Exco Technologies Ltd
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Good morning, ladies and gentlemen, and welcome to the Exco Technologies second quarter financial results conference call. [Operator Instructions] As a reminder, this conference call is being recorded.I would now like to turn the call over to your host Mr. Darren Kirk, Chief Executive Officer. You may begin.
Thank you, [ Rusa ]. Good morning, ladies and gentlemen. Welcome to Exco Technologies Limited's Fiscal 2019 Second Quarter Conference Call. I'm Darren Kirk, Chief Executive Officer of Exco. I will lead off with an operations overview, Drew Knight, our CFO, will then review the financial results. Brian Robbins, our Executive Chairman, is also here and will participate in the question-and-answer period.There are a number of analysts, shareholders and brokers on the line with us today. In addition, call-in details have been widely disseminated to the public through the news release process. This call is also being simultaneously webcast at our website, where we have also posted a short presentation that we will reference. We welcome all participants this morning.The format of this call will be the same as in the past. After the presentation, we will take questions. The call will end at about 10:40. [Operator Instructions] You should have all received our news release by now. If not, it is available on our website at www.excocorp.com or www.sedar.com.Before we begin, I would like to make some comments about forward-looking information. In yesterday's news release and on Page 2 of the presentation, you'll find cautionary notes in that regard. While I won't repeat the contents of the notes, we do claim their protection for any forward-looking information that we might disclose on this conference call today.In summary, I would say our operations performed stronger than indicated by our financial results this quarter. Revenues in each of our reporting segments were essentially flat against the backdrop of modestly lower vehicle production volumes and planned curtailment of uneconomic activity. While our profits were also down compared to the prior year, we expect many of the incremental costs that drove this decline will dissipate through the next couple of quarters and beyond. Moreover quoting activity and new awards continue at a robust pace across most of our businesses. Together, we expect these factors will support overall profitability improvement in the quarters ahead.For a more detail on the quarter, I'll start on Slide 4, with our Automotive Solutions segment. Here of course, we are talking about the combined results of Polytech, AFX, NeoCon and Polydesign. Notably, the segment no longer includes the results of ALC. That business was deconsolidated from our financials during the quarter following the voluntary filing of a liquidation petition earlier this year.Overall industry light vehicle production in North America and Europe was off by about 5% during the quarter. Nonetheless, excluding contributions from ALC the prior-year quarter and foreign exchange rate fluctuations, segment sales were essentially flat. Segment sales were supported by a number of program launches for both new and existing products, particularly at Polydesign and Neocon. These launches more than offset declines at AFX and to a lesser extent Polytech, which were impacted by mix issues and lower demand on certain programs before others ramp up.More broadly, the group's 4 businesses continue to focus their efforts on higher margin activity. Relatedly, the curtailment of uneconomic programs modestly dampened sales during the quarter, particularly at AFX. Despite generally softer industry production levels, management continues to see ample opportunity for future growth supported by robust quoting activity for new programs in both North America and Europe.Profitability within the segment was adversely impacted by a number of factors in the current quarter compared to the prior year period. In particular, our Polytech and AFX operations were adversely impacted by a widespread labor strike in the city of Matamoros, Mexico that lasted for roughly 2 weeks in January of 2019, associated with annual wage negotiations. While the strike was ultimately settled and Polytech's and AFX's operations have largely returned to normal, higher wages and bonus payments to production staff have suppressed segment profitability.The impact of the bonus payments totaled roughly $1 million in the current quarter and will continue through the remainder of Exco's fiscal year at an approximate cost of $1.5 million per quarter for a total cost of $4 million in fiscal 2019. At this time, we expect segment profitability will recover by a similar magnitude in fiscal 2020. As well, both AFX and Polytech experienced meaningful freight and overtime costs in the latest quarter associated with lost production days during the strike while severance costs associated with improving future efficiencies within the segment have also increased current period costs.Together, we estimate these factors have increased costs by roughly $1 million during the quarter. As production and inventory levels have now returned to normal, we do not expect these costs will be material beyond the second quarter of fiscal 2019. Lastly, costs in the current quarter were also adversely impacted by front end inefficiencies associated with several new product launches, particularly at Polydesign and Neocon. While such costs may continue into future quarters, we expect they will do so at lower levels and ultimately support higher segment profitability as the underlying programs mature.Moving onto the Casting and Extrusion segment on Slide 6 and starting with our Extrusion tooling operations. We saw continued strength in the performance of that group. The North American extrusion market remains generally robust, though the pace of growth has slowed somewhat from recent levels. The Extrusion group continues to benefit from its ongoing efficiency initiatives and multi-plant footprint, which provides it with significant competitive advantages. The group's new Extrusion tooling facility in Mexico is now operational, however it only began commercial production on April 1, 2019 and therefore did not contribute sales during the quarter. Sales efforts are in full swing however, and the order book is building nicely. We are very encouraged by what we see there.Castool, the group's innovative portfolio of products remains very well positioned. As in recent quarters, Castool continues to experience higher demand for its capital equipment globally. Demand for its consumable products, however was more varied during the quarter, with softer market evident, particularly in Asia. We believe demand has slowed in this region, due in part to a redirection of Chinese exports there following implementation of U.S. tariffs. The mix shift away from consumable products and towards capital equipment has adversely impacted Castool's margins. We have however seen a rebound in demand for consumables equipment through the month of April while the capital equipment side remains firm.Looking forward, Castool expects to break ground on its Uxbridge plant addition this month to provide incremental capacity. In addition, Castool has also identified land in Morocco for its third site. As discussed last quarter, we expect this new plant will enable Castool to better penetrate the European market where it is currently disadvantaged given it lacks the proximity for certain of the product itself.Turning to our Large Mould group, I would first like to congratulate the team on receiving a prestigious PACE Award for 3D printed die components, which clearly demonstrates Exco is at the forefront of industry innovation. The Large Mould group reported modestly lower sales during the quarter, with year-over-year variance mostly attributable to the completion and wind down of uneconomic programs as well as customer timing requirements.Quoting activity however, remains very robust and industry pricing continues to firm up. This is particularly true for the larger complex jobs that require our engineering strength, speed of execution and industry-leading mould performance. On this front, we see a number of very favorable opportunities that could hit in the near term and we are preserving our capacity accordingly. For these reasons, costs within the group have remained somewhat stable despite the continued improvement in performance of our new manufacturing cell.In summary, market conditions in quoting activity remain generally solid across the segment. We remain focused on advancing our capabilities, controlling our overall cost and improving manufacturing efficiencies. We expect such activities together with our sales efforts will lead to improved segment profitability through the remainder of the year.That concludes my remarks. I will now pass the call over to Drew to discuss the financial highlights of the quarter. Drew?
Good morning, ladies and gentlemen. My comments will cover slides 10 to 15 of the presentation. Consolidated sales for the second quarter ended March 31st were $123.5 million, a decrease of 17% or $24.9 million compared to last year. This reduction was almost entirely related to the ALC deconsolidation impact of $26 million. The significant fluctuations of the U.S. dollar, increased Exco's revenue by $2.7 million while the Casting and Extrusion revenue declined slightly by $1 million and the automotive business was essentially flat.Excluding other expense, consolidated EBITDA for the second quarter totaled $16.3 million, a decrease of $2.7 million or 14%. The decline from prior year is reflected on Slide 12 and is primarily driven by results in the Automotive Solutions segment totaling $2.1 million -- totaling a $2.1 million decrease or 17%, while C&E declined by 5%.Consolidated results for Q2 2019 yielded EPS of $0.21 per share versus $0.25 per share in the prior year quarter. EPS includes $0.01 of the final ALC write off and $0.04 of premium costs associated with the strikes at Polytech and AFX.Tax rates were stable in the quarter at 23%. However, year-to-date tax rate is 33% due to the impact of the $6.4 million ALC expense that cannot be tax effected. Free cash flow was $8.2 million in Q2 and Exco repurchased 193,000 shares for $1.7 million. Net debt position was $6.3 million at the end of Q2.Turning to the Automotive Solutions segment on Slide 13. Sales in Q2 were $73.3 million, a decrease of $25.1 million over last year. As noted earlier, the decline is primarily driven by the deconsolidation of ALC. Polydesign and NeoCon produced strong growth in Q2, while AFX and Polytech had reduced revenues primarily due to AFX rebalancing their programs away from un-remunerative business.Margin rates increased with ALC gone, though EBITDA was reduced 15% or $1.9 million to $10.6 million by the citywide strikes in Matamoros and some short-term launch costs in NeoCon and Polydesign.Turning to Slide 14. In the Casting & Extrusion segment, revenue was essentially flat for the second quarter compared to last year. As Darren noted, the extrusion die business increased while the Casting and Castool businesses experienced some sales softness. The casting and extrusion segment reported somewhat lower EBITDA in Q2, a decrease of $0.6 million or 6% from last year.Large Mould and Castool groups had slight EBITDA reductions mostly offset by improvements at the Extrusion group. Each of the 3 groups, however, recorded relatively stable to slightly higher gross profits. The overall deterioration in segment profitability was driven by modestly higher SG&A costs, but more so from unfavorable FX movements.Cash flow from operating activities was $14.8 million in Q2 and $19.7 million year-to-date despite significant investment in non-cash working capital, which tends to be a seasonal adjustment after December. Improved cash flow is expected in the second half of 2019 through improved net income and decreased investment in working capital and CapEx intensity.As indicated on Slide 15, Exco's balance sheet and liquidity remained very strong. Given the trailing 12-month EBITDA of [ CAD 75 million ] Exco's net debt-to-EBITDA is 0.1x. We expect our net debt position will steadily improve during the second half of fiscal 2019 through free cash flow generation in excess of our dividend payments and share repurchase activity.That concludes my comments. Rusa, we can now transition to the Q&A portion of the call.
[Operator Instructions] And your first question is from the line of Michael Doumet.
So first question, just could you help us quantify the annual increase in the wages at the Mexican facility. And just as a quick follow-up, can you provide some context around the quarterly bonus payment maybe why you view those payments as temporary? And then maybe just any passthrough mechanisms that you have to recover those costs?
Sure. So I guess, the catalyst for this wage discussion and the resulting strike was really, it's an annual thing. So we talk to the unions about the wages annually. But embedded in that union contract is an index that references the minimum wage in Mexico, and this year in the region where our plants in Matamoros are, the minimum wage doubled. And that is -- that's quite extraordinary that that occurred. And when that occurred that effectively opened the door to increasing the wages materially. And we were the first to settle on the strike on this issue and we ended up paying a 20% increase in wages and then a one-time bonus payment that will be paid throughout this year amounting to about USD1,700 per employee. Those bonus payments amount to about $4 million this year, $1 million in the current quarter, $1.5 million in the next 2 quarters. But then they will go away. The wage increase is about $2 million for the year or about a $0.5 million per quarter, and that will stick around. So I guess with respect to mechanisms to recapture that, for new programs, we are quoting a higher level of wages into the embedded pricing for those programs. And for existing programs, I mean, it's one of those things where we just have to suck it up and try and offset it through efficiencies and otherwise. But we have seen customer receptivity to the higher prices for new programs as well as we are having some, I guess, favorable response to pushing off so-called cost downs on existing programs in recognition of this.
Yes. That's great, Darren. And just maybe before I come up with the second question, just if you can remind us, the average length of the program at Polydesign and AFX?
They would be about 3 years, so kind of one and half years left on average for any given point.
Okay, perfect. And then maybe just flipping over to Casting and Extrusion, margins there have deteriorated over the last couple of years and I know there's a lot that's been at work to improve the operations in pretty much all of the segments. But just given the industry headwinds, how should we think about normalized margins in the medium-term in your view?
Well, I guess, the margins have been impacted by a number of things. The field tariffs in the rise of raw material prices has been a significant factor. We do tend to pass on those increased costs in revenues, but we don't capture margin associated with it. So it has a favorable impact on revenues, but it has suppressing impact on margins. So that's occurred. And then there is -- the Large Mould business has had some margin deterioration for sure over the last couple of years. But at this point, we would expect that we're at a trough and we're really very close to landing one or 2 contracts that would really begin to turn that segment around.
Your next question comes from the line of Nav Malik.
I was just wondering -- actually, first on the balance sheet, so I know your debt is very low and you're generating free cash flow. I'm just wondering if you have -- what sort of plans you have for using that cash?
We do have the normal course issuer bid as you know and we picked up a couple of hundred thousand shares or so in the current quarter and we'd expect to continue at at least that pace over the next few quarters. So that will consume some of the cash, but we would likely still generate free cash flow even after dividends and share repurchases through the near term. We don't have anything on the horizon for an acquisition. And we're focused on our operational projects, in our CapEx projects for our greenfield additions. So I think that you should expect at least over the next several quarters that we'll continue to build cash on the balance sheet and further strengthen the balance sheet, but I wouldn't expect much different than that.
Okay. Like -- but you wouldn't consider or would you consider a special dividend or anything of that sort to return some of the cash to shareholders?
No, we would not consider anything like that. I think historically, this company has had a very strong balance sheet and it's our desire to continue that. Periodically opportunities will exist on the M&A side and we'll have some firepower to absorb that, if and when the time comes.
Okay. And next question is on the quoting activity. I know, you've been talking about it for a few quarters in terms of it's strong -- you're seeing it strong in a few of your segments. Anything more specific in terms of -- anything more imminent in terms of winning new orders or where are you in the process? Like, how much is that quoting activity translating into orders and revenue?
Well, I think on the Automotive Solutions side, you're really seeing some very strong growth from Polydesign in Morocco given the influx of programs moving to Morocco out of the higher wage zones in Eastern Europe and that is continuing and having a very positive immediate top line impact on Polydesign's results. Neocon is also demonstrating very strong top line and that is primarily attributable to where they are in their product development cycle. It's an extremely innovative company, mainly on the accessory side of the business and they have been working on these new programs, new products for both existing and new customers and some of those are starting to hit now, which is pushing revenues up there.On the other side of the business, most of the sizable impact would come in the Large Mould business. The Extrusion group continues to grind higher and Castool fluctuates a little bit, but generally goes up over time. But the Large Mould group is now kind of seeing the wind-down of its uneconomic programs and we do have capacity there, which is increasing as we continue to ramp up the new manufacturing cell and we're seeing a number of opportunities on the horizon that, that really would take advantage of our strength there, which include the ability to make mould in a shortened time horizon at higher quality incorporating our 3D printed mould design. So we're thinking that that could start to bite in the next quarter or 2.
And your next question comes from the line of David Ocampo.
My question is on your current CapEx plans, I think last quarter you identified it as $35 million. Is that going any higher now that you've identified the land for Castool?
So I think we started the year off thinking it was perhaps going to be $35 million and then walked that number back at the last quarterly conference call. We're $15 million or so year-to-date. I think that Castool is going to proceed with its Uxbridge plant this year and will also likely acquire the land in Morocco for their third site and maybe have some deposits to start some [ph] activity there. But I would think that at this point, we're probably going to end up somewhere around $25 million, plus or minus for CapEx for this year and then next year once you start to build out the Castool Moroccan plant more fully and potentially pursue a heat-treat facility that we've been talking about, you might end up back at $35 million or slightly higher next year.
Okay. And for Large Mould, are you guys still running the old manufacturing line? Is anything going through there still?
Yes, it's still going through, although if you walk through that plant now, you'll see a lot of equipment has been decommissioned and pulled out of there. So with respect to our primary sizable programs, all the inserts are going through the manufacturing cell. For some one-off jobs and needed capacity, we still do use the traditional manufacturing process. And I guess, we're just being a little bit cautious in how we manage our capacity given what we see on the quoting horizon with respect to couple of these programs that could hit.
Your next question comes from the line of Ben Jekic.
I have couple of questions. I think some of them have already been answered to a point with Michael. But the first question, Darren, if you can just clarify, I think in your opening remarks, you were -- when you were mentioning this extra cost coming from Mexico, there was one section where you said, it's going to continue through the end of fiscal 2019, and then one element, you said is going to just occur in the second quarter and won't continue into further quarters. So can you just clarify that?
Sure. The elements that will continue in the third and the fourth quarter of our fiscal year are the bonus amounts and those bonus amounts will be approximately $1.5 million per quarter. And those bonus amounts are payable in conjunction with the settlement of the union discussions. And so beyond fiscal 2019, those bonus payments are not expected to reoccur, not to that magnitude by any means. The elements that are expected to go away relate to catch up for lost production days. Through the 2 weeks of the strike, we were essentially able to meet our customer demand requirements. But we did so at a large cost of expediting freight and paying overtime rates that continued well after the strike date through the second quarter in order to replenish our inventory levels and make things a little more fluid there. So those costs amounted to about $1 million in the quarter and we expect that that's going to be gone going forward.
Okay, understood. And then second question, again more specifically on the bonus payment. If you can just maybe take a deep dive for me into that amount. I am finding it a little bit hard to understand that if a union can win USD1,700 per workers in 2019, then in 2020, they will go and -- however they communicate to their members that they say, sorry guys, not this year. I'm getting a sense that maybe with this payment, union is then in a better position to -- maybe in 2020 will be redefined differently, but maybe they will put further pressure on you for some further increases. I'm just finding it hard that it's just simply going to go away.
Well, I think you really need to look at the nature of the contracts and how it indexes the wages to the minimum wage in Mexico and this year was very extraordinary where the new President came in and doubled that minimum wage along the border states of Mexico. And when that occurred, that opened the door for a big wage increase associated with the union contract and that wage increase was effectively paid by a 20% increase on the wage level, plus a one-time bonus payment. And so I think we have had the benefit of generally lower wages in Matamoros for some period of time. This minimum wage increase caused some financial headache here, but it's not our expectation at all that you're going to see anywhere near the magnitude of a minimum wage increase in future years, which is what would be required in order for these bonus payments to be -- to occur again.
Well, I think I might add that when we looked at it in various regions around Mexico, Matamoros seem to be depressed in terms of wage rates. So this extraordinary adjustment sort of level sets things and gets Matamoros' wage rates more competitive with the rest of Mexico. And that's why we think it's a one-timer to get them back up to market rate.
It's been a long practice of wages and the bonus payments, which have occurred, but in the magnitude of kind of 2% or 3% in and around where the minimum wage has gone up by.
[Operator Instructions] And your next question from the line of Peter Sklar.
You mentioned on the Large Mould business that there were some unprofitable programs that you terminated. Can you talk a little bit about like what were the nature of the issues and just how that business got into those unprofitable programs to begin with? Like what's the lesson to be learned from this?
We were trying to diversify the book of business as engineering in new market, both through new customers and through different moulds, namely for some structural components and these were all kind of new first off moulds and they were priced very aggressively. I think that -- the lesson is that they were price too aggressively and we weren't able to ramp up the new equipment at the desired speed in order to realize the efficiencies and therefore we ended up being kind of further penalized financially with our performance. And so those programs have effectively rolled off now. Most of the profitability drag was realized in the second half of fiscal 2018. Once those programs were nearing conclusion, we realized that there were going to be some losses and so those losses kind of hit the books in Q3 and Q4. So with those programs now effectively wound down and now coming up against a couple of quarters where we realized those losses, we should and we fully expect year-over-year improvement. And now as the capacity has increased, as the new manufacturing process has improved, we are targeting a couple of new programs that really do take advantage of our engineering strength and speed of execution and enhanced mould design by virtue of the 3D added to the element. And we think, we're pretty confident that one or more of these is going to hit and we're being quite selective about the programs that we pursue now, and that's also, I guess a lesson that we had since these programs were in the mix.
And these programs, I think you mentioned they are structural parts?
New ones are engine -- they are powertrain components. We did win a structural component mould during the quarter of a modest size. So we continue to gain experience there. But there's just so much business coming at us on the powertrain side of things and that's really where our strengths are, so it's our preference to pursue those opportunities where we can.
And I'm showing no further questions at this time. I would like to turn the call over back to Mr. Darren Kirk.
You can conclude the call. Thanks, everyone, for participating this morning.
And ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.