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BorgWarner, Inc. (NYSE:BWA)

Q4 2011

February 14, 2011 9:30 am ET

Executives

Ken Lamb – Director Investor Relations

Timothy M. Manganello – Chairman of the Board & Chief Executive Officer

Robin J. Adams – Chief Financial Officer, Executive Vice President, Chief Administrative Officer & Director

Analysts

Ravi Shanker – Morgan Stanley

Analyst for Richard Kwas – Wells Fargo Securities, LLC.

Rod Lache – Deutsche Bank Securities

Himanshu Patel – JP Morgan

John Murphy – Bank of America Merrill Lynch

Joseph Sack – RBC Capital Markets

Patrick Archambault – Goldman Sachs

Operator

At this time I would like to welcome everyone to the BorgWarner 2011 fourth quarter results earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer period. (Operator Instructions) I would now like to turn the call over to Ken Lamb, Director Investor Relations.

Ken Lamb

We issued our earnings release this morning at approximately 8 am Eastern Time. It is posted on our website www.BorgWarner.com on our homepage. A replay of today’s conference call will be available through February 21st. The dial in number for the replay is 800-642-1687. You’ll need the conference ID which is 44472821. The replay will also be available on our website.

With regard to our investor relations’ calendar we will be attending several conferences over the next few months. February 22nd we will be at the Barclays’ Industrial Select Conference in Miami. March 14th we will be at the UBS Auto & Auto Suppliers Conference in Boston. March 19th we’ll be at the Sidoti Conference in New York and on April 4th we’ll be at the BofA New York Auto Summit in New York.

Before we begin, I need to inform you that during this call we may make forward-looking statements which involve risks and uncertainties as detailed in our 10K. Our actual results may differ significantly from matters discussed here today.

Now, moving on to our results Tim Manganello, Chairman and CEO will comment on the fourth quarter, the full year and current industry trends. Then, Robin Adams our CFO, will discuss the details of our operating results and also our outlook for 2012. With that, I’ll turn it over to Tim.

Timothy M. Manganello

Today I’m very pleased to review our strong fourth quarter and full year results as well as our fourth quarter accomplishments. First, I would like to thank all BorgWarner employees for a fantastic 2011. Your strong performance reflects our dedication to BorgWarner’s customers and our shareholders.

Now, on to the results let’s start with the fourth quarter. Sales were $1.8 billion up 16% from the same period last year. US GAAP earnings were $1 per share but excluding a loss from disposal activities, earnings were $1.19 per share and Robin will explain the financial mumbo jumbo behind the disposal activities later. Our reported operating income margin was 10.8%, but again excluding non-recurring items, our operating income margin was 12% in the quarter.

Three key factors drove our results: increased global demand for our products; higher volumes in our base business; and well executed cost controls by our operating guise. For the full year, sales were $7.1 billion up 26% from 2010. US GAAP earnings and earnings excluding non-recurring items were $4.45 per share and in our full year operating income margin, it was 11.2% or 11.1% excluding non-recurring items.

Let’s go to the engine group. In the engine group fourth quarter sales were about $1.25 billion up 11% from a year ago. The engine group continues to perform very, very well and results were led by accelerating turbocharger growth around the world, increased sales of engine timing systems including variable CAM timing, and greater sales of fan and fan drives which are linked to the commercial vehicle market.

In the drive train group sales were about $534 million up 27% from the fourth quarter 2010. Drive train’s results were driven by increased dual clutch transmission module sales in Europe, increased traditional automatic transmission component sales in Korea, and the Traction acquisition which was formerly known as the Haldex acquisition.

Now, the drive train group continues to make progress with its capacity and productivity issues in Europe. In the quarter the groups’ margin was 8.8% up from last year and up from the previous quarter. Drive train’s performance in the fourth quarter is a solid foundation for achieving the 9% margin or better that we expect from them in 2012.

Looking forward to the future, BorgWarner continues to invest for the long term. Capital spending continues to grow. For the full year we spent about 5.5% of sales. We are committed to supporting our future growth and productivity improvements and our R&D spending was about 3.4% of sales in the quarter and for the full year. We continue to trend towards our targeted level of 4% for R&D.

I’m also proud to review some exciting announcements that we made during the quarter. BorgWarner’s regulated two stage, or R2S turbochargers have launched on the four cylinder Mercedes S Class BlueEfficiency engine. This is the first four cylinder engine in the history of the S Class. It delivers excellent performance while getting about 41 miles per gallon. We are proud to set a new benchmark for a turbo charged downsized engine in the luxury segment with the Mercedes Benz.

Now, BorgWarner’s double PIP platinum spark plugs are also featured with the next generation ignition coils for the Audi’s 1.8 and 2 liter engines. BorgWarner also supplies advanced technologies for five of Ward’s 10 Best Engines and to all of the winners and finalize for the North American Car and Truck of the Year. Finally, we announced $2.5 billion of net new business for 2012 through 2014 time period. That’s a 9% increase over last year’s backlog.

So now let’s take a look at our current outlook for 2012 for late vehicle production. We first announced our 2012 outlook at Deutsche Bank’s Automotive Conference in Detroit last month. Our view is unchanged from that forecast. We expect total global production volumes to be approximately 81.2 million units up 6% from 2011. In North America we expect 13.9 million of production up 6% from last year, in Europe 19.3 million units down 4%, in China 18.6 million units up 8%, and in Japan 9.3 million units up 18%.

In Europe we expect midsized and large passenger cars to outperform the overall market just like it did in 2011. This is due in part to exports through China and also exports to North America. We also believe that these segments will be more resistant to production cuts due to their more affluent buyers. As a matter of fact, I just went out and bought a Q7 Audi Diesel last night.

In the commercial truck market, we expect solid growth in North America and Brazil. We expect the commercial vehicle market in Europe to remain relatively flat and in China, we expect a slight rebound. However, BorgWarner’s commercial truck business in China is growing for turbochargers, thermo systems, and emission systems due to our increased penetration rates.

Finally, our sales and earnings guidance for 2012 also remains unchanged. Sales growth in 2012 is expected to be 10% to 12% or 14% to 16% if you exclude currency. In Europe we expect our sales growth to outperform vehicle production by a wide margin in 2012 and our performance in the fourth quarter of 2011 supports this outlook.

In the quarter, European production was down 4% while our sales excluding currency and the Traction acquisition, was up 6%. Our 2012 earnings guidance continues to be $5.35 to $5.65 per share and our operating margin is expected to be better than 11.5% for the year. The 12% operating margin posted in the fourth quarter of 2011 provides great momentum towards achieving this target and 2012 should be another great year for BorgWarner.

In conclusion, the outlook for our business remains strong. In 2012 we expect sales growth and profits in every major region of the world including Europe. No company in the auto sector is better positioned for short term and long term profitable growth than BorgWarner. The industry’s adoption of our leading edge power train technology will continues for years and because of this, I feel very good about BorgWarner’s future and so should our shareholders.

With that, I’ll now turn it over to Robin.

Robin J. Adams

To me this was a typical BorgWarner quarter just strong financially across the board. Before I go through the out performance of the company from a financial perspective, I want to go through the macro industry environment for the fourth quarter. If you look at fourth quarter global production it was about 19.7 million units, up about 1% from the fourth quarter of last year. And again, if you look at our sales on a reported basis, they’re up about 16% so very strong performance but that did include some foreign currency impact and also the Traction Systems acquisition which we made in the first quarter last year.

So if you eliminate those and really put the sales on a comparable year-over-year basis, fourth quarter sales increased was 12% and that’s 11 percentage points better than 1% fourth quarter growth in global vehicle production. Just another quarter-on-quarter-on-quarter-on-quarter, I don’t know how many quarters this is but frankly, it’s a lot where our sales growth significantly outperformed the market.

If you look at it on a full year basis, our sales were up 26% and again, if you eliminate the impact of currency and acquisitions we were up 16% with global production up 3% so we outperformed the market by 13 percentage points for the year. And again, consistently quarter-on-quarter-on-quarter and as Tim talked about our guidance for 2012, 2012 is just going to be another year where we just beat the pants off the market from a growth perspective.

Let’s look at the financials right now, particularly the fourth quarter income statement. Gross profit as a percent of sales was 20.3% up from 20% a year ago and [inaudible] in the third quarter this year. We had some commodity pressure in the quarter, not as much as we’ve had in previous quarters, it was about $3 million and that puts us at about $35 million for the full year.

SG&A expenses were 8.3% of sales in the quarter versus 9.7% in the fourth quarter of last year despite a year-over-year increase in R&D spending. R&D as a percent of sales was up slightly to 3.4% from 3.3% a year ago. If you look at total SG&A spending year-over-year it was relatively flat however, R&D spending was up about $9 million in the quarter or 17% higher spending in the fourth quarter last year.

In talking about SG&A, during last quarter’s earnings call we discussed a $10 million benefit that we got in SG&A in the third quarter related to equity incentive compensation expense. Again, this was a function of our stock price declining from about $80 a share at the end of the second quarter to about $60 at the end of the third quarter. We also at that time said our full year guidance assumes we got back to that $80 share price and would penalize the fourth quarter. However, our year end stock price was about $64 a share which resulted in only a $2 million negative impact in fourth quarter SG&A and operating income or about $0.01 per share negative impact. So not a big event for the quarter.

Looking at reported operating income in the quarter it was $191 million or 10.8% of sales as Tim said. However, we did have asset disposal activities in the quarter which resulted in a pre-tax book loss of close to $22 million. We already announced the sale of our tire pressure monitoring business in December and the loss related to that, and the majority of the loss on this line item is related to that transaction including a few other minor disposal activity clean ups.

The disposal activity loss shows on the other income expense line item of the income statement if you’re looking for it. It’s pretty easy to see, it sticks out and it’s right above the operating income line. Excluding these special items, this loss on disposal activity, operating income was $213 million or 12% of sales and that is an all time record for BorgWarner and that’s compared with $157 million or 10.3% of sales a year ago.

If you look at the improvement in operating income margin which is pretty meaningful, it really reflects the outstanding performance we have in this business controlling costs while we continue to grow our top line sales. As you look further down the income statement equity and affiliate earnings was about $10.2 million up slightly from $9.8 a year ago and if you remember the equity and affiliate earnings primarily reflects the performance of our drive train systems 50/50 joint venture in Japan which is NSK Warner. That joint venture services our Japanese customers for transmission products in the Asian market. It also reflects our India turbocharger joint venture as well to a lesser degree.

Looking further down, interest expense and finance charges were $17 million in the quarter, down from $22 million a year ago primarily due to the favorable impact of foreign interest rate swaps on our debt and lower average interest rate on some of our short term debt. Taxes in the quarter $58 million which if you do the math is an effective tax rate of about 31% and that’s quite a bit higher than what we’ve been given for expectations for the year of about 24%.

Now, included in there is the tax impact of the disposal activities and that was about $2.7 million of tax expense. So if you exclude the disposal activity tax implication our tax rate from operations in the quarter was about 27%. Now, this is still a little higher than the 24% full year forecast but when you look at it on a full year run rate basis, the full year run rate is about 24.8% versus our 24% forecast.

Unfortunately, that 8/10ths percent difference in the full year rate that all gets slammed into the fourth quarter and that’s why you get that 27% effective rate for the fourth quarter. So you’ve got 24% for nine months, 27% in the fourth quarter and it gets you to 24.8% for the full year, so we weren’t that far off. For the full year as Tim said, our reported US GAAP tax rate was 25.5% and again, that’s 24.8% excluding all the unique items.

Net earnings attributable to non-controlling interest which again, was formerly known as minority interest, was $5.2 million in the quarter up from $3.9 million a year ago. Again, this line item reflects our minority partners’ share in the earnings performance of our Korean and Chinese consolidated joint ventures. The fact that this charge is up just reflects the continued growth in this business, very strong growth of our business in Asia.

That brings us back to the bottom line of net earnings which were $122 million in the quarter on a US GAAP basis or $1 a share. Again, as we’ve already discussed, fourth quarter earnings included a loss from disposal activities of approximately $0.19 per share. We’ve identified that in a table in our press release as we typically do. This is to help you reconcile our reported US GAAP earnings measures with the financial performance of the continuing operations of our company and to help you in comparing our fourth quarter results with prior periods and future periods. We view this as an important part of our press release and we encourage you to review this information as well as our 10K which should be filed by the end of the day today.

On a comparable basis though, fourth quarter 2011 net earnings were about $146 million, $1.19 a share up 34% from $0.89 a year ago. Very strong performance for the company. Again, briefly touching on the full year, sales were a little over $7.1 billion up 26% from 2010 and again, adjusting that for acquisitions and currency puts us at about 16% versus a 3% market growth.

US GAAP earnings were $4.45 a share, up 47% from 2010. Now, there were a few non-recurring items throughout the year but when you netted them out it really had no affect on earnings. So it was $4.45 a share on a GAAP basis, $4.45 on what we would say a continuing basis.

If you look at operating income our margin was 11.2% reported, 11.1% excluding the non-recurring items. Solidly above our original guidance for the year which was 10.5% floor for 2011 so keep that in mind when we talk about our guidance for 2012 of 11.5% floor, right Tim? When we started 2011 we said that we expected incremental margins of about $0.20 year-over-year and excluding non-recurring items and currency, our incremental margin was about $0.19 on the dollar.

If you exclude the acquisitions in addition, our incremental margin was just over 23% and this was a record year for BorgWarner any way you look at it sales growth, margin performance, earnings, etc., etc., etc., cash flow, just a phenomenal phenomenal year for BorgWarner as Tim said. We’re really proud of the performance our operations put forth.

Speaking of our operations, let’s look at the segment data. Engine segment sales as Tim said, were a little over $1.2 billion, $1.245 billion in the quarter, up 11% versus fourth quarter last year. On a comparable basis or excluding currency, engine segment sales were up 12% compared with the third quarter 2010. If you look at the strong global growth across the engine segment portfolio, sales were driven by turbochargers, new timing systems, fans, and fan drives.

EBIT for the growth, adjusted EBIT, was $203 million in the quarter or 16.3% of sales significantly higher than the 14.5% adjusted EBIT margin reported a year ago. When you look at the year-over-year incremental margin excluding currency in the quarter, the engine guys hit the ball out of the park with a 31% incremental margin.

If you look at the drive train segment, sales were $534 million in the quarter, up 27% versus last year. On a comparable basis, or again if you exclude the currency impact and the Haldex Traction Systems acquisition, drive train sales were up 12% compared to the fourth quarter of last year. So with engine segment sales up 12% and drive train up 14% you can see both segments outperform the 1% global automotive industry products in the quarter very handedly.

Strong traditional transmission component sales in Asia and higher dual clutch transmission module sales in Europe were the key growth drivers for drive train in the quarter and have been throughout the year. On a reported basis, adjusted EBIT was $47 million or 8.8% of sales which was up from 7.6% reported in the fourth quarter 2010. As Tim mentioned, it continued the sequential improvement we’ve seen in drive train from the lull of 6.6% in the first quarter of 2011 , 7.4% in the second quarter, 8.1% in the third quarter and as we said in the third quarter we expected drive train to get close to that 9% margin level and in fact they did that with their 8.8%.

Even as we’ve said before throughout 2011, the purchase accounting expense amortization from the Haldex Traction Systems acquisition is negatively impacting drive train margins. If you take out the Haldex Traction Systems acquisition and look at the drive train segment margins on a comparable basis last year, they actually were about 9.6% a full two percentage points better than the fourth quarter of last year on an apples-to-apples basis and the best quarterly performance we’ve seen out of that business since prior to the 2008/2009 recession.

So again, if you look at the drive train system business they’re back, they’ve fixed their issues, they’re stronger than ever and that’s why, as we’ve said before, we expect them to generate all in, even with the Haldex Traction Systems, expect them to generate margins of about 9% plus for 2012.

On a year-over-year incremental basis again, excluding the currency and the Haldex transaction, incremental margins were $0.24 on the dollar. Very strong performance from the drive train group and as I said, we continue to see improvements in the business and fourth quarter again, is a solid foundation for the drive train segment achieve our targeted margin of 9% or better in 2012.

Now, let’s look at the balance sheet for a second and cash flow. We generated over $700 million from operating activities in 2011. That’s up almost $170 million from 2010, very strong performance. Capital spending was just shy of $400 million, up about $120 million from 2010 levels. The year-over-year increase in capital spending is indicative of the growth required to meet the increased level of program launches that we have around the world, particularly in markets like Asia, South America, Eastern Europe, and Mexico.

Free cash flow which we define as cash from operating activities or that little over $700 million, less capital spending, a little bit less than $400 million, was $314 million in 2011 up $52 million from $262 million in 2010 or almost 20% higher. If you look at the balance sheet itself, debt increased by approximately $150 million in 2011. Cash decreased by about $90 million. That’s about $240 million net swing and that was primarily due to the acquisition of the Haldex Traction System business which was in the first quarter last year, about a year ago, and the buyout of our emissions joint venture partner in India in the third quarter for about $30 million. That item shows up in our cash flow statement as purchase of non-controlling interests.

We generated enough cash internally to fund the growth of our capital spending, the growth of our business and also to fund the stock repurchase program that we had in 2011. If you look at the capital structure net debt to capital was about 28% at the end of 2011 compared to 24% at the end of 2010. Net debt to EBITDA on a trailing 12 months basis was just below one times at the end of the year.

However, as we’ve said before, we really review our balance sheet and capital structure on an if converted basis and we encourage all of you do to the same. The convertible debt, which we are converting from a capital structure perspective as we look at this balance sheet matures in about two months from now and frankly, I’ll be happy to be able to stop talking about this if converted, we’ll look at our capital structure because it will be converted. Anyways, on an if converted basis, net debt to capital is about 18% at the end of the year. Net debt to EBTIDA was approximately 0.5 times so very strong capital structure and ready for the next strategic acquisition to come along and be part of the BorgWarner fold.

As Tim said, 2011 was simply another great year for BorgWarner and really sets the stage for another strong financial year in 2012. As Tim said, our sales growth and earnings guidance remains unchanged from what we provided last month at the Detroit Auto Show Conference. Frankly, it was about 30 days ago so not much changes in 30 days. We continue to expect sales growth of 10% to 12% compared with 2011. But again, if you adjusted for currency about 14% to 16% again, which will be about 10 percentage points above the 5% to 6% global market growth we’re looking at right now for 2011.

Earnings will be in a range of $5.35 to $5.65 per diluted share which is approximately 25% higher than 2011’s all time record earnings for the company. From a margin perspective, we do expect to achieve better than a 11.5% margins with R&D spending up another 20% over 2011 levels and that’s on top of the 35% growth in R&D we had in 2011. So we’re really putting the money into R&D in this company to help fund the future growth of this business. Looking at 11.5% or better operating income margins, we just did 12% in the fourth quarter, so we feel pretty good about the better than 11%.

Incremental margins as we look at it year-over-year again, should be north of 20% although the impact of currency will have some reported impact. We are expecting the Euro to be $1.30, it was approximately $1.40 in 2011 so we’ll see about a 4% to 5% decline in sales related to currency as we pointed out in our guidance. That will have an impact on the incremental margins because the incremental margin on that currency is about the 11% to 12% range. If you strip that out, incremental margins again, will be north of 20%.

We expect to generate in 2012 approximately $1 billion in cash from operating activities and capital spending will be north of $450 million in 2012. We talk about higher raw material costs, approximately $35 million in 2011, we’re looking at about $25 to $30 in 2012. As always, that will change throughout the year. Again, as we’ve said before, whatever the raw material price increases are we’ll absorb that and manage that throughout the year. It will not have any negative impact on our earnings expectations.

To summarize here, we achieved record fourth quarter earnings. We outperformed the industry relative to sales by 11 percentage points. The drive train segment continued to improve margins and actually on a comparable historical basis are at an all time margin high and the engine segment margins again, also remained near record levels.

It was a strong finish to a very strong year and provides great momentum for us as we move into 2012. To me again, this was just another typical BorgWarner quarter on top of quarter-after-quarter of very strong performance. We expect 2012 to be another year of solid growth, record margins, and record profits. As we observe the trends in the market today, we see even more growth and more record profits beyond 2012.

Our confidence in this stems from a regulatory environment that continues to become more stringent, fuel costs that continue to churn higher, and as a result OEMs and end customers favoring advanced power train technology that only BorgWarner can bring to the market. Our product portfolio is focused on improving fuel economy and lowering emissions which is precisely what the market is focused on today.

We expect this strong demand for our products to continue for many years to come. Our technology leadership, strong global presence, financial discipline, and focus on attracting and maintaining a talented work force around the global have been the keys to the company’s success and the keys that will continue driving our success in the future.

With that, I’ll turn the call back to Ken for questions and answers.

Ken Lamb

We will now turn to the Q&A portion of the call. I would like the operator to please announce the Q&A procedure.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ravi Shanker – Morgan Stanley.

Ravi Shanker – Morgan Stanley

The 12% margin fourth quarter was really impressive but incentive comp helped you a little bit there. Robin, can you help us understand what the trajectory of margins looks like in 2012? Also, with your stock getting up to the high 70s will incentive comp be a headwind in 1Q?

Robin J. Adams

12% was a record margin and remember incentive comp would have been a negative relative to performance so there really was no benefit for incentive comp in the fourth quarter. We expected a penalty in the fourth quarter, we didn’t get the penalty so the run rate in the quarter was pretty much a normal run rate. We do given that the stock price again is higher running in the first quarter here, we’ll get a little negative implication in the first quarter of 2012 related to equity incentive comp but I don’t think anyone is going to be complaining about that, particularly our shareholders.

As we look at the 2012, the sequential for this business typically is from a margin perspective first quarter is a solid quarter from a margin perspective, the second improves a little bit, the third quarter is weak due to the seasonality and the fourth quarter is typically our strongest quarter from a margin perspective. I would expect the same type of cadence in 2012 that we’ve seen in 2011.

Ravi Shanker – Morgan Stanley

Did you say what material headwind is going to be next year in 2012?

Robin J. Adams

We’re looking somewhere about $25 to $30 million for 2012. But frankly, whether it’s $20 to $25, $25 to $30, $30 to $35 we’ll manage through it. I wouldn’t have any expectation of any negative impact in our earnings guidance related to material.

Ravi Shanker – Morgan Stanley

When you speak on the balance sheet you threw in there that the balance sheet is in good shape for new strategic acquisitions. Anything in particular you have in mind in terms of products or end markets?

Robin J. Adams

Well as always we’re looking for advanced power train technology. We’ve got a lot of things in mind, unfortunately we can’t get the sellers to sell them just like a lot of the transactions so we’re just going to have to continue to be patient. Our VP of M&A is going to have to continue to go out nice dinners, and drink fine wine, and eat food trying to woe these potential sellers. But that’s our focus. I tell them to spend a little bit more money on the wine this time around and maybe we’ll get one of these guys to sell their company to us. There’s some attractive things out there, we’ve just got to bring them in.

Operator

Your next question comes from Analyst for Richard Kwas – Wells Fargo Securities, LLC.

Analyst for Richard Kwas – Wells Fargo Securities, LLC.

I just had a couple questions related to the drive train segment. If we stripped out the purchase accounting, what kind of contributions are we looking from Haldex on the drive train segment? And from a cadence standpoint do you guys feel like you can get to that 9% early on in 1H or is that more like a second half kind of phenomena.

Robin J. Adams

If you look at the Haldex Traction Systems business, we purchased it in the first quarter so when you look at the fourth quarter versus the prior year there’s nothing to compare it to so really their incremental margin is their all in margin. If you exclude the purchase accounting they’re running right about the average of the drive train business at about 9%. So there’s no incremental there now we’ll see their incremental in the first quarter and I expect it to be comparable to typical BorgWarner incremental margins of about $0.20 on the dollar.

As we look at the drive train business again, fourth quarter was very strong for them and we don’t expect them to fall down in the first quarter. We’ll see some continued strong performance. As I said earlier, fourth quarter is typically our strongest quarter of the year so first quarter might not be as strong as the fourth quarter but it’s going to be close enough. And again, you’ll see strength throughout the year but we don’t expect to start the year off at 7.5% drive train margins in the first quarter. It will be pretty comparable to fourth quarter levels, maybe a little bit weaker but not much and then it will build in the second quarter, we’ll have that third quarter dip because of the shutdowns in the third quarter and then we’ll see a strong fourth quarter out of them.

Analyst for Richard Kwas – Wells Fargo Securities, LLC.

The question that I have is what we saw on the engine side is your revenues pulled back a little bit in Q4 as normally we see a material increase sequentially from Q3. I was just wondering if you could sort of explain that? Was that something more to do with fx or can you put a little bit more color on that?

Timothy M. Manganello

In the fourth quarter towards the tail end of the fourth quarter we saw a little bit of softness on some schedules in the southern European guys, the guys at PSA, Renault, Fiat and that impacted us a little bit on a couple of our business units including turbochargers. That softness is starting to come back now in January, we’re starting to see a rebound in the schedules in January so that contributed a little bit to the softness you saw towards the end of the fourth quarter.

Robin J. Adams

We also had negative impact in currency, you’re right. If you looked at quarter-over-quarter, first of all third quarter was a pretty strong quarter for the engine group, a little bit stronger than normal because our customers ran a little bit more in the third quarter than they normally do. But we were impacted by currency fourth quarter to the third quarter of about $45 million on the engine business. So on a comparable basis fourth quarter to the third quarter, engine was actually up about three percentage points.

Again, our reference point is versus the prior year and the engine group was more than 11 percentage points sales growth relative to the industry. So from that perspective we had a hell of a fourth quarter in the engine group and again, currency did impact the comparison fourth quarter to third quarter. If you took our currency, we’re actually up almost 3% in the fourth quarter versus the third quarter. Again, third quarter was a pretty strong quarter for them.

Timothy M. Manganello

When I talk a little bit about softness, I’m talking about relative to our plan and the actual schedules we had gotten from the OEMs themselves coupled with our plans.

Analyst for Richard Kwas – Wells Fargo Securities, LLC.

Finally, on the 32% contribution margin in the engine segment, how sustainable is that? How did the team generate that kind of return, I mean it’s pretty impressive?

Robin J. Adams

It’s very impressive. First of all I’ll tell you they worked their butts off. We had very strong performance out of all our business units. In fact, as we’ve said before we’ve got a couple of business units in the engine side, we had disposal in the quarter and they’re working real hard frankly on some of their overhead costs in the SG&A area. So that helped a bit in the fourth quarter.

