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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome, and thank you for joining the First Quarter 2018 Earnings Call. At this time, all participants are in listen-only mode [Operator Instructions] Today's call is being recorded. If you have any objections, you may disconnect at this time. I'll now turn the meeting over to Mr. Mark Oswald. You may go ahead.
Thank you, Jen. Good morning and thank you for joining us as we review Adient’s results for the first quarter 2018. The press release and presentation slides for our call today have been posted to the Investor section of our website at adient.com. This morning, I’m joined by Bruce McDonald, our Chairman and Chief Executive Officer; and Jeff Stafeil, our Executive Vice President and Chief Financial Officer.
On today’s call, and consistent with past practices, Bruce will provide a few opening remarks, followed by Jeff, who will review the financial results in greater detail. At the conclusion of Jeff’s comments, we will open the call to your questions. Before I turn the call over to Bruce and Jeff, there are few items that 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 a complete Safe Harbor statement.
In addition to the financial results presented on a GAAP basis, we will be discussing non-GAAP information that we feel 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 will now turn the call over to Bruce.
Okay. Thanks, Mark and good morning, everyone. And thanks for taking the time here to go through our first quarter results. As me mentioned a few weeks ago at the Deutsche Bank auto conference, the challenges and headwinds impacting our Seat Structures and Mechanisms intensified during the first quarter and has a significant impact on our financial results. In addition, when you look at our GAAP numbers, you'll see that we are impacted by like many other companies here to this quarter for the larger non-cash tax charge associated with our deferred -- re-measurement of our deferred tax asset. Although Jeff will go through our financials in more detail later on here in the call, maybe just on Page 4 I may just comment on a few key numbers.
Our adjusted EBIT for the quarter totaled $163 million, which is down $120 million year-over-year, primarily driven by the performance within our Seat Structures and Mechanisms business. Looking at earnings per share is $1.06 in the most recent quarter is lower level operating performance to operate down to our bottom line.
In terms of balance sheet and cash leverage, we ended the quarter with cash and cash equivalent on hands is above $390 million and a net debt to adjusted EBITDA 2.07x. Now clearly when we look at these numbers they are disappointing and quite frankly unacceptable. The Adient team is working hard to identify actions that we can implement to mitigate some of the challenges that we have in our business but also to put the resources and things that we need to put in place to get our metals business back on track.
I'll comment on some of these profit enhancement opportunities that we like to identify later on here but first let me comment on a few recent development that despite the near term challenges in seat structures and mechanisms, it demonstrate that we are moving the company forward and positioning Adient for long-term success. So first of all, just like to comment on the formation of Adient Aerospace, a joint venture that we formed that we announced a couple of weeks ago between ourselves and Boeing where Adient has a majority stake of company just over 50%. This act --the Adient Aerospace joint venture will develop manufacture and sell a portfolio seating products that airlines and aircraft leasing companies for both production line fit and retrofit content configurations, expanding Adient's revenues and profit for beyond the auto industry is a key part of the company's five year marker, so the formation of this joint venture is very much aligned with our long-term strategy.
When we think about the size of the addressable market for commercial airlines seating it is quite large about $4.5 billion today and is expected to grow at over $6 billion by 2026. We believe Adient's strong set of transferable capability will offer unique opportunity to create value for both companies in this joint venture.
Turning to Slide 5, just a few comments on the North American International Auto Show. Last week hosted a group of investors and media at our booth at the North American International Auto Show to showcase the company's future mobility solutions to address trends and driving that we expect to change with mobility such as autonomous vehicles and ride sharing. The event included our demonstration vehicle we call the Adient's AI18, is an interior seating concept book for urban electrically powered and autonomous vehicles. For those of you who were there the interior are highly flexible and well suited to the evolving models for mobility and vehicle usage as car sharing with several distinct usage modes to customize the passenger experience to the occupant's needs as and when they are using the vehicle. Customer feedback from both our traditional customers and our newer west coast customers was extremely positive.
In addition, we showcased our products and complete seating, our specialty seating business including RECARO, the Seat Structures and Mechanisms technology were also on display. Really even the event to highlight the concepts and innovations that will drive our business forward in the coming years. And then lastly, just point out at the bottom of slide, the company took action to further strengthen our leading position in China with the formation of a new joint venture called Adient Tianjin Automotive Components Sales Co., Ltd. This is our first aftermarket joint venture in China. This is a joint venture that will supply complete seats to the Chinese retrofitting industry.
