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Executives

Mary Brevard – VP, IR

Tim Manganello – Chairman and CEO

Robin Adams – EVP, CFO and Chief Administrative Officer

Analysts

Brian Johnson – Lehman Brothers

Chris Ceraso – Credit Suisse

Rich Kwas – Wachovia

David Leiker – Robert W. Baird

BorgWarner Inc. (BWA) Q2 2008 Earnings Call Transcript July 31, 2008 9:30 AM ET

Operator

Good morning. My name is Tina and I will be your conference facilitator today. At this time, I would like to welcome everyone to the BorgWarner 2008 second quarter results 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 turnover the call over to Mary Brevard, Vice President, Investor Relations.

Ms. Brevard, you may begin.

Mary Brevard

Thank you, Tina and good morning. Thank you all for joining us today. You should have received the releases. Copies were sent out today before the market opened. We've also posted financial talking points that should help you follow the financial discussions. They are located at borgwarner.com on the Investor Information page, the webcast section, second quarter 2008 conference call talking point.

The conference call today will also be replayed through August 7. The number for call-in is 800-642-1687. It's also being webcast on the web and available for replay there as well.

Before we begin, I just want to give you an idea of the – we've got an active conference schedule in the next three months. We will be at the JP Morgan Harbor Conference in Dearborn on August 13, the Credit Suisse conference in New York on September 4, Wachovia is having a one-on-one conference in Baltimore on September 22, Citigroup is having an environmental topics conference on September 24 in New York, the JP Morgan Mid Cap Growth conference in London on September 30, and then we will see many of you I hope at Ferris Auto Show IAA conference as well.

I also need to remind 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 we discuss today.

Moving on to our results, Tim Manganello, Chairman and CEO, will be providing comments on the quarter and Robin Adams, CFO, will discuss operating results in the rest of the year. Tim?

Tim Manganello

Thank you Mary and good day everyone. We are pleased to deliver another record quarter in a tough environment. Our performance reaffirms the benefits of our diversified customer base, our focus on fuel-efficient technologies, and our broad geographic footprint.

Strong demand for our fuel-efficient technologies in Europe and Asia more than offset the declines in North America during the quarter.

For the quarter, sales were up 11%, earnings were up 16% to $0.74 per share. Excluding a BERU adjustment, second quarter earnings were $0.78 per share. The engine group sales were up 16%, our Drivetrain group sales were down slightly. Our sales outside the U.S. were up 13% excluding the impact of currency compared with 9 U.S. vehicle productions which was up 6%. And our U.S. sales were down 17% consistent with U.S. vehicle production which was down 18% during the quarter.

I was a little surprised that we are managing our global business in two very distinct operating environments. In Europe and Asia, our businesses are expected to experience sustained growth. Conversely, in North America, our operations remained focus on fuel efficiency and cost management especially given the reason of dramatic production declines.

As a result, we have may be proactive but difficult decision to restructure our North American operations in the third quarter specifically during the first week of August. I grew up in the North America auto industry, and it is personally very distressing for me to see the difficulties facing our industry here in the U.S. and knowing that these difficulties affect the families, the lives of the people and our employee base.

Our decision to restructure was not made lightly or without regard for the interest of our employees. However, our people take pride in working for a successful company. But even our global success does not make us immune from the reason significant declines the North America nor from what we believe is the continued fundamental and permanent shift in the market place.

We believe that we need to take action now to align our North American operations with the realities of these market shifts in order to maintain a healthy future. We will be reducing our North American workforce by approximately 1,000 people or 16% of our North American employee base. About 22% of the reductions are salaried employees and the remainders are from the hourly workforce. This reduction will be spread across all of our operations in the U.S., Canada and Mexico. By taking action now, we expect to successfully manage our business to an extremely difficult period. Our actions are expected to provide a strong, a solid base to address the needs for future fuel reduction and fuel improvements for cars and trucks.

As we continue to adjust our North American operations to remain competitive, our growth from the rest of the world is keeping pace with our expectations and remains strong. We still expect company-wide sales growth in the range of 8% to 10% in 2008 and results that will outpace the industry.

We have adjusted our earnings guidance slightly to a range of $2.80 to $2.95 per share. And our revised guidance includes the benefits of the restructuring and adjustments for currency and excludes expected charges related to the third quarter restructuring and our final adjustments for BERU purchase accounting.

