博格華納 (BWA) 2012 Q2 法說會逐字稿

Good morning my name is Brandy and I will be your conference facilitator. At this time I would like to welcome everyone to the BorgWarner 2012 second quarter results earnings conference call. (Operator Instructions) I would now like to turn the call over to Ken Lamb, Director, Investor Relations. Mr. Lamb, you may begin your conference.

Thank you Brandy. 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 August 3. The dial-in number for that replay is 800-642-1687. You will need the conference ID which is 94006819. The replay will also be available on our website.

With regards to our IR calendar, we'll be attending several conferences over the next few months. August 13, we'll be at the JPMorgan Automotive Conference in New York. September 5 we will be at the Credit Suisse Automotive Conference also in New York. September 11, we'll be at the RBC Global Industrials Conference in Las Vegas, and on September 13, will be the Morgan Stanley Global Autos & Industrials Conference in New York. 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 10K. 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 second quarter and current industry trends, and then Ron Hundzinski, our CFO, will discuss the details of operating results and also our Outlook for the remainder of 2012. Also on the call, we will have a James Verrier, President and Chief Operating Officer, and Robin Adams, Vice Chairman and Chief Administrative Officer. With that, I will turn it over to Tim.

Thank you, Ken, and good day everyone. Today, I am very pleased to reveal our strong second-quarter results, as well as our second quarter accomplishments. First, our second-quarter results. Reported sales were $1.9 billion, up 2% from the same period last year. However, foreign currencies were working against us during the quarter. On a comparable basis, excluding currency, BorgWarner sales were up nearly 10%, versus about 2% for the global market, if you exclude total Japanese vehicle production. US GAAP earnings were $1 per share. Excluding non-comparable items, our earnings were at $1.36 per share, a new record for the Company.

Our reported operating income margin was 10.4%. Excluding the impact of non-comparable items, our operating income margin was 12.5%, also a new record. This is an outstanding margin performance in a very challenging market. Two key factors drove our results -- increased global demand for our products and efficient execution by our operating units. Now, in the Engine Group, second-quarter sales were about $1.3 billion, down 2% from a year ago. However, sales were up 7%, excluding currency and 2011 divestitures. The Engine Group continues to perform very well and results were led by strong sales growth in the Engine Timing Systems, including variable cam timing, greater sales of emissions products, and higher turbocharger sales in Asia and North America. In the quarter, the Engine Group margin was 16.6%, another all-time record.

Now, the Drivetrain Group also had strong second-quarter results. Sales were about $590 million, up 13% from the second quarter 2011. Excluding currency, sales were up 20%. Drivetrain results were driven by increased sales of DCT modules in Europe, growth in our traditional automatic transmission components in North America and Korea, and higher sales of all-wheel drive systems around the world. In the quarter, the Drivetrain Group margin was 9.2%, up from a year ago. And Drivetrain Group is still on target to achieve the 9% or better operating margin we expect for the full year.

Now, BorgWarner also continues to reinvest in our business. Our near-term capital spending plan includes increased capacity for dual-clutch transmission modules in Europe, engine timing systems in Asia, transfer cases in North America, and turbochargers all over the world. Now, for the quarter, we spent about 5% of sales on CapEx, and continue to invest in technology, which is the lifeblood of our Company. We spent about 3.6% of sales in R&D for the quarter.

I'm also proud to review some exciting accomplishments and announcements that we made during the quarter. BorgWarner silent chain and compact hydraulic tensioner helped improve fuel economy for Daihatsu's 660cc I-3 engine. In fact, Daihatsu presented us with a Suppliers' Excellence Award for our contributions towards their engines' outstanding fuel economy. The engine launched on the Mira e-S and will drive several other minicars for the Japanese market.

BorgWarner is also supplying turbochargers for the BYD's new 1.5L GDI engine. This is the first GDI engine ever developed in-house by a domestic Chinese OEM. The engine launched in the top-selling G6 sedan and will be available for other models. The engine is also Euro 5 compliant. BorgWarner's friction plates enabled ZF's new full hybrid 8-speed transmission to shift smoothly between the electric motor and the engine. The transmission launched in the 2012 Audi Q5 Hybrid Quattro. It will also be featured in other vehicles soon.

BorgWarner recently announced the sale of its spark plug business, part of the BERU acquisition in 2005. Sales were approximately $80 million in 2011, and this will allow us to continue our focus on expanding BERU's core product lines, including glow plugs, diesel cold start systems, and other gasoline ignition systems including eco-flash.

Now, on a personal note, I would like to congratulate the winners of this years BorgWarner Innovation Awards. We honored over 90 employees for their outstanding contributions in operational excellence, collaboration, customer excellence, and product development. Their passion and entrepreneurial spirit addressed real-world challenges and helped BorgWarner maintain its reputation as the technology leader for fuel economy, emissions and performance.

