Logo of jester cap with thought bubble.

Image source: The Motley Fool.

BorgWarner Inc (NYSE:BWA)
Q2 2019 Earnings Call
Jul 25, 2019, 9:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Sharon, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2019 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.

Patrick Nolan -- Vice President of Investor Relations

Thank you, Sharon. Good morning, everyone, and thank you for joining us. We issued our earnings release at 6:30 a.m. Eastern Time. It's posted on our website, borgwarner.com; on our homepage; and on our Investor Relations homepage. A replay of today's call will be available through August 8. The dial-in number for that call is 855-859-2056, and the conference ID is 9052479, or you can simply listen to the replay on our website.

With regard to our Investor Relations calendar, we will be attending multiple conferences between now and our next earnings release. Please see the Events section of our Investor Relations homepage for a full list. Before we begin, I need to inform you that during this call, we may make forward-looking statements, which involves 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'll highlight certain non-GAAP measures in order to provide a clearer picture of how the core business performs and for comparison purposes with prior periods. When you hear us say on a comparable basis, that means excluding the impact of FX and net M&A. When you hear us say adjusted, that means excluding non-comparable items. When you hear us say organic, that means excluding the impact of FX and net M&A.

We will also refer to our growth compared to our market. When you hear us say market, that means the change in light vehicle production weighted for our geographic exposure. Our outgrowth is defined as our organic revenue change versus the market. Now back to today's call. First, Fred Lissalde, our President and CEO, will comment on our Q1 results and our 2019 outlook. This will be followed by a high-level overview of our joint venture agreement with Romeo Power. Fred will conclude with a discussion of our recent product highlights.

Then Kevin Nowlan, our CFO, will discuss the industry outlook as well as details of our results and guidance. Please note that we have posted an earnings call presentation to the IR page of our website. We encourage you to follow along with these slides during our discussion. With that, I'll turn it over to Fred.

Fredrric B. Lissalde -- President and Chief Executive Officer

Thank you, Pat, and good morning, everyone. We're very pleased to share our results from Q2 2019 today and provide an overall company update. Let me start with the highlights of the quarter on slide five. I am pleased with the sequential improvements in our outgrowth. With more than $2.5 billion in sales, we were down about 0.3% organically. This compares to a market being down 5.7%. So our outgrowth was approximately 540 basis points in the quarter, which was ahead of our expectations.

Regionally, we saw outgrowth in all major regions. Our European light vehicle revenue was up 2%, outperforming the industry decline by more than 9%. Our North American light vehicle revenue was at -- up 4% year-over-year with 600 basis points of outgrowth. Our China revenue declined about 10% versus industry production decline of 16%. Adjusted earnings per share came in at $1 with our operating income performance at the midpoint of our guidance.

The higher-than-expected tax rates was a $0.02 headwind. I'm also pleased with our stronger year-to-date cash performance that Kevin will discuss in detail. As we focus on near-term execution in this challenging market, we're also, at the same time, maintaining an equal focus on investing in the long term. In the second quarter, we closed on our Romeo Power investment, which positions us to be a leading player in battery management, and I'll speak about this in a couple of slides.

We also continued to deliver new wins in hybrid and electric, which is positioning us to deliver continued revenue outgrowth. Overall, Q2 was a solid result compared to an industry backdrop, which continued to weaken throughout the quarter. Now I would like to address our full year '19 guidance, which is on slide six. While we were encouraged by the better-than-expected outgrowth in the first half, we expect our full year revenue to be in the bottom half of our prior revenue range.

We expect revenue to be down 2.5% to flat organically. This is based on an industry assumption of down 3.5% to down 5%, with the high end being 150 basis points lower than our prior assumption. We expect our outgrowth to be in the 250 to 350 basis points range for the full year. We expect our adjusted earnings per share to be between $3.75 to $4. This guidance reflects our updated revenue outlook, an additional margin pressures for the continuing production volatility and weaker cost performance from our supply base.

To be clear, we're not satisfied with our margin performance in the full year '19. Margin performance has historically been one of our strengths, and we are focused on maintaining that discipline. In order to meet our long-term margin and cash-generation objectives, we are taking more aggressive steps to adapt our cost structure to the challenges facing our business. This will include more steps to manage our near-term costs and more aggressive restructuring measures than the ones we have previously announced.

While we will continue to manage the current volume environment and cost pressures, we will continue to secure our future growth through new business awards, supplemented with M&A investments. Consistent with this, during this quarter, we announced our plans to enter into a joint venture with Romeo Power who we view as a technology-leading battery module and pack supplier. It's a good fit between the 2 companies: Romeo Power's excellent technologies, and we provide a customer reach and comfort level as well as the capability to apply and produce at scale and globally. BorgWarner will own 60% interest in the joint venture.

