Adient PLC (ADNT) 2018 Q2 法說會逐字稿

Welcome, and thank you all for standing by. (Operator Instructions) Today's call is being recorded. If you have any objections, you may disconnect at this point.

I'll now hand the call over to Mark Oswald. You may begin.

Thank you, Louis. Good morning, and thank you for joining us as we review Adient's Second Quarter Fiscal Year 2018 Financial Results. The press release and presentation slides for our call today have been posted to the Investors section of our website at adient.com.

This morning, I'm joined by Bruce McDonald, our Chairman and Chief Executive Officer; Jeff Stafeil, our Executive Vice President and Chief Financial Officer; and Byron Foster, Adient's Executive Vice President, Seat Structures & Mechanisms.

On today's call, Bruce will provide a business update, including a review of our Seat Structures & Mechanisms business, followed by Jeff, who will review the financial results in greater detail. At the conclusion of the prepared remarks, we will open the call to your questions.

Before I turn the call over to Bruce and Jeff, there are few items I'd like to cover. First, today's conference call will include forward-looking statements. These statements are based on the environment as we see it today and, therefore, involve risks and uncertainties. I would caution you that our actual results could differ materially from these forward-looking statements made on the call. Please refer to Slide 2 of the presentation for our complete safe harbor statement.

In addition to the financial results presented on a GAAP basis, we will be discussing non-GAAP information that we believe is useful in evaluating the company's operating performance. Reconciliations for these non-GAAP measures to the closest GAAP equivalent can be found in the appendix of our full earnings release.

This concludes my comments. I'll now turn the call over to Bruce McDonald. Bruce?

All right. Thank you, Mark, and good morning, everybody. Thanks for taking the time to sit in and go through our second quarter earnings results with you. Got a lot of information here to cover today. So I'm going to jump right into it.

First off, you'll likely notice within our release and our slide deck that the reorganization of Adient's management structure that occurred in the second quarter resulted in us deciding to make a realignment to our reportable segments. So we'll now be showing 3 segments, Seating, Seat Structures & Mechanisms or SS&M as we call it, and Interiors. We think the -- with the focus that we have on turning around our Seat Structures & Mechanisms business now, this will obviously improve on the transparency. We're going to show a lot of numbers for this part of our business and so it'd be pretty transparent on our ability to track improvements on a go-forward basis.

As a result of separating Seat Structures & Mechanisms into a new segment, we did take a net $279 million noncash goodwill impairment charge in the quarter. So we'll adjust that out when we talk through our adjusted EBITDA numbers.

Jeff's going to go through the financials, obviously, here in a few minutes, but let me just call out a few on the top of Slide 4, some of the highlights. So our adjusted EBITDA for the quarter came in at $363 million, which is down on a year-over-year basis about $58 million and that was more than explained by the reduction -- the year-over-year reduction in Seat Structures & Mechanisms.

If you look at our earnings per share at $1.85 -- adjusted earnings per share of $1.85 in the most recent quarter, you see that the lower level of operating performance dropped right down to the bottom line.

Turning to our balance sheet and our liquidity, cash at the end of the quarter was about $353 million, reflecting our second quarter operating performance, higher cash restructuring charges and unfavorable working capital movements, which we think are largely timing related.

Our net debt and leverage at the end of the quarter was $3.3 billion and 2.3x, respectively.

Although the team has been laser focused on stabilizing the SS&M business and positive progress was made in the most recent quarter versus last quarter, we clearly review -- we clearly view these results as disappointing. In addition to having significant impact on our financial results so far this year, we've also concluded, after completing a comprehensive strategic assessment of the SS&M business, that the 200 basis points of margin expansion that Adient has set a goal to achieve by 2020 is no longer going to be achievable.

If you turn to Slide 5. I'll just sort of remind the analyst community in terms of what our original targets were and how they were comprised. As we've made pretty good progress in terms of the SG&A reductions of 150 basis points, we have put in the growth investments, although they're probably going to be a little bit lower than that 50 to 150 basis points. But the 100 to 200 basis points of margin expansion by 2020, to achieve this in next time frame would require a $600 million improvement in our Seat Structures & Mechanisms business over the next 2 years and that's just clearly not possible.

Outside of SS&M, I'm pleased with the progress that we've made on our margin expansion actions. Even though we are expected to reverse the $300 million setback that we have had so far in Seat Structures & Mechanisms by 2020, like I said earlier, we don't see ourselves getting to $600 million improvement, which is what we need to do to get the 200 basis points of margin expansion.

I'd like to use the next several minutes updating you on the comprehensive strategic review of the SS&M business that was recently conducted. And to some extent, is still underway. I'm not saying we're completely finished, and we have all the answers, but we've made a lot of progress over the last 3 months.

Turning to Slide 6. The objective of our strategic review really is threefold. First of all, to rapidly stabilize the business and drive near-term improvements. The team has made great progress in this area evidenced by the approximately $40 million sequential improvement in our operating results in this segment. We expect to build on the positive momentum that we achieved here in the first quarter as we progress through Qs 3 and 4.

Our second objective was to revisit the strategic importance of the business. Basically, stepping back and asking the question does this add -- does this business add value to Adient and its shareholders? The review confirmed our belief that this business is strategic to Adient for a number of reasons. First, it's absolutely critical for us to be able to deliver complete fleet solution for the customers that buy seats in that way.

