Exco Technologies Limited

Ladies and gentlemen, thank you for standing by and welcome to the EXCO Technologies Limited Third Quarter Results 2021 conference call. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Darren Kirk, President and CEO. Thank you. Please go ahead.

Thank you, Tina. Good morning, ladies and gentlemen. Welcome to Exco Technologies Fiscal 2021 Third Quarter Conference Call. I am Darren Kirk, CEO of Exco. I will lead off with an operations overview. Matthew Posno, our CFO, will then review the financial results. Afterwards, I will discuss our outlook, including targeted levels of revenue, EBITDA, and net income by fiscal 2026. Let me warn you, our prepared remarks will go on a little longer than normal this quarter before we open up the call for questions. Before I begin, I would like to make some comments about forward-looking information. In yesterday's news release and on page two of the presentation that we have posted to our website, you'll find cautionary notes in that regard. While I won't repeat the contents, we are going into more detail about future events than usual, so I want to emphasize that the cautionary notes apply to this discussion today. In summary, we had a very decent third quarter, producing 22 cents of earnings per share and $15 million, or 40 cents per share, of free cash flow. I am particularly pleased with our results, given the ongoing challenges related to COVID-19, lower OEM production due to microchip shortages, supply chain disruptions, rising input costs, and a stronger Canadian dollar. I want to thank all of my EXCO team-mates for their fantastic efforts and of course commitment to working safely through such extreme circumstances. Looking first at our automotive solutions segment, overall vehicle production volumes in North America and Europe were materially higher year over year. We acknowledge we are lapping an unusually weak period when much of our operations came to a halt due to government-imposed COVID restrictions. Nonetheless, our foreign exchange adjusted segment revenues again exceeded industry growth by several percentage points. This reflects continuing gains in our content per vehicle at levels above our historical track record. On a sequential basis, our segment results were down from both Q2 and from levels that we would have otherwise expected this quarter. This shortfall is mainly due to reduced vehicle production volumes as OEMs continue to be crimped by the shortage of microchips. As a result, North American vehicle production in the quarter was 15% lower than what we would have expected in mid-April and 12% lower than in our second quarter. Consumer demand for vehicles, however, remains strong with sales incentives declining in dealer inventory levels, now at near record lows. This bodes well for a sustained period of higher vehicle production volumes once microchip supply issues ease, which we expect will begin in our current quarter. New program launches contributed to our results this quarter, and we also have high amounts of content on several refreshed vehicle models that are performing well. We did launch one new key program towards the end of the quarter which will continue to contribute strongly to our results in the quarters and years ahead. Quoting activity remains decent. We are seeing a number of important wins and sizable new opportunities, particularly with electric vehicles from both new and established OEMs. On the cost side, our margins were greatly improved from last year, but did slip from Q2 due mainly to reduced overhead absorption arising from lower vehicle production volumes. As well, we faced foreign exchange headwinds and heightened fluctuations in forecast versus actual order releases again this quarter. This occurred as our customers juggled their own production schedules in response to the chip shortage issue. These challenges were pushed down to the supply base and placed strain on our production planning process. Moreover, raw material cost increases picked up and we faced various supply chain challenges of our own. These elements required us to be nimble and also absorb a lot of extra costs related to overtime, material substitution, and expedited freight. Finally, we carried launch costs for one new large program through much of the quarter before beginning to realize revenues near quarter end. In our casting and extrusion segment, we again had terrific results. Demand was strong in all three of our segment business units. As I've mentioned several times before, the automotive industry's transformation toward electric vehicles and focus on emission reduction is extremely positive for EXCO's tooling businesses. We certainly saw that benefit in our results again this quarter. As OEMs make the change to greener vehicles and strive for greater manufacturing efficiency, there is an increased use of light metals and the demand for our associated tooling. There is also increasing demand for technical expertise at the supplier level as products become larger and more complex. This plays right into our strength. Tesla, with its gigapress, is a good example of this, as they are now producing entire subframe assemblies with aluminum die-cast components that are much larger than anything previously produced. Castool is the primary supplier for much of Tesla's shot-end tooling for its gigapresses, and expects to expand the relationship as Tesla ramps up its new facilities in Texas and Berlin later this year. More broadly, we also expect to benefit from the trends toward larger and more complex castings across the industry as OEMs seem likely to pursue similar processes. In addition, there is a heightened focus on efficiency by all manufacturers for sustainability initiatives that will be very positive for the entirety of our tooling business. The extrusion market remained strong this quarter, with high demand across the vast majority of end markets. Our extrusion tooling ultimately supports a diverse range of applications, including residential and industrial building and construction, solar panels, consumer durable products, and various modes of transportation. This quarter, we again demonstrated we could keep up with sizable demand growth by utilizing equipment and labor more efficiently while leveraging the harmonized manufacturing process of our numerous group facilities. With regards to the latter, this initiative has allowed us to centralize certain processes, such as programming and design, and utilize our capacity on a network basis. All of this keeps our cost low, capacity high, and provides us with the ability to manufacture a quality product in a standardized manner. We are making significant strategic investments to further shrink lead times drive down our operating costs, and in-source more of our own heat treatment requirements, all while reducing our environmental footprint. Our large mold group performed well this quarter, with COVID-related program delays easing and newer programs ramping up. We are very bullish on the long-term outlook of this business, given the growing demand for large and complex die-cast components, coupled with our leading market position. Full-service capabilities and view that supply chains will likely become more localized over time. As well, our additive business continues to perform strongly and is a critical differentiator, providing us with unmatched competitive advantages. Despite rising input costs, segment margins benefited in the quarter from absorption gains from higher sales, but more so by efficiency gains in the usage of both material and labor. This progress in part reflects our past and ongoing sizable investments in new equipment, but it is really driven by our people who continuously rethink the ways of doing things and who push the envelope on innovation and product performance. So in summary, we had an excellent third quarter. Despite the significant challenges we all face today, we are very well positioned to continue this momentum in the quarters and years ahead. That concludes my operations overview. I will now pass the call over to Matthew to discuss the financial highlights of the quarter before I come back to discuss our outlook. Matthew?

