Global X U.S. Cash Flow Kings 100 ETF
Q4 2013 Earnings Call Transcript

Published: 2 Aug 2013

[Operator:]

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Flow International Fiscal 2013 Fourth Quarter Financial Results Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, August 1, 2013. And I would now like to turn the conference over to Mr. John Leness with Flow International. Please go ahead, sir.

[John S. Leness:]

Thank you. I'm Flow's Secretary and General Counsel. 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. With that, I will now turn the call over to Charley.

[Charles M. Brown:]

Thank you for joining us today for our discussion of Flow's results for the fourth quarter of fiscal year 2013. Before we discuss the results, I will comment briefly on our process for investigating strategic alternatives. I refer you to our press release dated July 16 where we said the process remains ongoing, including confidentiality agreements with a number of parties. Consistent with that statement, we will not be providing updates and we will not field questions regarding it today. For the quarter, we reported revenue of $58.4 million and an operating loss of approximately $300,000, both in line with our pre-announcement in early June. This compares to revenues of $63.4 million and operating income of $2.4 million in the prior year quarter. Also for the quarter, we reported a net loss of $1.9 million or $0.04 per share. In the quarter, we booked charges of approximately $2.3 million related to our business in Brazil. Following an allegation of fraud and employee misconduct that was submitted to our internal whistleblower hotline, we conducted a thorough and costly investigation into this situation. This investigation revealed discrepancies in certain account balances, including inventory. The managers involved were summarily dismissed. The investigation, terminations and inventory adjustments represent roughly $1.1 million of the $2.3 million charge. The remaining $1.2 million relates to our Brazil tax position. During our deep dive into the Brazilian operations, we also found potential issues with our tax returns that were prepared by our third-party provider over the past 5 years. These potential issues, combined with not being able to deduct certain items under Brazilian tax rules, resulted in the $1.2 million charge. Resolving these issues was the main reason our 10-K filing was delayed. While we can always improve upon our overall investigation procedures, this experience has proven the value of our internal communications channels and once again demonstrated our firm commitment to act decisively when actions of employees contradict our core values. Now turning to the revenue picture. For the quarter, the Advanced segment revenue of $6.8 million was up 55% from the prior year. Spares revenue of $20.4 million was in line year-over-year, and Standard Systems revenue of $31.1 million was down 19%. The Standard segment results imply a solid level of factory utilization as shown by our Spares revenue, but a lack of business confidence levels required to support growth in capital equipment expenditures. Annually, the revenue situation was quite different in Q4 compared to the first 3 quarters. Q1, Q2 and Q3 were each all-time record revenue quarters for Flow. This was led by continued strength in the Standard segment, including Spares and Systems, which was up 10% year-to-date after 3 quarters then fell off 13% versus prior year in Q4. Profitability for the year was hurt by that revenue downturn and by the $2.3 million charges I just discussed. We ended the year with $12.7 million in operating income compared to $14.7 million in fiscal 2012, representing 5% operating margin compared to 6% in the prior year. Reported net income for the year was $5 million compared to $9.4 million, and EPS from continuing operations was $0.11 compared to $0.20 a year ago. EBITDA for 2013 was $21.2 million or 8% of revenue compared to 2012 levels of $24.4 million or almost 10%. I will now turn it over to Allen to discuss the details of our fourth quarter financial results and outlook for the upcoming first quarter.

[Allen M. Hsieh:]

Thanks, Charley. We reported an operating loss of $300,000 for the quarter and a net loss of $1.9 million or $0.04 per share. This compares to operating income of $2.4 million and EPS of $0.06 per share in the prior year. Also for the quarter, we generated EBITDA of $1.9 million compared to EBITDA of $5.5 million in the prior year quarter. Overall, our operating results were down compared to the prior fiscal year quarter, primarily attributable to lower revenues in the quarter, as Charley mentioned previously; with the lower sales, we had unabsorbed capacity in our operations; and $1.1 million of the Brazil-related charges that Charley mentioned as well. This charge negatively impacted our gross profit margins by approximately $700,000 and our operating expenses by approximately $400,000. Now to the details, starting with our segments. Standard segment gross profit margins of 37.6% in the quarter were down compared to 40.4% in the prior year quarter. While gross margins generally vary based on product and geographic mix, which was the case this quarter, our Standard segment gross profit margins were negatively impacted by approximately 120 basis points due to the inventory charges we took related to our Brazil operations. Our Advanced segment gross profit margin of almost 25% was consistent with both the prior year quarter and our expectations of future gross profit margins of 25% plus or minus a few points. On an aggregate basis, total gross margins of just over 36% were below our stated range -- our stated range of 40%, plus or minus 2 points for the reasons I just mentioned. Total operating expenses in the aggregate were $21.4 million in the quarter, 5% lower than the prior year quarter of $22.5 million and within our expected range of $21 million plus or minus 5%. As I previously mentioned, during the fourth quarter, we incurred costs of approximately $400,000 related to the investigation in Brazil. Please note that we just recently completed that investigation and a deep dive into our records. As such, similar charges for professional fees will also be incurred in the first quarter of fiscal year 2014. For the current quarter, we had net other expense of $840,000, up compared to $617,000 in the prior year quarter. Net other expenses are primarily comprised of interest expense and foreign currency adjustments, partially offset by interest income. The comparative differences were primarily the impact of foreign currency adjustments as well as an increase in interest expense. For the quarter, we recorded tax expense of $750,000. Offsetting any income tax benefit associated with the pretax loss in Q4 was the $1.2 million of Brazil tax-related charges that Charley mentioned. This charge had 2 components

