Patrick Nolan - BorgWarner, Inc. James R. Verrier - BorgWarner, Inc. Ronald T. Hundzinski - BorgWarner, Inc..

Joseph Spak - RBC Capital Markets LLC Rod Lache - Deutsche Bank Securities, Inc. David Leiker - Robert W. Baird & Co., Inc. Brett D. Hoselton - KeyBanc Capital Markets, Inc. John Murphy - Bank of America Merrill Lynch Colin Langan - UBS Securities LLC Elad Hillman - JPMorgan Securities LLC Brian A. Johnson - Barclays Capital, Inc.

Chris McNally - Evercore ISI David L. Kelley - Jefferies LLC Richard M. Kwas - Wells Fargo Securities LLC Matthew Stover - Susquehanna Financial Group LLLP Emmanuel Rosner - Guggenheim Securities.

Good morning. My name is Sharon and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2017 Second Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period.

I would now like to turn the call over to Patrick Nolan, Vice President of Investor Relations. Mr. Nolan, you may begin your conference..

Thank you, Sharon. Good morning, everyone, and thank you for joining us. We issued our earnings release at 6:30 AM Eastern Time. It's posted on our website, borgwarner.com, on our homepage and on our Investor Relations homepage. The replay of today's call will be available through August 10th.

The dial-in number for that call is 855-859-2056, and the conference ID is 49070364, or you can listen to the replay on our website. With regard to our Investor Relations calendar, we'll be attending several conferences between now and our next earnings release. Please see the Events section of our Investor Relations homepage for a full list.

I did, however, want to highlight of our upcoming Investor Day on August 7th. This will take place at the New York Stock Exchange and will feature presentations by James Verrier, our President and CEO; Ron Hundzinski, our Executive Vice President and CFO; as well as Christopher Thomas, our Chief Technology Officer.

The registration deadline is the close of business tomorrow, so please contact me for registration details if you'd like to attend. Before we begin today's call, 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. Also during today's presentation, we will highlight certain non-GAAP measures in order to provide a clear picture of how the core business performed as well as provide comparison with prior periods.

When you hear say on a comparable basis, that means excluding the impact of FX, net M&A and other non-comparable items. When you hear say on a reported basis, that means U.S. GAAP. Now, on to today's call.

First, James Verrier, our President and CEO, will comment on the industry, provide a high-level overview of our Q2 results as well as discuss some of our recent product wins. Then Ron Hundzinski, our CFO, will discuss the details of our results as well as our guidance.

Please note that we posted an earnings call presentation to the IR page of our website. You'll find the link in the Events and Presentations section beneath the notice for this call. We encourage you to follow on during our discussion. With that, I'll turn it over to James..

Thank you, Patrick, and good day to everybody. Thanks for joining the call. Ron and I are obviously very pleased today to be able to share our results from Q2 2017, and we'll obviously update you on our progress towards delivering our targets for 2017. I'd like to start, if I can, by sharing a few thoughts on the macro environment in the industry.

For those of you following along on the slideshow, this will be slide number 7. So what we've seen really is, we do still recognize some instability in many aspects from a macro perspective. But I would say, in general, the outlook for the auto industry is, I would say, in line or modestly weaker than our expectations going into the quarter.

So let me break that down a little bit. Global light vehicle production flattish in Q2 with production down about 1.5% for our adjusted geographic exposure. We saw European light vehicle production declining approximately 4%, which actually was slightly better than our expectations as we headed into the quarter.

China light vehicle production was down about 1%, slightly weaker than our expectations going into the quarter. And North America light vehicle industry production declined about 3% against slightly weaker than our expectations going into the quarter.

If I give a little bit of an outlook for the market as we see the rest of this year playing out, as usual, we are closely aligned with IHS. So we see light vehicle production in China at about 1% growth, we see Europe up around 2%, and we see North American production down a little over 2%.

If you weigh that for that global production for our geographic exposure, that means growth of less than 1% for us. A word on commercial vehicle. We see the outlook for Europe and China continuing to improve. I would say that we have seen expectations for North America growth moderate a little.

Just to share a few thoughts on what we're probably paying a lot of attention to. I would say, obviously where we are in the North American cycle is pretty clear in our minds. We do see schedules have weakened a little bit, although I would describe it as pretty modestly, and we continued to watch and monitor inventory levels.

Clearly for us diesel/gas mix is important in Europe, and we continue to see that shift occurring during Q2. So what we see is, diesel share declined approximately 390 bps year-over-year in Q2, and we expect diesel/gas mix to continue through the end of the decade shifting.

The good news out from a BorgWarner perspective is, we continue to offset that headwind. China, we still look forward to modest growth in the year 2017. But more importantly, from a BorgWarner perspective, that growth above that market continues to be very strong, driven by increase in share and content per vehicle.

So all of this said, if you wrap it altogether, we remain very confident in our outgrowth of the market in 2017 based on the strong demand for our products. Let me spend a moment on regulatory and technology outlook. The strong drive for fuel economy and emissions regulations does not slowdown at all.

We continue to see a pretty hard pace of movement there, and it's all around advanced propulsion technology. We see activity increasing particularly in gas engine technology, hybrid technology and EV technology and, rest assured, we're very busy in those fields with all of our customers around the world.

And we see the transition to electrification continues. Our Q2 new business bookings continue to show additional awards with a wide variety of customers, regions and propulsion systems.

And rather than dwell on that too much today, what we plan to do is share a lot more of that detail with you at the upcoming Investor Day, that Pat referred to, on August 7th. Let me now move to slide 8 and talk a little bit about a financial recap.

And clearly, Ron will take you through a lot more detail than I will, but let me just start out by talking about our Q2. I was very, very pleased with our Q2 performance. Our growth exceeded the high end of our guidance, and our operating performance was very much in line with our expectations.

