The LGL Group, Inc.
Q2 2013 Earnings Call Transcript

Published: 13 Aug 2013

[Operator:]

Good morning, everyone, and welcome to the LGL Group Q2 2013 earnings report. (Operator Instructions). This call also has a visual PowerPoint component, in addition to the conference call. To view the PowerPoint, please click on the Join the Meeting link you received in your invitation and included in the press release announcing today’s call. (Operator Instructions). I will be standing by, if you should need assistance. It is now my pleasure to turn the conference over to the company’s Chief Financial Officer, Mr. LaDuane Clifton. You may begin, Sir.

[LaDuane Clifton:]

Good morning and thank you for joining us today. Greg Anderson is with me as well, and will be our presenter. We prepared a slide presentation for your reference that may viewed as part of today's web conference and the presentation materials are also available at our website, lglgroup.com. Please refer to these and use them as you get through the call. Our call will be recorded and available for playback later today on our website. Other information, such as financial information and recent press releases are posted on our website as well. And please note that our comments are covered by the Safe Harbor Statement. (Operator Instructions). At this time, it's my pleasure to introduce Greg Anderson.

[Greg Anderson:]

Thank you, LaDuane, and good morning. Welcome to our second quarter earnings call. I'll start with a – just a short snapshot of corporate overview. We've been around for a long time. The Company was formed in 1917. Today, we are traded on the NYSE market. Our trailing 12 revenue is $29 million. About half of our revenue gets booked outside the United States. Yesterday's closing stock price was just a little over $0.6. We've got a market cap of just under $16 million, cash and cash equivalents of $9 million and we're a small player in a very large market. From a highlight perspective, LGL currently has one subsidiary, goes to market under the brand name of MtronPTI. Primarily, specialty component supplier for electronic communications and we serve large B2B clients. We provide solutions both to primarily the Internet Communication Technology market, as well as into the Aerospace and Defense market. So we have a nice balance demand. About two-thirds of our revenue today is booked into Aerospace and Defense clients. About one-third is into what we call, ICT, or Internet Communications. From a technology perspective, our value propositions, we are very much crystal-based in, at least, probably, half of our revenue. We tend to participate in really the precision on what we call the low noise environment. Things that really require a great deal of precision and performance. And we're not just a timing company. We have nice balance of filtering as well. And that that becomes very important to our clients, especially in radio applications. The platform itself is a global footprint in a number of US sites, some international sales, certainly some international supply. And know, we have an India manufacturing facility and really, that provides us a cost advantage, even for some of these high-performance products. Margin protection – again, we participate in more of the precision and we end up worth – often times, our components are designed into products and platforms of long life cycle, so they'll generate those repeat revenue streams, and certainly we've got an experienced management team, as well as the supply stream that really helps manager cost. Growth opportunities, we've got a number of very long-standing relationships with very large companies. And as the market is pressured today of our reduced supply base, it's never ever been more present than what's taking place today in the frequency control industry. We believe that presents some sure gain opportunities, of course, as well as our organic new product development activities. We look at second quarter results at certainly a step backwards for us, as compared to the first quarter, well probably with the exception of backlog. So real quick, revenue was $7 million. It was down 8%, as compared to a year ago. Sequentially, it was down 3%. Margins were about flat, as compared to a year ago, and is sequentially down almost 7%. We had a pre-tax net loss of $0.32, and really add some favorable to a year ago. I think a year ago, we had a $0.13 loss. And really, the decrease or the increase loss was due to a revenue drop, and as well as a change in product mix. We reported a one-time non-cash charge of $1.59 on evaluation allowance for deferred tax assets, coupled with our pre-tax that gets us to $1.91 on a net loss. And as I mentioned, the positive for the quarter, frankly, is a positive book to bill, and backlogs up 9% sequentially. Taking a look at the first half, where our revenues are down, just a few percent, as compared to the first half of last year. Margins, frankly, are up nicely almost 5%. We lost less – if we can use that word – by a few cents, as compared to the first half of last year, so maybe operated just a little bit more effectively. Again, we talked about the backlog being up sequentially 9% quarter on quarter, down just a few percent, if we look at a comparable period of last year. And EBITDA says we operated about a 1% better in the first half of this year versus last year. Our typical financial snapshot that has – in the bars – is revenue – the gray line is our margin and then EBITDA performance is the green. And, unfortunately, red color is at the bottom. You can see our revenue trend in the rolling 12. $7 million is the low point in that rolling 12 quarters. Margins a bit noisy and EBITDA is a bit noisy, as we move through mix. I think, overall, revenue is the challenge. Cash and cash equivalents for – at the end of June were $3.50. If we look at our capital position, assets dropped notably and that was really for the valuation allowance of the tax asset. Working capital – cash adjusted working capital, which is actually slightly more efficient. Debt was reduced. And then, of course, the shareholder equity was, again, down, primarily driven by the valuation. Book value at the end of the quarter was $7.60. Where are we trying to position for growth because that's the challenge before the operating business at present? Well, we do have – even though with our struggles of our biz unit, our capital position does remain strong and in some cases, that actually is different than some of our competitors. And so, we are able to make investments organically, as well as some of these other investments and sales and e-commerce and those kinds of things that help reach out and touch our clients. I want to remind our investors that a lot of our components are quite sticky and they have long product life cycles, especially in the Aero and Defense market. It's not uncommon for those products to run 10 years. And even though we live in the cyclical business, eventually – and when they need that equipment again, sales will rebound for those long sticky revenue