BorgWarner Inc (BWA) — Q2 2022 Earnings Call Transcript

Thank you, Chelsea. Good morning, everyone. 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 IR 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 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 foreign exchange, net M&A, and other noncomparable items. When you hear us say adjusted, that means excluding noncomparable items. When you hear us say organic, that means excluding the impact of foreign exchange and net M&A. We will also refer to our growth compared to our markets. When you hear us say market, that means the change in light vehicle and commercial vehicle production weighted for our geographic exposure. 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'm happy to turn the call over to Fred.

Thank you, Pat, and good day, everyone. We're pleased to share our results for the second quarter 2022 and provide an overall company update, starting on Slide 5. I continue to be impressed with the strength of our revenue relative to the overall industry. With approximately $3.8 billion in sales, we were up about 7% organically despite global production being down slightly, and we outperformed in North America and Europe. From a margin perspective, our performance was negatively impacted by a planned increase in eProducts R&D investment, net material headwinds, and sudden production shutdowns in China during this quarter. That said, we were able to partially mitigate these impacts through overall cost performance and progress on executing customer pricing actions with several key customers. You will see that our guidance implies a sequential improvement in margin into the second half of 2022, which is driven by volume improvements and our expectation of continued success in executing our customer pricing actions. We are pleased with the progress we made in Q2 on this front. However, there are still some ongoing customer discussions that we expect to resolve in the back half of the year. We expect that the successful execution of these actions will position our financials more strongly heading into 2023. While navigating the near-term industry environment, we also took steps to drive our long-term positioning during the quarter. First, we completed the acquisition of Rhombus Energy Solutions. In addition to deploying capital to fund our M&A investment, we opportunistically repurchased $100 million of stock. And lastly, we secured multiple new electrification program awards. Next, I would like to highlight our recent ESG report on Slide 6. In June, we released our 2022 Sustainability Report called Charging Forward Together. I am proud of the work of BorgWarner employees around the globe, delivering on our vision of a clean, energy-efficient world and embodying our beliefs of inclusion, integrity, excellence, responsibility, and collaboration. This comes across in the report. Together, we are accelerating the world's transition to eMobility by empowering everyone to drive sustainably while leaving cleaner, healthier, and safer lives. Our Charging Forward target to generate 45% of our revenue from electric vehicles by 2030 is consistent with our environmental goals. We remain committed to carbon neutrality in Scopes 1 and 2 by 2035. In addition, we have now introduced a target to reduce our greenhouse gas emissions by 85% by 2030. We have formalized our commitment to diversity, equity, and inclusion with measurable targets. We continue to advance towards our vision and build our future each day with the industry's top talent. Our employees are changing the world's mobility. I invite you to read more in our 2022 Sustainability Report on our website and join us on this journey. Next, I would like to highlight our eProducts portfolio for hybrids on Slide 7. Over the last quarter, we've been asked about the amount of revenue we were generating from these products on advanced hybrids. As you can see on this slide, it's actually quite sizable. We have a wide range of eHybrid products that are helping our customers bridge to EVs. To name a few, these include inductors, motors, advanced and efficient drive modules, and high-voltage cooling heaters. The hybrid products help provide the bridge to EVs for many OEMs by pairing efficient gasoline engines with electric drivetrains. In many instances, as I have mentioned before, the technical profiles of these products are very similar to the same eProducts used in a fully electric vehicle. This allows us to drive additional scale and product capabilities that help improve our overall competitiveness in the world of battery electric vehicles. As you can see from the chart, we expect our eHybrid sales to be close to $1.1 billion by 2025. This does not include our highly efficient combustion product that will also be used on many of these same hybrid vehicles. So this is a substantial revenue opportunity for BorgWarner that really reinforces our product leadership in electrification, which goes beyond pure battery electric vehicles. Now let's look at some pure BEV awards on Slide 8. I'm happy to announce that we have secured two additional high-voltage coolant heater programs. One is for a global OEM and the other is for emerging electric vehicle brands in China. By offering consistent temperature distribution inside the battery pack