Dauch Corporation (DCH) Q2 2019 Earnings Report, Transcript and Summary

Good morning. My name is Gary, and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the American Axle & Manufacturing Second-Quarter 2019 Earnings Conference Call. [Operator Instructions] as a reminder, today's call is being recorded.I would now like to turn the call over to Mr. Jason Parsons, director of investor relations. Please go ahead, Mr. Parsons.

Thank you, Gary, and good morning. I would like to welcome everyone who is joining us on AAM's second-quarter 2019 earnings call. Earlier this morning, we released our second-quarter 2019 earnings announcement. 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 1877-344-7529, reservation number 10132907. This replay will be available later today through August 9. Before we begin, I would like to remind everyone that the matters discussed in this call may contain comments and forward-looking statements subject to risk 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 will 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.Over the next few months, we will participate in the following conferences: the J.P. Morgan Automotive Conference on August 14; the RBC Capital Markets Global Industrials Conference on September 11; and the Morgan Stanley Annual Laguna Conference on September 12. In addition, we are always happy to host investors at any of our facilities. Please feel free to contact me to schedule a visit. With that, let me turn things over to AAM's chairman and chief executive officer, David Dauch.

Thank you, Jason, and good morning to everyone. Joining me on the call today are Mike Simonte, AAM's president; and Chris May, AAM's vice president and chief financial officer. To begin my remarks today, I'll provide some comments on our AAM's second-quarter financial results. AAM sales were $1.7 billion for the second-quarter of 2019, as compared to $1.9 billion in the second quarter of 2018.Our second-quarter sales came in lower than we expected and lower than the target we communicated on our first-quarter earnings call. AAM exited the second quarter with sales softer than anticipated, and we saw revenues down on several key programs across the globe in the second quarter when compared to a year ago. The year-over-year impact reflects lower GM full-size truck sales, which includes the impact of GM's previous sourcing decision related to the next-generation truck program, coupled with planned customer downtime in the second quarter of 2019 as they launched their new heavy-duty pickup truck. The GM full-size truck launches continue to go as planned and the execution of these launches has been very good.Adjusted EBITDA for the second quarter of 2019 was $266 million or 15.6% of sales. This compared to an adjusted EBITDA of $347.9 million in the second quarter of 2018. On a sequential basis, we did see over a $20 million improvement on adjusted EBITDA and 130-basis point improvement on EBITDA margins from the first quarter of 2019. This increase was driven primarily by continued operational launch performance, improvements, additional benefits from our synergy attainment and further savings from our business unit consolidation efforts that took place in early January.Adjusted earnings-per-share for the second quarter of 2019 was $0.55 compared to $1.23 in the second quarter of 2018. From a cash flow perspective, AAM generated nearly $120 million of adjusted free cash flow in the second quarter 2019 compared to $100 million in the second quarter of 2018. Let's discuss our business-unit segment performance. The driveline business unit recorded sales of $1.14 billion in the second quarter of 2019 compared to $1.27 billion in the second quarter of 2018.Segment-adjusted EBITDA for the second quarter of 2019 was $152.9 million compared to $204.3 million in 2018, primarily reflecting lower GM full-size truck sales, lower global production volumes and higher project launch and manufacturing costs. Sequentially, the driveline business unit improved margins by 130-basis points compared to the first quarter of 2019 on the strength of continued improved operational and launch performance. The metal forming business unit recorded sales of $484.2 million in the second quarter of 2019 compared to $530.4 million in the second quarter of 2018. Segment adjusted EBITDA for the quarter was $88 million in 2019 compared to $116.7 million in 2018.And despite the lower sales, our metal forming business unit performed at over 18% EBITDA margins in the second quarter of 2019. They continue to operate at a very high-level profitability. AAM's casting business unit recorded sales of $220.7 million in the second quarter of 2019 compared to $243.2 million in 2018. Segment-adjusted EBITDA in the quarter was $25.1 million in 2019 compared to $26.9 million in 2018.For the second quarter in a row, our casting-business unit performed a double-digit EBITDA margin, so we continue to see improvement, with a sequential increase in our EBITDA margins of 140-basis points. We're pleased with this business unit's performance as it addressed its workforce shortage issues, stabilized its operations and reduced premium cost. Overall for the quarter, despite lower-than-expected production volumes, each of our business units improved adjusted-EBITDA margins from the first quarter of 2019 to the second quarter of 2019. Our manufacturing facilities and leadership teams are focused on operating efficiently and effectively as we can in the current macro environment.Let me give you a quick update on specific issues we have previously discussed on prior calls. As it relates to our e-AAM supplier casting issue, we are making progress on this issue and expect to have it completely resolved by the fourth quarter of 2019. At the Twinsburg facility, the capacity issues that were affecting this facility are completely behind us. We have stabilized operations and are meeting our customer requirements, utilizing standard operating and transportation methods.For Bluffton, we have addressed the issues that were limiting throughput, reducing efficiency and causing significant premium costs. We will, however, see volumes continue to ramp up at this facility through the second half of 2019 for transmission programs that support key Ford vehicles, such as the Explorer, the Ranger, the F-Series Super Duty and the Lincoln Aviator. It is now up to us to continue to effectively manage this increased production over the course of the year and sustain the operational improvements that we have accomplished. We continue to close on operating issues, reduce premium costs, accelerate throughput into our launch curves and improve our business profile.We're very close to putting our operational issues from the second half of 2018 in the rearview mirror. While we were challenged with volume shortfalls during this quarter, our efforts to improve our operational performance were vital to hitting our targeted margin for the quarter and achieving sequential-margin improvement across all of our business segments. Let me now review our revised 2019 financial outlook. Back on our first-quarter earnings call, I noted that we're trending toward the lower end of our 2019 financial targets.Since then, we are experiencing lower global production volumes than expected in the major markets that we serve and on specific programs we support. As a result, AAM has revised our full year 2019 financial targets as follows: Sales are now in the range of $6.9 billion to $7 billion; adjusted EBITDA in the range of $1.05 billion to $1.1 billion; adjusted free cash flow of approximately $250 million, which also includes a reduction in our estimated capital spending from $515 million to approximately to $485 million.And as it relates to sales, we have included a walk in Page 5 of our presentation that shows the changes in our previous sales targets to the midpoint of our revised 2019 full year sales target. The largest adjustment we have made to our expected 2019 sales relates to our business in Asia.We have reduced our expected sales in the year in Asia by approximately $125 million. Most of it relates to all-wheel drive crossover vehicles of passenger car production in China, but it also represents lower-than-expected pick-up and commercial truck business across Asia. In recent months, nearly all of our key customers in this region have reduced production schedules.In addition, our full-year estimated revenue for non-GM full-size pickup truck programs has been reduced by $60 million compared to expectations included in our guidance. A large piece of this relates to the Nissan TITAN for which we have seen expected 2019 production volumes cut nearly in half.In addition, we have seen softer sales in global engine and transmission programs we support. This includes the impact of reduced light vehicle production in Europe, continued reduced demand for passenger cars here in North America and program cancellations and/or revised launch timing of certain programs.Furthermore, we are now expecting lower sales from our casting business unit of about $30 million, primarily reflecting the recent softening in the industrial and agricultural markets. As a result of our lower-than-expected production volumes, program cancellations and revised program launch timing by our customers, we are reducing our estimated 2019 new business backlog amount from $650 million, which was previously communicated, to $550 million.While some of these revenues may be pushed into 2020 or 2021, we do not plan to provide any updated backlog or guidance at this time and will do so at our customary time early next year. You can see on Slide 6 of our presentation that our profitability for 2019 has primarily been impacted by lower sales. In addition, we are increasing the expected spending on R&D in the second half of the year as we continue to support enhanced design activities on our future e-AAM book business, AAM's efforts to conquest new electrification business and expansion of our electrification portfolio.As I mentioned during the segment financial results discussion, we continue to be on track for our launch performance improvements that we have discussed with you recently. We do see margins in the second half of the year continuing to improve compared to the first half. As we expected, further benefits from these operational improvements, as well as higher sales and a decrease in launch activity and additional synergy savings being realized.At the end of the day, our industry has clearly been impacted by a reduction in global vehicle production. While we are not as exposed in Europe and China as many of our peers, we're very program specific in those regions and are being significantly impacted by certain programs that are not performing to our planned volume expectations.However, we are pleased to be continuing to improve AAM's operational performance and sequential quarterly margin increases and strong free cash flow generation. We are very focused intensely and efficiently operating our business and adapting to the changing market demand. This concludes my prepared remarks for this morning. I thank everyone for your attention today and your continued interest in AAM.I will now turn it over to Chris May.

