Ladies and gentlemen, thank you for standing by, and welcome to the Commercial Vehicle Group Q3 2019 Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded.

[Operator Instructions]I would now like to hand the conference over to your speaker today, Kirk Feiler, Vice President of Corporate Development and Investor Relations. Please go ahead sir..

Thank you, Jessa, and welcome to our conference call. Joining me on the call today are Patrick Miller, President and Chief Executive Officer of Commercial Vehicle Group and Tim Trenary, Chief Financial Officer. They will provide a brief company update as well as commentary regarding our third quarter 2019 financial results.

We will then open the call up for questions. This conference call is being webcast and a supplemental earnings presentation is available on our website.

Both may contain forward-looking statements, including, but not limited to expectations for future periods regarding market trends, cost-saving initiatives and new product initiatives among others.Actual results may differ from anticipated results because of certain risks and uncertainties.

These risks and uncertainties may include, but are not limited to economic conditions in the markets in which CVG operates, fluctuations in the production volumes of vehicles for which CVG is a supplier, financial covenant compliance and liquidity, risks associated with conducting business in foreign countries and currencies and other risks as detailed in our SEC filings.And now, Pat Miller with a brief company update..

Thank you, Kirk. Good morning everyone. Operationally, our third quarter 2019 shaped up as expected, with improved productivity on basically flat revenues versus prior year, driven by strength in the North American heavy and medium-duty truck markets.

The higher truck sales were offset by continued lower sales in Asia Pacific construction market and now some softness in North American and European construction markets as well.We continue to manage some ongoing cost challenges and experienced onetime impacts related to the recent acquisition.

Taken together, these items have resulted in a decrease in operating income as compared to the third quarter of 2018.

As we discussed, the mitigating actions we've taken which Tim will talk about in his comments have lessened the impact sequentially.Importantly, during the third quarter, we announced the strategic acquisition of the assets of First Source Electronics or FSE, an electronic system integrator which will further enhance our abilities and positioning in the Electrical Systems segment for growth.

FSE complements our high complexity low to medium volume electrical business while extending our customer and market diversification. We expect FSE to be a strong growth contributor to the company.

We are just over a month into the integration and we are very pleased with how well the business and sales book for FSE are progressing.We were able to retain key employees, who are excited and engaged and we have met with various customers to introduce CVG's capabilities. We have begun to lay the groundwork for cross-selling opportunities.

FSE's customers have responded positively to our global footprint and have expressed interest in our electrical segment capabilities.We are finding that their customer base, which is predominantly in industrial automation, military and transportation has additional needs that can be supported by other areas of CVG.

We have a 100-day plan that we are working to and overall the integration is going well. Our integration efforts target those areas where CVG can provide value, while allowing FSE to continue to operate utilizing their strengths of rapid customer response and flexibility, which are critical in the industries they serve.Turning to our segments.

Revenue for the Electrical Systems segment was up $3.2 million versus the third quarter of 2018, primarily due to the FSE acquisition. While operating income was up modestly, ongoing cost challenges negatively impacted the quarter. Absent these headwinds, the business performed at an expected conversion rate.

We continue to position the Electrical Systems segment for long-term growth. This includes efforts to more effectively meet changing customer needs and diversify into new end markets and applications.Furthermore, we are making changes in the commercial processes that support organic growth and customer service.

Improving flexibility and speed are important to many current and target customers. Our ability to capitalize on short-cycle projects is a critical competitive differentiator.

Although it is early stages, we are seeing positive results from our diversification efforts including the award of low-volume projects supplying electrical components for electrical mechanical systems, including electric drivetrains where there's tremendous focus and activity.Additionally, we are working with start-up OEMs as they design new and innovative vehicle architectures, requiring products from our core portfolio, as well as new products in development.

We expect some of this work is longer-term focused, but there are some near-term revenue opportunities as soon as 2020.As the industries we serve today and those we are targeting transition to more electric driven, electronically controlled subsystems, we see increasing prospects for the electrical team to support new markets and products including control panels, electric vehicle power systems, high-speed data requirements and high-voltage applications.

There are opportunities emerging with our traditional customers and in adjacent segments, like rail, industrial applications, material handling, powertrain, specialty vehicle and bus.Turning to Global Seating.

