Mr. Christopher Nutt reports
AUTOMODULAR CORPORATION: SECOND QUARTER REPORT
Automodular Corp. had net earnings of $800,000, or four cents per share, for the quarter ended June 30, 2013, compared with $4.4-million, or 22 cents per share, in the same period in 2012. For the six months ended June 30, 2013, and 2012, Automodular reports net earnings of $4.4-million and $8.0-million, or 22 cents and 40 cents per share, respectively. The current quarter and six-month 2013 figures have been impacted by the recording of pretax $4.0-million in exit costs relating to Ford Motor Co.'s decision to insource the work currently performed by Automodular in the second half of 2014.
The board of directors has declared a regular quarterly dividend of six cents per common share payable on Sept. 3, 2013, to shareholders of record on Aug. 20, 2013.
The results for the first half of the year are summarized in the table.
(In thousands, except per share)
Three months ended June 30, Six months ended June 30,
2013 2012 2013 2012
Sales $ 21,939 $ 29,701 $ 43,746 $ 53,519
Net earnings 774 4,388 4,410 8,019
Per share (basic) 0.04 0.22 0.22 0.40
On May 14, Automodular received the decision from Ford that, in the fourth quarter of 2014, Ford would insource the assembly work currently performed by Automodular. Ford acknowledged the continuous support, hard work and high-quality assembly performed by Automodular since production started in the fourth quarter of 2006. Ford noted that the decision on their its was a strategic one; they view the modules that Automodular assembles to be core to the assembly of a vehicle and its goal is to try to have all core modules assembled in its final assembly plants. While the company is disappointed by Ford's decision and recognizes the impact that it will have on its many stakeholder groups, the company also believes that it has a strong management team focused on building value. Automodular possesses considerable skillsets that are complementary to many businesses outside of the automotive space. The company would like to take this opportunity to provide shareholders with an update on what the Ford insourcing decision means to the business and plans for the future.
The existing multiyear agreement with Ford is set to expire on June 30, 2014. Ford has requested that the company continue to provide assembly services until a yet-to-be-determined date in the fourth quarter of 2014. Once Ford defines the actual end-date, the company will enter into commercial discussions for the relevant extension period. In conjunction with those discussions, the company will be meeting with the National Automobile, Aerospace, Transportation & General Workers Union of Canada (CAW) leadership in the near term to secure a contract extension in line with the commercial extension that Ford is seeking. Automodular will continue to provide support to CAW and Ford to facilitate the transition of as many members of the work force as possible to Ford.
The company has estimated the total closure costs to be an incremental charge of $8.0-million. In addition, Automodular already carries on its balance sheet a decommissioning provision of $500,000. The total of these two figures reflects the total estimated costs to shut down the Oakville operations, and includes hourly and salaried employee severance costs, operating lease termination costs, and all other facility-closure-related costs. Of the $8.0-million amount, the company took a charge of $4.0-million in the current quarter to reflect its contractual and statutory obligations to hourly and salaried employees. The company expects to record additional severance costs relating to the closure when it formalizes its plans with respect to the affected salaried employees. The company also expects to record facility and other related closure costs at the time that they are incurred or at the time the facilities are closed, depending on their nature. It is expected that the majority of the additional expected costs will be recorded in 2014. Given the long lead time before the insourcing of the work by Ford, it is expected that the total closure cost figure will fluctuate. The company will continue to re-examine its cost estimates on a quarterly basis and will revise these estimates as circumstances change or additional information comes available.
From an operations perspective, the Oakville operations continue to run well. The quality performance, and health and safety metrics remain strong. The Oakville hourly and salaried staff should be commended for their hard work and dedication in what has been a very difficult few months for them -- first from delays with respect to Ford making its decision and then finally receiving the news that, despite the outstanding job they have done over the last 6.5 years, Ford is insourcing the business. Production volumes are nominally up over the prior year-to-date period and earnings are relatively consistent with the same period in 2012, excluding the impact of the closure costs. The business has generated levels of earnings and cash flows over the past three years that significantly outperformed traditional finance ratios or benchmarks such as price/earnings, price/book, return on assets or yield. Since late 2010, Automodular has benefited from strong demand for the vehicles that Ford's Oakville assembly plant produces. Annual production volumes have consistently exceeded the traditional two-shift volume operating pattern. As Automodular is compensated by Ford on a fully variable basis, the company has benefited from these incremental units as the gross margin on the incremental units is higher than on the base production units. The challenge will be to continue to maintain operating performance in light of the expected departure of salaried and hourly staff as the contract winds down.
As would be expected given the Ford decision, the company has received many enquiries over the last couple of months on a variety of topics. The company wanted to take this opportunity to respond to a few of the more common questions that it has received.
Is the company going to wind down next year given the Ford announcement?
The board, together with the management team and outside advisers, has been focused on delivering continuing value both now and into the future after the Ford contract concludes. While winding down the company is one option, it is not an area of focus at this time. Automodular possesses considerable skills with project management and lean manufacturing skills being at the forefront, and it would be unfortunate if those were to go to waste. The goal is unchanged -- the company is looking to find opportunities to leverage its core skills for the betterment of the company and its shareholders by securing contracts organically or through acquisition.
While the trend to insource assembly work by the North American original equipment manufacturers (OEMs) limits opportunities in the automotive assembly space, the company sees numerous opportunities in other businesses that complement its skillsets. On the renewable energy side, it continues to have discussions with Vestas and other wind-based OEMs regarding opportunities in Canada and overseas. Now that Automodular has successfully completed its first contract in the wind energy space, it is seeing additional interest from other potential customers. In addition, the company continues to work with outside consultants and other contacts to generate potential opportunities in other industry segments where its skills could be utilized. Some other sectors which are currently being considered include but are not limited to: agricultural equipment, modular construction, aerospace, consulting and industrial equipment fabrication.
Automodular's balance sheet remains strong and operating volumes and cash flows continue to be robust. Automodular continues to carry excess cash on hand in order to help finance diversification initiatives once they are evaluated by the company. The company will not rush into doing a transaction just for the sake of completing a transaction. The focus is on finding the right fit for Automodular -- one that will be accretive to earnings and where there is a real fit with core skills and values.
Is the company planning on cancelling or suspending the dividend policy in light of the Ford announcement?
At this time the board has no plans to suspend or cancel the existing dividend policy. Automodular closed the second quarter with $31.4-million in cash and cash equivalents, and expects to continue to be profitable and generate positive cash flows over the balance of the Ford contract. At this time, the company does not expect that the payment of dividends in accordance with its policy will impair its ability to secure additional contracts or hamper any potential acquisitions. The board will continue to review the payment of dividends on a quarterly basis in conjunction with the review of quarterly financial results. At its Aug. 6 meeting, the board of directors declared a regular quarterly dividend of six cents per common share payable on Sept. 3, 2013, to shareholders of record on Aug. 20, 2013.
The automotive industry seems to be doing well, so why is the company losing the Ford contract and why hasn't it secured other business from Ford or other OEMs?
The North American automotive industry has been doing well and annual sales volumes have rebounded from the economic downturn of 2008/2009. It is important to remember, however, that the company's business is to provide just-in-time assembly of modules -- it does not design or manufacture parts. The business is based on the company's ability to deliver defect-free modules to the customer on time, every time, at a cost that makes it more profitable for customers to use the company's services rather than doing the work themselves or awarding the business to competitors. The business has historically been with two of the North American OEMs -- Ford and General Motors. The reason that the company has not had contracts with non-North American OEMs is twofold -- generally they do not outsource the assembly of modules and want to build the vehicles 100 per cent in-house, and the labour costs they incur are not dissimilar to those incurred by Automodular.
As disclosed in previous filings, the North American OEMs have been able to reset their internal cost structures, due in large part to the 2009 bankruptcy protection filings of General Motors and Chrysler. This enabled them to discard unprofitable brands and vehicles, and eliminate many financial obligations. At the same time, all three North American OEMs approached both the UAW and CAW, and won sizable concessions resulting in lower effective labour costs. Automodular has made efforts to similarly reduce its cost structure but has been unable to obtain similar concessions. As a result, the differential between the company's fully loaded labour rate and that of its customers is smaller than it once was. The company now receives fewer opportunities to quote assembly services as the trend from the OEMs is to insource work.
Why have insiders been buying shares since the Ford announcement?
Following the Ford announcement, certain members of management and one of the company's outside directors purchased approximately 250,000 common shares in the open market. The other insider purchases related to the purchase by the company, under the current normal course issuer bid, of approximately 400,000 shares at an average price of $1.63. Automodular made the purchases because the board was of the view that the share price did not reflect the underlying value of the company in spite of the Ford announcement; and the investment represented a good use of the company's excess cash. Automodular has been in an internally imposed blackout since the close of business on June 30, 2013, due to quarter-end and accordingly, no further purchases can be made under the NCIB. The NCIB is set to expire on Aug. 7, 2013.
Where does the GM litigation stand?
Complex commercial litigation, such as the litigation with GM, by its very nature is a slow and arduous process. Since the last quarterly update, the company has been working on preparing materials as part of the electronic discovery process. To put it in context, the original document set had over 100,000 documents/e-mails. It takes a long time to filter through the documents to isolate the documents that are relevant to the matters at hand. All parties have now agreed on the discovery plan including the timeline for the exchange of documents and the company is expecting examinations for discovery to occur in the beginning of 2014. If there is no resolution following the discovery process, the company would then be looking for the matter to get set down for trial.
Automodular has a strong, experienced management team, and an engaged and responsive board. The company has a solid balance sheet with over $31-million in cash on hand at June 30, 2013. The contract with Ford is expected to run at a minimum for another four quarters, and the company expects to generate positive earnings and cash flows over the remaining program life. The company has a diverse range of skills -- skills that have been honed in a very demanding environment. The company knows that it has knowledge and expertise that can be leveraged in other industry segments to make businesses more efficient, and the focus is on seeking out such opportunities to enhance shareholder value.
We seek Safe Harbor.
© 2014 Canjex Publishing Ltd. All rights reserved.