Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

SMTC Corporation (NASDAQ:SMTX)

Q4 2013 Earnings Conference Call

April 14, 2014 4:30 PM ET

Executives

Clarke Bailey - Executive Chairman and Interim CFO

Sushil Dhiman - President and CEO

Greg Gaba - VP, Finance

Analysts

George Melas - MKH Management

Operator

Good day, ladies and gentlemen, and welcome to your SMTC Corporation Scheduled Release of 2013 Results. At this time, all participants will be in a listen-only mode. And later, there will be a chance to ask questions and instructions will be given at that time. (Operator Instructions) And as a reminder, today’s conference is being recorded.

And now, I would now like to turn it over to your first host Clarke Bailey, Executive Chairman and Interim CFO.

Clarke Bailey

Thank you. Welcome and good afternoon. I’m Clarke Bailey, SMTC’s Executive Chairman and Interim CFO. On this call with me today is Sushil Dhiman, SMTC’s new Chief Executive Officer; and Greg Gaba, Vice President of Finance.

I’d like to remind everybody that the presentation includes statements about expected future events and financial results that are forward-looking in nature and subject to risks and uncertainties. The Company cautions that actual performance will be affected by a number of factors, many of which are beyond the Company’s control and that future events and results may vary substantially from what the Company currently foresees.

Discussions of the various factors that may affect future results is contained in the Company’s Annual Report on Form 10-K, on Form 10-Q and subsequent reports on Form 8-K and other filings with the Securities and Exchange Commission.

So when I joined the Company in May of 2013, I joined the management team in May of 2013, we identified numerous issues that required immediate attention. The management has spent the last three quarters addressing and eliminating those issues. In connection with the preparation of our 2013 financial statements, we determined that the Company should conduct a full physical count of its inventory. SMTC’s previous practice was to perform cycle counts of inventory on a periodic basis as permitted by generally accepted accounting principles.

As a result, we identified an overstatement of inventory at the Mexican operation that totaled $3.2 million. The majority of the overstatement related to errors in the inventory evaluation. We initially thought we would be able to allocate close to 1.9 million to prior periods. However, upon further review we have concluded that we are not able to do this due to lack of data. Therefore, we will not be restating prior period financials but will take the full charge in the fourth quarter of 2013. Please note that the comparison with prior period financials is probably not relevant given the overstatement of inventory.

As announced, we’ve received a waiver from PNC, our lender with regard to the covenant violations at year-end. PNC has also agreed to modify our covenants in 2014 by eliminating the financial covenants in the first quarter and introducing EBITDA and fixed charged covenants beginning in the second quarter. We believe the Company’s financial performance will improve as the year progresses and Sushil will address the plan for 2014.

Our priorities now have shifted to growing revenues and improving the profitability particularly in Mexico. We continue to aggressively manage working capital as reflected in the results. An important step towards achieving the new goal was the hiring on January 6, 2014 of Sushil Dhiman, as President and Chief Executive Officer. Sushil has spent the majority of his career in the EMS industry specifically managing and successfully managing and growing complex organizations. He has had responsible for companies with up to 1 billion in revenues and has managed multisite organizations.

Our search began in late June 2013 and involved the review of over 150 candidates. I am very pleased to be working with Sushil and look forward to many exciting developments under his leadership.

I’ll now hand it over to Sushil to discuss his observations and plans for the future.

Sushil Dhiman

Thank you, Clarke. Good afternoon, ladies and gentlemen. Let me express I am very happy to be part of SMTC Corporation and for the opportunity to lead great group of people. First let me share some of my observations and first impressions. We have a dedicated executive team, talented workforce across our global site. Our customer base is stable and I have personally visited top-10 customers over past three months. I’ve met with their executives and supply chain teams. These customers are committed to SMTC. Some of these customers have been with us for a long time and I want to publically thank them for their support.

As Clarke pointed out in his remarks, we have good relationship with PNC, our lender. I have three key initiatives which I’m driving. A, we have developed an aggressive cost cutting plan which should position us to achieve industry margins in 2014. As of this point, we are currently ahead of the plan. Second one, we are ensuring that we have the right people in the right jobs with robust processes and appropriate controls. We have made excellent progress on this front by making internal changes and also introducing external talent. These two initiatives alone should allow us to build a strong foundation and drive significant improvement in profitability.

Lastly to help grow the Company, I have hired Josh Chien as Vice President of Worldwide Sales and Marketing. His mandate is to expand what’s already a healthy pipeline of potential customers and to convert these prospects into revenue.

Now let me comment on the physical inventory write-off of $3.2 million for which we released an 8-K on January 27. I was very disappointed to discover the controlled efficiencies leading to the write-off. However, this has helped expose weaknesses in our Mexico operations and has allowed us to strengthen our processes and controls by implementing a robust remediation plan. The cross functional team in charge of this implementing remediation plan is making great progress. We have also formed a best practices and compliance team, with a charter of ensuring compliance to procedures, processes and implementation of best practices across all of our manufacturing sites.

Overall these actions should improve our profitability, further reduce our working capital in 2014 and put us on a revenue growth path. Longer term outlook, our goal is to grow the top-line while improving margins. We will continue to add quality customers in the key focus industries while working to make our factories world-class with a focus on lean manufacturing principles. Later on we will determine the appropriate capital structure to position SMTC to pursue a strategic acquisition. All of these long-term focus items will help us build shareholder value.

I will now hand over to Greg Gaba, our Vice President of Finance, he will present the financial results.

Greg Gaba

Thanks Sushil. As Clarke mentioned we reported a 3.2 million inventory adjustment in the fourth quarter, this adjustment combined with the deferred tax asset reduction of 4 million and a $300,000 provision for our legacy customer have heavily affected our quarterly and yearly results. Revenue for the fourth quarter was 67.4 million, a 7.5% decrease sequentially from the third quarter. The decrease was mainly due to a reduction in revenue from one customer. Gross profit was 2% and adjusted EBITDA was a loss of 2.2 million. However, when removing the effects of the inventory adjustments the gross profit and adjusted EBITDA were 7.3% and 1.3 million respectively.

Revenue for the year was 270.7 million, an 8.6% decrease sequentially from 2012. The decrease was mainly due to decreased volumes with three long standing customers in addition to two customer disengagements, as a result of the Markham production facility closure at the end of the second quarter. The gross profit percentage for 2013 was 5.7%. However, again when removing the effects of the inventory adjustments unrealized foreign exchange on derivatives and the negative gross margin from the closed Markham manufacturing facility, gross margin was 8.2%.

Adjusted EBITDA for the year was $840,000, however, when removing the unusual items that affected the gross profit in addition to 1.1 million of charges incurred during the year related to lease exit costs, executive severance and CEO recruitment fees, the adjusted EBITDA was 7.6 million.

Debt was reduced by 6.8 million in the fourth quarter compared to the prior quarter, including fully paying off our term debt loan. We were able to generate this cash to accomplish this by a significant improvement in managing our inventory levels as well as significant decrease in our past few accounts receivables.

I will now hand it over to Sushil for closing remarks.

Sushil Dhiman

Thanks Greg. I am confident that I have joined SMTC at an opportunistic time. Although much work remains that work should produce tangible results in near-term. We’re strategically located across the globe to provide our customer partners the best supply chain solutions. My priorities are to grow the top-line by rebuilding the sales team, to continue to strengthen the management team, to improve the profitability through efficiencies, to strengthen the balance sheet and continue to reduce working capital and longer-term position the Company to consummate strategic acquisitions.

We will now open the meeting to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Okay at the moment I am showing no questions, however, I will give the instructions just one last time. (Operator Instructions) I am showing just one question from George Melas from MKH Management. George please go ahead.

George Melas - MKH Management

Hi. Good morning.

Sushil Dhiman

Thank you, George.

George Melas - MKH Management

Great. I am fairly new to the story. I just want to ask you a few questions, just trying to understand the, first of all the bank covenants. It says fairly clearly in the press release that your EBITDA hurdle was 3.4 million and you didn’t reach that. How does the bank calculate EBITDA? Is it as the EBITDA or is it as the adjusted EBITDA? What was the EBITDA per the bank formula?

Greg Gaba

So George, this is Greg, the bank covenant it’s adjusted EBITDA, however we also add back the unrealized foreign exchange or loss in the quarter, as well the bank has specific one-time items that we can add back, for example restructuring cost.

