博格華納 (BWA) 2017 Q3 法說會逐字稿

Good morning. My name is Sharon, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2017 Third Quarter Results Conference Call. (Operator Instructions)

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

Thank you, Sharon. Good morning, everyone, and thank you all for joining us. We issued our earnings release at 6:30 a.m. Eastern time. It's posted on our website, borgwarner.com, on the homepage and on our Investor Relations homepage. A replay of today's call will be available through November 10. The dial-in number for that call is (855) 859-2056, and the conference ID is 49072509. Or you can simply listen to the replay on our website.

With regard to our Investor Relations calendar, we will be attending several conferences between now and our next earnings release. As always, please see the Events section of our Investor Relations homepage for a full list.

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.

Also, during today's presentation, we will highlight certain non-GAAP measures in order to provide a clear picture of how our core business performed and for comparison purposes of prior periods. When you hear us say, "on a comparable basis," that means excluding the impact of FX, net M&A and other noncomparable items. When you hear us say, "on a reported basis," that means U.S. GAAP.

Now back to today's call. First, James Verrier, our President and CEO, will comment on the industry as well as provide a high-level overview of our Q3 results. James will also discuss some of our recent product wins and our recently completed acquisition of Sevcon. Then Ron Hundzinski, our CFO, will discuss the details of our Q3 results as well as our updated 2017 guidance. Please note that we've posted an earnings call presentation to the IR page of the website. You'll find a link below the notice for this call. We encourage you to follow along during our discussion.

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

Thank you, Pat. And good day to everybody, and we appreciate you joining us this morning for our call. Ron and I are very pleased to share our results from Q3 2017 and also update you on our progress towards delivering our 2017 targets.

I'd like to start actually by sharing a few thoughts on the macro environment and the industry. And for those of you following along, that would be on Slide #6. We do recognize there's still instability in many aspects from a macro perspective as we look around the world. But I would say in general, production volumes were only modestly weaker than our expectations as we went into the quarter. Let me break that down a little bit for you. So from a global light vehicle production, it was up about 2% in Q3. When you look at that for our adjusted geographic exposure, production was flat.

European light vehicle production increased about 4.5%, which was slightly better than our expectations going to the quarter. China light vehicle production was also up about -- was up about 1%, and that was roughly in line with our expectations as we went into the quarter. North American light vehicle production declined by about 10%, which is a little more than our expectations as we went into the quarter.

If I talk a little bit about the market outlook, let me talk about light vehicle 2017 calendar year first. We are pretty closely aligned with IHS, which is calling for about a 1% growth in China, Europe up a little over 3%, North America production down about 3.5%. Now this implies global production growth of less than 1% when you adjust for our geographic exposure.

Market outlook relative to commercial vehicle. The outlook for Europe and China continues to improve, and we also see orders in North America have improved since our last outlook update. And I would say, we're cautiously optimistic that this strength will continue.

If I was to characterize what we're keeping an eye on and watching as we play out the rest of the year, I would point to 3 things, really. The first one is the mature cycle here in North America. North American schedules have continued to weaken, albeit modestly. And so far, production adjustments have been pretty much in line with our expectations, but clearly, we'll continue to watch that closely. For diesel-gas mix in Europe, obviously we continue to pay a lot of attention to that. I would say diesel share declined by approximately 530 basis points year-over-year in Q3, and we do continue to expect diesel-gas mix to shift through the end of the decade. The good news for us at BorgWarner is we continue to offset that.

China, we also pay close attention to, and we're still expecting modest industry growth in 2017. More importantly for us at BorgWarner, our growth over the market remains very strong due to the content per vehicle increases.

So all of this said, we remain very confident in our strong outgrowth for of market in 2017 based on the continued strong demand for our products.

Let me share a few highlights around technology. And I think I'll start with the first key point, which is the strong drive to fuel economy and emissions regulations and the pull for advanced propulsion technology continues. Activity in hybrids and EVs continue to accelerate, not slow down at all. If I break that down a little further, let me talk about what we see in hybrids. I would say the interest in 48-volt [model] hybrid continues to gather speed and gain momentum and grow. I'd say the most activity we're seeing is predominantly Europe, but we are seeing an increasing interest in pickup in both North America and in China.

From an electric vehicle perspective, we see the Chinese OEMs continuing to move at a rapid pace. I would say the work with Europeans continues to increase, and we have seen increased activity around EVs in North America also. So continued efforts there.

Now let me share a key takeaway that I've seen over the last few months as I've engaged with more and more customers. I think the key is all of our major customers are exploring a wide variety of options. We see there's no one solution. And for each of the customers, it depends on their vehicle fleet mix, regional balance and some of the specific propulsion strategies of the OEMs. What we clearly see though is they all have a balance of combustion, hybrid and electric propulsion in their portfolios. And we continue to work with them every day of the week, frankly, on 2 things. One is helping them to define the optimum mix of combustion hybrid and electric and also discussions around the specific propulsion technologies that they require to get where they need to.

Let me move to Slide 7. And as Pat alluded to, I want to share a few highlights of growth for us in the quarter. And I'm going to talk about 4 key announcements here that you saw.

The transfer case win for us on the new Range Rover Velar program, their SUV, was a great win for us and a sign of our continued growth in the all-wheel drive, four-wheel drive business for us. Our Two-stage Turbo for Honda's new 3-cylinder 1-liter engine, gasoline directed, was another significant win for us because this is a great story of growth for us with Japanese OEMs.

Our Cabin Heater technology for a new electric vehicle is another significant win in our push for electric vehicle growth, and this is with a globally known EV automaker.

The fourth one there you see is our electric motor technology at Scania on their new Citywide hybrid bus for urban areas, again points to another good win in commercial vehicle and electrical vehicle technology. So the key takeaway there, as you look at the 4, is a really great mix of business growth. And this is another evidence for me in yet another quarter that confirms our strategy of a balanced approach continues to work, and we see win rates across all propulsion systems for combustion, hybrid and electric products.

Now let me move to Slide 8 and talk -- give you a little bit of a financial recap. And obviously, Ron will take you through a lot more detail when he goes and speaks in a few minutes. So I'll start with the Q3 outlook -- results for BorgWarner, and let me start maybe with the obvious that I'm very pleased with our Q3. Our growth exceeded the high end of our guidance and our operating performance was in line with expectations. Sales of $2.4 billion is up 10.8% organically when we exclude FX and Remy, and this compares to our light vehicle end-market exposure, which was basically flat in the quarter.

Regionally, it was pretty much as we'd expected. Strong growth in China, particularly with DCT, and North America with new business and mix. Our Europe light vehicle revenue was up mid-single digit, despite the gas-diesel mix shift. And this light vehicle growth was supplemented by positive revenue trends in commercial vehicle, both on and off-road.

EPS at $0.95 excluding noncomparable items is a really good result for us. And again, Ron will share more of that with there. And our operating -- adjusted operating margin of 12.3% was solid, solid performance.

If I break that down a little further by segment, really, the key for me was I was very excited to see strong growth across all of our products. So engine sales of $1.5 billion, that's 8.7% growth organically, which is strong. Some of that strong growth came from turbo and timing systems and our thermal products. And again, despite the change to the diesel-gas mix, we're seeing solid top line growth in the Engine segment. Drivetrain, $922 million in the quarter, that's up 14.4% organically, strong all-wheel drive, DCT and transmission component sales in North America, China and Europe.

Let me spend a moment and give you a high-level view of our 2017 outlook, and I'm really pleased to talk about a raise again in guidance. We're increasing our revenue and earnings forecast for 2017. We expect organic growth of 9.0% to 9.5% year-over-year, and this compares to our prior guidance of 6.5% to 7.5%, and this again compares to a market that is growing less than 1%.

Our consolidated operating income margin is expected to expand 20 to 30 basis points. And our EPS guidance range is now $3.81 to $3.83 per diluted share, which is up from the $3.65, $3.70 previously.

Let me now move to Slide #9. And as Pat alluded to, I wanted to share a little bit of commentary on the Sevcon acquisition that we completed in the end of the quarter. First of all, we're really excited to add this business to the BorgWarner portfolio. We really believe that Sevcon complements BorgWarner's existing power electronic capabilities. And in effect, it doubles our number of dedicated power electronics engineers in the company. Now near term, this business will have a revenue run rate of about USD 60 million at year-end, and it will be modestly dilutive to 2018 results. But the real story is what Sevcon is going to add to our top line over the long term by integrating their technology with our current product portfolio.

So before I turn it over to Ron, I just wanted to share a few of my comments relative to the restructuring of our emissions business. I know we've discussed in the past few quarters, this business continues to not meet the expectations of BorgWarner. So this quarter, we announced a $12.6 million restructuring charge for this business. We do expect additional restructuring over the next several quarters. And as we formulate our plan, there are 2 items that we are addressing. Most significantly, there are product lines within our emissions business that we have determined are noncore. We plan to rationalize the footprint related to these products and would also explore our strategic options for these product lines as well.

The second part of the plan though is we will also take steps to improve the overall competitiveness of our remaining European emissions business. And again, Ron will provide a little more color on that shortly.

So let me bring all that together and summarize for us. Q3 was an excellent quarter. We exceeded our expectations for top line growth, and operating performance was in line with our expectation. And given our strong year-to-date performance, we're increasing our revenue guidance for the year despite a modestly weaker industry production outlook. So in summary, for me, I believe the company's positioned to deliver mid- to high single-digit growth over the long term by continuing to execute our strategy of propulsion system leadership across combustion, hybrid and electric vehicles.

So with that, let me turn the call over now to Ron.

Thank you, James, and good morning, everyone. Before I review the financial details, I would like to provide you some of the highlights as I see them for the quarter. First, it was another strong quarter. Second, operating performance was as we expected. And finally, given the strong performance year-to-date, we are confident in raising our full year guidance again. Now as Pat mentioned, I will be referring to supplemental financial slide deck that is posted on our IR website. I encourage you to follow along.

Let's turn to Slide 11. On a reported basis, sales were up 9.1%. On a comparable basis, our organic sales were up 10.8%, very strong performance compared to our weighted average light vehicle industry production for the quarter, as James mentioned, which was flat. We saw a 34% growth in China against the production market that was up 1%. And Europe revenue was up 7%, slightly better than the 4.5% production growth in the quarter. North American revenue was up low double digit versus the 10% production decline in the quarter. Commercial vehicle was a benefit again, contributing more than 200 basis points. Diesel and gas mix in Western Europe was a headwind, but lower than we expected going into the quarter.

Before I move to the operating profit, I would like to discuss our gross profit and SG&A line. Gross profit as a percentage of sales was 21.6% in the quarter, up 30 basis points over last year. SG&A was 9.3% of sales. R&D spending, which is included in SG&A, was 4.2% of sales. SG&A was down 20 basis points from a year ago, driven by leveraging higher sales.

Now look at the year-over-year comparison for operating income, which can be found on Slide 12. Q3 adjusted operating profit was $298 million or 12.3% of sales compared to $265 million in Q3 of '16, which was 12%, resulting in a 30 basis point improvement. Our organic basis operating income was up $32 million on $232 million of higher sales. That gives us an incremental margin of 14% in the quarter and in line with our expectation, and it was an improvement from the incremental margins we saw less than 10% for the first half of the year.

As you look further down the income statement, equity and affiliate earnings was about $14 million in the quarter, up $2 million from last year. Interest expense and finance charges were $18 million in the quarter, down over $4 million from last year due to lower debt levels. Excluding the $5 million favorable tax adjustment, the provision for income taxes was $86 million for an effective tax rate of 29% for the quarter.

Net earnings attributable to noncontrolling interest was about $10 million, flat from the third quarter last year. This line represents our minority partner's share in earnings performance in our Korean and Chinese consolidated joint ventures.

Earnings per share on a reported basis were $0.88 per diluted share. On a comparable basis, net earnings were $0.95 per diluted share.

Now let's take a closer look at our operating segments in the quarter beginning on Slide 13 of the deck. Reported Engine segment net sales were $1.506 billion in the quarter. Sales growth for the Engine segment on a comparable basis was 8.7%, as demand for our light vehicle OEM products was supplemented again by growth in our commercial vehicle business.

Adjusted EBIT was $239 million for the Engine segment or 15.8% of sales. On a comparable basis, the Engine segment's adjusted EBIT was up $16 million on $118 million of sales for an incremental margin of 14%. Within the segment, strong performance in our turbo and timing systems was partially offset by continuing operating headrooms in emissions business, as James mentioned earlier.

We announced an initial restructuring charge of our emissions business of $12.6 million in the quarter. We expect additional restructuring over the next several quarters as we formulate our plan to improve this business for BorgWarner levels of returns. The total cost of this restructuring could vary widely, depending on the strategy we optimally pursue. We expect to give you an estimate of these costs in the coming quarters.

Now turning to Slide 14 and starting on the right-hand side. Drivetrain segment net sales were $922 million in the quarter. This includes the reduction of $68 million of sales from the divestiture of the Remy light vehicle aftermarket. Sales growth for Drivetrain segment on a comparable basis was 14.4%, primarily due to higher all-wheel drive transmission components and strong dual-clutch transmission growth in China. Adjusted EBIT was $112 million for the Drivetrain segment or 12.1% of sales. On a comparable basis, the Drivetrain segment adjusted EBIT was up $22 million on $115 million of higher sales for incremental margin of 19%. This is very strong performance and reflects the successful ramp of new programs.

Now let's take a closer look at our balance sheet and cash flow. We generated $624 million of net cash from operating activities in the first 3 quarters of the year, and that's up $31 million over last year. Capital spending was $300 million year-to-date, up $35 million from a year ago. Free cash flow, which we define as net cash from operating activities less net capital spending, was $234 million, which is basically flat from 2016.

Looking at the balance sheet itself, balance sheet debt was up and cash decreased by $29 million compared with the end of 2016. The $205 million increase in net debt was primarily due to the purchase of Sevcon. Our net debt-to-net capital ratio was 33.6% at the end of Q3, which was down slightly from 35% at the end of 2016. And the net debt to EBITDA at the end of the quarter was 1.22x.

Now I'd like to discuss our 2017 guidance, which we have increased. So let's start with our sales growth guidance for the full year on Slide 16. Backlog, pricing and market-related growth are expected to drive 9% to 9.5% organic sales growth. Note, this excludes the Sevcon acquisition, which is expected to add $15 million of sales in Q4. Currency is expected to be a small tailwind now.

From a performance perspective, I'd like to turn to Slide 17. Again, we expect low-teens incremental margins on our sales growth. Included in this are headwinds from corporate costs, reflecting year-to-date headwinds as well as Q4 accruals based on stronger top line and earnings. Our consolidated operating income margin is expected to expand by 20 to 30 basis points.

To finish our full year guidance, please turn to Slide 18. EPS guidance range is now $3.81 to $3.83 per diluted share versus our $3.65 to $3.70 previously. The increase is driven by our sales guidance and an increase -- and a lower impact of foreign currency for the full year. Free cash flow, which defined as net cash provided by operating activities less CapEx, is expected to be $450 million to $500 million now. Capital spending included -- including tooling is expected to be in the range of $525 million to $575 million, which is up modestly to support several program uplifts. R&D spending as a percentage of sales is expected to be about 4% in 2017. The tax rate is expected to remain at 29% as well. Our assumption for the dollar to euro exchange rate has been adjusted to $1.25 (sic) [$1.125] from $1.10. As a reminder, every $0.01 change in the dollar to euro exchange rate equals about $30 million to $35 million of sales.

Our fourth quarter guidance is on Slide 20. First, sales. Note that Remy light vehicles aftermarket divested are about $20 million, and we have added about $15 million of Sevcon sales. So starting at a base of $2.239 billion, net new business pricing and market-related growth are expected to drive organic sales growth of about 5% to 6.5%. In addition, currency is now expected to increase sales growth by about $85 million. Therefore, 2017 Q4 sales is expected to be $2.47 billion at the midpoint.

On Slide 21 is our EPS walk for the Q4. As I have already walked through our full year walk, I will not go through all the details. So for Q4, we expect earnings of $0.99 to $1.01 per share. This includes about $1 -- I'm sorry, about $0.01 unfavorable impact from Sevcon.

So let me summarize Q3. It was a strong third quarter. Organic sales growth was more than 10%, despite flattish industry volume. Incremental margins improved sequentially as we were expecting. As we look forward at 2017 and beyond, we continue to drive intensity around our new product development and support it with acquisitions to participate in the impending electrification trend.

So with that, I'd like to turn the call back over to Pat.

Sharon, we're ready to open up for questions.

(Operator Instructions) Your first question comes from Colin Langan with UBS

I just actually wanted to follow up on Slide 7. You highlight sort of 2 things that are interesting. The Cabin Heater opportunity, is there any quantification of who the main competitors there? I haven't heard too many people talk about trying to target that market. And what kind of content opportunities there? And also the Turbocharger opportunity with Honda, I mean, are you seeing -- it feels like there's been more headlines around the Japanese OEMs. Are we seeing that opportunity start to increase there with Japanese moving to be a little bit more engine-downsizing.

