Exco Technologies Ltd
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Good day, ladies and gentlemen, and welcome to the Exco Technologies Limited Fourth Quarter Results 2018 Conference Call.[Operator Instructions] As a reminder, this conference call is being recorded.I would now like to introduce your host for today's conference, Mr. Darren Kirk, Chief Operating Officer of Exco.Sir, you may begin.
Thank you, Jimmy. Good morning, ladies and gentlemen. Welcome to Exco Technology Limited's Fiscal 2018 Fourth Quarter Conference Call.I'm Darren Kirk, Chief Operating Officer of Exco. I will lead off with an operations overview. Drew Knight, our CFO, will then review the financial results. Brian Robbins, our President and CEO, is also present and will participate in the Q&A session.There are a number of analysts, shareholders and brokers on the line with us today. In addition, the 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 posted a short presentation that we will reference this morning. We welcome all participants.The format of this conference 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 -- you should all have received our news release by now. If not, it is available on our website at www.excocorp.com or www.sedar.com.Before I 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 on -- in that regard. While I won't repeat the contents of the cautionary notes, we do claim their protection for any forward-looking information that we might disclose on this conference call today.Turning to the quarter, I would summarize our overall results as very decent measured by earnings per share of $0.27, which was 50% higher than the prior year quarter. This marks our fourth consecutive quarter of sequential earnings growth and record results for any fourth quarter in Exco's history. Just as important, we demonstrated meaningful operational progress on many fronts which will benefit our future results. This progress has instilled us with more confidence than ever that Exco will achieve record earnings in the year ahead.For more detail on the quarter, I'll start with the European operations within our Automotive Solutions segment on Slide 4. This, of course, represents the combined results of Polydesign in Morocco and ALC in Bulgaria. These operations contributed strongly to our improved results this quarter despite incurring substantial front-end operating costs associated with our many repositioning and growth activities. This is obviously quite the reversal from prior year periods when our European parts businesses have generally recorded operating losses.At ALC, we continued to execute on our turnaround initiative. Specifically, we have now moved the vast majority of nonseat cover programs as well as about 20% of the BMW Mini seat cover business out of Bulgaria and over to Polydesign in Morocco. By the end of next month, ALC's operations will consist almost entirely of the BMW Mini seat cover program. The only exception to this will be one small program which is housed in its own facility and which -- for which our participation will end by June 2019. We expect the more streamlined operations at ALC will enable the development of a workforce of higher overall quality and contribute towards our unwavering goal of restoring ALC to sustained profitability. Attainment of this goal, however, will still require ongoing price support from our primary customer, which continued this quarter. Discussions with this customer to make recent price increases permanent remain a focus. However, we have not yet come to a resolution. In the interim, we take some comfort in the pricing support we have received as an indication of [indiscernible] value in the supply chain to which it contributes.Moving on to Polydesign in Morocco. Our operations there continued to perform very well with solid organic revenue growth driven by programs transferred from ALC and new program launches, including takeover business from other Eastern European-based suppliers. As well, quoting activity for additional business remains extremely active at Polydesign. Our available capacity, however, is somewhat limited and we are being very selective in whatever we pursue. Nonetheless, we do own the last piece of vacant land in our industrial park, which is adjacent to our existing facility. With these details in mind, we are currently evaluating plans to expand our footprint as much as possible. This could translate into roughly 50% increase in Polydesign's building square footage to a total of about 330,000 square feet.Back in North America, on Slide 5, the combined results of our Polytech, Neocon and AFX operations continued to experience softness this