TTM Technologies, Inc.

Q4 2020 Earnings Conference Call

2/3/2021

spk04: Good afternoon, ladies and gentlemen. Thank you for standing by and welcome to the TTM Technologies Fourth Quarter 2020 Financial Results Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. You may press star 1 if you have a question. As a reminder, this conference is being recorded today, February 3, 2021. Samir Desai, TTM's Senior Director of Corporate Development and Investor Relations, will now review TTM's disclosure statement.
spk00: All right, thank you. Before we get started, I would like to remind everyone that today's call contains forward-looking statements within the meaning of the Private Securities and Litigation Reform Act of 1995, including statements related to PTM's future business outlook. Actual results could differ materially from these forward-looking statements due to one or more risks and uncertainties, including the factors explained in our most recent annual report on Form 10-K and other filings with the Securities and Exchange Commission. These forward-looking statements are based on management's expectations and assumptions as of the date of this presentation. TTM does not undertake any obligation to publicly update or revise any of these statements, whether as a result of new information, future events, or other circumstances, except as required by law. Please refer to the disclosures regarding the risk that it may affect TTM, which may be found in reports on Form 10-K, 10-Q, 8 , the registration statement of Form S-4, and the company's other SEC filings. We will also discuss on this call certain non-GAAP financial measures such as adjusted EBITDA. Such measures should not be considered as a substitute for the measures prepared and presented in accordance with GAAP, and we direct you to the reconciliation of non-GAAP to GAAP measures included in the company's press release which was filed with the SEC as available on TTM's website at www.ttm.com. We have also posted on this website a slide deck which we will refer to during the call. I will now turn the call over to Tom Edmond, TTM's Chief Executive Officer. Please go ahead, Tom.
spk02: Thank you, Samir. Good afternoon and thank you for joining us for our fourth quarter 2020 conference call. These continue to be challenging times, and I hope that all of you and your families are safe and healthy. I'll begin with a review of our business strategy, then an update on how COVID-19 has impacted our business, followed by highlights from the quarter and a discussion of our fourth quarter results. Todd Scholl, our CFO, will follow with an overview of our Q4 2020 financial performance, and our Q1 2020 guidance. We will then open the call to your questions. I'm pleased to report that in the fourth quarter of 2020, TTM generated revenues above the midpoint of guidance and non-GAAP EPS above the guided range. All end markets performed better than guidance while year-on-year growth in the automotive and defense end markets was offset by weakness in the medical, industrial and instrumentation and networking and telecom and markets. In addition, continued strong operational execution overcame production of inefficiencies and extra costs due to COVID-19. The COVID-19 pandemic has created operational difficulties, macroeconomic uncertainty and employee concerns. I am extremely proud of how TPM employees have worked to deliver excellent performance, despite the formidable and unprecedented challenges of this environment. I'd also like to highlight that in Q4, we repaid and settled our $250 million convertible bond with no dilution to shareholders, solid cash flow from operations, drove our net debt to EBITDA ratio to 1.4 at the end of Q4. Finally, we announced a $100 million share repurchase program as an additional tool to increase shareholder value following the strengthening of our balance sheet. For the full year 2020, excluding divested and closed businesses, TPM grew 3% with solid profitability, despite headwinds from COVID-19 and the strengthening Chinese currency. Full year cash flow from operations was $287.2 million, and along with the sale of the mobility business, enabled us to repay debt and reduce leverage, putting us in a strong position for the future. Next, I would like to provide an update on our long-term strategy. TTM is on a journey to transform our business to be less cyclical and more differentiated. We believe over time, investors will be rewarded with more stable growth, strong cash flow performance, and improving margins. A key part of that strategy will be to add capabilities and products that are complementary to our current offerings, both internally and through acquisitions. Looking forward, our balance sheet is in a strong position to pursue further acquisitions as well as to support our organic investment needs. I would also like to update you on the COVID situation. For the majority of 2020, we managed through COVID-19 with relatively minor impact to our production. Currently, the combination of colder weather in North America and the recent holiday season has created a surge of COVID cases. Since many of these infections are occurring in regions where our manufacturing locations or plants are located, we have also seen an increase of COVID cases within our employee population in North America, and we expect this condition to continue into 2021. While many of those that were infected returned to work after being cleared following testing, and quarantine protocols. We still have a number of employees in quarantine, which is causing some production inefficiencies. We continue to conduct rapid testing, contact tracing, and to quarantine individuals who are in close contact with infected team members, in addition to deep cleaning affected work areas. We also continue other measures, such as extensive internal communications, masking, temperature checks, and proper distancing in our facilities worldwide. Because of the stringent preventative measures in place and our culture of transparency in communications, these events have had less impact on our operations than might have been the case without these precautions. Now I'd like to review our end markets. All historical end market disclosures exclude the mobility business unit and the two EMS plants which halted production in December. For more details on end market disclosures, please refer to our fourth quarter earnings press release and pages four and five of our earnings presentation, both of which are posted on our website. The aerospace and defense end market represented 38% of total fourth quarter sales compared to 37% of