BorgWarner Inc (BWA) — Q2 2019 Earnings Call Transcript

Thank you, Sharon. Good morning, everyone, and thank you 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. A replay of today's call will be available through August 8th. The dial-in number for that call is 855-859-2056, and the conference ID is 9052479, or you can simply listen to the replay on the website. 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 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. During today's presentation, we will highlight certain non-GAAP measures in order to provide a clearer picture of how the core business performs and for comparison purposes of prior periods. When you hear us say 'on a comparable basis', that means excluding the impact of FX and net M&A. When you hear us say 'adjusted', that means excluding non-comparable items. And when you hear us say 'organic', that means excluding the impact of FX and net M&A. We will also refer to our growth compared to our market. When you hear us say 'market', that means the change in light vehicle production weighted for our geographic exposure. Our outgrowth is defined as our organic revenue change versus the market. Now back to today's call. First, Fred Lissalde, our President and CEO, will comment on our Q2 results and our 2019 outlook. This will be followed by a high-level overview of our joint venture agreement with Romeo Power. Fred will conclude with a discussion of our recent product highlights. Then Kevin Nowlan, our CFO, will discuss the industry outlook, as well as details of our results and guidance. Please note that we have posted an earnings call presentation to the IR page of our website. We encourage you to follow along with these slides during our discussion. With that, I'll turn it over to Fred.

Thanks, Pat, and good morning, everyone. We're very pleased to share our results from Q2 2019 today and provide an overall company update. Let me start with the highlights of the quarter. I am pleased with the sequential improvements in our outlook. With more than $2.5 billion in sales, we were down about 0.3% organically. This compares to our market being down 5.7%. So, our outgrowth was approximately 540 basis points in the quarter, which was ahead of our expectations. Regionally, we saw outgrowth in all major regions. Our European light vehicle revenue was up 2%, outperforming the industry decline by more than 9%. Our North American light vehicle revenue was up 4% year-over-year with 600 basis points of outgrowth. Our China revenue declined about 10% versus the industry production decline of 16%. Adjusted earnings per share came in at $1 with our operating income performance at the midpoint of our guidance. A higher than expected tax rate was a $0.02 headwind. I'm also pleased with our stronger year-to-date cash performance that Kevin will discuss in detail. As we focus on near-term execution in this challenging market, we also at the same time maintain an equal focus on investing in the long-term. In the second quarter, we closed on our Romeo Power investment, which positions us to be a leading player in battery management, and I'll speak about this in a couple of slides. We also continue to deliver new wins in hybrid and electric, which is positioning us to deliver continued revenue outgrowth. Overall, Q2 was a solid result compared to an industry backdrop, which continued to weaken throughout the quarter. Now, I would like to address our full year 2019 guidance. While we were encouraged by the better than expected outgrowth in the first half, we expect our full year revenue to be in the bottom half of our prior revenue range. We expect revenue to be down 2.5% to flat organically. This is based on an industry assumption of down 3.5% to down 5% with the high end being 150 basis points lower than our prior assumption. We expect our outgrowth to be in the 250 basis points to 350 basis points range for the full year. We expect our adjusted earnings per share to be between $3.75 to $4. This guidance reflects our updated revenue outgrowth outlook and additional margin pressure from the continuing production volatility and weaker cost performance from our supply base. To be clear, we're not satisfied with our margin performance in the full year '19. Margin performance has historically been one of our strengths, and we are focused on maintaining that discipline. In order to meet our long-term margin and cash generation objectives, we are taking more aggressive steps to adapt our cost structure to the challenges facing our business. This will include more steps to manage our near-term costs and more aggressive restructuring measures than the ones we have previously announced. While we will continue to manage the current volume environment and cost pressures, we will continue to secure our future growth through new business awards supplemented with M&A investments. Consistent with this, during this quarter, we announced our plans to enter into a joint venture with Romeo Power, whom we view as a technology-leading battery module and pack supplier. It’s a good fit between the two companies. Romeo Power has excellent technologies and we provide the customer reach and comfort level, as well as the capability to reply and produce at scale and globally. BorgWarner will own a 60% interest in the joint venture. It will also complement our existing portfolio and expand our system expertise for electric propulsion. Finally, we believe this joint venture can fill the gaps in the marketplace between hybrid and electric vehicle makers. Next, I will point you to Slide 8, which illustrates our competitive advantage in EVs. The products in blue are products that we now have capabilities to produce in-house. This is what positions us strongly for future growth. We are one of the few with products covering energy management from grid to wheel. Upstream of the battery, we have onboard chargers, and we are active in the stationary charging business as well. Downstream of the battery, we supply motors, transmission, and power electronics. We can supply these components individually or as an integrated module. We complement our proportion offering with cabin and battery heating technologies, for which we also see a strong market pull. And now with our battery pack joint venture, we can supply the battery packs and thermal management systems as well. We can develop, specify, and manufacture all the major components of a battery electric vehicle propulsion system. Our product breadth is truly our advantage. Now, I would like to discuss some of our product successes. This quarter, we announced that our innovative regulated two-stage turbocharging system will be used on BMW Group's latest two-liter twin-power engine. Innovation is still occurring in combustion propulsion, and our technologies are helping automakers comply with increasingly stringent regulations worldwide. I am strongly encouraged by our year-to-date wins across multiple hybrid architectures and products for electric vehicles. We have booked hybrid and electric business in Europe, Asia, and North America. While we cannot share all of the customers or program-specific details at this time, we have received awards across multiple hybrid platforms, including P1, P2, and P3. One example is a high-volume P3 hybrid system for a major European OEM. For this system, we're supplying a motor generator unit, power electronics and software, gear set, and disconnect controls. In electric vehicles, our cabin heaters are also continuing to win new business. Importantly, we expect to see additional wins across hybrid and electric in the second half of 2019, and I am very pleased with this. So let me summarize my opening remarks this morning. Q2 saw a recovery in our growth as expected, but we expect a challenging second half. We will take the necessary actions to adjust our costs to the current environment, and we are encouraged by our year-to-date wins in the three regions of the world across multiple hybrid and electric vehicle architectures. This positions us strongly for the future. Now, let me turn it over to Kevin.

