博格華納 (BWA) 2011 Q2 法說會逐字稿

Good morning. My name is Rebecca, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2011 second-quarter results earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period.

(Operator Instructions)

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

Good morning, and thank you all for joining us. We issued our earnings release this morning at approximately 8 AM Eastern Time. It's posted on our website, BorgWarner.com, on our home page. A replay of today's conference call will be available through August 4. The dial-in number for the replay is 800-642-1687. You'll need the conference ID, 79909349. Replay will also be available on our website.

With regard to our investor relations calendar, we will be attending a number of conferences over the next few months. August 11, we'll be at the JPMorgan conference at Detroit. September 7, we'll be at the Credit Suisse conference in New York. September 13, we'll be at the Frankfurt Auto Show Investor Conference in Frankfurt.

November 1 we will be at the Gabelli Automotive Symposium in Las Vegas. Also, as we do each fall, we will be announcing our 3-year backlog of net new business in early November.

Before we begin, I need to inform you that during this call we may make forward-looking statements, which involve risks and uncertainties as detailed in our 10-K. Our actual results may differ significantly from the matters discussed today.

Moving on to our results, Tim Manganello, Chairman and CEO, will comment on the second quarter and industry trends. And then 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'll turn it over to Tim.

Thank you, Ken, and good day everyone. I'm very please to review our second-quarter results, our accomplishments, some comments on the industry, and our revised guidance. But first, I'd like to thank all the BorgWarner employees worldwide for another record quarter.

In addition, we recently recognized over 70 BorgWarner employees with awards for innovation in product development, customer excellence, operational excellence, and collaboration. I'm very proud of our employees and their dedication, teamwork, and creativity that drives BorgWarner's success.

I'll begin by highlighting our strong second-quarter results. Sales were $1.8 billion, up 28% from the same period last year. Our operating income margin, excluding a non-recurring item, was 11%. US GAAP earnings were $1.31 per share. And excluding non-recurring items, earnings were $1.12 per share.

4 key factors drove our results -- increased global demand for our products; higher volumes in our base business; well-executed cost controls via all BorgWarner locations; and better-than-expected results from our Japanese operations.

Now, let's take a look at second-quarter results at the group level. In the Engine group, first-quarter sales were about $1.3 billion, up 28% from a year ago.

Higher sales in the Engine group were a result of growth in 3 key areas. Engine timing system sales were up in North America and China. Fan and fan-drive sales were sharply higher as the commercial vehicle market continues its strong recovery.

And the rapid adoption of turbocharger technology continued around the world. The turbocharger market continues to be a major driver for BorgWarner. It is a growing market that is attracting new competitors, but despite this, we expect to maintain or increase our global market share of the rapidly growing global turbocharger market during the next 5 years.

In the Drivetrain group, sales were up $526 million -- or I'm sorry, were about $526 million, up 29% from the second quarter. There were 3 primary drivers for Drivetrain sales growth -- increased DCT module sales in Europe; increased four-wheel drive and traditional automatic transition component sales in Korea; and the traction acquisition from Haldex. Regarding Drivetrain margins, the Drivetrain group's operating margins are improving.

In the quarter, margins were 7.4%, which is an improvement over Q1 of this year but not quite where we planned to be. The Drivetrain group continues to manage through capacity constraints and productivity issues in Europe, and these issues have been challenging, but we are continuing to execute plans that will improve their performance.

At the corporate level, capital spending continues to grow. It was about 5% of sales on the quarter, and we are committed to supporting our future growth with new investment and productivity improvements. We also repurchased about 1 million shares of common stock in the second quarter. We have now accumulated all of the shares required to settle our convertible-debt obligation, which is due in April of 2012.

We continue to invest for the long term also. Our spending for R&D and new program launches was about 3.6% of sales in the quarter, and this is slightly below our targeted level of 4% but an increase of -- or increase from 3.2% a year ago.

I'm also excited to tell you about several noteworthy business wins by the BorgWarner team. BorgWarner now supplies Torque-On-Demand Transfer Cases for the Tata Aria, India's first four-wheel-drive crossover vehicle. Torque-On-Demand technology provides improved traction and automatic four-wheel-drive when it as needed, and it will help Aria compete with imports in the Indian market.

In China, BorgWarner produces several advanced technologies for the Great Wall Motor new, 2.0-liter diesel Haval H5 and Hover SUV. These technologies include the VTG turbochargers, Torque-On-Demand Transfer Cases, self-regulating glow plugs, and EGR valves.

We are also very proud to produce compact plug-top ignition coils and timing-chain systems for Fiat's new 0.9-liter TwinAir gasoline engine. This engine was recently named 2011 international engine of the year, best new engine, and green engine of the year.

The Fiat 3.0-liter F1C engine features our regulated 2-stage or R2S turbochargers. They have been available in Europe and Asia since 2009, but the engine is now available in North America for the first time. Additional good news on this engine is one of Asia's leading commercial vehicle manufacturers plans to use this fuel-efficient engine for its next generation of medium-duty trucks in over 40 countries by the end of 2012.

In North America, Freightliner's Cascadia trucks offer BorgWarner's Visctronic fan drives, a first for Class 8 commercial trucks in North America. BorgWarner's electronically controlled Visctronic fan drives provide the right cooling at the right time to improve fuel economy for trucks.

We settled a patent infringement lawsuit with Honeywell in May. Honeywell agreed to pay $32.5 million for a paid-up license to use the asserted BorgWarner patents. We're very pleased with this outcome, and it validates our reputation as the leader in turbocharger technology.

I'd like to make a few comments about the broader auto industry for the second quarter. Global production was down 2% in the second quarter compared with a year ago. Robin will go over the details in a moment on that one.

