Aptiv PLC (APTV) Earnings Call Transcript & Summary

Good morning, everybody, and thank you for joining us for this session with Aptiv 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. Aptiv is a leading global supplier that develops solutions to make vehicles safer, greener and more connected. We are very pleased to host with us this morning Aptiv's CFO, Joe Massaro; and Vice President of Investor Relations, Elena Rosman, for a discussion. The format for this session will be a fireside chat around some of my prepared questions as well and mainly around questions from all of you on the call. [Operator Instructions] I highly encourage you to do so and get involved in the discussion. Only I will see your question, and I will ask them on this call without mentioning your name or affiliation. So with that, Joe, Elena, thanks also for being with us today, and let's get started.

Sure. Thanks for having us.

Maybe addressing the recent capital raise first. You conducted a fairly large capital raise earlier this week. Can you go over the motivations behind that, especially in the context of having a relatively solid balance sheet, the Hyundai JV reducing maybe the cash meant for autonomous driving? Just what are the priorities here? And what was the thinking?

Sure. No, that's a great place to start. So yes, listen, I think we -- as we talked about on the Q1 earnings call, as we got into late March and April, we spent a lot of time as a leadership team really focused on sort of liquidity and cash preservation steps. And we had a good, good insight into what could potentially happen to the business based on our experiences in China, which, obviously, we saw earlier on, and felt we did a good job, what I'll call, on the defensive side, on the liquidity and cash preservation, identified $600 million of cash savings initiatives and really had the business positioned from a liquidity perspective to operate through what will be a very negative second quarter and then into 2021 in a -- in sort of the COVID environment. So we had sort of addressed what I'll call defense in that time frame. As we started to see the recovery occurring, the plants opened in Europe and North America, albeit at low levels in the beginning, but have continued to ramp up here as we go through the quarter, our attention then turned to, "Okay, how do we go back to executing the strategy? How do we go back to playing offense? And what are the things we need to do to affect that?" And again, we had the liquidity covered for sort of the day-to-day operations, which included the CapEx and some investment in things like active safety engineering. But when you think some of the opportunities that we had prior to COVID, as recently as January and February 2020, around the M&A pipeline, which we believe will come back as you get to the end of 2020 and early 2021, and what we see is some opportunities to increase our share on -- in key areas like high voltage and whether it's active safety systems or perception systems as OEs start to evaluate the -- how well certain suppliers did coming out of this. We really felt it was important to get back on the offensive footing. When we looked at options, additional leverage didn't make sense to us. In our view of the world, you've got a 20% to 30% down vehicle production year in 2020, which is very consistent with where we were in Q1. I think it's possible to be at the lower end of that range. It's possible to be in the midpoint of that range, but still down 20% to 30%. And even if you see 2021 with sort of low double-digit growth, you're still off from recent vehicle production totals if you look back to '19 or '18. So for us, it didn't feel like the right environment for additional leverage. And that's when we settled on the equity offering. We did both a mandatorily convertible preferred stock as well as straight equity, very well received in the market. And I think those dual-tranche offerings, and I'm sure this group knows that, those dual-tranche offerings have become somewhat popular over the last month or 2 as part of sort of the COVID response of a number of companies. And that's ultimately the structure we settled on with really the goal of effectively, as of now, being ready to go on offense as opportunities present themselves.

That's a great overview. It feels like, when you're thinking about the offensive side, M&A seems to be a priority. I think you touched upon this a little bit in your answer. But which areas are you looking at? And when you were saying potential for additional market share, that was through M&A as well? Or were you thinking of accelerating some CapEx spending?

