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Measurement Specialties, Inc. (NASDAQ:MEAS)

F3Q2014 Earnings Conference Call

February 06, 2014, 11:00 AM ET

Executives

Frank Guidone - Chief Executive Officer

Mark Thomson - Chief Financial Officer and Secretary

Analysts

John Franzreb - Sidoti & Company

Larry Solow - CJS Securities

Sean Hannan - Needham & Company

Operator

Greetings, and welcome to the Measurement Specialties' third quarter fiscal year 2014 conference call. (Operator Instructions) It is now my pleasure to introduce your host, Mr. Frank Guidone, President and CEO of Measurement Specialties. Thank you sir, you may begin.

Frank Guidone

Thank you, operator. Good morning, everyone. Let me start by reminding everyone that comments made today fall under the Safe Harbor provision. The conference call will contain time-sensitive information that's accurate only as of today's date and time. In addition, we may make forward-looking statements during this call that may differ materially from Measurement Specialties' actual results.

Please review our most recent SEC filings for a detailed presentation of our business and associated risks, including the risk factors described in our most recent Annual Report on Form 10-K for additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements made during this conference call.

Additionally, during today's call, we will provide certain performance measures that do not conform to Generally Accepted Accounting Principles. We believe these non-GAAP measures enhance the understanding of our performance and we provide schedules that reconcile these non-GAAP measures with our earnings press release and reported results in our 10-Q filed with the SEC.

With regard to forward-looking measures of adjusted EBITDA and adjusted EBITDA margin reconciliation to the available GAAP financial measures are not provided, because they are not available without unreasonable effort.

I'm going to make some general comments regarding the quarter and the outlook for the year this morning, and then I'll hand the call over to Mark. And then we'll open it up for questions.

Regarding sales growth, well, the quarterly year-on-year growth looks terrific, approximately 28% overall and 19% organic. This is against the weak comp last year, and therefore I think the year-to-date numbers are more representative. Year-to-date, sales are up 19% consolidated and 9% organic. Recall our long range growth target is 7% to 9% organic and at mid-teens consolidated, which includes acquisitions.

Bookings for the quarter were $104 million, down from our record Q2 of $108 million, but kept pace with sales. We had a particularly strong January, taking in a record-high $38.8 million in bookings, improving our three month book-to-bill through January to 1.03. Given our January and sales backlog for the remainder of the quarter, we are reiterating our guidance of approximately $412 million for the year, which implies a flat Q4 as compared to the third quarter.

Adjusted EBITDA margin declined slightly from Q2 and Q3, largely due to one-time freight and efficiencies associated with our transfers to Chengdu. Along with some unfavorable mix in a few product families, particularly pressure, where we had unusually high consumer product shipments pre-Christmas, which carry slightly lower margin than the average for that product family.

Selectively, these issues drove down margin by about 50 basis points to 75 basis points. We would expect to see some improvement in Q4 to get back to 20%-plus EBITDA margin.

We continue to make very good progress with the testing and rollout of our line of SCR sensors. We have pre-production testing and production launch known as SOP or start of production, scheduled with approximately 17 customers across roughly 40 different part designs in calendar '14.

Our portfolio of SCR products includes in-line urea quality, in-tank urea level heater and quality combo, along with in-pump pressure and temperature sensors. Selectively, across the in-tank, in-line and in-pump sensors, we believe we have design wins or new design wins with over 30 customers that represent approximately $60 million in annual sales potential from Measurement Specialties at maturity, which is forecast run rate by the end of fiscal '17.

While SCR programs represent our largest opportunity in the funnel, we have a number of other exciting programs. Our portfolio of digital component sensors is gaining traction, most recently in fitness devices. Our miniature barometric pressure sensor is used to measure changes in altitude, a key input for the algorithm used to count steps.

We were recently awarded our first pressure humidity temperature combo application for an aftermarket handset weather app that's forecast for one million pieces in our fiscal '15 with a potential to be three times up. Our other major development programs include custom force sensors used in aerospace fly-by-wire, magnetic sensor used in banknote security, pressure transmitters used in hydraulics for construction/ag equipment and ultrasonic elements used in 10 digitizing applications.

Our consolidated sales funnel today represents approximately $450 million in annual sales of potential new business and the engineering project funnel, which is a subset of the sales funnel, shifted about $275 million in new business at maturity. Recall that our average won/loss for active development programs is running around 50%. Year-to-date, in fiscal '14, we've won approximately 200 new programs, worth about $80 million in new business at maturity, with maturity typically defined two to three years out.

