Nexteer Automotive Group Ltd

HKEX:1316

Earnings Call Transcript 2020-Q1

[Operator]

Ladies and gentlemen, welcome to the Nexteer Automotive Group Limited 2020 First Quarter Investor Communication Call. [Operator Instructions] Please note, today's conference is being recorded.

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

[Cameron Wang, executive]

Thank you, Rocco. Good day, welcome, everyone, from Nexteer Automotive 2020 First Quarter Global Investor Conference Call. Three weeks ago, on March 30, we reported 2019 annual results and followed a virtual NDR by phone with many investors. As a part of our annual communication scheme, today we hold this quarterly call. It will take around 30 minutes covering a few updates of the company.

Joining us today are our President and COO, Tao Liu; Senior Vice President and CFO, Bill Quigley; and the Senior Vice President, CTO and the Chief Strategy Officer, Robin Milavec.

During the presentation session, Bill will first give us an introduction of our company's operating environment and later summary remarks. Robin will provide an update from company's product and technology perspective. After the presentation, we will take some questions.

Before I hand over to Bill, I will remind you that today's communication package has been posted on our company's website on the Investors portal, where you can download it, under the safe harbor statement covering today's communication.

Welcome, Bill.

[William Quigley, executive]

Okay. Thanks, Cameron, and good day to everyone. As Cameron just stated, I'll start our Q1 2020 update with a quick overview of our current operating environment, then hand the call off to Robin, who will provide a technology update, and then I'll end some closing commentary and certainly an opportunity for questions.

So let's move to the next slide. It's only been a short time since we spoke with all of you post the release of our 2019 annual results announcement on March 30, and there's been really little change in our operating environment. All of us today are again calling in remote for this update as we do our part to help contain the current health crisis.

As we discussed a little more than a couple of weeks ago, our manufacturing operations in North America, India, Europe, Morocco and Brazil are currently in shutdown as well as our technical and administrative facilities, including our corporate headquarters in Michigan, in compliance with country mandates and customer production suspensions. Only our China operations are in [ serial ] production at this point in time. And like all of you, we're closely monitoring the news out of each country as to potential list of current mandates and coordinating with customers on their return to operations expectations. In North America and Europe, a number of our OEM customers are targeting May to recommence vehicle production, although any restart will be governed by existing facts and circumstances and potential government restrictions.

We also believe that as OEM assembly operations come online, production schedules will be gradual and staged to ensure that people's safety standards are in place and operating and supply chains are capable and responsive. This view is based on our recent experience in China which I'll review in a coming slide.

Meanwhile, we continue to execute cost actions, working capital management and capital investment reductions and deferrals wherever possible as we navigate the current environment. And although a firm restart date with certainty remains somewhat elusive at this time, we are also confident that the automotive industry will, in fact, restart in the coming months, and we've adjusted our manufacturing and operating playbooks accordingly with the top priority being the ongoing health and safety of all of our employees as we enter a new normal of operations for the foreseeable future.

Next slide. As we discussed with all of you during our 2019 annual results review, we engaged quickly and to date successfully in addressing the impact on our operations from the initial health outbreak in China in mid-January and February. And we are -- certainly are thankful and grateful for the tireless efforts of our local and global Nexteer teams, which allowed us to restart our China operations safely and as efficiently as possible. We also have view that while demand was low upon restart, we believe we would experience slow but steady increases in customer schedules as we move through March and into the second quarter.

The China Association of Automobile Manufacturers, or CAAM, recently released passenger vehicle unit production and wholesale activity for the first quarter of 2020, which is summarized on this slide and provides evidence of gradual recovery. As expected, February was a low point of vehicle production and wholesale activity, both falling around 86% sequentially when compared with January as China enacted aggressive lockdown measures to contain the outbreak.

