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Executives

Dennis Bunday - EVP & CFO

Pat Cavanagh - President & CEO

Analysts

Williams Controls Inc. (WMCO) Q1 2012 Earnings Call May 1, 2012 4:15 PM ET

Operator

My name is Shinal and I will be your conference operator today. At this time I would like to welcome everyone to the Williams Controls second quarter fiscal 2012 investor conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions)

I will now turn the conference over to Dennis Bunday, Chief Financial Officer.

Dennis Bunday

Thank you. Good afternoon everyone and welcome to our second quarter fiscal 2012 conference call. Before we begin, you should note that the following discussions and responses to questions reflect management's views as of today, May 1, 2012, and may include forward-looking statements.

Actual results may differ materially from those projected in the forward-looking statements. Information concerning risk factors and other factors that could cause actual results to differ materially is included in our filings with the SEC, including our 2011 annual report on Form 10-K, our fiscal 2012 reports on Form 10-Q, and our fiscal 2012 current reports on Form 8-K.

Specific factors that may cause such a difference include, but are not limited to, availability of adequate working capital, domestic and international competitive pressures, increased governmental regulations, increased costs of materials and labor, and general economic conditions in the United States and abroad.

I will now turn the call over to our CEO, Pat Cavanagh, for his comments on the quarter.

Pat Cavanagh

Thank you Dennis. Good afternoon everyone and welcome to our conference call. This morning we released our financial results for our fiscal second quarter that ended March 31, 2012 and I am glad to see as many of you joined us from New York as are on the call because I was kind of concerned about what was going on out there. Sales for the quarter were $16.8 million, up 13.8% or $2 million from the $14.8 million reported in the comparable period last year.

For the six month period sales increased $4 million or 14.1% to $32.3 million from comparable six month period last year. NAFTA truck sales was the primary driver of increased sales in the quarter and the six month period. Our NAFTA truck sales were up 46% in the quarter and 51% for the six month period compared to the same periods last fiscal year.

Last week I was at the Heavy Duty Business Forum meeting at Phoenix with many of your key supplier executives in the trucking industry. My opinion is that the outlook for sales this year is still a bit uncertain and many people now believe that the industry will build around 270,000 class A trucks and a 150,000 medium duty trucks this year, down from earlier projections but up from last year.

I think this view was reinforced when a couple of OEMs adjusted their production build schedules last quarter. Global off-highway sales were up 23% for the quarter at $4.2 million and up 29% year to date at $8.4 million compared to last year as a result of new products and programs coming to fruitions with key global off-highway manufacturers.

We are particularly excited about our success in this market at the TOEMs over the last couple of years. As we have discussed in the past we are in the midst of launching an aggressive sales and media campaign this month for our new CAN-bus Joystick product line.

This product was introduced at INTERMAT, a major off-highway equipment show in Paris two weeks ago and we have a number of print and digital advertisements appearing this month in major trade journals. We have provided units to a number of the North America and Asian OEMs at this point for testing and evaluation.

In our design, we have incorporated the voice of the customer which has resulted in an economical and very robust design. In fact a couple of weeks ago when we demonstrated our joystick to a technical executive at one of our major off-highway OEM customers for the first time, he commented that it was very similar to our pedals and described them in one word bulletproof. We feel that our long-standing relationship in context and quality certifications with all of the major off-highway OEMs combined with our global platform that will enable us to be successful with this new product, we intend to be manufacturing our joysticks for the Asian market and in our plant in China in fiscal 2013.

With the significant investment by the many of the global off-highway OEMs in the China market, it will simply be one of the largest markets for joysticks in the world and we will leverage our footprint in customer relationships in that market with this new product. You may remember in our last call we described the shortfall in sales in Korea and with one large European truck OEM.

At that time we believed this shortfall was largely contained in the first quarter and in fact sales in Korea and to this European OEM have returned to normalized levels in the second quarter. Sales in Korea were up sequentially a 167% to a more normalized basis and on the same basis through European truck OEMs, we were up 49% reflecting a return to normalized levels there also.

Sales in India reached over $750,000 for the first six month period with well over $500,000 coming in the second quarter as our business continues to grow in this market. As a comparison you may recall that all of last year we sold 1.2 million in India. We expect to see some volatility in this market going forward, but the trend is positive and we believe that we are well positioned for the tightening of emissions in this market scheduled for 2014.

Our sales in China were flat compared to the same quarter last year. We are facing the same macroeconomic challenges as other suppliers as the truck and off-highway equipment sales have slowed in this market. While we have discussed this at length in the past there is a growing sense that the Chinese truck OEMs that it is likely that Euro 4 truck emission standards will be implemented as scheduled in July of 2013. However it may be implemented in several phases starting with the coastal regions first.

I will now turn the call over to Dennis Bunday to discuss our financial performance for the quarter. Dennis?

