Linamar Corporation

Good afternoon, ladies and gentlemen, and welcome to the Lina Moore Second Quarter 2023 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Wednesday, the 9th of August, 2023. I would now like to turn the conference over to Linda Hasenfritz, Executive Chair and CAO. Please go ahead.

Thanks very much. And good afternoon, everyone, and welcome to our second quarter conference call. Joining me this afternoon are some members of my executive team, Jim Gerald, Dale Schneider, Elliot Berger, Mark Stoddard, and some members of our corporate IR, marketing, finance, HR, and legal team. Before I begin, I will draw your attention to the disclaimer currently being broadcast. I'll start off with a review of sales, earnings, and content. Sales for the quarter were $2.55 billion, up 29% to last year on recovering markets and supply chains, as well as market share growth. Normalized net earnings for the quarter were $160.8 million and normalized EPS $2.61. EPS is up 55% over last year on stronger sales and launching business. Our industrial segment had another excellent quarter, with sales and OEs significantly up at both MacDon and Skyjack on stronger markets and market share growth in targeted products. MacDon had a particularly strong quarter, and easing of supply chain issues helped our teams get products out the door. Our Salford acquisition also played an important role in both sales and earnings growth. Pricing increases and a favorable exchange rate helped offset higher costs that this segment has been experiencing. The mobility business had a strong quarter on the top line thanks to stronger markets in all global centers and strong launch performance. Higher costs continue to drag on results, notably energy and freight costs in Europe, although customer pricing relief is helping to offset part of the cost. The segment did see some improvement in earnings compared to Q1 as we expected. We do expect to see continued improvements sequentially in Q3 of this year for this segment, despite normal seasonal slowdowns as cost improvements continue and we see further pickup in Asia, as well as the impact of our Jura Shiloh battery enclosure business acquisition. It's great to see the continued trend upwards in terms of normalized net earning margins that we've been seeing since the recent low point in the fourth quarter of 2021. This quarter has been another excellent example of Linnemar's diversification strategy, again, paying dividends and driving consistent, sustainable earnings growth for us. We saw another quarter of market share growth in our mobility business with global content and vehicle up over last year. Both Europe and Asia Pacific saw content for vehicle growth on launching business with North America flat. Commercial and industrial sales were up 50%, with solid growth at both Skyjack and Macdon on market growth and market share growth in key targeted products. Macdon had a particularly strong quarter. Salford also played a key role in growing sales and OE in this area. CapEx continues to run at a more normal level than seen in recent years to support global launches and growth. CapEx has a percent of sales with 8% in line with a level of spending of 6% to 8% that would support our targeted double-digit growth level. We do expect CapEx to be significantly up this year over last year and at the high end of our normal range. Next year, CapEx will grow again, still staying at the high end of our 6% to 8% range. Free cash flow was $56.1 million in the quarter on strong earnings despite heavier CapEx. We have $1.8 billion of liquidity available to us, noting we will use an estimated $325 million U.S. for the Durashallow acquisition. Our net debt position has remained strong at just $493 million, thanks to continued positive free cash flow. Leverage remains very strong and remarkably consistent at just 0.42 times net debt to EBITDA. Our strong balance sheet and liquidity means we have the ability to continue to pursue acquisition opportunities as they arise in a dynamic market and drive even more growth. I'll turn now to a market outlook. Market demand is continuing to look good, with growth in most regions and businesses expected for this year and next year. Supply chain issues do continue to constrain industry's ability to deliver on the demand, but it does feel less volatile. Turning to the specific markets, industry experts are predicting growing light vehicle volumes globally this year to $15.5 million this 17.4 million and 48.7 million vehicles in North America, Europe, and Asia, respectively. That represents 8%, 10%, and 3% growth. 