So now, let's take a look at our current Outlook for 2012 light vehicle production. In North America, we now expect 14% year-over-year growth, compared with our previous Outlook of 11%. Strong monthly sales, better credit conditions, and strong fleet demand have improved our Outlook. Japanese OEMs continue to replenish their inventory, and this is also driving a significant portion of this year's growth in North America.

Our Outlook for Europe is less optimistic. We are forecasting a 6% decline in annual production volumes, and this appears to be in line with our previous guidance or forecast but our new Outlook continues more -- includes more positive results in the first half that are offset by lower projections for the rest of the year. We expect more production cuts by French OEMs and weaker sales in France, Italy, Spain for small cars. We also forecast a slight production cuts in large- and medium-sized or mid-sized passenger cars. We have less conviction about this market segment than we did in January when we made our original guidance.

In China, we now project 6% annual production growth, down slightly from 7% previously. Looking at the rest of the year, our projection for global light-vehicle production for the second half of 2012 light vehicle production, as compared with the second half of 2011 production, is relatively flat. Given this, BorgWarner still expects to outperform the market by 8% to 10% on a comparable basis. Our 2012 Outlook for the commercial truck market has also weakened. In all four markets where we compete -- Europe, North America, Brazil, China, projected volumes have decreased. We still expect low double-digit growth in North America in 2012, but the other three markets are expected to contract.

Finally, let's review our updated sales and earnings guidance. Our sales growth in 2012 is now expected to be 4% to 6%, compared with our previous guidance of 10% to 12%. Excluding currency, our sales growth is now expected to be 9% to 11%, compared with our previous guidance of 14% to 16%. The change in our sales a guidance is primarily due to weakening global economic conditions and weaker foreign currencies. Despite weakening market conditions, we expect our sales growth to outperform the market for this year. Ron will cover that shortly.

Our 2012 earnings guidance, excluding non-comparable items, is now $5.05 to $5.25 per share, down from the $5.35 to $5.65 per share previously. The change is primarily due to our expectation of lower sales, weaker foreign currencies, and higher effective tax rates. Again, Ron will discuss these items later. Our operating margin is still expected to be better than the 11.5% for the year. The 12.1% operating margin that we posted in the first half of this year, excluding non-comparable items, provides great momentum towards achieving this target and is a great start for the year.

In conclusion, we have lowered our expectations for the remainder of the year, but feel confident about our current guidance. We still expect to grow sales and profits in every major region of the world and, as I said earlier, we expect to outperform the market by 8% to 10% on a comparable basis. The new guidance still represents a record year for BorgWarner with an EPS increase of 13% to 18% over 2011. This is in spite of currency, volume, and tax rate headwinds. So, like I have said many times, no Company in the auto sector is better positioned to absorb short-term market fluctuations and to deliver long term profitable growth than BorgWarner. I'm very proud and feel very good about our Company's future and so should our shareholders.

Now I'll turn the meeting over to Robin, or to Ron. Bad habit, Ron. (laughter)

Good day everyone. Before I began reviewing the financials, I would like to put BorgWarner's performance into perspective within the larger auto industry. In the auto industry, global light-vehicle production was up 10% in the second quarter, compared with the same quarter last year. However, a substantial portion of that growth was related to Japanese vehicle manufacturers and their Q2 2011 tsunami-related production interruptions.

So, excluding the Japanese impact, global production was up less than 2% in the quarter. BorgWarner sales were up 2% from a year ago on a reported basis. As Tim explained earlier, if we exclude the impact of foreign currencies and imminent activity in 2011, our reported sales were up 10% in the quarter. Therefore, on a Japanese -- what I'm calling a Japanese tsunami-adjusted comparable basis, the Company outperformed the market by our typical 8% to 10% points in the second quarter. The favorable impact of the Japanese tsunami production recovery can be seen in our equity and affiliates earnings line which was up 55% over 2011.

Working down the income statement, gross profit as a percentage of sales was 20.6% for the quarter. That is up from 19.6% a year ago, despite about $9 million higher raw material prices. SG&A expenses were 8.2% of sales in the quarter, versus 8.7% of sales in the second quarter last year. As a percentage of sales, R&D was 3.6%, in line with a year ago. Reported operating income in the quarter was $193 million; however, this includes a $38 million charge related to the disposal activities associated with the sale of our spark plug of business. This charge shows up in other income expense line item of the income statement. Note that we anticipate future restructuring charges related to the sale of our spark plug business in the third quarter when the pending sale is closed.

