Nexteer Automotive Group Ltd

HKEX:1316

Earnings Call Transcript 2018-Q1

[Operator]

Ladies and gentlemen, welcome to the Nexteer 2018 First Quarter Investor Communication. [Operator Instructions] Please note that today's event is being recorded.

I would now like to turn the conference over to Investor Relations Director, Mr. Cameron Wang. Please go ahead.

[Cameron Wang, executive]

Thank you, Keith. Good day. Welcome, everyone, on the phone to Nexteer Automotive's 2018 First Quarter Global Investor Conference Call.

It was just over 1 month ago. Today, we meet again. Before today's meeting, a note for everyone. Our 2017 annual report has been [indiscernible] and was filed this week. You may download it now to have a complete view of the company's details for 2017.

Back to today's meeting. In our U.S. headquarter office today, we are pleased to have our Executive Board Director, President, Mike Richardson; Senior Vice President and CFO, Bill Quigley; and the Senior Vice President and Global COO, Tao Liu, to share with you over the company's latest development for the first quarter this year. Mike will give us the Q1 business update first, followed by Bill's commentary of the market. After Bill's remarks, we will open Q&A.

We would like to keep today's meeting to 40 minutes. Today's presentation slides are available on our company's website on the Investor Relations.

Before I turn over to Mike, as usual, I have to remind you of the safe harbor statement for today's discussion.

Welcome, Mike.

[Michael Richardson, executive]

Cameron, thank you, and thanks to everybody on the phone. As Cam mentioned, we were just on the phone with you 30 days ago to review 2017 full year. And the fact we just finished the NDR 2 weeks ago, so we're fairly current with most of you on the phone. And as you might expect, not a lot has changed, but we'll faithfully follow our schedule for quarterly updates. Q1, Q3 are always qualitative communication, and we plan to share complete first half results August 14.

You're familiar with our strategy to a profitable growth, 6 elements. Today, I'm just going to highlight 2. One is expand and diversify our revenue base, and that will be shared through footprint expansion that we use to take advantage of the commercial opportunities. And second, strengthen technology leadership. And this, again, is footprint expansion to expand engineering bandwidth. And the remainder, you're familiar with. We've covered them recently.

But before we get into those topics, I'm going to ask Bill just to update us briefly on backlog.

[William Quigley, executive]

Great. Sure, Mike, and thanks for everybody participating today on our call. I think, as Mike highlighted, while it's been a month since we issued our year-end results, certainly, I think, when we've spoken with many of you over the last several weeks.

So again, a update with respect to our backlog, which we've highlighted on Page 5 here. And you'll note here, at the end of the first quarter, our backlog stood about $24 billion. It does reflect a slight increase from our year-end report of $23.9 billion.

During the quarter, new bookings were slightly ahead of our revenue. And the distribution of backlog across product lines remained very stable, as you can see here, with EPS representing 70% of the backlog.

And certainly, as we discussed with all of you, the backlog is the best representation of what Nexteer's product line revenue composition will become in the future. And certainly, that heavy weighting to EPS drives an opportunity for margin accretion in the future.

We've also shared with many of you in the past, we do maintain a very disciplined approach in methodology preparing our backlog. I'm also pleased to note that the 4 China domestic NEV programs that we shared with you at year-end with BYD, GAC, Renault and Changan are now reflected fully on our backlog at the end of March.

Every year, our booking opportunities provides their own unique timing of award with our customers. And based on our assessment of our current year opportunities, we do expect the timing of customer awards this year to be weighted towards the second half, which will favorably impact our backlog performance.

And so with that, I'll hand it back over to Mike.

[Michael Richardson, executive]

Thanks, Bill. Just a brief update on launches. We had 4 new customer launches in Q1. I'd make mention of the new Ram 1500. It's a 0.5-ton, full-sized, body-on-frame truck. Our content is REPS, rack-based EPS and Columns throughout North America. If you haven't looked at this vehicle, it's worth taking a look at online. Chrysler has made a substantial redesign. This is a good-looking truck with a lot of content, more than they've ever had in the past.

Also 3 A-segment vehicles launched all with Changan, the X70A SUV and then the Eado, Eado XT sedans. Those are launched in China.

