BorgWarner Inc (BWA) — Q3 2015 Earnings Call Transcript

Thank you, Melissa. Good morning and thank you all for joining us. We issued our earnings release this morning at around 8:00 AM Eastern Time. It’s posted on our website, borgwarner.com, on our Investor Relations home page. A replay of today’s conference call will be available through November 6. The dial-in number for that replay is 800-585-8367. You’ll need the conference ID, which is 32249261 or you can listen to the replay on our website. With regard to our Investor Relations calendar, we will be attending the following conferences between now and our next earnings release. The Baird Industrials Conference in Chicago on November 9th, the Goldman Sachs Global Automotive Conference in London on December 3rd, and the Deutsche Bank Auto Industry Conference in Detroit on January 13th. A reminder our net new business announcement will not be in November but will be combined with our full year guidance announcement in January. Synchronizing the timing of these announcements ensures that our one-year and three-year outlooks will be based on the same program volume, currency, and launch timing assumptions, improving the link between the two. This is a permanent change going forward. Now, back to today’s earnings release. Before we begin, I need to inform you that during this call, we may make forward-looking statements which involve risks and uncertainties as detailed in our 10-K. Our actual results may differ significantly from the matters discussed today. Now, moving on to our results, James Verrier, President and CEO, will review highlights of our quarterly operating results, as well as some of our recent noteworthy accomplishments. And then Ron Hundzinski, our CFO, will discuss the details of our quarterly results. Please note that we have posted a set of supplementary financial charts to the IR page of the website. You will find the link to this document at the Events & Presentation section beneath the notice for this conference call. We encourage you to follow along with these charts during Ron's discussion of our results. With that, I'll turn it over to James.

Thank you, Ken, and good day, everyone. Ron and I are delighted to review our third quarter results and some recent accomplishments. Before I begin, I want to thank all BorgWarner employees worldwide for another successful quarter. Now, moving on to our results; during the third quarter, reported sales were just under $1.9 billion, down 7% from last year but up 3% when excluding the impact of foreign currencies. U.S. GAAP earnings were $0.70 per share, or $0.73 when excluding non-recurring charges. Our operating income margin, also excluding non-recurring charges, was an impressive 13.3% this quarter. Considering the lower growth, some restructuring inefficiencies, and the new plants and expansions we are managing this year, we believe this reflects very good operational performance. Regarding the Engine segment, third quarter sales were about $1.3 billion, down 7% from last year, but grew by 4% when excluding foreign currency impacts. This was driven by strong light-vehicle turbo sales, particularly in Europe, though partially offset by weaker market conditions in China and a downturn in commercial vehicle markets globally. In the Drivetrain segment, sales reached $584 million, also down 7% year-over-year but up 2% excluding currency effects. This performance was mainly driven by a resurgence in all-wheel-drive sales growth in North America, though again, this was partially offset by weaker market conditions in China. The slowdown in Drivetrain sales growth from a major North American program has returned to material volumes this quarter. We expect this program, along with European restructuring benefits, to contribute to solid growth and margin expansion in Drivetrain for 2016. Our financial strength and strong performance stem from our ability to anticipate and drive the next technological advancements. Looking ahead, BorgWarner continues to invest for the long term. Our capital spending has been increasing, at about 7.3% of sales during the third quarter, exceeding our long-term target of 5% to 6%. While we typically allocate our capital spending towards machinery and equipment, future growth necessitates investments in new plants and expansions, leading to elevated spending temporarily. This trend is expected to persist through the year's end before we revert to normal spending levels. Our R&D investment was 4% of sales this quarter, aligning with our targets, and our focus on organic integration and product development remains robust. I am also excited to highlight some recent achievements. BorgWarner is producing the 2-speed Torque-On-Demand transfer cases for Foton Motor’s newly launched Sauvana SUV. This technology automatically redistributes torque between the rear and front wheels, enhancing traction, stability, and dynamics without driver input. Additionally, BorgWarner received a 2014 World Excellence Award from Ford for showcasing quality, value, and innovation. We supply silent engine timing chains for various Yamaha vehicles, including motorcycles, snowmobiles, and all-terrain vehicles. Furthermore, we provide Eco-Launch stop/start technology and friction plates for General Motors’ new 8-speed rear-wheel drive automatic transmission, which enhances fuel economy by up to 5% compared to similar transmissions and will debut on the 2016 Cadillac CT6, also powering the Cadillac CTS and ATS. We have adjusted our guidance for 2015, narrowing our sales growth outlook to the lower end of the previous range. Sales growth is now anticipated to be between minus 6% and minus 5%. This adjustment reflects weaker than anticipated market conditions in China and sluggish commercial vehicle markets globally. Excluding currency impacts, we expect growth around 4.5%. Our earnings guidance has also been updated; we now expect earnings between $2.95 and $3 per diluted share, compared to a previous range of $2.95 to $3.10. Our operating margin is still projected to be approximately 13%. Ron will provide further details on our updated guidance shortly. I am encouraged by our year-to-date performance and optimistic about the remainder of the year. Despite challenging market conditions, our full-year guidance suggests mid-single-digit growth and excellent operating performance in 2015. With the ongoing restructuring and expansion activities, we foresee a smooth transition that will sustain our strong performance into 2016 and beyond. Looking ahead, the industry's ongoing adoption of our innovative Powertrain technology, paired with our commitment to operational excellence, is driving us to remain the leading supplier in growth and operational performance. With that, I will hand the call over to Ron.

