HZN - Horizon Global Corporation (HZN) Q3 2022 Earnings Call Transcript

Horizon Global Corporation (HZN)

Q3 2022 Results Conference Call

November 9, 2022 08:30 AM ET

Company Participants

Matt Meyer - CAO

Terry Gohl - CEO

Jian Zhou - CFO

Presentation

Operator

Good morning, everyone, and welcome to Horizon Global's Third Quarter 2022 Conference Call. My name is Sarah, and I will be your operator for today's conference. [Operator Instructions].

At this time, I'd like to introduce Matt Meyer Horizon Global's Chief Accounting Officer and Primary Investor Relations contact. Mr. Meyer, you may proceed.

Matt Meyer

Thank you, operator. Good morning, and welcome to Horizon Global's Third Quarter 2022 Conference Call and Webcast. On the call today are Terry Gohl, Horizon Global's Chief Executive Officer; and Jian Zhou, Horizon Global's Chief Financial Officer. Earlier this morning, we announced our third quarter 2022 results. The release is available on many news sites as well as in the Investor Relations section of our website at horizonglobal.com.

Turning to Slide 2. Today's presentation will include non-GAAP disclosures. These disclosures are reconciled to GAAP in the appendices to our quarterly press release and presentation, both of which are available on the Investor Relations section of our website at horizonglobal.com.

Turning to Slide 3. I'd like to remind you that statements in today's presentation will include our views about Horizon Global's future performance, which constitute forward-looking statements. These statements are subject to risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements. We described these risks and uncertainties in our risk factors and other disclosures in the company's most recently filed annual report on Form 10-K, quarterly reports on Form 10-Q and other filings with the Securities and Exchange Commission.

With that being said, I'd like to turn the call over to Horizon Global's Chief Executive Officer, Terry Gohl. Terry?

Terry Gohl

Thank you, and welcome to all of you who are participating in our call today as we review our third quarter results for 2022. As always, we welcome the many Horizon Global employees who have joined the call today. Thank you for all your efforts and dedication and providing support as we continue to address our company initiatives in the face of an extremely challenging business environment. We'd also like to extend our thanks to our stockholders, lenders and other key stakeholders. We have faced a lot of adversity throughout 2022. Your continued support is meaningful and greatly appreciated.

Turning to Slide 5 for an overview of today's presentation. In August, we announced that we would be undertaking a broad review of strategic alternatives with the ultimate objective being to maximize shareholder value. This could result in the sale of some or all of the company. This process is ongoing, and we will provide an update when appropriate. May, however, the focus will be on our Q3 2022 results and the aggressive actions we are taking to improve margin performance, overall cost structure and to position the underlying business for profitable growth. We will address these items in detail in the coming slides.

Turning to Slide 6. Simply put, our Q3 2022 performance was disappointing. On the right side of the page, you can see the company's net sales and adjusted EBITDA progression from Q3 2019 through Q3 2022. Our net sales and adjusted EBITDA are down $47.5 million and $18.9 million, respectively, from Q3 2021. The major takeaway here is volume softness during the quarter, primarily in our higher-margin non-OE sales channels. The historical selling season in Americas that we've discussed throughout the year never came to fruition.

As mentioned last quarter, our customers were holding heightened levels of inventory going into the historical season and with lower-than-expected market demand, customers continued to destock during Q3 2022. And as a result, order intake was lower from certain of our large non-OE customers. This significantly impacted sales volumes in our high-margin non-OE channels. This negative mix, along with operational inefficiencies driven by reduced volumes resulted in gross profit and adjusted EBITDA underperformance in the segment. As we will discuss later in this presentation, the primary focus is shifting our sales mix to the more profitable non-OE sales channels. As inflationary measures ease and large customer restocking ramps up, we expect this mix to shift and to enhance our margin profile. While we are currently in the off season, we expect to reap significant benefits as the market demand returns.

In our Europe-Africa segment, market conditions also drove lower-than-expected sales volumes and an unfavorable sales mix. Majority of the volume underperformance in the independent aftermarket sales channel, again, our higher-margin sales channel. We are also focused on sales mix in this segment and as described later, optimizing our geographic footprint.

Turning to Page 7. As our Q3 2022 results suggest, we are still facing significant market headwinds as well as other challenges throughout our business. We are addressing these challenges head on and making every effort to improve our commercial position and enhance our cost structure of the business. Our commercial position generally remains strong. We believe that our entire industry has been significantly impacted by market pressures with and that we have not lost any meaningful market share in any of our sales channels. As noted prior quarters, we built significant inventory in anticipation of 2022 selling season, which previously mentioned, didn't materialize. Our heightened inventory levels should serve as a competitive advantage and allow us to provide best-in-class fulfillment as our large non-OE customer demand patterns returned.

Customers continue to attribute value to our brands, innovation and quality. Customer acceptance of our pricing initiatives reflects the strength of our brands and products. This is critical to the viability of our business during times like these. While we continuously evaluate pricing versus market dynamics for the time being, we have fully implemented pricing recovery actions with our non-OE customers. Further, we have either implemented pricing or remain in active discussions with our OE customers. While pricing generally comes with a lag time, we expect the benefit of our implemented pricing actions to be fully recognized in Q1 2023 with the exception being certain specific economic price recoveries in Europe expected to be secured in Q4.

Further, we continue to launch new and exciting products and secure new businesses. We mentioned in our last quarterly call that we launched a record number of products during the first half of 2022. This activity continued in the third quarter with an additional 57 product launches. These launches are aligned with our profitable growth expectations. We continue to receive new OEM awards in connection with the ramp-up of our Brasov, Romania facility. Our capital investment plan is well underway, including successful implementation and certification of our state-of-the-art paint line. This is an example of investments made in support of significant awards secured for future platforms. All this being said, our OEM customers have been quick to recognize Brasov ability to function as a world-class Tier 1 facility and our ability to deliver best-in-class products under a competitive cost structure.

The Brasov transformation is a success story for us and will take lessons learned from this action and apply them as we continue to assess our global footprint. In the Americas segment, we have also been rewarded additional OE program awards, most notably a significant expansion of an existing program in our higher-margin electrical business. At the same time, certain legacy low-margin programs will run off in late Q4 2022. Key business initiatives continued across the organization in Q3 2022, including the refinement of our supply base and identification of opportunities with third parties in new geographies and where possible, vertical integration out of our own LCC locations.

We expect these actions to largely mitigate material availability issues with the exception of semiconductors and importantly, results in cost savings. Our port rebalancing initiatives, including sailings directly into Man's Neo Mexico is complete and resulting in lower freight costs and reduced transit times. The reduction of an additional 1,700 SKUs targeted for 2022 is virtually complete and on track for the remainder of the year. Our SKU rationalization initiative, which has resulted in the reduction of 5,900 SKUs or 53% of our product portfolio since 2018 continues to reduce complexity throughout our organization.

This initiative was focused on low-margin, slow-moving products. We are executing on our strategic initiatives to profitably increase direct import business content for the Americas, primarily for the retail sales channel. This is proving mutually beneficial for both Verizon and its customers and has resulted in margin improvement due to lower handling expense and reduced working capital based on title transferring upon departure from port of origin.

We continue to flex our workforce, discretionary spend and global purchases to reflect the significant reduction in sales volumes. These actions include a 20% reduction to our workforce in North America from Q3 2021 to Q3 2022. Year-to-date SG&A reduction of $12.1 million or 13% from the same period in 2021. Continued optimization of cost efficiencies through shift patterns and operational work days in our North American manufacturing facilities. Total costs have been flexed down 14% from manufacturing overhead perspective, a $31 million reduction in North America purchases in Q3 2022 versus Q3 2021, furlough actions in various geographies to align our workforce with market demand. All workforce-related decisions are extremely challenging and never taken lightly. However, we are focused on positioning this business to serve the market when sales demand returns to historical levels.

Let's turn to Page 8. On this slide and the next, we will look at 2 macroeconomic tailwinds that will positively impact performance going forward. Steel and freight. It's been a while since we've seen tailwinds in these areas, and we believe they will positively impact our performance going forward. specifically in relation to steel. Steel costs significantly softened in Q3 2022 from peak levels. Based on industry projections, we expect this trend to continue. The impact on our operational performance relative to steel cost is generally recognized on a 1- to 2-quarter lag, and we will experience the benefits of these cost reductions going forward. We continue to monitor steel market in light of the global economic and geopolitical issues. Steel costs should present a tailwind going forward. And together with our sourcing initiatives should be viewed as another opportunity to improve our margin performance.

Moving to Slide 9. Decreasing freight costs present another tailwind. Similar to trends in the steel market, we saw softening in freight rates throughout North America. Our average container cost in Q3 2022 is down well below second half 2021 peak rates. We expect recognition of this positive performance in Q4 2023 generally reflecting the 1 quarter lag we discussed in the past. As previously mentioned, we have implemented our port rebalancing strategy to improve freight costs, transit times and customer fulfillment. The strategies had supplement any market freight tailwind and positively impact margins going forward.

Now I'll turn it over to James for the financial review. I will return in a few minutes to provide some closing comments. James?

Jian Zhou

Thank you, Terry, and good morning, everyone. Please turn to Slide 10 for a review of the company's consolidated results for the third quarter of 2022. Consolidated net sales for the third quarter of 2022 were $149 million, a decrease of $47.5 million or 24.2% compared to the third quarter of 2021. The net sales decrease was attributable to lower sales volumes in both the Americas and Europe-Africa operating segments, primarily due to lower sales volumes in our non-OEM business. The net sales decrease also included $11.5 million of unfavorable currency translation in Europe, Africa. The decrease was partially offset by customer pricing initiatives implemented to recover increased input costs, including material and other inflationary costs we have experienced.

Gross profit margin decreased to 11.2%, down from a gross profit margin of 19.7% in the third quarter of 2021. The decrease in gross margin was primarily driven by the lower sales volume, coupled with a significant mixed shift from higher-margin sales channels to lower margin sales channels. We reported an adjusted EBITDA loss of $5.9 million comparing to adjusted EBITDA of $13 million during the third quarter of 2021. This was primarily due to the lower gross profit in performance previously mentioned.

Now let's turn to Slide 11 to review the segment performance for the quarter. Net sales in the Americas were $79.2 million. $36.6 million or 31.6% lower than the third quarter of 2021. The decrease in net sales was driven by lower sales volumes in the aftermarket, e-commerce and retail sales channels with certain customers using their existing inventory to satisfy consumer demand, coupled with material availability constraints.

However, this was partially offset by consumer price recoveries. Adjusted EBITDA for the segment decreased to an adjusted EBITDA loss of $1.4 million comparing to adjusted EBITDA of $14.5 million during the third quarter of 2021. The decrease was driven by lower sales volumes as well as a significant mix shift from higher sales margin channels to lower margin sales channels, coupled with a continuation of elevated material supply chain and other manufacturing input costs.

Transitioning to our Europe-Africa operating segment. Net sales were $69.8 million, a decrease of $10.9 million or 13.6% from the third quarter of 2021. This decrease was primarily due to lower sales volumes in the aftermarket and automotive OES self channels as well as unfavorable currency translation of $11.5 million. The decrease was partially offset by customer pricing recovery initiatives. Adjusted EBITDA loss for the segment was $0.2 million comparing to adjusted EBITDA of $3.4 million for the third quarter of 2021. This decrease was driven by lower sales volumes as well as a mix shift from higher-margin sales channels to lower-margin sale channels and unfavorable manufacturer input cost and operating inefficiencies.

Now move on to our working capital, liquidity and free cash flow on Slide 12. Total trade working capital was $99.9 million in the third quarter of 2022, which represented a decrease of $8.9 million comparing to the fourth quarter of 2021 and a decrease of $9.6 million compared to the third quarter of 2021. Specifically, receivables decreased $5.1 million to $75.6 million comparing to the fourth quarter of 2021. Days Sales Outstanding or DSO was 47%, an increase of 2 days over the fourth quarter of 2021. Inventories decreased $7.2 million to $155.6 million comparing to the fourth quarter of 2021. As of inventory on hand was 108 days, an increase of 7 days over the fourth quarter of 2021.

Accounts payable increased $4.5 million to $106.7 million comparing to the fourth quarter of 2021. Days Payable Outstanding, or DPO, was 74 days, an increase of 11 days from the fourth quarter of 2021. Cash and availability or liquidity totaled $17.5 million for the third quarter of 2022, which was compressed of $9.7 million of availability under our current facility and cash on hand of $7.8 million. This reflects a $21.7 million decrease compared to the fourth quarter of 2021 and a decrease of $37.4 million comparing to the third quarter of 2021. Primarily attributable to the use of cash flow from operations during 2022. Free cash flow year-to-date 2022 was a use of $49 million comparing to a use of $45.4 million during the same period in 2021. The use was primarily related to the company's financial performance during 2022, but generally in line with the use of free cash flow during the same period in 2021.

Turn to Slide 13 for a view of our current capital structure. Total gross debt plus redeemable preferred stock increased in aggregate by approximately $51 million from $300.9 million at the end of the fourth quarter of 2021 to $351.9 million at the end of the third quarter of 2022. This is primarily attributable to the redeemed preferred stock that was issued during the second quarter of 2022, coupled with increased ABL borrowings. With that, I will turn it back over to Terry for his closing remarks.

Terry Gohl

Thank you, James. Moving to Slide 14. In closing, our review of strategic alternatives is in process. The objective here is clear to maximize shareholder value. We look forward to providing an update when appropriate. Our financial performance in Q3 2022 was driven by a significant volume shortfall. We anticipated a strong 2022 summer selling season, consistent with historical patterns, but the season never came. We are disappointed in our results. While we feel secure in our commercial position, we are looking inward and taking aggressive action to optimize our operations and cost structure to position the company for success.

We are focused on margin improvement, and this is driving the actions we are taking. In addition to key business initiatives and cost optimization measures, all of which we've addressed at length. We'd like to further stress our belief that we are well positioned to service the non-OE sales channels as our large customers begin to restock and progress efforts to favorably shift our sales mix to these higher-margin channels. Taken together, we expect these actions to position the company for long-term sustainable growth and ultimately meet our double-digit margin target. Thank you for your attention, and I'll now turn it back to the operator for questions.

Question-and-Answer Session

Operator

Terry Gohl

Thank you, and thank you all for joining us today. We sincerely appreciate your continued support. And for those joining me here at the company today, thank you for your continued efforts to improve the company. We look forward to our next call where we'll present our Q4 results as well as full year results, and we'll see you then. Thank you very much.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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