Aptiv PLC (APTV) — Q2 2018 Earnings Call Transcript

Thank you, Crystal. Good morning, and thank you to everyone for joining Aptiv’s second quarter 2018 earnings conference call. To follow along with today’s presentation, our slides can be found at ir.aptiv.com. And consistent with prior calls, today’s review of our actual and forecasted financials excludes restructuring and other special items and will address the continuing operations of Aptiv. The reconciliation between GAAP and non-GAAP measures is included at the back of the presentation and the earnings press release. Please see slide two for a disclosure on forward-looking statements, which reflects Aptiv’s current view of future financial performance, which may be materially different from our actual performance for reasons that we cite in our Form 10-K and other SEC filings. Joining us today will be Kevin Clark, Aptiv’s President and CEO; and Joe Massaro, CFO and Senior Vice President. Kevin will provide a strategic update on the business and then Joe will cover the financial results and our outlook for 2018 in more detail. With that, I would like to turn the call over to Kevin Clark.

Thank you, Elena, and good morning, everyone. Thanks for joining us today. I’m going to begin by providing an overview of the second quarter and highlighting the key new customer awards and recent developments across the business. Joe will then take you through our detailed financial results for the quarter, as well as our outlook for the balance of the year. Our strong second quarter performance reflects the continued momentum resulting from the execution of our strategy. We delivered record second quarter revenue growth as well as record operating income, EPS, and free cash flow. Revenue was up 12%, that’s nine points over market. Operating income increased 19% to $474 million and margins expanded 30 basis points to 12.9%. Earnings per share totaled $1.40, that’s up 24%, and free cash flow increased 34% to $360 million. New business awards totaled over $6 billion, bringing the year-to-date total to a record $11 billion, supporting our outlook for revenue growth across the portfolio. In addition to delivering strong financial results during the quarter, we strengthened our product portfolio with two acquisitions. First, we closed on KUM, which enhances our competitive position in Asia. Additionally, we reached an agreement to acquire Winchester, a leading provider of custom engineered interconnect solutions for harsh environment applications. Both transactions increase our end market diversification and provide solid platforms for further adjacent market expansion, which we'll cover in more detail shortly. In summary, our strong second quarter performance validates the robustness of our strategy and business model. On slide four, you can see our portfolio of advanced technologies aligned to the safe and interconnected mega trends translating into customer awards. As I just mentioned, bookings totaled over $6 billion in the second quarter, bringing the first half total to over $11 billion. This record is largely a result of our leadership position in several advanced technologies. Beginning with Active Safety, we have $7 billion of customer awards since 2016, translating into $1 billion of ADAS revenues in 2018, reflecting over 60% revenue growth this year and robust double-digit growth over the next several years. We've experienced a substantial uptick in Level 2 plus awards from our traditional OEM customers, which I'll discuss in more detail shortly. This acceleration of Level 2 plus commercial activity dovetails nicely with our discussions regarding Level 4 and Level 5 automated driving, primarily with players serving the mobility market but also includes select OEMs. Moving to infotainment and user experience, bookings have totaled $6 billion since 2016, giving us confidence in strong revenue growth in this product line continuing beyond the end of the decade. Turning to signal power solutions, our engineered components business has booked $12 billion of new customer awards since 2016, including $1 billion of high voltage connectors, bringing customer awards for high voltage electrification to $2.5 billion over the last two years. Our first half pace with new business bookings puts us on a clear path to finish the year with a record $19 billion, giving us confidence in our outlook for continued strong revenue growth.

Great. Thanks, Kevin, and good morning, everyone. Starting with a recap of the second quarter financials on slide 10. Results exceeded the guidance we provided back in May with revenue of $3.7 billion, up 12% or nine points over vehicle production, reflecting a continued ramp of new program launches in both our segments. EBITDA and operating income increased 19% driven by higher sales volume and operational performance, and operating margins were 12.9%, up 30 basis points. Earnings per share of $1.40 was up 24% despite the expected higher tax rate on a year-over-year basis. Importantly, operating income earnings continue to grow double-digits while investing in future growth. Lastly, operating cash flow was $566 million, up 37% driven by higher earnings and favorable working capital. Turning to slide 11, sales of $3.7 billion were approximately $135 million higher than expected, largely driven by stronger volumes in both segments despite some variations in customer schedules in the quarter. FX and commodities were also a positive. From a regional perspective, North America sales were up 15% and benefited from a number of new program launches in advanced safety, user experience, and signal and power solutions, more than offsetting the continued passenger car production declines. Europe sales were up 9%, also better than expected, driven by the ramp-up of new program launches despite slightly slower production schedules, and China sales were up 11% as we continue to see strong revenue growth and expect to grow 8 to 10 points over market for the year.

