Nortech Systems Incorporated (NSYS) Q4 2014 Earnings Report, Transcript and Summary

Greetings and welcome to the Nortech’s Fourth Quarter 2014 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Paula Graff, Vice President and Chief Financial Officer. Thank you, Miss Graf, you may now begin.

Thank you. Good morning and welcome to Nortech Systems fourth quarter and fiscal 2014 conference call. I’m Paula Graff, Vice President and CFO, and with me is Rich Wasielewski, Nortech’s President and CEO. Following my introduction, Rich will offer comments on our fourth quarter results and fiscal year and some developments in the markets we serve and our industry. Then we’ll open up the call for your questions. Before we begin, please be advised that statements made during this call may be forward-looking and are subject to risk factors and uncertainties. Please see the Safe Harbor statements in our press release and SEC filings. Now, I will turn the call over to Rich Wasielewski. Rich?

Thank you, Paula, and good morning everyone. Yesterday we reported the fourth quarter and 2014 fiscal audit results and our 10-K filings with the SEC. Revenue topped a $112 million in sales for 2014 up slightly from the $111 million in fiscal 2013. Fourth quarter sales were $30.4 million up 4% year-over-year. Our 90 backlog at December 31, 2014 was $17.3 million that was up 7% over the prior year but down 18% from September 30, levels of $20.9 million. The majority of the backlog reduction in the quarter comes from two customers, one, our largest medical customer and the other a medical device company start up that took their first substantial order into the quarter that we ship the first substantial order in the quarter. We are now seeing signs that they will be working down their inventory over the first half of 2015 and it will impact their order patterns going forward. Our gross margins for 2014 were 11.9% a slight improvement of 10 basis points over prior year. The fourth quarter margin was lower by 60 basis points due to the heavy mix of industrial sales and working down that backlog. Operating income was down for the fourth quarter and in the year. The slight increase in gross margin was not enough to offset higher selling and G&A expenses in place to support the anticipated revenue increases in the business development activities. Although we increased nicely from the first quarter 16% in the fourth quarter, the mix and impact of the reduced backlog manufacturing didn’t allow for sufficient leveraging in the quarter. Net income for the year was $880,000 or $0.32 per share up 11% and was positively impacted by a favorable tax rate generated from a state tax audit settlement earlier in the year and a reinstatement of federal R&D tax credit here in the fourth quarter. A couple of items on liquidity. We generated positive operating cash flow in the year of $1.6 million compared with $300,000 in 2013. And we ended the year with $5.1 million in available cash. Our capital spending of $2.2 million was up $1 million over the prior year. Major investments in Mexico PCBA Capabilities, 3D Printers, New Automated Equipment for PCB and cable assemblies cover the majority of the increase. Now I’d like to further break down the revenue by markets and customers. For the year, revenue numbers continue to be mixed across our three key markets. Sales to medical customers rose 17% in the year led by our largest customer and our year-end medical backlog was up 4% the last year. As I mentioned earlier, we’re keeping a close eye on our medical 90-day backlog as they fell 37% from the start of the quarter. Due to the heavy shipments at the end of the year our field intelligence are indicating a potential higher than normal customer inventory requiring some time to sell through. There is no issues with customer issues and satisfaction of performance, it’s just a matter of they felt that they would sell through more in that fourth quarter. Our medical device operations are making progress in both process and performance improvements to meet the higher level requirements of larger medical OEMs. This includes increased supplier controls in quality management systems. We’ve developed quite a specialty niche in several areas, including women’s health technology, urological products and generated to create high temperature steam used to kill tumors and provide test samples. We are also pursuing new businesses in other medical fields utilizing our expertise in helping start up transition to a full scale commercial product. And these start ups are purchased by established companies and we help them successfully transition into the new companies by leading the way in manufacturing. Last month you may have seen the press release where we signed the manufacturing agreement with a new medical technology customer Medovex, who specializes in Facet Joint Pain and Spine treatment. We are building engineering units for them today and help them commercialize their product which will then lead to full production. We continue to actively pursue new medical customers in various stages of their production. Looking ahead, we expect their medical box building PCBA business to continue to grow as new key accounts are brought on board in our existing customer products matured in the market place. Our medical growth in 2014 helped offset lower sales to our defense customers which were down 25% year-over-year. The budget environment for defense is still challenging and we continue to adjust our business model to deal with the lower demand and reduce our economy. We’re encouraged by the news the U.S. defense budget could potentially increase in 2016 with the new performance budget taking effect here in October 2015. Since October, we’ve seen the highest code [ph] activity levels in the past two or three years, specifically in Army training systems, naval missile launches and Air force Pilot systems. We are also carefully watching several new products including the joint light tactical vehicle which is the strong fit for our extensive capabilities with vehicle communication systems like the Humvee. We’re seeing strong recording activities from commercial aviation customers including one of the projects being the Boeing 787 Dreamliner. The key of course is turning these activities in the firm orders and getting involved earlier in the design and engineering projects. Moving over to our industrial sales which is 50% of our overall revenue this finished flat for the year but we did see some momentum at the end of the year registering a 26% sequential increase in revenue over the third quarter with a growing backlog of 30% higher than last year and 80% higher than the beginning of the fourth quarter. The improving U.S. economy has taken hold with our capital equipments OEMs and leading the end of the year recovery here. Our semiconductor capital equipment customer saw a 15% sequential growth from Q4 over Q3, but continued growth expected for 2015. That’s a good sign, a good indicator for Nortech but the semiconductor business is certain to get back to some growth. For process measurement and control equipment manufacturers, the year ends on par with 2013, but we see 2015 starting off stronger and it’s led by metering systems which are up 20% Transportation although ended the year flat that has pent up demand for rail locomotives for example, our largest customers reporting four fold in fourth quarter orders. And the annual backlog rose 40%. Transportation now looks good to be strong for the next several years. Environmental controls saw increases aided by the usual harsh winter in much of the country. We all know control sales are heavily weather dependent. For power systems, we recently awarded a new project that will double our business for the key customer. There is some offset there and we’re receiving our oil and gas customers who have taken a hit lately due to the high inventory levels and the pricing pressures. But overall our traditional and industrial PCB and wire and cable customers are learning more and more about our integrated box built capabilities and designed services and this is a growth part of our selling process along with these OEM capital equipment customers. In addition, across many of our markets, [Indiscernible] continues to be a trend. We’ve recently expanded our Mexico capabilities to include PCBAs which is an important step. We can now offer our full service North America option for several of our locations. And finally this morning I’ll take a brief review of where we see the general economic needs in EMS industrial trends. Looking at the overall U.S. economy, it’s expected to drill a 3.3% rate this year, and with 2.4% last year with manufacturing production rise and 3.7. That bodes well for our OEM customers. Capital spending is predicted to match the 5% hosted in 2014 as you know two drags on capital spending have been the lower energy prices hampering investments and dollars rising overseas rising value. We’re pleased to be outperforming many of our North American peers among the largest companies and they appear with many over $100 million, we saw their year-over-year sales fall. As a group, they were more than down 10% while we were up slightly. We are pleased to be gaining market share in a very competitive environment even with the slight growth we had here in 2014. For the EMS industry and new venture research updated is forecast for 2015 and they now expect North America market to grow at 5.1%. In closing, as we look ahead, the trends are similar to recent years, we’re seeing a little bit of slowness here in the first quarter due to the change in the 9 day backlog, but we expect to gain momentum in the second half of the year. When we look – when we look at the past couple of years, we’ve not seen forecast that grow in our leading indicators such as today. We have the U.S. economy growing; we have capital spending up in the EMS industry as well feels that there is a growth in 2015. So for these reasons we are being cautiously optimistic. As I mentioned, we’re seeing good activity across all our markets to varying degrees depending on projects and customers. We are committed to strengthening our balance sheet and the operations with the right investments, while closely watching our cost structure and matching with the customer demand. Finally, I want to end by acknowledging that 2015 will be Nortech’s 25th anniversary. Our longevity is by no accident. It’s a major accomplishment and testament to all our employees, customers, suppliers and shareholders who believe in us and made it happen. Thanks, and now we look forward to answering any questions you might have this morning. Operator, please open the lines.