Our guidance also includes projected North American schedule declines and global commodity pricing pressures which are expected to be offset by our continued strength in Asia and Europe.

Now let us talk a little bit about Europe. I know that many of you have concerns about the outlook for Europe for the rest of the year. I can assure you that we are monitoring our customers’ schedules closely. While we believe that the European auto industry in general will experience a slowdown in the second half, we see positive growth for BorgWarner in Europe during the same period.

There are number of reasons for our positive expectations. First, even with the sales weakness on Western Europe, demand for fuel-efficient cars is driving increased penetration of downsized turbocharged diesels and turbo gas engines as well as demand for fuel-efficient, dual-clutch transmissions.

The trend towards smaller vehicles drives demand for BorgWarner products like turbo chargers for VW, Chrysler, and Renault as well as our dual-clutch transmission modules for Volkswagen and new customer programs being launched this year. These programs include those with the Getrag-Ford joint venture for their twin-clutch transmissions which will be used at Ford, Volvo, and Mitsubishi. We will be supplying Getrag for the BMW transmissions and Audi for their seven-speed dual-clutch transmission for the Q5.

The second reason for our positive outlook is that the projected sales growth in Eastern Europe is expected to increase demand for diesel engines and our other engine and transmission products. Third, the increased – we will continuously increase localization of the Japanese and Korean engine production in Europe which also drives demand for our products. And fourth, the commercial market continues to remain strong for BorgWarner.

Now, let’s talk about how engine downsizing will continue to drive our growth. In the next seven years, four-cylinder engines will account for about 80% of the incremental global engine growth and about 60% of the European engine growth. In North America, four-cylinder production will grow by about 30% during the period 2007 to 2014. Six-cylinder engines like the Ford EcoBoost will replace many V8s and BorgWarner has been chosen as the turbocharger supplier for the high volume 3.5-liter Rear-Wheel Drive EcoBoost six-cylinder engine of Ford.

For us, the engine downsizing trend is an opportunity to help customers develop and deliver turbocharged engines that are not only fuel efficient but also meet customer expectations for good performance.

So now let’s talk a little bit about hybrids. Hybrids are also gaining importance as part of our engine downsizing story and offer interesting new opportunities for our Drivetrain group. Hybrids are only a small portion of the market today and use many of our traditional engine and Drivetrain products. As fuel prices increase and battery technology improves, hybrids are expected to become a larger portion of the vehicle population.

In addition to adapting our current products to hybrid use, we see hybrids and the electrification of vehicles as viable opportunities for new BorgWarner products. There is a variety of activity around hybrids in our advanced engineering areas at both the corporate and business unit level within BorgWarner.

These activities are focused on new hybrid and electric vehicle transmissions, electric all-wheel drive, and technologies for air management and cooling. We presented some of these technologies in concepts to our Board of Directors just yesterday. Our Powertrain technology is at the forefront of solutions to improve fuel economy. As BorgWarner, we expect to continue to distinguish ourselves as a fuel-efficiency leader. High fuel prices, while currently disruptive, highlight the global need for our fuel efficient technologies. We expect to manage successfully through this difficult period in North America in order to take full advantage of the growth opportunities before us globally as BorgWarner.

With that, I’ll turn the meeting over to Robin.

Robin Adams

Thank you Tim. Good morning everyone.

We had another record quarter as Tim said despite the significant declines in the North American market. Production in the U.S. was – it seemed set down by 18% with the Detroit 3 light truck SUV down by 21%, and as you look at Europe, production was up 5%, production in Asia was up 6% in the quarter as well.

As Tim mentioned, our second quarter sales grew 11% or 2% excluding the impact of currency and our 2% growth rate is in line with global production in the quarter which was 2%. However, again, Tim talked about the story is dramatically different for BorgWarner by geography. Our sales in the U.S. were down 17% in the quarter in line with the decline in U.S. industry production. This is the largest quarterly drop in U.S. sales in BorgWarner’s history since going public in 1993.

Our sales in U.S. now represent 20% of the total versus 37% in the second quarter last year and despite that dramatic decline, we still achieved record second quarter overall sales and record second quarter earnings and this is a direct result of our strategic focus and leading Powertrain technology and our customer and geographic diversity. Our sales outside the U.S. excluding the impact of currency continue to grow at a double digit rate of 13% which is double the 6% non-U.S. industry growth production rate.

