Dauch Corporation (DCH) Earnings Call Transcript & Summary

Good afternoon, everybody, and thank you for joining us for this session with American Axle 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. American Axle is a leading supplier of driveline, metal forming, powertrain and casting technologies for automotive, commercial and industrial markets. We are very pleased to host with us this afternoon American Axle's CEO, David Dauch; CFO, Chris May; and Director of Investor Relations, Jason Parsons, for a discussion. The format of this session will be a fireside chat around some of my questions, but also and mainly, your questions from all of you on the call. [Operator Instructions] Only I will see your questions, and I will ask them on this call without mentioning your name or affiliation. So with that, thank you so much for being with us, and let's get started.

Well, so maybe just to kick it off, could you give us a state of affairs on the progress of restart of your production facilities in North America and around the world? And what have you been seeing as a trajectory for capacity utilization?

Sure, Emmanuel, this is David Dauch, and good afternoon, everybody. Clearly, we've all been impacted by COVID-19 and had to prioritize and have always prioritized the health and safety of our associates first. We spent a lot of time shutting our operations down, putting new health and safety protocols in place. At the same time, we put together a powering up document, which is all the new updated safety and health protocols. We've implemented that in not only our factories, but our business offices. We've now returned to our Asian operations. They're not at pre-COVID levels, but they're trending towards pre-COVID levels. I'm very happy with how those operations have started back up. Our operations in Europe started up in the May period of time, again, under the same health and safety protocol. Also, they are not at pre-COVID levels, but trending in that direction, but lagging behind Asia just because of the lead time. And then obviously, in the last couple of weeks here, we just started the U.S. operations a couple of weeks ago and ramping up according to our customers' operating patterns and schedules with increase in shifts over a period of time. And then Mexico started up last week in a similar format. We do expect to get most of our operations back to normal by the end of June, early July period of time. Again, that's going to be dependent upon and relying upon customer EDI schedules and customer operating patterns at their own facilities. When you look at the supply base, we've been managing our supply base very closely. We do not have any imminent issues with respect to continuity of supply. So we feel like we can protect our customer schedules going forward. There's always some issues that we manage, even pre COVID and to post COVID, with respect to the supply base, but nothing that should alarm us or our customers with respect to continuity of supply. Probably the thing I've been most pleased with is how our workforce has adapted to the new health and safety protocols that we've put into place. Clearly, our priority was on their safety and making sure that we reduced their anxiety as they come back to work. That's gone very, very well for us. Clearly, we'll make adjustments along the way based on further input from our associates. But overall, we feel very good about where we are with the start and restart of our operations.

That is a great and helpful overview. And any further color on how things going in Mexico? And I know you mentioned you started just last week. Is -- are things a little bit more difficult to ramp? Or do you expect sort of -- now that it's restarted, a pretty smooth ramp-up just with a delay versus the U.S.?

Yes. So far, we're seeing a smooth ramp-up, but just along the delay like you referenced, just a little bit behind the U.S., but at the same time, aligned with what we're trying to accomplish. And again, no major associate anxiety, and people are excited to get back to work and begin making product again.

Great. A few questions on the outlook for some of your main products on the GM trucks. Can you talk a little bit about your -- I think GM said, [ Mary Barra ] said [ at her ] conference and elsewhere that they expect to be back to full size -- full production by sort of the end of June. Can you expect -- can you elaborate a little bit what your volume expectations are as you move into, I guess, this quarter and then the second half of the year?

Yes. We're not providing any guidance as it relates to volume expectations at this time. But we're clearly aligned with what GM has communicated publicly. We're working very closely with GM, pre COVID, during the COVID process and now post COVID, to make sure that we can align our production support with their EDI releases. We work very closely together, along with other suppliers to benchmark the health and safety protocol to ensure that all of us had a smooth start-up because it only takes one supplier to have an issue to create a problem in the assembly plants. We feel very good about where we are. Clearly, GM was impacted before COVID with the strike that took place in 2019. So their inventory levels are low today. At the same time, they're launching a brand-new SUV. That SUV is launching right now and off to a good start, and I'm sure they'll want to push the accelerator with respect to getting [ this brand new ] product out there. On the truck side of things, their inventories are quite low. They're under 40 days compared to their competition around 70-plus days, but overall, the market is slow on pickups. So I think not just GM, but all the OEMs are going to be pushing the trucks and SUVs very hard. And we're seeing that on all of our schedules across the different customers that we're supporting here. So we're supporting GM's ramp-up from the 1-shift to the 2-shift and ultimately, to the 3-shift operations. And as you indicated earlier, the expectation is that we should be able to hit that by the end of the June period of time, barring that there aren't any issues that pop up along the way. But we feel good about where we are, and we think the schedule the second half of the year will be very strong as they try to replenish their inventory levels and support the dealer demand and the ultimate consumer demand. Probably the biggest uncertainty for all of us is just understanding where that consumer demand will settle in at, not only in the second half of the year, but going forward in 2021 and beyond. But we're prepared to adjust our operations accordingly, up or down.

