BorgWarner Inc (BWA) — Q1 2018 Earnings Call Transcript

Thank you, Dan. Good morning, everyone. Thank you all for joining us. We issued our earnings release at 6:30 AM Eastern Time. It's posted on our website, borgwarner.com, on our homepage, and on our Investor Relations homepage. Before we begin our call, I need to inform you that during this call, we may make forward-looking statements, which involve risks and uncertainties as detailed in our 10-K. Our actual results may differ significantly from the matters discussed today. During our presentation, we'll highlight certain non-GAAP measures in order to provide a clearer picture of how our core business performed and for comparison purposes with prior periods. When you hear us say on a comparable basis, this means excluding the impact of FX, net M&A and other non-comparable items. When you hear us say adjusted, excluding non-comparable items, that means on a non-comparable basis. When you hear us say on a reported basis, that means U.S. GAAP. Now, back to today's call. First, James Verrier, our President and CEO, will comment on the industry followed by a high-level overview of our Q1 results and full-year outlook. Then, we will discuss some of our recent product wins. Then, Ron Hundzinski, our CFO, will discuss the details of our guidance as well as our results. Please note that we've posted our earnings call presentation. At the IR page of our website, you'll find the link in the Events & Presentations section beneath the notice for the call. We encourage you to follow along with these slides during our discussion. With that, I'll turn it over to James.

Thank you, Pat, and good morning, everybody. Ron and I are really pleased to share our results today from Q1 2018 and also give you an update on our progress as we march towards delivering our 2018 target. Before I get going, I realize many of you on the call have been taking a lot of calls this morning, so I'm going to try and keep my prepared remarks a little shorter than usual. Albeit, I'll cover all the main points. So, let me kick off by sharing a few thoughts on the macro environment and the industry. And for those of you following along, we're on slide number 6 in the deck. At a high level, I would start with this: Our growth over the market was a little stronger than we'd expected in the quarter. During that same time, global light vehicle production was a little weaker than anticipated and, hence, our growth versus the market was a little stronger. If I give you some background on Q1 from an industry perspective, global light vehicle production came in about 2% for the quarter versus our expectation of it being pretty much flat as we went into the quarter. If I break that down a little bit regionally, European light vehicle production was down slightly with some volume pushed into Q2. We saw the continued shift from diesel to gas mix in Europe and I'll share a little more commentary on that later. We saw diesel share in the quarter declined by about 760 basis points from a year-over comparison to Q1. Let me switch to China. So, China light vehicle production was down 3% year-over-year and that was pretty much in-line with what our expectations were as we started the quarter. From a North American perspective in light vehicle, industry production declined almost 3%, but we did note that mix was holding up particularly well. The other thing of note from an industry perspective is growth in our CV business continued and that did somewhat offset some of the lower light vehicle industry trends. Let me continue on a little bit from an industry perspective and shift more towards a full-year view. Our expectations for the full year, global light vehicle industry is very consistent with our prior forecast. This implies global production growth of approximately 1% when you adjust for our geographical exposure. Again, quickly walking through the regions for you, we expect China growth of about 1% to 2%, we see Europe up similar level between 1% and 2% and North America flat to up slightly. From a commercial vehicle perspective, we do expect to see some benefit in the coming quarters, though we are assuming a little bit of a lower benefit than we saw in Q1. If you look at that, our industry assumptions appear to be pretty balanced, and I would say consistent with how we started the year, the view that we had coming into the year. Some highlights there. With the commercial vehicle, we're going to continue to watch and see if that commercial vehicle volume will continue to be sustained. China, we continue to pay a lot of attention to as we expect modest industry growth in 2018, maybe some potential upside in the back half. On the downside, we're obviously paying attention to the diesel gas mix where we're expecting at least a 500-basis point shift from diesel to gas mix in the year of 2018. We continue, like everyone else, to