Spectrum Control Inc. F3Q09 (Qtr End 08/31/09) Earnings Call Transcript

Sep.24.09 | About: Spectrum Control, (SPEC)

Spectrum Control Inc. (NASDAQ:SPEC)

F3Q09 Earnings Call

September 24, 2009 4:45 pm ET

Executives

Richard Southworth – President, CEO

Jack Freeman – Senior Vice President, CFO

Analysts

Ted Kuntz – Needham & Company

Chris McDonald – Kennedy Capital Management

Operator

Welcome to the Spectrum Control Inc. 2009 third quarter conference call. Representing the company today, we have Dick Southworth, President and Chief Executive Officer and Jack Freeman, Senior Vice President and Chief Financial Officer. Their discussion of the company's operating performance for the quarter ended August 31, 2009 should take about 20 minutes. They will then try to answer as many questions as reasonably possible. We expect to conclude this conference call at approximately 5:30 pm Eastern time.

As a reminder, the following discussion will include certain forward-looking statements which 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 results or those anticipated. These risks and uncertainties are described in detail in the company's most recent quarterly and annual SEC filings.

The words believe, expect, anticipate and similar expressions identifying forward-looking statements. Listeners 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

Thank you operator. Welcome to Spectrum Control's 2009 third quarter conference call. I will briefly review some key operating and financial highlights of the period after which Jack Freeman will review our financial performance in more detail. We will then be happy to take any questions.

For the third quarter of 2009 we reported net income of $2 million or $0.16 per share on sales of $31.5 million as compared to net income of $2.4 million or $0.18 per share on $33.1 million of sales for the same period last year. For the first nine months of 2009 we had net income of $6.4 million or $0.50 per share on sales of $98.2 million. For the comparable period of 2008 we had net income of $6.3 million or $0.47 per share on sales of $96.9 million.

Despite the global recession, the ongoing impact on virtually all of our commercial markets, we continue to generate positive operating results and year-to-date growth in both sales and earnings. Our fundamental strategy of serving both the commercial and military market is serving us well with our strong military defense business today offsetting the consistent softness on substantially all commercial product applications.

Current quarter sales and profitability were slightly below our previous expectations only reflecting changes in the timing of certain customer orders and related shipments for which we are sole source. This quarterly impact, however, does not have any effect on our long-term business outlook. Today total customer orders received in the current quarter were $32.4 million, an increase of $1.3 million or 4% from the same period of last year with our third quarter performance total year-to-date customer orders increased to $100 million. These customer order levels have generated a positive book to bill ratio for both the current quarter and the first nine months of 2009.

Demand for our products in the military and defense markets continues to be very strong. Shipments to military and defense customers were $19.2 million or 61% of our total consolidated sales in the current quarter. That compares to $15.8 million or 48% of our total sales for the same period a year ago. With this performance and our continued focus on reducing working capital requirements we have generated $13.8 million of net operating cash flow this year, a record for our company.

Now these are just some of the highlights and accomplishments. At this point I would like to introduce Jack Freeman, our Chief Financial Officer, and ask Jack to review our third quarter results in greater detail. When Jack has completed his presentation I will conclude with some final comments and then we will open the floor to questions. Jack?

Jack Freeman

Thanks Dick. During the third quarter of fiscal 2009 our consolidated sales were $31.5 million a decrease of $1.6 million or about 5% from the comparable period last year. This decrease primarily and almost solely reflects the global recession and its continuing impact on many of our commercial customers which has been partially offset by continued strength throughout our military and defense markets.

As Dick indicated, shipments to our military and defense customers were $19.2 million in the quarter compared with $15.8 million for the same period a year ago. That is an increase of $3.4 million or about 22%. Sales of our microwave components and systems were $14.5 million in the current quarter compared to about $11.5 million in the third quarter of fiscal 2008. This increase of $3 million or 26% year-over-year reflects the impact of our acquisition of SatCon Electronics last September as well as additional shipments of our microwave products in support of numerous military and defense programs including applications in secure communications, radar systems and counter measures for improvised explosive devices.

Sales of our sensors and controls amounted to $4.5 million in the third quarter of fiscal 2009 down about $1.6 million from the same period a year ago. Shipments of these products supporting military and defense applications, particularly military aircraft, increased slightly during the current quarter. Sales of our custom position and temperature sensor products used in various commercial applications decreased by about $1.7 million compared to a year ago, once again reflecting poor commercial market conditions.

In the third quarter of fiscal 2009 our gross margin was $7.7 million or about 25% of sales compared to $8.6 million or 26% of sales for the same quarter last year. This slight decrease in gross margin percentage principally reflects the impact of lower sales volume and fixed manufacturing overhead. As a percentage of sales our material and labor costs remained virtually unchanged during the period. Aggregate material and labor costs were just over $11 million or about 35% of our total consolidated sales in the third quarter of fiscal 2009 compared to about $11.7 million or also 35% of sales for the comparable quarter of a year ago.

Our total manufacturing overhead was $12.6 million or 40% of sales in the current quarter versus $12.8 million or 39% of sales for the same period a year ago. At the end of the current period we had a total workforce of about 1,300 employees worldwide. That is down about 14% from the end of last fiscal year. We expect to continuously review our organization and cost structure to further enhance our efficiencies while still maintaining the flexibility we think we need for additional production requirements.

During the current quarter selling expense remained unchanged at $2.8 million or about 8% of sales, the same as a year ago. Total G&A expense was $1.8 million in the third quarter of fiscal 2009 as compared to about $2.2 million in the comparable period of fiscal 2008. This $400,000 decrease in G&A expense reflects a net gain of just over $500,000 representing the excess of insurance recoveries over the carrying value of certain assets that were destroyed by water and fire damage earlier this year at two of our manufacturing facilities.

Our effective income tax rate remains at 35% compared to an applicable federal and state statutory income tax rate of about 40%. That 5% difference between our effective tax rate and combined federal and state statutory tax rate principally reflects various state tax provisions, research activity tax credits we generate, U.S. domestic production activity deductions as well as differences in foreign income tax rates.

Net cash provided by operating activities in the first nine months of fiscal 2009 have amounted to a record $13.8 million. That includes $5.7 million generated just in the third quarter of fiscal 2009. This increased cash flow reflects improved accounts receivable and inventory turnover rates with accounts receivable and inventories decreasing by an aggregate of about $3.9 million during the first three quarters of fiscal 2009.

During the current year with our positive cash flow as well as our existing cash reserves, we have been able to repay $10 million under our domestic line of credit which reduces our total outstanding borrowings under our $35 million domestic credit facility to zero. We fully funded $2.9 million of capital expenditures during the first nine months of 2009. Of that $2.9 million for CapEx, $1.6 million of expenditures were made by our microwave components and systems business to support manufacturing expansion and improvements needed for growing production requirements within that business segment.

At the end of the third quarter fiscal 2009 our ratio of current assets to current liabilities was well over six to one. Our total stockholders’ equity has grown to about $111 million which brings a book value of $8.67 per share and our total borrowed funds were less than $1 million as of August 31 of this year. We continue to believe that it our very strong financial position will not only serve us well during the current economic environment but it will enable us to effectively finance our future acquisitions and expected organic growth.

For the first nine months of the current year our consolidated sales were $98.2 million. That is up about $1.4 million from the comparable period of 2008. Our gross margin has improved and our diluted earnings per share for the first nine months of this year was $0.50 per share, up 6% from the same period of last year.

Given the current economic environment and the challenges that it proposes, this year-to-date performance continues to far surpass the vast majority of our peers within the electronics industry.

With that said, Dick will now make some concluding comments.

Richard Southworth

Thanks Jack. As announced earlier this month, we received a $9.1 million contract for integrated microwave assemblies used in upgrades of fielded RCIED jammer systems. This contract which we originally expected to receive earlier in fiscal 2009 was temporarily delayed as a result of a protest filed by a competitor of our end customer. With this protest having been denied, product shipments under this contract are now expected to commence in December of 2009 and continue through mid-2011.

Based on the timing of the shipments along with the current assessment of business conditions and overall customer demand, we expect our 2009 fourth quarter sales to be in a range of $32.5 million to $33.5 million with earnings of $0.16 to $0.18 per share.

Beyond the fourth quarter of 2009 we remain very optimistic about the future of our company as we continue to strategically invest in the development of innovative new products and seek to consummate strategic business acquisitions coupled with the gradual rebound of our commercial markets.

At this point we would like to open the discussion for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Ted Kuntz – Needham & Company.

Ted Kuntz – Needham & Company

The revenues were a little bit light as you indicated and the guidance as a little bit lower than what we had modeled. Would you say that is exclusively, the timing issue is on the defense side but it sounds like the commercial business is very, very soft. Maybe you could just comment a bit more on the commercial business and what you are seeing and the outlook for that?

Richard Southworth

The commercial business is not getting any softer than it was in the second quarter but it is flat. We had expected some rebound going into the fourth quarter. We have not seen that yet. The softness that we see were in expected shipments for our defense segment and for products where we are sole sourced and the programs have just…the orders were just delayed for our third quarter shipment. Our product is actually all manufactured. We certainly expect to ship that in the fourth quarter.

Ted Kuntz – Needham & Company

Are you seeing any light at the end of the tunnel on commercial or are the lead times here very short and you will be okay without much advanced notice for pick up?

Richard Southworth

The lead time in the commercial markets are very short. We are still designing many new products and solutions for our customers, but we really expect that we will only see it in a few weeks of when their actual demand is and when they release the orders. We are not going to have a lot of visibility for when that change takes place.

Ted Kuntz – Needham & Company

Is that true both on the communications side as well as the medical side? Those are your two biggest sub sectors in that commercial space.

Richard Southworth

Actually the communications side we are seeing some indications of an uptick but the medical demand is still very flat.

Ted Kuntz – Needham & Company

Is it due to any kind of market share changes do you feel or is it just a flow through to the end markets?

Richard Southworth

It has nothing to do with market share or the loss of market share. In almost all of our applications we are sole on. It is just our end customer sales have been I guess very soft.

Ted Kuntz – Needham & Company

Hopefully that should start changing.

Richard Southworth

They should be going through their inventories.

Ted Kuntz – Needham & Company

That is the other question. How much inventory overhang do you think is out there with those customers?

Richard Southworth

The feedback we are getting is it is very depleted so we are expecting an upturn or the initial rebound at any time. I just don’t have enough visibility that I can really predict that right now what the timing is.

Ted Kuntz – Needham & Company

Turning to the military defense side, a nice win on the [inaudible] program. Do you have any sense of other, what is the momentum in that space? You had a good book to bill. You had good bookings in the quarter. Book to bills were above one for the quarter. Do you expect that to continue? Do you have any sense of what the fourth quarter could look like in terms of quarters?

Richard Southworth

From a book to bill standpoint we expect the fourth quarter to be positive again.

Ted Kuntz – Needham & Company

Is there anything coming down the pipe of any significant size or is it just going to be a lot of smaller orders?

Richard Southworth

I would say we are only expecting normal order rates or order sizes during the fourth quarter. There is a lot of good potential out there but we have none that we are really expecting until the early part of next year.

Ted Kuntz – Needham & Company

In terms of gross margin guidance here, what would you comment on there? It is obviously a function of volumes. I assume nothing else is happening in terms of gross margin impact other than the fact you have the adverse overhead, under utilization or something. Do you expect gross margins to kind of remain at these levels? With a little uptick in sales in the quarter would you see gross margin tend to head up a little bit or remain at these levels?

