博格華納 (BWA) 2010 Q4 法說會逐字稿

Good morning, my name is Wendy and I will be your conference facilitator. At this time I would like to welcome everyone to the BorgWarner 2010 fourth 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, 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, www.borgwarner.com on the investor relations home page. There will be a replay of today's conference call available through February 17. The dial-in number for the replay is 800-642-1687. You will need the conference ID which is 38717863. The replay will also be available on our website.

With regard to our IR calendar, we will be attending a number of conferences over the next few months. In March, we will be presenting at the Sidoti Conference in New York, in April, we'll be presenting at the Bank of America Automotive Summit, also in New York. And in May, we'll be in New York again for the Wells Fargo Industrial Conference.

Before we begin, I need to inform you that during this call, we may make forward-looking statements, which involve risks and uncertainties that are detailed in our 10-K. Our actual results may differ significantly from the matters discussed today. Now moving on to our results, Tim Manganello, Chairman and CEO, will be providing comments on the fourth quarter, the full year and industry trends. And Robin Adams, our CFO will discuss the details of our operating results and also our outlook for the rest of the year. With that, I will turn it to Tim.

Thank you Ken, and good day everyone. Once again, I am very pleased to review our strong full year results and great accomplishments, followed by comments on the industry and our revised guidance. But first, before we get started, I would like to thank all the BorgWarner employees worldwide for a great 2010. I just want to say all of you guys out there in BorgWarner land, you did a great job. Thanks.

So now, I would like to briefly begin by highlighting the fourth quarter and then full-year results. For the fourth quarter, we posted sales of $1.5 billion, up 28% from the same period last year, with US GAAP earnings of $0.89 per share, up 98% from last year. Our operating income margin for Q4 reached 10.3%, which is sharply higher than a year ago. Our sales and earnings performance in the fourth quarter was the result of increased global demand for our products, higher buy-ins in our base business and well executed cost controls.

For the full year, we reported sales of $5.6 billion, up 43%. We had US GAAP earnings of $3.07 per share, or $3.02 per share if you exclude one-time items. And on operating income margin basis, we had 8.9%, or 9.3% if you exclude one-time events. Now, at the group level, the Engine Group fourth quarter sales were just over $1.1 billion, up 31% from the same period a year ago. The Engine Group's strong fourth quarter performance was driven by growth in the Asian markets, led by timing systems in China and India and turbochargers in Korea. In Europe, strong turbocharger and fans system sales, along with sales related to the ENSA acquisition we made last year also contributed to the Engine Group sales.

In the Drivetrain Group, sales were approximately $420 million, up 20% versus the fourth quarter of 2009. Our four-wheel drive business across Asia, along with higher DCT module sales in Europe, were key contributors to the Drivetrain Group's quarterly results.In addition, global sales of traditional automatic transmission components were higher. Our capital spending continues to grow at about 5% of sales and supports our future growth and our future productivity improvements.

We also repurchased 2.1 million shares of common stock in the quarter, bringing the total number of repurchased shares to approximately 7.1 million in 2010. These shares are intended to settle our convertible debt obligation when it matures in early 2012. And we continue to invest for the long-term, as shown by our spending for R&D and new program launches, which were approximately 3.3% of sales. Now, because of the strong sales level, R&D as a percent of sales was slightly below our normal level of 4%, but the actual dollar spent continued to increase.

In addition to our strong financial performance, there were several other noteworthy announcements made during the quarter. We are pleased to announce that we're supplying regulated two-stage, or what we call R2S turbochargers, for Volkswagen's newly developed 2-liter, 4-cylinder diesel engine. The engine is featured on the transporter T5 light commercial vehicles and the Amarok pickup truck.

We also announced that a major North American commercial truck maker launched a new engine in 2010, equipped with our R2S turbochargers and EGR coolers. The combination of these two technologies enabled truck makers to meet 2010 EPA emission standards, which requires an 83% reduction in NOX emissions. And our Cam Torque Actuated VCT technology and our new timing drive systems are featured on the all-new 2011 Ford Super Duty 6.2-liter gas engine.

We're pleased with all of our new businesses and all of our new business wins. But we are especially excited about our continued expansion into commercial vehicles and the commercial vehicle market, since this is one of our key strategies for the next decade. In another exciting development, BorgWarner's variable cam timing with mid-position lock has been named a finalist for the 2011 Automotive News PACE award, which is recognized around the world as the symbol for automotive innovation. This mid-position lock technology allows an increased range of cam shaft positioning and enables fuel economy improvements of up to 10%, compared with conventional VCT systems. We're honored to once again, be considered for this prestigious award.

In November, we reported our net new business backlog of $2.3 billion for the period 2011 through 2013. This equates to strong sales growth of 12% to 13% above market growth over the next 3 years. Now the breakdown is 45% Europe, 30% Asia, and 25% in the Americas. With the growing popularity of crossover vehicles, there has been a shift towards the passenger car market with front-wheel drive, all-wheel drive couplings. To improve our position in the market, we recently acquired Haldex Traction Systems, a leader in advanced front-wheel drive, all-wheel drive technology, providing best-in-class traction. Based in Sweden, Haldex Traction Systems predominantly serves the European market. But our strategy is to expand this business into other markets including China and Haldex acquisition is not included in the backlog.

Now, shifting gears, I would like to make a few comments on the broader auto industry. Global production was higher in the fourth quarter compared with the same period a year ago, and Robin will go over the details later. In summary, global production growth was mainly driven by China, North America and Korea, while Europe was up a few percentage points and Japan was down a few percentage points.

