博格華納 (BWA) 2012 Q4 法說會逐字稿

Good morning. My name is Brandi and I will be your conference facilitator. At this time I would like to welcome everyone to the BorgWarner 2012 fourth-quarter earnings release conference call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. (Operator Instructions) I would now like to turn the call over to Ken Lamb, Director of Investor Relations. Mr. Lamb, you may begin your conference.

Thank you, Brandi. Good morning and thank you all for joining us. We issued our earnings release this morning at approximately 8 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 February 21. The dial-in number for that replay is 800-585-8367. You will need the conference ID which is 93239384. The replay will also be available on our website.

With regard to our IR calendar, we will be attending a number of conferences over the next couple of months. February 20 we will be at the Barclay's Industrial Select Conference in Miami, March 12 we will be at the UBS Auto Supplier Mini Conference in Boston, March 19 we will be at the Sidoti Emerging Growth Conference in New York, and on March 27 we will be at the BofA Merrill Lynch Auto Summit 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 10-K. Our actual results may differ significantly from the matters discussed today.

Now moving on to our results. James Verrier, President and CEO, will comment on fourth-quarter and full-year results and current industry trends. Then Ron Hundzinski, our CFO, will discuss the details of our operating results and also our outlook for 2013. With that I will turn it over to James.

Thank you, Ken, and good day to everybody. Today I am very pleased to review our fourth-quarter and full-year results as well as our fourth-quarter accomplishments.

First off, I would like to congratulate all the BorgWarner employees on a truly outstanding 2012. Your dedication to our customers and shareholders is reflected in the Company's strong performance for this year.

Now on to our results and I will start with the fourth quarter. Reported sales were $1.7 billion, flat from a year ago excluding the impact of foreign currencies and dispositions made in the last 12 months. US GAAP earnings were $1.03 per share, but excluding the noncomparable items earnings were $1.16 per share.

Our reported operating income margin was 9.9%, but again, as we exclude noncomparable items our operating income margin was 10.9% in the quarter. Ron will discuss the noncomparable items later.

Now two key factors drove our results. First, our sales were impacted by a weak production environment, most notably light vehicles in Europe and commercial vehicles globally. And, secondly, strong operational efficiency and cost controls enabled us to post a solid operating margin despite challenging conditions.

If I look into the segments, first, the Engine Group, fourth-quarter sales were about $1.2 billion. That is down 2% from a year ago after excluding the impact of foreign currencies and dispositions made during the last 12 months. Our results were led by turbocharger growth in China, increased sales of BCT in Japan, but these positive results were offset significantly by the lower production volumes in Europe.

Now to the Drivetrain Group, sales were about $560 million and that is up 5% from the fourth quarter of 2011 excluding foreign currencies. Drivetrain's results were driven by increased all-wheel-drive system sales in North America and India, and we saw growth in traditional AT component sales in Korea. This more than offset the lower production volumes in Europe.

Now let me move to the full year. Reported sales were just over $7.1 billion, and after excluding the impact of foreign currencies and M&A activity, sales were up 6% from 2011. This represents strong sales growth considering the light vehicle production in Europe, a market which comprises nearly half of our sales, was down 6%.

US GAAP earnings were $4.17 per share, but after we exclude the noncomparable items net earnings were $4.97 per share, which is up 12% from 2011.

Our full-year reported operating income margin was 10.5%, or 11.7% as we exclude the noncomparable items. So in all three key metrics -- sales, earnings, and operating income margin -- we achieved all-time records in 2012. This is a tremendous accomplishment when we consider the weak market conditions in which it was achieved.

Now looking to the future, BorgWarner continues to invest for the long term. Our capital spending continues to grow. For the full year we spent about 5% of sales and we remain committed to supporting our future growth and productivity improvements.

Our spending for R&D was about 3.9% of sales in the quarter and about 3.7% for the full year, and we continue to trend toward our targeted level of 4% for R&D spending.

I'm also proud to review some exciting announcements we made during the quarter. In November we reported an expected backlog of $2.3 billion of net new business for the years 2013 through 2015 as demand for our advanced powertrain technologies remains very strong in the foreseeable future.

BorgWarner supplies its three-stage turbocharger technology to B&W for its M Performance diesel engine. The new engine is the most powerful six-cylinder diesel engine in the world.

We also opened another production facility at our campus in Ningbo, China. This high-tech facility will support engine timing and VCT components to support the launch of over 50 programs with 20 Chinese customers. The opening ceremony also celebrated the inauguration of BorgWarner's world-class Ningbo Engineering Center, which provides research and development, application engineering, and management support.

