Adient plc (ADNT) Earnings Call Transcript & Summary

Hi. Welcome back, everyone. We're going to move on to our next session. Once again, I'm Joe Spak, lead autos analyst here at RBC Capital Markets. Very pleased to have with us Adient, a leading seating supplier to the automotive industry. Pleased to have with us Jeffrey Stafeil, the CFO; Mark Oswald, who's the Vice President and Treasurer and Investor Relations. So Jeff and Mark, thanks for joining us today.

Thanks for having us.

Our So I guess the topic du jour, but really sort of the topic for a while up here has been what's going on in the industry in terms of production schedules. So I know since you've last reported, we've seen a flurry of automaker announcements of some downtime because of some shortages from the semiconductor perspective. So I'd be curious to sort of see or hear what you're seeing from a production standpoint and from a schedule and call off standpoint. And then maybe if we could even go beyond this sort of quarter, how is Adient thinking and planning about when things can get back to more normalized regularly scheduled schedules?

Yes. No, great question. And the last one is really the critical question. As -- what we're seeing, we reported on the 5th of August, and I would say we've been pretty skeptical that IHS was going to be right in the short term. And what we were seeing and what we continue to see is that there is more disruption, more unscheduled downtime, but quick call on a Friday and tell us they're going to be down next week thing. And that's throughout every OEM and region of the world right now. It is a very difficult operating environment. Back to IHS, I think IHS has historically geared its forecasting around demand and it's done really well on that. This is the first time in my career I can think that we've been limited by supply for any significant amount of time and across a significant number of OEMs, outside of a couple of small little crisis moments in the past. So we're in a bit of a unique time. We continue to see those call-offs. We continue to expect those call-offs. And it's very unclear of when they will get better. I can tell you that there's an enormous amount of views out there that generally align around the topic is it will come back. Some people think it's going to come back closer to the end of this calendar year. Some people may be in the middle or towards even the end. In some cases, 2022. But optimistic that it will correct itself. And the good news is there's significant demand out there and the inventory levels, you know, Joe, are really at record lows. So -- it's -- but it's just continuing to be a really difficult operating environment, and I don't see it changing anytime in the next month or two.

Yes. I guess to that point, Jeff, I mean, is it possible to sort of quantify how much this sort of schedule volatility is impacting conversion? Because I think one of the things you mentioned, right, is like it does seem like underlying demand is there. Eventually, the supply issues will resolve itself. And as we -- I don't think investors really want to sort of capitalize what's going on right now. But as we think out to '22, '23 and beyond, it seems like the elimination of some of that schedule volatility and the impact that's having on your flow-through is something that we can really come back out and sort of help future margin profile.

Yes, I would definitely say these times are not indicative of our earnings potential or our earnings outlook in sort of a longer-term sense. We try to do a little bit of that in our earnings call. You might remember, we included a little call-out and said that we thought the chip issues cost us about $1.1 billion in sales. And between that -- the flow-through on those sales, which you could say is around $200-ish million or so. And we also called out another $100 million of inefficiencies. And those inefficiencies were in a few different buckets. But there's definitely an inefficiency around the semiconductor issue itself. And that's primarily dealing with labor flexibility. When we get called off -- if we get called off 3 weeks in advance, we can adjust furlough our workers and cut our costs. When we get 10 hours of notice, we are then essentially having a much worse flow-through because we potentially have full plants. But we also were hit with the Texas storm earlier this year. We were hit -- COVID continues to be a challenge. And some of the freight issues are significant as well. So that was all rolled up into that $300 million of EBITDA impact that we think in a more normalized environment wouldn't be there. A lot of that is sales. We're going to have significantly lower sales than we would have thought a couple of quarters ago.

Right. And so maybe that's sort of a helpful jumping off point for again, I'm not asking -- I know you're not going to sort of issue any '22 guidance here now, but how should we think about some of these buckets, right? Because if we take even the midpoint of your guidance, your last guidance was for about $950 million EBITDA. Maybe there's a little bit of risk to that from some of the production. And then if sales do come back, we could make some sort of assumption about how historically you maybe incremented on the upside or mid-teens sort of incremental margins. But then you have the commodity issues that you sort of mentioned that -- it seems like some of that needs to annualize into next year. You have the $300 million of inefficiencies you sort of talked about. So how -- how do we think about how much of those inefficiencies can really come back? Because it seems like it's sort of a function of everything we just talked about, right? If the semiconductor issue doesn't resolve itself, a smaller percentage of that comes back. If it's fully resolved, maybe all of it could come back. So how do you go about planning for your business?

