博格華納 (BWA) 2018 Q2 法說會逐字稿

Good morning. My name is Tasha, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2018 Second Quarter Results Conference Call.

(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, Tasha. Good morning, everyone. We issued our earnings release at 6:30 a.m. Eastern Time. It's posted on our website, borgwarner.com, both on our home page and on our Investor Relations home page. A replay of today's call will be available through August 9. The dial-in number for that call is (855) 859-2056 and the conference ID is 3496229, or you can simply listen to the replay on our website.

With regard to our Investor Relations calendar, we will be attending several conferences between now and our next earnings release. Please see the Events section on 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 risk and uncertainties as detailed in our 10-K. Our actual results may differ significantly from the matters discussed on this call.

During today's presentation, we will highlight certain non-GAAP measures in order to provide a clearer picture of how our 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 noncomparable items. When you hear us say adjusted that means excluding noncomparable items. When you hear us say on a reported basis that means U.S. GAAP.

Now back to today's call. First, James Verrier, our President and CEO, will comment on the industry, followed by a high-level overview of our Q2 results and full year outlook. Then Fred Lissalde, our COO, will outline our second half priorities as well as review some of our recent announcements. Finally, Ron Hundzinski, our CFO, who's got the details of our results as well as our guidance.

Please note that we've posted our earnings call presentation to the IR page of the website. You'll find the link in the Investor -- in Presentation section beneath the notice for this call. We encourage you to follow along during our discussion.

With that, I'll turn it over to James.

Thank you, Pat, and good morning, everybody. Thank you for joining us this morning. Fred and Ron and I are very pleased to share our results from Q2 of 2018, and we're also going to update you a little bit on our progress towards delivering our 2018 targets.

I thought a good place to start is for me to share a few thoughts on the macro environment and the industry in general. And for those of you that are following along on the webcast, we're on Slide #6. The way I would characterize the headline summary, just to start off with, is, for us, our growth over market was in line with our expectations, and that was in an environment with global light-vehicle production a little bit weaker than we'd expected going into the quarter. So let me just give a little bit of color around Q2 industry results. From a global light-vehicle production perspective, it came in up slightly less than 4% year-over-year. And when you adjust that for our weighted geographic exposure, the market was up a little under 2% year-over-year. And if you think about that from our perspective, that was about 150 basis points weaker than our expectation when we provided our Q2 guide. If I break down that a little bit regionally for a moment, first of all, European light-vehicle production was up 4% year-over-year. The highlight on diesel-gas mix in Europe continues to shift. We saw diesel share declining by approximately 870 basis points year-over-year in Q2.

Moving to China. China light-vehicle production was up to -- close to 9% year-over-year, and that was pretty much in line with our expectations as we went into the quarter. From a North American perspective, light-vehicle industry production declined about 2.5% year-over-year, which was a little bit weaker than expected, driven in part by some lost production at one of our key customers due to the supplier fire incident. From a commercial vehicle perspective, growth there was modestly ahead of our expectations.

Now Fred will go through the details in a short while, but the full year industry volume outlook remains roughly unchanged for us. And as we look at the business going forward, the fundamental upsides and downsides to our industry assumptions appear to be pretty well balanced. So with that, our expectations for the full year global light-vehicle industry is consistent with our prior forecast. What that means is, it implies global production growth of less than 1% adjusted for our geographic exposure. The final point I'll make on this slide, though, and I think this is the best part of all, the key for us is we expect to continue to outgrow the market in 2018 based on the strong demand for our products.

Now let me talk a little bit about Q2 results and 2018 outlook, and I'm on Slide #7. So first of all, just a brief summary of the Q2 results, and again, Ron will cover this in more detail later. Overall, I was very pleased, really pleased actually. Our organic growth was in line with our expectations, and this was despite slightly weaker industry volume and customer downtime for one of our key platforms, which I mentioned earlier. Operating performance was also up very strong and managed to offset some of these revenue headwinds. So putting that into numbers for a moment, the quarter, $2.7 billion of sales, so that's up 7.3% organically when we exclude currencies and Sevcon. And this compares to our end-market exposure up less than 2%. So very, very strong outperformance again.

Regionally, as -- was pretty much as we'd expected, we did see strong growth in China. Our European revenue growth exceeded industry volume growth. Our North American revenue was flattish due to the lost volume at one of our key customers, and that was somewhat offset by positive revenue trends in commercial vehicle off-road.

EPS came in at $1.18 and excluded non-comparables. And one of my favorite metrics is that's a 23% year-over-year improvement, which is pretty fantastic. Operating margins were at 12.7%, which is up 20 basis points year-over-year. Again, very strong performance.

