Commercial Vehicle Group, Inc. (CVGI) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Q2 2017 Commercial Vehicle Group, Inc. 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 conference is being recorded. I would like to introduce your host for today's conference, Terry Hammett, Vice President of Investor Relations. You may begin.

Thank you, Glenda, and welcome 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 second quarter 2017 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 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 with a brief company update.

Good morning, everybody, and welcome. Our results for the second quarter of 2017 reflect that consolidated revenues have increased about 10% for the quarter as compared to the same period last year and up about 13% quarter over quarter. We discussed in the first quarter the strengthening in OEM orders that we were seeing in our largest segments, North American heavy-duty truck and also global construction. Those orders have been translated into sales increases for our operations. We have made many cost and infrastructure improvements in the past 18 months and we expect that these changes should translate into higher margins than historical performance. However, our earnings have been burdened by our refinancing actions in the second quarter and also by the prolonged headwinds in our North American wire harness business, which I will discuss shortly. Net income for the second quarter of 2017 was $0.1 million as compared to $2.7 million in the prior year period. Historically for CVG we expect higher sales to result in a profit pull-through of about 20% to 25%. In the second quarter we experienced some challenges in converting the higher sales into operating profit at our normal historical rates. When the production spikes this quickly, it can cause some short-term inefficiencies and capacity constraints. We have stated previously that our company has traditionally been adept in managing the cycles up and down and I believe that has not changed. We are continuing to manage this up cycle in many parts of the company that are going, especially in truck. We have a challenge in our North American wire harness business that has been lingering. We continue to experience labor shortage issues in our Agua Prieta facility which has been exacerbated by the increases in OEM orders. We have an operating presence in Agua Prieta for more than 13 years and have not experienced issues of this magnitude in the past. Labor challenges appear to be a systemic social issue in the region and our focus is now on protecting our customers while we balance our capacity in other locations. We have taken several actions to stabilize the production challenges in Agua Prieta, including ramping up capacity in other locations. Specifically, a new facility in Mexico that we opened in April located south of our current location. We engaging our Monona, Iowa facility that was previously targeted for closure and localizing some regional production back to our facility in China. These challenges are impacting our profits while we protect the customers, mainly with premium freight and production efficiency losses. We are committed to the long-term which means that we must take all reasonable actions to minimize customer disruption and we are doing that. As our new capacity has been ramping up we are seeing improved consistency of performance and output, and we expect this to continue which will diminish financial impact. Our current forecast reflect an additional $3 million-$6 million impact in the second half of 2017 before we return to normal operational levels. Aside from these short-term obstacles we are continuing to see positive impacts from actions taken to improve productivity and cost performance in our operations. Our operational excellence program team continues their effort training lean experts to drive improvement globally throughout the organization. Over 600 belts granted in the past two years and we are targeting another 600 belts planned for 2017. Our restructuring plans announced in late 2015 are close to being completed and our current number show that will meet the savings target in the upper end of the range. That is $8 million-$12 million, while reducing plant restructuring costs by more than 50% or the original announcement. Earnings per share as adjusted for restructuring and debt refinancing were $0.08 in the second quarter 2017 as compared to $0.10 for the same period in 2016. We would have exceeded 2016 excluding the $4 million in expenses associated with our North American wire harness operation. Moving to our business segments. Our global truck and bus segment achieved strong second quarter revenues, up about 7% compared to second quarter 2016, and up 17% compared to first quarter of this year. This growth reflects the continued increase in North American class 8 truck OEM build levels, which are up slightly from second quarter 2016 and up 29% compared to first quarter of this year. Our GTB segment continues to work on restructuring initiatives and other cost control actions exceeding our second quarter expectation of incremental conversion of sales to operating income from 20% to 25% to 33%. Even as the truck production levels ramp up in 2017, the GTB team continues to deploy resources and focus attention on launching next-gen programs across our product portfolio for major large truck OEMs in North America. Our customer partnerships are critical to our success and we are focused on providing the support necessary as new platforms come online. We are seeing strong order activity for both the newly launching vehicles and also the legacy platforms. We have revised our estimate for the North America class 8 build to be in the 220,000 to 240,000 range based on market and internal forecast. Up modestly from our earlier guidance of 215,000 to 235,000. In 2016, the North American build rate was 228,000. Market forecasters ACT and FTR have been adjusting 2017 full-year build rate throughout the first half of the year and are now projecting the heavy-duty truck production in North America at levels around 245,000 and 241,000 units with production levels in the second half of 2017 exceeding those in the first half. The industry outlook for 2018 and beyond continues to be positive with forecasts indicating incremental growth year-over-year in North American class 8 production through 2020. Regarding the North American medium duty market, market forecasters continue to show improved production year-over-year from 2016 to 2017 and this market appears to be generally steady as longer-term fundamentals look healthy. Turning now to our global construction and agriculture segment. First of all I would like to mention that in early June we announced the appointment of Doug Bowen as Senior Vice President And Managing Director Of Global Construction, Ag and military markets. We look forward to what Doug brings to CVG with his invaluable experience in commercial negotiations and successful organic growth programs with both our large global OEM customer base as well as our target customers in the emerging markets. Doug has more than 35 years of relevant global OE and aftermarket experience, which transcends our core and expansion markets and furthers our ability to broaden our total addressable market as appropriate. Doug is immersing himself in our GCA global operations in his early days with CVG and is engaging in our commercial activities. We look forward to getting an update from him in one of our future earnings calls. In the global construction and agriculture group, strong sales in the second quarter, up 14% year-over-year, were overshadowed by the capacity challenges already discussed at our wire harness facility in Agua Prieta, Mexico. Burdened by the operational headwinds in Mexico estimated at $4 million in the second quarter, historical conversion on sales was not achieved resulting in roughly $2 million of operating income on $78 million of sales in the second quarter. Changes we are putting in place as discussed above are helping to alleviate the abnormal operating expenses that we project to be $3 million to $6 million impact in the second half of 2017. Our plans are expected to resolve these issues by year-end and we believe it has not impacted our ability to achieve our restructuring cost savings projections as previously stated. In our European wire harness business, we are winning growth projects and we currently expect organic growth gains to continue to come online for the next several years as we are in various stages of launch and development. The global construction market continues to show improving order patterns from our key customers in all regions including Europe, Asia and North America. We mentioned previously our efforts to drive digitalization into our processes and products which we call CVG Digital. Recently I had the opportunity to review our new digitally enhanced seat assembly process coming online in the European group this month. It is a step change in improving productivity, built-in quality and material control. Some of our key customers are engaged with us in our process development and are also anticipating the benefits. I am excited about a myriad of other investments we are making that take advantage of new technology driven approaches to automating our systems, improving our processes and products, and generally increasing our effectiveness within our business. In summary, our core markets are trending in a positive direction from a cycle perspective. We believe we are continuing to make material improvements in our operating costs and are looking forward to realizing the benefits of actions taken to improve our competitive position. The challenges we discussed above are masking some of the improvements we are making and we have action plans to resolve them. We look forward to Doug Bowen's leadership and the many successes ahead as we ramp our efforts to expand our growth in his segments of responsibility. Our product development activity is keenly aligned with those of our OEM customers and our core and expansion markets and should help deliver profitable growth. Our goal is to enhance value for all stakeholders and we believe these actions are helping to put us on a solid path to do so. We look forward to providing you with updates on the progress being made across global enterprise. Tim will now cover the quarter's financial results. Tim?

