BorgWarner Inc. (BWA) Q4 2015 Earnings Report, Transcript and Summary

Good morning. My name is Melissa, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2015 Fourth Quarter and Full Year End 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 turn the call over to Ken Lamb, VP of Investor Relations. Mr. Lamb, you may begin your conference.

Thank you, Melissa. Good morning and thank you all for joining us. We issued our earnings release this morning at around 8:00 a.m. Eastern Time. It's posted on our Web site, borgwarner.com, on our Investor Relations home page. A replay of today's conference call will be available through February 18. The dial-in number for that replay is 800-585-8367. You'll need the conference ID, which is 25547967 or you can listen to the replay on our Web site. With regard to our investor relations calendar, we will be attending the following conferences between now and our next earnings release; The Barclays Industrial Conference in Miami on February 17 and the BofA Merrill Lynch New York Auto Summit in New York on March 23. 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 comment on the industry and provide a high level overview of our results and expectations for 2016. And then Ron Hundzinski, our CFO, will discuss the details of our results and guidance. Please note that we have posted an earnings call presentation to the IR page of the Web site. You'll find the link at the events and presentation section beneath the notice for this conference call. We encourage you to follow along with these charts during the discussion. With that, I will turn it over to James.

Thank you, Ken. And welcome to everybody. Thank you for joining us this morning for the call. As Ken alluded to, I'm going to provide some high-level commentary around both the industry and around BorgWarner. I will give a brief recap of some of our financial numbers and then Ron will go through the details around those numbers. So, I am now on Slide 1 for those of you following along with the deck. And I'm going to just provide a few overview comments about the macro and industry. Let me just start at a general high level. And I think what we are experiencing at BorgWarner just like everybody else, in general is a lot of uncertainty out in the world. And whether that's reflected in oil prices, strength of the dollar, Middle East and challenges. We do see a lot of uncertainty out there. But I think what we also see is a pretty solid auto industry. Now, I will provide more color and detail around that as I go through my comments here. But my message really is in spite of all of that macro uncertainty, we see strength in the auto sector. The other comment I'd like to just proactively talk a little bit about is China. And as you know, China is a really critical market for the growth of BorgWarner. So I want to spend a moment and just provide some overview there. So, as we go into the year, we see GDP levels for China in the mid-single digit type of a range. We see auto production in a like vehicle auto production in about 3% to 5% growth environment. We do see the incentive programs and initiatives that were enacted towards the end of last year. Our assumption is that they will continue on through the majority if not all of this year and you will see later in our numbers that did provide some benefit for us. So, our view on China is, we see a decent level of stability around GDP and auto production. And that gives us encouragement with such a lot of growth for the business in China. I will make a couple of comments specifically around the markets. I would start with, say, our views on production numbers for light vehicle and commercial vehicle are pretty aligned with IHS. And what that means for us, we see North America now starting to plateau or peak type numbers in the 17.5-ish range. We see China as I alluded to earlier at about 3% to 5% growth in light vehicle. And Europe -- the environment for Europe is somewhere between a 1% to 2% growth environment for light vehicle production. Commercial vehicle we see still remains quite challenged. We're going into a year where on an aggregate basis globally we see little or no growth in commercial vehicle. As you go around the regions in the segments, there is a little bit of differentiation but fundamentally we see still a pretty challenged commercial vehicle space. I wanted to share with you what I would describe the areas of watch that we at BorgWarner are paying close attention to as the year evolves. And I would say that the three major areas that we are paying a lot of attention to are commercial vehicle, as I mentioned, can there be upside there, could it deteriorate a little worse? So, we are paying a lot of attention to that. We are paying close attention to the China incentives and how that will play out through the year. And clearly for us our biggest customer remains Volkswagen. So we pay a lot of attention to what is going on at Volkswagen. But I would say to summarize on the market outlook, I would say so many things are playing out as we'd expected as we came into the year and that's what we are seeing reflected through the first six weeks of the year as we're going forward. Let me switch a moment and provide a couple of comments on the regulatory and technology environment. I would say very importantly for us, we still see a very strong drive for fuel economy and emissions regulations. We see no slippage in driving interest from our customers around cafe and other programs. In fact, the latest example we saw in Europe with the real drive and emissions standard for us points to further evidence of strong drive for enacting greater fuel economy and emissions standards. We've also seen the pace of the transition to increase electrification of the power train continues to gain momentum. And importantly for everybody on the call to know, we are aware of that because we are right in the middle of it as BorgWarner. We are meeting and discussing with multiple customers, many different architectures involving our products on 12-volt, 48-volt, mild hybrids, pure electrics, the whole spectrum of electrified power trains. We are right in the middle of that. And that's what's driving and building our growth for the long-term. I thought it would be good to share the electrification effort for BorgWarner is not just a long-term phenomenon. As we look here, right now in the year of 2016, I just want to give you an example, we are on pace to ship about 15,000 single speed transmissions for pure electric vehicles in China this year. So it's both a now story and a future story. The last comment around diesel, at this point we are not seeing any real shift in mix between gas and diesel in the short run. We do know as we talked about in prior calls there will be a transition to more gas engines from diesel overtime and we fell BorgWarner is very well positioned to take advantage of that trend. Let me now switch and give a few high level comments about BorgWarner specifically. I will start with a recap of 2015, and again, Ron will provide a lot more detail and color around these numbers after myself. So from a Q4 perspective, it was a really good finish to the year for us. I think from a growth perspective and an operating performance, we ended the year strongly. We were $2.1 billion of sales for the quarter, which is up 7% when we exclude both currency and Remy. And our EPS performance on a comparable basis is about $0.75 with strong performance and also the operating margins reported at 12.6 but significantly when we exclude Remy that was an impressive 13.2%. If I break Q4 out by segment, Engine sales were about $1.4 billion, which is a growth of 1% on a reported basis but 10% when we exclude currency. That was primarily driven by very strong turbocharger sales. On the Drivetrain side for the quarter $735 million that's up 20% but clearly Remy is a big influence there when you strip out Remy, it was about 1% growth. Two things that impacted the growth on the Drivetrain side we had very strong all-wheel-drive growth in North America and that was offset by lower growth on transmission in Europe. For the full year sales reported $8 billion, that's down 3% from 2014. But when we exclude Remy and FX and Wahler, it was up 4.3%. EPS 270, when we exclude non-comparables and Remy was $3.02 per share. Operating margin for the full year 13%, again, when we exclude Remy, an impressive 13.2%. And I think key for the business is we continue to drive investment for the growth for the future of the company and in the two key metrics, I focus on to make sure we are driving the growth, CapEx came in at 7.2% for the year and R&D was about 4% when we exclude Remy both of those give me strong confidence that we are investing for the future. Now, 2015 is behind us. And we are into 2016. So let me move and give comments on 2016. I would say as we started into the year and as we've gone into the year, we have an optimistic view on the year. We feel good about the year ahead of us. Today, we are reiterating our guidance both for Q1 and the full year that we announced in Detroit last month, and again, Ron will provide detailed commentary around that in a moment. I'm also pleased that we have largely got the restructuring efforts that we put a lot of work into over the last 18 months behind us so we can get that benefit as we go into the year. And we are heading into the year on pace to deliver mid-single digit growth and strong operating performance. The last thing I would like to address is just some highlights around growth for the company. Let me just start and make a few comments about Remy. We are very, very pleased with the acquisition. I think from a strategic perspective this was a really critical transaction for BorgWarner and we're going to talk more about that through the year. The integration on a pragmatic basis is going very well both from an operating perspective and a financial perspective. But I think I want to comment positive we are about the technology and as I mentioned earlier, we got multiple customers engaged in discussions around the combination of the Remy product line and the BorgWarner product line, particularly a lot of discussion around the combination of Remy's rotating electric motor machines and our clutch technology around hybrid vehicles a lot of emphasis and a lot of momentum we're gaining. Couple of other recent growth announcements that we made, we did announce the GEN-5 electro hydraulic all-wheel-drive coupling that will be on the Volvo XC90 vehicle. And we also announced engine timing and VCT product lines on the Hyundai V6 gas engines. I would say that I quote and our booking cadence remain strong and solid and is in line with our growth expectations. And as I mentioned earlier, the drive on electrification around the power train momentum continues for us. So I would summarize it this way. 2015 we had some challenges in 2015. We acknowledge that. And we're now going forward into 2016 with a lot of confidence. The business is operating very well. And we are heavily focused on driving the growth that we made through the adoption of our technology. And I think the last and most importantly, we are upbeat and we're positive about delivering on the guidance that Ron is going to take you through right now. So with that, I will turn the call over to Ron. Thank you.

