Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis in conjunction with the information set forth under “Item 6 - Selected Financial Data” and our consolidated financial statements and the notes thereto included in Item 8 in this Annual Report on Form 10-K. The statements in this discussion regarding industry outlook, our long-term strategy, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are forward-looking statements. See “Forward-Looking Information” on page ii of this Annual Report on Form 10-K. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under “Item 1A - Risk Factors.” Our actual results may differ materially from those contained in or implied by any forward-looking statements.
Business Overview
CVG is a global provider of components and assemblies into two primary end markets – the global vehicle market and the U.S. technology integrator markets. The company provides components and assemblies to global vehicle companies to build original equipment and provides aftermarket products for fleet owners. The company also provides mechanical assemblies to warehouse automation integrators and to U.S. military technology integrators.
Commercial Trends in the North American Commercial Truck Markets
Demand for our products may be driven by preferences of the end-user of the vehicle, particularly with respect to heavy-duty trucks. Heavy-duty truck OEMs generally afford the end-user the ability to specify many of the component parts that will be used to manufacture the vehicle, including a wide variety of cab interior styles and colors, brand and type of seats, type of seat fabric and color, and interior styling. Certain of our products are only utilized in heavy-duty trucks, such as our storage systems, sleeper boxes and privacy curtains. To the extent that demand for higher content vehicles increases or decreases, our revenues and gross profit will be impacted positively or negatively.
Current trends include future adoption of electric vehicles in the commercial truck segment. Commercial truck makers are developing electric models of all classes of trucks and buses in their fleets. This has created an increased number of platform opportunities relative to historical trends of platform changes as well as the aftermarket opportunities.
We generally compete for new business at the beginning of the development of a new vehicle platform and upon the redesign of existing programs. New platform development generally begins one to three years before the marketing of such models by our customers. Contract durations for commercial vehicle products generally extend for the entire life of the platform. Truck OEMs routinely upgrade their product platforms for aesthetics, electronic improvements, comfort improvements, energy efficiency, safety improvements, and feature enhancements. Additionally, there are new entrants to the global truck market that are focused on Electric Vehicle and low carbon emission product offerings. The Company competes to retain its existing positions on platforms that are getting refreshed, competitively win new positions on platforms on which it is not the incumbent supplier, and gain first mover positions on new Electric Vehicle platforms. The global truck market is evolving to include many offerings aimed at low emissions and less impact on the environment. The Company has a targeted growth plan that it is pursuing to grow the Company.
In general, demand for our heavy-duty (or "Class 8") truck products is generally dependent on the number of new heavy-duty trucks manufactured in North America, which in turn is a function of general economic conditions, interest rates, changes in government regulations, consumer spending, fuel costs, freight costs, fleet operators' financial health and access to capital, used truck prices and our customers’ inventory levels. New heavy-duty truck demand has historically been cyclical and is particularly sensitive to the industrial sector of the economy, which generates a significant portion of the freight tonnage hauled by commercial vehicles. North American heavy-duty truck production was 214,249 units in 2020. According to a February 2021 report by ACT Research, a publisher of industry market research, North American Class 8 production levels are expected to increase to 302,000 units in 2021, steadily increase to 330,000 units in 2023 and then decline to 302,000 units in 2025. ACT Research estimated that the average age of active North American Class 8 trucks was 6.1 and 6.4 years in 2020 and 2019, respectively. As vehicles age, maintenance costs typically increase. ACT Research forecasts that the vehicle age will decline as aging fleets are replaced.
North American medium-duty (or "Class 5-7") truck production decreased from 281,409 units in 2019 to 223,495 units in 2020. According to a February 2021 report by ACT Research, North American Class 5-7 truck production is expected to increase to 246,000 units in 2021, steadily increase to 279,000 units in 2023 and then decline to 274,000 units in 2025. We primarily participate in the class 6 and 7 portion of the medium-duty truck market.
25
Table of Contents
Commercial Trends in Warehouse Automation Subsystems
Demand for our warehouse automation subsystems is derived by expansion of supply chain infrastructures to accommodate increased customer orders in e-commerce. As the percentage of products ordered on-line increases, the delivery mechanisms must expand and increase output. Additionally, desire for cost reduction, increased throughput volume and SKU proliferation, a greater variety of order and package types, more frequent product returns by end consumers, and COVID-19-driven social distancing protocols on warehouse floors all have driven increased investment in automated solutions by warehouse operators. CVG assembles the material handling subsystems incorporated into automated warehouses.
Commercial Trends in Construction Equipment
Demand for our construction equipment products is dependent on vehicle production. Demand for new vehicles in the global construction equipment market generally follows certain economic conditions around the world. Our products are primarily used in the medium- and heavy-duty construction equipment markets (vehicles weighing over 12 metric tons). Demand in the medium- and heavy-duty construction equipment market is typically related to the level of large scale infrastructure development projects, such as highways, dams, harbors, hospitals, airports and industrial development, as well as activity in the mining, forestry and commodities industries.
