WABASH NATIONAL Corp Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the Q1 2020 Wabash National Earnings Conference Call. At this time, all participants are in a listen-only mode. After this speaker presentation, there will be a question-and-answer session. The operator provided instructions on how to ask questions during the Q&A. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Ryan Reed, Director of Investor Relations. Thank you. Please go ahead, sir.

Thank you, Felicia. Good morning, everyone and thanks for joining us on this call. With me today are Brent Yeagy, President and Chief Executive Officer; and Mike Pettit, Chief Financial Officer. A couple items before we get started. First, please note that this call is being recorded. I’d also like to point out that our earnings release, the slide presentation supplementing today’s call and any non-GAAP reconciliations are all available at ir.wabashnational.com. Please refer to Slide 2 in our earnings deck for the company’s Safe Harbor disclosure addressing forward-looking statements. I’ll now hand it over to Brent and ask that you please refer to Slide 3.

Thanks, Ryan. Good morning, everybody and thank you for joining us today. Let me begin by saying that we hope you and your families are healthy, and that each of you have found ways to better connect with those you love. The world has changed at a remarkable pace since our Q4 earnings call and we have a lot of topics to get everyone up to speed on with regard to the current environment, the state of our strong liquidity position, current customer sentiment and our supply chain stability. I’d also like to offer some thoughts and perspective on the company’s performance during the last recession in the 2008 to 2009 timeframe, and why we expect this experience to be very different. However, before we get into those details, I’d like to start by sharing the steps we’re taking to safeguard the health, wellness and safety of our people. As we are an essential business we have continued to operate from the onset of this pandemic. Wabash products and services enable our customers to transport critical goods, whether it’s tank trailers hauling feedstocks, pharmaceutical processors, refrigerated trailers transporting fresh food to groceries, or our truck bodies completing the last leg of the journey delivering goods to the home. We’ve been part of assuring that vital supplies and basic needs have been met, which has allowed people to stay home more comfortably and social distance more effectively. We’ve initiated a company-wide business continuity effort that’s been helping us navigate through this extraordinary time with agility and speed. In addition, we made organizational changes throughout our company to facilitate bringing fast and deliberate decisions to action as we act within the business to best manage this dynamic landscape. We have made frequent, candid and empathetic communication with all of our employees, customers and suppliers a top priority as we put plans in place around the current and anticipated disruption to the economy. Our supply chain and general work practices are being adapted to proactively manage the situation. We have adopted and implemented best practices gathered by the World Health Organization, Centers for Disease Control, and other respected sources of scientific fact to safeguard our people and our workplaces. In addition, we’ve been in close contact with the states and municipalities where we operate to ensure we’re in alignment with and supportive of local measures. In our manufacturing facilities and offices, we’ve implemented standard social distancing protocols as a process that we expect may need to be in place for longer than any of us would like to imagine. We’re implementing smart, effective and risk-based control measures that are sustainable and productive, some of which are facility changes to reshape the physical manufacturing and office environments, wide-reaching use of work-from-home or telecommuting tools, use of employee symptom prescreening tools, modification of common areas such as break rooms, cafeterias and other employee gathering areas, physical barriers, proper and effective use of personal protective equipment and administrative procedures such as enhanced, slightly modified travel protocols and visitor procedures. I’d like to take the opportunity to thank all of our employees for their dedication during these unprecedented times. I’ve been extremely proud of how our employees have reacted to and embraced the changes that allowed us to adapt our business to the current environment. Essential business or not, people are in different places in regard to their home situation, personal health, the health of those around them, as well as their own respective fear and anxiety regarding the risk of contracting this virus. By and large, our people have been