Dauch Corp Q3 FY2020 Earnings Call

Good morning. My name is Moderator and I will be your conference facilitator today. At this time, I would like to welcome everyone to the American Axle & Manufacturing Third Quarter 2020 Earnings Conference Call. As a reminder, today's call is being recorded. I would now like to turn the call over to Mr. Jason Parsons, Director of Investor Relations. Please go ahead, Ms. Parsons.

Thank you, and good morning. I would like to welcome everyone who is joining us on AAM's Third Quarter Earnings Call. Earlier this morning, we released our third quarter of 2020 earnings announcement. You can access this announcement on the Investor Relations page of our website, www.aam.com and through the PR Newswire services. You can also find supplemental slides for this conference call on the Investor web page of our website as well. To listen to a replay of this call, you can dial 1 (877) 344-7529. Replay access code 10147154. This replay will be available beginning at 1:00 p.m. today through 11:59 p.m. Eastern Time, November 6. Before we begin, I would like to remind everyone that the matters discussed in this call may contain comments and forward-looking statements subject to risks and uncertainties which cannot be predicted or quantified and which may cause future activities and results of operations to differ materially from those discussed. For additional information, we ask you to refer to our filings with the Securities and Exchange Commission. Also during this call, we may refer to certain non-GAAP financial measures. Information regarding these non-GAAP measures as well as a reconciliation of these non-GAAP measures to GAAP financial information is available on our website. With that, let me turn things over to AAM's Chairman and CEO, David Dauch.

Thank you, Jason, and good morning, everyone. Joining me on the call today are Mike Simonte, AAM's President; and Chris May, AAM's Vice President and Chief Financial Officer. To begin my comments today, I'll provide some color on AAM's third quarter results. AAM's strong third quarter operating and financial results and free cash flow generation reflects the benefits of recovering global production volumes and our cost saving actions. AAM sales were $1.41 billion for the third quarter of 2020 compared to $1.68 billion in the third quarter of 2019. We estimate that sales were negatively impacted by COVID-19 during the third quarter of 2020 by approximately $87 million. In addition, our third quarter of 2019 sales included $155 million related to our U.S. iron casting operations. This business was sold in December of 2019 and is therefore no longer part of our sales base in 2020. Adjusted EBITDA for the third quarter of 2020 was $297.1 million or 21% of sales. This compared to an adjusted EBITDA of $265.8 million or 15.8% of sales in the third quarter of 2019. We estimate that adjusted EBITDA was negatively impacted by lower sales due to COVID-19 by approximately $16 million during the third quarter of 2020. Despite these challenges, AAM benefited from strong sales mix, our aggressive cost-reduction actions and the timing of customer reimbursement items to achieve a record quarterly EBITDA margin. Adjusted earnings per share for the third quarter of 2020 was $1.15, nearly double compared to $0.58 in the third quarter of 2019. From a cash flow perspective, AAM generated over $217 million of adjusted free cash flow in the third quarter of 2020. This also represents a quarterly record for AAM. Despite the significant challenges we faced this year, AAM has generated over $130 million of positive adjusted free cash flow year-to-date and we expect to generate additional free cash flow in the fourth quarter of 2020. As a result of the strong operating performance and free cash flow, we lowered our net debt leverage in the third quarter, and we continue to have a very strong liquidity position of nearly $1.5 billion at the end of September. While our third quarter performance was highlighted by strong operating performance and financial results, I'd like to take a minute to give you an update on an unfortunate event that occurred last month. On September 22, we experienced a significant industrial fire at our Malvern manufacturing facility in Ohio. Thankfully, all associates were evacuated safely and without injury. Since then, the AAM team has done a phenomenal job working with our customers and our suppliers to manage around this immense challenge and avoid any significant supply disruptions. In addition, we had sections of the Malvern facility back up and running within three days of the incident and have been utilizing resources at our other AAM metal forming facilities to protect continuity of supply. While we still have some work to do, I can assure you that we will continue to coordinate with our key stakeholders that are doing everything we possibly can to care for our impacted associates and protect our customers' production schedules. Chris will provide a little bit more color behind the financial implications of the fire a little bit later in today's prepared remarks. There is no doubt that 2020 has been a difficult and challenging year for everyone. Significant challenges remain to mitigate the global pandemic and repair economies around the world. In response, AAM has flexed our operations and have adjusted our cost structure. We have positioned ourselves to be a stronger company as industry buyings recover from the impact of the pandemic. While we still see uncertainty related to COVID-19, to date the automotive industry has been resilient, and has recovered quickly in many of the key regions of the world. Most of Asia has returned to pre-COVID levels. North America reached a 16-plus million units SAAR in September, and Europe is slowly but steadily improving as well. Customer production schedules look strong for many of the key platforms we support and a favorable mix towards light truck continues to benefit AAM. Today, we want to provide our revised financial outlook for 2020. Assuming the industry continues to stabilize, and there are no significant production disruptions for the balance of the year, our revised full year financial targets for 2020 are as follows: sales of approximately $4.6 billion, adjusted EBITDA in the range of $665 million to $680 million and adjusted free cash flow in the range of $220 million to $235 million. Two quarters ago, we were walking you through our breakeven cash flow scenario. Over the recovering global economy and automotive industry, the execution of our downside production playbook and cost reduction strategy, AAM is now on track to generate sizable free cash flow and reduce debt in a year full of challenges and disruption. AAM's performance this year demonstrates our ability to adjust our business and deliver solid results in a dynamic market environment. And while much of our attention this year has been spent on protecting the health and safety of our associates, providing our customers with long support and continuity of supply, adjusting our business to the new market demand and reducing costs and preserving cash, we have not slowed down our efforts to enhance our technology leadership and drive critical initiatives and investment in growth opportunities with a substantial emphasis on electrification. We continue to support our customers on current programs and upcoming launches on our award-winning electric drive units. We are also investing significant human and financial capital on the advanced development of our next-generation technology, focused on achieving industry-leading power density performance and cost competitiveness in the electric drive space that can be scalable to all vehicle segments and regions and meet various customer requirements. We have weathered the storm and navigated through a difficult environment. We remain cautiously optimistic about the macro trends facing the industry for the rest of 2020 and heading into 2021 and have taken the necessary steps to achieve operational and financial success in an ever-changing marketplace. You can see the impact our cost savings initiatives have had on our financial performance, and we continue to look for ways to adjust our business, optimize our capacity and structurally reduce cost. We have built positive momentum as it relates to our financial performance, and we expect to continue to build that as we head into 2021, allowing us to continue to exhibit industry-leading profit margins, generate strong free cash flow and compelling free cash flow yield and further strengthen our financial profile. And with two more electric drive system launches and multiple electric powertrain component launches next year as well as many significant new business opportunities ahead, AAM is laser-focused on paving a path towards profitable growth and an even brighter future for AAM through important investments in our innovative advanced propulsion solutions. And stay tuned for more developments in this electrifying area. We'll have more to say about our 2021 expectations after we close out this year, but excitement is already building as we start to put our plan and targets in place. This concludes my prepared remarks this morning. I'll now turn the call over to Chris May. Chris?

Thank you, David, and good morning, everyone. I will cover the financial details of our third quarter of 2020 results with you today. I will also refer to the earnings slide deck as part of my prepared comments. So let's go ahead and start with sales. Sales in the third quarter of 2020 were $1.41 billion compared to $1.68 billion in the third quarter of 2019. Slide 6 shows a walk down of third quarter 2019 sales to the third quarter of 2020 sales. First, we stepped down our third quarter 2019 sales by $155 million to reflect the sale of the U.S. casting business unit that was completed in December of 2019. Next, we add back the impact of the GM work stoppage from the third quarter of last year. Then we account for the unfavorable impact of COVID-19 on third quarter 2020 sales, which we estimate to be approximately $87 million. One note about the estimated COVID-19 impact, nearly two-thirds of it related to lower than expected sales in Brazil and India. While these markets are relatively small for AAM, they still were significantly impacted by the global pandemic during the quarter. On a year-over-year basis, we are also impacted by GM's exit of its Thailand operations by approximately $15 million. And the transition from a rear beam axle to a new lightweight and highly efficient independent rear drive axle for GM's new full-size SUV impacted sales by approximately $55 million. Other volume and mix was positive by $17 million, mainly driven by strong light truck mix in North America. Pricing came in at $10 million year-over-year impact and metal market pass-throughs and foreign currency accounted for a decrease in sales of approximately $15 million year-over-year. Now let's move on to profitability. Gross profit was $249.8 million or 17.7% of sales in the third quarter of 2020 compared to $248.7 million or 14.8% of sales in the third quarter of 2019. Adjusted EBITDA was $297.1 million in the third quarter of 2020 or 21% of sales. This compares to $265.8 million in the third quarter of 2019 or 15.8% of sales. This marks the first time in AAM's history to post a 20%-plus adjusted EBITDA margin quarter. Let's walk through how we got there. You can see a year-over-year walk down in adjusted EBITDA on Slide 7. Similar to sales, we backed out the third quarter 2019 U.S. casting EBITDA to provide a comparable figure after the sale of the U.S. casting business unit and added back the third quarter 2019 profit impact of the GM work stoppage. We then estimate that lower sales, as a result of COVID-19, impacted EBITDA by approximately $16 million in the third quarter of 2020. Other volume and mix, which also includes the impact of the GM Thailand exit and the full-size SUV transition was approximately $10 million. There were a few other significant items to call out as it relates to our EBITDA walk. The first thing to note was customer reimbursement settlement payments were approximately $22 million in the third quarter of 2020. This primarily relates to past engineering and design costs for new product development that were reimbursed from one of our customers in the third quarter as part of our R&D cost recovery arrangement for our future program. This resulted in lower net R&D in the quarter and ultimately, higher EBITDA. Another major factor in our financial performance this quarter was our cost reduction savings, which were approximately $24 million in the third quarter of 2020 compared to the third quarter of 2019. These savings came in slightly higher than those realized in the second quarter and aligned with achieving our target of a total of $60 million of cost savings in 2020. We experienced about $3 million in COVID-related costs in the quarter. Back in May, we originally expected to incur about $40 million of COVID-related costs in 2020, but we have been able to mitigate and avoid many of these potential expenditures. We now expect to spend approximately $15 million in 2020 for COVID-related startup and inefficiency costs. We did see a benefit from metal market and foreign currency of approximately $8 million, mainly driven by FX. And overall, our operations teams continued to perform on productivity improvements on top of these significant cost reductions for an additional net $4 million. Even when backing out customer reimbursement and commercial settlement, along with the favorable foreign currency that was realized in the quarter, it was an impressive operating and financial performance for AAM in the third quarter. As it relates to restructuring and acquisition-related costs, we incurred $9.7 million of such costs in the quarter. We also recorded $8.6 million of net expenses related to the Malvern fire that David previously mentioned. These charges are primarily related to the write-down of property, plant and equipment as a result of the damage of the fire, net of estimated insurance proceeds less our applicable deductible. As this event was experienced at the end of the quarter, we continue to assess the extent of the damage caused by the fire and related impact. These costs have been excluded from adjusted EBITDA and adjusted EPS. Let's take a look at SG&A expense. SG&A, including R&D, in the third quarter of 2020 was $66.5 million or 4.7% of sales. This compares to $92.7 million or 5.5% of sales in the third quarter of 2019. R&D spending was approximately $18 million for the third quarter of 2020 compared to $37 million in the third quarter of 2019. The decrease in R&D on a year-over-year basis primarily reflects the previously discussed R&D recovery. Now let me cover interest and taxes. Net interest expense in the third quarter of 2020 was $50.5 million as compared to $52.1 million in the third quarter of 2019. We continue to experience lower interest expense costs as we pay down our outstanding debt. Income tax was a benefit of $22.5 million in the third quarter of 2020 as compared to $40 million in the third quarter of 2019. You may remember last quarter that we recorded a valuation allowance of $36 million against our deferred tax assets related to U.S. interest expense carryforwards. During the quarter, the IRS and treasury department issued final regulations and additional proposed regulations that included important changes and clarifications and ultimately resulting in us releasing this valuation allowance in the third quarter of 2020. Our effective income tax rate when adjusting for special items and the valuation allowance reversal was approximately 15% in the third quarter of 2020. We expect our tax rate in the fourth quarter to be in the 15% to 20% range. Taking all of these sales and cost drivers into account, GAAP net income was $117.2 million or $0.99 per share in the third quarter of 2020 compared to a net loss of $124.2 million or $1.10 per share in the third quarter of 2019. Adjusted earnings per share was $1.15 in the third quarter of 2020 compared to $0.58 per share in the third quarter of 2019. Now let's move on to cash flow and the balance sheet. We define free cash flow to be net cash provided by operating activities less capital expenditures, net of proceeds received from the sale of property, plant and equipment. AAM defines adjusted free cash flow to be free cash flow excluding the impact of cash payments for restructuring and acquisition-related costs. Net cash generated by operating activities in third quarter of 2020 was $249.5 million. Capital spending, net of proceeds from the sale of property, plant and equipment was $40.5 million in the third quarter of 2020. Cash payments for restructuring and acquisition-related costs for the third quarter of 2020 were $8.2 million. Reflecting these activities, AAM's adjusted free cash flow in the third quarter of 2020 was $217.2 million. This is a quarterly record for AAM to reflect strong operational profits, significantly lower capital spending and implementation of cost and cash savings initiatives. It also includes an income tax refund we received of approximately $31 million related to the utilization of net operating losses under the provisions of the CARES Act. From a debt leverage perspective, we ended the quarter with a net debt to LTM adjusted EBITDA or net leverage ratio at 4.7x. This is down from the second quarter of 2020 on the strength of our EBITDA and cash flow generation. Liquidity at the end of September was approximately $1.5 billion. We had over $0.5 billion of cash and no amounts outstanding on our revolver at September 30, 2020, and no significant debt maturities until 2024. David has gone through the details of our updated full year financial targets, so I will not repeat them. I believe our continued performance in 2020 highlights AAM's ability to adapt and flex our cost structure. Our cost savings actions have helped drive significant operating profitability and cash flow generation in a turbulent year. We are busy working to deliver and build upon these cost savings actions that we believe will position us well for a successful 2021. Stay tuned for more detailed guidance on next year as we turn the calendar. Meanwhile, we look to close out 2020 on a strong note and continue to make important progress on innovative next-generation electrification technology that will power our opportunities for growth for a long time to come. Thank you for your time and participation on the call today. I'm going to turn the call back over to Jason, so we can start the Q&A. Jason?

Thank you, Chris and David. We have reserved some time to take questions. I would ask that you please limit your questions to no more than two. So at this time, please feel free to proceed with any questions you may have.

Your first question comes from John Murphy from Bank of America.

Just a first question, there's obviously a lot of moving parts around COVID and then some of your rationalization activities. You've got MPG back on track here. It seems like just based on what we can see. You're applying 15.6% to 16.7% on EBITDA margin in the fourth quarter after what seems to be like a 19% plus even adjusted number in the third quarter. So I'm just curious, David, as you think about the EBITDA margin going forward, is there any reason that you could maybe get back to the 16% to 17% range you had in '18 and '19 pre the trouble with MPG and once we're through the COVID noise?

John, no, I mean, listen, obviously, this was an unprecedented year for us. And we've taken the structural changes that we need to make to our overall cost structure. We've resized the business to a lower market demand. We're letting buy-in be our friend as volumes continue to pick up globally around the world. We're clearly hopeful to be able to perform at that level that you've outlined. But we're not giving that guidance today; we'll give that in early next year. But clearly, we are comfortable in regards to the changes that we made to our business that we'll continue to generate industry-leading financial performance.

Yes, John, this is Chris. I'd also point you to our first quarter performance here this year, where we posted nearly 16% as COVID was starting to settle in. You see the cost savings actions we've taken really in the last three quarters, nearly $60 million, and you see a favorable truck mix and volume ahead of us. So we think we're lining up really nicely. We're very focused on continuing to deliver that $60 million here yet this year. And as you know, some of those were temporary in nature, but we're looking to convert those to more fixed in nature in terms of cost improvements. So we're excited for next year, and we're excited to deliver strong margins.

Okay. That's very helpful. And then just a second question. Any update on backlog on the bidding process what you've won, any news you can give us there?

The only thing we can say now is we've got two vehicle programs in production today. We've got two additional electrification programs that will be launching next year as well as some component support for the electrification. Our market basket is about $1.5 billion of new opportunities, of which nearly half of that is tied to electrification, the rest on traditional products. We're very comfortable with where we are with our technology advancement and where our backlog sits at this point in time. I mean, clearly, there's a shift from the traditional product to more of the electrification product, and we're just trying to position ourselves in the marketplace to win our fair share of the business. We clearly need to sort out what portion of the business the OEMs want to do themselves internally versus what will be outsourced and then make sure that we have a value proposition to support that growth.

David, is it fair to say that despite the mayhem, you're still making progress on bidding and everything you're pursuing? It doesn't seem like things are stalled or that there will be delays in building the backlog. Activity on that side still appears relatively normal. Is that a fair statement?

Yes. I mean, we're seeing a reduction in some of our traditional and conventional business opportunities as OEMs are looking to carry over more product going forward, but we're seeing an uptick in regards to electrification opportunities. So they'll balance themselves out going forward.

And our next question comes from Joe Spak with RBC Capital.

Chris, I want to clarify something. R&D was $18 million, but did you say that was netted against the $22 million settlement? So it was really more like $40 million, because I think you said it would be at a higher rate in the back half of this year.

Yes. The concept is correct. The $22 million includes R&D recovery as well as a commercial settlement. About two-thirds of that is R&D-related and will be netted in, so you would have to gross it up. That brings it closer to the $35 million range.

$35 million. And is that the right way to think about the quarterly spend on a go-forward basis?

Yes. In the near term, yes, obviously, we continue to; one, deploy resources in converting from traditional product into the electrification space, which will be cost neutral, but obviously deploying towards development and design of our next-generation product; and we'll probably continue to spend into 2021, probably step it up a little bit in terms of some R&D spend related to electrification. And you may recall some of our previous commentary if you rewind about a year ago, our range was in that $35 million to $40 million range. We're pressing closer to $40 million as we are investing in electrification. A lot of our cost savings initiatives that we put in place now have allowed us to redeploy existing cost into electrification, and we won't have to probably add as much as we've previously done.