Thank you, Fred, and good morning, everyone. Before I review the financials in detail, I'd like to provide you a quick overview of the two key drivers of our second quarter results. First, our revenue outgrowth was ahead of our expectations at 540 basis points in the quarter. This was driven primarily by higher volumes and new programs, especially in Europe and North America. We also benefited from some amount of pull forward of launch volume from Q3, and we remain on track for full-year revenue outgrowth of 250 to 350 basis points. Second, cost pressures continued to be a headwind during the quarter, which drove all inbound site conversion of 27% and prevented us from hitting the upper end of our adjusted EPS guidance range. Nonetheless, we still achieved performance within our Q2 guide, but we're disappointed that we didn't deliver a stronger result. Let's turn to Slide 11 where you can see our perspective on industry production. Let me start with Q2. Global light vehicle production came in about 5.7% lower on a year-over-year basis, which was slightly worse than the midpoint of our expectations going into the quarter. Within that global result, we saw European production down about 7% against a fairly tough comparison from last year. China production was down 16% as that market continues to remain under pressure, and North America declined by about 2%. As we look ahead to the remainder of 2019, we expect that the challenging industry conditions will continue. On a full year basis, we now expect the market decline to be in the minus 3.5% to minus 5% range. The stronger end of this outlook is 150 basis points lower than our prior expectation. Also as part of our outlook, we're now planning for China to be down anywhere from 10% to 14% on a full-year basis, while Europe is likely to be down 3% to 4.5%, and North America down to 3%. This new market outlook means we have become even more cautious on China and slightly less negative on Europe. Let's turn to Slide 12. Even with the global market down 5.7% in our second quarter, on a comparable basis, our organic sales were down only 0.3% year-over-year. This is the 540 basis points of market outgrowth I referred to earlier. And importantly, this outgrowth occurred in all of the major light vehicle markets around the globe. In Europe, our revenue was up 2% compared to the 7% industry production decline in the quarter. In North America, revenue was up 4% versus the 2% industry decline in the quarter. And finally, we did see a 10% decline in our China revenue, but the overall Chinese market was down more than 16% year-over-year. Underperformance in Korea reduced our global output by 100 basis points, and our commercial vehicle off-highway and aftermarket businesses were down about 1% year-over-year. Overall, we're pleased that we continued to deliver revenue outgrowth even in this challenging end market environment. Now, let's look at our adjusted operating income performance, which can be found on Slide 13. Q2 adjusted operating income was $303 million compared to $341 million in the second quarter of 2018. Our adjusted operating margin was 11.9%, down from 12.7% last year. On a comparable basis, adjusted operating income dropped $23 million on $7 million of lower sales. The $22 million shortfall compared to our long-term 20% decremental margins can be explained primarily by our supply chain cost reductions falling short of our target due in part to the year-over-year impact of tariffs and some insolvency issues in Europe. In addition, we incurred costs in the quarter related to new business launches scheduled for later in the year. Adjusted earnings per share was $1 for the quarter, slightly below the midpoint of our second quarter guidance. Even though the result was within our EPS guidance range, we are disappointed in this result as we anticipated managing the decremental margin better. Delivering bottom line results closer to the top end of our guidance remains our focus. In addition, our effective tax rate came in a couple of percentage points higher than planned, which reduced adjusted EPS by $0.02 in the quarter. We are proud of the fact that we delivered a strong cash flow result for the quarter. In the second quarter, we generated $300 million of free cash flow, significantly stronger than the $161 million we delivered in the same quarter a year ago. As you know, cash flow has become an important focus of the company over the last couple of years as we drive toward generating $1 billion in annual free cash flow starting in 2023. Now, let's take a closer look at our operating segments on Slide 14. Engine segment sales were $1.569 billion in the quarter. On a comparable basis, sales for the engine segment declined only 0.4%, or $7 million despite lower industry-wide production. Growth in North America and Europe for our engine business offset by the impact of the weaker China end market. Adjusted EBIT was $249 million for the engine segment or 15.9% of sales. On a comparable basis, the engine segment's adjusted EBIT was down $19 million on $7 million of lower sales. This weak decremental margin performance was driven primarily by the decline in sales and by supply chain cost performance not