Borgwarner Inc Q2 FY2021 Earnings Call

Good morning. My name is Jerome and I will be your conference facilitator. At this time I would like to welcome everyone to the BorgWarner 2021 Second Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. (Operator Instructions). I would now like to turn the call over to Patrick Nolan, Vice President of Investor Relations. Mr. Nolan, you may begin your conference.

Thank you, Jerome. Good morning everyone and thank you for joining us today. We issued our earnings release earlier this morning. It is posted on our website, borgwarner.com, on our home page and on our Investor Relations home page. 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 home page 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 performed and for comparison purposes to 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 markets. When you hear us say market, that means the change in light vehicle and commercial vehicle production weighted for our geographic exposure. Our outgrowth is defined as our organic revenue change versus the market. Please note that we've 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. First on Slide 5, I'm very proud of our strong performance in the quarter despite the ongoing component supply headwinds. With just under 3.8 billion in sales, our second quarter revenue increased over 72% organically with strong incremental margins and free cash flow. As Kevin will discuss we're increasing our full year guidance as we believe higher our growth in synergies, offsetting commodity and other headwinds. That's for the short-term execution. Now going forward, I'm very proud of our sustainability strategy highlighted in our report that our team just published. The acquisition of AKASOL was completed in early June, I'm very positive about what I see, great technology, great entrepreneurial spirit and mindset, welcome AKASOL to BorgWarner. And we secured multiple new product awards for electrified vehicles which I will speak about in a few moments. Starting with our over-arching sustainability topic and our vision to a cleaner and more energy efficient world, I would like to highlight some key takeaways from our global sustainability report called Evolving for All on Slide 6. Evolving for All compiles into one document where it is possible when nearly 50,000 people resolve to do the right things. It is a testament to our commitment to create an enterprise that is shaping the future of sustainable mobility. We are accelerating our clean mobility technologies, we're reducing our carbon footprint and are well on our way to achieving our stated goal of carbon neutrality by 2035. The report also includes Scope 3 emissions data to illustrate how our products are improving the world in which we all live with fostering a diverse and safe workplace and giving back to our communities. And our pay equity analysis shows parity results. I'm extremely proud of our sustainability focus. Moving on to another pillar of charging forward we have completed the takeover offer of AKASOL early June as detailed on Slide 7. Since then, we have increased our ownership stake to approximately 93% through additional share purchases. We have informed AKASOL of our intention to progress towards a squeeze out process to achieve 100% ownership. To put in perspective, we expect AKASOL to represent 20% to 25% of the M&A portion of our charging forward project announced just four months ago. AKASOL also continues to secure additional new business awards. Last month we announced an agreement to supply their battery systems to a major bus and commercial vehicle manufacturer from Belgium. AKASOL will supply the second and third generation of their high energy battery systems for the customer’s new all electric city bus starting in 2021. Now let's go to China and look at other recently announced new product awards for electrified vehicles on Slide 8. First, we announced new contracts to supply dual inverters for Great Wall Motor and another major Chinese OEM. The dual inverters will be featured on both hybrid electric vehicles and plug in electric vehicles for these customers. By combining different power electronic technologies into one compact package our dual inverter provides unrivaled functionality. A single unit can control and drive two electric motors while delivering cost and weight reductions. These advanced inverter awards showcase not only the product leadership we have in these domains but also the trust and confidence we have built in our electrified applications with multiple OEMs globally. In addition to our mid-term revenue opportunities, advanced hybrid programs such as these allow us to drive additional scale and product capabilities that help improve our overall competitiveness in the world of battery electric vehicles. Also downstream the battery I would like to highlight another iDM award. This new three-in-one has the biggest size and output functionalities than the one already announced a few months ago with Hyundai. This one also combines mechanical motors, vertically integrated electronics and software. We are partnering with a leading luxury new energy vehicle maker in China with SOP in 2023. Designed, developed, and manufactured by BorgWarner, this iDM features our electric motor, our gearbox, and our integrated power electronics. It operates at 400 volts and has a peak power of 250 kilowatts. Now adjacent to the battery packs I would like to shed some light today on our high voltage coolant heaters on Slide 9. This product line is a great example of advanced products developed organically by BorgWarner and now commercialized and manufactured at scale. It helps improve the battery operated range of our customer battery electric vehicles by controlling the battery temperature at an optimal level while also increasing passenger comfort, through the delivery of an ideal interior climate. We recently expanded our existing business with the launch of the new program with Geely. And as you can see by the chart on the Slide, the business is expected to grow rapidly from 600,000 units in 2021 to 4 million units by 2025, that's a 60% CAGR. With multiple customer awards, we expect the high voltage coolant heaters to already account for $400 million in revenue by 2025. Or to put it in another way, we expect this product to account for close to 10% of our planned EV revenue by 2025 and are charging forward. This product line does not get as much attention as the more high profile product lines like iDM inverters or motors but still contributes meaningfully to our EV content. So let me summarize our second quarter results and our outlook. The second quarter results were strong particularly considering the supply challenges currently impacting the industry. We delivered strong top line growth and we believe we're tracking well towards our full year margin and free cash flow objectives. We're increasing our full year revenue and adjusted earnings per share guidance. As we look beyond these near-term results, I'm extremely excited about our long-term positioning. We are continuing to secure new business for electric vehicles to support our long-term revenue targets, and I'm pleased to see awards both on the component and on the system level. BorgWarner continues to develop clean and energy efficient solutions like our iDM family of products, and lastly we're focusing on a disciplined inorganic investment approach like the acquisition of AKASOL that add great technology and additional scale to our portfolio while supplementing our growth profile. With that I'll turn the call over to Kevin.