A closer look at Europe, our largest market at 55% of sales, revealed that the mix of vehicles continued to shift in our favor. Preliminary data indicates that C, D, and E segment vehicles represented 16% of vehicles produced in Europe for the fourth quarter, and that compares with 64% in the fourth quarter of 2009.

Diesel penetration rate in Europe, an important measure for our turbocharger and diesel cold start businesses is also on the rise. Preliminary data indicates that more than half of the vehicles produced in the fourth quarter in Europe at diesel engines, which is up a few percentage points from the same period a year ago, and essentially flat with the third quarter 2010.

Now, let's look at industry and the industry outlook for 2011. Our outlook remains unchanged from the Deutsche Bank Automotive Conference in Detroit last month. We expect US production of 12.9 million units, Europe at 19 million, and China at 16.1 million units. In Europe, the vehicle mix compares, or compared with 2010 will continue to shift towards higher BorgWarner content vehicles, including diesels.

We also expect strong growth in the commercial truck market in 2011, with truck production expected to grow nearly 35% in both North America and Europe, and over 10% in South America. All of these developments are great news for BorgWarner, since our commercial vehicle business is largely based in these 3 regions. In addition, we're focussing on expanding our efforts on the commercial diesel market -- or commercial vehicle market in China.

And finally, our guidance for the Company's fiscal and financial performance in 2011 remains unchanged. Our expected sales growth is 16% to 20% of sales, for sales in 2010, our earnings guidance $3.85 to $4.15 per share, up approximately 30% to 40% from 2010. And we expect our operating margins to be a minimum of 10.5%.

The longer-term, the demand for our technology continues to gain momentum, and BorgWarner has become synonymous with improving fuel economy and lowering emissions, and both of these are long-term trends in the global auto industry. As a result, and as I have said many times, the high demand for our leading edge technology will continue to drive solid BorgWarner growth for years to come.

Before I turn the meeting over to Robin, I would like to comment on job creation at BorgWarner since the bottom of the recession in 2009. Now this information is not including the ENSA or Haldex acquisitions, and in 2008 and 2009, we eliminated approximately 5,000 jobs or 28% of our workforce during the recession. I am pleased to report that approximately 3,000 jobs have been restored globally at BorgWarner. Currently, we have rehired 1,400 employees in the US since the bottom of the recession. I am pleased to welcome everybody back. With that, I will turn the meeting over to Robin.

Thank you Tim, and good day to everyone. It's a great day for BorgWarner to report record sales, record earnings for the quarter, record sales, record earnings for the year. Again, in an environment that still has quite a bit of room to grow -- to strengthen -- from where we were prior to the recession. I'm excited about today.

Before I review the financials, I would like to read a macro environment for the industry in the fourth quarter, kind of put the performance we had, record-setting performance in perspective. Fourth quarter production on a global basis was about 17.9 million units. As Tim said, that is up 5% from the fourth quarter last year. And if you look at our sales, we were up 28% year-over-year excluding the impact of foreign currency and the ENSA acquisition, which we completed in the second quarter. The increase was still 28%, and that is 23 percentage points better than the 5% growth in the global vehicle market. And another quarter, and this is about our fifth quarter in a row, where our sales growth has significantly outperformed the global vehicle market. Quarter after quarter after quarter, we have seen 20 percentage points or more of growth in excess of the industry.

From a regional perspective, our sales growth outpaced the market in every major region of the world in the fourth quarter. In the US, our sales dropped 20% versus last year, while the market was up about 7%. In Europe, excluding currency and ENSA again, our sales were up 32% while the market was up 1%, and we just beat the pants off the European market. Now, as has been the case, I would expect that a month or so from now we will see numbers increase for the Europe market from a production perspective, but they still will get nowhere near the 32% that we performed in the fourth quarter. Japan and Korea, our sales were up 29%, while production was actual down in every region of the world, about 5%.

In China, we continue to grow at a rapid rate, up 28%, while the industry was up 13%. And if you look at it not only from a geographic perspective, but also from a product perspective, fortunately every one of our products was up strong double-digit growth in the quarter and the Engine Group on an apples-to-apples basis was up 30%, the Drivetrain up 24%. Good strong performance throughout the Company, and it's clearly driven by our strong backlog of net new business that has market penetrating new technology and that continues to differentiate BorgWarner from the rest of the industry and the overall market.

As we look at the earnings, as Tim mentioned for the fourth quarter, GAAP earnings were reported $0.89 per diluted share compared with $0.45 a year ago. That is more than almost double the performance and, again, it was a new all-time record for BorgWarner.

Our 2009 quarterly and 2009 and 2010 full-year results do include some non-recurring items that we've detailed for you in the table and the press release as we always do. And again, we provide this table to help you reconcile the reported US GAAP earnings measures with the financial performance of the continuing operations of the Company, and to aid you in comparing these results with the results of other periods on an apples-to-apples basis. We think this is an important part of the release, and we certainly encourage you to review that information. As we go forward through the discussing here, I am going to primarily focus on the financial performance and the continuing operations of the Company.

So as we, again, as we look at fourth quarter 2010. Earnings were $0.89 a share, an all-time record for BorgWarner in the fourth quarter, compared with $0.42 a share excluding nonrecurring items in the fourth quarter last year, and that is more than double last year. If you look at a full-year basis, again, it was a record sales and record earnings for BorgWarner, sales were up 41%. And that's excluding currency and the acquisition-related sales from ENSA, and that is compared with global production growth of 22%. So almost 20 percentage points of growth in excess of the industry for the year, which is phenomenal performance.

