Dauch Corporation (DCH) Earnings Call Transcript & Summary

Great. Well, thanks, everybody, for joining us again. Next up, we have American Axle, a leading supplier of driveline components and powertrain technology, and I'll emphasize powertrain technology because that often gets lost in the shuffle. Most commonly known for axle and an axle that drives -- that it supplies GM's trucks and SUVs, but obviously does a whole lot more. So we're going to learn a little bit more about that today. It's doing a great job of diversifying as product set and made an acquisition of MPG a few years ago, which has helped out quite a bit on diversification, certainly around product sets and customers. But it is still tied heavily to North America and light trucks. So that shouldn't be lost on anybody either, which is not necessarily a bad thing right now because it's a great region and it's a great segment that's going to be a gift that probably keeps on gifting for quite some time. They are generating tremendous free cash flow, deleveraging fairly aggressively. So we think that is a great part of the story on top of the operations. But for now, we're going to turn it over to Chris May, Vice President and CFO. We also have David Lim, who is Head of IR, that I think you all might know from other -- prior lives. But I'll turn it over to Chris maybe before we get into Q&A and to give us some opening remarks, and we'll go from there.

Fantastic. Well, good morning, everyone. John, Doug, thank you for hosting this great video. Of course, thank you to Bank of America. This is always a great event. Glad to be back here from, I guess, 2 years ago.

3 years.

3, yes, so that's awesome. Glad to be back in person. Before we begin today, I would, of course, direct everyone to our forward-looking disclaimers and comments on our website at www.aam.com for matters we're going to talk about here today. And when we think about American Axle as we sit here today, we come off the back of 2021, a very strong year for the company in light of the challenges that we faced and the industry faced through that time period. Sales, just over $5.2 billion. Sale -- EBITDA $833 million or 16.2%, very strong cash flow north of $400 million, a record for the company in terms of free cash flow. From a capital allocation perspective, we took that cash flow, paid down over $350 million of gross debt, committed to that continued reduction of our gross leverage and our net leverage as a company. You saw us drop internal leverage last year through the course of the year. But in addition, continued to advance some of our key business initiatives, the key growth initiatives of the company. We announced on our last earnings call, we secured our next generation of full-size truck programs for multiple customers that will be in excess of $10 billion, taking that core of the company out into 2030 and beyond. So that was a meaningful, I'll call it, replacement win for existing business that we have today. We continue to advance our electrification technology. We're launching as we speak, some premium luxury OEMs in Europe for our eDrive units, haven't announced to the customer yet. We will soon, so stay tuned. Continue to invest also capital into Autotech Ventures, which is -- gets us into the mobility space and exposure into that as we advance and push our core technologies, again, coupled with continued debt pay down. Most recently as it relates to capital allocation, we announced earlier this week, a nice tuck-in acquisition, core with the company of Tech 4 in -- primarily in Europe, about 2/3 of their revenue are there, almost $300 million of sales, a little under $300 million from a euro perspective. We paid EUR 125 million, and a high synergy deal, brings us continued exposure into some key components in the electrification space that we don't produce today in our cider metal form operations. And by 2025, about 40% of that book of business will be propulsion agnostic. So really exciting for us from our metal form space. Obviously, very attractive, high synergy deal, our estimate about 3x our '23 synergized earnings. So again, trying to find nice opportunities inside of our own space that we do really well can leverage our skill sets and advance some of our core initiatives, we think land is right on the spot. So '22, and I'm sure we'll have a lot of questions about 2022, but we're focusing on navigating the challenges in the industry, continuing to deliver strong results and continuing to deliver strong cash flow and continuing to work towards our capital allocation priorities that we've articulated to you all in the previous past couple of years. So maybe with that, John, I'll hand over to you.

Thank you very much for the opening comments, and thanks for joining us here in person. I guess the first question is, with all the supply constraints around the world, it seems like there's a greater focus on shipping anything and everything you possibly can in North America, right, because the demand is strong, the market is great on pricing, mix is very strong. And then when we look at your product sets, focused on trucks and crossovers, that seems like that's the most extreme focus from -- within North America. So as you look at the disruption in the supply chain, you theoretically should be at the point where the least, it doesn't mean it's easy. But if you could talk about what kind of disruption you're seeing here specifically in North America in key programs? How things have shaped up '21 when we were going through the extreme parts of the supply disruption we're still going through right now? How that's being managed by your customers, particularly on some on your key programs? And does that mean maybe there might not be as big a snapback in those programs because they've been favored or are they so depressed there's going to be a snapback anyway?

