Delphi Automotive's (DLPH) CEO Rodney O'Neal on Q2 2014 Results - Earnings Call Transcript

Aug. 3.14 | About: Delphi Automotive (DLPH)

Delphi Automotive PLC (NYSE:DLPH)

Q2 2014 Results Earnings Conference Call

July 31, 2014, 09:00 AM ET

Executives

Jessica L. Holscott - VP of IR

Rodney O'Neal - CEO and President

Kevin P. Clark - CFO and EVP

Analysts

Rod Lache - Deutsche Bank

Brian Johnson - Barclays

John Murphy - Bank of America Merrill Lynch

Itay Michaeli - Citigroup

Ryan Brinkman - JPMorgan

Ravi Shankar - Morgan Stanley

Patrick Archambault - Goldman Sachs

Joe Spak - RBC Capital

David Lim - Wells Fargo Securities

Emmanuel Rosner - CLSA

Colin Langan - UBS

Operator

Good morning my name is Wright, and I will be your conference operator today. At this time I would like to welcome everyone to the Delphi Second Quarter 2014 Earnings Conference Call. (Operator Instructions).

I would now like to turn over our call over to Jessica Holscott, Delphi's Vice President of Investor Relations. Jessica, you may begin your conference.

Jessica L. Holscott

Thank you, Wright, and thanks for joining Delphi's second quarter earnings call. To follow along with today's presentation, our slides can be found at delphi.com under the Investors section of the website.

Please see slide two for a disclosure on our forward-looking statements, which we will be making on today's call and only reflect Delphi's current view of future financial performance, which may be materially different from our actual performance.

Joining us today will be Rodney O'Neal, Delphi's CEO and President; as well as Kevin Clark, our CFO. As seen on slide three Rod will begin with an overview of the quarter, followed by Kevin, who will review our financial results in greater detail, discuss our 2014 outlook, and then we'll open up the line for Q&A.

With that I'd like to turn it over to Rod.

Rodney O'Neal

Thanks Jessica, and good morning, everyone. Thank you for joining us today. Our continued strong operating performance resulted in record financial results. And as we have in the past Delphi will continue to deliver on the strategic imperatives that drive shareholder value.

Let's move to slide five and before I get into the slide, just let me start our perspective on the current macro environment. Overall our view is that this year’s global vehicle production will increase roughly 3% to just under 91 million units, I expect the U.S. economy to remain relatively strong which should translate into approximately 5% growth here in North America vehicle production. Europe has continued to stabilize and we expect roughly 2% growth for the region and we remain very bullish with the China market, which we expect to expand in the high digit growth rates. The macro environment in South America well, it just continues to deteriorate. We expect vehicle production to decline roughly 15% and as a result we are implementing further restructuring actions to reduce our footprint in this region.

Now let’s just move on second quarter highlights, as I said we had a great quarter; revenue was up by 5%, OI was up 7%, earnings per share up 15%. We returned almost $300 million to shareholders, $220 million in stock repurchases as well as dividends of $76 million. And we remain confident in Delphi and our outlook for 2014.

Let's go to slide six, now this slide is a validation of our ability to execute flawlessly as we continue to receive accolades from our customers. So if you look at the chart, you can see a few examples of the awards that we received this year from a very diverse group of customers. It’s also important to note the number of awards from our fastest growing region, China, China continues to be a very important of our growth strategy. So recognition from our customers there is key. These awards underscore our technology and operational leadership in all areas of our product portfolio.

Let's go to slide seven, so we translate the success we have with our customers into strong financial results and increased shareholders returns. In addition, as I stated before, we further enhanced share value through a very balanced and disciplined capital allocation plan. Through 2016, Delphi would generate roughly $8 billion of operating cash flow. We continue to invest in the businesses, execute on opportunistic share buyback, increase the dividend aligned with earnings growth and execute accretive transactions.

Slide eight, our Q2 bookings were in line with the customer cadence for new business opportunities. We remain confident that we will achieve our target of approximately $26 billion for this year. Our second quarter booking highlights include electrical architecture awards of over $3 billion, a powertrain award Great Wall motors for a diesel common rail in China, almost $1 billion of electronics and safety awards with a nice balance between entertainment and safety, and thermal awards totaling approximately $500 million with several different customers, including BMW.

Slide nine, our priorities for this year remain unchanged and we are focused on one thing and one thing only that is increasing shareholder value. We do this through disciplined revenue growth, further optimizing operating footprint and aggressively rationalizing our cost structure. The introduction of the various technologies that provide solutions to our customer’s challenges all of which will turn its way into expanded margins and increased earnings. And we continue to drive increased shareholder value by deploying capital in a very disciplined manner.

With that I will turn the call over to Kevin to go through the numbers.

Kevin P. Clark

Thanks a lot, Rod. Good morning, everyone. I'll begin by covering our second quarter results, and then provide third quarter and updated full-year guidance. Consistent with our prior earnings call, today's review of our actual and forecasted results will exclude all restructuring and other non-recurring costs. The reconciliation between GAAP and non-GAAP numbers are included at the back of both this presentation and the press release for your reference.