Thank you, James, and good day, everyone. Before I begin reviewing the financials, I also would like to commend all of our employees for their hard work in the quarter. Also as Ken mentioned I will be referring to supplemental financials slide deck and it is posted on our IR website. I do encourage you to follow along. Now, on to our financials. James already provided a detailed review of our sales performance in the quarter. In summary as shown on Slide 2 of the slide deck, sales were down 7% from a year ago or 3% excluding the impact of foreign currencies. Working down the income statement, gross profit as a percentage of sales was 21.1% in the quarter or up 20 basis points from last year. During the same period SG&A as a percentage of sales was 7.9%, a 70 basis point improvement from a year ago. R&D spending, which is included in SG&A was 4%. You may have noticed that SG&A is nearly down $27 million year-over-year. Over half of this is related to currency. Of the remaining amount, corporate expenses were down $5 million and our miscellaneous expenses were down about $9 million. Operating income in the quarter was $237 million, excluding $9 million of restructuring charges and $4 million of M&A expenses related to the Remy transaction, operating income was $250 million or 13.3% of sales, up 80 basis points from a year ago as shown on Slide 3 of the slide deck. Excluding nonrecurring charges previously discussed, as well as the impact of foreign currencies, operating income was up $22 million on $66 million higher sales, giving us an incremental margin of 35%. As you look further down the income statement, equity and affiliate earnings was about $9 million in the quarter, down from $15 million last year. This line item represents the performance of NSK-Warner our 50/50 joint venture in Japan, which sells transmission components to our Japanese customers in Japan and China, as well as TEL, our turbocharger joint venture in India. Lower NSK-Warner sales in Japan and China was the primary reason for the decline in affiliate earnings. Interest expense and finance charges were $15 million in the quarter up from $9 million a year ago. The increase is primarily due to the $1 billion of fixed rate senior notes issued in the first quarter of 2015. Provision for income taxes in the quarter on a reported basis was $67 million. However, this included favorable tax adjustments of $6 million. You can read about each one of these adjustments in our 10-Q, which will be filed later today. Excluding the adjustments the provision for income taxes was $73 million, which is an effective tax rate of 29.5% in the quarter. Our year-to-date effective tax rate is 29.5%, which is also our estimate for the full year. Net earnings attributable to non-controlling interest were about $9 million in the quarter up slightly from $6 million the third quarter of 2014. This line item reflects our minority partner's share in the earnings performance of our Korean and Chinese consolidated joint ventures. That brings us back to net earnings, which were $150 million in the quarter. Net earnings excluding nonrecurring items were $165 million or $0.73 per share. Now let's take a closer look at our operating units' segments in the quarter; beginning on Slide 4 of the slide deck. As James said earlier reported Engine segment net sales were about $1.3 billion in the quarter. Sales growth for the Engine segment excluding currency was 4% compared to the same period a year ago. Turning to Slide 5, adjusted EBIT was $212 million for the Engine segment or 16.2% of sales. Despite inefficiencies related to investments in new plant construction and expansion and the Wahler restructuring, both of which are for our emissions product family adjusted EBIT as a percentage of sales was up 40 basis points from a year ago. Excluding currency, the Engine segment's adjusted EBIT was up $10 million on $55 million of higher sales for an incremental margin of 17%. A very good performance given the level of investment activity within the segment. Plant construction and expansion currently in progress should be largely behind us by the end of 2015 and the restructuring plan for Wahler is on target after which we expect it to be a double-digit margin business. Now turning to Slide 6, Drivetrain segment net sales were $584 million in the quarter. Excluding currency, sales increased about 2% compared with the same period a year ago. On Slide 7, adjusted EBIT was $70 million for the Drivetrain segment or 12% of sales. Despite inefficiencies related to investments in the new DCT plant in China and restructuring plant in Europe, adjusted EBIT as a percentage of sales was up 120 basis points from a year ago. Excluding currency, the Drivetrain segment adjusted EBIT was up over $8 million on $10 million in higher sales for an incremental margin of nearly 90%. If you recall the third quarter of 2014 we had about $3 million of headwinds related to restructuring inefficiencies. We are beginning to see those headwinds dissipate as we get closer to completing the restructuring. This benefit is reflected in the higher incremental margin in this segment for the quarter. Drivetrain's European restructuring plan is on target and expected to be completed by the end of 2015. The ramp-up of the new DCT plant in China which was expected to begin in early 2015 is under review considering the weaker than expected market conditions in China. The segment review highlights good progress on our restructuring and expansion plans, which will strengthen our competitive position and performance over the long term. Now let's take a look at our balance sheet and cash flow. We generated $470 million of net cash from operating activities in the first nine months of 2015 down $76 million from $546 million a year ago. Weaker foreign currencies, higher cash outlays for restructuring and a few other miscellaneous items reduced net cash from operating activities in the first nine months of 2015 as compared with the same period a year ago. Capital spending was $419 million in the first nine months of 2015. This is up $21 million from a year ago. The increase was driven by capital required to support our backlog of net new business. Free cash flow, which we define as net cash from operating activities less capital spending was $51 million in the first nine months of 2015 down from $148 million in the first nine months of 2014. We expect to generate between $200 million and $250 million of free cash flow in 2015. Investments in restructuring and expansion that are driving elevated spending will soon be behind us. We expect spending to normalize beginning next year. Also, our realignment plan which will provide increased treasury management flexibility will be complete. As a result we expect to see an increase in cash available for corporate initiatives beginning in 2016. We will quantify this improvement and clarify our intentions in our 2016 guidance call in January. Looking at the balance sheet itself; balance sheet debt increased by $469 million at the end of the third quarter in 2015 compared with the end of 2014. Cash increased by $236 million during the same period. The $233 million increase in net debt was primarily due to capital expenditures, dividend payments to shareholders and share repurchases. Our net debt to net capital ratio of 17% at the end of the third quarter is up from 12.8% at the end of 2014. Net debt to EBITDA at the end of the year on a trailing 12-month basis is 0.6 times. Now I would like to discuss our updated guidance for 2015. James reviewed our guidance at a high level, I will just discuss some of the finer points. We have narrowed our sales guidance to the low end of the previous range of minus 6% to minus 5% compared with the minus 5.5% to minus 2.5% previously. James described the weaker than expected market conditions that affected the change. Our business in China was the primary contributor. According to third-party sources light vehicle production in China was down 4% in the quarter. During that same period volumes at our four largest customers were down 12% in aggregate. And our sales growth in China for the quarter was flat. We expect our business in China to modestly improve to mid-single-digit growth in the fourth quarter. Our full year dollar-to-euro exchange rate assumption is $1.12, slightly higher than the previous assumed rate of $1.10. We have also narrowed our expected EPS within a range of $2.95 to $3 per share. The change in EPS guidance is primarily due to the impact of lower expected growth sales. Our share repurchase activity is gaining momentum. We spent $67 million on share repurchases in the third quarter and $130 million year-to-date. We still expect to spend $1 billion on share repurchases during the three-year period ending the first quarter of 2018. Our weighted average diluted share count is still expected to be approximately 226 million shares for 2015. Our operating income margin guidance is unchanged at approximately 13%. This implies a mid-teens incremental margin for the full year, incremental margins north of 20% in the fourth quarter. We continue to be confident in our ability to execute in any market. This company has demonstrated a heightened focus on efficiency and cost. This focus resulted in highly efficient growth and record margins in each of the last four years. With our solid growth and operations performing at a very high level 2015 should be another great year for BorgWarner. As we look beyond 2015 we intend to execute our growth plan yielding solid growth and to efficiently convert our sales growth to profits. The future is bright for BorgWarner. So with that I'd like to turn the call back over to Ken.