Yes, Colin, this is James. So let me start on the turbo one first, if that's okay. I -- we have seen increased adoption rates with the Japanese OEMs on turbo. That's probably evolved over the last, I would say, 5 years -- 4 or 5 years, and we see that trend continuing. And we see that trend continuing on both combustion-powered vehicles and also on hybrid vehicles, where they're utilizing turbo in both of those configurations. So we have seen that. And we've been particularly pleased with our win with Honda, and we've developed a really strong partnership there. And launching some of our latest 2-stage technology on that 1-liter engine on the gas engine has been a big success for us. So yes, we're seeing more and more usage of turbo with the Japanese OEMs. The cabin heating opportunity, we're really pleased about that. That was the technology came to us through the BERU acquisition a few years ago. And this is our first significant win with the U.S. And if you think of competitors in that space, I would say Eberspächer is probably the most well-known that you would probably know in the cabin heating space. We also see Wabash start playing in that space as well. So those are the 2 of the most well-known ones that I would point to, Colin. But we're pleased with how that's progressing for us. We like the technology. And as we've alluded to, it's a good growth platform for us on pure EVs.

And just any color on the emissions restructuring? I mean, when do you get the benefits from the actions that you're taking? And any sense that you said there's -- you're considering? Is there a (inaudible) you might actually consider divesting some of the products from there, is that right?

Yes, Colin, let me kind of give a little bit of a high-level answer to that, and then Ron could supplement it with any specific details. Again, I think there's -- again, there's 2 dimensions, so to speak, to what we're doing here. The one is we have identified a couple of noncore product lines, and we're evaluating all of the strategic options associated with those. So that's the one aspect. And then the other aspect is a more generic footprint optimization as well. We're still in the process of working through those details, Colin, as Ron had said to you. It could -- one option could be divestiture, one option could be restructure. There are sort of different options here. And as Ron and I thought about this, until we've got a little bit more clarity around that, we need a little more time to be candid, Colin. But it does include all options are on the table, frankly. And we're going to work our way through that through the fourth quarter. And I think we'll have more color for you when we come back onto the earnings call in February of next year.

Your next question comes from Ryan Brinkman with JPMorgan.

Just to follow up on that, have you discussed which sort of subsegment of emissions is considered noncore and how that differs from the portion of the emissions business that is still core? Does it relate in any way to -- for example, Wahler?

Yes, I can add a little bit of clarity there, Ryan. So the 2 product lines that we were viewing is noncore to -- from a BorgWarner perspective, think of thermostats and think of pipes. It has nothing at all to do with our core EGR business. EGR valves, EGR modules, EGR coolers, those are fantastic businesses that are doing really, really well for us. So it's in that -- those thermostats and pipes. When we look at the level of technology differentiation that BorgWarner excels in, I don't think they bring that kind of technology differentiation. They don't bring the growth profile so much as a BorgWarner product line. So those are the 2 product lines that we're referring to.

Okay, that's really helpful. Just lastly from me then. On the expected sequential deceleration in year-over-year growth as you go from 3Q to 4Q. You did 10% in 3Q, looking for a 5% to 6.5% in 4Q. Very simplistically though, I look at North American production, that was kind of a drag in 3Q, down 10%. IHS is looking for something more like minus 3% in 4Q. So just curious what those incremental headwinds are that you're seeing, maybe at something specific with your backlog or something? And if not, if maybe you think that, potentially, risk could be skewed to the upside for organic growth in 4Q?

Sure, Ryan. This is Ron. I'll give you 3 of them, high level. First of all is diesel mix in Europe. Like we mentioned on the call, we're not seeing the headwind that we anticipate in Q3. So if that gets pushed in to our Q4 where the sales starts showing through the production levels, we're assuming that could be as much as a 300 basis point headwind for us in the fourth quarter. That's one item. Korea has been an issue for us as well. That's going to swing to a negative in Q4 again over last year. And then if you remember last year, we had some really good launches in the fourth quarter, the Duramax, for example, and the F250. And we're going to lap those. So we're going to see not have that as a tailwind as well going into fourth quarter. So those are the 3 -- 3 of them at the high level.

Your next question comes from Rod Lache with Deutsche Bank.

First, I just wanted to ask about backlog. It was, like you showed, it's $268 million in the quarter. Your guidance was $100 million to $150 million. And it seems like every quarter, it's coming in a bit higher than your guidance. So I'm wondering whether there's any reason why we shouldn't be thinking about upside to the number for next year, the $460 million to $670 million. You did kind of hint that there's been some program uplifts and that's affecting CapEx. So it seems to suggest that.

Yes. Rod, this is James, yes. So a couple of thoughts from my end at least. You're right, we've been tracking ahead of what we've come into the year expecting, and that's a good feeling, obviously. And that is predominantly backlog related. To your point about next year, I would reiterate my comfort and confidence in the 7% CAGR number that we put out there. But obviously, over the next few weeks, we're going to take a good look at that. And then as we come into January into Detroit, we'll obviously give you more specificity around 2018 backlog and obviously the 3-year view as well. But I would think of it this way, Rod, the way this year's transitioned for us just gives me, at least, builds a lot more confidence and comforters at the numbers as we go into next year.

Okay, great. And just secondly, I was wondering if you thought there were any competitive implications from the strategic changes that were announced by your biggest competitor in turbos. We've seen that actually happen in other segments where multi-industry companies have announced divestitures. So any kind of high-level thoughts on what -- how they've been running the business today, how that's affected you, and how that may be run in the future?

