Dauch Corporation (DCH) Earnings Call Transcript & Summary

Okay. And I think we are live. Great. Thank you. As we continue the CS Global Industrials Conference, I'm Dan Levy. I lead U.S. autos research coverage at Crédit Suisse. I'm very pleased to have with me the team from American Axle, Chris May, CFO; as well as Jason Parsons and David Lim, who lead the American Axle IR efforts. I think we're going to -- Chris is going to provide some opening comments, and then we'll go through Q&A. To the extent you have any questions you'd like addressed in the webcast, you could please e-mail me [email protected], and I'll try my best to address the questions. With that, Chris, Jason and David, thank you so much for joining.

All right. Well, thank you, Dan. Good morning, and thank you to yourself and, of course, Crédit Suisse for hosting this event. Looking forward to the next half hour here. But before we begin, I would like to direct your attention to our forward-looking disclaimers and comments that we post on our website through our IR page as it relates to the topics that we may be talking about here today. So that said, good morning, everyone. I hope everybody had a fun and safe Thanksgiving holiday, and we're back at it here for the next few weeks before the next holiday shutdown here. But that said, maybe set the table a little bit about how we're going to progress through our conversation today kind of leading off with just the quick highlights from our third quarter and sort of where we're looking into 2021 and a little bit of our backlog and quotation activity that we see. Certainly, for those of you who follow us and those of you who don't, we had a very solid third quarter 2020 results on the back of a challenging first half as it relates to COVID. We posted in the third quarter adjusted free cash flow of $217 million, our adjusted EBITDA of $297 million or 21%. Both of those were records for the company, and we are certainly pleased with our performance. At the same time as our third quarter earnings release, we did provide full year guidance and reinstate that back for the calendar year of 2020, for which we see sales of $4.6 billion, adjusted EBITDA between $665 million and $680 million and adjusted free cash flow in the range of $220 million to $235 million. And think about that, from a cash flow perspective, just 6 months ago, we were sharing with you various breakeven scenarios. Now we're talking about a couple of hundred million dollars of positive free cash flow. So very exciting for us here in terms of 2020 and how we're going to close this year out. That said, we continue to be cautiously optimistic about our fourth quarter and beyond. But obviously, the risks of COVID continue to exist in this level of uncertain times. We continue to be focused on our safety protocols to protect our associates, at the same time, meeting our customer domain requirements, which are quite strong in various regions, and we'll talk a little bit more about that, I would suspect, through Q&A. But at the end of the day, we're prepared to react quickly to whatever the market brings, whether increased volumes or if we have to modify accordingly, we'll do that as well. And I think we've proved that out in the first half of the year. But as we start to look beyond 2020 and start to think about 2021 as it takes shape, we continue to see favorable mix as it relates to platforms that we support in the light truck space, nearing almost 80% in terms of share of what it sells in the marketplace. And of course, that is the sweet spot in terms of product set for American Axle. In particular, we see the full-size truck segment nearing nearly 18% in that space, which also bodes very well to our product set. Our cost savings that we put in place here in 2020 continue to gain traction, continue to solidify and continue to set us up for a good 2021. Not here to provide guidance for 2021. Stay tuned for that probably on our fourth quarter earnings call, where we'll talk more about that. And then lastly, from a cash flow management, top priority here for the company to not only manage our current cash, but to continue to generate strong free cash flow as a company. Our operations are converting EBITDA into cash flow. We're moderating our CapEx, and this continues to be a key priority for the company that will allow us to support near-term operations, reduce debt, but also to focus on the growth of the company. And the growth certainly brings some exciting segments and exciting awards and quotation activity in both our traditional product set as well as our E-drive or electronic suites through E-drive units, components and so on and so forth, and that activity continues to remain robust. But to be frank, at the end of the day, we're pretty excited about current year and closing this out strong, but also very excited -- more so excited about the future of this company. So that said, those are my opening remarks, just kind of set the table a little bit there, Dan. Maybe I'll turn it back over to you for any Q&A that you may have or any that come through from any of the investors online.

Great. Let's start. I think a good way to start, and this is a question we've been asking everyone, is maybe you could just discuss, give us some more near-term update what you're seeing in terms of COVID supply chain disruption, be it in Mexico or any other global linkages in the auto industry. You don't really have much in terms of Europe exposure, but are you seeing -- to the Europe exposure you do have, are you seeing any impact? And then how much of this COVID disruption to the supply chain has been embedded in the updated 2020 guidance?

Yes. No, that's a fair question. Maybe I'll start with the last part of your question first in terms of the guidance that I just mentioned and also, if you look at the materials we've provided through our earnings call last that, that guidance would exclude any significant disruption. It assumes no significant disruption from COVID or the fire at our Malvern facility. And right now, I would tell you, we have no significant disruptions through our supply chain or through our operations as it relates to this. But maybe it's worthwhile just touching a little bit on some of the geographies that we see and the activity to talk and address a little bit about your question. 80% or nearly 80% of our revenue is generated here in North America, about 10% in Europe, about 10% in Asia, and we have a little bit there in Brazil. Asia, in particular, China for us is running pretty strong. No significant disruptions. The risk of that seems pretty low in the near term associated with that. Operations in India and Brazil, a little bit more challenged in terms of getting back up to where they needed to be, and we did talk a little bit about that on our last earnings call that continues to be true. And Europe, I would say is okay. It's stable. It's reasonable. Our metal forming group supplies product into a broad range of customers. Our driveline group, a little more focused on some of like JLR, our E-drive units and things like that. I would say it's stable. Still challenge from a COVID perspective, but stable from what we've seen now consistent through the quarter. But for us, most, in terms of waiting, obviously, is our North America marketplace. We continue to see robust demand for our products. We continue to manage day in and day out with our customers, with our suppliers, risks associated with COVID or potential supply disruptions. And as I mentioned just a few minutes ago, we have no significant disruptions. I would tell you, we have a couple of our suppliers that, call it, on the red list or warning list that we continue to work with and monitor. But at this point, between here and the end of the year, we're not expecting any significant disruptions associated with that. So fingers crossed, I think we're in pretty good shape. I think collectively, the auto suppliers as well as our end customers and the OEMs have been working very collaboratively with us and with them to ensure continued supply and continue to remain strong production builds.

And the customers that are on the red list or warning list, presumably, that's -- or the suppliers, that's in Mexico?

There's some in Mexico. There's some in the U.S. They are -- it's sort of, I would call that a global statement. So inside of North America, our supply chain supplies all around, right? So you have U.S. that ships to Mexico, Mexico ships to Mexico. Mexico ships to U.S. That's a global statement, no -- it is not overweighted towards Mexico by any means. there are a couple that are in Mexico. It's not overweighted in Mexico.

Great. Okay. Let's think about your puts and takes on -- I realize you're not going to provide 2021, but let's maybe just start -- your 2021 guidance, but let's maybe just start with 3Q, which was extraordinarily strong for you and 21% EBITDA margins, an all-time high. And even if you strip out the onetime items that you had in terms of your recoveries and the metal benefits, it's still 19%, which I believe is still an all-time high. So maybe help us -- and if I look at consensus, which I don't have in front of me, I -- it's much lower than that. So help us understand what can be extrapolated from 3Q into 2021 and what cannot be extrapolated from 3Q into 2021?

Yes. No, that's a great question. Look, the third quarter was a phenomenal quarter for us. There's no doubt about it. You back out some of those one-timers, some recoveries from ED&D, commercial settlements we had with some customers. We had some gains on FX in metal a little bit. You do need to [ exclude ] those, as you mentioned. But if you look at the strengths you saw embedded inside of Q3 that will continue, you see our cost savings initiatives, where we articulated $60 million in 2020. There was a little bit of overweighting of that cost save into the third quarter as some of it was temporary, such as wage reductions. We had temporary wage reductions across our salary workforce around the globe. Those have come back. We'll replenish those with some more sticky cost saves. But probably a little bit disproportionate inside of the third quarter, if you're just trying to extrapolate the third quarter. But our goal is to maintain that $60 million total going from '20 into 2021, and I think we're in pretty good shape to do that. Mix was very favorable for us in the third quarter as well. You saw at the beginning of the third quarter, which would typically be some downtime with OEMs, you saw our strong mix, especially on the truck side. Those facilities run -- try to run heavy in the early part of July, which is not typical for a third quarter. So you get a little bit of mix blending on a go-forward basis as you bring in the rest of our product set, not just truck-related on a go-forward basis. You step into next year, we'll have some normal productivity. We'll have some price downs associated with that. The cost savings that I mentioned, obviously, will take hold. And we did have some, call it, COVID premium costs inside the third quarter of a few million dollars. I would expect that to continue at least in the near term. A lot of that related to disinfecting our facilities, PPE we provide to our associates to ensure that we can build our product in a safe and effective manner. That will continue, I would suspect, in the foreseeable future. And then lastly, R&D. Obviously, we tripped it down a little bit of R&D in the second and third quarter. We'll pick back up a little bit on that R&D spend as we continue to fund some of the growth opportunities inside our business. That's how I would think about the third quarter extrapolating it out across into future periods. But at the end of the day though, whether it be metal and FX and commercial arrangements and productivity, I mean it was a fantastic quarter. Everything fell our way. Not apologizing for our performance by no means, but it was a pretty darn good quarter. Tough one to just extrapolate.

Right. And then -- and I think you just answered a number of my next questions, which are some assumptions on 2021. That was good. Maybe you can just help us understand aside from that, as we think about the volume uptick in 2021, what type of incremental margin we might come to expect on that? And then any other discrete costs you'd flag, just return of cost post austerity measures? Or is that sort of netted into that $60 million cost saves? Anything related to USMCA now that it's gone live, other assumptions there?

Yes. From a margin perspective, typically, what we would see inside of our business is a variable profit margin of 25% to, call it, upwards of 35% margin. You saw that during the GM work stop, as you saw that impact for us here during COVID. I would expect that to continue at that ratio depending on mix into next year. So if it's more weighted towards full-size truck increases, you'll be at the higher end of that mix contribution margin range. If you start to bring in more of the company average, which is what we'll do, if you think about we're building probably a little bit overweight on trucks right now because of the demand of that product, it will be a little bit closer towards the midpoint or lower end of that range from the 25% to 35% incremental or decremental into next year. I think we touched a little bit on the cost save of the $60 million in the COVID cost. I think one other item from a working capital perspective to think about would be we've done a nice job here managing our payables, our inventory and our receivables. Inventories are down, continue to trend down, and the teams have done a great job to navigate those opportunities to conserve cash. As volumes come up, you'll build a little bit of inventory, I would suspect, back into the system. Receivables and payables would be, I would call it, on just normal trade terms and will ebb and flow with the business. Typically, we would see a change of a dollar sales or $100 sales, 10% to 15% of that would be consumed up or down working capital in terms of inside of our business. And then lastly, you mentioned about USMCA. Look, everything I have talked about here effectively would encompass anything that we saw understanding here today would incur or benefit from USMCA levels.

Great. On the cash flow, anything you can say on what we might expect for CapEx? Is there some deferred CapEx from 2020 that will hit in 2021? Or is just the view 5% of revenue, that typical target you've cited in the past?

Yes. Look, did we have a little bit of deferral going into next year from this year? Yes. But we've been managing CapEx very tightly. It's been a top priority here for our company from an operational cash flow perspective to successfully launch our products on cost, on time, on budget to continue to find ways to reduce that CapEx spend with our launches and otherwise, and I think we've been pretty successful at that. And I would expect going into next year, even with all the puts and takes, to be at that approximately 5% or less of sales, that would be our CapEx build for next year. So I think we're still holding firm on that. And I think we've got a really good shot at delivering that.

Good. And then as far as the backlog goes, maybe you can give us some sense. I mean your last update was $750 million for 2020 to '22. Some parameters on what we might expect for the next update, any geographies or products overweight? Just how to think of the net backlog.

Yes. The last time we did issue guidance in our backlog, as you mentioned, at the beginning of the year, I would expect we would provide much more details on that backlog, clearly, in 2021 related for the next 3-year cycle. So I don't want to get ahead of that. But what I would tell you is there's been a little bit of puts and takes based on -- in terms of overall market volume and customer launch timing that have changed associated with COVID. Not massive changes. So we're feeling pretty good about that backlog. From an attrition standpoint that we also talked about coupled up with our backlog, typically, we see anywhere between $100 million to $200 million of attrition in our business. It's been a little bit near the higher side of that recently in the past couple of years as some of the older transmissions have faded off. We're starting to now move that down from an attrition standpoint, and we do set it maybe towards the midpoint or lower on a go-forward basis. So we're seeing some mitigation of attrition, which is good for us as well. That would be the commentary I'd provide on the backlog. Obviously, we're very busy quoting a lot of new business growth for us on the electrification front, from our traditional product set. That will continue to emerge over time.

Great. Let's talk about your GM large truck business. And maybe let's just start more near term. I don't know if you can provide any commentary on if holiday shutdowns have been eliminated just due to inventory rebuild. Any comments on the -- on typical seasonal shutdowns, if that's been eliminated.

Yes. Look, at the end of the day, they have very strong production demands for those full-size truck platforms we supply, General Motors, FCA as well and Nissan as well, continued to expect strong robust demand in that space. The end consumer has interest in that vehicle. The underpinnings of low inventories in the field continue to support production, in our opinion, for an extended period of time in that platform. We do expect a traditional, I would call it, end-year holiday shutdowns around Christmas time to continue. You saw that even last year when General Motors was out on their work stoppage. They -- [ on embedding ] side facilities to take the shutdown during the holiday season. I would expect that to be true this year, so which will continue to provide for a robust production environment this year and into next year. But schedules continue to be nice and strong in that particular product set.

Right. And then GM just announced that they're going to expand truck capacity at Oshawa. I believe that takes hold in 2022. Maybe you could just comment, do you have the -- do you have that content? Will that be yours? Or is that going to be in-sourced? Do you have the capacity or what's the cost to build out the capacity to support that?

Yes. So they supply their full-size truck requirements today with 4 assembly plants here in North America. This would be a fifth one on -- and you may recall, Oshawa was building trucks up until about, I don't know, 18 months or so ago, which we also supplied into that facility with our product set. So we will continue to supply into the General Motors product set. Additional volume is additional content for us. We are on every single General Motor's full-size platform in one form or another and more trucks, it's more volume, and that's a beautiful thing for American Axle. So that's all good for us, Dan. We are excited to be on those trucks.

Great. And then as far as the in-sourcing transition, that is now complete, yes, on the content?

It's complete. Yes, it's complete. It was complete with the conversion to the full-size SUV, which had an architecture change, which we went from a rear beam axle to an independent rear. I mean we're still the supplier. It's just -- it was a content change. They ran a little deeper into 2020 due to COVID. So they built out the last model year of the previous SUV, basically to the end of the first quarter. So you will have a -- call it, a first quarter year-over-year lap in '21, but the conversion is done. That's more of a financial year-over-year impact in Q1 of next year versus Q1 of this year in 2020. But the conversion is done in the past.

Perfect. Let's pivot to the balance sheet and cash usage. Maybe you can just give us a sense -- look, we know that electrification is an incremental push for you, but also the priority is to delever. So maybe you can give us a sense conceptually how you think about balancing R&D or CapEx related to electrification versus the push to incrementally deleverage.

Yes. No, certainly. Great question. Look, when we talk about our ability to generate free cash flow as a company, right, that would be after we have supported our organic CapEx needs as well as our R&D needs as a company. So as we sit here today, we look at the opportunity set that sits in front of us. We think about the technologies we're in. We think about the technologies, the next-generation of those technologies that we continue to invest in from an R&D perspective. We feel we are investing in the appropriate amounts, both from a CapEx, from an R&D perspective, to provide very competitive advanced technology offerings into the marketplace and still have remained free cash flow that allow us to reduce some leverage on the company. As opportunities continue to present themselves, as our technologies continue to have interest from the OEMs, can we invest a little bit more there? Absolutely. Do we still have sufficient and plenty of cash headroom to continue to reduce the leverage of the company? Absolutely. So I think we're in a really good spot as it relates to that overall total mix of cash flow generation from our operations of the company to fund CapEx, R&D and debt reduction.

And as far as other actions you can take to deleverage, obviously, the big one was casting. Anything you'd say about other product lines, business areas, exposures that may be noncore? It seems like at this point, you're doing actions on the margin. And then I also flip that around, we typically don't think of you post Metaldyne as looking at M&A, but you did do a small deal about a year ago, this MITEC deal, which was pretty good, $9 million purchase price for $20 million in assets. How are you balancing any potential bolt-ons even if it's on the margin? So what goes away and what can come on?

Yes. Let's talk on the asset disposition side. As you mentioned, casting is a pretty sizable one for us that we disclosed it at the end of 2019. But this -- our product set journey over the next many years as we continue to look towards new product sets, supporting our customers and the requirements they have, we look internally to our product portfolio where we see areas of growth, areas of appropriate returns on capital and what is the appropriate product portfolio we have going forward. I would say there are smaller things inside of our product portfolio. We continue to look at it a little bit more closely, nowhere near the size of the casting operations that we disposed of a year ago. But there's some opportunities there that we're taking a look at considering as we continue to position ourselves in the best spot for the market. Nothing to announce today, of course, but it's something that certainly we continue to do. So just a year before last, right, disposed of some of our powertrain aftermarket. Last year was castings. We continue to take a look at that. On the flip side, to your question, is from an acquisition standpoint. I would tell you, if you look over the last year, right, we have the distressed asset, beautiful financial metrics associated with it. It wasn't very big, but a great opportunity for us to expand our VCS business. At the same time, we also invested in joint ventures last year and this year to continue to expand the relationship, in particular, in China. And since that has occurred, we have launched both some of our traditional products, both -- one of our electric drive units, supporting, for example, the Baojun E300 Plus was in conjunction with our joint venture there. So we see great opportunities to invest in terms of scale, smaller amounts that have outsized opportunities for us for segment growth, market growth, customer diversification and so on and so forth. So I would expect that to continue for us on our mindset and look for ways and opportunities to leverage that.

Perfect. Let's wrap up on electrification, given that's the [ idea ] of the year. So maybe you can help us with an overview, just by giving us a sense of what your focus is or an updated focus. And you noted you're quoting $1.5 billion of new incremental opportunities. In the past, that was more heavily weighted to combustion. But now I think you've noted recently it's, call it, 50-50 between combustion and electrification. So is that quoting more fully focused on integrated -- within EV fully integrated e-axles? Is it more components, regions in focus? Or are you having discussions with start-ups? And then I would ask, as far as your win rate, how does your win rate stand versus current market share?

Yes. No, [ great questions ]. What I would tell you, as we think about sort of that $1.5 billion as you articulated, half of it is related to electrification. What is it that we're looking at? What is it that we quoting? I think the great response here is that it's very broad-based in terms of what we're looking at. It's E-drive units, it's assemblies, it's components, it's a variety of regions, and it's a variety of customers. And I think from an opportunity set for us to grow, in each of those different areas and it presenting itself through the quotation opportunity, I think is a fantastic position to be in as we sit here today. Obviously, we have won some. We've announced those awards, both from an E-drive unit standpoint, but also from a component standpoint. You've heard us over the last, call it, 2 quarters talk about component wins with commercial vehicle, with new customers, pickup trucks, so on and so forth in that space. So that opportunity, broad in various products that we supply, customer and region. That said, obviously, we see the growth markets in China for our technology. That's where a couple of our current E-drive units have just launched or about to launch as well as on the European front, which also brings a little bit of geographic diversity for us. From a win rate perspective, look, we try to be targeted, we try to be financially disciplined in terms of how we approach these and not just chase your way to the bottom from a price perspective. So we have historically articulated we got, call it, 25%, 30% win rate on the quotation activity that we're in. I would expect us to have a very similar type of win rate with the opportunities that present themselves, whether it be traditional or E-drive units.

Good. Let's drill down on a couple of those points there. In Europe, we obviously see a very heavy inflection in EV, more so than any other region. Maybe you could just give us a sense of how much more so is Europe an opportunity today. How does the Europe EV inflection change the picture for you, especially given you don't really have much in terms of Europe exposure, and now it's small?

Yes. Look, our first E-drive unit was launched on the I-PACE in Europe, right? Our foundational roots of our E-drive technology was based in Sweden through our acquisition, ultimately -- the joint venture and ultimate acquisition that we had with Saab. So Europe has a strong roots in this technology. We're launching a significant award next year, as you know, in the luxury side in Europe as well. I would tell you, from a component side, from an OEM interaction side, you're seeing more and more engagement and opportunities surface from the European OEMs in this space. And for us, we view that as a nice opportunity. We're in the marketplace. We've got production in that marketplace. We have engineering talent in that marketplace. So it's a good spot to begin. And yes, the observations you make about the European market, we believe that's what we're experiencing and seeing as well.

And on the component side, maybe you could just help us -- walk us through what that opportunity is, whether it's subcomponents, gear boxes. I know we -- you had said in the past, the content value ranges from $50 to $500. How do we frame that opportunity? Looking at the pie of total EV opportunity, is that relative to fully integrated E-drive? What's your competitive positioning -- are you -- within each of those?

Yes. I think on a component standpoint, I think you articulated very well that our opportunity set from a content per vehicle [ is ]. We supply gears, shafts, cases, fully assembled differential, assemblies all the way up to gearboxes. That's where you get that $500 plus in terms of content per value per vehicle. But why we believe we could get overweight, especially on the component side because a lot of these components are very similar to what we do on our traditional driveline product, right? If you break down a traditional axle or PTU or RDM, you're going to find many of the same components or very similar components to which we do by the millions, and very high precision, very high technology, very high requirements for NVH, which played perfectly into E-drive unit assemblies. So we think that's a great market for us. And then of course, the E-drive units themselves, we're in the marketplace today, we're working on current gen, next gen and then the gen after that in terms of some advanced technologies. You want to be smaller, faster, more power, and of course, cost-effective for the OEM.

Right. Maybe -- and I know we're getting close to time. On the E-drive side, as you have 3 programs now. You have the I-PACE that have launched, I believe, the I-PACE, the Baojun E300, and then there was another one in China. You have another 2 next year. You noted the one on the premium OEM. Maybe you could just give us a sense of sort of the common learnings thus far that you've seen on the programs that you've had. What does that inform your next generation of product, your positioning or the way you go to market? So what is the early takeaway been so far in what you've launched or what you're preparing to launch right now and how that positions you for the future?

Yes. Look, I would tell you from a couple of different perspectives. Number one is good, close collaboration with your customer on the requirements, the design, working with them for vehicle integration. I think our ability to do that has been very successful. We were recognized this year by PACE award inside the industry for our close collaboration with our customer JLR for the I-PACE, which is a very prestigious award that shows how we can integrate and work with our customer base. I think that's a key learning from this process, especially as they're getting into new markets, new product sets, new designs. So that I think that's important. But look, the common learning, sort of as I mentioned previously, it needs to be smaller, faster, more powerful, right? And that's the technology curve, if you will, inside of these EDUs. And we think we have the right product, we think we have the right capabilities from an engineering, from a design, from a development, from a testing to take us to the next gen and again the next gen after that to stay on that technology curve. I think that would be a key learning as well over the last couple of years as we launched our new products in this space.

Perfect. And with that, I think we are just at time. So Chris, Jason, David, thank you so much. Very helpful to -- as we learn more about the narrative. And we look forward to hearing more so. Thank you very much.

All right. Dan, thank you. Thank you all for listening, and I hope everyone would be safe. Take care.

Thank you. Great. Over to Chase, you can now close the session.