Q4 2019 sales and 37% of sales in Q3 2020. We expect sales in Q1 from this end market to represent about 36% of our total sales. We saw solid growth in our A&D segment with Q4 revenues up 2% year on year to a record high and an A&D record program backlog of $687 million compared to $600 million in the year-ago quarter. Strength in defense more than offset weakness in the commercial aerospace end market. Growth in the defense market is a result of our strong strategic program alignment and key bookings for ongoing franchise programs. We saw significant bookings in the quarter for AESA radar systems, for Raytheon's Army, Navy, transportable surveillance radar to protect against ballistic missiles, Lockheed's SPY-7, a variant of the U.S. LRDR program for the F-110 Spanish frigate, as well as Northrop's upgrade of F-16 fighter jets with scalable agile beam radar. For the full year, Aerospace and Defense increased 7% and reached a record high as CPM benefited from increased defense spending and demand for multiple new programs. We were pleased to see the 2021 NDAA pass into law with bipartisan support, which suggests that defense budgets could stay stable at a high level going forward. Given our solid program alignment, we would expect to outperform broader defense budget growth. In 2021, we expect growth to be in line with market projections of 2% to 4%, driven by the defense side of our business. We expect the commercial aerospace portion, which was 16% of our A&D market in 2020, to be down in 2021. Automotive sales represented 17% of total sales during the fourth quarter of 2020, compared to 15% in the year-ago quarter and 13% during the third quarter of 2020. Automotive grew almost 40% sequentially, following the growth in Q3 and returned to year-on-year growth of 14%. We expect automotive to contribute 18% of total sales in Q1. For the full year, automotive declined 11%, as both demand and supply were affected by COVID-19 in the first half of the year, followed by a recovery in the second half of the year. In 2020, advanced technology was 26% of our automotive end market, compared to 20% in 2019. For the full year, we won design wins with a lifetime value of $629 million compared to $475 million in 2019. In 2021, due to the anticipated stronger start, we expect the market to be above longer-term forecasts of 3 to 6 percent. The medical industrial instrumentation end market contributed 16 percent of our total sales in the fourth quarter, compared to 17 percent in the year-ago quarter and 19% in the third quarter of 2020. For the first quarter, we expect this market to be 16% of revenues. For the full year, MI&I grew 12%, well above the trend line due to strengthen our instrumentation customers, specifically automated test equipment, and strengthen our medical customers, particularly for emergency requirements of printed circuit boards used in ventilators, and patient monitoring systems applied to the treatment of COVID-19. In 2021, we expect growth to be below the 2% to 4% forecast as these segments see moderated demand following the extraordinary strength of 2020. Networking communications accounted for 16% of revenue during the fourth quarter of 2020. This compares to 17% in the fourth quarter of 2019 and 17% of revenue in the third quarter of 2020. We saw relative strength in the networking segment compared to the telecom segment as 5G builds paused temporarily. In Q1, we expect this end market to be 15% of revenue due primarily to uncertainty around the timing and ramp of phase three builds for 5G in China. For the full year, networking communications declined 4%. We expect this market to grow, but be below the longer-term forecast of 5% to 8% growth in 2021 due to the anticipated soft start in the early part of the year, followed by a ramp of 5G infrastructure needs in the back half of the year, complemented by growth in networking. Sales in the computing storage peripherals end market represented 13% of total sales in the fourth quarter compared to 13% in Q4 of 2019 and in the third quarter of 2020. This end market was up 2% year-on-year as growth in our semiconductor customers offset modest year-on-year declines from our data center customers. We expect revenues in this end market to represent approximately 14% of first quarter sales For the full year, computing grew 9% as we saw growth across our data center and semiconductor customers. In 2021, we expect to be above the forecasted end market growth of 1% to 3%, driven primarily by data center growth. Next, I'll cover some details from the fourth quarter. Note that all of the following operations metrics exclude the mobility business unit and the two EMS plants that we closed. This information is also available on page six of our earnings presentation. During the quarter, our advanced technology business, which includes HDI, RigidFlex, and RF subsystems and components, accounted for approximately 31% of our revenues. This compares to approximately 27% in the year-ago quarter and 29% in Q3. We are continuing to pursue new business opportunities and increase customer design engagement activities that will leverage our advanced technology capabilities in new markets. Capacity utilization in Asia Pacific was 63% in Q4 compared to 61% in the year-ago quarter and 63% in Q3. Our overall capacity utilization in North America was 58% in Q3 compared to 58% in the year-ago quarter and 61% in Q3. Our top five customers contributed 34% of total sales in the fourth quarter of 2020 compared to 36% in the third quarter of 2020. Our largest customer accounted for 14% of sales in the fourth quarter. At the end of Q4, our 90-day backlog, which is subject to cancellations, was $483.9 million compared to $402.8 million at the end of the fourth quarter last year and $437.8 million at the end of Q3. Our PCB book-to-bill ratio was 1.19 for the three months ending December 28th. I'd like to conclude by again thanking our employees for continuing to contribute to TTM and our critical mission of inspiring innovation with our customers. Their efforts are particularly appreciated during these times by our customers in critical central areas like defense and the medical industries. Despite the COVID-19, and currency-related challenges we faced in 2020. Our business performed better than we expected as a direct result of operational excellence and market diversification, and our employees' concerted efforts to engage and support our customers. We've also taken positive strategic moves that will strengthen PPM for the long term. Now, Todd will review our financial performance for the fourth quarter. Todd? Thanks