quarter with a combined revenue reduction of 5% compared to Q4 last year. Our overall North American light vehicle production volumes were relatively flat compared to the prior year, although the trend away from passenger cars and towards trucks and utility vehicles remained clear. Our overall results continued to be hurt by these trends, although with decreasing magnitude. The main factors that contributed to lower sales this quarter were consistent with those experienced through most of the year. Those factors include isolated pricing pressures, modestly lower demand for certain of our accessory products, program launch timing and a focus on higher-margin business. The good news, however, is that the negative impact from these pressure points has mostly been felt. Looking forward, we expect the launch of several new programs and reduced pricing pressures, which should enable our North American parts businesses to return to a trend of revenue growth through 2019.Our underlying operating margin for our North American parts businesses also suffered this quarter. Price pressures and higher input costs contributed. However, operational disruption associated with flawed execution by a key supply chain partner was also a significant factor. We believe we have mostly resolved this issue. However, there will be some ongoing impact in our first quarter, albeit to a much lesser degree. Prospectively, with these issues resolved, material price increases now mostly absorbed and the anniversary of various cost increases reached, we believe the segment margins in North America will begin to recover.Looking at our cast and -- Casting and Extrusion segment. I'll start with a general comment on the U.S. field tariffs. As you know, aluminum tariffs don't directly impact us, as those costs are incurred by our customers for products they make with our tools, but as it relates to steel tariffs, they do impact about 30% of our tooling business, which is the percent of revenues derived from our operations located in the U.S. within the segment. In most cases, we are passing on 100% of the tariff to our customers, although there is still a modest drag on overall profitability and certainly margins.On to Slide 6. Our Extrusion group once again demonstrated very strong results during the quarter. Market fundamentals remained firm and our 5 plants collectively experienced solid demand growth. Our harmonization initiative is now essentially complete. However, we will continue to realize the benefits of improved efficiency for several quarters to come. We are now very focused on improving the performance of our Extrusion operations in Brazil and completing the construction of our new plant in Mexico. We expect this new plant will be operational by early calendar 2019, enabling us to better service the local market there and providing meaningful opportunity for growth.Turning to Castool. Sales were noticeably higher in the quarter as demand for the group's capital equipment continued to rebound. Profitability was also up sharply, as the group benefited from select price increases implemented earlier in the fiscal year meant to counter rising input costs. As well, Castool's operations in Thailand continues to season, reflected by higher sales and profits over the prior year quarter there. Looking forward, we believe Castool's product portfolio is very well positioned for continued success with many leading products in both the die-cast and extrusion end markets.Lastly, turning to our large mold group on Slide 7. Revenue growth was strong as we continued to execute on our healthy order backlog. Profitability within the group, however, continued to suffer as we incurred higher costs than expected to meet our delivery requirements. These higher costs were driven by ongoing inefficiencies with our new manufacturing process but also a few difficult programs which incurred increased losses towards program completion. We expect -- with respect to our new manufacturing cell, progress continues, albeit at a pace slower than we would like. Nonetheless, we continue to move in the right direction, with tangible results. Approximately 60% of our insert volumes are now going through the cell and we expect this will increase to 75% by the end of next month. This will enable us to finally begin reducing our cost structure, which remains burdened by our dual manufacturing processes. As well, we expect recent problem contracts will mostly conclude by the end of our first quarter, setting the stage for earnings improvement through the remainder of the year.That concludes my remarks. I will now ask Drew to discuss the financial highlights from the quarter.Drew?