If we spend a minute on 2 footprint topics. First is a groundbreaking that we completed on March 22 in Kenitra, Morocco. We were asked to locate there by both French OEMs, as they move to this new region. This will be their low-cost manufacturing site serving Europe first and Africa second. PSA has been a longstanding customer of Nexteer, and we're thankful for them. Renault, Nissan, Mitsubishi is a breakthrough customer, and I spent some time with you on the phone 30 days ago and then through our NDR discussion to share with you the success that we've had with them on the multiple product lines. And that includes the demand that will come through Morocco. The scope of our arrangement includes production programs with both -- and for both steering and driveline products, and our initial launch will be next year.

During the NDR, I also mentioned increasing demand and opportunity for software-driven features and functions in steering systems. They do this through software that we're able to bring to production, high level of safety; systems that are fail operational, cybersecure; the ability to perform B2X communication, including, first of all, communication on board with collaborating subsystems and then the environment and the vehicle autonomy.

So the second footprint example I'll share is centered on improving technical bandwidth to deliver software as a key differentiator among our competitive peers. We're finding increasing opportunity to differentiate ourselves and exploit software capabilities as a competitive advantage. We've been production coding electric power steering systems for more than 20 years. Steer-by-wire is a -- is the very current initiative, requiring about 3x the number of lines of code, 3x more than state-of-the-art conventional EPS today. We consistently code our products to the A-SPICE industry standard, and this is emerging as the standard that the world will move to over time. Defined software architecture, how it's structured and tested, effectively linking software back to every customer requirement.

So just to scale magnitude of this particular initiative, we plan to add 150 software engineers through the balance of 2018. This footprint initiative supplements 3 global tech centers that have been in operation now full year 2017, and 14 customer service centers where we position ourselves, where the customer makes key technical and commercial decisions.

We've also talked with you about vehicle autonomy and ADAS functionality over the last couple of years. During our full year '17 NDR, we shared with you that we had 7 active ADAS programs. Each project's scope is unique. When you look across the industry, just for context, the vehicles you see are generally sub-level 3 in their ADAS functionality. The Waymo minivan, the FCA Google initiative is level 4 capability, still in testing. You see them on the roads throughout the Western United States right now.

But one current initiative for us has taken us to participate in level 5 capability. The platform is the GM Bolt EV. The basic platform of this vehicle is excellent in terms of functionality, price point, vehicle range. The level 5 variant that we're steering now has no wheel or pedals. And it's a demonstration platform for now. This is not a revenue topic, but it's strategic to us and to General Motors, and we're thankful to be a part of this cutting-edge development.

The physical evidence you'd see, if you look at this product, are things I've talked to you about in the past, dual motor, redundant motor sensor, dual PCB with redundant microprocessor, dual vehicle communication, dual power supply, dual connectors.

So beyond a favorable CPV profile, we believe this is time well spent because these are all elements of the safety architecture we've acquired for steer-by-wire, which will be the next frontier.

Then finally, from my side, we also shared an update on the connects motion venture last month. Since we returned from the NDR, we spent some time with our technical team who's come back from Sweden. And I'd just add today that this winter test sequence gave us access to a broad range of customers. 14 different OEMs drove our vehicles, 150 evaluators, exposure beyond what we've ever had in the past. And since we've returned, we've been filtering many, many requests for follow-up, interest from these OEMs, several of which we don't serve today. And our intent is to down select those opportunities that represent the greatest opportunity for revenue and earnings growth.

So we'll continue '18 with continued product development based on performance feedback received during this critical winter test season.

Bill I'd ask you just to conclude our messaging today.

[William Quigley, executive]

Sure. And just a quick comment on our credit standing. Post our year-end earnings release, Moody's upgraded Nexteer's credit rating to BA3 or investment-grade based on our strong financial performance, balance sheet standing and product metrics. And we're certainly pleased with this rating and now have investment-grade ratings from both credit rating agencies.

We'll certainly continue to focus on the 4 elements of our capital allocation priorities, be it investor drive organic growth from the business, debt service and capital market access, pursuit of smart acquisitions and alliances and certainly shareholder returns. This certainly provides us the opportunity to continue to actually [indiscernible] our focus that provide the foundation of our strategy for profitable growth.

So with that, this concludes our formal remarks, and I will turn the call back over to Keith for questions. Thanks all for participating today.

