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Executives

David Calusdian – EVP, IR

Matt Boyle – CEO

Paul Farquhar – CFO

Sevcon, Inc. (TO) F1Q14 Earnings Call February 5, 2014 9:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Sevcon First Quarter Earnings Conference Call. Today’s call is being recorded and webcast. My name is Brenda, and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of this conference call. I would now like to turn the call over to your host for today, Mr. David Calusdian, with the Investor Relations firm Sharon Merrill. Please proceed.

David Calusdian

Good morning everyone and thank you for joining us, if you have not received the copy of the earnings press release issued yesterday afternoon. You can find it in the Investor Relations section of the Sevcon website, sevcon.com.

Please be reminded that remarks that management may make during this call may contain forward-looking statements about future financial results. Important factors that may cause the Company’s actual results to differ materially from the anticipated events, performance, or results expressed or implied by the Company’s forward-looking statements are described in the risk factors detailed in its periodic reports filed with the SEC, which can be accessed through the Sevcon website.

The Company advises you to read them and cautions you not to place undue reliance upon any forward-looking statements that may be made this morning, which speak only as of the date of this call. Sevcon undertakes no obligation to update any forward-looking statements.

With us today are Sevcon’s Chief Executive Officer, Matt Boyle and Chief Financial Officer, Paul Farquhar. At this point I will turn the call over to Matt.

Matt Boyle

Thank you David, welcome everyone. We appreciate you joining us this morning. I’ll begin our prepared remarks with some comments on the first quarter. Paul will follow with the financial review, and then we’ll open up the call for your questions.

Sevcon is off to a good start in fiscal 2014 with our quarter one results substantially better than in the same quarter fiscal 2013. We've continued to see consistence sequential top-line growth, since what appears to be our low point in quarter one of fiscal 2013.

Our sales for this quarter were up 36% compared to about year ago quarter and the strongest since quarter two of fiscal 2012. In terms of geography, sales were up mid-double digits this quarter in all three regions.

The growth we experienced in the US and UK was largely in the off-road EV sector. In the US demand for mining equipment customers was flat year-over-year, but we benefited from substantially stronger product demand from fork lift truck and aerial work platform application.

Our US sales also reflected solid growth in our after-market business which focuses mainly on providing low volume, end of late product support for aerial work platform customers. We've established a new consolidated channel for this part of the business enabling us to South East customers more efficiently through a [indiscernible] distributor.

In UK, our quarter one sales reflected the success of our ongoing efforts to expand Sevcon's business in the Far East. This was another quarter of increased demand in Japan and China mainly for aerial work platform and fork lift truck applications.

Quarter one sales to customers in Europe were also up in double digits. Largely driven by demand from industrial customers and for our size 8 controllers in on-road markets. Although, the Europe economy still faces significant challenges this was our second consecutive quarter of growth in that region year-over-year.

On our call last quarter, I talked about how the role we played as controllers supply to Renault has opened doors for us with a number of other European OEMs thus developing next-generation of 4-wheel EV city vehicles. It's encouraging to see business with these customers not only in France but also in Eastern Europe beginning to offset the effects of last year's decline in Renault Twizy production.

We are working to expand Sevcon's presence in Germany as well. The projects in Germany that I mentioned on our call last quarter, which ranged from two-wheel on-road to electro hydraulics to multi-controller system for industrial applications, are all making good progress.

The sales are up substantial year-over-year in both our traditional off-road markets as well as 4-wheel on-road and our only disappointment this quarter was for the two-wheel EV market which focuses primarily on scooters and motorcycles in the 125 cc to 550 cc equivalent range.

We bring to this market a unique combination of both cutting edge technology and proven experience and high volume production. As a result, we are continuing to make progress in our long-term effort to build relationships and grow our business with OEM and Tier 1 suppliers to scooter and motorcycle markets in Europe, Asia and North America.

This market is still in its early stages and likely to be one appeared from quarter-to-quarter. Looking forward we expect electric scooter and motorcycle applications to be a significant growth driver in the quarters ahead.

Our growth strategy for Sevcon goes behind expanding their OEM and Tier 1 relationships in the automotive sector. We are also working to penetrate a broader range of transportation related and industrial sector, where our motor control technology can open doors to new applications.

We are continuing to expand the sales and engineering capabilities in line with the strategy. I mentioned last quarter that, in addition to traditional recruiting channels. We've implemented an engineering apprenticeship program in UK. This program is continuing to be successful and attracting young top talent to Sevcon.

We're also continuing to pursue UK Government Grant opportunities as a means of supplementing our internal funded R&D programs. It's our policy not to discuss specific customer relationships until we're into natural production and shipping in volume. I will say however, that our new business pipeline has never been stronger.

As we announced yesterday, we've entered into a joint venture deal with Risenbo Technology Company Limited to market and sell our products for on-board, electric and hybrid vehicle applications principally to Tier 1 automotive suppliers in China.

We've received the required government approvals in China and we expect the JV agreement to become effective in the first quarter of calendar 2014. Under its terms, Sevcon and Risenbo each will own a 50% stake in the joint venture, which will be led by a Sevcon nominated Chair.

Based on Hubei Province, Risenbo is a subsidiary of the Tier 1 automotive supplier in China and an established and respected player in the Chinese automotive industry. As you know, China has long been one of the most important growth regions primarily in our traditional off-road sectors and more recently in the two-wheel on-road sector.

China is potentially the world's largest electric and hybrid vehicle market partnering with Risenbo will enable us to forge new customer relationships and capitalize on this potential far more rapidly and efficiently than we could do on our own.

Probably our biggest near term opportunity is with the growth of customers working on hybrid electric vehicle technologies. One of them are manufacturing of hybrid pure [ph] electric [ph] and combustion [ph] systems in the US. We are also making good progress on supply relationships related to hybrid vehicles in Europe.

In the industrial sector, we are continuing to explore using a Gen4, a new high voltage in [ph] per products to capitalize in opportunities related to electro hydraulics that is the replacements of all there and less efficient hydraulic systems with electrical.

Turning now to the electric steering technology, which is virtually replaced conventional hydraulic steering in automobiles like getting to electric drives in commercial and industrial applications has the potential to dramatically improve efficiencies, save energy and reduce total cost of ownership.

In summary, the underlying demand patterns appearing to be getting stronger in the majority of our markets worldwide. Our customers are expressing a greater sense of confidence in the future and the lead times, in order visibility is steadily improving.

The portfolio of customer relationships and put up pipeline continue to expand and we've seen four consecutive quarters of revenue growth. While we are building a momentum at the top-line, we are making progress in the bottom line as well. Our business continues to benefit from having a low cost, flexible manufacturing model.

As a result, we believe that Sevcon is positioned to deliver significant margin leverage and incremental sales as conditions in our markets improve.

I will now turn the call over to Paul for review of our financial results. Paul?

Paul Farquhar

Thank you, Matt and good morning everyone. As a reminder, the Controls segment that Matt discussed is Sevcon's core business. We also operate a legacy capacitor business that reported the small operating income in the first quarter of fiscal 2014.

Reviewing Sevcon's financial performance for the quarter and starting with the income statement. Revenues were $9 million compared to $6.6 million in the same period in fiscal 2013. With much said, in our Controls business segment. Sales in our traditional aerial work platform and fork lift truck markets were off this quarter compared to Q1 last year. As were sales for 4-wheel on-road applications.

However, these increases were partially offset by lower sales in the two wheel on-road sector. In terms of geography and excluding foreign currency effects. Revenues increased 31% from the first quarter last year in North America. This growth was driven by product demand in both the aerial work platform and fork lift truck markets, while demand in the mining sector was essentially flat year-over-year.

Sales in the Far East, showed 65% year-over-year growth due to stronger demand for aerial work platform applications in China and Japan. Sales in Europe increased 38% from quarter one last year, also reflecting strong aerial work platform business as well as higher product demand for 4-wheel on-road EV applications.

