Oshkosh Corporation (OSK) Earnings Call Transcript & Summary

Good afternoon, and welcome, everyone, to the fireside chat with Oshkosh. I'm Jerry Revich from Goldman Sachs, and I'm pleased to have with me Mike Pack, Executive Vice President and Chief Financial Officer; and Pat David -- Pat Davidson, excuse me, Senior Vice President and Investor Relations. Pat, giving your introduction apparently gets me all choked up. Mike and Pat, thank you very much for joining us.

Thank you. Great. Well, Jerry, thanks for having us. Really pleased to be talking to everyone. We have a lot of exciting things going on at Oshkosh. So I thought maybe we just spend a couple of minutes talking about Oshkosh and to give a little background for those of you that are a little bit newer to our story, and then we'll get into Jerry's Q&A. So at Oshkosh, our purpose is really to make a difference in the lives of the everyday hero. And that everyday hero, it may be a construction worker working at height or pouring concrete to build our nation's infrastructure, it's the firefighters responding to emergencies on a daily basis, refuse collection workers keeping our cities clean and protecting our -- and products that protect our troops. And now most recently, it's now the postal service worker that really touches every American household. So we're really excited about our recent win of the postal service contract to really refresh that postal fleet after more than 3 decades of really the same product. So we operate in 4 business segments. Our largest segment is the Access Equipment segment, most -- the main brand is JLG. Main products there are aerial work platforms and telehandlers. Exciting time coming out of the pandemic in that segment. We are seeing pretty robust customer demand coming back as the economies start reopening. So that's a lot of exciting activities in that segment. Our Defense segment, second largest segment. We have a number of large technical vehicle programs that support our troops. JLTV, or joint like tactical vehicles, are most significant product per volume, and that's really just been a great product for us. And now most recently, we won the postal service contract that I mentioned a few moments ago. So really excited to take our skill sets and serving large government -- working on large government-type contracts to the next level into a new product category. We have our Fire & Emergency segment that serves municipal fire customers that really many of the fire trucks you see throughout our communities around the United States, our Pierce brand. And we have our Oshkosh aircraft rescue fire fighting vehicles that you see at airports really around the world. And last but certainly not least, our Commercial segment. We're in the refuse collection space as well as concrete mixer space that really excited about the prospects, particularly in that environmental space as we -- as many large refuse collection companies are looking to increasingly electrify their fleets and so on, and we're participating in that space. So a lot of exciting things with our segments. If you look at our strategy, we're really focused on 3 things: innovating, serving and advancing as a company. So innovating. First of all, we talked about some of our innovative products, but we have really exciting projects taking place in all of our segments. We've talked about on our earnings calls, we have electrification initiatives literally in all of our segments, where a lot of focus on autonomy, moments of autonomy, active safety, connected and intelligent products. And not only do we innovate with our products, but also on how we build our products on the shop floor. So integrating digital technology into our manufacturing processes to drive efficiencies and ultimately, continuously improve the quality of the products coming off the line. In terms of serving, hey, there's a huge opportunity. We have hundreds of thousands of vehicles and units out in the field around the world and taking care of those products throughout the life cycle continues to be a great opportunity for us, one that we want to continue to double down on and drive further growth in that area. And really, last but not least, continue to advance. And when we talk about advancing, it's really driving growth, and that's growth into new product categories like last mile delivery vehicles with the U.S. Postal Service. It may be new geographies, and it may be near adjacent product categories. So -- but really excited about our prospects and a lot of the things that we have going on. And happy to answer your questions, Jerry.

Terrific, Mike. Thank you. Maybe as a starting point, if I were to recap the past decade for you folks, big structural margin improvements with the MOVE efforts, big military contract wins, the USPS win, not so much M&A. And going forward, I'm wondering if you could talk about the strategic priorities for the business over the next 3 to 5 years. Based on your discussions on conference call, it feels like M&A is moving into the equation, I guess, more prominently than before. But can you touch on broader strategic objectives as well as how you're thinking about capital deployment as well, Mike?