Now for the full year, I'm really pleased that we've increased the low end of our organic growth forecast, so we're expecting organic growth of 6% to 7%, and again, this is in a market that is growing less than 1%, so strong performance. Our consolidated operating income margin is expected to expand to 10 to 20 basis points year-over-year. And we're also increasing our EPS guidance range to $4.45 to $4.50 based on our updated growth outlook and more beneficial tax rate. And Ron will walk you through the details that go with that shortly.

So before I turn it over to Fred, I just wanted to say a few words as this is my -- this will be my last earnings call as I come to the end of a 29-year career with BorgWarner, which has been a wonderful journey for me to be in this great company. A few thanks, if I could. I -- first of all, I'd like to thank the board for their continuous support for me but also for the company. As we've repositioned the company in recent years, they've played a really strong pivotal role in helping us drive that forward. Obviously, I -- for sure, I want to thank the employees, all 32,000 of you that are out there listening, it's your commitment, your dedication to deliver these great results that has made Borg one of the great [company] it is. And whether that's financial performance, whether it's quality, whether it's safety, innovative products, BorgWarner knows how to do all of those things, and you are the folks that have done it, and thank you for your support. It's truly been an honor to lead you. But as I leave the company, I know a couple of really important things. First of all, I know I'm handing over to the right guy, and that makes me feel really, really good. I've known Fred for 19 years. We've worked together in many different capacities, and he's always been a superb leader, and he will continue to be a superb leader, and I know I can make that move in his very, very safe hands. Fred also has a great team around him. This is a team that's been together pretty closely over the last several years, and as we've built the strategy for the company, the current leadership team is the team that's put that together. And I think that great team will stay in place and continue to deliver the type of performance we expect at BorgWarner. I also leave knowing the company's in a great place. It's strongly positioned. And when I look at what the team has done over the last 4 or 5 years, it's pretty remarkable as we transitioned ourself to -- with a new vision for the company of clean, energy-efficient world, and we pivoted the company from a powertrain company to a propulsion company. And that wasn't just PowerPoint slides, that was real work. And here we are now, with the balanced portfolio for combustion, hybrid and electric products that will serve and deliver growth for the company whatever the end market plays at us. And that’s something that I feel really, really good about because we're balanced, we have a great strategy and we've got great results ahead. I also leave knowing the company is operating beautifully, and you'll see that in the comments from Fred and you'll see it in the results from Ron. So the company is in a really, really terrific spot.

The last thing I'd just like to say with the analyst community and investors that are on the phone, I want to thank you also. You gave us a lot of support, advice, sometimes criticism, often justified, and you challenged us, and you made us ask a lot of good questions. And it's a result of that engagement and that discussion with you that has made us a better company, and I want to thank you for that.

So finally, I'll turn it over to Fred. Fred, you're the guy, keep it going for us and best wishes to you. Thank you.

Thank you, James. On behalf of BorgWarner, I'd like to thank you for your leadership over the past 6 years as CEO and 29 years at BorgWarner. You are leaving us very strongly positioned for future growth. So we'd like to wish you and Tracy a great retirement and a great next chapter of your life.

As we look at our priorities for the next 6 months, there are 3 that we've focused on. One, we are laser-focused on delivering our updated guide, both in terms of organic growth and bottom line earnings. Two, we will secure significant new business awards. I'm very, very happy by the programs we've secured year-to-date, and there are significant second half opportunities across our 3 segments, combustion, hybrid and electric. And three, we will monitor and be prepared to manage through the industry risks. These include the potential for additional tariffs. We believe that we're strongly positioned on a relative basis. However, we'll need to manage any impact on our business going forward.

On Slide 10, you see some highlights of a few of our key announcements during the quarter. I think the most significant is the establishment of our Indiana Tech Center. This complements our existing investments that exist around the world related to electric propulsion. It's an impressive facility, very, very high-tech with outstanding virtual global collaboration tools. It will be one of the great research, development and testing hubs for us on the electric propulsion field.

We also wanted to highlight our upcoming Investor Day on September 18. It will take place at our Propulsion Technical Center here in Michigan and will feature presentations by several members of our senior management team. But as importantly, the event will give you the opportunity to touch and experience the products that will drive our future growth. I look forward to seeing many of you there.

With that, let me turn it over to Ron.

