BorgWarner Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 8, 2024

There are 11 speakers on the call.

Operator

Good morning. My name is Savannah, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2023 4th Quarter and Full Year Financial Results Call. All lines have been placed on mute to prevent any background noise. And after the speakers' remarks, there will be a question and answer period.

Operator

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

Speaker 1

Thank you, Savannah. Morning, everyone, and thank you for joining us today. We issued our earnings release earlier this morning as posted on our website borgwarner.com, both on our homepage and our Investor Relations homepage. With regard to our Investor Relations calendar, we will be attending multiple conferences between now and our next earnings release. Please see the Events section of our IR page for a full list.

Speaker 1

Before beginning to inform you that during this call, we may make forward looking statements, which involve risks and uncertainties as detailed in our 10 ks. Our actual results may differ significantly from the matters discussed today. During today's presentation, we will highlight certain non GAAP measures in order to provide a clearer picture of how the core business performed for comparison purposes with prior periods. When you hear us say on a comparable basis, that means excluding the impact of FX, net M and A and other non comparable items. When you're going to say adjusted, that means excluding non comparable items.

Speaker 1

And finally, when you hear us say organic, that means excluding the impact of FX and net M and A. We will also refer to our growth compared to our market. When you hear us say market, that means the change in light vehicle Light and Commercial Vehicle Production Weighted For Our Geographic Exposure. Please note that we've posted today's earnings call presentation to IR page of our website. We encourage you to follow along with these slides during our discussion.

Speaker 1

With that, I'm happy to turn the call over to Fred.

Speaker 2

Thank you, Pat, and Good day, everyone. We're pleased to share our results for 2023 and provide an overall company update starting on Slide 5. With approximately $14,000,000,000 in sales, we delivered more than 12% organic growth in 2023. Our margin performance was strong, coming at the high end of our guide. During the course of 'twenty three, We adjusted our e products top line guide to reflect what we saw in the marketplace.

Speaker 2

It resulted in lower top line for the company, but higher margins. This is a good example of the product portfolio resilience that exists At BorgWarner, we delivered $565,000,000 of free cash flow in 2023. This Free cash flow supported the $177,000,000 of share repurchases that we executed during the Q4 as well as the closing of the El Dor acquisition. Our charging forward progress continues on multiple fronts. We secured multiple new e product awards during the Q4, adding to those already announced over the course of the year.

Speaker 2

These awards were across our portfolio for both bev and hybrid architectures. We continue to see a strong sourcing pool for our products based on the strength of our portfolio globally. Lastly, we took steps to enable new business awards by executing several strategic actions To further strengthen our e product portfolio, like the acquisition of Eldor Electronics Business, as well as the strategic agreement with BYD, FinDream Batteries for LFP packs outside of China. Now let's look at some new e product awards on Slide 6. 1st, has been selected by Xiaopeng to supply its e motor rotor and stator for the X9 MPV as well as for their next electric B Class Sedan.

Speaker 2

Production began in January 2024 for the X9 And we're planning to start producing for the B Class Sedan in Q3 'twenty four. Our high voltage Airpin 220E motor offers high power and torque density and higher efficiency at a competitive cost. We are excited to supply Xiaoping with our proven stator and rotor as we believe it continues to position us for long term success in China, where NEV penetration is already more than 35% of the market. 2nd, BorgWarner secured an award with a major global OEM to extend its existing business, supplying 400 volt high voltage coolant heaters for some of the automakers' light vehicle best platforms, specifically for its passenger truck and SUV programs. This business win is one of the 3 awards with North American OEMs incorporating BorgWarner's high voltage coolant heaters into their vehicles.

Speaker 2

3rd, BorgWarner has secured an award with a major Chinese OEM to 90 kilowatt dual inverter on a series of the Automated Plug in Hybrid and range extended electric vehicles. Production is expected to begin in September this year. The dual inverter is developed for hybrid vehicles as an integrated solution. The product utilizes for 1 is 5, the power module platform and leverages our inverter product leadership and scale. Next, on Slide 7, in addition to securing new business, We took multiple steps to build additional capabilities within our e product portfolio, driving product leadership and differentiation.

Speaker 2

I would like to highlight 3 of them today. 1st, BorgWar completed its acquisition of the electric hybrid systems segment of L'DORE. This provides us with additional capabilities in onboard chargers, DC DC converters and integrated high voltage boxes, all of which are expected to complement BorgWarner's existing product portfolio in hybrids and BEVs. Next, BorgWarner is continuing to expand its product portfolio for battery electric and hybrid commercial vehicles, follow our agreement to form a joint venture with Shaanxi Fast Auto Drive Group, a Weichai subsidiary. We are working together to accelerate the product efficiency and growth in the Chinese CV market with the largest CV powertrain supplier in China.

Speaker 2

BorgWarner will then be able to use these products and technologies for the rest of the world. Finally, Polwan has signed an international strategic relationship agreement with BYD subsidiary FinDreams Battery for LFP sales and facts. Under this agreement, For Warner will be the only Non OEM localized manufacturer unaffiliated with FinFinder and Batteries with rights to localize LFP battery packs for commercial vehicles, Fitelizing FinDream's batteries blade cells. These packs are expected to be sold in the CV markets in Europe, the Americas and select Asia Pacific regions. The LFP battery chemistry is an exciting technology that is cost competitive In comparison with some other cell chemistries, we are seeing increased demand from our customers for packs with LFP sales.

Speaker 2

FinDreams battery is right for BorgWarner in this area with over 20 years of experience in batteries with numerous successful product launches. Next on slide 8, I would like to summarize the growth we expect in our e product sales in 2024. We expect 2024 e product sales of $2,500,000,000 to $2,800,000,000 representing a year over year growth of 25% to 40%. One important driver of our 2024 growth is expected to be our battery system product line. Battery systems demand from our commercial vehicle customers, Trucks and buses continues to outpace our ability to produce.

Speaker 2

However, We are continuing to increase our capacity to meet the strong customer demand, both in North Carolina and in Europe. We expect this capacity expansion to help drive a $250,000,000 to $350,000,000 increase in battery system sales in 2024, which equates to 55% to 75% year over year growth with more to come. Then looking at the other parts of our e product portfolio, our guidance assumes 14% to 27% year over year growth with the midpoint roughly in line with our expected dev and hybrid market growth. Overall, we expect 2024 to be a heavy year related to the number of launches across our light vehicle portfolio, from IDM to motors, from power electronics to thermal management globally, for both bevs and hybrids. While we expect another year of volatility in bevs and hybrids volume for the industry, We believe our capacity expansions and intense launch activities will support our outlook.

Speaker 2

Finally on Slide 10, I want to take the opportunity to remind you 1, e products growth 2, e product profitability and 3, maximize the foundational value. The first two pillars center around Long term profitable growth. We continue to believe that despite near term volatility, The mid to long term trends towards electrification, BEV and hybrid remain strong. We believe that borrower is clearly positioning itself to be among the leaders in terms of e product business awards and to do so profitably. The 3rd pillar of charging forward is an enabler of this long term growth.

Speaker 2

Our foundational business brings customer relationship, technological capabilities and the ability to internally fund our investments. As importantly, With its leading market positions and strong margin profile, we believe our foundational business provides near term earnings resiliency during times of bev and hybrid market volatility, Just as we highlighted at our Investor Day back in June, as Kevin will review, That is evident both in our 2023 results and our 2024 outlook. The key takeaway is that both our e product and our foundational business lines play important role in charging forward 2027. This was true when we unveiled our plan in June and it remains true today. As I look back on 2023, my take is this, Boardwalk has successfully managed another challenging environment during 2023.

Speaker 2

We delivered solid margins and strong free cash flow, which is a sign of the product resiliency that we built. We successfully completed the spin off of Finia. We secured new business awards that are supportive of our long term revenue objectives in all types of electrification, powertrain architectures. We also secured some critical alliances, especially on the CV side with subsidiaries of Weichai for inverters and BYD for battery packs. We also continued to return capital to shareholders.

Speaker 2

BorgWarner has repurchased about 600,000,000 stop since completing the Delphi acquisition in 2020. And over the last 4 years, We have also returned about $600,000,000 to shareholders in dividends. So Boardwalk has returned About $1,200,000,000 to shareholders since 2020 and that's before considering the tax free spin of Finia. Moving into 2024 and beyond. We are balancing nearer term margins Relative to our long term objectives, we expect to manage our incremental margin holistically while continuing to invest in our future growth.

Speaker 2

As we have always said, the industry growth in VAS and hybrids will not be a straight line. The near term volatility is a long term opportunity for the companies with the financial strength, earnings resiliency and the great product leadership focus that Coronav possesses. Our product portfolio is built for resiliency such that a longer combustion tail will help margin and cash generation. As a company, we are executing our charging forward 2027, which we expect will deliver value to our shareholders here and now and long into the future. This is Kevin's last earnings call with the company and I wanted to take a moment to personally thank him for his tremendous contribution to our company over the past years.

Speaker 2

Kevin has played an instrumental role In all of Borrara's recent major strategic initiatives ranging from the acquisition of Delphi to the creation and execution of Charting Forward as well as the spin off of Finia. On behalf of the entire Board of Directors and the management team, I thank him for his contribution to our company, for his friendship and wish him a fantastic retirement. I look forward to Craig Aaron stepping into the CFO role next month. I am confident Craig has the right skills, the deep knowledge of BorgWarner and our industry to execute our next chapter of profitable growth. With that, let me turn the call over to Kevin.

Speaker 3

Thank you, Fred, and good morning, everyone. Before I dive into the financials, I'd like to provide a quick overview of our 4th quarter results. 1st, revenue was at the midpoint of our guidance, supported by stronger than expected industry production in the quarter. 2nd, our margin performance was at the high end of our guidance, driven by strong conversion on higher revenue. And finally, we delivered strong free cash flow performance to finish out the year.

Speaker 3

Let's turn to Slide 10 for a look at our year over year revenue walk for Q4. Last year's Q4 revenue from continuing operations was just over $3,300,000,000 You can see that the weakening U. S. Dollar to over year over year increase in revenue of almost 2% or 55,000,000 Then you can see the increase in our organic revenue, which was roughly 4.5% year over year. The reason why our growth wasn't stronger is that we were negatively impacted in the quarter by customer launch and ramp up the plays of key e product programs in China, lower customer volumes on a North American EV program and lost sales due to the UAW strike in North America.

