AirBoss of America Corp.

All participants, the conference is now ready to begin. Good morning, ladies and gentlemen. Welcome to Airbus' third quarter 2023 financial results conference call. I would now like to turn the meeting over to Grant Shock, Co-Chief Executive Officer. Please go ahead, Mr. Shock.

Good morning, everybody, and thank you for joining us for the Airbus third quarter 2023 results call. For our agenda today, Chris Psikakis will start with a review of the operational highlights for the quarter and year-to-date, followed by Frankie Dilley, 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 four important statements, including our estimates of future developments. We invite listeners to review the risk factors related to our business in our annual information forum, and our MD&A, both of which are available on CDAR Plus and on our corporate website. Also, we will discuss certain non-GAAP measures, including EBITDA. Reconciliations of these measures are available in our MD&A. And finally, please note that our reporting currency is in U.S. dollars. References today will be in U.S. dollars unless we indicate otherwise. With that, I will turn it over to Chris.

Thanks, Grant. Looking at our Q3 results as we move through the end of 2023 and into 2024, each of our three business segments maintained their focus on strong operational performance, capturing new growth opportunities, and making select capital investments while navigating the current economic and market challenges. Consolidated sales levels were a couple percentage points off the sales posted in Q3 of 2022, and gross profit was substantially higher due to a one-time inventory charge we took in the third quarter last year. After adjusting for this charge, our adjusted EBITDA and adjusted earnings showed reasonable improvement over last year's Q3 results. Importantly, we have generated free cash flow year-to-date in 2023 and have continued to reduce our net debt levels, which have declined by over $18.8 million to date in 2023. As expected, our business units are carefully monitoring current demand levels, which in aggregate are indicating reduced customer activity and order volumes. Within Airbus Rubber Solutions, demand within the first part of Q3 was soft and showed some recovery through the end of the quarter. Airbus Defense Group saw some contraction in customer demand from both its industrial and defense segments. And last but not least, AEP maintained strong traction and built on momentum from prior quarters, despite some of the early impacts of the UAW strike. Within each of our business segments, we have moved ahead with the implementation and, in some cases, expansion of the cost-cutting measures we announced at the time of our Q2 conference call. Looking more closely at our business segment activity, starting with ARS, for Q3 of 2023, we saw volumes decrease by 9.1% over the third quarter in 2022, with decreases across most of the sectors we serviced and a continued decline in tolling volumes. In Q3, we made the strategic decision to close our Chicago location, which you may recall was added to our portfolio of facilities when we purchased ACE Elastomer in 2021. We have now shifted our production to improve capacity utilization at our other locations, while continuing to meet the needs of our customers previously served from the Chicago location. This, as well as other cost-containment efforts, have allowed us to continue to invest in our production capabilities and continue our applied R&D in partnerships with our customers. A long-term priority for ARS remains focused on delivering growth through our position as a leading supplier, specialty supplier in North America, one with a valuable portfolio of specialty compounds combined with strong production capabilities. The ARS team is also focused on replacing the volume gap from tolling customers with more advanced, more consistent non-tolling volumes. Moving now to engineered products, or AEP, we have seen continued solid momentum in its activity levels and financial contribution. We have definitely seen some negative effects of the UAW strike on the production schedules of the OEMs and Tier 1 suppliers, but given our success in updating our main supplier agreements in late 2022 and early 2023, we saw higher year-over-year volumes in our SUV and light truck platforms. Looking forward, we remain very positive about the potential for AEP to increase its contributions to our financial results through 2023 and beyond, through our focus on expanding our client relationships, developing new products, and diversifying the sectors we operate in. Moving on to ADG, we announced in late July that due to delays in converting sales opportunities for our suite of survivability products, we made the strategic decision to implement a series of measures to reduce ADG's cost, streamline operations, and reduce ADG's break-even 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 remains strong, which I also believe we have accomplished. The ADG survivability platform remains fully capable to execute against current and future awards as recent evidence of the capabilities of ADG's product portfolio. In early July, we announced new contracts for Airbus, Molded Glove, and also our Bandelier line charge system. In addition, ADG received two new orders for Bunny Boots during the quarter. On a combined basis, these new orders have an aggregate value of approximately $34 million and demonstrate the diversity of ADG's lineup of survivability solutions. During the Q3 meeting of our Board of Directors, the decision was made to return our common share dividend to pre-2021 levels as part of our overall efforts to maintain our emphasis and recent progress on strengthening our balance sheet. Looking forward, we continue to see the provision of a dividend as part of our value proposition to our investors. We remain confident that our products, along with our production execution capabilities, continue to position us to deliver long-term value for our shareholders. I will now pass the call over to Frank for the financial review.

Thanks, Chris, and good morning, everyone. As a reminder, all dollar amounts presented today are in US dollars except for dividends per share, which are in Canadian dollars. Percentage changes compare Q3 2023 to Q3 of 2022 unless otherwise noted. Starting from the top line, consolidated Q3 net sales were 102.2 million, which were 2.4% lower than Q3 of 2022, with a year-over-year decline in sales within Airbus rubber solutions and ADG that was partially offset by higher sales in engineered products. Consolidated gross profit increased to $13.8 million, which was substantially higher than our gross profit in Q3 of 2022, given the one-time charge taken against inventory within ADG during Q3 of last year. As a percentage of sales, gross margin contribution was 13.5%. Improved volumes within AEP were a significant contributor to our gross margins, along with the overhead cost reduction measures we have put in place in our business segments. Our adjusted EBITDA increased to $7.2 million in Q3, and our Q3 2023 adjusted profit was negative $2.6 million or negative $0.10 per diluted share compared to negative $11.8 million or negative $0.44 per diluted share in Q3 of 2022. Turning now to our individual segments, ADG's net sales decreased 10% to $21.2 million, with the decrease primarily due to a modest decrease in volume in the industrial sector and molded defense products. Gross profit at ADG increased to $2.6 million, with lower overhead costs implemented late in the quarter, offset by an unfavorable product mix and lower volumes. Net sales at Airbus Rubber Solutions decreased 12.9% to $51 million in Q3, driven by a 9.1% decrease in volumes across many of our end-use markets during the early part of the quarter, followed by a modest recovery towards the end of the quarter. Growth profit at ARS decreased 8.7% to $7.6 million due to volume reductions in product mix and was partially offset by overhead cost reduction initiatives. Q3 2023 growth profit as a percentage of sales was 15%, which improves on the 14.3% margin posted in Q3 of 2022. Net sales in the engineered product segment increased by 28.5% to $37.5 million due to higher volumes and product mix in the SUV and light truck platforms and partially offset by the impacts of the UAW labor strike on OEM production schedules. Gross profit at AEP increased by $7.7 million over Q3 of 2022 to $3.6 million. And this was due to volume improvements for certain vehicle platforms, product mix, improved arrangements with our key suppliers and customers, along with our ongoing cost management efforts. Free cash flow for Q3 was an inflow of $6.6 million, which supported our continued investment in capital assets and further reductions of our debt. CapEx was $2.1 million in Q3 of 2023, and we reduced our net debt balance by a further $4.3 million in Q3. We continue to ensure we maintain sufficient liquidity to fund the growth of our business. Our revolving credit facility availability is $250 million with an accordion of $75 million, and approximately $113 million was drawn at the end of Q3. As of the end of the quarter, we had net debt of $91 million for a net leverage ratio of 2.49 times trailing 12-month adjusted EBITDA. With that, I will now turn the call over to Chris.

Thank you, Frank. Operator, at this point, we can open up the line for any Q&A.

Thank you. We will now take questions from the telephone lines. If you have a question using a speakerphone, please lift your handset before making your selection. If you have a question, please press star 1 on your device's keypad. You may cancel your question at any time by pressing star 2. Please press star 1 at this time if you have a question. There will be a brief pause while participants register, and we thank you for your patience. First question is from Ahmed Abdullah from National Bank of Canada. Please go ahead.

Yes, hi. Good morning. Morning. Good morning. My first question is about the savings that were announced, which are expected to contribute $7.7 million adjusted EBITDA. Does this include the $5 million savings that you were already discussing at the corporate update that was given in July, or is this over and above?

No, thanks a bit for the question. This includes the $5 million that was previously announced for ADG. It was obviously expanded to the other segments, both ARS and AEP as well.

Okay, got it. Thanks. And is there, I know it's maybe a bit early, but is there any way that you can perhaps quantify or give us some sort of goalposts to the UAW strike impact that could occur in Q4?