Excluding the $30 million charge, operating income was $230 million, or 12.5% of sales, compared with the $199 million, or 11% of sales on a comparable basis a year ago. This is a 150 basis point improvement, which reflects outstanding cost controls. After excluding the impact of foreign currency and non-comparable items in both this quarter and the second quarter 2011, our incremental margin was about 26% in the quarter.

As you look further down the income statement, equity and affiliate earnings was up $13 million, up over 50% from $8 million last year. This is where you see the Japanese effect for us on a favorable side. This represents the performance of like I said, NSK-Warner, 50/50 joint venture in Japan, which sells transmission components to our Japanese customers in Japan and China, as well as TEL, our turbo charge joint venture in India. The 50% year-over-year increase reflects our participation in the Japanese market growth, which, due to accounting rules, do not allow us to show it in the top line sales numbers.

Interest expense and finance charges were $13 million in the quarter, down $21 million a year ago. This was primarily due to the material of our convertible debt settled in treasury shares in mid-April. Note that this reduction in convertible-related interest expense will not impact earnings per share since it has been excluded from our earnings per share calculation since the first quarter of 2010. We've been calculating EPS on an if-converted basis since then. Provision for income taxes was $69 million in the quarter. That equates to an effective tax rate of 35% on a GAAP basis. The provision includes two non-recurring items -- the tax impact of the spark plug business transaction, and an adjustment to our tax accounts, reflecting new assumptions for the repatriation of earnings generated in certain foreign countries.

Earnings generated in those certain foreign countries will no longer be permanently reinvested in those countries, but instead will be available for repatriation back to the United States. This gives us future flexibility, but it does come at a cost. Future profits generated in those jurisdictions will be taxed at the higher US rate. This will affect our tax rate going forward and, as a result, our estimate for our full year effective tax rate, excluding non-comparable items, is now 27%. Also an adjustment is required to chew up the tax rate applied to those earnings previously generated in those jurisdictions to the higher US tax rate, sort of like a catch-up. This non-comparable item shows up in income tax line item of our income statement in the quarter.

Net earnings attributable to non-controlling interest was $5.6 million in the quarter, up slightly from $5.3 million a year ago. This line reflects our minority partners' share in earnings performance of our Korean and Chinese consolidated joint ventures. The year-over-year increase reflects the growth in those businesses. This brings us back to net earnings, which was $120 million, or $1 per share on a reported basis. On a comparable basis, net earnings were $164 million in the quarter, or $1.36 per share, up from $1.12 per share a year ago. That's a 21% earnings growth on 10% sales growth. Excellent performance for the Company for the quarter.

Let's look closer at our operating groups. Engine Group sales were $1.3 billion in the quarter, excluding currency and 2011 dispositions. Engine Group sales were up 7% compared with the second quarter 2011. We are seeing good growth in Engine Timing, including VCT, emission systems, and turbochargers. However, the slowdown in light vehicle production in Southern Europe and in the commercial vehicle markets in Europe and China has had an impact. Adjusted EBIT for the Engine Group was $211 million in the quarter, or 16.6% of sales. That is a significant improvement from the 15.2% adjusted EBIT margin reported a year ago and a new record for the Engine Group. The year-over-year incremental margin was 31%, excluding currency in 2011 dispositions, a very strong operational performance by the Engine Group.

In the Drivetrain Group, sales were $594 million in the quarter. Excluding currency, Drivetrain Group sales were up 20%, compared with the second quarter of 2011. Strong all-wheel drive system sales around the world, growth in traditional transmission components sales in North America and Korea, and higher dual-clutch transmission modules sales in Europe are key growth drivers. On a reported basis, adjusted EBIT was $55 million, or 9.2% of sales, significantly higher than the 7.4% reported in the second-quarter 2011. As Tim said earlier, the first-half performance provides a solid foundation for the Drivetrain Group to achieve EBIT margins of 9% or better this year. The year-over-year incremental margin for the Drivetrain Group was 18%, excluding currency. Excellent all-around performance for the Drivetrain Group.

If you look at the balance sheet and cash flow, we generated about $310 million in net cash from operating activities in the first half of 2012. That is up $16 million from the first half of 2011. Capital spending was $188 million in the first half of 2012, up $28 million for the same period a year ago. This year-over-year increase is required to support our program launches around the world, particularly in Asia, South America, Eastern Europe, Mexico. Free cash flow, which we define as net cash from operating activities, less capital spending including tooling, was $122 million. Looking at the balance sheet itself, balance sheet debt increased by $176 million, compared with the end of 2011. Cash increased by $122 million during the same period.

