BorgWarner Inc. (NYSE:BWA) Q1 2023 Earnings Call Transcript

BorgWarner Inc. (NYSE:BWA) Q1 2023 Earnings Call Transcript May 4, 2023

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

Patrick Nolan: 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.

Fred Lissalde: 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 dedicated hybrid transmissions and range-extended electric vehicles with mass production expected to start in August 2023. We’re excited to supply this leading Chinese OEM with a new motor application, strengthening our partnership by providing them with the support needed to meet the growing challenges in new energy vehicles. Next, BorgWarner has partnered with the Pontiac, Michigan School District to provide direct current fast charges to support the district’s electric school buses.

This program will utilize BorgWarner sequential charging technology that allows up to five dispensers to charge from a single power control system. This greatly reduces the initial investment and lowers installation costs while providing the ability to charge at DC fast charging levels. Next, BorgWarner has been selected by a global commercial vehicle manufacturer to provide eFans for battery electric trucks in both the North American and the European market with production expected to begin in 2025. For this project, BorgWarner will supply its complete eFan R10 system, which includes a fan, an eMotor and an integrated high-voltage inverter. Notably, the high-voltage inverter utilizes the expertise and capabilities of Drivetek, the company acquired in December of last year.

Now, let’s look at the growth and expansion of our battery pack business on slide 7. BorgWarner has been selected by a global power technology company to supply battery packs for a series of electric buses with production beginning earlier this year. This battery pack contains state-of-the-art safety features including current overcharge protection, cell-level passive propagation resistance and electrical disconnect at the individual sale wire bonds that satisfy the industry’s strict electric vehicle battery safety standards. During the quarter, BorgWarner announced plan to expand its Seneca, South Carolina production facility by adding battery module Production to the facility. After this expansion, BorgWarner is expected to have annual U.S. battery module capacity of approximately 3 gigawatt hour.

This investment will contribute to the growth of the Company’s battery module and pack production in the United States, focused on commercial vehicles, trucks and buses. Our battery pack business is exceeding our initial expectations. Last quarter, we increased our 2025 revenue outlook for this business to approximately $1 billion, five years ahead of our 2030 business case when we announced the AKASOL acquisition. We expect volume demand from our largest battery pack customers to continue to grow, and we have secured multiple new product awards for our battery pack business over the past two years. We’re also making the organic investments to support this growth. This year, we expect to invest approximately $100 million of CapEx to support this business growth, which is a big driver of the step-up in our CapEx outlook for 2023 versus last year.

So in our opinion, the AKASOL acquisition from two years ago is poised to deliver well above our initial expectations. But now I’d like to turn our attention to how last year’s Santroll’s acquisition is performing on slide 8. Similar to our battery pack business, the revenue related to Santroll’s eMotor business has tracked ahead of the expectation we had at the time we announced the transaction. In 2024, we expect this business to generate approximately $250 million of eProduct revenue, about 40% higher than our original acquisition planning. If you recall, a key pillar of the transaction was for Santroll to improve our cost competitiveness through improved eMotor design and manufacturing capabilities. As a result of improvements that we are achieving, we expect this business to already approach BorgWarner’s average profitability levels by 2024.

We expected this business to increase our speed to market and increase our scale in eMotors, and we are seeing just that in our bookings, which are shown on the right side of the slide. The takeaways from today are this: BorgWarner’s first quarter results were broadly in line with the directional guidance that we provided on our earnings call last quarter. Importantly, our sales growth once again outperformed the industry, and we continue to make investment to support our growth. As Kevin will detail, we expect another year of strong top line growth in 2023, especially driven by strong demand of our eProducts. Our guidance is also increasing based on FX tailwinds. We continue to expect our eProduct portfolio to approach breakeven in late 2023, early 2024 and our new segment disclosure will help provide evidence of this.

Looking beyond the near term, we believe we are successfully executing on our long-term strategy, Charging Forward, which we expect will deliver value to our shareholders long into the future. Before I turn the call over to Kevin, I would like to again share a thank you to the BorgWarner team. Proud to see both our eProduct and our foundational businesses supporting our profitable growth in 2023. The progress made in just over two years since announcing Charging Forward is truly remarkable. It is the entire BorgWarner team and our culture of execution that continue to be the drivers of our ongoing success. With that, let me turn the call over to you, Kevin.

Kevin Nowlan: 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 Q1 to have a higher level of material inflation headwinds as we’re still in the process of negotiating with our customers the extent to which cost recovery mechanisms from 2022 carry into 2023. We expect to largely complete these discussions over the next couple of quarters, which is one of the reasons we thought we would have a lower margin in Q1 relative to the remaining quarters of 2023. Excluding these higher costs, both eR&D and net material inflation, we converted at approximately 19% on our additional sales. Our adjusted EPS improved by $0.04 in the first quarter compared to a year ago, driven by the increase in our adjusted operating income and a lower year-over-year share count resulting from the $240 million of share repurchases we executed last year.

And finally, free cash flow. Our free cash flow was a $290 million usage during the first quarter due to higher capital spending to support our growth in eProducts, increased working capital during the quarter, and the annual payout of the Company’s incentive compensation for the prior year’s performance, which we normally make in Q1. You’ll note that the rate of capital spending during the first quarter was ahead of the pace implied by our full year guidance. However, this was in line with our internal planning as we’re putting in place the capital that we believe is necessary to support the ramp-up in our eProduct revenue. Let’s now turn to slide 11, where you can see our perspective on global industry production for 2023. We expect our global weighted light and commercial vehicle markets to be flat to up 3% this year, which is unchanged compared to our prior guidance.

However, within this overall outlook, our regional expectations are mixed. Specifically, in North America, we’re planning our weighted markets to be up about 1% to 5%. In Europe, we expect our blended markets to be roughly flat to up 2%, which is a bit higher than our previous forecast based on the stronger start of the year. And in China, we expect the overall market to be down approximately 3% to up 2%, which is slightly worse than our previous expectation due in large part to the weaker-than-anticipated production we saw during the first quarter. Now, let’s take a look at our full year outlook on slide 12. First, it’s important to note that our guidance now assumes an expected full year tailwind from stronger foreign currencies of $55 million.

This is an improvement of $340 million in revenue versus our prior guidance. Second, as I previously mentioned, we expect our end markets to be flat to up 3% for the year, which contributes to the organic net sales change you see on the slide. But more important than the modest growth in end markets, we expect our revenue to continue to grow in excess of industry production, driven by our expectations for a modest increase in inflationary cost recovery from our customers and various expected new business launches, especially in our eProduct portfolio. As it relates to eProduct revenue, we are expecting to deliver between $2.3 billion and $2.6 billion in 2023, which is up significantly from the approximately $1.5 billion we generated in 2022.

Finally, the Santroll, Rhombus and SSE acquisitions are expected to add $70 million to 2023 revenue. Based on these expectations, we’re projecting total 2023 revenue in the range of $17.1 billion to $17.9 billion, which equates to organic growth of approximately 7.5% to 12.5%. This is higher than our previous revenue guidance of $16.7 billion to $17.5 billion due to foreign currencies, the impact of the recently completed acquisition of SSE and our slightly higher customer recovery expectations. Switching to margin. We continue to expect our full year adjusted operating margin to be in the range of 10.0% to 10.4% compared to our 2022 margin of 10.1%. As it relates to R&D, our full year 2023 guidance continues to anticipate a $60 million to $70 million increase in eProduct-related R&D investment.

With our ongoing success securing new electrified business wins, we’re continuing to lean forward by investing more in R&D to support our eProduct portfolio. Excluding the impact of this increase in eProduct related in R&D, our 2023 margin outlook contemplates the business delivering full year incrementals in the mid-teens, inclusive of net inflationary headwinds of around $65 million. Based on this revenue and margin outlook, we’re expecting full year adjusted EPS in the range of $4.60 to $5.15 per diluted share. Turning to free cash flow. We continue to expect that we’ll deliver free cash flow in the range of $550 million to $650 million for the full year. As a reminder, this cash flow outlook includes onetime cash cost of approximately $150 million related to the planned spinoff of our Fuel Systems and Aftermarket businesses.

Excluding this onetime cost, our free cash flow guidance would be $700 million to $800 million which is only slightly lower than the record free cash flow of $846 million we generated in 2022. That’s our 2023 outlook. Turning to slide 13, you can see our new segment disclosure for ePropulsion. In an effort to increase transparency into our eProduct profitability, we’ve made the decision, starting with the first quarter to break our previous ePropulsion & Drivetrain segment into two separate external reporting segments: ePropulsion and Drivetrain & Battery Systems. Our ePropulsion segment includes multiple eProducts, including inverters, eMotors, eGearDrives, IDMs and other power electronics, such as onboard chargers. We expect these eProducts to account for roughly two-thirds of the segment’s revenue in 2023.

In addition, the ePropulsion segment is expected to account for approximately two-thirds of BorgWarner’s total eProduct revenue in 2023. As you can see, the business reported a negative operating margin in the first quarter, but it’s expected to have a slightly positive margin by the fourth quarter. We believe a significant driver of this improved margin outlook will be the conversion on the growth in eProduct revenue as quarterly segment revenue is expected to grow to $750 million to $850 million by the fourth quarter compared to $487 million of revenue in Q1. And as you can see, the expected growth in eProduct R&D isn’t expected to keep pace with the growth in revenue and gross profit in the coming quarters. The result is an increasing operating margin for the ePropulsion segment.

Importantly, we expect profitability to continue to improve as we look forward beyond 2023. We believe this is a very good illustration of the profitability trajectory of our eProducts more generally. That’s because we expect that as each eProduct starts to see acceleration in revenue growth, the conversion on that growth starts to overcome the upfront cost of R&D and other investments, thereby leading to profitability. So, let me summarize my financial remarks. Overall, our first quarter results were broadly in line with our prior outlook. We outgrew the market with growth driven by various eProducts and foundational products, and our incremental margin performance, excluding planned eR&D investment and net inflation was strong. In addition, we continue to take steps to increase the financial transparency of our eProduct businesses.

As we look ahead in 2023, we continue to expect to deliver strong revenue outperformance compared to industry production, to complete the work to successfully spin-off PHINIA, which we now expect to happen by the end of the third quarter and to continue to make the necessary investments to support the profitable growth of our eProduct portfolio. With that, I’d like to turn the call back over to Pat.

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

Q&A Session

Operator: Your first question comes from Morgan Langan with Wells Fargo.

Colin Langan: 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?

Kevin Nowlan: 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.

Colin Langan: 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?

Kevin Nowlan: 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.

Colin Langan: 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?

Kevin Nowlan: 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.

Colin Langan: 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?

Kevin Nowlan: 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.

Operator: Your next question comes from Noah Kaye with Oppenheimer.

Noah Kaye: 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?

Fred Lissalde: 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.

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

Fred Lissalde: 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.

Noah Kaye: 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?

Kevin Nowlan: 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.

Operator: Your next question comes from James Picariello with BNP Paribas.

James Picariello: 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?

Fred Lissalde: 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.

Kevin Nowlan: 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.

James Picariello: 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?

Kevin Nowlan: 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.

Operator: Your next question comes from Emmanuel Rosner with Deutsche Bank.

Emmanuel Rosner: 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?

Kevin Nowlan: That’s correct.

Emmanuel Rosner: 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?

Kevin Nowlan: 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.

Emmanuel Rosner: And this is tied to the timing of your launches?

Kevin Nowlan: 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.

Emmanuel Rosner: 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?

Kevin Nowlan: Predominantly electronics.

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

John Murphy: 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? right now, and they’ll get to breakeven or better by the end of the year?

Kevin Nowlan: 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.

John Murphy: 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?

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

John Murphy: 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?

Kevin Nowlan: 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.

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

Kevin Nowlan: Ballpark.

John Murphy: 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?

Kevin Nowlan: 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.

Fred Lissalde: 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.

Operator: Your next question comes from Adam Jonas with Morgan Stanley.

Adam Jonas: 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?

Fred Lissalde: 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 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.

Adam Jonas: 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?

Fred Lissalde: 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.

Operator: Your next question will come from Dan Levy with Barclays.

Dan Levy: I wanted to just start 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?

Kevin Nowlan: 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.

Dan Levy: 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?

Fred Lissalde: 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.

Dan Levy: 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?

Fred Lissalde: 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.

Operator: Your next question comes from Luke Junk with Baird.

Luke Junk: 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?

Kevin Nowlan: 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.

Luke Junk: 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.

Fred Lissalde: 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.

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

Mark Delaney: 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?

Fred Lissalde: 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.

Mark Delaney: 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.

Fred Lissalde: 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.

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

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