Patrick Nolan - BorgWarner, Inc. James R. Verrier - BorgWarner, Inc. Ronald T. Hundzinski - BorgWarner, Inc..

Colin Langan - UBS Securities LLC Rod Lache - Deutsche Bank Securities, Inc. Brian A. Johnson - Barclays Capital, Inc. John Murphy - Bank of America-Merrill Lynch Chris McNally - Evercore ISI Jacob Hughes - RBC Capital Markets LLC David L. Kelley - Jefferies LLC Adam Michael Jonas - Morgan Stanley & Co. LLC Richard M.

Kwas - Wells Fargo Securities LLC Joe D. Vruwink - Robert W. Baird & Co., Inc..

Good morning. My name is Sharon and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2017 First Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period.

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

Thank you, Sharon. Good morning, everyone, and 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. There will be a replay of today's call available through May 11th.

The dial-in for that call is 855-859-2056, and the conference ID is 49068373. Or you can listen to the replay on our website. With regard to our Investor Relations calendar, we'll be attending several conferences between now and our next earnings release. Please see the Events section of our Investor Relations homepage for a full list.

Before we begin, I need to inform you that during this call, we may make forward-looking statements which involve risks and uncertainties as detailed in our 10-K. Our actual results may differ significantly from the matters discussed today. Now back to today's call.

First, James Verrier, our President and CEO, will comment on the industry, provide a high-level overview of our Q1 results as well as discuss some of our recent product wins. Then Ron Hundzinski, our CFO, will discuss the details of our results as well as our guidance.

Please note that we posted an earnings call presentation to the IR page of our website. You'll find the link in the Events and Presentations section below the notice for this call. We encourage you to follow along through these slides during our discussion. With that, I'll turn it over to James..

Thank you, Patrick and good day and welcome to everybody. Thank you for joining our call. As Pat said, Ron and I are really pleased to share our results from first quarter 2017 and update you on how we're progressing towards delivering our 2017 targets. So I'm going to start by sharing a few thoughts on the macro environment in the industry.

And for those of you following along, I'm now going to be on slide five. So, from a macro perspective, we recognize and see – there is instability out there in many aspects. But I think what's interesting and key for us is in general, the outlook for the auto industry has been good and remains good.

If I talk a little bit about global light vehicle production in Q1, growth was strong. In Europe, light vehicle production rose about 6%. China light vehicle production was up close to 7%, which was well ahead of our expectations as we went into the quarter.

And in North America, light vehicle industry production increased low single digits with continued strong mix. As I start to think about the outlook for the market, let me start light vehicle 2017 calendar year. And I would say we're closely aligned with HIS' view, which is calling for about 2% growth in China.

We see Europe up about 1%, and we see North American production down between 1% and 2%. Now if you look at that on a weighted basis from a BorgWarner perspective, that would imply global production growth of slightly less than 1% for us.

A word about commercial vehicle where we are seeing signs of improvement; in North America, we see orders and medium-duty sales improving. And as we look towards China and Europe, the outlook has improved, and we think it's going to be stronger. So, it's a good environment, as I mentioned earlier.

But as ever, you would always keep your eye on things that could go against us a little. So a couple of things, one is the North American cycle itself. And we recognize that we're kind of towards the higher levels.

We've seen a little bit of modest softening in North America schedules since the beginning of the year, and we'll continue to monitor and watch inventory level. Diesel gas mix in Europe shifted in Q1. And as we look at it, diesel share declined about 360 bps year-over-year in Q1.

And we expect this diesel-gas mix to shift throughout the end of the decade. The really good news for us though is we're offsetting that in the near term. And I'm going to talk a little bit more about diesel-gas mix in the next few slides. I'd say the other area we keep paying a lot of attention to is China.

We're still expecting modest industry growth in 2017. But I think more importantly for us, our growth over the market remains very strong due to increasing share and content per vehicle. So, let me wrap all of this up. I want to be really clear.

We're confident in our outgrowth of the market in 2017 based on the continued strong demands for our products. Let me make a couple of comments in regards to the regulatory and technology area. We still see a continued strong drive around fuel economy and emissions regulations and the pull for advanced propulsion technology continues to be strong.

I would say the activity is accelerating particularly around gas and hybrid vehicles and also in electric vehicles. And for us as a company, our transition to the increased electrification continues. As I look at our Q1 new business bookings, it was strong.

It continued to show additional awards with a range of customers, very balanced regionally and across all propulsion system architectures. And for those of you that may be keeping track, we'd shared that we had about mid-20s awards for hybrids and electric platforms at year-end, and we've added a couple more to that during Q1.

And we plan to provide a more detailed update around this at our Analyst Day in August. So as I mentioned earlier, diesel-gas mix is kind of a key topic, and we do get a number of questions on this. So I'd like to give you some additional color around this, and I'm on slide number six at this stage.

So as we started out this year, we had assumed 100 bps to 200 bps annually shift in Western Europe diesel-gas mix through the end of the decade. And as you look at the chart on the screen there, you will see that Q1, that mix shifted more and a little faster than we'd anticipated.

So, let me give you a little bit of a perspective on what does that really mean for BorgWarner. One of the best ways to think about this is, today, the net revenue impact for BorgWarner with 100 bps shift from diesel to gas mix is about a $20 million to $25 million annual number.

If you think of that in the context of a $9 billion company, that's very manageable for us. And in addition to that, by the end of our backlog period, we expect that gap will close significantly as our content per vehicle continues to increase on gas-powered vehicles.

