Tower International, Inc. (NYSE:TOWR) Q2 2016 Earnings Conference Call July 26, 2016 10:00 AM ET
Derek Fiebig - Head, Investor Relations
Mark Malcolm - President and Chief Executive Officer
Jim Gouin - Executive Vice President and Chief Financial Officer
Jeff Kersten - Senior Vice President and Corporate Controller
Christopher Van Horn - FBR Capital Markets
Ryan Brinkman - JPMorgan
Itay Michaeli - Citi
Ron Jewsikow - Wells Fargo Securities
Good morning ladies and gentlemen. My name is Karen and I will be your conference operator today. At this time, I would like to welcome everyone to the Tower International Second Quarter 2016 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. [Operator Instructions] I would now like to turn today’s call over to Mr. Derek Fiebig, Head of Investor Relations. You may begin sir.
Thanks, Karen and good morning everyone. I would like to welcome you to the Tower International second quarter 2016 earnings call. Materials for today’s presentation were posted to our website earlier this morning.
Throughout today’s presentation, we will reference the non-GAAP financial measures of adjusted earnings per share, adjusted EBITDA 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 to this presentation. As a reminder, today’s presentation contains statements which constitute forward-looking statements within the Private Securities Litigation Reform Act of 1995, including, but not limited to statements relating to revenue, revenue growth, adjusted earnings per share, adjusted EBITDA, cash flows, leverage, trends in our operations, potential divestitures 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 will open up the phone lines for questions and answers.
Now, I will turn the call over to Mark.
Thank you, Derek. Few key takeaways are on Slide 3. Consistent with our comments with the mid-June release announcing the stock buyback program, we are reaffirming full year earnings and free cash flow. Also consistent with that earlier guidance update, our full year revenue outlook is slightly lower. That reflects factors specific to particular customer vehicles and power. We have seen no evidence thus far with meaningful downturn in industry production in North America or adverse fall-out from Brexit in Europe.
Importantly, our reaffirmed outlook includes that we believe will be the onset of some very favorable earnings comparisons accompanied by strong free cash flow. Three examples highlighted here are second half of 2016 adjusted EBITDA up by more than 20% from the same period a year ago, free cash flow in this year’s second half and full year next year projected at a robust $130 million and diluted adjusted earnings per share that could exceed $4 next year depending in part on the pace of stock buyback.
None of us has a crystal ball when it comes to future projection before and this appears to be a time when there is an unusually wide range of opinion to which I’d only observe we do not have a history at Tower of overpromising and underdelivering as evidenced by the quarter reported today being the 24th consecutive quarter since our IPO that Tower has met or beat the earnings consensus.
Now I’ll turn it over to Jim to review the second quarter actual results and our financial outlook for the third quarter and full year. Jim?
Thanks, Mark and good morning everyone. Slide 4 shows summary financial information for our continuing operations for the second quarter. Revenue of $505 million was spot on with our guidance and up 12% from the second quarter of last year. Adjusted EBITDA of $50.3 million was down from $51.5 million last year.
The decrease is more than explained by the planned and anticipated upfront costs associated with our major new business wins. As indicated in our update in mid-June, we were about $3 million better than guidance, primarily due to timing of commercial and other factors.
Adjusted EBITDA margin for the quarter was 10%. Adjusted EPS of $0.81 was $0.11 ahead of guidance, inline with the higher EBITDA. Last year, our adjusted EPS was $1.10 as our profits in the U.S. were not taxed because of our valuation allowance, which was reversed in the fourth quarter of last year.
As noted on this slide, second quarter 2016 adjusted EPS would have been $1.06 at the 2015 U.S. tax rate.
Slide 5 shows our free cash flow for the second quarter. Capital expenditures were $35 million for the quarter. Working capital, excluding customer tooling, was a use of $22 million for the quarter. Customer tooling was an outflow of $11 million for the quarter, resulting in total free cash flow use of $23 million for the quarter which was inline with anticipated calendarization.
Slide 6 shows our net debt and leverage. As of June 30, our net debt was $369 million. Our gross leverage was 2.3 times and net leverage was two times. We expect these metrics to improve based on our expected financial performance in the second quarter of the year which is provided in Slide 7.
On the right is our full year guidance, which is inline with what we indicated when we announced our share repurchase program in June. We expect revenue of $1.95 – excuse me – we expect revenue of $1.95 billion, adjusted EBITDA of $205 million, adjusted EPS of $3.20 and full year free cash flow of $20 million.
For the third quarter, we expect revenue of $470 million, adjusted EBITDA of $50 million and adjusted EPS of $0.80. Year-over-year results for the second half of the year are presented in the middle of the slide. Adjusted EBITDA of nearly $110 million would represent a 22% increase in the second half of last year and will represent a very solid 11.5% adjusted EBITDA margin. Adjusted EPS of $1.74 would represent a 14% increase.
Finally, free cash flow, which includes cash changes to customer tooling is expected to be positive by about $60 million for the second half of the year.
Now I will turn the call back to Mark.
Let’s build a bit on the company’s favorable outlook with some related observations. Beginning first on Slide 8 with a summary of the key objectives in detail of our stock buyback program. Fundamental intention of our buyback program is to opportunistically deploy capital of what we expect to be a highly accretive manner, which happens to have no loan thrift as experienced with organic new business growth and no integration risk as with an acquisition.
In doing so, we are putting our money where our mouth is, demonstrating the company’s confidence and our projected earnings and cash flow we believe underpin an intrinsic value of the Tower stock that is significantly greater than the stock’s present share price.
Certainly not our style to bet the company on a particular action regardless of the strength of our position and that mindset guides us to maintain anticipated prudent leverage. As we will on an upcoming slide, we are not walking away from our long-term leverage target of one-time EBITDA. If our forecast for 2017 is reasonably accurate, we should have more than enough cash flow to pay for the stock buyback and further reduced leverage.
We must of course maintain good flexibility so that we can and will respond to changing conditions or outlook if appropriate and as required. These objectives in combination with our cash flow outlook are what led Tower supporting to authorize the stock buyback of up to $100 million, which will be executed through opportunistic purchases without a forced completion deadline.
Slide 9 summarizes our stock purchases at the end of the second quarter. A little over 100,000 shares were purchased at an average price of just under $20 per share for a total cost of about $2 million.
Slide 10 pulls together financial data provided today and previously to show Tower’s potential year end 2017 net debt and leverage. Jim just reported that our net debt at June 30 was around at $370 million. He also provided the outlook for $60 million of free cash flow for the remainder of this year and in our last quarterly earnings call, we provided a free cash flow outlook of an additional $70 million in 2017.
On top of all this free cash flow proceeds to be received in the next 12 months from the sales of our discontinued operations in Brazil and China, presently projected at about $30 million to $50 million. In terms of cash outflows, dividends to be paid to shareholders through 2017 total about $15 million and the stock buyback could range up to $100 million.
At the high end of the sales proceeds and if there were no share buybacks, net debt could decline to about $205 million at next year end. With lower sales proceeds and if the entire stock buyback authorization are completed next year, potential year end net debt would be about $325 million, which would still be less than actual June 30, 2016 net debt.
Relative to presently projected 2017 adjusted EBITDA of $225 million, net debt leverage would decline into the neighborhood of our long-term target. In my opinion it’s time to put to bed historic concerns is – high financial leverage being a reason to apply a big discount in Tower’s earnings multiple and stock price.
Slide 11 outlines our view of the potential valuation multiple for Tower’s stock in 2017 using these recent stock price and the outlook we have provided. At last Friday’s closing stock price, our market capitalization was about $470 million. At in the potential year end 2017 net debt just reviewed excluding stock buyback and the potential year end 2017 enterprise value would be about $675 million to $695 million.
Keep in mind of course, that unless the stock price increases, any stock buyback will reduce the market cap by the same amount as the net debt increases resulting in the same enterprise value. That enterprise value is approximately three times presently projected 2017 adjusted EBITDA.
We consider that to be a ridiculously low valuation for a company with Tower’s operating track record, our record of delivering on our financial commitment, our now very manageable balance sheet and our anticipated strong earnings growth. And as highlighted in the memo line at the bottom of this slide, there is one additional potential value game changer now emerging for Tower.
We are about to cross the threshold with the investments in the string of new business wins are expected to start providing the anticipated net returns on investment in the form of sizable free cash flow. The total of $130 million of free cash flow anticipated in the next 18 months represents an incredibly high 28% cash yield relative to the recent stock value.
This is arguably the first period since our IPO that we expect to have progressed to the point of delivering meaningful improvements and strong absolute results on essentially all key fronts at the same time.
That concludes today’s presentation. Let’s please move to Q&A.
Karen, if you can please open up the line for question and answers.
[Operator Instructions] And your first question comes from Christopher Van Horn of FBR and Company.
Christopher Van Horn
Thanks for taking the call and congrats on the quarter.
Christopher Van Horn
Can you give us a sense of how far along we are in the ramp up of some of these new business wins and because it looks like the back half we are going to see that’s kind of margin come through around that and so if you could give us a sense of what - maybe what inning we are in on the ramp up of some of those new businesses?
Yes, that’s an interesting way to put it. I’ll tell you we are not in the last innings. But we have passed the most expensive part where it peaks on us. The launch cost and the work and execution expense, not only through the back half of this year, but frankly through 2017 and into a good part of 2018. But as we anticipated, Chris, I’m trying to point out what was laid out to plan for this year, we said the first half is really heavily loaded and then things would improve in the back half of the year and that’s exactly how it’s playing out. So, come back to your innings, we are in the middle innings, but we knew the first part of this journey was going to be the toughest in terms of just the numbers that would come out both in, and so everyone understands and I know you do and we talk launch cost and I think people understand that there are costs associated with the starting up on new business but on a holistic sense when you are in a plant and you are starting up not only are you incurring the cost, but we rely heavily on our operating effectiveness, productivity improvements, our cost savings if you will and you can’t do those while you are launching and stabilizing production. So that’s what really has a multiplier effect early on and the comparisons in the back half of the year will be much better than the front half of the year because we won’t carry that big heavy weight in the first half of the year while we still have a lot of cost next year, the year-over-year comparison will benefit again, if you take a look at incrementality relative to the revenue pull through it will be very good.
Christopher Van Horn
Got it. And it seems like it was in Europe the margins are kind of starting to creep a little bit higher here and I am just wondering if you can comment on kind of the tailwinds within Europe specifically on the margins over there as well.
Yes, I’d say Europe is more steady-ish goes to be honest with the pick up that’s really in North America in the biggest sense, Chris. Europe is, European market is, okay and it’s coming off along a little bit. We are still getting as but it’s no evaluated through business. Now it won’t happen till the out years if in fact we land it. It just all happens that some of our customers’ products and we all know that BW is our biggest customer over there. They are losing some share. So we are suffering a little bit in terms of some of our vehicles that we have. We have another customer launching a product having real problem launching it. We are having some Tower-specific revenue issues that are holding back a little bit our revenue and margin in Europe, but even with that we are kind of holding our own in there in that ballpark 8.5%, 9% type of margins.
Christopher Van Horn
Okay, great. Thanks again for taking the call and congrats.
Your next question comes from the line of Ryan Brinkman of JPMorgan.
You mentioned in the prepared remarks the benefit of putting to bed any investor concerns about leverage by further reducing debt and you’ve also talked about how inexpensive your stock is and the $100 million buyback certainly makes a strong statement. So, how do you think about balancing these two benefits, the benefits of share repurchase versus the benefit of further deliberate? And then if another organic growth opportunity came along with high ROI that was just too good to refuse, but would you first look to pair back on repurchase or debt reduction?
Ryan, it’s a good question. It’s one we’ve been asked a lot of times that we’ve been kind of in this repair mode over a long period of time and still demonstrating that we have the ability to grow and deal with all these things that I feel particularly good about, usually I am talking about, we’ve got one thing and we don’t have the other. Right now we’ve got them all. That’s the first time we have been able to say that I feel very good about it. I am not going to give a simple answer for that’s formula, because we are paying attention to what’s going on. Our – my view always is, you can make advancements on all fronts. You never have to pick A versus B, you can do both, in fact, that’s why you invest in more than one stock, right. So, the plan you’d see laid in front us is, if the world unfolds the way we expect it right now, we can do both. We’ll buyback stock and improve the balance sheet as shown. If the stock were to run up to $60 a share, my guess we’d buyback less stock. Most of it would go to the balance sheet at this point in time. If we have a fantastic organic growth opportunity, that is great on all sorts of fronts, yes, we maintain that type of flexibility and what we have and we won’t close our eyes to it. But importantly, we are focused right now on executing a tremendous string of business wins that we have brought in, business wins that have as, everybody will kind of recall the individual wins as they can, they were capital-intensive. So they stressed our free cash flow for sure. But they also had along with that capital-intensity above average margin. And you are seeing some margin buoyancy that’s going to come rolling through along with this new business when it comes and the combination of growth and earnings, growth and margin, positive free cash flow gives us, I’ll just say, optionality to do all three of the things that we just talked about, Ryan and we are just going to have to see how things play out to see where we think we can get the best advantage for the company’s investors.
Okay, great. Thanks, and then just as we look out to 2017, I know you termed with this outlook as sort of preliminary, but $225 million of EBITDA versus $205 this year, can you kind of walk us through at a high level? What is the primary driver of that increase? Is it really just the volume leverage on the organic growth you’ve been talking about or is there cost cut assumptions in there? Commodity assumptions, what are you kind of thinking?
