ABC Technologies Holdings Inc.

Greetings and welcome to ABC Technologies first quarter fiscal 2023 earnings conference call. At this time all participants are in listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during today's conference please press star then zero on your telephone keypad. As a reminder this conference is being recorded. I would now like to turn this conference over to your host, Nathan Barton, Vice President, Investor Relations. Thank you. You may begin.

Thank you, Operator, and thanks, everyone, for joining us today. With me on the call are ABC's President and Chief Executive Officer, Terry Campbell, and David Smith, Chief Financial Officer of ABC Technologies. This call is being webcast live on ABC Technologies' Investor Relations website. The webcast and accompanying slides will be available for replay for 12 months following this call. The content of today's call is the property of ABC Technologies. It cannot be reproduced or transcribed without prior written consent from the company. Before we begin, I would like to remind you that today's call will include forward-looking statements in the meaning of applicable securities laws, which are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements. Any such statements should be considered in conjunction with cautionary statements in our earnings release and risk factor discussions in our filings with the Canadian securities regulatory authorities on CDAR. Please review the disclaimer on slide two of the earnings presentation for additional information. We assume no obligation to update any of these forward-looking statements or information unless required by law. I want to remind our investors that we are on a fiscal year that began July 1, 2022, All references to Q1 fiscal 2023 are to the three months ended September 30, 2022, and Q1 fiscal 2022 are to our fiscal quarter ended September 30, 2021. I also want to note that while ABC shares trade in Canadian dollars, the company reports its financials in U.S. dollars. With that, I'd like to turn the call over to Terry Campbell.

