SMTC Corp
Q3 2015 Earnings Call Transcript

Published: 28 Oct 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the SMTC Q3 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will be conducting a question-and-answer session, and instructions will follow at that time. [Operator Instructions] At the company's request this conference is being recorded. I would now like to turn the call over to Sushil Dhiman, President and CEO. Please go ahead sir.

[Sushil Dhiman:]

Thank you, Bryan. Welcome and good morning, ladies and gentlemen. I am Sushil Dhiman, SMTC's President and Chief Executive Officer. On this call with me today is Jim Currie, SMTC's Interim Chief Financial Officer; and Greg Gaba, Vice President of Finance. Before we begin the call, I would like to remind everybody that the presentation includes statements about expected future events and financial results that are forward-looking in nature and subject to risks and uncertainties. The company cautions that actual performance will be affected by a number of factors, many of which are beyond the company's control and the future events and results may vary substantially from what the company currently foresees. Discussions of the various factors that may affect future results is contained in company's Annual Report on Form 10-K, on Form 10-Q and subsequent reports on Form 8-K and other filings with the Securities and Exchange Commission. During this quarter, we experienced margin challenges as a result of higher than expected ramp up cost for new customers, overall product mix lower than expected utilization in one of our four factories and realized foreign exchange losses in derivative instruments. However, I'm pleased with our third quarter results relates to improvement in working capital, generation of cash flow from operations and significant improvement in debt leverage ratio as a result of inventory management which has reduced net debt. I will comment on each of these categories and provide additional color on new customer revenues. Our networking capital at $29.3 million improved by $4.5 million when compared to Q2 2015 and improved by $6.2 million compared to Q3 2014. During this quarter, we generated $4.8 million of cash flow from operations year-to-date cash flow from operations of $6.7 million is mainly due to improved results from operations sustainable improvement in inventory turns, strong account receivable collections and reduced working capital needed due to revenue reductions. As a result of the implementations of several inventory management and supply chain initiatives, our inventory turns improved during this quarter to 6.6 turns compared to 5.6 turns in Q3 2014. With the generation of cash flow -- free cash flow, we're continuing to pay down our debt. Our third quarter net debt position of $12.8 million is company's lowest since 2010. As I mentioned in the opening statement and also in the press release, we experienced margin challenges due to higher ramp-up cost for new customer and unfavorable mix and realized foreign exchange losses on derivatives instruments. Higher ramp-up cost resulted from employee onboarding and training due to new customers. Our revenue mix also changed during the quarter to one inclusive of lower margin business. As you remember from previous calls, we faced the loss of two major customers. Our response was to aggressively pursue new customers to replace this business. We're on track to successfully achieve this, the new revenues of $11.8 million in the quarter at slightly lower margin. Now, that we are beyond this challenge, we expect to return to business as usual with normal growth rate at 5% to 8% annually and gross margin of 8% to 10% during the first half of 2016. During the third quarter, one of our four factories was underutilized but still produced a positive size contribution. This factory is expected to return to utilization consistent with our other manufacturing sites over the next six months as it onboards and ramped a new significant new awarded customer in late Q3 2015. During the quarter, the company also experienced increased professional fees of $0.4 million in connection with our previously disclosed merger and acquisition strategy. These expenses may or may not occur in the future depending upon merger and acquisition activity. As a result of these costs and our expectations of flat revenue compared to 2014, we will not achieve our EBITDA expectations of 4% to 5% until 2016. During the quarter, we won five new customers; we are expected to build prototypes for these customers during the next three to six month leading to full production after successful qualification builds. We expect 2016 revenue contribution in excess of $15 million from these customers. We continue to diversify our customer base to help explain this, I would like to provide year-over-year comparative. In 2014, our top customer revenue concentration was 31% and top five customers represented 70% of the yearly revenue. In 2015, our top customer is expected to be less than 15% of revenue and the top five are anticipated to account for only 50% revenue thus reducing customer revenue concentration concerns. During the last year and half, we have significantly diversified the customer base and thus minimized the impact of a single customer on the performance of the company. Our new customer wins from 2014 and 2015 are fully expect to replace the revenue loss from two longstanding customers by the end of this year, while continuing to achieve organic growth, we're now focused on inorganic growth expansion. I will now hand it over to Jim Currie; he will present the financial results.