It will also complement our existing portfolio and extend our system expertise for electric propulsion. Finally, we believe this joint venture can fill the gap in the marketplace between cell manufacturers and hybrid and electric vehicle makers. Next, I will point you to slide eight, which illustrates our competitive advantage in EVs. The products in blue are products that we now have capabilities to produce in-house. This is what positions us strongly for future growth. We are one of the few with products covering energy management from grid to wheel.

Upstream of the battery, we have onboard charges, and we are active in the stationary charging business as well. Downstream of the battery, we supply motors, transmission and power electronics. We can supply these components individually or as an integrated module. We complement our propulsion offering with cabin and battery-heating technologies for which we also see a strong market growth. And now with our battery pack JV, we can supply the battery pack and thermal management systems as well.

We can develop, specify and manufacture all the major components of a battery electric vehicle propulsion system. Our product breadth is really our advantage. Now I would like to discuss some of our product successes, which are on slide nine. We continue to innovate in combustion propulsion. This quarter, we announced that our innovative regulated 2-stage turbo charging system will be used on BMW Group's latest 2-liter twin-power engine. Innovation is still occurring in combustion propulsion.

Now technologies are helping automakers comply with increasingly stringent regulations worldwide. I am strongly encouraged by our year-to-date wins across multiple hybrid architectures and products for electric vehicle. We have booked hybrid and electric business in Europe, Asia and North America. While we cannot share all of the customers' program-specific details at this time, we have received awards across multiple hybrid platforms, including P1, P2 and P3. One example is a high-volume P3 hybrid system for a major European OEM.

For this system, we're supplying a motor generator unit with power electronics and software, data set and disconnect controls. In EVs, our cabin heaters are also continuing to win new business. Importantly, we expect to see additional wins across hybrid and electric in the second half of 2019, and I am very pleased with this. So let me summarize my opening remarks this morning. Q2 saw a recovery in our growth, as expected, but we expect a challenging second half.

We will take the necessary actions to adjust our costs to the current environment, and we are encouraged by our year-to-date wins in the 3 regions of the world across multiple hybrid and electric vehicle architectures. This positions us strongly for the future. Now let me turn it over to Kevin.

Kevin A. Nowlan -- Chief Financial Officer

Thank you, Fred, and good morning, everyone. Before I review the financials in detail, I'd like to provide you a quick overview of the 2 key drivers of our second quarter results. First, our revenue outgrowth was ahead of our expectations at 540 basis points in the quarter. This was driven primarily by higher volumes of new programs, especially in Europe and North America. We also benefited from some amount of pull-forward of launch volume from Q3, and we remain on track for full year revenue outgrowth of 250 to 350 basis points.

Second, cost pressures continued to be a headwind during the quarter, which drove all-in downside conversion of 27% and prevented us from hitting the upper end of our adjusted EPS guidance range. Nonetheless, we still achieved performance within our Q2 guide, but we're disappointed that we didn't deliver a stronger result. Let's turn to slide 11 where you can see our perspective on industry production. Let me start with Q2. Global light vehicle production came in about 5.7% lower on a year-over-year basis, which was slightly worse than the midpoint of our expectations going into the quarter.

Within that global result, we saw European production down about 7% against the fairly tough comparison from last year. China production was down 16% as that market continues to remain under pressure, and North America declined by about 2%. As we look ahead to the remainder of 2019, we expect that the challenging industry conditions will continue. On a full year basis, we now expect the market decline to be in the minus 3.5% to minus 5% range. The stronger end of this outlook is 150 basis points lower than our prior expectation.

Also as part of our outlook, we're now planning for China to be down anywhere from 10% to 14% on a full year basis, while Europe is likely to be down 3% to 4.5% and North America down 2% to 3%. This new market outlook means we have become even more cautious on China and slightly less negative on Europe. Let's turn to slide 12. Even with the global market down 5.7% in our second quarter, on a comparable basis, our organic sales were down only 0.3% year-over-year. This is the 540 basis points of market outgrowth I referred to earlier, and importantly, this outgrowth occurred in all of the major light vehicle markets around the globe.

In Europe, our revenue was up 2% compared to the 7% industry production decline in the quarter. In North America, revenue was up 4% versus the 2% industry decline in the quarter. And finally, we did see a 10% decline in our China revenue, but the overall Chinese market was down more than 16% year-over-year. Underperformance in Korea reduced our global outgrowth by 100 basis points, and our commercial vehicle off-highway and aftermarket businesses were down about 1% year-over-year. Overall, we're pleased that we continued to deliver revenue outgrowth even in this challenging end-market environment.

