BorgWarner Inc (BWA) — Q2 2020 Earnings Call Transcript

Thank you, Sharon. Good morning, everyone, and thank you for joining us today. We issued our earnings release earlier this morning. It's posted on our website borgwarner.com, on our homepage and on our Investor Relations homepage. With regard to our Investor Relations calendar, we will be attending multiple conferences between now and our next earnings release. Please see the events section of our 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 detailed in our 10-K. Our actual results may differ significantly from the matters discussed today. During today's presentation, we'll highlight certain non-GAAP measures in order to provide a clearer picture of how the core business performed and for comparison purposes with prior periods. When you hear us say on a comparable basis, that means excluding the impact of FX, net M&A, and other non-comparable items. When you hear us say adjusted, that means excluding non-comparable items. 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. Please note that we have posted our earnings call presentation to the IR page of our website. We encourage you to follow along with the slides during our discussion. With that, I'm happy to turn the call over to Fred.

Thank you, Pat, and good morning, everyone. We're very pleased to share our results for the second quarter today and provide an overall company update. While the industry production rates were clearly weak during the quarter, we performed strongly on a relative basis. With approximately $1.4 billion in sales, we were down about 43% organically, and these compare to a market being down about 50%. This means we drove a significant outgrowth. In fact, for the quarter, we saw growth in major regions. Our decremental margin was about 28% in the quarter as our margin performance was impacted by the COVID-19 related shutdowns and inefficiencies related to the production restarts. We delivered positive free cash flow for the quarter, despite lower production levels, which we believe is a testament to the underlying cash-generating ability of this company. I am proud of how the entire BorgWarner team has reacted to this extremely challenging environment. We met the challenges of managing costs and cash during the production shutdowns, while ensuring our ability to supply our customers as production resumed. All this was done while putting the health and safety of our employees first. Let's now turn to Slide 6, where you can see our perspectives on the global industry production. Overall, we expect the challenging environment to continue throughout the remainder of 2020. However, our industry production expectations for the full year have improved, primarily due to the second quarter production coming in at the high end of our prior expectations. It is important to note that the market environment is still volatile with the risk of future production disruptions arising from COVID-19. With the important caveats in mind, on a full year basis, we expect the market decline to be in the minus 22% to minus 25% range, compared to a prior expectation of over 25% to 31% decline. Looking at this by region, we're planning for Europe to be down in the 26% to 28% range, and in North America, we expect a 24% to 27% decline. On a relative basis, the outlook for China is stronger, but we still expect a 13% to 15% decline for the full year. As you can see from the line chart, showing all different scenarios, we expect the second-half production declines to be less significant than those we experienced during the first half. However, at the midpoint of our guidance, we still expect low double-digit market declines in the second half. As we manage through the challenging global market environment, we continue to maintain a very active dialogue with both our customers and our suppliers, while remaining focused on pursuing new business and technologies. Next, I would like to highlight the significant new business program that we announced this morning on Slide 7. I'm really excited to tell you that we've built a power-packed integrated drive module, also called IDM, for Ford's new all-electric Mustang Mach-E. The IDM comes complete with BorgWarner thermal management systems and gearbox, integrated with a motor and power electronics from other suppliers and showcases our system integration expertise. The IDM is being supplied to power the Mustang Mach-E rear-wheel and all-wheel-drive configurations. On the all-wheel-drive GT version, BorgWarner is supplying the secondary drive unit as well. We were able to capitalize on our experience with scalable and modular approaches to IDM to deliver this customized drive module that met both stringent requirements. We're excited to partner with Ford to deliver a high-quality, clean, and efficient product propulsion solution to the high-performance electrification market. This is another significant milestone for our electric business. And there is still more to come, particularly as we expand our power electronics portfolio following the close of the Delphi Technologies acquisition. Let me provide an update on that particular pending acquisition on Slide 8. We achieved several milestones toward closing during the last few months. First, we completed a $1.1 billion senior notes offering at favorable terms. Second, Delphi Technologies shareholders approved the transaction by an overwhelming majority. We believe this underscores the value inherent in bringing our companies together. Third, we've now received regulatory approval in six of the seven jurisdictions required for us to close the transaction. Importantly, there have been no conditions placed on the regulatory approvals we've received so far. We expect to receive approval in the remaining jurisdiction in the coming month. And finally, the integration teams continue to work very well together. There is a high level of commitment and excitement among the teams as we drive towards day-one readiness and capitalize on the value-creating opportunities of the combination. To sum up, I'm pleased with the overall progress as we drive towards the expected closing of the transaction in the second half of 2020. Next on Slide 9, I'd like to highlight that we published our sustainability report last month. At BorgWarner, we embrace sustainability to deliver value to all stakeholders, and there are three pillars to our sustainability strategy. First, create a cleaner, more energy-efficient world. We do this first and foremost through the products we offer. Products that drive cleaner mobility and efficiency in moving vehicles from point A to point B. We're also very focused on how we manufacture these products in a cleaner and more energy-efficient way. Our goals include reducing our energy intensity usage by 37% and our greenhouse gas emissions intensity by 50% by the year 2030. Second is to live BorgWarner beliefs. We encourage our employees to live our beliefs, which serve as a foundation for how we work together. I would like to highlight that we are focusing on developing a talented and diverse workforce. In late 2019, I signed the CEO Action for Diversity and Inclusion with BorgWarner’s pledging to take actions to cultivate a workplace where diverse perspectives and experiences are welcomed and respected. BorgWarner employees around the world are also involved and engaged in their communities and have given about 63,000 hours of service helping others last year. Finally, we partnered with and report to our stakeholders. We want to promote responsibility and sustainability within our supply base while also providing transparency in our impact and reporting accordingly. In summary, BorgWarner strives to make the vehicles we drive more efficient and the world even cleaner. We embrace diversity and inclusion, develop our employees, and give back to the communities where we live and work. Before I turn it over to Kevin, let me summarize our second quarter results and our outlook on Slide 10. We achieved a significant second quarter outgrowth in all major regions and we're excited to continue to drive that outgrowth as the market shifts toward electrification. Wins like the IDM for the Ford Mach-E continue our evolution into electrification. We delivered positive free cash flow during this exceptional quarter, and as Kevin will discuss, we expect the second half free cash flow to meet or exceed our year-to-date generation. We are on track to close the Delphi Technologies acquisition in the second half of this year. There have been tremendous challenges in 2020 with the COVID situation. As I look at what we've accomplished at BorgWarner, despite this environment and what we're positioned to accomplish over the balance of the year, I'm confident that we remain strongly positioned to execute in the near and long term from both a financial standpoint and a technology standpoint, driving our profitable growth. Now over to you, Kevin.

Thank you, Fred, and good morning everyone. Before I review the financials in detail, I'd like to highlight two important takeaways regarding our second quarter results: First, our financial results were solid in the face of a very challenging production environment. During the second quarter, we delivered strong revenue outgrowth in all regions. We were able to maintain decremental margins below 30%, and most importantly, we generated positive free cash flow. The second key message is that we continue to execute on the financing measures that position us to successfully close on the Delphi Technologies acquisition. Let's turn to Slide 11. As we look at our year-over-year revenue walk for Q2, you can see that the stronger U.S. dollar reduced revenue by about 1.4% from a year ago. Excluding this impact, our organic sales were down just under 43%, compared to the 50% decline in weighted-average market production. That means we delivered revenue outgrowth of 730 basis points in the quarter. Importantly, that outgrowth occurred in all major light vehicle markets around the globe. In Europe, our light vehicle organic revenue was down 58% compared to the market decline of approximately 63%. The outgrowth was driven by better-than-expected diesel-related revenue as well as new programs. The good news is diesel has been a trend for us the last few quarters, as we believe our mix of diesel business has held up better than the overall market, but we don't expect that tailwind to necessarily continue over the longer term. In North America, we outperformed the market decline of 69% by over 7%, driven by a strong mix in new programs. From a mix perspective, our slightly overweight position in SUVs and pickup trucks has bode well for our ability to deliver outgrowth. In China, we outperformed the market by approximately 6%, primarily due to stronger-than-expected year-over-year growth in our DCT products, as well as strengthening our China commercial vehicle business, which was about a 150 basis point positive contributor to our outgrowth. Overall, we're pleased that we continue to deliver revenue outgrowth even in this challenging end market. Now let's look at our adjusted operating income performance, which can be found on Slide 12. Our Q2 adjusted operating loss was $9 million, compared to $303 million of income in the second quarter of 2019. Our adjusted operating margin was negative 0.6%, which was down compared to the positive 11.9% we delivered in the second quarter a year ago. On a comparable basis, adjusted operating income decreased by $310 million on almost $1.1 billion of lower sales, which translates to a decremental margin of 28%. As you know, when markets move downward quickly, we tend to see decrementals that can be 30% or higher, just like we saw at times last year. So we view 28% decremental as a reasonably good level of performance given the suddenness of the dramatic decline in industry volume during the quarter and the costs and inefficiencies related to the initial production restart. Adjusted loss per share was $0.14 for the quarter. The decline in adjusted earnings per share compared to the second quarter of 2019 was driven by lower adjusted operating income and a slightly higher tax rate. Moving to cash flow, we are proud of the fact that we delivered $10 million of positive free cash flow for the second quarter. In a quarter where global production was cut in half, which is what we saw in Q2, it is critical to maintain a very clear focus on cash flow. In the second quarter, we did just that. We achieved this through disciplined management of decremental margins, focus on driving working capital performance, and effective management of capital expenditures. Now let's discuss our full year revenue outlook on Slide 13. Our guidance is based on the end-market assumptions as Fred reviewed earlier, with global production being down 22% to 25%. We expect to drive market outcomes for the year but not at the level we saw in the first half. Our guidance now incorporates full year revenue outgrowth of approximately 450 basis points to 600 basis points. This assumes our outgrowth for the remainder of 2020 is in the range of 0 basis points to 300 basis points, which at the midpoint is relatively consistent with the outgrowth guidance we provided to start the year. This wide range of outgrowth expectations is wider than typical, given the volatility in OEM weekly production schedules and launch timing of new programs. We expect this volatility will continue for much of the second half. As a result, we expect a full year 2020 organic revenue decline of 16% to 20%, which translates to an expected 2020 revenue range of $8.0 billion to $8.4 billion. Let's turn to Slide 14, where you can see an update on our cash flow guidance and other important considerations. During the first half of 2020, we generated $156 million of free cash flow, which we view as a tremendous achievement in such difficult markets. As you can see on the slide, we expect the trend of positive free cash flow generation to continue with $300 million to $400 million of free cash flow for the full year. This implies approximately $150 million to $250 million of free cash flow in the second half, despite the working capital investment needed to fund the production ramp-ups and the sequential increase in capital spending in the second half. You should note that we do expect second half free cash flow to be weighted more towards the fourth quarter, as we expect a much larger working capital investment in the third quarter with a sequential step-up in revenue. Turning to margins, we continue to expect full year decremental margins to be in the 30% range for the full year. Second half decremental margins will be impacted by expected volatility in weekly OEM production schedules and some higher costs versus the first half, namely the end of our temporary wage reductions and higher R&D related to Q2. As we mentioned last quarter, we intend to continue to sustain the pace of our R&D investment during this downturn because we view it as important to deploy our positive free cash flow to invest in our long-term growth. Also, on decremental margins, I would point out that Q4 decrementals will likely be higher than the full-year decremental margin due to the really strong 13% operating margin comparable from Q4 2019. Nonetheless, we feel confident in our ability to deliver on our free cash flow guidance for the year, and that confidence is reflected in the Board's decision to maintain our current dividend again for this quarter. As we went through the depths of this COVID-19 downturn, we continued to generate positive free cash flow, which allowed us to sustain our dividend uninterrupted and unreduced. Next on Slide 15, I'll summarize the financing actions that we've undertaken related to the upcoming closing of the Delphi Technologies acquisition. First, as many of you are aware, we successfully renewed and up-sized our revolver in March. While a revolver is $1.5 billion today, as part of our revolver renewal from a few months ago, the capacity will automatically increase by an additional $500 million upon the closing of the Delphi Technologies acquisition. Next, during the second quarter, we completed a $1.1 billion senior notes offering. The proceeds from this offering will be used to repay amounts outstanding under the Delphi Technologies senior secured credit facility, while also allowing us to repay our own $250 million in notes maturing in September. Concurrent with this transaction, we entered into cross-currency swaps that synthetically converted the notes to euro denominated debt at an effective interest rate of 1.78%, which we view as an attractive rate, particularly in this environment. Finally, over the next couple of months, we plan to initiate an obligor exchange offering on Delphi Technologies $800 million, 5% notes. We intend to exchange substantially similar BorgWarner notes for the Delphi Technology notes, with the exchange becoming effective shortly after the closing of the transaction. By executing this exchange offering, we would avoid the potentially significant cash cost of a make-whole and refinancing transaction. Importantly, this exchange represents the last major financing action that we need to complete ahead of the closing of the acquisition. So let me summarize my financial remarks. Overall, we had a solid quarter in spite of the industry pressures, delivering strong outgrowth and positive free cash flow. We expect the market to remain under pressure throughout 2020, but we've increased our revenue and cash flow guidance for the year. Finally, we were able to execute an important financing transaction that positions us to close on the Delphi Technologies acquisition in the second half of 2020. Just as I said last quarter, we are proactively navigating through the current environment while ensuring the company is very well positioned for the eventual industry recovery and our future profitable growth. With that, I'd like to turn the call back over to Pat.

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

Good morning, guys. This is Aileen Smith on for John. First question, I appreciate that your outlook doesn't incorporate the impact of additional production downtime from COVID. However, for internal planning purposes, how closely are you monitoring your supply base and your production footprint? And are there any proactive measures you're taking to mitigate potential hiccups to production that may pop up in the back half of the year? And specifically, how are you planning for launches in this environment?

So the answer is absolutely yes. We are running the company all times ready for downturn. And we've shown in Q2 that we can manage that. So plants have downturn plans ready to be implemented. The good thing is that we've just done it. So it will be a repeat and like most of the repeats, it's easier than the first time you do it. We are also, as I mentioned in my prepared remarks, staying very close to our customers and suppliers to figure out in detail the schedules and expectations and potential issues. As far as launch is concerned, we see a little bit of program delays. But so far, we're pretty confident that we're going to be able to honor all the launches that we have up and running and ready to launch in the second half.

Great. That's very helpful. And second, a more strategic question. On the announcement of the IDM win on the Ford Mach-E, as you think about further quoting for integrated drive modules, should we expect a similar level of content coming through other suppliers that you're then integrating with your own components? Or is there a substantial opportunity to get some of the electric motor and power electronics content over time, particularly considering what you acquired with Remy? And what you will be acquiring with Delphi?

Yes, I would say first that we are super excited to partner with Ford on these great products. As I mentioned in the past, we don't have to sell the system. We are flexible. We have modular design. You may be right; we've extended our product portfolio in the past two years to be ready for more internal contents, but are very flexible around adapting our content intensity with what the customer wants.

Okay. And one last question if I may, more housekeeping on outlook for free cash flow, that's improved to $300 million to $400 million. Is that just consistent with the higher revenue outlook? Or does it also reflect more progress than expected on some of your cost-saving or cash conservation initiatives?

It's really in line with our revenue outlook. I think you can see that with the low end of our revenue outlook now matching the high end of what we had before, and that cash flow not coincidentally is $300 million at that revenue range. So as we look at the $400 million upside at the top end of our range right now, that coincides with the $8.4 billion of revenue.

I have a couple of questions. First, it's great to see the backlog this quarter. Could you clarify whether the backlog line includes the production mix? It seems like your production mix had a positive impact this quarter, but I want to know if this backlog really represents actual backlog. You mentioned that the backlog is entirely hybrid and electric vehicles, and we're observing strong demand in these categories worldwide. Can we use this information to gauge the reliability of the backlog you previously reported?

Yes, I mean backlog includes anything that's not market or FX effectively. So, it can pick up mix impacts and absolutely we're seeing some positive mix impacts in the quarter. That is a piece of the equation, basically anything that's driving us to outgrowth the market.

So, any color on what's happening with regards to the hybrid and EV, and is that a significant contributor already now or not yet?

I mean, I think from a mix perspective, a lot of the mix benefits that we were seeing in the second quarter in particular have to do with our exposure to pick up and SUVs in North America, as well as our diesel-related content in Europe seems to be holding up better than the overall diesel market, as we've seen for the last few quarters now. We have seen some DCT growth over in China as well, which is supporting that backlog. But as we think about the H&E content in our backlog, most of that's coming in the years to come in terms of where we expect to really see that driving our outgrowth and becoming more than 100% of the net backlog. That's really a comment on the '21 to '23 timeframe.