$2.4 billion of sales, that's representative of 7.8% organic growth when we exclude FX and Remy. And that compares to our light vehicle and market exposure, down about 1.5%. So, a very, very strong top-line performance.

Regionally, it was pretty much as we had expected from a BorgWarner point of view with strong growth in China, driven primarily by DCT, and we grew very well in North America both through new business and mix. Europe for us was flattish, which is strong performance when you look to the industry production declines.

And this light vehicle growth was supplemented by positive revenue trends in commercial vehicle off-road. That led us to a strong EPS performance of $0.96 when we exclude non-comparable items and an impressive operating margin of 12.5%.

If I look at it a little deeper by segment, the highlight for me was, I was really excited to see the growth across all of our products. So, from an engine perspective, $1.4 billion was our sales, which represents 4.5% organic growth. Some of the highlights, we did see very strong growth in timing systems and thermal products.

And again, despite the changes to the diesel/gas mix shift, we've seen top-line growth in our engine business. Drivetrain sales came in at $921 million, which is up 13.9% organically. This was driven by strong all-wheel drive, DCT and transmission sales in North America, China, and Europe.

Let me move forward and talk a little bit about the outlook for 2017. I'm pleased to say we're increasing our revenue and our earnings forecast for 2017. We now expect our organic growth to be between 6.5% to 7.5% year-over-year versus our prior guidance of 3.5% to 6%. Again, this compares to the market growing less than 1%.

Our consolidated operating income margin is expected to expand 30 basis points to 40 basis points, and our EPS guidance range is now at $3.65 per diluted share to $3.70 per diluted share, which is up from $3.50 per diluted share to $3.60 per diluted share previously.

If we can turn to slide 9 for those of you who following along, I'll just highlight a couple of key growth areas. I just thought it would be worthwhile spending a moment to focus on two of the product announcements that we've got there.

The dual-clutch and control modules for Great Wall Motors is a really important one for us, and this business is now ramping nicely. I had the pleasure to be in China just a couple of weeks ago to see this in action, and I was really impressed to see the move forward on DCT in China.

The 48-volt eBooster, critical technology launch for us with Daimler on their 3.0-liter gasoline engine, and this is a very important technology for hybrid vehicles. And one of the things that's important about this, it's a great example of BorgWarner at its best.

So we've got our leading-edge turbocharger technology for integrating our power electronics knowhow, so we can offer Daimler a real true systems solution. These are just two examples. I could go on and on, and we won't. Again, we'll share more with you at Investor Day. But the message really for us is, our balanced approach is working.

We continue to see very good win rates across all types of propulsion systems, combustion, hybrid and electric. On slide 10, let me just recap or share a few highlights on our recent announcement on the acquisition of Sevcon. This is a really important move for us. Sevcon is a global player in electrification technologies, including power electronics.

And I really believe this acquisition supports our existing strategy to supply leading technology for all types of propulsion systems; combustion, hybrid and electric.

And we consider the power electronics design and development knowhow to be a core expertise, and we believe that Sevcon complements BorgWarner's existing or power electronics capabilities.

Also very importantly for us, we believe the acceleration of our power electronics capabilities strengthens our position to satisfy the customers by providing more electrified systems that they are sourcing both near- and long-term. So more to come on this at a later date. We do expect the enterprise value at about $200 million.

And we anticipate closing this in Q4. More to come on that later. So before I hand over to Ron, let me just kind of summarize from my perspective. Q2 is a very good quarter for us. We exceeded our expectations for both top-line growth, and operating performance is in line with our expectation.

And given our strong first half performance, we feel comfortable about increasing our revenue and EPS guidance for the year despite a modestly weaker industry production outlook.

We absolutely believe that the company is positioned to deliver mid-to-high single digit growth over the long-term, and I look forward to meeting with many of you in – August 7 in New York, where we can share more details with you. And with that, let me turn the call over to Ron..

Thank you, James, and good morning, everyone. Before I review the financial details, I would like to provide you some of the highlights as I've seen for the quarter. First, it was another strong quarter, actually it was a great quarter. Second, operating performance was as we expected.

And finally, given the strong first half of the year performance, we are confident in raising our full year guidance. Now as Pat mentioned, I will be referring to the supplemental financial slide deck, which is posted on our IR website. I do encourage you to follow along. Let's turn to slide 12. On a reported basis, sales were up 2.6%.

On a comparable basis, our organic sales was up 7.8%. This was approximately 130 basis points ahead of the high-end of our guidance. Our weighted average light vehicle industry production was down more than 1%. So we saw also a 25% growth in China, against a production market that was down about 1%.

Commercial vehicle was of benefit as well, contributing more than 100 basis points. The primary headwinds versus our expectations were diesel/gas mix in Western Europe and market share loss by our largest Korean customer in China and North America markets.

Before I move to the operating profit, I would like to discuss our gross profit and SG&A line items. Gross profit as a percentage of sales was 21.5% in the quarter, up 20 basis points from a year ago. SG&A was 9% of sales. R&D spending, which is included in SG&A, was 4.4% of sales.

SG&A was up 30 basis points from a year ago, primarily driven by R&D and the timing of stock-based compensation. Now let's look at the year-over-year comparison for operating income, which can be found on slide 13.

Q2 operating profit was $300 million or 12.5% of sales compared to $287 million in Q2 of 2016, which was 12.3% of sales, resulting in a 20 basis point improvement. On an organic basis, operating income was up $18 million on $176 million of higher sales. That give us an incremental margin of 10% in the quarter and in line with our expectations.

As you look further down the income statement, equity and affiliate earnings was about $14 million in the quarter, up $4 million from last year. Interest expense and finance charges were $18 million in the quarter, down about $3 million from last year due to lower debt levels.

Excluding the $10 million one-time favorable tax adjustment, the provision for income taxes was $86 million for an effective tax rate of 29% for the quarter. Net earnings attributable to non-controlling interest was about $9 million, down $2 million from the second quarter of 2016.

This line item reflects our minority partner share in the earnings and performance of our Korean and Chinese consolidated joint ventures. Earnings per share on a reported basis was $1 per diluted share. On a comparable basis, net earnings were $0.96 per diluted share.

Now let's take a closer look at our operating segments in the quarter beginning on slide 14. Reported Engine segment net sales were $1.482 billion in the quarter. Sales growth for the Engine segment on a comparable basis was 4.5% as demand for our light vehicle OEM products was supplemented, again, by growth in our commercial vehicle business.

Adjusted EBIT was $244 million for the Engine segment or 16.5% of sales. On a comparable basis, the Engine segment's adjusted EBIT was up $12 million on $65 million of sales for an incremental margin of 18%. Turning to slide 15 and starting from the right. Drivetrain segment net sales were $921 million in the quarter.

This includes the reduction of $77 million of sales from the divestiture of the Remy light vehicle aftermarket. Sales growth for Drivetrain segment on a comparable basis was up 13.8%, primarily due to higher all-wheel drive transmission components and strong DCT growth in China.

Adjusted EBIT was $110 million for the Drivetrain segment or 11.9% of sales. On a comparable basis, the Drivetrain segment's adjusted EBIT was up $16 million on $133 million of higher sales for an incremental margin of 14%. I'd like to take a moment to discuss incremental margins a bit more.

Our total company incremental margin for Q2 was 10%, which is below our long-term goal of mid-teens, but was slightly improved from our quarter one performance. In order to better understand this, there are a few items we should highlight. First, segment incremental margins. The Engine segment incremental margins were 18%, which is good performance.

We were particularly happy with the performance here as we continue to have operational issues in our emissions business. Our Drivetrain segment incremental margins were 14%, which was up from 13% in Q1 and 11% in Q4, strong performance as we continue to ramp launching programs in this business. As a result, the segment incremental margins were 15%.

So, corporate costs were basically flat sequentially and are expected to moderate in the third and fourth quarters, but was up about $9 million year-over-year. The drivers of this increase continue to be the timing of additional stock-based compensation cost and various advisory fees for tax and legal planning.

These items unfavorably impacted incremental margins by approximately 500 basis points in the quarter. Now, let's take a look at our balance sheet and cash flow. We generated $399 million of net cash from operating activities in the first half of the year, up $37 million from the first half of 2016.

Capital spending was $254 million year-to-date, up $20 million from a year ago. Free cash flow, which we define as net cash from operating activities less net capital spending, was $145 million, up $17 million from 2016. Looking at the balance sheet itself, balance sheet debt was flat and cash decreased by $57 million compared with the end of 2016.

The $57 million increase in net debt was primarily due to return of capital activities. Our net debt to net capital ratio was 33.2% at the end of Q2, down slightly from 35% at the end of 2016. Net debt to EBITDA at the end of the quarter was 1.16 times. Now, let's discuss our 2017 guidance, which we have increased.

So let's start with our sales growth guidance for the full year on slide 17. Backlog, pricing and market-related growth are expected to drive 6.5% to 7.5% organic sales growth. Currency is expected to reduce sales by $100 million. The first half backlog was very strong, and this amount is flowing through in our increased guidance.

So, I'd like to note a few items which are impacting our second half organic growth relative to our first half as I suspect many of you will ask questions on this. So, first, North America mix changes from the key North American programs, some of which are changeover-related or having modernization issues on us in the second half.

Diesel production relative to sales are also having an impact to us in the second half. Continued volume reduction from our largest South Korean customer in China and North America, and North America commercial vehicle modernization from the first half are all the items that we see in the second half of our guide.

Many of these items are timing related when you look at the first half and second half. Overall, 6.5% to 7.5% organic growth for the year is very strong, given the industry backdrop and stronger than our expectations going into the year. Next, I'll walk our operating income on slide 18.

From a performance perspective, we continue to expect mid-teens incremental margins on our sales growth. Included in this are some headwinds from corporate costs, and we continue to expect an inflationary environment and compliance cost. Our consolidated operating income margin is expected to expand by 30 basis points to 40 basis points.

To finish up the full year guidance, please turn to slide 19. EPS range is now $3.65 per diluted share to $3.70 per diluted share. The $0.12 increase is driven by our sales guide increase. Free cash flow, which we define as net cash provided by operating activities less CapEx, is expected to be $450 million to $500 million.

Capital spending, including tooling, is expected to be in the range of $500 million to $550 million, which is up slightly to support several program lists basically that increased earnings and cash flows being offset by the increase in CapEx and cash flow.

Given our announcement of Sevcon, acquisition of our share repurchase program will be about $100 million in 2017. R&D spending as a percentage of sales is expected to be 4% in 2017. The tax rate is expected to be 29%. Our assumption for the dollar to euro exchange rate has been adjusted to $1.10 from $1.05.

As a reminder, every $0.01 change in the dollar-to-euro exchange rate equals about $30 million to $35 million. I'm aware that the exchange rate is about $1.16, but $1.10 is an average rate for the year. Our third quarter guidance is starting on slide 21. First, sales. Note that Remy light vehicle aftermarket sales divested are $68 million.

So, starting at a base of $2.146 billion, net new business, pricing and market-related growth are expected to drive organic sales growth from about 3% to 6%. Currency is expected to reduce sales growth by about $36 million. Therefore, 2017 Q3 sales is expected to be $2.2 billion at the midpoint.

From an EPS perspective, on slide 22, we expect $0.03 to $0.06 per share from backlog, foreign currencies are expected to lower earnings by about $0.02 a share in the quarter. Below the operating income line items are expected to contribute $0.05 per share from lower share count and a lower tax rate.

On a consolidated basis, we expect earnings of $0.84 to $0.87 per share. So, let me summarize the quarter. It was a strong second quarter and the first half for the year as well. Organic sales growth was nearly 8%, despite declining industry volume. Incremental margins improved slightly sequentially and then as we expected.

We anticipate this to improve in the second half of the year. As we look at 2017 and beyond, we continue to drive intensity around new product development and support it with acquisitions to participate in the impending electrification trend. There is no question that this will drive growth for many years.

And with that, I'd like to turn the call back over to Pat..

Thank you, Ron. Sharon, we're ready for questions..

Your first question comes from Joseph Spak with RBC Capital Markets..

Thanks. Good morning, everyone, and congrats on the quarter..

Good morning, Joe..

Good morning, Joe..

I guess, I just wanted to – the one thing which I guess has changed a little bit was margin expansion for the year a little bit less, it looks like there might be – and some of the FX flow through, is that some of the transaction along with the translation impact or is there something else going on there?.

That's correct. What happens with FX even though there is a benefit from our prior guide, we only pull about $0.12 on the dollar, 12% incremental versus operating incremental of mid-teens. So, there tends to be a drag on us on margins going forward from the incremental margins..

Okay. Right. Right. Right. And then, you clearly saw point into the margin expansion for the rest of the year.

It looks like based on your guidance a little bit more fourth quarter than the third quarter, so I was wondering what – is that just mostly volume that's driving that? I mean, and also by segment, maybe you could provide a little bit more color, because I think you've got some tougher incremental margin comps in Engine, but some easier ones in Drivetrain, so I just wanted to get a little more of the picture there?.

Yeah, Joe, a lot of parts moving. So, first of all, your question about the fourth quarter is correct, more margin expansion in the fourth. One item, I keep talking about the corporate cost, we love to have corporate cost. And we may even be lower than the prior year in corporate cost.

So we get the full benefit of the operating segment's contribution margin. So that would be more of an uplift in the absolute margin for us in the fourth quarter..

You're talking about the fourth quarter corporate costs?.

Yeah, yeah. This is mostly....

Of last year. Right. Okay..

Yes, it's most in the fourth quarter. And then also we get a little bit of volume that the DCT plant's really starting to hum along. So once that starts coming along, that might get a little higher incremental for us as well, which is in the Drivetrain segment. So, a combination of few items..

Okay. Thanks a lot..

Thank you, Joe..

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

Good morning, everybody..

Hi, Rod.

How are you?.

A couple of things, just – maybe you could just talk about on the guidance for the year. Noticed that the midpoint of your backlog guidance is $715 million, and you've done about two-thirds of that in the first half. And the backlog is only – the assumption is only $100 million to $150 million in Q3.

Is there some conservatism that you're baking into that number or are you including, for example, I think, a significant amount of the backlog right now that's being driven by China?.

So, Rod, it's Ron. You're right. The original guidance was – I'm going to round numbers a little bit on you. It was $0.5 billion – $500 million, and now the organic guide implies about $715 million, you're right. So, it's about $200 million increase. What we're seeing in the second half? I listed a bunch of items in there.

We're seeing some that wasn't anticipated actually until just recently. One of our largest Korean customers is having a difficult time, especially in the back half of the year in China and North America. We're anticipating that commercial vehicle is going to moderate as well.

We also have a changeover that's in North America in one of our largest customers' platforms that they've announced quite frankly yesterday, that's also going to be a little bit of a headwind for us. So we're seeing a few things in the back half of the year that are headwinds.

But if you really go back to our original guidance, that guidance include about $100 million per quarter, roughly $125 million, of backlog. So, we haven't adjusted that, right, at the end of the day. So, it's still outgrowth and we haven't really adjusted from the original guidance.

I think you got to look at the full year organic growth is how you got to look at it, not the cadence by first half, second half..

I understand, but maybe just to clarify, when you talk about these headwinds from diesel or a crane customer whatever, do you put that into the market growth in bucket or do you put that as a net against your backlog bucket?.

That would net out of – a little bit in market, but we probably net it out of the backlog number..

Yeah..

Okay..

For Korea, there were some launches we anticipated, and was hard to bifurcate between the two buckets. We're just kind of splitting hairs here. So we can get back with you on that, Rod..

Okay. And just secondly, the margin improvement in Drivetrain. As I recall, there were two factors that were a pretty big drag on Drivetrain; one was the DCT plant in China that was ramping, and you also were, I think, shifting some capacity to Eastern Europe.

Are those now behind you, and how should we be thinking about the margin targets for Drivetrain and what kind of timeframe should we be thinking?.

Yeah, Rod, this is James. In terms of your couple of points on the activity around Drivetrain, the transition into Eastern Europe is kind of done and behind us, that's all done up.

And the ramp in China for DCT is, it really starts to move forward a lot more in the second half of this year or certainly in the fourth quarter, and we'll really see more of that benefit even more so as we go into 2018. So I think, they're both largely behind us now, Rod, and we've got forward momentum.

Where that takes the Drivetrain margin for the longer-term? I tend to think of it is, we're just going to continue at the mid-teen incremental type of a rate in Drivetrain, and that will just continue to follow-up, which is we deliver on that volume..

Okay. Thank you..

Thanks, Rod..

Thank you, Rod..

Your next question comes from David Leiker with Baird..

Good morning.

How are you doing?.

Morning, David..

Good, David..

I guess, two things, just on the diesel/gas, open Pandora's box here. Now to the extent that diesel declines and, yeah, you're seeing some – I mean, we talk to people, I'm sure you talk to people, who say, vehicles are going to banned, what's going to happen.

The reality though is, this gas/diesel shift can't happen quickly, because the capacity is not there, is it, to replace diesel engines with gas engines in the next two years?.

So, yeah, let me give a bit of color on that, David. Obviously what we've seen this year is that acceleration obviously has continued. It was 400 – close to 400 bps in the quarter. And we do see that shift moving on. There is some kind of – to your point, some natural limit of timing of how this plays out.