Thank you, James. And good day, everyone. Before I begin reviewing the financials, I would like to commend all of our employees for their hard work in the quarter and more specifically a great finish to the year. Also as Ken mentioned, I will be referring to the supplemental financial slide deck that is posted on our IR Web site. I encourage you to follow along. Now on to our financials. Let's start on Slide 3. Sales on a reported basis were up 6.6%. However, to get a clear picture of how the core business performed, we exclude impact of FX and Remy. And excluding those items, sales are up 7.1%. Gross profit as a percentage of sales was 21% in the quarter or 21.4% excluding Remy, up 70 basis points from a year ago. SG&A as a percentage of sales was 8.4%. Again, excluding Remy, SG&A was 8.2% of sales, 30 basis points improvement from a year ago. R&D spending, which is including SG&A was 3.6% of sales. I would like to point out Remy did impact that number by 20 basis points. It was probably 3.8% without Remy. Now, let's look at the year-over-year comparison for operating income which can be found on page -- on Slide 4. Starting on the right, fourth quarter 2015 operating income adjusted for non-comparable items including Remy was $269 million or 12.6% of sales. Excluding Remy's $8 million of net contribution to operating income, operating income was $261 million or 13.2% of sales up 80 basis points from a year ago. Excluding non-comparable items, Remy and FX, operating income was up $34 million or $141 million of higher sales. That gives us an incremental margin up 25% -- 24% in the quarter. A reconciliation of the reported operating income to operating income adjusted for non-comparable items plus Remy can be found in the appendix on page -- Slide 9. For full year, our incremental margin excluding non-comparable items, Remy and impact of currency was 19%, very good performance despite some operation inefficiencies related to the Drivetrain restructuring activities earlier in the year. As you look further down the income statement, equity and affiliate earnings was about $12 million in the quarter in line with last year. Interest expense and finance charges were $18 million in the quarter up from $10 million a year ago. The increase is primarily related to the $1 billion and €500 million fixed rate seniors notes issued in the first and third quarters of 2015 respectively. Provision for income taxes in the quarter, on reported basis was $61 million. However, this included $12 million of net tax benefits associated with the non-comparable charges and an $8 million favorable tax adjustment. You can read about these items in our 10-K, which will be filed later today. But excluding these items, the provision for income taxes was $81 million or an effective tax rate of 30.7% in the quarter. Our effective tax rate for the full year was 29.8% or 30 basis points above our estimate. Net earnings attributable to non-controlling interest was about $10 million in the quarter up slightly from $8 million in the fourth quarter of 2014. That brings us back to net earnings which were $125 million in the quarter, net earnings excluding the non-comparable items but including Remy was $173 million or $0.77 per diluted share. Now for comparisons with prior periods, net earnings excluding non-comparable items in were $168 million or $0.75 per diluted share. Let's take a closer look at the operating segments in the quarter. So, beginning on Slide 5 of the deck, as James said earlier, reported Engine segment net sales were about $1.4 billion in the quarter. Sales growth for the Engine segment excluding currency was 9.8% compared with the same period a year ago. Turning to Slide 6. Adjusted EBIT was $230 million for the Engine segment or 16.5% of sales. Excluding currency, the Engine segment's adjusted EBIT was up $19 million on $136 million of higher sales for incremental margin of 14%. Turning to Slide 7 and starting with the right side, Drivetrain segment net sales were $735 million in the quarter. Excluding Remy and FX, sales growth for the Drivetrain segment was 1.3% compared with the same period a year ago. As James said earlier, higher all-wheel-drive sales in North America were offset by lower transmission component sales in Europe. On Slide 8, adjusted EBIT was $81 million for the Drivetrain segment or 11% of sales. Excluding Remy, adjusted EBIT was 12.5% of sales, an impressive 180 basis points from a year ago. Excluding Remy and FX, the Drivetrain segment's adjusted EBIT was up $12 million on $8 million of higher sales for an incremental margin of 156%. I would like to remind you that in Q4 2014, we incurred about a $5 million to $6 million headwind through restructuring inefficiencies which are behind us now. Drivetrain's 12.5% adjusted EBIT margin matches it's best quarter performance ever. It was just three years ago that Drivetrain margins were running around 9%. At that time, we committed to improving the margins in the segment and we are pleased with its progress. Now let's take a look at the balance sheet and cash flow. We generated $868 million of net cash from operating activities in 2015 up $66 million from a year ago. We had a very strong finish to the year generating nearly $400 million of cash in the fourth quarter driven by exceptional working capital management. Capital spending was $577 million in 2015 up $14 million from a year ago. As James said earlier, capital spending