Now before I get into the details of the financial statements, let me try to explain the accounting implications of recent actions with respect to BERU.

During the second quarter we completed the domination and profit transfer agreement with BERU given Borg Warner effective a 100% control of BERU. Under this agreement, minority share holders of BERU have no further interest in the profits or losses of the company or capital distributions.

Minority share holders can either sell their shares to BorgWarner at a EUR71.32 per share price or receive an annual dividend of EUR473 into perpetuity and I should tell you, neither of these amounts were offered by BorgWarner but they were determined by a German court appointed independent auditor which is in line with German law. As a result of this agreement, although we now own approximately 82% of BERU shares, from an accounting perspective, we now account for BERU as if we had acquired a 100% of the company.

So the second quarter we recorded a balance sheet liability of approximately $200 million related to our future obligation to BERU minority share holders; a portion of that is long-term, majority of it is long-term. We also eliminated balance sheet minority interest related to BERU. We increased goodwill and other purchase accounting related assets and finally we incurred an immediate write off of 5.1 million pre-tax, 4.5 million net of tax or $0.04 per share related to purchase accounting for in-process R&D or a back log in inventory write-up that immediately gives expense.

On a go forward basis, we will no longer report minority interest expense for BERU but will have increased amortization of purchase price and tangible assets of about 4 million a year and an interest charge will be incurred on the $200 million future obligation to BERU priority share holders which is approximately $12 million a year, and with that behind me let’s get back to the income statement.

In the quarter, our gross margin and operating margin were 18.5% and 8.3% respectively, excluding the impact of that BERU agreement, and that compared to 18.1% and 8.3% in the second quarter of 2007.

The (inaudible) and operating income margin was now incomparable to the second quarter of 2007, it was also a continuation of the first quarter strong performance. Sales in our base U.S. operations declined approximately $80 million in the quarter as I said that the largest decline in BorgWarner’s history, at least as far back as I can go, and the decline of sales was due to continuing reduced production volumes in the U.S. particularly the Detroit 3 light trucks and SUVs.

Below [ph] operating income annual sales was in $0.31 on a dollar and this is above our 20% to 25% target range for decremental margins and it is part of the reason that Tim’s talking about restructuring actions this morning.

The base U.S. operation sales decline was more than offset by a $108 million in growth and that’s excluding currency in our operations outside the U.S. and U.S. turbochargers with about $0.23 on a $1 contribution margin positive.

The impact of foreign currency loan netted approximately at $125 million in sales and about $0.11 on a $1 of operating income and net earnings per share impact of $0.07 a share in the quarter. Within these incremental operating income numbers, there is a 24.7 million increase in the SG&A cost in the quarter versus 2007 and an increase as well in the percentage of sales to 10.5% from 9.9%, 11.9 million of that increase or roughly half was currency related, (inaudible) million was related to increase our R&D investments and another 3.3 million was related to a portion of that BERU and immediate purchase price write off.

SG&A spending in the quarter was actually in line with first quarter spending levels and we remain on a trend of about 10.5% for the year. R&D was 3.8% in the quarter versus 4.2% last year. Raw material costs, net of recoveries, relatively flat in the quarter with increasing steel prices being offset by lower nickel prices.

Below the operating income line, equity in affiliates’ earnings of $11.9 million increased about $3 million compared to the second quarter last year driven by the strong performance of our Japanese transmission components joint venture on SK Warner and about $1 million of currency related to the stronger Yen.

The second quarter interest expense of 10.8 million was up 1.5 million compared with the second quarter 2007 and was 4.3 million higher than the first quarter. And the increase is primarily due to the flip of that first quarter $2.5 million favorable measurements of ineffectiveness of a cross currency interest rate swap and I know that’s a mouthful.

But if you remember on the first quarter call, I mentioned that interest expense in the quarter was low because of $2.5 million favorable swap measurement and that it would probably reverse itself in the second quarter, which it did. So if you look at interest expense smoothing the first and second quarter – interest expense is about 8.6 million per quarter, more of a run rate basis. So we got a little benefit in the first quarter, a little bit of penalty in the second quarter, year-to-date it kind of all evens out.