Post restart, March activity showed a rebound from the February low, reflecting a staged recovery and IHS in its most recent April production forecast release is now expecting China Q2 production to increase to around 4.8 million units, reflecting a 59% increase from the Q1 low, with April and May production to improve sequentially from March by 23% and 35%, respectively. Although we would also note that Q2 2020 expected production will be lower by about 12% compared with 2019, and IHS is now forecasting full year 2020 production down by about 16% compared with 2019. We expect the staged and steady ramp-up trend will likely be the scenario experienced in our other regional operations once customer production begins.

We've employed lessons learned from our recent experiences within our China operations as well as guidelines published by the World Health Organization and Center for Disease Control and Prevention as well as industry peers on how best to restart our operations, and we've incorporated those into our global manufacturing and operating procedures and protocol. These enhanced protocols will be our new normal with a safer workplace for all of our employees as our #1 priority. Our playbook is designed to protect all of our employees based on best practices learned across many industries as well as health organization guidelines with new standards and operating procedures further enhancing our already strong focus on employee health and safety.

Our playbook consists of 5 major categories. First, local regulations and requirements for national, state and regional health organizations; protecting the safety of all of our people in the business both in our manufacturing operations as well as our technical and administrative offices; third, additional quality control standards to further monitor and assess our suppliers' incoming components, including components of stage in our plants prior to shutdown; fourth, production readiness, focusing on equipment maintenance and a clear understanding of our customers' forward schedules to ensure we have the right resources in place to start up as efficiently and effectively as possible; and fifth, material readiness, which includes assessment of our supply base and transportation systems to ensure we have a smooth flow of material into our plants and out of our plants. Many of the additional protocols we are implementing are new for our people, and we are providing training and communication in the use of these new standards and requirements.

So if we turn to the next page, I just want to spend 1 minute further on people safety and the additional steps we are taking to ensure that our employees are confident in returning to work as well as having the means to be as productive as possible. We've added many new practices to how people will even report to work, including daily temperature and health questionnaire checks. All employees will need to pass a daily check to access our facilities, and this information will be electronically linked to everyone's badge. Physical distancing is being built into every part of the business. Every manufacturing position has been evaluated for proper distance and any position that does not meet the 6-foot standard will have a physical barrier put in place. All community areas, such as cafeterias, break areas and meeting rooms, are being rearranged to meet distancing requirements as well as break times modified to limit the number of people in any area at one time.

And finally, shift times have also been modified to limit the number of people coming through entry and exit points at any given time. While workstations are being modified to provide each person their own cleaning supplies and each person will be responsible for keeping their work area clean with job rotations limited to reduce the opportunity for contamination. Employees will also need to wear a company-provided PPE, or personal protection equipment, in specific areas in the plants and offices and will be trained in the proper use of this new equipment. We also have protocols in place if any unsafe situation occurs as well as the communication standards for such situations. Certainly, while our employee health and safety record is strong, these additional measures are being implemented across all of our facilities to further protect our people, again, in this new normal mode of conducting our business.

If we move to the next slide, our practice has been to provide an update on our quarterly bookings and backlog performance with the information provided here being our 2019 results. But I trust you would all agree on this call today, these certainly are not traditional times. Coming off strong customer bookings in 2019, we had targeted ongoing success in 2020 with an expectation that current year customer awards would be weighted to the second half of the year in line with previous customer program schedules as well as our experience in 2019. However, in the current environment, we expect our customers to continue to evaluate and potentially defer future product plans as the timing of restart of current vehicle production is a near-term focus and priority.

From a backlog perspective, forward year OEM production forecasts are a key input. Given the dynamics and volatility around OEM production forecast for 2020 alone, the reliability of rest of year as well as forward year production estimates remains low. So, as an example, you're likely aware that March IHS moved to providing twice monthly production forecasts. Compared with their initial March 2020 full year forecast, they have twice lowered global production estimates and significantly. In late March, they reduced their full year 2020 production forecast by 6.7 million units, or 8% compared to their initial March update. And on April 16, they again further lowered their full year production forecast by 7.8 million units or about 10% compared with their March 30 forecast. This is just one example of the tumultuous time we are in. So accordingly, at this time, we've decided to temporarily suspend our backlog update until the return of the more stable environment comes.

I'll now hand over the call to Robin to review several steering product technologies that we're bringing to market. Robin?

[Robin Milavec, executive]

Thank you, Bill. Hello, and good day to everyone on the call. When we recently rolled out our 2019 annual results, I mentioned that we have been awarded business with a new EPS product. That product being dual pinion EPS. Let me spend a few minutes discussing why we think this is a significant introduction that will enable Nexteer to continue our 2-year trend of retaining 100% of our incumbent business and conquest a significant amount of new business. From a steering load capacity standpoint, dual pinion sits above single pinion EPS and below Rack EPS. In the past, this has been a niche market without significant vehicle volume. Recently, however, there have been 2 trends that are creating a larger market in this segment. The first is cost-reduction initiatives for the lower output range of Rack EPS typically on midsized SUVs and larger passenger cars. Let me also highlight that this cost-reduction initiative does not apply to the majority of our current Rack EPS portfolio, because it is used on full-sized trucks and SUVs, where the steering loads are in the upper range of Rack EPS capability.

The second trend is the electric vehicles, where their steering loads are typically higher than their IC engine predecessors due to the added weight of their batteries. These 2 trends have created a growing market for dual pinion technology that Nexteer is poised to capitalize on. Nexteer is currently the #1 global supplier of both single pinion and Rack-based EPS systems. The dual pinion product leverages our existing technology and scale in both single pinion and Rack EPS and allows us to fully address the market from low to high steering loads and everything in between.

On the next slide, I want to spend a couple of minutes on the Nexteer advantage with dual pinion EPS. As the leader in single pinion, we have continuously been expanding the limits of that technology to become even more capable of higher steering loads. This technology development on single pinion is directly transferable to the dual pinion product and results in a market-leading steering capacity of 14.5 kilonewtons. Our dual pinion EPS product has already been fully validated in the laboratory and has been demonstrated to OEMs on SUVs and D-segment sedans. We will launch the first wave in 2023 on a light commercial vehicle application, and we are already in the hunt for new conquest opportunities with this technology.

Our competitive advantages will be twofold. One, leveraging our massive scale in single pinion and Rack EPS, the dual pinion product will immediately be cost-competitive. And two, with the steering loads capability up to 14.5 kilonewtons, this product will be able to steer loads higher than our competition, giving us a significant technical advantage. With an expanding market-driven by the electric vehicle powertrains, Nexteer is poised to conquest a significant additional volume with the dual pinion offering without cannibalizing our current single pinion or Rack EPS market share.

So now I'd like to move to high output REPS. As the world leader in Rack EPS technology, Nexteer has never been satisfied with the status quo. We have embarked on research and development activities aimed at increasing the steering capacity of our already class-leading REPS product. Steering up to 24 kilonewtons of load on a 12-volt electrical system would have been unmatchable just 1 or 2 years ago. Yet today, that capability exists with the Nexteer high-output Rack EPS product. This market segment today is primarily served by hydraulic steering systems. The market consists of the heavy-duty pickup trucks in North America and medium-duty commercial vehicles globally. Today, much of this market is not realizing the advantages of electric power steering, namely features such as enhanced fuel economy, premium and customizable steering wheel and ADAS features, such as lane keeping and other safety enhancements. In fact, in the heavy-duty truck market in North America, most OEMs are selling premium trucks without premium steering. This high-output Rack EPS technology will change that. Nexteer has already booked 2 applications for this technology, one for an electric vehicle and another for an ADAS Level 4 and 5 platform. Other OEMs are taking note of this technology, and we are getting significant amounts of new inquiries from within this market space.