in 2014 and 2015 was above our trend. We expect to return to normal spending levels beginning in 2016. Free cash flow which we define as net cash from operating activities less capital spending was $290 million in 2015 up $52 million from 2014 and $41 million above the high end of our guidance range provided in October. This positive trend is expected to continue. We expect to generate between $400 million and $475 million of free cash flow in 2016. At the midpoint that is up 50% from 2015, $200 million to $300 million of free cash flow will be used to repurchase shares in 2016. Looking at the balance sheet itself, balance sheet debt increased by $1.23 billion and cash decreased by $220 million. In 2015 compared with the end of 2014, the $1.45 billion increase in net debt was primarily driven due to Remy acquisition, capital expenditures, dividend payments to shareholders and share repurchases. We spent $315 million repurchasing 8.1 million shares in 2015 and that's on schedule for executing our 1 billion share repurchase program by the first quarter of 2018. Our net debt to capital ratio was 35.4% at the end of 2015 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 was 1.4x. Now, I'd like to spend some time on our 2016 guidance which is unchanged from our initial announcement. I'm going to go through the same numbers presented at the Deutsche Bank Global Auto Industry Conference that we did a couple of weeks ago. I would ask to please bear with me. I think as a management team we thought this is really important to go through this and it will be very detailed but nonetheless we think it's very important that I do this. So, let's start with sales growth guidance for the full year. I want to remind everybody the baseline for 2015 net sales excluded Remy, which was just under 7.9. So, starting point is without Remy. So net new business pricing and market rate growth are expected to drive 2.5 to 5.5 sales growth. Currency is expected to reduce sales growth within a range of 230 basis points at the low end and 80 basis points at the high end of the range. Those two items combined to equal 0.2% to 4.7% of expected sales growth for our base business in 2016. The Remy acquisition should add 13 to 13.5% growth leading to 13.2% to 18.3% growth for the total company. From an operating performance perspective, we are expecting an 18% to 20% incremental margin on our core business sales growth. Included in this are $15 million to $25 million of tailwinds from the Drivetrain restructuring and increased efficiency related to the completion of that activity. These tailwinds will be partially offset by about 5 million in higher compliance and other corporate expenses. On a comparable basis, we expect -- comparable basis, we expect our operating margin to be greater than 13% up from the prior year for the 7th year in a row. The Remy business is expected to deliver mid-single digit margins this year. Its net distribution to operating income includes cost synergies and purchase accounting adjustments. So our consolidated operating income margin is expected to be above 12%. We expect earnings of $3.11 to $3.32 per share on a consolidated basis, which includes about $0.13 per share from Remy. Excluding Remy, we expect earnings to be $2.98 to $3.18 per share. Now, let's review the first quarter guidance starting with sales growth. Again, this has been unchanged from what we gave guidance a little while ago. We expect new business pricing and market related growth of about negative 3% to a positive 2.7%. As we said in January, we do expect higher light truck related volumes in North America but this will be partially offset by two European transmission programs that begin phasing out in the fourth quarter. We are also layering in risk associated with the market volatility in China. Currency is expected to reduce sales growth between 380 basis points at the low-end and to 240 basis points at the high-end of the range. In 2015, the euro was at its highest point during the first quarter. If our currency assumptions for 2016 are correct, impact on currency will be relatively severe in the first quarter but less throughout the year. Those two items combined equal minus 4.1% at the low-end and 0.3 at the high-end of our core business. The Remy acquisition should add 12.4% to 13% growth leading to an 8.3% to 13.3% growth for the total company. We expect earnings of $0.75 to $0.79 per share on a consolidated basis, which does include about $0.03 per share from Remy. Excluding Remy, we expect earnings to be $0.72 to $0.75 per share. So let me summarize 2015. 2015 was a good year for BorgWarner. We grew mid-single digits. We expanded our operating margins, we also completed the Remy acquisition. We completed the Drivetrain restructuring and we made capital investments that set the stage for continued growth and improved operating performance going forward. Now, as we look into 2016 and beyond, we see improvements in a number of key areas. First and most important is the intensity around new product development to support the impending electrification trend James mentioned earlier. I have never seen this intensity higher in this company since I have been here. There was no question in my mind that this will drive growth for many years. Second, operating income and cash flow will go higher. And finally, the future is bright for BorgWarner. So, with that, I would like to turn the call back over to Ken.