Okay. No, great question. A lot embedded in there, and you're absolutely right. It's not easy. It's a very challenging environment for the entire auto space, especially in the supply chain method. So I think if you take a step back, our exposure, as you mentioned, were nearly 80% North America. Our core philosophy of the company has been really since the founding of the company is to build, secure, source and ship to our customers in the regions for which our customers are. And we have found over an extended period of time now, whether it's through tariffs, supply chain challenges, et cetera, that, that philosophy of our company, coupled that with a little bit of heavier waiting towards vertical integration inside of our own factories, has served us quite well. Clearly, does not insulate us from all these challenges in the supply base, but certainly helps mitigate some of the more extreme challenges that others may be facing. But that said, so what are we seeing, if we think about really kind of 2 perspectives coming off the back of last year, clearly, a lot of challenges as it related specifically to semiconductors. We lost -- the biggest impact to us was really our customers went down. They did not produce. We lost nearly $600 million of sales last year associated with that issue. A lot of erratic schedules, last-minute changes, we had to react quickly through that process to try to minimize any cost disruptions associated with that. As we've transitioned now into 2022, the semiconductor challenges still remain. We've seen them a little bit better in terms of the first quarter of this year versus maybe, what I would call, the third quarter of last year, though they still exist. We had a fair amount of downtime from some customers in January. We're now starting to see some more downtime in April. As you know, General Motors announced some full-size truck downtime here in April. So we'll continue to navigate through those challenges. But coupled with that, where you're starting to see building pressures inside of the supply chain challenges are on logistics, labor availability, which is our view, one of the top concerns we think we'll face going forward is labor availability. So putting things in place to attract and retain labor to mitigate those challenges, continuing to optimize and continuing to invest in your supply chain to ensure continuity of supply, to work closely with your customers to minimize those disruptions. I mean those are top of our priorities with core to our operating system of being flexible to whatever changes come our way. So it's a very challenging environment, but we're trying to react in the best position possible to navigate through the ups and downs of our customer schedules and the challenges faced through the supply base. That's sort of a macro view. I don't know if I got to all the elements of your question. If you want to...

Yes, a follow-up. So I mean, when you think about this, I mean, there's a question of mix, which has been probably a good guide for you guys generally in what's actually being produced, right? It's a lot that's being produced. Then there's a question of absolute volume, and then there's a question of stability of volume and schedules. So if you were to think about those 3 in simple terms is, I mean, we can get into cost inflation in a second, but this is revenue generation. Which of those would you like to sort of see come -- which is more important to you, right? I mean mix improving? I think you're probably -- there's not probably a whole lot more mix in absolute terms, things can improve. So I guess it might be the question between volume and volume stability.

Yes. Well, we love volume and we love stability. But if you think about one of the nice things about our company, our revenue mix, about half of that is exposed to the full-size truck in North America through General Motors, Nissan, Stellantis. We supply a lot of components even into Ford. So coming off really the back of COVID at the end of 2020, demand for that product from an end consumer standpoint and from the OEMs to build and prioritize as those are some of their highest profit pools has been very strong. They look to prioritize protecting those volumes through the course of semiconductor. So they're certainly not immune from those, but they look to prioritize them at the expense of other vehicle applications. So we have benefited from our end product mix. I think last year, we saw a lot of downtime on the crossover side of our business. That seems to be coming back here in 2022 as inventories in the field have just been depleted. So the mix, I think we're in a really good shape. And in near term, I would tell you, certainly stability of production would be probably preferred, right, because that allows us to better plan our business, be more cost efficient in the business. But holistically, at the end of the day, volume is always your friend as a Tier 1 auto supplier and good, strong, healthy volumes, consistent would be probably the ultimate preference.