responsible, open-minded and supportive of our efforts to remain open and constructive during the past 60 days. Our culture is what makes it special to be part of Wabash National, and I’m always humbled by it. Let’s move on to an update on the customer and supplier landscape. As an essential business, we’ve been able to maintain business continuity with our modifications in place. However, we have not been immune to supply-related disruptions caused by intermittent COVID-related issues, as well as state government pandemic response actions. Supplier impacts have been mitigated by agile supply chain actions taken as a result of changes made to manage the last three years of peak product consumption, supplier capacity limitations and tariff-related impacts. This speaks to the sustainability of those supply chain actions. We have also managed through supply chain issues by holding increased inventory of some at-risk inputs identified as part of our supplier risk management process. An area of risk that remains that we’re watching is in regard to truck chassis in support of our truck body manufacturing process. All major producers of truck chassis have implemented hard and relatively extended shutdowns in response to the COVID crisis. While we may expect chassis production to reopen in the near future, the full impact on the supply chain is still being worked through. Overall, our supply base has weathered the storm well. At this time, we do not see significant liquidity or solvency risk within our supply base as a result of shutdowns or reduced market demand. In terms of our customers, they’ve done an admirable job keeping the flow of essential goods moving in a challenging environment. Generally, they’ve gone from extremely busy as consumers stockpiled products during stay-at-home orders to experiencing a considerable market softening with non-essential business closures. They are now gearing up to handle increased volumes as states begin to open up again. While customers are managing their capital outlays closely at the moment, there’s also an appreciation for wanting to maintain average equipment ages at reasonable levels to ensure efficiency, attract driver talent and avoid the supply issues we saw in 2018 and 2019, where some customers could not get equipment as they managed their capital needs. We’re also finding, as we expected, customers within our strategically managed customer portfolio have been relatively resilient compared to their peers. We can observe that in their Q1 earnings, internal pandemic response efforts and through our overall backlog stability. Moving to Wabash’s financial results for the quarter, I’d like to split my comments between two distinct phases: January and February together, and March specifically. The first two months of the quarter were relatively in line with our expectations as our operating cadence was similar to historical performance during these months. Specifically for commercial trailer products, March tends to be the most significant month from a revenue and income perspective during the first quarter. And just as a quick refresher on revenue recognition, we recognize revenue when products move off a lot. In the case of trailers, pickups are typically heavy in March, a period this year that coincided with carriers being busy as freight activity received an unusual boost from pre-shutdown purchase behavior. So even though production was in line with our expectations, customer pickups were not. This resulted in a revenue shortfall for commercial trailer products during the first quarter. As we discussed on our last earnings call, Final Mile Products was expected to see an operating loss during the first quarter due to weaker-than-anticipated customer pickups, coupled with the initial operational impact of COVID-19; the loss in the quarter exceeded our initial expectations. Diversified Products’ quarterly performance was only lightly impacted by COVID-19 related production or customer complications. As such, revenue and operating income were near our expectations for the quarter. Let’s move on to customer orders and backlog. As reports have shown, backlogs have come down throughout the industry as production has outpaced new orders since year-end 2019. Wabash National’s backlog at the end of the first quarter was approximately $1 billion after registering $1.1 billion at the end of 2019. This is much less than the 20% decline that is seen in the broader industry over the same time period. We feel very good about these industry figures, as they continue to imply our share position. We have previously mentioned we continue to believe that the customer conditioning that our portfolio executed over the past decade has and will continue to dampen the level of volatility that we’ve historically seen with our commercial trailer products reporting segment. I will now move on to broader actions taken