So, Ahmed, we did see some small impact in Q3 from the UAW strike. That impact was small because a lot of our products go on SUVs and light trucks, and the UAW left that tool in their tool bag until later. So early in Q4, they did shut down some pickup truck and SUV plants, so the impact became greater. The good news is that it was very short-lived. And the indication that we're getting now from the big three and others is that we should be preparing to be working extra overtime to make up that gap. So at this point in time, it's hard to say what the overall impact is going to be from the UAW strike. But I would say we're quite pleased that it was quick, and there appear to be indicators that they want to make up that volume. So we'll know better as the quarter progresses, but at this point in time, don't see it as a dramatic impact either on Q3 or on Q4.

But do you have the capacity to make up that shortfall within the Q4 in case the orders come in?

Yes, we do.

Perfect. And then just last one for me. Chris, you've been in the co-CEO role now since July. What have been the takeaways as you reflect on all the segments and where things are going? What takeaways can you share with the street and should we expect some sort of strategy to be communicated to the street over the next coming months?

Yeah, that's a really good question. We could probably spend a lot of time on that. But since July, we started a very deep, in-depth strategic review on every single product line we have, every market that we operate in, how we're set up and structured operationally, what our back office systems look like. And so I've been putting a lot of effort with our team here to create sort of a strategy for the future. And luckily, we have a very strong foundation, some excellent products, and some incredible people that work for us. And so come towards the end of this year, we'll be reviewing that strategy with the board of directors and communicating something shortly after that to the market in terms of what we see the vision for Airbus to be in the short, medium, and long term.

Okay. Well, looking forward to that. And thanks for taking my question. I'll queue up.

Thank you. Once again, please press star 1 if you have a question. Our next question is from Jasroob Bain from T.D. Cohen. Please go ahead.

Good morning.

Good morning.

So, you guys already answered our UEW question, so we only have one additional question. We're wondering if you could provide some colour on the cost saving initiative. Last quarter, you noted that the majority of the then $5 million in cost savings have been executed on. Is the majority of the $7.7 million of cost savings executed on in Q3, or will some of it leak into Q4? Is that how we should think about it? Or if you could provide a bit more color, that would be much appreciated.

Yeah, thanks, Jasper. It's Frank here. Good question. Yeah, the $5 million that we mentioned after Q2 was fully executed, and the remaining $2.7 million, Substantially, all of that has been executed at the end of Q3, so we will start to see the full impact in Q4 for the full savings annual at $7.7 million.

Okay, perfect. And then, actually, I guess I just wanted a clarification on the UEW stripes. So you guys had noted that it had an immaterial impact on Q3 results as well, right? Or was that just in reference to Q4?

Yeah, Q3, I'd say with an immaterial impact. Q4, early in Q4, it's a more material impact. However, indications are that there's going to be some catch up on that volume. So there will probably be some impact in Q4, but we don't view it as going to be overly dramatic. But at this point, it's hard to estimate because not all the releases have come in yet from the customers that are forecasting exactly what their requirements are going to be by the end of December. But the indications from the different purchasing departments or customers is that we should prepare to run overtime because they're going to need to make up that volume. So that's kind of in that in-between phase that we're at right now.

Okay, perfect. Yeah, that's everything from us. I'll put myself back in the queue. Thanks, guys.

Thank you. Our next question is from Teresa Lee from Valkyrie Capital. Please go ahead.

Hi, guys. Hi, my question is more related to free cash flow generation going forward. Can you talk a bit about use of working capital if we're in an economic downturn? Do you generate more cash from working capital during that time?

Theresa, this is Frank. Usually, yes, we continue to focus on the leveraging. And obviously, during economic downtimes, we're very focused on pulling all the working capital levers to convert cash more quickly, managing our inventory, and also being very cautious with our capex spend. Again, we monitor very closely and work with each of the segments to make sure we're maximizing the cash flow opportunity to continue to pay down debt. And so we're being very cautious and very aware as we move forward. I would suggest, though, as we get into year end, as every company starts to tighten up things, there will be some pressure on free cash flow in Q4. But we anticipate continuing the trend that we've had so far this year into 24.

Thank you. And is maintenance capex about where you are now, like about $4 million a quarter? Or what's the annual maintenance capex?

Annual maintenance capex is usually in the 10 to 12 million range, but we've been, you know, cautious, obviously, but we'll continue to invest where appropriate.

