Unique Fabricating, Inc.

Please stand by. Good day, ladies and gentlemen, and welcome to your unique fabricating second quarter 2022 earnings call. All lines have been placed in a listen-only mode, and the floor will be open for your questions and comments following the presentation. As a reminder, today's call is being recorded. If you should require assistance throughout the conference, please press star zero. At this time, it is my pleasure to turn the floor over to your host, Jeff Stanliss. Sir, the floor is yours.

Thank you, Operator. I'd like to welcome everyone to Unique Fabricating's second quarter 2022 earnings conference call. Hosting the call are Doug Kane, Unique Fabricating's President and Chief Executive Officer, and Brian Loftus, Unique Fabricating's Chief Financial Officer. Before I turn the call over to Doug, I would like to remind everyone that matters discussed on this conference call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 that are subject to risks and uncertainties. Forward-looking statements relate to future events or to future financial performance and involve known and unknown risks, uncertainties, and other factors that may cause the company's actual results, levels of activities, performance, or achievements to be materially different from those expressed or implied by today's call. All such forward-looking statements are based on management's present expectations and are subject to certain risk factors and uncertainties that may cause actual results outcomes and performance to differ materially from those expressed by such statements. These risks and uncertainties include, but are not limited to, those discussed in the company's annual report on Form 10-K and quarterly report on Form 10-Q that are filed with the SEC pursuant to Rule 424-B, and in particular, the section titled Risk Factors. All statements on this call, including those in this afternoon's press release, are made as of today. Unique Fabricating does not intend to update this information unless required by law. In addition, certain non-GAAP financial measures will be discussed during this call. These non-GAAP measures are used by management to make strategic decisions, forecast future results, and evaluate the company's current performance. Management believes the presentation of these non-GAAP financial measures are useful to investors in understanding and assessing the company's ongoing core operations and prospects for the future. Unless it is otherwise stated, it should be assumed that any financials discussed in this call will be on a GAAP basis. Full reconciliations of non-GAAP to GAAP are included in the press release that was issued earlier today. With that said, I would like to turn the call over to Doug. Doug, the call is yours.