We can't just convert everything over from diesel to gas. There are capacity constraints, et cetera, et cetera. I think, the bigger important issue is so as they shift from diesel to gas, what are they doing? And they're using that....

Right..

...in many cases as an opportunity to put – to accelerate some of the advanced gasoline engine program timing. They're looking to pull forward some of the hybrid program timing, and that's a benefit to BorgWarner, because we're going to be content additive on those products versus diesel. So that's what we're seeing play out.

In the short run, it's a little bit of noise, and you see we've more than overcome that again in the second quarter. And on a go-forward basis, it's certainly neutral to positive for BorgWarner..

Do your customers in their Engine plants have the ability to switch over? Let's say there's an Engine plant that's got four diesel lines? Can they shift one line at a time? Or do they have to do the whole plant at a time? How does this – strategically how does that play out?.

Yes. I think probably each one is somewhat different to be open, David, but I think obviously the first call is utilization of existing gas capacity. And they have to get that filled up and utilize that. And then, it just gets into the detail of what individual customer has in terms of capacity utilization.

But to go invest in a brand-new engine gasoline line obviously is a pretty hefty lead time on that type of move, which is I think what you're inferring. So that the play right now is leverage and utilize fully the gas capacity. And then beyond that, obviously that's a longer – a little bit of a longer lead time for them..

And the, the last item here is, if you look at – as your customers do – that they're probably going to take down the lower efficiency diesel and shift them over to higher efficiency gas.

And as they do that transition to a fully-loaded downsize turbocharged DDI, EGR engine, how does your content differ between those two?.

Yeah..

Not just current Engine business, but what they would replace it with?.

Yeah. A couple of thoughts, Dave, just – I think, you're right, to clarify. So where the acceleration is obviously on the diesel decline is in the smaller engines. In terms of the bigger engines, two-liter and above, we've not seeing such a dramatic shift.

But clearly, you're right, what they're doing with those smaller engines – what they're going to look to do is to make those advanced as possible. So that's more variable about timing, that's putting gasoline EGR technology on those vehicles, more advanced turbos.

That's going to be net positive for BorgWarner, because we're going to put more content on those than smaller diesels that we have today..

Okay, great. Thanks for your time..

Thanks, David..

Thanks, David..

Your next question comes from Brett Hoselton with KeyBanc..

Good morning..

Good morning..

Hey, Brett..

You talked about the organic revenue growth and kind of the cadence through 2017.

I'm wondering how do we think – if we're exiting 2017 maybe at a little slower pace, how do we think about 2018?.

Yeah. The way I would think about it, Brett – and again, we'll talk a little more about this in New York in a couple of weeks. But as you can see even in the first two quarters, there's a little bit of a spread there, right, in terms of our organic growth. And then, that's also a little different in the backup.

What I would suggest you do is think of it as the full year of 2017 is a good basis way to think of it, because there is some little bit of volatility and noise through the quarters.

So if you just take the 7% organic growth, which is the midpoint of our new guide, on a full year basis, that's how I would be thinking of it in terms of a launch into 2018 and beyond..

I'd like to add something, James. And then the reason, Brett, is unlike last year where our backlog was concentrated on maybe four, five heavy launches. This year it's more dispersed. It's a wider width of launches that are going on. And that breadth is – it's hard to predict by the cadence exactly through the quarter, and it was more front-end loaded.

So the two years are different years in backlogs. But James is right, I think you got to look at the full year as you go into 2018, what we did for 2017..

And as far as incremental margins into 2018, is there anything that you think of that may be a significant tailwind or headwind, FX, that sort of thing?.

One area is the emissions business. It's been a continue issue for us, it's not performing well. And we're going to have to fix that. That's one that comes very quick to mind is that business..

But I would – Brett, I wouldn't be thinking much different to admit. We don't see anything coming off our mid-teen incremental margin approach at all as we go into 2018..

Yeah. You're right there..

Thank you, gentlemen..

Thank you..

Thanks, Brett..

Your next question comes from John Murphy with Bank of America..

Good morning, guys..

Hi, John..

Just a quick question. I mean, obviously the schedules in the quarter maybe deteriorated a little bit, I mean, and there's lot of concern about what's going to happen with the cycle in the U.S. and potential risk in China.

As you react to these changes, just curious if you can remind us what sort of leverage you have to pull through to really react? But also, very importantly, as we're seeing mix shift away from cars and towards crossovers, what kind of benefit is that highlighting to you? Because it seems like you maybe disconnecting more from these aggregate schedules than you have been in the past few years, and this mix might be a huge benefit, all up sort of that 25% growth in China against the negative 1% market, it seems like you're really disconnecting?.

John, if you think – the two markets you're referring to China and North America, very candidly what it means for us right now, if we see moderations in shift and schedule, we just slow our growth a little. And that's kind of an important thing for us. It's not like we're going into reduction modes. So we've been running mid-teen growth in China.

So if there's a little bit of a softening there, you can run 10%-ish type growth, and we've been outperforming in North America too. So, it's not that we're not paying attention, John, because we are, and we'll tweak as we need to locally at schedule levels and plant levels.

But fundamentally for the company, we're in growth mode in North America, we're in growth mode in China. We got to be thoughtful about it, but that's kind of how we're outpricing as a company in 2017 and likely into 2018 as well, John..

I'm sorry. But also the mix change, I mean, it seems like you're kind of sloughing the stuff of, because mix seems to be improving and your backlog is coming through. I'm just curious that the things which you're getting from mix....

Yeah. Sorry, John, I missed that one. Net-net, we're a little bit beneficial with truck mix in North America. Vehicle mix in China is less noise for us. But North America, we get a slight benefit with truck mix, but it's not huge. Because generally our content is pretty equal across cars and trucks.

We just get the added benefit of transfer case technology going on to the trucks, which kind of gives us a bit of a lift there. But it's not – to your point, John, it's not moving the needle dramatically for us, which is a good thing for us..

Okay, great. Thank you..

Thank you, John..

Your next question comes from Colin Langan with UBS..

Can you give us any color on your commercial traffic merger? I know, in the past, there was almost 10% of sales.

Is it still substantial today and is that recovery a nice underlying help to results here, given it seems like those commercial on-off highway markets have improved?.

Yeah, Colin, this is James. It's about 12% of revenue. For us, it's a total company for 2017. And it's split pretty equally between on-road and off-road is the way to think of this. We have about a third North America, a third Europe, and then the other third is split between China and South America.

And as I've said in my comments earlier, Colin, what we've seen is, it's been a tailwind for us, particularly in China and in Europe. I'd say, we got some benefit in the first half from North America, but probably that's moderated a little bit as we're looking to the second half, particularly on-road in North America.

So net-net, and obviously South America has been a tailwind as well for us, Colin. So, 12% of our business, and it's certainly contributed to the growth based on the recoveries.

So if that helps you a little bit and if you need a bit more from a product perspective, it's predominantly a turbo business, our emissions business and our thermal business are the products that are driving that growth for us..

Got it. I'd like to just sneak one more in.

Can you just provide – on the Sevcon acquisition, can you describe a little bit of what the powertrain electronic capabilities are that you're acquiring there in terms of what – a little more specific on actually what the product is that you're delivering and whether that acquisition is really more about cross-selling that with the rest of the business or is it about the backlog you're acquiring?.

Yeah. So, I mean, fundamentally what we're really getting with Sevcon is, we're getting tremendous design and development capability from their engineering organization. They can absolutely understand the electronics aspects of the system works. And that just coupled with BorgWarner's existing capability really accelerates it.

But it's not just an engineering play, Colin, they got revenue, they run about $50 million of revenue, and they ship a lot of invertors and converter-type products. They also have some battery charging technology that they ship out.

So, it's basically buying a lot of very strong engineering capability coupled with an existing revenue platform that is accelerating as they take that capability, add that to our capability, and we can offer a complete system solution to the light vehicle customers as well as the commercial vehicle customers..

Great. Thank you very much for the color..

Thank you, Colin..

Your next question comes from Ryan Brinkman with JPMorgan..

Hi. This is Elad Hillman on behalf of Ryan Brinkman..

Good morning..

Good morning..

Good morning.

Can you just comment on the margin progression at Wahler? Now that the outlook for commercial vehicle production seems to be improving, can you get any progress there?.

I'm sorry. Can you repeat the question? I didn't hear the beginning of the question..

Yeah. Sorry.

So, just wondering about the progression on the margins for the Wahler transaction, now that the outlook for commercial vehicle seems to be better?.

Hey, yeah, Wahler, okay. That business we acquired several years ago. And if you go back in time, it was low single-digit. And our expectations were to get that to migrate into high single-digit and hopefully ultimately get into double-digit. I would say, we're behind that schedule for numerous reasons.

In particular, we had a lot of product moves that we anticipate of doing from one of our facilities that we had to slowdown. And as a result to that, we haven't been able to get to profitability where it needs to be.

If we deal deeper into it, that acquisition was about valves, the valves and rivet business for us and valve market share that we have in Europe. But I would say, the operational performance at this point is somewhat of a headwind it has been for the last couple years it is this year, and we need to fix that going forward.

So, as we go forward, I was saying earlier on the call that would be maybe one of the little tailwinds that we can get going forward, and we're working on it very hard..

And, just on – sorry, just to add on to Ron's comments, which was a great summary. The broader question you asked him in terms of commercial vehicle overall from a BorgWarner perspective both growth and operating margin performance, we're very happy with our commercial vehicle business, it's contributing well to our performance.

But, Ron's right, we've got an isolated issue within the ex-Wahler business that we need to fix, and we will..

Okay. Thank you very much..

Thank you..

Your next question comes from Brian Johnson with Barclays..

Yes. Wanted to talk a little bit about the backlog. As mentioned earlier that it's coming ahead of the original guide, certainly understand some of the back half conservatism.

But as we roll forward to next year, you guided 460 to 670 – was the conservatism and risk adjustment around potential launch delays that you baked into the regional backlog? Is some of that now dissipating and that number could wind up being higher? Just another way of putting it, which you probably won't answer is, what sort of a gross backlog and then the discount for delay launches you've applied this year and how is it shaping up for next year?.

Yeah. Brian, I'm going to take a shot at it, and then if Ron wants to jump in, we'll let him. Let me start with a couple of points to backlog. First of all, I'm thrilled with the first half of the year, first of all. It's exceeded our expectation a little bit. It's been a terrific first half of the year. The second half is moderated.

It's basically the same as what it was from the prior guide. We've not really changed too much on the second half guide. Ron articulated some of the headwinds that we're going to pay attention to as we go into that. And all of that rose up to this strong 7% midpoint organic growth for the year, and you can see the full year backlog number.

You're right, it's a little too early to give you 2018 numbers. We will talk at the Investor Day a little bit on how we've seen our growth rates looking out over the next two years, three years, five years. So that will probably give you a little bit more of a sense.

But we're going through our process, Brian, as we get ready for 2018, but certainly there's nothing to be fearful of in terms of what we gave you last year, that's for sure, because we're executing very well against that target this year. So, I don't know whether that helps you enough, but that's how I'm thinking about the backlog..

So, Brian, I will add a few things. As you know, we changed our process a couple of years ago. And what we do is, we'll take a look at the gross backlog number and we will make subjective adjustments.

And given markets and given products and given customers to those numbers like we did this year and last year, and that process has done very well for us, and we'll continue doing that process into the next year backlog as well..

And can we look at the backlog and say, most of the growth we saw first half was due to just the risk factors not being needed or were there launches that were upsized or bigger magnitude than perhaps you originally....

I would say, Brian, it was launch cadence and volume. That's where the uplift – or the outperformance, so to speak, has been in the first half, less macro, if that makes sense to you..

Yeah..

So, the number of launches is the same. I would just say, it's a combination of summer coming in a little earlier or kicked in a little better or some of the volume assumptions that we've loaded in have run a little bit better, which I think, to back to Ron's point, Brian, kind of points to how we wanted to do it going into the year.

And I think it's prudent, and it's paying off actually..

Okay. I've got more strategic questions, but I'll save them for a couple of weeks..

Okay. Look forward to that, Brian..

Yeah..

Your next question comes from Chris McNally with Evercore ISI..

Morning, guys..

Good morning..

Good morning..

Maybe just a little bit on market share in electrification, particularly 48-volt and plug-in.

Do you have a better sense, it's been about a year that you've been taking strong orders for 48-volt or actually a little bit more, but a sense for what market share could be in the core product like eBooster, you didn't really exclusively give guides on the last Analyst Day, but you can kind of back into the numbers that it seem like a number between 15% and 25%.

And it just seems like you may have some more market intelligence now that 48-volt seems to be gaining some momentum?.

Yeah. Chris, this is James. Let me give some answers there. First and foremost, just to be open – we'll share quite a bit more detail on the some – hard numbers, so to speak, as we go into Analyst Day in a couple of weeks.

But what I would say you directionally is, the activity level around hybrid and electric has both increased pretty significantly from a year ago, and our activity certainly increased pretty significantly across hybrid platforms and electric platforms.

I think your intuition is right, on the 48-volt model, hybrid is becoming a very strong platform for growth, as is plug-in hybrids, I think those are the two that are really accelerated in the last year. What I can share with you from a BorgWarner point of view, we feel very, very good about the win rates we're experiencing around that technology.

So, again, we'll share you more detail in a week or two. Your point on market share as well, Chris, is right on. We – in a conventional combustion business, we generally have a market share in the low-20%s is a good reference point.

And the way we've modeled our business in terms of communicating outlooks, we've modeled a little bit of a lower market share assumption in the 15% to 20% range for hybrids and electrics, because it's a little bit of a newer space. And we want to give our self a chance to see how that will play out.

So hopefully that gives you a little bit of a sense, Chris, of what's going on. And again really looking forward to sharing much more detail on that with you in a couple of weeks..

That's fantastic. And just one quick follow-on in terms of – again, just from a qualitative standpoint. I mean the market tends to get very worried about these new businesses, whether they're going to be more competitive in terms of the more traditional powertrain.

Even though a lot of the players are the same, is it fair to say that expectations from kind of a – whether it's a pricing on a margin standpoint from a BorgWarner, when you look at your backlog, it's tracking as you thought and these continue to be, I think, as you indicated at the Analyst Day sort of corporate average-type margin businesses?.

Yeah, absolutely is the quick answer, Chris. And I'll give you two data points. One is, the business that we're quoting and winning on hybrid and electric type applications are absolutely meeting the BorgWarner typical threshold of 15% after-tax ROIC in their corporate margins. So we're very comfortable there.

But I think more important – or as importantly from a year ago, a lot of those products we talked to you about last year are now in production. So we can actually see real life data, if you wish of how they're running down the production lines, and the operating margins are coming in right where we'd expected them to.

So no dilution of margin performance as we go forward with new products on hybrids and electrics..

That's fantastic. Thanks so much, guys..

Your next question comes from David Kelley with Jefferies..

Hey. Good morning, guys. Just a quick follow-up to that – yeah, a quick follow-up to that 48-volt question prior here.

Maybe could you give us some color on the eBooster system content per vehicle opportunity in your minds? And maybe how that might compare to your traditional turbocharger content in gas and diesel? And also just on the earlier Sevcon discussion, how do we think about the incremental add to your addressable hybrid content opportunity, now that you're adding Sevcon into the fold here?.

Yeah..

Yeah. David, let me quickly mention the Sevcon piece first. I think, fundamentally what it's doing is, we already have a good basis of power electronics and electronics and software capability in the company. This is basically scaling us up and adding to that, which is super important.

But in addition to that, it's actually given us some hard products basically. They already build and ship inverters and those types of products. So we'll get that. And they've obviously got some existing customer relationships. So that's the real power.

But the real power is going to be when BorgWarner and Sevcon as a united group walk into the customers and can talk and offer a complete integrated system. Just to give you an example, take a P2 Hybrid as an example.

We'll be able to take BorgWarner's clutching technology, we'll be able to take the former Remy motor technology, and then the third element to that system is the power electronics. And that's the piece that Sevcon will bring to the table. So that's going to be a very, very powerful story.

It's a little early to know how that – what that's going to look like. But we'll get clarity around that. But from a strategic fit, it's a super thing for us. eBooster is still in the early phase of adoption, but we're seeing tremendous interest from a lot of customers.

Typical rough number for an eBooster is about couple hundred bucks, but don't forget you're adding that is plus the turbo, not just on its own. So a conventional turbo, I think couple hundred bucks, turbo plus and eBooster, $400. So we're seeing a lot of interest, David. We see a lot of growth in there.

And most important, from a BorgWarner perspective, we absolutely believe we're the leader in eBoosting technology. So, yeah, a lot of excitement around both of those, David..

All right. Perfect. Appreciate the color. Thanks, guys..

Thank you..

Your next question comes from Richard Kwas with Wells Fargo Securities..

Hey. Good morning, everyone..

Hey, Rich..

Hey, Rich..

Hey. Just I want to follow-up on the Sevcon.

So in terms of power electronics, does this satisfy your need for scale with that acquisition once it closes? Or are there other opportunities, other areas within power electronics you would look to add?.

Yeah, Rich. I think obviously we want to get a closer look once we've got the deal done and all of that good stuff. It's additive. I don't think we stop there. I don't think we stop there either organically or through acquisition. This certainly helps us, but I would love more, both organically and acquisition.

It's just going to be a function of focus on integrating Sevcon first, keep looking for other opportunities and other targets and add them. So we're going to scale up even beyond Sevcon in power electronics and electronics for sure, both organically and acquisition..

Okay, great. Thanks, James. And then just two quick housekeeping, Ron. The increase in CapEx, I might have missed that, but what is that related to? And then, just thoughts on steel prices. There has been a lot of discussion around Harris (56:30), et cetera, rising prices, some headwinds in some other areas of the economy, other industrials.

What are your thoughts on price there within steel?.

Right. So, first the CapEx. As you know, our backlog is – really came in strong in the first half. And some of that backlog is the DCT plant in China. So what we're doing is, we're going to put in some more capacity to continue those ramp ups from our customer there, so that's the DCT. And a little bit more in the four-wheel drive area.

On commodity prices, we came into the year anticipating inflationary environment. We saw some of it. Our operating folks did a very good job passing that up through to our customers on pass-throughs.

The question around what is going to happen on steel prices once the administration makes a decision on tariffs and imports and all that, I think whatever happens there, just say that they do go forward and put something in place to benefit the U.S. producers.

Again, that would flow through our normal process of pass-throughs and contract negotiations we have with our customer, Rich. So, yeah, that would be for the industry itself a headwind, but I think for BorgWarner itself, we could navigate through that..

Okay, great. Thank you..

Thank you, Rich..

Your next question comes from Matt Stover with Susquehanna..

Matt, good morning..

Good morning. Thanks for taking the question. Most have been asked, but two things. One, could you just kind of bucket all the factors that favorably – that impacted the Drivetrain comp year-to-year? I know you mentioned in a bunch different places, but I just want to make sure my head is straight on that.

And then, I wanted to ask you something about pricing after that?.

Okay. We have no problem. So, from a Drivetrain perspective, what's been pushing the growth, it's primarily coming from the backlog, so it's launching of a lot of new products. We've certainly gained a little bit, as I mentioned early, with the truck mix in North America helping our transfer case business.

Our DCT ramp is certainly accelerated, which has been good. We've seen all-wheel drive growth hovering in Korea as well. So it's kind of a combination of all of the above if that helps you, Matt. Those are the big drivers up..

Okay. And the second thing is on pricing. Going into the quarter, one of your German peers had talked about industry pricing and it kind of provoked a question.

I'm wondering if it's rising commodity prices, falling volumes you're seeing OEMs push back harder or push harder on price or is it more just a case of the dog ate their homework?.

I would articulate it this way, Matt. The pricing environment is tough, it's always tough, and we know how to operating in that environment. I wouldn't say it's got any incrementally tougher than it was last year or the year before.

The good news from a board perspective is, we got a great discipline in place around cost reduction to offset a lot of that price pressure. But we're not calling out or seeing any shift in the pricing environment at this stage for sure..

Okay. Thanks very much..

Thank you, Matt..

We have time for one final question, and that question comes from Emmanuel Rosner with Guggenheim..

Hey. Thanks for squeezing me in..

Good morning, Emmanuel..

So, wanted to get your take on a couple of developments that could sort of impact the industry.

The first one is sort of noise from the new administration that they could sort of freeze the standards at the 2021 level, and I wanted to know, in your opinion, is that a good, bad or neutral thing?.

Emmanuel, from a BorgWarner point of view, you're asking or...?.

Yeah..

Yeah. I think, our view, Emmanuel, is that the standards are going to continue to climb. There is a good chance, so there could be some moderation at the standard a flattening out, so to speak, of the line in the outyears. And our strategy that we put in place two years to three years ago have been well balanced between combustion, hybrid and electric.

We're kind of okay either way frankly, because all that happens with acceleration of more aggressive standards. You just shift the mix between hybrid, electric and combustion. And when we've got content per vehicle growth in all three, we're in a good place either way.

So, I would say, neutral to slightly positive is our view, if that helps you on that one..

Okay. That's helpful. And then, I guess, the second thing seems be sort of like a lot of movement in sort of the assets that are around in the combustion engine area. We see Delphi is spinning off their Powertrain business. They were seeing some noises from some of the German competitors that are they're flexible or looking at sort of options.

Do you expect some sort of consolidation of the combustion engine powertrain competitive landscape or do you think that the deals going forward will be mostly limited to electrical exposure?.

Yeah. That's a good thought, Emmanuel. I'll give you my take on it. I read the same stuff you do, and I can see the action some people are taking. I'll only tell you this. I just love our propulsion business. I love the growth that we have now.

And when I look at the outlook for us from a – with that portfolio and what we're adding to with Sevcon and others to come, I love it. I mean, we're going to grow mid to high single-digit organic growth. That's going to flow-through to EPS and we're in a really, really good spot. So, I can't speculate and speak for others.

I can only tell you I love our business..

And I guess, within BorgWarner, would you have appetite for additional – acquiring additional combustion engine powertrain revenues or will your deals be mostly focused on the....

I would say, yeah – Emmanuel, I would say, our bias is primarily adding technology around electronics. It might be software, it might be power electronics, and accelerating on the on the hybrid and electric vehicle type technology. You never say never to a combustion asset, you always look at those.

But our focus is adding and continuing to build system capability, so we can offer complete solution for all types of propulsion vehicles. And I feel really good about how that's working out for us so far..

Great. Thanks for the color..

Thank you, Emmanuel..

Sharon, you can close up the call. Thank you all for your great questions today..

That does conclude the BorgWarner 2017 second quarter results conference call. You may now disconnect..