I think the additional market share is more on the organic side, may require some CapEx. What we're starting to see here, very early days, but that there is sort of a consistent theme around, we think, OEs starting to evaluate, particularly for key programs, for key new technologies, OEs starting to evaluate how well the supply base is done and starting to maybe ask some questions around suppliers that are not in a strong financial position. And to the extent they're not in a strong financial position and have sort of key programs or key technologies, key launches on the horizon, we think there may be an ability to take some of that work. And certainly, we want to put ourselves in the best position to go do that. So that would be more on the organic side. As it relates to M&A, our strategy, because as we -- and I think this statement goes for a lot of things, particularly around things like our outgrowth. Our strategy was very much intact when we went into this. There's clearly been a lot of short-term disruptions that we've -- as we focused on plant closures and then plant restarts, but have yet to see anything that tells us, long term, our strategy isn't going to be on track, sort of once we clear this disruption in mid-2020 here. So things like greater levels of high voltage, things like greater levels of software and active safety in the vehicles, feel very strongly that that's going to continue. And our view is that our strategy on M&A of really working towards the revenue diversification targets that we had, but also taking advantage of opportunities like KUM, which was an auto connector deal that we did in mid-2018, that significantly improved our market presence in Asia Pacific, really helps solidify our relationship with Hyundai, which, obviously, had some knock-on benefits as that relationship's continued to mature and grow. So we think there's those types of opportunities. So really around those SPS -- the SPS segment around those bolt-ons. We'll continue to do add-ons for Winchester. Those will tend to be smaller. We've got one in process now going through CFIUS approval. But we also think there'll be an opportunity for deals that are sized somewhere between, call it, the Winchester and KUM size of $500 million to $600 million, all the way up to the HellermannTyton size of a little less than $2 billion that we did in 2015. So one of the interesting aspects of the M&A targets in that signal and power solutions space, a lot of them tend to be PE owned, right? So when something's PE owned, you know eventually it will be up for sale. And we had a number of deal processes that were going in early -- at the end of 2019, early Q1. We actually had a couple of management presentations that were first postponed from late February, early March into later and then ultimately canceled, just given all the travel restrictions. We expect those types of deals to come back. And I think what needs to happen for them to come back is obviously the travel restrictions and the ability to get to places needs to loosen up. You need a little bit -- you need some more visibility into -- certainly into 2021 and 2022. So both buyer and seller can get comfortable around valuations and price discovery. But again, we really feel that those opportunities will come back and wanted to be ready for them.

That makes a lot of sense. You've also stated in the past a goal of 25% revenue from nonautos by 2025. When you sort of look at this dry powder that you now have and sort of like the acquisition, should we expect it to be specifically geared towards nonautos end market? I mean it doesn't seem like it, but is that still a big piece of the strategy?

Yes. No, it's commercial. That part of the strategy will be commercial vehicle and other industrial. I think there'll be a couple of big components. Certainly, SPS -- the SPS segment, sort of the harsh environment electronics, will represent a portion of that. Well, listen, I think there's opportunities within things like -- and we've talked about this consistently since really the last couple of investor days, there'll be opportunities around data management and connectivity-type revenues. As we talked about it, again, we don't really see a change in this longer-term strategy. We certainly believe as the vehicles become more software-enabled and, quite honestly, software-dependent, you'll have revenue streams related to software maintenance and those type of areas where, although it might be related to a vehicle, there's subsequent follow-on revenues. It's not revenue that's tied to an incremental sale of one more light vehicle. So a number of areas. But certainly, the SPS business moving into different end markets is going to be a large piece of that. And we've gotten some really good experience at this part, right? We bought HellermannTyton in 2015, which is an engineered components business. Not quite a connector business, more on the cable management and fasteners, but very similar space and very similar financial dynamics to a connector business. And that business is now well over $1 billion in revenue and has performed very well. And when we bought it, it was about 60% industrial, nonauto. So have certainly gotten ourselves familiar with those end markets and how best to operate in those end markets and such.

Great. Maybe just closing the loop with 2 questions from the audience on this topic. Would M&A come as a result of potential targets being weaker than they were pre-COVID, valuations coming down? Or I mean, you've typically not really been going after sort of like cheap assets, more high -- sort of like high margins. So any changes here in the M&A environment?

No. Listen, I think philosophically, we try to buy or we do buy good businesses, well-run businesses. Could there be some valuation benefits coming out of COVID? Certainly, it depends on what end markets they're in and what the outlook looks like. We typically are not fans of buying sort of troubled businesses. We keep ourselves plenty busy with running our businesses, improving our businesses. And bringing a troubled business into that portfolio can -- in our view, isn't a smart thing to do. So they'll be good businesses. They'll be well-run businesses, much like a HellermannTyton, much like a Winchester or a KUM. I think valuations, where the M&A market shakes out over the course of the next 6 to 12 months, really depends on the rate of recovery. But I think the assets will look very much like we've bought in the past.

That makes sense. And then, I guess, a final one in the follow-ups. So specifically around market share in Europe for low and high voltage. Looks like one of your small competitors, Leoni, is going through company-specific struggles. They've given up a decent amount of volumes or refocused their business approach away from volume growth at all costs. Do you see that in terms of market share gains in Europe?