Tax rate in the quarter was about 24.5% versus 27% last year and this puts our year-to-date rate to 25% which was what we did in the second quarter. We adjusted our year-to-date to 25% and which is our new projected global effective 4-year tax rate and that reflects further declines in U.S. income versus where we thought we would be only at the started of the year. So obviously, a decline in U.S. income with a higher effective tax rate reduces our overall global tax rate.

Net earnings were 87.5 million for the quarter or $0.74 a share including the one-time BERU write-off. Excluding the write-off, earnings per share was $0.78, an increase of 22% or $0.14 a share over the previous year’s second quarter, or $0.07 a share or 11% excluding currency. A very strong quarter in what was, as I said, a record decline for U.S. business activity for BorgWarner.

Now, let’s move on to our operating segment performance. For the second quarter, engine segment sales increased 153.6 million or 16% and segment EBIT margin was 11.9% excluding the BERU purchase price write-off. And that 11.9% compares to 11.3% in the second quarter last year, so good strong improvement and fairly consistent with the 12% we reported in the first quarter of this year. So that's pretty strong consistent performance in the engine side of the business. Excluding the impact of currency, sales increased 5% for the engine group in the quarter.

The engine segment continues to benefit from European and Asian automaker demand for turbochargers, timing systems, and emission products, and European demand for diesel engine injection systems. This was offset by declines in timing systems, cooling systems, and emission systems product sales in the U.S.

For the quarter, the Drivetrain segment net sales decreased 3.3 million – we’ll do less on the percentage point. Excluding currency sales actually decreased 5%. The EBIT margin was 5.3% in the quarter down quite a bit from the 8% last year but an improvement from the 4.5% that we saw in the first quarter. And in line again with what we said in the first quarter, we expected Drivetrain margins to weak [ph] and get above the 5% level and trend – continue the trend upward towards the end of the year.

Drivetrain sales decreases were heavily impacted by lower North American production of light trucks and sport utility vehicles which offset continued growth of DCT product sales in Europe.

Transferring earnings before interest and taxes while continuing to be disappointing, do reflect an improvement over the first quarter as we better managed start-up cost related to our DualTronic transmission modules in Europe.

Lower North American sales of light trucks and SUVs, however, continued to exacerbate some product rearrangement activities we’ve got going on in our North American manufacturing facilities which is also negatively impacting our margin.

As I said earlier, we still expect to improve all of those situations. We have made some improvements, as you see in the second quarter and we see Drivetrain margins improving as we progress throughout the year. Not quite back to the 7% historical levels, as we said earlier, due to further significant declines in U.S. customer-production levels.

Now, let’s talk about the balance sheet and cash flow. Our investment grade capital structure continues to be strong. The debt-to-debt plus equity ratio was 19.7% at the end of the quarter versus 21.5% at the end of December. Net cash provided by operating activities was strong at 267 million for the first six months compared to 223 million for the first six months of last year.

Capital spending including tooling was about $162 million compared to $123 million in 2007, gain, further investments to support the growth of our business outside the U.S. market. We also repurchased about 28 million of our common stock in the first half of the year.

After-tax return on invested capital at the end of the period continues to improve to 13.6% on a rolling four quarter basis versus 11.9 a year ago. We continue to be very well-positioned to weather the difficulties in U.S. market and also are prepared to take advantage of strategic opportunities as they present themselves.

Let me talk a little bit about our guidance. After the first quarter, we told you that we would be reviewing our four-year earnings guidance and light up the positives and negatives that are occurring in the industry. The negative is being North American processing declines and global commodity prices, the positives for us being the continued demand in Europe and Asia for our products along with stronger currencies. The biggest negative has been the significant sales decline in our U.S. operations and I already told you the impact it had in the second quarter.

We started the year projecting a sales decline of about 5%, a $100 million to $125 million, based on the North American vehicle built of about 14.3 million vehicles. We are now projecting more than twice that level of decline, about a 12% to 14% decline in the U.S. sales or $250 to $275 million.

Again, we are expecting a decline in our U.S. operations $250 to $275 million versus where we started a year with 100 million to 125 million. And we are now expecting North American vehicle builds much closer to 13 million than the 14 million level we talked about as we started the year.