So let me begin at slide 11 with a snapshot of our second quarter financial performance, which Rod briefly touched on. Revenue was in line with our expectations, primarily driven by strong growth in China and North America partially offset by significant weakness in South America. Reported revenue totaled almost $4.5 billion, that’s an increase of 5%. Adjusting for the effects of FX and commodity prices, revenues increased roughly 3.5%, that's two points over Delphi target market. Operating income increased to $547 million and operating margins expanded 20 basis points to a record 15.3% which translates into 15.5% EBITDA margins.

Net income increased over 11% to $432 million, reflecting earnings growth and a lower quarterly tax rate. Earnings per share increased 15% to $1.42 and lastly the operating cash flow totaled $627 million. I will cover each of these items further in my presentation.

So let's move to slide 12 and I'll review second quarter revenue in greater detail. As I mentioned, reported revenue was in line with our expectations increasing 5% to almost $4.5 billion. Price downs of 1.4%, and lower copper pricing pass-throughs totaled $73 million, representing almost a two point headwind to year-over-year growth. These headwinds were largely offset by FX, which added $79 million to revenues and lastly volume totaled $205 million, adding five points of growth.

From a regional perspective, European revenues were as forecasted during our last earnings call, largely unchanged from the prior year; the result of solid growth in our electronics and safety and thermal segments, partially offset by lower revenues in our electrical architecture and powertrain segments, where lower automotive aftermarket revenue more than offset revenue growth with our OEM customers.

North America revenues increased over 7% primarily driven by very strong growth in our electrical architecture segment. Revenues in Asia continue to be very strong, increasing 13%, driven by 15% revenue growth in China. And revenues in South America declined almost 24%. That's a little more than our original expectations reflecting lower revenues across each of our segments as a result of the weakening macro environment. We will discuss this region in more detail when we review our third quarter and full year outlook.

Slide 13 reconciles the year-over-year change in operating income, which increased $34 million or almost 7% to $547 million. The increase was the result of solid operating performance, flow-through in revenue growth and benefits from FX, partially offset by price downs, increased depreciation and amortization expense and increased investments in information systems and engineering. As I already mentioned, operating margins increased 20 basis points 12.2% and EBITDA margins expanded 33 basis points to 15.5%.

Slide 14, includes our segment results; Electrical architecture’s adjusted revenue totaled almost $2.2 billion. That’s up just under 6% from the prior period, driven by continued strong growth in North America and Asia, partially offset by lower revenues in Europe and South America. Segment operating income increased 12% to $298 million, representing 13.8% operating margins, that’s up 80 basis points from the prior year, primarily the result of flow-through on revenue growth and continued very strong operating performance.

Revenue in our Powertrain segment totaled just under $1.2 billion, roughly flat year-over-year, the result of solid revenue growth with our OEM customers, principally in Europe and North America, offset by lower sales of aftermarket product driven by continued markets weakness in Europe. Segment operating income declined slightly to $142 million and operating margins totaled 11.9%, the result of increased investment in information systems and engineering as well as depreciation and amortization expense, partially offset by solid operating performance.

In our Electronics and Safety segment, revenue totaled over $743 million, representing nearly a 3% increase over the prior period, driven by very strong growth in Asia-Pacific, partially offset by lower revenues in South America and the effect of the continued rationalization of our reception systems and mechatronics product portfolio which represented roughly a three point headwind to this segment’s growth rate. Segment operating income totaled $89 million and operating margins decreased to 11.8%, the result of flow-through in sales growth offset by increased engineering spend.

Thermal revenues increased 5.1% to $392 million driven by solid growth in Europe, Asia and North America, partially offset by lower revenues in South America. Operating income totaled $18 million and operating margins increased to 4.5%, that’s up 130 basis points over the prior year, representing the third straight quarter of sequential margin improvement. We expect to exit the year with operating margins approaching 5% in this segment.

Turning to slide 15, earnings per share increased 15% to $1.42 driven by increased earnings, lower share count, and a three point reduction in effective tax rate to 14%.

Moving to the balance sheet and capital deployment on slide 16, we continue to maintain strong balance sheet. Debt totaled $2.5 billion and cash decreased about $200 million from the beginning of the year to just under $1.2 billion, reflecting the normal seasonal investment in working capital and the timing of CapEx spent and over $500 million of share repurchases and dividends. As a result, net debt increased to $1.3 billion representing a net debt-to-EBITDA ratio of 0.5 times.

As Rod mentioned we remain committed to executing a very balance and disciplined capital allocation plan, the M&A environment has improved and we continue to pursue value accretive transactions. We’ve come close to executing transactions couple of times this year. However we remain very disciplined and to the extent we cannot execute on a transaction that meets our strategic and financial criteria during the balance of the year, we will accelerate our pace of share repurchases from the second quarter levels.

Slide 17 details some of the assumptions underlying our updated 2014 guidance, As Rod has already discussed we’re forecasting global vehicle production of just under 91 million units. That represents a 3% increase in global production. Looking at our forecast by region in North America our guidance assumes a 5% increase in production. We’re forecasting European production to increase roughly 2%, that reflects improvement in the Western Europe market, partially offset by decline in vehicle production in Eastern Europe.

In China we’re expecting production growth of 9% and in South America we’re forecasting a 15% decline in production, due to continued deterioration of the macro environment, which is reflected in our third quarter customer build schedules. In light of the continued weakness in the market we have implemented restructuring initiatives in this region to further reduce our cost structure. For the third quarter, we are forecasting global vehicle production of a little less than 22 million units, that's up roughly 4% over last year or just over 3% on a Delphi weighted market basis.

