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Edited Transcript of ARCW earnings conference call or presentation 26-Sep-17 9:00pm GMT

Thomson Reuters StreetEvents

Q4 2017 ARC Group Worldwide Inc Earnings Call

DENVER Sep 27, 2017 (Thomson StreetEvents) -- Edited Transcript of ARC Group Worldwide Inc earnings conference call or presentation Tuesday, September 26, 2017 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Drew M. Kelley

ARC Group Worldwide, Inc. - Interim CEO, CFO & Director

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Conference Call Participants

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* Jonathan E. Tanwanteng

CJS Securities, Inc. - Research Analyst

* Ralph Weil

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Presentation

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Operator [1]

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Good afternoon, and welcome to the ARC Group Worldwide conference call. Today's conference is being recorded. With me on the call is Alan Quasha, ARC Chairman; and Drew Kelley, ARC's Interim CEO and CFO. Before we begin the formal discussion, I would like to turn the call over to Mr. Kelley to make a statement regarding forward-looking information.

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [2]

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Good afternoon, everyone, and thank you for taking the time to join our call. As most are aware, this call will contain forward-looking statements as defined by federal securities laws. Forward-looking statements are indicated by words such as expects, anticipate, plan, believe and similar words concerning future events. All future events are inherently uncertain, and actual outcomes may differ materially. We do not guarantee future performance, and past performance is not necessarily indicative of future results. Further, we undertake no obligation to update our forward-looking statements. We encourage you to review the risks that we face and other information about our company in our filings with the SEC, including our annual report on Form 10-K and quarterly report on Form 10-Q.

As discussed in today's press release, I'd like to begin today's call by highlighting a few key initiatives the company has implemented since June. As many are aware, for the past several quarters, we have not achieved our objectives, which correspondingly adversely impacted our operating performance, financial outlook and capital resources. As a result, on June 23, ARC's board addressed the situation by announcing the reorganization of our executive and senior operating leadership teams. Simultaneous with this internal reorganization, management aligned the company's focus and efforts on our core capabilities of metal injection molding and metal 3D printing. At the same time, we placed greater emphasis on the fiscal and operational discipline. We believe these corrective actions will move the company forward to a more profitable and exciting future.

From a macro perspective, we began the strategic review of all operating and other assets. In response to this review, we ceased operations at our unprofitable Mexico facility in July; we determined our flange division to be nonstrategic, and divested the subsidiary for $3 million or more than 5.25x trailing EBITDA on September 15; and we made numerous other strategic and operating changes to better align our business within the growing additive manufacturing marketplace. Notably, while this completed changes were swift and far reaching, we continue to evaluate our business model and may consider additional strategic alternatives or divestitures in the future.

Simultaneous to the strategic review, we began our -- to effect operational efficiencies through the rationalizing of our cost structure to be more productive and less capital-intense. We implemented headcount reductions and other cost-reducing measures at most of our facilities to materially reduce our fixed cost structure. Most materially, we reduced our domestic salaried and hourly full-time staff by more than 15% to more efficiently align with the current sales estimates. Overall, we estimate these savings have eliminated approximately $6 million in one-time and recurring annual costs. Again, while these initiatives are complete, we will continue to evaluate further cost reduction measures on an ongoing basis.

Separately, we also made the decision in the fourth quarter to exit products and projects which were deemed low margin or unprofitable, resulting in several one-time charges. While these non-cash charges were the primary drivers of decreases in gross profit during the period, we believe the company is significantly better positioned going forward. In particular, we incurred non-cash charges of approximately $5 million related to higher inventory reserves and write-offs for inventory, tooling and associated parts. Finally, we concluded the goodwill was impaired at our ATC and Kecy subsidiaries, recording a noncash impairment charge of $3.3 million to eliminate the carrying value of goodwill for these subsidiaries.

At the root of these changes was a desire to refocus the company on its core services but also, equally important, on increasing profitability. Overall, we believe ARC provides a unique and highly strategic value proposition to a growing customer base. And as such, our go-forward top line strategy should be priced accordingly.

Finally, we initiated a multipronged financial policy review, primarily designed to improve cash flow generation and reduce our capital intensivity through specific, addressable actions. As a result, we revised our accounts payable and receivable policies as well as other guidelines designed to ensure greater efficiency in inventory at all facilities. Overall, these financial policy changes, along with the impact of improved operations and strategic initiatives, are designed to assist in the material deleveraging of the company towards our long-term normalized rate of 2x debt to annualized trailing EBITDA.