streams. Our R&D investment today are really pretty targeted. We've got a number of new products being launched in what we call software-defined radio market, primarily for Aero and Defense applications. Some noise – some low noise radar, timing devices and some – a number or products in what we call harsh environment, again, Aero Defense directed. We have a strong position in commercial avionics. And similar to last year, that is a shiny spot with inside of our product offerings and our client positions, and really seeing double-digit growth, as the industry has predicted; we're feeling that as well with inside of our company. Below is the order backlog trend because it – the rolling 12 and we mentioned that quarter on quarter, we're up 8% with backlogs at just over $9 million. GAAP to non-GAAP reconciliation for earnings, as well as adjusted working capital. Some of this is repeat but I'll share again. We are towards growth. Some of clients reporting market softness. And in some cases, we know that because frankly speaking we have sole source design positions and when business is down there, we can track pretty readily how well our major clients are doing. And in some cases, you know, it's just part of a cycle. Repeat orders against existing contract – and especially in the ICT market, has been tough. And, of course, we're under price pressure really everywhere in the soft market that we're in. And really, our client demand in this networking business has been the toughest part in the first half of this year. On the positive side, our new product revenue stream is sort of at the percentage of new products – as a percent of the total revenue remains what we believe healthy – near at 15% to 20% mark. And so that says we are replenishing or refreshing our revenue streams. Again, the – our working capital position – although with – it has slid, we did generate cash from ops in the second quarter. And really, in the first half, margin and operating efficiencies – they remain favorable. Revenue remains our challenge. We've talked about our organic growth investments. Software-defined radios are really the avionics market. We are seeing repeat orders and share gain with our top seven or eight Aero and Defense clients strong in the double-digit category. We still think there's opportunity for indigenous sales in India. Anyway, we are continue to pursue how to grow within that market, especially due to some our larger clients. We are making investments and modules and sub systems that's a slow process. You have to develop the technology and convince your clients that this is an entry point for you. We are gaining some success. Of course, as we've talked in a number of announcements, joint ventures and M&A, those types of activities are certainly present for LGL. I added a slide that spoke, I think, generally but pretty plainly to the competitive landscape. Some of these are comments about the industry and the competitors. Some of them are a little bit more internal but I'm just trying to walk through those. I've been in this industry now more than 10 years and the frequency control product industry – I can speak most closely to the environment that I'd see, frankly, in North America, but I also have a number of touches in the Asia as well, and it's certainly going – undergoing change. And there's been a number of our key competitors that have formally announced – I'll call them strategic actions. Companies have formally announced spin-offs, so divisions of larger companies are now going to become divisions of smaller companies and sure are competitors that have announced major restructuring. We've seen couples – complete sale or a portion of their assets. Good will write-downs are common amongst all of that. And so, there is a fair amount of change today within the frequency control industry. And I just wanted to share with our investors that LGL and MtronPTI are not standing alone, when it comes to the state of the business. For us, our commercial product lines are under notable pricing pressures. We have a soft market like this. And frankly speaking, pricing pressures are ever present. And, of course, competitors that are struggling financially will dig deeper and work harder on margin. And so, that's probably just a factor of today's commercial market. So, on the macro economic effects, we talked about those often on these calls. Everybody reads about them. And it creates uncertainty. And I'll just – I'll try and share some specific example, where we have been notified by clients of orders that we have, frankly, bought to been awarded and yet the process of actually delivering the purchase order to us might lag by days. And so, I think, that's just a matter of – I call it – a good example of where the market is still tentative and it creates this uncertainty and know what to really books to buy and so they absolutely have to. And so it – that same uncertainty is reflected in our backlog, and then, of course, our revenue. We've had a number of recent announcements here at LGL in the past 60 days, and I just want to recap those for our shareholders. On June 13, we announced that LGL had received a number of – more than one and received some interest regarding acquisition of a portion of the MtronPTI. At the same time, our Board of Directors announced the formation of a special committee to really lead that review process, and more also took action to – and announced a warrant dividend to our shareholders. And we also reviewed our stock repurchase program. On July 17, we stepped forward and announced the finalization terms of the warrant dividend, and we also made additional commentary about the consideration of strategic options like streamlining operations, what would it mean if we reviewed the segmentation of the business, possible discontinuation and, of course, you know, the interest required – regarding acquisition as well. On August 5, the warrants are distributed to our shareholders, and they are now traded separately on the NYSE market. I just want to comment and below the Board of Directors are actively exploring these strategic options. Today, there's not a lot of detail that I can share. I think our listeners would be appreciative of the fact that we can't share, until it's public. And at this point, all I can say is it's an active process, between management and the Board of Directors, as we take a look at these options. One last slide before we recap and ask for your questions. Capital positions does remain strong. We do have an experienced management team. We are taking a look at JV and M&A and restructuring and all those kinds of things, just like many of our key competitors are going through at this time in the industry as well. The brand itself is – it's got some long-standing value. It's been around a long time. It's got great client positions. It's been good technology; a worldwide platform, and known to be, frankly, a high rail product line out there in the marketplace. So at this time, operator, I would open – I would open to our listeners that may have questions.

[Operator:]

Certainly. (Operator Instructions). And we will first go to the site of Sam Miller, who's a Private Investor. Your line is now open.

[Sam Miller:]

Hi. I was wondering if you could state through the idea of the dividend when it come to the warrants and about how you came up with the pricing of those warrants.

[Greg Anderson:]

Okay. We'll let LaDuane handle that question.

[LaDuane Clifton:]

Good morning, Sam. Thanks for joining us. Yes. So, the warrant dividend – we listed a number of ways – (inaudible) for ways to bring value to our shareholders. And the warrant dividend has nicely to the sense that it allowed us to provide – it's a means of returning a portion of the Company's future value to stockholders, while preserving the Company's balance sheet. We are active in our stock repurchase program, as we disclosed in our press release and in our 10-Q. And so, this was just another way to continue doing that. We need to preserve the cash. Obviously, this business cycle will continue to look for ways to deploy that. And so, the warrant dividend kind of made a lot of sense. With regard to the pricing, the stock pricing, or whatever, related in the warrant dividend, I'd say the Company – it analyses a variety of factors in determining the terms of the warrants and trying – we're really trying to maximize value to stockholders but balance that against some terms that could make sense in the long term. So, we think we accomplish that but; obviously, we had to apply a lot of judgment in trying to really strike the right balance.

[Sam Miller:]

Okay. Thank you.

[Operator:]

And our next question comes from (David Minghoff with DCM Management). Your line is now open.

[Unidentified Speaker:]

Good morning, gentlemen. The Company – I also have a question on the warrants. The Company issued five warrants but you need 25 warrants to buy share stocks at [750] set the five to one ratio. Why didn't the Company just issue one warrant and require the five warrants to buy a share of stock?

[LaDuane Clifton:]

Well, thanks for the question, David. It's nice to hear from you. The – Really, there's a balance of the exchange ratio that – which is the rate that can be exercised for and then the distribution ratio. We were trying to balance between providing sufficient liquidity, since the warrants will be traded separately. We wanted to provide sufficient liquidity for that separate trading, as well as sort of having exchange ratio that was meaningful that the number shared that can exchanged is sort a functional level available under our shelf registration, frankly. And so, we were balancing between those two ratios.

[Unidentified Speaker:]

Well, but still the five to one ratio – it seems the math would have been easier would it not have is just one to five?

[LaDuane Clifton:]

I understand that. That's – I mean we model that option. We thought the way we did the terms would provide more liquidity or better liquidity for the separate trading of the warrant.

[Unidentified Speaker:]

Okay. On August 6, the day before the X dividend day. It think the stock closed at ($6.40). And on August 7, the X dividend date – the stock was indicating ($3.90) and the warrants were indicating $0.50 or thereabouts. So, in other words, ($2.50) had come off the price of the stocks, so I guess either they were valuing the warrants at $0.50 for five of them $0.10 for 25. I'm not sure which. How did – who infuses that value of ($2.50) on the warrants? They never traded at ($3.90). The stock is trading about the sixth like you indicated. But the warrant is trading at $0.10, not $0.50. So how is that initial ($3.50 – $2.50) off the price of the next dividend amount come about?

[LaDuane Clifton:]

Well, I'm sure you realized those sort of pricing decisions particularly around the first day of trading really are outside the Company's control; we're not part of that process. I'd say between in the last day of markets, looking at the trading – how the stock trading would (do go) between the record date and coming up to the first day of trading, I know they do an analysis of the (do go) to see how things were trading during that time. And then, of course, the market may grow – roll, as related to whatever activity you're seeing as well. And so, those events you described, we were looking at them anxiously as well; wondering ourselves. And all I can tell you is I think now that they're trading actively in the market, the market decides the pricing of the – those first few estimates that came out of those decision makers. Maybe I had the same question as you did, I wasn't sure. But, yes, those things are outside of us. Although, we were speaking to them and understand after the fact it's all at the same time you did, right?

[Unidentified Speaker:]

All right. So, this was – the intention of this, of course, was to be an enhancer for shareholders. I know it's early but at this time, the amount that the stock are selling less than it was plus the dividend is about a wash really, right, because the warrant is what would then come off of the stock price, so it's a pure X dividend, so there's been no value created just yet admittedly it's early.

[LaDuane Clifton:]

Yes. No, I appreciate your comments.

[Greg Anderson:]

Yes. I think it's a fair statement. That's about as we can – simply as we can say it as well.

[Unidentified Speaker:]

And just, finally, I think you talked mainly about the reasons that there is a party that's interested in part of Mtron. I seem to recall – in a prior release, I can't find it just now – but there was another party interested in the entire company. Is that true? Are there several interested parties? Or just the warrant – how many are we talking about?

[LaDuane Clifton:]

I think they are at different levels of interest being expressed. I would say more than one and less than ten, and pieces are all certainly (inaudible) consideration but those kinds of interests.

[Unidentified Speaker:]

All right. Thank you very much for your answers.

[Operator:]

And we will now have the side of Hendi Susanto with Gabelli & Co. Your line is now open.

[LaDuane Clifton:]

Good morning.

[Hendi Susanto:]

LaDuane, first question. I would like to inquire more insight into gross margin. The magnitude of the decline in gross margin in the quarter was deeper than my expectation. Can you describe how much impact came from product mix and whether there are system variables that we need to be aware of?

[Greg Anderson:]

I would say – Hendi, this is Greg speaking. I would say that the contribution between mix, as well revenue declines probably split fairly evenly, okay?

[Hendi Susanto:]

Okay. And then let's say when you talk about mix like which mix has that total work gross margin?

[Greg Anderson:]

Today, I can tell you that – and it's historically not always been that the case. But today, in our current operating, there's just model – there are lines within our commercial products or networking group that run at less margin in today's environment for all the kind of reasons that I spoke to in the presentation.

[Hendi Susanto:]

So, let's say it is commercial, I know, and looking at, I believe, it is in ICT business then, which is well,

[Greg Anderson:]

Yes.

[Hendi Susanto:]

Like a third of your revenue...

[Greg Anderson:]

Yes.

[Hendi Susanto:]

So, it was like big enough to impact the gross margin?

[Greg Anderson:]

Yes.

[Hendi Susanto:]

Okay. Just like to confirm that. And then second question is among the options of the property review process. What did you mean by segmenting some or all and from PTI's operations?

[Greg Anderson:]

Okay. Fair question. Segmenting – well, we obviously have business – half of our sales are foreign, so there is some regional – I'll call it – options, if that's the right word. Considerations is probably a better one. There's certainly market considerations; how we participate in those markets, and there's considerations that we could segment along those lines. There's also various kinds of businesses. Largely, some of our businesses are what I would say more like customer-service and distribution base, when we have contract factories that are doing work for us. And then, of course, we have some parts of our business that are almost what I would call more manufacturing base. And then, we have some that are extremely custom and almost very specialized. And so maybe the right word is there could be a consideration on the kind of business model as well. So, I would – to recap, I would say – I would view it as regional, market and possibly business type, if you will, while inside of there.

[Hendi Susanto:]

Okay. And then, may I know how long the strategy cross sets, especially the review of the third party (inaudible) portion of that PTI?

[Greg Anderson:]

I'm sorry. I didn't hear that, Hendi. Could you repeat?

[Hendi Susanto:]

How long does budget strategy review process may take for let's say like for the considerations and also in viewing the third party influence in part of the Company?

[Greg Anderson:]

Yes. So, you're questioning what the length of timeframe that we'll be in the strategic review process?

[Hendi Susanto:]

Yes.

[Greg Anderson:]

Well, that's, again, a good question. I'd say at this point it's undefined. I can just tell you that it's active. You can't do anything quickly within a public company. And so, I would just say it's active. Obviously, we just had a Board meeting in different kinds of options and proposals – at least some of those were discussed and under consideration, so decisions are not just made yet. I would say that we understand the urgency in the operating business. It's likely not going to recover quickly in this kind of market. The Board of Directors understands that. We understand the cash burn situation. And there are pieces of the business that are performing well, others are not. And all that is certainly – creates a sense of urgency. I'm not going to give you a horizon of the say, create a sense of urgency. Management and Board understands that.

[Hendi Susanto:]

Yes. And (inaudible) and also end at leave you – is it reasonable to assume that it's just (inaudible)?

[LaDuane Clifton:]

Completed by when, Hendi?

[Hendi Susanto:]

By within a year?

[LaDuane Clifton:]

Sorry. Within a year? That was reasonable and estimate, Hendi, I'd say.

[Hendi Susanto:]

Yes. But – and then, Greg, could you elaborate on sales opportunities with PTI and what timeline or horizon with in India?

[Greg Anderson:]

For India investments or growth?

[Hendi Susanto:]

Okay.

[Greg Anderson:]

Okay. Well, it's active. And in – so, in particular we've constantly made investments there to really manufacture a number of our products lines. As I mentioned in the presentation, a number of those end up being the high performance products as well. But probably of note – and I've spoken to it in previous calls is being eligible for what we – what is called the offset dollars, and we are actively working with two clients and trying to bring that to reality and that may end up providing them benefits and a way for us to grow. It's probably less about manufacturing infrastructure, Hendi; more about, if you want to say, giving the right approvals within the Company – within our clients, as well as giving position in – within the, I'll call it the right – I mean these words are less – just certifications within the Indian government to become eligible. And we believe that that has a potential of stirring business our way. So at this point, it's not like the factory expansion so much per se as it is getting position for that eligibility.

[Hendi Susanto:]

And, Greg, would you talk about product groups within LGL? I think what I would like to understand better is that you have this number of product groups within LGL. And in my officer party of interest, I think one may think that under some potentials, you may be able to settle like system products both for system segment but at the same time one may think that it's a way – one may – one would like to know if it's like legacy business, gross business, product selling development or et cetera because (inaudible) a strong product group then there's some indications on how to use road maps as to some legacy business than to some notification that it may be of some smaller value?

[Greg Anderson:]

Okay. All right. It's a first statement. So from a product grouping perspective, I'll start with filtering. We have a number of filtering offerings. And primarily, they are an Aero Defense applications either in radios, avionic communications, and they tend to be, I'll just say, use in applications that are close to the antenna. Not always but they're certainly part of what's called the RF signal path. And it's also an area where we've done a fair amount of R&D investment in the past and certainly most last 18 months, it's been our heaviest area for R&D investment. That particular kind of business – could it stand alone and be segmented? Yes. I mean it tucked inside the infrastructure. It's certainly part of the Aerospace and Defense marketplace. We are not really a commercial products filtering company, okay?

[Hendi Susanto:]

Okay.

[Greg Anderson:]

From a timing device perspective, there's really two parts to it. There is really network timing; the things that going backhaul, switches, routers, all those kinds of devices. There is timing that goes into base stations, as we – as those piece of equipment convert signals – well, packets of information around. That business itself is – there's probably four or five kinds of products that make up network timing. And I would say that those could be grouped together. And then, there's timing that goes into Aero Defense applications, and some of that actually is – it also goes into the radio frequency signal path. And some of that actually goes into digital controls used in a lot of avionic applications. And could that be segmented? The answer is yes. I think it probably most cleanly segments between the very – the two markets. Either, network timing or Aerospace and Defense. And the reality – and the reason for that, Hendi, is clients – they buy that whole suite of products from us on Aero Defense. So first instance, (Rockwell) would be quite interested in having a front-end filter, as well as timing devices that could be used in the RF signal path, as well as timing devices that could be used in various kinds of avionics control applications. So, I think it probably – it would probably best fit, less on a product then maybe on a market but it's – but there's probably potential either way.

[Hendi Susanto:]

And then, can you tell us the likes of the party you go whether they are like a legacy product or whether they are, let's say, let's call it like productive product groups?

[LaDuane Clifton:]

Meaning growth product groups? Or...

[Greg Anderson:]

Yes. I would say that they tend to be legacy more mature. I think that's where – did I answer the question? I'm not sure.

[Hendi Susanto:]

And then last question is for my (inaudible). Despite of the past markets that you're facing, where are we, in terms of the Companies of (inaudible) for the year?

[LaDuane Clifton:]

You know we don't tend to give a lot of guidance. But forward look, I'd say the backlog – so some growth there and we're glad to see that. But I would simply say sort of second half if going to continue to sort of a tough go. That's probably all I can say on that. We don't tend to get too much forward guidance.

[Hendi Susanto:]

And then probably if I may add one more. What is the estimated CapEx for this year?

[LaDuane Clifton:]

We have a target CapEx rate we've shared publicly of around 1.5% of revenue that can fluctuate, depending on what opportunities we have in front of us. I will say that if you look at where we come out on Q2, CapEx was down rather than the Q1. That's a combination of things. Primarily, we're trying to work to get certain projects into production. But we're also trying to be prudent and make sure that we're investing in places that gives the best potential for growth in terms of product investment or CapEx to support product investments. So, yes. That's probably I'd say we are.

[Hendi Susanto:]

Okay. Thank you. And good luck for the second half.

[Greg Anderson:]

Thank you.

[LaDuane Clifton:]

Thank you.

[Operator:]

(Operator Instructions). We'll pause for just a moment to allow additional questions to queue. (Operator Instructions). At this time, there seems to be no additional questions. I'd like to turn the program back over to our presenters.

[Greg Anderson:]

Listeners, thank you for joining our call this morning. I would just finalize that a couple of comments. In the core operating business, it was nice to see the backlog pick up. We have some bright spots in the Aero Defense and the first half has shown some nice growth, and our largest clients – the top spot for us has been in our networking business. We understand we're not – Management understands, the Board of Director understands we're not delivering the kind of performance that our investors would expect. Frankly speaking, that's why the review process is underway. We're not really able to comment on that very broadly, as I've stated, but it is an active process with the Board of Directors and Management. So, once again, thank you for listening in this morning. And as decisions are made, we'll obviously bring those forward to you. Thank you.

[Operator:]

This ends the LGL Group's Q2 2013 Earnings Report Call. If you have any further questions, please send an email to greg.anderson at – [e-mail] or to laduaneclifton at – [e-mail]. That is [e-mail] or [e-mail]. Thank you and have a wonderful day.