博格華納 (BWA) 2012 Q3 法說會逐字稿

Good morning. My name is Chrissy, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2012 third quarter results earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period.

(Operator Instructions)

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

Thanks, Chrissy. Good morning, and thank you all for joining us. We issued our earnings release this morning at approximately 7.30 a.m. Eastern time. It is posted on our website, borgwarner.com, on our home page. A replay of today's conference call will be available through November 7. The dial-in number for that replay is 800-642-1687. You will need the conference ID which is 37209257. The replay will also be available on our website.

With regard to our Investor Relations calendar, we will be attending a number of conferences between now and the end of the year. November 6, we will be at the Baird Industrial Conference in Chicago. This is also the day we plan to announce our 2013 through 2015 backlog of net new business. November 8, we will be at the Morningstar Management Behind the Moat Conference in Chicago. November 14, we will be at the Barclay's Global Automotive Conference in New York. And, on December 6, we will be at the Goldman Sachs' Global Automotive Conference in London.

Before we begin, I need to inform that you 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 on to our results. Tim Manganello, Chairman and CEO, will comment on the third quarter and current industry trends, and then Ron Hundzinski, CFO, will discuss the details of our operating results and also our outlook for the remainder of 2012. Also, for the Q&A portion of the call, we have James Verrier, President and Chief Operating Officer. With that, I will turn the call over to Tim.

Thank you, Ken, and good day, everyone. Today, I'm pleased to review our third quarter results, as well as our third quarter accomplishments. First, our third quarter results. Reported sales were $1.7 billion, down 5% from the same period last year. However, foreign currencies were working against us during the quarter. On a comparable basis, excluding currency and 2011 dispositions, BorgWarner sales were up 2%. US GAAP earnings were $0.85 per share, but excluding noncomparable items, our earnings were $1.19 per share.

Our reported operating income margin was 9.6%, but excluding the impact of noncomparable items, our operating income margin was 11.3%, up from 11.1% a year ago. This is outstanding margin performance in a challenging market. Two key factors drove our results. Sales were down due to a weak global economy, most notably Europe, and our operating margin improved due to operating efficiencies and cost controls. In the engine group, third quarter sales were about $1.2 billion. However, excluding currency and 2011 dispositions, sales were about $1.3 billion, or up 1%.

Sales growth in the engine timing -- sales growth in engine timing systems in Asia and light vehicle turbochargers in Asia and North America were offset by weak market conditions in Europe. The Drivetrain Group also performed well in the quarter. Sales were about $534 million, up slightly from the third quarter 2011. Excluding currency, sales were up 5%. Drivetrain's growth in the quarter was due to solid growth in all wheel drive sales around the world, primarily in North America.

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. For the quarter, we spent about 6% of sales on CapEx, and we continue to invest in technology which is the life blood of our company. We spent about 3.8% of sales on R&D in the quarter.

I'm also proud to review some exciting announcements we made during the quarter. Three BorgWarner technologies have been named finalists in the prestigious Automotive News PACE competition. We are proud of our winning record and pleased to have our technologies in the final competition once again. BorgWarner is supplying our EGR technology to new markets. The MTU diesel engines used to power locomotives, mining equipment, and pumps for the oil and gas industry are equipped with BorgWarner EGR coolers to reduce NOX emissions.

BorgWarner's unique cam-torque xray device with mid-position lock helps the 2012 Subaru Impreza offer 30% better fuel economy compared with the previous model. BorgWarner turbo systems received the Porsche Supplier of the Year award. The honor was given for quality, reliability, and our partnership with Porsche in developing the world's first mass produced variable turbine geometry turbocharger for gasoline engines. BorgWarner recently finalized the sale of its spark plug business, which was a part of the BERU acquisition. Sales were approximately $80 million in 2011, and this will allow us to continue our focus on expanding BERU's core product lines which include glow plugs, diesel cold start systems, and other gasoline ignition systems, including Ecoflash.

Now, let's take a look at our current outlook for 2012 light vehicle production. In North America, our outlook has improved. We now expect year-over-year growth of about 5% for the fourth quarter, up a few percentage points from our previous outlook. Strong year-to-date sales, better credit conditions, and healthy inventory levels have improved our outlook. Japanese OEMs in North America continue to replenish their inventory, and this is driving a significant portion of this year's growth in North America.

Our outlook for Europe has weakened. The economic slowdown that has impacted southern Europe has now spread to northern Europe. As a result, we saw steep schedule cuts across Europe in the third quarter and in the fourth quarter. Previously, we expected light vehicle volumes to decline about 5% in the fourth quarter. We now expect volumes to be down around 13%. And, much of the change in our outlook is due to the volume declines in high-end vehicles. These high-end vehicles tend to have more BorgWarner content than the lower-end vehicles. We also expect slower light vehicle production growth in China for the remainder of the year. Previously, we expected growth of nearly 10% in the fourth quarter of 2012. We now expect growth in China of around 5%.

Our outlook for the commercial truck market has also weakened. In all four markets where we compete, Europe, North America, Brazil, and China, projected volumes for the fourth quarter have decreased. We still expect growth in North America for 2012, but this is down from our July projection. 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 zero to plus 1%, compared with our previous guidance of 4% to 6% growth. Excluding currency, our sales growth is now expected to be 5% to 6%, compared with our previous guidance of 9% to 11%. Our change in our -- or, the change in our sales guidance is due to the broadening global economic slowdown, especially in Europe, and its impact on the automotive industry. Despite this, we expect our sales growth to outperform the market this year on a comparable basis. And, Ron will provide details about our performance relative to the market in a few minutes. Our 2012 earnings guidance, excluding noncomparable items, is now $4.90 to $5.00 per share, down from $5.05 to $5.25 per share previously. This change is due to our expectation of lower sales. And, again, Ron will explain that shortly.

We are on track towards achieving our targeted full-year operating margin of 11.5% or better having posted 11.9%, excluding noncomparable items, in the first nine months of this year. Now, in conclusion, we have lowered our expectations for the remainder of the year in light of the broadening global economic slowdown and its impact on the automotive industry. Despite these head winds, our Company is operating at a very high level. Our expected operating margin of 10 -- 11.5% or better, excluding noncomparable items, will be an all time record high for BorgWarner. And, the new EPS guidance also represents an all-time record year for BorgWarner, with an increase of 10% to 12% over our 2011 EPS.

No company in the auto sector is better positioned to absorb short-term market fluctuations and to deliver long-term profitable growth than BorgWarner. Our confidence is based on our proven business strategy. We see fuel costs continuing to trend higher. The regulatory environment continues to become more stringent. And, drivers continue to demand better performance. BorgWarner's focus on advanced technologies to improve fuel economy, reduce emissions, and enhance vehicle performance is right on target. And, we expect strong demand for our products to continue for many years to come.

Our technology leadership, strong global presence, financial discipline and focus, and our focus on attracting and maintaining a talented work force have been the keys to BorgWarner's long-term success. I feel very good about the company's future, and so should our shareholders. And, now, I would like to turn the meeting over to Ron.

Thank you, Tim, and good day, everyone. Before I begin reviewing the financials, I would like to put BorgWarner's performance into perspective within the broader auto industry. Global light vehicle production was up 2% in the third quarter, compared with the same quarter last year. BorgWarner's reported sales were down 5% from a year ago. As Tim explained earlier, if we exclude the impact of foreign currencies and M&A activity in 2011, our sales were up 2% in the quarter. To get a clear picture of our performance relative to the market, we need to review light vehicle and commercial vehicle markets separately. First, let's take a closer look at the light vehicle market from a regional perspective.

In Asia, which I'm defining as China, Korea, and Japan, light vehicle production was up 2%. Our light vehicle sales in Asia, excluding currency, were up 15%. In Europe, light vehicle production was down between 6% and 9%, depending on the source. Our light vehicle sales, excluding currency, in 2011 disposals were flat. In North America, light vehicle production was up 12%. As Tim said earlier, Japanese vehicle manufacturers continue to replenish their inventories in North America. This activity drove much of the volume growth in North America in the third quarter. Our light vehicle sales growth in North America was about 12%, in line with the market. However, excluding what I will call the tsunami-related inventory replenishment, we outperformed the North American light vehicle market as well.

Now, let's review the commercial vehicle market. The third quarter saw continued weakness in commercial vehicle markets around the world with the exception of North America, which was basically flat. Each of our commercial vehicle markets experienced double digit production volume declines. As a result, our commercial vehicle sales were down 10% in the quarter. Let me summarize this. Our typical outperformance of the light vehicle markets was intact in the third quarter. Despite outperforming the market in Europe at 6% to 9%, volume decline in that market had an oversized impact on BorgWarner. The European light vehicle market represents nearly 50% of our sales, but less than 25% of the global light vehicle production market. Also, weak commercial vehicle markets around the world resulted in a 10% sales decline for us in the segment, representing nearly 20% of our business.

All right, let me go to the income statement now. Working down the income statement, gross profit, as a percentage of sales, was 20.3% for the quarter. That's up from 19.6% a year ago despite about $5 million in higher raw material prices. SG&A expenses were 8.9% of sales in the quarter, versus 8.5% of sales in the third quarter last year. The increase was due to an increase in R&D spending, which, as a percent of sales, was 3.8% in the quarter, up 50 basis points from a year ago. Reported operating income in the quarter was $163 million. However, this includes disposal and restructuring expenses associated with the sale of our spark plug business.

You may recall that in the second quarter, we signed a master purchase agreement for the business, to dispose of the business, and wrote down $38 million of prior purchase accounting adjustments related to the spark plug business. In the third quarter, we incurred an additional $28 million of restructuring-related costs associated with the acid disposal and future requirements of the BERU ongoing business. Of the $67 million total charge taken over the two quarters, only about $20 million will be cash payments, primarily related to severance costs. Most of this cash will be spent in the next two quarters. Although, there may be some minor payments that extend beyond that period. We estimate that our savings, also primarily related to severance, will be about $13 million per year, or about a year and a half pay back period.

The $29 million charge taken this quarter shows up in other income expense line item of our income statement. Excluding the charge, operating income was $192 million, or 11.3% of sales, compared with $199 million, or 11.1% of sales, on a comparable basis a year ago. The 11.3% operating income margin is a new third quarter record for the company. After excluding the impact of foreign currency and noncomparable items, in both this quarter and the third quarter of 2011, our incremental margin was about 17% in a quarter, which reflects outstanding cost control in a very challenging sales environment. As you look further down the income statement, equity and affiliate earnings was $11 million, down slightly from $12 million last year. This represents the performance of NSK-Warner, our 50/50 joint venture in Japan, which sells transmission components to our Japanese customers in Japan and China, as well as TEL, our turbocharger joint venture in India.

Interest expense and finance charges were $5 million in the quarter, down from $19 million a year ago. This was primarily due to the maturity of our convertible debt settled with treasury shares in mid-April. Note that this reduction in convertible related interest expense did not impact earnings per share. We have been calculating EPS on an if converted basis from the first quarter of 2010 until the securities matured in mid-April.

Provision for income taxes was $160 -- I'm sorry, was $64 million in the quarter, which is a 38% effective tax rate. However, the provision includes a few items worth noting here. There was an $8 million tax benefit related to the restructuring activities. There was a $7 million tax expense related to the closure of certain tax audits in the period. And, an $11 million tax expense due to capital gain on the asset disposals that we discussed earlier. The net impact of all these items is $10 million increased in tax expense. Excluding these discrete items, our tax expense was $54 million in the quarter, or a run rate effective tax rate of 27%.

Net earnings attributable to noncontrolling interest was $4.8 million in the quarter, down slightly from $5.1 million a year ago. This line item reflects our minority partner's share in earnings performance of our Korean and Chinese consolidated joint ventures. This brings us back to net earnings. Which were $101 million in the quarter, or $0.85 per share, on a reported basis. On a comparable basis, net earnings were $141 million in the quarter, or $1.19 per share, up from $1.15 per share a year ago. That's a 4% earnings growth rate on a 5% decline in reported sales. Very strong performance for the company. Also, note that foreign currency reduced earnings per share by about $0.08 in the quarter.

Now, let's take a closer look at our operating groups. Engine Group sales were $1.2 billion in the quarter. Excluding currency in 2011 dispositions, Engine Group sales were up 1% compared with the third quarter of 2011. We are seeing good growth in engine timing, including BCT in Asia and light vehicle turbochargers in Asia and North America. However, the slowdown in light vehicle production in Europe, and in the commercial vehicle markets around the globe, offset much of that growth. Adjusted EBIT for the Engine Group was $184 million in the quarter, or 15.8% of sales. That is a significant improvement from the 15% adjusted EBIT margin we reported a year ago. The year-over-year incremental margin, excluding currency and the 2011 dispositions, was over 40%, an outstanding operational performance by the Engine Group.

In the Drivetrain Group, sales were $534 million in the quarter. Excluding currency, Drivetrain Group sales were up 5% compared with the third quarter of 2011. Strong all wheel drive system sales around the world, but primarily in North America, were the key growth driver in the quarter. On a reported basis, adjusted EBIT was $44 million, or 8.3% of sales. This is up 20 basis points from the third quarter of 2011. The year-over-year incremental margin for the Drivetrain Group, excluding currency, was 9%.

While this appears to be under-performance to our BorgWarner standards, the year-over-year variances were very small. A $2 million improvement in operating income over a $25 million improvement in sales. This very small change in the business can have an outsized impact on the calculation when the numbers are that small. The group's EBIT margin for the first nine months of this year was 9.2%. This is a good indicator that we are still on track for the Drivetrain Group to achieve an EBIT margin of 9% or better this year.

If you look at the balance sheet and cash flow, we generated about $543 million of net cash from operating activities in the first nine months of 2012. This is up $70 million from the first nine months of 2011. Capital spending was $283 million for the first nine months of 2012. Up $9 million from the same period a year ago. Our capital spending is required to support our program launches around the world, particularly in Asia, south America, Eastern Europe, and Mexico. Free cash flow during the period, which we define as net cash from operating activities less capital spending, including tooling, was $260 million. Look at the balance sheet itself, the balance sheet debt decreased by $226 million compared with the end of 2011.

Cash increased by $262 million during the same period. This $488 million decrease in net debt was primarily due to net cash provided by operating activities and the maturity of our convertible debt, partially offset by share repurchases in the first and second quarters. At the end of the third quarter, our net debt to capital ratio was 14.3%, compared to 28.3% at the end of 2011. Net debt to EBITDA at the end of third quarter 2012, on a trailing 12-month basis, was 0.4 times. Our capital structure remains in excellent shape.

Okay, I will go to the 2012 guidance now. Due to weaker global economic conditions, particularly in Europe and its impact on the automotive industry, our sales guidance has come down. We now expect sales to grow from zero to 1% in 2012, compared with our previous guidance of 4% to 6%. If you do the math, our full-year guidance implies fourth quarter sales should be down 3% to 7% year-over-year. Excluding currency, our 2012 sales growth is now expected to be 5% to 6% compared with our previous guidance of 9% to 11%. We now expect our full-year earnings to be within a range of $4.90 to $5.00 per diluted share, compared with our previous guidance of $5.05 to $5.25 per diluted share. The lower EPS guidance is directly resulted of our lower sales guidance.

From a margin perspective, we still expect to achieve an operating margin of better than 11.5% for the full year. Our operating margin of 11.9% in the first 9 months of the year is a solid indicator that we are on track to meet that goal. We have tightened the reins on net cash provided from operating activities to $900 million to $950 million, within the previous range of $900 million to $1 billion. Capital spending is now expected to be within a range of $400 million to $450 million, down from $450 million to $500 million previously. Free cash flow, which we define as net cash provided by operating activities less capital spending, is expected to be about $500 million this year. The tax rate remains at 27%. And, the return on invested capital is still expected to be greater than 20%.

Our year-over-year incremental margin for 2012, is complicated by the projected sales decline in the fourth quarter. Year to date, our incremental margin was about 24%. In the fourth quarter, we are targeting a decremental margin in that same range. We still believe that the impact of higher raw material cost will be in the $25 million to $30 million range in 2012. As we stated all year, we will absorb and manage our inflationary costs, including raw materials. We will not [protemp] to have a material impact on earnings expectations for the year.

So, in conclusion, our operating margin and earnings per share in the third quarter on a comparable basis were third quarter records for the Company. Operationally, the Company continues to perform at a high level and a very challenging environment for growth. Weakening market conditions have resulted in lower outlook of sales growth and earnings growth in 2012. However, we expect 2012 to be another year of record margins and record profits for BorgWarner. Tim talked about confidence in our strategy over the long term. But, we are equally confident in our execution over the short term.

This Company has demonstrated a heightened focus on efficiency and cost control since the 2009 recession. This focus resulted in highly efficient growth and record margins in 2010 and 2011. And, despite the 2012 being a challenging year from a growth perspective, we expect to achieve record margins again. Over the long term, we intend to execute our growth strategy and over the short term remain focused on efficiency, regardless of the direction of the market. With that, I would like to turn the call back over to Ken.

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

(Operator Instructions)

Rich Kwas, Wells Fargo Securities.

Hey, everyone.

Hello, Rich.

I guess, Ron or James, could you give us just a feel for what you're seeing right now in Europe? You took the production down 13% for the fourth quarter. That may not be as conservative as what we've seen from some other suppliers that are thinking it could be 15% or more. How confident are you in the 13% number?

And then, it looks like first quarter looks up to be -- looks to be something similar in terms of a decline for next year, at least, according to HIS. What are you seeing? Are you seeing any signs of stabilization right now? Or is this still drastic cuts that are still that still have -- and then, there is still risk to it?

Yes, Rich, this is James. Let me talk, probably, about the fourth quarter more than the first quarter. I think, candidly, we need a little more time to really get a better view of the first quarter. We're trying to work our way through the fourth quarter.

In terms of the 13% number for the fourth quarter, we feel pretty comfortable with that number. The risk to it, frankly, is the month of December. That's the element that makes it a little challenging in terms of what the customers will do as they come to close out the end of the year.

But, as we sit here today, and we look at the schedule, and we talk to the customers, we look at our actual run rates in the third quarter, and we look at the projected run rate of actuals through the month of October, that gives us, frankly, more comfort and confidence around the 13% number. But, could it be a percent or so either side of that? Absolutely, that's a possibility, Rich. I think as Ron alluded to, though, if it is a little different to that 13%, we feel very comfortable and confident in our ability to execute against that, if there is a slight shift. So, that is -- if that helps you, Rich, that is the view that we're seeing right now.

And then, your temporary work force over there is much higher than it was 4, 5 years ago, right? Or is that -- are you starting to try to take advantage of that right mow? I assume you are. But, what's the status of it?

Let me give some color on that, Rich. In the earlier part of the year, I'd say the first half of the year, our temporary employees, as a percentage of our total direct work force, was probably in the mid-20%s range. Which, as you point out, is very much higher than where we were a number of years ago, which was very intentional strategy on our part. As we've worked through the third quarter, that number has come down a little.

So, we're probably in that 20%-ish range as we operated in the third quarter. And, based on the production outlook and the schedules we see for the fourth quarter, we're probably going to end up around approximately about a 10% number as we come towards the end of the fourth quarter. So, we are have used that flexibility to deliver the type of performance that we have shown. In addition, Rich, we also used a little bit of reduction in the actual workweek from the 6 days down to 5 in some of our facilities.

Okay, that's helpful. And then, just a broader question. Acquisitions, what are you seeing out there in terms of pricing? And the types of property that you're interested in? Any change? Any thoughts on that front would be helpful. Thanks.

Yes, Rich, we continue to look very aggressively. And, I think consistent with what we said in the past, our clear focus is to look for technology-leading companies and companies with growth. And, that's really been our focus and, it continues to be our focus.

And, I think, just as we've said in the past, Rich, we have a number of targets that we're continuing to work hard on, to try to bring one or more of those over the line. It will stay in the areas that we are, in adjacent areas of engine and drivetrain. There is a quite a number of them. And, we continue to be pretty aggressive in our search for bringing one of those home.