Thank you, Nathan, and good morning, everyone. Last quarter, I joined you on this call just two and a half weeks into my tenure as the new CEO of ABC. I introduced a new perspective that I plan to bring to the organization that would build on ABC's existing strengths while guiding the company into its next phase of growth. And today, roughly four months into my tenure, I'd like to discuss the financial and operational progress we've made, as well as unveil a little bit more of our plans. To begin with, on slide four, you will see in the dotted red box some exciting additions to ABC's leadership team that will help us focus on serving our customers better while pursuing operational excellence. We've appointed a seasoned group of automotive leaders to focus on product, process, customer, and operational excellence. These are individuals who have deep knowledge and decades of experience in manufacturing car parts and, this is critical for us, are familiar with our OEM customers and their expectations. Mike Fritz, as EVP of operation, leads the manufacturing, costing, and capacity functions, where his primary focus will be on safety, quality, operational excellence, continuous improvement, and plant profitability. As EVP of product and process engineering, Phil Gorella's team leads product management, design, and engineering, as well as process engineering. His team will be focused on establishing a governance model and providing technical guidance on the product and process engineering and design standards. The sales organization, under our new EVP of Customer Experience, Leonard Rowland, is now split by OEM customer, simplifying the number of touchpoints for our customers and strengthening those relationships. And finally, driving competitive advantage through M&A will be a primary part of John Lohr's scope as the new Chief Transformation Officer, whose broader mandate also includes the development and execution of enterprise-wide business transformation programs and the development of our strategic plan. These new leaders will be a key driver in the success of our new business operating model. Slide five outlines some of the key distinctions between our legacy model and our reorganized customer-focused operating model. These changes we've made have allowed us to remove unnecessary complexity and variability from our business while building upon subject matter expertise and aligning the technical community around our three product groups. And embedded throughout this new operating model is a philosophy of standardization and best practice transfer to drive operational excellence and efficiency across our entire business. This includes building upon the strengths and successes of our best performing existing operations, as well as incorporating new best practices and capabilities acquired through M&A. For example, our recent acquisition of Carl Etzel has provided us not only with greater scale in Europe, but also expanded our technical capabilities in interior products and expanded an important new customer relationship with Daumler. DLH Bowls deepened our leadership in fluids management while also growing our automation assembly knowledge. And finally, though these organizational changes were implemented in order to simplify our business and streamline our processes, they also benefited our cost structure. In the quarter, we right-sized ABC's corporate headcount to drive roughly 15 million annualized cash savings before tax and 7.5 million annualized EBITDA savings. With that said, let's move on to the slide seven for a higher-level overview of our results for the quarter. Despite the persistent and negative impact of supply chain and logistic issues on vehicle production, revenue increased to $318.9 million supported by top-line contribution from DLH Bulls and Carl Edsel. Unfortunately, inflationary headwinds continue to result in degraded margins well below the targets that we previously communicated. And as you might expect, these headwinds have only heightened the importance of the operational cost improvements being driven by our new leadership team, as well as the price recovery conversations we've been having with our customers. I'm happy to share that in recent days we've reached successful conclusions on these cost recovery negotiations with select customers. You will see the associated impact flow through our financials in coming quarters. We're still in discussions with several others and are hopeful that we will reach a favorable resolution in the coming weeks. And finally, before I move on from this slide, adjusted EBITDA for the quarter came in at $23.9 million and adjusted free cash flow was $2.4 million. Moving on to slide eight for an overview of the industry. The auto market continues to respond poorly to the acceleration of near-term inflation, which has resulted in downgrades to production growth forecasts, as well as notable rumblings of an economic downturn or possibly even a recession. As a result, the narrative in the auto sector has begun shifting from concerns about supply constraints towards demand destruction, which you can start to see in the data presented here from IHS. As a management team, we are acutely aware of the effect that softening demand has on OEM production levels, which just further elevates the importance of the cost reduction measures and operational improvements we are currently putting in place. These types of broader market trends are outside of any management team's control, but as we wait for things to normalize, we are committed to executing our operational reorganization and playbook to build a more efficient and resilient business. On the left of this slide, you can see the total U.S. inventories remain depressed, though on a slight improvement path since October 2021. With roughly 1.35 million vehicles on dealer lots and average inventory of 30 days, U.S. inventory broke a 35-month streak of year-over-year declines, increasing for the third straight month, though inventories are still clearly at one-third the levels at which the industry operated for most of the decade prior to the pandemic. Now shifting our focus to the production environment, improving production inventory restocking from 2023 onwards expected to alleviate pricing pressures for end users, generally retail and fleet customers. Production results over the course of the quarter have clearly shown improvement, but week to week, OEM output remains volatile and far from normal. This has included ongoing shortly downtime at customer plants with logistics and labor issues adding to constraints. As the market remains volatile, IHS has continued to play catch up to the macro picture with 5.5 million units coming out of the forecast for 2022 to 2025 between January and October. However, IHS still expects a very robust 4.1 million vehicles on average produced each quarter from calendar 2023 through 2029 or later. Moving to slide 9, where you will see some of our important launches and product wins during the fiscal quarter. In the quarter, we launched HVAC products with our growing Asian OEM customer base on both the Toyota Tundra and Honda Civic. We also launched air induction products on the Cadillac Escalade V Sport, the highest-end vehicle in GM's truck and SUV platform. Finally, we launched our high-temperature turbo duck on the Stellantis Global Medium engine. an inline four-power plant that spans across multiple platforms, including most of Jeep's lineup. In terms of business wins in the quarter, we also won both interior and exterior systems for a U.S. OEM SUV, as well as exterior systems for a U.S. OEM truck. Under our new commercial organization, we have decided to revise the way we report our business wins, opting for an annual sales volume metric as opposed to lifetime wins. We feel this metric is more transparent against the previously reported lifetime revenue, which can vary widely based on program length. And finally, 75% or $26 million of total awards this quarter were electric vehicle wins, made up of five unique electric vehicle platforms with four different OEMs. With that, I will turn the call over to David.