In summary, industry production was flat in Europe and North America, higher in China and India, and sharply lower in Japan. In Japan, production was better than we expected at our NSK-Warner drivetrain joint venture and at our wholly owned Japanese chain operations.

During our first-quarter earnings call, we said we believed both businesses would be break-even at best in the second quarter. But both businesses were actually profitable. This is a remarkable result and a testament to the resiliency of our team in Japan and our customers in Japan. Congratulations to both.

A closer look at Europe reveals the mix of vehicles continued to shift in our favor. C, D, and E segment vehicles represented nearly 66% of vehicles produced in Europe in the second quarter. This was 2 percentage points higher than the second quarter of 2010 and essentially flat with the first quarter of this year. The diesel market share was up a couple of percentage points from a year ago and essentially flat with the first quarter of 2011.

Next, let's take a look at our updated production outlook. North America remains unchanged at 13 million units. Our view on Europe improved to 19.9 million units, up from 19.2 million. And the vehicle mix will probably stabilize at the current percentages, which is good for BorgWarner.

We now realize that China will be a little weaker than expected at about 15.9 million units, down from 16.5 million. Higher interest rates and gas prices, along with reduced incentive programs, have tempered vehicle sales and production in China. However, it appears that sales of higher-end vehicles are now starting to come back and the China pass-car market will be improving.

In Japan, we expect production levels to continue to improve to normal levels throughout the year, although it does not appear that there will be much second-half recovery of lost first-half volumes. For the full year, our global forecast is down slightly. We expect higher volumes in North America, Europe, and Korea to nearly offset lower volumes in Japan and China.

In the commercial truck market, we continue to expect solid growth in North America, Europe, and South America. And in China, the truck market is expected to decline due to the same factors affecting the light-vehicle market in China. Despite this, our commercial truck business is growing in China due to our increased penetration rates.

Finally, we have raised our guidance for 2011. Our earnings guidance is now $4.25 to $4.45 per share, which is up from $3.85 to $4.15 per share. And we still expect our operating margins to be better than 10.5% for the full year.

Sales growth in 2011, compared with 2010, is now expected to be 25% to 28%, up from our 19% to 23% guidance earlier this year. The change is primarily due to an improved outlook for our business, along with updated currency expectations. Also, for the longer term, demand for our technology continues to gain momentum.

As you all know, BorgWarner has become synonymous with improving fuel economy and lowering emissions, and both are major long-term trends in the global auto industry and are driving our growth. As result, and as I have said many times, probably every time in the quarterly calls, the high demand for our leading-edge technologies will continue to drive solid BorgWarner growth for years to come.

And I'd like to emphasize one more time, no company in the auto sector is better positioned for short-term or long-term profitable growth than BorgWarner. Thank you. And now I'll turn the meeting over to Robin.

Good day, everyone. Before I begin to review the financials, I'd like to quickly review the macro environment for the industry in the second quarter to help put our record performance in the quarter in perspective.

As Tim mentioned, second-quarter global production was about 17.6 million units, down about 2% from the second quarter last year, and actually down 7% from the first quarter. Our sales moved opposite of the market and were up in the quarter, both year over year and also sequentially.

On a year-over-year basis, as Tim mentioned, our reported sales were up 28%. Excluding currency in the Haldex acquisition, which remained in the first quarter this year, the year-over-year increase was 15%, and that's about 17 percentage points stronger than the 2% year-over-year decline in the global vehicle market in another quarter where our sales growth significantly outperformed the market.

Sequentially, excluding currency in the Haldex acquisition, our sales were up about 3%, which is 10 percentage points better than the 7% sequential decline in the marketplace.

When you look at our sales from a regional perspective, our sales growth in the second quarter outpaced the market in every major region in the world. In the US, with our sales up 16% versus last year, the market was up only 3%. In Europe, on a comparable basis, excluding currency in Haldex, our sales were up 13%, and as Tim said, the market was up 1%.

Our sales in Asia, excluding currency, were up 11%, while the market was down 6%, again primarily related to the tragedy in Japan. Clearly the growth of our leading-edge technology products continues to penetrate all the markets around the world and continues to differentiate BorgWarner from the rest of the industry from an overall growth perspective.

If you look at where our sales took place in the quarter, approximately 57% of our sales occurred in Europe. About 45% were in Euroland, exposure to the euro. Approximately 23% in the US, about 15% in Asia, and the rest in South America and other smaller countries.

As we look at the earnings-per-share numbers, as Tim mentioned, on a GAAP basis we reported a record $1.31 per diluted share, compared with $0.68 per diluted share in the second quarter 2010. However, as we indicated in our press release, both periods included non-recurring items that really have nothing to do with the ongoing operations of the business.

We've identified those items in a table in our press release, and these include the $29.1 million net gain, net of expenses, related to the Honeywell patent infringement in the second quarter 2011 that Tim mentioned. And that's shown in the other income line item in our income statement. We also had positive tax account adjustments in the second quarter of approximately $6.2 million that kind of skews the tax rate, and I'll talk about that in a little bit.

In the second quarter last year, there was approximately $20 million of non-recurring items, also shown in the other income line item in the income statement. So it's easy for you to see where these large items are.

In the press release we have this table, and we typically provide it to help you reconcile our reported US GAAP earnings measures with the financial performance of the continuing operations of our Company, and also to help you in comparing these results with the results of other periods. As always, we encourage you to review this information as it is important part of the press release.

Excluding these non-recurring items, again, second-quarter 2011 earnings were $1.12 a share, a new all-time record for the Company, and up 44% from $0.78 a share a year ago. Another quarter in a string of very strong quarterly performances by BorgWarner.