itself, BorgWarner's high-voltage coolant heaters can be used to improve battery energy performance. They also allow comfortable cabin temperatures to be generated in a short time, improving passenger experience. This is a great internally developed product success story at BorgWarner and one where we've quickly established product leadership. Second, BorgWarner has been selected to deliver battery systems for a European commercial vehicle OEM. This battery system will be utilized in the company's first range of heavy-duty electric trucks expected to be announced in 2024. For this exciting new project, our customer will benefit from the latest generation of our ultra-high energy battery system, which provides a 50% increase in energy density over its predecessor. This upgrade significantly increases vehicle range, making it a great solution for long-distance electrified commercial transportation. Lastly, I'm excited to share that the first units of the new BorgWarner fast-charging station, Iperion-120, have been installed in Italy. We've been working on the organic development of charging capabilities at BorgWarner since 2017, and I'm really pleased to see our investments in this space starting to bear fruit. We will look to accelerate our success in stationary charging with some inorganic investments as well, which I will discuss on the next slide. This quarter's award activity once again highlighted a wide range of products and our grid capabilities. Next, on Slide 9, I would like to discuss the acquisition of Rhombus Energy Solutions, which we announced this morning. We plan to accelerate our charging business, focusing on high-value DC fast charging hardware and enabling software. We believe that we can leverage the local knowledge and footprint of Rhombus to complement our existing BorgWarner charging capability to accelerate organic growth. Specifically, Rhombus will add North American expertise. We plan to leverage BorgWarner synergies across product quality, engineering, supply chain, manufacturing, and global sales. We also see potential synergies with battery system customers. In terms of revenue, we expect Rhombus to add approximately $10 million to our 2022 revenue over the next two quarters. We expect our combined DC fast-charging business to approach $175 million to $200 million in revenue by 2025. As a supplier to the auto and commercial vehicle market, we are not only delivering innovative products for electric drivetrains but also care about supporting certain key elements of the infrastructure for electric mobility, especially charging. As we look ahead, we believe you will see further success as we continue to strengthen our capabilities in this area. As you can see, we've made progress on key aspects of our Charging Forward strategy. So let's look at what this means in progress on Slide 10. Starting first with organic electric vehicle revenue growth. With the awards secured as of this call, we now have electric vehicle programs that we believe account for about $2.9 billion of booked revenue in 2025. This is a great achievement by the BorgWarner teams. Turning to M&A, we have now completed three acquisitions since the start of Charging Forward: AKASOL, Central's late vehicle e-motor business, and Rhombus Energy Solutions. Based on our due diligence, we believe those businesses will generate $800 million of additional EV-related revenue in 2025. We're not done either. We expect to take additional M&A steps, and we are actively engaged with a number of potential targets that could enhance various parts of our EV portfolio. Less than 18 months since the announcement of Charging Forward, we're on track to achieve approximately $3.7 billion of electric vehicle revenue by 2025 based on new business awards and actions announced to date. So let me summarize our second quarter results and our outlook. Overall, our second quarter performance was solid. Our revenue once again outperformed the industry volume as we delivered strong organic growth. We also made key progress in the quarter on the pricing actions necessary to deliver our full-year commitments. As Kevin will detail shortly, our full-year 2022 outlook is unchanged from a top line and margin perspective despite industry volume pressure in our largest market in Europe. Our relative revenue performance outlook has improved, and we believe we are on track to deliver double-digit organic growth this year. As I look beyond 2022, I'm very proud of the continuing progress on Charging Forward. We're booking electric vehicle revenue across our portfolio, and we are successfully executing our disciplined M&A process. Our booked organic BEV business and M&A completed to date puts us on track to achieve $3.7 billion in electric vehicle revenue by 2025. Combined with our hybrid business, our total eProducts portfolio is now expected to reach approximately $4.8 billion in 2025 with what we've already achieved. To put that into context, this is nearly half the size of the company when I became CEO in 2018, but we're not done. We intend to carry on booking more new business and acquiring great assets to become even stronger as the world continues to accelerate towards electrification. I look forward to sharing additional progress with you in the future. With that, I will turn the call over to Kevin.

