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Edited Transcript of ARCW earnings conference call or presentation 9-Feb-18 10:00pm GMT

Q2 2018 ARC Group Worldwide Inc Earnings Call

DENVER Feb 12, 2018 (Thomson StreetEvents) -- Edited Transcript of ARC Group Worldwide Inc earnings conference call or presentation Friday, February 9, 2018 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Drew M. Kelley

ARC Group Worldwide, Inc. - Interim CEO & Director

* R. Brian Knaley

ARC Group Worldwide, Inc. - CFO & Principal Accounting Officer

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Conference Call Participants

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* 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 call is being recorded. With me on the call is Drew Kelley, ARC's Interim CEO; and Brian Knaley, ARC's 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 & 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 expect, 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 the quarterly report on Form 10-Q and the current reports on Form 8-K, all of which can be found in our website. Please note that during the call, all financial measures presented will be non-GAAP unless otherwise indicated.

Before we begin today's call, I'd like to explain a limited advance notice we were able to provide regarding today's earnings call. As most are aware, the company's currently pursuing a rights offering. In connection with this transaction, we've been in active dialogue with the SEC, and the sequencing of certain events left us with a very small window available for this call, one which we were only able to finalize within the past 24 hours. We will provide a brief update on the rights offering later in the call, but we appreciate your understanding in this matter and apologize for the short notice.

Now let me formally introduce Brian Knaley who joined ARC as its new CFO at the end of November. As previously announced, Brian is a highly experienced financial executive with a diverse knowledge of accounting, finance, mergers and acquisitions and operations management. I can tell you Brian has already hit the ground running. We're happy to have him onboard.

Brian, please go ahead.

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R. Brian Knaley, ARC Group Worldwide, Inc. - CFO & Principal Accounting Officer [3]

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Thanks, Drew. The company earlier today announced results for our second quarter ended December 31, 2017. Revenue from continuing operations was $18.3 million (sic) [$18.4 million], a decline from $27 million in the prior year period. As with recent results, the primary driver of the decline was Colorado MIM and plastics operation given reduced volumes associated with firearm and defense customers.

Additionally, we also experienced a modest revenue decline at our Florida MIM facility, as the new medical product launch was impacted by customer issues. Overall, we believe the plastic and MIM markets, which we serve, are stabilizing the select customers returning towards traditional normalized revenue levels.

Revenue at our stamping facility declined by $1.1 million relative to the prior year period, principally driven by the roll-off of expiring platforms in the automotive sector. However, we believe the division to be well positioned for improved financial performance throughout fiscal 2018 given anticipated new product launches and a growing overall sales pipeline.

Turning to our metal 3D operations. We had sales in excess of $925,000 in the quarter, which was a 63% increase over prior year. The results also represent record quarterly revenue for 3D metal technologies.

Turning back to overall consolidated results for the quarter. Lower production volumes and a planned targeted inventory reduction initiatives impacted the company's operational efficiency during the quarter as gross profit from continuing operations was a negative $0.4 million compared to a positive $4.5 million for the prior year period. In particular, as part of the company's plan to reduce inventory levels to improve cash flow and match current market conditions, the company reduced selected inventory by $0.7 million within certain business units comprising the Precision Components Group. This reduction in inventory resulted in a correspondingly similar increase in expense recognition, negatively impacting gross profit by $0.7 million in the quarter or 16.2% of the overall decrease in gross margin.

Further, the inventory initiatives also resulted in a significant reduction in production hours at associated facilities during the quarter. In particular, Colorado MIM recorded a 50% decrease in production hours compared to the prior year, which further affected profit due to a reduction and ongoing cost absorption.

Selling, general and administrative expenses for the fiscal second quarter 2018 declined to $3.6 million, a decrease from $4.7 million in the prior year period. Expense reductions were primarily attributable to the company's ongoing cost review and elimination initiatives. EBITDA from continuing operations for the fiscal second quarter 2018 was a loss of $1.2 million. This decline, relative to prior year, was primarily driven by the previously discussed lower production, revenue and the resulting gross profit. And finally, overall, fiscal second quarter 2018 net loss was a loss of $4.3 million compared to a net loss of $0.7 million in the fiscal second quarter of 2017.

