TTM Technologies, Inc. (TTMI) Earnings Call Transcript & Summary

Excuse me. Can you hear me?

Yes.

Okay. So I don't know if you heard that. I'll start again. It's the 48th JPMorgan Technology Conference and the first virtual version. My name is Paul Coster, I cover applied technology, IT hardware and also alternative energy for the firm equity research. It's my pleasure to introduce Tom Edman, the President and CEO of TTM Technologies. Good afternoon, Tom.

Good afternoon, Paul.

Thanks. Tom's the featured speaker for the next 35 minutes. This is a Q&A session, and the audience is welcome to participate and do so by tapping on the Q&A button at the top of your screen -- bottom of your screen, submitting a question. I'll do my best to incorporate it into the discussion with Tom.

So with which, Tom, thanks very much for joining us. And well, it's been a big year. We've got used to you making acquisitions every 3 to 5 years. And well, instead, you made a big divestiture. What's going on here? Why did you do it ultimately?

Sure. Thank you, Paul. Thank you for having me. A couple of things. I think number one, we were looking at -- strategically looking at our Mobility business. And we have been looking at this for several years. The reason that we've been focused on potentially separating from this business are, number one, it's a volatile business. We found that very -- it was very seasonal in nature, dependent on phone introductions every year. We had a very heavy customer concentration in the business. And thirdly, the return on invested capital was unpredictable in the business. And while it was a very capital-intense business, returns were difficult to predict, given the volatility. So as we looked at the business, we saw an opportunity to monetize the business, separate from it. We found the right buyer in AKMM, as they're called, Chinese-based buyer with a commitment to the customer base and to our employees and also able to pay the right kind of price for the business. So we were really pleased with the resulting transaction and the timing of the close, which occurred middle of the month, so -- in April. So very good timing on the close, excellent ability to help us shore up our balance sheet and allow us to both weather the -- whatever might come our way as well as having money available to invest in the business. So excited about that.

Yes. A big change. I think everyone welcomes it, particularly the sort of transition towards higher-margin business and less volatility. But a quick sort of follow-up question. Is there a noncompete element to it? So I'm kind of just thinking down the road a little bit. What if a large mobile handset company says, "Oh, we're bringing everything back stateside, and we're just not doing anything in China anymore." And they came to you, you can't really turn them down, as I imagine in my sort of sense. So what -- I don't even know how that would work out.

So there is a noncompete on the existing products and what is being built today. None of it -- nobody really can predict what will be built tomorrow. I think your scenario is, frankly, highly unlikely in terms of that space. And from our standpoint, again, we would be back into a similar situation with a very capital-intense requirement and a volatile business environment. So really, from a TTM standpoint, this was the right strategic move to make. And yes, they're sure. There are both protections on both sides in terms of short-term competition.

Okay. Got it. But the other sort of collateral sort of outcome is that you sort of -- you had a sort of full in the scale in the high -- very high-volume sort of situation. And now suddenly, you kind of lost a lot of scale, haven't you? And doesn't this also kind of move your way from some of the most leading-edge applications out there?

So from a scale standpoint, we're still in the top 5 in the printed circuit board industry. So our customers are, I think, you can rest assured that we still have a very strong position. And part of what they can rely on is the breadth of technology. So we have not given away the know-how that went with that business. In other words, we have retained know-how on the advanced technology side, to invest as needed for our customer base. And frankly, those needs in the customer base will be much smaller in terms of volume at a lower capital intensity. So we're in very good shape with the advanced technologies that we have retained. And in addition, last summer, we acquired -- that would be i3 asset acquisition. i3 was a company that really held on to the legacy IBM portfolio of technologies. With that asset acquisition, we actually have been able to bring in some high mix, low-volume advanced technology capabilities as well. So we've got a nice spread of advanced technologies that are still resident in the company.

Okay. Got it. We'll come back to the technology a little later, but let's talk about the $550 million, give or take, of cash that you received from this transaction. When do you get it? And what are you going to do with it?

Yes. The when is interesting. So upon close of the transaction, our -- the buyer has applied for -- with the Chinese authorities for the right to convert yuan, the Chinese currency, into dollars and complete the transaction. That's one method. But we have a backstop. So by August 7, if we have not received the dollar-based funds, there are bank guarantees with offshore banks that will kick in and will cover the funding. So we know that on the out -- the outward the longest period of time that it could take us would be until August 7 for the bulk of the transaction proceeds to be received. There's an additional $95 million or so in accounts receivable, which we'll be receiving over time here prior to August. So that will come in regardless, and then the major part of the transaction would come in by August 7.

And then what's the intended use of the cash?

So primary use will be to delever as we -- our first focus will be to delever our balance sheet. We'd like to be -- we've always liked to operate in the 2x kind of regimen or structure. We have an opportunity to get there with the funds that will be received. In addition, if we have needs inside the company, we can also use the capital there. Of course, what this also sets up for us is in a long-term structure is the ability to pursue the right kind of acquisition down the road. But first and foremost, the priority will be delevering.

Which begs the question of what is the right kind of acquisition moving forward then?

Yes. And so as a company, we've spent a lot of time on this. The M&A for us is a process, and so we consistently have an M&A pipeline and have worked that through in the company. Looking at the strategic ties to our direction as a company, where are we going? Well, from a TTM perspective, we have been really pleased with the Anaren acquisition from several years ago. What that brought us in terms of RF capability, the ability to engage with our customers earlier, very early in the design process, provide them with a complete RF solution. Building on that acquisition will be a major priority for the company going forward, both organically and inorganically. In addition, on the commercial side of our business, there should be smaller opportunities that will arise around the RF capability we have as well as storing up our footprint because we have a few holes in terms of prototyping capability, whether that's Europe, Southeast Asia, areas where our customers are, where having the right prototyping capability allows us, again, to engage early with the customer base. So those are a couple of the priority areas that we'll be looking at.

Now in exiting China, you did leave behind a big chunk of business, the electronic manufacturing services business. But now you're also rationalizing that. So can you explain what's going on there? And also with your last comments in mind and I'm thinking, well, don't you need prototyping capabilities over in China as well? And it -- wasn't that done by the E-MS business? So why are you closing that down?

So from a printed circuit board prototyping capability, we're in great shape in China, China and in Hong Kong. We actually have a facility in Hong Kong that does largely quick turn work. But on the E-MS side of the business and again, what really drives this is the tie to our core strategy. When we acquired the business with the acquisition of Viasystems, we made some real efforts to bringing the business in closer to our core printed circuit board capability and have it act as an extension. What we found over time, in automotive, in particular, was that the facility that we have in Shenzhen was undersized for large-scale automotive work. And the domestic customers that we're working with in China to support their prototyping needs were facing their own real challenges from a business standpoint. And so we were not really yielding the returns to TTM, both in terms of financial returns and strategic returns with that facility, and it also was dealing with a very large customer concentration. On top of that, we ran into the tariff challenges. And that's really started early last year. Our customers -- most of our customers, both for the Shanghai facility and Shenzhen are U.S. customers, and for obvious reasons, unwilling and unable to bear the burden of the tariffs. So that started to impact the businesses as well through the course of last year. And finally, for our Shanghai facility, we actually received an expropriation notice from the local government. So that was sort of the final step and, in fact, for TTM in determining that we needed to, at that point, step away from the businesses and move towards closure. We will hold on to our Shanghai backplane business as part of our printed circuit board offering. So that business will remain inside of TTM.

So the reason we're getting a classic view of your house there with the lobby study and so on is because we have COVID-19. And so tell us a little bit about what on earth is happening at the moment? I think that the first quarter you sort of came through reasonably unscathed, but things are starting to look a little bit tricky now. So can you talk about that a little bit, supply chain production and end market demand?

Sure. Sure, yes. Let me -- why don't I start -- I'll start with what we're seeing in the end markets and then talk a little bit about our operations and what we're seeing there. From an end market standpoint, there are really 3 categories, as I think about our markets. And if you start from sort of the weakest side of the scale. Automotive, very weak globally. Commercial aerospace, very weak. Now about 20% of our overall aerospace and defense revenues have traditionally been commercial aerospace. So it remains a small portion of our business, but that has also been weak from a demand standpoint. If you move into sort of the second category, I'd put that at areas that we're watching closely. Computing, really strong right now. But that -- is that -- the question is how long does the strength last? And so we're monitoring that business, both from a data center demand standpoint and also a semiconductor demand standpoint. Still robust, but certainly a market to watch. Medical/industrial/instrumentation for us has been also a very good source of growth. Medical, again, very strong right now. Instrumentation, which for us is primarily semiconductor capital equipment, also has been strong. Industrial has been weak. So another sort of market that we're watching here in the short term, making sure that the demand holds up. And then on the real solid side of the books, I would say aerospace and defense from an end market standpoint, now really, that's the defense side of aerospace and defense, has been strong and solid and visibility is good. Networking/communications with 5G coming and really, if anything, coming -- moving forward, has also a very strong demand profile with it. So that's how we look at the markets. In terms of our operations, and particularly, as we looked at Q1 going into Q2. In the first quarter, our focus was really on our Asia operations and recovering from Chinese New Year, bringing labor back into the facilities and then optimizing. In the -- as we moved into March, the concerns switched to our North America facilities. Now our facilities in North America are deemed essential facilities, so we have remained in operation in our facilities. And we've been wonderfully advantaged in the work that occurred in Asia Pacific around employee protection. So we were very early in bringing over the temperature controls and monitoring and bringing over masking requirements. In fact, we produce our own masks. So have been -- we're alert and I give credit to our operations management team and how they've acted to protect our employees really from the get-go. So we are in operation in North America. But as we look at the second quarter, we're also being careful because, naturally, absentee rates have picked up. We do not know what's going on with the supply chain, and we have a great supply chain and supply partners, and they understand that our work is primarily defense, and so we get the right prioritization. But you never know what will happen in this world. And so we've been careful as we've guided in the second quarter in just taking that into account and the potential impacts on North America production. So that's sort of the whole picture in terms of both demand and supply. I think it's a -- we're doing -- we've done well, we're managing the situation and we're closely watching our markets as we move through the second quarter.

So ordinarily, this would be a bizarre question. But I mean literally, days feel like weeks and weeks like months at the moment. So you only reported last week, but in that last few days, we've seen the first attempt to open up. And has it -- have you seen anything incremental?

I would say we haven't seen anything incremental. And in our North America facilities, we're benefited. And it's again strange thing to say, but as opposed to Asia, where we have high-volume facilities, in North America, we have a number of facilities. So with a high number of facilities, about 14 facilities, they tend to be smaller, where we -- which is helpful with a situation like this, where we're able to work, number one, to protect limited entrances in our facilities. We have a limited number of employees in those facilities. If we do run into a challenge with a COVID situation, we're able to isolate portions of the facility relatively easily and not have an impact on overall North America production, given the high-mix, low-volume nature of most of the work that we do here. So right now, I think we continue to work basically on the -- in the same kind of world we saw earnings.

Right. What is different now with some of the expectations. I think that we were all getting very excited early in sort of late '18 and felt like '19 was the cause, but that we were getting excited about prospects of electric vehicles ticking in. And I think part of the thesis that many of us had was that the industry would kind start to radically change its supply chain as they went from ICEs to EVs because they'd be moving to a different kind of solution set, and that was part of the really sort of bullish thesis. And that feels like it's going -- not just kind of hit a speed bump, it feels like more than that. Have you talked to the auto industry? Sort of what's the latest you're seeing there?

Yes. I agree with the premise. I think the EV -- the move to EV at this point has been trumped by the importance of just getting manufacturing facilities started up again. And so from that standpoint, I think how long term that is in terms of impact? Hard to say. But as we look at, certainly China, as an example, good news there is that facilities, our customers and our customers' customers are back in operation in China, that the government is moving to try to stimulate demand with a leaning towards EV. But I do think there's going to be a general consumer reluctance to move with the stimulus [ situation ]. I think the consumers are -- with the changes that have occurred in the world, it's going to take a while for that consumer demand to come back. And then to pay that kind of premium that's required for an EV, well, maybe they'll hold off on the decisions to do that. But in the meantime, what we're hearing from our customers overall is a lot of caution. I would say a little bit of improvement in China, which everyone is watching. But then European and North American demand really still bottoming out and production facilities largely idle still. So I think we're all staying tuned here to see what happens and how the demand profiles develop through the course of the balance of the year.

You mentioned medical. Of course, people are getting excited about elements of the medical -- med tech space. Is there anything there that can really move the needle for you that if we see massive deployment of testing equipment, for instance, is that something that you participate in?

A lot of work that we are doing today is oriented around ventilators and patient monitoring systems. We have been working with some of the test equipment suppliers as well. When I look at that medical area, that -- certainly, the demand levels are tremendous right now. But I also -- we also look at it sort of with an eye to 2 things. One, there is -- has been an impact on elective surgeries. So while we see some portions of our medical business doing extremely well, we also see some portions of our medical business a little bit soft as, for example, surgical automation or automation of surgeries, a little bit slower than it was or has been. And it has been growing very quickly over time. So it's interesting to see medical overall is strong, but it's largely being driven by that immediate urgent demand that our customers are facing, ventilators and patient monitoring being the 2 critical areas.

When I look across your top 5 customers, we see Apple's going to be fading away pretty quickly for obvious reasons. But Tesla is there. Tesla, I think, very visibly, is awaiting a restart in California and is having some issues over in China. The other 2, which maybe you can just talk about -- maybe you've already -- you had already talked about Tesla by talking about the EV situation. But the other 2 which I'm interested in the Northrop and Raytheon, where I think there's good news happening. So a little bit -- just touching on Tesla, anything you want to say there and then move on to the defense segment.

Yes. No. Like -- I think the Tesla situation reflects the broader situation in automotive. The good news for Tesla is they at least have the Shanghai operation running, right? But like the rest of automotive, we're sort of on hold here in terms of demand. But if you look at the other customers you mentioned, aerospace and defense, we really -- the number one consolidation going on there with -- between Raytheon and Collins or United Technologies, creates an even larger customer, more important customer there. Already important, now even more important. So we're going to be focused on that. And those 2 customers, plus the opportunity we see in the balance of our aerospace and defense customer base is still tremendous. And it's really all about how we can enable those customers as they look at their RF requirements for radar and if they're looking at needs to speed their time to market and also use their own engineering force most effectively. We're in a wonderful position to be an outsourced partner, if you will, for their engineering requirements for RF and RF development and module production. So that's what we're seeing as this industry moves forward and given the demand that our customers are experiencing, that opens up opportunities for TTM to help our customers and to take on more content.

We're all getting quite excited about the idea of your operating margins improving quickly. You, I think, aspire to low double digits, right, 12% to 14% for the overall operating margins and 16% to 18% EBITDA. Things have gone in the wrong direction in the last 2 years. So what's gone wrong? And why is it all suddenly going to go right? Because we really want to know.

Yes. So the -- and yes, we had published those goals in our Analyst Day several years ago. What we experienced last year really was a -- the model was predicated on growth in revenue, and we weren't able to drive the revenue growth. A big part of that was the automotive downdraft that you pointed to. Another piece of it was networking/communications being down as well. But the balance of the business performed well. But we are predicating -- we have predicated that model on growing revenue. The interesting thing is here we are in sort of an opportunity to reset with the sale of the Mobility business, volatile business, generally diluted to operating margins and an E-MS business that has been dilutive to the operating margins. So as we transition out of those businesses, Mobility now out and E-MS transitioning, then you will see, from a couple of standpoints, improvement. One, we are excited to be in markets that are growing from a trending standpoint. They may not be growing short term, but we're involved in the right megatrends in these markets. So returning to longer cycle growth opportunities there in those markets should allow us to improve. Also better transparency from -- to our investors in turn by eliminating the volatility and giving a more predictable run-up as we improve margins. And finally, even the resulting the -- even the margins in this next quarter as we move through the E-MS side of the business, exiting, you will see improvement. So I think you're going to see very visible -- if you look at the pro forma numbers, you're already seeing -- going to be able to see improvement in our margin profile with the businesses we have remaining. And from there, we can grow on an organic basis. We bring that revenue growth back into the picture to improve further.

You've already mentioned that you're intending to bring down the EBITDA -- net debt-to-EBITDA multiple from -- around 2x from -- I think it's about 2.9x exiting the quarter using the cash pay down, which is good. How well prepared are you for this downturn? And then just trying to -- sort of additional question there, which is what happens to working capital if revenues declines -- if demand declines. And some businesses adjacent to you see a sort of positive outcome from a working capital perspective.

Yes. I think we're in great shape. With the Mobility proceeds coming into the business, we'll be able to drive that debt leverage ratio down to really optimal -- an optimal level from a TTM perspective. And what that leaves us with is we like to operate with $150 million or so in terms of working capital. We also will be able to pay down our convert at the end of the year. And so those 2 purposes, coupled with being able to bring that debt ratio down, that's a wonderful position to be in from the standpoint of weathering the storm, as you put it. I think we're in very sound -- we have a very sound balance sheet behind us.

So you'll be paying down the converts at the end of this year? And then next year, if this does persist, which would be a drag, I guess you're going to just watch your cash, make tuck-in acquisitions and then hope that we get to a recovery at some point and then grow. You'll see operating leverage in this business model. And then also, I would have thought that Anaren -- you sounded happy about it earlier on. I guess I'm a little frustrated because I haven't yet seen the margin improvement from Anaren. But I guess they're off a smaller base and with more focus on these defense contracts, that will start to be expressed. Because it had about -- I mean it had a very significantly better margin than that.

Yes. Yes. And one of the reasons -- and you saw it short term, because we -- as we brought in Anaren, you pointed out correctly, Paul. We brought in aerospace and defense portion of Anaren and then the commercial business, which is about $70 million or so of the business that we brought in. With the commercial side of the business, that was our wireless component business and initially doing extremely well. But then we saw the impact of the Huawei export limitations, and so a small portion -- a significant portion of that business was hampered by the situation with Huawei, where we were not able to export out of our Syracuse operation. So you couldn't see the immediate -- the lasting bump-up there. What you're going to see longer-term is as the bookings come in from our aerospace and defense business, that, that will play out in the form of marginal improvement over -- again, as these bookings come in. And I can tell you, one of the reasons we're really excited is that we have been -- and if you look at an overall program backlog in defense, that's $612 million versus $400 million-ish a year ago, that's a huge improvement in terms of bookings profile. A lot of that really has been as a result of our combination with Anaren and the TTM that resulted from that. So yes, you'll start seeing that playing out on the aerospace and defense side of the business for sure.

Okay. I think that's pretty much it for me, Tom. I think we've used up our allotted time. And I very much appreciate you making the time for the JPMorgan TMC Conference today. Thank you so much for participating.

Thank you, Paul. Thank you, everyone, for listening. Appreciate you joining us.

Great. Okay. Thanks so much. Bye, Tom.

Thank you. Bye.