look to get better feels for diesel inventory in Europe, so we can get a better track on that. The key for all of that, if I step back for a moment, is that we're going to continue to expect to outgrow the markets in 2018 by the ongoing strong demand for our products. Talking about products, let me just add a little bit of commentary on what we're seeing in the world relative to hybrid and electric programs and how that's evolving. I would say the key message is our customers are continuing to march very strongly towards adoption of hybrids and electrics, particularly with some of the regulatory uncertainty out there. All the automakers are realizing they need that balanced mix in their fleet between combustion, hybrid, and electric and naturally we're working very closely with them. For us specifically at BorgWarner, I'm very encouraged by the hybrid and electric programs we've secured to date. You start to see some of that flowing through to our press releases. As we get to our Analyst Day in September, we'll be giving you a thorough and full overview of the progress we've been making around hybrids and electrics. So the key and the punchline for us is two things: We're going to continue to expect to book more growth and gain what we need to do from a business booking perspective for hybrid and electric; and we are really confident that our portfolio of products allows us to do that. So, we're very confident and comfortable with our product mix inside the company. Let me move to slide 7 now and give you a little bit of a view of our Q1 results and our outlook for 2018. Overall, I was very pleased. We came in with our organic growth above our guidance, as I said, in a slightly weaker market and solid incremental margin performance, which Ron will cover in some detail. We recorded $2.8 billion of sales, which is a quarterly record for us and that's up 6.6% organically when you exclude FX and Sevcon. This compares to our end market exposure of down 2%. Regionally, we saw very strong growth for the company in China. We also saw positive light vehicle revenue trends in Europe and North America despite declines in industry volume. This light vehicle growth was supplemented by positive revenue trends in commercial vehicle off-road. From an EPS perspective, we delivered $1.10 excluding non-comparable items. For comparison purposes versus the quarter last year, that's a 21% year-over-year improvement in our EPS, which is outstanding performance. Operating margin is solid at 12.2%, and Ron will provide more color and commentary on that. Let me switch to give you a high-level view for the full year. Our organic growth rate is unchanged, but once again we're going to be increasing our EPS forecast, largely driven by FX, which again Ron will cover in his remarks. We continue to expect organic growth of 5% to 7% year-over-year in a market that is flat to up 1%. We still see our consolidated operating income margin expected to expand between 10 to 20 basis points year-over-year. Let me move to slide 8 for those following along and talk a little bit about some of the highlights of recent announcements. It was another strong quarter for us where we booked a lot of business across the portfolio in combustion, hybrid, and electric. I'm just going to highlight three that you see on the slide here that I think are particularly important for us. First, we were very pleased to win a 2018 Automotive News PACE Award for our S-wind wire forming process for electric motors and alternators. For those of you that have listened to me talk about this for the last couple of years, I've mentioned that motors are not just motors. There's a lot of technology in the types of motors that we're using, both from a product and a process design point of view. For our perspective, this is strong validation of that from an external party. We also announced that we'll be supplying our eGearDrive transmission for two First Automotive Works Group electric vehicles. We're also supplying our Electro-Mechanical On-Demand transfer case for the Ram 1500 4x4 pickup truck, which is a terrific program for BorgWarner. So again, the message is consistent: This balanced approach of winning business and growing across all three propulsion systems for combustion, hybrid, and electric remains on track and remains very strong for us. Before I turn over to Ron, Q1 was a great start for us this year, showing very strong performance both top line and bottom line. We're feeling very confident about our full-year outlook, which looks like another strong growth year for the company. What's really important to me is that the year-to-date new business wins we've achieved across combustion, hybrid, and electric continue to give me a lot of confidence in the long-term growth and balance across propulsion for the company. So great start to the year. With that, let me turn it over to Ron.