Yes. Listen, I think I would say, broadly speaking, Leoni is not a competitor for our SPS business. We're at a sort of a much different level and scale. I think they initially were fairly bold in some of the high-voltage work they want. If you go back a couple of years ago, they were sort of certainly some of the -- a leader in that space. We were a little more cautious. So listen, I don't necessarily view them as a competitor to us continuing to grow high voltage. Listen, I do think, as I mentioned earlier, it's important -- it's going to be important for the industry for suppliers that are at the forefront of technology, at the forefront of big programs, big launches to be -- my view to be financially sound. Again, one of the reasons we wanted to make sure that we were able to go back on offense with these types of things. But I think our high-voltage opportunities, again, we've got content in that business on 1 out of every 3.5 vehicles manufactured globally. So as more and more of those have some form of electrified powertrain added to them, whether it's a hybrid or a full BEV, we've got a huge right to play in that high-voltage space and really feel good about our ability to capitalize on that.

Great. And I guess the -- so that was quite a bit of detail on the M&A market share opportunity. So maybe switching gears. Can you give us a quick update on progress of restarting in production in North America and Europe? In particular, any bottlenecks? How's the Mexico supply chain looking?

Yes. Listen, I think high-level restart, very much in line with the expectations we outlined on our Q1 earnings call. Europe, maybe a week to 10 days earlier than North America on the restarts. So restarts, we started to see in mid through late May. Slow ramps. A lot of schedule -- a lot of fluidness in the schedules in those first few weeks following a restart. I'd say they're starting to settle out a bit. Still waiting for sort of the formal official schedules for the back half of the year. But overall, I would say, and I know Kevin's echoed this in some of the comments he's made, I think the industry, both Europe and North America, did a very good job collectively as a whole of coming back online. I think there was a lot of collaboration across the supply base and across OEs on sharing best practices around safe restarts. I think there were sort of very deliberate efforts to make sure that employees not only were safe, but felt very safe, which directly relates to their willingness to come back and their ability to be productive once they're back. And I think across the board, we've -- the industry has done a very good job. We've certainly participated in it, but the industry has done a very good job. There's some bumping and thumping, as you'd expect, I think, nothing that we would call out as either unexpected or extraordinary. But overall, things are tracking well. And for us, the question really now becomes just what does the ramp of recovery in the back half of 2020 and 2021 look like? And again, really waiting for our customers to sort of firm up on that. I believe our customers are looking to see what ultimately happens with demand. Clearly, what you're hearing from the OEs, particularly in North America, around their views that certain products, certain platforms are -- the inventory levels are low and they're restocking dealers in areas like trucks and SUVs. That's very consistent with what we're seeing. So we're not -- I don't see any -- when I look at what the OEs are saying, and I look at what's happening in our business, I see a lot of consistency there. I think really, for all of us, the question is once the dealers get those cars back on the lot, once they feel like inventory has been restored, how well do they sell? And what are the next round of orders from dealers sort of tend to look like?

So actually, it sounded really positive in terms of it being more about demand than sort of like supply at this stage. But I guess a few of the suppliers we've heard of through the conference were maybe complaining a little bit about volatility in customer call-offs in Europe in particular. Is that something that you've seen? Is that something that can sort of affect the decremental margin?

Yes. Listen, I think we've seen it. Again, I think, Emmanuel, and we've talked in the past, there -- I think some of this is going to fall into relative to what initial expectations were, right? I mean we had assumed a very slow ramp in Q2, down 50%. So inherently, things like some call-offs, things like some schedule -- some fluidness in schedules, that was sort of encompassed in our expectations. And I think we've been cautious. I do think Europe, there may have been a couple of -- and it's almost platform-specific, at least from what we saw, a couple of platforms in Europe that came back stronger than maybe initially we expected, and then sort of backed that down a little bit in that sort of 2-, 3-week period out, right? So to us, as we look back, we were sort of in line with expectations. Okay, it came a little bit faster than we thought and then stepped back. But there's nothing that we're seeing at this point that was outside of our -- sort of our broader expectations. And I think, again, those are to my comments. We are seeing strong pickup in truck and SUV in North America. We are busy on those platforms. Our customers are busy on those platforms, but not necessarily, at this point, haven't seen anything that suggests that, that strength continues throughout the year. At this point, it looks like a restocking initiative. And I think that's where we're sort of our wait-and-see attitude on the balance of the year comes from. But again, nothing that has knocked us outside of that 20% to 30% down range that we saw in -- that we talked about at the end of Q1. And if you think about, just to put it in a little perspective, we were down about 20% in Q1. We've talked about vehicle production. We talked about thinking vehicle production is down around 50% in Q2. So if you think about that, that 20% to 30% range we're talking about for full year is really what we're -- is really back half volume that we're waiting to see how it shakes out, right? So that's -- and that's on a half year. That's a big range on a full year. It's even obviously bigger range than a half year. So that's really what we're waiting for. But it's, to some extent, where we expected to be at this point.