Revenue was down $5.2 million, due mainly to continuing softening in the global construction markets we serve, partially offset by strength in the North American heavy and medium duty truck markets. Operating income was down $900,000.

The team is achieving results by delivering improved productivity, driving focused cost reductions and managing SG&A and overhead spend as volumes begin to decline.Before discussing markets, I want to mention that a team of us participated in the North American Commercial Vehicle Show this past week in Atlanta.

Almost all of the traditional and new commercial on-highway OEMs were in attendance, along with major fleets and the industry supply base.

We demonstrated new technology including innovative interior trim with integrated embedded electronic controls and lighting; seats with digital bluetooth controls, some of which were voice-activated; and electrical wiring products for electronic and electromechanical systems.While some products are in a prototype stage, others are in launch phases, such as our next-gen modular seat line, targeted to leverage global volumes across industries and across varying feature levels.

The event was a good form to spend time with customers and discuss future projects.Turning to our markets. The global construction markets in APAC have been softer much of the year and this continued in the third quarter, but may start leveling off as the market adapts to the trade issues.

However, we see signs of weakness in the European and North American construction markets. Some customers are experiencing inventory reductions in the retail chain, impacting build rates.

But the underlying economic fundamentals are mixed causing uncertainty going forward.We are preparing for potentially lower production volumes in the construction and off-road markets when compared to the run rate of the last 18 months. Of course, positive changes to the trade environment and infrastructure projects could improve this outlook.

Class 8 truck production remained strong during the third quarter. Total builds for the quarter were approximately 90,000 units.

We estimate the 2019 Class 8 production rate at approximately 345,000 units, an increase of 6% over the 2018 build rate which is consistent with ACT's projections.The full year Class 5 through 7 production rate is expected to total approximately 273,000 units, flat compared to 2018 builds.

While Class 5 through 8 truck production in North America remained elevated during the quarter, all indications point to production returning to historical replacement levels, which is supported by customer sentiment and the OEM retail truck orders. The OEMs have started to take down their production forecast.

Although, we still see potential fluctuations in the fourth quarter build rates directionally, we expect our full year 2019 sales be modestly higher than prior year, including the FSE revenues.Based on what we see today, our sales will be lower in 2020 as compared to 2019.

As we have discussed previously, we have been working to reduce the impact of the North American Class eight 8 truck by extending into other market segments. OEM truck represents approximately 50% of our sales today, with the largest portion being North America Class 8.

Medium-duty applications tend to be more vocational in nature, which typically are less cyclical, providing some hedge against the Class 8 swings. Medium-duty sales represent roughly 10% of company sales.Furthermore, we see future growth in some of the new markets that FSE is participating, also providing some mitigation.

In anticipation of this projected decline, we are aligning the business to operate at lower production levels. We are in the process of implementing various cycle plan actions to reduce variable costs and SG&A expenses.Furthermore, we are considering other fixed cost reductions that may better align with longer-term direction.

While we are managing a pullback in volumes, we remain optimistic that over the long term, we have the right strategy in place. As we have discussed, secular growth themes point to the proliferation of electrical components, electronics, connectivity and power in both current and adjacent markets.

As such, we continue to position CVG as a more focused and increasingly valued supplier in growing markets with differentiated offerings, which we expect will accelerate long-term profitable growth.With that, I will turn the call over to Tim who will go through the financials in more detail..

Thank you, Pat. Third quarter 2019 consolidated revenues were $225.4 million in line with the prior year period of $225 million. Continued strength in the North American heavy and medium-duty truck markets was mostly offset by weakness in the global construction markets we serve.

FSE which was acquired late in the quarter contributed $2.5 million to revenues.

Foreign currency translation adversely impacted third quarter consolidated revenues by $2.1 million or by 0.9% when compared to the prior year period.Consolidated operating income for the third quarter of 2019 was $13.2 million or 5.9% of sales compared to $16.2 million or 7.2% of sales in the prior year period.

The decrease in operating income largely resulted from inflationary pressure on material and labor costs and an increase in SG&A.

Cost control and cost recovery actions reduced the impact on gross profit at these pressures.The Border Minimum Wage in Mexico, costs associated with a troubled supplier and manufacturing investments impacted third quarter results by approximately $1.1 million. The impact of these costs on the company have moderated.