Thank you, Fred and good morning, everyone. Given the number of financial topics we have to get through this morning, I'm going to dive right into the details. So let's turn to Slide 10. As we look at our year-over-year revenue walk for Q2, we begin with pro forma 2020 revenue of just under $2.1 billion, which includes 628 million of revenue from Delphi Technologies. Foreign currencies increased revenue by about 11% from a year ago. Then, our organic growth year-over-year was more than 72% compared to a 64% increase in weighted average market production. The significant year-over-year changes in industry production and the varying levels of supply disruptions among our customers make it difficult to draw conclusions from the quarterly outgrowth figures. Nonetheless, we were pleased with our performance in the quarter. Looking at our regional performance, in Europe we outperformed by double-digits, driven by growth in small gasoline turbochargers, VCT, and fuel injection. In China, we also outperformed the market by double-digits driven by growth in DCT, all-wheel drive, and fuel injection. And in North America we underperformed the market primarily due to customer exposure. The sum of all this was just under $3.8 billion of revenue in Q2. Now let's look at our earnings and cash flow performance on Slide 11. Our second quarter adjusted operating income was $401 million, compared to a pro forma loss of $52 million in the second quarter of 2020. This yielded an adjusted operating margin of 10.7%. On a comparable basis excluding the impact of foreign exchange, adjusted operating income increased $423 million on about 1.5 billion of higher sales. That translates to strong incremental margin of over 28% driven by conversion on higher volumes, restructuring savings, and Delphi related synergies in excess of purchase price amortization. We were particularly pleased with this performance, given elevated supplier and commodity costs that we experienced during the quarter. Moving on to cash flow, we're proud of the fact that we generated $133 million of positive free cash flow during the second quarter, which was achieved despite an investment in inventory to help us better manage the challenging production environment. Let's now turn to Slide 12, where you can see our perspective on global industry production for 2021. As you can see, we expect our global weighted light vehicle and commercial vehicle markets to increase in the range of 8.5% to 11%, which is down from our previous assumption of a 9% to 12% increase. This reduction from our prior market outlook reflects the ongoing impact of the semiconductor shortage on industry production, which is reducing our expectations for North American and European industry growth. We do expect light vehicle industry production to improve sequentially in the third and fourth quarters relative to Q2 as we believe the impact of the semiconductor shortages will be lower in the second half of the year than what we saw last quarter. However, given lower commercial vehicle production in the second half and the varying impact of ongoing supply constraints on our mix of customers, we're not expecting Q2 and Q4 revenues to return to Q1 levels. Now let's talk about our full year financial outlook on Slide 13. You can see that our end market assumptions from the prior slide are expected to drive an increase in revenue of roughly $965 million to $1.2 billion. Next, we expected drive market outgrowth for the full year of approximately 500 to 600 basis points, which is a meaningful step up from our previous guidance of 300 to 500 basis points. Based on these assumptions, we expect our 2021 organic revenue to increase about 14% to 17% relative to 2020 pro forma revenue. Then, adding a $520 million benefit from stronger foreign currencies and $75 million of revenue related to the acquisition of AKASOL, we're projecting total 2021 revenue to be in the range of $15.2 billion to $15.6 billion. From a margin perspective, we expect our full year adjusted operating margin to be in the range of 10.2% to 10.5% compared to a pro forma 2020 margin of 8.3%. This contemplates the business delivering full year incrementals in the low 20% range before the impact of Delphi related cost synergies and purchase price accounting. From a cost synergy perspective, our margin guidance includes $100 million to $105 million of incremental benefit in 2021, which is higher than our previous guidance of $70 million to $80 million. As I'll discuss in more detail, momentarily, the cost synergies are simply being realized faster than we previously expected. Partially offsetting this favorability are two things; first, the acquisition of AKASOL is expected to