Thanks, Terry. I'll begin on slide 11 with an overview of our financial performance in our fiscal first quarter ended September 30, 2022. The charts you see show revenue, adjusted EBITDA, and adjusted free cash flow over the course of our fiscal first quarter, but I will also give additional color to these and other major income statement lines. Looking at the first graph on the slide, ABC's revenue for Q1 fiscal 2023 was $318.9 million. This is up from $163.4 million in Q1 fiscal 2022, which was a 95.1% increase. $56.9 million of this increase in sales is attributable to DLH Bowles and Carl Atzel, accounting for roughly a third of the increase. Excluding the impact of the acquisitions, the strong year-over-year growth is largely due to last year's weak baseline, which resulted from the impact of disruptions and shortages in the supply of critical components and materials globally, which limited the ability of our OEM customers to produce, thus scaling back orders for the parts and assemblies we manufacture. Last year's fiscal Q1 marked the height of the semiconductor shortage, resulting in reduced OEM customer production, which materially and negatively impacted ABC's financial results in Q1 fiscal 2022. In contrast, production levels continue to steadily rebound in Q1 fiscal 2023, with industry OEM vehicle production in North America increasing by 24.2% in Q1 fiscal 2023 compared to Q1 fiscal 2022. Moving on to cost of sales, where the impact of inflation, cost escalation, and supply shortages continues to affect our results. In the quarter, cost of sales increased $125.7 million. or 77.3% from the $162.6 million in Q1 fiscal 2022, compared with $288.3 million in Q1 fiscal 2023. Though we've seen some softening in resin prices, which are now below the peak levels witnessed over the last 12 to 15 months, there remain a number of elements within the cost structure that have resisted normalization, such as utility, freight, gas, and energy costs, as well as other material input costs, including steel, glass, paper, glue, and fiberglass. Compounding this is significant labor cost inflation, where the shortages of workers has increased competition and pushed up wages nearly everywhere we produce. Inflation continues to wreak havoc, and the elevated cost environment remains an important component of our financial results. As Terry noted in his remarks, ABC's negotiations to recover a portion of these inflationary costs from our OEM customers have seen recent success. We expect conversations with our remaining customers to continue with the majority of these outstanding negotiations reaching resolution in our upcoming fiscal quarter or at the latest by Q3. Moving on to SG&A, total SG&A increased from $28.1 million in Q1 fiscal 2022 to $45.9 million in Q1 fiscal 2023. As Terry noted earlier, during Q1 fiscal 2023, the company completed actions to reorganize its senior leadership team and improve its cost structure, resulting in the elimination of approximately 150 salary positions and canceling approximately 50 other budgeted salary positions in both plant overhead and SG&A lines. These headcount eliminations were a result of the implementation of ABC's new operating model, which was designed to eliminate waste and streamline workflows within the organization. A one-time charge of $6.5 million was recorded in SG&A in the current quarter to effectuate these changes. SG&A costs in Q1 fiscal 2023 also include $2.6 million related to ongoing work related to evaluating potential acquisition targets. ABC reported a net loss of $23.4 million in Q1 compared to a net loss of $28.2 million in Q1 of the prior year, an improvement of $4.8 million, or 17%. The net loss per share in Q1 fiscal 2023 was minus 20 cents versus a net loss per share of minus 54 cents in the same quarter last year. Both figures are on a basic and fully diluted basis. Moving on to adjusted EBITDA in the middle of the page, adjusted EBITDA was 23.9 million in Q1 fiscal 23 compared to a negative 11.3 million in Q1 fiscal 2022. As discussed elsewhere, Q1 fiscal 2022 was adversely impacted by reduced customer OEM production, primarily related to supply chain disruptions, and to a lesser extent, the other effects of COVID-19 affecting worker availability across the automotive industry and the impact of inflation on our cost structure. In Q1 fiscal 2023, improved top-line results flowed through to EBITDA. However, the lingering effects of increased costs, primarily due to inflation and higher commodity costs, continue to weigh down in results compared to pre-pandemic periods. The adjusted EBITDA margin for the quarter was 6.7%. compared to a negative 6% last year and compared to the mid-teens where we believe the business should operate in a more normal production environment. Adjusted free cash flow was $2.4 million in the quarter compared to a negative $59.5 million in Q1 fiscal 2022. The $61.9 million year-over-year increase was primarily due to higher net cash flows from operating activities of $73 million, which was partially offset by increased CapEx of $8.8 million, primarily to support program launches. Slide 12 shows the walk from cash from operations down to adjusted pre-cash flow for the year. For the quarter, cash from operations was over $10 million higher than last quarter. However, adjusted pre-cash flow remained roughly flat to Q4 fiscal 2022 due to the higher capex mentioned earlier. During the quarter, we monetized certain currency hedges as they were in the money, and we took the opportunity to pull the cash forward while at the same time re-hedging the currency exposure at current forward grades. As you can see, we adjust out the impact of hedge monetization on our adjusted pre-cash flow. I view this as a conservative way to look at this transaction. On slide 13, you will see details of our capital structure and liquidity. The company had total liquidity of $219.9 million as of September 30, 2022, against last quarter's $173.4 million. Our liquidity is made up of cash of $47 million and net revolving credit line availability of $173 million, which is subject to covenant limitations. ABC's liquidity position has remained strong throughout the volatility of this fiscal year. As a result of conditions in our industry and our business, leverage is higher than our internal target. Our leverage multiple is expected to remain elevated as we navigate volatility in the market, as well as internal-external factors discussed earlier. As the market normalizes and ABC overcomes these challenges, we expect to return to leverage levels below our target of three times. With that, I'll turn it back over to Terry for a few closing remarks. Terry?