Okay. And then my second question is just, David, I realize you indicated you need to see what your customers plan to do in-house versus externally as they move to electrification. I'm wondering, on structure, whether you're seeing any changes in development in how customers are thinking about some of the larger vehicles, where we have seen some of these vehicles put motors closer to the wheel versus arrangements like the Model 3 or ID.3 or even the I‑PACE, which has the EDU more in the center of the vehicle. Do you think that approach is right for larger, more capable vehicles? Are you investing there, and what is your capability if that structure evolves?

Joe, the best cost solution from an electric drive utilization standpoint is still a center differential with motors and power electronics integrated into them, not necessarily out in the wheel hubs. We recognize that some OEMs are evaluating that technology. We ourselves are developing some of that technology as well. But we still feel that the best value proposition is more of a center differential with the integrated motor and power electronics or inverter. We have developed some wheel-hub motor technologies, but we still feel the integrated center solution provides the best combination of cost, packaging and performance for many segments. Ultimately, it's about the customer's value proposition and package constraints. We're developing modular architectures that allow us to go after a variety of segments, whether it's center-mounted EDUs or other integrated approaches.

Our next question comes from Rod Lache of Wolfe Research.

Can you hear me?

Yes.

So I'm just trying to think about what does the number that we just saw kind of mean? So if we ex-ed out the reimbursement and commercial settlement timing, you would have done $275 million of EBITDA. You'd be annualizing at about $1.1 billion on that. How should we be thinking about that number? Is it realistic that you could be doing $1 billion or more of EBITDA, if you were able to sustain, I guess, an annualized run rate of revenue of $5.64 billion?

Yes, Rod, this is Chris. Look, a couple of other things I would tell you to think about in what you're trying to articulate there. We did have some favorable FX and metals run through the quarter, right? And you see that spiked out also on our walk. I don't know that that's a number you would try to annualize; it happens from time to time just based on currency. So that's a little bit discrete inside the quarter. I would also tell you, our cost reduction actions at $24 million. Our objective was to be on pace for $60 million for the full year this year. And as we mentioned, some of that cost save is temporary, right, that will come out a little bit in the fourth quarter. So think of temporary wage reductions such as that. But we'll level out probably a little bit lower than that on a quarterly basis. So we had a very strong third quarter element to that, but you'll have a little bit of leveling from that perspective. But the rest will then depend on your sales level; we still see nice strong mix from the truck side, and we'll continue to obviously work on the productivity side. We'll focus on the cost side a little bit too, maybe R&D spend and things like that, that we were talking about on a previous question.

Okay. But we're talking about that; it's just that $8 million, maybe $30 million annualized or something like that, and some portion of that $24 million that you would say is something we wouldn't want to run rate. Is that clear? There's nothing...

Yes, I wouldn't run rate that on a quarterly basis, right? You would just annualize this quarter. You have to look at overall...

Okay. So you don't. I mean, we're not really dramatically lowering EBITDA here. It looks like you're at least at $1 billion at that level. Or is there anything else you would say we should keep in mind, a benefit that is not going to be sustained beyond what we're seeing right now? For example, the other markets you pointed out, like Brazil, are not that great. You've pointed out a number of other things that are not great, and we were operating with about a $15 million SAAR on average for the quarter.

Yes. When you look at the third quarter discretely, you have to look at the number of production days, you also have to take a look at the fact that our customers ran during what they would typically have as shutdown at the beginning of the quarter, which was even above and beyond normal production days inside the quarter, and you'll have seasonality throughout other quarters of the year. So just extrapolating one quarter, you have to take that into consideration as well.

Okay. And I know that, David, you'd been talking about savings opportunities even beyond the $60 million that you had originally laid out. Any updated views on that? Or should we be thinking, look, at this point, you really want to crank up the investment in some new areas like electrification. So we should be thinking that the cost structure we see today is something that you'd want to maintain?

Yes, Rod, again, this is David. We've done a tremendous job as an organization optimizing our capacity, structurally reducing our costs, and rightsizing our business to the new market demand. At the same time, as we've said for multiple quarters, we will continue to invest in electrification and advanced developments. So yes, we'll keep focusing on that and make sure we remain an industry leader in traditional and conventional products, generating the industry-leading margins we discussed, while also positioning ourselves to capture our fair share of electrification as the market transitions. The big question is when. I remain long on the internal combustion engine for a period of time, but I also recognize that electrification is here today and will grow. It's just a matter of how fast it grows, which segments grow, and which regions grow around the world. We feel we've really optimized our cost structure and will continue to look for ways to drive capacity utilization. Obviously, with the Malvern fire we experienced, we had to shift a lot of product, which increased utilization at some other facilities, but we were able to protect our customers that way. We've tried to turn a negative into a positive. Other than that, as we said earlier, volume is starting to recover in most of the major regions of the world, which bodes well for us, especially given how our products are positioned in the marketplace.

And our next question comes from Brian Johnson, Barclays.

Two questions. One, we're all kind of going after the same issue. But could you maybe help us with the walk from 3Q to 4Q? Looks like if you back out the $22 million reimbursement in the FX metals, it's still a 48% decremental margin. Does that imply there are other costs coming back? Or is it just typical seasonality?

Yes. Brian, this is Chris. Let me give a little insight as we think about walking from Q3 into Q4. My commentary is centered on the midpoint of our full-year EBITDA guidance and what that implies for Q4. You mentioned the $22 million one-time items, which will be excluded. Also consider the FX and metal market element of about $8 million. Another key factor is fewer production days. Our sales per day are very similar year-over-year if you extrapolate full-year sales, but we have four to six fewer production days. That represents nearly $100 million of revenue based on our guide, and you'll see that drop at roughly a 30% decremental in Q4, similar to how our profits move with revenue. There is also some performance leveling — about $24 million — that showed up a bit in Q3 and will settle down somewhat in Q4. Pricing is somewhat tail-weighted toward the back half of the year, particularly late in Q4, so you'll see an element of that as well. Finally, around the company some project expenses and launch activity are starting to pick up again as these activities restart into the balance of next year.

Okay. Secondly, can you give us maybe more of an update on your electrification efforts, which you did discuss in 2Q? But since then, there's been a number of announcements, certainly a number of start-up packs with getting into the EV market, GM announcing its LTM skateboard and which, as you are painfully aware sent your stock down the day they announced their plans to largely in-source that. So we know your three platforms that you're pursuing. But just as you think about your core large SUV pickup truck market, how do you see; a, participating in that on the electrification side; and b, the threat to the kind of solid beam axle driveshaft, traditional business as well as what you've gotten from Metaldyne should more of that go into the all-electric route?

Brian, this is David. First of all, the GM announcement wasn't a surprise to us. We've been working very closely with GM ever since our company started back in 1994 and we have a close working relationship. We clearly understood what they were doing from an LTM battery standpoint and some of the supporting EDUs and the different product lines they're looking to support from a vehicle standpoint. They've made investments there and made a strategic decision to in-source that work. Where OEMs are in-sourcing work, whether it be GM or others, we're still in the game supplying components and subsystems. Where OEMs outsource work, we clearly want to go after the full integrated EDU units, so we'll continue to focus on that. We have those units developed today. At the same time, we're working on advanced technology that we think will bring greater power density, better cost competitiveness and greater overall performance in a smaller packaging space. When it's all said and done, it's about providing the value proposition to our customers. We're going to defend our space and make sure we put forward the right value proposition for pickups, SUVs and crossovers, while at the same time developing product that's modular and scalable and allows us to go after the front-wheel-drive market that we, quite honestly, really don't support a whole lot today. We picked up some business when we acquired MPG in the front-wheel-drive passenger car market, so we see growth opportunity there. At the same time, we're positioning ourselves to defend our current business. As I stated earlier, I'm still long on the internal combustion engine for pickups; I think it'll be around longer than people think. But I also recognize that there are new vehicle entrants bringing electrification. GM, Ford and Chrysler or FCA are all going to do what they need to do to protect their truck market. Like any good supplier, we're going to offer them value propositions to help them protect their market share going forward. We feel very good about our products in the market today that are in production. We feel good about the new products we'll be launching next year, and we also feel really good about where we are with our advanced developments or next-generation products, which we're accelerating, improving and actively discussing with various customers.

Okay. Any wins in the heavier-duty light truck marketplace? Or is there anything in the pipeline there?

As I said, we're in discussion with customers right now but nothing to announce at this time. I don't know of anything that's really been sourced from the traditional Detroit 3, other than what GM has decided to do internally with their announcement. And Ford has indicated that they're going to have F-Series product that will be electrified as well. Again, the volumes are lower than compared to the bigger platform that pays all the bills today for their development, not only on electrification, but other things that they need to do. There is activity with, as I said, the upstarts or the new entrants, and we are in a position where we're supplying componentry in some of those cases.

Our next question comes from Itay Michaeli from Citi.

Just was hoping to maybe talk about, as you think about the next, let's say, two or three years for the company, your latest thoughts on how we should think about revenue relative to end markets, so growth over market and whatnot. As well as, Chris, maybe on the deleveraging front, hoping you can give us an update on kind of how you see that progressing over the next couple of years and when you expect to hit some of your prior leverage targets?

Yes. Look, Itay, look, obviously one of the key objectives of the company is to continue to delever. You saw us do it this quarter, while we're still obviously a little bit high from a leverage perspective, but our cash flow generation, our continued very strong focus on strong cash flow generation with lower CapEx, strong operating performance and then obviously, building EBITDA will allow us to continue to delever. So that path to delever is still, we think, very favorable for us, and it's a top priority for the company. As we think about our growth markets, look, I think you see a couple of things going on inside of that over the next couple of years. You see and think of our core product, for example, you see light truck vehicles, whether they be pickup or crossover vehicles continuing to gain share in that market, which obviously is a sweet spot for us, which we continue to supply into and enjoy the benefits of providing consumer interest in that product set. You heard David articulate a lot of the areas we have working now in the electrification space, where from a component side, from a full EDU side, we continue to invest in and win business in. That's an area of growth for us. Also on our more traditional component side, metal forming, powdered metals, such as those areas, we continue to see interest and growth in that segment. And then lastly, on our VCS business, which supports the downsize hyper type engines, a lot of opportunity in that space, winning business there as well. We see that growth continuing.

That's helpful. And then just a second question. With the COVID cases unfortunately rising in the last couple of weeks, are you seeing any additional risk in the fourth quarter of supply chain disruptions? I'm just curious if any of that risk is embedded into your fourth quarter guidance.

Itay, clearly, the risk with our supply base started back in January. We've been able to manage that risk successfully through the first quarter and the third quarter when we were actively running production, obviously the second quarter when our operations were down, mainly here in North America and part of Europe. There wasn't as big of a concern. But clearly, we have to watch that just because of country announcements or government announcements or regional announcements in regards to where our supply base is. So there are some challenges that are out there with respect to that. But at this time, they've all been very manageable. We've had nothing that's interrupted our continuity of supply to ourselves or ourselves to our customer as a result of the COVID issues right now.

Yes. Itay, as it relates to your question on our guidance, we embedded in our guidance a little bit of cost as we talked about $15 million for the full year, of which we incurred about $9 million year-to-date. No significant impacts beyond that have been included in that associated with COVID through the balance of this year.

Yes. Itay, again, the biggest thing that we're watching is volumes are picking back up and accelerating going forward. We're watching the financial health of the supply base right now to make sure that they can financially stomach the working capital demands that are going to be placed on them. And so we're keeping a watchful eye on the entire supply base and right now, that's a very manageable list for us at this time.

Our next question comes from Dan Levy of Crédit Suisse.

First, I want to ask a follow-up on debt paydown and how you view that relative to R&D. If you generate incremental EBITDA next year, assuming the cycle continues to recover, what is the opportunity for additional debt paydown? How do you prioritize deleveraging versus R&D? Deleveraging is clearly a key priority, but with the wave of EVs there's likely increased desire to boost R&D to enhance your EV offering. How do you weigh the two against each other? Is there incremental benefit to increasing R&D even if it means missing the opportunity to pay down more debt, or is the clear priority to deleverage first and defer R&D?

Yes, Dan. First, I would tell you regarding our ability to pay down debt: our debt instruments are very flexible. We can pay those down. We have prepayable debt at any time. So we're in a good position from that standpoint. But I think the crux of your question is, do you reallocate capital from debt paydown to R&D? I guess what I would tell you is embedded in our performance now is a sizable amount of R&D; we believe this is the appropriate amount to support the growth that we see in front of us and to continue to support the next generation of products we're getting ready to launch. And obviously, investment in our future and investment in growth areas such as that are critical to our long-term success. We will continue to support those. If at a point in time in the future we felt that opportunities continue to expand and present themselves, we would obviously continue to invest in our R&D space to drive our product set, to drive our growth, and to expand our customer base. That being said, if you look at the amount of free cash flow that we're generating as a company, we can clearly support debt paydown, and we can clearly support the investment in our product that we need to do.

Great. And then just to clarify your initial comment that you have flexibility in the debt paydown: do you need to see a certain sustainability in the end markets before proceeding with debt paydown, or as you realize upside should we expect you to move quickly to pay down that debt?

Yes. When we think about gross pay down, obviously, if you pulled cash, your net debt would come down. But from a gross debt paydown, certainly, time and circumstances are always considered a factor, when we think about it. You think about forward trajectory of the business, you think about timing and seasonality within the year. First quarter is usually an outflow use of cash flow, for example, for us. You want to think about the macro environment. But again, we have four years of no debt maturities being 2020 to 2024. So we have a lot of flexibility in how we handle it.

Okay. Great. And then as a second question. I wanted to ask actually about your, what we'll call, Powertrain 1.0 content. And I think we know, obviously, all of your customers are accelerating on EV development. And within that, there's significant deallocation of your own customers' resources away from current combustion vehicles. But obviously, at the same time, there is this dynamic that while this massive deallocation of resources, we still know what the mix of combustion vehicle is, and especially for your core markets, North America, combustion vehicles are still 98%. So is it possible that customers are shifting their focus to more EV that you could arguably gain more Powertrain 1.0 content that you could gain more, I guess, outsourcing as automakers have to rely more heavily on the supply chain as they shift thereafter?

Dan, the answer is yes to that. First and foremost, I'm long on the internal combustion engine, especially here in North America, and we're in a very healthy position in regards to our market share. And when you look at the mix of the vehicles today, heavily weighted towards trucks, SUVs and crossovers, which is right in our sweet spot. So we're going to continue to perform very well, not just for a couple of years but for multiple years going forward here. At the same time, as the capital demands grow and become larger within the OEMs, they're going to have to assess how much they want to stay in the manufacturing business of 1.0 technology versus what they might want to outsource. If they decide to outsource, they're going to look to companies like American Axle that have a proven operating capability, proven quality performance, proven launch performance and proven continuity of supply performance to them. Because they can't afford to have their profit pools interrupted from a financial standpoint. So we think we're in a very good position right now in regards to where our mature products are on the traditional product that the internal combustion engine related products. We're investing heavily in electrification to position ourselves appropriately in the various markets around the world based on what we think the timing and the adoption may be in those respective markets. And then we're just going to have to clearly monitor and stay close to our customers in regards to decisions that they make with respect to their portfolio. Every company, whether you're an OEM or supplier is evaluating our portfolios right now and deciding where we want to make our strategic bets from a financial standpoint. That's not only relevant today because it needs to pay the bills but also makes us relevant in the future for sustainability going forward. But again, the short answer to your question was yes, we think there'll be opportunity in the future there.

Right. And are you having any incremental discussions with customers on that front now or is it still just still too early in the game?

Yes. I'm not in a position to comment on that, nor should I, if I was in discussions, but nothing to announce or discuss at this time.

Your last question comes from Ryan Brinkman of JPMorgan.

Thanks for taking my question which is yet another one around the implication for out-year margin, although not specific to '21 from 3Q's big beat, cognizant, of course, that you're not going to be guiding until early next year. I think your normalized margin is maybe or hopefully, structurally increased here as a result of learning to be leaner post COVID. Firstly, if you could just confirm that that's your view also? And then secondly, in terms of trying to understand just how much normalized margin might have improved, you called out a couple of tailwinds, including FX, commercial settlement, et cetera. Even backing out those items, though, I think margin would still have been around 13% in 3Q. How would you rate the sustainability then of this $24 million in cost reduction actions? What proportion of those savings come back with volume versus being more permanent in nature? And how does that category differ from performance and other?

Look, in terms of that $24 million you saw flowing through the third quarter, I would think you hear our commentary. We said we would perform at $60 million for the full year of 2020, which was effectively Q2, Q3 and Q4. So you sort of had to level it out a little bit more in that range. And the delta between that, I would call core operational performance. So this would be rightsizing your overhead structures. For example, this would be limiting certain overhead spending in that area as well, manpower wise from a salary perspective. We're more, I would call, traditional productivity, traditional performance where you're increasing throughput on your lines, you're optimizing hours per part produced. Things of that nature, reducing scrap, where that will continue. Obviously, that's been a core of the company. We'll continue into perpetuity, quite frankly. But we do those things to offset things like price downs and inflation and things of that nature. So the $60 million we talked about delivering here this year, we expect to be sticky going forward. Some of it is temporary. We're repopulating that, as I mentioned, with some more structural stuff. It'll take a quarter to build that back in. But that would be our thought process going into next year and beyond.

Okay. Very helpful. And then finally, I'd be curious if you have any content on the new Hummer EV or other electrified products at GM that you're permitted to talk about? Or maybe just more generally, if you have been awarded or what you can talk about in terms of awards for electrified full-size pickup trucks that are currently out there in development?

Yes. Ryan, we're not in a position to answer that question at this point in time.

Thank you, Ryan. We thank all of you who participated on the call today and appreciate your interest in AAM. We certainly look forward to talking with you in the future.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.