Sure. And maybe foundationally, just I can quick run through our -- how we view capital allocation. So foundationally, we want a strong balance sheet. And we certainly have that, and it's been great how we've managed through the pandemic from a balance sheet perspective. And then it's said organic investment. So you're going to see us continue to focus on investment in megatrend areas, electrification, we talked about autonomy. You see the postal service vehicles, that's driving growth. That's been beneficial to our margins really in all of our segments over time. So you'll continue to see us deploy capital in the innovation space. We've consistently been growing the dividend over the last 7 years by double digits. We aspire to continue to do that on an annual basis. And then you get into the layer that we've been fairly active over the years or last decade from a share buyback perspective. That's still going to be an important part of our capital allocations priorities over time. But we really balance -- we're going to balance where we believe we can drive the greatest returns and growth to drive shareholder value between those buybacks as well as strategic inorganic growth opportunities. Recently, we acquired Pratt Miller. A great example of a nice company that gets us into some adjacent military programs on our -- with our defense business. But we look at it much more than that. Pratt Miller also has some great technical capabilities in the electrification, autonomy spaces. We're going to really use them as a force multiplier over time with all of our businesses to drive some of these technologies into our products. So I think as we look -- we have a pretty robust always on pipeline. I think you will see us more consistently acquisitive and probably to that you might almost think of us as programmatic acquirers over time, really looking at bolt-on type acquisitions. We're not looking at M&A as a scale play. It's really to try to get into adjacent product spaces that make sense with our products, acquiring a technology where there may be a life cycle service play in it. And really, if you look at Pratt Miller, it is both adjacent space opportunity as well as that technology play.

And Mike, in the past, when you folks would talk about M&A, the general conclusion is well, we compare everything versus our stock price and our multiple. And when we look at the opportunity to invest in Oshkosh versus elsewhere, we also feel like the risk is lower. Have those parameters changed at all in terms of benchmarking in May versus stock buyback? Can you comment on that?

Well, I guess our focus is, as I look to what John and I want to accomplish, I think we have -- we see significant growth opportunities. So we're really looking at buybacks, is where can we generate the greatest shareholder returns. And as we look at the M&A pipeline and companies out there and the opportunities for growth and adjacencies, we're seeing some nice opportunities out there. And so I think we'll take advantage of those opportunities. And when -- and if there's a point in time that -- at various points in time, it's going to make sense to do some buybacks. So I think you're going to see very much a balanced approach over time. And I think we're -- but the goal is the sort of the driving force is, where can we drive the greatest shareholder returns over time.

And your free cash generation has been strong and consistent. Would you lever up towards 2, 3 turns of leverage to do a deal? And is the pipeline healthy enough where that's even worth discussing?

Our objective from a balance sheet perspective is to generally keep our leverage less than 2x. So we're not looking today to lever up the balance sheet. We have liquidity that we're able to do deals. And when -- our focus is not necessarily on transformational big bang type acquisitions. It's going to be companies like Pratt Miller, more modestly sized, but give us capabilities.

Okay. And then in terms of the Pratt Miller example and the electrification core competency that you folks are building, can you talk about how you're thinking about scale in that technology and other technology areas? How do you think about cutting out the appropriate niche to focus on while leveraging other people's scale for some of the higher volume components? Can you just flesh out the strategy a bit more, Mike?

Yes. As we look at really any of our products, we're really good at building purpose-built vehicles. And as you look at that in the sort of an internal combustion engine world, I liken it very similar as you electrify. There are certain things, and we're really good at integrating. So I would see that we would continue to do similar to what we do today. Some of those powertrain components, you would be sourcing those from strategic partners like we have today in the internal combustion engine world and with really a focus on integration and our purpose-built vehicles. So like a postal service vehicle, really building that vehicle from the ground up and then partnering with really great companies out in the marketplace to integrate their components.

And can we just shift gears a little bit on the sustainability topic? You folks have pretty detailed sustainability report out. Can you talk about your highest ROI environmental investment opportunities? And what part of the portfolio are you folks most excited about in terms of what you can deliver for customers?

Sure. Well, first of all, we're really excited about the great strides and focus we have throughout the company on driving sustainability that really is reflective and us ultimately being on the Dow Jones Sustainability Index. And so really, if you look at sustainability holistically, the most important aspect, I would say, in some regards is obviously protecting our -- ultimately developing that workforce, making sure driving diversity and inclusion and because really, it's our talent and our people that are driving the innovation that's really the growth mechanism for the future. So I'd really start with our people. And then I think in terms of -- if you move to the product space, as we look at electrifying products and so on, obviously, great for the environment over time. And look at the postal service is a great example of a product that over time, that postal fleet will be increasingly electrified. And at the pace of the postal service can electrify and we just view that. It's a great opportunity, long term program, and I think that's going to be emblematic of other opportunities we have over time in leveraging green technologies.

Yes. The postal vehicles, Jerry, have a lot of enhanced safety features. And none of that was around when these original vehicles were built back in the late '80s, right? So the upgrade from the current LLVs from way back then to our NGDV, next-generation delivery vehicle, is huge. Whether it's fuel efficiency ICE, but, of course, battery electric vehicles, 0 emissions. You've got safety features and lots of things that just make this, frankly, a home run.

And on that note, on the earnings call, you folks spoke about you have essentially full capability to deliver 100% BEV on Day 1 if the customer saw demand, right, that would not impact the timing of production, correct?

Correct. Yes. We're -- so we start ramping up with production back half of 2023, and that could be really any mix up to 100% of battery electric.

And in terms of between now and then, you folks have gotten project awards, essentially to get you started and setting up the production line and engineering. When do we see meaningful revenue burn as you execute on that contract before we have a production?

The biggest -- of course, once you get into 2023 and we're delivering production vehicles, that's when you'll start seeing the revenue at much more scale. We'll -- as we're going through the project over the next, call it, 1.5 years, 2 years leading up to that point in time, you'll see some revenue from some of the engineering efforts and deliverables along the way. But certainly, a chunk of it is also going to be residing on the balance sheet that will from a deferred revenue standpoint. This will be accounted for as a contract similar to some of our other large programs in our defense segment.

Got it. And the other area of electrification is in scissor lifts. Can you talk about what's the pace of electrification for products? What proportion of your scissor-led sales are electrified today? What the customer economics look like versus diesel and any other product lines that are moving in that direction next as you see it?

Sure. If you look broadly at our Access Equipment segment, we've been electrifying products for really over 2 decades. And we've seen a lot of momentum just from electric over hydraulic or hydraulic over electric for a number of years. I think the next-generation now is our most recent all-electric scissors that have [indiscernible] -- use a small lithium-ion battery, single battery. They use electric actuators in place of hydraulics, it really takes -- regenerative charging as you're lowering it. So it really takes it to the next level. We're -- more and more, we're seeing electrification adopted in access equipment. I think with a lot of our initiatives on things like scissors, great application to use those for maintenance applications inside buildings, not having the hydraulic -- the risk of hydraulic fluid leaks and so on. So I think you'll continue to see adoption there. I think in construction sites, probably -- the infrastructure needs to continue to develop on work sites to be able to charge the equipment. But I think it's -- as I look at the construction side, I think it's going to be probably more evolution rather than revolution as it's electrified. But I think every year, you're going to continue to see momentum with the smaller products that can be used indoors probably happening at a more rapid pace.

And what do the economics look like, let's say, where outdoors, what's the comparable pricing point for diesel versus an electric scissor lifting? And how much cheaper are the operating costs for those products?

Yes. I think one of the big developments of those battery costs have come -- have begun to come down. The economic dynamics changing the economics make sense. I think your entry point or initial purchase is generally going to be -- and it varies depending on the product, but it's going to be more. But over the course of the life cycle, the cost is going to be less -- lower maintenance and so on over the life cycle. So I think the economics -- and I think John talked about it on the earnings call of that, too, that I think the economics are really helping to drive those use cases. And you see it in other places, too. We talked a lot about refuse collection space, and you have those fixed routes. You have drop off of -- at landfills or at recycling centers. So you have the opportunity to charge sort of defined routes. So the use case makes a lot of sense there, similar to the postal service or last mile delivery vehicles.

And what's your strategy in refuse? Are you going to partner with 1 or 2 OEMs or is it going to be a broader approach when it comes to [indiscernible]

We're -- right now, we're working with a couple of OEM chassis partners, and that's going real well. And as we just look more broadly at all of our products, I think you're going to see sort of a mix across our portfolio of products of how we -- whether we're -- the level of activity and level of vertical integration in the products.

We expect to deliver -- excuse me, deliver some units Southwest later this year. So...

Okay. And in terms of the margin improvement that you folks have delivered across Access and Fire & Emergency, is there more room to go for further structural margin improvement? Can you talk about what are the next steps to potentially drive profitability higher?

Sure. From a margin standpoint, the journey is never done. We're always focused on cycle over cycle over time improving those margins. And the journey is never done, and there's still opportunity in both the segments that I mean Fire & Emergency and Access. And really what drives that is the combination of -- we'll continue to drive our simplification initiatives. And so you see things like -- while we have very well-established manufacturing lines in many of our facilities, we're always taking it to the next level, further digitizing it, having connected tools to make sure you're torquing bolts correctly and that helps that first pass yield and drives labor hours out, but it's also on the product side and innovation. So I think our innovation has continued to drive strong margins in our products, and that's something that we're not going to rest on. We're going to continue to innovate. And I think that's -- again, that's going to help contribute to robust margins as we move forward in the future.

And for the Commercial segment, you folks have ramped up efforts on the move initiatives there. Can you talk about it as you've gone through the process and moved around the production lines? What do you feel like is feasible from a margin run rate standpoint? And over what time can you get there based on your experience in Access and Fire & Emergency?

Sure. We're seeing great momentum in the Commercial segment. And you saw this past quarter, strong year-over-year growth in margins. We have a little bit of a headwind was steel in the back half of this year, but the fundamentals of that business are solid and continue to improve. The focused factory approach that we're taking for concrete mixers moving those to London, Ontario, Canada as well as leveraging our Dutch Center Minnesota facility for -- really dedicated for refuse collection vehicles, driving some high flow manufacturing over time there. We absolutely see that momentum continuing into the future. This is a business that over the next few years, we believe, will be a double-digit business from an operating margin perspective. We don't necessarily see it at an F&E or Fire & Emergency type level. And the simple reason is for Fire & Emergency, they have a lower incidence of -- or use of third-party chassis. And so the third-party chassis are a little bit of a margin headwind. But again, I think we like the momentum we're seeing there. I spent -- before assuming the CFO role, I spent the last 10 years at Fire & Emergency. So I lived the journey we went through there firsthand. And I see a lot of those great successes and wins taking place at commercial. So we're really excited with what Brad Nelson and his team are doing there.

And a big part of the improvement in Access and Fire & Emergency has been the product innovation with better built-in margins and simplification. Is there a natural product cadence that we should be thinking about for the Commercial segment where we have a big product cycle kicking in?

We look at each fleet for certain.

Yes. I mean, I think you have just generally aged fleet, I think that -- and I think as in commercial, as you look at that business, that continuing innovation, whether it's electrification or other in, yes, I think we'll all be sort of tailwinds as we go into the future, increase focus on environmental, and I think those are all really tailwinds in commercial.

And in terms of setting up a new production line, we've seen you do it twice now once with this commercial change, the other in defense. Can you talk about how the operating methodology has changed? Because in the past, we would have seen higher variability down the same production line. And clearly, you're getting a return from setting up the new production lines in new areas. So can you just flesh that out for us? And what's driven the change in the process?

Sure. It's really the continuous improvement mindset. So if you look at some of the moves we've taken in defense, it's: number one, you need like a critical volume of product that you can put down those dedicated lines. And we have that with our -- with some of our defense products. But it's really -- it's something that it's a little less visible at Access, but this is something that Access is continually doing as well, but it's really implementing digital manufacturing, leveraging new tools to make it safer and more efficient to manufacture. And that's something we'll continue to drive. That's something once we get into postal service vehicle production, we'll be leveraging our learnings from the other moves as well. And -- but it's really safety, efficiency and ultimately, quality coming off the end of the line that these initiatives help.

And how much are you reducing labor hours per unit when you make this change? What's the magnitude of improvement?

Yes. So some of the moves we had in defense, you always see some labor benefit from these certainly the driving force behind them. I think it's a little more challenging in defense because we have -- we contemplated making these changes, and it really gets spread out over those contract margins when we have those cumulative contract adjustments and so on. So it's really baked in. But you can see some nice solid labor improvements over time, and we're always striving. We're always focused on what's the next initiative that you can get another 5%, 6%, 7% of your labor hours out, and that helps over time.

Got it. And then there's a little bit talk about steel inflation. So in the last steel cycle, you folks allowed up -- catching up the following year post the big surge because you have protected backlog. So price/cost was a positive the year after. How should we think about what aspects of this, the inflation cycle are similar to or different from the path on the last one with that context?

Got it. I'd say, first of all, what's a little bit unique about this one is it's -- I think, you had sort of a -- with tariffs that really drove it back in 2018, you had some inflation for a period of time is a bit more knowable. I think this has been a little bit unique that I think this has even alluded some of the best experts on commodity predictions, seeing the level of elevation. So it's something that we're continuing to watch on a daily basis. And we do have some headwinds in the back half of this year we achieve. We should get back to a price/cost balance over the course of next year. Of course, we're going to continue to watch what the trends are. And generally, you do get a little bit of a benefit on the back end. And I think we don't know when that end is in sight yet of when it starts reversing, but we don't have reason to believe that it would be different this time.

Perfect. And then can we talk about the business in China for you folks in access equipment? We've seen a number of new entrants into that market. Can you talk about how you're thinking about targeting in terms of the addressable market for you and how that's evolved, if at all?

Sure. China is a very robustly growing market, very, very strong double-digit growth year-over-year. It's going to be quickly emerging as one of the biggest markets in the world. As we look at China, it's a great market. Our goal is not to be all things to all customers really. We're focused on serving the higher end of that market sort of the premium product space where there's definitely demand for that product. So you probably won't see the levels of market share you see in some of our other markets over time. But it's a great growing market. We have a great place in the market and continue to see progress there.

And in terms of the cost structure for you folks versus the local competition, can you put into context for us and the pricing point as well?

Well, again, we're at the premium end of the market with the products that we're focused on. And we do have -- the products that we're selling in China are manufactured largely in countries. So we do have the manufacturing footprint there and are sourcing locally. And so that's -- so we have presence there.

And any consideration to roll out a second-tier product in China to attack that mainline segment and give folks a product option at a lower pricing point?

Again, our focus right now is on that top end of the market. And I think that's really what our strategy is. It's what's driven success in really across all the other markets around the world. So that's our focus at this time.

Okay. And then can you shift gears and talk about the markets in North America and Europe? As your field population of connected machines grows, can you talk about what you're seeing in the data? How are you using it to drive the aftermarket business? Any opportunities that are emerging as you get more and more data?

Sure. It is awesome with the level of connectivity of the products and the very valuable information, not only for our customers but for us. First off, I would look to utilization rates. Utilization rates have continued to improve as we come out of the pandemic. So I think it's very helpful having that more real-time type data and even get some regional flavor in that. So that's certainly helpful from a planning standpoint. From a -- I think over time, it's going to continue to help drive the aftermarket. I think we see -- one of the innovation areas that we're very focused on, I mentioned is, under innovate, serve in advance. You look at that center pillar or strategy of serving our customers throughout the life cycle. And connected products and telematics are really the future there to continue to increase the level of predictive maintenance that can be based on certain conditions and use cases and so on. So I think we'll continue to see that as a key information as we continue to drive that serve pillar.

And it's too early to see that moving the needle in terms of part share. We need to give it more time to mature in the field?

Yes. I think we need -- certainly, need more time, but we're seeing benefits continuing to mount there.

Is that right already?

Yes. Yes. I mean, I think, ultimately -- having that visibility, I think it's -- over time, it should -- we certainly expect to grow our aftermarket share of wallet.

Great. And then can we go back to the utilization rate comment. What are you seeing in the data in Europe, specifically? Where is the European market compared to 2019 levels from a utilization rate standpoint?

Sure. I would just say generally, North America has been very robust and recovering. Europe is actually -- we've said -- made comments on our earnings call that we thought that Europe would be a bit slower out of it. And certainly, Europe has had some challenges with the pandemic that they're -- from a vaccination standpoint, they're lagging behind the U.S. a bit. But ultimately, the utilization has been pretty solid there. It's not growing at the pace that North America is, but it's solid.

That's nice to hear. And Mike, you mentioned the ability to have higher visibility. Can you talk about what kind of visibility you have on your supply base today? How do the tools that you folks have to manage the supply base today, given what you've gone through with the pandemic, how those tools improved your ability to manage all of the pitch points that we're hearing about now?

Sure. I mean, supply chain is definitely a challenge right now. I think the good news is I would hats off to our supply chain folks that they've stayed very close to our vendors and throughout the process, and they've been outstanding partners and really to our workforce to manage through the pandemic. And -- but bottom line is it varies from day-to-day what the pinch points are. It's everything from -- you've heard about the semiconductor challenges, which is surprising on how many places semiconductors show up. And I've actually had a few head scratchers along the way of it. The good news is, we haven't had any major line stopping events. We've been very public about the -- how some of the automotive companies are -- had more extended shutdowns. We've been able to manage through that, but it's really -- from day-to-day, it varies. One day, it's wire harnesses have been a bit of a challenge from time to time with plastic connectors with the deep freeze in Texas affecting the plastic supply. There's hose challenges some days. There's some of the other components that have semiconductors. The teams have been doing a good job. I think with our products, they're a bit more conducive to shuffling the line a bit. If you're seeing critical shortages on certain products, you can shuffle other products ahead in the queue, if you look at like Fire & Emergency, as an example. But overall, it's a challenge, but they're doing a great job. And it's -- we do expect to have noise over the remainder of the year.

And you folks have been able to avoid meaningful premium freight charges as well. Can you talk about how you've been able to do that because some companies are build for that in addition to the raw material inflation that we spoke about earlier?

Oh, we are definitely seeing the higher transportation costs. I think if you just -- relative to the magnitude of impact of steel, and I would say more broadly, other commodities, it's probably not reading through as much. And I think, typically, with transportation, that tends to read when you make price adjustments on that, that tends to read through a bit quicker. So it's not so much that the costs aren't rising. It's a little bit the timing is a bit more favorable from a read-through perspective on the price side.

Got it. Okay. Let me address this one last topic. International JLTV orders, you folks have had some good flows. Can you talk about what the pipeline looks like? And what are your expectations over the next 18 to 24 months based on what you're seeing?

Sure. The pipeline remains robust on JLTV. We're still working with about a dozen different countries. And it's -- if you roll back the clock last year, it is about a dozen. And we book some orders so that the number of countries we're working with continues to grow. It's a process with all these orders, but it should generate some nice solid revenue. We had the bigger win earlier in the year with Belgium. There's some other -- there's a variety of size of some of these opportunities. Some are a bit bigger like Belgium. Some are a bit smaller, but to know that progress continues and about as we would expect, and we believe it will be a nice contributor in the future years here.

And the field population of Humvees outside of the U.S. is really significant. As you look at that field population, what proportion do you think will be replaced versus what proportion they're just going to continue to run like postal trucks today?

Yes. So I think there is -- the total installed base globally of Humvees is about 240,000, about half of those are up armored. That's sort of the -- and it's fairly evenly split between -- in the U.S. and outside the U.S. So you have -- that gives you an idea about 60,000 in the U.S. and then overseas, really about 60,000. So that gives you an idea of what the total market is. Those are -- they're not going to be replaced all at once overnight, but it gives you an idea. You think of how long that Humvee program was really 30, 40 years that it's...

Right. Old vehicles to replace.

Yes, it will be a process, but it gives you an idea that the size of the opportunity that's out there over time.

Okay. Terrific. Well, we're out of time. Mike, Pat, thank you so much for telecommuting to join us at our conference. Thank you.

No problem.

Thanks, Jerry.

Great. Thank you very much, everyone. Take care.