Finally, as Drew mentioned above -- previously, some of you may be aware, we have just initiated our $10 million rights offering that has been registered with the U.S. Securities and Exchange Commission. The rights offering is fully backstopped by commitments from our large shareholder and several other shareholders. Thus, we plan to raise the full $10 million. The record date was set at the close of business on February 6, 2018, and the subscription price was set at $2 per share. The registration statement containing the prospectus for the rights offering was declared effective by the SEC this afternoon, February 9, 2018. The expiration date of the rights offering will be February 25, 2018. We expect to receive the proceeds from the rights offering during the course of the week of February 26.

Please note, importantly, the rights offering securities may be offered and sold only pursuant to the offering prospectus included within the effective registration statement. A copy of the prospectus forming a part of the registration statement may be obtained free of charge at the website maintained by the SEC at www.sec.gov or by contacting our subscription agent for the rights offering, Broadridge Corporate Issuer Solutions at toll-free (855) 793-5068. The rights will be issued to the holders of the company's common stock as of the record date, February 6, 2018. This announcement shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sales of any rights offering securities in any jurisdiction in which such offer, solicitation or sale would be unlawful to the registration or qualification under the security laws of any such jurisdiction.

I will now turn it back over to Drew.

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO & Director [4]

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Thanks, Brian. To begin my commentary, I'm certain that there are many people outside of ARC who would view our quarterly results from a glass-half-empty perspective. On the contrary, while we're certainly not satisfied with financial results by any means, the company made significant operational progress during the quarter. Furthermore, it sees top operational changes, which lay the groundwork for improving financial performance going forward. Overall, management is keenly focused on our objectives to return the company's profitability and improving cash flow by driving existing product revenue, increasing operational efficiency and improving the balance sheet.

Among the more significant accomplishments this quarter, we refocused our sales approach and realigned our sales resources accordingly. While we expect the company's top line outlook to stabilize and begin to improve during the balance of our fiscal year, these changes were designed to better align our engineering and technical sales capabilities in order to drive incremental revenue from existing customers and on existing product parts.

Let me again reiterate and emphasize our strategy: to drive incremental revenue from existing customers and on existing production parts. While our new product pipeline is important, and I will speak to it later in the call with some developments there, new part development has been, for far too long, the sole focus of our company when, in fact, there are plenty of other more achievable near-term opportunities to increase sales. For example, why not seek to produce a greater share of production parts for dual source or to look to produce plastic parts when MIM opportunities are limited within a certain customer? In summary, these changes are designed to emphasize all facet of sales, not simply our traditional focus on new part sales.

Similarly, while we're encouraged by improving outlook on many of our customers in the firearm sector, we need to improve our revenue diversification. As such, we reallocated sales resources to drive growth in other key markets, specifically the medical and aerospace industries, 2 important areas of growth for both our 3D and MIM businesses.

Overall, while these initiatives are still in the early stages, we are already receiving positive reviews from our customers. And furthermore, once they take hold and given our recent cost-reduction initiatives, we expect flow-through from increased sales to impact the bottom line with greater efficiency going forward as revenue levels return to historic normalized levels.

Now of course, onto firearms. In general, the second half of our recently completed second quarter, we started to see some indications of an improvement with our -- within the sector. Our takeaway from these limited data points was that certain firearm manufacturers, particularly those focusing on innovation and those launching new products, were starting to see a pickup in sales. Following the SHOT Show in Las Vegas 2 weeks ago, we believe these conclusions remain true. Overall, we had good interaction at that conference with several of our key customers in the defense and firearm market. And while I don't want to be interpreted as portraying wide-scale or overnight recovery in the market, there are several reasons to be encouraged. Furthermore, our participation in several of the leading new product launches provides us with even more reason for encouragement. As this remains a fluid situation, I'm going to refrain from providing specific guidance at this point other than to suggest what we are working on is a pathway, which we can achieve and execute, which will allow us to return to firearm revenues -- excuse me, firearm revenue levels for our company consistent with our fiscal 2015 results.

Going back to new product pipeline. I'm also pleased to report that I am seeing progress with several new platforms as they approach the product launch. In particular, there are several key platform opportunities in the aerospace, medical, firearm and turbocharger market that are coming online in the coming months. Notably, some of these opportunities have been in development for several years when you factor in the alloy development aspects of the new launches. While we cannot guarantee success of these products from a consumer acceptance perspective, we believe the timing and investment to date has been warranted as these new platforms have the potential to generate significant recurring revenue streams for our company.

