Exco Technologies Ltd
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Good day, and thank you for standing by. Welcome to the Exco Technologies Limited Second Quarter Results 2021 Conference Call. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions].I would now like to hand the conference over to your speaker today, Mr. Darren Kirk, President and CEO of Exco. Please go ahead.
Thank you, Vic. Good morning, ladies and gentlemen. Welcome to Exco Technology Limited Fiscal 2021 Second Quarter Conference Call. I am Darren Kirk, CEO of Exco. I will lead off with an operations overview. Matthew Posno, our CFO, will then review the financial results.The format of this call will be the same as in the past. After a brief presentation, we will take questions.First, I would like to make some comments about forward-looking information. In yesterday's news release and on Page 2 of the presentation that we have posted to our website, you'll find cautionary notes in that regard. While I won't repeat the content of the cautionary notes, we do claim their protection for any forward-looking information we might disclose today.We had a very good second quarter, producing $0.30 of earnings per share. This brings us to $0.58 of earnings per share year-to-date and puts us firmly on track for a record year. I am particularly pleased with our results given the ongoing challenges of COVID-19, the extreme weather conditions we faced during the quarter as well as rising input costs, supply chain bottlenecks and a stronger Canadian dollar. I want to thank all of my Exco teammates for their fantastic efforts and, of course, commitment to working safely through such extreme circumstances.Looking first at our Automotive Solutions segment. Overall, automotive production was modestly lower in the quarter as OEMs were crimped by the shortage of microchips. Consumer demand for vehicles, however, remained near an all-time high with sales incentive declining in dealer inventory levels now at very low levels. We expect this backdrop will be met with a pickup in production as we go through the year once supply chain issues ease.Our foreign exchange adjusted segment revenues performed better than the overall market again, which represents continuing content per vehicle growth. New program launches helped achieve these results, and we have high content on several refreshed vehicle models that are performing well. Additionally, some inventory channels continued to be buffer stocked, although at much reduced levels compared to prior quarters.Quoting activity remains decent, and we are seeing a number of important wins and sizable new opportunities, particularly with electric vehicles from both new and traditional OEMs. On the cost side, our margins benefited from favorable product mix shift and a continued focus on efficiency.We did, however, continue to experience major fluctuations in forecast versus actual order releases again this quarter. This occurred as our customers juggled their own production schedules in response to the chip shortage. These challenges were pushed down to the supply base and place strain on our production planning process. As well, we lost several days of production associated with the Texas winter storm. We faced various supply chain challenges of our own and encountered rising input cost inflation.These elements required us to be nimble and absorb a lot of extra costs related to overtime, materials, and to expedite product shipments. As well, in Q2, we fully geared up for the launch of one new program, which our customer delayed into our third fiscal quarter. Nonetheless, we still produced an EBITDA margin of 16% in this segment. I must say this is pretty good margin even in favorable conditions.Looking forward, combined North American and European vehicle production levels are expected to be up sizably for the year as industry production normalizes from the OEM plant shutdowns that occurred a year ago. Our results will benefit accordingly and will be further bolstered by the launch of new programs as well as an expected increase in penetration levels for some of our key accessory products. Further out, we remain deeply engaged in quoting new programs that we expect will contribute outsized growth.In our Casting and Extrusion segment, we had terrific results. Demand was very strong in all 3 of our segment business groups. As I've mentioned several times before, the automotive industry's transformation towards electric vehicles and focus on emission reduction is extremely positive for Exco. It is hard to overstate this. We certainly saw that benefit in our results this quarter. As OEMs make the change to greener vehicles and strive for greater manufacturing efficiency, there is an increased use of light metals in the demand for our associated tooling. There is also increasing demand for technical expertise at the supplier level as products become larger and more complex. This plays right into our strength.Tesla with its Giga Press is a good example of this as they are now producing entire subframe assemblies with die-cast components that are much larger than anything previously produced. Castool is already directly benefiting from these developments, but it is a very positive trend for all 3 of our tooling businesses.The extrusion market remained exceptionally strong this quarter with high demand across the vast majority of end markets. As you know, our extrusion tooling ultimately supports a diverse range of applications, including residential and industrial building and construction, consumer durables, and transportation. This quarter, we demonstrated we could keep up with sizable demand growth by leveraging the harmonized manufacturing process of our numerous group facilities. This initiative has allowed us to centralize certain processes such as programming and design and utilize our capacity on a network basis when required. All of this keeps our cost low, capacity high, and with the ability to manufacture a quality standardized product.During the quarter, we received Board approval to make additional capital investments to further expand and upgrade our in-house heat treatment operations. These investments are quite strategic as they will shrink lead times, drive down our operating costs, and give us enhanced control over a critical part of our manufacturing process, all