As we look at the rest of the income statement, gross profit as a percent of sales was 19.6% in the quarter, slightly higher than the 19.4% a year ago and just under 19.8% in first quarter 2011. And remember, we've got a lot of purchase-accounting entries running through gross profit as a result of the acquisition of Haldex in the first quarter.

The year-over-year improvement in the quarter was realized, despite about $8 million of higher raw material prices in the second quarter this year than we experienced in the second quarter last year. It brings us to about $20 million year-to-date actually. SG&A expenses were $158 million, or 8.7% of sales in the quarter versus $138 million or 9.7% of sales in the second quarter last year.

Now this is an increase in spending year-over-year of about $20 million, but if you look at that $20 million increase in the quarter, nearly all of it was related to R&D spending. So we continue to see operating leverage in the business reflected in our SG&A expenses, particularly as a percent of sales.

Talking about R&D, as Tim mentioned, as a percent of sales, R&D was 3.6% in the second quarter, an increase from 3.2% a year ago and 3.5% in the first quarter. On a dollar basis, R&D spending was up 40% year-over-year, which is huge.

We continue to trend towards our 4% target, and although on a full-year basis, we'll probably fall short of that 4%, we expect to be closer to that 4% run rate by the end of the year. And again, we expect R&D spending to be up over 50% on a dollar basis versus last year, so a significant investment in the future of this Company running through our SG&A line items.

Reported operating income in the quarter was $228 million; however, this did include that $29 million net gain related to the Honeywell patent infringement settlement. Although I'd like to say that we'd love to see that settlement every quarter, it's really not going to happen. It has nothing to do with our operations, so as we exclude that, operating income, was $199 million, or about 11% of sales, compared with $137 million, or 9.7% of sales a year ago, here also excluding non-recurring items.

The 11% margin is a the new quarterly record for BorgWarner. And if you exclude Haldex, operating margins were 11.3% in the quarter. So relative to the where this business has been, we actually saw margins north of 11% in the quarter. That shows you how strong the performance of our business has been this year. As I said last quarter, whether you include or exclude Haldex, we are having a fantastic year, setting new operating income margin records quarter-on-quarter.

On a reported basis, if you look at incremental margins, the year-over-year incremental margin on incremental sales was approximately 16%. Again, if you exclude the impact of currency in the Haldex acquisition, if you look on a comparable basis, the year-over-year incremental margin was about 21%. This solid conversion of higher sales to incremental income reflects effectiveness of past restructuring activities, continuing well-executed cost-control programs, and the benefit of our operating leverage.

If you remember, when we started the year, we gave guidance and said that we were expecting about 20% incremental margins year-over-year throughout 2011 versus 2010. We've achieved 21% incremental margins on a comparable basis in both first and second quarters, and that's a pretty good performance relative to guidance.

If we look at the incremental margin on sequential basis from the first quarter to the second quarter, again, excluding currency, our sequential margin was about 19%. If you exclude Haldex, it was probably a little bit higher, probably in the mid-20%s.

If you look further down the income statement, equity in affiliate earnings was $8.1 million, down from $10 million last year, down about 20%. Our equity affiliate earnings primarily reflect performance of our drivetrain system's 50-50 joint venture Japan NSK-Warner that services Japanese customers for transmission products in Japan and China, and also our turbocharger joint venture in India.

Affiliate earnings were stronger than we expected in the quarter, and as we look at it, sales at our NSK-Warner joint venture in Japan declined about 33%, which was in line with our expectations as a result of the disaster in Japan.

However, they did a much better job of managing the cost structure, with decremental margins of only $0.20 on the dollar associated with that sales decline, versus our 40% expectation. As we look ahead, we will continue to see slightly below-prior-year levels of affiliate income in the third and fourth quarter, but the variance will not be as severe as we originally anticipated.

Interest expense and finance charges were $21 million in the quarter, compared with $14 million a year ago, and that's primarily due to higher debt levels. We've invested approximately $375 million in acquisitions in the last 15 months. Provisions for income taxes was $50 million in the quarter for a tax rate just below 24%.

This reported number includes both the tax impact of the Honeywell patent-infringement settlement and in other tax account adjustments related to changes to state tax laws and the closure of certain federal audits around the globe. If we exclude these items, the effective tax rate on our ongoing operations was about 24% in the quarter, in line with first quarter and pretty much in line with the guidance we've given for the full year 2011.

Net earnings in the quarter were $162 million, compared with $82.8 million a year ago. At the bottom of the income statement, thanks to our press releases, as always, you'll find information on how we calculate diluted earnings per share. It's kind of a convoluted process, but we've been through that in the last couple of quarters, and I'm not going to explain it to you again.

As we get down to diluted earnings per share on a US GAAP basis, we earned $1.31, as I said earlier, versus $0.68 a share. Excluding nonrecurring items, $1.12, an all-time quarterly record for the Company and again, up 44% year-over-year from the second quarter 2010. That's phenomenal performance.

Now let's look at the operating segments. Again, good performance on both sides of the equation here. The Engine segment sales were $1.3 billion in the quarter, up 28% versus last year, but to be fair on a comparable basis, excluding currency, Engine segment sales were up 17%, compared with the second quarter of 2010, significantly outperforming the industry. We are seeing strong global growth across Engine segment product portfolio.

Every product area in BorgWarner showing good strong double-digit growth versus last year on the engine side.

Adjusted EBIT for the Engine group was $197 million in the quarter, or 15.3% of sales. Again, new quarterly record for the Engine group at BorgWarner and significantly higher than the 13.1% adjusted EBIT margin reported a year ago. If you look at the year-over-year incremental margins, excluding currency, Engine really hit the ball out of the park with 29% incremental margins year-over-year.