Turning to slide 18 to discuss our 2014 full-year guidance, we expect revenues to be in the range of $17.2 billion to $17.6 billion, reflecting 6% growth, roughly two to three points over the underlying market. Based on year-to-date results and the economic uncertainty in South America we currently do not expect our revenues to exceed the midpoint of our guidance range. On a segment basis, we expect revenue growth in our electrical architecture segment to slow during the back half, reflecting the timing of roll-off and roll-on of new vehicle programs. In contrast revenue growth in our powertrain segment is expected to continue to accelerate driven by the ramp-up of new gas and diesel programs, partially offset by continued softness in the automotive auto market primarily in Europe.

Electronic and safety revenue growth is also expected to accelerate, principally in fourth quarter driven by the continued strong growth of active safety products which we foresee -- which we forecast increased roughly 30% year-over-year, partially offset by the continued headwinds related to the rationalization of our reception system and mechatronics portfolio that I mentioned a little earlier.

Lastly we expect thermal revenues to continue to grow 6% in the back half of the year. We’ve increased our outlook for operating income to a range of $2 billion to $2.05 billion which includes $600 million of depreciation and amortization expense reflecting 11.6% of operating margins and 15.1% EBITDA margins. We have increased our EPS guidance to a range of $4.95 to $5.10 reflecting the strength of year-to-date earnings, a 17% effective tax rate and a share count of 304 million. Cash flow before financing is expected to total roughly $1.1 billion with CapEx still expected to be $800 million.

Turning to the third quarter we expect revenues to be in the range of $4.2 billion to $4.3 billion reflecting a 6% increase year-over-year. Operating income will be in the range of $450 million to $480 million representing margins of 10.7 to 11.2%. EPS will be in the range of $1.10 to $1.18 assuming 303 million shares outstanding and an effective tax rate of roughly 18%. So with that we would like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Rod Lache from Deutsche Bank. Your line is now open.

Rod Lache - Deutsche Bank

Good morning everyone.

Rodney O’Neal

Good morning Rod.

Kevin P. Clark

Good morning Rod.

Rod Lache - Deutsche Bank

Couple of questions, first just on the outlook as you’re looking out to the back half, if the powertrain and the electronics and safety businesses accelerate in the back half, what -- could you just talk to us about what that means for incremental margins? My recollection is that, that those -- the incrementals on those businesses are a little bit above the company average.

Rodney O’Neal

Yeah, I will start with it Rod. Yes, when you look at the Powertrain business especially relative to the mix of Delphi's overall business the incremental margins generally are stronger. You will see stronger flow through on revenue in Q3 especially strong flow through on Q4 or in Q4. A bit of that can be offset by continued investment in IT and engineering. But you will see stronger net flow through on the back half of the year.

Rod Lache - Deutsche Bank

Okay, but doesn't at least preliminarily, didn't look to me like you guys were anticipating better incrementals in the back half. Could you just talk a little bit about and I think you said before like $100 million to $120 million of savings from restructuring and $90 million of higher R&D and IT spending. So what's the sort of cadence of that as you are working through these efforts this year?

Rodney O’Neal

Yeah I think part of what you probably have to keep in mind as you look at and maybe an easier way to talk about it is margin rate, operating margin rates in the back half of the year, principally Q3 and Q4 and year-over-year change. As you know in the third quarter you have summer shutdowns in North America as well as in Europe. You slow down production and then ramp production backup. So naturally you don't operate as efficiently as you do during your other quarters. So there is cost associated with that, that ramp down in volume and the ramp up volume.

I think as it relates to margin rate you will see sequentially a decline in margin rate in Q3 versus Q2 which is logical trend in our business. Then you will very strong flow-through in operating margins in Q4. A part of that is volume related, a part of that relates to restructuring and synergy benefits as you talked about it and a part of it again relates specifically to the mix of business.

Rod Lache - Deutsche Bank

Okay and just lastly could you just remind us it is the aftermarket business in Europe has been a pretty big drag, size that business for us and how significant is that then and any additional color on the types of things that you are looking for when you are assessing acquisitions, what businesses would you be targeting.

Rodney O’Neal

Sure, starting with your last question, in terms of M&A focus it hasn't changed. It really in there around electrical architecture, powertrain and electronics and safety. We have looked at and are looking at opportunities across each one of these segments. As it relates to our aftermarket business, it’s roughly a $1 billion business, about half of that revenue sits in Europe. A significant portion of those revenues relate to powertrain products, roughly 70% of revenues are powertrain products that we manufacturer or resource and stuff and it has been, given the market conditions in Europe, it has been a business that we have seen year-over-year reduction in revenues over the last 12 months. We expect that trend to change beginning in Q4 of this year as we ramp up some new programs.

Rod Lache - Deutsche Bank

Thank you.

Operator

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

Brian Johnson - Barclays

Yeah, couple of question, in therm can you just remind us the rough impact of South America in terms of revenue mix by segment and therefore kind of when we think about the segment growth where South America has had a disproportionate effect?

