Martinrea International Inc
TSX:MRE
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Martinrea International Inc
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Good morning, ladies and gentlemen. Welcome to the Martinrea International First Quarter Results Conference Call for 2018. [Operator Instructions] Please be advised that this call is being recorded.I would now like to turn the conference over to Mr. Rob Wildeboer, Executive Chairman with Martinrea International. Please proceed, sir.
Good morning, everyone. Thank you for joining us today. We always look forward to talking with our shareholders. We hope to inform you well and answer questions. We also note that we have many other stakeholders, including our employees, on the call, and our remarks are addressed to them as well as we disseminate our financial results and commentary through our network.With me this morning are Pat D'Eramo, Martinrea's CEO and President; and our Chief Financial Officer, Fred Di Tosto. Today, we will be discussing Martinrea's results for the quarter ended March 31, 2018. I will make some opening remarks. Pat will make some operational and strategic comments. Fred will review the financial results. I will finish with some closing comments. And then we will open the call for questions, and we will endeavor to answer them.Our press release with key financial information discussed on a fairly detailed basis has been released. Our MD&A, year-end AIF and full financials have been filed on SEDAR. These reports provide a detailed overview of our company, our operations and strategy and our industry and the risks we face. Given the detail in our press release and filed documents, our formal remarks on the call today will be generally overview in nature. We are very open to discussing in our remarks, and we hope in the Q&A, some highlights of the quarter, the state of the industry today, how we are addressing the challenges and progress in our operations. As always, we want you to see how we see the world.As for our usual disclaimer, I should note that some of the information that we are sharing with you today may include forward-looking statements, even if qualitative. We remind you that these statements are based on assumptions that are subject to significant risks and uncertainties. This is particularly the case given the present automotive, political and economic environment. Although Martinrea believes that the expectations reflected in these forward-looking statements are reasonable, we can obviously give no assurance that the expectations of any forward-looking statements will prove to be correct. Our public record, which includes an AIF and MD&A of operating results that I just talked about, is available on SEDAR, and you may look at the full disclosure record of the company there. I also refer you to the disclaimers in our press release, our MD&A and our AIF.Let me start with a few general comments. Our first quarter was great, and Pat and Fred will talk about it in a minute. I want to touch on our vision, mission and culture a little bit because they are the bedrock foundation of our company. We continue to drive our culture throughout the organization as we focus on our vision, deliver on our mission and apply our 10 guiding principles. We continue to instill our lean-thinking way into our operations, and our entrepreneurial can-do attitude is evident in our locations. Our vision, we updated it. It used to say 1 vision, to be the best preferred and most valued automotive parts supplier in the world in the products and services we provide our customers. And it's good, aspirational. It says what we do, hits the right notes. It benchmarks to others, though, not ourselves. It restricts ourselves to auto, and we felt we could do better. So we've updated the vision statement. So our aspirational vision now is making lives better by being the best supplier we can be in the products we make and the services we provide. Making lives better. That's a why. That's why we do what we do here. Being the best we can be. It means we will continuously improve once we beat the benchmark, and we're at or near the benchmark in some places already. We continue to improve, and we will beat the benchmark. And it's not limited to auto.Then our must-do mission stays the same but with the new lead-in, which ties in with our vision of making lives better. At Martinrea, we're spending a lot of time on culture because culture matters. It drives operational and financial performance over time. We believe that the improvements in our financial metrics go hand-in-hand with driving our culture as expressed in our vision, mission and 10 guiding principles. People don't come to work just to hit a margin percentage or make a part or fix a machine or get a paycheck, in most cases at least. People need to believe in something bigger than their job. They want to make peoples' lives better. And that it is more true of today's workforce than ever before. People come to work and perform well when they're treated with dignity and respect, when they can see that they are part of a team, when they're provided with a safe work environment, both physically and psychologically, and when they can see how they help make peoples' lives better.Study after study shows that commitment firms that operate this way outperform over time. They tend to have higher profitability ratios, tend to be leaner, tend to have fewer middle managers, tend to have engaged employees, tend to have less employee turnover, tend to have more employee satisfaction and tend to own their work. We are seeing the results of our focus on corporate culture in our improving performance. We remember that Martinrea was built, in part, through acquisitions of distressed assets, where more than operating performance was weak, where morale and culture needed some improvement. Our 1 Martinrea culture and focus is driving results and we believe will drive performance that our people have not yet seen.Last week, we had our Martinrea Accelerate 2.0 leaders conference, which Pat will talk to. Let me say briefly, it was a great cultural event for all of us, and is going to help propel us to the top of our industry in what we do.And now, here is Pat.