If you look at second quarter versus first quarter of 2011, or on a sequential basis, Engine sales were up about 3%, excluding currency, in a market that was down about 7%. And again, the incremental margin on a sequential basis was about 28%, and this Engine segment continues to perform at industry-leading levels.

In the Drivetrain segment, sales were $526 million in the quarter, up 29% versus the second quarter last year, but we did get benefit from currency in the quarter. And also, we now own Haldex, which we didn't own last year. On a comparable basis, if you strip that down on sales, Drivetrain segment sales were up 9%. Compared to the second quarter 2010, relative to the market, that's 11 percentage points stronger than the market, which was down about 2%.

On a reported basis adjusted EBIT was $39 million, or 7.4%, which was down from 9.1% in the second quarter 2010. As we said in our last earnings call, the sales that we have as a result of the Haldex acquisition will actually be a drag on margins this year as a result of the purchase accounting adjustments related to that acquisition.

The profits we're generating in that business, which are in line with our Drivetrain margins, before purchase accounting adjustments, are being eaten up. So it is impacting the margin reported for this business.

If you exclude the impact of Haldex and currency, Drivetrain segment margins were about 8.2% in the quarter, still below last year, but we are seeing quite an improvement in the Drivetrain business.

If you look on a sequential basis, or again, comparing second quarter to first quarter this year, Drivetrain sales were up 4% on a comparable basis, solid growth again in a market that declined about 7% sequentially. If we look at incremental margins on a sequential basis, they were at about 11%; below our target of 20%, but definitely turning in the right direction.

In fact, if you look at the Drivetrain margins, they actually bottomed out in the last half of 2010 and aren't showing improvement off those levels. If I look back sequentially starting in the first quarter 2010, Drivetrain margins were reported at 9.9%, in the second quarter 9.1%, in the third quarter last year, they were 7.8%, in the fourth quarter 7.6%.

As we got into the first quarter this year on a reported basis, they were 6.6%, but without Haldex, on a comparable basis, they were 8%, much higher than third and fourth quarter.

So you see the progression. And now as we look at the second quarter, again, reported 7.4%, but excluding Haldex, 8.1%.

They bottomed out in the last half of 2010. We're seeing some improvement in the first quarter of 2011, further improvement in the second quarter 2011, and we expect further sequential improvements in Drivetrain margins in the third and fourth quarter of this year, exceeding prior-year margin levels. As we get in the back half of the year, we should Drivetrain margins actually stronger than drivetrain margins in 2010, which is a good thing.

If we look at the balance sheet and cash flow statement now, moving away from the income statement, we generated about $249 million cash from operating activities in the first 6 months of 2011, up $40 million for the same period last year. We had a very strong second quarter from a cash-flow perspective, generating $290 million cash from operations activities.

If you look at where we are to date, we are on track to generate over $650 million of cash from operating activities for the full year, and that's up about $50 million from our previous guidance on cash provided in January.

Capital spending for the 6-month year is approximately $160 million, up about $107 million in the same period last year, indicative of the growth in capital spending that's required to make an increased level of program launches we have around the world, particularly in markets like Asia, Eastern Europe, and Mexico.

As we look at the full year, as we've said before, we expect an increase in capital spending versus last year. We're not talking about $350 million to $375 million capital spending, which is up slightly from our previous guidance, but we're generating more than enough additional cash flow to cover that.

Looking at the balance sheet itself, debt increased by $289 million from year-end, while cash decreased about $78 million in the quarter. If you look at this $350 million or so increase in net debt, it was primarily due to the acquisition of Haldex traction systems, which was over $200 million, as well as the purchase of the remaining treasury stock required to settle our convertible that matures next April. So we're in good shape there.

If you look at the capital structure, our net-to-capital ratio was about 31% at the end of the second quarter, compared to 24% at the end of 2010. If you look at net debt-to-EBITDA on a trailing 12-month basis, it was about 1.1 times at the end of the second quarter.

We view our balance sheet and capital structure on a net converted basis. That convertible is in the money. It will mature in April of next year. We bought all the shares to take care of that; it's sitting in our shareholders' equity right now. We encourage you to do the same thing when you look at the capital structure.

From that perspective, net debt-to-capital is about 20% at the end of the quarter. Net debt-to-EBITDA was 0.8 times. We also recently renewed our revolving credit facility in the second quarter.

The new facility is $650 million, with an accordion feature that allows us to upside to $1 billion in credit if we need. It's a 5-year term on the facility. Given all that, I think our capital structure is in excellent shape and makes us well-positioned to take advantage of strategic acquisition opportunities presented by the market.

I'm going to move on to guidance for 2010. Tim covered it briefly; I'm going to just hammer it home one more time. We have raised our sales growth and earnings guidance for the year. We now expect sales growth 25% to 28%, compared with 2010, versus industry growth of about 4%. I'm sorry -- 2011 guidance. I might have said 2010, but --

This is up from our previous sales guidance of 19% to 22%. Earnings per share, excluding non-recurring items, are expected to be within a range of $4.25 and $4.45 per diluted share, and this translates to an earnings-per-share growth rate of 40% to 47% in the year versus 2010, up from $3.85 to $4.85 diluted share, our previous guidance.

The dollar-euro exchange rate we have changed for the year. That's part of the increase of both the sales and earnings, but not all of it. We finally said uncle and decided to increase the exchange rate and expect the dollar to be about 6% weaker than previously expected. So we're at $1.40 to the euro in 2011 versus $1.32, and that $1.40 just happens to be where we are at the 6-months year-to-date performance.

