Dauch Corporation (DCH) Earnings Call Transcript & Summary

Good afternoon, and welcome back to the closing afternoon of the Global Automotive and Mobility Tech Conference. Very pleased to have with us in this slot, American Axle, represented by David Dauch, Chairman and CEO; and Chris May, VP and CFO.

I've covered a lot with the other suppliers and OEMs about the chip shortage, I'll kind of just get -- we don't have to kind of rehash. A lot of us know what's going on. But just kind of from an Axle perspective, what are you seeing in kind of 4Q versus 3 quarters, both about the volumes and as well as the choppiness of the schedules and ability to kind of manage your cost and staffing in line with what the OEMs are actually taking delivery of.

Well, thanks for hosting us here, Brian. Very pleased to be with everyone here today. Clearly, we thought the second quarter will be the trough of the semiconductor issue. That clearly moved into the third quarter. There's a lot of uncertainty in the marketplace as it relates to the volatility of schedules. Although we do see more stability now as we're going into the fourth quarter, and we think that we'll see sequential improvements quarter-over-quarter going forward here. The COVID rash that ramped through Southeast Asia is now behind us, at least for now. At the same time, OEMs are securing supply of semiconductors going forward. Clearly, we've made the necessary adjustments to our business to manage effectively during the period of time. I'm very proud of my team in regards to what we accomplished with respect to our third quarter results. We are seeing the OEMs give us more visibility. They are communicating that they have secured supply, and we're also seeing assembly plants being brought back upwards are all positive signs for the industry. I mean there's still concerns that are out there in the marketplace just in regards to the volatility of the supply base in general because it's extended. Plus the things that we're dealing with in regards to port delays and shipping container issues and freight increases and labor availability, not to mention the raw material issues that are out there in the marketplace as well. So a lot of balls in the air right now, but I think the AAM team is doing an outstanding job, managing it through the third quarter. We expect to have a strong performance in the balance of the year.

And beyond ships, are there any other parts of the supply chain where you're not worried about inflation, we'll get to that, but worried about actual shortages of required components?

It's not so much a component issue as much, Brian, as it is, I think, labor availability and how labor availability impacts continuity of supply from the tiered supply base going forward here. I mean, I'm confident in the OEM's ability. I'm confident in our ability as well as some of the other key Tier 1s. What I'm less confident about is just the fertility of the extended supply chain and the ability of the tiers to maintain continuity of supply because of labor availability issues or other pressures that are on their business.

Well, let's kind of drill down into that because it gets to a bigger picture question that I've been asking suppliers, which is, if you kind of think about just the whole Tier 1 OEM relationship, it's basically been structured with -- in a largely deflationary environment with contracts that typically call from 1% to 4% productivity price downs per year, which in an era when with specific indexing for volatile identifiable inputs like steel, SBQ, call it rollouts in the past. But if you kind of think of an environment where labor costs go up, energy costs go up, I can only imagine what it costs to run some of your metal bending, the forging and casting equipment, especially in Europe. A lot of costs that kind of flow through your cost of goods sold are not indexed in your OEM agreement. So where do you see that going in terms of being able to pass on inflation broader than just the mechanical pass-throughs?

There's no doubt in my mind that we're going to have to pass on some of the inflationary costs that are being experienced in the marketplace. We're all seeing the OEMs report record transaction prices and record profits. At the same time, there's significant inflation across the board in raw materials and labor and other types of things. And obviously, we're going to do our part as a leading Tier 1 automotive supplier to optimize our business, manage what we can control, curtail those costs as best as we possibly can, but there's no doubt in my mind that we're going to have to pass some of these costs out. And like you said, some of our agreements protect us already in regards to indices and middle market agreements, but we're now seeing much more from a base price increase on a number of the commodities as well as all the other wage inflation issues that are taking place that we discussed earlier.

So with that, how should we think about not just the net commodity impact in '22, but the net inflation impact? How much of a gross headwind could it be overall? And then how could recoveries, both contractual and discussion-based evolve?

