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BorgWarner Inc. (NYSE:BWA)

Q4 2007 Earnings Call

February 07, 2008 4:00 pm ET

Executives

Mary Brevard - VP of IR

Tim Manganello - Chairman and CEO

Robin Adams - EVP and CFO

Analysts

Rich Kwas - Wachovia

David Leiker - Robert W. Baird

Rod Lache - Deutsche Bank

Pat Archambault Goldman Sachs

Chris Ceraso - Credit Suisse

Rob Hinchliffe - UBS

Brian Johnson - Lehman Brothers

Brett Hoselton - -KeyBanc Capital

Joe Amaturo - Buckingham Research

Operator

At this time, I would like to welcome everyone to the BorgWarner 2007 fourth quarter and full year Earnings Call. (Operator Instructions)

I would now like to turn the call over to Mary Brevard, Vice President, Investor Relations. Ms. Brevard, you may begin your conference.

Mary Brevard

Thank you very much, Thea, and thank all of you for joining us today. We are having an out-of-town board meeting today with a very tight schedule of events, which is why we released mid-afternoon and are talking to you now rather than earlier in the morning when we would normally do this. So, this is just a one-time difference, because of our regularly scheduled board meeting.

The copies of the release went out to you today around 2o'clock Eastern Standard Time. We've also posted financial talking points on our website that should help you to follow the financial discussion. They are located at borgwarner.com, Investor Information, webcast fourth quarter 2007 conference call talking point.

The conference call today will be replayed till February 14, 2008. The dial-in number is 800-642-1687. Our conference call ID is 30058888. And then a replay of the call is also available on our website.

We have a number of analyst conferences that we will be having in the next few months: Lehman Brothers Industrial Conference, Monday, February 11th; The City Global Industrial Manufacturing Conference on March 5th; and the Morgan Stanley Global Automotive Conference on March 19th.

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.

Moving onto our results, Tim Manganello, Chairman and CEO, will be providing comments on 2007; and Robin Adams, our CFO will be discussing operating results.

Tim?

Tim Manganello

Thank you, Mary, and good day, everyone. Once again, BorgWarner has delivered excellent results both in the fourth quarter and the full year for 2007. Strong sales in Europe and Asia were coupled with the benefits of our restructuring plans in North America.

So, now let's take a look at the highlights. The full year highlights include record sales of $5.3 billion, up 16%. Sales outside the US grew 17% over 2006. Excluding the impact of currency compared with vehicle production outside of US, it was up 7%.

Sales in our US operations were flat despite lower domestic vehicle production, which was down 3%. We had record earnings of $2.44 per share, excluding special items. The Engine Group sales were up 19% to $3.8 billion, and Drivetrain Group sales were up 9% to $1.6 billion.

Our 2007 accomplishments include our $1.95 billion of net new business for the three-year period covering 2008 through 2010, which then implies a growth rate of approximately 11% for the same three-year period. 50% of our new business is expected to be in Europe, 30% in Asia and 20% in North America.

We also opened new facilities around the globe. We have a new European Drivetrain technical center in Germany, an expansion of our turbo facility in Hungary, an additional facility to Turbo Systems on our Engine Campus in Korea and a second Arnstadt, Germany facility opened this week to handle additional DCT growth.

We also have facilities under construction for 2008. And they include: Thermal Systems, which has broken ground for a new facility near Chennai, India, and they will open another new facility in Ningbo, China, this Spring; a new turbocharger plant in Poland that will have capacity to make 500,000 turbochargers per year; a Drivetrain manufacturing campus in Mexico that will produce dual-clutch transmission modules and/or will drive system products. Also, plans are underway for our new technical center in Shanghai.

BorgWarner has also received major awards during 2007. And these include: a 2007 Automotive News PACE Award for our innovative gasoline turbocharger with variable turbine geometry or VTG. In addition, BorgWarner and Porsche were presented with two special PACE recognitions for our successful collaboration on a gas turbocharger with VTG. And also, we had a high-energy Interactive Torque Management device for all of their systems on the same vehicle, both on the Porsche 911 Turbo. Our R2S or regulated two-stage turbocharger system has also been named as a finalist for the 2008 Automotive News PACE Award. So, we look forward to that this year.

Honda honored our Morse TEC business for both quality and delivery. They also honored TorqTransfer Systems for on-time delivery, our sixth performance award from Honda in the last six years.

Morse TEC was honored by Mazda with a Cost Management Award. This time, North America recognized us as one of the three suppliers to earn its highest honor, the Regional Supplier Quality Award. BorgWarner Morse TEC Japan received an award for outstanding quality from Daihatsu. BorgWarner Transmission Systems was nominated by Hyundai and Kia as one of only four companies to receive the Korean Presidential Commendation for Quality.

BorgWarner TorqTransfer Systems received quality and R&D awards from two leading Chinese OEMs, NAVECO and Great Wall Motor. And BorgWarner received three supplier awards from Mahindra & Mahindra. The awards recognize superior performance and quality, cost and product development.

2007 was also a year of continued globalization for BorgWarner. In the area of technology, we advanced the globalization of our dual-clutch transmission technology, announcing our first program in North America and launching the first DCT technology in our Japanese transmission with Nissan and the GT-R sports car.

In 2007, we were awarded the first dual-clutch transmission program or dual-clutch module program in China with Shanghai Automotive. And at full production in their timeframe of 2012 to 2013, we will be providing our innovative DCT technology and expected 2.5 million dual-clutch transmissions per year. In addition, we have over 20 additional development programs underway around the world.

We continue to take the lead in this game-changing technologies with the development of even more fuel efficient modules. In addition, we are going to develop a complete transmission of our own unique design. We believe this new transmission is the DCT of the future for a wide range of applications.

The transmission combines our leading-edge dual-clutch technology into a compact design, and the transmission provides the convenience of an automatic for a wide range of vehicle applications from the small vehicle segment, which is expected to grow 30% worldwide over the next five years, up through and including the mid-sized vehicle segment.

In turbochargers, our technologies like regulated two-stage and variable turbine geometry and the combination of the two are setting the pace for fuel efficiency and performance in markets around the world. And when we look at the trends that have continued to support the growth of our turbo business, they just continue to get better.

For those of you at the Detroit Auto Show, all of the automakers were talking about tubochargers and diesels along with gasoline direct injection engines. We are seeing a big shift especially in gas engines. As I have stated in the past, turbocharged direct injection gas engines or Turbo GDI engines are emerging as the next solution for better fuel economy for gas engines.

Advances in turbocharger design, manufacturing and materials are expected to boost the growth of turbocharger gasoline engines by 30% over the next five years. The number of engines is expected to more than triple globally from 1.9 million units today to 7.5 million engines in 2013.

The fastest growth is in the US, growing from almost nothing today to 3 million engines by 2013. This provides another growth segment for BorgWarner, since we are the technology end market share leader in gas turbochargers.

On the diesel front, diesel usage is increasing in every major markets around the world. BorgWarner and other industry experts expect strong diesel growth to continue for the foreseeable future, including diesels in North America with expected growth from 16 million units in 2007 to 20 million units in 2013.

As a global leader in turbocharger and glow plug technology, we are a major beneficiary of diesel penetration, because every diesel engine has at least one turbocharger, plus some form of glow plug technology.

So, now, let's talk a little bit about customer diversity. During 2007, we also continue to diversify our customer base as is evident by our 2008 projected sales. Our 2008 sales breakdown is expected to be 49% in Europe, 31% in the Americas, 20% in Asia. And of that 31% in the Americas, 12% of the 31% are with the Detroit Three.

What should be the regulatory environment? 2007 was also a year when events around the globe validated our strategic focus on improving fuel economy and emissions. A number of governments including the US took steps towards adapting stringent fuel economy standards. As a global leader in powertrain technology that improves fuel efficiency, lowers emissions and enhances vehicle performance, we are well positioned to enjoy sustainable growth.

Now, before I turn the meeting over to Robin, let's take a quick look at 2008.

As you know, we plan to have another strong year in 2008. On January 17th, we gave 2008 guidance and there is no change. We expect to increase sales in the 8% to 10% range with earnings guidance for 2008 of $2.85 to $3 per share.

We are not immune from continued declines in the US markets, nor “recessionaries” around the globe. However, we believe that we'll continue to update the industry because of our leading technology, broad customer base, new business backlog and a strategy that keeps us on target.

I believe that 2008 will be a year in which we continue to separate ourselves from other suppliers. We expect to be a solid, steady performer in the global auto sector.

And with that, I'll turn the meeting over to Robin. Thank you.

Robin Adams

Thank you, Tim, and good afternoon, everyone. Before I get into the details of the financials, let's go over the industry environment a little bit.

In the fourth quarter, as Tim said, we saw improved vehicle production growth in every region of the world with the exception of North America. Vehicle production outside of the US was up 7%, with Europe up 6% and Asia up 8%.

In the US, however, vehicle production slowed with the overall economy and was flat against the weak comparable in the fourth quarter 2006. For the full year, the results were pretty similar, strong growth in Europe and Asia, up 6% and 7% respectively, and weakness in North America where production was down 1.5%.

Now, let's contrast that with our sales growth. Our sales growth was 14% in the quarter and 16% for the full year compared to 6% and 5% global industry growth during the same periods respectively.

Excluding the impact of foreign currency, sales growth was approximately was 7% in the quarter and approximately 11% for the year, in line with our original guidance for 2007. And consistent with our results during the last few years, our growth at both the quarter and the full year came from our foreign operations.

In the quarter, sales outside of US were up 24%, 13% excluding currency, while sales in the US were down 3%. For the full year, sales outside of the US were up 27%, 17% excluding currency compared to about 7% industry growth outside the US.

In the US, sales for the year were flat despite the decline in North America production. And as a result, sales from our US operations in the fourth quarter on a consolidated basis represented 31% of our total sales, down 5 percentage points from the 36% in the fourth quarter a year ago.

For the full year 2007, US sales represented 34% of our consolidated sales versus 40% in 2006, and Tim has just given you the expectations for 2008.

Now, let's take a look at the rest of the fourth quarter financials. But before we do, I want to point out that in the press release we issued this afternoon, we provided a table to help you identify our US GAAP reported earnings and the items in the quarter and year that we will be discussing on this call and items that we believe should be understood and considered in reconciling our financial performance to prior periods, to current period expectations and for assessing future expectations.

As Tim said, this was the record fourth quarter for BorgWarner, and this was a record in a number of areas. Our net earnings on US GAAP basis were $0.60 a share, an increase of 70% versus reported earnings in fourth quarter 2006. But both this year and last year included a couple of one-time items, which really need to be considered in the comparison year.

First, the year-over-year adjustments may detect accounts based on the expected outcome of certain tax audits around the globe along with adjustments related to tax law changes in foreign jurisdictions and an unfavorable impact on GAAP earnings of $0.11 a share in the quarter. But you'll see when we talk about the full year, however, we ended up with the net benefit from tax account adjustments throughout the year.

Second, there were purchase accounting adjustments related to the acquisition of additional BERU shares in the quarter that also lowered US GAAP earnings by $0.02 a share. Excluding these items, our net earnings would be $0.73 a share, and this is an increase of almost 50% from comparable $0.49 a share in the fourth quarter 2006.

Changes in currency in the quarter added $0.05 a share a year-over-year. Adjusting for currency, earnings grew 40% in the quarter year-over-year, a very strong quarter and, as Tim said, a record.

Our reported operating income was $123 million in the fourth quarter, 9% of sales. But if you exclude the purchase accounting adjustments related to the BERU transaction, our operating income margins was at 9.2% of sales, up from a comparable $89 million or 7.4% of sales in the fourth quarter of 2006.

This is a quarter-over-quarter improvement or year-over-year and the fourth quarter improvement of 1.8 percentage points, almost 2 full percentage points. It put us back to the historical 9.2%, 9.3% operating income margin levels that we saw in fourth quarter of 2004 and the fourth quarter of 2005.