The dollar-to-euro exchange rate -- the change in guidance accounts for roughly 3% of the expected year-over-year sales growth rate. If you exclude currency, you're looking at 22% to 25%, compared to 19% to 23% before, so still a significant improvement.

The dollar-to-euro exchange rate represents approximately $0.12 a share in earnings growth relative to previous guidance. The remainder of the increase in guidance is phenomenal relative to where we were before due to an improved outlook for our business.

The Haldex acquisition will be a drag on margins for this year, and my rough estimate to the tune of about 0.3%. That's due to up-front transaction cost and purchase-price amortization.

Despite the Haldex margin drag, we still expect to achieve better than 10.5% operating income margins for the year, including Haldex. And if you look at where we are year-to-date, we have about 10.7% including Haldex and about 11% without Haldex. Very strong margin performance for this Company year-to-date and continued expected margin performance for the rest of the year.

The negative impact expected from our NSK-Warner joint venture in Japan has been minimized. We still expect affiliate income in the third and fourth quarters to be below prior-year levels only slightly, and certainly not as severe as we originally anticipated.

Also, the contagion from the disasters in Japan that some feared would severely impact the global industry, and we saw a lot of sell-off in stocks in the sector early in the second quarter, I think that was unfounded because that has not materialized, certainly not at BorgWarner.

As we look at higher raw material costs, we continue to believe that will be a negative impact of about $35 million to $40 million for us in 2011 versus 2010. As we said on our last earnings call, and we've said over the years, our intentions with respect to raw material prices have always been too absorb and manage these inflationary costs and not permit them to have any impact on earnings expectations for the year.

If you look at the year-over-year projected sales and earnings growth range for 2011, it implies incremental margins, excluding Haldex, of about 20%, in line with our target for the year and in line with the first half of 2011 actual performance. We did a pretty good job guessing that number for the year.

Let me summarize the quarter for you. It was another record from a sales perspective, another record from an earnings perspective, another record from an operating income perspective, and believe me, we do not believe we're done setting records this year. 6 months left to go, and this train's moving.

Engine margins are at all-time record highs, while Drivetrain margins have bottomed out and are improving sequentially. We continue to gain momentum in this business, and as I a look at this quarter from a critical perspective, for me it's hard to find anything to be negative about. With this performance, we just set the bar higher for ourselves, but I know everyone within this Company is up to the challenge. And with that, I'd like to turn the call back over to Ken.

We will now turn to the Q&A portion of the call. I'd like to ask the call coordinator to please announce the Q&A procedure.

(Operator Instructions)

We'll pause for just a moment to compile the Q&A roster. Rich Kwas, Wells Fargo

On drivetrain, Tim or Robin, could you give us some color on what's happening in Europe? It sounds like you still -- some of these issues that were -- that occurred earlier in the year are sticky. What's the update there?

And then I know you're spending some dollars in China for the DCT program, the DCT launch, where are you with that? And then just to confirm, it sounds like you expect margins to be up year-over-year for drivetrains for the second half of the year. Any color around magnitude would be helpful.

Well, we're continuing to see some issues in Europe, both on capacity constraints, because we're trying to get more capacity in. We've had some operational issues, and a couple of plants that are improving, but they're not where I want them to be yet.

I don't want to get into the details, but in China, we are -- I'm going to China actually next month, I guess early September, to do a dedication ceremony, the opening ceremony for that new drivetrain plant in Dalyan. We will be in production later, the end of this year, ramping up in the first quarter of next year, which is still on schedule.

Yes, we are continuing to invest money in R&D. We have more and more projects that we are involved with from the Chinese OEMs. This has already been public, but we're launching with Shanghai and then we're going to have a significant amount of business with First Auto. We're continuing to grow with other -- with those 2 main players, and we're getting more and more projects and more and more involved at development programs.

Our transmission -- the new BorgWarner transmission design that we worked on, the low-cost transmission, is moved into the next phase of development program, which is basically 1 phase before a production contract. So, we're in the pre-production contract phase with 2 major Chinese OEM and 1 major Japanese OEM. But, I can't announce them yet.

And so, we're spending money on engineering costs, and drivetrain is going to be well spent for the future but it's got a little bit of a drag on us right now. We've got some operational issues in Europe that are improving. Third-quarter and fourth-quarter projections are better on margins for drivetrain than the first or the second quarter. And we're just continuing to run our plan, Rich.

Okay. Sounds like the magnitude is -- we should expect some modest expansion from here, given the invest[multiple speakers]

Well, okay. I forgot to talk about the magnitude. The magnitude -- Robin gave you some historical ramp-up, and we're going to be -- start moving up in those ranges. So, go ahead, Robin.

Let me help you there, Rich. As I said, third and fourth quarter last year were 7.8% and 7.6%. In the second quarter this year, we were at 7.4% and again, we expect improvements for the remainder of the year. So, we'll be north of 7.8% in the back half of the year.

If you look at without Haldex, we're 8.1% in the second quarter. So, we will see sequential improvement beyond second-quarter levels. That will put us in a better position from a margin perspective than we were in the back half of last year and continue to improve, as Tim said, working on the gradual improvements in that business in Europe.

Okay, that's helpful. And then just final 1 for me. Ken, a bigger picture question, Cummins, it looks like -- is going to be -- is investing in a light-duty diesel for light-truck applications. How do you think that affects the overall competitive landscape going forward? It seems like it's a ways out, but I just want to get your thoughts on --

It's a ways out, and they're a player in the market. And as far as -- we're tracking turbocharger growth, both in the commercial market and in the pass-car. We are growing in that segment of the market that Cummins's new engine will play in.

