Dauch Corporation (DCH) Earnings Call Transcript & Summary

Okay, I think we're ready to go with our next session. Good morning, everybody, and thank you for joining us. I'm Itay Michaeli, Citi's U.S. autos and mobility analyst. I'm very pleased to have back with us, at the Citi Industrials Conference, American Axle for a fireside chat. From the company, we're very pleased to have Chris May, the CFO; and David Lim from Investor Relations. So look forward to a discussion. The company just reported earnings last Friday. So lots of topics to go through, but most importantly, we want to make sure that your questions get answered. So if you have any questions for the management team, feel free to just e-mail me at itay.michaeli@citi.com. I'll be staring on my other screen a lot throughout the session, and we'll be able to get all your questions answered in the next 40 minutes. And lastly, if you need our legal disclosures, we can also make those available to you. So Chris, welcome. Thanks again for joining us. Good to see you. I thought maybe we could just kick off the session with maybe some reflections on earnings and just maybe a brief overview of where the story sits today, kind of feedback you've received over the last few days. And maybe, yes, like from there, we'll go into questions.

Sounds great. Thank you, Itay. And of course, thank you to yourself and Citi for hosting this event. It's always a great venue. Always a little better in person, but we'll take what we can get these days, right? Certainly, good morning, everyone. I hope everyone is doing safe and maybe more importantly for today, everyone is staying warm. Before we begin any of our comments, I do direct your attention to our forward-looking statements that we have as part of our presentation deck on the IR section of our website. Yes. And as Itay mentioned, last week, Friday, we did release our fourth quarter of 2020 results. We also provided some outlook into 2021. But from a fourth quarter perspective, we were quite pleased, very strong performance. We continued on the back of a strong third quarter into the fourth quarter with 18.2% EBITDA margin. Solid free cash flow for the quarter, which really allowed us to kind of square up the year at total sales of approximately $4.7 billion, EBITDA of $720 million or 15.3% margin for the full year. And keep in mind, as you know, the second quarter was highly impacted by the COVID pandemic for us. So ending on a very strong note at 18% margins and full year 15%, very pleased with that. And I think in an even more meaningful way, from a free cash flow perspective, we concluded the full year of over $300 million of adjusted free cash flow. That's certainly a long way from where we were in the second quarter of that year based on significant cost reductions as well as our strong customer mix that we experienced in the back half of the year. Through that time, we also continued to strengthen our balance sheet. Through the course of 2020, we paid down over additional $200 million of gross debt. And we concluded the year with over $1.5 billion of liquidity on our balance sheet. And as I mentioned, we released our guidance for 2021 and pleased to talk about our sales growing to $5.3 billion to $5.5 billion, adjusted EBITDA of $850 million to $925 million and expecting a continued strong free cash flow performance of $300 million to $400 million in calendar year 2021. At the same time, we talked about our fourth quarter results, we talked about our guidance for 2021, we did release a couple of other interesting pieces of information. And I'm sure we'll talk a little bit about these through the course of Q&A. But we announced the successor program win for us on our Ram heavy-duty platform, and that is one of our top platforms we provide here today. Our net book of business now is secured through the 2030 timeframe. And over that time frame, we'll generate several billion dollars of revenue for this company. And also, prior to our earnings release, at the CES show, we did announce our technical agreement with Inovance out of China to advance the next generation of our 3-in-1 electric drive units, so really excited about that. And we have a really good partnership with them, continues to grow. We continue to win business with them as a key partner in the China region. Now you can see us taking that to the next level. We also talked a little bit about our investment in REE, which is an Israeli startup company, to work on their course in propulsion technologies to support some new mobility, so some exciting there from our technology standpoint. And then, of course, as you know, we have a bunch of electric drive launches coming on this year in 2021. But I think the key takeaways, as we think about our performance in '20, we think about the future for American Axle. Our core business is running very well, and we're having very strong free cash flow conversion on that business. We're focused on debt reduction and improving our balance sheet, and you've seen us continue to take steps in that direction. And then our engineering and our manufacturing strength is right in the sweet spot of developing world-class electric drive units to support our customers' shifts into electrification. And at the end of the day, it's a pretty exciting time to be at AAM, and we look forward to a nice bright future. So I think that sort of encapsulizes where we sit here today. I think maybe, Itay, maybe it makes the most sense to kind of flip it back over to you for any Q&A that you may have or anyone on the line would have as well.

