we feel very good about.

If you remember, our decremental margins in the first quarter were 21%, and about 20% in the second quarter, so we have been consistently performing to the top end of our expectations. In the third quarter, we actually outperformed on our expectations. And if you look on a year-to-date basis, we are slightly below $0.20 on the dollar from a decremental perspective.

Last time as we talked about the incremental margin on a sequential quarter basis, let's talk about the third quarter of 2009 versus the second quarter. If we compare that change, the change in operating income was about $27 million relative to an increase of sales of about $112 million. This translates to an incremental margin of $40 million.

However, when you look at the increase in sales third quarter versus second quarter, about $40 million of it was actually just related to currency. It had nothing to do with our operations and when you strip the currency out of the increase third quarter to second quarter, the incremental margin in the third quarter versus the second quarter was a pretty impressive 38%.

If you remember in the second quarter, the incremental margin from Q2 to Q1 was 27%. So if you average the first, the second and third quarter relative to the first quarter which we consider the industry bottom level for the year, we are averaging about $0.32 on the dollar incremental income on the incremental sales this year. And, again, we are very encouraged by the progress of our operating performance in the second and in the third quarter and expect that to continue to improve.

Again, let me give you some relative performance metrics to understand the quarter and, again, the fact that things are going on the upswing. If you look in the fourth quarter of 2008, basically we broke even from operating income perspective, the operating income margin was 0.4%. In the first quarter it was negative 2.1%. In the second quarter, again, basically break even at 0.1%. In the third quarter 2.7%.

So you can see, again, the trend is is coming back and we expect that trend of increasing margins to continue. And we expect that incremental margin of sales are going to continue to be at about that $0.30 on the dollar plus level.

Looking farther down the income statement, interest expense and finance charges were about $13 million versus $11.2 million in the third quarter last year. As we've said before, the cost of liquidity related to the convertible notes we issued in April to provide liquidity in an environment where there was no liquidity available is putting a little bit of pressure on the interest expense line item and the income statement.

Looking to the tax rate in the quarter, the effective tax rate for the quarter is about 7% which is really the result of a 54% year-to-date tax rate. And the 7% just flops out after you deduct the full year from the six months reported. And I know that number looks a little strange, but it is a function of losses and gains in different geographies around the world. I will use an operating term I get a lot from our operating guys, it's a mix issue. But trust me, it really is a mix issue with respect to taxes.

We've got some jurisdictions where on a year-to-date basis where there is a loss and others where there is a slight gain and we get this kind of strange effective tax rate. However, as earnings continue to grow we expect the tax rate to move closer to about the 25% level that we had prior to the significant decline in industry volumes.

And, in fact, as we look at incremental earnings on incremental quarter basis, those incremental earnings should be somewhere in the $0.20 to $0.30 on the dollar tax effective. Taking that all into consideration that gets you back again to the bottom line, which is a $0.15 a share earnings for the quarter.

And that's down from the third quarter's adjusted $0.44 a share, but as I said earlier it is up from where we have been in the last few quarters. Again, let me kind of reiterate where we were. In the fourth quarter 2008 earnings per share were break even. In the first quarter of this year earnings per share negative $0.12 a share. Again, this excludes the non-recurring items. In the second quarter, earnings per share were a negative $0.05 a share, and now we're in the third quarter at $0.15 a share.

Again, the same type of trends whether you look at industry production, whether you look at our sales, whether you look at our operating income, whether you look at our net income. Obviously, the trends are very favorable and this is the best quarter we've had in over year, and, again, I think the trends are back in the right direction for BorgWarner and that direction is growth.

Let's look quickly at the operating performance in the quarter by segment. Engine segment sales were $735 million. That's down about 20% year-over-year excluding currency. Earnings before interest and taxes for the Engine segment was $57 million, down $38 million from the same period a year ago, or about $33 million excluding currency.

