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Pulse Electronics Corporation (NYSE:PULS)

Q3 2013 Results Earnings Call

November 5, 2013 5:00 PM ET

Executives

Jim Butler - Senior Director, Finance

Ralph Faison - Chairman, President and CEO

Drew Moyer - Chief Financial Officer

Mike Bond - Vice President, Finance and Treasurer

Alan Benjamin - Chief Operating Officer

Analysts

Marco Rodriguez - Stonegate Securities

Operator

Good afternoon, everyone. And welcome to the Pulse Electronics’ Third Quarter 2013 Financial Results Conference Call. All participants will be in a listen-only mode. (Operator Instructions)

Please note that today's event is being recorded and there will be an opportunity for you to ask questions at the end of today’s presentation. At this time, I’d like to turn the conference call over to Mr. Jim Butler, Senior Director of Finance. Sir, please go ahead.

Jim Butler

Thank you, Jamie. I’m Jim Butler, Senior Director of Finance for Pulse Electronics Corporation. With me today are Ralph Faison, our Chairman, President and Chief Executive Officer; Drew Moyer, our Chief Financial Officer; Mike Bond, our Vice President of Finance and Treasurer who will be replacing Drew as CFO later this week; and Alan Benjamin, our Chief Operating Officer. This afternoon we will discuss our results for the third quarter of 2013 and provide our outlook for the fourth quarter.

Before we begin our presentation, let me take care of four administrative items. First, we will use a slide presentation to accompany our prepared remarks. A PDF of the slides has been posted to our website.

Second, this call is being webcast and a replay will be available on our website for two weeks.

Third, we will make statements considered forward-looking within the meaning of federal securities laws. These statements are based on our current knowledge and expectations and are subject to certain risks and uncertainties that may cause actual results to differ materially from the forward-looking statements.

For a discussion of such risks and uncertainties see the disclosures, including the Risk Factor section in our most recent 10-K, as well as in certain of our other SEC filings. We also encourage you to review our 10-Q for this quarter when filed. The company undertakes no obligation to revise or update any forward-looking statement.

Fourth, management's comments and the accompanying slide presentation should be read in conjunction with the third quarter earnings press release we issued this afternoon. The press release contains our financial results according to U.S. Generally Accepted Accounting Principles.

In this call, all references to operating profit or loss and diluted earnings or loss per share are on a non-GAAP basis. These non-GAAP measures exclude severance, impairment and associated costs, non-cash stock-based compensation expense, debt restructuring and related costs and legal reserves and applicable periods. For a reconciliation to U.S. GAAP results and a rationale for our usage of non-GAAP measures, see slides 19 and 20 in our presentation.

Now I’ll turn the call to Ralph.

Ralph Faison

Thank you, Jim, and thank you everyone for joining the call. Before I start with the formal part, I want to -- Jim mentioned that we announced earlier that Drew would be leading us, so Drew Moyer who has been with us for quite some time now moves back to the East Coast to be closer to his family.

We really want to thank him for his long years of service and particularly the time that he spent to almost three years now here in San Diego since we moved headquarters, commuting back and forth, and sacrificing his personal family time to help continue to improve Pulse. So we thank you.

We welcome Mike Bond who as the new CFO. I guess his official start is tomorrow. So we appreciate Mike for stepping into that position. Mike has been with us for a couple of years and guiding us through a lot of refinancing and as the Head of Treasury.

So, turning to the quarter, if you turn to slide three, you’ll see that we had sales of $98.4 -- $94.8 million, which was well within our guidance. You see that we produced non-GAAP operating profit about $3.6 million, again which is well within our guidance.

This was driven by nice growth in our wireless revenue and continuing improvement in operating results. And then if you look at network and power, still in a muted demand market, I’ll call the sales which Drew will cover in more detail momentarily, relatively flat, but operating profit continually improving there due to driving continued efficiency associated with factory consolidation, as well as just performance efficiencies of the manufacturing operations there.

This was our fourth consecutive quarterly increase in EBITDA to $5.4 million. So that’s -- of the six -- last seven quarters that six sequential quarters of improvement in EBITDA. And $5.4 -- over $5 million as we mentioned before is somewhat of a milestone for us to get back to a point as you will see in this quarter where we put a little cash back the balance sheet which Drew will cover momentarily.

Last comment I’ll make before I turn it over to Drew for a little more in-depth financial review is our ERP implementation that we started couple of years ago and was part of our major strategic initiative, I will turn around to Paul for substantial complete now.

There are a couple of small locations we still need to cut over but most of the major systems at all major locations are done and I really want thank the entire group of Pulse folks who have worked very, very hard.

ERP implementations especially at the complex international basis that Pulse operates under are never easy and this team has worked tirelessly and produced what I would consider almost a flawless implementation over this period of time. So we are very, very pleased with what has occurred.

And I guess I’d call out specifically to the ERP team that has spent the best part of the last two years without vacation and plenty of time working on this to make sure that we had an appropriate implementation.

So, with that, I’ll turn it over to Drew for a little deeper review of the financials.

Drew Moyer

Okay. Thanks Ralph. I’ll begin on slide five with net sales. Net sales, as Ralph mentioned, were $94.8 million in the third quarter, up 7.5%, compared to $88.2 million in the prior year quarter and also up 7.5% from the second quarter. This performance was mainly driven by higher revenue in the wireless segment as we experienced increased demand from customer smartphone programs on which we participate.

The network and power segments were down slightly or as Ralph said effectively even down just slightly as market conditions in those two segments remain muted. Sequentially wireless demand again drove most of the increase, as well as some accelerated orders in the network segment or product subject to the Halo injunction.

Please turn to slide six and I will review gross profit margin. Cost of goods sold increased 2.7% to $73.2 million in the quarter from $71.3 million in the prior year quarter. Gross margin was 22.8% in the quarter, compared with 19.2% in the prior year quarter.

This significant improvement in gross margin reflects improving wireless operations, the favorable effects of manufacturing plant consolidations and other cost reductions programs we have taken over the last two years and their resulting operational efficiencies.

Compared to the second quarter, gross profit margin decreased slightly, mainly due to the increased mix of wireless revenue and implementation of the second portion of government mandated wage increases at our facilities in China following the initial wage increases of 2013 that we discussed in the second quarter.

Now, let’s move to operating expenses which are covered on slide seven. Operating expenses were essentially flat compared to the third quarter of 2012, which included a non-recurring $1 million favorable impact of an intellectual property licensing agreement. Without that item operating expenses decreased 3.5% from the prior year.

Sequentially operating expenses decreased 3.1% due to ongoing expense controls, including the expense reduction initiative we announced last quarter, as well as lower compensation expense. As a percentage of net sales, operating expenses were 19.4% in the quarter.

Now moving to slide eight. Our non-GAAP operating profit was $3.6 million in the quarter, compared to a loss of $0.6 million in the prior year quarter, reflecting our continuing trend of improving financial performance.

The improvement mainly reflects higher overall gross margins and improved wireless operations. Our non-GAAP operating profit margin was 3.8%, compared to 2.5% in the second quarter and a loss in the prior year quarter.

Slide nine shows our quarterly adjusted EBITDA and our EBITDA margin as a percent of sales from 2012 to the present. We continue to see the results of our strategic initiatives and improving financial performance and as Ralph mentioned this was our fourth consecutive quarterly increase in EBITDA.

The $5.5 million of adjusted EBITDA we achieved this quarter was a milestone because we believe it represents our level of cash generation that provides sufficient funding to allow adequate investment for future growth initiatives, automation and further operational improvements.

The trend also confirms that our efforts to improve the overall performance of the wireless business, improve manufacturing performance through plant consolidations and reduce operating expenses have clearly led to a significant reduction in the company’s breakeven point and its ability to generate favorable financial results in the current revenue environment. We believe these improvements are permanents and any pick up in revenue growth should have a very good favorable impact on operating profit in EBITDA performance.

With that review of our consolidated results, let me provide a review of the performance of our three segments starting with network on Slide 10. Network sales were $39.5 million in the third quarter compared with $39.9 million in the prior year quarter as muted industry demand continued.

Operating profit of $1.7 million in the quarter declined from $2.5 million in the prior year quarter mainly due to the one-time favorable IP licensing agreement in the third quarter of 2012 that I mentioned previously. Without that item, the segment's financial performance was driven by improved gross margins, including plant consolidation and migration to lower cost Western China, somewhat offset by the unfavorable pressure of rising wage rates in China. Sequentially network operating profit increased mainly due to favorable product mix and our ongoing cost reduction programs.

Power is on Slide 11. Power net sales were $28.1 million in the third quarter compared with $28.9 million in the prior year quarter and down sequentially from $29.6 million in the second quarter. The decline from last year reflects the ongoing challenges across the industry including lower government and military spending and lower pricing for certain products.

Operating profit however was $2.2 million in the quarter compared with $0.7 million in the prior year quarter and $1.9 million in the second quarter, mainly due to favorable effects of migration of manufacturing to lower cost Western China and improved efficiencies.

Turn to Slide 12 and I’ll review Wireless. Wireless net sales were $27.3 million in the third quarter compared to $19.4 million in the prior year quarter and $20.3 million in the second quarter. The higher volume in the third quarter reflects increased demand in certain customers’ smartphone programs.

The operating loss of $0.7 million in the quarter compared with a loss of $4.3 million in the prior year quarter and a loss of $1.1 million in the second quarter. The lower loss in this quarter reflects higher volume and the continued progress in improving our wireless manufacturing operations.

With that review of our segments, if you turn now to Slide 13, I’ll briefly cover the balance sheet. We had $25.6 million of cash and cash equivalents at September 27, 2013 compared with $31.5 million at December 28, 2012. The decrease in cash reflects refinancing transaction fees, capital expenditures and working capital needs. In the third quarter, we generated approximately $5.8 million in cash flow from operations and increased our overall cash balance from the second quarter by $2.4 million.

More information on our cash flow for 2013 will be contained in the 10-Q which we will file this week. The total principal of the Oaktree term loans increased to approximately $114.1 million as a result of the addition of the payment-in-kind interest.

Please turn to Slide 14, now regarding our convertible bonds. We currently have $22.3 million of outstanding senior convertible notes that are due in December 2014. Given the company’s continuing efforts in improving its financial position, we have a strong desire to retire them before maturity to reduce our debt and cash interest expense and bring clarity to the capital structure.

We believe we have a number of options regarding the retirements of the bonds prior to maturity, including public and/or private exchange offers. We are actively pursuing these options with the goal of achieving the best possible outcome for all stakeholders.

With that review of third quarter financial performance, I’ll now turn the call back over to Ralph.

Ralph Faison

Thank you, Drew. I will cover now, if you turn to Slide 16, outlook for fourth quarter. I can tell you we are not terribly excited on the demand environment there. We have a continued muted environment for acquisition network and power unit. Some of the other key areas government military spending has some uncertainty.

And now on the wireless side, the velocity of customer smartphone ramps do vary from customer to customer. So on the demand side, not terribly excited, cost and expense reductions continue in their efforts that we announced last quarter and we’ll see continued reductions there to offset margin and weaknesses associated with volume.

So with that, net sales, we expect on a consolidated basis to range from $86 million to $92 million and reflecting the continued expense reductions and efficiencies we have been gaining from manufacturing. We’ll hold the operating profit guidance similar to last quarter at $2 million to $4 million even on that reduced revenue.

So if you turn to last Slide #17. This is a quick summary, Q3 revenue and non-GAAP operating profit was well within guidance. We feel we met a bit of a milestone EBITDA at $5 million that’s the fourth consecutive quarterly increase as we mentioned earlier. And we continue to pursue multiple paths to resolve our convertible bonds.

And with that, Jamie, we’ll turn the call over for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Marco Rodriguez from Stonegate Securities. Please go ahead with your question.

Marco Rodriguez - Stonegate Securities

Good afternoon. Thank you for taking my questions.

Ralph Faison

Sure. Hi Marco.

Marco Rodriguez - Stonegate Securities

Hi. I was wondering if we can first talk a little bit about the wireless business at a rather large substantial -- sequential increase there from a revenue standpoint, can you provide maybe some additional color on what drove that?

Drew Moyer

Yes, as you know Marco, most of what we focus on in the wireless side split between a consumer focus and in infrastructure focus. The consumer side was the primary incremental growth from Q2 to Q3 and in smartphone projects, we’re engaged in. So as the number of customers we work across always depending upon their forecast in this quarter, many of those projects performed closer to forecast and they have in previous quarter, therefore we saw that $27 million kind of hit the run rate.

Marco Rodriguez - Stonegate Securities

Okay. So it was more of the smartphone market across all of your customers kind of hitting their estimate not necessarily particular strength in one or two?

Ralph Faison

I would see -- I wouldn’t get that specific to say all, I would say that several hit where we wanted them to hit, one of these quarters, all of them were hit that will be a great quarter but this particular quarter more hit than not, may be I’ll categorize it that way.

Marco Rodriguez - Stonegate Securities

Got it. Okay. That’s helpful. And then in terms of that segment there, operating breakeven, it kind of looks like just where you are right now from an operational standpoint that $28 million revenue run rate is a fair assumption for breakeven for that business?