Okay, great. I will pass it on. Thanks.

Thanks, Rich.

Brett Hoselton, Keybanc Capital.

Hi, gentlemen.

Brett, good morning.

If I did my math correctly, I may not have, but to get to the $1.19 I'm using net interest expense of $4 million. And, that is lower than we would had anticipated. And, I guess my question is, on a run rate basis, where would you expect your net interest expense to be?

Brett, the way -- I think it was about $5 million, actually, I have, net interest. We had a couple of things in the quarter that was favorable. We have an interest rate swap that actually went favorable on us, as well. So, I don't think we're going to stay at that rate of $5 million interest expense going forward. I think the mark-to-market on that cross interest rate swap will come back. So, I would go more back to the second quarter and maybe adjust for the convertible on a run rate basis going forward, okay?

And then, as we think about the restructuring, the savings of $13 million per year, can you characterize the timing of that? I mean, you just announced the program. Is that something you expect to achieve in 2013? Or is it -- should we blend that in to 2014 as well?

I'm expecting to start seeing those benefits in 2013. Because the way the program works, is those employees should be out of our facilities fairly soon here. Which means I won't have that cost going forward.

I guess my question is, would you expect to achieve the full $13 million in 2013, or would you only achieve maybe 50% of that in 2013, and the remaining portion of it in 2014?

Well, I would like to see it all. But, I'm working with works councils in another country that I'm sure I will see some deterioration in that $13 million. So, maybe 50% or something like that for next year.

And then, as we think about the backlog, you normally make an announcement, I think, somewhere in that beginning in November. Can you talk a little bit about one, when you plan on making your backlog announcement. And then, two, it sounds like from previous comments, the bidding activity has been pretty robust but obviously production has been lower.

So, can you talk about when? Can you talk a little bit about the robustness of the bidding activity? And then, can you talk a little about maybe some variations in production expectations versus last year?

Yes, Brett, this is James. In terms of the when we will announce it, it is next week at the Baird Conference. So, that is next Tuesday. So, we will be announcing it and taking you guys through the details next Tuesday.

So, I don't want to comment, obviously, prior to that. But, we're working very hard. Kenny is doing his magical work as ever. So, we will be ready next Tuesday to give you an update there. In terms of the quoting and bidding activity, it remains very strong for us as we look at how this year is stacking up with prior years.

We're very pleased where we see our activity year-to-date. And, I would say it is healthy across the different product lines, and it is pretty healthy across the regions. Now, we're just going through the process of calculating that and putting it into the appropriate models. And, that's what we will bring to the meeting next Tuesday, Brett.

Excellent. Thank you, very much, gentlemen.

Thank you, Brett.

Thank you, Brett.

Itay Michaeli, Citi.

Great, thank you. Good morning.

Good morning, Itay.

I wanted to talk about the fourth quarter walk, sequentially, on margin. Typically the fourth quarter is a higher margin quarter than the third quarter. I think that has been typical even in quarters in the past where revenue has been flatter sequentially. It looks like from the new guidance you may be assuming flat to even down margin sequentially. If you help that in terms of the walk, is there anything different that is occurring this year versus prior years from a seasonal perspective?

The only thing I would say is that on the gross profit margin, I expect us to have the same performance we've had. I would say that we're probably deleveraging a little bit on SG&A, because of R&D spend. That's probably where I would focus, is what your walk issue is right now. We continue to invest in R&D. And, that's going to have a little bit of deleveraging in SG&A.

Great, Ron. And then, you mentioned, I believe, if I heard correctly, that you're expecting lower CapEx this year. Can you talk a little bit about what is driving that? Maybe talk to any additional deferrals you may be seeing in the backlog? And then, how should we think about CapEx maybe in the next couple of years relative to revenue?

Yes, Itay, I thought I would get that question. I want to be clear. It is not related to cancellations of programs, okay? What it is, it is just the spending rate is not where we thought it was going to be when we took a look.

The programs are still in place. It is just that the pace we're putting it on is not at the same pace we thought in the middle part of the year. As far as your view going forward, I would expect to spend at the same rate of percentage of sales that we have done in the past and no significant change in that area.

Great, and then, just lastly, given that the macro pressures everyone is seeing, how are you guys thinking or how confident are you around BorgWarner's ability to outgrow the market 8% to 10% per year going forward? Should we expect maybe a bit of a lull in that out-performance, given the macro pressures and you're over weight in the European region? Are you still fairly comfortable that you can deliver that type of growth in the next couple of years?

Yes, Itay, this is James. Let me start with maybe the basic thing. We have very comfortable and very confident about the story of BorgWarner. If you think about it over the long term, nothing has changed fundamentally. The need for greater fuel economy, better emissions, and better performance, all of those needs are still strong and very, very strong. And, BorgWarner absolutely has the products for that.

So, the fundamentals, Itay, of the story are absolutely solid. And, we feel very, very comfortable in that, in our technology and our ability to drive that growth. Really, the detail of what the next two or three years looks like, we will get a better look as we put together the net new book of business. 50% of -- a little more than 50% of our business is in Europe, so that does weigh on us a little. As does the Commercial Vehicle business, which is 15% of our Business, and that market is down a little bit. So, there are some pressures on us. And, I think, as Ron went through his breakdown about performance versus the markets, you see some of that weighing on us in the fourth quarter and somewhat in the third quarter.