Thanks, Ron. Now, let's move to the Q&A portion of the call. Melissa, please remind everyone of the Q&A procedures.

Good morning. This is for Deepa Raghavan for Rich Kwas. A few quick questions. What is your incremental margin assumptions by segment for 2016?

We don't provide that kind of guidance by segment. We just give the total company guidance which is on the deck that I was referring to earlier.

Okay. Secondly, could you also give us early read on integration synergies from Remy?

Sure. Back in the announcement in last July, I believe it was, we gave guidance that the synergies on the cost side were going to be $15 million. I would say we were on track of hitting that goal at this point. We didn't give any synergies at this point on the sales side but we are getting momentum there as well and now we have more clarity as we go forward.

Okay. This is for 16 -- 2016?

The cost synergies were 2016.

Okay. Thank you. That's all I have.

And to be more specific, we will realize half year savings of the $15 million in 2016, the run rate in 2017 would be $15 million, I need to be more specific there.

Your next question comes from Brett Hoselton with KeyBanc Capital. Your line is open.

Good morning.

Good morning.

Let's see here. Can you talk about Remy as we look into 2017 and 2018 and specifically your revenue growth expectations and your margin expectations?

Yes. I can -- let me take a shot at that, Brett. From the revenue perspective, I would say our outlook for growth is pretty similar to BorgWarner in general. So mid-single digit growth as we see it today Brett into 2017 and 2018. And from a margin perspective, what we are starting around that mid-single digit growth that's the start point is mid-single digit growth. And I believe -- and again, it's a little early in the process, but our belief is that we will be able to take that up to high single digits over the next two to three-year period.

And as you move into high-single digits, is part of that purchase accounting or is it, basically doing -- is it more restructuring oriented or is it some combination of the two?

I would say it's not purchase accounting coming off. It's more operational driven.

Is there a step function improvement as a result of purchase accounting at some point in time in the near future?

There is but I think its 18 -- maybe 18 or 19. Some of the stuff comes off after three years, some of its 10 years. There is a long tail for that. So we won't see some of those benefits for some time.

Okay. So hopefully we will be on a beach by then. The 2017 margin drivers in general direction, what are the -- maybe the key one, two, three margin drivers and then just do you, is it likely that they are going to go up or down. It seems like it should go up. But, I just want to know what your thoughts are?

So Brett, you are saying 2017, not 2016, right? I want to make sure I get the right -- I would say some of the -- as you know, we always target mid-incremental margins, mid-teens incremental margins on our sales growth. And that is above our nominal value right now. So that would drive increased margin expansion. Then you still have -- I will admit Drivetrain is still not where the Engine group is. So we still probably have more tailwinds there. Trying to think what else, probably the Remy what we just talked about as well. And then Wahler; Wahler as to also contribute more going forward. So I don't have all the numbers there Brett but I would say there are a lot of tailwinds I just mentioned.

Okay. Do you see any particular headwinds?

We don't see headwinds now. Commodity prices is still -- I think we are predicting those to stay flat, right? Oil prices and so on and so forth. I don't see them right now, no. I don't see anything right now.

