AirBoss of America Corp

TSX:BOS

Earnings Call Transcript 2019-Q4

[Operator]

Good morning, and welcome to the AirBoss of America fourth quarter results. With us, we have Mr. Gren Schoch, Chief Executive Officer of AirBoss of America; Mr. Chris Bitsakakis, President and Chief Operating Officer; and 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 us for the AirBoss Q4 results conference call. I'm Gren Schoch, and I'm the Chairman and CEO of AirBoss. Here with me today are Chris Bitsakakis, President and COO; Daniel Gagnon, our CFO; and Chris Figel, Executive VP and General Counsel. In terms of an agenda, we'll take a few minutes to review some of the operational highlights of the quarter and year-end, and then briefly, the review of our strong financial results before opening the call to questions. Before we begin, I'd like to remind you that today's remarks, including management's outlook for 2020 and beyond, anticipated financial and operating results, plans 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' annual MD&A, which is available on our corporate website and our filings with the Canadian Securities Administrators on SEDAR at www.sedar.com. With that, I'll turn this over to our President, Chris Bitsakakis, to review a few of the operational highlights.

[Chris Bitsakakis, COO & President]

Thank you, Gren, and good morning, everyone. I want to start by saying how pleased we are with our results for the year. Two years ago, we began making substantive changes to how we operate our business. We strengthened our executive and operational management teams and began recruiting individuals with years of rubber compounding and processing experience, who also had a track record of driving growth through product engineering and development. In parallel, we focused heavily on implementing Lean and Six Sigma initiatives designed to drive efficiency, reduce waste and improve financial performance. In 2019, we began reaping the benefits of many of these changes where, in combination with solid growth in Rubber Solutions and our defense business, we saw consolidated net sales and EBITDA climb to record levels, reversing the downward trend we saw in EBITDA in 2017 and 2018. I want to take this opportunity to thank all of our employees who were instrumental in driving our improved financial performance this past year. Since 2016, our Rubber Solutions business has grown at a compounded annual growth rate of approximately 10% or at least twice the industry average, and we think this is strong evidence of the progress we are making in gaining market share from our competitors. Building on all the work we've done to improve the business over the last 24 months, in 2019, we invested heavily across the organization, recognizing that there are opportunities to grow in each of the business units. Across the AirBoss enterprise, we are positioning ourselves to make product and process innovation core drivers of our business growth. On that basis, a significant portion of the $19.5 million we put into CapEx in 2019 was focused on upgrading our technical capabilities while driving efficiency improvements and creating a culture of innovation through investment in R&D. We created a plan designed to develop and produce new, more technically advanced products and solutions and installed more advanced manufacturing technologies. Rather than review many of these initiatives again in specific detail, I'm going to focus my comments on how they will contribute to the overall vision for each business segment and the organization as a whole. Turning first to Rubber Solutions. The investment we made in the new R&D tech center is one that we undertook to ensure the AirBoss name is synonymous with innovation, technical sophistication and high quality. This facility will allow us to work collaboratively with customers and ensure that we are helping them meet an increasingly complex array of technical challenges. This laboratory will help facilitate the creation of new proprietary compounds, building on the more than 2,000 we produce today. Being able to develop new solutions is only one part of the equation. We also need to be able to manufacture them cost effectively and to a high standard. In addition to upgrading our existing high-volume black rubber lining Kitchener in 2019 with a state-of-the-art large volume mixer, we also added a new white/color mixing line and the tilt mixing line designed to facilitate our entry into selected specialty compounding markets. These investments will ensure that we have the right asset base to service existing customers beyond their traditional black rubber compounding needs, but also allow us to attract new customers looking for increasingly specialized solutions. Over the mid-to-longer term, we want to establish defensible leadership positions in a variety of specialized compounds where we can be the supplier of choice. This would be in addition to our higher volume black compounds, and although lower volume, these new compounds would ultimately help support better margins for AirBoss.There are a number of ways that we can target these niche products, including attracting and retaining the top rubber chemists in the world, developing these novel formulations internally and adding specialty manufacturing capacity as needed. We intend to supplement these organic initiatives by targeting acquisitions with the existing knowledge base, assets and customers that we can integrate into our operational structure that could also afford us the opportunity to expand our existing operational footprint into new geographies where we have a limited presence today. The focus on innovation also extends to the Engineered Products segment. We've spoken at length about the steps we are taking to improve the performance of this group. Following on the heels of operational and management changes that began in 2018, we entered into a dialogue with customers around the profitability of certain components as well as, more recently, the treatment of tariffs. In most cases, we were able to secure agreements that will offer some relief and better protect margins going forward. In 2019, we invested heavily in advanced manufacturing solutions, installing new molding equipment, which should significantly reduce cycle times. In addition to sourcing a light cell robotic work cell that will allow us to better allocate labor costs going forward. Most importantly and to better support future growth, we took the decision