© 2024 Alpha Spread Limited. All Rights Reserved.
www.alphaspread.com is not operated by a broker, a dealer, or a registered investment adviser. Under no circumstances does any information posted on www.alphaspread.com represent a recommendation to buy or sell a security. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. In no event shall Alpha Spread Limited be liable to any member, guest or third party for any damages of any kind arising out of the use of any content or other material published or available on www.alphaspread.com, or relating to the use of, or inability to use, www.alphaspread.com or any content, including, without limitation, any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages. Past performance is a poor indicator of future performance.
You don't have any saved screeners yet
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, ladies and gentlemen. Welcome to the Second Quarter 2023 Financial Results Call. I would now like to turn the meeting over to Chris Bitsakakis, President and Co-CEO. Please go ahead, sir.
Thank you, operator. Good morning, everyone, and thank you for joining us for the AirBoss Second Quarter 2023 Results Conference Call. My name is Chris Bitsakakis, President and Co-CEO. For our agenda today, I will start with a review of the operational highlights for the quarter and year followed by Frank Ientile, our 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 risk factors related to our business in our annual information form and our MD&A, both of which are available on SEDAR plus 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. I'll start today by outlining our Q2 results and providing an overview of what we are seeing within our business segments as we move into the second half of 2023. In aggregate, our 3 business segments continued to focus on operational execution, growth initiatives and key investments throughout our business despite the current economic headwinds. Our consolidated sales levels and gross profit were higher than the second quarter of 2022, but a combination of elevated operating expenses and interest costs had a negative impact on our profitability for Q2 this year. From a demand perspective, some of the improvements we saw exiting Q1 continued through to Q2, but customer volumes remain below those experienced in 2022 within our AirBoss Rubber Solutions and AirBoss Defense Group. Even as we saw a reduction in our profit as compared to Q2 of last year, we have posted strong free cash flow generation for the quarter and year-to-date in 2023, which has allowed us to continue investing in the business while also reducing our net debt levels, which have declined by over $14.5 million to date in 2023. Turning now to our business segments. Looking specifically at ARS, we were active in 2022, making investments to improve our efficiency and expand the suite of compounds we supply to our customers, and ARS posted record performance in 2022. For Q2 of 2023, ARS saw improvements in demand over the prior quarter this year, but volumes are still below Q2 of 2022 with decreased volumes largely due to decreased demand from tolling customers.
And while we posted an 8.5% year-over-year decline in sales within ARS in Q2, we were pleased to see that our investments in production automation allowed us to successfully offset reduced sales volumes with improved margin contributions from this business segment. And as I mentioned earlier, the improvement from Q1 to Q2 of this year and volume was about 12%. ARS continues to apply its research and development expertise toward new collaborations with its customers and new products to add to its current range of solutions. And our long-term priority for ARS remains focused on delivering growth through our position as a leading specialty supplier in North America, one with a valuable portfolio of specialty compounds combined with strong production capabilities. For the balance of this year, ARS remains focused on replacing the volume gap from tolling customers with more advanced and more consistent nontolling volumes as we await a rebound in tolling volume. Looking at Engineered Products, or AEP. This business segment continues to build on the momentum recently established with key suppliers and customers to deliver strong performance in Q2. Economic headwinds continue to impact the production schedules across certain OEMs and Tier 1 suppliers. But despite these influences, we saw higher year-over-year volumes in our SUV and light truck platforms, which supported solid net sales growth and gross profit contributions from AEP in the second quarter.
We continue to see opportunities to increase that our contributions that AEP can make 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 solutions, 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 chart system. These new contracts have an aggregate value of approximately $22 million and demonstrate the diversity of ADG's lineup of survivability solutions. Regarding M&A, we actively monitor our main markets for acquisitions that have the potential to build our portfolio of products or compounds, advance our technical capabilities and expand our geographic presence. Looking forward, 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.
