Dauch Corporation (DCH) Earnings Call Transcript & Summary

Our next session, very happy to have American Axle back with us for the Citi Global Industrials Conference. I'm Itay Michaeli, Citi's U.S. auto analyst, and we're going to host a Q&A session here like a fireside chat and go through a lot of interesting topics. And of course, if you have questions, just feel free to ask throughout the session. We also have our legal disclosures outside if you need them. So from American Axle, very pleased to have Chris May, the company's CFO; as well as Jason Parsons from Investor Relations. Thank you both for being with us.

Thank you for having us.

Absolutely. So if we kick it off, I guess, with a couple of kind of revenue, industry questions, and I'll ask you the question, I guess, you're probably getting at every single one of your meetings. I know you reported earnings very recently, but any update just on coronavirus-related risks and supply chain since the last earnings call? I mean anything new there?

Okay. Well, thank you, and good afternoon, Itay. Good afternoon, everybody. Certainly, a very good conference, and appreciate you hosting us along with Citi. Before I begin, myself and any comments Jason may make, obviously, we'll be discussing some forward-looking information here today. And just as a reminder, please refer to our forward-looking disclaimers on our website. Okay. So I think with that, Itay, your first question centered around impact of the coronavirus that we've seen in our China marketplace. And we did release earnings and had an earnings call last Friday. And at that time, we provided an update to where we saw the impact to us, based around the midpoint of our guidance, around $25 million impact from a sales perspective. And that, of course, assumes that our customers come online here really through the balance of February and in early March. And then we have no additional updated information from that time stand. But of course, this is a pretty fluid and dynamic situation, and should it continue outside of that environment, obviously, we would need to update that accordingly.

Sure. The other recent development since earnings has been the announcement of some restructuring internationally from General Motors. Hoping you can review or just talk about any impact there, any exposure to some of those actions.

Yes. No, great question. That's obviously also a very real-time update that we were notified here this week of General Motors restructuring, in particular in the Thailand market, that would impact American Axle. And just by way of perspective, our -- if you look at our Form 10-K, our other Asia sales are around $255 million. About half of that is associated with our operations in Thailand, and about 2/3 of that is used to support General Motors on the platforms that they talked about restructuring. They also indicated they would begin to ramp down operations here in the middle part of 2020. So obviously, brand-new information, working with our customer on that. But that sort of frames a little bit the size and magnitude of the impact of that announcement this week by General Motors.

Got it. That's helpful, Chris. And then if we kind of step back and just -- of course, reported earnings and provided some new guidance for 2020. Obviously, last year, there are a number of puts and takes that caused some of the revenue shortfall. If you step back and think about where the company is today in terms of -- and particularly outside of North America, pickup trucks, how do you look at your revenue relative to sort of mid-cycle? Or what parts of the company's revenue do you think sort of potentially get better in the next few years, cyclically or otherwise, versus things that might be a bit more challenged to get better?

Yes, certainly. Think about our full revenue base, about half of our revenue supports full-size truck platforms in North America, a very strong solid foundation from a revenue perspective. If you take a look at some of those markets that we are experiencing outside of that product set, we've seen in 2019 our China sales down 16%, our overall Asia sales down 16%, Europe down about 2% in line with the market, and even our Brazil market is down almost 20%. And again, all of these based a little bit on product set but maybe a little wider scope than we've seen market declines. So there is some opportunity embedded in that as these markets stabilize and some of the products, of course, that we support into that marketplace, given that we had a little bit of an outsized down element in 2019 associated with that, which could propel some opportunity going forward.

Got you. So it sounds like if some of the production, I guess, schedules and environment in these regions improved -- obviously, you've got a major launch and a large SUV program here this year in North America -- I guess there would be some scope for revenue to improve, kind of all else equal?

Yes. All else equal, if you look at those markets I described -- and yes, coming on when you talk about the full-size SUV, of course, that would relate more towards the 2021 time frame as we go through the conversion this year with our largest customer, General Motors, on that platform.

Great. I think you also talked last week about your backlog, gross and net. And I think that the net backlog -- sort of the offset to create sort of, I guess, a minimal net backlog over the next few years. As we think about that environment, and we just talked about in terms of revenue, how should we think about it at a high level around the drivers of margins in the next couple of years? You gave, of course, your guidance for 2020, but how do we think kind of broadly about the puts and takes beyond that under the current revenue environment? And if the base revenue, of course, does improve in some of the regions that we just talked about and some of the programs that are launching and ramping, how to just think about incrementals in that situation?