Yes. No, this is a difficult time to plan in, as you could imagine. But you've got the building blocks, and sort of just building upon them a bit. We have -- we mentioned commodity exposure, so much on a few of the negative pieces that we have to manage through. We've talked about $200 million before any offsets or actions we're able to do. And as we said, we'll update you on those actions, but you can imagine we're working hard to do as many offsets as possible. As it relates to the semiconductor issue, our current view is we're going to see this start to improve as we go through 2022, but we don't see it magically correcting on October 1 as we start our fiscal '22. So exactly how that rolls through, we're trying to make some decisions around that. I wouldn't be surprised if we discount some of the IHS numbers that are out there right now, but we'll come and give you a more wholesome view. But in general, I would say the first quarter of our fiscal '22 will definitely have some impact, and I think that impact will dissipate. As that -- as we have those impacts on semiconductor, that does drive some inefficiencies. As those impacts dissipate, we think those inefficiencies will run their course and no longer really impact our business. As it relates to improvements, that's the good news, I think. As we did in COVID, and I think we've done now, we've tried to take the opportunity to either strengthen some of our commercial deals, work with our customers to push forward more VA/VE or more cost improvement, win-win type of ideas. We have a receptive audience because everybody is facing a lot of the same challenges. And the downtime or less production time gives us some opportunity to do some of those things. So I do continue to see the operational efficiencies rolling through. Another thing you -- I know is in your mind, but I don't know if you mentioned, our China deal. There's some footprint changes. We're going to lose roughly around $150 million, broadly speaking, of equity income. But we'll gain around $100 million of consolidated income on a -- before you consider market changes or anything else. But just kind of pro forma in the 2021 results, you would have something around there. And we'll continue to drive efficiencies where we can in SG&A and admin costs, et cetera, our engineering cost in the business as well.

Just one other point on there is you're talking about efficiencies coming into next year, too, right, with the work that we're doing around the balance sheet, right, taking down debt.

A good point.

Our restructuring should also be coming down, right, it was elevated in '21. So not only in the P&L, but as you look at the balance sheet, too, you're going to see some of those efficiencies roll through.

Maybe just building for a second there, Joe, because really fundamental to us and as we think about planning. I know we focus a lot on EBITDA margin in our conversations with you and Street, but fundamentally, we're very focused on cash flow. This is a business that should produce cash flow significantly more than it's produced in the past. And from us, we think we can do a lot of positive things and have a lot of productive conversations around capital allocation as we continue that. In 2022, we do think it's going to be -- I don't know if it's a tale of 2 cities again, but we do think it's going to start kind of inefficiently and -- but as we improve the cash flow, or I should say as the market improves, those improvements should really start to show in cash flow for some of the reasons that Mark was just mentioning, lower interest expense, lower restructuring, better EBITDA margins.

Do you -- it's a great point, Jeff. I mean, do you think about -- maybe internally, maybe this is something we need -- needs to be communicated to the industry a little more about free cash flow conversion, whether it's sort of net income or EBITDA or however sort of you want to talk about. And how do you guys think about it? And what are sort of longer -- midterm or longer-term targets in terms of conversion?

Yes. We'll be coming out with more of those. I think we'll be -- I don't want to say pivoting away from margin, because margin is always going to be a core component of converting cash flows to begin with, but especially with the proceeds from our China transaction to reduce debt, we see an improved SS&M environment which allows us to talk about things like positive cash flow and starting to have more constructive conversations around capital allocation, you'll see that a lot more in our messaging and trying to give you guys a much better view. But for now, I guess I would just kind of hang those out there, those are going to be central pillars here, and we'll give you more views as we give you and roll out 2022 guidance likely on our November -- early November earnings call.

And just since you brought up the China transactions a couple of times now, is that still on target from a timing perspective? And I know the cash payment is sort of phased. So maybe you can just remind us about the timing of all those events.

Yes. No, great question. And yes, it's still on the timetable we talked about. We always talked about a $1.4 billion net transaction. Excluding that potential put that one of our partners, I'll mention that in a moment, about $1.4 billion after tax. About half of it we expect before the end of our fiscal year, so the end of this month. And the other half of it, we expect by the end of the calendar year. You'd recall that there's a $125 million put for one of the entities, will end up as just part of the base transaction with a 75% interest in this CQ Adient entity, about $700 million, $800 million in sales, very profitable, nice entity. The 25% owner has a put option to us that hold up 30 days to decide on.

Yes. Maybe we could just go back for a second to some of the factors you brought up here that have been impacting year-to-date and obviously are still issues. So steel was sort of called that issue. It actually looks like steel has somewhat stabilized a little bit, although still obviously at elevated levels. Earlier this year, you mentioned foam from the Texas storms. We obviously recently had a hurricane here as well. And some of the refineries, I think, were brought down. It seems like that's maybe not yet impacted petrochems that go towards automotive. But I'd be curious, I'm sure you have your supply chain team is working on that. So what are you seeing as any sort of potential impact from some of these refinery shutdowns?

Yes. No, great question. The Texas storm was brutal for us for a number of reasons. But mainly, we were -- because of our producers were shut down for a while, we were taking [indiscernible] of chemicals from all corners of the earth, Korea, Japan, China, South America, Europe, et cetera, which is obviously not a cheap endeavor, but to keep our customers running, we were doing that. As it relates to the recent storms, haven't seen anywhere near that impact. We've also started -- one of the things you'll probably see us do a little bit is have a little bit more inventory of foam in particular and perhaps even a bit more storage tanks of that on-premise so we aren't as susceptible to even a couple few days of supply like we were in the past or have been in the past.

Yes. You mentioned logistics. And obviously, it's not a normal course of business to be airfreighting -- premium airfreighting these things all over the world. But maybe this is another area where there's been a lot of inflationary pressure. Can you just -- I think a lot of what you do is sort of in-country, [ or-country ]. I'm not sure how big a user of ocean freight you are, for instance. But even truckload, I think, has had some pressure. So can you talk about the freight and logistics impact you guys are seeing? And how you go about forecasting that business or that part of business?

Well, I think we've had to forecast some inflation into it fundamentally and rethink some of our supply chains. Container, a few years ago, was probably $4,000, $5,000. It's -- can be north of $20,000 today. That...

Do you do a lot of [indiscernible] or not?

We do some. Yes, to your point, we don't do tons of it, but we do take in some -- you can think of some of our mechanisms that we take, recliners, latches, height digesters, a lot of that stuff packs well, ships well. So we do it. But for the -- we're obviously not going to ship foam, terribly far. A completed seat structure isn't terribly economic. And [indiscernible] the final [ jet ] assembly is done pretty much on site. But there are components that go into our seat that we do have. So we are impacted pretty significantly. And it's becoming -- I'd say it's part of that $300 million of inefficiencies that have hit us here in 2021, and we would forecast to have some impact to us.

Yes. Maybe sort of another question on here now. Obviously, you've mentioned some of the choppy schedules. I think one of the things that seems to have caught maybe the industry by a little bit of a surprise was the big production downtime from Toyota. I know not all of that was sort of in North America or I think you have -- where I think you're overexposed to Toyota, but correct me if I'm wrong. But you -- but you do have more Toyota exposure than some other companies out there. So is that something that you think you planned for maybe on a contingency basis and it's something that the market is sort of -- was sort of made aware of at a later time? Or is that something that caught you by a little bit by surprise?

Well, a lot of that downtime really was in -- the surprise amount of that was probably more in Japan and less of exposure to us. And I would say I don't know if I'd ever claim us to be overexposed to Toyota, we really like [indiscernible].

Yes. That's numbers in the industry, but I...

Yes, they've been a terrific customer. But for the most part, they've been impacted, too, I wouldn't say dramatic surprises haven't come out of Toyota that come out of some other places.

Okay. So as we sort of maybe think beyond this year, the question we often -- there's been so much sort of focus on the cost side of Adient and the capital structure side of Adient which I want to get to in a little bit, but how do we think about sort of the top line opportunity at Adient? Because you went through this period where you're shrinking and now it seems like you're in this period where you sort of shrunk to be able to sort of grow again. So can you talk about how you think about the drivers maybe relative to the industry and what would cause Adient to outperform industry production over the coming years?

Yes, I think it's going to be a bit -- we're focused geographically and by customer on that. We've had a number of customers that -- breakthrough is always kind of a funny word, but we've really improved, enhanced our relationship with a number of our customers. And they see us as they have always had, but I think even more so as a key buyer for them, someone who can come in and not only make sure [indiscernible] goes well but really drive costs and drive improvements and drive ideas. And this VA/VE which concept, which evolved into the ES3 that we talked about over the summer a bit, but this -- I'd say the partnership we've had with customers have been really strong. And it gives us a strong belief that we can grow market share. China and Japan, I think, are 2 areas where we have a lot of ideas of where we can perhaps outpace the market. I think in -- and probably all of Asia. In some fashion, we have that. I think U.S. is an area where we'd probably expect to grow with the market. Might be some opportunities to improve that a little bit, but in general, we'd probably see ourselves growing with the market as sort of a base assumption and we'll look to be opportunistic. In Europe, we might, especially over the short term, maybe tick a little bit lower. We were pretty selective on some portfolio choices that we made, some customers and some products where we weren't making any money and actually had some negative margin. And pruning those things out, we think, will bring much better efficiency to the business, better margins, but might take the top line down in the short term. Over the longer term, I think we have opportunities to grow in that market as well, but it will be a little slower. And we're always a little bit more cautious there. You have to be very careful there just to make sure you don't make a commitment, spend a lot of capital and find yourself into a fee structure and situation, somewhat a bit harder operating environment.

Maybe you could talk a little bit about the opportunity. I know you mentioned Asia broadly, but specifically in China and how the sort of recent transactions and maybe some freedom that Adient now has sort of really helped driving some of that growth opportunity in that country. And is it still as consolidated -- I'm sorry, as fragmented a region as you sort of talked about a couple of years ago? Or has there been some sort of consolidation there?

There's -- I'd say it's definitely moving towards a little bit more consolidation. People are making some aggressive plays in that market. But we do think that there's a real opportunity to grow. The market is going to grow itself. The EV market, we expect to grow pretty significantly. So that's going to be an area where we think we can grab share. But this entity CQ ADNT, and I don't know if that's what we end up as its future name, but it's in -- headquartered in Chongqing, but a very nice operation, has extensive amount of business today with Volvo, but NIO, Xiaopeng and a few other EV brands are there. But that, operationally, they own 75% or 100%. We even have that type of a base in China in the past. And it's difficult to coordinate with your -- a group of loosely connected JVs to drive global programs at times. And we did an okay job of it. I do think there's a lot of excitement though in the team of additional things we can do with the enhanced ownership structure and the coordination we can bring. So a lot of excitement from our user team. A lot of excitement from our Europe and Americas team as well as they can extend on some of these global programs and use China to maybe help win business in other regions as well. So more to come, but I do think it will be a driver of future growth for us, having that foothold.

Yes. You mentioned EVs. I mean -- and obviously, this is a growth area within the industry. In some respects, it's sort of not different from the old industry where like one of the ways to outgrow is just to get on the right programs. But it seems like increasingly getting on the right programs will be getting on the right EV program. So you talked a little bit about this in recent months, several new program wins on EVs and some replacement wins as well. Can you talk a little bit more about those efforts? And how are you going about that business if it's a new entrant or a new customer or versus maybe a legacy customer that is now coming out with electric vehicles. Is there any difference in terms of how you approach those customers?

Yes. I think there's differences. There's differences in how we approach every customer in some fashion, whether they're traditional OEM or a new entrant. But what we have done is our engineering teams and commercial teams have combined force and looked at -- and had -- I don't even know how many hundreds of thousands of conversations with our OEM counterparts, with new entrants and looking almost even production too of -- because we have a lot in production in the EV space today, has put together a really coordinated set of offerings that we can see that, that -- that are unique to an EV vehicle's, electric vehicle's seating configuration or seating makeup. And we talked about that in one of our conferences, Mark could direct you, but I think we put out a presentation with some of the key themes that we saw in there, rather perhaps low block height, integration of sound, NBH issues, et cetera, that we've been wrapping together as service offerings or things that we can provide and doing tech days, doing presentations with the OEMs and really driving the message that we can help them on this. We can take out costs. We can also improve performance. We can do some of the unique things that are going to be critical, we think, into the EV seating makeup. So all that has been a coordinated effort. While we've moved to -- this is one thing I'd really like to see, we've -- a couple of years ago when Doug came in, he moved us more to a regional structure. But for big things like this and other, I'd say, other commercial opportunities, we really come together as a global enterprise. We -- our engineering leads in each country and our commercial leads by customer come together and drive these things. And we spend a lot of time just coordinating the messages. And so I would say that's there. The effort is going extremely well. We have -- I think we're overrepresented in EV market share. I do continue to see nice wins there. And they're attractive programs. They're not things that we're doing for lower IRRs or buying the business in any fashion. This is -- I've been extremely encouraged about that. But we have a lot to do there. The -- it's obviously a market that's changing a bit. As far as the new entrants in China, we've -- this is where CQ comes in pretty heavily. They're very strong with NIO and Xiaopeng and I think making some inroads elsewhere. But we also have strong business, let's say, with VW on their electric vehicle, but you'd see it throughout. So knock on wood, but the efforts there are going well, and I expect them to continue to accelerate.

Specifically on the new entrants, I think one of the difficulties that really all suppliers might face is really having high levels of confidence in the volumes associated with some of these programs. Is there a way for you to maybe make a more commonized seat for maybe some of these sort of new entrants that allows you to go after some of that business maybe more collectively. So if program A does 80 units instead of 100, you can sort of make it up maybe on another program that uses very similar, if not identical, seating makeup.

Exactly. We can help them simplify that seat, try to reuse or utilize other designs to the degree possible. A lot of times, the geometry of the vehicle itself doesn't allow you to have complete commonality, but there's lots of things we can borrow from and we're getting better at doing that. And it's I think one of the pitches we've had to the customer as we've been going forward. So yes, I'd say that's an opportunity.

Maybe just to close here, moving towards the capital structure and the cash. So you got nearly $1 billion of cash on hand as of the last quarter. Liquidity, I think, more like $1.85 billion. You're paying down debt, you're getting the China proceeds. Net leverage is down to 2.5. You talked earlier about the, not pivot, but increasingly focused, talking about sort of the cash generation potential of this company. So it seems like that's only really moving more in one direction versus another. So given all these changes that have occurred in the business and really the industry over the past couple of years, how do you now think about what the right optimal level of cash is? And what do you need to see to maybe think about redeploying some of that cash? Is it just greater certainty, greater visibility in terms of the schedules? Or do you want to sort of continue to sort of build the cash balance for some level before starting to redeploy some of that?

Yes. No, great question. This year, just to be -- or kind of maybe summarize a bit of what we've done. We took out about $100 million in the 4 7/8% about a year ago, those unsecured notes in the U.S. We took out the $800 million 7% notes earlier this year. And we took down the EIP balance $30 million, $40 million or so in the last year. So you can say we've taken out close to $1 billion of debt in the last year. As we collect the proceeds from our China transaction, expect us to do more. But effectively, the way I'd frame it for folks to look at we've put a target leverage of somewhere around 1.5 to 2x. And that number could move a little bit, but just kind of use that range as being a comfortable capital structure where people aren't worried about our leverage, we have plenty of resources, liquidity, et cetera, to handle the downturns that are inevitable to our space and allow us to go on offense if we need to. As it relates to cash, we've said around $600 million is the number we target, $500 million to $600 million, say $600 million for purposes of this and nothing drawn on the ABL. That gives us plenty of liquidity to go and manage the unexpected. Anything in excess of that is an opportunity first to get down to the leverage target we had. And then after we get there, to start to think about other things, be it share buybacks, dividend or whatever we'd like. And we'll give you more color on that as we start to give you a '22 guidance and start to think a little bit beyond the current situation we're in. We'd also certainly like to -- the current visibility right now is really rough. But I'd say it's -- we're getting so much cash in from these transactions. It's certainly more than we need. So we will start this journey or continue this journey of deleveraging, but we'll certainly have more confidence to do so and more aggressively as we get to the other side of the [indiscernible] issues in the industry.

Great. Well, with that, we are out of time. So Jeff and Mark, thanks once again for joining us at our conference. We really appreciate your continued participation. Thanks for all the color today. And that will conclude the session to everyone on the line. So thanks again, everyone. Really appreciate it.

Thanks, Joe. Thanks, everyone. Appreciate it.

Appreciate it.