Thank you, Jeff, and good afternoon, everyone. Unique Fabricating, Brian and I appreciate your investment of time for today's update of the company's outlook, overall operations, and financial results. In these extraordinary times, I would like to express my appreciation for the efforts, commitment, creativity, and sense of urgency from all our associates in each of our seven locations throughout North America. We have remained focused on providing excellent service to our customers as we face head-on the continuing challenges from rapidly changing customer demand schedules and ongoing supply chain issues. We are resilient and remain confident that we have taken the necessary steps to drive improved performance as volumes increase. Our second quarter results reflect the impacts from three significant items. First, we recorded a non-cash goodwill impairment charge of $12.2 million. Second, we recognized a $3.0 million benefit related to the employee retention credit. We experienced equipment and labor-related operating issues in our Lafayette, Georgia facility that we resolved as of the end of the second quarter, but that did result in higher operating costs of $1.2 million in the quarter. While overall market and supply chain challenges continue, we are well positioned to realize the benefits as the supply chain issues continue to normalize and customer demand rises. Despite the ongoing costs related to our forbearance agreement with the bank syndicate, we have seen a reduction in our SG&A costs to below the $5.0 million quarterly level we previously communicated. In addition, our Q2 operational performance continued to be negatively impacted by the ongoing labor challenges and the continuing cost increases in raw material, energy, and packaging in our supply chain. The complexities of effectively flexing costs to the short notice changing release schedules also had a negative impact on plant efficiency and operating margins. While we have seen and do expect to see continued challenges through Q3 and into Q4 of 2022 from the chip shortage and other factors outlined previously, we also continue to see improvements in raw material, logistics, and labor availability as well as a flattening of the cost curve for raw material and packaging through the first five weeks of Q3. Our comprehensive cost recovery activities initiated during Q2 of 2021 have delivered positive results to date by offsetting some cost increases. We are having success in our pivot to a more targeted cost recovery approach focused on specific programs most negatively impacted by logistics and continuing raw material cost increases. The latest phase will be fully realized in August with a cumulative more than 10 million annualized benefit, partially offsetting the higher inflationary costs we have seen. Simultaneously, our smaller customer rationalization project continues. During Q2, we exited approximately 30 smaller customer relationships. In addition, we are passing along more significant price increases and higher minimum order quantity requirements for other smaller customers. These actions improve the efficiency and productivity of our plants by reducing complexity with minimal revenue impact. Year to date, we have secured approximately $46 million in COI despite the continued commercial headwinds created by our ongoing forbearance condition which restricts our ability to win new business from certain larger customers in our transportation market. We have recently been nominated to supply NVH, noise, vibration, and harshness products for three high-volume EV applications with strategic Tier 1 customers. Additionally, we have been approached by multiple customers seeking to onshore consumer products currently produced and shipped from China. Our process capabilities and significant raw material buying power are an advantage for the consumer goods and medical market customers. Light duty new vehicle inventory has continued at historically low levels with less than 1.0 million units on hand each of the last nine months compared to more than 3.0 million each month throughout 2019 and 3.4 million units March the 1st of 2020. Resulting from the low inventories, U.S. light vehicle sales continued to be less than previously forecasted, providing additional pent-up demand supporting a positive longer-term outlook. The Seasonally Adjusted Annual Sales Rate, or SAR, did increase to approximately 14.0 million units in Q2 of 2022, representing the best quarterly sales performance since Q2 of 2021. The Independent North American Automotive Production 2022 forecast as of July 15th is 14.7 million units, or 12.7% above both 2021 and 2020 production. The combined production from 20 to 2022 forecasted volumes indicates an approximate shortfall of more than 9 million units from the average of the last four pre-pandemic years. The prolonged production shortfall and the low inventory levels lead to a positive North American production outlook for 2023 with 16.4 million units and an average of approximately 16.6 million units from 2024 through 2027. With the forbearance agreement cloud causing ongoing challenges to winning new business from certain transportation market customers and utilizing the third-party forecast for 7.6 million units, to be produced in the second half of 2022, we are reducing our range for second half 2022 net sales to between 71 and 75 million from the prior guidance of between 75 and 79 million. Based upon this revenue level, we would expect an operating EBITDA level of between 3.0 million and 3.5 million. For the full year, we're now forecasting a net sales range of between 141 to 145 million. With overall supply chain issues continuing to improve through 2023, increased COI enabled by a longer-term bank agreement, and the forecasted production levels of 16.4 million units, we are now forecasting sales for 2023 with a range between 169 and 175 million. Based upon this revenue level, we would expect an operating EBITDA level of between $11.5 million and $13.5 million. We continue to see similar positive trends for demand and improving supply chain conditions, both near term and longer term in our other markets. We also see supply chain costs flattening with the expectation of some decreases in the latter part of Q4 2022. We are experiencing an uptick in appliance production volumes, both near-term and in mid-term forecast, as well as increased quoting activity in consumer goods and appliance markets, as onshoring activities from China specifically gain traction. During Q2, we received the $1.8 million expected from the IRS for tax loss carrybacks. We still have $0.3 million remaining to be collected from the Initial Employee Retention Credit, ERC program, as well as the additional $3.0 million related to the ERC benefit recognized in Q2. We continue working with our bank syndicate and other stakeholders to develop a longer-term framework to enable the execution of our growth plans and lift the cloud that has been impeding our efforts to win the additional COI necessary to achieve our targets for revenue, both near and longer term. To date, we are maintaining sufficient liquidity for us to operate in these challenging times. Brian will now provide an overview of our second quarter 2022 financial results.