Thank you, Fred, and good morning, everyone. Before I dive into the financial details, I'm going to provide you with the key takeaways coming out of our second quarter. First, our revenue came in at the high end of our expectations, driven by strong relative revenue performance in North America and Europe. Second, our year-over-year margin performance was impacted by our planned increase in eProducts R&D investment, material cost inflation, and the sudden production shutdowns in China. And finally, our guidance reflects more normal underlying incremental margin performance in the second half of the year. Let's turn to Slide 11 for a look at our year-over-year revenue walk for Q2. After adjusting for the disposition of our Water Valley facility, last year's revenue was just over $3.7 billion. You can see that the strengthening U.S. dollar drove a year-over-year decrease in revenue of about 6% or more than $220 million. Then you can see the increase in our organic revenue about 7% year-over-year. That compares to a 1% decrease in weighted average market production, which means we delivered another quarter of strong outperformance. The sum of all this was just under $3.8 billion of revenue in Q2. Turning to Slide 12. You can see our earnings and cash flow performance for the quarter. Our second quarter adjusted operating income was $348 million or 9.3%, which compares to adjusted operating income of $421 million or 11.2% from a year ago. On a comparable basis, excluding the impact of foreign exchange and the impact of the Water Valley disposition, adjusted operating income decreased $51 million on $268 million of higher sales. There were three primary drivers of this margin performance. The biggest driver was the planned step-up in eProducts R&D, where we increased our investments by $56 million. Second, net material cost inflation was a $25 million year-over-year headwind in the quarter. Finally, COVID-19 drove disruptions and lower overall production in China. All of these items were expected when we provided our guidance in early May, which is why we anticipated second-quarter margins as the most challenged for the year. Importantly, excluding these items, our incremental margin would have looked more normal for our business. Although our adjusted operating income saw a sizable decline from last year, our adjusted EPS was down only $0.03 in the second quarter. That's because our effective tax rate came in below 20% due to the favorable geographic mix of earnings and the benefits of previous tax planning initiatives beginning to materialize. While the Q2 rate isn't sustainable at that sub-20% level, we expect to see some improvement in our full-year tax rate for 2022 and beyond, which I'll speak about more when I talk about our full-year guidance. Finally, free cash flow. We generated $62 million of positive free cash flow during the second quarter. Our cash flow continues to be impacted by elevated levels of inventory driven by supply chain challenges and the overall choppiness of global production. Let's now turn to Slide 13, where you can see our perspective on global light vehicle industry production for 2022. When you look at this slide, you can see that our market assumptions incorporate a range of potential outcomes. This is primarily a result of the ongoing semiconductor supply challenges, European production and demand challenges stemming from the conflict in Ukraine, and the trajectory of the recovery in Chinese vehicle production. With that background in mind, we expect our global weighted light and commercial vehicle end markets to increase in the range of 2.5% to 5% this year, which is flat relative to the assumptions underlying our prior guidance. Now let's take a look at our full-year outlook on Slide 14. First, it's important to note that our guidance assumes an expected $820 million headwind from weaker foreign currencies. While the appreciation of the U.S. dollar is having a significant top-line impact, remember that our strategy is generally to purchase and produce components in the same region as our customers. As a result, the impact of currencies on our guidance is predominantly translational in nature. Next, as I previously mentioned, we expect our end markets to be up 2.5% to 5% for the year, which will contribute to the organic net sales change you see on the slide. But the much bigger impact on that line item is the continued revenue growth we expect to generate above growth in end market production. That's about $1.3 billion of our organic revenue growth, or about 9% growth above market. That current outlook for outperformance is stronger than our prior outlook, primarily due to the impact of estimated pricing recoveries from material inflation and other costs. Finally, the Santroll and Rhombus acquisitions are expected to cumulatively add $45 million to $55 million to 2022 revenue. The result of all this is that even though FX rates have deteriorated our current outlook by $170 million from our prior guidance, our overall revenue outlook is unchanged at $15.5 billion to $16.0 billion. Switching to margin. We continue to expect our full-year adjusted operating margin to be in the range of 9.8% to 10.2%, which is also unchanged from our prior outlook. While higher material cost inflation continues to negatively impact our financials, we're pleased with the progress we've made in negotiating recoveries of a portion of these costs from our customers, and that's already started to help mitigate the impact on our P&L. We expect that the customer recoveries we're continuing to negotiate and put in place will continue to partially mitigate the impact of the inflationary headwinds that we're facing. For the full year, we now expect net material cost inflation to negatively impact our results by $145 million to $155 million. As it relates to R&D investment, our guidance anticipates a $145 million to $160 million increase in eProducts-related R&D investment in 2022. This is at the higher end of our prior guidance, driven by continued new business wins. Excluding the impact of material cost inflation in this eProducts R&D investment, our 2022 margin outlook contemplates the business delivering full-year incrementals in the high teens. This effectively implies that as volumes recover in the second half of the year, we expect them to flow through at normalized conversion, which supports the sequential step-up in operating margin implied by our guidance. Even though our revenue and margin outlooks are unchanged, we're now expecting full-year adjusted EPS of $4 to $4.40 per diluted share. This is an increase versus our prior guidance, reflecting two things. First, we're expecting a lower full-year tax rate of 27%, down from our prior guidance of 28%, driven by our mix of earnings and the benefits of previous year's tax planning initiatives. Second, we are benefiting a bit from the lower average share count as a result of the stock buybacks we executed during the second quarter. Finally, we continue to expect that we'll deliver free cash flow in the range of $650 million to $750 million for the full year. That's our 2022 outlook. So let me summarize. Overall, we had a solid quarter. We delivered positive organic growth despite industry volume declines. Our team successfully negotiated pricing recoveries with several key customers, and we're making progress on other key customers, which we believe helps to position us for a sequential margin improvement in the second half. We believe we're positioned to deliver our full-year guidance, including a step-up in adjusted EPS despite additional external headwinds. As we stated in prior quarters, while we focus on managing the present, we're also working to drive profitable growth and invest in our future. To that end, we had another quarter in which we secured meaningful new business awards for electric vehicles across multiple parts of our portfolio, and we deployed cash to create value for shareholders through the acquisition of Rhombus and the repurchase of $100 million of stock during the quarter. Our ability to balance these near-term commitments with our long-term objectives is the key to our ongoing success. With that, I'd like to turn the call back over to Pat.

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

Just wanted to ask a first question on Slide 10. Fred, as you look at this, you're outperforming on organic EV sales and not yet underperforming on the M&A. But as you look at these two bars together, could you consider, if you keep outperforming on organic, that you might not need to do the M&A that you have targeted here, and you look at this as sort of a total target as opposed to one that's specifically split between organic and M&A?

So I think the way we look at M&A is very strategic. We look at technology and product leadership and scale. I would say those are independent kind of work streams. We're not looking at revenue for revenue's sake. And even if at one point, maybe we collapse those two bars because we're not going to keep the March 2021 as a jump-off, which is the Capital Markets Day where we announced Charging Forward, I think those two things are somewhat different.

Okay. If I could ask a follow-up just on the pricing and commercial settlements that you're getting from your customers to help out with cost inflation. I'm just curious how those are being structured because we're looking at what might be peak cost inflation on raw and other input costs, and the automakers are playing ball right now. But if we saw some easing in this inflation or, God forbid, an actual reversal, would that benefit go to them based on how things are structured right now, or would you be able to capture some of that benefit as spreads would open up again?

Yes. As we look at the material cost recoveries that we're negotiating with our customers, we're generally trying to drive a meaningful portion of those through price adjustments in the portfolio. But undoubtedly, there is a linkage between those price adjustments that we're making and the material cost inflation that we're experiencing such that if there's continued movement of inflation higher, then we would expect to have further discussions with our customers. Just like if we thought or if we experience inflation starting to unwind, I think it's fair to think that we would expect to have to unwind some of those price increases. So I think that's the right way to think about it.

So it does sound like there could be a period where if raw material costs actually reversed as volumes are going up, you may be able to capture it for some period of time, and there could be a real upward pressure on margins for a period of time. Is that a fair statement that there is some lag that would go on there?

I'm not sure; I guess we'll have to see when we get to that point. I mean, I think it's a discussion that we'll ultimately have with the customers. It's not necessarily an automatic mechanism that's in place in terms of how those things are just additional upward or downward; it'll lead to further discussion. So we'll have to see if and when we get to that point.

Can you discuss how you see the transition from the first half to the second half of the year based on your outlook? What are the key factors to consider? I assume that volume is increasing, and its growth outpaces the market. How do you expect materials to factor in? Additionally, do you anticipate more recoveries in the second half compared to the first?

Yes. I think the right way to think about it, big picture, at a 50,000-foot level, is as you look at the first half versus the second half, the material cost headwinds that we're expecting kind of on a year-over-year basis when you look at both the commodity side of the equation and the other inflationary costs coming through from our suppliers and the recoveries we're getting, it's somewhat of a push first half to second half in terms of the total magnitude on a year-over-year basis. And same with eR&D. As you think about going from the first half to the second half, I would put it in a bit similar ZIP code. It's not a substantial headwind going from one half of the year to the next. Which means what's happening is as we continue to drive those pricing recoveries with our customers to mitigate the impact of what we're seeing coming through inflation, it supports our ability to allow the incremental volume to drive conversion. And that's effectively what's happening. Volume is stepping up in the back half of the year. We're getting the incremental conversion on that, that we would ordinarily expect, and we're managing the rest of the cost structure similar to how we're managing the first half of the year.

And then in terms of growth, second half versus first half, I think you mentioned 9% growth over market for the year. Does that mean sort of like double-digit growth in the back half?

Yes. I think it suggests that for the second half of the year, the growth rate will be in the range of high single digits to possibly low double digits, depending on whether we hit the lower or upper end of our guidance. Overall, we anticipate about 9% growth for the full year.

Okay. And now when I look sort of at your implied second half outlook, to what extent is it a good base to try to forecast your 2023 outlook? Like is the second half in the margin run rate sort of like a clean way to look at it as an exit rate?

Yes. I think what we're trying to do is we negotiate the price recoveries with our customers along with the inflationary impacts we're seeing from the supply base; is get to the point where we have a stable jump-off point using the second half margin profile as we head into 2023. That's really our objective. And so we go into 2023, and we can have hopefully a more normalized year from a conversion standpoint. But obviously, we're going to need inflationary pressures to cooperate with us and not create more noise as we head into next year.

Maybe starting with the Rhombus acquisition, meaningful revenue step-up to 2025, obviously, a lot of charging infrastructure to build out here in North America. So can you talk about the visibility to their build pipeline, maybe segments where they're winning and the kind of makeup of that revenue trajectory?

Yes. Their focus is essentially right now in North America, especially on commercial vehicles, such as electric buses, trucks, and depots, which, as you can imagine, we see quite some synergies from what we're doing in terms of varied tax standpoint, kind of the same customer profiles and vectors of growth. We really like the synergies, both on the top line and bottom line, that we can bring with our current footprint in Europe, which is more focused on DC fast charging cars and here it's more commercial vehicle-oriented.

Okay. Got it. And then your core charging expertise in Europe is more light vehicles; North America is more in the commercial space. So can you just elaborate on the leverageability of the two businesses? Do you expect to go after the light vehicle charging market in North America?

Yes, we expect to harvest the synergies on the top line and technology on manufacturing. So it's fair to assume that our goal is to be local as far as the demand and product definition is concerned. But global when leveraging the global scale of the company as far as the back office, technology, and modularity of the design are concerned. By the way, there is a supplemental deck on the BorgWarner IR website where you will see a little bit more granularity around the acquisition of Rhombus.

There's been some discussion about automakers potentially adopting a sole-source approach for internal combustion engine components in the future as they focus more on their ICE investments. Are you noticing this trend? Does it affect your perspective on how to manage those assets? It seems like it could be a positive development if you're in a strong position to be a key supplier for those components.

I think going forward, you will see a focus on efficiency for those combustion products and also cost competitiveness, i.e., what we call product leadership at BorgWarner. If you are a top buyer at one of the key OEMs, you need suppliers for one commodity in combustion, maybe not. Likewise, we think you're going to see some consolidation in the supplier panel in some of those key OEMs. Again, I think competitiveness and forefront of product leadership from an efficiency standpoint and scale will be important to support our customers around the globe with maybe fewer suppliers for that combustion market.

Got it. And then on the target for $3.5 billion in ICE dispositions, any update on the timeline there? It just seems like a pretty rough market to be trying to divest assets given any uncertainty out there.

Yes, and it is. I think it's fair to assume that given the current market environment, our disposition projects right now are temporarily on hold. I mean simply put, and you're alluding to it, Colin, the debt financing markets are not open to finance transactions in this nature right now. But that's okay. We're not desperate sellers here. These are cash flow-generating businesses that we're happy to hold for the time being. When the debt financing markets do reopen, which they eventually will, then we'll resume our disposition processes. But I think it's fair to think right now that it's just not practical to execute those transactions. Again, we'll continue to drive the performance of those businesses and generate the cash flow to continue to support our investment strategies.

I believe on the inflation side, you mentioned $60 million in Q1 and then $25 million in Q2. So if I'm understanding this correctly, there's another $65 million in the second half. I was hoping maybe you could tell me if that's about right and just based on the pricing negotiations, how much benefit kind of spills over into 2023 on a net basis? And then secondly, you mentioned the e-R&D increase; was the overall R&D up similarly, or did you reduce the other R&D?

Yes. So on the net material cost inflation, the cost net of the recoveries in the first quarter, I think we talked about $55 million, if I'm not mistaken. The second quarter, $25 million. So we're actually at about $80 million year-to-date on a year-over-year basis, which implies now that we're saying about $145 million to $155 million for the full year; there's another $70 million year-over-year headwind in the back half of the year. So roughly comparable to the headwind in the first half of the year; that's similar to my comments that I was responding to Emmanuel's question. In terms of the spillover effect, our focus is really on addressing the P&L issues we're seeing from the material cost inflation, addressing those with our customers this year. That's what's embedded in our guidance and effectively allows us to mitigate the incremental headwinds that we are seeing in the back half of the year so we can manage that year-over-year headwind somewhere in the $65 million to $75 million ZIP code. On the e-R&D question, the second quarter, we were up $56 million in eProducts-related R&D, which means we're up a little over $80 million in the first half of the year, which is right in line with our guidance for the full year being up $145 million to $160 million on a full-year basis. As for the other R&D in the quarter, it was actually down $15 million. So total R&D was up; of which e-products was up $56 million and call it, combustion-based R&D was down $15 million.

Okay. And then just secondly, on the M&A side. Obviously, just in light of the challenges in divestitures, I was hoping you might be able to share some high-level thoughts on scenarios. What would the impact be on kind of mid-decade targets if you wound up holding on to some of those businesses that you were considering selling instead of divesting of them? And then just lastly, really quickly, any high-level thoughts on what the competitive moats are for Rhombus.

I'll have Fred talk about the competitive moat. Let me take that first question. To be honest, we view this as a temporary hold in the execution of the disposition strategy. All of us, including you, have lived through these types of markets before where the debt financing markets can shut down and become cost prohibitive for a period of time, but they're generally not closed for years. From our perspective, we've got multiple years before we really want to hit our EV objectives and deliver on the priorities that we laid out at our Investor Day 1.5 years ago, and we expect to execute on that. We're not looking at scenarios where we're unable to dispose of these businesses through the middle of the decade. We still have plenty of time, and our process is still ready. I mean it's ready to go when the debt markets reopen; we'll resume those processes.

What's your question, Rod, on the competitive moat?

My question was just if you could just describe the competitive moat for this Rhombus acquisition.

Okay. Yes, we know that market; we've been in that market organically for quite some time, and we're selling products in Europe. The market is growing dramatically. In the regions that we're now addressing with BorgWarner's footprint, it's around $9 billion in 2030. It's still very fragmented, and I think we should expect consolidation in this field too. Again, I think technology is important. Rhombus is one of the first with bidirectional charging with U.S.-certified technologies in this field, which we really like. Hopefully, this will help them grow with these products. We feel that this market will need a strong local presence but also a very strong back office in purchasing, technology, and low-volume manufacturing. We are also very accustomed to low-volume manufacturing with our commercial vehicle products around the world. We also see quite some pull from our customers related to CV trucks and buses who want to offer complete solutions for their customers, and we can be an enabler for them to be able to do that.

It's great to see you expanding into the EV charging market, which presents an excellent growth opportunity. You already possess significant in-house expertise in efficient power conversion and advanced materials related to how electrons flow into an EV or electrified powertrain. Additionally, when considering charging, there’s the software aspect, including efficient charging dispatch at specific times and responding to grid signals. From a technology standpoint, does Rhombus contribute more to the software side or the power conversion expertise, or is it a mix of both in enhancing your core capabilities in power electronics?

I think it's both of them, and also they're helping us, and we can help them. We have substantial knowledge of the bill of materials that go into those challenging devices. We have global reach. We see some trends in power electronics where we can leverage our know-how on those topical products. We see synergies with our sales and government affairs relationship around the globe. I'm really excited about bringing BorgWarner to this charging business, stationary charging business. I believe we can bring a lot of technology and competitiveness in this field.

Okay. Helpful. And then a financial question, I guess, perhaps for Kevin. What's implied in the free cash flow outlook in terms of working capital in the back half? You guys have been paying your bills pretty timely and receivables and inventories have built here in the first half of the year. Where do you expect that to trend in the back half?

Yes. Fundamentally, we're expecting that the inventory that we've built in the first half of the year will be unwinded in the back half as we start to see volumes ramp up and consume some of that inventory. We also saw a little bit of elevated receivable balances because with the China shutdowns, we saw some of our China customers paying a little bit later than they ordinarily would. We expect that to reverse as well as we get into the third quarter here. So we're expecting to get back to where we started the year from a working capital perspective.

Just a quick follow-on regarding the Rhombus Energy and the charging infrastructure. How much of a factor does scale play into the competitive landscape in the space? Any color on just what the content per charging unit opportunity is, so that we can maybe start to work through the TAM.

So today, I would say that it is still very regional. It will still require some regional specificities as far as certification is concerned, as far as sales channel, as far as government contacts are concerned. But when the business ramps up like any business related to quite significant electronics and power electronics content, scale will matter and scale always matters. As for the total addressable market (TAM), Kevin, maybe you want to jump in here?

Yes. I was going to say, I think Pat will come back to you on maybe some ways to think about content per vehicle (CPV), but as we've mentioned, the market looking after 2030, we think it's about an $18 billion global market opportunity, of which about half of that is in North America and Europe, and we're positioned to play right now. But Pat can give you a little bit more detail on how to think about the different elements of CPV there.

Okay. And then China, the normalization and ICE programs called out in the quarter, to what extent is this just tied to weaker commercial truck production? Is this a dynamic that's expected to sustain in the back half? And just how are we thinking about China?

I believe we mentioned a little bit last year when we were talking about some of our programs actually exceeding our expectations because we were having higher customer penetrations on a few programs than we were anticipating as being steady state. Then we started to see in the back half of last year, in particular, that I'll say, outsized penetration unwound a little bit. That's what we're calling the normalization effectively of a key program or two in China. So we start to lap that benefit now as we head into the third quarter, and you shouldn't see that headwind materially anymore in our outgrowth.

I wanted to start with your 2025 organic EV revenue outlook. So insofar that you gave us an updated look at that this morning, it also provides a window into bookings for the first half of this year. I'm just wondering how you'd characterize the bookings environment right now, especially as it relates to electrification. And how do you think the second half sets up on that front?

I think there is a lot of momentum in the EV-related requests and requests for quotes globally. What we also see is an accelerated demand for capacity increase on what we have launched and also, funny enough, what we have not launched yet, but there is higher demand in the coming years. Overall, I see only acceleration in the EV booking and request for quotation in the second half versus the first half.

Okay. And then for my follow-up question, I have several inquiries regarding the effects of current market conditions on dispositions, which I understand. I’d like to take a different approach and ask about M&A. To what extent, if any, does the current volatility in the equity markets, along with rising rates and other factors in the environment, affect the quality of assets available to you? Does it alter the competition for deals? And does the Rhombus deal in particular indicate anything different in this context?

Yes. Generally speaking, when we consider the types of companies we aim to acquire, they typically fall into two categories: one that has a more established income statement and another that is just starting its growth journey and lacks a comprehensive profit and loss statement. Companies with a more mature income statement are more vulnerable to the current market and inflationary conditions, leading to increased uncertainty and due diligence regarding their ability to address customer pricing and inflation challenges. This scenario can create discrepancies between buyers and sellers until there is clarity on these matters, making transactions with such companies more difficult in the current landscape. As we mentioned last quarter, we had to walk away from a specific transaction because we couldn't reconcile some of these issues. In contrast, companies that are earlier in their growth phase are primarily focused on advancing their technology and securing new business, which will impact their financial statements in the coming years, like in 2024, 2025, or 2026. These are the types of companies we are more likely to engage with soon, similar to Santroll and Rhombus, which have profiles like that. Additionally, the challenging capital markets create fewer opportunities for these companies to obtain the funding needed for their growth, whereas we are positioned to provide that capital. As a result, our ability to offer strategic funding gives us an advantage when collaborating with such companies in the current environment.

Sorry, I just want to go back to charging, which I guess is the theme of the day, but you did have the installation in Italy and now the Rhombus acquisition. You talked about how this is still a pretty fragmented segment. You talked about the importance of scale. Should we expect that this will continue to be an area you look to build capabilities? Or do you think between what you have organically and what you're getting via this acquisition, that's enough to sort of really begin to scale in the two theaters you mentioned, North America and Europe? And also maybe if you could add how much of the $3.7 billion you expect to come from charging?

First, yes, you should expect us focusing on both organic and inorganic growth in the field of stationary charging, focusing on high-power DC fast charging. The second question was out of the $3.7 billion, we expect about $150 million for Rhombus and overall, I think $175 million to $200 million overall, including our organic exposure in these devices.

Okay. And then secondarily, I'm just curious, Fred, if you could tell us sort of in real time what your conversations are like with your particularly with your European customers, and everyone's sort of been concerned about energy shortages may be a little bit lesser than sort of at the peak, but how they are sort of planning for the balance of the year here, how you are preparing? Are you seeing any evidence of maybe moving some production into the third quarter or maybe fewer summer shutdowns to get ahead of what could be a more difficult winter?

I think it's too early to say. I have not participated in discussions along those lines. I believe we will have more clarity when Europe returns after the summer break. I would say by early September, or the end of August, we will know more about the production profile for the winter.

A question on the EV business. It's nice to see the momentum both in terms of the additional M&A as well as the organic bookings. When we start thinking about what that may mean for your prior comments for the EV business reaching breakeven, I believe, in the '23, '24 time frame, is there any change in when you think you may reach that breakeven when you consider some of these changes in terms of the M&A, organic revenue, and also some of the OpEx comments you made?

Yes. I think at this point, we haven't really updated that guidance, but I think it's fair to say it's in the same ZIP code as where we were from a breakeven perspective. There are a couple of key variables to keep an eye on. One is, as we continue to invest more in eProducts-related R&D, that can become a headwind to that near-term breakeven. On the other hand, as our EV revenue grows like we're seeing now $850 million, our expectation for full year 2022, that gives us incremental contribution, which is a tailwind. Those are the two key variables to keep an eye on and how both of those items grow. Directionally, there's no real significant change in our outlook even though we're not going to provide a specific update today.

That's helpful. My second was more conceptual on the pricing recoveries. Thanks for all the comments you already made around your expectations for net pricing this year. More high-level, though, a lot of companies are trying to manage expenses more tightly given some of the macroeconomic risk that are out there. Are you seeing that at all reflected in your ability to get net pricing? Is that potentially going to be harder to the extent some of the macroeconomic challenges do persist?

We always focused on staying lean and looking at any room for cost reductions overall. The actions that we've taken two, three years ago really allow us to manage through this. If you compute, we have about $100 million benefit this year from restructuring and cost reduction planning that we've started two, three years ago. We are doing that. It's part of what we do in the position of strength without compromising the long-term trajectory in EV. We won't do anything that compromises this, and we're not going to constrain anyone within BorgWarner to grow in the field of battery electric vehicles.

Thank you all for your great questions today. Chelsea, you can go ahead and wrap up the call.