Yes. And maybe we talk a little bit about the first element of your commentary associated with our backlog, maybe to kind of level-set on that, and then talk a little bit on the margin element. So from a backlog perspective, we did announce last Friday a $750 million backlog cadence for the next 3 years, $400 million coming online here in 2020, which is a nice healthy backlog for us; $200 million in 2021; and $150 million in 2022. So for a total of $750 million. Obviously, our objective through our quotation activities, through some of the growth elements inside our business, is really for our backlog to propel us ahead of attrition, propel us ahead of price-downs, to kind of gain, if you will, through that cycle with our backlog. And based on the amounts that we're quoting and looking at into the future, I see some real opportunities to do that. We're into bookings already for 2023 and beyond, obviously beyond the scope of a little bit of our disclosed backlog, with a lot of activity cooking in that range as well. Those, of course, do translate into continued margin support. But from a margin perspective, as we think about coming into 2020, a very healthy 16% margin guide for the full year which, as you know, is one of the top-quartile margin performers, and our objective, as we now run for the next couple of years really in a very solid, stable environment, is to use some of that core AAM productivity initiatives, core to our company for a long period of time, where we really then start to offset, get at price-downs and offset those, offset the impact of inflation really to maintain strong healthy margins through this period of time in this cycle. And that will remain to be our objective today.

If there are any questions, feel free to just come on in with any. Sounds like -- I guess maybe thinking with the current net backlog you should have opportunities with productivity to kind of offset pricing and be able to sort of sustain margins in, let's call it, a flattish revenue environment. Got it. And then again, if revenue does recover, particularly in the base business outside of North America where, as you mentioned, you had declines, some of which in double digits, how to think about -- just remind us on the incremental margins in those regions as we think about that base business.

Yes. No, look, as you know, in this business, revenue has an impact on margins, right? And we have seen, from an overall -- think of a company average 25% to 30% incrementals and decrementals on our book of business, obviously a little stronger on the full-size truck segment. You think about the China margins that we talked about, mid-year 2019, you saw strong incrementals and decrementals associated with that. So that would play into our favor as well as that market continues to recover. The rest of it, I would think as sort of in that kind of corporate average element to incrementals and decremental margins.

Got it. That's helpful. And then we talked about -- maybe we could go back to the backlog. And this $150 million that you disclosed, how are the win rates throughout the year relative to internal expectations? And yes, in terms of -- you typically kind of do give or disclose what you're quoting and what your typical win rate is. So what's the typical -- your win rate last year relative to that typical win rate and relative to what you were targeting internally?

Yes. No, from a quotation standpoint, we did, I think, mention this also on Friday. We're -- about $1.5 billion in terms of active type of quotations we're in dialogue with our customers or in our queue process through really our entire product set that we supply into the marketplace today. So that's pretty exciting. And you've heard us say previously, look, we expect to win 25% to 30% based on the programs that we go after. We try to be selective in the programs we go after. We want to maintain discipline in financial hurdles and returns. Those are key to the long-term performance of the company, which we believe very strongly in. And I would say that that win rate would be the expectation that we do. And you saw something very similar to that type of win rate in the 2019 period of time as we were looking to win new business for the future. And as I mentioned previously, we got bookings going in beyond our formally announced backlog that continues to build on that going forward.

Got it. So as you think about -- and clearly, to your point, Chris, that the backlog and the growth can fluctuate depending on product timing, what would you say would be a normalized kind of annual net backlog for the company? Or maybe you can -- gross, but net will be preferable. And how do you think about -- how should investors think about sort of a 5-year medium-term opportunity for the company to kind of grow above market, so sort of the growth-over-market revenue ratio that we all like to focus on?

Yes. I think in terms of from an opportunity set to growth over market, I think it's really in some of the key areas that we're pushing into today, whether it be electrification -- because we do have a pretty strong belief in some of our core products here today will continue to remain very robust -- but electrification, our VCS business, which is really geared towards engine downsized, hybridization, those type of elements, which we see has a lot of growth, a lot of interest from our customers. So those segments, we think, give us an opportunity to continue to propel over market growth in particular for those areas. But holistically, look, if we -- if our backlog can outpace attrition, outpace price-downs, that's going to push us then into growth beyond just the market move of our core product.

Got it. And then EV, it sounds like that's an area that's kind of part of driving that growth. Can you talk maybe just real quick what percent of the current quoting is electric, and then maybe for those who are newer to the story, an update on what you do with EV, the competitive set there? And then how -- whether -- because we often get this question a lot, EV content, is that accretive to what you sell today? Could there be situations where it's adversely impacting, it's replacing like very profitable business you have today? Sort of think about EV as sort of the opportunity versus threat, that's still a question we often get.