[Charles M. Brown:]

Thanks, Allen. Three years ago, we put together a plan to drive our quarterly revenue from where we were, about $48 million, to $75 million, generating $10 million of quarterly EBITDA. The fourth quarter that we just reported was the 12th quarter of that plan. For 11 quarters, we tracked very close to our projections and plans, allowing us to continue investing in our strategic imperatives while giving us confidence in our ability to reach our goals. Through 11 quarters, we had sequential growth in 9 quarters and record sales levels in 4 of the previous 5. During that 3-year period, plenty of bad news hit the headlines regularly, ranging from imminent bankruptcy for the U.S. government 2 years ago to the predicted demise of the euro. Through it all, we found ways to grow based on our dual channels of distribution and new products. In fiscal 2013, the Mach 4c and 2c new product combination generated $40 million of revenue, while our second or indirect channel of distribution sold $70 million of Flow products. Geographically, the U.S. market continued a steady order pattern while international markets offset each other with the pluses slightly outweighing the minuses. In February, prior to the sequester deadline, we saw a marked downturn in order patterns in North America followed by an encouraging return to more normal levels in March. Unfortunately, North American systems order patterns in subsequent months have been erratic, while internationally the minuses started to slightly outweigh the positives. This all resulted in our lower level of revenue for Q4. For the May, June, July first quarter time period, the order pattern has largely maintained itself without further deterioration. The Standard Systems geographic revenue mix has shifted a bit in favor of the North American market. We are also encouraged that global spares demand has remained consistent sequentially. Our market checks indicate that our waterjet market share is holding steady and that non-waterjet machine tools are experiencing similar trends to our category. In light of the current market situation, in June we announced $13 million of cost reductions to be implemented this fiscal year. This targeted savings represents more than 100% of our trailing 12-month operating profit. It consists of approximately a 10% reduction in operating expenses, or $9 million, plus the $4 million in COGS reduction that Allen also described, largely driven by ringing out the costs of our new products as they head into their second year of production. All reductions are on schedule and tracking well to plan. We are aggressively managing our way through a dip in demand. Our business model and competitive advantages remain firmly in place, and our long-term outlook remains robust. Over the past 5 years, we have reengineered our product line, significantly broadened our distribution and retooled our internal systems and capabilities, all funded by cuts in other areas so we did not increase our operating expenses. Having worked through many of these investments, we are now able to reduce costs significantly without compromising our future prospects for profitable growth. When we return to growth, we will enjoy the increased leverage that comes from the lower cost space. Meanwhile, we will continue to carefully manage our way through the current level of orders. We will now be glad to address your questions. Operator?

[Operator:]

[Operator Instructions] Our first question comes from the line of Joe Bess with Roth Capital Partners.

[Joseph Bess:]

My first question is on the reduction in operating costs. Can you talk a little bit more about how this might impact your deliveries moving forward? And is this something that you guys could have potentially have done before the downturn in your guys' end markets and continue to be able to sustain your revenue levels?

[Charles M. Brown:]

We don't believe that this will impact our ability to deliver product at all, to your first question. To your second question, we, as I said in the prepared comments, had about 11 quarters that we were tracking to plan that allowed us to continue investing in those items that were driving that growth. And having gone through most of the, shall I say, bow wave of investments in a lot of those projects, we feel that now we are able to pull them back -- some of the cost structure back and not impair our future ability to grow. So we don't feel that would have been the case as we marched through that time period because a lot of those projects, meaning the dual channels, the distribution and introduction of the new products and improving our internal systems and processes and ERP system, we could not have pulled the plug on those midstream without having a more serious effect on the business. However, having moved through much of that spending, we feel we can dial down the spending levels now without having a negative impact.

[Joseph Bess:]

Okay. And then thinking about gross margin a little bit more and your pricing strategy as you go through a tougher period versus year-over-year -- on a year-over-year basis, how do you view the improved operating structure and your pricing going forward? Is this going to be a net positive to margins by the end of 2014?

[Charles M. Brown:]

Yes. Yes, I think your question is that it's a competitive environment out there and will we be able to hold our pricing at current levels. We certainly don't comment a lot about our pricing in a public forum like this because many of our competitors listen. What we are seeing in the market, though, is the slight softness and the dip that we're seeing is not necessarily a result of lower average selling prices out there. It's really more of a result of just hesitancy to actually make an order at all in the cases where there is a bit of a downturn. So it's really a binary make the decision to buy or not as opposed to buy something for a few dollars less.

[Operator:]

Our next question comes from the line of Aaron Spychalla with Craig-Hallum Capital Group.

[Aaron Spychalla:]

Can you just give a little bit more clarity into the weakness in the Standard segment in Q4? I know manufacturing activity has been kind of soft here for a while, but you guys have been able to be close to $40 million or so each quarter in revenues. It was a pretty dramatic drop-off. I'm just trying to get better understanding if it was any kind of specific applications or maybe at the low end or high end of your guys' product offering. Just trying to get a little bit more clarity there.

[Charles M. Brown:]

Sure. The change that we saw as we came into the February time frame was not specific to any particular end market or any particular price point or any of those ways of sort of slicing in the business. It was really -- the change came really broadly across the North American marketplace as compared to what we had been experiencing for many quarters. And the sort of consistency "steady eddie" type of business we had out of that geography then became more uncertain. We've looked at it and, as I said in the prepared remarks, have done a fair amount of market checks in our category and in another machine tools around the country and found a fair amount of consistency with our experience. And so we attribute it to just the overall business confidence levels required to support the capital equipment expenditures at a growing rate as opposed to a slightly more tepid rate.

[Aaron Spychalla:]

Okay. And maybe can you give a quick update on the product launch, whether that's fully launched in North America now and kind of an update internationally and how long it might take to get fully ramped up there?

[Charles M. Brown:]

The product launch, as we're referring to, is the Mach 2c and Mach 4c combined in fiscal '13. We sold $40 million of those products, which, as a percent of our total Standard Systems sold in the year, was over 25% and so it was very successfully received in the marketplace from that standpoint. However, it is still not fully at run rate worldwide. It takes a while for these types of launches to fully penetrate all 90 of our distributors through all of our salespeople in over 80 countries. It takes a while to continue to ramp that. So we anticipate that we still have some continued growth available as the business confidence picks up to continue to improve even upon the $40 million run rate in a normal environment.

[Aaron Spychalla:]

Okay. Okay, that makes sense. And then maybe one last question on the Advanced segment. It's pretty strong this quarter. How do we think about that? Is it still kind of $7 million to $8 million in revenue kind of throughout 2000 -- fiscal '14 or how do we think about that here?

[Allen M. Hsieh:]

Yes, Aaron, as I mentioned, we ended the year at about $30.7 million in backlog in Advanced segment. We think of that business as roughly about a $25 million business throughout the year. So I think $6 million, $7 million per quarter is probably a good rate to use as you think about it given that backlog. These are long-lead cycle items, so it's -- they generally go from 18 to 24 months.

[Operator:]

[Operator Instructions] Our next question comes from the line of Joe Maxa with Dougherty & Company.

[Joseph A. Maxa:]

Wanted to get a sense on -- you gave some indications that internationally was weak a little bit and North America was picking up in the last few months. Can you give us the area -- was there specific areas internationally that are getting weaker than others? Just want to see what you're seeing out there.

[Charles M. Brown:]

It's not a dramatic trend, Joe. It's just a little bit of a shift as we look at our comparison sequentially or year-over-year that North America is a little bit better than in Q4. And really, the rest of the world, I wouldn't say it's dramatically tilted in one geography or another or any meaningful trend underneath all of it. It's just a little bit of a shift, so I thought I'd mention it.

[Joseph A. Maxa:]

Looking at your crystal ball, what do you think needs to happen in order till you get back up to the levels you were previously in the Standard segment?

[Charles M. Brown:]

I think primarily in the U.S. market, North American market, it's just we need to get a little bit more of that confidence, that little bit of sort of PMI type of data going a little bit further forward, capacity utilization nudging up a little bit instead of sort of flat and wobbling along as it has been. Those are some of the, I think, indicators that will help out. And certainly, a lot of the forecasts of professional people who look at crystal balls that I read would anticipate that those types of things are teed up for in the fall and on in through the winter of this calendar year. But I don't have any better crystal ball than any of them. But those are the types of things that we look at that tend to build that last level of confidence to go from a quote to a PO.

[Joseph A. Maxa:]

And have you seen any changes in competition, I mean, given everyone's apparently seeing this? Are they being more aggressive on price and maybe taking some deals away?

[Charles M. Brown:]

No, it's been pretty consistent over the last couple of years, I would say.

[Operator:]

Thank you. At this time, I would like to turn the conference back to Mr. Brown for any closing remarks.

[Charles M. Brown:]

Just want to thank everyone for your interest today, and hope you have a great weekend coming up. Thank you.

[Operator:]

Thank you. Ladies and gentlemen, this concludes the Flow International Fiscal 2013 Fourth Quarter Financial Results Conference Call. If you would like to listen to a replay of today's conference, you can do so by dialing [phone] or 1 [phone] and entering the access code of 4634066 followed by #. We thank you for your participation. You may now disconnect.