博格華納 (BWA) 2011 Q3 法說會逐字稿

Good morning, my name is Angela and I will be your conference facilitator. At this time I would like to welcome everyone to the BorgWarner 2011 third-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 session. (Operator Instructions).

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

Thank you, Angela. Good morning and thank you all for joining us. We issued our earnings release this morning at approximately 8 AM Eastern time. It is posted on our website, borgwarner.com, on our homepage. A replay of today's conference call will be available through November 4. The dial in number for that replay is 800-642-1687. You will need the conference ID, which is 11581019. The replay will also be available on our website.

With regard to our Investor Relations calendar, we will be attending several conferences over the next few months. November 1, we will be at the Gabelli Automotive Symposium in Las Vegas. November 8, we will be at the Baird Industrial Conference in Chicago. November 14, we will be at the Barclays Global Automotive Conference in New York. November 17, we will be at the Morgan Stanley Auto Meeting in Los Angeles. December 8, we will be at the Goldman Sachs Global Auto Conference in London, and we will be at the Deutsche Bank Global Auto Industry Conference in Detroit in early January.

Also we will be releasing our 2012 through 2014 backlog of net new business on November 8 and providing color on the backlog at the Baird conference.

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

Now moving onto our results, Tim Manganello, Chairman and CEO, will comment on the third quarter and current industry trends and then Robin Adams (technical difficulty), 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 over to Tim.

Thank you, Ken, and thank you, everyone, for joining our call. Today I'm very pleased to review our third-quarter results, our accomplishments, and our revised guidance. But first I'd like to comment on current production volume concerns within the investment community.

In recent weeks uncertainty about the world economy, particularly in Europe, has created nervousness and has caused speculation about vehicle production in certain parts of the world. In July before these issues surfaced, we raised our 2011 sales and earnings guidance and today we refined our guidance to the high end of that range at $4.35 to $4.45 per share. While the markets have been assessing vehicle production risks, the outlook for BorgWarner and our business remains strong.

BorgWarner's performance is linked to the industry's focus on fuel economy and improved emissions. There may be uncertainty about European vehicle production, but there is no doubt that fuel economy and improved emissions are a focal point for the industry now and for many years to come. Therefore we remain bullish about BorgWarner's near-term and our long-term future. However because there is uncertainty about Europe, I would like to address how BorgWarner will get through another downturn should the need arise.

In the aftermath of the last downturn BorgWarner emerged stronger than ever and today we are a leaner company and our sales and earnings performance continues to set records. Also we employ more temporary workers now than we did previously, and that means our total cost structure is easier to flex if necessary. We also have agreements or prearranged agreements with our various works councils in Europe.

In our view there are no clear signs of a downturn. However we are prepared to execute cost control plans quickly if needed, and we feel very good about our ability to perform well under any market conditions.

So now let's talk about our record third quarter. Sales were $1.8 billion, up 27% from the same period last year. Our operating margin -- income margin was 11.1%, another record. US GAAP earnings were $1.15 per share and the three key factors that drove our results were increased global demand for our products, higher volumes in our base business, and well-executed cost control.

In the Engine Group, third-quarter sales were about $1.3 billion, up 23% from a year ago. The Engine Group continues to perform very well and we saw growth in all of our engine products around the world. In the Drivetrain Group, sales were about $539 million, up 36% from the third quarter of 2010. Drivetrain results were driven by increased DCT module sales in Europe, increased four-wheel-drive and traditional automatic transmission component sales in Korea, and the Traction acquisition.

Also the Drivetrain Group's operating margins continued to improve just like we said earlier in the year. In the quarter, margins were 8.1%, up from last year and the previous quarter. The Drivetrain Group continues to show improvements in capacity and productivity issues throughout Europe.

We also continue to invest for the long term. Capital spending continues to grow and year-to-date we spent about 5% of sales. We are committed to supporting our future growth and our productivity improvements through continued spending. Our spending for R&D and other new program launches was about 3.3% of sales in the quarter. This is slightly below our targeted level of 4%, but an increase from 3.2% a year ago.

Switching gears, we also made some new business announcements in the quarter which I would like to highlight. We supplied transmission components for Hyundai's new eight speed transmission and it will drive the Hyundai Equus, the Genesis and Kia models. We are also supplying Hyundai with a new silent chain for its GDI engine balance shaft drives. This technology offers OEMs a lower-cost alternative with better durability and less noise.

And I am proud to say once again that three BorgWarner technologies have been named finalists in the prestigious Automotive News Pave competition. We are proud of our winning record and pleased to have our technologies in the final competition.

So now let's take a look at our updated production outlook for light vehicles. North America remains unchanged at 13 million units up 9% from 2010. Our view on Europe also remains unchanged in spite of the hassles over in Europe at 19.9 million units, up 5% from 2010. In Europe the vehicle mix of large cars and diesels, which we talked about in previous calls, will probably stabilize at the current levels. And we now believe China will be a little weaker than expected at 15.5 million units, up 6% from last year. Now, higher interest rates and gas prices along with reduced incentive programs continue to temper vehicle sales and production in China.

Moving over to Japan, our view in Japan has improved. Japan exceeded our expectations in the third quarter, and we expect this momentum to continue into the fourth quarter. Although we do not know what the Thailand effect will have on us yet. Globally, our forecast is essentially flat with our previous forecast and higher volumes in Japan should offset lower volumes in China.

