Aptiv PLC (APTV) Earnings Call Transcript

The first presentation is a fireside chat with myself and happy to say we have Chairman and Chief Executive Officer of Aptiv, Kevin Clark; as well as Joe Massaro, Chief Financial Officer, Senior Vice President for Business Operations. Kevin and Joe, I don't know if you have any remarks you want to make to start or we can just fire away or how would you like to proceed?

Yes, maybe just one, thanks for having us here. We appreciate the opportunity to kick off your conference. So thank you. We announced our earnings about a week ago. So we gave a preview or we gave an overview of our strong second quarter performance and our outlook for the balance of the year. I'd say we don't have a lot new to talk about since then. So I think it'd be best to maybe just turn it over to you and start with Q&A.

Yes. Absolutely. Terrific. We thought to ask all of the suppliers at the conference a few standard questions so we can compare and collate responses. And because the industry and the macro is so dynamic and changing, and we've been through so much, happy to get your latest takes. The first question is on demand. With demand for new vehicles in the United States in particular, having surprised quite positively thus far this year, how would you rate the strength currently of the different economies and end markets, most important for your company? And what is your outlook going forward?

Yes. As we talked about a week ago, demand remains strong, really across all markets, especially North America and Europe. We're a little less positive as it relates to underlying GDP growth in China. But when you look at North America, Europe, very strong. For -- I think for our industry from a supply base standpoint to be transparent, I think it's tough to separate how much of that is incremental demand versus how much of it is a more normalized supply chain, what had been pent up from a production standpoint and what OEMs are trying to push through their production facilities and get out onto dealer lots. It looks like likely a balance between the 2. We're watching very closely orders in North America, Europe, China, especially as it relates to late 2023 and heading into 2024. So that's something that we don't have clear line of sight at this point in time, but we're watching very closely. I know you've probably read Germany orders appear to be -- order intakes appear to be down somewhat at this point in time over the last couple of months, but we'll see what sort of trend that actually makes or creates. I'd say the other item for us, just given where we sit, setting aside vehicle production, which is always helpful from a revenue standpoint, when you're growing 8 to 10 points over underlying vehicle production, whether it be ADAS solutions, high-voltage electrification solutions, some of the other product areas that we operate in, that clearly continues to drive out growth, and that's something we expect to continue near term and longer term.

Great. And the second question is more around the supply side. Where do we stand here in the middle of 2023 in terms of the semiconductor chip shortage, port delays and all those other supply chain bottlenecks that have impacted the level and stability of customer production in recent years, and what do you think the outlook is going forward?

Yes. So the last -- it's tough to say we're done and we're through it. I mean, to be transparent, the last couple of years have been very challenging with COVID, supply chain disruptions, semiconductor shortages, material inflation. I would say we would tell you global supply chains across all regions are operating better than they have over the last 3 years. We would tell you they are still tight, especially in areas like semiconductors, select areas of semiconductors with select semiconductor manufacturers. We're managing through it. It's not as tight as it was. But I would say, both from a semiconductor standpoint, from a distribution transportation standpoint, from a supplier standpoint, more availability of parts, but we're also operating much better across the entire supply chain. So there's much more efficiency. So we're not running into the change in -- short-term change in schedules, the swings in labor management, the swings in manufacturing costs, and it's much more predictable. But we would say over the next 12, 24 months, that in reality, it's something, in our industry anyways, that we're going to have to watch very closely and stay on top of.

Very interesting. And next, I wanted to ask on the backdrop for operating margin for suppliers generally. EBITDA margins for the suppliers we cover averaged 11% last year, maybe they'll hit 12% this year, although in the years leading up to the pandemic had averaged more in the like 13% to 14% type range. So considering all the macro and industry factors that roll up into the backdrop for supplier margin, such as the aforementioned level and stability of customer production, the timing of commodity and non-commodity inflation and related recoveries and the needed spending on R&D at times in advance of revenue in order to support industry change, where do you think we are on the path to normalization of the backdrop of supplier margin? Or given structurally higher costs and recoveries, could we be potentially looking at a new normal with maybe return on invested capital or another metric perhaps being more helpful to gauge performance?

That's a very complicated question. And there's not a simple answer. Normalized margins, I guess I'd start and Joe can walk you through some of the specifics from an input standpoint. The first part of my answer would be it depends. It depends where you sit in the supply chain. It depends what you supply and provide OEMs. The reality is more cost is going into cars, whether it be battery-electric vehicles, it be advanced ADAS solutions, it be versions of autonomy, it be more advanced user experience systems, those need to be paid for. So there are areas within the vehicle that I would say are more standardized that are going to continue to become more commodity like. We fortunately have worked real hard from a portfolio standpoint to make sure that we stay out of those areas. Those are -- those have been challenging areas. They'll continue to be challenging areas in the future. I think we would say they're going to be even more challenged, so that OEMs could put more content in. As you look at the last 3 years and certainly, we were impacted by it from a cost structure standpoint, when you think about a global company like ourselves managing through COVID and keeping our manufacturing facilities running, our employees safe, our customers connected; when you look at what's going on from a supply disruption standpoint, where in reality, we're managing schedules on a day-to-day basis within our manufacturing facilities to respond to part availability with a real focus -- and we made the intention a real focus on keeping our customers connected that, that would pay longer-term dividends. And then third, just the material and to some extent labor inflation standpoint, what we see from a pricing standpoint. COVID, listen, we've managed through and Joe can talk about the numbers there. The supply chain aspects, those situations are improving. So the inefficiencies are certainly getting better. We're getting better. We continue our normal sort of productivity initiatives where we drive productivity. From a material inflation standpoint, it's really twofold. We've spent a lot of time over the last couple of years engineering in and out various solutions, one, for capacity; two, to drive efficiencies and productivity in our product portfolio; and then lastly, over the last couple of years, quite frankly, pushing a lot of that material inflation through to our customers. So over the last couple of years, it has been significant. So we've gone through a challenging 3 years. We've talked about our guidance in February for 2025. It's something that we have high confidence in. It's going to require continued work to get there, but we have clear line of sight and a path. But I think over the last couple of years, when you talk about normalized, I think there were a lot of abnormal things that some of us were dealing with. I don't know, Joe, if you want to give some specifics.

No, I think you covered it. We did, in February, talk about 2025 EBIT margins of 14% to 14.5% for Aptiv and laid out a path of how we plan to get there and have really started executing on that path really as we got to the end of last year. And to Kevin's point, COVID and disruption costs were very expensive for us. Just to give an example, in 2022, we spent about $315 million related to supply chain disruption costs and trying to work through the disruptions and keeping customers connected. The sequential improvement, Kevin talked about, the supply chain and the operating environment has helped this year. That number this year will be about $150 million, down from $315 million. So we're starting to see the improvements in the overall operating environment come through the numbers. And we saw that in Q2, in particular, where the improvement alone Q2 over Q2 was over $70 million because of Q2 2022 just being heavily disrupted. So the combination of those costs falling away and then a return to our -- and the ability to have time for the teams to work through our annual performance initiatives and sort of how to make the business better, big contributors to that margin expansion.

Maybe to just dig in on that margin expansion outlook. I think investors were surprised when you unveiled that guidance because you were looking at the time for a 10.3% to 10.8% margin this year, which has since been tightened, 10.4% to 10.7%. But that you would advance from that to the 14% to 14.5% aforementioned range in '25. It's well above the 11% that you generated in 2019 pre-pandemic, well above the 12.5% in the 5 years leading up to the pandemic. I know they were surprised because Bloomberg consensus was for just 12.6% margin. It's still not up to the guidance range. And your stock jumped 7% when you made that announcement because I think it does stand sort of -- thwart these industry pressures that are impacting other suppliers. So maybe you could just talk about what is giving you that confidence that you say that you have? And then what do you need to do like within the company, within your control to get there? And what is assumed that's kind of out of your control? What sort of industry backdrop or environment also needs to maybe fall into place to hit those very strong numbers?

Well, I think I'll start. I think it's a version of what Joe and I just talked about. One is a more normalized environment, certainly from a availability and supply chain standpoint. We don't fully control that, but it certainly has improved. We've taken actions -- the supply chain's taken actions. Volume helps. I think our outlook for vehicle production at our Investor Day on a relative basis was low growth, but there was an element of growth. So certainly, just given the nature of our business, the fixed cost nature of our business, that is helpful. Continuing on our initiatives as it relates to productivity, certainly drives margin expansion. And then again, a big piece of what we've been focused on over the last several years is how do we make sure from a product portfolio standpoint, we're positioned in areas that are higher growth, that are higher margins, that have better industry structures, that we're delivering more value to our customers. Therefore, we have much more pricing power. And that's reflected in what you saw in the second quarter. It's reflected in what you'll see in the back half of the year. We're confident in that and certainly into 2024, our competitive position, we think, is reflected in the literally hundreds of millions of price increases to our customers, at the same time, record bookings in some of the most advanced areas in and around vehicle, vehicle architecture, ADAS systems and software. And then lastly, I think the acquisitions that we've made recently, Intercable, Wind River, others, that certainly is accretive to our current and historical margin structure.

You mentioned the bookings. That's really an area where you've excelled over the last couple of years. I mean, '21 and '22 were both, by far, records for you for bookings. And in the first half of '23, you've already booked 3/4 of what you booked in the record last year. And you're at 2/3 of the $5 billion target for this year. What would you say accounts for that big uptick in the bookings? And does the trend in bookings potentially put you on track to even exceed the '25 numbers that you shared only earlier this year, which did come out after all before you announced some big awards? And what are the financial implications of booking huge amounts of business? I mean obviously, it will benefit profit at some point in the future, but is there maybe any kind of interim period where you might need to invest more heavily in development expense or capital expenditures to prepare for it?

Yes. We've been investing -- we've always been investing heavily in development expense. Our -- but our model has been, how do we take that engineering box? How do we keep the box at the same level? And how do we basically repurpose more of that into advanced development activities? So 10 years ago, I'd say it was roughly 10% of our total engineering and engineering to sales then was roughly in line with where we are now, call it, 6% on a net basis, 10%, 15% would be advanced engineering. Today, it's 25% to 30%. And that's on things like Smart Vehicle Architecture, advanced compute solutions, high-voltage electrification, ADAS solution, all those areas. So those are areas that we invest. Our success on bookings in and around Smart Vehicle Architecture, we began talking about that in 2015. We introduced our customers to our first solution in 2017. We worked with several of them in and around our view of the hardware aspect of the architecture and where it needed to go to have software-defined vehicles to effectively do what our customers are saying they wanted to do. And that translated into strong strategic relationships that have resulted in these big awards. I mean, we've developed strong relationships and confidence in our capabilities. And now we're expanding that from hardware, quite frankly, into what does the software stack look like as well? In terms of incremental investment, we would say in certain circumstances, may there be some incremental investment? There may be. Is it significant? No. Because in reality, we're launching 2,500 programs every year. And when you think about incremental costs, that tends to be from an execution standpoint where that incremental cost takes place. Well, as you can imagine, if we're launching 2,500 times per year, programs are rolling on, programs are rolling off, and we're able to reallocate resources within our businesses in various capacities to be able to fund and support those sorts of programs.

I wanted to ask about one award in particular, and that's the one that was announced in conjunction with 1Q earnings for a Smart Vehicle Architecture zone controller, the value of which was estimated at $4 billion. I haven't exactly been keeping track, but it strikes me as maybe the biggest award you've ever won and the biggest award that any supplier I cover has ever won. Maybe you would know better than I. And I know you're a little limited in what you can say, but what can you say about that award? You mentioned it was with a large North American OEM. I mean, would it be fair to say just given the value that it must be a high-volume platform, multiple top hats, et cetera? And then what are the implications of winning an award as large as this? What does it say about the trust that the automaker has in Aptiv or your relationship with that OEM?

Yes. It's a very large North American OEM. It's one we have a very good relationship. It's one we've been working with for a long period of time on advancing their vehicle architecture. It's a -- this particular solution, they'll replace out of 100 ECUs they'll reduce those by roughly 75%. So it's how do they take out content, which they're in areas where, quite frankly, we don't have products and how do they consolidate that. So that's an area where it's accretive from an overall content per vehicle standpoint for Aptiv. It will go across literally all their vehicle platforms over a number of years on a global basis. And the exciting thing about this is one, winning award; two, the reality is given the strategic nature of something like this and the closeness of our relationship with that customer, it brings with it other opportunities, both hardware and software. So it brings opportunity in vehicle architecture. So wire harness and connectors as an example that we can bring to bear and we can sell. It positions us with that organization to talk about the software stack and where there are opportunities like middleware, like Wind River, like engineering tools where we can bring incremental value to that particular customer. So we're very excited about that. There was an award we received last year from a very large global European OEM that is a very similar situation. Our expectation is, based on our conversations, you'll see more of these large awards on a go-forward basis. And there are very few players in our space that are actually positioned to design, develop and ultimately deliver these sorts of solutions for our OEM customers.

Ryan, one thing I'd add, and I think this speaks, to some extent, the size of the awards and we expect to see this continue. Kevin mentioned aggregating 75% roughly of the existing ECUs in the vehicle into that -- into those controllers, right? So this content aggregation, you're pulling a whole bunch of other content that Aptiv historically hasn't participated into, into those awards, which is one of the reasons they're getting so much larger.

Sticking with awards. I thought to ask how you go about managing the pricing risk when it comes to a newly won business. In case that inflation tracks differently between when the contract was awarded and when it enters into production, which can sometimes be several years, I know you're well protected when it comes to commodities, but we were all surprised in '21 when inflation went from 2% to 9% with a lot of impact on noncommodity costs. Thankfully, inflation, it looks like hopefully coming back down now, but if it were to pick up again, do you maybe have different, better or more complete protections in place in the contracts? Or if not, maybe better processes to more quickly reprice contracts through more ad hoc type negotiations?

Yes. Let me -- I can start with that. So you're right. On large commodities like copper, we are effectively indexed for sort of well over 70% of our copper buys. So we adjust prices automatically contractually, monthly, quarterly or semiannual depending on the customers. For us, the real challenge came in the electronics side over the last couple of years, particularly semiconductors, where we were seeing inflation of 25%, 30%, and I'm not sure that we're -- I wouldn't expect that, particularly on the semi side, to come down anytime soon. But we had a couple of challenges there. Obviously, we had production in process where those costs had gone up and we had programs that we'd be launching in the near term, call it, 12 months out. For those 2 categories, went back to the customers, with a very clear message of -- particularly for things like directed buys, direct material cost increases. So if a chip was $5 and then cost $8, we were passing through that $3. And there was a lot of documentation we shared with the customers. We were very transparent with them around sort of at almost at a PO level. To your question on bookings, obviously, we've adjusted prices up on new bookings programs over the last couple of years. But contractually, and this isn't something new, we've always had this in place, contractually prior to what we call capital going into the ground or ramping up the start of production, we have the opportunity to go back to our customers and discuss program economics. And it actually works to the OE's benefit as well. And historically, it's been used to discuss maybe changes in volume or changes in product design that have impacted the overall profitability of the program. And again, sometimes it works to the customers' benefit. There's higher volumes and they would expect maybe a different pricing structure if the programs -- volume estimates have gone up. We'll obviously be able to discuss BOM costs at that point as well. So from a bookings perspective for the things that are -- and on average, it's 2 to 3 years from when we book something to when we start production. So we do have those protections in place, and we're taking advantage of them. The challenge really was the in-process production and the near-term launches that we had to spend some time, obviously, going back to customers. And to Kevin's point, it's -- that was a significant amount. We are well over $800 million over the past 1.5 years of direct material price increases passed through.

Yes. And I'd say there are certain areas like we get asked, there seems to be a recent debate about penetration of battery electric vehicles was, is the industry overly optimistic? In areas like that, we have volume-based pricing. So to the extent an OEM doesn't hit platform volumes, price adjusts, right? So those areas where we've been more conservative than the industry, more conservative from a customer standpoint, selective from a platform standpoint, to create incremental insurance, we've made sure that there's certain commitments to volume. And if there aren't, those volumes aren't achieved that there's a pricing mechanism.