Dauch Corporation (DCH) Earnings Call Transcript & Summary

Hi, everybody. Doug Karson here at Bank of America Merrill Lynch. Thank you for joining us for our Leveraged Finance Conference. We're so pleased to have American Axle & Manufacturing. They've been great partners with the most importantly, the bond market, they've been a great partner with Bank of America. With us today, we have Chris May, the CFO; we've got Shannon Curry, the VP and Treasurer; and David Lim, the Head of Investor Relations. I'm going to turn it over to American Axle for about a 10- to 15-minute review some prepared remarks, and then I'm going to open it up to a fireside chat. But please send me some questions because I'll definitely use those in our half hour. What further ado, I'll kick it over to Chris.

Okay. Well, good morning, everyone. Hopefully, everyone had a great Thanksgiving holiday over the past week. And certainly, thank you to you, Doug, for hosting this event. And also thank you to Bank of America for sponsoring the event. So it's a great event to connect with investors and bondholders and look forward to having a very productive half hour and a good Q&A session after our prepared remarks. But before I begin, I would direct your attention to our forward-looking disclaimers. They are included in our presentation and also on our website, and they will cover matters that we talk about here today. So for the course of my prepared remarks, my intent here is to cover our Investor Relations presentation, which hopefully is in front of you, and you can also find that on the website. I will also try to refer to page numbers as I go through this presentation during the conversation. So that said, let's go ahead and start here on Page 4. I know many of you know who we are, but some of you are new to our story and certainly want to just give you a little touch points at the macro level of who we are, talk a little bit about our financial performance and then talk about some exciting things in the world of ESG, electrification. So to begin, we are a global Tier 1 automotive supplier. We are focused on engineering and manufacturing in both our driveline and metal forming business units. The core of the company is quality, technology leadership and operational excellence. And you can see on Slide 4, a variety of different facts about the company for making our company work each and every day with over 20,000 associates around the globe. On the next slide, on Page 5, you will see our third quarter financial results that we released about 2 months ago now. And to be frank, we just concluded a very challenging quarter. It contains significant production downtime due to semiconductor shortages, availability and capacity at our customer plants, including downtime at our customers' full size truck point. So very meaningful insight of the third quarter. But that said, with a loss of over $250 million of sales associated with the semiconductor downtime, we delivered operationally a pretty solid quarter. The team posted and controlled the items they could control. We posted a solid EBITDA margin of 15.1% or $183 million and had another continued strong free cash flow quarter. As a matter of fact, inside this challenging quarter, we paid down an additional $100 million of debt. And of course, as many of you know [ online ], refinanced a significant portion of $600 million worth of debt out into 2029. So a lot of activity going inside the quarter, a lot of challenges. The team delivered really to contain and control what we could and navigated through those waters. So that would be the third quarter. You can listen to the transcript and other available information, or any questions on that, happy to take also during the Q&A. On the next page, Page 6, I know we talk a lot about semiconductors through the course of this year, of course, COVID to start the year and last year. But the reality is 2021 has been a very busy year for American Axle and a lot of positive momentum in many fronts outside of the operational elements that we just talked about. So what I've included here on this slide is really to depict some of the key highlights I wanted to share with you so far on a year-to-date basis through 2021. And it's sort of organized on the left-hand side, some exciting electrification news in the middle, a little bit associated with our core product and of course, underway, a lot of good activity on the ESG front as well as financial performance and recognition for some of our technologies. But as we go through this, you'll see things such as new customers such as NIO and REE Automotive. New vehicles we support, such as the new GMC Hummer that's about to launch. And also a key for the long-term viability of the company, protecting our long-term cash flow and income opportunities with being named as a sole-source supplier in General Motors full-size truck assembly plant that they're