Dauch Corporation (DCH) Earnings Call Transcript & Summary

All right. Hello, everybody, and thank you so much for joining us for this session with American Axle as part of Deutsche Bank's Global Automotive Conference. My name is Emmanuel Rosner, and I'm the senior U.S. autos and technology analyst at Deutsche Bank. American Axle is the leading supplier of driveline, metal forming, powertrain and casting technologies for the automotive, commercial and industrial markets. American Axle has also been ramping up its electric powertrain business with several initial production contracts and a few partnerships. And so to discuss with us latest updates, both for the company, for the industry, as well as the mid and longer-term outlook, I'm very pleased to be joined this morning by David Dauch, who's Chairman and CEO; and Chris May, who's Vice President and CFO of the company. Thank you so much for being with us. The format for today will be a fireside chat around some of my prepared questions but also questions from all of you on the call. If you have any question, just type them on the left side of -- in the box, the left side of your screen, and I will try and weave them into the conversation.

So with that, thank you so much for being with us. And I think, David, would you like to share some -- a few additional thoughts on what you're seeing out there?

Sure. Thank you. [Technical Difficulty]

All right. Truly apologize to everyone for this technical difficulty and to American Axle first and to all the investors on the line. So thanks all for sticking with us. Apologies about all this. And I guess to start where we left it, David, can you share with us a few thoughts on what you're seeing out there?

Yes. Sure, Emmanuel. Thank you. And before we begin our presentation, I'll just refer the investors to our forward-looking statements and our presentation deck on aam.com. But guys, listen, we started off the year extremely strong, outstanding performance in the first quarter with strong sales, strong EBITDA performance, actually a record quarter for us in the first quarter and generate a significant amount of cash in an uncertain environment. So very pleased with my management team and the performance that we demonstrated in the first quarter. Clearly, the second quarter, there's a lot of uncertainty in the second quarter just because of the semiconductor issue. Our schedules have softened somewhat on the -- especially on the crossover vehicle side of our business, but our truck volumes continue to be very strong. As we've committed all along, we're going to continue to strengthen our balance sheet and pay down debt. We've demonstrated that the last several quarters here while continuing to maintain a very strong liquidity position of over $1.5 billion. So very pleased with that. Our core business, as I indicated, is performing very well. We expect continued strong free cash flow generation as we go forward through the balance of the year here. At the same time, as Emmanuel alluded, we've announced a number of partnerships with REE Automotive in regards to mobility and working with them on flat chassis platform type solutions or otherwise type -- skateboard activity. We also were selected by GM to be the sole supplier of axles for both the light duty and heavy duty at the Oshawa facility. So that's going to be incremental volume and growth for us as a company going forward. And then we continue to fund our electrification initiatives with our Gen IV and Gen V technology. Gen I and Gen III -- to Gen III are already in production. Gen IV and Gen V, we continue to develop but receiving very favorable comments from our customers with respect to the technology that we're demonstrating to them. We also received a grant from the Department of Energy for $5 million because they like what they saw in regards to our technology and, again, their support of this advanced technology as the Biden administration and others are looking to strengthen electrification across the U.S. At the same time, we are obviously very focused, like everybody else, in regards to ESG and DEI activity within the overall company. And we're going to do that. That's a process, and we'll continue to focus on what we need to do there. But again, we've got a very experienced management team. We've demonstrated our ability to navigate during uncertain times while delivering solid results. We're highly confident in our core business going forward, at the same time, investing greatly and expect to win our fair share of the business on electrification going forward. So Emmanuel, with that, I'll turn it back to you to start the fireside chat and Q&A session. But thanks for the opening comments.

Awesome. Yes. Thanks a lot for the overview. So let's just -- let's focus first on the near term, and then I was hoping to turn back to -- spend a little more time on your electrification efforts. First, for the near term. So GM yesterday raised their first half outlook in a very material way, due in part to an increased sourcing of chips, but also what they view this higher sales in May and June. Considering some of this was certainly used to complete partially built vehicles, but it seemed like there was quite a bit more than that, what sort of impact can this have on your outlook?

Well, first of all, we're excited to the fact that GM is addressing and pulling ahead some of the semiconductor issues here into the second quarter. That's positive. As they indicated yesterday, they've got a number of vehicles that are built off-line without chips, that they need to finish those vehicles and get them to the dealership. So that's a positive. To put it in context, GM generates a little over 100,000 units a month with respect to the T1XX application. So these chips will have and obviously an increase to that, but it won't have a material impact with respect to our overall business there. But as I said all along, we expected the second quarter to be a challenging quarter because of the uncertainty of the semiconductor issue, and the semiconductor issue would hit its trough in the second quarter. That's exactly what's happened across multiple customers. We certainly do expect the semiconductor issue to get better in the second half of the year. But as I also indicated in our earnings call -- our last earnings call that we expect the semiconductor issue will carry into the 2022 calendar year period of time. Our schedules on our truck platforms continue to be very strong, as fast as we can build them and as fast as the customers can build them. The consumers are buying them, which is a great problem for all of us to have. It is going to take a significant amount of time for GM and other customers to replenish their inventory levels, which are at record lows at this point in time. But we have had some challenges as far as some inefficiencies in our business in the second quarter. But like everybody else, we're navigating our way through that right now, and we expect to get stronger as the year progresses.

Okay. Great. And I guess in the first quarter, your EBITDA margin was strong at 18.4%. But then at the time you had left your full year guidance, pretty unchanged, 16% to 16.8%. What were the primary drivers of lower margin expected over the year?

Yes. Emmanuel, this is Chris. Look, as you know, we started the year very, very strong for the company. Obviously, very pleased with that performance. And as we think about the balance of the year, right, certainly, some of the challenges in the second quarter that David mentioned, we contemplated as part of our guidance, a little bit more probably choppy than initial thought, but still we'll work our way through here in the second quarter. But really post that, obviously, from a margin perspective, we benefited in the first quarter from some of those austerity measures that we still had in place from COVID that will start to unwind through the course of the year. That's a component of it. Some of the timing of our customer pricing, a little underweight first quarter versus the balance of the year, again, based on our initial guide coming into the year. And then R&D, I would expect to increase a little bit through the year. And then probably one of the more impactful from a margin perspective is metal market. And as you know, we have metal market pass-through mechanisms designed to protect the company. And as metal is going up, we pass those along to the customer. Those impact "on margin" protect the company from a dollar perspective. So we do retain some of that when metal goes up. So that will really impact margins as well but not necessarily as much on dollars. So we will have some negative impact with dollars in a widening environment just based on the nature of those mechanisms. So hopefully, that sort of frames a little bit how we anticipate the year to play out for us versus our first quarter performance.

Yes. Very much. And can you just quantify some of these factors, the returning austerity measures through the remainder of the year and then the R&D investment needs?

Yes. Certainly. If you think about some of the austerity measures that we put in place really started over a year ago, several of our offices were closed. Obviously, travel curtailed. Spending and kind of, I would call it, ancillary type of spending. Think of it as a couple of million dollars a quarter, we'll start to kind of come back online through the course of the year. That's how we think about it. Obviously, we're taking the learnings from kind of pre COVID, post COVID and being able to still optimize the cost structure, but some of it will come back, not as much as we had pre COVID. So we think that is very much from a positive perspective. As we think about R&D, we have historically, meaning over the last year or so, talked about $35 million to $40 million a quarter range. We were a little under that in the past couple of quarters. And as we continue to push and advance our e-Drive units, our next drive units, you'll have some kind of timing within different quarters where you'll see that kind of creep up a little higher and higher and then down a little bit, depending on either customer reimbursements or just timing of that activity. That's how I would think about our R&D spend in the course of the year and then subsequently into next year.

Great. Very clear. So let's maybe switch to your electrification efforts. There appears to be much more aggressive efforts by OEMs to launch BEV trucks and pickups in the next few years. And as soon as possible, really, what kind of content opportunity are you seeing and quoting on these programs?

Well, first and foremost, you've seen General Motors announce their electric pickup program, first starting with the Hummer program, but then also what they're going to be doing on their traditional pickup programs. Ford just recently came out with the Lightning program. Most of those products are going to be developed internally by those OEMs at this point in time. However, we're in discussion with both those customers and other customers regarding the pickup market. It's going to continue to evolve as far as the electrification market itself. We're highly confident in the technology that we have there, and it's demonstrated in vehicles to those customers and have received positive excitement from all the Detroit 3 as well as other customers around the world. When it comes to content per vehicle, when you get into EDUs or even beam axles, you're talking $2,500 plus of content, consider a full-size truck ICE engine today. Average CPV is about $1,600. So we see content enhancement opportunities. And if the OEMs decide to in-source some of this work or make some of it themselves, we do see components, subassembly opportunities that could be in the range of $500 plus. So either way, we see an opportunity to be successful and participate in the electrification business going forward. Clearly, we'd like to do more on the EDU and the electric beam axles themselves, and we're in good discussions with our customers with respect to that right now.

Okay. And I think you addressed some of this now, but how do you think about the CPV of individual components versus a full e-axle drive?

Yes. As I indicated, I mean, we've tried to approach the market 4 different ways. One, in the component standpoint, so think gears and think shafts. On subassemblies, think differential assemblies that go into the housings and then also from a gear box standpoint. And we have business booked in all 3 of those areas. But the main area that we're trying to ultimately attack the market is through supplying the full integrated unit, whether it's an EDU or an electric beam axle is really the objective that we're after. The content per vehicle, obviously, much greater for us on an e-beam axle and an EDU than it is on the component state, but it ranges in that -- it operates in that range that I just covered with you in that $500 from a component standpoint up to the $2,500 plus, depending on the vehicle and the axle configurations.

And some of the nice thing about the component side of the house, Emmanuel, is that $500, first of all, is a meaningful content on a vehicle, but it's also pushing us into other vehicle segments. Some of this componentry is starting to surface in front-wheel drive applications. We're seeing some commercial vehicle applications in that space. So really giving us an opportunity to grow a little bit of our served market through the component side and, of course, hopefully, more even on the EDU side as well.

Yes. The biggest challenge for us, Emmanuel -- and I shouldn't say challenge -- it's an opportunity for us is to demonstrate and offer a value proposition to our customers for our fully integrated electric drive units and e-beam axles. And the OEMs are developing some of their own technology. That's evident and clear. We're not fighting that at all. Our job is to give them a value proposition that they can't refuse. And either way, the OEM wins by either doing it themselves or benefiting from advanced technology or avoiding some CapEx that they would have to outlay, that we could outlay or our competitors could outlay, depending on the sourcing selection going forward. But again, we feel very good about the technology already in the marketplace. We feel even better about the technology that we're developing right now to bring to the marketplace going forward. And again, the OEMs have to make some decisions in regards to when they're going to be bringing these vehicles to the marketplace, but we're highly confident that we'll win our fair share of the business on the electrified truck side and passenger car and crossover vehicle.

Okay. And then one quick follow-up on this again. Are you seeing different dynamics in terms of powertrain in-sourcing on the EV side as you have on the combustion engine side? As one of your larger competitors said at our conference yesterday, I mean, a very decent portion of traditional axles today are being made already in housed by automakers. So are you seeing different dynamics as you move into EV? And I guess if that is the case, how do you offer the value proposition on the EV side?

Yes. No. Our competitors are accurate in regards to their statement. There's a number of axles that are made in-house by some of the OEMs today. At the same time, there's a significant amount that we all enjoy from the supply base today, and we're grateful for that. I don't see anything different, quite honestly, as it relates to transition your pivoting to the electrification space. I do feel that the OEMs need to understand what it takes to build an electric vehicle. I mean engines are going away. Transmissions are going away. You still have to deliver the power to the wheels to move the vehicle. That power is now coming from a battery configuration versus an engine and transmission combination but still has to go through the axle or the EDU out to the wheels to power the vehicle. Again, we're very confident in regards to our technology. We've demonstrated that technology and received very favorable comments from every customer that we've demonstrated to. It's not just a PowerPoint presentation. We've actually got hardware and actually have it in demonstrable vehicles as well. So they can see it. It doesn't mean that it's fully developed. It's -- but it's very advanced, and we've got more work to do in order to prepare to bring it to market. But as I indicated earlier, good excitement from our customers, at the same time, highly confident we'll win our fair share of the business.

And how important is it to have come and seen every single one of the components that go into it, including the motors and the power electronics? I guess in -- for those automakers looking to outsource either the full system or pieces of it, is there a competitive advantage from doing everything in-house versus working with some partners?

Well, clearly, we enjoy the vertical integration that we have today in regards to our ICE and hybrid business. We like to be in a more heavily vertically integrated going forward as well. Our strength has clearly been on the mechanical side that support ICE and hybrid today, but we do have a significant amount of software and controls engineer and are continuing to invest in that. We're also strengthening our motor and inverter capability in-house, but we've also supplemented it with partnerships on the outside. And one of those important partnerships is within advanced automotive, a Chinese-based company that's the leading producer of both motors and inverters in the China market from an independent supplier standpoint. And we've got a very good and powerful relationship with them. We're growing our business with them in China. At the same time, they're helping us advance our development of our Gen IV and Gen V product. At the same time, we're developing, as I said, quite a bit of experience ourselves. We've also partnered with another European engineering firm offer that's helping us in regards to software and controls and engineering to be compliant with the different axle applications that are out there. But again, everything that we're doing with our partners is to advance and to bring to market quicker our electrification capabilities. We do not need an acquisition in order to win and compete in the marketplace today between ourselves and our partners. We're highly confident that we can grow our business going forward. But as we've historically done, we'll look to bring more and more of that capability in house as we go forward and as the market grows.

Okay. And then can you tell us a little bit more about your partnership with REE? We actually had REE CEO present yesterday, definitely interesting -- very interesting company and technology. So how does the partnership work? What content are you providing? And how has the customer interest been since your announcement?

Yes. We've got an outstanding relationship with REE Automotive and Daniel, their CEO, specifically. I couldn't ask for a better relationship. And it's obviously in its infancy, but it's growing. They're clearly a leader in regards to some e-mobility solutions, especially when it comes to the flat chassis type systems or the skateboard platforms that have been developed. They had some challenges in regards to their corner applications. They want to have a more -- they wanted to have variability and optionality within the corners. Our technology that we've developed with our gen 5 technology of EDUs and wheel motors allows them to get the optimal design that they're looking for there. So we brought a technology solution to a challenge and a problem that they have. At the same time, they've got some great e-mobility solutions for the marketplace that will allow us to expand some of our served markets that we're working with. We're working with them on a number of different programs right now. And ultimately, we see ourselves growing with them as they grow. The content per vehicle can be very sizable for us because this technology requires either 2-wheel motors or 4-wheel motors, depending on the application that they're selling to their customers. But again, that could bring $1,200 per wheel minimum or higher, going forward. So you can do the math in regards to the content per vehicle that could be associated with us. So we're very pleased with the relationship, look forward to the growth. They've already got some major OEMs booked, and they're working on other OEMs as they go forward, and we expect to not only be their partner short term, but also long term. As they grow their business, we expect to be able to profitably grow our business with them.

And in terms of end markets, so your technology would be used for which one on the...

It can be used in the light vehicle market but can also be used in the commercial vehicle market. So that's why we're excited about it. It'll open up some new market opportunities for us that we typically have not serviced in the past.

Great. And I guess more broadly, what's your view of the commercial truck EV opportunity for American Axle?

Well, our main focus is still on the light vehicle side of things. However, we do feel that through the REE relationship and from a component supply standpoint that there's growth opportunities there. Clearly, with the technology that we're developing, we're demonstrating that first for the light vehicle segment, but there's no reason that it couldn't be expanded into the commercial vehicle segment. I mean we're in the commercial vehicle business today from a traditional standpoint. We would just need to modify those beam axle applications and integrate the latest technology that we're developing. So we see an opportunity there. But right now, our concentration is really on the light vehicle side initially.

And so EV solutions is 15% of your $600 million backlog of new business between 2021 and '23. Where could this ratio be down the line? Do you have any specific targets there?

I only expect it to grow. I mean, quite honestly, most of the OEMs right now are really looking to carry over a lot of their programs, maybe some horsepower and torque increases over the next decade on their traditional products. So we'll obviously be prepared to support that going forward, and we're working with all of those customers to secure that next-generation business, which will bode very well for our company because it'll allow us to have and maintain very strong cash flow, allow us to service our balance sheet while at the same time continue to invest in electrification and generate that strong cash that we're generating today but only expect to get stronger going forward. But we feel very good about where we are and the opportunities that it brings to us at this point in time.

Great. And maybe one quick follow-up on the backlog and sort of the growth profile. So your total gross backlog of $600 million over that 3-year period could be largely offset by normal business attrition and price downs. Do you see an opportunity to accelerate your midterm growth profile? What would that require? And would there be any margin implications?

Yes. I mean, Chris, I'll answer first, and you can make some comments. But Emmanuel, as I said, I mean, the most important thing for us right now is to secure our top line going forward over the next decade. We're working with all of our customers to do that. We've already announced the next-generation of RAM businesses secured through the 2030 plus period of time. There's other announcements that will be forthcoming. Just not at the appropriate time right now. So we're very excited about the various customers that we're working with in regards to securing that book business. We fully expect to grow with electrification as those opportunities present themselves. Again, in the driveline space, most of the things that we're working on is in that 2024 plus period of time. Most of the things that we're launching today in 2021 through 2023 have already been booked or in our backlog today and are contemplated within our CapEx plan. So that's all positive for us on that side of things. But we fully expect to grow our electrification business. We see tremendous opportunity in regards to the excitement that we're seeing from our customers. It's just a matter of understanding where they -- you want to go with that. Now in the short term, we've just secured the Oshawa incremental volume with General Motors. I expect that volume or that plant will run maximum value in that facility. That will benefit us here in the fourth quarter of this year but especially a full year of 2022 and beyond. With where inventory levels are right now, we expect our schedules to be very strong going forward. We see some upside potential associated with that, hopefully, both from a revenue and a margin standpoint. And right now, we're working at the low end of that attrition, more around that $100 million level. But over time, we do have some business that will be rolling off in that '23, '24 period of time. But we're -- again, we're very confident in regards to our top line. We see a growing bottom line, see very strong cash flow generation. We just have to work through this a couple of quarters of uncertainty right now because of the supply issues, especially driven because of semiconductor, but don't forget the steel issues, the winter storm issues is still having a ripple effect in the supply chain, and you still got port and container shortages in the marketplace compounded with all the COVID and labor shortages that are out there. But we've navigated our way through it in the past. We'll continue to navigate our way through it going forward, but we are very optimistic about what the future holds for us quarter-to-quarter and year-to-year going forward.

And Emmanuel, part of your question was related to the margin profile and whether it's near term, midterm, long-term business, right? We have internal hurdle rates. We have expectations on margins, and we continue to aspire and drive towards being a top end margin performer on all the new business we get regardless if it's near, mid or long term.

And so I guess following up on this, the -- what would you say is right normalized margin profile on the midterm basis? Obviously, you're operating at very high levels currently, which is great, and all the positives that are -- that you just mentioned. There's some EV investments that are required. And obviously, some of these EV programs could take some time to ramp up. I guess what would you say is the right margin target for your evolving business?

Yes. We've not provided any margin profile information post the current year, but what I would tell you as we think about this, right, we will require investments to continue to grow our e-business through R&D, like I spoke about. And we certainly wouldn't be shy about that, especially if we see long-term very positive returns on that. But being a top end margin performer as a company continues to be our focus. We're focused on restructuring our fixed cost footprint, which you've seen us take a lot of action over the last 12 months, optimizing the core of our business from just a core day in, day out, aligning capacity, capability, ultimately, throughput to continue to remain at the top end from a margin performer in the industry, and that continues to be our goal.

Great. And I'll just maybe squeeze one more since we, obviously, had some technical issues at the beginning. Curious on the M&A front. Are you looking for acquisitions, in particular, to boost your EV capability? And then on the other hand, are there any additional divestiture you're considering to refocus the business?

Yes. Emmanuel, I'll first start with the capital structure. I mean, first and foremost, I mean, when it looks at capital allocation, we're going to stay focused in regards to paying down our debt and working towards that 2x levered or below. That's priority #1 for us. Priority #2 is to continue to service the backlog of new business. We expect -- which we expect to only grow going forward. And then the third part would be the strategic side of things. I mean we are being opportunistic about tuck-in acquisitions as far as small things that we can manage within our capital structure, and we've just done a couple of those here recently, which will help us on that short-term sales and profit opportunity from a midterm -- short, midterm standpoint. From a long-term standpoint, we don't really feel like we need a large acquisition at this point in time in regards to the motors and the inverters with the technology that we're developing, the partnerships that we have. If the right opportunity presents itself, then certainly, we'll look at that. And -- but we do not need it in order to be successful in the electrification space. And on the divestiture side, we divested probably the largest thing that we were going to divest, that being our casting business. There may be some small product lines or some small pieces of the business that we may look at in the future, but nothing that's material in nature. So we think with what we have today, we'll continue to refine and optimize that business, while at the same time, as Chris indicated, I indicated, that we'll continue to make strategic investments in electrification with the hopes of growing our backlog there.

Great. They're a great place to conclude. So David and Chris, I truly appreciate your time and insights today. Great overview. I appreciate the discussion. I apologize again to both you and the listeners, investors, on the line for the technical issue at the beginning, which shortened our session a little bit. But hopefully, we made up for some of it after that. So again, thank you so much, and have a great day.

Thank you, Emmanuel. Yes, Thank you.

Thank you, Emmanuel. Thank you for your time.

Yes. Great being with you.

Thank you, everyone.

Thank you all.

Thank you.

Bye-bye.