We do not expect that $0.31 on the dollar incremental margin improvement in 2012. As I said earlier, we’re looking at about our traditionally $0.20 on the dollar out of both engine and drive train which is more typical. They did have a very good fourth quarter. There was a little improvement on some of our European guys in the fourth quarter.

Operator

Your next question comes from Rod Lache – Deutsche Bank Securities.

Rod Lache – Deutsche Bank Securities

Just a couple things, first relative to your guidance, if you just from a very high level apply 15% organic growth and 20% incremental margins and then as you suggested take off that 5% fx and maybe an 11% margin, you still come up with EBIT of [174/175] it’s in the low 12s. You’re guiding to 11.5% plus it just seems like a decent delta there. Is there something that I’m missing in that bridge?

Robin J. Adams

No, you’re doing a macro rough look. I wish the business were that easy Rod.

Rod Lache – Deutsche Bank Securities

Just relative to your SG&A, your SG&A to sales is falling pretty steadily over the course of this year. As a percentage of sales you had pretty steady revenue, how should we be thinking about that number going forward, the SG&A?

Robin J. Adams

As I said earlier, we’re looking for a sizeable increase in R&D spending again 2012 versus 2011 which will get us higher spending on the SG&A line. We’re looking at about a 20% increase. But, if you look overall to the business we’re still expecting SG&A closer to 9% than its historical 10% level.

Timothy M. Manganello

The other thing you’re seeing is we’re starting to leverage our existing platforms in Europe and North America. Take Europe for example, a lot of the growth we are going to see in China will be based on not just domestic OEMs in China but also European OEMs in China that are taking technology and launching vehicles in China that are using existing designs and existing products that we’ve already designed and manufactured and spent all the extra SG&A on in Europe. The guys in China, or Asia in general, are leveraging off the SG&A that’s already been spent in Europe with carryover products.

Rod Lache – Deutsche Bank Securities

Two maybe things you can maybe hit for us, your engine margins as you pointed out, our up very strongly low 16s here. Is there anything you see on the horizon that would cap that out? Then lastly, you may have mentioned this already, but IHS did adjust their production forecast subsequent to your guidance. Did you look at that and basically conclude that the platforms they had adjusted were not that relevant to you or were you not using IHS when you provided the guidance initially?

Timothy M. Manganello

We use a number of information including IHS but at the end we make our own determination and based on what we’re seeing and based on our analysis, basically we’re not changing our estimates for production in any parts of the world at this point in time. We think we’ve been pretty accurate in years past and we think we’re pretty accurate this year. We’re not changing anything but we continue to monitor it and as the year goes on we’ll typically make one or two adjustments in the middle of the year or the third quarter of the year as we see the year developed but there’s no need for us to change what we see right now.

Rod Lache – Deutsche Bank Securities

And the engine margins?

Robin J. Adams

Do they cap out? Relative to 2011 we still see a little bit of upside on operating income margins in the engine group. As we’ve said before, our margins will cap out when our sales growth slows.

Timothy M. Manganello

Our margins are somewhat dependent on our technology. The better we can [inaudible] technology and separate ourselves from our competition the better we can maintain or improve our margins. As far as I’m concerned margins are tied to two things, how well we develop new technology that our customers really want and how disciplined we are in running our business. I think we’re pretty damn good in both.

Operator

Your next question comes from Himanshu Patel – JP Morgan.

Himanshu Patel – JP Morgan

Tim, I wonder if you could update us a little bit on the competitive dynamics in the turbocharger space? I think maybe a little less than a year ago you guys had talked about Bosch and Conti having secured only about a 5% share of the sort of contracts that you saw being out there by mid decade. Two questions, one is that still the kind of ballpark of market share that you’re seeing for those guys? And then number two, I’m just wondering they may have secured a certain amount of share but they clearly would be bidding on a much larger scope of the market? I’m just trying to understand how much of the turbocharger bidding activity is such where you are seeing four players instead of the kind of two or three traditional guys?

Timothy M. Manganello

Even before Bosch and Conti got into the picture we saw four players because we had two Japanese competitors along with ourselves and Honeywell. Conti has got a little bit of business at Ford. I think they’re getting ready to launch it right now. I don’t know if they won anything more since then. Bosch [AMLA] joint venture has got a little bit of business at Volkswagen. I don’t know where they are in their launch cycle.

Actually, we see everybody bidding on all the projects. We bid based on our technology and what price levels we’re willing to live with and we’re winning a significant amount of turbocharger business and we’re doing it without sacrificing pricing or margins. I think, like I’ve said many times, we are focused on the higher tech part of the turbocharger business, the technology that delivers the best fuel economy at the same time giving the best durability.

Competing against Honeywell all these years is tough enough and it’s really not that different just adding a couple more competitors. They’re typically focused on the lower end technology portion. We have won a significant amount of new business in the last 12 months which will eventually roll into our backlog when we announce that in November. I don’t go by batting averages or anything else, I just track how much new business we win by dollars and we won a significant amount of dollars in 2011 as compared to 2010 or 2009.

Himanshu Patel – JP Morgan

Are you sensing that sort of 5% number is changing though?

Timothy M. Manganello

Not really. I think they’ve won some business and now they’re in the launch stage. They’re bidding on other new business but are they getting much more than they’ve won in the past? Not that I can tell.

Himanshu Patel – JP Morgan

A somewhat related question just given their proliferation of turbochargers in so many power trains, it seems like it’s so integral to the engine, any risk here that the OEMs consider in sourcing this product area?

