Apr 28, 2009
Williams Controls, Inc. (WMCO)
Executives
Patrick Cavanagh – President and CEO Dennis Bunday – EVP and CFO
Analysts
John Nobile – Taglich Brothers Chris Stanton
Operator
Good afternoon, my name is Jackie and I will be your conference operator today. At this time, I would like to welcome everyone to the Williams Controls second quarter 2009 results conference call.
All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there would be a question-and-answer session.
(Operator instructions). Thank you.
Mr. Bunday, you may begin your conference.
Dennis Bunday
Good afternoon everyone and welcome to our second quarter fiscal 2009 conference call. Before we begin, you should note that the following discussions and responses to questions reflect management’s views as of today, April 28th, 2009, and may include forward-looking statements.
Actual results may differ materially from those projected in the forward-looking statements. Information concerning risk factors and other factors that could cause actual results to differ materially is included in our filings with the SEC, including our 2008 annual report on Form 10-K, our fiscal 2009 quarterly reports on Form 10-Q, and our fiscal 2009 current reports on Form 8-K.
Specific factors that may cause such a difference include, but are not limited to availability of adequate working capital, domestic and international competitive pressures, increased governmental regulation, increased cost of materials and labor and general economic conditions in the United States and abroad. I will now turn the call over to our CEO Patrick Cavanagh for his comments on the quarter.
Pat?
Patrick Cavanagh
Thank you, Dennis. Good morning and welcome to our fiscal second quarter conference call.
This morning we released our financial results for the second fiscal quarter. I’d like to begin my making a few comments on the quarter and then on how we are dealing with a very tough business environment that we are facing.
Sales in the second quarter were $9.1 million, down 44.6% from the second quarter of fiscal 2008. As a result of the lower sales and some one-time charges, we incurred a net loss of $1.2 million or $0.17 a share.
Together, the one-time charges had a total impact on net income of $500,000 or $0.07 per share for the quarter and Dennis will comment on these charges later in the call. Sales in our second quarter were the weakest that we’ve seen in many years.
Sales were down in every geographic region and product segment. Sales to the European truck customers were hardest hit with quarter-over-quarter sales declines of 77%.
For the first six months, these sales were down 68% as many of our truck customers shut down and their – shut down their production lines to match production with lower demand. While this decline is dramatic, it was caused in part by the strong European market in 2008, which we feel accounts for a portion of the dramatic year-over-year decline.
Asian sales were down 43% for the quarter and 45% year-over-year. The decline in off-road sales was not nearly as dramatic as some of the other segments.
NAFTA off-road sales were off 19% quarter-over-quarter and 18% for the first six months of fiscal 2009. Worldwide, off-road sales declined 34% quarter-over-quarter and 29% year-over-year, mostly as a result of lower spending on construction equipment.
The NAFTA OEM truck market fared better than the European truck market, but it was still down 49% quarter-over-quarter and 37% for the first six months of fiscal 2009. In the North American market last quarter, the total Class 8 production was down 42.6% year-over-year at 28,536 trucks while the Class 6 and 7 build was down 46% at 24,149 trucks.
March orders for new Class 8 trucks increased 2,400 units over February, reaching 10,565 units, but it was still down 47% from a year ago. The March year-over-year order decline however is an improvement over January and February when the year-over-year decline in Class 8 truck orders were 61% and 55% respectively.
The Class 6 and 7 market also saw an order increase in March, reaching 7,646 units. But even with these improvements, the market is still at levels not seen since 1991.
Inventory levels of Class 6 and 8 trucks remain at historically high levels at this point. Consumer spending is off significantly, which has bloated [ph] both retail and industrial inventories.
As a result, freight volume and tonnages are off sharply and when this combined with high fuel prices and the difficulty of obtaining credit, this has resulted in record truck fleet bankruptcies. In 2008, over 3,000 truck fleets went bankrupt, taking 138,000 trucks out of service or approximately 7% of the total capacity.
This has put significant pressure on our customers’ ability to sell new higher-priced emission compliant trucks because of the glut of use, low mileage, fleet spec trucks available at prices that are estimated 30% lower than two years ago. Current industry forecast for the near term indicate that we will not see much change in the build rates in the next few quarters and it could even get worse, but industry projections expect higher build rates in the calendar fourth quarter in front of the new emission standards in effect for 2010.
As you may recall from our last conference call, we began to take action in late October to reduce operating costs by eliminating temporary employees, freezing hiring, reducing overtime, and moving to one shift in both of our plants. Additionally, in early February we took the following actions.