The company also announced earlier today results from our fiscal quarter ended June 30, 2017. While we were obviously disappointed by recent results as mentioned, we believe the company and ARC has positioned itself to take the necessary corrective actions and make great strides towards moving the company towards a more profitable and exciting future.

Sales from continuing operations for the quarter were $22.1 million, a decrease from the prior year period due to lower MIM and plastic sales, most notably in the firearm and defense sectors. Gross profit from continuing operations for the quarter was a negative $2.2 million compared with $4.6 million in the prior year. Facility EBITDA from continuing operations was a negative $5.9 million compared to $3.6 million in the fourth fiscal quarter of 2016. Both the facility EBITDA number and the net cash from operations -- or net loss from continuing operations in the recently completed quarter include the $5 million in non-cash inventory and fixed asset charges as well as the $3.3 million in non-cash goodwill impairment charges.

In addition, SG&A expenses during the quarter increased to $4.9 million from $4.1 million in the previous year. This increase was largely related to one-time items, including higher non-cash option expense and severance, and should revert back to below the previous year total given the one-time nature of these charges and the cost reductions.

As such, if you remove or pro forma all results for both the one-time accounting charges and the aforementioned $6 million in cost reductions, we believe the company has a clear and achievable path towards profitability in the current fiscal year.

Overall, given our recent results, our primary objectives are clear: improve our operational efficiency; drive cash flow and increases in profitability at all business units; and deleverage the company through specific, well-defined operational, financial and strategic measures. At the same time, let me reiterate: these recent initiatives do not jeopardize the company's ability to growth. Rather, we are better positioned, both internally and externally, to drive customer satisfaction, bottom-line results and shareholder value. In particular, we remain bullish on the company's sales pipeline. As we discussed in the press release, ARC recently received customer approvals on 166 new customer products, with many parts already in full production. Included in these launches are several holistic solutions for our customers in the medical and defense sectors. These complete solutions use a multitude of our complementary technologies, including metal 3D printing, MIM and plastic injection molding to garner a larger share of the previously untapped business opportunities.

Similarly, our metal 3D printing business continues to grow rapidly. With the addition of 4 new machines, ARC now operates 15 metal printers. We were especially excited about our recently opened new 30,000-square-foot dedicated 3D facility, which provides us with the ability to add up to 40 additional machines. The new facility does not simply improve our scale, however, but includes several dramatic improvements through our key capabilities in 3D printing, including designated areas for defense production, controlled environments for medical implants and in-house heat treatment and machining. As a result, we expect 3D revenues to continue to grow at its recent pace as we are forecasting 3D revenues to double in the current fiscal 2018 year.

Finally, I note that during today's ARC board meeting, I was informed that various ARC board members and other senior management personnel intend to purchase ARC shares in the public market when permissible and in compliance with the company's share repurchase window policy. I appreciate everyone's time on the call, and I'll now pass for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll now take our first question from Jon Tanwanteng with CJS Securities.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - Research Analyst [2]

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Can you talk about the headwinds you saw in defense and firearms? Was this customer-specific or market-wide? Any more color, that will be appreciated.

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [3]

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Absolutely. Generally, this was a market-wide or industry-wide factor that affected our business, most notably in our Colorado facilities. While I hate to speculate, what I generally understood is that there was a large political component of this headwind, specifically the recent presidential election, in that many of our key customers in the industry largely suspected the outcome to be different and proactively increased inventory levels in the anticipation that there would be either a significant or wide-ranging change to firearm policy with the new administration. The outcome in that election was not as they expected. And as such, may, in fact, be most beneficial to the industry, the firearm industry and defense industry as a whole, for the foreseeable long-term future. Nonetheless, that left them with inflated inventory levels. And as such, we have otherwise been asked to pull back our production as those levels revert back to more normalized results. What we have seen in all of this, however, is a continued robust demand by the consumer. And so unlike the impacts that we saw to firearm approximately 2 years ago where there was a significant lag in customer demand, the FBI checks and other key indicators of demand again illustrate that there remains a relatively robust demand. And as such, while we're not suggesting we'll return to normalized levels tomorrow or the next day, we are starting to see implications of a rebound and certainly expects by the, really, full-term firearm sporting season that there should be some improvement there as well. I'll also add that on top of that, we are in the process of launching several very large, very dramatic new firearm launches. And so while we stress that we continue to focus on diversifying our revenue stream, sometimes the easiest and best sale is to our existing customer. And for that, in all of this, we have not lost our customer relationships and, in fact, continued to position ourselves as one of their key suppliers going forward.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - Research Analyst [4]

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Great. And that actually leads into my next question. You had difficulty in launching large firearms customers in the past several quarters. Can you describe how that relationship has changed or gotten better or worse and if the opportunity there is the same as it was, call it, maybe 6 months ago?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [5]

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Absolutely. I think at the end of the day, the biggest mistake that we made was taking on a new customer that was unknown to us, perhaps unknown to the particulars of MIM, and too many parts, too quickly, too fast. That led to us incurring a significant amount of cost as we attempted to ramp up and develop those parts. And ultimately, what we both mutually decided is that it was in the interest of both parties, ourself and our customer, to scale back that initially to parts where we know we can produce to the next set of parts that we believe we can produce in short order and other parts that either are not well suited for MIM or well suited for our MIM capabilities. And as such, we won't move forward with those parts that we either cannot produce at a low or negative margin. As such, we continue to have, I think, a productive relationship with this customer, one that has the potential to be significant for ARC. But we're taking a much more modest approach, one that I think both rationalizes the relationship as well as shifts the risk not completely to us but really balances the risk/reward. And as such, we're very excited about the continuing relationship there. It's one that we continue and are producing currently parts for them. And our expectation is that we continue to have a relationship with one -- with them, one that continues to grow. So at the end of the day, I do believe that it's an important customer for ARC and for MIM as a whole. We believe that we are much better suited now to move forward in a rational, appropriate and capital-unintensive approach. And as such, I think we're -- all parties are very happy with the recent changes that we've made.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - Research Analyst [6]

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Okay, great. And then any other color or commentary on your other end markets besides defense and firearms, especially since we're very close to the end of the first quarter already?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [7]

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Again, I think what we're seeing in the first quarter is these tailwinds associated with firearms. For your reference, as I think you know, the first quarter fiscal for us includes, obviously, the July and August periods, many of which -- or traditionally which many of our customers have often shut down for an extended period of time. What we have seen, and while we don't provide color specific to the forward period, is many of our customers in the firearms sector took extended periods of time-off. And because we could not ship to them, we, in July, also shut down or otherwise continued our cost-cutting initiatives as we approached August. August then was a relatively good month for us. And as we look at the quarter as a whole, again, I think what you will see is a quarter that from a top-line perspective is not terribly dissimilar to the fourth quarter but certainly illustrates both the improvement on the top line and profitability as we progress through the remainder of the fiscal year. And for that, as I mentioned before, we are ultimately bullish on both the financial opportunities for ARC, the new pipeline -- sales pipeline and, specifically, 3D where we believe that, that business entity should continue its recent progress. And we expect that business to double its top-line production in the fiscal '18 period as it did in the fiscal '17 period.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - Research Analyst [8]

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What does the 3D business run rating at right now? You said it was doubled, so what number are you doubling off of?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [9]

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Well, I'm glad you asked that because we did make changes to the reporting structure. And I think that what you will see now is a new situation where we only show 3D not as we did before but in the past. And so with the publication of that information, you again will see the doubling of the revenues. And again, our expectation that, that continues. It's still relatively de minimis as a whole but remains very fast-growing. And for that, we're very excited about its growth. It currently does approximately $2 million in top line revenue.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - Research Analyst [10]

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Great. And you mentioned that you opened a new facility down in Florida. I know you had other facilities there. Any impact from the recent hurricane?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [11]

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No. Thanks for asking. Both facilities were shut down in anticipation of the hurricane. Fortunately, both our facility and our employees were generally spared the brunt of the hurricane. And while they were shut down for a number of days, in the grand scheme of things, that shut down will be relatively immaterial. So I don't foresee any specific issue other than a loss or 2 of a few production days.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - Research Analyst [12]

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Okay, great. And then finally, just on the debt side. I assume you've been negotiating with your lenders. Just update us on the status of your covenants and how you stand with your lenders.

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [13]

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Absolutely. So again, what you'll see in the K is that we did reach amendments with both our senior and our subordinated lenders. We again believe that we have a very good productive working relationship with them. Our objective was going in to achieve essentially 1 year of cushion so that we could execute the specific plan that we have addressed as well as some additional initiatives we intend to continue to roll out. And as such, we felt it was important to run the company for cash flow generation and profitability not necessarily our covenants. And I think that you will find with these amendments, again, not only a long-standing productive relationship but greater flexibility associated with existing covenants. And to be frank, we continue to believe that we'll have a good working relationship with both lenders going forward.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - Research Analyst [14]

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Okay, great. Just one more final. What are the expected one-time nonrecurring costs that are going to leak into Q1, if any?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [15]

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Most of those changes that we discussed, all were incurring in the fourth quarter and largely impacted the results. I'm happy to walk you through those again but, for all practical purposes, outside of a relatively de minimis amount of write-offs related to certain parts that we've seek and found greater clarification to as well as our traditional non-cash items, including stock, there shouldn't be too many other one-time items other than, as you know and probably saw, we did sell the GFF, the flange business. This was determined by the board to be nonstrategic. And as a result, we sold that business. It was announced in the K in a separate release. But we sold that business on the 15th and, as a product of that, there will be certain charges related to that transaction, albeit relatively de minimis in the current first quarter period.

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Operator [16]

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(Operator Instructions) And we'll now take our next question from Ralph Weil with R. Weil Investment Management.

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Ralph Weil, [17]

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The -- a few questions. In terms of prototyping versus end-product manufacturing and 3D, what is the breakdown as a percent of the prototyping versus the end-product manufacturing, if you can say? And what -- which one of them is more profitable for you?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [18]

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Thanks, Ralph. I think I'll answer it a bit different in that, we, at ARC and at 3D, in particular, have gone through several phases with the development of that business. At the end of the day, we do believe that like MIM, 3D and metal 3D printing is a viable production-oriented technology. And after the initial phases of R&D and some levels of production, we are increasingly shifting that business to match our long-term business objectives, which is, again, full production. Currently, and as we've announced before, most of our machines on a day-to-day basis are, in fact, fully dedicated to what we determine to be full production. Now again that may be several dozens, several hundreds or even, in some cases, several thousand parts that we produce by month. But increasingly, we believe that, that is our opportunity to drive cash flow and material cash flow both on the top line as well as high margin dollar opportunities. So I refrain from giving any particular, now, amount as to the bifurcation of the various different subsegments of our metal 3D printing. But I can say it again that while we will continue to do some production -- excuse me, some prototyping for both our standalone 3D customers as well as our standalone MIM customers, we increasingly are moving to a full production model. And within the next couple of quarters and continuing in the next few fiscal years, we anticipate that to be a whole scale or a large-scale generator of our cash flow in the 3D entity.

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Ralph Weil, [19]

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Are there new areas that you might be going into -- toward 3D printing besides the defense and the firearms and medical? And also -- okay, go on.

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [20]

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No, no. Please go ahead.

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Ralph Weil, [21]

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And also, does the 3D printing lead to more or less, or is it correlated, with the MIM, metal injection molding business?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [22]

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Right. Let me address the first part. Again, what we are very excited about is the new facility. It will be a dedicated facility. And while we continue to share the best practices of our Florida MIM facility where it previously resided, it isn't simply an expansion but really an expansion of both our scope and scale. And we will have the ability to have dedicated rooms, spaces and areas as well as printers for both separate industries as well as dedicating to certain feedstocks. And we believe that will not only be incredibly efficient in terms of the day-to-day production, but these are markets where we have had opportunity, material opportunity, and we simply have not had the capacity or the space, quite frankly, to dedicate to such an endeavor. So I do believe that while the firearm/defense sector will continue to also be prevalent in 3D, we are increasingly excited about the medical and dental area as well as the aerospace. And then, power generation and other opportunities, again, these are material good margin opportunities. And as such, we think there is a number of different spaces that we can both exploit and create a powerful brand and a powerful niche within them. So that really is why we're very excited about the new facility. And again, I don't want to suggest that the MIM solution and the 3D solution are standalone. They are very much symbiotic, and they offer our customers a unique, holistic solution. What we are increasingly seeing is large multinational OEMs approaching us and looking not simply for a dedicated MIM production facility but one that can provide MIM with plastic over molding, with metal 3D printing, et cetera, et cetera. And for that, we see our ability to not only grow our wallet share with our existing customers but for us to, again, exploit or otherwise develop new markets and new sizable markets in both the 3D and the greater additive space.

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Operator [23]

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(Operator Instructions)

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO, CFO & Director [24]

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Okay, if there are no further questions, I do appreciate everyone's time. And thank you very much, we look forward to speaking with you on our next call.

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Operator [25]

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And ladies and gentlemen, that concludes today's conference call. We thank you for your participation.