bringing online right about now. An extension of our full-size heavy-duty Ram product out to 2030. We extended that book of business and of course, supplying some new product into our fleet, such as the Ford Bronco Sport that we now support with our PTU applications. So a lot of really exciting stuff there, again, on both sides of our business, being recognized by pace for some of our technology in the electrification front. Also with David Dauch, our CEO, signing the Action for Diversity & Inclusion pledge, that was a great occasion here we celebrated in 2021 and then our continued strong performance, both from a profit as well as a cash flow perspective. So a lot going on inside of 2021, it's just not semiconductors. So a lot of really good stuff. On the next page, on Page 7, at the same time we announced our third quarter earnings, we also updated our full year outlook for calendar year 2021. That's updated on November 5. You can see here our sales target of $5.15 billion to $5.25 billion, adjusted EBITDA of $830 million to $850 million and a continued strong free cash flow delivery of approximately $400 million. And that's in light of many of these uncertainties that we had associated with COVID and/or semiconductor shortages. Now that said, it's still a very challenging and uncertain environment. And in the fourth quarter, in October, continued to have its fair share of production challenges from a semiconductor standpoint and while many of our customers' facilities have restarted here in November, still there are times where production has been interrupted and the level of uncertainty continues to remain. So that's our current guidance we updated in November, and we look forward to kind of working this year out with a good strong free cash flow delivery. So that said, that's our financial element of the business. I really want to transition now to give a brief update on some of the great strides we had made from an ESG perspective. So let's go ahead on Page 9, talk about some of those key details. You'll see here really earlier in 2021, we published our sustainability report. We continue to make significant improvements in categories that we track and you can see all that data inside of that report, of course, but also continue to increase our disclosure content. We've received some really good feedback associated with that disclosure. We'll continue to not staying still, and I would expect to see continued progress, both on metrics, but also on our reporting and our disclosures with our next annual report that should come out early part of next year. Some of the highlights of that report, if you look on Page 10 of our presentation, you can see the key areas of focus from an ESG perspective. The key takeaway here, I think is to go through each one of these, but to understand that these elements, very important, of course, to the company discussed and monitored at the highest levels of the company. But these priorities are aligned with our business objectives and aligned with the strategy of the company. So we continue to make good strides in that. We'll continue to keep you posted and updated on these through the course of our sustainability report, like I said, mentioned or published in the early part of next year. So that said, we talked financials, we talked to ESG. Let's move now on to technology. This is really, really an exciting element of our business going on right now. It's very fast pace. It's interesting, it's exciting, but that, of course, supports primarily the electrification of our business in our core product set. So this is an exciting time for us through the year, and I would refer you to Page 12 to begin this discussion. I really hope over the next few slides that I cover here with you, you'll be able to appreciate why this is so exciting for us. And one of the key things that we start with, of course, is our served markets, how we face that market and the products that we supply into that market. So let's start with that on Page 12, as I mentioned. And we really face off to the market with 2 core strategies. One, if the end OEM decides or prefers to build some of the drive units in-house, we have significant content associated with that in terms of supplying both components, subassemblies as well as whole gearboxes, and you've heard some of our recent announcements in terms of wins such as NIO and Hummer really fell into the component category, capturing that end of the market. And all the way up to electric drive units, whether they're independent drive units or eBeam drive units, we would support if the customer wants to do that outside of their operations. And as you know, we're in production on these today, and we'll talk a little bit more about some of that in the upcoming slides. But the key is, large served market facing off to the market from all the way from components up to full drive units and a lot of content opportunity, both on the component side, but also on the driving side, and you can see on Page 12, some of the content availability to us up to $500, depending on vehicle configuration from the component side and $2,500 plus on a full EDU application. I would tell you, if we are the primary driveline supplier, on a ICE vehicle versus an electrified vehicle, our content per vehicle, all things equal, will be higher in electric vehicle than it is on its traditional ICE products. So that momentum is certainly upon us. We're excited about it, and we look way to capturing some of those elements inside of the market. That said, let's move on now to Page 13, and this will cover a little bit about where we sit today in our product set outside meaning into the field already in production, some key things that are coming up and being launched as part of our cadence over the next couple of years, and you can see that growth really starting to take hold inside of our company. So on this slide, Page 13, you can see some of the key items we have in production today, such as the Jaguar I-PACE, which is a full drive unit. The Baojun E300 City Car in China, which is a full drive unit. Also working inside of the China market with our key partner, Inovance, multiple programs we supply from an eDrive unit perspective. We're getting ready to launch into Europe in the early part of the next year, a key drive unit on the luxury pass car. And also, we recently announced our award with REE Automotive to launch on their key platform that will start in 2024. So exciting stuff from a drive unit perspective. You can see on the lower right our electric drive components we supply into that space as well. So a lot of awards from that perspective. So on the next slide, on Page 14, you can see our engineers are not sitting still. Obviously, advancing not only the product we have in the field today, but also our product offerings that we have for our customers continues to press in terms of the edge and technology and really have a lot of customer interest here. You can see all the facts and figures on this slide and some of the core products that this will provide, but you'll see some of these elements on full display on the product that we're going to supply into [ REE model ]. So that will be in the marketplace in production in just a couple of years. So some great stuff coming from that standpoint. And as I said, our engineers aren't sitting still. They are obviously driving the market to far greater advancements in our product versus what we feel versus our competition. And next, I guess, pictorial slide on Page 15, I often get asked what are we most excited about in terms of electrification in American Axle. And I think the answer is, quite frankly, really simple. It allows us big content opportunity, which we talked about previously, but most importantly, it gives us a very wide platform reach. I think historically, you've known American Axle to supply crossover vehicles, full-size trucks and SUVs. You look here now on this picture, our scalable modular eDrive units. They're going anywhere from small City Cars that we talked about on Baojun. So micro vehicle all the way up to [indiscernible] and platforms, full-sized trucks, crossover vehicles, passenger cars, a deep, wide reach across this significant content. So this is what gets us excited here inside the company. And we're starting to win awards on these various different platforms. So we're starting to see that excitement pay off in terms of new business. So this is the great stuff, a lot of opportunity ahead for us, and we look forward to continuing to make our mark inside of this market. So I'll conclude on our final page on Page 16, just as a reminder, as we think about our electrification kind of encapsulating here inside of just a few words. We have proven systems in production on the road today. Some people seem to forget that point. But we are in production today on these components, winning wars, supporting and capable of all OEM strategies, whether they want to do it in-house or they want to outsource this product where there is supply with meaningful content of any one of that OEM strategies. Our global reach, our global footprint supports these applications. And lastly, we think with these high content per vehicle opportunities with this deep, broad, wide platform reach, growth sits in front of us to capture. So pretty exciting, as I mentioned, we look forward to this couple over the next 5 to 10 years to continue to play out, and it's going to be a great time in American Axle. So with that, I thank you for your time and attention to my prepared remarks, but I think now it would be really kind of a good spot, maybe, Doug, to turn it back over to you and any questions you may have or any of our investors have certainly happy to take either myself, Shannon, David and go from there. Doug, back to you.

Great. Thank you, Chris. And great overview. We'll definitely get to some of the EV stuff kind of as we kind of head down the Q&A here. I guess the first question is, you guys have done an amazing job navigating this chip shortage, which has been unprecedented. If you could just tell investors what exactly you've done to be as optimized as possible. And given your seat in the industry and you see a lot better than we can, how do you feel like this is going to play out over the next 12 months?

Yes. No, great questions, and thank you for the [ notation ] on our operations teams. I'll certainly share that back with them. I know they would appreciate it. But look good or bad, our AAM operating system has had the opportunity really over, quite frankly, the last 3 years. If you start with the back half of '19 with the strike of General Motors, COVID last year as well as semiconductors this year really do show its power and its capability, meaning it's flexible to meet customer demand, it's flexible from a cost structure standpoint, but still maintaining high-quality and high operational excellence. But the ability to flex our labor costs, our ability to have a variable cost enrollment with our purchased supply base, navigate that appropriately with them as well as over the last, call it, 12 months or so, we've doubled down in some of the restructuring of the company, optimizing our footprint, optimizing throughput capability and capacity of what's inside our 4 walls. Those elements all put together are really leveraging the AAM operating system to kind of navigate these challenging times. As I mentioned, we can't control all of these elements inside of some of these challenging times, but the ones we can control, I think the teams are stepping up and doing a great job. And it goes back to some of these playbooks we've shared with our investors in the past and how we deal with this. We continue to kind of work that playbook. I think that's the first part of your question, Doug. The second part was what is our insight to what we see maybe as it relates to semiconductor sort of unfolding. What I would tell you is if you've asked me this 90 days ago, [indiscernible] 90 days ago, we thought maybe the worst was behind us in the second quarter, that's some of the signals we were getting. As you know, the third quarter came out and was far worse than the second quarter. So uncertainty continues to exist. We see some of the plants coming back online here in the fourth quarter. I would tell you, October, obviously, saw lot of downtime, a lot of uncertainty. Some of these plants have come back online with many of our customers in November. They're not up to full run rates yet in all cases. So there's still some short shipments, et cetera, some last-minute cancellations, still an uncertain environment. But we do see some light at the end of the tunnel with some sequential improvement going forward into 2022. But our belief is this issue will be with us deep into 2022, maybe even early 2023, but should continue to get better over time.

That's perfect. I want to bounce around a little bit here. Commodities have just been another crazy part of this market to add to the insanity. If you could just give us a little color. You've always done a great job navigating that with pass-through contracts. But I have had a lot of questions from investors, very worried about fuel costs and pricing, what it will mean to your margins. So maybe you could just help shed some light on that, please.

Yes. No, that's a great question. Look, the impact to this is meaningful inside of the company even this year on a commodity pass-through mechanism. So I think as you think about this on business, you need to think about it really in 2 buckets. Number one, you have these indexed commodities that were on contract with the supply base as well as our customers that we pass through, call it, 80% to 90% of that either cost up or cost down. And in this year alone, meaning calendar 2021, we saw a pretty rapid rise start in, call it, maybe first quarter ish early second quarter. It really spike up through the end of the third quarter, early part of fourth quarter. It might be flattening out a little bit now. It's still premature to make that call, but that will amount to over $300 million this year alone that we're passing on to our customers. We're retaining a portion of that. You can see that in our quarterly [indiscernible]. But mechanically, think of things such as scrap indexes, aluminum, nickel, moly, et cetera, we mechanically adjusted our supply base every -- pretty much every 30 days, pass it on to our customers through the form of a price increase or decrease every 30 or 90 days. So there is some lag element associated with that. But it is designed to protect the company in a situation just like this, and that's exactly what it's doing. The second element, as you think about commodity inflation would be the base price that we go out and negotiate with our tiered supply group. It could be steel outside the commodities, it could be any of the other purchased components. And by way of sort of framing this up, about 60% of our cost of goods sold is purchased materials. Some of that also includes some of the commodity packages we talked about. But on the second category, it's our responsibility as a company to go out, negotiate and work with the supply base to have a good, strong, solid cost structure. So the extent they're facing inflation, they're trying to pass that inflation on to us, us to mitigate either through productivity, through negotiation or discussion with our customers on how to accommodate some of this. But this environment is very real, whether it be pressure from labor availability in the supply base, increased freight costs, increased commodity costs on our pass through and we're working through that right now in terms of setting up this for 2022. We have not had a lot of impact on this in 2021 because a lot of our contracts were in place. They are either annual or 2 or 3-year contracts, but many of these are now being renegotiated for next year on an annual basis, and we have to kind of work through this current environment. I would expect when it's all set and done, we'll probably have some impact associated with net inflation in this area. Some of it, like I said, will offset with productivity. Some of this we'll negotiate. Some of this, we're going to have discussions with the customers. But I would expect some level of net impact associated with this next year. A little too early to tell at this point, though. Hopefully, that frames up the long-winded question, but it's an important topic. And I want to make sure people understand that properly.

No, that was perfect. I want to ask about the balance sheet. It's always been a focus for the company to maintain a healthy balance sheet. You've been through cycles. We've seen how the balance sheet has held up very well during COVID and if you could just maybe talk to us about the priority of free cash flow, where you'd like leverage to be, what your kind of range is for -- where you'd like to see rating shake out, wherever you could help us on the balance sheet leverage front would be great.

Yes. Sure. Happy to do so. So from a balance sheet perspective, look, what we've been very focused on in terms of the core construct of the company is, a good cash flow conversion, EBITDA down to cash flow. And we've really been sort of tackling not only the EBITDA performance that we talked about, but also looking to minimize our capital intensity insight and business through reuse of capital, optimization of existing footprint, leveraging our purchasing power. And I think we've done a really nice job, to be frank, over the last couple of years kind of mitigating that because it's been a top corporate objective. So that cash flow is being deployed into CapEx. It's also being widened interest, which we've been reducing through our debt paydown. And taxes wise, obviously, that will change a little bit over time. I would expect some of that to go on. But that said, that residual cash flow will continue to support the capital of the company to grow organically. We'll continue to support our R&D investments, which I do expect to continue to increase as interest in that product that we just spoke about in some of my prepared remarks, continues to gain more and more attention of our customers, more and more inquiries, more and more RFQs. So that's really an exciting time. But we'll continue to invest that cash flow in R&D as well. So absent that, I think that brings us now to maybe our capital allocation view post that. I would expect we will continue to reduce our gross debt over time, but I would also expect that in the current environment, at least, as you've seen us over the last year or 2, continue to take selective investments, whether they be in joint ventures, where we've seen some growth in electrification, for example, the Baojun City Car that we produced our eDrive unit as of those joint ventures. I would expect some opportunity set inside even our traditional business, where you've seen us over the last couple of years pick up some small acquisitions associated with that. I would expect some of the consolidation in some of our core spaces. If it's opportunistic for us, we would consider certainly some of that type of activity as well. But those would be your 2 primary buckets. And then lastly, if there was some opportunity from a technology standpoint, certainly, we would take a look at it. That's where I see that residual free cash flow after we support the organic growth, the R&D of the business, that will be gross debt paydowns like what we've had now over the past couple of years, but also some limited M&A activity, where it makes good sense for our long-term product portfolio.

That's helpful. I've got a question coming in here on migration to EV. I think you did flag it in the early part of the prepared remarks that the content on the EV vehicle is quite high. What percent of your business right now is EV? And do you have the right capacity in line to grow with the EV kind of build rate that's expected out there?

Yes. So right now today, our current book of business from a key drive perspective of our electrification that we support, and it will follow in the category of some of the programs I mentioned in my prepared remarks, a couple of percent of sales. But that's a growing element inside of our business because some of the new programs we're launching are coming online in '22, '23 and '24, then, of course, a lot of the bidding activity we have is sort of in the '23, '24, '25 and beyond years to match up when customers launch schedules. But as it relates to capacity, one of the things that [ AAM ] was equally excited about this is [indiscernible] many of the components inside of the component space for EV, but also points inside of the drive units, we make very similar type of components in our traditional applications. So we have a lot of capacity on the industry converters to support electrification from that standpoint. What we need in terms of assembly lines that may be customized for particular drive units, we would obviously acquire and install no different, by the way, than on a traditional rear drive module or a traditional axle or [indiscernible] assembly line. From a geographic footprint standpoint, we think we're in pretty good shape. So the brick-and-mortar side of the business, we think, for the most part, is in good shape to support the growth inside the industry. So I think we're ready to rock and roll and support whether demand that exists for our traditional business, but also at the same time, convert into electrification. So we're in good shape from that perspective in our view.

I have a question coming in on labor. I know there is negotiated labor contracts you have. But if you could talk to us about how you feel about the tightness of the labor market? Are you able to retain the talent that you need? Or just maybe we'll focus on labor?

