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Measurement Specialties Inc. (NASDAQ:MEAS)

F2Q2011 Earnings Call Transcript

November 4, 2010 11:00 am ET

Executives

Frank Guidone – President and CEO

Mark Thomson – CFO and Secretary

Analysts

Larry Solow – CJS Securities

John Franzreb – Sidoti & Company

Michael Bertz – Kennedy Capital

Operator

Greetings, and welcome to the Measurement Specialties announces second quarter fiscal year 2011 conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Frank Guidone, President and Chief Executive Officer of Measurement Specialties. Thank you, Mr. Guidone, you may now begin.

Frank Guidone

Thank you. Good morning, everyone. Let me start by reminding everyone that comments made today fall into Safe Harbor provision. This conference call will contain time-sensitive information that is 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 end report on Form 10-K for additional information concerning factors that could cause actual results to differ materially from those found – from those in the forward-looking statements made during this conference call.

As we traditionally have done in the past calls, I'm going to make a few high level comments, then I'll turn the call over to Mark to make some specific remarks relative to the quarter and year-to-date performance.

As stated in our press release, we were very pleased with our second quarter performance. We posted record high sales, earnings per share, and adjusted EBITDA. We completed our first acquisition in 18 months. And we booked new orders in excess of sales, which is our best near term indicator of continued quarterly growth.

From a growth perspective measured in terms of our first half fiscal '11 as compared to our second half fiscal '10 – and let me just restate here that while Mark will do more traditional comparisons to prior year, given that our first half of last year was still deep into the recession, I think that it is in part more helpful to compare either quarter-over-quarter over the half-over-half results. So my comments here relative to growth are for the six months of fiscal '11 as compared to the last six months of fiscal '10.

We were strong in all regions, so Europe, US, and Asia all posted growth and strong in all market verticals, with the exception of test and measurement, which was flat for that period. And our business was (inaudible), which was down roughly 10% for that period in part due to their in-sourcing efforts, in part due to their effort to reach stock inventories in the back half of last year.

Consistent with the past few quarters, about 17% of our second quarter growth as compared to our trailing 12-month sales was driven by new business.

Despite a slow start, we had very good bookings for the quarter with a book-to-bill of 1.04. Recall that a book-to-bill greater than one signals continued quarterly expansion. The last two months, September-October, have been particularly strong booking nearly $52 million in those two months combined. Accordingly, as of today, our consolidated backlog, excluding the PSI, is at a record high of roughly $89 million. Given the strength of our second quarter bookings, along with the full quarter contribution from PSI, we believe the third quarter sales could approach $70 million, which would be a very exciting threshold for us to reach as a company right now.

We're particularly pleased with the quarterly earnings, adjusted EBITDA margin, so adjusted EBITDA as a percent of net sales hit 20% for the quarter. And as you may recall, this is consistent with our fiscal '13 target of $60 million on $300 million – $60 million EBITDA on $300 million in sales or a 20% margin.

With the growth that we've enjoyed in the core business and the associated improved leverage, along with the full year effects of PSI acquisition moving forward, it appears that we should be able to accelerate our $300 million goal from fiscal '13 and achieve that in fiscal '12 with the contribution from PSI.

As mentioned, we completed our first acquisition in roughly 18 months acquiring Pressure Systems from Esterline in September. PSI is a world leader in high frequency pressure scanners used in the aerospace research and test facilities, and provides hydrostatic level sensors, which are submersible pressure transmitters used in pump control and freshwater monitoring. PSI will add nearly $20 million in sales over the next 12 months and improve our operating statistics in terms of margins. Given its proximity to our existing facility in Hampton, we plan to consolidate operations sometime in the first quarter of fiscal '12, yielding cost synergies once completed of roughly $1 million annually.

If I look forward into some new developments, after three years of hard work, we are pleased to announce that we have our first official commercial program utilizing the mechanical tuning fork technology we acquired from Visyx. The program is for an automotive platform to be launched in the US by year-end and measures engine oil viscosity, particularly useful for this specific engine during cold starts. The initial engine platform is worth about $5 million in annual sales for Measurement Specialties. And we anticipate a second engine platform within the next 18 months that could triple that volume.

