American Axle & Manufacturing (AXL) Q1 2022 Earnings Call Transcript

American Axle & Manufacturing (AXL 0.43%)
Q1 2022 Earnings Call
May 06, 2022, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, everyone. My name is Jamie, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the American Axle & Manufacturing first quarter 2022 earnings conference call. [Operator instructions] And at this time, I'd like to turn the floor over to Mr.

David Lim, head of investor relations. Please go ahead, Mr. Lim.

David Lim -- Head of Investor Relations

Thank you, and good morning. I'd like to welcome everyone who is joining us on AAM's first quarter earnings call. Earlier this morning, we released our first quarter of 2022 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 1-877-344-7529, replay access code 7397562. This replay will be available through May 13. 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 risks 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 may 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. With that, let me turn things over to AAM's chairman and CEO, David Dauch.

David Dauch -- Chairman and Chief Executive Officer

Thank you, David, and good morning, everyone. Thank you for joining us today to discuss AAM's financial results for the first quarter of 2022. Joining me on the call today are Mike Simonte, AAM's president; and Chris May, AAM's vice president and chief financial officer. I will review the highlights of our first quarter financial performance.

Next, I will touch on some exciting news in the quarter, including our recent acquisition of Tekfor, and important win with Geely, AAM's PACE and PACEpilot Award nominations for electrification technology, and the publication of our sustainability report. Lastly, I'll discuss our updated 2022 financial outlook before turning things over to Chris. After Chris covers the details of our financial results, we will open up the call for any questions that you may have. So, let's begin.

AAM's first quarter 2022 financial results were affected by rising input costs and the continuing global supply chain volatility. The unprecedented operating environment that started in 2020 continues into this year. That said, we remain focused on the qualities that differentiate AAM, which are operating excellence, product quality, ensuring the continuity of supply to our customers, and generating profits and free cash flow. AAM's first quarter sales were 1.4 billion.

Sales were impacted by volatile production, but schedules did improve somewhat on a quarter-over-quarter basis. We believe the OEMs will continue to prioritize their light trucks schedules, which is good for AAM. However, supply chain stabilization, namely semiconductors, may not occur until 2023. Inventory levels on key programs that we support remain low, and consumer demand for these products appears resilient.

Simply, OEMs cannot build their respective large SUVs and trucks fast enough. AAM's adjusted EBITDA in the first quarter of 2022 was 196 million, or 13.7% of sales. In the quarter, we were negatively impacted by rising input costs, supply chain constraints, and continued semiconductor disruptions. Material and utility inflation accounted for nearly 200 basis points of margin degradation in the quarter.

This input cost headwinds will continue to be a challenge in this year. The operating teams are looking into cost structure improvements and value engineering initiatives. Additionally, we are also having ongoing discussion with our OEM customers and offsetting this inflation. So far, we have made some progress, and discussions have been constructive but are still ongoing.

AAM's earnings per share in the first quarter of 2022 was $0.01 per share. AAM's adjusted EPS was $0.19 per share. Even with these challenges, AAM continued to deliver positive free cash flow generation in the quarter. This is a compelling view of the strength of our operating model.

AAM's first quarter 2022 adjusted free cash flow was $54 million. Our capital allocation strategy is very straightforward. We continue to advance key strategic growth initiatives and strengthen the balance sheet, and we achieved both in the first quarter of 2022. Chris will provide additional information regarding the details of our financial results in a few minutes.

Now, let's talk about some recent key highlights, which you can see on Slide 4 of our slide deck. We announced that AAM entered into a definitive agreement to acquire the Tekfor Group for an enterprise value of 125 million euros. We are very excited about this acquisition, as it provides strong synergy potential diversifies both our geographic and customer mix, and enhances our portfolio in electrification components. This is a nice bolt-on acquisition for us, and we expect the deal to close in the second quarter.

Additionally, we won a major program with Geely to supply independent front and rear drive axles for a premium vehicle. Our products will support both internal combustion, as well as plug-in hybrid versions of this program. This win continues the theme of securing business for our traditional products, while we pivot to electrification. From an electrification standpoint, our P3 2-speed electric drive technology with 2-speed architecture in a drive axle has been nominated as a finalist for the 2022 PACE Award.