This was great color. Let's switch gears a little bit to the margin side. So your first quarter EBITDA margin ex COVID, using your own disclosures, was better than 17%. Similarly, in the fourth quarter, you had the disclosure ex the volume loss from the strikes was about 16%. So very strong underlying performance in the last few quarters for sure. What would it take to return to those levels? Is it just a question of -- do you need basically the volumes to go back to those levels?

Emmanuel, this is Chris. Yes. Look, great question, right? We were very optimistic coming into 2020. We were laying the planking as we were performing and stepping up our performance through 2019, a more stable environment, very strong focus on productivity, elimination of launch costs and other premium costs. And you saw us start to deliver that result in the first quarter of 2020 pre COVID. But your question is, "How do you get back to these levels?" And really, the first ingredient in that concept is it's very dependent on volume and mix and ultimately, capacity utilization because that does play into margin performance and has a role in that event. So obviously, aligning with the new normal and then rightsizing our cost structure, too, whatever that may be, will help continue to drive our margin performance. We are, at least in 2020, right, we'll incur some start-up and supplier inefficiencies. We've identified some of those costs, if you will, on some of our breakeven analysis as it relates to COVID-19. But at the same time, and maybe more importantly, we've identified a total pool of about $60 million of cost reductions we expect to benefit from here in 2020. And of course, we believe those will drive into future periods to help us perform even stronger. So look, the macro of stable environment, productivity focus once we get to a resumed consistent level of production, we would expect to continue and hopefully, we can also benefit from some of these cost reduction activities that we've seen, offsetting any maybe lingering costs you would have associated with COVID-19. But we're still bullish on our margins, but we're obviously dependent on those volumes, mix and capacity utilization.

And these $60 million are coming from, I think, salaries and other overhead cost reduction. How much of it is temporary actions versus structural that you can maintain?

Yes. We've articulated our $60 million, about 1/2 of that, I would call it, headcount reduction, so more permanent in nature, aligned with sort of the levels of lower-volume run rates. About 1/4 of that relates to temporary wage reductions across our entire salary workforce basically around the globe. We've experienced up to 30% temporary pay cuts. I think those, I would expect to come back. At the same time, the balance of the remaining 25% is a mix across a variety of initiatives, overhead reductions, travel reductions, focused reductions on spend, whether it be engineering and other costs of our business. Some of those are temporary, some which we think will be permanent in terms of structurally into the near term, benefiting us. But really, our goal, though, is any of these temporary items that I just articulated, whether they be the wage reductions or maybe some of the elements of overhead is to repopulate those with more structural cost savings that we can benefit from in future periods beyond the temporary nature of those specific actions. So we're driving towards maintaining and holding and trying to benefit closer towards a $60 million on an ongoing basis, at least in the current environment that we see here today.

Understood. That's good detail. Focusing really from a decremental margin point of view, I guess, putting it all together, first quarter came in around 28%. How do you see that looking second quarter and more importantly, the rest of the year?

Yes. Look, we've sort of articulated, we've actually experienced now, we think, 3 different, call it, events with an insider company, whether it be the first quarter of 2020 with COVID or the work stoppage with General Motors in the fall of last year. And then about a year ago, we had to sort of readjust some of our volume, lower volumes, that we were experiencing in the China marketplace. And you've seen our decrementals, on a contribution margin basis, somewhere between 25% to 35% with some of the mix, depending -- it's very mix dependent, meaning that the full-size truck applications that we support are at the higher end of that range, right, where the corporate average is more along the lines -- sort of in the middle of these ranges. But in terms of Q2, I would think about, obviously, we still got a bit here to go in Q2. But what you didn't have in Q2 that you had in Q1 was Q1 didn't -- you had full-size truck production running almost the full quarter. You'll have a higher weight in the second quarter of our full-size truck applications down compared to the reduced sales. So that would drive a little bit towards the higher side of that range of decrementals, if you will, in the second quarter. A big picture, sort of once you get past that, it is a little bit mix dependent, but that range is still a true and a good way to think about how our business would perform.

