TTM Technologies, inc (TTMI) FY 2021 Earnings Call Transcript

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TTM Technologies, inc (TTMI -0.35%)
FY 2021 Earnings Call
Nov 30, 2021, 3:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Ana Goshko -- Analyst

Welcome. I'm Ana Goshko, and again, welcome to the Bank of America Still Virtual Leveraged Finance Conference. So we are looking forward to being in-person again next year. But nonetheless, we're thrilled to have TTM Technologies with us today, and Todd Schull, who's the company's Chief Financial Officer. So Todd, thanks so much for joining us. And by way of introduction, I think probably a large part of the audience is pretty familiar with TTM, but I think it's always helpful, you could start by just providing a brief introduction of the company and the end markets that you serve.

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Sure. I'm glad to do that. Thank you. So TTM is a leading global circuit board manufacturer, focusing primarily on high technology applications or circuit board applications. We also manufacture -- design, manufacture and assemble, microwave RF components that are used primarily in the defense and communications industries. We're about $2 billion in revenue and we have operations located in primarily in North America with 17 factories, mostly in the US, we do have one in Toronto and seven facilities that operate in China.

We have a very diverse customers' profile and end market profile, which is kind of unique for us in the industry. We have five significant markets -- end markets that we focus on, led by aerospace and defense, which makes up about a third to, let's call it, 35% of our business. And then we also have automotive. We're a leading manufacturer globally in automotive in the top five producers. And that production volume has grown quite a bit now. We're approaching close to 20% of our business from the automotive end market.

Next up is data center computing. As it sounds, about two-thirds of our business is making high technology application boards that are used by the major cloud companies in running their data centers. So I think AI applications and whatnot. We do not focus on commodity-type products across our end markets. But generally speaking, we're dealing with the high technology applications. That's followed by Medical Industrial Instrumentation, we call it MII, about a third each in those end markets or submarkets. And that's representing about 20% of our business also. So that's been growing rather nicely. And then finally, we have networking and communications. About two-thirds of that end market is networking, which is a fairly mature end market. We're very well established with kind of a who's who customer list. And then the other third is telecom, which is really for us, focus on wireless 5G. And that's an end market that has been pretty soft for a couple of years, but it's starting to gain traction now and is looking at some good growth prospects as we go over the next few years.

So that's just a quick overview. Again, a significant player in the industry, focusing on high technology applications. That's how we differentiate ourselves and with a very diverse customer set.

Questions and Answers:

Ana Goshko -- Bank of America Securities -- Analyst

Okay. Great. Thanks so much for that introduction. Super helpful. So given how topical supply chain issues and constraints, cost inflation and labor issues are right now, let's start with that and a discussion of how TTM is navigating the environment. And then we can broaden the discussion out to some bigger picture topics of the company. But -- so how are the impacts from supply chain, inflationary points, logistics and labor issues impacting your revenue and your P&L?

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Yes, that's a big topic. If you kind of cast a broad definition of supply chain, you're not only dealing with our vendors and suppliers, we're also dealing with logistics, transportation and freight and how do you get things to different places as well as our customers supply chain challenges. We're just one component supplier to our customers, they have many. And so we get impacted somewhat by their -- in terms of what they can get and other complementary components to build an end product that they can sell. So we see those challenges. And then you mentioned labor. That's also a challenge, particularly in North America, not so much in Asia. And that's finding enough workers is putting some constraints on the business. So if you -- I'll finish with that first in terms of just talking about the labor situation in North America. Just can't get enough workers. Our utilization last quarter was 50%. We can -- we should be in the 60% to 65%. The difference, we need more workers. So being able to find enough labor to actually produce a product in North America has been a challenge, was significant in Q3. COVID was part of it. We lost some employees to quarantines and so forth, but they're back. But just finding enough labor is a challenge.

Ana Goshko -- Bank of America Securities -- Analyst

Can I ask you a question on that. So how qualified is the labor that you're looking for? I mean, what is the nature of the labor that you're...

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Generally, direct labors. Operators that we train. Okay? We do have some equipment operators that are more technical. And so if you hire a little more highly skilled labor. But generally speaking, we're working for direct labor operators to run our equipment to build the product.

Ana Goshko -- Bank of America Securities -- Analyst

Did you lose labor and why? I mean, have there been resignations?

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Certainly, we have [Technical Issues] and that's certainly an issue that you see, particularly, I think it's been pretty intense the last few months. You've probably read articles about people are moving and switching jobs and looking to upgrade, and wage inflation plays a role in that and you see some of that going on. And we've certainly been experiencing that like other manufacturers in the US.

Ana Goshko -- Bank of America Securities -- Analyst

Okay. Sorry for the interruption. You can...

Todd B. Schull -- Executive Vice President and Chief Financial Officer

That's fine. It's a real -- it's a topic that I think a lot of people are trying to understand better. In terms of our supply chain and dealing with our suppliers, we've been pretty good in being able to get sufficient supply. There are constraints. Copper foil is an important raw material that goes into -- we buy some of that directly, but primarily, it goes into the manufacturer of laminate, which is the critical raw material that we use to fabricate circuit boards. And that has had some supply challenges because copper foil is also used in batteries for EVs, and that market has been growing rather rapidly on a global basis. And so there's been some capacity challenges in that end market, which is serving to drive up price as well as cause some capacity constraints.

And then as you migrate into the laminate raw material, which is really the key for us, we're seeing price increases from copper. You're also seeing a strong demand environment across all of our end markets and that's true for us than our competitors. So it's putting some capacity challenges on the laminate suppliers. The bulk of which come out of China, but there are some important laminate suppliers that we get material from here in North America. So those supply challenges create pricing challenges. We're doing a good job managing the supply challenges, being nimble on our feet, adjusting where we need to, to be able to get product to satisfy our customers, but the pricing challenges have been pretty difficult and painful.

We've worked hard to manage through those, primarily with two-pronged attack. One is trying to get price increases to our customers and to have them understand the cost environment that we're dealing with. And we've been -- had a fair good success there that they get it. They understand the environment. And the second is, as we work really hard on various cost reduction initiatives as a company anyways. Things like yield improvement, which profit then goes straight to the bottom line, in this case, helps to mitigate cost increases that we're seeing in some of our raw materials as well as other productivity initiatives. Then you add on top of that the whole logistics challenge. So not only is freight very much more expensive now, the lead times and the transit times are substantial. We've gone through -- historically, we were six weeks to ship from China to Europe or China to America. Those cycled -- our transit times now are double to 12 weeks. So that causes naturally an increase in your inventory level, because you got more inventory on the water and you're working through challenges to manage that. So the supply chain picture is coming at us from multiple directions. And I think our team has done a really good job managing through that. Certainly, we've been impacted from our profitability, but not overly so. We're still delivering pretty good numbers. And then they've worked really hard to accomplish this. So I'm really proud of the team.

Ana Goshko -- Bank of America Securities -- Analyst

Okay. So thank you. So a few follow-ups on those points. So you did cite some production inefficiencies, I think that's something that you talked about on your last earnings call as well as capacity constraints in North America and in China. Is that largely a result of the labor shortages or kind of raw materials constraints or is there something else going on? And if you can give us a status update as to if those issues are still persisting with regard to the capacity constraints?

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Yes. So as I mentioned -- I think I mentioned, but our utilization in North America was only 50% last quarter in Q3. Typically, we'd like to run it in the 60% to 65% range. We have the equipment. The challenge was getting -- and we have the demand. The challenge is getting sufficient labor to [Technical Issues].

Ana Goshko -- Bank of America Securities -- Analyst

Got it. Okay.

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Played a role in that. The Delta variant reared its head in August and September, and that was pretty impactful. And the inefficiencies, just to give you an example. So a person might get sick. They discover they're sick, but they've been at work for a couple of days. And all of a sudden now their symptoms manifest. Then we have to shut down a whole section, all the people that they came in contact with, working in a department or a certain area of our manufacturing process. We got to quarantine him. They have to test back in. We do this to protect the rest of the population in our factories. And knock on wood, we've been very fortunate that we've had minimal cases actually transmitted at work. And that's I think a testament to us being very careful, but that creates an inhibition. You may only be down for a day or two, but that's an inefficiency. And so it eats into your capacity a little at a time. And that was really a big issue in August and September and was contributed to the challenges we had in the quarter. And then ongoing, we just need more labor on top of that to be able to fulfill up our factories and to run them fully. And that's an ongoing challenge and will be for a while I think. We're not unique there. I think a lot of manufacturers are running to those kind of challenges, but it's one that we're continuing to work with.

Ana Goshko -- Bank of America Securities -- Analyst

Okay. And that's equal in both China and North America?

Todd B. Schull -- Executive Vice President and Chief Financial Officer

No, that's primarily a North America comment. China, if you go all the way back to COVID, really has COVID under control and is really not a big issue there. So we're able to get the labor that we need to produce in China. China's utilization levels there last quarter were I think 90% or 91%, which is very high. We had some electricity outages, the government [Technical Issues] electricity, you heard probably a little bit about that. We got hit with a little bit right at the end of Q3 and at the very beginning of Q4, but our expectations, as we said in our earnings call were that we thought that that would be too bad for us that we've kind of gotten through the worst of it, hadn't really impacted us significantly. And knock on wood, hopefully, that will stay that way for the rest of the quarter.

Ana Goshko -- Bank of America Securities -- Analyst

Okay. Great. So can you just describe -- well, first of all, your current backlog, what's that like relative to normal levels?

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Very high. It's a nice problem to have. Demand picture is excellent really. Obviously, it's soft in commercial aero, which is a submarket of our A&D market for reasons that everybody understands. And the telecom piece is a little softer for us given the China rollout is slower than expected. But the rest of the markets that we're supporting are all doing really well. So that creates a really good demand picture for us. And so what we're working then is to try to do our best to meet that demand and that is an ongoing challenge. We talked about that in the different end markets.

Ana Goshko -- Bank of America Securities -- Analyst

Okay. And then could you describe the nature of your customer contracts and then your ability to pass-through any higher cost to your customers?

Todd B. Schull -- Executive Vice President and Chief Financial Officer

So our business is about 50-50. 50% is kind of under contracts and the other 50% is what I'll call more transactional. We live purchase order to purchase order. So when costs change on that 50%, that's more purchase order-driven. It's quick and easy for us to adjust pricing for the next order. So we're able to pass those costs along pretty quickly. And the -- when we have contracts in place, most of our contracts do not have escalation clauses built into them. So it becomes a negotiation. We present a situation to the customers and we go through that back and forth process of negotiation and we come to our pricing agreements for the next period. Some of them are six months, some of them are a year and we work through that. And this unique environment over the last year with the rapid increases in costs, we've gone to customers even under contract and said, hey, we've got to find a solution here. And we've been able to work out in many cases, ways around that or ways to supplement that effectively act as a price increase, although officially, it might be a surcharge or a premium or some other kind of you call it whatever you call it, effectively it's a price increase. But those take more time because it involves a lot more negotiation.

Ana Goshko -- Bank of America Securities -- Analyst

Okay. So if we pull this all together, and I know this is not an easy question, but from your vantage point, how long do you estimate it will take you to get through the bulk of these constraints? And I guess, labor is -- that's a tough one. I understand that, but...

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Yes. it's hard to see too far down the road. I mean, if you talk the broader picture, semiconductor, chips and those kinds of things, had lots of announcements of people that are going to build plants. I think Samsung just come out with announcement last week. But those take time. I mean, that's not going to help us next month. That's going to take -- fabs take one to two years to put up. So I think you're going to see some gradual progress on that front during 2022. That's an opinion. And then as new fabs come online late in the year or in '23, then I think you'll start to see some real significant relief.

On the labor side, I think that's a complicated picture in North America. People have tried to come up with or understand why workers are not coming back into the workforce, the way they have in past recoveries. And so there's a lot of speculation as the reasons. But hopefully, as the virus gets controlled, and I know we've got another variant coming around, but as people get more comfortable and as we learn to deal with that, workers will come back in the workforce. And that's going to be important for us to be able to tap into it. We're also working on automation opportunities to try to reduce our demand for new workers and as well as incentives to people to get their friends to come join us. I mean, we're doing the same things that everybody are to try to improve the labor force. But I still think that's going to take a while to work through.

And then as far as raw materials go, we're seeing a slowing in the rate of increase, which is encouraging. We need to hit stabilization. We can hit stabilization and that's going to be an opportunity for us then to kind of catch-up and get back where we normally would be in our financial models. So that I think has started, but we're not there yet. It's going to take a little bit more time.

Ana Goshko -- Bank of America Securities -- Analyst

Okay. Okay, great. I also wanted to remind the audience that feel free to send me any questions. If you're watching through the conference, there's a place to message me and you can also -- that's probably the best way to -- and you can also email me if you have my email. But I think if you're watching through the conference site, you can just use the tool, and I'll watch for those. So I think -- so let's talk more about the growth outlook. So for those watching, slides have been posted. And my favorite slide because I think it really sums up the business nicely is -- it would be Slide 13. So it's end market, growth drivers and outlook. So could you talk about just relative growth rates? So if we think about the next one to three years, how might we see sort of the proportion of your end market shifting? And obviously, you have aerospace and defense 35% plus right now as a percent of your revenue, how is that going to look one to three years from now? And then as part of your discussion, could you just highlight what are the growth drivers that you're most excited about?

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Sure. Aerospace and defense is our largest and are in a market that we're very happy to be involved with. And in fact, we would like to grow our presence there. You can see the five year CAGR there growth rate of 2% to 4%. The last several years we've grown in the high-single-digits, so well above that rate. We're going to be a little bit below this year, primarily because of the labor constraints we talked about and the soft commercial aero market, which is kind of bouncing along the floor right now, waiting for more planes to be put into service. But that's an area that we want to continue to grow.

We have a lot of capabilities that make us very competitive and attractive in that space. So we compete very well. We have a long history there, more than 50 years. We have relationships with all the major primes. And that's an area that we just feel is a good long-term market, good visibility, gives us consistency of business. So then -- and ultimately, we'd be comfortable in driving that up to 50%. However, I think from -- to get to that level, we would need an acquisition of some sort to kind of leapfrog it up. Everything that I was showing on Slide 13 is organic. So assuming organic, you can kind of see how the mix of business. Now automotive jumped up to close to, I have to put on my glass as I memorize all my numbers here...

Ana Goshko -- Bank of America Securities -- Analyst

Like 13% now.

Todd B. Schull -- Executive Vice President and Chief Financial Officer

It's up to 18% last quarter. So it's already had a big increase year-over-year. We're well above that 3% to 6%. I think year-over-year, in Q3, we grew 57%. And what we're seeing there that's really attractive to us is the electronic content. The cars have more features and those features are generally electronic-based and electronics start with the circuit board. So this is a great opportunity for us. And also the increase in electric vehicles is also a phenomenon that's going to be very constructive to our business in the automotive end market. So there's some nice, what I call -- we call macro trends that are very constructive to us in that business.

And then frankly, in the last couple of years, we've won some market share. So that's helped to drive some growth that we're seeing this year in the face of component shortages by our end customers. So even with that, we're still having some very smart growth year-over-year. That's a business that's going to continue to grow 3% to 6%. You're above it this year. But at that growth rate, that's a big number because we're one of the top five global producers there already. So you're working off a pretty sizable denominator in order to be able to drive that kind of growth. So that's very encouraging.

You see data center computing, it's close to that 13%, 14%. Staying pretty consistent there, but growing nice -- they grew 29% year-over-year. So that's a market that's very attractive to us. And it's really driven by the cloud. That's two-thirds of the business in that end market. And we're not talking to white box servers. We're talking AI applications, management systems and servers, very complex boards that play to our strength, which is a differentiated where our focus on the tough stuff. Leading-edge technology are very complex and a hard to build products. That's where we specialize.

We can see that continuing to grow as that end market is having strong growth rates. So I think last quarter when we looked at our Q3, we were up 29% year-over-year in Q3 in that end market. Then you come down to medical, industrial, instrumentation, a very fragmented market. We've probably got 1,000 customers in that end market. It tends to be low volume, high mix business. There are some exceptions, but generally, that's the rule. It's a good business for North America because of that business model. High volume stuff tends to go to our Asian facilities where it's more cost sensitive. But focusing on patient monitoring, the aging demographics of a lot of the western world is driving a lot in the way of medical.

In the instrumentation end market, we tend to be overly weighted to our semiconductor capex, particularly test capex. That's been a very good market. And given what we've heard about new factories coming online, new fabs coming online that will be -- continue to be an attractive end market for us. 2% to 4% is kind of an average, but we were well above it last year and we're above it again this year. It's just growing really nice. All three subsegments are doing pretty well.

And then networking communications. This one now right now is closer to 15% of our business, primarily on the softness in telecom. You can see the 5% to 8% growth rate there for the next five years, that's going to be driven by the 5G rollout. Networking is relatively stable, slow growth at this point. Short-term, it's overweighted to China, which is a difficult market right now and not quite as robust as was expected. But the rest of the world is coming. We're seeing it starting to ramp and that's going to be really good, and that will drive the growth here in the next few years.

So encouraging markets. You can do the math and kind of figure out where you think how things would happen organically. But automotive would stay pretty strong. And you're kind of 40-20 and medical at 20 and data center and the other two are kind of in that 15-15 range, is probably how you see the mix of the business. Nice diversification. Oftentimes, you have a couple of markets that may be struggling and some that are doing really well, as you can kind of see this year, and that helps to give us some stability in the business.

Ana Goshko -- Bank of America Securities -- Analyst

Okay. Thank you. So we had an audience question on something I had on my list anyway, but it's on M&A. So what is your desire for inorganic growth through acquisitions?

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Sure. That's been an important tool for us historically. We have been an acquisitive company. We often acquire companies for access to certain markets or particularly for certain -- to get technology. And you can kind of -- in our slide deck, there's a timeline in the appendix, I think you can look at it in your leisure. It kind of gives you our history. So we do that. What we're interested in right now is we've positioned ourselves, we have a very good balance sheet right now. Our debt leverage ratio is very low at 1.4 times on a net debt basis. Our target range is 1.5 times to 2.0 times. So we're actually below our target range. But we've historically done a key acquisition, levered up as high as 3.5 to 4 times with a clear path to drive that back down within two to three years and we've done that very successfully over our last two significant acquisitions.

What we're in the market for our appetite. We would like to continue to expand our presence in the A&D market, particularly in RF capabilities, leveraging and building upon what we acquired in the Anaren acquisition back in 2018 and adding more engineering skills and content and services to develop product and to support our customers. These are higher value-add opportunities and would be an improvement to the financial model too that way. So that's probably highest on our shopping list. Second would be our -- we have an RF and specialty components business that tends to sell in the commercial markets, primarily telecom and we have IT there. And so it's a small business. It separately broke out as a segment in our financials, so you can see that. But very good profit margins and that's something we would love to try to add to our portfolio of products there.

In the PCB business, our core business, we're really pretty happy with what we have. Two things that we'd like to do. One is to establish a Southeast Asia manufacturing capability to complement what we have in China and North America. Our customers are pushing for that. They like diversification in their supply chain, makes sense, and we like to try to help our customers out with it. The other would be a small prototyping capability in Europe so that we could support our customers' engineers in that market. That tends to be a more time-sensitive, quick turn, need to be in close relationship with engineers and so we'd like to do that. Both of those PCB opportunities are likely done from cash flow from operations. However, if we were to do a significant M&A, that's where we probably have to come back to the debt market at least to help finance that and as we have in the last two significant acquisitions.

Ana Goshko -- Bank of America Securities -- Analyst

Okay. That's super helpful. And we have only a few minutes left, so any more questions. This has been super interesting and I think it was important to spend so much time on supply chain given how topical and important that is. But as it is a debt conference, you did talk about your current leverage or leverage target, but it does sound like you've done in the past, you'd be willing to take that up for the right acquisition. Have you talked to the credit rating agencies or do you have a good sense of how patient they would be with kind of a levering transaction than is -- especially if you were able to sort of outline the cash to delivering again?

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Right. So the first time we did it in 2015, it was a hard sell. The second time in 2018, it was much easier, because we did what we said. We were committed to delivering and fulfilling our commitments to the debt community and did a good job with that. And we did the same again with Anaren. So I think we've got a pretty good track record now. We recently -- well, within the last year, late last year, Moody's upgraded us as I think they were kind of the last to appreciate that our business model has changed. We're much more consistent in our earnings and in our cash flow generation and that we are very consistent in terms of how we want to manage the balance sheet and what kind of leverage we want to maintain. We're good for our word. And so I think I don't anticipate that. I think they understand our business model and our willingness to look at acquisitions. But when we increase levers like that, it's always we have a clear path to how we're going to get back down. It's not we're jumping up here and we'll just see how it goes. So we are very focused on doing that. And I think we've demonstrated that the last two times and we've been very communicative with the rating agencies about that. So I think they understand us and I think they've rated us accordingly.

Ana Goshko -- Bank of America Securities -- Analyst

Okay, great. So for a credit conference, I think that was a great final point to make. Again, we're out of time, but this has been super interesting. I really enjoyed this session. And Todd, thank you so much for being with us. And I really hope that the next time I see you will be soon and in-person.

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Let's hope for that. Thanks, Ana.

Ana Goshko -- Bank of America Securities -- Analyst

Okay. Thank you very much.

Duration: 31 minutes

Call participants:

Todd B. Schull -- Executive Vice President and Chief Financial Officer

Ana Goshko -- Bank of America Securities -- Analyst

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