Thank you, James, and good morning, everyone. Before I review the financial details, I would like to provide you with some of the highlights as I see them for the quarter. First, as James has said, the quarter was strong and a solid start to the year. Second, organic growth was better than our expectations. I should note it was a record sales quarter despite weaker industry volumes. Finally, we are maintaining the organic growth guidance, but we're increasing our EPS guidance based on FX benefits. As Pat mentioned, I will be referring to the supplemental financial slide deck that is posted on our website, so I encourage you to follow along. Let's turn to slide 10. On a reported basis, sales were up 15.7%. On a comparable basis, our organic sales were up 6.6%. Very strong performance compared to our weighted average light vehicle industry production for the quarter, which was down 2%. We saw a 29% growth in China against the production market that was down 3%. Europe revenue was up 7% compared to the 1% industry production decline in the quarter. North America revenue was up 3% versus the 3% production decline in the quarter. Commercial vehicle was a benefit, contributing about 100 basis points of growth. Diesel and gas mix in Western Europe was a headwind for us. Now, let's look at the year-over-year comparison for operating income, which can be found on slide 11. Q1 adjusted operating profit was $339 million – this, again, was a quarterly record as well – compared to $292 million in Q1 of 2017. Our operating margin of 12.2% was a 10-basis point improvement year-over-year. However, if you excluded the tailwind from FX and Sevcon, margins would have expanded some 30 to 40 basis points. On a comparable basis, operating income was up $26 million on $157 million of higher sales. This gives us an incremental margin of 17% in the quarter, which is better than our expectations due to better cost performance and a lower headwind from our non-core emissions business. On an adjusted provision for income tax basis, it was $85 million for an effective tax rate of 28% for the quarter. I would also point out the year-over-year increase in net earnings attributable to non-controlling interest which reflects our minority partner share in the earnings performance of our Chinese consolidated joint ventures. We do expect this to increase throughout 2018. Earnings per share on a reported basis was $1.07 per basic share. On an adjusted basis, net earnings were $1.10 per diluted share. As James said, that's an increase of 21% year-over-year. Now, let's take a closer look at our operating segments in the quarter beginning on slide 12. Reported Engine segment sales were $1.716 billion in the quarter. Sales growth for the Engine segment on a comparable basis was 4.9% as demand for our light vehicle OEM products was supplemented by growth from our commercial vehicle sales. I would note that we reclassified Sevcon's battery charging business into our Engine segment, as we believe this business is better fit with our commercial vehicle and aftermarket business, which primarily resides in this segment. Adjusted EBIT was $280 million for the Engine segment or 16.3% of sales. On a comparable basis, the Engine segment's adjusted EBIT was up $16 million on $74 million of sales for an incremental margin of 22%. This incremental margin is a result of two factors: First, the segment showed very strong overall cost performance in the quarter, and second, headwinds from our non-core emissions business were less than we expected going into the quarter. Turning to slide 13, Drivetrain segment net sales were $1.083 billion in the quarter. Sales growth for the Drivetrain segment on a comparable basis was 9.2%, primarily due to strong DCT growth in China and transmission components in four-wheel drive as well. Adjusted EBIT was $121 million for the Drivetrain segment or 11.2% of sales. On a comparable basis, the Drivetrain segment adjusted EBIT was up $13 million on $85 million of higher sales for an incremental margin of 15%. This is good performance and reflects the successful ramp of new programs. Now, I'd like to discuss our 2018 guidance, which we have increased due to higher foreign currency tailwinds. Turning to sales growth guidance for the full year on slide 15. We continue to expect organic growth of 5% to 7%. The Sevcon acquisition is expected to add $50 million to revenue in 2018. Currency is expected to be a $400 million tailwind, up from $170 million. Total revenues are now expected to be in the range of $10.77 billion to $10.94 billion. From a performance perspective, we expect mid to high-teens incremental margins on sales growth. Our consolidated operating income margin is expected to expand to 12.5% to 12.6%. I would point out that this margin guidance is in line with our guidance prior to the reclassification of a pension income adjustment, which is in accordance with the new accounting standard. Those of you interested, it's FASB ASU No. 2017-07. This is a 10-basis point impact versus our original guidance, but with no EPS impact. To finish up the full-year guidance, please turn to slide 17. EPS guidance range is now $4.30 per diluted share to $4.40 per diluted share versus $4.25 per diluted share to $4.35 per diluted share previously. The increase is driven by the impact of larger FX benefits. This EPS guidance includes a $0.06 year-over-year EPS headwind related to higher minority interest and lower equity income. We continue to expect free cash flow to be in the range of $525 million to $575 million. The tax rate remains the same at 28%, and our assumption for the dollar to euro exchange rate has been adjusted to approximately $1.22 from $1.18. Now, our second quarter guidance is on slide 19. For sales, we continue to expect organic growth of 7% to 9%. This is above our full-year guidance, primarily due to stronger year-over-year industry production. EPS is expected to be in a range of $1.09 to $1.11 including a $0.02 year-over-year headwind from higher minority interest and lower equity income. This guidance is based on a 28% tax rate and incorporates a $1.23 to €1 assumption or about $125 million revenue benefit year-over-year. In conclusion, let me summarize Q1. It was another strong quarter to start the year, as James and I mentioned earlier. Organic sales growth of 6.6% despite a decline in industry volume. The Q1 incremental margin of 17% was slightly better than expectations. As we look at the remainder of 2018 and beyond, we see substantial opportunities to participate in the impending electrification trend while our combustion-related business continues to outpace market growth. With that, I'd like to turn the call back over to Pat.