This $290 million decrease in net debt was primarily due to the maturity of our convertible debt partially offset by our typical seasonal investment in working capital and the first quarter share repurchases we did this year. During the first half of 2012, we purchased approximately 2.9 million shares. That left us with a net debt-to-capital ratio of 18.6% at the end of the second quarter, compared with 28.3% at the end of 2011. Net debt to EBITDA, at the end of the second quarter 2012, on a trailing 12-month basis, was 0.6 times. Our capital structure remains in excellent shape.

Now like to discuss our guidance for 2012. As Tim mentioned earlier, our sales growth and earnings guidance has changed. We now expect sales growth between 4% to 6%, compared with our previous guidance of 10% to 12%. Excluding currency, our sales growth is now expected to be 9% to 11%, compared with our previous guidance of 14% to 16%. On a reported basis, that is a 16 -- a 6% decline in growth expectations. 1% is due to weaker currencies, the remaining 5% is due to weaker global economic conditions primarily in Europe.

However, we still expect our sales growth to outpace the market. We expect global production to be virtually flat in the second half of the year, compared to second half of 2011, just like Tim mentioned earlier. During the same period, we expect our sales growth to be in our typical range of 8% to 10%, excluding currency and 2011 and '12 dispositions. We now expect our earnings to be within a range of $5.05 to $5.25 per diluted share, compared with our previous guidance of $5.35 to $5.65 per diluted share. That is a $0.35 per share decline midpoint to midpoint.

Of the $0.35 per share decline, $0.06 of the share decline is due to weaker foreign currencies, $0.08 is due to higher estimated effective tax rate, which is now at 27%. Both of those are partially offset by favorable impact of share repurchases in the quarter, and the remaining decline is due primarily to lower sale volumes driven by weakening economic conditions. Our updated guidance implies continued strong performance on the cost side and implies a decremental margin of approximately 20% on the lower sales.

From a margin perspective, we still expect to achieve an operating margin of better than 11.5% for the full year. Our first-half operating margin was 12.1%. It is a great start to meeting that goal. However, we still need to get through the third quarter which traditionally is a lower margin quarter due to customer summer shutdowns and model year changeovers. Year-over-year, incremental margins should be around 20%. We still believe that the impact of higher raw material costs will be in the $25 million to $30 million range in 2012, and, as we said in our last earnings call, we will absorb and manage our inflationary cost, including raw materials. We will not permit them to have material impact on earnings expectations for the year.

To summarize, our sales will outperform the global markets Japanese tsunami adjusted once again by 8 to 10 percentage points, which is our target. Our second quarter operator margins and earnings per share were all-time records for the Company on a run-rate basis. The Engine Group margin was also a new record. The Drivetrain Group continues its strong sales growth and margin performance.

The first half of 2012 was a very good start to the year. With the market conditions have resulted in a lower Outlook for our sales growth and earnings growth for 2012. However, our overall growth story continues as we expect to outperform the global market for the rest of the year by our traditional 8 to 10 percentage points above the market top line growth rate. 2012 should be another year of solid growth, record margins, and record profits for BorgWarner. And as we observe the trends in the market, we see more industry leading growth and more record profits beyond 2012.

Our confidence is based on proven business strategy. Fuel costs continue to trend higher, the regulatory environment continues to become more stringent, and yet drivers continue to demand better performance. BorgWarner's focus on advanced technologies to improve fuel economy, reduce emissions, and enhance performance is right on target. We expect strong demand for our products to continue for years to come. Our technology leadership, strong global presence, financial discipline, and focus on attracting and maintaining a talented workforce have been the keys to BorgWarner's long-term success. With that come off like to turn the call back over to Ken.

Thanks, Ron. Now let's move to the Q&A portion of the call. Ron and James Verrier will be taking your questions. I would ask the call coordinator to please announce the Q&A procedures.

(Operator Instructions) Your first question comes from Rich Kwas, Wells Fargo Securities.

Hi, good morning everyone. Ron, digging into the guidance a little bit, I thought the FX, negative FX impact would have been a little greater, so just curious, what are you seeing for the Euro for the back half of the year?

The full-year guidance now is $1.27. You need to look at year-to-date; it was about $1.30, slightly under. That was our guidance -- our guidance was $1.30 which is where we were pretty much year-to-date. So, the back half obviously is where the deterioration is coming. I'm taking an average of the back half that comes down to like the $1.22, $1.24 range. I think the spot rate was maybe $1.21 as of yesterday.

So there is some seepage if we stay at $1.21 or so?

Yes, that's correct. There would be.

Tim, on the commercial vehicle guidance, North America, still low double-digit growth -- I think we had pretty good growth in the first half, so what does that imply for the second half, because there seems to be some potentially backlogs coming down here and there could be some production cuts so what are you factoring in for second half for North America commercial?