In the commercial truck market, our strong outlook for Europe and North America is essentially unchanged from July. In China, our outlook for the commercial truck market remains soft just like we talked about in the last quarter, due to the same factors affecting the light vehicle market. But despite this, our commercial truck business in China is growing for turbochargers, due to our increased penetration rates on turbochargers.

And finally, as mentioned earlier, we have refined our sales and earnings guidance. Our earnings guidance is now $4.35 to $4.45 per share, once again at the high end of the previous range. Our operating margins are still expected to be better than 10.5% and we are very proud of our 11.1% this quarter. And sales growth in 2011 is now expected to be 26% to 27%, which is within the previous guidance range.

The refined guidance is primarily due to a stable outlook for our business, good cost controls at our operations which we have been focusing on for the last number of years combined with high demand for our leading technologies which we talk about every quarter.

So in conclusion, the industry's adoption of leading-edge powertrain technology, particularly from BorgWarner, will continue for years and short-term fluctuations will not affect us. Because of this, BorgWarner will continue to thrive.

No company in the auto sector is better positioned for short-term and long-term profitable growth than BorgWarner. And what I would like to say is this, we will be in the automotive sweet spot for years to come.

Thank you and now I would like to turn over to Robin for the financials.

Thanks, Tim, and good day to everyone. Before I begin my review of the financials, I would like to again review the macro industry environment for the third quarter to help put our record sales performance in perspective.

If you look at third-quarter global production it was about 18.2 million units, which is up about 5% from the third quarter last year. Our sales -- reported sales -- were up 27%. Now they did have some currency -- foreign currency benefit, dollar versus the Euro. I think the dollar to Euro was about $1.32 last year here today and we are looking at about $1.41 this year, so there is a benefit there as well as the Haldex Traction Systems business which we acquired in the first quarter of this year. So, excluding those and to put the year on a comparable year-over-year basis, our sales were up 16% and that is 11 percentage points better than the 5% increase in global production year-over-year in the quarter and just another quarter in a row where our sales growth significantly outperformed the market.

If you look at the -- looking at the income statement, if you worked out from the sales line, gross profit as a percent of sales was $19.6 million in the quarter, slightly higher than $19.4 million of a year ago, flat with second-quarter 2011. The year-over-year improvement in the quarter was realized despite approximately $11 million of negative impact from higher raw material prices.

SG&A expenses were $151 million or 8.5% of sales in the quarter versus $150 million or 10.7% of sales in the second quarter last year and I am going to spend all of it of time on the SG&A, because there was an unfavorable event from a shareholder perspective but a positive event from an SG&A expense perspective that's flipping between quarter to quarter. So if you look at SG&A in the quarter, we were actually helped by almost $10 million as a result of the 25% decline in our stock price and a quarter and that 25% decline in the stock price it went from $80 a share at the end of June to $60 a share at the end of September and, obviously, we've recovered quite a bit of that already. But during the quarter, the 25% decline in the stock price had a positive impact on equity-related incentive compensation.

Basically the value of our compensation that is tied to BorgWarner stock declined dramatically in the third quarter, which from a cost perspective was a benefit and that benefit again showed up on the SG&A line item and that is why we are at $151 million. If the stock had stayed flat in the quarter, $80 at the beginning of the quarter, $80 at the end of the quarter, our SG&A expenses would have been $10 million higher or about $161 million and as a percent of sales would be 9% of sales.

So as I look at the quarter, I kind of factor out the benefit we are getting from the stock price. That will also be a penalty for us in the fourth quarter. I'll talk a little bit more about that.

But, if you adjust for the equity incentive compensation benefit we got in the quarter, SG&A would have been $11 million more than last year of which all of it was tied to [recent] R&D. In fact R&D spending year-over-year in the quarter was up $13 million.

So although SG&A reported looks relatively flat, the stock price issue was a benefit to $10 million. It is a short-term benefit, it is going to flip in the fourth quarter and we will make the same comment when we get down to operating income.

And as I said, we've recovered most of that third-quarter stock price decline already in the month of October. Stocks currently at about $75 a share, or $75, $73 -- sign says right here at my screen -- so we are getting back up to that $80 price and again that will be a penalty in the fourth quarter. And I hope everyone is pretty clear on that.

So I want to take us into the fourth quarter. So if you assume fourth-quarter SG&A, for instance, was $160 million for us, right now you better add $10 million to that and look at it as $170 million because as stock prices come back and we are getting that $10 million back as expense in the fourth quarter.

Operating income in the quarter was $199 million, 11.1% of sales, a record for us compared with $123 million or 8.7% of sales a year ago. Again to look at this on a comparable basis, you really need to adjust for that equity-related compensation expense and if you do that, operating income would have been $189 million or 10.6% of sales. Still tremendous performance relative to last year, 10.6% versus 8.7%.

And on an incremental basis, if you exclude the impact of foreign currency and again that Haldex Traction Systems acquisition, our year over year incremental margin in the quarter was 27%. If you adjust for the $10 million equity-related compensation expense it's 23%. 27, 23 -- whatever -- it's great performance.