Kevin P. Clark

Yeah, well South America in total is about 5%, 6% of our -- of total Delphi revenues. We were down across each and every one of our segments in South America. I’m trying to grab the numbers right now, Brian but for Q2 our powertrain segment was down couple of points, our thermal segment was down roughly 25% to 30% of revenues, E&S was down north of 30% and then our EA segment was down roughly in line with the market about 25%.

Our biggest player when you look at revenues for South America, roughly $200 million of revenues during the quarter, about half of that sits in our electrical architecture segment.

Brian Johnson - Barclays

Okay, and kind of second sort of related to headwind question, can you talk to me next about the roll off mechatronic and other things? I guess two questions. One when is that roll off through, is it that something that continues through second half 2015 and second are there other roll-offs to come in other segments that we should be aware of when doing growth [walks]?

Kevin P. Clark

Yeah, it's a trend that we would expect to continue through the first half of next year at roughly the same sort of rate that we talked about this year which is about three point headwind. It's factored into our revenue outlook quite frankly we have given regarding E&S in the past. But we thought it important to give you added visibility to it. Within the E&S division there are no other product lines that are of that size or have that impact and really there with respect to the rest of our segments there aren't -- there are no product lines that have that sort of a headwind impact or trend.

Brian Johnson - Barclays

Okay and final question, a bit more strategic, press reports confirmed by the parties that TRW and ZS are talking. It would appear to be outside of electric steering where is overlap, largely a diversifying acquisition for ZS. In fact some press reports said that their key goal was to bulk up, become and therefore better able to resist price downs from other from OEM customers. I am just wondering how you -- does that change anyway your M&A logic, what’s your position on diversifying acquisitions versus deepening or further focusing the Delphi portfolio?

Rodney O’Neal

I think we have been pretty clear since we went public with our story about how we would approach acquisitions and I think our strategy of bolt-ons is the right one and not trying to getter bigger for sake of bigness. Again when you look at price down, at 1.4% this quarter, it's been in 1.5% almost since our -- we began communicating that 1.5%-2%. It’s one of the lowest in the industry, and the way we plan on protecting our position is not through size but through products that have deep and wide modes from a pricing perspective and so I don't view our acquisition as a differential strategy but it will be a augmental strategy in terms of on-grading our product portfolio. So I guess net-net our bolt-on description on how we would view acquisitions in the space that Kevin outlined powertrain, safety, electronics, software those kind of areas is still the main driver.

Kevin P. Clark

Yeah, and Brian I think to the extent there is diversification it would be in those product areas, powertrain, electrical architecture and E&S, in those product areas where we have strong technical capabilities and it's expanding our product portfolio or it’s taking our existing product portfolio and moving it into markets that are relatively close to the automotive and commercial vehicle market.

Brian Johnson - Barclays

Okay. Thanks.

Operator

Your next question comes from the line of John Murphy from Bank of America Merrill Lynch. Your line is open.

John Murphy - Bank of America Merrill Lynch

Good morning guys.

Kevin P. Clark

Good morning John.

Rodney O’Neal

Good morning John.

John Murphy - Bank of America Merrill Lynch

Just a follow-up on M&A, I mean Kevin you alluded to being involved a bunch of potential transactions this year. Just curious, when you think about the size of those transactions, I mean are you looking at sort of MVL type of acquisitions as bolt-ons sort of $1 billion revenue companies or are they much more than that?

Kevin P. Clark

It's a good question John. It really ranges I mean from small as a couple of hundred million to as large as a billion dollars or little bit more.

John Murphy - Bank of America Merrill Lynch

But that $1 billion range is where you kind of would limit bolt-ons. I mean as you get above that it becomes a more -- I mean not completely transformational but that would be…

Kevin P. Clark

Yeah, I think it depends quite frankly on what the business is, what their product lines are and the level of integration is. I would say to the extent we get -- approach a transaction that's above $1 billion or a bit above $1 billion obviously it's something we take a step back and further scrutinize.

John Murphy - Bank of America Merrill Lynch

And you would be willing to take on a decent amount of leverage to do a larger deal if it made sense.

Kevin P. Clark

Well I think we would be willing to increase our leverage as long as there is a path back down to deleverage, so that we could maintain our investment grade rate ratings.

John Murphy - Bank of America Merrill Lynch

Then just a second question, if we think about South America and you guys alluded to restructuring down there. Obviously it's a small part of the overall business. I mean how much restructuring are you going to doing, what does it really entail, it really just entails downsizing and really ultimately what is sort of the necessity for you to be in South America.

Kevin P. Clark

Well I will comment on the size of restructuring and Rod will comment on the strategy. With respect to incremental restructuring initiatives in this quarter, the charge will be roughly $34 million. A bulk of that will relate to initiatives in South America, principally Brazil. It's primarily headcount reduction. Our plan is to take a fairly significant reduction in overall headcount in that region, in light of the weak volume environment today and what we are forecasting to be a weak market on a go-forward basis.

Rodney O’Neal

And the reason we are there obviously is because many of our global customers, particularly with some of the global platforms, we have to service in that region. So that's why we are there. It has been, it will continue to be an important market of -- as we all have seen over the years, it does tend to come and go. It’s a very big piece and so we just -- we can't exit but we can minimize our presence and that's where we are particularly until these governments down there do some things to make the fiscal policies a bit more conducive for capital influx. So that's why we are there.

John Murphy - Bank of America Merrill Lynch

Okay and then just lastly if you look at the margins in the quarter, I mean they were the best that we have seen in any quarter really in last four or five years and there is always this question of you reach some -- product limit or not, you’re behind on margins and you just keep going higher and higher. Do you think at this point you are sort of inflaming any attention from your customers or is there the potential for continuing margin expansion, particular as the mix of your business improves the higher margin product.

Rodney O’Neal

Sure, thanks for first of all recognizing the margin expansion and I think all that we are doing is proving out what we said we would do, which was we [thought] our margins although that wouldn't be where we would say that would be our end destination, we thought we could get to 16% range. And I believe we said we’ll get there by 2016. And so all you are seeing is the movement in the direction that we said, we do. The team is doing an excellent job of executing on the plan that we laid out.

And so I still think there is room for expansion, particularly as I go through, visit the various regions and parts of our company. As good as we are there’s improvement for us to do better as a result we are not maxed out in terms of being able to bring more cost out this machine. And so I feel good about that.

In terms of customers looking at our margins to be quite frank and my dialog with the customers are pretty complementary in the way we run our business and we’re not as focused on our margins as they are on the market cost. So there I mean we have a very competitive product portfolio. So I would -- I don't see the pressures of being anymore because we make money. I mean after the prices I think there is an appreciation of a supplier that can create tremendous return. So we don't see any more pressures than we ever have in terms of the commercial line of sight.

John Murphy - Bank of America Merrill Lynch

That's great news. Thank you very much.

Operator

Your next question comes from the line of Itay Michaeli from Citigroup. Your line is open.

Itay Michaeli - Citigroup

Great thanks, good morning, everyone.

Rodney O’Neal

Good morning.

Kevin P. Clark

Good morning.

Itay Michaeli - Citi

Just on electrical architecture another strong margin quarter. I think you are north of 16% now on the year. Maybe talk a little bit about that, the drivers there, maybe how much of it was favorable regional mix with Asia being strong? Then how should we think about 2016, I mean it's potential upside to your previous target of 16% margin in 2016?

Kevin P. Clark

Listen, Itay it's Kevin, the electrical architecture business continues, as Rod commented earlier, executed extremely well. We are getting the balance of flow-through in volumes. We are operating extremely well. We are getting the benefits of improved mix partly as the result of the MVL acquisition and the impact of selling more connectors, certainly delivering on the MVL synergies. So it's a basic story of a combination of delivering on the revenue growth and the operating execution. I think as we look at our larger margins in that business -- that we got to revisit what the longer term targeted margins, I think we are there. We will update people on that next year.

As it relates to margins by and he talked about mix of revenue growth and profitability. Again when you look at Delphi and you look at revenue mix by region, the profitability or margins are actually fairly tight around the corporate average, given the weakness in South America this last quarter, margins there certainly have deteriorated but on a more normalized basis. They tend to group around the corporate average and that's true with the electrical architecture segment. So it really is not regional mix.

Itay Michaeli - Citi

Great, that's very helpful and just secondly on slide 13, just on the net performance versus price down, I think this is maybe the third quarter in a row where that relationship has been slightly negative. With the restructuring you are doing do you expect that to normalize in the next several quarters or even couple of years towards sort of even or do you think you can kind of grow to your margin targets with that kind of remaining slightly negative.

Kevin P. Clark

Yeah, you are going to see -- you will continue to see improvement especially in the back half of the year. You got to remember, we talked about spending incremental dollars on information systems and engineering growth related investment on a year-over-year basis. That chart includes about $10 million of that and if you recall last year we talked about some one-time items in E&S and our powertrain segment totaled roughly $10 million. I think when you normalize for those two items you get much closer to closing that gap between price downs and performance.

Itay Michaeli - Citi

Great and just one last quick housekeeping, any sense of what the backlog contribution was in the first half of the year, I think the $800 million or so full year.

Kevin P. Clark

I haven't looked at it. It would be weighted towards the back half of the year quite frankly just given timing of launch schedules. Roughly you look at it, roughly 65% or 70% of our launches happen in Q3, Q4 versus the front half of the year.

Itay Michaeli - Citi

Perfect, great. Thanks so much everyone.

Operator

Your next question comes from the line of Ryan Brinkman from JPMorgan, your line is open.

Ryan Brinkman - JPMorgan

Hi, good morning. Thanks for taking my question. Regarding the thermal business, it looks like the improving revenue trend that emerged in 4Q has continued and EBIT margins were actually up there I think 130 basis points, after declining year-over-year for something like eight out of the last nine quarters. So can you talk about what is driving this improvement trend and how you expect it to progress and then maybe separate to that, if you could sort of remind us of your latest thoughts relative to corporates and non-corporate thermal and if that is impacted at all by the improving performance?

Rodney O’Neal

Yeah, I think what you are seeing in the thermal improvement, what we said were that, one, the topline would improve because the team had achieved a considerable amount of diverse bookings in the past and that's starting to roll on. And so what you are seeing is the topline expanding as the result of the business rolling on. And then you get the multiplying effect of improved operational performance and so as you go through the motions of actually removing cost, executing on the launches and sort of drastically with top line moving and the cost coming out, you just see things moving north. So we expect that cadence to continue its northward trend and as you recall out our objective is to be double-digit EBITDA margins in that business.

Kevin P. Clark

So I can add in there, as I said in my prepared comments, we would expect to exit the year with operating margins at or around roughly 5% EBITDA margins of roughly 8.5%. So we expect to continue to see some improved performance in that business, partly driven by just solid execution.

Ryan Brinkman - JPMorgan

Okay. Great thanks and then just on the new business bookings can you kind of talk about the fact that they are not higher year-over-year. Is this maybe just a function, I mean is it a function of maybe being more selective relative to the margin profile of business you are willing to take on. Or you have not really change anything there and it’s just due to some sort of normal lumpiness or variability in pace of bookings?

Kevin P. Clark

I think it’s all of the things you talk about and so just in the cadence, the normal cadence what we are seeing but we are very selective because it's very important to be that in this business and so it's all of the above but primarily it's just the cadence of the programs that are probably rolling out this year.

Ryan Brinkman - JPMorgan

Okay, that's fair and then just last question then on organic growth versus industry. Obviously you are out performing in North America and Asia inline with South America, Europe was a bit below again. In the past you have pointed some explanatory factors there such as the greater portion of commercial vehicle or after market exposure, sometimes you’ve talked about changing mix of diesel versus gas. Just you just kind of share how those factors fared during the quarter and how they might fare going forward and then if possible too can you just kind of cut to the chase, sort of say what your organic growth is for the OV light vehicle business in Europe, which is what may be like 70% or so I think of your revenue there, how that trended maybe versus the industry, was up 2% or so for HIS?

Kevin P. Clark

Yeah, I’ll make sure get all the questions here. So listen, I think when you talk about headwind in Europe for the quarter it really a couple of -- the primary aspect for us as a business was the automotive aftermarket. Weak market, our revenues were not strong in that market. We talked about -- that’s a segment that or a division that has roughly $500 million of this $1 billion of revenues in Europe. So we were affected by that slower market. You exclude automotive aftermarket. We grew roughly at vehicle production in Europe. So OEM growth was at production, slightly stronger than that in our powertrain, our E&S and thermal businesses, a bit below that in our electrical architecture business, when you look at customer mix.

Ryan Brinkman - JPMorgan

Great, that's very helpful to know. Thank you.

Operator

Your next question comes from the line of Ravi Shankar from Morgan Stanley. Your line is open.

Ravi Shankar - Morgan Stanley

Thanks, good morning everyone. Just a couple of questions on E&S again. So the year-on-year step down in margins and even the revenue growth is a little bit below what you were expecting. Was that entirely attributable to the mechatronic business and can you give us little more color there on why that transitions happening and what the margins of the business is like?

Kevin P. Clark

You are asking what's the growth for our -- the year-over-year in E&S business was exactly in line with what our expectations were as we headed into the fourth.

Ravi Shankar - Morgan Stanley

Okay.

Kevin P. Clark

I would say it was a bit stronger in all regions with offset in South America. So [nettings] are coming in line. The headwind as it relates to reception systems in mechatronics was as forecasted, as expected. I would say no surprises at the end of the day there, Ravi.

Ravi Shankar - Morgan Stanley

Got it and why is the mechatronic transition happening? Is that you’re giving up that business because you think it's not necessarily value added or is there something happening at the customer side?

Rodney O’Neal

Well, as a reminder one of the things that we said we were doing with that business and its portfolio was rotating away from the traditional more hardware and more software, visiting more sensing areas. And so this really part of the portfolio realignment to increase margins and above all drive return on invested capital. And remember I think (inaudible) as it is that we talked return on invested capital in this business would be breathtaking and I think it's proving to be true. So that's really all we are doing probably is continuing that journey and we are just doing what we said we are going to do.

Ravi Shankar - Morgan Stanley

That's a good point Rod. So if you were to look at the E&S business is it possible quantify what percentage of revenues today comes purely from software and what's the margin on that portion of business might be?

Rodney O’Neal

A lot of the software is embedded into the product. In terms of our, the pure play, that's just starting -- do we have the pure -- we don't really do it that way. It's embedded in lot of our products but I guess we’ll come back to you on it, Ravi what do you think.

Kevin P. Clark

A lot of it embedded in our product.

Rodney O’Neal

It’s not as if as we are producing some of the hardware now, we just buy it and we create the value through the software and make it work. And so that’s what you see in lot in our portfolio in this business. We will come back to you in terms of what the software number is okay.

Ravi Shankar - Morgan Stanley

Sure and then I just had a couple of quick follow-up. Kevin just to clarify what you said earlier on the call, when you have the new launches in the Powertrain business come in the second half of this year especially in the fourth quarter, you don't expect those new launches to be margin dilutive right?

Kevin P. Clark

No, we don't. We don't.

Ravi Shankar - Morgan Stanley

Okay and just lastly on the tax rate you obviously had an important development in the -- couple of months ago. Your press release kind of made it sound like you weren't sweating -- I don't know what was happening with the IRS. Can you just give us an update here and what kind of catalyst we shared or which are the points we should look out for?

Kevin P. Clark

Well listen what we feel is that we have a very good position. We feel very strongly about the nature and the structure of our transaction. We expect the appeals process to start at some point in time in 2015, hopefully early in 2015. It will take one to maybe two years, hopefully it’s shorter versus longer in terms of how we are managing our business and our capital allocation strategy. That process has no impact on it. So we will continue operating as we operate today. Does that answer your second question?