Brian, this is Chris. Maybe I'll take that one. So if you think about -- if you think about our cost structure from a cost of goods sold perspective. About 60% of our cost of goods sold is purchase components, and that's really been broken into 2 elements of how we face off to inflation. One is that commodity element of pass-through mechanisms, and you saw this year, that element was -- is going to be about $300 million alone that we're passing through by the end of this year. So you can see it's sizable. Other elements associated with that, we've been -- we've done a really good job this year of mitigating any of that inflationary impact through our longer-term contracts as well as commercial negotiations that David alluded to. We are facing inflation on the balance of that procurement buy. And we'll look to pack some of that on to the customer. We'll look to mitigate some of that through negotiation of productivity, but this is a very real issue for us as well as the rest of the supply base. If you think about the rest of our cost of goods sold, 8% to 10% is about depreciation and amortization. So that's pretty much fixed, and the balance is sort of split between labor and then all other overhead, tooling costs, cooling and things of that nature. So to the extent we have any labor inflation, obviously, it will flow into that pool of cost. We would look first to mitigate that with productivity. Same with some of the other elements inside of that cost structure and on cost of goods sold perspective. So it's very real. We're facing this issue and looking to deal with it from a manner, but I would expect we will have it. At the end of the day, we'll [ agree for ] some level of that inflation.

Okay. Let's go on to kind of the axle strategy, and we just had Mark Reuss prior to lunch around this. So before we get to GM's electrification strategy, just maybe kind of update us on the current business, in particular, the upside from GM Oshawa. Just to confirm, because that pickup truck, I think is that -- that's 100 -- is Axle the sole supplier what's going to be going through GM Oshawa? And then how do we think about additional production, not just off of the depressed '19, '20 levels, but kind of versus the kind of old run rate for T1 that Oshawa provides.

Yes. Just to start, yes, we are the sole supplier for the Oshawa production, and we made that in our announcement here a short while ago early in the year. So we're obviously very pleased with that announcement. At the end of the day, we would expect the demand for full-size truck for General Motors to be robust from a consumer standpoint, but also from General Motors themselves as they're looking to not only meet consumer demand, but also replenish inventories. As you know, our content per vehicle on average across the whole fleet of their full-size truck applications, SUVs, heavy duty, light duty is about $1,500 to $1,600. So that's a nice meaningful content for us in terms of our application and product we supply to them, and we would reap the benefit of any volume uplift. We've not provided any '22 specific volume guidance associated with that platform at this point, but we would expect demand holistically to be stronger.

And should we think about MPV and incrementals kind of similar to the rest of your T1 business on that?

Yes. Yes, absolutely.

Okay. And kind of moving into electrification. GM has confirmed that it will be announcing a Silverado BEV at CES in early January. And can we expect any Axle content on that truck? And if so, or on LTM in general, how it compared to an ICE truck?

Brian, this is David. Clearly, we can't comment on any of the customer announcements, whether it be GM or anybody else at this time, only when we get the appropriate authorization. But we're proud to have just recently announced that we're going to be supplying the differentials for the GMC Hummer EV. We expect to grow our relationship with General Motors in regards to electrification going forward, knowing that they're still going to be making some of these products themselves in-house. They've got to decide how much they want to do themselves in house versus how much they want the supply base to do on the outside, much like they do in their conventional product today. Obviously, we're doing a majority of that for them on the truck side of the business. We've got an inherent knowledge on the truck side. At the same time, we've got product offerings in the marketplace today. We've got other advanced developments that are being demonstrated in vehicles for the customers, whether it be GM or others. And there's a strong interest there because of the value proposition that we can offer, but also the advancements that we're bringing to them from an innovation and technology standpoint with performance attributes that [ our exchange ] and some of the other product offerings that they've seen in the marketplace. Clearly, all the OEMs have their goals and that's still evolving as it relates to what their individual strategies are from an OEM standpoint. What we're just trying to do is, make sure that we're listening to the market. We're listening to our customers, developing a product portfolio no different than what we've done on the conventional side to satisfy that market going forward and really position ourselves to be agnostic to the market, but make sure that we can quote and compete and win new business. We're quoting out of over $1.5 billion of total new and incremental business, of which about 70% of that business opportunity is electrification related. And we're highly confident that we'll win our fair share of the business no different than what we've done on the conventional side up to this point in time.