As you know, we've talked about this in the past. Customers buy -- some customers buy components, some customers buy direct components, other customers buy complete seats. We have a very strong market share, and it's profitable for us with the Japanese and OEM customers. Many of them buy complete seat -- at the complete seat level. And so it's critical for us to support almost 1/4 of our consolidated business are Japanese customers by having this capability.

Thirdly, as we think through around autonomous vehicles and new mobility solutions in the future. Right chairing, we think the metal structure part of the complete seat is going to be critically important, and we see a lot of evolution and technology in this space.

Then lastly, our business in China and that also just we started basically from scratch in 2012 is highly profitable, generating significant value for our shareholders. And we expect to see that to continue over the next 3 to 4 years. So you see good value creation in our metals business in China.

With that said, however, the review also highlit a fact that fundamental changes are necessary to ensure the business creates value for our shareholders in the future. And that takes us really to the third part of our strategic view. What transformation and potential restructuring efforts are required to enable sustained long-term value creation beyond the 2020 time frame?

Before commenting on the actions that we're taking here and what we're doing to stabilize the business, I know we've had a number of questions around what went wrong. The simple answer is a number of actions were put in place -- put into motion based on anticipated market factors' planning assumptions at that time. Many of these assumptions, including the pursuit of growth and the ability to manage the change in this business, with the benefit of hindsight were clearly overly optimistic. It's important for us to reflect backwards in terms of what happens. But right now, our team is laser focused on the future and what we're going to do to turn this business around.

On Slide 7, you can see a number of actions we've taken to already stabilize the business, and we've talked about some of these in our last call. But basically, we put a whole new leadership team in place in this business. We've implemented new reporting structure to drive end-to-end accountability. We've reinforced our launch team and driven a renewed commitment to improving our business processes here. We've executed action plans to mitigate our steel supply risks. We sent tiger teams to our most unprofitable plants to complement our plant leadership and drive rapid cost down action.

And lastly, we've completed a comprehensive review of our targeted business list and put in place clear boundaries centered on more selective participation, prioritization around strategic fit and profitability on our new business [course].

The chart on the right illustrates the progression of SS -- of the SS&M segment on an adjusted EBIT basis over the past several quarters. I think in our last call, we showed a number similar to this. These are restated to show our actual EBITDA on a segment basis. And so we -- you can see here, obviously, we made a big sequential improvement in the second quarter of 2018 and that was against our toughest year-over-year comps. So as new business improves here in Q3 and Q4, you can see we have easier year-over-year comps on a go-forward basis.

I'd encourage our investors to focus on the quarterly trend here versus the absolute dollars as we're in the early stages of a turnaround and things could be choppy. But nonetheless, we know we suffered a deep setback. We're in the early stage of recovery, and we're pretty pleased with the tracking of the improvement activities that we have in place right now.

Moving to Slide 8. It became clear to us that as we move this business forward and generate longer-term value for us, a number of major changes need to be actioned. Although we're in the early stages of analyzing and developing specific road maps and action plans, which will be flushed out over the next couple of months, we do have key -- we do have good, I'll say, line of sight into the key tenets of the transformation. These include pivoting to be more selective in areas where we want to participate, emphasizing profitability, strategic fit and, I'd say, supporting our just-in-time family business. This in the future will likely result in SS&M business for us being smaller in the future. It's important to note that this will take some time to achieve as we reduce our quoting activity.

Secondly, looking to be more aggressive in leveraging the scale that we have in mechanisms, specifically recliners. Our recliners and mechanisms part of our portfolio are high-margin businesses, and we look to leverage the returns that we make there to generate growth in the future.

We're also looking at new and greater outsourcing. Our business is very vertically integrated. We have a number of processes that we could -- we can outsource and use low tonnage stampings as an example. We can derisk the business, reduce the level of capital intensity we have in this business by outsourcing more of those types of processes.

We also look to better leverage our Chinese facilities to supply product back to North America and Europe. And here again, we'd be in the mechanisms part of our business. These are things that ship well, will make good returns in China, and we can, again, reduce the capital intensity of our consolidated Seat Structures & Mechanisms business.

And as I said, we are in the early stages of looking at potential restructuring activity. But our intent is to fund the restructuring initiatives that we have with the capital phasings that we expect to generate in SS&M. As we shrink this business to lower quoting activity and we get to the maturity of our new product launches, the CapEx requirements of Seat Structures & Mechanisms will decline.

If you look at the business today, Seat Structures & Mechanisms accounted for about 45% of our capital expenditure in 2017 and nearly 50% of our capital expenditure on a year-to-date basis. These for Seat Structures & Mechanisms are the high watermark. And as we plan -- as we go forward into '19 and '20, the CapEx requirements in this business, we do expect to trend lower.

We've been pretty consistent in the past about saying that about $100 million per year will be a normative level of restructuring, and we continue to believe that's the case. Obviously, that money will largely be focused on Seat Structures & Mechanisms business.

A key takeaway I want people have around restructuring is, we don't have a several-hundred-million-dollar bill that we're looking at. We -- this is something that's going to take some time to achieve, and we think we can live within that $100 million a year number that we've committed to at the part of the spinoff in Johnson Controls.

And then finally, there's clearly an element of improved commercial discipline required. And by that I mean, control of change management as these programs mature for the engineering phases and enhanced improvement in terms of our economic recoveries. We have good -- we have a spectrum of economic recovery from 0 risk to a lot of risk. We need to change the paradigm that we have there to be much more -- less risk exposed on material economics and this lag that we have in our business today.

