AirBoss of America Corp

TSX:BOS

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the AirBoss of America Second Quarter 2024 Conference Call. [Operator Instructions] The conference is being recorded. [Operator Instructions].

I would now like to turn the conference over to Gren Schoch, Chairman and Co-CEO. Please go ahead.

[Peter Schoch, executive]

Thank you, operator. Good morning, everybody, and thank you for joining us for the AirBoss second quarter results conference call. My name is Gren Schoch. I'm the Chairman and Co-CEO of AirBoss. With me today are Chris Bitsakakis, our President and CO-CEO, and Frank Ientile, our CFO; and Chris Figel, our EVP and General Counsel.

Our agenda today will start with a review of the operational highlights for the quarter, followed by a discussion of our financial results before we open the conference line to questions. Before we begin, I would like to remind listeners that our remarks today contain forward-looking statements, including our estimates of future developments. We invite listeners to review risk factors related to our business in our annual information form and our MD&A, both of which are available on SEDAR and on our corporate website.

We will discuss certain non-GAAP measures, including EBITDA, reconciliations of these measures are available in our MD&A. And finally, please note that our reporting currency is in U.S. dollars, therefore, references today will be in U.S. dollars, unless we indicate otherwise.

With that, I'm going to turn the call over to Chris for the operational review.

[Chris Bitsakakis, executive]

Thank you, Gren, and good morning, everyone. During the second quarter of 2024, AirBoss focused on operational execution and aggressive deleveraging activities despite the continued impact of the economic slowdown occurring in North America. The company addressed the effects of the economic slowdown with aggressive cost cutting in an effort to mitigate any profitability pressures.

These actions were particularly focused on the AirBoss Manufactured Products defense business, as was previously announced. The ability to recover from the volume shortfall over the remainder of 2024 will remain subject to the ongoing challenges related to the market softness and ongoing global geopolitical challenges and successful conversion of key opportunities.

We are, however, encouraged by the recently announced Bandolier awards, which have begun shipping in Q3 as well as increased momentum in the CBRN defense product lines at AMP. Despite weakness in the U.S. industrial base driving lower volumes, AirBoss Rubber Solutions improved gross margin percentage year-over-year through continued migration towards higher end niche products and operational cost improvements.

Although overall volume is down across multiple sectors, the onboarding of new customers has helped to offset some of the downturn in legacy volumes and is expected to drive additional growth as the economy recovers. The segment remained committed to executing on its strategy to deliver strong results of specialized products and expanded production of a broader array of compounds while driving forward on key long-term strategic imperatives, including newly launched automation initiatives.

AirBoss Manufactured Products experienced continued softness in Q2 of 2024 in both the rubber molded products and defense businesses. The rubber molded products operations were impacted by continued volume softness related to the original equipment manufacturers shuttering production in the current quarter to rebalance vehicle inventory levels.

The business continued its focus on managing costs and a commitment to drive efficiencies in best-in-class automation as well as diversification of its product lines into adjacent sectors. Defense business experienced continued softness in Q2 of 2024 across the product portfolio as sourcing delays with key customers continue. However, the recent delivery orders on CBRN products as well as the Bandolier award are expected to provide increased momentum into the second half of 2024 and well into 2025.

As previously communicated, the company's long-term priorities remain as follows: Growing the core Rubber Solutions segment by emphasizing Rubber Compounding as the core driver for sustainable growth and productivity, focusing on innovation and customer over compounding while aiming to expand market share through organic and inorganic means, while striving to achieve enhanced diversification by broadening our product breadth through technological advancements and investments in specialty compound niches.

Secondly, manufactured products growth strategy will be focused on diversifying and expanding its range of rubber molded products while simultaneously narrowing the range of defense products through a renewed focus on core competencies. And thirdly, the undertaking of a strategic review of all product lines currently manufactured and sold by the company in its manufactured products segment, while targeting additional acquisition opportunities with a focus on adding new compounds and products technical capabilities and geographic reach into selected North American and international markets.

AirBoss continues to focus on these long-term priorities while investing in core areas of the business to expand a solid foundation that will support long-term growth.

I will now pass the call over to Frank for the financial review. Frank?

[Frank Ientile, executive]

Thanks, Chris, and good morning, everyone. As a reminder, all dollar amounts presented today are in U.S. dollars. Percentage changes compared to Q2 of 2024 to Q2 of 2023, unless otherwise noted. I also want to remind you that AirBoss now reports results under 2 segments: AirBoss Rubber Solutions; and AirBoss Manufactured Products.

To be respectful of your time today, I will be brief in my summary of our Q2 2024 results. Starting from the top line, AirBoss's consolidated net sales for Q2 2024 were $95.4 million, a decrease of 16.4% from the prior year due to lower sales of manufactured products in addition to lower volumes at Rubber Solutions. Consolidated gross profit for Q2 2024 decreased by $9.1 million to $8.5 million compared with Q2 2023. This was driven by decreased volume at manufactured products and specifically in the defense business, with additional softness experienced with the rubber molded products operations, along with a $6 million glove and gown inventory write-down.

Turning now to our individual segments. Net sales in the Rubber Solutions segment for Q2 of 2024 were $59 million, a decrease of 13.1% compared to Q2 of 2023. Rubber Solutions experienced a volume decrease of 20.2% with declines in most sectors. Tolling volume was down 82.7%, while non-tolling volume was down 12.3%. Gross profit within Rubber Solutions for Q2 of 2024 was $10.3 million, which was consistent with Q2 of 2023. This gross profit remained in line with prior year, primarily due to margin expansion strategies, product mix, management of controllable overhead costs and continuous improvement initiatives.

At manufactured products, net sales for Q2 of 2024 were $40.7 million, a decrease of 22.7% compared to Q2 of 2023. The decline was across most product lines. Specifically, the defense product lines experienced continued softness in the rubber molded products business had lower volumes in SUV and light truck platforms, driven by economic headwinds and increased vehicle inventories, which impacted production schedules across certain OEMs and Tier 1 suppliers in the quarter.

Gross profit within manufactured products for Q2 of 2024 was a loss of $1.8 million compared to $7.3 million in Q2 of 2023. The decrease was primarily the result of a $6 million inventory write-down related to the inventory of nitrile gloves and medical gowns. Cash from operating activities during Q2 of 2024 was $11.1 million compared to $16.9 million from Q2 of 2023. During Q2 of 2024, the company invested $3.6 million in capital equipment versus $2 million in Q2 of 2023.

The capital expenditures were related to growth initiatives and maintaining existing plant and equipment. By the end of Q2 of 2024, our net debt balance was $92.6 million versus $88.2 million at the end of Q4 of 2023. We expect to fund the company's 2024 operating cash requirements, including working capital investments capital expenditures and scheduled debt repayments from cash on hand, cash flow from operations and committed borrowing capacity. Our current revolving credit facility provides financing up to $150 million. At the end of Q2 2024, $111.8 million was drawn against the credit facility.

With that, I now turn the call over to Chris.

[Chris Bitsakakis, executive]

Thank you, Frank. Operator, at this point, we can open the line for Q&A.

[Operator]

[Operator Instructions] Our first question comes from Ahmed Abdullah with National Bank of Canada.

[Ahmed Abdullah, analyst]

On the ARS volumes, you mentioned in your remarks that some inventory reductions and destocking at customers, that's specifically for ARS. Any visibility on how long that destocking can last? Is there an overhang that you see progressing throughout 2024?

[Chris Bitsakakis, executive]

Yes. No, in fact, if I'm understanding the question correctly, it's kind of the opposite, Ahmed. What we're seeing now is with the softness in the industrial base in the U.S., our key legacy customers that were ordering truckloads of material, keeping inventory and ordering ahead so that they could turn around orders that they got from their end customers quicker are now ordering significantly smaller quantities and turning them over quicker. .

So my suspicion is, and what I expect for the balance of 2024 is really related to what the overall economy is going to do in the U.S. as the economy turns as interest rates come down and we're starting to see some indication of that through vehicle sales and other indicators that we have. As that happens, we expect our customers to then start building up their inventories again as they go forward.

The timing of that, I'm not sure exactly, but I'd say it's going to happen fairly quickly once the economy starts to generate more traction. They'll start ordering the larger quantities. They'll start stocking their inventory because it's going to become important to them that they turn around the new incoming orders quicker, sooner rather than later.

[Ahmed Abdullah, analyst]

Okay. So it's not a destocking issue that's -- in terms of how much inventory is already in the channels.

[Chris Bitsakakis, executive]

No. If nothing else, they'll probably stay as they are now until the economy starts to show some better signs of life, and then there will probably be a more aggressive restocking. .

[Ahmed Abdullah, analyst]

Okay. Perfect. And in the instance that volume pressure continues, do you have more room for cost cutting in the ARS business to be able to continue the margin expansion trend that we've been seeing in the segment?

[Chris Bitsakakis, executive]

We have a very aggressive continuous improvement plan. We have installed some new automation as an example in one of our facilities in the U.S. that hasn't started to generate the improvement yet. So we see that as some upside on the margin side there.

However, product mix will have a fairly significant impact on that as well. As we saw in July, for example, some shutdowns taken from customers that were on the higher end of the margin spectrum. We see that coming back around in August and September. So we expect some level of recovery. But I think the answer to your question is, yes.

We still have ideas that we are implementing in our continuous improvement plan. For example, we've seen conversion costs come down in Q2. And we have additional improvements coming in Q3 and Q4, which will continue reducing our conversion cost. However, like I said earlier, product mix, will have some sort of play in that equation as well.

[Ahmed Abdullah, analyst]

Okay. And finally for me, just a modeling question. it's good to see that the Bandolier order is starting deliveries. Should we think about this to be equally divided over the next 18 months, or is it all going to come in 1 quarter versus the other? How should we think about it from a modeling perspective?

[Chris Bitsakakis, executive]

I think you're going to see a ramp up to about Q4 and Q1 of next year and then some stability at that level for the balance 2025. I don't know, Frank, if you have another...

[Frank Ientile, executive]

No, that's about right. There will be a ramp-up over the next couple of quarters, and then it will be more of a steady state through the end of the delivery period.

[Chris Bitsakakis, executive]

Probably by late Q4 and early Q1, we will be at that steady state. .

[Operator]

And the next question comes from Adam Schneider with Cormark Securities.

[Adam Schneider, analyst]

I'm just filling in for David today. My first question is, do you guys still have any inventory write-downs relating to the gloves and gowns?

[Chris Bitsakakis, executive]

Adam, at this point, we believe the net real level volume is at market and they're priced to move. So we don't anticipate any further reductions at this point.

[Adam Schneider, analyst]

Okay. Great. And just another question. What caused the margin strength in ARS? Was it mostly mix? Or are they being more disciplined on contracts?

[Chris Bitsakakis, executive]

I think it's a combination of things. Product mix, certainly, a couple of years ago, we announced that we were driving towards more specialty compounding, and that drove our acquisition of as elastomer as an example. But within the traditional ARS plants outside of Ace Elastomer, we've made a conscious effort to drive more into specialty higher-end compounding.

And as the tolling volumes have decreased, we've been able to fill some of that volume with that exact type of product line, which is our evolution towards that, and you see that in the margins going forward.

[Adam Schneider, analyst]

Okay. Great. And just one more quickly. Do you see any -- you might have touched on this already, but do you see any early signs of recovery in ARS volumes?

[Chris Bitsakakis, executive]

We anticipate recovery in ARS volumes to be very closely linked to the overall improvement in the U.S. industrial base. So there's a lot of people out there that are predicting interest rates dropping and driving some recovery. We haven't seen that year-to-date as yet, but we are optimistic that in the fall as interest rates dropped further, we will see a recovery in the industrial base, which will have a direct impact on the legacy customers of ARS.

Just as one small example of that, we're seeing a reduction of about 2.5% on the sale price of the vehicles in North America. So there are more incentives out there. Interest rates are starting to drop, and we expect them to drop more come the fall. And when you factor that into vehicle sales, which impacts our AEP product lines on the automotive side as well as the overall industrial base, around June time frame, the sales rate was at about 15.3 million vehicles in the U.S.

Today, it's sort of about 16.1 million vehicles annualized. So we see the signs that there is starting to be a turnaround in these areas, but we expect that to be a little bit more prominent and show up at ARS later this year as interest rates start to drop.

[Operator]

And the next question comes from Kevin Chiang with CIBC.

[Kevin Chiang, analyst]

Just back on the inventory comment, you do note in your inventory note that you have an agreement to sell the remaining inventory of nitrile gloves at book value. Just trying to get a sense of -- it sounds like you have a sales agreement in place, so the risk of this not moving is low, so if you can confirm that.

And then secondly, what that might imply for margins in AMP? Or how should we think -- how should we be thinking about the flow-through of this inventory onto AMP margins in near term? I suspect it would be just optically dilutive just as you kind of [ rid ] yourself off this inventory. Am I correct on that as well?

[Frank Ientile, executive]

Kevin, this is Frank. Yes, to answer your question, we have a steady flow of sales now, and we estimate the consumption to occur between now through the Q1 of 2025. And to your point, it will be more of a cash flow infusion on the conversion, but obviously, not realizing margin from that perspective, as you've said.

[Kevin Chiang, analyst]

Okay. And do you expect to get through most of this, I don't know, in the back half of this year in Q3? Or is the timing hard to call?

[Frank Ientile, executive]

I'd suggest right now that it would be sort of steady between Q3, right through to Q1 of 2025 sort of evenly distributed.

[Kevin Chiang, analyst]

Okay. That's helpful. Chris, you highlighted the challenging macro, which is a common theme. We've heard from other industrial exposed companies we cover. Just wondering what that means for the M&A pipeline. I know that might not be free cash flow priority in the immediate near term. But I have to imagine that some of these smaller players are probably suffering as well.

And just wondering what that means for -- in terms of what you're seeing on the M&A pipeline, in terms of seller interest, in terms of maybe valuations. Are those becoming a little bit more tempered here just as the market kind of transitions into maybe a slower economic growth period here?

[Chris Bitsakakis, executive]

Yes. We are certainly seeing more opportunities start to rise, particularly in some of the smaller players. And some of them are interesting. We're keeping an eye on that. And as you know, Kevin, we're trying to keep a very close eye on our long-term strategy.

And as we look at a potential nonorganic move, this is probably not a bad time to be able to look for opportunities that otherwise wouldn't exist. And so we are keeping a close eye on that. We have seen more pop up now than we have in the past. And certainly, we are poised to make sure that we're in a position to take advantage if the right opportunity comes around.

[Kevin Chiang, analyst]

Yes. That kind of makes sense. And maybe just last one for me. Tolling volumes down almost 83%, non-tolling down 12%. I guess how much of this is just, I'll call it, macro headwinds? Are you seeing share shift in terms of potential competitors acting irrationally? Or like, for example, the tolling volumes being down this much. Is that just -- that's getting insourced, and you're not really seeing a ton of share shift as maybe some players looked at irrationally in this tougher market.

[Chris Bitsakakis, executive]

Yes. No, we're not seeing a ton of share shift. We're seeing, in fact, probably more the other way, where we're gaining here and there, and we're continuing down that path as we're onboarding new customers. But yes, more of a general macro thing, particularly on the tolling side. When the big tire companies have open capacity, they insource everything. And when the economy is really hot and they don't have open capacity, they outsource a lot more. A lot of the key higher -- more technically important compounds that we do for our tire customers, we're still doing them.

But the massive tolling volumes only happen when they were running out of capacity. And right now, and particularly a lot of their capacity is tied to vehicle sales, as you can imagine, Tier 1 sales, in addition to trucking volumes. So when you see trucking volumes increase, when you see the sales volumes and the OEM increase, then generally speaking, the tire companies start to run at the capacity and that's where they overflow significant volumes of tolling opportunities towards us.

The good news here, I guess, if you want to look at it this way, and it's evident in our margin profile. The good news here is we're still doing a pretty good job, driving our strategy towards higher end, more specialty-type compounding, which is also more stable and it doesn't kind of flow in and out. And at the same time, we've implemented significant continuous improvement opportunities, which show in our conversion cost reduction in Q2 over Q1, and we're continuing that path in Q3.

So when you put all those together and then the tolling volume comes back, well, then that's a pretty nice filler to absorb some overhead, make a little bit of money and drive that forward. So I think we can -- with all the improvements that we're making, when some of that tolling volume comes back, we'll be able to convert even better on it.

So I think that's kind of the way we're looking at it. What we can't predict is when that overall macroeconomic climate starts to improve. But certainly, we're seeing signs of it now. And we're hopeful that with some additional interest rate cuts, we'll be able to demonstrate that in our numbers later this year and early next year.

[Operator]

This concludes the question-and-answer session. I would like to turn the conference back over to Chris Bitsakakis for any closing remarks.

[Chris Bitsakakis, executive]

Thank you, operator, and thanks, everyone, for attending today's call. Please feel free to reach out to us directly or through our Investor Relations team if you have any questions on our results or anything in general. Thank you again, and have a great rest of your day.

[Operator]

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