Adient plc Q2 FY2020 Earnings Call

Welcome and thank you for standing by. And at this time, all participants are in a listen-only mode until the question and answer session of the call. Today's conference is being recorded. Any objections, you may disconnect at this time. I would now like to turn over the meeting to Mark Oswald. Thank you. You may begin. Thank you, Andorra. Good morning and thank you for joining us as we review Adient’s results for the second quarter of fiscal year 2020. The press release and presentation slides for our call today have been posted to the Investor section of our website. This morning, I am joined by Doug DelGrosso, Adient’s President and Chief Executive Officer; and Jeff Stafeil, our Executive Vice President and Chief Financial Officer. On today’s call, Doug will provide an update on the business, followed by Jeff, who will review our Q2 financial results in more detail. After our prepared remarks, we will open the call to your questions. Before I turn the call over to Doug and Jeff, there are a few items I’d like to cover. First, today’s conference call will include forward-looking statements. These statements are based on the environment we face today and therefore involve risks and uncertainties. I would caution you that our actual results could differ materially from these forward-looking statements. Please refer to Slide 2 of our presentation for our complete Safe Harbor statement. Additionally, we will be discussing non-GAAP information that we believe is useful in evaluating the Company’s operating performance. Reconciliations to 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 Doug.

Thanks, Mark, and good morning, and thanks to our investors, prospective investors, and analysts joining the call this morning. I hope you and your families are staying safe and healthy during these difficult times. Turning to Slide 4, let me begin with a few comments related to our recent developments. I’ll then focus the majority of my comments around COVID-19 specifically, what we are doing today, the steps we’ve taken and will continue to take to mitigate the impact of the pandemic on our operations, our ability to restart our operations, and finally Adient’s expectations for the industry as we move past this crisis. On top of Slide 4, you can see Adient’s financial headlines, which when you exclude the impact of COVID-19, were solid and built on the momentum established in late 2019 and Q1 2020. These results further demonstrate that the improvement phase of our turnaround plan is accelerating and is ahead of schedule. Sales at $3.5 billion were down $700 million versus last year Q2 and just over $500 million. The volume decrease was attributed to lost production associated with the pandemic. Adjusted EBITDA increased to $211 million, up $20 million year-on-year. Excluding the approximate $100 million impact from COVID-19, earnings were on pace to exceed last year’s second quarter by $120 million, similar to the outperformance achieved in the first quarter of this year. Also worth noting is our year-to-date free cash flow, which essentially breakeven improved by over $200 million compared to the same time period last year, driven primarily by improved earnings and lower CapEx. In the bottom box, we’ve highlighted at a high level the proactive actions Adient took to help protect the financial health of the company as the impact of the pandemic intensified as the quarter progressed. These included implementing cash conservation initiatives. Actions bolstered Adient’s cash and financial flexibility, including the successful issuance of $600 million in senior secured notes and the development of restart procedures to ensure our operations are ready to reopen with proper safety protocols in place. I would like to highlight and thank the Adient team members who worked tirelessly to provide support to their local communities through various manufacturing initiatives, namely the design and production of face protection through 3D printing for parts. Turning to Slide 6, let me expand on a few key points. I plan to go through this slide relatively quickly, as I know you’ve had a chance to download the materials, and I’d like to leave ample time for Q&A at the end of this call. The current global automotive environment remains uncertain although, as we look to China, we are encouraged. All 79 of Adient’s plants are open; in fact, 45 plants are running two shifts. We are advocating that our customers are up and running, and plants in Wuhan and Hubei have opened, with SGM building 2,000 vehicles per year. That’s an encouraging data point related to Adient’s profitability through the ramp-up of production because the team acted quickly and decisively to improve on variable costs. Margins have returned to normalized levels in the first month since production resumed. We’ve taken the proven China playbook and applied it to Europe and the Americas, beginning with significant actions to improve our variable costs and reduce our cash burn while developing detailed plans to reopen with COVID safety precautions in place. We started reopening in Europe over the past weeks; specific customers have resumed production at various rates. We expect 80% to 90% of the original equipment manufacturers (OEMs) will be in production by the end of the month, with the UK expected to be the last country to restart. In North America, customer restart plans continue to evolve; limited restarts are planned for the weeks of May 4th and May 11th. We anticipate meaningful restarts to occur in the week of May 18th. In addition, given Mexico’s shelter-in-place orders, suppliers and OEMs will need to navigate through the added layer of complexity. We are in daily discussions with our customers and suppliers to ensure a successful launch.

Good morning everyone, and thanks, Doug, and I echo your earlier comments and hope everyone is safe and well. I’ll start on Slide 15. Adhering to our typical format, the page is formatted with the reported results on the left and our adjusted results on the right side. We will focus our commentary on the adjusted results which exclude the special items that we view as either one-time in nature or otherwise skew important trends and underlying performance. For the quarter, the biggest drivers of the difference between our reported and adjusted results relate to restructuring costs and purchase accounting amortization. Sales were $3.5 billion, down 17% year-over-year which included over $500 million of estimated negative impact due to COVID-19. Adjusted EBITDA for the quarter was $211 million, which included about $100 million impact related to COVID-19. Despite this headwind, EBITDA was up $20 million year-on-year, explained by improved business performance across the Americas, EMEA, and Asia. Note that equity income was down for the quarter due to COVID-19 as we only had $10 million of equity income in the quarter versus $63 million a year ago. As most of our equity income arises out of China, the impact of the virus heavily affected our equity income in both February and March. Finally, adjusted net income and EPS were up significantly year-over-year at $58 million and $0.62 respectively. The improved operating results and a lower effective tax rate drove the year-over-year improvement. Now, let’s break down our second quarter results in more detail, starting with revenue on Slide 16. We reported consolidated sales of $3.5 billion, a decrease of $717 million, compared to the same period a year ago. Lower volume and mix across North America, Europe, and Asia impacted the year-over-year results by approximately $634 million. Approximately $530 million of the volume decrease was attributed to lost production volume associated with the pandemic. Additionally, currency movements impacted the quarter by $83 million. Notably, our consolidated sales in China were down about 36% year-on-year, which was better than vehicle production in China, which was down approximately 49%. Adient’s exposure to luxury and Japanese OEMs benefited as those manufacturers outperformed the overall market. Sales in Thailand were essentially in line with industry production. Regarding Adient’s unconsolidated seating revenue, primarily driven through our strategic JV network in China, sales were down 35%, excluding FX, outpacing the 49% decline in China’s vehicle production over the same period. Importantly, sales in China improved as the quarter progressed, an encouraging sign that fortunately accelerated in April.

Good morning, everyone. This is Aileen Smith on for John. Thanks for all the commentary. When looking at the $100 million improvement in the monthly cash burn rate that you’ve been able to achieve through the period of production stoppage, how much do you estimate is more structural and will translate into stronger free cash flow on the other side of this crisis versus what is more temporary and may not persist as costs get added back with production?

Yes, good question Aileen. I’ll start and Doug can jump in. A lot of these actions are really more in the category of stopping the bleeding during a no production environment. So, putting our plants on furloughs, taking the actions we have on reduced salaries and compensation for employees, and reduced capital spending associated with the no production environment. The point we talked about, though, is we are taking the opportunity now to implement more permanent actions that will improve our profitability moving forward, but many of the actions that reduced our cash burn from approximately $300 million to $175 million are temporary and aimed at providing immediate savings during a period of zero production.

Great. That’s helpful. And I very much understood that the recent $600 million debt raise was a move to bolster near-term liquidity and withstand current market pressure, but over the longer-term, can you remind us what you view as a sustainable or ideal capital structure, specifically, any targets longer-term around net leverage and debt pay downs?

Yes, to the question. I mean, I mentioned in my remarks that we're looking for cash somewhere between the $500 million and $600 million range, and obviously we have a lot more than that today. We also have $575 million coming from the transactions that we expect to complete before the end of the fiscal year. The back half of the year is always a time period where we receive our dividend. We would have never taken that additional liquidity but for the COVID-19 crisis and the uncertainty it creates. Given our fixed costs, we thought it was prudent to do it with the limited amounts of utility for the ABL during the production shutdown. It led us to raise the notes. As we get to the other side of this, we will look to pay down debt and use that excess liquidity to get down to that $500 to $600 million range. We have the ability obviously to pay off our term loan B which is just under $800 million today, and we will look for opportunistic measures to reduce debt once we are on the other side of this crisis.

Okay. And the last question, do you have any visibility around customer releases beyond the next month or two in Europe and North America, particularly anything to inform the production ramp in those regions other than the examples that have occurred in China over the past month or two?