In the near term, as we have shown on Slide 5, we do expect the business to return to its pre-spend levels of profitability, which is a $300 million improvement versus where the business is today by 2020.

I would tell you that our improvement is front-end loaded. We expect a significant element of $300 million improvement to happen in 2019. So it's not back-end loaded like our previous Seat Structures & Mechanisms goals.

In addition to the improvement that we expect in our consolidated business and as I said before, we can -- we expect to see continued strong growth in profitability from unconsolidated Chinese Seat Structures & Mechanisms businesses. Of our equity income, our China Seat Structures & Mechanisms equity income is about 10% of Adient's total, roughly about 40 million a year. And we expect to see this grow strongly over the next 3 to 4 years.

As a result, if you look at Seat Structures & Mechanisms, we expect a combination of improved operating performance and lower capital expenditures to drive significantly higher cash generation. We know there is a lot of focus on our Seat Structures & Mechanisms business. And I think we indicated that our -- during our last call that we will be participating in the Wells Fargo Industrial Conference next week, and we plan to further elaborate on Seat Structures & Mechanisms and what we're doing with that business.

With that, I'll turn it over for Jeff to talk about the financial results in more detail.

Great. Thanks, Bruce. Good morning, everyone. Turning to our financial performance. As Bruce stated in his remarks, Adient's second quarter results are unacceptable, but generally consistent to what we outlined in January.

Although we saw positive sequential improvement in the SS&M business in the most recent quarter versus Q1, the company faced increasing pressures in other areas of business. More on that in a minute.

As you can see on Slide 11, the headwinds within SS&M combined with weakness in Interiors on a significant -- had a significant impact on our results. In addition, a onetime noncash goodwill impairment charge resulting from our segment realignment, specifically Adient SS&M segment, also impacted our GAAP results for the quarter.

Adhering to our typical format, the page is formatted with our reported results on the left and our adjusted results on the right side. We will focus our commentary on the adjusted results.

These adjusted numbers exclude various items that we view as either onetime in nature or otherwise skew important trends in the underlying performance.

For the quarter, the net $279 million noncash goodwill impairment charge was the largest special item. Other adjustments are related to the coming Adient restructuring-related charges and purchase accounting amortization. Just 1 additional point before I move on. I'd like to point out that with regard to the realignment of our reportable segments, the company has begun to assess the performance of our reportable segments using adjusted EBITDA.

As stated on prior calls, given the amount of growth investments and capital expenditures planned in the coming years, we view adjusted EBITDA and CapEx by segment as more meaningful measures versus adjusted EBIT. You'll find disclosure of CapEx by segment and thus be able to see key figures for each segment with greater transparency than in the past.

Moving on, adjusted EBITDA at $363 million fell $58 million year-over-year, more than explained by the operating performance within the SS&M and Interior segments. Meanwhile, adjusted equity income for the quarter was down $1 million compared with the same period last year. As I just mentioned, weakness in YFAI was the primary driver with a partial offset in our nonconsolidated seating business.

Finally, adjusted net income and EPS were down approximately 25% year-over-year at $173 million and $1.85, respectively. While sales are tracking better versus plan, we continue to face operational and execution challenges, primarily in our Seat Structures & Mechanisms business.

Now let's break down our second quarter results in more detail. Starting with revenue on Slide 12. We reported consolidated sales of $4.6 billion, an increase of $395 million compared to the same period a year ago. Benefits of the Futuris acquisition and China JV consolidation more than offset the negative impact of lower volumes, primarily in North America.

In addition, foreign exchange had a positive impact on our sales this quarter compared to the same period last year by approximately $285 million. The primary driver was the euro as the euro to USD rate averaged $1.23 in Q2 versus $1.07 last year.

Moving on, with regards to Adient's unconsolidated revenue growth. Revenue growth remains strong. Unconsolidated seating revenue, driven primarily through our strategic JV network in China, grew about 12% year-on-year. Adjusting for FX and the China JV that is now consolidated, sales were up about 8%. A very good outcome, especially when you consider production in China during the quarter was down 3%.

Unconsolidated Interiors recognized through our 30% ownership stake in Yanfeng Automotive Interiors, or YFAI, also experienced year-on-year sales growth. Adjusted for FX, Interior sales were up approximately 3% in Q2 versus a year ago. Although up year-on-year, I'll point out that the increase in sales was driven by a high mix of low-margin cockpit sales. Excluding FX in the low-margin cockpit sales, overall sales were down 2%.

Moving to Slide 13. We provide a bridge of adjusted EBITDA to show the performance of our segments between periods. The bucket labeled corporate are central costs that are not allocated back to the operations. These core costs include our executive office, communications, corporate finance, legal and marketing.

Big picture. Adjusted EBITDA fell to $363 million in the current quarter versus last year. The corresponding margin related to the $363 million of adjusted EBITDA was 7.9%, down approximately 210 basis points versus Q2 last year.

Weaknesses. Weakness in our SS&M and Interiors businesses could not be fully offset by benefits associated with the Futuris acquisition and the JV consolidations of around $29 million, and additional improvements in SG&A, call it, $43 million.

Similar to comments I made in the first quarter call, I point out that a portion of the SG&A improvements made in the current quarter should be viewed as temporary as certain of the near-term actions were taken such as extremely tight control over discretionary spending or taking down our bonus accruals will not be part of the run rate of the business going forward.

Assuming we would be at plan or target performance, anticipate that our SG&A expense would have been approximately $20 million higher for the quarter.

With regard to Interiors and consistent with our internal forecast and comments made on our Q1 earnings call in January, the headwinds impacting YFAI intensified in Q2. The year-on-year decline was driven by a combination of factors such as lower volume in North America, a higher concentration of low-margin cockpit sales and operational issues that are being worked through in Europe and the U.S.

We will continue to work with our partners to identify areas to improve profitability. Our latest forecast assumes Q2 is the low point in profitability this year with second half results improving versus the first half.

Before moving to our segment discussion, let me note that we incurred approximately $7 million of cost in the quarter related to a third-party assessment of our SS&M business, but we excluded this charge in calculating our adjusted results. We expect the effort to finish in Q3, but the bulk of the expense was booked in this past quarter. The initiative was intended to provide a look at the strategic importance of the business and the necessary and strategic shifts we need to make for the long term to make an economic profit. This work assisted in arriving at the strategy Bruce discussed earlier.

As the costs to complete the study were onetime in nature and related to the eventual restructuring of this business, we opted to exclude it from our reoccurring numbers.

Moving forward and in an effort to provide greater transparency into our Seating and SS&M segments, slide 14 and 15 show the key drivers between periods. Starting with seating on Slide 14, adjusted EBITDA increased to $411 million, up $13 million compared to the same period a year ago. The primary drivers between the periods include benefits associated with the Futuris acquisition and the China JV consolidation that occurred late last year and contributed about $29 million, of which Futuris was approximately $15 million.

Further benefits associated with SG&A savings initiatives, along with our incentive comp reduction, had a $22 million impact in the most recent quarter. Currency movements had an approximate 8 -- or $26 million benefit in Q2 this year versus the same period last year.

And finally, equity income was up about $6 million, excluding the impact of foreign exchange. These results include an approximate $4 million reduction relating to the China JV that we now consolidated. Partial offsets to these benefits included; a higher level of investment to support Adient's future growth, call it, $36 million. The increased engineering resources, program managers and increase launch activities supports our new business wins, which, as you know, are initiated 2 to 3 years in advance of production.

Regarding investments spending for Adient Aerospace, the announced joint venture with Boeing included in our Seating segment is tracking lower for the year versus our original estimates. We expect investment for this business will accelerate once all regulatory approvals are secured and the business is operational, which we are expecting later this summer.

Moving on, lower volumes and negative mix, primarily in North America, accounted for $20 million year-on-year variance. And finally, we saw a negative operating performance of approximately $14 million, primarily in North America, due to inefficiencies associated with the high level of launch activity.

Net commodity cost, specifically the foam chemical market, increased $10 million in the quarter versus last year; however, this was largely offset by other material improvements. And 1 last point in Seating. One of the reasons we moved to adjusted EBITDA is to provide more cash flow transparency, and we'll continue to do that by segments. While CapEx can be lumpy within periods and we wouldn't suggest that you attempt to annualize any quarter, we do think it's a useful metric to provide. As such, our CapEx for the Seating business was approximately $58 million in the quarter.

Turning to Slide 15 and our SS&M segment performance. Despite improving sequentially versus Q1 2018, adjusted EBITDA was negative $34 million or $74 million lower than Q2 2017. The primary drivers between Q2 this year and last year second quarter include an $8 million improvement in SG&A plus approximately $3 million contribution from higher sales. However, this was well more -- more than offset by a significant drop in operating performance of approximately $61 million, which includes the issues we've talked about in recent communications.

While we've seen nice improvements versus the first quarter, we're still suffering from launch inefficiencies such as premium freights and significant operational waste. As Bruce discussed earlier, we are seeing significantly -- significant monthly improvements, but as we've explained, the safety critical nature of the SS&M business requires most improvements and changes to happen incrementally. But the team is making good progress.

Commodity inflation hurt performance by $9 million but was offset -- partially offset by $4 million of favorable FX. And finally, we incurred $19 million of other items in the quarter, driven primarily by unfavorable material mix, higher engineering and net pricing.

Regarding SS&M's CapEx for the quarter. They spent approximately $65 million. As Bruce discussed on Slide 7, the SS&M business made positive progress compared to the first quarter results. We expect the positive trend to continue into the second half of the year, resulting in second half results being significantly improved versus the first half performance.

It's important to remember as the business goes through a deep operational setback and begins to stabilize and improve, various internal or external influences can result in choppy performance quarter-to-quarter. So in other words, I just like to emphasize this is a very difficult business to forecast at the moment.

Let me now shift to our cash and capital structure on Slide 16. On the left side of the page, we break down our cash flow. Adjusted free cash flow, defined as operating profit -- excuse me, defined as operating cash flow less CapEx, was a negative $146 million for the quarter. The outflow reflects the negative year-on-year operating performance, increased cash restructuring and negative trade working capital performance. Partially offsetting these factors included an increase in dividends received from our joint ventures compared to Q2 of last year.

Speaking of cash received from our joint ventures and similar to last year, a large percentage of the dividends are received in the second half of our fiscal year. Capital expenditures for the quarter were $123 million compared with $95 million last year. The increased spend year-on-year is in support of our new business wins. As you can see in the footnote, we do break out CapEx by segment.

Regarding the increase in working capital, we expect some of this to unwind in the back half of the year. We have significant planned collections of tool in receivables, for example, and have a number of initiatives ongoing to improve this metric.

In summary, our free cash flow performance for the first half of the year reflects the operating challenges the business has faced. As the environment continues to improve, we expect significant improvement in our free cash flow as well.

On the right-hand side of the page, we detail our cash and leverage position. At March 31, 2018, we ended the quarter with $353 million in cash and cash equivalents. Gross debt and net debt totaled $3,678,000,000 and $3,325,000,000, respectively, at March 31, 2018.

As a result of our cash balance, debt level and operating performance, Adient's net leverage ratio at March 31, 2018, was 2.3x. It's important to remember that the Futuris acquisition is providing only half a year benefit to the LTM EBITDA, whereas the entire purchase price has obviously come out of our debt figures.

Turning to Slide 17. Let me comment on certain of the macro influences that are impacting business. Starting with the positives. Global automotive demand remains strong and as a result appears to be supportive of current production levels and forecast, which are estimated to increase modestly in 2018 versus last year. In addition, the continued shift into trucks and CUVs remains a nice tailwind for content growth. Definitely good news for the industry in Adient.

Unfortunately, there are a number of downward pressures that have intensified over the course of the quarter, specifically commodities, both steel and foam-related chemicals, rising freight cost and uncertainty related to trade. First on steel. As you have read, the steel and aluminum tariffs that were imposed by the U.S. created a great deal of uncertainty through the industry when first announced.

Fears appeared to have eased as details emerged and various country exemptions were allowed. For Adient specifically, the tariff itself is not the big risk as very little of our U.S. steel is sourced offshore. Our primary risk is the rapid escalation of prices at U.S. mills. To put this in context, prices have increased close to $200 per ton since January. Although we have escalators and contracts in place to help offset these price movements, it's important to remember a time lag, call it a couple quarters, exists between the time we experience the price increase and the reimbursement from our customer occurs.

Sticking with commodities. Adient continues to be impacted by increases in TDI prices for our foam chemical business, which is driven up by global tight supply. Our latest outlook continues to forecast a moderation in pricing in mid-2018 as production at European facility is brought online.

In addition to commodities, we are also managing rising freight cost, driven by driver shortages and the full impact of recent legislation. Unfortunately, this does not appear to be temporary. As such, the team is focused on operational logistics and inventory management to limit and mitigate our exposure.

Finally, we continue to monitor trade negotiations that are currently taking place. We're hopeful the U.S. and China can avoid the implementation of additional U.S. proposed duties, which if implemented would negatively impact the industry, including Adient. NAFTA negotiations continue to progress with the latest U.S. proposal appearing to be neutral for the company.

Bottom line. Despite the company's effort to mitigate these challenges, the intensified macro headwinds are placing downward pressure on earnings, resulting in a very challenging environment, especially when combined with some of our operating challenges.

Turning to Slide 18. Let me conclude with our thoughts on the remainder of fiscal '18. Starting with revenue, given our first half performance and the assumptions for foreign exchange, our consolidated revenue is trending towards the top end of our guidance of $17.0 billion to $17.2 billion and possibly a bit higher.

With regard to adjusted EBITDA after factoring in our first half performance, the improvements in SS&M that are expected in the second half and the increased macro pressures just discussed, we're expecting fiscal '18 will settle towards the low end of our guidance range, which is between $1.40 billion and $1.45 billion.

We continue to expect equity income will be approximately $400 million, which is included in the adjusted EBITDA estimate. As mentioned earlier, the performance in YFAI is expected to improve as we progress to the second half of the year.

Moving to adjust EBIT. And similar to adjusted EBITDA, we are expecting to settle at the lower end of the $975 million to $1.025 billion range. For modeling purposes, given our increased growth investments, depreciation is still tracking towards our initial guide of $385 million.

With regard to interest, no change to our approximate $135 million forecast.

Moving on to taxes. Based on the geographic composition of our earnings, we continue to expect an effective tax rate of between 8% to 9% a year. Given that we are reporting deferred tax assets as a result of net operating lawsuits in certain jurisdictions, there is a risk that we may have to report a valuation allowance if the business outlook remains negative. Recording such a valuation allowance could significantly increase our tax expense -- our book tax expense but wouldn't have any immediate impact on our cash taxes paid.

For net income and aligned with our expectation for operating results, we're expecting our adjusted net income will settle towards the lower end of the $700 million and $740 million range. Although current expectations for capital expenditures are consistent with previous guidance of between $575 million and $600 million, the team continues to assess various opportunities that may reduce or re-calendarize planned expense.

Finally, with regards to free cash flow, based on our operating performance in the first half of the year and our expectations for the second half of 2018, we see some risks in the outlook, largely depending on our operational improvements and working capital initiatives.

It's important to point out that working capital timing and the calendar date on which a quarter ends can have a dramatic impact. For example, a 1-day increase in our AR days combined with a 1-day reduction in our AP days would have an approximate $80 million impact on our cash balance. Thus, I'd suggest looking at the components of our free cash flow over time and somewhat neutralizing the impact of working capital changes from 1 period to the next.

In summary, and as I mentioned earlier, we are operating in an environment that is difficult to forecast. Much depends on the cadence of the change and improvements being implemented in our Seat Structures & Mechanisms group. In addition, we are also in the midst of significant commodity inflation and some operational challenges in North America related to our core Seating segment. While we see and forecast significant opportunities to improve our performance, I'd characterize our 2018 guidance as having more downside risks than upside opportunities. That said, we will continue to push the improvement initiatives across the business.

With that, let's move to the question-and-answer portion of the call. Operator, can you please open up the lines?

(Operator Instructions) And our first question is from John Murphy of Bank of America Merrill Lynch.

