博格華納 (BWA) 2010 Q2 法說會逐字稿

Good morning. My name is Wendy and I will be your Conference Operator today. I would like to welcome everyone to the BorgWarner 2010 second quarter results earnings conference call. (Operator Instructions) I would now like to turn the call over to Ken Lamb, Director Investor Relations. Mr. Lamb, you may begin your conference.

Thanks, Wendy. Good morning and thank you all for joining us. We issued our release this morning, at approximately 8:00 AM Eastern Time. It's posted on our website, borgwarner.com, on the Investor Relations home page, which can found under investor information. There will be a replay of today's conference call, available through August 6. The dial in number for the replay is 800-642-1687. You'll need the conference ID which is 87308277. The replay will also be available on our website.

With regard to our IR calendar, we will be attending a few conferences over the next three months. The JPMorgan Auto Conference, on August 9. The Credit Suisse Automotive and Transportation Conference, on September 8. And the Paris Auto Show Investor Conference organized by UBS, on September 28.

Before we begin, I need to inform you that during this call, we 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 here today.

Now moving on to our results, Tim Manganello, Chairman and CEO, will be providing comments on the quarter and industry trends and then Robin Adams, our CFO, will discuss operating results. With that, I'll turn it over to Tim.

Thank you, Ken, and good day, everyone. I'm pleased to be here today, to review our second quarter results and accomplishments, followed by comments on the state of the industry and our revised guidance.

I'll begin by briefly highlighting our second quarter results. We recorded second quarter sales of $1.4 billion, up 55% from the same period last year. With US GAAP earnings of $0.68 per share or $0.78 per share, excluding non-recurring items. This marks the fifth consecutive quarter that BorgWarner posted both higher sales and higher operating profits, compared with the previous quarter. Our earnings performance in the second quarter was the result of increased global demand for our products, higher volumes in our base business and well executed cost controls. Our operating income margin continued to improve, reaching 9.7%, excluding one-time items. This is our highest quarterly operating income margin, since 2002.

At the group level, the Engine Group sales were just over $1 billion in the quarter, up 52% from the same period a year ago. A key driver of the Engine Groups performance, was tremendous growth in the Asian markets lead by turbochargers and timing change systems, in both China and Korea. Also during this quarter, turbocharger sales were strong in Europe.

In the Drivetrain Group, sales were approximately $409 million, up 64% versus the second quarter of 2009. Our four-wheel drive business in China, India and Korea was a key contributor to the Drivetrain Group's quarterly results. Also, European DCT and other automatic transmission component sales were significantly higher.

Our balance sheet remains strong, with a net debt to capital ratio of 27.5%. Our capital spending continues to grow judiciously, to support our future growth in our productivity improvements. Also, we continue to invest for the long term, as shown by our spending for R&D and new program launches, which was approximately 3.2% of sales. Now, because of our strong sales level, R&D was, as a percentage, was slightly below our normal level of 4% of sales. But the actual Dollars spent continued to increase.

Now, in addition to our improved financial performance, we also made several exciting announcements during the quarter. We brought-- we bought out our partner in the electric cabin heater joint venture. And this acquisition was made in anticipation of growth in the electric cabin heater market. We were selected by JCB Power Systems to supply both waste gate and variable turbine geometry, or VPG turbochargers, for the new 4.4-liter ECOMAX engines, starting in 2012. The engines are slated for use in numerous agricultural, construction and materials handling applications.

For the first time in a passenger car, BMW has combined direct fuel injection with BorgWarner's regulated two-stage and variable turbine geometry turbocharging. This engine sets new standards and improvements for --performance, torque, reduced emissions and better fuel economy. With the help of our turbochargers, the BMW's 740 diesel accelerates from zero to 60 in just 6.3 seconds, achieves a combined 34 miles per gallon and meets Euro 5 emission standards.

BorgWarner's Cool Logic variable speed fan drives, are now standard equipment on the Mack Granite, Titan and Pinnacle commercial trucks, used in dump trucks, mixers and snow plow applications, as well as highway hauling.

Another area, BorgWarner will supply its regulated two-stage turbocharging technology to MAN, or MAN, for engines used to power medium duty trucks and urban buses in the Latin America market, beginning in 2012.

Our turbocharger business continues to gain momentum in China. We recently announced that we are supplying turbochargers through Shanghai GM's 1.6-liter gas engine, that powers the new Buick XL XT. And we will produce timing systems for Fiat's new 2-cylinder TwinAir engine, debuting in the Fiat 500 this fall.

Now shifting gears, I would like to make a few comments on the broader auto industry. Production in the second quarter was higher in every major auto market, compared with the same period a year ago. Clearly, last year was an easy comparison. But nonetheless, the year-over-year improvement was stronger than we expected, and Robin will provide the details for you later. But in summary, vehicle production in North America and in each of the major Asian markets was significantly higher. European production was also higher despite concerns that there would be post-scrappage volume declines.

A closer look at Europe, reveals that the mix of vehicles continues to shift in our favor. CD&E segment vehicles represent nearly 65% of vehicles produced in Europe, compared with 61% in the second quarter of 2009 and 64% in the first quarter of 2010. Diesel penetration in Europe, an important measure for our turbocharger and diesel pull start businesses, is also on the rise with a 3% increase year-over-year, so far. Compared with the first quarter of 2010, global production volumes were down slightly in the second quarter. However, BorgWarner's results continued to improve, as you saw. Our robust second quarter performance was largely due to our strong backlog, cost controls and structural improvements in our business.

