Visteon Corporation
Q2 2021 Earnings Call Transcript

Published: 30 Jul 2021

[Kris Doyle:]

Good morning. I'm Kris Doyle, Vice President, Investor Relations and Treasurer. Welcome to our Earnings Call for the Second Quarter of 2021. Please note, this call is being recorded and all lines have been placed on listen-only mode to prevent background noise. Before we begin this morning's call, I'd like to remind you this presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future results and conditions but rather are subject to various factors, risks and uncertainties that could cause our actual results to differ materially from those expressed in these statements. Please refer to the page entitled Forward-Looking Information for additional details. Presentation materials for today's call were posted on the Investors section of Visteon's website this morning. Please visit investors.visteon.com to download the material if you have not already done so.

[Sachin Lawande:]

Thank you, Kris. Good morning, everyone, and thank you for joining our second quarter earnings call. Page two summarizes our results for the second quarter. Our sales were $610 million, up 59% year-over-year, excluding currency, while the global vehicle production grew 49% in the same period. While demand from automakers was strong in the second quarter, semiconductor supply was impacted by multiple factors, including the Texas winter storm, the fire in the supplies facility in Japan and the outbreak of COVID-19 in Taiwan and Malaysia. Despite these challenges, the Visteon team did a great job in mitigating the impact to our customers while keeping costs in check. I'm pleased that the company continued to outperform the market in a challenging environment due to supply chain disruptions in the COVID-19 pandemic. I will discuss our sales performance more on the next page. Adjusted EBITDA was $30 million or 4.9% of sales, an increase of $33 million compared to prior year. Compared to the COVID-19 impacted second quarter of 2020, adjusted EBITDA improved due to a combination of higher volume, cost efficiency measures introduced in 2020 and engineering recoveries. While our profitability improved significantly versus last year, it was below our initial estimates for the quarter. This was due to the lower-than-expected sales driven by supply constraints and the slightly higher costs incurred due to open market purchases of critical semiconductor parts. The company's liquidity remained strong, and we ended the second quarter with $470 million of cash and debt of $355 million, representing a net cash position of $115 million. Our product portfolio for digital cockpit and electrification continues to do well in winning new business. I'm pleased to report that we achieved $3.2 billion in new business wins in the first half, returning to pre-pandemic levels of performance. We also launched seven new products in the second quarter and remain on track to deliver above 50 digital cockpit and electrification products for the full year. We believe that long-term business success and the creation of shareholder value are integrally dependent on building our most sustainable business. Recently, ISS rated Visteon in the top quartile in our peer group for our ESG performance. While we are pleased with the progress we have made, we have set more aggressive sustainability targets for the company to achieve by 2025.

[Jerome Rouquet:]