So our view is the mix shift is a minor issue for us now, and over the midterm, it becomes negligible. If you take a look at slide seven, here's a good way to think about the shift from diesel to gas impacts our business. There's three fundamental products that are diesel oriented. I'll start with turbo.

So in Western Europe, pretty much all diesel vehicles are turbocharged 100%. Gas, it's about 75% to 80% and increasing, and pricing is pretty much similar. So for us, as the gasoline turbo penetration grows, this becomes a very negligible issue.

The second product line light vehicle diesel versus EGR product line; and what we're seeing there is as transition moves to gasoline vehicles, there will be more and more gasoline EGR content on those vehicles.

The third area is glow plugs, which are diesel-centric products, and they're going to be offset by a strong growth in variable cam timing on the gasoline – advanced gasoline engines. So again for us, the revenue impact is neutralized by the end of the backlog as we gain content on gasoline-powered vehicles.

Let me turn now to slide eight and give you a little bit of a financial recap for us. And Ron, as Pat said earlier, will provide a lot more detail on this following myself. So as I look at the first quarter for BorgWarner, I have to say I was very, very pleased, particularly around our growth.

Our growth came in well above the guidance, $2.4 billion of sales in the quarter, which is a record for us. That's up 12.8% organically when we exclude FX and REMY. And this compares to our end market growth exposure, which was about 4.5%, so strong out-performance.

Regionally as we'd expected, we did get strong growth in China, strong growth in North America and the European growth was just modestly ahead of our industry growth. This light vehicle growth was also supplemented by positive revenue trends in commercial vehicle, particularly off-road.

These all helped us deliver EPS of $0.91 excluding non-comparables, which I think is very strong performance, and an operating margin again at 12.2%. And again, Ron will provide a little more color on that.

If I look at it from a segment perspective, the most powerful thing for me as I looked at our Q1 performance was the growth across all of our products. It was really incredible. All of our product lines were growing at a very strong rate. That helped us deliver engine sales of $1.5 billion. So that's growth of just over 9.5% organically, very strong.

And that again is in light of the diesel mix shift that I explained earlier. We've still got that very strong top line growth. Drivetrain – Drivetrain sales at $925 million, that's up almost 19% organically. So you could imagine we saw a growth across almost every aspect of Drivetrain business.

We had strong all-wheel drive growth, strong DCT growth and strong transmission growth in most regions of the world, so a super quarter for growth in Drivetrain. Let me give a little bit of a view on our outlook for 2017. So revenue and operating margin outlook is unchanged from the guidance we provided last quarter.

That has us landing with organic growth of mid 3.5% to 6% year-over-year. And again, that's in a market that's growing less than 1%. Our consolidated operating income margin is expected to expand 40 basis points to 50 basis points and our EPS guidance range is $3.50 to $3.60 per diluted share.

That's up from our prior guidance due to favorable taxes, which Ron will talk you through in a few moments. I do want to talk a little bit about growth highlights. And we had a number in the quarter, and I'm just going to dwell on a couple of them for you, and you can see that on slide 9.

DCT clutch and control module for ChangAn was a really big win for us. That's ChangAn's first self developed DCT transmission and we will be providing a lot of content there. Also, good to see us supplying our HY-VO chain technology on hybrid and plug-in hybrid technology, you can see that.

So, this is a snapshot of just four leading-edge technologies that are providing growth. And again, the key message I wanted to share with you is it continues to be across the balance of combustion, hybrid, and electric platforms.

We also have another couple of announcements that will be coming out in the next couple of weeks that I think will also give you a lot of excitement in terms of our bookings for new business. So the key message here, our balanced approach around propulsion systems for combustion, hybrid and electric is strong.

We're winning and its driving long-term growth for us. So let me summarize before I turn over to Ron. Q1 was a really strong top line quarter for us. And again, I'm really pleased that we're seeing strong growth across all of our major businesses.

From an operating perspective, I think the business is absolutely operating in line with our expectations, which is really good to see. And with that, we feel very comfortable about our ability to execute toward the high-end of our growth expectations for the year.

We believe the company's positioned to deliver mid-to-high single-digit growth over the long term. In a nutshell, the future is very bright for BorgWarner, both in the short term and in the long term. And with that now, let me turn it over the Ron to provide some more detail..

Thank you, James and good day, everyone. Before I review the financial details, I would like to provide you some of the highlights as I see them for the quarter. As James said, I think the first one is outstanding growth, and it significantly was above our guidance for the quarter. And I will even give you more color on that a little bit later.

Our operating performance was as expected for us for the quarter. And most importantly, the quarter positions us stronger towards our full year guidance. So as Pat mentioned, I will be referring to supplemental financial slide deck that is posted on our IR website, and I do encourage you to follow along.

First, I'd like to focus your attention on slide 11. Throughout the presentation, I will highlight certain non-U.S. GAAP measures to provide a clear picture of how the core business performed and for comparisons with prior periods.

Specifically, we will be excluding the impact of FX, net M&A of the Remy light vehicle aftermarket divestiture and other non-comparable items from certain U.S. GAAP measures. When you hear me say on a comparable basis, that means excluding everything I just mentioned; when you hear me say on a reported basis, that means U.S. GAAP.

So now let's turn to slide 12. On a reported basis, sales were up 1.6%. On a comparable basis, our organic sales were up 12.8%. This was approximately 600 basis points ahead of the high-end of our guidance. Our weighted average industry production was about 4.5%. Our guide was set at 0.5%. So we saw 400 basis points tailwind from production.

