Exco Technologies Limited (OTCPK:EXCOF) Q2 2022 Earnings Conference Call April 28, 2022 10:30 AM ET

Darren Kirk - President & CEO

Peter Sklar - BMO Capital Markets

Good day and thank you for standing by. Welcome to the Exco Technologies Limited 2022 Second Quarter Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions]

I would now like to hand the conference over to Darren Kirk, Chief Executive Officer of Exco Technologies Limited. Sir, Please go ahead.

Thanks, Rachel. Good morning all participants. Welcome to Exco Technologies fiscal 2022 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 before we open the call for questions.

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 that we have posted to our website, you'll find cautionary notes in that regard. While I won't repeat that contents, I want to emphasize that they apply to the discussion today.

So our revenues held up fairly well in the quarter and in fact, showed modest growth year-over-year despite lower overall vehicle production volumes in our core markets of North America and Europe. However, it was a challenging quarter with extreme macroeconomic factors negatively impacting our operations and results.

Nonetheless, we recorded consolidated revenues of $119 million and earned $0.13 per share. Given all the headwinds we faced, I think our results were actually pretty decent. This speaks directly to the strengths of our businesses and of course, our very talented and dedicated team members.

Lower vehicle production volumes due to supply chain disruptions was certainly a contributing factor to our reduced profitability this quarter. In particular, this hurt our European parts business, but also our North American tooling operations through continued inventory destocking in the die cast channel. As well, U.S. vehicle sales were also about 16% lower year-over-year, which negatively impacted some of our accessory products in the Automotive Solutions segment.

And of course, widespread inflationary pressures, labor disruption to prevent greater spread of the Omicron variant, and logistical constraints, all contributed to margin compression. But while the quarter was again challenging, it is worth noting that our results improved significantly from the first quarter. And as I indicated in our last call, nothing has changed fundamentally for Exco or our medium-term outlook despite current macro conditions. We continue to expect much stronger results in the quarters ahead.

By this point, I think the constrained supply of microchips impacting the OEM's ability to manufacture vehicles is well understood. There has been an improvement in this constraint in recent months, and most industry players expect supply will continue to improve as we go through 2022. IHS, for example, is anticipating an 8% increase in combined North American and European production volumes in 2022 and a further 11% in 2023.

I've mentioned several times before that the automotive industry's transformation towards electric vehicles and focus on reducing emissions is extremely positive for Exco's tooling business. As OEMs make the change to greener vehicles and strive for greater manufacturing efficiencies, there is an increased use of light metals and 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.

In addition, there is a heightened focus on efficiency by all manufacturers for sustainability initiatives, including a trend towards reassuring, all of which will be very positive for the entirety of our tooling business. In anticipation that these trends will continue to take hold, we are making sizable investments to better position our various businesses to capture the expected growth.

To summarize, these investments include a new tooling plant for Castool in Morocco, which opened in November 2021 to better serve the European extrusion and die cast markets, another new facility for Castool in Mexico, which recently broke ground to add incremental capacity within Mexico and the Southern U.S., significant investments in heat treatments equipment across the entire tooling group to enhance capacity, reduce emissions, and enable us to in-source most of our needs.

Investments to upgrade the capabilities of our large mold group to handle molds of extreme science, which we expect will be increasingly demanded by all OEMs. Additional equipment for our 3D printing tooling business, which continues to see strong growth and addition to two of our production facilities in the Automotive Solutions Group to provide much needed capacity for awarded programs. As a reminder, our total CapEx budget this year exceeds $50 million and covers these and several other growth initiatives. We again made great headway on advancing these projects during the quarter.

Now just a few comments on our exposure globally, given the significant macroeconomic developments in the last few months. First, as it relates to the Russian invasion of Ukraine, we have no material direct exposure to either country on the supply or customer side. There obviously is indirect exposure across the industry as supply chain constraints in the Ukraine is negatively impacting European vehicle production volumes, given its proximity to the conflict. As well, developments from this situation are causing further challenges and increases in global inflationary conditions.

Next, looking at the recent COVID lockdowns in China, we again see limited direct impact to our operations. We source very little raw material and other components out of China, particularly in our Auto Solutions Group, and where we do have exposure, we are adding some buffer stock to mitigate against adverse developments. With respect to our tooling group, there is some exposure to certain die cast components procured from China, and we have some alternatives outside China for many of these purchases. But it is worth noting that our competitors generally have much greater reliance on China than we do.

Turning to the quarter, and first, looking at our Automotive Solutions segment. Overall industry vehicle production volumes in North America were down very slightly, while volumes in Europe were down 18% year-over-year. Nonetheless, our segment revenues were essentially flat year-over-year with our sales outperforming industry production in both regions.