offsetting normal decreases in customer pricing. This is in part due to the costs arising from the year-over-year impact of tariffs and costs related to supplier bankruptcies. Drivetrain segment sales were $998 million in the quarter. On a comparable basis, sales for the drivetrain segment increased 0.2% year-over-year. Also, meaningfully outperforming the market as growth in North America offset revenue declines in Europe. Adjusted EBITDA was $102 million for drivetrain or 10.2% of sales. On a comparable basis, the drivetrain segment's adjusted EBIT was down $10 million on $2 million of higher sales. The decline was driven by higher R&D spending and launch-related costs, primarily in China. Now I'd like to discuss our full-year and third-quarter 2019 guidance, which is on Slide 15. Our guidance is based on the end market assumptions I discussed earlier with global production down 3.5% to 5%. Despite that, we expect organic revenue to be in the range of down only 2.5% to roughly flat. That's because we continue to expect to drive significant market outgrowth of 250 basis points to 350 basis points for the full year. We're ahead of that mark through the first six months, but we do expect lower outgrowth in the third quarter as a result of the impact of lower launch volumes in China and negative mix in Europe. With these organic growth assumptions, we now expect total revenue to be in the range of $9.94 billion to $10.18 billion. That means we reduced the top end of our revenue outlook by 200 basis points. Three-quarters of this reduction is the result of lowering the high end of our market production assumptions, while the balance is driven by the lower backlog that we now expect as a result of those end markets now being lower than before in that high-end scenario. This lower backlog translates to a decline of a little more than $50 million in revenue from our prior guidance. Our adjusted operating income margin is now expected to be 11.4% to 11.8% versus 12.3% in 2018. The 40 basis point to 50 basis point decline in our margin outlook relative to our prior guidance reflects weaker cost absorption due to continuing production volatility and lower than expected revenue in the second half of 2019, weaker supply chain performance stemming in large part from the continued financial challenges in the supply base and weaker year-to-date margin performance than we were expecting. Full-year adjusted EPS is expected to be in the range of $3.75 to $4 per diluted share. The decline in the bottom end of the range primarily reflects the weaker margin outlook. In addition, our run rate effective tax rate is now expected to be around 27% for the full year versus our prior guidance of 26%. That has an impact of almost $0.06 on our adjusted EPS guidance range. And finally, we are now targeting free cash flow of $525 million to $575 million, which is down $25 million from our prior guidance. Lower earnings are being partially offset by a reduction in working capital. That's our full-year outlook. Now let's touch on the third quarter outlook starting with sales. We expect organic sales to be in the range of down 1.5% to up 1.5%, which would yield sales of $2.4 billion to $2.5 billion. These expected third quarter organic growth rates are roughly in line with our market forecast, which implies little to no market outgrowth in the third quarter. That's being driven by lower overall volumes on new programs in China and negative mix in Europe. Importantly, however, we expect this lack of outgrowth to be a one-quarter phenomenon as we see the fourth quarter likely to return to our more recent levels of outgrowth. And that keeps us on track for the full-year outgrowth of 250 basis points to 350 basis points that we've highlighted. Adjusted EPS is expected to be in the range of $0.83 to $0.90 per diluted share in the third quarter. On a year-over-year basis, earnings are expected to be negatively impacted by continued challenges with supply chain cost performance, inefficiencies related to lower launch volumes than planned, and higher R&D costs as we continue to invest in electrification-related programs within our drivetrain segment. Let me wrap up by summarizing how I think about the second-quarter results. We were able to deliver 11.9% adjusted operating margin, $1 of adjusted EPS, which was within our guidance range, and $300 million of free cash flow while also driving more than 500 basis points of market outgrowth. We did all of that in a very challenging end market. But from a financial performance perspective, we're not satisfied. Our decrementals have been higher than we expected in organization. We will take the necessary actions to get our decrementals back to target, because we fully intend to maintain our company's historically strong margin profile. Additionally, we remain committed to executing against our long-range plans in delivering on our long-range financial objectives around revenue outgrowth, margin performance, and free cash flow generation, even while we manage through a very difficult near-term market environment that we expect to continue for the remainder of 2019 and likely into 2020. With that, I'd like to turn the call back over to Pat.

