Earnings Call Transcript - TTMI Q4 2022

Operator, Operator

Good afternoon ladies and gentlemen. Thank you for standing by. Welcome to TTM Technologies Fourth Quarter and Fiscal 2022 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. As a reminder, this conference is being recorded on February 8th, 2023. I would now like to hand the call over to Samir Desai, TTM's Vice President of Corporate Development and Investor Relations to review TTM's disclosure statement. Please go ahead, sir.

Sameer Desai, Vice President of Corporate Development and Investor Relations

Thank you, Operator. 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 Litigation Reform Act of 1995, including statements related to TTM'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 more 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 disclosures regarding the risks that may affect TTM in other reports on Forms 10-K, 10-Q, 8-K, the registration statement on Form S-4, and other SEC filings. We will also discuss certain non-GAAP financial measures such as adjusted EBITDA. Such measures should not be considered as a substitute for 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 and is available on TTM's website. We've also posted a slide deck that we will refer to during the call. I will now turn the call over to Tom Edman, TTM's Chief Executive Officer. Please go ahead, Tom.

Thomas Edman, CEO

Thank you, Sameer. Good afternoon and thank you for joining us for our fourth quarter and fiscal year 2022 conference call. I'll begin with a review of our business highlights from the quarter and a discussion of our fourth quarter results, followed by a summary of our business strategy. Todd Schull, our CFO, will follow with an overview of our Q4 2022 financial performance and our Q1 2023 guidance. The quarter's highlights are also shown on slide three of the investor presentation posted on TTM's website. In the fourth quarter of 2022, TTM delivered solid results in a difficult business environment. While revenue softened, non-GAAP EPS was above the midpoint of guidance despite a challenging supply chain and labor environment, and the continued impact that COVID-19 is having on our business. Demand in our Aerospace and Defense market remained strong with record bookings and backlog, offset by weaker demand and bookings in our commercial end markets. We also saw improvement in our profit margins year-on-year in Q4. I am proud of our employees for delivering solid results this quarter in a tough environment. As we look into Q1, production inefficiencies in our Asia-Pacific facilities due to Chinese New Year, inventory adjustments, and weaker demand from some of our commercial end markets are causing revenue and margin declines, but we will continue to see strong demand in our A&D market, which now represents 40% of our revenues. For the full year of 2022, excluding the acquisition of Telephonics, TTM grew revenue 5.4% with improved year-on-year profitability despite the challenges I previously mentioned. Full-year cash flow from operations was $272.9 million, enabling us to purchase Telephonics and strengthen our balance sheet while returning capital to shareholders. In addition, we repaid $50 million of our Term Loan B on January 3rd, 2023. I am proud of what our employees have accomplished in the face of these challenges despite one of the most difficult manufacturing environments that we have ever experienced. I would now like to provide a strategic update. TTM is on a journey to transform our business to be less cyclical and more differentiated. Over the past several years, TTM has consistently emphasized that a key part of our strategy is to add value to the product solutions that we deliver to our customers, particularly in the Aerospace and Defense market. In 2018, we acquired Anaren, which broadened TTM's product portfolio into highly engineered RF components and sub-assemblies, as well as adding critical RF engineering capability and resources. In 2022, we acquired Telephonics, which builds on Anaren and TTM's customer-driven culture and disciplined approach to engineering and manufacturing. The addition of Telephonics expands TTM's Aerospace and Defense product offering vertically into higher-level engineered system solutions and horizontally into the surveillance and communications market while strengthening our position in radar systems. As a result of these strategic moves, over 50% of A&D revenues are from engineered and integrated electronic products, with PCBs being less than 50% of the overall contribution. An example of how this strategy is strengthening our business is our recent announcement of the multi-year agreement with Raytheon Technologies for the SPY-6 family of radars. This is an agreement to provide radio frequency assemblies, electronic hardware, and printed circuit boards for the SPY-6 family of radar systems. The agreement has the potential to reach $500 million over five years. The SPY-6 radar will be on 40 ships of seven different classes by 2030. TTM designs and manufactures the beamforming network, along with PCBs and specialized assemblies for these radars. This type of multi-year commitment for supply allows TTM to increase value to our end customer. Another important element of our differentiation strategy is the current construction of a new state-of-the-art highly automated PCB manufacturing facility in Penang, Malaysia. The decision to build this new factory is a direct response to our customers' increasing concerns about supply chain resiliency and regional diversification, particularly the need for advanced multi-layer PCB sourcing options in locations outside of China. The new facility in Malaysia will assist customers in our commercial markets, such as networking, data center computing, and medical, industrial, and instrumentation. We made great progress on the Malaysian facility this past quarter, as we completed the pilings required for the building, laid the majority of the foundation, completed the power substation, and the roof. We also received multiple deposits from customers, with whom we have signed long-term agreements, which provide a business base for over 70% of the planned capacity in this new building. Finally, I'd like to discuss today's announcement regarding the consolidation of our manufacturing footprint. After the market closed today, we issued a press release announcing that we plan to close three small manufacturing facilities in order to improve total plant utilization, operational performance, customer focus, and profitability. PCB manufacturing operations in Anaheim and Santa Clara, California, and Hong Kong will be closed and consolidated into TTM's remaining facilities. The planned closures are expected to improve both facility and talent utilization across our footprint, resulting in improved profitability. TTM is offering customers of the affected PCB plants continued support at our remaining manufacturing sites. We plan to close the Hong Kong facility by the end of our second quarter and the two North America facilities by the end of the year to allow for necessary customer approvals at other facilities. We expect the actions we are announcing today will allow us to better serve our customers with more focused operations as well as a more efficient cost structure. We will be working with our employees to transfer them into other facilities, and where that is not possible, to treat all of these employees with the respect that they are due for their dedication to TTM.

Todd Schull, CFO

Thanks Tom and good afternoon, everyone. I will be reviewing our financial results for the fourth quarter that were included in the press release distributed today as well as on slide seven of our earnings presentation that is posted on our website. For the fourth quarter, net sales were $617.2 million compared to $598.1 million in the fourth quarter of 2021. The year-over-year increase in revenue was due to the inclusion of Telephonics as well as organic growth in our Aerospace and Defense end market, partially offset by declines in our commercial markets. For the full year, revenues grew 5.4% excluding Telephonics, driven by our medical, industrial, and instrumentation, data center computing, automotive, and A&D end markets. For all of 2022, revenue was $2.5 billion. This compares to $2.2 billion in 2021. GAAP operating income for the fourth quarter of 2022 was $97.6 million and includes a gain of $51.8 million in December 2022 from the sale of the property occupied by our former Shanghai EMS entity. This compares to $33.1 million in the fourth quarter of 2021. On a GAAP basis, net income in the fourth quarter of 2022 was $6 million or $0.06 per diluted share. Our fourth quarter 2022 results include a tax reserve of $51.7 million to establish the valuation allowance for certain US deferred tax items and $14.7 million associated with the gain on the sale of the property noted earlier. This compares to GAAP net income of $8.4 million or $0.08 per diluted share in the fourth quarter of last year. The remainder of my comments will focus on our non-GAAP financial performance. Our non-GAAP performance excludes M&A related costs, restructuring costs, certain non-cash expense items such as amortization of intangibles and stock compensation, gains on the sale of property, and other unusual or infrequent items, such as the tax valuation reserve I mentioned earlier. We present non-GAAP financial information to enable investors to see the company through the eyes of management and to facilitate comparisons with expectations in prior periods. Gross margin in the fourth quarter was 19.8% and compares to 16.7% in the fourth quarter of 2021. The year-on-year increase was due to the addition of Telephonics, better product mix, favorable foreign exchange, and lower material costs, partially offset by higher year-on-year labor costs, particularly in North America as we raised wages this year to be more competitive, and lower revenue in our commercial markets. Selling and marketing expense was $18.8 million in the fourth quarter or 3% of net sales compared to $15.6 million or 2.6% of net sales a year ago. Fourth quarter G&A expense was $37.4 million or 6.1% of net sales compared to $30.4 million or 5.1% of net sales in the same quarter a year ago. The inclusion of Telephonics added $2.5 million and $4.1 million to sales and marketing and G&A respectively. In the fourth quarter, R&D expense was $6.4 million or 1% of revenues compared to $4.8 million or 0.8% in the year-ago quarter. $1.5 million of the increase was due to the inclusion of Telephonics. Our operating margin in Q4 was 9.7%, a solid result given the macro challenges we've been facing. This compares to 8.2% in the same quarter last year. For the full year, 2022 operating margin was 9.4% compared to 8.4% in 2021. Interest expense was $12 million in the fourth quarter compared to $11.2 million in the same quarter last year. During the quarter, there was a negative $3.2 million foreign exchange impact below the operating line. Government incentives and interest income decreased this to $1.9 million or a $0.02 negative impact to our EPS. This compares to a loss of $1.1 million or $0.01 impact on EPS in Q4 last year. Our effective tax rate was 6.5% in the fourth quarter, resulting in tax expense of $2.9 million. This compares to a rate of 1.6% or tax expense of $0.6 million in the prior year. For the full year, our effective tax rate was 13.1%. Fourth quarter net income was $42.7 million or $0.41 per diluted share. This compares to fourth quarter 2021 net income of $36.2 million or $0.34 per diluted share. For the full year, net income was $181.2 million or $1.74 per diluted share compared to $138 million or $1.28 per diluted share in 2021. Adjusted EBITDA for the fourth quarter was $81.6 million or 13.2% of revenue compared with fourth quarter 2021 adjusted EBITDA of $70.4 million or 11.8% of revenue. For the full year, adjusted EBITDA was $343.1 million or 13.8% of revenue. Depreciation for the quarter was $24 million. Net capital spending for the quarter was $20.8 million. Cash flow from operations was very strong at $77.6 million or 12.6% of revenue, exceeding our target of 10%. Free cash flow was also very good at $56.8 million or 9.2% of revenue. For the full year, cash flow from operations was $272.9 million or 10.9% of revenue. Free cash flow for the full year was $176 million or 7.1% of revenue. Cash and cash equivalents at the end of the fourth quarter of 2022 were $402.7 million, and our net debt divided by last 12 months EBITDA was 1.5 times, at the bottom of our targeted range of 1.5 times to 2 times. Following the end of the fiscal year, we repaid $50 million of our Term Loan B. Before I discuss first quarter guidance, I'd like to discuss the financial impact of today's facilities consolidation announcements. The company expects to record between $22 million and $28 million in separation, asset impairment, and disposal costs related to this restructuring, primarily between now and the end of 2023. Approximately 80% of these costs are expected to be in the form of cash expenditures and the rest in the form of non-cash charges. Today's actions are expected to yield an annual operating profit increase of approximately $22 million to $27 million after the facilities are closed and the transferred business is fully assimilated within our remaining footprint. Now, I'd like to turn to guidance for the first quarter. As Tom mentioned earlier, we expect a sequential decline in revenues due to weaker booking trends in our commercial end markets, resulting from inventory adjustments, weak end market demand, and the Chinese New Year holiday. We expect a sequential decline in margins due to lower revenues, inefficiencies associated with the Chinese New Year holiday, higher material costs, and unfavorable mix. Given these factors, we project total revenue for the first quarter of 2023 to be in the range of $550 million to $590 million, a non-GAAP earnings to be in the range of $0.16 to $0.22 per diluted share. The EPS forecast is based on a diluted share count of approximately 104.6 million shares, which includes dilutive securities such as options and RSUs. We expect that SG&A expense will be about 9.5% of revenue in the first quarter, and R&D will be about 1.2% of revenue. We expect interest expense to total approximately $11.9 million. Finally, we estimate our effective tax rate to be between 13% and 17%. 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 $11.7 million, stock-based compensation expense of about $5.9 million, non-cash interest expense of approximately $0.7 million, and we estimate depreciation expense will be approximately $24.5 million. Additionally, as you're building your financial models for 2023, I'd like to call your attention to three items. First, interest rates have risen and may rise further in 2023; thus, our average borrowing rate on our term loan, which is a variable rate debt, was 1.7% plus a margin of 250 basis points. Today, we are already incurring a rate of 4.6% plus our margin. Second, in 2022, we realized favorable foreign exchange below the operating line of $12.7 million. We cannot predict how the Chinese to US exchange ratio will move in 2023; consequently, we do not forecast this item. And third, we are investing in a new plant in Penang, Malaysia, which we expect to start production in the second half of the year and begin ramping towards full volume production. During the 2023 startup phase, we expect to incur a negative impact on our margins of between 30 and 50 basis points. We estimate that approximately 75% of that impact will be weighted towards the second half of 2023. Finally, I'd like to announce that we'll be participating in the Cowen Aerospace, Defense, and Industrials Conference on February 16, the JP Morgan High Yield and Leveraged Finance Conference on March 7, and the JP Morgan Industrials Conference on March 16. That concludes my prepared remarks. And now we'd like to open the line for questions.