Turning to Slide 6, in Seat Structures and Mechanisms, the development highlighted demonstrates the management team is committed and continues to make progress in advancing our strategy. Unfortunately and rightly so the challenges impacting our seat structures and mechanisms is casting shadow over of our whole business. And calling in the question the achievability of real term plan. Before handing the call over to Jeff, let me just spend a few minutes talking about Seat Structures and Mechanisms in a lot more detail. As Jeff mentioned earlier the Seat Structures and Mechanisms business is currently experiencing headwind much more severe than the guidance we provided back in November. Although, we identified some of that headwind and challenges last quarter, and specifically commodity prices, launching efficiencies, steel supply constraint and the cost of customer interruptions, the severity and the impact of these headwinds have intensified. As shown in our results today, when you experience problems meeting large curves, the cost expanded to avoid customer shutdown and minimize the impact of customer interruptions can be quite costly and can add up very quickly. We provided details on the headwinds related to specialty steel availability and launch specific issues in certain of our plants in North America at the Deutsche Bank conference. So I am not going to rehash both of them. But I'd like to use the time to provide insights on what we are doing to move the business forward.
Turning to Slide 7, on the left hand side you can see there are number of actions that are being executed immediately to improve cost our performance. These include a further reduction in SG&A, I think since Adient's spun off from Johnson Controls with the highly successful achieving our SG&A target reduction. As a result of that we've identified several areas within the organization that we can streamline further. Obviously, we need to continue to make the investments that we've talked about to get the business back on growth trajectory, we still feel loss of opportunities further reduce our SG&A level. We also intend to undertake a thorough review of our plant investments to ensure we have the right balance between allocating capital here in the short-term and pushing some of those investments for longer-term growth out. And then we'll obviously the basic locking and tackling such as things like limiting discretionary spending such as travel and expenses and things like that.
In addition, we've recognized fundamental changes need to be made in our Seat Structures and Mechanisms business. As several of you've written for too long as the business that as organized and is currently run today has destroyed shareholder value. The changes that we are implementing are pretty broad-reaching. First, let me comment on the personnel oversight of business. For starters, we are asking Byron Foster, Byron is one of our Executive Vice President; he will be assuming effective immediately the day to day operate -- responsibility for seat structures and mechanisms business. This will be his sole focus on a go forward basis. And Byron will have the full authority and responsibility to bringing to their -- the best talent that we have in the Adient to improve the operation in this business and to make sure the turnaround and transformation of this business is successful.
Secondly, Jeff Stafeil will lead a weekly Seat Structures and Mechanisms Steering Committee, which we will be forming and that oversight committee which we will meet weekly and will report a result to our Board on our monthly basis to make sure that our turnaround initiatives is properly staffed and we have the appropriate leading KPIs and that we are fully onboard and tracking all the actions necessary to get this business back on a proper shareholder value creating trajectory. I also noted earlier this month, we moved and we intent to move this in more of our A -team to the Seat Structures and Mechanisms business. The individual that are moving into this business will be highly compensated with specific metric that they control 100% around the profitability of this business, basically ensuring that the goals and their success are highly aligned of the interest of our shareholders.
The second fundamental change that we are introducing is we are going to organize this business in the complete standalone operation. Going forward assessing them will be 100% able to pull all the levers that they need to pull to control their own destination, those resources we'll report directly on a solid line basis into Byron. And then finally, we've undertaken a full strategic review of the business which we've already kicked off. Elements of this review will include which part of this business do we need to be in, that were very vertically integrated. I think we have some opportunities to look at what we make versus buy. We've always need to improve the commercial discipline that we have in this business and look to de-risk the business and better mechanisms for recovery commodity cost. We expect the fundamental changes that will be rolled out will drive the necessary culture as business change within seat structures and mechanisms and get it back on its proper profit improvement trajectory.
In the near term, the company plan that we introduced will help mitigate the current challenges. These recovery plans that will gain traction are expected trade positive momentum as the quarters progress throughout the year. Unfortunately, despite the recovery plans, and continued growth from our unconsolidated seating operation, overall margins are expected to be down year-over-year and Jeff will discuss our outlook here just in a minute. With regard to our midterm plan, we are certainly not backing away from our committeemen to deliver 200 basis points of consolidated adjusted EBIT margin improvement by the end of 2020.
With that said, we are currently examining the composition of this 200 basis points. So, for example, if SS&M our Seat Structures and Mechanisms is incapable of delivering the 100 to 200 basis points improvements by 2020, we'll look to execute other parts of -- other things within the rest of our organization to offset this shortfall. As promised, we'll provide you with an update of the midterm plan towards the end of April as shown on slide 8. Later in the year, we'll target a deep dive investor event to go through our seat structures and mechanisms business in a lot more detail.
So with that I'll turn it over to Jeff to go through the financial details. Jeff Stafeil.
Thanks Bruce. Good morning, everyone. Turning to our financial performance, as Bruce stated in his remarks Adient's first quarter results was both disappointing and unacceptable. The team is working with the sense of urgency to reignite a positive momentum.