This electric drive is on multiple variants for a premium European luxury automaker that is based in Germany. We're happy to say we have started production on this drive unit and we are receiving interest on this specific technology from other automakers at this time. And it's also been nominated as a PACEpilot Award finalist for our next generation 3-in-1 wheel-end electric drive unit. This assembly fully integrates the motor, gearbox, and inverter into an elegant, compact, and power-dense design.

This technology platform can be used in wheel-ends, EDUs, eBeam axles, and other applications across multiple vehicle segments. Our electric drive technology leadership and innovation are well-represented with our PACE Award nominations, as well as of our past wins in these areas. This is also evident with our very constructive electrification dialogues with multiple global OEMs, as manufacturers are focused on this very important transformation. Our state-of-the-art technology provides a formidable value proposition as OEMs have to balance various capital needs.

It's our goal to be a key supplier and partner when it comes to electric drive units, sub-assemblies, and components. These are very exciting times for AAM, as the electrification opportunities continue to grow and now represent over 70% of AAM's quoting activity. Finally, we're very happy to earn the 2021 GM Overdrive Award. This is a great distinction as it is reserved for suppliers who displayed outstanding achievements across GM's global purchasing and supply chain organization's key priorities.

AAM was recognized for our performance in the launch excellence category. From an ESG perspective, we're also very pleased to announce that we recently published our 2021 sustainability report. Within this extensive report, we outline new goals and objectives for AAM. Our goals are to be net-zero carbon emissions by 2040, to purchase 100% renewable energy in the U.S.

by 2025, and to achieve zero waste-to-landfill status for all facilities by 2035. These are ambitious goals, but AAM desired to create a better tomorrow. Further, we also set our 2030 DEI demographic goals to increase the representation of women and minority team members at AAM. We believe diversity drives creativity, which leads to long-term value creation.

We are deeply committed to properly growing our business in a way that is both sustainable and socially responsible. Now, let's talk about our guidance on Slide 7 of our slide deck. Given the challenges in the supply chain, the geopolitical uncertainty, and production schedule volatility, we have updated our 2022 financial outlook. AAM is now targeting sales of $5.6 billion to $5.8 billion, adjusted EBITDA of approximately $785 million to $830 million, and adjusted free cash flow of approximately $300 million to $350 million.

From an end market perspective, we now anticipate North American production at approximately 14.3 million to 14.7 million units versus our prior-year outlook of 14.8 million to 15.2 million units. Even during these uncertain times, operationally, our business is running well in the areas that we can control. And we believe we are well-positioned nicely as a production environment improves, driven by strong demand and inventory replenishment. That said, our aim is on the future, and we will continue to focus on generating strong free cash flow for the business, strengthening our balance sheet, securing our traditional business, advancing our electrification product portfolio, and positioning AAM to profitably grow, especially in the area of electrification and mobility.

That concludes my remarks. Let me now turn the call over to our vice president and chief financial officer, Chris May. Chris?

Chris May -- Vice President, Chief Financial Officer

Thank you, David, and good morning, everyone. I will cover the financial details of our first quarter results with you today. I will also refer to the earnings slide deck as part of my prepared comments. So, let's begin with sales.

In the first quarter of 2022, AAM sales were 1.44 billion, compared to 1.43 billion in the first quarter of 2021. Slide 9 shows a walk of first quarter 2021 sales to the first quarter of 2022 sales. First, we account for the unfavorable impact of the semiconductor shortage, which we estimate to be approximately $31 million on a year-over-year basis for the first quarter of 2022. Annual contractual pricing was approximately 8 million and metal market pass-throughs and FX added approximately $39 million to sales.

During the last several quarters, we have continued to see an increase in the primary index-related inputs to metal base materials that we purchase. You may recall, we mitigate a portion of this risk with our customers by passing through the majority of index-related changes. The metal portion of this column reflects the elevated pass-throughs on a year-over-year basis. Now, let's move on to profitability.

Gross profit was $187 million, or 13% of sales, in the first quarter of 2022, compared to $227 million in the first quarter of 2021. Adjusted EBITDA was 196.1 million in the first quarter of 2022, or 13.7% of sales, versus 262.9 million or 18.4% of sales last year. Please refer to our adjusted EBITDA walk-down on Slide 10. During the quarter, semiconductor sales disruptions had a negative impact of approximately $7 million.

Annual contractual pricing had an impact of $8 million. And net material, freight, utility inflation, lowered EBITDA by approximately $28 million. Our R&D spending in the quarter increased 3 million year-over-year, driven by launches and electrification development. The performance in other column reflects an increase in project expense and some inefficiencies caused by volatility in production schedules versus a year ago.

We continue to experience increases in index-related metal market costs, and the retained portion impacting us this quarter was approximately $7 million. Let me now cover SG&A. SG&A expense, which includes R&D in the first quarter of 2022, was $86.1 million or 6% of sales. This compares to 6.3% of sales in the first quarter of 2021.

AAM's R&D spending in the first quarter of 2022 was approximately $35 million compared to $32 million last year. We will continue to control our SG&A costs while investing in and increasing our R&D spend to advance our next-generation electric drive technology platforms. Let's move on to interest and taxes. Net interest expense was $41.7 million in the first quarter of 2022 compared to $48.2 million in the first quarter of 2021.

We continue to benefit from debt reduction and refinancing actions in the form of lower interest costs. In the first quarter of 2022, we recorded income tax expense of $3 million compared to an expense of $8.8 million in the first quarter of 2021. For 2022, we expect our effective tax rate to be approximately 15% to 20%. We would expect cash taxes to be in the $50 million to $60 million range.

Taking all these sales and cost drivers into account, our GAAP net income was $1 million or $0.01 per share in the first quarter of 2022 compared to $38.6 million or $0.33 per share in the first quarter of 2021. Adjusted earnings per share, which excludes the impact of items noted in our earnings press release. was $0.19 per share in the first quarter of 2022 compared to $0.57 per share in the first quarter of 2021. Let's now move to cash flow and the balance sheet.

Net cash provided by operating activities for the first quarter of 2022 was $68.5 million. Capital expenditures, net of proceeds from the sale of property, plant, and equipment, for the first quarter of 2022 were $24.4 million. Cash payments for restructuring and acquisition-related activity for the first quarter of 2022 were $8.4 million. The net cash outflow related to the recovery from the Malvern fire we experienced in September of 2020 was $1.4 million in the quarter.

In total, we expect approximately $20 million to $30 million in restructuring and acquisition-related costs in 2022. Reflecting the impact of this activity, AAM generated adjusted free cash flow of $54 million in the first quarter of 2022. From a debt leverage perspective, we ended the quarter with net debt of $2.6 billion and LTM adjusted EBITDA of $767 million, calculating a net leverage ratio of 3.3 times at March 31st. We expect to continue to strengthen AAM's balance sheet by reducing our gross debt and lowering future interest payments.

In first quarter of 2022, we conducted significant refinancing to further reduce interest costs and extend maturities. We also continue with our debt reduction initiatives by paying down $25 million of our term loan B in the quarter. Before, we move on to the Q&A portion of the call, let me close my comments with some thoughts on a revised 2022 financial outlook. As you can see from our press release, we've updated our outlook to $5.6 billion to $5.8 billion of sales, $785 million to $830 million of adjusted EBITDA, and adjusted free cash flow of $300 million to $350 million.

We've updated our outlook based on the latest best information we have regarding customer production schedules and operating environment, including inflation headwinds and projected recoveries. Our North American production assumption for 2022 is 14.3 million to 14.7 million units. And we expect the cadence of sales and related profitability to align with industry estimates of a stronger second half volume timing versus the first half of the year. We continue to assume our customers will prioritize going full-size pickups and SUVs.

But volatility remains across the entire spectrum of activities in our industry. That said, we will focus on what we can control, which are cost discipline, optimizing our operations, delivering high-quality products on time, and maximizing our cash flow conversion. We will navigate through the near-term challenges, and also, in the meantime, continue to provide compelling high-value products and customer diversification as evidenced by the new Geely business award we announced today. We continue to invest in electrification and bolt-on high-value acquisitions like Tekfor to position us for future profitable growth that is aligned with our strengths and capital allocation priorities.

And lastly, we will continue to develop and showcase highly advanced electric drive units, sub-assemblies, and components. Those efforts were recently recognized as PACE Award finalist, as David mentioned in his remarks. Thank you for your time today, and your participation on the call. I'm going to stop here, turn the call back over to David, so we can start the Q&A.

Thank you.

David Lim -- Head of Investor Relations

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

Questions & Answers:

Operator

[Operator instructions] And our first question today comes from John Murphy from Bank of America. Please go ahead with your question.

John Murphy -- Bank of America Merrill Lynch -- Analyst

Good morning, guys. Thanks for --

David Dauch -- Chairman and Chief Executive Officer

Good morning, John.

John Murphy -- Bank of America Merrill Lynch -- Analyst

Thanks for the detail this morning. If we look at Slide 10, I think about your comments about the, you know, discussions you're having with your automaker customers is potentially getting some recoveries or greater recoveries. I'm just curious where the greatest opportunity is, because, I mean, you traditionally have, you know, metals market, you have pretty good pass-through through indexing and other agreements. So, I mean, on the raw side, you're not to exposed, so it's sort of the untraditional costs or the costs that aren't typically pass-through that, I guess, you might be discussing with them.

So, as we look at this, I mean, it's really that 28 million that would be sort of a new area of discussion or focus. I'm just curious what the opportunity set. Is there and how far along your discussions? And what do you think the potential of success is?

Chris May -- Vice President, Chief Financial Officer

Yeah, John, just to maybe -- this is Chris. Good morning. Just to maybe frame up that $28 million, about two-thirds of that relates to net material costs that we've increased in terms of inflation. And we reset a lot of the purchasing prices with our supply base on the 1st of January.

The balance of that or the remaining third is about, consider that freight- and utility-related. So, in terms of how -- you know, look, we're addressing these issues with our customers. As you know, it's a very sensitive topic with our customers. We've continued to make good progress with them.

We've benefited from some progress in the first quarter, and I would expect progress in this discussions to receive ultimately a reasonable recovery at some of these costs through the course of the second quarter and early part of the third quarter.

John Murphy -- Bank of America Merrill Lynch -- Analyst

OK. But I mean -- I'm sorry, I mean, usually, there's kind of a takeaway on this stuff. So, you think there's a reasonable portion of the 20 million is going to be recovered in the coming second and third quarter. I'm sorry -- is that what you said, Chris?

Chris May -- Vice President, Chief Financial Officer

Yeah. On a perspective basis. As we have reset a lot of our pricing with our supply base, we are in with our customers having active discussions on compensation-related to some of those increases that we've already begun to experience here in the first quarter.

John Murphy -- Bank of America Merrill Lynch -- Analyst

OK, that's encouraging. And then just a second question on Slide 4. You know, I mean, obviously, you could argue that the Geely contract is kind of outsourcing of traditional products, but, you know, it kind of in that vein. So, just curious, if you think about sort of these new quotes that you're winning business with, how much opportunity there is there for some traditional products, and maybe even in the incumbents that there might be some level of outsourcing? Maybe, if you juxtapose that opportunity set on traditional products with, you know, your view of, you know, making acquisitions for technology like Tekfor integrate into your traditional product.

David Dauch -- Chairman and Chief Executive Officer

Yeah, John. This is David. You know, first and foremost, you know, our objective was to try to secure our next generation business on our traditional or conventional product. We've made tremendous progress on that, as we've announced, you know, previously in earlier calls.

So, we feel real good about the cash generation that we're going to be able to realize, you know, going forward in the future for an extended period of time. At the same time, there are other opportunities that are presenting themselves, some new program opportunities, as well as, you know, some potential outsourcing opportunities that fit right into our wheelhouse and on existing equipment. So, we're very pleased with the opportunity. Geely just happens to be one of the latest ones.

At the same time, it does have a plug-in hybrid application associated with that. So, it depends on which way you want to look at that, you know, electrification versus a conventional, but we're happy to take it either way. And then at the same time, you know, we do see a significant amount of electrification opportunities presented themselves. Like we said, each quarter that just continues to grow in our backlog that we're quoting versus their quoting opportunities, it now represents over 70% of the business there.

So, we're going to continue to grow in our conventional products. We're going to continue to grow in electrification, especially electrification, because it makes up the majority of what we're quoting today. But we also do think there'll be other opportunities that will present themselves as OEMs evaluate their strategies in the future, and we're here to help.

John Murphy -- Bank of America Merrill Lynch -- Analyst

Great. Thank you very much.

David Dauch -- Chairman and Chief Executive Officer

Yeah. Thanks, John.

Chris May -- Vice President, Chief Financial Officer

Thanks, John.

Operator

Our next question comes from Ryan Brinkman from J.P. Morgan. Please go ahead with your question. Mr.

Brinkman, is it possible your phone is on mute?

Ryan Brinkman -- J.P. Morgan -- Analyst

Oh, I'm sorry about that. Thanks for taking my question. As we go about model, which is on Tekfor, as we go about modeling that acquisition, what can you tell us at this stage about the margin profile of that business? And, you know, it was announced in the press release highlighting the pivot toward electrification? I understand you brought into your electrification product portfolio, but, you know, is there anything you can say about like what percentage of Tekfor's revenue or maybe backlog stems from electrified vehicles?

Chris May -- Vice President, Chief Financial Officer

Yeah. Hey, Brian, this is Chris. We did disclose in our press releases just in terms of framing the size of the Tekfor acquisition from a revenue perspective. Last year's revenues for Tekfor were approximately 285 million euro, and we're looking to close on that here in the second quarter.

We have not disclosed specific margin profile associated with that. But, I would think, as the crux of the key elements of this transaction, this is a high-synergy deal for us. By 2023 estimates, you know, think of that value of that purchase price around three times our synergized EBITDA. So that will give you a little bit of a framework of how we think about this business transforming over the next 18 to 24 months.

In terms of the revenue profile, you know, we project by 2025 of approximately 40% of the revenue for Tekfor acquisition will either be better or I would call propulsion-agnostic, meaning it serves both ICE vehicles and electric vehicles. So, this is was one of the more attractive elements of this transaction. It brings us some new components on our metal form side of the house to support the batt business, but also a lot that's fairly agnostic in terms of propulsion. So, again the key element of our strategy for that acquisition.

Hopefully that helps.

Ryan Brinkman -- J.P. Morgan -- Analyst

OK. Yeah, it does. Thanks. Maybe, just finally, still on Tekfor, you know, I recall, when you purchased MPG that they were a supplier to you also.

And so some of those sales became like intercompany transactions and with the benefit, in the case of those sales, to EBITDA instead of -- or EBITDA margin, or EBITDA instead of to revenue. And I was just looking on the Tekfor website, and I saw they had a press release about how they were in American Axle Supplier of the Year a few years ago in Brazil or whatnot. So. I just wanted to get a sense to, maybe I missed it, but what percentage of Tekfor's revenue was coming from American Axle as we sort of, you know, think about that the modeling implications of that, too.

David Dauch -- Chairman and Chief Executive Officer

Yeah, Ryan, this is David. A small percentage of their revenue comes from American Axle, although, they are a very good supplier to us out of our Brazilian operations. As Chris indicated here, we're going to continue to use our operational excellence and really focus on the synergistic opportunities to drive margin enhancement into the business. Clearly, we'll look at plant-loading initiatives, we'll look at buying power initiatives and other initiatives to achieve those synergies.

But we're very excited about this acquisition. And again, it just shows that we can continue to do tactical acquisitions, while growing our business and pivoting the business to supporting electrification in the future, so --

Ryan Brinkman -- J.P. Morgan -- Analyst

OK. Very helpful. Thank you.

David Dauch -- Chairman and Chief Executive Officer

Yeah. Thanks, Ryan.

Chris May -- Vice President, Chief Financial Officer

Thanks, Ryan.

Operator

And our next question comes from Joe Spak from RBC Capital Markets. Please go ahead with your question.

Joe Spak -- RBC Capital Markets -- Analyst

Thanks. Good morning, everyone.

Chris May -- Vice President, Chief Financial Officer

Good morning.

Joe Spak -- RBC Capital Markets -- Analyst

Chris, I was wondering if you just help us a little bit on the updated guide versus prior. I think, previously, you were looking for metal markets to be $150 million to $200 million plus, and call it about a $30 million negative on EBITDA. What's the updated contribution to the new guidance from that on both the top line and in EBITDA?