Timothy M. Manganello

I learned a long time ago both in this industry and outside this industry never say never. I don’t see any activity in that score right now. We see a little bit in Europe where people would like to be in the turbocharger business. Mercedes or Daimler has got a piece of the action with one of the Japanese turbocharger companies, they’ve got a small joint venture. It could happen but I don’t see any activity going on right now what’s over and above what’s normal.

Himanshu Patel – JP Morgan

The next question, I think for the fourth quarter you guys mentioned your kind of clean organic European revenue growth was 6% versus industry of -4%. That sort of 10 percentage points of outperformance can you just directionally talk to what you expect that to be for full year 2012 just given what you’re seeing on platform mix and your own backlog? Should we think about sort of a similar magnitude of European outperformance for Borg?

Robin J. Adams

Actually, we’ll probably be a little bit stronger. I think, as we’ve said before, we’re looking at a market in Europe that’s going to be down about 4% to 5%. We’re looking at our sales in Europe on a reported basis up about 10% and there’s a little bit of negative currency impact there as well. We’re going to be pretty strong relative to the market in Europe in 2012.

Timothy M. Manganello

As a matter of fact in 2011 we increased our European presence percentage wise a little bit already in 2011 for the full year and that didn’t include the Haldex acquisition.

Operator

Your next question comes from John Murphy – Bank of America Merrill Lynch.

John Murphy – Bank of America Merrill Lynch

Just a question on the drive train business, you guys have highlighted DCTs in Europe as a point of strength and your standard transmission parts in Asia as a point of strength, I was just curious where you stand right now with your old school drive train? Not disparagingly but your standard drive train transfer case business with trucks in North America, particularly with Ford, what level of capacity utilization you’re at there? As that market improves could that be a real source of upside for drive train?

Timothy M. Manganello

We’ll we’ve got all Ford’s standard duty transfer cases, we’ve got all of the Ram trucks standard duty and heavy duty trucks. As you see Ford and Dodge doing better month-on-month and doing very well in the truck markets, that’s a direct correlation to us in a positive way. Would I like to have some GM business? Yes, but I’m perfectly happy having the majority of Ford’s business, we have everything except the extreme heavy duty portion.

As the truck market is doing well we’re doing well. Capacity, we are tight on the capacity on the Dodge transfer cases. We are at capacity or just slightly below capacity on the Ford. We can do more Ford. We’re actually putting in capacity right now for Dodge. I would hope that they challenge us with more volume in the future because we can put capacity in fairly quickly on that product line.

John Murphy – Bank of America Merrill Lynch

Just a second question on the BERU double platinum spark plugs on the Audi engine, as we look at that is that purely incremental content or are you replacing some former BERU spark plugs there? I’m just trying to understand is that all incremental growth?

Robin J. Adams

That’s all incremental.

Timothy M. Manganello

That’s incremental new technology.

John Murphy – Bank of America Merrill Lynch

That’s on two programs right now but you’re talking about two more? Are those global platforms or engine platforms?

Timothy M. Manganello

In my comments we said we’re going to launch it on the Audio 1.8 2 liter. Those are global engines for Audi so I’m pretty sure when they go global we go global.

John Murphy – Bank of America Merrill Lynch

Lastly, just on the potential for a dividend obviously, there’s a lot of capital going to growth. You guys were previously a great dividend payer, I’m just curious what your thoughts are on the potential for a dividend reinstatement?

Robin J. Adams

That’s a great question. We continually discuss that issue. I think there’s a couple of things here, first of all as you point out, our focus is growth and we really like to reinvest our cash in the business. The way we make acquisitions, you never know when they’re going to come so we do have to have a very strong capital structure and be able to have the cash on hand to be able to make a transaction when something becomes available. So we’re holding a little bit more cash because of that.

Second, we found out in the last recession, 2008/2009 that having a revolving credit facility available to use as cash for an acquisition maybe is not the way to go in these days because we saw a lot of banks just walk away from lending during that time period. So we’re less comfortable relying on a revolving credit facility, a little more comfortable relying on some cash. So you’ll see us carrying a little more cash on our balance sheet than we would have prior to 2008/2009 when we were paying a dividend.

The second thing is the tax laws of the United States are really a disadvantage for an international company like BorgWarner and there’s a lot of talk about changing the tax laws. I think both from a corporate perspective and also from a personal income perspective the last thing we want to do is payout dividends and see them taxed at an ordinary income rate to our shareholders. We think there’s a more tax effective way to return capital to our shareholders.

So at this point in time the dividend is just going to sit a while until we get some clarity on US taxes. It’s going to sit a while while we continue to look for strategic acquisitions. Again, our first focus is acquisitions. We have had a history of purchasing shares in the market, we continue to do so. If you look, we purchased some stock in the fourth quarter of 2011. We’ll continue to be in the market repurchasing stock.

Right now a dividend is kind of lower on our list of priorities for returning cash to shareholders but we’re watching hopefully some tax law changes here in the next year or so that will provide some clarity on what is the best way to return capital to shareholders.

Operator

Your next question comes from Joseph Sack – RBC Capital Markets.

Joseph Sack – RBC Capital Markets

Going back to the drive train segment, if we strip out the Haldex acquisition, it looks like that’s sort of been growing mid teenish. Is that sort of you think a fair run rate for that segment going forward? I know you called out DCT but what other products are really help driving that growth?

