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Thank you for standing by, and welcome to the Exco Technologies Limited Third Quarter Results Call. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. Darren Kirk. Sir, you may begin.
Thank you, Tequila. Good morning, ladies and gentlemen. Welcome to Exco Technologies Limited Fiscal 2020 Third Quarter Conference Call. I am Darren Kirk, Chief Executive Officer of Exco. I will lead off with an operations overview. Matthew Posno, our CFO, will then review the financial results. Our Chairman, Brian Robbins, is also on the call with us. The format of this conference call will be the same as in the past. After a brief presentation, we will take questions. The call will end no later than 10:40. Before we 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 the content of the cautionary notes, we do claim their protection for any forward-looking information that we might disclose in this conference call today. First, I'd like to address the formidable challenges that we are all facing with respect to COVID-19. Exco continues to take the necessary actions to protect the health and safety of our employees, meet the ongoing needs of our customers and minimize the adverse impact on our finances. Of course, we are also continuing with the necessary investments to both solidify and enhance our competitive positioning for the immediate and longer term. In summary, I am very satisfied with our overall results this quarter in context of the extremely challenging market conditions we faced. Our performance demonstrates the benefits of our diverse operations, the strength of our leading positions in niche market segments, gains from our various efficiency initiatives and the essential nature of our tooling products, which feed into many critical industries beyond just the automotive sector. With the help of our enhanced safety measures and commitment of all of our employees to working safely, the vast majority of our plants operated continuously through much of the quarter. These attributes enabled us to generate positive EBITDA, significant free cash flow and achieved near-breakeven profitability. While we hope and expect the worst of this pandemic is behind us, we know much uncertainty remains. But with our strong market positions, continuous improvements in our efficiency and exceptional financial strength, we remain extremely optimistic in our future prospects. I'll begin my operations overview with our Automotive Solutions segment, where we started the quarter with automotive production in both North America and Europe at a virtual standstill. 3 of 4 plants in the segment were similarly idle through all of April and much of May due to lack of OEM production and in respect of stay-at-home orders in the regions where we operate. Altogether, combined vehicle production levels in North America and Europe were down almost 70% this quarter over the prior year period. Our foreign exchange adjusted revenues performed better than this, which continued our track record of outperforming industry vehicle production levels. Segment revenues in the quarter were supported by accessory product sales for which demand is more closely aligned with vehicle sales volumes rather than production levels. However, we did also have some program launches earlier in the year that contributed to our outperformance. Looking at industry vehicle sales levels, I would point out that even through the widespread shelter-in-place orders through much of the quarter, U.S. vehicle sales came in at roughly 2/3 of pre-COVID levels, signaling firm underlying demand for new vehicles. As can be seen on Page 7 of our presentation, monthly trends in OEM production and sales were positive through the quarter with sequential improvement in each May and June. Towards the end of the quarter, our 4 plants were operating at around 75% of normal volumes. OEM production is expected to further improve through the remainder of calendar 2020 with expectations for only a modest decline compared to last year. We remain focused on ensuring we are able to meet this demand as it materializes. We have taken several actions on this front, including refining employee safety measures, building finished good inventory levels where we can and strengthening the robustness of the supply chain across our businesses. Looking at core activity and new awards, it has remained relatively slow in the last few months across the group. Nonetheless, we are still very much active in this regard and continue to win new programs, which will bode well for our future results. Moving on to the Casting and Extrusion segment. Sales were modestly lower than the prior year quarter, but our sales held up much better than general economic conditions would otherwise suggest. This solid performance most reflects the long cycle and/or critical nature of our tooling products. Many of our extrusion tools, for example, feed into the -- into essential industries, including medical equipment, food and beverage packaging and building materials for emergency facilities, just to name a few. Our results, however, also speak to the strong market positions of our various businesses, contributions from the significant investments that we have made in recent quarters to boost our efficiency and the benefit of our scale and multi-plant footprint. These advantages are unmatched by any of our competitors across the segment. Within this segment, sales were relatively stable in the Large Mould group as work continued under many of our existing programs despite the sharp downturn in vehicle production levels at virtually all OEMs. As well, we did take on some short-term casting runs to help out one of our customers during the quarter, which improved mix and contributed to the group's solid results. Our various efficiency initiatives also continued contraction, further validating the radical overhaul of our manufacturing methods that we've undertaken in recent years. Quoting activity and new program awards remain decent, although customers are clearly being cautious with their spending plans. Nonetheless, we believe underlying demand is firm and that with our industry-leading capabilities and efficiency, there is ample opportunity for profitable program wins in the quarters ahead. Also within segment, sales were lower at the -- Extrusion and Castool groups due to reduced steel prices and generally weak market conditions through the quarter. Nonetheless, we believe we gained market share helped by our competitive advantages I just mentioned. We also continued to make the necessary investments in our people, equipment and infrastructure to further strengthen our competitive position. We are proceeding cautiously but continuing with our prior investment plans, including new machinery in the Large Mould group, the expansion of Castool's new facility in Morocco and ongoing upgrades and enhancement equipment across the segment's operations in general. I will now pass the discussion over to Matthew to discuss the financial highlights of the quarter.