and look to the future. Along with the well-being of our employees, we are focused on protecting the financial well-being of our company during these extraordinary times. We’ve taken rapid action to right-size our cost structure for the current environment. Understand that Wabash National has really been reacting to the pandemic in only the last 60 days, and those actions that we take will be seen in future periods. We have eliminated essentially all travel, implemented a freeze on all non-essential spending across the company, and are only moving ahead on operating and capital spending that is viewed as critical and customer supportive. We have ceased all hiring, cut expenses on outside resources, and implemented furloughs and headcount reductions. It is always difficult to part with team members who have devoted themselves to the betterment of our organization, but it’s our obligation as stewards of the company to ensure not only its near-term liquidity, but also to best position the company for overall stability as well as the creation of longer-term customer and shareholder value. We recognize that this is a period of shared sacrifice, and as such, myself and my team have taken voluntary salary reductions. Additionally, variable compensation for salaried employees will be reduced and potentially eliminated if we do not meet targeted performance metrics that were set out at the beginning of the year. Looking ahead, we have well-developed contingency plans to reduce spending further if necessary, based on further deterioration of product or macroeconomic market conditions. In terms of how we’re planning to operate in the near future: first and foremost, we will safeguard our people and our communities. We will then focus on serving our customers in the premium manner they deserve, while ensuring the previously mentioned priorities. We will work to produce as effectively and efficiently as possible. We’re in a very dynamic period of change and evaluation of how best to go forward, balancing customer responsiveness now with efficient operations, while looking to understand future operating needs. From a manufacturing perspective, furloughs are one tool that we have already used and will continue to evaluate to allow us to produce efficiently while up and running and then minimize our cost as much as possible during downtime. Our intent is to maximize efficiency while assuring ongoing stability for the customer. Finally, I’d like to express my continued confidence in the future. We’ve been preparing for several years for an eventual downturn in our end markets. And while no one expected the downturn to look like our world does now, the actions that we have taken and the strength of our balance sheet and ensured excess liquidity have proven extremely important. Although not all my leadership team was at Wabash National to learn from the company’s experience during the great recession like I was, the diverse perspectives that we bring from other companies and other sectors have been added to our approach to managing through this current situation. Our Board of Directors has also been extremely helpful through this time and has devoted their expertise to helping us think through our approach to both short-term and longer-term initiatives. We are fortunate that at all levels of our organization, many of our people have experience managing through a market downturn, regardless of cause. We expect to show through the cycle that Wabash National is a more resilient company than we’ve ever been in the past. Wabash National has enjoyed a number one or number two position in the vast majority of our markets and we intend to leverage this crisis to further distance ourselves from our competition. This crisis has afforded us the opportunity to move faster with organizational changes that were already underway, which we believe will allow us to increase our level of intimacy with our customers and drive an accelerated pace of customer-focused innovation that further differentiates our products in the marketplace. We’ll look forward to sharing those with you on future calls. In closing, our focus right now is on navigating the impact of coronavirus. I’m confident that we’re doing the right things to protect the health and safety of our associates, to continue serving our customers in this critical time and to play our part supporting the transportation sector. While the economic impact of COVID-19 will be severe, Wabash National has been through difficult times before and we have learned lessons from prior cycles that we have embraced to make a stronger and more agile company heading into this one. Finally, our resilient culture and a strong balance sheet provide us with the opportunity to emerge as a stronger company as we continue to execute our strategic plan throughout this crisis. With that I’ll turn it over to Mike for his comments.