Now I would like to review our current outlook for 2013 light vehicle production. We first announced our 2013 outlook at the Deutsche Bank Automotive Conference in Detroit last month and our view is unchanged from that forecast.

We expect total global production volumes to be up approximately 1% from 2012. In North America we expect production volumes to be 2% from 2012. We expect Europe to be down 3%, China up 10%, and Japan down 10%.

In the commercial vehicle market generally we expect stability in 2013 but not much growth. For most of the markets in which we participate, Europe, North America, and China, we expect production to be flat compared with 2012. In Brazil, however, we do see the potential for low double-digit growth.

Finally, our sales and earnings guidance for 2013 also remains unchanged from our announcement last month as sales growth in 2013 is expected to be 2% to 6%, or 3% to 7% when we exclude 2012 dispositions. Our 2013 earnings guidance is $5.15 to $5.45 per share and our operating margin is expected to be 11.5% or better for the year. I am confident 2013 will be another strong year for BorgWarner.

So as I mentioned before, 2012 was a tough year from a macro perspective; however, BorgWarner's financial results underscored our operational proficiency and our ability to manage costs during challenging times. As we look ahead we see that the outlook for our business remains strong. In 2013 we expect to grow sales and profits for the fourth year in a row with more growth to come in 2014 and beyond.

No company in the auto sector is better positioned for long-term profitable growth than BorgWarner. The industry's adoption of our leading-edge powertrain technology will continue for years, and because of this I feel very, very good about the Company's future.

So with that now I would like to turn the call over to Ron. Thank you.

Thanks, James, 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 1% in the fourth quarter compared with the same quarter last year. BorgWarner's reported sales were down 3% from a year ago, but as James explained earlier, if we exclude the impact of foreign currencies and M&A activity in 2011 and 2012, our sales in the quarter were flat with last year.

To get a clear picture of our performance relative to the market we need to review the light vehicle and commercial vehicle market separately. First, let's take a closer look at the light vehicle market from a regional perspective.

In Asia, which I am defining as China, Korea, and Japan, light vehicle production was up 6%. Our light vehicle sales in Asia, excluding currency, was up 13%. In Europe, light vehicle production was down around 11% in the quarter. Our light vehicle sales, excluding currency and 2011 and 2012 disposals, were down 4%. In North America light vehicle production was up 8%. Our light vehicle sales growth in North America was about 10%, slightly better than the market.

Now let's review the commercial vehicle market. The fourth quarter saw continued weakness in the commercial vehicle markets around the world. Commercial vehicle production in Brazil and China were sharply lower while North America and Europe were basically flat. As a result, our commercial vehicle sales were down 10% in the quarter.

So to summarize, our typical outperformance of the light vehicle markets was intact in Asia and Europe in the fourth quarter. Despite outperforming the market in Europe, the 11% volume decline in that market had a meaningful impact on our total company growth in the quarter. Weak commercial vehicle markets around the world resulted in a 10% sales decline for us in a segment representing nearly 20% of our business.

Now working down the income statement, gross profit as a percentage of sales was 20% for the quarter. That is down slightly from 20.3% a year ago, but includes about $2 million to $3 million of higher raw material prices. SG&A expenses were 9.1% of sales in the quarter versus 8.3% of sales in the fourth quarter of last year. The increase was primarily due to an increase in R&D spending, which as a percentage of sales was 3.9% in the fourth quarter of 2012, up 50 basis points from a year ago.

Reported operating income in the quarter was $171 million; however, this includes $17 million of related retirement obligations. There were two parts to this charge. The first part is a $6 million loss related to partial settlement of a pension obligations associated with our now closed drivetrain facility in Muncie, Indiana. The second part is an $11 million charge related to the Company's decision to waive the forfeiture provisions of an existing stock grant made to certain retiring named executive officers.

Excluding the $17 million charge, operating income was $188 million, or 10.9% of sales, compared with $213 million, or 12% of sales, on a comparable basis a year ago. About half of the 110 basis point decline in margin is related to higher R&D spending as I mentioned before. The rest of the margin decline is primarily related to typical cost pressures, including inflation and price bounce to customers, which we usually offset with growth-related income but were unable to do so in a challenging environment for growth in the fourth quarter.

After excluding the impact of foreign currency in non-comparable items in both these quarters, both this quarter and the fourth quarter of 2011, our incremental margin was not measurable as we had lower operating income on flat sales.

As you look further down the income statement equity and affiliate earnings was $10 million in the quarter, flat with last year. This represents the performance of NSK-Warner, our 50/50 joint venture in Japan, which sells transmission components to Japanese customers in Japan and China as well as TEL, our turbocharger joint venture in India.