Rich, this is Tim. I'm going to let James answer that.

Good morning rich. What we are seeing in the second half is just a little slower than the first half growth on commercial truck in North America, Rich.

Okay, so no big step down in commercial vehicle production first half to second half? (multiple speakers) Positive growth.

You are right Rich, just a little bit light too. Nothing dramatic or nothing significant. (inaudible)

Tim or James could you comment on quoting activity -- you've had a couple of pretty good quarters in a row, in Q4, and Q1. How did quoting activity play out this quarter?

Second quarter, Rich, was another strong quarter of quoting activity for us. I actually looked at, if you look at the first and second half, the first half of the year I am sorry, is a record for us. Very, very strong quoting activity. I would say the good news is, it is in all regions of the world and it is across all of our product segments. We feel very proud that it is a very very strong first and second quarter for us.

Okay, great. I'll pass the baton, thanks.

Your next question comes from Ravi Shanker with Morgan Stanley.

Ron, another question on the guidance, it looks like about $0.25 of your guidance is actually coming from lower volumes or just a weaker macro. I think you said you are still looking for Europe down 6% which is where you were before. You still have North America commercial vehicle up low double digits. What exactly is driving that? Is it all European light vehicle?

The majority of it is European light vehicle, correct. If you take a look at Europe, IHS came in after the first quarter was finished and actually upped the production volume so if we kept 6% for the full year, that meant that, that reduction in the second half of the year had to come down further and that is what basically we're looking at is a lower Outlook in Europe in the second half from what we saw previously.

This is James, the second, if you look at the second half of the year for European light vehicle production, versus our prior forecast, it's about 4% reduction, versus our prior Outlook.

Can you give us for the full year what you're expecting for your European light vehicle business to be at, you've given a number before.

Year over year production?

Your European light vehicle business.

Down 6%. Market.

And for you guys?

For us in Europe, we are actually up Ravi, for the full year, that is in the first half and the second half.

Okay so you are still going to be up for the full year?

Yes. For the full year in Europe we are up -- if you exclude currency, we're up about 5% in Europe on light vehicle production.

That is what I was looking for.

Maybe just one other comment maybe help a little bit, I gave the change in the second half of the year from what we saw earlier in the year, but in absolute numbers, the second half is down about 7% in European in light vehicle production. We are outperforming that significantly.

Just moving to Q2 itself, the drivetrain margin was down sequentially when I think typically your drivetrain margin goes up 2Q versus 1Q, anything going on there, or is it just a reflection of what is going on in the macro?

Ravi, I would maybe describe it this way -- when we look at the first half of the year for our drivetrain performance, now that is an operating margin around 9.5%, which we feel very, very good about when you look at it versus where we were last year, and it is absolutely in line with where we've guided, where we were going to be coming out. You get a little bit of noise quarter to quarter, but that is just more operational stuff going on. It is nothing significant, just natural quarter-to-quarter small percentage variations.

Finally, couple of housekeeping items. Ron, given the incentive comp delta versus last year in 2Q, and also, do you to have updated guidance for free cash flow for the year?

No, we have not changed free cash flow guidance for the year. They will remain the same. CapEx will remain the same as well.

You have EPS coming down, but you have FCF unchanged?

Correct.

Okay, and incentive comp for the quarter?

We froze the plans in the first quarter, so we don't have those large variations that we've seen in the past. So, from a sequential basis going forward, you won't see large changes. However, I will state that the first quarter we did record an amount in order to freeze the plan, the cash portion of that plan, which is on a sequential basis, there is a difference, but going forward, is going to be relatively the same.

Great, thanks so much for that.

Your next question comes from Matt Stover with Guggenheim Securities.

Two questions. Number one is, I want to make sure I have the numbers right, in the revised guidance, the FX portion on the sales was 1%. Then on the EPS line, it was $0.06.

Yes that is correct.

That seems like an awfully large hash through on the FX. Is there something unusual going on?

No. That is in line. 1%, it is $80 million, $90 million is what I think it was on value. Remember that is only for the back half of the year. Our guidance was $130 million. It's an average rate we use.

I was looking the back half of the year last year, you know 1% delta is about $35 million, and $0.06 is about $10 million pretax.

1% for the full year.

Oh, 1% for the full year, okay. The second thing is in Europe, as you consider the revision of the guidance and the macro uncertainty, your customers have, in the earnings calls this far, expressed a greater degree of uncertainty as it relates to Europe, which would imply to me that the predictability of their schedules in the second half would be going down. And as you thought about the production assumptions underlying the second half, are you making any special adjustments with respect to customer that is either more or less optimistic than what you are seeing in the market right now because, it would just seem that, to take the guidance of production down below the 6% in the current environment might be more prudent.

No, I think we feel pretty good about the numbers we're giving out there in terms of Outlook. I agree with you there is natural continued uncertainty in that region of the world and there is certainly instability, but we feel pretty solid about the projections that we are making. As we said earlier, they are down 7% versus our prior guidance, and we feel -- we are very close to our customers in understanding their schedules. Obviously, we look at a lot of macro economic indicators as well and compare that with IHS type data, so we feel pretty good about where we are guiding to. I would make one other comment, though, as we demonstrated year to date, and also in prior years, if those numbers do fluctuate a little bit, we've done historically a very very good job of adjusting costs in line with those reductions and we continue to feel good about our ability to flex our workforce and our cost structures. So, it may move another percent or so possibly but we are ready for that if that comes along.

Okay, thank you very much.

Your next question comes from David Leiker, Robert W. Baird & Co.

To start off, in past years, you have had a lot of upside opportunity from your backlog being pulled ahead, some of it showing up sooner that what you expected. What are you seeing in terms of that dynamic this year? Is it being pulled ahead, is it as you expected, some of the getting pushed out?

I would say David, this is a James, good morning. Slightly a little bit of push out, as opposed to pulling in. I wouldn't say to anything that significant, but we are seeing some small push out would be the general view overall.

How much of, I don't recall this number, but in Europe, how much commercial vehicle, how much European revenue is commercial vehicle?

About 5%.

5%. Is there any way you can characterize in your backlog how much of that might have been driven by commercial vehicle Euro VI emission standards? Is that a big opportunity for you in the backlog?

David, I don't know if we can give you the answer right now. I'm sure it is an opportunity for us. We would have to probably get back with you; if Ken would on that, more details.

In Brazil, I know you have a little bit of exposure there. We haven't really talked about that at all, is that meaningful enough to move the needle one way or the other?

No, European piece is not a significant piece for us. It is pretty much exclusively commercial vehicle business, David, but it is not a significant piece of our business.

Lastly on China, where are you in terms of building out your asset base there to launch the backlog in the business that you have there? I know you have several facilities that you have been putting up but where are you on that?

Yes, we are continuing, David, to increase investments pretty well across the majority of our product lines in China. Ningbo is our primary campus where produce a lot of our engine based products and we've, through this year, we're expanding both facility and equipment obviously in the facility and we are also expanding in our drivetrain segment, primarily in Darjeeling and Beijing. So those plans are continuing on. Our performance of the Chinese market continues to be very, very strong both this year and in future years, so we feel very good about placing that investment to be ready for that growth that we'll see.

And I think your China business is almost all automotive, right? I don't think there is any commercial vehicle there, is that right?

Yes, we have a little bit of commercial vehicle business, but you're right, the vast majority is certainly light vehicle.

Okay, great. Thank you very much.

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

Thank you, good morning. Just wanted to go back to the guidance, I was hoping we could walk through the change in the ex-currencies sales growth of 14% to 16% to now 9% to 11% because production forecast didn't come down all that much, so you mentioned maybe to push out on backlog, it would be great if you could quantify that. Also, are you seeing anything in terms of price downs or commercial settlement agreements changing around? Just wanted to get a bit more color on that walk.

We did not change the guidance in the Europe on total year over year of volumes being down 6%. But I think we said earlier, what we did see is a shift from the first half to the second half that deteriorated in the second half, what we thought we saw prior, once a IHS updated the first quarter production numbers. So, basically, sequentially we see a decrease in the second half of 7% sequentially going forward. That is where most of the deterioration is coming from is basically a rebalancing of the year.

Any change at all in the pricing activity with customers' commercial settlement agreements?

We are always a target for pricing. That activity continues day-in and day-out. I wouldn't say anything changed, those pressures are always there.

Okay, great. On a second half margins, you guys had a terrific margin in the second quarter and really the first half. It looks like revenue sequentially is sort of flattish in the second half of the year. So, what brings that margin down? Is it just sort of the typical seasonality and the shutdowns or is it down in terms of the walk H2 versus H1 on the operating margins.

I think you are right. The third quarter is an extremely low-margin quarter historically because of the sequential reduction from the second quarter in sales. Then it rebounds in the fourth quarter, but I think the second, the third quarter is what tends to drag that margin down is the third quarter.

Great, and just lastly, any additional thoughts to the tax rate next year? Is that 27% still a good place holder for now or does that go up?

We'll update guidance going into next year. At this point, it is 27% for the run out of this year. We will have to evaluate that for next year.

Great, thanks a lot, guys.

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

Good morning, guys. Just a first question and a follow up on Europe. Obviously, there's a lot of variability there. I'm just curious, if we look at the back half of this year and potentially next year, if things are much worse than expected, which is a possibility, if you could remind us the levers that you have to pull to respond to that potential weakness?