Sure. I think you asked me about 9 questions in there, Itay. So I'll break those -- I'll try to break those all down. So -- but let's start with the $1.5 billion in terms of what we're quoting. So think of that from an EV perspective, as I mentioned, we're covering all our product set really in that quotation process. The EV side, I would say, contains about 20% to 30% of that as we sit here today. And again, that's a dynamic piece that comes and goes depending on opportunity sets that present themselves.

20% to 30% of?

Of the $1.5 billion.

$1.5 billion.

Yes, in terms of...

Of the quotes or you mean also the...

Correct, on the quotation side. That's correct, correct. The question was, just in case anyone didn't hear online, what was -- that was a percentage of. It was a percentage of the piece that we're actively quoting. So -- but what do we do in the EV space? Let's start there. So we really do a wide, broad set in the EV space. We're into electric rear- and front-drive units. So for example, today, we're featured on the Jaguar I-PACE. That's our front and rear-drive units on that all-wheel drive application that launched in 2018. We're launching here in 2020 a P3 solution, a rear-drive application for another European OEM. And then through our joint venture in China, we're into that market where we're on a small value brand front-drive unit. So that would be the drive unit side. In addition, we are supplying now gearboxes and other componentry into the electrified side for the commercial vehicle market space, into the pickup market space. And then obviously, we got some integration in other capabilities that we can provide into other customers. So really a broad range of product set into that space, which really sort of dovetails a little bit, I think, into CPV, or content per vehicle application, and where -- from a market perspective, where does this go for us. So if you think about the core of the company, of course, is really under that full-size truck element. So where do we see electrification wins? We see them coming in the passenger car space, which is one we typically haven't played in the past, so it's sort of a new market for us. We're seeing it in the high-performance vehicles. We're seeing them in all-wheel drive applications also, obviously, in the I-PACE through Europe and global. So we're seeing a broader, if you will, served market vehicle types that we would supply electrification into. From a content per vehicle standpoint, look, we're in the $2,500 range on the stuff we have out on the road today for an all-wheel drive application. If you think about passenger car, that's significantly higher than we provide into that market today due to the fact we don't play in that space. If you think compared to our core product, I see this as at, or opportunities to be higher than, existing content per vehicle in some of the vehicles that we supply today. So we think it's a nice expanded market. We think it's a nice -- really nice content per vehicle opportunity for us as well.

Got it. And when you think about EV bookings, maybe talk a little bit about the margin structure there, both initially and over time, as well as just overall program risk management as you look to quote this -- the portion of the $1.5 billion that you're quoting with an EV that -- the 20%, 30%. How do you think about selectivity? Because obviously, we've seen companies, and you've had some yourself, run into issues with launches and other kind of R&D that creeps in as you begin to get closer to production and even thereafter. So how are you thinking about kind of the margin and program risk management in general and the selectivity that you're approaching EVs with?

Sure. Yes, great question. So from a margin perspective, our experience would be it's consistent sort of in that corporate average element for the programs that we're on here today. And sort of as I mentioned earlier, in some of our quotation process, right, we also have financial hurdles. We're trying to be disciplined within the company. We believe in that, again, to support the long-term strength of our company. And we carry that same philosophy in when we're going through the EV program, not just a race to the bottom, if you will, from a pricing perspective. That generally doesn't end well. So we're trying to be disciplined from that perspective. We're trying to be disciplined from customers that we work with where we see opportunities from a market perspective, where we think they're good product into that space that we could supply into for an extended period of time. So I think also from an investment standpoint, this does require some R&D, and we've been spending that now for a period of time and have a pretty sizable investment structure in technology and know-how in this space. We've been at it for about 10 years, starting back with our joint venture with Saab. And we continue to do so. We've got some great technology. We've got some great technology in the next generation of products you'll start to see come out of us as well. But from a margin perspective, like I said, [ about ] corporate average, and in addition, from a CapEx intensity into this product, because we do get asked that question quite a bit, it's very common with our other product. It does not require additional capital intensity compared to the other product we make today.

And actually, that's a good point, Chris, that kind of gets to my next question. We think about -- obviously, you're going through a period -- we'll talk about deleveraging in a moment, but CapEx is coming down. You're still increasing R&D. But presumably, as you mentioned, as you go through a period of lower net backlog, you're able to get more productivity. If we were to see a scenario where the backlog picks up, particularly for newer technologies within electrification, how much of your current sort of CapEx to sales or kind of R&D structure is -- how much growth is that able to support? Like what is sort of the -- maybe the growth over market or however you want to call it, I mean, backlog that you can say, "At these levels, we can grow the company in this way"? What may be the limit before you have to increase those materially?

Yes. No, from an R&D perspective, we've been spending a pretty consistent amount with a little bit of increases here recently oriented a little more towards electrification, at the same time supporting some of our older product, which is also still being actively quoted in the market and a lot of interest in. But if -- over time, I think that's a pretty reasonable spend for us to think about to continue to have that growth element. You've seen us come off of several very big launch years from a growth perspective. And from a backlog perspective, it was supported in the confines of the R&D spend that we had as a company. So I don't see major legs up in terms of step-ups to grow even further and faster for that from an R&D perspective. And from a capital perspective, obviously that relates a little bit towards there is a correlation with the size of the backlog. So if we came in with a massive backlog, you're going to have a little larger capital spend to support that, like you've seen us in the past. If it's a little lighter, you'll see that come down. So that will ebb and flow a little bit with the size and scale of the backlog, and there is a correlation to that.

Got it. Maybe one more on the booking environment, Chris. Away from EVs, anything interesting to kind of talk about in terms of what you're quoting? Obviously, this project, EcoTrac, QUANTUM, just any progress on some of the other areas you've shown before around kind of technology innovation and the progress there?

Yes. No, we continue to get a lot of interest on our EcoTrac platform. We're launching another program here this year in 2020, a lot of inbound to continue that in that space for the all-wheel drive application. As I mentioned previously, our VCS book of business continues to get, from a global perspective, a lot of interest to grow from a lot of different customers. And obviously that's a growth element inside the company which we're pretty excited about, both in Europe, in North America and also in the China marketplace as well. And then you've heard us talk about our QUANTUM technologies in years past. So taking those technologies that we've learned through that process and applying them into next generation of existing product we have today, we see interest from the OEMs into that technology as well.

Okay. Got it. And then -- just making sure if anyone has any questions -- any thoughts -- and then we'll get into more the kind of free cash and balance sheet, but just let's get your thoughts on just the recent powertrain consolidation that we've seen and maybe overall your views on M&A and just how the industry is progressing, what you're hearing from customers. Just maybe give us a little bit of an update on there.

Yes. And you're -- we're obviously seeing consolidation at the OEM level. We're starting to see more consolidation at the Tier 1 and below level. And from that perspective, commonizing capital intensity, leveraging that perspective, leveraging maybe certain technology elements through this perspective, we get -- to get global scale. Will that trend continue? It appears that it will continue. I think that you started it a few years ago by the leader of FCA, the capital junkie memorandum that he put out. And I think that theme will continue in for a while.

Okay. Let's talk about -- a big part of the story is deleveraging and free cash flow. Maybe a quick update for folks who might be newer on where you are today, what you're kind of assuming for the next few years, the level of priority that the deleveraging is and your -- kind of your latest targets and kind of a realistic time frame to get there.

Yes. Okay. So from a deleveraging standpoint, we closed out 2019 at a 3.2x levered at the end of the year. We have -- over the last 2 years, have paid almost $0.75 billion of gross debt down on the cash flow generation of the company. And I want to be very clear: our top priority for AAM, our top priority is to reduce leverage in the company. We talked about through our earnings call last Friday and the guidance for 2020 cash flow, which is approximately $300 million, that that will reduce that leverage organically. You saw us take some action to reduce gross debt in 2018 by the sale of our aftermarket element of our powertrain business. You saw us do that in 2019 with our casting business unit. We continue to look for other opportunities inside our business to make sure we have the right product portfolio going forward, but also any opportunities to take a look to further delever the company are certainly top of mind. But clearly, a top priority for the company to reduce leverage.

So as you're talking about organic deleveraging, and you kind of touched upon maybe other options to accelerate that -- and of course, obviously I don't think you're here to make any announcements on that, but any -- what does the list of options look like? Is it like -- is there a few, a handful in terms of the -- you as a company maybe thinks about deleveraging faster? What are the potential options? Or at a high level, how many options are there for you guys to potentially take other actions to get there even faster?

Yes. No, certainly, free cash flow is number one. Looking at some of the potential asset sales inside our business is certainly being -- continues to be very actively looked at for other opportunities. As I mentioned, I would put those in the top 2 categories. Obviously, there's different other options people could think about, but none here that I would talk about today.

Got it. And then when we think about -- obviously, there's a leverage discussion and a liquidity discussion, and liquidity is -- tends to be sometimes overlooked. Maybe a quick update on liquidity maturities as well as, in a much worse macro scenario, the cushion you have there; we often talk about downside in terms of breakeven or leverage, but let's talk just liquidity and the ability for the company to be -- to have enough flexibility to go through more adverse events.