Spectrum Control, Inc. F1Q08 (Qtr End 2/29/08) Earnings Call Transcript

Mar.28.08 | About: Spectrum Control, (SPEC)

Spectrum Control, Inc. (NASDAQ:SPEC)

F1Q08 Earnings Call

March 27, 2008 4:45 pm ET

Executives

Richard A. Southworth - President, Chief Executive Officer

John P. Freeman - Senior Vice President, Chief Financial Officer

Analysts

Ted Kundtz - Needham & Company

Operator

Welcome to Spectrum Control, Inc.’s first quarter conference call. Representing the company today we have Dick Southworth, President and Chief Executive Officer, and Jack Freeman, Senior Vice President and Chief Financial Officer. (Operator Instructions)

As a reminder, the following discussion will include certain forward-looking statements which reflect management’s current views with respect to future market conditions and operating performance. These forward-looking statements are subject to certain risks and uncertainties which could cause actual results to differ materially from historical results or those anticipated. These risks and uncertainties are described in detail in the company’s most recent quarterly and annual SEC fillings.

The words believe, expect, anticipate and similar expressions identify forward-looking statements. Listeners are cautioned not to place undue reliance on these forward-looking statements. Such forward-looking statements speak only as of the date on which they are made and the company does not undertake any obligation to update any forward-looking statements to reflect events or circumstances after the date of this call.

I would now like to introduce Mr. Dick Southworth, President and Chief Executive Officer of Spectrum Control.

Richard A. Southworth

We’d like to welcome you to Spectrum Control’s 2008 first quarter conference call. I will briefly review some of our key operating and financial highlights for our first quarter, after which, Jack Freeman will review our financial performance in more detail then we will be happy to take any questions.

As we discussed in our fourth quarter conference call, we began to detect softness in portions of our telecom equipment markets, as well as delays in the release of orders for certain military and defense programs. This soft demand continued throughout most of the first quarter of this year, negatively impacting our total customer orders and shipments.

Despite these market conditions, we are very pleased to report significant first quarter profit and near record cash flow. For our first quarter of 2008, we generated a net income of $1.8 million, or $0.13 per share on sales of $31.2 million, and our operating cash flow grew to $3.5 million.

Even more importantly, the excess inventory levels for certain telecom customers and programs appear to have been consumed, and customer inventory levels now appear aligned with current business requirements. Accordingly, orders from these telecom customers have significantly increased in the last four weeks.

In addition, we expect orders for several key military and defense programs, which were delayed in the first quarter, will be released in the second quarter of this year. With customer orders and production requirements expected to rebound in the second quarter, we have maintained our production capacity and workforce to respond quickly and effectively to the anticipated increase in business levels.

At this point, I’d like to introduce Jack Freeman, our Chief Financial Officer, and ask Jack to review our first quarter results in greater detail. When Jack has completed his presentation, I will conclude with some final comments, and then we will open the floor to questions.

John P. Freeman

Our operations continue to be conducted in four reportable segments: Signal and Power Integrity Components, Microwave Components and Systems, Power Management Systems, as well as Sensors and Controls. Although our Signal and Power Integrity Components business serves many different end markets, approximately one-third of these products are sold to customers in the telecom equipment industry.

For our Microwave Components and Systems business, currently, approximately 85% of these products are used in military and defense applications. Accordingly, these two business segments were negatively impacted by the soft market conditions in the first quarter.

Shipments of our Signal and Power Integrity Components were $13.2 million in the current quarter, down $2.1 million or about 14% from the first quarter of last year. Total customer orders received for these products amounted to $12.8 million in the current period, that’s a decrease of about 5% from the comparable period of fiscal 2007.

Shipments of our Microwave Components and Systems were $10.4 million in the first quarter of fiscal 2008, down just under $700,000 or about 6% from the same period a year ago. Customer orders received for our microwave products totaled $8 million in the current quarter, down about 37% from a year ago.

As Dick indicated, however, most importantly, we believe the excess inventory levels, which led to soft demand by certain of our telecom equipment customers, have been substantially consumed and that customer inventories are now properly aligned with current business requirements.

Accordingly, we anticipate orders from these customers to increase during the second quarter of fiscal 2008 and as we’ll discuss in a few moments, that increase has already started to be realized during the first four weeks of our second quarter of fiscal 2008.

This belief, as I said, has been supported by actual customer orders received so far this year and, in addition, we now expect orders for several key military and defense programs, which were delayed in the first quarter of fiscal 2008; we now believe they will be released in the second quarter.

Our Sensors and Controls business, which designs and manufactures rotary and linear precision sensors, temperature sensing probes, thermistors, resistance detector sensors and related assemblies. Shipments of these sensors and controls amounted to about $5.2 million in the first quarter of fiscal 2008, up almost $200,000, or about 4%, from the same period a year ago.

Customer orders for these products totaled $7.1 million in the current quarter, up $1.3 million, or 22%, from the first quarter of last year. In particular, demand for our custom position sensors, which are used in various medical equipment, commercial weather instruments and military, aircraft and vehicles, they continue to be very strong.

Our Power Management Systems Business designs and manufacturers power distribution units, breaker and fuse interface panels, custom power outlet strips, as well as our SmartStart power management systems. Shipments of our power management systems increased by almost $900,000, or 57%, with shipments of $2.4 million in the current quarter and $1.6 million in the comparable period last year.

Customer orders for these systems amounted to $3.7 million in the first quarter of fiscal 2008, an increase of $1.7 million or about 80% from a year ago. Demand for these products was particularly strong in applications for servers, optical networking equipment, voice-over-internet protocol equipment and switching gear. We are very excited about the ongoing growth potential for our advanced power system product offerings.

During the current period, our overall sales by industry remained relatively unchanged. For the first quarter of fiscal 2008, consolidated sales by major end market were 47% for military and defense, 6% for commercial aerospace, 19% for communications equipment and 24% for medical and industrial instrumentation. Throughout the current quarter, no single customer was more than 10% of our total consolidated sales.

In the current quarter, our gross margin was $6.9 million, or 22% of sales, compared to $7.8 million, or about 24% of sales for the same quarter last year. The decrease in gross margin percentage solely reflects the impact of additional manufacturing overhead costs and certain operating efficiencies from lower than previously expected production volumes.

In subsequent quarters, if our sales volumes increase as we expect, we will be able to better leverage our fixed manufacturing cost and our gross margin percentage would be expected to significantly improve.

With our State College ceramic facility continuing to satisfy all of our ceramic component needs, our material costs continue to decrease. Total material costs amounted to $7.8 million, or about 25% of sales in the first quarter of 2008, compared to $9.3 million, or 28% of sales for the same period last year.

As a percentage of sales, our SG&A expenses were held constant at about 13.5% of sales. In the first quarter last year, however, our G&A expenses included a $248,000 credit upon the final settlement of all of our insurance claims related to Hurricane Katrina. In the first quarter of this year, the absence of this credit was offset by reductions in professional fees, reductions in incentive-based compensation, as well as other numerous reductions in other discretionary expenditures.

During the first quarter of fiscal 2008, we activated our stock buyback program. Under this program, which was previously approved by our Board of Directors, the management was authorized to buy back on the open market up to $2.4 million of the company’s common stock. The amount and timing of the actual purchases was to be determined based upon management’s ongoing evaluation of the company’s stock price, our liquidity and other relevant factors.

During the first quarter of fiscal 2008, we repurchased nearly 245,000 shares of our stock at an aggregate positive $2.4 million. We believe these stock repurchases are a positive reflection of our future business outlook and our strong financial position. With these recently repurchased shares, the Board of Directors current authorization has now been fully extended.