Thank you, Fred, and good morning, everyone. Before I review the financial details, I would like to provide you with some of the highlights as I see them for the quarter. First, our organic revenue growth was within our guidance range despite close to 200 basis points headwind from weaker production and a customer plant shutdown. Second, incremental margin performance was stronger than our expectations, driven by a strong incremental within our Engine segment and corporate cost savings. And finally, we are increasing the low end of our organic growth guidance and lowering our expected tax rate for the year from 28% to 26%. And as a result, our 2018 EPS guide has once again been increased.

Now as Pat mentioned, I will be referring to a supplemental financial slide deck that is posted on our website, and I do encourage you to follow along. Let's turn to Slide 13. On a reported basis, sales were up 12.7%. On a comparable basis, our organic growth -- sales was up 7.3%. This is solid performance compared to our weighted average light-vehicle industry production for the quarter, which was up under 2% year-over-year. We saw 26% growth in China against a production market that was up 9%. Europe revenue was up 7% compared to 4% industry production growth in the quarter. North America revenue was flat versus the 2.5% production decline in the quarter. The outgrowth was despite the impact of the F-Series production shutdown that impacted us about 400 basis points. Commercial vehicle was a benefit, contributing about 50 basis points of growth in the quarter. And as James mentioned, diesel-gas mix in Western Europe was a headwind.

Now let's look at the year-over-year comparison for operating income, which can be found on Slide 14. Q2 adjusted operating profit was $341 million compared to $298 million in Q2 of '17. Our operating margin of 12.7% was a 20 basis point improvement year-over-year. On a comparable basis, operating income was up $33 million on $167 million of higher sales. That gives us an incremental margin of 19% in the quarter, which was a bit better than we expected due to better cost performance and lower headwind from our noncore emissions business. Our adjusted provision for income taxes was $82 million for an effective tax rate of 24% for the quarter, but again, 26% year-to-date. Earnings per share on a reported basis was $1.30 per basic share. On an adjusted basis, net earnings were $1.18 per diluted share.

Now let's take a closer look at our operating segments in the quarter, beginning on Slide 15 of the deck. Reported Engine segment net sales were $1.674 billion in the quarter. Sales growth for the Engine segment on a comparable basis was 7.2% as demand for our light-vehicle OEM products was supplemented by growth in our commercial vehicle business. Adjusted EBIT was $279 million for the Engine segment or 16.7% of sales. On a comparable basis, the Engine segment adjusted EBIT was up $24 million on $107 million of higher sales for an incremental margin of 23%. This incremental margin is the result of 2 factors. First, the segment had very strong overall cost performance in the quarter. And second, the headwinds in our noncore emissions business were less than our expectations going into the quarter.

Now turning to Slide 16. Drivetrain segment and net sales were up for $1.034 billion in the quarter. Sales growth for the Drivetrain segment on a comparable basis was up 7.4% as well. This is primarily due to strong DCT growth in China, transmission components and all-wheel drive. Growth was partially mitigated by the F-Series shutdown in North America. Adjusted EBIT was $116 million for the Drivetrain segment or 11.2% of sales. I'd like to note that the 70 basis points reduction in margin is all related to Sevcon acquisition. On a comparable basis, the Drivetrain segment's adjusted EBIT was up $8 million on $68 million of higher sales for an incremental margin of 12%. F-Series shutdown was a drag on incremental margins for us in the quarter.

Now I'd like to discuss our 2018 full year guidance, which we have increased due to higher foreign currents -- which we have increased due to higher foreign currency headwinds. Turning to sales growth guidance for the full year, it's on Page 18. We continue to expect organic growth of 6% to 7%. The Sevcon acquisition is expected to add approximately $53 million of revenue in 2018. Currency is expected to be a $220 million tailwind. This is down from $405 million in our previous guidance. And total revenue is now expected to be in a range of $10.64 billion to $10.75 billion.

Next, I'll walk through our operating income on Slide 19. From a performance perspective, we expect mid-to-high teens incremental margins on our sales growth. Our consolidated operating income margin is expected to expand to 7.5% -- I'm sorry, to 12.5% to 12.6%.

To finish up our full year guidance, please turn to Slide 20. EPS guidance range is now $4.45 to $4.50 per diluted share versus the $4.30 to $4.40 previously. The higher guide is driven by an increase in the low end of our organic growth guidance and lowering our expected tax rate for the year. We continue to expect free cash flow to be in the $525 million to $575 million range. The tax rate is expected to be in the low 26% range. Our assumption for the dollar to euro exchange rate for the second half has been adjusted down to $1.15.

Now, our third quarter guidance can be found on Slide 22. First, sales. We expect organic growth of 4.5% to 6.5%. This is slightly below our full year guidance due to some new business being pulled in the first half and the customer mix in China and Europe. EPS is expected to be in a range of $1.03 to $1.06 per share. This guidance is based on a low 26% tax rate and incorporates a $1.15 euro assumption for a $53 million revenue headwind year-over-year.