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 Q2 2023 to Q2 of 2022 unless otherwise noted. Starting from the top line, consolidated Q2 net sales were $114 million, which were 3.2% higher than Q2 of last year, with a strong increase in AirBoss Engineered Products more than offsetting a decline in sales within AirBoss Rubber Solutions during the quarter. ADG's net sales were relatively flat to Q2 of 2022. Consolidated gross profit increased to $17.6 million, which was 18.8% higher than our gross profit in Q2 of 2022. As a percentage of sales, our gross margin contribution was 15.4%, which was 200 basis points above our gross margin contributions in Q2 of last year. Improved volumes within AEP were a significant contributor to our gross margins as well as a strong gross margin percentage within ARS despite lower sales levels compared to last year.
These gains were partially offset by lower gross margin within ADG primarily due to an unfavorable product mix. Q2 adjusted EBITDA decreased to $5.2 million, impacted primarily by higher general and administrative costs as a percentage of sales. Quarterly loss was $2.6 million or negative $0.10 per diluted share compared to $2.5 million or $0.09 per diluted share in Q2 of 2022. Turning now to our individual segments. ADG's net sales increased 0.6% to $26 million, with the increase primarily due to increased deliveries of certain molded defense products. Gross profit at ADG decreased to $4.2 million, with the decrease driven by an unfavorable product mix and higher overhead costs. Net sales at AirBoss Rubber Solutions decreased 8.5% to $57.8 million, driven by reduced volumes across many of our end-use markets. Gross profit at ARS decreased to 1.7% to $9.6 million due to volume reductions and product mix. Q2 2023 gross profit as a percentage of sales was 16.7%, which was an improvement over the 15.5% margin posted in Q2 of 2022. Net sales in the Engineered Products segment increased by 40.3% to $37.7 million due to higher volumes and favorable mix in the SUV and light truck platforms. Gross profit at AEP increased by $8.5 million over Q2 of '22 to $3.7 million. And this was due to improve derangements with our key suppliers and customers, volume improvements for certain vehicle platforms and product mix, along with our ongoing cost management efforts. Free cash flow for Q2 was an inflow of $14.5 million, which supported our continued investment in capital assets and further reductions of our debt. CapEx was $2.4 million in Q2 of 2023, and we reduced our net debt balance by $10.6 million. 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 $116 million was drawn at the end of Q2. As of the end of the quarter, we had net debt of $95 million for a net leverage ratio of 3.11x trailing 12-month adjusted EBITDA. With that, I will now turn the call over to Chris.
Thank you, Frank. Maria, at this point, we can open up the line for Q&A.
[Operator Instructions] The first question is from Kevin Chiang from CIBC.
Maybe just on the volume trends you're seeing within ARS. I'd be interested in knowing just kind of how that progressed through to the second quarter? And I guess here, as we're in the middle of the third quarter. Are you seeing signs that I guess, the sales pressure has troughed? Or are you still seeing sales trying to find a bottom here as we progress through the second half of this year?
Kevin, we saw -- in terms of volume, we saw a 12% increase in volume from Q1 to Q2. What we saw in about December of last year was significant drop in our tolling volumes and some kind of residual softness around some of our other customers. And -- but the really big driver was the tolling volume that drove it down. We saw that continue into Q1. However, we've been successful in being able to bring on new nontolling customers for Q2, which brought us our 12% increase in volume from Q1. And we have lots of plans in place for Q3. We're bringing on new customers as we speak and into Q4 and this is a sort of a strategy we've had for a while to be a little less reliant on these tolling volumes. And because of the way -- I know you cover the transportation and automotive sector, the big tire companies, which are predominantly where a lot of the tolling volume comes from, a lot of their volume is related to truck tires. And when you see freight rates start to drop and trucking sort of start to drop a little bit, you see a lower demand in truck tires, which we think is what's driving that tolling volume decrease because what happens is it then opens up capacity in their own internal mixing, which then gets -- then they look at bringing outside mixing in. Now with several of these tolling customers, we have specialty compounds with them that don't go in and out. But the overflow that does come out as soon as there's a little bit of a decline, particularly in truck tires, then you see that volume go back into their own mixing capacity, which is why for years, we've sort of had a plan in place to make us less reliant on tolling volumes because when they're here, it's great because it eats up capacity and works well for us.
But at the same time, it gets kind of lumpy at times. So it's accelerated our strategy a little bit. It's allowed us to utilize the investments that we've made in research and development. so that we can develop new compounds, attract new nontolling customers, more specialty customers as well and bring them in for a much more stable volume, which is what you're probably going to see for the balance of this year.
