AirBoss of America Corp

TSX:BOS

Earnings Call Transcript 2017-Q4

[Operator]

Good morning, and welcome to the AirBoss of America Q4 results. I would now like to turn the meeting over to Mr. Gren Schoch, Chief Executive Officer of AirBoss of America. Please go ahead.

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

Good morning, everybody, and thank you for joining this conference call. I'm 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 I'd like to introduce for the first time, Chris Bitsakakis, who has recently joined [indiscernible] [ Compliance. ]We will give a summary of results, and then the conference lines will be opened up for questions.Before we begin, I would like to remind you that today's remarks, including management's outlook for fiscal 2018, anticipated financial and operating results, our plans and objectives and our answers to your questions will contain forward-looking statements within the meaning of applicable securities laws. These forward-looking statements represent our expectations as of today, and accordingly, are subject to change. Such statements are based on the current assumptions that may or may not materialize and are subject to a number of important risks and uncertainties. Actual results may differ materially, and listeners are cautioned not to place undue reliance on these forward-looking statements. A description of the risks that may affect future results is contained in our annual MD&A, which is available on our corporate website and in our filings with SEDAR.And now I'll turn this over to Lisa, who is our President, for the highlights of the quarter. And after she's done that, we will open up for questions.

[Lisa R. Swartzman, President]

Thanks, Gren. Good morning, everyone, and thank you for joining us.During the fourth quarter, we largely resumed the momentum we had started to build in the first half of 2017, with a significant improvement over our performance in the fourth quarter of 2016.On a consolidated basis, EBITDA in the fourth quarter improved 59% over Q4 2016 to $6.8 million and EPS improved to $0.16 versus $0.06 last year.On a year-to-date basis, consolidated EBITDA was $27.7 million, a 6.7% decrease versus the full year in 2016, and EPS was $0.54 versus $0.59. Included in these results is an approximately $950,000 pickup as a result of the changes in December to the U.S. Tax Act, which reduced U.S. corporate tax rates.We are very pleased to have entered into 2018 with strong pipelines and opportunities in most of our businesses, combined with a strengthened senior management team across all of our businesses and an experienced workforce, both of which are committed to growth, quality, customer satisfaction and profitability.In Rubber Solutions, volume increased approximately 15% in the fourth quarter and about 7% for the full year versus the respective periods in 2016. For the year, these improvements were driven primarily by improvements in our off-the-road infrastructure, [ truck ] and mining sectors, along with the pickup in the fourth quarter in conveyor belting and were partially offset by softness in the chemicals and solid tire sectors.As a result, in the fourth quarter, gross profit dollars improved 11% to $5 million, and EBITDA dollars improved 5% to $4 million.For the full year, however, both gross profit dollars and EBITDA dollars declined marginally to $19.6 million and $16.6 million respectively. The environment remained highly competitive and the volatility in raw material prices we have been experiencing throughout the year continued. We do not see either of these phenomenons dissipating and have and will continue to develop proactive programs in responses to protect our market position and profitability.Last quarter, I mentioned that while our business development pipeline is the most robust and diversified in our history, moving these opportunities through the various development trial and ramp-up stages has strained some of our resources, highlighting certain areas and processes that require attention and some adjustments to how we do things to improve our efficiency.We have started to make good progress on this, and with Chris Bitsakakis' feet firmly on the ground now, we expect this to continue.In Engineered Products, on a year-over-year basis, net sales in the fourth quarter increased approximately 12% to $43 million and were essentially flat on a year-to-date basis at $164.4 million, driven by increases in the defense business, which offset declines in the Automotive business.For the fourth quarter, gross profit improved approximately 45% and EBITDA more than doubled with strong gains in the defense business, more than offsetting declines in the Automotive business. On a full year basis, however, gross profit and EBITDA declined 5.7% and 10%, respectively, versus 2016.In Automotive, net sales continued to be negatively impacted by the previously disclosed completion of a larger muffler hanger program in the second half of 2016 as well as specification changes in certain of our bushing and boot programs. These declines continued to be partially offset by increased demand in damper and induction bonding applications.In the fourth quarter, we did not achieve the improvements we have targeted and have instituted several remedial action plans, focusing on operations and driving a concentrated effort to ensure rapid response engineering and manufacturing to meet escalating industry standards and improve our profitability.We expect to see incremental improvements from this as the year progresses. And with the new talent that we've added in the areas of marketing business development, engineering and operations, we're focused on developing proactive strategies to win new multiyear contracts to replace programs that have expired or nearing the end of their platform life cycle.Defense had a very strong quarter with net sales more than doubling, and even more significant improvements in gross margin and gross profit and EBITDA dollars versus 2016, driven by increases across all of our major product lines. And for the full year, net sales increased approximately 45%, again with even more significant improvements in gross profit and EBITDA dollars.We are now at full rate production volumes and delivery schedule on a previously delayed filter contract and have received additional, albeit small volume orders from a large foreign military for our new low burden gas mask.Global defense tender activity as well as inbound inquiries has accelerated in recent months as part of an apparent increased emphasis on military preparedness by both the U.S. and their allies.Looking forward, our pipeline remains strong, and the business is positioned to deliver strong growth this year.In 2018, our focus is to maximize top line growth and optimize capacity utilization, particularly in Rubber Solutions and in the defense business within Engineered Products, and an operational execution and efficiencies to ensure we have the platform in place to pursue the opportunities before us.The addition of Chris Bitsakakis in the COO role will enable us to implement consistent best-practice processes across our manufacturing facilities and enhance our ability to execute our strategic initiatives at the operational level.Our financial condition remains strong, and we are well positioned to continue making the required investments in resources, technology and capital expenditures to support innovation, improve operational efficiencies, while maintaining the capacity to execute on potential acquisitions.I'll now turn it back to Gren.

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

Thank you, Lisa. I will now open it up to the floor for questions. Operator? Nony?

[Operator]

[Operator Instructions] The first question is from Scott Fromson of CIBC.

[Scott Douglas Fromson]

Just wondered if you can give some detail on the operations' improvement initiatives at Flexible Products, please?

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

I'll let Chris answer that.

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

Sure. There's a few initiatives that we're rolling out and we have started rolling out since last December at AFP. We're rolling out the implementation of what we're calling the AirBoss Operating System, which is an operating system based on the Toyota production system. And we're making sure that we have senior leadership visibility on the plant floor, [indiscernible] problems to the surface and accelerating the action plans to take care of each of these issues as they arise. In addition to that, we've developed and are executing on a standardized and formal continuous improvement program, where we are identifying, through a pareto analysis, the top issues that are negatively affecting the financial performance at Flexible, and we're identifying and going after those issues expeditiously through a team process. And with those 2 initiatives, we have already started to see some significant labor improvements, the labor efficiency improvements, and we believe that those will continue on going throughout the year.

[Scott Douglas Fromson]

Can you talk about what personnel changes this involves? And can you talk about some of the fixed costs, please?

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

I can tell you that, prior to my arrival, we had ready put in new talent in both the engineering group and in the sales department. And those individuals are doing quite well in terms of developing a longer-term view as to how we start to bring Flexible to sort of a higher-end product line so that we can command better margins. In addition to that, we made a change in December with our VP of Operations in that business, and we have now brought on an experienced VP of Operations who knows the product line and the process categories quite well. He has hit the ground running, and he has made a good addition to help execute on the initiatives to reduce scrap, improve efficiency and all the key items that we're working on.

[Operator]

The following question is from Shawn Levine of TD Securities.

[Shawn Levine, Associate]

Couple of questions here. First, I was just wondering if you can comment on the dynamics in the raw materials market and AirBoss' ability to pass on changes in raw materials prices to customers.

