Dauch Corporation (DCH) Earnings Call Transcript & Summary

Hi, good morning. I'm Ryan Brinkman, the automotive equity research analyst at JPMorgan. Thanks for joining us for the 2020 JPMorgan Automotive Conference being held virtually this year. We're going to get going with American Axle on our next presentation in a moment. [Operator Instructions] So with that, I'd like to welcome David Dauch, Chairman of the Board and Chief Executive Officer; and Christopher May, Vice President and Chief Financial Officer of American Axle. David and Chris, thanks so much for being here.

Good morning, Ryan. Thank you. Thanks for having me.

Absolutely. I'm going to turn it over to David for any kind of introductory remarks and then we'll do some Q&A.

Great. Thanks, Ryan. Appreciate it. Well, good morning, everyone, and I hope you're all doing well and staying healthy. It's certainly an honor and a privilege for Chris and I to be with you here virtually after we've navigated successfully through a most challenging second quarter not only for AAM but for the economy and our industry. And as we covered in our earnings call on July 31, our second quarter was adversely impacted by the extended global production shutdown resulting from the COVID-19 activity. When you look at our financial highlights, our sales were $515 million for the quarter. Our adjusted EBITDA was a loss of $52 million, $52.1 million to be exact. Our adjusted EBITDA was a loss of $1.79, and our adjusted free cash flow was a use of $161.8 million. But despite the challenges that existed in the second quarter, I was really proud of my team as we demonstrated our ability and our resiliency as a company, the ability to flex our operations and the ability to quickly adjust our cost structure to the market demand, which was reflected in some of the decremental margins that we identified and shared. At the same time, even though we went through some of the challenges in the second quarter, we did have some highlights with GM, with issuing us our fourth consecutive Supplier of the Year award, so we're very proud of that from our largest customer. Chris and the team did an outstanding job issuing some unsecured debt that gave us more of a financial runway as we go forward. And we launched our second electric drive program, but our first in China on a passenger car program there. From a financial standpoint, just when you look at the other side of the financials, liquidity-wise, we finished the quarter at $1.66 billion. You need to back out the adjustments in regards to the debt that we took out in 2022, so we're closer to about $1.3 billion when it's all said and done, but still very healthy. I think Chris and his team did an outstanding job also renegotiating some of our covenants to give us that latitude that we need moving forward. Again, some of the major actions that we took during the quarter were really outlined in our downside protection playbook, where we adjusted our operations and structurally reduced our costs. As I mentioned, Chris and the team have given us a strong financial profile to operate in not only today, but for several years to come without any major debt maturities. But number one in our priority in this whole thing was to protect the health and safety of our associates, which we've done an outstanding job along the way here. Our plants are all back and operating at various levels, but near where we need to be. Our office personnel is still working from home and most likely will continue to work from home for a period of time as we all navigate through this. Probably the biggest thing that we're all managing our way through at this point in time is just the uncertainty in the marketplace and the consumer spending. But our schedules, I have to say, look quite strong in the second half of the year, especially how we're positioned on trucks and SUVs and crossover vehicles, so we feel good about what we're doing there. Chris and I can address some of what we're doing from a financial standpoint, on cutting some of our CapEx, but we're continuing to invest in our future as it relates to electrification and not cutting any of our R&D in that respect. And again, we're utilizing our operational excellence to continue to generate that positive free cash flow and EBITDA margins that you're used to seeing from American Axle. And with that, we look forward to the second half of the year. Ryan, I'll turn it back to you for any questions that you or any of the investors may have. But I appreciate everyone being with us here today. Thank you.

Yes. Great. Thanks for that introduction. We've been trying to ask all of the suppliers at the conference on questions around coronavirus and how it's been impacting their business. The first one is on profitability. During the global financial crisis, the profit margins for the suppliers, at first, they kind of crashed, but then as the industry subsequently recovered, margins rose to levels higher than they were before the crisis. Just fast-forward into the current situation, as you think about the extra cost that might be coming online, I don't know, relative to supply chain, redundancy or compression or something, but maybe other efficiencies as companies just learn to be leaner, do more with less, I'm curious how you think that the trajectory of margin shakes out for American Axle, in particular, as we eventually get past the current situation.