Good morning, ladies and gentlemen.My comments will cover Slides 9 to 14 of the presentation.Consolidated sales for the fourth quarter ended September 30 were $139.5 million, an increase of 6% or $8.1 million compared to last year. Full year consolidated sales were $575.6 million, a decrease of $8.6 million or 1.5% from last year.The significant fluctuations in the U.S. dollar have impacted Exco's results during Q4. It has increased the Canadian dollar value of U.S. dollar-denominated sales in the quarter and overall FX increased sales approximately $4.3 million. Otherwise, $4.7 million of the increase is attributable to the tooling group. As Darren noted, the Extrusion group harmonization effort has improved performance, and as such, the Michigan and Texas operations have increased revenues substantially versus 2017. Castool has also increased revenue as many of their innovative products have gained market share, although large mold group revenue was also higher.In the Automotive Solutions group, FX-adjusted revenue in Q4 declined $0.8 million versus 2017. As Darren noted, revenue increased in Europe. However, this was mostly offset by declines in North America, and this story is consistent on a full year basis also.Consolidated net income for the fourth quarter was $11.6 million or basic EPS of $0.27 compared to consolidated net income of $7.5 million or basic earnings of $0.18 per share last year, an EPS increase of 50%. This is a record Q4 result for Exco.While there were business improvements during Q4, the net income also improved by FX and a reduction to the effective tax rate from 27.4% last year to 18.7% this year. Though the tax rate was helped by the U.S. rate reductions, it was also helped by the reduction of losses that are not tax affected and the proportion of earnings in low-tax jurisdictions.EBITDA was up 27% or $4.3 million to $20.1 million from $15.8 million in 2017.As noted on Slide 11, the automotive segment EBITDA improved $3.7 million. The tooling group increased $0.3 million and FX increased EBITDA $1.2 million, and the Corporate segment decreased $0.8 million. As Darren noted, the improved automotive results occurred in Europe with Polydesign's continued strong execution and ALC's temporary price increases.Full year consolidated net income was $42.3 million compared to $42.5 million last year. And for both years, the basic earnings was $1 per share.Turning to the automotive segment on Slide 12. EBITDA increased 40% in the fourth quarter versus last year. The EBITDA margin increased 450 basis points as ALC improved pricing and operating efficiencies to record a profit compared to losses in the prior year. Also, profits in North America increased due to a gain on the sale of a building, while the 3 businesses in North America collectively experienced reduced earnings compared to 2017.On Slide 13. In the Casting and Extrusion segment, revenue was $50.5 million in -- for the fourth quarter, an increase of $6.2 million or 14% versus Q4 2017. Year-to-date sales were $199.9 million, an increase of $16.7 million or 9.1% over last year. The Extrusion business and Castool businesses experienced increases, while the large mold group declined.The Casting and Extrusion segment reported higher EBITDA in the fourth quarter, $6.9 million, which is an increase of $0.9 million or 14% from last year. For the full year, the segment reported EBITDA of $31.4 million, a slight increase from $31.2 million in 2017. However, the 2018 results were burdened by an $800k loss on asset disposals incurred during the Extrusion harmonization strategy.Extrusion and Castool had solid earnings growth in both Q4 and full year. However, this was mostly offset by further declines in the large mold group caused by inefficiencies in the ramp-up of the new manufacturing cell and losses experienced on contracts being concluded early in fiscal 2019.Cash flow was strong for the full year. Cash flow from operating activities improved $0.6 to $65.3 million for 2018, though this is somewhat offset by $4.3 million in CapEx -- or $4.3 million increase in CapEx and the temporary $8.1 million increased cash usage for changes in working capital. The net result is free cash flow of $27.4 million for the year and $3.5 million for the quarter. Though we expect the pace of CapEx to continue into Q2 2019 to launch Extrusion Mexico, we expect to see some turnaround in the working capital investment.As noted on Slide 14, Exco's financial position remains very strong. As such, the company balance sheet and availability under the existing credit facility allow considerable flexibility to support any strategic capital spending and acquisition activity as well as dividends and share buybacks should opportunities arise.That concludes my comments. We can now transition to the Q&A portion of the call.
[Operator Instructions] Our first question comes from Michael Doumet with Scotiabank.
So on ALC, it feels like there's still a number of unknowns there. First, can you discuss maybe the nature of the bad debt expense in the quarter there and if there should be concerns going forward? And second, when thinking about the temporary price increase and the reduced footprint, just how should we think about ALC into 2019?
Well, with respect to the bad debt expense, that was a onetime item at the conclusion of the Audi program. So that is a nonrecurring event, and we don't expect any risk over and above normal business risk. And Darren, do you want to handle the other?