[Operator Instructions] Our first question comes from the line of Sheldon [Indiscernible]. Please proceed with your question.

Good morning everybody.

Good morning Sheldon.

You may have covered it, but since we’re going very quickly for the presentation, why was the operating profit weaker in the fourth quarter, what was the principle clauses?

There were, I would believe three issues. Number one is the industrial mix. The industrial mix is generally 50% of our business and with its growth it was 55% in the quarter. So that margin is just generally a little light. The next issue was the rundown of the backlog; it went from $20 million to $17 million. That came out of operations leveraging of our locations. And I think, the third is just the selling and expenses that we built up throughout the year, because we – I'm trying to mention that the first quarter was about $26 million and the fourth quarter was $30 million, so that was 16% increase and that was due to our investments in business development. I think I've been mentioning that throughout the conference calls over probably last two years that this is a growth in a cost strategy that we have in place. And we're investing in that area. And that cost is up. And we did not see it in the total revenue growth, going from 11 to 112 was not enough to offset the investment. I think it was in the $300,000 to $400,000 range. So, we were anticipating higher sales than we got. Is that that correct, Sheldon.

Yes. Thank you.

All right thank you. Thanks for your question.

[Operator Instructions]. Our next question is coming from the line Vincent Rogato [ph] a Private investor. Please proceed with your question.

Good morning, everybody.

Good morning, Vincent.

How are you?

All right.

Good. Could you shed any light on the new contract that was announced I believe a month or so ago?

Yes. That was – you're taking about the Medovex?

Yes.