2024 will see Europe flat and further growth of 1.5% to 2.5% in Asia and North America. Industry experts are predicting on-highway medium heavy-duty truck volumes to grow moderately in Europe this year but more strongly in North America. and double-digit growth in Asia after a tough couple of years. Next year, we're going to see continued growth in Asia, but flat to down markets in Europe and North America. Industry experts predict double-digit growth in the assets market globally this year, with North America and Europe expecting high single-digit and Asia low double-digit growth. Next year, we'll see further growth of another 5% to 10%. Lastly, the agricultural industry, It's predicting growth in the combine draper header market this year in mid-single digits in North America, but reasonably flat in other parts of the world. The wind rural market will also see single-digit growth globally this year, driving mainly out of Europe and Australia. There is a causative outlook for market growth in both tillage and crop nutrition equipment this year as well. Looking at the access market in more detail, you can see first strong double-digit growth in all of North America, Asia, and Europe in the second quarter. All three regions are expecting solid growth this year and more moderate growth in 2024, as already noted. Rental company demand for equipment is strong as companies continue to look to counter fleet aging experience during COVID-19. Equipment utilization in North America is well ahead of 2022 throughout the first half of the year, in line with or exceeding peaks that we saw in 2019. Utilization levels in Europe are well above 2022 levels as well, and also exceeding 2019 peaks. Our backlog at Skyjack is solid, and with some relief on the supply chain side, we are increasingly enabled to deliver on such. With market and market share growth, we feel confident we can again grow Skyjack in double digits this year and next year. We're, of course, keeping a close eye on potentially shifting market conditions in the event of an economic slowdown. In the agricultural business, Q2 combined retails in North America were up 25% over prior year and high horsepower tractors up 13%. As noted, we expect to see market growth primarily in North America for both segments. Inventory at equipment retailers remains below historical levels, driving demand. Dealer sentiment remains positive, but with a cautious outlook. We have a significant backlog at MACDON, which is up over prior year. Supply chain issues, though still a challenge, are improving and helping the team get products out the door. Our current forecast is for double-digit growth this year again for MACDON, with continued growth in 2024. Salford is seeing a strong backlog in all products as well. In conjunction with the market growth referenced, also mainly in North America, Salford is also predicting double-digit growth in 2023 with continued growth in 2024. Looking at the mobility side, you can see vehicle inventory levels in North America have slipped back a little to 34 days, so well below historic levels. Refilling the pipeline with vehicles will still be a major priority for the automakers and will take some time to get done. In looking at production levels compared to what was forecast at our last conference call, you can see a slightly stronger Q2 in all regions, ending at 22 million vehicles, which was up 16% from last year, which was 19 million. Q3 is forecast to be 20.8 million units, down a little from prior year, but up a little from what we had forecast to you back in April. The full year, as noted, is predicting overall growth at 5% over 2022. Looking at launches for the mobility business, you'll be pleased to know we have another strong quarter in new business wins. a very strong quarter for WINS in the electrified and propulsion agnostic space, which is really dramatically shifting the landscape of our mobility business. We've had a solid first half of the year in terms of business WINS for both battery electric and hybrid electric vehicles. Year-to-date WINS are 58% for electrified vehicle and propulsion agnostic work out of our total new business WINS. Nearly 60% of our mobility sales as soon as 2027 are now for electrified vehicles or are propulsion agnostic, and this figure is growing every quarter. Our strategy is to continue to grow this percentage to minimize the concentration of our business at risk as internal combustion engine vehicles ramp down over the next decade. Overall, our numbers are as follows. We are seeing ramping volumes on launching programs, which are predicted to reach 30% to 40% of mature levels this year, generating incremental sales of $700 million to $800 million. We'll see further growth of another incremental $800 million to $900 million next year. These programs will peak at nearly $4.5 billion in sales. Only about $5 million of program moved from launch to production last quarter, which was more than offset by business wins in the quarter. Launching business in conjunction with growing markets will result in double-digit sales growth for the mobility segment this year and next year. So let's turn to a summary of that top-line outlook and also look at the bottom-line margins and next quarter in a little more detail, as illustrated on this slide. With strong markets and market share growth, we're expecting to see double-digit growth on the top line in 2023 and 2024 for Linnemar overall. This derives from double-digit growth in both our industrial and mobility businesses. Net margins will expand in 2023 on growing sales. We expect significant growth in margins in the industrial segment, where margins will expand back into their normal range. Mobility margins will contract for the year, noting stronger margins are expected in the back half than we saw in the first half of 2023. This will mean significant double-digit earnings growth in the industrial segment, coupled with reasonably flat OE performance in the mobility segment, which will combine to drive significant double-digit growth in earnings per share in 2023. In 2024, we expect continued expansion in overall margins, driving out of expansion in margins in both segments. This will mean double-digit growth in earnings in both segments and another year of double-digit EPS growth in 2024. We will also see continued positive free cash flow this year and next year, leaving us in an excellent position from which to drive further growth. Looking specifically at Q3... You should expect OE up from prior year, but seasonally down from Q2 of 2023. The mobility segment will see OE up sequentially over Q2 of this year, despite normal seasonal slowdowns in North America and Europe, thanks to our new battery enclosure plants, as well as improvements in Asia and in terms of cost overall and pricing, but flat at best performance to Q3 of last year. The industrial segment will see OE down sequentially versus a Q2-23 outperform due both to seasonality of the business and a stronger-than-normal Q2 this year for MacDot, but up in double digits compared to last year. Moving on to an operational update, we're very excited to announce the acquisition in the quarter of three battery enclosure facilities from Dura Shiloh. The acquisition adds complementary technology to our existing capabilities around cast and aluminum welded battery enclosures with a multi-material battery enclosure design including high-speed steel, composite materials, and a unique bonding process. The three facilities in aggregate are generating approximately $330 million in sales. Purchase price is estimated at $325 million U.S. Operating earnings levels are a little under our normal target range of 7% to 10% of sales for our mobility business, but we anticipate to see them reach that level within 18 months. The financial results will be consolidated into our existing mobility segment results. The transaction closed last week, and integration efforts are underway. We've already had a chance to spend some time with the teams and are impressed by their capabilities and the efficiency of their operations. We welcome the teams to the Linnemar family. These three facilities will join our new bigger casting facility that we announced last quarter, our existing Mills River high-pressure die-cast facility, and an existing Linnemar battery enclosure facility to form our newly created fully EV and propulsion agnostic group, which is the Lindemar Structures Group. We are very excited about this new global group at Lindemar, which is growing rapidly and will play a pivotal role in the future of our mobility business. With just the facilities and business one to date, this group is already poised to be approximately $1 billion in sales and has additional significant opportunities under pursuit. Moving on to new business winds, on the mobility side, I will highlight a few far more interesting winds this quarter. First, I'd like to highlight more than $110 million worth of winds in a variety of driveline components that are going to be used in battery electric vehicles. Production of these components is going to start later this year in facilities in all of North America, Europe, and China. Secondly, we had a very strong quarter for commercial vehicle wins, with more than $30 million of wins for transmission and driveline components for commercial vehicles. These will launch next year at plants in Canada, Spain, and France. It's great to see our commercial vehicle business starting to gain some traction again. It's a highly opportunistic market undergoing enormous technological change, which will create many opportunities for us. Lastly, I'd like to highlight a significant structural win for a European-based OEM, adding to our growing portfolio of propulsion-agnostic structural components. This will be used in the next-generation battery electric vehicle and will launch in 2024 in the UK. Turning to an innovation update, I'm happy to share that Skyjack is continuing to update its fleet with more purely electrified products. The E-Series scissor lifts with AC electric drive have been launched into production. This follows on the heels of our SJ-16 and SJ-20 mass lift launches last year. The electric direct drive powers the wheels directly and removes hydraulic actuation from the drivetrain, exceeding customer expectation when operating in certain indoor work environments. The pure electric system features improved run time per charge and lower operating costs, which means better return on investment for our fleet rental customers. And from the mobility side, we once again are thrilled to highlight the battery enclosure systems we add to our portfolio from the acquisition of the three Durashilo manufacturing sites. This battery enclosures product line enables us to offer our customers modular designs in multi-material structures with integrated cooling channels using either welded or bonded assembly techniques. This product line is built on modern, state-of-the-art equipment utilizing a highly optimized single-piece flow manufacturing process. This is an exciting addition to our electrified vehicle content offering. Finally, we continue to execute on our global digitization journey with more and more connected machines, data connections, and robots being commissioned in our global plants every day. With that, I'm going to turn it over to our CFO, Dale Schneider, to lead you through a more in-depth financial review.