Let's go. And then very quickly share repurchase what did you do in the quarter and what's kind of the run rate -- your expectation for run rate going forward?

Before we did 220 million a quarter, 350 for the full year, obviously, we are very heavily weighted in the fourth quarter. We purchased a lot. We intend to stay at a healthy pace right now as well, I would say that in the first half of this year, 2016.

Well, I guess my question is, that I mean, you did 39 million in the first I think and 25 in the second and 67 in the third and then you did 220 million in the fourth. And so do I model 50 million per quarter or do I model 200 million per quarter. I mean if you were me, what would you do?

I think at this point it may be more linear at this point to model, okay.

I guess, I'm not sure what that means.

Well, like 50:50 number you gave out, I would say at this point.

Okay, cool. Perfect. Thank you very much gentlemen.

Appreciate it, Brett.

Your next question comes from Joe Spak with RBC Capital Markets. Your line is open.

Hi. Good morning, everyone. Thanks for some of the -- first for going over the guidance again and also, I think adding a touch more color on some of the regions and some of the different puts and takes you see. If we sum it all up, though, and I think you even said you are sort of close to IHS, I just want to make sure the right way to think about the sales growth for this year is that an industry volume level it looks like you are probably looking for 1.5% to maybe 2% volume growth which may be offset, you know, the annual price downs. So if we look at the midpoint of your organic growth guidance, that is still about 4% which is -- if we look at it another way basically what you think you guys are adding in terms of content to the city? Is that a fair assumption?

Yes. This is James, Joe. That's a really good summary. I think markets are close enough to offset each other, which implies about 4% of organic growth. That is a good summary.

Okay. And then, so, it was in the range it's mostly volume or sort of timing of some of the programs come on that are going to take us from the high-end to the low-end?

Yes. Let me, maybe, if I can try to give it -- on this way. What's driving that organic growth obviously is the net new business. I think just to add a little bit of color to it, it's stronger obviously in China and Asia particularly. We are seeing some good launch activity in North America maybe a couple of good key program launches in Europe. So that's what's driving the growth. I think as we outlined in Detroit, Joe, as we built this up, we have been fairly prudent around the volume and the cadence of those launches to make sure that it's more pragmatic and we embedded in that number, we asserted some macro pressure as well which we again talked about in Detroit. So, it's has it was in Detroit, if that helps you, Joe?

Yes. Okay. That is helpful. I guess just -- sorry, if I missed this one, but the -- just the incremental flow through volume on power train in the quarter, well over 100% -- maybe -- sorry if I missed what drove that? If you can just review that? But then also, can you just remind us how we should think about the cadence of some of the European restructuring that you have done, how that should flow through this year? I believe you should be sort of at the right run rate in the back half? Is that the right way to think about it?

Right, Joe. Two questions. First to talk about the Drivetrain incremental margin of 156%. In my script, I pointed out that in Q4 of 2014, if you go back to transcript you will see $5 million to $6 million headwind. And you would have saw that actually sales erupt and incremental margins down a year ago. That's behind us. So what you're getting, are you're getting $6 million of flow through that we didn't have a headwind on in the fourth quarter of this year versus last year.

Okay.

So that $12 million, half of it is in one area right there. Then as we go forward into 2016, if you recall, if you go back in our notes, Q1 of 2015 was about a $9 million headwind -- $3 million headwind. And then we had another headwind in the second quarter as well. So, obviously, we're going to have those headwinds behind us in the first half of the year and we'll get tailwinds there -- they have strong incrementals and then we level off like you said in the back half of the year to more normalized margins. Hopefully that helps.

Sorry, but those headwinds you faced last year were for some of the costs associated with moving equipment and some other restructuring. I guess what about the benefits from the actions you've taken like when do those start coming in like aside from the non-repeats of the costs you incurred?

Well, right now they are starting to coming in. Remember, I also said --

Okay.

-- that we were running at 9% margins. We are up in the 12s, right? So we have been getting benefit quite frankly over time then this volume comes into play. So we are seeing the benefits now and then we are also seeing the inefficiency headwinds going away, so it's a combination of both that's uplifting those margins to the -- in this 12 range right now.

Okay, great. Thanks very helpful.

You're welcome.

Your next question comes from John Murphy with Bank of America/Merrill Lynch. Your line is open.

Good morning, guys.

Good morning.

Just a first question and I don't necessarily you won't agree that we are facing down the barrel of the abyss in the cycle here but clearly the market is indicating some extreme concern of a downturn hitting very soon. So, if we were to think about a downturn of 5% in volume and then maybe 10% in volume, could you just sort of run through how would you think about reacting from an operating standpoint as well as maybe capital allocations standpoint?

Yes. I can -- let me John take a short at the operating side. First of file, so the good news for us as we look around the world of the company and I compare it to some of the last, our temporary employees are in much healthier state. And depending on the region, John 10% to 20% of our workforce is temporary and that allows this opportunity to react pretty quickly flex on the labor side. Europe we -- I think we have more progressive agreements in place we had before. So, I feel comfortable on the labor side that we can adjust. And I think the other area that we got pretty proficient in this, if we need to flex on discretionary spend, we, how to do that from prior cycle. So that probably the two dials that you would move pretty quickly all leading to target and detrimental sales at around the 20% rate is where we look to manage the business to. But I would just add anecdotally John, for each other operations around the world have those plans in place kind of on the shelf in a lot of detail by region and by plant. So, bottom-line I feel pretty comfortable, if there is pressures we will be ready.