Medical device, yes, that was a very nice deal for us as we've been in now the medical device business since 2010. And we've been working hard. I think I mentioned to you guys the processes and quality improvements and visiting with our supplier quality in that area, because that takes a whole, whole different quality management system than our industrial and defense business working with the FDA. So, we're real proud of that accomplishments and that were the combination of working with the design staff and also working with the end customer, Medovex. They are up and coming company. They're starting up a division. Their expertise is in the spine treatment area, and they have some ex-management from Medtronic's which is another feather in our hat that they knew us from the past and looked us up. So, all along that entire project is going to pay dividends thus all the way through. So, that dollar wise it's in its early stages. I can throw some numbers out, but those are proformas, but there's not a lot of dollars as we said. We did pick up from engineering a couple of $100,000 in engineering fees and now we're doing a prototypes and taking it into the engineering samples to move into their clinical testing and then in the years – it generally takes between 12 and 18 months go-to-market for these products. So, we probably won't see any majority production until the end of the year here third to fourth quarter and then the full production in 2016.

Okay. In your opinion what would be your strongest segment?

Well, our…

Your bonds revenue growth little potential, I'm sorry…?

Our company has tradition over 60% to 65% industrials that now are about 50% industrial. We were heavy in defense during the wars, up from like 35% to 40% and then in the medical was in the 15% to 20%. So medical now will be 38% this year, industrial will be 50% and I believe aerospace going be 12% -- 12% to 13%. And that's an ideal situation be a third to third to third, but the growth in medical is by design and by strategy. The industrial, its – we do not – when you talk about industrial commercial for us, we don't deal with consumer automotive, communications, we deal with heavy capital equipment on, that's why emphasizing in our call, the capital equipment markets, and they were – they really took a hit and have been lagging since the financial recession here. But we're seeing that come back. I mean, there are 30% from just the – we’re just happy with that return and as long as we can keep growing the medical area, that will serve us well. The last piece of that is that we are to in our – we call it the aerospace and defense segment, but there's only about 10% of that business is aerospace, pure aerospace. We spend way too much time in the defense business during the wars and did migrate enough to the aerospace. So, we're little bit behind the times there and that's going to take some strategic investment.

And I’m from…

I'm sorry.

I assume the medical has the highest margins or am I'm not correct on that?

Yes. They're by far the higher margins and that how depending on the product, but they are definitely in the higher margins. I think if you found companies just in the medical area, you can see between 20% and 35% to 40% depending on the product in the competition. Our industrials can go from 10% to 20% depending on the amount of the quantity, the delivery, the complexity, the box builds they got a lot of material content. We're still in the contract manufacturing business where our value added is engineering and labor, not – although we need to be competitive material wise it's still in those two areas and that's a very competitive market. Defense used to be, it's getting very competitive with lot of capacity out there and lot of pressure from the budget. So, there's no question that we have put our eye on in the investments in medical, first because the segment by itself is growing, the market is growing, and that's where the money is and that's where the gross margin is.

Yes. I mean, and that's what you can control, I mean, I saw the control budgets, government budgets, let me -- last question I'm sorry that I’ve taken so much time, but let me…

No, that’s fine, I'm sure the other callers are interested as well.

The reason I ask, let me get your opinion on your stock like I said, I am an individual investor, so I own about 7,000 shares in total, [indiscernible] for almost two years now. It seems like every time you guys get a spike in price, it gets sold right back down. Last, I believe last quarter November we had nice spike into the [Indiscernible] it comes right back down, what are your thoughts on that? And what you think that is?

Our float is definitely low, that's number one. And we just talked about it for the last few minutes and how 400 shares turned almost 7% in a matter of 400 shares. So, we are lightly traded and that's a big part of it. So, the long term in the fundamentals when I'm selling to investors and talking to investors, I'm selling the long-term and that functionality of us, the foundation that we have. Again, we return $1.22 million roughly 3.5% to 4% return and that's been consistent what we've done. We're trying to add shareholders value for the long-term talking about 8.5 to 8.75 equity market capital, capital value stock versus the 5.50, 5.60 we are today. So, we're under our book value and that is pretty realistic for most of the EMS markets, the public companies.

You consider stock under value?

Of course I would say it's undervalued, but I think we're in for a long haul, I think the fundamentals are very strong. Our balance sheet is relatively strong, it could be stronger, we are carrying a little bit too much inventory, but that's to service our customers. We're not – we're probably average in the industry as far as inventory returns. We've got a great record on receivables in collections, so we're not mainly distressed. We're investing in the right things. I think the investment we've made this year in automation, 3D printers, medical device areas and processes are all building long term shareholders value and that’s what we do here at Nortech.

Okay. I'm just – I'm trying justify reason to holding up 3% growth stock and like I said I got 7,000 shares and sitting in quite a while at this morning's price, I'm probably even now. So alright, I really appreciate your opinion and your feedback?

All right. Well, thanks.

Thank you. There are no additional questions at this time. We will now turn back to Mr. Rich Wasielewski for closing comments.