Nu Horizons Electronics F3Q08 (Qtr End 11/30/07) Earnings Call Transcript

Jan. 8.08 | About: Nu Horizons (NUHC)

Nu Horizons Electronics Corporation (NUHC) F3Q08 Earnings Call January 8, 2008 4:15 PM ET

Executives

Richard Schuster – President, COO

Kurt Freudenberg – Senior Vice President, CFO

David Bowers - President of Distribution Division

Analysts

Matt Sheerin – Thomas Weisel Partners

Rob Damron – 21st Century

Jim Larkins – Wasatch Advisors

Mike Neary - Neary Asset Management

Operator

Good day and welcome to the Nu Horizons earnings conference call for third quarter fiscal year 2008. Today’s call is being recorded. For the purposes of the Safe Harbor Provisions of the Private Securities and Litigation Reform Act of 1995, our statements today may include certain forward looking statements that involve risks and uncertainties that could cause actual results to differ materially. Such statements are based upon, among other things, assumptions made with information currently available to the management, including management’s own assessment of the Nu Horizons’ industry and competitive landscape.

During the presentation your lines will be in a listen only mode. At its conclusion there will be a question and answer session, instructions on how to signal for a question will be given at that time. And now for opening remarks and introductions, I would like to turn the conference over to Mr. Richard Schuster, President and Chief Operating Officer of Nu Horizons Electronics Corporation. Please go ahead sir.

Richard Schuster

Thank you. Good afternoon and welcome. I am Richard Schuster, President and Chief Operating Officer. With me today is Kurt Freudenberg, the company’s Executive Vice President and Chief Financial Officer and David Bowers, President of Nu Horizon’s Distribution Division. Also participating in the conference call from a remote location is Arthur Nadata, Chairman and Chief Executive Officer of Nu Horizons Electronics Corporation.

Kurt will give an overview of the numbers for the third quarter of fiscal 2008, I will then give a brief overview of the market, a synapses of the industry and our company’s performance and then we will open the calls to questions you may have. At this point I would like to turn the call over to Kurt.

Kurt Freudenberg

Thank you Rich and good afternoon everyone. Net sales for the quarter ended November 30, 2007 were $210,824,000, compared to $186,080,000 for the comparable period a year ago, an increase of 13.3%. This represents a record sales quarter for the company.

Due to the expected but high level of professional fees in the third quarter for fiscal 2008 of $2,225,000 associated with the previously disclosed restatement of our financial statements related to income taxes and our continued cooperation with the inquiry by the SEC in the action captioned “In the matter of Vitesse Semiconductor Corporation,” and of Vitesse class-action, the net loss for the quarter was $373,000 or a loss of $0.02 per diluted share as compared to net income of $1,933,000 or $0.10 per diluted share in the third quarter of last year.

Overall our gross profit margin for the quarter ended November 30, 2007 was 15.1% as compared to 15.6% in the prior year quarter. The decrease in margin is primarily attributable to lower margin sales in the Asian market.

For the nine months ended November 30, 2007, net sales increased to $606,727,000 from $567,361,000 in the comparable period last year, an increase of 6.9%. Net income from the nine months ended November 30, 2007 was $2,098,000 or $0.11 per diluted share, compared to net income of $7,191,000 or $0.39 per diluted share in the comparable period of last year.

Overall gross profit margin for the nine months ended November 30, 2007 and 2006 was [inaudible] at 15.2%. Sequential total sales increased 3.6%, which came primarily from growth in Asia and Europe. Systems sales were $13,144,000 for the current quarter, compared to the prior quarter of $14,219,000. Sequential systems sales are up $1.3 million and gross profit increased to $1,183,000.

For the third quarter ended November 30, 2007 operating expenses as a percentage of sales increased to 14.4% from 12.9% in the prior year and year-to-date was 13.8% compared to 12.2% in the prior year. Operating expenses as a percentage of sales for the third quarter of fiscal 2008 increased over the prior year quarter primarily due to $2,225,000 of professional fees related to the previously reported restatement of our financial statements related to income taxes, the pending Vitesse related SEC inquiry and the Vitesse class-action suit. Additionally operating expenses in our German startup were $1,250,000 which were not in the prior year quarter.

