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 2019 First Quarter Results Conference Call. [Operator Instructions]. I would now like to turn the call over to Patrick Nowlan, Vice President of Investor Relations. Mr. Nowlan, 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 a.m. Eastern Time, posted on our website, borgwarner.com, both on the homepage and on our Investor Relations homepage. A replay of today's call will be available through May 9. The dial-in number is 855-859-2056, and the conference ID is 6599394 or you can simply listen to the replay on our website. With regard to our investor relations calendar, we will be attending multiple conferences between now and our next earnings release. Please see the Events section of our IR page for a full list. Before we begin, I need to inform you that during this call, we may make forward-looking statements which involves risks and uncertainties as detailed in our 10-K. Our actual results may differ significantly from the matters discussed today. During today's presentation, we will highlight certain non-GAAP measures in order to provide a clearer picture of how the core business performed and for comparison purposes with prior periods. When you hear us say on a comparable basis, that means excluding the impact of FX, net M&A and other noncomparable items. When you hear us say adjusted, that means excluding noncomparable items. And when you hear us say organic, that means excluding the impact of FX and net M&A. We will also refer to our growth compared to our market. When you hear us say market, that means the change in light vehicle production weighted for our geographic exposure. Our outgrowth is defined as our organic revenue change versus the market. Now back to today's call. First, Fred Lissalde, our President and CEO, will comment on the industry. He will then follow this with a high-level overview of our Q1 results, our 2019 outlook and the cost restructuring plan that we announced this morning. Fred will conclude with a discussion of our recent product highlights. Then Tom McGill, our Controller, will discuss the details of our results as well as our guidance. Also with us today is Kevin Nowlan, our recently appointed CFO. Please note that we have posted an earnings call presentation to the IR page of our website. We encourage you to follow along with these slides during our discussion. With that, I'll turn it over to Fred.

Thanks, Pat, and good morning, everyone. We're very pleased to share our results from Q1 2019 today and provide an overall company update. Before we begin, I'd like to welcome Kevin Nowlan to his first earnings call with BorgWarner as our new CFO. Kevin's impressive background speaks for itself. But suffice it to say, his experience will be invaluable as we continue our long legacy of strong financial discipline. He hit the ground running during his first few weeks, and you will be hearing more from him in the coming months. I also like to thank Tom McGill for his excellent financial leadership, and I'm very pleased that he is now our Controller with responsibilities for all our accounting, tax and enterprise risk management operations. Now I'll start by sharing a few thoughts on the industry shown on Slide 5, starting with Q1. The global light vehicle production came down about 5.2%, which is more than 100 basis points better than the midpoint of our expectation going into the quarter. In addition, I'm very proud to say that our outgrowth in Q1 was also stronger than expected, driven by higher volume of new programs, especially in Europe and North America. European light vehicle production was down about 5.5% as customers worked through the final stages of the WLTP certification. China light vehicle production was down mid-teens year-over-year as our customers reacted to lower demand and reduced their inventories. North American light vehicle industry production declined about 2.5% year-over-year. Now looking to the remainder of 2019. We expect that the challenging conditions in China and Europe will continue for the remainder of the year. Even with these challenging conditions, we expect to be able to deliver on our full year earnings and cash flow guidance. On a full year basis, we…