reduce full year margins by 10 basis points. And second, we're anticipating a net negative impact from commodities in the range of $70 million to $90 million, which is worse than we previously expected. But even with these two headwinds, we're holding our margin roughly in line with our prior guidance. Based on this revenue and margin outlook, we're now expecting full year adjusted EPS of $4.15 to $4.40 per diluted share, which is an increase from our prior guidance of $4 to $4.35 per diluted share. And finally, we continue to expect that we'll deliver free cash flow in the $800 million to $900 million range for the full year. This is flat with our prior guidance as we expect the higher sales outlook to drive an increase in working capital that largely offset higher adjusted operating income. This would still represent record free cash flow generation for the company. That's our 2021 outlook. Let's turn to Slide 14 for an update on the financial impact of the Delphi Technologies acquisition. As I alluded to earlier, the cost synergies related to the transaction are being realized more quickly than we previously expected. The primary driver is faster execution of headcount reductions related to our planned SG&A cost synergies. In fact, at this point, we've completed more than 95% of the headcount reductions associated with our synergy plan. As a result, we now expect 2021 cost synergies to be $100 million to $105 million, which means that cumulatively we expect to have achieved synergies of $115 million to $120 million by the end of the year. But to be clear, this is an acceleration of the timing of our synergies as opposed to an overall increase in our performance. Therefore, our total cost synergy target of $175 million is unchanged. In addition to higher cost synergies, Delphi's revenue contribution in 2021 is also tracking ahead of our original expectations. As a result of these two factors, the accretion to 2021 adjusted EPS from the Delphi acquisition is now expected to be positive $0.20 to $0.30 versus our expectation at closing of a dilutive impact of approximately $0.15. This is a great result and a testament to the work being done by the integration teams across the company. And as we look beyond 2021, it's important to note that the revenue synergies associated with the transaction are also progressing very well. We're pleased with the systems awards that we generated through combining our electric vehicle capabilities, including the iDM award in China that Fred mentioned earlier, we've been able to secure these and other components awards as a result of leveraging Delphi’s technology leadership with BorgWarner’s commercial relationships, operational capabilities, and financial strength. Let's turn to Slide 15 for a summary of the financial impact of the AKASOL acquisition. As you can see, we expect AKASOL to contribute 2021 sales of $75 million to BorgWarner’s second half results. Then we would expect those sales to grow significantly over the next few years with 2024 sales still expected to be in the $0.5 billion range. This growth is supported by AKASOL’s previously reported backlog. From an EPS perspective, we expect AKASOL to have a roughly breakeven impact on the total company in 2021 excluding the impact of purchase price amortization. Then as the business grows sequentially each year, we do expect to see conversion on the incremental revenue, which we expect to drive accretion of $0.12 by 2024 also excluding the impact of purchase price amortization. We're pleased with the transaction and the medium to long term benefits it is expected to deliver. So let me summarize my financial remarks. Overall, we had another solid quarter despite the industry challenges. We meaningfully outperformed the market, delivered a 10.7% operating margin, and generated $133 million of free cash flow. And then coming off that Q2 performance, we've increased our full year revenue and earnings guidance even while moderating our industry production assumptions and considering higher commodity costs. Looking beyond our near-term results, we believe the faster accretion from the Delphi Technologies acquisition and the completion of the AKASOL acquisition illustrate our ability to execute the inorganic actions that are part of our project charging forward initiative. The electrification wins discussed by Fred also highlights some of our progress towards the organic portion of our plan. Ultimately, it's the pillars of near-term execution, securing future profitable growth and disciplined inorganic investments that will drive the success of our strategy and thus drive value creation for our shareholders. With that, I'd like to turn the call back over to Pat.