Thanks, Brent. We’re going to do things a little differently on this call by spending more time discussing metrics that have taken on greater importance in this environment, like our balance sheet, liquidity and debt structure. As Brent mentioned, we feel that we’re better positioned than at any point in our company’s history to not only withstand a global recession, but also to use this period to set ourselves up to perform on the other side. But first, beginning on Slide 4, I’d like to briefly give some color on our first quarter financial results. On a consolidated basis, first quarter revenue was $387 million, with consolidated new trailer shipments of approximately 9,150 units during the quarter. As Brent mentioned, customer pickups of equipment were below our initial expectations for the quarter, leading to revenue also coming in below expectations. First quarter gross margin was 9.5% of sales, while operating income came in a loss of $110 million due to non-cash goodwill impairment charges. Operating income on a non-GAAP adjusted basis was a loss of $2.9 million. Given the uncertainty of the current environment, we recorded non-cash goodwill impairment charges totaling $107 million relating to the acquisitions of the Walker Group and Supreme Industries. Brent and I would like to reinforce in the strongest terms possible that our Final Mile business remains an exciting opportunity and a growth platform that we intend to leverage in the short, medium and long term. The progress we’ve made to recapture our share combined with Wabash’s technology offerings will continue to resonate in the marketplace, and we continue to work diligently on the operating performance within this business to ensure profitable growth. Finally for the quarter, GAAP net loss was $106.6 million or negative $2.01 per diluted share. On a non-GAAP adjusted basis, net loss was $2.3 million or negative $0.04 per share. Moving on to Slide 5, I’d like to review our cost structure and give you a little more detail about how we made quick adjustments from a cost perspective. In rough numbers, it’s fair to say that our cost structure is highly variable with material cost of 60% and direct labor equating to another 10% plus. So in total, I’d think of our total cost base as approximately 75% to 80% variable. We have moved quickly to ensure that our variable costs are coming down in line with volumes. Additionally, we have temporarily but significantly reduced fixed costs in the second quarter by executing a two-week company-wide furlough that incorporated 90% of all salaried employees. We plan to handle the near-term market disruptions with furloughs and downtime as we continue to work to permanently lower cost. We’ll give an update on some of these plans on the second quarter call. We’re also heavily scrutinizing and anticipating cutting most discretionary, non-essential expenditures in the short-term. In addition, Executive Officers took voluntary salary cuts as Brent mentioned, with a significant amount of incentive base pay that is tied to financial performance metrics like operating income and free cash flow, and these act as a release valve by significantly reducing, depending on financial performance. I’d like to stress that we have contingency plans for multiple scenarios, and while the actions we’ve walked through are important steps in reducing cost, we have additional levers that are ready and able to be pulled, should the situation dictate. Given that we’re all managing through unprecedented uncertainty and conditions that can change at a moment’s notice, we have decided the time is not right to provide detailed forward guidance. However, under current circumstances, we expect free cash flow to be positive in 2020. Moving on to our balance sheet, our liquidity, or cash plus available borrowings as of March 31, was $277 million with $155 million of cash and $122 million of availability on our revolving credit facility. In March of this year, we proactively drew $45 million from the revolver to bolster our cash balance. Our modeling suggested a $45 million revolver draw covered the worst case we could envision, which is to say, we do not expect to tap our revolving credit facility again in 2020. But it is there for liquidity and remains available to us. Moving on to capital allocation on Slide 6. Regarding capital expenditures, we are again heavily scrutinizing spend and only proceeding with projects that are critical to the maintenance of our existing operations. We are targeting a 50% reduction from our previous guidance to approximately $20 million in spend, and stand ready to reduce further if required. We expect to free up cash with working capital reductions and that, coupled with our quick and decisive cost cuts, should allow us to deliver positive free cash flow even in this difficult operating environment. With regard to capital allocation during the first quarter, we invested $6.3 million in capital projects, paid our quarterly dividend of $4.5 million and repurchased $8.9 million of shares prior to the pandemic. For the near-term, our approach to capital allocation centers around the preservation of cash. We’ll carefully control capital expenditures, prioritize our dividend and assess opportunities for debt reduction. Turning to our debt structure. Our nearest maturity is not until March of 2022, when our term loan matures. The balance stands at just $135 million and we expect to look to refinance this instrument in the next year. We are covenant light with no financial covenants on our term loan or high-yield bonds. The only potential financial covenant in place is on our revolving credit facility, which dictates a minimum fixed charge coverage ratio of 1 to 1 when excess availability on the revolver is less than 10% of the total facility. We obviously do not expect this covenant to come into play. We’ve been in close contact with our bank group over the past couple of months. They have been very helpful in advising on the trends they see developing in the debt markets and we have confidence in continuing with the partnerships that we have in place. Now finally, on Slide 7, I think it might be helpful to spend a moment comparing where the company stands now compared to prior cycles. With the uniquely severe nature of this crisis, it seems like the 2008 to 2009 time period will provide the most relevant comparison. While we know some of you have followed Wabash for more than a decade, I think it would be useful to discuss some of the challenges the company faced during the last cycle, and why we don’t expect a repeat this time. First and foremost, in early 2008, the company did not have the cash or liquidity balance that it enjoys today. This lack of liquidity, combined with limited access to fresh capital during the financial crisis, forced the company to take drastic steps that we will not repeat. I think it’s fair to say that experience has led to scar tissue around the organization and those are mistakes that we’ll not repeat; clearly our present liquidity situation speaks to that. Beyond our presently stronger liquidity situation, this company has also grown and diversified our product and end market exposure over the last decade. We have gone from primarily a producer of dry vans to a holistic provider of transportation equipment, expanding our portfolio to include tank trailers, truck bodies and expanding our customer and end market exposure accordingly. In summary, we feel that we’re well positioned to navigate this unprecedented time. Our cost structure is highly variable and we’re taking quick actions to reduce fixed costs. We have excess liquidity, no restrictive financial covenants at present, manageable borrowing levels and a patient debt structure. It is absolutely our intention to continue further in the progress of our strategic plan and prepare ourselves to be stronger as market conditions recover. With that, I’ll turn the call back to Felicia and we’ll open up for questions.