New program launches contributed to our results this quarter, including one key new program while we are supplying sizable content on a fleet of commercial EV vans. This program will begin to ramp up more significantly in our third fiscal quarter and continue for several years. Moreover, we will continue to ramp up several other key programs through 2023 that will provide outsized growth relative to our historical performance.

Revenues were also helped by certain pricing actions taken to protect margins as well as favorable vehicle mix with these trends generally improving through the quarter. Meanwhile, quoting activity and new program awards remain very decent and actually picked up a bit through the quarter. We are seeing a number of sizable new opportunities, particularly with electric vehicles from both new and established OEMs.

On the cost side, our margin suffered from higher input costs as well as unfavorable product mix during the quarter. Extra costs associated with carrying surplus labor in anticipation of higher demand levels also impacted our results. Compounding these issues were fluctuations in forecast versus actual order releases. This occurred as our customers juggled their own production schedules in response to the chip shortage issue and other constraints, particularly in Europe.

These challenges were pushed down to the supply base and placed strain on our own production planning process. Moreover, raw material cost increases remained a factor, and we faced various supply chain and labor availability challenges of our own. These elements required us to be nimble and also absorb a lot of extra costs related to overtime, material substitution, and expedited freight. Pricing remains tough in this business, and there is limited ability to use price as a lever. We did, however, take pricing action where possible to recover higher input costs, and we began to see the impact of these prior actions this quarter. We expect this trend will continue to be evident in the quarters ahead.

In our Casting & Extrusion segment, it was a mixed bag. Demand for extrusion related tooling and equipment remained quite strong, while die cast has been weak due to lower industry vehicle production volumes combined with inventory destocking in the supply chain. Our extrusion tooling ultimately supports a diverse range of applications, including residential and industrial building and construction, solar panels, consumer durable products, and various modes of transportation.

This quarter, we again demonstrated we could keep up with sizable demand growth by utilizing equipment and labor more efficiently, while leveraging the harmonized manufacturing process of our numerous group facilities. With regard to the latter, this initiative has allowed us to centralize certain processes such as programming and design, and utilize our capacity on a network basis. All of this keeps our costs low, capacity high, and provides us with the ability to manufacture a quality product in a standardized manner.

We are making significant strategic investments to further shrink lead times, drive down our operating costs, and in-source more of our own heat treat requirements, all while reducing our environmental footprint. The die cast market, which is driven by automotive production, however, remained soft in the quarter as lower vehicle production was magnified by inventory destocking. This negatively impacted demand for Castool's consumable die cast tooling, while the large mold group suffered from greatly reduced rebuild work.

Nonetheless, we achieved a number of program wins that will benefit future quarters. In fact, we achieved record levels of order intake in our large mold group, ending the quarter with pretty much the highest backlog in our history. We are very bullish on the long-term outlook of this business given the growing demand for large and complex die cast components, coupled with our leading market position, full service capabilities, and view that supply chains will become more localized over time. As well, our additive tooling business continues to perform very strongly, contributing record levels of sales and order intakes during the quarter. Additive tooling is a critical differentiator, providing us with an unmatched competitive edge.

Looking at the Casting & Extrusion segment margins. We experienced weakness this quarter from levels that we have otherwise come to expect. Segment margins were impacted by unfavorable product mix, including essentially no revenue from rebuild work in our large mold segment, as well, rising input costs, higher freight charges, and labor disruptions due to COVID were all a drag on our performance and outpaced ongoing efficiency gains.

As well, front end losses at Castool's new plant in Morocco added to the margin pressure this quarter, although we have started to generate revenue there. Lastly, with respect to our acquisition of Halex, Europe's second largest manufacturer of extrusion dies, we continue to work towards closing the acquisition in the very near term.

That concludes my operations overview. I will now pass the call 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, 2022 were $119.3 million compared to $118.4 million in the same quarter last year. This is an increase of $900,000 or 1%. Second quarter sales at our Automotive Solutions segment were down $1.1 million or 2%, and the Casting & Extrusion Group sales increased $2 million or 4%. Over the quarter, exchange rate movements and decreased sales of $1.5 million, excluding the impact of foreign exchange rates, in fact, consolidated sales for the quarter were up 2%. Automotive sales were flat and Casting & Extrusion sales were up 4%.

Consolidated net income for the quarter was $5.1 million or basic and diluted earnings of $0.13 per share compared to $11.7 million or $0.30 per share in the same quarter last year, the decrease in net income of $6.6 million. The consolidated effective income tax rate of 23% in the current quarter increased from 22% from the prior year quarter due to non-deductible losses from our recently launched Castool Moroccan facility.

The Automotive Solutions segment reported sales of $68.2 million in the second quarter, a decrease of $1.1 million or 2% from the prior year quarter. This segment's second quarter sales were consistent with last year when considering the negative impact of foreign exchange rate fluctuations. Compared to IHS, North American, and European production volumes, the Automotive Solutions segment outperformed the industry. Segment sales were supported by a number of key program launches for both new and existing products and a favorable vehicle mix.

Second quarter pretax earnings in the Automotive Solutions segment totaled $6.2 million, which represents a $3.2 million reduction from the prior year quarter. The segment's lower pretax profit was due to unfavorable market-driven product mix, higher material, logistics, and labor costs, partially offset by pricing actions, which were taken in the quarter.

Inflationary pressure continues to be a challenge in the segment, particularly on petroleum-based products, resins, plastics and rubber, energy, freight and labor. Management remains focused on improving the efficiency of its operations and reducing its overall cost structure. Pricing discipline remains a focus and actions are being taken on current programs where possible, though there is typically a lag of a few quarters before an impact will be realized.

The Casting & Extrusion segment reported sales of $51.1 million for the second quarter, an increase of $2 million or 4% from the same period last year. Foreign exchange rate changes were negligible in the quarter, approximately $200,000. Within the segment, demand for our extrusion tooling dies, dummy blocks, stems, et cetera., and associated capital equipment, die ovens and containers, remain strong due to both industry growth and ongoing market share gains.

In the die cast market, which primarily serves the automotive industry, demand has remained suppressed due to lower vehicle production volumes, which in turn is due mainly to broader supply chain constraints. Demand for Exco's industry-leading additive 3D printed tooling has continued to gain traction as customers focus on greater efficiency as the size and complexity of die cast tooling continues to increase. Sales were also aided by price increases, which were implemented mainly toward the end of the quarter in order to protect margins from higher input costs.

The Casting & Extrusion segment reported $2.7 million of pretax profit in the quarter, a decrease of $4.7 million from the same quarter last year. The lower pretax profit was driven by reduced activity for rebuild work in the large mold group, coupled with the shipment of a number of new lower margin molds. Profitability was negatively impacted by raw material and labor cost inflation before price increases were implemented. Unfavorable market driven product mix shifts within the Castool group, startup losses of Castool's plant in Morocco, which opened in November 2021, reduced labor availability and higher overtime costs across three business units to reduce the spread of COVID-19. Segment pretax profitability was higher sequentially and new business awards across the quarter are very strong, particularly for structural die cast components and EV platforms.

Exco generated cash from operating activities of $5.3 million during the quarter and $3.6 million of free cash flow after $1.6 million in maintenance fixed asset additions. Cash flow combined with cash on hand, our renewed and increased credit facility, funded $4.1 million of dividends, $9.1 million in growth capital expenditures, and repurchased $1.8 million of shares under the normal course issuer bid. As reported in previous quarters, management expects total capital expenditures to be in excess of $50 million to $55 million as we continue our strategic capital growth programs discussed by Darren previously.

Exco's financial position remains strong. The company's balance sheet availability on the expanded credit facility allows considerable flexibility to support strategic initiatives like our Halex Extrusion Dies acquisition. Our strong financial position, combined with our free cash flow, creates the foundation for the management to pursue high value growth capital expenditures, dividends, and other opportunities that may arise.

That concludes my comments. We can now transition to the Q&A portion of the call. Rachel, please?

Thank you, Matthew. [Operator Instructions] Your first question comes from the line of Miguel Ladeira from Cormark. Sir, please go ahead.

Hey. Good morning. I just wanted to touch on the Halex acquisition. You previously mentioned that you saw a pathway to achieving around 20% margins. Do you see this changing, given the European exposure, or would this just push these expectations if they are right? I'm assuming the business is being hit harder, more than the legacy Exco.

Sure. Thanks for the question. I don't think we've commented specifically with respect to Halex' margin, but certainly within Casting & Extrusion segments, we do have an expectation of achieving a margin of 20%. And the acquisition of Halex as I mentioned, when we announced the acquisition, would have a modest front end compression to the EBITDA margin, at that time, but we see no reason why within our five-year time frame for our 2026 target that we can't get the margin for the group or the segment back to 20%.

And with respect to developments in Europe, certainly there's an increase in inflationary pressures there, perhaps of a greater magnitude than what we're seeing in North America. But I will point out that what we've seen so far in terms of demand on the extrusion side in Europe is that there is significant demand as there is globally for those products.

And just to clarify, is there any direct exposure from Halex with regard to the Ukraine-Russia conflict?

Awesome. And then changing gears to the legacy business, can you remind me how much capacity is coming online with the introduction of Morocco and then Mexico coming down the road?

Sure. Well, what we've said when we built up our 2026 target is that we expect that those two plants together will provide annualized revenue of about $30 million or so. In fact, there is probably more upside to that than anything, but I would use that as a benchmark.

And just a follow-up there. If we were to back out the onetime startup costs associated with Morocco, is there a figure you can point to?

Typically, when we start these plants, there is a loss of $100,000 a month or so, but that quickly reduces as the revenue builds up, and as we indicated last quarter, we'd expect to be kind of on an EBITDA breakeven toward the end of this fiscal year for the Moroccan operation.

That's great. And then last one for me. You touched on the IHS forecast in your opening remarks, but specifically, where do you see production volumes trending given your conversations with customers? Are they more or less in line with these forecasts or do you have more, I guess, optimistic/pessimistic outlook

No. I'd say in line with IHS, based on what we're seeing, certainly an improvement that should continue through the remainder of the year and beyond, but nothing too dissimilar from what HIS has been.

That’s all from me. Thanks for taking time.

Thank you. And our next question comes from the line of Peter Sklar with BMO Capital. Your line is open.

Hi. Good morning. Hi, Darren. Like, in your auto parts business, like the revenue numbers, the sales were exceptionally strong. You kind of gave a laundry list in the write-up, but do you mind just elaborating a little bit? Like, why was your topline like so above and beyond kind of where the production volumes were in North America and Western Europe?

Sure. Well, I think generally, we have a track record of exceeding changes in vehicle production volumes by 5 to 10 percentage points over time. And as we've indicated, we are launching a number of outsized programs that are contributing to our Automotive Solutions revenues at this point and that has started and that will continue to pick up pace through the remainder of the year. You saw that growth in revenue from those elements. And the margin has improved sequentially, but there is a front end cost to launching some of these programs too. So as these new programs continue to grow in season, we expect that we'll continue to outperform the market and outperform our 5 to 10 percentage points in outperformance of the market for the foreseeable future and the margin should also improve.

Yeah. Okay. The other thing I want to ask you about is like, this European extrusion acquisition you've done, Halex. Can you just talk a little bit, like benchmark against your North American extrusion like how is their equipment, how is their technology, their know-how? I mean are you going to be learning from them? Are they going to be learning from you? Do they do heat treatment? All of those things, like how does it compare to the North American business?

Sure. There's a lot of similarities, and there's also quite a few differences. We are the largest player in the Americas by far. Halex is the second largest player in Europe. They build a very quality die. They have significant technical expertise. And I believe, as Nick mentioned on the call when we announced the acquisition, we do see synergies going both directions here from their know-how and our know-how and in leveraging that. I would say, with respect to their equipment, our equipment is generally much newer and more advanced.

We can't forget that Halex has been owned by private equity for the better part of 10 years. And these owners were not strategic players, but financially motivated. And as they typically do, they did not inject the sufficient capital in the business to maintain modern equipment. And we see the ability to improve things from that angle. And we're excited to close this acquisition, which we expect to do in our third quarter and get in there and start sharing the knowledge back and forth to our mutual benefit.

One of the things I understand you've done, like the North American extrusion business over the years is you've centralized all your engineering and CAD work. So rather than each plant having that capability and cost structure, it's kind of centralized into one area. So if I'm describing that correctly, how like, how is Halex like does each of their plants, do their own work in engineering and CAD or have they centralized it in the same way that you've tried to do here in North America?

It's a bit of both, depending on the country. We are certainly more centralized with those functions today than Halex is. We're not intending to, I mean Halex runs a very good operation. It's not our intent to go in there and change things drastically on day one. It's a quality operation, and we'll look to improve things over time.

Okay. And then just lastly, do they have more or less auto exposure than your North American operations?

I'm going to say its similar auto exposure as percent of extrusion demands are probably somewhere 15% to 20%, but growing strongly, and they would not be too dissimilar.

Okay. And this -- sorry, just on the -- sorry, I’ve one other thing, sorry. The large mold die cast business, as we're going to larger and larger molds. So you have to add equipment. What does that mean that you have to add milling machines that can deal with larger molds? I wasn't too sure what that meant.

Larger boring machines in particular, certainly increased crane capacity. We are taking our crane capacity to 100 tons, and that will be installed next month. So those are our primary elements. We're also on the back of our new market plant installing large heat treat equipment. We'll have the largest heat treatment equipment in North America after this install. It will give us capabilities that the market is going to require and don't currently exist.

Okay. And as I recall that new market, in the back, you have that one die cast machine. So does that have to be replaced for a higher tonnage machine?

No, not at this time. We're not planning to install our own Giga Press, but that's not currently on the cards.

But then how does it work? Like, how do you run prototypes and runoff?

We don't have to sample and process all the molds that we deliver. We have that function for any of the dies that we deliver currently. But it's not a requirement in order to build a mold or complete a rebuild for a mold of an extreme size.

So how does that work like do you start the sampling or the customer does it?

The customer would run it. We have engineers that go to the customer and participate in the process, to set things up, and we do it at the customer end.

Okay. I got it. Thanks for your comments.

Thank you. [Operator Instructions] There are no further questions at this time. Speakers, please continue.

Okay. Well, everyone, thank you for your time this morning. We look forward to speaking again next quarter. Take care.

Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect.