Delphi Automotive's CEO Presents at Merrill Lynch & Co., Inc.'s 2013 New York Auto Summit (Transcript)

| About: Delphi Automotive (DLPH)

Delphi Automotive (NYSE:DLPH)

Merrill Lynch & Co., Inc.'s 2013 New York Auto Summit

March 27, 2013 12:40 pm ET

Executives

Jack Monti

Rodney O'Neal - Chief Executive Officer, President and Director

Kevin P. Clark - Chief Financial Officer and Executive Vice President

Unknown Analyst

Moving so quickly through lunch, we really appreciate it. Next up, we have Delphi. Last year, around this time, the market cap was about $10.3 billion -- rather conference last year. Right now, it's about $13.6 billion. So that's about 32% round numbers and almost $3.3 billion of value creation for equity shareholders. So I think this is a story that's worked out well for the equity guys. And there's a lot of upside, still, to go from here.

Delphi, as you know, is one of the top global auto suppliers out there. They objectively went through the most comprehensive restructuring in the whole industry. I think they're positioned incredibly well right now from a technology standpoint, geographic standpoint and also very much so from our customer mix standpoint, as well as a great balance sheet. Really, one of the darlings in the industry, at least, in my opinion.

Today, we're very lucky to have the Delphi team here. Leading the charge is Rodney O'Neal, who's the CEO, President and he's on -- is a Director. Kevin Clark is the Senior Vice President and the CFO. He holds the reins on capital, as well as Rodney. And Jack Monti, from Investor Relations, who's been incredibly helpful since he's joined the team in the last year. Really do appreciate your help, Jack.

And with that, I'll turn it over to Jack to do the formal introductions and statements.

Jack Monti

John, thanks for the introduction. It's a privilege to be here today speaking, especially at this time. Before we get started, I want to touch on the forward-looking statements. You've all seen these. If you have any questions feel free to refer to our annual 10-K or SEC filings.

And it's our pleasure to have today's presentation being given by Rod O'Neal, Delphi's Chief Executive Officer and President. As you know, we're a few weeks off of our Analyst Day, and we thought it was a good opportunity to reiterate some of the key messages from that day around Delphi's competitive advantages, our financial model, our strong cash generation and capital-allocation priorities.

With that, Mr. Rod O'Neal.

Rodney O'Neal

Thanks, Jack, and good afternoon, everyone. And as you know, I love to talk about our company. Last year, we committed to delivering some very strong financial results and, above all, driving the shareholder value. And even in the face of European market, we delivered on those promises in 2012.

We continued to delight our customers with flawless launch and the introduction of award-winning technologies. And we further optimized our cost structure and expanded margins. And we successfully executed the acquisition of MVL, and we purchased over $400 million of our stock. And we were added to the S&P 500. So 2012 was really one heck of a year for us. And I think our performance, it's a testament to our laser focus as a management team on operational excellence. And that in turn, drives the shareholder value you see. So today, I'm going to share with you some of the reasons we believe Delphi is well positioned for the future.

The pace of change in the automotive industry, well, it's accelerating. And Delphi is uniquely positioned to be at the center of evolution and innovation that is taking place in the world today. We've seen the tremendous amount of change in the past 10 years. Global platforms have become a reality. By 2020, they will represent over 1/2 of the global vehicle build. China has evolved to the largest market on the planet. And by the way, you can see some of these changes firsthand at our China Investor Day on April 22. It coincides with the Shanghai Auto Show. It's going to be a great opportunity for investors to visit one of the largest automobile shows in the world, as well as tour some of our facilities, and see our China business up close and personal. So we'd love to have you join us. And I encourage you to speak with Jack afterwards to get more details.