Reiterating my earlier comments, however, I'm reluctant to place too much emphasis on this aspect of our business or describe a dollar figure to new sales pipeline at this time as I believe there are equally important other aspects to drive sales growth and as we've learned, the development of launch and successful launch areas of MIM parts is quite simply complex and time-consuming. That being said, we do see progress on our revenue outlook generally, and I'm personally very encouraged by the direction our company is headed.

Finally, I like to briefly follow up on the inventory reduction initiatives underway at the company. As Brian mentioned earlier, throughout the 6 months of the fiscal year-to-date, we've undergone a targeted reduction in inventory levels at certain facilities. These are generally associated with firearm parts. The targeted reductions serve to rightsize our balance sheet but also serve to generate cash for the company. Obviously, the plan had a direct unfavorable impact on our gross profit, EBITDA and other financial metrics just in the second quarter, but we believe the decision to be the correct one for the company.

Going forward, we expect to execute similar inventory reductions in the third and fourth quarters as we continue to move forward with this optimization plan. However, we believe that the negative P&L impacts will be lessened as our other facilities begin to ramp up and build inventory as a product of growing demand and new product launches.

Overall, as with the earlier cost elimination initiatives, we believe the inventory reduction plans be in the company's best operational and financial interest and that both programs will start to demonstrate their effectiveness in the company's upcoming financial results.

Having said all this, I appreciate everyone's time, and we'll now open for questions.

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Questions and Answers

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Operator [1]

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

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Ralph Weil, [2]

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Drew, you talked about new product launches, and it sounds good. But could you just elaborate a little bit in what areas these new product launches might be taking place?

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

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Certainly. I think when we talk about the greatest opportunity, we're talking about MIM and plastic, generally speaking, and what we're looking at is a wide portfolio of opportunities that, again, candidly have been in development for at least 1.5 years in many cases, if not, longer. So we're excited, first and foremost, we're finally coming to a point where we can launch these products after a long development gestation period if you will. Specifically, there are opportunities at nearly all of our facilities, Colorado, Florida, Hungary, and it's in a new -- in a number of different industries, including aerospace with some of very leading participants in that market. Again, firearms, there's still a great opportunity for us. And in particular, what I'll note with some of the firearm opportunities is that they're not just simply one part or several parts but multiple parts, including MIM and plastic. And for the reasons we discussed as well as the more recent data points we've seen at the SHOT Show, we do think that these are opportunities, which will be well received by the market for which there is a suitable amount of demand, and for that, we're eager to participate or partner with these OEMs to launch them. At the same time, we have new opportunities in Florida in medical devices, which, again, along with aerospace, is one of our primary focuses for revenue growth in terms of segments and industries. And finally, what gives us some comfort as we struggle or work through our struggles in Colorado in firearm, I note that Hungary is coming back and coming back relatively robustly, a product of launching products in the auto and specifically, the turbocharger market. The reason I say this is, again, not too long ago, they were struggling with similar consumer demand issues and other things of that nature that left us in a situation where -- situation of a period somewhat dire. Nonetheless, we were able to rightsize the cost structure, and we've been able to secure, again, this product development opportunity along with others. So as a general comment, again, many of these products are either launching as we speak or launched in the late second quarter, December 2017 period. This isn't to suggest that the run rate volumes are immediate, but again, they are significant. And as a general comment, the products that I'm speaking about are opportunities, which, if well received by consumers and similar, have the opportunity to produce on a run rate basis several hundred thousand dollars per year, if not, several millions of dollars per year. Again, only time will tell, and this is more of a, in many cases, fiscal or calendar '19 opportunity, but nonetheless, they will start to have a growing impact on our financial results. And for that, we are generally excited about the opportunities.

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Ralph Weil, [4]

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You mentioned firearms. What about the defense area or aerospace area? What kind of new products do you have there?

