Adient plc (ADNT) Earnings Call Transcript & Summary

Good afternoon, everyone. Pleased to restart the afternoon agenda. We have with us Adient, represented by Doug Del Grosso, CEO; Jeff Stafeil, CFO, who many of you know. Mark Oswald also on the line.

I want to begin, as we have with the other suppliers so far just the latest that you're seeing in terms of the production environment, is it as -- I think 2 questions. First is it as -- what is the overall level in 4Q? And is some of the choppiness that beset the industry in 3Q getting better or getting worse? And then kind of how do you think that of the outlook, you kind of -- with your fiscal year had to comment on calendar '22 before others do, but how do you see it going forward?

Sure. Thanks, Brian. Appreciate the opportunity to participate in the call today. Maybe I'll start out, Jeff, and then I'll pass it to you for some further comments. But with regard to choppiness, I would say right now, our Q1 is slightly better than Q4. And I'd characterize it that our customers are providing a little bit more transparency. And as a just-in-time supplier, that's critically important. If I compare it to the worst times in fiscal year '21, we were getting extremely short notice. I think about 60% of the time. For example, we were getting notification from our customer of shutdowns with 2 days' advance, which made it extremely difficult for us to flex costs because we didn't know when they were going to come back on. And therefore, we had to maintain full manning in our plants. Volume is down significantly from a capacity standpoint in Q1. But what's changed, and this is really addressing choppiness, is it's reflected in their EDI call-offs. So now there's slightly better performance through the releases, where before we would get the full release in the short notice, now we're getting the reduced release and with less short notification of shutdown. So it's given us slightly better opportunity to flex our costs, but that said, volume is still down pretty significantly, both in the Americas and Europe, so when we look at the quarter.

And how about going into '22? Are you getting preliminary schedules for calendar 1Q? Or do you -- even if you are getting them, are they worth the e-mail that they're written on?

Yes. I don't know if I'd go as far to characterize it that way. I would just say at this point, it -- which is why we didn't provide the guidance that we normally provide, in our last earnings call, it's pretty unclear. And so there's reason to be cautious on what the full year looks like at this stage. And our customers aren't being completely transparent on their ability to run without supply chain.

Now in terms of your supply chain, are there parts of the supply chain that are risks for you? We've seen chips, magnesium cop up. We see the boats piled up outside West Coast ports, petrochemicals, particularly in Europe, spiking and potential shortages. So how does that -- what are the supply chain risks that you're worried about coming into your own factories?

I mean, it's all those issues. It's Winter Olympics in China and what disruptions could be there. The one you didn't mention that's a heavy concern on our part is the vaccine mandate in the U.S. and what that does from labor availability, not just obviously, in our operations and our customers, but the ripple effect that, that has in the supply chain. COVID infection rates, which are trending in a negative direction at this particular time, and any intended mitigating actions taken by governments to address that, obviously, are all things that we're absolutely concerned with. I think what we're better equipped with now is our ability to peer into the supply chain, a lot more awareness on our part, a lot more investigation activity on our part to find out where those disruptions might be, and really dedicated resources to find mitigating actions that we might be able to take, whether it's pulling from different regions of the world, in some cases, or making more permanent changes in the supply chain, bringing onshore manufacturing that reduces the probability of a disruption.

And so let's start drilling into the major cost headwinds that you outlined for 2022. Material economics was a $70 million headwind to adjusted EBIT. You had about $450 million combined headwind. Is there any way to kind of dimension that across the supply chain disruptions, operating efficiencies, COVID costs, increased freight costs apart from -- and other costs apart from materials, labor shortages, labor inflation?

Yes. Maybe I'll take that one, or at least I'll start there. Yes. We talked about for 2021 and 2022, roughly around the same level of total inefficiencies, this $450 million number that you mentioned. You can dimension that, about $300 million of it, give or take, is volume related, just lost volume, give or take, around $2 billion in sales. We think it's impacted both our 2021 and will impact our 2022 by about the same number. The remaining $150 million or so are the inefficiencies you talk about. Different dimensions between 2021 and 2022. COVID was a bigger expense on its own in 2021. I think we've gotten better managing it and have brought down some of those costs. We had the Texas storm in 2021, which was a big impact to us. But the freight impact was smaller in 2021. In 2021, we had a big supply chain semiconductor impact. We see that continuing into 2022. And we also see significant premiums relating to freight for all the reasons Doug mentioned. But in many of our freight lanes, and we tend to look at all of our freight lanes, and we look at all of them in quite a bit of detail, and you can see where it was $2,000 a container from port to port or supplier location to our dock, it's gone up to $20,000 or in some cases, even more. So big increases there. We've seen increases in utilities and the like. But the net of that is, again, a different constituted, but about $150 million. As it relates to commodities, which is a separate pool, it was a $70 million impact in 2021, the year just passed. We have another -- we forecasted an additional $125 million impact into 2022. It was -- it would have been $200 million. We've gone through with a variety of actions and mitigated that down to $125 million, continue to try to work that further. But that's what we talked about last week on our earnings call.

And let's talk a little bit about the commodities are pretty obvious. But given you are kind of pretty big as I understand an upstream supply chain into your JIT plant reaching lower-cost countries for some of the components, how significant is that when you talk about $20,000 per container? If you talk about freight rates for trucking going up, how significant is that kind of internal freight to your cost structure?

It's significant.

It's very significant.

Yes, it's a big piece of the $150 million of additional cost we talked about, without giving an exact amount, but it's definitely north of $30 million, close to $50 million in that range, depending on where the rates move, and we've done a lot of things, and that's after mitigation actions where we've been trying to improve pack density, relocate some items that we can relocate. A lot of that, as you imagine, takes time. Validating and getting all that through if we want to change locations isn't something we can do in a month. But all that's impacted in there and all built into that $150 million of additional premiums over and above the sales loss.

Okay. And can you maybe talk a little bit more about the mitigating actions? So you talked about commercial negotiations on commodity recoveries, reducing the headwind from $200 million to $125 million. Is that just enforcing the contractual provisions you have, getting some of them accelerated? Or are they uncontracted for commodity recoveries that you're able to get?

Well, the incremental improvement we referenced from what we had originally projected has been more accelerated negotiations with our customers. We've gone into our customers and said, look, we're a value-added supplier here. Our commercial agreements aren't structured to handle this level of inflation for this sustained period right now. Where we have commercial agreements that either have a lot of painshare or leg and are annual in nature. So the progress we've made has been our ability to go with and renegotiate temporary terms with our customers, and we're continuing to do that today. So we expect we'll make some incremental improvements, but on the flip side, we also are conscientious of the fact that if we're too aggressive in those negotiations, and quite frankly, some of our worst commercial terms relative to material economics are with our favored nation customers, and so we have to move cautiously because we don't want to disrupt our backlog as a result of resolving some of these short-term issues. And I'm not suggesting that the material economics are transitory. I think they're here for a while. It's just how fast we can get special deals put in place to mitigate the impact.

And so how -- given what we just discussed about your internal freight cost headwinds given, for example, in European plants, the natural gas to heat them is probably up to 7x, your energy costs are up. in addition to trying to get commodity recoveries, how are you and how are particularly your customers who have been spoiled for years with price downs plus or minus commodities, thinking about just a general inflationary environment?

Yes. So I mean, the way we approach our customers, and I think it's somewhat unique to the seating business, anything that's a large module is -- I always refer to it as basket of goods. So we've got customer expectations and productivity. We've got material, labor inflation, logistics cost, that's all thrown into the discussion. We then put on top of that VA/VE opportunities. We talk about engineering change and the relative impact on a program. Our business is very transaction-oriented, and we're constantly processing cost price impact in our business. So what we try to do is pull that all together and see if we can come to terms with our customers with some sort of win-win solution that minimizes the burden on us, passes some of the burden on to them at least in the near term. And then as the situation evolves, we can reverse certain things if cost pressures mitigate. And so I like that aspect about our business. Our customers have been spoiled to a certain degree. We remind them constantly that really we're a B2B business. They're a B2C. So they're the only ones that really can pass this on. And back to my original point, it's way out of the scope of our commercial agreements, the original commercial agreements were put in place. So it requires a lot of transparency on our part with our customers to quantify the impacts associated with this and thoughtful discussions with them on solutions that we can bring forward.

Now I know you're not [ John Barth or the late Rob Rosner ], but let's kind of think back to the early days of my career where inflation was still a closer in memory, are there any lessons learned? And I recall your Chairman, Fritz Henderson once remarking that one reason GM rotated future CEOs through Brazil is so they could experience economic cycles and hyperinflation. So as you kind of think through that ancient history or more recent in Brazil, kind of is there a new model needed for Tier 1s around if we are going to be into an inflationary regime?

Yes. So if I were to reflect on those 2 gentlemen, I would say the lesson learned from them is you need to be extremely focused on the things you can control. And this is our motto is if -- we're providing a tremendous amount of value to our customers. We're executing on the launch. Our quality is good, our delivery, technology solutions. We invest a tremendous amount of time and energy into VA/VE activities to find ways to mitigate the impact of this. We have real expertise in our product that we can bring forward to our customer. What I think that does is it becomes a catalyst for us to get things done commercially. And if I would contrast that where we were a few years ago, where we were failing on launches, we weren't executing on the program management side, our quality was bad, our delivery was disappointing our customers, to go into negotiations with that backdrop as opposed to the backdrop we have today, it's very different. Now the environment is very different as well. So the cost pressure that we're under right now is different than it was a couple of years ago, but it's not self-inflicted, which is a good thing. I think we're in an excellent position with literally all of our customers as far as our level of performance on the things that we're capable of controlling. What we alluded to in the earnings call is if these cost pressures are sticky and they're going to be around for a while, yes, absolutely, then we have to have a different discussion. We have to have an alternative solution than just waiting for things to get better. That's not going to work well for us. Will we recover at all? We'll wait and see. But right now, our focus is, look, focus on the fundamentals of the business, be recognized as a real contributor to allowing our customers to achieve the objectives they have and then sit down and talk with them and try to find a reasonable solution to some of these problems.

Okay. [Operator Instructions] I already have one question I want to get to in a bit around capital allocation, which is usually towards the end. But before that, it seems like, certainly, if you listen to one of your competitors, that you might have lost some share in seating over the past few years. Some of it may be you walking away from underpriced business. When do you expect that share to stabilize? And then are you looking to grow -- at what point do you look to grow market share and where?

Yes. Again, I'm aware of the comments and who they came from. I would say 2 things. There is one significant contract that we've been pretty open about it. It occurred quite some time ago, an incumbent business that we walked away from because we felt that the price point with that particular customer that they were awarding the business -- and it was really our decision to accept or not. It was almost a right of last refusal, which we did walk away from. Beyond that, I -- we've been pretty successful in our win rate on incumbent business, and I can point to a number of awards we have had at the expense of our competitors. So with that one exception, I don't think there's been a material change in market share. The other point I would make is, and particularly true in China, I would say that is a developing market in -- and I'm not sure that IHS is the greatest predictor of what's going to develop in that market when you look at the EV revolution. We feel really good about the independence that we have right now as a result of our recent divestiture. We think we're extremely well positioned to capitalize on that change in the marketplace. And we think we've demonstrated that with wins with NIO, for example, where we've got a dominant position with them and the real strong contenders that have emerged. So I've heard those stats. I can think to one significant data point. But beyond that, we're doing extremely well winning the business that we want to win.

Now speaking about the leading competitor, they recently announced the acquisition of Kongsberg, which supplies the massage seats and other advanced seat components. Is that your record from the prior management on vertical integration was kind of mixed, especially buying German companies. So but in terms of just the CPV in seats and kind of having seats become more advanced, are there -- is that a threat? And then are there some components that you're, and I'll get the capital allocation down the road, interested in vertically integrating into or out of in the case of continued metals turnaround?

Sure. Relative to that acquisition, I would say it's not very transformative in our opinion. We know that supplier. We're actually the largest customer to that supplier. It's very Euro-centric, more aware of the technology that they have and where we see that technology as we assess it with others in the market. So I understand the rationale behind it. Like I said, I don't think it's transformative. Right now, we've decided in that specific commodity to not vertically integrate. We buy it on the open market. Much of it most recently has been directed from our customers. So we don't have to contend with that conflict of interest. Will that change as CPV and autonomous or just content in general increases? It might. Right now, we feel pretty comfortable buying that when we have the choice on the open market. We think there's equal to better technology out there in the U.S., certainly in China. We think it's very cost competitive as well. So not particularly concerned with that development, I'd say.

Okay. So let's turn to talk about the margins. You still -- if you exclude the transitory costs, you would have pro forma been 6.4% in '21. That's still a lower margin by about 100 to 150 basis points from the benchmark you put out there of 7.5% to 8%. So apart from the more transitory volume effects, how -- what are the continued steps needed to close the gaps and where are you on those?

Yes. To me, the biggest step is that backlog. And it's rolling off what we weren't able to fix that was dilutive to our margin and replacing it with a backlog that's more consistent with our margin expectations. And we've always said that's going to take a few more years for that to sort itself out. And quite frankly, when it comes to commodity inflation, if commodity inflation is still there, that new business comes in, but that issue being reconciled. So it doesn't carry that burden on a go-forward basis. I would -- the rest is what we call our back to basics 2.2, it's just to continue to execute and not have whatever our standard costs associated with bad launches, bad development programs, bad pricing on new business that isn't resolved during the development stage of the program. And Jeff, if you want to briefly comment on that?

Yes, just maybe in the -- you referenced the 6.4%, which we calculated the margin impact of the current environment we're in, in a couple of different ways. On that particular calculation, we had added back in the commodity inflation and the inefficiencies, but we didn't add back in the volume loss. The volume loss is pretty significant for us. And if you think our contribution margin on volume is 15-plus percent. On Page 5 of the presentation last week, we had said basically, all the improvement actions that we've done within the 4 walls of the business, it's more like 550 basis points of improvement action, which against that initial, you can say, 3% margins where Doug came in gets you up close to our benchmark margin. Now we had about 400 basis points of commodities and lost volume and the inefficiencies caused by the market, which offset it. We are starting to see the light kind of getting there. We definitely need some tailwinds to get there. All those things that Doug talked about though were other avenues we're looking, other levers we're looking at to increase the margin profile. But just don't forget the lost volume as you think about us and what the impact was to our overall margin as a result of that.

And how about pressures? Launch volume and complexity are -- should be up in fiscal '22. Is that going to be a margin headwind? Or is that made up for by some of the underpriced things rolling off?

The one region, it's up as far as number of launches and complexity most notably is in the Americas. Some of that was characterized because launches that originally were planned for fiscal year '21 pushed into '22. I don't see that having a drag. But to just point, unless there's a volume impact associated with it, our customers continue to push that launch out. That obviously is not favorable for us. But as far as number of launches, complexity, I feel very confident that we're in a position to manage our way through that.

And any other potential margin headwinds in '22, whether it's the metals turnaround or other non-repeated commercial or the $30 million non-repeated commercial settlements?

Probably the only thing is -- well, I think we've covered a lot of them, and I'd encourage you to go back or everyone to go back and read our transcript from last week as we spelled a lot of them out. But the labor market, a lot of uncertainty around what happens there. Doug mentioned the vaccine mandate or really testing requirements that are due to come in place in early January, what the impact will be to labor availability and then ultimately, labor cost was something we're watching very closely.

Okay. And now so let's move to kind of thinking about capital allocation, cash flow generation. So as things normalize, what is the likely steady state free cash flow?

As things normalize, I think we should -- as we're able to bring back money into the system, so a lot of these inefficiencies we've lost or lost sales, you start to factor in maybe a few components I'll help you with is generally, interest expense, we talked about $150-ish million this year. That should come down as we're able to delever. So that's going to be a benefit. Cash taxes, $80-ish million this year. The way our plumbing is set up from a tax standpoint and at least how we see our forecast moving forward a bit. We have the benefit of a lot of NOLs. I don't see cash taxes moving up materially as income moves up. So we won't have a lot of drag on cash taxes, maybe $20 million, $30 million, $40 million. But on big improvements in free cash flow or in earnings, we shouldn't have a lot of drag on cash taxes. CapEx, I think the level we're investing today is a reasonable amount. It can always tick up $30 million, $40 million one way or the other, but I don't see huge changes in our CapEx profile. So a lot of it will be as we're able to flow through the benefits of if we can get back to a normalized vehicle build, let's say, into the $90-plus million range globally on vehicle build, if we're able to kind of push through the things we need to as it relates to inflation and how that turns out, whether with transitory and prices come back or our prices increase to recover it. Over time, as a value-added supplier, I would expect our margins to normalize and kind of get back towards the target margin we're talking about. So the cash flows can be pretty significant. And this is the goal. As we look at this business, as we look at the earnings power, we think of it as a big opportunity on cash flow. We've clearly had a setback with COVID with the inflationary impact with supply chain and semiconductor issues. But as we look forward, our cash flow expectations as we wind through it are still pretty significant.

So let's say, just a number of clients you have, let's say that's $1.5 billion of free cash flow through '23. You also have $1.2 billion of proceeds coming in from YFAS. How do you think about capital allocation once production has stabilized?

Yes. Just on the point of the YFAS proceeds, we talked about $695 million came in on our September 30 balance sheet. The remaining $625 million will be coming in before the end of -- we expect to come in before the end of this fiscal quarter. As it relates to our capital allocation expectations, it's what we've spelled out in the past. And just to remind everyone what that is, we see our leverage long term somewhere between 1.5 and 2x leverage ratio we think makes sense for us. It gives us plenty of liquidity to operate the business. We'd expect to have somewhere between $500 million and $600 million of cash, sort of full availability of our ABL. And then anything over that, that we haven't used to pay down debt to get down to that leverage ratio, we could start to think about for things to benefit the shareholders. If we continue to see weakness or value in our stock and buying our stock ourselves, that's something we would prioritize eventually as cash flows in the industry stabilizes. Dividend is something we would think about as well. But again, living within that range, getting our leverage down to that 1.5 to 2 and then starting to apply the cash flow towards -- back towards to shareholders. The good news for us is there's not a ton of acquisitions or M&A opportunities. Always little things, and we'll look at them if there's nice value-added components that we can look to buy. But we have a pretty solid market share and solid capability across the seating sector. So a lot of those excess cash flows can be used productively back towards our shareholders.

And final question as long as we're in the capital allocation weeds. What is the likely timing of debt repayment? And you do have a 9% secured callable in April '22 that has the highest coupon. Is that something you'd be looking to take out earlier?

Yes. The short answer is yes, soon. We have -- we talked about since September of last year, we took out nearly $1 billion of principal in our debt, including the entire issuance of that -- the 7% note we had $800 million or so, we took out -- or we planned to take out that 9% note. That's something we talked about in the earnings call as well, plan on -- and our interest expense, we talked about assumes $1 billion voluntary repayment in 2022. And you could imagine we would focus on that 9% note.

Okay. I have a bunch of questions we didn't get to. I have to have you back in the future forum around autonomous and electric, but we do have to keep on time and really launch the next one shortly. So I want to thank Doug, want to thank Jeff, want to thank Mark for the updates around the Adient story. Thank you.

Yes, Thanks, everyone.

Yes. Thanks.