Pulse Electronics Corporation (OTCPK:PULS) Q4 2012 Earnings Results Conference March 11, 2013 5:00 PM ET
Ralph E. Faison - Chairman, President and CEO
Drew A. Moyer - SVP, CFO
Alan H. Benjamin - SVP, Chief Operating Officer
Jim Butler - Senior Director, Finance
Good afternoon and welcome to the Pulse Electronics Fourth Quarter 2012 Results Conference Call. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded.
I would now like to turn the conference over to Mr. Jim Butler, Senior Director of Finance. Mr. Butler, the floor is yours sir.
Thank you, Mike. I am Jim Butler, Senior Director of Finance for Pulse Electronics Corporation. With me today are Ralph Faison, our Chairman, President and Chief Executive Officer; Drew Moyer, our Chief Financial Officer; and Alan Benjamin, our Chief Operating Officer.
This afternoon, we will discuss our results for the fourth quarter of 2012, discuss our recapitalization transactions and provide our outlook for the first quarter of 2013.
Before we begin our presentation, let me take care of four administrative items. First, we will use a slide presentation to accompany our prepared remarks. A PDF of the slides has been posted to our website. Second, this call is being webcast and a replay will be available on our website for two weeks.
Third, we will make statements considered forward-looking within the meaning of Federal Securities Laws. These statements are based on our current knowledge and expectations and are subject to certain risks and uncertainties that may cause actual results to differ materially from the forward-looking statements. For a discussion of such risks and uncertainties, see the disclosures including the Risk Factors section in our most recent 10-K, as well as in certain of our other SEC filings. We also encourage you to review our 10-K for 2012 when filed. The Company undertakes no obligation to revise or update any forward-looking statement.
Fourth, Management's comments in the accompanying slide presentation should be read in conjunction with the fourth quarter earnings press release we issued this afternoon. The press release contains our financial results according to US Generally Accepted Accounting Principles. In this call, all references to operating profit or loss and diluted earnings or loss per share on a non-GAAP basis. These non-GAAP measures exclude severance, impairment and associated costs, non-cash stock-based compensation expense and cost associated with an unsolicited takeover attempt and other expenses in applicable periods. For a reconciliation to US GAAP results and a rationale for our usage of non-GAAP measures, see slides 20 and 21 in our presentation.
Now I’ll turn the call to Ralph.
Ralph E. Faison
Thanks, Jim and thank you everyone who is joining us on the call today. As Jim mentioned, our earnings release was distributed just a short while ago, so I will provide an overview of our fourth quarter performance and the situation at the Company following the Oaktree investment. Then Drew will discuss our financial performance and then update on the recapitalization transactions in more detail. And finally, I will review our outlook for the first quarter of 2013.
So if you're looking at our slides, turn to slide 3, our fourth quarter revenue was within our guidance and non-GAAP operating profit was slightly ahead of our guidance. So sales were $90.4 million and non-GAAP operating profit for the quarter was $1.3 million. Gross profit margins increased significantly both year-over-year and sequentially as a result of our cost reduction activities and manufacturing consolidation initiatives began reaping substantial benefits throughout the organization.
We are very pleased with the gross margin improvement, all the hard work over the last two years, we've reduced our manufacturing footprint in China from 10 plants to 4, relocated the majority of our manufacturing to low-wage areas in China. We have reduced material cost and invested in process automation. Our improvement in gross profit margin is especially notable, given the very challenging revenue environment and I believe it put Pulse in an excellent position to deliver strong profit improvement when our markets do return to more normal demand trends.
Although our wireless operating results were slightly lower than what we had hoped, they represented a substantial improvement from the third quarter and reflected improved volume efficiencies and better control of new product ramp cost. We continue to believe that wireless will be able to generate near breakeven profitability at revenue levels similar to this quarter.
The closing of the recapitalization with Oaktree thus mark an important turning point for Pulse. Not only did it achieve our goals of improving liquidity, addressing the looming maturity of our previous credit facility, and reducing cash debt service costs, it also allows the focus of our organization to return to improving operational performance and renewing revenue and profit growth.