So let me summarize quarter 2. Overall, execution was very strong. Organic sales growth of 7.3% was good despite that weaker-than-expected industry volume and impact of customer shutdown. The Q2 incremental margin of 19% was much better than we expected going in. And as we look at the remainder of 2018, we are focused on delivering our financial targets and continue to secure significant new business.

I'd like to take a moment and thank James for his outstanding leadership at BorgWarner. Our partnership was strong and very solid as we went along. There is no doubt that this company is the #1 -- is in #1 position to provide solutions to electrification of the propulsion system. Also, I am confident and very excited that Fred and I will continue to grow the company and generate the financial returns that our investors have accustomed to. So again, James, thank you for your leadership.

With that, I'd like to turn the call back over to Pat.

Tasha, we're ready to open it up for questions.

(Operator Instructions) And our first question comes from Joe Spak of RBC Capital Markets.

And James, congratulations on your retirement, and Fred, likewise, congratulations. I guess, Fred, I wanted to start with you. You focused on -- you mentioned some of the priorities for the second half, which sound reasonable. I guess, bigger picture, also I wanted to understand your view, just broadly, of the powertrain industry, how you view it, there's a lot of assets out there; how you think about consolidation, whether that's needed, and what BorgWarner's role in all that could be.

Yes. Thanks, Joe. In the propulsion area, our strategy to be balanced across combustion, hybrid and electric is the right thing. And this strategy will be executed -- is executed and will carry on to be executed. We have no missing pieces in our product portfolio to be able to execute this strategy and be growing at mid- to high single digits year-over-year. So we are very happy with where we are from a portfolio perspective, from a product perspective. And as I have mentioned before, if we could -- we're already very actively growing the organic portion of our power electronics business. And if we come across with some potential acquisition on power electronic, then we'd certainly look at that. But absolutely no need for us to look at filling a missing product gap that does not exist.

Okay. And then just maybe on the -- some of the puts and takes and sort of cadence for the rest of the year. I thought I heard you say a 400 basis point impact from the F-Series in second quarter. And I assume a good portion of that comes back in the third quarter. But then, is the offset maybe some of the WLTP issues in Europe? And then, it also sounded like, you said maybe some third quarter business was pulled forward into second quarter. So was I just wondering if you could dimensionalize some of those puts and takes, Ron.

Yes. Just to clarify some, Joe, when I said 400 basis points, that was a regional impact in North America. I just want to make sure that's clear, okay?

Okay.

Overall, 50 basis points, yes. I just want to make sure it's clear.

Okay. Perfect. Okay. So that makes a little bit more sense. But then, just in terms of some of the other puts and takes.

So your question is more around Q3 or?

Yes, the Q3. Because it would seem like some of that F-Series business would sort of come back helping it. But then, you talked about some of the offsets from the pull forward, and I was wondering your thoughts on WLTP issues in the back half.

Yes. So let me give you some color, too, on this. So our organic growth for Q3 is 4.5% to 6.5%. We've seen a lot of pull forward into the first half, where we've had a very, very strong backlog. And what we see, Joe, is really 2 market things that are touching us in Q3. One is from a customer mix perspective in China. We see a slight -- slightly slower growth in the second half, and also, from a European customer mix, including the WLTP certification, we see real slower numbers, too, from a market standpoint. On the full year basis, we've upped the -- we've upped our guide from 5% to 7% to 6.7% (sic) [6% to 7%]. So our full year growth is still very, very solid on a global, though on a weighted market growth of less than 1%.

And our next question comes from the line of Rich Kwas from Wells Fargo.

James, congratulations on retirement. Best wishes. it's been a pleasure.

Thanks, Rich.

And Fred, look forward to working with you in the future and best wishes as well. So on diesel, so down significantly more than I already kind of thought here going into -- at least going back to the beginning of the year. So how is it playing out in terms of the balance of the year on Europe? It seems like you're making up a little bit with the switch to gas, maybe new backlog, et cetera. But in terms of positioning here as you exit '18, how do you feel about getting to a neutral standpoint? I know, I think, officially, you've talked about '19, but just how should we think about the cadence? And then, in particular, larger displacement engines, which didn't suffer as much last year. That seems to be worsening this year, payback. But just broader comments there in terms of risks here as we think about the back half and into '19.