When we started the year, we talked about our expectation was 20% incremental margins year-over-year and we were above that level, frankly, through the first nine months of the year. We were up 21% incremental margins in the first quarter and in the second quarter and now in the third quarter we are -- you take your pick, 27, 23. I am going to pick the 23 because I don't want you to penalize me in the fourth quarter for that $10 million that comes back.

So no matter how you look at the third quarter, as reported, a quarterly record, operating income margin 11.1%. Or if you look at the 10.6% stock price performance adjusted which is how I am looking at it, that incremental margin year-over-year it was just 27% or 23%, you know, take your pick. Whatever you look at, it was another quarter of great performance for this Company in what is and continues to be a challenging quarter, the third quarter of the year.

As you look farther down the income statement, equity affiliated earnings was $11.5 million, up about $1 million from $10.5 million last year and again as we've said that equity affiliated earnings primarily reflects performance of our Drivetrain Systems 50-50 joint venture in Japan NSK Warner. And NSK-Warner services, our Japanese customers' transmission products in Japan and in China and, obviously, as we said earlier in the year, we expect that performance to continue throughout the year as the pace of the recovery of our Japanese customers continues to improve.

Interest expense and finance charges, looking down another line in the income statement we're $18.5 million in the quarter, relatively flat with the same period a year ago. Income taxes in the quarter, $48 million which is an effective tax rate of 24%, which is where we were in the second quarter and the first quarter as well, and in line with our full-year guidance. If you look at the third quarter last year, it did have a favorable tax adjustment of approximately $21 million. So they are really not comparable numbers.

Again we point that item out in our press release as we walk through what we believe is a comparable earnings per share number versus US GAAP. Although both important numbers.

So if you look at net earnings [total] non-controlling interest formally known as minority interest, it was about $5.1 million in the quarter, up slightly from $4.8 million a year ago. And again this reflects our minority partner share and the earnings performance of our Korean and Chinese consolidated joint ventures and the year-over-year increase reflects the growth in both of those businesses.

And that brings us down to net earnings again, which were $142 million in the quarter -- a record quarter for us, third quarter -- compared with $107 million a year ago. And on a diluted earnings per share basis we earned $1.15 a share, an all-time record. And as I said, we did get a $10 million benefit from the equity related incentive compensation, due to the decline in our stock price. That was worth about $0.06 a share.

So if you want to look at the quarter relative to kind of what you were expecting, what we were expecting, it is more like $1.09 a share. And again that $0.06 a share will penalize us in the fourth quarter.

So on a GAAP basis, $1.15 compared with $0.87 on a GAAP basis in the third quarter last year, again, as I said in the third quarter last year, we did have that -- excuse me, nonrecurring tax item which we have identified in the table in our press release. And you know we always want to provide you that table to help you reconcile US GAAP earning measures which are very important with the financial performance of the continuing operations of our Company and make sure you can compare the results with results of prior periods.

And again we encourage you to review this information in the press release.

On a comparable basis, third-quarter [2000] earnings were up 62% from the $0.71 a share a year ago. It is I said that 25% decline in our stock price in the quarter going from $80 to $60 a share, painful as it was for all of us, it actually provided $0.06 a share benefit in the quarter. And if you exclude that, that would put earnings up year-over-year at 54%.

It is, we said earlier, the dollar was a little weaker in the quarter this year versus last year, about $1.41 versus $1.32. That gave us $0.07 a share from currency perspective; so if you take out the benefit from the decline in the stock price if you take out currency, we are still up 44% earnings per share versus last year and, again, very strong performance no matter how you want to look at it.

Now let's take a look at our operating segments. The Engine segment sales were $1.258 billion in the quarter, up 23% versus the third quarter last year. Again on a comparable basis, or excluding the benefit of currency, Engine segment sales were up about 16% compared with third quarter last year. We are -- as Tim said, we are seeing strong global growth across the Engine segment portfolio most notably turbochargers, but also there variable cam timing products, engine timing systems and fan and fan drives.

Adjusted [EBIT] for the Engine Group was $188 million in the quarter or 15% of sales significantly higher than the 13.4% adjusted EBIT margin reported a year ago. And if you look at year-over-year incremental margins for the Engine Group, excluding currency, they were up 26%. Very -- continued very strong performance for the Engine Group. They keep hitting the cover off the ball there. Like the Cardinals did last night, by the way.

In the Drivetrain segment, sales were $539 million in the quarter or up 36% versus last year. On a comparable basis, again excluding currency and also excluding the Haldex Traction Systems acquisition, if you just look year-over-year comparables, segment sales in the Drivetrain business were up 17% versus last year -- good strong performance driven by strong four-wheel-drive system and traditional component -- transmission component sales in Korea, higher dual clutch transmission module sales in Europe as well, part of the key growth drivers for this business.

Now we spent a lot of time talking about EBIT margins in this business. On a reported basis, adjusted EBIT was $44 million or 8.1% of sales. Which again is a continued improvement in margins for the Drivetrain group. We have talked before, sequentially they continue to hit margins and again I remind you they were 6.6% in the first quarter, 7.4% in the second and now 8.1% in the third. So as we talked before, we expect to see progression here and we've seen it. So a great performance by them, $44 million, 8.1% of sales.