Ryan, this is David. As I said earlier, I mean, we've been an industry leader when it comes to EBITDA performance and cash generation. With the actions that we're taking now, we expect to be a stronger, leaner and more diverse and flexible company going forward. So we expect to be able to protect those margins and hopefully even grow those margins and cash performance in the future. Clearly, from a cost standpoint, all of us are incurring some incremental costs as we put in the health and safety protocol within our factories, but that's going to become the new norm. That's a onetime cost that we're incurring. Some of the PPE that we'll continue to utilize and exercise for an extended period of time, that's obviously an incremental cost, but because of the actions that we're taking, and you alluded to, there's incremental productivity that we feel highly confident that we can offset those incremental manufacturing costs and protect our margins or if anything, grow those margins. But Chris, I don't know if you want to add anything to that.

Yes. No, you saw it, Ryan, you kind of -- you alluded in your point. As we came out of the last downturn 10 years ago, the ability to capture the benefit of these restructuring costs are increasing our focus on capacity utilization and translating that into profitability and cash flow generation. We're still obviously setting up really for that dynamic and driving performance into this year and next year. It's a little early to make the call where we'll land. Obviously, we have no guidance today. But that dynamic exists, we're very cognizant of it, and that is where the team is very focused: cash flow generation, margin performance and optimizing the cash utilization and their cost structure to support whether it be a factory cost structure, but also our SG&A cost structure.

That's helpful. I'm curious, too, if the coronavirus caused you to think any differently about capital allocation. So for example, how are you thinking about how much capital cushion is appropriate? Or what the right level of debt-to-equity or leverage is? Or what the right amount and timing of our return of capital to shareholders is?

I think -- this is Chris. Coming into pre-COVID, you heard us articulate many times where we were deploying our capital, where it was focused on. One, organic growth, continue to invest in our future from an electrification standpoint, but also really reduce the leverage on our company that we took on as part of the MPG acquisition. Post-COVID, you'll hear that continuing themes of continuing to invest in the growth of the company, continuing to invest in R&D and electrification, but also focused on reducing that leverage of the company, reducing our gross debt balance, managing our maturity table, that will be a top priority for the company, continuing to be in the near term and midterm.

Great. And then just lastly, relative to the virus, I wanted to ask what impact you think you may have on the type or pace of technological change within the industry. Does coronavirus speed up, slow down or have no effect on pre-existing trends as could impact American Axle, such as vehicle electrification?

Speaking from an OEM standpoint, I mean we're seeing that many OEMs are accelerating some of the electrification activities, where others have actually delayed or some have even cut just because all, from a financial management standpoint, is what we need to do. We're not letting that really impact what our plans and our commitment are at that space, in the electrification space. As we announced earlier, we have launched our second electric drive program, our first in China, so that continued on. We already had the JLR I-PACE in production. Those volumes continue to get stronger going forward here. And we did have a slight delay in our third program that we'll be launching, so instead of launching late this year, to launch early next year. And then we have an additional program that we'll be launching as well. So we've got 4 of that are in our backlog -- or 3 that are in our backlog, 1 that we did, that's already in our production numbers. We're committed to electrification space and making sure that we have a product offering for the different vehicle segments that are out there. And all we want to do is make sure that we have bookshelf technology and that we're adapting to the market, that they want IC engine and hybrids, we've got those on product offerings, if they want electrification of those product offerings. So that's really the approach that we're taking. But clearly, when you look at General Motors, they're all-in pushing towards electrification, Volkswagen's all-in pushing towards electrification, where many of the others have adjusted some of their portfolio and their push towards electrification.