Good morning. A couple of housekeeping questions, then a more strategic one, in terms of housekeeping so couple of things around the guide for 3Q, it looks like and as called out delivery delays brand increasing production delays to reflect in IHS due to the need to push vehicles through the WLTP compliance. So, does your third quarter outlook kind of take not just the IHS numbers but some of the productions schedules emerging or likely to emerge from your customers when you put out that guide?

Yeah, Q3 has got schedules, Brian, as best as we have them from a customer at this point. Obviously, we get more from IHS as you get the final couple of months of the year, but at this point, it's the best we have, and we're tied out to schedules.

Okay. Second, sort of housekeeping, which will transition more from a strategic one. The third quarter operating guide implies an operating margin of 12 to 12.2, a bit lower than many of us had modeled. Could you maybe mention how much of that is due to mobility, launched cars or other kind of expenses?

Yeah, it probably starts, particularly if you are focused on the margin rate. The biggest change is going to be the effects and commodities. So, as I mentioned in my prepared remarks, that’s about 50 basis points off the midpoint. If you adjust for the FX and commodities including the revised macros we used for Europe, for Euro and RMB, you're up to about 12.6.

Okay, which gives the rate delta and we have this challenge going the other way in the first quarter. The rate challenge is really of the FX and commodities input.

Maybe, I'll start Brian. So, as you know, last year we booked about $3.7 billion in the Active Safety business. This year, we are on track to do well over $3 billion. As we’ve talked about in the past, typically in our product range when you launch a new program or a new technology, when you sized the revenue from zero to 300, you’re investing effectively in that technology and then from 300 on, you’re actually positive from an operating margin standpoint. And add $1 billion in run rate revenues today and our Active Safety business is solidly in the black from a margin standpoint. We’ve gone from five Active Safety customers back a couple of years to we’re heading pretty close to 20. So, there is launch activity and development activity affiliated with both of those.

Yeah. We have volume ramping obviously on the previous launches. The mobility investment, obviously that’s focused on the AMoD, Brian. And I think I mentioned in my prepared remarks, if you back that out, the core ASUX business, which includes all of its own development business, that’s really focused on AMoD.

Good morning, guys. Just wanted to think about the operating leverage, and we’ve discussed in the prepared remarks for Q3 and second half. But sort of to Brian’s question, as we start to think about 2019, you’ve had such a big jump in obviously everything autonomous, you had a lot of launch activity. Could we start to think about in 2019 that the incremental margins get back to a more normalized operating leverage, typically your kind of 20% or I think your longer-term guidance of 20 basis points to 30 basis points of margin improvement?

We will continue to focus on the framework we shared during Investor Day, aiming for 20 to 40 basis points of margin expansion while making investments in the business. Additionally, it's important to note that foreign exchange and commodity fluctuations have been quite volatile at the start of this year, which has a significant impact on our margin rate.

Yeah, Chris. It’s Kevin. I would just add one additional point. So, we’ll launch about 1,700 programs this year, of which about 250 we’d consider to be major launch programs. And a lot of that activity is in the SPS business that Joe talked about earlier. And when you look at that on a year-over-year basis, that’s roughly a 70% increase in critical activity. So, as that launch activity slows, as you head into 2019, we should get the incremental benefit.

Good morning, everyone. Kevin, just wondering if you could spend a minute talking about Level 3, because we have heard from customers it seems like conversations with companies are ramping up, I think in prior quarters you’ve indicated that as well as more interest in that product. But then we see stuff like Audi eliminating the Level 3 product in the U.S. so I guess I just want to understand where we really stand with Level 3?

That’s a great question. It's very customer dependent; there are OEs who are very focused on developing Level 3 and leveraging Level 3 into Level 4 and Level 5. So, we’re in a lot of those dialogues. There are other OEs who are looking at the incremental cost of Level 3 versus lets say a Level 2 or Level 2 plus solution and seeing more value in the Level 2 plus solution on a cost per benefit standpoint. So, it's a bit bifurcated, quite frankly.

Okay. So, the $2 billion Active Safety target that you set out in 2022, can you give us a sense of the breakdown of that between I guess more like Level 2 or then Level 3 plus?

Yes, a lot of that – well that would be ADAS business for us, so we’re – what guidance we have given is in 2025 we’ll do about a $1 billion of automated driving revenues, roughly $500 million as Level 3, $500 million Level 4 and Level 5. The $2 billion of ADAS business is Level 2 plus and Level 0, 1, Level 2 plus, with most of the growth being in the Level 2 plus over the last year.

Okay.

Good morning, guys. Just one other follow-up on that mobility, in mobility investments. And when you think about this over the long run, and then we just kind of went through sort of have these morphs into or supports other parts of the business. When you think about sort of returns in mobility, where do you think they ultimately go?

Yeah, listen, I think well before 2025, we are at or above our return on average capital in this business, right? We're not looking to manage fleet that's not the business we're in. So, we're not going to invest significantly in building car fleets that will be owned by others; we will provide the technology related to those fleet, software, and perception systems. The more software that goes into those solutions, the higher the return. So, I think it's well before 2025.

I wanted to talk about the mobility investment that you’re doing. That’s a $31 million increase year-over-year, obviously if I am reading that Joe right is that correct?

Correct. $40 million of mobility spend in the quarter, increase of $31 million year-over-year.

In the quarter, you’re talking about, yes.

And as we look, that number has been growing for you, what does that look like next year or the following year that total spend?

Yeah. So, obviously early days to roll it up. I mean, you won't see the step level change that you saw to 2017 or 2018. Could you wind up in 2019 at $180 million, maybe close to $200 million. It would really depend on the opportunities, the increase that we've come out with this quarter and quite honestly getting close to what I'd almost call commercial pursuits at this point with some of the major OEs and some of the mobility on-demand providers.

And then the last item on here, what do you think that timeline looks like to reach profitability for those efforts?

We've talked about having that sort of a billion dollars of revenue in 2025. Half a billion of that coming from AMR. I think we're on a sort of a growth trajectory that would evolve from 2021 through 2025, and it'll to some extent mirror our other product lines, where we sort of break even at that $350 million or revenue and would expect to grow from there. There may be some opportunities just given the nature of this revenue, some software sales, some recurring data service fees where we climb profitability a little bit faster than our traditional product lines, obviously. But we still look at this business from a revenue perspective evolving from 2021 through 2025.

Okay. Thank you, gentlemen.

Thanks, Joe. Let me wrap up on slide 20 before we open it up for Q&A. We delivered another strong quarter with record revenue growth as well as record operating income, earnings per share, and free cash flow. As a result, as Joe said, we’re raising our guidance for the second time this year with 8-9% adjusted revenue growth, 13% operating income growth, and 15% earnings per share growth. We continue to make significant progress executing our strategy and optimizing our business model, including increasing revenues faster than underlying vehicle production through content growth and market share gains, as customers increasingly look to Aptiv as their partner of choice as reflected in our bookings performance.

Thank you. We’ll now take our first question.

Good morning, Brian.

Good morning, Brian.

Good morning. A couple of housekeeping questions, then a more strategic one, in terms of housekeeping so couple of things around the guide for 3Q, it looks like and as called out delivery delays brand increasing production delays to reflect in IHS due to the need to push vehicles through WLTP compliance. So, does your third quarter outlook kind of take not just the IHS numbers but some of the productions schedules emerging or likely to emerge from your customers when you put out that guide?

Yeah, Q3 has got schedules Brian as best as we have them from a customer at this point. Obviously get more from IHS as you get the final couple of months of the year, but at this point, as best we have, and we're tied out to schedules.