SG&A expenses in the third quarter were $17.5 million compared to $15.6 million in the prior year period.This increase largely resulted from $0.7 million of costs associated with a strategic reorganization of the company earlier in the year to develop a platform from which to pursue business and corporate development activities.

Additionally, third quarter SG&A expenses include $0.9 million of transaction costs associated with the FSE acquisition.Interest and other expense was $3.8 million in the third quarter of 2019 compared to $3.4 million in the third quarter of 2018.

This increase is primarily the result of the mark-to-market of the interest rate swap agreements, partially offset by lower interest expense.

Consolidated net income in the third quarter of 2019 was $8.5 million or $0.28 per diluted share compared to net income of $12.6 million or $0.41 per diluted share in the prior year period.Turning now to our segment results.

For the third quarter 2019, Electrical Systems revenues were $131.4 million compared to $128.2 million in the prior year period. That's an increase of 2.5%. The increase was primarily due to the acquisition of FSE.Foreign currency translation negatively impacted electrical systems revenue by $0.7 million in the third quarter.

The Electrical Systems segment generated $14.6 million of operating income in the third quarter 2019 or 11.1% of sales compared to $14.3 million or 11.2% of sales in the prior year period.

The increase in operating income is primarily due to the higher sales partially offset by the Mexico Border Minimum Wage, costs associated with the troubled supplier and the manufacturing investments.Moving now to the Global Seating segment. Revenues were $95.7 million compared to $101 million in the prior year period.

This decline in revenues is primarily due to lower sales in the global construction equipment markets partially offset by higher revenues from the North American heavy and medium-duty truck markets.Foreign currency translation negatively impacted Global Seating revenue by $1.4 million in the quarter.

Global Seating segment operating income decreased during the third quarter of 2019 to $7.2 million or 7.5% of sales compared to $8.1 million or 8% of sales in the prior year period.

Decrease in operating income period-over-period is primarily attributable to lower sales in the quarter.As regards to the company's tax provision, the quarter benefited from $2.1 million of period specific adjustments associated with the amendment of certain income tax returns to reflect foreign tax credits.

We anticipate the company's full year effective tax rate to be in the range of 19% to 23%.For the nine months ended September 30, 2019, capital expenditures totaled $19.3 million higher than recent historical spend primarily because of manufacturing investments in the electrical segment.

We now expect capital expenditures to be in the range of $23 million to $25 million for the year. We expect to return to more normal levels of spend in 2020.In the third quarter, we amended the company's third amended and restated loan and security agreement, upsizing the revolving credit facility to $90 million from $65 million.

As of quarter end there were no borrowings under the facility and liquidity was $109.2 million $38.7 million of cash and $70.5 million of availability from our asset based revolver.This concludes our prepared remarks. I'll now turn the call over to Jessa..

Thank you. [Operator Instructions] And your first question comes from the line of Mike Shlisky from Dougherty & Company. Please go ahead..

Good morning, gentlemen..

Hi, Mike..

Hi, Mike..

So I know it's early you just bought FSE not too long ago, but can you give us a sense because you've been to the facility of short or recently.

Anything you can tell us about the culture there how you think it fits? Also do you think there's any operation changes that have been made there as far as their footprint? And also are there any earlier forecasts as to what you can get as far as synergies from the deal?.

Okay. So let's start with the first part here culture and the fit. So part of the reason that we made the acquisition is because we liked the culture there. They have a very -- a great relationships and rapport partnerships with their customer base.

And when we interviewed the customers during diligence it was pretty incredible to hear them talk about their relationship.We are borrowing some of their methods and methodologies. I mentioned a little bit in my earlier remarks about the way that they have rapid response.

They're able to satisfy customer needs in short-cycle type projects, which tend to really fit with some of the other parts of our business.

And so we are adopting some of their capabilities and trying to transform around.As far as the footprint goes, their footprint we've been in the midst of even expanding just where they are with some of the work that they have upcoming. We don't see any major changes to their footprint.

What we do see even in early days is some synergy on supply components from some of our other facilities so being able to in-source some things not purchase them.And also some of their newer customers which are still in the works we may have some landed cost effort that we can do from some of our other locations.