Thank you, Doug. Good afternoon, everyone. Turning to the second quarter results. Net sales for the second quarter of 2022 increased 4.1 million or 13.4% to 35 million as compared to 30.9 million in the second quarter of 2021. The increase in net sales as compared to the same period in 2021 is primarily due to higher demand for our products because of higher North American light vehicle production and the impact of our cost recovery efforts where we passed a portion of our input cost increases to our customers through pricing. Of the 35 million net sales for the second quarter, Customers in the transportation market accounted for approximately 89%, appliance at approximately 9%, with the remaining 2% primarily attributable to our consumer off-road market. Gross profit for the second quarter was $5.2 million, or 15% of net sales, compared to $4.6 million, or 14.9%, of net sales for the same period last year. The increase in both gross profit and gross profit as a percentage of net sales reflects the impact of the employee retention credits recognized in the second quarter of 2022, higher sales volumes, and our cost recovery efforts which offset the operational efficiencies in our Lafayette, Georgia facility Doug mentioned earlier, and higher manufacturing costs including material and labor as compared to the same period a year ago. Both cost of sales and selling general and administrative expenses were impacted by the $3 million ERC benefit recognized in the second quarter of 2022. Approximately $2.5 million of the benefit was recognized as a reduction of cost of sales and 0.5 million was recognized as a reduction of selling general and administrative expenses. Last year, during the second quarter of 2021, we recognized a 0.3 million ERC benefit as a reduction of cost of sales. Selling general and administrative expenses for the second quarter of 2022 were down to 4.2 million compared to $6.1 million for the second quarter of 2021. The decrease in SG&A was primarily attributable to lower salary expenses as a result of our 2021 cost reduction activities, the $.5 million benefit from the ERC program previously mentioned, and lower amortization expense as certain intangible assets became fully amortized since the second quarter of 2021. Operating loss in the second quarter of 2022 was $11.2 million compared to an operating loss of $1.5 million for the same period last year. The increase in the operating loss is driven by the $12.2 million non-cash goodwill impairment charge in the second quarter of 2022. Excluding the goodwill impairment charge, we would have had operating income of $1 million, which is reflective of the impact of the ERC benefit, higher sales volumes, and cost recovery efforts, which were partially offset by the higher manufacturing costs and the operating efficiencies in our Lafayette facilities. Interest expense was $0.7 million for the second quarter of 2022 compared to $0.8 million for the second quarter last year. The year-over-year decrease was primarily due to favorable mark-to-market adjustments on our interest rate swap. Net loss for the second quarter of 2022 was approximately $10.7 million or $0.91 per basic and diluted share compared to a net loss of $2.5 million or $0.26 per basic and diluted share in the second quarter of 2021. We had an income tax benefit of approximately $1 million in the second quarter of 2022, compared to an expense of 0.3 million in the second quarter of 2021. I'll now provide an update on our financial position and liquidity. Total debt was 47.7 million as of June 30th, 2022. compared to $48.4 million as of December 31, 2021. We ended the quarter with approximately $0.6 million of cash and cash equivalents and $4.3 million of net availability on our revolving line of credit. Doug will now provide closing remarks. Doug, back to you.

Thank you, Brian. Our team remains focused on continuous improvement in all areas in realizing the benefits from enhancements now in place. We are positive about the mid-term and longer-term outlook for demand in each of our markets, as well as the position we maintain within those targeted markets. With the operational challenges in our Lafayette, Georgia facility demonstrably behind us, we are seeing the resulting improved operating profit from higher volumes and reduced costs in Q3. We remain committed to our vision of delivering profitable growth and increasing shareholder value that follows from our brand of providing innovative, optimized, and sustainable solutions for our customers. With that, we will open the call for questions. Operator?

Thank you. If you'd like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to signal for a question, and we'll pause briefly to assemble the queue. And we go to our first question from Leonard Schleicher of Taglich Brothers. Please go ahead. Your line is open.

Hi, Doug. I'm filling in for John. So I just have a couple questions. Disregarding, I'll put it this way, do you see, should we take the projections for North America vehicle production at face value, or are you seeing anything else out there that might indicate that things are happening a little faster or slower than those numbers?

Leonard, thank you for the question, and I hope John's okay. Tell him that we said hello.

Yeah, sure. He's fine.

Okay, good. That's important. What I would say to you is, again, the volumes that occur after the IHS production forecast come out have tended to drift a little bit lower. One of the points is that the IHS forecast had been fairly consistent for the last three months. We also do track something in which there is a chip shortage impact report. and that's put out weekly. And for four weeks before the past week, there had really been no change whatsoever. In the last week, that number went up about 100,000 and then indicating about a $1.2 million unit production for 2022 from the original. And that still kind of puts you in that 14.5 to 14.7 range. Again, what eventually transpires is somewhat open in the communications we've made about revenue and volumes or whatever. We're trying to bias those down slightly for impacting that, but we have no better information. If you listen to what the OEs say, they are all saying that they're going to have higher production in the second half of the year, but we will see how that works.

Okay, great. Thanks for that. Also, last call you said that you were looking to expand your industrial business in light of current automotive market conditions. Could you talk a little bit about any progress that you've made in an effort to expand the industrial business?

Yep, so I appreciate that. Again, with the comments that I've made about the forbearance agreement and the impact that that's had on certain of our Transportation, OE, ability to win new business, we have, I'll say, refocused some of our efforts in those areas, and we are tracking several substantial opportunities in both medical and the consumer goods side that will enable us to meet what is really our new target that we've got for this year of about $115 million of COI. So we've identified, had them focused, and in fact, I'm in the process of meeting with several of our either large customers today or potentially larger customers to try and work through whatever issues may be outstanding so that we can get that business booked as soon as is possible. And we are, again, as I noted in the commentary, seeing some additional quoting activity and the desire for customers to move business onshore. for a lot of the well-documented reasons that are out there. So we're pretty encouraged by that as well as we are seeing growth with GE, who is our largest appliance business. They continue bringing business to us as they are, I'll say, moving production from other suppliers who may be having other of their own challenges or they're trying to consolidate things because of our footprint that we have that's an advantage for us. So we're just trying to focus our efforts there. as we continue working through the issues with a couple of our larger transportation OEs.