Chris May -- Vice President, Chief Financial Officer

Yeah, from a metal market pass-through perspective, Joe, that would still remain very similar. And you can see that run rate flowing through our first quarter. So, from a metal perspective, not a lot different from where our guide was 90 days ago, if you think about why the top end of our range from, revenue is down, think holistically. In particular, the North American markets are down about 3% versus our previous volume estimates.

Of course, half our business is full-size truck related to that our view has been very stable over the last 90 days in terms of volume projections. So, that really is the balance of our business, and metal is relatively very similar to where we were 90 days ago.

Joe Spak -- RBC Capital Markets -- Analyst

OK. So, the reduction is pretty much volume-based. I guess, if metal markets -- this is a dangerous statement, but if they actually hold you from spot, is there still an impact into '23? Or would '23 be more neutral on both counts?

Chris May -- Vice President, Chief Financial Officer

Yeah. If metal holds at these levels -- and as you know, Joe, they reset every 30 days --

Joe Spak -- RBC Capital Markets -- Analyst

Right.

Chris May -- Vice President, Chief Financial Officer

We saw a metal start to trail down in the first quarter, and then they've spiked up in May, for example, obviously very difficult to predict. But if they hold at these levels for the bulk of this year, on a year-over-year basis, stepping into 2023, it would be relatively neutral. I mean, there's a lot that goes into it, but that, at the macro, is how you should think about it.

Joe Spak -- RBC Capital Markets -- Analyst

Yeah. Perfect. And then just finally, you know, David, maybe even sort of ties in a little bit to some of your sustainability comments. I guess, just functionally, when you are selling a, what's called, a 3-in-1 or an electric drive unit that has a motor, right? I think, you're not doing the motors, but the motors clearly have some sensitive commodities in there.

One, have you done in audit of your suppliers to in terms of sort of making sure there's sufficient supply of rare earths or whatnot to sort of meet your goals. And then, I guess, and as well as, I guess, for sustainability purposes, that they're coming from the right place. And B, when there is a -- if and when there is a change in that price, just sort of see -- what we've -- given what we've seen in some other monetarily, like, who pays for that increase? Is that something you're going to have to absorb as you sort of pay for the motor and then sort of pass it on through the customer.

David Dauch -- Chairman and Chief Executive Officer

A couple of questions within your question, so let me just kind of walk my way through this a little bit here is, you know, clearly, what we're going to do is from a motor standpoint, inverter standpoint, we're buying some of those, you know, today. We have agreements in place with those customers, you know, or those suppliers today and obviously have agreements in place with our customers. When it comes to the rare earth metals, you know, we have to. Not only on semiconductors, but also all these other components, we need to understand where our supply base is getting their materials from, half transparency to that, understand what risk it may have, ask our supplier to provide us the robust, you know, supply chain or how they're going to protect our continuity of supply.

Obviously, that's become a huge issue in the last 18 months as it relates to supply chain visibility and transparency. So, there's a lot taking place already that the OEMs are asking for, as well as, you know, the Tier 1s are asking for, to get deeper into the tiers, including the raw material sources. Also, we're looking at alternatives to those rare earth metals. As far as advancements in technologies that make us less dependent on those rare earth metals and the countries that provide those rare earth metals.

And then, the material increase side of things, again, that's a negotiation case by case with our customers. But clearly, we're not going to absorb all those in the future. We've got to be able to have the ability to pass those adjustments on to our customer base. But again, that's individual negotiation.

Joe Spak -- RBC Capital Markets -- Analyst

Thanks.

David Dauch -- Chairman and Chief Executive Officer

Yeah. Sure.

Operator

[Operator instructions] Our next question comes from Dan Levy from Credit Suisse. Please go ahead with your question.

Dan Levy -- Credit Suisse -- Analyst

Hi, thank you for taking the questions. I'm sorry if I missed it earlier, I think you may have mentioned it. But just an update on your cost guidance, which was 40 million initially. And maybe you could just talk broadly about the types of costs that you're seeing, be it labor freight, we know that you're very energy-intensive in your operations and what piece of that might be sticky versus something that's more temporary.

Chris May -- Vice President, Chief Financial Officer

Yeah. Good morning, Dan. This is Chris. Yes.

The guidance that we released in our previous earnings call did show a net $40 million increase for purchased materials, Obviously, with our updated guidance you see here today, that has significantly increased in terms of the net cost associated with that. And as we mentioned on one of the previous questions, you know, we're still having active negotiations with our customers to mitigate some of that increase. But of course, still work to do. But that's, of course, why we provide a range from an EBITDA perspective.

The second half of your question related along the lines of stickiness, obviously, the negotiated elements of items that we're working with our customers on that kind of news that from a stickiness perspective in terms of impact to us. Freight, you know, obviously, will ebb and flow a little bit with market conditions. And we saw increases in freight here in the first quarter. We saw some of that in the back half of last year.

And we also have a fair amount of productivity initiatives in terms of that cost area for us that can help mitigate some of that. But, again, I think, some of the core elements of the company trying to regionalize production to support customers also tries to allows us to protect ourselves somewhat from that. But that, I would say, could ebb and flow over time. Then, of course, the other largest element that we're experiencing would be utilities and then labor.

Utilities, again, I would suspect that's going to ebb and flow some. Obviously, we're at a peak for a variety of different reasons on the macro environment sector. So, I would expect that to trend in different directions based on the macro. And from a labor perspective, we, as is pretty much everyone else inside of this industry and almost every other industry, are facing labor inflation pressures, and I would expect those to be, in terms of cost, sticky.

But the focus is leveraging our operating system to work on efficiencies and mitigate that cost over time through I would call it old-fashioned productivity, automation, and things of that nature to kind of keep some of that inflation at bay over an extended period of time. That's how I think about our different cost elements. Hopefully that answers your question.

Dan Levy -- Credit Suisse -- Analyst

Great. And even if some of this cost is sticky, and even though we just assumed that inflation is what it is, there's no reason to believe that your incremental margins on any volume recovery wouldn't be similar to what they've been in the past, call it, that 25% plus contribution margin. Correct?

Chris May -- Vice President, Chief Financial Officer

When you think, just pure impact of volume changes, you are correct.

Dan Levy -- Credit Suisse -- Analyst

OK, great. And then just as a second question, given it's a more uncertain environment, and the goal of the timeline of reaching 2x net debt-to-EBITDA is, you know, probably pushed out somewhat given the macro volatility. How does the balance sheet -- how did the playbook change for a balance sheet action? Clearly, you just did an acquisition. So I think that shows some confidence.

But, how do things change with an elongated timeline to reaching 2x net debt-to-EBITDA?

Chris May -- Vice President, Chief Financial Officer

Yeah, from a balance sheet perspective, look, I think our operations have been set up, and we continue to operate them to generate strong cash flow. We continue to take action on the gross debt side of our balance sheet, we paid additional debt down in the first quarter of this year, in addition to announcing our Tekfor acquisition. So, we'll just continue to strengthen the balance sheet from a gross debt perspective, meaning reducing it. The net leverage, obviously, will come when it comes.

We're going to continue to focus on reducing that over time. You know, we're highly confident in our ability to generate cash flow and to work our capital allocation playbook appropriately.

David Dauch -- Chairman and Chief Executive Officer

Yeah, Dan, it's David. You know, we've been very consistent regards our capital allocations is that we're going to support the organic growth of book business that we have, which is over $700 million over the next 3 years, as we talked. We're going to continue to pay down debt. We've demonstrated that every quarter, including last quarter.

And then we're also going to focus on tactical acquisitions that are within our capital structure that make good sense for our business, which is also evident with what we just did with Tekfor. So, we're going to do an all-in balance. One quarter by quarter may vary between those three items, but those three items are the main direction that we provide our organization as it relates to capital allocations.

Dan Levy -- Credit Suisse -- Analyst

Great. Thank you very much.

Chris May -- Vice President, Chief Financial Officer

Thank you.

Operator

And, ladies and gentleman, there are no further questions at this time and I'd like to turn the floor back over to Mr. Lim.

David Lim -- Head of Investor Relations

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

Operator

[Operator signoff]

Duration: 38 minutes

Call participants:

David Lim -- Head of Investor Relations

David Dauch -- Chairman and Chief Executive Officer

Chris May -- Vice President, Chief Financial Officer

John Murphy -- Bank of America Merrill Lynch -- Analyst

Ryan Brinkman -- J.P. Morgan -- Analyst

Joe Spak -- RBC Capital Markets -- Analyst

Dan Levy -- Credit Suisse -- Analyst

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