Our expectation for China growth was low double digits. Our growth came in at 29%, resulting in about 150 basis points of tailwind. Commercial vehicle was a benefit as well, contributing more than 100 basis points of tailwind. The primary headwind versus our expectations was the diesel-gas mix in Western Europe.

Before I move on to operating profit, I would like to discuss our gross profit and SG&A line items. Gross profit as a percentage of sales was 21.5% in the quarter, which is up 100 basis points from last year, great performance. On a reported basis, SG&A was 9.1% of sales. R&D spending, which is included in SG&A, was up to 4% of sales.

SG&A was up 80 basis points from a year ago and there's three main reasons for the increase. First, R&D spending was up 20 basis points from a year ago as we continued to invest for the future. 20 basis points is related to variable stock comp that was not accrued until the fourth quarter of last year. So it was a difficult comp.

And there is some 30 basis points as related to various increases in compliance costs, tax planning and other professional fees. And finally, there is a modest headwinds as some Remy costs were reclassified from cost of goods sold to SG&A. Now, let's look at the year-over-year comparison for operating income, which can be found on slide 13.

Q1 operating profit was $293 million or 12.2% of sales compared to $276 million in Q1 of 2016, which was also 12.2% of sales. On an organic basis, operating income was up $25 million on $277 million of higher sales. That gives us an incremental margin of 9% in the quarter, although this was in line with our expectations.

So I will discuss incremental margins more after I go through the segment performance numbers. As you look further down the income statement, equity in affiliate earnings was about $10 million in the quarter, up slightly from last year.

Interest expense and finance charges was $18 million in the quarter, down $3 million from last year due to lower debt levels. Excluding $3 million onetime tax adjustment, the provision for income taxes was $83 million for an effective tax rate of 29% for the quarter.

We have updated our full year guidance to reflect a full year effective tax rate of 29% versus 32% previously. The reduced tax rate is the result of lower statutory tax rates in Hungary and Japan, along with obtaining a lower tax rate for high tech status for our China facility.

Net earnings attributable to non-controlling interest was about $10 million, up $1 million from the first quarter 2016. This line reflects our minority partner share in earnings performance of our Korean and Chinese consolidated joint ventures. Earnings per share on a reported basis was $0.89 per diluted share.

On a comparable basis, net earnings were $0.91 per diluted share. Now, let's take a closer look at operating segments in the quarter beginning on slide 14. Reported Engine segment net sales was $1.495 billion in the quarter.

Sales growth for Engine segment on a comparable basis was 9.5% as demand for light vehicle OEM products was supplemented by growth in our commercial vehicle business. Adjusted EBIT was $247 million for the Engine segment or 16.5% of sales.

On a comparable basis, the Engine segment's adjusted EBIT was up $16 million on $133 million of higher sales for an incremental margin of 12%, which we expect to accelerate later in the year. Turning to slide 13 and starting from the right. Drivetrain segment net sales were $925 million in the quarter.

This does include a reduction of $90 million of sales from the divestiture of the Remy light vehicle aftermarket. Sales growth for the Drivetrain segment on a comparable basis was 18.8%, primarily due to higher all-wheel transmission components and strong DCT growth in China. Adjusted EBIT was $105 million for the Drivetrain segment or 11.3% of sales.

On a comparable basis, the Drivetrain segment's adjusted EBIT was up $20 million on $149 million of higher sales for an incremental margin of 13%. Like I said earlier, I'd like to take a moment to discuss incremental margins.

Our total company incremental margin for Q1 was 9%, which is below our long-term goal of mid-teens but in line with our Q1 expectations. In order to better understand this, there are a few items we should highlight. First, segment incremental margins.

The Engine segment incremental margins were 12% or about $5 million of headwind towards our incremental goal of mid-teens. Our realignment emission (21:12) products in Europe, which includes the Wahler acquisition, continues to see operational headwinds, but should improve in the second half of the year.

Our Drivetrain segment incremental margins were 13%, which was up from 11% in Q4 as we continued to launch DCT plants in China. So, the question is that Engine incremental margins were 12% and Drivetrain were 13%, why is the total company at 9%? In a nutshell, it's corporate and other costs.

So first, if you take a look at the reported segment income statement in the press release, which is on page 6, you will note a $5.3 million charge for the early termination of a lease. In addition, corporate costs incurred and additional stock-based comp I mentioned earlier and various advisory fees and tax and legal planning.

Adding back these items would generate approximately 500 basis points in improvement incremental margin, which gets you basically back to the mid-teens growth – incremental margin. Now, let's take a look at our balance sheet and cash flow. We generated $60 million of net cash from operating activities in Q1, up $26 million from Q1 of 2016.

Q1 is typically our lowest quarter in cash flow generation. Our investments in working capital wraps up the first quarter to match higher levels of business activity compared to the year-end. Capital spending was $131 million for the quarter, which is up $27 million from a year ago.

Free cash flow, which we define as net cash from operating activities less capital spending, was a negative $71 million, basically flat from 2016. Looking at the balance sheet itself, balance sheet debt increased by $76 million, and cash decreased by $85 million compared with the end of 2016.

The $161 million increase in net debt was primarily due to the seasonality of increased working capital to support higher level of business. Our net debt to net capital ratio was 35.8% at the end of the first quarter, up slightly from 35% at the end of 2016. And net debt to EBITDA at the end of the quarter was 1.24 times.