COVID-19 Update
The COVID-19 pandemic has caused and continues to cause, significant volatility, uncertainty and economic disruptions to our business. While we continue to operate our facilities, we may experience production slowdowns and/or shutdowns at our manufacturing facilities in North America, Europe and Asia Pacific as a result of government orders, our inability to obtain component parts from suppliers and/or decreased customer demand. In addition, many of our suppliers and customers may experience production slowdowns and/or shutdowns, which may further impact our business, sales and results of operation. Continued impact on the Company's business, sales and results of operations from the COVID-19 pandemic may also result in additional valuation allowances being recorded against our deferred tax assets. The extent of the adverse effect of the COVID-19 pandemic on our business results depends on future developments, including the severity and duration of the pandemic and its overall impact on the economy. Throughout 2020, the impact of the pandemic has been uneven across our global footprint based on local and regional outbreaks. Future waves may have a greater or lesser impact than the first wave, depending on the location of such breakouts and the response of the local government. We continue to proactively monitor, assess and minimize disruptions and delays in production and take reasonable measures to protect our workforce.
Commodity and other material costs, as well as difficult labor markets, have stabilized, but management cannot predict whether the COVID-19 pandemic will adversely impact these costs in future periods. Cost control and cost recovery initiatives, including pricing adjustments, reduced the impact of these cost pressures on gross profit. During 2020, the Company implemented a series of temporary reductions that were in place through September 30, 2020, including pay reductions, furloughs, suspension of the employer 401(k) match, and reductions in discretionary spending ("Temporary Actions"). On September 22, 2020, the Company announced that certain temporary actions were being halted, specifically temporary pay reductions. Certain other temporary actions remain in effect.
Climate Change and Weather Impacts
Our facilities can be subject to supply chain disruption sometimes because of disruptive weather. In particular, because of the recent storms in Texas and Mexico, the supply of chemicals that are used to produce foams (lamination) for our seating products may be in short supply, which could have a negative impact on our seating business during 2021, though the Company is taking steps to limit the impact.
2021 Demand Outlook
According to a February 2021 report by ACT Research, a publisher of industry market research, 2020 North American Class 8 truck build production was 214,249 units and Class 5-7 production was 223,495 units. 2021 North American Class 8 truck production levels are expected to be at 302,000 units and Class 5-7 production are expected to be at 246,000 units. This outlook supports demand for the Company’s truck products. The outlook for electric vehicle adoption rates are favorable as well and supports continuance of the Company's development programs in electric vehicles.
According to Interact Analysis, demand for warehouse automation products is expected to grow approximately 14% per year through 2026. This outlook supports demand for the Company's warehouse automation products.
26
Table of Contents
Our Long-term Strategy
The Company's long-term strategy is to increase its sales, profits and shareholder value by financially optimizing its core legacy businesses, adding new business streams from targeted areas, and adding to its business segments through a targeted M&A program. The Company will diversify its revenue and profits by product, customer, platform, and end market. Our products include seating systems, warehouse automation subsystems, wire harnesses, plastic parts, mechanical assemblies, mirrors, wipers and cab structures.
We believe we are having success with our strategy to diversify our business, including:
• A growing current business in the warehouse automation market primarily through business expansion enabled by the FSE acquisition;
• A growing amount of future business by becoming designed in on new emerging electric vehicle platforms as a multi-product global provider of electric vehicle design, subsystems and components; and
• A growing amount of new business wins that are in diverse end markets but fit the company’s current know-how, assets, and footprint very well.
These additional markets offer the ability to lessen dependence on certain markets, broaden the company’s customer list, broaden the company’s product offering. The goal is to become less cyclical and less customer concentrated and focus on secular growth in other end markets.
We have a long-term strategy to globally optimize our cost structure through manufacturing process enhancements, low cost footprint and global sourcing. We periodically evaluate our short-term and long-term strategies and may adjust actions in response to changes in our business environment and other factors.
We are also supplementing our organic strategies by evaluating strategic acquisition opportunities. The company has many opportunities to accomplish this type of business diversification and is being selective. The goal is to strengthen / enhance current positions, enter new markets, develop relationships with new customers, and enhance service to our customers, leading to increased return to our stockholders.
Consolidated Results of Operations
The table below sets forth certain operating data expressed as a percentage of revenues for the periods indicated (dollars are in thousands):
2020 2019 2018
Revenues $ 717,699 100.0 % $ 901,238 100.0 % $ 897,737 100.0 %
Cost of revenues 643,623 89.7 796,101 88.3 772,817 86.1
Gross profit 74,076 10.3 105,137 11.7 124,920 13.9
Selling, general and administrative expenses 64,794 9.0 62,549 6.9 60,679 6.8
Goodwill and other impairment 29,017 4.0 — — — —
Amortization expense 3,434 0.5 1,952 0.2 1,300 0.1
Operating income (loss) (23,169) (3.2) 40,636 4.5 62,941 7.0
Other (expense) income (728) (0.1) (2,225) (0.2) 1,311 0.1
Interest expense 20,603 2.9 16,855 1.9 14,676 1.6
Income (loss) before provision for income taxes (44,500) (6.2) 21,556 2.4 49,576 5.5
Provision (benefit) for income taxes (7,451) (1.0) 5,778 0.6 8,087 0.9
Net income (loss) $ (37,049) (5.2) % $ 15,778 1.8 % $ 41,489 4.6 %
27
Table of Contents
Year Ended December 31, 2020 Compared to Year Ended December 31, 2019
C ONSOLIDATED R ESULTS
The table below sets forth certain consolidated operating data for the periods indicated (dollars are in thousands):
2020 2019 Dollar Change % Change
Revenues $ 717,699 $ 901,238 $ (183,539) (20.4)%
Gross profit 74,076 105,137 (31,061) (29.5)
Selling, general and administrative expenses 64,794 62,549 2,245 3.6
Goodwill and other impairment 29,017 — 29,017 100.0
Amortization expense 3,434 1,952 1,482 75.9
Other (expense) income (728) (2,225) 1,497 (67.3)
Interest expense 20,603 16,855 3,748 22.2
Provision (benefit) for income taxes (7,451) 5,778 (13,229) NM 1
Net income (loss) (37,049) 15,778 (52,827) NM 1
1. Not meaningful
Revenues. Consolidated revenues of $717.7 million decreased $183.5 million compared to 2019 primarily due to North American MD/HD truck production volume decreases in 2020, resulting in decreased sales into that market. Consolidated revenues in 2020 compared to 2019 were as follows:
• a $185.3 million, or 42.2%, decrease in OEM North American MD/HD Truck revenues;
• a $86.0 million, or 277.4%, increase in warehouse automation and military revenues primarily attributable to the timing of the FSE acquisition which occurred in September 2019;
• a $49.4 million, or 29.3%, decrease in OEM construction equipment revenues;
• a $31.1 million, or 23.9%, decrease in aftermarket and OES revenues; and
• a $3.7 million, or 2.8%, decrease in other revenues.
While the end markets CVG serves were anticipated to decline somewhat in 2020 as compared to 2019, the sharp market declines noted in the twelve months ended December 31, 2020 were primarily a result of the COVID-19 pandemic on the end markets we serve. These sharp market declines were partially offset by increased sales in industrial and military end markets we serve through the FSE business acquired in 2019. Revenues were adversely impacted by foreign currency exchange translation of $0.2 million, which is reflected in the change in revenue above.
Gross Profit. Included in gross profit is cost of revenues, which consists primarily of raw materials and purchased components for our products, wages and benefits for our employees and overhead expenses such as manufacturing supplies, facility rent and utilities costs related to our operations. The decrease in gross profit is primarily attributable to the decrease in sales volume. Cost of revenues decreased $152.5 million, or 19.2% in line with the sales decrease of 20.4%. The cost of revenue decrease included a decrease in raw material and purchased component costs of $99.0 million, or 19.5%; a decrease in wages and benefits of $16.2 million, or 22.4%; and a decrease in overhead expenses of $37.3 million, or 17.3%. During 2019, the Company began implementing cost reduction and manufacturing capacity rationalization initiatives (the "Restructuring Initiatives") in response to declines in end market volumes. The Restructuring Initiatives consisted primarily of headcount reductions in each segment and at corporate. Cost of revenues benefited from the Restructuring Initiatives and the Temporary Actions. The twelve months ended December 31, 2020 results include charges of $4.7 million associated with ongoing Restructuring Initiatives. As a percentage of revenues, gross profit margin was 10.3% for the year ended December 31, 2020 compared to 11.7% for the year ended December 31, 2019.
Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses consist primarily of wages and benefits and other overhead expenses such as marketing, travel, legal, audit, rent and utilities costs, which are not directly or indirectly associated with the manufacturing of our products. SG&A expenses increased $2.2 million in the year ended December 31, 2020 as compared to the year ended December 31, 2019 due primarily to a $5.0 million charge for future milestone payments related to the performance of the FSE business, increase in charges of $1.4 million associated with ongoing Restructuring Initiatives, $3.1 million increase in incentive compensation costs, 2020 charges of $4.0 million associated with the 2018 and quarterly 2019 financial statements restatement investigation and $2.3 million in costs a ssociated with the CEO
28
Table of Contents
transition. These costs were offset by the Restructuring Initiatives and the Temporary Actions taken in response to the COVID-19 pandemic.
Impairment Expense . As a result of the Company's market capitalization maintaining a value less than the carrying value of its equity for a period of time, the Company determined it had an impairment indicator during the first quarter of 2020. Accordingly, we recognized a $27.1 million impairment of goodwill for the year ended December 31, 2020. Additionally during the first quarter of 2020, the Company determined it had an impairment indicator of long-lived assets due to market conditions resulting in an impairment of $1.9 million for the year ended December 31, 2020.
Amortization Expense . Amortization expense increased $1.5 million in the year ended December 31, 2020 primarily due to a full year of amortization of the intangible assets acquired in September 2019 as part of the FSE acquisition.
Other Expense. Other expenses decreased $1.5 million in the year ended December 31, 2020 as compared to the year ended December 31, 2019 due primarily to the prior year $2.5 million non-cash charge associated with the early payout of benefits to term vested participants in the U.S. pension plan, which reduced future financial risk associated with the U.S. pension plan and contributed to an improvement in funded status of that plan to approximately 100%. The offset to this decrease is primarily attributable to an unfavorable change in foreign exchange translation adjustments of $1.2 million.
Interest Expense. Interest associated with our debt was $20.6 million and $16.9 million for the years ended December 31, 2020 and 2019, respectively. The increase primarily related to a $5.4 million Payment In Kind interest expense resulting from the amendment to our credit facilities that occurred in the second quarter of 2020. The increase was offset by lower interest expense of $1.6 million due to declining interest rates.
(Benefit) Provision for Income Taxes. An income tax benefit of $7.5 million and an income tax provision of $5.8 million were recorded for the year ended December 31, 2020 and 2019, respectively. The period over period change in income tax was primarily attributable to the $44.5 million pre-tax loss sustained in the current year versus the $21.6 million pre-tax income generated in the prior year period, and unfavorable valuation allowance adjustments resulting in $2.1 million income tax expense in the current year versus a $2.1 million income tax benefit in the prior year period.
During the year ended December 31, 2020, the Company recorded a $1.3 million U.S. federal income tax benefit for the impact of the High-Tax Exception to GILTI which consisted of a $0.5 million tax benefit related to the year ended December 31, 2019, and a $0.8 million tax benefit related to the year ended December 31, 2018.
Electrical Systems Segment Results
The table below sets forth certain Electrical Systems Segment operating data for the periods indicated (dollars are in thousands):
2020 2019 Dollar Change % Change
Revenues $ 445,955 $ 530,901 $ (84,946) (16.0)%
Gross profit 42,811 60,008 (17,197) (28.7)
Selling, general & administrative expenses 19,811 15,815 3,996 25.3
Goodwill and other impairment 23,415 — 23,415 100.0
Amortization expense 2,917 1,415 1,502 106.1
Operating income (loss) (3,332) 42,778 (46,110) NM 1
1. Not meaningful
Revenues. The decrease in Electrical Systems Segment 2020 revenues is primarily a result of:
• a $110.2 million, or 40.7%, decrease in OEM North American MD/HD Truck revenues;
• a $79.8 million, or 259.1%, increase in warehouse automation and military revenues primarily attributable to the timing of the FSE acquisition which occurred in September 2019;
• a $32.4 million, or 36.0%, decrease in OEM construction equipment revenues;
• a $14.4 million, or 28.0%, decrease in aftermarket and OES revenues; and
• a $7.7 million, or 8.8% decrease in other revenue.
29
Table of Contents
While the end markets CVG serves were anticipated to decline somewhat in 2020 as compared to 2019, the sharp market declines noted in the year ended December 31, 2020 were primarily a result of the COVID-19 pandemic on the end markets we serve. These sharp market declines were partially offset by increased sales in industrial and military end markets we serve through the FSE business. Electrical Systems Segment 2020 revenues were adversely impacted by foreign currency exchange translation of $0.2 million, which is reflected in the changes in revenue above.
Gross Profit. The decrease in gross profit was primarily attributable to the decrease in sales volume. Cost of revenues decreased $67.7 million, or 14.4%, in line with the sales decrease of 16.0%. The cost of revenue decrease included a decrease in raw material and purchased component costs of $40.4 million, or 13.7%; a decrease in wages and benefits of $7.9 million, or 17.3%; and a decrease in overhead expenses of $19.4 million, or 15.0%. Cost of revenues benefited from the Restructuring Initiatives and the Temporary Actions. The year ended December 31, 2020 results include charges of $3.8 million associated with ongoing restructuring initiatives. As a percentage of revenues, gross profit for the year ended December 31, 2020 was 9.6% compared to 11.3% for the year ended December 31, 2019. The decrease was primarily due to fixed cost pressure during the second quarter related to COVID-19 disruptions.
Selling, General and Administrative Expenses. SG&A expenses increased $4.0 million in the year ended December 31, 2020 as compared to the year ended December 31, 2019 due primarily to $5.0 million charge for future milestone payments related to the performance of the FSE business. These costs were offset by cost reductions due to the Restructuring Initiatives and the Temporary Actions taken in response to the COVID-19 pandemic.
Impairment Expense . As a result of the Company's market capitalization maintaining a value less than the carrying value of its equity for a period of time, the Company determined it had an impairment indicator during the first quarter of 2020. Accordingly, we recognized a $22.3 million impairment of goodwill and an impairment of long-lived assets of $1.1 million for the year ended December 31, 2020.
Amortization Expense . Amortization expense increased $1.5 million in the year ended December 31, 2020 primarily due to a full year of amortization of the intangible assets acquired in September 2019 as part of the FSE acquisition.
Global Seating Segment Results
The table below sets forth certain Global Seating Segment operating data for the periods indicated (dollars are in thousands):
2020 2019 Dollar Change % Change
Revenues $ 277,830 $ 381,548 $ (103,718) (27.2) %
Gross profit 31,635 45,201 (13,566) (30.0)
Selling, general & administrative expenses 18,355 20,429 (2,074) (10.2)
Goodwill and other impairment 4,809 — 4,809 100.0
Operating income 7,954 24,235 (16,281) (67.2)
Revenues. The decrease in Global Seating Segment 2020 revenues is primarily a result of:
• a $75.1 million or 44.5%, decrease in OEM North American MD/HD Truck revenues;
• a $17.0 million, or 21.6%, decrease in OEM construction equipment revenues;
• a $16.7 million, or 21.2%, decrease in aftermarket and OES revenues; and
• a $5.1 million or 9.2% increase in other revenues.