Our turbocharger volume is growing in that segment in the next 5 to 6 years. And they're going to have -- we already know that the Chinese are targeting that market and that there's tremendous growth for us in China. We also know the Chinese are preparing to go into global competition, and they're going to be using turbochargers like the kind that BorgWarner makes.

Okay. All right. Thank you.

Thank you, Rich.

Rod Lache, Georgia Bank.

This is Dan Galves in for Rod. So, SG&A looked quite low in the quarter. It was down $7.5 million, and it sounds from what you were saying that R&D expenses were actually up about $5 million. So, what caused the decline in SG&A outside of the R&D line?

Well, the macro answer is, we're leveraging resources as we grow our sales, but we are continuing to grow our R&D spending. From last year to this year, there's tremendous growth in actual dollars.

As far as the rest of the SA&L, we're basically managing our hiring. We're managing our travel costs, and we're basically managing -- all the lessons that we learned during the recession, we're trying to continue on as we go forward in this Company, but we're still not doing anything that would harm our growth. So, we're just investing wisely.

Okay, great. Also just wanted to check if there were any kind of specific expenses related to Japan outside -- in your core business in terms of premium freight, anything like that. Was there anything material the quarter?

No, not really. It was just normal. We -- the guys did a great job of cutting costs, keeping their decremental margins as low as possible. Some of the things we did in Japan to keep our plants running was, we were tight on capacity in Korea on some products in the timing-chain area.

So, we started making -- we need similar products between Korea and Japan, so we basically cranked up our Japanese plant to ship products to Korea to relieve some of the capacity challenges in our Korean operations. So we kept our chain plant in Japan running as best we could, even though we were making products that wasn't necessarily being used and shipped and consumed inside Japan.

Okay, great. And just one housekeeping thing. Can you remind us what the impact on revenue from Haldex was in the quarter and what you expect for the full year?

As we said before, Haldex is about $200 million in revenue on an annual basis, so, divided by 4 it's about $50 million.

Okay. All right. Thanks a lot.

John Murphy, Bank of America Merrill Lynch.

First question on the engine business and the commercial exposure in aggregate. Tim you mentioned the commercial business was a really good positive in the quarter for the fan and fan drive business and the engine business. I'm just wondering if you can remind us how big commercial is in your aggregate portfolio right now?

And also it looks like it's going to be -- the outlook is a lot brighter there than it is on the light-vehicle side, particularly as we go to the second half of the year. Just curious how you're thinking about that business really ramping up and how big a contributor it will be in the second half.

Well, it's about 15% of our sales when you consider medium-duty, heavy-duty, buses, and some of the ag stuff, we'll call it off highway. If you define that -- for us, that's what we define as commercial. That's about 15% of our sales, and our sales are growing so significantly, and we're still maintaining that 15%, 16% range.

So, you're seeing really good actual growth in the commercial side. The turbocharger business is increasing on the commercial side pretty much worldwide, but particularly China. The fan and fan drives have seen tremendous growth in China and India and so forth. Although as we look forward, the turbocharger business is penetrating business in China and holding strong in North America and Europe, but the fan then drive is growing and doing very well and holding strong in North America and Europe.

I think we have now roughly 60% of the fan drive market in North America now, at least for the last month or 2, which is very high penetration rate for us. But the fan drive market is seeing a little bit of a softness in the Chinese market, basically because the Chinese market, they've lost some incentives. The fuel prices are going up.

The same things that we're seeing on pass-car, only they hit the commercial side of the market a lot heavier. The other thing is we're seeing tremendous growth in penetration rates for the fan and fan drive and the turbocharger business in South America, particularly Brazil and Argentina.

So, it's fair to say in the second half it might be a little bit faster growth in light vehicle because of the bounce there, but in aggregate, it's growing in line with your portfolio of businesses?

Yes, I'd say -- I don't have the numbers right in front of me, but we just gone through, and I can tell you this. Both commercial and light vehicle ares growing well in the second half of the year. Light vehicle may pull ahead a little bit more than usual in the second half, for no other reason than the fan drives on the commercial side in China may just be a little bit of a headwind, but yet, that's going to be offset by stronger tailwinds in Brazil. So, we'll have to wait and see how it plays out.

Got you.

I don't that helped you with your question or not.

Kind of, yes. It's getting me there. Second question on the adoption curve of turbos in the US. Do you get the sense there's a greater sense of urgency among the auto makers to really downsize and turbocharge their engines as there's this increasing pressure on [CafA] both in the near term, more importantly, in the long-term, and that we might see a faster adoption curve than we might have thought 6 months ago?

Yes. There's a tremendous amount of interest in turbochargers and a tremendous amount of interest in the US in all of our other technologies. Variable-cam timing is going to turn out to be a huge growth platform for BorgWarner because we've got the latest and greatest technology, and the people finally discovered how potent and how beneficial this technology is in terms of improving fuel economy. Chain systems are growing strong.

Like I said, variable-cam timing, turbochargers. We've got a really strong portfolio. Dual-clutch transmission is still strong around the world and growing rapidly. The parts of the world that have manual transmissions and want to convert to automatic but they want fuel efficiency out of their automatics, they're focused on that dual clutch.

We're getting the wet-clutch business real solid, and we're getting a good portion of the dry-clutch business now on the control modules. But the north, specifically to your question, the Detroit Three have finally and really discovered fuel economy, and it's a major focus for them.

Lastly, Robin, you mentioned as you got the new revolver you had this option to toggle it up to $1 billion. You also mentioned acquisitions might be a reason that you might toggle it up, and you seemed a little bit more enthusiastic there about making acquisitions, and at least it sounded like you were a little bit more enthusiastic.

Has anything changed on the landscape where you see anything that might be larger out there than what you've done more recently that would really be a good fit for BorgWarner?

I don't see anything out there that's a lot larger than what we've done historically. I'm just overall excited about the Company. Operations, acquisitions, cash flow, you name it.

That's great. Well, thanks guys. Keep it up.

Thanks, John.

Ravi Shanker, Morgan Stanley.

Thank you. Just on the competitive situation on the turbo side, can you give us an update in terms of what you're hearing and where -- I think Conti and Boscher are highlighted as 2 of your most prominent emerging competitors -- where they are in terms of development and contracts and such?

Well, it picked up some programs in Europe. They are mainly focused in Europe with their strong alliance partners over there, typically the Germans. I don't think they really into any major -- big launch phases yet. They haven't launched anything. They're creeping up on their SOP dates.

There's a big difference between being in production and talking about being in production. We'll see how things work out for them. Like I said, in my speech, though -- my presentation -- as we see the next 5- or 6-year horizon, we see ourselves gaining or maintaining market share globally on turbochargers.

And there may be a little bit of redistribution of what part of the world our turbocharger growth comes from, because up until now it's fairly been European-centered. Now our turbocharger footprint is becoming more balanced all over the world between Asia and now, soon to be North America, with all of the penetration rates, programs we're gaining in North America.

So, you're going to see strong growth in turbochargers for everybody, and there's huge opportunities for all of us. And there's plenty of room for all the competitors in the turbocharger side of the business.

All right. Thanks for that. And on the -- we're hearing almost every day a new investigation into suppliers for price fixing in different regions of the world. So a) can you confirm if any of your units are being investigated globally? And b) would you care to comment on what's causing this and how you see this ending?

Well, let's just say this -- none of that has anything to do with BorgWarner, and we've heard nothing, we've seen nothing, we do nothing. It has nothing to do with BorgWarner, totally and unequivocally. That is it.

Got it. That's pretty emphatic. Finally, Robin, I may have missed this in the numbers you gave out, but are you updating your [road map] guidance for the year, given that it is running ahead in the first half?

No. We're staying the same on raw materials.

Thank you. Thanks guys. Thank you, Ravi.

Himanshu Patel, JPMorgan.

Thanks for the antitrust answer. Very clear. I guess my bigger question on that is there any historical context you can provide us on this issue? For example, have there ever been any prior investigations over the last 15 years or so that you guys know about in some of the products segments that you're in, or even that has never happened?

No. Nothing has been -- we've never been involved in anything like that and I would expect that our sales people and anybody else in our Company is smarter to get involved with anything like that.

Okay. Had a question about operating margins. You guys did 11%. I know you have kind of an open-ended target on margins being better than a certain level, but I'm just curious how we should think about this new record margin. Is this a figure that could still have some upside potential from here? Should we think about this more as a ceiling or is this a new norm, if you will?

As I said earlier, we set a lot of records in this quarter, and they're not going to stand for very long, including that operating-income margin level.

I guess, you know Robin, there's been a couple of suppliers, not all, but that have reported so far that've had some fairly material intrayear increases that they've had to do on their CapEx guidance, engineering costs, et cetera. It's been various issues, whether it's emerging-market investments or greater launch velocity. I'm curious, are you guys seeing any of that?

And the heart of the question is are there any of those pressures building in your business such that maybe we could have a situation towards end of this year or early next year where we see some step-change increases and cost pressures for you guys?

On the capital side, we are increasing our capital investments. Previously, we were a little bit below $350 million. Now we're looking at $350 million, $375 million. On the same side, though, as we said, we're going to generate at least $50 million more of cash from operating activities than we thought before.

So, from a cash perspective for the year, we're look at the same number, maybe a little bit stronger. We've had a challenge from a capacity perspective since late last year, and we continue to have those challenges. We're working like crazy consistently to try to continue to get more capacity in place for ourselves and also to make sure that our suppliers are there.

At this point in time, that's 1 of our challenges in Europe in the drivetrain business. But we're slowly working our way out of that. From my perspective, if you think about the industry today, we feel much better about struggling to provide additional product to our customers and putting in capacity than we were in 2008 and 2009 when we had so much excess capacity, and we couldn't get a customer to take a product from us.

So, we'll take this pressure any day of the week, and we're going to manage through it, and it's not a concern for us. In fact, we're looking forward to any more pressure from increased volume.

I guess if you could touch a little bit on the China specifically. I think you and I have spoken about this before, but are you -- is that investment phase linear? Or is it maybe that you invested a lot several years ago and the business was just being drowned in fixed-cost growth and now we're -- you're hitting your stride on emerging markets where the incremental investment needs in that region is really just not that much, and you're seeing some operating leverage out of there for the first time?

I'm not sure. I'll take that 1. Basically, we're seeing operating leverage on some of the initial investments, but the investment going forward will continue to be -- I'll use your word -- probably roughly linear, because we're continuing to gain programs and programs.

And we have a compound annual growth rate, as I look forward, and it's going to be somewhere probably around 35% compound annual growth rate, and it's not a lumpy growth rate. It's fairly -- it looks like a 45-degree straight line almost.

So, it -- you're going to see us -- we're now, for example, in Ningbo, we're pretty much maxed out on our initial large building and maxed out on our joint venture building across the street. We're putting expansion into the wholly owned part of that Ningbo campus.

We're building a new building for basically for Morse Chain. We have turbo growth there, Morse Chain growth, and emissions growth. We're basically putting in new buildings on the second half of that site as we speak. But it's just actually built into our run rate.

