Edited Transcript of BWA earnings conference call or presentation 6-May-20 1:30pm GMT

Let me start with the highlights of the first quarter on Slide 5. While the industry production rates were clearly volatile during the quarter, we performed strongly on a relative basis. With approximately $2.3 billion in sales, we were down about 8.1% organically, and this compares to our market being down almost 20%. This means we drove significant outgrowth. In fact, for the quarter, we saw double-digit outgrowth in all major regions.

Our decremental margin was approximately 26% in the quarter, as our margin performance was impacted by COVID-19-related shutdowns. Given the pace at which the shutdowns occurred, we think this is a relatively good outcome.

We delivered strong free cash flow of $146 million for the quarter, providing an additional cash cushion as we manage through the lower production levels expected in the second quarter.

Lastly, I am proud of how the team has reacted to this challenging environment. We met the challenges of managing orderly production shutdowns at our facilities in Europe and North America while also managing production ramp-ups in China.

Let’s now turn to Slide 6, where you can see our perspective on the global industry production. Overall, we expect a very challenging environment in 2020, especially in the second quarter. On a full year basis, we expect the market decline to be in the minus 25% to minus 31% range.

Looking at this decline by region, we’re planning for Europe to be down in the 29% to 38% range. In North America, we expect a 27% to 35% decline. On a relative basis, the outlook for China is stronger as their shutdown in Q1 was shorter than what we’re seeing in the other 2 geographies, but we still expect 18% to 21% decline in China production for the full year.

As you’ll see from the line chart showing our different scenarios, Q1 is the quarter which has the largest expected production declines, and at the same time, the most uncertainty. The biggest drivers for these declines and the significant uncertainty of the production are the timing of production restarts and the pace of industry production ramps.

Under our high-end scenario, which is represented by the light green line, we’re expecting Europe and North America production to largely resume by mid-May. Our low-end scenario, represented by the dark blue line, uses the assumption that Europe and North America will not resume production fully until mid-June. For both scenario, we expect the second half of 2020 to remain challenged due to lower consumer confidence.

Visibility into the production outlook has certainly improved versus a month ago, but there is still a tremendous amount of uncertainty around plant restarts, the pace of production ramp-ups and ultimately, consumer demand. We’re maintaining a very active dialogue with our customers and suppliers in order to support an orderly production ramp-up and manage effectively through this challenging environment.

On Slide 7, you see the cost actions that we’ve taken to help moderate the impact of the severe production declines. This cost action has been across all major areas of the company. We’ve taken temporary salary reductions in many locations throughout the world, including 20% pay cuts amongst our senior executive leadership team. Employees at many of our facilities have been put on temporary layoffs due to lower production, or in many locations, the complete production shutdown. And we also work with our strategic third-party relationship vendors who have, in most cases, agreed to share in the economics of this situation by voluntarily reducing their work or billing rates.

These actions, while, painful, are the right things to do for the financial well-being of our company. I want to thank all involved, especially our internal team members, who have kept their focus and strong engagement despite the sacrifices that have been endured. The industry’s next big challenge will be to successfully manage the production restart.

Let’s take a look at how we’ll manage this on Slide 8. While we must be ready to supply our customers as they resume production, we are first and foremost focused on what is best in terms of health and safety of our people. We’ve formed a high-level task force that has and will continue to roll out our Safe-Restart Program to all our global facilities. The program includes a set of 17 minimum standards and 9 additional recommended best practices. However, our focus on the safety of our people will extend beyond these standards. We have already seen additional innovative safety solutions developed at the plant level, and we will continue to utilize and promote this innovation to our other facilities around the globe. It is this plant level innovation and the appetite to share ideas that is promoted by the BorgWarner culture.

Let’s now turn to Slide 9. I would like to briefly comment on our Seneca, South Carolina plant, which was unfortunately struck by a tornado on April 13. Seneca is one of our largest plants supplying transfer cases to multiple OEMs in North America. Thankfully, the plant was not in operation at the time of the tornado struck, but unfortunately, a security guard at the facility was killed. Our thoughts and prayers are with his family.

Now I’d like to give a status update on the plant. As you can see by the picture on the slide, the level of damage varied widely. The damage to machining portion of the facility was more limited. However, on the left side of the picture, you can see the roof of the final assembly area is missing. That assembly area sustained a more significant amount of damage.

Over the past several weeks, there has been a tremendous amount of remediation work completed. We have also performed a significant amount of equipment testing and validation, and where appropriate, we have erected temporary structure. With all of this hard work over the last 3 weeks, I am proud to report that the facility resumed production on May 4 and that the production rates should improve throughout the month of May. This was an amazing accomplishment. I would like to personally thank the team in Seneca for their hard work and our customers for their support. We have turned a terrible situation into a BorgWarner success story.

Next, I would like to provide an update on our planned acquisition of Delphi Technologies on Slide 10. This morning, we announced that BorgWarner and Delphi Technologies agreed to an amendment of the transaction agreement. This amendment effectively cures the breach of the debt covenant that we asserted at the end of March. Under the terms of the amendment, Delphi Technologies has agreed to new closing conditions, requiring that at the time of the transaction closing, its gross revolver debt cannot exceed $225 million and net of its cash balances will not exceed $115 million.

In addition, the parties agreed that Delphi Technology’s net debt to adjusted EBITDA ratio will not exceed a specified threshold measured at closing. This new closing condition were structured to provide Delphi with the flexibility it needs to manage through the current environment, and execute on its current forecast. At the same time, they also protect BorgWarner from scenarios that could result in more significant cash usage or EBITDA deterioration.

The party also agreed to revise the purchase price. In recognition of the potential incremental debt that could be outstanding at closing, the equity exchange ratio was reduced by 5%. As a result, current BorgWarner and Delphi Technology shareholders would own approximately 85% and 15%, respectively, of the outstanding shares of the combined company following completion of the transaction. We are pleased to put this issue behind us and turn our full undivided attention to driving towards the closing.

In regards to our effort to close on this transaction, there has been a significant amount of other work done over the past several months. The integration teams continue to work very well together. The regulatory filings are in process in several geographies. And last week, we closed on a $750 million delayed-draw term loan to support our potential financing needs at the time of closing. I am pleased with the progress as we continue to work towards the closing of the transaction in the second half of 2020.

Before I turn it over to Kevin, let me summarize our first quarter results and our outlook on Slide 11. We achieved significant first quarter outgrowth in all major regions. We delivered positive free cash flow during the first quarter, and as Kevin will discuss, we expect to be free cash flow positive for the full year. BorgWarner has one of the most robust liquidity position within our industry. It is this financial strength, combined with the operational discipline of the company, that will allow us to successfully manage the challenges we expect throughout 2020.

As I look beyond the challenges of 2020, I am confident that we remain strongly positioned, both from a financial and technology standpoint to capitalize on the long-term trends that will continue to support our future profitable growth.

Now over to you, Kevin.

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [4]

——————————————————————————–

Thank you, Fred, and good morning, everyone. Before I review the financials in detail, I’d like to highlight 2 overarching themes you’ll see in our year-to-date results. First, our financials have been quite resilient in the face of this challenging environment. During the first quarter, we delivered strong revenue outgrowth in all regions, sustained double-digit operating margins and generated meaningfully positive free cash flow. Second, our liquidity remains strong and has actually gotten stronger over the course of the first 4 months of this year.

Let’s turn to Slide 12. As we look at our year-over-year revenue walk for Q1, you can see the impact from the thermostat divestiture we executed in early 2019. Additionally, you can see that the stronger U.S. dollar reduced revenue by about 2% from a year ago. Excluding these items, our organic sales were down 8.1% compared to the 19.6% decline in industry production. That means we delivered revenue outgrowth of 1,150 basis points in the quarter. And importantly, that outgrowth occurred in all of the major light vehicle markets around the globe.

In Europe, our light vehicle organic revenue was down mid-single digits compared to the market decline of approximately 19%. The outgrowth was driven by better than expected diesel-related revenue as well as strong new programs. In North America, we were close to flat year-over-year versus the 10% industry decline, driven by new programs and strong mix. And in China, we outperformed the market by more than 20% due to the year-over-year growth in our DCT business and other new business. Overall, we’re pleased that we continue to deliver revenue outgrowth even in this challenging end market environment.

Now let’s look at our adjusted operating income performance, which can be found on Slide 13. Q1 adjusted operating income was $234 million compared to $295 million a year ago. Our adjusted operating margin was 10.3%, which was down compared to the 11.5% we delivered in the first quarter of 2019.

On a comparable basis, adjusted operating income decreased $54 million on $205 million of lower sales, which translates to a decremental margin of 26%. As you know, when markets move downward quickly, we tend to see initial decrementals that can be 30% or higher, just like we saw at points in time last year. So we view the 26% as a reasonably good level of performance given how quickly industry production declined. And we accomplished this objective while increasing R&D expenditures in our Drivetrain segment, where we’re continuing to invest in our electrification portfolio. Adjusted earnings per share was $0.77 for the quarter. The $0.23 decline in adjusted earnings per share compared to the first quarter of 2019 and was driven by the lower adjusted operating income.

Moving to cash flow. We are proud of the fact that we delivered $146 million of positive free cash flow for the first quarter. In an environment where revenues are under pressure, it’s critical to manage our working capital effectively. And in the first quarter, we did just that, which is why we were able to deliver such a great result.

So let’s discuss our full year revenue outlook on Slide 14. Our guidance is based on the end market assumptions that Fred reviewed earlier, with global production being down 25% to 31%. We expect to continue to drive total market outgrowth for the year, but not at the level we saw in the first quarter. Our guidance now incorporates full year outgrowth of approximately 400 to 500 basis points. This assumes our outgrowth for the remainder of 2020 is in the range of 150 to 250 basis points, which is in line with our prior full year guidance. But obviously, this full year guide is higher than our initial 2020 assessment, simply given how much we outperformed in the first quarter. As a result, we expect a full year 2020 organic revenue decline of 20% to 27%, and that translates to an expected 2020 revenue range of $7.25 billion to $8 billion.