Thank you, Sachin and good morning, everyone. As the industry rebounded from Q2 of last year, which represented the low point of industry production output during the COVID-19 pandemic, Visteon increased sales, expanded margins and improved adjusted free cash flow compared to prior year. Visteon grew sales 59% year-over-year when excluding the favorable impact of currency, outperforming customer production volumes. Adjusted EBITDA improved to $30 million, representing a margin of 4.9%. Through the first half of the year, adjusted free cash flow was negative $7 million. However, Q2 of 2021 had its own set of challenges, driven by constrained supply chain with semiconductor shortages impacting the overall industry, and Visteon was no exception. In Q2, we experienced a significant reduction in parts from key suppliers, including NXP, as a result of damages incurred to their facility from the Texas winter storm; and Renesas following a plant fire at their Naka Factory in Japan. As previously discussed, we established a cross-functional global task force early in the year, which has been working around the clock to optimize supply and minimize the ongoing impact to our customer production schedules as well as to our operations. The task force is in daily communication with our customers and suppliers to align on part availability and was able to provide additional products to our customers through open-market semiconductor purchases. This team has done an excellent job minimizing customer disruption, while at the same time, reducing the impact of fluctuating schedules on our own operational performance. This constrained environment driven by supply muted sales growth in the quarter. However, overall demand for vehicles as well as for Visteon's products remained robust, with initial OEM orders representing an increase from Q1 sales levels. We anticipate that the second quarter represents the low point in supply availability and that supply will steadily increase throughout the remainder of the year. Adjusted EBITDA margins were negatively impacted by lower scale and higher incremental costs associated with semiconductors and premium freight while benefiting from higher engineering recoveries from our customers and savings from previous restructuring programs. Adjusted free cash flow was a slight outflow in the first half of the year, primarily driven by use of cash from working capital. This was partially offset by the continued discipline on capital expenditures. We continue to have one of the best balance sheets in the industry with a total cash balance of $470 million, a net cash position after debt of $115 million and a negative net debt leverage ratio. For the full year, our outlook remains within our guidance range but below the midpoint as sales continue to be impacted by supply chain disruptions and the incremental costs associated with the semiconductor shortages slightly exceeding our initial estimates. Turning to Page 12. Sales in the second quarter of 2021 were $610 million, an increase of $239 million compared to prior year. In comparison, industry production volumes were up 49%, while production at our top customers was up 55%, representing a favorable customer mix on a year-over-year basis, primarily due to the uneven nature of OEM plant closures last year, early in the COVID-19 pandemic. Compared to our top customers, Visteon sales outperformed by approximately 4%. Adjusted EBITDA was $30 million, representing a margin of 4.9%, an increase compared to prior year of $33 million or 570 basis points. Compared to last year, adjusted EBITDA margins benefited from higher volumes, higher engineering recoveries from our customers as well as from our cost reset in 2020. This was partially offset by supply chain cost impacts and the non-recurrence of temporary austerity measures that were implemented in 2020 and have since ended. Net incremental costs associated with the semiconductor shortages were approximately $17 million in the quarter. The majority of these costs resulted from higher purchase prices of semiconductors on the open market through brokers and distributors. In the second quarter, open-market purchases represented two-third of our total incremental costs related to supply shortages. The decision to utilize brokers and distributors was a proactive approach Visteon took to ensure we optimize deliveries to our customers. Compared to the first quarter, the quantity of semiconductors purchased through brokers and distributors decreased as supply reduced. However, driven by high demand, incremental unit cost increased, resulting in higher cost for the company in Q2 versus Q1. Some of the incremental costs also included temporary surcharges from our Tier 2 suppliers as well as higher freight and logistics costs. We are actively negotiating with our customers to pass along incremental costs, and our recovery rate has increased as the quarter progressed, while many OEMs are passing along price increases to customers. In total, incremental semiconductor costs impacted margins by approximately 280 basis points, while lower sales compared to our recent run rate of approximately $750 million per quarter reduced margins by a little more than 300 basis points. When normalizing for these two items and for the higher engineering recoveries, we estimate that margins would have been closer to 9.5% to 10%, which is consistent with our normalized margins over the last few quarters. Turning to Page 13. Page 13 provides an overview of our cash and net cash position at the end of the quarter as well as our adjusted free cash flow for the first half of 2021. Our balance sheet continues to be one of the best in the industry with a net cash position of $115 million and a net debt to the last 12-month EBITDA ratio of negative 0.5 times with no material debt maturities until 2024. Adjusted free cash flow for the first half was negative $7 million, an improvement of $59 million versus prior year. Adjusted free cash flow benefited from higher adjusted EBITDA as well as from our continued discipline in capital expenditures. Capital expenditures were down approximately 50% year-over-year as the actions we implemented early last year continued to drive optimized levels of CapEx going forward. Working capital was an outflow for the first half, primarily driven by an increase in inventory levels. We have been building inventory to manage the variability of OEM production schedules, which will allow us to ramp up output as semiconductor supply increases. Turning to Page 14. Based on the conversations with our suppliers and customers, we currently anticipate that sales, adjusted EBITDA and adjusted free cash flow will all be within our guidance range but below the midpoint. As a reminder, our full year guidance is

[Operator:]

Your first question comes from 1 Luke Junk with Baird.

[Luke Junk:]

Good morning, thanks for taking the question. Wanted to ask about your outlook for the third quarter sequentially. Thanks for that color. What I'm wondering is if you could expand on the visibility into your own supply chain in terms of semiconductor availability and related components, and specifically, whether you're seeing any easing here in July at all as Renesas and the Texas facilities come back online, for example. And to what extent are your insights into your own supply chain informing your view on production as well?