Okay, great. Thank you.

Again, ladies and gentlemen, if you do have a question or a comment, please signal by pressing star 1, and next we go to the line of George Melas with MKH Management. Please go ahead.

Thank you. Hi, Doug. Hi, Brian.

Hey, George. Good afternoon.

Good afternoon. Maybe some of the issues at Lafayette, is there a way you can sort of give us a sense of when those issues occurred? And I think you put roughly $1.2 million additional cost there. Is there a way you can provide a little bit of a breakdown of that?

So relative to cost, the cost was broken up into two specific categories. One was higher expedite costs than we were normally seeing, which was 0.8 million in the quarter, and then higher labor costs related to inefficiencies. As I noted, we were having some significant machine issues and then getting the scheduling in place for the labor because of the location where Lafayette is. It's kind of off the beaten path, I would say. It's about 40 minutes south of Chattanooga and an hour and 45 minutes north of Atlanta. So about $0.4 million, I would call it, was in the area of excess labor or lack of labor productivity, and that came up at the $1.2 million that we had. This was not something that we had any indication of seeing based on all the key performance indication metrics used really through the end of March and even into the first part of April. But for a variety of reasons, including some items that had us make a leadership change in the plant management there, some decisions that were made that were done with the best of intention but had unintended consequences, such as not doing some required maintenance, not keeping some of the tools in place, and as volume increased in that location. And it's a location that does all of our processes. and in fact ships all over the country from there. Again, we've got two larger facilities. It got out of hand very quickly. That unfortunately can happen and does happen in the transportation market. So we ended up doing a lot of expediting from there into Mexico and into other areas out of Lafayette, and that's the reason for the very large 0.8 million impact on expedites. What we've done subsequent to that is, again, we've made a management change We have reorganized the plant scheduling. We have brought in additional supervision. We've also brought in both engineering and lean talent from our Mexico facilities where we've got excellent operations and have a gentleman that I put in place there two years ago who I'd worked with for years at both Mubea and at Alcoa. And utilizing that talent and utilizing some additional support that we've got from our Auburn Hills facility, we've eliminated the back orders basically, eliminated the expedites, and improved the labor productivity because we also made some investments that were required in some of the tooling maintenance and some of the other machinery maintenance. So as we're tracking in August today, we're really seeing no expedites and no excess labor costs that are there. It's something we're disappointed in. We've also made some changes in our early warning systems to focus on a couple of other metrics to ensure that this does not happen again. We also did work collaboratively with certain of our OE customers and moved some of the production that actually made more sense longer term that had been sourced into Lafayette some years back and actually moved it into Mexico where we have excess capacity, excellent operations, and it's actually closer to the customer, so it's a win-win for the customer. and for us.

Great. Thank you very much for the detail there. And then on the COI of 46, is there any way to sort of provide a little bit of a breakdown by appliances, transportation, and maybe consumer?

Of course there is. So the COI year-to-date in transportation is $36 million. In appliance, it's $3 million. And in the medical and consumer, it is $5 million. And as I mentioned before, we've got 16 identified, very focused COI targets that if we apply the probability that my commercial teams have given me, we do have a revised target that we're aiming for of $115 million in total COI this year. which would be another $69 million in the remainder of the year. And that actually is split because there are a couple of larger medical opportunities that are there. It's basically split about 40%, 45% medical appliance consumer goods in the remaining in the transportation. I have, again, even today, had discussions with two of our larger OE customers about the situation, as I mentioned, and I did it intentionally in the The script and also in the quotation, when we can have the forbearance agreement situation behind us, this opens up the opportunity for us to, I'll say, go back to a more normal condition because the customers want us to do the business, our footprint and our capability and our quality. They all need us to be in the supply chain, especially with some of the other challenges others in our space are having. And that's the reason we're working so diligently to get the banking situation straightened out because they have, you know, there are opportunities there that we need to capitalize on over the next month.

Okay. And you feel like if you have a COI for the year of 115, that's enough to meet your guidance for the 23 years?