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

So first question is around your full-year guidance or assumptions on the revenues that you are trimming the high end, but obviously, a fairly large cut through the margin outlook. Can you just go back over why does this modest decrease in the revenue guidance result in such a large negative impact on the guided margins? And in particular, I will be interested in any more detail you can provide on some of these comments around supply bankruptcies that you made during the quarter, maybe any quantification?

Emmanuel, let me start with the market. So we see the full-year market down 2.5% to down 5%, which is a change from the down 2% to 5% that we had back two quarters ago. Now, it's not the same minus 5%. China is down more and Europe we're a little bit more confident, that the prior guidance from a market perspective. So we want to share a realistic outlook, especially in China and in Europe. From a margin perspective, the foremost impact versus our prior guide is coming from our supply base. Kevin will give you more detail I guess in future questions. But overall this is what's happening in the markets and in margins.

And maybe I'll follow up on that. I mean overall if you think about the 25% drop, I want to just speak to that in the low end of guidance in particular. The $0.05 of that really relates to the tax rate change going up 1 percentage point. So if I put that aside, I'd say the other $0.20 is really coming from operational performance not hitting our objectives. And there's really three items that are driving that. The first, as I say, our second quarter came in weaker than we were anticipating. We expected to deliver at the top end of our guidance, and we missed that top end by about $10 million on a pre-tax basis. The second thing I would say is that with the volatility in the global markets and some of the markets coming down more quickly, just as Fred spoke to, we're seeing decrementals come in closer to 30% right now than the 20% that we target over time. And then the final thing with what you touched on, the supply cost performance coming in worse than anticipated. And that's due to the continuing impact of some of the insolvencies that we're seeing and frankly just the general macro environment making it more challenging to achieve cost reductions in the supply base. Those are the three items that are causing us to take the guide down.

Just a quick thought on this, and then I have a separate second question. But can you give more detail on those insolvencies? Obviously, it seems to be something that you're speaking about more now than before, the second quarter margins were okay. Obviously, the second half is much weaker than we expected. And any level of quantification you can give around what is this used to being for the full year in terms of incremental costs from that?

Emmanuel, we don't see more impact from bankruptcies. We're managing it. We've been managing it and we're going to continue to manage it. As Kevin alluded to, it's more than the market situation that is putting the supply base under pressure.

And then now maybe looking forward a little bit, so I think two of the trends that you're highlighting is taking basically more of the satisfactions to improve the cost base in light of this market and then obviously managing these insolvencies. How should we think about that as we look forward? How quickly can some of these actions show some impact on margins? And should we assume additional weakness from those insolvencies in 2020?

So in the prior call, we've announced some restructuring that we're essentially SG&A focused. Now, the more aggressive look is going to be around COGS and manufacturing costs. And so we know what to do, we know how to do it, and we're just managing through it.

And timing?

I think in the next quarter or two, we're going to give you an update.

First question is just if we look, if we compare your revision to the global production versus the revision to your organic growth, it's a little bit steeper for you. It looks like you maybe took down the backlog you expect to come on a little bit this year. Can you just talk about what's driving that? Is it slower ramp-ups on some of the programs that were expected to launch perhaps in China? And how do we think about the impact to profitability as you capacitize for a certain level of ramp that seems might be coming in a little bit softer?

From a backlog perspective, the major impact we have is primarily due to some program delays and a lower volume, mainly in China. The upper end of the backlog guidance is down about $50 million, while the lower end remains unchanged.

And then how much is that, how much is the like lower absorption on that driving the margins in the back half?

I mean, that has an impact on the way we're decrementing right now. As we're seeing the volatility in the markets, and some markets like China coming down more quickly than we anticipated, it's causing us to decrement more like the 30% rate as opposed to our target of 20%. And that some of the impact we're seeing as we head to the back half of the year.

And then I just want to circle back to this supplier cost reductions act keeping pace. I understand there's an unusual or extraordinary situation maybe with some of the bankruptcies. But is there anything more there? Like did you sign up for a certain level of efficiencies and you're expecting to get that and you're not? I guess what I'm trying to understand is the relationship between what you signed up from your customers and then what you expect from your supply basis? Seems like there is a bigger disconnect now.

I mean, as I look at the three things that are really impacting us from a supplier cost performance perspective. The first is we have had the impact of year-over-year tariffs. So that's something that's been a headwind year-over-year. The second item is the supplier insolvencies that we talked about, which has provided some headwind to our cost structure this year that we haven't been able to offset. And the third is that general macro environment, which is making it more challenging to execute on cost reduction strategies in the supply base. So, it's really a combination of those three things that's impacting us and causing us to fall short of offsetting normal customer price downs.

And those customer price downs are in steady, or has there been a change there?

They're relatively consistent. I mean, we haven't seen a significant change in terms of our annual customer price downs. They tend to be consistent with what we've seen in the last couple of years.

This is Aileen Smith on for John. Following up on Joe's question earlier around the backlog and the slight revision there for 2019 if possible within that full-year backlog estimate. Could you remind us what your realization was relative to expectations in the first half of the year? And maybe where that stacks up versus the implied realization on the backlog in the back half of the year?

In terms of our market outgrowth in the first half of the year, is that your question?

Yes.

I think in the first quarter, we reported that we had delivered about 190 basis points of market outgrowth. And then in the second quarter here, we delivered 540 basis points. And as we look ahead to the third quarter, we're expecting it to be roughly a little bit flat to up a little bit favorable from an outgrowth. And in the fourth quarter, returning to some of the higher levels we've seen relative to where we were in the first half of the year. So all that then gets us to the 250 to 350 basis points of outperformance.

So is it fair to say that perhaps 1Q and then specifically 3Q as you looked at your backlog at the beginning of the year, those are the two quarters where there's some relative weakness on backlog roll on versus expectation. Is that fair?

I believe looking at the backlog on a quarter-over-quarter basis is quite detailed. It would be better to analyze the backlog on a year-over-year basis. Last year, we experienced an outgrowth of over 600 basis points, while this year we expect to be between 250 and 350 basis points, which aligns with our long-term target. On average, this is 500 basis points above the market. However, examining it quarter-over-quarter with the new program launches and other factors makes it challenging.

And I'm not going to ask any questions around the 2020 backlog specifically, but just to give us a frame of reference as to some of the sensitivity on those numbers. Can you remind us what your underlying volume assumptions were through 2021 when you set your backlog estimates, your three-year backlog estimates at the beginning of the year?

