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Volkswagen Reports Profitability Despite Ongoing Emissions Scandal

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Supply Chain Matters provides an important follow-up to the ongoing diesel emissions scandal and brand crisis associated with Volkswagen. Today, in announcing its financial performance for the first quarter of 2016, the company surprised many by actually reporting respectable operating and net profits. VW characterized such results as “respectable” considering the challenging conditions and further re-iterated that it has the financial resources to weather the current emissions scandal.

Last September, the U.S. Justice Department initiated a wide ranging investigation into alleged use of software installed in nearly a half-million diesel powered cars that make these vehicles appear to have cleaner air emissions than they actually do in operation. Volkswagen has since acknowledged that the vehicle software installed in some U.S. diesel powered passenger cars make it appear that the vehicles conform to U.S. emissions standards. Since that time, there has been a series of internal and external investigations, management accounting and other management actions and/or missteps related to this situation.

Despite group sales revenue being down 3.4 percent from the year-earlier period, operating profit climbed to €3.4 billion, while net profits fell to €2.3 billion ($2.6 billion), down from the €2.9 billion reported in the year-earlier period. Automotive division’s net cash flow attributed to operating activities declined by a hefty 45.8 percent but total corporate-wide was slightly up because of a nonrecurring gain on the sales of LeasePlan. According to a published commentary from the Associated Press, the Volkswagen brand made only 73 million euros in the quarter, down from 514 million a year earlier, leaving an operating margin of only 0.3 percent.

It would therefore appear that the company’s broader brands and operating groups, in particular the highly profitable Audi and Porsche Divisions, are financially making-up the difference in the ongoing crisis.  Many manufacturers, not of the sheer global size and breath of Volkswagen would have suffered more financial implications.

In the announcement of financial performance, VW CEO Matthias Mueller states:

2016 will be a transitional year for Volkswagen that will see us fundamentally realign the Group. Nevertheless, we remain confident that our operating business will again record solid growth this year. The Group’s robust financial strength and earnings power are key to our ability to take the necessary decisions calmly and diligently and to resolve the strategic policies that will shape our future with the necessary determination

Today’s announcement of Q1 financial performance did not include any updates on financial contingencies related to ongoing actions related to the emissions scandal. The company outlook for the remainder of 2016 expects 2016 sales revenue for the Volkswagen group to be down by as much as 5 percent.

Reports indicate that a tentative agreement was reached with U.S. authorities in federal court in San Francisco to buy back or repair upwards of 500,000 vehicles. Attorneys for Volkswagen owners have until June 21 to file a final settlement with the court.


Some Sign of Light for Bombardier C-Series Aircraft Program Amid Ongoing Financial Challenges

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In the light of our previous posting related to Airbus and Boeing continuing to experience supply chain production scale-up challenges, we turn some attention to new news related to Bombardier’s C-Series program.

Bombardier C-Series

Source: Bombardier web site

For the past several years Supply Chain Matters has highlighted Bombardier’s C-Series aircraft program, particularly challenges related to gaining market attraction as a viable alternative to more technology advanced single-aisle commercial aircraft needs. This effort placed Bombardier in direct competition with the Airbus A320 and Boeing 737 for new commercial airline orders. In 2013 Supply Chain Matters declared that the C-Series could indeed be a competitor.

A series of multi-year program setbacks and lack of substantial customer orders have resulted in building financial loses and questioning whether the aircraft would indeed make any mark. The aircraft is powered by the new geared turbofan technology provided by Pratt & Whitney which has experienced its own start-up design and production challenges. Upwards of $3.2 billion have already been written off from the program. Now, there are some signs of life amid some important new orders.

Last week, Delta Airlines agreed to acquire 75 of the CS100 model aircraft with options for an additional 50 aircraft, along with agreeing to serve as the U.S. launch customer. Delta additionally has the option to convert some of the latter orders to the large CS300 model. The firm order was valued at $5.6 billion in U.S. dollars and was characterized as possibly providing some measure of street credibility for the C-Series program. In announcing the order, Delta’s CEO indicate that the airline’s decision brings the C-Series as a third option in the mainline aircraft marketplace.

Deliveries are expected to begin in the spring of 2018 and Delta now represents Bombardier’s largest commercial aircraft customer. Delta announced a new order for Airbus A321 jets as well. Industry watchers and executives indicate that Delta was able to negotiate a very attractive financial deal for the C-Series jets. According to Delta, the CS100 will provide better fuel efficiency and a 30 percent improvement in maintenance costs over Delta’s existing Boeing 717 aircraft fleet.

Last week Bombardier reported year-over-year revenue and profitability declines. According to business media reports, the C-Series is not expected to reach a break-even cash flow basis until 2020. The company remains saddled with a large debt load as-well.

With the new Delta order, the diversified transportation equipment manufacturer has secured 325 firm orders for both the CS100 and CS300 aircraft, including airline customer Lufthansa and its Swiss International unit. According to business media reports, the company is still awaiting a commitment from government owned Air Canada for 45 jets, amid some threats of violation of World Trade organization prohibiting direct subsidies of aerospace by domestic governments.  The company is seeking financial aid from Canada’s federal government but those talks remain uncertain. Bombardier has raised $2.5 billion since October after agreeing to sell almost half of its take in the C-Series program to the Quebec government as well as selling a stake in its train-making operations to a Quebec pension fund.

 


Airbus and Boeing Continue to Experience Supply Chain Scale-Up Challenges

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Supply Chain Matters has previously noted signs that commercial aircraft supply chains supporting both Airbus and Boeing may indeed be faltering in their ability to scale-up current and future production volume output commitment milestones.  The first clear sign came in February when Boeing transmitted a supply chain shock wave by warning that total 2016 production output and deliveries would be lower than that of 2015.

Last week, both commercial aircraft global producers announced their Q1 financial performance which included ongoing challenges related to supply chain challenges and expected performance for 2016 total delivery commitments.

Airbus CEO declared that 2016 has turned out to be the challenging year that was anticipated. Aircraft deliveries, cash and earnings were noted as heavily loaded towards the end of the year. While total revenues matched year-ago levels, net income and free cash flow were considerably below Q1 year ago levels. Further noted in the context of supply chain:

“The A350XWB ramp-up is progressing with the focus on bottlenecks in the supply chain, reducing outstanding work and controlling recurring costs. This is increasingly challenging. The target for a monthly production rate of 10 A350s by the end of 2018 remains unchanged. Five A320neos were delivered in the first quarter to two customers. Pratt and Whitney is committed to supplying new engines for aircraft delivery from the summer of 2016. The engines are expected to be delivered at the right level of maturity to enable the NEO (new engine option) ramp-up in the second-half of 2016. Overall, the A320 ramp-up preparation continues despite temporary supply chain challenges that are expected to be recovered at year-end.”

From or lens, such candid detail from a CEO related to the global producer’s most critical new product introductions is a clear sign of concerns related to various supply chain challenges.

In May of 2015, we noted that Airbus conducted an operational review of its crucial A320 supply chain amid a backlog of 5100 booked customer orders, many of which were for the new engine option version. In February of 2015, the company indicated that it had plans to increase the monthly production rate to 50 aircraft per month by early 2017, while evaluating an even larger cadence amid existing production of 42 A320 aircraft per month at the time.

In December of 2015, Airbus had to delay the initial A320neo delivery fulfilment milestone. Airline customer Lufthansa stepped-up at the last minute to serve as first delivery customer after former designated launch customer Qatar Airways refused to take first initial delivery because of last-minute operating limitations of Pratt’s new geared turbofan, PW1100G Pure Power aircraft engine.  Lufthansa did take delivery of the first A320neo aircraft in January, but without any ceremony, fanfare or appearance of the “neo” decal on the aircraft. The explanation for the delay provided by Lufthansa was added technical acceptance and documentation needs required from engine manufacturer Pratt & Whitney as well as Airbus.  Subsequent industry reports pointed to an engine cooling recycle issue for the engine when operated in dry high heat desert climate operational conditions.

Reporting on last week’s Q1 financial performance from United Technologies, the parent of Pratt, The Wall Street Journal provided somewhat more detail related to the new geared turbofan engine. Reported was that Pratt was changing its production process to eliminate a cooling issue with the engine when operating in high heat climates between flight cycles.  That correlated with the reports in January regarding performance and certification needs related to the new engine. The production change is expected to be completed by June.

Regarding the A350XWB, there were previous reports of supply challenges related to the aircraft’s seats and interior cabin features among other supply issues.

In Q1, Airbus delivered 125 aircraft to 49 customers. Deliveries included:

103     A320 aircraft including five A320neo models

13      A330 aircraft

4        A350 XWB aircraft

5        A380 aircraft

As of the end of March 2016, commercial aircraft order backlog was reported as 6716 aircraft orders, of which, nearly 81 percent consisted of the single aisle A320 family of aircraft. That equates to over 13 years of production at current quarterly output levels.

Boeing’s Q1 Performance

Boeing reported higher revenues but lower profits for its Q1 financial reporting. Total revenue increased 2 percent from the year-earlier period while core operating earnings decreased 21 percent, missing analyst’s profit expectations for the first time since 2011. Boeing incurred an additional $243 million pre-tax charge related to a new U.S. Air Force tanker development program that has been plagued by product design and subsequent production delays.

The Commercial Airplanes business segment reported that revenues decreased to $14.4 billion, a six percent decrease from the year-earlier period primarily from lower delivery performance.

Boeing executives have increasingly pointed to operational cost challenges brought about by a more competitive industry new aircraft pricing environment. In addition to reduced deliveries, Boeing had recently announced specific job cuts and cost reduction efforts involving cuts of more than 4500 positions by June. Boeing had indicated that the commercial aircraft business segment expected to initiate about 2400 of these cuts via attrition and approximately 1600 through voluntary layoffs. The cuts included “hundreds” of managers and executives which would indicate a trimming of organizational hierarchy. Boeing continues to maintain pressure on current suppliers for cost cuts and productivity increases. Yet, During Q1, Boeing purchased an additional $3.5 billion of the company’s outstanding shares leaving $10.5 billion remaining under the current repurchase authorization to be completed over the next two years. Boeing has additionally taken steps to leverage more revenue from service parts revenues involving proprietary part designs taking away some revenue opportunities from major suppliers.

In Q1, the latest quarter, Boeing delivered 176 commercial aircraft that consisted of:

121     737 aircraft

23      777 aircraft

30      787 aircraft

1        747 aircraft

1        767 aircraft

Order backlog remains described as robust at $480 billion with over 5,700 commercial airplane orders. At current Q1 product volume that backlog equates to a little over 8 years of customer order backlog.

Thus, for the two dominant manufacturers of commercial aircraft, supply chain challenges have once again come back as concerns amid an environment of robust order backlogs. Each has different manifestations and supplier challenges, and each reflects on internal operational scale-up as well. More and more, challenging product design among the most critical supply components, including aircraft engines will continue to be the linchpin towards achieving required production scale-up milestones.

Bob Ferrari

© Copyright 2016. The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.

 


A Counter Trend- Strong Galaxy S7 Sales Lift Samsung

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In an earlier Supply Chain Matters posting, we noted that this week, Apple provided a huge thud across Silicon Valley and global equity markets. The globe’s richest and most profitable company delivered a huge financial disappointment resulting in the first quarterly sales drop in 13 years. Executives pointed to macroeconomic headwinds and a far more competitive and challenging smartphone market. Yesterday, the Dow Jones Industrial Average suffered its biggest drop since February, fueled by the recent financial performance news from Apple, along with sharp declines provided by IBM and Cisco Systems.

However, this is a global world of industry competition and it is important to reflect on other players and other product, market, pricing and supply chain trends in similar industries and markets.

This week Samsung Electronics reported what was billed as the fastest profit growth in its core mobile business in nearly three years, attributed to strong initial sales for its Samsung Galaxy S7 model smartphones. Overall revenue rose 5.7 percent. The company’s mobile business operating profit for the March ending quarter rose 42 percent from the year-earlier period, noted as the largest year-over-year improvement in mobile profits since the second quarter of 2014.

Business media reports cite analyst’s estimates that Samsung shipped 10-12 million units of the new Galaxy S7 series phones in the past quarter. Keep in mind that Samsung elected to push-up the scheduled launch of this new S7 models to Q1, which may have led to the improvement in financial performance. Once more, Samsung’s guidance to investors reflected a continued optimistic sales growth forecast for S7 devices in the current operating quarter. In its reporting, global business network broadcaster CNBC quoted market research firm TrendForce as forecasting that S7 unit shipments will reach 52 million by year-end, surpassing a previous record of 47 million for the Galaxy S4 model. While that number does not equate to iPhone sales in a single quarter, keep in mind that Samsung offers abroad variety of other smartphone models in various competitive price ranges. One estimate indicates over 79 million total Samsung produced smartphones sold in Q1.

Thus, while the overall global smartphone market may be shrinking or turning toward a replacement cycle, there are pockets of provider growth. Among the current rankings of top five global producers of smartphones, besides Samsung and Apple, three are China based, offering price competitive models, especially for larger China and Asia based markets.

Operating margins for Samsung are noted to have risen to 14.1 percent from 10.6 percent from a year ago amid a streamlining of product line offerings and reductions in manufacturing costs.  Keep that number in perspective and recall that Apple’s current operating margin was noted as close to 28 percent in its most recent quarter, twice that of Samsung.  That may be an indicator of price performance and sensitivity reflected in today’s global smartphone markets. It also counters Apple’s claim of macroeconomic headwinds in current regions, since Samsung competes in similar geographies.

Readers should recall that Samsung is both a competitor as well as a major supplier to Apple in the form of proprietary processor chips as well as general memory chips produced by Samsung’s semiconductor operations. In the latest quarter, this chip business recorded its first year-over-year decline in more than three years, due to what was termed as a supply glut and cooling demand for processor and memory chips.

We have previously noted the importance of Samsung’s vertical supply chain integration strategy reflected by its chips business as both an internal and external industry supplier. From an advanced technology perspective, Samsung gains the benefit for first mover advantage in leveraging the most advanced chip based technologies. From a broader key strategic industry component supplier perspective, the risk is that when supply chain dominants such as Apple financially sneeze, the implication flows down to the component supplier, even large key suppliers. These reverberations will likely continue over the coming months.

Thus there are different sides to any coin and it is important for high tech and consumer electronics supply chain S&OP teams to focus on the core sales, pricing and product trends reflected in the overall market, not just certain players. Another key takeaway is the ongoing critical importance of responsive and timely product design and new product introduction.

Bob Ferrari

 

 


Apple- A Huge Thud Within Silicon Valley and Equity Markets

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This week marked a rather significant milestone and a rather huge thump within Silicon Valley and global equity markets.  The globe’s richest and most profitable company along with the most highly recognized supply chain delivered a huge if not somewhat expected disappointment. Note your calendars for reference, as this week; Apple did indeed report the company’s first quarterly sales drop in 13 years.

The growth streak has temporarily paused and the question is now what comes next.

The financial numbers are somewhat ugly by Apple standards- second fiscal quarter revenues declined 13 percent while profitability fell over 22 percent.  Then again, how many companies would envy a quarter that resulted in over $50 billion in sales and over 10 billion in net income?

Revenues across global regions were consistently down- a 10 percent reduction for Americas; a 5 percent reduction in Europe; a 26 percent reduction in the all-important Greater China region. Once more, Apple has issued lower sales forecasts for the current quarter. The impact of a strong U.S. dollar was somewhat a factor in global revenues with Apple indicating that revenue declines would have narrowed by 4 percentage points without such an impact.

For the past year, Apple’s shares have declined 20 percent and according to a commentary by The Wall Street Journal: “The decline erased more than $46 billion of the company’s market capitalization, more than the total value of Caterpillar Inc. or Netflix Inc.”

The unit volume picture was concerning- All important iPhone sales volume was reported as 51.2 million, down 16 percent from year earlier period. The firm’s iPad sales volumes declined 19 percent, continuing in a two-year long sales slump despite efforts to boost sales and a strategic alliance with IBM for more iPad focused business applications. Supply Chain Matters highlighted a number of ongoing published reports emanating from supplier information leaks indicating that Apple’s S&OP team has been consistently reducing iPhone production volumes since the beginning of the year. While inventories did increase, the situation would have likely been a lot worse since Apple had plans at one time to support an 80 million iPhone sales rate. Apple CEO Tim Cook indicated that the company plans to reduce inventories by $2 billion because of what he describes as the current challenging global economy. Gross margin for the current quarter is forecasted to be in a range of 37.5 to 38 percent, again below margin rates in the 40 percent range in prior years.

One bright spot was the introduction of the lower cost Apple iPhone SE that started shipping at the end of March. Apple CEO Tim Cook described current demand for this model as exceeding current supply, but too late to make any difference in second quarter performance.

The obvious question that reverberates across financial networks is when Apple, if ever will, return to growth.  Some would point to the need for an acquisition, some point to the need for the next “cool” product, perhaps electric cars or televisions.

Within the supply chain umbrella, one can anticipate a number of ongoing challenges.

Apple’s product design and product management teams are now under enormous pressure to develop the next successful groundbreaking product. The all-important design completion milestone date is mid-summer, since the global supply chain needs time to build supply and production to meet the traditional September new product announcement period and the critical October-December holiday sales period. Apple’s product design culture has always shown a tendency to push design changes to the very last minute.

Another reality is how long Apple can continue to support a premium price and margin point given an overall slump in global smartphone sales.  Emerging consumer regions where sales growth continues to exist are battlegrounds for price vs. performance, with lower price winning the majority of the time. If the iPhone SE turns out to be a sales volume success, it will have to be supported by a lower-cost supply chain channel.

Apple’s global direct materials procurement teams must continue to practice active supplier management since many of Apple’s suppliers have pinned their own financial performance outcomes on the large output volumes expected from Apple. When Apple sneezes, suppliers tend to catch pneumonia. Challenges will manifest themselves at annual supply contract reviews when volume expectations are clarified. With Apple practicing active segmentation, dual sourcing and key commodity risk mitigation, the role of supplier sourcing management should be very active.

Finally, Apple S&OP team must continue to be the arbitrator between sales and marketing teams who live in a hyped atmosphere of ever optimistic sales growth, a financial community now razor focused on margins and profitability goals, and supply chain operational teams that has not previously found themselves under an overt cost control looking glass.

A final open question is what if Apple elects to execute a large or complex acquisition. Perhaps an existing electric car or up and coming consumer electronics company?

There’s been an evitable thud in Cupertino, and the coming months will indicate whether this is indeed a temporary setback, or another turnaround milestone for the legacy and history of Apple.

Stay tuned.

Bob Ferrari

© 2016. The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.


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