John, I would, you know, we have a number of levers and I would say primarily we have got a lot more flexibility in our workforce. That is really one of the key things that we have in place. Historically we have carried a percentage of temporary employees in the single digit percentage range. We made some conscious choices over the last couple of years to increase that to the 20%-ish type of a number. That is really a major major advantage that we have and we will absolutely use those levers to manage appropriately as volumes come up or down. So, we feel very good about having that in place.

The second question, just a follow up on backlog. It does sound like there's some pushing and pulling and tugging there, but you haven't seen any changes or cancellations in programs or anything like that, and it sounds like the bidding activity is going pretty strong, so is it fair to characterize the quoting activity and capital allocation in the industry towards your products as really just not change in response to this macro environment whatsoever?

I would absolutely say yes. There is no fundamental change. I think it is natural you will get some small pushes or small adjustments, whether that be a launch, may move out a quarter or some of the new business could be adjusted very slightly. Fundamentally no, the growth story is intact, the need for our products is as strong as it has ever been, and as Ron outlined earlier, John, when you look at our second half of the year, that out performance continues on versus the marketplace. Specifically, no, we're not seeing any cancellation of programs or projects, not at all, not for our product.

John, this is Ron, I would just add that our capital spending programs is still on track and that is another indicator that I think that you could look at.

That brings me to my last question here, Ron, for you. As we look at the balance sheet strength, obviously you're in a great position, just trying to understand capital allocation and where you're going to put your excess capital because it seems like you have that high-class issue of having a lot of extra cash and capital and also, sort of in conjunction with that, why repatriate earnings if you are going to pay higher taxes on them? I'm just trying to understand why you think that the money flow back to the US, and why not reinvest it internationally?

First of all, on a cash basis, I have to make sure this is clear, I don't pay the tax in cash until I repatriate it, so I just want to be clear there. But, I'm setting myself up more for flexibility and in the countries, or the units that we identified, the need for keeping that cash there for investments are no longer really required. So, it is not very efficient to just to keep the cash there if it is not really needed. So, I'm setting myself flexibility, I'm going to reallocate that cash into the areas of the world that is more use for that cash. It is more of identifying those units not being able to consume that cash, John.

Okay, and the balance sheet strength, I mean is there a share buyback on the horizon, you know, God forbid, a dividend if we get some relief on taxes and obviously I'm sure policy is the real hurdle there, but just trying to understand in return of cash to shareholders.

You know we have talked about this in the past, M&A activity takes number one priority. We have a lot of projects we are working on, that is number one. From that point on, I did do some buyback as you saw in the second quarter as I just announced. That was more just an opportunity at that point from what I saw the share price at and what we think the intrinsic value is ourselves. We've reviewed dividends annually with the Board, and I think dividends is a bigger discussion around tax strategies for the Company and personal income taxes, and I am hoping that the US government makes and tax changes coming here next spring, hopefully, or next year, that gives them some opportunities in that area.

The dividend is where much tax depending, tax policy dependent right?

I would not say is dependant; that is one element that we look into that we consider for it

Okay, great. Thank you very much.

Your next question comes from Rod Lache, with Deutsche Bank.

Good morning, everybody. You're going to think I'm kind of thick here for asking the same question again, but I just would appreciate it if I could get a little bit of help here understanding it -- your full year top line guidance organically went from 14% to 16% down to 9% to 11%. You did say, there is a shift in Europe from the first half to the second half, but your full-year, again, your full-year numbers are down 6%, so that doesn't affect your guidance. You did talk a little bit about commercial vehicle in China being revised slightly but that's again not -- doesn't seem like that is sufficient to drive that down. What am I missing in terms of that full-year downward revision? You cited the French and Italian automakers, I'm not sure, I think that they're only like 6% or 7% of your overall European sales. Is there something happening with respect to mix?

I think a couple of things, Rod, this is James. Again, not to keep going to through it, but the second half of the year in European light vehicle as I said is down 7% year over year, but I think most critically, when you look at it versus where we were at with our prior guidance, we have reduced the second half of Europe by 4%. That is a very very meaningful adjustment that we have made. The other part that we talked about earlier was we are guiding down in all commercial vehicle markets with the exception of North America. So, we have seen deterioration in China, where we participate, Europe, where we participate, and Brazil. So, it is not purely the light vehicle Europe piece, Rod. There is an effect of commercial vehicle pretty much globally, with the exception of North America.

I'll just point out, Rod, that the back half of the year is flat in production, and we're still up 8 to 10 percentage points year over year. I just want to point that out, so we're still growing.

