AirBoss of America Corp

TSX:BOS

Earnings Call Transcript 2019-Q2

[Operator]

Good morning, and welcome to the AirBoss of America second quarter results. With us, we have Mr. Gren Schoch, Chief Executive Officer at AirBoss of America; Mr. Chris Bitsakakis, Chief Operations Officer and President; and Mr. Daniel Gagnon, Chief Financial Officer. I would now like to turn the meeting over to Mr. Gren Schoch. Please go ahead.

[Peter Grenville Schoch, Chairman & CEO]

Thank you, operator. Good morning, everybody, and thank you for joining the AirBoss Q2 results conference call. I'm Gren Schoch, and I'm the Chairman and CEO of AirBoss. Here with me are Chris Bitsakakis, President and COO; Daniel Gagnon, our CFO; and Chris Figel, our executive VP of Corporate. In terms of an agenda, we will review some of the operational highlights for the quarter and briefly review the financial results before opening the call for questions. Before we begin, I'd like to remind you that today's remarks, including management's outlook for the second half of fiscal 2019, anticipated financial and operating results, our plans and objectives and our answers to your questions will contain forward-looking information within the meaning of applicable securities laws. This forward-looking information represents our expectations as of today and accordingly are 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' annual MD&A, which is available on our corporate website and in our filings with the Canadian Securities Administrators on SEDAR at www.sedar.com. Before I hand this call over to the rest of the team, I would like to remind everyone that during the quarter, we appointed Chris Bitsakakis to the role of President, in addition to his ongoing duties as COO, recognizing the strong leadership he has shown. Chris joined the company just under 2 years ago. Chris has been instrumental in improving operational discipline, streamlining tiers in the business, and attracting a highly experienced managerial talent, particularly at the senior management level, within the individual businesses. In combination, these changes and transforming how we operate, with Chris being able to put in place a team of many well-known [ talent ] that will guide and support the evolving long-term vision for AirBoss. This in turn will help drive our next phase of growth over the next few years and beyond. I'd also like to note that yesterday afternoon we announced the appointment of Anita Antenucci to our Board of Directors. Anita brings more than 25 years of investment banking experience in aerospace, defense and government services space, and is currently a Senior Managing Director with Houlihan Lokey, based in Washington, D.C. We believe her fresh perspective and specific expertise will be very valuable as we work to complete and then leverage the previously announced transaction to create the AirBoss Defense Group.With that, I will now turn the call over to Chris to review a few operational highlights.

[Chris Bitsakakis, COO & President]

Thank you, Gren. Good morning, everyone, and thank you for joining us for our second quarter investor conference call. We felt we had a solid second quarter, especially on the Rubber Solution side of the business, where volumes measured on a pounds shipped basis were up about 11% for the year. We believe the North American Rubber Compounding market has grown at a rate of approximately 4% on a compounded annual basis over the last 5 years. So we're pleased to continue to outpace the market with our efforts to gain share over our competitors. There were a number of reasons for the increase, including higher volumes from a number of our large existing blue-chip customers, where we enjoy long-standing relationships as well as the addition of 18 new customers since the beginning of the year.The increased volumes and new customer ads are due in part to AirBoss' growing reputation for innovative R&D, strong customer collaboration in solving technical challenges and high-quality, often proprietary compounds. That said, some of the strengths we saw in the Rubber Solutions segment was offset by a 3% decrease in net sales on the Engineered Product side, but I will let Daniel speak to specific numbers more fully in a few minutes. Now as we continue to focus on short-, medium- and long-term growth and improvement plans for our business, we've significantly increased our level of investment right across the business, with capital expenditures through June 30, this year coming in at $7.5 million. For the Rubber Solutions segment, areas of investment include new mixing lines in Kitchener, Ontario and Scotland Neck, North Carolina, that in addition to increasing annual capacity by 20 million and 50 million pounds, respectively, will support production of a broader array of compounded products, white and color, for example, on our new specialty line in Kitchener as well as enhanced flexibility in growing our market share in key U.S. markets. In Kitchener, we are also just finishing upgrading our building with a new state-of-the-art laboratory facility to support enhanced collaboration with customers and better reflect AirBoss' ongoing focus on innovation and proprietary technical solutions that we believe are key to our continued growth. In the Engineered Products segment, we are piloting new injection molding presses for the anti-vibration business that are expected to support reduce cycle times and lower labor costs, which should help improve margins.Additionally, we've designed and ordered our first robotic workcell that will allow us to significantly improve throughput and reduce labor cost while we bid on new contracts. More broadly, we are also investing and developing new anti-noise, vibration and harshness products in segments outside of the automotive space, while we continue to prepare for the launch of the next-generation Low Burden Mask, which is already in production for the Canadian and Australian defense forces. Turning to specifics on the anti-vibration business. We continue to see some contraction in financial performance and are working to address key challenges head-on. Near-term focus remains on driving margins through better cost management and improved pricing strategies.This includes a more proactive approach in dealing with market variables, such as commodity, price fluctuations and tariffs. In addition, the recently strengthened sales and marketing team is working to both increase penetration with existing customers as well as target new ones, including major automakers and Tier 1 and 2 part suppliers. Over the medium and longer term, the team is focused on launching new products that diversify initially into opportunities adjacent to the automotive space, which could include trucking, busses, construction, motorcycles and ATVs, to name a few, but increasingly across a range of sectors where anti-noise, vibration and harshness solutions are required, including renewable energy, marine, rail and appliances.We remain in the relatively early stages of identifying and exploring opportunities in a range of adjacent sectors and expect this will be an ongoing process, but we believe strongly that diversifying our products across a wide variety of segments is key for our future growth. As preliminary step, we've created a dedicated new, nonautomotive products team, which is comprised of sales and engineering talent from North America and Europe, with extensive experience in NVH products across a wide variety of segments.As Gren mentioned, we've made significant changes to the operational management teams across the organization, and anti-vibration business was no exception. We've significantly strengthened our teams in each of our business in order to focus on innovation, growth and margin improvement. In last quarter's call, we spoke at length about the transaction to create AirBoss Defense Group, so I won't spend a lot of time here in our prepared remarks.While we believe there are a number of synergies inherent in the transaction, the most important will be the creation of a strong platform with the scale, capabilities and flexibility to act on an array of future growth opportunities, both organic and transactional. In the near term, we continue to identify and submit to tenders around the world, similar in nature to those we've successfully closed in 2018. As many of you know, these types of contracts have longer sales cycles, but also support commensurately large awards in dollar terms once awarded. With respect to the transaction itself, we are awaiting the approval of CFIUS which we currently expect in the fourth quarter of this year.In closing, I would like to remind listeners, that as a management team, we remain clearly focused on the 4 key priorities: Growing the Rubber Solutions segment and positioning it as a supplier of choice in the consolidated North American market; completing the ADG transaction and then leveraging the new entity's enhanced scale and capabilities to pursue an array of growth and value- creation opportunities in the broader defense sector; driving improved performance from the anti-vibration business through a combination of efficiency improvements; client relationship with expansion, new product development and sector diversification; and finally, we continue to take a disciplined approach to the targeting of acquisition opportunities across the business, with a focus on strategic fit. We feel each of these initiatives will be important contributors to improve financial performance and growth of the business over both the mid and longer term. With that, I will now pass the call over to Daniel for the financial review. Daniel?

[Daniel Gagnon, Chief Financial Officer]

Thank you, Chris, and good morning, everyone. As a reminder, please note all dollar amount presented are in U.S. currency, except for dividends per share, which are in CAD dollars. As Chris mentioned, we saw a continued solid performance from the Rubber Solutions segment, partially offset by lower net sales in the Engineered Products segment, and now primarily in the anti-vibration business. On a consolidated basis, net sales for the 3- and 6-month period ended June 30, 2019, increased by 1% to $82.6 million and by 1.8% to $165.2 million, respectively, compared with the same period last year. In the second quarter, consolidated gross profit increased slightly to $12.5 million compared with the same period in 2018, with increases at rubber solutions being offset by decreases in, the Engineered Products segment. In the Engineered Products segment, gross profit in defense business was broadly similar to last year, while down in the anti-vibration business.Overall gross profit margin for the quarter was consistent with last year at 15.2%. For the year-to-date period, consolidated gross profit decreased slightly $24.9 million compared with the same period in 2018. In the Engineered Products segment, the increased gross profit in defense business was more than offset by a decrease gross profit in the anti-vibration business. Gross profit margin decreased slightly for the first 6 months of 2019, to 15.1% from 15.5% in the prior year period.Consolidated EBITDA improved by 32.3% to $9.4 million in the second quarter and 18.2% to $17.3 million in the first half of this year, as a result of solid performance at Rubber Solutions and some realized operational efficiencies. A portion of the increase was also due to the settlement of an insurance claim of $1.2 million, recovering costs incurred as a result of a fire in our Scotland Neck, North Carolina facility that occurred in Q1 2019. Kudos to our team that worked so diligently to minimize the interruption to the business and our clients, and we're pleased to have the facility back functioning normally after just 5 weeks. Net income totaled $3.3 million for the quarter compared with $2.7 million for the comparable 3-month period in 2018. The basic and fully diluted net earnings per share in the quarter were $0.14, up from $0.11 a year ago.Adjusting for the insurance claim benefit in the quarter, EPS would have been $0.12 versus $0.11 last year. Net income totaled $6.2 million for the year-to-date period compared to $5.9 million for the comparable period in 2018. The basic and fully diluted net earnings per share in the 6-month period were $0.27 versus $0.25 last year.Now turning briefly to the segmented data. Net sales in Rubber Solutions segment for the second quarter increased by 6.2% from the comparable period in 2018. The increase in net sales was principally due to a 10.9% increase in volume that Chris mentioned earlier. The growth in net sales was supported by many of the sectors we served, with primarily in the off the road, tolling and defense sectors.These increases were partly offset by softness in the chemical and track sectors. Net sales in the Rubber Solutions segment for the 6-month period ended June 30, 2019, increased by 7.3% from the comparable period in 2018. The increase in net sales was principally the result of a 9% increase in the volume supported by many of the sectors we serve, but primarily in conveyor belt, off the road, tolling and defense sectors. These decreases were partly offset by softness in the chemical sector.Gross profit at Rubber Solutions for the 3-month period ended June 30, increased by 23.1% to $7.1 million, up from $5.8 million in the comparable period in 2018. Gross profit for the 6-month period ended June 30, 2019, increased by 24.4% to $13.9 million, up from $11.2 million in the comparable period in 2018 For both periods ended June 30, 2019, these increases were principally due to higher volumes, as we just discussed, and lower conversion costs related to labor.For the 3- and 6-month periods ended June 30, 2019, net sales in the anti-vibration business within Engineered Products segment decreased by 3.7% and 5.5%, respectively, from the comparable periods in 2018. For both periods ended June 30, 2019, the decreases occurred across most product lines and in particular, bushings and dampers, but were partly offset by increased demand in the grommet product line.In the second quarter, net sales in defense business within the Engineered Products segment decreased by 1.8% from last year. The decrease was seen in the shelters, filters, and masks product lines, and was partly offset by an increase in the boots and gloves product lines. These changes were largely due to the timing of contract awards and delivery schedules, which shifted into the second half of the 2019 calendar year. For the 6-month period ended June 30, 2019, net sales in defense business increased by 5.7% versus the comparative period last year. The increase was in the boots and gloves product lines, and partly offset by more demand in filters and shelters.Gross profit in the Engineered Products segments for the second quarter was $5.4 million, down $1.3 million from $6.7 million in the comparable period last year. The decrease in gross profit and gross profit as a percentage of net sales were principally due to lower net sales in the anti-vibration business.Despite the decrease in net sales in defense business, gross profit was relatively similar to a comparable period in 2018, and that was due to a favorable product mix.Gross profit in Engineered Products for the year-to-date period was $11 million, down $2.9 million from $13.9 million last year. The decrease in gross profit and gross profit percentage of net sales were principally due to lower net sales in the anti-vibration business and that was partly offset by higher gross profit in the defense business as a result of increased net sales and a favorable product mix.As Chris mentioned earlier, we continue to invest in a range of initiatives to help support the long-term growth and performance of the business, with an investment of $7.5 million in CapEx. We expect to continue to invest in the business in the second half of the year, and to reach the range of $18 million to $20 million for the 12-month calendar period ending in 2019. CapEx for 2020 is expected to be closer to depreciation level. Going to the balance sheet, cash balances were reduced in the quarter, in part, as we invested in property, plant and equipment and paid down debt. Our operating revolving loan facility provides financing up to $60 million and remains undrawn at June 30, 2019. We remain in good financial health, with a net debt to trailing 12-month EBITDA sitting at just 2x at the end of the second quarter.Operator, that concludes our prepared remarks this morning. We would now like to open the call to questions.

[Operator]

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

[Navdeep Malik, Research Analyst]

Firstly, just want to ask on the defense business. I guess, revenue was a bit weaker this quarter, maybe because you had mentioned some items in the prepared or in the release, but just wondering if you could just comment on the lower revenue this quarter.

[Daniel Gagnon, Chief Financial Officer]

Nav, this is Daniel. The drop, as we mentioned, is really timing of when orders come in. Last year, you'll recall, we were finishing off a big contract with filters. So this year, in the second quarter, it was just a timing of when orders -- or the POs were coming in for deliveries. And as we mentioned, we do expect to see this pickup in the second half of the year, mostly in the fourth quarter, actually. So again, it's not just turning the cycle as things are turning down in a sense, there are a lot of activities, a lot of business with the awards we won and it's really just a question of timing.

[Navdeep Malik, Research Analyst]

Okay. And then, I guess, kind of on the same in the defense business, with the transaction with CSI, are you working collaboratively now with CSI on the defense in terms of new business, trying to win new business or what, maybe could you give us quite of an update on that front?

[Chris Bitsakakis, COO & President]

Yes, it's Chris. For sure, we have fully integrated, the management team of CSI into what we are doing at AirBoss. So any new opportunities, we're working with them and because they're quite strong on the sales and marketing side of things, we've already seen significant benefits in how we approach new tenders, the type of lobbyists that they work with, and the opportunities that we're addressing are significant in scale, and it's starting to jell quite nicely the 2 teams together. Although the transaction hasn't closed, we are operating and integrating their teams with our team as we go forward on new contracts.

[Navdeep Malik, Research Analyst]

Okay. Great. And then just lastly, I want to ask on the anti-vibration business. I know there is a lot of initiatives that you are pursuing. Is there any sort of way you can kind of give us a sense of timing, when you will start to see some of these initiatives really start to impact financial performance?

[Chris Bitsakakis, COO & President]

Yes, I think many of the initiatives have already started to improve financial performance in one perspective, but a lot of those improvements are getting washed away with the sales drop that we saw. So we continue to focus on kind of 3 categories of improvements: commercial, operational improvements and focusing on growth for the top line, and all 3 of those have ongoing action plans that are being worked on daily and being completed. So we see some good opportunities for the future, and we expect things to get better in the ongoing quarters.

[Operator]

Our next question is from Scott Fromson with CIBC.

[Scott Douglas Fromson]

Just on the anti-vibration business, Nav kind of asked the question on timing. But what is the basic issue with the business that sales growth and I don't know if it's new product development has been slower than expected, this has kind of been going on for a couple of years now?

[Chris Bitsakakis, COO & President]

I think it's a highly connected problem. It's not -- there is not one sort of -- root cause that we're talking about, but in the Automotive space, as new contracts come in and replace old contracts, there is continued pressure on pricing in order to be awarded those new contracts. And if you are continuing to hit market prices without making the commensurate improvements in operational efficiencies, you tend to take that out of margin, and it also shows on the top and the bottom line. So what we're doing now is as we are creating these operational improvements, we are bidding new contracts based on those improvements. We announced earlier that we are replacing many of the older presses and machines that we have, some of the new presses and machines that we have are showing significant improvements in operational efficiency. The new robotic workcell that we're bringing in has taken sort of a whole other level of where we can quote and hit market prices and still retain some acceptable margin for ourselves.So as we continue to have good relationships with our customers, instead of taking those new awards that come in out of our margin, we're building up the operational improvement such that we can hit those new prices and still make some margins. So that's kind of the reason why we've seen this decline over the past year or 2. Additionally, we've obviously had some significant issues with tariffs and raw material increases that have also affected the bottom line, and we are also, from a commercial strategy standpoint, working with all our customers to be able to pass a lot of those on.

[Scott Douglas Fromson]

So how do these improvements coincide with the timing of the refresh or replacement model cycle?

[Chris Bitsakakis, COO & President]

The model cycles are little bit longer in Automotive than in other industries. It's normally a 4- to 5-year cycle. And so right now, we are bidding on new work that will start hitting in the next few years, but much of the work that we bid on in the past -- prior years, we'll now be able to launch under the new technology. So the margins that you would expect from the new work will actually appear versus wondering kind of where the margin is going. So the operational improvements will have both the near-term and long-term effects on the bottom line. And as we focus on growth in the non-auto market, there will be opportunities to grow the top line in a much shorter sales cycle, and also at a margin level that's been less commoditized. So we think that those plans altogether will start to continue to create the improvements that we're looking for.

[Scott Douglas Fromson]

So does that mean that in the near term, we may not see the revenue improvement, but we'll see profitability improvements, margin improvements?

[Chris Bitsakakis, COO & President]

The revenue improvements always take a little bit longer, the profitability improvements will show up earlier, but of course, as the sales drop a little bit, you see that negative pressure and the profitability improvement are not as obvious. But we're also taking steps to reduce our breakeven point and recently just last month, we consolidated our 2 -- our 3 factories in Detroit into 2 factories and that's allowed us to reduce our breakeven point. We're constantly looking at other opportunities to reduce that breakeven point, so that any reduction in sales doesn't have the impact to the bottom line that it's currently having.

[Daniel Gagnon, Chief Financial Officer]

Yes and I would add to Chris' comments that, with our strategy of leaning out the organization, making it more operationally efficient, when the revenues do come in, being lean, we expect -- we would expect to see the margins will improve even further, but with a larger incentive.

[Operator]

[Operator Instructions] Our next question is from Ben Jekic with GMP Securities.

[Ben Jekic]

My first question is on the Rubber Solutions segment. I think it's encouraging to see that the volumes in terms of pounds shipped, both on tolling and non-tolling business, are picking up consistently. And I wanted to ask sort of on the bigger picture, how sensitive is that trend to any potential for a macro slowdown or as far as a recession going forward?

[Chris Bitsakakis, COO & President]

Well Ben, as you know, we are well diversified across a variety of different segments and sectors. And I think that protects us quite a bit from individual segments that may run into some trouble. And so I think, we're kind of safe in that perspective. Also from a competitive standpoint, as you can see, we are outpacing market growth, and we're providing solutions to our customers that many of our competitors aren't necessarily focusing on. Our commitment to quality and delivery and service and technology and innovation allows customers that come to us over our competitors to help strengthen us at the times when maybe the overall market may be softening a little bit. So we're pretty comfortable with the space that we have. We're proving that we can compete with our competitors and outpace them in terms of growth. And so that, along with the way we're diversified across many sectors, I think protects us more than most.

[Ben Jekic]

Okay. And my next question is, if you could just remind us on where do you stand with regards to capacity expansion in Scotland Neck and Kitchener? And where the -- I think, the colored rubber -- I think that's going to come out of Kitchener, but if you can just provide us with an update on that and how to think of the contribution for the remainder of this year and next year?

[Chris Bitsakakis, COO & President]

So the colored rubber line was launched last month. We're very pleased with the installation and the startup. And as of this week, we've already started accepting purchase orders. We have new customers coming in that are helping us fill that capacity. And as you recall from last year, we wanted to focus on having an asset that would allow us to compete in the sort of specialty sector that we didn't have before, and we are very pleased with the amount of traction that we're getting. We've targeted quite a few new customers for that line and already we're receiving purchase orders and starting shipments towards the end of this month. And now it's going to take us a little bit of time to fill that line, but we're encouraged with the level of traction that we're seeing already. In terms of the Scotland Neck facility, we have now installed the second compounding line, it is up and running, and we're also aggressively going after the customers in that region and across The United States to fill that capacity, and we are already seeing new awards coming in. So we are happy with the capacity we installed, it's going to take a little bit of time to fill it, but so far, we're seeing good results.

[Ben Jekic]

So both -- so the incremental capacity in both centers has already been -- is already in place?

[Chris Bitsakakis, COO & President]

Just as we speak, yes. The color mixer just came online a few weeks ago, and the black mixer in Scotland Neck just came up last week.

[Ben Jekic]

Okay. And it's installed?

[Chris Bitsakakis, COO & President]

Installed, yes, and the capacity is available.

[Operator]

Our next question is from Maggie MacDougall with Cormark.

[Maggie Anne MacDougall, Director of of Institutional Equity Research]

Can you guys tell me what the effect of IFRS 16 was on the reported EBITDA number?

[Daniel Gagnon, Chief Financial Officer]

Yes, Maggie, so if you look on -- look up quarter-to-date, the depreciation in interest impact would be about -- the depreciation would be about 700 and 200 -- so $900,000 will be the impact to EBITDA compared to last year.

[Maggie Anne MacDougall, Director of of Institutional Equity Research]

Okay. And then with regard to your outlook for the defense business, you mentioned that you would expect I think orders or shipments to pick up in the second half of this year and that the Q2 softness is largely timing related. Outside of that dynamic, can you comment on the broader environment for defense spending and any new developments you may have seen with regards to demand for your products and also under your new AirBoss defense divisions products as well?

[Peter Grenville Schoch, Chairman & CEO]

Maggie, we have the largest defense budgets that we've seen in years, and I think in ever. And the forecast for next year is another big defense budget. We had record orders last year as we announced in the pipeline or I shouldn't say in the pipeline, we are tendering on more business than we were awarded last year, so there are some very large international and domestic contracts out for -- who are at the request for proposal stage right now. So as you know, it takes a little while to get these and takes even longer to get the order, but the future looks better than it has in a long time in that business.

[Maggie Anne MacDougall, Director of of Institutional Equity Research]

Okay. Great. And then just one further question. You talked about for a while diversifying the anti-vibration business into a number of other end markets, and it strikes me as though that might be a nice solution to some of the pressures, Chris, that you were discussing around the Automotive market. And so wondering, how you're going about sort of tackling new markets and then whether or not that might require some M&A in order to sort of get across the line?

[Chris Bitsakakis, COO & President]

Yes. Thanks for the question, Maggie. We have, for the first time, created a dedicated sales and engineering team that is focused on this nonautomotive markets for anti-vibration, and we've hired people with extensive experience, particularly in the construction and heavy truck market that we don't really participate in right now.And so this team is now focused on all of these different areas to try and grow and expand. We've already been awarded 1 nonautomotive contract, which will launch in July of next year. We are in late development on a military application for a rubber to molded product, that we expect to see some good news on that in early 2020.And as we've now been going to many segments with our capabilities, we've also made a small acquisition of equipment in a technology that we didn't have before that allows us to go after some of these more delicate markets. And so from a technical standpoint and from a sales standpoint, we are now presenting the right product line for these nonauto customers, we're seeing good traction. There is a room in that space, and we are also looking at bolt-on acquisitions that can jump-start our nonauto segment on the anti-vibration.And so we're hoping that organically, this team starts to do what we expect them to do, and we continue to look at acquisitions that could help bolster that and give us a head start on that. Our goal being that we'll be able to diversify and have -- and not just be an automotive-focused anti-vibration unit, and so far, we're pretty optimistic we'll make that happen.

[Peter Grenville Schoch, Chairman & CEO]

Yes, I just wanted to add, Maggie, I don't know if you noticed it or not, but we put up a new investor presentation this morning on our website. And I think there is a little bit in there on some of the nonautomotive target markets.

[Maggie Anne MacDougall, Director of of Institutional Equity Research]

Okay. Gren, I will take a look at that.

[Daniel Gagnon, Chief Financial Officer]

And Maggie on your question on IFRS, the number I was quoting was an EBITDA impact. On the net income impact, it's negligible, it's like under $100,000, if that helps.

[Operator]

There are no further questions registered at this time. I would like to turn the conference back over to Chris Bitsakakis for any closing remarks.

[Chris Bitsakakis, COO & President]

Thank you, operator, and thank you to everyone for attending this morning's call. We remain excited for the longer-term prospects for AirBoss and feel we've taken real strides in transforming the business and positioning for long-term growth. That said, there is still work to do, and we expect that our efforts on a number of fronts will continue through the balance of the year and beyond. We look forward to updating you all on our progress on our Q3 call in November. Thank you, have a great day.

[Operator]

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