Good morning. My name is Leo, and I will be your conference facilitator. I would like to welcome everyone to the BorgWarner 2023 Third Quarter Results Conference Call. I will now 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 foreign exchange, net mergers and acquisitions, 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 foreign exchange and net mergers and acquisitions. 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 which we have committed to reduce Scope 1 and 2 emissions 85% by 2030 and Scope 3 25% also by 2030. BorgWarner's Charging Forward strategy is expected to play a pivotal role in reducing Scope 3 emissions as the portfolio shifts towards our e-mobility products. We will also focus on how we design and purchase those products and components. From a design perspective, we're expanding our circularity efforts and placing a greater emphasis on lightweighting. Within the supply chain, BorgWarner is working to enhance our green material sourcing and supplier contributions to our goals. We're proud to have our targets validated by the SBTi as it affirms the direction we are headed and the positive impact we're making in furthering our vision of a clean, energy-efficient world. Now let's look at some new eProduct awards on Slide 7. First, BorgWarner will supply a bidirectional 800-volt onboard charger to a major North American OEM. This onboard charger will be on premium passenger car BEV platforms with an expected start of production in early 2027. The technology leverages BorgWarner's silicon carbide power switches for improved efficiency and delivers superior power density and safety compliance. This is a big accomplishment for the BorgWarner team, highlighting our first major eProduct win with this OEM and also our first onboard charger win in North America. Second, at the IAA in September, we disclosed that BorgWarner will supply silicon carbide inverters for Volvo cars' next-generation electric vehicles. Next, BorgWarner entered into an agreement with a major global OEM to supply its 400-volt high-voltage cooling meters for the automaker's European light vehicle program. We anticipate the start of production in 2026. This business win marks the second recent contract secured with this global OEM over the course of just a few months with wins spanning different regions. Finally, a premium European OEM has awarded BorgWarner a program to supply combined inverters and DC/DC converters for use in the customer's always drive B and C segment hybrid applications. Production of this program is expected to start in 2025. By combining the inverter and converter elements, we can manage both the electric drive and the accessory systems of an electrified vehicle, in this case, a hybrid, in a lighter, smaller and more cost-effective package. Our knowledge, scale, and production experience on inverters, DC/DC converters and onboard chargers or what I would call power conversion technology is a key enabler for BorgWarner to be adding value to our customers by combining these technologies into efficient system packages. Now let's touch on our eProduct sales outlook on Slide 8. Today, we're reducing our 2023 eProduct sales outlook by about $300 million. The two largest drivers of the adjustments are launch delays and forecasted slower volume ramp-ups from customers. We now expect eProduct sales to increase by about 40% year-over-year. As we have seen these continuing near-term pressures on electrified vehicle production in the marketplace, we have taken the opportunity to reassess what that might mean looking out over the next few years. Looking through that lens, we do believe this has the potential to impact industry-wide new energy vehicle production over the next couple of years. As such, we now expect our eProduct sales to be in the range of $4.5 billion to $5 billion in 2025. As we have looked at the situation program by program, it is our view that the headwinds we are seeing are likely to be short to midterm in nature. As we look further out, we continue to believe that the long-term trends towards electrification remain strong. That is why our view of overall industry penetration of electrified propulsion is unchanged looking out to 2027. I would make the following three additional observations. First, we have seen no meaningful changes in the world of quoting activity from our customers. We continue to secure new business awards that are very much supportive of our long-term revenue objective. The pace of new business development has not slowed. Second, our estimated midterm exposure to eProduct customers and regions is well diversified. As we are in the early stages of eProduct revenue growth in 2023, BorgWarner does tend to be currently more exposed to a handful of important launches and ramp-ups of customer products, particularly in China. As we look further out and announce many additional programs over the next two years, we expect to benefit from more diversity in the portfolio. Our 2027 eProduct revenue expectations are fairly balanced across customers, across regions, as well as across vehicle sizes. Third, we believe our long-term profitability objectives are still intact. As we've told you previously, the biggest driver of our improving eProduct profitability is our ability to leverage the rapidly increasing scale of the business. Since that ramp-up is not happening as quickly as we previously anticipated, it means the path to our ePropulsion segment achieving break-even margin is slightly delayed. As we look ahead to next year, we will assess what, if any, actions are necessary to appropriately balance near-term margins relative to our long-term objectives. Regardless, break-even margins remain in sight and our 2027 outlook remains unchanged, both from a revenue perspective and a profitability perspective. The takeaways from today are these: BorgWarner's third quarter results were strong. We delivered strong organic growth and margin performance. As we wrap up 2023, we expect to finish with another year of strong top-line growth, top-quartile margins, and solid free cash flow generation. As we look at our Charging Forward strategy, which is focused on aggressively positioning the company to win in the world of electrification, we do see some near-term, industry-wide challenges that we will manage through. We remain convinced in the long-term prospects for electrification and believe we are successfully executing on our strategy in that regard. I have stated on multiple occasions that the industry growth in BEV and hybrid will not be a straight line. The near-term volatility, while frustrating, is not entirely surprising given the magnitude of the industry shift. As we highlighted in our Investor Day in June and as you can see evidenced in our Q3 results and full year guidance, we believe that we have structured our portfolio to be resilient and to deliver strong earnings under a wide range of BEV and hybrid penetration scenarios. That is true today, and we fully expect that this will also be true going forward. With that, I will turn the call over to Kevin.

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 mergers and acquisitions, adjusted operating income increased by $46 million on $344 million of higher sales. This performance includes a planned eProduct-related R&D increase of $13 million. Excluding this higher R&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 and lower effective tax rate. Finally, free cash flow generation from continuing operations was $36 million during the third quarter. Now let's take a look at our full-year outlook on Slide 11. Our guidance now assumes that weaker foreign currencies will reduce revenue by $110 million in 2023. This is a headwind of $75 million in revenue versus our prior guidance with the Chinese yuan and the euro being the largest drivers of the change in our outlook. Second, we expect organic growth of approximately 12% to 14% year-over-year compared to our prior guidance of 12% to 15%. The narrowing of this outlook incorporates both an increasing industry production outlook as well as our updated outlook for eProduct revenue. As Fred mentioned earlier, we're now expecting eProduct revenue of between $2.0 billion and $2.1 billion in 2023, which is up from the approximately $1.5 billion we generated in 2022, but that's down from our prior guidance of $2.3 billion to $2.4 billion. That decline is due to a number of customer programs that include our ePropulsion products experiencing launch delays or ramping up more slowly. Finally, the Santroll, Rhombus and SSE acquisitions are expected to add approximately $63 million to 2023 revenue. Based on these expectations, we're projecting total 2023 revenue in the range of $14.1 billion to $14.3 billion, which compares to our prior guidance of $14.2 billion to $14.6 billion. Let's switch to margin. We expect our full-year adjusted operating margin to be in the range of 9.4% to 9.6%, which compares to our prior guidance of 9.2% to 9.6% and our 2022 margin of 9.3%. 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. Despite the near-term eProduct revenue headwinds, we continue to see significant new award and quote activity. Therefore, we're investing in eProduct-related R&D to support those growth opportunities consistent with the plan we outlined at the beginning of the year. Excluding the impact of this planned increase in eProduct-related R&D, our 2023 margin outlook contemplates the business delivering full-year incrementals in the high teens. Based on this revenue and margin outlook, we're expecting full-year adjusted EPS from continuing operations in the range of $3.60 to $3.80 per diluted share. Turning to free cash flow. We expect that we'll deliver free cash flow from continuing operations in the range of $400 million to $450 million for the full year. This compares to our prior guidance of $400 million to $500 million as we expect capital spending to come in at around $800 million, in line with the high end of our prior CapEx guidance range. Our cash flow guidance contemplates a strong Q4, which is normal for us due to seasonality and traditionally strong working capital performance. But in addition to those typical trends and similar to last year, we expect to collect in Q4 a significant portion of the full-year customer inflation recoveries that we've negotiated to date but have not yet collected. That's our 2023 outlook.

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

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.

I understand. Recently, there has been significant attention on the delays in electric vehicles. I recall from your Investor Day that you mentioned, particularly looking towards the 2030 timeframe, that you are somewhat insulated from risks. If electric vehicle adoption increases, it could lead to higher sales but lower margins, while a decrease in adoption would result in lower sales but higher margins. In terms of dollar amounts, those scenarios might balance out. How should we approach this in the short term? Is there an effective hedge or offset? Or will the extensive engineering needed before these electric vehicle launches pose challenges if volumes drop in the short 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 scenarios. And I think what you see also this year is an example of what happens if EV goes down 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 electrification. But if you see a slowdown, the products that we have in combustions are going to generate proceeds, cash, and earnings.

I would like to follow up on Tom's question in a few distinct ways. Looking at Slide 8, I'm curious why you've lowered the expectations for '23 and '25 but not reconsidered '27. Additionally, Fred, to your point, you have positioned yourselves well to handle the volatility, so great job on that. Is there an opportunity on the ICE side of the business to achieve better economics since automakers are increasingly invested in EV products? Also, regarding your EV products, can you discuss the structure of those contracts and whether there are buying guarantees? If they are significantly off track or if programs are delayed, are you safeguarded in any way with those contracts?

A lot of questions, John, in one question. Let me take it in pieces. 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 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 in '22 to '23. In '27, we have a strong new business that will be very comfortable with. We're launching in '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 scenarios. Again, when you look at the CAGR, '25 to '27, if you take out $1.7 billion of acquisitions 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.