Great. So let's drill down into some of those. Since you brought up -- of course you can't talk about the GMC Hummer EV, you talk -- for the actual, the non-automotive engineers and [ non-directorated ] specialists and the viewing public, what does the locking part differential do? And why is it important for an operated-capable SUV?

The locking differential essentially is helping to distribute torque and power to the appropriate wheel, and the open differential situation is going to go to the path of least resistance, locking differential. It will lock up the front 2 wheels and push the torque or the power to the wheel that's desired or push it equally to both of the wheels to provide traction and performance, especially for off-road type vehicles, of which the Hummer is going to have that capability and that much more with some of the crab walk or some of the other offerings that it have. So again, it's an innovative product that we developed. It was very well received by GM in regards to our product offering there, and we're just again proud to be part of that first big electric vehicle from a pickup to truck standpoint with General Motors. And like I said, we're hoping that we can continue to grow and foster that relationship.

And any idea -- tell us anything about the rough CPB that you can expect on that kind of product?

Yes. Typically, we would say, on the component side of our business up to $500 and the maximum, the $500 would be really just supplying the gearbox itself. These are differentials, so they're more subassembly type things. So they're going to be at the lower end of that range, but it's still well within the component range of what we've identified. And that's where we have a very unique capability at American Axle to supply components either in the gear and the shaft state. We can supply sub-assemblies in the differential state gearboxes and then also the full EDUs and e-beams, which is obviously we like more the latter that we use e-beams as the content per vehicle. At the same time, because of the uniqueness and the capability of our company, we're able to supply all 4 of those different models that I just outlined for you.

And just to kind of drill in on that before we get to EDUs because we -- you and I have talked about that a lot. But if we think of the components business and think about the Metaldyne footprint in terms of they didn't really make engines or transmissions. They made very value-added components that go into there or at least the semifinished parts of those. You mentioned, Chris, today, that, that the kind of backlog related to electrification. So can you give us some flavor to what extent either legacy AAM or legacy Metaldyne facilities can be quoted, are involved with quoting and are winning business on the type of metal work they do that goes into an EV, even if it's not the full electric drive unit or other purely electric parts.

Yes. Just looking at some of the Metaldyne portfolio, I mean, obviously, they had a number of engine components, [ thin ] connecting rods. That business over time will go down. There's no doubt about it, but we're the largest supplier of powdered metal connecting rods in the marketplace. We've consolidated that market, and we still think that there'll be strong volume for a period of time, and obviously, we'll have to rationalize or convert some of those facilities in the future. Powdered metal, we -- there's a significant amount of core powdered metal parts that are supplied. A lot of those parts will continue on whether it's in a conventional product or in the BEV application. We're actually looking at some innovation elements on the powdered metal side from a gearing standpoint that could be very attractive to the OEMs going forward. The vibration control system of Metaldyne, that is more for downsized engines, 3 cylinder 4 cylinder type engines. We're seeing some big runs in regards to that at this point in time, especially in Europe, as they're transitioning to a whole BEV environment. So there's a good runway for the next 5 to 10 years regarding those products, and then if then we'll convert some of those facilities in the future. And then on the forging side, I mean that was really the big intent of bringing the 2 companies together was consolidated in the metal forming business. There's still going to be a need for steel forgings and powdered metal fortunes in the future for BEV vehicles, no different than there are for conventional vehicles today. Some of the products will be different, but we've got the installed to pass in the technology and innovation to be able to support that. So we feel very, very good about where we are from a component standpoint, supporting the conventional side as well as pivoting the organization to support the future needs on components and subassemblies and electrification that way. On the driveline side, obviously, we're working very hard to secure our core business today, both from a conventional standpoint because I do think there's a longer runway for trucks and SUVs than maybe luxury passenger cars and small passenger cars just because of the technology offerings today. There's no doubt there's going to be an offering for each vehicle segment. It's just the adoption rate that will take place in the marketplace. The OEMs need the cash generation of the current trucks today to help fund a lot of their electrification efforts, but at the same time, they're clearly identifying and putting it in a position offerings for the different segments, as I mentioned to you. And again, we are highly confident in our conventional portfolio today. It's well routed. We've optimized what we need to do there. You can see we're still performing at industry-leading type margins even under an uncertain and difficult environment today, and we're really taking a lot of cash that we're generating for the business. One, paying down debt, which we've been very disciplined, and you can see the progress that we've made over the last several years, especially the last several quarters, even during a difficult time. We're also investing in electrification to expand that portfolio, and again, bring forward that innovative technology and that value proposition that is our responsibility to offer to our customers. And the big thing that we just need to do is continue to grow our backlog in the business, and we've got a lot of business already in production. We've got more launches of electric vehicles late this year and early next year and over the next several years. And we're working on securing a lot of new business in 2024 and beyond as we go forward. But we feel very good, Brian, about the ability to pivot our business. The big thing that we just really need to understand is to get a little bit more clarity from our customers in regards to what they're going to do versus what they want the supply base to do, but we're an engineering and manufacturing company that can adjust with the times and the marketplace and pivot the business we need to other products. And we're doing that to support what needs to be done on electrification.