Thanks, David. To conclude, while the top line results we've seen in the fiscal quarter have been promising, management sentiment going forward remains cautious as the industry storyline has rapidly shifted from supply chain issues to consumer demand concerns as rising interest rates put pressure on spending power. The market has made no secret of interpreting the consequences of the inflationary environment we've all been navigating, anticipating a recession in North America within the coming quarters. With this in mind, ABC's leadership team is committed to the successful execution of its new business operating model. Over the next several quarters, we expect our efforts at improving customer relationships, streamlining our cost structure, and standardizing our operations to partially insulate ABC from the impact of a potential recession. Another key factor will be our ability to share the impact of inflationary pressures with the OEM customers. These conversations are ongoing, and we hope to be able to provide you with some further detail at next quarter's earnings call. That concludes our prepared remarks. Thank you everyone for listening and for your support. Dave and I are now happy to take questions.

Thank you. We will now begin the question and answer session. To join the question queue, you may press star, then 1 on your telephone keypad. You'll hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star, then 2. We will pause for a moment as callers join the queue. Our first question comes from Ryan Brinkman of JP Morgan. Please go ahead.

Hi, great. Thanks for taking my questions. I wanted to start by asking what you think normalized adjusted EBITDA margin for the company may now be. I think prior to going public, you'd achieved almost a 15% margin, some hope to grow from there. With all the changes in the industry, but also your acquisition of some higher margin businesses, just wanted to check in with regard to, firstly, what you think the new normal may be, and then secondly, what the path to normalized margin might look like. For example, how long does it take to get there? Is the margin recovery, do you think, more front-end loaded or back-end loaded, or should we expect sort of more linear improvement? And what are the biggest drivers to getting back to normal? Is it the operating leverage provided by higher customer production? Does it relate more to the reopening of existing contracts and repricing of new contracts to better recover premium costs, as I suspect? Or is it more from cost saves or just however you're looking at the situation? Thanks.

Thanks, Ryan. Good morning. This is David Smith. There's a lot in your question. And I think the way the question is answered sort of is the way we would answer the question as well, because there is a lot at stake and a lot at play here. I think what we see, first of all, is the new business operating model gives us the ability to leverage the cost structure in a more efficient way. So I think that's first and foremost. And we can see that taking hold throughout the business and continue to drive. And there's a lot of things you do every day in terms of driving continuous improvement, entering the negotiations, making decisions about how you spend CapEx. And I think all of those things, there's kind of like they're in progress and they're underway and they're ongoing. I think the other thing too is in terms of integration on the acquisitions. I think those are going according to plan, but I think there's still more in the way of completing the integration and getting completely the leverage out of those that we expected when we bought them. And so we feel quite confident that we'll realize that. I think one of the biggest wild cards we're still seeing is what's happening in the greater economy relative to some of our input costs. As we said in our prepared comments, we're not really expecting to see labor costs go down But perhaps some of the things we'll put some things that will help to make it where it's more available and give us more leverage in the marketplace. And then finally, I think one of the biggest variables is with respect to the question you asked for customer pricing. I think those conversations are, as I said, very, very productive. But there's a lot of things to go to get to a final conclusion. We think that this will happen in the near term. and that we'll start to see it impacting our results immediately when the results are concluded. But again, there's a lot to do and there's a lot of play and there's a lot of moving pieces as it relates to what's happening for the input costs that underlie those inflation cost recoveries. So I think we feel quite optimistic that we're going to come to a deal that's both fair and reasonable and reflects the cost in our business that'll help us to get back. And I think we've been, we've still said, we still see ourselves wanting to get back to those mid-teen margins we experienced on a pre-pandemic basis. And so I think driving the cost structure, working to offset the impact of insulations, and getting where production is normalized, so some of the disruptions that we still see in the business relative to semiconductor shortages, and even the conflict in Ukraine is causing Karl Edsel, the new acquisition, there's some difficulty because it doesn't necessarily relate to our ability to produce, but it still causes supply shortages that are even apart from semiconductors.

Okay, that's helpful. Thank you. And then lastly, for me, maybe just delving a bit more into the experience, but DLH Bowles and Carl Etzel are able to say, for example, like how much of the $45.2 million increase in revenue attributable to those businesses, like how much of that represents organic growth, if any, at those companies? What kind of growth over market do you expect those businesses to generate? And are there any examples that you could point to so far of maybe revenue synergies or planned revenue synergies, perhaps from customer introductions, et cetera?

I can say that I think that what we're expecting to see is that those businesses have above average growth opportunities. I think they're both in places where they're positioned well and in places where the market would grow. So I think the number in the quarter was roughly $57 million. You know, and you'd say that they're engineered products just like all of ABC. So there's a timeframe that it takes to win, engineer, and launch those products, which we think is completely normal for the industry. But the takeaway for us is we still see above-average market growth possibilities in both of those businesses.

Okay, very helpful. Thank you.

Once again, if you have a question, please press star, then 1. Our next question comes from Andrew Lopez of TD Securities. Please go ahead.

Hi, good morning. I'm Brian Morrison. Just wanted to ask about this kind of looking at the acquired versus legacy business. Are you able to reconcile this notable difference in the rate of gross margin that we're seeing?

I'm sorry, Andrew, could you restate that question? You're just asking why does it seem like the gross margin that we're seeing in those businesses is different than the historical ABC business?

That's right. Yeah. And just because we just are noticing kind of a big gap there and trying to understand what makes up that difference. It's a function of pass-throughs that you're not seeing in your legacy business or something else.

Yeah, I think as we look at the business, and I think that historically ABC has done the level of gross profit that those businesses are doing. So, again, I think it's some of the other impacts that we're seeing, the inflation, it is having a stronger impact in the historical ABC business, as well as some of the customer recoveries that will come. So I don't think that the profiles are so dramatically different. I do think there are different places as it relates to the impact of inflation that's having on the business. And I would say it is greater on the ABC historical business. And I think it's just because of the depth of the products that we're buying, I think, in terms of there's steel that's in there that isn't so much in the acquired businesses and rubber and paint. And even some of the impacts on labor is just a little bit stronger for ABC historical. So I think those are all things that we can overcome. Okay.

And I guess, yeah, following up on that, just on the cost recovery piece, just speaking to the – are you able to speak at all to the magnitude of cost recoveries and if they'll be retroactive and what percentage of customers it would cover? I'm not sure if you're able to speak to that at all.

I would say we feel like it's inappropriate at this time to get into some of those details, and they are still being kind of worked out. And I think everything is on the table from potential retroactivity. So I think right now it feels a little premature in the process. We do have one particular customer where we have worked things out, and that is it has been on a combination of prospectives. retroactive basis but but there are other customers and and some of the ones that are still yet to go the details have not been finalized at this point okay okay no thank you that's helpful um and i'll just uh jump back into you thanks once again if you have a question please press star then one this concludes the question and answer session

as well as today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.