[Operator]

[Operator Instructions] And the first question comes from Nick Lai with JPMorgan.

[Y.C. Lai, analyst]

I know we talked about this just about a month ago, but 2 very simple question. First on margin and second on payout ratio. And on the margin side, yes, second half last year, we've had some additional effect on [ intangible ]. And also, we offer effective pricing to customer. And I guess, both are more one-off in nature. And we are, right now, in middle April, so can you help us understand on how we should think about first half margins? That's the first question. And secondly, given you have a lot of cash, can you remind us of [indiscernible] strategy?

[William Quigley, executive]

Sure, Nick. This is Bill. I'll take a shot at the first -- actually, both of them. From a margin perspective, you're right. Our second half results last year compared to our first half results, we did see some margin deterioration. There were a couple of, I would say, nonrecurring items, as we spoke to, one being, obviously, a impairment charge or a D&A uptick related to the cancellation of certain programs with the PSA acquisition of Opel. Secondarily, we also -- as we discussed in our NDR and on our update, we did experience some premium launch cost in the second half, most notably the fourth quarter, in North America regarding a customer program launch that obviously went through the end of the year and to somewhat into the first of the year as we're rightsizing our production capability to the demand that we're seeing from the customer. That impact was about $12 million to $14 million in the second half, largely a North American nonrecurring item, if you will, the premium costs as well as what we saw on the impairment charge or the D&A uptick impact in Europe. I think, as we look into the first quarter, we're -- I'd say, we've stabilized on North America with respect to that program launch still somewhat in a higher elevated cost profile, but certainly not to the magnitude that we experienced in the second half. So we are seeing our margin recovery there second half, the first quarter at least preliminarily. With respect to pricing that you highlighted, that was largely an Asia-Pac phenomenon in second half versus the first half. You'll recall, we had very high margin profile in first half of the year 2017, but still ended the full year at about almost 20% EBITDA margin for Asia-Pac. But we did give some pricing back to the customers in the second half. Pricing comes and goes. We have contractual pricing, obviously, in many of our contracts with our OEs. But this is pricing more, I would say, was kind of unique and anticipation of retaining current business as well as awarded new business. So I think that's going to be a little lumpy. But certainly, the margin profile and the business we expect to move back, if you will, more in line to where we ended full year 2017. There's going to be some, obviously, equation there with respect to volumes that we see from our key customers in Asia-Pac, and we're very closely monitoring production schedules. Nick, you'll probably note that China production was up in the first quarter. We're looking at that by platform with our customers to ensure that we're, at least, aligned line with their production schedules. And certainly, we'll give an update in the first half. Moving to the second piece of the equation. The net cash position at the end of 2017 was $110 million. We did uptick the payout dollars to -- from a dividend perspective to about $70 million. It does represent a 20% payout ratio. We hold that constant. We are also providing our shareholders the cash benefit related to the significant onetime tax benefit we received from the enactment of tax reform. And you'll recall that was about $39 million noncash benefit at the end of 2017. So we're passing along a 20% payout ratio on that noncash portion as well.

[Operator]

And the next question comes from Jia Lou with BOCI.

[Jia Lou, analyst]

I have very quick questions. The first one is about how our order backlog. We find the backlog in the first quarter seems quite stable compared with that at the end of last year. I wonder if you will face a potential order backlog growth in this year, likely the third quarter or sometime else. And the second one is about how our new clients. We see some new businesses already [indiscernible] the massive OEMs, such as Changan, BYD and GAC. I wonder if we have got new businesses with other Chinese-owned brand [indiscernible] such as [indiscernible] or anyone else. And the third one is about the autonomous driving business. We've seen today some traffic accidents related to the autonomous driving vehicles, such as that of Uber. Has that influenced the public's or the government's attitude towards autonomous driving? Or will it influence our long time table of steer-by-wire in 2020?

[Michael Richardson, executive]

Lou Jia, this is Mike. Just to echo some comments Bill made, the -- we're pleased with where the backlog is in Q1 because we know that looking at '18, each year has a different profile of opportunities. We really pursue a fairly finite number of programs each year. And we have clarity about when the customer intends to source, when the customer intends to launch. Some years are front-end loaded. Some years, it's Q2, Q3. This year is more heavily loaded Q3, Q4. So we think about this on a calendar year basis. I'm happy with the alignment of opportunities we have. Quarter-by-quarter, it's just going to play out and follow the customer sourcing decisions. New business, nothing to announce yet today. But I can tell you with great confidence, we'll have something to tell you about when we get to the first-half call. Autonomous vehicles had been in the press with people cautious about reaction to accidents, very, very public accidents, well publicized. This has not, to my knowledge, really changed any of our program timing. But every OEM is aware. We're in discussion with every OEM about what preventative actions we need to take to be sure that we steer clear of trouble like this. It's just a natural part of the evolution of such a profound technology change in a big industry. And I'd say, statistically, there will be more events like this. The industry is going to have to absorb them and adapt to them, and we'll move along with those changes.

[Operator]

And the next question comes from Yizhe Wang with UBS.

[Yizhe Wang, analyst]

I'm going to ask 3 questions. The first question is about China, and we have noticed that China recently announced that they lifted the flooring OEM shareholding cap. Just so from a supplier's perspective, how do you see the impact to future expansion plan in China? And my second question, more on the North American market. Given GM will gradually shift the platform to T1 platform starting from this year, so what's the outlook for our pricing [ model for this year ] and the margin level for our steering products after the migration? And then the third question is about the 10% repurchase mandate. Assuming it is approved, so under what conditions we will consider the option?

[Cameron Wang, executive]

This is Cameron. So can you repeat the first question?

[Yizhe Wang, analyst]

The first question is about China. And China recently announced to lift the flooring OEM shareholding cap. So from the supplier's perspective, so what's the impact to our future expansion in China?

[Michael Richardson, executive]

The 50-50 joint venture relationship, right? Let me take the second question, first of all. I was with General Motors yesterday. We had a very good discussion at a high level. And one of the topics we discussed was their transition from K2 to T1. Full transparency, I had shared with you information from the public domain that indicated they intended to take 2 of 4 plants down for 12 weeks. Their plan today is not that extensive. They have a very coherent plan to carefully ramp down K2 as they ramp up T1. So I'm really more optimistic about unit shift than I was because we're on both the old and the new platforms. But they do still intend to transition 2 plants this year, 2 plants next year. They'll lead with pickups, and they get to SUVs. The -- I wouldn't worry about that transaction price because, typically, when we do a model-to-model change, we have reduced our cost base to allow us to be competitive on any contest. This is just one example we're talking about. Margin profile should be equivalent. We have the same hurdles we've always had. There's really nothing exceptional there to report. Now let me pause. Can one of you speak to the...

[William Quigley, executive]

Yes, I think -- at least it's a perspective, I think, with respect to the ownership percentages, the JV percentages, if you will, that President Xi outlined in his remarks, that there will be an opportunity potentially to take as a controlling interest in local JVs. That's interesting to us, obviously. It's a good opportunity. But as you recall, we've got a number of JVs that we operate under a 50-50% relationship right now, one being, obviously, in full operations, our Chongqing joint venture as well as one that's in startup with Dongfeng. So we kind of look at that. Those are our key domestic OEM customers in the market. And as we've talked to all of you in the past, as we approach these customers and work through the product lines they offer and so and so forth, we also have the opportunity to supply that JV as Nexteer for various components. And obviously, we then have the opportunity to reflect that revenue that we sell to the JV in our own consolidated financial statement. So those types of relationships have worked well for us, so we'll continue to explore those into the future. But I think the comments made by President Xi were, I would say, provide some upside. And certainly, as we move forward in the future, we're very optimistic with respect to our footprint in China and the relationships that we're developing and maintaining not only with our current customers, but certainly with new domestic OEMs, as we highlighted in our year-end report.

[Michael Richardson, executive]

One thing I would add is when we enter a new region, we often have a mother plant to help them, a mother-daughter relationship between an established plant and a new plant. And we will get them started by providing the major content, so they learn how to assemble function test, determine suitability for use and so forth. But at this point, in China, in particular, we're quite mature. And each site, whether it's wholly-owned or JV, is fairly autonomous. And the supply lines remain, for the most part, within China. There was a question about 10% repurchase that I'm not...

[William Quigley, executive]

Yes. I think it's really -- I think it's a real question around our capital structure and our capital allocation approach. Certainly, as there are opportunities for a repurchased plant, I don't think that's really, in the near term, a area that we would be focusing on from a Nexteer perspective. We certainly want to provide a return to the shareholders. And I think, over the last several years, we provided a pretty substantive return to shareholders via dividends. We're obviously focused on growing the business organically, increasing capital where we need to, to take advantage of opportunities in the market, but also certainly focused on what alliances can we deliver as well as what acquisitions may be available to us. So I think, in the nearer term, while share repurchase may be one tool available to us, it's probably not a tool that we'll use in the near term.

[Operator]

Again, the next question comes from Ethan Liu (sic) [ Yuqian Ding] with Goldman Sachs.

[Yuqian Ding, analyst]

So 3 questions. So first of all, we've mentioned our strong business development momentum. We've also heard the fact that some European clients to breaking to them. We'll probably give like 1% of the bad business also across the [indiscernible] from the feedback of other suppliers who are trying to break into European accounts. And also secondly, the domestic brand, I think is also breaking into them, generally people are concerned they don't have much quite good price discipline. So it feels like the midterm will gain some growth momentum, but probably at cost of the near-term marginal expense cost. Could you share a bit more context about this potential conclusion? And secondly, we've had increasing policy and regulation momentum in connected and autonomous vehicle in China. So from your business development activities with the China OEs versus the global OEs, do you get a feeling that in China, the steering-by-wire rollout might be much faster given all the government pushes behind that? And thirdly, you mentioned earlier about the global acquisitions and where we're trying to looking for. So when we [indiscernible] these deals, the SOE ownership, will that be a negative factors? Or will that be taken as a global firm?

[Michael Richardson, executive]

Okay. Maybe just a comment on the first one. The simplest way I can represent it is we continue to run, far and away, the majority of the business in a very conventional pattern. We're serving nearly 60 customers to date, 10 of the world's top 12 OEMs. And as we grow with them, we've got a natural cadence on modeling the price down, cost reduction that they collaborate with us on because it needs to be validated. And we've done very well preserving our margins. But I told you a year ago, we recognized opportunities beyond our current customer base and taken us to breakthrough customers, like Renault as one example. We don't really have any substantial revenue stream. We have 0 revenue stream prior to breaking in on EPS. And so sometimes we have to incentivize them to spend time with us and validate because they don't really have a reason to bring in a new supplier, we're forcing the issue, so they get to know us and we become a preferred choice for them. So there will be, sometimes, one-time payments made to break through and develop that first revenue stream that we can use to our advantage over time. We've done very well with scale, as you've seen. I'm going to turn to Robin Milavec. Robin is our Vice President and Head of all engineering globally. Slide down here by this microphone, Robin. Just wondering if you've got any comment on autonomous vehicles, steer-by-wire when it comes to China, specifically.

[Robin Milavec, executive]

Yes. So hello. It's good to be with everybody today. I would -- the comments I would have about autonomous vehicles is, certainly, globally. We're seeing interest in most OEMs on autonomous vehicle development. In China, market is no different. I think a lot of the work that we've done over the past 3 or 4 years, as Mike highlighted, with level 4 and level 5 vehicles is really paving the way. That technology is an enabler to steer-by-wire and has put us in a leading position in our ability to serve the market from that technical standpoint. We are working with China OEMs on that technology. And I see this as an evolutionary step as we begin to pursue steer-by-wire. Globally, China will certainly play a key role. And we are partnering with specific OEMs in China to develop that technology today.

[Michael Richardson, executive]

Thank you, Robin. And just a comment about acquisitions. Most of the time we spend with you talking about the business, we stick to the facts, things that we can prove and demonstrate and repeat. And so it's generally been an organic growth story. I will say, though, behind the scenes, we're highly interested in opportunities for acquisition. There really is no opportunity that we're aware of right now that would take out one of our competitors. But there are so smaller opportunities that would allow us to expand our geographic presence or allow us to gain technical capability. Chairman will be with us in the U.S. later this month, and we've got several topics queued up to review with him. But I'd say, Yuqian, we have not crossed that line yet to have something to share with you. I'll just say, for now, it's very much top of mind for us and part of our normal cadence of discussion with the Chairman.

[Operator]

[Operator Instructions] As there are no more questions, this does conclude our question-and-answer session. So thank you so much for all the questions and for today's participation. If there are further queries, please contact us at [e-mail]. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.