Okay, so if you generate kind of cash flow of, call it 25 million a year and 10 to 12 million in free cash flow, 10 to 12 million in maintenance capex, then you have kind of 10 to 15 million in free cash flow to pay down debt annually. Okay. Right. Okay. Thank you. That's all.

Thank you. Thank you. Our next question is from Ben from PI Financial. Please go ahead.

Yeah, I wanted to ask one. Can you hear me? Yep. I wanted to ask about the dividend cut. Can we read into that a certain payout ratio that is implied for 2024-2025? What made the $0.03 reduction come about and not, say, $0.02 or $0.04? It was...

Our best estimate of what we should be doing, obviously you can't pay out more money than you're earning forever. The dividend had been increased significantly when the Defense Division was doing much better than it is now and when it had those big contracts. So, you know, right now we have a focus on deleveraging with interest rates where they are. Our interest costs are very high. And I think just the way the stock was trading, the market was speculating that the dividend wasn't sustainable. Could we have sustained it at 10? Yes, we could have, but we felt that it We weren't getting any real benefit from doing that, and it also demonstrates to the market and our lenders that we are being conservative and trying to maximize our deleveraging efforts. Okay, perfect. That's it for me. Thank you.

Thank you. Next question is from Adam McBain from Cormac Securities. Please go ahead.

Great. Thank you. Good morning, guys. Just very quickly, most of my questions have been answered, but it's nice to hear your commentary around your commitment to paying down debt. I'm just curious, more of a clarification question. What is your target ratio? Like, where are you trying to take the balance sheet to going forward?

Adam, this is Frank. I mean, obviously, if you look at us from a historical perspective, you know, our comfort level is at leverage at, you know, below two and a half. And I think that's where we want to get to high ones, low twos. But we continue to make that the biggest priority and continue to focus on converting cash, paying down debt and being very efficient. you know, efficient with how we're managing the cash flow and obviously, you know, then giving us, you know, some bandwidth to look at other strategic investments as required.

I got it. That's helpful. And then I realized that you've, you know, you've been reducing some of the headcount and ADG. I'm just curious, if you were to win a large contract, how quickly would you be able to ramp up for that?

Yeah, we were very careful and very surgical in the reductions at ADG, which, as Frank mentioned earlier, we expanded some of those same processes to find those efficiencies in the other two groups as well. And we did it very carefully so that there would be no impact in our ability to ramp up. large and healthy pipeline of opportunities, and we want to make sure that we can capitalize on them when they happen. So we were very careful not to affect that ability to ramp up quickly with some of the changes that we made.

Perfect. That's very helpful. Thank you very much, guys. That's it for me.

Thank you.

We have a next question from Ahmed Abdullah, National Bank of Canada. Please go ahead.

Yeah, just a follow-up. Are we expecting to see another add-back of restructuring charges in Q4?

Ahmed, it's Frank here. Not at this point. As I said, we're very careful and sure we did what we needed to do, which has been announced, but now we're really looking to execute on the strategy, the cash conversion, and obviously the gain deficiencies as a result of the restructuring. Okay.

Thanks for the call, Ahmed.

Thank you. And last question this time from Kevin Chang from CIBC. Please go ahead.

Hey, thanks for taking my question. I apologize if some of this has been asked already. I jumped on from another call here. It feels like a pipeline, you know, feels pretty good, right? You've been talking about that for a few years here. Just getting these orders through has been a little bit more challenging. I think if you take a step back here, I'm just wondering, outside of some of the restructuring you've done and, as you mentioned, some of the changes you've made in ADG, are you rethinking maybe the broader strategy here to maybe give yourself or things you can do to give yourself more earnings visibility or maybe reducing kind of the boom and bust nature of of your earnings profile, just given, you know, if a big contract comes through, you obviously earn multiples of what you're earning today. And if it doesn't, you're at a fraction of that. Just, I guess, strategically, how you think about that to maybe smooth this out through the cycle.

Yeah, it's difficult to give too much color on that right now because we're right in the middle of that sort of deep dive strategic review on all our product lines and kind of what we want to focus on and don't want to focus on. Certainly, the pipeline of opportunities for ADG is still very, very strong. Clearly, the government contracts related to executing on those uh opportunities have been a little bit elusive and and we see governments struggling with funding to governments you know with debt ceiling issues and a bunch of things like that that make uh the conversion of that pipeline for us very frustrating and it does lead to sort of that that boom and bust uh fluctuation where there are times where we have you know uh immense amounts of work and there are other times where we go dry for an extended period of time. So that fluctuation is something that concerns us, of course. And it's one of the many items that we're considering in our strategic review in terms of how we want to be able to go to market with a more consistent expectation on revenue and profit generation without these massive swings and what that means in terms of either broadening the portfolio and narrowing the portfolio, adjusting the markets we serve. All these things are sort of on the table as we would like to find a way to a path to a more consistent operating model based on the markets that we serve.

I would have thought, and maybe you would have thought the same thing, and it would be interesting to know what you're hearing from from, you know, I guess the US Defense Department and other defense bodies that you work with. But, you know, I would have thought what you sell into that end market is more recurring in nature, you know, more of a fixed spend versus, you know, when I think of defense projects that typically get or are at risk or get cut during budget issues are usually, you know, larger, programs, you know, like fighter jets and things like that, where you can maybe push that out, or maybe more marginal programs. I guess, do you have a different view as you sit here today around maybe the recurring nature of some of this stuff? Because I would imagine you would need this equipment regardless of where the budget is. I guess I'm surprised that this is the stuff that's getting cut, or this is the stuff that gets delayed, just given its It seems like a low dollar amount, and obviously there's a significant PPE component to this.

Yeah, I agree with you. I think we have that same expectation. Now, having said that, Q3 was actually a pretty good quarter for us in terms of some singles and some doubles on some recurring business. We got a new CBRN glove order. We got a couple of bunny boot orders. So we're seeing some orders coming in that's more that recurring nature that is sort of our – at least our base business from that perspective. But it's interesting. You know, you mentioned fighter jets and things like that. It seems like – during times of conflict like we have now, those get more attention than some of the products that we have. And with the constraint on budgets and, you know, particularly the U.S. government with the amount of support and all the G7 governments, really, the amount of support that they're giving to the Ukraine and to other hotspots in the world now, it seems to be really driving up sales of things that are sharp and pointy versus the types of products that we make. But, you know, we have an expectation that especially with some of the talk around, you know, chemical weapons and the threats of chemical weapons that at some point we're going to see a fairly significant uptick on what we do. But we just haven't seen that yet. And it appears that, you know, with all the budget concerns, some of the more, you know, sexy items are getting more attention. But, you know, we expect that soldier protection will always be there and will continue to drive revenue. But at this point in time, other than, like I said, a pretty good quarter in Q3 for some of that base load business, up until now, we hadn't seen much of it.

And just last question for me. Does the U.S. presidential election next year, does that impact, when you look back historically, would that impact how orders would come through? Is next year a potential year where people are more reticent to spend just because you might have a change in administration or historically when you look back, that's been kind of a non-event in terms of impacting bids and potential orders.

Obviously, the presidential election has an effect, although I think Both presidents are in favor of strengthening the military. The biggest issue we've had in the U.S. is the stalemate in Congress and the threats to shut the government down. Debt ceilings were passed on the condition that they take unspent PPE money and claw it back. they had announced that they were going to build up a huge strategic stockpile of PPE in case there was another pandemic. Well, that hasn't happened to some extent, but certainly not to the extent that they've been talking about. And one of the conditions that the debt ceiling was passed the last time was that they... agree to call back unspent PPE money. So that directly hurt us. It doesn't change the need. They will need it, but it's not, you know, they need a new budget to pass it. So the political theater that's happening in the U.S. is not constructive. And Canada... Not that we matter, but our prime minister is seen fit to – we don't even come close to making our NATO commitments. Yet our prime minister seems fit to take a billion dollars out of the defense budget, which is already 50% of what it should be. It's very frustrating, but that's what we're dealing with.

No, those are all very good and very valid points. I'll leave it there. Thank you for taking my questions, and best of luck as you get through the remainder of this year.

Thank you. Thanks, Kevin.

Thank you. There are no further questions at this time. I will return the meeting back over to the floor for closing remarks.

Thank you, Operator, and thanks again to everyone for attending today's call. Please reach out to us directly or through our investor relations team if you have any questions on our results or in general. Thank you and have a great day.

Thank you. Your conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.