Now, I'd like to discuss our 2017 guidance. At the high end, our revenue and margin guidance is unchanged from last quarter. So, let's start with our sales growth guidance for the full year on slide 17. Backlog pricing and market-related growth are expected to drive 3.5% to 6% organic sales growth.

I'd like to note that the net unfavorable market growth/pricing amount on the slide is negative. Our full year assumption is that our weighted average market growth is slightly less than 1% and price reductions are in line with historic levels. Currency is expected to reduce sales by $310 million or about 350 basis points.

Adding all this up and incorporating our Q1 performance, our full year revenue is tracking at the high end of our guidance range. Next, I'll walk our operating income on slide 18. From a performance perspective, we continued to expect mid-teens incremental margins on our sales growth. Included in this are some tailwinds and headwinds.

Tailwinds include continued improvement in Wahler and Remy, offset by expected headwinds from commodity prices and corporate costs. We do expect an inflationary environment in commodities and rising compliance costs. Our consolidated operating income margin is expected to expand by 40 basis points to 50 basis points full year.

To finish up our full year guidance, please turn to slide 19. EPA guidance – EPS guidance range is now $3.50 to $3.60 per diluted share. The $0.15 increase is primarily driven by the lower tax rate I mentioned earlier.

Free cash flow, which we define as net cash provided by operating activities less CapEx, is expected to be in the $450 million to $500 million range. Capital spending including tooling is expected to be in the range of $475 million to $525 million.

We expect to continue executing our share repurchase program, targeting $100 million-plus depending on M&A activity. R&D spending as a percentage of sales is expected to be 4% in 2017. The tax rate is now expected to be 29%, down from 32%. Our assumption for the dollar-euro exchange rate is $1.05.

As a reminder, every one cent change in the dollar-to-euro exchange rate equates to about $30 million to $35 million of sales. Our second quarter guidance starts on slide 21. First, sales. Note that Remy light vehicle aftermarket sales divested are $80 million. So the starting point base is $2.25 billion net new business.

Pricing and market rate growth are expected to drive organic sales growth of 3% to 6.5%. Currency is expected to reduce sales by 510 basis points. And therefore, 2017 Q2 sales is expected to be $2.24 billion at the midpoint.

From an EPS perspective on slide 22, we expect $0.03 to $0.07 per share from the backlog, market and pricing, with about $0.01 of headwind from corporate and other costs. Foreign currencies are expected to lower earnings by about $0.05 per share in the quarter.

And below operating income line items are expected to contribute $0.07 per share from a lower share count and a lower tax rate. On a consolidated basis, we expect earnings of $0.87 to $0.91 per share. So, let me summarize quarter one. Quarter one was a great start to the year. Comparable sales growth was nearly 13%.

And even after subtracting strong industry production, we grew in the high-single digits. The sales growth was seen in all of our products and segments. Although our incremental margins were slightly below our mid-teens goal, they were as we expected, and we anticipate this improvement in the second half of the year on top of it.

As we look at 2017 and beyond, we continue to drive intensity around new product development to support the impending electrification trend. There is no question in my mind that that won't drive growth for many years. And with that, I'd like to turn the call back over to Pat..

Sharon, we're ready for questions..

Your first question comes from Colin Langan with UBS. Please go ahead..

Hi. Great. Thanks for taking my question. Why – and if you're indicating (28:54) the high end of sales guidance is likely, but given your very strong organic growth out of the gate, why not raise sales guidance? I mean, actually, I'm surprised like things are fairly flattish from here on out..

Yeah. Good morning, Colin. This is James. Fair question. First of all, thanks for the comment on a strong Q1. We really did feel good about that strong organic growth. A couple of things to think about. It's only one quarter in, and I think we need to calibrate that.

As we alluded to, there are a couple of things that we're paying attention to – the diesel/gas mix, the China and North America. So we've got to watch those a little bit. So I think it's just a prudent thing at this stage to get another quarter under our belt.

With that said, as Ron and I both alluded to, we are comfortable that we're certainly trending towards the high end of our guidance. And let's get another quarter under our belt is kind of a key thing, I would say..

Got it. And on your comments, you've indicated China was very strong, a big outperformer.

What's driving that? And any update on the DCT joint venture in China? Is that finally starting to kick in?.

Yes. No. Ron explained it. I think it was 29% growth for the first quarter, so well above the market. The really good thing, Colin, was it was pretty much across all of our product offering, we saw that growth in China, so both on the engine side and the Drivetrain side.

I think, from a, let me say, a strategic perspective, we are starting to see the strong acceleration of DCT in China. I know for many of you that have been following us for a while, that's been a little bit long in coming. But we did see a notable uplift in DCT revenue in China, which is a big part.

But really it was across the whole product portfolio we saw strong growth in China..

Got it. All right. Thanks for taking my questions and congrats on a good quarter..

Thank you..

Thanks, Colin..

Your next question comes from Rod Lache from Deutsche Bank..

Good morning, everybody..

Good morning..

Had a couple of things I wanted to ask. One is just on the backlog, if I add the first quarter and then your forecast for the second quarter, your first half backlog contribution is $350 million, $400 million. Your full year is $410 million to $590 million. So, it looks like 85% of it is happening in the first half.

Is that a timing issue? Is the first half taking away from something that you had in the back half? Or is that just conservatism?.