while reducing our environmental footprint.Our Large Mould Group continued to be negatively affected by COVID-related program delays. These constraints did ease sequentially, however, and we expect will further improve in the second half of our fiscal year. We are very bullish on the long-term outlook of this business given the growing die-cast demand, increasing complexity of components, localizing of supply chains in our leading market position. During the quarter, we completed a detailed analysis of our operations and committed further capital to ensure we remain best-in-class as a full-service operation.Segment margins benefited significantly in the quarter from higher sales, but more so by efficiency gains in the usage of both material and labor. This progress reflects our past and ongoing sizable investments in new equipment, but it is really driven by our people who continuously rethink the ways of doing things and who push the envelope on innovation and product performance. The need for suppliers to be both low-cost and bring solutions to the customer has never been greater. Tolerances are becoming tighter, lead time requirements are shrinking, and demand for lower prices are intensifying. Yet there is a lot of profitable growth ahead, provided we meet these requirements. And I think our segment results this quarter with 11% revenue growth and a 22% EBITDA margin clearly demonstrate we can.On the capital deployment side, we expect our spending to pick up in our second half. We anticipate this remaining spend could total towards $25 million as Castool nears completion of its expansion plant in Morocco, and we make deposits on new machinery for further investments in our Large Mould Group and heat treatment facilities.So in summary, we had an excellent second quarter and first half to our fiscal year. Despite the significant challenges we all face today, we are very well positioned to continue this momentum in the quarters ahead. Once again, we thoroughly expect our fiscal 2021 to be a record year for Exco.That concludes my operations overview. I will pass the call over to Matthew to discuss the financial highlights of the quarter. Matthew?
Thank you, Darren. Good morning, ladies and gentlemen. Consolidated sales for the second quarter ended March 31, 2021, were $118.4 million compared to $120.2 million in the same quarter last year, a decrease of $1.8 million or 1%. Second quarter sales at our Automotive Solutions segment were down $4.1 million or 6%, and the Casting and Extrusion Group sales increased $2.3 million or 5%.Over the quarter, exchange rate movements decreased sales of $6.4 million. Excluding the impact of foreign exchange, consolidated sales for the quarter were up 4%. Automotive sales were flat, and the casting and extrusion sales were up 11%. Consolidated net income for the second quarter was $11.7 million or basic and diluted earnings of $0.30 per share compared to $9.5 million or $0.24 per share in the same quarter last year, an increase in net income of 23%.The company did not receive support from the Canadian wage subsidy program this quarter. The consolidated effective income tax rate of 22% in the current quarter was the same as the prior year period.The Automotive Solutions segment reported sales of $69.3 million in the second quarter, a decrease of $4.1 million or 6% from the prior year quarter. The segment sales were favorable when considering the negative impact from foreign exchange rate fluctuations, the global microchip shortage, continued COVID-19 challenges, the Texas snowstorm, and shipping delays from congested ports, which reduced the vehicle production in the quarter. Segment sales were supported by a number of program launches for both new and existing products and a favorable vehicle mix.Second quarter pretax earnings in the Automotive Solutions segment totaled $9.4 million, which is consistent with the same quarter last year. The segment maintained traditional profitability despite the slight sales decline through continued cost discipline. In addition, new product launches and a favorable sales mix were offset by ramp-up costs for future programs, supply chain challenges, raw material cost inflation, and fluctuations with customer releases caused by uncertainty due to the microchip shortage.The Casting and Extrusion segment reported sales of $49.1 million for the second quarter, an increase of $2.3 million or 5% from the same period last year. Excluding the negative impact of foreign exchange rate movements, the segment sales were up 11% and continue to rebound and exceed pre-COVID levels. Extrusion Group sales were supported by strong results at all 6 locations, reflecting high demand for extrusion tools across North and South America across all industry segments.Demand for die-cast consumable tooling has been the primary driver of Castool's sales performance. In addition, orders for larger capital goods in extrusion end markets has increased throughout the second quarter. The Large Mould Group sales were down as customers delayed shipping dates on existing programs. However, inventories increased and new business from current and new customers continue to outpace shipments for this group.Pretax earnings from the Casting and Extrusion segment improved by $2.9 million or 65% over the same quarter last year to $7.4 million. The segment's profitability improvement was driven by strong efficiency gains in both material and labor usage, coupled with greater overhead absorption.Exco generated cash from operating activities of $11.9 million during the quarter and $6.8 million of free cash flow after $5 million in net capital expenditures. This cash flow was more than sufficient to fund the $3.9 million of dividends, capital expenditures will be back-end loaded this year as commitments for new equipment have increased and will continue in the coming months.Exco ended the quarter with $28.4 million in net cash, continuing its practice of maintaining a strong balance sheet and liquidity position. Exco's financial position remains very strong. As such, the company's balance sheet and availability on our existing credit facilities allow the considerable flexibility to support strategic capital spending, dividend, and other opportunities that may arise.That concludes my comments. We can now transfer to the Q&A portion of the call. Thanks, Vic.
[Operator Instructions]. Your first question comes from the line of David Ocampo.
Darren, when I take a look at your casting and extrusion margins. This is probably the highest level that it's been in almost 5 years. So I'm just wondering, can you continue at this level or perhaps even directionally at the same level, especially with all the demand that you're seeing towards the back half of the year with your Large Mould division?
Well, I certainly would expect so. I think one attribute is that the Large Mould business is continuing to have a lagging impact from COVID. So it really can, and we expect will contribute more to the profitability and the margin of the segment. So to the extent that volumes remain healthy, I could certainly see continuation of that margin and even some further upward potential.
And Darren, maybe perhaps you can comment on some of the competition that you're seeing in the marketplace. I know that was an issue in the past. Are those competitors largely out of the market or you're not seeing them as a competitive threat anymore?
I would say there's no material change. The competition in these markets is incredibly intense. Now as I mentioned, components are getting much larger and more complex, and we're seeing that from a number of customers. And we are really the go-to player when it comes to providing tooling for that part of the market. So I think competition remains intense, and we are making investments to be more competitive. And you're seeing that show up in the margin and the performance of the segment.
You touched a little bit on the chip shortage, and that's pretty well documented. And I think Ford put out some pretty weak guidance over the last week or so. So do you have any visibility on what the impact could be for the back half of the year, especially in the context of having discussion with your customers?
I probably don't have much greater insight than what's available in the public press. Just -- the numbers do seem to be growing in terms of the impact of production declines. I see Ford was out this morning with some news on that front. But I think we're really positioning our business to deliver the products for whatever the production levels are, and we would aim to exceed that growth as we've done in the past.
And then last one here for me on your uses of capital. Do you have an update on the CapEx spend this year? And what are your plans for your cash? Are you just going to harvest it as you've done in the past year or so?
Yes. So I mentioned that our CapEx spend will be weighted to the back half. We've spent $10 million so far. And we could likely spend another $25 million through the next 2 quarters. And that is primarily to finish off the construction of Castool's new facility in Morocco, which will be up and running this fiscal year. And also making some investments or some deposits on new equipment for our heat -- various heat treat programs and some additional capital for the Large Mould business.
And then beyond that, are you just planning on harvesting the cash from here because the free cash flow profile is quite strong and has been for the last few years?
Well, we do continue to look out for additional greenfield investments. As I mentioned last quarter, we're kind of narrowing down our sights on an additional plant likely for Castool in Mexico. And we are really accelerating our spent for new equipment. We're bringing it forward from potentially future years to really solidify our competitive positioning for a market that we see is very strong, both die-cast and extrusion. And that's being driven by all of the comments that I've made, the electric vehicle, the lightweighting, building and construction activity. And so we'll continue to have kind of an elevated level of CapEx for the next couple of years, but I would still expect us to generate free cash flow.
And if I may add, David, the -- a lot of the back end capital we're seeing, some of that is deposits because it's for larger equipment as well. So a lot of that's carrying forward, as Darren said, into the next year. So there's a lot going on.
Your next question comes from the line of Michael Doumet.
First off, nice quarter. I want to start maybe on the Automotive Solutions segment. The margins there looked solid, I guess, given the long list of challenges faced in the quarter. I wonder, do the headwinds, namely the higher raw mats, chip shortage, and the ramp-up costs, do they become more meaningful into next quarter before it's moving out, just to get a sense for the sequential impact?
There's going to be pluses and minuses. The raw material costs are going up and we're trying as best we can to offset that with efficiency measures. And we were also impacted this quarter by the Texas ice storm, which I'm guessing is not going to happen again in the next few quarters. But we do have some -- or one program, in particular, that is going to ramp-up in Q3, and we were fully geared up for that program to start the last -- in our Q2, and it didn't. So that will be a positive influence on margins from overhead absorption as we go through the next couple of quarters. So there is still quite a potential here that that margin has some upside at this point despite the headwinds that will continue.
And then on the market share gains in Extrusion and Castool, can you maybe get into that a little bit? Just what's really driving the share expansion there? I mean, you've obviously got new facilities across different areas. But is it just new capabilities? Is it better pricing? Just to give us a sense for what's driving that and how sustainable it is?
Well, it varies by business. Extrusion, we have made significant investments over a multiyear time frame to make the manufacturing of our dies, the same in any of the 6 plants that that group has. And that has really given us increased fluidity of manufacturing across the network of those plants and such that we can balance loads better. We have opened up capacity. And at the end of the day, we produce a very high-quality die, and we do that in a short period of time. And when you do that consistently to your customer, you get the next order, and we've been growing from those elements. And on Castool, these guys are really innovative with their products and product suites that they have. They really play to this need for larger and complex components. They're a dominant player in the shot sleeve market as part of the die casting business. You can see what Tesla is doing with that business in terms of these Giga Presses and Giga castings. And Castool is participating directly in that. So it's a number of things, but it really does speak to the investment that we've made in equipment, but really, our people and the way that they innovate our products to our customers' demands.
Yes, thanks for that, Darren. And then just, I guess, going off some of the last questions. I mean, it sounds like the growth focus will come from internal investments rather than M&A. Maybe just talk about what you guys are targeting as investment hurdles for some of the greenfield and some of the investments that you're making, any incremental EBITDA growth that we should expect over the next several years as CapEx ramps up?
We've always had a good return on investment, kind of targeting that in the 20%-plus range is ideal. And we're going to continue to expand our margin from making products more efficiently and from taking market share in both existing markets and in new markets, as we're doing with Castool doing with its investment in Morocco. So a hurdle in that range is kind of what we target, and I think we've got a very good shot at getting there.
And that hurdle, is that pretax or posttax? Just to make sure that I know.
Both tax.
[Operator Instructions]. Your next question comes from the line of Peter Sklar.
Darren, I just have a question first on, you seem to be making these investments in heat treating, both the Large Mould business and as well the extrusion business. What is the significance of the heat treating? Is that that you treat the metal prior to machining and that improves machine speeds and results? Could you explain kind of in layman's, what you treat --?
Yes. Well, the tool steel that we use for both extrusion and die-cast needs to be heat-treated to enhance the hardness properties of the steel through the manufacturing process. And so all of our steel goes through heat treat at some part of the process. And for our extrusion business, we have in-house heat treat capabilities, and we've long had that. And we have needed that in order to keep the lead times short. The lead time in that part of the business is 7 to 9 days. And if you outsource it and you lose control over that aspect, you won't meet the objective of the lead time turnaround. In Castool's part of the business, they've grown significantly over the years, and they have relied on third-party heat treat providers. And as the complexity and these products increases and the scale of their business increases, we have determined that it is advantageous to bring that heat treat in-house. And so we're doing that and we're making significant investments to do so. And so, I guess, with respect to extrusion, again, we are adding new heat treat equipment that is much more energy efficient, and that will have positive impacts for our operating costs as well. So there's a few heat treat programs going on, but they're all to upgrade our internal capabilities and reduce our costs.
And then the Large Mould, do you outsource the heat treating?
We do currently. And the heat treat operation that Castool is putting in will actually go in the back of the plant of the Large Mould business up in new markets. So Large Mould will have access to in-house heat treatment as well.
And then last thing I wanted to talk about was on the opportunity, given the necessity for lightweighting of vehicles. So where is that opportunity largely? Is it in the Large Mould business? Or is it in Castool? And like what does that mean for the Large Mould business? Because they make -- because now you make the tooling for engine blocks and transmission case covers, and then you need to transition to tooling for structural parts. So if you can just talk a little bit about that.
So the opportunity is in all 3 of our tooling businesses. But at a high level, it's both on the die-cast and extrusion side. Large Mould has traditionally had the bulk of its business in engine blocks and transmission housings and making moulds for those components. But increasingly, over the past several years, they have made moulds for structural applications. And those structural applications are increasing significantly in volume as these OEMs lightweight their internal combustion engine vehicles and then also with respect to electric vehicles, the battery weighs so much that they've got to make more of the structure of the vehicle out of aluminum. So Large Mould is today making several moulds for structural components for both electric vehicle and for lightweighting of internal combustion engine vehicles. Castool similarly feeds its products into trends -- whatever the powertrain is or whatever the die-cast process is to make structural components. Castool is a significant player in that market today. And as structural components are larger and more complex, it really requires tooling that can -- to handle that complexity. And so Castool is benefiting significantly from that. And then even in Extrusion, where they will -- OEMs will make some extruded components for the vehicle structure. They need extrusion dies for that. So we're seeing a benefit there. But given the diversity of that extrusion business, it's not as sizable, but it's still very positive.
Presenter, as there is no further question at this time, please continue.
Okay. Well, thanks, everyone, for your time and interest on the call this morning. We look forward to speaking with you again next quarter. Take care.
This concludes today's conference call. Thank you for participating. You may now disconnect.