Great. And there was a very sharp positive reaction in the shares when you reported first quarter earnings this year. I think because of the downside scenario that you outlined, where you talked about expecting to be cash flow breakeven in an environment where your revenues are down 25%, 30%. Firstly, are you able to sort of tie that to U.S. light vehicle SAAR number? Might be it's too simplistic, but if we were to just kind of take last year, 17 million SAAR, and adjust that down 25%, 30%, comes to 11.9 million to 12.75 million. Now I understand that doesn't equal North America production, it doesn't take into account what's happening with Mexico or Canada sales or rest of the world. But simplistically, would it be reasonable to assume that you're saying or implying that you could get the business to a cash flow breakeven in even a 12 million SAAR scenario?

Ryan, this is Chris. Look, when we offer that table, we did that as a percent of our total revenues. And as you know, we're approximately 80% North America, which is driven by North American production, which is ultimately driven by U.S. and SAAR predominantly, right? So if you take that percentage application that you just articulated, you would find that's very close to how we think about it, running in at approximately 12 million U.S. SAAR or call it a 12 million North American production-type level into a breakeven cash flow. And you can see the components on how we achieved that objective, that's good.

That's great. And then next question is about the plan that you have discussed on both the 1Q and 2Q earnings calls this year to reassess and realign your business to adapt to a 14 million SAAR environment. I think you've said that you expect your EBITDA margin to remain in the top tier amongst peers at this level of SAAR, and it's clear that you expect to be cash flow generative because of what we just talked about, 14 million SAARs is only down 18% versus 17 million in '19 as compared to the breakeven target in a 25% to 30% down. But is there anything more you can say about how you expect the business to perform from an EBITDA margin or cash flow perspective in a 14 million SAAR?

I mean we expect to again perform in that higher quartile as it relates to EBIT performance and cash generation. I just felt strongly that we needed to cut deep, and I'd rather let volume be our friend going forward here. So therefore, we've identified the cash flow breakeven scenario, we feel that we can continue to deliver the margins that we are offering in the past, that 14 million U.S. SAAR. And That's the direction that was given, that's the adjustments that have been put into place, and then we continued adjustments as we go forward. Again, if the buying drops below that 14 million units SAAR, then we'll take the necessary actions to deal and address that. If it goes above that, then hopefully, volume will continue to be our friend and hopefully we won't have to add back as many of the resources, but we'll do as appropriate in order to support our customers and support the business. But we feel very confident that we can restructure and realign the business at 14 million units SAAR. Anything above that, our goal and our job is to deliver that to the bottom line.

If you think about what the team is focused on, Ryan, in that environment, it's maximizing the capacity utilization at that 14 million run rate. It's alignment of our fixed cost, both our semi-fixed costs in our factory load, but also our SG&A cost and then ultimately converting that cash flow from our EBITDA all the way down to free cash flow of the company. So tightly managing CapEx, tightly managing interest and working capital and taxes to that effect that you can see on a breakeven scenario sort of a little bit of a road map on how we would get there in terms of [ maintenance ].

Great. I've got a couple of questions now about electrification. The first one can be on China light vehicle. So China is really the country that most observers expect to grow the fastest in terms of electric vehicles. You've had several award wins there, one of which I think is entering production this year. Can you just talk about those wins? And how the product in China, too, might differ from what you do, for example, on the I-PACE in Europe? And then what is the outlook for your electrification business in China? Should investors expect more wins over there and over what kind of a time frame?

Yes. We agree with your assessment, the market assessment, that China is going to be the fastest-growing market when it comes to electrification. As you just indicated, we did launch our first electric drive program there just this past month, so we're very pleased with that. That was with ex GM moving through our joint venture there and for the Baojun E300 program. That program is a value brand opportunity, much different than what we launched in Europe. Baojun is a high-tech, high-performance crossover application for Jaguar Land Rover. We do have an incremental program that we will be launching in China, so we've been successful not with 1 but now 2. And we reported on a significant number of other programs. At this time, nothing to announce, but we're highly confident in our ability to win incremental business there. So we've positioned ourselves to have a value brand offering because they're really focused a little bit on technology, but more on cost in the China market, whereas the western markets clearly have an emphasis on cost, but more of an emphasis on the technology and the overall performance of the vehicles. And so therefore, we've got to adapt our product offerings to the various geographic regions and the different customers to make sure that we're bringing forward a value proposition to them, and we're highly confident that we can sustain that value proposition going forward.

Great. Thanks. And maybe just another question on electrification. On the recent 2Q call, you talked about conquesting some component work on electric pickups and commercial vehicles. Is there anything more you can say about those conquests? Also, there's been a lot of excitement amongst investors, as you can imagine, from these disruptive and alternative type OEMs in this space that they're offering, for example, Rivian and Nikola with its Badger pickup, Tesla with its Cybertruck, they've just got the new plant announcement in Austin, et cetera. Are you targeting to try to supply into those kinds of vehicles and OEMs in addition to the traditional automakers that you currently work with?

Yes. Ryan, this is David. The answer is yes. I mean clearly, our approach towards electrification is a multipronged approach. We want to be able to service it from a component state, so think gears and shafts; from subassembly states, so think differentials; from an assembly state, think gearboxes, but then also from an integrated 3-in-1 type solutions. So those are the different approaches that we're taking. We're meeting with the various OEMs based on their electrification offerings, but we have been successful in regards to the pickup truck applications, both in the light vehicle segment as well as some of the heavy vehicle segments from a component subassembly standpoint. And then clearly, we're positioning ourselves to do more gearboxes and 3-in-1 solutions as we move forward. And so our opportunities from a new business growth opportunities are presenting themselves, and we hope to win our fair share of the business as we go forward. But again, with the approach of components, subassemblies, gearboxes and integrated solutions is what we're trying to accomplish.

Great. I thought to ask your view -- I'm sorry, we're you going to say something? I thought I was interrupting. I'm sorry. I was just going to get your take on this really a very profound segment shift that we've seen this year in terms of full-sized pickups as a percentage of total sales in the U.S. In the past, we'd be doing pretty good if we had 15% or 16% full-sized pickups as a percentage of total. In some months this year, it's been like a staggering -- I think it got up to 28%, hung out in the 20% range longer than people thought. At the peak of the pandemic, it was attributed to the geographical dispersion of sales or something. But I just thought to ask you guys because you're sort of the pickup truck experts maybe in the sector, would be great to get your opinion. What drove the surge? And what can we expect going forward?

First of all, we love the fact that there's a surge in this segment. Pickups and SUVs are the lifeblood of our business. Crossover vehicles, we've clearly expanded into that. If you look back 5 years ago, 55% of the market was passenger car, 45% was trucks, SUVs and crossovers. You look today, it's 75% to 77%. With pickup trucks continuing to gain and SUVs really gaining, so we feel we're very well positioned for that. We think there has been a shift, and we've been saying that for several years, that there's a shift to consumer buying habits towards crossover vehicles. But also with the value propositions that the OEMs are offering consumers today on trucks and SUVs is outstanding. And they have tremendous performance features to those vehicles, tremendous versatility to those vehicles. At the same time, as we said, there's a pent-up demand for those vehicles, and where energy and gas prices being where they are, it's going to continue to foster that. So we feel really good about it. We're seeing that pent-up demand in our schedules because of the low inventories that exist across the different OEMs, but especially with General Motors. And we're looking forward to the second half of the year, as I mentioned earlier.

All right. And speaking of GM and their trucks there, the platform that's most important for you is their full-sized trucks in terms of percentage of your revenue, also, I think maybe when it comes to contribution margin. So I wanted to ask on the outlook for the production of those vehicles in the back half. I think at the end of July, the Silverado inventories were only like 47 days, the Sierra, a little bit less even. The trend in sales is obviously hard to predict, but just with inventories where they are, how are you feeling about the outlook for your largest program there?

Well, first of all, we think GM has a great product offering. The T1XX platform, as we mentioned, we already launched the light-duty program. It's been received very favorably in the marketplace. We launched the heavy-duty last year, again, favorably received in the marketplace. We're right in the middle of launching the SUV program, which is a fantastic flip to vehicle that I think will be received very favorably in the marketplace. I expect that GM will be able to call back some of the market share that they've lost just because their product had gotten long in the tooth. But now they've got a new fresh offering that's out there with a lot of advanced technology in this vehicle. I think that vehicle will sell very well. Clearly, we've had some content changes as they moved away from a beam axle to an independent suspension, an independent axle for that. So we had some content reduction on that program, that being the SUV specifically. But again, they're leveraging our state-of-the-art technology from an independent axle standpoint and probably drive axle for four-wheel drive axle performance. So overall, we feel good about where GM is with their launch, where we are in supporting that launch. And as I indicated earlier, we don't have any issues with our supply base supporting that launch item.

Okay. Maybe just going back to electrification again. You're providing these electric drive units, including incorporating the electric motors and inverters of others. Is it your long-term intention to supply the motors, inverters, power electronics yourself or are you satisfied with continuing to partner with other suppliers for those components? I saw in Q2 your SG&A, it was flexed down, ex R&D, by like 28%, while the R&D was pretty much protected. Just wondering if you're protecting it because you're looking to expand maybe the types of components that you might supply in the future.

I've got a couple of things there. First and foremost, as you know, we're highly vertically integrated company on our traditional products today, and we benefit from that significantly. So we would like to do something similar to that from an electrification standpoint. Do we have to have everything vertically integrated? The answer is no. The biggest issue we need to do is offer a value proposition to our customers that is sustainable value proposition. We've done that already in regards to the programs that we've won on electrification. We have good partners today already on motors and inverters. We're not sitting still. We're doing some things independently to look at what we can do to strengthen our position on motors and inverters, but there's also an economy of scale that needs to be factored into this, and there's a level of expertise that needs to be factored into this. So if it presents itself and we can vertically integrate, we'll look at doing that. At the same time, we have no problem leveraging our partnership arrangements, whether it's a technical arrangement, a joint venture arrangement or just a normal customer-supplier relationship as long as we can offer the value proposition that the market needs and our customers. So again, we're open and we're flexible that way, but we've got a model right now that's been successful in winning business in the marketplace. And we think with the actions that we're taking independently and with our partners, we'll strengthen that value proposition and be able to win new business going forward.

Great. And a question has come in here from an investor. It says lightweighting. What materials offer the largest benefit other than aluminum? And how is American Axle positioned with regard to expertise in these different types of materials?

Yes. I mean aluminum is a material that's already being used, but not being used fully across our product line today, so there's opportunity even within aluminum that I think we could address some of the lightweighting and mass-optimization initiatives. Clearly, we're trying to design our products to be near net wherever possible, again, to mitigate the amount of machining, the amount of weight that's in a product. Magnesium is other products that you would look at. There tends to be a higher cost associated with that, so we've got to balance that with what the customer, the ultimate consumer is willing to pay. There's other things in regards to carbon fiber and other types of products that are available that are out there. But again, just across diversed at this point in time, but especially as CAFE legislation, CO2 legislation, those demands increase in the future, it's going to require all of us to continue to stay focused on efficiency, mass optimization and lightweighting. And that's something that we've demonstrated and have a proven track record on over the years. And we have a number of things that are in our portfolio today. It's just a matter of, is the customer ready to adopt some of those technologies. But clearly, they're going to have to have the CAFE and CO2 emissions tightened up on a global basis.

Right. I thought to ask on your business that makes products to reduce noise, vibration and harshness. Is there any update that you can provide there, including if it may be leveraged to secular trends, such as, I don't know, when vehicles are quieter, battery electric vehicles, et cetera, what's going on there?

Yes. So our vibration controls business is doing quite well, and it's just growing very fast for us at this point in time. Obviously, we participate in rubber dampers, viscous dampers, isolation pulley dampers, balance shaft, balance shaft modules, and engines are downsized into 4-cylinder, 3-cylinder type engines, so that's very -- there's a need for our types of products there. And obviously, American Axle already had a strong NVH background, and we complemented that with the acquisition of MPG and the vibration controls business, and we're making investments in that business, and we're seeing tremendous opportunities on a global basis. And as I indicated, it's a fast-growing business for us right now.

Maybe another smaller part of your business that doesn't get discussed this much, the commercial vehicle business. You get the Albion business, was it up in Scotland or something? I think that's always been kind of there. But also in India, don't you do some work for heavy commercial vehicles there as well? I don't know if this is an area that you might increasingly focus on in the future, what the strategy is?

We're clearly in the commercial vehicle space today. We're not a large player in the commercial vehicle space. Clearly, here in North America, Dana and Meritor dominate that business. We are not active here in North America. We made a decision to be in Europe, and we're a large supplier in Europe, mainly through the Leyland DAF organization, which is a subsidiary of PACCAR. And then in India, as you alluded, we're doing a lot of work for Daimler in India, but also for a number of the Indian OEMs, Ashok Leyland and Tata and others. So that's a business that we're in. I wouldn't say we're putting a lot of effort into growing that business at this point in time. And we've decided to concentrate our effort more on the light vehicle side, especially crossover vehicle growth and also electrification growth. So I think that addresses your question there.

Yes. And then maybe just kind of sticking with sort of portfolio strategy questions. After having sold castings, is there anything else that could potentially be divested in the future or are you pretty satisfied with the makeup right now?

We're pretty satisfied right now where we are. There's always some things. Every year, twice a year, we look at our portfolio and assess what's core and non-core and does it change our priorities in regards to what we need to do. Where we can ultimately trim the sales a little bit or adjust some of our business and divest certain technologies, we'll do that. But I don't think there's anything out there, Ryan, that's really material like the casting business was that will have a major impact in regards to things at this point in time.

I thought to ask, too, on the GM SUV program. I think it was the last one. Maybe the Escalade is a little bit later in the year, but the last -- to transition to their new T1 platform on which you have some lower content per vehicle. Just curious, as you've been working through that process, how the decremental margins are tracking if the profitability has been in line with your expectations.

Yes. Ryan, this is Chris. From a profitability standpoint, right in line. I think we clearly articulated over the past couple of years from a revenue perspective, that impact. You are right, the last piece of that leg was the conversion to the full-sized SUV that was launched in the first half of 2020. And of course, our main content change on that was the architectural change that David articulated earlier. But margin-wise, right in line with where we expected, revenue line-wise, we're in line with where we expected. We're very pleased with that program.

And then lastly, just in the minute that remains here. I think the last couple of calls have been just taken up by coronavirus, right? The last of earnings calls is all anyone talks about on many of these calls, but I think you just sort of cycled past some of the earlier software execution in some of the former metaldyne plants. Just maybe just sort of revisit if that -- if you completely turned the corner there, if there's still some, I don't know, workstream items that you're working on, et cetera.

No. We've turned the corner from the major issues that we had back in the 2018, early 2019 calendar period of time as we had covered that with the investors. We were very transparent to some of the challenges that we inherited. We've navigated our way through it. We viewed the operational excellence and the technology leadership of AAM to manage our way through that. So we've maintained good customer relations even through some challenging times, but we're through all that. And as Chris indicated earlier, we were average of roughly 50, 60 launches a year for 3, 4 years there. We're now under 20 launches a year for the next several years. So a lot more balanced, a lot more stability. We can really focus on dialing in the productivity and the operational performance at the plants. Clearly, with COVID, we're looking at other plant-loading, plant-optimization, plant-utilization aspects. And again, that's the strength of American Axle, and we'll continue to make the right decisions for the best interest of the company and our shareholders as well.

Okay. That's great to hear. It looks like we are out of time. So thanks, David and Chris, so much for all the great color you provided today.

All right, Ryan. Thank you very much. Have a great day. Thanks for all the investors.