The improvement here is basically the improvement we've seen quarter-over-quarter throughout the year. It's attributable to the incremental margin on higher sales, which came in for this quarter at close to $0.20 on the dollar along with the structural improvements we made in our North American business in the last half of 2006.

Operating income line in the quarter, equity in affiliate earnings were up primarily due to continued strong performance of our Japanese Drivetrain joint venture. Interest expense was down reflecting more debt levels, and we'll talk about strong cash flow in the quarter in a second. And the effective tax rate in the quarter, excluding all the adjustments I previously discussed, was a little over 27% and again in line with our guidance throughout the year.

This was not only a record quarter, but also a record year for BorgWarner. Net earnings on a US GAAP basis were $2.45 a share and the year also included a few one-time items that we've detailed in our press release and happen to net out about $0.01 a share. So, comparisons are a little bit earlier.

This compares to a run rate adjusted EPS of $2.03 in 2006 and reflects 20% year-over-year growth in earnings, again, in line with our expectations of a good strong year. Currency provided approximately $0.13 a share in earnings versus 2006 and the higher tax rate of 27% in 2007 versus 26% in 2006 cost about $0.04 a share.

And just to clarify something that has caused some confusion on past calls, and I apologize for this, but the sell-side analysts estimate from that first call to which you made me comparing our results to and referring to, those exclude a warranty charge in their evaluation of our earnings, which we require in the first quarter of 2007 that translate to about $0.09 a share.

All the numbers that we use on this call, all the comparisons that we use include this charge as part of our run rate earnings operations. So, our discussions might be about $0.09 a share lower than discussions you might have with analysts or anyone else, all other things being equal. And I hope that clarifies that.

Our reported operating income for the year was $4.8 million and was $425 million, 8% of sales up from the comparable $358 million or 7.8% of sales in 2006. For those of you who do exclude that warranty charge that we had in the first quarter, you would be comparing to an operating income margin of about 8.3% in 2007.

The year-over-year improvement in operating income and margin again is largely attributable to the incremental margin on higher sales outside of US, which for the full year approached almost $0.20 on the dollar along with the structural improvements made in our North American business, which eliminated our decremental margin on declining sales to just below $0.20 on a dollar for the year and also offset by the net cost of nickel increases of approximately $25 million for the year.

And for the full year, talking about raw material prices, the full year increase in raw material prices ended up to be approximately $55 million, again of which nickel was about $25 million and the rest of the commodities about $30 million.

Below the operating income line, the story for the year is very similar to that of the fourth quarter, higher equity in affiliates' earnings, primarily due to the continued growth of our Japanese Drivetrain joint venture, customers, the transmission components we sell there, lower interest expense, reflecting lower debt levels for the year, offset by a higher tax rate, excluding the one-time cash adjustments of a little over 27% this year. I think it calculates to about 27.1% versus 26% in 2006.

Now let's move on to our operating segment performance. Both of our operating segments, again, had very strong fourth quarter. The Drivetrain Group's fourth quarter sales were up 9%, up 12% outside the US, excluding currency, while down 1% in the US. The Group's EBIT margin was 7.5% in the quarter versus 7.1% in the fourth quarter 2006.

On a full year basis consolidated sales up 9% versus 2006, again up 11% outside of the US, excluding currency, and down 3% in the US. From an EBIT margin perspective, the Group's segment margin was 7.4% in 2007, up from a comparable 6.2% in 2006. You may remember that the Drivetrain Group's profitability in the last half of 2006 was fairly impacted by the deep production cuts by our North American customers, and the majority of our 2006 restructuring activities were focused on the Drivetrain business. And you see that significant improvement in margin year-over-year as a result of those actions.

In the quarter and in the full year, the Group benefited from increased demand for dual-clutch transmission components and transmission solenoids in control modules, but again was negatively impacted by lower US production of vehicles equipped with its traditional transmission and torque management products.

Now let's talk about the Engine Group. Fourth quarter sales up 16%, 13% outside of the US, excluding currency, while down 5% in the US. The Group's segment EBIT margin improved to 12.6% from 11.7% of fourth quarter 2006. So both the Engine and the Drivetrain saw over 1 percentage point or almost 1 percentage points or more improvement in margin in the quarter.

For the full year, consolidated sales were up 19%, 16% outside the US, excluding currency, very strong performance, and actually up 4% in the US. The Group's EBIT margin for the year was 11.1% and that is down from 11.6% in 2006. And if you remember, in the first half of the year the Engine Group was negatively impacted by higher nickel prices, which negatively impacted their results by approximately, again, $25 million, also impacted their EBIT margins by seven-tenths of a percent. So that 11.1%, excluding nickel, would have been about 11.8% versus 11.6% last year.

Also as I mentioned previously, in the first quarter of the Engine Group did record a $14 million warranty related charge that also depressed their margins. In the quarter and in the full year the group continued to benefit from European nations automaker demand for turbochargers, timing systems, thermal management products and emission products as well as higher sales of turbochargers and emission products in the US.

Now let's talk a little bit about the balance sheet and our cash flow. Our investment grade capital structure continues to be very strong. Our debt to capital ratio was 22% at the end of the year versus 28% prior yearend. Net cash provided by operating activities for 2007 was a record $602 million, and that's $160 million increase from the $442 million last year, a very strong year.

Earnings, sales and cash flow. The strong growth in earnings along with tight working capital controls drove that strong year-over-year improvement in cash generation. Capital expenditures, including tooling outlays for the year were just under $300 million compared with approximately $270 million last year. These investments that we make continue to support almost $2 billion book to new business, as well as our cost reduction and productivity improvement programs to help maintain our margins.

The strong cash flow we generated in 2007 also helped fund the $138 million of purchase of additional shares of BERU and almost $50 million of share repurchases throughout the year. Our after-tax return on invested capital in 2007 improved over 1 percentage point to 13.4% versus 12.2% in 2006.

We said in late 2006 that 2007 will be a transition year for us financially as we implemented the restructuring of our US operations and continued our strong growth outside the US. We also said that we would have our margins back in line with historical levels by the end of the year. And I think our fourth quarter performance confirms our expectations and commitment to that goal.

We fought to increase nickel prices and never changed our expectation for the year despite those increases. We set records for sales and earnings and net cash provided by operating activities, and grew our earnings by 20% year-over-year despite the continuing turmoil in the US industry. And while the global business environment in 2007 showed some improvements over 2006, the US market continues to struggle. And as Tim said, 2008 is shaping up to be another challenging year for our US customers.

The slowdown in the US economy has dampened expectations for the US auto industry and it may affect global markets as well. That said, BorgWarner remains well positioned to exploit a number of trends in the industry that continue to gain momentum regardless of the macro environment, and we are looking forward to another record year for BorgWarner in 2008 with, as Tim said, earnings growth again in a range of 17% to 22%.

Thank you for your continued support. And with that, I will turn the call back over to Mary. Mary?

Mary Brevard

Thank you, Robin. I will, Thea, the call coordinator please to go into the Q&A session. Thea?

Question-and-Answer Session

Operator

(Operator Instructions)

The first question is from Rich Kwas with Wachovia.

Rich Kwas - Wachovia

Hi. Good afternoon.

Tim Manganello

Hi, Rich.

Rich Kwas - Wachovia

Tim, in Europe here there seems to be some concern about economic weakness over there. I know a couple of weeks ago you indicated that you're seeing substantial growth over there with new business and that would offset expected any potential weakness in Europe. How do you feel about Europe now that we're about five weeks into the new year and what you're seeing out there?

Tim Manganello

Well, Rich, the quick answer is nothing has changed. Our products continue to have strong demand. Our challenge is to make enough turbochargers, continue to expand. Like I said, we're putting in more expansion on dual-clutch transmissions. So, for us, the strong demand for better fuel economy and the European cars coupled with the down-sizing from larger engines to smaller engines plays to build BorgWarner's strength and is a benefit to us. So, so far so good, and we expect it to continue for the year.

Rich Kwas - Wachovia

Okay. Could you remind us what you are assuming for European production for 2008?

Tim Manganello

I think we we’re flat in Europe, as a basic assumption, down about 5% in North America, sales slightly up in Asia, and the global market up about 3%. That will take care of the whole spectrum.

Rich Kwas - Wachovia

Okay. And a bigger picture question in terms of diesel, here in North America with the Japanese, what are you seeing on that front in terms of development contracts and momentum with them?

Tim Manganello

You are talking about diesel development with the Japanese OEMs in North America? Well, let's just say that we are working and we have a lot of active development programs going on with diesels with the Japanese. I know they are developing diesel engines for both Europe and North America.

We work in Japan with the Japanese. We have active programs with the main players. And where they shift those engines or what vehicles they put them in and what countries they end up with, I don't know. But all I can tell you is that the core developments done in Japan and we're in the thick of it.

Rich Kwas - Wachovia

Okay. And then finally, Robin, what should we be assuming for the tax rate 2008?

Robin Adams

We reaffirmed our guidance today for 2008 that we gave a couple of weeks ago. Within that guidance, we assume 26% effective tax rate.

Rich Kwas - Wachovia

Okay.

Robin Adams

Lower than 2007. And as we said before, it's a result of lower tax rates in the foreign jurisdictions.

Rich Kwas - Wachovia

Okay. Thank you.

Operator

The next question is from David Leiker with Robert W. Baird.

David Leiker - Robert W. Baird

Good afternoon.

Tim Manganello

Hi, David.

Robin Adams

Hi, David.

David Leiker - Robert W. Baird

Just a housekeeping item first. Purchase accounting adjustment, is that an SG&A or does that fall in cost of goods sold or somewhere else?

Robin Adams

Mostly in cost of goods sold. There might be a little bit in SG&A, but it's predominantly cost of goods sold.

David Leiker - Robert W. Baird

Okay. And, Tim, if you look at downsizing the gas engines and going to direct injection with turbos, there are some pluses and minuses there in terms of timing system and cooling in the turbo and the transmission. What kind of change do you have in vehicle if you have all those components? What kind of change in content?

Tim Manganello

Well, if you downsize and go from a larger engine to a downsized turbocharged smaller engine, it actually plays to our strength, David. It requires more BP or robust timing drive systems, stronger transmission components. While they are doing that, they may be interested in switching from a traditional automatic transmission to a dual-clutch automatic transmission. Those are all things that play to our strengths.

David Leiker - Robert W. Baird

And you said 20%, if you had timing and transmission on a larger and then downsize that still have those in turbo, that 20%...

Tim Manganello

I think another way to look at it, Dave, is if you go from a V8 dual to dual-overhead cam that we happen to be a famous player of, you have a right bank and a left bank. Okay? And that maybe, I don't know. Let's just say $80 contact per engine. Now, let's say you are going to sort of -- if you go all the way to a four cylinder, which -- you can actually go from a gas V8 to a downsized turbocharged four cylinder and get probably the same performance of the gas as a V8. You actually obviously eliminate bank, so the timing driver is slightly less complex. So we may see a more robust timing drive, but it will have a little bit less content because of only one bank.

David Leiker - Robert W. Baird

Right. But then you would add a turbo to that?

Tim Manganello

Yes, you picked up the turbo and maybe you picked up some more transmission speeds. Typically, they may go from the four-speed to a six-speed or something like that. Those are all more clutches on a traditional side. And if it's a dual clutch, we'll probably open it.

David Leiker - Robert W. Baird

I'm trying to get the scale of increased content that you have there.

Tim Manganello

I'd have to go back and have some people run some numbers. If I give you a number now, it'd be really a ballpark guess. And I'll just follow-up with you on a real, more accurate number.

David Leiker - Robert W. Baird

And then as you go through this process, how quickly can a one-year customer take gasoline engine and convert it to direct injection turbo or is that a newly designed engine?

Tim Manganello

Pretty much a newly designed engine. You're right on there.

David Leiker - Robert W. Baird

Okay.

Tim Manganello

Engine programs are like in the three or four year time horizon. But some of these guys have been working on it for a year or two. So, it's not likely they are caught totally with their pants down.

David Leiker - Robert W. Baird

Okay, great. Thank you.

Tim Manganello

Thank you, David.

Operator

The next question is from Rod Lache with Deutsche Bank.

Rod Lache - Deutsche Bank

Hello, everybody.

Tim Manganello

Hello, Rod.

Rod Lache - Deutsche Bank

I have a few questions. Firstly, you show corporate expenses net of equity in affiliate earnings in your release. And if I make an adjustment for the equity in affiliate earnings, it looks like your corporate expenses went from almost $39 million down to $31 million year-over-year. Is there a big drop in corporate overhead here or am I looking at this incorrectly?

Robin Adams

The year-over-year change there is primarily related to provisions for environment expense that we incurred in 2006 versus 2007.

Rod Lache - Deutsche Bank

Okay, all right. And that's contributing to the incremental margin that we're seeing, I guess, on year-over-year basis, or did you exclude that?

Robin Adams

At the corporate level, yes. But at the business unit level, if you look at the reporting segments, the incremental margin year-over-year, obviously they had nothing to do with it.

Rod Lache - Deutsche Bank

Okay. And, Ken, did you give us the organic growth excluding FX for Drivetrain and Engine?

Ken Lamb

Yes.

Rod Lache - Deutsche Bank

Would you mind repeating that just overall for those divisions?

Ken Lamb

If you're talking about for the quarter?

Rod Lache - Deutsche Bank

Yes, for the quarter.

Ken Lamb

Net of FX is $95 million for the company. And sales-wise, sales were up 16% with currency for the Engine group, actually 16.3%. But excluding currency, the sales were up 7.4%. On the Drivetrain, sales were up 9.2% including currency and up 3.8% if you exclude currency for the quarter.

Rod Lache - Deutsche Bank

Okay. And did you say what the EBIT impact overall from currency was?

Robin Adams

It comes pretty close to our average operating income for the business. So the quarter was slightly above 9%.

Rod Lache - Deutsche Bank

Okay. And then, lastly, what percentage of BERU do you own now and what's the plan for that?

Robin Adams

We own in excess of 75%. The requirement under Germany now is that we tender for the remaining portion. And we're just going to have to see if the rest of the shareholders that own the stock are interested in selling. They weren't interested a few years ago.

Rod Lache - Deutsche Bank

Okay. So there will be some kind of release or something on that coming out?

Robin Adams

There will be details in the 10-K. There is a requirement in Germany that there'll be a transaction that gets approved at their Annual Shareholder Meeting. Basically that will require a tender for the remaining shares.

Rod Lache - Deutsche Bank

Okay. Thank you.

Operator

The next question is from Robert Barry with Goldman Sachs.

Pat Archambault Goldman Sachs

Hello, can you hear me?

Tim Manganello

Yeah, we can hear you.

Pat Archambault - Goldman Sachs

This is actually Pat Archambault here for Rob.

Mary Brevard

All right.

Pat Archambault - Goldman Sachs

Yeah. In terms of the outlook that you reaffirmed of 8% to 10%, I was wondering if you could maybe break that down by business group and potentially even by geography for us, just in terms of what you expect to do for '08.

Robin Adams

I'll handle it by geography, which is probably an easier discussion. As we said when we gave the guidance, we're expecting 2008 to be another year of sizable decline in the US market. We're expecting our sales in North America to be down 5%, which is approximately another $100 million, and then our growth outside the US to be 15% plus. So, from a geographic perspective, if you look at that 8% to 10% growth, you are looking at the US down 5% and outside the US up 15%. We expect good growth performance in both the Engine and Drivetrain segments in 2008.

Pat Archambault - Goldman Sachs

And how about within the US, can you just give us a little bit more color as to your expectations for the various businesses, Engine versus Drivetrain?

Robin Adams

Well, we continue to see pressure from all our customers in the US markets, if they are not building vehicles or not building engines or transmissions or four-wheel drive. So we're seeing pressure on both side of the business in the US.

Pat Archambault - Goldman Sachs

Okay. So in terms of the Engine Group, there is no offset from increasing segment of turbos and the US starting to trickle down to light vehicles or anything like that?

Robin Adams

No.

Pat Archambault - Goldman Sachs

Okay. Last question, can you just give us, or refresh us, in terms of your outlook for commodities that factored into your guidance?

Robin Adams

As we look to 2008, we look for a little bit of a breather maybe. Commodity increases right now for us are about $25 million plus or minus, a few million. Not an exact science, stuff to catch right now.

Tim Manganello

And I think as we said at the last call, there's still a little bit of a question mark kind for aluminum and steel for this year, not necessarily with BorgWarner, but within the industry.

Pat Archambault - Goldman Sachs

Is most of your buy contracted out on a longer term basis? I guess at what point would sort of that amount be relatively baked in without much credibility?

Tim Manganello

Well, some of our buy is covered by contractual pass-through. So we have contracts with our suppliers and contracts with our customers and some just goes right through. There is a lot of aluminum on some of that pass-through. We've got some nickel on that pass-through. We have some hedging. I think my people have done a really good job of managing commodities over the last couple of years. This year, like Robin said, we're going to see the total numbers definitely less than the total number was last year.

Robin Adams

Yeah. Patrick, if you look at the level of expectations in 2008 it’s kind of back to our normal run rate of business. 2007 was a unique year for us, primarily due to the increase in nickel in the first half of 2007. But for the back half of 2007, raw material prices, while increasing, were more in line with our historical levels, and 2008 looks to be more of the same. So, this is nothing out of the ordinary for BorgWarner. It's part of our G&A each year to see raw material price increases $25 million to $35 million range, and that's just part of our cost reduction efforts throughout the year to offset that.

Pat Archambault - Goldman Sachs

Okay, great. Thanks a lot, guys.

Operator

The next question is from Chris Ceraso with Credit Suisse.

Chris Ceraso - Credit Suisse

Thanks. Good afternoon.

Tim Manganello

Hi, Chris.

Robin Adams

Hi, Chris.

Chris Ceraso - Credit Suisse

A few things. Tim, you mentioned all of the interesting downsized gas turbos, which was very clear at the trade show this year. Can you talk a little bit about your plans to grow your capacity? You mentioned a few things in your prepared remarks, but maybe if you can talk through where your current utilization rate is on turbo production capacity and what does that mean for CapEx over the next few years. Would you have to meaningfully dial up your capital spending to keep up with all the demand for turbos?

Tim Manganello

Yes. I can give you a real quick answer on the capacity utilization. Our demand is higher than capacity. We are probably producing 110%. We are putting capacity in China. We're putting capacity in Korea. We're putting capacity in Mexico. We're putting capacity in Poland. And it still probably won't be enough.

So, we're having internal discussions as to how to forecast maybe more capacity than actually some of the customers have asked for, because what happens is the customer typically -- especially in Europe, but I think it will show up in lot of places in the future -- the customers will give us forecasts for the year. They end up taking more than that forecast, and we put capacity in for their forecasts or maybe even a little extra. And they end up taking more than we have capacity for. So, we are back to where we were a few years ago.

The only difference is we're doing a better job of predicting the business and managing the business. And we're starting to see a profitability improve too. So, there will be more capacity put in, but I am not going to say where at this point in time for competitive reasons.

Mary Brevard

But --.

Chris Ceraso - Credit Suisse

I am sorry go ahead, Robin.

Mary Brevard

I am going to say, Chris, it's not going to be outside our normal capital expense.

Tim Manganello

No, it all falls within our 5.5% to 6.5% range, which is, we kind of average in that 6% range, plus or minus. But with our growth platforms, 6% target per year, because there is plenty of room to work in terms of increased capacities or capital spending.

Robin Adams

I want to be clear that capital spending, if you add in tooling, it's more like 6.5% to 7%.

Tim Manganello

Right.

Chris Ceraso - Credit Suisse

Okay. What side of --

Tim Manganello

Chris, could I go back for a second and answer while we are still on this issue? Dave, I liked your asset question, which was a good question. I had a chance to do a little more noodleing here.

If you go from a V engine with two banks to a four-cylinder engine on a downsized gas engine or even for diesel, you are taking out maybe 30% to 40% of the cost of the timing drive, and so you're maybe going from $80 an engine to $60 or maybe even, let's just roughly, even down the $50 or something like that. So, you're from $80 to $50, let's say.

But you are adding in a turbochargers that could be, if it's a single turbocharged engine, it could be in that 250 to 350 range and if it's a regenerator of two stage, which you could have an R2S regenerator of two-stage four cylinder that would replace an eight sounder, you can double that in terms of turbocharger sales. So, the net is a big gain, if they downsize engines for BorgWarner.

That assumes all the transmission stuff stays the same.

Chris Ceraso - Credit Suisse

Okay. The flip side of the first question I asked about all the turbo demand is that it does seem to be bringing more competitors into the market. Any signs yet that there is extra pressure on pricing, or are you concerned that there will be me more pressure on pricing? Generally when you add more competitors, the pricing tends to go down?

Tim Manganello

The people who have announced that they're coming into the market are very smart rational suppliers. I think they are good companies, and we're used to competing against good turbocharger companies. We have been competitive all these years. We plan to continue to be competitive.

We're focused on the higher technology portion of the turbocharger business. So as is typical across all our product lines, technology leadership tends to help us with our pricing structure. And I think that will continue in the future, including on turbochargers.

That being said, the people who are thinking about coming into the marketplace are not known for being irrational suppliers. There is a huge amount of market growth. We have a strategy and not to be the market share leader. We have a strategy to be the technology leader.

We are in lower mid-30% market share range, and that market is going to explode in terms of increased volumes. There is room for another competitor, no doubt about it. We have a strategy if we just keep our market share and growth at the market or even a pick up a little percent here and there, it shouldn't be too difficult for us to do. And I think we'll do very well for a long period of time.

Chris Ceraso - Credit Suisse

Last one real quick. Do you have production contracts yet for the new compact DCT transmission?

Tim Manganello

I couldn't hear the end. You faded all at the end. Fresh for the new what?

Chris Ceraso - Credit Suisse

Do you have any contracts yet for the new compact DCT?

Tim Manganello

Let's just say this, we've got development contracts. We're close to having some of our customers make some final decisions on what they want to do in terms of that technology versus, maybe, competing technology. We think we're in a good position to win some business. It tends to be in Asia right now. I won't say where, but we have a couple of countries in Asia that have a strong interest.

So we don't have to worry about if we're going to sell that new unique BorgWarner design transmission. It's just a matter of when for dual-clutch.

Chris Ceraso - Credit Suisse

Okay. Thanks a lot.

Tim Manganello

Thanks, Chris.

Operator

The next question is from Rob Hinchliffe with UBS.

Rob Hinchliffe - UBS

Thanks. Good afternoon.

Mary Brevard

Hello.

Rob Hinchliffe - UBS

Hey, just a couple left here. One, could you talk about the cadence for '08 in terms of earnings, obviously with the full year, and first half, second half; and when does your new business come in, and what do you think of the economy globally in general?

Tim Manganello

Well, I think as we're looking at 2008, we certainly see the first half of the year tougher than the second half of the year. Two things: I think the there is some inconsistency by some our customers here in North America with respect to schedules in the first quarter that's going to make it difficult for us. But to your point, as we ramp-up new business, a lot of new programs will be starting in the summer and early in the fall. And so we'll see more sales growth year-over-year in new programs in the back half of the year. But we're not expecting any quarter to be a decline from the prior year. Some will be just little higher than ours.

Rob Hinchliffe - UBS

Okay. And then, just one more. Magna is getting close with the UAW up in Syracuse, it sounds like. Any implications, any read-through for your business, if Magna gets a little bit more aggressive on price and that impacts Drivetrain business or what should we think there?

Tim Manganello

The way I look at it is the longer they stay in Syracuse, the better off it is for BorgWarner. We're going to be in Mexico with a very competitive facility. We're going to compete head-to-head against anybody in the four-wheel business for transfer cases or the all-wheel drive side. We're going to be a fairly low-cost producer. Our footprint will be in Mexico, China, Korea, in addition to Seneca, which is currently and has been, is and will be a competitive location for us on transfer cases in all-wheel drive.

So that being said, the customers, let's just say the North American customers are heavily involved with transfer cases. They are looking for multiple options. Some of them have been single sourced for long time without competition, some of them are looking for, when the contracts break up, they are looking for alternate sources and let's just say dual-sourcing arrangement. So we think in the long run we are going to be a beneficiary.

Rob Hinchliffe - UBS

Makes sense. Thanks, Tim.

Tim Manganello

Sure. Thank you.

Operator

The next question is from Brian Johnson with Lehman Brothers.

Brian Johnson - Lehman Brothers

Good afternoon. On the Engine Group you certainly understand the longer term story about smaller engines in turbochargers and GDI. If we look, our fourth quarter sales were down 5% more than they were in Drivetrain and about in line with production, where do you see Engine Group going midterm in the US, and is it a platform issue, a product issue, just timing of some backlog issue?

Tim Manganello

Well, I think you're going to see some growth in North America maybe on some variable timing products. You're going to see some growth in North America, slight growth maybe on some tiny chain products. You're going to see growth. I don't know what your definition of midterm to long-term is, but we're going to see growth in turbochargers on pass cars and light truck vehicles in North America overtime.

We continue to grow, although it's a lousy market, on the commercial truck side, we continue to do well. And we're growing our market share on the commercial truck side North America, really that's not pass car. In terms of engine growth, that will probably do well on the thermal side. So, North America may be shrinking as a percent of our total sales but we're still growing in North America. Just that we're growing so fast everywhere else that the percentages start to slip.

Brian Johnson - Lehman Brothers

Right. But if you look at the difference in 4Q between Drivetrain down 1% US and Engine Group down 5%, what was driving that?

Robin Adams

If you're talking about a sales decline of about $12 million in the quarter, no, it's not a significant decline relative to the size of the business. But certainly, you look at some of the reductions in production --

Tim Manganello

Well, on the Engine side in North America, we saw a little bit slippage on turbos, Morse products, chain products, emissions products, and they are down. And turbos kind of have to do with the Ford truck. And then the Morse and emissions tends to be on some of the truck side along with -- the thermal is up in North America. So there is a little bit of an offset. So, I mean once you see North stabilize, you're going to see growth.

Brian Johnson - Lehman Brothers

Right.

Tim Manganello

I should also point out that compressor hasn't been really good for us is in the fourth quarter either.

Brian Johnson - Lehman Brothers

Okay. So, it sounds like for the short term, meaning the next couple of quarters, Engine Group US won't be simply better than US production, it sounds like.

Robin Adams

As I said earlier, we're expecting a decline of almost $100 million in our operations in the US, and that will be both in the Engine and Drivetrain side of the business.

Brian Johnson - Lehman Brothers

Okay. Thanks.

Operator

Your next question is from Brett Hoselton with Key Banc Capital.

Brett Hoselton - -KeyBanc Capital

Good afternoon, gentleman.

Tim Manganello

Hi, Brett.

Robin Adams

Hi, Brett.

Brett Hoselton - -KeyBanc Capital

First of all, just kind of a softball question for you, Tim. Something you could tell us how did you approach the new DCT transmission versus the old DCT transmission? In other words, I think people are under the impression that you're just making a cheapy DCT transmission.

Tim Manganello

Well, I appreciate your telling me the softball questions, you can give all the tough stuff to Robin. But actually that's a very good question, Brett. It's not a low-cost transmission. It's not a cheapy transmission. It is a transmission when we back up the original DCT transmission, it started as a manual transmission. It was currently in production with various manufacturers of manual transmissions. They wanted to convert it to automatics.

So, the original DCT product started with -- first of all, it was new technology, so it started with the fairly sophisticated and somewhat slightly expensive design, which we have cost reduced and are continuing to cost reduce. But it also started as a manual and had to be converted. So, there were some inefficiencies in that conversion.

The new design starts with a blank sheet of paper. We just say, don't design a manual, don't design an automatic, design an optimized fully-efficient, fully-optimized from clean sheet of paper approach on a DCT transmission. So, we are able to come up with completely new designs, patented architecture from BorgWarner, lower cost designs.

We have probably confused the marketplace a little bit. Originally, we developed it for all those high-volume, low-cost cars that only had a manual transmission that wanted a very competitive price point automatic transmission. So, we developed that transmission for that market.

But what we've done now is being able to reengineer that basic concept on that transmission, and we've now taken a torque range all the way up to 330 newt meters for diesels and gas, and that pretty much covers all the way up through the mid-sized vehicles.

So, what started as a concept for one part of the market segment, we've now expanded to a significant portion of the light vehicle market segment.

Brett Hoselton - -KeyBanc Capital

Okay. So, as you think about China who is developing or building new transmission plants and adding capacity and so forth, they're faced with a traditional automatic transmission, a manual transmission or the choice of your transmission possibly, which sounds like… a CVT. Why would you choose your transmission design versus a manual and an automatic?

Tim Manganello

Better fuel economy, lower cost. China loves to be the leader in new technology. This will put them on the leading edge of technology. And those are three major points. Reduced packaging size, reduce costs, like I said.

Brett Hoselton - -KeyBanc Capital

So, as you are looking out into the future, Tim, and you're thinking about the revenue growth opportunities for the DCT transmission, do you see that as kind of just growing slowly or consistently with where we are at, or do you see if there is a possibility of a hockey stick increase in revenue growth for the DCT transmission?

Brett Hoselton - -KeyBanc Capital

Well, transmissions, they are on a long growth curve. People don't change transmissions and develop new transmissions, or launch new transmissions, or incorporate new transmission very quickly. They do it typically with new power trade, new engine combinations or new vehicles.

It will be a long, steady growth platform, but there will be some major step functions in that curve where transmission capacity doesn't go in a little at a time, it goes in 150,000 to 200,000 units at a crack. And so, once you get an application, you're pretty much making step functions of 200,000 units at a pop.

And I don't know if you call that steady, or do you call that large growth step by step, but it has the ability to be very a long self-sustaining growth platform with significant amount of content for us.

Brett Hoselton - -KeyBanc Capital

Thank you very much. And, Robin, BERU, the current ownership is, what, 75%?

Robin Adams

North of 75%.

Brett Hoselton - -KeyBanc Capital

75%-plus. The minority interest hit for BERU at this point in time? In other words, you consolidated BERU.

Robin Adams

Yes.

Brett Hoselton - -KeyBanc Capital

And you deduct the minority interest portion? How much is that?

Robin Adams

It will be less going forward.

Brett Hoselton - -KeyBanc Capital

How much is it today? Robin, I think you just said that you're going to have to tender the shares, right?

Robin Adams

Right.

Brett Hoselton - -KeyBanc Capital

And you may go from 35%-plus up to 100%. It depends on what the sellers might do. And you and I both know the game they are playing in China and Germany. So, the question is what would that 25% count -- how much would that juice your EPS by?

Robin Adams

I think this will help you. The increased acquisition of shares of BERU is not meaningful from an EPS perspective. It's slightly accretive, but it barely rounds to a penny.

Brett Hoselton - -KeyBanc Capital

Okay. And then, finally, just on the acquisition front, what are you guys thinking at this point in time?

Tim Manganello

We have money to spend. We are looking at acquisitions that are strategic in nature. It's the same answer, probably the last year or two. We are very interested in doing acquisitions. They have to be the right opportunity for technology, or customer base, or geographic location, or all three. And they will be in the power train arena. There's probably a better chance that they will not be a distress asset. We're not in the business of going and cleaning up somebody else's problems. We have too much growth and we're too lean to go in and keep a lot of extra managers on board to solve somebody else's problems. So someone like a BERU will be a fairly robust decent asset.

Brett Hoselton - -KeyBanc Capital

If you were to say, look, we're in discussions with this many folks right now. Realistically, we think that we might be able to do something over this timeframe, what kind of --

Tim Manganello

Let's just say we have some kind of a program, some degree of activity, and a half dozen programs. And I would expect that we would land one fish, hopefully, sometime in the next 12 months.

Brett Hoselton - -KeyBanc Capital

Okay. Perfect. Thank you very much

Robin Adams

Thanks, Brett.

Operator

We have time for one final question and that question comes from Joe Amaturo with Buckingham Research.

Joe Amaturo - Buckingham Research

Good afternoon.

Robin Adams

Hi, Joe

Joe Amaturo - Buckingham Research

How are you? Just a quick question. Remind us how many shares to remain under your share repurchase authorization, and if you have any expectation of continuing to buyback the stock?

Robin Adams

Just shy of 1 million left, under the existing authorization. And as we did in 2007, we'll continue to look at opportunities to kind of manage the capital structure.

Joe Amaturo - Buckingham Research

Okay. And then, with the respect to the cash flow, how should we think about the working capital fluctuations in 2008 compared to 2007?

Robin Adams

That's a good question. We did have a very strong year from a working capital perspective. In 2007, just a little bit more attention on our operations to managing working capital. Traditionally, as we grow sales, we add somewhere between $0.10 to $0.12, on a dollar of invested working capital. Sometimes a little bit more, if it's in regions of the world where their payment terms are significantly longer than they would be in the US. But that's a fair guideline.

So, if you're at 8% to 10% growth in sales, you can calculate the dollar value, and then use $0.10 to $0.12 of sales per increased working capital.

Joe Amaturo - Buckingham Research

And then, Tim, what's your expectation for the content per vehicle for these gasoline injection engines that are going to probably wind-up in the United States, and what's your market share expectation in the US for those engines?

Tim. Manganello

Well, at the lower end, we'll probably be in the typical market share we have now on a global basis, which is in the 30s, okay. But given the fact that we are a technology leader in the market, share leader on gas turbos, there is a strong chance we could be higher than that if we're successful, as we, hopefully, plan to be. So, who knows? Hopefully, we can get 50% on that, but if I had to give you a target number, it would be in the 30s.

Joe Amaturo - Buckingham Research

And then, what about the content per vehicle?

Tim Manganello

Content will be high. You're talking just on a turbocharger alone, it could be, let's just say, $200 to $700 of increased content, depending on how much turbochargers they use, and how sophisticated the turbo is. If it's a simple turbocharger, it's a low end. If it's a regenerative two-stage variable turbine geometry, it could be towards the high stage or high end.

And that doesn't include any changes over, whether required to the transmission of four-wheel drive or any other parts that we make. Don't forget, it's not just turbochargers, it's glow plugs and instant starting systems that give us more penetration. In those things, BorgWarner, BERU is the leading technology supplier on that side too.

Joe Amaturo - Buckingham Research

So basically, with this technology or these engines coming to United States, it just opens up the opportunity for you to pick up additional content per US vehicle, per se?

Tim Manganello

Right.

Joe Amaturo - Buckingham Research

All right, thank you

Tim Manganello

Thanks, Joe.

Mary Brevard

With that, we will end our call today. You can direct any follow-up questions to Ken Lamb or to me. As most of you know, Ken is moving into a new job as Manager of Business development and M&A. I want to thank him for his great contributions to our IR programs over the past few years.

I'll be moving back into the day-to-day IR and will be our primary contact. I look forward to working with all of you more closely again.

Thank you for being with us today and good night.

Operator

That does conclude the BorgWarner 2007 fourth quarter and full year earnings conference call. Thank you for joining. You may now disconnect.

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Source: BorgWarner Inc. Q4 2007 Earnings Call Transcript
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