Executives
Craig LaBarge – CEO and President
Don Nonnenkamp – VP and CFO
Analysts
Fred Buonocore – CJS Securities
Matthew Crews – Noble Financial
Paul Memola [ph] – Dowding Company [ph]
Bill Wilbur – Sterling Capital Management
Dewey Taylor [ph]
LaBarge Inc. (LB) F3Q09 (Qtr End 03/29/09) Earnings Call Transcript April 30, 2009 11:00 AM ET
Craig LaBarge
Good morning, everyone. Thank you for joining us today for a discussion of LaBarge’s financial results for the fiscal 2009 third quarter and first nine months, which ended March 29th. With me today is Don Nonnenkamp, Chief Financial Officer for the company. As is our practice, we will begin with some prepared remarks and then open up the call for questions.
I’d like to begin by saying that although our year-over-year sales and earnings were down from last year’s third quarter record results, our fiscal 2009 third quarter results were bolstered by a strength in the defense and medical market sectors, improved operating efficiencies, internal cost reductions, and the addition of Pensar Electronics Systems in Appleton, Wisconsin, which we acquired in December, 2008. The business environment however remains challenging.
I should note that a reconciliation of the GAAP and non-GAAP financial measures mentioned during this call is provided in today’s press release which is available on the company’s Web site. I’m now going to turn the call over to Don for a review of the company’s second quarter results.
Don Nonnenkamp
Thanks and good morning. Fiscal 2009 third quarter results were as follows; net sales was $72.2 million compared with $75.4 million in the fiscal 2008 third quarter. The Appleton acquisition contributed $13.6 million to this year’s third quarter net sales. Net earnings were $3.8 million or $0.24 per share – per diluted share compared with $4.3 million or $0.27 per diluted share in last year’s third quarter.
The Appleton acquisition operated at break even in the current year third quarter. Remember that acquisition accounting rules require us to step up the value of the finished goods inventory that Appleton had on its books at closing to nearest full selling price. About 80% of that stepped up Appleton inventory has now been shipped. It continues to look like Appleton’s contribution to second half earnings will be positive.
Gross margin was much stronger than expected at 20.3% compared with 19.9% in last year’s third quarter. A number of factors converged in the third quarter to generate the higher margin; such as improved operating efficiencies, including our best ever labor and material efficiencies, internal cost reductions, better than expected profitability in Appleton, and the sales mix that was more favorable than anticipated.
SG&A as a percent of sales was 10.8% compared to 10.2% in the fiscal 2008 third quarter. In natural dollars, this year’s third quarter SG&A expense increased 2% from the previous year’s third quarter, and includes $910,000 from the Appleton acquisition. Operating income was 9.5% of sales versus 9.7% in the fiscal 2008 third quarter. Interest expense was $508,000 compared with $392,000 in the fiscal 2008 third quarter. The higher interest expense reflects higher average debt levels in the fiscal 2009 period, related again to the Appleton acquisition.
Net cash flow from operating activities was $12.2 million compared with a negative $46,000 in the fiscal 2008 third quarter, and $6 million – I’m sorry, $6.03 million in the fiscal 2009 second quarter. The higher cash flow from operating activities in the current year third quarter was largely attributable to reductions in accounts receivable and inventory, higher depreciation and amortization related to Appleton, and lower estimated tax payments.
Offsetting cash flow from operating activities during the fiscal 2009 third quarter was $5.1 million in capital expenditures, including new manufacturing equipment and facility upgrades. Total debt at March 29th was $45.5 million, compared with $15.6 million at fiscal year end and $51.4 million at December 28th, the end of our second fiscal quarter. The increase in debt from June 29th level began as a result of the Appleton acquisition.
Stockholder’s equity at March 29th was $100.3 million, compared with $91.5 million at June 29th, and $96.4 million at December 28th.
And finally, back log at the end of the third quarter was $185.6 million, compared with $238.1 million a year earlier, and $200.7 million at the end of the current year second quarter. Back log decline is the result of continued softness in certain key markets and a fiscal 2009 second quarter reduction of $39.6 million due to the removal of the Eclipse orders. Approximately 80% of the back log at March 29 is scheduled to ship in the following 12 months.
I’m now going to turn the call back to Craig.