And just as you think about growing the nontolling volumes, it sounds like you've been -- you continue to be successful in grabbing market share. I guess I'd be interested in understanding what exactly -- I guess what's the value proposition that you're putting forward here as you grab some of that market share, is it the mixing capabilities, some of the R&D you've done? Is it price? Is it just having that excess capacity? So maybe service is better? Just wondering what that value proposition that you're bringing to the table to drive some of that market share shift?
Yes. Our value proposition has always been the same. It's not really a price-driven value proposition, at least not a -- from our perspective, a sale price. We've really invested in research and development, we have the, I think, the best R&D team in R&D facilities in North America for custom compounding. And we're able to utilize those assets to develop new compounds that can solve problems for our customers.
And quite often, some of the problems that we solve make them more efficient, which in the end for them is a cost save. But it's not a strategy that we're going to go in and take a compound and just drop the price and create a price war with our competitors. That's not the intention. The intention is to use technology, innovation and the value equation of our higher-end equipment are more consistent mixing and our high quality to be able to still command a better margin but solve problems for our customers so that their end cost is actually lower.
And maybe just last one for me. I mean, obviously, you're probably seeing all the headlines with the union negotiations with the big 3 auto. Just wondering, I guess, from your perspective, if you're taking any contingency plans now? Are you seeing anything from the OEMs themselves in terms of maybe ramping up capacity to build inventory in the event that there's a labor disruption. Just wondering what you're seeing within AEP as the industry potentially faces this existential risk?
Yes. We are seeing certain product lines, certain vehicle lines that are working a little bit over time, but we're not seeing the sort of massive buildup of inventory from the customers. And I'm sure you could probably answer that question even better than me. Of course, we're concerned about it. We hear the rhetoric and the rhetoric seems to be quite aggressive and the demands are quite aggressive. . And from our perspective, because most of our products are on light truck and SUV, those are the most valuable sort of product lines for our customers as well. So I suspect that they're going to defend their ability to keep producing those products, and we'll negotiate in good faith. And at this point, we're hopeful that they can find a resolution. But in terms of a crystal ball, I'm not seeing any sort of panic from the customers where they're ordering way ahead or anything like that. So I'm assuming that they have a strategy in place that they feel could work.
The next question is from Tim James from TD Cowen.
Just staying with AEP for a moment. I think the indications, if you will, from the first quarter call were for revenues there to kind of head towards that 2019 level, I think it was sort of in and around $125 million. The company has reported $77 million through the first half of the year, employing obviously much less than in second half. Is there kind of an update to that full year indication that we should have for AEP revenue? And if so, what has changed?
Tim, it's Frank. Thanks for asking. I think Q2 is now more reflective run rate of what we're going to see and still in line with sort of what we had indicated as it related to 2019, obviously, with top line being maybe a little bit heavier, but the margin profile as we mentioned previously in the double digits with EBITDA and sort of the mid- to high single digits is sort of where we're looking to land.
Keeping in mind that there were some other adjustments and things that took place in Q1. And obviously, what happened also in Q4 of 2022, which really sort of maybe distorted the figures. But going forward, I think this is more sort of a landing and run rate moving forward.
Okay. That's helpful, Frank. Then I'm just wondering if it's possible, Chris, to get into any more detail on the cost savings initiatives in ADG. You've outlined kind of $5 million annually, I assume that's primarily kind of operating costs, excluding any D&A. How long will it take you to implement those cost savings initiatives? And when should we kind of see them hit a full rate benefit?
Tim, the majority of those savings have already been executed on. There are some small amounts of noncritical items that still need to get tidied up. But for the purpose of this question, everything will be completed in Q3.
So we can expect or should think about sort of $5 million annualized reduction in the operating costs in ADG then effectively as of kind of Q4 is pretty reasonable.
Yes, that's correct. And we were quite surgical in what we did there to make sure that with this continued pipeline of opportunities that we still expect not to be -- not to kind of handcuff ourselves in a way that we can't execute appropriately on them. So I think the team did a good job in lowering the breakeven point while still retaining the capabilities to execute on the new awards.
Then same with defense, I'm just wondering if you could provide a bit of an update on, there were a number of kind of Husky awards that the company has received recently, there was a 10 vehicle contract, a 3 vehicle for a West African customer and then I believe there were some spares and parts from a contract a couple of years ago.
How much of these contracts -- is it possible to sort of give us a rough idea of the contribution from Husky related revenues in the quarter? And if you could just update us on the status of those contracts.
Yes. Tim, on the financial part, I could say from what we had announced, roughly 25% of that Husky award was delivered in the quarter. Obviously there is still more to go through the rest of this year and beyond from what we had announced previously.
Sorry, Frank, 25% of which one? The combination, so 10 plus...
Correct.
Sorry, the 10 vehicle one?
Correct. The 10 vehicle one. So essentially 3 were delivered.
Yes. So I don't know if you have caught up, but 3 of the vehicles were delivered in Q2, Tim.
And then approximately 25% of the 10 vehicle, 1 was also recorded. Is that right?
No.
No. So that was a bit of a misunderstanding, I think. Out of the 13 vehicles, 3 of them were delivered in Q2.
Okay. Is there any -- the contract from -- I can't remember whether it was '21 or '20, some spares and parts that was going to run for a fairly prolonged period. Is that generating any revenue today? Or is that -- what's the status of that piece of business?
Yes, Tim, that contract extension is still in play, but again, nothing has come to fruition at this time, but we're obviously staying close to them and available to support demand as we move forward.
[Operator Instructions] We have a question from Adam McBain from Cormark Securities.
I am filling in for David Ocampo. When I look at leverage, as you pointed out, I see it's at 3.1 turns versus 2.4 turns at the end of last fiscal year. So my understanding that you have a couple of financial covenants in there, but specifically one capping max leverage.
Can you just remind us how much room you have under that covenant, how you're thinking about the balance sheet in that context? And maybe share with us some of the levers that you have available in order to stay on side?
Yes, Adam. As it relates to our covenants, we're obviously very focused on liquidity and delevering as you saw the generation of free cash flow for the quarter. So as a result of our actions as it's related to converting AR, reducing our inventory and obviously, supporting our cash conversion cycle. We're very comfortable that we're still obviously within our limits, and we are very proactive with our bank syndicate as well always to make sure that we're on site and that we're working towards delevering.
And as we've said before, part of our process here is to really stay on top of our cash collection but also as we landed and announced some of the new deals as EBITDA comes in, that's going to help support us on the consolidated net debt ratio. And the other one is on the consolidated interest expense ratio, which interest is going up. So we're obviously monitoring it closely. And we've, as disclosed in our financial statements, entered into several interest rate swaps to help reduce and mitigate some of that interest expense.
Again, being very proactive in how we're managing the leverage going forward. So we don't anticipate any issues through the end of this year and obviously continue to focus as we forecast out into 2024 as well.
The next question is from Ahmed Abdullah from National Bank.
Looking at where the stock is right now and the dividend yield, is there a yield target or a payout target that you guys are considering for maybe freeing up some liquidity?
That's a good question, Ahmed. I mean I don't think we have a specific target in mind. We're very focused, obviously, on managing our cash flow, as mentioned previously. We're also very focused on returning to our shareholders and very committed to that as well. So I think we're just being very cautious as we move forward. But at this point, we're proceeding as is from that perspective. But staying the course understanding that there has been some challenges on the share price recently.
And with the loss on the ADG EBITDA, can you give us a sense as to why the Husky contract, which was, to my understanding, a higher-margin business was not able to offset some of the weakness that's there given that you've got 3 vehicles out of the 13?
Yes. Ahmed, there was some additional cost and charges that flowed through ADG in the quarter, as noted in the financial statement, Note 5 related to inventory. So part of our quarterly review of inventory aging. So there was some additional obsolescence that was booked that obviously offset some of that. And that's just normal course as we go through our business. So we're obviously very focused on that as well.
There are no further questions registered at this time. I would like to turn back the meeting over to Mr. Bitsakakis.
Thank you, operator. This concludes our question-and-answer period. Thanks, everyone, for attending today's call. Please feel free to reach out to us directly or through our Investor Relations team if you have any questions on our results or anything in general. Thank you, and have a great day.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.