And how extreme is this volatility? I mean is it the kind of stuff where it's day-to-day or week-to-week? I mean usually, you're looking at 2- to 3-month schedules and things might ebb and flow a little bit from that, but you can generally plan pretty well. I mean how extreme is this volatility that you're dealing with at the moment?

Yes, I would not say it's occurring. It's not as extreme as we experienced in the third quarter of last year, but we get weekly releases from our customers. We get annual releases from our customers so we can plan. But we do get, I'm going to call it, near or last-minute changes from our customers as they may reduce over time, for example, or cancel a Saturday. We're getting maybe if downtime for -- a plant goes down for an extended period of time, maybe a couple of weeks' notice now versus in the past, we may have found out on a Sunday that you weren't going to ship on starting Monday. So we're getting a little bit better visibility to that, though it is still quite volatile. The challenge with that, of course, is as we look to order our supplies to build that inventories, for example, we're a long lead order of steel. We have to place 16-week orders with steel. So we have to rely on customer schedules to place orders with the steel mills to have the product there to build it when they need it. So you can imagine the logistical challenges associated with that. You've seen our inventories over the last year, it's well up over $100 million as we've tried to put in every one a little bit of buffer to accommodate some of the volatility to make sure we have the appropriate product in place and build to our customer schedules. So of course, we'll reap the benefit of that over the next year or 2 as we unwind that inventory. But those are some of the logistical challenges we face.

I mean there's obviously some incremental cost with not running your lines at full speed. There's incremental cost with cost inflation. There's incremental cost with probably some premium freight because you're also dealing with the -- sending -- thought that might be a little bit more volatile to your suppliers. So you're having these inefficiencies and then just cost inflation that are coming in. In your discussions with your customers, is there anything sort of ongoing as far as recoveries, near term or recoveries in longer-term contracts or changes in contracts where you may have more volume guarantees or you may go put in premium freight as part of a contract that's on their dime, not your dime? I mean how are these discussions going as you're kind of facing these challenges?

I would describe at least from an inflationary cost increases that we would experience really sort of would fall into 2 buckets. We have, I would call it, metal market indices type arrangements with our supply base. We procure a lot of steel, which includes elements such as scrap steel, nickel, moly, we buy a lot of aluminum, right, for the components we buy. Those are spot market procured by our supply base. We have ongoing contract with our supply base. To compensating from that, we generally have back-to-back arrangements with our end customer to pass those cost increases or decreases down fairly mechanically. And we are projecting versus where we were in 2020, an increase of over $0.5 billion of costs associated with passing through. And you can see those on our walk downs each quarter through our earnings call. And we retain a residual amount, call it, 10% to 20% of that change. The other half of the question -- the equation, which I think is a little bit more where you are directing some of your comments in terms of base price inflation, inefficiencies in our factories for schedules, et cetera. These are, of course, costs we're starting to incur. We are in an inflationary environment, and I think that's no surprise to anybody. But we are in active discussions with our customers to compensate for some of those cost increases, especially ones that we see as inflationary and structural in terms of costs going forward. Some inefficiencies and downtime through the plants. Obviously, that's a discussion point we have with our customers. We try to minimize that on our own. That's our best defense against that cost. But working now with the supply base, getting them under contract in the current environment and now going to our customers and having some discussions with that, which we've been ongoing over the first half of this year.

But is there -- so right now, you're looking at automakers that are making record profits at lower volumes, right? And your stock, you're dealing with the lower volumes and these cost inflations. So you're kind of looking at sort of the value chain the automakers are making more money than ever. You're getting -- you guys are managing the business well, right? So it's not -- it's certainly not the majority, but I mean, you're under these macro pressures and they're getting all the benefit from the constraints on the macro pressures. Do they have greater because of that or for any other reason, do they have a greater receptivity to these discussions than they may have in the past?

Yes. If you think about the dynamic inside the industry, as inflation enters into the supply base holistically, it can only -- there is no avenue other than our customer, right? There are supply chain, their avenue is us. At the end of the day, the end OEM has vehicle pricing associated with that. So that's really the ultimate payer of the inflation through the entire supply chain. So yes, they've been more receptive to these conversations in the past. And if you think about over the last -- framework for the last 10 to 20 years, they've been in the mindset of price downs, right? Now we're in an inflationary environment that's different than what we've experienced for an extended period of time. So that's why these discussions are ongoing with the customers. As I mentioned, we're working through this in the first half of the year with them on that. I'm sure you're hearing very consistent from other Tier 1 suppliers.

Thank you for that color on cost. But I wanted to, I mean, dig a little deeper maybe on steel. Your firm has done an excellent job. You're navigating an insanely difficult steel buy. If you can maybe just talk a little bit more about the ability for you to pass through those costs? I think some bondholders look at that and they're nervous about the steel cost. But then when earnings come out, it seems like you've managed it quite well. So if you can maybe just go through that in a little bit more detail, please?

Yes. If you think about, we are one of the largest SBQ steel buyers as bar stock of steel for our forging operations, which vertically integrates into our business and also supplies to other customers. We're one of the largest buyers of that in the world. But also the supply base that we procured from castings, carriers, machining components also are predominantly metal based. So they have those input costs. So if you think about those input costs, again, would really fall into 2 elements sort of base price increases and then those industry-related pieces. In some of these indices, you've seen now scrap, for example, aluminum have reached peaks over the last couple of months. What's important to that, and we put these in place many, many, many years ago with most of our OEM customers is the ability to mechanically pass those increases on. So as we adjust based on the current market rate for that price with our supply base, we have a back-to-back arrangement with our OEM customer to pass that on to them. And we -- like I mentioned, we retain about 10% to 20% of that. But the purpose of this is really to risk manage the company, right? So -- and it's doing exactly as it's designed. Well, we'll have anywhere from a 30- to 90-day lag on this process, but over time, they all [ quarterly ], right? So you'll pay -- if a period of rising prices, you'll feel a little bit of as it rises up and when it comes down, you'll capture that benefit on the back side. And over time, we've seen prices go up and down in all of these indices. It never feels good when it's up, which is where it is today, but the reality is it's working as designed and protecting the company.

That makes sense. So you mentioned inventory going up and building some buffer stocks, right? And I think that the whole value chain, you guys aren't chip suppliers, so not directly, but this is a concern kind of across the whole value chain for suppliers. You want to have buffer stocks in almost everything, right, because you never know where the unfortunate events may hit. The irony is that we started last year with excess inventory in finished goods on dealer lots, and now we don't have enough finished goods on dealer lots and that's -- have sent through all the supply chain as there's not enough inventory. So I mean, you could certainly argue that you should have the inventory in unfinished goods or raws and you guys would then ultimately process or you should have it in the finished goods. We're also planning where we shouldn't have it in finished goods. So seems like we're now going to be trying to build buffer stocks somewhere down in the value chain with you guys or into your Tier 2 or 3 suppliers. How do you think that's going to get managed? What are your kind of discussions with the automakers? How much you're going to have to carry? Is it 20, 30 days of inventory? Whether it'd be finished or unfinished that you would ship out? How is it going to be managed? And what does it mean for sort of capital intensity and/or costs or both?

Yes, it will go in reverse. And you really saw in terms of capital intensity, you really saw us build our inventories last year because as I mentioned, nearly $100 million, really through finished with and raw material. I don't see that expounding anymore from that level of magnitude on a go-forward basis. And each one of those elements of inventory has a little different tail to it. And what do I mean by that? So finished goods inventory, so think of those finished axle we ship into OEM assembly plants. There's a practical limit to how much we can hold. There's racks throughout the system and when you run on a rack, which the OEM owns by the way, you can't store anymore. So once those racks are full, once the system is full, as long as we continue to maintain that system fill, we're in pretty good shape. And from a finished goods standpoint, we're there. Where the challenges come more for us as a Tier 1 supplier, and steel is probably one of the largest ones with these long-term lead times to order this, you have to place orders that we believe will cover the schedules we think are coming. And as I think schedule stability starts to come into play, hopefully. And at some point in the future, we'll be able then to kind of recalibrate our inventories, and you'll start to see those come down. But I think from our perspective, the inventory levels are probably near very close to where they will be from a peak perspective, given the current volume environment and we'd look to optimize those as we get stability in the industry over next year. Hopefully, that addresses your question. We don't have the same dynamic from a vehicle standpoint. We're more inside of the component side.