Year-to-date operating expenses as a percentage of sales increased primarily related to previously mentioned professional fees of $3 million and the inclusion of the expenses of DT Electronics which was acquired on August 29, 2006 and is therefore included in the first three quarters of fiscal ’08 and not in the first half of fiscal ’07. Also our operations in Germany commenced in fiscal ’08 and had approximately $2.5 million in operating expenses for the nine months ended November 30, 2007, but no operating costs in the prior year.

The operating loss for Germany was $855,000 and $1.7 million for the three and nine months ended November 30, 2007. In November 2007 we implemented a reduction in work force of 34 domestic employees which is expected to decrease our annual operating cost by approximately $3 million. Total severance cost of $258,000 was recorded in this third quarter. We expect this operating cost savings to contribute to our goal of increasing operating margins, however we may reinvest a portion of these savings in the business. As a percentage of sales for the third quarter of fiscal ’08, interest expense remained constant when compared to the prior year quarter.

As previously announced on October 3, 2007, the company restated its fiscal ’07 form 10K and first quarter fiscal ’08 form 10Q due to an understatement of our provision for income taxes for prior years and related US income tax obligations. Consequently our effective tax rate for the three and nine months ended November 30, 2007 is higher, principally due to penalties and interest associated with amending our US Federal and State tax returns due to the restatement. Interest and penalties were $237,000 and $1,036,000 for the three and nine months ended November 30, 2007 respectively. Year-to-date, the effective tax rate, excluding interest and penalties is 38.5%.

On a pro forma basis, excluding professional fees as mentioned above, Germany net losses due to being a startup, severance costs and interest and penalties associated with amending our tax returns, diluted earnings per share would have been $0.10 per diluted share for the three months and $0.31 per diluted share for the nine months ended November 30, 2007, as compared to $0.10 and $0.39 per diluted share for three and nine months of the prior year.

Our balance sheet is strong and liquid with $195,000,000 in working capital and a current ratio of 3:1 at November 30, 2007. Our days sales outstanding was 62 and our inventory turn was 5.1 times on average.

At November 30, 2007 our extending debt was $64 million under a US revolver and UK credit line and we had an aggregate of $61 million available under both credit lines. Cash is kept low as possible by applying cash against our US revolver on a daily base to keep interest rates low. Now I’ll turn the call back over to Rich.

Richard Schuster

Thank you Kurt. We are encouraged with our results for quarter three excluding the impact of professional fees and we believe that we have now begun to offset the negative results caused by the decline in our systems business. We continued our strong market share growth in quarter three of fiscal 2008 and achieved good quarter-to-quarter and year-to year growth in our core electronic components distribution business.

We grew this business 3% sequentially and 15% year-over-year same-quarter, recording new semi-conductor distribution revenue records in Asia-Pacific and Europe while holding our operating expenses flat, excluding professional fees. Top line revenue was essentially flat in fiscal 2008 quarter three, compared to fiscal 2008 quarter two in the Americas, while we grew 21% in Asia-Pacific and 6% in Europe from quarter two to quarter three of fiscal 2008.

On a year-over-year basis, we down 3% in the Americas primarily due to decline in our systems business and recorded increases of 105% in Asia-Pacific and 71% in Europe. The international portion of our global distribution business revenue grew to a record 37% of total revenue for the quarter. We are particularly encouraged with the global aspect of our business as we have built both our Asia-Pacific and Europe organizations into strong regional competitors as part of a single global enterprise.

We grew both in demand creation and fulfillment revenue, notably recording strong growth in our higher margin demand creation activity. The number of new design wins grew 5% from quarter three of fiscal 2007 while we recorded 8% year-over-year same-quarter growth in our higher margin design win revenue. Additionally, due to our continued improvement of the semi-conductor distribution business, with new customer awards, we recorded a 13% year-over-year same-quarter increase in our total customer base. Notably, the year-over-year growth of our core electronic distribution business was quite broad, coming from increases in suppliers and customers, together with increased penetration with existing suppliers and customers.

We also grew year-over-year in 16 of the 30 market segments that we track, including strong double-digit year-over-year growth in the automotive, set-top box, computer peripheral, consumer, major computer, personal computer, telecom, white goods and wireless RF markets.

We are continuing to strengthen our supplier partnership base, which expanded substantially in fiscal 2007 and in the third quarter of fiscal 2008, we announced new or expanded partnerships with Exar, [Sincor] and Gennum Semiconductor. In total, on a year-to-date basis, our new partnerships have resulted in an increase in Nu Horizons served total available market of more than $350 million annually, an increase of more than 15% in the Americas served total available market alone, which we believe will substantially improve our ability to continue growing our business at greater than market rates.

Our margins in the electronic components distribution business were relatively stable, quarter-to-quarter and year-to-year. As previously highlighted, we undertook a reduction in workforce in our North America components distribution business in our quarter three of fiscal 2008 and recorded severance costs of $258,000 as a result of this. We expect to see an annual operating cost reduction of approximately $3 million as a result of this change and should begin to see that effect in our quarter four of fiscal 2008. However, we may reinvest a portion of these savings in the business.

We have specifically discussed our systems business and a substantial revenues in margin contribution decline from that business. This decline began in our quarter three of fiscal 2007 and we had seen continuing smaller declines through our quarter two of fiscal 2008. I am happy to report that as a result of our reorganization and retargeting of that business, we are again seeing growth, with top-line growth of 4% from quarter two to quarter three of fiscal 2008 and a strong positive book-to-bill ratio. We believe that we will be able to continue to show growth from the current revenue levels and that we will be able to keep investment costs in line in order to continue to grow the margin contribution of this business from its current levels.

Looking forward, we see mixed reports of market conditions for this business with forecasters expecting slow growth or a slight decline for the worldwide semi-conductor industry in calendar 2008. We believe that our strengthening worldwide supplier, customer and employee base positions us for continued gains in market share in all regions. Our goal is to continue our expansion into Europe through a combination of startup and additional partnerships and/or acquisitions that are designed to provide us with a strong market position while we continue to increase market penetration in the Americas and Asia-Pacific through share gains with both long-standing and new suppliers as well as new and expanded key customer engagements.

Thank you and now I’d like to open the conference call to any questions you may have.

Question-and-Answer Session

Operator

Thank you, the question and answer session will be conducted electronically, if you would like to ask questions please do so by pressing the star key, followed by the digit one on your touch-tone telephone. If you are on a speaker phone today, please make sure that your mute function is turned off to allow your signal to reach our equipment. Again that’s star one for a question or comment. We’ll pause for just a moment to assemble our queue. Our first question comes from Matt Sheerin with Thomas Weisel Partners.

Matt Sheerin – Thomas Weisel Partners

Thanks, good afternoon everyone. Question regarding the Vitesse lawsuit and investigation. Could you just update us where we are, how long do you think that’s going to play out and what the incremental costs associated with that will be in the next quarter or two?

Kurt Freudenberg

Hi Matt, this is Kurt. The status of the Vitesse inquiry is ongoing, so, we don’t know how much longer it’s going to be going but it is ongoing, we’re responding to any requests that are made and the suit itself, that is also in its beginning stages so we don’t know how longer.

With regard to professional fees, I will tell you that half of what we incurred in the past quarter was associated with the restatement, so we know that will go away and it’s finished. The remainder, I can’t tell you this for sure, but we don’t expect it to go higher, but I don’t know how much longer it will go on into the future.

Matt Sheerin – Thomas Weisel Partners

Okay. And then, you said there was some reduction in headcount, 30 plus some employees, what’s the headcount now in North America or in overall?

Kurt Freudenberg

I’ll give you that in a second.

Matt Sheerin – Thomas Weisel Partners

Okay. And then, Dave I know you are on the call, maybe you can just talk about what you’re seeing in terms of demand trends in semi-conductors, I know your North America semi-distribution business looks like even with the system business, it’s kind of flattish year-over-year, maybe down a little bit, your competitors are probably down a little bit more, maybe you’re taking share, but are there more opportunities to take share and what are you seeing just in general in terms of demand and outlook?

David Bowers

Good question Matt. So we were for the quarter positive book-to-bill and interestingly in all geographies in the distribution business, so, we’re not seeing downtrends, in fact we’re seeing, it should be moderate growth in each of the geographies with Europe and APAC contributing more. Americas is, I mean and we’re all seeing this within the industry, the US and Canada continue to bleed manufacturing, we’re continuing to lose manufacturing here so, we would expect that’s going to continue.

The market forecast generally would say that semi-conductor distribution business in North America if you look out over the next 12 months is probably going to be something less than the past 12 months, just billings into North America and where we see our growth opportunities is really as a result of the new lines that we signed in North America and we’ve highlighted those. Atmel, Micron being a couple of the majors, the lines that we just talked about today on semi-conductor coming on board with us nine months ago and we are beginning to see good growth in each of those major suppliers and that along with opportunities for continuing to gain share in the Americas, which is a long term trend for us, we have been doing that now for years and we expect that will continue with our current major suppliers as well. So we think we can continue to grow in a declining market, it’s a question of how much the North America market declines.

Matt Sheerin – Thomas Weisel Partners

Yeah and then with Asia continuing to grow very rapidly for you, I know that margins both on demand creation and the fulfillment side are lower than North America in your op, is that a concern that you could see that continued gross margin erosion or are there some efforts in place to try and turn that around?

David Bowers

Yes, so, we believe generally speaking the Europe and Asia should offset each other from a margin contribution standpoint, that is if we’re able to continue to grow in Europe through expansion, through acquisition, accretive acquisition specifically and improvement obviously in Germany which we’ll start seeing now, that that will offset or mitigate some of the margin reduction driven by APAC.

Matt Sheerin – Thomas Weisel Partners

Okay, okay thank you.

Kurt Freudenberg

So, Matt, your headcount question, we’re roughly, domestically, 500 employees and internationally 300. And on the international side of course is up over last year and the domestic side is down.

Matt Sheerin – Thomas Weisel Partners

Okay thanks.

Kurt Freudenberg

Welcome.

Operator

Our next question comes from Rob Damron with 21st Century.

Rob Damron – 21st Century

Good afternoon guys. Wanted to ask about the systems business, it does look like it has stabilized and maybe increased a bit sequentially, could you just talk about what you’ve done to stabilize that business and are there opportunities for other suppliers to add into that business, I guess what’s the longer term outlook for systems?

David Bowers

Sure, Rob, it’s Dave. So, we highlighted that two quarters actually that we brought in a new vice president, Chris Winslow, in order to run that business for us and his charter was to immediately analyze where we were. We knew what had driven the decline and we were not happy with the business model that led to that, so we wanted to find ways to strengthen the business model and that’s what Chris has led for us, we’ve really focused the business much more on mid-tier customer base, higher margin engagements and engagements that provide us with higher value, some more value-add than moving boxes which was a lot of what we were doing historically.

So that has begun and most of the sales pipeline that we’re looking at now is with the target customer base. It’s with mid-tier customers and it is higher margin, deeper engagements in terms of doing more value-add work for those customers and we are starting to do some integration as well and that aspect of the business is growing, so, we think that will continue. The pipeline is continuing to look better and we said obviously here that we had a very solid book-to-bill, substantially over 1:1 book-to-bill during the last quarter on systems.

Rob Damron – 21st Century

How about new suppliers in that space?

Richard Schuster

Yes, we’ve talked about discussions with at least one additional supplier and those discussions are continuing apace. So, that’s probably it but those particular discussions are continuing to move forward and should come to a head, I would expect, within this quarter, one way or the other.

Rob Damron – 21st Century

Okay and then just the typical seasonality that we see as we look into Q4, includes December, I don’t know if you care to talk a little bit about December, was it the typical softness and would you expect a slight sequential downturn from Q3 to Q4?

Richard Schuster

We can’t be specific on that but the activity has been stronger than what we expected considering, historically December is a relatively quiet month, you also have February which includes Chinese New Year, which could have some impact on the Asian business. But we are encouraged by the activity that we’re seeing so far this quarter.

Rob Damron – 21st Century

Okay that’s helpful, thank you.

Operator

At this time we have one more question in the queue, I’d like to make a remind you that it is star one for a question or comment. Moving on we’ll hear from Jim Larkins with Wasatch Advisors.

Jim Larkins – Wasatch Advisors

Good afternoon, just a detail question. On the pro forma effect of unusual items that you have, could you maybe give us some insight into what line items on the income statement those would pertain to? I mean did most of it just come out of operating expenses or would some of that, would you apply to costs of goods sold?

Kurt Freudenberg

No, I would apply most of it to operating expenses.

Jim Larkins – Wasatch Advisors

And including like say the Germany startup, would that be more of a costs of goods sold or would that be operating expenses?

Kurt Freudenberg

Well that one’s going to be kind of split because that’s actually the bottom line net loss for the period.

Jim Larkins – Wasatch Advisors

Okay. Alright so just to kind of…

Kurt Freudenberg

So just proportionally to what our normal split would be.

Jim Larkins – Wasatch Advisors

Okay, perfect. Alright, that’s very helpful. Thanks guys.

Kurt Freudenberg

You’re welcome.

Operator

We do have another question in the queue, this comes from Mike Neary with Neary Asset Management.

Mike Neary – Neary Asset Management

Hi I had a question about the German startup. What is your hope for that business over time and how much longer will you see losses like this for that business?

David Bowers

It’s Dave. So, first I’ll point out we are profitable in Europe on an overall basis and we absolutely expect that to continue. Germany we knew with the approach that we took that we would experience losses for some period of time, so that was what drove the combination of a startup and the acquisition and the acquisition that we made was a small acquisition.

It is bringing incremental profit dollars in which are offsetting some of the startup costs that we’re experiencing. The business is growing, we expect that we’re going to see improvement on an ongoing basis in the operating numbers out of Germany and would not reasonably expect these losses to continue at this level for a long period of time. Certainly 12 months from now it should be at or near breakeven and our goal would be sooner than that.

Mike Neary – Neary Asset Management

Okay, so, total you think this could cost what $1 million, $1.5 million in startup expenses and we could recoup that in what, a two or three year period?

David Bowers

We should so, comment specifically…

Kurt Freudenberg

Two or three years is probably reasonable but the actual cash investment might be a little higher than your number.

Mike Neary – Neary Asset Management

Okay and then I guess you’re talking about expanding to additional European markets and I would assume that it would have similar results early on in those new markets, unless we did an acquisition of an already profitable company?

David Bowers

I’ll just say as we expand our preference is to expand through accretive acquisitions, we spent a year doing market research in Germany, specifically, and could not find within the market a good approach or good way to do that. The German market is the largest, it’s twice the size of the second largest market in Europe, that’s why we chose this path, so going forward the preference is still going to be in major markets to acquire in an accretive fashion versus startup.

Mike Neary – Neary Asset Management

Okay and just kind of refresh me, bigger picture, several years ago the plan was, you know we have the infrastructure in Asia, additional sales that we can tack in are going to come in at higher operating margins, we’re going to grow our operating margins over time and we did that for a couple years and now this year, even if I take out these added expenses for these one time items, even things like the startup, which seems more like an ongoing type of thing, but even if I take those out, our operating margins still are down year-over-year. Is that primarily because we’ve built added infrastructure for sales that didn’t happen or what happened this year with our cost structure?

Richard Schuster

Well some of that is additional investments and some of that was the weakness in our systems business and our asset component business. I believe we have made our major investments in the Asian market, as Dave just said, our additional investments in Europe should be, we plan to be through accretive acquisitions and the cost, we’re still looking at ways to reduce the cost of business through efficiencies, productivity. But of course we believe that the top-line growth with actually bring the operating margins to where we’re targeting.

Mike Neary – Neary Asset Management

Okay and where are we targeting?

Richard Schuster

We’ve said publicly that we’re looking at the 4% operating margin range.

Mike Neary – Neary Asset Management

Okay and what type of a revenue level would we need to get to that? I mean is this you know three years out or is this seven years out?

Richard Schuster

No, certainly we’ve said our plan is to get to that, get close to that operating margin in our next fiscal year.

Mike Neary – Neary Asset Management

Okay and one question on the tax rate, so 38.5% this year. Is that what we should budget going forward?

Kurt Freudenberg

That’s a safe rate to use going forward, yeah.

Mike Neary – Neary Asset Management

Okay could you just talk a little bit, you know when you look at your competitors you know their tax rates are 33%, 34% and we’re the ones that get dinged for underpaying our past taxes and we’re the ones that always have a higher tax rate than everybody else, are there things that we can do better for this in the future, now that we’re more international to lower this rate or do you think that’s where it’s going to be?

Kurt Freudenberg

There are things that we’re looking at. We actually just recently brought on a tax professional house and we have a top notch outside firm helping us. So, 38.5% is a sure thing, that’s what I know for sure, but I also know that we’re working on things to make improvements. So, our goal is to bring it down to somewhere in the range of where our competitors are because that’s a good benchmark. What was in the past, I can’t speak to but I can tell you that we are driving to lower that rate.

Mike Neary – Neary Asset Management

Okay and last question on cap-ex, this year it’s going to be higher, what were the major expenses for cap-ex this year and then going forward where do we think that number is going to be?

Kurt Freudenberg

The major expense was our Mississippi warehouse in terms of filling that out with shelving and so on and moving into it. And that is complete. If we decide to expand that warehouse going forward, we would incur more capital expenditures there. I’m not saying we’re going to do that this moment but there is a thought of that and in the UK because of our European expansion, we are looking for warehouse space there as well, so that may require some capital.

Mike Neary – Neary Asset Management

Okay…

Kurt Freudenberg

But I don’t think it’ll be more than the level that we’ve been experiencing.

Mike Neary – Neary Asset Management

Okay and what was cap-ex in the third quarter? $400,000, $500,000?

Kurt Freudenberg

In that range. Yes.

Mike Neary – Neary Asset Management

Okay so that’s kind of our base level cap-ex and then if we did the UK addition or expanded warehouse in Mississippi that would add to that?

Kurt Freudenberg

It would add to that, that’s right.

Mike Neary – Neary Asset Management

Okay and are there any major technology changes we need to make in terms of our accounting software or anything on the immediate horizon?

Kurt Freudenberg

No, not in the immediate horizon. We recently put in a Hyperion system on top of our ledger units so we have a pretty good reporting tool that everybody is now getting access to and the base ledge I don’t foresee any changes to that other than we have an internal-wide T staff that is accommodating or trying to make changes as we add different acquisitions.

Mike Neary – Neary Asset Management

Okay great thank you very much.

Kurt Freudenberg

Welcome.

Operator

Gentleman at this time we have no further questions.

Richard Schuster

Okay, I’d like to thank all of you for participating in the conference call and we welcome your questions and look forward to the next conference call. Thank you all and have a good evening.

Operator

Available today beginning at 7PM ET and will be available until December 6 by dialing 888-203-1112 or 719-457-0820 use the pass code 3548147.

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