Okay. Great. Let's maybe focus on your growth above market. A couple of questions. It was in the low teens in the first quarter. I think you indicated then that you see no reason why it couldn't stay at sort of like the high single digit or so above market going forward. Is this something that we could see over the rest of this year as well?

Yes. Listen, I would be -- let me start off with my earlier comments around our long-term strategy. We've experienced -- we have not experienced, we have not heard anything from customers that would suggest the broader trends in sort of safe, green and connected that are driving our outgrowth, that 6% to 8%, are changing longer term. So as we clear the disruption and noise around 2020, we very much believe we'll be within that, back within that range. And certainly, we've been at the higher end of that range if you think about sort of -- certainly in 2019. So our view, as we normalize out and go back to that range, I would be cautious. And I mentioned this, again, as part of the Q1 discussion, growth over market doesn't always shoot straight on a quarterly basis in normal times. And you can see some -- I do think you can see some swings or variations in that number to the positive or to the negative over the next couple of quarters because it's significantly impacted by restarts, plant closures, right, because it's a relative calculation to what was produced. So again, you see a really strong rebound in truck and SUV production. As a percent of total, that could drive a little bit of different math. But long term, we remain very comfortable with the 6% to 8%. The 13% in Q1, we felt was a pretty good number, a little bit of noise in there from China. But Europe had a great, great Q1, really driven by high voltage and active safety. Expect to return to that normalized level. Do think you could see some lumpiness in the next couple of quarters. And we'll certainly provide details on those as we report out. But I wouldn't read too much into a very high growth over market in a particular quarter with restarts or particularly lower -- lower-than-expected growth over market in a quarter with restarts. I think it's going to be somewhat driven by just the lumpiness of production. But no change in the longer-term view.

That's fair. And then on the booking size, the first quarter bookings were, I guess, on the softer side at $2.8 billion, I think that you very much indicated that this was not a source of concern. Are you seeing better trends so far over the rest of the year?

Expected level of activity, all the programs we were talking to customers about continue to be discussed and to be worked upon. The teams, even if they're on work from home, continuing to work on those. So again, I wouldn't expect any significant changes, cancellations, redirects on expected wins. I do think -- listen, is it possible things like that are a little bit lumpier over the next 2 or 3 quarters than normal? Possibly. There is -- I think the industry's done a reasonable job adjusting to work from home, but there's been a lot of focus on restarts. So again, no communications where we've got a customer saying, "Hey, that Level 2+ program we were expecting for 2022 is now canceled." We've seen none of that. The -- certain things on the administrative side work a little more slowly now just given all the disruption than they were this time last year, yes. So I think you could see a little bit of that lumpiness, but, again, nothing -- we're seeing nothing that says, longer term, this business is going to be different than we thought it was going to be in mid-February 2020.

And certainly no change in win rates either?

No, it tends to be -- we're not losing stuff. It's just the slower bid process at this point. Q1 was just slower with things pushed back, work from home and such. It's not a -- somebody wants something, we're expecting to win it. It's not that type of situation at all.

Great. Shifting to margins. First quarter decremental was 31%. You suggested the second quarter could be over 40% despite having the benefit of deconsolidating some of the mobility investment losses. So could you go over the drivers for this, separate out what is caused by sort of that steep volume versus sort of like the need to maintain these incremental engineering investments?

Yes. So that's a fair question. So decrement, we've always talked about decrementals depending on region, timing, business being between 25% and 35%. Q1 was 33%. The additional engineering spend, that $90 million, $95 million we talked about at the very beginning of the year, is pretty much ratable throughout the year. And so you can do that math. That is not a big driver of the decrementals, right? That's -- now $95 million is a lot to spend on engineering. I'm not saying that. But when you think about the decremental math, when that's spread out over 12 months, it isn't a particularly big driver. Q1 was within the range of that 25% to 35% at 33%. It was actually a little heavier than, obviously, I would have liked to have seen. Part of that is because we took the 6 weeks of shutdown in China. And the way the China shutdown work, the -- sort of by decree, the Chinese government effectively extended the Lunar New Year. And the Lunar New Year is a paid holiday. So we were incurring even though shutdown basically full on payroll at that point. So that drove that decremental up. The Q2 decremental at 43%, again, really driven by the plant closures. So you closed down the plants for 8 weeks. There was originally supposed to be 4 weeks. Then it grew to 6. Then it grew to 8, right, so very hard to do much on the cost levers. We sent the folks home, but they go home on TLO or temporary layoffs. So they are -- we did maintain their medical benefits for everyone that went home, which we thought it was important to do just given the circumstances we all found ourselves in. But also they get a certain percent of their salary. Anywhere from 50% to 75% of their pay, they kept during this period. So that's just a very negative P&L and cash impact. Now we're doing it for the right reason. If you take Mexico, for example, we have 65,000 employees, right? We were initially going down for 4 weeks, and then it turned into sort of, call it, 8 weeks in North America. The -- to take those costs out, there's about a 6-month severance in Mexico, right? So if you're going to shut down for a month or 2, it's -- as tough as the P&L math is, it's actually smarter to keep paying them for the 2 months than pay them 6 months' severance and then try to hire as many of them back in 2 months as you can. So that's really what's driving decrementals. I would certainly expect year-over-year decrementals in the second half of the year to look much more like Q1 within that 25% to 35% range than Q2. Q2 was really driven by the extended shutdowns.