Craig LaBarge
Thanks, Don. These shipments to customers in the defense, natural resources, industrial, and medical market sectors comprised about 91% of LaBarge’s fiscal 2009 third quarter revenues, including the Appleton acquisition. The Appleton acquisition added significant new customers and greatly expands LaBarge’s presence in the medical, industrial, and natural resources market sectors.
Our shipments to defense customers comprised the largest portion of our fiscal 2009 third quarter net sales, representing 45% of total revenues versus 37% in the year ago third quarter. Sales from the defense market sector grew 16% in the third quarter and 30% in the first nine months, compared with the comparable periods a year earlier. The growth reflects increased shipments on a wide variety of different defense programs.
Shipments to natural resources customers comprised 20% of fiscal 2009 third quarter net sales, compared with 24% in last year’s third quarter. About 35% of this year’s third quarter sales to the natural resources market sector was contributed by the newly acquired Appleton operation. Total sales from natural resources customers declined 21% in the third quarter and 25% in the first nine months compared to comparable periods a year earlier due to significantly lower shipments to oil and gas and mining customers.
Shipments to industrial customers comprised 16% of fiscal 2009 third quarter net sales, compared with 19% in the year ago third quarter. About 14% of this year’s third quarter sales to the industrial market sector were contributed by Appleton. Total sales from industrial customers declined 18% from the previous year’s third quarter, primarily due to lower shipments of equipment used in glass container manufacturing systems.
For the first nine months of fiscal 2009, net sales to industrial customers were up 5% from the comparable period a year earlier, buoyed by stronger shipments of equipment for glass container manufacturing systems in the first half of the current fiscal year as compared to last year.
Shipments to medical customers comprised 11% of fiscal 2009 third quarter net sales versus 7% in last year’s third quarter. About 51% of this year’s third quarter sales to the medical sector – medical market sector was contributed by the Appleton operation. Total sales from the medical market sector grew by 49% in the third quarter, and 31% in the first nine months compared with comparable periods last year due to the addition of the Appleton operation.
Shipments to commercial aerospace customers was just 3% of fiscal 2009 third quarter revenues, compared with 8% in the fiscal 2008 third quarter. Total sales from the commercial aerospace market sector declined 67% in this year’s third quarter and 51% in the first nine months due to cessation of shipments to Eclipse Aviation in this year’s second quarter.
In response to the current year decline in sales volume, we’ve redoubled our efforts to increase operating efficiencies through lean and operational excellence initiatives. And we’re achieving great results. We’re also focused on making prudent cost reductions. As is our operating practice, we’ve adjusted the size of our manufacturing workforce throughout the year to keep it in line with lower production requirements.
In addition, we’ve implemented a 5% reduction in base salary for executive officers and put in place a wage freeze for all other positions. Payments under the incentive compensation programs for fiscal 2009’s performance have been eliminated and we’ve temporarily suspended the company’s 401-K matching contribution.
We believe we’ve acted early and decisively, taking appropriate steps to help ensure that LaBarge emerges from this recession in a position of real strength. We anticipate that shipments on defense and medical programs will remain strong during the fiscal 2009 fourth quarter. But we’re continuing to see further weakening in the industrial and natural resources market sectors.
This as well as the absence of Eclipse shipments will impact our fourth quarter results. Based on the visibility we have today, we expect 2009 fourth quarter net sales, gross margin, and earnings will be lower in the fourth quarter than those in the current year third quarter.
Like many companies, we’re not immune from the – to the effects of the global economic down turn. But we believe we’re taking the appropriate actions to maintain a healthy level of profitability despite lower sales. Our operational performance is excellent and we continue to believe our long term business and financial outlook is very bright.
We anticipate that the diversity of our customers and end markets, our very high customer retention rate, financial health, neutral operating focus, and strong tight line of mid-term and long-term opportunities, positions us to grow earnings once again as the economy stabilizes.
At this time, Don and I would be happy to take your questions.
Question-and-Answer Session
Operator
Thank you. Ladies and gentlemen, at this time we will conduct a question-and-answer session. (Operator instructions) One moment please for our first question. Our first question comes from the line of Fred Buonocore with CJS Securities. Please go ahead.
Fred Buonocore – CJS Securities
Yes. Good morning, gentlemen. How are you today?
Craig LaBarge
Good, Fred. How are you?
Don Nonnenkamp
Fred.
Fred Buonocore – CJS Securities
I’m sorry. I joined the call a few minutes late. I’m sorry if I’m making you repeat yourself. But on the gross margins, which were surprisingly strong, I could see what you talked about in the release. On the mix side of things, can you elaborate a little bit more just on the gross margin strength in general and then specifically, on the mix? Is this mix shift something that could be sustainable for a few more months at least? Thank you.
Craig LaBarge
Well, we had a number of factors that converged in the third quarter to contribute to the better margins, better than we certainly had originally anticipated and expected. Included among those are much better operating efficiency results than we had anticipated. And Don had mentioned in his comments earlier that it really about the best ever in terms of both material and labor efficiencies. And that contributed significantly.
In addition, we had I would say, more – the cost reductions had greater impact in the quarter than we had modeled and we had expected. Profitability at Appleton was slightly better than we were anticipating. And we had commented that we though Appleton might be slightly dilutive in the third quarter and slightly accretive in the fourth quarter and ended up about break even. So that was due to some slightly higher margins than we were predicting.
And then product mixes is more favorable during the period than we anticipated. So when you add all those positive variances together, we ended up with a really better gross margin than we had been expecting.
Fred Buonocore – CJS Securities
Great. And as it relates to your guidance, to the extent you can – that you gave good directional comments, but if you could comment a little bit more maybe on the magnitude and the possibles [ph] that the cost reductions and efficiency improvements that you made could, even in the face of even lower volumes, possibly maintain those margins? And if not, is it going to be that you expect an even – a step down in volume in the quarter?
Craig LaBarge
Yes. I’ll try to give you a little bit of – a little more information. The biggest issue that we have right now is volumes. And our sales volume as it looks now, will be down in Q4 versus Q3. Not by a huge amount, but in a few of our plants, we’re getting to the point where volumes are lower and we’re going to be facing some greater under absorbed overhead that eats at the margin.
I would think margins – gross margins are going to be down modestly. I don’t think – there’s certainly not going to be – we’re not even anticipating at this point, a real train wreck for the quarter or anything like that. Just some modest reductions in gross margins.
We should see higher margins actually in Appleton since we’ve been working through that inventory that was required to be written up at the closing. So we should see some slightly improved gross margins in Appleton which will help.
Fred Buonocore – CJS Securities
Okay. Thank you. I’ll jump back in queue.
Craig LaBarge
Okay.
Operator
Thank you. Our next question comes from the line of Matthew Crews with Noble Financial. Please go ahead.
Matthew Crews – Noble Financial
Yes. Thank you. Going back to the gross margin. One thing I would like to achieve and get to more clarity on is what part of that – we looked at the company at about a 20% goal for gross margin. We had a good quarter. Is some of that sustainable with the cost efficiency side? Obviously if you have good mix you have good mix. But do you see some longer lasting improvements that might ratchet up the bucket [ph] if you will?
Craig LaBarge
Yes. I think so, on the operating efficiency side. We’ve continued to invest heavily in those initiatives and to really try to drive productivity gains. And it’ showing up in our labor efficiencies, material efficiencies, and we certainly don’t expect to take our foot off the pedal on that at all.
If anything, we’ve actually – in spite of the overall reduction in employment and in headcount in the company, we’ve hired some really outstanding people to help us continue to drive those improvements. And we’re getting those results. We think that they’re results and improvements that we can maintain and continue to expand upon.
The internal cost reductions will continue to be a fact before us and we’ve taken – made the cuts that we think are appropriate and prudent under the circumstances and given our outlook internally over the next few quarters. So that will be a factor.
On the mix, it’s hard to say except that we know that some of these improvements we’re making in efficiencies had a particularly major effect on certain projects and programs where we’re – that we will continue to see better margins then we had in the past. But the volume overall and its impact on our ability to fully absorb our – all of our overheads is going to be a drag on the margin for at least the next quarter or so.
Mathew Crews – Noble Financial
Great. Thank you very much for that
Craig LaBarge
Does that help?
Mathew Crews – Noble Financial
Yes, it does. I’m just trying to get an understanding of the volume is going to impact if the mix is beneficial, but in terms of the efforts to lower the overall cost of doing business. The second question I had was, last quarter we discussed about a 5% lower second half versus fiscal 2008. Obviously we’re looking at a lower sequential fourth quarter which will imply a little bit lower than expected revenue that we we’re looking at three months ago. Did anything materially change in your outlook over the last three months that you weren’t anticipating? Any more detail that?
Craig LaBarge
Nothing by itself that’s dramatic but just a continuing weakness in some of those more commercial markets that are resulting in – have had been resulting all this year in some rescheduling, some cancellations, some delays in placing orders that the cumulative effect is probably another percent or two, since we talked about 5%, lower revenues in the second half. And it’s probably more like 6% or 7% now.
Mathew Crews – Noble Financial
Okay. Great. Thank you very much.
Craig LaBarge
Okay.
Operator
Thank you. (Operator instructions) Our next question comes from the line of Paul Memola [ph] with the Dowding [ph] Company. Please go ahead.
Paul Memola – Dowding Company
Hi. Good morning, everyone.
Craig LaBarge
Hi, Paul, how are you?
Paul Memola -Dowding Company
Good, thanks. Sorry to go back to gross margin. Could you give us a sense what the gross was on the legacy business or on Pensar or both?
Don Nonnenkamp
The Pensar gross margin was just little bit below 9%.
Paul Memola – Dowding Company
I see. Okay.
Don Nonnenkamp
So the legacy business as you will was 21%.
Paul Memola – Dowding Company
So essentially, the write-up didn’t affect you as much as it has paid off obviously, right?
Don Nonnenkamp
The write-up in Appleton inventory?
Paul Memola – Dowding Company
Correct
Don Nonnenkamp
Well, it certainly had an impact on that gross margin. But I think the – it is a couple of things that helps. There were cost reductions in Appleton that were not initially cooked into our thinking. That had an impact on their gross margin for sure. And their mix also changed a little bit. So they contributed more than what we anticipated they would in Q3.
Paul Memola – Dowding Company
Okay that makes sense. Thanks, Don. What is the near approximate headcount reduction thus far?
Craig LaBarge
Companywide?
Paul Memola – Dowding Company
Yes
Craig LaBarge
Since the beginning of the year it is in the neighborhood at 300 people.
Paul Memola – Dowding Company
Do you think thus far you’ve chopped off enough overall cost to keep SG&A in $8 million range? Do you think that’s fair?
Craig LaBarge
Yes. I think the biggest factor in terms of cost reduction this year is one that in some sense, sort of takes care of itself and that is the incentive compensation. And almost all of that ends up in SG&A. So our various insider compensation programs, short term and long term, probably result in a $3 plus million of savings this fiscal year compared to last fiscal year.
Essentially all of that is in SG&A. So once we get to a point where things return to more normal levels, we would expect that we’d be at some point in the future, paying bonuses again.
Paul Memola – Dowding Company
We’re looking forward to that.
Craig LaBarge
That will push the SG&A numbers up a bit.
Paul Memola – Dowding Company
Okay.
Don Nonnenkamp
But the number of $8 million is a good bench mark number for the fourth quarter.
Paul Memola – Dowding Company
Yes. Okay. That’s what I was looking for. Is there an internal margin target on an operating basis for fiscal 2010? Do you think it’s fair to assume what we’ve seen so far in the 10% range maybe a little bit above that?
Craig LaBarge
I certainly don’t think it’ll be above that in 2010. But we’re still working on 2010 budgets and forecasts and all of that. But in terms of an internal target, what we’ve really tried to cut the size of the business for is to be able to achieve at least 9%.
Paul Memola – Dowding Company
Okay
Craig LaBarge
So operating profit. Yes. I think that’s what your question was.
Paul Memola – Dowding Company
Yes. That’s perfect. And then finally, do you think you can source a lot more cash out of working cap or do you think that’s really the peak right there?
Don Nonnenkamp
You know we’ve done very well in – from cash flow point of view from operating activities in terms of receivables and inventory. There’s always more efficiency in our inventory account. I’ll never throw in the towel on that.
But the reality is, part of what is happening here is the business has slowed. The reinvestment in inventory and eventually on accounts receivable has also slowed. And that takes money out of those two balance sheet accounts. So that’s a portion of our cash flow, no question about it.
Now as the business sales and bookings recover, I expect that those numbers will reverse and we’ll be making investments on those two categories and the ability to generate more and more cash flow just out of balance sheet is going to be reduced or eliminated. I think you should not anticipate that we will continue to show the cash flow from operating activities in a $12 million number like we did here in Q3.
Paul Memola – Dowding Company
Sure, firmly understood. Thanks for your time, guys.
Don Nonnenkamp
Thank you.
Craig LaBarge
Thank you.
Operator
Our next question as a follow up question from the line is Fred Buonocore with CJS Securities. Please go ahead.
Fred Buonocore – CJS Securities
Yes. I just wanted to quickly touch on the bookings that you indicated in the release, that bookings were up slightly on a sequential basis. Is this largely due to contribution from Pensar and the orders they’d be receiving or there’s some areas where you’re starting to see trends that are just more favorable and should we take something from this about maybe getting close to a turn in demand?
Craig LaBarge
Yes. I will say, just to touch on that, that’s certainly where I would think the first signs would be of a real turn, is in our backlog really and it’s obviously going to come from bookings. But we’ve seen our back log number decline, obviously there was a significant decline in fiscal Q2 this year because of the removal of Eclipse. But that was partially offset by the acquisition.
So even with all of that netting out, it’s still – we’ve seen back log decline now for five consecutive quarters and we think that there are some encouraging signs with regard to bookings and with regard to some of these numerous new opportunities that we’ve been working on and pursuing. We think the first place that we’ll start to see some real encouraging signs about the overall revenue growth again is going to show up in the back log. And we’re hopeful that were a quarter – within a quarter or two away from seeing back logs start to climb again.
A lot of things have to go right. We’re thinking that a number of these major new opportunities that we’ve been working on are going to fall our way and that will be able to start to see that turn here in a relative short term.
Fred Buonocore – CJS Securities
Great. And would the new opportunities largely be in medical, given your new capabilities with Pensar? Or are you saying more things getting outsourced from defense? If you could just characterized some of those for us please?
Craig LaBarge; They’re fairly wide spread. There’re a lot of them in defense that we’re feeling pretty good about. We’ve got some in more industrial and some in medical. But the biggest ones tend to be more in the industrial and defense area.
Fred Buonocore – CJS Securities
Interesting. Okay. Thanks very much, Craig. Thanks, Don.
Operator
Thank you, our next question comes from the line of Bill Wilbur [ph] with Sterling Capital Management. Please go ahead.
Bill Wilbur – Sterling Capital Management
Good morning.
Craig LaBarge
Good morning.
Don Nonnenkamp
Bill.
Bill Wilbur – Sterling Capital Management
I don’t know whether you folks – I was late to the call too. Not by my choice. I was on hold for 14 minutes. I don’t know if anybody else experienced that problem, but did you mention anything in your statement at the beginning about Eclipse, where that is.
Craig LaBarge
Yes. But we did not mention anything about Eclipse. Eclipse is still – the future of Eclipse is still kind of hung up in bankruptcy court. It was converted from a Chapter 11 to a Chapter 7 and it’s still hung up there.
There are several groups that have come forward with statements that they would like to acquire the intellectual property. I think at least a few of them have the -- appear to have the ability to raise the money or produce the money when the time comes. But I do not have a schedule.
I don’t believe the court has established a schedule for any kind of an auction of those assets. I say we continue to feel that were well positioned to benefit to some degree from that when it finally happens because we were the supplier and are the supplier of record on the cable assemblies and wiring harnesses on the aircraft. Some of which will require replacements in order to implement the necessary upgrades on the 259 planes that the Eclipse did deliver.
Bill Wilbur – Sterling Capital Management
Craig, are you more or less optimistic today than you were say 60 or 90 days ago that you will realize something out of this?
Craig LaBarge
Well let’s see. 60 or 90 days ago I was – about 90 days ago we were expecting that the Chapter 11 restructuring was going to go through. So I have to say we are more probably optimistic then. However, I’d say we’re more convinced then ever that we will realize some – we will see some real opportunities. We will have some revenues involved in the upgrade and retrofit of those aircraft that are already out there. Not as optimistic about any kind of resumption of production on that aircraft in the foreseeable future.
Don Nonnenkamp
And then let me add that we are not optimistic about any recovery from the estate.
Craig LaBarge
Yes. Any recovery we have will come from sales to those parties that are operating the aircraft, at least for the foreseeable future.
Bill Wilbur – Sterling Capital Management
Owens-Illinois coincidentally reported last night and there was some blurb on the wire this morning and they held a conference call and their stocks’ up about – at one point it was up about 30% which doesn’t mean – I mean in this crazy market we’re in now, but there was some mention that they were – gave some encouraging remarks about volume in the next quarter or so. Are you nosing any – are you getting any feedback from them along that line?
Craig LaBarge
Nothing yet. But that’s encouraging. I haven’t read – I actually have their press release but I haven’t had a chance to read yet because we’re getting prepared for this call.
But I would say that would be very encouraging.
Volume is the key there for us. It sort of drives our repair business, our support business with them. And depending upon the volume, might very well trigger some new capital spending for them in terms of new lines that would be very beneficial.
Bill Wilbur – Sterling Capital Management
And my last question, I think one of the other callers maybe touched on it. You alluded to the fact in the live conference call, Craig that you might possibly pick up some business from some of your lesser capitalized – that’s a probable way of putting it, but some of your competitors that didn’t have the financial wherewithal and survival ability that LaBarge has, are you seeing any of that or are you still optimistic that’s going to lead to some additional business?
Craig LaBarge
Yes. We’re very optimistic about that. We’re continuing to see customers unlike anything I’ve ever seen before, but customers that are quite concerned about the financial viability of their supply base. And that we come out quite well at any kind of a comparison there and we are seeing or quoting on, we’re pursuing opportunities that I would say would be – would fit that description precisely.
Bill Wilbur – Sterling Capital Management
Okay. That’s all I have. Thank you very much.
Craig LaBarge
Great.
Don Nonnenkamp
Thank you.
Operator
Thank you. (Operator instructions) Our next question comes from the line of Dewey Taylor [ph], private investor. Pease go ahead.
Dewey Taylor
Hello, Craig.
Craig LaBarge
Hi, Dewey. How are you?
Dewey Taylor
I’m fine. At this point I’d say I was surprised and pleased to hear how well you’re doing with your acquisition. In this tough time so often when you try to assess the contribution that the company like that, it’s hard to really know how it’s going to play out in this very difficult times.
Apparently, the contribution not only accretive to your earnings, but more so, because I understand, than you had anticipated. And that sounds like a pretty optimistic scenario considering the business climate we face here. And I’m wondering in lieu of that – looking now you have not much time to evaluate it, but looking ahead three or six months or a year, this acquisition could be a lot more meaningful perhaps in the contribution than you originally anticipated?
Craig LaBarge
Yes. I would say that – certainly I want to say that we’re pleased with the acquisition and how it’s performing. We like the customer base a lot and we think there are real growth opportunities with some of those key customers that the former Pensar had developed. They’ve got great relationships and we think we can help expand on those relationships.
We’ve got some work to do in the integration, but it’s progressing. You know some of the things have gone easier than expected. Some of them more challenging. But overall it’s continuing to progress about like we had hoped.
We have seen a lot of opportunities with the customer base and really we see a lot of opportunities in that region of the country and having the operation up in Appleton, Wisconsin which gives us a real easy access to a lot of companies that are in the upper Midwest up there. And that’s exciting for us.
Dewey Taylor
Well that’s great. I thank you for that and congratulations on the work you’ve done here in this tough economic environment. Looking really good. Thank you.
Craig LaBarge
Thank you.
Operator
Thank you. And there no further questions at this time. Please continue.
Craig LaBarge
Okay, I want to thank everyone for joining us today and for your continued interest in LaBarge. We hope that you’ll be able to join us when we announce results for the fiscal 2009 fourth quarter and full year in late August. In the meantime, of course as you know, if you have any questions at all, please feel free to call. You can always reach Colleen Clements, our Director of Corporate Communications. Again, thank you and have a good day.
Operator
Thank you. Ladies and gentlemen this conference is available for replay. (Operator instructions)
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