Ravi Shankar - Morgan Stanley

Yes, yes that's very helpful. Thank you so much.

Operator

Your next question comes from the line of Patrick Archambault from Goldman Sachs. Your line is open.

Patrick Archambault - Goldman Sachs

Hi, thank you very much. Good morning, I guess just there has been a lot kind of discussed on the margin trajectory but I guess tying things together sort of a first half, second half view, it does look like your -- kind of the incrementals that you have are accelerating in the second half implied by your guidance. That seems to dovetail with what's kind of been talked about here but I just wanted to make sure, we have kind of the right puts and takes. It sounds like you do have some of this restructuring that will help both ongoing and some of the new stuff from South America, you have the new launches in Powertrain and then potentially some mix tailwinds as well if I am not forgetting anything. So I just wanted to make sure, I was thinking about that correctly as we think about modeling the back half.

Kevin P. Clark

I think as you talk about flow-through, flow-through on incremental, incremental sales [downwards], second half versus first half you will see incremental flow-through most of that from a timing standpoint will be in Q4 versus in Q3 because Q3 just the natural, the natural summer shutdowns in North America and Europe affect operating productivity and performance. When you look at back half versus first half that certainly is the case, most of it will be weighted to Q4.

Patrick Archambault - Goldman Sachs

And kind of that catalog of items there that I just cited are pretty much the right ones to be thinking about?

Kevin P. Clark

They are the right ones to be thinking about.

Patrick Archambault - Goldman Sachs

Terrific and then last one for me is just your commentary on M&A it's sounds like from what you said that, you had a few things that got close and that kind of fell apart at the altar, what -- why is that, is has just been, dispute on valuation have things become more difficult to close, given the run in some of these shares or were there other issues at hand and I guess how you are feeling about closing on your targeted levels of acquisitions now relative to maybe a quarter ago?

Kevin P. Clark

Once we got close on -- in reality it ultimately didn't end up being about value but ended up being about potential contingent liabilities that could come with the business, which I guess at the end it gets factored into value. But if you want risk of those liabilities versus the view that another buyer would potentially pay.

Patrick Archambault - Goldman Sachs

Got it and then how do you assess your ability to close some of these acquisitions now -- I mean that doesn't sound like a fundamental thing, that sounds actually quite stock -- company specific. So how are you assessing the environment now?

Kevin P. Clark

It’s no different, again we are very active. We are looking at lot of opportunities, we have strategic and financial thresholds and metrics that we hold out there and use to evaluate opportunities. They need to meet those parameters. I think given where we are at this point in time of the year it's probably unlikely that we close a transaction this year. I think it's very possible we can announce something.

Patrick Archambault - Goldman Sachs

Okay, great that's very helpful color guys. Thank you very much.

Kevin P. Clark

Thank you Patrick.

Operator

Your next question comes from the line of Joe Spak from RBC Capital. Your line is open.

Kevin P. Clark

Hi Joe.

Operator

Joe's line may have dropped. Joe if you could just re-queue by pressing star one. Joe is back. Your line is open.

Joe Spak - RBC Capital

Hi, can you hear me?

Kevin P. Clark

Yes.

Joe Spak - RBC Capital

Hi sorry about that. So just two points of clarification one on the confidence on the powertrain business not being margin dilutive, is that a function of some of that business has already started up and it's just continuing to ramp a little bit more or is it really that this is some higher margin business or potentially mix related, that's not margin dilutive because if it is sort of new business, I would have thought that the incrementals were a little bit lower during the startup?

Rodney O’Neal

Yeah, we have talk about this in the past, in reality we are always launching programs. We launch over a thousand programs a year. They tend to back half weighted, but you could argue we are in perpetual launch. You are right in terms of getting business ramped up, it tends to not be as profitable as business that you have been running on for period of time. But just given the puts and takes in our business it’s not -- they are not programs we would call as margin dilutive. They are programs quite frankly that we did start launching in late in Q2 and we are continuing to see ramp up in volume. So there is partial benefit from that. But all of those, the launch which you call efficiencies are in the number that Kevin outlined, so it's…

Joe Spak - RBC Capital

All right thanks, that's helpful. And then just thermal good to see some contraction there and sounds like a strong exit rate for the year. I guess just two questions related to that, should we -- it's seems like historically there was a bit of lumpiness in there. So is it -- should we see sequential improvement from here to the fourth quarter and then as we think about ‘15 is that exit rate a solid base to think about that business.

Kevin P. Clark

Yeah, I think just given again the summer shutdown pattern in North America and Europe I would expect margins in the thermal business to be flat to slightly down Q3 versus Q2 and then up significantly in Q4.

Joe Spak - RBC Capital

Okay and then in terms of…

Kevin P. Clark

As you head into 2015, it's a business that will continue to have solid revenue growth and as the result solid margin expansion and flow through volume as well as operating execution.

Joe Spak - RBC Capital

Okay great. Thanks a lot guys.

Operator

Your next question comes from the line of David Lim, Wells Fargo. Your line is open.

David Lim - Wells Fargo Securities

Hi good morning everyone. Just wanted to ask a quick question about commercial vehicles both on and off road. Just wondering how did CV affect the quarter and where do you take going just to remind us, is CV revenue heavily related to Powertrain?

Kevin P. Clark

Yes, CV revenue is heavily weighted towards Powertrain, our heavy duty diesel business.

David Lim - Wells Fargo Securities

And -- yes go ahead sorry.

Kevin P. Clark

Your question was -- is what was the impact on the quarter?

David Lim - Wells Fargo Securities

Yes, and going forward your thoughts there?

Kevin P. Clark

Sure, well the CV market, the market -- the production schedules, we ended up relative to where we expected it to be as we entered the quarter. The market was weaker, principally in Europe, Asia was a bit weak as well as South America. We saw high single digit growth in our heavy duty diesel business and even in light of that so we see a continued ramp up of revenue in that product category. We expect it to continue during the balance of the year. A part of it is launch of the new program that we touched on, part which is driving growth within our Powertrain product portfolio. But for the full year we would expect the CV market to be not quite as strong as we expected it to be three or four months ago, growing but not growing at the rate we originally estimated or the industry originally estimated.

David Lim - Wells Fargo Securities

And any preliminary views on 2015 related to the commercial view?

Kevin P. Clark

Not at this point in time.

David Lim - Wells Fargo Securities

Thank you very much.

Rodney O’Neal

Okay.

Operator

Your next question comes from the line of Emmanuel Rosner from CLSA. Your line is open.

Emmanuel Rosner - CLSA

Hi good morning everybody.

Kevin P. Clark

Good morning.

Emmanuel Rosner - CLSA

Wanted to ask you, a question about your outlook for the ability to keep outgrowing the market growth. Obviously this quarter we saw maybe a couple of points of outperformance versus your geographically adjusted production, seems like you are gaining through sort of say maybe two- three points for this coming quarter. Yet at the same time when you look at $800 million backlog that would have been probably like more maybe five points of outperformance, but more importantly looking mid-term we could -- the backlog numbers we’ve given would probably translate into six, seven points. So I am just curious are we going to start seeing an inflection point later in the year, so let's say maybe fourth quarter this year where things are going to start picking up meaningfully in terms of your ability to outgrow the market.

Kevin P. Clark

Yeah, I think what you will see in Q3 principally in Q4 is growth relative to market increasing in comparison to where we were in first half of this year. So you will see a continued acceleration in that growth relative to market.

Emmanuel Rosner - CLSA

And that's principally a function of the timing of the launches of the new business.

Kevin P. Clark

Timing of new programs, customer mix, it’s a few items, but principally timing and new programs.

Emmanuel Rosner - CLSA

Okay. And then one final one for me M&A you’ve obviously given lot of good color. One of your earlier prepared remarks was saying that the environment has improved. Can you maybe tell us sort of in what way, is it just in terms of number of opportunities you are being presented with or do you generally feel like there is something else out there that's getting better.

Rodney O’Neal

No, we would say it's opportunities. There are more opportunities that are being presented. Sellers are more willing or potential sellers are more willing to have discussions about separating some assets.

Emmanuel Rosner - CLSA

Understood, thank you.

Operator

Our last question comes from the line of Colin Langan from UBS, your line is open.

Colin Langan - UBS

Great, thanks for taking my question. Any color on the pace of the purchases you mentioned you think it's likely may -- you probably won’t close a deal but may announce something, I mean that does give a lot of timing, should we think purchase should pick up in the second half them if you are not going to be closing on a deal.

Kevin P. Clark

Yeah, Kevin, that's a good question. We bought $220 million in Q2, I would expect without closing on a transaction for that pace to increase slightly maybe be run at a rate of $250 million a quarter, assuming we are not going to close on a transaction this year or early next year.

Colin Langan - UBS

Okay and then looking at the Powertrain margins were down year-over-year. I am not sure, if I missed this in your comments but was that partly reflecting the commercial and legal settlement last year or was that the segment where that was a help last year?

Kevin P. Clark

Yea, there is a little, that was about $5 million. So there is a little bit of that and then the other piece is just you know, net-net flat sales.

Colin Langan - UBS

Okay, and just lastly just the kind of, your organic growth is only 3% this quarter, isn't too far from global production. Can you just remind what are the reasons why you had this, you not outperforming the way you would normally and what are the main factors and really, more importantly when those maybe [side] going forward?

Kevin P. Clark

Well organic growth was 3.5% of weighted markets, so it’s about 1.6%. So we grew above markets and yes if want to look at global vehicle production and assume we are on -- our mix matches global vehicle production you could have a different view but that will vary each and every quarter. The big headwind to growth rate, quite frankly this year has been the aftermarket business for us. That's been a significant headwind. South America clearly has been a market that's been challenged and our revenues been challenged there. But in our view relative to revenue growth we are in line with exactly where we told people we would be at this point of the year and you will see it continue to accelerate in the back half of the year.

Colin Langan - UBS

Okay, all right thank you very much.

Operator

We have no further questions on the line. I would like to turn our call back over to Jessica Holscott.

Jessica L. Holscott

Great. Thank you for participating in today’s call. As always, we’ll be available for any additional questions you may have after the call today. Thank you.

Operator

That concludes Delphi second quarter 2014 earnings conference call. Thank you for joining. You may now disconnect.

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