One way to look at it, Rich, is on the year-over-year basis, we drop -- the market drops 600 to 700 basis points. And you remember, 1% of shift in diesel-gas mix is, for us, $20 million to $25 million. What we see, and you're right, we see that the headwind declines in '19 due to our growth in gasoline, turbo, EGR and DCT. What we also see is that, overall, as you mentioned, the decline is faster on small diesel than on big diesel. And we also see that the pace of the decline is moderating on a month-over-month basis. We've always managed through those diesel headwinds, and we are -- we will manage those headwinds going forward.

Okay. So it sounds like you feel pretty comfortable about it easing and being able to offset that as you've been doing so.

Yes.

Okay. And then just 2 for Ron. So the noncore emissions business, where are you in terms of settling all that? And then second, I know we've seemed to have a little bit of a respite with regards to tariffs here in the 24 hours. But just any thoughts around whether -- how much 301 is in the back half from China? And then just any initial thoughts on a 232 impact. I realize maybe you're still going through the numbers but any color there would be helpful.

Sure, Rich. So let me talk about emissions first. I would say that the headline is basically we're on track. And what I mean by that is we're doing management presentations with some potential buyers, that should finish up here shortly with final bids coming in. We are moving products out of one of the facilities in Europe. And if all goes well, we're looking at probably an end of a Q3 or early Q4 close at this point. So I would say that, in general, everything is on track. I'm pretty close to the transaction and things are going well there. On the tariffs side, Rich, so I'm going to go through a little bit more detail here on that. So the first thing I'd like to talk about, this -- the commodity inflation of the 232 around steel and aluminum, we have been experiencing already year-to-date. So this is something that's just not new. When this was put in place, we were seeing some headwinds, but we were finding ways to mitigate that, and that really dragged those issues into our results. So that's the first thing I want to note, and that will continue through the year. And I think that the operating folks have done a fantastic job mitigating through the 232 steels and aluminum ones. Now when you get into the 301, we have incorporated, and it's already reflected in our guide, but we are seeing some cost inflation of about a $10 million to $20 million headwind in the back half. But again, like I said, we're working through that and we're finding very -- we're finding a lot of alternative ways to get around this, but it isn't -- it's baked in there. Now you referred to the 232 automotive. That -- I would just say that's a big issue. The numbers are easy to apply because, if you look at our total purchases coming into the U.S. that we're still sorting through, it's significant. And then -- so those will have significant impacts on us, but we're not really finalized with all those calculations. But that's a big impact. And that’s more speculative and going into next year as you know. But it's a big number for everybody, not just for BorgWarner. And then, I just want to comment on NAFTA. That’s still kind of hanging out there. And then there's this extra, what's it, the $200 billion that's across-the-board as well. That's a little bit speculative because they haven't really identified all the components that would come under the tariff. The 301 was -- we can identify components. That's why we came up -- we can identify the $10 million to $20 million. And in fact, in those numbers, we know by component pretty much what the headwinds are. So hopefully, that’s a little bit more clarity around that for you. And I missed anything that maybe -- I'll have Fred to add anything about that as well.

Yes, Rich, what I just wanted to add is that we think that, on a relative basis, we're pretty well positioned since we produce our final product in the same region as our customers' production facilities are. So -- but for sure, the commodities and tariffs certainly impact the business through our supply base. And as you mentioned and it's, I would say, fairly fluid, changes every hour. So our goal is to be agile and monitor those changes and react appropriately going forward.

For your product portfolio, you wouldn't be at a disadvantage versus your key competition with regards to 232 automotive?

We don't think so.

Not at a disadvantage. No.

And our next question comes from the line of Chris McNally from Evercore.

James, Fred, but I know it's been echoed a bunch, but congratulations to you both again. Two questions, so one on Drivetrain and the second on just the environment as a whole in Europe. So when I look at the incremental margin on Drivetrain, despite that the total incremental margin for the company continuing to be in a pretty attractive mid-teens level, we're seeing Engine move into the 20% range in first half despite lower growth, and Drivetrain, with a lower base, still in the lower teens. Can you just maybe give some color when we could sort of see that inflection in Drivetrain as clearly there's a longer-term opportunity to drive margins there higher? And then the second, can you maybe quantify -- you mentioned Europe in Q3 for WLTP as a headwind, would you be able to maybe just put some numbers around that?