Thank you, David, and good morning, everyone. I will cover the financial details of our second quarter of 2019 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 start with sales.Sales in the second quarter of 2019 were $1.7 billion compared to $1.9 billion in the second quarter of 2018. Slide 8 shows a walk down of second quarter 2018 sales to the second quarter of 2019 sales. In the second quarter, our sales reflect a year-over-year reduction in sales of $160 million relating to the GM full-size truck program, including the impact of transition to the next-generation GM full-size truck platform, as well as lower production volumes related to customer downtime at General Motors heavy-duty pick-up truck assembly plant as part of their model changeover process.Keep in mind that GM's conversion to the next-generation truck began in the third quarter of 2018 and the year-over-year sales impact in 2019 is heavily concentrated in the first half of this year. The year-over-year impact in the second half will be substantially lower.In the quarter, we benefited from about $75 million in new business, net of attrition, including sales from key launches of driveshafts on the Ford Explorer, power transfer units on the redesigned Ford Escape, rear axles for Daimler India and several engine and transmission component launches during the quarter. Offsetting this new business backlog was other volume and mix. We saw year-over-year production decreases in Asia and in particular, several China cross-over vehicle and passenger car programs across multiple customers.On a year-over-year basis, AAM sales in Asia were down 25% in the second quarter of 2019 compared to 2018. In North America, we saw lower driveline volumes for programs such as the Nissan TITAN, several passenger car platforms and the Jeep Cherokee. We experienced reduced sales on several engine and transmission component programs in North America and Europe, and we also saw lower sales year over year on our casting business, primarily in our industry-related sectors. And lastly, with some commodity pricing decreases, our metal market pass-throughs to customers and foreign exchange impacts were lower by $34 million.But as you know, the metal market pass-through mechanisms are good risk-management structures for AAM. Now let's move onto profitably. Gross profit was $248.3 million or 14.6% of sales in the second quarter of 2019. Adjusted EBITDA was $266 million in the second quarter of 2019 or 15.6% of sales. This compares to $347.9 million in the second quarter of 2018 and $245 million in the first quarter of 2019.As you can see, year-over-year walk-down of adjusted EBITDA on Slide 9. The contribution margin impact of lower volumes as the primary driver of lower EBITDA accounting for $52 million of the decrease when compared to the second quarter of 2018. We are also impacted by normal year-over-year price downs.On a year-over-year basis, we are impacted by increases of about $7 million for material freight and tariffs. You can see this year-over-year impact starting to decrease compared to recent quarters. The good news here is that we've seen commodity and freight inflation taper off in 2019. We experienced higher launch and project-related costs in the second quarter of 2019 of about $7 million.Again, you can see this year-over-year impact coming down from prior periods as our operations launch programs and convert to ongoing production. The next column contains the impact of inflation pressures we experienced starting in the second half of 2018 as it relates to utilities, labor and other cost increases. We also expect to see this year-over-year impact of these improve in the second half of the year as we continue to take actions to mitigate some of these increases.And lastly, we continue to see the benefit of our integration activities, as cost reduction synergies and business unit reorganization savings improved our performance by $11 million in the quarter compared to the second quarter of 2018.On a sequential basis, adjusted EBITDA improved from the first quarter to the second quarter by $21 million despite lower sales. We were positively impacted by areas such as further synergy attainment, realization of benefits of our business unit reorganization and improvements in launch and operational performance. As it relates to restructuring and acquisition-related costs in the second quarter of 2019, we incurred $12.2 million of restructuring and acquisition-related costs. Let's take a look at SG&A expense.SG&A, including R&D, in the second quarter of 2019 was $91.3 million or 5.4% of sales. This compares to $95 million or 5% of sales in the second quarter of 2018. R&D spending for the second quarter of 2019 was $33 million compared to $34 million in the second quarter of 2018. We now expect to see R&D expense ramp up in the second half of the year as we increase spending to enhance and support our electrification growth as David mentioned earlier.Now let me cover interest and taxes. Net interest expense in the second quarter of 2019 was approximately $56 million as compared to $54 million in the second quarter of 2018. The increase in net interest expense reflects higher interest rates on our variable debt and lower capitalized interest, partially offset by lower gross-debt balances. Income tax expense was $6 million in the second quarter of 2019 as compared to $2 million in the second quarter of 2018.Adjusting for the impact of restructuring charges and nonrecurring items, our effective income tax rate would've been 12.4% in the second quarter of 2019 and 14.4% year-to-date. Based on our mix of profit by region, we