Rod, this is Tim. This may help you little bit. We had North America up a little over 6% for the second half of the year as compared to 2011. We have Europe down 7%, as James and Ron said a couple of times. We have China up about 8% for the second half of the year over 2011, but then you get into Japan, we have Japan down 6.5%, as compared to second half of last year globally. And then Korea is flat. So, that may help you understand why it's not just Europe, okay? You have a down Korea and a down Japan.

If we're doing the math right, your margins in the second half of '12 versus the second half of the '11, you are talking about maybe 11% to 11.5% in the second of this year. Last year was 11.6%. Is this basically kind of, in the past you have said you kind of need 8% to 10% organic growth to maintain margins and maybe you are anticipating 7% to 8% organic growth here. Is that essentially the function, just some kind of cost creep that you need to achieve a certain speed of top line growth to mitigate?

There is no question that, if we are going sequentially not having growth, the margins are going to be challenged. That is correct. But you also have this third quarter affect as well dragging it down because that is typically a low margin quarter. You are right, as a sequentially the growth rate is not there; the margin expansion is going to be more stressed.

Yes, I was thinking more year over year so, looking at third and fourth last year to third and fourth this year. That seems to be happening. It seems you would agree that is more a function of just the growth rate, as opposed to something happening with respect to mix or pricing changes.

Yes, correct.

Alright, thank you.

Your next question comes from Collin Langen with UBS.

Oh, great. Thanks for taking my question. Can you clarify your comments on Corporate expenses? I think you said that stock comp would no longer be, was a factor in Q1, so that is why there is this big decline in that line item. And it actually should stay flat through the rest of the year, is that correct? It should be around $21 million?

What I would do is I would take the first half of the year maybe and take an average there into Corporate expenses running forward. I wouldn't just launch from the second quarter base. Back to your question, stock comp is not going to have the variation that we've seen historically. I would kind of reset your numbers. I'd take maybe a year-to-date average to go forward.

Okay, not to keep honing on it, but you kind of gave the -- your Outlook for the second half of the year in your sales guidance. So, what changed from your original guidance? You said Europe full year was the same so is North America now weaker, is Japan now weaker than your original guidance had anticipated?

Yes, I think what I would say again is, with the macro level, we've seen deteriorated economic conditions, particularly in the second half of the year and, as we were talking earlier, Europe is obviously the major driver for us, but it is other regions of the world as we outlined earlier and also commercial vehicle is a key driver there and then it little bit of a softening on some of the backlog as we also described earlier.

Last question, there's some news about in Europe some thermal investigations. I know you have some small components there. Any involvement in some of those investigations?

We are not involved at all as BorgWarner.

Okay, great. Alright, thank you very much.

We have time for one final question. And that question comes from Ryan Brinkman, with JPMorgan.

Hi, good morning. Thanks for taking my call. Obviously, you just posted a very strong gross margin quarter, several of your peers though have recently been citing greater automaker price-downs as pressuring margins. You were already asked about those pricing pressures today on the call. Perhaps you could update us on what actions you are taking on the cost side that are seemingly offsetting, or more than offsetting, the impact of these price-downs.

First comment is from a price-down pressure point of view, that for us is always there. It's no different now to prior years, that is just part of our business. We have not seen a fundamental shift in pricing pressure. It is always tough and it always will be. And what we do, through productivity in our facilities and a lot of good cost control management, we go a long way to offsetting those price-downs. I think that is what you have seen in prior years and prior quarters and it is what you have seen in this year. But, that is a more, let me say shorter-term tactical answer, I think in a more strategical higher level perspective, which I think is absolutely critical, is our continued advanced technology and better technology enables us to avert a stronger position in the marketplace as we go forward, and offers us a competitive advantage, which continues to fuel our growth well above the market rates as we see and that enables us a good position with our customer base. So, it is a combination -- to summarize, it's a combination of very very good cost control and superior advanced technology that we bring to the market.

Okay, great. Last question then. Can you update us a little bit about the current dynamics and the turbochargers space. I believe there is some relatively newer competitors which are try to gain market share. I'm just curious how you feel your book of business is holding up in the face of that?

Our turbocharge business continues to be extremely strong. It is a big part of our growth; it's a big part of our backlog. We have said before, we are roughly about one-third of the market and we expect that to continue on. We do see obviously activity from the new entrants, which has been planned for a number of years, but we absolutely believe we have great technology and we absolutely have confidence that the turbocharger business will continue to grow, and we don't anticipate any market share erosion in that segment and it will continue to be a huge part of our backlog.

That's great to hear, thank you.

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

That does conclude the BorgWarner 2012 second quarter results earnings conference call. Thank you for joining, you may now disconnect.