Measurement Specialties, Inc. (MEAS)
F4Q08 Earnings Call
June 12, 2008 9:00 am ET
Executives
Frank Guidone –Chief Executive Officer
Mark Thomson – Chief Financial Officer
Analysts
Larry Solow – CJS Securities
Ted Kundtz – Needham & Co.
John Franzreb – Sidoti & Co.
Operator
Welcome to the Measurement Specialties fourth quarter and year end fiscal 2008 earnings results. (Operator instructions) It is now my pleasure to introduce your host, Mr. Frank Guidone, CEO for Measurement Specialties. Thank you Mr. Guidone, you may begin.
Frank Guidone
Thank you. Let me begin by reading the Safe Harbor provision. Management wishes to caution investors that certain statements made on today’s call are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, section 27A of the Securities Exchange Act of 1933 as amended in section 21E of the Securities and Exchange Act of 1934 as amended.
Forward-looking statements may be identified by such words or phrases as: believe, expect, intend, estimate, anticipate, project, will, may and similar expressions. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future are forward-looking statements.
The forward-looking statements used herein are not guarantees of future performance and involve a number of risks and uncertainties. Please refer to the risk factors outline in the company’s SEC reports for more detail.
The company from time to time considered acquiring or disposing of businesses or products. Forward-looking statements do not include the impact of acquisitions or disposition of assets which could affect results in the near term. Actual results may differ materially and the company assumes no obligation to update the information provided in today’s call.
With that, let’s get started. Good morning everyone. We’ve got quite a bit to cover today so I will start with some high level comments and then hand the call over to Mark Thomson our CFO.
Total sales for fiscal 2008 were $228.4 million, up 14% over last year. Excluding sales from Intersema of $4.4 million in the fourth quarter, sales increased $224 million or 12% over last year. We’re defining this as our organic growth. While this was very close to our original guidance of $225 million for the fiscal year, sales mix was less favorable than we had originally forecast which resulted in lower than expected gross margin and operating income.
Further pressure on margin came from the weak dollar. While we are generally long Euro, we are short Chinese Renminbi, much more than we’re long the Euro, which has put material pressure on our margins. Commodity pricing, increased freight and utilities expense as a result of higher energy costs and wage inflation in China have also created increased headwind.
We’ve been reasonably successful this year at offsetting commodity inflation with negotiated reductions in supplier spend via our global sourcing initiative. However, this remains an area of concern for us in fiscal 09.
We were very successful leveraging SG&A in fiscal 08, reducing SG&A as a percent of sales from 28.1% to 26.5%. Of the $4.1 million increase in total SG&A, $1.6 million of that was associated with Visyx and Intersema acquisitions. We feel that slower total growth in fiscal 09 in part due to Sensata being flat to down which we will discuss in more detail later along with R&D investments like the Visyx fluid properties technology will make it difficult to achieve additional SG&A leverage in fiscal 09.
Long term, we still believe a low 20’s SG&A as a percent of sales is reasonable. We posted full year earnings of $1.13 per fully diluted share. If you recall in the second quarter, we took a $900,000 tax expense associated with a favorable tax law change in Germany that resulted in a revaluation of our deferred tax assets in Germany.
Our guidance has consistently excluded the impact of this tax law change, roughly $0.06 per share. Offsetting this expense was a $600,000 favorable tax pickup in the fourth quarter associated with a reduction of a prior year tax accrual. This tax accrual was set up more than eight years ago and we recently produced documentation from the tax authorities that concluded it was not a liability.
Netting these items to compare our reported results with our previous guidance, you’d add back roughly $300,000 or approximately $0.02 to get to the $1.15 per share, the lower end of our guidance range.
As previously disclosed, Sensata, our largest customer has been concerned about the sole source situation with Measurement Specialties for quite some time. We’ve been cooperatively working on an in source program were Sensata has established internal capacity to produce a portion of the volume currently supplied by MEAS.
As a result, we expect sales of Sensata in fiscal 09 to be down slightly, roughly 5% over fiscal 08. Our arrangement provides an incentive to Sensata for maintaining certain minimum volumes with Measurement Specialties over the next three years as well as royalty payments associated with in sourced production.
Our new building in China, while behind our original schedule is progressing nicely. We’re anticipating completion in the fall and should be moved in by the end of the calendar year. We’ve recently posted some new pictures of the facility on our website. I invite those interested to please visit. Construction is within budget in Renminbi, however due to the weakening US dollar, when stated in dollars the project will be at or perhaps slightly above our upper range of $12 million in total cap ex expense.
Perhaps the most exciting financial story is the improvement in free cash flow. Defined as cash from operations less capital expenditures, free cash flow improved 206% from $6.7 million in fiscal 07 to $20.4 million in fiscal 08. This includes nearly $5 million spent on the China facility in fiscal 08.
This improvement is in part a reflection of our organizational changes and increased focus and attention to working capital management this year. We’re guiding to $255 million in fiscal 09 sales. This represents a 12% increase over fiscal 08. However, adjusting for the full year effect of Intersema, organic growth is expected in the 6-7% range.
As previously mentioned, we expected Sensata sales to be down year on year approximately 5% while non Sensata business is expected to post low double digit growth. While we maintain a very full pipeline of new opportunities, growth with existing business has slowed somewhat and customers are generally cautious to assign resources to new opportunities until the economic environment improves.
Bottom line, in a slow environment with neutral to negative churn, which means for us more decline than growth in existing business, we can expect to post growth in the high single to low double digits while in a strong environment with positive churn, meaning more growth than decline in existing business, we can expect organic growth of 15-20% as we’ve seen in the last couple of years.
We’re particularly excited about our progress with the fluid property sensor technology acquired in the Visyx transaction. We had at least two commercial commitments for volume production and anticipate several others. Based on customer feedback and testing, we’re convinced our technology provides the best means for measuring situ fluid properties and will generate meaningful new revenue in fiscal 10 and beyond.
Intersema underperformed as compared to our expectations for the first quarter which contributed to our results being at the low end of our guidance range. We’re in the process of introducing an internally developed application specific integrated circuit or ASIC that will greatly improve our margin in Intersema, as well as provide access to a low cost ASIC for other Measurement Specialties pressure applications across the board.
Expenses associated with this development ran higher than we expected which impacted results. Additionally, some price concessions to third nation customers along with onetime deal expenses affected results.
Based on backlog and incoming orders as well as the implementation of the new ASIC which should come online in the next month, we expect the situation to greatly improve by the second quarter.
While we have provided full year guidance on sales and earnings this year, we do not intend to provide quarterly guidance this year. In general, we would expect fiscal 09 sales to follow a similar pattern as fiscal 08, Q1 down somewhat as compared to Q4, an increase in Q2 with similar sales in Q3 and then a step up in Q4.
The China facility move may create some disruption to our sales in the second or third quarter, depending on when we actually move. And with that, for a general overview, I will now hand the call over to Mark.
Mark Thomson
Net sales for the quarter increased to $62.8 million, a 15% increase over the same period last year. Sales for the fiscal year increased to $228.4 million, representing 14% growth over fiscal 2007. Excluding sales generated from the Intersema acquisition of $4.4 million, organic growth was 12%.
Sequential organic growth which excludes Intersema was 4% over the third quarter. The fundamental macro drivers of the sensor market remain strong. The companies seek to increase the intelligence of their products, the application of sensors content per product is increasing accordingly.
Due to our broad portfolio and flexible applications approach to engineering and low cost infrastructure, Measurement Specialties continues to capitalize on favorable market trends and gaining share, even during difficult economic periods.
For fiscal 2009, we maintain our net sales guidance of $255 million. This represents more organic growth than what we’ve historically posted due to, A, in sourcing program with Sensata and their associated decline versus historical growth in sales, B, the general cautiousness with the customers regarding existing and new programs and finally, C, the loss of a $3 million SPO2 program to a competitor. This is a relatively low margin program, the earnings impact is less significant.
Gross margin for the fourth quarter and fiscal year was 40.9% and 41.8% respectively. As compared to fiscal 2007, full year gross margin was down by 1.9%. The decrease in gross margin was primarily attributable to unfavorable sales mix, heavily influenced by higher growth in Sensata sales which carries a lower margin than other product line averages.
In addition, we’ve experienced continued headwind on gross margin by the weakening dollar relative to the Chinese RMB. The RMB has appreciated 9% during fiscal 2008 which translates into $1.7 million in annualized margin erosion.
As we look forward to fiscal 2009, we expect gross margin to improve and fluctuate between 42-44% mainly driven by improves sales mix which is strongly influenced by lower Sensata sales as a percentage of the total sales and gross margins generated by Intersema which are expected to exceed historical company averages in the second half of fiscal 2009.