I would like to stop and say I am extremely proud of the way Pulse employees around the world continued to focus on the objectives of our core business during these weak market and economic environment times and the resulting financial stress on our Company over the past two years. The situation was clearly a distraction to everyone and severely constrained our resources. But now with the recapitalization behind us, I am more confident than ever that the commitment of our people to technology leadership and serving our customer paints a very bright future for Pulse.
So with that overview, I'll turn the call over to Drew for more thorough review of our fourth quarter financial results and then an update on the Oaktree investment.
Drew A. Moyer
Okay. Thank you, Ralph. I'll start on slide 5, with net sales. Net sales were $90.4 million in the fourth quarter, essentially flat compared to the $90.5 million in the prior-year quarter and up 2.5% from the third quarter. This performance was within the revenue outlook range we provided earlier. The industry challenges in network and power remained, but we are offset by improved wireless sales in new programs and to new customers.
Please turn to slide 6, and I will review gross profit margin. Cost of goods sold decreased 3.5% to $70.7 million in the quarter from $73.2 million in the prior-year quarter. Gross margin was 21.8% in the quarter compared with 19.1% in the prior-year quarter. This significant improvement in gross margin reflects improved efficiencies and lower ramp up cost in wireless business and the favorable effects of manufacturing plant consolidations and other cost reduction programs that Ralph also mentioned. Compared to the third quarter, gross profit margin increased primarily due to improved cost absorption resulting from the higher revenue in wireless.
Now let's move to operating expenses, which are covered on slide 7. Operating expenses were essentially flat at $18.9 million in the quarter compared to $18.8 million in the prior-year quarter. Our operating expenses remain under control due to expense reductions implemented in 2011 having full effect in 2012 and continued scrutiny overall discretionary spending. Compared to the third quarter, operating expenses increased 4.9% due largely to a $1 million favorable impact from intellectual property licensing in the third quarter and higher fourth quarter legal costs in the Halo matter as the jury trial occurred during this period. As a percentage of net sales, operating expenses were 20.9% in the quarter.
Now moving to slide 8, our non-GAAP operating profit was $1.3 million in the quarter, compared with a loss of $0.9 million in the prior-year quarter. The improvement reflects higher wireless sales and resulting improved production efficiencies and the favorable effects of plant consolidations and lower material cost in network and power.
With that review of our consolidated results, let me provide a brief review of the performance of each of our three segments, starting with network on slide 9. Network net sales were $37.7 million in the fourth quarter compared with $40.1 million in the prior-year quarter as lower industry demand continued. However, operating profit improved to $1.1 million in the quarter compared with a loss of $300,000 in the prior-year quarter.
The segment's financial performance was driven by improved gross margins, including plant consolidation, migration to lower-cost labor and parts suppliers as well as improving pricing and product mix. The sequential decline in operating profit was mainly due to the favorable $1 million intellectual property licensing agreement that we booked in the third quarter.
Power is on slide 10. Power net sales were $27.4 million in the fourth quarter, down 2.1% from $28 million in the prior-year quarter and down 5.3% sequentially. The decline from both the year-ago and last quarter reflects the ongoing challenges across the industry and lower pricing for certain products. Operating profit was $0.9 million in the quarter compared with $1.3 million in the prior-year quarter. Sequentially, operating profit improved from $0.7 million in the third quarter as the favorable impacts of manufacturing initiatives have begun to be fully realized in the segment.
Turn now please to slide 11 and I will review Wireless. Wireless net sales were $25.3 million in the fourth quarter compared with $22.4 million in the prior-year quarter, which reflects the continuing recovery of this business as sales to new customers continue to grow. Sequentially, wireless revenue increased 30.3% from the third quarter due to recovery from customer delayed product ramps that occurred during the third quarter. Operating loss was $1.2 million in the quarter compared with $2.6 million in the prior-year quarter and $4.3 million in the third quarter.
The sequential improvement in the wireless operating results was due to improved volume efficiencies on the higher sales and reduced new product ramp cost following a concerted effort across the organization to improve the operating efficiency of this business. This quarter's operating loss in wireless was the smallest in over two years and shows that the segment remains on track to achieve near breakeven profitability.
With that review of our segments, turn please to slide 12, and I will cover our balance sheet. We had $31.5 million of cash and cash equivalents at December 28, 2012 compared with $17.6 million at December 30, 2011. The increase is largely attributable to the cash received as part of the Oaktree recapitalization, net of fees and some year-end supplier payment’s. It also includes the effect of diligent working capital management throughout the course of 2012.
I would now like to update the status of the Oaktree investment beginning on slide 14. As you know we completed the closing of the recapitalization transaction on November 20, 2012. At the closing, Pulse received $75 million in cash under new term loan A, and we issued to Oaktree approximately 36.7 million shares of Pulse’s common stock and a warrant to purchase shares of a subsidiary. The common stock issued to Oaktree along with other common stock Oaktree already owned represents approximately 49% of the outstanding common stock with Pulse.
Additionally Oaktree exchanged approximately $28.5 million it owned of the Company’s $50 million in outstanding senior convertible notes for new term loan B. We used the proceeds to repay approximately $55 million outstanding under our senior credit agreement with previous lenders. The new capital of approximately $20 million is being used for fees and expenses associated with the transactions, working capital and general business purposes. It also allows us to maintain a higher level of cash on hand as noted in my comments above on the balance sheet.
Additionally as part of the initial phase of the recapitalization at a special meeting on January 21, 2013 shareholders approved amendments to the Company’s articles of incorporation to authorize the issuance of non-voting preferred stock and Oaktree was subsequently issued 1000 shares of a new series-A preferred stock. The new Pulse preferred stock will automatically convert into additional shares of Pulse common stock upon discharge of our senior convertible notes. Upon issuance of the preferred stock the subsidiary warrant issued to Oaktree at the closing was terminated.
Since the closing of the initial phase of the recapitalization, Oaktree and Pulse have been in frequent communication about the strategic plans of the Company and the resources necessary for a success in our renewed focus on improving our operational performance. To eliminate any possible concern that a risk event could threaten the Company’s ability to meet it's commitments to it's customers and vendors, Oaktree and the Company have entered into a letter agreement which includes an incremental term loan commitment of $23 million upon which the Company may draw if it's common stock is de-listed and the holders of it's senior convertible notes require the Company to repurchase those notes.
While we believe it is unlikely we will need to access these additional funds, the commitment by Oaktree ensures we have the necessary flexibility to continue our investments for growth regardless of the pace of recovery of our markets and any possible implications on our continued listing on the New York Stock Exchange. Terms of the incremental term loan if drawn will be identical to those of term loan A.
In addition Oaktree has agreed to forebear if the company fails to satisfy certain financial covenants of the loans, including leverage of minimum liquidity restrictions in 2013. In consideration for the forbearance and additional commitment the Company has agreed to adjust the conversion ratio for the preferred stock held by Oaktree such that the total common stock issued to Oaktree upon conversion of the preferred stock will equal approximately 67.9% of our total common stock.
Please turn to slide 15 now and I’ll provide an update on the equity components of this agreement. This chart illustrates the relative equity interest as of today following completion of the first phase of the recapitalization and ultimate relative interest following completion of the anticipated bond exchange, consideration for the incremental loan commitment and conversion of the preferred stock to common stock. In consideration for their $75 million term loan A, debt investment in Pulse, Oaktree was issued common stock that combined with common stock they already owned comprised 49% of the total common stock. This represents the situation today.
Secondly, the consideration of additional equity for the incremental term loan commitment I mentioned a moment ago will represent 10% of the common stock on a fully diluted basis after the conversion of series-A preferred stock. This is represented by the purple bars in the ultimate equity interest scenarios. This additional equity issued to Oaktree will reduce the ultimate proportions attributable to the convertible bonds and existing equity compared to those which existed before the additional commitment. The convertible notes will now be entitled to up to approximately 31.5% of the equity as a result of the planned exchanged offer represented by the orange bars on the chart. Oaktree has already exchanged their holdings of convertible notes of approximately $28.5 million for their pro rata share of this portion or approximately 17.4% of the total equity.
In the exchange offered, non-Oaktree holders of the convertible notes will be offered to exchange their holdings for the remainder of the 31.5% portion of the equity reserved for the convertible note holders or up to 14.1% of total equity depending upon participation. The holders of Pulse common stock prior to the recapitalization will be entitled to the remaining portion which now could range from a maximum of 32.1% if no non-Oaktree convertible note holders exchange their bonds to a minimum of 18% if 100% of the convertible notes are exchanged.
With that review of our fourth quarter financial performance and the equity structure, I’d now turn the call back over to Ralph.
Ralph E. Faison
Okay. Thank you, Drew. If I can turn you now – attention now to slide 17, you’ll see the outlook for the first quarter of 2013. Consistent with what you’ve likely heard from industry experts and peer companies, we’re encouraged by order rates that have been increasing albeit slowly into the New Year. We’re also encouraged by the reengagement of a number of key customers that may have been concerned about our financial condition throughout last year. Since the investment by Oaktree most of these customers have indicated their higher confidence in Pulse and they’ve begun discussions to increase business share and new program awards to us.
We believe we’ve maintained our technology leadership in our core markets and this continues to attract the attention of our large electronic industry customers that depend on the latest technology for their products. We are hopeful that these signs of strengthening will continue and have favorable effects on our sales in coming quarters. However our normal first quarter seasonal softness, the effects of Chinese New Year, overall weak order rates we experienced in the fourth quarter of 2012 and the timing and strength of wireless product ramps will keep our first quarter revenues somewhat lower than the fourth quarter.
On the more positive side we continue to see progress in improving our cost structure as demonstrated by our improving gross profit margins in the fourth quarter which will continue and result in a non-GAAP operating profit at a level similar to the fourth quarter despite the lower revenue guidance. So, at this time we expect first quarter 2013 consolidated net sales to range from $80 million to $86 million and a non-GAAP operating profit will range from a loss of $1 million to a profit of $1 million. So if I actually turn to the last slide, on slide 18 I’ll summarize just four takeaway points from the call.
First, our fourth quarter sales were in line with our guidance. Second, non-GAAP operating profit was better than our guidance mainly due to significant improvements in gross margin across all of our business as the positive effects of our cost reduction actions have begun reaping benefits throughout our operations. Our wireless segment performed much better as sales recovered from the customer ramp issues in the third quarter, wireless operating profit improved substantially from the third quarter and we continue to believe the business is [soundly] on the path to recovery and significantly improve profitability.
The successful closing of the Oaktree investment has resolved our issues with liquidity, debt maturity and cash debt service, and now allows us as a Company to refocus on operational performance and building long-term shareholder value.
So, with that I want to thank you for your continued support, and we look forward to reporting progress on our objectives in future quarters. We will not be taking question-and-answers on this call, but we invite you to call us directly with any questions or comments.
Investors and other parties with questions or comments on our announcement today are welcomed to contact me or our CFO, Drew Moyer at 858-674-8268 or by email to the Company at Investor Relations at pulseelectronics.com. Again, thank you very much for your participation today. Operator, we’ve now completed our presentation.
We thank you sir and the rest of the management for your time. To access the digital replay of the Pulse Electronics fourth quarter of 2012 results conference call, you may dial 1877-344-7529 or area code 412-317-0088 beginning one hour after the conclusion of this conference to March the 26th of 2013 at 5 O’clock PM eastern time. You will be prompted to enter a conference number which will be 10025349, again that is 10025349. You will be prompted to record your name and company when joining. The conference call is now concluded. We thank you all for attending today’s presentation. At this time you may disconnect your lines. Thank you and have a good evening.
[No Q&A for this event]
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