Thanks, Rob. Good morning, everybody. As noted in our press release, our good story continues with Q1 adjusted net earnings per share coming in at $0.65, north of the high end of the quarterly guidance as well as above consensus. Our adjusted operating income margin came in at 8.1% for the first quarter, a great start to our path to our new margin targets we set. This is on sales of $964 million. Q1 results represent our best quarterly earnings to date. This is now 14 consecutive quarters of record year-over-year adjusted earnings performance.As you know, we've committed to another substantial margin increase over the next 3 years for adjusted operating income margin of greater than 8% for '19 and greater than 9% for 2020, with a clear line of sight of how we will achieve it. As already noted, Q1 was a very good start, and we expect that to continue in Q2, with Q2 adjusted EPS projected to be between $0.62 and $0.66. We expect adjusted operating income margin to be somewhere north of 8% for Q2 depending on the level of tooling sales. Production sales for Q2 '18 we estimate will be between $860 million and $900 million.As a reminder, 2018 is the first year we will see a full effect of the GM contract change for Cami moving from a component pass-through sales model to a consignment model, or what is referred to as VAA pricing model. The annual revenue impact for this component sales moving to VAA model will be approximately $300 million.New business wins for Q4, as noted in our press release, came in at approximately $300 million, representing annualized revenue at peak volume, a fantastic start to '18. Quoting activity is very high in our product groups, particularly in our aluminum product offering, where we have now seen some solid new business wins. Overall, we continue to expect sales to be flat for '18 compared to '17, given anticipated timing of our new launches and the full year impact of the modular assembly sales in our Ingersoll plant moving to the VAA model, but expect sales will start increasing in '19 and grow to over $4 billion in 2020 based on our budgets.We have started this quarter with some great new business wins. First, a steel sub-frame for the new Ford crossover in Hermosillo, Mexico, where we currently make the Fusion sub-frame. In addition, we won the sub-frame assembly business, including engine dress on this platform. Winning the assembly business is significant not only because of the additional engine dress, which is new for us, but it's our first-ever assembly business for Ford. This is great news for both our metallic and our flexible manufacturing product groups.In our aluminum business, we won powertrain work for Volkswagen in our Spain high-pressure dye cast plant. And in low-pressure dye casting, we have some great news. We have 3 significant wins starting with the Ford hybrid sub-frame that we will make in our [indiscernible] facility in Mexico; a hybrid sub-frame kit for Daimler in Europe produced at our Meschede plant in Germany; last, a third hybrid sub-frame for Geely automotive in China on their electric vehicle platform. This is significant because it's a local win at our Yuyao plant for a new customer that is growing at a fast pace in the China market. This platform represents our first substantial step into the China market with a wholly owned Chinese OEM in a market where electric vehicles are bound to flourish. We have a lot of launches throughout the year, though weighted more toward the back half, which will increase our launch-related activity and costs in the latter part of 2018.Launches over the next 4 quarters include the GM Silverado, affecting 3 of our plants, both metallics and fluids, and the new Ram truck and Jeep Wrangler affecting 4 plants. We're also launching the Ford Maverick engine block and the 4-cylinder Volvo engine block in Europe along with the JLR aluminum knuckles and control arms in China. In Mexico, we're launching the new BMW sub-frame as well as a number of Daimler metal assemblies.Operationally, we continue with our lean activity and are finding ways to expand the effort on a larger scale. Our work in lean has depth and is providing both operational improvements as well as a better way of thinking relative to our work at all levels of the organization. We just completed our global General Manager's Conference with our top 120 leaders at Martinrea. We reflected on our successes, our challenges and, most important, our way forward. It was a tremendous meeting as we look back as well as forward on our Martinrea 2.0 strategy that was put in motion a little over 3 years ago. We're now accelerating 2.0 moving even faster down the path to assure that we meet or exceed the commitments we have made to our people, our customers as well as our investors.As discussed last time, we are now occupying our new tech center in Auburn Hills, Michigan. Two of the 3 office facilities we planned to close, or better said combine, are complete. And our grand opening in Auburn Hills will be May 17. This state-of-the-art facility has more lab space to enhance research and development efforts as well as a modern office. As I've said previously, we're very pleased with some of our new products and product designs, which we had expected to come to market in the next few years.As you can now see, the hybrid aluminum sub-frames that we've discussed in the past and have been developing are now coming to fruition with these 3 wins we just announced.Last, I want to thank to Martinrea team once again for their outstanding work. It allowed us to progress so well the Martinrea way.With that, I'll pass it to Fred.
Thanks, Pat, and good morning. As Pat already noted, the first quarter was another great quarter, our best ever from an adjusted EPS and EBITDA perspective. As our press release highlights, Q1 financial results made it 14 consecutive quarters of year-over-year improved record financial performance. Based on our financial results during that period of time, it is clear that our objectives have been achieved. It's also clear that our Martinrea 2.0 strategy, amplified through our just completed Accelerate 2.0 leadership conference, is taking hold and achieving results. The company has come a long way, and it has been wonderful to see the progress on many fronts. We are stronger today than we have ever been before. And it's not just from a financial perspective, I'm referring to all facets of the business, including our people, our processes, our products, our quality, our safety. The list goes on and on.There's a lot of great things happening here at Martinrea. The 2.0 movement continues to gain momentum with, we believe, the best yet to come.First quarter sales, excluding approximately $71 million in tooling sales, were $893 million, just above our previously announced sales guidance range due to slightly higher-than-expected volumes on certain OEM light vehicle platforms. Overall sales for the first quarter were slightly lower year-over-year by $37 million, or 3.7%, with just under half of that related to negative foreign exchange translation.Sales in North America continued to be impacted by lower volumes in passenger cars, in particular, the Chevy Malibu and Ford Fusion, while sales in our Europe and Rest of World segments were both up year-over-year.Further, Q1 was our second quarter with a full impact of the suspension modular assembly for GM moving to the VAA pricing model. The impact to sales from this contract change will start being offset later this year with new program launches, as Pat outlined in his remarks. As such, we continue to expect sales in 2018 to be flattish year-over-year with top line growth expected to start up again in 2019. I refer you to our Q1 MD&A for full account of the year-over-year variances.Adjusted net earnings per share in Q1, on a basic and diluted basis, was $0.65 per share, in excess of our previously provided earnings guidance range due to generally for higher-than-expected production volumes in certain OEM light vehicle platforms, as already noted, and the higher net foreign exchange gain recognized during the quarter.Excluding the FX gain, adjusted net earnings per share would have been $0.63, still at the high end of our earnings guidance range.Q1 earnings performance represents a record quarter for us, up very nicely year-over-year and quarter-over-quarter. We did have one adjustment to earnings during the quarter related to the warrants we hold in our NanoXplore investment. This is further explained in our MD&A.Margins were also up significantly year-over-year and quarter-over-quarter for that matter. Adjusted operating income margins for the quarter increased year-over-year to 8.1% from 5.6% in Q1 '17 and quarter-over-quarter from 7% in Q4 '17, some very healthy result. On a trailing 12-month basis, our overall adjusted operating income margin has increased to 7.1% from 6.4% at the end of the previous quarter. Operational excellence activity, the cornerstone of our Martinrea 2.0 strategy and general sales mix, including new and replacement work that launched and all programs that ended production during or subsequent to the first quarter '17 continued to contribute to the margin expansion. Based on this positive margin trends, it's absolutely clear that we're getting stronger in a lot of places.I also just wanted to quickly touch upon the balance sheet. You will recall that we met our net debt-to-adjusted-EBITDA target of 1.5x, ending '17 at 1.45x. And although we do not have a specific leverage ratio target in mind at the current time, the positive trend in this area continues.Net debt-to-adjusted-EBITDA decreased yet again in Q1 following decreases in each of the previous 4 quarters, ending Q1 at 1.4x. We are very pleased with the progress in this area. It is clear we have a strong balance sheet from this industry and the ability to generate cash. And we intend to maintain a strong balance sheet over time. As you can tell by our numbers, things are coming together quite nicely. We continue to consistently deliver strong operational and financial performance. Martinrea 2.0 continues to take hold of organization, and we believe that things will continue to get better from here.Thank you. And now I'll turn you back over to Rob.
