Good morning. My name is Leo, and I'll be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2023 Third 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, Leo. 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, both on our home page and on our Investor Relations home page. 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 Investor Relations 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 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. 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 have posted today's 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 pleased to share our results for the third quarter 2023 and provide an overall company update, starting on Slide 5. With approximately $3.6 billion in sales, we delivered double-digit organic growth in the quarter. Our margin performance was strong. Our free cash flow was modestly positive in the quarter, which we believe sets us up nicely to deliver on our full year cash flow outlook. Our Charging Forward progress continued on multiple fronts. As I will discuss in a moment, our long-term Scope 1, 2 and 3 emission targets were validated by the Science Based Target Initiative, the SBTi. We secured multiple new eProduct awards during the quarter. I'm encouraged to see these awards across several parts of our portfolio both for BEVs and for several types of hybrid architectures. I continue to be impressed by the sourcing pool for our products and the strength of our EV and hybrid portfolio globally. BorgWarner continues to focus on the long-term growth opportunities in our eProduct encouraged by the high intensity of the new business quoting activities in spite of the fact that we're seeing some near-term pressures on the industry production ramp-up of electrified vehicles. Gaining scale now on EV and hybrid architectures globally is our strategy, and this remains unchanged. We're proud to be in production or launching eProducts for 7 out of the 10 leading OEMs in the electrification area as well as several other OEMs outside this top 10. Now let's turn to Slide 6, which summarizes our commitments to reduce emissions through the end of the decade. Building on our previous commitments to achieve carbon neutrality by 2035, late last year, we submitted Scope 1, 2 and 3 targets to the SBTi. In August, SBTi validated those targets in…

Thank you, Fred, and good morning, everyone. Let's dive right into the third quarter results by turning to Slide 9, where you can see our year-over-year revenue walk. Last year's Q3 revenue from continuing operations was just over $3.2 billion. You can see that the weakening U.S. dollar drove a year-over-year increase in revenue of approximately 1% or $44 million. Then you can see the increase in our organic revenue close to 11% year-over-year. We're particularly pleased that as we look at this growth, it's being driven by eProduct-related growth across all major geographies in which we operate. Finally, the acquisitions of Rhombus and SSE added $8 million to revenue year-over-year. The sum of all this was just over $3.6 billion of revenue in Q3. Turning to Slide 10, you can see our earnings and cash flow performance for the quarter. Our third quarter adjusted operating income was $349 million, equating to a 9.6% margin. That compares to adjusted operating income for continuing operations of $305 million or 9.5% from a year ago. On a comparable basis, excluding the impact of foreign exchange and the impact of M&A, adjusted operating income increased $46 million on $344 million of higher sales. This performance includes a planned eProduct-related R&D increase of $13 million. Excluding this higher ER&D investment, we converted at approximately 17% on our additional sales. As it relates to customer recoveries of inflationary cost impacts, we were able to finalize full year agreements during the third quarter with nearly all of our major customers. Those third quarter customer recoveries, net of material cost inflation from our suppliers, did not have a significant year-over-year impact on our adjusted earnings. Our adjusted EPS from continuing operations improved by $0.18 compared to a year ago by the increase in our adjusted operating income…

Thank you, Kevin. Leo, we're ready to open up for questions.

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

If I look at the full year guidance, it implies a pretty low margin or a step down in margins into Q4 of around 9.2%. Anything unusual going on in Q4 driving that weaker margin? Should we be thinking about that sort of run rate into next year? Or is this something more one-off going on in Q4?

No. I mean as we look at it overall, we're pleased with the fact that our margin percentage on a full year basis we took the bottom end of the guide up and held the top end of the guide despite some of the eProduct revenue pressure. As you look at it, what it implies at the high end of the range is Q4 is right in line with where we've been on a year-to-date basis at 9.6%. And at the bottom end of the range, we're seeing effectively a sequential decline in revenue, and we're just generating negative conversion on that. So I don't think there's anything out of the ordinary on that.

Got it. And there's obviously a lot of focus the last couple of weeks off of the EV delays. And I do remember from your Investor Day, you highlighted, and I think it was more in the 2030 time frame, that you're somewhat derisked because if EV penetration was a bit higher, you'd have higher sales but lower margin. And if it was lower, you'd have lower sales but higher margin. And dollar-wise, that might be similar. How should we think about that more near term? I mean, are you -- can you -- is there a good hedge offset? Or with all the engineering that's required ahead of these EV launches, that's going to be a bit of a burden if the EV volumes are pulled back a bit in the near term?

Colin, I think you're right. The portfolio is resilient, and that's exactly why we've structured it that way. And that's what we presented in the Capital Market Day. And it's resilient under a wide range of scenario. And I think what you see also this year is an example of what happens, E going down and and actually margin is slightly going up. And you see that the top line is somehow resilient too. So this is absolutely the purpose of the portfolio the way it's laid out. We have a great portfolio to enable growth in E. But if you see a slowdown, the products that we have in combustions are going to generate proceeds, cash and earnings.

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

Maybe I can follow up on Tom's question in 3 kind of distinct ways. If we look at Slide 8, just curious why you've taken down '23 and '25 and maybe not reconsider '27. And then also, as we look at this, Fred, to your point, I mean, you guys have set yourself up well to deal with the volatility here. So kudos to you for doing that. But is there an opportunity potentially on the ICE side of the business to maybe get better economics because the automakers are meeting you in this direction of investing in EV products? Then also on the EV product side, is there -- can you just talk about sort of the structure of those contracts, their buying guarantees? If they're widely missing or pushing programs out, are you protected in some way, shape or form on those contracts?

A lot of questions, John, in one question. Let me take it in pieces. So first, '23, '25, '27, right? That's a bit of your question. So '23, when you look at the reduction, it's mostly in our ePropulsion segment. It's coming from, as you mentioned, timing of launches and volume reduction, volume reduction in ramp-up. And since we're launching a lot of new products, a delay has a big impact in the quarter and a delay -- and a ramp-up change has a big impact in the quarter. We continue to see volume pressures. But if you take a step back, in fact, it was still growing 40% year-over-year. So that allows us to. When you look at beyond 2023, we've looked at program by program looking at '25. And from what I remember, we announced 29 programs in June, and we booked more programs. seeing a lot of programs. What we see potential delays and downsides enjoy '22 to '23. In '27, we have a strong new business that will be very comfortable with p '25, the launching '25, '26, '27. And so we see a path to $10 billion. But also we've structured the portfolio to be resilient under a wide range of scenario. Again, when you look at the CAGR, '25 to '27, if you take out $1.7 billion of acquisition that we've also taken into account in the $10 billion, CAGR is about 35%, which is a little lower than '22 to '23. That's why we feel comfortable about the fact that the long-term prospect is unchanged. Yes, I think you had a question...

I can talk about the others. I think you had a question about -- on the foundational and if there's a longer tail on that, are there opportunities there. I think you were maybe alluding to pricing. I mean, overall, our objective as part of Charging Forward 2027 is to sustain that strong margin profile we've had in the business. And that means we look at all aspects of the P&L, whether it's on the cost side or the pricing side to make sure that we're driving towards that. And so we'll continue to work with our suppliers, we'll work with our customers to make sure that we're executing successfully on that. And then the last thing I think you asked about was on EV contracts and how they're structured, particularly in light of some of these volume shortfalls. As we've talked about in the past, one of the things that we've made at a particular area of focus when we book new business on E because of a lot of the uncertainty around the ramp-up of E programs is to make sure that we put volume clauses in those agreements. And those volume clauses traditionally work like they've worked historically for us in a way where if volumes are outside a certain band, then there is a discussion that happens between us and our customer about how we ensure that we recoup investment or pricing or some other adjustment to make sure that we're not out for the fact that the revenue came in significantly short. So as we head into 2024, we're going through our planning process right now. You can imagine that's something we're thinking about.

Your next question comes from Emmanuel Rosner with Deutsche Bank.

One follow-up on the ramp-up in eProduct revenue -- maybe actually a couple of follow-ups, if I may. First of all, how did you go about the assumptions that are now underpinning your new revenue walk? I assume, obviously, for 2023, you have direct production schedules and commentary from the automakers. But as you move into sort of like mid-decade, is this sort of like a top-down approach or like EV adoption or penetration curve or assumptions that you could share with us? Or how do you compare with previous one?