Jack Freeman

No, with the uptick in sales we would certainly expect some very nice incremental margins and improvement in the overall gross margin. You are right, our material and labor costs which are clearly variable costs, as a percentage of sales in this last quarter they were identical to what we had expected. They were actually marginally better than what we had realized in the preceding quarter. So it was all the absorption of manufacturing overhead that led to the overall gross margin to soften during the quarter. Just as we have that negative impact when revenues are below expectations, we would expect to get the complement of that as the revenue starts to increase a little bit so the gross margin percentage will increase as we can leverage some of that overhead with greater sales volume.

Ted Kuntz – Needham & Company

On the insurance claim, could you just review that one more time? All of that was booked as a gain and reduced the SG&A line?

Jack Freeman

That is correct. There were two entirely separate events that occurred. Earlier in the year back in January we had received a partial advance on the insurance claims but we deferred any recognition of income or expense pending the final resolution and final settlement of the claims which occurred during the third quarter. In round numbers we received in total about $1.3 million of insurance recoveries and we had the book value of the assets that were destroyed along with the costs associated with some clean up and some business interruption was about a round number of $800,000. So there was about a $500,000 pre-tax, about $346,000 after tax, but the $500,000 pre-tax shows up really as a reduction within our SG&A expense for the quarter.

Ted Kuntz – Needham & Company

So that SG&A line was really up to $5.1 million?

Jack Freeman

Without that, that is right. That would have been right in line with our expectations.

Ted Kuntz – Needham & Company

So that is kind of the run rate we are running at here?

Jack Freeman

That is right. Our total SG&A expense we would expect to run between 15-15.5% of sales which given a $33 million quarter that means about $5 million of SG&A. That is very much in line with our plan.

Ted Kuntz – Needham & Company

It looks like you will be generating cash going forward as well. It is nice to see you expect to continue to generate cash.

Jack Freeman

Absolutely. We have had excellent generation of cash for the first nine months of this year that has enabled us to become virtually become totally debt free. We repaid $10 million on our line of credit which really positions us well with having virtually no debt we think we are in a very strong position to take on hopefully some strategic acquisitions as Dick indicated in the future and be in a very strong position to assume more and incur some debt as part of that. We do expect to continue to generate positive cash flow. We think part of that will be from overall profitability. The other is we think we can continue to make strides and improvements in controlling our working capital requirements and receivables and inventory.

Ted Kuntz – Needham & Company

That would be a priority, the acquisitions as opposed to a stock buyback or anything?

Jack Freeman

Clearly at this point, as you know, we still have maintained and have an active or open stock buyback program but we are hopeful and expect there is going to be some sufficient acquisition opportunities so that we are trying to conserve some of that cash and borrowing capability because if we can’t find those right one or more strategic acquisitions we think in the long run that will generate a better return for the shareholders than a current buyback.

Operator

The next question comes from the line of Chris McDonald – Kennedy Capital Management.

Chris McDonald – Kennedy Capital Management

I wanted to ask about the microwave area because it seems like you are seeing solid growth prospects there. Can you just talk a little bit about product applications that might be driving the need for you to expand in that area?

Richard Southworth

Probably our single greatest growth area is in our integrated assembly or really a lot of different applications. These are the higher end products that are in the $10,000 to $50,000 range. It is for applications for surveillance. Basically it is all military of some sort.

Chris McDonald – Kennedy Capital Management

Can you talk about margins from a product mix perspective? I know volume tends to be the biggest drive of the gross margin but you have certainly a lot of incremental business with the IED jammer area going forward here. Wondering if that will have any noticeable impact or drive on the margins?

Jack Freeman

Generally there is not a great deal of disparity among our four businesses in margins. Historically our advanced specialty products and our microwave products have had slightly better margins than our other two businesses but that is largely because it is based on those are our two largest business segments and their ability to leverage some of their own overhead. In general there is not a significant mix impact among our four businesses.

Operator

There are no further questions in queue. I would like to turn the call back over to management for closing remarks.

Richard Southworth

We thank you for joining us today. We will conclude this conference call. Thank you.

Operator

This concludes the teleconference. You may disconnect your lines. Thank you for your participation.

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