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Flow International (NASDAQ:FLOW)

Q1 2014 Earnings Call

September 09, 2013 5:00 pm ET

Executives

John S. Leness - General Counsel and Secretary

Charles M. Brown - Chief Executive Officer, President and Director

Allen M. Hsieh - Chief Financial Officer, Principal Accounting Officer and Vice President

Analysts

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Flow International Fiscal 2014 First Quarter Financial Results Conference Call. [Operator Instructions] This conference is being recorded today, Monday, September 9, 2013. I would now like to turn the conference over to Mr. John Leness with Flow International. Please go ahead, sir.

John S. Leness

Thank you. I'm Flow's Secretary and General Counsel. With me this afternoon are Charley Brown, Flow's President and CEO; and Allen Hsieh, Chief Financial Officer.

This call will include forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. During the call, we will discuss selected financial results. Any statements about future results, including trends, risks and plans should be considered as forward-looking. These are based on current expectations only. Actual results may differ from these forward-looking statements and are subject to risks and uncertainties as are detailed in our filings with the Securities and Exchange Commission. Flow takes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

I will now turn the call over to Charley.

Charles M. Brown

Thank you for joining us today for our discussion of Flow's results for the first quarter of fiscal year 2014. Before we discuss the results, I will comment briefly on our process for investigating strategic alternatives. We are very pleased with our progress to date, which is tracking well for the timeline we have set for ourselves. Given the timing of our process, we have delayed our Annual Shareholders' Meeting to a future date to be determined. Other than that, we are not going to provide further updates or field questions on this topic today.

For the quarter, our revenue was $59 million with $2.5 million of operating income excluding the onetime charges we discussed on our last call. These charges, which totaled $1.6 million, relate to 3 items. One, our cost reduction efforts, which were primarily severance. Two, professional fees related to the finalization of our investigation in Brazil. And three, our continued evaluation of strategic alternatives. Reported operating income, including those charges, was $935,000. Both revenues and operating income were in line with our expectations. Also for the quarter, we incurred foreign currency adjustments to other income or expense totaling $1.5 million, also negatively impacting our results.

This $1.5 million charge, combined with the $1.6 million of onetime expenses, led to a reported net loss of $845,000 or $0.02 per share.

Now turning to revenues. For the quarter, Advanced segment revenue of $8.3 million was up over 20% sequentially from the fourth quarter and up almost 100% compared to the prior year. This revenue level reflects working through with the orders we took several quarters ago according to the plans and schedules for those projects.

Overall Standard segment revenues were $50.7 million for the quarter. Within that segment, we had Spares revenue of $21.3 million, up 5% sequentially from Q4. Compared to the prior year quarter, Spares revenues were down 4%. However, you may recall that we ran a Spare Parts promotion in the first half of the year in fiscal 2013. Excluding the incremental revenues from that promotion in Q1 last year, spares revenues were essentially flat year-over-year.

Standard Systems revenue was just under $30 million for the quarter, down sequentially from Q4 by 5% and down 27% compared to the prior year. While order patterns around the world have been lower than we prefer, they appeared to have first stabilized then modestly increased. In fact, during the quarter, we saw an increase in revenues sequentially from Q4 in North America. This trend has continued with recent orders showing some green shoots that we believe will bode well for the coming quarters this year. We anticipate this improvement to begin next quarter when we expect revenue to increase by as much as 5% sequentially to the $60 million to $62 million range, after 2 quarters in the $58 million to $59 million range. I will now turn it over to Allen to discuss the details of our first quarter financial results and outlook for the upcoming second quarter.

Allen M. Hsieh

Thanks, Charley. As we have discussed on our last 2 calls, we have recently experienced uneven order patterns towards the beginning of Q4 of FY '13. More recently, our order patterns have either stabilized or started to improve depending on the geographic region. As such, I will limit my discussion to sequential comparisons as they are more relevant.

For the quarter, we reported operating income of $935,000. This compares to an operating loss of $315,000 in Q4. We incurred nonrecurring costs in both quarters, $1.6 million in Q1, $1.1 million in Q4. These costs include severance charges related to our cost reduction efforts and costs related to our evaluation of strategic alternatives and inventory charges and investigation fees related to our Brazilian operations. Excluding those nonrecurring costs in both quarters, operating income would have been approximately $2.5 million or 4.3% of sales in Q1 compared to $800,000 or 1.4% of sales in Q4. At similar level -- at similar revenue levels, this 3-point lift in pro forma operating margins demonstrates that our cost reduction initiatives have started to positively impact our income statement.

We also reported a net loss of $845,000 or $0.02 per share in Q1, which includes both the $1.6 million of onetime expenses and the foreign currency adjustments to our other income/expenses, totaling $1.5 million. This compares to net loss of $1.9 million or $0.04 per share in Q4.

For the quarter, we generated EBITDA of $3 million as compared to EBITDA of $1.9 million in the fourth quarter. Absent the onetime charges, EBITDA was $4.6 million and $3 million for the Q1 and Q4, respectively.

Now for the details. Starting with our segments, standard gross profit margins of 38.4% in the quarter were up compared to 37.6% in Q4. The improvement from Q4 to Q1 is primarily due to inventory charges that we recorded in Q4 related to our Brazilian operations and to a lesser extent, improvements in our gross margins from our new products. As a reminder, last quarter, we discussed that gross margins from our new products are 10 points below our normal fleet margins. We have put in place productivity programs to bring those margins back in line by the end of this fiscal year. We're very pleased with the progress being made on this front.

Our Advanced segment gross profit margin of 25.8% was consistent with both Q4 gross margin and our expectations of future gross profit margins of 25% plus or minus a few points. On an aggregate basis, total gross margins just under 37% were below our stated range of 40% plus or minus 2 points. We anticipate returning to those levels by the end of the year as we improve the gross profit margin on our new products.

Total operating expenses in the aggregate and including all onetime items I just mentioned, were $20.7 million in this quarter as compared to $21.4 million in the fourth quarter. On our last call, we announced that we have put plans in place to lower our operating expenses by approximately $9 million on an annualized basis. Anticipating that they would start to materialize in Q1 with savings of approximately $1 million, ramping up to the full rate by the end of the fiscal year. Excluding the impact of the nonrecurring charges in both quarters, operating expenses decreased from $21 million in Q4 to $19.1 million in Q1 mostly due to our cost-saving initiatives and to a lesser extent, timing of projects. Overall, we are ahead of schedule in achieving our cost reduction initiatives.

For the current quarter, we had net other expense of $1.9 million, up compared to $840,000 in Q4. Net other expenses are primarily comprised of interest expense and foreign currency adjustments, partially offset by interest income. The comparative differences were primarily from the impact of foreign currency adjustments of $1.5 million in the quarter that I have previously mentioned as compared to $362,000 in Q4.

For the quarter, we recorded a tax benefit of $121,000. The effective tax rate for the quarter was not consistent with our normal rate due to having losses in foreign jurisdictions where the tax benefits could not be recognized. Keep in mind that since we have significant amount of NOLs in both U.S. and in Germany, 2 of our more significant markets, our cash taxes are expected to be less than our normal effective tax rate.

Now to the balance sheet. At the end of the quarter, our net cash position, including our subordinated notes, was $2.6 million with no outstanding balance on our credit facility. Our net cash position was down compared to the end of last year, primarily due to the timing of collections on our receivables and payments to vendors. In August, we repaid a $10.8 million subordinated notes including interest. We utilized our existing $40 million credit facility to repay that balance. Going forward, we anticipate paying down that credit facility through available cash generated from operations.

At the end of the quarter, net accounts receivables were $46.5 million, up compared to $42.7 million at the end of the last year. The increase was primarily due to timing of sales recognition, mostly related to our Advanced segment, where we recognized significantly more revenue in the quarter. We have not experienced any deterioration in the quality of our receivables or the aging of outstanding balances.

Inventory at the end of the quarter was $41.8 million, in line with the balance at the end of last year. Capital expenditures for the quarter were $1.5 million, consistent with our expected range of $6 million to $8 million on an annual basis. The majority of our capital expenditures continue to be for upgrading manufacturing equipment, subsequent phases of our ERP system and investments in our intellectual property. At the end of the year -- sorry, at the end of the quarter, our Advanced segment backlog was $22.7 million, down from $30.7 million at the end of last year. The decrease is consistent with revenue earned in the current quarter.

Now turning to our near-term outlook. As Charley mentioned, we anticipate that Q2 revenues will be up by as much as 5% compared to Q1 levels, in the $60 million to $62 million range. We expect gross margins to fall within our previously stated range of 40% plus or minus 2 points, but at the lower end of the range as we await the roll through productivity improvements with our new products. Excluding costs related to the valuation of our strategic alternatives, we anticipate operating income to be in the $3.5 million range plus or minus 10%. We also anticipate returning to more normalized tax rate of 40% in Q2. With that, I will turn the call back to Charley.

Charles M. Brown

As I mentioned a moment ago, we are seeing early signs of improvement in orders. This is occurring in the U.S. as well as a variety of international markets. Broader market trends that we all watch also seemed to foreshadow improving revenue patterns. For example, purchasing managers surveys in the U.S. and key parts of Europe have been moving upward for several months now. Net, we experienced a temporary drop, which has stabilized and we now feel cautiously optimistic regarding the revenue outlook. As you know, our response to the lower revenue for the past 2 quarters was our announcement in June that we are removing $13 million out of our cost structure, representing more than 100% of our prior year operating income and achieving this by Q4 of this fiscal year. In the 3 months since that announcement, we have aggressively moved forward with this plan. $9 million of the $13 million came from operating expenses. Of that amount, we had anticipated about $1 million reading through in Q1 or a $4 million annualized rate. The actual read through was 25% higher than planned, about $1.25 million in the quarter, representing more than a $5 million run rate. We are confident the remainder will be realized this fiscal year, reaching the full run rate in Q4.

Beyond the $9 million of operating expense reductions, the remaining $4 million was targeted at our new products cost of goods. We have now successfully identified and executed that entire amount internally. It will take a couple of quarters to fully read through to the income statement as we work through inventories. Meanwhile, we continue to find additional opportunities that should further improve profitability beyond that timeframe.

We are very pleased with the speed of execution we have achieved on the $13 million of cost reductions. If you add up the pieces I just described, it all means that at this point, 1/4 of the way into the year, 2/3 of the $13 million in reductions are already, "In the bag". Meaning their execution is complete. This represents an important and appropriate response to the revenue softness we have experienced in the past 6 months. This new, lower cost base, positions us well as revenue begins to grow again.

In summary, we have reacted aggressively to a temporary dip in demand by reducing our cost structure and it appears that revenue has turned the corner with our projection for up to 5% sequential growth in Q2.

If there's any questions, we'll now be glad to address them. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Eric Stine with Craig-Hallum.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Can I just clarify a comment you made earlier on? Did you say that North America was actually up sequentially in this first quarter?

Charles M. Brown

Yes.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Okay. And then you've done this in the past, I'm just wondering if you're willing to just talk about what is going on in the other regions, maybe just to help us out -- help us out there on the outlook.

Charles M. Brown

Comment briefly on that, Eric, in the interest of competitiveness, we don't want to say too much, especially in an environment that we're in. But we have seen as we said, North America solidify and dip upwards a little bit. And then also I would point to Asia, where we've seen some renewed firming up of the order pattern there. And that's not to say other places that are notoriously weak, but I'd have to point to 2 of the 4 geographies that probably would be the 2 that I would look at.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Okay. Maybe just sticking with North America. I mean, any clarity you can give into where you're seeing that recovery? I mean, first of all, when you saw the weakness, I mean was it low end, high-end or pretty broad-based and where are you seeing things come back as kind of a first indicator?

Charles M. Brown

What we've seen is consistent as in our markets over the years as they tend to dip up or down, or come up a little bit that is generally based on overall confidence levels. And therefore, what we tend to see is that there's not 1 or 2 single areas that are stronger or weaker as it leads to the change up or down. And that's pretty much what we've been seeing this time around, although this time around again, it was relatively shallow compared to the Great Recession and relatively short compared to that timeframe as well. But overall, I wouldn't say it's more driven by general attitude and market perspective and psychology, more than 1 market or 1 end market or 1 segment or 1 price point standing out in one direction or the other.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Okay, that is helpful. Maybe just turning to the Spares. I am just curious what this level tells you about utilization in the field and maybe how fast or slow you think the market could come back as the recovery takes hold?

Charles M. Brown

Sure. We went from a -- sort of a sequential single-digit consistent growth rate, so pulling back from that a little bit. And what that tells us is that there was just a bit of a breather for 4 to 6 months in overall, probably utilization. Well -- and I think that was publicly available information, which showed that as well. So that utilization rate was climbing a little bit at a time that it went flat, maybe pulled off a little bit fairly consistent with what we saw. So as we see that firming up, that would indicate we would expect those public reports would also firm up and maybe even tick up a little bit as well.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Okay. You mean as far as going forward, you expect just kind of typical seasonality?

Charles M. Brown

I would say that we feel based on our recent order pattern in the U.S. that the orders have picked back up a little bit. And so we would expect a little bit coming back to the growth rate rather than sort of a steady as she goes flat rate in the North American market for our Spares.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Okay. Maybe just last one for me, just an update on where you stand on the new product launches in international markets.

Charles M. Brown

We've -- we are selling the new products around the world now, and we are talking with customers, working with customers and taking orders in all major markets around the world. As you know, we first launched those products in the North American markets, so we have a longer running path, if you will, starting point was much earlier in North America. So the international markets lag the North American market, but we are now moving forward and should see that as one of the things that could drive our growth as well going forward is the additional penetration available from fully selling and then having the order cycle complete itself to be able to deliver product in international markets from our new products.

Operator

Thank you. There are no further questions at this time. Ladies and gentlemen, this concludes the Flow International Fiscal 2014 First Quarter Financial Results Conference Call. If you'd like to listen to a replay of today's conference, please dial (303) 590-3030 or 1 (800) 406-7325, with the access code 4637943. We thank you for your participation. And at this time, you may now disconnect.

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