Yes. But is that of your own volition? Or was there pressure that came from your customers to say, "Hey, listen, don't short us because we want to fire away and start building, you better be ready."

Yes. Well, they certainly want you to be ready to their schedules, right? So part of that was making sure we place a premium. I think you've heard us articulate on making -- it's our job to ensure continuity of supply to our customers. So we take great pride in being able to do that. We think that's one of the value propositions we bring to our customers. So part of that was -- it was our own doing to insure that we have the right product. And if we saw challenges in certain segments of our supply chain, we wanted to make sure we have the supply to build -- bring timely supply. There's some dynamics in how we order some of the components as steel is such as I mentioned. But the -- yes, so that's sort of we're managing that. And then as schedules were erratic and you had inventory built or brought in to build that and the schedules dropped and you had a little bit of an increase for your inventory associated with that. So you had a little bit of just the cadence of the customer schedules that was driving some of our inventories up. So it was really sort of a mix of all of those.

But I mean it seems like it's you being a responsible supplier into the automaker that's driven that conservancy as opposed to somebody coming to you and saying, I need to make sure that you have X, Y and Z [ gains ] of other inventory ready to go forward.

Yes. Well, the inefficiency in the scheduling system that was causing us to carry that more not just us consciously doing that.

Yes. Okay. With all this mean that's going on, we often losing the shuffle right now, new business bookings and wins and quoting activity. So I'm just -- can you talk about what's going on in quoting activity? Is it normal? Has everybody been so way laid by supply chain management that programs are being pushed out, things are not evolving as normal? Or I mean, how is that process going?

Okay. Yes. We're not experiencing programs being pushed out or delayed. So I would say the quoting activity is very robust. It's very robust for us, especially inside the industry as it's pivoting towards electrification. You'll hear us talk about we're quoting on $1.5 billion in new business opportunities. That's now 2/3 of that is related to electrification-type products. So it continues to be very active, very robust, many different dialogues with many different customers. You've seen us grow our backlog from what we announced first quarter of this year versus first quarter of last year. You see that electrification segment growing inside of that backlog. But no, it's a robust environment. We're pretty excited about it. I mean a lot of opportunities out there for us from our metal form side, from our driveline business, on traditional product. But also, obviously, as the industry is pivoting to electrification, so that's where you're seeing more and more of that share of quotation activity coming on.

So certainly, with where your stock price is, there's a lot of skepticism about your ability to make this transition to the EV world, right? I mean it's very clear, it creates a huge opportunity in the stock.

We agree.

But I mean when you look at this, you said 2/3 of what you're bidding on in the $1.5 billion is EVs. What are the products that you're going to market on? And maybe you can talk about some key wins that you've had so far in the EV world.

Okay. Yes. No, it's -- as we face off to the EV world, we think we're in somewhat of a unique position in terms of the products we supply into that, especially leveraging our core driveline expertise and our metal form expertise and what do I mean by that? As we face off to the market from an electrification perspective, from -- all the way from components to full integrated driveline systems, from eDrive units. So in terms of a component side, so think of gear shaft subassemblies, gearboxes that are required to be assembled into drive units. So if a customer chooses to build their own product inside their own operations, they're looking to us to supply components. So we can have content per vehicle up to $500 just on the component side of electrification. And you're seeing us announce wins with Hummer and NIO and several other customers where we are -- our capabilities there are bringing us business opportunities and that's global, in Europe, North America and Asia. On the drive unit side, we have a wide variety of product offerings where we continue to gain new business wins there. As you know, we started in earnest for our first product launch on the I-PACE with Jaguar several years ago. We have won multiple different platforms since that standpoint. Very high content opportunity for us in excess of $2,500 a unit or a vehicle. And you see us expanding not only where you think traditionally American Axle on the truck and the crossover vehicle side, but now our arrangement with REE, for example, puts us into platforms and chassis. You see us in China now on front-wheel drive vehicle segments, both from a micro car and more of a kind of midsize platform in China. So we're really excited about the -- how we go out to market with our electrification product from a segment expansion standpoint on the full drive units, but also really leveraging the core competencies of the company from a component standpoint.