Yes, Rod. This is James. I'll take a shot at it and then Ron can add as needed. I think the way I look at it at least is we feel good about the backlog. The first quarter is coming in a little bit ahead of what we thought. Second quarter backlog looks pretty good too. I don't think it's so much of a pulling.

I think it's a little bit of a, let's give ourself a little bit more time to see how things play out, frankly speaking, before we would want to readjust the backlog number. There's nothing materially pulling in from a launch perspective, Rod. It's not a big shift of product mix, launch or anything like that.

I think it's just Q1 came in stronger than we'd anticipated. We're digesting that. We want to see how that runs into the second quarter. And then we'll have a better view of what the second half backlog looks like. But no fundamental shift kind of is the point, Rod, in terms of technology, adoption, launch cadence, those types of things..

The only thing I would add, Rod, is sometimes, you hit on all cylinders and it was one of those quarters where we actually hit on (32:51) cylinders, in the past, we have some positive news and then we have some negative news.

This is one of those quarters where everything just, quite frankly, came in positive, right where we hoped it would come in and it did. So, it was a great quarter..

Great. And then secondly, just given the magnitude of the diesel decline that we're seeing in Europe, it would seem that the European market broadly may actually be seeing a rise in CO2 emissions rather than a decline, just given that CO2 is less for diesel.

So, I'd imagine that they'd be scrambling, your customers would be scrambling for technologies to help offset that.

And I was hoping you might be able to give us some kind of a quantification or a sense of what is actually happening, what's the pace of contract awards that you're seeing this year versus maybe last year? Is there anything that we can take away from that vis-à-vis your growth and as you get out towards – closer to 2020?.

Yes, Rod, I'll take a shot at that for you. I think you're right. First of all, we do as we showed in the chart there that the diesel decline has accelerated faster than I think what everybody was anticipating. So that's moved down that 350 bps in the first quarter versus our expectation of 100 bps or so.

We do see that potentially going down further through the rest of the year. So, we're seeing it accelerate a little faster move to gas more a little faster. It's certainly going to put pressure on 2017 CO2 attainment for sure.

What we're seeing from a more, I don't know, medium-term perspective, Rod, I would say it's fair that we are seeing even more increased development activity in contracts around gas, advanced gas particularly, and hybrids and less focus on diesel development.

I don't want to portray that there's not optimization in programs going on for diesel, because there is. But it's fair to say that we've seen an uptick in focus on EV architecture discussions, hybrids and particularly a lot of work around optimizing the advanced gasoline engines. So, hopefully that helps a little bit, Rod.

I think where it all ends and settles, we'll have to see how it plays out during the year. From a Borg perspective, we feel good. We feel well-positioned because we're participating on those hybrid architectures, the gas architectures and obviously EV architectures too. So, more to come, Rod, but I think the key message is, it's accelerating..

Yes.

And just lastly on a housekeeping item, can you give us your expectation for raw materials for the year? And what was the dollar headwind from light vehicle diesel and tailwind from commercial vehicle in the quarter?.

I'll talk about the commodity. Commodity headwind was $10 million for the full year. But it was mostly weighted to the first quarter. But, what really happened in the quarter, Rod, is we saw the inflationary environment. And as we said before, roughly 65% is contractually passed through.

And then we typically do better than that on negotiations, and what happened is we did better than that. We were able to negotiate more pass-through. So, therefore, you didn't really see any kind of headwind in the quarter in commodity. But, inflationary environment is there, I'd like to point that out..

(36:29) for the year?.

Pardon?.

What are you expecting for the year in terms of inflation?.

It was $10 million of – this was the commodity impact-wise, and that includes some corporate, as well, cost in there for the full year, Rod..

That's what you're expecting for the full year. So, okay, great, thank you..

Right. You got another question on commercial vehicle, what was your....

Yes.

So can you quantify the commercial vehicle tailwind in terms of revenue in the quarter and the light vehicle diesel headwinds, just in terms of ballpark?.

We can give you more numbers later on, but I'll tell you the magnitude. We saw low double-digit growth in that segment to give you an idea of how much of a tailwind it was, All right? So, that's on top of, we haven't seen growth now for three years or four years. So, I mean, it definitely was a nice tailwind.

And then I think in the script, it was about 100 basis points of the outgrowth that we had, okay?.

Great. Thank you..

Thanks, Rod..

Your next question comes from Brian Johnson with Barclays..

Hi. Yes. Thank you. Couple of questions. First around diesel, I see the slide in terms of the back – the shift in the backlog from diesel to advanced gas.

Can you give us a sense of, A, the manufacturing footprint for those substitute products, and, B, what that implies about the decrementals, incrementals, as you ramp down diesel, things like turbos and EGR and ramp up the gas equivalents?.

Yes, Brian, I can take a shot at that. So, for us, what it implies is, when customers, OEMs shift capacity from diesel to gasoline turbos, we're in a good place. Most of the capacity that we have is generic between a gas turbo and a diesel turbo. There are some unique things within the supply chain. But that's manageable.

Likewise, on the EGR technology, those products migrate from a diesel EGR platform to gas, it's transferable. I would say the (38:41) is a little sticky that's really not that transferable, but that's a smaller one of the three and our VCT capacity ramp is well underway.

So, for us, it's not a big deal, really, and we'll be able to move much quicker and much more flexibly than the OEMs. That's for sure, Brian..

Okay.

Second question, if we look at the organic growth, impressive in Drivetrain for last several quarters, and take out that DCT launch, what is roughly the organic growth rate (39:12) markets that's in? And is there any one driver or is it everything from chains to clutches and so forth?.