[Sachin Lawande:]

Very good, Luke. First of all, what I would say is, in the second quarter, we had a really challenging supply situation, intermittent supplies that impacted our operations and as well as our customers. We buy hundreds of unique semiconductor parts, and all it takes is one part for us not to be able to build a full product. So, we pay a lot of attention to the supply plans from our key suppliers. We have a good visibility, I would say, into the third quarter and at least with our larger suppliers also into the fourth quarter. One thing to note is that, the semiconductor supply, this issue that we have faced with shortages, has shifted in its nature. Earlier on into the first quarter and in the second, it was more about having enough wafer starts. That has now shifted, and some of the constraints are actually are now in the back-end processing of assembly and test. And late in the second quarter, there were some issues in terms of outbreak of COVID-19 in places like Taiwan and Malaysia impacted supply. Now, those issues have lingered and has impacted us in July, so July is going to be a slow start for us in the industry. And we expect that to then recover from there. So given all that, we feel that we will continue to see improvements in supply in the third quarter and then continue into the fourth quarter.

[Luke Junk:]

Okay. Great. That's really helpful color. Thanks. Thank you for that. My follow-up question is for Jerome, a modeling question and just hoping to get your updated view on net engineering costs for the full year, including how we should think about engineering recoveries in the back half of the year given the uptick that you saw here in the second quarter? Thank you.

[Jerome Rouquet:]

Sure, good morning Luke. So, our net engineering as a percentage of sale has been a little bit lower than our run rate for the first half of the year. We've been running at 7.8%. And we've always talked about being close to 8% for the year. So, that means we'll see a little bit of an uptake in the second half of the year. The benefits that we got in the first half were largely related in Q2 to better engineering recoveries that we've been focusing on. So overall, for the second half, you'll see a percentage increasing slightly to be close to 8% for the full year, which means that in dollar terms, we'll see an uptake sequentially from 1H to H2. And most of that engineering as well cost is going to be, if I could add, related to launch costs that we'll have, launch programs that we'll have as well as new business that we are winning, which requires additional engineering. So, think about it for the full year close to 8%.

[Luke Junk:]

Okay, thank you. I'll leave it there.

[Sachin Lawande:]

Yeah, thank you.

[Operator:]

Your next question is from Shreyas Patil with Wolfe Research.

[Shreyas Patil:]

Hey thanks everyone. This is Shreyas on for Rod. Just following up on that last question. So, you've talked about 8% engineering cost as a percent of revenue. But you are obviously launching more business as you get out to ’22 and ’23, and so there would be presumably launch costs associated with those programs. So, should we still be thinking about that 8% target as sustainable even as your new business activity accelerates?

[Sachin Lawande:]

Yes. First of all, that's a great question, Shreyas. And the answer is yes, because one of the things that we have done very successfully is we have shifted more and more to a platform approach of developing these new products. We're able to leverage the platforms more effectively. We have moved away from building products custom for each OEM like what we used to do in the past. So, we should be able to achieve that level of engineering spend even with our new business wins returning to the pre-pandemic levels.

[Jerome Rouquet:]

What I would add is going into ’22, again, we'll have probably a slight increase in dollar terms, but again, our percentages are expected to be below the 8% going into ’22 and even into ’23.

[Shreyas Patil:]

Okay. And then just also on, you've talked about in the past, it seems like you're starting to -- SmartCore, you're gaining some wins there. You mentioned it's about 30% of your first half new business wins. Can you talk about what you're seeing from the OEM perspective? Are they looking to increasingly consolidate the cockpit domain? And what role are they looking to play in that as that domain is being consolidated? Are they looking to go more downstream towards middleware and app development? Or are they still kind of just looking to basically purchase that from the supply chain?

[Sachin Lawande:]

Right. As the car becomes more and more software-driven, the move towards having more integrated, more capable computers that are running more software that is also capable of being upgraded over the air is really where the industry is headed. And SmartCore, as we have talked about before, is our platform technology that enables you to integrate different components, whether it is the cluster, infotainment and eventually, also ADAS in a manner that preserves all of the requirements of automotive, which are pretty stringent in some of these specific applications. Now these lower-level capabilities are not something that you can hope to develop shortly if you want to bring that in-house. That's not what we see the OEMs wanting to do. Where they will have a role to play is in some of the applications and the user experience that they want to deliver inside the cockpit. The how in terms of the technology is what the suppliers are best suited to deliver. So, we believe that the shift and the transformation that's happening with the move toward more software-driven approaches is really what's going to continue to drive our SmartCore business here in terms of being a greater share of the new business wins going forward.