Speaker 3

Finally, the acquisitions of Eldor and SSE added $5,000,000 to revenue year over year. The sum of all this was just over $3,500,000,000 of revenue in Q4. Turning to Slide 11, You can see our earnings and cash flow performance for the quarter. Our 4th quarter adjusted operating income was $332,000,000 equating to a 9 point percent margin. That compares to adjusted operating income from continuing operations of $321,000,000 or 9.7 percent from a year ago.

Speaker 3

On a comparable basis, excluding the impact of foreign exchange and the impact of M and Operating income increased $16,000,000 a $145,000,000 of higher sales. This performance includes a planned e product related R and D increase of $15,000,000 Excluding this higher ER the investment, we converted at approximately 21% on the organic sales increase. Our adjusted EPS from continuing operations was down $0.04 compared to a year ago and higher adjusted operating income was offset by a higher effective tax rate. Recall that our adjusted effective tax rate in Q4 of 2022 was only 18%, lower than our typical tax rate. And finally, free cash flow from continuing operations was $679,000,000 in the Q4, which allowed us to deliver full year free cash flow of 565,000,000 On Slide 12, I'd like to take a moment to look at our 2023 results compared to the post Finneas spin off guidance that we provided in June, Because I think it provides a helpful look at the resilience we believe underlines our current product portfolio.

Speaker 3

You'll see that overall sales came in modestly below the midpoint of that guidance. While e product sales fell short by about $400,000,000 relative the midpoint of our $2,300,000,000 to $2,600,000,000 guide, foundational sales largely offset this coming in about $300,000,000 higher than the June guidance. However, the real evidence of our earnings resilience is in our adjusted operating margin performance. Despite the shortfall in sales relative the midpoint of our June guidance, adjusted operating margin and adjusted operating income dollars came in above the midpoint of that June guidance. This demonstrates precisely the resiliency we've been speaking about since our Investor Day.

Speaker 3

If e products are weaker, then our revenue isn't going to grow as quickly, but our margin is likely going to be stronger and that's what happened in the second half of twenty twenty three. Let's now turn to Slide 13, where you can see our perspective on global industry production for 2024. We expect our global weighted light and commercial vehicle markets to be flat to down 2.5% this year. Looking at this by region, we're planning for our weighted North American markets to be down 1% to up 1%. In Europe, we expect our blended market to be down 2% to 4% year over year.

Speaker 3

And in China, we expect the overall market to be down 1% to up percent. Now let's take a look at our full year outlook on Slide 14. First, it's important to note that our guidance assumes minimal impact from foreign currencies on full year sales. 2nd, as I previously mentioned, we expect our markets to be flat to down 2.5% for the year. Despite that, we expect to continue to deliver year over year organic sales growth, driven by growth in our e product sales.

Speaker 3

Specifically, in 2024, we are expecting to deliver between $2,500,000,000 $2,800,000,000 in e product sales, which is up significantly the approximately $2,000,000,000 we generated in 2023. Finally, the Eldor acquisition is expected to add approximately $40,000,000 to 20.24 revenue. Based on these expectations, we're projecting total 2024 revenue in the range of $14,400,000,000 to $14,900,000,000 which equates to organic growth of approximately 1% to 5%. Let's switch to margin. We expect our full year adjusted operating margin to be in the range of 9.2% to 9 point percent.

Speaker 3

It's important to note that this guidance includes a negative operating income impact due to the Eldor acquisition. With ZalDor, we purchased strong engineering capabilities that we believe more clearly puts us on the path to achieving product leadership in an addressable market that we expect will approach $30,000,000,000 by 2,030. However, that business has very little revenue today, which means we'll be generating operating losses for the next few years. Excluding the impact of those Eldor related losses in 2024, we expect adjusted operating margin to be in the range of 9.6 percent to 9.9 percent, which compares to our 2023 margin of 9.6%. That implies the rest of the business delivering full year incrementals in the mid to high teens, including our planned growth in ER and D.

Speaker 3

We believe this margin performance is a reflection of the underlying earnings power of the company with the ability to manage costs and drive conversion even in the face of volatile bev and hybrid markets. Based on this revenue and margin outlook, We're expecting full year adjusted EPS from continuing operations in the range of $3.65 to $4 per diluted share. Turning to free cash flow. We expect we'll deliver free cash flow of $475,000,000 to $575,000,000 for the full year. The midpoint of this outlook is slightly lower than the $565,000,000 we generated in 2023 due to a modest build in working capital that supports our revenue growth.

Speaker 3

That's our 2024 outlook. So let me summarize my financial remarks. Overall, we delivered a solid 2023 result despite volatility in EV markets and our associated e product revenue. Our adjusted operating income and free cash flow performance shows the resilience of our portfolio. Specifically, when e product growth is under pressure, It's likely to be offset by stronger performance in the rest of the portfolio.

Speaker 3

Now as we look ahead to 2024, The company will be keenly focused on delivering organic growth despite near term volatility in the global bev and hybrid markets and the expected softening of production, delivering strong incremental margin performance on an all in basis, including our spending to support growth and continuing to make the prudent investments, both organic and inorganic that we believe will help secure our growth and financial strength long into the future. This will be my last earnings call after 5 years working with Fred and the team to drive the transformation of Board Water. I'm proud that I can leave the company in a moment where I truly believe it's positioned to be a winner in the world of electrification across a variety of e products, which is probably not the case when I joined in 2019. With a resilient portfolio, I believe the company is poised for long term success no matter how the progression toward electrification plays out in the coming years. And as a result, I expect that will translate into value creation for our shareholders.

Speaker 3

I'd like to thank Fred and the team for the opportunity to be part of this journey. And I know I'm leaving the finance function in good hands with Craig. Finally, thanks to all of you in the investment community for our engagement over my last 11 years as a public company CFO. It's been a fun ride and I've enjoyed the relationships I've had the chance to build with many of you over the years. With that, I'd like to turn the call back over to Pat.

Operator

And our first question will come from John Murphy with Bank of America. Please go ahead.

Speaker 4

Good morning, everybody, and congrats, Kevin. Look forward to crossing paths sometime in the near future. Thanks, Just a first question here. I understand you have to run a business and sometimes it makes sense in the volatile world that we live in to take a slightly conservative tack. But I were to tell you instead of your volumes being flat to down 2.5%, they might be flat to up 2.5%.

Speaker 4

The midpoint of the range, I would add about $355,000,000 in revenue to your outlook. Would it be reasonable to sort of assume that those could convert sort of a 15% to 20% incremental margin and that would kind of really translate into about 5% margin and that would kind of really translate into about 5% upside to earnings and potentially cash flow. Is that a reasonable way to think about it if that were to happen?

Speaker 3

It's a reasonable way to think about it. Yes, I mean, our guidance premise that our expectation that our markets are flat to down 2.5%, but if market in stronger, we fully expect that we would execute on that, deliver the revenue and convert on it. And you can see the conversion On an all in basis implied in our guide is a mid teens conversion. And so if we see upside in revenue, you should expect to see us converting on that incremental revenue.

Speaker 4

Okay. And then just a quick follow-up. I mean, the market is shifting all over the place, although it's not moving as quickly as It's kind of some of the commentary we lead you to believe. If we saw a greater hybrid penetration, not just in 2024, but maybe in 2025 and beyond, Fred, is there potentially a shift in cap allocation and slightly in strategy that you could execute and not leave capital stranded. I mean, how sensitive are you to shifts between EVs and hybrids?

Speaker 4

And how much would you have ship the strategy and cap allocation?

Speaker 2

The products for the East side of the hybrids are similar than the products on dev. They are the same motors, they are the same power electronics, they are the same transmission cases, they are the same High voltage coolant heaters, so it's from an R and D perspective, it's extremely fungible. Those are the same engineers. And from a standpoint, it's pretty fungible too. So we've developed an e product portfolio that is, I would say very fungible across hybrids and bev, very much so.

Speaker 4

That's helpful. Thank you, guys.

Speaker 2

Thank you, John.

Speaker 1

Savannah, we're ready for the next question.

Operator

Question will come from.

Speaker 5

Great. Thanks for taking my question and congrats Kevin as well.

Speaker 1

Thanks, Tom.

Speaker 5

Just talking on Contribution margins, it does come out to something like a 16% if you exclude Eltor. Any other puts and takes? You mentioned ER and D, how much of a

Speaker 6

headwind is there? Any commodity or labor

Speaker 5

issues that we should be thinking about? And then when we think about commodity or labor issues that we should be thinking about? And then when we think about outdoor, when does this drag start to go away? Or is that sort of to be here for several years.

Speaker 3

With respect to the year over year conversion in 2024, there's nothing unusual to really think about. You're right, we're looking at the mid teens and that is on an all in basis. If you look at we are investing a little bit more in e product and D again in 2024, it will be up organically about $40,000,000 to $50,000,000 but that's embedded within that conversion. So we're looking at our conversion now given the scale of the business from an e product perspective on an all in basis and we expect to contribute in the mid teens

Speaker 5

And Eldor, any thoughts on why that moderates?

Speaker 2

So let me take a step back here. I think Borov is very good at taking great technologies and commercializing them and globalizing them. Look at what we've done with Delphi. Look at what we've done with Akasol, which literally had no revenue. This year we had about $750,000,000 at the midpoint.

Speaker 2

The plan with Eldor on DCDC converters on onboard is exactly that. And so I'm very optimistic about the drive that we can generate and profitable growth that we can generate from the engineering base that we've acquired with Endor.

Speaker 3

And maybe I'd just add to that, Colin. This is something we anticipated when we gave guidance back at our Investor Day as well. Because Eldar was well in flight and we knew that would have an impact on our margin in the short term, a position us for long success in a $30,000,000,000 addressable market in 2,030. So it is impacting the near term. But over time, as we start to have some success in that business into the next few years out, it will start to be a positive for us, but that's still several years away.

Speaker 3

We expect to have operating losses in that business for the next years as we support the R and D necessary to support our capitalizing on that business.

Speaker 5

Got it. That makes sense. And Just you touched today on this year's guidance being sort of flexible between EV and ICE profitability. And at your Investor Day, you talked about 27, same dynamics of the EV mix is higher, the sort of offset higher or lower, you'd add a dollar basis to be similar in 20 27. But you're still forecasting, I think, a 5 fold increase in your e powertrain sales through 27, I mean, that would imply probably a lot of ER and D as you try to prepare for those launches.

Speaker 5

So is that flexibility going to be consistent over $1,000,000,000 that you talked about in 20 27?

Speaker 3

Yes. When you look at the e product related R and D, as we've mentioned in the past, we thought the real peak in that was going to be in 2022 in terms of the growth in the e product R and D. You might remember it stepped up $150,000,000 that year. But then we said we expect the pace of the growth in the ER and D to step down year over year. And you can see that happening.

Speaker 3

Last year, it stepped up about $60,000,000 So not as big an increase as what we saw in 2022. And as we look ahead to 'twenty four, it's going to step up about $40,000,000 to $50,000,000 organically. So the pace of the growth in that ER and D is definitely slowing, but still growing because it's supporting our ability to successfully launch and ramp up programs as well as to capitalize on continued profitable opportunity down to the future. So we think the pace of what we're seeing right now is supportive of our long term outlook for electrification.

Speaker 5

Okay. Sounds good. Thanks for taking my questions.

Operator

Our next question will come from Joe Spak with UBS.

Speaker 7

Thanks. Good morning and congrats to both Kevin and Craig. I guess I just wanted to sort of touch on a couple of the midterm factors here in light of what's going on and your strategy. So first, if I look at Slide 13 and I look at Combustion plus hybrid of the industry, you're showing about a 4% decline roughly at the industry level. Your implied foundational revenue growth is like minus 1.5%.

Speaker 7

So that like 2% to 3% op growth, is that like a reasonable level of outperformance on the foundational stuff as ICE continues to decline over the coming years? And can you still hit that 13% foundational margin target that you laid out if ICE continues to decline?

Speaker 2

So, I would say, Joe, that we are growing the foundational Say, by about 300 basis points. I would tell you that on the ex side, I see more upside than downside at this point in time. And we are constantly, As we presented a few months ago and as we review the team regularly, we're constantly restructuring in a position of strength. And that I believe will allow us to maintain the foundational margins as it is called by our 3rd pillar of charging forward.

Speaker 7

Okay. Thank you for that. And then I guess a sucky question maybe to build off of Colin's question a little bit. Let's call it $2,500,000,000 e Products guidance for this year. Your prior $25,000,000,000 was $4,500,000,000 to $5,000,000,000 it looks like a big jump.

Speaker 7

So maybe a couple of things there. Like it seems like maybe some of that product launches through the year. So Maybe the 24 exit rate is a better sense. And I don't know if you would agree with that. And I guess just secondly, Is that sort of 25 level free products still attainable?

Speaker 7

I mean, it doesn't seem like the market really Believes it is, but I'd be curious to understand your view.

Speaker 2

So if you take the CV packs growing 65% CAGR year over year. And we are ramping up In U. S. Significantly in Q2 and in Europe at the end of the year and more to come. So I would say that The 2020 end of 2020 for jump off point on CV is much higher than the car year.

Speaker 2

On light vehicle, Roughly 60% of the programs that we've disclosed so far, We're launching this year or we've launched at the tail end of last year. So Even if there is some variability possible, I think you're right, the jump off point at the end of this year is going to be from a much bigger base on a light vehicle standpoint as it is, I just alluded to on the CV side. So I would say that if The customer volumes are holding as we are currently forecasting, we would expect to be within that range in 2025.

Speaker 7

Okay. So Obviously, a volatile market we need to monitor, but based on what you see now and sort of the growth through the year on you just sort of talked about, it still seems achievable.

Speaker 2

For now, we're focusing on 2024. We are launching so many products. We are focusing on 2024 and we will let you know what we think finally on 2025 in due course. 24 is our focus, but I just wanted to give you the color of the different building blocks between CV and light vehicles.

Speaker 7

Okay. Appreciate that. Thank you.

Speaker 2

Thank you.

Operator

Our next question will come from Rod Lache with Wolfe Research. Please go ahead.

Speaker 3

Good morning,

Speaker 8

everybody. Hey, Brad, congrats, Kevin.

Speaker 5

I want to first of all confirm

Speaker 8

on the question that Joe just asked. Based on the growth in heat products and in a flat market, it would appear that there's some moderation in the foundational business, But you are maintaining that 13% margin, so you're not delevering. And secondly, can you remind us what's embedded for M and A within the e products revenue target for 2025, I'm referring to the 4,500,000,000 to 5,000,000,000

Speaker 2

So, I take the second part of the question. There is no M and A in the 4, 5 to 5. It is booked business. There is a significant portion about $2,000,000,000 of M and A in 2027.

Speaker 6

Okay.

Speaker 3

And then on the foundational margin, one of our Key strategies is that we know over time as electrification continues to grow at the expense of the underlying combustion based technology that will put pressure over time on our revenue outlook. And our challenge is to make sure we're managing the cost structure in that business. Should even say the overall P and L of that business, whether that's on the price side or the cost side to make sure we're delivering and sustaining our margin profile. We fully expect that to be the case as we go through 2024 and well beyond that.

Speaker 8

Thanks for that. And maybe just bigger picture, when we take a step back and you kind of analyze the regulatory requirements your light vehicle customers, I'm curious if you have any thoughts on how much flexibility the OEMs really have to defer electric vehicles? Do you think that they would be able to shift to plug ins or hybrids to a much greater extent? And are you seeing any benefit from the fact that you have a lot of kind of off the shelf hybrid technology, which if these are sort of late decisions, I would imagine they might accelerate?

Speaker 2

Yes. So for customers, I think most probably you need to ask them. I think there is some flexibility. We are hearing commentaries as you do that In the U. S, there is some intention to wrap up hybrids.

Speaker 2

Outside of the U. S, hybrid is a big portion of the new energy vehicles. In China, it's 30% to 40%. In Europe, it's a big percentage too. What's important to me is that we've built a product portfolio that is totally fungible across hybrid and On these motors, transmission, thermal, it's the same thing.

Speaker 2

For us, it does not matter. We can support our customer to wherever they want to go.

Speaker 8

So Fred, just to clarify, are you actually seeing that? We're reading about it. We're hearing about this increased interest in the U. S, are your customers now sort of accelerating activity with you in that area?

Speaker 2

Ron, I think it's a little too early to see the communication and the RFQ materializing on the hybrid side. But I would say that with the scale that we have in our e products that have to graph hybrids, different types of hybrids and dev, We can be one of the enablers of the rapid launch of hybrid powertrain for those customers.

Speaker 8

That makes sense. Thank you.

Speaker 2

Thank you, Rob.

Operator

Your next question will come from Dan Levy with Barclays.

Speaker 9

Hi, good morning. Thanks for taking the questions and

Speaker 3

Congratulations

Speaker 9

to Kevin and Craig on the many roles. And maybe we could just start with Eldor, broader M and A strategy specifically. How are you managing, I guess we could say the integration deals because if you have done a lot in the way of M and A, what is the process for integration, how do you manage any integration risks? And then maybe you could just remind us on Eldor, are these losses in line with what originally anticipated or is this a function of maybe a weaker EV environment than you originally did the deal?

Speaker 2

So first of all, the financial profile of Ildo was fully comprehended when we did the due diligence and it was fully comprehended into the views of our financials. Integrating companies becoming, I think, a real strength And we do that in a very disciplined way And we're doing it with a very disciplined way with El Dor, too. We are locating for 1 of the people on location And we are managing the business starting day 1. We've owned indoor for a couple of months now, but We are going to just manage the indoor business as we manage the pool on the business with financial discipline. There are attractive businesses in onboard charger, DC DC converter and 1 box, which again is totally the same products, either it's a hybrid or a bev.

Speaker 2

And we see A lot of pools and a lot of demand from our customers in those power electronics Technologies too.

Speaker 3

And maybe I'll just piggyback on that Dan back to the losses being in line. Keep in mind, if you look at what's implied in our guidance this year, we're at 9.6% to 9.9% without Eldor. And as we looked at the 2027, we thought we were on track to be a 10% margin business. So we'd already be on the cusp of that without doing Eldor. But Eldor was contemplated impacting us to the tune of 30 to 40 basis points in the short term because we knew we were investing in a strong airing shop that doesn't have a lot of revenue today.

Speaker 3

And so that was contemplated in our original guide.

Speaker 9

Okay. And then maybe just as a follow-up on that. Given we've seen some shifts In product plans, maybe you could just give us a sense of what the go forward capital allocation? I mean, Fred, you mentioned A moment ago that there's $2,000,000,000 of M and A assumed in the 2027 targets. I know we're not going to get an update on that today, but maybe you can give us a sense of how this environment shifts, what your appetite is For assets, how does the capital allocation change?

Speaker 9

And what else is remaining that still isn't in your portfolio from a capability or product or customer exposure standpoint that still would require some M and A?

Speaker 2

I would say that the capital allocation strategy is pretty much unchanged. We are looking At M and A, it's an important part of strengthening electrification capabilities. We are very disciplined in the way we look at M and A. We are looking at way more companies than we actually putting the trigger on. And We think that the current environment could provide some attractive value opportunities and be rest We will include and consider the near term impact in the valuation assessments.

Speaker 2

We are looking at M and As with Discounted cash flows, we're taking those near term impacts. Really importantly, The policy on capital allocation also includes The dividends that we've left unchanged even during COVID, we've repurchased stocks and buyback The start of the strategy, I alluded to in my prepared remarks on how much we've given back to our shareholders And the spin off of Finnair, which I think was a great success, is also part of the

Operator

Our next question will come from Adam Jonas with Morgan Stanley.

Speaker 5

Hey everybody, and congrats, Kevin. Just two simple questions. First one, what portion of your 2024 budget of CapEx and R and D is allocated to e systems?

Speaker 3

We don't really break that out publicly in terms of what we've been disclosing in of an overall R and D or CapEx allocated that way. But what I would tell you is, if you look at R and D first and foremost, We invested about $475,000,000 in the product related R and D in 2023 versus the $700,000,000 or so $7.15 or of R and D in total. As we look ahead to 24 organically, we'll add another $40,000,000 to $50,000,000 there from e product R and D perspective. And you can expect The foundational based R and D will probably come down a little bit on a year over year basis as it's been doing the last few years. So The R and D will continue to be increasingly weighted towards e products and it is the majority of the investment.

Speaker 3

From a capital perspective, you see we stepped up our capital investment last year pretty meaningfully a couple of $100,000,000 relative to 2022. And that was really focused on investing in some of the e product portfolio ramp ups that we needed, particularly within our e Propulsion segment as well as our battery pack business and you'll see a comparable level of investment in capital in 2024 going toward that. I think these will be a couple of the peak years of investment from a CapEx perspective, particularly on that battery pack business. And then you'll probably see it come back down a little bit to more normalized levels as we hit 2025

Speaker 2

and beyond. Adam, what's really important is to understand that the R and D and CapEx are for EV and hybrids. And again, I'd say one more time, the Products are the same for us in light vehicle, whether it goes in the hybrid or EBITS. It's the same people. It's the same R and D.

Speaker 2

It's the same CapEx.

Speaker 5

Thank you. And then just going to attempt at that point, Fred, that there are many aspects of E Systems that are agnostic, I'd say agnostic between bev and hybrid. I'll ask you, I won't hold you to specifics, but what would be your best guess or range of how much of your 2024 E Systems and foundational business are going into hybrids that includes plug in hybrids. If you were to isolate just hybrids specifically, because of course some of your foundational stuff stuff increasingly is going into hybrids as well as we all know. So I didn't know if you could isolate a guess of how much hybrid would account for the revenue in 2024?

Speaker 5

A range would be great.

Speaker 3

Yes, I guess maybe just a couple of days. I think Pat can come back to you on the details, but what I would say is when you look at the $2,500,000,000 to $2,800,000,000 guide, The first thing I'd say is off the top, the $700,000,000 to $800,000,000 associated with battery packs is all EV. It's EV in the commercial space, in the CV space. So then what you're really looking at is the other $1,800,000,000 to $2,000,000,000 of e product revenue And we'll have Pat come back to you with a specific breakdown. I don't want to quote a number and have it a little bit off.

Speaker 6

Appreciate it. Thanks.

Operator

Our next question will come from James Picariello with BNP Paribas.

Speaker 9

Hi, everyone, and congrats, Kevin. Just a clarification question first. So Based on the margin guidance excluding Eldar, the implied loss rate for Eldar this year is roughly $50,000,000 Is that right? And then in addition to that impact, You're stepping up organic e products R and D by $40,000,000 to $50,000,000 So all in at an additional $90,000,000 to $100,000,000 in spend. Did I add that right?

Speaker 3

Roughly, yes. The Eldor the portion of the Eldor loss that engineering related is somewhere around $40,000,000 So you're right, it's $40,000,000 to $50,000,000 of organic step up of the R and D and then Eldor adds about another 40 dollars The overall loss in Eldor is around the midpoint is around what you said.

Speaker 9

Yes. Okay. And then Can

Speaker 5

you confirm what the appreciate

Speaker 9

that color. And then can you just confirm what the e product margin was in 2023? And then Based on what we just covered, is it possible e product losses are close to flat year over year? Just how should we be thinking about that? Or asked another way, Part of the impetus behind separating out ePropulsion was to provide that clarity and transparency on the ePropulsion.

Speaker 9

Is there a segment specific guidance to share maybe on the e Propulsion? Thanks.

Speaker 3

We're not going to give any segment specific guidance this year. But what I would say when you look at the e Propulsion segment, obviously, we were focused on driving toward breakeven in the Q4 of last year. That was the guidance as we started out the year last year and that was purely premised on our ability to successfully convert on the incremental revenue and we were disappointed that we had to pull back on that when we saw some of the volatility in the e markets and how that was impacting our revenue. So as we ended the year, you can see when you look at the e Propulsion segment, we ended up in at about $540,000,000 of revenue in the Q4, which is about $200,000,000 to $300,000,000 short of our original guidance when we were expecting to get to breakeven. So that business ended up losing about I think $16,000,000 or so in the Q4.

Speaker 3

I think what gives us some comfort in the way we're managing The ability of that business is the fact that we were down $200,000,000 to $300,000,000 in revenue versus our original guidance. If we had simply let contribution margin flow through on those lower that lower revenue, we probably would have had a bigger loss than $16,000,000 in the quarter. So I think we feel good about the fact that we're managing the profitability of that business in light of some of the near term volatility. But ultimately, the path to Breakeven into long term profitability in that business comes from successfully converting on the incremental revenue. And what we take a lot of comfort in is that we see the contribution margin really flowing through the business.

Speaker 3

I mean, you can see it in the 2024 guide, We're converting on an all in basis at mid teens and all of the growth in 2024 is coming from the E businesses. So we see the underlying fundamentals of the profitability coming through. And so as we scale that business, we see the path towards the profitability of the company intact for that portfolio.

Speaker 2

Thanks.

Operator

Our next question will come from Emmanuel Brosner with Deutsche Bank.

Speaker 10

Thank you so much. I was hoping to On the incremental margins and just trying to understand a little bit how the math would work for the foundational side of your business. So we've basically reached a point now where within your 2024 guidance, foundational revenues are already down, I guess, even with the growth of the market. And so I guess, how should we think about contribution margin within foundational? Like, is it Does it become sort of like the decremental margin?

Speaker 10

Do you need sort of like restructuring to sort of like offset this? And if I think about Some of our sales here around basically cash in decisions

Speaker 5

in the future, like how quickly can

Speaker 10

we go from having sort of like incrementals if the volume plays out better versus having to sort of like restructure to offset any potential downtime?

Speaker 3

Yes. I mean, With respect to the foundational business implicitly, you're right, the revenue is down a little bit year over year somewhere in our guidance implicitly around $60,000,000 to $260,000,000 If you come which means we're down about a half a point to 2 points in that portfolio year over year. If you look at the underlying markets that those products support being the combustion and hybrid markets, those are down anywhere from 3% to 6% on a year over year So we are outperforming those markets as those are coming down a little bit year over year, but we are seeing a revenue decline. And as you know at our Investor Day, we talked about our expectation that over time we were going to see revenue in the foundational portfolios coming under some pressure. And what we needed to do is make sure we're managing that P and L holistically, pricing, cost, restructuring to make sure that we would sustain that margin profile over time.

Speaker 3

And we fully expect to do that. And we expect to execute that in 2024 as well as all the way through the end of the charging forward plan. I would add one thing.

Speaker 2

And then I would add one thing is that on the combustion side, we don't really see no new we don't really see new engines or new transmissions being developed. It is more longer life or slightly higher volume on the current product. So even if combustion, as you mentioned, may go back up or longer

Speaker 10

That's super helpful. Just to make sure I understand, because 2024 could help us really understand also The mid- or longer term picture because you have a guidance obviously about it. But so you mentioned this mid teens incremental margins all in for this year. Any way to and what direction do you think about it on what does that look like on the foundational versus e product? Because obviously, as mentioned, foundational is actually revenues and then e product is up a lot.

Speaker 10

So what does that look like? And I think you could help us

Speaker 6

a little bit better understand how you manage this going forward?

Speaker 3

I mean fundamentally, we're not going to break out the details in terms of our guide, but fundamentally in order for us to execute on our foundational margin profile Over the coming years in line with charging forward, it means we need to decrement on an all in basis in that mid teens. And for our e portfolio to deliver on its margin expectations, we need to convert in the mid teens. And I think you see the blend of that actually coming through the financials and the P and L in our 2024 guide.

Speaker 10

Great. Thank you.

Operator

And we have time for one final question. And that

Speaker 6

well in retirement and appreciate all the dialogue over the years. And with that, I'm going to get to ask you a couple more questions before

Speaker 3

you go.

Speaker 6

First, just sort of a clarification on what Blake said earlier. You talked about really this year in for UP SEX being kind of the peak For CapEx, is that meant to be CapEx in absolute dollars? Should we think about sort of reversion to more like 5% of sales on a go forward basis, would that be in the 26%, 27%. I'm just trying to understand the intents of your comments.

Speaker 3

Fair question, A. I mean typically we've run-in the past at 5%. We've had years where we've dipped below and we've been in the 4.5% to 5% range. Then you see the last couple of years we've been elevated running closer to 6% than 5%. My expectation over time is that As we get to more of a normalized run rate environment, we're probably coming back down toward that 5% range.

Speaker 10

Great. And then, Fred,

Speaker 6

there was a good color earlier on the battery pack expectations for this year, but I'd actually love to delve a little bit more into where you're at in terms of tooling and automation, staffing up Cell supply, just help us understand your true visibility into the production ramp as you go throughout the

Speaker 2

Yes, we are ramping up a second production line in Seneca, North Carolina. We have our first production line in the Michigan area. This is ramping up in Q2. And The same line is being commissioned for Europe and this will ramp up later in the year. And that is the 65% year over year growth at the midpoint for those battery packs.

Speaker 2

The demand Much higher than what we can produce. And we don't see in the commercial vehicle Any noise of any slowdown whatsoever to the contrary. So that's pretty much what we're doing on the battery pack, we don't see any issues on sales supply. So And all that is reviewed and monitored very in a very focused way and very precisely.

Speaker 6

Maybe I have to ask one more. It's more generally to help our understanding of your insights into customer behavior. Given the shifting dynamics around powertrain of choice versus Increase in labor costs for some of the OEMs well publicized in North America, but more broadly. How those translated to the customer expectations around pricing versus value proposition, you still feel comfortable in being able to hit the ROIC target that you've always quoted for this program. Is there anything noteworthy you'd call out in terms of kind of customer expectations in the area right now?

Speaker 2

No, I think we're always Quoting businesses with 15% return on invested capital, we have Volume based closes and everything that I see is Trending towards meeting those 15% return on invested capital. And we're very experienced on how to do that. For us, it doesn't change whether it is a new product or f product. The rules are all the same.

Speaker 6

Appreciate that. Thanks, Fred.

Speaker 2

Thank you, Bill.

Speaker 1

Thank you all for your great questions today. If you have any follow ups, feel free to reach out to me or my team. With that, Savannah, you can go ahead and close today's call.

Operator

And that does conclude the Board Warner 2023 4th quarter and full year results

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Earnings Conference Call
BorgWarner Q4 2023
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