CA - AirBoss of America Corp. (ABSSF) Q3 2023 Earnings Call Transcript
2023-11-11 12:44:06 ET
AirBoss of America Corp. (ABSSF)
Q3 2023 Earnings Conference Call
November 9, 2023 9:00 AM ET
Company Participants
Gren Schoch - Chairman and Co-CEO
Chris Bitsakakis - President and Co-CEO
Frank Ientile - CFO
Conference Call Participants
Ahmed Abdullah - National Bank of Canada
Jasroop Bains - TD Cowen
Ben Jekic - PI Financial
Adam McBain - Cormark Securities
Kevin Chiang - CIBC
Presentation
Operator
Good morning, ladies and gentlemen. Welcome to AirBoss' Third Quarter 2023 Financial Results Conference Call. I would now like to turn the meeting over to Gren Schoch, Co-Chief Executive Officer. Please go ahead, Mr. Schoch.
Gren Schoch
Good morning, everybody, and thank you for joining us for the third -- AirBoss Third Quarter 2023 Results Call.
For our agenda today, Chris Bitsakakis will start with a review of the operational highlights for the quarter and year-to-date, followed by Frank Ientile, CFO, who will discuss our financial results before we open the conference line to questions.
Before we begin, I will remind listeners that our remarks today contain forward-looking statements, including our estimates of future developments. We invite listeners to review the risk factors related to our business in our annual information form and our MD&A, both of which are available on SEDAR plus and on our corporate website.
Also, we will discuss certain non-GAAP measures, including EBITDA. Reconciliations of these measures are available in our MD&A.
And finally, please note that our reporting currency is in U.S. dollars. References today will be in U.S. dollars, unless we indicate otherwise.
With that, I will turn it over to Chris.
Chris Bitsakakis
Thanks, Gren. Looking at our Q3 results, as we move through the end of 2023 and into 2024, each of our 3 business segments maintained their focus on strong operational performance, capturing new growth opportunities and making select capital investments while navigating the current economic and market challenges.
Consolidated sales levels were a couple of percentage points off the sales posted in Q3 of 2022. And gross profit was substantially higher due to a onetime inventory charge we took in the third quarter last year. After adjusting for this charge, our adjusted EBITDA and adjusted earnings showed reasonable improvement over last year's Q3 results. Importantly, we have generated free cash flow year-to-date in 2023 and have continued to reduce our net debt levels, which have declined by over $18.8 million to date in 2023.
As expected, our business units are carefully monitoring current demand levels, which in aggregate, are indicating reduced customer activity and order volumes. Within AirBoss Rubber Solutions, demand within the first part of Q3 was soft and showed some recovery through the end of the quarter.
AirBoss Defense Group saw some contraction in customer demand from both its Industrial and Defense segments. And last but not least, AEP maintained strong traction and built on momentum from prior quarters despite some of the early impacts of the UAW strike. Within each of our business segments, we have moved ahead with the implementation and in some cases, expansion of the cost-cutting measures we announced at the time of our Q2 conference call.
Looking more closely at our business segment activity, starting with ARS. For Q3 of 2023, we saw volumes decreased by 9.1% over the third quarter in 2022, with decreases across most of the sectors we service and the continued decline in tolling volumes. In Q3, we made the strategic decision to close our Chicago location, which you may recall was added to our portfolio of facilities when we purchased Ace Elastomer in 2021.
We have now shifted our production to improve capacity utilization at our other locations, while continuing to meet the needs of our customers previously served from the Chicago location. This as well as other cost continuing efforts have allowed us to continue to invest in our production capabilities and continue our applied R&D in partnerships with our customers.
A long-term priority for ARS remains focused on delivering growth through our position as a leading supplier, specialty supplier in North America, one with a valuable portfolio of specialty compounds combined with strong production capabilities. The ARS team is also focused on replacing the volume gap from tolling customers with more advanced, more consistent non-tolling volumes.
Moving now to Engineered Products, or AEP. We have seen continued solid momentum in its activity levels and financial contribution. We have definitely seen some negative effects of the UAW strike on the production schedules of the OEMs and Tier 1 suppliers. But given our success in updating our main supplier agreements in late 2022 and early 2023, we saw higher year-over-year volumes in our SUV and light truck platforms.
Looking forward, we remain very positive about the potential for AEP to increase its contributions to our financial results through 2023 and beyond through our focus on expanding our client relationships, developing new products and diversifying the sectors we operate in.