[Shreyas Patil:]

Okay, thanks a lot.

[Operator:]

Your next question comes from Brian Johnson with Barclays.

[Brian Johnson:]

Yes. Thank you. Can you hear me?

[Sachin Lawande:]

Yes, Brian, go ahead. Good morning Brian.

[Brian Johnson:]

I just want to drill in a bit on gross margins. And obviously, there's lots of puts and takes with the chip shortage. But if you add back the extra engineering expense and some of the one-time things, you're still getting kind of number, I think I get to kind of 15-ish percent. That's a little, yeah, would get you to 16%. You used to run 18% last year. You were in the low 20s before it. So just want some way of thinking about gross margin on kind of a normalized basis.

[Jerome Rouquet:]

Yes. No, it's a good question. In fact, it's pretty simple. It's really all about scale and all about the semiconductor costs, incremental costs that we're getting. So, I think we've talked about the semiconductors 280 basis points for the quarter. And we'll probably we should go into a little bit more detail, so I'll come back into that. The scale is as well maybe a piece that we forget sometime. With $610 million in sales, you're losing a lot of scale. We've got a structure, which is essentially set up for $3 billion-plus. That's how we started up last year when we spent a lot of time reorganizing and restructuring the business. So, if you do simple math and add $140 million in sales at essentially a low to mid-20% margin rate, you get more than 300 basis points extra in the quarter. So, scale represented about 300 basis points as a minimum, and then semiconductor 280 basis points. So, the two add up to almost 600 basis points that we've lost because of the semiconductor supply and as well the semiconductor cost. These comments are valid at EBITDA level. They are very similar at margin level. And at margin level, obviously, you don't have the SG&A, but you do have depreciation, for example, which is backed out of depreciation. So, it's fairly simple. It's all about scale and semiconductor costs.

[Brian Johnson:]

Great. And a more strategic question. We took a group around the Chicago Auto Show, the first in-person one in quite a while. And we're just struck by the perfusion of dual-screen kind of smooth, curved digital clusters. Can you give us a sense of, as you look at your backlog, as you look at your quoting opportunities, one, how big an opportunity is that? Two, is it better business than if you just do either individually the digital cluster or the center screen? And three, can you make even if you don't get the SmartCore on those systems, is that still a high-margin opportunity set?

[Sachin Lawande:]

Yeah, that's a very good question, Brian. And if you think about what that implies, this larger multi-display integrated panels that you are now seeing in cars, it also means that the underlying electronics that's driving those need to be then separated from the display itself. The systems of the past, including some of the digital clusters that we have talked about here on the call, are integrated with electronics and the display attached to each other. We are seeing a separation of that as the displays get larger. And because of that, as the display resolution increases, the number of displays also go up, the complexity and, therefore, content in the electronics that's driving those displays is also going higher. So, it's actually an increase in content driven by complexity across the display itself but also in the electronics. Now we have worked very hard at Visteon to position the company to take advantage of both these trends. So, we believe we have one of the better displays design and engineering capabilities in the company. And we have talked about some of the wins that we have had recently, including in the last quarter. And we see these trends continue. However, there is a certain incremental cost associated with that, that not all of the car models and segments will be able to afford. So, we see a sort of a bifurcation of the business going forward where we will still see this standalone integrated digital clusters, which is very well represented. By the way, this quarter and the win that we talked about, which is a very large win, is an integrated 8-inch cluster with the electronics attached. And this is going to last for a number of years. But that will deliver at a price point that this integrated larger system will simply not be able to achieve for the foreseeable future. So, we see that bifurcation. I think this is really good for the company. And it means certainly an increase in ASPs, especially before those integrated larger displays and SmartCore type of products.

[Brian Johnson:]

And just a quick follow-on. We did see the Grand Wagoneer, I don't know if that's your program or not, but include extra touchscreens for seat and body controls. Is that a trend you're seeing and that Visteon is participating in?