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

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Well, when I speak firearms, there's generally 2 aspects, again, defense and of course, the sporting or sportsman more consumer aspect. With a lot of these new platforms that we are launching with our firearm partners, there is 2 aspects, again, those consumer and/or professional government, if you will, defense aspects. And so for that, that's leading us to be both excited about the overall potential and the fact that, from elasticity perspective, the government opportunities tend to be a little more robust or at least less beholden to the volatile consumer market. So again, within this segment there is several different opportunities with several different OEMs in the space for which we, again, are generally encouraged by the recent developments and the opportunities to place them both in the consumer and in the government markets. Again, as you mentioned, aerospace, we are really starting to see some inflection points in terms of acceptance by aerospace and other companies in that ecosystem, of not only 3D and metal 3D in particular but of MIM. And so we've had literally dozens of individuals from a specific organization or 2 who've come to learn in our MIM schools, in our 3D schools about not only the process itself but how ARC and its holistic solutions can manage its development opportunities for these customers. And so again, these are opportunities, which are still exploratory in some cases but in other cases, are starting to lead to opportunities in both the commercial and defense markets, in commercial aircraft applications both in engines and things of that nature as well as in the more defense-oriented aspects of the sector. And so one of the key opportunities for us and one of the reasons we're considering or have considered the rights offering is being able to have greater dry powder to execute on that and to facilitate growth on our 3D ventures with our new facility and the rollout there. We anticipate having a dedicated, really, building within a building that will allow us to facilitate some development and production of top secret or similar type parts for aerospace and government-oriented entities. And so that's a tremendous opportunity and one we're very excited about, still on the come if you will, but nonetheless, we are moving in that direction with great efficiency.

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Operator [6]

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(Operator Instructions) Ralph, your line is open.

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Ralph Weil, [7]

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Hello, is my line open?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO & Director [8]

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We can hear you. Are there any other questions?

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Ralph Weil, [9]

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Yes, I do. I guess, I'm the only one asking questions. I was waiting. Can you just tell me about the 3D facility that you have and the 3D capability? Do you have that because it was a planned thing to have to make your metal and plastic injection molding business a significantly better business? Is it very complementary? And also, will you be looking for -- to produce in this facility molds for your business? Or will you be looking to do prototype and/or end product manufacturing, like, for example, a Proto Labs might be doing?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO & Director [10]

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Well, Ralph, several questions there, so let me attempt to answer them in a slightly different order. Unequivocally, our view on 3D is such that we view metal 3D as both complementary and synergistic to our MIM business. At the same time, we do view metal 3D production not just simply prototyping but full production as a viable good business model and a significant market opportunity. For that reason, we believe that our metal 3D business is, on itself and on a stand-alone basis, incredibly attractive opportunity for us. The reason we've been able to achieve our successes to date, however, really is a product of the fact that, at the end of the day, while some of my colleagues that aren't financially -- have a background like myself may disagree with the statement, it's essentially very similar in that our MIM technology takes powdered metal and using a laser or a similar process, we are essentially sintering metal as we've been doing with MIM for almost 30 years. It's that metallurgical expertise, the knowledge of how the processes interact and perform that has allowed us to, really, I think, be in a level of understanding as it comes to metal 3D that few can offer. So again, our view for metal 3D is not only production and prototyping, but it allows us, again, to be that full holistic supplier to our customers, both existing customers and future new customers. And for that reason, that was the investment and our continued focus on it. Now at the same time, as you mentioned, one of the more important aspects of 3D is the ability to offer conformal cooling. And that, in particular, has significant advantages for our metal business as well as our general speed to market. So that, in of itself, is something that we are refocusing on and dedicating resources to because we do believe that it allows us to be, again, a step ahead of our competitors. And so for that reason, we believe that the combined package, our metallurgical expertise, the fact that we have size, scale, multiple facilities and the like really makes this an attractive opportunity and one that almost sells itself to a certain extent with our customers. As it relates to our customer base in some of the companies you may have mentioned, again, we view ourselves as a company that is best suited providing a number of different parts in higher volumes to a concentrated but targeted customer database. And by that, I mean, we believe the best opportunity for us is not to have literally millions of customers we produce one part for but a handful of customers, a diversified customer base for which we produce a series of recurring revenues. And by emphasizing, again, the value proposition that we can bring to customers both in terms of quality and economics, we believe that, that really will facilitate not just periodic relationships but long-term substantial customer relationships. I'll pause. Did that generally answer your questions? Or what other items I might have missed?

