Abc Technologies Holdings Inc

TSX:ABCT

Earnings Call Transcript 2023-Q2

[Operator]

Greetings, and welcome to ABC Technologies Q2 Fiscal 2023 Earnings Conference Call. [Operator Instructions] As a reminder this conference is being recorded.

I would now like to turn this conference over to your host, Nathan Barton, Vice President, Investor Relations. Thank you. You may begin.

[Nathan Barton, executive]

Thank you, operator, and thanks to everyone for joining us today. With me on the call are ABC's President and Chief Executive Officer, Terry Campbell; and David Smith, Chief Financial Officer of ABC Technologies. This call is being webcast live on ABC Technologies Investor Relations website. The webcast will be available for replay for 12 months following this call. Content of today's call is the property of ABC Technologies cannot be reproduced or transcribed without written prior consent from the company.

Before we begin, I would like to remind you that today's call will include forward-looking statements within the meaning of applicable securities laws, which are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements. Any such statements should be considered in conjunction with and subject to cautionary statements in our earnings release for the last completed fiscal quarter and risk factor discussions in our filings with the Canadian Securities regulatory authorities that can be accessed on the company's profile on SEDAR.

I would also invite everyone to review the non-IFRS measures and key indicators as well as the forward-looking statements of the company's filings for the last completed fiscal quarter and the Risk Factors section in the company's annual information form for the fiscal year of the company ended June 30, 2022.

We assume no obligation to update any of these forward-looking statements or information unless required by law. I also want to note that any third-party data concerning the market and economic data referenced in today's call is the intellectual property of such third parties, and the company makes no representation as to the accuracy and completeness of such market and economic data.

I want to remind our investors that we are on a fiscal year that began July 1, 2022, all references to Q2 fiscal 2023 are to the 3 months ended December 31, 2022, and Q2 fiscal 2022 are to our fiscal quarter ended December 31, 2021. I also want to note that while ABC shares trade in Canadian dollars, the company reports its financials in U.S. dollars.

With that, I'd like to turn the call over to Terry Campbell.

[Terry Campbell, executive]

Thank you, Nathan. Good morning, everyone, and thank you all for joining us today. During our last earnings call, I spent some time outlining ABC's new customer-focused operating model that we implemented to reduce complexity while aligning our technical teams around our 3 product groups and our commercial teams around our customers. Over the last 3 months, our leaders and their respective teams have made meaningful progress in executing their mandates.

Beginning on the commercial side. The sales team has continued to sharpen their top line focus and cost discipline by strengthening both the customer-facing as well as related support functions to make sure we're not just growing revenue, but meaningfully improving profitability. While this has resulted in ABC being more selective about its commercial pursuits, we are focused only on programs that will allow us to increase both our total profitability as well as improved margins.

The commercial team has also been laser-focused on pursuing labor and material cost recoveries from our customers, as we discussed in prior quarters. And as you see, many of our supplier peers announced this quarter and last. I'm happy to report that we're seeing many of these conversations coming to resolution and have realized a significant amount of our targeted recoveries from some of our major OEM customers.

Next, the operations team has continued to prioritize quality, on-time delivery and improvement within some of our underperforming lines that we've spoken about at a high level on prior calls. By focusing daily on plant level economics and proactive management of KPIs as well as our management talent operating the plants, we are seeing signs of improvement in areas of operational weakness, and we expect these will bear more economic fruit in the coming quarters.

Finally, linking both these functions, our engineering group is focused on enhancing our product and our process strategy across our full network of plants and product suite, standardizing best practices and implementing centers of excellence across the operating base. These initiatives form the building blocks of our value creation strategy, complemented by our M&A and operational transformation agenda, where we've seen some exciting and meaningful developments over the last few months.

Just before the end of the quarter, ABC entered into a definitive agreement to acquire WMG Technologies for $165 million with additional potential earn-outs related to profitability targets. WMGT is a leading Tier 1 and Tier 2 exterior supplier to major global automotive OEMs with facilities across North America. The transaction is subject to customary closing conditions and regulatory approvals, and we anticipate the acquisition will close during Q3 fiscal 2023.

WMGT brings with its strong operational history as a family-owned Canadian business that parallels ABC's own story. Founded 2 years apart, both companies built strong legacies guided by intentional and focused leaders. 6-plus years after our own transition from being a family-owned business, we look forward to welcoming WMGT into its next exciting chapter as part of the ABC family.

The acquisition strengthens ABC's exterior products offering, expands our injection molding technical expertise and brings additional value-add tooling in-house. From a customer standpoint, WMGT will further strengthen our relationship with GM and Ford, while bolstering our growing relationship with Toyota.

Subsequent to the end of the quarter, on January 18, 2023, ABC and Inoac reached a mutual decision to dissolve the 2 companies' North American joint venture. The transaction closed on February 1, 2023, as ABC sold its equity interest in the venture, pursuant to the relevant share purchase agreements. Both companies will work together to unwind the partnership and transition full ownership to Inoac over the coming months.

As you might gather from these developments, ABC continues to focus on creating value through the accumulation and rationalization of assets and products to improve our performance and set the business up for greater focus and success in the future. We are confident that this approach will position ABC to deliver value for our employees, our customers and our investors. We believe the landscape, any economic environment will continue to present us with strategic opportunities that can improve our product portfolio and financial profile.

With that, I'll move on to a snapshot of our financial results for the quarter. Revenue for the quarter increased nearly $118 million against last year to $321 million. This top line growth was supported by significantly improved industry volume versus the prior year period, nearly $50 million of contribution from the acquisitions of Karl Etzel and dlhBowles which were completed in Q3 fiscal 2022, along with recoveries from our customers. While we started to see some cost pressures begin to abate during the quarter, resin, for example, gross margin continued to be negatively impacted by inflationary pressures on labor, freight and overhead costs.

Offsetting these negative margin pressures during the quarter where the previously mentioned successful inflationary recoveries with certain customers. Discussions with several other OEM partners are still ongoing, and we expect to reach conclusion with these in the coming 1 to 2 quarters as well. In general and going forward, we anticipate continued and regular collaboration with our OEM partners as we navigate the complexities of an evolving macroeconomic environment together.

And finally, adjusted EBITDA for the quarter came in at $41.7 million, and adjusted free cash flow was negative $9.3 million. David will provide further details on our financial results in his remarks.

Now moving on to an overview of the industry this past quarter. While quarter-over-quarter, North American vehicle production showed a slight decline from 3.7 million vehicles in calendar Q3 to 3.6 million in calendar Q4. This past quarter saw year-over-year industry volumes up 8.1%, which helped drive some of our improved revenue for the quarter.

Additionally, full year production in calendar 2022 grew 9.7% year-over-year to 14.3 million vehicles. We are hopeful that the worst of the supply chain-related OEM production slowdowns are behind us, and we'll see continued improvement in calendar 2023. We saw some divergence between the production and sales environments in calendar 2022, with U.S. sales declining by 7.9% over the same period as new car prices hit an all-time high in December, supporting an inventory recovery while highlighting the potential for demand realignment. With roughly 1.58 million vehicles on dealer lots, an average inventory of 33 days, we're seeing promising though somewhat muted signs of an inventory rebuild with the U.S. inventory at a 20-month high as of December 2022.

Looking forward, an anticipated mild U.S. recession in the first half of calendar 2023, paired with improving supply chain dynamics is expected to continue to curb inflation, which we are hopeful will have the impact of reducing operating costs while allowing for production to continue to grow in order to refill the inventory funnel to a greater degree.

Finally, I'll review some of the commercial highlights from the fiscal second quarter, including important launches and wins before you hear from David about the details of our financial performance. In the quarter, we launched 19 programs in total. Though a majority of these launches were in North America, we had a continued success with our Japanese OEM customers, launching interior system products on the high-volume Honda CRV and HVAC ducts on the Lexus Rx. We also launched HVAC and Fluid Systems on the F-250 and F-350 Super Duty trucks, 2 of Ford's most popular heavy-duty vehicles.

Moving on to wins in the quarter. We had 13 different business awards for a total of $8.2 million in annual sales, which is a bit slower than some recent quarters, but was expected due to the holiday period and a brief law in major quoting activity on some of our largest customer major platforms, which we expect will pick up later in the fiscal year and into next.

Even with a slower quarter, ABC won Fluid Systems, air induction and HVAC on a future South America GM vehicle as well as both HVAC and flexible products on a future small Toyota SUV.

Of our total awards in fiscal Q2, 45% of our electric vehicle wins made up 4 unique platforms. And while global production capacitizes towards battery electric vehicles and plug-in hybrids, it's worth mentioning that North America continues to lag on electric vehicle adoption relative to China and Europe who are the regional EV leaders.

As such, ABC continues to balance its focus between representation on electric vehicle platforms as well as major high-volume internal combustion engine platforms with meaningful staying power which we believe will continue to be the most profitable and predictable production plan going forward.

From a commercial perspective, along with the benefits I noted earlier, our acquisition of WMGT will also bring with an opportunity to diversify and expand our customer and platform base. In particular, we are excited about the increased exposure to Japanese OEMs like Toyota as well as Ford, including major exposure to F-150, the best-selling vehicle in the U.S.

With that, I will now turn the call over to David.

[David Smith, executive]

Thanks, Terry. I'll begin with an overview of our revenue performance in our fiscal second quarter ended December 31, 2022. ABC's revenue for Q2 fiscal 2023 was $321.0 million, this is up from $203.4 million in Q2 fiscal 2022, an increase of $117.6 million or 57.8%. $49.8 million of this increase in sales is attributable to dlhBowles and Karl Etzel, accounting for 42.3% of the increase. We also recovered amounts from certain of our customers during the quarter, both as lump sum and purchase order adjustments to partially alleviate the inflationary pressures we've been experiencing due to the current economic conditions, as Terry discussed in his remarks.

Excluding the impact of the acquisitions and the recoveries from select customers, ABC enjoyed slightly better than industry growth year-over-year as a result of improved sales to a number of significant customers due to our product mix relative to the industry.

Moving on to cost of sales where the impact of inflation and cost escalation continues to affect our results in the quarter. Cost of sales increased $82.1 million or 43.6% from the $188.3 million in Q2 fiscal 2022 to $270.4 million in Q2 fiscal 2023. As a percentage of sales, cost of sales was 84.2% in Q2 fiscal 2023 compared with 92.5% in Q2 fiscal 2022. The improvement was primarily due to the recoveries received from customers in Q2 fiscal 2023 that were recognized in sales and flows directly down the P&L. Otherwise, gross margin would have continued to be negatively impacted by higher labor and freight costs as well as raw material costs, primarily resin, glass, rubber, paint and steel. But we are encouraged by some of the recent improving trends ABC is still suffering through elevated input costs, and we remain in close discussion with our OEM partners, should we need to take additional action in the face of these unprecedented impacts on our profitability.

Total SG&A increased to $42.3 million in Q2 fiscal 2023 from $29.1 million in Q2 fiscal 2022, an increase of $13.2 million or 45.6%, of which just under half or $5.9 million is attributable to our dlhBowles and Etzel acquisitions that were completed in Q3 fiscal 2022.

As a percentage of revenue, SG&A improved slightly to 13.2% in Q2 fiscal 2023 compared to 14.3% a year ago. ABC reported a net loss of $22.7 million in Q2 fiscal 2023 compared to a net loss of $16.4 million in fiscal Q2 of the prior year, a deterioration of $6.3 million or 38.4%. This was largely due to a onetime [indiscernible] impairment charge taken on the value of ABC's joint venture with Inoac.

This is connected to the dissolution of the JV with Inoac, Terry mentioned earlier, and was completed on February 1. The net loss per share in Q2 fiscal 2023 was negative $0.20 versus a net loss per share of negative $0.31 in the same quarter last year. Both figures are on a basic and fully diluted basis.

Moving to adjusted EBITDA, which was $41.7 million in Q2 fiscal 2023 compared to $11.5 million in Q2 fiscal 2022 or $30.2 million higher year-over-year, primarily due to customer recoveries as well as higher sales and gross profit on both existing operations and recently acquired companies. The adjusted EBITDA margin for the quarter more than doubled to 11.7% from 4.9% in Q2 fiscal 2022. A promising improvement in trends for the last several quarters, but we are still laser focused as a management team on returning the business to the mid-teen EBITDA margin business where we were prior to COVID-19, the semiconductor production issues and supply shortages where we believe the business should operate in a normal production environment.

For the quarter, cash flow from operations was $13.4 million, a decrease of $26.8 million in Q2 fiscal 2022. The decrease is primarily due to changes in working capital and higher interest paid partially offset by higher adjusted EBITDA in the current fiscal quarter compared to the prior year. Adjusted free cash flow was a use of $9.3 million in Q2 fiscal 2023 compared to roughly $5 million in the prior year. This $14.3 million decrease was due to lower net cash flows from operating activities and higher purchases of property plant and equipment, partially offset by the net impact of hedge monetization between the 2 periods.

I'll conclude my remarks on our financials with some details of our capital structure and liquidity. As of December 31, 2022, the company had outstanding obligations under its credit agreement of $370 million while total liquidity was $216.9 million, unchanged from September 30, 2022. Our liquidity is made up of cash of $38.5 million and $178.4 million on our credit facilities, which is subject to [indiscernible] limitation.

ABC's liquidity position has continued to remain strong throughout the volatility of this fiscal year and last, and we do not expect this to change moving forward as we continue to grow the business organically and inorganically.

On December 5, ABC amended its credit agreement to include a nonrevolving term facility of $185 million, under which it can draw the financing acquisition of WMG Technologies. This new term loan is expected to be drawn upon closing of the transaction in fiscal Q3 and its maturity will be coterminous with our existing revolving [ credit line ] facilities in February 2027.

Despite overall improvements in liquidity in the market environment, conditions in the industry in our core business have ABC operating at leverage levels that are higher than their internal target. Our leverage multiple is expected to decline over subsequent quarters, but we will remain elevated for the time being as we navigate volatility in the market due to internal and external factors discussed earlier than prior quarters.

As the market normalizes and ABC overcomes these challenges, we expect to return to leverage levels well below our target of 3.0x.

With that, I'll turn it back over to Terry for a few closing remarks. Terry?

[Terry Campbell, executive]

Thanks, David. To conclude, though, we've had some exciting wins in the quarter, including a successful resolution of price negotiations with select customers and announcing our acquisition of WMG Technologies, recessionary pressures remain a foremost consideration for us as we evaluate and plan for the calendar year ahead.

Extending past the current year, though -- and the recovery [indiscernible] are predicting, economic cycles are a persistent reality that the auto industry must contend with. Consumer wallets will inevitably be stretched resulting in demand destruction that will apply pressure to light vehicle sales, necessitating a business model that can remain strong and resilient during these cycles. In particular, the [ trough ].

As I noted in my introduction, this is exactly the business our team is committed to building under our new operating model, and we're well along the path of getting these things where we need them to be.

And finally, beyond the focus of fortifying our core business, we exited our JV and expect to close on the acquisition of WMG Technologies during fiscal Q3, and we're continuing to evaluate further opportunities to augment our operations, focus our business and grow both organically and via M&A. Our teams have been hard at work on integration planning, and we look forward to working closely with the WMGT team upon successful completion of customary closing conditions and regulatory approvals.

That concludes our remarks for today. If you have any questions or comments, please feel free to reach out to Nathan Barton, Vice President of Investor Relations after this call. Thank you, everyone. You may now disconnect.