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Tower International (NYSE:TOWR)

Q1 2014 Earnings Call

April 30, 2014 11:00 am ET

Executives

Derek Fiebig - Executive Director of Investor and External Relations

Mark M. Malcolm - Chief Executive Officer, President and Director

James C. Gouin - Chief Financial Officer and Executive Vice President

Analysts

Itay Michaeli - Citigroup Inc, Research Division

Richard Michael Kwas - Wells Fargo Securities, LLC, Research Division

Ryan J. Brinkman - JP Morgan Chase & Co, Research Division

Christopher Van Horn - FBR Capital Markets & Co., Research Division

Operator

Good morning, and welcome to the Tower International First Quarter 2014 Earnings Conference Call. [Operator Instructions] Thank you. Derek Fiebig, you may begin your conference.

Derek Fiebig

Thanks, Stephanie, and good morning, everyone. I'd like to welcome you to the Tower International First Quarter 2014 Earnings Call. Materials for today's presentation were posted to our website this morning.

Throughout today's presentation, we will refer to the non-GAAP financial measures of adjusted earnings per share, adjusted EBITDA, adjusted free cash flow and free cash flow. Reconciliations of these non-GAAP financial measures to the most directly comparable financial measures calculated in accordance with GAAP are included in the appendix of this presentation.

As a reminder, today's presentation contains statements which constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including, but not limited to, statements related to revenue, adjusted earnings per share, adjusted EBITDA, adjusted free cash flow, trends in our operations and expected future contracts. Forward-looking statements are made as of today's presentation and are based upon management's current expectations and beliefs concerning future developments and their potential effects on us. Such forward-looking statements are not guarantees of future performance and we do not assume any obligation to update or revise the forward-looking statements. Additional information and risk factors are available in today's materials and in our regular filings with the SEC.

Presenting on today's call are Mark Malcolm, our President and CEO; and Jim Gouin, Executive Vice President and CFO. Also joining us in the room is Jeff Kersten, Senior Vice President and Corporate Controller. Following our formal remarks, we’ll open up the phone lines for questions and answers. Now I'll turn the call over to Mark.

Mark M. Malcolm

Thanks, Derek, and good morning. Key takeaways are on Slide 3. I think if I needed to provide a headline summary, it would be so far, so good. First quarter earnings were a bit better than we had anticipated, driven by good net cost performance on in-line revenue.

Based on this first quarter earnings good news and our present views on the remainder of the year, guidance for the full year is being raised at or above the prior high-end projections for revenue, earnings and adjusted free cash flow. And this favorable outlook is supported by the strongest quarter-end financial position that Tower has ever reported, including record liquidity and recent rating upgrades by both S&P and Moody's.

Now here's Jim to review first quarter details.

James C. Gouin

Thanks, Mark, and good morning, everyone. Slide 4 shows summary financial information for the first quarter. Revenue of $548 million was up 3% from the first quarter of 2013. Adjusted EBITDA of $54.2 million surpassed our guidance for the quarter and was up 4% from a year ago. Adjusted EBITDA margin was 9.9%, up 10 basis points. Adjusted earnings per share of $0.72 was up $0.40 or 125% from a year ago as we benefited from lower interest expense and higher EBITDA. All in all, it was a solid quarter.

Slide 5 explains the year-over-year change in adjusted EBITDA during the first quarter. The volume of mix was net favorable versus a year ago as lower customer production in China and Brazil was more than offset by increases in North America and Europe. All other factors were net favorable $1 million as efficiencies more than offset customer price reductions and labor and overhead inflation.

As shown on Slide 6, adjusted free cash flow for the first quarter was $24 million, benefiting in part from relatively low CapEx and advanced customer funding of the previously discussed China factory relocation. As a reminder, adjusted free cash flow excludes the impact of customer tooling, which as noted on this slide, was an outflow of $8 million for the quarter.

Net debt, leverage and liquidity are shown on Slide 7. We ended the quarter with the strongest financial condition Tower has ever reported. As of March 31, we had cash of $185 million and $545 million of debt, resulting in net debt of $360 million. This represents a reduction of $83 million from a year ago, including pro forma adjustment for last April's debt tender and refinancing. Leverage was 2.5x on a gross basis and net leverage improved 0.5 turn from last year's pro forma position of 1.7x. We ended the quarter with record liquidity of $362 million. Also during the quarter, both Moody's and S&P increased their rating on Tower by 1 notch, with S&P moving to BB-.

And now I'll turn the call back over to Mark.

Mark M. Malcolm

Slide 8 provides our present outlook for the second quarter and full year. Changes in the full year outlook are shown on the far right column. Anticipated higher revenue is expected to be converted into better earnings and free cash flow.

The outlook shown for the second quarter includes present customer production schedules for vehicles with Tower content and our present expectation regarding the timing of anticipated expenses to support customer product launches. As you may recall, our initial guidance for 2014 projected about $10 million more in launch cost than in 2013. We expect this will primarily affect our results in the second and third quarters.

That concludes our presentation. Let's please turn to Qs & As.

Derek Fiebig

Stephanie, if you could please remind the participants how to get in line for question-and-answer.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question is from the line of Itay Michaeli of Citi.

Itay Michaeli - Citigroup Inc, Research Division

Just a few questions. One, just I think, Mark, you just mentioned on the cadence, of the $10 million of launch costs for the full year, can you quantify how much of that is impacting you in the second quarter?

Mark M. Malcolm

Yes. Itay, if you were to say we said $10 million, and it's primarily second and third quarter. If you were to say roughly $5 million in both, I don't think you'd be far off. As you know and presumably many others know, it's a continuous flow process, where it's immediately expensed. This is not like controlling an SG&A budget. So can it fluctuate? Onesies, twosies, it sure can. But if you split that $10 million roughly between second and third quarter, I think you're in the ballpark.

Itay Michaeli - Citigroup Inc, Research Division

Great. And then just a follow-up to that. Last quarter, you gave a preliminary view for 2015. And of course, part of the tailwind was a nonrepeat of the $10 million of launch cost for the new business. Any updated thoughts on 2015? And just to kind of clarify, the $10 million is still the forecast for the full year. So it's not like you're seeing that benefit or you're seeing those expenses come in better than you thought initially such that in 2015, there still is that sort of nonrepeat factor?

Mark M. Malcolm

Yes. The year was still certainly at $10 million. And launch is one of those things that more likely goes bad than goes good because you have to get it done and you do not restrict expenses. You make sure you get quality parts out and get up to run rate. So I hate to say I'm confident we'll spend the full $10 million. I'm confident we will spend the full $10 million. And we have no material updates to 2015 outlook. We expect 2015 to be a very good year for Tower.

Itay Michaeli - Citigroup Inc, Research Division

Great. And then I noticed the margins in the Americas very strong in the quarter. Mark, hopefully, you can just give us an update on what you're seeing in South America and Brazil, particularly.

Mark M. Malcolm

Yes. South America is not good. The first quarter, the IHS has production down. I'll make a prediction here right now that when their actual numbers are in, they're going to revise them down even further. The second quarter is they're showing down over 20% on a production basis. We can confirm it's bad from where we are right now. Now the second half of the year, the comparisons should be better, in part because it was the first half of last year that was relatively strong. So it's become easier comparisons. And we would expect, it's been the history down in Brazil that the government steps in at a point in time. But whether they step in, in the second quarter or third quarter, I would expect something to happen there to help a little bit. We were cautious going into the year. I think if you can recall, we were more optimistic. It could be pluses relative to kind of consensus views in North America and Europe. And oh, by the way, we still feel that same way and we were very cautious in Brazil. And if anything, it's been worse than we anticipated, so we'll power through that up until now.

Itay Michaeli - Citigroup Inc, Research Division

That's very helpful. And then just 2 quick last housekeeping questions. One, firstly, cash flow. Are you still looking at a $20 million outflow for customer tooling? I think you mentioned $8 million in Q1. And then any updated thoughts on the tax rates for 2014? And that's it for me.

Mark M. Malcolm

Yes. The outflow of the customer tooling hasn't changed much from where we were before. I'll let Jim talk to tax rates.

James C. Gouin

Yes. The tax rate is always an interesting question, Itay, and one that is not really meaningful for us at this present time. What you end up seeing here that's happening in the first quarter is that the rate compared to last year is significantly lower. And the reason it's significantly lower is because we now have PBT-positive in the U.S. That, of course, is going into the denominator, but it's not being -- there's no tax being accrued on it. So when you look at what we gave for guidance around cash taxes at the end of last year, that's still probably where you should be thinking and probably is also good from an expense standpoint as well as a cash standpoint at this point.

Operator

Your next question is from the line of Rich Kwas with Wells Fargo.

Richard Michael Kwas - Wells Fargo Securities, LLC, Research Division

Just on the European comments for the second quarter, I think IHS said it was down slightly year-over-year, 1% or thereabouts. You talk to your platforms seemingly being worse. Is there a way to think about that relative to overall European production?

Mark M. Malcolm

I don't think for Europe, if I said that our platforms would be worse, I certainly didn't mean to say that. I mean, we have again factored in what we can see on our platforms. If anything, Rich, I've got to tell you, I don't -- unless production affecting Russia and Ukraine, which is having some impact, has a bigger impact than I anticipate, I would bet on the over in terms of the second quarter industry in Europe. And I think it's going to be different effect on different suppliers, maybe depending on their exposure into Russia and Ukraine. And we're seeing it on some of the lines in terms of exporting into those markets. I think the main part of Europe is actually stronger. My personal view is stronger right now than it is included in IHS's forecast. And again we have put our customers' schedules into our guidance for the second quarter.

Richard Michael Kwas - Wells Fargo Securities, LLC, Research Division

So the comment about Q2 is just really just a broader mix issue for your business rather than anything regionally? I mean, I know you just discussed South America and Brazil being weaker than expected. But it's more related to just your platform than how they're playing out for Q2.

Mark M. Malcolm

Yes. And again I don't think our issue, I don't see it so much as a revenue issue in the second quarter as it is an EBITDA issue. And that EBITDA issue relative to some expectations I had seen, I think, is now coming on the clarification of the cadence of our launch cost during the year, and not a change in our full year launch cost, but then just the cadence.

Richard Michael Kwas - Wells Fargo Securities, LLC, Research Division

Okay. Yes, that makes sense. And then Jim, just a clarification. When you look at the noncontrolling interest line, that came in under our expectation and under the year-ago period. It looks like it was $400,000. Is that -- should we think about it as the right run rate going forward from a modeling perspective?

James C. Gouin

I think it's probably around that range. That's one of our joint ventures down in China that's creating that. So yes, I think you're probably going to be pretty close.

Richard Michael Kwas - Wells Fargo Securities, LLC, Research Division

Okay. And then just longer term, Mark, on -- with last quarter, you were a little more ebullient about the opportunity with OEMs in terms of winning some business, potentially winning some business down the line from an outsourcing standpoint. How have the conversations gone here first quarter and the year? I know it's still early and those conversations are ongoing. But any color you could share on what you're hearing from OEMs on that front?

Mark M. Malcolm

Yes, I am -- if you interpreted my comments as being positive, they're equally positive now. None of the studies that we're involved in have culminated at this point in time. It's one of these things, however, that I had to temper my enthusiasm with the fact that these things play out over a period of time. If I can make a bad analogy and I realize I've worked in an OEM for a long period of time, these changes come slowly. And it takes a while to turn the ship for good and legitimate reasons. But once it turns, I think you're going to see it pick up. So it will take a while for these things to pull their way through. But to me, putting a longer-term perspective on it, I am equally as positive and more positive now than I've been at any given point in time. And I'm certainly no less positive this quarter than I was in the last quarter's discussion.

Operator

Your next question is from the line of Ryan Brinkman with JPMorgan.

Ryan J. Brinkman - JP Morgan Chase & Co, Research Division

Given that you tracked toward the high end of your revenue guidance for the quarter and not above it, I'm just curious, what gives you the confidence to increase the full year by $25 million? Is there something in particular you're seeing relative to product mix or strength in the programs you're levered to? Or is it just a more optimistic view on the industry overall?

Mark M. Malcolm

There are puts and takes obviously, Ryan. I think again we were -- may have held back a little bit, not knowing -- in the initial full year guidance, while I felt positive, if you'll recall in my comments on Europe, we hadn't actually experienced any real results. And so I would say, on a confidence-weighted basis, what our sense was that Europe would be a little bit stronger. And it's been confirmed thus far in the year. So you're really just seeing a confidence weighting more than any other big trend.

Ryan J. Brinkman - JP Morgan Chase & Co, Research Division

Okay, great. And then it looks like, as mentioned, you benefited that revenue by $25 million for the full year. Your EBITDA goes up by $2.5 million, I guess, if you sort of like take the midpoint of the $210 million to $215 million, and now say it's at $215 million. So $2.5 million increase in EBITDA and $25 million in revenue, it's about a 10% incremental margin. Can I do that math? Or are there just too many things that go into it like FX and product mix and stuff? And then just more generally, can you kind of comment on how you feel about incremental margins generally, where you think they're tracking now or they could track or should be tracking, et cetera?

Mark M. Malcolm

They track in a wide range from depending on the mix of what happens, literally from negative to full contribution margin at 25%. For a while, we've been saying, I wouldn't change that now. But kind of in the fully accounted range of double-digits in 10% to 15% relative -- not 0, not 25% but kind of straight down the middle in there.

Ryan J. Brinkman - JP Morgan Chase & Co, Research Division

Okay. And then just kind of switching topics, given your record liquidity and your leverage, which has come down by a lot, I wonder if it's relevant now to start at least beginning to talk about the potential for some sort of return of capital. In the past, you've talked a lot about how you would use excess liquidity to invest organically. Is that still the priority? Or is buyback potentially on the table, if not now, in coming years? And I know there's been a lot of changes to your credit agreements over time. So can you kind of maybe just remind us of where you stand currently relative to debt covenants with regard to return of capital?

Mark M. Malcolm

So let me talk to this slide because I don't think the covenants aren't the issue at this point in time and they're not holding us back, nor factoring into our decision-making process right now. But I'd refer everybody, Slide 12 from our conference call on February 13 is exactly where we are right now, which is 1A is profitable growth and 1B is to continue to reduce the leverage to work our way down to the target. And we default into reduced leverage so that we don't chase the growth on something that would be nonaccretive. We think the opportunities will be there over time, Ryan. And I think, frankly, if you only take a look at our relative valuation, multiple is the issue. And the best way to put that to bed and bury it forever to the benefit of our shareholders is demonstrate -- continue just as -- I think we did with the 2 major new sources of profitable growth for 2015 that we have a better outlook and we're still being recognized more in the market today.

Ryan J. Brinkman - JP Morgan Chase & Co, Research Division

Okay, that's very helpful color. And if I could just kind of continue on my list of questions. On the last call, you briefed us on your new business wins. You had a conquest win in the U.S. and this new project in Mexico. And I think how we left it was that with regards to the Mexico business, you were very highly confident that, that would materialize. But you did mention that there wasn't a signed contract yet. I'm curious if maybe now you have a signed contract or any sort of update on that.

Mark M. Malcolm

Yes. We have a signed LOI as opposed to a pending LOI, really just between ourselves and the customer. Practically speaking, we're just figuring out what numbers to put into the contract. But we're both working on the plan and the timeline that supports production later this year. So the technical correct answer is we do not have a signed PO. Now I'm telling you that this is kind of like Ivory soap, chances of it happening, 99.44%.

Ryan J. Brinkman - JP Morgan Chase & Co, Research Division

Okay, great. And then you're still expecting roughly about $80 million in sales relative to both of those projects in 2015?

Mark M. Malcolm

Yes.

Operator

Your next question is from the line of Chris Van Horn with FBR Capital.

Christopher Van Horn - FBR Capital Markets & Co., Research Division

Could you just give me a sense of European margins on an adjusted EBITDA basis? Is it fair to look at kind of what you did in the Americas and equate that to what's going on in Europe? Or is there any way to kind of break that out from the international numbers?

Mark M. Malcolm

No, we don't -- again for competitive reasons and customer reasons for our negotiations, we combine together Europe and China into our international region, and likewise, North America and Brazil for our Americas region. The international region is a little over 8% for the quarter. Certainly, Europe is the larger piece of the 2. So that could give you a sense. You can't be far off with that in order to hit that number that was there. I can tell you and everyone else, I mean, you see a decline year-over-year in the quarter at least for the international region that would have been accounted for, primarily in China. And again for the further color going back in time, we had a program that was continued on through the first quarter of last year in China that was discontinued and affected us from the second quarter on. So that accounts for some of the decline experienced in China.

Christopher Van Horn - FBR Capital Markets & Co., Research Division

Okay, great. And then from a program perspective, were there any specific programs that stood out to you, either on the positive or negative side? Or regionally, from a regional perspective?

Mark M. Malcolm

No. I mean, there are -- we always have puts and takes. And I think things worked out, I hate to say, pretty darn close to what we expected. But you can see with that revenue falling almost right on our midpoint, things came out about as we had anticipated.

Christopher Van Horn - FBR Capital Markets & Co., Research Division

Okay, great. And then just one last question, if you will. How does any changes in leadership at your customers affect you guys? Is there a delay? Is there different philosophies around production? Is there any affect if there's a change in leadership at your customer? And if so, what's the kind of the timing around that?

Mark M. Malcolm

Yes. If you're talking about CEO changes, my practical answer to that is no. We're more likely to be affected frankly on a practical basis by changes in purchasing organization. Purchasing is tied to engineering, is tied to wherever. So there is no simple blanket answer there. More likely than not, it's not personality-dependent, if that's the question.

Operator

At this time, we have no further audio questions.

Derek Fiebig

Okay. Well, we'd like to thank you for joining us on our call today. And I'll be around for the rest of the day to answer any questions you might have.

Mark M. Malcolm

Thanks, everybody.

Operator

Thank you. This concludes today's conference call. You may now disconnect.

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