Adjusted SG&A increased to $16.6 million in the fourth quarter as compared to $14.9 million for the third quarter. Of the $1.7 million increase, Intersema and Visyx, our recent acquisitions, represented $1.6 million. As a percentage of sales, SG&A decreased to 26.5% of sales in the fourth quarter from 27.5% of sales in Q3.
SG&A increased to $60.6 million in fiscal 2008 as compared to $56.3 million for the prior year. Of the $4.1 million or so increase, recent acquisitions represented, again $1.6 million.
As a percentage of sales, SG&A decreased 1.6% to 26.5% of sales for the year. Excluding Intersema and Visyx, SG&A increased approximately 5% on 12% growth in sales, mainly driven by increased headcount in support of sales growth. Amortization of intangibles decreased by $0.9 million to $3.6 million in 2008 despite the $0.6 million of additional amortization expense associated with recent acquisitions.
Assuming no new acquisitions, amortization expense is expected to be approximately $5 million in fiscal 2009. We thought it would be helpful to provide a high level bridge between Q3 and Q4 at the EBITA level or operating income before amortization. Q4 sales were roughly $6.8 million higher than that of Q3. At 20% EBITA, the additional sales would have generated an additional $1.4 million of EBITA, however EBITA was relatively flat quarter to quarter.
A reconciliation of the $1.4 million gap can be put into three buckets. First, as Frank mentioned, Intersema underperformed as compared to expectations by roughly $600,000. This was a function of high material costs associated to an ASICs that is being phased out, higher development costs for the new ASICs, which will resolve the material cost issue and price concessions to certain Asian customers.
Q1 should be an improvement over Q4 but we don’t expect Intersema to perform to target until Q2. Secondly, as Frank mentioned, our investment in the development of the fluid property sensor as a result of the Visyx acquisition was roughly $375,000. And lastly, unfavorable overhead absorption as a result of inventory reductions in Q4 was roughly $300,000-$400,000.
While this negatively affected our income, it was a significant boost to cash flows. The company’s cash flow balance as of March 31, 2008 was approximately $21.6 million which reflects an increase of $13.9 million since the beginning of the year. We reduced our revolver balance by $11.4 million in Q4 alone, resulting in a balance of $58.2 million at March 31, 2008 and opened availability under our revolver of nearly $63 million.
Cash from operations increased sharply in fiscal year 08 as compared to prior periods, increasing 138% from $14 million in fiscal year 07 to $33.2 million in fiscal 2008. The sharp improvement in results of, are primarily the result of increased earnings as well as improved working capital management.
Changes in operating working capital defined as accounts receivable plus inventory less accounts payable improved from $13.9 million use of cash in fiscal year 07 to a $6.3 million source of cash in fiscal 2008. It is important to note that cash balance sheet values for AR, Inventory and AP as of March 31, 2008 include assets and liabilities acquired in the Intersema and Visyx transactions and also reflect translation adjustments associated with changes in foreign currency.
For example, as the dollar weakens against the Euro, assets and liabilities denominated in Euro will increase in value when translate to the US dollar. While this translation affects the balance sheet, it does not affect operating cash flows. Accordingly, our working capital management from a cash flow perspective is much better than what the change in balance sheet would suggest.
Free cash flow is defined as cash from operations less capital expenditures, also improved dramatically from $6.7 million in fiscal 2007 to $20.4 million in fiscal 2008. Included in capital expenditures in fiscal 2008 is roughly $5 million associated with the new China facility construction project. We expect to invest a similar amount in fiscal 2009 as we complete the facility.
Excluding the China facility project, we expect capital expenditures to run in the 4-5% of sales range. I’d like to take a moment to address a material weakness disclosed in our 10-K. As part of our international cash management strategy, initially established with Grant Thornton several years ago, we created an maintained a series of intercompany loans that allowed the company to move funds between various legal jurisdictions.
These notes have traditionally been considered long term in nature and accordingly foreign currency transaction gains or losses determined in the revaluation of these notes have been a balance sheet adjustment recorded through other comprehensive income or OCI, rather than recorded as a component of income.
In Q4 we determined that a small portion of these intercompany loans were in fact short term and intended to be repaid and therefore, translation gains and losses should have been recorded as a component of income rather than OCI.
Given this impact and change was considered material to our fourth quarter and fiscal year, specifically as it related to a note in conjunction with the Intersema acquisition, we concluded that our controls were inadequate with respect to this specific item. We have modified our controls to evaluate all significant intercompany transactions to ensure they are accounted for properly in accordance with financial account standard number 52, foreign currency translation.
Our overall effective tax rate from continuing operations was approximately 26.7% during the year ended March 31, 2008 as compared to 20.7% last year. Excluding discrete tax adjustments, including among other things, changes in tax laws, return to accrual adjustment and tax liability corrections, our overall effective tax rate was approximately 24%.
Total income tax expense increased $2.9 million to $6.0 million as compared to $3.1 million last year. The overall increase in income tax expense is because of the overall increase in profits before taxes and the increase in the consolidated effective tax rate. The company’s overall effective tax rate has been impacted by a higher portion of taxable income earned in tax jurisdictions with higher tax rates as compared to fiscal 2007 as well as the impact of China tax law changes.
The China tax authorities announced an increase in income tax rate to 18% in December 2007 effective in January 2008. Also effective in January 2008 is a 5% withholding tax on the distribution of earnings. The company’s [inaudible] fluctuate proportionately to the allocation of earnings between various taxing jurisdictions and with changes in tax rates.
We expect our overall effective tax rate to generally increase due to more of our total income being generated in Europe and in the United States which are subject to higher effective tax rates than our overall and the impact of the increases in the China income tax rate effective January 1, 2008.
With that, I’d like to turn it over to Frank Guidone.
Frank Guidone
Thanks Mark. In summary, while this year has put many challenges, we are happy with our progress and particularly pleased with our dramatic improvement in operating and free cash flow. We believe this is the right long term focus for management and will ultimately yield the best long term returns for shareholders. Operator, with that, we will open it up for some questions.
Question-and-Answer Session
Operator
(Operator instructions) Your first question comes from Larry Solow – CJS Securities.
Larry Solow – CJS Securities
Can you confirm Mark, you said 42-44% of your gross margin, but in your 10-K I believe you say 41-43%, I mean it’s a small difference but what am I missing there?
Mark Thomson
I think we do have a different range. We have historically been over the last year in the 42% range. You know we’ll have plus or minus 1% on the low end and on the high end. So we could say 41-44%.
Larry Solow – CJS Securities
That range, part of the range have to do with how the RMB appreciates, do you have any kind of expectations of the RMB appreciating in there already?
Mark Thomson
Yes we do.
Larry Solow – CJS Securities
So assuming that the RMB doesn’t go gangbusters, your low end would be 41%?
Mark Thomson
That’s correct. We’ve assessed foreign currency in depth as we’re painfully aware, the RMB appreciated 9% in 2008. And based on banks and institutional estimates, our best estimate is somewhere in the 7% for 09.
Larry Solow – CJS Securities
Could you just discuss pricing trends, of course Sensata is coming down but ex Sensata, how are prices going in the industry and are you able to pass on some of these higher costs, rising material costs and what not?
Frank Guidone
We did go through a fairly sensitive evaluation this year on pricing and price increases. And it’s kind of a mixed bag. We have, particularly if you look at A customers, customers that represent 80% of the sales, in many cases we have kind of negotiated pricing and have limited ability to push through price increases.
But we do have some flexibility there and I would say that our pricing power is greater with the B and C customers. If you blend that all together, we have been able to push through some price increases this year and offset some of the commodity inflation pressure.
You know kind of net where we’ve ended up, it’s hard to say because included in our budget every year is an assumption around improvement on material spend over standard as a result of our global sourcing initiative.
So I would say right now, we feel kind of cautiously optimistic that the combination of pricing that we’ve been able to push through on a blended basis as well as the global sourcing initiatives will be able to offset kind of the wage and commodity inflationary pressures we’re seeing.
But I say that’s cautionary simply because it’s a really odd environment right now. And you know you’re seeing what’s going on with airlines, that effects freight and it’s a bit of a wild card to call.
Larry Solow – CJS Securities
If you can provide any more color on the Sensata agreement, I know you kind of talked about it for this year, are you actually locked in over the three year period that you mentioned?
Frank Guidone
Yes we have minimums over the three year period that define the minimum thresholds for an incentive rebate program that we setup with them.
Larry Solow – CJS Securities
Okay so we can kind of assume that the level you have this year will kind of be flat over the next three years or in that ballpark?
Frank Guidone
In that ballpark, yes.
Operator
Your next question comes from Ted Kundtz – Needham & Co.
Ted Kundtz – Needham & Co.
Your backlog at the end of the year was up nicely year over year, can you talk about what the order trends were like in the quarter and what kind of environment you’re seeing out there currently on order trends?
Frank Guidone
You and I have talked about this I’m watching closely and trying to see how accurate of a forward predictor backlog and booking trends are for us. And while I would say blended, when I step back, the overall blended number has remained strong over the last couple of months relative to where we ended the quarter, it’s kind of a mixed bag when you drill down and look month to month.
So the beta is high right now and I’m a little cautious about using it as a statistic yet until we get a little more comfort and data particularly with folks like Intersema which are new in terms of how we’re tracking this information. But, with that said, the order flow is, you know on a blended basis, reasonably stable.
Ted Kundtz – Needham & Co.
Can you comment at all about the different sectors that you’re serving, the different, maybe, I don’t know if it’s end users or if end customers, end industries that you’re seeing, any trends there. When you talked about the automotive Sensata being kind of down a little bit this year but only a couple million bucks.
Frank Guidone
And again, it’s not that Sensata is going to be down in their programs, it’s just the agreements, they’re going to in source some of the volume, Sensata is still going to see. I know Sensata as a business is feeling some pressure in North America. But their exposure is less in North America than it is to Europe and Asia where they remain reasonably strong. And so that obviously filters through to us.
You know the other automotive programs that we have, you know humidity for example, remained strong this year, although we’re seeing more growth in some of the heavy truck off road applications that are starting to benefit from some of the regulatory changes regarding emissions that we’re piggy backing on.
So I would say that business will be, should be better this year than it was last as people were kind of buying ahead of the regulatory changes, we saw low last year that we should see pick up this year. Visyx and the fluid property sensor is also targeting that market which is helping our penetration in that space.
Medical remains pretty strong, we’ve got lots of medical opportunities on the table and we’re trying to push that heavily and so that’s an area that you know is reasonably robust. Where we have exceptions I think are more unique sig circumstances with those customers and I would say effects of any economic environment or trend.
I think where we’re seeing the biggest economic pressure is in kind of general industrial capital spending is cautious. So certainly areas where we have exposure in home building and semiconductors still remains slow as compared to what we’ve seen in prior years. And we’re not expecting any real change in that in the near term.
Ted Kundtz – Needham & Co.
So if you were to look to sources of upside to your estimates for the year, revenue estimates, where would they be coming from or concerns about downside, where would you think the most sensitive areas would be?
Frank Guidone
I think it would be too general for me to say that there’s upside or downside in a particular market. For us you have to drill down and say where upsides can come from would be un-forecasted programs. I mean there’s two real ways that we drive business above what we’re forecasting.
One, you know, existing business, customers where we have existing products and production pull in excess of what we’re forecasting. And certainly that’s possible given that we’ve tried to take a relatively conservative approach with customers. And then secondly, new programs that either begin faster or new programs that aren’t in our, what we’ll call our must hit, new product development.
And we have some opportunities to influence the equation there, although I would say not meaningfully. Again because of our lead times, even with a relatively simple what we’ll call a same as except, same as the standard product with a minor change, you know generally if we can get something in production in those three to four, three to six months, that’s pretty quick. So things that we would identify now are going to influence the third or fourth quarter.
Ted Kundtz – Needham & Co.
You mentioned you know the targeted improvement in SG&A, as a percent of sales, although in the 10-K you mentioned you thought it would be kind of flat this year in fiscal 09, roughly at a 26.5% rate.
Frank Guidone
Yes, if you look at 08, you know we increased SG&A about 5%, excluding the acquisition, kind of an absolute number. That to me, you know, I think barring any aggressive restructuring activities, that kind of represents the floor. So we need growth obviously in excess of 5-6% in order to see leverage. If you look at it that way, that’s kind of a reasonable way to consider the equation here.
So with Sensata at 18% of sales being down and the non-Sensata business, having actually decent growth in a down environment but not being able to offset that slug, that chunk of business that’s not growing, you know we’re looking at consolidated sales growth in that 6-7% range which means leverage of SG&A is going to be limited this year.
Ted Kundtz – Needham & Co.
Mark you gave a very eloquent explanation of the tax rate issue there, but what’s the bottom line on this, do you have a forecasted expectation for this year of the effective tax rate, I wasn’t quite sure I heard that?
Mark Thomson
Yes we actually didn’t say in our financial summary a forecasted tax rate. I will say that it will vary quite a bit based on earnings in various tax jurisdictions. So as I did mention in the notes, we do expect to have more and more earnings migrate to the US and also to Europe relative to that of China.
So we do see our tax rate moving up, I think in the 28-29% is probably a good target for right now but as the customers and evolution. Now I will say one thing that we have to be cautious of and we note this pretty much every call, you know we have a fairly sizable net operating loss carry forward and we have one in the US and we have one in Germany.
So if you take those two into consideration and when you look at business valuation, you’ve got roughly $16.5 million of an NOL in the US, we’ve got $13.6 in Germany, a little over $20 million, so from a cash ECR perspective, sorry, $30 million. From a cash ECR perspective, you’re probably going to be in the 17% range.
So we should be getting somewhere in the $2 million tax benefit or you know you can knock of $1.5-$2 million of tax expense that technically won’t be paid by virtue of this NOL. And I think that’s an important note when considering our projections on ECR. And that was again, that’s one of the benefits and one of the key differences between kind of a book earnings versus cash view of our business.
I mean it’s quite a gap if you look at the free cash flow and look at that on a per share basis, you know, as a cash proxy, it’s a meaningfully more attractive number than our book earnings.
Ted Kundtz – Needham & Co.
Absolutely, do you expect the cash flow to be as positive as it was this year, free cash flow?
Mark Thomson
I don’t think, we’re not going to see the percent improvement but I think we’ll see improvement dollar wise. So you know the working capital aspect was a nice pickup for us this year. I’m not sure we can forecast a source but we’re not forecasting a meaningful use of cash in working capital either.
Ted Kundtz – Needham & Co.
Just quickly on the acquisition side, Frank are you still seeing opportunities out there, are you still looking for some?
Frank Guidone
We are, I think we have a good balance sheet right now and this is a good time to do it, despite some of the challenges we had in the first quarter with Intersema, we remain very confident in that deal and comfortable that that’s going to be a transaction that will be valuable for us and accretive from a shareholder value perspective.
And you know I think a time like now is a time for a company like us and with our strategy that you have to be aggressive in down periods. So we remain active. I don’t think that the issues in the credit markets are going to have as much influence to our targets as they would in say larger companies where there’s a larger competition for financial buyers.
We’re going to be most impacted by the issues with tough credit. So I’m not expecting wild changes in valuations. But I think it affects everyone and we should see some benefit there.
Ted Kundtz – Needham & Co.
You mentioned Intersema cost you about $600,000 underperformed was that in the quarter?
Frank Guidone
Yes.
Ted Kundtz – Needham & Co.
And do you expect that to continue this quarter, probably at a lower rate, I’m not sure what you said but [inaudible] expectations by the second quarter.
Frank Guidone
Right.
Ted Kundtz – Needham & Co.
And that means what? Does that mean it’s going to be neutral or it’s going to be contributing?
Frank Guidone
It’s contributing now.
Ted Kundtz – Needham & Co.
Okay, I didn’t know what that cost you.
Frank Guidone
No, our company average EBITA, operating income before amortization is running around 20-21% of sales and we’re expect Intersema to perform at that rate or maybe a little better. And so it underperformed to that by about $600,000.
Ted Kundtz – Needham & Co.
Okay, I don’t know the numbers of that because I don’t know what Intersema is generating but.
Frank Guidone
It’s $4.4 million in sales so you can figure that at 20% we would have expected it to do around $900,000.
Ted Kundtz – Needham & Co.
Got it, and it did $300,000. And next quarter it’ll be, this quarter it’ll be a smaller negative [inaudible] not as big a contributor [inaudible].
Frank Guidone
From a gap, we would expect it to be better than on similar sales, we would expect it to be better than the $300,000 but we’re not going to hit the $900,000.
Ted Kundtz – Needham & Co.
Got it but you should see that come back pretty quickly by Q2?
Frank Guidone
Yes, I mean the new ASIC is a big deal, it’s a big part of their cost structure. And you know a few other changes there we believe will hit that, will perform at that level.
Ted Kundtz – Needham & Co.
And those were the only issues, you mentioned integration and short term operating issues hurting results, is it basically the ASIC issue being the dominant, sounds like that was a dominant factor.
Frank Guidone
The ASIC was the issue, foreign exchange and the translation of the sales that they have in dollars denominated in dollars and in Euro given the strength of the Swiss Franc against the Euro and the Dollar in the quarter. We had some onetime deal expenses that flowed through in the quarter and we had some price concessions that were kind of forward pricing the impact of this ASIC with some Asia customers that impact us more heavily now in front of the implementation of this new component.
Ted Kundtz – Needham & Co.
No other high inventory costs or something like that that would come back and bite you?
Frank Guidone
No. I would say that we had some expense associated with the fact that they’re not yet on our standard cost system. So they’re more of a period expense approach right now and so some of the expense was associated with the fact that they’re building some inventory ahead of higher orders in the upcoming quarter. And under a standard cost environment, some of that would have been capitalized. But that’s just some timing differences.
Operator
Your last question comes from John Franzreb – Sidoti & Co.
John Franzreb – Sidoti & Co.
Could we go back and talk a little bit about the price concessions that you gave to a Chinese customer. What product line was that and why was that necessary?
Frank Guidone
Relative to Intersema, this would be for a consumer oriented product and it’s purely competitive pricing issues.
John Franzreb – Sidoti & Co.
It wasn’t locked up, usually you designed in, you kind of maintain it, why was there a competitive pricing issue?
Frank Guidone
For product I would say more so than some of our industrial and medical applications, more aggressive about kind of constantly quoting alternative suppliers and putting pressure on the supply base from that regard. So it’s not, I would say that business is more like automotive in terms of what you’re accustomed to there for kind of annual price concessions.
John Franzreb – Sidoti & Co.
Absent the Intersema discussion we just had, was there any other discrete quality events that happened in Q4, you kind of referenced that in the 10-K.
Frank Guidone
No, the discrete quality that we had was in the second quarter with Sensata, I mean that was the only kind of major even that we had disclosed. But there’s nothing specific in the fourth quarter that was materially out of the ordinary.
John Franzreb – Sidoti & Co.
Now you said that you expect China sales disruption as you relocate production, do you think Q3 and Q4, is that what you said?
Frank Guidone
I said Q2 or Q3 depending on exactly when our move is. And you know I’m a little bit vague here because quite honestly I’m not sure how it’s going to operate. Some customers may choose to order ahead of that in which case we may see actually a bump up in sales in the second quarter and then a dip in the third or vice versa, we may end up building inventories in the second and then kind of selling that out in the third.
So it’s a little tough to call. I think it would be unrealistic for us to expect that there’s no impact to our normal order flow. There’s got to be some and we’re looking at kind of a phased downtime approach, but not meaningful downtime in any one area.
John Franzreb – Sidoti & Co.
With you building inventory, will it be more difficult to maintain the working capital gains that you’ve kind of targeted or that you’ve achieved actually in fiscal 2008?
Frank Guidone
Right now we’re expecting to, we’ve got a kind of inventory build plan that assumes at its peak around $4-$5 million inventory built in support of the shut down. But we have that, the expectation is we have that bled off by the end of the fiscal year.
I’ve been more conservative on our working capital assumptions this year as a result of thus, just given that whenever you build ahead there’s some risk in mix. But at this point, assuming we’re in the facility sometime in the fall, but before the end of the calendar year, we think that we’ll bleed it off in the fourth quarter.
John Franzreb – Sidoti & Co.
Now you mentioned commodity costs were an issue and you said your global sourcing initiative was going to be key to that. Can you kind of provide any more additional color of what you’re doing and how you can offset some of those commodity costs?
Frank Guidone
Yes, a couple of years ago we brought on a head of global sourcing basically to work strategically across the company looking at our commodities and spend by commodities and do kind of the traditional consolidate vendors, classify vendors as preferred versus those that were trying to phase out. And use consolidated spend to improve our negotiating leverage with a fewer number of suppliers.
And so we’ve been working through that, initially starting in China and now more aggressively incorporating other regions in the world. So as you can imagine, given the companies that we’ve put together, it’s a pretty diverse supply base and so there’s a fair amount of opportunity in this area. But it’s hard work because it often requires requalification and customer approvals if we’re going to be changing vendors and even if the customer is not involved, we do that ourselves.
So it’s a lot of work but it’s the biggest opportunity bucket for us, material spend as a percent of sales is about 37-38% of sales for us as a company and you know is the single largest cost bucket. So small changes in that can yield some meaningful opportunities.
Operator
There are no further questions.
Frank Guidone
Thank you, if there’s no further questions we’ll conclude today’s call. I appreciate everyone’s participation this morning and as always, feel free to contact Mark or myself if you have additional questions.
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