And just at the [ being ] real for the investors, are there any kind of components you can talk about publicly in terms of there are on this EV, you had a piece of equipment, whether it's a forge or a casting or a middle finishing that used to do X and now -- for IC and now it's doing Y?

Yes. I mean there's forge presses today that are making products for both conventional and electrification. It doesn't -- they don't really care what product they're making. They -- we just need a certain tonnage that forms and shapes the product into size whether it's needed for the conventional axle or for electric axle going forward. So that's a prime example of that. Our gear cutting machines and our component machinery, that's all flexible equipment. Probably, the biggest place that we'll need to make investment will be in some of the assembly lines. Many of the stations can be reused, but some of the assembly lines are unique to the products that we're manufacturing, but we've tried to make them as flexible as we possibly can. And then as we switch more towards and away from a more high point range -- [ opinion ] configuration for traditional product over towards more of a helical gear application for our electrification product, we'll probably need to make some more investments in that area as well. But we're doing some innovative things from a forging standpoint there that will hopefully allow us to avoid a lot of CapEx going forward.

Okay. So let's now talk about the more visible or controversial part of the strategy around the electric drive units. There are a lot of Tier 1s working on it. We've had Borg earlier today, Dana, Bosch, Valeo, Siemens. What is unique about the Axle product line? And when you won business, what's the reason?

Well, let me just go back a little bit. In 2010, we formed a joint venture with Saab, anticipating the advancement of electric and just for all-wheel drive, but also the future of battery electric vehicles. Clearly, in the market wasn't fully ready for it back in 2010. We ended up taking Saab out of the business in 2012. So we've had a portfolio ready to go, which is the 2010, 2012 period of time. Obviously, we were successful in contracting work with Jaguar Land Rover, one of the first to bring that 2-in-1 type engineered solution together. I'd say, 2-in-1, taking the gearbox that we manufacture and assembling that with the motor that was a purchase from a partner of ours, and then we supply that 2-in-1 solution to Jaguar Land Rover. And then they bought the inverter separately and bolted it on to the unit. Today, really, what we're focused on really is that next advancement, Brian, and that's what's gotten me excited and our team excited is on the 3-in-1 type solution, where we're integrating not only the gearbox and the motor, but also integrating the inverter with that. And it's all about managing a packaging space, reducing mass driving performance attributes, especially in the area of efficiency here and doing it at a value proposition that's attractive to the customer. And that's really what's got the attention of our customer base, and we're already making some 3-in-1 solutions in China with our partner, Inovance, over there. We've got multiple programs in production today. But we're even taking it to another level where we're spending the motor at a much higher level and rate and also, like I said, integrating the inverter into the full design. So that's really what's got us excited and our customers excited, and I think what's going to be a big differentiator for us. At the same time, as I mentioned earlier, it's the inherent knowledge that we have with truck axles and EDUs -- e-beams and EDUs that can't be taken for granted. It's a very difficult space to operate in. And at the same time, we do it quite well as do some of our competitors. But again, I think we've got some really unique offerings. We've got strong interest from our customers. We've got ride and drives going on. We've got customer visits going on. We've got other demonstration vehicles taking place and more to come, but that's really what's going to be the big differentiator for us is that 3-in-1 integrated solution. And we're working on what we call our Gen 4 and Gen 5 technology today, but have already spec-ed out the next advancements of the Gen 6 clutch going forward. Because I think technology is going to continue to evolve, and we need to make sure that we can stay on the cutting edge and stay at least equal to, but more importantly, in front of our competition.

