Dauch Corp Q1 FY2021 Earnings Call

Good morning, my name is Chad and I will be your conference facilitator today. At this time, I would like to welcome everyone to American Axle & Manufacturing First Quarter 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. I would now like to turn the conference over to Mr. David Lim, Head of Investor Relations. Please go ahead, Mr. Lim.

Thank you and good morning. I would like to welcome everyone who is joining us on AAM's First Quarter Earnings Call. Earlier this morning, we released our first quarter 2021 earnings announcement. You can access this announcement on the Investor Relations page of our website www.aam.com and through the PR Newswire services.

Thank you, David and good morning everyone. Thank you for joining us today to discuss AAM's financial results for the first quarter of 2021. 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 review the highlights of our first quarter 2021 results. Next, I'll touch on some exciting recent business announcements with Ford and REE and lastly, we will discuss the challenges within the supply chain and our financial outlook. After Chris covers the details of our financial results, we will then open up the call for any questions that you may have. In the first quarter 2021, AAM delivered solid operating performance and strong cash flow generation. Although the industry is facing continuity of supply issues, we continue to navigate through these challenges while delivering very strong results. AAM sales for the first quarter 2021 were $1.43 billion, up approximately 6% compared to $1.34 billion in the first quarter of 2020. The increase in our revenues on a year-over-year basis primarily reflects the recovery from COVID-19 related industry shutdowns that we experienced last year. Although North American industry production was down 4% according to third-party estimates, light truck production was up 5% year-over-year and volumes on our core platforms increased 9% year-over-year. Furthermore, light truck inventory on a number of the key platforms that we support remained extremely low. Consumer demand for light trucks remained strong and our customers are building them as much and as fast as possible.

Thank you, David and good morning everyone. I will cover the financial details of our first quarter results with you today. I will also refer to the earnings slide deck as part of my prepared comments. So let's begin with sales. In the first quarter of 2021, AAM sales were $1.43 billion compared to $1.34 billion in the first quarter of 2020. Slide 8 shows a walk of first quarter 2020 sales to first quarter 2021 sales. First, we add back the impact of COVID-19 of approximately $169 million, then we account for the unfavorable impact of the semiconductor shortage which we estimate to be approximately $64 million inside the quarter. On a year-over-year basis, we are impacted by GM's transition from a rear beam axle to a new lightweight and highly efficient independent rear drive axle for GM's new full-size SUV which impacted sales by about $38 million. The first quarter of 2021 is the last quarter of this year-over-year impact to occur. Other volume and mix were negative by $26 million. Pricing had an unfavorable impact of $4 million on a year-over-year basis. Metals and FX accounted for an increase in sales of $44 million. During the last six months, we have continued to see an increase in the primary index-related inputs to the metal-based materials that we purchase. You may recall, we hedged this risk by passing through the majority of index-related changes with our customers. The metal portion of this column reflects these elevated pass-throughs on a year-over-year comparison. Now, let's move on to profitability. Gross profit was $227.1 million or 15.9% of sales in the first quarter of 2021 compared to $195.3 million or 14.5% of sales in the first quarter of 2020. Adjusted EBITDA was $262.9 million in the first quarter of 2021 or 18.4% of sales. This compares to $213.3 million in the first quarter of 2020 or 15.9% of sales. As David mentioned, this was AAM's highest first quarter adjusted EBITDA margin in our company's history. You can see a year-over-year walk down of adjusted EBITDA on Slide 9. We benefited from the contribution margin on the increase in net sales from last year, but most importantly, we continued our strong cost reduction actions reflecting a year-over-year benefit of $28 million. Let me now cover SG&A.

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.

And the first question today will come from Rod Lache with Wolfe Research. Please go ahead.

This is Shreyas Patel on for Rod. Just wanted to pick up on that last point about the second quarter. You did mention it is going to be the trough in terms of the semiconductor issue. Any ways you can kind of frame the magnitude of the decline based on what you're seeing and how confident are you that supply is coming back, it's starting to come online and by the second half should improve?

Yes, this is Chris. We disclosed for our first quarter impact from a revenue perspective, a decline of $64 million. Our expectation for the second quarter is that it will be greater than that. Then it would moderate along that in the second half of the year on a quarter-by-quarter basis. That's how I would frame it as we sit here today from a revenue perspective. There will be a bit more customer-scheduled disruption in the second quarter versus the first quarter; we'll have a little bit of temporary inefficiencies inside our production schedules, which will again be discrete within the second quarter.

And then in the quarter, it looked like performance and cost performance was quite good. I think it was plus $28 million year-over-year. I was just wondering was there any semiconductor-related supply chain costs in the quarter and maybe what are some of the factors that really drove the strong performance?

Inside the first quarter, we did experience a little bit of drag related to metal-market indices. We do pass that through, but we only passed about 90% through, so it was slightly negative from that perspective and there was a little bit associated with premium freight as we coordinated our supply logistics through the semiconductor issues. But in terms of year-over-year holistically, you may recall in the second quarter of last year COVID was setting upon the entire industry. We announced and discussed significant cost saving measures for the balance of the year and you may recall we talked about a quarterly run rate of nearly $20 million. So the first quarter last year didn't have that benefit. We are still experiencing and benefiting from those initiatives we started really in the second quarter of last year that continued through the balance of last year and the beginning of this year.

Okay. And then just lastly on the agreement with REE, just wanted to understand a little bit more about the scope of this agreement. It looked like this was going to be a co-developed propulsion system for commercial applications. Would that be something different from what you already have developed on the light vehicle side in terms of your product portfolio? And is this kind of an exclusive agreement so their propulsion system would go into their platform going forward? Just trying to get a sense of that.

As we've communicated before, we've been working very actively on our next-generation products for electrification and our designs are modular and scalable. At the same time, we've integrated the motor, the inverter, and the gearbox into the EV unit. So there is a much smaller packaging space and we want to drive power density and performance. Electrification is really measured in the form of efficiency. We're seeing all of that and we designed the product so that it can meet various vehicle segments and support different regions of the world. We're adopting and transitioning that product to support REE Automotive's design needs so that we can support not only their e-mobility solutions but ours for the marketplace. This gives them an opportunity to enhance their product given the designs we've developed. We're integrating our solution into their chassis design, so it's a full flat-type design for commercial vehicle applications. We feel very good about the relationship and partnership and are excited about what the future holds for our two organizations. We have an aggressive timeline to develop the product for them, but we have a strong foundation that we're already working from and expect that we can bring this to the market sooner than later.

Okay. So it's kind of leveraging your existing product, and so we kind of think about content per vehicle, kind of similar to what you've talked about in the past, I think $2,500 something like that?

Yes. The only thing I would comment on is there are four units per vehicle, so the content per vehicle should be much higher for us based on the application and the design strategy to support their chassis design and platform.

The next question will come from Ryan Brinkman with JPMorgan. Please go ahead.

Thanks for taking my question. I guess this is the third quarter in a row now you've pretty substantially exceeded either your own margin guidance or consensus expectations, and I realize you've got some difficult year-over-year margin comparisons in the back half of the year, but still wanted to sort of check in on the likelihood of incrementals decelerating from like 61% in 1Q to something more like 16% in the remaining quarters of the year and then maybe just kind of looking beyond all this noise with regard to COVID a year ago and semiconductors and commodities this year. How are you generally thinking about normalized margin potential as we move beyond the current period including maybe relative to what your answer might have been prior to COVID?

This is Chris. Certainly there's a lot of noise with the puts and takes from COVID and semiconductors, and it's always a challenge to extrapolate a full-year run rate performance from a particular quarter. But in terms of key elements to think of on a go-forward basis, a lot of the cost initiatives and restructuring initiatives we've been putting in place over the last 12 months will continue to benefit the company. I would expect that to continue. Discrete items: R&D was a little light in the first quarter; our full-year run rate is typically in the $35 million to $40 million a quarter range, and we're a little light in the first quarter. That will ebb and flow with our electrification launches, but we think it's sized right to support our objectives. Pricing from a year-over-year perspective was a little light in the first quarter; that comes on usually in the second, third, and fourth quarters for us. The cadence of our launches was a little bit late in the first quarter, and project expense comes on a bit in the back half of the year. Big picture, our full-year guidance implies nearly 17% at the high end of our ranges, running at a very strong healthy pace, and there is continued opportunity to grow margins based on attacking our cost structure and optimization of footprint and throughput. That is clearly within line of sight in our guidance.

Okay. And then, yes, another on the collaboration with REE announced today. I realize they're using a fully flat or skateboard-type chassis, but can you remind us whether this technological solution qualifies as a hub motor approach and then maybe a related question. I think previously you haven't been as interested in expanding organically to compete more in the commercial vehicle driveline market. Given the investments incumbents have there and what that might imply for margin, but with the technological change taking place that could potentially disrupt current investments and with some of the things you're doing with REE, might it make sense or are you evaluating potential organic expansion into that end market?

We're very excited about the technology we've developed. Combined together with the motor and inverter and gearbox integration, we think we bring differentiating technology to the marketplace to serve multiple vehicle segments, including commercial vehicles. We're very open to expanding there. REE Automotive's flat chassis will allow us to open up other market applications. The technology we're bringing gives REE more freedom and functionality for their customers and will strengthen their product offerings. We think it's a tremendous opportunity for us to work together to address the market where we both can benefit greatly.

And the next question will come from John Murphy with Bank of America. Please go ahead.

I just wanted to ask a first question on GM's trucks and maybe even some of your luxury products that have been protected by the customers so far. If there were incremental pressures that came from chip shortages in the second quarter on production, would you have a higher-than-normal decremental margin in the second quarter? And then also if we think about those potential losses, not saying they're actually going to happen, but if potential losses occurred, do you think there is capacity to catch back up on some of that lost production specifically on GM's trucks? It seems like they're kind of running hard, not a lot of room to make up that production, so would that just be a net loss of production that couldn't be made up later in the year if losses occur specifically around GM's trucks?

John, GM has protected their products from semiconductor chip issues and they have clearly prioritized their full-size truck; we're seeing the benefit of that. They are running their plants flat out and using overtime where they can. At the same time, they plan on bringing the Oshawa facility back online, which will add incremental capacity going forward. Remember, their inventory levels are extremely low because they haven't fully recovered from the strike that took place over a year ago and were then impacted by COVID. Right now we see pedal to the metal with respect to the GM full-size truck platform.

So maybe if you could take that another way, David. Historically they did 1.6 million to 1.7 million on those trucks and right now I think capacity is around 1.2 million plus or minus. As you're bringing Oshawa on, where do you think that takes that up to and what is the potential upside in revenue?

It's around 1.35 million units for that platform. We're closer in line with that. That does not include Oshawa, so we expect that number to go north of that based on the volume they ultimately intend to produce out of that facility.

Okay, that's very helpful. And then just a second question on the re-agreement. As you think about the change of the powertrain or potential change in powertrain architecture, and I would say this would be only in limited cases, if you look at hub setups or whatever you want to call it, what does that mean for your content? In some ways a pessimist would say you're basically eliminating axles in that setup, but the reality is I think you have a lot of content potential there anyway. Can you help us think about what that means for you as far as content and whether there's any real significant risk to your traditional setup even on EVs going forward?

On traditional products, current electrification architectures have content per vehicle similar to prior ICE architectures, but with our integrated designs—motor, inverter, gearbox—we actually think we can improve or increase our content on the traditional driveline system. With respect to REE Automotive's approach, which is weighted toward commercial vehicles but can expand to other segments, our content per vehicle should increase significantly because of the vehicle architecture there. We feel very good about where we are. Our product designs are getting attention from traditional OEMs and new entrant OEMs, as evidenced by the partnership with REE and REE's partnerships with Mahindra and Hino and others. We're extremely excited about our technology and the receptivity from various customers.

You asked a couple of months ago when we laid out a lot of our next generation of architectures. We focus on designs being scalable and modular to adapt to many different platforms. This is textbook of what we're talking about.

Just one follow-up on payload and towing capacity. How does that compare from a more traditional axle setup as opposed to these hub motor set ups? Are these meant for lighter duty commercial vehicles or could they truly compete with body-on-frame typical setups?

It's still to be proven out. Over time it's more on the lighter side, but it can be enhanced to compete on the other end. I still think body-on-frame vehicles will persist for an extended period. We want to be agnostic to the market and have traditional ICE and hybrid applications available while also having electric offerings in different forms, including the traditional design and the REE flat-load EV chassis approach.

The next question comes from James Picariello with KeyBanc. Please go ahead.

I've got a content question as well, but maybe of the more traditional variety. Can you provide any CTV color on the power transfer units you're supplying to the Bronco Sport?

Typically on our all-wheel drive applications where we're supplying front mean modules and a PTU, think of it as a $1,000 to $1,200 range, and on the Bronco Sport, we're supplying the PTU so it's roughly half or slightly less than that range in terms of content.

Okay, that's helpful. And the company took an accelerated depreciation charge in Brazil during the quarter. Last year at this time it was in Thailand concurrent with axles exit from the country there. Just wondering what your thoughts are on the company's future in Brazil?

We still see a very strong future in Brazil. We're just responding to customers' changes in their strategy.

The next question will come from Dan Levy with Credit Suisse. Please go ahead.

Thank you for taking the questions. First, just a question on guidance for the year and maybe the cadence for how the year plays out and specifically, could you give us a sense for how much premium freight you incurred in the first quarter and how we should expect that over the course of the year? And then just second, as far as the dynamic on commodities goes, because I know a lot of it is pass-through, could you give us a sense for the cadence on what you expect on the metal market or commodity side and what the spill-through effect into 2022 might be?

On premium freight, as I mentioned earlier in the call, we spent maybe a few million dollars in the first quarter on premium freight for a variety of reasons, most related to coordinating our supply chain and some of the disruptions we've been discussing. I would expect that to increase a little into the second quarter and then dissipate in the back half of the year. As it relates to metals, the metal pass-through elements of our agreements are contractual and tied to market indices depending on the metal. These pass-throughs reflect current market pricing every 30, 60, or 90 days and will reset automatically. So as metal goes up, we will reset prices, typically with a 30- to 90-day lag on the index changes. That dynamic works across our supply base and customers, and over time it flows together across quarters, though timing can create some temporary disconnects. Based on current prices today, you'll see the impact in the first quarter; if prices go down, our metal pass-throughs will go down, and if they go up next month they will go up. It's hard to predict going forward since they are subject to market conditions.

So let's just assume prices stay flat versus going forward into 2022, there won't be as much of an effect because most of the lag is more limited. Is that correct?

Yes. If prices stay flat where they are today, you may see some re-calibration in the second quarter due to the lags I mentioned, but then it would reflect in subsequent quarters. The indices have been trending up through the first quarter, so you will see some movement as they reset.

Okay, great, thanks. I guess my second question, I wanted to think about the cycle. We have this massive inventory rebuild ahead given how tight inventory is and how strong demand has been. Whenever supply gets back online, you could be well positioned into 2022. It could help accelerate deleveraging. I know you can't take action right now given macro uncertainty, but can you give us a sense that if your earning stream accelerates, what options that opens up? What would your playbook be—what are the things you might do that you aren't doing right now? I assume there's some opportunity to accelerate prepayment of debt. What's the flexibility there and how does that affect EV development? If the cycle accelerates and there's a large inventory rebuild enabling you to do things, what could you do that you can't do today?

We see a very bright future and strong demand for the platforms we support for years to come, especially given low inventory levels and strong consumer demand. As fast as the OEMs can build them, consumers are buying them, so it will take an extended period to rebuild inventory levels. That will put us in a healthy position to generate a lot of cash. We'll use that cash, as we always have, to continue to support organic growth, with a big shift in organic growth toward electrification. We will continue to fund our R&D in electrification and profitably grow our backlog of new business. In addition, we will stay focused and disciplined with respect to paying down debt and will accelerate paying down debt—much like we just paid $100 million this past quarter—to further support getting the balance sheet where it needs to be.

On debt and prepayment, our entire term loan stack that's due in 2024 is pre-payable at par at any time, and then the bonds in subsequent years are starting to fall into call positions. So we have a lot of options available to address our debt profile.

The next question will come from Joseph Spak with RBC Capital Markets. Please go ahead.

If we go back in time a little bit, we know GM made a sourcing decision on the axles for the new pickup; you retained some and they took some in-house. They've been protecting that program which helped you. What I have less visibility into is the mix within that pickup truck mix and whether you think the plants and programs within that pickup truck mix have favored the axles you supply. Do you have any sense of that?

Between GM and AAM, we will make all the axles we can to support their vehicle production and as they expand production, we expect to be making more axles going forward.

Keep in mind we supply the heavy-duty SUVs and the split axles on the light duty. As those segments grow, we directly benefit.

They have installed capacity and will utilize that installed capacity, and the incremental growth has been supported by that.

And then maybe just to go back to the joint development agreement with REE, can you talk a little more about what types of vehicles or range of vehicles you expect this to be applicable for and who is doing what—how far into the propulsion system do you go? I believe REE has a skateboard architecture. I'm assuming you're not getting into that element, but any more color would be helpful.

We're not getting into their skateboard platform. What we're doing is integrating our newly innovative designs—integrated motor, inverter, and gearbox—into the wheel-end configurations for all four wheels that allows REE to have an even lower and more compact fully flat chassis that supports multiple vehicle program applications, heavily weighted on commercial vehicles, but able to expand to multiple segments.

Okay. So it's better suited for larger vehicles in its current application?

It can be scaled up and down vehicle segments but is currently targeted towards the middle to higher end right now.

Your last question comes from Brian Johnson with Barclays. Please go ahead.

Thank you. Everyone focuses on driveline as the big segment. However, it looks like some pretty dramatic margin improvement in metal forming, the businesses and part you got from metal dying that had some issues. Could you talk a bit about the margin expansion there and where it could go?

I'll make some initial comments and Chris can pick up from there. We took over the metal dying operations and incorporated them into our operations. We've worked very hard over the last three years to fully integrate that capability. We've consolidated facilities, increased capacity utilization at the remaining facilities, optimized the workforce to the new market demand, and integrated many AAM operating advancements into the facilities which drive throughput and productivity. We've been able to minimize some CapEx expenditures that each individual company might have spent because of excess capacity that existed due to market conditions, and because of our buying power in the marketplace we've picked up some new business in metal forming. One, because of some open capacity, and two, because of our purchasing power and operational skillset. That's been very positive. We also have a proven reputation for operational excellence and we're seeing customers come to us to protect their continuity of supply in this dynamic environment.

Brian, in terms of margin performance in that business unit, it has historically been strong—16% to 17%. You're now seeing it in the 18% to 19% plus range and the majority of this improvement is due to capacity rationalization, plant consolidation, throughput optimization inside our factories, and some purchasing power benefits with our strong steel buys. That was part of the thesis when we acquired MPG and how we would benefit that business unit.

And to add, think not only of traditional forgings for metal forming but also powder metal connecting rods, core powder metal parts, and some high-pressure die casting from an aluminum standpoint in that business segment.

Good. A second question, but more housekeeping prompted by trade at your headquarters. As we think about Q2, is there any sort of shipments that you were able to book leaving the factory that may or may not, when you talk about the end of Q2, if there are shutdowns or production disruptions in Q2, that means the parts are already on their way and you might see a little dip in terms of orders? Or is it more that even if that happens because of the rebuild, you're not really worried about that?

The customers for the most part take delivery at our docks. They do ship around and may ship later, but once they take delivery at our dock that is our sale. That's the simple way to think about it.

So could there be some work in process that they wouldn't need or order in Q2?

That would most likely depend on their initial July shutdown plans. But again, they book weekly orders and take delivery at our dock. We book the sale when they take delivery.

Okay. Thank you, Brian and we thank all of you who have participated on this call and appreciate your interest in AAM. We certainly look forward to talking with you in the future. Thank you.

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