Tom and good afternoon everyone. As Tom mentioned earlier, in 2020 TPM announced the closing of the sale of its Mobility Business Unit. As such, the disclosure of TPM's GAAP results reflects the Mobility Business Unit as a discontinued operation. During this call, I will discuss non-GAAP financial information which excludes the results of the Mobility Business Unit. The EMS Business Unit is still included in both the GAAP and non-GAAP results we have reported. Please refer to the earnings schedule for additional details on exited businesses and continuing operations. Page 7 of our earnings presentation and the appendix of our investor presentation also contain this information. For the fourth quarter, net sales from continuing operations were $523.8 million. compared to $535.7 million in the fourth quarter of 2019. The year-over-year decrease in revenue was due to declines in our medical, industrial instrumentation, and networking telecom end markets, with roughly a third of the decline coming from the EMS plant, which we have closed. This was particularly, or excuse me, this was partially offset by growth in our automotive, aerospace and defense, and computing end markets. Excluding the impact of the two EMS plants being shut down, our revenues were down 1.1% year on year. GAAP operating income from continuing operations for the fourth quarter of 2020 was $29.2 million, compared to GAAP operating income of $29.4 million in the fourth quarter of last year. On a GAAP basis, net income from continuing operations in the fourth quarter of 2020 was $39 million, or 34 cents per diluted share. This compares to a net income of $10.8 million, or 10 cents per diluted share, in the fourth quarter of 2019. The remainder of my comments will focus on our non-GAAP financial performance. Our non-GAAP performance excludes our divested mobility business unit, non-routine tax items, M&A related and restructuring costs, certain non-cash expense items, and other unusual or infrequent items. We present non-GAAP financial information to enable investors to see the company through the eyes of management and to facilitate comparison with expectations and prior periods. Gross margin in the fourth quarter was 17.5% compared to 19.1% in the fourth quarter of 2019. The year-over-year decrease in gross margin was due to lower revenue, COVID-19-related costs and associated labor inefficiencies, and foreign exchange headwinds which increased our China-based costs. Selling and marketing expense was $15.2 million in the fourth quarter, or 2.9 percent of net sales, versus $17 million, or 3.2 percent of net sales, a year ago. Fourth quarter G&A expense was $24.4 million, or 4.7 percent of net sales, compared to $29.8 million, or 5.6 percent of net sales, in the same quarter a year ago. In Q4 next 2020, R&B was $4.6 million or 0.87% of revenues. This compares to $4.3 million or 0.81% in the year-ago quarter. Our operating margin in Q4 was 9%. This compares to 9.6% in the same quarter last year. Interest expense was $11.6 million in the fourth quarter. a decrease of $4.8 million from the same quarter last year to the lower interest rate and the term loan repayment of $400 million. During the quarter, we recorded $5.3 million of foreign exchange losses. Government incentives reduced the net loss to $1.9 million, or approximately two cents of EPS. This compares to a loss of $1.8 million, or approximately one cent of EPS, in Q4 of last year. Our effective tax rate was a negative 19% in the fourth quarter due to a change in the non-GAAP full year tax rate from 15% to 6%. Fourth quarter net income was $40.2 million or 37 cents per diluted share. This compares the fourth quarter 2019 net income of $27.5 million or 26 cents per diluted share. Adjusted EBITDA for the fourth quarter was $68.2 million, or 13% of net sales, compared with fourth quarter 2019 adjusted EBITDA of $72.8 million, or 13.6% of net sales. Depreciation for the fourth quarter was $22.7 million. Net capital spending for the quarter was $18.7 million. Our balance sheet and liquidity positions remain very strong. Cash flow from operations was $55.5 million in the fourth quarter or 10.6% of revenue. Cash and cash equivalents at the end of the fourth quarter 2020 were $451.2 million. This cash number is after we paid $250 million to settle our convertible bond on December 15th. This cash number, excuse me, At the end of the fourth quarter, our net debt divided by last 12 months EBITDA was 1.4 times. During the quarter, we also received a two-notch upgrade from Moody's to BA II. As Tom mentioned in his comments, today we announced a two-year, $100 million share repurchase program. As we continue to transform our company, we have modified our capital allocation strategy. M&A will still be our priority for increasing shareholder value, but as the company becomes more consistent in its cash generating performance, we believe that we can utilize both tools to increase shareholder value. Now I'd like to turn to our guidance for the first quarter. Looking ahead, we believe that COVID-19 may continue to cause end market demand disruption, supply chain challenges, as well as inefficiencies with our own production. With this in mind, we estimate total revenue for the first quarter of 2021 to be in the range of $490 to $530 million. We expect non-GAAP earnings to be in the range of $0.19 to $0.25 per diluted share. The EPS forecast is based on a diluted share count of approximately 109 million shares. Our share count guidance includes diluted securities, such as options and RSUs, but no shares associated with our warrants. We believe we expect that SG&A expense will be about 8.4% of revenue in the first quarter and R&D to be about 1% of revenue. We expect interest expense to total approximately $11 million. And finally, we estimate our effective tax rate to be between 10% and 15%. To assist you in developing your financial models, we offer the following additional information. During the first quarter, we expect to record amortization of intangibles of about $10.9 million, stock-based compensation expense of $4.7 million, non-cash interest expense of approximately $0.5 million, and we estimate depreciation expense will be approximately $22 million. Finally, I'd like to announce that we'll be participating virtually in the Cowan Aerospace and Defense and Industrial Conference on February 9th. the J.P. Morgan Leverage Finance and High Yield Conference on March 1st, and the Truist Technology Networking and Services Conference on March 9th. That concludes the prepared remarks, and now I'd like to open the line for questions. Tulare?
