Adient plc (ADNT) Earnings Call Transcript & Summary

All right. Good morning, everybody, and thank you for joining us for this session with Adient as part of Deutsche Bank Global Automotive Conference. My name is Emmanuel Rosner, and I'm the senior U.S. autos and technology analyst at Deutsche Bank. Adient is the largest supplier of automotive seating with leading market share in every region. It has been operating a radical transformation to streamline its operations and boost returns and profitability. And we believe there's still large additional opportunities. So to talk to us about this and provide an update on the company, I'm very pleased to be hosting this morning Doug Del Grosso, who's President and CEO; Jeff Stafeil, who's CFO; and Mark Oswald, who's Head of Investor Relations. So the format for this morning, I think Jeff will run through a few initial thoughts and comments around a couple of slides, and then we'll dive right into Q&A with some questions from me and questions from all of you in the audience. If you'd like to submit one, it's at the bottom left of your screen, and we'll try to weave that into the conversation. So with that, we really appreciate you being here with us today, and over to you.

Great. Thanks, Emmanuel. And thanks, everyone, for taking the time to listen to us this morning. We did post some material online here, a presentation that we call our ES3 development, kind of maybe click forward a slide here. I won't go through this deck, but I will just give a couple of comments around it. This is, in a nutshell, some of the tools and maybe a summary of the tools that Adient has been using to stay competitive and maybe push the envelope a bit on the seating industry. Seating is -- remains one of the most costly systems within a vehicle. It's critical. It's consumer-facing. It has a number of touch-points. But it's also very expensive and very differentiated in a vehicle. And a lot of that differentiation doesn't manifest itself into differentiation of the vehicle. Some of it's just complexity that doesn't really turn into value. And this effort we've put in, which grew out of a VAVE effort, but effectively is us working with customers to identify opportunities to take significant costs out of the vehicle, working with them. So as they move forward and have experienced the disruption that's been caused in the last couple of years or the inflation that's coming at us and is already in the business or the investments they're making in electrification, a real clear pathway that we can go to customers to take significant cost and while increasing the competitive elements that are important in the seat. And as Doug has -- just a little bit of an analysis of how we do that and how it manifests itself even in things, lightweighting, warranty analysis, innovation and benchmarking across competitors. The fact that we have around a third part of the world's supply in seats, we have all these tools. We have all these comparison points. We have all the engineers. We have all the capabilities to provide a very rich array of analysis to our customers that helps us and helps them make better decisions on future vehicle programs. And this is something we've brought to each of our customers. We've gone through really customized individual workshops with them, and it's been extremely well received. And we think it's 1 of the points that underlines the growth opportunities we continue to have in this business as customers look to give us more -- direct more of the bill of material to us, so we can continue to have stronger vertical integration, continue to find win-win opportunities with our customers and drive margin enhancements as we move forward as well. I see Doug just joined. He's finishing up a customer meeting, but I'll let Doug, if you heard any of that or want to add anything to my commentary, please feel free.

Sure, Jeff. So first of all, I appreciate the opportunity to participate in today's session and the follow-on sessions. I just got the tail end, so I'm going to avoid repeating, hopefully, anything that Jeff just went through. But really, what we are trying to do with this presentation today and where we're at and our ability to talk more, I would say, in terms of financial performance that will happen in our Q3 call, was to talk a little bit about how we're reacting in today's environment. And to me, I'd characterize -- and I just finished a call with Volvo, and we just had this discussion with them is they're faced as an example with their conversion to electrification, the investment that's required, the new competitive set that they have to deal with versus their traditional competitor set. And quite frankly, the complexity that's been created in seating systems that's evolved over the last 20 years and what we're trying to introduce to them is that there is a more elegant and simplified solution that they should be considering. And by taking all this data and evaluating that into where real value is generated, particularly in the environment that we are in right now with volatility because of chip availability, cost pressures because material labor economics. We found this process as a way for us to work with our customers and navigate and address cost issues in a way that drives value into their vehicle. And it's been really well-received by our customers. As we've rolled it up, some customers who are more appreciative of this approach are further along the path than others. But generally speaking, it's provided a tremendous amount of value to them. So Jeff coming in cold I am -- as far as advancing slides, I don't know if we want to get into this level of detail or just convert to Q&A and proceed down that path.

I think we can convert to Q&A. The slides are there, and I think they're pretty self-explanatory, but just provide some more context around what Doug and I introduced. So Emmanuel, feel free to lead us through some questions.

Yes. Perfect. Really appreciate the introduction. So maybe if we could start, just from talking about the current environment you're operating in. How has the volume impact from the semi shortage played out so far for you this quarter or for the industry compared to your earlier expectation? How have you managed through this shortage given your exposure to Ford and other OEMs that are seeing larger impact?

Sure. Jeff, I don't know if you want to quantify what the impact has been for the quarter. I can certainly talk for a minute about how we're reacting to it. And it's been challenging because, as you know, we've been given pretty short notice in many cases. And when you're just-in-time supplier, it further is complicated, because the impact is immediate. And I think if you're a component supplier, what we've seen is some of our customers have continued -- because of their concerns on availability have continued to release, but in the just-in-time world, you stop dead. And it depends where we're operating. In Europe, we can go to short-time work that provides some short-time release. We can quickly cut off our releases to our supply base, where we think there's ample inventory to operate as we restart. We go through the normal cadence in the U.S. of refortification after fortification from a labor standpoint then we go into a layoff scenario. So it's -- I'll say it's the typical actions that we've taken any time there's a disruption, whether it's because of customer having a strike that we went through with General Motors not so long ago to obviously the COVID shutdown. But it's a real challenge to navigate through that. And with Ford in particular, it's been problematic. Europe, they've obviously taken a tremendous amount of volume. And we supply Saarlouis and that's had an impact on us there. But probably more critical to us has been the disruption in F-Series production, which is a pretty important product for us. We're cautiously optimistic that comes back online as we move into our Q3 -- throughout our Q3 into our Q4. But there's not been a tremendous amount of clarity or transparency with our customers, either because they won't say or they don't know. So we're just reacting as quickly as we can to it.

And as far as quantification of it, I'd say it's a difficult -- for all the reasons Doug mentioned, it's very difficult to quantify. We had a lot of things built in as we gave guidance last time. The picture is fairly cloudy, I'd say. In the short term, it was probably marginally worse. We had a lot of it contemplated, but some of the short-term repercussions, we've continued to see through the May and June timeframe. Some expectations are that it does start to turn the corner here. And certainly, there's demand for it, it's just -- if the whole supply chain can really react accordingly. And that's where probably the visibility is less to us. But as Doug said, we're optimistic here. Certainly, overall supply and inventory on hand, et cetera, is so low that we do imagine that on the other side of the chip issue, we'll start to see significant improvements in production. It's just been slow getting there.

And I guess the other point to it -- I was just going to add 1 more point. The other point is -- that can't be lost is our ability to restart. And we get a tremendous amount of appreciation from our customer when we can restart when they restart. So we -- as much as we look to pull back cost in the downtime, we quickly shift to our ability to restart. So when they restart, we create no disruption. And that certainly has been earning us points, earned us a tremendous amount of points during COVID, and it's been the same during the chip situation as well.

Understood. And I guess the other aspect of this situation you highlighted last quarter is additional temporary headwinds from supply chain, but also commodities, in particular, steel and foam. How have these progressed throughout your second fiscal half, I guess, so far? And could that become a challenge into fiscal 2022?

Yes. No, great question, Emmanuel. A year ago, we were buying hot-rolled, cold-rolled steel for $450 to $600 per ton, respectively. If you look -- or actually, those are the market prices on those commodities. If you look today, you're at probably $1,500 to $1,600 a ton and that's gone up quite a bit from even the levels where we were starting to raise our voice about it a few months ago, and it's continuing to rise. Expectations had been that they would start to fall. We've continued to see escalation in those prices. As we've talked about, we have a lag impact on commodity recovery. And thus as the prices continue to go up, it does put pressure on our short term, but it also puts pressure starting to move into 2022. We'll come back with better visibility of that. But if the current prices hold, I would expect the -- we had expected tailwind to happen as prices leveled out. But as the prices have continued to increase, this could be a bit of a headwind for us in 2022.

And can you just remind us the mechanism of your recovery or the magnitude of it?

Yes. They're different with every customer. We generally have some customers that are immediate or 1/4 and then some that go 4 to 5 quarters. Depending on the algorithms with each one, I'd say, on average, it's 6 plus months. And thus, we're getting that recovery and -- from our customers sometime after we're incurring the cost increases in materials.

Understood.

And I would say that, that covers somewhere north of 70%, and then we work to fight the remaining of it through individual negotiations. But for the most part, 70-plus percent is contractual, and then the remaining requires us to go and fight for it in other ways. And we're usually successful in getting it.

Now turning attention to some of your restructuring and self-help initiatives. So you've guided for $35 million to $60 million of sequential improved -- business improvement from the first half to the second half of your fiscal year. What actions are driving these expected savings? Are there -- are these made more complicated in the current environment? And looking forward, can you sort of quantify what is the expected additional benefit we could still expect from these actions beyond this year?

