BorgWarner Inc.

Good morning. My name is Brittany and I will be your conference facilitator. At this time, I would like to welcome everyone to the BoardWarner 2023 First Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during that time, simply press star 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before asking your question. 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, Brittany. Good morning, everyone, and thank you for joining us today. We shared our earnings release earlier this morning. It's posted on our website, boardwarner.com, on our homepage, and on our Investor Relations homepage. With regard to our investor relations calendar, we will be attending multiple conferences between now and our next earnings release. Please see the event section on our homepage for a full list. Before we begin, I need to inform you that during this call, we 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 with 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 markets. When you hear us say market, that means the change in light and commercial vehicle production weighted for our geographic exposure. Please note that we've posted today's earnings press release and earnings call presentation to the IR page of our website. We encourage you to follow along with these slides during our discussion. With that, I'm happy to turn the call over to Fred.

Thank you, Pat, and good day, everyone. We're very pleased to share our results for the first quarter 2023 and provide an overall company update starting on slide five. 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 ERMD investment, debt inflationary costs, and the impact of low production in China. Our free cash flow usage in the quarter reflected our planned capital spending to support our e-product growth, as well as working capital usage and our normal annual payout of incentive compensation. Importantly, our charging forward progress continued on multiple fronts. We secured multiple new e-product awards since our last earnings report. We also announced multiple new e-product 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 continue to work towards the intended separation of FINIA. Since our last call, we announced FINIA's name, as well as the key leadership roles. Brady Erickson will serve as President and CEO, while Chris Groff will serve as the CFO for Finnair. Both Brady and Chris have been at Port Warner for more than 20 years and have served in numerous important roles across a variety of Port Warner business units. Teams are progressing well through the various work streams. We now expect to complete the separation of Finnair by the end of the third quarter. Now, let's look at some new e-product awards on slide six. First, Portland has been selected to provide e-motors to a leading automotive manufacturer in China. The e-motors will be used in the Chinese automaker's 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, Port Warner has partnered with the Pontiac Michigan School District to provide direct current fast chargers to support the district's electric school buses. This program will utilize Port Warner's 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, Port Warner has been selected by a global commercial vehicle manufacturer to provide e-fans for battery electric trucks in both the North American and the European market, with production expected to begin in 2025. For this project, Fort Warner will supply its complete e-fan R10 system, which includes a fan, an e-motor, and an integrated high voltage inverter. Notably, The high-voltage inverter utilizes the expertise and capabilities of Drivetech, a company acquired in December of last year. Now, let's look at the growth and expansion of our battery pack business on slide 7. Bourgogne 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 cell wire bond that satisfy the industry's strict electric vehicle battery safety standards. During the quarter, BorgWarner announced its 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 GWh 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 Acasol acquisition. We expect volume demands 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 Acasol 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 Central's acquisition is performing on slide 8. Similar to our battery pack business, the revenue related to Central's e-motor 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 e-product revenue, about 40% higher than our original acquisition planning. If you recall, a key pillar of the transaction was for Central to improve our cost competitiveness through improved e-motor design and manufacturing capabilities. As a result of the 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 e-motors. And we are seeing just that in our booking, which are shown on the right side of the slide. The takeaways from today's are this. Port Warner's first quarter results were broadly in line with the directional guidance that we provided on our earnings goal last quarter. Importantly, our sales growth once again outperformed the industry and we continue to make investments 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 e-products. Our guidance is also increasing based on FX tailwinds. We continue to expect our e-product 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 e-product 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 BoardWarner team and our culture of execution that continue to be the drivers of our ongoing success. With that, let me turn the phone over to you, Kevin.

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 e-product-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 Santral 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 e-product-related 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 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 e-products, increased working capital during the quarter, and the annual payouts 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 four-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 e-product 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 lightened 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 e-product portfolio. As it relates to e-product revenue, we're expecting to deliver between $2.3 and $2.6 billion in 2023, which is up significantly from the approximately $1.5 billion we generated in 2022. Finally, the Santral, 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 to $17.9 billion, which equates to organic growth of approximately 7.5 to 12.5 percent. This is higher than our previous revenue guidance of $16.7 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 four-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 four-year 2023 guidance continues to anticipate a $60 million to $70 million increase in e-product-related R&D investments. With our ongoing success securing new electrified business wins, we're continuing to lean forward by investing more in R&D to support our e-product portfolio. Excluding the impact of this increase in e-product-related 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 to $650 million for the full year. As a reminder, this cash flow outlook includes one-time cash costs of approximately $150 million related to the planned spinoff of our fuel systems and aftermarket businesses. Excluding this one-time cost, our free cash flow guidance would be $700 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 e-propulsion. In an effort to increase transparency into our e-product profitability, we've made the decision starting with the first quarter to break our previous e-propulsion and drivetrain segment into two separate external reporting segments, e-propulsion and drivetrain and battery systems. Our e-propulsion segment includes multiple e-products, including inverters, e-motors, e-gear drives, IDMs, and other power electronics such as onboard chargers. We expect these e-products to account for roughly two-thirds of the segment's revenue in 2023. In addition, the e-propulsion segment is expected to account for approximately two-thirds of BorgWarner's total e-product 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 e-product revenue, as quarterly segment revenue is expected to grow to $750 to $850 million by the fourth quarter, compared to $487 million of revenue in Q1. And as you can see, the expected growth in e-product-related 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 e-propulsion 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 e-products more generally. That's because we expect that as each e-product 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 e-products 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 e-product 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 Finia, 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 e-product portfolio. With that, I'd like to turn the call back over to Pat.