that we needed to better balance the contribution from the automotive space, by diversifying into adjacent sectors with specific antinoise, vibration and harshness requirements, by developing new products for the military, heavy truck, bus, construction, agriculture and recreational vehicle sectors. We believe we are well positioned to address some of the technical challenges these sectors are facing. And although these products may be lower volume than their automotive counterparts, they will involve a higher degree of technical sophistication and a more advanced raw material input, supporting higher margins.As an example, in 2019, we took a positive step in this regard, developing the ability to develop rubber-to-metal hybrid components with a hydraulic or liquid-filled element. This is an important step in advancing our anti-NVH offering up to technical scale and is consistent with our focus on innovation. In pursuit of further diversification of this business, we will also look to bolt-on acquisitions that deliver new products and enhance technical capabilities or create opportunities in new sectors. We recognize there's still work to do here, but we are encouraged by the progress we made in 2019.Turning briefly to the defense business. On January 1, 2020, we completed the transaction that saw the formation of the AirBoss Defense Group. Against the backdrop of a $750 billion budget request by the U.S. Department of Defense, significant global political instability and the specter of the emerging COVID-19 outbreak, we believe this business, built around a strong survivability platform, is well positioned to grow in the quarters and years ahead. Our strong results in 2019 were supported by deliveries against a number of the contracts we won late in 2018 and 2019, and we expect to continue to deliver against these in 2020. Likewise, ADG continues to build -- bid on hundreds of millions of dollars in tenders globally, while also working to identify and develop new products. As an example, exposure to blast overpressure is increasingly being recognized as a contributor to brain injury and PTSD and driving hundreds of millions of dollars in treatment costs as well as raising significant quality of life concerns for veterans.Blast Gauge is a wearable sensor that measures exposure to blast overpressure and uploads data to a soldier's file for assessment by staff physicians. The Blast Gauge is currently an advanced testing with the U.S. military and widespread rollout to translate into a significant source of recurring revenue for ADG. As with our other business segments, we will also continue to identify potential bolt-on acquisitions that offer new solutions for the defense and first-responder markets that can further expand our new survivability platform. Just before I turn the call over to Daniel, I want to briefly touch on the COVID-19 outbreak that continues to emerge around the world. AirBoss did not see any meaningful impact to its business in the fourth quarter of 2019. And to-date, we have not seen any significant impact in the first quarter of 2020. That said and given the high levels of uncertainty as to the global near- and longer-term impact of the virus, we have taken steps to minimize the impact to AirBoss and to our customers' businesses. Over the past month, our supply chain team has been working daily with our vendors to identify any supply exposure and secure alternate sources of raw materials, both domestically and internationally, to support the overall integrity of our supply chain should the outbreak continue for extended period of time. Additionally, in an effort to protect our employees, we have taken measures to limit travel for only essential purposes and to cancel all travel to global hotspots, while taking appropriate precautions with all visitors to our facilities. Our defense group has also been in contact with the World Health Organization and governments around the world in an effort to provide disease containment options through our patient transfer systems and mass decontamination shelters. In closing my prepared remarks, I want to reiterate that 2019 was an excellent year for AirBoss, marked by significantly improved financial results and targeted investment in our future growth. As a management team, we continue to focus on bringing innovation to every element of our operations and diversifying our product and solution offering. In parallel, we intend to grow our technical capabilities and expand our manufacturing capacity, all in the name of driving long-term profitable growth. As we focus on these key initiatives in the coming quarters and years, we are confident that we can build on the strong performance we delivered in 2019.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 that all dollar amounts presented are in U.S. currency except for dividends per share, which are in Canadian dollars. As Chris mentioned, we are pleased with the 2019 financial results, as we saw continued growth in our Rubber Solutions segment as well as in the defense business within the Engineered Products segment. On a consolidated basis, net sales increased by 12.1% to $85.8 million for the fourth quarter and increased by 3.6% to $328.1 million for the year versus prior year periods. Growth in the fourth quarter was primarily driven by the defense business within the Engineered Products segment, offset by a small reduction in net sales and Rubber Solutions with full year growth being driven by the defense business and the Rubber Solutions segment. The drop in the fourth quarter net sales in the Rubber Solutions business was due, in part, to the mix of tolling net sales, as I will explain shortly. Consolidated gross profit dollars grew by 28.5% in the quarter compared with the same period in 2018, with the improvement driven by the Rubber Solutions segment and the defense business within Engineered Products. Gross profit margins improved from 13.5% last year to 15.4%. For the full year period, consolidated gross profit dollars increased by 8.4% from the same period in 2018, with improvements in Rubber Solutions and the defense business within Engineered Products segment. Gross profit margin improved from 14.2% last year to 14.9% this year. Consolidated EBITDA improved by 54.1% to $8.8 million in the fourth quarter and 25% to $32.1 million in the full year period as a result of solid performance, like Rubber Solutions and growth in defense business. A portion of the EBITDA increase was also due to the settlement of an insurance claim, totaling $1.3 million, recovering costs incurred as a result of a fire in our Scotland Neck, North Carolina facility that occurred in Q1 2019 and a gain relating to the adoption of IFRS 16, which is a lease accounting of $2.1 million. These favorable impacts were partly offset by $1 million increase in professional costs associated with the AirBoss Defense Group transaction. After normalizing for these onetime items, full year EBITDA would have been $29.7 million, which is still ahead of last year's reported $25.7 million and EPS would have remained at $0.44 versus $0.37 reported last year, and this includes the $0.4 million in impairment charges related to that fire in Scotland Neck. Net income totaled $2.5 million in the fourth quarter, and that's up $1.3 million a year ago. And basic and fully diluted earnings per share were $0.11 compared to $0.06 last year. For the full year, net income totaled $10.2 million compared with $8.5 million last year. And basic diluted -- fully diluted net earnings per share were $0.44 versus $0.37 for 2019 and 2018, respectively. I'd like to point out that the basic and fully diluted earnings per share dropped $0.02 as a result of increased income tax expenses due to professional fees associated with the ADG transaction that were not deductible for tax purposes in 2019. This explains the effective tax rate growing to 43% and 33% for the fourth quarter and full periods, respectively, versus a statutory rate of approximately 26.5%. For modeling purposes, we would expect the tax rate to normalize back to the statutory rate of 26.5% through 2020.Turning briefly to the segmented data, fourth quarter net sales in Rubber Solutions segment decreased by 1.9% from last year. The decrease in net sales was in track and conveyor belt sectors. And these decreases were partly offset by increased demand in the mining sectors. Overall volumes, measured by pounds shipped, however, were higher, driven by a 49.4% increase in tolling volumes. And as a reminder, in tolling applications, we only realize net sales on the provision of compounding services for customer-supplied material, versus nontolling, where AirBoss also supplies the raw material inputs that are reflected in net sales. As such, net sales in isolation does not provide a complete picture of what's really happening in that business. Net sales to Rubber Solutions segment for the full year increased by 2.3% for the comparable period in 2018. The increase in net sales was principally the result of an 8.4% increase in volume and that was partially offset by a 3% decrease in raw material costs, where the savings were passed on to customers. The increased net sales was reflected across a number of sectors, but particularly the mining, tolling and defense sectors. Tolling volumes increased 24.7% compared to 2018, and nontolling volumes were up by 3.8%. Gross profit in Rubber Solutions for the fourth quarter increased by 0.6% and was 17.5% of net sales and that compares to 17% last year. For the 12-month period, gross profit increased by 15% and were 17.3% of net sales, and that's up from 15.4% a year ago. For 3 and 12 -- for the 4- and 12-month period, the increases were principally due to higher volume.Turning now to Engineered Products. Overall, the segment net sales were up 24.3% and 4.8%, respectively, for the fourth quarter and full year 2019 compared to 2018. For the 3- and 12-month periods, net sales in the anti-vibration business decreased by 4.7% and decreased by 3.4%, respectively, over the prior periods. And in defense, for the 3- and 12-month period, net sales increased by 115.5% and increased by 30.2%, respectively, over the prior periods. The increase for the fourth quarter and year were driven by gloves, boots and mask product lines, and in the face of the latter, we delivered the majority of the masks we hope to deliver in the fourth quarter, with some of the mask being delivered in the first quarter of 2020. Gross profit dollars in Engineered Products for the fourth quarter increased by 68.5% and were 14% of net sales versus 10.4% of net sales in 2018. The improvement reflected the increase in net sales in defense business and its favorable product mix. As Chris mentioned, we invested $19.5 million in the business this year, in line with our guidance and consistent with a focus on innovation across the organization. I would note that this number excludes leased assets. Including the leased assets, capital additions increased to $26.7 million. In 2020, we expect CapEx, excluding leases, to trend closer to historical depreciation levels. Turning to the balance sheet. Our balance sheet remains strong at the end of December 31, 2019, and I'd like to remind everyone that the term loan and other debt presented in the MD&A and financial statements includes $14.5 million related to the adoption of the new accounting standard, IFRS 16, which is discounting. In accordance with this new standard, leases were capitalized effective January 2019 and with no prior -- or no restatement to prior years. Excluding the impact of the new leases -- of the new lease accounting standard, our net debt to TTM EBITDA was at a healthy 1.85x at the end of the fourth quarter in 2019, and our credit facilities remain undrawn.Before opening the call to questions, I want to briefly highlight some of the reporting changes we expect to reflect in our Q1 2020 financial results. Following the closing of the transaction to create ADG on January 1, 2020, we will now be reporting 3 separate segments: Rubber Solutions will still be shown separately, but the industrial business in Acton Vale, Quebec, will now be presented with the newly created ADG segment. Also included in the ADG segment will be our defense business along with that of Critical Solutions International. Engineered Products segment will consists of our traditional antinoise vibration and harshness business. We will report the 2020 financials with restated prior years' data for comparative purposes. I would remind listeners that because we have a 55% ownership in the ADG segment going forward, earnings and retained earnings will reflect the allocation of the 45% minority interest to the owners of ADG and that AirBoss of America's bottom line will be impacted accordingly and only reflecting our 55% ownership interest in that segment. Operator, that concludes our prepared remarks this morning. We would now like to open the call to questions.

[Operator]

[Operator Instructions] Our first question comes from David Ocampo of Cormark Securities.

[David Ocampo, Analyst of Institutional Equity Research]

Chris, I appreciate your commentary on the Blast Gauge. But I was wondering if you can help frame that opportunity for us and kind of the expected time line of the testing phase?

[Chris Bitsakakis, COO & President]

Sure, the U.S. military is in advanced testing, as we speak. There are approximately 10,000 units in the field that are being tested, and they're accumulating data for the people that are wearing them. And as they're finalizing all of those tests and developing systems to accumulate data, we are also getting extra support as Congress has passed legislation, basically insisting that the military come back to Congress with a plan to make sure that they have a methodology to track all overpressure exposure for the soldiers that are in the field. So I think we're kind of in a perfect storm at this point where we have significant concern over PTSD. We have a product that really helps track this overpressure. We have documented clinical evidence that overpressure contributes to this type of condition. And we have the political system in the United States actually pushing the military to go faster on implementing this type of a solution. I don't expect 2020 for this to be a significant dollar figure for us, but we see every day an acceleration and the desire to get this going faster. So as we work with the government agencies, the Department of Defense, we'll know later on this year how quickly this thing could ramp up, but we are the single technology at this point that the government is in advanced testing with. And we feel pretty confident that we are going to see this start to grow fairly soon. The time line, I can't, at this point, commit exactly to yet, but we are beyond the testing phase -- beyond the initial testing phase and really in the longer-term trial at this point.

[David Ocampo, Analyst of Institutional Equity Research]

That's great. And kind of just to follow around the defense business. There was a huge step-up in revenue this quarter versus Q4 last year. Is this the expected run rate kind of excluding CSI for the next few quarters, kind of given all your contract wins last year? Or was there anything that kind of inflated it?

[Chris Bitsakakis, COO & President]

No. I mean what you saw in the fourth quarter was really the contracts that we were awarded in '18 and '19 starting to come to fruition. We are continuing to deliver on those orders going into 2020. And there are some products like the MALO award that we announced, that we actually haven't started delivering yet, that we'll begin delivering in April and May this year and continue throughout the year. So we -- some of the products that we are finishing shipments on are coming down to a more normalized level. There are other new products coming on that will advance our sales. So we expect to see several more quarters of fairly good results on those products.

[David Ocampo, Analyst of Institutional Equity Research]

That's great. And on Rubber Solutions here, can you guys provide an update -- sorry, go ahead, Gren.

[Peter Grenville Schoch, Chairman & CEO]

No, I was just going to say, as Daniel mentioned, our defense revenues going forward, starting with Q1, will include CSI.

[David Ocampo, Analyst of Institutional Equity Research]

Yes, sorry. And shifting gears to Rubber Solutions. Can you guys provide an update on the utilization of the new mixers? I know Scotland Neck would take a little bit longer to ramp up to speed, but any color on that would be great?

[Chris Bitsakakis, COO & President]

Yes. In Scotland Neck, the second mixer is operational, and it's running every day. It's not running 24/7, but we've already started filling the capacity. It will be a little bit longer term, but it's already showing us the importance in that region, as most of our existing and new customers in the region have already been in and qualified that second mixing line. We're already in advanced trials so -- and we're already in production on some products on that second mixing line. So that's progressing according to plan. But like you said, filling an entire big mixing line is not going to be done in a few months. It will take us a little bit of time, but certainly, we're showing that, that region requires that extra capacity for us. The color mixing line, as well, is right on track. We're close to 40% utilized on the color mixing line, and we still have lots of room to grow with lots of opportunities on the color mixing side. And our smaller specialty mixer just came online a few weeks ago, and already, we are in trials with specific customers for that line. So at this point, we don't have any production on it, but we are in the trial phase. So we are right on track with what we expected as these things ramp up. Again, they won't fill up overnight, but having that capability and having that asset base that allows us to attend to our customers' needs across all of the products that they require, is going to be definitely a long-term growth propellant for us.

[Operator]

[Operator Instructions] Our next question comes from Tim James with TD Securities.

[Tim James, Research Analyst]

Just a quick kind of housekeeping question on the taxes. I'm sure if you can give us an indication of what a good kind of tax rate would be to use for modeling purposes going forward in 2020 and '21?

[Daniel Gagnon, Chief Financial Officer]

Yes, Tim, I think we're expecting to go back to the more of 26.5% rate going forward, and that's the rate we're suggesting that we use for modeling.

[Tim James, Research Analyst]

Okay. Great. Then looking at the defense in the antivibration businesses, I know that segment, overall, the gross margins improved nicely year-over-year. Can you comment if both within that were defense gross margins different relative to last year? And then was there any improvement in antivibration gross margins on a year-over-year basis?

[Daniel Gagnon, Chief Financial Officer]

In defense business, because of the incremental volume, we did see a favorable product mix, we did see improvements in margin. Not so much on the antivibration side, though. Their sales were down, so that negatively impacted the gross margin as well as for the -- we saw overall segment gross margin go down, and that was attributable to the performance of antivibration.

[Tim James, Research Analyst]

Okay. And then just to confirm, when you mentioned CapEx in 2020 going back to kind of normalized levels, should we assume that means kind of what you've reported historically, that's always been a fair bit below your annual depreciation, amortization expense. Will it continue then to be well below that and we should think about '16, '17, '18 CapEx as a good run rate?

[Daniel Gagnon, Chief Financial Officer]

No, those years, Tim, were below, as you said, depreciation -- we said depreciation were excluding the impact of leases. So we're thinking like a $15 million range would be our normal depreciation levels historically. And that's kind of what we're looking at going forward to maintain the asset base and keep it updated.

[Operator]

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

[Chris Bitsakakis, COO & President]

Thank you, operator, and thank you, again, everyone, for attending this morning's call. 2019 was a year of strong financial performance for AirBoss, and it started to reflect some of the longer-term potential we see in this business, particularly for the Rubber Solutions segment and ADG. That said, we believe we also have a solid plan in place to grow the Engineered Products business, and we continue to focus on innovation and product offering diversification across the organization, which will be important factors in our overall value creation strategy over the next few years. We look forward to updating you all on our progress in our first quarter call. That concludes our call for today. Goodbye, and thank you for your time.

[Operator]

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