Adient plc
Q2 2018 Earnings Call Transcript

Published: 3 May 2018

[Operator:]

Welcome, and thank you all for standing by. [Operator Instructions] Today's call is being recorded. If you have any objections, you may disconnect at this point. I'll now hand the call over to Mr. Mark Oswald. You may begin.

[Mark Oswald:]

Thank you, Lee. Good morning and thank you for joining us as we review Adient’s second quarter fiscal year 2018 financial results. The press release and presentation slides for our call today have been posted to the Investors section of our website at adient.com. This morning, I’m joined by Bruce McDonald, our Chairman and Chief Executive Officer; Jeff Stafeil, our Executive Vice President and Chief Financial Officer; and Byron Foster, Adient’s Executive Vice President, Seat Structures and Mechanisms. On today’s call, Bruce will provide a business update, including a review of our Seats Structures and Mechanisms business, followed by Jeff, who will review the financial results in greater detail. At the conclusion of the prepared remarks, we will open the call to your questions. Before I turn the call over to Bruce and Jeff, there are few items that I’d like to cover. First, today’s conference call will include forward-looking statements. These statements are based on the environment as we see it today, and therefore, involve risks and uncertainties. I would caution you that our actual results could differ materially from these forward-looking statements made on the call. Please refer to Slide 2 of the presentation for a complete Safe Harbor statement. In addition to the financial results presented on a GAAP basis, we will be discussing non-GAAP information that we believe is useful in evaluating the company’s operating performance. Reconciliations for these non-GAAP measures to the closest GAAP equivalent can be found in the appendix of our full earnings release. This concludes my comments. I will now turn the call over to Bruce McDonald. Bruce?

[Bruce McDonald:]

All right. Thank you, Mark, and good morning, everybody. Thanks for taking the time to sit in and go through our second quarter earnings results. There are a lot of information here to cover today, so I’m going to jump right into it. First off, you will likely notice within our release and our slide deck that the reorganization of the Adient's management structure that occurred in the second quarter resulted enough, despite to make a realignment to our reportable segment. So we'll now be showing three segments

[Jeffrey Stafeil:]

Great. Thanks, Bruce. Good morning, everyone. Turning to our financial performance. As Bruce stated in his remarks, Adient’s second quarter results are unacceptable but generally consistent to what we outlined in January. Although we saw positive sequential improvements in the SS&M business in the most recent quarter versus Q1, the company faced increasing pressures in other areas of the business. More on that in a minute. As you can see on Slide 11, the headwinds with SS&M combines with weakness in Interiors in a significant – had a significant impact on our results. In addition, a onetime non-cash goodwill impairment charge resulting from our segment realignment, specifically Adient SS&M segment, also impacted our GAAP results for the quarter. Adhering to our typical, the page is formatted with our reported results in the left and our adjusted results in the right side. We will focus our commentary on the adjusted results. These adjusted numbers exclude various items that we view as either onetime in nature or otherwise view as important trend in the underlying performance. For the quarter, the net $279 million non-cash goodwill impairment charge was the largest special item. Other adjustments related to coming Adient restructuring-related charges and purchase accounting amortization. Just one additional point before I move on. I’d like to point out that with regard to realignments of our reportable segment, the company has begun to assess the performance of a reportable segment using adjusted EBITDA. As stated on prior calls, given the amounts of growth investments and capital expenditures planned in the coming years, we view adjusted EBITDA and CapEx by segment as more meaningful measures versus adjusted EBIT. You'll find disclosures of CapEx by segment and thus be able to see key figures for each segment of greater transparency than in the past. Moving on, adjusted EBITDA of $363 million fell $58 million year-over-year, more than explained by the operating performance within the SS&M and Interior segments. Meanwhile, adjusted equity income for the quarter was down $1 million compared with the same period last year. As I just mentioned, weakness in YFAI was primary driver, with a partial offset in our non-consolidated Seating business. Finally, adjusted net income and EPS were down 25% year-over-year at $173 million and $1.85, respectively. While sales are tracking better versus planned, we continued to phase operational and execution challenges primarily in our Seat Structures & Mechanisms business. Now let's break down our second quarter results in more detail, starting with revenue on slide 12. We reported consolidated sales of $4.6 million, an increase of $395 million compared to the same period a year ago. Benefits of the Futuris acquisition and China JV consolidation more than offset the negative impact of lower volumes, primarily in the North America. In addition, foreign exchange had a positive impact on our sales this quarter compared to the same period last year by approximately $285 million. The primary driver was the euro, as the euro's USD rate averaged $1.25 in Q2 versus $1.07 last year. Moving on. With regards to Adient's unconsolidated revenue, growth remained strong. Unconsolidated Seating revenue, driven primarily through our strategic JV network in China, grew about 12% year-on-year. Adjusting for FX and the China JV that is now consolidated, sales were up about 8%. A very good outcome especially when you consider production in China during the quarter was down 3%. Unconsolidated Interiors recognized through our 30% ownership stake in Yanfeng Automotive Interiors, or YFAI, also experienced year-on-year sales growth. Adjusted for FX, interior sales were up approximately 3% in Q2 versus the year ago. Although up year-on-year, I'll point out that the increase in sales was driven by high mix with low-margin cockpit sales, excluding the FX in the low-margin cockpit sales, overall sales were down 2%. Moving to Slide 13, we provide a bridge of adjusted EBITDA to show the performance of our segments between periods. The bucket labeled Corporate are segment cost that are not allocated back to the operations. These core costs include our executive office, communications, corporate finance, legal and marketing. A big picture, adjusted EBITDA fell to $363 million in the current quarter versus last year. The corresponding margins related to the $363 million of adjusted EBITDA was 7.9%, down approximately 210 basis points versus Q2 last year. Weaknesses in our SS&M and Interiors businesses could not be fully offset by benefits associated with the Futuris acquisition and the JV consolidations of around $29 million and additional improvements in SG&A, call it $43 million. Similar to comments I made in the first quarter call, I’ll point that a portion of the SG&A improvements made in the current quarter should we viewed as temporary, as certain of the near-term actions we’re taking, such as extremely tight control over discretionary spending or taking down our bonus accruals, will not be part of the run rate of the business going forward. Assuming we would be at plan or target performance, anticipate that our SG&A expense would have been approximately $20 million higher for the quarter. With regard to Interiors and consistent with our internal forecast and comments made on our Q1 earnings call in January, the headwinds impacting YFAI intensified in Q2. The year-over-year decline was driven by a combination of factors, such as lower volume in North America, a higher concentration of low-margin cockpit sales and operational issues that are being worked through in Europe and the US. We will continue to work with our partners to identify areas to improve profitability. Our latest forecast assumes Q2 as the low point in profitability this year with second half results improving versus the first half. Before moving to our segment discussion, let me note that we incurred approximately $7 million of cost in the quarter related to a third-party assessment of our SS&M business, but we excluded this charge in calculating our adjusted results. We expect the effort to finish in Q3 with the bulk of the expense was booked in this past quarter. The initiative was intended to provide a look at the strategic importance of the business and the necessary and strategic shift we need to make for the long term to make it economic profit. This work assisting in arriving the strategy we discussed earlier. As the cost to complete the study were one time in mature and related to the eventual restructuring of this business, we opted to exclude it from our reoccurring numbers. Moving forward, and in an effort to provide greater transparency into our Seating and SS&M segments, slides 14 and 15 show the key drivers between periods. Starting with Seating on Slide 14. Adjusted EBITDA increased to $411 million, up $13 million compared to the same period a year ago. The primary drivers between the periods include

[Mark Oswald:]

Lee, can we have the first question, please?

[Operator:]

[Operator Instructions] And our first question is from John Murphy of Bank of America Merrill Lynch, your line is open.

[John Murphy:]

Good morning, guys. Just a question as we think about what’s going on with the Structures & Mechanism business here. I mean, do you think there is something else going on just as far as sort of the accounting or reporting structure in a company that where this kind of crept up on you quickly and you don’t necessarily have the greatest handle on it to-date you’re bringing outside folks and the separation from JCI may have filed up systems? Or is there something like that going on in the background that’s also being worked on?

[Jeffrey Stafeil:]

Certainly not on our actual results, John. I would characterize graph some of the visibility that we have is certainly limited and it is really around the new launches though. So I wouldn’t necessarily put it to our accounting systems and more sort of our ability to forecast through those launches was -- certainly characteristic is the problem.

[John Murphy:]

Okay. And then the second question. When you think about the business in China, it sounds like that’s working very well. I mean, I’m sorry, Structure and Mechanisms. So what’s going on there that it’s working so well, that’s not working in the rest of the businesses? Is it really just launches? Or is there some other thing that is greenfield-ing this and ramping it up that is you kind of learned from mistakes in the other side?

[Bruce McDonald:]

Yeah. This is Bruce here, John. A few things. First of all, our China business, we started from a clean sheet of paper. So we don’t have old-generation product and new-generation products. So that’s number one. Secondly, it has the to-be manufacturing process that we want to have in place. A big one, though, is business that has much better job managing launches and it has a much smaller or less complicated supply chain, I would say. So if you can think about our Shanghai-based metals operations, it’s -- we’re building right now a second facility. It’s going to be 200 million -- 2 million square feet facility metal and sort of structures and mechanisms. And so they’re sort of collocated on one site, which is we tend to ship mechanisms from Europe and all over the world tracked Mexico up to North America. So they were much simpler supply chain. And then the last thing I would point to is if you looked at the mechanisms, the percentage of high-margin mechanisms -- as I said on my call, we want to emphasize the mechanisms more, the margins are higher in that business. And if you will look at the share of mechanisms that we have in China versus this year of mechanisms that we have outside of China, it would be much higher skewed to that higher margin product.

[John Murphy:]

Okay. And then just lastly. I mean, if you think about coating activity, I mean, there was an assumption that the backlog would build and growth will grow very significantly as you we got to ’19 -- calendar year ’19 or fiscal year ’19 plus. Is that still the case? And it has any of the -- any of these take-ups really impacted sort of your competitive position in end of the first coating activity?

[Bruce McDonald:]

Yeah, I would say, when we’ve looked at our original investments pieces, I think our Seat Structures & Mechanisms business -- and again I'm talking excluding China here -- was about $1.8 billion, and we thought that we were going to grow that from the spin-off to 2020 to be able to $3.5 billion, say about 25% growth. Right now we would say we're probably going, it's going to be more like flat versus where it’s starting at 2.8 or 2.9, something like that. So we've as a result of this review that we've done some prior to the end of the first quarter, we've cut back on some of the new business coating activity that we had. And I would say focused in more on customers supporting our -- business and closing on customers where the pure economics profile is better. And I guess what I would say is, if you look at the pure economics, here in North America the risk sharing tends to be better than in Europe, and I'm just talking in aggregate here because there is outliars on both size. But I would just say the environment recovering yield economics in North America is better and quicker. And so we -- as a result of kind of look at where we're going forward here, we will be focus more on saying on North America book of business in last month on outside of North America.

[John Murphy:]

And Bruce, just a follow-up on that, though. I mean outside of the SS&M business, in Seating and Interiors, has there been any change in sort of your view on what your coating on and what you've been awarded or how you would be awarded. Is that totally separate and not sort of conjoined with the problems in SS&M.

[Bruce McDonald:]

Yeah, I would say SS&M problems are have not affected our coating activity or our customer issues. I mean we've had challenges in SS&M and I would tell you that we as an expense of our balance sheet our income statement I'd say we've protected our customers by enlarge.

[Operator:]

Thank you. And the next question is from Emmanuel Rosner of Guggenheim. Your line is open.

[Emmanuel Rosner:]

Hi, good morning. So wanted to ask you about some of those strategic actions that’s you're potentially conflicting beyond sort of just stabilizing the mills business. What's sort of like timeline and can we envisage for that? Can you just be lower coating activity? Or can you actually proactively look to exit some of the contracts?

[Bruce McDonald:]

It's difficult for us to -- first of all, I guess it's just [Indiscernible] that our business times for any centers. This is the timeframe for the programs is longer. I mean, we're as large someone as we look to the seating program with the customer. Option metals part of it last two cycles maybe more. So the timeframes are long here. Secondly, as this is obviously safety critical component. It's highly engineered and specific to the customer. And so the ability to sort of, cut from the resource that is very difficult, so it’s not like we can go and get back a whole bunch of business is there ability that we’ve been awarded that we have an opportunity for you, guys, but it bounced some but not like, it’s not a big thing that we can do is a short period that we were moving -. And if you look at our manufacturing footprint that we have, it’s pretty good. So we aren’t sitting here with the problem – well, our problem is we got a bunch of high-cost plant and let’s spend several 100 million dollars closing down Western European footprint and moving it to lower-cost Eastern Europe or closing in North America here and moving it down to Mexico or stuff like that. That opportunity – again, I wouldn’t say there is none of it but it’s not a big opportunity for us. I think our restructuring manual will be if where we’re not coating replacement business and we have to take out some sales of these plant. Again, I would remind people aren’t content customer focused really unlike our jet business roughly were to exit something we can close the whole plant. Here you’re talking downsizing a portion of a plant. We see the restructuring things like we’re looking at to be in that category, and also – and I talked about exiting out some lower, some of our vertical integration like small tonnage and things like that. So the restructuring is not going to be - this many dot.com in the app and when we see a whole bunch of closures. Maybe there is we can sell some component plant that supply to our other components plant, but that’s the kind of thing that we’re talking – restructuring. I mean I saw there is a one analyst report out there that has you know several hundreds million, I think $700 million-type number. We don’t see anything. There is no opportunity of anything like that.

[Emmanuel Rosner:]

Okay, that’s helpful. And then my follow-up would be -- so when you sort of first signal the issues in this business, you have said you served like picked the quarter just to figure the things out and then the 2020 outlook. I think one of the considerations with into look into beyond dress – what do in here was are there any other buckets of savings that can serve like help you get closer to the 2020 target. After sort of looking at it for like the last few months or so, hat I guess where were your findings because are there any additional savings beyond what was sort of initially signaled in other areas of the business that’s possible?

[Jeffrey Stafeil:]

Yeah, I mean if you think about our regional target, it was kind of 200 basis points, excluding equity income right? And so I would say the equity income there is probably more opportunities but that’s sort of counts in the margin expansion goals. And as we look to not just a Seat Structures and Mechanisms as a give you an example, you know when we started off spin off you now our equity income in the seat structure of mechanisms was 10 or 15 million, it’s up to like 40ish million this year and if you sort of fast forward to let’s say 2022 with ’90 year or million. “ Or something like that. So our China business in metals doing very well, but again that doesn't really help us in that in the goal that we’ve set [Indiscernible] before. There are some pockets of pluses and minuses elsewhere. I think we're probably peak at where we need to be for investment point of view. So that's sort of minus amount I think will kind a get better as we get into '19 or '20. But we thought it is important right now as what we had $300 million net back in approximately metal. It's going to be smaller than it has going forward, which means it's going to generate more cash. So think about the margin expansion we also don't have capital intensity in the business to be a higher. And at the end of the day, can we improve our metals process by running the business better, been more selecting coating. Absolutely there is a huge improvement we can generate here over the next couple of years we're not saying by 2020 we're done, because we have seen more opportunity beyond 2020 just for a trying to reference back to what we said by 2020 for what we said we see now I think it's a big improvement but we can't get there.

[Emmanuel Rosner:]

I appreciate the color.

[Unidentified Company Representative:]

Okay thanks. Thanks.

[Operator:]

Thank you. And the next question is from David of Wells Fargo. Your line is open.

[Unidentified Analyst:]

Hi, good morning, everyone. Just quickly. Can you go into a little bit more of these detail on the operational issues that you're I think facing in on the interior side. And then on the SS&M side of the business, the $300 million improvement through 2020. What are the major buckets of improvement that you guys forecast? Thank you.

[Bruce McDonald:]

Maybe I'll take the interiors and then I'll let Byron talk about the SS&M business. The Interior's business, we mentioned this is another part. We owned 30% of the interiors operation as you with the --. And that business is global. I think sometimes here is referenced a lot of the China business, but it's really important to remember that a lot of the sales would half or about half of them occurred outside of China. There is a number of new facilities, new programs and some other things that have been launching at that business. So it's been growing. And I think a lot of where there are issues that's baked this in similar to some of the issues we face is getting labor in places like Eastern Europe, big labor shortages in Eastern Europe. And that I think have for -- whole groups from Magnolia to come in and plans in the Czech Republic that is just absent to available to do the working facility. So that's been a little bit there, there is been some startup of new plants in North America. So I think good programs, I think generally good results or good momentum in that YFAI business, but definitely going threw to a little bit of growing pain as they're expanding.