So China isn't the only area that we're seeing massive change. Stricter fuel economy and emission standards are taking hold worldwide. And consumers are demanding to be connected from the car. Delphi is firmly situated at the center of this evolution. We have the advanced technologies that addresses the challenges that our customers face every day that relate to fuel efficiency, Connected Cars, and Active Safety. We have the footprint to serve our customers globally. We have the most competitive cost structure in the industry. We have capabilities to execute flawlessly. And we have a very diversified customer and regional mix. So to put it simply, we are uniquely positioned for the future. And this is how we will continue to provide value to our customers and create additional value for our shareholders.

Delphi, where we're all about solving the unique problems of our customers. And for 2013, we will continue to shape the market with our innovation, and we will add to an already great portfolio of recently introduced products such as gas, direct injection and our MyFi suite of safety and infotainment offering. Our engineers and our technologists have been recognized more times than any other supplier for the game changers that they brought to market. In fact, we're very proud to have 4 products, which are finalists in the PACE Awards and 1 in the finalist for the Edison Award.

Advanced technology is really, really important in its own right. But being able to deliver consistently in all regions across the globe, while still meeting local requirements is another way Delphi is uniquely positioned. Having global scale with competitive regional approach allows us to design and engineer for local needs and improves our speed to market, lowers our logistics costs, and we benefit from growth in emerging markets such as China and the trend towards global vehicle platforms. So with this trend, we will be a winner. And I just got back from the Geneva Auto Show. And based on my discussions with customers, global platforms are a fast-growing reality. And our footprint has us well suited to capitalize on it.

I want to reiterate that we do have the industry's leanest cost structure. 92% of our manufacturing employees are in low-cost countries. One year ago, 30% of our hourly employees were contract in nature or temporary. Today, that percentage is 24%, as the result of our flexing the workforce in Europe to adjust for the lower volumes there. And given the flexibility of our cost structure, we have built a very balanced business model that generates EBITDA margins of roughly 10% to 16% across the industry cycle. And to reinforce the point of our flexibility on our cost structure, even in the face of the European contraction, we actually expanded EBITDA margins in Europe last year.

Delphi is a very large and a very complex company that earns the trust of our customers through outstanding, flawless execution. We don't talk about this enough, but Delphi's enterprise operating system, it's what drives the business. This system sets our objectives, creates the plan, deploys our portfolio, drives our quotation process, ensures flawless execution of our designs, deliver products to our customers and drives shareholder value.

So to put this in context, we purchase 0.25 billion parts every day from 6,400 supplier locations. Our 110,000 people in our 141 global facilities deliver 60 million parts every day at quality levels of less than 2 rejected parts per million and with on-time delivery of 99.5%. This finely tuned system is a big reason why we've been very successful with our new business bookings and the continued expansion of our margins.

We continuously focus on enhancing our customer and regional revenue mix. And we will continue to see further diversification through time. Our objective over the next few years is to have no single customer to be more than 15% of the revenue, and for North America, Europe and Asia to each account for roughly 30% of our business.

We believe the role of the Tier 1 supplier is becoming increasingly more important. OEMs rely on system integrators like ourselves. And there are only a few Tier 1 suppliers like us that are focused on innovation and even fewer that can execute globally like we do in China and Brazil just as we do in North America and in Europe. And there's a long list of consumer electronics companies that's at the top of the game and the connectivity technology. But being able to make that technology, automotive grade and make it work in a car, now that's a different story, and that's where we come in at Delphi. Those companies don't know cars like we do, so we work very closely with companies like Microsoft, NVIDIA and Google and always know that they can depend on Delphi for innovation, high-quality products, and that's why we have content for nearly every leading OEM in the world.

So the competitive advantages I just covered are why we book new business. And those new business bookings have increased at an annual rate of 25% since 2009 to over $26 billion. In 2012, our bookings were twice what we booked in 2009. And over the last 16 quarters, we've generated more than $80 billion in new business bookings.

As you can see by the chart, the regional mix of our bookings reflects the ongoing rotation of our business through high-growth areas such as China. These record new bookings will result in an acceleration of our revenue over -- in the out years, and we are forecasting revenues to increase to $22 billion by 2016. Additionally, after 3 straight years of margin expansion, we are confident that the EBITDA margins will continue to expand to 16% in 2016.

The leverage in our operating model, combined with our low tax rate allows us to efficiently convert earnings into cash flow. And to bring this more into focus, we will generate just over $9 billion of operating cash flow over the next 4 years, which provides us with tremendous flexibility to invest in organic and acquisition-related growth opportunities and at the same time, return a meaningful amount of cash to our shareholders. And this positioned us to further accelerate EPS growth through share repurchases.

I've talked a lot about how Delphi is positioned at the center of evolution and innovation in the ever-changing automotive industry. Now I'd like to discuss how this all ties back to Delphi. First, and foremost, our management team is laser-focused on creating value for our shareholders. And we will continue to develop advanced technologies that are aimed at improving vehicle safety, emissions, fuel economy and connectivity in the vehicle. We will continue to execute flawlessly. We will accelerate the rotation of our footprint to low-cost countries. And just as I mentioned earlier, we will continue to deploy capital in a very disciplined manner to create shareholder value.

I want to thank you for coming and listening. I'd like to turn it back over to John. And we're going to Q&A. Thank you so much.

Question-and-Answer Session

Unknown Analyst

While we queue for questions, I've got a bunch here. But I'll try to start with one and then turn it over to the audience. As we look at your return on invested capital of north of 20%, and that's pretty impressive, forget about whatever industry you're in but certainly for an auto supplier at this point -- as we look at sort of the reinvestment that you were talking about on your cash, obviously, some of that's going to be going back into the business but some of it's going to be coming out in share repurchases and dividends. I mean, do you see an opportunity set that may, actually, even be greater than what you're looking at right now to keep those returns higher and potentially grow faster? Or is what you're talking about in your backlog really kind of limit where you can put capital in the ground to get 20% plus returns in the auto industry?

Kevin P. Clark

Do you want me to answer it? So to make sure I understand those questions, effectively, do we have a business model in a book of business that can continue to drive increased returns on capital?

Unknown Analyst

You keep it above 20%. And if you put it out there, would there be some degradation to that return?

Kevin P. Clark

No, listen. We are very focused as a management team and a company on increasing free cash flow generation, in judiciously deploying capital. We are very focused on expanding our margins, generating or enhancing our free cash flow conversion and being very disciplined with respect to the amount of capital that we invest in the business. We have a plan, what we've laid out here, in terms of our longer-term projections that actually have return on capital increasing over that timeframe. We have a management incentive plan from a -- both a short-term and a long-term standpoint that really only pays if we do increase return on capital over that period.

So from a philosophy, we're very focused on: we're in a cyclical business, we need to be judicious about deploying capital, where we deploy capital and when we do, generating very high margins and high returns and it's with a focus of all of our compensation plans are.

Unknown Analyst

That's incredibly helpful and encouraging, I should say. I've been pretty impressed with the European business there. And you covered the entire industry. Europe has seen a lot of challenges for other companies. I know you started a while back restructuring that business. Can you give us some of the game plan that you had? What your successes were? And what the capacity utilization now there is? And how you are positioned kind of going forward?

Rodney O'Neal

Well, let me just set the stage. And, Kevin, you can follow in after I just do it. I think one of the things that I think was very unique about our transformation was the simultaneous conversion of our European operations into our stellar cash generation and high-margin business at the same time that we were doing the transformation here. As a result of that hard work, we were able to take Europe and not only make it profitable, make it a front runner in terms of margins. I mean, the margins in Europe are double-digit and near what some of our best earning regions are. So we're very proud of that work. And what that allowed us to do was essentially be extremely flexible because of the rotation of our footprint into Eastern Europe and Northern Africa. And it allows us to be flexible. And as a result of that, in the face of the contraction that we've seen in Europe, we've been able to adjust ourselves and adjust ourselves rapidly to the point where even last year, our margins were expanded in the face of Europe contracting. So I think the model is built where it performs wonderfully as we had designed it to do so. So we're very proud of that. Kevin, do you want to talk a little bit more?

Kevin P. Clark

Sure. And maybe some overlap with you, I think what's it's important is Rod and the team, really, over the last number of years have been rotating our cost structure as it relates to Europe, into Eastern Europe and North Africa. So we have a model where we serve the European market out of Eastern Europe and in North Africa. North America, for instance, we serve primarily out of Mexico. And to Rod's point, we have a very flexible cost structure last year with -- for us, reported -- or FX adjusted revenues in Europe were down 6%. We expanded our European margins. We've used the slowdown in Europe late last year. And what we're projecting for this year, really, is an opportunity to continue to fine-tune and accelerate some of the planned rotation that we had, bring it forward. It's easier to, obviously, to rotate business when bonds are a bit lower. It tends to be a little less costly to do it. And we have a little bit more negotiating leverage to do it when the market isn't quite as strong. So most of you probably know in the fourth quarter this year we announced that we're going to do roughly $300 million of restructuring. That was really twofold: One, related the integration of the MVL business we acquired; but secondarily, primarily related to accelerating the rotation of our portion of our manufacturing footprint that remained in Western Europe, as well as some of our engineering footprint. So we've used the view the slower market as an opportunity to do that. As it relates to Europe, the question that we're getting -- the first questions in all the meetings is "what's our outlook for Europe?" Our guidance for 2013 was for European production to be down 4% on a year-over-year basis. In general, our view was the first half of this year from a production standpoint looks a lot like the fourth quarter of last year. And through the first quarter, that's really been the case, it's what we've been saying. So we're very comfortable with our position in Europe. To Rod's point, even with the slowdown and the softness, we have an extremely profitable business. And we view this is as an opportunity to continue to fine-tune our cost structure.

Unknown Analyst

I have a couple of questions. You mentioned that there are very few manufacturers that you still do not sell to. Why -- who are they, and why? And what stands in the way? My second question is on the GM K2XX program, where I was wondering if you could comment on looking out into '13 and '14, how it ramps up for you both in terms of volumes, as well as, say, DNA or engineering payback from them in terms of its incremental margin for you versus what you would expect would be a probably very high margin-mature business, but prior generation. And the third question, relating to Western Europe, if it like, becomes more like Japan, aging off deer [ph] and urban and shifts away from diesel fuel subsidies and into very low cost cars, how does that affect your business?

Rodney O'Neal

It's a lot. Let me start with the Delphi model in terms of our customer base. And also one of the things you get when you join Delphi on this journey, you get a management team that knows what business it's in and also what business it's not in. And we're a very high-tech company with very special products, and there's an extra amount of percent of the vehicles on the planet that will not utilize ours, particularly, a lot of the entry-level emerging market types of vehicles. They're not heavily contented in our space, and we do not try to engineer down into that. So there's probably 35% to 40% on the vehicles that we don't want to be on because they won't generate the kind of value that we want to generate, and we don't plan on taking our technologies and trying to cheapen them, and brand them down to meet into that space. In addition to that, we don't -- we only have about 5% of our business with the Japanese OEs. And most of that's here in the U.S. And hopefully, that sort of explains to you who we don't sell to and why. The rest, I guess, you can handle.

Kevin P. Clark

I can try. You had a question about the K2XX launch and the implication for our business. I'd first would start with just, in general, we're typically launching anywhere between 800 to 1,000 launches a year. So we're really almost in perpetual launch. The K2XX, which replaced the GMT900. GMT900, it's obviously, a meaningful platform for us like everything else. The K2XX is consistent from a content standpoint. But from a sequencing standpoint and impact of launch cost and ramp cost, it really, in the grand scheme of things, based on what we have going, it's not overly significant. So it doesn't have a impact on our revenues and our profitability from one period to another, if that answers your question. In the European market, I think, Rod answered your question. You painted a scenario. I think we'd characterize that as short-term, you can see trends like that but in all likelihood, that's a very unlikely scenario over a period of time. And our space is highly contented vehicle. That's where we make our money. That's where OEs need problems to be solved.

Unknown Analyst

Actually -- real quick, if I can ask a follow-up question to Margaret's question. You have highlighted the business climate as one that you're in, because in '15 and '16 or out years -- I'm not -- won't put an exact year, I'm not sure, but that it will lead you into new customers and new business. So it does sound like there are some automakers out there, which you're making -- you'd like to make headway with that you're starting to do so in that climate business. I don't know if you can talk about who they are, or how significant that climate business could -- have business that could lead to? I mean is that the kind of...

Rodney O'Neal

I can't identify, but let me explain how we've been able to successfully rotate ourselves from the 2005 position that we've found ourselves in as a company, which was 70% of our business was here in North America and 50% was with one customer, General Motors. To where we are our today, where General Motors is right around 18% and North America is 30% and 70% of our business is elsewhere in the world. And the way we've been able to make that rotation is that we would establish a beachhead with a customer that we traditionally haven't done business with, delight that customer with our technology, execution, flawless launch, and then they would want more of that from other parts of Delphi's portfolio. We have -- the Thermal team has been able to penetrate 2 customers that we historically have not done much business with. And I see no reason why that model that I just outlined would not create draft for us to be able to do more with these other customers. Hopefully, we'll be able to announce those in the coming months. But it's -- actually one is Japanese and one is German. I think I can say that.

Unknown Analyst

If we think about the increasing fuel economy standards in the U.S., the 54.5 by 2025, I guess the first question would be do you think this can be met with advanced internal combustion engine technology? Or do you think it's going to necessitate more hybrid electric vehicles? And then I guess the second part would be, how is Delphi positioned to kind of meet either scenario?

Rodney O'Neal

We believe it's going to be a combination of the 3 that you just mentioned, which will be the conventional Powertrain -- much improved conventional Powertrain through technology improvement, it will lead the way. It will be the majority of what you see in the new [ph] vehicle fleet followed by the hybrid and the plug-in and then the EV. And the way Delphi has positioned itself is to capitalize in that outcome and playing that entire spectrum, both from the Powertrain improvements through direct injection, smaller power plants, et cetera. And also being part of the recreation, I guess, of a different power plant in terms of electrified. And to be honest, when we look at our content per vehicle, it's actually higher on the electrified vehicle than it is on the conventional vehicle. So we're very much interested in this space, but we will make money in both aspects and create value as both, so that's the way we see it playing out, that's the way it's definitely going to play out in terms of how we see the future, and we're perfectly positioned to deal with both.

Unknown Analyst

Just a quick question on your customer profile, you've got about same amount of customers that are German-based as you do that are U.S.-based. Given the fact that Germany held up longer than a lot of the Rest of Europe, what's your outlook for, let's just say, 6 to 24 months out in Europe? I mean, if we have a steeper-than-expected decline, particularly among the German OEMs, is that baked into your plan at this moment. And kind of an ancillary question off that is, how much business do you have with them that's export out of Europe?

Kevin P. Clark

Sure. Well, if you break down, let me start by -- I'll answer the last question first and then with your first collection. Revenues in Europe account for 40% of our total revenues. When you break it down by customer category mix, roughly 12.5% of those revenues are commercial vehicle revenues, 12.5% is automotive aftermarket, 25% would be the luxury, primarily German OEs. 12% today is VW, the non-luxury brand, and then the balance would be the -- the remaining light vehicle automotive manufacturers. Of that portion that's exported, it's in the luxury category, the 25%, we estimate that, that's between 1/4 and 1/3. You can't get a precise number, you can imagine, but I -- we think that's a reasonably good estimate at this point in time. Going to your first question, as I said earlier, our guidance for 2013 is that European revenues -- European production would be down 4%. Our longer-term outlook for Europe, the 12 to 16 period is that European production volumes would grow at a compounded rate of roughly 3%. And it -- that has that 4% decline in 2013 contemplated in that estimate.

Unknown Analyst

Have you invested down?