Operator, Operator

Thank you. And today's first question will come from James Ricchiuti with Needham & Co. Your line is open.

James Ricchiuti, Analyst

Hi. Thank you. Good afternoon. So, maybe putting aside the aerospace and defense where you have pretty good line of sight, which are the commercial markets, as you look at them today, do you believe perhaps the most uncertainty attached to them and you're clearly seeing weakness in several of them?

Thomas Edman, CEO

Yes, I think there are two areas of weakness we observed during the quarter. We saw significant challenges in the data center market, which impacts our computing and data center computing sectors, with two-thirds being data center related and one-third semiconductor, both showing signs of weakness. In the data center sector, there is considerable chatter around inventory control and digestion. I expect this market to remain weak in the first half. The second area is networking, which is similar; there are discussions about declining demand and the spending environment, particularly in telecom. Everyone is waiting for investments in India, which are progressing but slowly, and this is a relatively small portion of our networking market. Those are the two markets that are presenting challenges. Our Medical Industrial Instrumentation sector is facing significant weakness, while the medical and industrial segments are performing better, albeit with ongoing discussions around inventory control; however, I believe this is a short-term issue. The automotive sector is performing fairly well. We will take time off for the Chinese New Year in our facilities, which will lead to a revenue dip in Q1. However, if you account for the week and a half to two weeks of lost production, we should be back up to our Q4 numbers in automotive, so it’s holding up quite well.

James Ricchiuti, Analyst

Got it. Follow-up question I have, as you may have made some reference to this in the opening remarks, but to the announcement today with respect to the manufacturing footprint, does that in any way change the investment plans or timing for Malaysia?

Thomas Edman, CEO

No, absolutely not. We regularly look at our footprint. These smaller facilities in Hong Kong and the two facilities in California have been struggling in terms of profitability and their plant charter. That's been the struggle. And as we looked into our forecasts, they also don't look much better for the long term. So these difficult actions are necessary, and we will continue the investment in Malaysia because our customer base is counting on this; it's a critical investment for TTM. This decision is in terms of supply chain resiliency and efficient production volume capability, so we're proceeding there as scheduled and holding to our schedule at this point.

Mike Crawford, Analyst

Thank you. I heard from your remarks that you basically have 70% of your capacity generally sold with customers for the Malaysia plant that is opening. Is that a case where you're hoping to run that facility at what? 80% plus utilization? Or is it going to be the same type of metrics that you had for your China facilities? Or is it going to be slightly different?