Whitney, we're ready to open up for questions.

At this time, I would like to remind everyone, if you would like to ask a question, press star 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before asking your questions. In the interest of time, please limit yourself to one question and one follow-up question. We'll pause for a moment to compile the Q&A roster. Your first question comes from Logan Lagan with Wells Fargo.

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

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

Got it. Okay. And it's actually – it's not related to the steel price. It's actually related to your sub-supplier costs of pressure coming through?

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

And what helps you keep your guidance, I guess, actually slightly up when you're raising sales, but with the $65 million incremental headwind, what's offsetting that?

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

And just lastly, fuel systems look pretty weak in the quarter. Anything unusual going on in Q1, and should that sort of bounce back, or is that stay at these kind of levels.

Thanks. If fuel systems was one of the segments most impacted by some of the China mix issues we saw, particularly China CV, 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 four-year basis, we do expect, much like the rest of Board of Warner, 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. Got it. All right. Thanks for taking my question.

Your next question comes from Noah Kay with Oppenheimer.

Good morning. Thanks for taking the questions. And thank you for breaking out e-propulsion. 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 e-propulsion really depends on production cadence and supply chain. And would that primarily be a function of your own supply chain for electronics and other components, or is that more gated by the OEMs?

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

And your thoughts online aside to getting the chips this far in the year?

that's what i mean we have teams of people working really hard with 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 little blip somewhere then it impacts us and our ability to ship so That's why you have that band of revenue that is still open from 1.5 to 1.8.

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

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

Your next question comes from James Pigario with BNP Corrales. Your line is open.

Can you hear me? Yes. Good morning, everyone. So the Finney spin is now targeted 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 Finneya?

Yeah, I think, you know, 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, you know, end of the third quarter, and it's a lot of work, but people are working really diligently and just wanted to give you a little bit more precision.

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

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

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

Your next question comes from Emmanuel Rosner with Deutsche Bank.

Thank you so much. So just to clarify again, the inflation headwind. So are you expecting $65 million on a full year basis as a net number, and then $28 million of that happened in the first quarter? Is that correct? That's correct. And I guess the 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 gross headwind, inflation headwind. What are the drivers, would you point to?

Yeah, I mean, fundamentally, the two things that really drive the performance over the balance of the year, one is inflation. we do expect to start to generate some of the customer recoveries, you know, 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 $4,180,000. 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 So there's still revenue growth coming over the balance of the year, particularly driven by the growth in our e-product portfolio. So converting on that as well as mitigating some of these inflation impacts over the balance of the year are really what drives the conversion and gets us to that 10.0% to 10.4% margin for the full year. And this is tied to the timing of your launches? Correct. It's really the ramp up of our e-product revenue over the balance of the year. And you can really see it in that e-propulsion segment disclosure that we had in the deck. The primary driver of that growth growing from $487 million of revenue in Q1 to $750 to $850 million in Q4 is e-products. And so really capitalizing on that growth is what we're looking for over the balance of the year.

Thank you so much. And then following up just on that disclosure, so e-products expected to be about two-thirds of the net segment sales. I guess what else is in e-propulsion?

Predominantly electronics. Understood. Thank you so much.

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

Good morning, guys. 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 e-propulsion segment, and that kind of sort of indicates that there's about $1.3 billion in 2023 that's outside of this segment, and I'm presuming that that's all in drivetrain and battery. If that's correct, are we looking at a similar – progression in the profitability in that other $1.3 billion? You need to lose money right now, and it'll get to break even or better by the end of the year.

Yeah, 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 to $2.8 billion of e-product 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 e-products-related revenue are really the battery pack business, which is in the drivetrain and battery system 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 the air management segment as well so that's that's really where you see the other components of the e-product 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 way to think about the progression of margin in any one of those e-product 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 startup 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 e-product portfolio within e-propulsion, 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 e-propulsion, we expect the exact same type of trajectory.

Okay, and just to follow up on that, I mean, the midpoint is 2.6. If that's two-thirds of your total e-product, that would indicate it's another billion three outside. I mean, that's the math. I mean, is there something else? I'm just Am I misunderstanding something? I mean, 2.6 divided by 3 gets you about $850 to $900 million. Oh, you're saying that's the total? Okay, because the way this is shown is that that's what's in the e-propulsion segment. So you're saying that's the full number?