As you can see on Slide 10, the headwinds within seat structures and mechanisms had a significant impact on results. In addition to one-time charge primarily associated with the re-measurement of deferred tax asset 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 in the right size. We'll focus our commentary on the adjusted results. These adjusted numbers exclude various items that view as either one time in nature or otherwise skew important trend and underlying performance.
For the quarter, the newly enacted US tax legislation was the largest special item primarily related to the re-measurement of Adient's deferred tax asset, resulting in a provisional $258 million charge. Other adjustments include becoming Adient restructuring related charges and purchase accounting amortization.
Moving on, adjusted EBIT and adjusted EBITDA fell $120 million and $103 million respectively in the quarter versus last year, driven on the large part by the operating performance within SS&M business.
Meanwhile, adjusted equity income for the quarter was up $10 million compared with the same period last year. Although, overall growth was solid, there was a diversions emerging between the operating results of unconsolidated seating JVs and YFAI which I'll dig into in just a minute.
Finally, adjusted net income and EPS were down just under 50% year-over-year and $99 million and $1.06 per shares respectively. While sales have come in our plan, we have faced unexpected operational and execution challenges namely in our Seat Structures and Mechanisms. I'll elaborate more on this in a moment.
Now let's breakdown our first quarter results in more detail. Starting with revenue on Slide 11. We reported consolidated sales of $4.2 billion, an increase of $178 million compared to the same period a year ago. Benefits of 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 $127 million. The primary driver was the EURO as the EURO to USD rate average 1.18 to Q1 of this year versus 1.08 in Q1, 2017.
Moving on with regard to Adient's unconsolidated revenue was remaining strong. Unconsolidated seating revenue driven primarily through our strategic JV network in China grew about 11% year-on-year. Adjusting for FX and the China JV that is now consolidated, sales were up about 12%. Broadly speaking, this outcome significantly outpaces vehicle production in the region which was down slightly. Unconsolidated interior recognized through our 30% ownership stake in the Yanfeng automotive interiors also experienced year-on-year sales growth. Adjusting for FX in the low margin cockpit sales from both periods, interior sales were up approximately 3% in Q1, 2018 versus a year ago.
Moving to Slide 12, an adjusted bridge is provided to show the key drivers between periods. If you recall from our Q4 earnings call, given the amount of growth investment and capital expenditures planned in the coming years, and the resulting difficulty of predicting the exact timing of depreciation, we view EBITDA as a more meaningful short term measurement than EBIT. With that said, we'll continue to provide status of our margin progression using both measures. Big picture, adjusted EBITDA fell $260 million in the quarter versus last year. The corresponding margin related to the $267 million of adjusted EBITDA was 6.4% down approximately 280 basis points versus Q1 last year. The primary drivers of the movements between period include further benefit associated with the SG&A saving initiatives which contributed approximately $51 million of improvement year-over-year excluding engineering.
Our Futuris acquisition and the China JV we were able to consolidate late last year performed well and better than planned during the quarter. In total, they contributed about $26 million. And a higher level of equity income which is I mentioned a moment ago was up year-on-year. The $6 million shown on the slide is adjusted for FX. Important to note, mix results existed between our unconsolidated seating and unconsolidated interiors business specifically YFAI. On the seating side, adjusting for FX, equity income was up $15 million year-over-year. I'll point out last year's Q4 consolidation of the China JV negatively impacted equity income by $3 million versus Q1 last year. Unfortunately, YFAI did not keep pace with the sales growth as equity income adjusting for FX declined $6 million in Q1 at this year compared to the last year's first quarter. The year-on-year decline was driven by a combination of factors such as mix, investment and growth initiatives, certain customer pricing headwind and operational issues. Currently, we expect these factors will continue to impact YFAI results especially in Q2 where these headwinds are expected to intensify.
We continue to work with our partner to identify areas to improve profitability but unfortunately with only a 30% ownership stake, the amount of influence we have is limited. Despite the positive EBITDA drivers just mentioned and as the chart illustrate, we did have approximately $190 million of offset to these items, primarily headwinds related to the SS&M business which totaled just under $100 million on a year-over-year basis. As Bruce mentioned and as discussed in detail at the January auto conference, a number of factors contributed to this outcome. The biggest by far related to launching efficiencies driven by launch complexity, pressure and capacity, demand outpacing our ability to produce premium for it and steel availability to name a few. The team is working hard to stabilize the business. I'll share our expectations on how we expect the business to progress throughout the rest of the year in a few minute.
As mentioned on the revenue bridge earlier, volume, pricing mix negatively impacted revenue by approximately $200 million, and this flow through was just under $40 million reduction to profit. Investments in our future captured under growth accounted for $33 million of the year-on-year variance. Spending has increased as engineering resources, program managers increased at the launch activity to support our new business win. As you know, these costs are incurred about 2 to 3 years in advance of production.
Finally, we did experience some additional operational margin mix in the quarter of approximately $23 million as a lower volume drove inefficiencies throughout the organization. FX from commodities for the most part has minor impact on the quarter. Growth commodity headwinds of about $21 million were mostly offset by recoveries totaling $17 million. As mentioned at the DB presentation earlier this month, we do anticipate the commodity headwinds will mount in the coming quarters mostly in the foam and chemical market.
One final point in the slide to provide with a perspective on how the business running excluding SS&M. We noted on the bottom of the slide, the EBITDA margin for our consolidated business excluding SS&M for the current quarter versus last year's first quarter. As you can see, our most recent quarter at 6.1% is down about 70 basis points year-over-year. The uptick in our growth investments accounts for majority of our variance as well as the stronger euro which had an approximate 20 basis point impact by itself. And as just mentioned, volume and its impact on other performance contributed but to a lesser degree.
Given Q1 performance we heard and read a lot of commentary about the achievability of the 200 basis points margin improvement target, you can see our progress towards that goal on slide 13. Our Seat Structures and Mechanisms business stands out in a page as an outlier performance with 120 basis points reduction from our starting point. No doubt the headwinds impacting this business have significantly offset the approximate 143 basis points of improvements we've achieved in SG&A and makes achieving our goal that much tougher.
As noted at DB conference, we will provide an update on our plans to achieve the 200 basis points in margin enhancement towards the end of April. Despite progress made to date in achieving the SG&A target saving the team is still is not standing still. We continue to expect further improvement to this recent headcount reduction and mitigation actions. We are executing to offset performance headwinds take hold. It should be noted certain of the near-term actions we are taking such as extremely tight control of our discretionary spending or taking down our bonus accruals, will not be part of the run rate of the business going forward. That said we are comfortable leading and likely exceeding our 150 basis points target for SG&A reductions. With regard to the third bucket, growth investments, spending are progressed as planned in support of our backlog. Future spending will be reviewed and monitored to ensure the correct balance is struck between near term program needs and long term growth.
And finally, we continue to look for efficiencies and an improved performance from our business outside of our Seat Structures and Mechanisms. Through December 31st, we picked up just under 40 basis points of margin improvement in this area. Meanwhile, our unconsolidated businesses shown through our equity income and accounting for roughly 45% of our net income in 2017 continues to experience strong growth. In fact, the margin expansion associated with our equity income is roughly 47 basis points over our baseline starting point.
Let me now shift to our cash and capital structure on Slide 14. On the left side of the page we breakdown our cash flow. Adjusted free cash flow defined as operating cash flow less CapEx with a negative $270 million for the quarter. The outflow reflects the negative year-on-year operating performance combined with normal seasonality. Capital expenditures for the quarter were $143 million compared with $207 million last year. On the right hand side of the page, we detailed our cash and leverage position. At December 31, 2017 we ended the quarter with $390 million in cash and cash equivalent. Gross debt and net debt totaled $3,501 million and $3,111 million respectively at December 31, 2017. As a result of cash balance, debt level and operating performance against net leverage ratio at December 31, 2017 was 2.07x. Important to note that the Futuris acquisition and the Q4 JV consolidation in China, are providing minimal benefit to the LTM EBITDA, as only one of out four quarters -- of the last four quarters are in our numbers, whereas the entire purchase prices is come out of the net debt numbers.
Turning to Slide 15, just a few comments on the tax legislation in the US. Overall, I'd say it's roughly neutral. The legislation is going to be slightly beneficial to 2018 rate as some of the negative influences do not kick in this year due to the timing of our fiscal year end. However, we will enjoy the benefit of a lower rate. As we think about the negative influences, there are two. The limitations on interest deductibility and the base erosion, anti-avoidance minimum tax was commonly called BTAX. Absent any kind of changes to our structure, we would likely incur an estimated 1% increase in our global effective tax rate. Again, it's left unmanaged. But we continue to review opportunities to manage that going forward as most of the detrimental changes do not impact us until fiscal 2019, we have a bit of time to evaluate options. We will continue to provide updates going forward but for now the main takeaway is a neutral outcome for Adient.
Turning to Slide 16, and as we think about the progression of fiscal 2018 earnings, we wanted provide some insights and how our Seat Structures and Mechanisms business has performed since the June 2016 LTM period and more importantly what we expect going forward through 2018. The operating performance shown in the slide isolate the SS&M business and include the allocation of approximately $100 million at annual cost associated with certain central activities such as IT, purchasing and commercial resources. In addition, we provided the unconsolidated contribution at the bottom of the page so you can get a better feel at how our consolidated SS&M business has and is expected to perform. As you can see the operations were just above breakeven of the June 2016 LTM period. If you adjust out the $26 million of earnings related to our unconsolidated businesses, the consolidated operations were running at a slight loss. You can see the operating performance hover around breakeven until Adient's fiscal Q4, 2017 results. As previously mentioned, the headwinds related to launching efficiencies and commodities drove the business to a significant loss about $55 million in Q4 of 2017 for the consolidated operation. The losses in our most even recent quarter became more severe as the headwinds intensified. In addition, as the headwinds intensified, a new issue arose such as mandatory containment actions required by our customers and the availability of certain specialty steel that also became apparent the original time period we estimated to resolve the issues was optimistic given the current state of the business.
As the company executes its containment plans and rolls out the fundamental changes Bruce mentioned earlier, we expect the operating results will improve sequentially and essentially at the same run rate as last year's Q4 when we acted fiscal 2018. That said, even though sequential improvement is expected as we move into Q2 this year, the year-over-year variance will still be quite negative as last year's Q2 was a relative high point for the Seat Structures and Mechanisms business. Analyzing the changes since the LTM June 2016 time period shows approximately $225 million of the forecasted decline related to seven plants in our network. These are all structured facilities. Additionally, our mechanisms facilities are projected to decline approximately $50 million, in part due to inefficiencies related to the conversion to the 3,000 product lines. The remaining reduction from the baseline is scattered across the over 15 or so remaining facilities in our network, as well as also relates to commodity inflation. The SS&M midterm plan review presently being conducted as a bottom up plant by plant, program by program review that will enable us to better understand where this business will be in 2019 and 2020. As you would expect, the results will also lead to a roadmap of options that will be executed to ensure the company is earning an appropriate cost to capital on business.
Finally, turning to Slide 17, let me wrap with our thoughts in the remainder of 2018. One point is refer to slide 18, the guidance provided today includes the impact of aircraft investments which we pointed at the January auto conference is expected to be about $30 million, of which Boeing will reimburses for their share. As noted in our auto conference materials, both Boeing and Adient are initially contributed approximately $28 million each to fund the venture.
Okay, starting with revenue. Our current projection for our consolidated revenues continues to be $17.0 billion to $17.2 billion. With regard to adjusted EBIT, after factoring in our Q1 performance, our profit mitigation plans, expenditures related to Adient Aerospace and expected rise in chemical prices, we are expecting fiscal 2018 will settle into a range of between $0.975 billion and $1.025 billion. As the year progresses and the mitigation actions within SS&M gain traction, we would expect to see positive earnings momentum builds. Included in the revised full year adjusted EBIT estimate, we now expect our equity income will be approximately $400 million, down $35 million compared to our earlier guidance. The revised outlook is more than driven by challenges at YFAI. As mentioned just a few minutes ago, we continue to work with YFAI to identify profit improvement plans. Important to note the challenges facing YFAI are not impacting our unconsolidated seating business. In fact, that business is running stronger than original expectations with year-over-year equity income growth for unconsolidated seating is now forecasted to grow 10% adjusting for the China JV that was consolidated in Q4 of last year.
Moving on adjusted EBITDA is expected to range between a $1.40 billion and $1.45 billion. The implied margin at midpoint excluding equity income will be down about 140 basis points versus fiscal 2017. For model and purposes, given our increased growth investments, depreciation is still tracking our initial guide of $385 million. With regard to interest, no change to $135 million forecast.
Moving on to taxes. Based on the geographic composition of earnings and factoring in the recent tax reform in the US and our reduced guidance, we expect an effective tax rate of between 8% and 9% for the year. When our business recovers we would anticipate to be back at the normalized rate of between 10% to 12%. As the bottom line, the range for adjusted net income is expected to be between $700 million and $740 million. Although current expectation for capital expenditures are consistent with previous guidance of $575 million and $600 million, the team continues to asses various opportunity that may reduce or re-calendarize the planned event.
Finally, with regard to free cash flow, based on our revised operating performance and the elevated calls for cash mentioned at the start of the year, which includes cash restructuring, becoming Adient's cost and to a lesser degree Futuris integration cost. We now expect free cash flow to settle in around $225 million for the year.
In closing, this is not the start we intended for 2018, however, the team is moving with the sense of urgency to mitigate the headwinds and execute path of recovery plans.
With that let's move on to the question-and-answer portion of the call. Operator, first question please.
[Operator Instructions]
And our first question comes from the line Colin Langan from UBS. Your line is now open.
Great, thanks for taking my question. Let me just start-off, it sounded like the metal issues initially were somewhat one-time in nature, things like expedited freight, your outsourcing component to get some produce, and now the forecast as the slide shows has headwinds going through all the way to the second half of the year. What is changed in the business? Is there something structural now and should we expect it to persist into 2019 and 2020? I mean it sound like a lot of your initial issue was more one- time in nature related to particular plant?