So, in the short term, we are going to see some of those head winds weighing on us a little bit from an out-performance versus the market. But, we're still outgrowing in most regions and in most product lines. And, fundamentally we think that is absolutely going to continue on. But, we will provide more data and more color on it next Tuesday when we do the net new book of business, Itay.

Great, that sounds great. Thanks, guys.

Thanks.

Chris Ceraso, Credit Suisse.

Can you hear me okay?

Yes. Good morning, Chris.

Okay, terrific. I was trying to -- I was wondering if you could help me parse out the impact of weaker commercial volumes in the quarter. Back of the envelope math, I'm thinking revenues in dollars were down maybe $30 million year-to-year. Tell me if I'm in the right neighborhood there. And, if that is so, what was the ballpark decremental margin on that? Is it a higher decremental hit because it is in a commercial market?

No, our decremental margins are in line with our normal decremental margins, first of all, Chris. The commercial vehicle market was down 10%.

Actually, our sales.

Our sales are down 10% in the commercial vehicle market in the quarter.

Right, I was trying to translate that into dollars. Is it around $30 million?

Well, you figure it is about, what, 6 -- almost 20% of our sales. We're down 10%. Okay, Chris? So, 20%, almost 20% of our sales were down. Yes, $30 million, $35 million, all right. In that range.

And then, can you give us an update on how much new business came on in the quarter? And, what you're expecting in terms of new business to come onstream in the fourth quarter?

Chris, that is a hard number for us to do. We typically look at the backlog on a linear perspective through the period. So, basically, period one, or year one, two, and three, is linear by $833 million, is what we've done in the past.

Now, as you go through the cycle of a given year, it is not necessarily linear sometimes because the launches take place in the beginning of the summer, right? I would have to do some numbers and get back with you to crunch that over and get some numbers around that, Chris. I don't have that handy in my head right now.

Okay, and, just the last one, maybe talk about the mix of business, particularly in Europe. Some of the markets where you have good diesel penetration were hit pretty hard. Was the decline in the diesel mix a big problem for you in Q3? And then, is that something that you think gets worse in Q4? Or is it better or is it the same?

I think there were two major shifts, if that's the right word, Chris. One was, I will say, the Northern European customers, or focused primarily on the German OEMs, that really started to cut schedules at a faster rate than they had done earlier in the year. And, there was still a little bit of further erosion with the Southern European guys. But, the real story was the Northern European, predominantly German OEMs, really started to cut into the schedules.

And then, the other thing that we see that is an impact on BorgWarner is what I call the higher content cars, the higher value type vehicles, which typically BorgWarner is a little biased to, or weighted to, because of our technology. Those schedule cuts were quite significant in the end of the third quarter and the fourth quarter. And, a lot of those cuts had already been made in the smaller lower technology, lower-end vehicles.

So, those are the two fundamentals, Chris, that did it. It was less gasoline diesel mix. It was more vehicle content mix. And, Northern European/Southern European shift. Does that help you out?

Yes, that is very good. Thank you. Thanks, for the help.

Thank you.

Patrick Archambault, Goldman Sachs.

Hi, yes, thanks, good morning.

Good morning, Patrick.

I guess -- I think you used to characterize your operating leverage as being, if you outgrew the industry by 8% to 10% that was what would allow you to see margin expansion, or at least hold margins. And, clearly -- I mean, it is a bit difficult because you have the distortion of the commercial vehicle side. But, it seems that your content growth was probably lower than that across your end markets this quarter.

Yet you still managed to post a decent margin expansion year-on-year. So, maybe you can just talk to us a little bit about that equation going forward. Is that need to outgrow the industry by that number gone down, just given your cost structure, given some of the levers that you've been able to find? Just help us frame the margin expansion opportunity from this pretty high level here.

Sure, Patrick, the way we look at margin expansion is over the long run, not specific to a quarter to a quarter. Over the long run, we know that we need that growth to expand our margins. Now, if I bring it back to the quarter, I will just be honest, our operating guys have just done an outstanding job to ensure that we're managing the market right now, and getting costs out of the plants on the short run, and getting discretionary spending down, getting our labor costs inline.

And, they're just doing a great job. They're outperforming themselves right now. Now, over the long run, that is going to be difficult for them to do that. In the short run, they did a great job. And, I still hold that in the long run I need that 8% to 10% sales growth to expand my margins.

Okay. So, you revert back to the backlog, obviously, being the principal driver. I mean, one other one. Just getting back into the performance for this quarter.

On page 6 of your release, I think you said that incremental margins for engine was 40%, which is indeed pretty big performance. I mean, what -- can you just give us a little bit more color, what was behind that? Because I always thought drivetrain was the one with some low-hanging fruit. But, the engine conversion was obviously pretty phenomenal.

I said in the script about smaller numbers having a larger impact, and that applies to the engine group, as well as the drivetrain.

We could have, in a given quarter, a huge cost reduction program that really took effect. The volumes came in, as far as the cost reductions, and had a big bump in our incremental margins. That can happen in a given quarter. Because it is not smooth throughout the year. Again, I go back to the operating guys, just really watching the Business, and executing on the operating front is what we're seeing it in the quarter.

Okay, great. Thanks. That's all I had.

David Leiker from Robert W. Baird and company.

This is Joe Vruwink on the line for David.

Okay, hi, Joe.

If I just take the end market assumptions Tim mentioned, and I weight them by your sales mix, I am coming out with a global volume assumption of let's say down 6% in Q4. And, if I compare that with where I think your organic growth guidance places you, I think you're looking for maybe down 1%. So, that type of margin, a down 5% is, obviously, below what you normally do, and, this quarter, you maybe saw a few percentage points. So, can you maybe touch on why that margin is below the normal 8% to 10%?

I think what you're not taking in consideration is the mix in that change as well, that James talked about a few minutes ago, which gets him to another dimension of calculations, I guess, is what I would say. So, that is the missing equation there for you.

Okay, and then, maybe just switching over to an expense item, you have said in the past that you expect your company to generally be, or need, R&D around 4% of sales. I think the target for this year is still around 3.7%.

While the 4% is in line with what you historically have done, you're obviously a much bigger company now versus historically. So, at some point, does just the absolute level of R&D spending facilitate the growth ambitions you have? And, we might not actually need to get back to the 4% level?

I would at this point still subscribe to the target of 4%. We struggle this year to get to the 4% in the early part of the year. Only because the sales grew in the first part. And, our goal is still to continue to spend in R&D at whatever level is appropriate, and, we currently still think that is about 4% of our sales. I don't see us coming back on that at all, at this point.

Okay.

Joe, this is James, I will just add on to what Ron said. And, I fully agree with Ron, we're not -- we have no intention to slow down our R&D investment and growth rate. And, as I think we've disclosed in prior earnings call, it has been a challenge for us to get to that 4% rate because of our rapid sales growth.

But, when I look out there at the areas of opportunity that I see for technology development for this Company, and how we can support the OEMs around the world, that -- there is no reason for us to slow down. We've got some phenomenal technology, next generation technology that we're working on. That has been the heartbeat of this Company for a long time and it will continue on. So, we're going to drive aggressively to that 4%.

Okay. And then, my last one. If I think about your acquisition strategy historically, I mean, when you've made these big acquisitions you've also been growing at the normal level of out-performance.

And, I think what we might not be seeing is that while the former version of BorgWarner maybe is having slowing growth, the fact that you have acquired technologies and then are growing those and layering that into the business mix keeps that 8% to 10% margin at that level. And, it has been at that level for more than a decade. Now, that margin, seemingly, is starting to maybe erode a little bit.

So, are acquisitions a more important piece of hitting an 8% to 10% out-performance? Or are you confident with the technologies you have, Dytech and Haldex acquisitions the past few years, that organically, without acquisitions, you can get back to your normal outperformance margin?

Joe, the quick and simple answer is we expect, and we believe, by the way, we will get the growth both from the organic piece of our Company and from the acquisitions that we bring into the Company. One of the things that we talked about in the past, where we're looking for companies that we're trying to acquire, two critical elements that we need. One is technology and the other is the ability to grow.

And, obviously, those two things go hand in hand. So, if you look at the, let me say, the track record of the acquisitions that we bought in and integrated to the Company, yes, they performed very well and they delivered on the growth targets and expectations that we had, as well as the financial performance. But, the organic, or existing, base part of the Company is absolutely the same way. All of -- if you look across our Business, all of our products are lined up for the growth rates to meet the fuel economy standards and emissions performance that is out there.

So, we don't really differentiate, Joe, between one carrying the other, or one outweighing the other. You may get small variances year-to-year in a business unit or a product line. But, in general, the belief and the way we run the Company, is both organic and acquired companies, we're expecting to drive that double digit growth rate.

Okay, great. See you guys next week.

See you next week, Joe.

Rod Lache, Deutsche Bank.

I would like to follow up on Patrick Archambault's question on the 8% to 10% historical growth needed to maintain margin. The reason for that, as you guys have explained it, is you have to offset about $100 million of price, and maybe $25 million or $30 million of raws and other content costs and $50 million of wages. Can you just speak broadly about as you look out to 2013, you're taking mitigating actions, you're taking shortened work weeks, and there is some restructuring. So, as we look out over the -- in the future, how might that 8% to 10% be modified, looking forward, just from some of these actions that you're taking?

Rod, I don't expect -- we run this Business over the long run. We've always stated that. And, our stated goal is 8% to 10% over the long run. I would expect that that same operating model to be in place over the next several years, as well.

Obviously, you're going to have quarters that are a little bit more narrow in growth and quarters that expand. And, I would just say that over a three-year period, that we still expect over that average of the three years period, we would still be in that 8% to 10% growth rate, over a three-year period. I mean, historically, we haven't seen a flat market that long. It is usually one, two, three quarters and then you start to get growth again.