Thank you, Ron. Dan, we're ready for questions.

Hi. Good morning, everyone.

Good morning, David.

Good morning, David.

Two questions. First, a numbers question. The working capital number I'm guessing is distorted a little bit by currency and FX, but I thought there was a reasonable amount here year-over-year. Any thoughts on that?

The only thing is this is a general trend in the first quarter. Working capital is needed to get into production after the fourth quarter where volumes ramp down, David. I would say that, year-over-year, we were not alarmed. Our ratios of days on sale for inventory and receivables were pretty much payables, and we probably paid our bills a little bit quicker. The emissions business probably had an impact as well. So, nothing alarming. We're still holding our full-year cash forecast.

Okay. And then, secondly, on the portfolio products that you're billing out for hybrids and EVs. I guess two different parts of this: one from the drive motor, the gearbox. What do you need to do there? Is there anything you need to do there to broaden that product range at all, and what is the timing for bringing those types of products to market? And then, secondly, as you're out there booking a lot of great new business and new contracts there, do you have any sense of what your win rate or market share is of those programs that you're going after?

So, David, this is James. I would say the first thought I would share with you is that we're very happy with the technology we have from a drive motor and a gearbox perspective, and now obviously with the added power electronics capability we've got from Sevcon, that just strengthened us. We have a lineup of motors and a complete range of gearboxes that run the full requirements for hybrid and electric. That's why you can probably tell in my comments that we're booking really well. We're picking up the business that we need to and you're starting to see that flow through the press releases. I can have Pat, actually, David, give you the amount we've secured this year on eGearDrives and motors as we have some specific data. I would say in general, if I look back six months ago to the Investor Day, David, on what we hoped to book around hybrid applications and electric, I would say we're ahead. I don't have a specific number to give you in terms of revenue or percentage, but I would say directionally we're absolutely running ahead of where I thought we would be both in terms of win rates, absolute bookings, and dollars. I just don't have that specific info with me, but we're definitely doing well, and we have the necessary portfolio.

Okay, congratulations. Congratulations on the contract.

Yeah, thanks.

Or award, yeah.

Yeah. Thanks, David.

Great. Thanks for taking my questions.

Hey, Colin.

Any color on how much diesel mix as a headwind within the quarter? I know it looked pretty bad, so I wanted an update there and if you could also maybe update the dollar exposure, I think you said in the past like 80 cents on the dollar gas-diesel ratio?

Yeah, Colin. So for the quarter, it was a 760 bps year-over-year shift from diesel to gas for the quarter. For the full year, we're estimating about 500 bps full-year, year-over-year 2017 to 2018 diesel to gas mix. For every 100 bps that moves, it's a net revenue impact for BorgWarner of about $20 million to $25 million. Did that help you?

No, it's very helpful. And that – when your initial guidance was a 200 basis points to 300 basis points decline, so is it a bit worse?

Yeah, 300 basis points to 400 basis points is how we started the year, Colin. So, we're trending a little worse than what we'd expected because we've now shifted to about 500 basis points to 600 basis points. The first quarter was 760 basis points down. So, that's kind of where we're at right now.

Okay, I'd just like to add some. That's what the market is doing. We're not seeing, again, in 2018 the full impact that we did. The same thing happened to us in 2017. The market's moving faster than what we're experiencing in our business.

Yeah. Got it.

Colin, one of the things not to overdo – these things drive you crazy, but obviously we're talking light vehicles here, just to separate the commercial vehicle aspect.

Yeah.

And actually, the irony of this which is kind of cool for us is that the strength in commercial vehicle is pretty much offsetting that light vehicle diesel shift. So, that's why we're delivering the outcomes we're doing.

Got it. And any thoughts on the potential for the U.S. fuel economy fares to get pushed out? Do you think that helps your Engine product and then maybe they have a longer life? Does this really make a difference to your business? Any color there?

Yeah. So, that's a fair question and we – like everybody else, we don't really know. We know obviously there's a lot of discussions going on. There's a lot of review going on. I think the sentiment is one of, if anything, it's kind of relaxing 'the standard' a little bit. But here's what we do know, Colin. The rate of improvement and efficiency required across all three architectures: combustion, hybrid, electric. Has to continue to climb from where we are today. So on combustion, what that's going to mean is more advanced turbos, more advanced variable cam timing, et cetera. That's what's driving our growth. As we're optimizing, we get more efficient on the combustion products. And hybrids and electrics obviously, we've got a strong portfolio. So the net for us as a company, Colin, we have growth in all three vehicle types: combustion, hybrid, and electric. What happens for us is that with the different OEMs, the mix of hybrid, electric, and combustion will vary a little bit depending on the adoption rate and the climb with the standards. But for us, net-net, we're growing independent of that shift or slowdown or acceleration of standards.

Got it. All right. Thank you very much for taking my question.

Thank you, Colin.

Thank you, Colin.

Good morning, everybody.

Hey, Rod.

Good morning, Rod.

I had a couple questions. First one, I just want to apologize just given the number of companies that have reported today, I should have dissected this already, but your full-year guidance change basically appears to reflect the upside from Q1 when I look at the earnings per share. Can you just clarify, for the rest of the year, it sounds like you raised your FX assumption, but did you offset that with downward revisions to diesel mix or something else?

No. We're still concerned about our emissions business going forward. They had one great quarter and they gave us good tailwind. I'm not in a position. I don't think we are as a management team to say it's going to continue to be headwinds going forward, Rod. So, we're just going to watch that business quarter-by-quarter until we sell it.