In other words, our sales growth outperformed the industry consistently every quarter in the year. The fourth quarter was just another quarter for us. If you look at the reported earnings for the year on a GAAP basis, $3.07 a share versus $0.23 a share last year, excluding non-recurring items our full-year 2010 earnings were $3.02 a share. A sharply higher than the $0.40 a share that we earned in 2009 and that is like sevenfold, 7.5 times earnings last year. And again, we kind of beat the pants off the earnings part of the equation as well. The gross profit as a percent of sales, 20% in the quarter, compared with just below 18% for the same quarter last year, and about 19% in the same quarter of 2010. Continued improvement on the gross profit line.

If you look at the year-over-year improvement, it was realized despite some higher raw material prices of about $7 million in the quarter, approximately $35 million for the full-year. SG&A costs, we continue to focus on containing those while we're growing our business. 9.7% of sales in the quarter, or $148 million, versus $144 million or 12% in the fourth quarter last year and compared to $150 million in the third quarter this year. So sequentially, basically flat with a percent of sales in the third quarter was 10.7%, in the fourth quarter, 9.7%; so we continue to see good trends on the SG&A line and we expect that to continue in 2011. If you look at the performance, net R&D spending was up in the quarter, $5 million so non-R&D spending was basically flat on a year-over-year basis. As Tim mentioned, R&D as a percent of sales is about 3.3% below our target of 4%, but when you grow the business at 40%-some a year, it's a little bit harder to increase costs at that level.

If you look at the quarter-over-quarter and year-over-year improvement, both in gross profit and SG&A, it certainly reflects the effectiveness of our past restructuring activities, a well executed cost control program, and the benefit of operating leverages.Our sales growth continues to gain momentum in our business. Operating income in the quarter was $157 million, compared with $67 million a year ago. And this $90 million increase in operating income relative to about $335 million of sales increase translates to an incremental margin of $0.27 on the dollar. If you exclude currency, the incremental margin is about 23% year-over-year. And this is in line with incremental margin growth reported throughout 2010, well above our historical average and continues to be very strong performance on a relative basis for the Company and it sets a good trend for moving into 2011.

If we look at the sequential margin from third quarter to fourth quarter, reported sales were up about $123 million. There was a bit of a currency impact. Without currency up about $82 million, operating income was up about $30 million excluding currency. So on an incremental margin basis, fourth quarter, third quarter, we were up about $0.37 on the dollar. Strong performance in the fourth quarter.

As Tim mentioned, on an all-in basis, the operating income margin in the quarter was a very strong 10.3%. That is the highest margin I have seen since the early 2000s, and again, really sets the tone for a 2011, where we really expect the stronger operating income margins as we continue to grow the top-line of this business. If you look further down the income statement, equity affiliate earnings was about $10 million, basically flat with last year, which is a little above $10 million. Again, that line primarily reflects our 50/50 joint venture in SK Warner, which is how we approach the market in the Drivetrain systems in Japan and China, and it also includes a little bit of sales from our turbocharger joint venture in India. If you look at interest expense -- finance charges, $22 million in the quarter compared with $16 million last year.Part of that is due to higher debt levels and some of it is related to the favorable impact of hedges on some of our debt, foreign currency hedges on some of our debt.

As you remember in the third quarter, we issued $250 million of tenured senior notes, and we also increased the size of our receivable securitization facility from $50 million to $80 million. In the convertible notes we had, which we issued in 2009, as you remember, carried a discount and accrete to face value at an accelerating rate, and I think the accretion in 2010 was about $18 million to $19 million. So, that is part of the increase in interest expense throughout the year. The provision for income taxes on a GAAP basis was $30.6 million, which translates to an effective rate of about 20.9%.

The effective rate for the full-year on a run-rate basis was 21.7%, pretty much in line with our 22% of guidance for the year. Again, if you look at the fourth quarter, there was some true-ups for the full year. But the effective rate was pretty much where we thought it was going to be. Earnings attributable to non-controlling interest, which we used to call minority interest when I was younger, was about $3.9 million in the quarter, which is basically flat with last year. And again, this reflects our minority partner's share in the earnings performance of our Korean and Chinese joint ventures. And that brings us back to net earnings, which were approximately $112 million in the quarter, compared with about $50 million a year ago. Again, excluding non-recurring items.

At the bottom of the press release, on the income statement you will find additional information related to how we calculate the diluted earnings per share. Again, this is related to the if-converted accounting for the convertible debt we issued in April, 2009. I have been through this before and will mention it one more time. Basically, if-converted basis, we assume that the convertible debt is actually fully converted to equity, and we eliminate the interest expense on the after-tax basis from our earnings. Nonetheless, we ended up with fully diluted earnings per share of $0.89 on a US GAAP basis, and as I said, up almost 100% from fourth quarter 2009, an all-time record for the Company and very strong performance capping off of a great 2010, and setting the tone for what we think is going to be a phenomenal 2011.

Let's look at the operating segments right now. As Tim motioned, the Engine segment sales were over $1.1 billion, excluding currency and acquisition as I said earlier, some 30% compared with fourth quarter last year. Adjusted earnings before interest and taxes were $162 million, or 14.5% of sales. This is sharply higher than about the 10% adjusted margin we reported in the fourth quarter last year, or even the 13.4% reported in the third quarter of 2010. And you see the Engine is actually approaching the margin levels that we haven't seen in a long time either. If you look on an incremental margin basis, on the Engine side, we were up about 31% incrementally on a sequential basis. Third quarter 2010 incremental margin was about, again, excluding currency, about 36%.

If you look at the Drivetrain segment, sales at $420 million in the quarter, up 24% excluding currency versus last year. And adjusted earnings before interest and taxes were $32 million, or 7.6% of sales. Again, quite a bit higher than the 5.9% reported in the fourth quarter of 2010. And down a tad from third quarter, 7.8% margin in the third quarter 2010.Year-over-year incremental excluding currency was about 14% and on a sequential basis, basically flat. Looking from a dollar perspective.

As Tim mentioned earlier, as we look at the Drivetrain business, we're launching a new program in China for significant growth we expect in DCT products, and frankly we've been struggling to keep up with capacity requirements of our customers in the European market, again, the DCT. Those are all good problems to have. There is nothing better than having growth problems, much better than 18 months ago. So we're happy to have those problems and we expect the growth margins to improve as we get into 2011.

Let's move on to the balance sheet and cash flow. The net cash provided by our operating activities was $539 million in 2010, a strong improvement of $188 million from 2009 levels, and slightly ahead of our $500 million guidance throughout the year. Capital spending, including tooling, was $277 million, up about $105 million from 2009 levels of $172 million and they were pretty depressed levels. Again, pretty much in line with our guidance for the year.

If you look at free cash flow, which we define as net cash provided by operating activities, less capital spending, it was approximately $262 million in 2010, of which approximately $140 million was generated in the fourth quarter, which is typical in this business. The fourth quarter is typically a strong quarter from a cash flow perspective. And first quarter is a quarter where our treasure is always looking for $0.01 on the Street because it's a poor quarter from a cash flow perspective. You will see that probably when we report on the first quarter earnings.

If we look at the balance sheet throughout the year, debt -- balance sheet debt increased by $338 million, primarily related to again, as I mentioned earlier an $80 million increase in the adoption of the accounting rules that require us to put our $80 million receivable securitization -- so again, on the balance sheet prior to 2010, that was an off-balance sheet transaction. And again, we upsized that in the third quarter from $50 million to $80 million. And second, we issued $250 million of senior notes in the third quarter to take advantage of the very favorable market conditions in the debt market.

And the strong cash generation, which I mentioned before of $260 million in capital rate, the debt we talked about in part was used to fund the $150 million acquisition of Dytech ENSA. And as Tim mentioned, we're already seeing benefits of that and the program awards that was closed in April, 2010. And again, the $325 million approximately that we spent to repurchase a little over 7 million shares of treasury stock. As we said before, those repurchased shares are intended to be used to settle our convertible debt obligations, when that security matures in 2010. The security is weighing the money and those of you on the call that bought the security, I am sure you're flipping cartwheels every time you look at the stock price. It was a great transaction for you; it was a good transaction for the Company as well.

Year-end, we have close to 60% of the shares required to settle that conversion and throughout 2011 we'll pick up the rest of that. We have gone through a lot of the details of these transactions in our 10-K; it will be released by the end of the day, and if you want to go through all the details, they're all there for you. I'm not going to go through them right here. We ended the year with $450 million of cash on the balance sheet. Again a very strong performance for the year despite the significant stock repurchase and the acquisition of Dytech ENSA. Unfortunately that cash with fund the Haldex Traction Systems acquisition; actually it was already used -- recall that in January that Tim mentioned earlier. And the remainder will be used to repurchase the remaining shares required and also available for other potential strategic acquisitions that could be available in the market in the near-term.

As a result of all that strong cash flow generation throughout the year, the ratio balance sheet debt net of cash-to-capital is 24% at the end of the year. And on a net debt-to-EBITDA basis, it was 0.9 times at the end of the year. And that's on a reported basis. Again, if you look at the convertible debt, which is clearly in the money, it converts at $32 a share, we're really looking at our capital structure on an if-converted basis. And if you look at it from that perspective, our net debt-to-capital was about 13% at the end of the year. And net debt-to-EBITDA was 0.5 times, and our capital structure remains in excellent shape at the end of the year and we expect it to remain in excellent shape as we get throughout 2011.

As we look at 2011, ahead -- it's going to be another record-setting year for the Company. And we feel great about that. Last month as Tim mentioned in Detroit, we provided guidance for the year, on a number of performance metrics. And as he mentioned, it's early February, it's a little bit early for us to be doing anything, so at this point, our expectations remain unchanged and we expect the sales growth of 16% to 20% compared to 2010. And again, that compares to a global market where we're expecting maybe 5 to 6 percentage points of growth. The significant out-performance on a sales side as Tim mentioned, we're looking at earnings per share in the range of $3.85 to $4.15, and approximately 30% to 40% on a rounded basis. For those of you who calculate the math to 0.1%, it actually translates to 27% to 37%. I can't get Tim to be that exact all the time, so he rounds his numbers. Unchanged there.

Operating income margin, 10.5% or better and I think you see the momentum in the Company in the fourth quarter and operating income. As you look at the sales growth in 2011, I, again, we say 10.5% or better, it's the or better part I'm focused on. We're looking at incremental return, operating income on those incremental sales in the year about $0.20 on the dollar. So depending on where you lay your sales growth at, you put $0.20 net incremental income on that, you can calculate how much better than 10.5% we're going to be.

Free cash flow for the year, we're looking at a little bit closer to $300 million, again, we were $262 million in 2010, so we see stronger free cash flow growth in 2011, primarily driven by the strong increase in earnings for the year. Again, after tax we're trying to invest in capital, which for 2010, was at about 15% which, is our hurdle. 2011 will be greater than that 15% level.

If you look at the industry, I think there is a number of people expecting to have a strong year in 2011, but if you look at our expectations, I think, again, we're clearly at the high-end of the group and our performance will continue to be at the high end of the sector. Our sales guidance implies growth that is at least 10% to 15% higher than the industry, and that is among the peer group. The earnings guidance range in place reflects earnings growth of 30% to 40%. If you want to fine tune, it's actually 27% to 37%, rounded 30% to 40%. Also, that's among our peers.

Operating margins, free cash flow, ROIC, are all expected to climb higher in 2011, and all signs point to another remarkable and industry-leading year for BorgWarner in 2011. At this point, let me sum up where we're at. 2010 was a great year; it was a record-setting year for the Company from a sales and earnings perspective. Again, in an industry environment, it still has a long way to go to get back to where we were prior to the recession. As I said last time, I'm really excited about the future of this Company. And 2011 is one step in that future growth.

As we continue to grow around the globe and in -- driven by the increasing strength of regulatory environment, the rising fuel costs and the continuing evolution of powertrain technology in the developing markets, most notably China, where BorgWarner is at the forefront of technological change. And all of these will drive for the BorgWarner in the future, beyond 2011. Our product strategy focused on improving fuel economy, reducing emissions and enhancing vehicle performance has proven over and over again in 2010 that it's just another example of that and well-aligned with the direction of the industry. Not just for 2011, but for the future as far as we can see.

Our focus remains, though, as a leadership team, on the key drivers of this Company's success. Technology leadership and attracting and maintaining a talented workforce, and Tim talked about the workforce a little briefly here earlier. This is one of the most dynamic periods in the history of this industry. I have never seen this environment in my career. I don't think Tim has either, and it will really take a dynamic company to lead the way. We believe that our financial strength, our technology, our people will enable us to remain at the forefront of this industry for many years to come. And with that, I would like to take the call back over to Ken.

Thanks, Robin. We will now turn to the Q&A portion of the call. I would like to call the coordinator to please announce the Q&A procedure.

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

Thank you, can you hear me.

Hello, Rick. How are you doing?

Good morning.

Hello, how are you? Robin, quick question, Drivetrain, so you've talked a little bit about capacity constraints in Europe and, I guess, some launch costs in China. Can you give a little more color on why the incrementals were lower, lower at least than what we were expecting?

Yes. I think you just hit on it, two things. You know, this -- weve talked before about the joint venture that we have in China for DCT products. It's in Dalian. We're the two-thirds owner and we're to the point now in that ramp-up where we are starting to spend a significant amount of money to get ready for production, which will be starting at the end of 2011.

So it's -- compared to the third quarter of the year and the second quarter year, you are just seen a lot more activity in China on the ground trying to get ready for that launch that starts at the end of 2011. And we'll see that pressure in the first quarter as well in 2011, but as we get closer to the launch, we'll start to see a little bit more consistent cost structure and then finally some revenue in the fourth quarter here to take up the cost side of the equation. And the other part is we talked a little bit about this before in the third quarter. There is such strong demand for our Drivetrain products in the European market, frankly our customers have been surprised by the demand, and we have been struggling to keep up.

So there is a lot of expedited freight, where we're working -- we've talked before that some of our facilities we are working six, seven days a week trying to keep up with our customers. And we are putting in capacity in our operations in Europe. And we expect that pressure to lessen as we get into at least the second quarter of 2011 and we'll start to get the capacity in place to satisfy what we see as continuing very strong demand in the European market for our Drivetrain products.

Okay. That is helpful. An then the second question just on commercial truck. Classic Cummins talked about some supply constraints on their, for their turbo charger business. Are you seeing anything similar? And then just broadly speaking, how would you characterize the health of the Tier II, Tier III supply base for you?

Rich, this is Tim. We -- our suppliers continue to make all the shipments to us on turbos and on all our other products. Some products -- or some of the suppliers and products that they supply are a little bit tight on capacity just like we are on some products. We're not -- although we're tight, we're making all our schedules and the turbo charger side has more capacity then let's say what we just talked with Robin on the dual clutch side with the Drivetrain.

So we're watching it; we've been watching our Tier II's and Tier III suppliers for awhile, and so far so good. But I will tell you, the industry is being stretched because the OEMs didn't forecast the kind of demand that they're seeing now and because they forecasted in terms of the capacity planning. We're capacitized to the levels that are a little lower than what they're surprisingly seeing today.

Okay. And then just last one Robin, $35 million, is that still the outlook for raw mat hit for steel hit for 2011?

Yes, $30 million to $35 million. I will tell you some of our guys are getting a little nervous and typical purchasing guys, though, from my perspectiveI think the $30 million to $35 million is still a good range for us. As we've said before, anything beyond that on the upside, we're going to work to offset, and you're not going to hear us complain about raw material costs jeopardizing our earnings guidance for the year.

Okay, thanks, guys.

Sure.

Your next question comes from Ravi Shanker with Morgan Stanley.

Thank you. Guys can you help us quantify what some of the launch cost might be next year and also highlight some of the bigger programs that are coming down the pike in 2011.

Ravi, we've got a backlog of net new business, that's north of $2 billion here and so, we're consistently launching the new programs and we typically don't track launch costs because it's just part of life at BorgWarner.However, we point out that this program in particular, because it is a large program in China for us, and it's in a new region in the world as well. So we have a lot more new infrastructure on the ground than we normally would if we were launching a program in Europe, or we were launching a program in North America, or in a more developed part of the world.

So launch costs are part of life at BorgWarner. They're basically in our margins, but at this point in time in the quarter, you're seeing a little bit of a drag on the Drivetrain business because this is a large piece of business for us -- towards the end of the 2011, we're kind of in the phase right now where we're ramping up on the cost side and the engineering side as well to get this product to market.

Got it. And when you talk about 10.5% being the floor operating margin, can you also give us some color on what that means for each segment? Are we looking at Engine segment being in the mid-to-high teens and the Drivetrain being around the 10% level? Or is it going to be more -- are they going to convert it back?

As we said before, I think you're looking a about $0.20 on the dollar of incremental sales conversion, and we would expect that both on the Engine and the Drivetrain side of the business. We don't anticipate Drivetrain getting to 10%, but certainly it will be improved over 2010 levels and the same thing for the Engine group. We expect improved margins in 2011 versus 2010, and again if you're looking at the sales side, it's more like a $0.20 on the dollar incremental in both sides of the business.

Got it. And just finally, can you give us more color on Haldex and what that means to the numbers. I think you've spoken about $200 million, you paid less than one times the book. What does that mean to margins and how much of your 16% to 20% is coming from that?

Yes. Okay. Haldex is not in any of our numbers from an operating perspective. It's in our capital structure view, but there's no sales for Haldex, there's no operating income, there's no earnings in our guidance related to Haldex. As we said before, we paid less than one times earnings for Haldex.

We will have 11/12 of our Haldex sales in our financials this year, and so it could be close to what we paid for from a sales perspective. As we said before, Haldex has operating income margins in line with BorgWarner margins. The mystery here is, as always when you make an acquisition, is how you allocate the excess purchase price. And we've not completed that exercise phase, so that's really going to drive what the impact for Haldex is on our margins and again we don't expect any material impact from the Haldex acquisition on our margins. But it certainly will impact their particular margins as part of BorgWarner, and also impact how much additional earnings per share we'll get from this business.

The rough numbers would indicate anywhere from $0 to $0.04 a share accretion in 2011 from Haldex. Again, depending on how we allocate the excess purchase price, and most of you know that is quite an exercise and you need 10 rooms of accountants to help get you at the right number, and at the end of the day I'm looking at EBITDA in the business and that's not relevant to me. But nonetheless, that will drive the impact of Haldex for the Company. And from an accretion perspective, it's anywhere from $0 to $0.04 a share.

And this starts showing up in 1Q right?

Yes, we'll see some impact -- you'll see two months of sales for Haldex in the first quarter and any impact from an earnings perspective.

Great, thank you.

You're welcome.

Your next question comes from the line of John Murphy with Bank of America Merrill Lynch.

Hello, guys.

Hello, John.

Hello, John.

I had a question on the Drivetrain side. It sounds like technology is advancing there and there's shortages of product in Europe, and it sounds like people are very concerned about those shortages. But in reality, when there are shortages, that usually means it's a good thing for a market, and that pricing can increase over time, and margins can increase over time. Are we looking at Drivetrain developing into something that is more similar to your turbo-charger business where you have real proprietary technology that really leads the industry and that we can see these margins just rip up to levels where Engine margins are over time?

Well let me talk about the capacity a little bit more. Robin talked about the capacity, and we've talked about the fact that it's been a little bit of a drag on margins. But I will tell you, we have the capacity coming in. The first tranche of increased capacity on the Drivetrain side for Europe is coming in on the end of the first quarter. We have capacity coming in throughout the whole year but we should have capacity -- should be out of the woods on capacity constraints between -- during the second quarter.

So as far as growth, we have tremendous growth opportunities in the Drivetrain side; not just on the four-wheel drive side, but as we've said for a number of years now, on the DCT side, we -- and on the transmission side. Increased speeds of traditional automatic transmissions is driving -- are driving really good growth.

On the DCT side, we have tremendous growth opportunities coming at us in China with a number of wins that we haven't announced. But we also have a tremendous opportunity in DCT for small cars that are being -- with this new transmission we talked about for a number of years. This is now starting to get traction, and like I said on past calls, we're in development programs with the Japanese and Chinese OEMs. They're putting in their money now, so that all the development is being done on their money and not ours, and on a new low-cost, dual clutch automatic transmission.

So it's going to take us a year or two or three for some of this stuff starting to show up, and we're seeing the cost of that right now on the Dalian plant we're building for DCT in China. But we've got the costs now and the sales are coming later, more like the end of this year. But will DCT or will Drivetrain ever hit the margins of Engine? I don't know. We'll wait to see how it goes, but they -- I fully expect that they will improve into the double-digit range.

Great, thanks. And then Robin, just a question on capital allocation. You're out there buying back shares now, which sounds like it makes a lot of sense in front of the convert. But I was just wondering as you get through that buyback and you're still generating a tremendous amount of cash, how we should think about share buybacks versus dividends versus acquisitions. Are there enough small bolt-on acquisitions out there where you can get this good 15% plus ROI that you just keep chopping those off instead of doing share buybacks or dividends once you get through this tranche, or is there the opportunity to do both dividends and share buybacks and these acquisitions going forward? Or prioritize those?

Certainly acquisitions, and we do believe there are some more bolt-ons out there. As we had in the last two acquisitions, we had to convince the sellers that they need to sell the business. If you look, we've spent between Haldex and ENSA almost $375 million in acquisitions within the last 12 months. We certainly want to keep our powder dry for opportunities in the market that should come about here, and we think there will some opportunities in the market in the next -- within the next two years, and we definitely want to be prepared for them. Our bias between the share repurchase and dividends after we make sure we're in a comfortable position on the acquisition side.

We've historically done both. If you look back, we have had a dividend program, we've also repurchased stock. Obviously the stock repurchase activity has accelerated recently because of this convert, but I would see us continue to be in the market from a share repurchase perspective at lower activity levels. And then we continue to discuss if -- when and if we would reinstate the dividend, I think that is a good discussion point within the Company, and as we have not announced anything, you can deduce that we haven't decided to do anything. So but I think as we think of the capital structure, we're really looking forward to adding some more technology strength to this Company in and around Powertrain through additional bolt-on acquisitions.

Great. Thank you very much.

Sure, thank you, John.

Your next question comes from Himanshu Patel from JPMorgan.

Hello, Himanshu.

Hello, guys. My question was really just on-- I think Robin made a comment earlier, I don't know if I heard it right. I think, did you say non-R&D expenses were flat year-over-year, and was that on a percentage basis or on dollar terms

On a dollar basis.

So --

SG&A, SG&A, if you look at SG&A, the increase year-over-year is about $4 million or $5 million, R&D is up about $4 million or $5 million year-over-year.

Yes.

So real -- real spending is flat.

Yes, so Robin I mean, I guess just broader question is, how do you kind of feel about just the rate at which costs are going to come back into the business? And I am more kind of talking about the kind of costs you can control. Not necessarily commodity costs. Are you -- I mean kind of do you feel like this is a just kind of a gradual creep up or could we have a brick wall moment halfway through 2011, where suddenly there is just a big step up that you need to support the sales growth that you've got coming?

I think that it's a creep rather than all of a sudden a big event. If you look at -- and we talked about this before, our incremental margins quarter-over-quarter-over-quarter, we expect them to slow, and as get -- as we said in 2011, we're expecting a more like $0.20 on the dollar in -- for 2011. And as we get into 2012, they will slow a bit, you know we have had this discussion before. When do we get back to our kind of $0.15 to $0.20 on the dollar on incremental sales that gets offset by raw material price increases and wage inflation and so on. So that we're in an environment where margins aren't really growing much. And I think we're comfortable that 2011 is not the time period, and 2012 could be the transition year, as we move through 2012 and into 2013 where we get to a more normalized level that we flatten out here. But certainly it is not 2011.

I think there is still some room to grow. And Tim is going to kick me under the table here, but I think there is still a little bit of room to grow on the margins into 2012 incrementally, as we look at this $0.20 on the dollar, and then 2012 won't be $0.20 on the dollar; it will be trending down and more towards $0.15 and then eventually we'll get back to our kind of our normal growth rates will be just about 10% in excess of the industry. And that will generate incremental margins of $0.15 to $0.20 on the incremental business and then we'll have our raw material inflation, our wage inflation and our 1.5% to 2% price reductions that kind of keep margins constant at a much higher level, but constant going forward.

I think let me add something here, as far as our costs that are non-controllable or non-commodity, really I should say, the cost that we -- we have initiatives going on to watch our inventory, we have initiatives going on to judiciously hire salaried employees. Our guy's have done a pretty good job on inventory control, given the fact that we're putting in some inventory where we can to handle future growth. We're judiciously hiring salary people, like I just said.

We have new systems in place to track what I call hourly employee hires, so we're watching our sales per employee grow over time. And I think what you are going to see from our 10.3% margin that we just announced for the fourth quarter as we go throughout this year, you are going to see margin growth continue to grow incrementally throughout this full-year. Which is I think, the best answer to your question.

So it's sort of $0.20 on the dollar blended for this year maybe getting to the mid-teens the year after and then you hit a convergence point after that?

Yes, I think that is a pretty fair view.

Yes, okay. And then I guess a separate question. Just a lot of chatter going back and forth in the industry about pricing pressure. I know you guys have always kind of taken the view that nothing really changed for you guys. You're pretty down turned during the down turn or post.I wonder if you could revisit that and also talk not just about where you think pricing pressure is with OEMs, but also just given that the visibility on commodity costs is fairly good right now, it's going up. And also, I think most of us kind of started going into this recovery knowing that commodity costs would go up. So it wasn't that much of a surprise, perhaps, for the OEMs. So I'm curious, is there a greater willingness to share the burden with you guys on that stuff, or do you kind of feel like that particular portion of your cost structure is still pretty much your responsibility?

I don't see any particular willingness to share the burden amongst our OEM brethren -- but I will tell you this. We've already as part of our forecast for 2011, we have already taken in commodity costs and we anticipate $30 million to $35 million of increased commodity costs, it's a typical range for us. You won't hear us whining about commodity costs throughout the year unless something really happens that we have totally not predicted. Steel is probably more of the wild card than any of the other commodity costs.

As far as pricing pressures from OEMs, they seem to be playing around with their pricing and incentives on the -- at the dealer level but as far as pricing pressures with us, they are normal at BorgWarner. They're more interested in our technology. They realize that we're going to negotiate with BorgWarner and our OEMs; we're going to negotiate a fair price, that's a fair value for our technology, and what I think is fair value for them because we're providing them leading technology.

I would say the pressure is no different than anything we have ever seen before, but there is more focus on jointly working together to reduce the cost and the weight of the vehicle than there is just pure demands for price cuts. And as you know, we pick and choose our programs. If the bidding on a program gets too low, we just walk away and there is another program for us that gives us a 15% return on invested capital or better. So, we have the ability with our growth rates and technology to pick and choose and walk away from programs that are just too down and dirty for us.

Okay, thanks.

By the way, tell [Yan] we said hello.

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

Thanks, good morning.

Hello, Chris.

Hello, Chris.

So just a couple of follow up items. First, on the raw materials, can you just remind us what your agreements are on nickel that has been moving up, but if I recall, that you have taken care of that largely in terms of pass throughs?

Yes we have. And again, it depends on the customer mix. But I'd say right now, I'd say we're probably running about 85%, maybe 90% of our contracts, and this is primarily on the turbo side, where we have passed through for nickel.

Okay.

And again it's not a perfect pass through. Sometimes there is a little bit of timing difference; it's a little sloppy, but nonetheless, there is coverage there.

Okay. You mentioned a strong performance on SG&A. Was there anything in the quarter that was a special good use item, whether it was an engineering recovery, or an increased amount of capitalized R&D, or should we expect you to be able to run it less than 10% of sales?