And in the 3-in-1 product, obviously, we had BorgWarner earlier in the conference, which bought Delphi primarily for its power electronics. So remind us of how you're sourcing your power electronics? And how you, therefore, can kind of handle that part of the 3-in-1 product?

Yes. So as I mentioned, with the Jaguar Land Rover, JLR was purchasing that separately and bolted it on to the unit. In the future, we've come up with some very unique designs -- in-house designs as well as supported by our partners, [ Holper Engineering ] as well as with Inovance. There are certain of those things that we can do some of that ourselves in the future going forward. So we're -- some people think we're disadvantaged because we don't have motor and inverter capability today. We're obviously demonstrating our ability to be competitive and win new business within a partnership arrangement, but at the same time, we're designing and developing products that we can make the choice as to do we want to make those motors and inverters in the future? Or do we want to continue to buy them from partners based on volume thresholds and what makes sense from a business case to CapEx standpoint. But we're positioning ourselves to have strong vertical integration. The electrification space is no different than what we're doing today on the traditional business.

Okay. And let's go into a couple of things you've mentioned. So first, can you talk about -- in particular, in China, maybe starting with NIO, what you're doing on their next-generation ePowertrain program? How to think about CPV timing and volume around that?

Yes. The NIO is much similar to what we're doing with GMC on the Hummer EV in regards to we're supplying a differential assembly for them. They had some issues with other suppliers from an NVH and performance standpoint. We fixed all those issues for them. At the same time, the content per vehicle, like I said, will be at the lower end of the component range, under that $500, but towards the left side of that. And again, for us, it was an important win because it's a breakthrough into NIO, which is one of the largest EV suppliers in China and only growing. And so we see an opportunity to not only just penetrate that customer, but also demonstrate our full capability and depth and breadth and hopefully, see our opportunities to grow from a business standpoint.

And can you tell us more about your partnership with REE and specifically, the new program platform win? Did REE look at other EDU partners? And what made them choose Axle?

Every OEM looks at multiple suppliers when evaluating technology and evaluating who they really want to partner with. And all we could do is to just really demonstrate what we thought was our advanced technology, which is that 3-in-1 type solution I mentioned to you. So REE selected us. We announced that here recently. We think there's more opportunity to grow with REE going forward as they conquest and book new business, and then we can announce other things in the future. But we really does design a product that's scalable and modular, that is very complementary to their REEcorner technology, which is very innovative in itself. So you take our innovation with their innovation, it's allowed them to lower the load floor or the skateboarder or a [ full-pledged ] chassis-type design. At the same time, the other big thing that was on their mind was looking for volume from a passenger or from a packaging holding space in regards to the vehicles that they're going to be producing in the future. So to me, it was a win-win. At the same time, they wanted a proven supplier that had knowledge and experience in this space. So we clearly can demonstrate that. They see the benefits of partnering with us. At same time, they've got other partners as well. We're just one, but a very critical one with them, and we see a very bright future partnering and working with REE.

And a couple of questions here. Will they be developing the software controls for the motor and suspension? Clearly, their skill is around suspension, but will they be doing motor control software? Will you at American Axle play a software role as well?