Just a question as we think about what's going on with the Structures & Mechanism business here. I mean, do you think there is something else going on just as far as sort of the accounting or reporting structure in the company where this kind of crept up on you quickly and you don't necessarily have the greatest handle on it to date, you are bringing outside folks and the separation of JCI may have fouled up systems or just something like that going on in the background that is also being worked on?

Not -- certainly not on our actual results, John. I would characterize perhaps some of the visibility that we had was certainly limited. It was really around the new launches, though. So I would not necessarily put it to our accounting systems and more sort of our ability to forecast through those launches was certainly characteristic of the problem.

Okay. And then second question. I mean, when you think about the business in China and sounds like that's working very well, I mean -- I'm sorry, Structures & Mechanisms. So what's going on there that is working so well that's not working in the rest of the business? Is it really just launches or is there some other thing that is you're greenfielding this and ramping it up, that is, you kind of learn from mistakes in the other side?

Yes, this is bull(expletive), John. A few things, a few things. First of all, our China business, we started from a clean sheet of paper. So we didn't -- we don't have old generation product and new generation product. So we -- that's number one. Secondly, it has the tubing manufacturing process that we want to have in place. A big one though is a business that was a much better job managing launches and it has a much smaller or less complicated supply chain, I would say. So if you think about our Shanghai-based metals operation, if -- we're building right now a second facility. It's going to be 200 million -- a 2 million square feet facility metals and -- sorry, Structures & Mechanisms. And so they are sort of co-located on 1 site. We kind of ship mechanisms from Europe all over the world tracks, Mexico up to North America. So they have a much simpler supply chain. And then the last thing I would point to, if you looked at the mechanisms, the percentage of high-margin mechanisms, and I said, "Oh, my colleague will want to emphasize the mechanisms more," the margins are higher in that business and if you would look at the share of mechanisms that we have in China versus the share of mechanisms that we have outside of China, it would be much higher skewed to that higher-margin product.

Okay. And then, just lastly, I mean, if you think about quoting activity, I mean, there was an assumption that the backlog would build, and growth would grow very significantly as we got to '19 -- calendar year '19 -- or fiscal year '19 plus. Is that still the case? And has any of the -- have any of these hiccups really impacted sort of your competitive position in the market and quoting activity?

Yes, I would say when we looked at our original investment thesis, I think our Seat Structures & Mechanisms business, and again, I'm talking this excluding China here, was about $2.8 billion. And we thought that we were going to grow that from the spin-off till 2020 to be about $3.5 billion. So we have about 25% growth. And right now, we would say we're probably going to -- it's going to be more like flat versus where it started at $2.8 billion or $2.9 billion, something like that. So we've -- as a result of this, review that we have done and some prior to the end of the first quarter, we've cut back on some of the new business quoting activity that we had. I would say focused it more on customers, supporting our JIT business and focusing on customers where the material economics profile is better. And I guess, what I would say is, if you looked at material economics, here in North America, the risk sharing has to be better than in Europe. And I'm just talking in aggregate here because there is outliers on both sides. But I was just saying the environment for recovering deal economics in North America is better and quicker. And so we -- as we felt -- kind of look at where we're going forward here, we'll focus more on, say, on North America book of business and less on outside North America.

And Bruce, just to follow up on that, though, I mean, outside of the SS&M business, in Seating and in Interiors, has there been any change in sort of your view on what you're quoting on or what you have been awarded or how you would be awarded? Is that totally separate and not sort of conjoined with the problems in SS&M?

Yes, I would say, SS&M problems are -- have not affected our quoting activity or our customer issues. I mean, we've had some challenges on SS&M, and I would tell you the we -- at the expense of our balance sheet, our income statement, I'd say, we've protected our customers by and large.

And the next question is from Emmanuel Rosner of Guggenheim.

So wanted to ask you about some of those strategic actions that you are potentially contemplating beyond serve like just stabilizing the metals business. What sort of like timeline and -- can we envisage for that? And can you just be lower quoting activity? Or can you actually proactively look to exit some contracts?

It's difficult for us to -- first of all, I guess, I'd say, just my way of seeing center. But the time frame for the programs is longer. I mean, we're somewhat -- as we looked at a seating program with a customer, often the metals part of it lasts 2 cycles, maybe more. So the time frames are longer here. Secondly is, this is -- it's obviously safety critical component, it's highly engineered and specific to a customer. And so the ability to sort of -- the customer to resource it is very difficult. So it's not like we can go and give back a whole bunch of business. It's their business that we've been awarded that we have an opportunity to do that? Yes, there is some, but not like -- not a big thing that we can do in the short period that would really move the needle. I -- and if you look at our manufacturing footprint that we have, it's pretty good. So we aren't sitting here with oh, our problem is we've got a bunch of high-cost plants and let's spend several hundred million dollars closing down Western European footprint and moving it to lower cost Eastern Europe or closing in North America here and moving it down to Mexico or something like that. That opportunity -- again, I wouldn't say there is none of it, but it's not a big opportunity for us. I think our restructuring, Emmanuel, will be where we're not quoting replacement business and we have to take out some cells. These plants, again, I would remind people aren't 100% customer focused. So unlike our JIT business, where if we were to exit something we can close a whole plant, here you're talking downsizing a portion of the plant. We see the restructuring things that we're looking at to be in that category. And also like -- and I talked about exiting out some lower -- some of our vertical integration like small tonnage stamping and things like that. So it -- the restructuring is not going to be, "Hey, we have this many dots on the map, and we see a whole bunch of closures. Maybe in there we can sell some component plants that supply to our other components plants." But that's the kind of thing that we're talking about restructuring. Not a -- I mean, I saw there is 1 analyst report out there that has several hundred million -- I think, $700 million type number. We don't see anything -- there is no opportunity in anything like that.

Okay. That's helpful. And then my follow-up would be, so when you sort of first signaled the issues in this business, you had said you sort of liked picked a quarter to sort of figure things out and then the 2020 outlook. I think one of the considerations we're going to look into beyond just what you do with metals was, are there any other buckets of savings that get -- sort of like help you get closer to the 2020 targets? After sort of like looking at it for like the last few months or so, what, I guess -- where were your findings? Like is -- are there any additional savings beyond what was sort of initially signaled in other areas of the business that are possible?

Yes, I mean, in the -- if you think about our original targets, we -- it was kind of 200 basis points excluding equity income, right. And so I'd say the equity income, there is probably more opportunity, but that sort of didn't count in the margin expansion goal. And as we look to, let's just say, Seat Structures & Mechanisms, just to give you an example. When we started off this -- the spin-off, our equity income in Seat Structures & Mechanisms was $10 million or $15 million. It's up to like $40-ish million this year. And if you sort of fast-forward to, let's say, 2022, it's $90 million or something like that. So our China business in metals doing very well, but again, that doesn't really help us in that -- in the goal that we've set ourselves for. There are some pockets of -- also pluses and minuses elsewhere. I think we're probably peaked at where we need to be from an investment point of view. So that sort of minus amount, I think, will kind of get better as we get into '19 and '20. But we thought as important right now is, look, we've had $300 million snap back in [profitably] for metals. It's going to be smaller business going forward, which means it's going to generate more cash. So think about we don't have the margin expansion. We also don't have the capital intensity in the business being higher. At the end of the day, can we improve our metals process by running the business better, being more selective quoting? Absolutely, there's a huge improvement we can generate here over the next couple of years. We're not saying by 2020, we're done because we do see more opportunity beyond 2020. But just sort of trying to reference back to what we said by 2020 for what we said we see now, it's a big improvement, but we can't get there.

And the next question is from David Lim of Wells Fargo.

Just quickly, can you go into a little bit more of these detail on the operational issues that you're, I think, facing on the Interiors side? And then on the SS&M side of the business, the $300 million improvement through 2020. What are the major buckets of improvement that you guys forecast?

Maybe I'll take the Interiors, and then I'll let Byron talk about the SS&M business. The Interiors business, we mentioned -- this is another part of -- we own 30% of the Interiors operation, as you know, with Yanfeng, and that business is global. I think sometimes I hear referenced a lot as a China business, but it's really important to remember that a lot of the sales, more than half of them or about half of them occur outside of China. There is a number of new facilities, new programs and other things that have been watching as that business has been growing. And I think a lot of where there issues have faced is in similar to some of the issues we faced is getting labor in places like Eastern Europe. Big labor shortages in Eastern Europe. We -- in that business, they've had to bring in whole groups from Mongolia to come in and plant in the Czech Republic that is just absent available workers to do the work in the facility. So that's been a little bit there. There has been some start-up of new plants in North America. So I think good programs, I think generally good results or good momentum in that YFAI business, but definitely going to little bit of growing pain as they're expanding.

But just to follow up on that. So the cost issues, they are more isolated and can be more readily overcome or not? I mean, I don't mean to be prickly here. It's not going to be like another SS&M, right?

No, I mean, this business. And we do things that probably for this business -- for the YFAI business, this last quarter should have been sort of their low market, should be getting better. As you look at SS&M, one thing you should just remember is how capital-intensive. We broke out CapEx. We're spending half our capital there. It's hugely safety critical, making changes to processes, designs, et cetera, require all kinds of testing, validation, approval, even changing materials require significant amounts of time. The Interior, it's much more a cosmetic setup. And the approvals and making changes is a lot easier. And I'll let Byron talk through the $300 million improvement.

Yes, in terms of kind of the big components there, I would start with launch stability. So we've, I think, shared with the group here that we struggle through a number of critical launches. We now have most of those issues behind us. We have good line of sight of the upcoming launches and the ones that we would deem kind of high risk and those are the ones we're focused on, have the right resources on to make sure that those launches go off as planned. I mean, one of the drivers when we get into difficult launches, I will just give you 1 statistic around premium freight. So we spent over $40 million on premium freight in the first half of the year. So as those launches come in more stable, that's 1 line item that we will see improvements in.

Steel supply has been a big challenge for us the first half of the year, particularly some of the specialty steels that are required for our mechanisms. We had a real gap in our supply versus our demand. So that drove a lot of in-plant inefficiencies as well as premium freight. We've now got the steel supply issue fixed. So we'll have better, more consistent flow of raw material into our mechanisms plant that's going to drive in-plant improvements and better machine utilization, longer runs and ultimately, again, attack the premium freight topic. Engineering cost is another area where we'll see improvements and lower cost, again, as a lot of these launches get behind us and as we have a more targeted approach in terms of new business acquisition that was possible come down as well. So that was -- we're beginning to see those and we're seeing that in the results Q2 versus Q1. And as we look forward into the second half of the year, we expect those improvements to continue.

And the next and the last question is from David Tamberrino of Goldman Sachs.

