Good morning. My name is Britney, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2023 First Quarter Results Conference Call. [Operator Instructions] 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, Britney. Good morning, everyone, and thank you for joining us today. We issued our earnings release earlier this morning. It’s posted on our website, borgwarner.com, on our homepage and on our Investor Relations homepage. With regard to our Investor Relations calendar, we will be attending multiple conferences beginning now and our next earnings release. Please see the Events section of our IR home page for a full list. 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. During today’s presentation, we’ll highlight certain non-GAAP measures in order to provide a clearer picture of how the core business performed and for comparison purposes of prior periods. When you hear us say on a comparable basis, that means excluding the impact of FX, net M&A and other non-comparable items. When you hear us say adjusted, that means excluding non-comparable items. 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 and commercial vehicle Production weighted for our geographic exposure. Please note that we’ve posted today’s earnings press release and 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’m happy to turn the call over to Fred.

Thank you, Pat, and good day, everyone. We’re very pleased to share our results for the first quarter 2023 and provide an overall company update, starting on slide 5. With approximately $4.2 billion in sales, we delivered double-digit organic growth in the quarter, and we outperformed the market in both Europe and North America. As we expected going into the quarter, our margin performance was negatively impacted by our planned eR&D investment, net inflationary costs and the impact of lower production in China. Our free cash flow usage in the quarter reflected our planned capital spending to support our eProduct growth as well as working capital usage and our normal annual payout of incentive compensation. Importantly, our challenging forward progress continued on multiple fronts. We secured multiple new eProduct awards since our last earnings report. We also announced multiple new eProduct capacity investments during the quarter. And as I will highlight, our battery pack expansion in Seneca, South Carolina shows our ability to utilize our foundational assets and people. Lastly, we continued to work towards the intended separation of PHINIA. Since our last call, we announced PHINIA’s name as well as the key leadership roles. Brady Ericson will serve as President and CEO, whilst Chris Gropp will serve as the CFO of PHINIA. Both Brady and Chris have been at BorgWarner for more than 20 years, and have served in numerous important roles across a variety of BorgWarner business units. Teams are progressing well through the various work streams. We now expect to complete the separation of PHINIA by the end of the third quarter. Now let’s look at some new eProduct awards on slide 6. First, BorgWarner has been selected to provide eMotors to a leading automotive manufacturer in China. The eMotors will be used in the Chinese automakers…

Thank you, Fred, and good morning, everyone. Before I dive into the financials, I’d like to provide a brief overview of our first quarter results. First, we reported double-digit organic revenue growth driven by outgrowth in Europe and North America and higher industry production despite weaker production in China during the quarter. Second, our margin performance reflected a planned increase in eProduct related R&D investment and net inflation headwinds, both of which we had indicated would be margin headwinds during last quarter’s earnings call. Despite this, we believe we remain on track for our expected full year performance. Let’s turn to slide 9 for a look at our year-over-year revenue walk for Q1. Last year’s Q1 revenue was just under $3.9 billion. You can see that the strengthening U.S. dollar drove a year-over-year decrease in revenue of over 4% or approximately $162 million. Then, you can see the increase in our organic revenue, about 12% year-over-year. That compares to an approximately 7% increase in weighted average market production. Finally, the acquisitions of Santroll and Rhombus added $22 million to revenue year-over-year. The sum of all this was just under $4.2 billion of revenue in Q1. Turning to slide 10. You can see our earnings and cash flow performance for the quarter. Our first quarter adjusted operating income was $396 million, equating to a 9.5% margin. That compares to adjusted operating income of $389 million or 10.0% from a year ago. On a comparable basis, excluding the impact of foreign exchange and the impact of M&A, adjusted operating income increased $32 million on $446 million of higher sales. This performance includes a planned eProduct R&D increase of $26 million and about $28 million of net commodity and other material cost inflation headwinds. As we mentioned on last quarter’s call, we anticipated…

Britney, we’re ready to open it up for questions.

[Operator Instructions] Your first question comes from Morgan Langan [ph] with Wells Fargo.

It’s Colin. I just want to follow up on the comments. I’m not sure if I misheard. Did you say there’s -- you’re expecting $65 million of inflationary costs for the year. I thought the initial guidance was reflecting something that it would be not material for the year?

That’s correct. We’ve effectively increased the expectation of the net inflation cost to $65 million. It was relatively small in our previous guidance, but the increase as we’ve seen the continued escalation of supplier costs, predominantly non-commodity-related costs. But despite that, we’re continuing to expect to hold our margin guide, 10.0% to 10.4% for the full year.