No, good question, Brian. It's the full spectrum in Drivetrain. So, let me give you a few examples or a few highlights. We clearly benefited from the truck mix in North America as an example. So transfer case technology is clearly in the Drivetrain segment. So. we're seeing growth there.

We're seeing growth on the rotating electrics from the ex-Remy business across regionally. We're also gaining on our, what I would call our core transmission business, so as we move forward with friction plates and clutch packs, that's driving growth.

And then DCT, particularly in China, where we're seeing growth, both with the domestics and the global guys. So, not one product, Brian. The good news for us, it's a balance across all of the Drivetrain products we're seeing growth and it's balanced regionally also..

Okay.

And then can you give us a number of Drivetrain ex-DCT growth?.

I don't know. We can probably get that for you later, Brian, (40:28) some calculations, All right. We'll get back to you, Brian..

Thanks..

Your next question comes from Ryan Brinkman from JPMorgan..

Hi. This is (40:43) on behalf of Ryan Brinkman..

Good morning (40:47)..

Good morning. There are some news articles recently that suggested that Continental and Delphi are considering combining their powertrain businesses.

So, the articles are suggesting that Delphi and Continental would retain themselves (41:01) seemingly like growth here, electrification enabling technologies, while contributing to some sort of joint venture than more conventional products, the ones that would boost efficiencies for internal combustion engines.

Now, you made clear a couple of times on many occasions that BorgWarner is definitely very strongly levered to all different types of powertrains and Drivetrains. My question just relates to the more conventional product areas, the ones that would solely boost the efficiency of internal combustion.

So, do you think these are also growth areas? Like for example, like turbochargers' (41:41), so we know there's a lot of growth in electrification and hybrids. But what about the just conventional combustion optimization technology, so are these also growth areas? Thanks..

Yes. Yes, sure. It's a good thought. Let me give you a couple of comments. First of all, I want to be clear, I'm not going to make any comments regarding Conti or Delphi. That's not my place to do that. What I can do is talk about why we're excited about the growth of BorgWarner in our propulsion business.

To specifically get to your quick question of do we see growth in combustion or internal combustion-related business? Yes, we do. We do. And when we published our data towards the end of last year in our Investor Day, the way to think about the combustion space is it's essentially a flat market as you look out the next five years to seven years.

So, there's no real growth there in the market. BorgWarner expects to grow in mid-single-digit growth and that's primarily driven through content adds (42:42) and more increased penetration around turbochargers, EGR technology and variable valve timing technology.

So we do see growth for BorgWarner in the mid-single digits for combustion-related products. That's why we're so excited about it. And we also leverage then on top of that the growth in hybrid products and electric products that makes for us, propulsion's absolutely a great business for us to be in..

Okay. Great. Thank you..

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

Good morning, guys. You did a great job of kind of delineating through the revenue shift when you look at the diesel shift to gas in Europe.

Just curious, as you look at the profit returns in that, are they similar or are they better on the gas side? And then also as we think way out in the future as Remy really grows, and our expectation takes off, will we see better profit returns from that content, or will it be similar?.

So, John, this is Ron. The mix from diesel to gas are similar in margins. If you take a look at the manufacturing process and the components, as James said earlier, there's not a lot of investments to be made. You're going down the same production lines. Turbocharger still has a compressor wheel in it, for example. And the EGR products are very similar.

So we don't see any kind of negative movement or positive movement either way quite frankly, in the mix from diesel to gasoline..

And then with electrification (44:16)?.

Yes..

Yes, so electrification, as you know, we are shifting products in electrification, so we have experience already in what the cost looks like, what the sales prices are. And they go through a very rigorous review as far as approval, quite frankly, to make the capital investment.

And they've all passed, which means that they line up with the current profile of return on invested capital in this company, and the margin profile is very similar. So again, we don't see any negative impact by the movement into that area..

And any early read on the GM Europe sale to PSA, what that means sort of positively, negatively or from an opportunistic standpoint for you guys?.

Yeah, not – we haven't really seen anything at this point, I would say, John. To be fair, we've historically done well with GM in Europe and we've done well with PSA in Europe. So our thought is it'll be okay for us, it will be good for us. But we haven't really seen anything materially emerge if that's the right way to think about it, John.

But when it does, we feel pretty good about it..

Great. Thank you very much..

Thank you, John..

Your next question comes from Chris McNally from Evercore ISI..

Thank so much, guys. And really appreciate the extra detail on the call. Just a further question into – sorry to beat a dead horse on the Drivetrain growth. Since we saw the step up come in Q4 of last year, it's now been two really strong quarters.

Is there also something within there on client mix? Meaning, you had some of the launches, I think it was on the Super-Duty in Q4.

So could we expect as we sort of comp through that for a year, we can have roughly high growth in the Drivetrain? And then obviously once you comp through that in a couple of quarters, growth would come back down, more in line with Engine and Drivetrain growing at the same rate..

Yeah. I'll take a shot for you. I think, first of all, we feel very good about the traction we're getting in around Drivetrain growth. It's positive. It is pretty broad across a lot of different platforms and products. So, it's difficult to single out one platform or one type of thing.

As I would say to you, I think the bigger move – the things that are going to move it around will be think of truck mix in North American definitely moves it because that's transportation (46:53) content. DCT in China will move or move it up and down fairly quickly. And the growth of ex Remy starter alternator business will also move it.

