Dauch Corporation (DCH) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to our next episode of the 11th Annual Global Automotive Conference. Very pleased to have with us American Axle. We're joined by David Dauch, Chairman and CEO of American & Axle Manufacturing; along with Chris May, Vice President and CFO. Jason Parsons is on the line as well. So we may hear from him as well. Before I get to my questions, I want to just turn it over to David to give us a little brief update on the company.

Great. Thanks, Brian, and good morning, everybody. Before we begin our presentation or our discussion here today, I just, please, refer you to our forward-looking statement on our presentation deck or on our website at aam.com. As all of you know and have seen by now, we reported solid third quarter adjusted free cash flow of $217 million compared to $161 million last year in the quarter. Our adjusted EBITDA was $297 million or 21% margin compared to 15.8% last year. And clearly, the combination of our structural cost-saving efforts and the resurgence of our customer demand and the low dealer inventories that are out there right now are boding well for us and yielding nice contribution margins for us, especially during the third quarter. At the same time, we announced in the third quarter that we had an unfortunate event, a significant industrial fire at our Malvern manufacturing facility in Ohio. We've worked tremendously hard ourselves and with our customer base to mitigate any disruptions and protect continuity of supply to our customers there. So we're very pleased that we've managed through a very difficult period of time and a significant issue, but we still got work to be done there, but again, managing it effectively for not only ourselves but also our customers. And then we also reinitiated guidance for the full year. Our sales for 2020 will be $4.6 billion in revenue. Adjusted EBITDA will be in the range of $665 million to $680 million, and our adjusted free cash flow will be in the range of $220 million to $235 million. So very pleased with that, especially when you consider where we were pulling our guidance and talking about a cash flow breakeven scenario. So very happy with the team's performance. And again, reflects our ability to adjust our cost structure to the changing market demand. Clearly, like everybody else, we're continuing to monitor COVID-19. With our third quarter performance being very strong, we're cautiously optimistic about the fourth quarter here. And also looking into 2021, but we also need to recognize that it's still an uncertain time that's out there and we all need to be prepared to adjust either way. Clearly, our highest priority and #1 priority has been, and will continue to be, protecting the health and safety of our associates. We've been doing that, and we put a lot of new health and safety protocols in place. Our team has been disciplined in regards to following that and operating in a safe environment, both in our offices as well and especially at our manufacturing facilities, where we've had very little incident with respect to COVID matters. So we're pleased with that. I think what you've really seen, go back last year with the GM strike and then also this year with COVID, is our ability to flex our cost structure. And we have a highly flexible cost structure, and we can address our variable costs very quickly here. We've demonstrated that during the previous strike and also through COVID here. And if required, we'll do that again. And the key thing I communicated to the investment community before was the fact that we were adjusting our workforce, USD 12 million, USD 14 million and that's exactly what we continue to be doing. And we're seeing the benefits of that coming through in the financial performance. So overall, very pleased with the management team and what we've been able to accomplish during this challenging and difficult time. As we start to look beyond 2020, we're cautiously optimistic about 2021, especially because of the uncertainty that I mentioned to you earlier. But when you look at consumer demand, the signs are very strong for consumer demand, especially in the vehicle segments that we support at this time. Light truck mix is migrating, grown up 76% from 72% last year. We also see the full-sized truck and SUV penetration increasing to over 18%. So that's positive for us. And then again, our cost reduction actions that we've taken in 2020 and further, that will take as we go into 2021 is just going to continue to benefit us in our overall performance. So we look forward to that. We're not issuing any guidance for 2021. We'll do that early next year as we typically do. What I will say is that we're going to continue our emphasis on strong cash flow management. We've clearly prioritized that as our #1 thing in order to support the debt reduction, which is a priority for us from a capital use standpoint. But we're also tightening up the business even more with our CapEx management activity and just the overall performance of the plant and how we've improved our cost structure as we go forward. And even with that, we're going to continue to invest in electrification, in advanced technology and future profitable growth as an overall business. So our backlog of business continues to be fairly healthy there. But the big thing that we're doing from an R&D standpoint is we're really optimizing our traditional and conventional business. We see those programs running on longer duration than maybe originally forecasted because of the migration to electrification. That's a positive for us and will help us generate even more positive free cash flow as we go forward. But we've had to shift a significant amount of our engineering resources over to the advanced technology, in our case especially electrification. Our goal has been and continues to be to be agnostic to the market, let the market dictate what powertrain configuration, whether it's ICE or hybrid or electrification that they want and need. And we just want to make sure that we got a product offering that's supportive of that going forward and a strategy that supports the various different penetration rates between Europe, Asia and here in North America. So with that, Brian, I'll turn it back over to you. Those were my quick opening remarks, and we'll go from there. So thank you.

Thank you, David. Well, let's pick up on what you talked about in electrification. Maybe just start -- can you talk about the content per vehicle you expect to see -- achieve on hybrids and EVs, if it's going to be different between hybrid EVs? And then the sort of the puts and takes, what content could you add, but what historic American Axle or Metaldyne, the former Metaldyne, content goes away?

Yes, sure. Clearly, when it comes to the electrification space, our ideal situation would be to provide a fully integrated e-drive-type system. However, as I've mentioned to you before, we're also looking at it from a gearbox standpoint and a component standpoint. And the CPV can vary depending on the approach that we take with the customer or what the customer does with us. From an electrified component standpoint, in subassemblies, that can range and be in the range of $50 to a few hundred dollars. When you get into the gearboxes, that's really in the range of $200 to $500, and when you get into fully integrated driveline systems, depending on if they're a value brand or high performance luxury-type brands, it's going to range in the area of $500 to $2,500. Again, dependent on the performance and the characteristics and the specifications of each of the customers. So there, I'm going to address your question on the content per vehicle, or from a CPV standpoint, and not only do we see the CPV as an opportunity for us, especially on trucks where the content per vehicle could be even larger. We also have the opportunity to grow in markets that we typically have not participated in, especially the front-wheel drive passenger car market. We won 2 programs in China that are both value-based type programs. So we've demonstrated our ability to compete in that market and win business, and we're quoting more work in that area today as well. So we see that as an opportunity. In addition, we've been able to supply components and subassemblies to the commercial vehicle space to support some of the growth in that area as well. So again, we want to position ourselves to be flexible based on what our customers' needs were and what the market needs were and the vehicle segment needs are. And I think our wins are demonstrating that our strategy is paying off that way. Now what we're continuing to do is continuing to develop even further advanced technology that is going to have greater power density, greater overall performance. And again, all focus on the value proposition to our customers regardless of the strategy that we take with them.

That's very helpful. So you mentioned component sales, and that's a topic that comes up because as we've heard from many of the major legacy OEMs, they're looking -- and then, frankly, some of the start-ups as well, they're looking to vertically integrate it into their skateboard, largely assemble things themselves. And of course, OEMs in Western Europe and North America have unions working at engine and powertrain plants that they expect to transition to doing other things. So we've heard about your e-Drive business. We know about your wins there. But I think what we'd really like to hear about is where the component opportunity is? How does the competitive space around those components compare to players seeking to do e-Drive system? And then what's uniquely Axle in terms of winning component business?

Yes. So speaking on the component side. So when we talk components in American Axle language, we really are talking gears, shafts, differential units as well as carriers. Clearly, we're an industry leader when it comes to that technology. And the performance that goes with that, so think noise vibration and harshness, which is not an easy thing to address and satisfy. We've definitely got some component wins that are in our backlog that will be launching in next year as well as the years thereafter. So we're pleased with that. I think when you look at the competitive space there, it's the normal people that we see, the Linamars and some of the other component suppliers that are out there and machine suppliers, but they also have the capability to do full integrated systems. So very similar to what our capabilities are here today. When it's all said and done, Brian, it comes down to, like I said, the value proposition. And all we want to do is make sure whether customers are outsourcing and buying the work or even in-sourcing and doing the work themselves, that we're flexible to satisfy whatever that need is. And clearly, the OEMs are in different states. Some of the OEMs are looking to in-source their initial round of electrification programs to gain knowledge and as well as use that content and to address some of the union issues. But they really need to understand that market and the cost structure that goes with that market, their ability to make money there. There's going to be other OEMs that don't have that full complement capability. And therefore, we want to make sure that we can offer them a full integrated system that is offered from a value proposition standpoint that meets their needs, and we can leverage our engineering and manufacturing capability to support them that way.

And in terms of the gearbox opportunity. Yes, what are the moats around that? And do you have to be established as a high-precision machining? Of course, now you have casting and forging skills, and we hear in electric motors, Nidec's thinking about coming -- or is coming in according to Siemens Valeo. And there are a lot of players in motors who don't necessarily have that heavy-duty machine shop skills that you folks have. So is that going to be a kind of moat around that kind of the component business around gearing?

We think our component capability is a major differentiator for us in the marketplace. There's a lot of people that can design systems, gearboxes and other things. But we've got not only the engineering capability, but we've obviously got the manufacturing know-how over the years that we've been in business, and that's clearly demonstrating and playing out when where we're visiting with the different customers here because we've seen a lot of NVH concerns based in some of the initial designs and we've been able to come in and provide solutions that address those concerns. At the same time, people have always recognized for our operational excellence as well as our technology capability. And so therefore, as I mentioned, I see that being a differentiator for us as we go forward.

Brian, this is Chris. You mentioned 2 questions ago, what makes it unique for American Axle, and the comments that David just mentioned gives us not only access to the main drafting, which I know a lot of people talk about, but a much broader market in supplying these components. Quite frankly, our capacity and our technology aligns with perfectly, and not anybody else can do that. So that makes it very unique to American Axle and a lot of opportunities for us.

And just looking back to the CPV, can -- you threw out a bunch of numbers. I just want to make sure we get them clear. Can you talk about the CPV of an E-axle for a higher-end vehicle, if you get all of it as a module; the E-axle for a value customer, e-components, and then, of course, versus the current CPV for an integrated Axle system?

Yes. On the component side, Brian, it's going to range from $50 up to several hundred dollars. From a gearbox standpoint, in the range of $200 to $500. And then when you look at the full integrated system on a value brand, probably closer to $500; on the high performance luxury area around $2,500, for clarification.

Okay, great. And can you say anything about the pipeline, win rates in terms of the electrification quoting activities?

Well, clearly, we've been successful in winning business, and we've already launched 3 programs now, and we've got 2 that we're launching next year from an integrated standpoint, but also some component work that we'll be launching next year and the year thereafter. So we're pleased with the book business that we have that's in our backlog. And at the same time, we indicated in our earnings call that we're still holding on to about $1.5 billion in new and incremental opportunity. What's really changed over the last couple of quarters here is that what's heavily weighted towards traditional and conventional in the past has now shifted to where it's about 50-50 with respect to electrification versus traditional. So again, we're seeing growth in the electrification opportunities. Our historical hit rates have been in that 25%, 30% for our conventional and traditional business. I'm not going to sit here and say that will be 25% or 30% for the electrification space because there's a lot of players that are out there. There are some players that are doing some crazy things. We're just going to be very disciplined with respect to our financial hurdles and what business that we'll go after. But I'm highly confident that we'll win our fair share of the business based on the value propositions that we bring forward.

And perhaps a question around electrification, we'll get to the traditional business. How do you compete in the war for talent for electrification, people working on electrification? Your competitors, some are doing M&A. Certainly, for example, Dana's done a number of tuck-ins to acquire technology and internal capabilities. Do you need to do M&A? Can you do it with your balance sheet? Do you -- can you attract the people? And then how do you, David, as CEO, kind of manage the different skill sets, the different time frames between kind of the legacy machining, high, really, process-oriented business and then sort of the R&D going into electrification?

Yes, Brian, I'll start first on the traditional and conventional business. I mean I think we've demonstrated and done an outstanding job of demonstrating our performance in that area, not just here in the third quarter but consistently year-over-year in the past. And what we're doing is we're really dialing in and optimizing that business. Especially based on the fact that we've see many of the programs now that we've already launched -- if you remember, we had 60 launches a year for the previous 3 years. Those programs are all launched now. We're optimizing those businesses. And the way we see it now with the shift towards -- more towards electrification, some of those traditional programs are going to run much longer than what was originally forecast and planned. An example of that is where we made some big investments on 8-, 9- and 10-speed transmissions. Those are going to run not for your typical 5 years but well beyond that, probably 10 years until you start seeing some of the true penetration of electrification going forward. But back to your comment in regards to talent and the comment in regards to M&A activity. What a lot of people forget is that we did some M&A activity back in 2010 when we first started with the joint venture with Saab and then acquired their assets, and we've had electrification technology on the shelf since that 2010 period of time. And the market just wasn't ready for that then. We clearly had to evolve our product portfolio based on what the market is asking for today because as we've said, it varies based on the different regions of the world and the different price points. Some are looking for the value brand. Others are looking for the higher performance brand. What we've done is made sure that our product is scalable and modular. And so in that sense, think about putting together a shopping list and the customer can identify what performance needs they want, and we can adjust our product portfolio and our offering to be able to support that. But when it comes to the talent side of things, again, we've got talented people and resources today. We're clearly reallocating and reassigning a number of our traditional conventional engineering resources then to work more heavily on electrification. In some cases, they already have that skill set. In other cases, we're training them on that skill set. We've added a significant amount of software controls engineers already, but I foresee us continuing to do more and more of that as we go forward as the demands for this type of business grow. And then as we've been very forthright, I mean we're not in the motor business and the power electronic business today from a large standpoint, so we've got a capability and know-how. We're adding resources in that area there to strengthen our know-how. We've also leveraged partnerships that our customers have asked us to work on. We've also leveraged other partnerships that we've established ourselves. And right now, we still feel that we're competitive in the marketplace with that value proposition that we're bringing forward. And as we go forward, we'll look to strengthen that internal capability of both motors and inverters. And whether we do that organically or strategically is to be determined, but I'm highly confident that we'll be able to provide a value offering to our customers.

Well, let's move back to some of the traditional questions we'd always ask every year. What are you thinking about in terms of 2021 GM pickup truck production? And let me just start there with the kind of full-size truck volumes?

Yes. We're not giving any volume expectations at this time. But what I can say, Brian, and you know this as well, is that GM operates with 4 assembly plants today. However, they just announced a fifth assembly plant coming on board in 2022. Their straight-time capacity was roughly around or approximately around 1.2 million units on straight-time. When you flex that with overtime and other things, you can get another 15% to 20% out of that. So that's going to put you in the range of 1.3 million to 1.4 million units. So I think it's directionally aligned with where IHS has identified for 2021. But again, we're not giving any volume expectations, but it gives you a rough idea of what we're thinking. What I can say is that the truck demand is very strong. The inventory levels for GM are very low. They haven't fully recovered from the strike. So therefore, it's positive for us that they're bringing on the Oshawa facility, a fifth assembly plant now. So that will potentially be even more incremental volume starting in the 2022 calendar year period of time. But historically, GM and the other OEMs like to see around 75 to 80 days of inventory on their lots. You recognize today that those inventory levels, depending on which model, range of between 30 and 40-plus days. And so there's a lot of pent-up demand and dealer inventory that needs to be filled. And so therefore, we see our schedule being very strong for the balance of this year and carried into next year, assuming that we're not negatively impacted by this COVID resurgence.

And just drilling down on Oshawa. First, I want to confirm you will be supplying the driveline for the vehicles that go there? It's not part of what they're in-sourcing. And then second, is there any way to think about where that volume could go, of course, assuming the demand and the market share is there?

Yes. There's no doubt in our mind that we'll absolutely be providing the products for that and incrementally benefit from the volume that's coming on at Oshawa. GM has got an install capacity that they don't plan on investing beyond based on what they've communicated to us at the time. If that changes, I'm sure they'll let us know that. But right now, we don't foresee any change. So we'll definitely benefit from this going forward here. And I think it's a very positive move on behalf of what GM is doing because the market has shifted in that direction towards trucks and SUVs. They've got an outstanding product that's fully launched now, now that they're getting their SUVs out there. As you know, they already have their light-duty and heavy-duty trucks out there. They've been gaining market share, which they typically do when they launch the new programs. So we're very pleased with that, and we've benefited from that also. So we're very happy with where they are with their launch and where they are with their recent announcement of the Oshawa facility coming on board.