Okay. That was actually my second question, just on that emissions business. How much of a drag was that at this point and what's your timing on resolving this?

Going into the quarter, we anticipated it would be about a $5 million per quarter headwind for the first two quarters and then it would kind of even out in the back half of the year. We didn't see all the $5 million headwind in the first quarter, Rod. Now, that's not to say – we're cautious. They did very well, and we're all supporting them. But to have that flow through for the year here is premature.

Rod, maybe I can just give you a little bit of an update on what we're doing with the business more strategically. The plan was to sell and divest the thermostat and pipe, non-core product lines, and that's moving along as planned, Rod. This means we've used the first quarter to really get some groundwork done in terms of marketing the business. We'll be moving into that over the next 60 days. Our early thoughts indicate it's a good opportunity and a good business for somebody. We're not the natural owner or the best owner for that business. We are comfortable, and I think we'll get a sale. We just need another quarter to go through the process of engagement with potential buyers, and I think we'll know more. We're encouraged by early interest regarding being able to move that business out of our portfolio as we go through the year.

Okay, thank you. And just one more if I could just slip this in. It sounds like there's a pretty significant pickup in electrification and other technologies being added to comply with the regulation, particularly in Europe. Was wondering if just from your perspective in speaking to customers, are you hearing about anything more strategic vis-à-vis their plans for Europe? There seems to be a recognition that some segments are structurally challenged. It's hard for your customers to pass along some of these cost increases. What do you think that might mean for you, just in terms of the volumes or those relationships over time?

Yeah. It's a good question, Rod. Our view is that, generally, we have seen a growth in the pace and acceleration towards electrification in Europe for sure. An element of that is the transition from diesel to gas, which is accelerating for obvious reasons. All OEMs are looking at what is the best solution for their fleet uniquely. They're generally looking for a balanced fleet so that we are not seeing a lot of big jumps towards pure electrics or hybrids. What we're seeing is that they’ll have a mixture of advanced combustion technology which is continuing to advance pretty aggressively. We're seeing significant investment in combustion to meet new fuel economy standards, while hybrids and electrics are in scope too. That varies by OEM, particularly on fleet size and the fleet mix. But the key is that we have growth in all three vehicle types: combustion, hybrid, and electric. The adoption of different technologies as outlined will vary OEM by OEM based on the mix and the local regulations. However, our positive outlook on all three architectures remains intact.

Great. Okay, thank you.

Thanks, Rod.

Good morning.

Good morning.

So on the organic growth, you outperformed your own prior expectations by 200 bps for the quarter at midpoint, even despite the diesel headwind and the lower industry production. I think we have some elements of it here from your prepared remarks, but can we just pin down what were some of the major contributing factors leading to that higher organic growth versus the outlook?

Yeah, sure, Noah, this is James. The two things that I would say are the most meaningful, as I mentioned in the prepared remarks, is that commercial vehicle was a little stronger. If you remember, we came into the year with a view that really no growth for commercial vehicle for us. We saw some growth there in commercial vehicle, which contributed probably about 100 basis points to the stronger growth. The overall view of the backlog in terms of launches was a little stronger, a mixture meant some programs may have come in slightly quicker or ran a little faster than what we had anticipated.

Yeah, no, that's very helpful. And then, the China Show – the China Auto Show that's ongoing, clearly, the EV models are being showcased here, right, ahead of the quota requirements that are going to kick in. Then we've had the announcement around ownership liberalization. I was just wondering what's your view of the potential impact to the business. Obviously, the local content requirement on batteries doesn't impact your ability with your products to play in the market. Would this at all help you to increase your market share in electrification? How to think about that effect?

Yeah. I'd give you a couple of thoughts, Noah. First off, China is a major growth engine for us as a company and has been for the last year or two, it continues to be very strong. Over 30% of our backlog is derived from China. The fastest adoption of pure electric, battery electric vehicle technology has been in China, and we've been right there with that. If you look at some of the eGearDrive announcements we've made over the last few quarters, that's evidence that we're strongly in there. We have also launched our electric drive module, which is a combination of both the motor and the gearbox. In addition, what we find particularly is that domestic OEMs are adopting technology at a very fast pace. They rely heavily on propulsion system partners like us because we bring all the discrete technologies needed. We see tremendous EV growth in China. We're right there with them and see more adoption of hybrid technology where we're also present. So, this is all super positive for BorgWarner and growth in China.

Thanks very much for the color.

Thank you.

Good morning. Thank you for taking the question.

Good morning.

You've made a lot of progress towards becoming propulsion agnostic. But when I look at the slide from Detroit or the Investor Day where you have the content per vehicle and the participation rate, the content per vehicle is going up as we transition to different architectures. But your participation is trending lower. I know it's early days, but can you help me think about how you think about being propulsion agnostic? In my mind, it would be where the content per vehicle times the participation rate starts to even out. It's certainly moving in that direction. But do you see that ultimately as being the equilibrium? And if so, what are the factors to get there?

Yeah. So, let me give you some color on what we see. What could be useful is if you set up a detailed discussion with Pat where he can walk you through distinct numbers for content per vehicle and participation rate. But to articulate it generally, we see growth across all three platforms: combustion, hybrid, and electric. In a flat to declining combustion marketplace over the next few years, we generally grow at about 5%. This growth is through additional content as technology advances in combustion-powered products. On hybrid, we are increasing our content per vehicle and the participation rate continues to grow. That's combined with the carryover of our combustion products and the hybrid product. For electrics, historically, our content was exceptionally high when we only shipped one product, the transmission. As we adopt more products, that content per vehicle narrows but our participation rate is climbing from about 3% to 26% over the next few years. When you net that, we anticipate the following: combustion content per vehicle in the low-200s, hybrid content per vehicle in the mid-200s, and electric in the high-300s. Participation rates will also be about 50% on combustion, mid-20s on electrics, and mid-30s on hybrids. Does that help a little bit? Pat can give you the multiplier.

It does. No, this is helpful. And then, Pat has been helpful as well. Just when I think about the transition electric, where do you see the equilibrium on participation rate for yourselves? Do you see it sort of not by 2020, but further out, higher than the mid-20% range and what do you need to do to get there?

Yeah, we’ll climb beyond the mid-20s. That’s a great number for us considering we’re coming from 3% just a couple of years ago. We will get to mid-20% and climb from there. We have a robust portfolio across the space. We can continue to climb. I don’t have a definitive number of where that will settle, but intuitively, if you think about it, why would there be less participation on electric than hybrid or combustion? I don’t think it will. It’s just a matter of when we get there.

Okay. Thank you for taking the question.

Thank you.

Thank you.

Hi. Good morning. Thanks for taking my question.

Morning, Ryan.

Maybe just first regarding the modestly lowered EBIT margin guidance for the year. Thanks, Ron, for the comment on the competitive impact. I imagine the FX tailwind to revenue was also diluting the all-in contribution margin. Are there any other factors at play such as a decision to spend more on investments in electrification or other technologies to drive future sales growth or is it really just those other factors?

It's accounted for those other factors and we are maintaining our incremental margins right in the mid-teens, so no. It's those two factors, FX and then the reclassification of the pension.

Got it. That's helpful.

Ryan, sorry. Just want to reiterate—there is absolutely no slowdown at all in R&D spending. We continue to maintain the pace of over 4% across the portfolio. I don’t want you to think we are scaling back on R&D. If anything, we’ll spend more, not less.

Very helpful. And then just, James, I recall you saying a couple of years ago before Sevcon that you'd be happy to make a number of power electronics acquisitions if you could. I'm just curious what other power electronics capabilities exist out there that were not addressed by the Sevcon acquisition that you could still be potentially interested in acquiring?

Yeah. I would say it's probably similar stuff to what we – what Sevcon brings, but just more scale, more engineering capacity, and capabilities. We're happy with what we've got; we're doing well. As we're marching towards an $11 billion company and growing at the rate we are, we're becoming a big company and it’s a lot of activity we're managing. If we can add more capability, more capacity, Ryan, it would only help us. I don’t need to add other discrete products to deliver on the growth targets. We can do that with what we've got plus Sevcon.

Okay. Great. Yeah. No, that's great. Thanks. And then just the last question for me is, in the past, I think you've talked about a breakout of the alternate powertrain mix in your backlog or for the industry as a whole. We see the IHS figure kind of 5% to 6% DAV penetration in 2028. I think this is as far as they go. Just curious, given all the anecdotal evidence and announcements we've seen from automakers, if you see anything shifting in your conversations with them, are your conversations still mostly tied to discussions around hybrids and NEVs?

A couple of thoughts, Ryan. One, obviously, as we get closer to implementation dates, I will refresh this for you and give you the outlook of vehicle architecture breakdown based on IHS view and our view. Fundamentally, we've not seen a huge change from six, nine, or twelve months ago other than the ongoing strong pull for 48-volt mild hybrid, which continues to gain momentum in various parts of the world. There are a lot of announcements regarding pure electrics, which I think we are paying a lot of attention to. However, I wouldn’t say there's been any large shift. We're getting closer to the dates now, and there's a lot of urgency to implement these technologies. The adoption of 48-volt mild hybrid technology is growing, coupled with battery electrics and optimization of combustion which are the primary drivers we see in the business.