Thanks, Darren. Good morning, ladies and gentlemen. Consolidated sales for the third quarter and of June 30, 2021, were $115 million compared to $71 million in the same quarter last year, an increase of $44 million, or 63%. Third quarter sales at our automotive solution segment were up $32.9 million, or 117%. The catching and extrusion group sales increased $11.1 million, or 26%. Over the quarter, exchange rate movements decreased sales $11.2 million compared to last year's quarter. Excluding the impact of foreign exchange, consolidated sales for the quarter were up 78%. Automotive sales were up 139%, and catching and extrusion sales were up 37%. Consolidated net income for the third quarter was $8.7 million, or basic and diluted earnings of 22 cents per share, compared to a loss of $800,000, or 2 cents per share, in the same quarter last year. An increase in net income of $9.5 million. The consolidated effective income tax rate was 12% in the current quarter, compared to 10% in the prior year period. The income tax rate in the current quarter was favorably impacted by the recognition of scientific research and experimental development income tax credits during the quarter. The automotive solutions segment reported sales at $61 million in the third quarter, or an increase of $32.9 million, or 117%. This strong sales growth reflects a normalization of activities compared to the prior year when three of our four manufacturing plants in this segment were shut down for April and much of May due to COVID-19 government restrictions. Notwithstanding this improvement, growth in the current year period was hampered by the global microchip supply issues, which management estimates reduced segment sales between 15% to 20% in the quarter. Segment sales were supported by a number of key program launches for both new and existing products and favorable vehicle mix. Third quarter pre-tax earnings in the automotive solution segment totaled $5.1 million compared to a loss of $3.8 million in the same quarter last year, an increase of $8.9 million. The segment's profitability growth reflects three-month sales compared to less than a full quarter due to the plant shutdown in the prior year from COVID-19 restrictions. Overall profit margins were lower than expected due to decreased fixed cost absorption from sales reductions arising from the microchip shortage, raw material price increases due to inflationary pressures, high freight and transportation costs, and ramp-up costs for future programs. Management remains focused on improving the efficiency of its operations and reducing its overall cost structure. The casting and extrusion segment reported sales of $53.9 million for the third quarter, an increase of $11.1 million, or 26% from the same period last year. Although the impact of the microchip shortage was not as significant in the casting and extrusion segment as it was in the automotive segment, sales in Castool and the large mold groups were still negatively impacted. Third quarter segment sales reflect the third consecutive quarterly increase, 10% over the second quarter of fiscal 2021, even with the negative impact of foreign exchange and the microchip issues. The extrusion group experienced higher sales at all locations, reflecting demand for extrusion tools across industry segments, coupled with operational improvements that have continued to reduce lead times, contributing to market share gains. Demand for CAAS tools, die-cast consumable tooling, and extrusion products was solid, with a slightly stronger demand for the die-cast consumable tooling solutions leading for the quarter. The large mold group sales were up 31% from Q2 fiscal 2021, with diversity of its customer base and solid additive sales representing key drivers of the results. New business from current and new customers was awarded in the quarter. As a result, inventories and backlog continue to grow. The casting and extrusion segment reported $7.8 million of pre-tax profit in the third quarter, an increase of $2.8 million or 57% from the same quarter last year. Similar to the automotive segment, the catching extrusion segment profitability growth over the prior year is a result of higher sales due to the impact of COVID-19 last year. The COVID impact was somewhat muted last year by the nature of much of this segment's tooling products as they feed into many essential industries. Consistent with the higher third quarter sales, segment profitability continued to improve through fixed cost absorption. We benefit from greater labor efficiencies reflecting our continuing investments in new equipment and processes. These improvements were partially offset by higher freight and raw material input costs. EXCO generated cash from operating activities of $19 million during the quarter and $15.3 million of free cash flow after $3.6 million in maintenance capital expenditures. This cash flow funded $13.1 million of growth capital expenditures and $3.9 million of dividends. Consistent with recent quarters, there was no activity in the company's normal course issuer bid. Capital expenditures were above our historical levels and will continue higher this year and heading into fiscal 2022 to support our growth initiatives. EXCO ended the quarter with $26.3 million in net cash, continuing its practice of maintaining a strong balance sheet and liquidity position. EXCO's financial position remains strong. As such, the company's balance sheet and availability under the existing credit facility allows considerable flexibility to support strategic initiatives. This, combined with our free cash flow, creates a foundation for management to pursue high-value growth capital expenditures, dividends, and other opportunities that may arise. This concludes my third quarter financial review. Before we open up the call to questions, Darren has some additional comments regarding EXCO's outlook. Darren?