We took a 20% – I took a 20% reduction in salary and we reduced the Board fees by 20%. The officers of the company took a 10% reduction in salary.
All of my other direct reports reduced their salaries by 5%. We laid off six people in the office and three hourly employees in Portland and we laid off 10 employees in our Suzhou plant.
We went to four-day work weeks in our production areas in both Portland and Suzhou. In March, we took the following additional steps to reduce our operating cost, which resulted in further staff reductions, 5% salary cuts in the office or four-day work weeks depending on the individual and the department.
We eliminated the 401(k) match. We feel these changes are a measured response to the changing economic environment that we are experiencing.
While some of these changes are temporary, at this point we have reduced our annualized operating cost by $3.5 million. We feel these reductions will allow us to operate approximately cash flow break-even levels.
We are also carefully controlling our capital expenditures. While we are reducing costs, we are continuing to invest in our product development, manufacturing technology, and market development to secure new business.
Our visibility to the future is relatively poor. We expect the current sales rate for the next few months is in the $3 million range, $3 million a month range.
While this is going to be a difficult year for many market participants, we feel that we are in good shape to manage in this market. I’ll now turn the call over to Dennis to comment on the important financial aspects in this quarter.
Dennis?
Dennis Bunday
Thank you, Pat. Second quarter sales of $9.1 million represents a 44.6% decline from last year’s second quarter sales of $16.
5 million and 15% below the first quarter sales of $10.7 million. The weakness that was evident in all market regions including NAFTA, Europe, and Asia and across essentially all product lines in the first quarter continued into the second quarter and in most cases, accelerated.
Comparing the second quarter of 2009 to the first quarter, sales were 15% lower in this quarter than last due to further weakness in the NAFTA and European OEM truck markets. One bright spot on the quarter-over-quarter comparison was Asia where sales in that region were up 56% from the first quarter, with some of that increase due to market timing.
Although our volumes are down significantly, our market share and pricing remain consistent. Second quarter net loss was $1.2 million or $0.17 per diluted share and the loss for the first six months of 2009 was $2 million or $0.28 per diluted share.
In addition to the low sales levels caused by the difficult worldwide truck and off-road market, there were also several one-time items and adjustments recorded in the quarter. In the second quarter, we increased our reserves for bad debts, increased our warranty reserve, recorded an asset impairment charge, settled an outstanding labor issue, and recorded severance costs for some terminations made during the quarter, which in total increased the quarterly after-tax loss by approximately $500,000 or $0.07 per share.
In addition to these items, included in the first six months’ results was a write-down of marketable securities, which increased our net loss by $317,000 or $0.04 per diluted share. The quarterly loss compares to net income of $2.5 million or $0.32 per diluted share for the second fiscal quarter of 2008.
For the current quarter, both basic and fully diluted EPS share count was 7,256,206 and for the six months, the basic and fully diluted EPS share count was 7,361,286. At quarter-end, we had 7,265,415 shares outstanding.
Second quarter 2009 gross profits were $1.2 million on $9.1 million of sales for a 13.4% gross profit margin compared to $5.6 million on $16.5 million of sales in last year’s second quarter. For the first six months, gross profits were $3.8 million on $19.8 million of sales for a 19% gross margin compared to $10.5 million on $31.5 million sales in last year’s first six months.
As was the case last quarter, by far the largest factor in the lower margins was our lower sales volumes. However, the gross profit line was also impacted by several of the one-time items discussed earlier.
These items impacted the gross margins by approximately $590,000. Excluding these items would generate a gross margin for the second quarter of approximately 20% and would increase the first six months’ gross margin to 22%.
Recurring overhead expense decreased in the second quarter compared to the first quarter, but was not adequate to offset the declining sales. Further cost reductions made toward the end of the second fiscal quarter that Pat discussed will help lower overhead, starting in the third quarter.
However, as overhead is never completely variable with sales volumes, we will need a recovery in our markets to return to our historical gross margin percentages. Operating expenses, which include engineering, selling, and administrative, were up $90,000 during the quarter from last year’s second quarter.
The increase was due to increase in our bad debt reserves, a $160,000, for a potential exposure primarily with some of our smaller OEM customers and distributors. Offsetting a portion of the increase due to the bad debt reserve was the impact of the wage reductions Pat discussed earlier, which were instituted in the first quarter of the year.
Six-month operating expenses were up $464,000. In addition to the comments on the second fiscal quarter, the remaining factors for the six-month increase were increased new product development costs and a one-time $275,000 non-cash expense related to our deferred compensation program.
As you may recall, for over five years now we have been aggressively defending against the Cuesta class action lawsuit in Oklahoma. This suit claimed a defect in certain diesel pickup truck pedals produced in 2000 and 2001 by a subsidiary of the company.
That subsidiary was subsequently sold in 2004. In early 2008, the Oklahoma Appellate Court denied class status.
The plaintiffs appealed that decision to the Oklahoma Supreme Court and late last week the Supreme Court issued an opinion certifying the class. While obviously this is not the opinion we had hoped for, the court did play some limits on the case and it will now be remanded back to District Court.
At this point, we cannot estimate the impact this decision will ultimately have. However, we clearly continue to feel this case has always been without merit and we will continue to defend against it.
Now, turning to the balance sheet and cash flow. Although always an important consideration in difficult economic times, cash management understandably takes on increased emphasis.
While this economic downturn has impacted our profitability, we are fortunate we have a very solid financial structure. At quarter-end, we had increased our available cash balance slightly to $6.8 million from $6.4 million at the end of the first quarter.
We also continue to have no short or long-term debt. Our cash balance is down from the $9 million at the end of the last fiscal year due solely to executing on our share repurchase program.
To date, we have purchased 310,893 shares, mostly in the first quarter, for a total of $2.4 million on an average purchase price of $7.58 per share. This represents approximately 4% of our outstanding shares.
In the quarter, we made significant progress in aligning our inventory levels with our current sales volumes, although there is still further progress to be made in this area. In the first quarter, inventories increased as our customers extended delivery dates and cancelled orders, leaving us with higher inventory levels.
In the second quarter, we were able to start reducing inventories and by quarter-end, our inventories were $1 million lower than at the beginning of the fiscal year and our expectation is that they will reduce further in the third quarter. Net trade receivables are down $4.9 million from the beginning of the fiscal year on the lower sales volumes.
During the second quarter, it became increasingly difficult to collect receivables from some smaller OEMs and distributors and as a result, we increased our bad debt reserve to $160,000. We have a number of our smaller customers on credit watching credit hold and are monitoring our receivable situation closely.
With our loss position, we have generated a $1.1 million US income tax receivable, which is reflected in our other accounts receivable. We will be able to claim a net operating loss carry-back when we file our 2009 taxes and recoup these funds.
We have not satisfactorily resolved our loan compliance issue with GE Capital and GE still remains insistent on a large loan modification fee, which we are unwilling to agree to. We are also in discussions with another bank that we believe may resolve in a new loan agreement.
However, until that time, we feel comfortable that with our current cost structure and strong cash balance, we have more than adequate financial resources for the current economic climate. Depreciation and amortization for the second quarter was $504,000 and non-cash stock option expense was $191,000.
CapEx for the quarter was $563,000, and for the first six months, is $1.3 million. We are limiting our capital spending for the remainder of the year to new product development and safety items and I expect our capital spending will be no more than $2 million for the entire year.
This concludes our formal comments. We would now like to turn the meeting over to questions.
Operator
(Operator instructions). We’ll pause for just a moment to compile the Q&A roster.
Your first question comes from John Nobile.
John Nobile – Taglich Brothers
Good afternoon. I’d like know in January –?
Patrick Cavanagh
Hi, John. How are you?
John Nobile – Taglich Brothers
Good. Thank you.
In January you mentioned that you went through four-day work weeks in manufacturing. And what level of revenues do you believe it would take to go back to a five-day work week?
Patrick Cavanagh
Well, I’m thinking about $4 million to $4.5 million a month, John.
John Nobile – Taglich Brothers
Okay. So, we may not see something like that maybe till calendar ’04 if industry projections are correct with the build rates increasing.
Well, hopefully we’ll see. But anyway, in February you instituted the significant reduction in operating expenses, which obviously are taking place in the March quarter, but assuming that the current rate is where you are going to be going forward, what would you say your annual operating expenses would be on a typical year from what you are right now?
Patrick Cavanagh
Give us just a second, John.
Dennis Bunday
Yes.
John Nobile – Taglich Brothers
Yes. I know you had mentioned you reduced your operating cost by $3.5 million annually.
Patrick Cavanagh
Yes, on an annualized rate and –
John Nobile – Taglich Brothers
Is that from fiscal – if I could say fiscal ’08 or from like a quarter that I could take this as a basis?
Dennis Bunday
Let’s see. John, what I think would probably be best is if I can get back to you on that.
John Nobile – Taglich Brothers
Okay, later on in this call maybe.