George Melas - MKH Management

Okay and can you give us some sense of what are the EBITDA hurdles that they’re pulling that you will negotiate for the second, third and fourth quarter or is that not disclosed?

Greg Gaba

George, that’s not disclosed unfortunately.

George Melas - MKH Management

Okay. Alright, you have had -- the regional operations have sort of performed fairly differently, Mexico and the U.S. have had much lower profitability in the earlier part of 2013, can you give us some color on the results of the operations by region and excluding the inventory sort of restatement in Mexico?

Greg Gaba

Yes I think as we said in the prior conference call that we had with investors, the challenge that we’ve had has been Mexico. We’ve known all along that they’ve been experiencing operating efficiencies and you can see it in the headcount, when Larry and I first came on-board in May the headcount was growing quite aggressively and we knew we had an issue there with regard to cost and overhead structure. And so Mexico it being our largest facility and a very substantial portion of our revenue is important. The other facilities are performing fairly well and so therefore we feel very good about China, we feel very good about San Jose and Mexico has been the focus and I could tell you that Sushil has spent a lot of time in Mexico since he’s joined, part of that was a request by the bank that he be down there. And that the aggressive cost cutting program he talks about, I can tell you it is very aggressive and we have been taking out a substantial amount of headcount and we’ll probably see that happening through the course of next year, the large amount of people coming out came out in the first quarter and every quarter through the remainder of this year you’ll be seeing additional people coming out of that operation, as we train, with better trained and better established processes in Mexico, we’re able then to bring those people out, Sushil you want to comment on that.

Sushil Dhiman

Yes in addition we have made some management changes in Mexico operations, I go back to the prepared remarks that I said we want to put right people in the right place, that effort is well in progress, we believe a majority of the heavy lifting is done in current quarter and it’ll continue on for the next two to three quarters.

George Melas - MKH Management

Okay, I have read the transcript of the previous calls, but there was not much specificity about sort of how you define or what happened in Mexico. Clearly the profitability went way down. Can you give a little bit more color in, sort of a diagnosis or sort of what happened?

Greg Gaba

Sure we can, the Mexican operations, I would say that there were two things that affected the profitability of that organization. The first of which was just a substantial growth in business in Mexico over the last couple of years, that’s point number one, point number two is there was a change in mix as well where we went from just building boards to doing complete box fills. And so there was assembly involved in that process, so the issue and the question that came up was the labor force, do we have a proper processes in place, skill sets and labor force to be able to take on that additional business and that change in mix. Obviously the answer was no, so the solution of prior management was just to hire additional body to try to fix that.

Part of the problem we had is as and this ties into the inventory adjustment, as they were building boards and those boards were determined to be defective, they were put to the wayside and they stacked up and during the year rather than actually scrap those with a scrap and taking the charge and literally just scraped it and send it out the back door and there was no record of the inventory going out. So that was a major problem, we had there over work orders on inventory that didn’t exist in the building. So we had a combination of bad skills, combination of a new product mix and a combination of just throwing bodies at it to try to figure it out, so it all ties in together.

George Melas - MKH Management

Okay. And how do you actually solve that, through better processes or by actually adjusting the mix?

Greg Gaba

Not adjusting mix, I’m going to hand it over to Sushil but it really involves a lot this through remediation plan that we have put into place, so Sushil you’re best suited there for that one.

Sushil Dhiman

So as again we have mentioned about the remediation plan that several prong approach, there are different elements of the organization and the process weaknesses we identified and remediation plan we have put together with the cross functional team which is managing this. And again a take even on that front we’re ahead of our schedule, in addition having the best practices and compliance team in place which will look at not just the Mexico operations but look at the rest of the global site and do the copy exact of our best processes that’ll help us in making sure that these type of issues are not accumulating in future.

George Melas - MKH Management

Okay, great.

Greg Gaba

And I think the other thing to speak of too is this aggressive cost of really rightsizing a plan that Sushil has developed, if you looked at the direct labor increase from 2012 to 2013 it was substantial. And you didn’t see a concurrent increase in business and so as a result there was -- this really ties into the comment that I made that the direct labor was increasing quite substantially over the year while the sales worked. So we saw -- I will have to say it’s probably $4 million or $5 million increase in direct labor and indirect labor, during the year, to try to solve these problems and that’s what we’re now focused on taking back out of this organization. So the combination of training people, the combination of establishing good processes, the combination of establishing good controls, the whole mix of business, it has not changed substantially but those three items put us in a position with reduced labor force and will lead us back to the industry type margins over the course of the balance of this year.

George Melas - MKH Management

But those remediation problems started in January or they started well before that when we had the interim management in place?

Greg Gaba

Well no it started -- I would say that the substantial increase in business started in the first half of 2012, in Mexico. The change in business started over the course of 2013.

Sushil Dhiman

And the new programs, first job, Larry and Clarke they used to stabilize the Company, work on the working capital and then by Q4 we had then started off on a right sizing the organization, so some work was done in Q4 and the balance started in Q1.

Greg Gaba

And I think that the prior management team recognized that they had a problem in Mexico and as a result they replaced the General Manager at the end of 2012. Actually Alex Walker stepped in as the Interim General Manager of Mexico and he looked for a replacement in the beginning of 2013. That person was hired, but that person, shortly after being hired, resigned because I think that the issues were overwhelming to that individual. Not so with the new team. The new team has got their arms around the issues.

George Melas - MKH Management

Okay great, and I think Sushil you mentioned that some of these efforts would bring you back to industry margins, or industry sort of extended margins, what do you define as industry standard margins on a gross and on the EBITDA line?

Sushil Dhiman

In our business if you look at the EBITDA as a percentage of revenue, it’s between 4% to 5%. We’re nowhere near that right now, but given all the plan we put together, the plan really expands over three to four quarters and as I mentioned heavy lifting in Q1 and we are at par or ahead of our listed plans which is shared with our bank and we’ve also have it independently verified by a strong firm.

Greg Gaba

I think here is a way to summarize it to say we’re pretty confident at this point and now that we’ve taken the physical and we have been here -- I have been here for almost a year. We’re pretty confident that we have identified all of the issues and we have got them behind us. This year is going to be spent really solidifying the foundation of the Company in other words making sure that we have the right people, processes and controls in place which will lead the margin improvement over the course of the year. Well concurrent with that we’re starting to rejuvenate the sales engine, but we really see that as fueling at the end of the year and the beginning of next year. So the growth plan would start kicking in at towards the end of this year and beginning of next year, but the real high priorities in the organization right now is ensuring that what happened before won’t happen again. That a very strong foundation from which to bring on organic growth and inorganic growth in the future.

George Melas - MKH Management

Okay that makes a lot of sense. And from a sales perspective, I imagine that it must not be easy to attract new customers with sort of the recent past, I am sure the change in management and the improvement in the balance sheet are really positive, but I imagine it must be very difficult?

Sushil Dhiman

It’s quite the contrary actually George I happily report that we have a very healthy customer pipeline. The prospects -- we’ve actually signed on two customers over the course of last three months for which we are beginning to do a quantification build and as you know typically in this type of scenario they takes nine months to a year to take that customer into a credible revenue run rate. You do qualification, then you do the material alignment but if you take a look at the material lead time it takes nine months to a year to have a sizable revenue out of those opportunities. But we are happy that we have started on two new customers and that we have currently a very healthy pipeline of prospects.

George Melas - MKH Management

Well, that’s encouraging to hear that. And are there customers are within that nine to 12 months pipeline, that could produce meaningful new revenue in 2014?

Greg Gaba

I mean the answer is yes. I mean there is a lot in varying stages of discussions and RFQs but with the addition of Josh, who Sushil has worked with over 15 years and has been very, very successful in the past, we’re pretty optimistic that with his skill set and his leadership, we are going to see good progress at our firm.

George Melas - MKH Management

Okay, great, thank you very much for taking all my questions.

Greg Gaba

I appreciate it. Thank you.

Operator

(Operator Instructions) And right now I am showing no further questions.

Sushil Dhiman

Okay. And that concludes our call. Thank you ladies and gentlemen and we will be fielding additional call if you need just call our investor relation number. Thank you.

Operator

Okay. Ladies and gentlemen this does conclude your conference. You may now disconnect and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: SMTC's CEO Discusses Q4 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts