博格華納 (BWA) 2010 Q1 法說會逐字稿

Good morning. My name is Carmen and I will be your conference facilitator. At this time I would like to welcome everyone to the BorgWarner 2010 first quarter results earnings conference call. (Operator Instructions) I would now like to turn the call over to Ken Lamb, Director of Investor Relations. Mr. Lamb, you may begin your conference.

Thanks, Carmen. Good morning and thank you all for joining us. We issued our release this morning at approximately 8 AM Eastern. It's posted on our website, Borgwarner.com on the Investor Relations homepage. There will be a replay of today's call available through May 6. The dial-in number for the replay is 800-642-1687. You will need the conference ID, which is 66803637. The replay is also available on our website.

With regard to our IR calendar, we will be attending the following conferences over the next few months. The KeyBank Industrial, Automotive & Transportation Conference in Boston on June 2, the Wells Fargo Industrial Conference in New York on June 14, and the Deutsche Bank Industrial Conference in Chicago on June 23. 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, we'll be providing highlights from the first quarter and he will also share his perspective on recent industry trends. Then you'll hear from Robin Adams, our CFO, for the detailed discussion of our first quarter results. With that, I will turn it over to Tim.

Thank you, Ken and good day, everyone. While I am very pleased to review our first quarter results and accomplishments, followed by comments on the state of the industry and our revised 2010 guidance. I'll begin by briefly highlighting our first quarter results.

We recorded first quarter sales of $1.3 billion, up 57% from the same period last year, and US GAAP earnings of $0.63 per share. This marks the fourth consecutive quarter that BorgWarner has posted both higher sales and higher operating profits compared with the previous quarter. Our earnings performance in the first quarter was the result of increased global demand for our products, higher volumes in our base business, and cost control. Our operating margins continued to improve, and we are 8.3%, which is within the range of our historical margins.

At the group level, the Engine Group sales were $900 million in the quarter, up 45% from the same period a year ago. Increased demand for all of our engine products in every major region of the world drove higher segment sales and operating profits. In the Drivetrain group, sales nearly doubled to approximately $386 million, versus the first quarter of 2009. Sales growth in our transmission and all wheel drive businesses significantly outpaced industry growth in every major region of the world.

Our balance sheet remains strong with a net debt to capital ratio of 19.3%. Our capital spending continues to grow judiciously to support our future growth, and our productivity improvements. Also, we continued to invest for the long term as shown by our spending by R&D and new program launches, which was approximately 3.3% of sales. In addition to our improved financial performance, we also made several exciting announcements during the quarter, including an acquisition, a number of business awards, and the grand opening of two new facilities.

We were very pleased to announce the acquisition of Dytech ENSA, a leading producer of exhaust gas recirculation, coolers, tubes, and modules. ENSA is precisely the type of acquisition we are looking for. It is a well-run company with leading technologies, a solid growth profile, and BorgWarner-like profitability. Low temperature exhaust gas recirculation, or cooled EGR, is an important technology that helps reduce NOx and particulate emissions in diesel and gasoline engines. Today, ENSA predominately serves the light-vehicle market in Europe, but our strategy is to quickly grow this product line globally and increase our penetration in the commercial vehicle market. BorgWarner's expertise in air management and turbocharging combined with ENSAs EGR cooling technology will enhance our systems capability. Furthermore, BorgWarner's global footprint will accelerate the global expansion of this new business.

It was a very exciting quarter for business awards, and we made a number of high-profile announcements. The 2011 Mustang GT is equipped with our cam torque actuated DCT and timing systems. Our twin scroll turbochargers are featured on new BMW 535 Grand Turismo. The 2011 Ford transit connect electric vehicle, their first all electric-production vehicle, will use our eGearDrive transmission. And BorgWarner has developed in close cooperation with BMW, a new generation of high-voltage electric cabin heaters for BMW's Mini E cars.

We also opened two facilities in Asia, increasing our expansion into the world's fastest-growing region. Last month, we had a grand opening ceremony for our new thermal systems facility in Chennai, India. The facility will house manufacturing, engineering, sales, and admin functions for our growing thermal business. The building was also designed as a green building, with many environmentally friendly features. Also last month, we had a grand opening ceremony for our new facility in China, called the China Technical Center in Shanghai. This 175,000 square-foot facility will provide local management, engineering, sales, and finance support for all of our growing businesses in China. These announcements are evidence of BorgWarner's continued commitment to powertrain leadership around the world.

Now, shifting gears, I would like to make a few comments on the broader auto industry. Global production volumes remain stable in the first quarter. China, India, Korea, and Europe had production volumes in the first quarter that were similar to the fourth quarter of 2009. In North America, first quarter production was higher than the fourth quarter of 2009. And during our last earnings call, we discussed the uncertainties surrounding Europe.

OEM suppliers and others, including us, warned that there were -- that there would be a post scrappage drop off in production volume. The low end of the previous -- or our previous 2010 guidance included this conservative scenario. These warnings still persist in some forecasters, but based on our best market intelligence, we now believe that this conservative scenario is unlikely. In addition to an improved outlook for production volumes in Europe, we continue to see a favorable mix shift towards higher BorgWarner content vehicles, including diesels.

After two relatively strong quarters of production in Europe and North America, that's Q4 2009 and Q1 this year, combined with better visibility of Q2 in Europe, and the strong performance of our operations, we have an improved outlook for our Company in 2010. Therefore, as you saw in this morning's announcement, we revised our guidance upwards. Our expected sales growth is now 28% to 32% compared with 2009 levels, and our revised earnings guidance range is now $2.20 to $2.50 per share. A 52% increase midpoint-to-midpoint over our previous range of $1.40 to $1.70 per share -- $1.70 per share.

This new outlook considers a number of macroeconomic factors, including, in the US we expect annual production of approximately 11.3 million units in 2010, up from our previous expected guidance of 10.5 million units. In Europe, we expect annual production of approximately 16.6 million units in 2010, up from our previous expectation of 16.3 million units. Vehicle mix, compared with 2009, will continue to shift towards higher BorgWarner content vehicles, including diesels, as I said earlier. In Asia we continue to believe that China, India, and Korea will have strong growth compared with 2009.

Our 2010 production outlook for commercial truck and North America has improved since last quarter. Also volumes were stronger than expected in the first quarter and we now expect stronger volumes throughout the remainder of the year for commercial truck. Our outlook for European commercial truck production in 2010 remains unchanged. We still expect higher volumes in 2010 compared with 2009, with most of the improvements in the second half of the year.

Globally, production volumes were done in the first quarter compared with the fourth quarter of 2009, yet BorgWarner still showed sequential improvement in our results. Our robust first quarter performance was largely due to our backlog, strong cost controls, and structural improvements in our business. Our improved outlook for the company in 2010 reflects our view that volumes will continue to recover and that we will continue to deliver outstanding operating performance throughout this year.

Longer term, the demand for our technology continues to gain momentum, and improving fuel economy is one of the major long-term trends in the auto industry. As a result, as we have said many times, our leading-edge technology and high demand, we expect this to continue for years to come. With that, I will turn the meeting over to Robin.

Thank you, Tim, and good morning to everyone. Before I go through the financials in detail, let's go over the macro industry environment in the first quarter Tim talked about a little bit. The first quarter reflected a slight pullback from the fourth quarter of 2009 on a global basis of about 3.6%. But I don't think anywhere near the falloff that some industry experts had predicted, particularly in Europe, which actually was only down about 2.7% from the fourth quarter of 2009. Alternatively, compared to the record-low production levels in the first quarter of last year, 2010 production was a blowout, up 39%. If there was a slaughter rule in the auto industry for year-over-year production performance, it would have been invoked in the first quarter, believe me.

Year-over-year. BorgWarner sales were up 57% in the quarter versus last quarter, and 50% excluding currency. Outpacing in the 39% global vehicle market growth by over 10 percentage points, year-over-year in the quarter. Our sales in the first quarter were up 7%versus the fourth quarter of 2009, also about 10 percentage points better than the market. We benefited not only from the fundamental underlying market growth, but also from improved mix in Europe and our strong backlog of net new business, which was once again is differentiating BorgWarner growth from the market.

For the quarter, as Tim mentioned, US GAAP earnings were $0.63 a share compared with the US GAAP loss of $0.06 in the first quarter of last year. The results from both periods, US GAAP results, included nonrecurring or unusual items that we have detailed in the press release table as we traditionally do. And we provide this table to help reconcile the US GAAP earnings measures with the financial performance of the continuing operations of the Company and to aid in the comparison of results from one period to another. We think this is an important part of the release. We encourage you to review this information.

At this time I'm going to focus more on the summary numbers, so excluding the unusual items, first quarter 2010 earnings were $0.65 a share, significant improvement from first quarter 2009, were we incurred a loss of $0.12 a share. As we move down the income statement from the sales line item, gross profit in the quarter as a percent of sales was 18.5%, compared with 9.7% for the same period a year ago and 17.8% in the fourth quarter of 2009. The improvement relative to the fourth quarter end year-over-year reflects both the effectiveness in our past restructuring activities, a well executed cost control program, and the benefit of our operating leverage as sales growth returns.

First quarter SG&A costs were $130 million or 10.1% of sales versus $74 million or 9% in the first quarter of last year, and $139 million over 11.6% in the fourth quarter of last year. SG&A in the first quarter 2009, or a year ago, included a $28 million gain related to the Muncie closure, and a $5 million expense related to purchase accounting rule changes. If you exclude those two items, 2009 SG&A on a comparable basis was approximately $97 million or 11.9% of sales. If you look at the year-over-year increase on an operational basis about $33 million of spending, $407 million worth of sales increase. The dollar spending increase was related to R&D costs of about $9 million, some OPEC expense of $4 million, FX of about $3 million, and the rest primarily incentive compensation.

If you look at operating income, in the quarter, almost $107 million versus $5.5 million on a reported basis in the same period last year. Again, excluding the Muncie closure items and purchase accounting rule changes in the first quarter of 2009, first quarter of 2009 on a comparable basis was an operating income loss of almost $18 million. So the change in operating income year-over-year, quarter-to-quarter, was $124 million. And relative to the $467 million increase in sales, that translates to a year-over-year incremental margin of about 27%. You exclude the impact of currency, our incremental margin from a year ago was about the 30% level. Very strong performance.

The operating income margins in the quarter was a very strong 8.3%, and as Tim mentioned, starting to approach our historical 8.5% to 9% range. I have to tell you the operating income margin turned out obviously stronger than we expected when we started the year, and almost solely due to stronger sales in the quarter, and good incremental profit generation by our businesses. On a sequential basis, sales were up $89 million in the first quarter versus the fourth quarter of 2009, while operating income was up $39 million. This translates to an operating income margin of $0.44 on the dollar, and also really helped drive the surprising 8.3% operating income margin in the first quarter. We may see a little payback on that incremental margin, as we go from Q1 to Q2 comparisons.

Clearly that 44% incremental change from fourth quarter to first quarter had to have some spending timing benefits in those numbers. As you look farther down the income statement, equity affiliates earnings were $9.3 million up from basically zero a year ago, and down just a tad from the fourth quarter -- fourth quarter of 2009. The equity affiliates primarily reflects the performance of our Drivetrain systems 50/50 joint venture, NSK-Warner, which is located in Japan and services our Japanese customers. Light-vehicle production was up over 50% in Japan, in the first quarter 2010 versus first quarter 2009 and helped drive the big year-over-year increase in demand for our transition components.

Interest expense and finance charges were about $14 million in the first quarter versus $19 million on a reported basis for the first quarter last year. If you remember in the first quarter, we incurred about $11 million of reported interest expense related to unwinding certain interest rate derivative agreements. Now if you exclude this $11 million nonrecurring item, interest expense last year was just under $8 million in the first quarter. So on a run rate basis interest expense was actually higher year-over-year by about $6 million.

And as we've said in previous quarters, an increase in interest expense year-over-year is related to the cost of the convertible notes we issued in April of 2009 last year, to provide liquidity in what was a very difficult liquidity market. The provision for income taxes was $21 million in the quarter, which reflects an 18% effective tax rate on the business, and an additional $2.5 million of tax expense related to a change to Medicare Part D tax law, which came into effect in the first quarter. Net earnings attributable to noncontrolling interests, formerly known as minority interests -- still can't understand why we have to use that long word, but anyway, was $5.2 million in the quarter. Again up dramatically from the first quarter 2009 and reflects our partner share of the strong earnings performance in the top part of the income statement.

And finally earnings to BorgWarner are $76.2 million in the quarter, versus a loss of $7 million in the first quarter a year ago, and $45.5 million in the fourth quarter of 2009. Normally, I stop right there and we do want to talk about other things. However, you'll notice in our press release on income statement, some new information at the bottom of the income statement. And that is a calculation of diluted net earnings, which is now required to get to diluted earnings per share.

And this new information is related to the accounting for our convertible debt that, again, we issued in April of last year. US GAAP rules require us to calculate diluted earnings per share two ways related to the convertible debt, and then to use the most diluted method for reporting. One calculation is as -- is as if the convertible debt, is truly debt, or not converted to equity in other words. Which means we would include the full interest expense in the income statement and exclude any potential debt conversion to additional shares in the diluted share comp. And this is pretty much the method we've used since we issued the security.

The alternative method is on an if converted basis, I hope you all appreciate the accounting lecture you're getting here. The alternative is on if converted basis where you eliminate the interest expense related to the convertible debt from the income statement and assume the debt is converted to equity, which in our case involves approximately 11.4 million shares at conversion. And the -- if converted method for this quarter happens to turn out to be more diluted by about $0.015 per share and therefore that was the method we used.

And you see the calculation it shows the after-tax elimination of the if convertible interest expense, a little over $5 million and an $11.4 million increase in diluted shares outstanding in the table of financial statements. And now diluted shares outstanding is 129.7 million, again which reflects 11.4 million converted shares, if converted. There is a lot more detail in the calculation provided in our 10-Q, and I encourage you to read that as that will be filed later today. So after having said all that, our fully diluted earnings per share are $0.63 on a GAAP basis of which $0.02 is loss attributable to the Medical Part D tax law change.

Now let's look at the operating segments in the quarter. Engine segment sales were $906 million excluding currency, that translates to a $238 million improvement from the same period a year ago or about 38% growth and pretty much in line with global production levels. Earnings before interest and taxes for the Engine segment were $107 million or up to 11.8% of sales, good strong margins. And up $71 million versus the first quarter of last year. The incremental margins for the group, excluding currency on a year-over-year basis was 27%. So good in line performance from our Engine group.

With the Drivetrain segment on a relative basis provided much of the improvement year-over-year and much of the excitement. Similar to the third and fourth quarters of 2009, Drivetrain segment sales were $386 million, up approximately a $172 million from a year ago and excluding currency, that's about 87% growth. The Drivetrain group saw very strong growth in every region of the world, most notably in Europe, DCT component sales are sharply higher while sales of torque management devices and traditional transmission components were strong across Asia and in North America.

Earnings before interest and taxes for the Drivetrain segment were $37 million or a whopping 9.5% of sales. And that compares to a loss of $33 million last year, which is a $70 million year-over-year improvement and an incremental margin of 39% year-over-year in the quarter. That is quite an impressive turnaround, and I think a confirmation that the restructuring actions taken over the past three years, though painful, were the right things to do for BorgWarner. The 9.5% EBIT margin is an all-time record for the Drivetrain group. My compliments and gratitude to all the employees in the Drivetrain group for a very fantastic quarter.

Let's move on to the balance sheet and cash flow statements. Net cash provided by operating activities were $64 million for the first quarter 2010, slightly below last year as a sizable sales growth in the quarter resulted in a build up of working capital, particularly accounts receivable. This is a seasonal effect we get every year in the first quarter. So it's no surprise. Capital spending including tooling, was $55 million, up from $39 million a year ago. After deducting the capital spending from net cash provided by operating activities, free cash flow was approximately $9 million during the quarter. Good performance again considering the typical seasonal working capital demands of the first quarter now that we're back in a growth mode.

Balance sheet debt increased by $64 million in the first quarter compared with the end of last year, but that's primarily due to new accounting rules, which requires the company to put its $50 million receivable securitization facility back on the balance sheet. So the increase in short-term debt, $50 million of that is related to receivables being put on the balance sheet and you see a corresponding increase in accounts receivable of $50 million related to that change in accounting. Previous accounting rules resulted in the facility being off balance sheet.

So during the same period first quarter, excluding the change in accounting rules debt increased by $14 million, cash increased by $17 million. As a result our investment grade balance sheet remains strong with a net debt to capital ratio of 19.2% at the end of the first quarter, and are trailing 12 month net debt to EBITDA of a little over one times. Very strong financials.

Now let's look at our revised guidance for 2010. In our last earnings call, in early February, we talked about guidance and we talked about our expectation that guidance would be increasing the next time we talked to you because we would be a little bit smarter agenda in the first quarter. And that is truly the case. With one third of the year behind us, we have had time to watch the market develop and have better visibility for the remainder of the year and as Tim mentioned, we revised our sales growth to 28% to 32% from last year's levels and raised our earnings guidance from $2.20 to $2.50 a share.

Tim reviewed the underlying market assumptions from a vehicle production perspective, in detail. So I'm not going to go over those, but let me quickly summarize. We have increased confidence in the stability of the post-scrappage European vehicle market and believe there is potential for year-over-year growth in 2010. We have seen a mix shift away from A and B class vehicles in Europe toward vehicles with a higher BorgWarner content including diesels and our volume expectations for North America have also improved.

Let me go over the underlying financials assumptions for our updated guidance for you. The dollar to the Euro exchange rate is $1.35 in our guidance. Previously we had a range of $1.35 to $1.45. The new sales guidance does include approximately $150 million in sales related to the April Dytech ENSA acquisition and about $0.01 per share of earnings accretion.

Commodity costs increases, as we now believe will be closer to $35 million versus our previous guidance of $20 million to $25 million year-over-year. We are looking at a tax rate of approximately 20% for the year versus our previous range of 15% to 20%. The dilution related to the convertible debt and the associated hedge overlay, we expect anywhere from $0.10 to $0.12 a share. For the year it was $0.015 in the first quarter and we expect that to increase as the year moves as on and Borgwarner stock price continues to increase.

Traditionally, third quarter, relative to the other quarters of the year is part of our assumption, and that's just due to standard industry summer shutdowns and a third quarter pullback in the European production versus Q1 and Q2 levels. We expect SG&A around 10.5% sales level for the year. Remember in the first quarter was 10.1%. Operating income margins for the year around the 8% level in each of the quarters except again for the traditionally depressed third quarter. If sales become stronger later in the year, then we expect we could see higher margins at the eight plus level, with incremental margins at around 20%.

R&D expense we are projecting around 4% of sales. Capital spending, $250 million to $275 million, that's up a little bit from previous guidance, and cash provided by operating activities less CapEx will be approximately $250 million versus the $200 million guidance we provided previously. Let me finish here with talking about where we are. The first quarter was an outstanding quarter for BorgWarner. There's no doubt about it. And this was not a peak quarter for us as we hear others in the industry referring to the first quarter.

Our first quarter financial performance is repeatable and something we will build upon throughout the year. There is no doubt we are back on our historical growth track. Achieving the high end of our earnings guidance rates for the year actually would put us back to BorgWarner's previous all-time high earnings per share level in 2007.

So going from a dismal challenging year like 2009 to a potential all-time high EPS in 2010, is why we continue to believe that BorgWarner is one of the premier global automotive suppliers. Our backlog of net new business is supported by one of the strongest secular trends in the marketplace. And accelerated demand for powertrain technology that delivers better fuel economy and emissions performance. We have a proven track record of operational excellence that delivers superior financial results during all stages of a market cycle. And we have a very strong balance sheet enabling us to weather difficult market conditions, make strategic acquisitions as they come along, such as the Dytech ENSA acquisition.

We believe our strategy is proven and sustainable, for the long-term and our track record speaks for itself. Now having said all that, I want to assure you we remain focused on the key driver of the Company's long-term success, and that's our people and our powertrain technology leadership. We are a leader Company now, after having gone through the last two years with a workforce that has rededicated itself to insuring BorgWarner maintains its reputation and its position as the leader in powertrain technology and operational excellence throughout the world.

We are both well-positioned financially and technologically to remain at the forefront of the growth curve in this growing industry. So with that, I'd like to turn the call back over to Tim.

Thanks, Robin. We will now turn to the Q&A portion of the call. Carmen, if you could go over the Q&A procedure again, please.

(Operator Instructions) Your first question comes from the line of Rich Kwas with Wells Fargo securities.

Good morning.

Good morning, Rich.

Congratulations. Drivetrain margin, Robin, how should we think about this? This is an all-time high as you mention. You've got more DCT components for you coming into the mix. Should we think about these margins continuing to go up from here?

I don't see them moving up materially. I think certainly we can maintain these levels. We will see a little bit of incremental margin with some incremental sales growth. I think what you're going to see is as we continue to ramp up activities in China, you're going to see some increasing R&D expense and some increasing infrastructure costs putting into that Drivetrain business.

Rich, the other thing I would add is you mentioned DCT, but there's also improving margins in our four-wheel drive business also.

Right. And then on your incremental margin commentary, Robin, the 20%, should we think of it as still going to be hanging around 30% in the next -- current quarter and then moving down toward 20%? Or is that coming down more significantly than what we first thought?

I think as we said, we previously expected, kind of, the first couple of quarters at the 30% range. I think you'll see a little bit of balance in the second quarter, with that first quarter 44%. But I think the first -- you look at the first six months, it's going to be about the 30% range. The back half of the year we'll see closer to the 15% to 20% as we said before. It will be moving down. Great.

And on the M&A front, Dytech is a decent sized acquisition. Are you seeing other entities out there similar size that are potential opportunities?

Rich, we are -- we're continuing in discussion. Give you an idea, we were in discussion on the Dytech acquisition for three years to three and a half years from the time I had that first meeting with the potential seller to when we closed. Some of my guys closed earlier this month. We're continuing to have those king discussions with a few other companies. The fish we are looking for are tough to land, but they're very strategic for this Company.

And what was the price paid for it?

Or do I have to wait until later today? You won't see it today with the second quarter event.

Right.

We trade full price for that. I'll give you -- somewhere around 75% of sales.

Okay. Great. Thank you.

Your next question is from the line of Itay Michaeli.

Great. Thanks. Good morning.

Good morning, Itay.

Robin, question on just the long-term operating margin target that you've had out there. You have more confidence now with the great results in Q1, that you'll (inaudible) back to say 2008 or 2007 industry volumes in the backlog -- that you'll get to somewhere higher than 9%? What might prevent you from getting above the historical range?

That's a good question, and I've been thinking that through myself. As I look back, we've certainly had some quarters above 9% but seemed to have averaged somewhere peeking at about the 9% level. Is it possible to get up to the 9% to 9.5%? I'm sure its -- anything's possible in this environment. With what surprise we have, I think of where we are at -- it's possible.

As we continue to say, we're very happy to look at this Company from a long-term perspective with the type of industry-leading sales growth we have, achieving margins at the 8.5% to 9% level. That drives enough value for us. To us, anything about 9% is just icing on the cake. Is it possible? I think after looking at the first quarter and getting a sense of where we're at, I'm sure it's possible that we put a couple of quarters up there that are north of 9% -- not this year.

The issue is there's still a tremendous amount of pricing pressure out there, so any margin improvement we gain is going to have to come from internal improvements. Where we take increasing [buy-in] and convert it to operating income without increasing our cost basis too much.

I can almost guarantee you that all our sales guys will be calling Tim and I tomorrow complaining because of the calls they got from various customers' purchasing department wanting to talk about price reductions. Given the strength of our quarter performance and expectation for the year. So, to Tim's point, there continues to the prices pressure in the industry.

Absolutely. And one more follow-up on the backlog and new business environment. With production forecast going higher, can you maybe size of the backlog maybe, or should we expect anything different in 2011 and 2012 than we have been talking about. And also, Tim, if you can just comment on what you're seeing out there in terms of new business quoting activity and what the environment has been like?

Well, our quoting activity is up. I would approximate the quoting activity that we have seen in the first quarter as compared to a full year average for 2009. On a full year 2009 average, our Q1 quoting activity is probably up 30% to 50%, depending on the product line. Some of that quoting activity is attributable to -- we had companies that were in bankruptcy last year, and didn't -- weren't quoting anything, and now they're quoting. Because their programs are now starting to -- their plans are starting to kick in. And plus the continued push on better fuel economy.

So we're getting a lot of quotes driven by growth by companies that haven't had growth and quoting activity by fuel economy changes and all the restrictions in the new laws. Our backlog, we won't be looking at that until the fall of this year, but at the rate we're going, I expect our backlog to go up towards our historical high levels. I don't know how quickly that will happen. It may happen quicker than we expect.

Great. Thank you.

I was going to say our current backlog of $1.8 billion that we announced last fall is well within the range of BorgWarner's historical -- I think our last range was -- we were in the $1.7 billion to $2.1 billion range. And at $1.8 billion -- as we said today at $1.8 billion, we are well within the range and I think we're going to move towards that. higher end.

That's helpful. Thanks guy and congratulations.

Thanks Itay.

Your next question is from the line of Rod Lache with Deutsche Bank.

Good morning, everybody. Just first of all, just to follow up on that last question on the long-term margins. You are in the eights now. Your looking at double digit growth next year, even if the market doesn't really rise, just based on the backlog that you have disclosed previously. With 20% growth, or incremental margins, I think you can add two points to the margin even before anything else happens. So I was just hoping you could give us a little more color on some of the offsets. What is the magnitude of the drag from investing in China or how much incrementally does this pricing deteriorate from current levels?

I can tell you real quickly that 2 percentage points gets eaten up January 1 when new pricing kicks into our customers at 1.5% to 2% levels. You have wage inflation, we'll see commodity inflation, and as you point out, we are still growing in regions of the world where additional infrastructures is required. And that being said, we still have a hiring freeze on right now for salaried people. So anybody that wants a hirer salaried person has to come to me for approval. We're very, very frugal in the way we are bringing back hourly directs. And we're doing everything we can to improve our margins, and you can see that starting to show up in our results. But we still have a growth business, and we are not a Company that ever makes any decisions that starves our growth.

So we're going to continue to invest in growth both on the engineering side of the CapEx side. I will say, though, Rod that I think we are pretty much done with buildings for a while. We don't see -- there may be an incidental opportunity where we have to put in a building here and there, but, we have expanded in China. There is still some -- we're in the middle of construction on this joint venture in China for DCT, but we have expanded in Eastern Europe. We have expanded in China. We've got a plant that's ready to roll now in Mexico that's fairly empty and the turbocharger business is moving in down there at the end of year -- as we speak right now.

So, we're trying to be frugal and we would like to improve our margin just like you probably would like to predict them.

So if you're not bumping up against physical capacity constraints, what is the factor that causes the incremental margins to moderate from the 30% down to the 15% to 20%?

As we discussed this before. What we are trying to do is as the business comes back, increase the direct workers in the facilities and try and hold back people -- the support -- indirect people to support the purchasing, those type of functions. And we'll be successful in the short term.

In the long-term we're going to have to start bringing those people back once it's evident this growth is real. And it is evident that this growth is real, as we continue to see new business come on stream, which we will, we talked about the net new business backlog. So we are going to have to add more than just the direct labor component and sales increase later in the year. I gave you this example once before. You might be getting by with one forklift operator in an area in a shift right now, but eventually, you're going to have to add that second one. And incremental sales relative to incremental forklift operator isn't a direct relationship.

So we will start putting some, what I call support/infrastructure people costs into the business later in the year. Tim said he reviews every salary he had that's required. The operational side, the hourly is required their put into the business. And we do see increased activity from a growth perspective in Asia. We will have increased R&D activity in the Asian market. And so, it's mostly people costs, Rod. And it's a good problem to have, frankly.

You have to remember, we carry a lot of costs because we're pretty - we're a little bit more invested in R&D than a lot of other suppliers. So we carry a lot of extra engineering costs, we probably will be adding some back in there. Not that we starved engineering at all, but we're trying to go back to our traditional growth curve and this quarter's a good start at that.

Two quick things on the growth. There was an EPA report that came out a few weeks ago, predicting 75% DCT penetration for the US by mid-decade. I was wondering if you have any thoughts on that and whether your expectations for that business are getting revised higher. And can you also get just give us some color on where the European mix for diesel is settling out now and should that be driving above trend Engine division growth here going forward? Yes.

I can tell you right now, the European diesel next for light-vehicles is, mainly past cars, is pushing 50% right now. Which is back up to its -- near its historical levels. It's been averaging about 49.5% to 49.8%. It's close to 50%. The traditional level I think got up to about 52% or 53%. So I would expect you're going to see that pushing back up to that range and it's happening probably as we speak.

Regarding DCT, I didn't see the report, but I can tell you right now DCT is being accepted as the main transmission globally to improve fuel economy and emissions. There's a face-off going on right now between dry DCT and wet clutch DCT. We started with the wet clutch DCT and we have kind of helped create that business. And we're still -- we're the premiere supplier for all the clutch modules and control modules there. We also are a major participant in the dry clutch DCT now with our solenoids and control modules.

I can just -- I can just say that back in the early 2000s -- 2003, 2004, 2005, when I had this job. Everybody, including the Wall Street analysts, were predicting and asking of me all questions on CVT, thinking that, that was the transmission of the future. And we kept saying DCT was the transmission of the future. The market has proved us right, and I think it's just going to continue to grow.

Not just in North America, which there is a big opportunity for North American penetration because there is almost no DCT over here in North America right now, but it's growing in China, Japan, and Europe obviously.

Thank you.

Your next question comes from the line of Patrick Archambault with Goldman Sachs.

Hi. Good morning.

Hi.

Actually I just want to drill a little bit further into the capacity question. In terms of Turbo specifically, where would you place the industry capacity utilization right now? And just given what we know about CO2 standards and obviously CAFE standards in the US, ultimately. At what point did we really start to push the capacity? Just because it would seem if we're getting into normal levels now, right, just given the increased demand that is implied by your backlog, you have to be adding more buildings, so to speak, at some point, right?

Yes, we will be adding more buildings and more capacity at some point. For now, I think we're okay on buildings. What you're going to see there is tremendous growth in turbocharger capacity --- turbocharger needs and market growth, for sure. To give you an example, diesel turbochargers will probably go -- grow from less than 12 million units in 2005 -- I'm sorry, 12.5 million units, a little less than that in 2009 up to a little less than 20 million units in 2015. And that's just for diesels.

And then you go to CAFE in 2009 it's going from about 2.5 million units up to a little over 8 million units. The capacity today is probably a little less than 100% utilization right now. Some lines are probably underutilized, not just at BorgWarner but at some of our competitors. But some lines because of market demand our overcapacity -- demand is over the capacity. And we're working very fast to catch up on capacity. So, meaning we're converting existing capacity to other product lines. But you're going to see tremendous growth. People are going to be adding capacity. We're going to be adding capacity.

We are -- our market share is in the 30[%]s. Somewhere, between 30%, let's just say 33%, plus or minus market share. We're going to maintain that market share over time, and the world -- there's going to be a lot of people enjoying tremendous growth in the turbocharger business. We'll be one of them.

Okay. It sounds with -- how tight things are, that maybe it's not this year. But in relatively short order we're going to have to be adding facilities to make this doubling and tripling of demand, right?

Yes. We have a whole empty building in Mexico right now that can handle all of the North American capacity that we're going to need for the next probably four or five years. We may have to put some more capacity in China. We probably might have to put in some capacity in, in Korea. But not for probably -- not for a year or two, would be my estimate.

Europe -- we've been adding capacity in Poland and we have plants in Germany, Hungary, and Poland. We have room for expansion in Hungary and Poland. But we're very frugal in the way we use our plant space and the way we use our equipment.

Okay, great. Thank you. And one other one, if I may, on raw materials. I think you had said that was a $30 million for this year.

$35 million, Patrick.

$35 million. Can you tell us a little bit more about the structure of your contracts? It sounds from just anecdotally, that there's a little bit more pass through in contracts in the suppliers than there used to be. Maybe pricing at the OE's has gotten better so they're willing to do that. I don't know.

So how much of that, let's say it goes up, right, beyond your expectations. What percentage of the increases would be your responsibility and what's your ability to sort of recoup those in this environment?

Well, we have more and more pass through on nickel and some of the other commodities that have indexes. And the stuff that we don't have pass through on we basically have -- basically have had some hedging. I would say we're probably exposed on -- I'll let Robin come up with a number shortly.

We also have -- we're protected on aluminum. We're typically are protected on copper. Steel is going to be our biggest question mark and our biggest potential risk. And I would say that our exposure, on all of our commodity costs, we're probably exposed on 35%. The rest of it we can cover through longer-term -- through long-term contracts on our purchases. Hedging or pass throughs.

I think, to summarize, our biggest exposure is steel. And that's why, previously thought $20 million to $25 million was going to be our increase in commodity costs this year. And now are looking at $35 million. It's pretty much related to steel. We have seen an increase in steel costs relative to what we thought the year was. In fact, that is something that historically has been difficult for us to pass through to our customers. It continues to be difficult to pass through.

As Tim mentioned, there is no active market to hedge that. So that continues to be our biggest exposure, and has been historically. Besides nickel, as Tim mentioned, we've got nickel put in the box right now with respect to pass throughs for our customers. And there is an active hedge market.

Great.

Does that help?

It does. Thank you.

Thank you, Patrick.

Your next question comes from Himanshu Patel with JPMorgan Chase.

Hi, good morning.

Good morning.

Just two questions left. One, was there really a big sequential improvement in European mix Q1 to Q2? I know there was a year-over-year improvement, but I thought sequentially in the A and B segment mix -- production mix at least viewed on that spectrum, was flattish. I'm just trying to understand the big -- driver of the big sequential improvement in operating margin.

Himanshu, it wasn't a big, big shift. It was more a gradual, but it was encouraging for us. We took that margin as a sign of what the rest of the year could be rather than any impact on the first quarter.

To give you an idea, some of the [CD and E] platforms in Europe, going up towards the high 60% of the market penetration, whereas in 2009, they were around the 60% market penetration. So that's 7% to 10% increase in market penetration, is a big jump in one year and that doesn't include the doubling down opportunity with some of these vehicles, and a lot of these vehicles are diesels.

Okay. And then, Robin, earlier, you mentioned, I think some that there were some spending timing issues that could have benefited the sequential contribution margins. Can you dimension that and how should we think about that for next quarter?

Well, as we have said before, we expect incremental margins at about $0.30 on the dollar. Which ran about $0.44, which was about $10 million or so[inaudible) in operating income, maybe more than we would have expected. We are crawling to the details of the income statement right now, quarter to quarter. It appears we got a little bit of benefit from a prototype sales in recovery on the engineering side that was probably a little bit timing related. It's more on the SG&A level. As I said, SG&A percent of sales are 10.1% for the first quarter. We're really looking at 10.5% for the year. So it was more on the SG&A area of business. We have a little bit of discretion on timing.

Okay. And, lastly, I have a bigger question. We are seeing a lot of suppliers post basically historic peak margins this quarter. That's your sense on how this translates into pricing pressure? I mean is this -- is it in a perverse way? Maybe should we think about it as industry volumes start going up, the initial phases of volume recovery start seeing accelerated volume? I mean accelerated OEM pricing pressure whereas in the last six months or so they were a lot nicer?

Well, I'd hate to predict them getting more difficult because it may become a self-fulfilling prophecy. But I think that North America, the OEMs are starting to appreciate healthier suppliers or suppliers that aren't distressed and suppliers that are willing to invest in new technology. So I think that's holding.

If you listen to Ford, their strategy is profitable growth for all. Alan Mulally, who seems to be walking the talk and delivering his plan, that's his mantra, profitable growth for all. He didn't say what level of profitability, but I think we're in a decent range. The Europeans are a little bit more pricing conscious right now. So I'd say the pressure shifted more from North America towards Europe. But, the Europeans have a high appreciation for technology. So we're on the right side of the curve because they are willing to pay a premium for leading technology.

So, pricing pressures come and go. I'd just say right now they are average.

Again, as we said earlier from our perspective, this is not a peak quarter from the margin perspective. You will see higher income operating margins going forward. Again, we've got this third quarter -- a lull in activity. I think as we continue to progress, you'll see some higher margins.

Okay. Thank you.

Thanks Himanshu.

Your next question comes from the line of John Murphy.

Maybe if we could just mention capacity utilization just in general in this quarter, and last year. And what you expect through the remainder of this year? I'm just trying to get an understanding of where the capacity utilization levels are.

I would say that some product lines were at 100%, maybe even over 100% on our utilization. Some products were still down around 70% And so if you want to say on an average, maybe it's 85% to 90%. But there are some product lines where we are going full out right now, particularly in Europe. We are going full out on dual clutch right now, clutch modules and control modules. And the biggest question is not necessarily us, although we have the capacity. It's our supply base.

And, on turbochargers, we have a mixed bag. We have some products where we're under capacity -- we're not utilizing or capacity. We have some products where demand is very high, and we are at 100% of our capacity and growing. So it takes a little time, but we will convert existing capacity where we need it.

You are going to see increased spending on our CapEx this year. I think last year they were a little less than $200 million -- $180 million but we are probably going to be pushing $270 million this year. And that is below our historical levels. So that's another way of indicating -- we're still getting tremendous growth so we're putting in capacity for growth. But we're still being able to convert some of our existing capacity to new projects. So we have -- like I said, we are not fully utilize yet. Maybe 85%.

So as we go through the remainder of the year, that will trend probably into the mid-90% range to high 90% range based on current forecasts?

Yes. And we're putting in some capacity as we speak for certain products -- certain programs.

Okay, and just lastly, on the impact of the F150 and the F series trucks on your Drivetrain business. What was the impact -- was there an improvement in mix in the F150 and maybe the super duties in the first quarter? What should we expect to see in the second quarter? What's your exposure there? How much might that help?

Well, first of all, we're not out on the Super Duty. We're on everything but the Super Duty at Ford. Ford's volumes have stayed real strong on trucks, and we benefited from that.

And we also benefited from the fact that we closed down our plant in Muncie, Indiana. They used to make all the transfer cases for Ford. And now we've moved that down to an existing plant in Seneca. We are now seeing the full benefits of that move.

I said earlier on one of the questions, we are seeing an improvement in margins on four-wheel drive it's because we've gone from a high-cost location to a lower cost location. And we have been able to utilize some of the existing infrastructure and gain efficiencies. GM truck business -- the business we have is strong and in general GM trucks are strong. I just had -- wish I had some more GM business.

And we're going to pick up some Chrysler business, like we said, we have announced we're going to be supplier of all Chrysler trucks. I can't say when we are going to start production, but we're hoping to start production as soon as we can.

Great. Thank you very much.

And we have time for one final question. And that question comes from Brian Johnson with Barclays capital.

Good morning. Tim and Robin, I want to go into your thinking behind the Dytech deal. And how important was it for you to get into EGR coolers? How quickly can you go there -- grow their revenue?

Will you be getting in on engines where you're already doing the EGRs? Do you have to wait for new powertrain programs? And then they seem to be unusual in addition to Iberia there in India? How important was the India presence for you -- for them for you?

Well, let me just say this. EGR coolers are very important for technology going forward - to improve, to lower emissions, and get some fuel economy improvement. Mainly for lower emissions in the future, you want to have cool EGR as you recirculate through the combustion chamber, and that gives you a lower NOx and better emissions, like I said in my talk.

That was one of the large missing pieces of our air management strategy. We've now got pretty much everything covered on air management -- engine air management. And between variable [cam] timing turbocharging, the [Beirut] product line and now the EGR product line, and these guys are big in diesels, but they also have past car technology. I'll give you an example. I can't say that the -- the OEM name, but one of the customers that ENSA had -- said that they weren't big enough to have their EGR business.

But now that their part of BorgWarner, they can now quote new business because they are a larger supplier and they're affiliated with a healthy supplier like BorgWarner. Consequently, they now -- a whole new OEM which is a large user of EGRs, particularly for diesels, is now available to them as a potential customer. And right away they are working on new development programs because they are now part of BorgWarner.

Before they just weren't that large, so the OEM didn't feel comfortable giving them such a strategic product line to such a small supplier. To give you an idea strategically how it fits in. Like I said, technically it fits the portfolio very well in terms of the missing piece to our strategy. As far as our top customers, Renault-Nissan is 30-some percent of their business, Ford is 20% of their business, Volkswagen is mid-teens part of their business, Navistar is a big part of their business.

These are all people that we have -- do great business with, and we do have great relationships with. And so strategically, this was a very nice opportunity for BorgWarner. And it takes a small business of BorgWarner and makes it about a $300 million business of BorgWarner.

And how quickly can you grow that? Do you -- is it only a new powertrain projects or your customers willing to swap out their current EGRs? I know one of your customers had problems with one of their prior EGR suppliers.

There will be some chance to swap out. And I'm not -- I'm not the world's expert on EGR programs. But a typical engine program -- your best opportunity is on new programs. So we will be -- all new programs are being developed right now. We'll probably be right in the mix as a potential supplier and technology partner very quickly. I think there are some swap out opportunities. I just don't know all those specifics yet.

Okay. And was India a part of this or is it mainly ground-up product technology?

Let's put it this way. They're big in diesels and they're big in Europe. What's part of this is they -- we have the ability now to take them to China, take them to the United States, take them to India, although they just started -- I think their Indian operations is only a couple of years old.

It's a joint venture, and it's a small but growing piece of their business. India is a very strategic location for BorgWarner. All this does is stack another big chip on top of the pile for why this was a good acquisition for BorgWarner. As part of our global expansion strategy.

Okay, thanks.

Sure. But they are nowhere in China, and we can take them to China, and that is a huge opportunity. Because they have a missing part for our system in China. And we'll -- they will grow very well in China.

Were they also nowhere in North America?

They are nowhere in North America for all practical purposes, except a little bit of commercial stuff with Navistar.

So you're really talking about taking a toop supplier, probably a good product technology, Europe only, and then taking them to two or three other continents.

Exactly right. And they have the technology to do it immediately.

Okay, thank you.

I'd like to thank you all for joining us. As Robin said, we expect to file our 10Q later today, which will provide more details of our results. But in the meantime, if you have any follow-up questions, please direct them to me. Carmen, you may close out the call.

That does conclude the BorgWarner 2010 first quarter results earnings conference call. Thank you for joining. You may now disconnect.