It’s predominantly is we’ve talked about less of these – the less intense amount of new product-related cost. Going back to the discussion I just had with Chris Van Horn, the first half of the year weighed extremely heavily with those costs. You can see it in the second quarter, frankly, well, we didn’t pull through a higher margin and that intensity of cost associated with the new product launches will be less than the second half will continue at a similar level in next years, because now like it’s going down to zero, but it also started in the back half of last year as what the comparisons looks very good in the second half of this year and that’s why kind of carrying through from where we are in next year, already has built into it margin improvement and high implementality if you want. It’s not the volume leverage, so margins were now starting to get to the strong margin that are always embedded in these new business wins that have been covered over by the upfront cost to get them executed.
Okay, I appreciate that. And just my last question, on the slight trim to revenue for this year, is that, can you break that out how much was currency-related versus related to production? And if it is production, is there any particular region or automaker coming for the reduction, it seems like an answer to one early question maybe Volkswagen in Europe, but just curious?
Yes, Volkswagen in Europe is part of it and again they’ve lost some share over there. It did – because it’s public, I don’t – I am going to have an aversion to callout particular customers and the vehicle, but Chrysler did take a very pointed action, shall we say on some of their small cars. Let me trust there is – those sales have declined pretty importantly. We had one other Tower-specific factor. We had some tier-2 business that’s not progressed the way we had anticipated our customer hasn’t been profitable business and frankly we are giving them process, given that back to that particular customer. So it’s a modest amount of revenue and really no profit on that particular get back.
Great. Thanks so much.
And your next question comes from the line of Itay Michaeli.
I apologize if I missed this, but did you shared kind of the expected timing on the Brazil and China sale process and are the projections for 2016 that you gave last quarter still more or less intact to those assets?
The – Itay, the – when we did it, by definition we span it within 12 months. It will take a while to get these done. My own personal kind of planning, I don’t think the cash flow rise in any meaningful way into 2017. Now if that comes in quickly than that, I’ll think it is a happy surprise. But, again our net value is approximately $50 million. We think, given the nature of the particular asset and how things are going in places like Brazil, we may have to go off at somewhat of a discount. That’s why we are estimating that range of $30 million to $50 million.
That’s helpful. And then just on the 2017 outlook, can you just remind us what you are assuming roughly for CapEx next – either just a dollar amount or a percentage of revenue?
I am going to hold off if I can, Itay, I’d like to give everything at one time. I’ll tell you, we are at about $115 million, I certainly don’t do the CapEx going down meaningfully next year. That’s for sure. But give us a chance as we like to do, I’d like to give you all the items rather than just kind of pull one item out and we will do that at the back-end of the year when everybody can get a clear handle on the volumes et cetera.
Sounds good. And then just lastly, on the free cash flow, you just remind us what the assumption is both second half and for next year ballpark for the customer tooling portion of it?
Customer tooling this year is negative. We are still growing at the back half of the year. We’ll actually go negative in the third quarter some more and then come back in the fourth quarter. In fact, our $60 million of free cash flow so everybody is aware in the second half of the year is going to be all in the fourth quarter. As we look at it right now, because the tooling I anticipate it will be negative in the third quarter, but we feel very good about the fourth quarter, in part the normal seasonal working capital along with some of those tooling proceeds come in at a fairly meaningful way. Now for next year, we have built up along the tooling and then in the fourth quarter it starts turning to come in and right now and again not getting specifics on any particular number, we will have some net inflows on next year as well contributing to that $70 million goal.
Great, that’s very helpful. Thanks so much.
And your last question comes from the line of Rich Kwas of Wells Fargo Securities.
Good morning. This is Ron Jewsikow for Rich Kwas.
Good morning. I had a quick question just on the Ford inventory levels. I wanted to see if you have seen any scheduled pushback, or are you seeing any risk for the production scheduled particularly F-150 given inventory levels?
The demand that we have has been good and steady and full.
Okay, and then, just one housekeeping item. With the 2017 preliminary EBITDA guidance unchanged versus what you gave last quarter, is 370 still the relevant EPS target or is that changed with potential share repurchases?
Yes, 370 absent share repurchases, we can’t estimate, I am not going to get into a guessing game of what we might do there. So we’ve really haven’t revised, done anything further in terms of that outlook. So 370 excluding the buyback and that’s why we say depending on how it goes, it’s pretty easy to see how if we get the $4 or better.
Okay, completely understand that. Thanks for taking my questions and congrats on the quarter.
Thank you very much. Well, thank you for participating in today’s call. I’ll be around for the rest of the day if anyone has any follow-up questions.
This does conclude today’s conference call. All participants may now disconnect.
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