Thanks, Fred. There are a few topics that I would like to touch on briefly.The first is the dividend. We've declared our increased dividend in order to provide greater returns to our shareholders. Please enjoy. It reflects our confidence in the future. As you can see from our product awards, we see and have many opportunities to invest in our business, which is a priority. And we intend to employ our cash to strengthen our operations and to take advantage of the right opportunities.Some have asked us whether we could consider some share repurchases in the future given the continued strengthening of our balance sheet. The answer is yes, of course, if, as and when appropriate.The second is a brief comment on NAFTA. A discussion has been going on for many quarterly calls now. The negotiations continue and may be closer to resolution at least on the auto side. We think there will be higher rules of origin numbers. That's probably a good thing for us. We think there will be a minimum wage jurisdiction component for vehicles, although the details and impact of that may be unclear. We don't think that that's a good thing for the competitiveness of our industry as a whole, so wouldn't support it in principle, but if our customers can live with that, so can we. We think there will be a NAFTA, and that's a good thing. And it will not have really bad things, like border adjustment taxes or overly punitive measures, and that's a good thing too.From a purely Martinrea perspective, I would like to emphasize that we have a terrific North American footprint, with approximately half of our North America revenues coming from the U.S. and the other half from Mexico and Canada. We've almost 5,000 employees in the U.S., double that of Canada, and about the same amount in Mexico as the U.S. We are a U.S. supplier, a Canadian supplier and a Mexican supplier. And for NAFTA purposes, a key point for us is that 90% of our products or more are shipped intracountry, from our plant to a customer plant in the same country. We locate near our customers. We will continue to do so. In that sense, on a relative basis, we are as well positioned as any supplier for a NAFTA disruption or tougher NAFTA content rules. Indeed, we may have a good competitive advantage vis-à-vis other suppliers.On NAFTA, our basic position is let's get it right. Let's make North America the best place in the world to make cars, modernizing NAFTA to the betterment of all the NAFTA countries, our industry and our people.Overall, we continue to remain bullish about the state of our industry and our position in it. The automotive industry is a wonderful place to be, at the leading edge of many technologies, ranging from electrification initiatives to driverless and many others. Our core product offerings remain essential to our markets as every vehicle, regardless of how it is propelled or who is at the wheel, requires safe and strong structures and a power plant that are lightweight. We are at the forefront of the trend to lightweighting of vehicles in order to improve fuel economy or reduce carbon footprint. Electric vehicles give us great opportunities in a variety of new products, such as battery housings and electric motors. Our fluid management products will be core products on vehicles for very long time as we remain a leading-edge provider of environmentally friendly fuel systems, including thermal management with some great products such as capless filler systems and battery cooling systems for electric vehicles. While others may stress the software and electronics of vehicles, we are very much at the heart of the hardware, which is a critical part of the industry today and in the future.Looking forward to the rest of the year and beyond, we anticipate another record year of financial performance. Our Q2 projections are in our press release. We anticipate continuing margin improvement in 2018 and the years ahead. We will continue to drive quality, entrepreneurship, lean thinking and safety. And yes, we will continue to embrace our culture of making peoples' lives better by being the best supplier of products and services we can be, fulfilling our mission and driving a principles-based company built to last and thrive, you can count on that.Now it's time for questions. We see we have shareholders, analysts and competitors on the phone. So we may have to be a little careful with our answers, but we will answer what we can. Thank you all for calling.
[Operator Instructions] Our first question is from Mark Neville with Scotiabank.
Just, I guess, on follow-up on some of Rob's points. First just, I guess, on CapEx. You're weighing a lots of work, a lot of aluminum work, and I think you previously said about $300 million for this year. I'm curious if that's still the guidance. And as we look out, does that number pick up as -- again, as you're ramping up this work or you're weighing all this work?
No. So the guidance for '18 has not changed. To some extent, we've built in some growth in there as well. So the $300 million is give or take in timing. It's still the guidance for '18. I think what these new business wins does more so is actually validate that '19 will be consistent with '18 as well, so be fairly high. So we continue to win work and we continue to invest in business.
Okay. I guess just stepping back a bit. Just I know some of the North American OEs, I guess, are de-emphasizing smaller sedans or sedans in general. I know, you're overweight trucks and SUVs generally, but you do have some exposure, I guess, in North America. Some of your top programs are on sedan. So I'm curious to just what kind of impact do you think that could or may have on the business. And how quickly you can maybe pivot those facilities to supply other programs.
The Ford Fusion was probably one of the ones that's on your mind based on Ford's announcement, which they're making in Hermosillo, Mexico. And as I said in the call, we won the same basic parts. In fact, we have more work than we had on the current vehicle with the replacement vehicle, at least one of the replacement vehicles that's going in there.