Got it. Okay. And it’s actually -- it’s not related to the steel price, its’ actually related to your supplier cost pressure coming through?

It really is. I mean, if you look at indices, commodity indices are a little bit all over the place. You have certain indices -- certain steel indices, aluminum are down on a year-over-year basis. You have copper, which is actually up relative to the second half of the year. And you have nickel and stainless steel that are actually up on a year-over-year basis. So, commodities are a little bit of a mixed story, but the bulk of what we’re seeing come through is really non-commodity-related, the other inflationary costs coming through the supply base.

And what helps you keep your guidance, I guess, actually slightly up related to sales. But with the $65 million incremental headwind, what’s offsetting that?

Yes, the continued performance of the business and conversion on incremental revenue. So, we continue to have confidence in our ability to deliver on that conversion, which mitigates the impact of that $65 million.

And just lastly, Fuel Systems looked pretty weak in the quarter. Anything unusual going on in Q1? And should that sort of bounce back, or is that kind of stay at these kind of levels?

Yes. Fuel Systems was one of the segments most impacted by some of the China mix issues we saw, particularly China CD. So that had an impact on margin. In addition, the segment also saw some impacts from higher supplier related costs and higher R&D costs. But as we look at the business on a full year basis, we do expect much like the rest of BorgWarner, to see sequential improvement over the balance of the year and fully expect that business will continue to perform in line with where it’s been performing the last couple of years.

Your next question comes from Noah Kaye with Oppenheimer.

Thank you for breaking out ePropulsion. Very helpful to get that visibility. I guess, would it be fair to say that getting to the high end of the revenue guide for ePropulsion really depends on production cadence and supply chain? And would that primarily be a function of your own supply chain for electronics and other components, or is that more gated by the OEMs?

No, I would say that -- yes, it’s not demand related. It’s -- if we get the chips, we’ll be at 1.8. If we don’t get enough chips, we’ll be at 1.5. So, it’s essentially linked to the ability to get what we need in order to deliver the demand.

And your thoughts on line of sight to getting the chips thus far in the year?

Well, that’s what -- I mean, we have teams of people working really hard with our suppliers. And so far, so good, I would say. But we still have volatility. And as you know, the supply chain is -- has no buffer whatsoever. So, if you have a little blip somewhere, then it impacts us in our ability to ship. So, that’s why you have that band of revenue that is still open from 1.5 to 1.8.

And then just the last one. I mean the margin trajectory in ePropulsion, should we potentially extrapolate similar incrementals moving into 2024? And I think the dynamics here of the gross profit contributions more than offsetting the R&D increases, is what we’re seeing here from 1Q to 4Q kind of a fair trend line to continue?

I think it’s a fair way to think about it. I mean, it’s what we’ve been suggesting all along is that as we start to get the scale and start to see the revenue ramp up, that revenue ramp up drives gross margin and the pace of that growth is outpacing the growth in R&D. You can see the R&D starting to flatten a little bit more relative to that growth. So, as we get beyond ‘23 and into ‘24 and beyond, we do expect to see that continued improvement in the margin trajectory linked to the continued growth in the eProduct-related revenue.

Your next question comes from James Picariello with BNP Paribas.

So, the PHINIA spin is now targeted by -- to be completed by the end of the third quarter. Any thoughts or color on the timing of the CMD and the capital structure potentially for PHINIA?

Yes. I think nothing has changed really. We’re getting more precise. The teams are doing a great job, and we’ll come back to you when we have even more precision on those dates. But we’re marching towards end of the third -- by the third quarter. And it’s a lot of work, but people are working really diligently, and just wanted to give you a bit more precision.

And so, as we get more honed in on a particular date, then we’ll be in a position to talk about when those investor days might be for both companies. And at that time, we’ll also talk about the capital structure of both businesses.

Got it. And then, on the commodities front, so the net impact now for the year at $65 million headwind. As you think about the topline recovery component of this, last year, I believe it was roughly $580 million flowing through your revenue in terms of commodity recovery. What does that number now look like within your revenue guidance?

On a year-over-year basis, it contributes about a point to our revenue. So that -- and net of that recovery, we end up with $65 million of headwind.

Your next question comes from Emmanuel Rosner with Deutsche Bank.

So just to clarify again the inflation headwind. So, are you expecting $65 million on a full year basis as a net number? And then, $28 million of that happened in the first quarter. Is that correct?

That’s correct.

And I guess the general drivers of sort of improvement in sort of like total incremental margins from the first quarter to the rest of the year. So, you would have a higher proportion of recoveries, I guess, on that growth headwind -- inflation headwind, or what other drivers would you point to?

Yes. I mean, fundamentally, the two things that really drive the performance over the balance of the year. One is, we do expect to start to generate some of the customer recoveries linked to the inflationary headwinds. So the biggest headwind is really in the first quarter. But second, we do see sequential improvements in revenues and converting on that over time. I mean, if you look at -- our Q1 revenue is $4,180 million. If you look at the midpoint of our guide, it suggests that the average quarter for the last three quarters is higher by $260 million of revenue. So, there’s still revenue growth coming over the balance of the year, particularly driven by the growth in our eProduct portfolio. So converting on that as well as mitigating some of these inflation impacts over the balance of the year are really what drives the conversion and gets us to that 10.0% to 10.4% margin for the full year.

And this is tied to the timing of your launches?

Correct. It’s really the ramp-up of our eProduct revenue over the balance of the year. And you can really see it in that ePropulsion segment disclosure that we had in the deck that the primary driver of that growth growing from $487 million of revenue in Q1 to $750 million to $850 million in Q4 is eProducts. And so, really capitalizing on that growth is what we’re looking for over the balance of the year.

And then, following up just on that disclosure. So eProducts expected to be about two-thirds of the net segment sales. I guess, what else is in ePropulsion?

Predominantly electronics.

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

I just wanted to focus on slide 13. Kevin, you kind of alluded to that two-thirds of actual electric product will be in this ePropulsion segment. And that kind of sort of indicated there’s about $1.3 billion in 2023 that’s outside of this segment, and I’m presuming that’s all in Drivetrain & Battery. If that’s correct, are we looking at a similar progression in the profitability in that other $1.3 billion? [Indiscernible] right now, and they’ll get to breakeven or better by the end of the year?

Yes. I mean, I think your $1.3 billion is a little bit high when you’re doing the math on that because we’re guiding to overall the $2.5 billion to $2.8 billion of eProduct revenue. So, when you do a third of that, it’s going to be a little bit less than that number. But where you see the other pockets of eProducts related revenue are really the battery pack business, which is in the Drivetrain & Battery Systems segment. You have a lot of our thermal products, which is in the Air Management segment as well as the charging stations, which are in the Air Management segment as well. So, that’s really where you see the other components of the eProduct related portfolio. In terms of the trajectory, I think it’s right to think that what you see on slide 13 is the right template or a way to think about the progression of margin in any one of those eProduct businesses. They start off by generating losses when they don’t have much revenue scale because we’re making a lot of upfront investment, particularly in R&D and other start-up costs. And as we start to get the scale and we start to grow revenue to the point where the revenue growth outpaces the growth in R&D, we start to drive profitability. So when you look at the eProduct portfolio within ePropulsion, we’re already starting to get to that scale point. Some of the other businesses are simply at different points of maturity along the way. But as they get to the same levels of maturity as what we see in the ePropulsion, we expect the exact same type of trajectory.

Okay. And then just to follow up on that. I mean, the midpoint is 2.6, so that’s two-third of your total eProducts that would indicate there’s another $1.3 billion outside. That’s the math. I mean, is there something else -- am I just misunderstanding something?

I mean, 2.6 divided by 3 gets you about $850 million to $900 million. So it’s...

Oh, you’re saying that’s the total? Okay. That’s -- okay, because the way this is shown is if that’s what’s in the ePropulsion segment, you’re saying that -- so you’re saying that’s the full number?

The expected net -- so the $2.5 billion to $2.7 billion, that’s the ePropulsion segment revenue, two-thirds of which is eProduct related. It also happens to correspond to being two-thirds of BorgWarner’s total eProduct revenue is also in this segment.

So basically, we should be thinking about $866 million outside of this segment. Is that correct?

Ballpark.

Okay, got it. Okay. I just wanted to make sure we got that right. Then just a second question. We think about PHINIA, and it sounds like this is going faster than expected, so it sounds like there’s good progress. How should we think about post separation potentially stranded costs and opportunities to work those down?

I mean, from a cost perspective, we’ll talk about that more when we get to the investor days that we expect to have closer to the date of the spin. And when you think of the potential dissynergies we see from the transaction, one of them is just, as you’re alluding to, some of the incremental costs associated with establishing a corporate cost structure for a new public company, PHINIA. So we’ll give more details on that and the impact overall of that dissynergy, but as we look at it, the value creation opportunity of creating two separate companies, both focused on pursuing their independent strategies more than offsets the potential dissynergy associated with setting up the corporate cost structure for PHINIA.

John, the -- PHINIA is made of two reporting segments that we run under the board -- a decentralized operating model. So besides the creation of a top co, there is not much stranded costs.

Your next question comes from Adam Jonas with Morgan Stanley.

So for your internal combustion businesses, across Air Management and within Drivetrain, given they’re in some, let’s say, early stage of a runoff phase, I would imagine that the capital requirements for these businesses in a runoff over the next 10 or 20 years, maybe very different versus the past 10 or 20 years. Can you confirm the CapEx and R&D spends, for example, as a percentage of sales for the ICE focused products can decline versus history? And can you quantify that?

First, I would say that what we’re doing with the plant in Seneca, which is our biggest plant in North America is a good proxy of what we’re doing to utilize the capital and the human capital that we have in our foundational products, putting berry back in there. If you look at e-heaters -- we announced more than 4 million e-heaters in 2025, we are using plant in Michigan and Portugal and China. For motors, IDMs, we’re using Wuhan and Tianjin and Korea and North America. Also in Mexico, we have a power [indiscernible] program where already about 300 engineers have gone through and they are, I would say, now very up to their task in the world of it. So we are focusing on utilizing both capital and human capital when we also make the transition from C to E. From a capital standpoint, R&D standpoint, we think that -- and Q1 is a good proxy, too. eR&D goes up, cR&D goes down, pretty much equally or proportionally. Capital is very, very limited. And what we do when -- and since quite some years, combustion businesses are quoted with the amortization of the full capital in the length of the program with volume closes. So I think we’re doing everything that is possible to limit debt risk.

That’s great, Fred. Just as a follow-up on your EV backlog, I would be very interested in your comments on how you see the Chinese-based domestic China EV players growing in your book vis-à-vis the legacy European, Asian and U.S. EV products. How is that backlog tilting?

Yes. Just to give you a high-level set of numbers. So this year, we’re guiding $2.3 billion to $2.6 billion of eProducts and in 2025, about $5.6 billion. And that’s 50% CAGR, just to give you a perspective on how fast we’re growing in this field. In China, our business is 70% with the local Chinese. It was actually the other way around 5, 6 years ago. But the vast majority of our business is with the Chinese OEMs. And out of that 70%, 50% of those are with the big guys, the top Chinese OEMs. I hope that helps.

Your next question will come from Dan Levy with Barclays.

I wanted to just start [Technical Difficulty] on incremental margins. So I appreciate the disclosure about ex the inflation in R&D would have been 19%. But just in light of an environment where some of the supply constraints seem to be dissipating and you’re coming off of relatively, I’d say, easier comps -- or more difficult situation a year ago. Is it possible that as the year progresses, ex-R&D, ex-inflation that that incremental margin goes higher?

Yes. I think we’re pretty comfortable with where the guide is right now. I mean, when you cut through the math and you look at the full year guide, excluding the eProduct-related R&D, we’re expecting to be converting at about 16-plus percent year-over-year, and that’s inclusive of the $65 million net material inflation headwind. So, it suggests without that headwind we’d be converting even higher. So we’re pretty pleased with that level of conversion, in spite of the fact that we’re seeing material inflation pressures in the year.

Okay, understood. Thank you. And then as a follow-up, I wanted to just ask about silicon carbide. A, could you just remind us of your inverter backlog, how much of that is silicon carbide versus IGBT? And then, B, we heard a comment from Tesla at its investor day, plans to reduce silicon carbide content by three quarters. I’m just wondering, in the future, how you’re looking at the design of your inverters, whether you think that you can reduce silicon carbide content -- in general, what the direction is on silicon carbide?

I’ll start with the second half of your question. The way we use silicon carbide and if you do teardowns and analysis, we use silicon carbide with a cooling on both sides. And the more power you can get through silicon carbide is related to how smart you cool those chips. And we think we’re actually more competitive from a power density standpoint, thanks to our thermal management and the cooling on both sides than some of the competitions. That’s item one. Item two, some people are talking about reduction of usage of silicon carbide and we do exactly the same. This is something that we all do and all those things are part of our product roadmap. It doesn’t mean that the need for silicon carbide is reducing. It is still increasing, and we’re very happy to have secured the capacity corridor with Wolfspeed in order to deliver on our long-range plan. The first part of your question was around what’s the share of silicon carbide versus silicon on our inverter business. I would say that, if you look at the announcement that we’ve seen, we’re more tilted towards high-end, high-voltage silicon carbide than lower voltage silicon type of products with an average price around $700 atop. So that’s why I would say we’re tilted towards the most advanced inverters in the marketplace.

And within the context of automakers trying to drive cost down to make EVs more affordable, is there -- are you seeing a push from automakers to sort of reduce the silicon carbide content to make the inverters more affordable?

The puts and takes are a little bit more complex than this, and you need to put -- take into consideration the power output, the level of battery pack, the range, et cetera. And it all depends about -- I think it all depends upon the -- what the carmaker wants to do, what car type, what end products they want to put in the marketplace. The push for efficiency is such that we don’t see a slowdown in the usage of silicon carbide. And most of the things that we see in the marketplace is pushing for more efficiency. And more efficiency, more range or smaller batteries is sometimes linked to usage of silicon carbide. But overall, you should ask the OEMs that question because the strategy that we have -- that they have is more linked to their system and how they want to put their differentiation into the marketplace.

Your next question comes from Luke Junk with Baird.

For starters, I was hoping we could just unpack what’s currently reflected in your ePropulsion gross margins there about 15.5% this quarter, not far off from Borg overall? And what’s inherent in the incremental gross profit in terms of a margin assumption as you look through the rest of ‘23, especially what you’d anticipate gross margins to look like as you ramp volumes and launch new product -- eProduct business, should we expect that margin percentage to move higher as well in addition to just the higher GP dollars?

Yes. I mean, you should expect the gross margin percentage to be improving. If you cut through the math of what’s on that slide 13, it implies that there’s improvement in gross margin. And one of the main reasons you see that is we’re growing into the fixed assets as well because there’s depreciation in the gross margin that’s not fully up to scale yet. So, by the time you get to Q4, you would expect to see an improvement from that 15% level you’re calculating.

And then, a follow-up question. Just quickly, did you say you’re expecting now slightly higher recoveries if you just speak to what’s driving that? And how that aligns with the remaining price execution this year versus what you’ve already achieved? Thank you.

Yes. Luke, it is obvious that those negotiations take some time, like it did last year. We expect that it’s not going to take as much time as last year since we have a pretty robust framework that was used last year to negotiate the inflationary headwinds. And the negotiations are happening. We’re pretty pleased with the pace that it’s going. It’s just not happening in Q1. It’s going to take Q2, maybe early Q3 to get to where we want to be.

We have time for one final question. Your last question comes from Mark Delaney with Goldman Sachs.

First one, sticking on the semiconductor side. I was hoping to better understand the flexibility that BorgWarner has as you think about procurement and supporting your customers, either in terms of having multiple silicon carbide supply sources or being able to perhaps flex between IGBTs and silicon carbide? I ask in part because you guys have made public your announcement and Wolfspeed, I think a few weeks ago, they talked about a slower ramp-up of their the Mohawk Valley fab. So anything you can help us understand around your ability to perhaps derisk from one supplier?

Yes. So, the -- we have full flexibility from a design standpoint, 400-volts, 800-volts silicon, silicon carbide, very modular, that is clear and we are pretty relevant in all those inverter types, full flexibility from a manufacturing standpoint also. Regarding the agreement with Wolfspeed, this is not an exclusive agreement. So, we can get silicon carbide from other sources, and we can also work with direct and source if the OEM wants us to work with a particular silicon carbide maker. So, we feel pretty comfortable about the different level of support and optionalities that we have related to our growth in inverters.

Very helpful context. And another was just on the design-in environment. And you guys have had for a number of quarters some good traction designing in your EV powertrain products. Given how competitive the EV market is for OEMs in terms of the prices in the market, I’m curious, are you seeing any incremental interest from OEMs turning to BorgWarner for some of your powertrain products perhaps as a way for them to be more efficient in the near term using BorgWarner as opposed to maybe trying to do some of their own work in-house? Thanks.

We’re very happy with the cadence of discussions that we have, development -- advanced development and bookings that we have with a lot of customers around the world. And the drumbeat is only increasing. It is absolutely clear that when we produce north of 3 million inverters in 2025 and 2 million to 3 million motors, scale matters, and scale brings competitiveness and scale brings the ability to design and manufacture in a very modular and flexible way. So, we’re happy with the scale that we’ve gained pretty rapidly. And what we hear from our customers is that, as usual, with BorgWarner, our products are at the forefront of efficiency. Not talking about fuel efficiency, but we’re talking about electrons efficiency and low power losses. And I think we’re doing a pretty good job here.

With that, I’d like to thank you all for your great questions today. Britney, go ahead and conclude today’s call.

This does conclude the BorgWarner 2023 first quarter results conference call. You may now disconnect.