Yes. No, I would say from my point, Rod, that Honeywell has always been an excellent competitor, a very strong player, and I don't see that really necessarily changing. We'll see how it plays out. The most important part for me though that I would want to reiterate is we just continue to see 2 things: strong penetration growth with turbos in general. So we still see the turbo business as a strong growth engine for BorgWarner and we still see our 1/3 market share position that we have very solid, very solid as we look this year and we look at a 3-year and a 5-year view. So for us, it's kind of no change is the way I look at it, Rod. We feel great about the turbo business. We love the growth and we love our strong competitive position, and I think Honeywell will do what they need to do.

Your next question comes from John Murphy with Bank of America.

Maybe just a follow-up on sort of the backlog question that Rod just asked. I mean, you kind of highlighted it in drivetrain that the programs are running a little bit better than you're expecting as far as new program launch and your rate of CapEx. And Ron, you tend to be pretty conservative or tight with capital. So it seems like something really positive is going on, and I mean that as a compliment, Ron. What's happening there? I mean, is it higher buyings than you're expecting on new programs? Or there are actual wins that are manifesting faster than what you thought? Or is it just a [poet] of launches? I'm just trying to really understand what's going on there.

Yes. So John, by the way, Ron really took that as a good -- big compliment. He loves any comment like that.

Okay.

So yes, I think it's a little bit of all. Frankly, I think we've had some of the launches this year have come on maybe a faster ramp, some of the volumes have been a little stronger. So it's not one thing, John, it's been a combination. I would say the biggest link though between -- for me, between backlog strength on the drivetrain side is DCT China, and that's the biggest kind of mover, if I can say that way, John. And that's a function of real good DCT adoption and success for us in China both with the Chinese domestics and the global guys, and that's just pulling forward a little bit of the capital [inlay] for us. And I would say that's probably the biggest piece. But generally from the backlog, it's been -- it's strong, both cadence and absolute volume.

John, I'm just going to say a couple of things. James mentioned this in the call. This year, we're seeing every one of our product lines are growing really well. In the past, you have a couple of product lines that has really good launches and then maybe the other ones are in a cycle where their launches are not hitting. This year is one of these years where every one of our businesses, all the launches are hitting and they're hitting at the time that we would hope they would hit, which is good, and we're getting this tremendous growth across the whole portfolio. And in addition, we don't have the headwinds of commercial vehicle to boot. So it's across everything.

Okay, that's helpful. Maybe just second question on acquisitions. I mean, Sevcon looks interesting. I'm just curious, as you think about Sevcon and potential future acquisitions, are you looking for more human capital or products? And if you could kind of just delineate maybe in Sevcon. I mean, it sounds like you doubled your engineers, focused on electric powertrain. So that sounds good. But is there also a product suite that comes along with it or it really [wasn't] the engineers you're going after in that acquisition?

Yes. No, it's a good thought, John. And I would say the Sevcon as an example, is kind of a combination. So it brings a revenue stream, right? It brings an order book. It brings real product that they're putting in boxes and shipping, so to speak. So it's not just a pure engineer's perspective. But I would also say, clearly, they bring to us terrific people capability on the engineering side, particularly. They bring a lot of that. So it's both. And I would say, as we look forward, John, I'm thinking more of the same. Our acquisition focus would be around electronics, power electronics capability, and we'll look to obviously add people and talent. But our preference also is where we can, is to actually have physical product content where we can, particularly around electronics and power electronics. So that's how we're thinking about it. Obviously priority 1 right now, John, is to integrate Sevcon and get that up and running well, which we're confident in, but we're going to keep our eyes and ears open for additional opportunities as well.

And then just one last follow-up question. I mean, James, it looks like a lot of your peers or competitors are going in the opposite direction, where they're splitting up ICE and sort of electric powertrain components. Any -- what kind of position you think that you'll have competitively in the market as you go head-to-head with these folks? And will you be advantaged and disadvantaged by having a full product suite and being somewhat agnostic to where powertrain goes?

Yes, we -- obviously, I'm a little biased, John. I think we have an incredible advantage, I really do because we're the -- I don't want to say the only one, but we're one of the few that can go in and discuss with the OEMs what are the trade-offs between combustion, hybrid and electric architectures. And we do we have those dialogs because we can help them understand, if you put this type of hybrid application into this set of vehicles and you could go electric on this. We are engaged in those conversations because we play across the space. And then the other part of the differentiation for us is we then bring the technology that helps them get there. And what they see in a BorgWarner, John, which I think is really interesting, is they know we're not in there lobbying to overly influence them on a pure EV platform or a 48-volt [model] hybrid platform because we play on both. So they view us as a neutral partner in that respect, but we then follow it up with the content because we have electric motors, we have single-speed transmissions, we have cabin heating and then we have all the suite of combustion products and hybrid products. So I think, and again I'm biased, we have a big advantage.

Our next question comes from Joe Spak from RBC Capital Markets.

First, I just wanted to talk a little bit about the change in backlog relative to the change in CapEx because the backlog, I think, is 50% higher than what you indicated that we may be at the midpoint. CapEx is only 10%. So is that greater efficiency? Or does it speak to maybe there was just more conservatism on the revenue side versus the capital side?

No. Joe, this is Ron. Remember, the capital that goes in is a ramp cycle. This what's happening, right? It -- so it's not a direct relationship with the sales increase. So it's not fair to say that for a 10% increase in sales, you need 10% of capital. It doesn't work that way. You're putting capital over several years. So the capital tends -- well, on the ramp side, we tend to lag the sales increase because, in my comment, I said it was primarily due to ramp increases, right, not new programs. So that tends to lag the sales increase. Is that clear?

The -- yes. So -- well then...

It's uplift, it's not new programs. So the cap increased, yes...

Okay. Well, what about -- can you sort of help us dimension how much capital was put in place for backlog coming in, in future years? Or it would seem like not much based on that comment.

This is a long discussion, Joe. But typically, it follows up on it, and I'll follow up with you. I'll get some ratios and take this offline. It's a long discussion, all right, Joe?

Okay, perfect. And then just if you go to like Page 11 in the bridge, I know you made some comments on commercial vehicle helping, I thought you said by 200 basis points, is -- and then you mentioned market growth was the minus $36 million. I thought you called that just light vehicle market growth? So does commercial vehicle go in somewhere else in that walk? And then can you also let us know what you're thinking on commercially on off-highway for the fourth quarter embedded in the guidance?

So commercial vehicle goes under the backlog and the mix, the $268 million on that slide, okay? Not in -- that market is typically more light vehicle, the market growth and pricing, okay, that answers your first question. And the second one is we're assuming for the fourth quarter is -- although it was a tailwind of about 200 basis points, we're going to go back more to what we saw prior in the year, which is about 100 basis points improvement for the fourth quarter for commercial vehicle. Remember, last guidance, we had none. This guidance, we are going to take a little bit of a tailwind for commercial vehicle, but not what we saw in the third quarter.

Your next question comes from Brett Hoselton with KeyBanc

Let's see, I'm thinking about your longer-term revenue outlook, your organic guidance and so forth. And your backlog has been coming in stronger than expected. You're talking quite enthusiastically about some of the higher contented products, hybrids, electrics, et cetera. And it kind of just begs the question, as we look out over the next 5 years, is -- could we see BorgWarner's revenue growth accelerating?

No, it's a good question. I'd tell you this, Brett. What we laid out at the Investor Day there in New York, enough of that 7% guide over the next 3 years. Obviously, this year has played out. We've just got -- we're very comfortable with that outlook. I'm not in a position at this point where I want to start changing that, because I don't think we need to. But I think that 7% midpoint CAGR for us is a -- organic is a good number, and let's just keep executing at that at least in the short run. We are going to take a good look at it obviously as we go into January, Brett, and we'll provide any update from there. But I think, at this point, I think the 7% organic CAGR is a good number to think about for us.

Okay. And then secondly, as we think about the backlog unfolding not necessarily over the next 3 years, but let's say over the next 5 to 10 years and so forth. And we think about the move in the direction of some of these non-ICE powertrain and so forth, how should we think about margins? You typically have thought about contribution margins, but is there the possibility that the margins could be better or worse on these products as we kind of move out into, let's say, the next 5, 10 years?

So Brett, this is Ron. We get this question quite often, and we've been addressing it several ways. And then, again, referencing the Investor Day that we had here in August, I had a slide in there. If you go back to that presentation, I think it's still on the website, where I gave returns on invested capital are very similar on their hybridization and are pure electric products as they are in combustion, and that slide was to present that. And the reason why we're comfortable is because that slide represents products that we have been awarded and are starting to ship as well, and it's across customers and across regions. So the evidence that we're seeing right now of the programs that we're winning don't substantiate in the deterioration in margins or returns.

(Operator Instructions) Your next question comes from David Kelley with Jefferies.

Just a quick follow-up on China. I believe you posted 30% growth Q4 last year. The production hurdle is a tough one here. You're obviously winning in areas like DCT and with some early-model hybrids and electrics. I guess, how do we think about some of the puts and takes as we weigh your China opportunity going into year-end here and maybe a more difficult hurdle going into '18 as well?

So I would say, first of all, David, yes, the third quarter is strong and we've been running pretty strong through the year. And you're right, it's driven by a lot of that technology that you referenced, so we're ramping well with DCT, but it's also on our combustion product line as well. So things are good. Fourth quarter is a more challenged -- it will be a little bit more of a challenging comp, but we'll be over the market. So I would think about a high single to low double digit over the market, if that make sense to you. So that's how we're thinking of going into fourth quarter. And I would think that's a pretty good proxy, David, for going into next year as well. Think of us high single to low double-digit growth over the market in China.

Okay, great. I appreciate it. And just to quickly shift gears, the -- you referenced potentially accelerating diesel market decline in Q4. It's still early in the ballgame. Are you seeing that mix shift go to ICE? Or is it more towards hybrids and EVs? And I know you've alluded to it before, but maybe if you could remind us on how you see your -- the longer-term offset opportunity as we do see the mix shift ultimately switch to alternative powertrain and away from diesel.

Yes. No, in the short run, David, it's clearly diesel out and gasoline in, so to speak. We've talked about this before. Net-net for Borg for every 100 bps of shift from diesel to gas in the short run is about a $20 million to $25 million annual revenue noise for us frankly, which we're obviously offsetting in other areas. As it transitions over the next 2, 3, 4 years, it's a couple of things. One, it will be even more advanced gasoline engines to be somewhat comparable to diesel technology. There will be obviously increased hybrid in Europe. So we're going to see that. And then longer term in the more 4-, 5-, 6-, 7-year outlook, you'll see more pure EVs coming into the space. All of that adds up as positive news for us, David. So as we go forward, we've got great content on hybrids, and obviously, we're growing our electric business. So that's kind of an outlook of how we see it, a little bit of short-term noise, but it's transitioning to more advanced gas and hybrids and electrics where we'll do fine.

Your next question comes from David Leiker with Baird

This is Joe Vruwink for David. Two questions on commercial vehicles. The first, if it added 2 points to your growth in the quarter, my math would imply that's like 20% growth for your commercial vehicle business. Does that sound about right?

I haven't broken up between off-road and on-road, but that's about right, Joe.

Okay. And the second question, so it almost feels like 5 years ago what you went through with automotive and just trying to see OEMs plan around greater electrification. The big heavy-duty truck OEMs, they're all in that stage right now. And whether it's -- Daimler showed a vehicle this week or the others are planning 2019, 2020, that sort of time frame for launches. What is BorgWarner seeing from an interest perspective, a development perspective and launching either hybrid electric or pure electric commercial vehicles? And by what time frame you expect that?

Yes, we're seeing a lot of interest actually around electrification in the commercial vehicle space. We put in the deck actually, the Scania win on our drive motor there for that particular bus application. So we're seeing increased interest, Joe, across the space. And we see obviously urban bus-type environment is particularly attractive. But U.S., we see small midsized truck applications again predominantly more city-oriented. So we're seeing that. And if you think about it, a lot of our technology that we have on the light vehicle side is leverageable over to the commercial vehicle space. Drive motor has been a good example of that. So we are seeing it. I think we'll probably have a better view, Joe, when we do our backlog show in January because there we'll break it down by technology and we'll break it down a little bit by -- and talk about it by end market. So that will be a good point to kind of break it down a little more for you. But directionally, yes, we're seeing a significant increase in electrification in commercial vehicle, and we're participating strongly in it.

Your next question comes from Matt Stover with Susquehanna Financial Group

You vaguely address this, but I just want to talk about it. I mean, over time, the return on capital of the company has been pretty good. And over the last few years for a variety of reasons, it's -- sort of moved to a lower level, but we're seeing some stability here. I'm wondering as you sort of think through the new revenue opportunities that are emerging for you over the course of, let's say, the next 2 to 5 years, if you think that there's an ability for you to sort of rethink the capital intensity or the profit profile of those businesses would allow the company to resume its previous near best-in-class returns on capital.

Matt, this is James. I'll give you, I guess, at least my quick high take and then, I think, Ron can weigh in. From what -- as you rightly point out, what served this company really, really well is that after-tax 15% ROIC threshold and hurdle, and that's not changed. We continue to drive that metric pretty relentlessly. So I would start there and say that remains the core and the primary metric for us. Ron may want to add specifically around cash, so if you want to talk.

Well, I want to talk about capital deployment in general. Matt, I think what the organization going forward is going to have to do is we're going to have to take a look at our product lines and determine which product lines get more capital, which product lines start to not have as much capital as the portfolio starts to evolve and change in a different direction. But as James mentioned, as we go through their process, we'll reallocate resources, but we're not going to give up on the goal of 15% after-tax return. That's not going to happen. We'll redeploy our capital in the right resources of the growth to achieve the growth that we have in our portfolio, but we're not going to give up on that return metric.

Your next question comes from Richard Kwas with Wells Fargo Security.

I'll take another -- a little different strategy on the backlog. So going back to the beginning of the year, the midpoint was $500 million. You're going to be -- not quite double that, but almost. I mean, I imagine you had some expectation you could outperform the top end of your initial range. But any way to think about how what your internal expectations were versus what actually happened?

I mean, I would say, Rich, we're obviously -- first of all, we're pleased obviously. But yes, we're ahead. It's coming stronger than -- it's coming stronger. But what I would also say, Rich, is you remember the history here of how we got to the methodology around developing the backlog, and I don't want to go back all the time in history. But we took an approach where the roll up of the detail was the same, but we were maybe a little more prudent around cadence and volumes of launches. And we also built in some macro stuff. So I think we took that approach, and I think that's helped us. But I think even with that said, from an internal perspective, we're definitely running a little better and ahead than what we'd anticipated. And I think it's really what Ron said, it's a combination of across all of our products and across all of our regions, we just had -- the ramp has either been a little bit quicker or the volumes have been a little stronger. And when you add all of that up around the world and across the products, you get to the kind of result that we're at. So yes, it's pleasing.

I know you said across products and regions, but DCT seems like it's one of the areas that probably contributed a little bit more than average. I know there's some positive payback, it would seem, given there are delays in prior years or by customers and whatnot. So is that a fair assessment?

I think that's a good perspective, Rich. We've seen -- the ramp has been a little better and stronger. And I think, to your point about history, you probably couldn't blame us for being a tad conservative over in that space based on the ramp has taken a few years to get where it needed to. So -- but that's -- your assessment's a good one, Rich.

Okay, great. And then last one, just on Sevcon. So do we think about the penny impact, negative impact in the quarter? Do we just kind of flow that through on a quarterly basis for '18, just big picture?

At this point, I think that's probably a good assumption, Rich. We're going to have to fine-tune it and update it. We do think that it will moderate a little bit going forward, but I think we're going to have to give you more clarity probably in January.

Your next question comes from Brian Johnson with Barclays.

I'll ask a kind of bigger questions because I think there's been a thorough draining of the swamp on backlog. The Volkswagen is putting some of its businesses into something that potentially could be spun out, I mean, 20 years after the U.S. OEMs did that in this form of Delphi, of course, the Honeywell Garrett transaction, the spinoff of Delphi. So just as you look at broadly the powertrain space, given the challenge of kind of managing the transition from ICE, given the challenge in [ICU], GKN, American Axle, Dana all investing in the e-modules, magna, long list. Do you think this is an industry that's going to consolidate over the next 10 years? And if so, what role do you see BorgWarner playing in that kind of consolidation?

Yes. It's a good thought, Brian. I'm going to try and give you the best answer I can here. But I'm going to start with something I think I said on the last earnings call, and that is I love our propulsion business, I really do. I'm very, very happy with where we positioned ourselves and the products -- and the product lines that we've got. I think there's a great future for the propulsion guys like us. And the reason for that is our balance, again, across combustion hybrids and electrics, we're agnostic to those shift, Brian. So if there's a quick fast acceleration of EV penetration, that's fine. We have a great products there if hybrids become a predominant architecture, that's fine. So we're beautifully positioned on whatever that evolution and shift is. In terms of how that plays out in terms of consolidation and who wants to keep what core, that I don't know. What I know, the one thing I do know, is we're a propulsion company. We're very happy with that. We don't plan to do anything different than be a leading propulsion company. I got to let the other guys do what they're going to do, but we're just going to grow the heck out of our propulsion business across all of the vehicle architectures.

And as you look across competitive landscape, I mean are there redundant RD&E and capital investments going across competitors and OEM? Is it something where it's -- it could use consolidation just not so much for strategic, but just to maximize the cash flows given everyone is making roughly the same products -- product investments?

I'm not so sure. I wouldn't want to speculate too much, Brian. The one thing I would offer you is when you get down to the real core technology in propulsion, there's not an overabundance of players in the space. So if you think of our business and think of how many transfer case guys there are on the planet or how many turbo guys are on the planet or DC module guys are on the planet, there's not so many, right? When you get to other less differentiated products over in our space, I'll use the example earlier, thermostat, it's a little bit of a different story. So I think individual discrete product lines may lend itself to that. But I think when you look at the core of propulsion whether it's electric, hybrid or combustion, there's not an overabundance of core suppliers in my opinion, Brian.

Your next question comes from Chris McNally with Evercore ISI.

I wanted to take this follow-up to the China question that was asked a couple of questions ago. Remembering that China was one of the issues that will -- in 2015 on some of the new launch volumes. How do we start to think about China in 2018, post this big stimulus that -- we've seen the Chinese [solar vote] from 18 million to 25 million. Is it crazy to fear that 2018 could be down sort of low to mid-single digits in China? And if that's the case, how do you start to scenario plan around just a temporary blip in production and new launches? It could start to grow again later in the year and going forward.

Yes. No, so I thought as we get to think about 2018 is I think you're going to see modest growth in light vehicle production in China, 1% or 2%. We're not certain exactly the number. But yes, the days of 6%, 8% growth I think are behind us. So from a market perspective, you're in a 1% to 2% growth environment for China next year. For BorgWarner, we're well in excess of that. We're going to be high single to low double-digit growth over and above that market. So even if there was a little bit of adjustment in China ren flat to slightly down, for a year or so, we're still going to be delivering very significant growth there driven by penetration story of our product. So not a big deal, frankly, if China is off a couple of percent next year. What we're focused on is launching flawlessly our products that are driving the high growth for us in China.

Okay. James, that's great. And is it fair to say that the comments that you've been making about drivetrain with some of the all-wheel drive and DCT growing the launch cans, is it still pretty good specifically in China as we think about '18 and '19? Maybe it's not as good as it was in sort of the last 4 quarters, but is China specifically for drivetrain? Still a nice new backlog, new launch cadence over the next year or 2.

Yes, it is. And specifically, if you think about it, we -- one of our big launches and growth stories there in drivetrain is with Great Wall on our dual-clutch technology. And if you think about it, this really only been ramping up in the third quarter and it will be ramping up further in the fourth quarter. Next year that ramp is just going to continue to climb. And then obviously we've been putting in capacity to support our Volkswagen in China, and that's in -- also, in early ramp mode. So you're going to get that. That's going to be a tailwind for us as we go forward. So yes, still a lot of opportunity for growth for us in drivetrain in China.

We have time for one final question, and that question comes from Richard Hilgert with Morningstar.

I was thinking about the comments earlier in the prepared remarks about the phenomenon that we're seeing with crossover sport-utility vehicles outside of North America and the tremendous growth that we're seeing in these products not only in Europe, but in South America, in Russia, in China. And with the changeover in powertrain to both hybrid or battery, electric, given the way that the portfolio is set up now, do you envision at some point potentially more products coming on the torque delivery side to match some of these new energy powertrains that we're seeing to go into the crossover segment? And is that an area that you could potentially see some additional growth rates on top of what you've already forecasted for the longer-term growth at BorgWarner?

Yes, Richard, let me take a shot at that for you. I think, first of all, your observation is right on. We do see globally a shift to more SUVs. And obviously here in the United States, more light truck or truck is strong. Directionally, it's helpful for BorgWarner because it does offer the opportunity, as you say, for more all-wheel drive content and transfer cases, specifically obviously for 4-wheel drive applications. So it does. I mean, directionally, it does help us with larger vehicles and SUVs on the drivetrain side, but -- so yes, I think the quick answer is yes, Richard. We do see that as a slight tailwind. I would say, it's best to think that we probably factored that into our update that we gave back in New York. So I'm not seeing that necessarily in the short run as necessarily upside, upside. I think that's already reflected in our projections that we gave in New York, which is that 7% CAGR at the midpoint for us over the next 3 years, Richard.

Okay. On the Sevcon side, converters, the high-voltage, low-voltage products they've got there and the software that goes behind that, it seems to me like the battery chargers is probably the area that you might have been referring to with respect to what might not be core to BorgWarner's business. But I was wondering, the software development behind that, is there anything there that might give you some expertise on working with your OEM customers on how the battery energy flows coming in and then optimizing going out for the output? Is there anything there that you would want to retain from that aspect of Sevcon that could help you further develop that business?

Yes. So a couple of thoughts, Richard. One is the noncore product line I was referring to earlier was in our emissions business, which is thermostats and pipes. So certainly nothing -- I'm not disclosing anything noncore at all on the Sevcon side. As you alluded to, the power electronics capability is particularly core to us because that is where we're going to be able to integrate that power electronics into our -- the BorgWarner products and systems and modules as we go forward because that's critical to us. The battery charging piece of the business is also very interesting for us. It's fair to say, I would describe it this way, that's the one we don't know so much about yet candidly. So we're going to get in and work with the Sevcon team and better understand what the opportunities are for that piece of the business. But overall, Sevcon is a wonderful acquisition for us. And it's really going to help accelerate our efforts in power electronics and system capabilities, so positive on that.

With that, I'd like to thank you all for your great questions today. And Sharon, you can close the call.

That does conclude the BorgWarner 2017 Third Quarter Results Conference Call. You may now disconnect.