SMTC Corp
Q2 2013 Earnings Call Transcript

Published: 8 Aug 2013

[Operator:]

Good day, ladies and gentlemen. Welcome to the SMTC Q2 2013 financial results. At this time, all participants are in the listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder this conference call is being recorded. I would now like to turn the conference over to your host Larry Silber, Interim President and Chief Executive Officer. You may begin.

[Larry Silber:]

Thank you. Welcome and good morning. I’m Larry Silber SMTC’s Interim President and Chief Executive Officer. Present with me today on this call is Clarke Bailey, SMTC’s Executive Chairman and Principal Accounting Officer and Greg Gaba, the Company’s Director of Finance. I’d like to remind everybody before we begin today that this 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 that 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 the company’s annual report on Form 10-K, on Form 10-Q and subsequent reports on Form 8-K and our other filings with the Securities and Exchange Commission. As you may know Clarke and I joined SMTC as executives in mid-May and have been very busy improving operations and attacking many issues we’ve discovered in the business. As Interim President and CEO, I am responsible for the operations, customer facing functions and vendor relations, just to name a few. As Executive Chairman and Principal Accounting Officer, Clarke is responsible for the financial organizations within the business, as well as the relationship with the banks, auditors and other third-party lenders to the business. We will devote this call to providing you with an update on recent actions and financial performance of the business during this past reporting period. Over the past 80 plus days, I have personally visited every SMTC facility, met with site management and held operating reviews at every location. Additionally, I met with most of our key customers, our key vendors and our senior leadership team around the globe. Clarke has spent his time improving relationships with the bank and our auditors as well as strengthening our internal financial organization and assessing our talent and addressing the financial matters he will discuss today. Clarke is also leading the search for the new CEO with a globally recognized executive search organization. The team has accomplished a lot in a very short period of time but also please recognize there is much more to be done, we initiated an early and often communications program with all of our partners which is helping our situation and establishing confidence up and down the chain from our suppliers, to our customers, our lenders and most importantly our employees. I’d like to briefly mention some of the most significant changes that we’ve made and during the question-and-answer period, I’ll be glad to discuss any of these items with you in more detail if you desire. First of all, we put together an aggressive campaign on working capital improvements focusing on inventory reduction particularly our excess and obsolete inventory reductions. Our accounts receivable collections which Clarke and Greg will discuss in some detail later in this call. Concurrent with this effort processes have been changed for each of these key areas to ensure continued success in managing our working capital going forward. Sequentially, we hired two senior executives replacing previously departed employees in operations and engineering and quality both with extensive experience in electronic manufacturing and with prior track records of outstanding performance in the areas where we needed help, they both have been primarily focused on our manufacturing operations in addressing productivity and quality improvements with significant initial success and we expect more to come in the weeks and months ahead. We have completed the shutdown of the Markham Manufacturing facility and have successfully transitioned those customers that we wanted to retain to our other manufacturing sites. We are focused on improved communications internally and externally with the establishment of cross functional meetings for sales and operations planning, new business development, Information Technology requirements, and financial performance reviews. We have reestablished and refocus our business development guidelines, our quotation in pricing process, and our supply chain methods. We additionally have reviewed all of our customer and site profitability and have taken action for improved performance. What I’ve mentioned to you in the last few moments, is a just a few on the key focus areas that have been addressed with numerous other day-to-day activities that Clarke and I have been engaged in during this brief time period. I’m sure that it sounds like a lot, but realistically it’s been more about blocking, tackling, and consistency, that has delivered the improving trend which we will discuss today. I’ll now hand the call over to Clarke Bailey to introduce the financial results and elaborate on some of the items that I’ve mentioned.

[Clarke Bailey:]

Thanks, Larry. Before I begin, I want to point out that we’re very pleased that we’ve appointed a new Director yesterday. His name is Rick Wasserman. He comes as – he is an accomplished Director and Manger of Businesses over 35 years and also he is the Chief Compliance Officer of one of our shareholder, Wynnefield Capital. So, we welcome Rick to the Board and know he will be a great contributor going forward. Our two principle objectives, upon joining were to identifying and address the issues and aggressively manage the working capital. As you analyze the second quarter results, please be aware that there are $6.7 million of expenses of which I will call unusual charges. In the gross profit our charges totaling $4.6million, which our $2.1 million in unrealized foreign exchange loss, $1.3 million loss from the market manufacturing facility, which is now closed, and $1.2 million in non-recurring expenses. These non-recurring expenses include physical inventory count adjustment, scrap inventory and inventory reserves. In SG&A, there were $1.2 million of charges consisting of executive severance, a lease exit cost and CEO recruiting. And lastly, they’re below the line charges of $1 million consisting of an additional reserve for the Markham shutdown and contingent consideration for the ZF acquisition, which was completed in 2001. Greg will present the results with and without these charges. With regard to working capital at the beginning of the year, our sales declined yet working capital increased causing great concern with our lenders. By more aggressively focusing on the collection of receivables in the management of inventory, we’ve reduce receivables by $7.7 million, inventories by $9.7 million and working capital by $5.6 million compared to the first quarter. Furthermore our debt net of cash was reduced by $8.9 million. We believe the situation will improve even more by year end and Larry will talk about the measures we’re taking to accomplish that. Unfortunately, once again we violated our covenants in the second quarter. We work closely with our primary lender and they have agreed to waive the second quarter violations and to also amend the covenants going forward. They have eliminated the cash conversion covenant relating to working capital and modify the EBITDA and capital expenditure covenants to a more realistic level. I’ll now hand the call over to Greg to review the financial results.

[Greg Gaba:]

Thanks Clarke. As you can see from our press release issued yesterday the second quarter was challenging with decreased revenue levels and non-recurring charges as Clarke mentioned which have negatively impacted our gross margin and pretax income this quarter. We reported revenue of $64.9 million which only represented a drop of 1% compared to the prior quarter but represented a 13.6% drop compared to the second quarter of 2012. Due to reduced demand from one long-standing customer in addition to the disengagement of some customers related in part to the closer in the market manufacturing facility. Gross margin is $1.3 million, or 1.9%, compared to 10.6% last quarter and 9.7% from the second quarter of 2012. This was mostly the result of unrealized foreign exchange losses on outstanding derivative contracts, in addition to the non-recurring charges related to the physical inventory account, scrap inventory and inventory reserves. If we exclude the impacts of the unrealized foreign exchange loss under derivative contracts of $2.1 million, the negative gross margin related to the Markham manufacturing facility of $1.3 million and the non-recurring charges pertaining to inventory account adjustment, scrap inventory and inventory reserves of $1.2 million. The gross margin would have been $5.9 million, or 9.1%, which is more in line with the previous quarters. Adjusted EBITDA was a negative $1.3 million in the second quarter, compared to $2.3 million in the prior quarter and $4.8 million in the second quarter of 2012. However, when removing the gross margin from the Markham manufacturing facility and the non-recurring expenses, adjusted EBITDA was $2.3 million in the second quarter, compared to $1.9 million in the prior quarter and $4.7 million in the second quarter of 2012. We generated positive cash flow from operations $9.5 million during the quarter, compared to cash used from operations of $12 million in the prior quarter do in large part to aggressive focus on working capital management. With the addition of collections and accounts receivable and reduction in inventories, we paid down our debt by $8.9 million. I will now hand it over to Larry for closing remarks.

[Larry Silber:]

Thanks Greg. As we can see it’s been a busy quarter for all us. We are confident that the actions we’ve taken to-date will lead to improvements in our operating results in the future. We’ve shared with you so far a little bit of what we’ve done. Now I’d like to talk to you a little bit about what we plan to do going forward. First of all, successfully completed the CEO search that Clarke is leading and implement a smooth transition for both Clarke and myself to ensure a stable operating environment going forward. We’ll continue the intensive campaign to reduce working capital that was started when we joined and we hope to have continued excellent results from that. We’ll initiate actions leading to margin improvements such as slow manufacturing processes, expansion of vendor managed inventory and efficient planning and scheduling systems. Finally, we’ll rebuild our sales and account management teams focusing on customers that better fit our profile. On a very positive note over the last few weeks, we’ve recently been business from two of our key accounts, and we’re in a process of closing on another new account that could quickly become a significant customer for the company. We believe that our profitability will improve in the third and fourth quarter of this year. However, we are suspending the practice of guidance. Our order book is very strong and we are working diligently on the efficient and timely delivery of that order book. With that, I’ll now open the meeting to questions from our audience.

[Operator:]

(Operator Instructions) Our first question is from Fang Li from Baleen Capital, your line is open.

[Fang Li:]

Hey Clarke how are you guys doing?

[Clarke Bailey:]

Doing fine, thanks. How are you?

[Fang Li:]

Good. Good job so far.

[Clarke Bailey:]

Thank you.

[Fang Li:]

I had a couple of questions and thanks for taking them. My first one was if you could give a little bit color on performance by geographies so your Mexico, San Jose and Asia?

[Larry Silber:]

You know generally it’s been pretty stable across all three areas. As you know Mexico is our largest manufacturing facility, and it carries bulk of our activity that we do. And hence that’s probably the strongest area. We have been able to secure some new business for our Asian facilities, as well as we’ve had some increases in volume in our San Jose facility as a result of a new customer projects or existing customer projects, but new items, new things that they’ve given us. So all three areas have been fairly strong and a couple of them have received the benefits of transitioning business from the Markham facility to those operations.

[Clarke Bailey:]

Yeah I would say one of our challenges in Mexico has been capacity and efficiency and Larry and one of the executives that you referred to in the opening comments have done a really good job of initiating a substantial improvements in the operations in Mexico. So we expect them to get better in the future, we’re also spending some capital expenditures in the third quarter of this year. To improve the capacity of that operation as well as the backlog is strong we just need to be able to get it out efficiently and effectively. China is as always as doing well and China-based doing well.

[Fang Li:]

That’s great. Could you give a little bit color around the customer that reduced your order, and you’ve talked about kind of new bookings from new customers or existing customers over the last couple of weeks. Was it a one-time (Inaudible) that the customer kind of permanently I guess reduced their business of you and why?

[Larry Silber:]

One of our longstanding customers had a reduction in their demand of their end product it’s more of a consumer oriented area and commercially oriented area and they just had a reduction and demand which they in fact pushed back up to channel to us. Still one of our top three or four customers still very actively engaged just a reduction in demand on a couple of line items, with the other customer projects that we’ve seen just this sort of the reverse. One of our major customers had an increase in demand in one of their key products which came our way, and we’ve seen significant uptick in that area and then the other customer has done some consolidation of their other EMS suppliers, around the globe and they’ve given us the benefit of that consolidation and uptick in business that we were doing with them.

[Fang Li:]

Great. As we look forward and not – without giving guidance but just trying to understand the – what the business looks like without Markham, I guess if you didn’t have Markham in Q2 what your revenue had been.

[Clarke Bailey:]

Hold on with that, we’ll get that figure for you. It wasn’t, the sales were not substantial in the second quarter, but hold on one minute, we got the figure, and we are looking out in the 0-Q.

[Fang Li:]

Okay that’s fine I can wait thank you. I guess the other question vis-à-vis kind of run rate earnings and I guess profitability, as you talk about continuing margin improvement over the rest of the year, what did you exit, I guess, if you think about Q2 being in April, May, June. What is you exit, I guess well of margins in June versus margins in April were they not particularly higher than I guess over the course of the quarter?

[Clarke Bailey:]

But that’s hard to say, because there is seasonality in the quarter, as you know a lot of the shipments go out in the last quarter, or last month of the quarter so, that probably wouldn’t be a good indicator for you. I think as Larry said in the script, if you looked at – if you backed out all these non-recurring and these unusual events. I mean the first quarter we did about a $9 million of EBITDA and in the second quarter about 23 and as we said we think things will improve going forward. So I think that kind of gives you a feel for our view. We’re just suspending guidance, because as you know, we’re all only been here since May 13th. We’re getting our arms around the operations, there’s a lot of moving parts here, but if can see we have got of those parts stop moving on us.

[Fang Li:]

That’s great, and you have done a great job in short timeframe so.

[Clarke Bailey:]

And Tim, by the way the sales in Canada were about $5 million so, it was less than 10%.

[Fang Li:]

Did the $5 million entirely go away or does – some of it get redirecting for the facilities.

[Clarke Bailey:]

No. Some will be transferred right?

[Larry Silber:]

Right, some will be transferred to our other facilities, some will go away.

[Fang Li:]

Great.

[Clarke Bailey:]

So when I said earlier is normal, the amount that goes away is not meaningful.

[Fang Li:]

Got you, that’s awesome. Anymore one time expenses over the rest of the year?

[Larry Silber:]

There could be. And for instance one item that we’re currently looking at and aggressively pursing as you know we closed down the Markham facility, the manufacturing portion of the Markham facility. That’s about 70% of our building. We’re aggressively trying to either sublet that space, or even potentially we have an option to buy or find a buyer to buy the building and move us out. If we can’t find a solution, we’ll take a lease impairment charge as a non-cash charge. So this thing is like that, there could be another small severance related to an executive that was terminated. So there is a little item like that. We think that we’ve discovered most of the major items. And the things that for instances the scrap, the inventor reserves and the inventory count. So we’ve gone in and one of the things we did this quarter is we sent Greg down to Mexico to ensure that he’s clubbed the operations, that the finance team has clubbed operations, effectively that was not the policy in the past, it is the policy going forward. So we think we’ve done a good job of identifying the issues. But having said that no promises. We’re continuing to work hard diligently to ensure that there are no other issues here, but the two that I discussed with you are a couple that we’re aware of.

[Fang Li:]

That’s great. And my last question is actually pertaining to just the macro environment. And we see in terms of kind of overall demand and also I guess competition, a competitive landscape?

[Larry Silber:]

Well, I would tell you that we are feeling rather good about the overall environment despite what you hear about some things in the economy. I think we’ve received a fair amount of increase and opportunities from new customers and new business development areas. Our existing customers for the most part are talking about increased demand going forward. So I think we’re fairly optimistic about the marketplace and I think we’ve now refocused ourselves, account management team, as I said during the initial part of the call. On opportunities that better fit our capability and SEDAR facilities, so that when we do go after a customer will be more focused and better position to accept that kind of business.

[Fang Li:]

Great, thanks guys

[Unidentified Company Representative:]

Thank you, I appreciate.

[Operator:]

Thank you ladies and gentlemen (Operator Instructions) we have no more questions at this time, ladies and gentlemen this does conclude today’s conference. You may now disconnect. Everyone have a great day.

[Unidentified Company Representative:]

Thank you everybody for joining and we look forward to our next call with you.

[Unidentified Company Representative:]

Thanks.