spk04: Well, thank you. If you'd like to ask a question at this time, just a reminder, please signal us by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach us. Once again, that's star 1. To ask a question, we'll pause for just a brief moment. We'll move and take our first question from Matt Sheeran with Stifle.
spk01: Yes, thank you. Good afternoon. I wanted to ask a question regarding the forward guidance, backing into the gross margin number. It looks like that's going to be down sequentially on modest revenue decline. So I'm trying to figure out what are the drivers of that. I know that we're hearing on a lot of these conference calls that there are incremental costs, supply costs, logistics costs, materials costs. I know you spend a lot on copper and other things. So are there any cost headwinds that you're seeing in the next quarter or two?
spk02: Well, are you going sequentially or year over year, Matt?
spk01: Well, year over year, it looks like you're – well, sequentially, sequentially.
spk02: Okay, sequentially. So when we look at Q1 compared to Q4 and looking at our gross margins, you're right to observe that that would be down slightly sequentially on the margin line. What's really driving that for us is obviously our revenue is down sequentially a little bit. Now, a lot of that comes from the GMS business. which for the two closed plants that we completed production in Q4. And so there's a little bit of profit that goes away from that. But also what we have is we have Chinese New Year in Q1. We obviously didn't have that in Q4. And although revenue is stronger in Asia, we have to work through that Chinese New Year, and you have to pay holiday pay, which is a bit of a headwind. And then, of course, We continue to challenge, be challenged with the strengthening Chinese currency, which sequentially is a modest increase. We watch that every day. Year over year, it's a bigger headwind. So those are the three really big issues that are affecting us. I think sequentially, the COVID issue was pretty challenging in Q4. We expect it to be similar in Q1. So that's not really a variant sequentially.
spk01: Okay. And on that COVID issue, could you quantify perhaps the number of employees that have been affected and the cost associated with that, maybe on a basis point metric in terms of the headwind that you're seeing?
spk02: Well, I'll let Tom comment on the employee information, but in regards to cost, There's certainly direct out-of-pocket costs for things like masks and extra cleaning expenses and things like that, which we can quantify that part of it's relatively modest. What's proving to be the bigger challenge is, although our plants are open, when you have a very significant sickness or quarantine as a precautionary measure to avoid people getting sick, You have production inefficiencies. The department might be down one day, or you have to work overtime to keep up production schedules. Those are the kind of production inefficiencies that we're referring to that were much more pronounced for us in Q4, and we expect to have some additional challenges in Q1. A direct quantification is difficult to do, but it was a substantial amount in terms of the impact that we could see in terms of our labor efficiency. Tom, did you want to add anything to that? Yeah, I would just add a couple things. One is the other inefficiency, Matt, and we've talked about this in the past. We have a structure, particularly in North America, because our plants are smaller, when they're dealing with challenges around new products, potential complexities of technology, Um, we bring in tiger teams from our other plants. Uh, we also have a lot of involvement, uh, hands-on from management. Um, obviously with, with the situation, uh, with COVID, we've not, we've been prevented from, uh, from doing that, you know, from, from organizing that kind of assistance. And that goes into that production inefficiency that, that Todd talked about. Very difficult to quantify, but clearly, you know, an impact on, on yield and also an impact on total production. The other piece, in terms of labor force, about 10% to date of our labor force has been impacted by COVID during the course of this pandemic. So what we saw, and I think others have seen, is a real uptick in incidents in cases starting mid-November. carrying through December into mid-January. We may be starting to see a little bit of tail-off there. We're encouraged by that, but we're also being very careful, given what has happened here. It seems like every social event leads to another influx of cases. So we're very, it's nice to see that the cases are starting to come down a bit, but we're not counting on that.