So I hope that gives you some sense. We do expect strong growth, as we've said, in Drivetrain. It's going to continue, but it's a little bit difficult when you try and break it down by vehicle platform or get too granular because I think there's just a lot of broad growth regionally and across a lot of different customers and platforms now.

But the punch line is, Drivetrain is a strong growth part of the company and which we feel very good about..

Okay. That's fantastic.

And then is it fair to say at least when we look at the really strong growth in Q1 and we'll see in Q2, that probably the first half we are benefiting, at least, from one of those three truck mix is pretty strong, I mean, in the first half? And we'll see the builds in the second half, that's at least maybe one of the reasons you're just holding off.

You want to see a little bit more of the production schedule for the second half of the year before you're able to make more of a comment on full year Drivetrain growth being at this level?.

Yeah, I think that's a fair perspective. And in addition to that, I would say China DCT also. Those are the two that are going to – another quarter is really going to help us get more clarity for the rest of the year for you guys. Truck mix and China DCT are the two that are going to move the most, and we want to just get a sense.

Just to give you a little bit of additional color, part of the truck mix is relatively easy to track. China DCT, remember that a lot of these are in launch and start-up volume mode. So that's a little bit trickier to predict, if that helps you.

That's kind of what drives a little bit of the uncertainty is how fast will the launch go, what's the vehicle adoption rates in China. But generally, as you can see in the first quarter, we're off to a good start and feeling good about it..

Got it. That's great. Thanks so much guys..

Thank you..

Your next question comes from Joseph Spak with RBC Capital Markets..

Hi. This is Jacob Hughes on for Joe..

Hey Jacob..

Hey, how are you doing? I think Great Wall Motor (49:17) announced they'd start manufacturing dual-clutch transmissions in April.

Is that a change versus prior? Or are they just doing the final assembly? Or what's the impact there?.

Well, they've talked obviously publicly about building dual-clutch transmissions in China for themselves. So they've talked about that publicly, and I've talked about that ramp. At this stage, I'm not really in a good position to give you clarity and detail on what that means for BorgWarner..

Okay..

But I – yeah, I can confirm that – as they've already confirmed that they're moving towards DCT. And frankly speaking, it's not a surprise. As I put in my comments this morning, China (50:05) has launched its DCT with BorgWarner content. And we're seeing more acceleration and adoption of DCT in China. So that's what I can tell you at this point..

Okay.

And then on diesel, are you seeing more pricing pressure on legacy diesel content as you bid for electrical content with those same customers?.

I would say, in general, the pricing environment is fairly consistent with historical levels. So there is generally, as you know, that pressure exists in the market. We have a – historically, we've done about 1.5% to 2% price down. That's a little better than the industry based on our strong market position. And we think that will continue on..

Okay. Thank you..

Thanks..

Your next question comes from David Kelley with Jefferies..

Good morning, guys. Thanks for taking my questions. Just a quick one on the organic growth in the Engine business and despite the European diesel mix shift here. You mentioned strength kind of across the board in China. Just maybe wondering if you could talk about turbocharger penetration in China and maybe North America as well.

Are you seeing any accelerated adoption there in either market? And how it compares maybe to your expectations going into the year so far?.

Yeah, David, good thought. I think in general, it's playing out pretty much as we had anticipated in terms of both China and North America for turbo penetration numbers. I don't have the number in front of me. Maybe we can get back to you, David..

Penetration in China is 35%. North America is 20%..

Okay. But I would say it's pretty much in line, David. And that's obviously what's driving good growth for us in those two regions. But no acceleration or deceleration in terms of adoption rate from what we had anticipated at the beginning of the year, if that's helpful for you..

Okay, great. Thank you. Very helpful.

And then kind of switching gears here, it'd be great to get some commentary on the Autotech Ventures investment, maybe kind of the thought process behind the move, how you plan on leveraging the investment, and is there any specific segments or high-level secular opportunities you're actively looking for that may be that investment might help connect you to?.

Yeah. No, thanks for bringing that up, David. It's – yeah, it's really exciting for us. What it fundamentally has done for us is given us a very, frankly, effective and efficient way to get access to a lot of start-up business and operations focused on ground transportation. So this is not a highly broad-reaching area for ground transportation.

So it's focused in our space. And it basically gets access to start-ups in – around the world. So, it's not just a "Silicon Valley Initiative". We see start-up ideas from Tel Aviv. We see them from Europe. We see them – and we have the ability to engage with these start-ups in very different ways.

Key to us, though, is getting access to some of those start-up technologies that can help our business, could be disruptive to our business, and making sure that we don't ever get surprised with some new inventions that are coming out of there that we're not part of. We want to get in on the front end of it.

So, yeah, it's pretty exciting, it's pretty early for us. But we're really, really encouraged by both the amount of start-ups that are coming through and the relevance to our propulsion space. So there'll be a lot more to come on this, David, but it's very exciting and we're off to a good start with it..

All right, great. I really appreciate the color. Thanks for taking my questions, guys..

Thanks..

Thank you, David..

Your next question comes from Adam Jonas with Morgan Stanley..

Hey, everybody. So the first question is in reference to Continental's Capital Markets kind of powertrain day, a couple of days ago. They had disclosed that they were loss-making in their EV efforts, and perhaps temporarily so as they're kind of ramping up.

I'm just wondering, is that – as – they think they're working on their last-generation internal combustion engine. I don't know if you agree with that.