Right. Maybe I'll start, and Doug, you can jump in. But last year, we talked about an elevated level of restructuring, which was primarily bringing down some of our fixed cost in Europe. That made its way through this year -- late last year to the beginning of this year and has been rolling through -- started to roll through our P&L. We expect the pace of -- some of those actions to pick up in the second half of this year. So that's a big part of what you're seeing. We also continued to make advancements in the back-to-basic strategy and other things that encompass our strategy around bridging the margin gap with Lear and some of the things you see in that deck we had from S3. Some of those things continuing to take impact or make impact on the business, including our improvements in the seat structures and mechanisms business. That's what's encapsulated in those improvements. What's offsetting that are all the other things we've talked about, such as inflation, such as chip availability, and the production downtime and those type of things. As you go into 2022, I would expect us to continue to make advancements of those things that are in our control, and it's just going to be a question of how the other factors stabilize. From production to material inflation with labor inflation, also raising a concern, probably the big question marks of what 2022 will bring.

And so following up on this target that you've had of closing the margin gap with Lear. When you look at recent underlying performance, what still needs to happen operationally to get you there?

Sure. Maybe I'll start off on that one, Jeff, and then you can provide further commentary. Our target for that gap closure is -- remains in that 2025 timeframe. And even in the environment that we're operating in right now, whether it's inflationary pressure or production disruption, I mean we see these as relatively short-term issues. So the steps we're taking to drive the performance of the business are on track. And as our mechanisms for recovery flush through, which they will, they either will be because the formal mechanism on current production will ultimately catch up or new launches that occur have a true-up mechanism. So when they launch, they launch at current economics, so there shouldn't be a gap there. That will flow through. The basic elements of our business that are functioning well, the things we do around launch performance, operational excellence, the way we manage it -- our supply chain, particularly the part that we can control this whole ES3 process where we can drive cost reduction and benefit from the shared savings associated with it. That's where our foot is on the accelerator, and we're continuing to keep that forward. So we're still on track. We've got some -- as we keep mentioning, some headwinds. We'll have to navigate through in the short term. But we're very confident we can get there, and we know exactly the levers to pull to get there. And I would just -- the last point I would point to as evidence, as Jeff referred to, is the metal and mechanisms business. We beat that plan despite a lot of these headwinds about a year ahead of schedule. And that was just primarily focused -- definitely some commercial recoveries, but more importantly, it's been driving efficiencies in our operation and not repeating some of the mistakes we've made in the past, particularly associated with launch. So we don't have that spike that we have to overcome.

What's the magnitude of -- I guess, how much of the additional margin upside relies on further improvement in metals and mechanism? I think the targets you mentioned ahead of schedule that was to get back to free cash flow breakeven, is that right?

Right.

Correct.

So how much more opportunity is there?

That's going to be a decent component of it. We -- free cash flow is not -- free cash flow breakeven is not our goal for the metals and mechanisms business. Nor do we believe it's anywhere close to the ceiling of where that business can perform. So there is some improvements there. But there's improvements that will come from a variety of pieces, including our Foam and Trim business and greater amounts of vertical integration in those areas and continuing to get those opportunities. So I don't have the -- or at least I don't have available to give to you a breakdown of all the components of it, but I will say that the SS&M business should be a cash flow contributor. So we have a bit of ways to continue to improve, and we have a road map to get there.

Great. And let's shift gears to your backlog, win rates and then position within electric vehicles. So what can you tell us about your quoting activity in this environment and your win rates?

So on the quoting activity side, just generally speaking, across all of our customers and across all segments -- vehicle segments, whether it's in ICE or hybrid or electric, we're having good success on our win rates. And in fact, beyond that, we've had incremental success, particularly on ICE programs that are incremental to our backlog, both in North America, but in Europe and Asia as well. I think we've been pretty open about some of the new customers that we're bringing on board like NIO and Xiaopeng, pretty exciting customers. I mean the Shanghai Auto Show introduced, I think, 20 new automakers that we're selectively going through to see what makes sense for us from an investment and what doesn't. As our traditional customers convert, we continue to have a dominant market share position with those customers, so solid success. We've protected our backlog. Our win rate is good. Probably more importantly is our commitment that the business we win we have an assured level of profitability associated with it. We're -- there's been a few customers where we walked away, where we couldn't convince ourselves that we were going to get the necessary returns on our investment. That's not something we're afraid to do. We don't look at all customers being equal. That's certainly not. They don't behave the same way. And as a result, we're very selective, and we're not diving for market share. We're diving for returns on invested capital.

And so you disclosed last quarter that Adient has about 50% share of complete seats on the global electric vehicles, which is well ahead of your overall market share. So what technology or innovations drive that?

Yes. We've done a lot of work in this area. And I would say the stage that we're at right now is -- and it's going to transition over time. If you look at the initial stages of electrification, basically the seats that they were using, with some minor modifications, were the same seating system that they used in, I'll say, conventional propulsion. And in fact, in many ways, our customers were looking for quick adoption into an electric vehicle. So another way of saying is something off the shelf that didn't require a lot of investment. They were moving quick to convert, and speed was a key element in -- because we have such wide portfolio of product available that we can provide them. I think that's what initially gave us that lead on market share. I think we can have a sizable market share position. But what's developing now is, as they transition from a conventional vehicle architecture to skateboard architecture, they are looking for technology associated with seating systems. And that gets into discussions about block height. It's the distance between the bottom of the seat and the floor of the vehicle, as they try to package batteries in. That distance is shrinking, and that drives a different configuration in the architecture of seating. And then there's more progressive things that are being done. And our customers are looking at the efficiency gains they get by moving heating and ventilation into a seating system at the expense of having HVAC units in the instrument cluster area as more conventional vehicles have. So it's a really wide range. In fact, we debated for this particular meeting, whether we should focus on electrification in seating technology or ES3. Right now, our customers are asking a lot more of ES3, and second priority is what you can do with seating as they move into, again, their vehicle architecture change as they make that full transition over. But you can think of it in terms of thinner profiling. So we've developed some technology around that, where you can eliminate the amount of urethane foam and go with a better suspension system. You can think about it in terms of, I'll say, heavy use of carryover components. You can think about it in terms of efficiency gains through electrifying the seat as well. But those won't really start to show up until '24, '25 vehicles when our customers make that conversion into their new vehicle architecture.

That's very interesting. Let me just maybe conclude with 1 or 2 questions about China. Can you just go back over the rationale for your recent divestiture of some of the JVs you had over there? And as you complete these divestiture, what will your China business look like? And what's your strategy in the region?

Okay. Maybe I'll start with some opening comments and then Jeff, if you want to feed into that, that would be great. Simply said, our strategy in China is a result of us wanting to gain a level of independence. And I think we've been pretty transparent that under -- certainly the YFAS we -- because we were an unconsolidated partner, we didn't have quite the influence on the direction that business was going. Historically, it's been a hugely beneficial joint venture, but the market in China, in our opinion, is changing. There's new starts that are populating that we have to pay attention to. There's technology change, some of which I touched on, that we have to develop and can be proprietary and provide us a competitive advantage in the market. And I'll say that traditional partner with your customer and that becomes a way to secure really high market shares is also changing. I think that traditional structure is becoming a bit archaic. And because of those things, we felt that a level of independence was necessary. And that's what drove us to the current path that we're on. We retained some really important relationships with some of our key global customers, but we now have the flexibility to go after some of the new starts that we think are compelling. So I think we can go on. We think we get a lot of synergies operating that business collectively as opposed to multiple independent joint ventures. We think we get better synergy value when that becomes an extension of overall Adient as opposed to being a nonconsolidated partner with not as much global participation. So there's a number of areas we think we can dramatically improve the business.

Yes. And the infusion of capital really helps our balance sheet and helps us fund our future China strategy, et cetera. But overall, it de-risks Adient as well. So there was an economic gain to add to all the strategic points that Doug just laid out.

And just a quick follow-up on China to conclude here. So where does that -- once the transaction is complete, where does that -- where do you start from in terms of China seating market share? And what are your long-term aspirations?

Yes. I'll cover that one, I guess. The -- we'll be just under 20% and effectively by at least our math kind of in a dead heat as a top 3 leader between Yanfeng, our former partner in seating, and Lear. As it relates to the overall growth, I mean, China is a very large market. It's going to continue to grow. It's important by itself. It's important as an extension of our global footprint and support of customers globally. We have the footprint to continue to grow there. We'll look to profitably grow and continue to put investment out there, but we think our footprint will be very strong, $4.5 billion or so in revenue, including our nonconsolidated joint ventures. So -- and significant engineering, significant capability from a vertical integration standpoint to go after that market. We've got -- geographically, we feel we've got the region covered with operations in the north, south, middle and west through close to 30 -- over 30 manufacturing sites, 5 engineering centers. So we think we're well-positioned at a minimum to grow with the market and perhaps grow that market share, but we think at a minimum at least to continue with market growth.

Great. We'll leave it there in the interest of time. But Doug and Jeff, really appreciate your time and insights today, this morning. I appreciate everyone joining in, tuning in and sending your questions. So best of luck, and have a great day.

Thanks, Emmanuel. Thanks, everyone.

Bye.