And just putting it in the context with the 28% that you did in the first quarter?

Yes. The 28% was sort of, one, you probably had a little bit of underweight in terms of the full-size truck in terms of revenues being down. You'll see the full-size truck probably in terms of elevation is you'd have it down completely, if you will, in the month of April, right? And then you have some of our inefficiencies and things like that coming back on for -- online into production that will also impact you in Q2 where you actually have the benefit of some of the fixed cost elimination in the first quarter. So that will be sort of the recipe between first quarter and second quarter.

Okay. Perfect. Shifting gear to maybe some of your efforts on the electrification side. There appears to be much more aggressive efforts by automakers towards developing and commercializing battery electric vehicle pickups to launch as soon as possible, some of them scheduled for next year. What kind of content are you able to offer or bid for on these type of programs?

Yes, Emmanuel, this is David. We certainly see and read everything that everyone else is seeing and reading as well with respect to the OEMs and their efforts in electrification. And the first thing I want to clarify is that we definitely believe that there is a market for electric pickup trucks, and that's being demonstrated based on the communication that both GM and Ford have put out as traditional pickup suppliers, but also with the likes of the new entrants of the Teslas, the Rivians, the Nikolas and the Lordstown, okay? I do believe that the ICE pickup trucks will be around for generations. I think the electric pickup truck is more of -- going to be a niche application initially and but with growing volumes over time, I can't sit here and tell you exactly what that time will be, but I do not think it will displace the traditional ICE pickup for multiple generations of product. But we're not standing still on that. I mean, we're -- as you know, we're committed to electrification. And we've already demonstrated that capability. We've booked business on passenger car and crossover vehicle, both on a luxury and performance base, but also on the value brand. We're doing a lot of work and not sitting still on the truck side. So we're doing -- we're in conversations with multiple customers in regards to the truck offerings from the component state to the subassembly state to the gearbox state to the finished integrated EDU-type solutions. The OEMs have to decide themselves, in some cases, what they want to do themselves. I can speak that we have booked business in regards to component opportunities on an electric commercial truck as well as electric pickup truck program. So that just bodes well with our strategy of supporting electrification at the component level all the way up through to the finished product. We're going to continue to leverage our inherent knowledge of trucks. And the performance requirements of trucks while also leveraging our operational prowess and technical capability. And we understand trucks very well. We understand how to design driveline systems to support them and whether those are IC based or electric based, we feel very confident that we'll have product offerings to support that. And that clearly comes down to the customer and their determination of whether they want to make some of this in-house themselves or whether they want to leverage suppliers like us like they do today on some of the traditional products. But we feel very good about our electrification strategy, the wins that we've won, both from a full EDU-type solution versus the component of supply that we're also supporting. But then also, clearly, we want to be relevant and we want to be a player and protect the turf that we enjoy today with respect to trucks and SUVs and crossovers.

Yes. So that's a good framework. How could we think about content per vehicle opportunity there? And so if it was -- I mean, we could pick pickup as an example or another vehicle if you should prefer. But if it was sort of versus your traditional axle business on the commercial engine vehicle versus the potential business that you would be able to win on an electric version of it, how should we think about the delta in content per vehicle?

Yes. Just to set the baseline, our crossover vehicles, the content per vehicle averages between $900 to $1,200, somewhere in that range. Our full-sized truck averages around $1,600 of content per vehicle. When you look at what we're doing for Jaguar Land Rover, the I-PACE electric vehicle, that content, because there's 2 electric axles in there, is around the $2,500 of content. So a full-sized truck would have most likely 2-axle applications as well. So we actually see an opportunity to protect our content per vehicle, but maybe even grow it. When you look to some of the value brand-type product, the range of content per vehicle could fall as low as $200 to $250 all the way up to maybe, let's say, $2,500 as it relates to the high-feature, high-performance, luxury-type application. So it's a large range within the electrification space, it's dependent upon the markets that we're serving between Europe, Asia and North America, and then clearly, dependent upon the vehicle segment that we're serving as well. But that should give everyone a reference to the content per vehicle.

