Cooper-Standard Holdings Inc.: Form 10-Q for the period ended Mar 31, 2015

This Management’s Discussion and Analysis of Financial Condition and Results of Operations presents information related to the condensed consolidated results of operations of the Company, including the impact of restructuring costs on the Company’s results, a discussion of the past results and future outlook of each of the Company’s segments, and information concerning both the liquidity and capital resources of the Company. The following discussion and analysis, which should be read in conjunction with our condensed consolidated financial statements and the notes included elsewhere in this report, contains certain forward-looking statements relating to anticipated future financial condition and operating results of the Company and its current business plans. In the future, the financial condition and operating results of the Company could differ materially from those discussed herein and its current business plans could be altered in response to market conditions and other factors beyond the Company’s control. Important factors that could cause or contribute to such differences or changes include those discussed elsewhere in this report (see “Forward-Looking Statements” below) and in our 2014 Annual Report (see Item 1A. Risk Factors).

Business Environment and Outlook

Our business is directly affected by the automotive build rates in North America, Europe, South America and Asia Pacific. New vehicle demand is driven by macro-economic and other factors, such as interest rates, manufacturer and dealer sales incentives, fuel prices, consumer confidence, employment levels, income growth trends, government and tax incentives, as well as life expectancy.

Details on light vehicle production in certain regions for the three months ended March 31, 2014 and 2015 are provided in the following table:

(In millions of units)

(1) Production data based on IHS Automotive, March 2015.

(2) Production data for 2014 has been updated to reflect actual production levels.

The expected annualized light vehicle production volumes for 2015, compared to the actual production volumes for 2014 are provided in the following table:

(In millions of units)

(1) Production data based on IHS Automotive, March 2015.

The expected light vehicle production volume for the second quarter of 2015, compared to the actual production volumes for the second quarter of 2014 are provided in the following table:

(In millions of units)

(1) Production data based on IHS Automotive, March 2015.

Competition in the automotive supplier industry is intense and has increased in recent years as OEMs have demonstrated a preference for stronger relationships with fewer suppliers. There are typically three or more significant competitors and numerous smaller competitors for most of the products we produce. Automotive suppliers with a global manufacturing footprint capable of fully servicing customers around the world will continue to shape the success of suppliers going forward.

OEMs have shifted some research and development, design and testing responsibility to suppliers, while at the same time shortening new product cycle times. To remain competitive, suppliers must have state-of-the-art engineering and design capabilities and must be able to continuously improve their engineering, design and manufacturing processes to effectively service the customer. Suppliers are increasingly expected to collaborate on, or assume the product design and development of, key automotive components and to provide innovative solutions to meet evolving technologies aimed at improved emissions and fuel economy.

Pricing pressure has continued as competition for market share has reduced the overall profitability of the industry and resulted in continued pressure on suppliers for price concessions. Consolidations and market share shifts among vehicle manufacturers continues to put additional pressures on the supply chain. These pricing and market pressures, along with reduced production volumes in certain regions, continue to drive our focus on reducing our overall cost structure through lean initiatives, capital redeployment, restructuring and other cost management processes.

Results of Operations

(dollar amounts in thousands)

Three Months Ended March 31, 2015 Compared with Three Months Ended March 31, 2014

Sales. Sales were $800.1 million for the three months ended March 31, 2015 compared to $837.6 million for the three months ended March 31, 2014, a decrease of $37.5 million, or 4.5%. Sales were impacted by unfavorable foreign exchange of $77.0 million, decreased volumes in North America and South America and customer price concessions. These items were partially offset by increased volumes in Europe and Asia Pacific and our Shenya acquisition.

Cost of Products Sold. Cost of products sold is primarily comprised of material, labor, manufacturing overhead, depreciation and amortization and other direct operating expenses. Cost of products sold was $669.2 million for the three months ended March 31, 2015 compared to $703.3 million for the three months ended March 31, 2014, a decrease of $34.1 million, or 4.8%. Raw materials comprise the largest component of our cost of products sold and represented approximately 49% and 50% of total cost of products sold for the three months ended March 31, 2014 and 2015, respectively. The three months ended March 31, 2015 was impacted by decreased volumes in North America and South America and continuous improvement savings. These items were partially offset by increased volumes in Europe and Asia Pacific and our Shenya acquisition.

Gross Profit. Gross profit for the three months ended March 31, 2015 was $130.9 million compared to $134.3 million for the three months ended March 31, 2014, a decrease of $3.4 million, or 2.5%. As a percentage of sales, gross profit was 16.0% and 16.4% for the three months ended March 31, 2014 and 2015, respectively. The increase in gross profit margin was driven primarily by increased continuous improvement and material cost savings and increased volumes in Europe and Asia Pacific.

These items were partially offset by unfavorable foreign exchange and decreased volumes in North America and South America.

Selling, Administration and Engineering. Selling, administration and engineering expense for the three months ended March 31, 2015 was $76.3 million, compared to $79.6 million for the three months ended March 31, 2014, but remained flat at 9.5% of sales.

Restructuring. Restructuring charges were $18.8 million for the three months ended March 31, 2015, compared to $3.1 million for the three months ended March 31, 2014. The increase is primarily due to expenses incurred related to our recently announced European restructuring initiative.

Interest Expense, Net. Net interest expense of $9.2 million for the three months ended March 31, 2015 resulted primarily from interest and debt issuance amortization recorded on the Term Loan Facility. Net interest expense of $15.0 million for the three months ended March 31, 2014 consisted primarily of interest and debt issuance amortization recorded on the Senior Notes and Senior PIK Toggle Notes.

Other Income, Net. Other income for the three months ended March 31, 2015 was $11.1 million, which consisted of the gain from the remeasurement of previously held equity interest in Shenya of $11.6 million, partially offset by $0.5 million for foreign currency losses and a loss on sale of receivables. Other income for the three months ended March 31, 2014 consisted primarily of foreign currency gains of $0.5 million and loss on sale of receivables of $0.5 million.

Income Tax Expense. For the three months ended March 31, 2015, we recorded an income tax expense of $14.7 million on earnings before income taxes of $35.9 million. This compares to an income tax expense of $12.1 million on earnings before income taxes of $33.4 million for the same period of 2014. The higher effective tax rate for the three months ended March 31, 2015 as compared to the three months ended March 31, 2014 is a result of losses due to restructuring in foreign jurisdictions where we cannot record a tax benefit due to valuation allowances offset by a discrete benefit on the remeasurement of the Company's investment in Shenya. The income tax rate for the three months ended March 31, 2015 varies from statutory rates due to income taxes on foreign earnings taxed at rates lower than the U.S. statutory rate, the inability to record a tax benefit for pre-tax losses in certain foreign jurisdictions to the extent not offset by other categories of income, a discrete benefit on the remeasurement of the Company's investment in Shenya, tax credits, income tax incentives, withholding taxes, and other permanent items. Further, the Company’s current and future provision for income taxes may be impacted by the recognition of valuation allowances in certain countries. The Company intends to maintain these allowances until it is more likely than not that the deferred tax assets will be realized.

Segment Results of Operations

The following table presents sales and segment profit (loss) for each of the reportable segments for the three months ended March 31, 2014 and 2015:

(dollar amounts in thousands)

Three Months Ended March 31, 2015 Compared with Three Months Ended March 31, 2014

North America. Sales for the three months ended March 31, 2015 decreased $15.2 million, or 3.5%, compared to the three months ended March 31, 2014, primarily due to unfavorable foreign exchange of $9.5 million, a decrease in sales volume, and customer price concessions. Segment profit for the three months ended March 31, 2015 increased by $4.6 million, primarily due to the favorable impact of continuous improvement and material cost savings, partially offset by decreased sales volume, unfavorable foreign exchange and customer price concessions.

