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Executives

Chad Utrup – CFO, EVP and Secretary

Merv Dunn – President and CEO

Analysts

Ann Duignan – JP Morgan

David Leiker – Robert W. Baird

Commercial Vehicle Group Inc. (CVGI) Q3 2010 Earnings Conference Call November 4, 2010 10:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the Third Quarter 2010 Commercial Vehicle Group Earnings Conference Call. My name is Grace Ann and I will be your operator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. (Operator Instructions) As a reminder this conference is being recorded for replay purposes.

I would now like to turn the presentation over to Mr. Chad Utrup. You may proceed sir.

Chad Utrup

Thank you and welcome everybody the conference call. As usual allow me to read through our Safe Harbor language then Merv will give a brief company update. And I’ll take you through our results for the third quarter of 2010 and afterwards we’ll take time to answer your questions.

With that, I’d like to remind you that the conference call contains forward-looking statements. Actual results may differ from anticipated results because of certain risks and uncertainties. These may include, but are not limited to expectations for future periods with respect to cost savings initiatives, market conditions or financial covenant compliance and liquidity, the economic conditions in the markets in which CVG operates, fluctuations in the production volumes of vehicles for which CVG is a supplier, risks associated with conducting business in foreign countries and currencies, and other risks detailed in our SEC filings.

And with that, I’ll turn the call over to Merv.

Merv Dunn

Thank you Chad and thanks to all of you that have joined our call today. During the third quarter, we continued to see an improvement in North American Class 8 builds and according to Transport Topics, truck tonnage has continued to rise over 2009 levels. In addition to these positive truck market trends, we’ve also seen our global construction markets increased sizably over the last year and recently again this past quarter.

Although, we don’t currently expect these dramatic increases to be sustained, we are optimistic for 2011 and eager to move further past this economic downcycle. We believe our cash position and in fact that we had no debt on our revolving credit facility at the end the quarter, continues to place us in a favorable position to develop new geographic markets and respond to our improving end markets.

As we’ve stated before we see Mexico, China and India’s key develop areas to leverage our capability to be a global supplier to the global OEMs. And along with that, to develop a local presence within these markets. In September, we were pleased to announce an agreement with Daimler Trucks North America to provide trucks for DTNA’s manufacturing facilities in Saltillo, Santiago, Mexico, as well as three of their facilities in United States.

In accordance with that agreement, we also announced that we will open a new facility near Saltillo, Mexico. We expect this new facility which is an addition to our facility in Agua Prieta, Mexico to be in operation by mid to late 2011. Daimler has been valued long-term CVG customer and partner. The fact that they chose CVG for this strategic partnership is a testament to our engineering and production capabilities and our financial strength.

In line with our strategy, this agreement represents an opportunity for us to work with an existing customer and to also expand our geographic footprint to find new business opportunities in growing low cost production region. During the past quarter, we have also gained additional business awards in several exciting areas. The first is with the Texas based defense contractor to provide electrical components for use on a wheeled mine-resistant vehicle. This additional military business is meaningful because the M-ATV business we do for Oshkosh has moved from peak production volumes to more to a traditional replacement levels.

We anticipate production will begin in the first quarter of 2011 and the revenues to be approximately $2 million on annualized basis. Next CVG customer awarded us with approximately $5 million to $6 million incremental electrical component business for its compact construction equipment. Currently, we are ending the launch phase with this business to be produced in our Agua Prieta, Mexico facility. Additionally, we launched local production of wiring harnesses is to be used on excavators that John Deere manufactures with its partner XCG, in China.

We’re especially pleased this business is our first harness production in China. We anticipate annualized revenues for this new business to be around $850,000 in 2011 and grow to approximately $2.5 million in 2012, and rise to a range of $4 million to $4.5 million 2013. Finally, our Czech Republic operation has just been awarded $10 million to $12 million euros of annualized business to produce wiring harnesses for Skoda, a neighboring light vehicle automotive customer.

This business starts in 2012, as expected to hit peak revenues levels during 2013. CVG evaluates light vehicle business on a purely opportunistic basis. This award is a unique case for historical relationships paired with a great performance record that makes sense for both CVG and our customer. In September we had a very successful exhibit at the 63rd IAA Commercial Vehicle show in Hannover, Germany. The IAA show is one of the largest in the world and gave us a great opportunity to show up our products and capabilities on a worldwide stage and to meet with existing and potential new customers.

At the end of show, we featured several displays including the concept vehicle that address industry issues such as safety, fuel economy, driver comfort and vehicle weight savings. We also presented our self-extinguishing interior trim product called FlameTEK, that reduces potential property damage and operator harm in the event of a vehicle fire. Finally, during the quarter, we launched an updated version of our company website. It featured more user friendly ways for distributors, OEM representatives and retail and aftermarket customers to find expanded information about CVG products and to more easily interact with our company.

We continue to focus on top line growth and bottom line accountability. We remain heavily focused on our top line growth and overall strategy as outlined by the new business awards, global expansion and product development plans I mentioned. We believe the positive trends we are going, that we are seeing in our end markets and the incremental positive gains we are both achieving in global growth, are the foundation for our long-term outlook and the driers that will continue to make CVG a successful company in the future.

At this point I’d like to turn over the call to Chad for a financial overview, Chad?

Chad Utrup

Thanks Merv. Our revenues this past quarter as you saw were $115.9 million, which is an increase of $40.1 million or 36.2% from the third quarter of 2009. This increase is not only the result of an estimated 35% increase in the North American Class 8 build rate from the prior year but also reflects an increase in our global OEM construction revenues, which were up more than 160% from the prior year period, as well as our military revenues which were up more than 25% from the prior year period.

Our operating income was $5.1 million, which is an improvement of approximately $12.9 million over the prior year period. This represents a 32% contribution margin on the incremental revenues of $40.1 million which is a direct result of our cost realignment and margin enhancement efforts. Sequentially, revenues were up approximately $8.6 million from the second quarter with an operating income increase of $1.2 million excluding restructuring charges.

While we would normally expect a 20% to 25% contribution on incremental revenues, two primary drivers are affecting this for this quarter on a sequential basis. First is our higher contribution military revenues, which declined approximately $2.7 million from the second quarter to the third quarter. And second is an increase in SG&A and other areas of the business, we believe are necessary to continue our strong momentum in continuous improvement new business wins and overall strategic objectives.

Depreciation was approximately $2.6 million and amortization was $60,000. Capital spending was $3 million for the quarter or 2% of revenues. We did record our gain of approximately $1 million as other income which is primarily related to mark-to-market of our foreign exchange contracts. Our tax provision of $0.6 million recorded for this quarter is primarily attributed to changes in tax reserves, geographic tax rates and valuation allowances against our deferred tax assets.

This quarter’s tax provision rate of 35% is primarily related to the mix of geographic income and related rates for the quarter and is not an indicator of future provision rates given our overall valuation allowance status. As at the end of this past quarter, we had a cash balance of approximately $43.8 million and the capability to borrow an additional $22.5 million under our ABL without financial covenant requirements.

As mentioned, we do not have any funds borrowed in our ABL revolver. With this level of financial flexibility, we believe we’re in very good position to absorb further working capital needs as our end markets continue to recover as well as pursue key areas of growth.

As Merv mentioned, we announced during the quarter our agreement with DTNA for the expansion of the facility in the Saltillo, Mexico region. We currently estimate the initial capital requirements for this facility to be in the range of $4 million to $5 million with initial startup expenses net off savings and incentive programs in the range of $1 million to $2 million. We expect these capital expenditures and startup costs to begin during the fourth quarter of this year with the majority being incurred during 2011 as we ramp up the facility and related production.

In summary, we’re pleased to report our sixth consecutive quarter of operating income improvements excluding restructuring charges. We look forward to continuing our focus on operating and financial improvements as well as our long-term growth strategy as we move forward.

With that Grace, we’d like to open up the call for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Ann Duignan of JP Morgan.

Merv Dunn

Good morning Ann.

Ann Duignan – JP Morgan

Hi Merv, good morning. How are you?

Merv Dunn

Good morning, good.

Ann Duignan – JP Morgan

Glad you made it back safely from Hanover.

Merv Dunn

We are kind of too.

Ann Duignan – JP Morgan

I bet, just a couple of questions I suppose, on the balance sheet. Your inventories were up a little bit sequentially, days sales outstanding up a little bit on a day’s basis and days payables also, should we read no more into that other than the fact that these are up in support of growing sales or is there anything structural we should know about?

Chad Utrup

Some of its –a little bit of its timing Ann, and frankly the most of it is plans that we’ve got in place to take inventory out. Inventory crept up more than we wanted it to at the end of the quarter. So there is, our net debt I guess is a best way to look at, it went up about $9 million to $10 million from the second quarter. Recall, we have a bond payment in July of about $4.5 million. So that’s half of it and the other half is some creep in working capital that we’re working to take back out.

Ann Duignan – JP Morgan

So if we were to look forward we would expect to see days inventories come back down in the fourth quarter, is that the way I should interpret that?

Chad Utrup

Yes.

Merv Dunn

Yes, and also as we do cost improvements in purchasing and areas like that, sometimes there is inventory bills to be able to do engineering changes. There is inventory bills to be able to move suppliers. There is things like that just normally happen in the event of your continuous improvement that you’re doing in your operations.

Ann Duignan – JP Morgan

Sure, and I appreciate that in particularly if you are moving things around from facility-to-facility which leads me to my second question, if you could talk a little bit more about the investments that you’re making. The DTNA business, you said $1 million to $2 million in startup costs. Will those flow into SG&A somewhere, is that where we should kind of model that, and if you could talk about, will it to start slowly in Q4 and the vast majority of that cost will flow into 2011 or again just from a modeling standpoint how should we think about that?

Chad Utrup

Yes, there will be some in SG&A Ann, although I wouldn’t say that’s the small portion of the startup costs. I would say very little at this point will come into the Q4 of this year, majority of it and frankly mostly all of it will come into 2011. So I’d say mostly cost of sales and almost all in 2011.

Merv Dunn

We are carrying a few hits to deal with the Mexico project. We are also having a lot of travel, but we’re having a lot travel into many regions of the world with new business opportunities that we’re dealing with.

Ann Duignan – JP Morgan

Yes and I appreciate that, and that’s exactly kind of what I was thinking about is that until the facility is up and running it’s going to be more hiring people, getting stuff organized, etcetera. So good, I just wanted to make sure I understood that correctly.

Chad Utrup

Yes.

Ann Duignan – JP Morgan

And then can you give us any guidance in terms of directionally I know we’re early thinking about 2011 thus far, but things like tax rate, where would you expect that to normalize out, and then maybe incremental profits next year again with the ramp up of DTNA. Should we expect some headwinds for incremental profits? Just trying to get a sense of we can all come up with our own revenue outlook for next year but what are some of the puts and takes that we should be looking at that we should be careful about at this point?

Chad Utrup

Well I think the Mexico startup is one, we’re in that $1 million to $2 million range like I said most of that will be in 2011. That’s probably a big one. From a tax rate perspective, that’s a real difficult one because it just really depends on the geographic region, but given the large valuation allowances, we still had in place and the 35% we had in third quarters is more of a coincidence than anything. I still think we’ll probably be in that, maybe for the next couple of quarters at least, a couple of hundred thousand dollar up to maybe $0.5 million provision level regardless of pre-tax and that’s a real tough guess because the word geography pre-tax income falls out.

Those are I think specifically to address your two questions. The other thing as you look at 2011, you mentioned revenue, I mean one of the big things that we saw this year that we’re not quite confident on yet is the military. Military was so strong for us this year and we’re really taking a hard look in seeing where we think that may shakeout for 2011.

Ann Duignan – JP Morgan

Could your military business with Oshkosh, could that potentially go to zero or would you anticipate aftermarket, I know they will get the aftermarket but is there any kind of follow-on, kind of annuity with that business?

Merv Dunn

I think with anything military like that, we would always take our direction from Oshkosh. So he’s looking at how Oshkosh builds are going up or down or Navistar’s or anyone else is more of an indication of how ours is going to go.

Ann Duignan – JP Morgan

Okay, so.

Merv Dunn

And some of that we hear at the same time you hear.

Ann Duignan – JP Morgan

Yes, got you. And then your outlook for truck, yes we understand that you’re a little ahead of us for next year, but I think, frankly, we are probably a bit low. What are you hearing on the construction side by region, I mean what are your customers telling you to get ready for, I mean CAT is out there saying that their revenues will approach $50 billion next year, are they giving, are they out talking to suppliers again like they were last year ensuring that you guys can ramp up, or at this point, do they expect that everybody has their supply chain in order, and can ramp up with them?

Merv Dunn

I think most of the customers are still checking on suppliers to make sure that they’re comfortable with them, doing financial reviews because if you look at it and you look at the shakeout that we’ve had with the supplier base or the bankruptcies that we’ve had in the supplier base, and I’m not just talking about the tier ones, down tier two, tier three, that’s something we all pay attention to during ramp ups. So I think that would continue and as far as the construction build to sell we’ve kind of got layered in our plan kind of flat from this year to next year on a global basis.

Chad Utrup

Ann I think just to add on that, last year obviously was down for us for construction and was, we’re probably in the $67 million, $60 million range in revenues for construction, OEM construction and this year, especially the last few quarters have really ramped up. I mentioned more than 160% over ‘09. We know ‘09 was down but if you look at where our full year may end up this year versus 2009 it’s going to be almost pretty close to a doubling.

So we’re a little bit reluctant to pile on a lot more of market increase on that given where we’ve ramped up to today.

Ann Duignan – JP Morgan

But we are still coming off of a five year decline in US construction. So, is that just you’re being a little bit conservative at this point?

Merv Dunn

If we’re going to falter on anything, we will falter on conservatism side.

Ann Duignan – JP Morgan

Okay.

Merv Dunn

That we really think it’s going to be kind of flyer, but hopefully we’ll be wrong and you’ll be right.

Ann Duignan – JP Morgan

And just on DTNA again. We understand the CapEx and the ramp up costs, can you just remind us when revenues will start up, will that be in 2012 revenues, do you have to build the facility from scratch?

Merv Dunn

Yes, we’re building the facility from scratch. We’ve actually worked with the construction part down there. We got the building defined, we think building will be about seven more months before its completed and that doesn’t necessarily mean it will be that long before we’re functioning more in Mexico, but that’s.

Ann Duignan – JP Morgan

So you’re saying that sales may start to ramp up earlier than seven months?

Merv Dunn

Well keep in mind, we’re still selling.

Ann Duignan – JP Morgan

Yes.

Merv Dunn

To those plants. We’re just shipping it out of other plants.

Ann Duignan – JP Morgan

Right, okay.

Merv Dunn

So the new business – there’ll be some business start when the plant is completed, but as of right now we’re still continuing to ship our products out of three or four facilities here in the US to Saltillo.

Ann Duignan – JP Morgan

Okay, well I don’t know if there is anybody else on the line – in line for the questions, but I’ll jump.

Merv Dunn

Yes, there appears to be.

Ann Duignan – JP Morgan

Okay, so sorry. I didn’t mean to hog at. So I’ll get back in the queue.

Merv Dunn

It’s okay. It’s always a pleasure to talk to you and certainly with the way that the economy is going right now, it’s always little bit more pleasure to talk to all of you.

Ann Duignan – JP Morgan

Sure. Okay, I’ll get back in line. Thanks guys.

Merv Dunn

You’re welcome.

Chad Utrup

Thanks Ann.

Operator

Your next question comes from the line of David Leiker of Robert W. Baird.

David Leiker – Robert W. Baird

Good morning y’all.

Chad Utrup

Hi David.

Merv Dunn

Hi David, good to see you or hear you.

David Leiker – Robert W. Baird

A couple of things I want to dig through, as we look at the revenue numbers here going sequentially and you take the build rates out of it. Are you all done with the business that is rolling off, from Navistar or is there still some left there?

Chad Utrup

There is a little bit say in Q3 David, not much obviously 10 to 11, you’ll have the difference but Q3 its I’d say substantially out of there.

David Leiker – Robert W. Baird

Okay, and then in terms of timing of the new things coming in, some of that is starting now, right?

Merv Dunn

Some of it’s already come in a little bit and it’s starting to ramp and yes we’ve still got some to be coming in 2011.

David Leiker – Robert W. Baird

Is there – when we look at it quarter-by-quarter, is there an inflection point where all of a sudden it starts to accelerate at all or is it pretty smooth ramp up for you?

Merv Dunn

So far the business that we had bringing in, has fit well into the processes that we have in-house and the ramps been pretty smooth.

David Leiker – Robert W. Baird

Okay, the business with Skoda. How much of your business today is automotive related?

Merv Dunn

There is very little. We have some Skoda business that we had since we bought the company.

David Leiker – Robert W. Baird

Right.

Merv Dunn

And it had kind of moved some of it away from us, before we bought the company. And with the improved performance and everything, it’s coming back. We’ve always kept our fingers in automotive, I guess maybe our fingertips is more of the right analogy even in 2006, when we hit record breaking revenues of 900 some million, we were doing the Ford GT back before we became public, we designed the – and program managing interior for the Chevrolet SSR. So we’ve always, we didn’t build any products for it but we did – so we’ve always done design work or small programs, niche markets or things that fell into take enough capacity into the facility as we go and that’s the way we’ll continue to do automotive.

We’re not an automotive company, but we have the capability because of our strong engineering abilities to function in that arena and it also helps us with R&D, keeps us current.

David Leiker – Robert W. Baird

Okay, great.

Merv Dunn

Long answer to a short question, how’s that?

David Leiker – Robert W. Baird

Well that’s all right, one of the things that’s been coming out here in recent weeks is Caterpillar coming out and talking about working more collaboratively with their suppliers and reducing their supply base. And I just want to know what kind of opportunities that presents from you, and if you’ve seen any of that develop yet?

Merv Dunn

Well we’ve, excuse me David, we travel quite a bit with CAT going into the facilities, have invited to their strategic partner meetings. We just had one not too long ago with them. I was in the CAT China plants few months back, I think right before, right after IAA. Our relationship with them is extremely good. We have strong relationships with them on some of their metal components. We have strong relationship with them on the wiring and very strong relationships with them in the seats. And we’re looking to expand that relationship in the other products whether maybe interiors or flooring or metal structures. CAT is a key customer of ours and a key partner of ours. So anytime we can expand whether it’s geographically or whether its products or innovations, we’re right there with them

David Leiker – Robert W. Baird

Okay, great. and then the last item, as we look at the opportunities that you’ve talked about with the proceeds from the equity offering and these investments in growth initiatives, how much of that have you, is underway versus what you need to do yet going forward?

Merv Dunn

Well, so much of this we can’t really talk about and we have many customers that are not – when they make supplier changes, they do not want to announce those until the process has started. So some of those we just can’t talk about, we have spent myself and Chad and the presidents of each one of the businesses has spent a ton of time traveling to our customers and working with our customers on new potential programs whether it be in Thailand or whether it be in Brazil or India or Mexico or China and in the US obviously or North America.

We are very determined to get the top line growth, while managing the bottom line to continue a strong trend. We’re in the growth mode. We want to outgrow the market.

David Leiker – Robert W. Baird

Did you think, it sounds like you have most of those initiatives are underway at this point.

Merv Dunn

We got our fingertips in most of them.

David Leiker – Robert W. Baird

Okay.

Chad Utrup

I think Mexico is the clear-cut one Dave, I mean that ones out there, we’re underway with, we talked about that about at the beginning of this year about expanding in Mexico, India and China. Mexico is a clear-cut one, and that we’ve talked about for couple of quarters about new facility and what not and.

Merv Dunn

Czech Republic, the wiring harnesses we’ve also producing seats there now.

Chad Utrup

And Merv and I and Gordon had a trip planned late this year to India to explore that opportunity further as well, so.

Merv Dunn

India and…

Chad Utrup

And…

Merv Dunn

Australia. So we’re getting plenty of points that we’re willing to share with you David.

David Leiker – Robert W. Baird

And where does – where is Brazil on your hit list there?

Merv Dunn

Brazil is real close behind India for us. We’re getting a lot of pull to be there like anywhere else, we’re going in but we go in small but we go in with a plan to light up pretty well to get the growth I think, it’s been obvious how we do it with our model with we did in China starting out with $4 million that we transferred there. And today that thing is greater than 10 fold what it was when we started four or five years ago.

David Leiker – Robert W. Baird

Okay, great. Thank you.

Merv Dunn

You’re welcome.

Operator

(Operator Instructions) We have no further questions. I will now turn the call back over to management for closing remarks.

Merv Dunn

Well, I think as everyone is seeing, the company is very focused on performance. We have been over a good while now, the economy is starting to respond a little bit and all the hard work and the efforts that we put in place are starting to show. And I think they’ve been showing now for about four consecutive quarters. And we’re seeing a good response to that. We plan on to continue like I’ve said on our top line growth with bottom line accountability and we’re very positive the way that we see our company going. Chad?

Chad Utrup

Well I echo the same thing. Thank you everybody. We look forward to next quarter.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. And you may now disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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