Technitrol Inc. Q1 2009 Earnings Call Transcript

Technitrol Inc. (TNL)

Q1 2009 Earnings Call

May 4, 2009 5:00 pm ET

Executives

David Stakun - VP of Corporate Communications.

Jim Papada - CEO

Drew Moyer - CFO

Analysts

Shawn Harrison - Longbow Research

Michael Gallo - CLK

Sean Hannan - Needham & Company

Presentation

Operator

Welcome to the Technitrol Incorporated First Quarter 2009 Results Conference Call. (Operator Instructions).

At this time, I'd like to turn the conference over to David Stakun, Vice President, Corporate Communications. Mr. Stakun?

David Stakun

Thank you. Good afternoon, everyone. Welcome to our discussion of Technitrol's first quarter of 2009. Also, on the line with you are Jim Papada, our CEO; Drew Moyer, our CFO.

In a moment, Drew will summarize the results presented in the press release that you just received. Then, Jim will quickly review the current business environment and our thoughts about the future.

After Jim's brief remarks, we will take questions. We plan to finish no later than 5:45 PM Eastern Time. This conference as the operator said is being recorded to provide replay service. Instructions for getting the replay by phone and Internet are in the press release.

Keep in mind finally that today we will make forward-looking statements, as defined in the 1995 Safe Harbor law. These remarks are based on our best knowledge today, May 4, 2009.

Actual results may turn out to be materially different, because they are subject to risks. The risk factors are discussed in our 10-K for fiscal 2008 and very soon in the 10-Q for the March quarter of 2009, which is about to be filed.

Now, let me turn this over to Drew. Drew?

Drew Moyer

Thanks, Dave. Consolidated revenues in the first quarter were $182.2 million, down 14% from the fourth quarter and 34% from the first quarter of 2008, reflecting a continuation, mainly during January and February of the global demand decline and customary inventory reductions in most markets.

Of that $92 million decrease from the first quarter of last year, $13 million was due to a weaker Euro on average against the dollar and about $9 million was due to lower precious metal prices. Silver prices fell sharply from $17 to $18 per troy ounce in the first half of 2008 to between $12 and $13 by the end of the first quarter of 2009.

First quarter revenues were $123.6 million in our electronic segment and $58.6 million in the electrical segment.

Tables in our earnings release reconcile non-GAAP disclosures with the amount shown in our GAAP financial statements. Non-GAAP amounts exclude severance, impairment, and associated costs. Please review these tables in connection with the financial results.

On a US GAAP basis, there was a loss of $1.83 per diluted share for the first quarter. Excluding discontinued operations, tax affected severance and impairments, and the effect of favorable foreign exchange adjustments, the loss per share was $0.03. Including the foreign currency gained, pro forma earnings were $0.15 per share.

The impairments related mostly to goodwill and to a much lesser extent, the portion of fixed assets in business divisions, experiencing lower demand and production equipment dedicated to end-of-life products.

The good will impairment of $69 million related to another round of testing dictated by the accounting rules, and based on internal business forecast, and the closing stock price at the end of the first quarter.

Fortunately, the stock price has more than doubled since that analysis, but unfortunately, the rules required a write-down in the first quarter. First quarter EBITDA was $12.3 million, adjusted to exclude special items outlined in the release.

We had an income tax benefit of $129,000 in the quarter. It was very small in relation to the pre-tax loss, because it reflects a combination of pre-tax earnings and losses that varied significantly by jurisdiction.

In addition, a majority of our interest expense and impairment charges were not deductible for tax purposes. Cash at the end of the quarter was $33 million. Debt was $340 million.

The cash and debt balances were impacted significantly during the first quarter by the following: The last payment of the 8-3/4 cents per share dividend we paid in January, one-time fees amounting to about $3 million to amend our credit facility, cash outlays of approximately $2.9 million for severance which we expect to diminish sharply in the second quarter before phasing out completely, and finally cash expense of about $2.1 million to fund retirement plan obligations.

Without these non-recurring cash payments, totaling about $11 million and including the proceeds from the sale of the MEMS business which took place last week, we expect to repay considerably more of our debt in the second quarter than in the first quarter.