Thanks, Ron. We are going to now move to the Q&A portion of the call. Melissa, please remind everyone of the Q&A procedure.

Hi, good morning everyone. On Drivetrain Ron you talked about comping against some of the inefficiencies from last year but this is a pretty big step up in the margin. So it would seem like going forward here less than inefficiencies, leverage in some of your key platforms and there's an upward trajectory from here, is that the right way to think about it versus the 12% you have trended this quarter?

Rich, I will say at this point it was a really good quarter, but the overall intent is for upward trajectory on margins in that segment, right. First thing I would note is that we did get a little bit favorability from North America F1 50 obviously because the volumes have returned, that also is driving some of the upper movement in that segment.

Okay. Then just a broader question, I know you are not going to give the backlog until January and give your 2016 views then, but how should we think about growth for the company as in the current environment, assuming that the China production outlook is relatively modest next year and the developed markets are relatively modest as well? Just trying to get an understanding of where you think growth can go over the course for the next 12 months considering the landscape and considering what's happened with some of your key customers within the backlog that you provided last year at this time?

Rich, this is James. Maybe what I will do is take a shot if I can and just giving you a little bit of high level commentary and then I want to ask Ken to talk maybe a little bit more specifically about maybe some of the math about how to think about the details of the backlog if that works for you. So I think, as we kind of transition through this year first of all and we are looking to pinpoint mid-single-digit type of growth which clearly is pretty decent. The two headwinds that we really faced from a macro point as we have gone through the year are commercial vehicle and China. China being obviously the bigger piece of that. So those are the two kind of headwinds that we have kind of have faced this year. I think it's fair to say as you look at commercial vehicle going into next year we are not looking for meaningful improvement in those end markets. I think in China what we are looking for from a light vehicle perspective as we look to next year in China, Rich, is 3% to 5% type growth rate of the market in China. As you know our content will grow well above that market rate in China because of the adoption of our technology. So we are looking for a strong growth here in China next year and that coupled with other elements of our backlog we are looking for a good growth here next year. But I am going to ask Ken to just put a little bit more detailed commentary around that so he can help you from a math point, Rich.

Thanks, James. This is Ken. Based on the preamble of your question you are not expecting a lot I think. But we want to be as transparent as we can be about where we think we are throughout next year. So let's talk about the math a little bit. So rough math, this year's backlog is coming in at about 55% of what we expected coming into the year. Now with the conditions that caused that lower growth persist into next year and you know the conditions I am referring to is our business in China and commercial vehicles. Then we can reasonably assume that the backlog will come down similar levels next year. So essentially what we are saying is that's about cutting it in half. Then once you layer on the potential impact of other macro risk factors, it's reasonable to expect that we are looking at low-to-mid single-digit growth next year. Now regarding these other macro factors, if you look at the last five years we have had recessions, natural disasters, debt crisis, currency devaluations, business disruptions at some of our largest customers, just to name a few. The magnitude of the impact of these factors has varied for us but they all have had an impact. We intend to do a better job accounting for these risks in our guidance going forward. Did that answer your question?

Yes. Basically, 55% of $1.1 billion that you mentioned last year, and what are the other macro factors that you are indicating will be decreasing?

We don’t have specific numeric data to share on that, but we want you to know that we will definitely be considering it as we provide guidance for next year.

Okay. So that would be developed markets and other things that are going on basically.

Yes. Sure.

Thanks, Rich.

Good morning guys. I could just follow-on just on that top line thought process. Is there any change in your view of the revenue generation that Remy will bring in next year? And if you could remind us roughly what you would expect that to be for '16?

Yes. John this is James here. It was about $1.2 billion is the approximate revenue stream that we were expecting to generate from Remy. Obviously we are going through the closing pressures so we are going through some additional validations and we will bring a more accurate number of course for the meeting in January. But we are not expecting a meaningful shift away from that $1.2 billion number, is a good way to think of it John.

If we consider your base business this year, and you expect low-to-mid single-digit growth, combining that with the previous information would give us a reasonable way to think about it.

I think that's right. So the low-to-mid single-digit growth was on the base business and then later on Remy on top of that.

All right. Just want to make sure we are clear on that. Second question, Ron, you talked about some delays or sort of some real stalls here in this DCT launch in China, yet you are getting up the F150 really ramping up pretty hardcore here and you are getting the restructuring in Eastern Europe working fairly well and should be running full throttle as far as benefits in '16. Is there any reason to think the Drivetrain should have a margin not above 12% next year, just given all those big guys? But is China really going to derail this or is that something then won't be that bad?

So these negative there, I agree that it should be above 12%, John. The DCT plant is a Western OEM and at this point of all the headwinds we have had in DCT in China that's really basically the last one left, I would just say it that way. But we will give more color on that impact as I said in my script and will actually articulate exactly that headwind that we might see next year. But the bottom line is that the margin going forward should be known for that 12%.

Okay. That's helpful. And then just lastly, if you think about capital and free cash flow, looks like there was a down tick in your free cash flow guidance to the $250 million, I think it previously $250 million to $300 million. What's the key driver of that? And as you think of maybe that might in the same context of the share repos, why don’t you think you would be more aggressive with share repos just given what's happened with the stock more recently?

Well, again, this movement in free cash flow, the combination of a little bit in earnings and a little bit items on the balance sheet movement. But to get back to the more important question right now we surely intend to be more aggressive. If you look at the year-to-date number it's not a well-represented number because we had a self-imposed blackout period during the Remy acquisition. Our intent quite frankly is to be more aggressive given where the stock price is, I can just say that John.

Okay. That's very helpful. Thank you.

Good morning. I appreciate the information on the '16 backlog. Everyone seems to be trying to gauge those numbers. Regarding the 55% figure, you've previously mentioned that approximately 40% of your backlog comes from Asia. The commercial vehicles sector is also facing challenges. Can you clarify how much of the backlog has shifted from '15 to '16 and into later years due to reduced volumes in the Chinese market? The calculations indicate that you might be losing nearly all of the Asian backlog. It would be helpful if you could provide some insight into what's been lost versus what has been deferred by a year or two from '15-'16 into '16-'17. Thank you.

So the way I want to frame this is we provided that sort of directional guidance to help you think about where things may land. As far as the split of backlog, how much is going to be Asia, how much is Europe-North America, how much of its push out and how much of it is just program cuts, you got to give us a little bit of time to work through that. I think as we sit here today, Asia as a percentage of the backlog is coming down. That's the market where we are having the most impact from what's going in the world today. In commercial vehicle the percentage of the backlog is also very likely coming down. Let us hold through that, what we wanted was to give people to have a good sense for where we think we're headed next year. We will give more details in January.

Okay. Maybe just quantitatively if we take out China and CV would the backlog numbers for all other global production would they have come down as well and so that we are essentially near the $1.1 billion number that we were referencing probably would have been lower regardless other than a weak China and a weak commercial vehicle?

Well. Sure. If you want to kind of recap the year and the things that affected the backlog we talked about primarily China, our mix of business in China. We have talked about the commercial vehicle issues around the world. We had some issues with the Asia launches that were coming down last year. We had some mix issues in North America as well. As I kind of go over those four or five topics, the two persistent ones is the impact of China and commercial vehicles. The mix issue in North America, we think that's going to normalize with the F150 coming back on screen for us. And the Asia launches that's all linked to China. China kind of drives that whole market anyway. So let us continue to do some work on that. But I think you are speaking about it correctly. We just have to work through the numbers for you.

Good morning everyone. I am going to take one last stab at this comment about the backlog. How much of the shortfall that you are seeing from the backlog that's realized this year is coming from currency? I think when you did the backlog last year you had enough pretty high euro value in there.

I think we are $1.20 texture. But the European portion of the backlog was pretty small. It was remember coming into the year we thought it was going to be what 15% of the backlog. So the euro while it came down significantly, it didn’t move the backlog number.