[Sachin Lawande:]

Exactly. So, one of the wins that we talked about, that actually is launched, not a win with Geely, actually has three displays plus an augmented reality head-up display. The third display is exactly a control display with a touchscreen that replaces all of the hard buttons of the past. So that's powered by, again, a SmartCore type of a product more so than independent discreet electronic systems.

[Brian Johnson:]

Okay, thanks.

[Operator:]

Your next question is from Emmanuel Rosner with Deutsche Bank.

[Emmanuel Rosner:]

Hi. Good morning everybody.

[Sachin Lawande:]

Hi, Emmanuel. Good morning.

[Emmanuel Rosner:]

Hey, good morning. Wanted to drill down a little bit more on what exactly is playing out a little bit worse than expected in your full year outlook? In particular, on the top line, you're still assuming 8% LVP growth. The growth of the market is still guided mid-to-high single digits. And so, I guess, what is exactly hurting sort of the revenue to a certain extent? And then just a little bit more clarity also on at the margin level, anything beyond the semiconductor cost?

[Sachin Lawande:]

Yeah. So, Emmanuel what I would say is nothing has fundamentally changed in our perspective on the industry other than that we are living in a semiconductor supply constrained environment. And so, what we see here in the second half is that the supply of semiconductors is going to improve across the board, but it may not be a very even improvement across all of the hundreds of unique parts that we build. Now the reason for that is that the various sub-suppliers have different supply chains with fab suppliers, they are outsourced assembly and test suppliers that are all impacted by the same things that you are hearing about, whether it is excess demand or impacts of COVID, et cetera. Nonetheless, what we expect is a gradual improvement Q2 to Q3 of supply of semiconductors, and we expect that double-digit improvement to continue into Q4 from Q3 levels. Now depending upon exactly how that will play out, that will drive our market outperformance. In the second quarter, some of our clusters were impacted more than the other products, and we expect that to improve. But depending upon the level of improvement, that's going to drive our market outperformance. So, our assumption for our sales for second half assumes that it's going to be an improvement over the first half in general for the industry at about 3% to 4% in terms of sequential second half to first half volume improvement, but a more positive customer mix in the second half for Visteon as compared to the first half. And that's going to drive our overall sales within the range that we have discussed earlier in our commentary between the midpoint and the low end of the range that we had already provided.

[Jerome Rouquet:]

So maybe yes, on the margin side, elaborating on Sachin's comment, so sales will be, for the second half higher than $1.5 billion -- slightly higher than $1.5 billion. So, we are coming back to the scale levels that we've had essentially in Q3, Q4 of last year and even in Q1 of this year. And with this, back to my previous comment, we are back to 9.5%, 10% margin, which is our run rate, which we've demonstrated on a normalized basis in the last few quarters. And the only thing to remove from that is essentially still the leakage that we'll have on incremental supply chain cost. And we're expecting this to be close to 60 basis points for the second half of the year. So that's to be removed from our 9.5%, 10% run rate that we'll see for the second half.

[Emmanuel Rosner:]

Okay. That's helpful. When you’re saying that's to be removed, you mean this will come -- it will reduce the run rate?

[Sachin Lawande:]

Exactly, yes.

[Emmanuel Rosner:]

Okay. Great. And then, I guess, same question, but I guess, looking-forward to potentially past this year. When would you expect based on growth over market, you trend back towards your midterm framework of maybe in the low double digits? And then on the supply chain costs, do you foresee any risk that some of those could actually spill and continue into next year, either in terms of availability to support production or in terms of continued cost inflation that could maybe make it into the contract cost of some of the components you buy?

[Sachin Lawande:]

So, if you look at our market outperformance growth over market, we had a very good year last year in terms of the number of new product launches, and we have a similar level of new products that we're going to launch this year. So, that's working as per our earlier indicated plans, and that's going to drive market outperformance, provided we are able to get enough semiconductors to meet the demand. Now the demand, by the way, even when you look ahead into 2022, although the nature information from our customers should be treated just that as initial data, is very positive. It's higher than what we would have initially expected. There's no doubt that the trends that we're talking about, digital clusters, infotainment, larger displays, et cetera are continuing and are, in fact, picking up momentum. So, if we can get an improvement next year in supply over this year, which we fully expect, and all of our discussions with our suppliers points to that being the case. We expect our growth over market to return to the high single-digit level for next year. And if it improves even more than what we currently believe, then it might even go into double digits. So, we are not going to be limited by demand. We will still be driven more by the level of supply we can get. And as far as the supply is concerned, I think it's really important to understand that 2021, from a semiconductor demand perspective, was a confluence of a few factors that caused the year-over-year growth in the demand to be significantly higher. If you look at the historical performance of the semiconductor industry, growth is somewhere around 5% CAGR. This year, 2021, is going to be more than twice that. Automotive semiconductor demand is going to be a healthy 20% to 25% growth. Now next year, many of the other industries growth expectations are moderating, and even automotive year-over-year is not going to have another 25% growth year next year. So, all of these things point to maybe some of these constraints that we currently have, perhaps lingering into the first half of next year, but then dissipating as more supply comes onboard. I'm sure you have read about more wafers being provided to the semiconductor industry more capacity investments being made into the back end. All of that is going to come into play. And we expect that by the second half, the industry to return to more of an equilibrium between demand and supply.

[Jerome Rouquet:]

And I would add maybe on the cost side, it follows essentially the same pattern. The cost increases that we see are largely driven by this imbalance between supply and demand. So, we still expect to see some level of leakage from a cost standpoint in the first half of next year. And as supply and demand gets rebalanced, this should ease. And if it doesn't, we'll go back to our to drawing board, which is essentially look at our business equation, pricing to customers, purchase price improvement from our suppliers and as well the activities on the manufacturing side.

[Emmanuel Rosner:]

Great, thanks for the details.

[Sachin Lawande:]

Welcome.

[Operator:]

Your next question is from Colin Langan with Wells Fargo.

[Colin Langan:]

Great, thanks for taking my questions. Just first, more of just a clarification. The outlook has $35 million to $40 million in supply chain costs. I think you touched on it a little bit ago. But I mean, can you remind us what it was? I think it was like $14 million in Q1. I think the 280 basis points is around $17 million in Q2. So that means there's just a small impact left. And then maybe by Q4, all these costs surpass. Is that the right way to think about it?

[Jerome Rouquet:]

That is correct. So, $14 million in Q1, $17 million in the second quarter. I think what's really important to understand is what is in the nature of these costs. So, most of them, in fact, two-third of these costs were related to spot buys that we had to make largely in at the end of Q1 and at the beginning of Q2 as we were essentially trying to bridge the supply that was impacted by the winter storm in Texas as well as the Renesas fire. So, a lot of these costs were related to open-market purchases that we've made to bridge that supply. We've seen a fairly significant decrease of these costs as we went into the later part of Q2 and as we were getting a better supply. It's still obviously constrained by COVID outbreaks in Malaysia and Taiwan, but the costs have gone a little bit better in June, and we've seen that as well in July. At the same time, we've been more and more successful negotiating recoveries with our customers. And one way to think about it, for Q2, is that about 85% of our costs in Q2 were incurred in April and May. That means that June was much lower. And we've seen some further improvement in July already as well. So, we are very confident that we'll be able to reduce these net costs for the corporation as we go forward. So, we've incurred so far $31 million in cost, and we are planning to be at $35 million to $40 million net for the full year, which implies to your point a $9 million at the high end of the range for the rest of the year.

[Colin Langan:]

Got it. And just remind me about the BMS win. Is that launching in the second half of the year? And how should we think about that from a cost-to-margin perspective? I mean should we anticipate some higher launch costs as that hits? And then can that get to the 12% EBITDA margin you're targeting long term, given that, I guess, the first platforms probably don't have the same scale?

[Sachin Lawande:]

Exactly. So, it's going to launch in this second half. And as this launch is tend to be, as we've just mentioned, the volumes initially are going to be low and will ramp up as we go forward. But as we project the volumes and our ability to drive costs lower from the initial launch costs, we believe that we will be able to drive this to a 12% margin business going forward, yes.

[Colin Langan:]

Got it. Alright thanks for taking my questions.

[Sachin Lawande:]

Thank you.

[Operator:]

Your next question is from Michael Filatov with Berenberg Capital MK.

[Michael Filatov:]

Hi, guys. Thanks for taking my questions. I guess just to harp on the margin stuff a little bit more. So just thinking about it, you previously said 20% normalized incremental margins for the business. And then, let's say, we add on sort of the $35 million to $40 million of supply chain costs and then we take the low end of the midpoint of your prior guidance, and it seems to imply maybe roughly 8% EBITDA margins, maybe even a little bit lower. Does that sound right? Or is there some sort of upside to the normalized incremental margin from some of the cost-saving initiatives you guys have undertaken recently?

[Jerome Rouquet:]

Hi, Michael. No, absolutely, that's the right way to think about it. Another way to think about it is elaborating on what I was saying earlier. The fact that we are for H2 back to more normalized levels from a sales standpoint and, therefore, more to a normalized level of EBITDA margin 9.5% to 10% to which you deduct the 60 basis point for supply chain cost. The one thing to note, it was highlighted earlier on in the call is the fact that, engineering cost will be probably slightly higher than 8%. 8.1%, maybe 8.2%. So, it's not a huge change versus the full year, but the dollar amount will obviously go up as sales go up.

[Michael Filatov:]

Okay. Understood. And then just around sort of the details of that, the supply chain cost, two-thirds of that is spot buy. I guess what's the reason for the increase, aside from purely just extended disruptions? I mean these temporary surcharges, what visibility do you have to those going away, I guess, in the back half of the year?

[Sachin Lawande:]

So first of all, in terms of the increase, we actually had the number of parts in the second quarter decrease in terms of what was available in the market, but the prices were higher. So, we were paying a higher premium on the open-market purchases in the second quarter as compared to the first. And so, that is in line with what Jerome just mentioned. We see that diminishing as we go forward. On the surcharges that are the temporary increases that we are discussing with some of the suppliers, we do expect that we will recover most of that from our customers as we go forward here.

[Michael Filatov:]

Got it. This is… sorry, go ahead.

[Jerome Rouquet:]

The fact that, so if you look at our 280 basis points incurred in Q2, about 200 basis point is spot buy-related; 80 is essentially premium freight and surcharges. So, and it's pretty evenly split between the two. So, I think once you remove the spot buys, and we are probably a little bit more impacted than other Tier 1 just because of the nature of our business. 80 basis point, I think, is within ballpark to what other Tier 1s have been showing out there.

[Michael Filatov:]

Got it. Thank you very much.

[Sachin Lawande:]

Thank you.

[Operator:]

And your final question comes from Jeff Osborne with Cowen & Company.

[Jeff Osborne:]

Good morning. Just a couple of questions on my end on the semiconductor side, which we've talked a lot about. But I was curious on the SmartCore product, if you've been able to redesign, if you had, let's say, MBUX being Renesas-based, if you've been able to design NVIDIA or Qualcomm to mitigate some of the challenges?

[Sachin Lawande:]

Right. We actually have already two different suppliers for SmartCore. We have Renesas and Qualcomm. We're shipping on both, so we have the ability to switch between those two. And we continue to look for additional suppliers such as Samsung to make sure that we are not single-sourced or limited by supply. Having said that, virtually all suppliers in the semiconductor space have supply constraints. So yes, it is an ability for us to manage. But fundamentally, things have to get better in terms of supply for the industry to get into an equilibrium, which we do expect in the coming quarters here.

[Jeff Osborne:]

Got it. And just very quickly, I believe Jerome mentioned that there was the spot buys had lower quality. Is there any risk to warranty reserves in the second half because of that?

[Jerome Rouquet:]

Lower quantity. Lower quantity.

[Jeff Osborne:]

Lower quantity. All right, my mistake. Thank you. That’s all for me.

[Sachin Lawande:]

Thank you.

[Kris Doyle:]

Great. Thanks. This concludes our earnings call for the second quarter of 2021. Thank you everyone for participating in today's call and your ongoing interest in Visteon. If you have any follow-up questions, please contact me directly. Thank you.

[Operator:]

This concludes Visteon’s second quarter 2021 earnings call. You may now disconnect.