The underlying market assumption is overall 1% growth year-over-year and flat on commercial vehicle. And I suggest that maybe you can take follow up on that offline.

What we alluded to last quarter was intended to do two things. One, to help fund some of the incremental R&D costs that we're expecting. And second was to sustain our strong margin profile. We expect to get the full run rate delivery of that by the time we exit 2020. I will say, though, that there are some cost performance actions that are taking in the back half of the year that's helping our incrementals as we get into the fourth quarter, but in a small way. The bigger impact is in '20.

I just want to dig through a little bit on China. You're talking about down 10% to 14% for the year. That 14% decline number is higher than where a lot of the past third-party people are, just curious of your thoughts. Is that putting a little bit of a cushion in there? Or is that what you're hearing from the market of where your customers are expecting things to be?

So, Dave, at the midpoint of our guidance, we are at minus 12% for the full year and actually about minus 8% in Q3, close to minus 11% in Q4. This is what we see. And you've seen also some lower pull from the electric vehicle segment in China this quarter, or let's say in Q2. So this is what we see and we want to share that realistic outlook. This is our best guess. And I agree it might be lower than some third-party estimates, but we want to share what we think.

And then just on Romeo. Can you give a little bit of detail in terms of what that business is today? I'm sure there are multiple options in terms that you could partner with. Why did you choose them and what customer base do they have? Just if you'd flesh that out a little bit would be great. Thanks.

Technology drives our decisions related to mergers and acquisitions, as well as our analysis of various components in the battery management and thermal management systems. We determined that Romeo Power was the best partner due to their flexibility in sales options. Currently, they are in production with some low-volume commercial vehicle applications. The joint venture is straightforward, as I believe joint ventures should be. Our focus is on product development, customer intimacy, and scalable global manufacturing. We are in discussions with several customers worldwide regarding different applications.

Yes, let's just stick with Romeo. Is that something that your customers were asking you to do? I mean, is this something that you wanted to do in order to provide a full solution? What was the internal evolution of thinking of going on and adding this to your portfolio?

You've heard us talk about the fact that we want to enhance our system focus in electric vehicle and hybrid vehicle. If you look at all the components that we are making in the slate that shows the components in blue, there was one missing piece. We wanted to have products from grid to wheel. With all those products, we felt that we can add value to customers from the system understanding, potentially from the product integration path. So we proactively decided to go into this field, and I think it is also an element where we think in addition to the system understanding and expertise that we can still get between the cell makers that do battery packs and battery thermal management and some of the OEMs that do that too, and we feel good about that.

And then as a follow up, there's been some reports of incremental competition within the turbo charger market. Is that impacting the margin profile on new business that you're quoting, or you're not seeing any impact in the marketplace?

So on the turbo market, the new program pricing is challenged. This is coming from competitive dynamics that are currently existing. We are absolutely focused on our financial discipline. We're focused on getting the best products in the hands of our customers. But there are programs that we're not going to chase.

Just hoping you could help me get my head around something here. So the midpoint of your full year EBIT guidance came down by $55 million on an $81 million revision to revenue, if I use the midpoint of revenue guidance. So it looks like the bigger change to your expectations were on the cost side. And if I do a simple bridge, the first half decremental margin on the revenue decline was 23%. But if I do the same math on the second half, it's 38%. And maybe you can just elaborate a little bit more on, it seems like this is a cost thing. Is it costs coming into the platform, or is it the inability to take costs out due to some of the factors you're describing here with the Tier 2s?

Rob, this is Kevin. I'll answer that. I think it's predominantly what we're seeing on the cost side in a few different ways. The first bucket I'd say is we expected to deliver better performance in the second quarter from a decremental perspective, and we didn't deliver on that. Some of the reasons are due to some of the supply chain performance. That was about $10 million of that $55 million as you think about it that we expected to be at the upper end of our guidance range. Second is because of all the volatility that we're seeing in the markets, especially with some of the markets coming down in a more accelerated way, we are decrementing at the moment closer to 30% than 20%. 20%, which is our target and will remain our target means that we have to take some costs out to be able to achieve that. But when the markets are moving this quickly, it takes a little bit more time for us to execute. So we're seeing decrementals at that 30% level, and you can do the math and see how big an impact that is, call it $25 million on a full-year basis. And then the final thing is really the supplier cost performance coming in worse than anticipated for the reasons that we talked about earlier. And that's really the bridge for that $55 million or so that you've pointed to. When you look at the first half versus the second half, the one other thing I think you need to keep in mind as you do a year-over-year causal is that we do anticipate our R&D expense being higher in the second half of the year than the first half based on what we're planning right now.

Okay, that might be a big factor there. And in terms of the supplier issues. How widespread is this within Europe? And if there were to be a downturn in this market, should we interpret this as something that poses an additional risk? With the downside sensitivity be greater?

So, the bankruptcies are essentially centered in Europe. But the supplier distress, I would say from the current microenvironment and volatility that one see, is varied at — is at different degrees, but I would say it's global.

And just lastly, you alluded to additional restructuring. Are you seeking, at this point, to mitigate additional pressures that you see coming into 2020 and trying to get ahead of that? Or are you primarily looking to restore to your current margin targets based on the current level of production?

We're trying to be proactive and ahead of the curve.

Yes, just try to get to a couple of questions that might be left. In terms of the backlog, how comfortable are you with the Q4 launch cadence, especially, well, both in China given the micro pressures there and then in Europe, given the uncertain outlook for CO2 compliance?

What we see right now is that launches are on time. We don't see program cancellations. We see very rare program delays. But what we see is that when it launches, it launches at lower volume. That's the key impact of the backlog shift.

Just following up on this line of questions, I assume that there is a fairly fluid discussion between yourself and the OEMs on what they're trying to achieve. So, could you just give us a sense, the latest thing that you're hearing, OEMs have a number of options of meeting these targets, whether it's just more beds and pay TVs, or to enhance the internal combustion engines, or pay the credit fund. Where does the enhanced internal combustion engine fit in on this? And as it relates to yourselves, I mean your internal combustion engine portfolio is obviously mature, it's been around for a while, the hybrid and BEV piece, this is newer. Where are you in terms of capacity on ICE versus the hybrid and that piece, and the ability to meet incremental demand on both sides?

So first again, we're not going to speak for our customers. What I can tell you is that for every product that we do that enhances fuel efficiency and reduces emissions, we see a strong pull. Everything we can do to add capacity and to push production lies to deliver more in Europe to help our customers, we'll do.

I think I have a similar question to Brian, so I might counter that you said you could address it later. I think what we're all trying to figure out and my colleague has been running this for some time. Is it fair to say that BorgWarner's sitting here in the middle of the year is very conscious that there is probably a disconnect, first what you see as the gap in 2020 and 2021, fuel efficiency in Europe to meet regulations need to grow up by 20% to 25% in the next 12 to 18 months. And that you have to do something to gain scenario for that, because OEMs are not really admitting to the problem. There's definitely going to be some repercussions. I think is that something that you recognize right now, or are we on the sales side seeing numbers that maybe are skewed and we're missing something in our analysis?

We're not going to speak for our customers. But what I can tell you is that for every product that we do that enhances fuel efficiency and reduces emissions, we see a strong pull. And everything we can do to add capacity and to push production lies to deliver more in Europe to help our customers, we'll do.

I wanted to follow up on China. It’s clearly a challenging market right now, and you are aiming to maintain your efforts in the second quarter. However, when I compare your current situation in China to the past couple of years, when you experienced substantial growth of about 20 to 30 points, it seems different now. Is there a shift in your product mix, or are you focusing more on hybrids and electrification? It appears that the uptake might be slower than before, when you had more DCT. I'm trying to understand the changes in China’s growth.

So, two things I want to try to give you some color. First of all, year-on-year, our base revenue is becoming higher, so the outgrowth in percent is based on the higher revenue. What you see in China is that as I alluded to before, the volumes of the products that are being launched are lower than what we expected in the past because of the macro environment and customer confidence and other changes in this market. You see ups and downs on take rate on battery electric vehicles, and that impacts us quite a bit.

Maybe just a quick one on Romeo. I think you explained your strategic rationale. Obviously, this is a large AFP or content for vehicle item. Can you talk a little bit about the backlog that you're seeing where the coating activity, just for us to try to understand what the growth trajectory could look like for BorgWarner to be the battery system supplier?

No, it's still very early days for the joint venture. We're getting everything ready. We have customer pool. We are in coating phases. In any case, between now when we quote and when we launch, most probably won't have any significant impact on our three-year backlog.

And then I understand, I mean, you're really targeting niche volume productions, tens of thousands. Is that correct?

That is correct.

So then just to go back to some of the breakdowns with the supplier bankruptcies. I guess, obviously, we've gone through this before in a much more severe way globally in decades past. I guess what does surprised you at all about what's happening now in that supply base, and what mitigating actions are you taking?

So I would say, if there is a surprise, it's how many suppliers are impacted. As I mentioned before, it's essentially Europe. And in Europe, you've seen an impact on the supply base of the diesel drop, which is not significant for us but for some of our suppliers, it is significant. We have to find a way to manage these costs. We have to find a way to get through those tough times. We know how to do it; we've done it before and we're doing it. It's just the magnitude and the number of them that if there was a surprise, that would be the surprise.

Good morning, thank you for taking the question. Presumably this is already incorporated into the guide around European production. But maybe you could give us some color around how your customers are thinking about RDE coming up here in a few months?

So I think we see the impact of RDE coming in a few months. And so right now, our outlook in Europe is that it's going to be flat second half of the prior year at the midpoint of our guidance from a market perspective. I think it's a bit early to talk about the impact of RDE, at least at our level.

And then the other question is just more broadly we're seeing in partnerships with BMW and Jaguar Land Rover around the electric drive unit. Volkswagen is talking about 30% less employees for an electric vehicle versus an internal combustion engine. Just as we gravitate towards that world. How do you think about the potential risks of in-sourcing and how do you position yourself?

So we've always been in products that have potentials of in-sourcing. And from a battery electric vehicle standpoint, motor and drive motor being a good proxy, our hypothesis is that the available market is going to be 50% of the total market, i.e., 50% of those motors could be in-sourced. And again, it's not going to be one size fits all. You're going to see a lot of different customers moving in a lot of different strategies, technologies, and products strategies. Whatever they do, they can do it through BorgWarner. From a combustion product standpoint, as I mentioned in my prepared remarks, customers are still wanting to bring innovative solutions that make their engine and transmission leaner and more efficient. So we see that pull also.

When I look at the Q3 guidance, it seems to imply a pretty good bound in margin. I mean, how should we think about margin cadence? So it just seems like Q3 looked little rough based on their earnings guide. And then it has to pick up a big step in Q4. Is that the case and why the sequential decline here?

Colin, this is Kevin. From a sequential perspective, the reason we're seeing the step down is first and foremost, revenue stepping down $50 million to $150 million in our guidance. And with the quick moves we're seeing to the downside and some of the revenue, we're decrementing it closer to 30%. So that's a big piece of the equation. In addition to that, we are seeing a sequential step up in our R&D expense as we head into the third quarter. Some of what we anticipated in the second quarter slipped into the third quarter, and so that's going to be north of $5 million, in the $5 million to $10 million range sequentially in Q3.

And so you should expect though as to jump back up in Q4 get full year to Q4. What makes Q4 so strong?

Well, Q4, our revenue takes back up you can see that in our guide. The Q3 is the low point. So we do expect to convert on the incremental revenue sequentially. When we look at the back half of the year, there are a couple of things that we normally expect. One is that we do tend to generate certain types of prototype income or government grants in a modest way that impact the quarter. We're also expecting to see some of the cost performance that we talked about last quarter starting to kick-in in our Q4 results as well. But again, a big piece of that is really coming from the conversion on incremental revenue.

And just lastly, just to clarify prior comments about pricing in turbo. When we're thinking about that impact in the market, how would hit your backlog when it comes to us, if it's not a factor in the margin performance currently?

It would most probably be passed to backlog, because this is something that we are quoting now. So, it would be impacting the backlog very marginally.

With that, I'd like to thank you all for your good questions. And if you have any follow-ups, please feel free to reach out to me. Sharon, you can go ahead and close the call.