博格華納 (BWA) 2016 Q3 法說會逐字稿

Good morning. My name is Chris and I will be your conference facilitator. At this time I would like to welcome everyone to the BorgWarner 2016 third-quarter results conference call.

(Operator Instructions)

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

Thank you, Chris. Good morning, and thank you all for joining us. We issued our earnings release this morning at around 8:00 AM eastern time. It's posted on our website, borgwarner.com, on our home page and on our investor relations home page.

A replay of today's conference call will be available through November 10. The dial-in number for that replay is 800-585-8367. You'll need the conference ID which is 76352046. Or you can listen to the replay on our website.

With regard to our investor relations calendar, we will be attending the following conferences between now and our next earnings release. The Baird Industrial Conference in Chicago on November 10, the Barclays Automotive Conference in New York on November 17, the UBS Industrials and Transportation conference in Key Biscayne, Florida on November 18, the Goldman Sachs Global Automotive Conference in London on December 8, and finally, the Deutsche Bank Global Auto Industry Conference in Detroit on January 11 where we will be providing our initial guidance for 2017 and updating our three-year net new business for 2017 through 2019.

Now, back to today's earnings call. 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 the industry and provide a high-level overview of our results and expectations for the remainder of 2016 and then Ron Hundzinski, our CFO, will discuss the details of our results and guidance. Please note that we have posted an earnings call presentation to the IR page of the website. You'll find the link at the events and presentation section beneath the notice for this conference call. We encourage you to follow along with these charts during our discussion of our results.

With that, I'll turn it over to James.

Thank you, Ken, and welcome to everybody, to the call. Ron and I are really pleased today to share our third quarter 2016 results with you as well as give you some thoughts and outlook for the rest of the year.

I'd like to start, actually, by sharing a few thoughts on the macro environment in the industry in general, and you can see that on slide 2 if you're following along. So just a few thoughts on the macro state of the world. I think the word that we think about is still -- there's a level of uncertainty in the macro world. I think the slowing economic growth around the world is still on everybody's mind and that's presenting some challenges. You know, the world is still not without a lot of tenseness around some of the political climate. You think of the Middle East, you think of US election and those types of things, so there's still an environment of uncertainty.

But with that said, you know, what we've seen in the auto space is things have been moving along pretty well as anticipated and as expected, particularly in the third quarter. If I turn a little more specifically to the outlook around the auto space, let me start with some comments around light vehicle 2016 calendar year. Generally, our view on the marketplace is well aligned with IHS, which is calling for approximately a 7% growth in China on light vehicle. We see about 2% growth in Europe and the US is somewhere in the 2% to 3% growth. And we, like IHS and I think many on this call, we certainly acknowledge that the US cycle is maturing and in a slower growth mode.

If I reflect where we are on commercial vehicle, I think I would characterize the global commercial vehicle space as still challenged. We see North America and South America still down and challenged for sure. We do see a little bit of improvement this year running through Western Europe and China also. So while it's a mixed bag globally, overall this space is still challenged.

I always like to start these calls and talk a little bit about areas of watch that we think are particularly relevant to BorgWarner. And I would point, for us, to three in particular. The North American mature cycle I referenced earlier, and how that's going to play out with inventory. Recently we saw Ford aligning its inventory to match sales with their production schedule reductions. I think from a BorgWarner perspective, we felt that was well contained within our guidance. But we're going to pay close attention of will there be further adjustments as we go through the fourth quarter.

The second area of watch that we pay a little bit of attention to, for sure, is diesel penetration in Western Europe, or in Europe in general. And that's true this year. If we look at how 2016 is playing out versus 2015, we see about a 2 percentage point drop in diesel penetration in Europe. And we've talked about this for a long time, we've been watching this trend of a decline in diesel, and I think we're very well prepared as BorgWarner as we've been aligning our products closely around gasoline and hybrid technology.

The third area we're paying close attention to is China. We're enjoying some strong growth in the third quarter, and we're going to look to see what happens with the incentives as that phases out towards the end of this year and how that plays into next year. All of that said, I would say two things so far have been going very much as planned for our guidance, and naturally we're excited to discuss our performance.

So let me talk a little bit about one other aspect before I get into our detailed numbers and that's in the regulatory and technology trend area. We still see a very strong drive around fuel economy and emissions regulations and the pull for advanced propulsion technology is not changing. There is a very robust intensity around the pull for advanced propulsion technology.

I would say within the last quarter, we've seen a notable acceleration in discussions on gas and hybrid and EV technology, and that is playing itself out. And as that transition to electrification continues, we remain very active here. Multiple customers working with us on electrification solutions, whether that be a 48-volt architecture, hybrid architecture and EVs. Not just long term, this is also for products in the here and now.

At our recent investor day, we highlighted there that we had approximately 19 new customer awards in the hybrid and electric vehicle space and I can assure you that number continues to grow. Our [quoted] activity remains robust with multiple customers and multiple products. As normal, we will publicly announce additional new business awards in this category when we receive additional customer approvals. But I will say, again, I'm very pleased with our bookings.

Our win rates remain strong and the diversification of our bookings is also exciting for us. Both regionally it's well balanced, customers it's well balanced and we're pleased with the booking rates across the combustion, hybrid and electric space. And last but certainly not least, we're also pleased with the profitability that we're booking that new business at.

