American Axle & Manufacturing Holdings, Inc.

Good morning, everyone. My name is Jamie, and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the American Axle and Manufacturing Second Quarter 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press the star key, then the number one on your telephone keypads. If you would like to withdraw your question, you may press star and the number two. As a reminder, today's call is being recorded. At this time, I'd like to turn the conference call over to Mr. David Lim, Head of Investor Relations. Please go ahead, Mr. Lim.

Thank you, and good morning. I'd like to welcome everyone who is joining us on AEM's second quarter earnings call. Earlier this morning, we released our second quarter of 2021 earnings announcements. You can access this announcement on the investor relations page of our website, www.aam.com, and through the PR Newswire services. You can also find supplemental slides for this conference call on the investor page of our website as well. To listen to a replay of this call, you can dial 1-877-344-7529, replay access code 10156999. This replay will be available beginning at 1 p.m. today through 1159 p.m. Eastern Time, August 6th. Before we begin, I'd like to remind everyone that the matters discussed in this call may contain comments and forward-looking statements subject to risks and uncertainties which cannot be predicted or quantified and which may cause future activities and results of operations to differ materially from those discussed. For additional information, we ask that you refer to our filings with the Securities and Exchange Commission. Also, during this call, we may refer to certain non-GAAP financial measures. Information regarding these non-GAAP measures, as well as a reconciliation of these non-GAAP measures to GAAP financial information, is available on our website. With that, let me turn things over to AEM's Chairman and CEO, David Dowk.