Dennis Bunday

Net income for the quarter was $895,000 or $0.12 per diluted share compared to $224,000 or $0.03 per share in the second quarter of 2011. When looking at quarter to quarter comparisons, it is important to note that one-time charges in the second quarter of fiscal 2011 for a terminated acquisition and a legal settlement reduced the 2011 quarterly net income by approximately $290,000 or $0.04 per share.

For comparative purposes excluding those charges the second quarter 2011 net income would have been $514,000 or $0.07 per share and without these one-time charges net income for the second quarter of fiscal 2012 was still up $381,000 or 74% from 2011 on the 14% higher sales. Other than costs directly variable with sales such as materials of labor most other costs were relatively consistent with last year. The only exception to that was India which is still somewhat of a drag on earnings as we continue with our investment in that important market.

We are aggressively making progress with our planned localization of the supply base but until that is completed which we estimate will be later this year India will continue to focus with our planned localization of the supply base. But until that is completed, which we estimate, will be later this year, India will continue to post modest losses. Additionally, accounting conventions require that we do not factor in a tax benefit on the India loss at this time.

Overall, the India startup reduced earnings approximately $0.03 per share in the 2012 second quarter. Looking at the six month numbers, net income for the first six months of this year was $1.9 million or $0.25 per share, which was more than double last year’s first six months net income of $868,000 or $0.12 per share. Again, to gain a better understanding of the comparisons, it is preferable to eliminate unusual items from both periods.

The first six months of this year includes an after-tax gain of $145,000 or $0.02 per share related to reducing our environmental accrual in the first quarter for the Portland facility. The State of Oregon Department of Environmental Quality recently modified the allowable exposure levels for certain contaminants, reducing the amount of remediation we will be required to perform and the amount necessary in our clean up provision. The first six months of 2011 included after-tax charges of $410,000 or $0.06 per share for the terminated acquisition and legal settlement costs. Comparing the results, excluding these one-time items, the 2012 first six months net income would have been $485,000 or approximately 40% higher than 2011, again on 14% higher sales. Observations for the six months are similar to the quarter. Other than costs that vary directly with sales, costs are generally in line with last year. India impacted the six months performance by approximately $0.07 per share.

For the quarter the basic EPS share count was 7,321,315 and the diluted EPS share count was 7,502,045. At quarter-end we had 7,332,750 shares outstanding. Operating expenses comparisons for both the quarter-over-quarter and the first six months were relatively flat when comparing 2012 to 2011 after excluding the one-time charges in all the periods. For both the quarter and six months, our selling expenses are higher as we have added additional technical support to our European sales team. However, small costs savings and other areas have offset the majority of that interest.

For the second quarter, the effective tax rate was 41.8% compared to 53% for the second quarter of fiscal 2011. Our effective tax rate can fluctuate rather significantly based on several factors including the tax jurisdiction in which the pretax income is earned, income tax rate differences between domestic and foreign jurisdictions, our repatriation status and the valuation allowances or reserves placed on our deferred tax assets among other things.

Normally, our tax rate would be in the mid-30% range. However this quarter our tax rate was higher as we continue to place evaluation reserve on the India deferred tax asset, the exploration on December 31 of the lower rate China tax holiday we were granted and recognition of additional US tax expenses associated with foreign earnings that we do not intend to indefinitely reinvest in China. The tax rate was higher in the second quarter of fiscal 2011 due primarily to the initial recording of a valuation allowance against our deferred tax asset for that subsidiary. Note that we expect this valuation reserve in India to be a temporary factor as we will be able to recognize the tax benefit at some point in the future when we establish a consistent earnings history in India.

Turning to the balance sheet and cash flow, our net cash position at the end of the quarter was essentially a small borrowing position of $200,000 consisting of 1.3 million in cash and 1.5 million in short term revolver borrowings. EBITDA, which consists of operating income, depreciation and the non-cash chart for stock option expense contributed $4.8 million in the first six months of fiscal 2012.

Inventories decreased to 2.1 million during the first six month of 2012. The reduction was mostly related to reducing certain safety taxes, supplies and stabilizers for some component, particularly rare earth magnets and more closing balancing inventory requirements with our sales mix. Trade payables and accrued expenses were down from a year-end due to the timing of payments of accounts payable and seasonal payments of accounts accrued at the end of prior year for property taxes, compensation and insurance payments.

Depreciation and amortization for the second quarter was $530,000 and non-cash stock options expense was $199,000. CapEx for the quarter was $242,000 and $502,000 for the year-to-date. Although our capital spending is much lower than normal through the first six months of 2012, we anticipate that our capital spending will be in the $2 million range for the full year as certain larger projects are completed later this year.

Today we announce our regular quarterly dividend of $0.12 per share payable on May 24 to stockholders of record as of May 17. Thus far this fiscal year, we have paid out approximately $1.8 million in cash dividend to stockholders.

This concludes the formal comments. We would now like to turn the meeting over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from [Mat Berry].

Unidentified Analyst

I have two questions. Firstly, regarding the valuation reserve which impacted income tax expense. I am just wondering you have, essentially, a 100% valuation, is that right against all of those NOLs?

Dennis Bunday

Yes, that’s correct.

Unidentified Analyst

Okay. So what is the balance of those NOLs before the valuation reserve?

Dennis Bunday

We are looking right now at about $400,000 on our total valuation reserves. And when we started having a consistent earnings pattern in India, we will then take those in and probably remove that reserve, I would think, in one particular quarter. It’s about -- right now it’s about $0.05 to $0.06 a share somewhere there.

Unidentified Analyst

Okay, alright. Also and then ---

Dennis Bunday

That’s cumulative from the start. That just for the quarters.

Unidentified Analyst

Okay. And then secondly, I was expecting gross margins come on a little bit higher this quarter and it may just be my optimism, or somewhere close to the variation. I know gross margin was comparable year-over-year but it is still tracking little low than I would expect for the current level of sales. So could you, is there any more information you can give me just on how we get that 29.7% gross margin this quarter. It is down very significantly from last quarter.

Dennis Bunday

I think I can help you little bit with that math, a couple of things. First, of all you know last year in our March 31 quarter we were still ramping; we did not have a full quarter in the operation since that time we think of March 31 through this period. We have continued to progressively develop that facility there, so that added some overhead.

And secondly, until we get localization on our India supply base, our material cost are higher because we are having to pay freight and duties to bring in those components from China into India. And with that, I am going to say, we probably – it’s probably costing us point 1.5 may be a little more by 2 points in margins and right now in gross margin, because of the India investment, the start-up there.

Unidentified Analyst

Okay.

Dennis Bunday

And that’s the biggest factor there.

Unidentified Analyst

And is there anything else, I know that there were some things that last quarter I was wondering with clearance and stuff that that’s all normalized and is there anything else in that we should know about?

Pat Cavanagh

Well, I think the point Matt you should consider is this as a result of some of this, the rare earth magnet situation, that rapid increase that we’ve experienced over the last 18 months or so, we have implemented some price increases that will start taking effect in fact in this quarter. So that should help the margins in a couple of places including Europe and India.

Operator

(Operator Instructions) And we do have a follow-up question from [Matt Berry].

Unidentified Analyst

One of the things, so I could see the joysticks and you are making progress on actually executing and getting this in that market. So what's your timeline, you know we begin the Media Blitz now with adverts in the TradeMax.

So what is your timeline do you think for the various stages going forward from here; obviously, you've got to build awareness, you've got to find some orders. So I am just wondering what's the timeline for this thing to ramp up and what are the stages I should be looking at?

Pat Cavanagh

Well, you know its kind of an interesting process. We are surprised that we have two OEMs, major OEMs that have shown a lot of interest in the product. And we thought that would take a little bit longer.

The ramp up with an OEM is probably a year. You know from the time they start looking at it, evaluate it and make sure that we have the capacity for their needs. Each one of these is a little bit different and I am sure they will come up with some specific proprietary way that they want to modify the handle or something like that. And so to put an OEM in production, it’s probably a year away.

On the other hand there are some really small OEMs and so on that we could find replacement opportunities for and we are searching for those right now. And I am sure that we will find some and I am hopeful that we will have some sales in this calendar year. I don't think it’s going to be significant, but I am guessing it’s going to be a year before we start to see a real contribution from the joysticks.

Unidentified Analyst

Why do you think those contributions are likely to come geographically?

Pat Cavanagh

Well, what’s really important for us is that you know we have a great footprint Matt in China. With over we’ve been there since 2005, we have the sales team on the ground, we are selling at this point to Sony and Zoomlion and SMG and several of the other or highway OEMs we’re selling them pedals right now.

Ultimately, and of course Gator, and so we see them as five customers for the joystick and the China market for of highway equipment is going to be the largest; its not already the largest market in the world, because of all the construction that’s taken place over there and the export from that markets.

So we’re hoping, not hoping, we will have a production in our fiscal 2013 in our plant in China of joysticks; we currently have that production capability now that is up and capable in Portland. But we expect to have that same capability there and we maybe one of the very first manufactures of joysticks in China, maybe, I don’t know that’s kind of the I haven’t seen many Chinese manufacturers at this point, but I’ve heard rumors that there are some, but I think the western manufactures are well know for joysticks, we’re probably one of the first ones there. And we are going to exploit the footprint that we have got and the relationships we have with the customers there and we’re very hopeful that that would be very a significant market for us.

And of course as you know from our plant in China we supply Japan and also Korea and there is very significant customers in those markets and some of those are looking at these joysticks now. So we are excited about the prospects.

Operator

(Operator Instructions) And there are no further questions at this time.

Dennis Bunday

This concludes in that case our second quarter conference call. I would like to thank everyone for attending today. Bye, bye.

Operator

Thank you everyone for joining today’s conference. You may now disconnect.

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