Dennis Bunday
Yes, let’s see if we can – depending on how long it lasts.
John Nobile – Taglich Brothers
I just wanted to get an idea because that’s a huge reduction, $3.5 million. But just to see the basis of – you are looking at it on fiscal ’08 or you are looking at it from what you currently were in Q2, just trying to get an understating on that one.
Dennis Bunday
I think probably, John, the best way to look at that is that if you take a look at our fourth quarter run rates for R&D, selling, and admin. I mean that’s – the – obviously the four-day work weeks, some of that comes out of cost of sales for the direct labor, some of the indirect labor, plant support and those types of things come out also, but a lot of it comes out of R&D, selling, and admin.
John Nobile – Taglich Brothers
Okay.
Dennis Bunday
And so, I would take like your fourth quarter. What you are seeing in the fourth quarter, that was relatively clean.
John Nobile – Taglich Brothers
Annualize that and then –?
Dennis Bunday
And then annualize and then back off on that, yes.
John Nobile – Taglich Brothers
And basically expect that in this current environment, obviously, if things pick up I’m sure it will change. And I know you throughout the industry forecast for basically run rates thing or build rates thing at the level that they have been in the last quarter or two and not picking up till Q4 calendar.
I was curious with the 2010 emission regulations if you feel that a pickup might occur even in your fourth calendar – fourth fiscal quarter.
Patrick Cavanagh
Yes, there might be something there, John, but –
John Nobile – Taglich Brothers
But you are not seeing that yet?
Patrick Cavanagh
I’m not really planning on it. With the amount of used trucks that are out there right now and the price of the new trucks, I think one of our customers announced that the new 2010 trucks are going to be about $10,000 more expensive.
John Nobile – Taglich Brothers
I heard $12,000.
Patrick Cavanagh
Yes, this depends on – and if you look back, I mean there was a $7,000 or $8,000 increase on trucks that were produced in the year 2007. So, the end users are – the fleets are looking at a $17,000 increase over 2006 trucks.
Pretty significant, and they don’t get a dime more to haul the freight with those trucks as opposed to the older trucks. So, until – even though the older trucks are at kind of record age levels, they still have pretty low mileage on them.
John Nobile – Taglich Brothers
Okay.
Patrick Cavanagh
Their life gets burnt till they burn some of those off. There is a bit of inventory out there that needs to be used up and there is not the freight – with the freight levels that where they are at, I mean the volumes are down.
It’s a difficult environment for our customers and so, they are struggling with some of that. So – and we are struggling as a result of it.
John Nobile – Taglich Brothers
Okay. No, I understand that.
Just two quick questions. Your sales to China in the second quarter, how do they compare to last year?
Patrick Cavanagh
Let’s take a look.
John Nobile – Taglich Brothers
I just – I wanted to know if they were growing and if they are, by what rate.
Dennis Bunday
I’m sorry. Compared to when John?
John Nobile – Taglich Brothers
Well, this year’s – your fiscal second quarter compared to last year’s.
Dennis Bunday
They were up – okay, yes, we were – it looks like we were down in China about 13% for the second quarter of 2009 versus 2008.
John Nobile – Taglich Brothers
Okay, second quarter of 2008. Okay, down.
Dennis Bunday
And then on a quarter – although on a year-to-date basis, for the first six months versus first six months, we were up 5.7%.
John Nobile – Taglich Brothers
Okay. And how does business look in that area going forward?
I saw a report that said that heavy truck sales will be improving in China. So, I’m not sure if you are seeing that yet, if it’s something to look forward to?
Patrick Cavanagh
Yes, generally we are – they are still working through a number of the emission issues in China and we sell our product on what they call Euro 3 version trucks that are the most emission compliant, but there are still kind of Euro 2 style trucks out there. And so, until this market gets completely switched over to Euro 3, sales are going to remain – and we get segment of the sales and not all of it.
John Nobile – Taglich Brothers
Okay.
Patrick Cavanagh
But we expect that as they move to Euro 3, we are going to sell more pedals and until that happens it’s still going to remain a little bit muted and obviously there has been a slowdown in the economy there too.
John Nobile – Taglich Brothers
No, I understand that. I just saw a report that said it was improving.
But anyway, I just wanted one quick comment on the Q2 gross margins. Without one-time charges, you had rounded off a number earlier, if you could just repeat that?
I know they were 13.4% on a GAAP basis, but without the non-recurring charges, what were the gross margins for the second quarter?
Dennis Bunday
For the second quarter it would be about 20%.
John Nobile – Taglich Brothers
About 20%?
Dennis Bunday
Right.
John Nobile – Taglich Brothers
Okay. Thank you very much.
Dennis Bunday
All right.
Patrick Cavanagh
Thanks, John.
Dennis Bunday
Okay, thanks John.
Operator
(Operator instructions). There are no more questions.
Dennis Bunday
If there are no further questions, this concludes our second quarter conference call. Wait, wait just a second.
It looks like maybe we have one more call here real quick.
Operator
We have a question from Chris Stanton [ph].
Chris Stanton
Hi guys, how are you?
Dennis Bunday
Hi Chris. Boy, you got this one in just under the wire.
Chris Stanton
I thought there might have been someone else asking questions. So, I waited to see and yes, you are right, I got in just under the wire.
Thanks for taking my question and I guess – can you give us some sense, at least anecdotally, on what you are hearing from your customers? I know you gave – it sounded like loose guidance for the next couple of quarters that you expect revenues to be in around a $3 million range per quarter.
So, it sounds like you have some sense for what their demands are going to be. Can you give us anymore color on those conversations?
Patrick Cavanagh
Well, it – from our standpoint, kind of it looks something like – yes, we saw a little bit of an improvement in March and I heard that when seasonal factors were applied to it, it really wasn’t an increase, but we are actually seeing – we saw a slight increase in volume on the March orders for new Class 8 trucks. And we are seeing – I hate to say that we’ve reached the bottom because it could always be worse, but there is a little bit of an improvement that we’ve seen in the orders that we are looking at, but depending on the time of the year and the market, we are looking at kind of trying to operate at this $3 million to $3.5 million level over the next couple of quarters and our customers seem to believe that that’s pretty close.
But one of the things – the problem is the guidance at this point from anybody is really poor. Nobody just really has a good feel or any decent visibility to what’s really going to happen and you find a lot of open – our customers have a lot of open spots in their builds schedules and they are trying to fill those very, very quickly when they get orders, which causes some scrambling on our part to be able to fill those because it is certainly difficult.
But it seems to be getting – I hate to say better, but it seems to be a little calmer at this point and not quite as crazy as it was towards the end of last year and early in this – last quarter and the second quarter.
Chris Stanton
Okay. So, the rate of decline is – or hopefully kind of they will be plateaued.
Patrick Cavanagh
Yes. So far we saw the weakest months as – well, our sales in March were down, we’ve seen – if you look at the figures and we look at orders primarily that our customers are seeing and when we look at those orders, their orders improved in March and they were the weakest in February and January.
They’ve improved in March and so, that usually comes to us four to six weeks later.
Chris Stanton
Okay. So, potentially there is some seasonality, but maybe there is some glimmer –?
Patrick Cavanagh
Chris Stanton
And operating at that $3 million level, can you give us some sense for what you expect the cash burn to be for the balance of the year?
Patrick Cavanagh
Well, our plan – well, on a month-by-month basis, we think that with the three of the cuts that we’ve made in our expenses that – management of our capital expenditures, we are going to be able to kind of be break-even on a cash basis month by month. So, it’s kind of where we are at.
Chris Stanton
That will be great. Last question, with respect to the new trucks –?
Patrick Cavanagh
I wouldn’t qualify that by saying – sometimes it depends on the mix of products that we are selling too because they have different margins, but that’s our intention with the cuts that we’ve made.
Chris Stanton
Great. And I guess that (inaudible) to this question, which is the 2010 trucks that I guess you are designing pedals for or you may have already designed, are there – how would you characterize the margin opportunities with those pedals for the new trucks?
Are they the same pedals or are they slightly different and is there an opportunity there for Williams?
Patrick Cavanagh
Well, some of them are virtually the same, some are not. Some of them may have different sensor requirements.
But I think our intention is that – and hopefully the margins will stay relatively similar. There has been several changes in market share, obviously the people – the Caterpillar has withdrawn from the truck market and that has an impact on margin and mix, but in general, we are hoping to stay in the kind of the same range.
We face a dilemma every year, I mean our costs generally go down on long-term agreements with our customers and we have to fight with commodity prices and other – reducing other costs to maintain that margin. So, it’s always a tough environment.
Chris Stanton
Right. Okay, great.
Thank you very much.
Operator
(Operator instructions). There are no more questions in queue.
Dennis Bunday
Thank you very much. This concludes our second quarter conference call and I would like to thank everybody for attending today.
Good-bye now.
Operator
This concludes today’s conference call. You may now disconnect.