Yes, Colin. It's Bruce here. So I think a couple of things I just noted it takes some time to work through the containment cost that we have. So once we experience a difficulty there is a number of milestones the customers make us quite rightly make us demonstrate before we can sort of peel those resources away. I think we've tried to be realistic here. I mean we talked about continuing to experience problems with specialty steel and that's driving a lot of inefficiencies and when the guidance that we are giving here today, I would say we are being realistic in terms of what we think the usual one, usual items that we are going to face. I mean it came -- Q1 with a view that we were going to be down 60 and we were at 120 and so you should think about some of those things going away overnight. It's hopefully that will happen but I think we tried to put a better realism here in terms of what we think is going to happen. And as it relates to your comments about 2019 or still going 2019, clearly, we are very pretty comfortable with the launch related problems that we have or we are going to get behind us. With the resources that we are putting in place, we are certainly feel good about avoiding every occurrence in 2019 results. You think about especially if you look at the hits that we've taken in Q1 and Q2. We are going to have significant year-over-year improvements in the first half of next year. In terms specialty steel, we are working on bringing in an additional supplier or two, that's going to take us through the next couple of quarters and then it's just a question how long it takes for us to get testing done with our customers. But I think we'll get that issue behind us here in 2018. And then we do have a fairly elevated high level of engineering expense that's going through metal associate, some of this big global program and finishing up our track 3,000 and recliner 3,000 investments. So, again, the expectation is that we would have pretty significant reduction in engineering expense in the business next year. So I think kind of long answer but I think we tried to be realistic so that we don't disappoint here in the next few quarters in terms of the challenge that we face from an operational perspective but I think we feel that we get that businesses certainly back to the run rate that we had when went into this year in a few quarters from now.
And when you look at the Q4 number, is there an assumption that you still have to do expedited freight and additional labor cost or is that just --
It's fairly minor but the main reason for the sort of loss in the fourth quarter is really Q minus September and the quarter for us is really the impact that the business is pretty large in Europe and it's the impact of the summer shutdown. So it's our weakest quarter. So Q4 is not really good proxy for the run rate.
Got it. And just to clarify from your comments so you are still reaffirming the 2020 target which would imply like a 6.5% margin like JV income? Because looks like the guidance this year ex -JV income is about 3.5% and you would have 300 basis point under 2020 and what are the major levers that you could get up metals on that business?
So that's what we are talking about is coming back here sort of in the April timeframe with what the bars are to get there, Colin. I mean we are not locking away from our commitments. What we want to do here is over the next quarter sort of rebuild the metals plan up and they are same as like you saw in Jeff's chart things like operational improvement which we made across the organization. It was not a lever that we had planned on when we sort of built it up. So we'll come back in the April timeframe with the new ways to get there. But it will -- it's likely get involved some operational improvements elsewhere in the business, perhaps a better number in a bigger improvement in our SG&A structure because we are going to take cost out of structural and we'll stay out. Metals will definitely be something, we are not sure if it will be the one with 200 at this point in time. And then same thing with the size of the investments bar, we will sort of -- now that we let say we've kind of got in our cost base the investment that we need to get the business growing again. Now that we have the aircraft investment in our cost base, I think the size of the bar that we put in for investments likely going to be lower.
Thank you. And our next question is from the line of John Murphy from Bank of America. Your line is now open.
Good morning, guys. Just a first question it seems there were some illusion to some potential customer disruption along with the seat and mechanisms business. I was curious if there are any real customers that try to change or is there any sort of perception for customers that may impact sort of the ability to win new business or impact the backlog at all?
Yes. Its' a good question. I mean why don't I let Jeff talk about the customer and I should -- then I can maybe talk about the backlog implication, our relationship with our customer.
Yes. Hey, John. The customer disruption side of things, there is definitively charges, going back to some of the earlier question the things that kind of took us off guard, the broad turn of this business into sort of where we are sitting today did take us by surprise. There was --and we as we react to that there is certain other surprises of course that sort of mounted in the topic of what impacted our numbers to some degree were customer stoppages. We did stop few lines and certainly had a variety of rework as we struggle to get up to production rate from a bunch of launches. I guess the good news is we didn't necessarily have that focus in one particular customer. We did it with a few different customers. It not uncommon that in our space we would have a launch challenge, there are OEMs who experience launch challenge and some of these types of products. We just happen to have a number of them all sort of at the same time and as far as customer disruption, I guess Bruce can attest to it but as a result it we didn't necessarily have one customer that was singled out the customer reaction has been -- they have been focused getting through issues but I don't think it's impacted our long term ability to win business.
Yes, correct, I can confirm that.
And then sort of as you think about the actions outside of the seat business, I know you sort of mentioned potentially thrifting CapEx either in total sort of or in planning, I am just curious what magnitude you could think about there and if there are other sort of major cost initiatives that also maybe more sort of in cash thrifting or cash conversation or savings that you think you could put in place as a result of this. You kind of alluded that as well, but didn't really dimension it.
Yes. John, you could imagine that few things that we've done over the last couple of -- I guess we've been in sort of that mode for several weeks, months or month or so, now as these results have kind of become or come into our view, what we can do to offset our overall capital needs, we got to be careful on one side to make sure we are not saving capital that will cause a similar launch issues as we go forward. So that's probably the first priority for us to make sure as we are looking at those CapEx plans to make sure that nothing puts us into jeopardy in the future launch. But then beyond that I think we have opportunities. There is definitely we have as we've spun off from Johnson Controls we don't have -- our people are sort of scattered around a bit and from the facility standpoint we certainly need some space for slowing down or sort of modifying some of that investment is one but looking at areas where we can take some things that aren't program related for instance and move them, and that's something we are doing. And that's as you just look at all other things, we have a fair amount of opportunity I'd say in our working capital metrics. We have some long running issues where some people have paid us late and some systematic issue there we are pushing so really pushing hard on working capital and some of those things that plagued us for a while as well as just any kind of discretionary capital or discretionary expense is being very brutal on all of them.
And then just maybe lastly on raws. I mean obviously we understand what you are alluding to on steel and specially steel, you did mention foam and chemical being headwind and you truly be thinking is effectively oil derivatives or if you can sort of outline sort of relationships you have with the automaker as far as indexing and pass through and other sort of coverage you have for foam and chemical, raws.
Yes. Unfortunately it doesn't move as much towards the base oil price. It's an oil derivative but I got the -- what I am told is the production capability of it globally, there has been a big facility that came off line I think in Europe and as a result and this is like TDI and it's chemical but that go into foam. And while they are petroleum derivative, the supply issues have been more on production capacity of those particular chemicals that have shot up prices. As far as the dynamics of recapturing, it's similar dynamics to what we have in steel. We have a mix of straight indexing arrangement that go from one quarter to up to four quarters. And those are mechanical. And then we have other customers that required negotiations. But generally we are able to get recovery from them. It's just always in a lag so that $35 million that we projected at Deutsche Bank of commodity headwinds was primarily relating to foam chemicals. Although we've seen some elements of steel sort of increases and as we look in the European market in particular that play through we could have some additional steel inflation if the market continues to move in that direction.
And just any visibility on facility coming back on? Or is that something that's just offline and closed capacity?
I don't have the view. I ask, first thing focus at all the time, I do understand that it is something that could happen this year but I don't have any kind of time attached to it unfortunately.
Thank you. And our next question is from the line of Emmanuel Rosner from Guggenheim. Your line is now open.
Hi, good morning, everybody. Your slide number 16 is helpful in terms of understanding your current expectation for the metals business over the next few quarters. Can you maybe talk about what those expectations would have been as part of the previous outlook? The thing like I guess it puzzles me little bit is your first quarter was a miss by only about $60 million versus your own guidance but the outlook for the year is cut by about $300 million. So can you maybe talk about the before and after in terms of expectations for metals.
So, Emmanuel, a great question. And from where we sat when we gave the November 2nd earnings call and this data came to us, we obviously has seen, if you just kind of focus on this chart for a moment, we has been sort of relatively around flat line through until the fourth quarter where meaning we hadn't change too much versus our performance from the LTM June period. It got very negative in Q4. We were incurring and we could see on daily basis and obviously new, we were experiencing enormous amount of premium freight in particular. We were putting airplanes to deliver most of the part. We thought our production capacity and other activities would have quicker recoveries than they did, so built in $60 million of essentially those types of cost into our Q1. And then really assumed we kind of follow the same curve that you see that we had for the first three quarters of 2017. And maybe even marginally little bit better, we actually thought there would be some improvement in this business. And the team in that business has been projecting improvement in it as well. Obviously, especially as November continue to go and November results came in early December, we could see that the issues were more serious we thought that time to correct them were longer and thus that drove the additional I guess losses that you see for the rest of the year here. We do see it getting better. We are seeing improvement but just those improvements are getting back it to the 2017 levels quite yet that's what the team is obviously working incredibly hard to get that path and get to the-- I guess number of structural and different moves we are going to need and do it to recover from this business.
Okay. That's good color. And then just one follow up on the metals business as well. I do get your slide 7 and some of the fundamental changes that you are planning and making. And so one of them is being setting it up as a standalone operation. So I understand how -- that could obviously be helpful to fix it going forward. Is that also -- does also provide you as an option to dispose of the assets. Is that something that you would look as plan B?
Not really. I mean I was -- this is Bruce here by the way. I mean this is the business that certainly there is a lot of commentary out there around the business and fact that we've these problems before and I acknowledge that. But this is -- the capability that we have in this business are differentiating. And the challenge for us is to make this business is to get paid for it. Quite frankly, we get paid for the technology. Our customers need one lighter seat, they want -- they need more complex mechanisms in the second row practically around in the CUV side of thing right now. As we look at some of the trends and technology around new mobility, we see longer rail, we see swiveling seats and things like that. So these are things that we need to have to be a complete seat supplier. We've just, there is no point in sugarcoat that mean we've just really screwed it up in terms of the way we manage this business. I would tell you that we still have the proper discipline in place like if you think about the rest of our business, our seating business, and our just -in- time business foam and trim, I mean we can accommodate changes, rapid changes from the customers and duck and weave and impact that are relatively minor. We need to get back to the basics here in term of this the highly engineered part of our business where one and two years before production we need to have design signed off and the production design validated and a run rate demonstrated, much, much further before launching rest of our business. And I think one of the things that we historically not done a good job of doing here is having enough discussions with our customers much further back from job one and say, hey, we can't accommodate any more changes to the design, can't accommodate some of these features that changes or if we are going to make them, we have to have a discussion and how we are going to launch this product. And that's where we've said, we try to be customer friendly but we end up shooting ourselves in foot and we just can't keep doing this. So it's a business that's core to us that we need to fix. That we need to be the same size, that's a good question. Do we need to every thing that we do today? That's a good question. Do we need to sell metal component through better direct -- to our competitors? That's a good question. That we are going to answer and ask ourselves all three of those things. But whether we need to have the capability in-house, I think that something that we are convinced we need it.
Certainly. And our last question comes from the line of David Tamberrino from Goldman Sachs. Your line is now open.
Hey, thanks very much guys. Thanks. I got a one question and couple of follow ups for you. At the Detroit auto show you basically said half of the business of SS&M, a bit roughly half of is internal the other half goes to the third parties. Which part is the larger headwind today? Because it sounds like it's your internal SS&M business that kind of gets vertically integrating ahead of your customers? Is that correct?
Our two big launch issues, David, were actually -- we were supplying as a Tier 2 effectively to one of our competitors.
Got it. So as we think about that business and some of the comments that Bruce just made, what type of run down in years of run off would it take to exit some of that external third party businesses where you are Tier 2 supplier? We are talking two to three years lead time.
Yes. You can imagine that pretty much all of our business is sourced with two to three year lead time to begin with. So as we start to make some of those adjustments, there will be a bit of tail for us to have it out of our network. But in the meantime what we are going to be doing, that's not going to be the only lever obviously we can pull here. It's going to be looking hard on some of the pricing and then making sure we've been disciplined on change management. Bruce mentioned here on the just- in-time start of our business, we are very good as their change orders that we are able to get pricing for it. What we have is have a best discipline here while there are actually many more change orders that didn't happen on this program. We haven't gone in with the same level of discipline because where you really need to get that price is right as you're -- as the customer making the change; you really can't do it a year after the fact. That's an area we are making sure we are start up to succeed here. And that's going to be a part of -- as we are looking all of our future launches and programs that are coming down the pipeline to make sure we are keeping that discipline and putting that discipline into the system.
Got it. And just lastly for me, how critical to your aerospace investment and the build up of that business is the SS&M part of your equation right now? Because is this something where you could transition this kind of Tier 2 supplier position away and into that aerospace investment if you are able to win business over a period of time or is it not as important for the aerospace market versus automobile?
Well, it's -- I think it's very important and I think the thing that little bit difference is -- I mean I would think we have a substantial -- I don't know if you are worried about the tier product, we have a substantially different essentially a full flat business class seat, so it's substantially different product and part of our differentiator is a structure. So in that regard I would say it's quite critical but in the aerospace of side of our business, we are not -- this isn't something that would be tailored by customers. So we would love to have one seat structure then the tailoring would be around the trend and the foam so we wouldn't have like we have it in the market today. If you went into a pickup truck or SUV and you went looked at it, you took a party you find its different structure and mechanism portfolio depending on what the customer application is. In the aircraft side, it would be standard frame. So when we talk about all these launch difficulties and engineering changes, it's kind of one and done from an engineering perspective.
Okay. I think, with that we're up against the top of the -- the bottom of the average year. So maybe just a few concluding remarks, I mean thanks again everyone for dialing into our call. And clearly this isn't the way we intended to start 2018. I know our second year as an independent company. We know management team, myself, we have a lot of hard work to do to sort of deliver a set of numbers that are better than we are laying out here today. I can tell you that the team is going to work with the sense of urgency. We get the metals business back to stable position and that we are going to regain positive year-over-year momentum as quickly as possible. And we look forward to providing you with an uptick on your progress as we announced our second quarter numbers towards the end of April. So with that thank you everyone.
Thank you. And that concludes today's conference call. Thank you all for joining. And you may now all disconnect.