AirBoss of America Corp

TSX:BOS

Earnings Call Transcript 2018-Q2

[Operator]

Good morning, and welcome to the AirBoss of America Q2 Results Conference Call. With us, we have Mr. Gren Schoch, Chief Executive Officer of AirBoss of America; Ms. Lisa Swartzman, President; Mr. Chris Bitsakakis, Chief Operations Officer; and Mr. Daniel Gagnon, Chief Financial Officer. I would now like to turn the meeting over to Mr. Gren Schoch. Please go ahead, sir.

[Peter Grenville Schoch, Chairman & CEO]

Good morning, everyone, and thank you for joining this conference call. I am Gren Schoch, and I'm the Chairman and CEO of AirBoss. Here with me are Lisa Swartzman, President; Daniel Gagnon, CFO; Chris Bitsakakis, COO; and Chris Figel, VP Legal and Compliance. We will give a short summary of results, and then the conference lines will be open for questions. Before we begin, I'd like to remind you that today's remarks, including management's outlook for the remainder of 2018, anticipated financial and operating results, our plans of -- and objectives and our answers to your questions will contain forward-looking information within the meaning of the applicable securities laws. This forward-looking information represents our expectations as of today, and accordingly is subject to change. Such information is based on current assumptions that may not materialize and is subject to a number of important risks and uncertainties. Actual results may differ materially and listeners are cautioned not to place undue reliance on this forward-looking information. A description of the risks that may affect future results is contained in AirBoss's annual MD&A, which is available on our corporate website and our filings with SEDAR at www.sedar.com. I will now turn this over to Lisa, our President for the highlights of the quarter.

[Lisa R. Swartzman, President]

Good morning, and thanks again for joining us. In the second quarter of 2018, a variety of internal and external forces impacted the business, including raw material and other input cost increases and a systemic trend towards higher freight costs. However, we continue to see positive improvements, which start with the cultural change in awareness from the AirBoss operating system. And we have a strong pipeline of growth opportunities, a strengthening management team and a healthy balance sheet with low leverage at 2x trailing 12 EBITDA, with which to realize these opportunities. On a consolidated basis, EBITDA in Q2 declined 4.6% to $7.1 million versus Q2 2017. And on a year-to-date basis, at $14.5 million, was marginally higher than the first half of 2017.EPS of $0.11 in Q2 was $0.03 lower than Q2 2017, and on a year-to-date basis was $0.25 versus $0.26 last year. Included in these results was an FX loss of approximately $400,000 in the second quarter, and approximately $800,000 on a year-to-date basis, as compared to a slight gain in Q2 and $120,000 year-to-date gain last year. As well as the impact to our consolidated tax rate as a result of U.S. tax changes.The combined effect of these negatively impacted EPS by $0.02 in the quarter and by $0.05 on a year-to-date basis. In Rubber Solutions, volume increased approximately 11% for the quarter and 10% on a year-to-date basis versus the respective periods in 2017. The volume improvements were across several sectors and in particular were in mining, conveyor belting, tolling and track. These improvements were partly offset by softness in the infrastructure, third-party Automotive and chemical sectors. As a result, gross profit for the quarter improved to $5.8 million, and EBITDA improved to $5 million. And on a year-to-date basis, both gross profit and EBITDA were essentially flat at $11.2 million and $9.7 million, respectively, as compared to 2017.The environment remains highly competitive with continued increases in raw material and freight costs, dampening the benefit of higher volumes to gross profit and EBITDA dollars.The pipeline of business remains strong and we're experiencing meaningful gains from the implementation of improvement initiatives. Despite the aforementioned cost increases and the general uncertainty of the global trade environment, we remain committed to working with our customers to minimize the impact of these challenges, while optimizing our upside.In Engineered Products, net sales in the second quarter increased approximately 10% to $45.4 million, and on a year-to-date basis, increased approximately 12% to $90 million versus the same periods in 2017, driven by strong improvement in defense, with Automotive sales slightly higher in the quarter and down marginally on a year-to-date basis.For the quarter, gross profit and EBITDA increased to $6.7 million and $3.8 million, respectively versus the comparable periods in 2017, as improvements in defense more than offset declines in the Automotive business. On a year-to-date basis, these improvements were more pronounced with gross profit increasing 24% to $13.9 million and EBITDA increasing 26% to $8.1 million.Automotive sales were, again, negatively impacted by the previously disclosed completion of a spring isolator program and lower muffler hanger sales. These were partially offset by increased demand in bushings and induction bonding applications as well as increased demand for dampers in the year-to-date period. And as I mentioned earlier, we see positive improvements from our operational and commercial initiatives and are focused on securing new multiyear contracts over the medium term to grow the business and replace those programs which have or are nearing the end of their program life.Net sales in defense improved significantly in the second quarter and on a year-to-date basis, increasing approximately 49% and 77% respectively, driven by increases across the majority of our suite of products, but particularly, in filters, masks, shelter systems and powered air purifiers, purifying respirators or PAPRs. These were partially offset by declines in our glove and boot lines, as we await the onboarding of anticipated new awards.We continue to see strength in our defense business with increased spending in the U.S. as well as other NATO and western militaries, although some level of uncertainty as to the timing and size of orders, tenders that have been awarded is expected, particularly, given the ever-changing geopolitical landscape and associated shifting priorities.So as we look forward to the remainder of the year, we are encouraged by our progress, but know there is more to be done, and we're aggressively pursuing the opportunities before us. We continue to invest in key leadership resources to further improve productivity and build best practices across the organization. With these initiatives, combined with management's ongoing efforts to expand and diversify our product lines, customer base and target market segments, we believe we're in a strong position to take advantage of growth opportunities, and we'll be able to adapt well to any further market volatility.Thank you, and I'll now turn it over to Gren or to the operator for any questions that anyone might have.

[Operator]

[Operator Instructions] The first question is from Nav Malik with Industrial Alliance.

[Navdeep Malik, Research Analyst]

I guess I just wanted to focus on the margins in terms of -- on the number of costs that increased during the quarter. And I just wanted to know in terms of passing those cost increases through to customers, what the challenges were? Or where you are in that process? Or how that's progressing?

[Chris Bitsakakis, COO & President of Rubber Solutions Division]

It's Chris Bitsakakis, I'll answer that question. In the Rubber Solutions side, we have a mechanism in place with the majority of our customers that we're able to pass those increases on. There's a bit of a timing issue as those increases come through. By the time they get passed through, there's a little bit of a lag there on the way up, but then you take that lag on the way down as well. In terms -- on the Automotive side, it's a little bit more complex. The automotive companies have very distinct models on certain commodities and what they will approve or won't approve. And if the price increase does not fit that particular model, it takes some additional negotiation to get some of those price increases through. So I would say that the lag time on the Automotive is probably a little bit longer. But we still have opportunities to go after those returns from them.

[Navdeep Malik, Research Analyst]

Okay, and how about on the -- I guess on the terms of the competitive environment, is there some pressure from competition, that kind of keeps you from raising prices as well? Or what's --- what would you say the competitive environment is now? Has it changed or is it similar to the past or...

[Chris Bitsakakis, COO & President of Rubber Solutions Division]

Yes, the competitive environment has always been tight. So whenever you go in for a price increase, the first response that you get is, well your competitors aren't or are. I think in most cases we've been successful in getting much of those passed through eventually. There are some times where some bigger customers have more leverage with other suppliers that we've had to make some compromises. But more often than not, a lot of these raw material price increases are affecting us and our competitors equally. So it's really more of a strategic decision on how aggressive we get on passing those through.

[Navdeep Malik, Research Analyst]

Okay. And I'm also just wondering if you could, just wanted to clarify, I guess, a couple of statements in your release. In terms of -- you mentioned there's some uncertainty with respect to global trading relationships and potentially changing levels of demand. But then you also note that the pipeline of business is strong. So I guess, how do you reconcile between those two? I mean there's some uncertainty, but you still have a strong pipeline, like, maybe just help me kind of fill in the gaps there.

[Lisa R. Swartzman, President]

I think -- Nav, what we mean there is we've got -- we've talked over the last couple of quarters about both the improvements that we've made in customer relations that when Chris has been out to visit with them and also the demand that's in the U.S. What's creating some havoc, though, quite honestly, is Trump. And so with the sort of global trade uncertainty, and what I mean by that is mostly on tariffs. And right now, there's been a number of announced tariffs that have not yet gone into place. But on an enormous number of rubber products, everything from raw material to finished goods coming out of Asia, it's wreaking a bit of havoc into our customers, particularly in the U.S. And in some cases, that's very good for us or could potentially be good for us. So for example, the OTR guys, the off-the-road customers that we have, have faced a tremendous amount of competition over the last couple of years by really cheap Chinese tires that are being exported into the U.S. And basically customers can buy virgin tires cheaper than the retreaded tire. So now with some of the tariffs that Trump is announcing and that he intends to do, that could potentially sort of even the playing ground there and increase demand in that way. But on some of our other customers where they are still getting a lot of raw materials from Asia, those tariff increases and the input cost increases to them is changing their outlook and what they're trying to do. And so what we're seeing is just in terms of people aggressively moving forward, just a little bit of uncertainty in sort of how quickly they want to do that until they sort out, basically, what their cost base is going to be.

[Navdeep Malik, Research Analyst]

Yes. Okay, I guess I follow you there. So I guess in terms of opportunity wise for you, does that give you an opportunity to maybe sell more specialized compounds? Because you're not facing sort of the same maybe lower-margin imports coming in, or what -- where would that help you?

[Lisa R. Swartzman, President]

It's not so much in sort of necessarily changing our input costs. I mean, we are in the Automotive business, at least we're facing similar issues on the steel tariffs and that's in some other raw materials. What it does for us I think is it changes -- or doesn't necessarily -- it changes where our focus should be with our sales and business development guys and which customers that they're going out to. So for example, the ones like OTR, we'll spend more time making sure that they're addressed and that we're addressing any concerns that they have in trying to get a bigger push in there, because we think [ out ] that they'll have bigger demand. With others, I think that Chris can probably speak more succinctly to it. But it means a little bit about working with them, we had talked before about pricing strategies that we had where we're working with our customers and some of our bigger ones to kind of share the way that we would go out to market, and so it gives us an opportunity to create a closer working relationship with our customers where we can be a little bit more helpful.

[Chris Bitsakakis, COO & President of Rubber Solutions Division]

I can probably add a little bit to that as well, and Lisa's 100% correct. And her example of the OTR is a really good one, because we're a dominant player in that space. But there is always lots of competition, they're under a lot of pricing pressure with these cheap imports that we suspect will improve with some of this new climate. However, on the agricultural side, you'll notice that a lot of the retaliatory tariffs are related to agriculture in the U.S. So a lot of the original equipment manufacturers in the U.S. that are also customers of ours are kind of in a nervous holding pattern to see kind of how things -- where they lay out, so we're making sure that our business development initiatives are focused on the areas that have the potential for near-term and medium-term growth until some of these questions get clarified.

[Operator]

The next question is from Shawn Levine with TD Securities.

[Shawn Levine, Associate]

In the last couple of quarters, you guys noted that there was a significantly large Rubber Solutions opportunity that could potentially start up in -- later in '18 and achieve full commercialization in 2019. I'm just wondering if you can provide an update on that. Does that put at the size and the timing of that has shifted?

[Chris Bitsakakis, COO & President of Rubber Solutions Division]

Yes, I can add some color to that. We continue to have ongoing conversations with that customer. The conversations are very positive and going quite well. The -- several of our customers in that space are seeing some softening in their respective markets, and so there has been a little bit of a delay, but what we're looking at is a new opportunity that they're launching. They're committed to working with us on that particular supply chain. And so the conversations are ongoing, and we have reason to be optimistic that, that will come to fruition at some point this year and early into next year.

[Shawn Levine, Associate]

In the MD&A, you noted the impact of freight costs on expenses. I'm just wondering if you can provide a little bit more color on that, what some of the dynamics are around that? And whether you have the ability to pass those higher costs on to customers?

[Chris Bitsakakis, COO & President of Rubber Solutions Division]

Yes, so freight costs are sort of a -- an industry-wide problem right now across the board. Many drivers are retiring in the U.S. and the whole supply and demand on getting the right freight lines with qualified drivers has put a -- quite a tightness on that market which is increasing pricing. We've seen across North America about an 18% increase in freight costs, not just in our industry but if you read any of the data, that's kind of what's going on everywhere. We have made some efforts to put that through on our pricing increase. As we're looking at the raw material pricing, we are now also looking at the freight cost and making an effort to pass some of those freight costs onto our customer whenever, wherever we can.

[Shawn Levine, Associate]

And I guess kind of keeping on that same vein, how much more runway do you guys have to implement additional process or efficiency improvement initiatives? And would I be correct in kind of saying that most of the low-hanging fruit has been picked but that you continue to look for smaller opportunities to continue to improve margins? And kind of offset some of these cost increases you're seeing elsewhere?

[Chris Bitsakakis, COO & President of Rubber Solutions Division]

Yes, I'd say we're relatively early in that cycle of cost improvements that are making it to the bottom line. We've laid a very good foundation with a continuous improvement process that is quite advanced. We have the AirBoss operating system that is now operational in each of the plants. It takes some time for some of those savings to start filtering through and making their way into the financial results. And so I'd say, really we kicked this off about 6 months ago. They now -- a lot of those savings are starting to kick in, and we expect that, that's only going to get better throughout the year.

[Operator]

The next question is from Scott Fromson with CIBC.All right, we'll move along, the next question is from Ben Jekic with GMP securities.

[Ben Jekic]

Just one question is on defense business. Could you maybe elaborate on what the dynamic is? Very good numbers now. But is there anything special with your kind of optimism for the remainder of 2018 and 2019?

[Lisa R. Swartzman, President]

Sorry, Ben, what do you mean by special?

[Ben Jekic]

Sorry, special source maybe...

[Lisa R. Swartzman, President]

[indiscernible] on something.

[Ben Jekic]

No. I mean a special source of that optimism, whether it's U.S. Canada or international?

[Lisa R. Swartzman, President]

Well, as we've said frequently, it's always the U.S. because they're the world's biggest military that sort of buys. So with them coming -- with them having a budget, and I think Trump just passed more defense spending this morning, with them having a budget coming in this year and having gone through sequestration over the last few years, they've obviously -- they're obviously doing a lot more spending than they have before. So we're basing it off of that, and basing it off of the conversations and the actual sort of larger multiyear contracts that we're currently bidding on. What we are also seeing is also because of what's going on just geopolitically, which is changing all the time given, predominantly, driven by the U.S. and what's going on with their relations and changing relations with North Korea and Iran and Russia. We're seeing some shifts in that but we're definitely seeing the entire world a little bit on edge. And there's no question that recent incidents have raised everybody's awareness and spectrum on the CBRN space. And there's been a plethora of articles out of a variety of military magazines over the last couple of weeks, speaking directly to the fact that the U.S. and other militaries are underprepared for Chem/Bio activity. And so, we take that with a -- we take that as encouraging but with a grain of salt. And what we're basing the optimism on is actually what we have sort of in the pipeline and what we're talking about with our customers.

[Ben Jekic]

Okay. And then another question is, just in terms of your gross margin, I mean sort of qualitatively maybe more conceptually, if I think sort of 2 or 3 years from now, is -- what's going to -- what has more likelihood of giving in first? Cost -- input costs? Or are the volumes going to pick up significantly for kind of needle to move?

[Lisa R. Swartzman, President]

I think both need to. So I think if you're talking, I mean, obviously, it depends on which business we're talking about, because the margin profile is different amongst the different lines, automotive being somewhat compressed and -- on an ongoing basis. Rubber solutions, as I always say, I caution you not to look at the percentage just because of the impact of the raw material pricing as well as the proportion of tolling in our business, which is quite high at the moment. And then defense, of course, of all the businesses probably has the best margin profile given the proprietary nature of their products. I think as Chris just said though, there's a lot of work that we can still do, both on our internal costs and then changing our processes to address any external headwinds in that way and obviously, I can't predict what's going to happen with raw material or foreign exchange or anything like that, but I think what we're really trying to do is manage it on both fronts, which is grow the business from a volume perspective across all of the business lines and make sure that we have the most efficient processes that we have in order to be able to execute on those -- that transaction and that business. And so I think it'll be really tackled on both fronts.

[Operator]

The next question is from Scott Fromson with CIBC.

[Scott Douglas Fromson]

Sorry about that earlier [indiscernible] been having trouble [indiscernible]

[Lisa R. Swartzman, President]

I'm sorry, Scott, you're breaking up. We can't hear.

[Scott Douglas Fromson]

Wondering if you can give some color on Flexible Products, how maybe the outlook for gaining traction with new platforms is going?

[Chris Bitsakakis, COO & President of Rubber Solutions Division]

So Flexible Products -- we're in a fairly significant launch mode now on 2 major programs, and the launches are going effectively and to plan. We're seeing growth with the big three over the next few years. We're seeing opportunities with one of those customers that -- those opportunities that didn't exist in the past, although we are seeing some drop-off in other areas. So I'd say from a product-development standpoint and a customer-relationship standpoint, things are going quite well. The first 6 months of the year, we've improved significantly all our ratings at each of the customers that we have, both for quality and delivery, which were a little bit below what you would expect to put you in the top rung to be receiving new business. So we are -- we have that operation now at a point where quality and delivery are where they need to be. We are in conversations on every new quote and we're aggressive and we're well thought of at the customer. So I suspect from the Automotive side, we should have some good traction going forward.

[Operator]

This concludes the question-and-answer session. I'll now turn the call back over to Mr. Gren Schoch for any closing remarks.

[Peter Grenville Schoch, Chairman & CEO]

Thank you, everybody for attending, and we will talk to you after the next quarter.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect your lines. Have a pleasant day.