So on a decremental margin basis excluding currency it translates to about $0.16 on the dollar, good strong performance and cost containment on the Engine side of the business. However, as Tim mentioned, it was the Drivetrain side of the business that really provided a much overdue lift for the Company and if I was a drinker after this call I would go out and celebrate and have a cocktail on this one because they had a great third.

Third quarter sales were $297 million, down 15% from the same period a year ago or 10% excluding currency. Earnings before interest and taxes was $8 million, which is up $10 million despite lower sales. And that's really excellent relative performance by the Drivetrain group and we have been waiting for this.

As you remember, during our first quarter earnings call, Tim stated that he was intensifying the focus on the Drivetrain group, and that we expected improvements throughout the year, including the benefit of the closure of the Muncie facility. And I think as you look at that third quarter performance it is solid evidence that that business turned around and those efforts have yielded results. And we're very excited about the performance of Drivetrain in the quarter and the future performance from that segment of our business.

Let's get to the balance sheet and cash flow. Net cash provided by operating activities was close to $225 million in the first nine months of 2009. Capital spending including tooling was $127 million. And while down significantly from $266 million a year ago, it is in line with our expectation of spending $200 million for the full year.

So that leaves about $73 million for the fourth quarter which is a pretty hefty level of spending, but I believe our operations still continue to plan to spend that money. After deducting capital from net cash provided by operating activities, operating cash flow was approximately $100 million during the first nine months of 2009, of which about $14 million was in the third quarter.

As most of you know, the third quarter is a challenging quarter from a cash flow perspective due to working capital buildups we saw that in the quarter. Despite that we are still generating cash from our business. Working capital relative to last year has improved dramatically. Inventory levels are down by about $145 million since the end of last year. Receivables are up on the balance sheet at the end of September versus year end December.

But that's a good thing, and it's a very good thing. It's a result of increased business activity. As you look at September sales versus December, our sales are up almost $200 million in September versus the level they were in December. And while it's an increase in working capital, it's a very exciting increase in working capital for the Company.

Overall, the focus that we've had on managing capital here has paid off, but we feel we still have a little bit more to do on the inventory side before year end. The balance sheet debt in the first nine months of the year increased by $67 million, which really is the net effect of the issuance of the $374 million convertible notes in April that I mentioned before offset by the retirement of $137 million in senior notes in the first quarter and payments related to other short-term debt obligations.

During the same period, the same first nine months, cash increased by $156 million. Again, that's a result of parking some of the proceeds from that convertible senior note to provide liquidity for the Company in this environment. If you net the increase in debt versus increase in cash, there is a decrease in net debt close to $90 million.

We further strengthened our investment grade balance sheet during the quarter with a net debt to capital ratio of 21% versus 24% at the end of the second quarter, and 25% versus year end 2008. So despite the first six months of the year being pretty drastic reductions in industry activity, our balance sheet is actually stronger today than it was when we started the year, and even where we ended the second quarter.

If you look at net debt to EBITDA on a trailing 12-month basis, little over 2 times, right now. However, if you look at just the third quarter EBITDA which was about a little bit north of $100 million, and you annualize that at a run rate basis, that would put net debt to EBITDA at about 1.5 times. A very, very respectable leverage ratio for BorgWarner.

Let's talk a little bit about the rest of 2009. Tim talked about 2009 and as he mentioned we do remain cautiously optimistic about the remainder of the year. Our internal view in North America is pretty much directionally in line with those of you experts that report market forecasts. And if you look at the experts right now, the fourth quarter projection is somewhere around 2.7 million units, and as I said earlier, third quarter was 2.4 million.

So that translates to about 12% growth over third quarter levels. Again, this is based on the experts, and as we've said before we're relying on the experts with a lot of this data. However, there continues to be a surprising degree of uncertainty in Europe considering where we are in the year.

The average expectation is that European volumes will be flat or improved slightly compared with the third quarter. We are watching that closely, as Tim mentioned. Again, back in January of this year we provided guidance of positive cash flow and positive earnings for the full year and that guidance remains intact, and I think if you look at our performance to date there is very little question about our ability to meet that guidance.

This implies that our cost cutting efforts in combination with a sustained recovery in production volumes will generate another quarter of positive earnings for us in the fourth quarter. In fact, we expect the fourth quarter to be the first quarter in a long time where we will be able to report year-over-year growth in sales. I'm looking forward to a quarter where I don't have to talk about declines.

I will be excited in January when we talk again about performance here. The data suggests that we are slowly coming out of the industry bottom that we experienced in the first half of the year. Again, I went over production levels from fourth quarter 2008 all the way through third quarter 2009 and I think the trend, regardless of where you look, suggests we are slowly coming out of that bottom.

However, we do maintain a level of caution regarding the pace of the industry's recovery. And regardless of that, though, we remain focused on the key driver of this Company's long-term success and that's our power train technology leadership. As Tim mentioned in his comments, we are a leaner Company now. But with a work force that has rededicated itself to ensuring BorgWarner maintains its reputation and its position as the leader in power train technology throughout the world.

We are well positioned both financially and technologically to remain at the forefront of the growth curve in this growing industry. With that, I would like to turn the call back over the Ken.

Thanks, Robin. We will now move to the Q&A portion of the call. I'd like to ask the call coordinator to please review the Q&A procedure.

(Operator Instructions) We will pause for just a moment to compile the Q&A roster. Your first question comes from Richard Kwas with Wells Fargo Securities.

I had a few questions regarding just turbochargers and how you think about mix here for 2010. I know it's a little early, at least what you've disclosed so far, but, I guess, Robin or Tim, how do we think about the volume volatility that could occur in Europe and then how that plays out with the improving mix that you're starting to see on your end?

Good morning, Rich. We are starting to see a change in mix back towards both premium vehicles and larger sized vehicles, and a decline, like I said in my report, in the smaller vehicles.

We are starting to see a rebalance back towards diesels. There's a projection that we think that diesel probably dropped from 52%, 53% of the penetration rate last -- in recent historical past -- down to about 44% plus or minus. We think that's going to come back about another 4% increase to about 48% plus or minus. We are seeing a shift back, a little bit back towards diesels.

Obviously, we're seeing a tremendous growth in downsized turbocharged gas engines. And so turbochargers, we are seeing a strong growth platform in turbos over the next 15 months. We'll be launching 20 new turbocharger programs that are either new programs or conquest programs from our competitors. And we will get into, I think it's November 9, we will do our book of new business. These 20 new programs we are working on is about a third in North America, third in Europe and a third in rest of the world.

Okay. Then your primary competitor in that business talked about gaining share last week as 2010 unfolds, it seems like they've been picking up some business on larger displacement engines. Can you give us some more color on how that's all playing out with the primary competitors on the turbocharger side?

Well, I'm not going to speak much about Honeywell. But they may have lost share so they are trying to gain some back. What I foresee and the forecast we have for our long-range plan is we will be maintaining share in a very fast growing market. So if they are gaining share it must be with somebody else.

Okay, okay. Then last question, Robin, how do you feel about the cost structure in Europe at this point? Looks like you've made some progress here sequentially. How much more do you have to go to get it where you want it to be?

You know that's a great point, Ken. Actually, Rich, I'm sorry, Rich, one of the improvements in the third quarter versus first and second on the decremental margin was in our non-U.S. operations, particularly Europe. As we've said before those costs tends to be sticky.

And while in the first half of the year we struggled with adjusting the cost structure using short work weeks, I think now that we are seeing a little sales growth on a sequential basis we are doing a good job of managing the cost structure in Europe and trying to contain it before bringing back the full complement of costs back with those sales.

I expect continued good performance outside the U.S. in the fourth quarter as well from a cost containment perspective. As I said earlier, actually we'll be pretty excited to talk about increasing sales and increasing earnings in the fourth quarter versus the prior year.

Okay. Just lastly the salary reductions, as we think about it, it's benefited you this year. As we think about next year, how much, when are you expecting to change that, that will probably be a headwind next year, right?

Rich, you sound like one of my employees, I get that question every day now.

Mostly, from me, Rich.

(laughter) Well, I only talk about what the people that deserve it. But, anyhow, it's our goal and it's our intention to do it as quickly as possible and like I've said to our employees, in a letter to all of our employees just recently, we are going to try to do it as quickly as we can and possibly as early as the beginning of next year.

Okay, great, thanks.

Your next question comes prom the line of Himanshu Patel with JPMorgan.

Hi. Sorry about that. I missed the earlier part of the call. But, Robin, can you just talk about as we start seeing European production ramp up even further in the fourth quarter, and then I think in Q1 2010, CSM's schedule is actually calling for a bit of a moderation. Where do you think about sequential contribution margins over the next two to three quarters?

I think as we've said before, first, let me address the European volume. There is still a little bit of uncertainty in the marketplace with respect to Europe both for fourth quarter and first quarter, and I think if you look at the data some people would suggest that Europe is flat at best in the fourth quarter versus the third quarter.

But volume aside, as we look at incremental margins in the business in the next couple of quarters we are still looking at about that $0.30 on the dollar plus incremental margin sequentially from a quarter perspective. As I said, I think for a second and the third quarter we've averaged about $0.32 of incremental margin and the third quarter was quite a bit stronger at $0.38. But in the next few quarters we are still looking for some pretty solid incremental margin performance.

Himanshu, I would just like to add when you get into the first quarter we are actually, if you look at the schedules, the schedules are actually, for the schedules we have so far, they're actually holding up pretty well. We are a little bit cautious on that because the first quarter still a little bit ways away. And anything can happen. So if you went by our schedules, the schedules look good, at least if the first couple of months, but we are a little bit guarded.

Okay. And then lastly, when do you guys start worrying about commodity cost inflation?

We are worrying about it now.

Well, I guess in terms, what quarter should we start thinking about that surfacing on the P&L?

I think we are going to start to see that pretty early in 2010. What is keeping raw material costs in line for us right now, obviously, is nickel. And we are starting to see nickel creep up a little bit and relative to 2009, at current spot rates, nickel will be actually be an increase in raw material costs for us 2010 versus 2009. As we've said before, our purchasing guys continue to be concerned about steel.

We have seen increases in steel-weighted components. In fact, in the third quarter we saw a close to a $4 million increase year-over-year steel related from a commodity perspective. Now that was more than offset by improvement in nickel commodity costs in the quarter. But we are seeing steel creep, continue to creep, and as I said, as we look at nickel in 2010, it will be a negative relative to 2009 kind of levels.

Okay. And then last question, Robin, I think in Q2 there was like a $5 million non-cash charge related to options or RSUs or something because of changes in the stock. What happened to that particular line item in the third quarter?

It didn't increase, so when you look at second quarter versus third quarter we actually got a benefit. I may have gone through that quickly, the SG&A third quarter versus second quarter, but I did try to cover that. If you look at third quarter 2008, 2009 versus second quarter 2009, the sequential performance you're talking about, SG&A on a reported basis was up $9 million third quarter versus second quarter.

As you point out, the second quarter we had the good fortune to have increase in compensation related to our stock in equity to a tune of about $5 million. And as we said in the second quarter, that increase of $5 million would not be an increase in the third quarter, basically be a benefit as we look third quarter versus second quarter spending.

So while spending us up $9 million we got the benefit of that stock-related non-cash increase. So it was really up $14 million excluding that item. And as I said earlier, $5 million of that was related to increased R&D, $4 million is related to the impact in currency versus the third quarter over the second quarter. And the rest of that is related to incentive compensation in some of our operations around the globe.

Okay, understood. Thank you.

Your next question comes from Chris Ceraso with Credit Suisse.

Thanks, good morning.

Hi, Chris.

A few things, on the topic of SG&A, it's been running around 12% recently, but as recently as the fourth quarter of last year it was closer to 10%. So as we get volumes back up to 4Q 2008 levels can we get it back down to 10% or is it structurally a bit higher going forward?

No, Chris, I think you are going to see it coming back down to historical levels. We have chosen not to touch engineers and some of the people that are tied to our future growth in R&D, on the R&D side, and actually in areas on some of the manufacturing and manufacturing engineering side.

As the volume comes back, you are going to see the percentages, they should be drifting downward towards historical levels.

Okay. And then on the Drivetrain business, you had some nice improvement as Muncie came out. If I look back historically that business used to run at around a 7% or 8% EBIT margin, can you exceed that now that Muncie is out of the picture or, no, because you are also doing less transfer case business? What's the long-term expectation for profits in that business?

I think there is always going to be a differential between the Engine and the Drivetrain side of the business because despite closing Muncie we still have all the legacy costs related with that facility. They are going to continue to be burdened by a good portion of the legacy costs which is what drives the difference between Engine and Drivetrain predominantly.

We certainly expect to at least get back to the levels we were previously. I think to your point as we grow more and more DCT as part of the Drivetrain business and less four-wheel drive transfer case, we should see some margin improvement over where we were historically.

The other thing I would remind everybody is we look at the world in terms of return on invested capital. Although the margins or the EBIT margins are down a little bit when you talk about the four-wheel drive business, not down, but they are historically lower compared to some of our other businesses.

The capacity's already in place, we've already got the CapEx and we actually, when it comes to return on invested capital they do pretty well and they will actually start to do better as volume starts to come back.

You mentioned a couple of times that you expect something in the 30% range on an incremental margin as you go forward. Are there workers in Europe still that are on three or four-day shifts that you have to bring up to full time and does that depress your contribution effect in that region?

Well, Europe has always been a sticky region for us in terms of labor costs. I think my team has done a very good job of managing it as well or better than most suppliers in our industry both in terms of what they've done and being proactive and doing it very early. But we have, I think, probably around 70% of our plants plus or minus are back to five days, but that's after they've already -- that's five days now versus five days before, but the difference is before we had anywhere from 10% to 20% temps or contract workers in these plants.

So the temps and contract workers are pretty much, they are all gone. And our permanent workers are, probably about 70% of them are back to like I said a five-day schedule. But there is about 30 % that are still on a four-day schedule. I don't think anybody except maybe one plant is on three-day schedule right now.

But if volumes pick up, we have the ability to handle more volume with pretty much the same work -- the same amount of work force or labor that we have today. And if volumes go down, we can go back to four days fairly quickly.

But at some some point you'd want to bring them back to full time, right? Does the subsidy from the government that's allowing you to do that expire at some point?

It's got about a 24-month horizon on it. We've probably only used less than 12 months. I would say on average about nine months out of a 24-month horizon.

The other thing that has been done and I didn't mention in the first answer is a lot our plants, right off the bat they went from 35-hour work weeks to 30-hour work weeks. So since they get paid by the hour that was automatic five-hour per week pay cut. So we actually have some, we can go back to fuller work weeks at the same time.

Okay. Thank you very much.

Sure.

Thanks, Chris.

Your next question comes from Rod Lache with Deutsche Bank.

Hi, it's Pat Nolan in actually for Rod Lache.

Hi, Pat.

Hi, Pat.

Good morning. Just two questions, first, on the working capital line, we are used to seeing working capital be negative for suppliers as production increases. And it doesn't seem to be playing out this way this time, both you and some of your competitors have seen not the typical drain you would see in this level of pick-up in production. What's going on there? Do you think that's going to continue or is there going to be some payback as we move into Q4?

I think it's all tied to the inventory reduction plan that we have at BorgWarner. I can't speak for the rest of the supply base, but I imagine a lot of them as well. When you are looking at is nine-month period of 2009 compared to a year end 2008 where I think a lot of us got caught with, because of the significant decline and quick decline in schedules a lot of us got caught with excess inventory.

If you look at our working capital story, we are not going to take $145 million out of inventory out of our business year in and year out. So a good portion of the working capital improvement for the year has been excess inventory that, frankly, we wish we didn't have at year end 2008 but we did have. To your point, as we see growth going forward, we will see increases in working capital requirements.

As I said earlier, we think we've still got a little bit more fine tuning to do within BorgWarner from an inventory perspective in the fourth quarter. But generally as we see stronger sales we will see increases in working capital. And, again, to my point about receivables, if you look at receivables they are up for the first nine months of this year about $175 million, and it's a function of business activity.

Our sales in September are $200 million higher than they were in December. You're right, you will see that working capital build once everyone finishes their work out of the inventory reduction programs.

That's helpful. Just ahead of November 9, could you just remind us what your $2.1 billion backlog was based on as far as industry production and currency assumptions, and just briefly comment on the content for vehicle opportunities you see in the electric vehicles? I know you commented on the Coda earlier in your presentation.

If I remember right, let's just say 12 months ago seems like an eternity based on what we've gone through lately. But if I remember right, 12, our $2.1 billion of backlog that we announced last year was based on just the first indication of schedule cuts that we were starting to see in the end of the third quarter, beginning of the fourth quarter. I guess we saw some schedule forecasts for the fourth quarter last year. We had some schedule cuts in the third quarter.

So we took some of that into consideration on the $2.1 billion. So the $2.1billion was modified for a little bit of the recession. At the time, we didn't know it was a recession. Obviously, when we come out in November we will have the full impact of what we think will be the volume reductions as we look forward over the next few years.

The currency, if I remember right, was about $1.25 to $1.30 dollars to the euro. I think it was $1.25. So that gives you a little bit of a framework or context, so when we come out on November 9 and we tell you how great our backlog is of net new business, we will have to reset the framework in terms of currency and what we think the recession levels will be.

Got it.

And I'd just point out, we don't know what our backlog is as of yet and Tim is --

I'm just hoping.

Yes, he is anticipating.

And just lastly, on that (inaudible) vehicle for electric vehicles how should we be thinking about that? I know your pretty significant content on the Coda for your transmission, if you were talking about a volume type vehicle, would an electric vehicle be a negative content vehicle or could you make up that? Obviously, the transmission going forward won't be as highly priced as at these low level of volumes.

Well, let's just say that we are going to have to get farther down the path to know exactly what the content match is between our traditional gas and diesel technology and our new electric vehicle technology. The reason is we are developing products right now for like cabin heaters for electric vehicles that don't generate much heat through engine because it's mostly an electric engine or electric motor, so they need technology to provide a cabin heat.

That's part of our BERU core competency. We are developing technology for that. We are developing technology for a more robust start-stop technology. There is a lot of these hybrids that they talk about in the future, most of them are going to be very mild hybrids with basic start-stop hybrids, which is kind of a -- to me it's not much a hybrid. But that's what they are classified as.

So we've got new chain technology we're developing for that. It's hard for me to say what the match-up is going to be on content.

But I will tell you on the transmissions that we've developed and we're starting to sell, the Tesla, when we launched the Tesla transmission, it brought a whole lot of players to our, potential customers and people that are working in the hybrid or totally electric vehicle space, they brought them to our doorstep and we are working with probably about, I think it's like 14 active development programs on either pure electric vehicles or what I will call high content hybrid electric vehicles. By high content, I mean mainly electric.

So it's been a -- that program has been a big plus for us and the other thing I would add is on that 13 and 14 programs I'm talking about, three of them are with traditional OEMs and 10 of them are with non-traditional OEMs. People that, I will be honest with you, a year ago I didn't know that these companies existed. Because just in the last year or two they are start-ups. I don't know if that answered your question, sorry for the long answer.

