Global X U.S. Cash Flow Kings 100 ETF
Q3 2013 Earnings Call Transcript

Published: 11 Mar 2013

[Operator:]

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Flow International Fiscal 2013 Second Quarter Financial Results Conference Call. [Operator Instructions] This conference is being recorded today, Monday, March 11, 2013. Now I'd like turn the conference over to Geoff Buscher, Main [ph] Investor Relations. Please go ahead, sir.

[Geoffrey Buscher:]

Thank you, operator. I'm responsible for Flow's Investor Relations. With me this afternoon are Charley Brown, Flow's President and CEO; and Allen Hsieh, Chief Financial Officer. This call will include forward-looking statements, as defined by the Private Securities Litigation Reform Act of 1995. During the call, we will discuss selected financial results. Any statements about future results, including trends, risks and plans, should be considered as forward-looking. These are based on current expectations only. Actual results may differ from these forward-looking statements and are subject to risks and uncertainties as are detailed in our filings with the Securities and Exchange Commission. Flow takes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. I would now like to turn the call over to Charley Brown.

[Charles M. Brown:]

Thank you for joining us today for our discussion of Flow's results for the third quarter of fiscal year 2013. For the quarter, I'm pleased to report revenue of $67.7 million, another all-time quarterly record. This is an increase of 3% from the prior year. We have now reached record sales levels for 3 quarters in a row and in 4 of the 5 last quarters. We generated operating income of $4.8 million, or just over 7% of sales, and $0.06 of earnings per share from continuing operations. This compares to prior-year operating income of $6 million and $0.07 of earnings per share from continuing operations. Breaking down our revenue. Total Standard Segment revenue for the quarter was $62.6 million, growing 6% versus the prior-year quarter. Geographically, we saw growth in most regions of the world, led by North America and Europe. Within this segment, Standard Systems revenue in Q3 reached its own new record level at $41.9 million, a 4% increase from the prior-year quarter. This was led by 11% growth in North America, where year-end tax incentives seemed to have overcome fiscal cliff concerns. Our Spares revenue also grew nicely during the quarter, up 9% to $20.7 million. As expected, Spares revenue declined sequentially from Q2 as a result of fewer selling days, which is a consistent trend going from Q2 to Q3 that we have experienced in the past. Revenues from our Advanced segment were $5.1 million in the current quarter, sequentially higher than Q2 revenues of $3.8 million. As we mentioned on our last call, we have received more than $30 million of new project commitments, which now show up in our record backlog of $37.2 million. Since we are currently in the design phase of many of these projects, we expect overall revenues in this segment will start to ramp up towards the end of the upcoming fourth quarter end into fiscal year 2014. Before I turn it over to Allen to discuss the details, I would like to discuss the current economic landscape and the variability it can cause within a given quarter. We are very pleased with our trajectory, having delivered sequential growth in revenues for 9 of the past 10 quarters and setting record revenue levels in 4 of the last 5 quarters, including a string of 3 in a row. We have been able to deliver this consistent growth through our diversity. This diversity has many facets, including our unmatched product range that includes many new products, our dual channels of distribution, our broad geographic reach and our numerous end markets. This significant diversification has helped us grow right through the macroeconomic uncertainty that has continued to plague much of the world over the past several years, from the slowdown in the economies of China and India, to austerity measures in Southern Europe, to broader Eurozone doldrums to the U.S. fiscal crisis in August of 2011, to the recent fiscal cliff drama and, now, the sequester. Through it all, we have experienced sequential growth in all but 1 quarter over the past 2.5 years. This macro-driven uncertainty showed up most recently in late January through February in the U.S. market. Based on our discussions with a good cross-section of the U.S. machine tool market, there was a temporary slowdown in machine tool orders during that 4- to 6-week period. We believe it was due to the uncertainty that existed, leading up to the sequestration deadline. Our orders also slowed during this timeframe, but are no longer at the reduced rate. In total, we estimate the U.S. market pause, or sort of wind pocket, had a short-term effect, probably reducing our Q4 revenue by about $3 million to $4 million versus our previous expectations. This includes a dozen-or-so machines, plus a brief slowdown in North American aftermarket sales. As I mentioned, we are now back to more normal order rates. However, this pause in the market means that in Q4 we will probably break our string of record quarters. We like setting new records, but we're not concerned. We anticipate we will continue to grow on a year-over-year basis in Q4, likely at a rate similar to Q3's 3% range. This brief U.S. wind pocket has not changed our long-term trajectory or outlook at all. I will now turn the time over to Allen.