We intend to closely monitor the company’s stock price, its liquidity and all other pertinent factors and depending upon our evaluation of these factors, we may request and the Board may approve additional stock repurchases.

Our operating cash flow continues to increase. Net cash provided by operating activities was $3.5 million in the first quarter of fiscal 2008, up $2 million, or 135% from the first quarter of fiscal 2007. In the current quarter, our positive operating cash flow enabled us to fund all of our capital equipment expenditures of nearly $900,000 and all of our stock repurchases, totaling $2.4 million, and we did this without incurring any additional bank borrowings or any other additional external financing.

Our overall financial position we believe remains very strong. At the end of the first quarter, our current ratio was up to 4.4:1 and our debt-to-equity was only 0.2:1. We currently have $33 million of borrowing capability under our domestic line of credit to support our anticipated future growth, as well as to support acquisition opportunities. We continue to think we are strategically positioned to support our future anticipated growth.

Based on our existing sales order backlog, recent customer order trends and the forecasted requirements for certain major customers and programs, we currently expect customer orders of $38 to $40 million and shipments of $33 to $35 million for our second quarter ending May 31 of this year. If this sales level is achieved, we anticipate generating earnings of $0.18 to $0.20 per share for the second quarter of fiscal 2008.

While the first quarter market weakness may moderate our growth expectations for the full year, we believe our future results will increasingly reflect the leverage and the effectiveness of our business model. We continue to build a diversified platform of products, while strengthening our status as a key supplier to all of our major customers.

With our broad product portfolio and participation in a wide variety of markets, we are increasingly insulated from sustained weaknesses in any particular market sector. We firmly believe that this business strategy will deliver long-term shareholder value across all market cycles.

Dick will now make some concluding comments.

Richard A. Southworth

For the first four weeks of our second quarter, customer order rates are up significantly. For our Signal and Power Integrity business, telecom continues to strengthen with orders up 60% from our 2007 fourth quarter run rate.

Military contracts which were delayed in the first quarter of this year are now being released. Already in the second quarter, we have booked $3.1 million for intelligence and secured communications programs and another $4.4 million is expected to be booked in the next few days. These military and defense orders are for custom application-specific products for which we are either sole source or prime source and that goes really across all of our businesses.

Overall, orders for our second quarter are currently running 32% above our first quarter run rate and 23% above our average run rate for 2007, and that’s for the entire year of 2007. Obviously, we are greatly encouraged by our recent customer order rate and we believe it reaffirms our positive outlook for the rest of 2008.

Now at this time, we would like to open the discussion for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Ted Kundtz - Needham & Company.

Ted Kundtz - Needham & Company

Could you give us a little more color on do you think this is a sustainable kind of order trend that you’re seeing? Maybe if you could hit the telecom sector first and then maybe a little more color on the military aeros and defense side. What do you see kind of on a longer-term basis around the balance of the year?

Do you get any sense of that or is this just kind of what you’re seeing right now and you don’t have a whole good lot of sense for the balance of the year, maybe you could just sort of help us with that a little bit.

Richard A. Southworth

I would say for the balance of the year, it’s always difficult and I think you realize that it’s whether the programs get funded. We have a lot of new programs and I think one of the key indicators that I look at is the fact that we have a large technology team. We have over 125 people that are working every day to develop and create new products, new custom products for our customers. And these people are swamped today.

In fact, all of our business managers continue to drive that we could expand our team probably by 20% or even more and keep everyone busy with these programs, but it’s always a matter of economics on how fast we move on these things. For the immediate quarter, there are significant programs yet. The commitments are all there. We’re just actually waiting for the paperwork so that we can book them and move on.

I can say right now we’re very high on the second quarter and I think that trend holds true for the whole year. We see also some opportunities that are and probably will be Crew related for the second half of the year that we believe in. It’s going to come our way.

Ted Kundtz - Needham & Company

Crew related, is that the Crew program you’re talking about?

Richard A. Southworth

On the CREW program, we have a lot of different customers Crew related.

John P. Freeman

And Ted, if I might, just to make sure there’s no misunderstanding, the current strong uptick that we have seen recently in orders, both from telecom and for military and defense, the military and defense that we have seen and what we are forecasting for the rest of the second quarter does not include any significant Crew. That opportunity is something that we see later in the year?

And one other point I just wanted to perhaps clarify is that we saw a significant slowdown for us in telecom starting in the fourth quarter, which has now started to significantly pick up. And with all the indications we receive from customers being that for the particular programs that we participate in, there were some excess inventories which now appear to have been consumed.

That significant uptick, we think is a natural reversal of what happened in the fourth quarter of last year, but it does not indicate or we’re not interpreting that to be a indication of a strong uptick throughout the rest of the year in telecom. We think that we’ve gotten through the temporary excess inventory situation, which has certainly helped us, but on an ongoing basis throughout the rest of this year, our expectation would be telecom would be flatter or modest growth.

So the other sectors that we expect to really support and generate our growth would be in military and defense, and some of the commercial markets other than telecom, so I just wanted to make sure that we’re not expecting telecom to take a....

Ted Kundtz - Needham & Company

That’s what I was wondering. That was the question, right, was the gist of the telecom duration of this uptick and you’d be a little more cautious in saying that it’s looking good right now, but we expect a flattish to slightly maybe modest growth forward.

And then if you do that, Rick, you mentioned the gross margins, at 22% that was obviously volume related. Where do you think they can get back to? Can we still get back to the mid-20s or slightly better than that going forward if we get the volumes back up into the mid-30s, higher 30 level?

Richard A. Southworth

Absolutely, based on the guidance we’re giving for the second quarter and revenues between $33 and $35 million, based on that increase in revenue, we would have expect very little increase in our overall manufacturing overhead, so we could leverage those sales we think pretty effectively.

And even at that level, we would expect gross margins to get up to the 26% or slightly above that. The opportunities to get even significantly above the 26 or 27%, we think will arise as that top line continues to grow.

Ted Kundtz - Needham & Company

Is there anything else you can say about the Crew programs because that is a big program for you potentially, the Crew 3 program? Is there any update on that or is it still kind of on hold at the moment and you’re still working on some of the Crew 2?

Richard A. Southworth

Well, I think the program right now is in a, I want to say, almost in the stagnant mode. And we don’t expect that to really get any significant breaks on that until the second half of the year.

Ted Kundtz - Needham & Company

The optimism then that you’re seeing in the rest of the military defense business is just from a wide variety of programs. Is there any particular ones that you would like to highlight or is it just pretty broad-based?

Richard A. Southworth

No, it’s pretty broad-based, but it’s multiple agreements where the value of them may vary from $1 million per year up to maybe $4 million. And I gave a couple of examples earlier on, but certainly as we go through it, we have some significant ones. I want to make sure that we clarify. In the first quarter, we didn’t mean in any way to indicate we didn’t get any military contracts; we got less than what we had expected.

And we’re seeing the ones that did not get funded in the first quarter, we’re now seeing those come through and, in some cases, we’re seeing them even at a higher volume from what we had expected. But it’s really a change and I think it’s really exciting after we’ve seen this softness for Q4 and Q1.

Ted Kundtz - Needham & Company

Do you think your order level could exceed last year’s numbers? I think last year you booked almost $140 million of revenue.

Richard A. Southworth

Yes, we booked $138 last year.

Ted Kundtz - Needham & Company

Is there a chance that you think you would be exceeding that this year at this point or is it too early to tell?

Richard A. Southworth

Well, I think there’s a good opportunity to do that. Is it too early to tell? It’s always too early to tell. We believe our first half of the year is going to exceed the first half of the year of last year.

Operator

I’m showing no further questions in the queue.

Richard A. Southworth

I think with no further questions, we will terminate the conference call. Thank you all for joining us.

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