Exactly. If you take the 115 number that I provided you there, and then we are targeting the number for 2023, again, all that's predicated on having the banking situation put together, then that supports the foundation of the revenue numbers that I provided as guidance, and we are confident that all of those things will occur. And that's the reason I was confident enough to make that statement about what we have in front of us. Again, for historic, before we ended up in forbearance, we had $206 million of COI in 2020, even in the midst of COVID occurring in 2021. Being in a forbearance agreement going all the way back to the first quarter of 2021, we had $100 million of COI. So there's no reason for us to believe that those numbers that I gave are not achievable. And in fact, because of, I'll say, our lack of getting some business over the last, 12 months are certainly something that can be exceeded.

Okay. And then just one final question on the cost of sales. The cost of raw material is a big chunk of your cost of sales, and that has increased on a both dollar and absolute basis. Is there any way you see that maybe coming down back to maybe 50, 51% of your sales, or was that like, or do you think it's kind of a permanent change in the model?

Okay. And you always ask the good questions or the probing questions, and that one I also appreciate. So when I went back historically, and if you made the different adjustments that were made, and I'm really only going back to 2019 as I started in September the 30th of 2019, The material cost was about 52% in 2019, maybe 51.8 or something after we had made the adjustment that was required as part of the Q3 2019 results. So that's kind of the baseline rather than a 50 or 51. Maybe sometime earlier it was a little bit lower than that, George, so I don't want to comment that it wasn't, but we're kind of looking at this 52 as being a baseline. Then if you take the inflation that we're looking at, so again, when we talk about our cost recovery efforts, and I'm now only going to talk about raw material, we're tracking with the latest stuff, again, that we will see fully beginning in August. We saw some in Q2, a little bit more in July, but we'll fully see it in August. We've got cost recovery, as noted, of over $10 million based upon the run rates that we have today. Unfortunately, the raw material and logistics cost, which include the fuel surcharges and everything else that are going on, exceed $12 million. So while we have done our best to recover as much as we can, again, recognizing that our customers don't really allow you to recover 100% because we don't have anything that's indexed, there's a little bit that you give up there. The second thing is then when you inflate both your cost of sales, your material costs, in your revenue and say, okay, your revenue is $10 million higher and your costs are $10 million higher, this actually tends to inflate your material costs at the levels that we're running right now about 2.5% to 3%. So when we look at it that way, our other cost reduction activities that we've done, including material utilization, some other changes that we've made have offset in large measure that number. So, if everything were going to stay the same, what we are tracking in our internal forecasting is using a little bit over a 53% material cost. Now, I say that with the caveat being what I did mention in the script, that we are seeing a bending of that curve a little bit on the raw materials. So, very few, if any, cost increases. And we've seen a couple of nominal cost decreases today. I know everybody on the call pays attention to what's going on with the inflation rates and the producer price index and all these different things. My view, our view, is that we will see a further bending of this curve down and likely see some, I cannot quantify it right now, but some cost reductions in Q4 of 22 and into 2023. And without saying more than I should, recognizing that I've got customers and suppliers and other people on the call, as sticky as it was and as difficult as it was for us to get costs increased, so we have always been behind the curve. If you've got an inflationary environment and you're trying to raise prices with your customers, you really can't get ahead of it if your supply base is continuing to give you increases. So we've kind of leveled out at the point in time where we are now. When the prices decrease, it will be sticky for us to give back any prices for some period of time even with raw material and hopefully some logistics costs falling. So that we believe will be an opportunity for us to improve the material margin. And then the second thing is we do now have installed in our plants, we have three lasers that we've got installed. We've got a couple of more that are in the planning to install. These improve our material utilization a great deal. And we're also looking at some other robotics investments either that we've made or that we're continuing to make to further improve not only our labor productivity but our material utilization. So our target would be to get back to a 52% number, let's say, even with some of the inflation. But getting back to 50, I'm not sure that I would see that to be the case.

Okay, great. Okay, thanks for the clarification. That was super useful. Thank you, guys. You're welcome.

We have no further questions. We turn to Doug Kane for closing remarks.

Once again, I appreciate the investment of time for all those who dialed in to participate in the call. Again, we remain very positive and encouraged about the future. We appreciate the support from all of our stakeholders. each and every one of them, including all of our employees who have worked diligently and dedicated and passionately to work on all the improvements that we've got in some very trying circumstances, both in the macro and in the micro environment. And as always, Brian and I are here to answer any questions, and we'll make ourselves available to speak to anybody on any of the topics that are out there. And look forward to talking with you in about three months. Thank you.

This concludes today's teleconference. We thank you for your participation. You may disconnect your lines at this time. Have a great day.