So Chris, this is Ron. Let me address the margin question you had on the Drivetrain. If you go back and look at the last 6 quarters, and I could be off a quarter here, Drivetrain margins have actually been outstanding, very high, 15-plus. It was really only Q2 of '18 that we've seen this 12% in quite a long time. So this is primarily driven, like we were talking about, the F-Series is having a drag on incremental margins. So I wouldn't -- I would say that the Drivetrain incremental margins have been outstanding in the prior quarters. And we fully expect, once we get through the transition of F-150, that we'll be back to the mid-, high-teens incremental margins again in Drivetrain. So if you go back and look at a few things, you'll just see this was just one of those quarters. But the exciting part for us was actually -- was the Engine group being up that high [19%]. Because that was the segment that was lower historically. But again, with the emissions business improving for us year-over-year and some good cost controls, the segment -- the Engine segment did well. And then, when you add in the corporate costs, actually we're down. That just leverages us a little bit more for a total company accrual margin. And so the Drivetrain was just a quarter, too, at this point, and I don't think it's going to stay in that range. And then WLTP, Fred?

Yes. So on the -- Chris, on the WLTP certification, I would say that the impact that we may see is already baked in our market assumption. And we don't see any company-specific major impact.

Okay. That’s great. And just a quick follow-up on the WLTP is, if we saw some recovery in Europe in Q4, would you have enough exposure where that could be upside or sort of conservatively baked into your guide?

It's in the band.

It's in the range.

It's a bit too early to know exactly what upside we could see in Q4.

And our next question comes from the line of Noah Kaye from Oppenheimer.

Ron, with the tax rate moving lower to 20 -- towards 26%, is that the right baseline we should think about for future years? How do you see the potential for that to potentially even go lower through tax planning as we look at '19 and '20?

Well, first, thank you for asking the question because I'm actually very excited about the tax rate, but it hasn't come up yet. Good question. When we came into the year, we held our guide at 29%. We did bring it down to 28%. And we knew we can lower the tax rate, but we thought it was going to be a 2019 event. We're extremely excited and actually very happy that the tax department was able to move that up a couple of quarters to 26%. They do have a lot of planning ideas to lower that rate. The question is how low and when? And I think you're going to have to wait for more clarity going forward, unfortunately, Noah. But I will say this, the rate will come down. And I unfortunately cannot give you a number right now because there's a lot of planning activities that we're doing, but we're very comfortable it's going to come down. And again, like I said, unfortunately, I can't give you the timing. But for modeling purposes, you're going to have to wait, Noah, all right?

Sure, sure. But I think that's helpful directionally. And then, a couple of references now to F-Series margin drag on Drivetrain. Would you mind just telling us what that was so we can actually call it out here?

As far as the amount of sales that we've lost in the quarter or...

No, what the headwind was to margins from that, yes, in Drivetrain.

You can basically take $25 million of sales headwind. And we didn't take out the cost. So I'd have to do some calculations and get back with you as far as what the headwinds were, Noah. But it was about $25 million in the region -- in the North America region for us, which -- and if you just tie the standard margin to us, you can get some decent numbers there.

Okay. Great. And then, if I could ask one more. And James, I'll echo what others have said, a pleasure getting to know you and work with you, and the very best wishes on your retirement. And Fred, much success to you in this new role as well.

Thank you, Noah.

I think you talked a bit about the power electronic portfolio, and it looks like you maybe ever so modestly raised the expected 2018 revenue contribution from Sevcon. I guess, as we look at the pipeline for power electronic sales, what are you seeing now is more of a driver? Is it 48-volt mild hybrid? Is it growth in plug-ins? Can you talk a little bit about how you see the future growth opportunities there?

Yes -- no, we see the use of the power electronic portfolio in all of the above. We see an extended product portfolio. For example, on P2 48-volt, on P2 high-voltage, on iDM for electric vehicles. So this power electronic product portfolio is going to be instrumental for our growth, and not only on Drivetrain. It's also the case for eBoosters. So this is part of what we've done already for quite some years and that's [going to] only added horsepower behind it. But power electronics is pretty much in everything we do and will be part of our products as you will see in the Investor Day going forward.

And our next question comes from the line of Brian Johnson from Barclays.

James, been a pleasure working with you, and, I guess, bienvenue to Fred. Just a couple questions, first, short term and then more of a longer-term one. The shorter-term one is, what are you seeing in the European marketplace on diesel? The German OEMs are supposedly saying it's reached a floor for maybe perhaps the longer-range autobahn applications and commercial, where it make sense. But what are you seeing? And then, how is it kind of affecting your thinking this year and next?

Yes. Brian, I wouldn't say that it's reached a floor, but as I mentioned before, the pace of decline is moderating. We still see some decline in the small displacement. So what I would characterize as below 1.8 or 2 liter. And as far as we're concerned, we're managing the diesel mix fairly well, we have and we will the future. And by 2019, we'll be totally agnostic in Europe on that mix due to our really good growth on efficient small gasoline engines.

