Commercial Vehicle Group, Inc. (CVGI) Q3 2016 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Commercial Vehicle Group, Incorporated Q3 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Mr. Terry Hammett, Vice President of Investor Relations. Mr. Hammett, you may begin.

Thank you, Kerry, and welcome everyone to the conference call. Patrick Miller, President and Chief Executive Officer of Commercial Vehicle Group, will provide a brief Company update; and, Tim Trenary, our Chief Financial Officer, will provide commentary regarding our third quarter 2016 financial results. We will then open the call up for questions. This conference call is being webcast. It may contain forward-looking statements including, but not limited to, expectations for future periods regarding market trends, cost saving initiatives and new product initiatives, among others. Actual results may differ from anticipated results because of certain risks and uncertainties. These risks and uncertainties may include, but are not limited to, the economic conditions in the markets in which CVG operates, fluctuations in the production volumes of vehicles for which CVG is a supplier, financial covenant compliance and liquidity, risks associated with conducting business in foreign countries and currencies, and other risks as detailed in our SEC filings. And now Pat Miller will provide a brief company update.

Thank you, Terry. Good afternoon and welcome everybody. First I would like to comment briefly on the market dynamics as we understand them today. The heavy-duty truck market in North America continues to be soft as the OEMs are managing production rates tightly to reduce inventory levels and match order rate. Backlog just fallen again but are expected to bottom out soon. Some freight indicators are reflecting leveling out and projected to turn positive over the next few months. Truckload rates and capacity utilization both are showing tighter conditions and indicate some improved pricing for fleets. Our expectation is that larger fleets will place regular orders for the 2017 replacement cycles while the smaller fleets may be more conservative. Two areas we are monitoring our economic growth and also the regulatory environment. If the GDP continues on the current growth trends, it should reflect in a more positive freight environment. The regulatory change for electronic logging could impact fleet efficiencies and some freight capacity constraints in 2017 and fuel efficiency changes could drive a potential pre-buying in a longer-term. On the construction side of the business, North Americas went down versus 2015 and is the main driver behind our GCA segment sales reductions. For the rest of the world, construction sales for CVG seem to have leveled out and then somewhat flat or slightly up. The regions we mostly participate outside of North America are in Asia and Europe. India is a bright spot for us as their economy continues to grow. Our global construction customers are indicating they expect a mostly flat environment for 2017. In spite of the difficult sales environment, we continue to effectively manage through these conditions. As discussed previously in late 2015, we started activities to better position the company to be profitable through the cycle. Immediate objective with the better lines of company cost structure with the changing market dynamics, as well as to reduce our fixed cost structure. Our plan included not only preparing for the expected decline in North American truck and a soft construction equipment build, but also our longer-term business objective, improve the core while positioning for long-term profitable growth. Initiatives to address the immediate objective were developed in action. Most of the large impact actions have been announced, some are in progress and some are complete. We're pleased with the contribution these changes are making to our financial results. Third quarter adjusted operating margin was 3.9% despite 24% less sales in the prior year period. And there's more to come as we wrap up a productive 2016 and move in to 2017. Our immediate objective to accomplish returned to our longer-term objective of improving the core and building for long-term profitable growth. As a key supplier to major commercial vehicle OEMs around the world it's imperative that we deliver the lowest landed cost to our customers. In is the first three quarters of this year we've made significant progress in the adjustment of our manufacturing footprint in North America and associated rationalization of manufacturing capacity, the lowering of SG&A, as well as the realignment of the executive structure. I also want to emphasize the importance of the positive progress in our Lean Six Sigma programs which we call operational excellence. Jack Feng who is our OpEx leader, along with other key operational leaders is helping to institutionalize the Lean competencies throughout our company. We are exceeding our goal this year for the number of Belts awarded and expect to have 540 awards of yellow, green and black belts by year-end including a 100 awards to individual that some of our suppliers who recognize the value of our program and have joined Jack's training event. This isn't really about the number of belts, operational excellence is about delivering cost-savings, augmenting talent, improving process efficiency and significantly upgrading our capabilities for the long-term. Importantly some of the savings been realized from our efforts are being redirected in the form of resources to expand our product and process portfolio. For example, we've been investing in our interior trim business to enable growth in both the hard trim area which is an expanding segment, as well as the new composite technology for headliners and interior panels. Global truck and bus team is fully engaged in numerous launches in North America and Asia. We are involved in a historic high number of new North American truck platforms launching over the next 12 months. For CVG this launches include interior trim, seats, wiper systems and cabin structures. Our agreements with our OEM customers preclude us from commenting on specific win and it can take several quarters for these sales to show up in the revenue and earnings but the programs are in place, we are well-positioned as a partner with our customers and look forward to the expected contribution these programs will make the future financial results. Next I would like to switch gears and talk about the global construction and Ag team. The GCA team is achieving excellent financial results which are reflected in the segment number that Tim will go over in detail next. I’m proud to say they are generating improved margins on lesser sales which validate the targeted efforts being made. The improvements also are evident and the operational performance reflected in the key performance indicators that we and our customers measure. Our leverage Czech Republic facility was recently recognized by Caterpillar with an award of platinum status in their supplier quality program. And you are the Agua Prieta, Mexico plant was awarded bronze status by Caterpillar. Congratulations to those two locations. Lastly GCA has concentrated on developing new product lines and expanding our available market. We are unveiling our new generation off-road seat product lines targeted for the construction and agriculture segment this month. We will demonstrate our construction lineup at the Bauma show in China and the agricultural products will be shown at the [indiscernible] in Italy. Lithium and heavy duty construction equipment is the traditional space where we've competed. However our new products will open up the agriculture seat market and a light-duty construction segment. Both represent areas that we have limited participation in today. In addition to seating GCA's wire harness business continues to grow and we are aiming new programs with approximately 27 million in annual sales one so far this year. We are continuing to find more opportunities beyond construction and wire harnesses including agriculture, truck powertrain, material handling and power generation. We intend to continue to grow this business focusing our expansion on the segments that need customer service focused wire harness support. We are on schedule to launch our newest facility in Mexico in the first half of 2017. With cost effective processes in place we can handle greater mix of product and higher volume. Regarding the emerging markets, India has been a growth area for us and we're beginning to see interest in suspension driver seats that have increased content. Our locally design and produced product offering is allowing us to support the domestic truck, bus and construction OEMs. We intend to continue to invest selectively in the emerging markets where we participate. Although we have a large addressable market and therefore much opportunity to realize long-term organic growth, we think there are potentially very select acquisitions that could add value for us by improving our strategic positioning. Some of the important criteria being considered include being able to expand our product portfolio in complementary ways, deepening our penetration of certain geographies to create diversification, and long-term opportunities for profitable growth within our targeted segments. Unfortunately today valuations have been challenging and we are reluctant to pursue deals that would not be advantageous for the short and long-term. To sum it up, we're pleased with the progress we've made to-date. Our 2016 initiatives are at varying stages of completion. Overall we are on track with our plan and look to generate the full breadth of anticipated savings by the end of 2017. We've made great progress and we remain excited about the future. Our ongoing objective is to continuously improve our competitive position and to outperform with our distinct advantages. We know we can do it and we look forward to providing you with updates on the progress being made across our global enterprise. Tim will now cover the quarter's financial results. Tim?

Good morning. Sales were down considerably period-over-period but the operating income margin is holding up because of the proactive cost reduction and restructuring actions taken to date and the balance sheet continues to improve. Debt less cash was just under $100 million at September 30. As regards CVG's financial results for the quarter, consolidated third quarter 2016 revenues were $153.6 million compared to $202.7 million in the prior year. That's a decrease of 24% primarily as a consequence of the 35% decline in heavy-duty truck production period-over-period in North America. The strength of the U.S. dollar is still a burden on the top line but not so much as in the recent past. Foreign currency translation negatively impacted third quarter revenues by $2.3 million. The benefits of the various cost reduction actions and the ongoing facility restructuring to North America are reflected in the financial results. Gross profit margin is relatively unchanged period-over-period notwithstanding the decline in sales. Selling, general and administrative expense in the third quarter was $14.1 million compared to $17.6 million in the prior year period, 19% less than a year ago. A handful of items came together this quarter to provide a bit of a tailwind in SG&A but in the event core SG&A spend is down significantly year-over-year. Before giving effect to the special items arising from the facility of restructuring, adjusted operating income in the third quarter was $6 million compared to $10.3 million in the prior year period, about $4 million less on almost $15 million less sales and that’s a good conversion on net change in sales. Adjusted operating income margin was therefore 3.9% compared to 5% in the prior year. As adjusted for the special items net income was $2 million in the third quarter or $0.07 per diluted share compared to $2.8 million or $0.10 per diluted share in the prior year. Net income in the third quarter includes $1.5 million of tax benefit primarily as a consequence of the geographic profile of the pretax income. More specifically a shift of pretax income away from the U.S. We expect this profile to continue for the remainder of the year and the company therefore you experienced little or no tax provision in 2016. Depreciation expense for the third quarter 2016 was $3.8 million, amortization $0.3 million and capital expenditures were $2.5 million. We now expect capital spending on the order of $11 million to $13 million for the year, lower than we had anticipated largely as a consequence of a handful of programs launching a bit later than planned. Turning now to our segment financial results. Global truck and bus revenues in the third quarter of 2016 were $96 million compared to $142.9 million in the prior year period. A decrease of 33% nearing the decline in North American heavy-duty truck production year-over-year. Operating income for the third quarter was $5.1 million compared to operating income of $16.4 million for the prior year period, a decline consistent with the conversion on sales that we generally expect. Operating income in the third quarter of 2016 and 2015 was impacted by charges associated with the facility restructuring of $1.3 million and $0.3 million respectively. As for the global construction and agriculture segment, revenues in the third quarter of 2016 were $59.4 million compared to $62.5 million in the prior year, a decrease of 5%. Foreign currency translation adversely impacted third quarter revenues by $2.4 million or by 3.8%. Operating income was $3.9 million in the third quarter of 2016 compared to $0.8 million for the prior-year period. This $3 million increase in operating income on lower sales reflects significant operational improvements achieved by China Ag team via Lean Six Sigma efforts. Some early benefits from the consolidation of wire harness production in North America into their Agua Prieta, facility and other cost reduction actions. Third quarter 2016 results include $0.2 million of charges associated with the restructuring actions. As for the company's balance sheet, cash continues to build in part due to our focus on managing down working capital employed in the business consistent with the contraction of the top line. Cash flow from operations for the nine months ended September 30, 2016 was $50 million and cash on the balance sheet at quarter end was $137 million up $45 million from year-end 2015. About half of this $45 million in cash build is from the reduction and operating working capital, receivables and inventory net of payables employed in the business. As I mentioned earlier, debt less cash is now just under $100 million. This puts the company's leverage debt less cash at just over two times trailing 12 month adjusted EBITDA of $48 million. The company has $175 million of liquidity, $137 million of cash and $38 million of availability from the ABL facility. Consistent with our capital allocation strategy, we continue to consider M&A opportunities and/or bringing in the senior secured notes. The redemption premium on the notes steps down to zero next April. To wrap up, CVG Associates have made a number of adjustments to the company's cost structure to-date. The North America facility restructuring is still underway and is expected to further improve the company's cost structure. This when taken together with the improved balance sheet bodes well for value creation at CVG when sales improve. That concludes our prepared remarks. Thank you for joining us this morning and we'd be happy to take any questions you may have. Kerry?

[Operator Instructions] The first question we have comes from Mike Shlisky of Seaport Global. Mr. Shlisky your line is open.

Good morning, guys. Can you hear me okay?

Hi, Mike.

All right, great, couple of questions here. Let me start off just I know you didn't put out 2017 outlook per se, so you've been hearing and we've been hearing what some of your major OEMs have been talking about both in on-highway and off. It seems like most people are thinking it’s going to be a down year in 2017 in most areas of the world but perhaps nowhere near as down as we've been seeing here in 2016? And so I guess I was kind of wondering if you agree with that, maybe a Class 8 outlook was down probably by mid single digits and maybe an off highway flat to down slightly as well. So guys do you agree with that, one. And secondly kind of based on what the various major OEMs have been saying, and your own mix do you feel like without community individual customers away, but you feel like in your mix, you might actually do a bit better or little bit worse than what sort of a broad index would be telling us right now?

So I just want to clarify Mike with the second part of the question still about the North American truck market or was that in reference to construction?

Actually, I think both questions are kind of for everything, both trucks - both on highway and off.

Okay. Well, I would tell you we've not come out with our position on 2017 truck build, reserving judgment till we kind of see how the orders are going here in the fourth quarter, which as you know is tends to be the high order season. They just released. I just saw the orders numbers for October yesterday and I think the net orders were 13,800 something in that range. But there was some - the actual orders as I understand it were around 21,000 and there was some clean up by one of the OEM's at least as it was reported to me. So 21,000 is actually a pretty good month compared to where we have been. And if we see a few more of those, I think it could change what 2017 looks like compared to what some of the people have said based on the last few months of order. So I don't think we’re ready to commit to what 2017 looks like. What we're currently planning for as we're looking at where the build rates are in Q3 and Q4, which is slightly down from Q1 and Q2 of 2016 and we’re looking at those rates as probably carrying into at least mid 2017. So that’s how we’re planning right now. We’ll probably come out with some numbers in the near future on where we think 2017 total build will be. As far as our mix goes, specifically I think the mix has more to do with the construction side of the business and it does the truck side. We continue to see pretty decent numbers outside of the rest of the world in the form of at least being flying flat for us for next year 2017. And some of the construction customers that we’re talking to are saying the same thing for their business in aggregate. So don’t expect any big negative surprises in 2017, as well as some of the new business that would bring on ramps up according to the customers plans, it should be an okay year for us on the construction side.

Is it fair to say something - your comments at the start of all here, you have a lot of new things that you’re ramping new product and new program in 2017. Is it kind of fair to say that there will be pretty decent amount that will be material that will start to impact your topline in 2017 and just brand new business that you didn’t have in the past? Could it be a driver of a few percent or more growth in 2017?

Yes, I think a lot of the new launch that I referred to, are predominantly replacement business for current product lines and as one ramps, the other will ramp down. So I don’t know there will be a big hit to the topline at least in reference to those new launches. Now there are topline improvements in regard to some of the wire harness launches that I mentioned. We are going to see some content increases. So they should be some slight pickup and I think on the bottom line, we’ll also see some beneficial results.

Okay. Tim, you also mentioned SG&A were down significantly, but there was a divergence of positive variances in this quarter. Can you give us some color as to what those variances were and kind of give us a sense as to what do you think the more normalized SG&A run rate is going forward?

Yes, Mike, it’s Tim. It was - listen as you can appreciate while we do our best at the end of every month to make sure our balance sheet is in order. We especially do that at the end of every quarter and it just so happened this month and they were small amounts and if you just gather them all up various accruals and prepaid accounts and reserves et cetera. And you put all of those small adjustments together, it provided the little bit of benefit which allowed our SG&A to be a little bit lower than what otherwise have been. I would put all our run rate sort of core SG&A absent those small items I just mentioned at about $15 million is where we are sitting at today, which is call it $2 million, $2.5 million less than I guess it was a year or so ago.

Sure. That's great stuff. It sounds like you also got your restructuring and cost reduction benefit the will - that have still yet to lack and so you've got some more benefits in your plan that are brand new to your books at least for the first part of 2017, is that a fair statement?

I think that's fair. The numbers through September reflect a little bit of benefit from - certainly year-over-year we close the Oregon facility last year, but the lion share I think I can use that word realistically. The lion share, it's a benefit from the remaining restructuring yet to really be realized in the financial results.

Okay. That's good to hear as well. I just want to touch on two more things. One from a balance sheet perspective, you did mentioned that premium to retire debt was on zero in April is the basic thought look, keep on thinking about China trying to find some M&A deal at a decent price until April. I think comes up that's only if I just hit down the debt at that point. I guess is the key - I think is the key you're just trying to wait until day one, it's really buyback on the debt or are you holding up to find the appropriate deal for your excess cash?

We're going to continue to manage the balance sheet in a fashion which we have in the past, which obviously includes paying attention to our operating working capital. And so we'd hope to maintain the cash position that we have today. And more specific to your question as you mentioned the redemption premium steps down in April, if you do the arithmetic on that, call it a three months cash payback on any sort of a triggering of that of any redemption prior to April. So I think that you characterized it fairly. I mean given that there is a three months cash payback, as we sit here today, we think that there is some - certain benefit. If you only say this way there might be an opportunity cost to triggering redemption if we're to do one sooner rather than later vis-à-vis the possibility of doing some M&A transactions.

Are you just talking about the you say a few months cash payback is that at today or do you mean to do on April 1 or April 15, the payback is on the fee that you might have to incur just the bankers fees and so forth?

The payback on the redemption fee.

Okay, got it. So last one from me. I mean there is a new public company - this week that does auto seating pretty big one out there. I presume they're going to be in organic growth mode going forward now that three of their larger operations that they were part of. I'm sure you know little about them. I don't know if they do too much in trucks but I'm wondering if you just kind of go for all of us here. What you feel the barriers to entry are in the current global truck seating market? And how you would feel about the seat company but perhaps if there were another company that want to come here initially although it's way in with other truck platform trying to enter the U.S. as well?

Let me just play back your question, you are saying, what are the barriers to entry to come into the truck seat market in North America?

Exactly.

So first of all most of the contracts for the foreseeable future are awarded and locked up. So in a large-scale way it would be difficult for anybody new to drive any significant revenues or share change. In a short term you can possibly get to fleet. In North America we have pull through capability but I would tell you that anybody trying to do pull through with the fleets has to have some partnership or handshake with the OEMs, as well as fleet codes and there are some complexity just to make pull through happen and if you didn’t have any experiencing doing that it would at least be some period of time before you would be able to overcome those hurdles. So if you are not already in here in some significant way I think it’s a pretty tough stretch at least for the foreseeable future.

Just a follow-up to that. Is there any advantage for auto seat maker to attempt to go into truck seats or are the volumes just too low. I presume it’s their margin business I am not really sure but do you get the sense that it’s not even worth them trying at this point?

If you are referring to a light vehicle...

I am sorry Pat, I meant is it not worth them to try to buy their way in as opposed to organically roll their way in. Sorry, go ahead.

Well I don’t believe buying your way into anywhere does much good in long term. That tends to destroy value in the marketplace but typically what we find is if a company is predominantly a light vehicle supplier, seat suppler, they have very different processes, very different approach to manufacturing. Their systems are set up differently. They tend to be higher volume, more automated, less complexity. It's really a very different proposition. We build the order, we have tens of thousands of SKUs that the customer orders at any given time and we deliver those in sequence and consequently we have to be set up in a flexible manufacturing mode that's quite a bit different than what some of the light vehicle players have to do in order to complete in that segment. And as a result of that we rarely see much cross over around the globe. There are a few very minor exceptions to that rule but for the most part we don’t really compete that much with the light vehicle seat guys.

Okay. Well said Pat. I appreciate it and thanks again guys.

[Operator Instructions] I am not showing any further questions at this time. I would now like to turn the call over to Mr. Pat Miller, CEO for any closing remarks.

Okay. Well I'd just like to reiterate once again that our CVG team is managing our way effectively through this cycle and we will be positioned well going forward. I want to thank you for your time today and have a good afternoon. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.