Yes, just, I guess, further thought on the bad debt expense. I mean that's -- that bad debt expense was something that we took the charge on in the quarter, but it's really a customer dispute. And we think, at the end of the day, it's a customer throwing its weight around at the end of a program, and we're taking every measure possible to recover that amount. So with regards to ALC more broadly, what we've tried to do is really narrow the scope of the activities of that entity, and we've moved all the complexity by virtue of the diversified programs to Morocco. And really, what's going to be left at ALC is an operation that'll be probably half the size of what it was before. That'll enable us to get access to the labor force that we need in order to have efficient operations, but even with that -- those measures that we're going to take there, that we are taking, we do need a price increase to reach sustained profitability. And those discussions continue to achieve that goal on a permanent basis, but we're just not there yet. But in the interim, we are gaining sufficient price to enable ALC to remain solvent and remain liquid.
Yes, that's helpful. Maybe just to follow up there. Just if it's possible at all to size up the Bulgarian operation just so we can better get a sense for it in 2019.
Well, that operation, what's left, would probably have revenue of about CAD 60 million in 2019.
And then maybe just a second question. So Extrusion and Castool appear to be lining up well going into 2019. You also commented that the large mold should be at an inflection point going into the year. I think Q1 could be a little soft. Any way you can help us just in terms of the margin expectation for the segment as a whole? And any color around the cadence for the margin improvement there, whether it's more in the first half or in the second half?
Well, certainly, the large mold contribution will occur in the second half. The drag at the front end is the completion of some of these challenging programs that we have, but we expect those will be substantially complete by the end of our first quarter. So large mold will contribute increasingly in the second quarter and through the remaining half of the year. With respect to Extrusion and Castool, I think their improvement will be more progressive through the year. So hopefully, that helps you a bit.
And our next question comes from Nav Malik with Industrial Alliance.
I just want to ask, first, on CapEx, I guess, for the year. First of all, it was about $20 million for the year. And I think earlier guidance that you had provided was that it was coming around sort of $29 million. So is there any maybe just comment on where your CapEx came in and, if it was light, why it was light?
I guess the $20 million is perhaps net of the building sale, but also some of the Mexico extrusion facility plant CapEx has bled into fiscal '19 out of '18. And I think if you go back over time, you'll see that we have a history of falling short on our CapEx plans.
Okay. And then, I guess, following on that, what -- do you have a number that you can provide us for 2019?
I'll give you a number that we'll probably won't reach, but it's we're planning for about $35 million in fiscal '19, and that really reflects 3 primary principal projects. And one of those is the conclusion or completion of the Mexican extrusion plant. The second is a large capital program at our Castool facility to potentially install a heat treat facility, which will provide Castool with reduced operating costs and quality benefits as well as additional capacity. And then the third element is a likely building expansion that we're going to pursue in Morocco so that Polydesign can keep up with the expected growth there.
Okay, no, that's great. That's very helpful. And I just also want to talk maybe in terms of what's happening industry wise. Of course, we saw the announcement with GM. First, I guess I'm wondering if there's any sort of direct implication for your business.
There's no direct implications from the GM announcement on our business. I think GM is taking its actions that you would expect at this point in the cycle. We still see things overall as being relatively healthy. Industry volumes are, call it, flattish. Passenger cars are now down to about 30% of overall volumes. And our mix has improved on that front as well, where we used to have a wider gap between our passenger cars and we were more exposed to passenger cars in the market. That gap has come down. So we think that the overall industry fundamentals are quite sound.
Okay. And then I mean I understand, on the cars versus trucks and SUVs, that you guys are reducing this shift or, I guess, matching your -- trying to match your focus with the industry trends. I'm wondering in terms of one of the other things, obviously, GM and other companies in the industry are focused on is on the -- on electric vehicles and on autonomous vehicles. Can you give us a sense maybe of where or how you might be able to sort of realign or shift some of your focus to capture those particular trends?
Well, in the Automotive Solutions segment, we're really agnostic to powertrain. It's -- if we're going to have an interior trim component, it's not going to matter whether it's an electric vehicle or an internal combustion engine vehicle. Where the difference may hit is on the Casting and Extrusion segment, but even there I think the trend towards electric vehicle provides one of opportunity in that aluminum is finding its way into more cars regardless of powertrain. It's particularly true with respect to the electric vehicle because of the weight of the battery and the need to maximize the range of the vehicle. So whether it's -- whether the powertrain is ICE or electric, we see significant growth in the amount of aluminum going into these vehicles and therefore the demand for the tooling that we provide.
Our next question comes from Ben Jekic with GMP Securities.
Two questions from me. One is on the tax rate. This quarter, it came much lower than I had expected. Is this a sustainable trend, that more and more profits -- especially now with Thailand being in good shape and -- that more and more profits are coming from these low-tax jurisdictions? And what would be the tax rate that we can kind of comfortably use?
Yes, I think, going forward, Q4 is maybe unusually low. And part of that was driven by activities in Bulgaria, but going forward, it's probably closer to 20% to 21%. And you're right. Many of our former greenfields are now black ink and doing well and have low tax rates such as Thailand.
Okay. Well, that's encouraging. And then my second question is on potential acquisitions. I'm getting a sense that this is not something that's extremely pressing, but how is -- what is the mindset that you guys have in terms of like what you're going to go after? And especially like -- given that some of the recent acquisitions are kind of taking -- either have not worked as well as you had hoped or are taking some time to ramp up, like is there anything -- in the methodology on how you evaluate the targets, is anything changing? Or is it just sort of delayed until, well, later?
So I guess I got a few thoughts on that, Ben. The first is that acquisitions do remain a focus for us. We look periodically, but having said that, we are very selective. I think that one of the things that drives that selectivity is the amount of opportunity that we have for internal growth. Over the next year, as I mentioned in my comments about CapEx, we have 3 significant projects that will consume some capital and operational resources but then provide meaningful growth opportunities on the back end of that. And so we've had tremendous success with greenfield investments over the years and we feel very comfortable with respect to making those investments. And to the extent that we have those opportunities on the horizon here, I mean, that's been our best use of capital. And so I expect us to focus on that. Also another part of the thought process is we want to fix ALC before we go off and make any other meaningfully sized acquisitions. And we are getting our hands around the neck of the problem there. And we should, hopefully, have some conclusion in the next couple of quarters or so, but that's some backdrop that drives our thinking around acquisitions at this point.
Ben, can I just add? I mean ALC was not a good acquisition, and we acknowledge that. And we screwed up, but we've done some very good acquisitions. And I mean Polytech was an acquisition. Neocon was an acquisition. AFX, and I'm surprised it's somewhat stigmatized these days. Yes, they were more exposed to cars rather than SUVs and trucks, but they are adapting rapidly. And if I had to do it again, I would buy ALC and I will pay the same amount of money we paid for it.
AFX.
No, excuse me, AFX. So yes, we screwed up, but I don't know anybody who does acquisitions who hasn't screwed up. But we've done some very good ones as well.
No, no, no. I meant more ones in the last 3 or 4 years. And then just the last question to just to make sure I heard correctly what you said to Michael. The ALC, the current run rate, revenue run rate, is about $60 million.
CAD 60 million a year.
Yes.
Our next question comes from Peter Sklar with BMO Capital Markets.
Drew, can you go through the adjustments, please?
Sorry. Which adjustments are you referring to, Peter?
The -- like the footnote one says that there are adjustments for onetime items. Can you just review them? I'm looking at the press release, on the front page.
Yes, yes, yes. Well, that's in the comparative period related to South Africa as we were winding down South Africa.
Sorry. Are there any adjustments this period?
No.
What about the building sale?
No, that's not normalized out of that.
What was the gain on that?
$1.8 million pretax.
And which segment was that recorded in?
Automotive.
In auto, okay. And then this price support that you're getting at ALC, what is the justification for that? Is it that the programs have -- were mispriced? Or you're threatening not to supply. Or I'm just trying to understand what the backdrop is and what the prospect is for a permanent price increase.
The backdrop is that it's a fixed-price program that was entered into 4 years ago when the labor market in Bulgaria and pretty much across Eastern Europe was completely different than the situation that exists today. Over that period of time, the unemployment rate has plummeted from 13% to 3% in some of the manufacturing regions that we're in. And wages on an average manufacturing basis in Bulgaria have increased by 50%. And when you have that change in the labor market, the old economics of the program just don't work. And ALC had been bleeding money for some period of time, grinding down its equity base to effectively nothing. And we just weren't going to support a program and an entity that had those kind of economics. And so getting the price support in order to sustain ALC at a decent level of liquidity and remaining solvent has been the interim goal, pending ongoing discussions to make those price increases permanent and reflection of the current market activity.
Okay. And then lastly, on the large mold business. Like I understand how you have the costs associated ramping up the new cell and the duplicative efforts, but could you explain kind of in layman's language like what happened with these mold programs that you described them as near-complete programs and there were issues there?
Well, we have a whole host of issues, but one of them as it relates to the manufacturing cell is that we entered into fiscal '18 with record levels of backlog and continued to underwrite new business at the front end of the year on a high level, with the expectation that our capacity would increase in new market as we had ramped up that new manufacturing cell. And to the extent that we fell behind pace on our agenda for increasing the capacity and the utilization of those pieces of equipment, we had to juggle things operationally, which meant pursuing outsourcing of some requirements and the like. And all of those things compound up on you and end up costing money. And that drove some of the unfavorable results related to those programs.
But additionally to that, in effort to diversify our customer base, about 2 years ago, we took on some new programs and which had very aggressive pricing on them and unfortunately turned out to be too aggressive. And we had come to an end of those programs at the end of this quarter. And in the end of the first quarter, they'll all be complete. And then the remaining business that we have, which is ample, is at much better pricing.
Okay. And whatever happened -- like you used to talk a lot about this -- the opportunity and new market for die-casting structural parts. Where are you on that, in that opportunity? I haven't heard much about it lately.
Well, we are winning more programs on it. And we will win more programs, but really the meat and potatoes in that business is in engine blocks. And that's where we're focusing mostly, Peter, because we have more experience in it. I mean, over time, I think we'll gain more knowledge on the structural parts, but we've done several, and quite frankly, we've struggled with them.
And our next question comes from Michael Glen with Macquarie.
Just wanted to circle back on the balance sheet. At what point -- I mean it does feel like you could pursue some sort of accretive action with your balance sheet, maybe something along the lines of a substantial issuer bid. At what point does something like that make sense for you guys?
So Michael, we have been stepping up our share repurchases over the last quarter in recognition that the cash flow profile of this business is very strong, and we do have an unlevered balance sheet. Whether or not we would go out and accelerate that further by borrowing money to pay back shares is a -- is something completely different. I mean this company hasn't typically done that. We've built up balance sheet capacity and used it for acquisitions over time, but I think the strategy, for the time being, will be to continue with the share repurchases at the current pace, which is still inside of the free cash flow that we generate, and have a bit of both improving the balance sheet and reducing the share count.
Okay. And when you look at the company right now on a stand-alone basis assuming no other M&A, what would be sort of -- what do you think the right number for leverage is on that business?
Well, we're comfortable with 0 or being in a net cash position. I don't, we don't have a problem being under-levered.
Thank you. And I'm showing no further questions in the queue at this time. I'd like to turn the call back over to the speakers for any closing remarks.
That concludes our remarks. Thanks, everyone, for participating.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude your program, and you may all disconnect. Everyone have a great day.