While the end markets CVG serves were anticipated to decline somewhat in 2020 as compared to 2019, the sharp market declines noted in the year ended December 31, 2020 were primarily a result of the COVID-19 pandemic on the end markets we serve.
Gross Profit. The decrease in gross profit is primarily attributable to the decrease in sales volume. Cost of revenues, which decreased $90.2 million, or 26.8%, in line with the sales decrease of 27.2%. The cost of revenue decrease included a decrease in raw material and purchased component costs of $63.8 million, or 28.6%; a decrease in wages and benefits of $8.2 million, or 31.1%; and a decrease in overhead expenses of $18.1 million, or 20.9%. Cost of revenues benefited from the Restructuring Initiatives and the Temporary Actions. The year ended December 31, 2020 results include charges of $0.9 million associated
30
Table of Contents
with ongoing Restructuring Initiatives. As a percentage of revenues, gross profit was 11.4% for the year ended December 31, 2020 compared to 11.8% for the year ended December 31, 2019.
Selling, General and Administrative Expenses. SG&A expenses decreased $2.1 million for the year ended December 31, 2020 compared to the year ended December 31, 2019, resulted primarily from Restructuring Initiatives and the Temporary Actions taken in response to the COVID-19 pandemic. These reductions were partially offset by charges of $0.2 million associated with ongoing Restructuring Initiatives.
Impairment Expense . As a result of the Company's market capitalization maintaining a value less than the carrying value of its equity, the Company determined it had an impairment indicator during the first quarter of 2020. Accordingly, we recognized a $4.8 million impairment of goodwill for the year ended December 31, 2020.
Year Ended December 31, 2019 Compared to Year Ended December 31, 2018
Consolidated Results
The table below sets forth certain consolidated operating data for the periods indicated (dollars are in thousands):
2019 2018 Dollar Change % Change
Revenues $ 901,238 $ 897,737 $ 3,501 0.4%
Gross profit 105,137 124,920 (19,783) (15.8)
Selling, general and administrative expenses 62,549 60,679 1,870 3.1
Other (income) expense (2,225) 1,311 (3,536) NM 1
Interest expense 16,855 14,676 2,179 14.8
Provision for income taxes 5,778 8,087 (2,309) (28.6)
Net income 15,778 41,489 (25,711) (62.0)
1. Not meaningful
Revenues. Consolidated revenues of $901.2 million were substantially unchanged in 2019 compared to 2018. Heavy-duty truck production volumes in North America in 2019, our largest end market, were markedly higher than truck replacement level volumes, but production volumes declined significantly in the second half of the year. Production volumes in our second largest end market, global construction equipment, declined in 2019. Consolidated revenues in 2019 compared to 2018 were as follows:
• a $26.8 million, or 7%, increase in OEM North American MD/HD Truck revenues;
• a $10.3 million, or 54%, increase in military revenues primarily attributable to the acquisition of FSE;
• a $20.3 million, or 11%, decrease in construction equipment revenues;
• a $8.3 million, or 6%, decrease in aftermarket revenues; and
• a $5.0 million, or 4%, decrease in other revenues.
2019 revenues were adversely impacted by foreign currency exchange translation of $10.4 million, which is reflected in the change in revenue above.
Gross Profit. Cost of revenues increased $23.3 million, or 3.0%, resulting from an increase in raw material and purchased component costs of $12.1 million, wages and benefits of $2.0 million and overhead expenses of $9.2 million. Supplier price increases and costs associated with difficult labor markets, including higher labor costs, adversely impacted material and labor costs. Beginning in the first quarter of 2019, the imposition by Mexico of a new statutory minimum wage in the Free Zone of the Northern Border (the “Border Minimum Wage”), a geographic area running along and just south of the U.S. / Mexico border and encompassing our wire harness facility in Agua Prieta, Mexico, adversely impacted labor costs. A number of actions, including pricing adjustments on certain products, reduced the impact of the Border Minimum Wage. The net unfavorable impact of the Border Minimum Wage on the 2019 results was approximately $2.3 million. Costs associated with a supplier of fabricated metals that sought bankruptcy relief in the second quarter of 2019 (the "Troubled Supplier") adversely impacted the current year by $3.1 million. Costs associated with manufacturing investments in our global wire harness and North American trim businesses (the "Manufacturing Investments") are included in 2019 results and approximate $1.8 million.
31
Table of Contents
Employee separation costs and charges associated with manufacturing capacity rationalization (the "Restructuring Initiatives") that began in 2019 totaling $2.2 million adversely impacted gross profit in 2019. The Restructuring Initiatives are expected to mitigate the impact of lower production volumes in 2020. As a percentage of revenues, gross profit margin was 11.7% for the year ended December 31, 2019 compared to 13.9% for the year ended December 31, 2018.
Selling, General and Administrative Expenses. SG&A expenses increased $1.9 million in the year ended December 31, 2019 as compared to the year ended December 31, 2018 due primarily to costs of $0.9 million associated with the acquisition of the assets of FSE and costs of $0.8 million associated with the Restructuring Initiatives.
Other (Income) Expense. The 2019 results include a $2.5 million non-cash charge associated with the early payout of benefits to term vested participants in the U.S. Pension Plan, which reduced future financial risk associated with the U.S. Pension Plan and contributed to an improvement in funded status to approximately 100%.