And as we've mentioned before, the purchase accounting expense amortization related to the Haldex Traction Systems acquisition is also negatively impacting Drivetrain margins. We are amortizing north of $3 million a quarter of excess purchase expense there which, again, that is an important part of the accounting system. But from my perspective it muddies the waters.

If you take that out of the equation, so if you look at Drivetrain segment margins excluding the Haldex Transaction Systems purchase price amortization, Drivetrain segment margins actually were 8.7% in the quarter and that is a comparable number to the 7.8% last year. So we are up 1 full percentage points in the Drivetrain business on a truly comparable basis year over year.

So again, significant improvement in the performance of that business. That is just shy of 9% which is, we expect them to get to 9% shortly a 9% plus. So they are heading in the right direction. If you remember after the first-quarter call, Tim said that he expected margins to improve gradually, that by the third quarter to kind of get back to where they expect to be, and they are just about there.

So my compliment to our guys in the Drivetrain business. Good work.

So again, we are just shy of that 9% level we saw at the beginning of 2010. And that business continues to progress towards expected performance levels for us.

Let's take a quick look at the balance sheet and cash flow statement. We generated $473 million from operating activities cash flow-wise in the first nine months of 2011. It is up $160 million from the same period last year. And if you look at the third quarter, we had a very strong third quarter from a cash flow perspective. We generated $224 million of cash in the quarter from operating activities versus $104 million in the third quarter last year. And right now we are on track to generate about $700 million for the full year. This is a little bit higher than the $650 million guidance we previously given you. So we are seeing a strong year from a cash flow perspective.

Capital spending, as Tim said, was $274 million in the quarter for -- I mean, for the first nine months of the year -- up $188 million versus the first nine months of last year. And again the spending is indicative of the growth required to meet the increased level of program launches that we have around the world. Particularly in markets like Asia, Eastern Europe and Mexico.

We are still targeting about $350 million to $375 million of capital spending for the full year. But frankly, as this business continues to see growth, we might pull forward a little bit and you could be a little bit north of $375 million.

If you look at the balance sheet items itself, balance sheet debt increased by $212 million from the year while cash decreased about $73 million, so combined that is about $285 million increase in net debt. And that was due primarily to the acquisition of Haldex Traction Systems business again which was north of $200 million and the buyout of our emission's joint venture partner in India which was -- we completed in the third quarter and if you look at our statement of cash flows, that shows up on the line item as purchase of noncontrolling interest. A little bit north of $30 million.

If you look at the business, we generated more than enough cash internally to fund the internal growth of our capital spending and also to fund the stock repurchase program that we carried on throughout the year. As you look at the result in capital structure, our net debt to capital ratio is about 29% at the end of third quarter compared to 24% at the end of 2010. Net debt to EBITDA on a trailing 12 month basis was just below one times at the end of the third quarter.

However as we have said many times before, we view our balance sheet and our capital structure on an in converted basis. In other words if that convertible debt matures and gets converted. And we encourage all of you to do the same thing. That security will mature in April of next year. So we are within six months of the maturity and really that's a fair way to look at the balance sheet and if you look at it from that perspective, net debt to capital was about 19% at the end of the quarter and net debt to trailing 12-month EBITDA was approximately 0.6 times. So it doesn't get any better than that.

Tim talked a little bit about 2011 guidance and I am going to reconfirm. As Tim mentioned earlier, we've refined our sales growth and earnings guidance frame. We now expect sales to grow 26% to 27%. We have just tightened around the midpoint of the previous guidance range of 25% to 28%. And earnings now are expected to be at the high end of the range. We have taken $0.10 a share off the bottom, the $4.25 to $4.35 is gone, and we are now looking at $4.35 to $4.45 a diluted share.

And as Tim mentioned, good cost controls at our operations, good performance at NSK-Warner, our joint venture, enable us to push that earnings guidance to the high end of the range.

And again, I want to remind you, don't forget fourth quarter will be negatively impacted on the SG&A line item and the operating income line item by about $10 million. As our stock price climbs back to that $80 a share level it will also impact our share -- earnings per share at about $0.06

Clearly we are well-positioned to achieve the better than 10.5% operating income margins guidance we gave you at the beginning of the year, having posted a 10.8% operating income margin excluding the gain from Honeywell's settlement earlier in the year. Excluding that, we are at about 10.8% operating income margin after three quarters. And this is again despite the impact of the Haldex Traction Systems acquisition, which was not in our original guidance and is a drag on margins as a result of the purchase accounting adjustments, if you exclude Haldex and look at BorgWarner year for year on a comparable basis, our margins year-to-date are at 11.2% and compare very favorably to our original guidance for the year and make us feel pretty comfortable that again this is not the margin level for BorgWarner. We are going to see some upside from here.

We believe the impact of high raw material costs will still be in the $35 million to $40 million range for the year. And as we have said on our last earnings call, we have said many times, it is our job as leadership of this Company to absorb and manage our costs including raw materials and really not permit them to have any negative impact on our earnings expectations for the year. And they don't and they won't.

So let me summarize again what was another great quarter for BorgWarner in a string of great quarters. We achieved record third-quarter earnings by converting industry-leading sales growth to income. The Drivetrain segment continued to improve and is almost back to kind of prestruggle levels. The Engine segment margins remain at near record levels consistently here. And as I said if you look at this quarter from any perspective, you take out the $10 million benefit we get from the stock price decline, this was another great quarter for BorgWarner.