Kevin P. Clark

Do we look at it at a lower level? Sure. I'm not quite sure I understand what is it that you're looking for.

Unknown Analyst

What's the risk if you invested down?

Kevin P. Clark

It's easier if maybe you can run your scenario and then I'll -- so I can give you the information as a way to think about it.

Unknown Analyst

Let's say for example we're not down 4% this year. We're hearing rumblings that it could be down, let's say 8%, okay.

Kevin P. Clark

I understand, so I'll give you. So for given our mix of European revenue in '12 and in '13, for every 1% reduction in unit production or 1% increase, we can go either way, for us, given the mix of European revenues, that translates into about $60 million of revenue and on a flow-through basis roughly $15 million of EBITDA. Okay.

Unknown Analyst

If I can sneak in one last question before we wrap up. Obviously, with the electronic architecture, the electronics you have on the man-machine interface, and then even the electronics go all the way into sort of your ECMs or electric [ph] control modules. I mean, you got a lot of content that could theoretically really be wrapped together in a module or really give you a lot of leverage in sourcing a lot of those parts together. I'm just curious, we've talked about this before, but where do you think the automakers are in accepting you as sort of a more modular or module supplier? And what kind of advantage you have in the interim? Is that the kind of thing that could be 5 to 10 years out? I think it's tough to say that it's happening right now. But curious as to what's your take? And what kind of advantage you have really ultimately over your competition because we see a lot of companies that have pieces of what you have but not the whole portfolio?

Rodney O'Neal

I think as you enter the emerging markets and some of the emerging OEMs that are local there, their system capability is not as advanced as the Western. And so we're seeing much more of the emerging OEs that will require system integration -- integrators like a Delphi to do that business. Historically, from a auto perspective, the OEs have sourced more parts than they have systems. Some change in that, but not radically as we look out over the time horizon. The biggest shift, I think, has been the global platform sourcing with some subsystems involved. But the one advantage that you always have, though, is when you are a system player like we have, is we can morph back and forth between the 2 formats and do it seamlessly. And we're agnostic in a way. But in emerging markets where there's a lot of growth, we're seeing that the local OEs want more system integrators.

Unknown Analyst

That's great.

Kevin P. Clark

Can I go back and make a comment on your first question, on return on capital, because the bright light distracted me and I don't think I did as great a job as I could've done. Listen, I think at the end of the day, from a management team standpoint, and John you've heard this, we are very focused on return on capital. It's our primary focus. And we have a process in place where as we look at new business opportunities, anything with an annual revenue of north of $50 million needs to be reviewed and approved with Ron and myself before it's bid on and actually booked. And all of that business as we look at it by business has an underlying threshold that it needs to meet margin requirements, return on asset requirements, free cash flow requirements that are levels that are consistent with at or above what we have in our baseline business plan, which you could imagine internally, our business plan tends to be more aggressive than what we communicate to you guys. So we have a great deal of visibility, and we manage it very closely on a weekly basis. I think, secondly, from a management compensation, so how does it turn into? And how does management deal with it? When you really look at our compensation plan, which is really two-fold like any company, we have an annual bonus plan, which is 50% based on expanding OI margins or net income margins depending on whether you sit at a division or a corporate level, expanding them. And 50% based on increasing free cash flow generation. And then when you look at our longer-term incentive plan, it's really -- it's primarily performance based, 75% of it's performance based. Of that performance-based, to invest [ph] half of it is tied to increasing return on invested capital. So we are very, very focused on we realize we're in a cyclical industry. We realize that we need to really squeeze the asset base. And we are extremely focused on judiciously deploying capital, one, and then, two, expanding our margins.

Unknown Analyst

That's great. That's very helpful. I appreciate the detail. I think with that, we can take a really quick coffee break before the next meeting. And I want to thank the team from Delphi for presenting today and actually participating in tons of one on ones. I really appreciate the time guys.

Rodney O'Neal

Thank you, John.

Kevin P. Clark

Thank you very much.

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