now expect our adjusted effective tax rate to be between 15% and 20% for the full year of 2019.Taking all these sales and cost drivers into account, GAAP net income was $52.5 million or $0.45 per share in the second quarter of 2019 compared to $151.1 million or $1.30 per share in the second quarter of 2018. Adjusted earnings per share was $0.55 per share in the second quarter of 2019 compared to $1.23 per share in the second quarter of 2018.Let's move on to cash flow and the balance sheet. We define free cash flow to be net cash provided by operating activities, less capital expenditures, net of proceeds received from the sale of PP&E. AAM defines adjusted free cash flow to be free cash flow excluding the impact of cash payments for restructuring and acquisition-related costs. Net cash generated by operating activities in the second quarter of 2019 was $217.1 million.Capital spending net of proceeds from the sale of property, plant and equipment was $111.9 million in the second quarter of 2019. And cash payments for restructuring and acquisition-related costs for the second quarter of 2019 were $14.1 million. Reflecting these activities, AAM's adjusted free cash flow in the second quarter of 2019 was $119.3 million, an increase of $19 million from the second quarter of 2018.As David mentioned, our revised target for full-year adjusted free cash flow is approximately $250 million, which primarily reflects the impact of lower-than-expected EBITDA, offset by actions we have taken to reduce capital expenditures.From a debt-leverage perspective, we ended the second quarter with a net debt to LTM adjusted EBITDA or net leverage ratio of 3.35 times. We expect to see the net-leverage ratio turn back down in the second half of the year as we realize year-over-year EBITDA improvements and generate additional free cash flow. Liquidity at the end of June was over $1.2 billion, consisting of available cash and borrowing capacity on AAM's global credit facilities.As we announced on our last call, we made the final $100 million payment on our 7.75 notes back at the end of May. We now have an average debt maturity of over five years with no significant maturities until late 2022. We also conducted an opportunistic refinancing activity in July as it relates to our revolving credit facility and term loan A. Among other things, we've extended the maturity of our revolving credit facility and term loan A and expect to achieve future interest savings as a result of this refinancing. You will see in 8-K filed later today that contains further details on this refinancing.As it relates to our revised 2019 full-year guidance, David has gone through the details, so I will not rehash them. It's important to note that we are subject to macroeconomic conditions, global automotive-production trends, as well as customer program and product demand dynamics that are specific to AAM. We have seen all of these impact our 2019 financial outlook. And as production volumes are a key driver of our profitability and cash flow generation in the near term, it remains an important variable to meeting our revised targets for 2019.That being said, we have improved our operating and launch performance over the last nine months, and we did a solid job of maintaining profit-margin performance in the second quarter of 2019, despite sales softening through the quarter. On Slide 11, we have included an adjusted-EBITDA walk that takes our profitability in the first half of the year and details how and why we expect it to increase in the second half of the year.While lower than previously estimated, we still expect increased sales due to less customer program changeover downtime and additional backlog to drive higher sales than in the first half of the year. We continue to expect quarter-over-quarter benefits from additional synergy attainment and further savings from our business unit reorganizations.We do expect a higher run rate of R&D spending on our e-AAM hybrid and electric driveline solutions as we continue to invest in both short-term and long-term growth in the area of vehicle electrification. And we also expect to see the continued benefit from launch and performance improvements across our operations. All of this activity has AAM improving consolidated margins in the second half of the year compared to the first half. And as for the second half cadence, we expect the third and fourth quarters to be very similar from a sales and margin perspective.As for beyond 2019, we are not providing any updates to our 2020 objectives. Certainly, the global production volume reductions we have recently experienced increases the risk of achieving our previously disclosed targets. However, improving financial performance, reducing debt and generating cash flow are priorities for AAM. We are very focused on continued actions to drive free cash flow.AAM's variable cost structure provides our experienced management team the tools to properly adjust to the industry volumes and market demand. We are focused on making the appropriate adjustments while continuing to invest in advanced technologies and our global manufacturing footprint.Meanwhile, we expect our performance trends to continue in the second half of 2019 and see continued sequential margin improvements throughout the rest of the year. We look forward to continuing to leverage the strength of this company, including AAM's operating system, productivity initiatives and our engineering and manufacturing talents to have a successful future.Thank you for your time and participation on the call today. I'm going to turn the call back over to Jason so we can start Q&A.

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

[Operator Instructions] The first question comes from Armintas Sinkevicius with Morgan Stanley.

When we think about the $1.5 billion free cash flow guidance and the two times leverage by the end of 2020, obviously, the macro has taken a bit of a hit here in 2019. But maybe you could help us contextualize how we should be thinking about your targets here and how the impact here may have adjusted some of those.

Armintas, this is Chris. Certainly, as I just mentioned in some of my prepared remarks, it increases the risk of hitting those targets. But as we think about 2020 what obviously you see our targets for 2019 continuing to generate cash flow. But as we think forward into 2020, obviously, that cash-flow generation is very critical to the success of this company.We continue to take actions to focus on margins improvements. We look to continuing to take actions to reduce things such as CapEx that will increase free cash flow generation year over year. So our objective is to continue to align with those principal goals we set out previously. And that's what we're marching toward.

Okay. And then on the R&D front, I think, David, you and I talked about this at our conference last year. You mentioned that the growth opportunities there around R&D, and we didn't really see it pick up here in the back half of '18, and I don't know maybe it was the operational challenges that came to your attention that you focused on. Is this effectively the same sort of line of thinking in R&D? And any context there would be helpful.

Armintas, this is David. Again, we made a commitment to support electrification. We want to be agnostic to the market from a propulsion standpoint, meaning the IC hybrid or electrification. We're clearly a player already in the electrification business with the JLR I-PACE, and we've got book business that's launch in 2020 with multiple variance off of that.We made a conscious decision to spend more money in the area of electrification just because of the activities that we see picking up, especially in China. We see enhanced designed opportunities on our book business today based on some variance and some customer requirements that they're looking for.At the same time, we want to make sure that we position ourselves well, especially in China with other products to support that market because of different needs and requirements than what we're seeing in Europe and maybe even in North America. And then as we said before that we want to try to expand our product portfolio in this arena here, and that's why we're increasing some of that spending.

The next question comes from Joseph Spak with RBC Capital Markets.

Thanks good morning. First question, just, you brought up the backlog a little bit. I think you originally said $650 million gross, I think that would be like $450 million net based on what you've sort of seen on historically on the roll-offs. So can you just update it? Like, how much has actually come on to date and what are you looking for it now for this year?

So we're going to roll into on a gross basis, the $650 million will go to $550 million. So some of this relates simply timing between 2019 and 2020, some cancel in minds and some of the transmission programs that we support.

And I think originally you were expecting it to be back half loaded. So is that reduction in the back? Like, do we see it already? Or is it still to come?

Yes. And you'll see it a little bit in the back half, but the overall backlog is still a little bit more weighted toward the back half through the first half of the year. But that's principally why you're seeing some of the macro sales reductions that we think.

Okay. And then the second question just on the lower metals pass-through. Sorry, if I missed this, but was there any, what was the EBITDA impact there? Did that just all come through? And like, because I thought you guys had like 90% pass-throughs there. So I'm just wondering if there's something else going on, maybe are the automakers pushing back on some of those contractual pass-throughs.

No, the contractual pass-through, you're exactly right. It's about 90%. Generally in a decline, we get a little bit of profit. It's also mixed in with a little bit of FX that went the other way. So it's pretty much neutral for the quarter for us...

On an EBITDA basis, it's neutral?

Net-net, [Indiscernible] still exist. No change.

So it did, it impacted the top line, sorry, so just to be clear, it impacted the top line, but did not have an EBITDA impact is what you're saying?

Correct. That's correct.

Okay thank you.

The next question comes from Rod Lache with Wolfe Research.

Hi everybody. Had a couple of questions, obviously, the decremental margin on the revenue revision. You talked about $110 million of EBITDA and what looks like $315 million of revenue drop associated with that, so that's 35%. It's a bit higher than what we've seen in the past. So I was hoping you could talk a little bit more about why we should or should not extrapolate from that kind of operating leverage.And then more importantly, in the past, you've talked about the levers that you can pull in a downturn in terms of taking costs out of factories or SG&A or CapEx. I know you're not giving guidance for 2020, but can you just address the mitigating actions that you see at a high level to improve the EBITDA and free cash flow into next year, just based on what you're operating at, at this point? Are there other, some levers that you think you can pull here to restore profitability?

Yes. Rod, this is Chris. First, I'll take your first question as it relates to the contribution margin drop on our guidance of the $110 million. So what I would tell you here, if you look at the sales walk, you can see a mix. We sort of articulated by subcomponents from some of the revenues.And as we've articulated previously, our full-size truck segment is a high-contribution margin business for us. That includes the non-GM full-size truck portions as well. And in terms of the overall contribution margin, what we have here is a rather rich mix that is moving here at the top related to our China programs, as well as the full-size truck. So net-net, the answer is mixed on that product for us as we downgraded those sales.

Yes. And then, Rod, this is David. In regards to some of the actions that we can take and we have been taking, we did the business unit consolidation in January period of time. We're seeing benefits from a synergistic standpoint on that right now.At the same time, we've also taken actions in regards to SG&A, both from a manpower standpoint, as well as just SG&A expense standpoint. Clearly, we're driving productivity and throughput through our plants. We're also looking at capacity utilization. We have closed a couple of plants already.We'll evaluate what else we might need to do in the future based on where we see the changing demand leveling out at. So I feel OK about that. And then, again, we'll work with our supply base in regards to anything that needs to be done that way. But we have the playbook. We know what to do. We continue to do it quietly, adjusting to the changing marketplace. And if we need to step it up even further based on a deeper draft than expected, then we'll take the appropriate actions.

Rod, this is Chris. I would also frame 2020, these are, we're now completing our final steps of our synergy and consolidation savings, which will reap benefit into next year, regardless of volume levels. The integration of MPG will be then substantially behind us. And we're converting from launch mode as a company to steady-state production mode.So our ability to get throughput to focus on productivity, reduce our cost, produce lower project expense will all drive part of 2020 in addition to the items that David just mentioned as well.

Yes. I understand that. But look, I mean, in the past you guys have talked about, you think you have the playbook and it sounds like it's time now to pull out the playbook. So is it reasonable to say, look, there've been some pretty rapid changes in production schedules for Titan or forged transmissions and so forth?It's hard to really make adjustments on the fly within a quarter. But as you look out into next year, you would start to whittle down what we're currently seeing as a north of 30% decremental margin that is something that's significantly less. Are there any brackets at all that you can provide for us on that?

The answer is yes, absolutely. We'll continue to take actions to rationalize our capacity, as David mentioned. We will take out facilities, if necessary. You have fixed-cost elements embedded in these factories that will take out.We'll continue to address our SG&A structure to align with, I would call, comparable and relevant top-line sales generation, continue to reduce that impact of a drop of CM to where that's getting closer toward a normal EBITDA run rate.

Yes. Rod, this is David. I mean, the volume reductions came out as very strong in the May-June period of time here. We've obviously, we're already taking actions.We're accelerating those actions and you should see improvements which we factored into our guidance for the second half of the year, and all of that should carry into 2020. In addition to that, we'll continue to look at other actions that we needed to take as it relates to capacity utilization. And when all is said and done, we need to get facility utilization, manpower utilization and equipment utilization, and we're very good at that. And we'll drive those decremental margins to where the appropriate level and historic levels have been.

Okay and then just lastly, at one point, you talked about CapEx, I think, as a percentage of revenue, but I think it corresponded with something like $450 million of CapEx for next year. Could you just talk at a high level, should we be thinking that some of those prior numbers, you'll revisit those and maybe you can ratchet that down? And should we be thinking about R&D continuing to rise from here? Or is there any kind of high-level view on where that element…?

On the R&D side of things, we'll continue to put the investments into the electrification side, like, we said, and we'll balance our priorities there. But electrification is clearly at the forefront. We've done an excellent job positioning ourselves with our current product portfolio on the traditional products. There aren't many gaps that we need to close or any further enhancements that we need to do above and beyond the innovations that we've already identified and demonstrated to our customers.So again, you'll see continued investment in the electrification and hybridization space when it comes to CapEx, yes, absolutely right. We'll continue to look at readdressing the CapEx side of things, the working capital and the inventory side of things. But on the CapEx side, again, it's all about utilization.And if we're not getting the full utilization, then we're not going to buying incremental component equipment, assembly equipment and utilize what we have. So we'll clearly look at that, and we've already projected and communicated that we expect our CapEx to come off to approximate 7%, working its way toward the 6%. We'll work hard to see what we can do to get it below that.

OK. But just to clarify, and I don't mean to hog this time here, but are you suggesting that R&D continues to go up because your answer wasn't…

No. I don't think it will go up so much as where we're, but based on -- our reallocated and rebalance the priorities based on what we see the market needs and the opportunities presenting themselves.

We previously articulated, Rod, that we've been running R&D from $35 million to $40 million per quarter. We've been running at the lower end of that over the past couple of quarters. So that's why you see the step-up in the second half of this year. But as David just mentioned, we'll be rebalancing some of those resources between the different priorities to stay within our ranges. We don't see that going on.

Okay thank you.

The next question comes from Ryan Brinkman with JP Morgan.

I guess just another one on the conversion of the lower, both revenue and EBITDA and the free cash flow, because it looks like the FCF guide coming down $100 million, $150 million and $150 million reduction in EBITDA, pretty steep to flow through. Some of the revenue reduction is attributable to the lower metals pass-through, which have a pretty benign impact.And then CapEx is coming down $30 million too, so that's another help. What are the offsets? Are you seeing some working capital headwinds, any kind of timing issues that could later reverse that would protect investors' assessments of free cash flow in 2020, etc.?

So as it relates to, just level set for the revised cash flow for 2019, you're exactly right. It's a reduced EBITDA, which we are able to offset by reducing our absolute CapEx spend, so as to protect that element of the cash flow. As we think about into 2020, as we articulated, I would expect we'll continue to reduce our CapEx. We will continue to reduce inventories.We see them crescendoing here at the second quarter of 2019. Our full expectation is we will drive inventories down the balance half of this year, and we'll continue to look at that opportunity as working capital upside for us again into next year from a sales I mean, from a receivables, payables, traditional working capital, that's just normal customary subject to just kind of your timing of your sales through that piece. But we'll continue to focus on reducing CapEx year over year.We'll continue to focus on reducing inventory and net working capital consumption piece.

Yes. And Ryan, this is David. And you'll understand that over the last three years, we've had well over 180 launches. We're getting to the end of that big launch wave that has gone through our organization.You guys also know that we inherited some challenges from MPG. We're fixing those, those that have taken some premium costs associated with getting through those initiatives. At the same time, we're realizing some of the synergies in the capacity utilization, like I mentioned earlier. So we're taking all the necessary and appropriate steps.Like I said, the buying shortfall came on as quickly here in the May-June period of time, and we'll continue to adjust the business to the market demand.

Okay and then just lastly to follow up on that volume shortfall. You'd mentioned that your revenue outlook was materially pressured by the softer volumes in Asia, even while not being as materially exposed whereas other suppliers, given that your exposure is highly program-specific. So can you please remind us of your revenue exposure in Asia, which are these programs, which platforms, with which customers, that are contributing to the decline in the outlook this quarter so that we can monitor them more closely going forward?