No, it does, very helpful. Thank you very much.

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

Good morning. Couple of questions around the torque transfer business. First, you reported that was 7% of driveline. How did that look in this past quarter and then if you look sequentially with how much of the uptick in driveline was due to the Big Three coming back on line in the rear wheel drive business?

The four-wheel drive business is a little bit lower as a percentage of our total business today than that last public disclosure. And as you look at the relative growth in the quarter in the Drivetrain business it was more on the DCT side of the business than the four-wheel drive side of the business. We are not seeing a big reversal in trend where light truck and SUV production is increasing.

We are starting to see some pickup in volume on that. Because --

Relative to earlier in the year, though.

Right, relative to --

How's it going sequentially, is that up?

Yes, right. Relative to the truck we are starting see some input -- increases.

It's not going to be what it was in the past, obviously?

I doubt if it will ever be what is was in the past.

Secondly, on the cost side you mentioned legacy costs in the driveline, last year you had ex the curtailment gains about $12 million of pension expense and about $10 million of OPEB expense, so that's $22 million. How much of that is in the Drivetrain business and how much is down to the Muncie plant?

It's all in Drivetrain business. The majority of that is related to the four-wheel drive business.

So that's going to be -- excuse me.

And some of that is related to discontinued businesses as well.

So will that continue to be charged against the Drivetrain business every quarter?

Yes.

Okay. Thanks.

Although they continue to tell us that it ought to come to corporate. I don't know if they asked you to ask that question for them.

So even though it's a discontinued op you can't move that expense out of the income statement?

Well, we're still in the four-wheel drive business. We are still making that product, we just do it in different parts of the world now.

I need to find out which of the guys from the four-wheel drive business prepped you for this question.

I've just been inside corporations so long I can guess. Any chance doing a VEBA or any way to defease the OPEB liability? Is that worthwhile?

Not at this point in time, no.

Okay, thanks.

Your next question comes from the Patrick Archambault with Goldman Sachs

Patrick, are you there? Guess not.

Patrick your line is open. Your next question comes from the line of Brett Hoselton with KeyBanc Capital.

Tim, Robin, Ken, good morning.

Good morning.

Let's see, interest expense, $12.5 million, is that a pretty good run rate?

Yes. $13 million, so. $13 million or so, $13.5 million.

Then, I apologize, I kind of stepped out for a minute, Drivetrain sales, obviously, much better, what were the key drivers that caused the Drivetrain sales to kind of pick up and do significantly better than I expected?

It's the transmission component, dual clutch component side of the business.

Okay. Is that kind of one-time in nature or is it more just, look, it's really starting to pick up some steam and it's really starting to have an impact on the sales so we should expect that going forward?

It's not one-time in nature. We are continuing to -- in years past we told you there was going to be a ramp-up over time towards couple of million units of production for Drivetrain or for DCT.

We are still continuing to see that ramp-up, we are still continuing to see that penetration and we are picking up some new business and -- not just on the -- while we are ramping up on the wet clutch side of the business we actually will be picking up some business on the dry clutch side of the business for dry DCT where we supply the control module for certain customers.

And then as far as the bidding activity on products in general, versus six months ago, is bidding activity the same as it was six months ago? Some people suggested it slowed down six months ago due to all the disruption and possibly has picked up a bit in your neck of the woods. Your thoughts along those lines?

Okay. Is quoting activity is picking up now? Versus?

Yes, exactly.

I would say that quoting activity is picking up a lot on the emissions side of the business. There is a lot of new programs that people are working on and we are -- obviously on the turbocharger side, we are very active on some new programs now. We are starting to see some continued and stronger interest with our DC technology in China with a couple of programs that haven't been announced because we are in the what I call the beginning of a production development phase.