Great. Very helpful. Thanks for all the color.

All right. Thank you, Ryan.

Thanks. Hello, everyone.

Hey, Joe.

Hey, Joe.

So just on the diesel commentary, I know you said the market was down, I think, 760 basis points. Within that, one of the things we've observed is that the smaller engines are declining at a faster rate than the larger engines. Are you mostly aligned with the industry mix or did you perhaps outperform or underperform based on your mix?

Yeah. So, Joe, this is James. The 760 basis points is the right number for the quarter. You're right; it's biased towards smaller vehicles switching out of diesel quicker. We've seen that trend over the last six months to twelve months. On average, we’re slightly weighted to the larger vehicles. I don’t have any specific data point, but generally we don’t get impacted as much as the industry average because of that slight bias toward larger vehicles.

One thing I will add, Joe, is that looking at the impact we experienced in Q1, it was in line with our guidance of 300 basis points to 400 basis points. That's what we experienced, okay? We didn't experience the 760 basis points in the quarter.

Okay. So, the drag to sales in the quarter was 300 to 400 basis points, but given that commercial vehicle offset that. The inference is that commercial offset the guidance we thought we would experience, and we still performed better than what the market did.

Right.

Yeah.

Okay. The second one is just – so, I appreciate the comments on 48-volt, and that makes a lot of sense given some of the near-term targets that the automakers have to hit. Presumably, because of your capabilities, you're also involved in a lot of discussions with the automakers about where they go after that. I'm curious about those conversations for the next generation. What are they thinking there? The reason I'm asking is it seems like 48-volt could be this really strong growth, mid-term solution, but ultimately, it seems like it may get replaced by some of the other technologies in your content.

Yes. A couple of thoughts, Joe. First, we are absolutely involved in discussions across the industry with all automakers, which is interesting because we get a view of what each automaker is doing. We're hearing discussions of what's the optimal mix of propulsion technology for their vehicles both now and through 2025 and even beyond 2025. The general trend that we see is that all of them are looking toward a balanced fleet. We don’t see a lot of will hybrid be an interim solution to use an example and everybody switching over to pure electrics. We see even in a sustained period to 10 years out that they'll have a mix of advanced combustion technology, which continues to get better. They will invest in optimizing combustion and hybrid technologies as well as embracing some battery electric solutions. The difficulties may vary OEM by OEM and region by region, but those are some of the key high-level trends that we're seeing.

Yeah, no. That is helpful. Just one quick follow-up because you mentioned the sort of P2 configuration. Is there a preferred motor setup for BorgWarner over the others? Or are you pretty agnostic regarding where they place the motor?

No, what we’re finding, Joe, the reason the P2 solution is beneficial is it gives the OEMs the opportunity to use the current engine and transmission configuration they have and basically place the P2 model in between, providing flexibility. It gives them the ability to use that engine transmission as a combustion or hybrid vehicle. If you look at the companies that understand engines, transmissions, clutching, motors and electronics, which are all the elements needed to pull off a P2 mild hybrid solution, there is BorgWarner and not many others. All of that is our competitive advantage. We have a range of motor technology so we can scale or adjust based on the required application. That’s why we’re gaining a lot of traction.

Great. Thanks. That's helpful.

Thanks. Hey, guys, I really just wanted to discuss a little bit about the high-voltage industry outlook maybe more in detail and specifically on power electronics. Now that you have Sevcon for the last two quarters, and you had a strong interest from OEMs. So, two questions. The first is on the bundling of the electric motor and power electronics. If you can give any qualitative or just some guidance for how much you're seeing those two bundled together versus bid out separately among different suppliers. And then, the second on insourcing. I think you gave some comments last year that you thought on the electric motor side that it was going to be about 50% insourced from OEMs. We really don’t have a good industry check on power electronics, outside of Tesla. It seems like most OEMs are going to outsource, but any color you can add there would be great.

Let me start with the motors, Chris. You are correct, our assumption was about 50% will be insourced and 50% outsourced by the OEs. Out of that outsourced, we would likely pick up about 15% of that market share. The two things I’ve seen since we talked about that: I think the 50/50 insourced and outsourced by OEs still holds. If I had to do an over/under, I think they’ll do a little more outsourcing. As far as our ability to win that 15%, I’m feeling incrementally more positive. We’re probably running ahead of that. It’s still early in that race, but directionally, that’s where I would go. Now regarding power electronics, I agree with your sentiment that the OEs are generally leaning towards outsourcing it for sure. On bundling, that varies a little bit by the OEMs. Generally speaking, the Chinese OEMs are much more inclined to bundle everything, and we are seeing that play out strongly. In Europe and North America, that’s less so, but the key is that as a supplier, if you’re going to compete, you need to understand how they all interact. That’s the message I’ve heard loud and clear from the OEMs: don’t come to me with just parts that you don’t understand how they interact. You’ve got to comprehend the system as a whole.