So let me give a little bit of color on the financials and, obviously, Ron will step through this in a lot more detail. So I start with the third quarter at a BorgWarner level, and the conclusion for me is I'm very pleased with our third quarter. We delivered growth towards the high end of our guidance range and solid operating performance with sales of $2.2 billion, that's up 6% when we exclude FX and Remy. I think that's pretty impressive when you look at the global light vehicle production, essentially it was flat around the world with the exception of China that was a strong growth market.

Regionally it played out pretty much as expected from a BorgWarner point of view, which resulted in strong growth in China and North America and Korea, partially offset by Europe aftermarket and CV. We delivered $0.78 EPS excluding non-comparable items. And our operating margin at 12%, when we exclude Remy, that's 12.9%. Strong operating performance for us.

If we break that down by segments, the engine business was at $1.36 billion, which grew just under 4%. Primary drivers there were turbo and variable cam timing. And from a drivetrain perspective, we were $866 million reported, that's up 48%. But when we exclude currency and Remy, we grew at an impressive 11.4% in the drivetrain segment. That was primarily driven by strong all-wheel drive sales in both North America and in Europe.

Now turning to our outlook for the rest of 2016, you see we did narrow our guidance around the center of the previous range. Ron will give you more details there.

I would also say as we've gone through this year we've talked to you about some major launches that BorgWarner has been actively involved with. That's the Pentastar, with FCA, Ford Scorpion, Ford Super Duty and the GM Duramax. All have launched, and in our view, all are on track.

So the outlook for our Q4, as we step into Q4, I would articulate that our risks and opportunities are pretty well balanced. We see good strong growth in China and a slowing North America, but we think our risks and opportunities are balanced, and the punch line is we feel confident in our guidance of 3% to 5% organic growth for the quarter and continued strong operating performance.

Just a couple of comments around growth highlights, and I'll start with Remy. Ron will talk a lot more about the detailed financial aspects of the light-duty aftermarket transaction that we recently announced. I think this is a really good deal from a BorgWarner perspective. The primary thing for me strategically is this really allows the team to focus on what I would describe as the core Remy business and combining that rotating electrical expertise with the BorgWarner product offering. So this is a good transaction that we're going forward with.

I would characterize the integration going well. I think operationally and financially it's performing as expected albeit with sales coming in a little lighter, primarily driven by CV and aftermarket. We remain very positive about the strength of the technology, multiple customers are engaged with us in discussions about the combination products, particularly, again, around the motors and clutches for hybrid vehicles that we talked extensively about at our investor day.

Also a comment about M&A. The M&A pipeline remains very strong for us, very active, considering things. And as I mentioned at investor day and on prior calls, power electronics is the big priority for us as a Company.

So let me kind of summarize. I think, so far I would characterize it as been a very good year for us so far. We've delivered what we said we would do, and with my count, and this is four very strong quarters for us consecutively where we meet or beat both the top line and the bottom line.

The business is operating very well and we're heavily focused on executing the short-term performance, but also securing the growth for us in the future. Key for me is I absolutely believe we have a winning strategy that's going to focus on delivering advanced propulsion technology for combustion, hybrid and electric vehicles that will deliver the mid- to high single-digit growth that we've committed to. Finally I remain upbeat and very positive about delivering our 2016 guidance.

So with that let me turn the call over to Ron. Thank you.

Thank you, James, and good day, everyone. Before I review the financial details, I'd like to provide you some of the highlights as I see them for the quarter.

First, we saw good growth. Second, we delivered solid operating performance, and third, we continue to see improvement in CapEx spending and free cash flow generation. So now, as Ken mentioned, I will be referring to the supplement financial slide deck that is posted on our IR website. Please follow along.

First I'd like to focus your attention on slide 3. Throughout the presentation I will highlight certain non-US GAAP measures to provide a clear picture of how the core business performed, and for comparisons with prior periods. Specifically, we will be excluding the impact of foreign currency, Remy and non-comparable items from certain US GAAP measures. When you hear me say on a comparable basis, that means excluding the impact of foreign currencies, Remy and non-comparable items. When you hear me say on a reported basis, that means US GAAP.

So let's turn to slide 4. On a reported basis, which includes the change in sales due to market growth, price, net new business and currency, and the Remy acquisition, sales were up 17.5%. On a comparable basis, our sales are up 6.1% toward the high end of our guidance range. On reported basis, gross profit as a percentage of sales was 21.3% in the quarter, but on a comparable basis, gross margin was 21.9% of sales, up 70 basis points from last year.

On a reported basis, SG&A was 9.5% of sales. R&D spending, which is included in SG&A, was 4% of sales. On a comparable basis, SG&A was 9.1% of sales which is up 120 basis points from a year ago.

There's three reasons for this increase. First, R&D spending on a comparable basis was up 40 basis points from a year ago as we continued to invest in the future. I would like to point out, it was still at 4% of sales. Second, as we discussed in our second quarter earnings call, we implemented sharp cost controls in the third quarter of 2015 in response to macro uncertainty making the year-over-year comparison challenging, so about 40 basis points of this increase was due to that rough comparison. The remaining 40 points is that increase is due to higher administrative costs in the Company.