Let’s turn to Slide 15, where you can see an update of our liquidity profile. As of March 31, we had $2.4 billion of liquidity or 24% of 2019 sales. This consisted of our quarter end cash balance of $901 million and our undrawn revolver of $1.5 billion. You might recall that at the end of December, our revolver capacity was $1.2 billion, but in the middle of March, we worked with our bank group to increase the capacity to the new level, thereby bolstering our liquidity by $300 million. It’s also important to note that we have a leverage ratio that is more than 2 turns below the covenant in our revolving credit facility, which means that we have full, unfettered access to the $1.5 billion facility.

Adding to this, last week, we entered into a 364-day delayed-draw term loan facility, which provides us with an additional $750 million of liquidity. To be clear, we don’t think we need this additional liquidity to manage through the current environment. Instead, we put this facility in place as an insurance policy to support any potential financing needs at closing related to a Delphi Technologies transaction. Nonetheless, the facility is available to us right now prior to any such close, which simply means that we have that much more liquidity today.

Finally, while we’re not providing specific earnings guidance, we did want to give you color on our free cash flow outlook. In light of our first quarter results and our success thus far in managing our working capital, we expect to generate positive free cash flow for the full year in the range of $100 million to $300 million, even in the challenging environment suggested by our revenue outlook. That’s a testament to the strong financial condition of the company. Our Board’s confidence in our financial condition was evidenced by their decision to maintain our current dividend at this time. However, I would note that given the current global macroeconomic pressures, we don’t expect to be executing on our share repurchase program in the near term.

So let me summarize my financial remarks. Overall, we had a solid quarter in spite of the industry pressures, delivering strong outgrowth and positive free cash flow. We expect the markets to remain under tremendous pressure throughout the year, down 25% to 31% from last year, yet we expect to deliver positive free cash flow. And finally, we have significant sources of liquidity to manage through this environment.

As a management team, we are taking the necessary actions to navigate through the current environment while ensuring the company is strongly positioned for the eventual industry recovery and our future profitable growth.

With that, I’d like to turn the call back over to Pat.

——————————————————————————–

Patrick Nolan, BorgWarner Inc. – VP of IR [5]

——————————————————————————–

Thank you, Kevin. Sharon, we’re ready to open it up for questions.

================================================================================

Questions and Answers

——————————————————————————–

Operator [1]

——————————————————————————–

(Operator Instructions) First question comes from John Murphy with Bank of America.

——————————————————————————–

John Joseph Murphy, BofA Merrill Lynch, Research Division – MD and Lead United States Auto Analyst [2]

——————————————————————————–

It’s great to hear from you, and thank you for all the detail and the stab at the outlook for this year. It’s very helpful. Just really a first simple question. As we look at Slide 6, there’s some variability that you’re indicating around the second quarter, but we’re in the second quarter. So I’m just trying to understand, Fred, when you were mentioning mid-May restart versus mid-June restart, sort of as some of the scenarios you’re looking at, we’re hearing early May, which is what we’re in right now for Europe and mid-May for North America. So that information should be reasonably available to you from your customers.

I’m just curious on schedule releases, what kind of information of lead time you’re getting from your customers that hopefully can eliminate some of that variability and scenario planning? And how much lead time you expect from them? Because it just seems like some of the stuff should be reasonably well communicated to you at this moment for the restart.

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [3]

——————————————————————————–

John, there is a wide range of restart date and restart scenario. I think we have to not think about just the date of restart, but at what level of capacity will it restart. And it is changing daily, both from a restart date and ramp up production. So I think it still varies, and we still have a lot of uncertainty in Q2 from a volume perspective.

——————————————————————————–

John Joseph Murphy, BofA Merrill Lynch, Research Division – MD and Lead United States Auto Analyst [4]

——————————————————————————–

Okay. So it would be fair to say that you’re getting some communication on restart dates, but obviously, the uncertainty is still flowing down from the customers. So there’s still tremendous uncertainty on what the levels may be starting to even mean at this point. Is that a fair assessment?

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [5]

——————————————————————————–

I think the fair assessment is that we are in constant communication with our customers. And yes, we’re following that very, very closely. And yes, things change. Things do change.

——————————————————————————–

John Joseph Murphy, BofA Merrill Lynch, Research Division – MD and Lead United States Auto Analyst [6]

——————————————————————————–

Okay. And then maybe just a quick follow-up. I mean, the 26% decrementals on the lower volumes towards the end of the third — I mean end of the first quarter, it’s very impressive. As we think about sort of the pressure in the second quarter and throughout the year, I mean, is that the kind of number we should be thinking? Are there any actions that might make that better? Or because you’re lower in the cap U curve, maybe it will be a bit worse? I mean how should we think about sort of bracketing around that 26%, which was very good performance in the first quarter?

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [7]

——————————————————————————–

Yes. I think we were pleased with that 26% as well, and that’s really a function of the — a lot of the cost restructuring actions that we were executing on throughout last year that we announced back in April, and it allowed us to manage the decrementals now, and we’re seeing the benefit of that. And that’s even while we were investing additional dollars in R&D in the Drivetrain segment. So a good result, all things considered in this environment.

I think with the pace at which production is coming down on a year-over-year basis, I think it’s still challenging to manage decrementals that are something less than the 30% range in this type of an environment. I think that’s a reasonable directional proxy to think — how to think about our decrementals going forward.

——————————————————————————–

Operator [8]

——————————————————————————–

Next question comes from David Leiker with Baird.

——————————————————————————–

Erin Alexandra Welcenbach, Robert W. Baird & Co. Incorporated, Research Division – Analyst [9]

——————————————————————————–

This is actually Erin Welcenbach on for David. So my first question is just about if you can kind of walk us through what you’re assuming in terms of the Q3, Q4 production scenario that you put on your slide, what that means in terms of kind of the pace and the cadence of OEM ramp-ups in the back of the year? Any color on that.

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [10]

——————————————————————————–

So we are looking at — your question is very broad, but let me give you some color here. So on the high scenario, we’re looking at 25% down for the full year. We’re looking at a 53% down in Q2, a 16-ish in Q3 and about 10% in Q4. And the low scenario would be a little bit lower than that, especially in Q2, as you’ve seen in the chart on the page that John alluded to. So what matters is really when customer restarts and how fast they restart. And I’m certainly not going to go customer by customer, but on an aggregate standpoint, this is where we are quarter by quarter.

——————————————————————————–

Erin Alexandra Welcenbach, Robert W. Baird & Co. Incorporated, Research Division – Analyst [11]

——————————————————————————–

Okay. That’s helpful. And then just my second question is, if you can talk about kind of the drivers of outgrowth in Q1. I mean, obviously, you mentioned a number of factors by region, but was there any impact on kind of stocking or timing benefits in terms of what you’re shipping to OEM plants? And could there be a bit of a delay, I guess, on what you’re shipping in early Q2 as that production ramps back up?

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [12]

——————————————————————————–

We don’t think it’s stocking. And we add in Europe, our Engine Group stronger — with actually stronger diesel demand and stronger new small gas engine demand. China DCT was strong. and also strong from an emissions business standpoint. And our turbo business was pretty strong in North America. So that’s pretty much what drove the significant growth in Q1.

——————————————————————————–

Operator [13]

——————————————————————————–

Next question comes from Dan Galves with Wolfe Research.

——————————————————————————–

Daniel V. Galves, Wolfe Research, LLC – Director of Equity Research & Senior Analyst [14]

——————————————————————————–

Hoping you could talk a little bit about how headcount might have changed from year-end to the…

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [15]

——————————————————————————–

To year end?

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [16]

——————————————————————————–

Dan, I think we lost you.

——————————————————————————–

Patrick Nolan, BorgWarner Inc. – VP of IR [17]

——————————————————————————–

Can you repeat your question, Dan? We lost you.

——————————————————————————–

Operator [18]

——————————————————————————–

We have the next question from Brian Johnson with Barclays.

——————————————————————————–

Brian Arthur Johnson, Barclays Bank PLC, Research Division – MD & Senior Equity Analyst [19]

——————————————————————————–

A couple of questions. First, could you comment a bit more on the decremental performance? Not only was it different between Engine and Drivetrain, when we think of real production impact in the quarter, it was kind of the month of February in your China operations and then second half of March in North America, Europe. So if you could give a little bit more color on the decremental margins, maybe ideally by geography, by division, if you don’t want to go that far, at least kind of geographically, so if you begin to think through 2Q.

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [20]

——————————————————————————–

I think I would give it more directionally by the segments the way we disclose publicly. And I mean in the Engine segment, you can see the simple math says that our decrementals were around 20%. That’s because the bulk of the cost restructuring actions that we’ve taken over the past year have been in that segment, and they’re getting the benefit of that even as they manage the decremental margins on lower revenue.

I think you could see in the Drivetrain segment, their decrementals came in, in the low 30s, say, for the quarter on a year-over-year basis. But the bulk of that was because of the increase in the R&D spend on a year-over-year basis in that segment to support our electrification program. So if you were to strip out that increase in the R&D, they would have had decrementals that are in the low 20s.

——————————————————————————–

Brian Arthur Johnson, Barclays Bank PLC, Research Division – MD & Senior Equity Analyst [21]

——————————————————————————–

Okay. I guess what I was getting at is, can we expect worst decrementals in 2Q because of your European and North American cost structure perhaps being less flexible than that in China?

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [22]

——————————————————————————–

Yes. I think the decrementals are really driven by the pace at which the revenue is down as opposed to something unique about the geography. So I wouldn’t expect that to be the driver of a change in decrementals. I think just the challenge of operating with significantly lower production, the magnitude of that decline is really the driver of a decremental that’s probably at a higher rate just like we experienced at points in time last year. I think this year, it’s even under more pressure. So something in that 30% ZIP code is probably the right way to think about us.

——————————————————————————–

Brian Arthur Johnson, Barclays Bank PLC, Research Division – MD & Senior Equity Analyst [23]

——————————————————————————–

Okay. Second question is, we go in the second half. Can you talk a little bit about the — since you probably analyzed it, the impact of social distancing, PPE, sort of steps you’re going to need to take in the factories and how that might affect productivity and margins? In particular, do you have kind of operations where it will be relatively easy as opposed to maybe, say, a [credit] cut and sell for another parts supplier to kind of keep the kind of protections that work — that best practices dictate?

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [24]

——————————————————————————–

Brian, safety is where for BorgWarner excels. We have extraordinary safety results from a [TR&I] perspective. And we’re using exactly the same excellence that we have built in this company over the past decade to restart production with safety in COVID-19. So we have done a tremendous amount of work to figure out how we would restart, plant by plant, including exactly what you said, social distancing, which is possible but not always, and PPE. But also it goes way beyond the production area also. It impacts the way people break out, the way people do poses and so on. And all that has been looked at, and our plant managers have done a terrific job, wonderful job in getting our plants ready to restart.

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [25]

——————————————————————————–

And I’d just add to that, Brian. I think that’s part of the reason, when we talk about the 30% decremental, it’s a directional guide at this point. It’s part of the reason we’re not giving specific earnings guidance. I think there’s a lot of variables when you have a revenue range that’s from low to high, $750 million wide. Some of it can be, what is the operational efficiency in the plant? It can be, what are commodity prices doing? What’s happening in the supply base? Are there struggles there? What additional cost actions might we take? So there’s a whole host of things that I think we’re going to be learning over the coming months that will ultimately impact what those decrementals are and how efficient we operate.

——————————————————————————–

Operator [26]

——————————————————————————–

Next question comes from Noah Kaye with Oppenheimer.

——————————————————————————–

Noah Duke Kaye, Oppenheimer & Co. Inc., Research Division – Executive Director and Senior Analyst [27]

——————————————————————————–

Yes. Okay, great. A 2-part question as you prepare to reramp. First, how would you assess the stability of the supply base? And two, how are you…

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [28]

——————————————————————————–

I think we lost Noah, too.

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [29]

——————————————————————————–

Noah, I think we lost you. But (inaudible)

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [30]

——————————————————————————–

I can answer on the supply base. I would say that we are absolutely clearly seeing that the supply base is under some kind of undoubtedly some stress. And to date, we have not seen any disruption. But the key for those Tier 2 suppliers will be their ability to fund a production restart. We are playing all the best practices that we’ve developed when it is around managing supply distress over the past several years. But I would say that, Noah, that yes, potentially, this is clearly a different scale.

——————————————————————————–

Operator [31]

——————————————————————————–

Next question comes from Chris McNally with Evercore.

——————————————————————————–

Christopher Patrick McNally, Evercore ISI Institutional Equities, Research Division – MD [32]

——————————————————————————–

I think we’ve had a couple of questions on the decrementals this year. I know it’s super, super early. But as we think about exiting the year, you guys used to give a rule of thumb that essentially incrementals could be in the high teens when production turns essentially flat to positive.

Could you just maybe help us through — I think a lot of us are trying to figure out the increased cost that comes when production restarts. So even trying for us to model sequential incremental margins, do you think we’ll still be able to achieve high teens into the low 20% when things get better sequentially Q3 into Q4?

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [33]

——————————————————————————–

I think that’s how we think about it in terms of the way we manage our incrementals and decrementals. Obviously, right now, we’re in the process of managing decrementals in the challenging Q1 as well as Q2, which will be under even more pressure as you can see from our revenue chart in terms of what we’re expecting from a production standpoint. So right now, we’re in the process of managing decrementals, which means making sure we manage operational efficiency, supplier risk and additional cost actions that we take to manage in that environment. And then that positions us as we start to see the rebound, whether you’re looking on an incremental — sequential basis or a year-over-year basis to be able to deliver at something consistent with our historic guidance of operating in that high teens basis on a ramp-up.

——————————————————————————–

Christopher Patrick McNally, Evercore ISI Institutional Equities, Research Division – MD [34]

——————————————————————————–

Okay. Great. And then just a technical — when we’re trying to like back solve from maybe (inaudible) to sort of an implied EBIT for the year, can you just talk a little bit about the working capital assumptions? Are you assuming that you’ll have a working capital inflow, which we would sort of expect, given the production decline?

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [35]

——————————————————————————–

That’s exactly right. And that’s some of the tailwind that we’ve seen already in Q1 as well as heading into Q2 because we do run positive working capital. If you look really receivables, payables inventory, we tend to run in the, call it, around 12.5-ish percent. So I think when you think about the decrementals, we obviously have real cash flow pressure coming from the decremental, but we also have an offset coming from free cash flow — or I’m sorry, from working capital, and we’re experiencing that right now.

Now I would say in this type of an environment — and we all saw this in 2008, 2009, inventory tends to come out of the system much more slowly. But that said, we still run positive working capital when you look receivables versus payables. And that’s the real benefit that we’re seeing at the moment.

A couple other things that you should think about from a cash flow perspective as well is right now, we’re continuing in our planning assumptions, you can see at the high end, to maintain our capital investment at the levels that we operated with last year. And that’s because with a company like us, one of our strengths is because of our liquidity and free cash flow profile, we can continue to invest in programs in the long-term to support our customer needs. But obviously, that’s something we’ll continue to monitor as the year goes on, whether we need to do anything differently there. So I think those are some of the key puts and takes as you think about cash flow.

——————————————————————————–

Operator [36]

——————————————————————————–

Next question comes from Joe Spak with RBC Capital.

——————————————————————————–

Joseph Robert Spak, RBC Capital Markets, Research Division – Analyst [37]

——————————————————————————–

Kevin, just to follow-up on that point, and to be clear, that within your free cash flow guidance for the year, working capital is still a source. Because I would expect there to be some use of working capital as you have to ramp back up in the back half.

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [38]

——————————————————————————–

Yes. I mean when you ramp back up, it’s a use, but net-net, we’re down on a full year basis in each quarter of the year. And so that allows it to be a pickup when you look at each quarter as well as the entirety of the year. So yes, working capital is going to be a positive for the year. That’s our expectation.

——————————————————————————–

Joseph Robert Spak, RBC Capital Markets, Research Division – Analyst [39]

——————————————————————————–

Okay. And then maybe just on the quarter. And I know this is all sort of prior guidance gets thrown out the window here. But your backlog, I think, previously was $400 million to $530 million. We can mark that down, obviously, for sort of industry volume assumptions. But in the first quarter, really strong, I think, over $300 million you guys showed. So did that come in better than you were initially planning? Is some of that timing? Or maybe you could just talk a little bit more about how some of that backlog rolled in.

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [40]

——————————————————————————–

Joe, I think we’re very happy with Q1. It was better than expected. We don’t think that it’s a pull forward of backlog. But we’re not willing to assume that this — our growth is going to continue at this point. We are watching especially the diesel demand that was strong versus our assumption in Q1. And also, we’re looking in great detail the China outgrowth.

——————————————————————————–

Joseph Robert Spak, RBC Capital Markets, Research Division – Analyst [41]

——————————————————————————–

Okay. And Fred, lastly, just on — back to the supplier stress comment. I mean, maybe you can sort of remind us what Borg has sort of done in the past, but how would you support your supply base to sort of ensure your supply, if needed? I mean is that just payment terms? Would it be sort of potentially taking them in? Or are you hoping that some of those businesses will be able to rely on some government assistance?

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [42]

——————————————————————————–

Well, we’re using the same tools that we’ve used over the past, I would say, about 2 years when we started talking about the distress of some of the supply base in Europe. We know how to do it. We have risk management departments, and we understand all the levers that we can pull. You’re right. What’s a bit different now is that you might have some government state help, and we will put this input in consideration when we decide how we — what we do and how we do it. One of the key things is really to stay close to the supply base, close to the customers to understand ramp-ups and link it.

——————————————————————————–

Operator [43]

——————————————————————————–

Our next question comes from James Picariello with KeyBanc Capital Markets.

——————————————————————————–

James Albert Picariello, KeyBanc Capital Markets Inc., Research Division – Analyst [44]

——————————————————————————–

Just curious. Does the current environment affect the timing of your SG&A and COGS, your restructuring savings and all relative to the cadence you outlined last quarter? Is there a delay or a possible acceleration in what you can achieve?

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [45]

——————————————————————————–

I don’t think there’s a significant movement one way or the other. We’re going to continue to support funding of the restructuring actions that we identified and talked about back on the January call. In this environment, there can be some modest movements, just some timing movements, pull forward or even pushed out a little bit. But that’s — I’d say, overall, directionally, there’s not a material change in what we guided to from the January outlook. We’re still proceeding on that path.

And the good news, I mean, that’s — remember what we talked about when we announced that restructuring, that set of restructuring initiatives. We were trying to be proactive to manage unforeseen risks to offset potential unforeseen risk to manage our margin profile. We didn’t anticipate COVID-19 necessarily, but here it is. It’s one of those unforeseen risks. And the good news is we were out in front of trying to make sure that we have an ability to sustain our long-term margin profile, but taking those types of actions.

——————————————————————————–

James Albert Picariello, KeyBanc Capital Markets Inc., Research Division – Analyst [46]

——————————————————————————–

Got it. That’s helpful. And then just based on what you’re willing to share, can you just walk through the rationale on the acquisition amendment, the 5% reduction on the conversion rate? Just curious. What led you to that number maybe from a valuation standpoint? And I mean, clearly, compared to the original timing of the announcement, the world has changed pretty dramatically beyond just 5%, let’s say. So any color there would be helpful.

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [47]

——————————————————————————–

Yes. I guess the first thing I’d say about that is we remain confident in the strategic merits of this transaction. And so all of us see the long-term prospects of combining these 2 companies. And so remember what the nature of this consent agreement is that we signed up to this morning is to resolve an issue with an operating covenant. And we view the amendment then as a way to provide Delphi with the flexibility it needs to execute on its financial plan in this environment while protecting us from further unanticipated downside risk. The reduction in the equity exchange ratio that we agreed to is intended to compensate us for that additional risk we’re taking by providing that covenant relief. And remember, the financials of all companies in this environment, BorgWarner included — BorgWarner, Delphi, others in this sector, have all been under pressure. And our stock prices reflect that. And since this is an all-equity transaction, the effect of equity purchase price has already been impacted as a result of the environment we’re in. So that’s really the totality of how we think about this.

——————————————————————————–

James Albert Picariello, KeyBanc Capital Markets Inc., Research Division – Analyst [48]

——————————————————————————–

Okay. Fair enough. That’s helpful. And just last one on the strong diesel demand in Europe. This is a follow-on to the uptick in demand that you saw in the fourth quarter, which I don’t think you expected to continue. So just what’s your take on the carryover there?

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [49]

——————————————————————————–

Yes. We’re looking at that in great detail. I would not call it a trend. And we’re doing that study with a lot of granularity, but we haven’t seen this in registration. So I think it might be also due to the different element of diesel sizes, and we’re more into the big diesels. But I would say that this is something that this is not a trend that we’re ready to bet on yet. Actually, if you look at the penetration rate for diesel, it’s still, in Q1 2020, about 5% lower than Q1 ’19. So it has happened, but I’m not ready to bet on the fact that this could be a trend.

——————————————————————————–

Operator [50]

——————————————————————————–

Next question comes from Emmanuel Rosner with Deutsche Bank.

——————————————————————————–

Emmanuel Rosner, Deutsche Bank AG, Research Division – Director & Research Analyst [51]

——————————————————————————–

First question around the — a clarification around the backlog outlook. So it is close to $350 million in the first quarter. Is the right way to look at the full year outlook, the outgrowth market is essentially the backlog? In which case, it’s less [than] $400 million to $500 million or so. So are you assuming no — limited amount of new business over the rest of the year? And if that is the case, is that a result of delays or things that you’re seeing? Or is there an element of conservatism in there?

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [52]

——————————————————————————–

We don’t see major delays. I would say that Q2 to Q4 are in line with the prior guide, which is 150 to 250 basis points of our growth.

——————————————————————————–

Emmanuel Rosner, Deutsche Bank AG, Research Division – Director & Research Analyst [53]

——————————————————————————–

Okay. But was my math — I don’t know if Pat wants to chime in. Was my math right? Like is the 400 — the $397 million to $487 million in the 2020 outlook, is that comparable with the $333 million you did in Q1? Or is that a different thing?

——————————————————————————–

Patrick Nolan, BorgWarner Inc. – VP of IR [54]

——————————————————————————–

Emmanuel, I’ll take you through the backlog math off-line. But just mathematically, the way to think about it is the outgrowth through the remaining 3 quarters. The average will be that 1.5% to 2.5% that Fred referenced, which is in line with the prior guide.

——————————————————————————–

Emmanuel Rosner, Deutsche Bank AG, Research Division – Director & Research Analyst [55]

——————————————————————————–

Okay. Okay. Understood. And then I guess just on the more mid-term basis. So it’s encouraging to see you’re not seeing any delays as well as you see the strong outgrowth in the first quarter. From a high-level point of view, do you think there could be any structural changes in the face of adoption of various powertrain technologies post COVID? Like could there be some automakers pulling back on electrification, if they’re not under mandates, let’s say, North America or vice versa? Could there be an acceleration of some other technologies? Do you see anything changing the midterm mix of powertrain as a result of COVID?

——————————————————————————–

Frédéric B. Lissalde, BorgWarner Inc. – President, CEO & Director [56]

——————————————————————————–

So the first thing I would say, Emmanuel, is that our strategy of being balanced across [CH&E] makes it like, it doesn’t really matter for us. What I can tell you is that in China, we are not seeing any slowdown on electrification programs. We see things moving very fast from an electrification standpoint. In Europe, we see that the 2025 and 2030 regulatory on CO2 and emission leading to more electrification is not questioned. Actually, if you look at it in detail, in some countries, some programs related to electrification were deemed essential. In the U.S., it might take a little bit more time. But the U.S. will benefit from our great technology in a combustion standpoint, making engine cleaner and leaner. And wherever we are around the world, we will see electrification accelerating growth for BorgWarner and also a great product in combustion making customers happy when they decide to go and have a longer tail in combustion.

——————————————————————————–

Operator [57]

——————————————————————————–

Next question comes from Armintas Sinkevicius with Morgan Stanley.

——————————————————————————–

Armintas Sinkevicius, Morgan Stanley, Research Division – Associate [58]

——————————————————————————–

Looking at the exchange ratio here with Delphi, I understand it compensates for the additional relief that Delphi is looking for. But on the other hand, you mentioned that you don’t expect to be executing on the share repurchase program in the near term. And part of that transaction was adding some additional share buyback. So just trying to think through the implications for share buybacks and why you didn’t try to take that into account with the exchange ratio.

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [59]

——————————————————————————–

[Ami], with respect to the share buyback, we remain committed to the $1 billion program we announced back at the end of January. I think all we’re saying is that in the near term, in this environment, with all the uncertainty that we have, we don’t think it’s the prudent decision to be deploying liquidity at this moment to start executing on that program. We’re subject to a number of blackouts anyway in the environment where we’re operating in as a result of where we stand in the transaction with Delphi. But nonetheless, I think just in the coming months, we don’t think it’s prudent to be executing on that. That said, we remain committed to the $1 billion program.

——————————————————————————–

Operator [60]

——————————————————————————–

That question comes from Dan Levy with Crédit Suisse.

——————————————————————————–

Dan Meir Levy, Crédit Suisse AG, Research Division – Director & Senior Equity Research Analyst [61]

——————————————————————————–

Great. First, we’ve seen others cut their own share buybacks and dividends to preserve cash. What’s the rationale for why you’ve maintained your dividend? I mean I saw you had 0 buybacks in the quarter, but your dividend is [placed]. So why keep that?

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [62]

——————————————————————————–

Yes. I mean ultimately, the dividend is a decision of the Board of Directors. But I think the way we as a management team think about it is the dividend is a commitment that we make to returning free cash flow to our shareholders, and generating $146 million of free cash flow in the first quarter with an outlook that suggests even under these difficult revenue scenarios that we’re going to generate positive free cash flow for the full year. I think the Board undoubtedly took that into consideration and thought it was good to continue to live up to its commitments to returning that cash flow to shareholders. Undoubtedly, that’s a decision the Board will continue to monitor each quarter as it looks at the environment and sees how things might be changing, but I’m sure that was the calculus that went into it.

I think with respect to buybacks, buybacks, we remain committed, as I mentioned to Armintas, to the $1 billion program, but the timing of the execution of those tends to be more discretionary. And so we’re going to be prudent with the liquidity in this environment and look at the right timing to start redeploying the cash toward that buyback program, but we don’t think now is the moment to do that.

——————————————————————————–

Dan Meir Levy, Crédit Suisse AG, Research Division – Director & Senior Equity Research Analyst [63]

——————————————————————————–

Great. And just a follow-up on the deal with Delphi. Assuming everything goes forward, you’ll close the deal in a different world than what we saw at the time the deal was announced. And Delphi is probably going to be coming in with higher leverage. So how does the higher leverage ratio change the way that you think you will operate the go-forward entity? Is there maybe — are you going to have to be more aggressive on restructuring? Or would you have to adjust spend in different areas? So how does leverage change the calculus for how you think you may need to operate the go-forward entity?

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [64]

——————————————————————————–

Keep in mind, when Fred talked through this slide, what we agreed to with Delphi as part of this consent agreement is to put a limitation on the amount of debt that can be outstanding at the closing. And in the grand scheme of things, when you think about that potential for incremental indebtedness, we don’t think it materially alters our view on the expected leverage ratio or the financial prospects of the combined company.

——————————————————————————–

Dan Meir Levy, Crédit Suisse AG, Research Division – Director & Senior Equity Research Analyst [65]

——————————————————————————–

Okay. So still the entire entity as a whole is still intact with this new requirement in place.

——————————————————————————–

Kevin A. Nowlan, BorgWarner Inc. – Executive VP & CFO [66]

——————————————————————————–

Yes. I mean, remember, Delphi has, call it $1.5 billion or so of debt. We have a couple billion dollars of debt. And we talked about the potential — not the requirement, but the potential that there could be additional net debt at closing of $115 million according to the consent agreement we signed up for. So in the grand scheme of an entity that has $3 billion-plus in debt, that’s not a huge number that really swings the overall leverage prospects of the company in a way that causes us to want to operate it any differently post closing.

——————————————————————————–

Patrick Nolan, BorgWarner Inc. – VP of IR [67]

——————————————————————————–

With that, I’d like to thank you all for your time and your good questions today. With that, we’re going to wrap up the call, and stay safe. Sharon, you can close the call.

——————————————————————————–

Operator [68]

——————————————————————————–

That does conclude the BorgWarner 2020 first quarter results conference call. You may now disconnect.