Robin J. Adams

I’ll talk about the run rate, Tim can talk about the products. As we look at our backlog, our three year backlog, if you look at the total growth of the company we see the drive train business growing just about the same rate as the engine business. As we look at growth as a company of 10 percentage points in excess of the market that’s both engine and drive train growth. So we expect continued good strong growth in the drive train business along with the engine business. Tim, do you want to talk about the technologies?

Timothy M. Manganello

Traditionally automatic transmissions they’re going from four speeds to six speeds and six speeds to eight speed automatic transmissions. Every time you put another speed on a traditional automatic transmission it’s another clutch opportunity for BorgWarner. Also, because of the race between dual clutch and the competitive nature of people who are making dual clutch automatics versus the people who are making traditional automatics, the traditional automatic transmissions are trying to up their game in terms of fuel economy which is driving better shift quality.

We make the [solenoids] for traditional automatics that people are upgrading to, to get better crisper and quicker shift quality with less parasitic losses. Consequently we’re growing very well on transmission [solenoids] with traditional automatic transmissions. We’re growing very well on clutches on traditional automatic transmissions.

Then you shift gears and go over to dual clutches. There’s two parts of the market on dual clutches there’s the dual wet clutch and the duel dry clutch. When you do the dual wet clutch which is a growing market globally, we supply the clutch module and the control module for the dual wet clutch. That’s pretty much two big pieces of content on the wet clutch. On the dry clutch, even though we don’t make the dry clutch module, we make the control modules for a number of the dry clutch transmission manufacturers so we’re picking up having the competing business on the module itself.

The you go with four wheel drive business. Four wheel drive business has continued to be a growth business now with trucks recovering in North America. Actually, we were in China last week with our board and SUVs are becoming more fashionable in China so I see some opportunity for transfer case growth in China due to the SUV market becoming more fashionable again.

That coupled with the fact that we took a lot of cost out of the transfer case business that we have by basically closing down our [inaudible] operation and consolidating all our transfer case business in North America, in Seneca South Carolina. Between a lot of products that are growing on the drive train side coupled with improving cost controls not just on the transfer case side but also on the transmission side should help us. Consequently we should see growth in our sales and hopefully growth in our profits on the drive train side.

Joseph Sack – RBC Capital Markets

I appreciate the color on contribution margins and I think you said 20% for both segments, but for the drive train is that ex Haldex or sort of including the Haldex amortization costs?

Robin J. Adams

That will be including Haldex.

Joseph Sack – RBC Capital Markets

So implying it will be higher without the amortization?

Robin J. Adams

The amortization cost is basically fixed so what you’re really looking at when you look at incremental margins year-over-year you’re looking at the core operations both for the traditional drive train business plus the acquired traction systems business. So on an incremental basis year-over-year we expect to see operating performance and the purchase accounting numbers are flat year-over-year, should have no incremental impact.

Operator

Your last question comes from Patrick Archambault – Goldman Sachs.

Patrick Archambault – Goldman Sachs

I had one remaining one because a lot of mine have been answered. On the diesel penetration, following a few years of uptick in that in Europe, now that obviously we’re heading into a much softer macro environment, how do you see that playing out? I know that the export market is likely to remain okay which may help it but is that something that could impact you from a profitability standpoint if people down shift a little bit just given a more frugal environment?

Timothy M. Manganello

We’re seeing globally between 2011 and 2016 a 25% growth in diesel applications in the light vehicle market. We’re seeing some slight growth in Europe, but percentage wise it’s about flat at 54% in Europe. The percentage is flat in Europe but there’s still growth in Europe. What we’re seeing growth in the rest of the world for diesel engines. We’re actually starting to see a little bit of uptick and interest in the United States for diesel also.

But, whatever happens on the diesel side, if they don’t buy a turbocharged diesel there is a high probability they will buy a turbocharged gas engine with GDI. So we’re going to sell turbochargers either way it’s just a matter of whether they’re gas turbochargers or diesel turbochargers. But the diesel market is still a growth market it’s just not as fast as the growth market for gas turbochargers.

Patrick Archambault – Goldman Sachs

Just on that, is the content more or less the same between a diesel program and a gas program assuming kind of a similar vehicle similar power train output?

Timothy M. Manganello

Let’s just say it depends on application. It varies from application to application but on the whole and on the average gas tends to be a little bit higher priced for a gas engine application turbocharger than a diesel application for a pass car. When you get in the commercial side there is no gas engine it is just high priced diesel turbochargers and we like it that way.

Patrick Archambault – Goldman Sachs

Lastly, is a lot of the growth in diesel that you see outside of North America and Europe, is that mostly commercial applications or is there actually some hope of a take up in diesel in places like Latin America and Asia as well?

Timothy M. Manganello

For pass car you mean?

Patrick Archambault – Goldman Sachs

Yes.

Timothy M. Manganello

Oh yes, we’re seeing increased penetration rates on diesel in other parts of the world. India, we’re seeing some in Asia and Korea, but it’s not growing as fast in those parts of the world as turbocharged gas engines are. Right now turbocharged gas engines – well, to give you an idea I said diesel engines for light vehicles globally are growing roughly 25% over the next five years, turbocharged gas engines are growing 150% roughly over the next five years.

Ken Lamb

I’d like to thank you all for joining us. We expect to file our 10K before the end of the day which will provide plenty of details on our 2011 results. If you have any follow up questions about our earnings release, the matters discussed during the call, or our 10K once it’s filed, please direct them to me. Operator, please close out the call.

Operator

That does conclude the BorgWarner 2011 fourth quarter results earnings conference call. Thank you for joining. You may now disconnect.

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