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Ralph Weil, [11]

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Are there -- well, I'm not sure if I understand one thing. There are a number of other companies in metal injection molding or plastic injection molding. I assume that your 3D capability -- they don't have 3D capability at this point in time, right?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO & Director [12]

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Absolutely and in fact, many MIM providers don't even provide plastic. So again, it's that one-stop shop opportunity that we believe, as you look at the manufacturer ecosystem and you realize that many customers, say, large customers are dealing logistically with a number -- a significant number of vendors, the more opportunities we can provide to service them, the easier it is for them for a known quantity, in many cases, because we've been producing parts for them for a number of years. And for that reason, we, again, believe that, that provides an opportunity to get -- capture greater percentage of their wallet while increasingly being sticky if you will. So for that, we think, again, it's a win-win proposition.

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Ralph Weil, [13]

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One last thing [and then] someone else. There's been a lot about parts going on airplanes, on spacecraft, on autos that are made by 3D printing. Is this an area that you're trying to get involved in?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO & Director [14]

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I correct you, not trying to. We are involved. Unfortunately and fortunately, the good news, bad news all of this is that I wish I could tell you the customers and I can wish I could tell you some of the opportunities that we're producing, but the confidential nature restricts that. I can only say that, again, it is a very large focus of ours. We've had some initial success. We're developing and expanding relationships, and we do feel that we are in a tier of providers that is very limited given the fact that few can produce with the specificity or at the technical level that we can. So we're not trying to be everything to everyone, but in the medical space and in the aerospace as well as some defense opportunities, we do we think that our, again, holistic approach is very well received by these customers and can address this market in the future.

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Operator [15]

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And next, we'll go to [Paul Renew], private investor.

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Unidentified Participant, [16]

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Question, can we assume that most, if not, all of our goodwill is written off at this point?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO & Director [17]

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Well, again, we took a very hard look at the goodwill at the end of the last fiscal year, [6 30], and at that point, we made decisions to write off a material portion of certain of that goodwill. There is still goodwill out there, but on a quarterly basis, we evaluate, and we believe that, currently, the amounts that we've written off are sufficient to this point. So I'm not going to make statements about the future, but it is something we evaluate relatively consistently and are required to do so. And as such, we feel the current position best reflects the ongoing values.

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Unidentified Participant, [18]

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One other thing. Given the company's new focus on MIM and 3D, something very specialized and something, obviously, you guys do very well. How does the stamping division, which I've seen was broken off into its separate entity, how does that fit into the company's new direction and focus?

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO & Director [19]

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A fair question. We did, as you mentioned, break off our business segment into stamping. And while we do view that as a core holding, it has a unique fundamentals, a different customer base and for that, we felt it was most appropriate to allow investors to see the specific financials of that entity. At the end of the day, that was an entity that we believe continues to service, again, somewhat repeating myself, our ARC holistic solution. There are many customers that our MIM and 3D customers who have interest in that segment, who have stamping, either existing business or the potential therefore. And for that reason, while we continue to evaluate all aspects of our business, we think that there is a opportunity to expand our customer database and to service our existing customers better by offering our stamping opportunities. So we're very excited about that business in particular even on a stand-alone basis. As Brian mentioned, several platforms are at the cusp of launch, and given the more longer-term nature of these opportunities and the platforms that they service in the auto industry, we're very encouraged by not only the next quarter but the next several quarters given that current database of sales opportunities.

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Unidentified Participant, [20]

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Another thing, could anymore light be shed upon the intentions of that offering, the rights offering, what that money is going to be basically used for? I see every quarter, as everyone else does, I'm sure, that 11% note's sitting right in front of us...

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Drew M. Kelley, ARC Group Worldwide, Inc. - Interim CEO & Director [21]

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Well, Paul, it's a fair question, and given the period that we're in, I'm going to refrain from making too many general comments beyond what's in the specific document other than we were obviously evaluating the use of those funds. And for that, we're looking at opportunities to use it beyond just simply general corporate purposes but ways to improve operations, strategic opportunities and of course, looking at the balance sheet. So we're very cognizant of such opportunities that you described. It's a wait-and-see approach, but at the same time, our job is to drive profitability and drive cash flow. And for that, we'll certainly do our best to make sure that the proceeds are used accordingly to achieve those goals.

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Unidentified Participant, [22]

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I'm sure you can understand our concern and given that past track record of what was going on. So I appreciate your clarity on that, Drew. Appreciate it.

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Operator [23]

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It appears we have no further phone questions at this time.

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

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Thank you, everyone. We appreciate your time, and we look forward to speaking with you in the future. Have a good evening.

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Operator [25]

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And this concludes today's conference call. Thank you all for your participation. You may now disconnect.