I think that as we look at the quarter, actually there were some challenges in SG&A rather than some good time benefits there. We will see some increase in dollar spending in SG&A. There is no doubt about it. The discussion we had with Himanshu about costs will start to creep into the business as we continue to grow. We're trying like heck to increase our engineering staffs, and so you will see some increase in SG&A related to engineering spending.

You know we spent 3.3% of sales on R&D for 2011, we're getting close to that 4% level, at least that's where our expectations are. So you will see some -- it's not a negative creep, it's a positive creep; it's a good creep. It's a required creep to grow this business. So you will see increased spending in SG&A. Is 10% the right number? It's pretty close. It's pretty close.

I will to answer this, Chris. We're hiring salaried people, particularly in engineering and we're hiring to support our global growth. Since I see every salary hire, and question a large percentage of them, I can tell you that we're putting -- we're doing a lot of hiring to support our global expansion. We're doing a lot of hiring to support all of the new engineering programs that coming at us. That being said, our increase in sales is more than covering those hires. So the percentages are not changing. If anything, the percentages are going to be flat. You may see some slight dithering plus or minus from flat. But we're hiring in all the right places, but our sales growth is more covering it -- more than covering it on a percentage basis.

Okay. Last question, kind of technical question. I think you mentioned that one of your commercial vehicle customers with your turbo and EGR coolers meeting 2010 NOx requirements. Are they doing that without SCR and without credits?

I can't say. Because if I did, you would know exactly who I'm talking about and I have been sworn not to talk about anybody specifically. So I'll just say it that -- I will just leave it at that.

Okay. Thank you.

But I will tell you one thing. Since you brought up the subject of commercial vehicles, nobody has asked the question yet. But I can tell you right now, as far as our business wins for new business for 2010, we had a record year of new rewards for net new business -- well for new business wins that will eventually show up in our -- some of it are already in our net new business, but we had a record fourth quarter for new business wins and most of the fourth quarter new business wins don't show up, didn't show up in the $2.3 billion because that $2.3 billion was announced in early November.

So we're on a record pace for new business. I would say that our new business wins for 2010 were the best total we've ever had in the history of this Company, since we've been tracking, and we have been tracking all the way back to like, I don't know, 1997 or something like that and when Robin kicked it off.

It was 1995.

1995, okay, well what the heck.

Are these fourth quarter wins Tim, things that will come on in '11, '12, or '13 or are they outside your current forecast?

Well actually I have that data, and surprising enough -- in that new business wins, out of the top seven, three of them were commercial vehicle type -- either on highway or off highway type wins. And what we know about the commercial vehicle market, is when you get a new win and the pass car side, it may show up in maybe three to four years, but when you get the win on the commercial side it shows up in roughly two years, two to three years. So everything on the commercial side tends to be about one year earlier on a new program. I'm not saying that is exact, but I'm saying when you look at the lumps on the commercial side, they tend to be higher within a two-year window or three-year window than the pass cars, which are three to three year windows.

Okay, thanks, guys.

Thanks, Chris.

We have time for one final question and that question comes from Rod Lache with Deutsche Bank.

This is Dan Galves in for Rod, actually.

Hello, Dan.

Hello, Dan.

Looking at the group level, the divisional level, operating margin was up 80 basis points sequentially, but it was up 160 if you look at the corporate level. It looks like corporate expense came down quite a bit from where it was in the first three quarters. But it looked like that might have been a bit elevated. I'm just looking for some color on where we -- where you think corporate expenses should be going forward. Is the fourth quarter a good run rate?

Yes, actually, fourth quarter should be a pretty good run rate.

Okay, great. And then just to clarify on the SG&A. It sounds like R&D was 3.3% in 2010, but it sounds like you guys are running it at about 4% now. Are you saying that will probably add 20 to 30 basis points to SG&A in total and then leverage on the non R&D can bring that back down to right around 10%? Is that kind of the way to think about it?

Well let me jump in first. We target 4%. There is nothing sacred about 4% and we target over the years, that is what we typically run at and a 4% R&D supports this company extremely well. But with the sales we have now, it's going to be hard for us to invest enough to get up to 4%. We're investing to support all of our programs and we're investing heavily for new technology. And we're not -- if anything, we're investing more than people are asking for that work for me, to support future growth and new technology. But because of the sales growth is so fast and coming at us so well, we're going to be hard-pressed to catch 4% as we look at quarter-on-quarter going forward.

And if we do get the 4%, I think I look at it and view it as a great thing. Because that just is more, more opportunities for BorgWarner. Right now, we're supporting extremely well, we're supporting all of our growth programs and launch programs at the current level of spending. And whatever the percentage turns out to be, that's what it is.

That makes sense. Could you tell us what R&D was as a percentage of sales in the fourth quarter? And also, I just wanted to ask if Haldex has a backlog of new business and if so, how big is it?

They have a nice backlog of new business. That was part of our growth consideration when we bought them. They have a good backlog of opportunities in Europe. More importantly, they don't have anything in their plan or they don't have much in their plan for China, and we think we have an opportunity with the BorgWarner brand name and the BorgWarner reputation. We can take Haldex to China and do extremely well. And I don't know how far up that backlog goes, I just know what the data we looked at -- and through due diligence. But we have an opportunity to grow that business and I hope you will see that in the future.

R&D's percent of sales in the further quarter was 3.3%.

Okay, thanks very much, guys. Appreciate it.

And we'll see that creep.

I would like to thank you all again for joining us. As Robin said, we expect to file our 10-K before the end of the day, which will provide details of the results. But of course, if you have any follow-up questions in the interim, please direct them to me. Wendy, please close out the call.

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