Okay. But, over a temporary, let's say two-, three-quarter period of inventory destocking, should we be thinking about other mitigating factors that you might be taking?

We're going to manage this Business on a day-to-day basis, over a period of two to three quarters and I wouldn't -- if you're trying to get at that the margin deterioration would happen in that period, we are going to be hard pressed to hold margins, there is no question. But, I'm confident that we have an operating group right now that understands this and is going to work everything -- do everything they can right now to hold their margins.

Okay. And, I would like to ask, also, about the outlook for NSK-Warner, if you can just provide some commentary about that earnings contribution. Just given what has been happening with the Japanese automakers and exposure to China through that. Is that something that you would expect would be material or any thoughts broadly on how we should be projecting that business for you?

No, I wouldn't say it is material. You are going to have $200 hundred thousand changes here, and stuff like that, but I wouldn't suspect it is a material event for us.

Okay. All right. Thank you.

Thanks, Rod.

John Murphy, Bank of America, Merrill Lynch.

Good morning, guys.

Good morning, John.

Hi, guys. I mostly have a short term question that has been asked and answered here. Just curious on this thing. When you look at your (inaudible) --. (technical difficulties)

Excuse me, John. John, excuse me, we can't hear you very clear.

Can you hear me now?

Yes, that's better. Okay. If you could start over again, John.

Okay. Sure. You guys were highlighting the Germans are actually now seeing weakness with their production.

I was just curious, as you look at the mix of their business that shipped out to China and then shipped out to the US, two markets that remain relatively strong for sales and actually may be improving as we go into next year. As we think about your content on those vehicles, can you mention, better or worse, maybe on a dollar basis or just directionally what those vehicles have versus what is actually being shipped into Europe?

I would -- John, I would say the one way to look at it is Europe as a percentage of our total business is about 56% of our sales. About 5% to 8% of our total sales go from out of that European content into North America or to China, primarily. And, I would say the content on those vehicles is relatively similar to what we would have in Europe.

So, the vehicle mix, said a different way, John, or the mix that we see in Europe, how that helps us in our base European business, it is probably similar on that 5% to 8% of our Business that gets exported out to predominantly China and the US. If that helps you out, John.

Yes, so the strength in China and the US would only be a very small offset to weakness in Europe, is what I'm getting at. Is that a correct characterization?

Yes, it helps us a little bit, but that is a good assumption, John.

Okay, and then, also, just in the longer term, we're slowly seeing the death of the dream of the electric car here in many different avenues. It is becoming more obvious that is not a near-term phenomenon. I'm just curious, as that becomes more of a reality, is -- the slowing of that, or the death of that, are you seeing more quoting activity or more interest from some of the automakers that were really putting a big focus on electric vehicles? And them shifting maybe their long term and even short term strategies?

Yes, the death of the dream is an interesting phrase, John. I've not heard that one before. But, what we're seeing, and what we've continued to see, is somewhat of a reduced or diminished focus on electric vehicles and more and more focus on the internal combustion engine technology and hybrid technology.

And, the type of transmission technology that we've always talked about. So, we're' seeing that activity very, very strong. And, I agree with you, we see less focus, less enthusiasm around full electric vehicle.

Okay, great. Thank you, very much, guys.

Thanks.

We have time for one final question. Joseph Spak, RBC Capital Markets.

Hi, good morning, and thanks for squeezing me in. I just wanted to quickly go back to the outperformance in Europe. I just want to, from a longer term perspective, make sure I'm thinking about this correctly. If we are to enter a period in Europe over the next three, four years where it is flattish growth, do you still see enough content being added and penetration to get back that 8% to 10% for out-performance in that region?

The way I would think about it is if I look at -- just look at this year-to-date, or if you look at this year where we've seen some pretty significant reductions in Europe, and, our out-performance has stayed through that. Now, will that change a couple of percentage points quarter-to-quarter? That's very possible. We can't always say every quarter it is going to be 8% to 10%.

There is vehicle mix. There's things that go on. But, fundamentally, I look at this year, and I look at a challenging quarter like the third quarter, I look at the fourth quarter, I look at the reductions that we're seeing in European schedules, and our performance in Europe remains to outperform that. So, that is how I'm viewing it.

I look more at what has happened and our actuals to give me comfort and confidence. So, the short story is yes, I believe we will continue to outgrow, outperform Europe. Will that always 8% to 10%? Will it be a little less, a little more? There will always be some variability. But, the fundamentals of us outperforming Europe will continue on, is my view.

Okay. And then, moving on to the luxury, where there is a obviously a little bit of catch up in destocking. Is it fair to assume that, given that it is a smaller market than the volume market, that the destocking could happen over a quicker time frame than what we've seen occur in the volume market?

Could it be quicker? Yes, that's a good question. I'm not really sure it would be quicker. I mean, to your point it is a smaller piece of the overall pie. But, they can adjust those schedules the same as I would say the high volume schedules, so I don't view it fundamentally differently. If that makes sense to you.

Okay. And then, just one housekeeping, and I apologize if I missed this. But, are there any further buybacks factored into the outlook?

At this point, no, there is not.

Okay. Thanks a lot, guys.

Thank you.

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

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