Perfect. Thank you, Chris, for that overview. And again, if you have questions, everybody, just feel free to e-mail me. I'd like to start maybe at a high level on [working with] EV topics. Obviously, the transition is a major topic for American Axle, particularly when investors debate the terminal value of the company and the transition, whether it's by your key customers and what they're doing or regions where you're over-indexed and under-indexed. And obviously, we don't have all the answers today to this transition as it develops, but how are you thinking about -- or how should investors think about terminal value scenarios for the company? What is -- as you sort of tick around the next 10 years and how the progression might unfold, are various scenarios that you might be running on things like revenue, margins, returns on capital, free cash flow? Just love to kind of talk about that debate around your transition and the terminal value.

Sure. Happy to take that. I know this is very topical today, this exact topic. But as we think about that concept inside our company, we think, as a management team, very long term in our business. That's how we plan our business, which is very, very much aligned really with the spirit and the concept of this question of terminal value. We think a lot about our product positioning and where we sit inside the market to support our customers, both in the short term, medium term and long term as they transition their product portfolio. And some of the key elements to that concept, right, is maximum flexibility in our business. And to be -- ultimately, you'll hear -- if David, our CEO, was here today, he would discuss with you how we want to be agnostic from a propulsion standpoint to take our product set into wherever the market may lead from an end customer standpoint. Obviously, very focused on ICE today. We continue to grow our hybrid applications of our business. So think of our VCS element inside of our business, which is still very much core to us and continues to show strong growth, but also growing in that electrification space, which will drive, I think, a little bit more of the attention on the terminal value question. And if you think about some of our investment commentary that we've talked about and advancing into those next generation of products, as customers transition to an electrification world, right, we have very strong product in the market today, developing advanced product on an e-Drive unit or electric drive units that have very high content per vehicle opportunities for us on a global reach. At the same time, the same core element of the business that supports our traditional side from a component standpoint is very relevant and very important as a part of e-Drive units and customers that may want to do something in-house. So we have a very strong capability set that supports the component side of that business as well. And this isn't something that somebody can go just do, right? The skill sets and the requirements that we need today for heat management and noise and things of that nature are critical to our success, both traditional product as well as e-Drive. So you start to kind of peel the onion back a little bit here, you see how the terminal value of this company or our product set continues to evolve and have a very meaningful role to our success on a long-term basis. Couple that with our manufacturing facilities are very flexible. We make in our facilities today, side-by-side, traditional product as well as e-Drive units. Our component side of the business is very flexible to adapt to either these electric drive units or traditional product sets. So that flexibility on the manufacturing base allows us to pivot as our customers demand whichever product they ultimately align to. But at the end of the day, you look at the core of the company, and that's strong margin performance, and this is from a financial standpoint, strong free cash flow conversion. We see both on traditional product set as well as electric product set that same sort of recipe of managing -- tightly managing costs, managing disciplined CapEx investments, optimizing your footprint for a good, strong financial performance in whatever terminal value year you pick. We see our product set being meaningful in that set as well as our financial performance to be very strong, especially on the free cash flow generation side of the business.

Terrific. Yes, that was a great overview [indiscernible]. And maybe as we think about share of future EV business, I think last week on the call, you expressed confidence about AAM winning its fair share within future EV awards. How do you define that kind of fair share? And where are you today in the backlog relative to those targets?

Yes. Fair share, when you hear us refer to that commentary, if you think past several years, we talk about businesses that we pursue, opportunities that we pursue. And we recognize, as would any supplier, you're not going to win 100% of that. We've typically got 20%, 30% win rate now in these targeted areas we pursue, because in some cases, you're knocking off and trying to knock off incumbent or competing in-house or you're bringing a new technology. So our view is, as we pursue these opportunities, as they present themselves, that we will sort of still be in that sweet spot of our "fair share", winning that book of business with our advanced technology, winning our book of business based on our cost effectiveness to our end customer. And we see that our technology side now starting to emerge even stronger into that recipe mix, especially as you move into electrification. That gives us the confidence that we'll continue to win for "our fair share" of that book of business. And I think as you start to see volumes increase in the electric drive space, as more platforms come out, as OEMs expand their product set, I think the opportunity sets that present themselves to us will expand to allow us to win even more business in that sector.

Great. And on that point, I think you gave the kind of e-Drive backlog last week for the 3-year period. Any chance that you can kind of give us the lifetime revenue –- or [indiscernible] revenue of those awards? Clearly, some of your -- I think one of your major customers recently kind of announced the plans to kind of go all EV in the not-too-distant future. How do we think about: a, the lifetime opportunity kind of beyond the next 3 years of your current EV and hybrid awards; as well as maybe update us on the quoting pipeline as well and how that sort of moves. I think previously, there was kind of a $1 billion number that you've communicated. Any update there?

Yes. So as we think about -- we've talked about, at least inside of that backlog period, if you take basically any one of the years, our e-Drive business from an annual revenue is about $100 million to $200 million. If you think about the business that we have secured and one that we've launched, whether it be on the I-PACE today that's in the marketplace as well as some of this backlog cadence and some of the backlog of the programs we're launching in this period also goes to, obviously, well beyond 2023. You're nearing $1 billion of lifetime revenue in the product set. We would fully expect as we expand into further dialogues with our existing OEMs, but also new customers where we have seen some of these wins in this e-space for us with some new customers, also in new segments for us. Think of it as front-wheel drive passenger cars in China, for example, or a little bit on the commercial space, a little bit with some of the new entrants into this market space, growing those relationships and expanding that backlog as we go forward.

Perfect. And when we think about -- when we speak with investors about the transition to EV, there's sort of a kind of 2-sided argument. One is look at some of the in-house [work] GM is doing on Ultium, and that's been perceived as a headwind for you. But on the other hand, if you look at just the growth of EVs in China and Europe where you’ve been under-indexed, that seems to be an opportunity. I want to kind of spend some time on both and maybe just start with GM Ultium. Catch us up on what's happening there. Where do you see your role there kind of migrating over time?

Yes. Look, we don't talk specifically about each of our customer platforms and their roles. But look, they obviously have made their announcements as it relates to their initial steps into these vehicle platforms being supported by their Ultium platform, which is battery systems, drive units, chassis, et cetera, to support that. We have announced wins at a component level related to pickup trucks. We've not specifically said Ultium, but I think you could probably connect a few dots in there. So look, they're going to reach through the supply base to have -- and they've articulated that when they announced Ultium, right, to support key elements of that platform. But that's only sort of step 1, in our view, for them, right? That platform will expand out into probably greater volume, greater platforms, other vehicle lines, et cetera, for them. And look, that will create a lot of demand for that type of product. And we have a very strong capable supply base that can certainly help and willing to assist in that process. I would suspect they're going to leverage some of that.

Yes. Maybe on that point, Chris, on the component side of the kind of EV business, can you just remind us what the content per vehicle opportunity range might be? And then the [expected] share -- on this particular pickup program, what that might look like as well?

Yes. Look, from a content side, as we think about components for a particular vehicle, it could be anywhere from $100 up to $500, depending if it's an all-wheel drive application, meaning you have 2 drive units, if it's gearboxes or subassemblies as well as some integration elements. So I know when you think components, you think, well, small, but that's -- we can have meaningful content on vehicles on the component side of the house, there's no doubt about it. And that aligns, again, perfectly with what we're doing on our -- leveraging our traditional skill sets as well as the advanced technology side that we're doing when we do our own drive units. It is a critical, critical component, no pun intended there.

Right, right. Absolutely. So now let's talk about the regional mix and maybe how might that evolve over the next 5 or 10 years. Obviously, you've got some customers in Europe and partnerships as well. Maybe talk about the opportunity within increasing the company's presence outside of North America as EV penetration rises? And maybe at a super high level, how should investors think about where the company's regional mix may go in the next 5 or 10 years?