The engineering expense is built into that 4% annual expense that we spend on R&D. The CapEx, as we typically run 6% plus or minus annually on CapEx, and it's all built into our business model. And so far, those kinds of investments, which are somewhat linear investments, continue to drive our current compound annual growth rate that as significantly greater than the industry.

Okay. And then the last question on contribution or incremental margins. It sounds like the date when incrementals converge to your operating margins keeps getting pushed back. Is it -- are you thinking about that now as being more kind of middle of 2012 is when we should think about that, or could that start happening even at the end of this year?

You know, as we said before, 1 of the biggest drivers for that is that top-line sales growth number. If we continue to increase our sales growth projections for the year, we're going to continue to push out the leveling off of operating income margins.

So, we'll see what 2012 looks like, but given where we're running right now, and running into the back half of the year, I have a feeling that our growth rate next year is going to be higher than would have thought maybe a year ago, which means the leveling off of margins will take a little bit longer.

Great. Thanks a lot guys.

Thank you.

Chris Ceraso, Credit Suisse.

Thanks for taking my question. A couple of questions for you. First, this gets back to the incremental margin question.

You keep talking about things ex-Haldex, Robin, but that amortization is going to stay with you. But, my question is, when we lap the acquisition, will we start to see more normal incrementals in the driveline business? Maybe in the high teens or even 20%?

Oh, yes. There's no doubt about it. I mean we said before, on an incremental margin basis, there should be no difference between the engine and the drivetrain in those product areas. We've been pretty clear that in the first -- that this business is struggling in Europe and it has struggled. And you see the margin decline from the first half of last year at the 9% level down to let's call it 7.7% average for the last half of the year.

It's starting to come back for us, but they're still not where they need to be. We expect that business to generate 20% incremental margins just like the engine side of the business. There's no expectation of any lower performance in that business. They just need to work a little harder to get where they're supposed to be.

Okay. And then bigger picture question for Tim, can you give us your view on the proposed 54-mile-per-gallon new standard for 2025, if you think it's realistic first of all? Can the car companies get there largely with internal combustion engines? And what do you think the mix of electric and hybrid vehicles might have to be in that world at 54 miles per gallon and what's Borg's role in that world?

Well, as far as the 54, I think it's going to be very challenging. Is there technology that will work to get the car companies towards that goal? Yes. We have a significant number of those. If you look at a list of 10 drivetrain technologies or powertrain technologies that can improve fuel economy, we're on probably 7 out of the 10, which is basically based off an EPA list.

And we're 1 of the market leaders in probably 7 out of the 10 key technologies. All I can tell you is it's going to be very challenging. Every day -- we just finished R&D reviews on new technologies in our advanced engineering area for both drivetrain and engine. And each product we're looking has got a 1%, 2%, 5%, 7% improvement in fuel economy. And yes, there are going to be -- there's no doubt about it, to get that higher fuel economy, people have to pay higher prices.

Now, that being said, the higher prices that they pay will probably still be cheaper and more beneficial than the higher prices you'll pay for an electric vehicle. Regarding electric vehicles, I don't see that as being -- unless there's a major change in battery technology, major change in distribution of charging stations, and a major change in the pricing of electric vehicles, combined with the range-anxiety issues that go with electric vehicles, I don't see a major penetration rate of electric vehicles, other than for certain applications like commercial trucks, that run a certain route every day and go back to the home base and get charged up at the end of the day.

Maybe taxi fleets of New York and some of the other places, but there's a lot of technical challenges on electric vehicles, and in terms of -- everything you do from air-conditioning in the summertime or heating in the winter time or up a hill or down a hill -- these all influence what your range is on electric vehicle.

But just to be -- to wrap it up, I think the 54 -- if the car companies and the federal government agree on it, which is sounds like they're working towards an agreement, then it's going to be doable. The question is how much are people willing to pay for the technology? I think companies like BorgWarner have the technology to get them there, or get them very close over time and will continue to invent technologies that will get them all the way there by 2025.

So, it sounds like you're still saying that the industry can get there without a big increase in hybrid penetration. Is that fair?

No, I said electric vehicles. Hybrids are a different story. Hybrids are basically traditional passenger cars that have a supplemental electric powertrain to go with it.

So, basically, a lot of hybrids are going to be considered stop-start technology, which is basically a traditional automotive with an IC engine, a traditional automatic transmission or a dual-clutch transmission, and it'll have a stop-start. That's going to be the major proportion or the major volume of what people in the future will call hybrids.

Yes, there'll be more full hybrids, which will have electronic assist for the first 40 miles or something like that on a battery, 25 miles on a battery, and then you can go the rest of the time on a traditional gas engine. But, hybrids are the very broad term for a lot of different types of technology. Most of the hybrids will have traditional engine and traditional transmissions to improve fuel economy.

Right. And in that world, the traditional engine in that set-up, they're going to want to be as fuel-efficient as possible. So, you're still in the game.

Not only are we in the game, we're helping to create the game.

Right.

We're going to be driving turbochargers on 2-cylinder and 3-cylinder engines, and we're going to be driving low-cost, fuel-efficient, dual-clutch transmissions and those kinds of things.

Okay. Thanks, guys. I appreciate it.

Sure. Thanks, Chris.

I would like to thank you all for joining us. As Robin said, we expect to file our 10-Q before the end of the day. We'll provide details of our results. If you have any follow-up questions about our earnings release, the matters discussed during the call, or the queue, please direct them to me. Rebecca, please close out the call.

That does include the BorgWarner 2011 second-quarter results earnings conference call. Thank you for joining. You may now disconnect.