Now let's look at our adjusted operating income performance, which can be found on slide 13. Q2 adjusted operating income was $303 million compared to $341 million in the second quarter of 2018. Our adjusted operating margin was 11.9%, down from 12.7% last year. On a comparable basis, adjusted operating income dropped $23 million on $7 million of lower sales. The $22 million shortfall compared to our long-term 20% decremental margins can be explained primarily by our supply chain cost reductions falling short of our targets due in part to the year-over-year impact of tariffs and some of the insolvency issues in Europe.

In addition, we incurred costs in the quarter related to new business launches scheduled for later in the year. Adjusted earnings per share was $1 for the quarter, slightly below the midpoint of our second quarter guidance. Even though the result was within our EPS guidance range, we are disappointed in this result as we anticipated managing the decremental margin better and delivering bottom line earnings closer to the top end of our guidance. In addition, our effective tax rate came in a couple percentage points higher than planned, which reduced adjusted EPS $0.02 in the quarter. We are proud of the fact that we delivered a strong cash flow result for the quarter.

In the second quarter, we generated $300 million of free cash flow, significantly stronger than the $161 million we delivered in the same quarter a year ago. As you know, cash flow has become an important focus of the company over the last couple of years as we drive toward generating $1 billion in annual free cash flow starting in 2023. Now let's take a closer look at our operating segments on slide 14. Engine segment sales were $1.569 billion in the quarter. On a comparable basis, sales for the Engine segment declined only 0.4% or $7 million despite lower industrywide production.

Growth in North America and Europe for our Engine business was offset by the impact of the weaker China end market. Adjusted EBIT was $249 million for the Engine segment or 15.9% of sales. On a comparable basis, the Engine segment's adjusted EBIT was down $19 million on $7 million of lower sales. This weak decremental margin performance was driven primarily by the decline in sales and by supply chain cost performance not offsetting normal decreases in customer pricing.

This is in part due to costs arising from the year-over-year impact of tariffs and costs related to supplier bankruptcies. Drivetrain segment sales were $998 million in the quarter. On a comparable basis, sales for the Drivetrain segment increased 0.2% year-over-year, also meaningfully outperforming the market as growth in North America offset revenue declines in Europe. Adjusted EBIT was $102 million for Drivetrain or 10.2% of sales. On a comparable basis, the Drivetrain segment's adjusted EBIT was down $10 million on $2 million of higher sales.

The decline was driven by higher R&D spending and launch-related costs, primarily in China. Now I'd like to discuss our full year and third quarter 2019 guidance, which is on slide 15. Our guidance is based on the end-market assumptions I discussed earlier with global production down 3.5% to 5%. Despite that, we expect organic revenue to be in the range of down only 2.5% to roughly flat. That's because we continue to expect to drive significant market outgrowth of 250 to 350 basis points for the full year.

We're ahead of that mark through the first 6 months, but we do expect lower outgrowth in the third quarter as a result of the impact of lower launch volumes in China and negative mix in Europe. With these organic growth assumptions, we now expect total revenue to be in the range of $9.94 billion to $10.18 billion. That means we reduced the top end of our revenue outlook by 200 basis points. 3/4 of this reduction is the result of lowering the high end of our market production assumptions, while the balance is driven by the lower backlog that we now expect as a result of those end markets now being lower than before in that high-end scenario.

This lower backlog translates to a decline of a little more than $50 million in revenue from our prior guidance. Our adjusted operating income margin is now expected to be 11.4% to 11.8% versus 12.3% in 2018. The 40 to 50 basis point decline in our margin outlook relative to our prior guidance reflects weaker cost absorption to continued production volatility and lower-than-expected revenue in the second half of 2019, weaker supply chain performance stemming in large part from the continued financial challenges in the supply base and weaker year-to-date margin performance than we were expecting.

Full year adjusted EPS is expected to be in the range of $3.75 to $4 per diluted share. The decline in the bottom end of the range primarily reflects the weaker margin outlook. In addition, our run rate effective tax rate is now expected to be around 27% for the full year versus our prior guidance of 26%. That has an impact of almost $0.06 on our adjusted EPS guidance range. And finally, we are now targeting free cash flow of $525 million to $575 million, which is down $25 million from our prior guidance. Lower earnings are being partially offset by a reduction in working capital.

That's our full year outlook. Now let's touch on the third quarter outlook, starting with sales. We expect organic sales to be in the range of down 1.5% to up 1.5%, which would yield sales of $2.4 billion to $2.5 billion. These expected third quarter organic growth rates are roughly in line with our market forecast, which implies little to no market outgrowth in the third quarter. That's being driven by lower overall volumes on new programs in China and negative mix in Europe. Importantly, however, we expect this lack of outgrowth to be a 1-quarter phenomenon as we see the fourth quarter likely to return to our more recent levels of outgrowth.

And that keeps us on track for the full year outgrowth of 250 to 350 basis points that we've highlighted. Adjusted EPS is expected to be in the range of $0.83 to $0.90 per diluted share in the third quarter. On a year-over-year basis, earnings are expected to be negatively impacted by continued challenges with supply chain cost performance, inefficiencies related to lower launch volumes than planned and higher R&D costs as we continue to invest in electrification-related programs within our Drivetrain segment. Let me wrap up by summarizing how I think about the second quarter results.

We were able to deliver 11.9% adjusted operating margin; $1 of adjusted EPS, which was within our guidance range; and $300 million of free cash flow while also driving more than 500 basis points of market outgrowth. And we did all of that in a very challenging end market. But from a financial performance perspective, we're not satisfied. Our decrementals have been higher than we accept as an organization. We will take the necessary actions to get our decrementals back to target because we fully intend to maintain our company's historically strong margin profile.

And in addition, we remain committed to executing against our long-range plans and delivering on our long-range financial objectives around revenue outgrowth, margin performance and free cash flow generation, even while we manage through a very difficult near-term market environment that we expect to continue for the remainder of 2019 and likely into 2020. With that, I'd like to turn the call back over to Pat.

Patrick Nolan -- Vice President of Investor Relations

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

Questions and Answers:

Operator

[Operator Instructions] And your first question comes from Emmanuel Rosner with Deutsche Bank.

Emmanuel Rosner -- Deutsche Bank. -- Analyst

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

Fredrric B. Lissalde -- President and Chief Executive Officer

Right. Emmanuel, let me start with the market. So we see the full year market down 3.5% to down 5%, which is a change from the down 2% to down 5% that we had back 2 quarters ago. Now it's not the same minus 5%. China is down more, and Europe, we're a little bit more confident that -- than the prior guide from a market perspective. So we want to share realistic outlook, especially in China and in Europe.

From a margin perspective, the first and foremost impact versus our prior guide is coming from our supply base, and Kevin will give you more detail, I guess, in future question. But overall, this is what's happening in market and in margins.

Kevin A. Nowlan -- Chief Financial Officer

Yes. Emmanuel, I'll follow up on that. I mean overall, if you think about the $0.25 drop, and let me just speak to that in the low end of guidance in particular. The $0.05 of that really relates to the tax rate change going up 1 percentage point. So if I put that aside, I'd say the other $0.20 is really coming from operational performance not hitting our objectives, and there's really 3 items that are driving that. The first is, I'd say, our second quarter came in weaker than we were anticipating.

We expected to deliver at the top end of our guidance, and we missed that top end by about $10 million on a pre-tax basis. The second thing I would say is that with the volatility in the global markets and some of the markets coming down more quickly just as Fred spoke to, we're seeing decrementals coming in closer to 30% right now than the 20% that we target over time. And then the final thing was what you touched on, the supplier cost performance coming in worse than anticipated, and that's due to the continuing impact of some of the insolvencies that we're seeing and frankly, just the general macro environment making it more challenging to achieve cost reductions in the supply base. Those are the 3 items that are causing us to take the guide down.

Emmanuel Rosner -- Deutsche Bank. -- Analyst

I appreciate it. Just a quick follow-up on this and then I have a separate second question. But can you give more detail on those insolvencies? Obviously, it seems to be sort of like something that you're speaking about more now than before. The second quarter margins were OK. Obviously, the second half is much weaker than we anticipated. So any level of quantification you can give around what did this use to make for the full year in terms of incremental costs from that?

Fredrric B. Lissalde -- President and Chief Executive Officer

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

Emmanuel Rosner -- Deutsche Bank. -- Analyst

Okay. And then now sort of like maybe looking forward a little bit. So I think sort of 2 of the trends that you're highlighting is taking basically more decisive actions to sort of improve the cost base in light of this market and then obviously sort of like you seem to managing these insolvencies. How should we think about that as we sort of like look forward? Like how quickly can some of these actions show some impact on margins? And should we assume additional weakness from those insolvencies into 2020?

Fredrric B. Lissalde -- President and Chief Executive Officer

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

Emmanuel Rosner -- Deutsche Bank. -- Analyst

And timing?

Fredrric B. Lissalde -- President and Chief Executive Officer

The timing for the -- I think in the next quarter or 2, we're going to give you updates.

Operator

Next question comes from Joseph Spak with RBC Capital Markets.

Joseph Spak -- RBC Capital Markets -- Analyst

First question is just if we look -- if we compare sort of your -- the revision to your sort of the global production versus the revision to your organic growth, it's a little bit steeper for you. It looks like you maybe sort of took down the backlog you expect to come on a little bit this year. Can just talk about what's driving that? Is it slower ramp-ups on some of the programs that were expected to launch, perhaps in China?

And how do we think about the impact to profitability as you capacitize versus sort of a certain level of ramp and that seems it might be coming a little bit softer?

Fredrric B. Lissalde -- President and Chief Executive Officer

So from a backlog perspective, the major impact that we have is, I would say, some of the program delayed and also a program lower volume when we launched, and it's essentially in China. The top end of the guide -- the top end of the backlog is down about $50 million, and the low end is unchanged. If that gives you the color that you need, Joe.

Joseph Spak -- RBC Capital Markets -- Analyst

Okay. And then how much is that? So how much is like lower absorption on that is -- in fact, is driving the margins on the back half?

Kevin A. Nowlan -- Chief Financial Officer

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

Joseph Spak -- RBC Capital Markets -- Analyst

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

Kevin A. Nowlan -- Chief Financial Officer

Yes. I mean, as I look at the 3 things that are really impacting us from a supplier cost performance perspective, the first is we have had the impact year-over-year tariffs. So that's something that's been a headwind year-over-year. The second item is the supplier insolvencies that we talked about, which has provided some headwind to our cost structure this year that we haven't been able to offset. And the third is that general macro environment, which is making it more challenging to execute on cost-reduction strategies in the supply base.

So it's really a combination of those 3 things that's impacting us and causing us to fall short of offsetting normal customer price-downs.

Joseph Spak -- RBC Capital Markets -- Analyst

And those customer price-downs are sort of steady? Or has there been a change there?

Kevin A. Nowlan -- Chief Financial Officer

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

Operator

Next question comes from John Murphy with Bank of America.

Aileen Elizabeth Smith -- Bank of America -- Analyst

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

Kevin A. Nowlan -- Chief Financial Officer

In terms of our market growth -- outgrowth in the first half of the year? Is that your question?

Aileen Elizabeth Smith -- Bank of America -- Analyst

Yes.

Kevin A. Nowlan -- Chief Financial Officer

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

Aileen Elizabeth Smith -- Bank of America -- Analyst

So is it fair to say that perhaps 1Q and then specifically 3Q as you look at your backlog at the beginning of the year, those are the 2 quarters where there is some relative weakness on backlog roll-on versus expectations? Is that fair?

Fredrric B. Lissalde -- President and Chief Executive Officer

I would say looking at the backlog, quarter-over-quarter is really something that is very granular. I think we should -- one should look at the backlog year-over-year. Last year, we had an outgrowth of 600-plus basis points. This year, we will be at 250 to 350. Our long-term target, and we said it's on average, it's 500 basis point above market. But looking at it quarter-over-quarter with the noise of different program launches and stuff like this, it's really, really something that is difficult.

Aileen Elizabeth Smith -- Bank of America -- Analyst

Okay. That does make sense. And I'm not going to ask any questions around the 2020 backlog specifically, but just to give us a frame of reference as to some of the sensitivity on those numbers. Can you remind us what your underlying volume assumptions were through 2021 when you set your backlog estimates, your 3-year backlog estimates at the beginning of the year?

Fredrric B. Lissalde -- President and Chief Executive Officer

So the underlying market assumption is over 1% growth year-over-year and flat on commercial vehicle. And I suggest, Pat, maybe you can take a follow up on that offline.

Aileen Elizabeth Smith -- Bank of America -- Analyst

Okay. Great. And then one last question. The cost restructuring plan that you outlined at 1Q that was help -- intended to help support investment in future technology, did you get any of the benefit of some of those actions in the second quarter? Or is this more likely a 2020 story, which explains some of the pressure on Drivetrain margin with higher R&D and launch costs?

Kevin A. Nowlan -- Chief Financial Officer

Yes. That -- what we alluded to last quarter was intended to do 2 things: one, to help fund some of the incremental R&D costs that we're expecting; and second was to sustain our a strong margin profile. And we expect to get the full run rate delivery of that by the time we exit 2020. And we'll say, though, that there are some cost performance actions that are kicking in, in the back half of the year that's helping our incrementals as we get into the fourth quarter. But in a small way, the bigger impact is in 2020.

Aileen Elizabeth Smith -- Bank of America -- Analyst

Great, that's very helpful. Thanks for the questions.

Kevin A. Nowlan -- Chief Financial Officer

Thank you.

Operator

Next question comes from David Leiker with Baird.

David Leiker -- Baird -- Analyst

Good morning, everyone.

Kevin A. Nowlan -- Chief Financial Officer

Good morning, Dave.

David Leiker -- Baird -- Analyst

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

Fredrric B. Lissalde -- President and Chief Executive Officer

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

David Leiker -- Baird -- Analyst

Okay. All right. That makes sense. And then just one change subjects here for a bit, on Romeo. Can you give a little bit of detail in terms of what that business is today from there are -- I'm sure there are multiple options in terms of who you can partner with. Why did you choose of them? And what kind of customer base do they have? Just if you flesh that out a little bit would be great.