Well, we have the capability to offer the full vehicle software controls capability. We've demonstrated that to multiple OEMs. In this case, I believe REE will control the majority of the vehicle's software controls, and then we'll integrate our stuff into theirs. But we've got the ability and we're there to offer assistance to them should they need that going forward, but they'll take the lead on the vehicle side.

And it's -- when -- so REE is, in some sense, a kind of partner supplier. Where are you when they're finding actually go-to-market customers to kind of take the REE platform with the Axle EDU content out to generate actual sales?

Well, they've clearly already established some relationships with Hino and Mahindra and others that are publicly known that are in the marketplace. At the same time, they're working on a number of other customers in the last-mile delivery segment that I really can't comment on. They'd have to speak to those types of things. But we're just very excited about the opportunity that they presented us, what the future holds in a segment that we think that we can be a formal partnership with them and a formal force as a partner in that space. And we've got some very innovative technology. So we see a bright future for both of us as we roll this partnership profitably together.

Okay. And I want to move on and again, encourage people to hit the bucket, if you want to send in an e-mail or hit me on Bloomberg. On capital allocation, currently, you're about 3 -- you're getting below 3x net debt to leverage. You're generating very strong cash flows. We think you could get to 2x by '22 year-end. So assuming you get there and you probably have your own internal forecast, how are you thinking about capital allocation between M&A, debt buydown, organic investments in the context of that?

The key word for us is balanced. We've said that and have been saying that for quite some time. We're going to be very disciplined. I mean the most important thing for us is to focus on optimizing our business and making sure it's running efficiently and that we're maximizing that cash generation. That cash generation gives us a lot of options, and clearly, we have an obligation or responsibility to our customers with our backlog in new business or our organic business that we need to launch. So that's an important part of that, and that backlog continues to get stronger for us. Obviously, the debt pay down, we've made sizable improvements already this year, a little setback in the third quarter only because of the volume adjustments. But like you said, a clear solid glide path to getting under that 2x levered. So we feel very good about where that is. We have no customers really asking us anything about our balance sheet at this point in time. The real focus is looking at what do we need to do to continue to put investments in R&D to position our product portfolio and then looking at appropriate strategic activities, both on the conventional space because I think there'll be some there that we can continue to roll up, and we've proven to be a consolidator in that space. And I think there's more opportunities that will present themselves, but also to strengthen our vertical integration capability on electrification going forward. But again, those would -- I would say would be the priorities. Then obviously, shareholder activity, your friendly activity, whether it be a dividend or a share buyback, it makes sense. But again, we're just going to assess the market and assess the time. Most important thing we can do is just stay focused on the things that we can control that generate cash. Solves a lot of issues for us in the future.

Right. And in terms of potential areas of interest in electrification, there's inverters, power electronics, software capabilities for things like motor and torque control, suspension control. Where do you feel like you could use -- you could do something externally to build upon your capabilities?

Again, it's going to be heavily weighted towards both the electrification space and the mobility space. And we happen to make a lot of undercarriage components today, but we can make a lot of other mobility parts in the future. So we're really assessing that as a management team and as a Board to figure out how we need to position ourselves, and there may be some strategic things that make sense for us to go after and partner with in the future. But short term, again, it's really to continue to strengthen our software and controls capability, which we've already done a lot in that area. Ourselves, but also with our partners with [indiscernible] and Inovance. So we'll look there. Same thing on the motor and the inverter side and with our advanced technology there, we're making plans to look at what we need to do as far as either buying or making based on when it gets to a critical mass. And then it's just a matter on the mobility side. I do think there's some other opportunities that we could capitalize on that we can leverage our strength to really shift and pivot our business differently from how people interpret us today.

Okay. Good. Well, with that, I think that's a great way to kind of wrap up. So looking forward to a hopefully year of great cash generation and progress on the strategic front. So I want to thank David, I want to thank Chris and look forward to continuing the dialogue.

Thank you, Brian.

Thank you, Brian.

Thank you all.