Okay. Got it. And then secondly, could you just update us on the status of the $110 million cost reduction plan that you've talked about? This is specific to the BorgWarner business, not the synergies or the Delphi side. And is that 30% decremental that we're seeing now, is that including some benefit there? How should we be thinking about incrementals into next year with the savings and non-recurrence of temporary actions you've taken so far this year and any color on that?

Yes, I mean the decremental is absolutely including the benefits associated with the restructuring actions, and we've started to see the benefits of both last year's restructuring actions that are taking hold and helping on a year-over-year basis, as well as we're starting to get some benefit associated with the restructuring that we announced back in early February timeframe. So that is mitigating the decremental and should continue to be a tailwind as we look out to the next few years to help offset any other bad news that could come into the equation like COVID-19 did this year. Overall though, I would say to the question that is on track. We're continuing to execute according to the plan that we laid out several months back. And we're on track for that.

So just to help us out if we wanted to sort of disaggregate that 30% decremental. What is the incremental savings that you're seeing this year? And what is the incremental number that you were targeting for next year?

Yes, I think we disclosed back in February that we expect the 2020 numbers to benefit by about $50 million of incremental savings. I would say we're on track to deliver that in our decremental number. That is a tailwind in the decrementals. In addition to any temporary types of cost actions that we executed in the second quarter like temporary layoffs and wage reductions helped us in the second quarter as well.

And the next, you've got another 50. Was it or do I remember that well?

I think it was in the 35-ish zip code as I recall, but we'll give more specific guidance on that when we get to the beginning of next year. Overall, I think you should think that plan directionally remains intact and on track.

Maybe this is definitional, but in your backlog today it has been very strong. But the midpoint of the range for the year is basically equal to what you did in the backlog for the first half. So, can you just explain the bridge between the two metrics? Are you saying there's no backlog in the back half?

Yes, I think backlog and outgrowth are two slightly different things. Backlog is basically outgrowth before you consider pricing. Outgrowth actually is backlog net of pricing. If you look at what our backlog, actually is to date through the first six months, I think it's around $525 million. Our backlog for the full year effectively if you take the outgrowth and you add pricing back to it, we’re somewhere in the $580 million to $730 million range. So that's kind of how we get to the walkout towards the backlog.

Okay, thank you. And then just on the Mach-E and the IDM. One, maybe you could let us know when Ford sort of brought you into the process? And, I know you mentioned some other suppliers. Are you at liberty to mention if one of those other suppliers on like the power electronics is Delphi? And then finally on that you talked about how your integration expertise really helps with this business. But if you have all the elements ready?

Joe, we lost a little bit there towards the end. So, yes. So Joe, we don't have all the details. But Ford and BorgWarner have been working together for a few years on this; it was a few years back. And two, it's not the power electric supplier. Three, yes, with the portfolio that we have added over the past years, we sit in a position to do the whole thing. But again, as I mentioned before, we don’t ask too, and we are very, very constructive with BOEs and depending on what they want to do and what they want to work with, and we’re flexible.

Hi, team. This is Jason on for Brian. Kevin, you've already given some good color around 2021. I was just going to try to ask again, because I think 2020 is fairly straightforward, but as we think after 2021, I was wondering if you could maybe just comment on how the cost base in 2021, the fixed cost base compared to that of 2020? And I guess the moving pieces I would wonder about are the incremental restructuring savings that we're supposed to get in 2021, have any of those been brought forward into 2020? Any step up in engineering that we need to think about? And then any COVID-related inefficiencies in 2020 that may bleed into 2021? Sort of all of those things wrapped together, should we still see the fixed cost base lower next year versus this year?

Yes. I think it's premature for us to start talking about 2021. But I can comment on a few of those elements. From a restructuring perspective, as I mentioned in response to Rod's question earlier, we are on track for executing against the plan we laid out a few months ago, and I wouldn't say there's any accelerations or delays in that plan. I think it's right on track. So, I think it's fair to think about the incremental that we were showing back in February going from 2020 to 2021 to remain intact. From an engineering and R&D perspective, I think you should continue to expect us to invest in that low 4% to 4.5% range as a percent of revenue. Now this year it'll be elevated because we're sustaining our dollar investment in R&D around that $400 million level, and that's a conscious decision we made as a leadership team in this environment to sustain our investment, supporting long-term growth prospects for the company, because we have strong liquidity and strong cash flow generation. In terms of the inefficiencies arising from COVID-19, I think we're going through that process right now, as we're building our long-range plans to understand what if any types of efficiencies do we expect to carry into next year? The last thing obviously, and we're not prepared to comment on it further as we start to think about 2021, obviously, we expect to close on the Delphi transaction in the second half of this year, and that's going to have some meaningful implications on what 2021 looks like as a consolidated company. So those are some of the things to consider.

Understood. Okay. Very helpful. And maybe just on your last point. Just a quick clarification on the Delphi deal. Can you remind us of what the last jurisdiction requiring approval is? And I think you mentioned what happened in the next month, is the approval of that jurisdiction really the last bottleneck in this deal? I know there's a exchange need to do with the Delphi bonds. But if you could just maybe remind us of what the bottlenecks are between now and when the deal closes?

Yes. The last jurisdiction that we have at this point is the European Union, and we've been going through interacting with the regulators and going through that administrative process. We think where we are in that process keeps us on track for closing in the second half of the year consistent with what we've been saying for the last number of months. So that is really the last major administrative hurdle between now and closing. The other big one that we had, obviously, were the other jurisdictions that are now behind us, as well as the Delphi shareholder vote, which took place back in late June and received overwhelming support from the shareholders. I'd say that is really the last major step. As we get to closing, Delphi will have to meet the conditions to close to ensure that they meet those. We fully expect they'll be on track to do that.

Yes, thanks so much for taking my question. And I think you’ve covered the margin. Maybe two questions on a little bit of the cadence of outgrowth. And this is more qualitative. And I know we're not committing on '21 or '22. But I think as we see these EV wins announcements and as a lot of people are seeing the amount of new EV introductions is only going to accelerate as we get into sort of the 2022 timeframe. I know you've talked about this sort of balanced approach where you have a rough 5% outgrowth. But maybe you can just add a little qualitative commentary to can we see that outgrowth gets better '21 into 2022. Because we have just opposing forces '21 is going to be the height of all things, legacy power training to be a great outgrowth to you. But then, if you make any new announcements on products that are coming in 2022 that leads us to think that there's also growth. So maybe just a little bit qualitative, but how we think about when these EV products could start to really be accretive to the overall outgrowth number.

Yes, Chris. So electrification accelerates our growth. Being E or H, what you see is that everything that is being booked at this point in time is going to see daylight past 2022. This is in our goal of outgrowing the market year by year by 500 basis points, and we are on track to do that. The current guide for the year for 2020 is 450 basis points to 600 basis points. I would also tell you that we see, we don’t see a slowdown of requests for quote or systems support and discussions at a very high level between OEMs and BorgWarner to discuss the next generation IDMs but also the next generation, most advanced hybrid architectures.

That's great. And then maybe a question around the more near-term scale. This idea of diesel within the net. I think a year or two ago, we thought sort of the "diesel drag" would be sort of done late '19 into 2020. The diesel numbers are less bad than we feared. At what point do we sort of stop talking about diesel where it probably doesn't have a mix and sort of Europe is balanced from gasoline versus diesel turbo? When are we essentially fully unbalanced on the European diesel front?

So, I think you're right. I think you see the quarter-over-quarter reduction reducing. So it's flattening around a 29%, 30% take rate. We've outgrown that diesel market for a few quarters. I think we're going to stop lapping the European diesel benefits that started in the second half of '19. I would say in 2021, the diesel headwinds will start fading away, and you won't see any impacts soon.

That's great. So, if we see a reduction from 30% to 20% from 2020 to 2025, you think that by that point you'll be balanced, so you won't be really talking about a drag, even though the number of diesel will be going down.

I would say so.

I guess first on the subject of the vertical integration of some of these electric solutions. Just given that there's been some focus on that with the Ford announcement this morning. Maybe a couple of weeks ago, you announced the three awards in China, just apply the IDM to three new electric models. I presume those – well with the exception of power electronics those are vertically integrated for you. You're supplying a complete solution there.

Yes.