We are also working with a new Japanese OEM on DCT with the, what I will call production, beginning of a production development program. We are seeing increases in strong interest in our variable cam timing technology.

Not just with our historical customers. Currently we are supplying for GM and Jaguar, but we're staring to see interest with Japanese OEMs. And it's all because of strong regulations and strong interest in improved fuel economy and emissions.

Then, Robin, as you look from the third quarter earnings to the fourth quarter earnings, what would be some of the major positives or pluses and minuses as you move forward here? I mean, obviously, production you've already mentioned. Is there any significant change, for example, in new business, restructuring, commodities, SG&A, interest, taxes, anything along those lines. I mean what would be the major pluses and minuses?

Well, I think as we look at the fourth quarter, at this point in time it looks to be more of the same from the third quarter.

Okay. Good. Thank you very much, gentlemen. I appreciate it.

Thanks, Brett.

We have time for one final question. And that question comes from Colin Langan with UBS.

Thank you for taking my question. You actually mentioned the the impact of steel in the quarter. What was the overall impact in the quarter from commodity costs? I thought you said last quarter it would be a benefit this quarter?

It was a benefit, I think,of about $8 million.

Okay. And your leverage ratio seems pretty low. What is your intent going forward for cash? Any thoughts on acquisitions or assets out there that still interest you?

First, I'm going to bring you with me when I go to see Moody's in November. (laughter) See if we can get an upgrade. We are still, despite the strength of our balance sheet, we are still a little cautious on where we are at, but we believe there will be some opportunities that might open up here in the near term. And while we are a little cautious we certainly feel that we are getting to the point where we might be able to take advantage of some opportunities that present themselves in the marketplace.

Any change in the way you view acquisitions going forward?

Well, I will jump in on that. The way we view acquisitions is the same as we've always viewed them. We are looking for acquisitions that are complementary to our technology. We are looking for technology leadership in an acquisition.

We are looking for something that stays within the power train area. And we are not looking for distressed assets. We also look for a strong management team. And I don't know if that was the intent of your question, but that's the way I interpreted it.

And how about in terms of trying to move toward more electrical vehicles, but you would stay in the power train portion of those vehicles?

Yes, we would look look at something in the electric vehicles. Although I would move more towards hybrid electrics or range-extender type electrics than pure electrics. Although we are developing technology for the electric vehicle market, the pure 100% electric vehicle market, we still have a question mark as to what is the relative size of that market for the long term.

Okay. Then one last one, I think you were just mentioning that you are doing more business with Japanese -- or doing more bidding with Japanese OEMs. What percent of your current business portfolio is with those OEMs and is that a big opportunity if you start winning more business with them?

If you go to our pie chart that's actually on our Web site, we do a lot of business with the Japanese. When you consider what we sell directly and what we sell through our joint venture, we have Toyota at about 5%. This includes our joint venture, Hyundai-Kia at about 3%. The Renault-Nissan combination, this would be the Nissan portion of it at 2%.

And then we have the Chinese that are actually 1% to 2% now, but, obviously, growing more rapidly than actually anybody else in Asia. So most of our Chinese business will be in the next -- start to show up in the years, let's just say, one, two, three, and four from now.

So the bidding that you are seeing is consistent with your current business mix or is --

Yes, well, what you'll see historically in our book of new business -- on average it's pretty much been held true is we typically, our book of new business shows up as 50% Europe, and about 30% Asia, and about 20% North America. But yet today our current business is roughly 50% Europe, 30%, maybe a little less than 30%, but 30% on the slight, the low side of 30% in North America, and on the plus side of 20% in Asia. So you are seeing a shift from Asia going from roughly 20% up towards 30% in the future.

Okay. All right. Thanks for taking my questions.

I would like to thank you all again for joining us. As Robin said, we expect to file the Q by the end of the day which should provide many of the details that you are looking for in our results. However, if you have any follow-up questions, please direct them to me. Darlene, please close out the call.

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