Interest Expense. Interest expense includes the mark-to-market impact of an interest rate swap agreement, which resulted in a $1.9 million non-cash charge in the year ended December 31, 2019 and a $0.8 million gain in the prior year.
Provision for Income Taxes. Income tax provisions of $5.8 million and $8.1 million were recorded for the fiscal years ended December 31, 2019 and 2018, respectively. The year over year change in the tax provision was primarily attributable to the lower tax expense resulting from the decrease in income before provision for income taxes, offset by a decrease in the amount of favorable, period-specific tax adjustments and an increase in withholding tax expense recorded in the current year for the impact of the repatriation of earnings from certain foreign subsidiaries.
S EGMENT R ESULTS
Electrical Systems Segment Results
The table below sets forth certain Electrical Systems Segment operating data for the periods indicated (dollars are in thousands):
2019 2018 Dollar Change % Change
Revenues $ 530,901 $ 512,754 $18,147 3.5%
Gross profit 60,008 71,104 (11,096) (15.6)
Selling, general & administrative expenses 15,815 15,390 425 2.8
Operating income 42,778 54,967 (12,189) (22.2)
Revenues. The increase in Electrical Systems Segment 2019 revenues is primarily a result of:
• a $18.6 million, or 7%, increase in OEM North American MD/HD Truck revenues;
• a $10.2 million, or 55%, increase in military revenues primarily attributable to the FSE acquisition;
• a $2.0 million, or 2%, decrease in OEM construction equipment revenues; and
• a $8.7 million, or 6%, decrease in other revenue.
Electrical Systems Segment 2019 revenues were adversely impacted by foreign currency exchange translation of $3.7 million, which is reflected in the changes in revenue above.
Gross Profit. Included in gross profit is cost of revenues, which increased $29.2 million, or 6.6%, as a result of an increase in raw material and purchased component costs of $13.8 million, wages and benefits of $4.4 million and overhead expenses of $11.0 million. Inflationary pressures affecting the Company’s raw material, purchased component, labor and labor associated costs adversely affected cost of revenues. Also adversely impacting 2019 results, was the Border Minimum Wage, approximately $2.3 million; the Troubled Supplier, approximately $3.1 million; and costs associated with the Manufacturing Investments, approximately $1.8 million. Cost control and cost recovery initiatives, including pricing adjustments, reduced the impact of these cost pressures on gross profit. Gross profit for the year ended December 31, 2019 was also adversely impacted by costs of $1.8 million associated with the Restructuring Initiatives. As a percentage of revenues, gross profit for the year ended December 31, 2019 was 11.3% compared to 13.9% for the year ended December 31, 2018.
32
Table of Contents
Selling, General and Administrative Expenses. Electrical Systems Segment SG&A expenses increased $0.4 million, or 2.8%, in 2019 compared to 2018. SG&A includes costs of $0.4 million associated with the Restructuring Initiatives.
Global Seating Segment Results
The table below sets forth certain Global Seating Segment operating data for the periods indicated (dollars are in thousands):
2019 2018 Dollar Change % Change
Revenues $ 381,548 $ 397,501 ($15,953) (4.0)%
Gross profit 45,201 54,231 (9,030) (16.7)
Selling, general & administrative expenses 20,429 22,433 (2,004) (8.9)
Operating income 24,235 31,245 (7,010) (22.4)
Revenues. The decrease in Global Seating Segment 2019 revenues is primarily a result of:
• a $8.2 million, or 5%, increase in OEM North American MD/HD Truck revenues;
• a $18.3 million, or 19%, decrease in OEM construction equipment revenues;
• a $5.4 million, or 6%, decrease in aftermarket revenues; and
• a $0.4 million, or 1%, decrease in other revenues.
Global Seating Segment 2019 revenues were adversely impacted by foreign currency exchange translation of $6.7 million, which is reflected in the changes in revenue above.
Gross Profit. Included in gross profit is cost of revenues, which decreased $6.9 million, or 2.0%, as a result of a decrease in raw material and purchased component costs of $3.1 million, wages and benefits of $2.4 million and overhead expenses of $1.4 million. Inflationary pressures affecting the Company’s raw material, purchased component, labor and labor associated costs adversely affected cost of revenues. Cost control and cost recovery initiatives, including pricing adjustments, reduced the impact of these cost pressures on gross profit. Gross profit for the year ended December 31, 2019 was also adversely impacted by costs of $0.4 million associated with the Restructuring Initiatives. As a percentage of revenues, gross profit was 11.8% for the year ended December 31, 2019 compared to 13.6% for the year ended December 31, 2018.
Selling, General and Administrative Expenses. Global Seating Segment SG&A expenses decreased $2.0 million, or 8.9%, for the year ended December 31, 2019 compared to the year ended December 31, 2018, reflecting a focus on cost discipline. SG&A includes costs of $0.1 million associated with the Restructuring Initiatives.
Liquidity and Capital Resources
During the year ended December 31, 2020, the Company borrowed under its revolving credit facility; however, as of year ended 2020, the Company did not have any outstanding borrowings under the facility. At December 31, 2020, the Company had liquidity of $138.9 million; $50.5 million of cash and $88.4 million availability from its revolving credit facility.
We intend to allocate resources consistent with the following priorities: (1) invest in growth; (2) invest in operational improvements; (3) manage working capital; (4) to reduce debt; and (5) other actions deemed appropriate by management to improve operational performance.
Our primary source of liquidity during the year ended December 31, 2020 was cash and availability under our revolving credit facility. We believe that these sources of liquidity will provide adequate funds for our working capital needs, planned capital expenditures and servicing of our debt through the next twelve months. However, there is no assurance that these sources of capital will provide for our funding needs. We also rely on the timely collection of receivables as a source of liquidity. As a result of the increase and expansion of the warehouse automation business, we have experienced increases in accounts receivable, inventories and accounts payable during 2020 which we expect to continue into the future. As of December 31, 2020, we had no outstanding borrowings under our revolving credit facility and had borrowing availability of $88.4 million.
As of December 31, 2020, cash of $41.9 million was held by foreign subsidiaries. The Company had a $0.3 million deferred tax liability as of December 31, 2020 for the expected future income tax implications of repatriating cash from the foreign subsidiaries for which no indefinite reinvestment assertion has been made.
33
Table of Contents
Covenants and Liquidity
Our ability to comply with the covenants in the TLS Agreement and the Third ARLS Agreement, as discussed in Note 3, Debt, may be affected by economic or business conditions beyond our control. Based on our current forecast, we believe that we will be able to maintain compliance with the financial maintenance covenants and the fixed charge coverage ratio covenant, if applicable, and other covenants in the TLS Agreement and the Third ARLS Agreement for the next twelve months. However, no assurances can be given that we will be able to comply. We base our forecasts on historical experience, industry forecasts and other assumptions that we believe are reasonable under the circumstances. If actual results are substantially different than our current forecast we may not be able to comply with our financial covenants. If we do not comply with the financial and other covenants in the TLS Agreement and the Third ARLS Agreement, the lenders could declare an event of default under the TLS Agreement and the Third ARLS Agreement and our indebtedness thereunder could be declared immediately due and payable. The TLS Agreement and the Third ARLS Agreement contain cross default provisions. If we are unable to borrow under the Third ARLS Agreement, we will need to meet our capital requirements using alternative sources of liquidity which may not be available on acceptable terms. Any of these events would have a material adverse effect on our business, financial condition and liquidity.
Cash Flows
2020 2019 2018
(In thousands)
Net cash provided by operating activities $ 34,372 $ 36,746 $ 40,992
Net cash used in investing activities (6,420) (57,979) (14,101)
Net cash used in financing activities (19,262) (10,113) (5,835)
Effect of currency exchange rate changes on cash 2,302 (56) (2,387)
Net increase (decrease) in cash $ 10,992 $ (31,402) $ 18,669
Operating activities . For the year ended December 31, 2020, net cash provided by operations was $34.4 million compared to $36.7 million for the year ended December 31, 2019. The decrease in net cash provided by operating activities is primarily attributable to the decrease in net income associated with the sales declines in the year ended December 31, 2020 as compared to the to the prior year period. This reduction was offset by cash generated from working capital primarily resulting from timing of the payment of payables and expenses.
For the year ended December 31, 2019, cash provided by operations was $36.7 million compared to $41.0 million in the year ended December 31, 2018. More than all of the decrease in cash provided by operations for the year ended December 31, 2019 compared to 2018 was due to a decrease in net income partially offset by less cash used for working capital changes in 2019 than in 2018.
Investing activities . For the year ended December 31, 2020, net cash used in investing activities was $6.4 million compared to $58.0 million for the year ended December 31, 2019. The decrease in investing activities is primarily due to the FSE Acquisition for $34 million during, 2019, and decreased capital spending in 2020. In 2021, we expect capital expenditures to be in the range of $20 million to $25 million.
Net cash used in investing activities was $58.0 million for the year ended December 31, 2019 compared to $14.1 million for the year ended December 31, 2018. The increase in cash used in investing activities for the year ended December 31, 2019 compared to 2018 was due to the FSE acquisition and an increase in capital expenditures.
Financing activities . For the year ended December 31, 2020, net cash used in financing activities was $19.3 million compared to $10.1 million for the year ended December 31, 2019. Net cash used in financing activities for the year ended December 31, 2020 is attributable to additional repayment of $10.0 million of the senior secured term loan credit facility and associated fees, along with a contingent consideration milestone payment of $1.0 million related to the FSE acquisition.
Net cash used in financing activities was $10.1 million for the year ended December 31, 2019 compared to $5.8 million for the year ended December 31, 2018. The increase in net cash used in financing activities for the year ended December 31, 2019 was due primarily to repayments on the term loan facility.
Debt and Credit Facilities
The debt and credit facility summaries described in Note 3, Debt, are incorporated in this section by reference.
34
Table of Contents
Contractual Obligations and Commercial Commitments
The following table reflects our contractual obligations as of December 31, 2020 (in thousands):
Payments Due by Period
Total
1 Year 2-3 Years 4-5 Years More than
5 Years
Debt obligations 1
$ 150,950 $ 4,375 $ 146,575 $ — $ —
Estimated interest payments 24,388 10,811 13,577 — —
Leasing obligations 39,548 11,182 15,750 8,676 3,940
Non-U.S. pension funding 18,303 1,063 2,302 2,557 12,381
Total $ 233,189 $ 27,431 $ 178,204 $ 11,233 $ 16,321
1. The balance includes $5.4 million of Payment In Kind interest accrued through December 31, 2020.
We estimated future interest payments based on the effective interest rate as of December 31, 2020. Since December 31, 2020, there have been no material changes outside the ordinary course of business to our contractual obligations as set forth above above other than as set forth in Note 19, Subsequent Event.
We expect to contribute approximately $1.1 million to our UK pension plan in 2021. No contributions are expected to be made to our U.S. pension plan in 2021.
We enter into agreements with our customers at the beginning of a given vehicle platform’s life to supply products for the entire life of that vehicle platform. These agreements generally provide for the supply of a customer’s production requirements for a particular platform rather than for the purchase of a specific quantity of products. The obligations under these agreements and regulations are not reflected in the contractual obligations table above.
As of December 31, 2020, we were not a party to significant purchase obligations for goods or services.
Off-Balance Sheet Arrangements
We use standby letters of credit to guarantee our performance under various contracts and arrangements, principally in connection with our workers’ compensation liabilities. These letter of credit contracts are usually extended on a year-to-year basis. As of December 31, 2020, we had outstanding letters of credit of $1.6 million. We do not believe that these letters of credit will be drawn.
We currently have no non-consolidated special purpose entity arrangements.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). For a comprehensive discussion of our significant accounting policies, see Note 1, Significant Accounting Policies, to our consolidated financial statements in Item 8 in this Annual Report on Form 10-K.
The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and assumptions on an ongoing basis, particularly relating to accounts receivable reserves, inventory reserves, goodwill, intangible and long-lived assets, income taxes, warranty reserves, litigation reserves and pension and other post-retirement benefit plans. We base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets, liabilities and equity that are not readily apparent from other sources. Actual results and outcomes could differ materially from these estimates and assumptions. See Item 1A - Risk Factors in this Annual Report on Form 10-K for additional information regarding risk factors that may impact our estimates.
Revenue Recognition — We recognize revenue when our performance obligation has been satisfied and control of products has been transferred to a customer, which typically occurs upon shipment. Revenue is measured based on the amount of consideration we expect to receive in exchange for the transfer of goods or services. We enter into agreements with our customers at the beginning of a vehicle platform’s life to supply products for that vehicle platform. Once we enter into such agreements, fulfillment of our requirements is our obligation for the entire production life of the platform and we have no provisions to terminate such contracts. Management judgments and estimates must be made in estimating sales returns and allowances relating to revenue recognized in a given period.
35
Table of Contents
Goodwill - Assets and liabilities acquired in business combinations are accounted for using the acquisition method and recorded at their respective fair values. Goodwill represents the excess of consideration paid over the net assets acquired and is assigned to the reporting unit that acquires the business. A reporting unit is an operating segment as defined in ASC 280, Segment Reporting, or a business one level below an operating segment if discrete financial information for that business is prepared and regularly reviewed by segment management. The Company conducts annual impairment tests of goodwill in the second quarter or more frequently if events or circumstances indicate a reporting unit’s fair value may be less than its carrying value. If an initial assessment indicates it is more likely than not goodwill may be impaired, it is evaluated by comparing the reporting unit’s estimated fair value to its carrying value. If its carrying value exceeds its estimated fair value, goodwill impairment is recognized to the extent that recorded goodwill exceeds the fair value of goodwill. Estimated fair values of the reporting unit are Level 3 measures and are developed under an income approach that discounts estimated future cash flows using risk-adjusted interest rates and also the market approach.
Business Combinations — Assets acquired and liabilities assumed as part of a business acquisition are generally recorded at their fair value at the date of acquisition. The excess of purchase price over the fair value of assets acquired and liabilities assumed is recorded as goodwill. Determining fair value of identifiable assets, particularly intangibles, and liabilities acquired also requires management to make estimates, including as it relates to fair value of contingent consideration, which are based on all available information and in some cases subjective assumptions with respect to the timing and amount of future revenues and expenses associated with an asset. Accounting for business acquisitions requires management to make judgments as to whether a purchase transaction is a multiple element contract, meaning that it includes other transaction components such as a settlement of a preexisting relationship. This judgment and determination affects the amount of consideration paid that is allocable to assets and liabilities acquired in the business purchase transaction.
Inventory — Inventories are valued at the lower of first-in, first-out cost or net realizable value. Cost includes applicable material, labor and overhead. We value our finished goods inventory at a standard cost that is periodically adjusted to approximate actual cost. Inventory quantities on-hand are regularly reviewed, and where necessary, provisions for excess and obsolete inventory are recorded based primarily on our estimated production requirements driven by expected market volumes.
Income Taxes — We recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been included in our financial statements or tax returns. Deferred tax assets and liabilities are determined based on the difference between the financial statements and tax basis of assets and liabilities using enacted tax laws and rates expected to be in place when the deferred tax items are realized. We recognize tax positions initially in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. We provide a valuation allowance for deferred tax assets when it is more likely than not that a portion of such deferred tax assets will not be realized.