So there is no major changes expected to their operation. What we're trying to do is ensure that we have a light-touch integration that allows them to keep the momentum going that they have going..

Okay.

And can you tell us how does FSE fit into your long-term framework of 20% to 25% operating pull-through for the broader company? Are they in the same bandwidth there? And if not do you think you can get them there?.

So the question Mike is whether FSE's pull-through variable contribution margin financial performance is similar to the company is with right now is that the question?.

Yes.

And if not can you eventually make that happen?.

It's pretty simple. It's very comparable to our current, sort of, financial profile and more specifically the variable contribution margin..

In the electrical segment..

In the electrical segment..

Okay. Fair enough. And now just moving on to the broader CVG guide.

Can you give us a little bit more color on the troubled supplier issue? I guess I'm kind of curious what's changed from last quarter to this quarter what have you done to kind of mitigate the impact here?.

Well, not a lot has changed except for one thing. The supplier remains in Chapter 11 reorganization. The supplier continues to develop its plan of reorganization and the company our company continues to negotiate with the supplier in good faith to arrive at a long-term supply agreement.

What -- and so what we're really waiting for is the plan of reorganization and the culmination of the negotiations on that long-term supply agreement.What has changed Mike is that, the company CVG has been working with the supplier to stabilize -- help the suppliers to stabilize its manufacturing operations and more specifically, its supply to our facility in Kings Mountain.The supply instabilities over primarily, the first, second and a little bit into the third quarter were adversely affecting our manufacturing operations and productivity.

So we've managed to work with the supplier to reduce the impact of it on the company. And that's largely what has reduced the impact to date..

I think, I would just add one thing to Tim's comment..

Okay..

Working with the supplier we were able to resource some parts of that business that they were not performing so well on. And that was part of the improvement into other supply channels and partners, so all of those things help contribute to our improvement, on our side, on the productivity side, and the quality and delivery, from the supply chain.

Also helped mitigate our....

Okay. Also you mentioned, the NACV Show in the slides and in your comments and I'm glad it went so well, so many follow-up offline about some of the class that were shown there.

But that was a Q4 show.So from a modeling perspective, are there any elevated marketing costs we need to know in for Q4? And then similarly, is there anything you need to be modeling in during Q1 for the CONEXPO Show that's only, I think once every three years?.

You mean from a cost standpoint?.

Correct, the cost standpoint..

Yeah. No. I think that was well within our normal running rate. The show doesn't -- being in Atlanta it doesn't cost us too much to get our team there. And put our booths together. We do most of the work ourselves and in-house. So I don't think that's material really..

Okay and the same thing for CONEXPO coming up in the first quarter?.

I would say the same thing for CONEXPO..

Okay, perfect. Maybe one last one for me, I guess, I'm just -- kind of a broader view Pat do you think that both in trucks as well as construction.

If next year is more of a year of equipment used rather than buying new equipment, do you think that there are some additional opportunities for aftermarket next year?.

Well we're always working on our aftermarket business to further that side of the company. We have been having some success. And in the actual pull-through side and our fleet support with some of the bigger fleets out there.

We continue to emphasize that side.I count that as aftermarket because of the -- that's the same group really that participates there. But when we look at -- I've -- historically for our product lines we've not seen large increases or decreases on the aftermarket side in relationship to the build rates on the OEM side..

Okay, okay. Fair enough. I leave it there guys. I'll back in a queue. Thank you so much..

Thank you, Mike..

[Operator Instructions] There are no further questions -- oh! We have a follow-up question from Mike Shlisky from Dougherty & Company. Please go ahead..

Hey guys. Well if it's just me, I'll ask one or two more, if you don't mind. I'm not sure. But let me just ask one other one here. So I do appreciate that the FSE deal was a good-sized deal. It's great to see it. But I assume you do have some more room on the balance sheet.You have more room in debt agreements.

You have some more room hopefully some good free cash flow coming if inventories are reduced across the entire channel at some point over the next couple of quarters.Could you give us a sense as to whether you might pursue something additional in the near-term? And if so, what kind of companies are you currently looking at these days?.

Hi. It's Tim, Mike. We're very pleased with the establishment of the business and corporate development function earlier in the year.