Ralph Faison

You know Marco, it does depend largely on mix, both mix of product type and mix of different customer projects. And depending upon the content we have with a particular customer. So mix can vary that, so I would lock it in, specifically at the 28. I would tell you a range of 25 to 28 could easily be a breakeven depending upon mix of product.

And it’s just a function of which projects come through and what the complexity of content we have with a particular project. A smartphone may have one antenna that we work on versus another smartphone may have several or a complex module assembly and it just depends, obviously the more complex the more margin contribution because of the value add that we do would hit there.

Marco Rodriguez - Stonegate Securities

Okay. Fair enough. And in terms of your expectations, I heard the commentary in terms of the sequential decline from a seasonality standpoint, are you expecting anything different on the wireless side from a seasonal standpoint, passing the trend?

Ralph Faison

Yeah, I think we’re seeing -- while wireless still has more growth in our traditional power and network side, we are seeing a little variability amongst forecast of customer. So, I expect maybe a little more volatility amongst our smartphone customers, a little more dispersion from one doing very well and the others maybe not so, that we saw in third quarter, maybe a little more exaggerated for us, being a little less revenue there. But in general, the mix still could swing favorably for us that we’ll just have to watch how that plays.

Marco Rodriguez - Stonegate Securities

Got it. And in terms of the overall every gross margins had a slight decline about 70 basis points sequentially and you talked about it being because of the mix on wireless and wage increases in China, can you kind of -- can you quantify how much was the wage increase?

Ralph Faison

I don’t know if we have that for breaking that out specifically. I’ll just try to attribute to those two areas. Obviously, wireless, as it continues to improve we expect it to be more of an equivalent player within the mix of three segments over time. But for now as it continues to improve it will be a bit diluted to the overall margin performance. So that is just mix increases relative to the other, we will see a little pressure there.

And then the wage increases as we talked before, we expected about 20% per year in wage increases in China. We saw that last year, we expected this year and probably expect that over the next couple of years in the future given China’s directive in there I guess what I called their grand plan.

And what we saw this year was at least the [separate] effect between second and third quarter being able to take some of that in second quarter and the remainder in third and that was pretty much what hit the quarter.

Marco Rodriguez - Stonegate Securities

Got it. Perfect. And then in terms of your operational expenses, the ERP implementation I think you said in the prepared remarks that it was pretty much down by October. Did you see the vast majority of that reflect in your operational expenses, or should we see something more in Q4?

Ralph Faison

Well, here is I would talk about that, in terms of implementation expenses, adding two operating expenses we don’t see much of that impact in terms of the implementation. Having done a number of lease types implementations over my career, I expect to start seeing efficiency somewhere in the six to nine months period of time after the full implementation of our system, a new ERP system, that’s more training time, learning times, skill time and utilization time so that you can drive the human factors efficiency that some of the new ERP systems afford us.

So, cautiously optimistic the implementations have gone well, nice to see the vast majority of it behind us and expect over the next six to nine months to see further efficiency gains. A part of this we reflected in our, let’s see second quarter announcement of $6 million operating expense reduction. A portion of that $6 million was a reflection of the anticipated efficiency gains associated with SAP. But I expect again, over a six to nine months period you’ll see incremental operating efficiencies associated with that.

Marco Rodriguez - Stonegate Securities

Got it. And two real quick house-keeping items here. In terms of your guidance for operating income next quarter, what are the assumption for D&A and stock comp in there?

Drew Moyer

The stock comp is usually about $300,000 to $400,000 a quarter.

Ralph Faison

And I would expect that to be about the same.

Drew Moyer

And then the depreciation and amortization should be pretty consistent. We are -- I was going to add it. Ralph just said on the ERP implementation. To the extent, we have had cost not capitalized and hitting the P&L, things like training and some of those implementation costs.

They are going to be winding down, are not as substantial as they have been. But on the other hand, we will have a little more depreciation coming into the P&L should be depreciating the cost of the project that we capitalized. So, I think for the quarter we have depreciation and amortization of about $1.8 million and that was the number for the third quarter. It shouldn’t be a whole lot different, might tick up just a hair in the next quarter or two.

Marco Rodriguez - Stonegate Securities

Perfect. And lastly you guys mentioned there was some accelerated revenue I believe in the network segment, can you quantify that amount of that revenues?

Drew Moyer

Well, we referred -- I referred briefly to the Halo injunction and a little bit of advance ordering. We had the injunction and then we had to stay at the injunction which expired in -- on October 15. So particularly in the latter part of the quarter, we saw a little heavier ordering and taking of parts, while the injunction was under stay. But I wouldn’t say, I mean, I guess, I could see low seven figures in terms of revenue impact for the quarter.

Marco Rodriguez - Stonegate Securities

Got it. Thank you guys.

Ralph Faison

All right. Thank you very much Marco.

Operator

(Operator Instructions) And our next question comes from [Mark McCain] from (inaudible). Please go ahead with your question.

Unidentified Analyst

Yes. Hey, thanks for taking my questions.

Ralph Faison

Sure.

Unidentified Analyst

What happen with the original exchange offer that you guys had mapped out a while back with reflect to the balance of the converts?

Ralph Faison

Yes, about a year ago when we did the Oaktree transaction in the refinancing of our senior debt and the portion of our convertible bonds that Oaktree had owned, we did have a contemplated exchange offer that was listed within that transaction. That offer was subject to agreement between us and Oaktree as of June 30th. As we announced -- let say, I believe the last quarter for the second quarter, we said we had not yet come to agreement, we were still in the process of having that conversation.

Subsequent to that, we’re continuing to work through that as Drew mentioned, wide open to both public and private resolution and early resolution of the -- with bond holders. So we are in that profit now and we’ll continue down the path. I probably won’t go to any more detail than that but contacting via privately and/or publicly through continued efforts to retire those bonds.

Unidentified Analyst

Great. And how much equity have you issued to Oaktree today?

Ralph Faison

Oaktree today, if you look at where they are, if I were to -- just in terms of percentage, they earned about 49% of the outstanding common shares today. They have an additional preferred share that if on a fully executed basis and converted to full of comment, we would expect Oaktree to own around 60 -- don’t know how many exactly to the percentage, 67%, 67 and change percentage of Pulse.

Unidentified Analyst

And then the -- I think there was some discussion in your Q last quarter. The term loans that were issued to Oaktree, are those still subject to forbearance agreements with respect to not meeting certain convenants?

Drew Moyer

Yes, throughout 2013.

Unidentified Analyst

Okay, so have to go back to them end of this year to renegotiate before that.

Drew Moyer

I wouldn’t make that assumption. We don’t -- I don’t see addition of that at this point in time. We did forbearance for 2013, wouldn’t necessary making any comment on whether we’ll do that going forward or not.

Unidentified Analyst

But I guess if you are -- I guess if you are not in compliance and you need to get forbearance for that fair function.

Ralph Faison

Yeah, that’s true. But I guess as we sit here today, we’re in compliance with all the covenants and expect to remain in compliant with the covenants, not with the forbearance that you negotiated.

Unidentified Analyst

So you are in compliance with the covenants under the term loans at this point?

Ralph Faison

Yeah.

Drew Moyer

Yes.

Unidentified Analyst

Okay. So there is no need for the forbearance agreement anymore or--

Ralph Faison

Thus far in 2013, there has been no need for the forbearance agreement.

Unidentified Analyst

Okay. So, I guess, I was just trying to understand, but they were put in place at a time when you needed them.

Ralph Faison

They were put in place in anticipation basically to ensure that we wouldn’t have any concern for the marketplace. Given the fact that we’re coming off some pretty difficult years, this year has certainly turned out to be a much improved financial performance than previous years. Coming into the year, we just learned to be sure that we didn’t make anybody nervous, particularly our customers.

So, Oaktree being the good partner as they are for forbearance agreement. Just to ensure that none of our customers had any concerns about us in our going forward statue and strength. And then as it turns out, the improved operational efficiencies, they weren’t needed but of course a year ago this time, we weren’t a 100% sure. So we just want to be sure no one was nervous.

Unidentified Analyst

Okay. I got it. So, as of a quarter end you were in compliance with the terms of the term loans.

Ralph Faison

Correct.

Unidentified Analyst

Okay. Fair enough. Thanks so much.

Ralph Faison

All right. Thank you very much.

Operator

And at this time, I’m showing no additional questions. I would like to turn the conference call back over to management for any closing remarks.

Ralph Faison

Okay, Jamie. Thank you very much and thank you all for participating today and listening to our call. We look forward to bringing you further results at the end of our fourth quarter.

Operator

And ladies and gentlemen, that concludes today’s conference call. To access the playback of the conference you may dial 412-317-0088 and enter the conference number 10035897, followed by the pound key. Press one to play the recorded conference. Today’s conference has concluded. We do thank you for attending. You may now disconnect your telephone lines.

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