Thank you, David, and good morning, everyone. Thank you for joining us today to discuss AM's financial results for the second quarter of 2021. Joining me on the call today are Mike Cimani, AM's president, and Chris May, AM's vice president and chief financial officer. To begin my comments today, I'll review the highlights of our second quarter 2021 financial results. Next. I'll touch on some exciting business development news in the quarter, including announcements with the Chinese EVOM, NEO, and our recent communication about GM's Oshawa plant. And lastly, we'll discuss the ongoing and unprecedented challenges within the supply chain and our financial outlook. After Chris covers the details of our financial results, we will then open up the call for any questions that you may have. AM delivered strong operating performance in the second quarter of 2021, navigating industry production volatility stemming from the continuity of supply challenges. These challenges were greater than we originally anticipated at the beginning of the quarter, but our team did an excellent job in managing these obstacles, resulting in solid financial results. AM sales for the second quarter of 2021 were $1.28 billion, up approximately 149% compared to $515 million in the second quarter of 2020. The increase in our revenues on a year-over-year basis primarily reflects the recovery from COVID-19-related industry shutdowns that we experienced last year. North American industry production was up approximately 130% according to third-party estimates. Light truck production was up 150% year-over-year, and volumes of our core platforms increased significantly year-over-year. Inventory levels on key light truck programs that we support remain well below normal levels. Consumer demand for light trucks remains robust, and our OVM customers are building them as fast as possible. We believe the demand environment for these products, combined with a lack of inventory, should lead to an extended recovery through 2022, which will certainly benefit AAM. AAM's adjusted EBITDA in the second quarter of 2021 was $222.6 million, or 17.3% of sales. This compares to a loss of $52.1 million last year. In addition to benefiting from higher production levels, our intense focus on optimizing the business and flexing our cost structure over the past several quarters greatly contributed to our performance in the quarter. We remain committed to driving efficiency and managing factors underneath our control. AM's adjusted EPS in the second quarter of 2021 was $0.29 per share compared to a loss of $1.79 in the second quarter of 2020. And as for cash, I'm very excited about our cash flow generation in the quarter. We generated adjusted free cash flow of over $136 million, compared to an outflow of approximately $162 million in the second quarter of 2020. Our operating performance and commitment to efficient capital spending drove this high level of free cash flow. Additionally, we prepaid over $140 million of term loans in the second quarter. And since the fourth quarter of 2020 to the second quarter of 2021, we have paid down approximately $360 million of long-term debt. As we previously stated, we are committed to reducing our debt and strengthening our balance sheet this year, and we are delivering on that goal. We achieved 2.5 times net leverage ratio in the second quarter. It is this management team's focus to further strengthen AM's balance sheet. On the business front, we are very excited to announce that we will be supplying electric vehicle components to NIO, supporting their next generation of e-powertrain program. And for those of you who don't know who NIO is, NIO is a leading Chinese electric vehicle OEM and a pioneer in China's electric vehicle market. We continue to see good growth opportunities to support electric vehicles with drive units and a wide range of sub-assemblies and components. This applies with both existing and new customers. Today's announcement clearly underscores AM's technology in electric vehicle propulsion and our commitment to excellence within the space. We're very eager to support this new customer. The electrification dialogue with multiple global OEMs continues to be very constructive as manufacturers are intensely focused to support this transformation. We see plenty of opportunities over the next several years as our state-of-the-art technology, engineering, compact design, and new product offerings are attracting strong global interest. Our engineering teams are rapidly developing next-generation technology while supporting the launch of multiple new electrification programs globally. Our technology, innovation, and focus on customer service are strong value propositions allowing OEMs to compete to win business with both traditional and the startup OEMs. It's our goal to be the supplier of choice when it comes to the electric drive units, sub-assemblies, and components. Clearly, these are very exciting times for AEM. Having said that, we continue to deliver on our theme of securing the future by protecting the core. We are very pleased to reiterate that AM would be the sole supplier of front and rear pickup axles for the production at GM's Oshawa facility. This development demonstrates our high-quality products and on-time delivery capabilities, as well as our strong relationship with General Motors. We look forward to supporting GM as they expand their production of their successful full-size trucks to meet consumer demand and rebuild their inventories. In the quarter, we completed an acquisition which specializes in producing powder metal components. And as we mentioned before, we will do smart, quick-return, bolt-on acquisitions that will complement our core business, drive synergies, and provide solid financial returns. This was a compelling, high-value purchase which should immediately benefit AM and is also part of our long-term lightweighting component strategy. Finally, we were recognized as GM Overdrive Award winner in 2020. We're very grateful for this award as it demonstrates our commitment to the continuity of supply while addressing an unfortunate industrial fire last year. Operational excellence is a core value for AM and will certainly benefit us and provide us the competitive advantage going forward. Before I transition to Chris, I want to talk about our current operating environment and our financial guidance. The stress on the value chain stemming from shortages in semiconductors, labor, steel, shipping containers, port delays, and rising commodity prices is unprecedented. Second quarter 2021 was a challenging environment with the semiconductor challenges causing the production volatility that we saw in our schedules. These headwinds are continuing and schedules will remain volatile. We believe the second quarter 2021 still to be the trough of this issue and the semiconductor availability to improve in the second half of the year However, we expect supply chain challenges related to this and other constraints to continue into 2022. For AAM, we will continue to work diligently with our customers and our extended supply base to protect continuity of supply and support our customers. Let's discuss our financial guidance. Although there is continued operating uncertainty, especially within the availability of semiconductors, we are maintaining our guidance for revenue and raising the low end of our EBITDA range, we are also raising our adjusted free cash flow outlook. Our guidance is as follows. Our revenue will be $5.3 to $5.5 billion, adjusted EBITDA $875 to $925 million, and adjusted free cash flow of $350 to $425 million. Chris will provide more details about our guidance in his prepared remarks. Aside from the impact of the semiconductor issue and metal market challenges, operationally our business is running very, very well. We are focused on managing our costs and expenses while ensuring operational and capital efficiency to optimize our business. As I've mentioned before, these fundamentals should support strong margin opportunities as we return to normal operating conditions. At AEM, we have two overachieving priorities, and both are equally important. First, we're focused on the here and the now. That means operational excellence, strong cost management, and an unwavering commitment to support our customers. We have continually demonstrated these qualities and managed factors that we can control, leading to strong free cash flow generation and, yes, a stronger balance sheet. Second, we're focused on our future. We will continue to make investments in R&D to develop the next generation of electrified products, and lightweighting of components to drive possible future growth. Our engineering teams are developing creative solutions to offer solid value propositions to our customers. This is demonstrated by high interest in our electric vehicle products. And for us, our breadth and depth in drive chains provides us with a competitive advantage in not only technology development, but also an understanding of the OEMs, what the OEMs want from the propulsion system. Clearly, these are very exciting times, and the future is very bright for AEM. And with that, let me turn things over to Chris May. Chris?

Thank you, David, and good morning, everyone. I will cover the financial details of our second quarter results with you today. I will also refer to the earnings slide deck as part of my prepared comments. So let's go ahead and begin with sales. In the second quarter of 2021, AEM sales were $1.28 billion compared to $515 million in the second quarter of 2020. Slide 7 shows a walk of second quarter 2020 sales to second quarter 2021 sales. First, we add back the impact of COVID-19 from second quarter of 2020 of approximately $947 million. Then, we account for the unfavorable impact of the semiconductor shortage, which we estimate to be approximately $162 million in the second quarter of 2021. Other volume and mix in pricing was negative by 99 million. Metals and FX accounted for an increase in sales of $82 million. During the last several quarters, we have continued to see an increase in the primary index-related inputs to metal-based materials that we purchase. You may recall we hedged this risk with our customers by passing through the majority of index-related changes. The metal portion of this column reflects those elevated pass-throughs on a year-over-year comparison. Now, let's move on to profitability. Gross profit was $190 million, or 14.8% of sales, in the second quarter of 2021, compared to a loss of $99 million in the second quarter of 2020. Adjusted EBITDA was $222.6 million in the second quarter of 2021, or 17.3% of sales. This compares to a loss of $52.1 million in the second quarter of 2020. You can see a year-over-year walk-down of adjusted EBITDA on slide eight. we benefited from the contribution margin on the increase in net sales from last year as we continue to experience positive improvements in performance. As a result of short-notice production schedule changes and receipt of long-lead inventory items such as steel, our raw, whip, and finished goods inventories increased in this quarter. This drove a $16 million benefit from inventory absorption timing, which should reverse out the second half of the year as we anticipate reducing inventories during that time frame. As we mentioned, throughout the quarter, our schedules were more volatile than expected, but we were able to close the latter part of the quarter on a strong note. Now let me cover SG&A. SG&A expense, including R&D, in the first quarter of 2021 was $86 million, or 6.7% of sales. This compares to 14.3% of sales in the second quarter of 2020, as revenues rapidly declined last year due to COVID-19-related shutdowns. AAMP's R&D spending in the second quarter of 2021 was $30 million, compared to $32 million in the second quarter of 2020. We will continue to focus on controlling our SG&A costs, while at the same time continue to invest in key technologies and innovations, with an emphasis on electrification. This emphasis includes an appropriate level of funding to be successful and meet our objectives. but also includes smartly utilizing current resources from traditional products to support new technology development in a cost-effective manner. We do expect R&D to increase in the second half of the year as we are positioning to launch and pursue more electric vehicle business. We continue to experience significant customer interest in our new products and technology. Now, let's move on to interest and taxes. Net interest expense was $47.3 million in the second quarter of 2021 compared to $51.6 million in the second quarter of 2020. We expect this favorable trend to continue as we benefit from continued debt reduction. In the second quarter of 2021, we reported income tax expense of $2.4 million compared to a benefit of $43.9 million in the second quarter of 2020. As we continue into 2021, we expect our effective tax rate to be approximately 15% to 20%. we would expect cash taxes to be in the $30 to $40 million range. Taking all these sales and cost drivers into account, our GAAP net income was $16 million or 13 cents per share in the second quarter of 2021 compared to a loss of $213.2 million or a loss of $1.88 per share in the second quarter of 2020. Adjusted earnings per share, which excludes the impact of items noted in our earnings press release, was 29 cents per share in the second quarter of 2021 compared to a loss of $1.79 per share for the second quarter of 2020. Let's now move to cash flow and the balance sheet. Net cash provided by operating activities for the second quarter of 2021 was $167.1 million, compared to an outflow of $142.5 million last year. Capital expenditures, known as the proceeds from the sale of property, plant, and equipment, for the second quarter of 2021 was $41 million. Cash payments for restructuring and acquisition-related activity for the second quarter of 2021 were $16 million. The net cash inflow related to the recovery from the Malvern fire we experienced in September of 2020 was $5 million in the quarter. However, we anticipate the Malvern fire to have a neutral cash impact for the full year as the timing of cash expenditures and cash insurance proceeds align over time. In total, we would expect $50 to $65 million in restructuring and acquisition costs in 2021. This is no change from prior guidance. Reflecting the impact of this activity, AAM generated adjusted free cash flow of $136.1 million in the second quarter of 2021. From a debt leverage perspective, we ended the quarter with net debt of $2.6 billion and LTM adjusted EBITDA of $1 billion, calculating a net leverage ratio of 2.5 times in June 30th. This continues the trend of a declining leverage ratio and marks the achievement of a critical goal for 2021 to reduce our leverage by a full turn or more this year. Based on AAM's strong free cash flow generation, we prepaid over $140 million on our term loans in the quarter. Subsequent to the end of the second quarter, we redeemed an additional $100 million on our six and a quarter notes due in 2025. We continue to expect to strengthen AAM's balance sheet by reducing our gross debt and lowering future interest payments. As of today, we have paid down approximately $350 million in our term loans and notes in 2021 alone. Before we move on to the Q&A portion of the call, let me close out my comments with some thoughts on our 2021 financial outlook. As you can see from our press release, and as David mentioned, we have maintained our revenue outlook at the $5.3 to $5.5 billion range. We raised the lower end of our adjusted EBITDA range, and we increased our outlook for adjusted free cash flow. Our outlook is based on the latest and best information we have regarding our customer production schedules, including the reduction in GM truck production we are experiencing this week. We continue to assume our customers will prioritize building full-size pickup trucks and SUVs going forward. But the uncertain backdrop related to semiconductors remains, thus the ranges we have provided. The revision to our free cash flow range is a result of focused and efficient capital spending, restructuring and cost reduction initiatives, your margin growth, and working capital optimization. Our strong financial results will be used to reduce debt and support our research and development initiatives to solidify our position for future profitable growth. AAM continues to focus on building long-term shareholder value and success. We are focused on our future in electrification, We continue to allocate more engineering and financial resources to technology development to provide compelling, high-value products to OEMs and drive our future profitable growth. You are now beginning to see tangible results of the new business award announcements we are making. We will continue to secure business on our legacy core platforms that will yield strong cash flows well into the future. And let's not forget our passion to run an efficient, highly focused organization that centers around performance optimization, strong cost structure, and the delivery of best-in-class results. The second quarter of 2021 continues the theme of managing factors under our control in a difficult operating environment. There are plenty of near-term challenges and uncertainties as it relates to the supply chain in the second half of 2021. With that stated, this management team is experienced and confident in navigating these obstacles. Thank you for your time and participation on the call today. I'm going to stop here and turn the call back over to David so we can start the Q&A. David?

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

Ladies and gentlemen, at this time, we would like to remind everyone that in order to ask a question, please press star and then the number one on your telephone keypads. We'll pause for just a moment to compile the Q&A roster. And our first question today comes from John Murphy from Bank of America. Please go ahead with your question.

Good morning, everyone. This is Aileen Smith on for John. First question, as your automaker customers have clearly been benefiting on the margin side from very favorable price and the tight inventory environment, have they in any way been more cooperative with recovery mechanisms for let's call it the stop and go production environment that you and others have experienced with the semiconductor shortage? We've heard from some suppliers that automakers have been receptive to cost recoveries where those suppliers have had to spot by semiconductors to avoid disruption. But just wondering if that's extended to automakers also helping out on cost overrun for logistics or manufacturing or other buckets for those suppliers that are just trying to meet their customers with very choppy schedules and releases.

This is David Dowd speaking. First and foremost, we've been able to work with our suppliers and our OEMs with respect to protecting semiconductor supply to our business, so there's been no need to have to go to the customer to ask for relief there. We're protecting as they're prioritizing and allocating chips accordingly. We're adjusting and following their lead with respect to that. With respect to any premium costs that are being incurred because of some of the supplier and other shortages in the marketplace, we deal with that on a case-by-case basis with each of the respective customers. I don't really want to go any further from a detail standpoint on that. But the customers have been very understanding of the situation that's out there. At the same time, they're asking for some pain sharing in the process, which we've been supportive of. At the same time, we're all just trying to protect continuity of supply and keep the industry rolling.

Okay, that's helpful. And then second, I wanted to ask a question around the EBITDA margins. Obviously, we've seen a bit of a return to normal, but it's still incredibly strong margin performance from some pretty elevated quarters over the past year. But can you help us bridge how you land at what I think will probably be a 16 or sub-16 margin in the second half of the year to get to your full-year outlook versus where you stood in the second quarter? We've got the volume environment that will probably be sequentially better, but what offsetting factors are there to that? Is it commodities, mix, or just costs lingering through the value chain?

This is Chris May. Yeah, certainly, if you think about our second quarter performance, our first half, very similar in terms of strong performance. Bridging that to the second half, a couple points I would sort of emphasize with you. I would expect some benefit as some of the semiconductor sales return off of a, obviously, second quarter of the trough. So we'll have a benefit there. We'll have a benefit of some continued performance. Setting some of that is a couple of different items, one of which you see in our year-over-year EBITDA walk bridge where we had some benefit of a build of inventory in the second quarter. That will actually bleed out through the back half of this year. Neutral to the whole year, it's just a timing difference. But if you think about how we're advancing also some of our electrification initiatives, new business opportunities, so we're going to step up some of our product engineering spend associated with that. This is, you know, things we've been sort of dialoguing with you and others over the past six months. A little lightweight on the first half of the year. It's going to be a little heavier in the back half of the year in terms of product engineering spend. Mechanically, some of the timing of our price decreases year over year, a little bit more weighted to the second half of the year. That will impact us a little bit. And as you know, metal markets and others continue to rise here throughout this quarter and expected to rise a little bit into the second half of the year. You'll have a little bit of impact associated with margin associated with that as well. Those are the primary elements. And, again, we'll pick up some sales and benefit from performance as well and mitigate some of that.

Great. That's a very helpful caller. And one last question on the balance sheet, if I may. Clearly, you continue to make good progress in generating cash and delevering. Can you remind us what your timeframe is to get to a sub-two times net leverage target? Is that something that could be theoretically achieved in the next 12 months? And then as you get to that target that you've talked about in the past, How might the capital allocation framework change in any way?

Yeah, in terms of a two-times leverage target, as you know, we're obviously two and a half times here in the second quarter, making meaningful progress already here to date. You've heard us articulate our objective to get to two times, and the goal there, well, we've not laid a specific target to that. Obviously, sooner rather than later is our objective. And then when you get into that level of framework from a leverage perspective, that certainly opens the dialogue on that topic.

Okay. Thanks for taking the questions.

Thank you.

Our next question comes from Rod Lash from Wolf Research. Please go ahead with your question.

Thanks, everybody. Really nice to see these incrementals in the quarter, and frankly, I'm a bit surprised, just given the short-notice production volatility. Just to Aileen's question, it does look like those decrementals in the back half are very high, or at least that's what's implied by your guidance. And I'm just wondering, I understand the timing of pricing, but I'm wondering if you are sensing that there's any change in production schedules that would also be contributing to that, or are you actually gaining or still having limited confidence in production in the short run?

Yeah, Rob, this is David. I'll make a couple comments. I'll turn it to Chris. Obviously, OEMs have been protecting their major core platforms to manage their profit pools. We, AM, have benefited greatly, as have many other suppliers with respect to that. Obviously, we took our first downtime this week with respect to some of the GM full-size chart platform at select plants. That's all coming back online starting next week, so that's positive. We do still continue to see extended downtime with respect to some of our crossover vehicle business, and clearly the uncertainty that we're managing in the marketplace, and we just need to understand that that's going to be a challenge for the balance of this year, and as I indicated, we'll carry into 2022. But we think our major core platforms will be protected going forward, but we also need to be prepared because we didn't expect the GM stuff to go down and we've done that. And we just utilize that time efficiently to give our people a blow, do maintenance in our facility, and then just catch up on some service part aftermarket type work. So it actually, you know, we turn a negative into a positive. But Chris, any comments you want to make to Rod's question?

Yeah, Ron, I mean, just, I mean, I listed out sort of the key drivers on the previous question. But if you think about, for example, that inventory absorption, and that's a 50 basis point margin impact on us in the second half. And that's truly just a timing within the year. It's neutral in total. And if you think about The other elements as well, a lot of them are timing driven. And you see we didn't change, for example, the top end of our margin or our EBITDA guide, which would imply a lot of this stuff was previously known to be timed at different points throughout the year.

Okay. And then just secondly, it looks like you're going to get to that two turns of net leverage over the next year or so. And it sounds like that should provide you with a lot more flexibility for acquisitions or other things. Can you just talk a little bit about the opportunities that you're seeing, particularly assets that would be complementary to you on electrification? And also organically, if you could just provide any color on the magnitude of bidding opportunities that you see at this point.

Yes, Rob, this is David. I'll start on the latter question first. We're quoting about a billion and a half worth of new and incremental opportunity for our business, which is consistent with how we have been quoting in the past. The biggest difference is the fact that the mix of that quoting now has shifted dramatically to hybrid and electric vehicles, whereby about 80% of what we're quoting today is in that category. which is a positive because that's where the industry is pivoting to and shifting to, and we're seeing quotation opportunities, especially based on the technology days that we've had with our various customers, the excitement that we've garnered with the products that our engineers have developed, and now it's just a matter of converting some of those RFQs or RFIs into book business going forward. So we're very excited about what that has to hold going forward. When it comes to the acquisition side, as I noted in my prepared remarks, we did a small bolt-on acquisition in the core powder metal business. Again, we want to be smart about that. We've said that where it's appropriate to consolidate the traditional business, that we can leverage our size and our scale and get synergies and have a financial benefit to the overall business. We're going to act on those types of things, especially as our capital structure and balance sheet becomes even stronger. And we see more opportunities both on the metal forming side of our business as well as on the driveline side. But we also want to keep in front of us there are certain things that we want to do to strengthen our vertical integration capabilities or partnership capabilities with respect to electrification and and clearly we'll keep that as a priority as well when we're looking at acquisitions.

Great. Thank you.

Our next question comes from Ryan Brinkman from J.P. Morgan. Please go ahead with your question.

Hi. Thanks for taking my question. I wanted to check in with regard to the still relatively new venture with InAdvance in China, so a couple questions around that. Firstly, I realize Magna also operates its integrated electric drive unit business via a joint venture, in their case with LG Electronics, although I think BorgWarner has claimed some benefits to having all capabilities within one company. So I wanted to get your thoughts on that, you know, what advantages or disadvantages either approach may have, if any. And on a related note with regards to the new NEO win, I'm curious if you think the venture in advance helps with, you know, go-to-market strategy or customer introductions in China where they're based and if these customer introductions might also confer some benefits on the component or other side for you, such as with differentials, as well as for complete electric drive units.

So Ryan, this is David. As it relates to the NEO business, the NEO business is sub-assembly work that we won directly from an AM standpoint with NEO. We did not have or need any involvement from our partner in advance with respect to that. That's just a budding and a building relationship that we've established with NEO as they continue to grow their market share in China, and they have greater demands and needs for their product and the performance of that product, they really turn to us based on our overall capabilities, especially in the area of MBH. So that's been a big positive for us in regards to building that relationship. On the in advance question, in advance has certainly been a good partner for us in China. They've helped us introduce us to many startup OEMs as well as, you know, other OEMs within the China market. We're clearly growing our business in China with, in advance, support and leadership in some cases. So that's been a positive for us, and we expect further growth opportunities. We're jointly developing some next-generation products today that will only strengthen our capability as far as product offerings to the marketplace, whether it be in China or globally around the world, and that relationship is going very positive. As we've said before, when it comes to the market, we don't necessarily have to be completely vertically integrated in order to win business. We're bringing a value proposition to the table with the partners that we have today, and we've been successful in winning our fair share of the business. Clearly, as we go forward, we'd like to strengthen our knowledge and capability there, but it doesn't mean that we have to do everything ourselves. But the partnership within Avance is going very well right now.

Okay, thanks. And then the last question is about how you've been named as the 100% sole supplier of front and rear pickup truck axles for production at GM's Oshawa, Ontario facility. You know, how should we be thinking about this in the context of your earlier having gone from, I think, 100% to more like 65% of the content on GM full-size pickups as that program transitioned from the K2XX to T1 architecture? does this potentially signify any kind of shift in how GM thinks about producing these components in-house versus outsourced? Or is GM maybe already at capacity in terms of what driveline components they can produce out of Arlington and they didn't want to make an additional investment whereas you already had some excess capacity maybe more nearby? And then on this topic, as GM insources driveline capabilities for its Ultium drive program, do you think as they reallocate resources that might in the future You know, they could reassess, you know, how much of the non-Oltium pickup driveline work they want to do in-house, maybe benefiting American Axle.

Yeah, let me start with the traditional side of the business before we talk about electrification. Clearly, GM made a decision. We understood that decision, and we've executed that decision with GM in regards to they decided to take a portion of the light duty pickup truck program only in-house into their Grand Rapids facility. That business is running. We helped them get that business started, and they're running that business essentially to the capacity that they've installed. So that's positive for them. Obviously, it impacted us, but we've overcome that, and we've managed that through our financials over the last several years. I'll remind everyone on the heavy duty and on the SUV, GM did not insource any of that work, and we're the supplier of that. that business directly. All the incremental capacity programs that GM has had have all come towards American Axle. So that's positive in regards to our relationship, the latest being the Oshawa program. And we're very grateful for their confidence in us. At the same time, we've earned it based on our performance and the value propositions that we've brought to them for decades, but even here lately. So our relationship with GM is very, very strong. They need us. We need them on the traditional products today. At the same time, we've had very good involvement with their senior leadership in regards to our technology and electrification. We recognize and understand what they're doing on the Altium platform, both from a battery and from an EDU standpoint. That will apply to many segments within their vehicle models. But at the same time, as they've shared with us, If there's a good value proposition from the supply base and it benefits General Motors, then they'll entertain that, and we're highly confident, and they recognize that we have some value propositions to offer them in the field of electrification. So more to come. Nothing more to say at this point in time, but we're very confident about where our relationship is with General Motors. Great. Thank you.

Our next question comes from Dan Levy from Credit Suisse. Please go ahead with your question.

Hey, good morning. Thank you for taking the question. Sorry if I missed this earlier, but in the second quarter, how much did MIX play a role in the strong margin? And maybe you could just comment on what you're expecting for MIX into the second half.

Yeah, Dan, this is Chris. Clearly, with the semiconductor impact here inside of the second quarter, the focus our end customers, whether it be Stellantis or General Motors and others, their emphasis has been building full-size truck applications to really the detriment of some of their crossover vehicles. So you do get a small benefit associated with mix in terms of our overall revenue profile. You would expect that to continue for a little bit here into the third quarter, but as they bring those facilities back online, that will sort of obviously, I would call it, mitigate more towards our previous normal mix through the course of the back half of this year. Now, in the third quarter, as you know, they've taken some downtime on the full-size trucks that we're experiencing this week that we talked about. So that dynamic plays a little bit inside of the third quarter.

Great. And then the premium freight in the quarter, any color on the magnitude of premium freight as a drag?

Yeah, we had a little bit. Think of it in the concept framework, a couple million dollars worth of premium freight inside of the quarter due to – basically challenges inside of the supply chain to make sure we have adequate supply. It wasn't material.

Got it.

Thank you.

And then as a follow-up, I think in the past you talked about this award in Europe with luxury OEM for an eDrive unit. I think that program is supposed to launch in the back half of this year. It's like a P3 eDrive unit. So, A, maybe you could just give an update on that program. But on top of that, has that program created an entry point for discussions with that customer, whomever that may be, on their bed programs? Just trying to get a sense for whether any progress you're getting on advanced hybrids is giving you an entry into, you know, higher content discussions on BEV.

This is David Doak. You're right. We are going to be launching a new electrified program, a P3 application for a luxury European OEM at the end of this year. At the same time, there will be seven variants to that program that will launch over multiple years going forward here. Clearly, any time you have the opportunity to work that closely with an OEM and advance in new technology, you're going to build and strengthen their relationship, not only strengthen their confidence in us as it relates to our development side, but also our ability to launch successfully that OEM. Because of the technology that we're developing, we're also seeing other opportunities that could use that P3 type application, and the luxury OEM that we're working with today is supportive of us sharing that capability with some others that are out there right now. So we feel very good about opportunities that are, first of all, the opportunity that we have with them, and at the same time, other opportunities that will present themselves. four applications in the future. And then, clearly, we're working on a lot of other advanced technology in the electrification space that we'll demonstrate to the customers. And then it's just they've got to determine, based on their long-range product plans, what their technology needs are and what they want to do in-house themselves versus what they want the supply base to provide. All we can do is provide them a competitive offering and solution that offers that value proposition that we referred to earlier. Okay.

And that P3 eDrive unit, how much does that differ technically from a Bev eDrive unit?

I mean, it's just a different architecture completely from a full Bev-type application. It's more technical than I really want to get into here, but at the same time, this is a high-performance passenger. Often that's where the other vehicles that we're spending most of our time with P4-type solutions are full battery electric-type vehicles.

Got it. Thank you.

Our next question comes from Joseph Spock from RBC Capital. Please go ahead with your question.

Thanks. This is Garrett on for Joe. Maybe going back to the margins but taking a step back, I mean, you just put up almost 18% margin in the first half. I think even if you normalize for some of the timing differences associated with the inventory and kind of more normalized R and D, I think you're still, you know, high 16s right around 17. So, I mean, what can we kind of extrapolate about the underlying production or performance of the business in the first half, as we think about, you know, a more normalized operating environment where, you know, hopefully, you know, schedule volatility comes down as the semi situation improves, you know, Commodity supply chains should improve. I realize kind of, you know, pricing maybe normalizes and then mixes maybe a slight headwind. But, you know, what is kind of the underlying performance in the first half say about, you know, what this business can do as things normalize?

Yeah, I don't want to oversimplify the answer to this, but our underlying business X, those items you talked about, such as, you know, semiconductor impact and metals, very strong in the first half. It's going to be very strong in the second half. It's going to be very strong going forward beyond that.

Okay. And then maybe just switching, you know, switching gears to the NEO win. I mean, I think in the past you said components, you know, CPV can kind of, you know, be as high as $500. Maybe give us some sense of where the NEO win lies in that. And then of kind of the EV sourcing activities, you know, the 80% of the $1.5 billion that you're quoting, I mean, What percentage of those is, you know, based on conversations where customers are looking for you to supply the full eDrive solutions versus just components?

This is David Dowd speaking. As we indicated to the investment community, I mean, we're approaching the market, you know, four different ways as it relates to our electrification strategy. One is on the component states, so think gears and shafts. Two is on the sub-assembly states, so think differential assemblies and others. Three is on the gearbox, and four is on the fully integrated unit. We're clearly seeing opportunities in every one of those categories right now. We're capitalizing on that, the latest one being the NEO award, which is a sub-assembly application. The pricing is in line with some of the things we've guided you in the past and we see more opportunities presenting themselves going forward on the fully integrated electric drive units just because our technology has been more demonstrated and more understood and well-received by the customer base, and just because of the content per vehicle is going to swing it disproportionately in that direction. However, there's plenty of opportunity that's presenting itself in the other three categories I mentioned to you.

Okay. Thank you very much. Thank you. Thank you.

And our next question comes from Brian Johnson from Barclays. Please go ahead with your question.

Yes, just have a question around the issue of OEMs, particularly by protecting their full-size truck platforms, building vehicles that don't have chips and stored on lots around their factories. You know, just as we kind of get out the sharp pencils for this quarter and next quarter, do you have any sense of the magnitude of that bill? Because that may not show up in IHS or Woolworths production numbers because they're not finished trucks. But from your perspective, you would have delivered an axle set to those factories.

Yeah, Brian, this is David. I don't know a specific number. There's clearly every one of the OEMs is building full units with chips. They're building or changing configuration of some trucks to take out chips so they can still sell those directly to the marketplace just with less capability and performance than maybe the fully integrated ones. And there's clearly other vehicles that are being built short of chips right now. I can't tell you what that exact number is, but it's impacted all of the Detroit 3 truck manufacturers. And, you know, clearly they're going to have to, as soon as they get the steady supply of chips, they'll put those back into the system. I just don't know what that volume is off the top of my head. It's probably better to ask the OEM that question.

Okay. And a second question, just following up on, you know, the big, the NEO win. Congratulations. Did that start as a component discussion, or did you pitch the drive, the e-motors and the drive modules in person with your kind of knowledge of the capabilities and then wound up with a subcomponent?

You've got to remember they have existing suppliers today, and they've got some issues with some of those existing suppliers as it relates to the capability of the product and the performance, especially in the area of MBH. We bring a tremendous skill set there. So first, we solved an issue that they have. Second, we obviously identified opportunities that we could quote going forward. And third, there's extended dialogue that's taking place. We're hopeful that there will be other opportunities That could even include some of our advanced technology going forward.

Okay, thank you.

Our next question comes from Adam Jonas from Morgan Stanley. Please go ahead with your question.

Hey, everybody. First, a clarification. The 80% of the quoting activity that was electrification, you mentioned it was hybrids and other forms of electrification. Can you tell us the split of hybrid versus BEV, for example, of the 80%? Quoting?

Adam, this is David Dow. The majority of it is electrification. So, I mean, when I say majority, almost all.

Meaning electrification, meaning non-hybrid, like pure BEV?

Correct.

Thank you. And David or team, any comment on – I know it's a tricky question because it's in flux and scale economies are not comparable – So the profit of these wins, the margin profile of these wins versus what may be rolling off of the de-adoption, can you provide color on that? I'm not expecting an exact answer, but just color on if it's lagging, how much, or is it approaching break-even at EBITDA, and any kind of color you could say so we can think of as these programs ramp when we can narrow the gap between presumably, I would guess, margins that just by virtue of the starting point is a bit lower than what you're what's rolling off.

Thanks. Yeah, Adam, this is Chris. You know, as we think about new business that we source or are sourced with our customers and we price and approach it, right, we maintain a very tight financial discipline. Margins are one element of that. Return on invested capital is another element of that. But big picture, our objective is to continue to be a high-margin performing supplier both in our traditional business and in our future business. Appreciate it. Thanks.

Our next question comes from Itay McCally from Citi. Please go ahead with your question.

Itay McCally Great. Thanks. Good morning, everyone. Just a quick housekeeping to start. If I just look at the DNA and CapEx outlook for the year compared to the first half, I think it kind of implies CapEx up significantly and H2 DNA down quite a bit. Call on the flows there.

Yeah, CapEx is clearly weighted to the back half of the year, and in particular more so in the fourth quarter as we're launching some of the programs that we've previously announced and beginning that process. As it relates to DNA, a little bit weighted to the first three quarters of the year, you may notice we had some accelerated depreciation associated with one of our customers that exited a region in Brazil. So that actually ceases that acceleration at the end of the third quarter. So that's the dynamic you're seeing from a depreciation standpoint.

Great. That's helpful, Chris. And just kind of going back to maybe a bigger picture incremental margin question, and I know it's early to talk about 2022, but if we do have a smoother production cadence next year, and then also considering some of the investments you're making in electrification, is there any updated thoughts on how to broadly think about a range of incremental margins beyond 2021, just given the choppiness this year?

Yeah, if you think about going into next year, right, you'll pick you in If the semiconductor issue passes, you'll pick up volume, which you know our contribution margin is generally very attractive with that. As you know, some of our customers are adding full-size truck capacity and volume requirements, and we just talked about Oshawa previously. That's obviously very attractive to our overall revenue line into next year. And that's very positive from a revenue perspective. On the cost side of the house, as we've mentioned, we'll continue to invest in the R&D space. So I would expect that to continue to increase slightly over time. And those are probably our two major items thinking about walking into next year. But you have your normal stuff that we would typically talk about in terms of pricing, partially offset with productivity, and a few other items.

Great. Just a quick follow-up. Did you share what R&D is expected to come in this year?

Right now, the first half of the year, we're a little over averaging about $30 million a quarter. We said that would step up the back half of the year. That step up will probably be similar to what we would see into next year. Typically, we've been talking that $35 million to $40 million range. We've been trailing under that recently, but we're going to start to move into that range here over the next 3, 6, 9, 12 months. Perfect. That's all very helpful. Thank you.

And our final question today comes from Emmanuel Rossner from Deutsche Bank. Please go ahead with your question.

Yeah, hi. Good morning, everybody. Good morning, Emmanuel. I just wanted to come back to the 80% of quoting activity from electrified solution, which is a very big number. And I was comparing that to your, I think, 15% of the three-year backlog, which is EV solutions. So, Would you expect over the next three years or more to sort of have your backlog shift to an overwhelmingly electrified solution? I guess how should we think about it?

Yeah, Manuel, this is David. The answer to that question is absolutely yes. I mean, we're seeing less and less traditional opportunities from the OEMs right now and more and more of the electrification, which is clearly indicative of what I just covered with you, 80% of our quoted opportunities are in that electrification space.

Okay. And do you have any initial data, obviously early days on the electrification efforts, but do you have any initial data on win rates on some of this quoting activity and maybe in comparison with the traditional business? I'm generally curious to know if you have the opportunity over the next few years to get your annual backlog contribution above the $200 million that it's averaging right now and back to higher levels that maybe used to be a few years back?

Yeah, no, we're clearly comfortable in regards to our ability to win business going forward. As you know, historically, we've been in that 25% to 30% win rate on our traditional business. as long as we can continue to support that, and then we'll have plenty of opportunity to offset any business that's trading out of here, which is in that $100 to $200 million range, but trending to the low end of that range right now. We recognize our backlogs. One of the lower backlogs that we've had in some time, but we fully expect that we'll be growing that backlog in years to come going forward.

And I guess just from your initial experience on electrification winds is that 25% to 30% win rate potentially applicable for those opportunities as well?

We're winning our fair share of the business, and that's all I really want to say about that.

Okay. Thank you.

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

Ladies and gentlemen, with that, we'll conclude today's conference call and presentation. You may now disconnect your lines.