Adient plc (ADNT) Earnings Call Transcript & Summary

Good morning, everybody, and thank you for joining us for this session with Adient as part of Deutsche Bank's Global Automotive conference. My name is Emmanuel Rosner, and I'm the Senior U.S. Autos Analyst at Deutsche Bank. Adient is the leading supplier of automotive seating with leading share in every region and especially dominant market share in China. We're very pleased to host with us this morning, Adient's CEO, Doug Del Grosso; CFO, Jeff Stafeil; Head of Investor Relations, Mark Oswald; and Manager of Investor Relations, Dustin Liron. The format for this session will be some short prepared remarks from Doug using the slides that should be available in your webcast window. Then we will move to Q&A with some of my questions as well and mostly with your questions from all of you on the call. To submit a question, please type it in the box on the left side of the webcast window. I highly encourage you to do so. I highly encourage you to get involved in this discussion. Only I will see your questions, but I will bring them into the discussion or I will just read them out loud. So with that, Doug, thanks a lot for being with us today, and over to you.

Okay. Well, thank you, Emmanuel. Thanks for having us, and thanks for everyone participating. Today, we set out some formal materials associated with the call. It's not my intent to go through that. But as opening remarks, I did want to make a few comments before we turn it back to you, and we can address whatever questions the group may have. Really the key message that we were trying to communicate in the material and hopefully, we'll resonate in our comments in the call is we feel that Adient is -- although these are very challenging times, we feel very confident in our position. Much of that has to do with the turnaround actions that were taking shape prior to COVID that were best reflected in our Q2 earnings performance. When COVID hit, we responded quickly and decisively taking a lot of actions to preserve liquidity. But also to take actions anticipating post COVID that the market was going to be down, and that's where we spent a lot of time, and we can talk to some of that activity today. We are expecting the market to be down. We look at it as to reduce our breakeven point to have positive cash flow in a 20% down market. With regard to transaction, we're continuing the pursuit of closing those transactions. When we look at the expected raise and the payment of dividends, we anticipate that to happen in the second half of this year. And then in the post COVID environment, we think the actions that we're taking right now to improve our breakeven cost, as volume continues to ramp up and stabilize, will allow us to improve our overall margin performance and also allow us to deleverage as production returns. So with that as opening comments, I'll turn it back to you, and we can go into Q&A.

That's perfect. Thank you so much, Doug, for this overview. So I guess maybe just getting to a little bit more detail on the restart of production. Can you just update us on what is the progress of restart production in North America and in Europe? What kind of trajectory of capacity utilization you're seeing so far? And how is the supply chain looking?

Sure. So the restart has gone relatively well, done very well, almost without issue in Europe. And we provided some comments in the package that revenue is running about 40% of pre-COVID levels in May. We're seeing sequential improvement in June. We're in early stages in the U.S. right now. Over the course of the first few weeks, the plants have just started to open up. The schedules are strong and continue to be strong, particularly around the light truck side of the business. So it's gone for the most part as anticipated. As our customers have been pretty transparent, it's not met with great efficiencies. They've started 1 shift. They're bringing second shift on at a reduced line rate. But as they debug their operation and debug the supply chain, they're pushing hard, and it's -- volumes are ticking up as we expected. As we pointed out in our material, the one focus area that we continue to pay a tremendous amount of attention to is Mexico and its impact on the U.S. market. As I think you're aware, the Mexican government has restricted output, particularly in the Juárez region. And that is anticipated to resolve itself over the coming weeks, which would allow us to run at full production and correspondingly support operations in the U.S. at full production. But we're not there as we speak. And -- but we're gaining confidence that, that can be achieved each day as we move forward.

Good. It's a great overview. Are you seeing any delays or cancellation among some of your important launches this year?