spk01: Okay. Thanks very much. Very helpful.
spk02: Thank you, Matt.
spk04: We'll move next to William Stein with Truist Securities.
spk02: Great. Congrats on the good results and the buyback announcement. Thanks for taking my question. First, I'm wondering if COVID is restricting your revenue in any way, either in the Q4 results or the Q1 outlook? I can jump in on that. Yeah, definitely, Will, and from the standpoint of productivity in our North America facilities had an impact in Q4, will have an impact in Q1. Again, that impact on yields, that impact on total production, and Todd really hit on it. It's difficult to forecast if you go into the quarter, but in different production cells, we may be more impacted than others, and that causes an imbalance in the operations. So that absolutely impacts overall production and therefore revenue. I'm going to ask another, but I'll also ask if you have any way to quantify what the shortfall might have been, like if you didn't have COVID, putting the margin impact aside, how much potential revenue do you think you left on the table? But the follow-on question is, to what degree do you think you're being affected by shortages, either for your own business or from the perspective of your customers not being able to get chips to put on boards? Sure. Yeah, so in terms of impact on revenue, again, it is difficult to quantify. What I can tell you is if you look at Q1 as an example, in aerospace and defense, we're relatively flat. A piece of that, of course, is commercial aerospace being soft, but Also, a significant piece of that is our inability to get production out. And so if you think about what would be a normal growth rate in that aerospace and defense area, and we talked about being in that 2% to 4% range, more towards the high end. Of course, last year we grew 7%. It's clearly... Yeah, the COVID situation is having an impact on that. There's also, of course, how bookings lay out between quarters. But, yeah, COVID is pretty significant there. In terms of other shortages and how they're impacting our business, I think, Will, you're referring really to components. And, of course, we've been reading along with everyone else about the chip shortages how that relates to automotive. What I tell you is, yeah, on the edges we've seen shipments be affected by customers running into shortages, but it has not had a large impact on us. We are continuing, particularly in automotive, to monitor the situation carefully. Um, and, uh, you know, and, and, and we're thrilled to see the bookings, uh, coming in as they have, uh, but still watching those hub pulls, um, out of inventory hubs, uh, to see if that has at all impacted so far so good. But, um, you know, I would expect eventually that's going to trickle through the supply chain that we would, that we would start to see, uh, you know, more of an impact in terms of hub pulls. Um, So that's what we're watching. So far, so good. But again, something to keep our eyes on.
spk00: Thank you. Thank you.
spk04: We'll move next to Stephen Fox with Fox Advisors.
spk00: Thanks. Good afternoon.
spk02: First question, I was curious if you could go into a little bit more detail on the the big uptick in the percent of auto revenues tied to your advanced technologies. You said it went from 20% to 26%. So what advanced technologies was driving that and what applications? And then I had a follow-up. Sure. Yeah, Steve, predominantly that's RF that's driving it. You know, RF going into ADAS and other autonomous vehicle-related centers. needs, but that's the bigger driver. Secondary factor is HDI and the impact of HDI positively. That's more tied to infotainment and infotainment developments as miniaturization of components becomes more and more a factor driving a need for HDI. Both of those areas, but more RF than anything else. So some of the bookings that we've talked about in the past in the ADAPT area now translating into revenues. Understood. And then in terms of the data center, the networking communications area, can you just sort of talk a little bit more specifically about your expectations for 5G and data center? I guess... You're still waiting to hear in terms of actual orders for China 5G, but I'd love to just sort of get your feel for maybe beyond Q1 in terms of how you're thinking about those markets. Thank you. Sure. Yeah, so I'm going to separate that discussion. And the way we look at it, 5G falls into our networking communications end markets. So I'll talk to that first, and then I'll talk a little bit about data center trends which fall into our computing end market. On the network and communication side with 5G, what we saw last year was a real strong demand coming out of China related to Phase 2 of their 5G investments. we've all been waiting for phase three. Initially, that was slated to start in the fall of last year. It was delayed to this year. The questions were really revolving around, would it be before Chinese New Year or after? I would say definitively it will be after Chinese New Year. And frankly, I think the Chinese government is, monitoring the situation with Huawei, their design development, and we'll time phase three for the right timing when Huawei and others are ready to provide the equipment. So there's a little bit of, you know, I think that's where the uncertainty comes in. I think it is a first half of the year situation where we should see that. To give you a sense of at least officially what's out there, the Chinese government has said that last year approximately 580,000 base stations were installed. And what they're calling for this year is closer to 600,000. And then what you can pick up in sort of the other factors, rest of the world, which frankly, was very small last year. The estimates from market forecasters, somewhere around 150,000 base stations, compared to that 600,000 in China. This year, I would expect to see, or what the forecasters are expecting to see, is a good uptick. There could be 250,000, could be north I think anywhere between 250,000 and 400,000 are the forecasts that I've seen. That's going to be driven out of North America and we're starting to see some of the initial signs of that followed by Europe and then rest of Asia. So that activity is what we're starting to see a bit of here, which is encouraging. And then what we're waiting for from a real significant volume standpoint would be that China piece combined with further rest of the world expansion through the course of the year. But that's why we've been pointing really, this is more of a second half of the year phenomena than the first half of the year, which we expect will be soft. In the meantime, networking will continue to pull us along in terms of that end market. In data center trends, always interesting. Last year, second quarter was phenomenal with the data requirements out there driving some very urgent needs for equipment. I would say that we've come off of that. Q4 was better than we expected, which is encouraging. I think Q1 looks good from a data center requirement standpoint. And, again, I think the longer-term trends are there in terms of data needs that will help that data center demand to continue to grow this year. So encouraging on that side. Great. That's super helpful. Thank you very much. Thank you.
spk04: Next, we'll move to Jim Ricciuti with Needham & Company.
spk02: Hi, good afternoon. You talked about the caseloads increasing and the impact of COVID and the impact it's having on your workforce. And I'm just wondering if Have you guys seen variability in some of the orders that are coming in from your customers that you think could be tied to this, whether it's in the U.S. or elsewhere, where we're seeing some caseloads, cases increase? I'm not sure I caught all of that, Jim. Can you repeat the last part of the question? Yeah, hopefully I'm not breaking up. But the question I had was just regarding the – the impact of COVID. I mean, clearly it's impacted, had an impact on your workforce. And I'm just wondering if you're seeing the variability in orders that have been coming in from customers who themselves are being impacted by this. Are you able to see that at all yet? Or just curious if that's playing into any of the forecasts? Uh, what I would say, and, and, um, So again, it's primarily going to be aerospace and defense where we hear that. And I think the supply chain as a whole has been challenged. Our customers are moving programs around. It's pretty dynamic, but they're moving program needs around to accommodate uh, the situation, the supply chain. And so far, I think they're doing a pretty good job of the gym, um, to allow, uh, you know, certainly allow the TPM and others to continue to, uh, to ship. Um, there's also, I think, you know, part of this component, if you just think broadly about component shortages, um, part of that is probably, you know, impacted, uh, by the COVID situation, um, as well. Uh, and, uh, So it's hard to separate the two. But I would say that overall, customers are adjusting to this, and they're allowing us to continue shipments on critical programs and adjusting needs as they look out over several quarters. But I think, again, they've done a really good job of handling what is a very complex supply chain situation. I know you guys don't guide beyond the quarter, but as we start coming out of this, hopefully, over the next several months and we see more of the vaccine getting out there, there should be, it would sound like there should be some lift to your gross margins just on the basis of the disruption that you've seen in Q4 and you're anticipating in Q1.
spk00: Is that a fair way to think about it?
spk02: Well, there's no doubt that we're carrying an anchor, if you will, in Q4 and Q1 related to COVID in terms of the impact on our cost structure. Through those inefficiencies that we talked about, as we saw a significant ramping in cases and impact to our employees. So, yes, we would expect that to relieve as we get to, you know, as the country is really, or the world gets COVID situation, particularly North America gets the COVID situation under better control. Is that Q2? Is that beyond that point? I think we can all watch the news and speculate on the vaccine rollout, but I think there's no doubt that that's certainly holding us back a little bit. When do the comparisons get easier, Bob? in the commercial aerospace area. When was a big hit last year for you in that area? If you think from a revenue standpoint, you know, really the Q3, so started in Q2, started Q2 really impacted us then in Q3 and Q4. And so... I think that's when, you know, again, we're going to go through the course of this year. Until we get to that second half of the year, it's going to be a tough compare. Got it. And last question, and, you know, we're seeing more of these reports coming out of the new administration about, you know, buy American initiatives. And, you know, I'm just wondering, do you see any benefit if, in fact, that's real that it might have in terms of supply chains for you guys? Yeah, so it is early. And I think it's early to predict how that will all come together. Clearly, when we look, you know, we are well established in North America. We have the opportunity, we have certainly the footprint we can continue to invest in. The administration looks at Buy America initiatives. What we are certainly thinking through is a lot to do, Jim, with if you start to think about our business, you start to think about a few things. One is our supply chain, whether it's laminate supply chain, whether it's equipment supply And there are a number of areas where, frankly, the U.S. infrastructure is insufficient. So we end up importing, and we bear quite a bit of cost associated with that. I'd say the second area is just simply volume manufacture, because we and others have really moved to a high-mix, low-volume type production. in the U.S. And so there needs to be a recognition with our customer base, perhaps encouraged by the U.S. government that it makes sense for larger scale commercial production to come back into the U.S. And then you're looking at a full scale infrastructure requirement both in our supply chain as well as in the scale demanded by those customers, that's when it would get interesting. But, yeah, we're obviously watching that closely, and at least the discussions around it could be encouraging longer term. But it does sound like it's very early days, and it sounds like there's still just lots of challenges that they do want to execute on this. Yeah, you know, for us it always starts with our customers. To the extent that our customers are looking, have that supply chain need, we will do our utmost and we will encourage our supply chain to do their utmost to meet those needs. So that's where it all starts. Okay. Thanks a lot. Thank you.
spk04: And just a reminder to our audience, please allow for one question and one follow-up only. And we'll take our next question from Paul Koster with J.P. Morgan.
spk03: Yeah, thanks for taking my questions. I'm a little late to the call, so some of these may have been touched upon. It's just two questions, really. First up, on the auto front, are you seeing a change in the customer base? We're seeing just dozens of companies entering this space, especially with EVs at the moment. And It strikes me that there must be some new logos in your mix by now, but perhaps you can enlighten us.
spk02: Yeah, well, interesting. And thank you for the question. I'll broaden it slightly. I think what's interesting to me as we look at the automotive space and what happened in the fourth quarter is that we saw strong year-on-year growth across the board. But if you start to look regionally, where we saw the strongest growth continue to be Asia, and then with Europe coming in right after Asia, North America, good year-on-year growth, but not the same level. And what I attribute that to is what you commented on. We have seen a lot of innovations in the EV space, certainly in Asia. And that has helped our customers, primarily Tier 1 suppliers. I think that's really helped their business, and it's energized their business as consumer demand has come back. And so that's a really encouraging feature. I think on the European side, Also, it's encouraging to see this kind of growth because if you remember, we were dealing a year ago with really that transition from out of diesel. And the big question in Europe was where would the demand go as the consumer transitioned out of diesel? And I think the answer is starting to emerge. I think more and more EV adoption is And, yes, some good solid demand for internal combustion engine as well. But EV certainly playing a role in that geography as well. So, yeah, for us, yes, there are direct shipments to some of these new customers. Don't get me wrong. When they're doing development work, we're doing a lot of work for them. But the major volume continues to be with the Tier 1s. and they're turning around and they're seeing a very different landscape as they look out at their customer base.
spk03: Okay, got it. And then my follow-up really also in the auto segment, really perhaps more in the ICE area at the moment, and that's the... The supply constraints, not related to COVID people, people related, but more to do with silicon, whether it's microcontrollers or system-on-chip technology. Is that affecting you?
spk02: Yeah, so yeah, I did comment a bit on that. The straight answer, Paul, is we haven't seen it yet. We're still seeing very strong demand. You can see that reflected in the backlog numbers, which are strong for us coming out of the fourth quarter. But we're watching it really closely, and that's going to be a function of hub inventories and the pull out of those hubs. So we're watching it closely, and I would expect that, yeah, there will be an impact here eventually, but it just hasn't materialized yet.
spk03: Very good. Thanks so much. Thank you.
spk04: We'll take our next question from Christian Schwab with Craig Hellam Capital Group.
spk02: Great execution in this challenging environment. If one wanted to be an optimist in this environment and we assume vaccines accelerate and we get into the fall and everything's a more predictable and safer environment as well as we have phase three production starting and utilization up in particular in Asia Pacific. If we wanted to think about you know, how much gross margins could improve from your implied guidance in Q1 to something we could be executing at, you know, in the back half of the year? You know, can you bridge that gap for us? Sure, I'll take a crack at that. I mean, what we've talked about is really looking at that revenue level and what happens, right? If auto maintains, that's great. And if we see the phase three with the 5G rollout in China kick in, let's say, let's just pick a quarter Q2 and it starts to ramp from there and we have a good strong second half, that's going to be very constructive. When we look at our incremental margins associated with that revenue that comes through, we're looking at somewhere in that I use 20% to 30%, but it's really 25% to 30%, depending on the complexity. The higher the complexity, the higher the incremental margins. But, you know, it flows through to our operating income level as a result of that incremental revenue that we pick up. And it's really key for us. As Tom quoted in his comments earlier, you know, our utilization levels in Asia are relatively low. They're in the low 60s. Low 60% range, which is a very low number for us historically. And we have plenty of capacity and capability. Yes, we have to add some labor and so forth. But in terms of the fixed infrastructure, we have that in place. And so there's a rich flow through on incremental revenue. So as we look at our end markets and say, okay, Tom mentioned the first half could be a bit of a tough compare because we're very excited. medical, industrial, and to some degree the telecom and networking and telecom section in the first half of 2019. There might be some tough compares there, but as those end markets strengthen as we go through the year, that's going to have a nice flow-through effect. If auto remains strong or continues to improve, keep in mind that as excited as we are about auto, we're still not yet back to our 2018 levels. And as Tom quoted in some of the information he provided, you know, our lifetime wins in automotive this past year was a very robust number. And it was on top of a very good year last year in wins. Now, there's always a lag here, but we're building the pipeline. And if we get that incremental revenue through, that's good business because, again, a lot of the fixed costs are already taken care of. So we look for a nice flow through as we grow revenue in the various markets that we're competing in. And we're optimistic about that as we go. But the big opportunity particularly is in those commercial end markets where we are underutilized in our facilities, particularly in Asia. Great. Good. That's a great answer. My second question has to do with Anarin. Is there any way for you to quantify how big that business is today? Well, the real answer is we don't think about it that way. So what I'd like to point to is if you think about the business that we acquired, which has been integrated with our aerospace and defense business, what I would look at is that the overall backlog. And when we acquired Anarin 2018, That overall backlog is in the $400 million range. And obviously, you know, we're now reaching record levels from an overall backlog standpoint. And so, you know, if you look at that uplift to $687 million, not all of it, But a good majority of it is in the RF space, which is a direct contribution from the combination of the two companies. So that's the impact that really the combination is having. That's probably the best deal I can give to you on the energy impact. Is there even a margin similar to what they were at when you acquired them? I mean, they're materially higher than your combined business. Should we assume that they're still that high? So the only headwind we've had there on the commercial side of the RF and S segment, which we break out, but that side we did lose the Huawei um, business, uh, which, which obviously had an impact both on revenue and on, on profitability. But other than that, it's, yeah, it's a very, you know, similar, similar kinds of margins. Okay. And that gets me to the punchline. So if you look at that business in, in back of the envelope math and you, you put, you know, what a market multiple on that business may be if it was trading by itself and not hidden inside your company, it could be, the lion's share of your market cap. Are you guys exploring that, or is it too integrated for that to ever be something to contemplate? Yeah, we're completely integrated at this point. So, yeah, I think that, you know, at this point as a company, it's really the When we're looking at our aerospace and defense business, that's an integrated business. And, you know, a piece of it is an integrated module, RF designed spec element that utilizes the full company capabilities. But we may in other programs be supplying a portion, maybe the printed circuit board portion and maybe the component portion, into a certain program. But it's that ability to really be, you know, flex to meet the customer needs that is so critical in the combination. So, you know, short answer is it really is an integrated, heavily integrated business at this point.
spk00: Great. No other questions. Thanks, guys.
spk02: Thank you.
spk04: We'll take our final question from Mike Crawford with B. Reilly.
spk02: Thank you. And if you continue to generate free cash flow along your balance sheet, you might get disinvited from the audio conference. On your defense tax, $187 million defense tax law, I know the majority is RF, but is there any way to quantify how much of that might be related to your new advanced i3 technology now or perhaps in the future, given the design wins it might be coming to fruition? That's a great example, Mike, of how the business works today. So what we essentially acquired with I3 was a capability to produce in high mix, low volume, substrate-like printed circuit board, dense circuitry for miniaturization. There are different ways the product then moves from our printed circuit board facility into the market. One is as an internal supplier because we need some of those capabilities for our RF component business, and so we're an internal customer. Another way is in the aerospace and defense industry. We have customers that need those boards. We also have customers that are very integrated in a microelectronics, you know, an assembly, a module. So now they're looking at what can we do in terms of integration out of our facilities that would combine that board capability with the RF component capability into a full module. And those are longer-term programs that we're seeding today that will come into fruition three to five years from now. So if you look at the overall revenue of that piece today, the biggest portion is what we're using internally for our own component needs. If you look at that business three years from now, it's going to look very different. And it's going to be a combination of module business and board business and then an internal piece. So that's the kind of development, you know, that the organization is achieving now by bolting in the I3 element and what we brought in with Anarin and combine that with the overall PCB capability that PTM brought to the table. Okay, thank you. My final question is, is it more a function of volume or mix to get to that 16% to 18% EBITDA in your target model from where you are today? I think obviously we have the short-term issues with COVID that we'd have to work through. But beyond that, we need some top-line growth. You can't have 60% utilization in your commercial facilities And, you know, which are volume-oriented facilities and get there. We've talked about the need to get our revenue levels up to an approximate run rate on an annual basis of about $2.3 billion. We're roughly at $2 billion now. So we need to see some growth there to be able to adequately utilize our facilities, given our current footprint. And that's what we're driving for. Now, we see that opportunity. We look at our revenue growth targets of, you know, mid-single digits organically. You can get there in the timeframe that we're looking at. Obviously, other things can happen to make that quicker or slower, depending on NACO levels or acquisitions or other things. But that's what we're looking at, and we certainly believe it's attainable with the footprint and the capabilities that we have today. Great. Thank you. Thank you.
spk04: That concludes our question and answer period for this time. I'll turn the call back over to Mr. Edmond for any final or additional comments.
spk02: Thank you. And thank you everyone for joining us. Just wanted to reiterate a few points. We delivered revenues above the midpoint, earnings above the guided range, and that's despite COVID-19 challenges. Second, our end market diversification has allowed continuing operations to be stable and despite some weakness in a couple of our end markets. Third, we generated very solid cash flow. We repaid and settled our convertible bond. And as a result, we brought our leverage down to 1.4 and announced a stock buyback program. So quite a busy quarter for us. In closing, I would like to thank you and also thank our employees and our customers for your and their continued support. Thank you very much.
spk04: That does conclude our conference call for today everyone. Thank you all for your participation.
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