So I've highlighted 2 examples of technologies directly focused on new business growth for the electric steering market, and it's technologies like these that will enable conquest business wins that will add to our future revenue opportunities.

With that, let me turn it back over to our CFO, Bill Quigley, to wrap up today's communication.

[William Quigley, executive]

Thanks, Robin. Like electrification sustainability is a continuing mega trend shaping the automotive sector and will have a significant effect on how we all operate and compete in the future, we see this as an opportunity to further differentiate ourselves with not only our customers but with all of our constituents. So just wrapping up our 2019 reporting cycle, our 2019 sustainability report will be published by the end of July in accordance with the requirements of the Hong Kong Stock Exchange.

Our sustainability framework focuses on 5 key priorities: environmental impact, health and safety of our people, business ethics, supply chain and value creation and community engagement. And with this focus on the progress we continue to make each and every year, our efforts are certainly being recognized. For example, at EcoVadis, a third-party CSR rating service used by many of our European OEM customers, again, elevated Nexteer's assessment to the highest quarter to date.

At MotoSolutions 2019 forum, Nexteer Poland earned the Best Practice Award for CSR, and we have won several great place to work awards globally. But certainly, we're not satisfied and future competitiveness requires us to continue to embrace an expanded role for sustainability in our daily business activities. And consequently, we continue to focus on strengthening our culture of sustainability to continually elevate our performance across our 5 key priorities, which will only further success and reputation of Nexteer.

So let's turn to the next slide for a summary. As we've just discussed, based on current information, which we accept changes frequently, we are hopeful that Q2 2020 may be the industry low point and that a gradual restart of OEM production in currently impacted regions will commence in May and June. Yet we also recognize how fluid and evolving the current situation is in many countries around the world. And no matter our efforts and desire, we have little control over factors that will continue to come into play which may further extend the interruption of our customer operations. We also know that we must be prepared for the eventual resumption of the business with the continued health and safety of our employees around the world remaining again our top priority.

We continue to be very focused on cost containment and cash flow management and are staying closely connected with our customers, our employees and our suppliers during this stressful time. And while we cannot provide a reasonable estimate of the ultimate impact on the business for all the reasons we've highlighted during our update today, we know we are also fast approaching our first half 2020 reporting period and can only advise at this time that our comparative financial performance to 2019 will be significantly negatively impacted across all of our key financial metrics, given our current expectations of the timing of production restart for our facilities currently in shutdown.

Yet on a final note, there continues to be a strain on and shortage of medical supplies used by frontline health care personnel and first responders during this global pandemic, with particular pressures now in the U.S. and Europe, given the quick and broad spread of the virus. In the midst of all the turmoil and uncertainty and with no mandate or direction, our engineers in Saginaw, Michigan and Tychy, Poland moved forward in search of ways to help our local Nexteer communities and those in need. They put their creative problems solving skills to use, along with our 3D printers, to create medical mask and face shield components for protecting health care workers who are working tirelessly to stem the spread of this health crisis. In Saginaw, the team is producing about 50 face masks a day via 3D printing, and we're ramping up production to more than 1,000 masks per day via injection molding production. While in Tychy, the team is producing about 100 face shields a day. They're providing complete face shields to the medical community by 3D printing the headbands and procuring the plastic face shields from a third party. Employees at CNXMotion, our joint venture with Continental, as well have also joined the effort using their 3D printers to produce face mask components in Michigan. And we're working with local government and medical organizations in both communities in donating these supplies to nearby medical operations. While the production numbers may not be significant compared to the immense need, we know that in this fight, every bit helps those on the front lines. Our entire leadership team and organization are very proud of the actions of our team. They see -- they saw a need and used their ingenuity to help people and make a difference. This truly demonstrates what our one Nexteer culture is all about with a broad [indiscernible] of making tomorrow better than today.

So with that, this concludes our Q1 2020 formal comments, and we'll now take some questions, and I'll hand the call over to Rocco for that. Thank you.

[Operator]

[Operator Instructions] Today's first question comes from Rebecca Wen at JPMorgan.

[Rebecca Wen, analyst]

Again, hope you are staying healthy and well. So 3 questions from my side. First, how should we think about our revenue performance in each regions compared with the industry auto production? Last year, we've seen sharper declines in China dragged by potentially some customers such as pooling. And in the U.S., we've also underperformed the market due to GM strikes. So how should we think about our revenue performance for this year, considering our customer mix and new program launches, et cetera? Second, you've previously shared that 28% of the EPS backlog are ADAS Level 4 and Level 5. Could you remind us what's the approximate price and margin differences of these ADAS Level 4, Level 5 products versus our current portfolio? And which year do we expect a more significant contribution from these products? And lastly, you've shared about the dual pinion EPS. What is the percentage of the backlog from this product currently? And about how much of that -- of the EPS market do you expect to transfer to this DP EPS product in the future?

[William Quigley, executive]

All right. Thanks Rebecca, I'll start with the first one, and then Robin and I can tag team number two, and then I'll let Robin kind of wrap up with number three, Rebecca. Thank you for your questions. Revenue performance by region, kind of interesting, right? All of you know that, obviously, from a North American perspective, we have good concentration with GM, Ford, FCA. With respect to our performance 2019 versus 2018 in North America was impacted by a couple of factors. One being, obviously, the ongoing K2XX, T1XX launch, which impacted our columns business, as well as the impact of the 40-day GMW -- GM and UAW strike. So certainly, those were factors impacting '19 versus '18 for North America. Yet I think as we move forward, set aside the current situation that everyone finds himself in, we see very good opportunity to continue moving forward in North America, given our representation, if you will, and market position with the big 3, if you will, or the domestic big 3, of that being largely on larger SUVs as well as full-sized truck platforms. So again, I think from a revenue perspective, '19 was somewhat impacted by 2 events, one being as we have updated previously that K2XX transition as well as the GMW, UAW strike -- with the GM, UAW strike. Ongoing, we'll see what happens in North America. And per our comments, it's difficult to address what ultimately 2020 may look like from a revenue perspective, but we're confident we'll be in a position to restart as efficiently as possible once our customers do.

I'll turn to Europe and South America. As many of you know, we're bringing online our Morocco plant in the Europe segment. We obviously had a number of very important launches, both late in 2019 as well as planned for 2020. Certainly, given the current situation, those launches in 2020 will likely be deferred, but we're very hopeful that we'll see an uptick, obviously, over the longer term given the penetration and the acceptance that we've had from customers not only with Europe in general, but also with our Morocco operation.

And then last, but not least, you're right. China has been under pressure in the last several years largely due to underperformance, if you will, of a number of our key customers currently in the portfolio, largely around the DPCAs, the SGM Wulings, so on and so forth. I think it remains to be seen, Rebecca, as we move forward, how those brands participate in the market in 2020 and 2021. Certainly, 2020 being a very, very tumultuous and unprecedented time for all automakers around the world. So as we move forward, we're continuing to expand and look for opportunities with additional customers in that region, and we'll continue to update you all in the future as we get back to a normal mode of operation.

Robin, do you want to jump to dual pinion EPS, #3, and then we'll wrap up on #2. Robin?

[Robin Milavec, executive]

I was on -- sorry, I was on mute. Can you hear me now?

[William Quigley, executive]

We can.

[Robin Milavec, executive]

Okay. So relative to dual pinion EPS and the backlog, we currently have one program that has been booked with European OEM and that's currently in our backlog. I believe it's about $200 million in lifetime revenue. But that's just the beginning. As I mentioned before, I think there's many opportunities relative to dual pinion EPS that we continue to explore and have many inquiries from global OEMs, particularly in the Japan OEM base where we see future opportunities.

[William Quigley, executive]

All right. Great. Thanks, Robin. And I'll circle back to number two, Rebecca. With respect to L4, L5 applications, as you noted in our backlog reporting that we provided as part of our 2019 year-end reporting. With respect to prices and margin, price points, obviously, from an average selling price, we would see additional content for those types of applications. With respect to derivatives of or factors of, you could see anywhere from 10%, 15% to 20%, depending on features and benefits. With respect to margin profiles, we are continuing to maintain our internal rates of return and our internal margin targets. So we would expect those -- that business as it launches in the future to be somewhat accretive to our current environment or our current profile, if you will.

With respect to magnitude, certainly, we'll see what happens as we move forward here. With respect to those types of technologies, given somewhat of the dislocation we're seeing currently in the market and what ultimately our customers lay out from a program perspective a way forward, if you will, with respect to those types of technologies. But we feel very good about our position. We feel very good about our returns on those programs as awarded. And we believe, obviously, we can compete against anyone in the market with respect to L4 and L5.

[Operator]

Our next question today comes from Yizhe Wang at UBS.

[Yizhe Wang, analyst]

I have 2 questions. The first is on the dual pinion EPS. May you provide more details on the competitive landscape of the product like the market share of incumbents? And the second question is more on the current virus situation. Do we see changes in our and our clients' future procurement patterns in light of potential future production disruption? Again, do we see like potential changes in our future working capital deployments?

[Operator]

Pardon me, everyone. This is the operator. It looks like Mr. Quigley's line has disconnected. We will work to get him back in.

[Technical Difficulty]

[Robin Milavec, executive]

So I can briefly discuss about the dual pinion EPS competitive landscape. As I mentioned before, this has been more of a niche market in the past. There have been very few applications of dual pinion. Some of the Japanese OEMs implemented dual pinion as a cost savings reduction for lower-load Rack EPS systems. So there really hasn't been a large market share in the past on dual pinion EPS. But as I mentioned, we do see this market growing, primarily growing due to electric vehicles usage. And as that percentage of EVs grow in the market, we think the percentage of dual pinion will continue to grow as well. And then there's a segment of the low end of Rack EPS, that are currently Rack EPS systems, primarily today on midsized SUVs and larger sedans that due to cost savings initiatives, there's a trend towards implementing dual pinion EPS on those applications to be more cost-competitive compared to the low-end Rack EPS. That's also an opportunity for us in those 2 markets. So even though in the past that market has been relatively small, it's growing significantly. And I believe the technology that we've developed, leveraging off of single pinion and our Rack-based, we will be able to fill the void in that market and be very competitive and grow that market share for Nexteer as we go forward.

Bill, are you back online to talk about the...

[William Quigley, executive]

Yes. Yes, I am and I apologize for that, but one of the hazards of working from home or on the phone. So I believe the question was around working capital, and do we see a potential change to working capital deployment. I'll just talk about working capital, but I think capital allocation is the real question here. We're not going to see a fundamental change in terms, in my opinion, on the longer term with respect to working capital movements, be it customer receivable terms and/or supplier terms. We certainly need to work through the current dislocation, and we're doing that. But with respect to future capital deployment, I think as we move through this environment, 2020 and probably into 2021, we are going to continue to align our capital investments around program launches, ultimately driven by customer schedules and timing. We do see opportunities in the future, and we've been working on this quite diligently actually to increase our capital equipment utilization. We have a team in place that's led by Tao with respect to looking at all of our plants around the world, where do we have opportunity from a capacity perspective, what we need to do to further utilize and, if you will, minimize capital investment moving forward. So I think from that perspective, that's the focus that we have really moving forward. And hopefully, I caught most of your question there, if not all.

[Operator]

Given our time, ladies and gentlemen, that was today's final question. Thank you all so much. Thank you so much for all the questions and today's participation. If there are any further queries, please contact us at [e-mail]. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

[William Quigley, executive]

Thank you.

[Robin Milavec, executive]

Thank you.