[Unidentified Analyst:]

But just to follow up on that. So the cost issues there are more isolated and can be more readily overcome or not. I mean quickly hear started to be like SS&M right. No, I mean this business, and we just think that probably for this business, or for the YFAI business this last quarter should have been sort of their low-market should be getting better. As you look at SS&M, one thing just remember is how capital intensive. We broke out CapEx. We're setting half our capital there. It's hugely safety critical, making changes to processes, design, et cetera require all kinds of testing, validation, approval and even changing materials require significant amount of time. The interior is much more a cosmetic set up and the approval was in making changes is a lot easier. And then we‘ll again talk to you guys for the 300 million.

[Bruce McDonald:]

Yeah, in terms of one of the big components there, I would start with launch stability. So we’ve I think shared with the group here that we struggled to a number of critical launches. We now have most of those issues behind, we have good line of sight of the upcoming launches and the what we would gain kind of high risk and those are the ones that are focused on have the right resources to make sure that those launch is still of as planned. And then one of the drivers when we get into difficult launches I’ll just give you one statistic around premium freight. So we’ve spent over 41 gallons of premium freight in the first half of the year. So as those launches come in more stable that’s more a line item that we’ll see improvements there. Steel supply has been a big challenge for us. The first half of the year particularly some of the specialty that are required for our mechanisms. We had a real gap and our supply versus our demand, so that drove a lot of inefficiencies as well as premium freight. We now have the steel supply issue fixed, so we‘ll have better and more consistent flow of raw material and to our mechanism plant, that’s going to drive in plant improvements and better machine utilization, longer runs and ultimately again what - the premium freight topic. Engineering cost is another area where we’ll see improvements in lower cost again as a lot of these launches get behind us, and as we have a more targeted approach in terms of new business acquisition, those cost will come down as well. So that was, we’re beginning to see those and we’re seeing that in the results Q2 versus Q1. And as we looked forward into the second half of the year, we expect those improvements to continue.

[Unidentified Analyst:]

Thank you.

[Mark Oswald:]

Operator, we‘ll take one more question, and then if we can turn it back to Bruce for his closing remarks, that would be great.

[Operator:]

And the next and the last question is from David Tamberrino of Goldman Sachs. Your line is open.

[David Tamberrino:]

Great. Good morning. And, Bruce, thanks for reading the research. Slide 5 seems to imply a flat consolidated EBITDA margin in 2020 versus the LTM mid-year, mid-2016 level. Just trying to understand is that what the guide is now for 2020? Or do you think you can come and feel better from this from an incremental SG&A savings? I know in the past you’ve kind of talked about potentially shifting around that bucket and just it wasn’t clear to us whether 2020 is now kind of just flat with where we started or slightly above that level? How should we think about it?

[Bruce McDonald:]

Good question, David. Actually what we’ve -- we went through a process -- we went through a big process to reevaluate all of our businesses and there is other pieces we knew we could lean on and I think we can get a bit more out of the some of the SG&A savings that we outlined and we’re pushing probably a little bit maybe lastly some of that growth investment as we move forward, especially while taking maybe some of the emphasis SS&M growth away. The challenge for us on meeting the 200 basis points of margin expansion without equity income was SS&M we thought being really flat. We didn’t see – we needed the SS&M business to sort of make up some of the slack. We think that business can be better and more efficient in a lot of things. So while we see some improvement opportunity from our 2016 starting point, we just don't think we can get all the way to 200 basis points and that's why we turn back and so this was as we reassess all parts of our business that we felt that this 200 basis points goal was not reasonable in the mid-term. Well, we don’t do better than where we started.

[David Tamberrino:]

And that's fair. But if I were to try to put some quantitative metrics to that qualifying language. We talking kind of in the 0 to 100 basis points or 50 to 100 basis points range? Or is that too high of potential opportunities?

[Bruce McDonald:]

I'd say there is -- and there is a lot of things that have to be worked out, David. But certainly probably more in the 50 to 100 basis points would be where we would see this without some sort of structural change to what we have today in particular on the Seat Structures & Mechanism.

[Jeffrey Stafeil:]

In this timeframe.

[Bruce McDonald:]

Yeah, in this timeframe. Beyond 2020, there is more opportunities, but that timeframe, that's probably all…

[Jeffrey Stafeil:]

And I think, David, it's kind, you can kind a say, “Hey, if I have another four years left with where do I kind a get back there versus what we do on the next two years?” And we're trying to, we also have tactics or walk away from your commitment, but we're trying to be transparent in terms of what we think we can do in this timeframe, what was not doing right now and I want to caution that as because, as I said in my remarks, we're still looking at some of these longer-term thinking about outsourcing utilization in China [Indiscernible] non-selective restructuring et cetera, et cetera. So not in a position to kind a say clearly the timeframe that we had, and as I'm sure you can appreciate, there is an awful lot of focus on the short term and sort of getting out of the clap that we're in right now. But in the timeframe that we have, we have, we are done in 3 months to say, “Okay, here is what you see yourselves into 2022.” Yeah, that's -- I mean the answer you like to hear, but that's kind of where it is.

[David Tamberrino:]

No, that's incredibly helpful. And look, I think most investors understand what the position is just looking for how you're thinking about it today versus just to be flatter now. So the 50 to 100 was extremely helpful. And just lastly from us. Do you see any risk to any potential market share losses as you complete some of the exits of the SS&M business? Is there risk of losing some of the marque products that you're on assets comes to that? I know we heard from some other seasoned suppliers that there could be an opportunity for them as a result of this -- as a result of your operational issues at this juncture.

[Bruce McDonald:]

Yeah. I guess I would tell you -- I mean obviously when we look at this business and what we want to do in terms of coating or exiting or things like that, I mean for sure we're going to look at how it reflects on our customer position in the aggregate. So we're not going to do stupid in the Seat Structures & Mechanisms business that's have huge and aggregate impact on our global business with our customer. So we did -- our customer, especially in the metals business our customers do tend to source global structures. And so we have not -- and that's another thing that for sure we have to take into consideration. So we're going to -- we're just got to be mindful and sort of do the right thing here. So maybe I don't we're kind over at times. So maybe just make a few closing comments here. I mean clearly we recognized that the first half results are disappointing. It’s not the way we look to start this year. On the other hand, being balance here, we are pretty encouraged with the improvement that we’ve made here quarter over quarter from Q1 in terms of Seat Structures & Mechanisms. I think we’ve outlined a number of tenants that were focused on to create value in the Seat Structures & Mechanisms, and I think these building blocks, if you sort of think back, it’s transforming our Seat Structures & Mechanisms not only recapturing the loss profit since the spin but little bit in the segment smaller behind 2020 with smaller less capital intensive and much more profitable in cash generation. Clearly, we have an absolutely end of the industry position in our businesses in China. We’re moving from strength-to-strength. I think if you just look at the quarter, our China production and have seen numbers down 2%. We had up 12% in terms of our revenue there which just sort of demonstrates the strength of the partnerships that we have there and the performance of our business there that we’re able to continue to build on a strong topline growth in a flattish production environment. We do have a backlog that we’ve build up and we expect to see topline growth, again, here in ’19 and beyond. And then lastly, we are -- once we start to trend the capital intensity of the Seat Structures & Mechanisms as we get some of the cost that’s becoming Adient as restructuring trends back to sort of the $100 million nominal-type level, we do expect to see significant step up in free cash flow generation beyond 2018. So we’re pretty obviously a lot of our time is spend on the challenges that we have today, but we’re pretty encouraged and excited that we’re getting through those with significant opportunities ahead. And we look forward to seeing many of you in the next week. I know we’ve felt like dinner and we’re reaching out to all of our big shareholders next week. So I appreciate the interest in Adient, and thank you very much for attending our call today.

[David Tamberrino:]

Thank you.

[Operator:]

Thank you, everyone. And that concludes today’s conference call. Thank you all for joining. You may disconnect at this time.