[Jim Currie:]

Thanks Sushil. Revenue for the third quarter was $53.4 million compared to $55.5 million of revenue recorded in the third quarter of the prior year. Within the quarter we saw $17.2 million reduction of revenue from two disengaging longstanding customers. Removing these customers other revenue would have grown 47% versus the prior -- versus the same quarter in the prior year. Gross profit for the third quarter excluding unrealized foreign exchange was 7.3% compared to 9.9% in the prior year, with realized foreign exchange losses in the third quarter this year of $1.2 million compared to $0.1 million last year having a significant impact on the margins. Our goal remains to generate 10% in gross profit. Third quarter adjusted EBITDA was $1 million or 1.9% of revenues as compared to $2.1 million or 3.7% of revenue in the third quarter of 2014. As mentioned in our press release, adjusted EBITDA would have been $1.5 million without professional fees related to the merger and acquisition activities and other severance costs. The decrease in adjusted EBITDA was primarily due to ramp-up costs related to new customer builds, product mix, realized FX losses on derivative instruments and acquisition related expenditures. Our debt net of cash was $12.8 million at the end of the third quarter, compared to $21 million in the third quarter of the prior year. As a result of improved financial performance, our trailing 12-month we have continued to exceed our bank covenant, fix charge coverage ratio [indiscernible] reduction in the interest rates on our revolving debt facility. I will hand it back to Sushil to provide some closing comments.

[Sushil Dhiman:]

Thanks, Jim. In summary, while we continue to address margin challenges in Q3, we experienced continued progress across inventory management, customer growth, lien manufacturing principles and working capital initiatives. Our new customer win track record is expected to continue to add to our revenue growth in 2016 which will improve factory utilization. Continuous improvement as a result of these initiatives will allow us to achieve our long-term goal of including revenues annually at 5% to 8% and delivering EBITDA of 4% to 5% in 2016. Next year, we are planning to add another segment to our market segment focused strategy and over the next few months we have plans to obtain the required registration. This addition will be in the area of aerospace, defense and security or ABS, this market segment typically has a longer sales cycle and as a result, the real profits of this strategy will not be seen until 2017. However, these products have a longer life cycle and command better than average margin. This is an integral part of our customer diversification and margin expansion strategy. Finally, I want to thank our customers for their trust in SMTC, thank our shareholders for their continued investment in our company and thank our employees across the globe for their hard work and dedication. We will now open the lines for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of [Steve Cole with Mangrove] [ph]. Your line is now open. Please go ahead.

[Unidentified Analyst:]

Yes. Good morning, guys.

[Sushil Dhiman:]

Good morning, Steve.

[Unidentified Analyst:]

A nice concise over view. I guess, I've got a couple of quick questions Sushil. If you look at margins, I look at the two of your backup for a minute look at those two customers that have been facing out, what was the margin on those customers and was it different on one or both of those top two versus the -- margin was coming on and when we adjust for the onboarding expenses, are those margins expected to be inline with a corporate goal of 9% or 10%, I guess as you work through there?

[Sushil Dhiman:]

Steve, this is Sushil. So margin for the two longstanding customer, we have talked about for two, three quarters now, we're within 1% to 2% of each other and our average performance in 2014 early 2015. With that said, those customers reduced the revenues and we boarded some of our revenues at lower margin and factory utilization also -- the challenge we faced as we reported in our call today. Combination of all of those impacted us in Q3 and we expect to recover from that over next couple of quarters.

[Unidentified Analyst:]

Okay. And when we look at, I know the target in the 5% to 8% -- target Sushil for revenues and the margin target of 4% to 5%. I wonder when you are going to get to that, obviously, the -- that was kind of the goal that what you are kind of eyeing on this year and obviously, we are pushing at the 2016, when we are expecting to see -- when we're going to see a depth about what will come, what you've seen. Obviously, you're doing a good job holding the pipeline and getting new revenues but obviously shareholders, we would like to see how we are going to get to that level?

[Sushil Dhiman:]

Good question. First I must remind that 30 on for 2015, we guided that we will be flat year-over-year, so that was very clear based on the events we have seen for this longstanding customer. With that said, if we work to have this customer, if at our 2014 run rate, we have -- we would have significantly surpassed our 5% to 8% goal of revenue growth, however, is a reality and with that said and going into 2016. We expect that we are entering 2016 with a stable customer base and with our revenue funnel and historical performance we are continuing to add to our pipeline and we will deliver that 5% to 8% revenue, increase in 2016. We typically don't give quarterly guidance but we are expecting in Q4 the revenues to be 60 plus million dollar.

[Unidentified Analyst:]

Okay. And would we expect margins to be better in Q4?

[Sushil Dhiman:]

We are directionally improving the margin based as our customer mix is changing and we are adding to the factory utilization, correct.

[Unidentified Analyst:]

Okay. And last question, just on the M&A spending, you spent $400,000 I saw this quarter, can you give us some flavor for what you guys are -- are you looking in acquisitions, is that where the money going or what -- have you retained somebody to help or what is the -- this professional fees, what are they being spent on?

[Sushil Dhiman:]

It's our policy Steve not to comment on specifics. But as I've talked in 2014 and 2015 Q1, Q2, our goal remains to add to our organic growth -- inorganic element and we expect to add more color on this expense in next quarterly earning.

[Unidentified Analyst:]

Okay. Very good. Thank you very much, appreciate the time and colors always.

[Sushil Dhiman:]

Thank you, Steve. Thank you for support and interest in the company.

[Operator:]

Thank you. [Operator Instructions] I'm showing no further questions in queue. I would now like to -- I'm sorry. We have a question from the line of [Tony Dolgoff] [ph], Private Investor. Your line is now open. Please go ahead.

[Unidentified Analyst:]

Good morning, Sushil and Jim.

[Sushil Dhiman:]

Good morning, Tony. How are you?

[Unidentified Analyst:]

I'm doing well. How are you?

[Sushil Dhiman:]

Excellent.

[Unidentified Analyst:]

My question is, you have done a great job on [technical difficulty] does the reduced debt level a little more flexibility as far as size when you're looking at potential acquisitions or is that sort of going to be mitigated by either sequential revenue growth from Q3 to Q4?

[Sushil Dhiman:]

That's a great question. Thank you, Tony. If you look at the comments we made not only the reduction in debt quarter-over-quarter but comparing the last year, we are -- for a similar range of revenue $8 million to $9 million better in our debt reduction. With that said, we also made a mention that a portion of this is a sustainable debt reduction, working capital reduction and that is because our inventory turns are improving given the efforts we are making in our supply chain initiatives and the factory inventory management initiatives. However, as the revenue grow, we expect some of this working capital to climb up and in our revolver that you have at $40 million, we're continuing to have enough room to provide organic growth and growth with our existing customer. One more thing to point out, with our debt level at $12.8 million and the TTM performance, our debt leverage ratio is historical best that we are currently at about 2.0.

[Unidentified Analyst:]

Thank you.

[Sushil Dhiman:]

You're welcome. Thanks Tony.

[Operator:]

Thank you. I'm showing no further questions in queue. I'd now like to turn the call back over to Sushil Dhiman, President and CEO for closing remarks.

[Sushil Dhiman:]

Thank you, Bryan. And thank you all for joining the call and your continued support of SMTC. We expect our next earning call to be at the end of March. We look forward to speaking with you then. Thank you.

[Operator:]

Ladies and gentlemen, this does conclude today's program, you may all disconnect. Everybody have a wonderful day.