Further, the US EPA has recently taken a more aggressive stance in terms of their recommendation for a urea quality sensor, which is used in conjunction with selective catalytic reduction or SCR host treatment systems for off-road – on and off-road heavy truck diesel engines. This presents a meaningful opportunity for Measurement Specialties given that our tuning fork technology is one of, currently, two commercially available sensors that are prudent for this application in the field. Depending on OEM adoption, we expect this application to drive $10 million to $20 million in annual sales for us over the next – within the next three-year timeframe. And this is also very consistent with our efforts to increase content in this particular market in the heavy truck market.

So we're very excited about this development. It creates some interesting opportunities for us. It's a real differentiator with our tuning fork technology and finally allows us to apply this very exciting that we've been investing quite heavily in over the last few years.

So with that, I will turn the call over to Mark.

Mark Thomson

Thank you, Frank. I'll cover the financial results for the three and six months ended September 30th, 2010 in more detail. As Frank noted, we ended the quarter strong with solid sales and earnings growth. We continue to focus on execution through sales growth, cost management, and maintaining a strong balance sheet.

The second quarter represents the second consecutive quarter of record sales and earnings. Net sales for the quarter increased $17.2 million to $65.2 million, a 36% increase over the same period last year. Approximately $1.9 million of the sales increase came from our recent acquisition of PSI, which was consummated in early September. The balance of the growth is attributable to improvements in the economy, the expanded share of existing and new customers, and new programs.

Including PSI's sales contribution – excluding their sales contribution, organic sales for the quarter increased $15.4 million or 32% to $63.3 million over the same period last year. Organic sales increased $2.1 million or 3.5% over Q1. Roughly 60% of this growth is from sales to new customers.

Given the global nature of our business, sales may fluctuate from time to time based on changes in foreign exchange. The most notable FX impact is due to the fluctuation of the euro relative to the US dollar. Due to the fact that the euro was valued higher a year ago, our year-over-year sales comparisons are skewed by changes in foreign exchange.

For example, if the average euro to US dollar exchange rate had not changed during the three months ended September 30, 2010 as compared to the three months ended September 30, 2009, the company's net sales would have been higher by roughly $1.3 million. Although changes in foreign exchange, in particular the euro, impact how sales are reflected, the impact on profits is small given the balance of the euro denominated sales and euro denominated costs.

Gross margins for the quarter improved by over 660 basis points relative to the same period last year reflecting the increases in sales and production volumes and resulting overhead absorption of fixed overhead. Our gross margins in Q2 were favorably influenced by the PSI acquisition, which carries slightly higher gross margins than the company's average. Overall, our gross margins in Q2 were strong coming at 42.6%. Gross margins declined by 200 basis points from Q1, which is well within the normal quarterly fluctuation based on product mix.

Total operating expense for the three months ended September 30, 2010 increased $2.4 million to $18.7 million as compared to the corresponding period last year. Operating expenses of $0.7 million were associated with the PSI acquisition. Of this amount, roughly $0.2 million were transaction-related expenses that historically were capitalized in purchased accounting.

Excluding operating expenses attributable to the PSI acquisition, organic operating expenses increased $1.7 million or 11% and reflects increases in operating expenses in – or investments in human capital, compensation costs with the reinstatement of salaries, 401(k) match, and accruals and of compensation. Relative to the prior quarter, organic operating expenses decreased by $0.7 million.

During Q1, the company wrote off roughly $0.6 million in deferred financing costs associated with its GE led credit facility. Excluding the effect of this Q1 charge, the company's organic operating expenses were flat in Q2 relative to that of Q1. As a result, the company improved its operating leverage during the quarter.

Excluding amortization and stock compensation expense, adjusted SG&A as a percentage of sales improved by roughly 100 basis points in Q2 relative to that of Q1. We expect continued improvement in our adjusted SG&A leverage as the company continues to increase sales as a – at a higher rate than that of operating expenses.

Foreign currency exchange gains and losses represent the impact of changes in foreign currency exchange rates with, among other things, the revaluation of balance sheet accounts. The company reported foreign exchange loss of approximately $0.3 million during the second quarter as compared to a foreign exchange gain of approximately $0.4 million during the same period last year. The FX loss during the quarter is largely due to the revaluation of US dollar denomination assets at the company's European operations, which were adversely impacted by depreciation in the US dollar relative to euro during Q2.

Overall, the company believes it has successfully implemented natural hedges and has put in place formal hedge contracts to mitigate the volatility in foreign exchange. In particular, the company hedged a majority of its short position in the renminbi through deliverable forward contracts in China. These RMB impact – contracts are for – that end as of September 30th, 2011. The company continues to monitor foreign exchange and will continue to evaluate hedge strategies accordingly.

Income tax expense for Q2 increased to $1.2 million from $0.5 million as compared to the same period last year. The increase in income tax expense is primarily due to the generation of higher taxable income during the current period. The estimated effective tax rate, without discrete items for fiscal 2011, increased from 15% during Q1 to approximately 16.5% due to the estimated incremental profits generated in the US as result of the PSI acquisition. The overall estimated effective tax rate is based on expectations and other estimates and involves complex domestic and foreign tax issues, which the company monitors closely and is subject to change.

Despite larger capital investments during Q2 than in prior periods, the company generated free cash flow of $6.0 million during the quarter. We ended Q2 with cash balances of $26.5 million, approximately $3.3 million higher than that of our fiscal 2010 year-end; and, $2.0 million higher than that of Q1. The company did not make any payments to reduce overall debt levels during the first half of fiscal 2011, but retained cash balances to fund capital projects and to fund operations to support increased working capital requirements resulting from higher sales as well as partial funding of the PSI acquisition.

Our total indebtedness net of cash balances at September 30th was approximately $67 million, approximately $20 million higher than that of last quarter due to borrowings to fund the PSI acquisition. The company intends to reduce cash balances in the second half of fiscal '11 by reducing debt.

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

Frank Guidone

Thank you, Mark. Operator, at this time, we'd like to open the lines for some questions.

Question-and-Answer Session

Operator

Thank you. We'll now be conducting a question-and-answer session. (Operator Instructions) One moment please while we poll for questions. Our first question comes from Larry Solow from CJS Securities.

Larry Solow – CJS Securities

Hi, good morning.

Frank Guidone

Good morning, Larry.

Mark Thomson

Good morning, Larry.

Frank Guidone

I guess in terms of your longer term target and your 20% EBITDA margin goal, which has very nicely risen the last two quarters, Frank, as you look out and as sales grow towards that $300 million number, and clearly you probably have SG&A leveraged, but do you think that this 20% goal maybe actually could be exceeded into the low to mid-20s?

Frank Guidone

I think logically, if you listened to Mark's comments that our intent is to grow sales more quickly than we grow operating expense. You could say that, all else being equal, then that has to be the case. I would say that the only offset to that would be as we attack larger programs, those larger programs tend to carry a lower margin so we may get some mixed weighted weighing down on the contribution margin side.

So I think at this point – and to be fair, we've had an aggressive ramp-up in sales, perhaps slightly ahead of our ability to add back people and costs that were reduced during the recession. So it's some catch up of SG&A that we may do, so we may not see as much leverage as we would otherwise see here in the short term.

So I think the short answer is, clearly, the 20% number is a real number. Is it logical that as we grow, we can exceed that? I think yes, that's a fair comment. But the caveat's that it's not all upside. There is some give and take at the margin level; and perhaps at the operating expenses, we scale up for larger programs.

Larry Solow – CJS Securities

And some of the newer products and programs that you have in the queue right now, are these – would these be somewhat lower margin than – or a similar margin or what you're running now?

Frank Guidone

I would say that it's not always the case, but it's reasonable to conclude that as we attack – as the program size increases, you’re dealing generally with a more sophisticated customer and with some more sophisticated competition. And unless we are dealing with a particular technology that we have very well protected, you can assume a little more margin pressure in that scenario.

Larry Solow – CJS Securities

Got you. And then I guess the PSI numbers, margins are a – the gross margins are little better, but it's relatively a small piece of your business.

Frank Guidone

Correct.

Larry Solow – CJS Securities

Have you seen any pressure from rising raw materials or anything?

Frank Guidone

We are. Commodity materials have been increasing in availability, particularly on electronic components. It's been a real challenge. And it's forced us to do a lot of spot buying rather than long term purchases, which has affected – negatively affected our purchase price variance or PPV. So we have seen that over the last couple of quarters.

And as a result, we're running behind on our PPV goals for the year in terms of material cost reductions. We're getting material cost reductions, but basically just keeping our head above water and offsetting where we're having other expenses. We generally planned for that to be upside, so you're not seeing that filter through as negative impact. But we are seeing some of that.

Larry Solow – CJS Securities

And then just last question, just in terms of PSI, are their margins on the EBITDA level? Are they similar to you guys? And I think you had mentioned that when you acquired them that there were some opportunities to consolidate some facilities.

Frank Guidone

Right. I would say the margins today are similar to slightly better, and the margins get even better when we consolidate and get the operational cost reductions as a result of that consolidation.

Larry Solow – CJS Securities

Okay, great. Thanks a lot.

Operator

Thank you. (Operator Instructions) Our next question comes from John Franzreb from Sidoti & Company.

John Franzreb – Sidoti & Company

Good morning, guys. Frank, when you look at the business and you compare it to pre-recession levels, that base business from back there, has it recovered to pre-recession levels? Or is there still a mix that has yet to come back? I know we talked about, in the past, the heavy truck business. Can you just talk about how that business looks then versus now?

Frank Guidone

The heavy truck business, I would say, is in general completely recovered, at least in terms of what we're shipping. What would make it a little difficult, John, to compare apples and apples here is that, for example, our TRICAN, which is used in engine management in the heavy truck market, this is being driven by some of the more stringent regulatory requirements that phased in last year – this year. And so we've picked up content. And so for us, our heavy truck business is up in part due to the heavy truck companies actually just shipping equivalent or close to the equivalent number of vehicles, but in part being more driven by more content.

John Franzreb – Sidoti & Company

Okay. And are there any other laggard pieces of your company that have not yet come back?

Frank Guidone

I would say test and measurement was the piece that has come back most slowly. In part, if you – particularly, if you include the factory automation sector in that, which really is tied very closely to factory capacity and utilization. Although I would say that our business in France, which is the site that is most closely tied to T&M, has got a record backlog right now. So it's improving. I don't think I could say it's at pre-recession levels, but it's getting close. And certainly the bookings that we're taking over the last three to four months put us at a level that's more consistent with pre-recession levels.

John Franzreb – Sidoti & Company

Okay. And the tuning fork technology that is going into the engine viscosity measurement, that $5 million annual number that you threw out there, what is the timing of that? When does that start to roll in?

Frank Guidone

We go into production at the end of this month. So there's a ramp-up, of course. But our estimate for fiscal '12 is $5 million for that program.

John Franzreb – Sidoti & Company

And the larger one that you said is three times the volume, what is the thought about when that announcement comes through?

Frank Guidone

Yes. The larger is two times the volume. It makes a total of three times.

John Franzreb – Sidoti & Company

Okay.

Frank Guidone

We should know within the next 12 months whether that's going to move forward or not.

John Franzreb – Sidoti & Company

Okay. And Mark, you mentioned about normal seasonality product mix in the quarter that impacts the gross margin. Could you just remind me what that is?

Mark Thomson

Sure. We've got various product lines that have different, I'll call it, contribution margins. So dependent upon the actual sales within any given quarter, that mix may influence our overall gross margins.

Frank Guidone

And I wouldn't call it seasonality, John.

John Franzreb – Sidoti & Company

Okay.

Frank Guidone

I think it's really not. It's just the fact that we have such a diverse mix of products and customers. And those different products and customers on various programs carry different margins. The given mix of business that we have at any given quarter, we can see varying gross margin of a point, and really have nothing to do with other than just a mix of how the business has shifted in that particular period.

John Franzreb – Sidoti & Company

Yes. I guess I can understand if you're going to say to me it's European shutdown and that changes the mix. But I just wanted to know if that was it or something other than that. That you tend to have volumes pick up in this quarter versus another quarter. That is the color I was looking for, guys.

Frank Guidone

Yes. The top 50 customers represent about 40%, 45% of our business, right? So those are generally larger programs, are fairly stable and steady that we can project quarter-to-quarter. But then, there's another 2,000 customers that make up that bottom 55%, and there's an awful lot of customer orders. They may place a $250,000 order this quarter and then we don't see them again for a year. And that might carry a very good margin and therefore mix weights us up in this particular period. So there's a lot of mix like that that's not repetitive that influences the overall gross margin at the end of the day.

John Franzreb – Sidoti & Company

Okay. Thanks a lot. That's all for me.

Operator

Thank you. Our next question comes from Michael Bertz from Kennedy Capital.

Michael Bertz – Kennedy Capital

Good morning, gentlemen. Just a couple of questions to follow-up on the PSI piece, you talked about your ability to grow revenue overall faster than OpEx. Is there any above or below trajectory you would cite for this, the PSI piece that you are adding here, whether you can do that faster? It's a mature group. Is there something you can either extract more sales out into your channels that they weren't being able to exploit before or how do you think about that?

Frank Guidone

Yes. I think PSI was interesting because there was both an interesting strategic play as well an operational play. On the strategic side, I think where you're alluding is a piece of the business, at least, is in a very fragmented segment in the water monitoring segment, specifically in more of the water utility, which is pump control for waste treatment facilities, things like that. That is a more cost sensitive market. And it's one that we can bring a lot to PSI in terms of dramatically cost reducing our transducer that we are supplying into that space and being more aggressive in taking share with a well-performing, real value product.

So we're in the process of developing that now to be able to introduce that and be aggressive and taking share in that space. That is something that PSI, by itself, would not have been able to do. But with the resources that we have and our understanding and capabilities in China, it really gives us the opportunity to build – to do building blocks that they can then combine to still offer a custom solution, but do it at a much lower price.

Michael Bertz – Kennedy Capital

Okay, great. Then you talked about being it being accretive on the margin sign. But across the balance sheet, as you think about this addition to your business, anything you need to do there to – are you are required to hold more inventory than you might for that given volume in another part of your business? Or anything where you can turn the plant turns faster?

Frank Guidone

It won't be material. The inventory turns are a little better than ours overall. But that may be offset a little bit as we integrate more of China in this strategy I just mentioned. So I don't we'll see a material change one way or the other as a result of PSI's addition to the business. It looks, for example, in this period because we've got all of the inventory on the balance sheet in this snapshot. But in our trailing three months, which is how we typically do our turns calculation, we've only got three weeks of the cost of good. It is going to negatively influence this particular period snapshot. But as we roll into next quarter, we'll see the inventory turns consistent with where we were for the last quarter.

Michael Bertz – Kennedy Capital

Okay. So if you were to look at – again your snapshot for the trailing three months, would you say that the days of inventory ex the acquisition inventory would be basically flat with where you were previously?

Frank Guidone

We were slightly down in the quarter as a result of ramping up inventory in support of growing volumes. But it's not materially changed from last quarter.

Michael Bertz – Kennedy Capital

Okay, great. Thanks, guys.

Operator

Thank you. (Operator Instructions) We appear to have no further questions. I'd like to turn the call back over to the speakers for any closing comments.

Frank Guidone

Thank you. Well let me just close by saying that we are very excited about how the company is performing and about how we are positioned within our target markets. A combination of recovering end markets along with traction on new programs have given us the top line lift needed to fully absorb fixed costs and deliver exciting earnings. Our ability to take share on new programs coupled with strong organic market growth could yield continued top line expansion, which we believe will translate into exciting growth in shareholder value.

On our investor conference schedule, we've got the Sidoti conference scheduled in New York on November 16th. And we'll be in Boston on the 17th and Baltimore on the 18th with Needham and CJS, respectively. Those who are interested in trying organize meetings during that week you can contact Mark or the respective firms.

We appreciate everyone's interest and continued support. And, operator, that will conclude today's call.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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