The operator now opens the call for questions. Your first question comes from Justin Long from Stephens.

Good morning, everyone.

Good morning.

Good morning, Justin.

So it was good to hear that you expect to remain free cash flow positive this year. As we think about that outlook, could you talk about what you’re assuming for the working capital tailwind in 2020? Just curious how much you can adjust there. And then also, as you made that comment that you feel like the revolver pull of $45 million could cover a worst-case scenario, is there a way for us to think about what that worst-case scenario looks like from a trailer production perspective or any other way you want to frame that up?

Sure. I’ll start with that one first. When you look at the timing when we pulled it back in March, it was a period of pretty high uncertainty. So we looked at a second quarter pullback that would have been far greater than a 50% drop year-over-year in revenue. At that point in time in March, we weren’t sure what the reactions from the economy or industry would be. So we modeled something that was greater than a 50% pullback in revenue as our worst-case scenario. In terms of free cash flow and the working capital, we feel that a reduction in the $25 million to $40 million range is highly possible. Again, it would be dependent on how much revenue contracts. Those obviously are connected. We have already seen some nice efficiency in our working capital based on some inventory reductions. So it’s somewhere in that ballpark; we think we could reduce working capital and help our free cash flow position.

Okay, that’s really helpful. As you know, the outlook is really uncertain here and we’re all running different scenarios in terms of the top line. But if you think about all the cost cuts that you’re implementing and it sounds like you’re taking a pretty aggressive approach there, is there a way we could be thinking about decremental margins for the business? Do you have a specific target in mind? Maybe you could talk about decremental margin across the different segments and how that might vary.

I would say, as a total, what we saw in Q1 is something that we would feel pretty comfortable with going forward. As it relates to the segments, we’re looking at it more in total. But I would say that the mid-to-high teens, roughly 15% to 20%, is a good range that we’re trying to manage within. That’s because we’re able to do that by actively pursuing fixed cost reductions along with variable cost reductions. There are two points in there: when people look at us they sometimes overestimate the level of fixed costs. We have a pretty high variable cost structure, so we’re able to reduce variable costs with volume. And we are also taking some pretty quick action to lower fixed costs which allows us to keep those decrementals in that just-under-20% range.

Yeah, and I would add to that just from a relative preparedness standpoint for this environment. Remember that when we think about our history with the 2008–2009 recession, the pre-planning that we’ve done gave us a pretty solid variable cost playbook and a book of actions that we already knew what we would pull, how we would pull and the degree at which we would pull them under various market conditions. So we were able to move relatively fast in late March and April on the fixed cost basis. We’ve been talking about restructuring the company for the last year. Those were active evaluations and work streams already underway prior to the COVID-related crisis. All we’ve done at this point is accentuate and accelerate those as we move the business forward. So that’s why we feel good about how we’ll be able to manage those decrementals going forward — we’re not starting from a dead stop as many companies may be.

Makes sense. And one last one on Final Mile: I was a little bit surprised by the impairment charge. Could you give a little more color on that and maybe say how much of that is related to COVID in this downturn versus other adjustments that would have happened regardless of this downturn? And then thinking about that Final Mile business longer-term: do you still feel like the financial framework in terms of the top-line opportunity and margin opportunity is intact? Or should we be thinking about something lower than what you’ve talked about historically?

Yeah. So the goodwill impairment: when you have market disruption like we had in Q1, it forces us to relook at all our modeling on goodwill; usually you do that heading into the end of the year. With the stock price pullback that we saw in the quarter and then the overall market conditions, that forced us to do another quantitative look. The major change in our modeling of the Final Mile business was the near-term cash flows, which as you know, have the highest impact on a cash flow model. So it was really a 2020–2021 look, given the environment we’re in; we believe there would be significantly lower cash contribution from Final Mile in 2020 and 2021 than what we would have modeled in Q4. That said, nothing really changed about our long-term outlook for that business. We believe that business will return to the same level of long-term growth, cash generation and profitable growth that we had modeled at the time of acquisition and in earlier modeling. So we don’t think it changes the future outlook of the business, but there’s a short-term disruption based on COVID.

Yeah, and I’ll add to that and echo that we’re not retreating in any way from the long-term strategic impact that Final Mile Products will have on our top line and margin performance. We are dealing with an unfortunate and unplanned environmental condition with COVID that has had a larger impact on Final Mile than we would have planned for. We were discussing in Q4 the variable cost basis of that business and how it would impact Q1; we guided to that. We saw incremental improvement on a month-to-month basis in that variable cost structure as we moved through Q1. So for what we control, we’re acting on it. Unfortunately that gets washed through when you have something as significant as a 40% top-line reduction caused by a myriad of COVID-related issues. I’ll give you one example: being unable to ship into New York and much of the East Coast because of severe shutdowns and fear of contracting the virus. That is something that has been worked through over the last 45 to 60 days and wasn’t in anyone’s plan in terms of how to manage the quarter.

Makes sense. Appreciate all the time today. Hope you guys stay safe.

Thank you.

Thanks, Justin.

Your next question comes from Joel Tiss from BMO.

Hey guys. How’s it going?

Joel.

It is good.

I know you don’t want to give us any guidance, but somebody always has to ask the mandatory question: if you can give us a little color on how April and maybe the first week of May started. Some other companies have hinted that week-by-week since the beginning of March things have gotten a little bit better or are stabilizing. Anything you can help us with there?

Sure. I’ll give you a round-the-horn view, some macro and some micro. One thing we talked about was that we furloughed 90% of our salaried workforce and all of our hourly workforce effectively for two weeks in April to manage overall cash spend. What we experienced during that period was when those employees came back to work, they were healthy, engaged and productive coming right out of the gate, and that speaks to the resiliency of Wabash National. I think that’s something that gives some level of forward-looking stability for the company from an operational standpoint. Our operations were not impacted in April by mandatory shutdowns in any material manner and we were able to weather through without significant supplier impacts. We see that rolling into May as well. So the operating picture looks good. From a commercial standpoint, our customers are still ordering and cancellations have remained non-material at this point as we manage the in and out of backlog. We’ve maintained relative backlog stability and that is a really good sign as we look at the remainder of the year.

That’s great. Could you spend another minute on what you’re hearing from your customers in terms of holding onto their orders? I’m sure they’re doing the same as you: cutting outside spending as they can. Any color about when they plan to pick up the trailers and those sorts of things?

I’d say you can see it in earnings calls from some of our largest customers how they plan to maintain capital spending specifically on trailers as they look to manage fleet age and operating cost per mile throughout the rest of the year. They don’t want to get on the wrong side of average trailer age as they did coming out of the 2008–2009 period. We tend to sell to the most sophisticated and well-capitalized customers in the industry and they are managing their assets with that sophistication today. We track our portfolio to leverage that. When we talk to them one-on-one they echo back, and we can see that in the level of cancellations, which are primarily in our indirect channel, not with large customers. We have not seen significant push-outs in trailers or other Wabash National equipment across our segments. So not only has overall backlog stayed stable, but we’ve seen stability in the sequencing of product as well. Their intent signals they will pick up product; the exact timing is complicated by the nature of the time we’re in, but ultimately we’re a build-to-order company. They want their product scheduled and it will get picked up.

And maybe also to add, the diversity of our customer base matters — we have customers for whom this has been a very busy time, such as liquid tank, food-grade haulers or refrigerated trailer or truck body customers. So demand is very diverse across customers.

Okay. Last one, maybe it’s a little unfair, but can you see any signs of distress in competitors or any chance to consolidate the industry a bit? I know it’s not really the time to think about that, but anything that would give you a tactical advantage a year from now?

I’m not going to speculate on acquisition or consolidation activity; it’s too early to discuss. What I will say is that we’ve been dynamic and deliberate in the way we manage our sales and operations planning process coupled with how we’ve derived our customer portfolio; you can see that in our backlog. We were taking variable cost actions and rightsizing our business in Q4 in anticipation of initial demand patterns; we’ve furthered those actions. Based on our backlog, our capacity changes are effectively done. I believe a portion of our competitors will still go through capacity rightsizing as they move into mid-summer. That may put us in a very competitive situation and allow us to respond to potential demand in the fourth quarter and into 2021. It gives us a more responsive footprint depending on what demand looks like, and that’s a potential competitive advantage.

That’s awesome. Thank you.

Thanks, Joel.

Your next question comes from Ryan Sigdahl from Craig-Hallum Capital Group.

Good morning, guys.

Good morning, Ryan.

Good morning, Ryan.

So first off, CTP and DPG gross margins held up well despite a challenging environment, but negative gross margins in Final Mile were certainly surprising to us because of the magnitude. Why the outsized pressure? And how do you think about those margins trending throughout the rest of the year?

For Final Mile, the reason margins came in worse than expected was because, as Brent mentioned, we were seeing improvement through the first quarter. We knew the first quarter was going to be challenging and we talked about that in the Q4 call. As we were seeing operational improvement — hours per unit and productivity moving in the right direction — that improvement was interrupted by the pandemic. Revenue pulled back and pickups and shipments became difficult. So the lower revenue base with absorption and the stalled improvement really caused margins to be worse. We would expect improvement to continue into Q2, but the slowdown in the first quarter due to COVID is what caused the worst of the hit.

You have to really think about a 40% revenue decline that predominantly occurred in early February into March. The vast majority of our Final Mile product pickups are customer-arranged and occur in urban centers, which were disproportionately impacted by municipal restrictions. Those areas were significantly more impacted by the virus and by fear and distraction; picking up truck bodies was probably not high on many customers' lists during that period. Additionally, some non-essential businesses and dealer outlets for Final Mile-related products were shut down or had skeleton crews, limiting their ability to manage logistics for moving truck bodies. Those businesses were encumbered roughly until the second or third week of April and only began loosening up more recently as states and local governments moved toward reopening.

Great, that’s helpful. As we think over the medium term, I don’t think anyone argues with the longer-term opportunity and secular trends, but Mike I heard you say the biggest change to the goodwill analysis was changes to 2020 and 2021 cash flows. I guess we were previously expecting a pretty sharp bounce back in the second half of this year in Final Mile, but it sounds like that could be a little longer. How do you think about the next 6 to 18 months?

We would expect the second half to improve, but it would be a slower recovery than what we would have been expecting in Q4. We were seeing improvements in that business in Q1 and expect to see that continue. We expect improvement through 2020 and significant improvement in 2021. It’s just that absolute levels will be lower than what we would have originally modeled at year-end 2019.

Last one for me: you talked about Q2 worst-case scenario back in March being down more than 50%. Has that expectation changed as things have improved or worsened since then? Any high-level directional guidance you can give without getting too specific?

Yeah. At the end of March when we drew on the revolver, the range of scenarios was wider because it was hard to see the bottom. We were modeling things severely down. As we stand today, our general base case is relatively intact; the bottom is coming into view and is a little more stable. So it’s not that the base case moved much; it’s that the bottom is easier to see. We feel pretty good about our liquidity levels and what we did; we probably wouldn’t need to have pulled that money today if we had known then what we know now.

Great. Thanks, guys, and good luck.

Thanks, Ryan.

Your next question comes from the line of Felix Boeschen from Raymond James.

Hey. Good morning, everybody.

Good morning.

Felix.

Maybe if I could start with a bigger-picture question, Brent. I appreciate some of your comments on social distancing measures within facilities. Can you expand on that a little bit — exactly what you’ve done within the facilities? And maybe how you think about increased automation opportunities going forward or any short-term increases to cost we should be thinking about?

Yeah. Obviously we have two different types of facility considerations: office and manufacturing. From an office standpoint, roughly 40% to 45% of our salaried workforce is working from home right now to facilitate social distancing within the office environment. We have significantly changed the administrative and physical layout of common areas: break rooms, cafeterias and similar spaces. We are taking a phased approach to reintroducing portions of the salaried workforce back into physical environments at a pace that allows effective social distancing. We’ll make additional facility modifications to allow that to happen, and we likely will not have the same density of people in our office environment that we saw in the past. That could change physical needs going forward and may create opportunities for facility rationalization or office consolidation, which would reduce fixed costs. From a manufacturing perspective, we’ve implemented effective safeguards on the manufacturing floor across all our businesses. We have a diverse set of manufacturing systems but they lend themselves much more than industries such as automotive to putting in appropriate procedures. Where procedures can’t fully mitigate risk, we’ve implemented physical barriers to prevent droplet transmission between nearby workers. For the vast majority of cases, the productivity impact has been minimal. We did see some impact on Final Mile initially in March but have mitigated it over the last 30 days and have been working to reduce it further. From a capital standpoint, I don’t see us needing to shift significant capital to tackle COVID-related social distancing protocols impacting productivity. I actually see the opposite: we’re using enterprise lean tools to improve standard work on the shop floor to encourage social distancing through efficient use of people without large capital investments. That’s the direction we’re heading.