And again, this projected decline in sales resulted in the restructuring actions Tim outlined this morning. With the intention of limiting the decremental margins at most sales declines to the $0.20 to $0.25 margin range versus the 31 plus that we experienced in the first 6 months of this year.

The significant decline in our U.S. operations and the decremental margins associated with those sales declines has reduced our expected upper income margins to the 8% range from the previous 8.5% to 9% range. If you lose a $150 million a sales, at a decremental margin at 20% to 25% on the dollar, it is very difficult to maintain operating income margins at consistent levels.

It has also resulted in lowering our protected tax rate for the year to 25% from 26%. We have also updated our currency exchange rate assumptions close to current marked convictions with a dollar to the Euro 150 and Yen at 105.

As Tim said, we have revived our guidance slightly to 280 to 295 per share for the year, from $2.85 to $3, given all these puts and takes. That translates to a record strong year, this revised guidance, a record strong year for BorgWarner with over 15% earnings growth versus last year.

As Tim mentioned, the earnings guidance does exclude the currently estimated restructuring cost of $10 to $12 million, which is about $0.08 a share, and the one-time second quarter BERU purchase price adjustment write-off which is about $0.04 a share, but does include any 2008-related benefits of the North American restructuring that Tim discussed.

Including the restructuring cost of BERU one-timer guidance on the U.S. GAAP basis is $2.73 to $2.88 per share, still 12% to 18% growth versus last year's 2.44 a share performance. A very strong year for BorgWarner.

We are now expecting net raw material increases primarily steel, around almost $35 million levels for the year. If you remember, our original guidance was in the $20 to $25 million range. Year-to-date raw material is increased about 6 million for the year, so that means we are expecting approximately 30 million in the last half of the year, split evenly about 15 million per quarter.

Our guidance also includes no changes to net cash provided by operating activities which we expect to be about $550 million this year, a very strong year. Capital spending including tooling about 400 million so the net cash after capital spending of about $150 million. R&D spending is still about 4% of sales, return on invested capital creeping up above that 14% level moving towards the 15% target.

It feels that our overall outlook for 2008 remains generally positive, however, we do remain concerned about North America and that is why we are taking proactive measures to adjust our employee levels in out North American operations.

We are currently faced with dramatically lower industry production levels at North America. In fact, we have not seen these levels since 1992. Sixteen years ago when BorgWarner was still a private company and my hair was all black, there wasn't any gray in it, and some of you may have been in college or even high school at that time. And if you look at relative activity, Japan and Korea will build more vehicles this year than we will in the U.S..

It is a dramatic change in this industry. However, despite those conditions, we still expect our sales to grow an excess of a projected moderate global vehicle production environment with growth in Europe and Asia expected to offset significant declines in North America, and that really shows the strength of BorgWarner.

We have had a good strong start to the year and are taking the necessary but difficult steps to ensure we finish the year just as strong. We intend to stay on top of our cost structure around the world to ensure that we provide solid incremental earnings growth on our incremental sales. We continue to have a strong investment break balance sheet, and these unprecedented industry volume reductions has not materially changed the strong financial performance of BorgWarner or endangered our ability to continue to execute our technology-driven growth strategy.

With that, I will turn the call back to Mary.

Mary Brevard

Thank you very much Robin. I will now ask the call coordinator. Tina, would you please announce the question-and-answer portion of the call.

Question-and-Answer Session

Operator

(Operator instructions) Our first question will come from the line of Brian Johnson with Lehman Brothers.

Brian Johnson – Lehman Brothers

Hey. Questions are more strategic this morning. Can you give us any update on the likely pace through 2009, 2010, and 2011 of turbo rollout in turbocharged gas in the U.S.?

Tim Manganello

What you’re going to see is continued increased penetration of gas turbocharged engines as they come, as they're develop and launched through the U.S. just like you said. I don’t know the whole market, but I can tell you on the BorgWarner side of the equation, we’ll going to be rolling out 22 gas turbocharged vehicle platforms or vehicle engines in the next couple of years. So that’s a pretty healthy rollout plan and pretty healthy launch schedule for gas, and we’re going to have a significant amount of diesels that we would be rolling out. Now, these vehicles maybe start out as European vehicles that are sold in North America and some are maybe North American vehicles that are manufactured by North Americans, but it’s going to be a very healthy penetration of turbocharged gas engines in North America.