And as we look beyond 2011, we still see opportunities for long-term growth and as Tim mentioned, increasingly stringent regulatory environment, rising fuel costs, and the evolution of powertrain technology in the developing markets of the world to meet those challenges just to name a few.

Tim mentioned that a number of our new innovations were recognized by the Pace organization as having significant margin impact that act as gamechangers in the industry, quote unquote. And these accolades further support the assertion that BorgWarner continues to lead this industry in developing powertrain technology focused on improving fuel economy, lowering emissions, and improving vehicle performance. And we don't see that changing anytime soon. Long after I retire, believe me.

Our focus on technology leadership, a strong global presence, financial discipline and attracting and maintaining a talented workforce have been the keys to this Company's success and will continue to drive our success in the future. All I can say is just another great quarter and I can't be more pleased with the performance of our operating guidance.

With that, I will turn the call back over to Ken.

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

(Operator Instructions). John Murphy with Bank of America Merrill Lynch.

This is actually John [LaBallawon] for John Murphy. How are you?

First question is can you speak a bit about the DCT penetration rate globally today and where you think that that can go?

DCT penetration rate will continue to grow. I don't have the exact numbers in front of me. We have all sorts of charts, I just don't have them in front of me. Usually I do.

You are going to see DCT penetration rates probably grow at 20%, 25% of the total market globally. And what you're going see is a continued swing towards probably wet clutch DCT because dry clutch DCTs -- people that have dry clutch DCTs right now are starting to see operational difficulty in the operational performance of the product line in the market place. I won't mention any customers.

I've got that data, John. If you look at the two major markets in the world where DCT really is going to take hold, the European market five years from now, 50% of the automatic transmissions will be dual clutch and five years from now approximately 40% of the automatic transmission from China will be dual clutch.

And those are big markets. But globally it will be less because of the United States penetration rates.

Great, that's helpful. Next question. You guys are certainly growing nicely in China. How big a part of your business do you think China can be and more importantly, is there sufficient skilled labor there to kind of meet your needs?

Skilled labor is a challenge, but we always find the right people and we've got the right people and we continue to grow our business. We are growing significant -- it will be a significant percentage of our business. Because we are growing so strongly now in Eastern Europe and in Korea and we're back to growing in the United States, China will -- as a percentage will outgrow or outpace on a percentage wise will outpace the Company, the rest of the regions. But because the rest of the regions are growing also, the percentages -- the difference in percentages of growth won't be that significant.

Let me just say this though, our sales from in the last three years have probably tripled in China. And as I look forward to the next five years, our sales will probably more than double in China over the next five years and that doubling is off of a much higher base than the base that we had three years ago when we tripled between three years ago and now.

So we don't break out, we don't break it out that -- by country -- that specifically, but China will be let's just say this, the sales in China will probably be equal to or stronger than our domestic sales to the Detroit Three in North America.

Okay, great. And then the final question would be from a capacity standpoint, how are you guys doing in China and maybe in South America as well?

Well we're putting in capacity in China as we speak for dual clutch transmissions. Rob and I alluded to that now. We are putting in capacity for Morse chain on a chain product, we're putting in capacity on turbochargers and also in Ningbo.

We are putting in capacity because like I said we are doubling sales in the next four to five years and that's on a conservative -- what I consider a fairly conservative long-range plan for China. I think that we'll -- China will just -- China is just a phenomenal growth opportunity for BorgWarner for sure because of our focus on fuel economy and emissions. But it is an equally good growth opportunity for the rest of the industry, probably just not as good as it is for BorgWarner.

Mexico? Brazil, we are growing in Brazil very strongly right now on the commercial side. We are moving as the Germans are starting to localize in other -- as the Koreans -- Brazil's just changed their localization laws and that is going to force the people who are shipping product into Brazil that will be the product that was made in other countries and they are shipping into Brazil, they will have to localize in Brazil now. And that -- we are ready for them.

We are just putting in a new campus. I was just down there a couple of months ago. We are under construction for a new building, new buildings, a new tech center. And what we see in Brazil is what we were doing in China five years ago. We are on the launch pad for more growth in Brazil.

And Mexico. Mexico is growing because we are making all the turbochargers for the Ford Ecoboost down in Mexico right now and we have tremendous volumes for Ford on the Ecoboost. Not just on the six-cylinder rear-wheel drive pickup trucks like that are growing that are very hot right now for turbochargers, but we picked up -- globally, we picked up all the four cylinder turbo charger business for Ecoboost. So we have -- at Ford.

So we have a tremendous opportunity for growth in Mexico. Now not all of -- those products will be made in Mexico, there will be shipped to plants in Mexico and North America.

Peter Nesvold with Jefferies & Company.

Good morning. Just for a quick question on the incentive comp for 3Q. Thank you for the detailed explanation on the trends in 3Q to 4Q. Just so I can get a clean EBIT margin number for third quarter? Is there a way of breaking down the impact of 3Q between the two different divisions?

No. That all sits at corporate. If you look on our segment disclosure on the second page of the press release, we show Engine, we show Drivetrain and then there's Corporate and all other kind of stuff. It's in there, it is very clear. If you look I think we are $20 million, $21 million in the third quarter this year and like $34 million last year.

That's right, that's right. Okay, good. Sorry.

That's where you see the difference.

(multiple speakers). That's it.

Just let you know, we all suffered the same pain in the third quarter unfortunately.

A lot of us did. All right, take you for the time.

Chris Ceraso with Credit Suisse.

Thanks. Good morning. I'm thinking about one of these dry dual clutch programs at one of your biggest customers that doesn't seem to be doing that well in the marketplace. Is there an opportunity for you to go in there and win some business with your wet dual clutch?

Well, I think there's always an opportunity for our customers to upgrade their technology and we give them that option. We don't make the whole transmission. We just make the wet clutch module and the dry clutch module.

I think that the people that are in the dry clutch business, I am not going to mention any specific names, but people in the dry clutch business or the people who are working on dry clutch that are working on dry clutch programs are probably reassessing the path they're going to take in the future on wet versus dry clutch. And I -- we are seeing a lot of more activity on dry clutch technology and dry clutch development. Or -- I'm sorry, a lot more activity on wet clutch activity and wet clutch development programs.

You said you didn't really have a feel yet for what sort of an impact the Thailand issue might have on you, but maybe you can help us with a little bit of background. Do you know roughly what percent of your sales is represented by manufacturing there or vehicles that you supply there? And what components are you sourcing from that region?

Almost nothing. We do almost nothing there. We have a little option with BERU right now. The issue is our customers, mainly the Japanese customers do a lot of work and source parts from Thailand. So we don't know.

We saw yesterday in the paper that Toyota is kind of looking at some of their overtime schedules and they may be tweaking overtime temporarily. So for us it's no -- there is no production effect to speak of, because the percentages are so small, it's rounding there inside BorgWarner. But it's what it does to our Japanese customers mainly.

And then, just last one. Robin, you gave some expectations about cash flow for the year. If I look at that relative to what you are talking about in terms of earnings, it looks like cash flow is about 50% to 6%, roughly, of your net income. I understand there's an awful lot of growth here. Is that the kind of level we should expect for the foreseeable future in terms of your cash conversion on your net income?

It's probably a fair number. This year the real driver there is income taxes. We are paying -- for the first nine months here, we are paying about $70 million more in cash taxes this year than last year. And so one thing, it is a little bit hard to gauge, but I would expect that level we are running at now is a pretty fair level.

Okay. Thank you.

Rich Kwas with Wells Fargo Securities.

Good morning. Robin, your comment around Drivetrain on the 9% number. Is that going to be an all in number or is that excluding Haldex in terms of getting to that 9% level?

Well, I think excluding Haldex that is not a problem. All in, maybe a little more work to do, but they are driving towards that level.

Right, I mean based on kind of the issues you had earlier in the year, late last year and those getting better is that something that early 2012 we should expect to see that level?

Yes. You know, as Tim said before, we expected a sequential improvements in second quarter, third quarter and we expect an improvement into the fourth quarter as well. So that core year-over-year comparison, that business should be north of 9% in the fourth quarter. And they are working hard at it.

Right. Okay. And then I know you are going to give guidance for next year at the auto show, but you think about how Europe, there's a lot of uncertainty there and there could be volatility in schedules and there could be a decline in overall production next year. You've talked about incremental margin being above norm for some period of time. How does that affect the potential for above average incremental margins with increased volatility in Europe. Does that dampen that outlook at all? Or just how should we think about that?

Well, you know -- and we've said this before. As sales decline, the incremental margins are higher or the decremental margins versus sales increasing just a function that when sales are increasing, it is typically in regions of the world where you are putting growth in place. And in Europe, as we've said before, we don't have the type of flexibility that we have in other parts of the world.

Having said that though, Tim went through earlier and talked about our plans in case volumes turned down in Europe. We do have a number of temporary workers at least to get us through the first phase, but volatility is an issue for us.

As anyone in the industry, we'd love to see our facilities run 1,000 units a day for 242 days a year instead of 600 and 1,200 and 300 and 1,500. It is a challenge from an operating perspective.

We will do everything we can to protect our margins if there is some kind of a significant downturn in Europe, let's say, hypothetically. I said we've got pre-agreements with Works Council. We got everything set to go so if we ever had to flip a switch, we've taken all of the lag time out of the reaction time. So we pretty much are going to do everything we can to protect our margins in Europe.

And I think our margins will continue to do well or hold strong in North America, Japan, China, Brazil and all the rest of the world. So Europe, in my mind, Europe is probably just the only question mark on what happens and what how long, how strong we can hold the margins.

And again, Tim laid out earlier that all the work that's been done and getting prepared and we've looked at that and the actions that are planned would result in managing to about $0.20 on the $1 decremental margins. So which is kind of where we performed in the last downturn.

The other thing is that since the last downturn, part of the reason why our margins today are doing so well and are stronger and higher than -- is because we actually never put a lot of people back in after the last recession. When things started to pick up and we started to get the growth rates back for 2010 and 2011, we didn't hire a lot of salaried people back. We hired enough to support all our growth, continue all our development programs and invest for the future on technology, but we still held the line. And to this day, I'm still approving every salary hire worldwide. And I think you are going to see that is going to turn out to be a tremendous benefit for us.

Now that kept us lean so because of that we are -- hopefully will stay lean and we won't have as much to go after if there is another downturn when it comes to salaried workforce.

And that shows up in our SG&A. Again, if you look at year-over-year if you, again, excluding the benefit of the stock decline in the quarter, SG&A was only up about $10 million $11 million year-over-year and $13 million increase in R&D which means that the rest of the spending in the SG&A line item is being held fairly flat and tight to Tim's point.

Right. And then last one for me just on NSK. So, the production came back here nicely in the third quarter. Do you see more benefit here from the Japanese? I know the Thailand issue kind of threw some noise into it, but just all else equal, were you going to see more benefit here on the production ramp into the fourth quarter and the first quarter of '12?

On the macro level, if you take the Thailand noise out like you just said, Toyota and the rest of them have not come back up to full pace yet in terms of filling their pipeline on inventory, meeting all our orders. So there's still more upside on sales and more upside on production because of filling their, replenishing their inventory worldwide. So there is more upside on the production side.

So now I'll let Robin -- if you want to jump in on the rest of it.

As we look at -- if you look at affiliate earnings which is kind of what you are driving your question to, it appears to us there was quite a bit of catchup in the third quarter. So we are not expecting affiliate earnings in the fourth quarter to the level of third quarter that we saw. It will be close, but it's --. We think we peaked for the year for NSK-Warner affiliate earnings third quarter.

As Tim said though is the business continues to grow. We expect that to grow for us in 2012. But for the rest of this year, I think third-quarter has peaked for us.

Okay, great. Thanks, everyone.

Tim Denoyer with Wolfe Trahan Research.

Thanks for taking my question. If I look at content per vehicle and obviously it was a great quarter, I don't want to nitpick, but content per vehicle year to year growth looked like in the Engine segment slowed a little bit from 2Q to 3Q if you look at just vehicles worldwide. Was there any destocking in the channel? We've certainly heard some of that from more commercial customers. I realize the commercial and aftermarket isn't a huge part of what you do, but can you comment on that?

Well we don't track content per vehicle, number one. So I couldn't even give you a clue as to what it means to us. As far as the aftermarket, our sales have stayed pretty even as a percent of sales. Aftermarket is about 6% of our sales and that's typically what it has been.

On the commercial side, you mention commercial. The commercial side for this year and for the last number of quarters is about 15 to 16% of our sales and has stayed constant. I think year-to-date it is 15% of sales so we are seeing strong growth in the commercial side in Europe and North America. China is the only place where the market has kind of fallen down and we are still doing well in China because like I said in my call or my part of the call, we are selling more turbochargers due to the increased penetration rates on turbochargers in China. I don't know of any destocking going on and I don't know -- and to be honest with you I can't comment on content per vehicle because that is not the way we look to run the business.

Yes, that's my estimate and sorry, go ahead.

Yes as we look at the growth of the business, the Engine business was up year-over-year 17% in the second quarter and 16% in the third quarter. So fairly consistent from our perspective.

Yes it was up sequentially on my numbers too, just a little slower year on year and it was a tough comp. But on the commercial side again, how exposed are you to Europe and what -- do you have any thoughts on some of the cuts that we've seen there? How does the commercial break down between China, Europe and the US?

Europe, right now, Europe and North America are about even on commercial. They are spread out between turbochargers and fan and fan drives mainly and I don't, I can't remember the split between which one is large and which one -- between turbo and thermal, I can't remember. But it is probably not that important.

We are seeing strength -- still seeing strength and like I said, commercial turbochargers in Europe, strong, North America, strong. Thermal in Europe, strong, North America, strong. So and it's about 50-50 for us between Europe and North America.

Brian Johnson with Barclays Capital.

Good morning, gentlemen. Would like to talk a little bit about the things in Engine other than turbochargers. Couple of questions. I would start by [levering] the detailed product profitability and growth, but maybe -- which you won't give -- but at a higher level what percent of turbo is roughly of that? What is the next two or three biggest products that's -- I'm looking at your description on your investor deck. And then which are growing, what is the relative growth rate as we go across the product lines?

Without getting into any numbers, Morse chain is a big growth product or BorgWarner globally. Within Morse chain, you have two sides of the business. You have the chain side of the business, some of which is timing drive systems of the chains and the rest of the timing drive systems, brackets, and guides and [smelters]. Good growth globally. China, Brazil -- opportunities in Brazil in the future, growth in Korea right now. So tremendous growth on that side.

The other part of the Morse chain side which is kind of like the -- maybe the sleeping giant for the future is variable cam timing. We had this variable cam timing which I have said over the last number of years and quarters that it's kind of like the generation 2 or generation 3 technology and it basically is so sophisticated that it will allow, when combined with turbo charging, it will allow these OEMs from around the world -- and we are working on development programs with some of them right now -- to recalibrate and re-design their engines which will get them a long way to meeting this 54.5 mile per gallon cafe in North America and the more stringent standards for CO2 emissions in Europe.

But variable cam timing could be the sleeping giant of the future of this Company. But obviously turbochargers still dwarf everything else on the Engine side.

EGR Coolers, when we did the acquisition on EGR Coolers combined with our diesel EGR technology for the EGR valves, we are seeing great growth. The ENSA acquisition combined with our emissions business beforehand has -- basically the ENSA acquisition is hitting its targets. We bought it earlier in the year, I think right at the beginning of the year or the end of last year I think it was. And they are actually starting to exceed our expectations and they are doing better than the original plan.