Thanks, Matthew. Turning to the outlook section of the presentation material beginning on page 16, we highlight some of the key factors supporting our expectation for top line growth in the back half of calendar 2021. A rebound in vehicle production volumes driven by an easement of microchip supply constraints is chief among these factors. But we are launching several new programs and we are seeing increased demand in both of our business segments generally from the rapid transition to electric vehicles and broader global sustainability trends. With respect to EXCO's ESG strategic priorities, we have highlighted on page 16 of the presentation the key categories we are focused on to ensure our operations are sustainable and we are being a good global citizen. With respect to our goals, our ESG marketplace opportunities are substantial, and with respect to the environment, we are investing significant capital to improve the efficiency of our operations and lower our carbon footprint. But we view each of our five strategic priorities as important, and we expect to update the market on the status and progress of these initiatives over the coming quarters. Beyond the near term, we are pleased to announce our targets for revenue, EBITDA, and net income by fiscal 2026. Over this five-year horizon, we anticipate growing our top line by an average of 10% per annum while targeting EBITDA, net income, and EPS growth at slightly higher levels. Altogether, we are targeting a more than 50% increase in our various financial metrics in this time horizon. This would increase our annual revenue to roughly $750 million, EBITDA to $120 million, and earnings per share to $1.90 by fiscal 2026. Digging into the elements of the revenue growth on slide 19, we see several factors contributing. With respect to the casting and extrusion segment, we are targeting incremental revenue of $30 million per annum by fiscal 2026 from the launch of two new greenfield facilities being constructed by Castool in Morocco and Mexico. These facilities will provide access to new geographies where we are somewhat inhibited from competing effectively due to proximity constraints. Market share gains will contribute the bulk of the growth that these local markets are also expected to grow strongly in both the extrusion and diecast end markets. Next, with respect to our casting and extrusion segment generally, the intensifying global focus on environmental sustainability is creating significant growth drivers that are expected to persist through at least the next decade. Automotive OEMs are looking to lightweight metals such as aluminum to reduce vehicle weight and reduce carbon dioxide emissions. This trend is evident regardless of powertrain design, whether it's internal combustion engine, electric vehicle, or hybrid. As well, a renewed focus on the efficiency of OEMs in their own manufacturing process is creating higher demand for advanced tooling that can contribute towards their profitability and sustainability goals. We expect traditional OEMs will ultimately follow the trend of increased casting sizes, and we are positioning our operations to capitalize accordingly. Altogether, we expect these operations, along with GDP plus type growth in the broader extrusion market, will provide us with $90 million of annual revenue incremental opportunities. Moving on to the automotive solutions segment, we have already begun to launch $65 million of recently awarded programs. Roughly half of these programs are on electric vehicles, and the launches will occur steadily over the next couple of years, ramping up fully by early fiscal 2024. Lastly, with respect to our broader automotive solution segment opportunities, we are targeting to maintain our track record of increasing content per vehicle in the vicinity of 7% per annum. This is within range of our historical track record and could be enhanced by higher vehicle production volumes, which we have not factored in. Drivers behind the content per vehicle growth are mainly twofold. First, OEMs are increasingly looking to the sale of higher margin accessory products, as a means to enhance their own levels of profitability. EXCO's automotive solution segment derives a significant amount of activity from such products and is a leader in the prototyping, development, and marketing of the same. Secondly, the rapid movement towards an electrified fleet is enticing new market entrants into the automotive market while causing traditional OEM incumbents to further differentiate their product offerings. All of this is driving above-average opportunities for EXCO. On the cost side, inflationary pressures have intensified in recent quarters while prompt availability of various input materials and components has become more challenging. We are offsetting these dynamics through various efficiency initiatives and taking pricing action where possible. While there is typically several quarters of lag before the countermeasures are evident, we do expect to generally hold our segment EBITDA margins near current levels over time. In particular, we are targeting margins of 20% in the casting and extrusion segment and 15% in automotive solutions, producing a consolidated EBITDA margin of 16% on an annual basis. With respect to the ample amounts of free cash flow that we expect to generate, we are prioritizing the use of these proceeds for growth capital and dividend increases. Even so, we expect to have significant surplus cash flow over our five-year horizon, which will add to our exceptional balance sheet strength. Acquisitions remain an area of focus. We expect we may pursue opportunities that add around $250 million to our top line while sustaining a very strong balance sheet. Any acquisitions, however, will be pursued very cautiously and with a strategic view. In any event, they are not included in our EPS target of $1.90 by fiscal 2026. With all of that, we know these goals can't be obtained without the dedication of our people. I'd like to again thank the entire team at EXCO for their focus, hard work, and immense flexibility during the past quarter and year. I know we are all looking forward to a very bright future. That completes our prepared comments. We can now proceed to questions. Tina?

As a reminder, to ask a question, press star 1 on your telephone keypad. To remove yourself from the question queue, press the pound key. Your first question is from David Ocampo.

Hey, good morning, everyone.

Good morning, David.

Yeah, Darren, on your guidance, you know, when you provide that 2026 EPS target, how should we think about how that scales to that number? Is it, you know, something that's more back-end weighted, or should we think about it as more evenly distributed by year?

I think, you know, when you look at the buildup of that, David, and, you know, I guess I point to page 19 of the conference call deck, there's really four components there. And that's the new plants in Morocco, the above-average market share growth from share gains and casting extrusion, and the various programs awarded in automotive solutions, and then automotive solutions organic growth being the four components. The various programs awarded in 21, the $65 million, that'll ramp up steadily, I guess, between now and early fiscal 2024. You know, the other components I would... guide you toward kind of layering it in on a steady basis through the time horizon.

Okay. When I think about that 7% CAGR that you have on the CPP growth, how much visibility do you guys have on that just based on your discussions with your customers? Is it something that is reasonably attainable?

Well, near term, I'd say it's pretty decent. But looking deeper into the horizon, really that expectation is based on our long-term historical track record of growing at 5% to 10% percentage points better than changes in vehicle production volume. And I guess it Again, points back to the unique nature of the accessory products that we have being a key driver of that growth. And as OEMs look to these accessory components to bolster their own profitability.

Great. And I appreciate the commentary on the inflationary pressures that you guys are seeing. And you guys noted that you do have some initiatives to mitigate it. But is that enough to completely offset it, or is that something that's only possible with the new contracts that you guys put in place over time?

Well, you know, it's difficult to say what the intensity of these cost inflation measures may be over the near term. And, you know, as a result, you know, it's difficult to guide you to what the margins can be on a short-term basis. But We do feel that with time and focus that the segment margins of 20% for casting extrusion and 15% for automotive solutions will be sustainable.

Okay, the last one for me before I just hop back in the queue, but just for Matt, when I think about the CapEx, is that elevated for, call it the next year or so, and then falls back to your kind of normal run rates?

Yeah, I mean, we think we'll hit around 40 plus this year, and that's obviously considerably higher than the last couple of years. Fiscal 2022, my guess will be very similar. We're just in the midst of our budgets, but I see that continuing. 2023 and beyond, I think it will taper off a bit, but as we get bigger, there'll be more maintenance capex and other things, but I do see things tapering a bit after 2023. It's just a question of the timing and how it flows through.

Okay. That was very helpful. I'll hop back in queue.

Thanks, David.

And your next question is from Peter Sklar.

Yeah. Good morning, Darren and Matthew. Hi, Peter. Yeah. First, just on this margin that you had in the auto solutions segment. So, like I understand with the chip shortage, there's obviously the issue of overhead absorption. so that will put a lot of pressure on your margin. But when I look historically, when that segment, like it has previously been at this kind of revenue level and did post much higher margins, so what was weighing on the business, you know, besides the overhead absorption issue? Was it just largely this, like was it the disruption related to the chip shortage or something? Are there plastic prices? We're really pressing you. Can you talk about, do you have protection on plastics? Is there any pass-through or what's going on there?

Yeah, so there's a number of elements there, Peter. While we've had higher margins with similar type revenue in the past, our operations were, quite frankly, geared up to have even higher revenue this quarter. that didn't materialize due to the chip shortage issue. So we're carrying costs that aren't reflective of the sales that we did generate. And so that's the biggest component of the margin pressure that we faced in the automotive solution segment this quarter. But as I mentioned and as you pointed out, cost inflation, expedited freight, as well as new program launches and FX were material components. It's hard to give you an exact magnitude for each, but they all influenced the margin. With respect to pass-through costs, there are some. By and large, cost inflation on the short-term basis is something that we have to absorb. And, you know, we look to fix that over time through various means. But, you know, that's obviously a factor as well.

And, Peter, for some of our releases, we were showing, you know, volumes coming a month down the road, and then they changed it. I mean, you see the numbers on the news, and, you know, one minute they say they're going to ship, and then they shut down for two weeks. And that's hard to manage your production flow. And so you talk about sales to historics. How do you manage that flow of up and down?

Yeah. Okay. Um, understood. Um, and then, um, like with, with these releases and the volatility and the releases, um, you know, because of the chip shortage, like how much, like how much, um, like how much are you seeing as you go into the, you know, production weeks a week or two ahead of you? Can they, can they literally like, can the production schedules literally change at the last moment? Is that what you're saying, Matthew?

You know, not like one week out, but, you know, two or three weeks, things are looking good, and then, you know, a week later, they kind of slow it down a bit. So it's, you know, I was looking at Audubon News yesterday about some of our OEs, and one minute they're saying it's on, and then they're off for three more weeks.

So, you know, that... Yeah, we would typically have eight weeks of visibility, and then all of a sudden, you know, things get yanked out of the order system. within two weeks of shipment, and things were just very erratic during the quarter as the OEs shifted production around as this microchip issue remained quite fluid. I think the good news is that we think that our Q3 and calendar Q2 was the peak of this impact, and it is expected to improve from here. I think the impact will be with us for some time, but at a reduced level of intensity.

Yeah, okay. Just moving on to the Tesla relationship, these larger aluminum castings that they're doing, what are the castings? Are they structural parts?

Yeah, they're structural parts. They're casting the entire back end of the Y, and they're casting the entire front end of the Y with really one shot. These Giga presses and the Giga castings are basically replacing 70 different stamps and welded ferrous metal components that are assembled by robots in the body shop. This trend toward just producing much larger parts of the frame with a casting is seen to be much more efficient way of manufacturing. And it makes the vehicle lightweight and improves the manufacturing efficiency. And we have a pipeline into the OE providers of these large die-cast machines. And it does seem that there's strong interest in the established OEs of going down this route as well. And we're gearing up our operations to... take advantage of the fact that we do expect that these larger castings will become much more prevalent across the industry.

So these big castings, then, they're not specifically targeted towards battery electric vehicles. They're also being employed in contemporary vehicles. Is that what you're saying?

Yeah, I mean, today, Tesla's really the only one that's doing it, and obviously their battery, but I think there's nothing that stops the non-battery type vehicles from employing the same approach. And I think you'll see it used across a widespread swath of vehicles.

Right. Okay. And then just my last question, Darren, this five-year guidance that you've provided, I don't think you've provided five-year guidance before. So I was just wondering, like, what was the motivation to provide that now?

Sure. There's really a number of reasons. We do have these sizable contracts in the automotive solution segment, the $65 million. Quite frankly, it's trending even higher than that already. And we think that that's kind of a material element of growth. All these changes that are occurring in the industry with respect to larger castings, are another impact. We're spending much higher levels of capital than we have in the past. And we think putting all of that in context of where we're going, quite frankly, I'm not so sure that the story and understanding of our growth prospects are well understood by the broader market. So we're trying to highlight that as well.

Okay, thank you for your comments.

Thanks, Peter.

And we have no further questions at this time.

Okay, well, thanks, everyone. Appreciate your time on the call today, and we look forward to talking to you next quarter.

Thank you again for joining us today. This does conclude today's presentation. You may now disconnect.