Brian Johnson – Lehman Brothers

On the Ford ones in particular, can you clarify which EcoBoost you’re on versus your competitor?

Tim Manganello

Yes, very easily. We are on the high-volume rear-wheel drive 3.5 liter V6 Ford EcoBoost which we’ve been told by Ford will be the high-volume portion of the V6 EcoBoost family.

Brian Johnson – Lehman Brothers

Okay, have they said what platforms they will put that in?

Tim Manganello

Well, I don’t know if they've said it or not, but let’s just say this, it will be replacing V8s, and V8s – there’s a significant amount of V8s used in rear-wheel drive vehicles and so you can pretty much figure out that there’s a – the rear-wheel drive platforms within Ford are significant – mainly passenger car and trucks.

Brian Johnson – Lehman Brothers

Pickups and taxicabs. And is that –?

Tim Manganello

Some SUV – and some SUVs.

Brian Johnson – Lehman Brothers

Right. Is that a move forward of their plans?

Tim Manganello

Well, I know, I can’t tell you what their plans are but I can tell you this, Ford in general is accelerating their focus on fuel-efficient engines. In North America, they are pulling their programs ahead as fast as they can to improve fuel efficiency. And as you already know, they’re moving very quickly. They’re bringing European power trains and European vehicles over to North America to increase their fleet fuel economy average.

Brian Johnson – Lehman Brothers

Okay. Final question. Was this reflected in last November’s backlog items or will this be part of the puts and takes rolling in that we’re going to hear about this November?

Tim Manganello

Brian, help me out with – specifically –

Brian Johnson – Lehman Brothers

Well, you have [ph] announced backlog through last November, did it contemplate this level of North American turbocharger development in this timeframe?

Tim Manganello

No.

Brian Johnson – Lehman Brothers

Okay. Okay. So therefore, we could think that’s going to be a net add to backlog.

Tim Manganello

It’s a net add on the turbocharger side. You got to remember that we do have some content on some of the engines that are being replaced. But all and all, it makes for a healthy BorgWarner.

Brian Johnson – Lehman Brothers

Okay and where could this take engine margins over time? Do you have a long-term goal?

Tim Manganello

I couldn't hear that, what was that last question?

Brian Johnson – Lehman Brothers

Where could it take engine margins over time, does it have a long-term goal?

Tim Manganello

We don't talk about margins on specific – but let us just say this, all of our programs that we launched are focused on returning at least a 15% return on invested capital.

Brian Johnson – Lehman Brothers

Okay. Thanks Tim.

Tim Manganello

Sure, thanks Brian.

Operator

Our next question will come from the line of Chris Ceraso with Credit Suisse.

Your line is open please go ahead with your question.

Chris Ceraso – Credit Suisse

Okay, thanks guys, can you hear me?

Tim Manganello

Yes, hi Chris.

Mary Brevard

Go ahead Chris.

Tim Manganello

We can hear you.

Operator

I am sorry sir, he has disconnected his line. Next we will from the line Rich Kwas with Wachovia.

Rich Kwas – Wachovia

Good Morning.

Tim Manganello

Good Morning Rich.

Rich Kwas – Wachovia

I think, Tim, you mentioned commercial vehicle strength, is that going to help you in the – I guess it helped you in the second quarter and you expect it to continue to help you. Is that a global comment or is that specific to a particular region?

Tim Manganello

Specifically it is global, but we know first hand that we are seeing continued strength in Europe, Eastern, and Western Europe and it is more European oriented than North American oriented in terms of the strength of the growth in the commercial sector, but we are not being hurt on the North American side, there is slight growth in North America also.

Rich Kwas – Wachovia

Okay. And then on the –

Tim Manganello

Rich?

Rich Kwas – Wachovia

Yes.

Tim Manganello

One thing I would add is we are continuing seeing increased strength in the off-highway side of the commercial side of our business, which puts us well-positioned with the traditional players like Cat and Deer.

Rich Kwas – Wachovia

And that is helping your North American business?

Tim Manganello

Yes, it is.

Rich Kwas – Wachovia

All right. And then in the press release you talked about Europe, you expect some slowing there, how comfortable are you with the financial potential downside in Europe, how much cushion have you baked in into your guidance for the rest of the year?

Tim Manganello

Well, we are still comfortable with our guidance relative to Europe. We are watching Europe closely like I said. There is some softness in Spain, Italy, and the UK, but there is continued strength in Germany because Germany is not only seeing some strength here – holding in solid in Germany but there they have a lot of export into Eastern Europe and France is still strong but maybe not as strong as it used to be.

What we are seeing now is there has been a slight softening but what it has done is it has relieved some of the pressure between the demand which was very high and our capacity which was slightly less than demand. So we still have more demand than capacity, but it has taken a little bit of a pressure on. Like you already know Rich, there is a continued shift from large-sized engines to downsized smaller engines, and that plays to our strength.

Rich Kwas – Wachovia

Okay. And then, Robin, on the restructuring, is that largely cash?

Robin Adams

Yes, at this point in time, it is all cash.

Rich Kwas – Wachovia

And then you mentioned $12 million related to this BERU transaction in terms of interest. Should we assume that starts to hit in the second half?

Robin Adams

On an annualized basis, it is interest and it is amortization of excess purchase price. That is an annualized number and you will see half of that in the back half of the year. So when you think of our guidance for the year, we did roll in about a $0.03 a share penalty for this change in ownership of BERU and the accounting implications.

Rich Kwas – Wachovia

Okay. But going forward, you talked about interest expense running about $8.5 million and you stripped out the swap treatment, but should we assume that the $12 million is going to be another $4 million ahead of quarter or is that – ?

Robin Adams

Yes, that is right. And again, a portion of that will be operating income and a portion will be interest expense. About $8 million of the $12 million will be interest expense-related and then the other $4 million will sit above operating income as amortization of intangibles.

Rich Kwas – Wachovia

Okay, great. Thank you.

Operator

Our next question will come from the line of David Leiker with Robert W. Baird.

David Leiker – Robert W. Baird

Can you hear me all right?

Tim Manganello

Hey David, how’re you doing?

David Leiker – Robert W. Baird

I’m doing well, thanks. A number question first. The BERU item here in the quarter, what line item does it fall in?

Robin Adams

The one-time charge in the income statement?

David Leiker – Robert W. Baird

Yes.

Robin Adams

$3.3 million of it sits in SG&A and the other $1.8 million is in cost of goods sold.

David Leiker – Robert W. Baird

Great. Thanks.

Robin Adams

I just want to ask how the Brewer is doing against the Cubs, David?

David Leiker – Robert W. Baird

I'm grumpy today, okay? We’ll see what happened at the end of the year, all right?

Robin Adams

All right.

David Leiker – Robert W. Baird

Tim, can you give me some perspective of competitive landscape on gas turbos?

Tim Manganello

I think that the market is increasing globally for increased penetration and gas turbos. We’re getting a significant share. I don’t know what the proportions are, all I can tell you is I think BorgWarner has demonstrated we are the technology leader and the market leader for gas turbocharged engines.

As such, we are getting a significant number of programs awarded to us on gas engines. Like I said, in the next couple of years, just in North American market – not all of these vehicles will be manufactured in North America, but they’ll be 22 gas applications in North America with BorgWarner turbochargers on them.

David Leiker – Robert W. Baird

Do you think you’ve stronger competitive position in gas than diesel or you think they’re comparable?

Tim Manganello

Well, I think we have a strong competitive position in both and the market is increasing for both. What I will say is we’re increasing on market share in an increasing market and we’re doing it both in turbochargers in total and I can tell you we’re really strong in gas. We’re doing extremely well also in diesels.

David Leiker – Robert W. Baird

The commercial vehicles that you talk about – a piece of that is turbos. Is it all turbos or is there something else in there?

Tim Manganello

I couldn’t hear – what was that question, David?

David Leiker – Robert W. Baird

In commercial vehicles –

Tim Manganello

Yes.

David Leiker – Robert W. Baird

And in terms of product offering there, I would guess that a meaningful amount of that is turbos but do you have other products that you’re selling into the commercial vehicle market?

Tim Manganello

Yes. We have cooling products, fan and fan drives, and we’re doing very well on the fan drives. It’s a profitable business. It’s a growing business. I like it – I wish it was a larger business for us but we’re doing extremely well. We've get about a million units of turbocharged gas engines coming at us in the United States for this year.

David Leiker – Robert W. Baird

Okay.

