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Sevcon, Inc. (NASDAQ:SEV)

Q3 2014 Earnings Conference Call

August 6, 2014, 09:00 AM ET

Executives

David Reichman –IR

Matt Boyle – President and CEO

Paul Farquhar – CFO

Analysts

Operator

Good day, ladies and gentlemen, and welcome to the Sevcon Third Quarter Earnings Conference Call. Today’s call is being recorded and webcasted. My name is David, and I'll be your coordinator today. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of the conference call.

I would now like to turn the call over to your host for today, Mr. David Reichman, with the Investor Relations firm Sharon Merrill. Please proceed.

David Reichman

Good morning everyone and thank you for joining us, if you have not received a 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 also 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 business. Paul will follow with a financial review, and then we’ll open the call for your questions.

Sevcon's financial results continue to improve this quarter. On a year-over-year basis, sales were up 11% from quarter three of fiscal 2013. Sequentially, we extended our trend of consistent topline growth since the recent low point in quarter one of fiscal 2013 as quarter three sales increased 5% from quarter two.

On a geographic basis, sales for the quarter generally tried global economic trends. We recorded double-digit sales growth year-over-year in both the Far East and the U.S., but our sales in Europe were flat.

As in quarter two, sales growth in the Far East was driven primarily by the demand from traditional sectors and from on-road applications in China.

The stronger sales in the U.S. primarily reflected increased shipments for hybrid on-road vehicles as well as shipments for applications in our other EV category, both of which I'll discuss in a moment.

In Europe, quarter three sales were flat year-over-year. This was largely a consequence of higher sales to the Aerial Work Platform market, offset by lower aftermarket sales, reflecting our shift this past year to a third party distribution model, as well as lower demand in the forklift truck market.

In Asia, although Sevcon's growth continues to be fuelled mainly by demand in our traditional off-road industrial and construction sectors, our new unit initiatives in the on-road sector are beginning to bear fruit.

We continue to expand our portfolio of development programs with large Asian OEMs in the region.

A majority of these projects are for scooter and motorcycle and quartercycle applications, reflecting interest in twitty-type vehicles as well as electric scooter and motorcycles in the 125 CC to 550 CC equivalent range throughout the Far East. These on-road EV markets are still in their early stages.

Our sales for quarter three in the two wheel on-road sector were down in double-digits year-over-year, following mid double-digit growth in quarter two. We expect this business to continue to be lumpy from quarter-to-quarter going forward.

Looking now at the four wheel on-road sector across all geographies, Sevcon's total sales were up mid-single digits in quarter three year-over-year, a significant portion of this growth was driven by shipments to a company called Excel Hybrids, a U.S. based manufacturer of hybrid power and condition systems for commercial vans and trucks.

Excel Hybrids is one of a number of customers that we're working with on projects related to hybrid, electric vehicle technologies. Several of these projects are in Europe, including two in Germany that could become significant opportunities for us over time.

Our quarter three sales for four wheel on-road applications also reflected a seasonal increase in our business in France with Renault for the Twizy electric city car.

We made significant progress this quarter on several projects focused on four-wheel on-road applications in the Far East, one of them with a supplier of a mid-size electric passenger car being developed by a large government-owned automaker.

As we discussed on our conference call in May, early in quarter three, we received the required government approvals in China for a joint venture with Risenbo Technology and the JV agreement became effective. Risenbo is a subsidiary of a Chinese Tier 1 automotive supplier based in Hubei Province.

We and Risenbo each own 50% stake in the joint venture, which is being led by me as the Sevcon nominated Chair.

By partnering with an established and respected player in the Chinese automotive industry, we are now in better positioned to capitalize on that country's growing electric vehicle demand. The JV is initially targeting on-road electric and hybrid vehicle applications, marketing and selling principally to Chinese Tier 1 automotive supplier.

The JV activity in quarter three largely focused on building our commercial infrastructure, including facility, staffing, training and supply chain work, we anticipate making our first shipments to customers and recording our first sales in China during the current fourth quarter. Paul will discuss our expectations for JV related start-up cost in a few moments.

Looking forward, we expect that our joint venture with Risenbo, coupled with our new business initiatives in China will enable us to forge relationships with additional new customers and what is becoming the world's largest market for two and four wheel electric vehicles.

I mentioned earlier that we recorded higher quarter three sales in the other EV category. This quarter was primarily a consequence of strong shipments for recreational vehicle applications in the U.S. We also recorded our first shipments to a U.S. manufacturer of gyro stabilizers for leisure yachts and commercial marine applications, part of a growing electrification demand.

Looking forward, we feel good about our new business pipeline. It's our policy not to discuss specific customer relationships until we are in commercial production and shipping and volume.

In general however, in addition to the hybrid vehicle projects that I mentioned, our pipeline also includes products that target the new off-road industrial sectors. These products include our Gen4 controllers as well as new high voltage power products for the electro hydraulic market.

Electro hydraulic provides us with near-term entry points for capitalizing on the world-wide trend towards electrification on ancillary powertrain systems, not only our motor vehicles but in commercial and industrial traction and power applications.

That is replacing outdated, inefficient systems such as hydraulic steering, hoisting and component such as belt driven coolant pumps, super chargers, turbo chargers and cargo refrigeration units with electrically powered solutions.

We also have opportunities in new functionalities such as start-stop and regenerative breaking to be increasingly stringent miles per gallon and emission standards.

From a technical standpoint, electrification is now feasible for these applications due to the advent of the lithium Ion battery in commercially viable forms. The consequence of this is that our customer's traditional engineering skill set moves from mechanical to electrical as electrification gains acceptance.

With a growing number of supplier and OEM relationships aimed at this opportunity, many of these relationships are focused on developing integrated sub systems that leverage our unique hardware and software capabilities per management and inverter technology as well as motor controls.

Put simply we believe that Sevcon's future is brighter than ever. Quarter three marked our sixth consecutive quarter of sequential revenue growth and our fourth straight of growth year-over-year.

Looking ahead near term, the positive comments we are hearing from our customers suggest that our business environment will continue to improve. We are adding new relationships to our portfolio of customers.

At the same time, 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 on incremental sales as conditions in our markets improve.

As we said in our call last quarter, our key strategic challenges scaling the business to capture growing opportunities in a timely basis, whether organically or through acquisitions. Among them are the applications electrification, which I just mentioned.

Capturing these opportunities requires the strength in our balance sheet. As a consequence, capital structure and capital allocation are key strategic priorities for Sevcon at both the Board and Management levels. We're rightly executing against these priorities and the rates offering that we discussed conceptually on our call last quarter is now underway. Paul will discuss the offering in more detail.

We had substantial opportunities to date to expand our business both organically and through acquisitions, particularly in new markets for us like China and in the electrification of systems. The success we achieved the organic growth we need to increase resources such as headcount and engineering and sales.

In addition, we are regularly reviewing plans and seeking to grow the business profitably, which could include acquisitions. We believe that when we identify possible acquisitions, it would be desirable to have the resources at hand to complete any transaction quickly. We are looking forward to reporting results of our offering on our next quarter call.

With that, I'll turn the call over to Paul for a review of our financial results. Paul?

Paul Farquhar

Thank you, Matt and good morning, everyone. As a reminder, the control segment that Matt discussed to Sevcon's core business, we also operate a legacy capacitor business that continue to report a small amount of operating income in the third quarter of fiscal 2014.

Reviewing Sevcon's financial performance for the quarter and starting with the income statement, total revenues increase 11% to $9.7 million, from $8.7 million in the same period in fiscal 2013.

As Matt said, in our controls business segment, sales in our traditional aerial work platform and forklift truck markets showed double-digit growth this quarter compared with Q3 last year as did sales for on-road applications principally in the Far East.

Whilst we saw overall sales growth of 12% in the on-road sector of our business, this reflected a mixed results from sales to manufacturers of two wheel and four wheel vehicles.

Our sales for the quarter in the two wheel on-road sector were down 39% following 32% growth in the second quarter. We expect this business to continue to be volatile from quarter-to-quarter going forward.

In the four wheel on-road sector and across all geographies, total sales were up 54% in the quarter. In terms of geography and excluding foreign currency effects, sales generally tracked economic trends across the territories in which we operate.

Revenues increased 18% from the third quarter last year in North America. This growth being driven by increased sales to the four wheel on-road sector to manufacturers of off-road recreational vehicles and to the new sector Matt mentioned earlier, gyro stabilizers for leisure yachts and commercial marine applications. Together these areas more than offset a reduction in sales to the mining sector.

Our third quarter sales in the Far East were up 38% year-over-year, driven by stronger product demand for aerial work platform and forklift truck applications in China and Japan. Sales in Europe were largely flat compared with quarter three last year, largely a consequence of lower after market sales.

This reflects our shift in the past year to a third party distribution model as well as lower demand in the forklift truck market.

Turning now to operating expenses, we continue to benefit from our low cost manufacturing model. We've traditionally relied on third parties for the majority of our production. Outsourcing to trusted manufacturing partners allows us to add capacity while minimizing the addition of fixed costs.

As a consequence, our operating expenses consists primarily of product development, engineering, sales related expenses and general and administrative expenses, including compensation and direct R&D costs.

Total operating expenses to Q3 increased by $419,000 from the third quarter of fiscal 2013. This increase largely reflects continued investment in sales and marketing and engineering and research and development, including the hiring of additional staff in response to the strong topline growth as well as the impact of adverse currency movements compared to the prior year.

In addition, the company recorded grant income of $132,000 in the third quarter of 2014, compared to $40,000 in the third quarter in the prior year. This grant income was recorded as a reduction of a reduction of research and development expense in each year.

Our reported operating expenses include engineering and R&D, which are reported net of grants received. R&D expense, net of grants was 10.8% of sales in the third quarter of fiscal 2014, compared with 11.2% in Q3 last year.

This continuing level of expenditure reflects our ongoing commitment to product development and improvement.

As Matt mentioned earlier, we now have the required government approvals for our Chinese joint venture to start trading and we anticipate initial shipments to customers in the current quarter.

The activities of the joint venture company in the third quarter were limited to the investment of initial capital by each party, resulting in business premises and the hiring of engineering and sales and marketing staff.

This activity will result in as recognizing in our fourth quarter, our share of the related initial business establishment costs, which will reduce Sevcon's net income for the quarter by approximately $150,000 after tax. The financial statements of the joint venture company have been consolidated within Sevcon in Q3.

Operating income for the third quarter of fiscal 2014 was $213,000 compared to $293,000 in the same period last year. Adverse foreign currency movements reduced our third quarter operating income by $94,000, compared to Q3 last year.

Excluding foreign currency, operating income was comparable with the prior year quarter.

We reported a small income tax benefit of $34,000 this quarter, compared with an income tax charge of $47,000 in Q3 last year. Our effective tax rate for the first nine months of 2014 was 7%.

This low rate reflects the significant variance in income tax rates in the jurisdictions in which we do business and the relative profit or loss made in each business in each period. In addition, there was continuing impact of the year-on-year reduction in the corporate income tax rate in the U.K. and also the availability in the U.K. of favorable R&D tax credits, which further reduces our effective U.K. and global income tax rate.

Sevcon reported GAAP net income of $222,000 or $0.06 per diluted share for the third quarter of 2014, compared with $171,000 or $0.04 per diluted share in Q3 of fiscal 2013.

Turning now to cash flow and working capital items and excluding the impact of foreign currency, receivables increased by $800,000 and inventories and prepaid expenses increased by a combined $1.4 million in the first nine months of 2014, all of which reduced cash during the period.

Accounts payable accrued expenses in the accrued taxes increased by a combined $400,000, which increased cash during the period. the number of days receivables was 66 at June 28, 2014 versus 65 at the year ended September 30, 2013.

On our last call, we discussed an approximate $550,000 receivable from [Seattle Bryant] (ph) Motors one of our customers in France, which entered into legal administration protection for a minimum period of six months in early January 2014.

Also in late April, the commercial quarter Lyon in France gave Sevcon the option to recover from the customer the entire inventory of material represented by the $550,000 receivable.

The inventory concern represents current saleable product and in the opinion of management could be sold by company’s French subsidiary to alternative customers in a reasonable timescale.

In late June 2014, the Commercial Court in Lyon announced that it had approved the acquisition of [Seattle] by Central Motor Corporation and Nevada-based manufacturer of all electric vehicles.

Central, which is an existing user of Sevcon Controls, has since announced that it will inject an initial $20 million of working capital into the former [Seattle] operation. It will create a new French company, which will serve as the European Head Quarters at the Central Motors Group.

We are currently seeking to engage with Central Motor Corporation to discuss the recoverability of the outstanding receivable and the future supply controls for electrical vehicle manufacture.

Although we are pursuing full payment of the debt, given the ongoing legal uncertainties, it remains unclear as to whether this receivable can or will be repaid. As we said last quarter, the full amount of the receivable was recorded on the balance sheet at June 28, 2014.

And turning to the balance sheet currently Sevcon ended the third quarter with cash and cash equivalents of $1.3 million, flat with a year earlier. Finally we closed the third quarter fiscal 2014, with $1.7 million of long-term debt, compared with $1.8 million 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 drawn down at the end of Q3, which represented the long-term debt just mentioned. This revolving credit facility was extended as of September 30, 2013 and will expire on June 14, 2017 when the principal will be payable in full.

We also have a $1.5 million bank overdraft facility with RBS NatWest Bank available to our U.K. subsidiary companies. This facility was renewed for a further period of 12 months in July 2014 and was unused at the end of the third fiscal quarter.

Last week we finalized and filed with SEC a rights offering of Series A convertible preferred stock and tended to raise $10 million before expenses. As we announced in mid July the record date for the offering was July 25.

The rights offering, gives all of Sevcon’s existing shareholders the opportunity to participate. The net proceeds will be used for general corporate purposes and growth including funding Sevcon’s ongoing research and development, product commercialization initiatives and acquisitions of other businesses.

The preferred stock, which has a stated value of $24 per share and carries a 4% cumulative annual dividend, will be convertible at any time as the holder's option into shares of Sevcon’s common stock at an initial conversion price of $8 per share representing a conversion ratio of three share of common stock to each share of preferred stock.

Sevcon will also be able to require conversion at any time after five years if the closing sale price of the common stock has exceeded $15.50 of 20 out of 30 consecutive trading days.

The subscription price is $20.50 per whole share, which is equivalent to $7.17 per share of common stock on an as-converted basis, a 7.3% discount from the closing sale price of $7.73 per share on July 28, 2014.

The subscription rights, which will be listed for trading on NASDAQ under the symbol SEV [RR] (ph) will expire on September 8, 2014, unless Sevcon extends the rights offering period.

The company has received standby commitments for Mason Capital LP whose managing partner is Ryan Morris a Director of Sevcon and Walter Schenker another Director to purchase shares of Series A convertible preferred stock, not subscribed for by other stockholders up to an aggregate amount of $1.15 million less than the amount they invest to purchase shares upon exercise of subscription rights. A majority of other directors and officers have indicated their intention to participate as well.

Stockholders of record on July 25, we will shortly receive the prospectus and subscription rights together with information about the process for exercising their rights.

Now turning to our income statement results for the first nine months of fiscal 2014, Sevcon sales for the nine-month period were $27.9 million compared with $23.3 million in the same period last year, a 20% increase year-on-year.

Gross profit for the nine-month period was 39.5% of sales compared with 36.4% of sales a year earlier, reflecting better sales mix on cost savings achieved from the restructuring exercise in the second quarter last year.

Sevcon’s operating income was $1.1 million, compared with an operating loss of $1.4 million for the nine-month period last year after charging $605,000 in onetime restructuring costs.

Our net income for the first half of this -- for the first nine months of this year was $872,000 of $0.25 per diluted share compared with a net loss of $1,116,000 or $0.33 per share in the same period last year.

In conclusion, 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 the remainder of fiscal 2014 and continuing into 2015. We look forward to reporting our progress in the quarters ahead.

David, you can now open the call for questions please.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question and answer session. (Operator instructions) Mr. Boyle, it appears that there are no further questions. Therefore, I would like to turn the call back over to you for any closing remarks.

Matt Boyle

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

Operator

This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.

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