Great and then just what's the status on your -- the second program launch? Let's see. Yes. The I-PACE was your first one. The second one's a European automaker's. This is -- is this still on track?

That one has been delayed slightly into -- it was going to launch at the end of this year. It's going to launch early next year. We do have another electrification program that is launching this year, a value brand opportunity out of China. And so think about the luxury European OEM launching now over a 2-year cadence in 2021 and 2022. So we're very excited about that program, getting out there and people really seeing the technical capability today and bringing it to the table in concert with the luxury OEM that we're working with there. In addition, I think we've now proven ourselves in the Chinese market with the value brand opportunities with 2 big -- booking 2 programs in that market, and there's more opportunity presenting itself. So again, as I mentioned to you, I just expect there are a few opportunities in conquest business to grow in the electrification space as those opportunities present themselves.

What's your view of the commercial truck electric vehicle opportunity? Is this something that you're interested in pursuing?

Our interest is really predominantly on the light truck is where our interest is. As it relates to trucks, clearly, the passenger car crossover vehicle is another part, but let's just say, light vehicles is where our concentration and interest is. However, on the commercial truck, we're not so much looking after going after the full electric drive system there, but rather being a component or subassembly-type supplier is what we're doing, and we've already booked some business in that area as well.

I have one follow-up question on your electrification comments from an investor on the line. So can you comment about margins for a program like the I-PACE or any other electrification programs versus the ICE product? Let's see. On the content per vehicle, you are very clear. Like any big differences? I assume that there's some element of engineering and research and development currently, but maybe more on a normalized basis?

Yes. Emmanuel, this is Chris. Look, on a normalized basis, you would find those programs sort of more along the lines of our corporate average. That's been our experience here, and that is our expectation as we bring out new programs. At the same time, you're right, we do incur some engineering ahead of those programs, but which are -- and run rate is basically plus or minus within our range of our corporate average.

Perfect. That's very clear. Shifting to the backlog. Can you provide us an update on the industry quoting environment? Has activity returned back to normal levels?

No, it certainly hasn't returned to normal levels. Prior to all the COVID activity, we had about $1.5 billion of new and incremental business opportunity that we were working on. That market basket still exists, but there has been little to no major activity taking place during the COVID period of time here. Right now, I think everyone was focused on health and safety of their associates ramping down and now starting back up the operations, and that's where the priority should be. But I fully expect that here in the third quarter that the commercial discussions will start picking back up again and we'll win our fair share of the business like we typically have done year-over-year.

Okay. The backlog, how should we think about your 3-year backlog compared to the original $750 million disclosure given at the beginning of the year? Is it just a question of flexing it down in line with what global volumes look like? Or any other things that we should think about?

Yes. I would say, clearly, the backlog is going to be impacted just because of volumes, both on a global and on a regional basis, but -- as we factor that into the backlog. And then as I alluded, we had one program that's moved from a 2020 launch into 2021. But when you look at the 3-year launch cadence, it's still captured within that backlog, but it may be -- the timing may be a little bit different from this year to next year. But it's in line with what we've communicated to you in the past, just adjusted for some of the adjustments in volume.

Emmanuel, when we went through our guidance, too, we had not provided an updated number to this.

To this year or to the 3-year backlog?

Correct. We've not updated this.

What I would say, that is -- this is David again, is that, as I mentioned to you earlier, I mean, the good news is that the customers have all come back to us and have indicated that their programs are either solidly in place, slight adjustment, meaning a few weeks, some have month -- multiple months' adjustment. Nothing has been delayed more than a year, and nothing has been canceled. So very important for you to understand that and the investor to understand that our backlog and new business, our launch cadence is in line, and with some slight modifications, but still intact. The biggest adjustments associated with the volumes because -- and the uncertainty of those volumes right now.

Perfect. Very clear. Switching to free cash flow. You have a lower CapEx target of about $250 million versus prior, maybe $325 million for this year. Is it more efficiencies and internal initiatives or more a result of some of the delay launch that's moving into 2021? And then I guess, what is -- is there any change in your long-term CapEx target?

Historically, as you know, with the acquisition of MPG, we were running in that 7% to 8% of sales as far as CapEx as a percentage of sales with a clear understanding and communication to the investor that we would be trending down to that 5% or less. We've gone from an average of 60 launches a year to less than an average of 20 launches a year. So naturally, our CapEx was going to come down because of that. At the same time, we've taken measures internally to reduce CapEx. We're still protecting all of our maintenance CapEx in that 1% to 2% of our overall sales. So that still leaves us plenty of growth CapEx going forward to support the business and that aligns with what we think the market basket and the hit rate will be on some of that new business. And then clearly, with COVID right now, we're going back and revisiting all of our CapEx requirements and looking at our capacity utilization. And where we can avoid future CapEx, we will because we just want to drive higher CapEx -- capacity utilization on the existing assets that we have. But overall, we made a commitment on CapEx to bring it down. We're delivering on that. And obviously, with the COVID activity, it's got even more scrutiny associated with it.

Understood. A few questions online from -- on the leverage side. So leverage increased to 3.3x exiting Q1 will naturally get higher in the second quarter. What's your longer-term target again? And when is now a realistic time line to achieving it?

Yes. Emmanuel, this is Chris. Look, obviously, right now, our main focus is continuing to preserve cash, maintain our liquidity, get our operations back up and running in a safe and effective manner and also to meet our customer demands. Look, from a capital allocation perspective, we're continuing to support organic growth, which we've told you and articulated a little bit here through our dialogue. But at the same time, our top objective from a capital allocation is continuing to reduce our leverage, which generally will come in the form of our organic cash flow, reducing gross debt and obviously, continuing to construct strong EBITDA performance as a company. Look, I think at this point, given where our focus is right now on the cash and maintaining liquidity and with no guidance in the marketplace, I think we'd be -- it'd be a little premature to reset -- articulate specific targets for where we want to get to that lower leverage. But the thought process we had coming into 2020, that reducing leverage, getting it more in line with what you've heard some -- where we wanted to get it directionally, but more in line with a normalized leverage ratio, more in line with our peer group is still a top priority for this company.

Yes. Emmanuel, this is David. On top of what Chris just said, I mean, I think Chris and his team have done an outstanding job, one, making sure that we've got plenty of liquidity to run our business, which he's done. At the same time, we didn't have any major debt maturities due until the 2022 calendar year period of time. Earlier this week, we took action in the bond market to raise some additional or raise an additional bond that will allow us to take out those 2022s and push out some of that debt maturity. So Chris and his team have done a wonderful job, provided myself and the operating team the financial runway we need to be able to manage the business with plenty of liquidity. At the same time, we're highly confident, based on what we've talked about earlier, on the trucks and SUVs and some of the schedules, on our ability to generate cash and be able to service that debt and get to that desired target level of leverage going forward. We clearly are levered. We're not hiding from that. That was part of the responsibility we took on when we did the MPG acquisition, but that was known. And obviously, we had a couple of setbacks with respect to the GM strike and now COVID. But at the same time, we'll overcome that going forward here with some of the cost reduction initiatives that we're putting in place and where we think the market and the volumes will pan out going forward here.

That's very clear. I'm going to read you a couple of more questions on the topic from investors. One investor asking, "I'm curious why American Axle only decided to issue $400 million in bonds on Tuesday. Why not raise a little more liquidity here?"

Yes. This is Chris. Look, we raised $400 million. We're taking out $350 million of notes, right? That's what's the maturity in 2022's that remain. So we brought in some liquidity to the company, point one. Point two, we have a healthy amount of liquidity as we sit here as a company. You saw what our balance was and our liquidity availability balance at the end of the first quarter was $1.46 billion. We have said we'll be growing $1.2 billion at the end of June, and that's well above our target levels of liquidity. And then, of course, we have strong cash balances, along with access to our revolver would help bringing on additional debt at this point. Was the right step at that time.

And I guess, on the other side of the question, one investor is writing, "I think you said in May that the leverage of the company was driving a somewhat negative perception of the business. Are you contemplating selling any assets or additional assets to delever the company faster?"

Well, I mean, last year, we took a major action in regards to the divesting of our Casting business, and all those proceeds were used to -- paying down debt. Every year multiple times a year, we look at our portfolio and identify what's core and noncore. There will clearly be some things that will present themselves as noncore. But I don't think there's anything else significant or that's material in nature that's going to move the needle in a large way. But at the same time, there are some things that we're contemplating at this time. And obviously, every little bit helps. And we'll continue to improve and manage our portfolio and optimize our portfolio accordingly. We want to be the leader in the driveline. We are the leader in the driveline. We want to be the leader in the metal forming side. We are the leader in the metal forming side. And all we need to do is just continue to stay focused on delivering the operational performance to service the debt going forward. But in the interim, like I said, Chris and his team have given us great runway to work with.

One more on the investors. Any interest in the aftermarket opportunity to supply some of your components, in particular, if electrification ramps up, the IC installed base, presumably, we still need some of those parts?

Yes. Historically, aftermarket has not been a large part of our business. We've typically been OEM based that way or as far as service in the OEM side of things. I mean, it's something we can clearly look at going forward, especially as electrification may ramp up and have an impact in regards to some of the installed capacity. Right now, it's not a priority to us at this point in time because most of our capacity is being utilized for ICE engine or being converted over to support alternate technologies, including electrification.

Understood. Can you just go back over -- maybe to conclude, outline some of your expectations for how to think about free cash flow through the rest of the year? And in particular, working capital dynamics?

Yes. Yes, it's Chris -- obviously, the first quarter, we generated positive free cash flow of $83 million, and when we say free cash flow, we talk about adjusted free cash flow. We generated $83 million here in the first quarter. With no guidance for the full year, we did provide some illustrative examples of breakeven cash flow scenario for the company, and that's in our current IR materials. It was also part of our earning slide deck on May 8. So you can take a look at that. But in terms of cadence and the key elements of free cash flow for the rest of the year, I think, obviously, EBITDA is a main ingredient into that. For CapEx, we articulated stepping down to $250 million of CapEx for the full year of 2020. So you can see what we spent in Q1. And then you can see what the balance would be for the last 3 quarters. As it relates to working capital, it's going to be quite an interesting ride of working capital. And what do I mean by that? Basically, the first 2/3 of the second quarter as sales essentially went to near 0, if you will, for your North America production, Europe and China very low for us in terms of absolute numbers relative to us, we were a beneficiary of working capital as we were collecting receivables for a product that was shipped in February and March. That starts to turn in the back half of the second or the back third of the second quarter as now we're ramping up production, financing debt inventory and payroll to ship product and ultimately, the receivables which you finance, and then they will start to consume it in the latter part of the second quarter and into the early part of the third quarter. So -- and you've had significant swings in sales. And then normalize that for the balance half of the year, it's a normal seasonality. I think when you take a step back and look at the full year for working capital, we're going to need to ultimately compare the last 2 months of 2019, meaning November and December. How does that compare to 2020? And that will be your ultimate movement on working capital for the full year. Couple that with, Emmanuel, what I would tell you, in addition to that, we're trying to drive -- and again, when we talk working capital, it's receivables, payables, inventory, sort of the big 3 of working capital, if you will. We're trying to drive further reductions in our inventory days on hand or increase our turns from productivity initiatives coming off the back of launches over the last 2 years. You saw us build inventory in 2018. We took some of that out in 2019, and we thought we still had some more yet to go here in 2020 to optimize from an inventory perspective. So couple the normal movement of working capital plus a continued drive to generate some cash out of reducing our data on hand of inventory in this company. So -- but that's sort of in the additional basket as well. So that's how working capital moves through the year. That's how we think about inventory, talk about CapEx and then we've already articulated, you know what our interest is. And then from a taxes perspective, we gave some guidance on that on our May 8 call.

Lots of great color. Thank you. So it looks like we're fresh out of time. So David, Chris, Jason, I really want to thank you for participating today, for all the insights you provided. I want to thank all the investors on the line for tuning in and for submitting interesting question. For the investor online, please stick with us. We have the Tenneco management team up next in 7 minutes. And again, to the American Axle team, thank you so much for the support.

Thank you, Emmanuel, and thank you for everyone online for participating.

Thanks, Emmanuel, have a great day. Good luck for the rest of the conference.

Thank you so much.