Sure. With all of our customers, we typically get a 12-week broadcast at our just-in-time (JIT) plants. We have good visibility, and as we commented in our formal remarks, we expect Europe to come online pretty quickly and be back to 100% production. The only area that is still a little fluid right now is in the Americas, primarily due to the coordination of the state governments providing OEMs the opportunity to resume operations, along with the heavy reliance on Mexico, which still has stay-in-place orders.

Good morning, everybody.

Morning.

I had a couple of questions, just a follow-up. Your consolidated EBITDA was $201 million and I was wondering if you might help us walk through some of the adjustments that we might want to think about to extrapolate to an annualized rate of EBITDA. I think you mentioned that there was $20 million of unusual compensation benefits that I suspect would – we might want to track. And it appears there was $41 million of positive from commercial settlements on a year-over-year basis. Last quarter, you talked about how some of that was normal and some of that was maybe non-recurring, kind of true-up from prior periods. Could you just give us a little bit of a sense of what the run rate of EBITDA might be at this level of revenue?

Yes, good questions, Rod. On the $211 million of EBITDA that we posted for the quarter, we mentioned that there was roughly $100 million of impact from COVID-19-related issues. Effectively, if you think about it, like a $120 million of total issues offset by $20 million that we took back in some of our incentive compensation. So the $100 million was a net number. You can use $311 million as a more normalized number. Regarding your question on commercial, that’s a part of our business all the time; we called it out in the fourth quarter because that is a period where we have an unusual amount of end-of-year negotiation settlements with our customers. Overall, our commercial accrual on our balance sheet has moved much during the quarter. I would say that’s more due to our business performance and now that we weren’t doing as well before the turnaround. So I would say it’s much more normal for us in this quarter regarding commercial settlement activity.

Okay. That’s helpful. But just to clarify, that $100 million COVID impact also had a corresponding revenue impact. So, if we were just to say you are at a $14 billion annualized run rate of revenue, would we annualize the EBITDA and maybe just make the adjustment for the consolidated part of the EBITDA which was $201 million and adjust for compensation adjustments and things like that?

Yes, if you are trying to build another variable of bringing it down into a lower volume environment, the $120 million of impact, less the $20 million of SG&A was the $100 million we talked about. If you want to start thinking about that for what we look like in a reduced operating environment, I’d tell you, for the quarter, we talked about $530 million estimated COVID impact from sales. About two-thirds of the $100 million of impacts relate to our consolidated business, about a third related to equity income. The decremental margins were just under 13% at that level, so, perhaps you can use that to fill in whatever revenue level you want to use to arrive at an EBITDA estimate.

The only thing I would advise caution on is extrapolating that directly. Particularly in the Americas, we had a relatively comparable amount of launch activity in the first half of the year that will dramatically increase in the second half, especially with launches like the F-series. Even though that’s delayed, it is still going to roll into the second half. With that as an exception, you can see we are making strides when it comes to overall material margin performance, be it commercial or cost that we are taking out, freight, launch operations waste, etc., as well as the improvement we have in SG&A.

To clarify, the $201 million consolidated excluding equity income reflects a net impact of approximately $67 million of COVID-related issues. This is already net of the $20 million. Thus, we would be closer to the $270 million range, and you can make any volume adjustment you need based on a post-COVID reduced environment.

Yes, just want to follow-up on some comments you made about potentially exiting unprofitable segments or customer relationships. You’ve talked about downsizing over time portions of the SS&M Tier-2 business. Did the shutdown accelerate this effort in any way?

The specific comments were directed more towards some actions we took in China, specifically associated with some customers we felt were in our best interest to have in our portfolio. These were primarily a result of the Futuris acquisition. We’ve been more focused on finding ways to reduce costs and find commercial settlements associated with that business. Beyond that, there are a few customers we want to deemphasize, but I prefer not to disclose them at this time.

And in terms of the cash, you mentioned, I think two housekeeping questions. First, with receivables coming down, does that mean that the ABL revolver needs to be paid down and that you will use some of the term loan proceeds to do that? Secondly, especially with one of the largest product lines coming up for a grand launch, are you looking for accelerated payments from OEMs?

Yes, from an ABL standpoint, our cash balance at the end of the quarter was roughly $1.6 billion. Half of that represented the ABL draw and half just our normal cash. We mentioned $137 million required pay down in April, along with another $350 million voluntary payment in April that reflects our best guess of what those pay downs will have to be in May. So, we would use the proceeds from the base $800 million and the $1.6 billion to make those repayments. We also have the proceeds of the note from April for $600 million.

Regarding favorable terms with our customers, we took the opportunity to build positive relationships with our customers. We sought creative ways to help us in the short term. Most successes have been in the area of tooling, particularly during launch activities. We managed to push for immediate compensation on tooling payments ahead of schedule and had success in doing so.

Hi, good morning, everybody.

Good morning, Emmanuel.

Good morning, Emmanuel.

I wanted to ask you a bit more about the actions you are taking as you restart, particularly the items detailed on your Slide 11. You mentioned a range of actions, commercial items, and exiting platforms. How material are these actions, and do they enable you to accelerate some commercial and cost actions that would have otherwise taken much longer?

Yes, from a materiality standpoint, we pointed to China, where despite the 18% volume drop, we maintained EBITDA at historic levels. Much of that activity is captured in the slides, and we think it is material. We are in early days in Europe and the Americas; whether we can capture the full value is still to be determined. However, we are hopeful to maintain profitability in the face of lower and normalized volumes.

Okay, that’s helpful. And then the follow-up, specifically on this issue. You are executing actions to become cash flow positive in lower sales environments. Given you expect this lower sales environment to last for 12 to 24 months, any timeline on achieving cash flow positive benchmarks?

There are many moving parts to that, Emmanuel. We aim to achieve that sooner rather than later, with many actions underway. However, the timing largely depends on how the market restarts and at what level of lower production it stabilizes. We anticipate significantly lower production levels, but the specific estimates vary quite a bit, depending on customers' launch plans.

The one point I would emphasize is that it’s uncertain how our customers will ultimately operate. If this plays out similarly to the 2009-2010 crisis, there could be a significant pullback in the launch and development activities of customers. This situation would change our approach on cost reduction initiatives and the subsequent financial performance depending on customer decisions.

Great. Good morning. Thank you for taking the question. I thought it was particularly encouraging to look at the ability to get the operations back up and running in China despite the manual labor involved. That bodes well for your ability to restart in Europe and North America. Can you talk about some of the measures you've implemented in China to accommodate distancing and safety?

Absolutely. We implemented spacing within our operations, particularly in final assembly, which was relatively easy to enforce. Our industrial engineers rearranged the lines to provide distancing. Personal protective equipment and employee screening have been critical to our operations. You can find a detailed list of the measures we have implemented on our website. In our cut and sell operations, we re-laid facilities more dramatically, and in our automated processes, there were fewer challenges as compared to manual operations.

Given the measures you’ve taken, how has your capacity or output been impacted? Are you operating at sort of 90% of normal capacity?

Quite frankly, it hasn’t had a significant impact. Measurements from China indicated we have actually improved our labor efficiency, largely due to the early restrictions on employee availability. Health and safety aside, this situation forced us to operate more efficiently. The challenge arises more from how our customers operate within their facilities, particularly if their efficiency is impacted by a lower line rate.

Thank you very much. I wanted to get back to the decremental margin discussion, which I think was impressive in the quarter. However, the mix of regions impacted in the next quarter looks significantly different. Can you help us with that sequential bridge of your expectations to hold margins up, especially during the last two weeks of this past quarter?

Yes, good question, Joe. Our decrementals in Europe tend to be a little bit worse than in other areas, due to lower flexibility. However, we have been aided by government programs that have allowed us to reduce labor costs temporarily. The good news is Europe seems to be transitioning back to work faster than the Americas, helping to reduce decrementals for May versus April.

Looking at the historical context, a large portion of your issues stemmed from complexity in managing launches. If we assume industry volumes continue to be impacted, does this create a scenario where margins could improve due to better management of volumes?

I don't want to get too far ahead, but there are scenarios where that could be true. Right now, our focus is on getting the restart going while ensuring our employees feel safe. Supply chains take time to stabilize, thus, we must manage unforeseen circumstances diligently. If the 2009-2010 model repetition occurs, many suppliers could indeed benefit from reduced launch cadence.

Great. It looks like we are at the bottom of the hour. So, this concludes the call for this morning. If you have any follow-up calls, please do not hesitate to call. We’ll get back to you, and again, thank you very much.

Thanks, everyone.

Thank you for your participation in today’s conference. Please disconnect at this time.