Okay. Is it generally the trend? Or do you see a regional variation in trends where you are tending to have more vertical integration in one geography versus another? So, can you provide color on that?

There is no geographic trend. It's certainly not a one size fits all. You see customers that want us to integrate the full system, and we do that and we capitalize on our integration and system knowledge and experience. Some customers want us to supply transmission and motor, so we're flexible. It is true that more will come as we are adding more products in our portfolio and be able to deliver all and by doing that drive the maximum efficiency out of that device. But again, there is not one size fits all as far as we're concerned.

Okay. And last question, I think we've seen an uptake in interest and frankly in public capital market access for alternative powertrains on the commercial vehicle side in the last quarter both EV and fuel cell. Can you talk a little bit about the positioning and the interest level you're seeing from customers on the commercial vehicle side? And where that interest might be coming from, medium-duty electric bus, regional delivery. Just how are you positioned and how is the interest?

All of the above. We see a decent acceleration in electrifying different vehicles, including long-haul trucks, with different types of technologies. Obviously, that vehicle will be the biggest volume for us. But we're very committed to supporting commercial vehicle electrification too. With all the products portfolio that we have, there is no variable product in the propulsion area from an electrification standpoint that we can supply. So we're supporting all our customers, and commercial vehicles included. Yes, we see an acceleration in this field.

Hi, thanks for taking my question. Firstly, are you able to quantify the non-repeat in the back half or I don't know maybe even the catch up from any austerity measures taken in 2Q. I'm trying to gauge the degree to which the implied back half decremental guide may be driven in part by conservatism versus something maybe more specific you're seeing from a cost perspective such as you mentioned R&D. Just given the outlook for 30% decremental for the full year versus 26% in 1Q and 28% in 2Q, as hopefully the industry backdrop in the back half should be improved quite a bit from the first.

Yes. I mean, I'm not going to dimension the specifics of each component of how we mitigated the decremental margin. We're able to manage it down to 28%. But obviously, you can imagine our contribution margin as well north of 28%. And so the types of things that we had to execute to manage to that level include the restructuring actions, which are providing a tailwind and are more sustainable and permanent from a cost reduction perspective. But then, we do have benefits coming from some of those temporary actions like the temporary layoffs in the wage reduction. So those will creep into the second half. We'll also see some level of higher R&D spend in the second half of the year. As I look sequentially from Q2, we were a little bit lighter in the second quarter than where our full year run rate average is expected to be. The other thing just to keep in mind, Q4 decrementals are going to be impacted mathematically by the fact that we're jumping off a 13% plus operating margin from a year ago. And so that just makes the comp pretty challenging as you look at Q4.

That's helpful, thank you. Lastly, I have a question about the integrated drive module success. Ford has many electric vehicles on the way with their Team Edison initiative. I'm interested to know if your work on the Mach-E positions you well to secure more contracts with them. If you can't provide specifics, could you share an update on your interactions with automakers regarding IDMs? I'm wondering how those discussions have evolved since the pandemic. It seems like announcements across the sector have slowed down as automakers have concentrated on the crisis, but do you see any signs of increased discussions about electric vehicles behind the scenes?

The development and design work for propulsion architectures in electric vehicles and hybrids are being done and on time is pursuing a sense with confidence that our wells are going to carry on. More to come on this field; we are very uniquely positioned, especially with the Delphi Technologies acquisition to add again, both mechanical motor and power electronics under one roof and being able to work on all the types of efficiencies that those subsystems interact with. We think we are well positioned to supply whatever customers ask us to work on either system or subsystems. So it's moving at the right pace, and I'm happy with what I’m seeing.

With regards to the Delphi integration, I'm curious what you've seen since you announced the transaction that may be progressing better or worse than you expected? I think the first quarter results were quite strong for Delphi and they had similar benefits from diesel with regards to their growth over market. The decrementals were a bit better. So maybe, then things like there’s some momentum there around GDI power electronics that wasn't really the case in the last couple of years. Can you comment on where your integration teams are working on it? And what you’ve learned from the company over the last few months?

What I would say is that we're very pleased with how the integration teams and the match-payers on both sides are working and collaborating in a virtual environment. We have not missed a beat, and I'm very happy with the way those teams interact and create value. We're not in a position to update the financials. We do that closer to the closing date, but it's moving at the right pace, and I really like the engagement and the results that I'm seeing.

Okay. And then maybe on the cost side, your restructuring actions are helping you get to those 30% decremental margins for the back half of the year. I think their cost actions are also necessary to drive their incremental decremental margins at the rate that you'd be comfortable with in order to get to those 11% margins. Maybe you could talk to where there be opportunities for upside from the restructuring program, outside of the normal course of incremental decremental margins for either company?

With respect to the restructuring, we're pleased with the fact that our program remains on track. I mean, both the program we announced a year ago, about 15 to 16 months ago, as well as the program we announced earlier this year, which was a pretty aggressive program to manage and sustain our margin profile to offset headwinds, including things like COVID-19 which we didn't know about at the time. It was a proactive measure to sustain our margin profile, and we're going to execute against that plan to help mitigate the impact of things like COVID or whatever else might get thrown at us. From a Delphi perspective, I'm not going to comment in detail on their business, other than overall, we're pleased with the progress they've made on their restructuring programs and feel like they're on track delivering what they've committed directionally. I think you'll see, they’ll file their financials today or tomorrow, and so you'll get to see what their results are looking like here for the second quarter, but directionally we're pleased with what we see and we'll give a more fulsome update as a financial outlook of the combined companies when we get to closing.

So two questions on backlog. First, when I look at the $2.1 billion through your backlog back in February, obviously there is a production assumption underlying that. So we do have a lower environment. Could you give us a sense of how you might be thinking about how much you need to haircut that backlog? Or is it potentially in fact, given that you have a more favorable environment on hybrids or how do think the haircut on backlog?

Yes, I'm not sure the haircut you'd be referring to. But I mean directionally we're pleased with our backlog shaping up this year. As we entered 2020, we actually expected that we were going to have lower revenue outgrowth than what we're actually seeing. And that's really across the globe. So our backlog in total, if you look at it, we're guiding for $580 million to $730 million of backlog coming through our P&L in 2020. In terms of what our 2021 through 2023 and beyond horizon looks like, we’re not prepared to provide any updates to that other than directionally. I think we still feel very confident about the fact that we're going to deliver 500 basis points of outgrowth from a BorgWarner standalone perspective in terms of what our overall outgrowth is expected to be over those years. Some years might be higher or lower than others. But on average, we should be in that 500 basis point zip code. The good news is that's actually playing out this year in 2020, as well which we didn't anticipate as we started the year.

That's helpful. And then just a follow-up also on backlog. So we notice the majority does fine. We heard some good news in the quarter. I think hybrids getting better credit in the NAV system in China. So what can you tell us about hybrid demand in China? Is this potentially upside to your backlog? And to the extent we do have an uptick in hybrids in China, what would be the timing of this incremental demand? Do you think this is over the next year or two, or is this really outside of your three-year planning period, more so beyond 2022?

So, no, you're absolutely right. I think we've always been talking about the fact that electrification in China is not only battery electric vehicles but also including the most advanced hybrid propulsion architectures. We see launches; we see our request for quotation; we see partnerships with Chinese OEMs on hybrids. We’re part of that. Will it have an impact before the end of the current backlog season? Probably not because this will be launched past the backlog season for the majority of the businesses. But when you see more hybrid powertrains in China, especially the most advanced hybrid absolutely, yes.

I wanted to ask about the situation and overall business in China. In the first half, sales of EVs declined much more rapidly than the overall market. Are you experiencing any cancellations of EV programs? How is the business developing? Do you anticipate an improvement in the latter half, or is this trend likely to continue?

The trend of electrification, we think is profound. It's not going to be a quarter-over-quarter steady increase. You'll just see some ups and downs. So we see some downs in the first half in China, but the long-term trends as far as we're concerned, we think are unchanged. It's just timing related. We see some programs related, but we see a lot of focus in getting this done and bringing those hybrid and electric powertrains into the marketplace. It’s really in other parts of the world too. It is essential when you look at the newly published regulations. It is essential for all of us to move into cleaner and more energy-efficient powertrains, being electrical or hybrid or also efficient combustion powertrains that I meant. So, it's accelerating, and we're not missing a beat.

With that, I'd like to thank you all for the good questions today. Sharon, you can go ahead and close out the call.