There is tremendous growth opportunity for them because they offer a systems approach to EGR and EGR cooling, combined with turbo charging.

So we have all these complementary technologies that all work together, whether it is variable cam timing, EGR cooling, EGR valves and turbo charging that all come together to this optimized engineer management for efficient combustion which we have talked about as a strategy for BorgWarner for the last eight years.

Fan and fan drives on the commercial side, tremendous opportunities. So I mean, I could take a whole lot of products, we have probably 15 products I could talk about. But those are some of the big hitters on the engine side which is where your question was.

Let me help you. Every product in the Engine Group had double-digit sales growth in the third quarter. So it isn't just turbo driving growth and everyone else relatively flat. Every product area to Tim's point is growing strongly across the world and we had double-digit sales growth in every product area.

I get the VCT adoption curve. What is driving timing chain? What's the buying proposition for the --

Couple of things. There are still a few engines that are going from belts to chains, but more important, we have better noise performance, better durability performance, and we have better efficiency on a chain that allows you to get slightly -- slight increases in fuel economy. And the last thing a company wants when they are buying a timing chain systems is they don't want noise, they don't want chain stretch, and they want variability. And we actually are the leaders in probably all three of those benefits within the chain business. We have probably better durability, better noise, and low chain stretch or chain wear.

Great, bring one with us -- with you when you come to New York and we can show people.

Sure, we'll show you timing chains. It is a fairly mundane product, but it is a hell of a winner.

Ravi Shanker with Morgan Stanley.

Good morning. Just a few follow-ups here. Robin, I know you addressed the drive frame margins quite a bit, but just to clarify, are you guys completely passed all of your execution issues there and now and so the only real headwind to true margin power there is the Haldex acquisition costs?

No, they have still got some work to do in Europe.

Can you quantify that at all?

Not exactly, but as I said we expect there -- if you exclude Haldex -- and again we are about 8.8% in the third quarter we expect that to be about 9% in the fourth quarter and growing. And so, they've got more work to do.

I am going to just say this. I am not going to be satisfied until I see them with at least a number that is in the 10 or better range -- percent margin range over there on the Drivetrain. So we have got -- it may take us a while, a long while to get there, but we are on an improvement curve that some day can get -- hopefully get us there.

Got it. And also given the [site of the bead] and the good results of this quarter, it looks like you are -- you moved to the higher end of your guidance range, but it probably could have been a little bit stronger. Is the reason 4Q looks a little bit conservative the SG&A incentive cost? Or is something else going on?

Yes, definitely. As I said, if you look at our guidance, what you need to do is if you look at year-to-date performance it implies the fourth quarter of $1.09 to $1.19 a share. And what you need to do is take $0.06 out in the third quarter, add $0.06 to the fourth quarter. So fourth quarter versus what you were thinking before excluding this timing on the equity, our implied guidance is really $1.18 to $1.25 for the fourth quarter. Which is going to be a record quarter for us for the year, significant improvement over fourth quarter last year.

You know, I expect by the end of fourth quarter to be pretty happy talking to you all and you should be pretty happy as well, given the type of -- if we had the guidance level we are indicating here, it will be a damn good quarter.

That makes sense. Thank you.

Rod Lache with Deutsche Bank.

Good morning. It is actually Pat Nolan on for Rod. Just two quick ones. Most of my questions have been answered.

On the SG&A, it looks like you are going to end the year right around 9% of sales. How much leverage do you see in that as we go forward? I mean you are going to be continuing probably mid double-digit gross probably through mid decade. Where do you ultimately think that can go as a percent of sales on the SG&A line?

One of the things we've said before is we are struggling to catch up on the R&D side and we are still -- when you look at R&D spending, we are going to be maybe 3.5% for the year as a percent of sales. And we have traditionally been 4%. So you have got a little bit ago on the R&D side. So we would expect -- as Tim says, he still approves every hire for salaried employees and I have got five that he hasn't approved for like nine months now. I want to remind him in front of everyone. And --

(multiple speakers)

But nonetheless, so we do have good cost control focus still on the salary side, but the R&D spending will increase with this business. So we'll see operating -- SG&A margins. They will creep up from that 9% level, but they are not going to be 10%. I will tell you that. There will still be closer to 9%.

And that is our historical range. Between 9% and 10% is our historical range for a number of years. So every once in a while we will pop above that, but mostly we are 9% to 10%.

Thanks very much. Just lastly on raw materials, I think you said $35 million to $45 million this year. (multiple speakers). What is it looking like for next year if we held at current prices?

I don't have it off the top of my head. There is a little bit of material inflation next year. We are still going through our look at 2012 and I know there's some material inflation in there I can't quantify right --. Historically we have been about -- no matter what is going on in the world, we have been about $25 million to $30 million of the increase in raw material prices. And without knowing any details my expectation it's going to be no worse than that next year.

Thanks very much. Good quarter.

Thank you.

Thanks.

I would like to thank you all again for joining us. We expect to file our 10-Q before the end of the day which will provide details of our results. If you have any follow-up questions about our earnings release or anything to discuss during this call, please direct them to me. Angela, you can close out the call now.

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