Liquidmetal Technologies, Inc. (OTCQB:LQMT) Q2 2008 Earnings Call August 18, 2008 4:30 PM ET
John Kang - Chairman
Larry Buffington - President and Chief Executive Officer
Gerry Morrow – Chief Financial Officer
Welcome to the Liquidmetal Technologies 2008 second quarter conference call. (Operator Instructions)
This afternoon's conference call will be hosted by John Kang, Chairman; Larry Buffington, President and CEO; and Gerry Morrow, CFO.
Before turning the call over to Mr. Kang, the Company wishes to remind everyone that the comments presented this afternoon may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from the forward-looking statements contained herein. Detailed information about risk factors are set forth in Liquidmetal's periodic filings with the Securities and Exchange Commission and press releases including but not limited to those risks and uncertainties listed in the company's filings with the SEC. Liquidmetal Technologies is under no obligation and expressly disclaims any obligations to update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise.
The management of Liquidmetal Technologies fully complies with the SEC regulations FD and its relationship with the investment community with regards to disclosure and encourages investors to visit the company’s website frequently through press releases and other information updates.
I will now turn the conference over to Mr. Kang.
Welcome to everyone joining us as we report our quarterly results, which are presented in our second quarter 2008 earnings release issued today. Gerry Morrow, our CFO, joins me today to report on our financial result for the second quarter and Larry Buffington, our President and CEO, will provide an overview of our operations.
Overall, the financial results of the second quarter saw reductions from the results of the first quarter. Some of it was due to the overall market conditions, as I’ll explain later, and part of it was also do to activities we have undertaken during the slower time of the year to transition our manufacturing base to China, which positions us well for the future, but had a negative impact on the short-term results for the quarter.
For the second quarter 2008, total revenue was $5.7 million. First, in our bulk alloy business, migration of our mass production to China began early in the second quarter. This required the relocation of our production equipment, tooling, and personnel to China, drawing down both management and capacity during the setup in China.
Small levels of production commenced in China in April and by the end of the second quarter, over half of our mass production activity was occurring there. With $3 million in second quarter revenues, our bulk alloy business accounted for $200,000 of the revenue decline between the first quarter and second quarter of 2008. Due to capacity issues, we missed out on approximately a million in business, $1 million in business, for the quarter, which we could not deliver.
With such a major shift in our production, we feel fortunate to have been able to make the shift with only a slight drop in our revenue.
In our coating business, after several strong quarters of growth, second quarter revenues came in at $2.7 million dollars below the first quarter by $900,000 dollars. We believe this was the result of the oil services market taking a breather after the masses ramp up and drilling production that has occurred over the last year due to the rapid increase in the oil prices.
We expect this plateauing of the activity in the oil services business to be short lived, lasting four, possibly several quarters, as the drilling industry catches its breath, but we should pick back up as the price of oil has put into motion plans for more drilling capacity, which we believe will once again drive our business to new levels as we enjoy the position of market leadership for high performance coating in the oil and gas drilling industry and, in fact, we have already started to see some signs of increased activity during the past several weeks.
In addition to the flat revenues in the oil services industry, we saw very little revenues in our power plant business for the quarter. This was due to the seasonality of the business where the utilities can send most of our services in the early spring and fall when the power demand is slower and they can afford to bring the power plants down for servicing. These two activities resulted in the lower results in our coating business for the quarter.
Although revenues declined in the second quarter and expenses related to the migration of our mass production to China were incurred, the company still managed to maintain positive EBITDA adjusted for non-cash expenses and warrant conversion features, up approximately $100,000. Though modestly positive, this reflects a cost control and operating discipline that have been installed within the company.
In terms of the highlights, in the second quarter of 2008, our customer activity was led by Novato, Samsung, and Apple. The SIM card ejector is our first project with Apple and we remain proud to be a small part of the launch of the 3P iPhone. Customer relationships are built over time and we hope to leverage this into a greater opportunity as we have done with other customers, most notably Samsung.
House abating new opportunities with customers require focus, resources, and nurturing initial opportunities and new industries can take intense initial effort. As we migrate mass production to China, we have been able to maintain a smaller, experienced team of high level resources in Korea. This team is equipped to prototype projects with new customer like HPC, a leading manufacturing of small phones.
Migration to China was also a major activity for our manufacturing team for the quarter. While it did create disruptions in our capacity, the move positions us well for the future. As our production ramps up in China, we’re expecting our production costs to be reduced on average 30 to 40% from our cost in Korea. We recognize that this has some short-term consequences for us in terms of lost revenues for the quarter, as well as increased production costs due to severance and moving costs incurred during the quarter. However, we believe the pain of the migration was well worth it and will pay dividends in the future.
Perhaps even more important to the future is the continued implementation of our new die-casting machine from Buehler Print.
Initial casting runs on these next generation die-casting machine achieved several of our expected goals and improved casting quality and yield. Already this is expanding our opportunity in the luxury products market, where the surface quality and appearance are at the high levels.
We’re going into the production on several of our new product lines with the new machines and we expect to see great improvement in yield and cost.
As the company also emphasizes our licensing strategy, our intellectual property position comes to the forefront of our activity. While we do not discuss our development activities for obvious reasons, the company had very positive developments and had three new patents issued in the second quarter of 2008.
I mentioned this only to let you know that the research and development, our patent portfolio and trade secrets remain as core activity and of high value to our company. We expect our activities in this area to increase going forward.
While there were changing dynamics in our bulk alloy and coating businesses in the second quarter of 2008, the company’s strategy to lower manufacturing costs, move toward a licensing model, and advance our manufacturing technology, and to build our intellectual property portfolio continues to move forward. These actions have enabled the company to achieve a modest but respectful EBITDA, even when the added cost of the move to China, which had a significant impact on the quarterly results are added.
At this point, let me ask Gerry to discuss our second quarter financial results, which will be followed by Larry’s update on our operations. I’ll close our call with a few observations on the outlook for the remainder of 2008.
As reported in our press release, second quarter revenue was $5.7 million, which is 16% lower than the $6.8 million realized in the first quarter of 2008. Our bulk alloys business reported a $3.0 million in the second quarter revenue compared with a $3.2 million in first quarter.
Although the first quarter trend tends to be seasonally slower than the second quarter, we have experienced capacity limitations while the migration to China occurred.
In our coatings business, second quarter revenue came in at $2.7 million versus the first quarter at $3.6 million. The decrease was driven by a leveling of demand in the oil and gas industry from high activity levels at the end of last year and seasonal decrease of our solutions business, which primarily serves the power industry. The power industry conducts its maintenance and includes its application of our coatings during the early spring season before the summer electricity demand begins to peak.
Our second quarter gross margins were 18%. This is a decline from the 28% in the first quarter and is primarily attributable to the additional production costs incurred during the migration to China.
We incurred cost well in excess the $500,000 for outsourcing costs as we needed to have duplicate capacity during the move as well as severance and other moving costs, which we choose to expense during this quarter. Even with these additional extraordinary costs compared to a gross margin of 8% from the same quarter a year ago, progress made in improving our manufacturing cost structure is evident.
Selling, general, and administrative expenses were $1.3 million in the second quarter, a decrease of almost $600,000 from the first quarter of 2008. We continue to manage our costs aggressively and have seen results.
Research and development expenditures were $0.3 million, which remains consistent with the past quarters.
Our operating loss of $600,000 for the second quarter is slightly higher than the first quarter of $300,000, but significantly better than the $2.1 million loss a year ago.
As a result of cost improvement, the company achieves a positive adjusted EBITDA of approximately $100,000. This now represents the fourth consecutive quarter of positive EBITDA for the company.
While we have incurred near term expenses involved in our migration of mass production to China. This will result in a fundamental improvement in our cost. So Korea remains an attractive business environment for higher value projects, the cost of capacity in broad based manufacturing companies in China, particularly in consumer electronics remains competitive advantage which the company must continue to utilize.
As the company manages through this transition, our finance team remains very active in supporting of this progress. Our ability to support our management team with timely reporting and accurate measurements towards our goals is vitally important to realizing our objectives.
Now let me turn this call back over to John.
Let me now ask Larry to provide you with his comments on activities of our operations.
It’s my pleasure to provide you with an update on our operations during the second quarter of 2008.
Let me start by highlighting a few of the important efforts in our company that have been touched on earlier during this call. First, in the bulk alloy business as previously mentioned, we have been migrating our mass production to China. Initial production began on a small level in April. By the end of second quarter, over half our mass production was taken place in China. While we have reduced our manpower in Korea by a similar magnitude, we have focused on returning our most skilled and experienced personnel from prototyping and development of new customer projects.
Without the distractions of mass production and manufacturing activity, our goal is to continue to build our capabilities in Korea to rapidly prototype new projects to maximize our customer opportunities in various industries.
Second, we installed the first unit of our next generation die-casting machine in Korea during the first quarter of 2008. Buehler Print’s die-casting machines are designed to lower manufacturing costs through yield improvements in cycle time reductions while expanding our capabilities with higher tonnage capacity and precise system controls.
Our initial prototyping with the new machine have already demonstrated the greater potential from this new manufacturing technology. For example, initial prototypes made for a customer in the luxury goods market, which has extremely high surface quality requirements, produces parts with surfaces appearances previously unattainable with the original die-casting machines. As our production and engineering teams gain more experience with the Buehler Print’s machines, we will begin to realize the potential of this next generation manufacturing technology.
In our coating business, we experienced a pullback in the market after several quarters of robust activity. In short, we believe that part of this pullback is due to the high level of activity around the end of 2007 and as material prices, particularly steel for pipes, were increasing. The market may be in a period of consuming the pipe inventory buildup. In addition, the consolidation of two major customers, Grant Prideco and National Oil Well Barko, is causing a pause in the industry, but despite these events and the recent decline in oil prices, we feel certain that the fundamental drivers of demand for oil as well as the industry’s need to tap into oil reserves that are increasingly difficult to reach, represent a long-term growing market for our coating materials.
In our coating solutions business, which provides coating materials and application services primarily to the power industry, we are successfully building this business, which was acquired approximately one year ago. Leveraging our expertise in material science and technology, we have recently deployed in the field one of our proprietary’s zirconia, containing materials in the power plant and we expect this material to surpass the 16-year outstanding performance of Armacor M in this particular application. While it is still early, this initial field application will provide results which support broad use of this proprietary material.
We also have recently decided to invest in HBOF systems, which expand the conveyance capability of our materials. Combined with the improvements already made to our facilities and improvements of a topnotch quality system, including an in-house quality lab, we are quickly positioning ourselves as the complete solution for coating protection in an environment where erosion and corrosion are a concern. When we acquired this business in June of 2007, it was largely a neglected division of a much larger company. Since that time, we have successfully revitalized the business to bring in new sales and elevate our capability. We are now seeing much more potential in the business, particularly as we leverage our material expertise and target new markets such as pulp and paper in mining industries.
In summary, the second quarter of 2008 can be viewed as a challenging one, when it’s simply based upon our revenues; however, the progress of our business operations is contributing to a sound foundation for our business and the future of our technology.
At this time, let me turn it back to John.
In our last conference call, I had mentioned that the company is entering into a period of transition. Our second quarter reflects this transition. As I summarize our outlook for the remainder of 2008, I’d like to discuss four factors affecting the company.
First and most immediately noticeable is our transition of mass production to China. We have discussed the reason for this migration and the near-term impact of manufacturing costs, output, and revenue. The separation of our mass production manufacturing in China from our prototyping in Korea will be a healthy one though. Mass production must continue to drive incremental efficiency, even when market prices decline, with strong emphasis on profitability.
In fact, when the migration is complete by the end of the third quarter, we expect savings to be in excess of $400,000 dollars per month, based upon the current volume of business.
The second major factor has been our manufacturing technology. The development and implementation of the new Buehler Print machine has been an intense effort for the past year. By placing the first unit of this next generation machine onto our production floor, we’re at the beginning stages of migrating to our new manufacturing technology.
After initial prototyping efforts, we’re beginning production of several customer projects on this new machine. Needless to say, we’re excited to be at this point. Meanwhile, the knowledge gained through this process opened several new horizons in terms of where we can take our manufacturing technology into the future.
The third factor has been our move toward a licensing model. The transition to a licensing model has many implications, but it’s necessitated by the vast range of applications of our technology beyond our reach. Having proven the basis of our technology and the demand in a few commercial markets, we must share the financial investment, as well as the opportunities through partnerships, joint ventures, or strategic alliances.
I know that many of you are eager to see progress in this area, but rest assured that it remains a major emphasis for the company. We’re in discussions with many companies currently about possible joint ventures, licenses and other alliances, which we hope to be able to share with you very soon.
Also, the transition to licensing places great importance upon our intellectual property. The company now had 39 issued patents that are owned or exclusively licenses to Liquidmetal. We remain very active in areas of research and development of amorphous alloy in related technology. The company will be increasing expenditures and making prudent investments into this area going forward.
Finally, as we see the improvements in our finances and cash flow, we’re focusing on reducing our financial debt burdens of the company. As stated, we expect our operating cash flows to improve with the migration to China, which will be completed by the end of the quarter. With improved cost positioned by producing in China and also added businesses coming on line in the second half of the year from our existing customers, as well as new ones such as HPC and Nokia, we expect to see an improvement in our cash flow overall.
Our plan is to utilize this on debt paydown as one of the major goals for the business in the coming months. With that in mind, we have worked out an amendment with our convertible note holders where we will begin to amortize our notes starting in October of this year.
In addition, we are hopeful to sell our factory in Korea, since our manufacturing has migrated to China. We’re hopeful to receive $8 million for our plant and our intention is to pay the debts with the proceeds from the building.
In summary, while the first look at our second quarter results might not be as impressive as we would all like, there are many reasons to be optimistic about the progress being made in the company. Real changes now without some expense in investment. In the second quarter, we managed to make real changes all the while maintaining an EBITDA positive operation.
In the third quarter, we expect a major program with HPC to go into production; however, with the limitation and capacity due to the move in China, we’re targeting only moderate growth in the casting revenues for the third quarter.
We also expect a slight increase in our coating revenue for the quarter as the oil service business is picking back up, but we do not expect to see our business from the utilities to have much impact for the quarter.
Overall, we see the great increase in the revenues will come in the fourth quarter when the capacity in China is ready at full production for our customers and our coating business returns to strong growth.
An area we do expect to see solid improvement is in our earnings. We believe the manufacturing cost position based out of China and the increased business will have a dramatic impact on our EBITDA. While we expect EBITDA to be only slightly higher in Q3 due to the remainder of the moving expenses, we expect EBITDA in the fourth quarter to be in excess of $1 million dollars at which point we’ll be starting to amortize our notes.
All in all, we believe we are still on the right path to bringing this technology to reality. We believe the steps we have taken during the past quarter and those which we will continue this coming quarter are the right ones in positioning us for the long-term success. We do appreciate your patience as we strive to reach our goals.
In closing, I’d like to thank you again for joining our call. We welcome your calls to our office with any of the questions and thank you again for your support and interest in joining us today on this second quarter update.
That concludes today’s conference.
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