Now, let's take a look at the year-over-year comparison from operating income which can be found on slide 5. Starting on the right, third quarter 2016 operating income excluding non-comparable items, but including Remy, was $265 million or 12% of sales. If you also exclude Remy's $7 million of net contribution, operating income on a comparable basis was $259 million or 12.9% of sales, down 40 basis points from a year ago. On a comparable basis, operating income was up $8 million on $115 million of higher sales, that gives us an incremental margin of 7% in the quarter.

This performance is below trend, but was expected due to the higher SG&A spending. From an operations perspective, or if you look at the segment levels, another way of saying it, incremental margins were up actually 14% in the quarter. As you look further down the income statement, equity and affiliate earnings was about $12 million in the quarter, up from $9 million last year.

Interest expense and finance charges were $22 million in the quarter, up from $15 million a year ago. The increase is primarily due to the [$500 million euro] fixed rate senior notes that we issued in the third quarter of 2015. Provision for income taxes in the quarter, on a reported basis, was $49 million, however, this included a $31 million tax benefit related to our non-comparable item and other favorable tax adjustments. You can read about each of these adjustments in our 10-Q, which will be filed later today. Excluding these items, the provision for income taxes was $80 million for an effective tax rate of 31%, which is in line with our full-year guidance.

Net earnings attributable to non-controlling interests were about $10 million, up $1 million from the third quarter of 2015. This line represents our minority partners' share in the earnings and performance of our Korean and Chinese joint ventures.

So let's take a look at our diluted earnings per share on slide 6. Net earnings, excluding non-comparable items, but including Remy, were $0.78 per share. On a comparable basis net earnings were $0.76 per diluted share.

Now let's take a closer look at our offering segments in the quarter beginning on slide 7 of the deck. Reported engine segment net sales were $1.36 billion in the quarter. Sales growth for the engine segment on a comparable basis was 3.8%, primarily due to higher turbo charger and variable cam timing sales, partially offset by weak aftermarket and off-road commercial vehicle markets around the world.

Turning to slide 8, reported EBIT was $218 million for the engine segment or 16.1% of sales, excluding currency, adjusted EBIT was 16% of sales, down 20 basis points from the prior year. On a comparable basis, the engine segment's adjusted EBIT was up $6 million on $50 million of higher sales for an incremental margin of 12%.

Now turning to slide 9 and starting from the right, drivetrain segment net sales were $866 million in the quarter. This includes $215 million of sales from Remy. Sales growth for the drive train segment on a comparable basis was 11.4%, primarily due to higher all-wheel drive sales. Strong growth for the drivetrain segment.

On slide 10, reported EBIT was $87 million for the drivetrain segment or 10% of sales. Excluding Remy and currency, adjusted EBIT was 12.4% of sales which is up 40 basis points from the prior year. On a comparable basis, the drivetrain segment's adjusted EBIT was up $10 million on $67 million of sales for an incremental margin of 15%.

Now let's take a look at the balance sheet and cash flow. We generated $593 million of net cash from operating activities in the first nine months of the year, and that's up $123 million from a year ago. Capital spending was $355 million for the first half, which is down $64 million from a year ago. As a percentage of sales, CapEx was 5.2% of sales in the first nine months.

Free cash flow, which we define as net cash from operating activities less capital spending, was $238 million in the first nine months, up $187 million from a year ago. We are still on track to generate between $400 million and $475 million of free cash flow in 2016, at the midpoint, that's up 50% from 2015.

Looking at the balance sheet itself, balance sheet debt increased by $65 million and cash decreased by $59 million in the first nine months compared with the end of 2015. The $124 million increase in net debt was primarily due to share repurchases. We spent $250 million repurchasing just under 7.3 million shares in the first nine months, already achieving our expected $200 million to $300 million of share repurchases this year.

Our net debt to net capital ratio is 35.6% at the end of the quarter, up from 35.2% at the end of 2015. Net debt to EBITDA at the end of the quarter on a trailing 12-month basis was 1.4 times.

Now, before we move on to guidance discussion, I'd like to review the sale of the Remy's light vehicle aftermarket business announced earlier this month. As James said, strategically the business was not core. While aftermarket is an important segment for us, this aftermarket business sells to big box retailers, which is a very different business model from our aftermarket business, which sells to wholesalers and distributors.

The deal is a win-win for both the buyer and BorgWarner. The buyer has a strategic focus in this market segment. They will invest in this business and combined with this existing business gain a scale advantage. BorgWarner will retain the rotating electric components that compliment our strategic focus on hybrid and electric vehicle propulsion systems.

We sold the business for $80 million, which is a fair price. From an accounting perspective, we recorded a pretax loss of $106 million due to the revaluation of the business reflecting current market conditions.

There are two additional favorable outcomes of the deal. First, it is accretive to margins. Year to date, Remy's margins have been just over 4%. Excluding the light vehicle market business, Remy's margins would have been 100 basis points higher.

Second, due to the payment terms with its customers, that business factored the majority of its receivables, which is considered debt by the rating agencies. With the sale of that business, our debt as calculated by the rating agencies is reduced by $75 million.

Now I'd like to discuss our current 2016 guidance. Returning to the slide deck, let's start with our sales growth guidance for the full year on slide 11. Note that the baseline for 2015 net sales excludes Remy, which was just under $7.9 billion. We have narrowed our sales guidance range around the center of the previous range. All in, we expect to grow between 15.2% and 16% this year compared to 13.7% and 17.5% previously.

A few points on updated sales guidance. Our outlook for organic growth has improved. Market-related growth and new business growth net of pricing is now expected to be 4.3% to 4.8% compared with 3% to 5.5% previously and we expect the impact of currency to be less negative than it was before. However, these favorable items are offset by a weaker outlook for Remy sales, as James said earlier, primarily in the commercial vehicle and the aftermarket business.

Net-net, the midpoint of the sales guidance range is unchanged, and I'd like to make one other point here. The assumption is that the Remy aftermarket remains at BorgWarner throughout the end of the year because of uncertainty of exactly when the closing date is going to be on the sale.

Now let's take a look at our operating income guidance on slide 12. We are now expecting 13% to 14% incremental margins on our core business sales growth, which is slightly down from our previous guide of 15% to 17%. Incremental margins were about 14% through the first nine months of the year, and we expect our fourth quarter incremental margin to be in the low- to mid-teens as well. On a comparable basis, we still expect our operating income margin to be above 13%, and including Remy, our operating income margin is still expected to be greater than 12%.

On slide 13 we have our EPS guidance. We expect earnings of $3.24 to $3.28 per share, including a $0.12 per share contribution from Remy, up from $3.16 to $3.32 previously. An improved outlook on the impact of currency and a lower share count are driving the change.

Now let's review our fourth quarter guidance, which is simply the remainder of what's left in our annual guidance, starting with the sales growth on slide 14. All in, we expect to grow between 14.3% and 17.8% in the quarter, including between 10 to 12 percentage points from Remy and about one percentage point due to favorable currency.

On a comparable basis, our organic growth is expected to be between 3% and 5% in the quarter. From an earnings perspective, as shown on slide 15, we expect earnings of between $0.82 and $0.86 per share in the fourth quarter, which includes about $0.02 per share from Remy.

So in conclusion, we had a solid quarter. As James said, this is the fourth quarter in a row of exceeding our EPS and sales goals, and as we look at the remainder of the year, we expect to continue to be on this path. Solid sales growth, strong operating margins and improved cash flow from a year ago.

So with that, I'd like to turn the call back over to Ken. Thank you.

Thanks, Ron. Now let's move to the Q&A portion of the call. Chris, could you please remind everyone of the Q&A procedures?

(Operator Instructions)

Your first question comes from the line of Rich Kwas with Wells Fargo. Your line is open.

Hi, good morning, everyone.

Hey there, Rich.

How are you doing? So just on -- a question -- so on the incremental margin on a core basis, so the 13% to 14% -- is the target as we think about longer term in a stable production environment, is that still mid-teens, Ron?

I'd say it's still mid-teens, Rich, but the question is how you define mid-teens, is it 16%, is it 14%, 15%? It's in that range, 14% to 16% is what I would say, all right?

Okay. Okay. And then just -- I know you're going to give the outlook for 2017 in January, but last year when you updated the backlog, it appeared you took a more sanguine view of the market and your outgrowth over the longer term.

And so when we think about 2017 and 2018, and we think about -- now that we're 9, 10 months into the year and have a little bit better view on how 2017 may play out at least, anything that we should think about from a macro standpoint as it would potentially effect 2017 and 2018 for your backlog contribution?

Yes. Let me try to take a shot at that for you, Rich. So I think I would say, maybe a couple of things that may be helpful.

Let me say the discipline and the methodology and approach that we used for 2016, we feel good about, and the reason we feel good about that is, as Ron and I both alluded to, we've been hitting our numbers pretty well with some fluctuations in the market. We've seen noise in the market place. We've seen launch noise and macro noise.

And we've been executing really well in that mid-single-digit organic growth area or range. And so we'll be applying that same approach, that same methodology, as we march toward 2017 and 2018. I would say at general level, our launch cadence, our launch volumes, has played out pretty much, there's obviously puts and takes. So that gives me at least comfort that the methodology is solid, the business strategy is very solid, the win rates are very solid.

So, we'll go through all our mathematics, as you can imagine, in the fourth quarter, as we get ready for January. But I would say at a high level, there's nothing fundamentally there that's different to where we were thinking a year ago. And I would just say, you and we should take comfort in the way we've executed this year, both on the top line and the bottom line as we get ready for net new business in January.

Okay. And, James, just one last quick one. Thanks for that color. On China, what's kind of the going assumption at this point?

Is it that come year end the government goes cold turkey with the subsidy? Or is there any expectation, just internally as you're thinking about it, there may be some additional subsidy or some kind of incentive that continues into 2017?

Yes. Our thought right now, Rich, is that it would continue, you're right, through the fourth quarter. And we're continuing to test and question and evaluate whether that will -- whether there will be any continuation of that into 2017. It's a little early, we don't know.

Our modeling would probably suggest that it will not continue on into 2017, but things can move in that part of the world very quickly, as you well know. But we're more in the -- it likely won't continue, incentives into 2017, but we're watching it closely, Rich, in case that moves.

Okay. Thanks for the color. Appreciate it.

Your next question comes from Brian Johnson with Barclays. Your line is open.

Yes. Good morning. I have two questions. One kind of shorter term and one just revisiting some topics from your investor day.

On the short to mid-term, can you maybe give us a little color within the engine segment? I think a number of investors were braced for even slower growth there given the Ford production pressures and the European diesel shift mix, so can you give us a sense -- as well as soft-ish commercial vehicle, can you give us a sense of some of the puts and takes within the drivers of engine revenue?

Yes. I can talk a little bit about that, Brian. So you're right, commercial vehicle is not helping. I mean, frankly, there are puts and takes amongst commercial vehicle, but commercial vehicle is essentially no growth. So that's the one that impact on the engine business.

I talked a little bit about diesel mix and so if you do a year-to-date comparable, Brian, from 2015 to 2016, our view is in Western Europe it's down a couple of percentage points, and I think we've been fairly consistent through the year that that's not -- that doesn't move the needle for us materially when it moves a percent or two down.

The question as you look out, will that trend continue down, our view is it will. And we feel we're well prepared there with the growth that we're delivering on gas turbos.

In the quarter itself, the two big drivers for growth on engine were turbo and variable cam timing. Those were strong and I would say that was on a pretty global basis, so it wasn't one region particularly that stood out.

And relative to Ford, Brian, if we go back to the prior earnings call, I know there was a lot of concern on that day of Ford's lowering expectations or lowering volume projections, what are you going to do? We felt we had that pretty well contained in our guidance and we delivered. And I think, with some of their recent announcements through the last few weeks, we'd like to believe we feel pretty comfortable we've got that covered, as well, as we go into the fourth quarter. Hopefully that gives you a little bit of color that's useful, Brian.

Yes. Now on the longer term. A number of investors have remarked, in fact, we have new powertrain forecasts that have EVs in China, in particular, as well as Europe, well ahead of the IHS projections.

[Mary Barr] said on the call yesterday, she expects China's EVs to be growing faster than they -- be the region with the most to-be penetration in the next decade. I guess a couple things. One, you did talk about being neutral with those, but are you seeing any evidence in your quoting activity and any in China, vis-a-vis, EVs, are they going to skip the hybrid step and go right to EVs?

And then kind of within that, as a non-chinese player, given a lot of the market in China -- subsidies tend to favor the hometown players. How do you see playing in the emerging new energy vehicle market in China?

Yes, Brian. That's a good question. I think if you go back a little bit to investor day, and I can maybe use that as a reference point, I would say nothing has materially changed since investor day which is not a surprise because that's only a few weeks out.

I would say from a China perspective we see -- we'll see a combination, it will use hybrids and electrics. I don't think there will be no hybrids in China. I think there will be a balance, but I would tend to agree with you that the intensity and the drive towards pure battery electric vehicle is probably strongest in China than any other region of the world.

That's not to say it's not going to get adopted in Europe and North America, but there is a strong push for pure electrics in China, and we've been announcing that we're benefiting from that. Our single speed transmission technology is adopted on a number of those vehicles that are out there and we've got other products going on it.

But directionally, I would agree, Brian, that it's the fastest area which is penetrating the most from a pure EV, but I would not say it's without any hybrids because I think there will be hybrids for sure in China.

Okay. And then in terms of your position, is what you're saying maybe even if there's favoritism towards local battery suppliers, or at least locally-made batteries, things like the transmission and other elements you might involve with are more of a -- are at least a level playing field?

Yes. Maybe just -- yes, to that point, Brian, when we were articulating it at investor day, in simple numbers, the compound annual growth rate for pure electric vehicles globally, from now through 2023, was in the mid-20%s, and BorgWarner's CAGR is in the 50%s.

So, yes, we're going to benefit from EV adoption in China and it will be -- transmission is today. We're shipping those today on electric vehicles, but our thermal management products will play there together with some of the other products we highlighted at investor day. So we feel good about the drive to pure electrics in China. It's helpful for BorgWarner, Brian.

Okay. Thank you.

Thanks, Brian.

Your next question comes from Rod Lache of Deutsche bank. Your line is open.

Hello.

Hello.

Mr. Lache, your line is open. You may be on mute. Your next question comes from the line of Chris McNally of Evercore ISI.

Thanks, guys. Just a follow-on to questions on pure electrification. Could you just maybe discuss how you balance the risks given that some of the targets of region been thrown out by maybe some of the Germans, which I think we all see as somewhat aggressive.

There's been a history in the industry of overestimating penetration for electrification given consumer adoption has seemed to trail what regulators and emissions would call them ideal. It seems like you're taking a very gradually pace, but just how do we think about the pace of investment if, let's say in 2020, some of these volumes are less than expected?

Yes. It's a very good thought, and I would refer us back to the conversations we had at investor day, and it goes something like this. BorgWarner has an extremely clear strategy around being the leader in propulsion, in advanced propulsion technology, for combustion, for hybrids and electrics.

And to your point, Chris, we know that those penetration rates of the different hybrid vehicles and the different electrics are going to move around. Nobody has a crystal ball to know exactly what the penetration rate is on any of those platforms.

What we're doing, and we will continue to do, is position ourselves to offer product offering for all of those architectures and support the customers as needed. And we're putting ourselves in a position with the portfolio that we have that if hybrids accelerate a little faster than electrics or electrics go a little faster than hybrids, we will be great, because we're going to grow with any of them.

We're going to grow on hybrid content, we're going to grow on electric and we're going to grow on combustion. So I appreciate your point. I think there is some uncertainty out there, and that's what we're looking, frankly speaking, to take advantage of by offering a broader portfolio than anybody else, that we can participate and it will play out as it plays out.

BorgWarner will continue to grow in that mid-to high single-digital growth rate, independent of ships within the different propulsion architectures, if that helps you.

Yes, that's great. Is it fair to say, from your initial comments about some of the conversations accelerating, clearly over the last six months or a year, is it fair to say that's open, call it mild hybrid 48-volt, as well as sort of higher voltage plug-in and EV, that you're seeing accelerations in both categories?

It's a good thought. If I go back, maybe look at a six-month period, Chris, to use your reference point. I would say generically the shift away from diesel has intensified and increased. We don't see it as a clip event, but I think it's fair to say the shift away from diesel has probably increased over the last six months.

I think that the focus on 48-volt mild hybrid and plug-in hybrids is about the same. I think that's a strong trend and it has continued strong. And I think we've seen a stronger voice in Europe and China around pure electric vehicles. Probably the move is, if you wish, over the last six months, and again, we feel very good about that. Again, it reconfirms the fact that there will be these shifts and we're well positioned to take advantage as the shifts occur.

Great. Thanks so much.

Thank you.

Your next question comes from Emmanuel Rosner of CLSA. Your line is open.

Hello.

Emmanuel?

No? Okay.

Can you hear me?

We can now, Emmanuel. Yes, we can. Good morning.

Sorry about that. Good morning. So I apologize, I joined the call a little bit late, so maybe some of this color has been provided before. But as we see this slightly faster shift away from diesel that you just described, in the near term -- I understand in the mid term obviously you have a lot of [opportunity] on hybrids and electric vehicles. But in the near term, can you just remind me what the content impact is between -- if it's an automaker replaces a diesel vehicle with a gas vehicle, what would be the near term content impact?

Yes. I'll take a shot at that, Emmanuel. Good to talk to you again. So you're right. What I alluded to earlier, Emmanuel, I'm not sure if you were on the call --

Our view of Europe is, if you look at a 2015 year to date versus a 2016 year to date, the diesel share or diesel penetration is down about 2%. Our view is that, that will continue to creep down. We're not seeing a cliff-type event. So we see that trending down.

I think, fundamentally what we are seeing is those -- so the question is really what are those diesel vehicles being replaced with. And I would say the vast majority, in our view, of those are with turbo charged gasoline vehicles. So that obviously plays well for BorgWarner.

We are not seeing a shift from diesel to naturally aspirated vehicles so much. We're seeing turbo charged gasoline and sometimes turbo charged gasoline hybrids, so near term, it's a pretty small impact for us. Obviously it affects some of our emissions products a little, but net-net for BorgWarner, Emmanuel, it's relatively small impact for us as it shifts from diesel to gas, particularly if it's at a gradual pace that we've seen thus far.

And just to reinforce, I think, your other point, as we get to the mid term, let's say three-years-plus out, then it's not an issue at all for BorgWarner. So small is kind of the conclusion, Emmanuel, if that helps you.

No, that definitely helps. So I guess in this context where the mix shift seems manageable -- so at you're investor day you were essentially suggesting a mid to high single-digital organic growth rate going forward, that would imply, obviously, a bit of acceleration versus your guidance for this year, in the sort of like the 4% to 5%.

As you look to -- we're entering 2017, do you feel comfortable about being able to get this acceleration in organic growth even with some of these small mix headwinds?

Yes. I think a couple of points, Emmanuel, I would point to. First of all, we feel very good about where we're at right now. It's coming towards the end of October. We stood and talked to you in January about our guidance, and we've delivered on that. We're in four good quarters now.

So we feel good that we're hitting our stride on executing that mid-single-digit growth organically, which is excellent. I think one of the things I would say as we start to think about 2017, 2018 and 2019, one of the things we articulated at investor day is I want people to think that we're going to operate in a band of mid- to high single-digital growth rate. So that means there may be a year or two where we're at high, and there may be a year or two where we're at mid.

It's not a linear upward curve or arrow, if that makes sense to you, Emmanuel. I don't want people to think we're going to be running a 3%, 4%, 5%, and then we go to 6%, then we go to 7%, then we go to 8%, then we go to 9%. It's not that way.

What we're saying is we are confident and comfortable in our strategy, in our portfolio and in our technology that we will consistently be able to deliver in a mid-to high single-digital growth band, and external factors will move us a little bit in the band, Emmanuel, of that mid to high single-digital band. Does that help a little bit for you?

Yes, absolutely. But to be really clear, you're not expecting a hockey stick within it? It's essentially any given year should be in the mid to high single-digits, am I right?

That's a good way to think of it, Emmanuel. Yes.

Okay, great. Thanks for taking my call.

You're welcome.

Your next question comes from the line of John Murphy of Merrill Lynch. Your line is open.

Good morning, guys. I apologize. I got on the call a little bit late, so I've got a few questions that you may have talked about a little bit already.

Just first on schedules here in the [near] term, particularly in North America, there appears to be some disparate strategies where some companies like Ford are cutting production pretty quickly to try to adjust inventory down relative to demand, and some companies are not.

I'm just curious what you guys are seeing as far as schedules and volatility and as you look, on 30 and 60-day releases, are there significant changes that have been occurring or volatility that are tough to handle, or is it really pretty consistent and they're giving you a good heads up and seems logical so far?

Yes, John, this is James. I'll take a shot at that. I think -- I would say in general, visibility is about the same as it typically was, if you like, 45, 60 days. I think in general we've been getting good communications and good visibility from all of the OEMs here. We're not getting too much of last minute cuts and those types of things.

Obviously, like you and everybody, we're going to pay a lot of attention to this because -- as you start to come towards the year end, but I would say, to use a phrase, the discipline around scheduling and releasing has been pretty good. An example for us would be, John, when we had this exact same call last quarter, that was at a time when Ford was suggesting releases, reductions, et cetera, and we talked about it then that we believed we had that well contained in our guidance. And I think it's fair to say we delivered on that, so that's encouraging.

And I mentioned earlier in the call, John, I'm not sure if you were on, the latest news from Ford, so to speak, we feel that's contained in our guidance, which essentially was unchanged as we went into this quarter. So I think generally, John, it's reasonably well disciplined. We watch it and pay a lot of attention to it, but so far so good.

Okay. That's helpful. Then underlying the results, Remy seems to be doing relatively well, maybe a little bit ahead of expectations. Is there anything that's changed there as you're getting deeper into it or is it really running in line with your internal expectations?

Yes. I would say, John, generally it's running well. Overall, it's running well. The top line has been a little softer through the year. We saw that, but that was pretty much end market driven on commercial vehicle and aftermarket, so that's just macro driven. But on OE side, about pretty much as we had expected.

I think from an operating point of view, John, it's been running well. And I think -- I would say we're incrementally positive on our dialogue with the customers, particularly around the combination of Remy's rotating electrics with our mechanical know how around P2 hybrid modules that we talked about at investor day. That continues to go extremely well for us, globally, by the way, Europe, Asia and North America. So overall really good.

Ron gave a couple comments earlier, John, if you weren't on, about -- it's a really good thing that we can complete this transaction on the light duty. Retail aftermarket business, that's just not core to us, and I think that will allow us to focus more on the core, so I think that's another incremental step forward with Remy.

As Ron alluded to, that helps the margin profile as well of the business. So, yes, it's going well, John. A lot of work ahead of us, but it's going well.

Okay. And then just lastly, as we think about cap allocation, Ron, there's a growing concern that we're getting closer to peak, and given how strong volumes are, it's hard to argue that -- we might have some more upside, but we're getting close. And there's a lot of concern about what the down side could mean here in North America or in Europe with the Brexit risk or China ultimately slowing down.

With all of those kinds of potentially [toppy] environments that may or may not occur, but thinking about them, would you consider maybe getting a little bit more conservative on capital allocation, meaning maybe building up a little bit larger of a cash cushion to take advantage of whatever opportunities might prevail themselves as the cycle ultimately does turn?

So, John, you're correct. I can tell you that internally over probably the last four months or so, we've had discussions about liquidity. I'll use the term liquidity, right? Because that's what it really comes down to at the end of the day.

And how do you preserve liquidity through a cycle and how much liquidity do you need going through a cycle. So I think you're absolutely correct. I know inside BorgWarner we are looking at the liquidity numbers and making sure that we're very liquid through a cycle. So, yes, you're correct, we are looking at this.

Okay. But would you favor potentially building that up pretty significantly relative to buybacks now so that you could potentially take care of advantageous opportunities over time? I'm just trying to gauge how you're going to allocate capital here in the near term, ultimately, rather than the longer term.

Yes. I know what you're getting at, John. So let's refresh ourselves here. We are about 2/3 into the $1 billion buyback program, correct?

And I think it's safe to say that we're going to give a lot more color here in January as far as what we're thinking. And I think you're right, in the context, I would say that we are considering maybe a more conservative posture, but we have to weigh that against other items. Maybe M&A activity potentially, and also the peak cycle that we're in, and there's a couple other factors we have to look at as well. So I would say, though, in general, we're probably more bias to the conservative side right now, but we'll give more color in January.

Okay. That's very helpful. Thank you, guys.

Thanks, John.

Your next question is from David Leiker of Baird. Your line is open.

Hey, guys. This is Joe [Growing] for David.

Hey, Joe.

Hey, Joe.

I don't want to steal your thunder giving the 2017 updates, but if I use those backlog numbers you provided last January, it would kind of foot to a number that would be closer to 3% after price, and so I just want to make sure your comments on targeting mid- to high, is that something that returns -- talking about revenue growth -- that returns as soon as 2017? And does that imply that maybe the backlog numbers are trending a bit better than what you provided at the beginning of the year?

Yes, Joe. This is James. Ron can weigh in after me. You're right, we're going to do it in January. So we've got a little bit of time here, and we're going to work our way through it.

The way I view it strategically, Joe, is we talked a lot at investor day that with our propulsion technology, we're comfortable that we're going to be a mid-to high single-digital growth company on an organic basis. And we reminded everybody, I think, at investor day that it will fluctuate in that band of mid to high single-digit growth. I would say there's been nothing materially or substantially that's changed -- for us to change that view.

So what that all translates to in exact dollars and percentages of organic growth for 2017 and 2018, Joe, we've got a few more weeks of work to get to that point. But we're comfortable in this mid to high single-digit organic growth for the future.

I'm going to add just a little bit of color on the numbers, Joe. I believe the mid point of the back of 2017 was $500 million of sales. I don't know what your starting point is, but I get quite a bit higher number than the one you just gave us on the call when I did the quick math here.

I was not as low as you were, so you may want to fine tune your number crunching here a little bit. You should get a higher number. Maybe Ken and you can talk about that later, all right?

Okay. And one more, if I shift back to 2016, it would seem like the contribution from new business has to be stronger than those original numbers for just talking this year because you have customers that probably haven't produced what the plan said they would at the beginning of the year, off highway markets have been weak. Is that fair? And if it is, can you maybe provide some color on what's tracked better within the new business backlog this year?

I would say, Joe, you're right. The net new business for 2016 has run a little better than what we'd expected, and I think you summarized it pretty well. Remember, we didn't factor much in at all for commercial vehicle, so we weren't expecting much, and guess what, we didn't get much.

If you look at it regionally, we've run pretty strongly in North America and Korea has been pretty good and China has been pretty good. So I wouldn't say it's any one product or region, but intuitively you're right. We're running a little better on the net new business for 2016 than what we guided to at the beginning of the year.

Yes, we are.

Okay, great. Thank you.

Thank you, Joe.

We have one last question, and that question comes from Joseph Spak of RBC Capital Markets. Your line is open.

Thanks for squeezing me in. Guys, maybe just to elaborate on that last point, so, again, you don't provide the [ethan] of the backlog today, but if you could sort of back into -- at least directionally, where it's trending? And it does seem like it's coming in better.

I was wondering if you could just maybe, again, high level sort of critique your own internal approach you've taken towards giving the forecasting and whether that should give us confidence in some of the prior -- or the outer year backlog numbers you gave earlier this year?

That's fair, Joe. The way I look at it, from my perspective, Joe, we rolled out what our methodology and discipline was as we went into the year. And you recall, right, we took a more prudent approach to the launches in terms of both the volumes and sales in the cadence of the launch. And then we also made the judgment to be a little bit more -- apply a little bit more of a macro factor to the number.

Our view, and we're a little biased, Joe, is we think that was a smart call because I think as we've gone through the year we've been consistently hitting our numbers in that -- just around that mid single-digit growth rate. That would imply, and I think you're right, that the backlog is running a little better than we'd anticipated, which is good. And I said earlier on the call, Joe, that we'll be utilizing that same discipline and methodology as we go into -- as we go into 2017.

And I think if we look at what the three-year view of the backlog that we went into this year was in that mid single-digit growth range. I think 4% to 6% was the range for the three-year period, and as we're executing in that range this year, it gives us comfort as we go into -- as we go into the process for 2017, 2018, 2019.

So we've got some work to do, Joe, on the detail, but I gain comfort from our strong execution this year in delivering the growth that we set out to do. It helps me get comfort and hopefully you get comfort as we go into the out years.

Yes, Joe, let me give you some numbers. I believe that in January we gave mid-point guidance of about $315 million of backlog, and I think the current guidance is around $355 million, $360 million, so we are performing better than we indicated in January. That's nearly a year ago, so we're some $40 million, $50 million higher in numbers.

Right. Despite a number of adversity and headwinds.

Oh, yes. Despite a lot of puts and takes as James was saying. At the end of the day, we still performed better than we anticipated in January.

Okay. And then last quick one. There was a report earlier this month which indicated that some auto makers -- and this gets back to engine shifts in Europe, that they may have to meet a real-world emissions, scrap smaller engines and upsize engines to help meet those standards.

And I always thought that your content generally moves with the size of the engine. So, A, is that true, is that a potential benefit for you? And, B, have you seen any of the future sourcing actually revert back to some smaller engine -- to some larger engines?

That's a good thought, Joe. I'll give you a couple of thoughts. The term that we're hearing a lot is right sizing, which is a good way to think of it. So it's right sizing the engines.

What I would say is it's not a -- it's not dramatic shift. So it's not like they're taking a one-liter engine and replacing it with a 2.5-liter engine. It's subtle shifts that may go from a 1.6 to a 2, or a 1.8 to a 2. So we are seeing that.

We're seeing -- adjustment is a good word for me, and what we see is fundamentally the technology on the engine is very similar. If it's a turbo charged direct injection engine with variable cam timing, they're shifting up from maybe a 1.6, to a 1.8 or a 2 and that's helping us.

Generally speaking, your observation is a good one, Joe, the larger engines are generally slightly beneficial for BorgWarner. So this is net-net a good move for BorgWarner. It's a helpful for BorgWarner. I'll put it that way.

Thanks.

Thank you, Joe.

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

That does conclude the BorgWarner 2016 third quarter results conference call. You may now disconnect.