Earnings Call Transcript - LGL Q4 2020

James Tivy, CFO

Good morning, everyone. I am James Tivy, CFO of The LGL Group, Inc. Thank you everyone for joining our Full Year 2020 Earnings Call. Please note this call will be recorded and we anticipate making the recording available on our website at www.lglgroup.com sometime after the call. We've issued a press release reporting results for our fourth fiscal quarter and our full year of 2020. Before getting underway, we're required to advise you and all participants should note that the following discussion should be taken in conjunction with the most recent financial statements and notes there too, contained within our 2020 10-K to be filed with the SEC for this most recent period in the next couple of days. This discussion may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21-E of the Securities and Exchange Act of 1934. These forward-looking statements involve known and unknown risks and uncertainties, which are detailed in our filings with the SEC. Although the company believes that its forward-looking statements are based upon reasonable assumptions regarding its business and future market conditions, there can be no assurances that the company's actual results will not differ materially from any results expressed or implied by the company's forward-looking statements. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are cautioned that any forward-looking statements are not guarantees of future performance.

Marc Gabelli, Corporate Representative

Thank you, James. We will now begin with a corporate snapshot of LGL Group. The company was founded in 1917 and went public in 1946 on what was called the American Curb Exchange. Today it trades on the New York Stock Exchange under the symbol LGL. And we can just review some of the highlights of the company and its basic corporate profile, its principal operating subsidiary today is MTronPTI, a business that's engaged in the manufacture of robust precision-engineered designs for frequency control used in various forms of communications, medical, and avionics devices. We'll talk about that further in a moment. As of December 31, 2020, the company completed the year with $31.2 million of annual revenue, 5.2 million shares outstanding, with $24 million of cash and marketable securities. In addition to the $24 million, $3.34 million was invested on a gross basis into a sponsor of a SPAC, LGL Systems Acquisition Corp. LGL Systems Acquisition Corp on March 15, announced a merger business combination with IronNet Cybersecurity. We would recommend shareholders look at both IronNet's website as well as LGL Systems Acquisition Corp's website for further information and SEC filings. It is the intention of The LGL Group to continue to participate in SPAC sponsorships across multiple industry verticals. We'll talk a bit more about that in a moment. If we turn to the next slide, slide 4. As we use this opportunity to look back on 2020, we want to underscore our deep thanks to all the professionals in the team at LGL Group and subsidiary businesses who delivered for our customers and stakeholders during what is and continues to be a challenging backdrop. As you've seen in the press release, the results for the year 2020 reflect strong underlying fundamental business oriented very much towards defense, space, and medical technologies. 2020 had significant shifts in customer mix as avionics within the aerospace industry had a precipitous decline on the back of COVID-19 risks. At the same time, COVID-19 caused supply chain disruptions across the entire manufacturing footprint of the LGL Group and its customers and suppliers. And we'll talk a bit about that in a moment. So again for the full year, LGL Group's revenue was $31.2 million versus $31.9 million, which was actually the most robust reported results for the company that was in 2019. The margins reflected really good operating discipline and management led by Bill Drafts in Orlando, and his team continued to deliver and adjust as the environment changed. And it changed quite a bit. And we thank Bill; we thank all his team in Orlando, Yankton, in India, and in Hong Kong for their efforts on behalf of our key clients and stakeholders. The balance sheet for LGL Group is strong as we just outlined, and we continue to look for ways to increase the strength of the balance sheet. We think it's important being that LGL Group and the MTronPTI businesses are essential businesses. For example, during COVID-19 shutdowns, our India facility which was shut down by government mandate was reopened at the request of General Electric Health, so GE Health helped us reopen the facility. Because the MTronPTI facility in Noida, India produces a critical component for ventilators, which we are all very acutely aware is a critical device during the COVID-19 pandemic. So we're very proud that we continued to deliver during that period of time. Also in 2020, we issued our shareholders of record warrant dividends; you can find information on the warrant dividend on our website and on SEC filings. There's a strong message and distribution of value for shareholders as we look forward. In 2021, which is a subsequent event, as of recent, LGL Systems SPAC announced the business combination with IronNet Cybersecurity. Again, we think that's a good way to deploy capital, earn a return on that capital, and have residual benefits for the broad shareholder set of The LGL Group. And then, most excitingly, we've also, as of today, announced that Michael Ferrantino has been named President and CEO. Michael replaces the Interim CEO, Ivan Arteaga, who was in place and helped steward the business during the COVID-19 dynamics. So we thank Ivan for his efforts on behalf of shareholders during this time; Ivan remains on the board of LGL Group. Let's turn the next slide.

James Tivy, CFO

Hey, Marc. This is James. Sorry to interrupt. We're having a couple of folks indicating they're not hearing on the call. I just wanted to double-check if we can with the operator. Michelle, are you there?

Marc Gabelli, Corporate Representative

Maybe we lost connection, James.

James Tivy, CFO

I suspect they may have just dialed into the WebEx and not the dial-in number.

Marc Gabelli, Corporate Representative

So this is being recorded right now. I do believe that this is still being recorded.

Operator, Operator

You are not lost, sir. Mr. Marc is correct. Some participants might have dialed into the WebEx portion of the call only.

Marc Gabelli, Corporate Representative

I see. So they cannot hear the voice. Is that right?

Operator, Operator

This is the audio part, sir. They have to dial here.

Marc Gabelli, Corporate Representative

Okay. So we can only continue, James. And operator, this section that we've just had banter for those that are on the call that are our shareholders. We apologize. But the operator, you're going to need to cut this out for the recorded message. Okay?

Operator, Operator

Sure, sir. I will inform the post-conference services.

Marc Gabelli, Corporate Representative

Thank you. So we're on slide 6. James, if you do have an efficient way to let shareholders know that they need to dial a certain number, their press release may have been confusing. It's fully understandable. But what I don't have is a mechanism to apologize to them at this time.

James Tivy, CFO

Yes, I don't either.

Marc Gabelli, Corporate Representative

Okay, so let's continue on slide 6. We were leaving off on the network effects for the benefits coming from the SPAC and the relationships that we all bring to the table. Let us now move on to the operating business. And I pass this to our new CEO and President, Michael Ferrantino.

Michael Ferrantino, President and CEO

Thank you, Marc. I'd like to give a brief overview of MTronPTI and first I'd like to echo Marc and thank both the MTronPTI and PTF teams for all of their hard work last year. They handled the many challenges related to COVID-19 and were able to keep revenues close to the 2019 levels. Next slide, please. MTronPTI sees significant opportunity in the defense landscape. As a result, our focus has been to become a preferred supplier of critical frequency and spectrum control components and modules used in the avionics, military, aerospace, and space markets. These markets place high value on the highly engineered, ruggedized, and custom solutions our team is capable of providing. Next slide please. So we are a provider. We are a provider of Tier 3 and Tier 4, where we do components and modules of the offerings I just mentioned. There is lower price sensitivity in these modules where small variations in price could mean not much to the end system but a great deal to us. Next slide, please. MTronPTI is a global company with 132,000 square feet of design and manufacturing space in the US and India. Additionally, we have a sales network of over 30 representatives primarily across North America, Europe, and Asia. Despite the challenges posed by COVID-19, 2020 brought several positives, including the introduction of multiple new products and an expansion into new markets beyond our existing customer base. This success resulted in significant design wins and an increase in market share among our growing customer base. We are committed to investing in automation and yield improvements to enhance profitability, as well as boosting our marketing efforts to highlight our new products and capabilities. However, COVID-19 adversely affected our gross margins due to workforce and supply chain disruptions and a decline in our avionics sector. A six-week shutdown of our operation in India necessitated a shift in production back to the US. Looking ahead, we see promising growth opportunities in both established and new sectors, particularly in the development of new technologies and products that meet our customers' demands for greater integration, smaller sizes, higher frequencies, and reduced phase noise. These innovations will enable us to capture more market share among our existing premium clients and expand into fields like medical and space. We will persist in investing in both capacity and capabilities to enhance our international sales with competitively priced, high-performance products. We will also continue to explore synergistic acquisitions to support our customers' needs. Now I will hand the call over to Linda.

Linda Biles, Company Representative

Our annual revenues in 2020 were $31.2 million versus $31.9 million, a decline of $0.7 million or 2.2%. As mentioned previously, the company and its team were successful in being able to offset the decline in the avionics market, with increased revenues in space, defense, and the medical market. Our gross margins declined from 39.2% in 2019 to 31% in 2020, returning us to the historic gross margins that are in the strong mid-30s. And we were able to do this as we shifted the onshoring back to the US with the shutdown of our facility in India. Our adjusted EBITDA was 8.6% in 2020. When we look at our backlog, our backlog decreased from $21.9 million in 2019 to $19.8 million in 2020, where it remains strong and steady going into 2021. Mike, I'd like to turn it back to you.

Unidentified Company Representative, Company Representative

Thank you, Linda. Let me conclude by first thanking the company's directors for their vote of confidence, and let the shareholders know that I look forward to continuing to serve them in this new role. The opportunity for LGL is strong and I am proud to be part of the team who will lead it into the future. We will strive for growth through continued product development and market share gains, mergers and acquisitions to diversify and expand, as well as look for alternative areas of growth using our key strengths. I'd now like to open the floor to questions. Operator, please open the floor to questions.

Operator, Operator

Your first question comes from Dobb from Private Investor.

Unidentified Analyst, Analyst

Hey, good morning, all. I appreciate you doing the call. I had a question as related to the SPAC franchise business. Could you put any kind of parameters around that and some kind of magnitude to give us something to think about in terms of how meaningful the IronNet deal is and how meaningful potential ones going forward are relative to the investment?

James Tivy, CFO

Sure, thanks. And thanks for your question. We had some problems with the line; some investors weren't able to listen in. So we're glad that you were able to dial in and listen to the presentation. With regards to the SPAC franchise and the meaningfulness of the IronNet transaction, as I'm sure you're familiar with, the SPAC business combination was announced. SPAC has a trust value that is at $10 per share. There are also warrants. LGL Group invested in the sponsorship that had both the economic participation in B shares that convert to A shares. That conversion occurs when the SPAC business combination is completed and therefore, voted on by shareholders. That's not expected until July. So the actual liquidity of the investment doesn't occur until that time. What's unique about the IronNet transaction, and you will see in various SPAC transactions, there are multiple terms and conditions for these transactions in the market. IronNet, the PIPE, which is the private investment, raised $125 million, which is also equal to the minimum cash condition to close. So in that context, the IronNet transaction has met its financing conditions to close and therefore, we can view that this transaction has already economic value for The LGL group. There is of course variability to economic value that will be tied directly to the pro forma trading pattern of the stock. But at $10 a share, the economic value, without including the benefits of the full warrant participation and without including the potential for the share price to appreciate, that economic benefit is in the range of about $12 million to The LGL Group, not just to LGL as a sponsor, participants sponsor within the SPAC partnership. So that's a net number after the initial $3.3 million initially invested. And it is also not including any other additional investments that LGL Group may have done or will do with the company on a pro forma basis. So the multiplier, though, just a rough math on the multiplier, will vary. And each SPAC sponsorship will have a differentiated return profile. But certainly without share price appreciation, assuming $10 on the trust account for IronNet itself, so that's holding a lot of items static, you can kind of roughly assume that $12 million plus the $3.35 million already invested. So that's on a gross basis, kind of north of 15 and roughly around 12 net. And again, there can be upside there as well as downside to that based on stock price fluctuation. So I hope that answers your question. We will of course, as we've just outlined, continue to pursue the build-out of the opportunities around SPAC. And for those of you that were able to listen to the IronNet cybersecurity call for investors, the SPAC management team has outlined that they've seen well in excess of 100 transactions and IronNet had the attributes for them to transact on. And keep in mind, those transactions all have to fit the criteria for the SPAC, which would be closer to the IronNet pro forma cap of a $1 billion or more. Certainly, residual benefits for LGL Group and its shareholders would be any related flow of opportunities in a much smaller set. So I hope that helps with the question. Thank you for it. Operator, next question.

Operator, Operator

Your next question comes from Tom of MFF.

Unidentified Analyst, Analyst

Yes. Good morning. My question also has to do with not only the SPAC that we're currently involved in, but you mentioned in your presentation, that seems to be one of your pillars going forward. My understanding, until I just heard your answer, was that LGL had just had an investment in the warrants. Am I mistaken on that? Because how do you know that $15 million value to the company at $10 wouldn't attribute any value to the warrants which I think are exercisable at 11.5? Can you explain that facet as far as the current investment is concerned? And how you look at that as you do more SPAC in the future, as you alluded to, because I never quite understood how we only invested in the warrants rather than the actual SPAC itself, because otherwise we're just taking, we're lower on the totem pole there in terms of risk.

James Tivy, CFO

Yes, Tom, thanks for the question. No. So the first thing is that the SPAC, The LGL Group invested in the SPAC sponsor, the SPAC sponsor includes both B shares which are non-tradable and restricted and have that binary risk, which is either up to $10 plus or to zero if there's a deal not announced. But it also includes the warrants. So just for the point of clarification, LGL Group invested in the sponsor, which took on all the risk capital. The sponsor is designed to have both a direct attribution to its investment plus incentives to the team broadly, which includes those folks that are involved in the in the day-to-day opportunity seeking for the SPAC. But ultimately, LGL Group did not invest only in the warrants. Okay, it's a partnership, it's all wrapped in. And that's what you can see in the financial results under the variable interest accounting. For example, if we follow GAAP, EBITDA takes a haircut when the variable interest entity has an expense that flows through to The LGL Group. It's from an economic perspective, it's not an LGL Group expense, but it shows up in the reported results due to the accounting. In terms of the actual detail of the SPAC business and further opportunities with SPAC investment, should LGL Group invest in further sponsors, which it intends to do, and there are several in registrations, we will have a separate call for investors around that topic. We do think that, as public companies, as sorry, as companies seek to go public, we think 2021 is really the year that we're all going to mark in our calendars for the future in the capital markets. Because you have not only traditional IPOs, which have been around, but you now have direct listings that can obviously help raise capital. But then you have this SPAC phenomenon, this SPAC phenomenon, besides SPAC obviously seeing its growth, because of very low interest rates and liquidity in the market. SPAC also offer several very strong features for a company looking to go public. So we do plan to continue to invest in SPAC, in the fashion that we've just outlined, which is in the sponsor partnerships, that do take on all the risk capital, but therefore also have requisite rewards. And obviously, Tom, the best mechanism to mitigate the risk is to ensure that the management team can identify and transact with a business combination, wholly dependent on the capital markets, but also wholly dependent on deal flow and relationship sets. So The LGL Group hopes, certainly believes that it's bringing forward quite a lot of good relationship sets for that opportunity and for shareholders. I hope that answers your question.

Unidentified Analyst, Analyst

Yes, that explanation is very helpful. I initially thought we only had the warrants and needed to exceed 11.5 at some point for the new company to have value for LGL. I was confused about why we would invest under those conditions. What you're saying is that right now LGL has an economic interest of $24 million in cash on the balance sheet, plus around $15 million if the stock trades at $10 when the new company launches. Together, that brings us close to $40 million just from those two figures, in addition to the existing business you are managing. Is that a correct way to understand it?

James Tivy, CFO

That's correct. There are some NOLs that we haven't discussed today. And then also you have ultimately, the SPAC franchise will continue. And as that continues, we believe there is a real opportunity to continue to bring companies to market and help add value to those companies in the process. Thank you, operator.

Operator, Operator

There are no questions from participants online. Sir, you may continue.

Michael Ferrantino, President and CEO

Well, if there are no more questions, I would like to thank everyone for participating and your continued interest in The LGL Group. And this would conclude the call.

Operator, Operator

Ladies and gentlemen, that does conclude today's conference call. Thank you for participating. You may now disconnect. Speakers, please stay on the line for your post-conference call.