I gave you some, David. I told you basically in China we were flat, that was in the script.

We are just looking at the data.

Because remember we had modest growth in both of those regions in the light vehicle area. Both North America and Europe we did grow modestly, and obviously in commercial vehicles not much growth at all.

Thank you very much.

Good morning gentlemen. Two questions here. First on 2015 margins lower sales guidance but you maintained your margin guidance. Kind of what are the offsets there? Normally you would expect a little downward leverage there?

On just really good operational performance. I mean we had a good third quarter. As you can see we are anticipating that to continue that performance level. So that we didn't feel that we need to take down the margin when the sales came down that we could still hold the margin. And it's probably through just good operations performance that's what's going on there Brett.

Then as you think about 2016 margins, I know you are not going to provide guidance here. But can you kind of talk about some of the major puts and takes there, pluses or minuses that you see.

So we have been very clear about our objective is to get mid-teens incremental. So if you take sales and assign mid teens incremental that's the starting point. Now so some of the items that are going to be a tailwind for us, these inefficiencies we would see in for three quarters this year and we said that those inefficiencies will be tailwinds for us. So you take the mid-teens incrementals and then add in the inefficiencies that will now be headwinds and they will be on top of it. So the end result would be higher than mid-teens incremental margins going into next year.

Can you remind me about the inefficiencies, specifically how much they amounted to?

Sure. In the second quarter, we experienced headwinds that varied between approximately $3 million and reached as high as $7 million or $8 million, with fluctuations around $4 million or $5 million at times. The most challenging period was the second quarter, where we faced around $7 million in headwinds. In the past year, we first noted these headwinds in the third quarter, starting at $3 million. Overall, it has stayed within that $3 million to $7 million range. While I don't expect all of that to completely diminish—whether it's the $7 million or $5 million you consider—the majority of it will. Some of it is typical operational activity, but I anticipate that most of the impact will subside as we approach next year.

Minor correction, $9 million.

What was it $9 million in the second quarter?

Yes.

$3 million in the first and kind of $9 million-ish in the second something along those lines.

That $9 million was the highest amount we experienced in the second quarter, and I believe that will be the peak in the near future. The amounts were fluctuating, generally between $5 million and $7 million, with $9 million as the upper limit. While we cannot simply disregard the $6 million to $7 million range entirely, a significant portion of that will not be considered going forward.

This is Dan Levy on for Brian. Thanks for taking the questions. First question are you seeing any signs of program delays from any of your larger customers that may have been impacted by certain issues in the past quarter?

Okay. Let me take a shot at that and answer this answer. I think know maybe which OEM you may be referring to and the answer is we have not. We have seen no impact on any of our product development activities and we have really not seen anything relative to the engineering activity or launch activity with the customer that I think you are referring to.

Okay. More broadly on the diesel front, any signs that the diesel activity globally and I guess specifically within Europe still remains intact?

Thank you for the question. I think it’s important to address two key issues. First, regarding the Volkswagen emissions situation, it’s useful to put this in context and assess the potential impact on BorgWarner. Secondly, I will discuss the broader concerns surrounding diesel. Starting with Volkswagen, it accounts for roughly 16% of our total revenue, with about 4% tied to light vehicle diesel engine products. This provides some clarity, indicating that the debate primarily involves around 4% of BorgWarner's business related to diesel products for Volkswagen. When we analyze the affected engines disclosed by Volkswagen, they represent less than 0.5% of BorgWarner's total revenue. I'm emphasizing this because I know there's been concern about our exposure and the potential impact. For further clarification, if anyone would like additional detail on how we arrived at the 0.5%, feel free to follow up with Ken for more specifics. From BorgWarner’s perspective, this does not represent a meaningful impact. Additionally, there have been no changes to our schedules or releases with Volkswagen. Going forward, as Volkswagen engages in recall efforts next year, we believe there will be no impact on BorgWarner, since our products are not part of any recall solutions. Now, on the broader topic of diesel: we’ve anticipated a slowdown in diesel adoption over the past couple of years and have proactively managed around this trend. The transition to gas is slow but we see diesel remaining integral to our customers’ plans for meeting fuel economy and emissions standards. Light vehicle diesel sales make up about 15% to 20% of BorgWarner's revenue. As the shift from diesel to gasoline engines occurs, BorgWarner's contribution is currently about 70% for gasoline compared to diesel. Over time, this balance is evolving as we add more content to gasoline engines. Looking ahead over the next couple of years, we see gas-diesel dynamics becoming more neutral from our perspective. I hope this information helps clarify these important issues for BorgWarner, and I'm here for any follow-up questions either now or through Ken later.

Thank you very much. That's very helpful.

Great. Thank you. Good morning. Just want to go back to the backlog discussion. Ken with the 55% arithmetic for 2016 and also roughly applied to 2017, the reason I am asking is just because if you kind of apply that it does make the 2020 revenue even if you adjust a little bit for M&A and FX kind of implies an acceleration in the last three years. And if so maybe talk about booking activity and kind of you know the visibility around the trajectory over the next five years or so?

It's a great question. So let me answer it this way. So the part where we were talking about making sure that we account for macro-rich factors in our backlog, I think that it's fair to say that we intend to apply that thinking to the entire backlog. Now the actual cutting the backlog in half directionally and how that applies to the out years of the backlog is still under development. I can directionally that's probably a pretty fair way to think about it. We have to continue to work through that. But we expect the backlog in those out years to also come down kind of at similar level but again we have to work through that. I am going to let James speak to the 2020 target of $15 billion, but that's kind of in the next few years is kind of the way we are thinking about it.

I think Ken explained that very well. Let me add a couple of points that might clarify things, Itay. What you're hearing are some macro headwinds presenting a challenge for us, particularly in China and its commercial vehicle sector. However, it is essential to note that the adoption rates of our technology have not slowed; we continue to see strong demand and adoption rates for all our products, consistent with what we've observed over the past few years. This consistent adoption gives us significant confidence regarding the future growth of our products. Although we recognize that we are facing some challenges this year, which Ken mentioned will extend into 2016 and somewhat into 2017, the adoption rates of our products remain robust from a technology standpoint. This leads to a solid outlook for mid-single-digit growth. Additionally, part of our $15 billion target for 2020 includes further acquisitions we are focusing on. The fundamental story here remains unchanged: BorgWarner's technology adoption is strong, and we are poised for growth, although we are currently in a transition period this year and into the next. Despite this, we are still delivering single-digit growth, which we find quite strong in this industry and are translating that into solid earnings per share performance.

That's very helpful and thanks so much.

Thank you, good morning everyone. I appreciate all the additional insights and commentary. Regarding Volkswagen, they have publicly discussed pursuing significant savings from their suppliers to manage their upcoming costs. I was curious if this topic has come up in your discussions, and if so, how do you feel about your positioning to handle what seems like it will be more challenging conversations in the future?

Yes. Certainly Joe, we sure saw some of the information and we pay a lot of attention to that of course. Frankly at this stage we have not seen I would say meaningful increased pressure specifically around pricing reductions and those types of things. I think our mindset right now, Joe, is it may likely intensify as we go forward. But our belief right now is that we can push back and contain that and stay somewhat in the range of the margins we have done over many years which is in the 1.5% to 2%. So quick answer, yes, we expect the intensity to come. We feel comfortable about our ability to deal with that and not deviate from our historical annual average profit margin type numbers that we provided.

Okay. Just one more on the backlog. You pointed out that Europe was much lower for next year, which I believe is due to decreased diesel penetration there. Do you think that any shift away from diesel and the impact from Volkswagen are not factors related to the backlog for next year, or are they included in the more conservative macro view you are taking?

Yes. That's a good clarification there. So that's a good way to think about it. Our view in diesel has been pretty well-established in the backlog. We brought that up last year, I am sure you remember when we came out with the new backlog back in 2014. So yes, the changes are mostly happening in the areas that we talked about, which would be China and commercial vehicle. Diesel's kind of already built into that. And to James' point earlier, the impact of the Volkswagen issue is diminished. So that's not expected to impact our backlog as we sit here today. So I think as you think about it that the Europe is probably as a percentage of the total backlog is going to go higher because that feels like probably the most stable region for us out of the three between the Americas, Asia and Europe.

I have a couple of follow-up questions. The margin improvement in Drivetrain year-on-year was very strong. It looks like there was a slight margin improvement on the Engine side as well, around 40 to 50 basis points. I'm curious about the growth potential for margins in Engine. Are we nearing the expected levels, or is there still some upside potential?

I would say that our objective has always been mid-teens. Now the question is how you define mid-teens. But I would say that Engine still has room for improvement.

And if you were to benchmark like the main drivers is it just efficiencies with better growth or anything sort of more specific than that?

Well we have a couple of things. One is the growth and being able to convert in the mid-teens is above the average now. That's one area. The second one which is probably more important is the Wahler acquisition is going to gain momentum as time goes on. And quite frankly somewhat of a drag on our margins now as we go forward and then become a double-digit business that will start to move margins up. And then someday I don’t know when commercial vehicle might actually start being a net tailwind for us and that will obviously start driving margins up too. But I am not going to predict that for '16, that's somewhere down the road.

Can I have a follow-up on the European light vehicle diesel? When you mention 15% to 20% of your sales, does that refer to total diesel, or is there a portion that includes commercial vehicles which would likely be unaffected? Additionally, could you discuss your relative share in Europe for gas and diesel products? Are you well-balanced in both products, or given your strong position in Europe, do you currently have a greater market share for diesel products?

Yes. Colin, let me address your first question and then maybe Ken can provide some insight on the European split between gas and diesel. I want to clarify that light vehicle diesel sales make up about 15% to 20% of our total company revenue. We intentionally wanted to exclude the commercial vehicle segment in this context. So, it's 15% to 20% light vehicle diesel sales of our total overall BorgWarner revenue. I hope that clarifies things for you.

I will take part two of that. So the commentary that we had made around $0.70 on a $1 of content for advanced gasoline engines versus diesel, that's kind of a direct comment on our mix of business in Europe diesel versus gas, okay. Two other factors, that gap is closing over time. There is going to be more and more content on gas engines as we continue to evolve in that market. We have seen that happening over the last few years and that's going to continue going forward. And secondly our market share for gasoline turbochargers is higher than it is for diesel today and it's only continuing to get stronger going forward. So that's going to give us a bit of a lift as we see the shift from diesel towards gas. A few points higher for gas than it is for diesel.

Okay. That's very helpful. You talked earlier about take rates being stable, but I think some of the recent award data shows that turbo take rates are flat year-over-year which is consistent but they have been growing for the last few years. Has that been a factor in your outlook for this year that you would have probably anticipated if gas wasn't so cheap that take rates would have actually continued to grow? And when do you think that starts to reaccelerate because I can't getting to the 2025 standards without more turbo adoption?

Yes. Let me address that. We have not observed a slowdown in penetration rates at all. As you know, the two main regions experiencing rapid growth in penetration are China and North America, and we are not witnessing any fundamental slowdown in the adoption rates of the technology. However, there are some volume reductions this year in China and some launch impacts in Asia that may be related to turbo. But these factors do not fundamentally affect the adoption rates of turbo. I hope that clarifies things.

That's very helpful. For my last question, can you provide some insight on the margin direction? I'm trying to understand the numbers. It appears that while sales should increase slightly, the margins seem to be relatively flat. How should we approach thinking about margins?

Are you talking sequentially or are you talking into the fourth quarter?

Yes. To Q4, yes.

I think if you do the math it will be down slightly sequentially more in line with what you saw in the better half of the year.

Yes, we have some other factors affecting costs in the fourth quarter that may reduce margins slightly from the third quarter. This is reflected in our guidance. When you calculate the guidance, you will notice margins are expected to be somewhat lower in the fourth quarter, but they will align more closely with what we observed in the first half of the year. Furthermore, our SG&A expenses were significantly lower in Q3, but we don’t expect that trend to continue into Q4. The SG&A run rate for Q4 will likely resemble the average over the first three quarters of the year.

To kind of following up on Patrick's question. On organic growth into Q4, it seems like you and the guys need to do somewhere 7%, 8%, 9% in Q4. Can you talk about what your organic growth expectation is specifically for Q4 and if there is a big acceleration from the first three quarters of the year why wouldn't that slow into at least the first half of next year?

I believe the calculations show that the organic growth for the fourth quarter, excluding foreign currency effects, is approximately 5%, which is slightly higher than the year-to-date average at this stage. That's how I interpret the figures, although I think you estimated a higher number.

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