Thanks, Darren. Good morning, ladies and gentlemen. My comments will cover Slides 12 to 17 of the presentation. Consolidated sales for the third quarter ended June 30, 2020, were $71 million compared to $119.9 million in the same quarter last year, a decrease of $49 million or 41%. Casting and Extrusion revenue declined by $6.1 million, and the automotive business declined by $42.9 million. Foreign exchange rate fluctuations contributed $1.8 million to the sales during the quarter. Consolidated net loss for the third quarter was $800,000 or basic and diluted -- sorry, diluted loss of $0.02 per share compared to $0.18 per share -- earnings per share in the same quarter last year. The consolidated effective income tax rate for the quarter was 10% compared to 20% the prior year period, with the difference primarily attributed to the impact of operating losses in certain jurisdictions, partially offset by gains elsewhere. Year-to-date, the consolidated effective income tax rate was 21%. Turning to the Automotive Solutions segment on Slide 15. Sales in Q3 were $28.2 million. Excluding foreign exchange rate movements, segment revenues were lower by $43.6 million or 60% during the quarter. Reductions in sales during the quarter were primarily driven by the virtual standstill of automotive production levels in Exco's key markets as a result of COVID-19 response measures through much of April and May. As Darren referenced earlier, economic activity picked up as the quarter progressed, with June segment showing an improvement over May although at levels below the prior year. The segment's reported pretax loss of $3.8 million in the third quarter compared to pretax profit of $7.9 million in the same quarter last year. For the quarter, segment profitability was negatively impacted by reduced overhead absorption and other fixed costs arising from lower sales together with labor costs for certain production workers in Mexico, where there's limited ability to temporary lay off employees onto government support programs. Turning to Slide 16. The Casting and Extrusion segment reported sales of $42.8 million for the third quarter, a decrease of $6.1 million or 12% from the same period last year. The Casting Extrusion segment reported $4.9 million of pretax profit in the third quarter, an increase of $1 million or 28% from the same quarter last year. Higher profitability during the quarter was supported by continued progress with various efficiency initiatives, favorable mix in the Large Mould group, lower steel prices and receipt of R&D credits. As well, management undertook significant actions to minimize the negative impact of lower sales volumes during the quarter, including implementing work-share arrangements, reducing expenditures and availing government support programs where possible. Cash flow from operating activities in the second quarter was $20.6 million compared to $15.6 million in the comparative quarter and $48.9 million year-to-date compared to $35.4 million. Cash generated from noncash working capital and higher noncash expense has far exceeded consolidated net losses in the quarter and lower net income year-to-date to generate increased cash flow from operating activities. The company generated free cash flow of $16.2 million in the quarter after $4.3 million in capital expenditures. As indicated on Slide 17, Exco's balance sheet and liquidity remained very strong. Exco's net cash position totaled $23.7 million as at June 30, 2020. Principal source of liquidity include generated free cash flow, $47.4 million of balance sheet cash and $27 million of unused availability under its $50 million committed credit facility matures February 2023. The company has stress-tested its financial and liquidity position, the significant cushion to bank facility covenants. As a result, the company will continue to make its dividend payments a priority. However, the normal course issuer bid remains suspended as we favor preserving capital given broader market uncertainty and to take advantage of opportunities that may arise. That concludes my comments. We can now transition to the Q&A portion of the call.
[Operator Instructions] Your first question comes from the line of Michael Doumet with Scotiabank.
So obviously, particularly a unique quarter for the auto industry. I mean lots of pressure on the Automotive Solutions due to the fixed cost absorption. So with -- recovering from their lows, I mean, how should we think about margins? I mean can you achieve pre-COVID margins with, say, 75% to 90% of pre-COVID volumes?
Well, I think it is going to be a challenge to get the margins back to pre-COVID levels with only 75% of volumes. We are doing what we can to take costs out and improve the efficiency, but that gap would be too sizable to get that. But having said that, it would certainly be a big improvement from where we were in the latest quarter.
Got you. And any way you can break out what you would consider fixed versus variable costs for the Automotive Solutions segment, just so we can get an idea of what to expect in terms of margins going forward?
Yes. I think you'd have to look to the performance in our third quarter here relative to where we were in pre-COVID situations to kind of get there. But I don't want to give you an exact number on it, but I think that's probably the best approach.
Okay. Fair enough. And then maybe just turning to capital allocation. I mean, look, Exco is a -- it's a high free cash flow generation business with a net cash position. So in terms of capital efficiency, I think there's a good argument to increase the leverage ratios. So longer term, I mean, I guess the question is longer term, what are you targeting in terms of long-term leverage ratios that we should think about if an M&A opportunity does arise?
Well, I guess I would say that we are very comfortable with our balance sheet where it is. When you go through 1 of these kind of once-a-100-year storms, of which seem to happen every 10 years now or so, the last thing you want is debt. We would only consider debt at a very minimal level that we had a clear path to reducing with cash flow that we would generate, and we would likely only put debt on the books to facilitate a strategic acquisition. So I think that you should always expect that our balance sheet is going to remain exceptionally strong. And we'll use it to leverage -- lever it up periodically for the right opportunity.
Your next question comes from the line of Peter Sklar with BMO Capital Markets.
Darren, the first question is, I read somewhere that you increased your reserves, I guess, for doubtful accounts. What -- was that -- did I notice that somewhere? And which segment was it in? And what did that relate to?
Peter, it's Matthew here. We did that in Q2 right as with COVID coming in and knowing that they'd probably see some impact with our customers and some credit risk out there. And it was pretty equally shared between the automotive and the Casting and Extrusion segments because we see those risks on both sides.
But how do you see risks in the autos? Like, is this where you're not a Tier 1 but maybe you're a Tier 2 so you're concerned about the Tier 1?
Yes. No, it's more on the customer end of things as we went kind of into the third quarter to the dark unknown. We took those reserves to prepare ourselves for what seem likely to occur. Now as we've gone through the third quarter, we haven't had to -- we haven't had material amounts of bad debt by any means. But liquidity has remained very strong, and access to credit has remained strong as the various federal banks of -- dump stimulus money. And there could be still some damage to come as stimulus gets pulled back. We're not sure, but we just haven't seen it yet.
Okay. And then I want to talk -- if you could talk a little bit about the Large Mould business, it seems to be doing quite well, and maybe if you could just elaborate a little bit. Is it just you've got some good programs in there that are high margin and the plants are full? Or is it these new cost manufacturing initiatives that you've been working on for a few years now? What's unfolding there? Because that business seems to be performing.
Well, it is consistent with our direction for that business and reaping the benefits of the efficiency and productivity drive that we've had over the last number of years that we've talked about for a long time now. The way that these new manufacturing sales are working, we're pushing through steel there at a rate that we've never been able to come even close to. So efficiency is certainly a big contributor to the performance of the Large Mould group. But in addition to that in the quarter because the overall EBITDA margin for the segment was, I think, pretty good, much higher than where we've been for a while, it was also helped by a favorable mix of programs. But efficiency is certainly a big driver there.
Yes. And like these new cells that you've put in that allow the high-speed machining, I've seen them in new market, but are they also located in some of your other die-cast plants? Or is it just new market?
No. We have these machines in our other plants as well.
And does that include -- I've seen the automated tool change is kind of the --
No, they don't quite have the volume to require that. So it's -- we don't use the machines at our Toledo location, for example, with all the automated -- and the tool wall.
Okay. And then, Darren, did I hear you correctly, did you say you ran parts, aluminum die-cast parts for a customer?
It's a very good news story. We had made a mold for 1 of major customer last year. And some other competitors also made a mold for this customer. Our competitors' molds performed so poorly that our customer didn't have the die-cast machine capacity to run all of the molds and make the parts that they needed. And so they asked us to run our mold on our machine and make parts for them. And we did that extremely well, running parts consistent with the quality that our customer would generally receive. And so we've been helping them out on that front, and that program certainly was in the third quarter, and it will continue into the fourth quarter.
So how would you have done that? That would have been off the die-cast machine at the back of the new market plant?
Yes. Yes, exactly.
Yes. Okay. And was it a transmission case? Or what, an engine block? What was it?
It was a structural component.
Structural. Okay. And then lastly, like in your auto solutions business, like specific -- on the auto parts business, given the dramatic downturn in global vehicle production volumes we saw in the quarter, like, did that business perform in line with your expectation? Or are you disappointed? Or it did better in that context? I'm just wondering how you thought about how you performed given the environment where volumes are down 60%-ish.
Yes. Well, at a high level, combined volumes in North America and Europe were down close to 70%, maybe 68%. But our foreign exchange adjusted revenue was down 62%. And so I would say that, that is outperformance. And as I indicated in my comments at the front end and in our press release disclosure, that is due to both a mix of accessory products, which continue to be sold through the quarter even as OEM production was at a standstill. But then we also did have some outperformance by virtue of programs that we had launched pre-COVID, which helped us do better than the industry. So I'm very pleased with our performance, and it continues a longer-term trend of us outperforming vehicle production level volumes.
[Operator Instructions] Your next question comes from the line of David Ocampo with Cormark Securities.
I just wanted to dig a little bit on the acquisition environment that you guys are seeing today. Do you think multiples have come down to a reasonable level where you guys can start to deploy some of your excess cash? And are you seeing more opportunities in automotive solutions or in Casting and Extrusion?
So I guess, we have seen more things come across our desk. However, the quality of what we've seen is pretty poor, such that we've passed pretty quickly on it. I think at this point in the cycle, you're really seeing the very distressed companies come sale because, again, access to credit and liquidity is still pretty good, helped by stimulus programs. And I suspect that as stimulus programs inevitably get pulled back at some point, maybe the better candidates become available. But we just haven't seen it yet. And so it's even hard to comment on multiples at this point. And that kind of backdrop is also a reason that we continue to preserve capital on our balance sheet and are not pursuing the share buyback at this point even though our shares look very attractive to us.
Yes. And building on Peter's question on Casting and Extrusion, margins broke 20% for the first time since 2016. And in your MD&A, you called out mix and R&D credit as being a benefit. Can you quantify the R&D credits? And what does the outlook look for sort of the new bids that you have in place? Is this a margin that you think is repeatable?
The R&D credit wouldn't be a huge driver in that. It was certainly a positive, but $200,000 or $300,000 kind of thing. But I think also, you do have the price of steel coming down, which doesn't impact the Large Mould business to a great extent in the short term, but that lowers the revenue for Castool and Extrusion sales, but it doesn't -- it's a pass-through, so it just has a margin enhancement factor to it. But -- so it's really a combination of all things, of efficiency mix, the steel price coming down. And also, there's the government stimulus wage benefits that flow through as well.
And maybe, Matt, can you perhaps quantify the employee cost that you got incurred in Mexico because that you guys couldn't lay off any employees? Just trying to understand what the total impact is there.
Yes. It's hard to get exact, but somewhere around high $1.8 million to $2 million kind of would be the impact for the 3 months.
There are no further questions at this time.
Okay. Well, I appreciate everyone's time on the call today. We look forward to talking to you next quarter. Take care, everyone.
Thank you.
Thank you for your participation. This does conclude the call. You may now disconnect.