Yes. Well, just to maybe level set with everyone listening from -- if you look at our regional mix, rough numbers predominantly about 75%, 80% North America today, about 10% Asia, 10% Europe. We got a small amount in Brazil outside of really those main regions. Clearly, underweight to Europe and Asia. If you think about where we are seeing our electrification growth, right, we launched, for example, the I-PACE Jaguar was in the European market. You heard us talk about a big launch we have tail end of this year for another premium European customer in our e-Drive units. But at the same time, over the last 12 months, you've heard us talk about our relationship with Inovance and awards that we've won from that application. Our joint venture with Liuzhou, where we've launched now in the Baojun E300 as our e-drive unit, so expanding into China. So we're seeing these opportunities initially. And probably if you think about the electrification adoption of the curve more weighted towards both Europe and Asia, China in particular. So you can see that sort of also emerge in our backlog disclosures where you have a little bit more overweight into these regions, which will help to sort of kind of bring up proportional share, if you will, of our content or our revenue mix in those regions, and that's where we see the growth. Ultimately, do we see growth in North America for electrification? Yes, you're starting to see some of that now starting to percolate. But I think initially, you'll see the electrification piece driving some content and revenue growth in those 2 regions that would balance out a little bit more against our strong North American business.

Perfect. A couple more on EV, then we'll switch to financials, and we do have some questions coming in as well. Maybe talk about -- update us on the competitive environment in e-Drive and kind of any components as well. Then maybe talk a little bit about the kind of 3-in-1 e-Drive technology that was referenced on the conference call, if you can. You did a tour already before. Maybe you could talk about your competitive environment in both e-Drive units and the component as well as just the 3-in-1 technology that's been previously referenced.

Okay. Yes, look, the competitive environment in terms of the auto supply space is always very competitive, one point. It doesn't matter if you're in traditional or e-Drive. We obviously are very familiar with our competitors on the traditional set. If you move over to the e-Drive space, again, very competitive. We see many of our traditional competitors in that space. We have seen some, I would call it, new entrants into this space that maybe typically you wouldn't associate as a driveline supplier. But at the end of the day, what you are seeing is the OEMs sourcing to key driveline suppliers because of that, call it, skill set, the technology, that know-how to integrate drive units to deal with NVH, noise, vibration, [harshness] to deal with heat management, which maybe isn't a core skill set of some of these other applications. It doesn't mean you have -- they're not working together. They're obviously working together with multiple partnerships. But the driveline element of this, the characteristics of these in the vehicle are very critical. And that's why you're starting to see the driveline guys sort of prevail a little bit in these awards but working with some of these new entrants. But that does create an overall environment for a lot of competition. And obviously, people are very interested in these awards, which creates a little more competitive initially. That will ultimately, we think, all balance out. That's on the drive unit side. On the components side, which we talked about a few moments ago, I would say similar competitors that we would see in our traditional space, same on the component side, not a lot different. But we also are starting to experience where customers are reaching out to us specifically and say, look, your -- quality of your product is required on e-Drive units, because these things need to be whisper-quiet. You don't have an engine dampening noise inside the vehicle. We need you to take your expertise and help us on that side as well. So we see our competition there similar to traditional side, but we see a little bit of edge weighting towards us based on some of our skill sets in that area.

Great. Yes. On the -- a question that came in around the win rate. So I think you mentioned 20%, 30% of what you're pursuing. Maybe at a high level, Chris, could you talk about how much of the opportunity set out there you are actually pursuing or being invited to pursue? I imagine that 20%, 30% is an RFQ win rate when you kind of get to the end of the process. Maybe trend that to sort of how much of the overall opportunity are you trying to go for or being asked to bid on?

Yes. No, great question. And I think I skipped over your 3-in-1 technology by purpose. We'll come back to that one. I don't want to forget that. That's a good one. Yes. No, we're quoting -- and you hear us, this number sounds consistent, and it's consistent for a reason, about $1.5 billion of new business opportunity. About half of that is sort of in the e-Drive space or subcomponent space. The other half, as I would call them, are more on traditional side, because there's still a lot of growth. We see a lot of growth on our VCS business, which I mentioned is tied in with downsize and hybrid engines. We see that -- a lot of growth in the Asian marketplace for that as also as well as the European side to that product set as well. So about $1.5 billion. And as you kind of work through time, you win some awards, some fall off, new ones come in. And we continue to see that sort of continual pool come back at us, at least the opportunities to kind of quote on a go-forward basis. So maybe we should go back to that 3-in-1 question you want to get back to? Yes. No, that's some pretty cool stuff, by the way. So just to calibrate, so for example, our I-PACE that we have out in the field in many other vehicles, you'll hear there's a 2-in-1. So you have basically a transmission, a motor and the inverter technology. The inverter is sort of separate. So you've got the 2 components and the inverter separate. But the 3-in-1 will bring all 3 together. I believe some of the -- I think Tesla and others use a 3-in-1 technology today, but looking to continue to expand that. So we announced our technology with Inovance to bring to market a new 3-in-1 technology. At the same time, we're working on even some other 3-in-1 technologies advanced beyond that more in-house as well. But what's the difference? So you've got to think smaller, think less expensive, think much more power and more efficient. And the efficiency is very critical, because that is what drives battery life, so you can certainly understand why an OEM would be very interested in that. More power, obviously, you can price for power, but you can also use smaller scale, which creates more room inside the vehicle. And obviously, less expensive is, you know what the OEMs are looking for. They're always looking for good price, good value and a good technology proposition. So we're really pushing on that 3-in-1. We're excited to have that one out working with Inovance as well as some other internal applications we're doing with that. But we're starting to see interest in that, not only in traditional sets, but in some of these other type of, we call it, mobility applications where this 3-in-1 technology we're working on applies.

Awesome. Because you mentioned, I guess, out of the $1.5 billion quoting, maybe half of this on the EV side and the other half is more traditional. Kind of how is that split when we think about your R&D spending or at least maybe the incremental R&D spending? I think maybe you talked about $15 million-or-so incremental this year. Yes, just curious what the split looks like there between EV and traditional.

Yes. Great question, Itay. From an R&D spend perspective, we spend today, so meaning, call it 2020, 2021 timeframe today, about 30% to 40% of our R&D dollars are more on the electrification space. And as you probably would surmise, that has increased over the past several years. At the same time, we're expecting that to increase proportionately higher. We will invest some additional dollars into R&D. But I think equally and maybe even more important, we are converting from traditional ICE component support or advanced technologies and redeploying those dollars and resources to support electrification. So we think we're in a pretty good spot from the amounts we're investing into this side of the business to allow us to grow and develop next products in a very cost-effective way. We don't feel we're short changing this. Will there be spikes where we'll maybe invest a little bit more as some opportunities present themselves? Yes, and that's okay, right? That creates good future growth for us. But in the meantime, we think we're doing this in a very effective manner to give us the right products where we need them to be, but also managing our costs appropriately.

Excellent. Maybe switching gears to some financial questions. And one that we got in is, can you maybe talk about the impact to the company if we end up seeing more steel inflation? Maybe just an update on the contracts and the impact there.

Yes, for steel, so typically, as it relates to commodities, you have a couple elements to that. You sort of have an indices-related driver of that with our contracts, for example, in SBQ steel that we buy would be one, aluminum would be another, obviously, with a lot of our light-weighting has a lot of aluminum content. And then you sort of have base price increasing, and you see that in some of the sets. So to talk about the base price increase, this is typically one we manage ourselves, right? We have long-term supply contracts. We've got large buys. We have scale. We can kind of leverage and mitigate that particular type of inflation in a reasonable manner. From a commodity standpoint, we typically would have arrangements with our supply base that those prices change monthly or quarterly. At the same time, we have, for lack of a better word, back-to-back relationship with our customer, where we've kind of passed either a price increase or decrease on. And about -- and there's probably about a 90% ratio there. So any -- 90% of the costs we get, we pass on up to our customers. Obviously, you carry a little residual. Any price decreases, the same phenomenon. We've seen pricing come up over the last, call it, a quarter or 2, but those prices do reset every 30 days and can go either direction. But we believe from a commercial mitigation standpoint, we think we're generally protected from that. But in a rising environment, we'll feel a little bit of a pinch on it, but a little bit versus what the real exposure is that we have protected.