Okay. Second question, as you kind of think about the role you play with the new product lines around motor -- electric motors and electric drivetrains, and just think about the kind of electric content of those as opposed to on hybrids and the gas, some of the enhancements of the internal combustible engine, part of those. How do you think midterm and longer term about OEMs potentially insourcing that, especially, Fred, in Europe, where, since James' country may no longer -- is no longer part of Europe, or the OEMs have substantial engine and transmission employment base and high-cost unionized plants that they may want to convert into electric motors and electric drivetrains?

I would say that the -- we see many different insourcing/outsourcing strategies. And those strategies are fluid. What it will -- I think, one color I would like to give you is, I think, the insourcing/outsourcing strategy is going to be volume related. And when we will make -- and when we make motors, and depending on the volumes that we produce, when it's made by a supplier, the volume is going to be much, much bigger than if an OEM does it for his own consumption. You have a lot of different factors that are impacting these make-or-buy decisions from a motor perspective. What I can tell you is that we have, in our portfolio, one of the best motor in the world with our [S1] informing process that you will see at the Investor Day. The power density of that motor is one of the best that exists around the world. And in our business, it's all about having the right product to drive efficiency in propulsion, and I think we're really well positioned with the product that we have to offer.

And if an OEM does want to insource some portion of assembly for electric motors and drivetrains as they do, for example, transmissions, do you still see a component business there? And how would that affect your kind of longer-range growth targets?

We will never say no for any business.

And our next question comes from the line of Colin Langan from UBS.

And congrats, James and Fred. Just my first question is very basic, you raised your organic growth range to the high end, but it seems like the quarter was pretty rough from a market perspective. What were the factors that gave you confidence to raise them?

Well, one thing, Colin, you've got to give some consideration is that Q1 was actually a very good quarter for us. And Q2 was -- F-series is going to kind of get rightsized going forward. And we were taking a look at a couple other launches that are coming in the back half of the year in -- year-to-date, we're at 7%, to keep in mind, right? So from what we're seeing in the marketplace, it's shaping up still that we can keep the guide -- lower the lower end of the guide. And I guess that raises the midpoint is what it does. We're just -- for what we're seeing, we're pretty confident about it.

Great. And any color on, you mentioned steel, I mean, how much is just baked into as the headwind for this year? And how much -- is there any recovery help in the second half [that's not going to last]?

Well, yes, so when you talk about the 232 steel portion, like I was saying earlier, we've already experienced headwinds, but we've also mitigated that. We have plans in place as we took -- it came into the quarter for the full year, and we felt that, that was not going to significantly impact our operating results on the steel, and we looked at alternative ways of mitigating that. So -- but it's not really a net number at this point. And if it is, it's an immaterial portion that's not affecting our operating income. The other one I was mentioning, too, was the 301, which is a relatively a new tariff that’s come in that we're still sorting through. But that one is experiencing $10 million to $20 million, and we found ways to mitigate that, that we're working on. But on the steel side, we've done a good job just mitigating it.

Got it. And just lastly, the Sevcon deal gives you sort of the inverter capability, and it seems like a trend of taking the e-motor and merging that. I imagine that might be some of the strategy there. I mean, is that in the product pipeline, a merge to e-motor and inverter?

I don't know exactly what you mean with merge, but an inverter is a motor controller. So having a motor in-house makes the controllability of that motor much easier when you know exactly all attributes of that motor. And our strategy has always been and will always be to position ourselves as being one of the only one in the world, from a battery electric vehicle, that not only specifies but makes the transmission piece, the motor piece and the controller, which is just the inverter. I hope that answers your question.

I guess what I was talking about -- I think in certain vehicles, they are 2 separate actual physical products, and like in some of the recent ones, they're actually 1 large product. Is that in the (inaudible).

Yes, yes. I see, okay. Yes, we -- yes, it's not one type fits all. There is a logic to integrate inverter and motor. I think, on a -- in a battery electric vehicle, what our customers are trying to do is limit the 400 volt or high-voltage cables in the car. And when you combine the motor and the inverter together, that helps you doing that. But we also see other architecture types that would keep those 2 elements separate. It's not because it's separate that it shouldn't work together, like on dual-clutch transmission, the control and the clutch are separate. Nevertheless, they function jointly. So whether or not it is 1 unit or 2 different units, it has to talk to -- both units have to talk to each other seamlessly.

Our next question comes from the line of John Murphy from Bank of America Merrill Lynch.

And James, congrats on a long, very successful career and transitioning the company for the future. And Fred, congrats, but you've got a lot of -- you've got some big shoes to fill, so we're looking forward to it, literally and figuratively, right? So maybe a first question, as you think about all the trade tariffs, everything that's going on right now and the uncertainty, how do you think about capital allocation decisions? Right, I mean, Ron, you kind of went through the list, and it's very helpful and you've obviously thought a lot about this. But I mean, if something changes, right, it could change back in 2 years or 6 years. So like -- so are you just going to have to follow your customers' lead on this stuff? Are there other actions you can take? Because you make long-term capital commitments not short-term capital commitments.

Yes. The first thing that, and Fred mentioned this, John, is that we typically produce in the region that our customers are in. We don't have a lot of cross-border products going. In other words, we don't serve our North American customers with products coming out of China, for example, right? So that's a benefit for us for the first thing. But with that said, the 232 total automotive parts, obviously, if that were to enacted down the road, that would significantly alter our decisions going forward about capital allocation and investments and where we put it. I would say that -- I think the lesson that's being learned here is that you have to remain flexible and balanced as you start to put investments throughout the world. And when you have a policy environment that tends to be unstable, that just means that you have to build in more flexibility in the manufacturing footprint is what we're starting to learn.

Okay. And then maybe a second question as a follow-up to that. I mean, as you look at the rise in the buyback from $100 million to $150 million, does that mean that there are less opportunities sort of internally and as far as acquisitions that you're seeing on the horizon? Or is this just your position looks better -- your financial position looks better and the stock looks cheap to you?

It's what you just said, the latter. Financial position's good and the stock is cheap. It has nothing to do with the outlook on the M&A side. It's just an opportunity to buy stock cheap, you're right.

Okay. And then just lastly, I mean, when we look at Slide 19, it looks like the op income forecast went down ever so slightly, but the actual operations are better. FX is a little bit less of a benefit. So net-net, it's about the same. I mean, given all the puts and takes in the second half of the year that you're looking at Ron, is this a conservative view just based on uncertainty? Because your first half performance has been very strong, and in light of sort of the disruption on Ford's trucks, which should catch up in the third and fourth quarter, it seems like that things might be a bit better than you were initially expecting. But is this a conservative guide? Really, how should we think about your positioning on this?

I wouldn't say it's conservative. I would say that there's a lot of risk factors in the back half of the year that we're focused on right now. And because of all those risk factors, things can move around rapidly for us. So I think we've put in all the risk elements that we're aware of and it's a very realistic number that we hope to deliver here -- actually, we will deliver it.

As I mentioned, we're focused on delivering this guidance, delivering our commitment.

And we have time for 1 final question, and that question comes Armintas Sinkevicius from Morgan Stanley.

When I think about the propulsion-agnostic portfolio that James has assembled here and Fred will be taking over, one of your peers reports a bookings figure for power electronics, and I know you just opened up a technical center. And I'm just trying to think through, when should we start to see some of these power electronics products from Remy and Sevcon start to flow through the backlog and really start to impact the numbers here?

First of all, the power electronics is part of a bigger system, a bigger product that we sell. It's either embedded into hybrid modules or a drive module for electric vehicles. So I don't think you see us breaking down the power electronics portion of what we sell. It is, as you will see in the Investor Day, it is embedded in everything that we sell going forward, and you'll be able to witness that touching the products. But I don't think, going forward, we'll break it down like we won't break down friction versus mechanical or any other pieces of the system we sell.

Okay. Okay. Got it. And then, I guess, just how should investors be thinking about getting comfortable with the growth in power electronics? Just what should we be watching for as far as announcements or disclosures?

Yes, we'll -- we'd love to announce more but we can't. And we are very respectful of the confidentiality that we have with our customers. I think one way to look at it is, if you look at our growth on H&E, a certain portion of it will always have power electronics in there. So that will give you a little bit of light on our growth in this field of product.

Okay. That's helpful. And then one more on the 232 automotive tariffs. You said it was a big impact. Is it a big direct impact as far as direct tariff costs? I know, you said, you produce in country for country. Or does it lead to sort of bigger question marks around the supply chain? Just trying to think through how we should be thinking about the big impact coming.

Yes. As Ron mentioned, we produce where the final product is concerned, so there is -- there will be very, very marginal direct impact, if not any. So it's going to be -- if it comes, it's going to be all indirect.

Thank you all for your very good questions. With that, we'll be ready to close -- Tasha, you can close the call.

Thank you. That does conclude the BorgWarner 2018 Second Quarter Results Conference Call. You may now disconnect.