The LGL Group, Inc. (LGL) Q1 2014 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to the LGL Group Q1 2014 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] It is now my pleasure to turn the conference over to the company's Chief Financial Officer, Mr. LaDuane Clifton.

Good morning, everyone, and thank you for joining the call today. With me as well is our President and CEO, Mr. Greg Anderson; and LGL's Vice Chairman, Michael Ferrantino. We prepared a slide presentation for your reference that may be viewed as part of today's Web conference. Those materials are available on our website at lglgroup.com. This call will be recorded and will be available for playback later today on our website. Other financial information and recent press releases are posted there as well. Please note that our comments are covered today by a Safe Harbor statement. [Operator Instructions] At this time, I'd like to introduce Mr. Greg Anderson.

Thank you, LaDuane, and good morning. I'll start by giving a quick corporate snapshot overview of LGL just to refresh folks. We're obviously publicly traded, formed in 1917. Today, we have one operating subsidiary that goes under the brand of MtronPTI. Trailing 12 is $25 million, cash and cash equivalents is approximately $7.5 million, our revenue is approximately 50% outside the United States, our current stock price as of Monday was $4.75, we got a market cap of $12.3 million and we're a small player in a very large market. When we look ahead to our investment highlights, LGL subsidiary, MtronPTI, we really are a large -- serve a large B2B type of client. And really -- we're really in primarily 2 market sectors: Internet Communications Technology, and more largely in Aerospace and Defense. Today, approximately 2/3 of our business is Aerospace and Defense and about 1/3 Internet Communications. Our technology is core, is based upon crystal technology in the timing arena. We tend to work and perform on the real low noise or, what we call, the performance aspects of the value chain in these kinds of products. The company's platform itself is enabling. We have a global footprint, we've got a number of U.S. sites, international sales and international supply. And we do have a low-cost manufacturing facility in India, and we have the opportunity to even produce these high-performance products from that particular facility. Our margins -- we gain margin performance, really, because of the high-value and high reliability of the kinds of applications that our products go into. We strive to have long product life cycles with these repeat revenue streams, and we certainly have an experienced supplier management team to help drive cost. Our growth opportunity, we have several long-standing relationships with industry leaders. Some of these relationships go back tens of years. And in all cases, we're really a fairly small market share, and so we've got those share gain opportunities as we bring on new products. Slide 5, we're going to talk about our operating environment in the first quarter of this year. I mentioned on our previous call that we had completed the acquisition of filter product line from Trilithic. In the first quarter, we did reconvert those open orders and we actually began shipments during the first quarter, so I'm going to call that immediately accretive. In the first quarter of this year, we did realize some benefits from our restructuring that we announced in the fourth quarter. At present, that run rate is about a little over $1 million a year annualized, or $300,000 in this first quarter. On the positive side of our business, we are reporting a positive book-to-bill, and really, even though it's single digits, it's actually been building for 3 quarters in a row. We knew the first part based upon backlogs at the end of last year, we knew the front half of 2013 (sic) [ 2014 ]was going to be difficult. We are positioning the company for better results in the second half of this year. Cost, new products and I mentioned this favorable bookings trend. Slide 6. I'd just like to spend a moment commenting on some of the strategic transformations that we've gone through over these past several years as we try and -- try to strive to create this long-term value. We continue to stay committed to organic R&D, and really, what we're doing is we're trying to revitalize or are revitalizing our intellectual property at the company. So our spend in R&D, we disclosed that in the K. It's running about $2 million a year. I think I've talked to you and investors many times that it take several years once we get -- start a program with one of our OEMs before we really turn that into revenue. And so these R&D investments that have been going on these past years, we do expect those to reap new products and certainly increases in revenue. We're targeting the software-defined radio market and many low-phase noise applications around the sort of high-rel performance areas like radar. We've made a number of investments into our infrastructure and our company, and really trying to improve our overall operating efficiencies. We've made investments in our ERP system. Those have been notable and sizable to CapEx, and we've certainly gone through a number of changes in our structure as our product mix, as our transformation in the market has taken place to really try and maintain those variable costs, which end up driving our gross margins. You'll see in a slide or 2 when we talk about improvements in gross margin and those trends, and that's really where we're aiming. And then we mentioned earlier that we had acquired the assets of Trilithic's filter product line at the end of January. Very consistent with our investment strategy of moving upstream to more complicated or complex products with these long and sticky revenue streams and improved margins. So in essence, we're well underway to transforming our product portfolio towards these longer product life cycles, where we've got enhanced capability integration into our OEM systems and really provide better solutions for them. With that, we believe that provides a more stable business by which we'll have improved margins and returns for you, shareholders. The first quarter financial results. Revenues were $6.1 million, that's up almost 7% from the fourth quarter, down notably from last year's first quarter. I would like to say that last year's first quarter was certainly our strongest quarter financially for the year. Gross margin was at 26%. That's sequentially up almost 4%. And on increased revenue, it is down from first quarter of again last year, which was our strongest quarter. Net loss was $0.31, and that's sequentially less than the $0.50 we reported in the fourth quarter. On a positive note, backlogs are up almost 6% sequentially over the fourth quarter. And with the margins, with the revenue, we're seeing some improvement in our adjusted EBITDA. Still not where we want it to be, but a notable improvement as compared to the fourth quarter. The next, Slide 8, we have our typical rolling 12-quarter, I call it our bar chart. But essentially, in the blue bars, we have the revenue for the quarter; in the gray, we have the margins; and the red-green line is really the adjusted EBITDA. The point that we spoke to, we can see revenue trended up slightly. Margins are up as well, and part of that is our restructuring, part of that is our mix and part of that is our operating efficiency. And you can see the trend line on adjusted EBITDA, yes, it's still negative, but it is trending the right way. We talked about our cash position. Cash and cash equivalents is just under $3 a share, and book value at the end of March was $6.18 per share. We continue to try and position the company for growth. We do have a strong capital position. I mentioned our R&D investments are running almost $2 million a year, and we're fairly targeted with our large OEMs of where we're trying to bring new products into the marketplace. Again, those adoption cycles are quite long in our business. On the other hand, once we do win those design positions, they can often run 10 years or longer. These kinds of components that we make are very sticky and they've got high barriers to switching, and we're well under our way of transforming the company's backlog and product investments along these lines. We do have a strong position in commercial avionics, either in flight controls or communication systems, and that's certainly the strongest part of our portfolio at present. I mentioned our backlog is up to $9.1 million, almost 6% sequentially. Slide 10. When we talk about how we're working towards growth, it's been tough on the price side in the business. The networking business has seen a fair amount of price compression, and certainly, that has an impact on our ability to maintain margins and grow [ph]. In the first quarter of this year, again, we talked about our Trilithic acquisition, and certainly, with that, comes some onetime variable costs. And so we expect those to improve as we look forward into the rest of the year with that acquisition. But they certainly challenged -- somewhat challenged our financial performance in the first quarter. We still have strong new product revenue streams from -- we measure that on a 36-month rolling basis. Certainly, we're going to get some benefits from the impacts of Trilithic I mentioned. We're beginning to see the improved cost structure and what that can do for our P&L, and we remain having a strong working capital position. Our drivers: again, we are investing for organic growth; we think we have a good chance to share gain inside of our existing clients; we're looking hard at opening up India sales opportunities and some additional operational investments; IP investments towards more functional or highly -- more highly integrated products, especially along the RF and microwave signal management area; and of course, opportunistic and certainly, looking always for synergistic and strategic kinds of acquisitions and joint ventures. Slide 11, our strategy. Simply stated, to revitalize our intellectual property, really, through our organic investments, as well as these acquisitions. We do have a strong brand with our OEMs and we're going to continue to leverage that as we bring on these new capabilities and diversify our product offerings. In any way we can, we're looking for ways where we can differentiate our offering and bring increased value to our OEMs, so we're very focused on that. While we're doing that essentially, we are transforming our product portfolio towards these offerings that have longer life cycles and higher switching costs or higher competitive barriers and better margins. Slide 12, a recap of our investment considerations. Strong capital position at LGL, experienced management team, experience with joint ventures and M&A. And today, we are trading at less than book, we've got 0.8 here. Our brand itself has been around a long time; MtronPTI, a great list of clients; a couple of key markets that we serve; a world-class team and platform to work from. Several of our quality standards are recognized. We've spent a lot of time in the last couple of years working towards AS 9100, and we certainly have that certification now worldwide for our company. And we are certainly, today, recognized as an industry leader. So at this time, operator, I would entertain questions from our listeners.

[Operator Instructions] Our first question comes from Hendi Susanto.

So Greg, Q1 revenue declined by 7.8% on a year-over-year basis, and then on the other hand, you reported that LGL continued to expand share gain in Aerospace and Defense, and I would assume that your overall end markets declined at a lower rate than 7.8%. So how should we view that revenue decline relative to your overall end market trend?

Well, it's a thoughtful one. Honestly, I'm not sure that, that is completely out of line with end markets, especially in the networking side. So a fair amount of price compression, I mentioned that, Hendi. And in that particular market space, double digits is, year-on-year, is really not that hard. And in fact, it's probably required in some of those networking products to maintain share. And I think the rest of it has really just been a compression, really, of a continuation of sequestering and softness. I don't really feel that we've lost share, at many of our key accounts we certainly have felt some price compression. And I think through the -- you want to call it the budget cycle, there are some signs in the electronic industry, a number of companies are reporting positive book-to-bill, so we're not the only one out there doing that. So maybe some of the budget, I'll call it, program funding is now beginning to come through. So yes, it was an aggressive step-down, but the markets that we serve at this time, they were under a fair amount of pricing pressure over this past year.

How do you characterize the pricing pressure in Q1 compared to historical numbers? I'm wondering whether you can share some insight whether it's like over, below or on par with like recent historical trends.

I'm not sure I heard that so clearly, Hendi. So the pricing pressure historically -- can you restate that for me?

How do you characterize the pricing pressure in Q1, whether it's steeper, on par or below recent historical trends?

Oh, I think it would be steeper this year. So typically, our contract -- another aspect of it, our contract cycles typically follow the calendar as well, Hendi. So the stuff that we have in our revenue stream in the first quarter of this year versus the first quarter of last year would certainly be under a new contract cycle, which really means new pricing. And so I think the last 2 years, for certain, in the networking space, pricing pressure has been steep and more aggressive than the previous, certainly. In fact, I was on a call with one of our OEMs yesterday, and essentially, they had affirmed that. Will that stabilize? I think the pricing pressure is certainly going to be tough through this year as well.

Got it. And LaDuane, would you be able to share what Trilithic's assets contribution in Q1 look like and what the revenue run rate? And then, perhaps, whether you can share also Trilithic assets, customer profiles and the number of customers?

Okay, yes. So margins in Q1, we came up with gross margins of about 26%. It is going -- the Trilithic is going to help us in the margin area, but it's relatively a small component of it. However, we think that Q1, that rate will prevail. It could improve some, as volumes improve. If we look across the year, the run rate currently, $6 million over the last couple of quarters, that was largely expected, as Greg mentioned, based on where our backlog was at end of year. We've seen backlog improve as we've reported, and that will come out later in the year. So the run rate for revenue, we have some backlog to support that. It could improve, but it's hard for us to predict or forecast that for you today. The last part of your question, Hendi, I didn't understand.

Oh, would you [ph] share Trilithic assets, customer profile and the number of customers?

Okay, well, let me take that one, Hendi, and I'll just comment just a little bit more on the margins. So in the first quarter, Trilithic probably didn't have a positive impact because of our onetime transition cost. So I would say, it probably didn't hurt our margin profile in the first quarter. I do believe it will help our margin profile in the quarters ahead, okay? And we're taking a different structure than Trilithic did, with those particular models we're able to, again, leverage some costs out of those products by largely producing those from our India facility. So that, I think, that will help frame the margins. Overall, I believe, Trilithic will be richer than our typical historical gross margin profile in the company -- for us, anyway. From a customer profile perspective, they had a couple of exceptional customers, companies like divisions of Boeing, and so there are some very key designs there in UAV platforms. And so, what's coined in Aerospace and Defense, EW platforms. And so rather than probably giving you detailed profile, there's probably, in total, dozens of clients. A few make up probably half of the revenue and they're the kind of companies and applications that I just mentioned. So that's certainly target areas for us. They're strategic areas for us. It blends nicely with the kind of technology that we're developing and where we're trying to broaden our product portfolio. So there were several very good things, clients, margin, products. There was a few things there that we got from Trilithic that we think will pay strong dividends for our shareholders in the future.

Greg, do you have updates on software-defined radio, and whether or not we should expect to see initial sales happening in 2014?

So the answer is yes. We have -- the prototype activity and the interest in the market is strong. So nearly every sales call that we're on, we find success in uncovering a, I'll call it, a complex filtering opportunity for software-defined types of applications. From a revenue perspective, we're seeing small hits at present and nothing that I would commit to that would, I'll call, being notable in our financials. On the other hand, I'll be a broken record, it takes a long time in this business to turn it into revenue streams. It's not uncommon for it to take 3 years. And on the other hand, once you are, the barriers and the switching costs are quite high. So we're active, we're active in the engineering aspects, we've taken some small orders. It's still an area of investment. It's providing a lot of, I'll call it, enthusiasm in the market for our sales and engineering folks and marketing folks. When we're out selling, there is a lot of interest. And it's quite obvious a lot of our OEMs do that kind of work inside on their own bench. It's not just competing with other folks that have these types of complex components. A lot of times, that kind of engineering is done inside of our OEMs. So we're trying to bring a nice, I'll call it, compelling market reason for them to be able to move that engineering over to us. So yes, still excited about it. I wish I could report 10% company growth on it, but I can't yet, Hendi, but we're still investing there.

Okay. And then last question for me. Greg, do you have updates on new product pipeline? In the last earnings call, you mentioned about the g-sense and vibration-sensitive oscillators and then EMI power filters?

The answer is yes. We are making inroads in bringing some g-sense products to market. We did take an order. And I'm probably not going to mention that as being material, but we have taken an order for one of those very sensitive g-sense kind of applications. So I will -- we will be shipping revenue inside of 2014 on those kinds of products. And -- so we're pleased with that, and that's actually just happened recently, in the month of April actually. So yes, we are developing there. We're actually going to have revenue this year. And as I've mentioned, that's probably where we started a couple of years ago. So that's probably our largest areas for investment, it's really this software-defined kinds of filtering applications, and really vibe, shock, g-sense kinds of timing applications is where we're spending most of our R&D dollars.

[Operator Instructions] And it appears we have no further questions.

Thank you, investors, for joining our call this morning. A couple of positive trends, still a tough financial quarter for us, but certainly, our -- an improved backlog, improved margins, better cost structure, those are all somewhat positive. We are obviously pressing hard for better performance in the second half of this year. Thank you for attending and -- okay, operator?

This ends the LGL Group's Q1 2014 Earnings Report Call. If you have any further questions, please send an email to Greg Anderson at ganderson@lglgroup.com, or to LaDuane Clifton at lclifton@lglgroup.com. Thank you, and have a wonderful day.