I understand capital allocation depending on the cash flows, we will have to reassess what we do with capital allocation, 5%, 10% might have some impact I think, we would have to watch, John. But I don't know 10% will become more stressful, I guess, 5% probably wouldn't.

Okay. And then just a second question, I mean Ford announced this morning that they are launching four new SUV's in the North American market and actually maybe beyond that. FCA is talking about adding truck capacity or changing over car capacity to truck capacity. So it just seems like the whole world is moving towards these cross-over in trucks. That should be good for your content. Can you talk about what you are seeing in the market and what kind of potential you have both in engine and Drivetrain as we see the shift going forward?

I think your thought is right, John. For us and I'm talking obviously, just North America at the moment. The truck to car mix generally speaking the truck mix is slightly favorable for us. I think it's pretty well known we have, you know -- it varies a little by customer. So we are well contented clearly on the Ford platforms and F1 50 platform in particular. FCA were well positioned, GM would have a little less well positioned but we are taking steps to address that. And I would say to you it's pretty well-balanced both on Engine content and Drivetrain content. On the Drivetrain side we are well positioned on the transmission content, but clearly the transfer capability that we have there is strong. And on the Engine side, I would say one of the big shifts has been more turbocharged engines for those vehicles which we benefited from, which is a bit positive for us and on Engine timing also were picking up good content. So net-net it's a positive tailwind for us.

And on margins, any color there on the delta between the car and cross-over and truck?

Not really much of a difference there for us, John. It's pretty consistent cars to trucks and region to region actually which we've set fairly consistently so it doesn't change that much for us.

Okay, great. Thank you very much.

Thank you.

Your next question comes from Brian Johnson with Barclays. Your line is open.

Good morning. Yes, I wanted to talk a little bit about the transmission business. The short-term question like a mid-term question, the short-term question is, what's behind the lower transmission component in Europe. You talked about maybe some programs being phased out, there are replacement programs coming later in the year. Are there any trends we need to think about in terms of AMT versus traditional, planetary versus CBT going on?

There is a couple of moving pieces on that transmission Europe aspect. One aspect is, one of our German customers did inventory shifts in Q4 and we saw a little bit of that in Q1 on transmission related products. And you have seen that's been in the news publicly so you probably know that. That was an element of it. The other element of it was European transmission programs that are phasing out for us. The replacement programs, I would say net neutral to negative for BorgWarner. It's hard for me to speak to the exact detail because of the customer. Importantly these were planned, this is all part of our net new business assumption. It was all expected for us, so it's not a surprise. It's nothing knew. And I would say a high level brain it's a signal of a significant shift in transmission architecture. This is not people making massive moves between stepped automatics to DCT or automated manual. I think it's more specific program by program for a couple of customers.

And then, second question which you kind of touched on but maybe just kind of pull the pieces together, X Remy a fairly incremental margin which means pricing or restructuring or some benefit. Can you kind of elaborate on the margin improvement ex-Remy and the Drivetrain and the cadence of that as we think about the rest of the year.

Okay, Brian, so, the incremental margin for the quarter 24% was primarily driven by the Drivetrain segment being up 156%.

Yes, that's 156 in Drivetrain.

So the Drivetrain really drove the full company, right? Although we had 14%, 15% in engine. I would say that there is about $6 million or $5 million last year of headwinds that we didn't see. So, of that $12 million increase in operating income, half of it alone was just not having those inefficiencies in our face quite frankly. The other half I would just say is that the business is improving. There is a whole point of the restructuring. As we go forward, remember, we had -- Q1 and Q2 of last year we still have these headwinds coming. It wasn't until 3 and 4 that the headwinds dissipated and the incremental margins started returning. So the first half of 2016 should have good tailwinds because we don't have those inefficiencies in front of us any more and then they will level off in the second half to more normal incremental margins.

Yes. Then finally within Drivetrain is there a way to think about the Remy contribution in terms of an engine -- the Remy contribution in terms of traditional Remy products versus new growth in terms of getting them into new areas or kind of showing efforts together and how that is begun to shape up since you closed the deal?

Yes. Let me talk to that a little bit, Brian. I think what we have alluded to so far, we feel comfortable, as we look out into the next couple of years that Remy is going to deliver good mid-single digit type growth for us. As you can imagine, that's primarily driven off the existing portfolio products into new channels. So what I mean by that is, this two primary channels of growth for us with the current portfolio. One is customers. They have a relatively narrow band of customers. With BorgWarner's breadth of coverage on customers that's going to drive content with their existing products. The second growth driver for us is a regional play where they have a strong position in North America, they are well positioned in China but quite weak in Europe. So that's going to be a series of opportunities for us to sell current portfolio of products. And that will drive the content growth over the next two or three years. Then to your point in parallel to that, there is a lot of discussions that we are having with customers around combination products of the Remy architecture and BorgWarner architecture. I'd say there is a number of areas and we can talk more about this offline. But the most prevalent area of discussion right now is the notion of a P2 hybrid architecture, so combining clutching know-how together with the motor know-how and we got a lot of interest in that. That's likely to be a revenue stream that's probably four to five years out but it's very active and driving it. So hopefully that gives you a sense of both the shorter term growth levers then the longer term growth levers.