Interest expense and finance charges were $7 million in the quarter, down from $17 million a year ago. This was primarily due to the maturity of our convertible debt settlement with Treasury shares in mid-April. Note that this reduction and convertible-related interest expense did not impact earnings per share. We had been calculating EPS on an if-converted basis from the first quarter 2010 until the securities matured in April of 2012.

Provision for income taxes was $48 million in the quarter, which is a 28% effective tax rate; however, the provision included two items. The first is a $6 million tax benefit associated with the retirement-related obligations I mentioned earlier and a $3 million of net unfavorable tax adjustments which include the closure of certain tax audits and other tax assets no longer viable.

Excluding these items, our tax expense was $51 million in the quarter, or a run rate effective tax rate of just under 26%. For the full year our run rate effective tax rate was 26.8%, in line with our guidance of 27%.

Net earnings attributable to noncontrolling interest was $5.4 million in the quarter, up slightly from $5.2 million a year ago. This line item reflects our minority partner's share in the earnings performance of our Korean and Chinese consolidated joint ventures.

Let's go back to earnings per share which was $120 million in the quarter, net earnings, or $1.03 per share on a reported basis. On a comparable basis, net earnings were $136 million in the quarter, or $1.16 per share, slightly down from $1.19 per share a year ago. That is a 3% decline in earnings per share on flat sales. Good performance for the Company, considering the challenging market conditions, and in line with our guidance provided last October.

Also note that foreign currency reduced earnings per share by about $0.02 in the quarter.

As James mentioned, 2012 was a record year for sales, earnings, and operating income on a comparable basis. Additionally, our full-year incremental margin was 17% excluding the impact of foreign currency and 2011 and 2012 dispositions. This is excellent performance considering the weak market conditions in which it was achieved.

Now let's take a closer look at the operating groups. The Engine Group sales were just under $1.2 billion in the quarter. Excluding currency and 2011 and 2012 dispositions, Engine Group sales were down 2% compared with the fourth quarter of 2011.

Adjusted EBIT for the Engine Group was $182 million in the quarter, or 15.6% of sales. That is down from 16.3% adjusted EBIT margin reported a year ago. The year-over-year decremental margin, excluding currency and 2011 and 2012 dispositions, was about 80%.

This is below our typical results, but distorted by a couple of very unique items. The higher R&D spend, as I mentioned before, was almost entirely in the Engine Group. The investment for the long term was required despite the weak market conditions that impacted our sales in the quarter. We also had a customer-specific issue in our North American commercial vehicle business as well.

For the full year, the Engine Group's adjusted EBIT margin was 16% and that is an all-time record for the Engine Group.

In the Drivetrain Group sales were about $560 million in the quarter. Excluding currency, Drivetrain Group sales were up 5% compared with the fourth quarter 2011. On a reported basis adjusted EBIT was $49 million, or 8.8% of sales, in line with the fourth quarter of 2011.

The year-over-year incremental margin for the Drivetrain Group, excluding currency, was about 6%. The year-over-year variance in the Drivetrain Group's financials were very small, a $2 million improvement in operating income over a $26 million improvement in sales. When the variances are that small minor changes in the business can have a meaningful impact on the incremental margin calculation. For the full year the Drivetrain Group's adjusted EBIT margin was 9.1%, which was on target with our guidance of 9% or better.

Moving to the balance sheet and cash flow. If you look at the balance sheet and cash flow, we generated $879 million of net cash from operating activities in 2012. That is up $171 million from 2011 and was driven by a strong focus on working capital management that generated that extra cash flow.

Capital spending was $407 million in 2012, up $13 million from the same period a year ago. Our capital spending is required to support our program launches around the world, in particularly 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 $472 million.

Looking at the balance sheet itself, balance sheet debt decreased by $262 million compared with the end of 2011. Cash increased by $356 million during the same period. This $618 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. We spent just under $300 million to repurchase 4.2 million shares in 2012, including 1.5 million shares in the fourth quarter.

At the end of the year our net debt to capital ratio was 10% compared with 28.3% at the end of 2011. Net debt to EBITDA at the end of 2012 on a trailing 12-month basis was 0.3 times. Our capital structure remains in excellent shape.

Now moving on to 2013 guidance. Now I would like to discuss a little bit more of the details of the 2013 guidance, which is basically unchanged from what we provided last month. James reviewed our guidance at a high level, but I will go in more finer points here.

Our sales growth expectations of 2% to 6%, or 3% to 7% excluding 2012 dispositions, assumes no currency impact. We recognize that the euro is trending stronger than original guidance of $1.28 to EUR1, but conversely the Japanese yen is trending weaker than we expected. If currencies remain unchanged from today's spot rates we will see some benefit, primarily due to the strength of the euro.

We expect raw material inflation of $15 million to $20 million in 2013, down from just under $30 million in 2012. As James mentioned earlier, our operating income margin is expected to be 11.5% or better in 2013. Similar to our 2012 margins. In other words, despite sales growth below the typical 8% to 10% we need to maintain margins, we expect to come very close to maintaining margins this year.

Slower sales growth will mean less incremental income to offset the inflationary cost pressures, but we expect to supplement our incremental income with increased productivity gains and spending controls. Our expected tax rate of approximately 27% for 2013 is in part based on an assumed level of cash repatriation from foreign operations. If our cash repatriation strategy is modified our tax rate could trend slightly higher. We will provide quarterly updates on this as we progress through the year.

Our diluted share count at the end of 2012 was approximately 117 million shares. This is the approximate share count on which our guidance is based. Any dilution from equity-based compensation in 2013 is assumed to be offset by the share repurchases and any additional share repurchase that we may execute over the course of the year are not factored in our guidance.

So in conclusion, we continue to be confident in our ability to execute in any market. 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 each of the last three years.

Weak market conditions, particularly in Europe, will likely result in sales growth below our long-term trend in 2013. Despite this 2013 should be another year of record sales and record profits for BorgWarner. 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 return the call over back to Ken.

Thanks, Ron. Now let's move to the Q&A portion of the call. I will ask the call coordinator to please announce the Q&A procedure.

(Operator Instructions) Rich Kwas, Wells Fargo Securities.

Good morning, everyone. Ron, in terms of the guide, I know unchanged for the year, but Europe is going to be down pretty significantly in terms of production in the first quarter. I know you don't give quarterly guidance, but just generally speaking how should we think about the cadence of the earnings performance as the year goes on?

I would say that it is incrementally improving throughout the year, Rich, so every quarter on quarter it is improving.

Okay. So is that kind of the sequential comment on the EPS line, sequentially improving?

Yes.

Okay, all right. Then anything from a mix standpoint that we should be aware of as it relates to Europe or other parts of the world? I know European mix got worse as 2012 progressed. What is the assumption there for 2013 as it relates to that?

Rich, this is James. Good morning. As we look out into the year we are seeing not a significant change in mix as we are looking out.

As you know, as we came towards the end of last year the high end, higher contented vehicles kind of caught up a little bit as the year progressed. We have got that assumption into our guidance and we feel pretty comfortable that that mix level is not going to shift too significantly. So that is where we are seeing it right now.

Okay. Then just on the Consumer Reports article from a week or so ago. They came out, as you are probably aware, they came out with some negative comments about the benefits of turbochargers and the OEMs have kind of backed the performance in terms of what they have seen. But what are your thoughts on that?

I can imagine -- I know where your stance is, but just what is your thoughts on the report? And what are any -- are you aware of any key differences in terms of the testing? Or any color you could share on your thoughts would be helpful.

We are fully aware of it, obviously, Rich. I would say with any of those types of reports we take them very seriously. We certainly don't want to dismiss them or anything like that, so we do take a hard look at anything like that, particularly when it relates, obviously, to one of our core products.

But I think there is a couple of key points here. In that specific report -- it is very difficult to get a sense of what the testing and driving conditions that are associated with the results that are coming out of that report. As you know, Rich, and I think everybody else kind of gets it, that you can get variations in the results that you get depending on what test cycle you use, what type of driving behavior actually independent of any technology. So that is our view.

I mean at a simple level, though, our view is that almost every indicator we look at towards turbocharger penetration continues to be very strong. We see that in our quoting activity. We see it in our net new book of business.

We are not seeing any slowdown in adoption rates. We are not seeing any slowdown in activity and interest levels from customers. And I think that is just driven by, from our view, the fundamentals of turbochargers remain extremely solid.

It is a key technology to help the engineers downsize their engines and get the type of fuel economy that we need. We have seen that success all around the world for many, many years and we just see that trend continuing on.

So, in a nutshell, we pay attention to the report but we pay attention to all of those reports. And there is an awful lot of them that are very positive about turbocharger performance and adoption rates. So hopefully that helps you a little bit, Rich.

Yes, it does. All right, thanks, I will pass it on. Thanks.

Chris Ceraso, Credit Suisse.

Thanks. Good morning. Maybe just a follow-up on that, James. So I think the big picture is the difference between what the EPA says fuel economy is versus what real-world driving is. And as point out, it is not just turbo; it is a host of different technologies.

But I wonder if the EPA sort of figures this out and says, you know what, we need more realistic testing procedures and window sticker numbers end up coming down a little bit, does that threaten at all what you think car companies will be willing to pay for certain technologies? Had there been a link in the past where they said, okay, if I add a turbo I am going to get a 15% bump in my window sticker number; maybe now it is only 10% so I am not going to pay as much as for turbos? Do you think that is a risk?

In a nutshell, Chris, I don't see that as a risk. I think there is always a discussion around real-world driving conditions and the stated conditions, as I have said, independent of technology. So I don't see that as a risk to us.

We remain very comfortable as we work with the OEMs and they go through all the testing and validation that they go through. And the data that they are seeing is still consistently driving towards the type of technologies that BorgWarner has in the profile. So we are not seeing this as a significant risk to BorgWarner at all, Chris.

Okay. So even the OEM data supports the improvement, so they are willing to go for the technology?

Yes, absolutely. That is why we continue to see the adoption rates and penetration rates of the BorgWarner-type products that we offer.

Okay. Then a follow-up again for Ron about the progression of earnings through the year. Not to get too cute, but typically your cadence is roughly 50% first half, 50% back half. Do you expect this year it will be more like 40%/60%, or can you give us some bands around first half versus back half?

So we are talking sequentially, right, Chris, first of all. I would have to go back and take a look at some numbers here. I would say it is more weighted to the back half of the year. I wouldn't say it is 50/50. I would say it is more back-end weighted than it is front weighted.

Right, of course. The question is normally you are 50%/50%. Is this year going to be more like 40% first half, 60% back half? How tilted is it is the question.

It is not material; I guess I will say it that way. There is going to be a slight difference, but it is not material.

Okay. Then just lastly on the incremental margins. Drivetrain you commented was pretty low, sub 10%. What is your expectation there for 2013?

Our guidance on total company is 11.5%-plus or better, very similar to what we saw in 2012. I would suggest that operating margins within those segments would be relatively similar as well in 2013 as they were in 2012.

Okay. All right, thank you.

Joe Spak, RBC Capital Markets.

Is there any update on a -- I know in the past you have talked about being able to flex down in Europe on some of the temporary workers. Can you give us just the latest metrics there and what you see going forward?

Sure, let me talk to that. Just a quick recap, where we were last year was we were in the mid-20%s type number. And to clarify that is temporary employees as a percentage of total direct temporary employees.

So we were in the mid-20%s in the second quarter, and as we explain I think in the past that we would come down to high-single digits, that type of range, that is fairly much where we are at. So we may be in the 10%, 12%, 13% type range of temps as we are going into the year and we think that is a pretty good number for us if there is any further erosion.

Just to add another comment on to that though, as we look around the world we are still seeing growth in all parts of the world from a BorgWarner perspective. The markets may -- production volumes may be down, but from a BorgWarner perspective we are still seeing growth in every region of the world. So we feel good that we have got that 10% to 15% type number of temporary employees in place.

Okay, great. Then any updated thoughts on the cash? The free cash flow guidance is again strong for 2013; the cash balance builds quite quickly.

So I know you talked about repatriating the cash. That would lead me to believe it is maybe not as M&A focused as in the past. Can you just provide any more color there?

I wouldn't say it is not M&A focused. I think that is our number one focus is M&A. I am very much aware of where my balance sheet is and where the cash, and like I demonstrated in the fourth quarter, I am being very proactive in addressing that with the share repurchases.

So that flexibility still continues for me, but we are very much M&A focused on where the cash needs to be, where we need to spend the cash.

Okay, thanks.

Brett Hoselton, KeyBanc Securities.

Good morning James, Ron, Ken. Two questions for you. First of all, with reduction regards to production, [there is] some concern that European production is going to be down in the first quarter.

My question is as you talk to your customers about Europe in particular with regards to first-quarter production schedules, with regards to full-year production schedules do you sense a particular bias towards the upside or the downside? I think everybody was surprised that fourth quarter came in better than expected. I am wondering what is the first quarter shaping up like.

Let me take a shot at that, Brett, and talk about the year first of all, the 3% down for light vehicle production in Europe that we talked about a few weeks ago. We still feel good about that number. We feel pretty comfortable, and I would say as we have rolled through the first couple of weeks here in the year it is off to a decent start.

There is nothing we have seen in our January run rates as we go into February run rates that would make us feel uncomfortable at all. I think we feel good about where we are at from a run rate perspective from where we were, say, five or six weeks ago.