Emmanuel, so for 2023, it's obviously linked to EDIs and schedules and detailed discussions that we have with our customers. It's the same for '25. '25 is a bottom-up line-by-line analysis of programs by programs and launch timing accuracy and discussion with our customers. '25 revenue is just around the corner. So we know pretty well, and we see pretty well through when the customers are going to actually launch those programs and the impact that this has on 2025.

I guess, if I could follow up on this, and I do have another question after that, but just following on this one. I'm struck by the fact that some of the large North American OEM, for example, have obviously pushed out meaningfully some volumes in the near term and certainly next year as well being pushed out. But at the same time, in some cases, sort of like pretty forcefully sort of left unchanged like for a some of the midterm or mid-decade targets. And so I'm sort of like wondering, how could you give investors confidence around the amount of derisking that you have now embedded in your sort of like mid-decade revised outlook?

Emmanuel, we're launching globally. It's just not the North American OEMs. As we mentioned before, we're launching programs -- around 35 new programs that we've announced over the past quarters with 7 out of the 10 largest OEMs in the electrification area and a few others outside of the top 10. So the view that we have is a real global view. As you remember, we were pretty relevant in China and still are. We're launching a lot of new products in Europe, and we're launching in North America. But our view is very global.

Understood. My follow-up is on hybrid. Can you just remind us, as part of this new product, how much is hybrid in terms of revenue contribution? And importantly, are you seeing any movements from important customers and automakers towards essentially maybe growing hybrids faster than previously expected as a way to better respond to market demand right now with the EV slowdown?

We've always been a player in hybrid powertrain, in essentially high-voltage plug-in hybrids, a few range extender programs in China. This product portfolio is absolutely relevant for BEVs and hybrids. And in hybrids, most of the combustion products that we had also see a path because there is no hybrid without an efficient combustion engine. Our content per vehicle on hybrid is pretty similar than the ones that you have on BEV. So electrification accelerates our growth, whether it's BEV or hybrids. We've always seen a traction on hybrids, and we're happy to be on some key platforms globally on hybrid powertrains.

Your next question comes from Luke Junk with Baird.

A couple of bottom line really questions around eProduct. First one for me would just be how we should think about the trajectory of eProduct RD&E going forward. I'm thinking over the next couple of years, maybe. And how you might be able to manage that relative to the lower forecast volumes that you're looking at as well as, I guess, the offsetting pressure from the continued high level of RFQ activity that you're seeing in the market?

Yes. A couple of things on that. I mean one of the things that we showed in Investor Day, and it continues to be our plan, is that the pace at which the investments are growing is slowing for us which is why we expect to get the scale benefit flowing through the P&L as eProduct revenue ramps up. And you can actually see that happening this year, even while we're seeing a year-over-year increase in eProduct-related R&D as we've talked about in that range of $60 million to $70 million. As you look at it sequentially each of the last couple of quarters, it's actually been only growing about 2% to 4% the last couple of quarters. And it will be relatively flat to slightly up in the fourth quarter on a sequential basis, point being the pace at which we're seeing the growth in the investments isn't growing as quickly as the pace we expect revenue to grow. And that's the path to profitability. Now in terms of what we might do going forward, just -- it's important to keep in mind, we're in the midst of our annual budgeting and long-range planning process right now. And as we're going through that process, we will continue to look at what, if any, adjustments we need to make to manage the profitability of the business over the near term and the medium term, but importantly, balancing it to the point you made: making sure that we're balancing it with the need to ensure we're executing on the long term. Because we continue to believe that the long-term outlook and trajectory for electrification looking out through 2017 and beyond remains intact. So we'll go through that process, and we'll provide you more insight on how we're seeing that when we get on the Q4 call in February.

One thing I would add is, as we presented in our Capital Market Day, with the scale that we have and the number of programs that we're launching and developing globally, that allows us to really implement a very modular design approach that builds from from previous developments and also very flexible and modular production strategies. And that's very important when we grow and scale up.

And then for my follow-up question, just hoping you could speak to the flexibility in your manufacturing footprint protect margins given variable outcomes around eProduct. And I'm thinking specifically as you flex between foundation and EV products in shared facilities, just how much that can help to protect any leakage amid what looks like lower EV volumes from here, both maybe what we saw in the quarter and how that might look over the next couple of years.