No, James, that's fantastic. And do you think, just as a quick follow-up on the bundling, when you're going to the OEMs, is there a very strong value proposition that, if we are able to do both or able to offer x in terms of savings or efficiency? Or is the value proposition only so-so, not just for yourself, but for the industry, that combining those, you're not really gaining a lot of efficiencies?

I would say there is a little bit, Chris, OEM-to-OEM. If you’ve got the capability to do all, you’re in a much stronger position for two reasons. One, you can understand the tradeoffs between the different pieces of technology. Two, if you can offer it, provide it, and if you can insource it, you have an advantage. It’s still early, but I would say in general you are better off if you have all elements as opposed to only a few.

Great. Thanks so much.

Thank you.

Thanks, Chris.

Good morning, guys.

Hello, John.

Hello, John.

Just a question on the Drivetrain business. Ron, when you were going through the walk, you were talking just about how you've benefited from mix there, what we’re hearing on four-wheel drive, from the automakers, is an increasing focus on crossovers and trucks in relation to the potential cancellation of many car programs. Just curious as we think about the Drivetrain business, what kind of potential upside you see as we see the shift towards more crossovers and trucks that will have more four-wheel drive or at least all-wheel drive capability?

I'll start, then maybe James would follow up. It's not just about transfer cases; it's also about couplings. We see good growth in the first quarter in the coupling business in Europe, for example, and in China. In the U.S., we often think about the trucks and the transfer cases, but it's not just about transfer cases; it's also about couplings.

Ron, that's a good perspective. The only other thing I’ll add, John, is that not to beat a dead horse, but having the broad elements of Drivetrain, all the key pieces gives us a competitive advantage because you can understand both parts of the vehicle. That's a big advantage for us.

But, simplistically, directly from a passenger car to a crossover to a truck, what is the content potential for you in Drivetrain just on a more traditional standpoint?

The biggest thing that moves the needle is the transfer case. That’s the biggest shift for us, if that makes sense, John. We have equal content of transmission across the vehicle, but transfer case is an additive to trucks and four-wheel drive applications. The rise in China of more SUVs is calling for more functionality for all-wheel drive or four-wheel drive and calling for dual-clutch applications because they're better equipped in an SUV.

Okay, that's helpful. And then just a second question, can you remind us what your commercial vehicle exposure is there because it sounds like the market is running a lot hotter than flat or is going to run a lot hotter than flat this year? I'm just trying to understand what the potential upside is from that.

Commercial vehicle is about 12% of revenue, total company, and it's about a third in North America, a third in Europe, and the other third is split between China and Brazil, weighted to China. In total commercial vehicle, about two-thirds is over the road and about one-third off-the-road.

And profitability on that, is that sort of around corporate average or is there a higher profile there?

Yeah.

It's around corporate average.

Great. Thank you very much.

Thank you.

Hi. Good morning, everyone.

Hey, Rich.

Hello, Rich.

Just a couple here for 2018 on the guide. So, implying second-half organic growth slows down, production comps particularly in North America get easier. Is there backlog timing or anything we should read into with regard to conservatism?

I don't think there's anything to read into. It's early right now in the year. We're only four months in. I don't think there's anything to read into that at this point.

Okay. And then on the equity and affiliates, so that number is going to be a headwind. So, it's going to be down year-over-year. That's related to, I think, you have Korean and Japanese joint ventures. Is there something else there not just production or is there programs or what's driving the lower contribution?

There are two elements to that line that we want to focus on: affiliates and then the equity. Both of them are headwinds. One of them on the joint venture is what’s happening is, as we make more money in those joint ventures, we have to give them more money because we don’t have 100% ownership. For example, the dual-clutch transmission for the Chinese OEMs is a good example. As we do better there, we have to give our partners more. Additionally, we see startup costs in NSK-Warner expansion plans coming through, and we expect they should encounter some cost issues due to expansion.

Okay. So that was the one I was looking for, I understand the DCP piece of it.

Yes.

So, there's some investment going on there, okay.

Yes.

That's great. Okay, that's all I had. I appreciate it. Thank you.

All right.

Thank you, Rich.

Thank you, everyone, for your very good questions today. Dan, you can now conclude the call.