Europe. Sales for the three months ended March 31, 2015 decreased $41.3 million, or 13.4%, compared to the three months ended March 31, 2014, primarily due to unfavorable foreign exchange of $58.8 million and customer price concessions, partially offset by an increase in sales volume. Segment loss increased by $1.3 million, primarily due to the unfavorable foreign exchange, higher staffing costs, and customer price concessions, partially offset by the gain from the remeasurement of a previously held equity interest in Shenya as the legal ownership was held by one of our Europe entities, continuous improvement and material cost savings and increased sales volume.

South America. Sales for the three months ended March 31, 2015 decreased $9.6 million, or 24.1%, compared to the three months ended March 31, 2014, primarily due to unfavorable foreign exchange of $7.3 million and a decrease in sales volume. Segment loss for the three months ended March 31, 2015 increased by $2.6 million, primarily due to unfavorable foreign exchange, decrease in sales volume and higher other operating expenses.

Asia Pacific. Sales for the three months ended March 31, 2015 increased $28.6 million, or 50.1%, compared to the three months ended March 31, 2014, primarily due to the Shenya acquisition which was completed February 27, 2015, and increased sales volume. Segment profit for the three months ended March 31, 2015 increased $1.8 million, primarily due to increased sales volume, the Shenya acquisition and the favorable impact of continuous improvement and material cost savings, partially offset by customer price concessions and higher other operating expense.

Liquidity and Capital Resources

Short and Long-Term Liquidity Considerations and Risks

We intend to fund our ongoing capital and working capital requirements through a combination of cash flows from operations, cash on hand and borrowings under our Senior ABL Facility, in addition to certain receivable factoring. The Company utilizes intercompany loans and equity contributions to fund its worldwide operations. There may be country specific regulations which may restrict or result in increased costs in the repatriation of these funds. See Note 6. “Debt” to the condensed consolidated financial statements for additional information.

Based on our current and anticipated levels of operations and the condition in our markets and industry, we believe that our cash on hand, cash flow from operations and availability under our Senior ABL Facility will enable us to meet our working capital, capital expenditures, debt service and other funding requirements for the next twelve months. However, our ability to fund our working capital needs, debt payments and other obligations, and to comply with the financial covenants, including borrowing base limitations under our Senior ABL Facility, depends on our future operating performance and cash flow and many factors outside of our control, including the costs of raw materials, the state of the overall automotive industry and financial and economic conditions and other factors. Any future acquisitions, joint ventures or other similar transactions will likely require additional capital and there can be no assurance that any such capital will be available to us on acceptable terms, if at all.

Cash Flows

Operating Activities. Net cash used in operations was $9.5 million for the three months ended March 31, 2015, which included $50.0 million of cash used that related to changes in operating assets and liabilities. The use of cash related to operating assets and liabilities was primarily a result of increased accounts receivables and inventories, partially offset by increased accounts payable and accrued liabilities. Net cash provided by operations was $3.9 million for the three months ended March 31, 2014, which included $56.6 million of cash used that related to changes in operating assets and liabilities.

Investing Activities. Net cash used in investing activities was $73.5 million for the three months ended March 31, 2015, which consisted primarily of $51.3 million of capital spending and $24.4 million for the Shenya acquisition, offset by proceeds of $2.2 million for the sale of fixed assets and other. Net cash used in investing activities was $60.7 million for the three months ended March 31, 2014, which consisted primarily of $63.8 million of capital spending, offset by a $1.0 million return on equity investments and proceeds of $2.1 million from the sale of fixed assets and other. We anticipate that we will spend approximately $185.0 million to $200.0 million on capital expenditures in 2015.

Financing Activities. Net cash used in financing activities totaled $6.7 million for the three months ended March 31, 2015, which consisted primarily of an increase in short term debt of $2.4 million, payments on long-term debt of $1.9 million and taxes withheld and paid on employees' share based awards of $1.0 million, and the the purchase of noncontrolling interests $1.3 million. Net cash provided by financing activities totaled $9.6 million for the three months ended March 31, 2014, which consisted primarily of $4.6 million related to the exercise of stock warrants and increases in short and long-term debt of $2.3 million and $4.4 million, respectively, partially offset by taxes withheld and paid on employees' share based awards of $0.9 million and debt issuance costs of $0.7 million.

Non-GAAP Financial Measures

In evaluating our business, management considers EBITDA and Adjusted EBITDA as key indicators of our operating performance. Our management also uses EBITDA and Adjusted EBITDA:

• because similar measures are utilized in the calculation of the financial covenants and ratios contained in our financing arrangements;
• in developing our internal budgets and forecasts;
• as a significant factor in evaluating our management for compensation purposes;
• in evaluating potential acquisitions;
• in comparing our current operating results with corresponding historical periods and with the operational performance of other companies in our industry; and
• in presentations to the members of our board of directors to enable our board of directors to have the same measurement basis of operating performance as is used by management in their assessments of performance and in forecasting and budgeting for our company.

In addition, we believe EBITDA and Adjusted EBITDA and similar measures are widely used by investors, securities analysts and other interested parties in evaluating our performance. We define Adjusted EBITDA as net income (loss) plus income tax expense (benefit), interest expense, net of interest income, depreciation and amortization or EBITDA, as adjusted for items that management does not consider to be reflective of our core operating performance. These adjustments include, but are not limited to, restructuring costs, impairment charges, non-cash fair value adjustments, acquisition related costs, non-cash stock based compensation and non-cash gains and losses from certain foreign currency transactions and translation.

We calculate EBITDA and Adjusted EBITDA by adjusting net income (loss) to eliminate the impact of a number of items we do not consider indicative of our ongoing operating performance. You are encouraged to evaluate each adjustment and the reasons we consider it appropriate for supplemental analysis. EBITDA and Adjusted EBITDA are not financial measurements recognized under U.S. GAAP, and when analyzing our operating performance, investors should use EBITDA and Adjusted EBITDA in addition to, and not as alternatives for, net income (loss), operating income, or any other performance measure derived in accordance with U.S. GAAP, nor as an alternative to cash flow from operating activities as a measure of our liquidity. EBITDA and Adjusted EBITDA have limitations as analytical tools, and they should not be considered in isolation or as substitutes for analysis of our results of operations as reported under U.S. GAAP. These limitations include:

• they do not reflect our cash expenditures or future requirements for capital expenditure or contractual commitments;
• they do not reflect changes in, or cash requirements for, our working capital needs;
• they do not reflect interest expense or cash requirements necessary to service interest or principal payments under our Term Loan Facility and Senior ABL Facility;
• they do not reflect certain tax payments that may represent a reduction in cash available to us;
• although depreciation and amortization are non-cash charges, the assets being depreciated or amortized may have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect cash requirements for such replacements; and
• other companies, including companies in our industry, may calculate these measures differently and, as the number of differences in the way companies calculate these measures increases, the degree of their usefulness as a comparative measure correspondingly decreases.

In addition, in evaluating Adjusted EBITDA, it should be noted that in the future we may incur expenses similar to the adjustments in the below presentation. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items.

The following table provides a reconciliation of EBITDA and Adjusted EBITDA to net income, which is the most comparable financial measure in accordance with U.S. GAAP:

(dollar amounts in millions)

(1) Gain on remeasurement of previously held equity interest in Shenya.

(2) Includes non-cash restructuring and is net of noncontrolling interest.

(3) Write-up of inventory to fair value for the Shenya acquisition.

(4) Non-cash stock amortization expense and non-cash stock option expense for grants issued at emergence from bankruptcy.

Recent Accounting Pronouncements

See Note 1. “Overview” to the condensed consolidated financial statements included elsewhere in this Form 10-Q.

Forward-Looking Statements

This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of U.S. federal securities laws, and we intend that such forward-looking statements be subject to the safe harbor created thereby. We make forward-looking statements in this Quarterly Report on Form 10-Q and may make such statements in future filings with the SEC. We may also make forward-looking statements in our press releases or other public or stockholder communications. These forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, future revenue or performance, capital expenditures, financing needs, plans or intentions relating to acquisitions, business trends, and other information that is not historical information and, in particular, appear under “Management’s Discussion and Analysis of

Financial Condition and Results of Operations,” “Risk Factors,” and “Business Environment and Outlook.” When used in this report, the words “estimates,” “expects,” “anticipates,” “projects,” “plans,” “intends,” “believes,” “forecasts,” or future or conditional verbs, such as “will,” “should,” “could,” or “may,” and variations of such words or similar expressions are intended to identify forward-looking statements. All forward-looking statements, including, without limitation, management’s examination of historical operating trends and data are based upon our current expectations and various assumptions. Our expectations, beliefs, and projections are expressed in good faith and we believe there is a reasonable basis for them. However, no assurances can be made that these expectations, beliefs, and projections will be achieved. Forward-looking statements are not guarantees of future performance and are subject to significant risks and uncertainties that may cause actual results or achievements to be materially different from the future results or achievements expressed or implied by the forward-looking statements.

The risks, uncertainties, and other important factors that could cause our actual results to differ materially from the forward-looking statements in this report include, among others: prolonged or material contractions in automotive sales and production volumes, the Company's liquidity, the viability of the Company's supply base and the financial conditions of the Company's customers; loss of large customers or significant platforms; foreign currency exchange rate fluctuations; the Company’s substantial indebtedness; the Company's ability to obtain financing in the future; ability to generate sufficient cash to service all of the Company's indebtedness; operating and financial restrictions imposed on the Company by the credit agreements governing the Company’s term loan and ABL facilities; underfunding of pension plans; availability and increasing volatility in costs of manufactured components and raw materials; escalating pricing pressures; the Company's ability to meet significant increases in demand; the Company's ability to successfully compete in the automotive parts industry; risks associated with the Company's non-U.S. operations; ability to control the operations of the Company's joint ventures for the Company’s sole benefit; effectiveness of continuous improvement programs and other cost savings plans; product liability, warranty and recall claims that may be brought against the Company; work stoppages or other labor conditions; natural disasters; ability to meet the Company's customers' needs for new and improved products on a timely or cost-effective basis; the possibility that the Company's acquisition strategy may not be successful; the ability of the Company's intellectual property portfolio to withstand legal challenges; a disruption in, or the inability to successfully implement upgrades to, the Company's information technology systems; compliance with environmental, health and safety laws and other laws and regulations; the volatility of the Company's annual effective tax rate; significant changes in discount rates and the actual return on pension assets and other factors; the possibility of future impairment charges to the Company's goodwill and long-lived assets; the concentration of stock ownership which may allow a few owners to exert significant control over the Company; stock volatility; and dependence on the Company's subsidiaries for cash to satisfy the obligations of the holding Company. See Item 1A. Risk Factors, in our 2014 Annual Report for additional information regarding these and other risks and uncertainties. There may be other factors that may cause our actual results to differ materially from the forward-looking statements.

All forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this report and are expressly qualified in their entirety by the cautionary statements included in this report. We undertake no obligation to update or revise forward-looking statements to reflect events or circumstances that arise after the date made or to reflect the occurrence of unanticipated events.

There have been no material changes to the quantitative and qualitative information about the Company’s market risk from those previously disclosed in the Company’s 2014 Annual Report.

Evaluation of Disclosure Controls and Procedures

The Company has evaluated, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Report. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Based on that evaluation, the Company’s Chief Executive Officer along with the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this Report.

Changes in Internal Control over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting during the quarter ended March 31, 2015 that have materially affected, or are reasonably likely to affect, the Company’s internal control over financial reporting. During the quarter ended March 31, 2015, the Company completed the purchase of Shenya and is currently integrating Shenya into its operations, compliance programs and internal control processes. As permitted by SEC rules and regulations, the Company has excluded Shenya from management's evaluation of internal controls over financial reporting as of March 31, 2015.

In addition to other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our 2014 Annual Report which could materially impact our business, financial condition or future results. Risks disclosed in the 2014 Annual Report are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may materially adversely impact our business, financial condition or operating results.