Okay, that helps. And I guess, just one last one. I know, Rob, you touched on this, just wage inflation or higher minimum wage. I think you are probably speaking more about Mexico. You guys have a fairly big footprint there and quite a few employees. So just curious as to -- again you talked about it qualitatively, but if you've run any sort of quantitative analysis or anything you can maybe share with us how you're thinking about it or how effectively you complete or maybe it helps you relative to others just maybe just if you can touch on that.
I think, we have the best competitive footprint in North America in the work that we do. And on a relative basis, we're competitive in Canada, we're competitive in The States, we're competitive in Mexico. I think that wages and compensation for employees will go up in Mexico over time. It's not going to a minimum $15 an hour like has been discussed in some of the NAFTA discussions. But as people get more educated, as they get -- as they effectively develop a lot of trades in Mexico, we'll see some pricing go up. And Mexico is still an extremely attractive place to be. The comment on wage inflation that I mentioned in connection with NAFTA is the discussion that's been put forward for the United States to replace the minimum U.S. content rule, which would be very bad thing, I think, with a percentage of work of parts and cars coming from highways' jurisdictions is effectively one of the issues that's on the table. Not particularly supportive of it, but it's certainly much better than a minimum U.S. content rule. And it's something that we'll be able to adjust to. And I think at the end of the day, that's the last hurdle waiting for the NAFTA negotiations. I think, we're pretty close to getting a NAFTA deal that's going to be very workable and certainly a lot more benign than some of the discussions that we were hearing 6 and 12 and 18 months ago.
Yes, agreed. And maybe just when you're saying you're not supportive of that, was that just more, I guess, your footprint or just -- again because it just means higher costs [indiscernible] footprints find?
I think, there's 2 aspects. On a relative basis, I think, we can handle better than just about anybody. On an overall basis, the issue for the North American industry is we make really good cars and trucks here, and we're very competitive on a worldwide basis. And so anytime there is a potential discussion that could potentially make us less competitive on a worldwide basis, I'm a little cautious about that. And so the reality is that a lot of growth in Mexican vehicle production has resulted in exports to other parts of the world. And those exports have a lot of parts made by North American suppliers. So in that sense, I want to be a little cautious about that. We don't want to effectively create something that we, as a continent, end up producing less vehicles. But as I said, even as you look at that, the potential penalty for that is a relatively low tariff rate and so forth. So as we work through it, as I said on the -- in the prepared remarks, if GM and Ford and our customers are going to be okay with this, then we will be too. Because at the end of the day, I think it's relatively benign. I think from our perspective and I think from the industry's perspective, NAFTA has been a very good thing for our supply chains, and we want to support it. We think it's been really good for our industry, it's been really good for our customers, it's been really good for the supply base, it's been really good for us. And I think that's where we're going to be.
Our next question is from Michael Glen with Macquarie.
Can you just talk a little bit about the Ford announcement in conjunction with the Hermosillo plant? Remind us what your manufacturing base look like down there. And how we might see that situation play out as they go through a change there.
Well we've build the cradles for the Fusion, which is primarily the work we have. We're able to do a little fluids work down there as well. And currently, the thinking is that it'll go through 2020, though there is some belief it could go longer than that. But they're adding a vehicle, crossover vehicle, and I can't give you a lot more detail than that other than to say that the -- we won the cradle work. And in addition to that, we've won the cradle dress work or the assembly work. And in addition to that, we've won the engine dress work. So from an overall vehicle content, we've actually increased. What's not clear in the moment is the volumes and those types of things. But for us, it's not a bad story at this point.
The Ford Hermosillo plant is a wonderful assembly plant. And insofar as it is producing vehicles for Ford, we'll be there. They have an industrial park. We have some great facilities in that industrial park. And we will win more than our share of our business there, as we have actually.
And with the new business wins that you've been able to secure, does that mean you have to add some capacity down there? Or would you be okay with what you currently have?
We're currently challenging the plant to see if we can put the assembly work in the same building or maybe a slight addition to the same building, and the reason being to try to share the overhead costs. So we may end up having to put an addition on the plant, but we would prefer to do that over having 2 separate plants.
The reality is, it's going to be dependent on how long the Fusion goes. So depending on that time line will dictate the capacity requirements we'll need to put in there. The customer is a very rational being. If they're selling lots of Fusions in 2020 and their capital is in place and they're making lots of money, they're going to still sell a lot of cars. The other thing that we have to be a little aware of in this business is the assumptions that we make in 2018 may not necessarily all be applicable in 2020. 10 years ago, we saw gas prices go up a lot, and there was a shift towards cars. So I think, there has to be a certain amount of flexibility in the predictions. I think that as our product mix shows, we've really benefited from and follow the trend to more trucks and SUVs and CUVs. But as a supplier, quite frankly, our plans are adaptable enough to follow the products that the customers want to make, and we'll put lots of structure on them.
On the cradle side of the business, we'll be able to reuse all our capital, which is the best news. Of course, the tooling and so forth will change, but from that point of view that was really good win for us from my perspective.
The other aspect is, Ford is still going to spend a lot of money on their other vehicles. What they're basically saying is, here's how we're going to prioritize what we're putting in our plants and where we're going to focus our efforts. And insofar as they're putting more money in refreshing other vehicle platforms, and they did say by 2020 we expect to add the freshest or the most refreshed lineup in the auto industry, those vehicles sell. And as they sell, then if we have product on the other vehicles, and we have products on a lot of different Ford vehicles, as you know, then it gets taken up somewhere else. They basically said, this is what we're going to use our assembly capacity for. This is where we think we're going to focus. And that's not a bad thing for an OEM to do. A lot of OEMs in the past have said, I want something in every segment. The problem with that some time is you've got winners in some segments and others they don't do as well. And I think, it's very legitimate for a company to say we're going to focus on areas where we can make more money.
Okay. And you highlighted the significant amount of new business win in the quarter. Can you help put that into some context, like what would you anticipate the level to be in a more normalized basis? And was this number ahead of your expectations? And like what would you expect to win on in a normal quarter?
