Spectrum Control Inc. Q4 2008 Earnings Call Transcript

| About: Spectrum Control, (SPEC)

Spectrum Control Inc. (NASDAQ:SPEC)

Q4 2008 Earnings Call

December 7, 2008 4:45 pm ET


Richard Southworth – President, CEO

Jack Freeman – Senior Vice President, CFO


Andres Aranda – Needham and Co.

[Adam Ooms – Private Investor]


Welcome to Spectrum Control Inc. 2008 fourth quarter and fiscal year end conference call. Representing the company today we have Mr. Dick Southworth, President and Chief Executive Officer and Mr. Jack Freeman, Senior Vice President and Chief Financial Officer. (Operator Instructions)

As a reminder, the following discussion will include certain forward-looking statement which will reflect management's current views with respect to future market conditions and operating performance. These forward-looking statements are subject to certain risks and uncertainties which could cause actual results to differ materially from historical events or those anticipated. These risks and uncertainties are described in detail in the company's most recent and annual SEC filings. The words believe, expect, anticipate and similar expressions identify forward-looking statements. Persons are cautioned not to place undue reliance on these forward-looking statements. Such forward-looking statements speak only as of the date on which they are made and the company does not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this call.

I would now like to introduce Mr. Dick Southworth, President and Chief Executive Officer of Spectrum Control.

Richard Southworth

Welcome to our fourth quarter and year end conference call. I'll briefly review some key operating and financial highlights for the period after which Jack Freeman will review our financial performance in more detail. Following that we will be happy to take any questions.

For the fourth quarter of 2008, the company reported net income of $2.5 million or $0.20 per share diluted on sales of $33.8 million and compares to a net income of $3.2 million or $0.23 per diluted share on sales of $34.7 million for the same period last year.

For the full year of 2008, the company had net income of $8.9 million or $0.67 per diluted share on sales of $130.7 million. In the year 2007, the company had net income of $11.1 million or $0.81 per diluted share on sales of $136.5 million.

More importantly, for the third consecutive quarter, we've generated sequential improvement in sales, gross margins and net income and earnings per share. As a result, we're pleased to report that our fourth quarter results are consistent with and well within our previous guidance.

Customer orders received in the current quarter total $35.4 million, up $4.4 million or $14% from the immediately preceding quarter. Despite ongoing challenges presented by the world wide economic conditions, we expect to build upon our recent performance throughout 2009 and continue to generate revenue growth and increased earnings.

At this point, I'd like to introduce Jack Freeman our Chief Financial Officer and ask Jack to review our fourth quarter and year end results in greater detail and when Jack has completed his presentation, I will conclude with the final comments and we will open the floor for questions.

Jack Freeman

Sales of our Signal and Power Integrity components were $12 million in the current quarter. That's down slightly from the preceding quarter with customer orders of $11.6 million received in the fourth quarter of fiscal 2008. Although our Signal and Power Integrity components business serves many different end markets, about 20% of these products are sold to the communications equipment industry directly to our OEM customers.

Demand for our Signal and Power products within this industry segment continue to be somewhat soft. Recently however, to spur future growth for this business segment we have significantly expanded our product offerings to include engineered ceramics, antennas, specialty circular connectors as well as cabling assemblies.

These offerings will complement our long standing specialized EMI filter products and custom application specific power and coaxial filter connectors. As a result of this extended focus, we are immediately renaming this business segment Spectrum Advanced Specialty Products to more clearly express to our customers the unique capabilities of this business segment.

Sales of our Microwave Components and systems amounted to $13.7 million in the fourth quarter of fiscal 2008. That's up $2.2 million or 19% from the preceding quarter, and it's also up 12% from the comparable period of a year ago. Much of this increase reflects our acquisition of SatCon Electronics Inc. on September 26 of this past quarter.

SatCon Electronics which is operated out of Marlborough, Massachusetts, designs and manufactures high performance micro electronic components. SatCon capabilities and technologies include high frequency millimeter wave products which we believe are a natural complement and extension to our existing microwave products and capabilities.

The aggregate cash purchase price for SatCon Electronics was $5.6 million which was primarily funded by borrowings under our domestic line of credit. During the current period, SatCon Electronics was successfully integrated into our microwave components and systems business with product sales of $2.3 million generated and included in our fourth quarter consolidated sales.

Total customer orders for our microwave components and systems were about $14 million in the fourth quarter of fiscal 2008. That's an increase of $2.1 million or 18% from the immediately preceding quarter and it's also up $1.3 million or about 10% for the same period of a year ago.

Approximately 83% of this business segments' sales are to the military and defense markets and OEM customers. Overall demand for our microwave products within the sector continues to be strong.

Customer order rates for our other two business segments were also strong during the quarter. Customer orders received in the fourth quarter of fiscal 2008 for sensors and controls totaled $7.1 million. That's up $1.5 million or 27% from the preceding quarter and it's up $2.6 million or 56% from the comparable period last year.

Demand for our custom position sensors in particular, which are used in various medical equipment, commercial weather instruments as well as military aircraft and vehicles has been particularly strong throughout fiscal 2008.

Customer orders received in the current quarter for our power management systems amounted to about $2.7 million. That's an increase of $1.1 million or 66% from the third quarter and it's also up 20% from the fourth quarter of fiscal 2007. Opportunities for our power management systems continue to arise and increase in connection with various military and defense applications.

Total shipments of our power management systems amounted to $2.1 million in the current quarter. Shipments of our sensors and controls were just under $6 million in the current quarter. That's up about $1 million or 21% from the same period of a year ago.

During the current period our overall sales by industry remained relatively unchanged. For the fourth quarter of fiscal 2008 consolidated sales by major end markets were about 54% of our sales to the military and aerospace market, 24% to medical and industrial instrumentation, 18% for communications equipment which the remaining 4% to various commercial applications and markets.

Throughout the current quarter as well as all of fiscal year 2008 no single customer was more than 5% of our total consolidated sales.

In the current quarter our gross margin was $9.2 million or about 27.3% of sales, up from the $8.6 million of 25.9% of sales in the preceding quarter and also up from the $8.1 million or 24.8% of sales in the second quarter of this past year. This continuous increase in gross margin reflects improved production yields across virtually all of our businesses.

In addition, we continue to have made a strategic decision to maintain our production capacity and infrastructure to enable us to quickly and efficiently respond to our customers. Accordingly, our sales volume has grown in the current year. We have not needed to add any significant production capacity, allowing us to leverage our fixed manufacturing overhead and thereby enhancing our operating margins.

At the end of fiscal 2008 we had a total work force including the employees acquired as part of the SatCon acquisition of approximately 1,500 employees. That's down about 6% from where we were at the end of last fiscal year.

We continue to expect to review our organization and cost structure to continuously enhance our operating efficiencies while maintaining flexibility to respond to additional production requirements.

During the current quarter selling expenses amounted to about $2.8 million or 8.3% of sales which is very much in line with our normal operating levels and recent expectations and performance.

Aggregate general and administrative expenses were also about $2.8 million collectively in the fourth quarter of fiscal 2008. These G&A expenses include approximately $400,000 of non recurring items for certain moving and relocation expenses as well as some legal and professional fees that were incurred during the fourth quarter that would not expect to re-occur in future periods.

During the fourth quarter of last year we also received about $122,000 of royalty and license fee income in connection with some of our patented technologies. Looking ahead to fiscal 2009 we would not expect this source of non operating income to continue as most of the related patents have recently expired or will expire within a relatively short period of time.

For the fiscal year ended November 30, 2008 our effective income tax rate was 34.3% which compared to an applicable Federal and State Statutory income tax rate of about 40%. The difference in our effective tax rate compared to the statutory rate continues to be driven the domestic production activities production, research tax credits as well as various state tax provisions and foreign income tax rates.

Cash provided by operating activities in the current quarter amounted to $2.3 million. With this positive cash flow and our existing cash reserves we fully funded about $1.2 million of capital expenditures for new equipment during the quarter and we also repurchased on the open market about 245,000 shares of our common stock at an aggregate cost of $1.7 million.

During the entire fiscal year ended November 30, 2008 we repurchased just over one million shares of our common stock at an aggregate cost of about $8.2 million. Under our Board of Directors current authorization we may expend an additional $4.2 million under our current stock buy back program.

The amounts and timing of future share repurchases if any, will be based on our ongoing assessment of the company's capital structure, our liquidity and the market price of our common stock as well as other factors. We believe our ongoing stock buy back program is a positive reflection of our future business outlook and our strong financial position.

Our overall financial position we believe, remains very strong. At the end of the 2008 fiscal year our current ratio was three to one and our debt to equity ratio was about 0.3 to 1. We currently have approximately $25 million of borrowing capability under our domestic line of credit to support future growth as well as acquisition opportunities. For the entire fiscal year ended November 30, 2008 the weighted average annual interest rate that we incurred on our short term borrowings was less than 4%.

Our cash position at the end of the most recent fiscal year was about $5.4 million. With our solid financial position, we continue to think we are strategically well positioned to support our future anticipated growth. With that, Dick will now make some concluding comments.

Richard Southworth

Based on our current assessment of business conditions and customer demands we presently anticipate our 2009 first quarter sales to be between $33 million and $34.5 million. Based on this shipment level, we expect our 2009 first quarter earnings to be $0.18 to $0.20 per diluted share.

If this operating performance is achieved it would represent an increase of somewhere between 6% to 11% in sales and 35% to 54% in earnings per diluted share from the comparable period of a year ago.

Beyond the first quarter which is historically our lowest quarter for revenues and earnings we really remain optimistic. Total customer orders received in fiscal 2008 were $140.6 million generating a book to bill of 1.08 to 1. This positive book to bill along with the sales order backlog assumed as part of our acquisition of SatCon Electronics has generated a record sales order backlog for our company.

As we begin fiscal 2009 our total sales order backlog is over $69 million. That's up $22 million or 45% from the same period a year ago. With this record backlog and our positive operating momentum, we believe 2009 will be a year of revenue growth and enhanced profitability for our company.

At this point I'd like to open the discussion for questions.

Question-and-Answer Session


(Operator Instructions) Your first call comes from Andres Aranda – Needham and Co.

Andres Aranda – Needham and Co.

Your gross margins were up pretty nicely this quarter. I was hoping you could talk about trends in gross margins going forward and maybe share some targets that you might have for next year.

Jack Freeman

What has driven our gross margin improvement over the last few quarters has been a consistent yield improvements, particularly within what we used to call our Signal and Power Integrity components within our ceramic operation, but as well as all four of our businesses so with those production yields increasing and with a little bit better leveraging of our fixed manufacturing overhead, our gross margins have improved.

Looking ahead, we would expect to continue to strive for and achieve those same sorts of improvements. We expect to continue to be able to leverage our overhead as we're able to generate additional sales volume and we do think that there are additional material cost reductions and yield improvements that can be generated throughout all four of our businesses.

On a long term basis, our goal has been and continues to be a gross margin of around 34%. In order to achieve that, we certainly do have to generate some additional sales volume, but we think that we're continuing to position ourselves for that with the expansion of our product offerings, having strategic acquisitions like SatCon.

Again, looking ahead, we would expect to see continuous improvement in gross margin. Quarter to quarter there may be some mix impact so it may not be in a straight line but overall we would expect to see pretty consistent improvement in the gross margin and getting up to that 30% gross margin. That would be more of a short term goal and the 34% the long term goal.

Andres Aranda – Needham and Co.

Do you think the 27% range would be attainable in fiscal '09?

Jack Freeman

Right now based on a reasonable assumption of what the sales mix will be and what the total sales volume will be, yes we would see no reason for that gross margin to deteriorate and we certainly see some upside with leverage overhead and further yield improvements so that we can improve upon that. We think we will continue to build upon the 27.3% that we generated in the fourth quarter.

Andres Aranda – Needham and Co.

Can you talk a little bit about the outlook for order trends going forward? You had a great looking number this quarter. If you could just talk about going forward and maybe any kind of products that you might have some visibility on?

Richard Southworth

I think we have some of the build up right now obviously coming in through the adjunct box program for the [Nuke] systems that are out in the industry which will be a good add on for us through 2009.

The only area that we really see some level of softness is where our OEM's have in-house stores. They have them managed by distributors and we see distributors, because of their commodity business, they're pulling back their funding and reducing their inventories. But we expect that only to be for a short period and really because of our sole source position in most of these programs. So they're reducing their inventory.

Specifically in Q1, we see a one to one book to bill. We believe that that could be down as low as a .95, but we typically in our second quarter, we have a very strong book to bill and all of our numbers right now are coming up that will continue to be a very strong second quarter.

Andres Aranda – Needham and Co.

What kind of impact have you seen in the business given the state of the global economy and which of your end markets are you most concerned about?

Jack Freeman

It's Telecom and it could be a little bit in temperature control for our temperature sensors but our military, aerospace – if you look at our business, we're 54% of military, aerospace, 46% commercial, and in that commercial side I would say that's our area that we keep a very, very close tab on right now for weakness.

It's Telecom. Telecom has been down now for almost two years and it's continuing at the rate it was at. We have not really seen any more weakening.

Maybe the best answer, just Telecom.


Your next question comes from [Adam Ooms – Private Investor]

[Adam Ooms – Private Investor]

Historically hasn't the power management systems had exposure to wireless infrastructure spending?

Richard Southworth

It's mainly been server, data storage.

[Adam Ooms – Private Investor]

So that would be going into the data centers?

Richard Southworth


[Adam Ooms – Private Investor]

So the 3G build out in China over the next year to three years will not be a factor in that segment of our business.

Richard Southworth

Obviously we are over there. We are working with all the companies that are there. We have a plant in China and we do a lot of the power filters and the like over there. We don't see relative growth in that area.

[Adam Ooms – Private Investor]

Whatever happened to our initiatives with the motor line feed through product line, the MLFT?

Richard Southworth

That's still in play and actually we have landed some business but the big players have still not introduced it.

[Adam Ooms – Private Investor]

Is that like with Bosch over in Germany, would be the critical factor?

Richard Southworth


[Adam Ooms – Private Investor]

How is the landscape looking for further acquisitions? You have done a wonderful job over the years. Are there numerous candidates and we've got to get their prices down or what would be?

John Freeman

If you look back in history, we're always very active in that. We review a lot of different potential companies and right now we are certainly continuing in that space. There's nothing to announce.

[Adam Ooms – Private Investor]

On the previous conference call you mentioned that there are all sorts of designs being funded to our engineers so as far as looking at for us to produce. Is that activity still very strong?

Richard Southworth

Yes, and sometimes it's almost overwhelming, we have so much. It's a load on our engineering people. We're managing it very well and some of these programs can take five years before they really bear fruit for us, so it's a very important investment at this time for our future.

[Adam Ooms – Private Investor]

Is that because or a combination thereof? Because we're so good or the competition has fallen by the wayside or are we just strengthening ourselves niche wise in all these different technologies?

Jack Freeman

What we believe is we continue to strengthen our relationship with our key customers and that we become their supplier of choice and they come to us. That happens in all four of our businesses.

[Adam Ooms – Private Investor]

Is there a situation where maybe some of our customers are saying that they don't want to manufacture certain components and they turn it over to us?

Jack Freeman

That can happen. I would say it would be more on the side of the next generation of equipment coming out they're coming to us rather than manufacturing it internally.


There are no further questions at this time.

Richard Southworth

With no further question we will conclude the conference call today, and we thank you all for joining us.

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