Fredrric B. Lissalde -- President and Chief Executive Officer

So we -- as you know, technology drives whatever we do on M&A. And after having analyzed every players in the battery management system, the thermal management system and the battery, and also, they have flexibility on what type of sales to use, we found that Romeo Power was the best one. And that's why we choose them. They are in production with some low-volume application, commercial volume -- commercial vehicle application, and the joint venture is very simple.

The -- and I think joint venture has to be very simple. They focus on product development, and we focus on customer intimacy and manufacturing at scale and globally. And we are in talks with a few customers around the world for different types of applications.

David Leiker -- Baird -- Analyst

Okay, thank you.

Operator

[Operator Instructions] And your next question comes from David Tamberrino with Goldman Sachs.

David Tamberrino -- Goldman Sachs -- Analyst

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

Fredrric B. Lissalde -- President and Chief Executive Officer

You've heard us talk about the fact that we want to enhance our system focus in electric vehicle and hybrid vehicle. And if you look at all the components that we are making in this slide that shows the components in blue, there was 1 missing pieces that we wanted to add to be having products from grid to wheel. And with having all those products, we felt that we can add value to customers from a system understanding potentially from a product integration path, and so we proactively decided to go into this field.

And I think it is also an element where we think, in addition to the system understanding and expertise, that we can fill the gap between the cell makers that do battery packs and battery thermal management and some of the OEs that do that, too. And we feel good about that.

David Tamberrino -- Goldman Sachs -- Analyst

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

Fredrric B. Lissalde -- President and Chief Executive Officer

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

Operator

Next question comes from Rod Lache with Wolfe Research.

Rod Lache -- Wolfe Research -- Analyst

Hoping you can help me get my head around something here. So the midpoint of your full year EBIT guidance came down by $55 million on an $81 million revision to revenue, if I use the midpoint of your new revenue guidance. So it looks like the bigger change to your expectations were on the cost side. And if I do a simple bridge, that's the first half decremental margin and the revenue decline was 23%, but if I do the same math on the second half, it's 38%.

Maybe you could just elaborate a little bit more on -- it seems like this is a cost thing. And is it costs coming into the platform? Or is it the inability to take costs out due to some of the factors you're describing here with the Tier 2s?

Kevin A. Nowlan -- Chief Financial Officer

Yes. Rod, this is Kevin. I'll answer that. I think it's predominantly what we're seeing on the cost side in a few different ways. And I'll take it in the 3 buckets. And I think the $55 million that you quoted is a good way to think about it. The first bucket I'd say is we expected to deliver better performance in the second quarter from a decremental perspective, and we didn't deliver on that. Some of the reasons because of some of the supply chain performance.

That was about $10 million of that $55 million as you think about it that we expected to be at the upper end of our guidance range. Second is because of all the volatility that we're seeing in the markets, especially with some of the markets coming down in a more accelerated way, we are decrementing at the moment closer to 30% than 20%. Yes, 20%, which is our target and will remain our target, means that we have to take some costs out to be able to achieve that.

But when the markets are moving this quickly, it takes a little bit more time for us to execute, and so we're seeing decrementals at that 30% level. And you can do the math and see how big an impact that is, ballpark, call it, $25 million on a full year basis. And then the final thing is really the supplier cost performance coming in worse than we anticipated for the reasons we talked about earlier. And that's really the bridge for that $55 million-or-so that you pointed to.

When you look at the first half versus the second half, the one other thing, I think, you need to keep in mind as you do a year-over-year causal is that we do anticipate our R&D expense being higher in the second half of the year than the first half based on what we're planning right now.

Rod Lache -- Wolfe Research -- Analyst

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

Fredrric B. Lissalde -- President and Chief Executive Officer

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

Rod Lache -- Wolfe Research -- Analyst

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

Fredrric B. Lissalde -- President and Chief Executive Officer

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

Rod Lache -- Wolfe Research -- Analyst

Okay. All right, thank you.

Fredrric B. Lissalde -- President and Chief Executive Officer

Thank you, Rod.

Operator

Your next question comes from Brian Johnson with Barclays.

Brian Arthur Johnson -- Barclays -- Analyst

Yes. Trying to get to a couple of questions that might be left. In terms of the backlog, how comfortable are you with the 4Q launch cadence, especially -- well, both in China given the macro pressures there and then in Europe given the uncertain outlook for CO2 compliance?

Fredrric B. Lissalde -- President and Chief Executive Officer

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

Brian Arthur Johnson -- Barclays -- Analyst

Okay. And then second, as we kind of start looking at 2020, 2021, your CO2 compliance, can you help us balance out, on the one hand, it would seem to drive additional take rates across your product lines and install rates and how you're factoring that? And on the other hand, it's not lost on investors that the European auto market particularly in the mass market is a disaster from the OEM point of view and only going to get worse as these mandates come in, which could underscore both pricing pressure and/or ability to recover cost overruns. So how do you kind of think about your 2 to 3 outlook in light of those trends?

Fredrric B. Lissalde -- President and Chief Executive Officer

So this is a question that I'd like to answer later in the year. We're currently going through the process of getting our arms around 2020. And with the volatility that we experienced, this is going to take some time. So I'd like to reserve my answer to a little point in time in the year.

Brian Arthur Johnson -- Barclays -- Analyst

Okay, thank you.

Fredrric B. Lissalde -- President and Chief Executive Officer

Thank you, Brian.

Operator

Next question comes from Chris McNally with Evercore.

Chris McNally -- Evercore -- Analyst

I think I have a similar question to Brian's. So I might have questions that you said you could address later. I think what we're all trying to figure out, and my colleague Arndt has been writing about this for some time. Is it fair to say that BorgWarner's sitting here in the middle of the year is very conscious that there is probably a disconnect versus what you see as the gap in 2020 and 2021, sort of fuel efficiency in Europe to meet regulations needs to go up by 20% to 25% in the next 12 to 18 months, and that you have to do something to gain -- sort of gain scenario for that because OEMs are not really admitting to the problem?

There's definitely going to be some repercussions. I think is it -- is that something that you recognize right now? Or are we on the sell side seeing numbers that maybe are skewed, and we're missing something in our analysis?

Fredrric B. Lissalde -- President and Chief Executive Officer

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

Chris McNally -- Evercore -- Analyst

Okay. That's it. So you are starting to at least consider a scenario where in that -- the ends hour, customers come to you with a need for higher adoption rates of fuel-efficient products, whether that's ICE or on the electrification side.

Fredrric B. Lissalde -- President and Chief Executive Officer

We're seeing it, and it's good for us.

Chris McNally -- Evercore -- Analyst

Okay, perfect. Thank you.

Operator

Your next question from Dan Levy with Credit Suisse.

Dan Meir Levy -- Credit Suisse -- Analyst

Just following up on this line of questions. I assume that there's a fairly fluid discussion between yourself and the OEMs on what they're trying to achieve. So could you just give us a sense, the latest thing that you're hearing? OEMs have a number of options of meeting these targets whether it's just more BEVs and PHEVs or to enhance the internal combustion engine or is pay the credit-front. Where does the enhanced internal combustion engine fit in on this? And as it relates to yourselves, I mean, your internal combustion engine portfolio is obviously mature.

It's been around for a while, the hybrid and BEV piece, this is newer. Where are you in terms of capacity on ICE versus the hybrid and BEV piece and ability to meet incremental demand on both sides?

Fredrric B. Lissalde -- President and Chief Executive Officer

All right. So first, again, we're not going to speak to our customers. But we -- since we are pretty relevant in the propulsion area and we have a breadth of product that gets cross combustion hybrid and electric, and that's what we do, right, we have discussion at the highest level at customers. And each customers have different options to meet future regulatory obligations, either 2020 or 2025 or 2030. They have different options.

And each customers are going to take potentially different path and different options, depending on what their fee is, depending on what they are used to do. And for us, we position ourselves as a system supply able to supply and support them in anything they want to do. So it's not going to be a one-size-fits-all. You're going to see a lot of different customers moving in a lot of different strategies and product strategies. And whatever they do, they can do it with BorgWarner.

From a combustion product standpoint, as I mentioned in my prepared remarks, customers are still wanting to bring in their portfolio innovative solution that makes their engines and transmission leaner and more efficient. So we see that pool also.

Dan Meir Levy -- Credit Suisse -- Analyst

Got it. And then just one more, wanted to just follow up on China, obviously, a very challenging market environment, and you're still able to maintain outgrowth in the second quarter. But if I just contrast your current sort of China profile versus the last couple of years where you were experiencing very significant and robust outgrowth in the order of magnitude of 20 to 30 points, just a very robust outgrowth, is there something that's happening in terms of the product mix that's shifting? Or is it now that you're emphasizing more hybrids and electrification that, that uptake is maybe a little slower than I think previously was more DCT? I'm just trying to understand the shift in the China growth.

Fredrric B. Lissalde -- President and Chief Executive Officer

Yes. So 2 things. I'm going to try to give you some color then. First of all, year-after-year, our base revenues becoming higher. So the outgrowth in percent is based on the higher revenue. What you see in China also is that, as I alluded to before, the volumes of the products that are being launched are lower than what we expected in the past because of the macro environment and the customer confidence and other changes this market. You see ups and downs on take rate on that electric vehicle, and that impacts us quite a bit.

Dan Meir Levy -- Credit Suisse -- Analyst

Got it., thank you very much.

Operator

Your next rate comes from Noah Kaye with Oppenheimer.

Noah Kaye -- Oppenheimer -- Analyst

Maybe just a quick one on Romeo. I think you explained your strategic rationale well. Obviously, there's a large ASP or content per vehicle item. Now can you talk a little bit about the backlog that you're seeing or the quoting activity just so as to try to understand what the growth trajectory could look like for BorgWarner to this could be a battery system supplier?

Fredrric B. Lissalde -- President and Chief Executive Officer

Noah, it's still very early days for the JV. We're getting everything ready. We have customer pool. We are in quoting phases. In any case, between now when we quote call and when we launch, most probably, it won't have any significant impact in our 3 backlog.

Noah Kaye -- Oppenheimer -- Analyst

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

Fredrric B. Lissalde -- President and Chief Executive Officer

That is correct.

Noah Kaye -- Oppenheimer -- Analyst

That is correct. Okay and then just on the initial.

Fredrric B. Lissalde -- President and Chief Executive Officer

Initially.

Noah Kaye -- Oppenheimer -- Analyst

Initially, I see.

Fredrric B. Lissalde -- President and Chief Executive Officer

That is correct, initially.

Noah Kaye -- Oppenheimer -- Analyst

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

Fredrric B. Lissalde -- President and Chief Executive Officer

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

Noah Kaye -- Oppenheimer -- Analyst

Understood. Thank you.

Operator

Next question comes from Armintas Sinkevicius with Morgan Stanley.

Armintas Sinkevicius -- Morgan Stanley -- Analyst

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

Fredrric B. Lissalde -- President and Chief Executive Officer

So we don't -- I think we'll see the impact of RDE coming in a few months in a few months. And so right now, hypothesis in Europe is that it's going to be flat second half versus prior year, at the midpoint of our guide from a market perspective. I think it's a bit early to talk about the impact of RDE, at least at our level.

Armintas Sinkevicius -- Morgan Stanley -- Analyst

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

Fredrric B. Lissalde -- President and Chief Executive Officer

So we've always been in products that have potentials of insourcing. And from a battery electric vehicle standpoint, motor and drive motor being a good proxy, our hypothesis is that the available market is going to be 50% of the total market, i.e., 50% of those motors could be insourced. And again, it's not going to be one-size-fits-all. It's not going to be we think 1 customer is doing it all in-house. Some customers are not going to do it. Some customers are going to do some and outsource some.

And even if customers do, let's take motor as a proxy in-house, they will still need components, and they will still need efficient rotors, and we're here to support them also in this. So for us, supplying systems is certainly a target. Understanding system is certainly core. But we are absolutely supportive in selling components, too.

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Appreciate it.

Operator

We have time for one final question, and that question comes from Colin Langan with UBS.

Colin Langan -- UBS. -- Analyst

Okay, great. Thanks for taking my question. When I look at the Q3 guidance, it seems to imply a pretty good step-down in margin. I mean how should we think about margin data? It just seems like Q3 looks a little rough based on the earnings guide, and then it has to pick up a big step in Q4. Is that the case? And why the sequential decline here?

Kevin A. Nowlan -- Chief Financial Officer

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

Colin Langan -- UBS. -- Analyst

And so you should expect though is to jump back up in Q4 to kind of get to full year. So Q4, what will make Q4 so strong?

Kevin A. Nowlan -- Chief Financial Officer

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

Colin Langan -- UBS. -- Analyst

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

Fredrric B. Lissalde -- President and Chief Executive Officer

It would most probably be passed the backlog because this is something that we are quoting kind of now, and SOP would be -- would not be impacting the backlog -- will be impacting the backlog very marginally.

Colin Langan -- UBS. -- Analyst

Okay, all right, thank you very much.

Patrick Nolan -- Vice President of Investor Relations

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

Operator

[Operator Closing Remarks]

Duration: 62 minutes

Call participants:

Patrick Nolan -- Vice President of Investor Relations

Fredrric B. Lissalde -- President and Chief Executive Officer

Kevin A. Nowlan -- Chief Financial Officer

Emmanuel Rosner -- Deutsche Bank. -- Analyst

Joseph Spak -- RBC Capital Markets -- Analyst

Aileen Elizabeth Smith -- Bank of America -- Analyst

David Leiker -- Baird -- Analyst

David Tamberrino -- Goldman Sachs -- Analyst

Rod Lache -- Wolfe Research -- Analyst

Brian Arthur Johnson -- Barclays -- Analyst

Chris McNally -- Evercore -- Analyst

Dan Meir Levy -- Credit Suisse -- Analyst

Noah Kaye -- Oppenheimer -- Analyst

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Colin Langan -- UBS. -- Analyst

More BWA analysis

All earnings call transcripts

AlphaStreet Logo