This quarter was, I mean, based on my history, I mean, probably one of the biggest quarters we had from a new win perspective. Now we've been saying in the past couple of quarters that quoting activity has been robust. That's not a surprise to us. I mean, we had a lot of activity around, in particular, in the aluminum side in terms of quoting. So we were expecting the stuff to come through. It's just a matter of timing. And as it relates to our expectations going forward, I mean, I think, we noted in our opening remarks that our revenue guidance for 2020 has not changed. So to some extent, there is some built-in growth in there that had to be booked. This goes a long way in getting us there. So the expectations from our perspective haven't changed.
Okay. And just to circle back on the CapEx, you're $300 million over the next 2 years. What would that number be in a -- how much above your kind of normalized run rate is that number right now?
I mean, I think a lot of this is a minimum work. Again a lot of this is brand new capacities, presses, machining centers. So this is -- these are investments that are going to be around a long time. So it's clearly on the high end. If I were to ballpark at this point, I would say a normalized rate would be about half of that, give-and-take.
Okay, that's good to have...
It's a good problem to have, right? We had -- this is an exceptional quarter. We've been asked before where you see your growth. We said we see a lot of opportunity in the aluminum business. We anticipate to double our book within 5 years. This is a good chunk of that book.
Our next question is from Brian Morrison with TD Securities.
Fred, can you just address how we should think about SG&A as a percent of sales in the second half of the year? Or really how launches may impact your margin in the back half? And the reason I ask is, the strong operation margin this quarter and then forecast for Q2 really unless you have margin degradation in the back half of the year, you should really be handily tracking a mid-7% EBIT margin this year.
Well, I think, we've highlighted the fact that we have a lot of -- and we always have launch activity. And the reality is what's coming online in the next little while, these are big packages. I mean, T1XX alone is $300 million of business. $100 million engine block business for Ford on the Maverick program. So there's a lot of activity. And I acknowledge what you're saying, but the reality is in the back half of the year, we're going to be incurring some costs for launches work. And that's going to temper the margin expansion that we've been experiencing in the last little while. All good news because heading into '19, this work will be launched, add to the top line and our margin expansion story will continue there. But the reality is at the back half of the year will be a little more difficult. And on the top of that, the back half of the year is generally, from a volume perspective, weaker than the first half. So it's also a factor.
It's not difficult in the sense that there's a financial degradation in that sense. It's a cost of being prepared to launch well.
Totally understand. But we are talking about margin expansion. Correct?
That's right, yes.
Fair enough. So just a follow-up on the major contract wins, just a couple of questions with the material orders. Does the quoting activity continue to remain high? And then aside from Hermosillo, are there any other areas or facilities that may be capacity challenged with the significant launches forthcoming? And then maybe just upon the OEM's criteria for awarding you such material business. Is it simply the right lightweighting product and OEMs are increasingly confident in your launch and operational capabilities?
I think from a plant perspective in some of these cases, we'll be making additional purchases, some additional building, but everything within the plan, I would say, when we don't have any surprises along the way. And capacity constraint wise, there may be some physical space, like I referred to earlier, but I would say, nothing alarming. Pretty much all within plan that we've been working toward in the last few years.
Yes. Especially on aluminum side, recall that we did big expansions in Spain and Mexico and China. And I think, I may be off a little bit, but around 0.75 million square feet of manufacturing space. That's a lot of space and a lot of space to fill, and we're filling that. I think China with the Geely...
We're expanding in China, we'll expand in Mexico, both in the aluminum plants. And as I said, possibly some building space in Hermosillo depending on what happens to the Fusion.
And I think on your first part of your question, so I think going forward, quoting activity continues to be quite robust. So we're not expecting that to necessarily die off. I'm not saying we're going to be announcing $300 million of business every quarter. This was a very special quarter from that perspective. But we believe we'll continue to execute on some of those quotes and win some business, particularly in aluminum space.
Just in the context of the structural point that we make, we're part of the hardware of the vehicle. We've been saying for a long time that we think we're well positioned on the steel, especially the high-strength steel. We're well positioned on the aluminum. We're well positioned on the combination. I think, you see, particularly, with this set of contract wins, that's exactly the case. And the other thing is I was looking at -- as I was listening to Pat, I think, he mentioned 8 different customers. There is a broad range of interest in the stuff that we're doing. We are expanding our product offerings, but we're also expanding our customers and our depth with the number of customers, not just the traditional ones. And that's a very good sign for a good baseline for growth in the future too.
I was just going to say one of the things I find the most exciting about this is, I've talked about these hybrid sub-frames for going on a year now. And now, they're starting to drop into reality. So I think that will be a continued growth area in our business.
And Pat talks about hybrid sub-frames all the time, and I talk about culture all the time, but you know what both are delivering.
Right. Well, maybe I can just close up here, Rob, with not going back to your culture, but your vision. You mentioned within your vision not just auto a few times. I'm wondering if this is foreshadowing a more material move into the other sectors or just encompassing your current portfolio. And if so what are those verticals that are of interest to you?
I'm not sure we're going to do farm implements, although we do have a little in...
We already do.
Yes, we do. We actually do work for John Deere, and we do have -- depending on how you characterize some of the assembly, but it's not $100 million of annual revenues, but it's approaching that. I think, lightweighting is something that is applicable to anything that involves mobility. So that's -- so in that sense, I want you to think of that. I think also with respect to lightweighting products, we've done the investment. We're doing some work with the NanoXplore folks on graphene. We think that there are graphene opportunities in the context of auto products. But at the end of the day, there's opportunities in different places as well. What I'm not suggesting -- I don't think what we're suggesting is that you're going to see us announce an acquisition of an industrial company or something like that. I think we've got a lot of focus on here. But our expertise in the areas that we are, which are bringing structure and using metals, we can make anything out of metal. We do it very well. And I think that we're saying to our people open up your mind-sets and see where it goes. One of the things that we do very well, we had our conferences, we had our own guys make a beautiful lectern. We could get into the lectern business. Absolutely, beautiful. The fact is that people can be really good. Thanks, we gave a gift to some of our people of pizza ovens. We can do that too. I don’t think that's a really big business, though.
If you recall, we moved in some of our industrial business to our plant in Riverside in Kansas City. And the reason for that is, you're kind of in the heart of the U.S. relative to a lot of the agricultural manufacturers, defense manufacturers. So we definitely see some potential there though the timing of that and how quickly it'll come and how big it'll be is unclear. But certainly, the capability we've moved to there, we have the equipment there now, and we can do all our industrial business in the center of the U.S. as well as Canada and Mexico.
Our next question is from Todd Coupland with CIBC.
Couple of questions for me. Just on -- following up on the graphene. I know you announced the partnership with NanoXplore and have made a couple of investments. Can you just talk about milestones and/or potential, and how that might impact products and wins? What's the time line we should be thinking about for these opportunities?
I want to be really sensitive because they are a public company as well. And so in that context, I'll leave those types of discussions for them to answer. I want to be really careful about that. I think in terms of the product, Pat?
I'd say one of the places that the graphene can apply the quickest is in polymer base materials, which we do have, especially in our fluids group. And things like permeation are a big deal. As you continue to reduce CO2 permeation in fuel lines and so forth, are continued challenges for the OEMs. And so we're doing things along those lines that can reduce permeation as an example. There's a few other things, too, I don't want to get into the middle of, but I think there's tremendous opportunity in the future for this product.
And the stock has performed pretty well. Do you view this as part of your partnership and a long-term holding for the company? Is that the way to think about it?
Are you referring to the fact that our stock has done well or the Nano's?
Your stock has done pretty well, but theirs has as well.
I think that there -- I mean, we made an investment because we like the people and we like the focus. In that sense, that's good. I think that we didn't invest in the stock just because we're stock pickers or whatever. We like the product, we like how the product fits into our overall theme of lightweighting. And quite frankly, I think, graphene has a lot of potential to a lot of applications in automotive. It isn't used a whole lot. And so we're kind of at an early stage as far as that goes. I think that if the product that we get from them and the relationship we have with them is good, and we're developing automotive product or even industrial product over time, I'd view this as the beginning of a very good, long happy relationship.
Yes. Okay. That makes sense. And I just wanted to go back to the debt for a second, if I could. So the ratio has, obviously, moved into a very comfortable area. I accept that point. But the absolute dollar amount creeps up a little bit. How do you think about just absolute debt levels? Do you -- would you like to see it down $100 million to $200 million with the rising cash flow here? Just talk about your thoughts on that.
Okay. Maybe well I'll take a shot at it. I think you have to have a certain amount of debt in your capital structure. So it's not bad to have a certain amount of debt. We're very comfortable with the level. That's point one. Point two, we've made a lot of investments. Those investments tend to be focused on our operations, and we'll continue to invest our operations because that is positioning us for strength for the future, and we've got a very good baseline as far as that goes. I think that we've indicated that with the dividend, even on a nominal basis, it's not a very high level, but returning some more money to shareholders as something that factors into the equation. Then the other thing in terms of the absolute level of debt, remember that a certain amount of that is tooling, which is kind of not really debt, okay. This is something that at the end of the day, the customer has to pay for the tool. And if they don't pay for the tool, then they can't control where that tool goes. And so the absolute numbers is actually a little less. Fred?
I was going to kind of build on that point. I mean, ultimately we're comfortable with these levels, both on our ratio and on absolute basis, just given our cash flow generation and our continued margin expansion. So we're very comfortable here. But Rob talked about the tooling aspect. I mean, if you look at our Q1 financials, I mean, our tooling inventory balance shot up in Q1. So there's an element of that. And as I note earlier, we got some big programs coming online, and the tooling builds on these programs are huge. So we're financing that. And then over time, that will normalize, I guess, depending on what we've got going on, but there is a large tooling aspect to our debt level.
I will say this also, we spend a lot of time -- as I think a lot of people know and there's a lot of analysts on the call that work for our lending institutions, we spend a lot of time with our lenders, and they're extremely comfortable with us. They've indicated that if we want higher lines and to finance different things, they're all in as far as that goes. And I think that maintaining a certain amount of debt and maintaining a certain amount of good relationships with the lending syndicate, and ours is absolutely fantastic, is very useful when something comes along. So we say -- and then we have used this when we bought TK, effectively. We had the banks lined up to support it. When we bought Honsel, both the first tranche and then the second tranche, we just wrote a check. So we aren't beholden to go off to the equity markets and so forth in order to finance transactions. But I think that we want to maintain a certain amount of powder there, but you also want to maintain a certain level of debt with your financial institutions so that you are of significance. I think at one point before Magna and Linamar went on their acquisition road, we were -- we had the highest debt facility in among -- for the Canadian banks. And so with that, you become an important customer, but you need to have good relationship.
And the other aspect-- I just want to add one other point. At the end of the day, we are -- we've been clear. I mean, we're not going to shy away from investing in the business. We've putting a lot of work, wining a lot of work and we will continue to invest in business. The returns are there, the margins are there. And as long as that dynamic exists, we'll continue to do so.
Our next question is from David Tyerman with Cormark Securities.
It's good to see the EPS growth and the ROIC improvement and the leverage improvement. My first question is on the product awards. I'm wondering if you can give us an idea, it's nice to see the big awards, whether you have a target in terms of sales growth that this could turn into or a process like this could turn into over the medium term. Like you think you can grow the company 5%, 10% on the top line over the medium term?
Well, I think what I'll point to is over the next 2 to 3 years, we've provided our guidance, where we're still going...
I mean, beyond that?
And beyond that, there's no reason why we can't continue to grow that top line absolutely. So we have some R&D activity in the pipeline that we hope will bear some fruit in some new products. This hybrid sub-frame is one particular that's starting to bear fruit, and we expect that to continue. So we'll continue to quote those type of packages and execute on those. So yes, I mean, we don't have necessarily a goal or target in mind in the next 5, 10 years. But beyond 2020, we continue to expect that top line to grow.
One of the things that's unique about this sub-frame we keep talking about is, it's basically in pieces. So you can make the castings in one location. We can ship them to our current metallic locations, which are nearby all the assembly plants, and assemble them there, where we would weld them, machine them, heat treat and then ship them. And at that point, the OE wants you close by because your logistics become an issue. So why we like this product so much is, we can utilize current capacity as more and more OEs convert more and more to aluminum on this product, and are still continue to be steel. And we believe from what we're working on is there'll be combinations. In some of the cases that are out there, there's different ways of bonding, bolting, what have you, steel and aluminum together, because they both have different advantages and disadvantages. So the ability to combine those 2 products into a new product, I think, we'll be able to grow this because we're on the front end of this. And I believe, this is where the industry is traveling.
Okay, that's helpful. I would encourage you to think about the sales growth. I think that's one of the criticisms that investors have is that you're not really a growth company in a way on the top line. Something to think about. And Linamar makes a big deal, but I think maybe you're aware of that that's something that people like about Linamar.
Well, we like Linamar, too, because they're good people, and we like Magna, too. Just in the context of, let's just put the evolution of the company, we really grew really fast -- nobody has grown as fast as we have over the last 15 years. And we grew organically, and we grew with acquisitions, because we wanted that footprint and you've all heard that story a lot of time. And then what we've been saying over the last couple of years is we're really focusing on strengthening the core, strengthening the core with operations, operational excellence, keeping our entrepreneurial depth and developing that culture, the Martinrea culture that, I think, will be second to none in our industry as we continue to drive it and you're seeing those results. As you go, as you become a leader in what you do, as you become doing lightweighting better than anyone else, as you do fluid systems better than anyone else, which is our objective and I think we'll get there, is you see more customers, existing customers, give you more opportunities and so forth going forward. So in that context, I think, we will turn into an organic growth story. And in that context, you have to build your base first. And you can see in essence what is -- what's happening. This is a quarter that, if you think about it, it's like what 8% of our revenues in terms of quarterly awards in a 6-week period as we came to you at the end of -- I think, last time we talked was early March, okay, 8-week period. So as we go, as you go forward, as you launch, this is good stuff. And then the other thing is what we're doing is products and systems that are going to be core to a vehicle, no matter how propelled for a long period of time, right, and that's a good thing. So in the context of what is in our bailiwick in the context of our products, those are things that are going to be on any vehicle for a long period of time. We aren't doing like an outsourcing machining services to use that, which at the end of the day the question is, where is that market going to be in 10 years? Because at the end of the day you're reducing waste in your product. What we're going -- what we are doing is we're going to build structure, lightweight structure for a vehicle, whether that vehicle is driverless or not, whether it's propelled by electronics or not, or whether that's electric or not, you're going to need that structure and we're going to be structural leaders. And we believe that we've positioned ourselves extremely well with different materials to be a leader no matter what that material is.
I think, the other important thing to recognize here also is when Martinrea grew, it was a lot of distressed companies and it didn't have the core. And as you guys remember, historically, there were some bumps in the road. Now if an acquisition opportunity that makes sense comes, our ability to bring it to the higher level of production, margin and so forth is much better today than it has ever been because the strength of the base is so much better. And of course, though there might not be anything sizzling on the stove, that's always still an option out there as well.
Okay. That's helpful. So just on that point, is M&A something that would be a bit higher in priority now that you have strengthened the core so much?
I think that the tradition here has been to look for a good deal. And it's pretty much been distressed and bankrupt companies. So it will be interesting to see what happens as the industry moves forward over the next 2 to 3 years. If there is opportunities from a distressed point of view, certainly that would be potentially attractive because we could buy and fix even faster than in the past. And there's also bolt-on opportunities, lightweighting expands beyond lightweight, aluminum and high-strength steels. There's other things out there. So something makes sense strategically, certainly we would look to that as well.
I think in the context of M&A, we get whether it's Fred, Pat or myself or other people here, we see an acquisition opportunity probably every day. There's a lot of M&A activity. At the end of the day, anyone can buy something at a valuation that's above market. The way the nature of M&A works is unless you have a distressed situation or you have something that's very complementary to what you do, there is a tendency to overpay. Everybody who sells has financial advisers, they run auction processes, they do something, they get the highest possible dollars that you can do. So then if you're going to buy something, you've got to basically look at that asset and say, how do I add value to that asset? You can't just look at it and say, how does that asset add value to me? It's an inverse way of looking at it, but that's how I look at M&A and I think it's a better way to look at it. So in the context of -- unless there is a material or something that is absolutely something that we can bring value to it, you're not going to see us buy stuff at 8x EBITDA or 10x EBITDA and then say "hey, this is a wonderful complementary situation." The fact is you're paying full value for something and you've got to careful about doing that. 8 out of 10 acquisitions fail, not that the acquisition isn't necessarily brought in, they fail because they don't create the value opportunities that you say they're supposed to create. And so we've done 7 acquisitions over a 15- to 16-year period. I would argue that everyone has made sense and it has turned out well, but with a lot of work. And so in that context, will we look at M&A? Absolutely. Do we look at M&A? We looked at it on a consistent basis. We actually sit down together and talk about it every month, but it's going to be something that's got to make some sense for us. And in that context, I think, it is part of our future, but at the same time I think organic growth is part of our future.
One of the other nice things is because of -- I'd like to think because of our improved performance, we've been approached this past year by OEMs on a number of occasions to take a look at something that we could help out with. So that's always good when a customer comes to you and says, "Hey, we'd like you to take a look at this business over here that is struggling." So haven't found the right mix yet, but it's good to know.
That's great. And good to hear the discipline.
Yes, and the other thing that's what -- that -- back to Todd's question on the financial capacity and debt, et cetera. We have a lot of powder. There is also an ability to issue equity. I'd like to continue to try and strive to improve our equity price over time, which is what we've been doing pretty well in the last couple of years. But there's certainly a lot of powder on the debt side to do something that makes sense, but it has to make sense because if we're going to stand in front of you folks and have an acquisition, then we're going to have to justify it. And we're going to have to justify it more than saying "hey, it's really cool and kind of it's complementary and strategic and all that type of stuff." We've got explain to you the value that it brings.
Yes, absolutely. Two last questions. The Geely sub-frame, by hybrid, does that mean you need to add some traditional metallics capability in China?
No. In this case, it's more of an assembly. I mean the weld, any kind of welding and so forth certainly would bring metallic technology. But I don't want to get too deep into the product, but there isn't a plan to put a stamped part on it in the moment.
Okay. And then last question, Fred, in the quarter what was the VAA revenue impact?
So the annual impact is about $300 million so 1/4 of that, so about $70 million, $80 million.
Our next question is from Peter Sklar with BMO Capital Markets.
Just one question. Like if you look at your North American business, which did fairly well, you had like a lot of platforms, where the volumes were down during the quarter, like the Fusion, Escape, Malibu, the GM full-size pickup trucks and SUVs. Those are some pretty important platforms for you. So what was on the other side of the ledger that, like, went well for you that you had such good performance?
Well, we highlight on our MD&A the ones year-over-year that were down, and they're predominantly passenger cars, so Fusion and Malibu. Both those sedans are in our top 10 platform mix, and those have been trending down for a while. We're also seeing on the current GM pickup truck, now that they're retooling to the new program, volume is down there as well. And then essentially to offset that, I mean, you had VAA impact as well and natural offset to that is you've launched some work. You had new work on the Equinox. You launched some work on the Wrangler as well. So there was some uptick there in terms of new business.
One of the -- it's probably a little more subtle, but last year, we made a smart move when we moved the weld line out of our Riverside plant and put it in Hopkinsville to share overheads and those type of things and technical people. This did 2 things for us. One, ultimately, it will help us with the Malibu situation. It also opened up space for industrial business. And then of course, we left the VAA in Riverside, next door to the plant, which gets paid regardless of volume. So those little things that we looked forward on, I think, help out a bit as well.
Okay. And then, Pat, just one question, like, if you look at the contract wins you had during the quarter, they seem to be heavily weighted on the aluminum side. What you're feeling about the traditional metal stamping business and your backlog there and your ability to win business.
Yes. I feel very comfortable with it. And the only place where we're seeing and so far it has been accretive for us. But when we ever -- when we see the day when somebody says we're going to go from steel to aluminum on a sub-frame, as I mentioned earlier, the way we've designed these hybrid sub-frames, is you can build part of them in the aluminum plant and finish them. In fact from a content point of view, the majority of the content ends up in one of our current metallic plants in a lot of the future designs. So I actually feel good about that conversion, if and when it happens. And again I think we're going to start to see a hybridization more between aluminum and steel. And in fact, in one case, not any you had mentioned, but one that's in design right now, it's actually steel combined to the aluminum. And I believe, in one case that we did win, I'm not 100% sure, but I'm pretty sure we have one steel reinforcement on one of the products that we announced, but I'd have to go back and confirm that. So from that point of view, I feel pretty comfortable. In the case of body in white, certainly the high-strength steels aren't going away anytime soon, like what you saw at our D2U facility in Alfield. That's a much -- I want to say much less expensive way to go for that type of a product, and you get the lightweighting because of the high-strength steel. So I think we're going to see a combination. I feel very comfortable with our current footprint.
[Operator Instructions] Our next question is from Ben Jekic with GMP Securities.
I do have 2 quick questions. One is housekeeping. Just a reminder on what is the tax -- appropriate tax rate for going forward. And the second one is just if you can elaborate a little bit on the Auburn Hills R&D facility. Is that -- if you can -- to the extent if you can share, what is it going to focus on? And is it sort of totally central to Martinrea? Or do you have any sister facilities with existing plants? And how is that going to function?
I'll address the first question. So the guidance there hasn't changed. So I'm expecting somewhere between 23% and 26% for '18 depending on mix.
And in the case of Auburn Hills, it's not our only facility, that won't be our only facility, but it did allow us to combine some that were out there already that the lease was expiring on and in doing that, we were able to expand it. I would tell you, our product engineering and our fluids and thermal management activity is predominantly there, though there's some in Mexico as well. Product wise in Auburn Hills, process wise in Mexico. On the aluminum side, the majority of that is still done in Germany and will continue to be, but on specifically the hybrid sub-frame and the chassis area, a lot of that is being done and will be done on Auburn Hills. And in the case of body in white, on a product side, we'll do on Auburn Hills, but on the process side, we do here in Canada in an office next to our Alfield facility. And then we have some other labs and some of our plants that do some process work and product work like BCA in Michigan and so forth, and we don't see that going away. So it's really more of an expansion than it is a replacement other than those 2 buildings and one more that will eventually close and move equipment to Auburn Hills.
There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Wildeboer.
Thank you very much. Those were great questions and a great discussion, I think. And I'm confident that as you see the consistent improvement in numbers, in performance and everything else that you will see where we're going and you'll be much more comfortable and confident of where we are going to be in the future. We're stronger today than we've ever been, and we're going to be stronger a year from now, 2 years from now than we are today. If any of you have any further questions or would like to discuss any issues concerning our company, all 3 of us are available. The contact information is in the press release, and we look forward to talking to you. Our annual meeting is in June, June 12. We'll show some of the things we're doing. Got some cool video and that type of thing, and we always love to meet our shareholders, our analysts, those people that are on the call, at those meetings. And we're also accessible to you in terms of trying to show you plant. If anyone's down in Auburn Hills, we'll show you our Auburn Hills at any time. Thank you very much. Have a fantastic day.
Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.