Thank you, Kevin. Jerome, we are ready to open up for questions.

(Operator Instructions). Your first question comes from Chris McNally with Evercore. Your line is open.

Great. Thanks so much, everyone. Wanted to maybe talk a little bit about the second half assumption. Just based on your guidance, you had a very strong first half of 850 million of EBIT guidance in the second half implied something lower in the 750 million to 800 million range, which would obviously be down sequentially, but also down year-over-year versus the pro formas that you have provided on up revenue. So if you could just provide some of the puts and takes there, that would be really helpful?

Yeah, I think maybe to make it simple why don’t I speak relative to the midpoint of the range. But as you think first half to second half, I think when you exclude the impact of AKASOL which is $75 million revenue sequentially, first half to second half is down a couple of hundred million dollars. So obviously we have lost conversion on that revenue. But then on top of that as you're going first half to second half, you've got the net commodity headwinds, which are an incremental $20 million to $40 million in the second half. Our R&D on a net basis is stepping up in the second half, another $25 million to $30 million and those things are being partially offset by about $20 million to $25 million of incremental synergies. So, that's kind of the walk as you look first half to second half. I think the thing if you look year-over-year, if you're talking second half of this year versus our pro forma second half of last year, I think one of the things you have to keep in mind is part of the revenue walk is AKASOL of $75 million and foreign exchange, which is a little bit over $100 million, so $200 million of our revenue improvement comes with virtually no margin because FX converts to basically our operating income and AKASOL actually because of purchase price amortization is dilutive this year about $10 million. The net is no conversion on that incremental $200 million which means what it means then on the revenue that's left, there's actually the downside conversion at the midpoint of our guide, plus those other things I spoke of the commodity costs, R&D being up, but synergies being a little bit of an offset. So hopefully that helps.

Yeah, that's great detail. Thanks so much. And then on the second side of the business, you announced several EV wins in the quarter. In particular, the three mid-voltage wins—the dual inverter and iDM—are obviously of more significant value. Could you talk about, roughly, how you would think of a hard number: are we talking about hundreds of millions being added to the backlog where these are 100,000-per-year type vehicles, or is it something you expect to be a bit smaller?

I think the volumes are meaningful and what we've seen also is it is time we book a business in this field, volume expectation is going up and up. So, those are two great programs for us. And from an iDM perspective, as you've seen, we're building a modular portfolio, it's a different power output, different power level, and so very happy about that and hitting the market with great products.

Great. Thanks so much.

Your next question comes from Luke Junk with Baird. Your line is open.

Yeah, good morning. First question I want to ask is if there's any additional color that you could share in the scope of the iDM whether you disclose today, should we think about this as an award on the single vehicle or could it potentially cut across platform at the customer?

Right now the iDM is defined by a power level. Within that power level it applies across the vehicles the customer wants to tailor for it. That's the color I can give you. It starts with the platform and will cut across the 250-kilowatt power level.

Okay, that's helpful. Thank you. And then bigger picture, one of the filters here is that you had highlighted at your Investor Day in March was iDMs in Asia in general, seeing here five to six months later, you've now booked a couple of these awards and we're still not even a year out from the closure of the Delphi deal, is it fair to say that the level of interest in Asia is consistent with or it maybe even a little better than you had anticipated in March?

It's in line with what we expected and this is currently where the music is played the loudest from an EV acceleration standpoint. This is where we're going to gain scale early, very happy about that. And the technology that we bring into the market and the competitiveness that we bring into the market with in house transmission, motor electronic software is very, very well received.

Your next question comes from Brian Johnson with Barclays. Your line is open. Brian Johnson from Barclays, your line is open.

Jerome, I think we can go to the next question.

Okay. Your next question comes from Joseph Spak with RBC Capital Markets. Your line is open.

Thank you very much. And thanks for that first half to second half walk, that was helpful. I guess just on the commodities, if I'm following along it seems like on a year-over-year basis, you're talking about another $55 million or so headwind in the back half. I just want to confirm that. And also if you could just sort of remind us of your policy here because I thought over time, you tend to get some recoveries there, so as we begin to think about the bridge into 2022, does this sort of headwind remain or do you start to get some of those recoveries on the raw materials?

Yeah, I think you've got the number right. As you look at the second half of the year on a year-over-year basis it's in the $45 million to $64 million range. So you've hit the midpoint exactly right. And that is a net number, net of our recoveries. Now obviously, there are some timing lags as it relates to recoveries, but the bulk of those recoveries are expected to be in our results as we progress through the year. And so that number that we're talking about the 45 to 65 in the back half of the year on a year-over-year basis is net of the recoveries already. But there might be a little bit of a tailwind heading into the first quarter of next year.

So, I mean, if these commodity levels hold, then it's fair to assume at an absolute level there's still a headwind in the first half of next year, even if maybe it's mitigated somewhat by some of the recovery timing?

Yes, a little bit. The headwinds as we move from the first half to the second half are clearly more negative, roughly $20 million to $40 million. If that carries over into Q1 of next year, it would be an incremental year-over-year headwind relative to Q1 of this year. There are a lot of moving pieces as we head into the beginning of the year. Next year, in 2023, we have another $55 million to $60 million of synergies to recoup from the Delphi transaction. We also have the legacy BorgWarner restructuring actions we announced 18 months ago; as you recall, we said those actions were intended to mitigate unknown risks. These are exactly the types of risks we were geared toward, things that were unforeseen at the time, and that represents another $25 million plus of tailwind next year from the legacy Delphi restructuring actions project, which is incremental tailwind next year. And then there is any conversion from our continued outgrowth. So there are a lot of puts and takes as we head toward next year, but if commodity levels hold, there would be an incremental headwind heading into next Q1 versus this year's Q1.

Okay. And then the second question is just, Fred, maybe this is a question we've been getting a lot from investors. At your Analyst Day, I think you put up a slide showing you forecast 80% of inverters would be outsourced. It seems that during the quarter, whether with Tesla or others, there are more announcements of automakers trying to do power electronics themselves, so it seems like that figure may be increasingly challenged. I'm curious whether your view has changed or is this just a definition issue, meaning by insourcing you mean the OEMs actually make it, but in some of these cases the OEMs might help with design without necessarily building.

Yes. I think relatively we are in a very, very strong position. We've already announced more than 1.1 million units by 2025 in Europe. If you do the math, that's a significant share of the overall European inverter volume, and since then we've received additional bookings. We don't see much change. I think this is due to two or three factors; specifically, we are successful in this field for three reasons. First, product leadership: our 400V and 800V silicon carbide solutions, where we continue to innovate to reduce cost, increase efficiency, and improve production rates. Second, scale — I absolutely believe this will continue to be a strength, and we are leveraging our entire electronics business. And last but not least, we have a high degree of vertical integration and in-house capabilities, including integrated silicon development, software, power modules, and possibly more in the future. This is a very competitive business: you need the best efficiency at the best cost, and you need scale. I'm very confident we are well positioned to capture a significant portion of what will be outsourced, and we are not seeing a change from about 80% of inverter volume being outsourced to suppliers.

Okay. Thank you.

Your next question comes from Colin Langan with Baird. Your line is open.

Great, thanks for taking my question. You've done a pretty good job here. You keep cutting your sort of production assumption and yet you keep raising your sales guidance. I mean, what is driving that much better than expected growth over market, does mix have anything to do with that with the commercial maybe holding it better?

So, I think we all grew the market in Q2. We underperformed in North America due to customer exposures and we overperformed in Europe and China double-digit, driven pretty much by all products. There is not one product that drives more than the other. Now in Q2, I must admit there was a lot of moving pieces. And we're not looking at our growth per quarter, that is too finite. So, we're very happy with the way our top line is evolving this year. And very happy to be able to beat and raise in the short-term. Also very focused in the long-term. We are investing in R&D in order to support the programs that have been booked and very happy with where we are both short-term on the margin and cash flow and also the activities from a long-term booking. And I want to take the example, people focus a lot on downstream at that rate, but the example of that high voltage I think it's a great example where BorgWarner can develop in house and really solve a problem of battery electric vehicle. Battery electric vehicle require innovation solutions for two critical functions, battery thermal and cabin heating. And the solution that we gave to the market is taking a lot of traction. You won't be surprised we have our own integrated electronics and software and we are leveraging the heating technologies that we have from other BorgWarner product lines. So very happy about where we are both organic and inorganic in the long term.

Got it. Any color on the commercial market? I thought it was holding up better, but when I look at your guidance from Q1 to Q2, your outlook actually came down. Did it hold up better in the quarter, or does it get a lot worse in the second half? I know that's a pretty high-margin business, and with the top-five deal it's a larger chunk of your business now.

Yeah, I mean, one of the big things is that China we would expect to see headwinds as we look at the back half of the year from a year-over-year production perspective and that obviously has an impact on us and our overall outlook.

Okay. And is that okay. So the second half is getting weaker. Okay, thanks for taking my question.

Yeah, second half is weaker on a year-over-year basis definitely. And China is a big driver of that.

And your next question comes from Dan Levy with Credit Suisse. Your line is open.

Hi, good morning. Thank you for taking the question. I just want to follow-up on Colin’s question there just from the outgrowth. Can you maybe unpack some of the items that you saw in the second quarter that drove the outgrowth between DCT and Turbo and GDI, just maybe a little more color on what exactly was driving that and as we're thinking about especially in Europe to push the beds, is there any shift in where GDI and Turbo sits in automakers pushing toward their CO2 targets?

Yes. As I mentioned before, we outgrew Europe and China by double digits, driven by many factors. You're right that gas turbos, VCTs and GDI in Europe also contribute. Also, don't forget that in any hybrid architecture you have a strong gasoline engine with turbo and GDI and other elements. Hybrid powertrains, especially in Europe but also in China, and the business we booked with the dual inverter are ramping up very quickly. That gives us scale and long e-side expertise that are translatable into the BEV world. On the combustion side, it pulls through our products that drive efficient combustion engines. I think that explains it. I don't have the breakdown of how much is Turbo versus VCT or GDI or all-wheel drive, but I'm sure Pat can follow up with you offline.

Okay. And then the line of sight for the remainder of year as far as GDI and Turbo in Europe, is that something that it's still playing rolling in driving CO2 targets?

Absolutely it does. Absolutely it does. It does in reducing the CO2 and emissions of combustion engines. It does because it is an enabler of hybrid power trains and as you've seen, this is helping car makers in Europe especially to meet the CO2 target. So absolutely it does help.

Great. Thanks.

You are welcome.

Your next question comes from Noah Kaye with Oppenheimer. Your line is open.

Thanks. Good morning. Appreciate your taking the questions. I guess first, congrats on closing AKASOL. Just wanted to understand what margins roughly are you assuming for AKASOL by 2024 and the accretion estimates you provided excluding amortization. And then more strategically, how do you see AKASOL maintaining competitive differentiation in battery tech over time?

Yeah. With respect to the margin, we're not disclosing a margin outlook at this point in time, but I think you can probably do some math underlying our EPS and get a sense as to what the pretax assumptions are as it relates to the overall performance of that P&L relative to the 0.5 billion or so of revenue that we're expecting by the year 2024. But at this point, again, not going to disclose any margin profiles other than we think it's going to be a profitable business over time. As far as technological edge at AKASOL, a few things Noah. First, they are currently producing the Gen 2, they are launching their Gen 3 later this year and being able to launch generation and improve efficiency and power density regularly is key. Now they are part of, soon they will be fully part of BorgWarner. And you can imagine that we will be working with them and linking them with the battery management system and software that we have currently in production coming from Delphi Technologies. We certainly are going to link them also to the high voltage coolant heaters. Those elements are heating the coolant for the batteries. And I expect that we're going to find innovation and products that are going to be generating value for our customers and for BorgWarner going forward.

Very helpful. Thanks. And then just around R&D to clarify the new guidance, 725 million of spend that compares to 5% previously. So, just to understand, are you actually bumping up R&D levels from prior guidance and so is that driven by EV programs, kind of where is the focus, just help us understand?

Yeah, I'll take that. A couple of things worth noting around the R&D guide. First, when you look at our Q2 results — when you get a chance to go through our 10-Q, you'll see that our net R&D was down sequentially in the second quarter versus the first quarter. That was because we had higher-than-anticipated customer engineering recoveries; in Q1 those recoveries were about $20 million. If you look at our gross R&D from Q1 to Q2, it was actually up sequentially, but the net was down. That has had an impact: we've lowered our implied full-year R&D from roughly $740 million at the beginning of the year to about $725 million in our current guide, driven by the higher recoveries we generated in the second quarter. We provided a dollar guide rather than a percentage because the percentage is coming down. The percentage in 2021 is falling because revenue is increasing, not because we're cutting R&D spend. We had better recoveries, but our R&D spend is still $725 million. With revenue going up, R&D as a percent of sales is about 4.6% to 4.8%, which looks like a lower percentage but does not imply lower spend. So the $725 million represents about a $15 million reduction driven by recoveries. Looking ahead to next year and beyond, we continue to expect R&D spend to be in the 5% plus range on a go-forward basis.

That's very helpful detail. Thanks Kevin. I will jump back.

Jerome, we are ready for the next question.

Your next question comes from David Kelley with Jefferies. Your line is open.

Hi guys, this is Gavin Kennedy on for David. Two from my end. First, you mentioned that North America customer mix was a headwind in 2Q. Just was curious what BorgWarner is seeing as far as visibility to customer schedules in North America three year in?

What we're seeing is a better mix and recovery coming into Q3 and Q4 from the Q2 level and still very volatile, especially because of the semiconductor supply issues, that's what we are currently seeing Gavin.

Okay. That's helpful. And then switching gears, at your Investor Day you mentioned 3 billion to 4 billion in targeted legacy ICE disposition by 25 and about call it 1 billion in the next year or so. Can you comment on how disposition conversations are going, particularly given the volatile current environment and any additional commentary you can give us on what products you might be focused on in these dispositions, that would be helpful?

Yeah, I mean, it's in progress. Just as you noted, the 1 billion or so we expected to execute over a 12 to 18 month timeframe from what we announced at Investor Day, which means as we get to the end of Q3 we expect to complete that full billion or so. And we're in progress right now. And as we talked about, we're really focused on disposing product lines or businesses that don't meet the long-term financial objectives of our portfolio. Which means they lack one of three things, they either lack product leadership, they lack medium to long term growth prospects, or they lack strong margin and cash flow generating ability. And so if our product line or a business doesn't tick off three of those boxes, it's a candidate for disposition. So, at this point, we're actively moving forward in line with what we talked about at our Investor Day, and we think we're on track to deliver that billion or so of dispositions, I call it mid to late 2022 consistent with the timeframe that we laid out back at Investor Day. And then we continue to expect $3 billion to $4 billion by the end of 2025.

Great. Thank you, everyone.

Your next question comes from Brian Johnson with Barclays. Your line is open.

Thank you. And I apologize if this was covered in the opening, but I kind of doubt it. When you look at the 800 volt market and I was struck at the Chicago Auto Show by the Hyundai 800 volt systems and of course, the advantages. A small question is, can you confirm it around that or not? But the bigger question is 800 volts started in the high performance market with the Porsche. Now we see it in Hyundai. I know your new EV motor runs on 800 volts for commercial. So my question is, do you see 800 volts as a big trend, one? Two, is the inverter product line you got from Delphi Tech uniquely positioned in that market relative to competitors? And three, are there synergies then between your 800 volt converter capability, your e-motor capability, and where AKASOL could go and is AKASOL capable of doing 800 volt packs?

So, the answer to your first question is 800 volt a big trend and is it going down in vehicle size? The answer is yes. Why, because it increases the power density and decreases the charging time. Are we well equipped, absolutely. The answer is absolutely yes. We are going to be one of the first ones launching very soon, 800 volt silicon carbide at high volume. This is a competitive advantage that we have to master high voltage silicon carbide and also master 800 volts made in house power module, which is the heart of the inverter. Synergies, absolutely I was talking about high voltage coolant heaters. We will start in 2024 an 800 volt high voltage coolant heater and yet our synergies across the different product portfolio that we have running at 800 volts Brian.

And could AKASOL do 800 volt packs?

I need to check that. My answer is yes, but I need to go back to you on this one particularly.

Okay. Thank you.

And your next question comes from Emmanuel Rosner from Deutsche Bank. Your line is open.

Thank you and good morning everybody.

Good morning.

The first question was about your crossover market outlook. It is good to see you boosting the outlook for the full year. Can you talk in a little bit more detail around what you are expecting for the second half of the year, obviously, you mentioned mix improving and customer mix in particular, but then obviously, you had pretty solid growth of market already in the second quarter and then for the full year, you had 500 to 600 basis points. How would you see this play out in the second half? And then just looking a little bit more forward, how should we think about the mix going forward, does this then represent a headwind in 2022, does this acceleration in growth of market make you rethink your framework for growth of our market?

Yes. I mean, a couple of things. When you look at the first half year-to-date, we're somewhere between 650 to 700 basis points of cumulative outgrowth for the first half. And so as we look at the second half of the year, we don't think we'll be operating at quite that pace. We think we're probably in the 400 to 550 basis points for that second half. The first half we've benefited from some mix. We've probably benefited from some production of vehicles that were ultimately in the production numbers of the OE. So there's probably some level of impact that's implied in our numbers in the second half, which is why you see a lower year-over-year and implicitly step down sequentially going from the first half to the second half. But overall feel good about our ability to deliver 500 to 600 basis points for the full year. In terms of what that translates to for future years, not prepared to give any update on that. I mean, we feel good about the backlog we've disclosed previously looking out 2022 to 2024 and we'll probably give an update on that as we get into the beginning of next year.

Okay, thanks. And then second question on iDM, just diving a little bit deeper here, can you just give us a sense of how you think about the range of content per vehicle and how would you see your either volume or revenue and margin profile of that line of business evolve over the next few years. So sort of like a mid-term outlook and how you would see iDM go from here.

Our price per vehicle is going to range from about $1,000 for the small versions and times 3 or 4 for much higher sizes. I'm not going to comment on volumes, I am not allowed to comment on volumes. Only I think that gives you some color on the content vehicle. And then on the margin side of the equation, because we've talked about before, any new product programs, whether they're combustion based product or an EV product like an iDM, we look at on our return on invested capital basis. And given that we are predominantly from a manufacturing perspective in the assembly business, what that means is the capital intensity of our programs including the iDM tend to be similar to our other product lines. And so as we drive to deliver consistent ROIC across our product portfolio and we have relatively consistent capital intensity, it means the margin profile on any discrete program looks substantially similar to the margin programs of other business that we approved throughout company, whether it's EV or not. Well, that's the life of a program. So when you look at our EV programs, generally speaking, they tend to have much more R&D intensity, which tends to be upfront. So as we're growing in EVs, what happens is we have a lot more R&D hitting the P&L upfront. And then you generate the contribution margins over time and the blend of all that hits our ROIC targets over the life of the program. But what that means as you're in ramp up mode across EV, your R&D is much higher proportionately relative to the conversion you're generating on the incremental revenue because the revenue is still coming in the future. So the EV portfolio in total has a more depressed margin while you're in ramp mode, but that's not because of the underlying fundamentals of the business. It's because we're growing and investing in R&D to support the contribution margins that we will generate over the coming years as we start to generate the revenue.

Two things I would add. First, everything Kevin has said and the additional R&D we do for EV are already reflected in our margin profile. Second, we are currently spending 30% of R&D on EV while our EV revenue is only 3% to 5%, similar to the market, quite frankly. That shows how deliberate we are in accelerating the path toward electrification.

Yes, definitely. Appreciate it. Thanks.

We have time for one final question and that question comes from Mark Delaney with Goldman Sachs. Your line is open.

Yes. Good morning and thanks very much for taking the question. First, I wanted to talk on Delphi and reflecting back when that was announced. Part of the industrial logic was that Delphi would give the company a broader set of technologies, including for EVs. I know some of that's with iDM but more holistically, so you that you've had that asset for a longer period of time, you have a few wins with iDM, can you give more clarity on your win rates and to what extent you're converting on that broader set of solutions is to the extent that you had been anticipating?

So, yeah, only six months after the close we booked iDM, which is very important, but it's not limited to those systems. We also booked a lot of inverters that we think could be booked only with that combination. We are also accelerating on battery management system, the software battery management system. So from a top line synergy perspective, we're absolutely on track with what we expected coming into the Delphi acquisition.

Got it, it’s helpful. And then you talked already a little bit about the supply chain situation and your views on a second half versus the first half. But maybe you talk a little bit more on the longer-term implications from the supply shortages, some of the OEMs have said that they want to change, are they going to procure supply and then work more directly with some semiconductor companies and how do you think that may impact a Tier one like BorgWarner in terms of how you may partner both with your customers and suppliers and some of the implications around margins and working capital? Thanks.

So we are not seeing that trend, at least in the products we focus on. But what the semiconductor issue has shown us is that it is extremely important to partner both upstream and downstream — upstream with our customers and downstream with our semiconductor suppliers. The second lesson is that scale matters and it is easier to get things moving when you have already achieved scale. We will keep those two lessons very close to mind as we move forward over the next year.

Got it. Thank you.

Thank you all for your great questions today. If you have any other follow-up questions feel free to reach out to me directly. Jerome, go ahead and close up the call.

Alright. That concludes the BorgWarner 2021 second quarter results conference call. You may now disconnect.