Viasystems Group Management Discusses Q3 2013 Results - Earnings Call Transcript

| About: Viasystems Group, (VIAS)

Viasystems Group (NASDAQ:VIAS)

Q3 2013 Earnings Call

November 06, 2013 11:00 am ET


Kelly E. Wetzler - Vice President of Corporate Development and Communications

David M. Sindelar - Chief Executive Officer, Director and Member of Executive Committee

Gerald G. Sax - Chief Financial Officer and Senior Vice President


Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division

Jiwon Lee - Sidoti & Company, LLC


Good day, ladies and gentlemen, and welcome to Viasystems Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce Ms. Kelly Wetzler. Ms. Wetzler, you may begin.

Kelly E. Wetzler

Thank you, Saeed. I'd like to welcome, everyone, to the Viasystems investor conference call for the third quarter of 2013. If you need a copy of today's earnings press release, you'll find it at We have also prepared some slides, which you will find on our website. Our presenters today are Viasystems' Chief Executive Officer, Dave Sindelar; and our Chief Financial Officer, Jerry Sax.

In the course of our discussion, we are likely to make forward-looking statements. I wish to remind you that any forward-looking information we provide is given in reliance upon the Safe Harbor provision of the Securities Litigation Reform Act of 1995. The comments we will make today are management's best judgment based on information currently available. Our actual results could differ materially from any forward-looking statements that we might make. The company does not intend to update this information to reflect developments after today and disclaims any legal obligation to do so. Please review today's press release and recent SEC filings for a more complete discussion of factors that could have an impact on the company's actual results.

Some of our discussion today will include non-GAAP measures, in particular, adjusted EBITDA and adjusted EPS. These non-GAAP measures are reconciled with our GAAP results in today's press release and in our slide presentation. Management believes that these measures are useful for analytical purposes and to assist in comparing results over time and across companies. But we remind you that adjusted EBITDA and adjusted EPS exclude certain material items and are not a replacement for the reported results under Generally Accepted Accounting Principles.

I'll now turn the call over to our CEO, Dave Sindelar.

David M. Sindelar

Thanks, Kelly, and good morning, everyone. I'll begin by referring to Slide 4 in the presentation material.

On our last call, I commented that we expected our third quarter sales to exceed $300 million. In fact, in the follow-up questions, I recall that I estimated a range of $300 million to $310 million. As you probably noted from our press release this morning, our reported sales for the quarter were near the upper end of the range of $309.2 million. Now this resulting in overall sequential sales growth of approximately 8.3% over the reported second quarter sales period.

Both segments, PCB and Assembly, have reported solid sequential sales growth in the third quarter. And our book-to-bill ratio for the quarter was a little over 1:1. With the continued recovery of our PCB capacity in China, the majority of the Printed Circuit Boards sequential sales growth was in that region. We have now finally gotten back to the sales level for, from China comparable to a year ago.

Sales from our PCB side to the United States also grew slightly on a sequential basis, but declined about 10% compared to the same period last year on generally soft market conditions. I will talk more about market conditions for each one of our end markets when we get to the next slide.

Despite higher sales volume for a number of reasons, the increased sales did not fall through to margin at a rate you might expect. As you can see in the third bullet point on the slide, we faced several cost challenges in the third quarter. We don't have much control over market mix, but the mix of customers and product orders in the third quarter was not as rich as it has been in prior periods, which resulted in downward pressure on our margin rate as well.

Chinese labor cost challenges continue to grow. This is not limited to minimum wage increases, which happened early in the year. We're also finding that the workforce is more transient now than anytime in the past, with workers job hopping for even small increases in earnings potential. The resulting training cost and production inefficiencies are incremental to the higher wages for shift differentials and other methods we are using to attempt to retain a base of employees after they have been trained. And social taxes, like those of retirement funds, housing funds, et cetera, continue to grow.

As I highlighted on our last call, we continue to incur air freight cost rather than less expensive sea freight cost. You may recall that this began during the second quarter to support some of our PCB customer's needs for delivery of PCBs more quickly than our depleted Chinese capacity could handle. While we continue to make progress on our capacity expansion and recovery efforts, this incremental cost is likely to continue to -- until the additional capacity comes on line near the end of the year.

With previous factory locations in China and Mexico now complete, the affected operations are continuing to make progress towards achieving the expected manufacturing efficiencies. However, during the third quarter, we took -- we undertook the majority of the efforts needed to move our Anaheim facility into an owned site, which created a drain on gross margins at that site.

On the past calls, a couple of calls, we talked about replacing some of our lost wind energy and other product sales with a new customer, as well as some new projects with existing customers. While we have begun to see the positive effect of the sales over the past couple of quarters, these new projects are still in the ramp phase and not yet producing the margins we anticipate.

Adjusted EBITDA of $32.9 million and adjusted EPS of a $0.19 loss for the quarter are both improvements over the second quarter. Jerry will talk more about the third quarter SG&A and other expenses, but I can tell you that our primary near-term focus is on improving our manufacturing cost profile to get the earnings fall-through back to historical levels.

Moving to Slide 5. You will see the pie chart on the left representing our end market sales mix in the quarter. On the right, you'll see a table of end markets sales changes, both sequentially compared to the second quarter and year-over-year compared to the third quarter of 2012.

Automotive Billings increased about 12% sequentially in the third quarter. That continues the upward trend we've noted in both the first and second quarter earlier this year. The most significant contributor to the continued growth has been the new and restored PCB capacity in China. However, we have also increased our E-M Solutions product offering in this end market. In particular, product sold through relatively new players in this market, which buys both PCBs and the E-MS products from Viasystems.

Importantly, for the first time in several quarters, we're reporting year-over-year automotive sales growth. This sector represents -- represented 31% of our net sales in the third quarter.

Our I&I market represented about 25% of sales for the third quarter. And as I projected on our last call, we recorded another sequential increase compared to the second quarter. A third consecutive quarter of positive book-to-bill suggests continued momentum as we enter the final quarter of 2013.

Our PCB sales into this end market have been stable to growing in recent quarters. Our Assembly segment continues to be challenged by the customer taking production back into the internal operation. This is essentially the wind energy product as we've discussed on the last several calls.

Our telecom sector has been essentially flat for some time from a growth perspective until reported sequential growth in our second quarter. In the most recent quarter, we saw the trend continued, growing by about 16% sequentially and about 11% year-over-year. This end market has grown to 18% of our consolidated net sales for the quarter.

You may recall that on our last call, I highlighted a significant new E-M Solutions customer win for a telecom products that have further diversified our Assembly segment customer base. The initial ramp-up for this new product began late in the second quarter and continues throughout our third quarter.

Computer/datacom sector sales rebounded during the third quarter and improved by approximately 10% sequentially. Sales to customers in this end market represented about 16% of our net sales for the quarter. The widely publicized global softening in this market and our now historical capacity challenges have combined to make this end market the slowest to recover back to the pre-fire levels.

Our mil/aero end market business continues to hover about 10% of our consolidated net sales. Not surprisingly, soft demand resulting from U.S. government budget issues are having a adverse effect on our recent billing levels. And it is unclear how long this may continue.

As a follow-up to our call last quarter, you may remember that I noted a newly awarded significant new PCB project in North America. During our third quarter, we made progress in preparing for this new business, but we have not yet seen meaningful sales. These factors resulted in a single-digit sales decline in this market, both sequentially and year-over-year.

Moving to Slide 6. I'll share a couple of comments about where -- what we're expecting for the coming quarter. Unfortunately, visibility remains limited, but we continue to pay close attention to what we're hearing from our customers and suppliers in order to set our own expectations. Because we do not serve the consumer markets, we usually do not look for a year end growth in any of our end markets. Instead, we tend to see a demand slowdown as we approach the year end holidays. With that said, I expect that we will see sales levels remain stable compared to the third quarter. A recent project awards, plus our continued capacity addition, should combine to offset any seasonal demand declines.

From an operational perspective, we continue to vote the majority of our focus to our cost profile. The cost of new projects introduced should ease as these programs continue to mature. And we look to make more progress on production volumes by the end of this year to enable us to convert back to less expensive airfreight -- or less expensive freight alternatives. However, labor cost will continue to be a challenge.

Before I hand it over to Jerry, let me summarize by stating what is probably obvious. I'm happy that we've achieved recent sequential sales increases and that the new sales opportunities give us more to work to work with now and in the future. However, I'm not satisfied with the level of cost that we are expending to achieve the sales throughout the third quarter.

With that, let me turn it over to Jerry to discuss the rest of the financial results.

Gerald G. Sax

Thank you, Dave. Good morning, everyone. Our press release this morning, included the summary of the financial results and those results are also included in the online presentation materials posted for today's call. You should also be able to access our full 10-Q filing some time within the next couple of days.

Slide 7 shows our summary statement of operations for the third quarter, compared sequentially to the second quarter of 2013 and also compared year-over-year to the third quarter of last year. Dave already talked about our third quarter net sales of $309 million and our 18% gross margin, so let me begin my comments on our $25 million SG&A expense line. Excluding the $2.3 million of noncash stock compensation expense, which is included in our reported SG&A, our third quarter cash SG&A costs were $22.9 million. The sequential sales growth that Dave talked about did result in slightly higher SG&A spending than in our second quarter in terms of dollars, but our third quarter's level is lower as a percentage of net sales.

When we talked at the beginning of 2013, I noted that we expected those cash SG&A costs to be in the range of $26 million to $27 million per quarter during 2013, which as you can see on the table, is closer to what we experienced in the third quarter last year. Ultimately, I expect that we'll need to increase our SG&A support beyond the current level of spending, but we'll continue to keep a lid on those costs until we see the gross margin improvements that Dave highlighted.

Depreciation and amortize expenses in the quarter were again both in line with post-acquisition results. And at our current levels of CapEx, I don't expect to see much variation in those noncash charges in the near term.

We reported a little over $300,000 of restructuring costs in the quarter, which related primarily to the cost of exiting our former Anaheim factory site that Dave mentioned earlier. I expect only minor restructuring costs in the coming quarter.

The resulting $6.4 million of operating income for the third quarter is modestly favorable to the $4.5 million for each of the comparable periods presented in the table. The $6.4 million of operating income also reconciles to the $32.9 million of adjusted EBITDA that Dave highlighted earlier, as demonstrated in a separate table at the back of the presentation materials and in this morning's press release. And you'll see in that table that the nature and amount of reconciling items are sequentially consistent.

Looking to our nonoperating income and expense items for the quarter. You'll note here as well that each line item is consistent with the immediately preceding quarter. Our income tax expense of $2.5 million in the third quarter continues to relate primarily to our operations in China. And based on the continued cost challenges in our Chinese operations, you'll note that the third quarter run rate remained a bit below the $15 million annual estimate that I usually use in my modeling.

Another table at the back of the materials reconciles our $0.45 loss per share on a GAAP basis to the adjusted EPS of $0.19 loss that Dave highlighted earlier. Again, the nature and amount of reconciling items are sequentially consistent.

Slide 8 reflects our September 2013 balance sheet. You'll note that the increased level of net sales has expectedly resulted in higher levels of working capital. A working capital metric, like DSO and inventory turns, have remained consistent with our normal levels, so the increased working capital is in line with our own expectations.

Moving on to our summary cash flow statement on Slide 9. Year-to-date, we've generated $54.3 million of cash from operating results with $13.9 million of that being generated in the third quarter. Cash spent on CapEx was about $26 million in the third quarter of 2013, drawing our 9-month total CapEx to $65 million.

In the third quarter, $13 million of the CapEx related to recurring or maintenance projects and the remaining $13 million related to special projects, such as capacity expansions, factory relocations and replacement of equipment in our Guangzhou factory.

Debt repayments totaled $2.1 million for the first 9 months of 2013, including an approximate $300,000 optional prepayment made during the third quarter on one of our highest rate U.S. mortgages, which we assumed is part of our DDi acquisition last year. The $663,000 related to stock awards was paid as federal and state withholding taxes on a tranche of stock awards that finally hit their vesting period during our second and third quarters.

The net result for the first 9 months of 2013 has been a use of just over $13 million of cash. September's ending cash balance of $62 million, combined with our available credit facilities, both in the U.S. and in China, resulted in liquidity at the end of the third quarter remaining solid at more than $165 million.

That concludes my prepared remarks. So I'll turn the mic back to Dave at this point.

David M. Sindelar

Thanks, Jerry. And with that, I will open it up for questions, and hopefully, answers.

Question-and-Answer Session


[Operator Instructions] And our first question comes from Matt Sheerin from Stifel.

Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division

Just first question, Dave, on the -- the outlook on revenue seems fine. But on the gross margin, do you expect to see any improvement in gross margin? It still sounds like you still have some of these cost headwinds facing you in Q4?

David M. Sindelar

Yes, I think we're going to see some cost headwinds. I mean we talked about the airfreight, I think the airfreight's going to continue until, at least, the end of the year. I'm hopeful most of -- or a lot of the other ones are kind of getting behind us. But I would see some improvement in the gross margins from the third quarter. I would expect it to be kind of north of 19%.

Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division

And as you look at cost savings and more normal operations in terms of capacity utilization, et cetera, what kind of operating margin or EBIT -- either gross margin or EBIT margin, are you targeting at this current sales level, give or take?

David M. Sindelar

We have -- I guess, Jerry, what kind of -- compare and contrast where we -- where kind of margin profile was prior to all this, I guess. We were kind of in the 13% to 14%,15% kind of percent range. And I think as we look, I would expect us to kind of be moving back in that direction over the next 12 months. One of the biggest, not biggest, but one of the issues that we have been dealing with is that we have had a tremendous amount of success on the E-M Solution side. E-M Solution tends to carry a little bit lower margins, historically, than the PCB. And then you have all the startup and the testing and the kind of the new cost associated with it. So as we move into the first quarter, those products should be fully ramped. And we should start seeing the benefit of some improved margins. But there's several moving parts to it, so to speak.

Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And it seems, Dave, like one headwind that's not going away is the rising labor cost. And then you talk about this accelerated turnover of your employee base. Could you give us -- I mean, what are you looking at in terms of trying to deal with that? And in terms of that turnover, what's the rate today versus what it was a year or 2 ago?

David M. Sindelar

Yes, the labor cost -- and I think you're right. The pricing environment throughout the world hasn't gotten to the point, I guess, the cost haven't got to the point where everybody in the industry has decided to start raising prices. At some juncture, that's going to need to happen. So we have continually been, I think, historically on the front end of price raising. But the market right now, I don't think will allow us too much flexibility on it on the price increases. So from a labor point, we are working on trying to do it quicker, faster, better. We're trying to get more efficient, we're trying to get more automation into the plants. And so that's kind of right now our main focus on just the pure labor cost. On the turnover, we have, whether it's a good strategy or a bad strategy, on the cost side, we have tried to drag our feet as much as possible on raising the labor cost. So at the beginning of this year, our turnover was really high. But as a result of us adjusting to, what I would call, kind of market rates where each one of our plants are, we've seen the turnover come down pretty substantially. But it is still, by Western world thoughts, extremely, extremely high. We could have as much as 10% turnover in any given month, much less. If we had 10% turnover in the United States, we would, we'd probably all have a heart attack. But in Asia, the system is kind of set up for turnover. I mean I would like to be in the 5% to 7% range, and 10% is a bit of a challenge, but we're set up to handle it.

Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division

Okay, that's helpful. And just lastly for me. Your commentary on telecom where you've seen a good quarter-on-quarter growth for, sequentially, for 2 quarters now. Some of your competitors and other suppliers, the E-MS guys are talking about that being now lumpy, where they're seeing orders come down going into Q4. So it looked like we were in a nice recovery and then slowed a little bit. What's your take on that market right now?

David M. Sindelar

I guess, generally, I would agree with kind of the competitors and ancillary people in the industry. And I think our results are primarily the result of kind of new project or new program wins or new customers. So I think we're seeing a little bit of bucking the trend because of some of the wins that we've been able to obtain.


[Operator Instructions] And our next question comes from Jiwon Lee from Sidoti & Company.

Jiwon Lee - Sidoti & Company, LLC

Could we just talk a little bit more about your sequential growth in the automotive sector? What drove that little bit of a modest improvement first?

David M. Sindelar

Yes, and the reality of it is that if you look at our book-to-bill, and we don't -- we said we're a positive of book-to-bill, I think the strongest book-to-bill that we have is in the automotive sector. And the thing that we have been limited to all year long is really capacity. So we've been trying to catch up with rebuilding the Guangzhou facility from the fire, putting capacity and to get it back up and running, get programs or customers back in and requalified. Our Guangzhou facility has been pretty much at capacity with the automotive customers. And then if you also recall about a year or so ago, we were forced by the Chinese government to shut down our HZ, or Huizhou facility. So kind of in the last 12 months, we've set down a plant that was due in about $80 million, $90 million worth of revenue. We transferred it to our other facilities, and so we've been juggling 2 or 3 balls from a capacity standpoint. But right now from an automotive perspective, it's really capacity limitations as opposed to kind of market demands.

Jiwon Lee - Sidoti & Company, LLC

So on that note, on the capacity additions that you mentioned, do they relate mainly to support this automotive growth?

David M. Sindelar

Yes, yes, yes, absolutely.

Jiwon Lee - Sidoti & Company, LLC

How does that additional capacity affect your margin goal, EBITDA?

David M. Sindelar

I'm not sure it necessarily affects it. I think arguably, any sales increase should be at a, more of a variable margin as opposed to a, kind of fully loaded margin. So I guess, in that regard, we're hoping that the fall-through on those new sales should be higher than our average margin fall-through. But other than that, it shouldn't change it dramatically.

Jiwon Lee - Sidoti & Company, LLC

Understood. And last quarter, I believe you guys have highlighted the impact on the margin side with the airfreight cost. Could you quantify that for the third quarter?

David M. Sindelar

Did we...

Gerald G. Sax

I don't think we've given a specific number, and it depends a little bit on -- every month is a little bit different. But I think of it in the range of $750,000 to $1 million per month, so that creates a bit of a range. But it, at least, gives you something to work with.

Jiwon Lee - Sidoti & Company, LLC

And did you comment that you expect that to kind of move over to the -- ship by the fourth quarter, or how should we be thinking about that?

David M. Sindelar

I think that, that will continue until the end of the fourth quarter, and we should be back to normal, normal shipping terms early in the first quarter.


[Operator Instructions] And I'm showing no one else in the queue at this time. I'd like to hand the conference back over for any closing remarks.

David M. Sindelar

Great. Well, again, thanks for your time to listen to our call. And we look forward to talking to you again in another quarter. Thanks a lot.


Ladies and gentlemen, thanks for participating in today's conference call. This concludes our program. You may all disconnect, and have a wonderful day.

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