Great. Slide 5 seems to imply a flat consolidated EBITDA margin in 2020 versus the LTM midyear -- mid-2016 level. Just trying to understand, is that what the guide is now for 2020? Or do you think you can come in still better from this from incremental SG&A savings? I know in the past, you have kind of talked about potentially shifting around that bucket and just -- it wasn't clear to us whether 2020 is now kind of just flat with where we started or slightly above that level. How should we think about it?

Good question, David. Actually, what we'd -- but yes. We went through a process -- I mean, Emmanuel asked, we went through a big process to reevaluate all of our businesses, and there is other pieces we knew we could lean on. And I think we can get a bit more out of some of the SG&A savings that we had outlined. And we're pushing probably a little bit maybe less than some of that growth investment as we move forward. Especially while taking maybe some of the emphasis on SS&M growth away. But the challenge for us on meeting the 200 basis points of margin expansion without equity income was SS&M we saw being really flat. We didn't see -- we needed the SS&M business to sort of make up some of the slack. We think that business can be better, more efficient in a lot of things. So while we see some improvement opportunity from our 2016 starting points, we just don't think we can get all the way to the 200 basis points and that's why we turned back and said, this was -- as we reassessed all parts of our business that we felt that this 200 basis point goal was not reasonable in the midterm. But we still can do better than where we started.

And that's fair. But if I were to try to put some quantitative metrics to that qualifying language. Are we talking kind of in the 0 to 100 basis points or 50 to 100 basis points range or is that too high of a potential opportunity?

I'd say there is -- and there is a lot of things that have to be worked out, David. But certainly, probably more in the 50 to 100 basis points would be where we would see this without some sort of structural change to what we have today, in particular on the Seat Structures & Mechanisms.

All in this time frame.

Yes, in this time frame. Beyond 2020, there is more opportunities, but that time frame, that's probably...

And I think, David, it's kind of -- you can kind of say if I had another 4 years, where do I kind of get back there versus what we do in the next 2 years? And we're trying to -- we obviously, [plastics] sort of walk away from your commitment, but we're trying to be transparent in terms of what we think we can do in this time frame. What we're not doing right now, and I want to caution that is because as I said in my remarks, we're still looking at some of these longer-term things around outsourcing, utilization of China footprint and selective restructuring, et cetera, et cetera, et cetera. So I'm not in a position to kind of say being the time frame that we've had and as I'm sure you can appreciate, there is an awful lot of focus on the short term and sort of getting out of the crap that we're in right now. But in the time frame that we have, we haven't -- we aren't done in 3 months to say, "Okay, here is where I see ourselves in 2022." So anyway -- that's, I mean, probably not the answer you'd like to hear, but that's kind of where it is.

No, no, that's incredibly helpful and look, I think most investors understand what the position is, just looking for how you're thinking about it today versus sort of just be flat or not. So the 50 to 100 was extremely helpful. And just lastly from us, do you see any risk to any potential market share losses as you complete some of the exits of the SS&M business? Is there risk of losing some of the marquee products that you're on as that comes about? Because I know we've heard from some other seating suppliers that there could be an opportunity for them as a result of this -- as a result of your operational issues, at least at this juncture?

I guess, I would tell you. I mean, obviously, when we look at this business and what we want to do in terms of quoting or exiting or things like that. I mean, for sure, we're going to look at how it reflects on our customer position in the aggregate. So we're not going to do something stupid in the Seat Structures & Mechanisms business that's going to have a huge negative impact on our global business with our customer. So our customer -- especially in the metals business, our customers do tend to source global structures. And so we have to -- that's another thing that for sure we have to take into consideration. So we're going to -- we got to -- we just got to be mindful in sort of doing the right thing here.

So maybe I know we're kind of over our time slot. So maybe just make a few closing comments here. I mean, clearly, we recognized that our first half results are disappointing. It's not the way we look to start this year. On the other hand, being balanced here, we are pretty encouraged with the improvement that we have made here quarter-over-quarter from Q1 in terms of Seat Structures & Mechanisms. I think we have outlined a number of tenets that we're focused on to create value in Seat Structures & Mechanisms. And I think these building blocks if you sort of think back, it's transforming our Seat Structures & Mechanisms not only recapturing the lost profits since the spin, but moving the segment smaller -- beyond 2020, but a smaller, less capital intensive and much more profitable and cash generative. Clearly, we have an absolute envy of the industry position in our businesses in China. We're moving from strength to strength. I think if you just look at the quarter, our China production, I see numbers down 2%. We had up 12% in terms of our revenue there, which just sort of demonstrates the strength of the partnerships that we have there and the performance of our business there that we're able to continue to build our strong top line growth in a flattish production environment. We do have a backlog that we've built up, and we expect to see top line growth, again, here in '19 and beyond. And then lastly, we are -- once we start to trend the capital in terms, we have Seat Structures & Mechanisms as we get some of the cost of becoming Adient as restructuring trends back to sort of this $100 million normative-type level, we do expect to see a significant step-up in free cash flow generation beyond 2018. So we're pretty -- obviously, a lot of our time is spent on the challenges that we have today, but we're pretty encouraged and excited that we're getting through those, we have significantly -- with significant opportunities ahead. And we look forward to seeing many of you next week. I know we have a sell-side dinner, and we are reaching out to one of our big shareholders next week. So I appreciate the interest in Adient and thank you very much for attending our call today.

Thank you.

Thank you, everyone. And that concludes today's conference call. Thank you all for joining. You may disconnect at this time.