And on the way up, I guess, when volume are -- as volumes hopefully recover, are we in the 25% to 35% as well?

Listen, there's -- we've always talked about incrementals being sort of that 20% to 22% range just given the lack of visibility into things like how long and how much PPE will be in the system going forward, how disruptive some of these safe working protocols are when you start to get really back to normalized volumes. I'd be cautious above, and Kevin's mentioned this, we're comfortable with sort of the historical incremental range. I'd be cautious taking it up at this point until we really get a better sense of just what it looks like to operate with COVID in the environment. But certainly, if you're talking about -- we got asked the question during the road show on Tuesday, "If you had $1 billion of incremental revenue in 2021, are you comfortable it would flow at sort of 20% to 22%?" And we responded, yes. So I think that's -- I'd be, at this point, more comfortable with that range until we get better visibility.

Great. One last one on margins. The margin in AS & UX have come under decent amount of pressure despite, I guess, deconsolidating this mobility investment. And we obviously spoke about this growing engineering spending. Do you think they'll stabilize -- the spending stabilizes at current levels? Or do you see the need to keep growing this cost to support future growth?

No. Our expectation -- we're right where we were still at year-end. Our expectation, this was an incremental $95 million to take advantage of some opportunities and -- both on the accelerated launch side as well as the new business wins. And we continue to believe in terms of both -- on what we said, and, from a business perspective, why that business needs to get back to those margin levels, believe that business will get back on track and hit those Investor Day margin levels at this point. We've -- the incremental investment, as we talked about at the time, for 2020 was, our view at that time, a discrete investment that made sense, but not something that we see as a long-term margin headwind.

But a discrete annual investment? Or you're saying that the dollar money in engineering will stay constant and you can sort of like leverage that up. Or was it sort of like onetime in this?

Yes. No, I think it's going to be a combination of it's not all -- we don't put all of that investment, continue all of that investment in the business, but the business also grows. So I was more on the impact on margin rate. We may get there in a couple of different ways, but we'd certainly expect that margin rate that we've talked about is the long-term margin rate in that active safety business to get back on track over the course of 2021 towards that margin rate.

Great. So since we only have about a minute left or so, 1 or 2 -- actually 2 quick ones on the technology and specifically ADAS and mobility. On ADAS, are you still seeing some outsized win rate in semiautonomous system Level 2+? How's the competitive environment looking? And then on the mobility side, any update to your either targeted time line to have that as a business? Or any update to the business model there in mobility?

Yes. I think that -- no changes in the competitive landscape of AS & UX. And what we're seeing, again, for those high-end satellite Level 2+ systems really view it's ourselves and Bosch as the lead provider of those systems. That continues. The JV is doing well. We've actually had a couple of Board meetings since the close. No changes in that time line of sort of vehicle out of the -- or driver out of the vehicle by the end of this year and a robotaxi-type product by 2022. The JV has fully stood up. They're in their own offices at this point. That -- Karl's leadership team is fully staffed, obviously, put a few additional corporate types in there, a CFO and a general counsel, as a stand-alone business. The Board meetings, although they've been via Zoom, we haven't been together as a team obviously yet. But the business is up and running, and Karl continues to deliver on his technology road map.

And in terms of the business model, any shifts? Is it still about robotaxi? Is there a good delivery piece of it, like, I guess, where would their first revenue come from?

So still focused on the robotaxi. There's another -- a number of other areas, including those types of sort of automated commercial vehicle potential, that he has been evaluating and continues. But at this point, no significant augmentations to the strategy.

Great. Well, listen, we're out of time. But Joe and Elena, I really want to thank you so much for joining our autos conference again this year and for all the insights this morning. For everyone on the line, all the investors, thank you so much for your participation. Thank you so much for your great question that you submitted, and please join us in 9 minutes for a fireside chat with the CEO and CFO of Magna. Thank you so much.

Great. Thanks, guys. Stay safe, everyone.

Thanks.