Yes, we've seen some in all regions. There's not been anything significant, I would say, in terms of the impact that occurred during 2010, for example. Most of the delays have really been consistent with the time frame of the shutdown. So an example would be the Ford F-Series moved from a July launch date into September. That was, for the most part, aligned with how long they had their plants down due to COVID. But it's -- and we've seen similar impact in China. We're seeing somewhat similar impact in Europe as well, but not a program has been canceled, the launch has been delayed a year. If that is going to happen, we're expecting that to happen over the coming weeks. Certainly, COVID has made launches a little bit more complicated for some of our customers just because they can't deploy resources as effectively, efficiently as they did pre-COVID because of the travel restrictions. But I would say that's been somewhat isolated. And most of the delays have been in the 2- to 3-month time frame at this stage.

Great. Maybe shifting gears to some of the margin dynamics. The second quarter -- fiscal second quarter decrementals on a consolidated basis shaped out around 13% or so. How could we think about decrementals going forward accounting for your geographic mix profile? Any big differences by region?

Yes, there are definitely some differences by region. But in total -- so we've always talked about a contribution margin for the company in the high teens, call it 18%. And through a lot of activities, we were able to bring that decremental down quite a bit in our fiscal Q2. That we would expect to be probably though not as much as we can bring it down, so we would expect a little bit more of a decremental in Q3, primarily just because of the magnitude of the sales fall. But -- so somewhere in between that 13% and 18% category, we do think we can keep it a bit under the con margin. So I don't know, maybe somewhere in the middle, but it's a pretty volatile number. And as you said, it does matter with our mix and those things complicated, not just from a geographic mix, but also from a vehicle mix and product area mix. But Europe would probably have the highest decremental margins because it's harder to flex a lot of their cost structure.

That's helpful color. Yes, no. And we've heard from a few suppliers being worried a bit about starts and stops in terms of production schedules or maybe a little bit lack of visibility. Is that something that worries you and that could sort of impact the decremental margin?

Sure. Well, the start and stop in JIT plants, obviously, it's not a good situation. I think on the component side, you can better manage it, you can build inventory and more efficiently manage your labor costs. But on a JIT complete seat, which is obviously a significant portion of our business, it's very inefficient. And we -- in a plant that's not building live, where we have a finished good inventory, we can build inventory to cover half of a shift. But after that, we really have to shut down. And certainly in Europe, it creates a problem where we don't have the ability to flex. But even in the U.S., where we can flex if we can't lay off an employee because they have to come back in the next day that, that creates a problem. Now all that being said, those are situations that create a commercial discussion with our customer, which we pay a lot of attention to. So concerned us, but I think it's something we can manage in the short term.

That's a great perspective. I had a question actually around those commercial negotiations. Any way to quantify over the past few quarters? What sort of benefit you've gotten from commercial negotiations? And how much room do you think is left? And if you can put a dollar amount on it, even just in terms of percentage term, how much is done? And is there a lot more to do?

So I would look at it this way. Prior to COVID, a lot of the heavy lifting and the serious commercial problems that we had were, for the most part, resolved with our customers. So I think we outlined a lot of that in our Q2 package of where that year-over-year improvement came. And we've always pointed to some significant platforms that were out there and particularly in the metal and mechanisms business that we're commercially troubled on it. Operationally, we've -- again, if you look at metals, I mean the year-over-year performance in off-standard costs associated with poor launches is improved greatly. The second phase of -- from a commercial standpoint was to bring this next generation of product that was launching this year with margins that were more consistent directionally with where we wanted to go and a launch that was not disruptive and didn't have a lot of off-standard costs associated with it. We feel pretty confident, even with COVID, the exception of some of the start and stop related issues we've got, that we've addressed a fairly significant portion of it. It will be difficult to articulate as we look to earnings in Q3 and maybe to a certain degree in Q4, just because of the impact of COVID. But as volumes normalize, we think that will pull through. The last piece was we still had some of the platforms that we're going to have to run out for us to really fully close that gap and that was going to occur over the next couple of years, as we look to close the gap with -- the margin gap with one of our largest competitors. And that's essentially on track as we -- as we've indicated in prior statements.

And I just wanted to drill a little bit more down on to what extent you've been able to apply the China playbook to other regions. On the last earnings call, you indicated that margins had returned to I guess pre-COVID or normal levels in China within the months of production resuming. I assume things might be different outside of China, but what sort of ramp are you looking at? And then one thing that intrigued me also in your earnings release, it seems like, at least specifically in China, you're taking advantage of some of the shutdown to potentially even not to restart some unprofitable business relationships. Is that something -- is that true? And is that something that has been doable in the other regions as well?

Sure. So the playbook is being applied to do some -- to Jeff's comments, the ability to implement a playbook that we deployed in China, in Europe takes more time. So as we look to pull SG&A cost out or direct and indirect labor costs out, in the case of Europe, that's a restructuring activity that, again, there's a pretty well-known process to implement that in Europe. So we anticipate the benefits associated that will occur over a longer time horizon, less of an issue in the U.S. We've been pretty aggressive on the SG&A costs in the U.S. We implemented a lot of activity over the last few weeks. And I think we -- with an 8-K announced some creative things we're doing in executive comp structure to further reduce our cost. So each region is different, what we can do and how long it takes to be done, but I'd say, essentially, the playbook is the same. And I think what we've done is we've taken COVID as a catalyst for us to move quick and drive our cost structure even more aggressively because we're anticipating volumes are going to be down and we have to be able to respond to that.

Any comments on the -- on some of the unprofitable customer program [indiscernible]?

Yes, I apologize. Yes. So again, those were some isolated cases with, I'll say, domestic Chinese low volume customers, where we had the contractual freedom to exit that business and shut down those facilities. It is really unique to that particular region. But I would say COVID allows us to always recalibrate every single contract we have and see if it creates an opportunity for us to have a different dialogue with our customer that we had before. In the case of -- if we have a bid contract that our customer decides that they want to extend in the contractual terms, that opens the door to introduce a commercial discussion with them to support that. That's not developed in any significant way outside the China market, but if it does, we certainly plan to take full advantage of it.

Understood. Maybe a few more on the margin profile, obviously, a big part of the story and the opportunity here. So excluding the -- in the second quarter, excluding the EBITDA hit, which you quantified at $100 million from COVID, it seems like you're indicating you are on pace to show year-over-year improvement in margin. In line with what you also saw in the fiscal first quarter, at what point do you expect margins to get back to that trajectory?

To get back to the trajectory where we were in Q2?

Yes, correct. Yes, a trajectory of essentially improvement -- year-over-year improvement.

Yes. Well, I would say -- I mean not to be flipping, but Q3 -- our fiscal Q3 should be easy to beat next year. But if you look at kind of all the actions we've done, our Q1 and Q2 were both on pace and be very good quarters and make 2020 a year of real improvements. When you couple those with the transactions that we announced and are yet to close here, it was going to be a good year for deleveraging and all that. And clearly, the COVID virus has slowed that progress down a little bit as sales has gone the wrong way. We've taken advantage of that time to, as Doug said, be aggressive on some of the cost improvement exercises. So a lot of -- I guess the answer to that is going to rest with volume. We are lowering our breakeven volume. We're doing a lot of -- continuing all those efforts we had of improving our SS&M business, which was up despite COVID, almost $80 million in the first half of the year, continue to see big opportunities to improve that business from an earnings and a cash flow standpoint. We continue to drive the efforts in our JIT, foam and trim business and with VA/VE actions with our customers with just better operating efficiency, and as we continue to deliver better to our customers, being rewarded with the kind of programs and new business that we want. So all those are definite positive measures for continuous improvement in our overall margin portfolio. I will just say it's still a fixed cost business. But everything we've done to lower our breakeven, et cetera, we still need volume in this space. So as we start to see stabilization and then improving volume, which we eventually think we'll be right back on to the trajectory where we were with the objective of closing the margin gap we have with our peers. We started the year with roughly a 600 basis point margin gap if you exclude equity income. We narrowed that a bit and we lowered...

Inside of 4.

Yes, we lowered it perhaps inside of 4. We'll look to continue all those type of actions. As I said, it's not 1 or 2 things. It's multiple things to continue to bring that margin gap down over time as volume recovers.

Great. And then 1 question from an investor, you had addressed some of it actually, but looking out over the next 12 to 24 months, do you see yourself generating enough free cash flow to delever the balance sheet?

Yes. So there's a couple of pieces to that. Delevering is a priority and a focus of the management team and the Board. I said 2020 was going to be on good progress to make significant strides in that direction. As you look through this year, we would expect, and as we get to the other side of the COVID uncertainty and return to a more normalized capital structure where we're not storing excess liquidity, we think something in the $500 million to $600 million of cash makes sense and essentially nothing drawn on the ABL. That's sufficient liquidity as we look at the business in a more stable environment. We do think we would have excess cash over and above that. We would look to apply some paydowns in our structure. And then the other side of it is, this business should have better margin. We continue to -- for all the reasons that I just said, we expect the earnings to improve, which will help deleveraging. But the key component here, and I'd say one of the objectives or clear top objectives of the team is cash flow generation. The seating business is a good cash flow generator. We would look to, as we get to the other side of COVID, an improving margin performance to have excess cash flow and continue to work down our debt portfolio as we increase earnings. From a target perspective, we've set inside of 2x as a target. Exactly where we end, it's going to be some discussions. But clearly, the first step is to get ourselves under 2.

And timing wise, any sense what that would take? Obviously, you have some divestiture proceeds coming your way.

Yes. I mean a lot of it -- the reason it becomes a little difficult on that one, Emmanuel, is just understanding exactly what the vehicle environment is going to look like. We're probably a little more optimistic than we were a few weeks ago on where the environment can shift to, but a lot of things could change that pretty quickly. A second wave of COVID, et cetera, could put a curveball so to speak. China has been a very positive development. We've seen demand come back in the U.S. The European market is probably a little behind in total, but our operations are doing very well there. So if the market continues to improve, it's going to be a lot quicker. If there's a second wave of COVID or if there's more stoppage or what have you, it's obviously a little more fuzzy to predict.

And another question from an investor. Is it possible for you to quantify the decline in the breakeven point of volumes as a percentage of 29 volumes that has already been achieved? So I guess, in comparison, that's sort of like trying to be profitable 20% below, like in any sense where you sit?

Where we sit on that journey? We've made a lot of progress on it. I wouldn't say we're done. It's something we're doing through the rest of the fiscal year. I'd say the Americas actions are primarily complete. A lot of the Asian steps are primarily complete as well. The European market is one where it takes a bit more time due to some of the work rules and negotiations that you have to create social plans. But in the other 2 regions, U.S. and Asia, we're mostly there.

Okay. That's really good color. One more from investor. Do you still think you can close the entire 600 basis point margin gap to peers in the permanently lower volume environment?

Yes. Yes, we do. I don't think that objective changes. We may require some additional restructuring dollars to do that as under a lower volume environment. We have to flex down our overhead structure to align with it, which wasn't necessarily anticipated in our original view of that, but it absolutely can be achieved.

Great. Switching gears quickly to China, I guess ones have so much recovered. Beyond the next quarters, what do you think is a normalized level of margin or profitability for your China Seating business?

Well, we've essentially already come back to our pre-COVID levels profitability from a margin perspective, as we've mentioned. I'd say the story in China is going to be much more around volume and in terms of pace of recovery there. We're optimistic about May. But the business has done a good job of managing its business accordingly to the environment and has kept margin pretty solid. So the big question is going to be China or is China going to be more volume than this underlying performance.

Yes. As I think about the business, we had trouble in Europe and in North America, most recently that we've focused a lot of attention on addressing. Our business in China actually is running extremely well. So you could say historic margins be reflective of future margin. Jeff's point, that then just becomes a function of demand and volume in the region. So as demand returns, it was a pretty depressed market over the last couple of years or somewhat depressed market, as that continues to return to higher levels of volume and certainly, profitability will perform.

Understood. Turning to free cash flow. So you successfully flexed down the cash burn to just $175 million from $300 million per month. I guess, among the swap cost actions are more on the permanent side versus some of the temporary actions such as what you did on the executive compensation side. Any way to sort of like frame this on a go-forward basis?

Yes. The steps mostly to get from 1 -- or $300 million to $175 million were temporary in nature as we rather quickly experienced the downturn or almost real shutoff of production in the back half of March. The actions we started to do, call that COVID 1.0, as we put people on furlough, reduced salaries, and took a number of other swipes at our cost structure, I'd call those more temporary in nature. As we've put in place these COVID 2.0 actions, we'll call them more structural reductions taking out employment -- reducing permanent headcounts, that's the $75 million to $100 million on an annual basis versus 2019 levels that we're talking about. Much of the -- what we did to take the breakeven down, it was a different equation because essentially, we had no production. So taking out our factory workers, taking out our factory -- our salary staff, putting people on furloughs and reduce pay was primarily the method here on that first step.

Great. 2 more, I guess. The metals business has been a big drag on cash. What's the progress here? Obviously, Doug, you said earlier that some of these contracts just need to run out. Anything more specifically around profitability or pace of cash burn in that business?

What we've said in the past is that from a cash perspective by the end of '22 into '23, we expect that to be neutral to the overall business. That plan is in that time line, I think, is still the time line that can be achieved. Prior to COVID, we -- I think we were a little bit ahead of that schedule. We had some really positive performance, particularly in our European operation. But COVID has disrupted that, but that's still the time line that we've got in front of us.

And to be clear, that's a key part of closing the margin gap?

Yes, absolutely.

Okay. And then...

And Emmanuel...

Go ahead.

So just to continue that right, if you think about it, right, in terms of closing margin gap, last year, we lost about $180 million of EBITDA in that segment, and we had about $220 million of CapEx. So that was a $400 million cash burn. We've also indicated that we would expect to get to that free cash flow neutral state in '22 run rate, right? We would probably take CapEx down to about $150 million from the $220 million, which means on a simplified basis, need to have about $150 million of EBITDA. So you're going from a minus $180 million to a positive $150 million, right? So that's a big piece of that margin improvement gap closure there.

Perfect. That makes sense. And then maybe just a final topic. So your large seating competitors has been pretty vocal about growing conquest wins in Seating. I think they spoke about $0.5 billion of conquest in Q1 alone. But at the same time, you're consistently reporting strong business renewal rates. So are these wins in a business that you've passed on due to lower returns or is the conquest just not from Adient?

Sure. I won't comment on what our competition is saying. I would say, though, from our perspective, there is -- the business that we want to win, we're winning. As we've commented in the past, we don't treat every customer, every product and every region the same. We weigh each revenue dollar different. We've also said if we don't think we can ensure that we're going to have an acceptable level return on capital that even in an incumbent position, we're prepared to walk away from the business. I would say that is -- the reason we can say that our retention rate is so high is because that doesn't occur very often. To say that it hasn't would be untrue. It has. But we did that with our eyes wide open, completely understanding the financial consequences for us. And we're confident that, that was the right decision for the business. And I don't want to make any bold statements today, but I would say that, that occurs in both directions as well. So I will leave it at that.

Okay. We were actually hoping for the bold statement. I definitely appreciate the color. It looks like we're out of time here. So I want to thank you so much for being with us, for all your insights, for your time. Thanks to the entire Adient team for joining our conference. Thank you for all the investors on the line for your participation, for your great questions. And see you all at the next one, which is Aptiv starting in 8 minutes. Thank you so much.

Thanks, everyone.

Thanks, Emmanuel. Thank you. Appreciate it.