Over to you, Dale. Thank you, Linda. Good afternoon, everyone. As Linda noted, Q2 was an exceptional quarter for sales and earnings growth despite the continuation of supply chain issues impacting sales and other cost issues that are further impacting net earnings. Of course, net of any customer recoveries achieved in that quarter. Q2 was another positive quarter for cash generation with strong liquidity reaching $1.8 billion. For the quarter, sales increased 28.8% to $2.6 billion. Earnings are normalized for FX gains or losses related to revaluation of the balance sheet and potentially other items that may have occurred. In the quarter, earnings were normalized for FX losses related to revaluation of the balance sheet, which impacted EPS by 20 cents per share. Net earnings were further normalized in Q2 as a result of the net withholding taxes paid related to the repatriation of cash from our Chinese operations, removing this net loss impacted EPS by $0.22 per share. The total of these two issues impacted EPS by $0.42 per share, and as a result, normalized EPS for the quarter was $2.61. Normalized operating earnings for the quarter were $230.8 million. This compares to $149.2 million due to 2022, an increase of $81.6 million, or 54.7%. Net earnings, normalized net earnings increased 51.5 million or 47.1% in the quarter to 160.8 million. Fully diluted normalized EPS increased by 93 cents or 55.4% to reach $2.61. Included in earnings for the quarter was a foreign exchange loss of 16.6 million which was a result of the $16.7 million loss related to the revaluation of our operating balances and $100,000 gain due to the revaluation of our finance expenses. As I mentioned, the net FX loss impacted EPS for the quarter by 20 cents. From a business segment perspective, the Q2 FX loss of 16.7 related to the revaluation of operating balances as a result of $11.8 million loss in industrial and a $4.9 million loss in mobility. Further, looking at the segments, industrial sales increased by 54%, or $272.7 million, to reach $777.3 million in the quarter. The sales increase for the quarter was due to the higher agricultural sales driven by growth in both the global markets and our market share growth in our core product. Higher access equipment sales driven by growth in the global markets and also with market share growth in our European boom products. The acquisition of Salford last year also added additional sales this year. Higher sales price achieved to help relieve some of the current supply chain costs also impacted sales. And finally, we had a positive impact from the changes in FX rates since last year. Normalized industrial operating earnings for Q2 increased 102.2 million or 206.9% over last year to 151.6 million. Primary drivers impacting industrial earnings were the increase in contribution from the strong agricultural equipment volumes, the increased contribution from the higher access equipment volumes, the positive impact from changes in FX rates since last year, and the increased margins from the sulfur acquisitions. These were partially offset by increased SG&A costs that are supporting this growth. Turning to mobility, sales increased by 298.5 million or 20.2% over Q2 last year to 1.8 billion. The sales increase in the second quarter was driven by increased volumes on launching programs, the positive impact from changes in FX rates since last year, and cost coverage that we were able to achieve in the quarter. C2 normalized operating earnings for mobility were down over last year at 79.2 million. In the quarter, mobility earnings were impacted by the increased labor, materials, freight, and utility cost net of any customer recoveries. The increased SG&A costs that are supported in the growth, and these are largely offset by increased contribution on the higher launch volumes. Returning to the overall Lenmar results, the gross margin was $361.9 million, an increase of $112 million compared to last year, due to the same factors that drove the segment results that I just discussed. Cost of goods sold, amortization expense for the second quarter increased slightly to $116.6 million compared to Q2 last year. COG amortization as a percent of sales, though, decreased to 4.6%. Selling general and administration costs increased in the quarter to $131.2 million from $100.7 million last year. The increase is primarily the result of increased management and sales costs supporting the growth, incremental SG&A costs from our acquisition of Salford last year, and increased costs of travel that is also supporting the growth. Finance expenses increased $10.5 million from last year. mainly due to the additional interest expense from the Bank of Canada and U.S. Fed rate hike since last year, the increased debt due to the 2022 acquisitions and share-by-back programs that were completed last year, and to a lesser extent, the new private placement notes issued in June 2023, which were partially offset by increased interest earned by the interest rate hike from last year. Consolidated effective interest rate for Q2 2023 was 4.3%. The effective tax rate for the second quarter increased to 32.1% compared to last year, mainly due to the non-deductible expenses in the quarter and the net withholding tax on the repatriation of funds from China. For Q2, the effective tax rate would have been 25.3% if the repatriation of the cash from our Chinese operations did not occur. We are expecting the 2023 full-year tax rate excluding the net withholding tax in Q1 and Q2, to be in the range of 24% to 26% and higher than 2022 full-year rate. Minimized cash position was $1.4 billion on June 30th, an increase of $515.3 million compared to December 2022, mainly due to the private placement issue in June 2023, which was partially used to fund the closing of the acquisition of the battery of closure plans last week. The second quarter also generated $260.9 million in cash from operating activities being used primarily to fund CapEx and debt repayments. As a result, net debt to EBITDA remained flat at 0.42 times in the quarter from last year. Based on our current estimates, we're expecting 2023 to maintain our strong balance sheet and leverage is expected to remain low. The amount of available credit on our credit facilities was $465.8 million at the end of the quarter. Our available liquidity at the end of Q2 also remained strong at $1.8 billion. As a result, we currently believe we have sufficient liquidity to satisfy our financial obligations throughout the year. To recap, sales and earnings for the quarter was a story of improving markets and increasing market share in both segments. which drove overall sales up almost 30% and normalized EPS was up 55%. Supply chain shortages that have been hampering OEM production requirements have continued to see improvements, adding additional mobility sales. The supply-related cost increases continue to impact both segments' earnings. Menomar has continued the discussions with our customers for price increases and cost recoveries, and those negotiations are ongoing. Despite these challenges in the quarter, we are still able to maintain our strong liquidity at $1.8 billion. That concludes my commentary. I'd now like to open up for questions.