The expected net is at the $2.5 to $2.7 billion. That's the e-propulsion segment revenue, two-thirds of which is... e-product related. It also happens to correspond to being two-thirds of BorgWarner's total e-product revenue is also in this segment.

But basically, we should be thinking about $866 million outside of this segment. Is that correct? Ballpark. Okay, got it. Okay, just wanted to make sure we got that right. Then just a second question. When we think about Finian, it sounds like this is going faster than expected, so it sounds like there's good progress. How should we think about post-

separation um potentially stranded costs and opportunities to to work those down if i mean from a cost perspective we'll talk about that more when we get to the uh the investor days that we expect to have closer to the date of the spin and when you think of the the potential dis synergies 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 finia So we'll give more details on that and the impact overall of that dis-synergy. 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 dis-synergy associated with setting up the corporate cost structure for Finio.

John, the finia is made of two reporting segments that will run under the board of decentralized operating models. So besides the creation of a top call, there is not much stranded cost.

That's very helpful. Thank you very much, Chris.

Your next question comes from Adam Jonas with Morgan Stanley.

Thanks, everybody. 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 may be very different versus the past 10 or 20 years. Can you confirm the capex and R&D spend, for example, the percentage of sales for the ice-focused products can decline versus history? And can you quantify that?

Yeah, thanks. First, I would say that, you know, 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 Barry Pack in there. If you look at e-heaters, and we announced more than 4 million e-heaters in 2025, we're using plants in Michigan, in Portugal, in China. For motors, IDMs, we're using Wuhan and Tianjin in Korea and North America. Also in Mexico, we have a power-to-level 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 E. 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, 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 that risk.

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

Yeah, just to give you a high-level set of numbers. So this year we're getting 2.3 to 2.6 billion of e-products, 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 five, six 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. Hope that helps. It does. Thanks.

Your next question will come from Dan Levy with Barclays.

Hi, good morning. Thanks for taking the questions. I wanted to just start with the incremental margins. So I appreciate the exposure that X inflation and 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 a more difficult situation a year ago. Is it possible that as the year progresses, X R&D, X inflation, that that incremental margin goes higher? Yeah, 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 e-product related R&D, we're expecting to be converting at about 16 plus percent year over year. And that's inclusive of the $65 million net material inflation headwind. So it suggests without that headwind, we'd be converting even higher. So we're pretty pleased with that level of conversion in spite of the fact that we're seeing material inflation pressures in the year. Okay, understood. Thank you.

And then as a follow-up, I wanted to just ask about silicon carbide.

A, could you just remind us of your inverter backlog, how much of that is silicon carbide versus IGBT? And then B, we heard a comment from Tesla at its investor day plans to reduce silicon carbide content by three quarters, and just wondering in the future how you're looking at the design of your inverters, whether you think that you can reduce silicon carbide content in general, what the direction is on silicon carbide.

I'll start with the second half of your question. On 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 that 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 wall speed 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 a pop. So that's why I would say we're more tilted towards the most advanced inverters in the marketplace.

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

The puts and takes are a little bit more complex than this, and you need to 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 what the carmaker wants to do, what car type, what end product 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 they have is more linked to their system and how they want to put their differentiation into the marketplace. Great. Thank you.

Your next question comes from Luke Junk with Baird.

Good morning. Thanks for taking my question. For starters, hoping we could just unpack what's currently reflected in your e-propulsion gross margins. They're about 15.5% this quarter, not far off from full growth overall. And what's inherent in the incremental growth profit in terms of a margin assumption as you look through the rest of 23? especially what you anticipate gross margins to look like as you ramp volumes and launch new e-product business? Should we expect that margin percentage to move higher as well, in addition to just the higher GP dollars?

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

And then a follow-up question just quickly. Did you say you're expecting now slightly higher recoveries? Would you 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.

Look, 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.

I'll leave it there. Thank you.

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

Yes. Good morning, and thank you very much for taking the questions. First one, sticking on the semiconductor side, something 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. And I ask in part because you guys have made public your announcement earlier And Wolfspeed, I think a few weeks ago, they talked about a slower wrap-up of their Mohawk Valley Fab. So anything you can help us understand around your ability to perhaps de-risk from one supplier?

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

Very helpful context. My other was just on the design and 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

uh for some of your powertrain products you know perhaps as a way for them to be more efficient in the near term uh using uh borg warner as opposed to maybe trying to do some of their their own work in-house thanks we're very happy with the the cadence of uh discussions that we have uh development advanced development and bookings that we have with a lot of customers around the world and the drumbeat is is only increasing It is absolutely clear that when we produce north of 3 million inverters in 2025 and 2 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 the forefront of efficiency. We're 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 there.

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

This does conclude the Board Warner 2023 First Quarter Results Conference call. You may now disconnect.