So I mean the hub motor architecture that's something we're going with, what does that mean for the business? I mean -- and I mean, it seems like there might be an opportunity for different parts in there. Some people might say, "Hey, listen, we're not going to have real axles." The way they traditionally would have thought of. So that might c*** you out. I mean how do you think about stuff that's theoretically that extreme where the motors go to the wheels?

Yes. You're not seeing that as a prevailing architecture today. One of the things I would say very similar to that is the REEcorner application, which is a unique design for REE, which is our Gen 5 units. We've built these to be very flexible for different type of, I'm going to call it, propulsion architecture, you use wheel hub or wheel corners or if it's a center drive unit. So we think that creates a tremendous amount of opportunity. And if you think about, again, just using REE as an example, making about 4 of these units on a platform where traditionally on a car, we would have 1, maybe 2. So it creates a significant opportunity for us from a revenue perspective, but it also creates and demonstrates the capability and power of our Gen 5 electrification units to have flexibility to accommodate these different type of architectures. So we welcome those. It's a great content opportunity for us, but also a great way to show our technology.

And when you think about the content potential in a full-size electric trucks or Silverado or Sierra, what is the -- I mean, that might not be the greatest example, but I mean what -- I mean, if you were to think about on a full-size truck, your content potential on an electric truck versus the GM trucks? I mean what do you think the differential is, positive or negative?

It's absolutely positive. So if you think about a traditional ICE truck for us, North America full-size truck, average content per vehicle is around $1,600, okay? If we think about an electric drive truck, it could be configured with 1, 2, even 3 units, depending on the OEM's architecture of those and it should be on a like-for-like basis, well in excess of what we experienced on an ICE perspective. The content wins we have now with our EDU drive units are $2,500 plus. If they want 3 units, 4 units, like you're seeing in some of these REEcorners, it will be substantially greater than that. So on a like-for-like basis, it will be higher.

That's not a lot of people were expecting or at least our stock.

That's what we're experiencing.

Yes. And if you were to think about the potential for insourcing into automakers, are there any risks for some of the products that you're working on? Or is there any potential for incremental outsourcing on "traditional axles"?

Yes, 2 questions embedded in there. Yes, little bit on the traditional side, clearly opportunity for us to leverage our installed capability, have low capital intensity for these replacement programs that will run for a long time. We'll generate a lot of cash associated with that. And then obviously, as OEMs look to optimize their focus and their capital focus going forward creates additional opportunity to leverage our installed infrastructure. So I think that creates a really interesting cash flow scenario for a very long time. As it relates to -- on the electrification side of the equation, our view is that OEMs, some will do some of this product inside of their operations. Some will go to the supply base and some will be mixed. And interesting enough, and I think people -- this doesn't resonate well with people very often, but on our traditional products, we're in the exact same situation. Every one of the OEM customers that we supply to does some of the same product inside their own operations. We expect the same to be on the electrification space. So should they elect to do it inside their operations, that's where those component opportunities are very relevant for us. And of course, as they put some of the volume, put some of the broader programs out to the supply base, we'll obviously be the beneficiary and you know the content as we talked about a few minutes ago.

So on the [indiscernible], John, you have to also think about the whole aspect of the make versus buy situation too. And for AAM, we have to come out, and this is what we're doing with our 3-in-1 Gen 5 is we're making a compelling value proposition where it's compact, it's super powerful. You could see it on the REEcorner module. But at the same time, these OEMs are spending a ton of money, as you know, like $40 billion, $30 billion. And I'll tell you what, I think the next generation of where the competitive advantage will come from is really power density of that battery. Getting that below 100-kilowatt hours. And there's a -- the chemistry is extremely complex, and they want to get into connectivity, they want to get into AV, they want to get to ADAS. That all takes money. And going through someone like the connectivity stuff, it's going to be a hot knife going through butter and how much money that they would spend.

Yes. And I think that was kind of a follow-up question I had on -- if you think about sort of the traditional products where they're doing some of the stuff inside, I mean, it does seem just on the traditional product side, Axle's drive shafts, they might say, "Listen, we've got other things to do here. Please take over this." I mean -- and that's a great cash flow business for you because the incremental investment for you is relatively low.

Absolutely.

I mean are you hearing about anything like that happening just yet? I mean it makes industrial logic and sense all day long to me and to you and I mean, but are they kind of contemplating doing that so that they can just focus on the future?

Yes, certainly, we can't speak for the OEMs on their behalf as it relates to that. But the question you asked is certainly one I would expect is going through their mind and their thought process and their analysis, as they're looking to pivot the bulk of their business, where they're going to put those big capital dollars into those vehicles. And you have a very capable, strong supply base that can accommodate the economics of what you just described.

Without getting into this year's financials right now, and putting you on the spot, but I mean on that, but I mean, you've performed very well in a very, very tough environment. I mean some of that is internal execution. Some of that is the markets that you're exposed to generating a lot of cash flow, deleveraging is still, I think, a little bit of a priority, right, a bit more. And pretty soon that's -- they're going to be -- well, it seems like from our forecast, you'll be through that sometime sooner than where you're trying to get. What do you do 1 to 2 years out when the balance sheet issues, they're not issues but like the leverage is taken down and you have all of a sudden a lot of flexibility as to what you might be able to do in the future in allocating cash flow? Because cash flow is presuming the world doesn't spin backwards, any more than already is, it's going to remain pretty damn strong. I hope, earnings up or down a little bit, blah, blah, I mean, you're just going to have a lot of cash to deal with.

Yes. No. And if you think about the capital allocation playbook that we've articulated, we'll continue to invest in R&D and capital expenditures to support the growth of the business. We see real meaningful opportunities on our Gen 5 or Gen 4 units from an electrification standpoint. I would expect that to continue in a meaningful way. Two, as you said, once we clear through this debt, then it sort of what it does is open up the playbook from a capital allocation perspective. You've seen us now take actions for some tactical M&A or bolt-on M&A. We've done now a couple over the last few years. Obviously, we just had the one I mentioned earlier in my opening remarks associated with Tech 4 to leverage strong opportunities out in the marketplace. We'll continue on that. And then we'll take a look, 1, 2 years from now as our leverage is sort of in that target zone that we talked about. It gives us that flexibility to assess the marketplace and where we sit, how does the macro environment sit and obviously gives us opportunities to work around the rest of the capital allocation playbook. But the nice thing is it's going to give us great opportunities for capital deployment in just a couple of years.

Okay. Just a quick follow-up on the balance sheet. If you could just kind of refresh us on what the leverage target is? And we're in very uncertain times, but maybe the time frame that you'll get to that target? And then I have a kind of follow-up question on inventory build.

Yes, sure. So we closed the year, meaning last year, '21 at 3.1x. We've articulated our objective as a company is to get towards that 2x net debt leverage, right? Look, historically, the last couple of years, we've been an outlier in the industry and we faced some pressure associated with that. So we consciously have deployed our capital and cash generation to reduce that leverage through both gross debt pay down and continued EBITDA performance. And our objective is to get 2x in the near to midterm. And we see a line of sight to that. We've not given a specific year, Doug, associated with that. But clearly, it's -- we're on the cusp of that.

That would be a great target to reach. On the inventory build, I don't know, John, hit on it yet, but in the industry, we have about 1 million or 1.5 million units of inventory, and we used to have closer to 3 million plus. There'll be a big inventory build at some point. And are you guys prepared for that and there could be a lot of upside given your operating leverage if the production starts going through the roof at the OEMs and they're asking for lots of product from you? It could be in a sweet spot.

We are 100% ready and look forward to those orders. It will be great. Look, we -- one of the things I think we have our playbooks, right? People always ask us, what's your downside playbook, et cetera, has navigated the challenges of the industries. But one of the key things -- the flip side of that is we'll capture that upside when that volume comes. And I mean, it will be fantastic. That's one of the strengths of our operating system as we can pivot in both directions, support the higher volume needs of the customers, but also protect the downside and we'll absolutely leverage that environment. No doubt.

That's a great story. I think we'll end on that high note to remind everybody that there are incremental margins, not just decremental margins, right? Incremental margins can be pretty powerful when moving in the right direction. That's a great place to land. Thank you so much, guys. I really appreciate you guys coming.

Thank you.

Thanks, Chris. Thank you, everybody.