Source: Seeking Alpha
General Motors Company (NYSE:GM)
Q2 2014 Earnings Conference Call
July 24, 2014 10:00 AM ET
Randy Arickx – Executive Director, Communications and IR
Mary Barra – CEO
Chuck Stevens – EVP and CFO
Tom Timko – VP, Controller and CAO
Niharika Ramdev – VP Finance and Treasurer
Rod Lache – Deutsche Bank
Itay Michaeli – Citigroup
Brian Johnson – Barclays Capital
Colin Langan – UBS
John Murphy – Bank of America Merrill Lynch
Patrick Archambault – Goldman Sachs
Ryan Brinkman – JPMorgan
Adam Jonas – Morgan Stanley
Ladies and gentlemen, thank you very much for standing-by and welcome to the General Motors Company Second Quarter 2014 Earnings Conference Call. During this presentation, all participants are in a listen-only mode. Afterwards, we will conduct a question-and-answer session for analysts only. (Operator Instructions) As a reminder, this conference is being recorded on Thursday, July 24, 2014.
It’s now my pleasure to turn the conference over to Randy Arickx, Executive Director of Communications and Investor Relations. Please go ahead, sir.
Randy Arickx – Executive Director, Communications and IR
Thanks, operator. Good morning and thank you for joining us as we review the GM financial results for the first quarter of 2014. Our press release was issued this morning and the conference call materials are available on the Investor Relations Web site. We are also broadcasting this call via the Internet. Before we begin, I would like to direct your attention to the legend regarding forward-looking statements on the first page of the chart set. The content of our call will be governed by this language.
This morning, Mary Barra, General Motors’ Chief Executive Officer will provide opening remarks followed by a review of the financial results with Chuck Stevens, Executive VP and CFO.
After the presentation portion of the call, we’ll open the line for questions from the analyst community. Marry Barra will then conclude the call with some closing remarks. In the room today, we also have Tom Timko, Vice President, Controller and Chief Accounting Officer and Niharika Ramdev, Vice President, Finance and Treasurer, to assist in answering your questions.
Now I’ll turn the call over to Mary Barra.
Mary Barra – CEO
Thanks, Randy and thanks to everybody for joining this call. On our last earnings call in April, I spoke about GM’s resiliency during a very challenging first quarter. As you all know, the ignition switch recall and difficult market conditions in some parts of the world put tremendous pressure on our bottom-line. Nevertheless, we remained profitable. Just as important, we also continued our steady investment in new products and we returned more than 480 million in capital to common shareholders, stockholders through our first quarter dividend. Years of hard work to improve our vehicles, our operations and the customer experience made this possible.
As expected the same issues continued into the second quarter, but once again we had strong operating performance and we earned a profit on both in EBIT adjusted and a net income basis and we stayed on our plan. I’ll speak to all these points starting on Slide 2, which presents a summary of our second quarter results. Then I’ll review the highlights that speak to the heart of our business, which is to build great products, satisfy its customers and do it very profitably.
At the top of Slide 2, you can see that we delivered 2.5 million units in the quarter. As we announced last week, this was our highest second quarter volume since 2005. Sales in North America and China, the two largest and most profitable markets in the world were up 6% and 8% respectively. However, this was offset to a large degree by declines in markets like Russia and Venezuela, where the industry is weak as well as the strategic decision we made to wind down Chevrolet Europe, this also had an impact on market share. Our global market share in the quarter was down three tenths of a point. However, market share in the United States was equal to a year ago. On a revenue basis, we improved our results by more than 570 million, based on large measure to improvements at GM Financial.
Turning to the bottom-line, net income to income to common stockholders was 200 million or $0.11 per share. Combined the recall-related charges and special items we sited in our press release reduced net income by $0.91 per share in the quarter. Absent these items net income would have been about 1.7 billion in the quarter.
Looking at net cash, net cash from our automotive operations activities was 3.6 billion and the year-over-year decline reflects recall activity as well changes in working capital due to timing. And what’s not on shown on the slide, our automotive available liquidity improved by 4 billion from a year ago.
Finally on an EBIT adjusted basis, GM earned 1.4 billion and our adjusted automotive free cash flow was 1.9 billion. Absent recall and restructuring expenses, EBIT adjusted in the quarter would have been improved slightly from a year ago. For the first half of the year, adjusted automotive free cash flow was nearly 1 billion better than a year ago. Chuck Stevens will break all this down for you in just a few minutes.
Let’s look at Slide 3 which presents several highlights from the quarter starting with GM North America, where our core operating performance was exceptionally strong. In fact our EBIT adjusted margins excluding recalls climbed above 9%. This marks the fourth consecutive quarter of year-over-year margin growth excluding recall. In China, we reported record sales and our margins improved by six tenths of a point from a year ago.
In Europe, the wind down of Chevrolet Europe is ahead of schedule and costs are below expectations. Meanwhile the recovery of the Opel/Vauxhall brand continued. Opel/Vauxhall sales increased 3% in the quarter and 4% in the first half. Our share was up in 11 European markets in the first half including Germany, which here rose three tenths of a point to 7%. In June alone, our share in Germany reached 7.6% which is almost up a full point versus a year ago. New products have made a big difference. For example, the Mokka was the best selling SUV in the first six months of the year in Germany.
All of this keeps us on-track to be profitable mid-decade. We are also targeting European market share of 8% and EBIT adjusted margins in the 5% range by 2022. GM South America meanwhile continues to be very challenging with volumes under pressure across the region. But our core underlying performance in the region is improving. Finally GM Financial continues to execute its growth strategy in order to support increased GM vehicle sales. For example the acquisition of Ally Financial European and Latin American businesses in 2013 as well as GMF’s growth in the North America lease market helped increase their share of GM financing activity from 13% to 20% compared to a year ago.
This trend should continue as GMF expands their prime retail loan program in the United States starting in the second half. The next step for GMF is to complete the acquisition of Ally’s joint venture in China, which we expect to close subject to certain regulatory and other approvals late 2014 or as soon as possible thereafter.
Let’s turn now to Slide 4, which discusses our recall activity in the quarter. Let me begin by stating that my total focus is to make GM the best automotive company for our customers as it relates to the safety, quality, reliability and overall value. We are not going to be satisfied by simply solving our current problems. We are completely aimed at being industry leaders. By now, all of you are familiar with the findings of the Valukas’ report which was presented to our Board of Directors in June and then shared with NHTSA and other government agencies.
I have fully embraced the report and pledge to act on all of the recommendations. Importantly a great many were acted on before the report was even released. Actions that we have taken include elevating safety decision making to the highest levels of the company. Creating a new position, the Vice President of Global Safety, that’s Jeff Boyer and he has full access to me and has regular reporting out to our senior leadership team as well as the Board.
We also reorganized vehicle engineering and created the new product integrity organization which I am confident will improve quality safety and the functional performance of our vehicles through a better design, execution and systems integration. We also removed 15 employees from the Company, some for misconduct or incompetence, others because they simply don’t take responsibility or act with a sense of urgency.
We instituted a Speak Up for Safety program to encourage and recognize employees when they report potential safety issues and do it quickly. We have already received more than 280 suggestions. And we’ve now added 60 safety investigators to identify and address issues much more quickly and we’ve aligned the legal staff to help assure transparency and information sharing among the staffs and other business units across the entire company. Overall, we are dramatically enhancing our approach to safety.
You can see it in the aggressive stance we are taking on recalls and the redoubling of our efforts. This year we have looked at vehicles going back to the 1990s and the results were 60 individual recalls in United States covering 29 million vehicles in North America. About two-thirds of the recalled vehicles are no longer in production and more than 12 million of the vehicles will be fixed by simply replacing or modifying the key.
In addition, some of the recalls were quite small. We had 13 recalls of less than a 1,000 vehicles and 5 with less than a 100. The financial impact of this activity in the second quarter is outlined on the slide. A recall related charge of 1.2 billion in this quarter. This work is now substantially complete and I believe we have now addressed the major outstanding issues. But if we see new data we will address it.
Today we are bringing greater rigor, discipline and urgency to our analysis and decision making process with regard to safety and our recall. We are mining every source of data available to us from the factory floor to warranty information to customer calls to social media to legal claims, all sources of information. And we’re not waiting to see if the trend develops. We want our customers to know that if we identify an issue that could possibly affect their safety we will act quickly.
With respect to the ignition switch recall itself, as I have said before, we are taking responsibility for what happened and we are treating the people who suffered physical injury or loss of loved one with compassion, decency and fairness. As you know the compensation program that independent program administrator Ken Feinberg has developed will begin accepting claims on August 1st. The creation of the program has resulted in a 400 million pretax special item in this quarter as you can see on the slide.
Also, vehicle repairs are well underway. More than 550,000 vehicles have been repaired and we are on-track to have enough kits to repair the majority of the recalled vehicles by early October. As parts availability has improved and the pace of repairs has accelerated, we have seen a corresponding decline in the demand for rental cars. This was expected. Okay. Let’s turn back to earnings and I’ll now ask Chuck to walk you through a detailed review of the quarter. And then Chuck and I will take your questions. Chuck?
Chuck Stevens – EVP and CFO
Thanks Mary. On Slide 5 we again remind you of the results for the quarter. Net revenue for the period was 39.6 billion. So nearly 600 million increase from the prior year is primarily attributable to favorable mix of 1.2 billion, favorable price of 1.1 billion, increased revenue from GM Financial of 400 million, partially offset by a negative 1.8 billion associated with lower wholesale volumes and unfavorable foreign exchange of 400 million primarily due to the weakening of the Brazilian real and the Argentine peso against the U.S. dollar.
Our operating income was a loss of 500 million primarily attributable to 1.2 billion in recall-related expenses, and 1.3 billion in special charges which I will cover in more detail later. Net income to common stockholders declined 1 billion to 200 million and our diluted earnings per share came in at $0.11, again, influenced by recall-related expense and special charges. As Mary indicated, net income was 1.7 billion excluding recalls and special charges.
Automotive net cash from operating activities was 3.6 billion, a 900 million decrease from the same period in 2013. For our non-GAAP measures EBIT adjusted was 1.4 billion in the second quarter including 1.2 billion of recall-related expenses and $200 million of restructuring. And EBIT adjusted margin was 3.4%, down from a year ago again adversely impacted by a negative 2.9% due to recalls. Adjusted automotive free cash flow decreased 600 million to 1.9 billion for the second quarter. However, this is nearly 1 billion higher for the first half of the year compared to the first half of 2013 including $300 million of recall-related cash costs.
On Slide 6, we disclosed the special items that impacted earnings per share. Net income to common stockholders was 200 million and our diluted earnings per share were $0.11. Included in our special items for the quarter is a 900 million non-cash pre-tax charge relating to a change in how we estimate costs for recall campaigns in GM North America. This reduced net income by approximately 500 million in the quarter and I’ll go into more detail regarding this change in the next chart. Additionally, as previously announced GM will implement a compensation program for those who have lost loved ones or suffered from physical injuries as the result of the — an ignition switch failure related to the 2.6 million vehicles recalled earlier this year.
A special charge of $400 million pre-tax was taken for the GM ignition switch compensation program, which reduced net income by $200 million on an after-tax basis. There is no cap on this program but this charge is to the Company’s best estimate of the amounts that maybe paid to claims. Due to the unique nature of the program, this estimate contains significant uncertainty and it is possible that total cost could increase by approximately $200 million. The impact of these special items had a $0.47 unfavorable impact onto diluted earnings per share in the period.
On Slide 7, we give you an update on our GMNA recall expense. We have substantially completed our efforts to address outstanding recall issues and also enhanced the analytical data available which contributed to better overall estimating capabilities. In addition, we have made several significant organizational changes such as the creation of a new global product integrity organization and the appointment of a new Global Vice President of Vehicle Safety responsible for the safety development of our vehicle systems as Mary mentioned earlier.
As a result, beginning in Q3, GMNA will accrue estimated recall expense at the time of vehicle sale which will be a similar method with how we currently accrue for policy and warranty and will be in line with other manufacturers. Going forward, we expect future recall expense to normalize at levels higher but not materially so than levels prior to the first half of 2014.
Additionally, we expect to identify issues sooner which may result in the frequency of announced recalls increasing but the number of vehicles per recall and the cost per recall event would be down. As a result of changing how we estimate recall campaigns in North America, we took a 900 million non-cash pre-tax special charge during the quarter. This is our best estimate of the remaining recall expense we expect for the next 10 years for 30 million GM vehicles on the road today.
On Slide 8, we show our consolidated EBIT adjusted for the prior five quarters. At the bottom of the slide, we list the revenue and margins for the same periods. Our operating income margin for the second quarter for 2014 was a negative 1.2%, down significantly from the prior period as a result of recall-related expenses and the special items I reviewed earlier. Our EBIT adjusted margin decreased 2.4 percentage points to 3.4%. Our consolidated wholesale vehicle sales were 1.5 million vehicles in the second quarter, approximately an 8% decrease from the prior year and our global market share decreased 0.3 percentage points to 11.3%.
On Slide 9, we explain a 900 million decrease in year-over-year consolidated EBIT adjusted. Volume was 300 million unfavorable due primarily to lower wholesale volumes in GMIO and GMSA as a result of the wind down of the Chevrolet brand from Europe and the challenging market conditions in South America. This was partially offset by higher wholesale volumes in GM North America.
Mix was 200 million favorable primarily attributable to North America. Price was 1.1 billion favorable due primarily to recently launched vehicles in North America like the new full-size SUVs, full-size trucks and vehicles such as Corvette Stingray, as well as pricing performance in GM South America. Costs were 1.6 unfavorable including the impact of the 1.2 billion in recall-related costs in the quarter, 900 million in material costs associated with recently launched products, incremental restructuring expense of 200 million, partially offset by 500 million in fixed and variable cost improvement. Other was 300 million unfavorable primarily related to foreign exchange.
Slide 10 gives our year-over-year EBIT adjusted performance by segments GMNA decreased 600 million to 1.4 billion including 1 billion in recall-related expense. GME decreased 200 million to a loss of 300 million for the quarter primarily driven by 200 million in incremental restructuring expenses. The performance GMIO improved 100 million to 300 million and in South America EBIT adjusted decreased 100 million on a rounded basis to a loss of 100 million for the quarter. GM Financial continued to deliver solid results with 300 million in earnings before taxes adjusted for the period and our corporate sector was a 200 million loss, including 100 million in recall-related legal expenses for a total EBIT adjusted of 1.4 billion in Q2.
We now move on to our segment results with the key performance indicators with GM North America on Slide 11. For the second quarter of 2014, our total U.S. market share was 17.9%, flat versus the same period a year ago but up 90 basis points from the first quarter. Our retail incentive levels on an absolute basis were higher than the prior year period and slightly higher than the prior year quarter. Our incentives for the quarter were 10.6% of average transaction price. This puts us at a 108% of the industry average.
Slide 12 shows GMNA’s EBIT adjusted for the most recent five quarters. At the bottom of the slide, revenue in this segment as a business was 25.7 billion, up 2.2 billion from the same quarter in 2013. GMNA’s EBIT adjusted margin was 5.4% for the second quarter, which included the negative impact of 3.8 percentage points associated with recall-related expenses.
Excluding the impact of recalls, GMNA’s margin is above 9% for the quarter and is up over 115 basis points in the first six months of the year compared to the first six months of 2013. In fact, excluding the impact of recalls, GMNA EBIT adjusted margin has been up for four straight quarters on a year-over-year basis. Our U.S. dealer inventory increased to 799,000 vehicles, up from a year ago, but down approximately 17,000 units from the first quarter.
This is equivalent of 72 day supply at the end of the June, down from 83 day supply at the end of Q1 and up slightly from 70 day supply a year ago. GMNA’s wholesale vehicle sales were 830,000 units, 21,000 units higher than the prior year. North American market share came in at 17.2%, which was a 0.1%, point decline from the prior year period but higher than the prior year three quarters.
On Slide 13, we provide the explanation of the 600 million year-over-year decrease in GMNA’s EBIT adjusted. Volume was 200 million favorable due to the 21,000 unit increase in wholesale volumes driven by a growing industry and our successful products such as the full-size pickup trucks. Mix was 200 million favorable due to our full-size trucks and products such as the Corvette Stingray. Price was 800 million favorable on the strength of our full-size trucks and all new full-size SUVs. Cost was 1.6 billion unfavorable primarily due to the 1 billion of recall-related expenses and material costs associated with new launches, partially offset by fixed cost savings and material performance on carryover products. Other was 100 million unfavorable due to foreign exchange.
On Slide 14, GMA reported an EBIT adjusted loss of 300 million for the second quarter, a 200 million decrease from the prior year. Revenue increased 6.6% to 6 billion for the quarter and EBIT adjusted margin in the segment decreased 3.1 percentage points to a negative 5.1%, primarily attributable to incremental restructuring expenses. GME’s wholesale vehicle sales for the quarter were 305,000 units, up slightly from the prior year. And our European market share was 6.8%, down 0.9 percentage points from the prior year, primarily related to the wind down of the Chevrolet brand.
As mentioned earlier, the Opel/Vauxhall brand increased sales nearly 4% in the first half of this year and market share increased 8 basis points year-to-date. After adjusting for incremental restructuring expense and despite challenges in Russia, GM Europe is near breakeven and well on its way towards profitability by mid-decade.
On Slide 15, we provide the major components of GME’s 200 million decrease in EBIT adjusted. Volume was flat as improving Western European markets were offset by conditions in Russia. Mix was also flat on a year-over-year basis. Price was flat as competitive pressure in the industry was partially offset by price recovery for foreign exchange. Cost was 100 million unfavorable primarily due to 200 million in incremental restructuring costs, partially offset by material and fixed cost savings. Other was 100 million unfavorable due to foreign exchange. This totals to GME’s EBIT adjusted loss of 300 million for the second quarter of 2014.
We’ll now move on to GMIO’s profitability for the prior five quarters on Slide 16. EBIT adjusted was 300 million including 500 million in equity income from our joint ventures. At the bottom of the slide, GMIO’s revenue from consolidated operations was 3.6 billion. The 1.2 billion declined from Q2 2013 is primarily due to lower wholesale volumes in the Middle East and Chevrolet brand vehicles in Europe. Consolidated operations’ EBIT adjusted margin was a negative 5.7%, down significantly from the prior year, primarily related to reduced volumes in the region.
Our net income margin from our China JVs remains strong at 10%, up 0.6 percentage points year-over-year. The region’s wholesale vehicle sales were 157,000 for its consolidated operations and 830,000 for our China JVs, which was up 7.5% from the prior period in China. Our market share in Asia-Pacific Middle East and Africa region was 9.7%, flat from a year ago. Our market share in China was 14.4% for the first six months of the year, relatively flat compared to the first six months of last year as we work to keep pace with the quickly growing industry.
On Slide 17, we provide the major components of GMIO’s year-over-year performance. Volume was 300 million unfavorable due to 83,000 unit decline in wholesale volumes in our consolidated operations. Mix was flat on a year-over-year basis. Price was 100 million favorable primarily in our Middle East operations. Cost was a 200 million tailwind associated with the wind down of the Chevrolet brand from Europe and lower cost in Australia, India and Middle East markets, partially offset by incremental recall and restructuring expenses. Other was 100 million favorable due to improved equity income from our strong China operations.
Going forward, we continue to expect our China business to remain strong. With regard to consolidate operations, we should see the benefit of important launches of the new full-size pickup trucks and full-size SUVs in the Middle East.
Slide 18, provides a look at GM South America’s performance in recent quarters. Revenue decreased 1.1 billion to 3.2 billion primarily due to lower wholesale volumes and foreign exchange, partially offset by favorable pricing and mix. The EBIT adjusted margin in this segment was a negative 2.5%, 3.8 percentage points lower than the prior year. GM South America’s wholesale vehicle sales were 211,000 units, 67,000 lower than the second quarter of 2013 and South American market share declined to 16.7% in the quarter.
On Slide 19, we look at the change in year-over-year EBIT adjusted, a decrease of 100 million. Volume decreased 200 million primarily due to lower wholesale volumes in Brazil, Argentina and Venezuela. Mix was flat. Price was 200 million favorable due to actions we have taken in Argentina and Brazil to partially offset foreign exchange in those markets. Cost was flat as incremental restructuring expense was offset by fixed cost savings. Other had a 200 million adverse impact primarily due to unfavorable foreign exchange in Brazil and Argentina. This totals to an EBIT adjusted loss of 100 million in GM South America in the second quarter.
Slide 20 provides a walk of adjusted automotive free cash flow for the second quarter. As a reminder, our net income to common stockholders was 200 million. After adjusting for non-controlling interests and Series A preferred dividends and deducting GM Financial earnings our automotive income was 100 million. We had 800 million in non-cash special items. And our depreciation and amortization was 1.6 billion expense. Working capital was a 600 million use of cash. The variance from prior year is primarily due to production timing.
Pension and OPEB cash payments exceeded expenses by 200 million in the quarter. Other was 1.9 billion primarily attributable to recall charges during the quarter, evidenced from China joint ventures and timing of sales incentive accruals versus payments. This totals to automotive net cash provided by operating activities of 3.6 billion. We have 1.7 billion of capital expenditures in the quarter giving us an adjusted automotive free cash flow of 1.9 billion.
On Slide 21, we provide a summary of our key automotive balance sheet items. We finished the second quarter with 28.4 billion in cash and current marketable securities and 10.4 billion in available credit facilities for a total available liquidity of 38.8 billion. Our book value of debt was 7.5 billion and our Series A preferred stock obligation was 3.1 billion. Our U.S. qualified and non-qualified pension plans were underfunded by 7 billion and our non-U.S. pensions were underfunded by 12.3 billion. Our unfunded OPEB liability was 6.3 billion in the second quarter.
Slide 22 provides a brief summary of our auto financing activities. GM Financial has already released the results and will hold their earnings conference call at noon. Our U.S. subprime penetration in the second quarter was 8.1% down 0.4 percentage points from the prior year. Our U.S. lease penetration increased 4.3 percentage points to 24.2% in Q2, as we continue to leverage our financing relationships and improve residual values to drive toward industry competitive levels in key segments.
Lease penetration in Canada was at 27.5% up significantly from last year, but more in line with industry. GM new vehicles as a percentage of GM Financial originations rose to 75% and GM Financial’s percentage of GM’s U.S. consumer subprime financing and leasing was 30% in the quarter. GM Financial’s annualized net credit losses remained low at 1.4% and their earnings before tax adjusted were 258 million for the second quarter. Reflecting both continued strong performance of their North American business and international operations.
Finally, on Slide 23 we highlight a few areas of focus for the second half of the year. Customer care remains our top priority as a Company, we will continue to work with our suppliers, our dealers and others to repair recalled vehicles as quickly as we can and to continue to focus on improving our processors around our vehicle safety and commitment to our customers.
We have some important launches in the second half of this year in many of our regions. We will continue to focus on the important work of delivering flawless vehicle launches and introductions in these important markets. With the successful new vehicle launches we’ve had thus far, we continue to generate strong results in the U.S. and China and we remain on-track to be profitable in Europe by mid-decade.
We are confident we are currently on or ahead of plan to deliver the results we promised earlier this year excluding the effects of recalls. Finally, Mary will have more to say about our second half focus in her closing remarks. But I want you to know that we are committed as a Company to continue driving the strong underlying cooperating performance we delivered in the first half of this year, across all regions and despite the challenges we face.
Now Mary and I will take your questions after which Mary will have some closing remarks, Sandy?
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