Yes. Ryan, again, this is David. In Asia, not necessarily in China, we're doing a lot of work on mid-size truck for multiple customers. You guys can figure out who that is. At the same time in China, specifically, we're doing a lot of work for crossover vehicle customers. There's multiple customers there, including SDA and their partner, as well as GM and their partner. So that's predominantly where the vehicles are being impacted.

The next question comes from Brian Johnson with Barclays.

This is Jason Stuhldreher on for Brian. Hi guys good morning. Staying on the revenue, the lower revenue outlook, if I look at the $400 million in the reduced guidance, is there a way to just simply bucket that into how much was general macro, how much was, call it, program-specific reductions or program cancellations, and then how much was simply delays in launches of programs so if those three buckets, would there be any way to frame it maybe one-third, one-third, one-third as far as that impact on the $400 million?

Yes, Jason. This is Chris. If you go to that sales walk where we walked from previous guidance to current guidance, we sort of had it bucketed by different categories, for example, Asia, non-GM full-size truck. I would tell you that Asia and non-GM full-size truck very program-specific.Obviously, a little bit of the macro weighs on the Asia piece. The global engine and transmission programs would be more macro-oriented. The casting piece is associated, I would call it macro, but associated with the industrial end markets that we support are down and then other would be more macro.

Okay that's very helpful. Thank you for the detail there and then last question, just on the R&D spend, the increase in R&D. I recognize there's only a minor step up. Can you say how much of that step up was purely R&D, so for programs that you don't have, just to build out capabilities.And then how much of it is for programs that are currently booked? And if it was for the current programs currently booked, how much of that is just overspend on those programs and how much of it is design changes requested from a customer that presumably you're being compensated for?

This is David. I'm not going to get into the details by category. What I would say is that's heavily weighted toward product expansion and new business opportunities presenting themselves. But there is some design changes on the existing book business as the customers ask whether we're spending some incremental, yes.

Okay thank you.

The next question is from Dan Levy with Credit Suisse.

Hi, good morning and thank you. I wanted to just touch on K2XX and RAM as it relates to the back half outlook. And if you just view third-party volume forecast for those platforms or if K2XX and RAM HD and you make some assumptions on CPV, it looks like those platforms account for something over 35% of your revenue in the back half. It's really outpunching typical exposure for you. And those are higher contribution margin programs, but we have a weaker margin outlook.So I guess I wanted to understand why we're not seeing those programs or the strains really shine through a bit more in the back half? Is it that relative to where expectations were in the beginning of the year, those are largely intact? And then as far as the contribution, is that still very much, the contribution margin, is that still very much intact with what you've seen in the past?

Yes. This is Chris, Dan. I will tell you, as it relates first of all, on the margin question, we'll go reverse order, yes, still very much intact from what we've seen in the past. In terms of the two different platforms you're talking about would be the General Motors full-size truck platforms and the Ram platforms, I would say, the General Motors platform is very consistent what we have thought about all year.That program continues to run very strong. The RAM program is, you've heard us talk about that previously, is probably little softer than we've thought from previous expectations earlier in the year, and we've talked about that a couple of times. But that's how I would frame those two platforms today.

Just to be clear on RAM HD expectations into the back half of the year. Is that, from what you've heard, fully ramped now? Because I believe, I know there were some issues in the first half of the year in terms of, as you alluded to, just timing of the launch. But what it seems from your customer is that at least what they've publicly indicated is that back half, it's very much on track. So I wanted to confirm that, that's what you're hearing as well in terms of back-half expectation.

Yes. We're not only hearing it, we're starting to see it as well in regards to our schedule. So yes, we're aligned with our customers in their view of the second half.

Great. And then just, I wanted to follow up with a broader strategic question and if we just think about how the axle, the broader narrative has shifted over the years. If we go back maybe six, seven years, this was much more platform-specific, much more, you didn't have as much geographic diversification, it was much more North America-focused.But really the theme was, it was a more concentrated exposure, but what you did, you did really well. And over the years, you've diversified a bit more into other geographies and you've diversified outside of your core platforms. With the idea that you're having a more diverse exposure, that should help a bit more. But at the same time, it seems like what we've seen in terms of these macro shifts, that there is a higher decremental margin, a little more volatility than one would anticipate.And it seems to sort of fly in the face of that view, the benefits of having been concentrated in something really well. So how are you thinking today strategically about that geographic diversification, the idea of balancing, focus on a fewer areas, but do them well versus diversifying more?

This is David. Listen, we're a global Tier 1 automotive supplier. We're still heavily weighted and concentrated in North America, even with the acquisition of MPG. The MPG acquisition allowed us to address a lot of diversification issues, whether it be customer, geographic or products and/or market served.That is definitely benefiting us. We're positioned well in each of those markets in that respect. On the truck platforms, again, that continues to be a core of this business, the strength of this business, and we'll continue to deliver on that. When you look into the power-train, like, the transmission and the engine components, again, they trend and move in that direction for downsized engine and multispeed transmissions were prepared to support that very well.What we didn't expect when we did the acquisition was the downturn in the passenger car side, so we're having to deal with that softness or program cancellation. So yes, we've introduced some risk-based on the diversification globally, but it's the right thing for us to do. We'll manage that effectively. But we're also, I think, positioned very well to profitably grow this business.And let me remind everybody, we still generated 15.6% margins in the quarter. That's nothing to sneeze at. At the same time, I recognize that there are some improvements that can be done from an operational standpoint. But again, as I mentioned, the sales downturn came out so quickly in the May-June period of time, and we're, we will and are taking appropriate actions to get that in line.So I'm not concerned. We are delivering on what we said we're going to deliver on. At the same time, we're still performing the top quartile from a margin-performance standpoint. We said we've generated cash; we're meaningfully generating cash year over year.And at the same time, we've got to adjust the business to the changing market demand. And you guys have known us to do that, and we'll continue to do that. And as I just covered with you, we just went through 180 launches in a three year period of time with an average of 60 a year. And then that will go down considerably over the next three years, and we'll dial our operations in and have it via well-oiled machine, and we'll start generating strong financial performance going forward or stronger financial performance.

And should we expect further revenue geographic diversification? Is that still on track [Indiscernible]?

Yes. Our goal to get more balance from a diversification standpoint geographically, but we also understand that introduces some risk and volatility because of the macroeconomic issues across the globe. But it's in our best interest and our shareholders' best interest that we have a better diversified business with greater concentration in Asia and greater concentration in Europe than we experienced today.

Okay thank you.

The next question comes from James Picariello with KeyBanc Capital Markets.

Just on Asia. Sales were down 25% in the quarter. Based on your prior-year sales mix in Asia, the $125 million revision is 20% decline on its own. So I mean, just curious, what did you have baked in for the region within your prior guide from a year-over-year standpoint?

Yes. I mean, in terms of some of the macro in terms of guides, we've included there also in our pack here today what our previous and current update is. It's Slide 13 and our projections. But again, that would be a macro level, which wouldn't necessarily impact our product portfolio in the same direction, right? This is where we talked about a little bit more heavily concentrated on specific platforms, in particular all-wheel drive platforms in the China market.If you can see in Page 13, our previous and current assumptions, where we are more flat coming into the year and now we're down 8% to 10% in terms of macro China revs.

Okay all right. So maybe you're assuming flattish sales for your business.

That's our view on the particular platforms we support.

Got it. Okay and then just on the Bluffton facility, the power-train business. I think the comment was made that you expect to see a ramp-up in second half transmission volumes. You did take that business unit down by $50 million within your revenue guide. So I mean, will this ramp-up at that facility delay in any way the efficiency and planned productivity gains that you have going through there just curious of your thoughts?

No. There should be no impact on that. So the adjustments that we made on the engine and transmission side were for other related programs in that segment, but will not impact the specific programs that we're talking about in Bluffton.

Okay any change to your tariff outlook?

No. And with recent announcements, no change.

Okay thanks.

Thank you, gentlemen. Your last question comes from John Murphy with Bank of America.

Good morning guys. Just a couple of questions here. If you are looking at the incremental actions that you may take in response to lower industry volumes, whether it be macro or program-specific, I mean, is there any material cash component to that kind of rationalization or the actions you're contemplating at this point? Or would these be more operating actions that wouldn't necessarily necessitate any real significant cash outlays?

More operating actions that we'd be taking to utilize our capacity efficiently done, there may be some restructuring, but I wouldn't consider it to be material.

Okay and then the second question, as we think about the backlog and your bidding activity, has anything changed there in response to this slower macro environment? Because I think as we're looking at your business over the next couple of years, growing the backlog, the backflow from some of the lost business and actually great growth, has been a key component sort of our thought process. Has anything changed there as far as what you're bidding on or any activity?

Yes. What I would say is that we've conquested some new business that we're not here to announce today. We'll update our backlog of new business as we normally do in the first quarter of January period of time next year. But we're pleased with the progress that we're making in regards to our sales objectives.

Okay so it's fair to say year-to-date you're making some material progress on business wins that may be a little bit greater than normal?

We're in line with what our expectations are from a sales win standpoint.

Okay and then just lastly, has there been any incremental sort of pricing action or discussion on efficiencies with some of your customers? It does seem like there's sort of an undertone of them looking for more cost or sort of better performance out of their suppliers. Has there anything changed there at all, in any region or with any customer?

Nothing out of the usual, John we always are in dialogue with the customers with respect to pricing activities. Clearly, with some of the softening of the market demand and cancellations of some of the programs that's intensifying some of the discussions from us to them. But we're not seeing much of a change with respect to the other side. We've got long-term agreements in place and they're on their contracts and we are as well.

Okay thank you very much guys.

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

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