Several years ago, we reorganized a sales force in order to create a single face to the customer. At that time, we created four specific market verticals; engine and vehicle, medical, military aerospace and test and measurement along with a regional general OEM group.

To increase our focus and accelerate growth in specific segments, we're introducing two additional market verticals in '15, heating, ventilation, air conditioning and refrigeration or HVAC&R, along with consumer products and business/business equipment. These two verticals are being carved out of the general OEM and will reduce the combined general OEM sales from approximately 45% to roughly 30% in fiscal '15.

At the end of the day, our objective is to leverage the market vertical structure to develop a more proactive sales and development strategy. While we have not yet completed our annual budget process, given the time lapse between the third and fourth quarter conference calls, we felt it appropriate to provide preliminary fiscal '15 guidance now, which we can refine in our fourth quarter call.

While fiscal '15 will be a very active year, qualifying SCR programs, accumulative sales impact in fiscal '15 is small. Accordingly, we expect our fiscal '15 sales to be in the range of $438 million to $442 million, which is at the low-end of our 7% and 9% organic growth target with a clear implication that we expect to be at the high-end of the range or potentially exceed in fiscal '16 and '17 as a result of SCR SOPs.

As previously discussed, we expect to see a steady improvement in EBITDA margin as a result of improved mix via the decline in Sensata and facility restructuring efforts. For modeling purposes, we believe approximately a 100 basis point improvement in EBITDA margin each year over the next three fiscal years is a reasonable assumption.

Finally, the fiscal '15 guidance of course seems no new acquisitions. We're currently managing a pipeline of 30 to 40 targets with active discussions on five to six. We feel good about achieving our objective or adding approximately $30 million of acquired new revenue to get a sensitive mid-teens consolidated growth.

With that, I'll turn it over to you Mark.

Mark Thomson

Thank you, Frank. I'll now cover the financial results for the three and nine months ended December 31, 2013, in more detail. First, I'd like to highlight that there were a number of items that impacted earnings after income taxes.

We reported an adjusted net income and adjusted earnings per share, as we believe these non-GAAP measures more accurately reflect the company's performance. More specifically we have removed the income generated and resulting from the revaluation of acquisition earn-outs and adjusted net income for other items, including but not limited to restructuring costs, overlapping cost in connection with facility consolidations, professional fees related to acquisitions, amortization costs and non-cash discrete income tax adjustments. For more detail regarding these adjustments, please refer to the company's non-GAAP reconciliation table in our earnings press release.

The net sales for the third quarter were $104.4 million, an increase of $22.8 million or 27.9% over the third quarter last year. Organic net sales for the quarter, which exclude $7.4 million in sales for the Spectrum and Sensotherm acquisitions, increased $15.4 million or 18.8% over the same period last year. Our December year-to-date net sales were $307.8 million, an increase of $49.8 million or 19.3% as compared to the same period last year.

Excluding sales attributed to RTD, Spectrum and Sensotherm acquisitions of approximately $31.5 million for the first nine months ended December 31, 2013, and $3.7 million in sales for RTD for the nine months ended December 31, 2012, year-to-date organic sales increased $22 million or approximately 8.7%. This increase is net of year-to-date Sensata sales reductions of approximately $4.1 million.

Our gross margins in the third quarter were up slightly to 40.8% as compared to 39.9% in the third quarter of last year. As noted on our last earnings call, we expected to see pressure on our gross margin, due to third quarter facility consolidations and associated overlapping expenses.

These expenses include production transition and production startup costs, including direct labor, manufacturing overhead and other production related expenses. These duplicative costs adversely impacted gross margin by approximately $0.6 million during the third quarter.

Selling, general and administrative or SG&A expenses for the third quarter increased $6.1 million to $31 million as compared to the corresponding period last year. Organic SG&A, which exclude SG&A expense of Spectrum and Sensotherm, increased by $4.3 million relative to the same period last year.

The increase in organic SG&A is largely driven by increases in research and development expense, higher compensation cost including stock compensation expense, facility consolidation restructuring charges and higher professional fees tied to work on acquisitions.

Income tax expense for the third quarter increased approximately $1.0 million to $2.1 million as compared to the same period last year. The overall increase in income tax expense is primarily due to generation of higher profits before taxes, which were partially offset by small discrete income tax adjustments recorded during the quarter. The company's overall effective tax rate without discrete adjustments in the third quarter was approximately 22.5% as compared to roughly 23% last year.

The company generated $17.8 million of operating cash flows in the third quarter and $44.2 million during the first nine months of fiscal 2014, an increase of $9.4 million as compared to the first nine months of the prior fiscal year.

Company generated free cash flow of $13 million in Q3 and $31.7 million year-to-date, an increase of $8.2 million as compared to the first nine months of the prior fiscal year. Company's cash balance at December 31, was $51 million and our total indebtedness, net of cash balances was approximately $78.7 million. Again, we're pleased with our third quarter results and look forward to a solid finish to our fiscal 2014.

I will now turn the call back over to you, Frank.

Frank Guidone

Thank you, Mark. Operator, you can now open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from John Franzreb, Sidoti & Company.

John Franzreb - Sidoti & Company

Frank, you pointed out that the organic growth was largely driven by a weak comp versus a year ago. But it seems to me like it's still accelerated on a sequential basis from 2Q to 3Q. If you look at it on a sequential basis, is there any particular driver behind the organic growth that you can point to?

Frank Guidone

I mean, there is nothing, John, that I think is unique. We had a little bit of lift in the third quarter topline number as a result of some of the sales of consumer products, particularly the fitness devices and GPS customers, and some large customers that get a bump towards the pre-Christmas run-up. But I don't think that that's not going to be more than a $1 million or maybe a $2 million kind of influence. So I wouldn't carve that out as being a significant driver, although there was a bit of some tailwind in the topline, but a little bit of pressure on the margin.

John Franzreb - Sidoti & Company

You mentioned there was a 75 basis point hit to the margin?

Frank Guidone

No, no. That was A item that was included in, I also mentioned, we had some unusually high freight expense as we were bringing in material into Chengdu in support of our consolidations there. That was a bigger item, but the two collectively were 50 to 75 bps.

John Franzreb - Sidoti & Company

How about if we look at Europe, on a year-over-year basis, I noticed that the growth was up 31%, I imagine it had similar easy comps. Is there anything you can discern in Europe as far as trends that give you any kind of confidence that the growth you are seeing over there has some tailwind to it?

Frank Guidone

We've done pretty well in Europe over the last year and we've been comping well. And if you look at the PMI numbers, while Europe had been running below U.S. there has been a positive trend to the PMI for quite a while and a expansion numbers about 50 for the last six months or so. The latest PMI that I saw yesterday out of Europe actually was quite strong in terms of its improvement and that tends to help us. We're also more heavily weighted in the E&V space, which has been doing well in Europe, both in terms of just unit volume growth as well as some of our content growth there.

John Franzreb - Sidoti & Company

The restructuring actions, the redundancy costs, the net benefit is supposed to be about $4 million next fiscal year. Two questions. One, are you still on track with that target? And two, what is the ramp impact? Will we see that immediately once those costs go away? Can you talk a little bit about that?

Frank Guidone

$4 million is a good number that we should see in fiscal '15. We haven't finished budgeting yet, so there is always some give and take, but just all else being equal, that's the number that we're looking at relative to the things that have been completed. There is probably another $1 million associated with some additional work we're doing to migrate business out of Europe into Asia to get to the overall $5 million target that we've identified, but we're not going to see that until little later in the year. So I wouldn't look at as step function $4 million run rate in Q1, but I think we should quickly kind of realize that by the first, no later than second quarter in terms of that run rate.

John Franzreb - Sidoti & Company

One last question, the $80 million of new revenue won. You said it is a three year before maturity. How does that roll in year by year?

Frank Guidone

Very difficult to say, John.

John Franzreb - Sidoti & Company

Just in big bucket strength?

Frank Guidone

It's really not a linear ramp on new business. We tend to see more of a non-linear. So it's a backend loaded with the crossover point, I would say, being in the back half of the year or two. So you might get a 10% of that in the first year and 30% in the second and then the front rate into the third year or something like that. But the point is it's not a linear progression. It's generally a non-linear progression as we see ramp in customers' adoption rate. And its kind of depends whether we're stepping into running volume or not. And I don't have that specific detail within that $80 million. I was just to collecting some statistics over the last couple of days for the call relative to our overall sales volume.

Operator

Our next question comes from Larry Solow with CJS Securities.

Larry Solow - CJS Securities

Just in terms of your initial outlook for '15, maybe a little too early to do a full bottoms-up analysis, and you sort of mentioned I guess most of the newer products, or at least the SCR and what not is back-end loaded. How do you come up with this number? Is it sort of just looking out at what the PMIs are and some bottoms-up? And does China slowed down? Does that come into play at all?

Frank Guidone

It's all bottom-up. We're going through budgeting now, all regions in terms of our sales force are looking at their existing and new customers, deciding what we're going to include in the budget versus what we're going to exclude. And so this is in early rollup. Obviously, we're still early related to where we are in our budget process. So I don't want to push the right hand margins. But also want to give some kind of realistic guidance here. So I think it's a reasonable range as our first cut, and maybe we can refine it next quarter.

Larry Solow - CJS Securities

Thanks a lot for a lot of the granularity on some of the newer products. You mentioned the SCR programs. Now, you sound like you've secured $60 million, up from I think the targeted $50 million. So it looks like you are already ahead of your sort of longer-term goal.

Frank Guidone

Larry, just to be clear there, I'm sorry to interrupt, to be clear I included in that $60 million was urea quality sensors along with some in-pump design wins for pressure and temperature. So we've talked about those separately in the past. I am grouping those as SCR opportunities, which is how I get to the $60 million.

Larry Solow - CJS Securities

So in terms of that $50 million number, excluding the in-pump sensors, are you still on target for that? I think you were at $40 million in that last quarter

Frank Guidone

We're still on target for that.

Operator

Our next question comes from the line of Sean Hannan.

Sean Hannan - Needham & Company

Frank and Mark, just wanted to see if we can get a little bit more color in terms of the contributions from the vertical segments this quarter, at least in a general sense. Then as you think about that and discuss that, what do we think about mix expectations for the fourth quarter and how that could impact margins? And I have a follow-up to that.

Frank Guidone

When we look at the implications of mix internally, we're still looking at it by product line, not by market vertical. So market vertical makes a lot of sense for us to talk and we look at our portfolio and growth prospects in the out years relative to implications of mix, it makes more sense for us to look at it in terms of product line, pressure versus temperature et cetera.

So with that as I mentioned, I think there were some items that put pressure on our contribution margin in the third quarter as compared to where we ran in the first and second, that we expect to see some improvement, and I mentioned kind of 50 to 75 bps there. Otherwise, we don't see big dramatic changes in the fourth quarter. We're not projecting the changes one way or the other in terms of our overall mix within product lines. Sensata has forecast at 9.5% of sales in Q4, which is pretty consistent with Q3, so that doesn't drive any big mix change either.

Sean Hannan - Needham & Company

So then in terms of, as you think about the 50 to 75 bps in the release that comes off that from December, just to be clear, that is inclusive of mix assumptions as well as some of the cost pressures that you had seen within the December quarter that should be alleviated now in March?

Frank Guidone

Yes, so just based on my current outlook in terms of mix as well as the elimination of some of these items that hit us in the Q3 that I don't expect to continue to Q4, I expect to see a 50 point to 75 point improvement overall on the contribution in EBITDA margin.

Sean Hannan - Needham & Company

And then as you think about the guidance for '15, is there a way for you to provide a little bit more color for what you're expecting than perhaps from a sensor application level, whether it'd be pressure, temperature or what have you? Those contributions for what might be bigger growers, less impactful in terms of growth for your expectations for the year. And then if you were to step back and reflect on how fiscal '15 is starting to shape, what perhaps are some applications that are shaping a little bit differently, upside or downside, versus you're thinking a few months or quarters ago?

Frank Guidone

We knew that '15 is a kind of a transition year for us relative to the big growth programs around SCR that we have a lot of work in terms of qualification and it is kind of a last step of investment ahead of the benefit on the topline. So I wouldn't say '15 is any different than where we thought it would be a year ago. We have been projecting that. We're really going to see an acceleration of growth in '16 and '17 at the high-end or even exceeding that range that we've provided.

So I think '15 is what we're providing as guidance is a reflection of kind of where we expect our business to operate in a relatively stable, but sluggish global GDP world, right. If we're a 2% global GDP and we're forecasting 6%, 7% organic growth, that's kind of where we've said, we should be all else being equal. The acceleration of that in '16 and '17 really comes on the heels of the investment we've made over the last five years in the SCR program.

Sean Hannan - Needham & Company

Then lastly, this might be more for Mark, can you remind us what drove the lower tax rate there within the quarter?

Mark Thomson

Yes. So there's couple of things. As you know, we have quite diverse regional tax rate. So China, Switzerland, Ireland all carry lower tax rate than, let's say, French, Germany and U.S. So the shifting of profits for one affects what our actual ETR is. In addition, during the quarter, we had a small, it was about $200,000 discrete tax event, which was favorable, which really has to do with our submission of our final tax return relative to what our original provision was and we called that a return to accrual provision adjustment. So between just some changes in the shifting of profits in that discrete event that actually affected our third quarter.

Operator

Our next question is a follow-up from John Franzreb with Sidoti & Company.

John Franzreb - Sidoti & Company

Yes, the two new market verticals, HVAC&R and consumer products, could you just go over again why you decided to call those out? And are they equal in size or is there one larger than the other?

Frank Guidone

The decision is that we've really seen a benefit and believe in the advantages of a market vertically-oriented sales force where we can concentrate on a limited number of customers in specific set of applications to focus on the cross-selling multiple sensors and generating a greater share of the sensor spend of that limited set of customers.

I differentiate that from kind of our general OEM force, which is more of a regional opportunistic sales force, where either through what we're doing, try to generate business or through people who are inbound and approaching us, we are evaluating sensor opportunities there, but really not part of a long-term strategic plan. But that's a big bucket. It's 45% of sales, so it still represents a big, kind of other catchall.

And so as we gain more concentration in that other, we want to continue to carve out and when we get in a scale, when we can do this, dedicate a sales force along a more specific and focused lines to help us drive, what we think will be an accelerated growth profile within that market variables as compared to the general, kind of opportunistic approach. So that's kind of the objective there about evenly split in terms of size on that carve out, it was around 15% in aggregate.

John Franzreb - Sidoti & Company

So you pull salesmen from the OEM and move them into this new grouping? Or will you be hiring additional overhead to support this vertical?

Frank Guidone

It's more of the former, right, because we're covering the same customers, we're just organizing differently. Although, we'll use this as an opportunity to perhaps still roll. I'm trying to limit the amount of sharing of resources as much as possible that creates a focus and dedication. But clearly '15 will be somewhat of a transition year.

So consumer product business equipment is really focused around the digital plug-and-play component. And this along with the digital component focus, there is a heavy software application aspect to this market vertical. So in order to play in the consumer space, where we want to provide a set of sensors that are plug-and-play sensors, generally those are interfacing with certain microprocessors that are designed to sensor hubs. And so you got to have the associated software and all the application notes to be able to talk to that.

And so it's part of the effort, by carving this out is we've got now a pretty good suite of sensors and we've got a fair amount of work to do this year, in order to make sure that we make it easy for people from an applications perspective to buying off the shelf product, plug it in and make it work.

HVAC&Rs is far more consistent with more of our standard packaged transmitters, where our focus is around pressure, temperatures, humidity level types of sensors in chillers, boilers, commercial airflow, from variable airflow and humidity perspective commercial automation. And then even, now reaching some into residential, where more home automation, particularly our HVAC is driving sensor needs.

Operator

At this time, I would like to turn the call back over to management for closing comments.

Frank Guidone

Thank you, operator. So in summary, we believe our performance in fiscal '14 is indicative of our overall growth in earnings model, high single-digit organic growth, mid-teens total growth, accelerating earnings growth. While fiscal '15 organic growth will be slightly lower than '14, of course against a much tougher comp, fiscal '16 and '17 are shaping up to be very strong. We believe we have unusually good long-term visibility right now and are very excited about the value creation potential over the next three years.

Mark and I will be presenting at the Sidoti Conference in New York City on March 17. And along with our management team, we look forward to ringing the opening bell at the NASDAQ on Thursday, March 20.

I want to remind everyone that we will be hosting an Investor Day at the Benjamin Hotel in New York City from 2:00 PM to 5:00 PM later that afternoon on the 20. This will be an exciting event that will allow analysts and investors to interact with our product and market vertical managers as well as see some of our related new products. We hope to see everyone there. Operator, that will conclude today's call.

Operator

Thank you. This does conclude today's teleconference. Thank you for your participation. And you may disconnect your lines at this time. And have a great day.

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