[Allen M. Hsieh:]

Thanks, Charley. Operating income for the quarter was $4.8 million or 7.1% of sales as compared to $6 million in the prior-year quarter and $4 million in Q2 of this year. For the quarter, we reported net income from continuing operations of $2.7 million or $0.06 per share as compared to $3.3 million in the prior-year quarter and $2.2 million in Q2. Net income, as reported, which includes adjustments related to discontinued operations, was $2.6 million or $0.05 per share. For the quarter, we generated EBITDA of $6.9 million or 10.3% of sales. This compares to EBITDA of $8.1 million in the prior-year quarter and $6 million in Q2. Now to the details. Starting with our segments, Standard segment revenues were $62.6 million, with gross profit margins of 40.1% in the quarter. Gross margins were slightly down compared to 41% in the prior-year quarter and in line with Q2 gross margins. Overall, gross margins are at the midpoint of our stated range, which varies depending on product and geographic mix. Our Advanced segment revenue for the quarter was $5.1 million, with gross margins of 30.9%. We are pleased with the improvement of our margins in this segment to a level above our normal range and up compared to prior-year gross margins of 27.1%. Going forward, we anticipate, at our current revenue levels or higher, gross margins will be in the 25% range, plus or minus a few points. On an aggregate basis, total gross margins were 39.4%, which were in line with aggregate gross margins in the prior-year quarter and within our stated range of 40%, plus or minus 2 points. Total operating expenses in the aggregate were $21.9 million, at the higher end of our expected range. This was higher than the prior-year quarter of $20.1 million and sequentially compared to $21.5 million in Q2. As we have talked about in the past, our operating expenses will vary quarter-to-quarter, primarily due to variable costs related to increased sales, the timing of internal projects, as well as variability in personnel-related costs. On a year-to-date basis, if you exclude the variable cost associated with higher sales, our total operating expenses for the past 9 months were consistent with the same period last year. For the current quarter, we had net other expense of $539,000, down compared to $689,000 in the prior-year quarter and up compared to $437,000 in Q2. Net other expenses are primarily comprised of interest expense and foreign currency adjustments, partially offset by interest income. The comparative differences were primarily from the impact of foreign currency adjustments. For the quarter, we recorded tax expense of $1.6 million, at an effective tax rate of approximately 36.5%. Since we have a significant amount of NOLs at both the U.S. and Germany, 2 of the more significant areas that we operate in, our cash taxes are expected to be 2/3 or less than our current effective tax rate. Now for the balance sheet. At the end of the quarter, our net cash position, including our subordinated notes, was $2.2 million with no outstanding balance on our $25 million credit facility. Our net cash position was down compared to the end of last year, primarily as a result of timing of collections on our receivables and payments to vendors. At the end of the quarter, net accounts receivables were $52.9 million, up compared to $46.8 million at the end of last year due to timing of sales at the end of the quarter and cash receipts. We have not experienced any deterioration in the quality of our receivables or the aging of outstanding balances. Inventory at the end of the quarter of $40.1 million was in line with the balance at the end of last year. Capital expenditures were $1.2 million for the quarter and $4.9 million for the past 9 months, in line with our expected range of $6 million to $8 million on an annual basis. The majority of our capital expenditures continue to be for upgrading manufacturing equipment, subsequent phases of our ERP system and investments in our intellectual property. Lastly, at the end of the quarter, our Advanced segment backlog was $37.2 million, up significantly from $14.4 million at the end of Q2, based on the recent orders that we discussed on our last call. Now turning to our near-term outlook. Consistent with Charley's comments, we anticipate that our revenues will come in around $65 million in Q4 for a year-over-year growth rate in the 3% range. Also, we anticipate that Q4 revenues in our Advanced segment will be comparable to Q3. Our Advanced segment backlog is at record levels, but we are currently in the design phases of the new orders. So we anticipate revenue will start to ramp towards the end of the quarter and in the fiscal year '14. At this revenue level, we anticipate operating profit margins will be in the 5% range for Q4. While we continue to manage our operating expenses in a disciplined manner, we do expect slightly gross -- lower gross profit margins from excess plant capacity at these lower revenue levels. We also anticipate that our effective tax rate will remain at the normalized rate of just under 40% for the upcoming quarter. With that, I will turn the call back to Charley.

[Charles M. Brown:]

Thanks, Allen. As you can see, we're continuing the march to our next quarterly milestone of $75 million of revenue and $10 million of EBITDA. Our trajectory is consistent and sound even in the face of several years of macroeconomic variability. Our formula is no secret; continued emphasis on our new products through our dual distribution channels into diverse end markets all over the world. Our expense profile remains steady at a level to support these significant ambitions. Our profitability continues to be solid, with EBITDA margins of 10% and margin expansion available through operating leverage, as we grow to that next milestone. Some of the early macroeconomic indicators around the world appear to be trending more positive than in the recent past. As I've said before, the pace at which we grow to the $75 million and $10 million levels will be accelerated or decelerated by those variables. We feel we have all of the elements in place to reach those goals. Allow me to illustrate. Our backlog in the Advanced segment is at record levels, giving us good visibility to $2 million to $3 million more per quarter from this segment in fiscal 2014. Bridging from Q3, that puts us at about $70 million, quarterly. Next, add continued growth in our aftermarket business based on continued favorable manufacturing trends and our ever-increasing install base, and you're left with about $3 million to $4 million per quarter of incremental Standard Systems needed to finish the push to $75 million per quarter. This represents 1 to 2 additional machines per week. Clearly, our goal is within reach. I do not predict when we will get there because too many macro variables enter the equation. But we are confident in our trajectory and the path we are on. We'll now be glad to address your questions. Operator?

[Operator:]

[Operator Instructions] First question is from the line of Joe Maxa with Dougherty & Company.

[Joseph A. Maxa:]

So, the Advanced segment, you're thinking $8 million is a good number to look at for next year based on this ramp. That's helpful, if I got that number correctly. Help me on out the Standard Segment just a little bit. I mean, you've had some nice growth historically, just a little slowdown this quarter. I know the timing is uncertain, but you still sound pretty confident getting that up to a double-digit growth rate based on what you're seeing out there today. Is that -- how realistic is that for 2014?

[Charles M. Brown:]

Let me start with your comment on the Advanced. What we said was that our current run rate is about $5 million, then we're thinking there's $2 million to $3 million range on top of that per quarter in the fiscal '14 timeframe. And on the Standard Systems, as I said, we're a couple of machines -- 1 to 2 machines per week away from the run rate we need in that part of our business to be at that $75 million level. If you take that as sort of a quarterly number of $3 million to $4 million on a base of $40 million, yes, we're within single digits, maybe 10% in that piece of our business from being at that run rate. So we feel that with the continued quarter-over-quarter steady climb that, that is within our gun sight.

[Joseph A. Maxa:]

And sorry, on the Mach 2 and 4, you've had some pretty good uptake. I mean, just give us an idea of how that's rolling -- or progressing as you roll it out geographically? And then, an update on the Mach 3, if there's a timeframe when you're maybe switching your electronics package over to the newer package that you expect to give you higher gross margins?

[Charles M. Brown:]

Sure. The Mach 2 and Mach 4 continue a steady march around the world. We're taking orders in all of our major geographies. We, as you know, rolled it out first in the U.S., so we've got more installations already in place in the U.S. than we do elsewhere. But it is continuing to move forward all around the world, and we're pleased with the steady progress there. The Mach 3 transition into the new electrical package is a project we're working on. We're not prepared to announce anything specific on the timing of that, but it is certainly a live project for us.

[Joseph A. Maxa:]

And, lastly, if you could comment on expectations of cash generation?

[Allen M. Hsieh:]

Joe, our surrogate for cash is, kind of, EBITDA plus a level of capital expenditures that we've outlined at about $6 million to $8 million per year. If I back into it and look at the last 4 quarters, we're at about $25 million in cash flow from an EBITDA standpoint. So you take that, less $6 million to $8 million, that's -- we're still on that track until we start to generate significantly more in our revenue base.

[Operator:]

Next question is from the line of Joe Bess with Roth Capital Partners.

[Joseph Bess:]

Charley, I joined the call late. And you were in the middle of talking about the sequestration, some of the order flow that's kind of slowed down the quarter. Can you talk a little bit more about that, what happened?

[Charles M. Brown:]

As I mentioned in the prepared remarks, the -- what we saw was a -- across the U.S. machine tool landscape, if you will, a 4- to 6-week timeframe, late January and into February, there was a bit of a pause or a wind pocket, as we've called it, in orders. And we believe it was due to the uncertainty in people's minds regarding what was going to happen with sequestration. We have seen our orders return back to normal, so it was a pause, a brief period of time. And I did also comment that we would be -- that would affect our results to some degree, so we wouldn't be able to set another record in -- sequentially in Q4, but would still anticipate growing versus year ago.

[Joseph Bess:]

Okay. And that's just going to affect Q4. And then moving forward, are you anticipating higher growth rates?

[Allen M. Hsieh:]

Yes. Joe, we expect that we're on that same trajectory that we've gone on before. Nothing's changed from that angle. We just hit this pause in Q4.

[Joseph Bess:]

That's perfect. And then, thinking about your international markets, can you give a little bit more color on what you're seeing in those spaces, particularly in Europe and Asia?

[Charles M. Brown:]

Sure. Our Europe business continues to be very solid. We've talked in these calls in the past that our European aftermarket and our European Systems business, we continue to have good orders, and we're pleased with the rate of progress there. In Asia, we are also seeing good business in some areas, and we're still seeing some softness in some others. China has not yet rebounded. India is still a little bit soft. But other parts of Asia are treating us well. So they offset some of those areas.

[Joseph Bess:]

Okay. And in thinking about R&D and your new product launch going forward, what should we be anticipating in 2014 in terms of new launches and just your spend on R&D?

[Allen M. Hsieh:]

On the spend side, Joe, I think you can look at it from very similar to what we spent in this fiscal year and prior fiscal years. So in that neighborhood of that $3 million per quarter range. In terms of the new products, I'm not -- for competitive reasons, I really don't want to talk about any of those type of things.

[Operator:]

[Operator Instructions] Our next question is from the line of Eric Stine with Craig-Hallum.

[Eric Stine:]

So I just want to clarify. I know this has been asked a few times. So really, you do expect this is kind of a 1 quarter pause in your commentary -- that you're 1 to 2 per week away from making significant progress to your goal. I guess that would seem to imply that that's the case. I just want to clarify that.

[Allen M. Hsieh:]

That's well said.

[Eric Stine:]

Okay. In the context of that, I mean, just how should we think about consumables in Q4? I know that, that's typically quite a significant sequential bounce-back sequentially. I mean, should we think of that more as kind of a flattish quarter just based on your commentary sequentially?

[Allen M. Hsieh:]

Yes, I think -- Yes. Eric, as Charley mentioned, we did hit a little bit of a pause both in the systems and in the aftermarket. So I -- as we look at it, that's what both the Systems and the Spares are driving us toward that $65 million.

[Charles M. Brown:]

Good point of clarification there, though. The pause we're talking about is U.S.-based. It has nothing to do with the rest of the world's sales. So for example, our aftermarket business, as I said a moment ago, in Europe is continuing on the good pace that it's been on.

[Eric Stine:]

Okay. That helps. And maybe -- just touching on the new products -- and you've discussed them a fair amount. But do you -- I mean, anything you can provide as far as details -- maybe how much you feel it impacted this quarter? I mean, do you feel that you're still a ways away from getting the full impact from your new product launch?

[Charles M. Brown:]

The short answer to that last question is, yes, we do feel that it is still something that we're slowly ramping to, and it's at a pace that we're comfortable with. Again, as we have talked about before, there are a lot of elements that have to come together all around the world in order to really get the traction that's required to make a more meaningful impact. But the other piece of it is that it's very difficult to -- at the end of the day to look back at the results and say how much of that business was incremental versus how much of it was just up-sale from what they would've bought otherwise. For example, the M4c has a higher price point than the M3b, and we could, in many instances, a customer could make a decision either way. And as the new product, the M4c, becomes available in a given market, are we able to tilt some of those sales to the M4c. In that case, the little illustration I just gave, then the incremental revenue is not 100% M4c, it's the delta between the price points. So there are a lot of different ways to think about the growth that's available to us through the new products, one of which is average selling price bumping up a little bit.

[Eric Stine:]

Got it. No, understood. That's helpful. Maybe last thing, just the indirect channel. It's been a big part of your growth. I'm just curious, where you feel that stands and maybe how you think about the channel in terms of, kind of, in the Tier 1 channel partners and how you see that trending over time? Do you feel you need to add more of an indirect sales force, or is it just bringing that indirect sales force up to speed as time goes by?

[Charles M. Brown:]

Sure. We feel like we're in a good position with the over 90 partners that we have worldwide in that indirect channel, representing -- pushing 250 to -- or more individuals within those companies that are now able to sell Flow products. And so, we like the footprint that, that gives us. In that type of situation, you're always going to be evaluating and determining if the partners are right, and you'll always be doing some turnover that's healthy. So we're very comfortable by and large with that overall footprint, and the partners we have are very strong. Now we're into the phase of that growth, where the partners know how to sell Flow at a certain level. And it's our challenge now to continue to go deeper with those partners, to train them more thoroughly, to bring them into a higher comfort zone of being able to walk in and talk about Flow and be deep enough in the product knowledge that they can field most questions that the customer would have. And so, that's -- the pretty standard approach that needs to be taken with this type of a channel is ongoing effort on the manufacturer's part to make sure that the agent or distributor is getting all the information that they need and have -- has a very comfortable interface with the manufacturer. That's where we are on our curve with these partners now, is being able to continue to enhance their capabilities and giving them more and more confidence and reason to proactively sell Flow products.

[Operator:]

And I'm showing no further questions at this time. I'd like to turn the conference back to management for any closing remarks.

[Charles M. Brown:]

Thank you, everyone, for listening, and we look forward to speaking with each of you soon. Thank you.

[Operator:]

Ladies and gentlemen, if you'd like to listen to a replay of today's conference, please dial 1 [phone] or [phone] using the access code of 4603891 followed by the pound key. This does conclude the Flow International Fiscal 2013 Third Quarter Financial Results. Thank you very much for your participation. You may now disconnect.