Okay. Second housekeeping which will transition more from strategic one. The third quarter operating guide implies, third quarter guide implies an operating margin of 12 to 12.2, a bit lower than many of us had modeled. Could you maybe mention how much of that is mobility, launched cars or other kind of expenses?

Yeah, it probably starts, particularly if you are focused on margin rate. The biggest change is going to be the effects and commodities. So, that as I mentioned in my prepared remarks, that’s about 50 basis points after 12.1 off the midpoint. So, if you adjusted for the FX in commodities including the revised macros we used for Europe - for Euro and RMB, you're up to about 12.6. We've taken the RMB down of 680 had ended Q2, it would have been in the 63s. So, we’ve got a straightening above or below 680 now.

Okay, which give ...

The rate delta and we have this challenge going the other way in the first quarter. The rate challenge is really of the FX and commodities input.

Maybe, I'll start Brian. So, as you know, last year we’ve booked about $3.7 billion in the Active Safety business. This year, today just under $2 billion and on track to do well over $3 billion. As we’ve talked about in the past, typically in our product range when you launch a new program or a new technology, when you sized the revenue from zero to 300, you’re investing effectively in that technology and then from 300 on, you’re actually positive from an operating margin standpoint. And add $1 billion in run rate revenues today and our Active Safety business is at the ASUX operating margin range, X the investment in mobility. So, for us, it’s strong, very profitable business.

Okay. So, if you are scaled, then the increased bookings don’t lead to a margin headwind from development expense.

Well, I mean it creates development expense and probably creates some margin headwind, but the incremental volume more than offsets that, that's how I would describe. Listen, we’ve gone from five Active Safety customers back a couple of years to we’re heading pretty closed to 20. So, there is launch activity and development activity affiliated with both of those. But at $1 billion of run rate revenues, we’re solidly in the black from a margin standpoint.

Yeah. We have volume ramping obviously on the previous launches. The mobility investment, obviously that’s focused on the AMoD, Brian. And I think I mentioned in my prepared remarks, if you back that out, the core ASUX business, which includes all of its own development business, the only thing that’s in that mobility number is truly the AMoD investment. Those margins expanded about 80 basis points year-over-year. So, we’re seeing that business perform as we would have expected.

Good morning, guys. Yeah, just wanted to think about the operating leverage and we’ve discussed in the prepared remarks for Q3 and second half. But sort of to Brian’s question, as we start to think about 2019, you’ve had such a big jump in obviously everything autonomous, you had a lot of launch activity. Could we start to think about in 2019 that the incremental margins get back to a more normalized operating leverage, typically your kind of 20% or I think your longer-term guidance of 20 basis points to 30 basis points of margin improvement?

We will continue to concentrate on the framework we presented at Investor Day, aiming for 20 to 40 basis points of margin expansion while also investing in the business. It's important to note that foreign exchange and commodity fluctuations have been quite volatile at the start of this year, impacting the margin rate significantly. However, based on our current estimates of foreign exchange and commodity rates, we anticipate a headwind of just over 10 basis points on the margin rate for the year. This would still allow us to achieve more than 20 basis points of margin expansion despite increased investments in mobility, and we are committed to maintaining this framework.

Yeah, Chris. It’s Kevin. I would just add one additional point. So, we’ll launch about 1,700 programs this year, of which about 250 we’d consider to be major launch programs. And a lot of that activity is in the SPS business that Joe talked about earlier. And when you look at that on a year-over-year basis, that’s roughly a 70% increase in critical activity. And as Joe mentioned, there were couple of areas from an operational standpoint I think we could have performed a little bit better in Q2 and quite frankly in Q3 and Q4. So, as that launch activity slows, as you head into 2019, we should get the incremental benefit.

Good morning, everyone. Kevin, just wondering if you could spend a minute talking about Level 3, because we have heard from customers it seems like conversations with companies are ramping up, I think in prior quarters you’ve indicated that as well as more interest in that product. But then we see stuff like Audi eliminating the Level 3 product in the U.S. so I guess I just want to understand where we really stand with Level 3?

That’s a great question. It's very customer dependent; there are OEs who are very focused on developing Level 3 and leveraging Level 3 into Level 4 and Level 5. So, we’re in a lot of those dialogues. There are other OEs who are looking at the incremental cost of Level 3 versus lets say a Level 2 or Level 2 plus solution and seeing more value in the Level 2 plus solution on a cost per benefit standpoint. So, it's a bit bifurcated, quite frankly.

Sounds good to me. And just lastly, maybe one odd question right now just given that you just executed sort of the separation spin. As we look at what’s going on at auto leave, I mean you have some great technology that is much higher growth than maybe average particularly in Active Safety and high voltage, would you ever consider sort of another spin of this super high growth stuff just given some of the fanatical valuations have been put on some of this high growth stuff even out in the positive cash flow?

One, I think our high growth has positive cash flow, so I want to make sure and every business is different. So, the auto business is a very good business with great technology and I don’t have all the specifics as it relates to their product portfolio and where they’re investing. But we have a great business that’s high growth and has positive cash flow with significant software capabilities. Again, we drive and I go back to we entertain whatever creates the most value for shareholders. Now having said that, we think being able to leverage both the hardware and the software capabilities is very unique. And we think that’s one of the reasons we’ve had the win rates, we’ve had on - from a booking standpoint, from an ADAS standpoint, or from an infotainment user experience standpoint.

Hi. Good morning. How are you doing guys? I wanted to dig in a little bit more in the advanced tech user experience business I think you mentioned a couple of integrated cockpit controller wins. Wondering how much growth you’re seeing within your business. How much further RFPs are out there from OEMs and what the competitive landscape is for that subset within advanced safety and UEX?

Yeah, I mean we’ve had strong bookings over the last couple of years, the user experience business is growing at a mid-teens CAGR. We expect to continue to do that through the end of the decade. There will be some movement up and down based on programs rolling on and off. There continues to be significant demand for the product. OEMs are looking for ways to consolidate controllers and increase compute power.

Understood. And then I guess in terms of your efforts to sort of diversify the revenue stream, so you guys spoke about non-autos at 25%, that’s obviously an ambitious target. So, what is required to get there? And then separately still on the diversification. I think you had laid out some directional targets for having a portion of your revenue from software or from recurring sources. Can you sort of like quantify those or put a timeline on that?

Yeah. I think we have concentrated much of our discussion on 2025, where we mentioned the expectation of $1 billion in revenue from automated driving, with half coming from those providers. A significant portion of this revenue is anticipated from data services and software sales linked to non-auto revenue, which is certainly a key element. Additionally, we need to focus on executing other important areas, and I believe we have already begun to make progress regarding the organic growth of our commercial vehicle business.

Just two for me. So, I didn’t hear anything on tariff, so I assume that is immaterial at this point, on 301.

Yes, so good question. Yes, it is, we’ve benefited from our operating model; we’re very focused on localize production, localize sourcing.

And then Kevin just a question, so Winchester gets into portion as it is – how much scale does this give you, are there other opportunities out there, that could do additional M&A and further scale?

Yes, definitely. So, Winchester has a strong operating teams, strong business team, great systems with experience in M&A in these small spaces. And our EBIT will be continuing to go out and do what they have been doing and we’ll provide them support in certain areas from utility standpoint and the control standpoint.

Hi, good morning. First question just, getting back to the mobility landscape, there has been a lot of activity in last 90 days along the line with tie ups between different types of companies, what is it say for how the landscape is changing relative to your position?

Yes, I think, and Joe should comment as well. Listen, I think it depends at – the answer to question depends on the perspective through which you are pursuing opportunities in this market, right. I think it’s important to know, we are focused on selling autonomous driving systems and perception systems and vehicle architecture into the automated driving market, whether that be with OEMs or that be with mobility providers.

No, I think from what we see, and one of the reasons we’ve increased spend sort of accommodate the level of commercial discussions we’re seeing now. When you have a big announcement from WeMo or CM Cruise, the other folks interested in being in this space tend to want to accelerate their development and we’re viewed as a leading enabler of this technology thinking of the Lyft cars on the road in Vegas are a clear demonstration of that.

Thanks everyone for joining us for the Aptiv Q2 2018 earnings conference call. We appreciate your time and questions.