Thomas Edman, CEO

So the goal will be to run it north of that. Ideally, you'd love to be between that 80% and 90% utilization rate. You’re absolutely right, Mike. It's very similar in terms of our China facilities in terms of volume capabilities, and the need to leverage your footprint and keep that utilization high. These will be volume requirements for our customers, and we won't hit that 80% right away. We've got a good ramp that'll carry us through the end of this year and next year to get there. But again, yes, it's a very strong backdrop to have those customers lined up and willing to, sort of with their deposits to help us as we invest in this critical capability.

Mike Crawford, Analyst

Okay. Thank you. And then my second question switches to a CSO. What is the potential upside for, more ships being included in that program, perhaps as a result of the forthcoming budget and budget requests we'll see in a few weeks? And secondly, for potential military sales to allies?

Thomas Edman, CEO

So I can't really speak for our customer, but there certainly is upside there. You're right, there's a possibility of foreign military sales as well. We should stick to their announcement. I think even that is a very strong base for us. We continue to see a number of other radar systems and programs move to ESA that are allowing us to grow strongly in that market. So we’re not solely relying on that program, but it is a program that has potential upside for sure. Our focus will be on servicing the customer and making sure that we ramp here successfully through the course of this year for our aerospace and defense market. It’s critical that we resolve supply chain bottlenecks in that sector.

Matt Sheerin, Analyst

Yes, thanks and good afternoon, everyone. Just a question on the outlook for the automotive sector. Sounds like you're looking below the market growth there. And I know you're starting out down, I guess mid-teens year over year in Q1. Most of the suppliers sound more optimistic. Some are seeing a little bit of inventory, but most expect some production growth this year and content growth. Do you expect auto to grow for the year even though you're going to be down significantly in the first half?

Thomas Edman, CEO

So the answer is yes. If you look sequentially, you'll see the Chinese New Year impact. And that’s what this is. Last year, we ran through Chinese New Year. We had a full complement of labor, as the government was encouraging employees to stay in place. So, yes, if you do the quick calculation and add back that production loss, we would be right back on top of the Q4 numbers in automotive. The overall demand environment is slightly off from where we were in Q1 last year, but not substantially. So the market is holding up well.

Matt Sheerin, Analyst

Okay. Thanks for that. And I know someone just asked about the commercial markets being weak, in terms of the cloud computing and inventory correction you're seeing, same thing in the related semiconductor markets. Are you seeing signs that all of that is bottoming in the next quarter or two, or will it get worse before it stabilizes?

Thomas Edman, CEO

Yes, I think we're looking at a situation where there’s a quarter or two of weakness. The indications we have are for the first half. We will see how demand shifts in the second half of the year. But most of the commentary from customers has been related to the first half and digestion due to substantial inventory buildup.

Todd Schull, CFO

What I would say about Q1 guidance is that we expect SG&A expense to be about 9.5% of revenue, and then R&D will be an additional 1.2% of revenue in Q1.

Thomas Edman, CEO

Thank you. Yes, I'd like to close by summarizing some of the points that I made earlier. First, we delivered non-GAAP EPS above the midpoint of guidance and saw good year-over-year improvement in margins. Second, we announced the consolidation of our manufacturing footprint to streamline our operations to better serve our customers and lower our cost structure. Third, we generated strong cash flow, resulting in a net leverage of 1.5 times at the low end of our target range of 1.5 to 2 times. Fourth, despite weakness in our commercial markets, we are seeing very strong demand in our aerospace and defense market. In closing, I'd like to thank our employees, our customers, and our investors for your continued support as we navigate the challenges to our business. We will continue our long-term strategic focus on diversification, differentiation, and discipline. With that, I'd like to thank you again. Goodbye, everyone.

Operator, Operator

Thank you all for participating. This concludes today's program. You may now disconnect.