I can discuss the other points. You had a question regarding the foundational aspect and whether there is a longer tail on that, as well as opportunities related to pricing. Our goal as part of Charging Forward 2027 is to maintain the strong margin profile we've established in the business. This involves examining all facets of the profit and loss statement, including both cost and pricing, to ensure we are making progress toward that goal. We will continue to collaborate with our suppliers and customers to ensure successful execution. Additionally, you inquired about how EV contracts are structured, especially given some of the volume shortfalls. As we've mentioned previously, we have made it a priority to incorporate volume clauses in our new EV business agreements due to the uncertainties surrounding the ramp-up of EV programs. These volume clauses typically operate as they have historically; if volumes fall outside a specified range, we engage in discussions with our customer to determine how to recover our investment or adjust pricing to mitigate any significant revenue shortfalls. As we approach 2024, we are in the midst of our planning process, and this is certainly an aspect we are considering.

I have a follow-up regarding the increase in eProduct revenue. How did you develop the assumptions for your updated revenue guidance? For 2023, I understand that you have direct production schedules and feedback from the automakers. But as you look toward the mid-decade, are you using a top-down approach based on EV adoption rates or penetration curves? Could you share any insights on this or how it compares to your previous projections?

Emmanuel, so for 2023, it's obviously linked to EDI 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 left unchanged like for 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 are launching our programs globally, not just with the North American OEMs. We have announced around 35 new programs in the past quarters, partnering with 7 of the 10 largest OEMs in the electrification sector and several others outside of that group. Our perspective is truly global. As you recall, we have been quite prominent in China and continue to be. We are introducing many new products in Europe and are also launching in North America. Our outlook remains very global.

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 R&D 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. One aspect to note is that during Investor Day, we indicated that the growth rate of our investments is slowing, which is why we anticipate seeing scale benefits reflected in the P&L as eProduct revenue increases. We're already witnessing this trend this year, even as we see a year-over-year increase in eProduct-related R&D, which we estimate to be between $60 million to $70 million. When examining the last few quarters, the growth has only been about 2% to 4%, and we expect it to remain relatively flat or slightly increase in the fourth quarter. The key point is that investment growth is not keeping pace with our revenue growth expectations, which is crucial for our pathway to profitability. Looking ahead, it’s worth noting that we are currently engaged in our annual budgeting and long-range planning process. During this time, we will assess if any adjustments are necessary to manage our profitability in both the short and medium term, while also ensuring we are focused on our long-term objectives. We maintain confidence in the long-term outlook for electrification through 2027 and beyond. We will provide further insights on our progress during 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 previous developments and also very flexible and modular production strategies. And that's very important when we grow and scale up.

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 believe it's reasonable to consider this in the short term similarly to how we described it during Investor Day. With the content potential per vehicle related to electrification, as electrification speeds up, it creates an opportunity for us to increase our revenue more rapidly, but it may also place some pressure on the overall margin percentage we achieve. Conversely, if the industry's electrification tempo slows, it could lead to slower revenue growth, but likely enhance our margin profile. You might have noticed some reflection of this in our full-year 2023 guidance, which aligns with our long-term perspective as well. Overall, when we look at the bigger picture, we believe that our portfolio remains financially resilient. Whether electric vehicle adoption is rising or falling, our portfolio is designed to generate similar levels of adjusted operating income over the long term regardless of these scenarios.

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 with the automakers that previously may have been a bit more keen on vertical integration that are now realizing maybe they don't have the 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 to see 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.

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. Yes. I mean, overall, as we've talked about in the past, we're really focused on 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 our growth 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.

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 still affects the guidance. However, this is in the fourth quarter, and we did not experience any significant impact in the third quarter.

I want to revisit the slower ramp of eProducts and the route to profitability. It appears that most of your launches are in China, where we're not observing significant slow growth, despite lower volume in some North American products. I’m curious about the notable effect on the profitability ramp, if that’s true. Are you also adopting a more cautious outlook regarding the pace of growth in China and Asia, along with any challenges related to managing the number of ramps and ensuring flawless execution?

Joe, I believe there is a distinction between the timing of launches and ramp-ups that we are fine-tuning, and the overall situation in the Chinese market. A delay of just one quarter in a launch results in a total impact for that quarter, which is why there is some volatility. This is our observation based on slightly slower ramp-ups and a few programs being pushed back by a few months.

Yes, as we look at our growth from an electrification perspective at BorgWarner, we're still in the early stages. Currently, quarterly fluctuations can have a significant impact until we achieve more scale. Over the next few years, particularly through 2025 and possibly into 2026, BorgWarner is in a substantial ramp-up phase while operating at a relatively modest revenue level. Therefore, changes in launch timings and ramp-up schedules can significantly affect our quarterly and annual figures.

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?

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.

I would like to follow up and get some insight on the product mix concerning programs that have been delayed or postponed. Specifically, regarding the product mix for 2025 in the adjusted revenue number, is it still heavily skewed towards power electronics, or has that skew increased? Is power electronics less represented compared to some of the other programs? I'm trying to understand which areas of the portfolio you expect to see strong sell-through.

Yes. I think the main pressure we are experiencing is primarily in the ePropulsion segment. When we examine the battery pack business, we actually continue to see strong demand compared to our previous planning assumptions. Currently, this is more of a supply-constrained situation rather than one limited by demand. Therefore, the challenges we are facing are mainly within the ePropulsion segment.

Thank you, Kevin. And thank you 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.