Moving on to ADG. We announced in late July that due to delays in converting sales opportunities for our suite of survivability products, we made the strategic decision to implement a series of measures to reduce ADG's cost, streamline operations and reduce ADG's breakeven point metrics as we await new contract awards. Our focus during this process was to create a much closer alignment of the operating cost base within ADG and its ongoing level of business activity.
The cost saving measures are expected to result in approximately $5 million in annual cost reductions once fully implemented. Through this process, it was also imperative for us to ensure that our ability to deliver against current and future supplier agreements remain strong, which I also believe we have accomplished. The ADG survivability platform remains fully capable to execute against its current and future awards as recent evidence of the capabilities of ADG's product portfolio.
In early July, we announced new contracts for AirBoss Molded Glove and also our Bandolier line charge system. In addition, ADG received 2 new orders for Bunny Boots during the quarter. On a combined basis, these new orders have an aggregate value of approximately $34 million and demonstrate the diversity of ADG's line of survivability solutions.
During the Q3 meeting of our Board of Directors, the decision was made to return our common share dividend to pre-2021 levels as part of our overall efforts to maintain our emphasis and recent progress on strengthening our balance sheet.
Looking forward, we continue to see the provision of a dividend as part of our value proposition to our investors. We remain confident that our products, along with our production execution capabilities continue to position us to deliver long-term value for our shareholders.
I will now pass the call over to Frank for the financial review.
Frank Ientile
Thanks, Chris, and good morning, everyone. As a reminder, all dollar amounts presented today are in U.S. dollars, except for dividends per share, which are in Canadian dollars. Percentage changes compare Q3 2023 to Q3 of 2022, unless otherwise noted.
Starting from the top line, consolidated Q3 net sales were $102.2 million, which were 2.4% lower than Q3 of 2022 with a year-over-year decline in sales within AirBoss Rubber Solutions and ADG that was partially offset by higher sales in Engineered Products.
Consolidated gross profit increased to $13.8 million, which was substantially higher than our gross profit in Q3 of 2022 given the onetime charge taken against inventory within ADG during Q3 of last year.
As a percentage of sales, gross margin contribution was 13.5%. Improved volumes within AEP were a significant contributor to our gross margins, along with the overhead cost reduction measures we have put in place in our business segments.
Our adjusted EBITDA increased to $7.2 million in Q3, and our Q3 2023 adjusted profit was negative $2.6 million or a negative $0.10 per diluted share compared to negative $11.8 million or negative $0.44 per diluted share in Q3 of 2022.
Turning now to our individual segments. ADG's net sales decreased 10% to $21.2 million, with the decrease primarily due to a modest decrease in volume in the industrial sector and molded defense products. Gross profit at ADG increased to $2.6 million with lower overhead costs implemented late in the quarter, offset by an unfavorable product mix and lower volumes.
Net sales at AirBoss Rubber Solutions decreased 12.9% to $51 million in Q3, driven by a 9.1% decrease in volumes across many of our end-use markets during the early part of the quarter, followed by a modest recovery towards the end of the quarter. Gross profit at ARS decreased 8.7% to $7.6 million due to volume reductions in product mix and was partially offset by overhead cost reduction and mix initiatives. Q3 2023 gross profit as a percentage of sales was 15%, which improves on the 14.3% margin posted in Q3 of 2022.
Net sales in the Engineered Products segment increased by 28.5% to $37.5 million due to higher volumes and product mix in the SUV and light truck platforms and partially offset by the impacts of the UAW labor strike on OEM production schedules. Gross profit at AEP increased by $7.7 million over Q3 of '22 to $3.6 million, and this was due to volume improvements for certain vehicle platforms, product mix, improved arrangements with our key suppliers and customers, along with our ongoing cost management efforts.
Free cash flow for Q3 was an inflow of $6.6 million, which supported our continued investment in capital assets and further reductions of our debt. CapEx was $2.1 million in Q3 of 2023, and we reduced our net debt balance by a further $4.3 million in Q3. We continue to ensure we maintain sufficient liquidity to fund the growth of our business. Our revolving credit facility availability is $250 million with an accordion of $75 million and approximately $113 million was drawn at the end of Q3.
As of the end of the quarter, we had net debt of $91 million for a net leverage ratio of 2.49x trailing 12-month adjusted EBITDA.
With that, I will now turn the call over to Chris.
Chris Bitsakakis
Thank you, Frank. Operator, at this point, we can open up the line for any Q&A.
Question-and-Answer Session
Operator
[Operator Instructions] First question is from Ahmed Abdullah from National Bank of Canada.
Ahmed Abdullah
My first question is about the savings that were announced, which are expected to contribute $7.7 million adjusted EBITDA. Does this include the $5 million savings that you were already discussing at the corporate update that was given in July? Or is this over and above?
Frank Ientile
No. Thanks, Ahmed, for the question. This includes the $5 million that was previously announced for ADG, was obviously expanded to the other segments, both ARS and AEP as well.
Ahmed Abdullah
Okay. Got it. And is there -- I know it's maybe a bit early, but is there any way that you can perhaps, quantify or give us some sort of goalposts to the UAW strike impact that could occur in Q4.
Chris Bitsakakis
So Ahmed, we did see some small impact in Q3 from the UAW strike. That impact was small because a lot of our products go on SUVs and light trucks and the UAW left that tool in their tool bag until later.
So early in Q4, they did shut down some pickup trucks and SUV plants. So the impact became greater. The good news is that it was very short lived. And the indication that we're getting now from the big 3 and others is that we should be preparing to be working extra over time to make up that gap.
So at this point in time, it's hard to say what the overall impact is going to be from the UAW strike. But I would say, we're quite pleased that it was quick, and there appear to be indicators that they want to make up that volume. So we'll know better as the quarter progresses. But at this point in time, don't see it as a dramatic impacts either on Q3 or on Q4.
Ahmed Abdullah
So -- but do you have the capacity to make up that shortfall within the Q4 in case the orders come in?
Chris Bitsakakis
Yes. We do.
Ahmed Abdullah
Perfect. And then just last one for me. Chris, you've been in the co-CEO role now for -- since July. What have been the takeaways as you reflect on all the segments and where things are going, what takeaways can you share with the Street? And should we expect some sort of strategy to be communicated to the Street over the next coming months?
Chris Bitsakakis
Yes, that's a really good question. We could probably spend a lot of time on that. But since July, we started a very deep, in-depth strategic review on every single product line we have, every market that we operate in, how we're set up and structured operationally, what our back office systems look like.
And so we -- I've been putting a lot of effort with our team here to create sort of a strategy for cost of the future. And luckily, we have a very strong foundation, some excellent products and some incredible people that work for us. And so come towards the end of this year, we'll be reviewing that strategy with the Board of Directors and communicating something shortly after that to the market in terms of what we see, the vision for AirBoss to be in the short, medium and long term.
Operator
[Operator Instructions] Our next question is from Jasroop Bains from TD Cowen.
Jasroop Bains
So we -- you guys already answered our UAW question. So we only have one additional question. We're wondering if you could provide some color on the cost saving initiatives.
Last quarter, you noted that the majority of the then $5 million in cost savings have been executed on. Is the majority of the $7.7 million of cost savings executed on -- in Q3? Or will some of it leak into Q4? Is that how we should think about it? Or if you could provide a bit more color, that will be much appreciated.
Frank Ientile
Yes. Thanks, Jasroop. It's Frank here. Good question. Yes, the $5 million that we mentioned after Q2 was fully executed and the remaining $2.7 million, substantially all of that has been executed at the end of Q3. So we will start to see the full impact in Q4 for the full savings annualized $7.7 million.
Jasroop Bains
Okay. Perfect. And then actually, I guess, I just wanted a clarification on the UAW strikes. So you guys had noted that it had an immaterial impact on Q3 results as well, right? Or was that just in reference to Q4?
Chris Bitsakakis
Yes. Q3, I'd say was an immaterial impact. Q4 -- early in Q4, it's a more material impact. However, indications are that there's going to be some catch-up on that volume. So there will probably be some impact in Q4, but we don't view it as going to be overly dramatic.
But at this point, it's hard to estimate because not all the releases have come in yet from the customers that are forecasting exactly what their requirements are going to be by the end of December. But the indications from the different purchasing departments or customers is that they -- that we should prepare to run over time because they're going to need to make up that volume. So that's kind of in that in-between phase that we're at right now.
Operator
Our next question is from [Teresa Lee] from Valkyrie Capital.
Unidentified Analyst
My question is more related to free cash flow generation going forward. Can you talk a bit about use of working capital in a -- if you're in an economic downturn, do you generate more cash from working capital during that time?
Frank Ientile
Teresa, this is Frank. Usually, yes, we continue to focus on deleveraging. And obviously, during economic downtimes, we're very focused on pulling all the working capital levers to convert cash more quickly, managing our inventory and also being very cautious with our CapEx spend.
Again, we monitor very closely and work with each of the segments to make sure we're maximizing the cash flow opportunity to continue to pay down debt. And so we're being very cautious and very aware as we move forward.
I would suggest though, as we get into year-end, as every company starts to tighten up things, there will be some pressure on free cash flow in Q4, but we anticipate continuing the trend that we've had so far this year into '24.
Unidentified Analyst
And does maintenance CapEx about where you are now, like about $4 million a quarter? Or like what's the annual maintenance CapEx.
Frank Ientile
Annual maintenance CapEx is usually in the $10 million to $12 million range. And -- but we've been cautious, obviously, but we'll continue to invest where appropriate.
Unidentified Analyst
So if you generate kind of cash flow of, call it, $25 million a year and $10 million to $12 million of free cash flow -- $10 million to $12 million in maintenance CapEx then you have kind of $10 million to $15 million in free cash flow to pay down debt, annually?
Frank Ientile
Correct.
Operator
Our next question is from Ben Jekic from PI Financial.
Ben Jekic
Yes. I wanted to ask -- can you hear me?
Chris Bitsakakis
Yes.
Ben Jekic
I wanted to ask about the dividend cut. And can we read into that a certain payout ratio that is implied for 2024, 2025? Or -- what made the $0.03 reduction come about and not, say, [$0.02 or $0.04].
Gren Schoch
It was our best -- our best estimate of what we should be doing. Obviously, you can't pay out more money than you're earning forever. The dividend has been increased significantly when the Defense division was doing much better than it is now. And when it was -- when it had those big contracts.
So right now, we have a focus on deleveraging with interest rates where they are, our interest costs are very high. And I think just the way the stock was trading, the market was speculating the dividend, wasn't sustainable.
Could we have sustained to that 10%? Yes, we could have, but we felt that we weren't getting any real benefit from doing that. And it also demonstrates to the market and our lenders that we are being conservative and trying to maximize our deleveraging efforts.
Operator
Next question is from Adam McBain from Cormark Securities.
Adam McBain
Just very quickly, most of my questions have been answered, but it's nice to hear your commentary around your commitment to paying down debt. I'm just curious, more of a clarification question. What is your target ratio? Like where are you trying to take the balance sheet to going forward?
Frank Ientile
Adam, this is Frank. I mean obviously, if you look at us from a historical perspective, our comfort level is leverage at below 2.5, and I think that's where we want to get to high 1s, low 2s, but we continue to make that the biggest priority and continue to focus on converting cash, paying down debt and being very efficient with how we're managing the cash flow and obviously then giving us some bandwidth to look at other strategic investments as required.
Adam McBain
Got it. That's helpful. And then I realize that you've been reducing some of the headcount in ADG. I'm just curious, if you were to win a large contract, how quickly would you be able to ramp up for that?
Chris Bitsakakis
Yes. We were very careful and very surgical in the reductions at ADG, which, as Frank mentioned earlier, we expanded some of those same processes to find those efficiencies in the other 2 groups as well. And we did it very carefully so that there would be no impact in our ability to ramp up. We still have a very large and healthy pipeline of opportunities, and we want to make sure that we can capitalize on them when they happen. So we were very careful not to affect that ability to ramp up quickly with some of the changes that we made.
Operator
We have next question from Ahmed Abdullah, National Bank of Canada.
Ahmed Abdullah
Yes. Just a follow-up. Are we expecting to see another add back of restructuring charges in Q4?
Frank Ientile
Ahmed, it's Frank here. Not at this point. As I said, we're very careful and sure we did what we needed to do, which has been announced, but now we're really looking to execute on the strategy, the cash conversion and obviously, the gained efficiencies as a result of the restructuring.
Operator
And last question at this time from Kevin Chiang from CIBC.
Kevin Chiang
I apologize if some of this has been asked already. I jumped on from another call here. It feels like a pipeline, feels pretty good, right? You've been talking about that for a few years here. Just getting these orders through has been a little bit more challenging.
I think if you take a step back, I'm just wondering outside of some of the restructuring you've done and as you mentioned, some of the changes you made in ADG, just -- are you rethinking maybe the broader strategy here to maybe give yourself or things you can do to give yourself more earnings visibility or maybe reducing kind of the boom and bust nature of your earnings profile just given, if a big contract comes through, you obviously earn multiples of what you're earning today and if it doesn't, you're a fraction of that. Just I guess, strategically, how you think about that to maybe smooth the sell through the cycle.
Chris Bitsakakis
Yes. It's difficult to give too much color on that right now because we're right in the middle of that sort of deep dive strategic review on all our product lines and kind of what we want to focus on and don't want to focus on. Certainly, the pipeline of opportunities for ADG is still very, very strong.
Clearly, the government contracts related to executing on those opportunities have been a little bit elusive and we see governments struggling with funding, see governments with debt ceiling issues and a bunch of things like that, that make the conversion of that pipeline for us is very frustrating. And it does lead to sort of that, that boom and bust fluctuation where there are times where we have immense amounts of work, and there are other times where we go drive for an extended period of time.
So that fluctuation is something that concerns us, of course. And it's one of the many items that we're considering in our strategic review in terms of how we want to be able to go to market with a more consistent expectation on revenue and profit generation without these massive swings and what that means in terms of either broadening the portfolio and narrowing the portfolio, adjusting the markets we serve. All these things are sort of on the table as we would like to find a way to a path to a more consistent operating model based on the markets that we serve.
Kevin Chiang
And just -- I would have thought, maybe you would have thought the same thing, and it'd be interesting to know what you're hearing from, I guess, the U.S. Defense Department and other defense bodies that you work with. But I would have thought what you sell into that end market is more recurring in nature, more of a fixed spend versus when I think of defense projects that typically get or are at risk or get cut during budget issues or usually larger programs, like fighter jets and things like that, where you can maybe push that out or maybe more marginal programs.
Just I guess, is there -- do you have a different view, the ideal situation today around maybe the recurring nature of some of this stuff? Because I would imagine you would need this equipment regardless where the budget is. So I guess, I'm surprised that this is the stuff that's getting cut or this is stuff that gets delayed just given it seems like a low dollar amount. And obviously, there's a significant PPE component to this.
Chris Bitsakakis
Yes, it's -- I agree with you. I think we have that same expectation. Now having said that, Q3 was actually a pretty good quarter for us in terms of some singles and some doubles on some recurring business. We got a new CBRN glove order. We got a couple of Bunny Boot orders.
So we're seeing some orders coming in. That's more of that recurring nature that is sort of our -- at least our base business from that perspective.
But it's interesting, you mentioned fighter jets and things like that. It seems like during times of conflict like we have now, those get more attention than some of the products that we have. And with the constraint on budgets and particularly, the U.S. government with the amount of support and other -- all the G7 governments really the amount of support that they're giving to the Ukraine and to other part -- other hotspots in the world now, it seems to be really driving up sales of things that are sharp pointy versus the types of products that we make.
But we have an expectation that especially with some of the talk around, chemical weapons and the threats of chemical weapons that at some point, we're going to see a fairly significant uptick on what we do. But we just haven't seen that yet, and it appears that with all the budget concerns, some of the more sexy items are getting more attention. But we expect that soldier protection will always be there, and we'll continue to drive revenue. But at this point in time, other than, like I said, a pretty good quarter in Q3 for some of the baseload business. Up until now, we haven't seen much of it.
Kevin Chiang
And just last question from me. Does the U.S. -- I guess presidential election next year, does that impact when you go back when you look back historically, would that impact how orders would come through? Like -- is next year a potential year where people are more reticent to spend, just because you might have a change in administration? Or historically, when you look back, that's been kind of a nonevent in terms of impacting bids and potential orders.
Gren Schoch
Obviously, the presidential election has an effect, although, I think, both presidents are in favor of strengthening the military. The biggest issue we've had in the U.S. is the [sale made] in Congress and the threats to shut the government down. Debt ceilings were passed -- on the condition that they took, that they take unspent PPE money and cut back.
So there -- they had announced that they were going to build up a huge strategic stockpile of PPE in case there was another pandemic. Well, that has impact -- it's happened to some extent but -- certainly not to the extent that they've been talking about. And one of the conditions that the debt ceiling was -- past the last time was that they agreed to call back unspent PPE money.
So that directly hurt us. It doesn't change the need, they will need it. But it's not that they need a new budget to deposits. So the political theater that's happening in the U.S. is not constructive.
And Canada, not that we matter, but our Prime Minister has seem fit to -- like we don't even come close to making our NATO commitments. Either our Prime Minister sees fit to take $1 billion out of the defense budget, which is already 50% of what it should be. It's very frustrating, but that's what we're dealing with.
Operator
There are no further questions at this time. I will return the meeting back over to the floor for closing remarks.
Chris Bitsakakis
Thank you, operator, and thanks again to everyone for attending today's call. Please reach out to us directly or through our Investor Relations team if you have any questions on our results or in general. Thank you, and have a great day.
Operator
Thank you. Your conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.
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AirBoss of America Corp. (ABSSF) Q3 2023 Earnings Call Transcript