Yes. And we are leveraging the existing footprint that we have. As we discussed before, so far, we are leveraging 25% of our existing facilities around the globe to launch eProducts. And that gives us some flexibility from a facility, from a four-wall perspective. But we also are focusing a lot on flexible manufacturing, where we're not investing production equipment for a particular program, a particular customer but having several types of products flowing through production lines, whether it is power electronics-related, motor-related or, I would say, transmission- or iDMs-related. So we are pretty pleased with what we are doing as far as leveraging the existing capacities and capabilities, including human capabilities.

Your next question comes from Dan Levy with Barclays.

One, just wondering on the ICE business itself. To the extent that that EV uptake is a little lighter in the near term than what some have anticipated and ICE is a little heavier, should we just think of the benefit to you as purely incremental sales flowing through at normal incremental margin? Is there any offset we should be thinking about that?

Yes. I mean, I think it's fair to think about it in the short term much the same way we characterize it in the long term at Investor Day. I think we -- with the content opportunity per vehicle that we have on electrification, as the pace of electrification accelerates, it provides us an opportunity to grow our revenue more quickly, but it probably puts a little bit more pressure on the absolute margin percentage that we're delivering. But if electrification across the industry slows down a little bit, it probably slows the revenue growth, but it probably improves our margin profile. You saw that a little bit maybe here in the full year 2023 guidance that we have, but that's consistent with our long-term view as well. I think overall, taking a big step back, we feel like -- that's why we think our portfolio is really resilient from a financial perspective. Because whether EV adoption is accelerating or decelerating, the portfolio is positioned to deliver comparable levels of adjusted operating income over the long term under any of those outcomes.

Got it. And then as a follow-up, I wanted to just go to the question on sourcing that's been asked in the past. And I think one of the commentary that we heard from some of your OEM customers is that with a lighter EV outlook, this may change the way they are thinking about vertical integration within EVs, EV components, et cetera. Are you seeing any impact in your discussions on the automakers that previously may have been a bit more keen on vertical integration that are now realizing maybe they don't have a scale at this level of volumes that are more willing to engage with you as a partner on the EV powertrain components that they need?

Dan, we're starting seeing that. And as you mentioned, I think this makes sense. We have a very solid and recognized portfolio. We're already incumbent at many customers, and we have the financial strength to support them. So I would not call it a trend, but I would say that we're seeing beginnings of discussion along those lines. And I would say that the major onboard charger business that we have announced today that we booked with a global North American OEM is a sign of that.

Your next question comes from James Picariello with BNP Paribas.

Can you just put a finer point on what the potential range in margin benefit could be associated with the lower eProduct revenue now slated for 2025? Because they should lead to additional ICE and hybrid business, assuming there's a decent overlap in your customer bases on both sides of the propulsion mix?

We're not prepared to address a specific margin in 2025. I think we showed you, though, the long-term trajectory of what it could look like as you head out to 2030. We tend to think that we're going to operate into the mid-9s trending towards 10% margin as we look through our planning horizon and then being plus or minus that depending on where the ePropulsion markets actually go. But not prepared at this point to comment on '25.

Okay. And then just on this year's guidance, we could, of course, quantify the impact to lower eProducts for you. But just high level, what else is driving the lower growth of the market because it cuts about 4 points? Like what element of this could be attributed to lower recoveries due to lower inflation versus customer and regional mix factors?

Yes. I mean, overall, as we've talked about in the past, we're really focused on the organic growth. And before, we were guiding to 12% to 15% effectively, and now we're at 12% to 14%. So we feel pretty good about that. The biggest driver of the drop in revenue and any of outgrowth math that you would do is really that $300 million drop in the eProducts revenue outlook. We have also factored in some element of the impact of the UAW strike that we've incurred to date and assume that, that doesn't recover through the end of the year. It's less than $100 million, but it's still an impact on the company and embedded in the numbers as well.

Your next question comes from Joseph Spak with UBS.

Kevin, maybe just to follow up on that. That $100 million, that's a fourth quarter impact on the strike or a full year impact?

Both. It's less than $100 million, but it's still an impact on the guide. But it's in the fourth quarter. We didn't really have any impact -- any material impact in Q3.

Okay. And then I just want to circle back to sort of this whole slower eProducts ramp and the path to profitability. Like it seems like -- and you've communicated that a lot of your launches are in China, a lot of new business in China, where we really aren't seeing some of that slower growth. Obviously, there's some lower volume with some North American products. But I guess, I'm wondering why there would be such a meaningful impact to the profitability ramp, if that is the case. Or are you also sort of taking a more cautious view on some of the the pace of those Chinese and Asian ramps or -- and maybe some challenges given the quantity of the ramps and making sure you execute all those flawlessly?

Joe, I think there is a difference between what we see in fine-tuning the timing of launches and ramp-up and overall, what you see in the Chinese market -- what you can read in the Chinese market. And so the impact of a quarter delay in a launch is 100% of impact in the quarter. And so that's why it's a little volatile. That's what I would tell you. This is what we see on the ground with slightly slower ramp-up and a few programs that are delayed by a few months.

Joe, just to add to that. I mean, yes, as you look at -- we're still in the early days of growth from an electrification perspective at BorgWarner. And so those quarterly moves right now, until we get to more scale, have a significant impact. And as you look at right now through really 2025, maybe even into 2026, it's a big ramp-up phase for BorgWarner while we're still at a relatively modest level of revenue. And so some of those movements in launches and ramp-up timing can have a meaningful impact on the numbers in a quarter or for a particular year.

And maybe just to follow up then, like of the reduction to the '25 eProducts, can you give us a sense regionally of where that's coming from? Is it predominantly North America and maybe a little bit of Europe? Or is it broad strokes across all the launches?

In terms of the $300 million, you're saying?

Yes, exactly -- no, in the '25 -- reductions in the '25.

It's really across regions. I mean, we've gone back and, as Fred mentioned, taken a look program by program and looked at what we think the cadence is likely to be for some of those launches in light of some of the things that we're seeing in terms of near-term headwinds. And as we look at that and assess what we think the likely ramp up is, we think it probably puts us more on track towards that $5 billion level. But as Fred also indicated, the reason we're giving a range now as we've layered on an incremental risk to say what if there are further delays, particularly on the ePropulsion portfolio in terms of those launches getting delayed another X number of months. And that's what we've layered on to get to the $4.5 billion as a downside to that range.

We have time for one final question, and that question comes from Noah Kaye with Oppenheimer.

Just first, wondering to follow up on that one, if we can get color. Just on the product mix in terms of programs being delayed or pushed out, if we think about the product mix for '25 in the adjusted revenue number, does this still skew heavily towards power electronics -- does it skew even more so? Is power electronics less represented versus some of the other programs? I'm just trying to understand where in the portfolio you're expecting relatively strong sell-through.

Yes. I mean, I think as we look at where we think the biggest pressure is, most of it is really hitting in the ePropulsion segment. As we look at the battery pack business, for instance, we actually think -- continue to see really strong demand there relative to our prior planning assumptions. And it's really more of a supply-constrained situation there than a demand-constrained situation at the moment. So it does tend to be more in the ePropulsion segment where we're seeing some of the headwinds.

Okay. That's very helpful. And second, just to touch on your M&A outlook. How does the dynamic that you're describing today impact your appetite to do further M&A? What is sort of the assumed M&A contribution now to the '25 outlook? I think at Investor Day, you had indicated there would be some additional M&A to be completed to support the outlook. Do you take a pause there? Do you assess what you have in the current portfolio? Just trying to understand.

So we will always assess M&A from a technology standpoint. I would say that we are at the verge of closing a transaction that we've already announced that will give us even more strength on accessory power electronics. I would say that the current market does not change our appetite on M&A towards E. And I would say the current environment might also help us from a valuation perspective. And we're always going to stay very opportunistic along those lines but also very, very disciplined as we've always been.

Thank you all for your questions today. If you have any additional follow-ups, feel free to reach out to me or any member of my team. With that, Leo, you can conclude today's call.

That does conclude the BorgWarner 2023 Third Quarter Results Conference Call. You may now disconnect.