Thank you, Fred. Good morning, everyone. Before I review the financial details, I would like to provide you some of the highlights as I see them for the quarter. First, our outgrowth was better than expected at 190 basis points. This, combined with a more modest decline in industry volume, allowed us to deliver a stronger top line sales performance. Second, decremental margin performance was below our long-term targets, but the shortfall was in line with our expectations going into the quarter. As a result, the stronger sales from the quarter flowed through in line with our long-term incremental margin expectations. And finally, we are maintaining our guidance for the year, but feel increasingly confident in our earnings and free cash flow outlook for the full year. Let's turn to Slide 9. On a comparable basis, our organic sales were down 3.3% year-over-year. This is solid performance compared to market, which was down approximately 5.2% year-over-year. We saw a high-teens decline in China against a production market that was down mid-teens. Europe revenue was down 1% compared to the 5.5% industry production decline in the quarter. North America revenue was flat versus the 2.5% production decline in the quarter, and our commercial vehicle and aftermarket business was flat year-over-year. So now let's look at the year-over-year comparison for adjusted operating income, which can be found on Slide 10. The Q1 adjusted operating income was $295 million compared to $339 million in Q1 of '18. Our adjusted operating margin of 11.5% was down versus 12.2% last year. On a comparable basis, adjusted operating income was down $29 million or $91 million of lower sales. This gives us the decremental margin of 32% in the quarter, which is worse than our long-term decremental margin target of 20%. This $11 million shortfall compared…

Thank you, Tom. Sharon, we're ready to open it up for questions.

[Operator Instructions]. And your first question comes from John Murphy with Bank of America Merrill Lynch.

Just wanted to ask a first question on your sort of the step-up in R&D versus the restructuring actions. I'm just curious, I mean, as you're thinking about this, are the restructuring actions being taken because there's some potential underperformance that you're seeing in things that need to be fixed or is the direct motivation to fund a step-up- in R&D going forward, and it really will be almost a 1-for-1 offset? Just trying to understand what's going on there between the two.

I think it's both, John. We asked to adjust our cost structure to the latest industry evolutions, and we then are going to focus on our growth and also make sure that our operating margin evolutions are in line with what we've announced and what we committed to. So it's both, John. It's absolutely both. So we're taking a company-wide view to reduce the cost structure. And at the end of the day, the pool is there from our customers, and we see growth potential that require R&D. I think those two things have to be done, and we're doing it. We're executing it, and we'll execute it. And that's going to be good for profitable growth for the company.

So should we think about the $40 million or $50 million of ongoing cost saves would be directly offset by a step-up in R&D that should drive sales, which should keep R&D as a percentage of sales roughly in the low 4% range? Is that a sort of a logic that's correct? Or am I missing something?

No, your logic is correct. The R&D would be up a little more than that, and that would be topping 2020, 2021. Don't consider that the R&D that is currently at 4.1% of sales in 2019 is going to change. And also the margin profile expectations are going to be unchanged.

Okay. And then if I could just sneak in a follow-up. Just on this Slide 10, Fred, and maybe for you, Tom, as well. I mean, as you're going through the tariffs impact, the supplier bankruptcy and the new launches as headwinds to your decremental margins or sort of losses to decremental margins, are those relatively equal? Or how should we think about the three of those as we go through the course of '19 and potentially into 2020?

Are you talking about full year?

Well, I mean, in the quarter, but then, also, it sounds like they're going to persist a little bit in the second quarter. So I just want to understand what are the sort of the buckets of those? Were they equally split in the first quarter? And is that the same allocation we should think about going forward? Or is there something changing going forward?

Yes. So with the tariffs, we've talked about that being up to maybe $10 million a quarter, and that will continue through Q2. And then come Q3, that year-over-year comparison, the tariffs will be in both. So again, a little bit in Q2, but by Q3, the year-over-year will even out. For the supplier bankruptcies, yes, that will continue in Q3 and probably through the year, but we'll see that coming down in Q3 and Q4, especially on a comparable basis.

And for R&D in Q2, John, it's about $10 million, and it's timing.

Your next question comes from Rod Lache with Wolfe Research.

A couple of things. To make the full year number, it implies that the second-half margins are in the 12.5% range after the mid-11s in the first half. And it sounds like part of this is moderation of R&D, and part of it is the supplier bankruptcies. And I presume that you're also anticipating easier comps in European production, but I was hoping you might be able to just elaborate a little bit more on each of these components and how we should be thinking about that because it's pretty unusual to see BorgWarner have stronger back-half margins versus first half.

So one is related to R&D timing. We have Q4 R&D, which is $10 million to $20 million lower than Q2. And also you have a stronger growth in the second half of the year which is linked to stronger backlog and demand of our products for Europe and North America, but also in the second half of the year, and we see that starting in Q2 in China.

What's the bankruptcy part of this? And what are you assuming for European production in the back half?

So our midpoint to European production is estimated at a little bit less than -- let's say, down more than 3%. And to give you an idea, on the supplier side, we consider that the bankruptcy costs and everything that we have to go through is about $5 million a quarter.

Okay, okay. And then secondly, I know that you're...

Which is the supplier bankruptcies started last year. So there's $5 million of growth that we'll start lapping in the second half.

Okay, got you. Secondly, I know your backlog is bigger, I mean, your business backlog is bigger in 2020 versus 2019, but I don't think that either of those backlog numbers incorporate any changes in mix in Europe. And the reason I'm asking is, obviously, a lot needs to happen for European OEMs to go from 120 grams of CO2 per kilometer down to 95 over the next year or so. So do you -- just setting aside the macro issues and thinking about your business in Europe, do you see an additional net positive from mix coming in here as some OEMs eliminate some of the lower-performing models from a CO2 perspective? Just generally, what are you hearing from your customers as you look out to the next year or so as far as their plans for CO2 compliance?

So you're right. But again, when you look at our European backlog, you need to factor back about 10% of our overall backlog linked to the diesel mix. And the other thing that you're going to see longer term is that I think you're going to see a very, very positive push for hybrid propulsion architecture post 2020. This is also one of the reasons why you've got an acceleration of the backlog in 2020 linked to those new launches.

But do you see, just from a mix perspective -- forgetting about backlog, do you see a shift towards more a kind of higher BorgWarner content of vehicles in 2020 versus what you're just seeing right now simply because these automakers need to shift to their -- to better CO2 compliance?

In the short term not in a meaningful way.

Next question comes from Noah Kaye with Oppenheimer.

So can you talk more about the factors that led you to conclude that higher investment in hybrid and EV products were necessary? Does this contemplate a faster mix shift towards electrification than you saw previously? If so, why?

Because the customers are in high demand and because we're winning.

Can you expand on that a little bit?

Well, yes. I mean, we have technologies from a hybrid perspective that are being pulled by our customers in different architecture, in different regions of the world, especially in China and in Europe. At this point in time, we're winning advanced hybrids in Europe. And we'll just ask -- we're focusing on the long-term profitable growth. The returns are going to be good, and we need to deliver.

Okay. Yes. So if I understand that, then this is really R&D supporting an elevated number of launches than maybe we've previously thought? This is not core R&D or some sort of gaps you saw in the portfolio? Am I understanding that right?

You're right. It's essentially more at new business development application type R&D than, how would you call that, advanced R&D.

Your next question comes from David Tamberrino with Goldman Sachs.

This is Mariel Kennedy on for David Tamberrino. Just our first question, looking toward your second quarter guidance, what are your regional production assumptions for the industry?

So for Q2 regional production for the industry is pretty much North America, slightly down; Europe, down more than 5%; China, down double-digit. And overall, on the global, both on a weighted average, we're pretty much down around 5%.

Okay. And then just looking at commercial vehicle, it looks like that was just kind of flat in the quarter, where you've been seeing it positive in the past. What sort of expectations do you have for that going forward?

So when you look at commercial vehicle, our business in commercial vehicle represents about 12% of our revenue. And it's very, very -- we have about 1/3 of that revenue in the U.S., 1/3 in Europe and 1/3 in China and Brazil, China being 2/3 of that last 1/3. And we have 60% of our business which is on-road and 40% off-road construction agriculturals. So this business is very, very wide and very spread. And our hypothesis is going into forecasting and is that we are considering it by default flat because of that complexity. So don't attach a Class 8 North America market or industry volume to us. We're way more complex than this.

Okay. Then just one last question, if I could get it in there. As we're looking, and you have more backlog in hybrids and EVs, are you starting to see any sort of material customer mix shift, especially in China? Or is it still kind of the same as you've seen in the past?

We don't see a meaningful customer mix change.

Your next question comes from Chris McNally with Evercore ISI.

If I could just follow up to, I think, just one of the questions that have been asked before, particularly Rod's question, around Europe. I mean, if we think about the next two years, where you're talking about sort of an increase in R&D specific for new launches in Europe, can you just give a little bit more color on the type of vehicles that you're getting, maybe increased requests for or maybe volume requests are going up, so that European OEMs can meet the O2, which starts essentially in 2020? Is there still P2 PHEV 48-volt? But are you also seeing some EV programs pull forward for you specifically in Europe?

Okay. Chris, until 2020, 100% of the business is booked. And the stuff that we're booking right now is past backlog period. It's 2021, 2022. And yes, it's going to be around advanced hybrid. Most of those programs are going to be advanced hybrid, 48-volts and higher voltages, a variety of products.

Okay. So is it fair to say that we're not actually seeing volume change? I think there's a view out there that essentially, some of the volumes on some of these programs that need to be increased, the OEMs are going to push them to avoid fines because of a greater-than-expected shortfall that they've seen in, for example, diesel.

And here you're asking within the next two years, right? Shorter term, right?

Yes, exactly.

Well, shorter term, we can react. If we have the program, we can react. And if they want more volume, we'll react, and we can react pretty fast. The impact of the additional R&D is certainly past 2020.. And, yes, that's what I was saying.

Okay, that's perfectly clear. If I could just ask one more on a more near-term basis. As we think about the second, where even, I think, in your assumptions, if Europe is down roughly 5%, 6% in the first half and you have it down 3%, we have a recovery essentially in the second half to get there. And some of that's the easier comps. Can you talk a little bit about RDE in Q3? I think most of the industry was hit with the surprise of WLTP. We're hearing that people are more prepared. Is there any comments that you can get on when schedules for the summer may be more firmed up with respect to the next level of testing in Europe?

Chris, the way we see it is it that in Europe, for the second half of the year, the market's going to be pretty flat year-over-year. And our hypothesis is that, yes, you're going to -- our customers are going to go through RDE as they went through WLTP last year. And that's our assumption going into the second half of the year.

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

Sorry if I missed this, but just you initially guided the backlog to be effectively 0, and it ended up being about 3.7% to growth. What change that sort of maybe came in that you didn't expect? And how should we think about that as it trends into the second quarter?

Yes. So in Q1, we guided with no outgrowth to market, and we are effectively outgrowing the market by about 200 basis points. Two major drivers: one is Europe Engine business slightly better; North America, also slightly better. And China was in line, which means no outgrowth.

But I thought the commentary previously was that because of sort of the market outlook, some of the launches were maybe going to be delayed. And it seems like maybe some of those launches did come in. So can you maybe sort of, maybe if not customer-specific, like did stuff launch in China that you didn't originally expected? Or where did they come in from?

So in China, things did not bounce. In China, we were, as I said, in line with our expectations going into Q1. Europe was the driver.

Europe? Okay. On -- just maybe to sort of talk about the R&D spending and sort of the electrification program going forward a little bit differently. I think in your backlog, you have 70% allocated towards hybrid. I was wondering if is it possible to sort of disaggregate that 70% to -- from the -- maybe from like the ICE side of the hybrid versus the electric side? And how does that sort of change with the sort of R&D talk beyond this sort of backlog period as it sort of gets to more advanced hybrids?

We really look at hybrid as an addressable content. And we have, from a hybrid perspective, we have our P2 hybrids. We have P1. We have P3. We have motors. We have -- and past the backlog, we will have power and electric. So it's very difficult to put a number on the combustion side of hybrid or the electric part of hybrid. What is true and what's driving growth, and that's why electrification is great for this company, is that the more advanced hybrid you get, the higher content of vehicle you're going to get from BorgWarner. And that's why electrification accelerates our growth.

Okay. And just, I guess, lastly, with the structural costs you're taking out, did you mention specifically what it is? Like are you shuttering capacity for some specific types of products? Or what exactly are you restructuring?

So as I said, it's a company-wide view, but the largest share is going to be into the engine side. That's where we have to pick, as you saw some of the too heavy decremental. Corporate also will contribute. So we look at it from a holistic approach in order to get that done.

Next question comes from Colin Langan with UBS.

Any color -- I mean, the numbers came in better than your guidance for Q1. Any thoughts on why not just tweak up the full year guidance? Or it's just too early in the year out there? Or has something gotten worse than the full year outlook?

I think it's just too early in the year. The volatility in the market is still here in pretty much all the regions. And I think it's just -- we think it's just too early.

And I apologize if I missed this. The decrementals were pretty large, particularly in Engine. What were the big issues year-over-year on the quarter?

Yes. So this is Tom. So in Engine, well, we have tariffs that impacted both Engine and Drivetrain. In Engine, the supplier bankruptcies in Europe that we talked about were primarily in the Engine Group. And then it was just kind of the launch timing and then the lower volumes that also contributed.

Got it. And when we're thinking about diesel, I mean, how was that trending? And what are your expectations for this year?

So the assumption on diesel is that for this year, we assume a 300 basis point shift from last year. And what we also see is that there might be a little bit of a reduction in decreases quarter-over-quarter, 300 basis points down from prior year.

The next question comes from James Picariello with KeyBanc Capital Markets.

So just on electrification programs in China, hearing farther up the supply chain as it relates to cash flow materials that China EV programs are getting pushed by as much as like 12 to 18 months. We're also seeing cobalt prices come down. So I'm just curious what you're seeing in the China market as it kind of relates to this commentary from another supplier of the supply chain?

No, that's -- we see no changes at all from our allowance cadence on that electric vehicle propulsion in China. The EV pool is still very strong.

Okay. And just on the timing of the restructuring plan, the $40 million to $50 million in savings by 2021, is that sort of a 50-50 split over next year in '21? Or is it weighted to the -- to later half there? How should we think about that?

The timing's still being worked out, but it's going to be over the 2 years. We're still working it out, but all of those actions for those savings will be in place by the end of 2020.

Got it. And just last one on buybacks. You have the $100 million target for the full year, $70 million deployed in the first quarter. Just wondering if there's still maybe some upside to that or maybe the prototype spending and the restructuring actions consumed cash that otherwise would have been deployed?

Right. So I kind of just have the same answer there. We have the $100 million guidance, but we do potentially look at opportunistically buying back more depending on other uses of cash like for potential acquisitions and other things. So some we continue to look at and we'll be opportunistic with.

We have time for one final question, and that question comes from David Kelley with Jefferies.

And just a couple of quick ones. I think, clearly, the China production weakness was well broadcast, but we've been hearing from others that the market appears to be at least stabilizing. Just can you speak to if there's any change from your vantage point in either customer sentiment around potential volume improvement on the horizon or if there's any change in maybe the potential outgrowth you're seeing for the pipeline in your market?

So the market is stabilizing from the current run rate. Now what we see is the next generation of new programs -- next generation of our new programs in China. And we see schedules for those new programs starting -- accelerating, starting in Q2. But from a market standpoint, we're not thinking that the market is going to recover.

Okay, great. And just a quick housekeeping, could you update us on your implied tariff headwind? I guess, is that still $20 million? I think if I recall, you weren't building in a step-up in those three costs there. So I just wanted to follow up.

Yes. So for that, it's still at that $20 million. There's very little impact for us with those three. But again, $20 million, $10 million in the quarter in Q1 and 2. And by Q3 and four, that will be in both years.

With that, I'd like to thank you all for your good questions today. If you have any follow-ups, feel free to reach out to me afterwards. Thank you.

Thank you all.

That does conclude the BorgWarner 2019 First Quarter Results Conference Call. You may now disconnect.