But can you, at least, if you isolate the EV efforts for passenger car propulsion – I'm excluding the core business of Remy, let's say, that you acquired, is it reasonable to assume that as you kind of invest and build that up, at least temporarily, there's some losses that won't be covered by revenue for a number of years before the payoff comes?.

Yeah, Adam, let me take a shot at that for you. We don't see that is the quick punch line. We're not – and there's a couple of data points here. We've been invested into hybrids and electrics for a number of years. And if you think about it, our R&D percentage has kind of trended around that 4% through that period. So that's one indicator.

And if you look at our after-tax ROIC numbers over that period, they're not coming materially down. They're bouncing around that 15% area. And as we look today at the products that we're shipping today in boxes to customers, single-speed transmissions and other products, those are all at the BorgWarner-type levels.

So we are not experiencing any headwinds as we migrate the portfolio to more hybrids and more electrics for the company (55:35). We're not seeing that at all..

Thanks, James.

And just as a follow-up, what is your working assumption of when the cost of owning an EV becomes lower than owning an internal combustion engine?.

You asking for the when, Adam, what year or what....

Yeah. Well, I mean, like roughly. And I know you can't pinpoint a year.

But do you have a working assumption of when your customers – or the end customer is going to find an EV to be more affordable to own than an internal combustion engine?.

Yeah, I would say this way, Adam. We have – we – for sure, we model out the various propulsion architectures over time and look at those kind of variables. We don't have a pinpoint number that we look at. What we look at is what do we see as the future of a hybrid propulsion system costing and what are the drivers behind that, same with the pure EV.

But, candidly speaking, we're not in the game of deciding the when and the what. We're going to participate across all three architectures and be well positioned there. So for us, it's not a big, big driver either way, what that mix is between hybrid and electric and combustion products..

That's it (56:48) James. Thank you..

Thank you..

Thanks, Adam..

Your next question comes from Richard Kwas from Wells Fargo Securities..

Hi. Good morning, gentlemen..

Good morning, Rich..

Hey, Rich..

Just a few quick follow-ups, hopefully. So, Ron, CV assumption for the year, my recollection was within the initial guidance, it was kind of flat. Is that revised higher at this point? I would assume it had..

Rich, you're right. First of all, the guidance was flat. And I would say the guide at this point – we had a good quarter, but at this point, the guide still is flat, Rich. This market's fooled us in the past and we got to see – like James said earlier, we got to see another quarter of continued improvement before we get really excited about it..

Okay.

And what's China heavy truck for you now, as a percentage of the commercial vehicle, your commercial vehicle business?.

I'd say about 15% or 20% for the total CV business, Rich..

Okay. All right, great.

And then – also within the guidance is the diesel penetration closer to down 200 basis points for the year? Is that what's embedded? I know you've said 100 to 200 basis points annually over the next few years, but are you embedding a more slightly conservative outlook?.

Yeah. I would say as we came in 100 to 200 basis points, we're probably at 300 to 400 basis points now, Rich, is what we're thinking..

Okay. And then last one just longer term on EGR, my recollection was gas EGR had a pretty low penetration, single-digits, but my numbers are stale going back a few years ago.

Where are you now or at least the industry is now with regards to adoption of EGR and gas?.

Yeah, your recollection was right, Rich, it's – it's single-digit-type numbers, but we're finding it's starting to climb. So we're starting to see more quotes, more interest, and more applications. And so, I would say, it's pretty much in line with what we were at six months ago.

And I would tell you the perspective is we feel good about win rates in that space. That's the other area I'm feeling pretty good about. So it's a climb up, Rich, from single-digits and it's just going on keep on climbing up over the period..

Is there a number by 2019 that we should think about as the.....

We can get that for you, Rich..

(59:07)..

Okay. That's fine..

(58:09) number..

All right, we'll take it offline..

We look at that..

Yeah. Thanks so much..

All right, thanks, Rich..

We have time for one final question. And that question comes from David Leiker with Baird..

Okay. This is Joe Vruwink for David..

Good morning, Joe..

Hey, Joe..

Morning. Just one question, one thing we hear a lot – and I think you guys have said in the past as well as when an automaker picks up the phone and is thinking about electrifying the powertrain, that first call is typically to the mechanical component supplier.

And the question is, can you handle the electrical piece with the mechanical? It's not the inverse? Do you agree with that sentiment? And is that still accurate? It would seem like your current competitors that ultimately – even though you're typically butting up against five and six good suppliers.

It would seem like that narrows even a bit more, because obviously the companies that can handle both are certainly fewer.

Just your thoughts on both of those?.

Yeah. I'll take a shot at that for you, Joe. I think the first and most important thing that's on the OEM's mind is to call the guy that understands the propulsion system and all that comes with that, the interface between engine and transmission and the vehicle.

And I think it's fair to say a lot of that resident knowledge, expertise generally as a – in general, will start or lead with the mechanical – electromechanical aspects, but they absolutely want somebody to understand that, the electromechanical, the system, the power electronics, and the motor.

And that makes us one of a few – a small group that can offer them that support and that capability.

And the last point I would make, Joe, that's really important is they want to make that call whether it's a combustion propulsion, a hybrid, or a pure EV propulsion, because they want that partner to help determine with them what propulsion mix they should be working forward with (61:21).

And that's definitely BorgWarner in our perspective over the last couple of years..

Great. Thank you..

Thanks, Joe..

Thanks, Joe..

With that, I'd like to thank you all for your questions today and thank you for participating. Sharon, you can close the call..

That does conclude the BorgWarner 2017 first quarter results conference call. You may now disconnect..