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

We're seeing, definitely, an upward trend in a lot of the raw materials that we are buying for the Rubber Solutions side. Oil, carbon black and polymers and some small chemicals as well. We have a process where these increases are passed on to our customers, and so we do a review of what the increases are, and then our sales team brings those price increases to our customers to make sure that we're not absorbing the brunt of the raw material increases.

[Shawn Levine, Associate]

I think last quarter, Lisa highlighted some of the, perhaps, nonrecurring or nonpersistent factors that accounted for the changes in raw materials prices. I'm just wondering if you're seeing any of those kind of headwinds abate.

[Lisa R. Swartzman, President]

I think what you're talking about in the last quarter was, if I'm not mistaken, is a couple of issues that happened as a result of some interruptions in supply chain, not just to AirBoss but to the entire industry, that resulted from a couple of things. One was the hurricane that was in Texas, which impacted the supply of carbon black briefly. And then, also there were some instances in China. One was a fire at a factory, but the other thing that was impacting things were the -- was more of a crackdown on the environmental issues in China related to chemical production. And some of our major suppliers, they are setting up shop in Mongolia and other sort of Asian countries. And so I'd say carbon black is no longer affected by weather, but there is, obviously, with the economy picking up, there is increased demand for it. And Chris can probably speak a little bit better on where things are going with chemicals. I don't think we're having an issue, but there is some transition as some of those suppliers set up shop in other locations.

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

I think the issues that Lisa mentioned were onetime things that happened in the last quarter and the quarter before, but the -- what we're seeing now is pretty significant sustained commodity price inflation. And raw material costs are probably up close to 20% year-over-year, and it doesn't look like it's -- doesn't look like that, that trend is stopping. The only one which is somewhat volatile is oil, but everything else, particularly carbon black and rubber seem to be experiencing pretty good inflation.

[Shawn Levine, Associate]

Okay, that's helpful. The defense pipeline was characterized as being robust and momentum continues to grow there. I'm just wondering if there is any particular geographies or product lines that are seeing the bulk of that tendering activity.

[Lisa R. Swartzman, President]

We are -- I mean, we're obviously a bit sensitive, just given the confidential nature of a lot of these things. If you read the news though, and you take a look at who's meeting who in the next little while and what's going on in Europe, there is a number of tensions that are growing over there. And so what we are seeing is continued, obviously, demand for our regular product, our boots, our gloves, and a pickup in our extreme cold weather boots, given the terrain there. And given some of the other, I guess, concerns about chemical use on civilians, we are seeing a pickup in our shelter business as well and a lot of interest on that side.

[Shawn Levine, Associate]

Okay. Another question here. On the cash flow priorities over the kind of near- to medium term, how do you guys weigh organic growth versus growth via acquisition? And then assuming there aren't any organic or acquisition-related growth opportunities, how would you weigh dividend growth versus buybacks?

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

Obviously, if we had a preference, we would do organic growth. But our history is of making strategic acquisitions that are relatively small and growing them organically, fairly dramatically once we buy them. So we are aggressively looking for acquisitions as always. And you have to be patient, you have to be diligent and you must not pay too much. But if you make the right ones, they can pay off. I mean, I think I told the market when we bought IRT 3 years ago that it was -- or 2015, we bought it, I told everybody that this was not an instant success story that we were buying it -- that we were buying it to position ourself for the future. And we struggled for the first 2 years with that, and I think we're just now starting to see how that is going to pay off. And if things continue as they look like they will, that will be a very, very good acquisition for us. Flexible Products was probably a little more successful immediately, but we are now going through the trouble that you have to go through to set it up for large organic growth in the future. In terms of share buyback versus dividends, we have done a bit of both. We've had constant dividend growth over the last 10 years and significant dividend growth. The share buyback bit has been a little more sporadic. The shares are relatively illiquid. It's there to provide a mechanism for us to make acquisitions of shares that the market conditions result in a big bulk of stock coming available that there's no other buyer for. I don't know if I answered your question or not.

[Shawn Levine, Associate]

Yes, that's helpful. And finally, just a housekeeping question. Given the changes in U.S. tax rates, what would be a good effective tax rate to use for 2018 and going forward?

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

So Shawn, for our modeling purposes, we're using 26.5% for consolidated effective tax rate.

[Operator]

The following question is from Neil Linsdell of Industrial Alliance.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Just on the -- you mentioned with your balance sheet strength, you do have the option to -- or the capacity to do some acquisitions. Could you -- it's always a sensitive question, I realize, but do you have specific areas, maybe, in the ancillary markets that you've talked about before or geographically or product lines where you could see either the most value to your entire platform or where you're seeing opportunities?

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

We have areas that we are focusing on that we would like to make acquisitions, and if they come around, I don't want to say specifically anything that we're working on right now, but we are looking -- I have said in the past, we're looking for acquisitions which would be complementary to Flexible's business; and also, the Rubber Compounding business is becoming a much broader business than it ever has in the past, and we're getting into new polymers and new product lines. And the end is the strongest that we have seen for a while now. So we need to start looking at our capacity in the future. So that could be organic, through the addition of new equipment or that could be through strategic acquisitions that fit geographically or product-wise with us.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Okay. And within the capacity on the rubber side of the business, I think last quarter you were talking about some trials that you were doing with at least one of your large customers had, I think, the word was enormous potential, if you went to full volumes. Can you give any kind of update on how these types of discussions or trials are going?

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

I'll let Chris answer that.

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

The conversations with this customer are going quite well. We are in the approval process in 2 of our facilities, one in Canada and one in the U.S. And as this process continues on, we think there is some upside potential this year, but it depends a lot on the approval process at this tire manufacturer, and it takes quite a long to get everything approved, but so far we're pretty pleased with the progress that we're making.

[Neil Linsdell, Head of Research & Equity Research Analyst]

And I think, under full capacity, you'd actually be running up to the high end of your capacity to -- capacity utilization within your facilities, right?

[Lisa R. Swartzman, President]

Well, I think that's why we're looking at sort of putting it through. And this is sort of just to further the integration strategy that we did with our previous Rubber Compounding and industrial products businesses, where utilizing the various facilities and geographies that we have, it will still take up an enormous amount of capacity, but at least spreading it out amongst the 2 or 3 of them will help mitigate some of that. And then, of course, some of the other work that Chris is doing, that's realigning the way that we move things through the facilities to create efficiencies and shorten our mixing times will help a bit with that. And if necessary, it's one of those things that we would look at, whether there's capital expenditures required to expand our capacity.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Okay, well, that would be good. On the auto program, so I know you talked about ramping up some activity at the end of 2018 for 2019, 2020 model years under programs that you are in discussion with now. Are these contracts programs that are -- you've got a full lock on? And is there any kind of additional, I guess, startup costs or expenses that we should be thinking about as far as...

[Lisa R. Swartzman, President]

[ Very big. ]

[Neil Linsdell, Head of Research & Equity Research Analyst]

Sorry?

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

I think I understand your question. We do have a ramp-up of the DT program, which is the new ramp truck. It is starting -- the start of production is April of '18, but, of course, the production will ramp up quite significantly towards the end of 2018. So depending on how that truck is received in the market, there could be some good upside potential from that.

[Neil Linsdell, Head of Research & Equity Research Analyst]

And should we expect it to increase expenses between now and then on ramp-up or margin pressure? Anything like that?

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

Any time you launch a program, there are certainly launch costs involved that we've anticipated. And at this point in time, it looks like we are close to what those anticipated launch costs should be. And so as we get into Q3, we'll know better if anything arises that was unexpected. But at this point in time, it looks like we're on track for the launch costs we expected.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Okay. And then, just finally, on the defense side, obviously, there's -- it sounds like the pipeline is up significantly. Can you talk about the difference between the pipeline that you're looking at, the opportunities you're in discussion with and the deliveries that you're expecting through this calendar year?

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

The -- if we don't get any more orders for this year, we will probably have the second best year in defense. We are -- I think it's very likely that we will get more orders for existing products this year. Of course, our 2 big gas mask contracts still haven't been awarded, and they will be for next year. Some of the new business, which has come in for some of our historical products that we have installed too much of in the last couple years, is multiyear business. So the pipeline for next year is quite a bit stronger than it was for this year, at this time last year. So that business is -- has definitely turned and is accelerating.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Okay. And 2009 (sic) [ 2019 ], you see even more potential than the growth that we've seen in 2017 and this year for delivery...

[Lisa R. Swartzman, President]

There is a number of large-scale tenders that are expected to come out at the end of this year. So a lot of the products and sort of deliveries that we're working on this year will continue into 2019 as well. And then, should those tenders be awarded at the time line -- on time -- on their time line, then production for those and delivery for those would also start in 2019.

[Operator]

The following question is from Ben Jekic of GMP Securities.

[Ben Jekic]

I have 2 relatively housekeeping questions, and then one more conceptual. So the one -- first question is, could you remind us the delayed defense contract that's now shipping? What is that referring to?

[Lisa R. Swartzman, President]

Not really because it's confidential.

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

I think, well, there's also the filter one. The filters was the one that was delayed by 1 year, that we started producing in September. So the -- we had a large multiyear filter contract that, if you recall, was supposed to start 2 years ago.

[Ben Jekic]

And you had testing -- retesting?

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

We had to redesign it, yes.

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

So that just started in -- that just started first production in September and is still ramping up, but is running at a pretty good capacity right now.

[Ben Jekic]

Okay, that's good. And the second question is on CapEx. What should we model for the coming 2 years? Should it be higher or significantly higher than 2017? Or...

[Lisa R. Swartzman, President]

I would anticipate yes. So 2017 was slightly above 2016. I think, for a couple of reasons. Number one, we are putting in a new ERP system, which will be kicking off later this year in sort of more earnest, so there will be some on that front. But then, I think as well with some of the -- both organic and -- growth that we're were talking about in the areas that we're focused on where we've been doing some mixing in, but in terms of higher-end polymers and different colored rubbers and things like that, we, in the absence of finding an appropriate target to acquire, I think that we will get to a point where we need to add in more specialized equipment that handles it better than our current equipment does.

[Ben Jekic]

Okay, that's great. And then, the third question is, I just want to make sure I put it sort of succinctly. With regards to the Automotive business, I mean, when you bought these businesses, as Gren said, it really started quite strong off the bat. But you always, I think, gave an impression that your vision was for something a lot better and with a lot higher margin. And I think that theme on trying to kind of spruce up that operation has been ongoing for several years. Now it seems like you are at the point where that is really accelerating. So I guess, my first question in this -- on this topic is, is it a question of what the operation was lacking? Or is it a question of the growth in 2019 is so strong that we have to sort of prepare?

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

No, look, I think it to be blunt about what happened, Ben, is that before we bought it, they focused very, very heavily on sales. And they had grown quite massively. They had grown from $50 million in sales to about $107 million or $108 million when we bought them. They had a pretty good pipeline. And they -- very soon after we bought them, the sales grew to $140 million, I think, at the peak. The problem was that they were so stretched internally in trying to launch and deal with all those sales that they stopped selling. And the processes and systems that need to be in place to run a $140 million business just weren't there. They were there -- it was run, basically, by the seat of your pants, as a $50 million business. The right discipline and manufacturing that's required to grow from $140 million was not there, and that is what Chris is struggling to put in place. Additionally, because they -- the engineers stopped selling for a few years just trying to deal with the rapid growth that they had experienced. As you know in Automotive, it's 2 to 4 years from sales to getting business awarded, so we're now experiencing that trough, if you want, of new business. That, coupled plus -- with the fact that there haven't been a lot of new models introduced in the last year has resulted in the top line not growing. So what -- we are fixing all those problems. As Chris mentioned, we've got a new sales team in there, we have a strong new VP of Engineering and they've been -- I think that part of the business is much stronger than it's ever been. The manufacturings part of the business still is not close to where we want it to be. And although we are -- now with the new people involved and with Chris here, we're already seeing some improvements. So I think, don't expect any top line growth there, really, for '18. Maybe some in '19, but not for '18. Hopefully, operational efficiencies will improve the EBITDA for this year there.

[Ben Jekic]

Okay. And then, are you -- I mean, we've been there not so long ago, and your R&D pipeline seems very encouraging. Is there any effort to accelerate that? Or is that part of the operations, something that you're pleased with?

[Lisa R. Swartzman, President]

In which business?

[Ben Jekic]

In the Automotive.

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

No, I think -- okay, directionally -- I'll let Chris talk a little more about this, but directionally, we want to move the business from more of the low-tech shoot-and-ship products to more complex, value-added Engineered Products. And I'll let Chris say a few words on that.

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

Yes, what we're trying to do is, we've put together a fairly aggressive product development strategy that looks at taking our lower-end products that are more susceptible to commodity-type pressure and bringing them upscale to more highly engineered type products. So moving away from, let's say, muffler hangers and more into steer-and-gear bushings and that sort of thing is the direction that we're taking. We've had some very good success with several partners, talking to them about our unique design ideas. And as Gren mentioned, on the Automotive cycle, it doesn't happen overnight. But I think we have a good strategy, and so far, the customers that we've been talking to about some of these ideas have been very receptive. So I think we're on the right track to taking that product line and over the next few years moving up that curve in terms of a little bit more higher technical development required versus just shoot-and-ship.

[Operator]

The following question is from Maggie MacDougall of Cormark.

[Maggie Anne MacDougall, Analyst of Institutional Equity Research]

Most of my questions have been answered. I just have one housekeeping item.

[Lisa R. Swartzman, President]

I like it like that.

[Maggie Anne MacDougall, Analyst of Institutional Equity Research]

Yes, so just on the tax in Q4, the rate was really low. And I'm assuming it has something to do with the remeasurement of your tax liabilities? Is that the case?

[Daniel Gagnon, Chief Financial Officer]

Yes, that is correct. The $966,000 that we disclosed is a onetime adjustment because of that U.S. tax reform.

[Maggie Anne MacDougall, Analyst of Institutional Equity Research]

Okay. And do you know what your earnings per share would've been in Q4 if you back that out?

[Daniel Gagnon, Chief Financial Officer]

It had about a $0.04 impact overall.

[Operator]

[Operator Instructions] The following question is from Scott Fromson of CIBC.

[Scott Douglas Fromson]

Just to follow up on working capital, so you saw a -- quite an increase in cash used to support working capital over the year. Have there been any changes in the way that you're managing receivables or payables?

[Daniel Gagnon, Chief Financial Officer]

No, not really. The big increase that we've seen in working capital was a couple of things. One is, with the increase in raw material prices that had an impact on both the receivables and the inventory going up as well as the increasing sales for the AR. And then in the defense business, as we saw the business picking up towards the end of year, we were ramping up for deliveries, so again, that had another impact on volume for the inventory. So we're not doing anything different. We haven't changed anything in our collection or our practice or our terms with payables. It's really the effect of the raw material prices and the increase in volume.

[Operator]

There are no further questions registered at this time. I'd like to turn the meeting back over to Mr. Schoch.

[Peter Grenville Schoch, Chairman and Chief Executive Officer]

Thank you all for attending. If there are no further questions, we will talk to you, I guess, pretty shortly after the Q1 results are up. Thank you.

[Operator]

Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.