Good morning. Our two largest end markets continue to improve and sales are up but conversion of the improving sales and operating income or pull-through is well below CVG's historical experience. For the consolidated second quarter 2017, revenues were $195.1 million compared to $178.3 million in the prior year period, up approximately 10%. This improvement in sales is primarily attributable to our heavy-duty truck market in North America and the construction end markets we serve. Truck orders continue to be encouraging in the second quarter and are now being reflected in the bill. Our second-largest end market, construction equipment, is also improving. The strength of the U.S. dollar remains a burden on the top line but less so than in the recent past. Foreign currency translation negatively impacted second quarter revenues by $2.1 million or 1.2% as compared to the second quarter of 2016. Selling, general and administrative expense in the second quarter were $14.8 million compared to $15.6 million in the prior year period, 5% less than the prior year period. This 5% reduction in SG&A reflects the cost containment initiatives action over the past two years, not all of which were in place this time last year. Before giving effect to the special items arising from the facility restructuring, adjusted operating income in the second quarter was $8.4 million compared to $8.9 million in the prior year period. This roughly flat operating income period over period on a 10% sales improvement does not reflect the pull-through we have historically achieved due primarily to our wire harness business in North America. Adjusted operating income margin was 4.3% for the quarter compared to 5% in the prior year period. The company's net income in the second quarter reflects the cost, primarily transaction costs associated with the refinancing of the company's debt. We took out the 235 million in senior secured notes with a 175 million institutional term loan and cash on hand this past April. Annual interest expense with the new institutional term loan should be about $6 million less than we were incurring on the senior secured notes. In large part due to less leverage but also a lower interest rate on the term loan. As adjusted for the special items, net income was $2.4 million in the second quarter or $0.08 per diluted share compared to $3 million or $0.10 per diluted share in the prior year period. The company's effective tax rate is sensitive to the geographic profile of our pretax income, more specifically the mix of the pretax domestic and foreign income which has begun to shift away from the foreign tax environment to the more expensive domestic tax environment. We model a 30% to 40% effective tax rate for 2017. Depreciation expense for the second quarter 2017 was $3.6 million, amortization $0.3 million and capital expenditures were $3.2 million. Quarterly capital expenditures were consistent with our expectation. We anticipate CapEx for the year to come in at $15 million to $18 million. Turning now to our segment financial results. Global truck and bus revenues in the second quarter of 2017 one $119.9 million compared to $112.1 million in the prior year period, that's an increase of 6.9%. This increase is attributable to higher North American heavy-duty truck production. Operating income for the second quarter was $11.1 million compared to operating income $8.5 million for the prior year period. Pull-through on the improving sales exceeding that which we have historically achieved. Having said that, rising commodity prices and some production inefficiencies from the spike in North America and truck build are adversely affecting pull-through. Operating income in the second quarter of 2016 was impacted by facility restructuring and associated charges of $0.3 million. As for the global construction and agriculture segment, revenues in the second quarter of 2017 were $78.2 million compared to $68.5 million in the prior year, an increase of 14.1% due primarily to improving global construction equipment build. Foreign currency translation adversely impacted second quarter revenues by $2.4 million or by 3.6% as compared to the second quarter of 2016. Operating income was $1.9 million in the second quarter of 2017 compared to $5.5 million for the prior year period. More than all of this decrease in operating income is attributable to the North American wire harness business. As Pat described, labor challenges at our Agua Prieta facility have been more difficult to resolve then we had anticipated. The cost impact therefore is taking longer to manage down. The second quarter cost impact was $4 million and we expect an additional $3 million to $6 million and the remainder of the year. GCA operating income in the second quarters of 2017 and 2016 included $0.9 million and $0.2 million respectively, of charges associated with the ongoing restructuring actions. As of the end of the second quarter, the company had a $115 million of liquidity, $52 million of cash, and $63 million of availability from the ABL facility. To wrap up, our two largest end markets are improving, made a lot of progress in cost-containment and right sized the organization, as well as the facility restructuring. We still have some work to do in our North American wire harness business. Once we get that behind us, we expect pull-through on improving sales to return to historical levels. That concludes our prepared remarks. Thank you for joining us this morning. It's a pleasure to be with you today and we will be happy to take any questions you may have. Glenda?

[Operator Instructions] Our first question comes from Michael Shlisky from Seaport Global. Your line is now open.

So, I guess I wanted to start off with asking about the labor cost issue as you may have guessed. We are in mid-August now, almost half way through the quarter. Can you give us any update as to how things have trended most recently? Are you looking at maybe $4 million in the third quarter and a very [indiscernible] on the fourth quarter or could it be more spread out there, cost issues for the rest of the year.

Yes. So we have given the range. $3 million to $6 million. I don’t know that we are going to break that down by quarter. What I will tell you is that we are seeing some stabilization in the operation from a consistency standpoint. The labor issues there have not receded and we know that the best way for us to deal with the issue is to grow our capacity outside of that are, which we are in the midst of doing. We are having pretty good success on a performance basis. The ramp is starting to get traction and we have seen some minor reductions in some of those costs where we are at today. But I think it will be a trend down through the year as we have projected.

Are there any cost levers elsewhere in this segment that you could pull to perhaps offset the dollar impact at least for the rest of the year? Or is that not being considered at this point.

Yes. So it's a good question and we are certainly looking at that to try and offset some of the impact. And discretionary spending, those levers are being evaluated now as well as hiring where it's not critical to some of the growth activity that’s going on. So it's good comment. It's certainly something that we do as a regular discipline. We are having underperformance in area, we are trying to make up for it in other areas.

And as you see things today, do you think this issue is going to persist into 2018 or you are fairly confident that it will be all said and done by the end of this year.

Our current plans, and I am confident in those plans, show us getting out of this issue, transitioning out of the issue over the second half of this year 2017. You know I think, Mike, it would be helpful to understand the business, the wire harness business in general for us has historically and traditionally has been a very sound and profitable business. It has been a growth business of late with the strategies that we have discussed in previous calls and it continues to be a growth business for us. We are seeing growth in Europe, as I mentioned in the script. But also new customers even here in North America. So we have been hit with an extraordinary cost related to protecting the business. The business is worth protecting and we are doing that, we are working very closely with the customers that are being impacted, which are some of our core customers, and as a result of that I think that we will come out of this in better shape and the company will be better for it once we get through mitigating the labor capacity issue.

That’s great, Pat. Maybe I will just ask one more on this issue. Looking at your 2018 cost structure and the outlook for your margins next year and the operating pull-through situation. Is the right way for investors to kind of think about this is you will still get the 20% to 25% that you usually get after you sort of take out the $8 million you saw in the first half and 3.06 in the second half on the cost issues. So in other words, you think that operating pull through above the usual range just because you won't have these issue again and is it simply as simple as the $8 million in the first half and $3 million in the second half that lead to kind of disregard to put it for 2018.

Mike, it's Tim. Let me take that question if I may. As we sit here today and think about what you just ask, we do not have any reason to believe that there will be any material impact going forward on the company's operating leverage. That is the 20% to 25% pull through that we have historically achieved. There will be some step change impact in the restructuring savings that we had in intended to receive from the wireless, the North American wireless part of the restructuring efforts. That step change change we again do not expect it to be material at this point an as Pat said, we fully expect that the overall savings from the restructuring efforts that we initiated a year and half ago, that range you might remember is $8 million to $12 million annually. We still expect to be at the upper end of that range. So just to sort of summarize, I believe at this point a small change in step change expectations with respect to savings, but no significant change on the pull through.

I think I would add just a little bit to that as well. These are not normal operating expenses that we are incurring. Premium freight we have got. When you get into these kinds of situations where you create a backlog with the customers, we have to make extraordinary efforts in order to get out of them. And that includes production inefficiencies, more frequent changeovers in orders to deal with the shorter lead time to keep the customers in product. And those things will go away once we have resolved the issue.

I appreciate that color. Perhaps, maybe I should ask the question in a different way. To get that kind of pull through next year is very easy now given what happened in the first half of the year. At least for the first half of next year. So what I am asking is, do we need to assume 20% or more incremental margins on operating profit that would actually be $8 million higher. Maybe I am not asking this question the right way. I am trying to [indiscernible] you will have a much higher operating pull through next year than this due to easy comps. Maybe that’s the best way to put it.

No, I see what you are saying, Mike. No, the 20% to 25% pull through that we expect to continue to be able to achieve in the future. That’s does not include, if you will, any benefit from the savings that Pat just mentioned for managing down this freight. Said another way, once the excess freight and the inefficiencies are gone and that operating income comes back, it's been burned by that, then the 20% to 25% is on top of that.

Okay. Okay. I might have to follow up on that one offline. Last one from me, I want to get some more color on your construction market outlook. It sounds like you have some good orders in the quarter. Can you just confirm that, from what we heard from your last quarter, that the outlook for the rest of the year has improved there? And I don’t want to ask for guidance directly but some of the main customers in your portfolios, some of the multinationals are looking at a 15%, 20% growth in the back half of the year on a pretty good recovering market here. I don’t want to ask you if you would agree with that but can you give me a sense as to, in the first half you saw double digit growth, could that sort of range 10% plus, continuing on the back half of the year as far as the growth rate goes.

Yes. I don’t know if I have the exact numbers comparable to what you discussed there, Mike. But I would tell you that our orders, I mean part of the reason we have a backlog is our orders are much higher and we are not achieving all of that order output today and our orders tend to precede, obviously our customers shipments right. So we are seeing a strong pull from the customer base in the construction site and it's coming from multiple regions especially in North America, Europe and Asia where we are participating and we are seeing good demand and it's not softening fur it's a little hard for us to put it into an exact quarter basis as to where they are seeing it. Obviously we don’t really understand that part of it.

Thank you. [Operator Instructions] And I am not showing any further questions over the phone lines at this time. I would like to turn the call back over to Patrick Miller, Chief Executive Officer, for closing remarks.

Okay. Well, I want to thank everybody for joining. Obviously, we had some difficulties this quarter with some of the pull through but I would like to just reemphasize, we are seeing strong fundamentals in many parts of our business from a market perspective and also from an operating performance. And we will manage these as we go through the rest of this year and you will see the performance transition the way that we hope to see it. So thanks everybody for joining and I look forward to talking to you in the future.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great day.