Matt, mentioned on the cost manufacturing model and I would like to expand on that. We traditionally relied on third parties for the majority of our production. Outsourcing to trusted manufacturing partners that allows us to add capacity while minimizing the addition of fixed cost.

Our consequences, our operating expenses consist primarily of product development, engineering, sales-related expenses and general and administrative expenses including compensation and direct R&D costs.

During the second quarter of fiscal 2013, we implemented a number of personnel and cost reduction measures with the goal of returning the business to profitability given the highly challenging industry conditions at the time.

Our results for the first quarter of fiscal 2014 indicate that we are continuing to deliver the $2 million in annual run rate savings that we anticipate through these initiatives. In terms of both gross profit and operating costs.

Gross profit for the first quarter of 2014 improved nearly 9% points to 42.3% of sales compared to 3.7% in quarter one last year. As much as our restructuring initiatives have reduced our cost of sales and an improved sales mix in the Controls business also contributed to the gross margin improvement this quarter.

Total operating expenses to Q1, were $300,000 or 9% lower than the first quarter of fiscal 2013. This decrease year-on-year partly reflects the cost savings implemented in the second quarter of 2013 just mentioned but also in addition the company recorded grant income of $115,000 in the first quarter of 2014 compared to $6,000 in the first quarter in the prior year.

This grant income was reported as a reduction of research and development expense in each year. I've also note however, the operating expense a year ago reflected a final round of consulting and legal expenses related to the replacement of our defined benefit UK Pension Plan with a defined contribution arrangements effective on the 1 October, 2012.

Sequentially, operating expenses were up about $200,000 from quarter four to fiscal 2013 driven mainly by higher sales and marketing expense. Our reported operating expenses include engineering and R&D expense, which are reported net advance receipt. R&D expense, net advance was 10.3% of sales in the first quarter of fiscal 2014 compared to 16.3% in our revenue challenge Q1 last year.

Sevcon reported operating income to the first quarter of $710,000 compared with an operating loss of $1.2 million in the same period last year. We reported an income tax provision of $121,000 this quarter compared with an income tax benefit of $108,000 in Q1 last year.

Sevcon reported GAAP net income of $488,000 or $0.14 per diluted share for the first quarter of 2014 compared with a GAAP net loss of $1.3 million for the loss of $0.39 per share in the first quarter of fiscal 2013.

Turning now to cash flow and working capital items. Receivables increased by $1.7 million from the first quarter last year and inventories and prepaid expenses decreased by $500,000 and $600,000 respectively. Accounts payable, accrued expense and accrued taxes increased by combined $1.4 million year-over-year.

The number of day's receivables was 63 at both December 28, 2013 and December 29, 2012.

As announced in yesterday's press release, last month one of our customers in France was placed into administration. The receivable from the customer is $555,000 including taxes. Although, we are receiving full payment of the debt, it's not clear at this time but it can or will be repaid and its collection is subject to an ongoing legal process.

The full amount of this receivable is recorded on the balance sheet at December 28, 2013. Turning to the balance sheet, Sevcon ended the first quarter with cash and cash equivalents to $2.2 million compared with $1.3 million a year earlier.

Finally, we closed the first quarter of fiscal 2014 with $1.8 million in short and long-term debt. This compares with $1.8 million also, a year earlier.

As a reminder, we currently have a $3.5 million secured revolving credit facility with RBS Citizens Bank, $1.7 million of this facility was drown down at the end of Q4, which represented the majority of the $1.8 million in short and long-term debt just mentioned, which was the same amount at the end of Q1, 2014. This revolving credit facility was extended as of September 30, 2013 and will expire on June 14, 2017 when the principle will be repayable in full.

We also have a $1.5 million bank overdraft facility with RBS NatWest Bank available to our UK subsidiary companies. These facilities were unused at the end of first quarter fiscal 2014 and the year earlier.

Coming up, and in line with Matt's comment with improved sentiment in our customer base. A lower cost structure and conservative balance sheet. We are confident that Sevcon is well positioned for growth and improved profitability in fiscal 2014. We look forward to reporting our progress in the quarters ahead.

Operator, you can now open the call for questions, please?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Walter Rensi [ph] with Wallace Partners [ph]. Please proceed with your question.

Unidentified Analyst

Thank you. Congratulations on everything. Really great quarter, great outlook. Got a few things, the company in China, Risenbo can you kind of fill us in little bit on big they are, what their sales are, who their customers are, what their current product line consist of?

Matt Boyle

Not at this point, Walter. We are still looking through the legal processes once we've been allowed to mentioned them, but I haven't been able to go any further than that and probably just yet. The other subsidiary in the last Tier 1, the other headquartered Hubei Province, in China and although we are not a technology company and therefore not competitive of ours, we have agreed deal of synergistic products and customers.

Unidentified Analyst

Yes. Okay, I see okay as far as that transaction is concerned. I think indicated it's going be a 50-50 deal, can you just give us a sense of what Sevcon is going to contribute to venture and what the Risenbo will contribute?

Paul Farquhar

Walter, this is Paul Farquhar here, thank you for your question. Well look, we'll be in the initial capital contribution to the joint venture, the odds are $300,000 to $400,000 there is a committed amount of capital, which we don't want to talk to probably at the moment. But the process in China is that you have a few at a time, which to contribute the capital to the business, which is the order of two years.

So our initial capital contribution just to get the business started will be about $300,000 to $400,000.

Unidentified Analyst

Okay, that sounds good and as far as when that thing actually becomes operational. You said that, deal will close this quarter I guess but when do you expect to actually generate some business there?

Matt Boyle

We are already working on projects in China. Both through Risenbo clients at the moment and also in our off-road sector Walter. We should be heading the ground running fairly quickly I suggest.

Unidentified Analyst

That sounds terrific. That deal in France, you indicated that one of customers was in dire straits I guess, can you tell us how of that $555,000 represents the value added tax and whether there is better chance getting that back or whatever, I mean how does that even work. I mean, I'm not from there I don't know, how that works?

Paul Farquhar

Can't say question again, by Walter. It's Paul here. Yes, to take your first question of the $555,000 total receivable there's 20% French value added tax included in so, it's in the low $400,000 was the amount of the net sale. In terms of recoverability, as we said in the press release and in our prepared remarks. We can't hit the stage assessed the degree of recoverability.

It's subject to a court appointed administration process in France, which is a very formal process. The administrator has been appointed for an initial six months period and he needs to, is obliged to report back to the commercial cost in the area of France in which the company is based, here biddings to report periodically on the progress of that administration.

So unfortunately, we can't get any more information until the first report to the court, which we understand is on March 6 and just over among this time.

Unidentified Analyst

Okay and just one other thing as far as that one goes. The products that you sold to that French company are they long gone or is there a way to maybe get them back, they're just kind of sitting in the warehouse somewhere over there?

Matt Boyle

Yes, thank you. Walter, we understand although we can't get a definitive answer yet from the administrator but we understand that the product is still up at premises of the customer. We don't believe it's been incorporated electric vehicles yet, so whether we can or cannot recover that material will depend on the outcome of the administration process that will all come out in due course over the coming weeks and months.

Unidentified Analyst

Okay and just one last thing. I didn't get a chance to see the 10-Q if that's out but, can you just tell me what the stock option expense was for the quarter?

Paul Farquhar

Yes, 10-Q hasn't been filed yet Walter it will be filed next week. But the stock option expense in the first quarter was $59,000.

Unidentified Analyst

Great. Okay well, congratulations again. It looks like you guys are on your way. Thanks a lot.

Operator

Thank you. It seems we have no further questions at this time. I would like to turn the floor back over to Mr. Boyle.

Matt Boyle

Thank you very much, Brenda and thanks everyone for listening this morning. We look forward to speaking to you next quarter and this concludes our call.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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