We are in compliance with all of our debt agreements and expect to remain so. On April 17, we paid a dividend of $0.025 per share, and as noted in the release, the board has declared a similar payout to be made on July 17.

Jim will now expand on current business conditions.

Jim Papada

Thanks, Drew. As everyone knows, I think Q1 was not for the faith of heart. Overall, our first quarter revenues were far less than our original expectations, but I'm happy to say that EBITDA actually exceeded our expectations and we are very proud of what we were able to accomplish in the first quarter and I'll talk more about that in a few minutes.

As you know from our last call, we are intensely focused on cash flows. Proceeds from the divesture of assets and progressive increasing free cash will be applied directly to debt repayment.

In the case of MEMS, as Drew just mentioned, the free cash benefit extends beyond just the sales proceeds. MEMS microphones are pretty much still in the early stages of developments and require heavy R&D expense to satisfy customers' unique demands.

Also their production requires sourcing of costly semiconductor components, which we don't make, and which we have to purchase in huge quantities in order to be cost effective, so we’re happy this is now behind us.

As for the electrical business, while it’s still too early to conclude that we will in fact sell AMI DODUCO, we’re very encouraged by the process and response from potential buyers, both strategic and financial.

I’ll now get back to the first quarter results.

In Q1, we worked very hard to bring our expenses in line with anticipated revenues and we brought the total annual savings from cost eliminations to around $30 million due to the ongoing nature of cost reduction. The first quarter reflected only about 70% of these savings.

In Q2, we’ll see a full quarter of benefits in resulting stronger operating performance so long as revenues hold up. From a SG&A point of view, we believe, we’re now appropriately structured and we expect no significant additional reductions.

While the bulk of the cost elimination activity in Q1 was in the area of SG&A expenses and indirect labor, we’ve also begun to realize savings and cost of goods sold for plant consolidations and production transfer.

In the automotive electronics business, the transfer of production of ignition coils to China is now complete. All production in Germany and Tunisia has stopped. We expect much better operating results in our automotive lines again so long as revenues hold up which is pretty well done so far.

In our Medtech business, we completed most of the transfer of medical component production whole into Vietnam on an accelerated schedule. Annualized savings when complete will be about $13 million on today’s revenues, about 80% of which was reflected in Q1.

Finally, during Q2, we will begin and substantially complete the relocation of our last significant legacy facility from Southern China to Western China where costs are significantly lower. This initiative is well underway.

We've had a full court press on inventory reductions in both of our businesses. By the end of Q1, we reduced inventories more than 30% from Q3 levels and almost 20% from the end of Q4. We'll continue to aggressively pursue opportunities to more tightly manage receivables and payables as well.

On the CapEx front, we succeeded in reducing our spending to half what it was in the previous quarter, and we're comfortably within our $15 million annual budget which is about half of our 2008 spending. We will continue to commit capital to the development of the product lines that serve high growth markets.

A few final thoughts on how we feel about 2009 as a whole, and feel is the keyword because conflicting forecasts abound from economists, customers and assorted pundits.

While our markets remained for the most part anemic, we're encouraged by the fact that demand is apparently stabilized. In fact, overall orders for electronic components have shown signs of life in March, leading us to believe that some supply chain inventory replacement is occurring in some markets, whether this can be sustained and for how long, we don't know.

For now, based on what our customer say, we believe that each quarter of 2009 will slightly better than the previous quarter. I believe that the real test will be the first quarter or two of 2010, rather than last half of 2009.

Keep in mind that given are now very, very low break-even point, very small revenue improvements will results in disproportionably larger improvements in operating profit.

In the electrical contacts business, market weakening has been as or more severe than in electronics, but about two months lag, and so we expect shipments in this segment to bottom sometime in the second quarter, as demand for electrical equipment continues to wind down. The bright spot here has been China where our recovery assort appears to be underway driven we think by Chinese stimulus money.

With some incremental demand improvement in electronics and continued softening in electrical market outside China, we expect Technitrol's consolidated revenues in Q2 to be not much different than in Q1. However, as I said a moment ago, we do expect to see our EBITDA improve as a result of the various actions I have discussed.

And when the markets begin to really crank up again and of course they eventually will, we have created the opportunity for enormous operating leverage as a result of our new low cost structure, which will deliver outsized returns to shareholders.

I cannot fail to mention that tremendous sacrifices made by our employees in this economic downturn. Many people around the world are participating involuntary, not mandatory furloughs foregoing up to 20% of their pay in order to forestall deeper layouts, which for us might be proved to be too deep to be prepared for the future.

They are the group or the heroes of the day, and to them I and all of our shareholders owe a huge debt. It is our honor to be a colleague of each and everyone of them.

That concludes today's opening remarks. We will now take a few questions.

Question-and-Answer Session

(Operator Instructions). Your first question is from Shawn Harrison of Longbow Research.

Shawn Harrison - Longbow Research

First question gets to the guidance that was put out and that was kind of I guess in the middle of February of $16 million to $18 million EBITDA target for the June quarter. My back of the envelope math was some of the incremental cost savings here implies that you would get to that low-end of that range. Is that a correct statement?

Jim Papada

Well, if that's your math, I am sure that you get it correctly. We have nothing more to say about that other than what we said. We put the fact in the press release and you reach whatever conclusions you reach.

Shawn Harrison - Longbow Research

May be another way to ask as it looks like on the $30 million of savings, there is about $2.25 million of incremental savings for the June quarter, plus say another $700,000 from the medical moves, any incremental savings that I missed in terms of the dollar target that you could provide?

Jim Papada

I think we provided what we are providing.

Drew Moyer

I think Shawn the other thing is that, not necessarily anything more on the savings, but revenue will be what revenue will be and that will drive the EBITDA. So that would be a few million more and that's what we met.

Shawn Harrison - Longbow Research

To Jim's point on the reduced break-even point here, how should I view incremental margins for Pulse on an EBIT basis going forward now? Historically, I thought it was kind of in the mid-20s.

Drew Moyer

I think it's at least at that point. We have said 20% to 30% incremental operating margin on incremental Pulse revenue and given where we are right now, it will be at least that good.

Shawn Harrison - Longbow Research

So may be initially a little bit higher before you revert to that normalize range possibility?

Drew Moyer

It's okay.

Shawn Harrison - Longbow Research

Second, I don't think I heard the sale price associated with the MEMS business?

Drew Moyer

Yes. We did not disclose that. It was inline with what we indicated or signaled earlier. We are actually still totaling up the costs associated with the transaction. We will repay at least $5 million out of the net proceeds and probably a little better than that.

Shawn Harrison - Longbow Research

In the second quarter?

Drew Moyer

Correct.

Shawn Harrison - Longbow Research

Okay. And then just a clarification point, the $0.03 gain from the insurance settlement tied to the earthquake last year, was that another income or was that run through gross profit?

Drew Moyer

It's in operating results as was the unfavorable effect in the second quarter of 2008.

Operator

Our next question comes from Michael Gallo of CLK.

Michael Gallo - CLK

I just had a couple of questions, you were looking at the adjusted number for Q1, what tax rate were you using?

Drew Moyer

I'm sorry, Mike the adjusted number meaning?

Michael Gallo - CLK

The adjusted number for the, I guess you gave a couple of different numbers. I think you said an operating loss of $0.03, but I think that includes the $0.03 insurance recovery. Is that right?

Drew Moyer

That's without that. I mean we said, if you go to the back of the release, the pro forma cable, we have scheduled out the things that we exclude. So that the biggest items in the non-GAAP table, which were the severance costs and impairment charges, those generally didn't have any tax benefit associated with them.

Michael Gallo – CLK

Okay. But just if I heard you right, the $0.15 that shown reconciled in the table that include the $0.18 of foreign tax credits, but does not include the insurance recovery. Is that right?

Drew Moyer

It's foreign exchange gains, not foreign tax credit, yes, correct.

Michael Gallo – CLK

But, it does not include or does not take out the $0.03 insurance gain.

Jim Papada

The insurance gains in gross profit.

Michael Gallo – CLK

Okay. The insurance gain shows up in gross profit. That was another way of answering my question. Jim, in terms of if you just look at the environment, give us a little bit more color on, as you look at in more detail the areas where you're starting to see some improvement in electronic component. I mean, is it a broad-based bottoming? Is it some area, you are seeing a little pick up, some are still anemic, I mean what additional color can you provide us in terms of what areas you think pick up versus areas you are not?

Jim Papada

I would say that the recovery in electronic components is pretty broad-based if I can use the word recovery. You have to remember, I mean I am sure you have been, listening to other companies similarly situated. And the situation that we face in the first quarter was pretty much a complete shutdown of order entry in the month of January and February. And I mean quite literally completely shutdown.

And then March was a much more favorable month, both in terms of order entry and in terms of revenues, which mean a lot of people were spot buying, which led us to believe that inventories were rolled way down to where people had no choice but to buy. And we are continuing to see that kind of a pattern, which is actually quite similar to what we saw in the end of 2003-2004 period.

So, we are not seeing what I would say wholesale replenishing of confinement stocks or vendor managed inventory stocks, but we are seeing buying which is significantly better than it was in January or February, keeping in mind that it does take much pretty significantly better than January and February. So, that’s why we say, anemic but improving.

Michael Gallo – CLK

So, is there any feel for whether it's just summary rebuilding of inventory to channel or is to whether it's really being built to improve upon?

Jim Papada

My guess is that there is not a whole lot inventory being put anyplace. I think just as we are buying only what we need to make what somebody is buying, our customers are buying only what they need to make what somebody is buying. It would be rather shocking to me if inventories were bring filled.

We see, not in all cases, but in a lot of cases, we have a visibility into consignment stocks and vendor managed stocks, and they are not being built up. So, goods are being pulled through and either somebody is building something or if somebody is holding inventory on their floor and not in their consignment stocks, and that will be hard to believe.

Michael Gallo – CLK

Could you give us any update on where things are, the AMI or the books out?

Jim Papada

As I mentioned to you, we are quite happy with the process at this point. We've gotten good response from both strategic and financial buyers. That would imply that the books are out, and we'll see where it goes.

Operator

Our next question comes from Sean Hannan of Needham & Company.

Sean Hannan - Needham & Company

Thank you, a quick question. So last quarter you folks had talked about as far as this restructuring process and the consolidation that you're doing within the Pulse division, you're collapsing five divisions I think into two. And I was looking to see if we could get a little bit of detail in terms of what that breakdown looks like now and how that mix compares to December?

Jim Papada

I'm not exactly following that question.

Sean Hannan - Needham & Company

Okay. On your last call, I think that you folks had talked about collapsing five divisions into two divisions. Is that not a process you're going through?

Jim Papada

What we've done is we've taken our various product divisions and we've reorganized them into two broad divisions, wireline and wireless in effect.

Sean Hannan - Needham & Company

Okay. And so, is there a way to get a sense in terms of what that breakdown is today for wireline versus wireless?

Jim Papada

When you say breakdown, you mean the revenue breakdown?

Sean Hannan - Needham & Company

Yes, the percentage mix.

Drew Moyer

We don't disclose that. Let's say it this way Sean before and I think what we talked about last quarter was really in the networking area, which is part of wireline, as Jim just mentioned, and we used to have telecom and power and LAN and we combined some of those smaller divisions into the wireline division.

Now, it is much comparable in size to the wireless division, which is also the third likely the store will be the Medtech division. So while we don't disclose revenues by product division, you can think them in more or less comparable size.

Sean Hannan - Needham & Company

Is it possible, can we look at pricing for a moment? How would you categorize the pricing environment overall? And are there any pockets whether even if pricing is generally from their particular pockets where you’re seeing may be a little bit more aggression if it's coming from perhaps some smaller less financially stable competitors?

Jim Papada

No. Pricing environment is relatively benign. I think that a lot of our former esteemed small less stable competitors are gone having been with us in the last year or so. When we know of at least two competitors, for example, in the LAN business who were a pain in the (inaudible) who no longer exist having put themselves out of business by their aggressive pricing activity, and in one case our aggressive IP activities.

But anyway, I think that most people are still, if not everyone certainly in China is still impacted by the fixed cost that got wrapped into the system, that cost went up and they didn’t go down. Our labor cost went up, social cost went up and none of that went down. They haven’t gone up anymore in the last three or four months, but they didn’t go down any from the 50% they went up in the last two years.

So I don’t think and people spent a lot of the second, third and fourth quarter last year increasing prices and I haven’t spoken anybody who is particularly interested in reducing prices. So while you may find a 1% or 1.5% reduction here and there, no because people just want to stay on the good side of customers. We’re not even seeing people ask for massive price reduction.

Now may be that’s because there is no sense in asking for a price reduction on something you not buy, and when demand picked up again maybe things will be a little more frothy, but at the moment the atmosphere is pretty benign. Matter of fact we just went through a pricing negotiation with a major customer for product which is going to come out of China, replacing products which was coming out of a different jurisdiction and the negotiations were smooth and fruitful.

Sean Hannan - Needham & Company

Okay, that's helpful. If I could ask a little bit around your ignition, actually your automotive business in a general sense, I think that your ignition coils have been doing very, very well on a relative basis. The other automotive coils had been a bit challenge and I was just looking to see if we can get an update for the March quarter and present?

Jim Papada

Situation remains the same. Now as I mentioned, manufacturing all of our ignition coils in China we have no more manufacturing in Europe. We've realigned our relationship with Volkswagen, Audi Group, primarily as to where we are delivering coils and the demand that we're filling. You could imagine we've become more Asian centric than Euro centric now which was the idea to begin with.

So, the demand for ignition coils is holding up firm. We actually expect that to increase somewhat as we move forward because of some programs that Volkswagen is engaged in Asia. So, we're happy with that, actually interestingly enough, just while on the subject of automotive.

Even our German automotive business AMI DODUCO picked up substantially during the quarter which we think is attributable to the stimulus package that I believe the German and Italian governments put in place for trading in owned cars for new cars.

So that business which was dead as a doornail in Q4 actually had a quite a significant pick up, although the small part of our business had quite a significant pickup in Q1. So, you never know about the automotive business.

Sean Hannan - Needham & Company

Then just a small housekeeping question. As far as your goodwill and intangibles level exceeding the quarter, I saw you took a write-down, where do you net out in terms of what that number is on your balance sheet today?

Jim Papada

Let's see the goodwill I think is about $80 million, maybe $85 million at the end of the quarter after the write-down. That is everything everywhere. So, there is not a whole lot left.

Sean Hannan - Needham & Company

If I take a look at the revision that you have where you went down to about a 165 after the write-down in December and I take 68.9 and added to about 96, and I just wanted to make sure that that was about in the range?

Drew Moyer

Yes, I think you are actually going to see on the 10-Q, on the balance sheet, you will see a number that is little less than that, I think there is probably some translation issues for goodwill not in US dollars and of course the first quarter amortization of the balance that was there. So you will see a number of around 86 million, 85 million.

Jim Papada

This as you know is driven by county conventions that pick up point in time and what happens the next day or 5 days after that doesn’t matter. So because the stock had a price when it was measured in the first quarter for that particular test, a little less than two, you had a result that are paying.

Now, it has a value of well more than 100%, a better than that, but the same results are paying anyway because that's what the stock price was on that given day. It's a very strange way of doing things, but that's how you are doing. If I get trouble to say that, but that's my view anyway.

Operator

(Operator Instructions)

Jim Papada

If there are no further questions, I will ask our operator to conclude this evening's call. Thank you everyone for participating. We'll talk to you next quarter. Good evening.

Operator

Thank you for participating in today's Technitrol Incorporated results conference call. To access the playback of this conference, you may dial 412-317-0088 and enter the number 374010 followed by the pound key, press one to play the recorded conference. This concludes today's event.

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