We thought it was a wonderful investment of resources and believed that the acquisition of FSE is a reflection of that belief.Accordingly, we – notwithstanding, that the cycle is going to turn here a little bit we intend to continue to maintain that investment in that group. And that group is very small group. I shouldn't say group.

It's really two people. Or I continue to be focused on flushing out possible opportunities for the company.I would say that the opportunities that we're looking for are exactly like that which gave rise to FSE. So we will continue to explore those possible opportunities, develop the M&A pipeline.

And we will see what comes out of that.I do hope something of -- some value-accretive opportunity comes out of it. And with respect to the balance sheet and the company's financing have any possible acquisition, we'll evaluate how best to undertake that at that time..

I would just….

Sure..

… add a little color. So as we have -- we feel like we've got a pretty good handle, on the types of categories that we are filtering through our system.

And as we look at the technology road map and where we're at with our electrical and electronics business and the kinds of things that could help facilitate more participation in that.So, in and around that space, is certainly one of our criteria points.

And as we see that, the market continue to develop electric and electronic the traditional markets that we're in, are pursuing electric and electronic controlled mechanical devices within their equipment these subsystems.It is going to continue to foster opportunities for us, both inorganically but also organically.

So we have also made some of the investments in what I would call evolutionary products to what we do today to help fill some of those needs. So I think we're on the right path. And if the right opportunity presents itself then we would try to move forward..

And on the organic front and you did put some commentary out there last quarter. I didn't hear much of the same this quarter.

Where there any appreciable new contract or new platform or kind of new customer wins that we should be kind of aware of in the quarter?.

Well I think, we mentioned a few things. I don't know that they've been -- we're in a position to be able to announce certain wins. But I thought a couple of them were worth mentioned anecdotally, related to some of the new technology.So what we're seeing is opportunities to get involved with the electric-driven powertrain vehicles.

And so we've had -- we have a couple of pieces of business now in and around that space. And as we can tell more publicly we will.And we also have a lot of interactions with some of the new OEMs that are coming into the scene. I think it stands to be determined, how they progress.

But we feel it's very important that we're involved with them at an early stage. And help them with anything that we can do, within our portfolio..

Great stuff, perhaps one last one and this is for Tim here. So that's my other question about free cash and inventories.

If you're going into a downturn or a lighter environment a more normalized Class eight environments at the very least in 2020.Do you anticipate any liquidation of the working capital? Could you give us any kind of sizing as to what you think you might see if they were take place?.

Yes. We absolutely do intend to harvest some working capital off the balance sheet where we've a demonstrated ability to do so. In terms of the magnitude of that, Mike.

One -- I think, the best way to look at this simplest way, and I think an effective way in terms of a high level modeling is to assume that the working capital, the company's working capital receivables plus inventory, plus the payables, is approximately 15% to 16% of the trailing annual sales, okay.So as we go into this down cycle, it doesn't happen immediately, especially with respect to the inventory.

And obviously the receivables and the payables trail depending on the terms.But we will endeavor to manage that working capital down harvest it off the balance sheet, turn it into cash at the rate of about 15% to 16%, at trailing 12-month sales..

And do you take that cash and do you basically go right to your debt to flex it up and down? Or is there a different use that you see for that kind of cash going forward?.

It's -- okay. So, we're a global company obviously, and so some of that harvesting will occur in the foreign affiliates very round numbers, 75% of the companies domestic 25% foreign. So about 3/4 of that cash will sit on the balance sheet, the balance sheet in the U.S. entities.

And at this point in time, the plan is to leave it there for the moment and use it for general corporate activities including possibly some M&A -- an M&A opportunity if it presents itself..

So, let's hope that the harvesting is only temporary, guys. Thank you so much for the answers. Appreciate it..

Thank you, Mike..

Thanks Mike for joining..

Your next question comes from the line of Chris Howe from Barrington Research. Please go ahead..

Good morning, everyone..

Hi, Chris..

Good morning, Chris..

Good morning. No specific order, just starting with some of the commentary you made about power systems high-speed data, high-voltage and then your follow-on comments with regard to industries served.

Can you dig a little bit deeper, perhaps talk more about which areas, whether it be by system type or industry served where you're seeing greater acceleration versus the others? And which environments provide perhaps greater opportunity for gaining market share?.

Okay. I don't know that I can compare the industries as far as the speed of conversion.

But what we see is very similar activities whether it’d be some of our current traditional vehicle builders or whether it's an industrial applications, but as you move to more electronically controlled automation either on the industrial side or electronically controlled mechanical systems inside a particular vehicle, it is driving the need for higher voltage systems, which results in needing high-voltage cable -- cabling which is some of the investments that we've been making here recently are developing better capabilities to help support that growth.When we look at each of these systems now generating information and communicating with the various systems within a vehicle or within the architecture of an industrial project, then now you've got to have data cables, coaxial cables of different types running between those things.

And so, it's proliferating the need for that type of application. So, that's within our traditional business. When we see -- we have done in the past some control panel, building and FSE brings a skill set in that arena.And so most of these things require, varying sizes and complexity depending on what the application is of the control panels.

And all of those things are just proliferating. So, I'm not sure I can give you comments about the speed of which area is growing the fastest as far as those items are concerned. But what we see is it's very similar.

The OEMs making vehicles are driving toward that type of space, and it's creating certain types of requirements for products that maybe -- might have -- some of have existed but not in the same quantities.We see shorter-term opportunities in some of the new markets that we're targeting because of the project faster. Right, the lead time is shorter.

So things like the industrial automation space is moving very rapidly, as these large logistic companies convert their warehouses to automating -- material handling systems. We're seeing the same thing with some of the smaller OEMs as they move toward their systems.

So, traditionally I think our larger customers are trying to move quickly, but their systems tend to have a bit of a lag just inherent in the validation and testing for their type of equipment.So, I think from a -- how fast it can impact us in a positive way, some of these other areas and segments that we're getting into probably have a shorter cycle where they can help us and help us participate in that revenue generation..

Okay. Okay. And you talked about -- just following-up on some of the previous questions that were asked.

The variable contribution margin of FSE being similar to the business within Electrical Systems, can you comment on the M&A environment? In other words, what type of opportunities would represent superior variable contribution margins to Electrical Systems? Are those opportunities out there? Or should we look at the recent acquisition? It's kind of a benchmark plus or minus.

What's normal in the industry for electrical systems?.

Well, that's a broad question. Now here's the way I think I would answer it. The portfolio of opportunities that we're looking at they vary, but they're not -- they don't vary dramatically. So what I would suggest Chris is if you want to sort of think about how any future acquisition might impact the company's variable contribution margin.

For the moment, I would assume that it would be comparable..

I would -- I understand what Tim is saying here. But I would also add that as we move up that technology curve and the real differentiator is whether you are inputting software -- developing software inside the hardware. And so, we are mostly on the hardware side of things today even though we may -- FSE may interact on the software side.

They're not necessarily owners or the IP of that software.As you move up that curve, just maybe another notch, you start to see some licensed control software. And when you get into that the margins do get better. And so I think that as we grow our capability, I think there's opportunities for that.

But certainly when you're on the other side, it's in the range of where we are..

Okay. Okay. And also on FSE, you mentioned your revenue mix before -- between industrial, military and transport.

Can you talk about this revenue mix and how you see it evolving over time, specifically within commercial vehicle groups FSE and for the business as a whole?.

Well, I'm not sure that we have. Today, I think their revenue mix is more heavily weighted toward the industrial automation side. That is a very -- a dynamic market right now. And therefore they get -- they're getting a bigger growth side. Their growth is skewed towards that side. They continue to participate in the military as well.

And so I think those -- I think we've shared this publicly a little bit of a split of where they're at. And so today that Industrial automation side is growing, and so it continues to remain a bigger part of their pie. We think as we start to share customer basis we may see some pickup for them on the transportation side.

And we would hope to see the opposite effect for the core CVG business..

Okay, great. That’s all I have for now, and I hop back in the queue. Thanks..

Okay. Thanks, Chris..

There are no further questions at this time. I turn the call back over to Mr. Miller for closing remarks..

Okay. Well, I want to thank everybody for joining the call today. We've got some challenges, which we've discussed today, but I think we've demonstrated in the past, we understand how to manage those challenges.

And we're doing a lot of the right things as we believe to follow our strategy as the markets that we're pursuing tend to -- are tending to grow. So, look forward to future opportunities, discuss those with you and have a nice day..

Thank you. And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect..