A New Auto Industry, Different Challenges, New Opportunities

David Knill, Managing Director, BBK

BBK/ PI LLC Overview

• International business advisory firm• Core competency is manufacturing with

significant automotive experience• Unparalleled expertise in supplier risk

and supply chain management• Senior executives with problem solving

reputations through hands-on interaction

• Interrelated team of finance and manufacturing expertise proficient in executing business strategies

• Middle market prices with global reach and superior results

• High impact professionals providing

variable cost solutions• Results - driven business model• Focused on operational metrics

improvement, VA/VE, supplier assessments, interim management, and production/quality system implementation

• Global support of production and launch activities

• Strategic analysis: manufacturing footprint and supply base rationalization studies and execution

• Hands-on implementation

The Market: Past to Present

2009:Gloom and doom

2010:Stabilize and start to recover

2011 & on:New challenges (good news!)

?

??

What’s the major challenge facing us? -Good News and Bad News

12.6

8.6

11.913.0

14.4

0.02.04.06.08.0

10.012.014.016.0

2008 2009 2010 2011 2012

N.A. production volume in millions per year*

+38% +9%

+51%

+11%

*Source: IHS

? ?

Two Supply Bases vs. One

‘TheSupply Base’

• Distinguishing the two different supply bases

Large

Public Small to mid-size

Private

State of Supply Base – Public/Large Suppliers

• OEMs have good visibility• Still challenges, but fewer

Volumes are on an uptick, leading to strong profitability

and stability

For the largest, healthiest suppliers

with access to public credit

markets, most restructurings have been accomplished

(both balance sheet and

operational)

Costs have been adjusted to break

even at much lower volumes

Ratings Trends 2010 vs. 2011- Public Suppliers

• Public companies demonstrate year over year improvement in Ratings

• The A/B Rated companies have increased, while D/F risk companies have significantly declined. C Risk companies have decreased as well

• Improvement is due to increase in Profitability, measured as, EBITDA as a percent of Sales, and increased Revenues

• Profitability, on average, has increased by 9 percent, with an average Revenue growth of 18%

• Debt Leverage, measured as Debt/Total Assets, remains stable

and consistent year over year

• 9% of the companies reviewed, remain a D/F risk, in spite of increased Revenues

• The high risk companies have low EBITDA at 6% versus the average EBITDA of 12% in 2011, and high Debt Levels at 49% of Total Assets. These companies have high Short-term Debt at 12% of Total Assets when compared with an average of 4%

64 public companies Year over Year trends

Overall, any pressure on the Revenue generation ability may create an additional risk on these companies financial position.

Corporate Ratings*- Public Suppliers/OEMs

Company CompanyS&P S&PMoody’s Moody’s

* Data taken from Capital IQ, Thomson Reuters LPC Loan Connector, S & P’s Leveraged Commentary & Data

Historical Yields 2010 vs. 2011*-

Public Suppliers/OEMs

Term Loan Spreads

High Yield Bonds

* Data taken from Capital IQ, Thomson Reuters LPC Loan Connector, S & P’s Leveraged Commentary & Data

State of Supply Base – Private Suppliers

• Profitability improved with higher volumes

• However, meeting the demand is a major concern

• Restructurings have not all been accomplished

• Financing options are still restricted

• Consolidations remain a concern

• Suppliers unwilling or unable to spend money

• Legal changes being implemented by various groups (customers, government, etc.) How will they impact the supply base?

For 2/3 of suppliers (mid size

and smaller) without

access to the public

credit markets, the

picture is different

Public Suppliers

+3x

Private Suppliers

+2x

• In 2009, supply base adjusted break even to 9-10m vehicles

• Industry is a fixed cost business• Therefore with volume increases in 2010:

EBITDA for NA suppliers (2010 vs. 2009)*

• Europe not as good for either group

*according to BBK Ratings data for 2009 and 2010

Private Suppliers - Profitability

Focus on fixed costs, management of liquidity and improving volumes is critical

Private Suppliers - Demand

• In 2008/2009, suppliers significantly reduced structural costs to survive now the need to deal with:

Global platforms

Maintaining current fixed cost structure

Constant pressure

on competitive pricing

Rising demand

• Many have not restructured their balance sheets– Although much improved overall, over-leverage still

exists for some– Percentage of suppliers rated as D/Fs in 2010 (BBK

Ratings data):• 23% in North America• 31% in Europe

– Restructuring options are more limited

Private Suppliers - Restructurings

So why haven’t we seen the lenders take action?

• Poor liquidation values (real estate and equipment) = amend and pretend

• This will change • Levels are below historical levels even in

good times

Private Suppliers – Lending Market• Lending market has not fully reopened

– Concern over market consolidation and margin degradation– However, the lending environment is slowly improving

• For middle market, transactions are primarily structured as ABL with isolated cash flow based deals and limited term debt

• Funding for cap ex and tooling can be an issue (poor liquidation values, lenders seeing uncertainty around new program volume)

• Unwillingness of borrowers to go “all in”Implications

• Lack of excess availability to fund growth and working capital needs (need to fund internally)

• Refinancings taking longer and may involve non-traditional lenders

• In a 2010 BBK study of >150 mid-sized suppliers, 50% had financing challenges

Entrepreneurs’ resistance to

go “all in” again

Why are they unwilling or unable to spend money?

• Unable: tied to lack of lending in this market

• Unwilling: due to concern over future– 2008/2009 memory– Is demand real? Which demand will

prosper?– Global economic impact– Impact of raw material pricing– Fuel prices– Price downs– Washington wizards

Good News Problems!

• Gloom and doom is over, but new challenges still need to be addressed

• Uncertainty does exist in many areas• Many of the challenges are greater for the tiered suppliers• Clear visibility and action are they keys to success• Operations is the most critical challenge now, but as a

supplier you still must focus on all these:

Failure to manage any of these challenges can jeopardize your long term viability.

Financial viability

Operational

Capability

Stability of lending relationshi

ps

Automotive Industry Tends to Have Short Term Memory

Learn from the past, actively manage today’s challenges and cautiously plan for the future.

Volume 15m this year, 17m next

year

Double capacity so

you are prepared

Go all in

Life is good

= noise in the market

Operational Challenges and Opportunities

Survey

• Recent Survey of 620 manufacturing executives*– External concerns: economy, political gridlock, rising

raw-material costs and federal over-regulation– 60% pessimistic about U.S. economy. 64%

pessimistic regarding world economy– 44% growing, 52% stable, 3% declining– 76% improved productivity in last 12 months. – 88% expect raw-material costs to rise. 85% plan to

pass those costs onto customers

*according to McGladrey Manufacturing and Distribution Monitor

Data

Recent BBK operational capability supply base study; based on a review of >150 mid-sized suppliers

Survey says…44% had supply chain risk

25% lacked capacity for increased volume

15% needed to bolster

quality managemen

t systems

10% lacked sufficient

qualified staff to handle volume changes

Major Drivers Facing AutoGlobal Markets/US Economy/Consumer Confidence

• Will it stay level?

Gasoline Prices

• Trucks vs. Cars vs. Hybrids vs. Electrics

Volume/Throughput• Capacity in the tiers - Japan earthquake delayed impact

• Suppliers unwilling or unable to spend money

Raw material pricing and availability

• Internal and external cost pressures will only increase

Struggling suppliers fewer but still around

• Consolidations still a concern• Viability needs to be proven

Key Challenges

• Meet rising demand while not willing to add costs- Short term (?) strategy driven by skepticism/profits- Stressed labor (salaried and hourly) and equipment- Turnover, quality and throughput at risk- Supply base capabilities/raw material costs

• Competitive pricing- 2008/2009 the suppliers had to focus on reducing structural costs. - 2011 pressure on reducing piece price due to lack of

attention in this area and focus on global market

• Rapidly changing environment- Need to be nimble and react FAST - both cost and revenue - Japan crisis- Fuel prices

Strategy

• Understand the capabilities/capacity/pricing of your supply base

• Resource utilization - caution not to over-task

• Waste/cost reduction efforts

• Be the leader within your segment

• Technological advances

• Improve working relationship with customers and supply base

Best Practices

• Increase your sense of urgency– Slow to deal with inefficiencies can be a death

sentence

• Benchmark your processes – prove your leadership– Purchasing, Risk Management, Quality, Operations,

Technology, etc.

• Take a “variable cost approach” to supplementing resources– Limited resources can struggle to cover all the

necessary ground

• Drive cost down/efficiency, throughput and quality up

• Comprehensive approach– Product (VAVE)– Process (Lean Manufacturing)– Manufacturing Footprint – Supply Chain (Rationalization)

• Flexible and robust sourcing and supplier monitoring strategies– Clear Visibility

Moral of the Story

• Sooner you address problems/inefficiencies (internal and external) – the more options you have and the cheaper the fix

• Slow to take actions to be the best is a problem

• Consolidations say if you are not one of the best you most likely will not be a survivor

• Remember: poor operating performance will quickly lead to financial distress

and production risk