Now let's take a look at our industry outlook for the remainder of the year. In the US, we now expect annual production of approximately 11.6 million units in 2010, up from our previous expected guidance of 11.3 million units. In Europe, we expect annual production of approximately 17.3 million units in 2010, up from our previous expectation of 16.6 million units. As I said earlier, vehicle mix compared with 2009, will continue to shift towards higher BorgWarner content vehicles, including diesels. In Asia we continue to believe that China, India and Korea will have strong growth, compared with 2009.

Our 2010 production, positive outlook for commercial trucks in North America and Europe has remained unchanged since the first quarter. We expect solid growth in both markets in the second half of 2010. And as a leading supplier of both turbochargers and thermal management systems or cooling systems for the commercial vehicle market, we expect to benefit from this growth.

A combination of favorable trends has also caused us to raise our guidance for 2010. The combination of higher volumes, improved mix and new program launches, are enabling BorgWarner to significantly outpace the global market. Our expected sales growth is now 32% to 35%, as compared with 2009 sales. And our revised earnings guidance is now $2.60 to $2.80 per share. The midpoint of this earnings guidance range, is 15% higher than the midpoint of our previous range of $2.20 to $2.50 per share, that we gave just three months ago. Our outlook for the Company in 2010, reflects our view that global volumes will continue to recover. And we will continue to outpace the overall market throughout the remainder of 2010.

The longer term, the demand for our technology continues to gain momentum. Since improving fuel economy is one of the major long-term trends in the global auto industry. As a result, and as we have said many times, because of our leading technology, combined with higher demand, we expect solid BorgWarner growth for years to come. And with that, I'll turn the meeting over to Robin.

Thank you, Tim, and good morning to everyone. Before I go through the financials in detail, let's review the macro industry environment for the second quarter, just one more time, just to put things in perspective. Second quarter global production was about 17.7 million units. Basically flat with the first quarter 2010, compared with extremely low production levels of 13.7 million in the second quarter last year. 2010 production was sharply higher, up 29% year-over-year. Now, compared with the same period a year ago, BorgWarner sales were up 55% in the quarter. If you exclude currency and the impact of the ENSA acquisition we completed in April, it's 52%. And that's 23 percentage points better than that 29% year-over-year growth in, global vehicle market.

Our year-over-year outperformance was in Europe, where the market was up 13% and our sales were up 56%. Japan and Korea, where production was up 32% and our sales were up 75%. In China, where production was up 24% and our sales were up over 110%. Clearly, our strong backlog of net new business with market penetrating new technology, is once again differentiating BorgWarner's growth from the rest of the industry and the overall market.

As you look at it on a sequential basis, second quarter versus first quarter 2010, our sales were up 13%, excluding currency and the ENSA acquisition, while the vehicle market was flat. So we outperformed on a sequential basis, by 13 percentage points. No matter how you look at it, it was a very strong growth quarter for BorgWarner, consistent with our expectations.

For the quarter, as Tim mentioned, US GAAP earnings were $0.68 a share, compared with a loss of $0.31 a share, on a GAAP basis, in the second quarter of last year. The US GAAP results for both periods, include non-recurring or unusual items, that we've detailed in the press release, in a table, as usual. And we provide this table to help you reconcile the US GAAP earnings measures, with the financial performance of the continuing operations of this Company. And to aid you in the comparison of resultsm from one period to another. We think this is an important part of the release and we encourage you to review this information.

I'm going to focus primarily on our earnings from continuing operations, as we go forward. Excluding the non-recurring items, first quarter 2010 earnings were $0.78 a share, a significant improvement from second quarter 2009, where we incurred a loss of $0.05 a share. Gross profit, as a percent of sales, was 19.4% in the quarter, compared with 12.7% for the same period a year ago and 18.5% in the first quarter 2010. The improvement year-over-year and also relative to the first quarter of 2010, reflects the effectiveness of our past restructuring activities, a well executed and continuing execution of a cost control program, and the benefit of our operating leverage, as sales growth returns to the business.

SG&A costs were $138 million, or 9.7% of sales in the quarter, versus $115 million, or 12.9% in the second quarter last year, and $130 million, or 12.1% in the first quarter this year. The incremental spending year-over-year of about $22 million, compared to a $500 million increase in sales. So it's significantly less SG&A spending, relative to the sales growth. The nominal Dollar increase in SG&A, was partly due to higher R&D spending of about $10 million. With the rest primarily attributable to incentive compensation.

While R&D spending was actually up 29% year-over-year and up 10% from first quarter 2001-- 2010. As Tim mentioned, R&D spending, as a percent of sales, was only 3.2%, below our 4% target. And it's below, as a result of the extraordinary growth of sales of some 50% in the quarter.

Operating income in the quarter was $117 million on a reported basis. However, there were two non-recurring items in the quarter-- a $28 million charge, related to an environmental litigation settlement in the quarter, and an $8 million gain, related to an equity investment for the remaining 50% ownership of a joint venture. Excluding these items, operating income was $137 million in the quarter, compared with $800,000 a year ago. The $136 million increase in operating income, relative to the $500 million increase in sales, translates to a year-over-year incremental margin of about 27%. If you exclude currency and ENSA, the incremental margin is still about 27% year-over-year, good performance.

As we look at the comparison with first quarter 2010, the increase in operating income relative to the increase in sales sequential incremental margin of about 22%, excluding currency and ENSA, maybe it's 21%. Now, if you remember in our first quarter earnings call, we talked about the incremental margin growth from the first quarter to fourth quarter, which was about 44%. And I told you at that time, that the 44% was too high, should be around 30%, but that in the second quarter we would get some pay back. And that's actually what happened here in the second quarter. If you average the first quarter of 2001's 44% with the second quarter at 21%, you get an average incremental margin over the two quarters of about 32%, 33%. More in line with the 30% incremental margin we expected for the first half of 2010, when we started the year.

The operating income margin in the quarter, as Tim mentioned, was a very strong 9.7%. And this is the highest margin that we've achieved since 2002. As in the first quarter, our operating income margin was much stronger than we expected, when we started the year. Primarily attributable to stronger sales in the quarter and good incremental profit generation by our businesses. That puts our operating income margin at 9% year-to-date. And I'll talk a little bit further about expectations for the year and beyond, when we talk about the 2010 guidance.

As you look farther down the income statement, equity in affiliate's earnings were $10 million, up from $4.8 million a year ago, up slightly compared with the first quarter 2010. And this primarily reflects the performance of our Drivetrain systems 50/50 joint venture, NSK-Warner. Which is located in Japan and China and services our Japanese customers. Light vehicle production was up 31% in Japan, in the quarter, compared with last year. And helped drive this year-over-year increase in demand, for our transmission components.

Interest expense and finance charges were $14 million in the second quarter, versus a reported 9 million last year. But, if you recall last year, second quarter 2009, we recorded about a $6.5 million gain at the interest expense line, related to interest rate swap ineffectiveness, which explains the year-over-year difference. Basically, their interest was kind of flat year-over-year, excluding net.

The provision for income taxes on a GAAP basis was $26 million in the quarter, translates to an effective rate of about 23%. If you exclude the non-recurring items in the quarter, the tax rate was about 25%. And when you combine the 25% with the 18% in the first quarter, the year-to-date average is about 22%. Which means our full year estimated tax rate, for recurring operations, is now expected to be 22% for the year, up from the 18% in the first quarter and our expectation of 18% to 20% for the year. That actually costs us between $0.04 to $0.07 a share, in the quarter. This increase in estimated effective tax rate for the full year of 22%, is related primarily to higher profitability in some of our higher tax jurisdictions where we do business.

If you look at the earnings attributable to non-controlling interest, which was formerly known as minority interest. $4.9 million in the quarter, up sharply from last year. And reflects our Korean and Chinese joint venture minority partner share, of the strong earnings performance of those Asian entities.

And finally, back to net earnings on a GAAP basis. $82.8 million in the quarter, versus a loss of $36 million in the second quarter a year ago. A net earnings of $75-- $76 million in the first quarter 2010. Excluding non-recurring or unusual items again, net earnings were $95.3 million in the quarter, versus a loss of $6 million in the second quarter year ago and earnings of $79 million in the first quarter 2010.

You'll notice, at the bottom of our press release income statement, there is additional information related to the calculation of diluted net earnings. Just as there was in the first quarter 2010. Which is required to get to our earnings per share calculations. And this table or additional information is related, again, to the accounting for our convertible debt that we issued in April of last year. US GAAP rules require us to use the if-converted method, to calculate earnings per share, which assumes the debt is converted to equity. So, we exclude the interest expense, related to the convertible debt, from the income statement. And then, include the additional shares in the diluted share calculation, which amounts to approximately 11.4 million extra shares. So -- having said all of that, our fully diluted earnings per share are $0.68 on a US GAAP basis, or $0.78, excluding the non-recurring items discussed earlier. And the year-over-year math is too hard to calculate for me, it's millions of percentages better.

So, let's look at the segments now. If you look at the operating segments in the quarter. Engine segment sales were over a $1 billion in the quarter. Increase, excluding currency and acquisitions, of about 46%, compared with the second quarter of last year and about 13% compared with the first quarter. Adjusted earnings before interest and taxes, were $133 million, or 13.1% of sales. A very strong operating margin and getting back to more historical levels for them. The incremental margin year-over-year, again on a comparable basis, excluding currency and acquisitions, was 27%. And on a sequential basis 23%.

Drivetrain segment sales were a little over $400 million. And excluding currency, that's about 66% growth year-over-year and 11% growth, compared with the first quarter. Adjusted earnings before interest and taxes, were $37 million, 9.1% of sales. A very strong performance, relative to historical margins in the Drivetrain segment, down a little bit slightly from the first quarter. But still a very strong margin for our Drivetrain business. The incremental margin on a year-over-year basis, on a comparable basis, is 28% in the quarter. On a sequential basis 5%. And that sequential incremental margin in the Drivetrain segment was down a little bit to our expectations more like 20% primarily because the cost timing that we mentioned on an overall basis in the quarter, that 44 versus 21 for a Company and also increasing costs related to DCT, Dual Clutch Transmission production expansion, particularly in China.

Let's move on to the balance sheet and cash flow statements. Net cash provided by operating activities was $208 million for the first six months of 2010, a strong improvement from $174 million in the same period a year ago. Second quarter cash provided by operating activities was $144 million, more than double first quarter this year and up 36% from second quarter 2009. Capital spending, including tooling, was $107 million, up from $88 million in the first six months of 2009. And this increase for capital year-over-year, is largely due to higher spending levels required to meet the increased level of program launches around the world, particularly in Asia. After deducting capital spending from net cash provided by operating activities, free cash, as we define it, was approximately $100 million in the first six months of 2010, and actually $92 million in the second quarter. So, very strong cash generated by our business in the second quarter.

Looking at the balance sheet, despite the cash generation, balance sheet debt increased by $124 million during the first six months of the year. $50 million of the increase is related to the adoption of an accounting rule, that requires us to put our $50 million receivable securitization facility back on the balance sheet. And previous accounting rules resulted in that facility actually being off balance sheet. So, the remaining $74 million increase in debt, along with the $170 million decrease in cash on hand, was primarily due to the, approximately, $150 million acquisition of Dytech ENSA, in April, and $155 million of stock repurchases, approximately 4.1 million shares, late in the second quarter. More details on these transactions are available in the 10-Q for your review. Which, again, will be filed later in the day.

The repurchase shares in the quarter, are intended to be used to partially settle our convertible debt obligations, when the securities mature in early 2012. We currently have on hand, approximately 40% of the shares required to settle that convert, when it matures. Additionally, our Board of Directors, two days ago, authorized the repurchase of an additional five million shares of common stock. Which, when executed, would put us in a position to have 80% of the shares required to meet the conversion in 2012.

As a result of all this activity-- the strong cash flow generation by our operations, of the acquisition in the quarter and the stock repurchase. The ratio of balance sheet debt, net of cash to capital, was 27.5% at the end of the second quarter, compared with 17.9% at the end of 2009. Net debt to EBITDA is 1.2 times at the end of the quarter, on a trailing 12 month basis.

Now, since the convertible debt is clearly in the money. We're really looking at our capital structure on an if-converted basis. And so, if you look at the capital structure on an if-converted basis, that puts net debt to capital at about 16% and net debt to EBITDA at 0.7 times. And either way you look at it, the balance sheet is solidly investment grade. And the Company retains over $700 million of liquidity. We are in phenomenal shape, from a capital structure perspective.

Now, let's look at our revised guidance for 2010. In our last earnings call, in April, we talked about a strong first quarter for the Company and improved visibility for the remainder of the year. And as a result, we raised our guidance at that time, to $2.20 to $2.50 per share. Well, with another strong quarter behind us and increased confidence in our markets, and more importantly, our own growth trajectory, we have even higher expectations for the remainder of the year. We now expect to earn $2.50 to $2.80 per share, for the full year, on a continuing--

$0.60.

Pardon?

$0.60.

$2.60? $2.60 I'm sorry, not $2.50. $2.60 to $2.80 for the full year, on a continuing operations basis, with revenue growth of 32% to 35%, compared with 2009. As Tim said, even at the low end of the range, this would be a record year for the Company. After a challenging 2009, posting record earnings for the very next year, would be a remarkable accomplishment. Particularly in an economic environment that has yet to show consistent meaningful growth.

Tim reviewed the underlying market assumptions from a vehicle production perspective, that supports our guidance in detail. So, I'm not going to go over those, but let me quickly summarize. We have increased confidence in European production schedules, that are stronger than we anticipated, as of our last earnings call. And I think everyone in the world continues to increase expectations for European production, for the year. And we also continue to see a mix shift away from A and B class vehicles in Europe, towards vehicles with higher BorgWarner content, including diesels. And our volume expectations, as Tim mentioned, for nearly every major automotive market has improved.

Now, let me go over the underlying financial assumptions for our updated guidance for you. The Dollar to the Euro exchange rate in our guidance, is now $1.25 .Which is a 7% decline, versus our previous guidance of $1.35 to the Euro. That impacts sales, of about $200 million decline, versus previous guidance. And costs us about $0.10 a share, relative to our previous guidance. It is in our previous guidance, our sales growth includes approximately $150 million in sales. Which is three quarters of a year, related to the April Dytech ENSA acquisition, and approximately $0.01 a share of earnings accretion.

With regard to raw materials, we still expect commodity cost increases to remain about $35 million year-over-year, consistent with our previous guidance. As I mentioned before, we're now looking at a tax rate of approximately 22% for the year, versus our previous guidance of around 18% to 20%. The negative impact of that tax rate is about $0.10 to $0.15 per share, from previous guidance. For dilution, related to the convertible debt, and associated hedge overlay, we expect to be anywhere from $0.10 to $0.12 a share for the full year. Again, consistent with our previous expectation. It's about $0.04 a share, on a year-to-date basis.

SG&A we expect to be between 10% to 10.5%, for the year. For the first half of the year, it was 9.9%. And we do expect to see increased spending for R&D, relative to sales growth, in the back half of the year.

The operating income margin for the full year, is now expected to be back within our historical range of 8.5% to 9%, excluding non-recurring items, versus our 8% plus number we gave you last quarter, in our last guidance. So, we are seeing increased operating income margins for the year, back to our historical levels already, which is amazing to me. While our operating income margin was 9% for the first half of the year. The full year range does include the seasonal decline in sales and margins, that traditionally occurs in the third quarter, due to summer shut downs. Plus, again, some expectation of increased R&D spending, as a percent of sales, in the last half of the year, relative to the first half of the year.

Our other guidance items remain unchanged. R&D we're targeting to spend about 4% of sales, which will take some increase in the back half of the year. Capital spending still expected to be in the $250 million to $275 million range. And cash provided by operating activities, less CapEx, will be approximately $250 million. Without the change in currency in the tax rate, that guidance of $2.60 to $2.80 a share, would have been more like $2.80 to $3. So, this is a significant move upward ,from an operational perspective, in this business. And again, it just goes to show the strength of this Company's performance.

Let me finish, with talking about kind of where we are, as a Company, today. The first half of 2010 was outstanding for BorgWarner. I don't think you could call it anything other than that. We followed a strong first quarter with an even stronger second quarter. And our second quarter financial performance was at a historically high level, a level that we believe that we can maintain going forward. There should be no doubt that we are back on our historical growth curve. And growing with a more efficient cost structure in place, as well.

We have already achieved our historical operating income margin range of 8.5% to 9%, and expect that to continue for this year. And we expect to record all-time higher record earnings for this year. And this is in a vehicle market that is still depressed from normalized production levels. As industry production levels normalize over the next three years, we expect to continue to grow our sales in excess of the market, as we've done historically. And with that industry leading sales growth, we now believe that we will see operating income margins, in the period beyond 2010, in excess of our 8.5% to 9% historical range.Which will further accelerate our future earnings growth.

We believe our product strategy is proven and sustainable for the long term. And our track record of managing the cost structure, speaks for itself. Having said all that, I want to assure you that we continue to remain focused on the key driver of the Company's long term success. And that's our people and our strong powertrain technology leadership. We are both well positioned technologically and financially, to remain at the forefront of a growth curve in this growing industry. And so with that, I'd like to turn the call back over to Ken.

Thanks, Robin. We'll now turn to the Q&A portion of the call. Wendy, could you please announce the Q&A procedure?

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

Hello, Rich.

Can you hear me?

We can now. Good morning.

Okay, sorry about that. Good morning. I just had a few questions here. In terms of the spending in Drivetrain, did-- Robin when you look at that sequentially, did that-- would we-- would you have been at the 30% level in terms of sequential contribution margin without the incremental spending in China?

I think, Rich, it's a combination of the incremental spending and a leveling off with first quarter levels. As we said before, first quarter I think both in the Engine and Drivetrain business, we took advantage of a little bit of a timing on spending, timing benefit, so it's a -- I think you look at the first quarter and the second quarter kind of combined it gives you a better sense of the run rate of that business.

And then for both segments, Engine and Drivetrain, do you expect sequentials to be in the 20% to 25% range for the second half of the year?

Well if you think of where our guidance is and where we are year-to-date, actually third quarter sales will be down a tad, as is traditionally. And the challenge on the decline is to make sure we manage those declining margins at that 20% level that we did last year. But as we ramp sales back up from third quarter levels, yes, our expectations I mentioned earlier, we're-- although R&D spending was up close to 30% year-over-year in the quarter as a percent of sales, it's lagging a little bit our target. We will see some increased R&D spending in the back half of the year as well. So we expect incremental margins to trend away from that 30% down to that 20% to 25% level kind of later in the year and then back to our 15% to 20% incremental level as we get into 2011.

Okay, and then on commercial truck, could you tell us what the incremental content is for you on these new engines, the EPA 10 engines that are starting to be ordered right now?

Yes, Rich, we're starting to see increased penetration rates on the thermal side. We've gone from a roughly 25% share to 50% share of our business as we go forward. And we're seeing increased penetration rates on turbochargers and some glow plugs or diesel emission systems. So those are the three areas where we basically have the biggest penetration rates or at least the three products where we have the significant penetration rates in commercial.

And is there a step up in the content to meet the regs or is it pretty similar?

Yes, we're starting to see a tremendous amount of growth. I can tell you that moving up towards the top of our list in terms of new business you're seeing companies like MAN and Deere and JAC and [Doits], these guys are starting to move up on the list in terms of new business awards.

Okay and then final question, Robin. What should we assume for share count? Should we assume back half of the year is around this 129 level?

Rich, for this share-- diluted share calculation, you have to use kind of a monthly weighted average. And so as I said, we purchased four million shares at the end of the second quarter and I-- you would think versus where it was at the beginning of the year you'd like to see a four million share reduction in the count but it works its way in over time. So just with the four million shares alone we'll be down to about 128 by year end and then additional share purchases through the remainder of the year we'll start to work that down as well. You'll see the full benefit of the share repurchases in that share count once we start 2011 basically because we'll start with the December 31, 2010 share count as the base. Right now we're working off of December 31, 2009 and monthly totals thereafter.

Okay, thanks so much.

Thanks.

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

Good morning, gentlemen. How are you?

Hi, Brett. How are you?

Doing good. As we think about margins, 9.7% is very impressive. What are your thoughts longer term, Robin? I understand that your guidance kind of gets you above that 8.5% range, but boy 9.5%-- 9.7% seems pretty good and sales are likely to go up as we move over the next couple years here.

Yes. Brett, I think what I indicated was for this year we'll be back to our historical range, 8.5% to 9% where we are today that we feel very confident about that. And going into 2011, this is the first time you've heard me say this, we expect our margins to level out in excess of our historical range. We will set the new kind of historical range level for operating income margins in this business in 2011 and beyond.

Okay, so something in your mind north of that 9% range?

Yes.

Okay. And then a little surprised at the share repurchase activity. Typically you don't do that, and so I was hoping you could talk a little bit about your expectations there, the rationale and so forth. And then dividends, what should we be thinking about as far as the dividend is concerned?

I think as we've talked before, our uses of cash flow, our acquisitions, are obviously our first choice on the list and then it was dividends and share repurchases kind of half and half. We have repurchased shares in the past and most of it has been used to offset the dilutive effect of compensation-related share issuance. The share repurchase activity currently is solely focused on the maturity of that convertible debt that we have outstanding. When that debt matures, we have 11.4 million shares that we'll have to issue and/or satisfy in 2012. And obviously as we look at the Company today, we view those shares are going to be very expensive in 2012 and it's our intention to take those shares out today over time, so we've done it.

So as I said earlier, we've already taken about 40% of that convertible debt to date, five million share authorization a couple days ago from the Board, when executed would take about 80% of those shares out and then we've got maybe a couple million more left of shares that we'd have to pick up to totally satisfy that security when it matures.

As far as dividends, as we've said before, we'll review those as we typically do in the fourth quarter of the year. But obviously with that convert sitting out there, we do have some incentive to continue to purchase shares to make sure we can settle that convert at a share price level that we feel more comfortable with than what the share price could be in 2012.

Good. Thank you very much, gentlemen.

Your next question comes from the line of John Murphy with Banc of America.

Good morning guys.

Hi, John.

With the balance sheet in good shape and likely to get better going forward with the numbers that you're talking about, are there any other potential strategic bolt-on acquisitions like Dytech ENSA that might be larger or smaller and is there the potential for any other JV consolidations in buying out the partners?

We will continue to look for strategic acquisitions, some things pop and then we never know when they're going to pop but we are always actively engaged in looking and we're continuing to actively engage in our process. We probably will start to look more aggressively than we have so far.

As far as buying out acquisitions, or buying out joint ventures, we don't have that many joint ventures that we're already-- on all of the large joint ventures we have we're either 70% or 80%, there's maybe one or two like with NSK-Warner we're 50/50 and we'll never be able to buy more than that and they'll never be able to buy more than that because both companies are so happy to own that 50% that nobody wants to sell anything. So I don't see-- if there is any buying out of JV partners, they'll be-- we only have one or two small JVs and we may try to pick some off in India or China or something like that.

But that would be immaterial?

Yes, it would be rounding error.

Got you. And then on thinking about capacity utilization and where it was in the quarter specifically in the turbo business and as we think about that business ramping up in North America, would there be the need for an increased capital committment or capacity or do you have enough capacity in place to fulfill the growing demand I guess really would be forward in the near term?

No we're adding some capacity to fill new demand. We'll be added capacity like on that GM business I just talked about in China. We're adding capacity to launch the four business like in the 4-cylinder business which follows the launch of the Ford V6 in [Ramos]. We-- we'll be adding a little bit of incremental capacity in Poland probably and-- but we're not planning a lot of new plant construction. We'll just be either utilizing some existing equipment or adding new equipment for new lines. But these, all of these capacity additions, will fall in our traditional CapEx spending range of 6% plus or minus.

So it's fair to say that your (inaudible) rates right now are running anywhere from 90% to 100%?

Yes, and we're talking in Companywide or turbo?

Just turbo. You're running pretty full, I mean your pretty full out on turbos?

We're running pretty full in turbo and in some areas I guess you'd say we might be running tight to the wire, maybe even past 100%, but we're probably 90% to 100% on average.

And then lastly just on the commercial vehicles, it seems like it's a growing theme for you. I just wonder if you could remind us where you are in that business as a percent of your total business currently and where you think the potential for that to go as far as total mix and the profitability on that business?

Could you just repeat the first part of that question please?

I just-- on the commercial vehicle business, it seems to be a pretty growing theme within your potential growth going forward. I was just wondering if you could remind us where you are right now as a percent of total and where it might go?

Yes. Well right now, if you lump medium duty and heavy duty and buses, we're at about a little less than 9% of our business. If you throw in the off highway or the agricultural, adds another 6%, so we're a little bit less than 15% in what we would maybe you and I would typically call commercial/off highway, and that's about 15%, a little less than 15% of our Company and growing. Now percentage wise, it's a little bit-- the actual dollars are growing substantially. Percentage wise, our light vehicle business is starting to grow again because of the increased volumes and tremendous growth in North America, Europe and China. So as a percent of our sales, commercial trucks going to have to grow rapidly just to maintain their percentages.

Got you. Thank you very much.

Your next question comes from the line of Chris Ceraso with Credit Suisse.

Thanks, good morning.

Good morning, Chris.

Hi, Chris.

So Robin, you did mention the significance of the fact that you're saying that you can now go above 8.5% to 9%. You've been steadfast in your view that there's a lot of pressures that keep you in that range so what has changed here? I mean obviously there's still price pressure from customers and you've got investment to make in R&D and so forth. What is it that's given you the comfort to kind of deviate from that view?

Well first of all let me just say this and I'll let Robin answer, but the pricing pressures aren't changing. The pricing pressures are still strong, so-- but I think there is a tremendously high appreciation by our customers for BorgWarner technology, especially in the technology that improves fuel economy and reduces emissions. So we have a little bit of help there. But we are becoming very frugal about the way we're running our plants and our business and we're frugal in the way we're hiring salary people, we're tight on the way we're hiring operating people. We're almost back to our historical high sales rates but we're doing it with 3000 less employees.

We have restructured our Company to take out some of what I'll call the inefficient plants of our organization like Muncie. We struggled on some financial and efficiency issues in Margam. So we're basically doing some structural changing inside the operating portion of our plants. It took us a little while to gain traction over the last six to 18 months but now we're starting to show some pretty good results on the structural changes and we'll have more to come.

Yes, Chris, I think Tim pretty-- summarized it pretty well. I mean we've made structural changes in our cost structure. The first couple quarters we saw those stronger margins. We weren't comfortable that these were long-term changes. And now we've been through two quarters here, running the business and the business is running well and we can run at these levels as I said earlier, we expect to continue to run at these levels. We've got a better look at what the last back half of the year looks like giving us more confidence in being able to run this business at the cost structure levels we have today. And as we look at incremental sales coming out in the future, we've got more confidence that with the incremental margins associated with those sales growth that we ought to be able to drive margins higher than our traditionally after 9% level solely because of the structural changes we made in costs in the last two years.

Okay, that's a good answer. One thing to think about, Conti seems to be getting a little bit more aggressive in it's commentary about growth in the turbo business and share that they think they can capture. What is your latest view on the turbo market and any risks to your growth there and any risk to pricing at the industry level?

Well, I'd just say that we continue to gain share, not share, we're continuing to gain volume. We tend to sell in the premium higher tech end of the market. We think we're going to maintain that, we always had a strategy to maintain our share which is about a third of the market, and I think we're going to continue to hold that share. We tend to focus more on higher technology at a more premium price than just chasing market share. And anybody can say anything, so I'd take whatever that is being said there as a grain of salt.

Okay, and then just lastly you mentioned strong four-wheel drive sales in Asia, maybe just a quick comment on who that's with, what kind of vehicles and what we're talking about in terms of dollars here of revenue?

Four-wheel drive sales in Asia was a Korean-- improvement in volume on the Korean side. We have in China where we're increasing penetration with companies like Great Wall and we're picking up some of the smaller truck companies more and more of the smaller truck companies. We haven't necessarily picked up penetration rates with new customers because we've always been with those customers, but those customers are seeing tremendous growth in their volumes.

To be honest with you, the biggest area where we've seen four-wheel drive growth is in North America because the North American market, truck market's, up about 75% this year and we're up about 75% this year on our transfer case business down in-- out of our transfer case plant in Seneca. So that's where most of the growth is. But we're continuing-- we restructured the business, and because we've restructured the business our cost structure seems to be attracting more and more, I should say our cost structure combined with what I think is a favorable price and good margin improvement, seems to be attracting more and more business for us on transfer cases.

Okay, thanks guys.

Sure.

Thanks, Chris.

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

Good morning, everyone.

Good morning, David.

Hi, David.

A couple of follow-up items here first. Tim, when you were talking about the medium and heavy duty market being 9% of your revenue, how much of that are these heavy duty pickup trucks that are on that medium duty section?

Not much, because we're not-- we're having transfer cases and stuff like that, we're not on like the 3500s or the 350, so not much of that is heavy duty pickup truck type stuff. Although there probably maybe a little bit in there.

Yes, because you're on this new engine from Ford aren't you, Scorpion?

No, we're not.

Oh, you're not, okay. The MAN business down in South America, who would have been the competitor supplier of the turbocharger there for-- that you won that business from?

The competitive supplier to the turbo charge in on MAN?

Yes.

To be honest with you I'm not sure but it's probably it's a good bet it's probably Honeywell.

Okay. And then as we look at the-- one more turbo question. As you look on the gas side, the gas turbos, Ford and BMW at the moment seem to be the most aggressive. What other OEs would you put in there as being more aggressive than others on turbocharging gas engines?

What do you mean, aggressive in terms of going after that application or using that technology?

Yes, well yes, putting turbochargers on gas engines?

Well to be honest with you Ford is probably one of the most aggressive right now with-- and we picked up probably some 75% of that business as I look forward between the -- and we picked up a majority of the V6 turbo gas on the rear wheel drive platforms and we picked up all of the 4-cylinder global four-wheel drive turbochargers for Ford. So that's been a big-- and we're starting to increase our penetration and get more business with GM, so we're seeing a lot of GM gas business. We're seeing more and more out of Honey-- Hyundai, we're seeing more and more out of, well you mentioned a couple of them with BMW. We're starting to see Daimler is starting to pick up for us. We're seeing Fiat is picking up for us, Cherry, (inaudible) well that's a commercial, getting some Nissan business on turbochargers, we're picking up turbocharger business almost everywhere.

Okay, great.

And I think a good chunk of it, not all of it's gas, but I'd say a favorable-- a fair amount of it probably maybe even the majority of it's gas right now.

Okay, great. And then on the electrification side, you're kind of on the investment side of that where you're putting development work in and capability in where-- in place ahead of the revenue side of that. How-- is there any way you could characterize how big that mismatch right now, how much of a drag that might be on the numbers at the moment?

It's not that big of a drag. It's part of a-- it's actually just part of that what we target to be 4% of the R&D but it's actually, the actual number for the last quarter was 3.2%, but it's in that-- it just rounds into that number. It's not too far of a mismatch because we're doing it very efficiently and very effectively and although I will say that we're working on electric cooling, electric vehicle battery cooling, and-- but we're doing it, I would say very profitably and frugally but we'll do it in typically BorgWarner fashion, which is basically superior fashion.

And then you have a lot of irons in the fire on electrification across a lot of different product categories. Do you think you're satisfied with what your-- what the breadth of the product offering you have there or are there some things that you're looking at doing that you're not involved with yet?

Well we're satisfied with the breadth of the market so far because to be honest with you in 2020, we only think the pure electric vehicles are going to be 5% to 10% of the market anyhow. So-- but we are looking at other areas where we can increase our concentration of pure electrics if it makes sense for BorgWarner and we are looking at some other things. David, I'd love to tell you what they are but I can't say that right now.

Well we'll find out in time.

Yes.

And then Robin on the margin, if I could look back to 2003/2004 time frame when engines were 60% of your revenue, today it's 75% of your revenue, and it looks like that shift in mix alone is worth about 100 basis points in margin. I understand what you've done on the manufacturing side. Is that the right way that we should look at that, that that's one of the bigger items behind the margin improvement?

Well I'll let Robin get into specifics on margin because he loves to get into those numbers, but I will say this. We are working very hard to improve the margins on the Drivetrain side, you're starting to see that.

Right.

We've done structural improvements on the transfer case side and the torque transfer side and transmissions we're working on improving the margins on the transmission side. But I'll let margin-- I'll let Robin go into the comparison on Drivetrain versus Engine.

David, I don't think it's the Engine Groups relative margin in the percentage of sales that's really driving us to a new level. I think, as I've said before, the Drivetrain Group has a lower all in margin due to some legacy costs that sit in that part of the business. On an incremental basis you look at Engine and Drivetrain both improving margins pretty much at the same corporate wide level. So if you look at what Drivetrain was a couple years ago as a percentage of the business, it was a higher percentage than it was in 2003 and 2004 and we still weren't able to achieve margins above that 2003/2004 level. It's definitely an overall improvement in both sides of the business.

Yes, no I recognize that. It just if I did my math correctly if I just changed the revenue mix back there with what the margins were then, you would have been about 100 basis points higher. But-- great, thank you.

Fine, thanks, David.

Thanks, David.

Your next question comes from the line of Itay Michaeli with Citigroup.

Thanks, good morning.

Hi, Itay.

Robin, I wanted to go back to the new longer term operating margin goal of 9% plus. Maybe two questions there. One, is there sort of a longer term incremental margin range we could think about for BorgWarner? And two, when you-- do you envision it being more in the kind of low 9%, mid 9%, because it doesn't seem like you would need much more than maybe a 15% incremental margin next year to bump you up to even as high as 9.5%? So any detail there would be helpful.

Yes at this point in time, I think it should be enough that you got me to say that it's higher than 9%. But let me-- it certainly, we're not expecting higher incremental margins going forward than we have historically. What we are expecting is the fundamental changes we've made to the cost structure to remain in place. We're not going to go back and recapture some of the costs that we've taken out of this business that frankly shouldn't have been there, so that's part of the equation. As you look at-- and I'll give you a walk through.

There's still a tremendous amount of work to be done to give incremental margins in this business to go to the bottom line. If you look at 2010 as a base and let's just throw out a number of $5.3 billion in sales. 2% price reduction to our customers puts us $100 million in the hole at the beginning of the year. Wages are about 25% of the business, a 3% wage increase is about $40 million. You have material inflation of about $35 million and some increased depreciation amortization because of investments, you're talking about almost $200 million of lost income before you even start the year.

If you throw on the incremental sales of our backlog next year, I think projected to be $600 million plus the market growth, and let's say that $750 to $800 million at a 15% margin, that's only $170 million worth of additional operating income, but at 20% it's $220 million. So there's some work to be done still on productivity in the business to be able to generate increased margins over where we are today. But we believe that we have structured the business from a fundamental cost perspective that is going to remain and then we will get that incremental productivity to help drive margins above the historical 8.5% to 9% leverage-- level. How much above 9%? Still a little bit unclear to me but certainly I think we're going to be above 9%. I don't know if the new range is 9% to 9.5% or Tim would like it to be probably 9.5% to 10.5% but that means we've to work a little bit harder with our operating guys.

Which we will be doing.

But I think it's too early for us. I think we'll have a better look at how much stronger margins can be relative to our historical levels as we get into the 2011 planning process. But again, Tim and I both feel today, and that's why we made the statement, that the 8.5% to 9% historical level is the historical level of the past and we're going to set a new historical level going forward.

That's helpful. And then, Tim maybe back to the booking and quoting activity, it looks like you had a very successful quarter again. I think last quarter you shared some numbers that booking activity was up, or quoting activity, was up about 30% to 50% year-on-year and that you thought the backlog might move towards the high end of the historical $1.7 billion to $2.1 billion. Could you maybe update us on some of those numbers post-Q2?

Well I don't have those statistics, but the quoting activity is still strong. The-- it looks like our win rates are still strong Companywide. And I don't-- it's way too early to talk about the backlog number for next year, but at the pace we're going I do expect to have a decent backlog for next year. And that-- our historical levels used to put us in the $1.8 billion to $2.1 billion, $2.2 billion range and I hope to get back to-- like everything else that's happening inside BorgWarner, I hope to get back to our historical levels in that area or better.

That's great. Thank you so much.

We have time for one final question. And that question comes from the line of Ravi Shanker with Morgan Stanley.

Thank you so much. Good morning, everybody.

Hi, Ravi.

I just-- hi, just a follow up on that backlog question. The strength of the backlog you're seeing right now and all of the new programs that you announced, are those incremental or are you getting a sense that some of this backlog is getting pulled forward from 2011 to 2010 given the improved conditions right now from the OEMs?

I don't have any feeling or any sense that those-- or that that's a pull forward on backlog. That's-- we're starting to see-- what we're seeing is this is all business that's new opportunities and it's not-- my personal, look I haven't done a complete analysis, but my personal sense is that it's not replacing much existing business, it's basically new business.

Got it. And the 4-cylinder EcoBoost, is the Explorer going to be the first product for that?

I can't say because we're not allowed. Gut all I can tell you is we will be the supplier of all the 4-cylinder EcoBoost turbochargers and I think it's going to launch on passenger cars out of Europe.

Got it. And do you also have a sense of if launch costs are going to peak in any particular quarter, if it's going to be in Q3 or Q4?

Launch costs aren't going to be-- you mean launch costs on that particular program?

No, I mean just overall launch costs.

Oh, just launch costs in general aren't going to be anymore different than any other quarter. And we just had a-- we continually have, what I can say, an ongoing series of launches in this Company so no one quarter sticks out more than another quarter in terms of launch costs. So it's just kind of a smoothing effect because we're always launching something in this Company with a reasonable amount of cost, which we handle within our normal cost structure.

Very good. Thanks very much.

Sure.

Thank you.

I'd like to thank you all again for joining us. As Robin said we expect to file a Q before the end of the day which should provide details of our results. Of course if you have any follow-up questions, please direct them to me. Wendy, please close out the call.

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