That’s very helpful. On the backlog: the $1 billion from $1.1 billion is much more stable than in the broader industry. Is there any way to parse that $1 billion further? How much is Final Mile contributing to that versus the legacy trailer side? Any color would be helpful.

I can’t give super-specific figures on the breakdown, but the backlog by business reflects the normal breakdown we have seen over the years. We do not have a disproportionate mix issue with backlog; it reflects our normal customer behavior and seasonality. It is stable in many ways beyond the headline number, and that gives us great confidence in how we will manage the business going forward.

Okay. And my last one for you, Mike: on the CapEx side, that 50% reduction — would you categorize that still as maintenance levels? I’m trying to get a better flavor for what exactly you’re deferring or cutting this year.

Yeah, so the $20 million target would be primarily maintenance, safety and regulatory spend. There will be a couple of key strategic initiatives that we continue to spend on in there; MSC, for example, could be contained in that. But largely we would reduce significant growth CapEx. We feel like $20 million allows us to maintain our facilities, which is important so we can come out of this pandemic running hard, and also allows us to maintain some of our most important strategic initiatives with some level of funding.

Okay, I appreciate it. That’s all I had.

Your next question comes from the line of Jeff Kauffman from Loop Capital Markets.

Thank you very much. Good morning, everyone.

Good morning.

Quick question: you mentioned customers didn’t pick up trailers to the extent you would have liked. Sales are down about 27%, receivables about 30%, inventories only down about 3%–4% year-over-year. As these pickups balance out, where do you believe inventories go?

They’ll come down. A lot of that sits today, Jeff, in finished goods. We built significantly more units in the first quarter than we shipped. So finished goods inventory levels will come down, all else being equal.

Jeff, just to be clear: when you look at the characteristics of our finished goods, we’re a build-to-order business. We invoice upon finished production and recognize revenue upon moving off our lot in many cases. We may have been paid for units prior to recognizing that revenue; I don’t want anyone to misconstrue these as speculative. Effectively every unit in finished goods is expected to ship — it’s just a matter of timing.

It’s important to know we watch the receivables closely because we regularly will get paid for units that are still on Wabash property. So we can’t recognize revenue on that, but we’ll actually have cash, and our cash flow has been really positive into early parts of Q2. Part of that is because while customers aren’t always picking up in a timely manner, they’re paying in a timely manner.

And I’ll add that customers are paying in a timely manner and are not extending terms, while continuing to make logistics plans to pick up trailers. Everything still boxes that need is out there.

All right. So if I think about free cash flow as we convert a lot of this finished goods inventory into revenue, that’s going to help free cash flow. How should I think about where you want to position your inventories in this environment? In theory, should we assume inventories come down roughly in line with sales?

We would certainly strive to reduce inventories in line with revenue; that’s essentially my comment on working capital. We would expect to see a reduction in working capital which would be a benefit to free cash flow. Exact level and timing is tough to project, but we are planning on and we will see some reduction of working capital.

Just one other question: we talked about deferring non-essential CapEx. There are many new products slated to be introduced this year — new DuraPlate products or development of MSC and refrigerated Final Mile solutions. How is this environment impacting the timing of new product introductions?

It has had zero impact on the timing of products we’ve communicated to market. Our core product is out on the road. Our MSC is where we want it to be — Michael alluded to maintaining funding for that. A host of other products we have not delayed; many are already commercialized and are available to the market now.

Okay, great. That’s all I have. Congratulations and good luck.

Thanks, Jeff.

Thanks, Jeff.

Well, seeing as well that’s all of our analysts who have queued up questions —

I would now like to hand the conference back to Brent Yeagy for closing remarks.

We’ll close it there. Thanks, Felicia, and thanks to everyone for joining us today. More importantly, stay healthy and safe and we’ll look forward to following up during the quarter.

Thank you.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.