Tim Manganello

I’m sorry. That’s globally.

David Leiker – Robert W. Baird

Global.

Tim Manganello

We got a million of gas engines globally.

David Leiker – Robert W. Baird

That you’re selling.

Tim Manganello

For turbochargers, yes.

David Leiker – Robert W. Baird

Okay. And then one last item, in terms of the restructuring actions you’re taking, what’s the savings from that?

Tim Manganello

The savings on that –

David Leiker – Robert W. Baird

(inaudible) charge is that a one-year pay back on that or –

Robin Adams

Yes. It’s less than one year, David.

David Leiker – Robert W. Baird

Less than one year. Okay, thank you.

Operator

(Operator instructions) Our next question will come from the Chris Ceraso from Credit Suisse.

Chris Ceraso – Credit Suisse

Hey, better luck this time guys? Can you hear me?

Tim Manganello

Yes, thanks.

Robin Adams

Yes, thank you.

Chris Ceraso – Credit Suisse

Okay. All right. I think Honeywell had some comments on its quarter that turbos in Europe weren’t going so well. Is that a function of the engine size bias where you’re better in smaller engines? Are you picking up share in diesel turbos in Europe?

Tim Manganello

Yes. That’s a very easy answer. We’re picking up share because the market is shifting from larger engines to smaller engines. We have a significant market share in small engines.

Chris Ceraso – Credit Suisse

Okay. What is the trend these days in diesel penetration in Europe? Has that slowed down at all or is it still increasing?

Tim Manganello

The rate of increase is starting to slow down. People are starting to look at the price of gas versus the price of diesel since diesel fuel has risen recently. But we don’t know if that’s a short-term or long-term phenomena. But, diesel is hanging in there around 50%, it’s been in there like 53%, 54% range. There’s projections that it’s going to slow down to maybe – the penetration rates is going to slow down though like 50%, 51% while at the same time gas penetration on turbocharges is increasing significantly.

Chris Cerasco – Credit Suisse

Okay. Can you take us through briefly your remaining exposure in the U.S. market to truck-based products? We know you’ve got the transfer cases on the Ford trucks but can you just kind of take us quickly through the overall U.S. market and let us know where you’ve got content on truck-type vehicles body-on-frame?

Tim Manganello

We have significant content at Ford, but a lot of the volume has been washed out of the pickup and SUV market. So we’re – there’s not a whole lot – let’s just say this, we can’t be hurt too badly in the future based on reduced truck sales because a lot of that stuff has been washed out. We’re down at a point where the people are just – that have to buy trucks are buying trucks and that’s where we’re at. We have some content on GM and some content on Chrysler. Chrysler, at its pas car, GM at the pas car and some truck, and at Ford it’s mainly the truck. So our transfer case volume is the major customers, Ford followed by GM and Chrysler. Now that’s the Detroit 3. We’re shipping transfer cases to Audi and the Q7; that’s holding strong so far. We’re doing well in Asia so far; Korea and China, we’re shipping transfer cases. We’re manufacturing in Asia and shipping to Russia. So those parts of the world are still holding up well. It’s just North America that’s causing us a big problem.

Chris Cerasco – Credit Suisse

Okay, last one. Robin, if you hold everything else equal, what did the change in your foreign exchange exemption do to your guidance for the year?

Tim Manganello

Yes. That’s a good question. Here’s a real easy way to think about it. North American sales declined versus what we thought before, it is about $150 million at a 25% incremental rate, that’s about $0.24 a share decline from our previous guidance. Currency will give us about $0.14 a share, so that’s net down $0.10. The tax rate will give us an improvement of about $0.04 a share. The BERU acquisition with the additional run rate cost us about $0.03 a share, so it’s about $0.11 a share swing.

Chris Cerasco – Credit Suisse

Perfect, thanks.

Operator

And we have no further questions at this time. I would like to turn the call back over for closing remarks.

Mary Brevard

Once again, thank you all for joining us. If you have any follow-up questions, you can direct them to me and we will talk to you again and hope to see you at some of our upcoming conferences. Thank you very much.

Operator

Ladies and gentlemen, this does conclude today’s BorgWarner 2008 second quarter results conference call. Thank you for joining and you may now disconnect.

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Source: BorgWarner Inc. Q2 2008 Earnings Conference Call Transcript
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