Thank you.

Your next question comes from Rod Lache with Deutsche Bank. Your line is open.

Hi, everybody. A couple of housekeeping things first. Just I apologize for asking this again, but in the Drivetrain business, can you clarify what the combined benefit is of the non-recurrence of the headwinds plus the restructuring savings that you expect for 2016?

If you go back to our guidance full year, I think it was on slide deck -- that we gave at Deutsche Bank, Rod, remember? There is a slide in there that shows that we have about $10 million to $20 million tailwind for the full year -- that was a headwind in 2015, okay? So, it's $10 million to $20 million as a full year. It's in that deck. And that's what drives the 18% to 20% incremental margins for the company for the full year. Normally it's mid-teens. But the tailwinds are driving it around to the 20% range.

Right. That part I saw. That's the non-recurrence of the headwind. I just -- there is an additional part that you were asked about earlier on the savings from some of the restructuring actions you have taken.

Sure. If you go back in time -- this goes way back in time. We said that the benefits were going to generate about $30 million of operating income benefits going forward. What's really happened over time, was we probably incrementing and getting some of that as we go forward and the margins have lifted up over time from 9% to 12%. So we have been getting a little bit of these benefits as we go forward because the labor cost are lower for example so and so forth. So we have been getting some of these benefits. But it's over 3 almost -- three years now, right? So, that math looks a little bit more difficult. But basically its absolute rise in the margins as well that we are getting.

Okay. So, a lot of it is -- we are seeing it in the numbers on that part of things?

Yes.

And can you remind us what your R&D assumption is for 2016?

It's still -- well, all right, so, it's 4% but I will be honest right now with the Remy coming on board, it might be 10 basis points lower. I'm splitting hairs right now.

Okay. Got it.

But I've got it 4%, all right?

Okay. And then, just lastly on the organic growth, is it correct in, you know, if we are looking at 2.5% to 5.5% that's basically all engine this year because the transmission programs that are phasing out? And when we look at the organic growth over the course of the year, it's starting off obviously below the full year forecast. So, what kicks in over the course of the year that causes the acceleration?

Rod, this is James. It's absolutely both Drivetrain and Engine. So we are delivering growth on both segments. Those two phase-out programs I talked about are relatively small actually. They are in there. Just to give you a sense, to put a bit more color there to help you, it's -- we drive upwards through the year. So, our launch activities are a little backend loaded which is not unusual for us. But it's across both Engine and Drivetrain. So, we are launching for example DCT uplift in China. We're launching Solenoid activities in China. We've got all real drive launches with another Chinese OEM that's Asia. If I talk about North America, we got a super duty launch. So it's a real mixture, Rod, I wouldn't want you to think its only engine. It's certainly both. And I would say it's weighted to China and North America which is consistent with the net new business announcement.

Okay. Great. Thank you.

Thanks, Rod.

Thank you, Rod.

Your next question comes from Patrick Archambault with Goldman Sachs. Your line is open.

Yes. Hi, good morning. A couple from me. Just on Wahler, if I have this right, I think you had extended the timeframe to become -- for margins there to converge with the corporate average I think over three years. And this is, I believe probably the last year, right? And, so, how much of a tailwind is that in the walk that you presented for your guidance, was it included in that 18% to 20%? Because I didn't really see it broken out and conceivably that would be yet another area that would be over earning from an incremental perspective relative to other things.

Sure. So, the guidance that we've issued implied about $8 million nominal value of extra operating income related to Wahler. The other thing I want to clarify is, when we purchased Wahler, we said two to three years. And we also said after we got into the business it was going to be more like three years, not two years. And that would still take us into 2017. It's where the run rate would be where we are happy where the business should be.

Got it. And that $8 million is -- is that sort of incremental -- I mean, is that just the contribution -- how do we think about it, is that kind of the margin contribution piece of it I guess?

Yes, the margin improvement, correct.

Got it. Okay. And then the other question I had is, I think James in your comments earlier, you had spoken to not really seeing any changes on the regulatory front and there does seem to be an initiative by some OEMs to try and change the cafe standards right at the mid-cycle review which I think is happening this year. It's not to say that that may not have as much of an impact on internal combustion engines as it will on perhaps EVs but you just -- wanted to get your opinion. Is that sort of incorrect or do you have a view that that initiative is not going to be successful? I mean just a little bit more perspective would be helpful.

I would be happy to do that. And let me give you some commentary. Our view is that there will be the mid-cycle review obviously that's all planned. Our view based on the multiple different inputs we get is -- we are not anticipating significant adjustments or change to the plan. There is going to be sure robust discussion. That's obviously even more robust with gas at less than two bucks a gallon. So I think there will be discussion. But I think significantly or changes I don't think are going to happen is our view of the world. So we think it's going to continue on as planned frankly speaking. What we do see, which I alluded to in part of my comments, Pat is, there is absolutely a push for a spectrum and alternative types of power trains. So, we are not seeing people at all step away from advanced IC engines. That's absolutely front and center. There is a tremendous amount of activity and launches around advance gas engines. Yet we see a strong push for the pure electrics which we are right in the middle off and high breads as well in the many different configurations of hybrids. So I think there is a general March towards execution of the standard maybe with a few tweaks and each of the OEMs getting a suite or spectrum of architectures that they can get to deliver on those numbers and we are right in the middle of all of those architectures in discussions with them. So that's our view of how we see it right now, Pat.

I mean it sounds like it's more based on what you are hearing from your customers rather than an opinion on sort of regulators?

Yes. I would say it this way, Pat. Clearly we are engaged very deeply with all of our customers. That's a real strength source. But we talk to regulators, we talk to different business groups, different industry groups. So we are taking a large variety of inputs, it's not just our own narrow self view, if that makes sense to you, but it clearly is driven off a lot of what the customers are doing. Because they are the ones that are working with us on what the architectures need to look like.

Got it. Okay. Thanks for the color guys.

Thanks Pat.

Thanks.

Your next question comes from Ryan Brinkman with JPMorgan. Your line is open.

Hi. Good morning. A couple of questions on backlog, first on China. Now for the tougher backlog developments in China in 2015 which included delay of some vehicles, lower sales in production of others. I'm curious if the stronger trend of sales and production in China in 4Q and So far in 1Q might be possibly impacting your backlog in anyway. Are you seeing any signs that earlier delayed vehicles might be coming back on the schedule or vehicles from which you've trimmed yourself in production expectations or maybe selling faster being produced in higher quantity?

I would say, I will give you this sense that Q4 is a good quarter for us in China. We had about 20% growth in the quarter in China very strong and as I alluded to earlier, part of that was some of the incentives. And we are seeing that strength roll into Q1. So, it's still early in the year. We feel comfortable in the net new business announcement. We feel comfortable with our guidance around growth. I'd say if anything I feel incrementally a little more positive about China than I did a few weeks ago. How much of that is going to translate into real revenue by quarter and by backlog, we will see how that plays out. But I would say I'm feeling more comfortable around China after a strong Q4 and the incentives flowing into Q1. And you know, Ryan, a large part of our backlog is China related. So I think it's a net help for us right now.

Okay, great. Think this is the last question on backlog relative to Remy, on the revenue synergy which you talked about earlier, given your comment that you are making progress there but haven't quantified the opportunity, is it fair to say then there are not any such sales synergies included in the backlog through 2018? And then what is the timeline for realizing such synergies if they occur. Is there a chance it could positively impact the backlog within the present window or would the benefits more likely accrue beyond 2018?

Okay. So in the net new business we delivered a couple of weeks ago, we didn't have those -- those synergies were not in, Ryan. And the reason just to be transparent with that, we only owned the company a few weeks. It was premature. I think give us a little bit of time is what I would say is, as we walk through that this year. But if I was thinking out loud, I would say, as we get our arms around that, I think the contribution to the net business as we go forward will be stronger from Remy than it was in this one. And again, you got to hopefully give us a little of time to flush that detail through and go after meetings with the customers et cetera. But I think we will see a step up in contribution from Remy in terms of growth when we do the next new business. When that will play in and how much, Ryan, we need a little time there, but I will tell you direction, I feel very positive about it.

Okay. That's great color. Thanks a lot.

Thank you.

We have time for one final question and that question comes from David Leiker With Robert W. Baird & Company. Your line is open.

Hi, guys. This is Adam Schmitz on the line for David.

Hi, Adam.

Just first on the Remy cost synergies, can you outline some of the low hanging fruit that you expect to occur in 2016 and now that you had the business in house for a few months what are the longer term opportunities for cost synergies?

So when we made announcements about a year ago, we identified corporate governs cost is a really easy one to grab. Obviously, they don't have a Board of Directors any more and the executive group is gone. That was one. Another was cost synergies on our purchasing side. That's the one that will take more long-term, I would say. Over time, we'll get those benefits. But those are the two main ones we pointed out at the time. Then there was another one, just basic redundancy, I would call active corporate, not the corporate officers but corporate staff itself, some redundancy cost there. We said that we need to get about $15 million full year run rate which in 2016 we would see about half of that.

Okay. And then last one from me, James, as you alluded to the company saw a kind of number of market headwinds in 2015 outside of just China, off highway, Brazil among others. Can you just talk about some of the biggest headwinds you saw in 2015 and kind of where you see those affecting the company in 2016?

Yes, the -- you covered the two big ones which was the China was a lower absolute growth market for China and everybody. That was weighted because of our launch activity and commercial vehicle was the other significant headwind we faced. In commercial vehicle, and I would say that was globally. But Brazil to your point was probably the worst. As we come into this, our assumptions are based off 3% to5% light vehicle production growth in China. No growth in commercial vehicle globally. Those are our two macro assumptions and that's how we are going into the year and that's how we built our guidance. So --

All right. Thanks, guys.

Thank you.

Thank you.

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

That does conclude the BorgWarner 2015 fourth quarter and full year end results conference call. You may now disconnect.