Yes. Labor is -- well, obviously, as you know, it's critical to our company's success. It's critical to every company success, to be frank. But labor availability, we view as a big challenge inside the industry today. If our CEO, David Dauch was here today, he would tell you aside from some of the inflation on the commodity side, the #1 issue is potentially labor availability across the board. We're fortunate we have some great contracts in place. We have good partners to work with on so many of those contracts. So we'll continue to work with them to make sure we have appropriate level of labor in all our facilities. We obviously are adapting to markets where we need to, to be competitive, whether it's on the sale and workforce side or even on the labor or the hourly workforce side. It is keeping our HR teams and our operations teams very busy in this area. It's a very real challenge for us. But so far, we've been doing okay. It's not been easy, but we've been doing okay, using all the tools in the toolbox to ensure the appropriate amount of labor inside our facilities, obviously, to be competitive in the space that competes for our labor, we want to be competitive as well, and we're stepping up to wherever we need to do to address that. Like I said, not going to -- it's been okay so far, but not many -- there are challenges, a lot of challenges inside our business as I would suspect that every other business has similar challenges.

As we look at the balance sheet, there -- I don't believe there's any maturities until 2024. So correct me if I'm wrong on that. If that is the case, maybe just give us a little color on your capital allocation, what are you going to do with the cash? I know deleveraging is a focus, but are there growth opportunities you're starting to look at more so or bolt-on acquisitions? I know you had a big acquisition a few years ago, so you've integrated that already with [indiscernible]. So just give me a little color on that.

Yes. You're absolutely correct from a maturity standpoint. Really our term loans that mature in 2024, then I believe 2026 is really where our next significant maturities begin. So we're in a good shape from a maturities standpoint, that keeps [ channel ] busy with refinancing and debt pay down, but we're in pretty good shape from that standpoint. In terms of capital allocation, similar to some of my comments I made in terms of some M&A, look, we'll continue to focus on the gross debt and address that because there is true savings associated with that from the cash flow, from an interest call, from a risk management perspective. But we'll also take a look at present themselves smaller M&A opportunities to either consolidate our core business, but also as it relates to technology on our electrification front. We wouldn't be shy in terms of something like that if we saw a great benefit for our future product portfolio. But we're very cognizant of our balance sheet, paying that down is important. I think over the last 2 years, we've put our money where our mouth is in terms of addressing capital allocation into that space, and we'll continue to work on our gross debt, but also look at some M&A opportunities, smaller ones if they make sense inside. But firstly, it has to make sense for our long-term product portfolio and ambition.

Chris, I've got some follow-up questions from investors and maybe I didn't ask the question properly, but I've got 3 or 4, the kind of target steel prices still. The question is steel prices have doubled, are you able to go to OEMs to try to get price? How does that affect your overall commodity buy? So maybe I wasn't clear enough for investors of exactly what steel you mean to the company and how you're navigating that elevated steel price, because after I get to the phone, I'll probably get all those questions and I'll get in trouble for not asking.

No, it's an important question. Yes. Look, from a steel perspective, yes, a lot of those input costs have doubled. A lot of that also gets passed through to our customers with that commodity pass-through and as I mentioned, over $300 million of loan already we passed through just this year. So that will even on a run rate basis, increase next year because the increase didn't start this year until the first half of the year versus the second half. But -- so that's one piece. We are seeing other steel price pressures at us to negotiate. We're negotiating with the supply base, our customer base. We do bring a large -- we are one of the largest buyers of SBQ steel in the world. So we do bring a little leverage into that negotiation power as well. But it's our job to mitigate some of that inflation. And there is real inflation in the space. So we'll attack it through negotiations with customers, with the suppliers and also some productivity.

Great. I think that was very helpful. So I think without further ado, I think this wraps us up for American Axle's fireside chat. Chris, Shannon and David, thank you always participating, and it was a great run-through. And good luck with the rest of your meetings, and thank you for everyone who dialed in.

Thank you, Doug, and I hope everyone has a great day and a great time. Bye-bye.

Thank you.

Bye-bye. Thank you.