I think if you take it in a slightly broader perspective it seems to me that the range of guidance on European light vehicle production seems to have narrowed a little bit. I think people were talking some fairly large spreads of what it could be a couple of months ago and that seems to be narrowing a little bit.

So the bottom line, Brett, we feel pretty good where we are at from a guide of the 3% down.

Okay, thank you. Ron, can you maybe get a little bit more -- provide a little bit more color on your expectations for share repurchases? I mean over the past 10 or 15 years as I have covered you you have never really been an aggressive repurchaser of shares. And this past quarter you have gone out and bought 1.5 million shares.

You obviously have a very good balance sheet, and I know your priority is to grow the business and make acquisitions and so forth. But I am wondering what are your expectations for share repurchase over the next year, two years, or something along those lines.

Brett, we have never announced a formal program as you know. The way I would say this is that the M&A activities are not always at a schedule that you would like to have the transactions done every year so much. So as our cash starts to build on the balance sheet I am very much aware of the leverage initiative we have on our balance sheet, which then says I need to be much more proactive in those periods where the M&A activity is slower and that I have to return capital using the flexibility of share repurchases.

So what I would say is that I use share repurchases in a periods of time where the M&A activity is not being able to close a transaction. It gives me the flexibility to still maintain a return of capital strategy for our investors while the M&A activities that we do internally continue. Does that help you?

Yes, absolutely. Is there any particular metric or threshold that you use as a guide to say, look, if I got X amount of cash or X leverage ratio and I start to get beyond a certain point I'm going to use that is excess and I ought to use that to repurchase shares?

There is several things that go on, Brett, that I look at internally. We do some valuation modeling ourselves internally for the Company, so I got a basis from where I think the value should be. We take a look at the stock prices as well. We know where we are at on M&A activity.

So it is not just one item. I look at several items that is going on at a given time and we make decisions based on that. Do we have a targeted net debt to equity ratio in all of that? We have been higher in the mid-20%, as you know, in the past but I wouldn't say it is one metric that I use to determine what I am going to do and when I do it. It is several factors.

Fair enough. Thank you very much, gentlemen.

Rod Lache, Deutsche Bank.

Good morning, everyone. It's actually Pat Nolan on for Rob. Just a couple of questions.

First, on the cost side -- and I apologize, I missed the first part of this -- where are you expecting R&D to sales to be for the full year in 2013? As we are looking further out as to a potential production recovery in 2014 you are doing a very good job this year of controlling costs, actually keeping flat margins without the historic high single-digit growth you have said you needed to have to maintain margins. Does that imply the incrementals in the eventual production recovery won't be as high as historic because the costs will come back a little bit faster?

Let me answer the first question first on the R&D spend. We have always stated that our targeted percent to sales of R&D spend is 4% and we got to 3.9% in the fourth quarter. And I would say that our target still is the 4%.

Now can you go through that second part, because it was kind of a long question? Exactly what you are trying to get at in the second part of your question.

I apologize. So this year you are doing a very good job of controlling costs and as a result you are able to maintain margins with lower growth than you have historically needed to achieve flat margins. So in the eventual production recovery that we could see in 2014 and 2015 does that mean your incremental margins would be lower than your historical because the costs would come back in a little bit faster?

No, no. Okay, I see what the question is. As we start to get growth again on the top line my incremental margin will be in that 20%-ish range, plus or minus. That is where you could expect our margin, that is where we drive our business is at that 20% range.

Okay. So the cost-cutting measure you are taking in 2013 we should view those as temporary measures that eventually that cost [is set to] come back?

Pat, I wouldn't classify them as cost reductions. I would classify them more as cost controls I guess. There is a difference.

What we would do is we will defer certain investments at times. It is not that I am taking costs necessarily out. Now with that said, we are being more productive. I am not wanting to discount the productivity side of it, but that is just normal work.

So we are not taking out people and costs right now. We are just being very prudent on many line items in our expense reports as far as where we want to put investments in the short term and what we can defer as far as investment. So it is more cost controls than cost reductions.

If I could just sneak one more in. Can you give us a rule of thumb for your yen sensitivity to the top line and how it flows through the margin?

We have a facility in Japan. It is not a significant portion of our exposure, quite frankly, but it can impact us. We just point it out because it is a sizable operation we have up there. It's -- I'm trying to think percent of sales.

3.5%.

Yes, 3.5% of sales.

Okay, that is helpful. Thank you.

David Leiker, Robert W. Baird.

So I want to take a cut at this quarterly number in a different fashion. As we are hearing a lot of comment that some of those production cuts you saw in December, particularly with Audi, carried over into the first quarter January. As we look at Q4 to Q1 what things do you think are different? Weather is about the same, seasonality is about the same. What things do you think are different that make Q1 different than what we saw in Q4?

You are referring to the market?

Your earnings.

Oh, earnings, earnings. What I would say is that, obviously, the top line sequentially has to be looked at very closely.

Going through the cost structure side of it I think we managed our gross profit margin fairly well. We were down 30 basis points year over year. I would suspect that we can maintain decent gross profit margins as well going sequentially.

If you go further down the SG&A line items, in corporate charges there were some, what I would call some investments in the fourth quarter that maybe increased the spend in the corporate line items and SG&A, especially the R&D spend. Maybe that would go back to a more normalized spend level. David, that help you?

Great, that is useful. Then just to circle back on this turbocharger thing. I think some of what has gone around in the market here are people -- I think Consumer Reports was comparing a 1.6 liter normally aspirated engine with a 1.6 liter turbocharged engine.

And I think, James, in that scenario the fuel economy differences may not be that great. What is the real opportunity for the (inaudible) doing a 1.2 turbocharged engine versus a 1.6 liter. Is that some of the misunderstanding that is going on here?

That could well be, David. Your example there is a good one. I mean not to keep repeating myself, but I think the key here is the fundamentals of what we are doing with turbochargers is generally to enable the downsizing of the engine and maintain similar levels of performance and get good fuel economy. And that fundamentals still remains intact.

We have got this test data out there with this Consumer Report and it is very easy to mix and match and not draw the appropriate conclusion.

What is the fuel efficiency gain on a 1.6 liter versus a 1.6 liter turbo? It is single-digit percentages, isn't it?

First of all, I don't want to comment for Ford, David, on that particular thing. They would be better, because it can depend on the whole issue of the calibration of the engine and what other technologies they are utilizing on that engine. So I don't want to comment specifically for Ford on that 1.6 application.

Okay, I was just talking generically. Then on Europe on the truck side there is a Euro VI emission change here at the start of 2014.

I guess two questions. One, does Euro VI present a content opportunity for you as you look to 2014? Secondly, what are your thoughts of whether there is a pre-buy there or not that might push off launches of 2014 Euro VI engines?

The first part, David, I think as we migrate to Euro VI in general that will help us as they adopt more technology to that level of engine. So that at a general level will help BorgWarner.

In terms of a kind of pre-buy as we get through 2013, ahead of 2014, I don't think that is going to be significant for us. We are actually showing Europe year over year about flat for commercial vehicle, so not significant or material for us in terms of pre-buy. But Euro VI does help us a little bit from a technology perspective.

Okay, great. Thank you very much.

Itay Micaheli, Citigroup.

Good morning. Just want to go back to cash deployment. Ron, you mentioned M&A still a top priority but typically when the environment isn't as active you do go out and buy back more stock.

So is it fair to characterize the current environment as not particularly active in terms of what you are seeing out there in M&A? And if so, why? Maybe you can just talk about the M&A landscape a little bit. What you are seeing out there, what is available out there, and so one.

I would not say that M&A activity is not active. It is extremely active. What I was referring to is that the ability to close a transaction currently in the environment we are a little behind paste than we would like, quite frankly. But I would not say that the activity level is any lower than it ever has been. In fact, it is I would say increased in some ways.

So if I said that activity was decreasing I didn't mean to say it that way.

Okay, that is helpful. That is good to hear. Then just in terms of a couple housekeeping items, just help us in terms of how to think about interest expense in 2013; is Q4 a good run rate. And then also depreciation and amortization.

Interest rate I would say is what you saw on the end of the fourth quarter is a good run rate going forward. Depreciation and amortization on a full-year basis has been around that 4% of sales. I think it was slightly higher in the fourth quarter, but I think you are going to have to look at it on a total year basis it's at that 4%.

That is helpful. Then just lastly as we just sharpen up our euro sensitivities. Can you remind us how the European operating margin fee looks relative to the corporate average?

They are the same, so if you are trying to understand what margin impact would be on a change on the euro I would use the corporate average.

Still the corporate average. Great, thanks so much.

Colin Langan, UBS.

This is (inaudible) on behalf of Colin. Could you provide us a little more color on what is driving the strong growth in all-wheel drive, and is this becoming the story for the drivetrain business going forward?

It is a couple of things that are going on. First of all, it is a critical part of our growth plan and we are very confident about the growth opportunities for the all-wheel drive segment.

It is a couple of things that we are benefiting from. Our transfer case content in the North American market is strong as we have seen growth and recovery in the North American market, and our acquired business, the Haldex business, from a coupling perspective is also seeing significant growth in different parts of the world.

So, if you like, both parts of the all-wheel drive segment for us, both couplings and transfer cases, are seeing both growth in the region and some incremental gains.

What sort of potential does it have to outperform the industry production over the next couple of years?

I would say there is probably a little more opportunity on the coupling side of the business for us versus the transfer case side of the business. But as we look at our long-term projection we see some level of outperformance on the transfer case business and the coupling business offers us very good opportunities as we look forward.

Then one housekeeping item. The corporate expense of $33 million seemed like it was up quite notably year over year. Could you help us understand what drove that?

It was up about $8 million year over year. I actually look at the sequential, but I will address the year over year.

It is a whole host of items. Everything from a little bit of -- we put our advanced engineering expenses in corporate. The R&D expenditures related to our segments stay in the segment, so we had increased R&D spend. We had some foreign corporate offices, primarily in Germany and in Shanghai, China, that we have been adding talent to as well. But it is basically a whole host of miscellaneous items there.

And is this a good rate to model going forward?

I would -- what, from the fourth quarter or from which period?

From the fourth quarter.

I would say the fourth quarter is pretty much in line where you could expect it going forward. I mean change a few million here and there, but it is not way off.

Okay, thank you. Congrats on the great results.

Ravi Shanker, Morgan Stanley.

I only have a couple of housekeeping items left and one bigger picture question. You said you had a customer-specific issue in the quarter. Has that been resolved or is that going to continue for another quarter as well?

Ravi, this is driven by a commercial vehicle customer that had some, how to say, technology changes that they were going through that affected us. It's not really naming the customer.

I have no idea who you're talking about, but anyway.

I don't want to name the customer, Ravi. (multiple speakers)

Fair enough, understood.

It is a volume-related issue; I will say it that way. Not a cost side. Volume-related; in other words, they are changing technologies.

But is that expected to persist into next year as well?

It is related to a year-over-year comparable issue. I think the run rate on this customer will stay where it is at, but on a comparable basis it becomes an issue for us.

Okay, understood. Speaking of CV, you said that was 20% of your revenues. That is a bit higher than normal I think. It is usually in the 15% level.

So is there something going on? Is it because the European light vehicle business is so weak, or has your CV business run rate kind of stepped up a little bit?

Let me clarify that, Ravi. Commercial vehicle is about 16%, 15%. Aftermarket makes up that difference up to 20%. I kind of use 20% because I combined the two of them together because a good portion of our aftermarket really is commercial vehicle.

Understood, thanks for that. What exactly was your share count at the end of the quarter?

117.4 million.

So similar to the fourth-quarter average. Finally, a bigger picture question. When you look at R3S turbo versus R2S what are the advantages of using R3S? And do you see that as being more of a niche product of these high-performance diesels or do you think it becomes more widespread?

I think, Ravi, just my sense right now it will start out as more of a niche product. I mean if you look at the application that we are utilizing it on with BMW it will start out as more of a niche application, but will have the potential to grow.

I guess the reason I feel pretty comfortable about that is that was the same story with R2S. If you go back many years ago that was applied to a niche application and it became a little bit more mainstream. Will it become a large part of the turbo segment? Probably not, but what it does do is obviously enables us to support our customers with specific type niche applications such as this BMW M6 that we are talking about with R3.

The other follow-on comment I would make is as the technology leader, which we absolutely view ourselves as in turbochargers, it is another good example for us to utilize some of our new and breakthrough technology which the R3S is a good example of that.

Ravi, it's Ron; just want to correct something. I told you it was 117.4 million; it was actually 117.8 million, so just 400,000 share difference there. Just want to correct my number.

Got it. Thanks so much.

Matt Stover, Guggenheim Securities.

On the assets that were sold were they a favorable contributor to income or neutral, or didn't track last year?

Neutral.

Neutral, okay. Thanks very much, guys.

Brian Sponheimer, Gabelli & Co.

Just a question on the luxury automakers as they get more involved in some of the entry level luxury markets or platforms with the CLA Class and the 1 Series. How do you guys view this penetration in North America? Is it a good thing for you or is it something that could potentially dilute some of your higher content on some of your larger vehicles if consumers trade down in size?

I would say, in general, it is good for us. As we look at the luxury guys bringing those types of vehicles in our sense is that the adoption rates of the types of technologies that we have, whether it be turbochargers or other products, will be strong. So we see that as favorable.

Okay. Thank you very much.

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

Brandi, please close out the call.

That does conclude the BorgWarner 2012 fourth-quarter results earnings conference call. You may now disconnect.