Nortech Systems Incorporated (NSYS) Q1 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to Nortech's First Quarter 2018 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, Connie Beck, VP & CFO.

Thank you. Good morning, and welcome everyone to Nortech Systems' first quarter 2018 conference call. With me today is our President and CEO, Rich Wasielewski. I'm going to start today's call by going over our financial results which we released on Friday morning. Then I'll turn it over to Rich for additional comments on the first quarter results and last week's annual shareholder meeting. Finally, we'll open it up for questions. At the annual meeting all of the proposals up for shareholder vote-past including the slates of Directors by approximately 90% of the vote. Further details will be in our 8-K filing. Before I continue, please note that the statements made during this call and Q&A session may be forward-looking regarding expected revenue, earnings, future plans, opportunities, and other Company expectations. These estimates, plans, and other forward-looking statements involve known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied on this call. These risks include those that are detailed in our most recent Annual Report in Form 10-K and may be amended or supplemented. The statements made during this conference call are based upon information known to Nortech as of the date and time of this call. We assume no obligation to update the information in today's call. You can find Nortech's complete Safe Harbor statements in our SEC filings. Turning to our first quarter results. Our first quarter 2018 net sales as reported were $26.4 million, which compares to $28.3 million for the first quarter of 2017, a decline of $1.9 million or 7%. Our first quarter 2018 net sales include approximately $700,000 of additional revenue recognized due to our adoption of new FASB accounting standards this fiscal year. Under the new standards, revenues recognized when the customer obtains control of the product or service. Based on the nature of the contract manufacturing and services we provide to our customers, a substantial portion of our revenue is now recognized overtime concurrent with the performance of the manufacturing or service rather than the historical method of recognizing revenue at a point in time upon completion or shipment. Our prior year reported amounts were not required to be restated to be comparable. Our Form 10-Q includes more details and disclosures. On a pro forma basis, our first quarter net sales were $25.7 million, this is a $200,000 sequential increase from the fourth quarter of 2017. In the year-over-year comparisons, our revenue results vary by market. Medical sales decreased by $3.5 million or 26%, the decline was evenly split between custom medical component products and medical devices. Industrial sales rose slightly up $200,000, aerospace and defense sales increased by $1.5 million or 45%. At March 31, 2018 our 90-day shipment backlog was $21.9 million, this is up 13% from the beginning of the quarter. Medical backlog climbed over 50% sequentially from the fourth quarter as several large medical customers began working through their on-hand inventory level. Aerospace and defense backlog increased 5% sequentially and industrial backlog increased 12% sequentially, primarily from reduced orders from our semiconductor capital equipment and transportation customers. Our gross margin percentage for the first quarter of 2018 was 11.5%, up 60 basis points from the prior year first quarter and up over 300 basis points from the 8.4% gross margin in the fourth quarter of 2017. Because of new revenue recognition policies, we've recognized $1 million of revenue related to non-cash consideration which is recorded at zero margin. This impacted our gross margin negatively by over 40 basis points. The year-over-year gross margin improvement resulted from product mix, increased plant utilization, and getting our costs in line with current demand levels. Our selling expense for the first quarter was $1 million or 3.8% of sales versus $1.2 million or 4.3% of sales for the prior year period. G&A expenses were consistent at $2.1 million or approximately 8% of sales for the first quarter of 2018 and 2017. Our first quarter operating profit comparisons are impacted by one-time gain of $354,000 in the first quarter of 2017 from the sale of our Augusta Wisconsin facility last year. When you exclude this one-time gain from the sale, our operating loss in the first quarter of 2017 would have been $233,000. This would compare with an operating loss of $120,000 we reported in the first quarter of 2018. This represents an improvement of $113,000 in operating profit and $2.6 million lessened revenue on a pro forma basis. Despite an operating loss, we incurred tax expense because of our foreign operations and related minimum taxes generated from the recently enacted U.S. Tax Reform. As a result, we reported a net loss of $391,000 or $0.14 per share compared to a loss of $15,000 or $0.01 per share for the prior year period. Moving onto the balance sheet; our liquidity comes from operational cash flow and a credit facility with Bank of America Merrill Lynch of upto $21 million for working capital and equipment term loans with an additional $20 million accordion option in place to fund potential growth opportunities or expansions, new R&D and technology activities, and strategic acquisitions. Cash provided by operations was $542,000 for the first quarter compared with $255,000 of cash used in the first quarter of 2017. Cash flows were positively impacted by the non-cash add-back of depreciation and amortization along with the increased crude liabilities, decreased inventory and contract assets. This was partially offset by an increase in accounts receivable. We ended the first quarter with $3.9 million available on our line of credit, this compares to $4.2 million at the end of the fourth quarter. As we mentioned in our March call, our ability to react to early indicator and backlog tracking at the end of 2017 has enabled us to minimize the profitability impact in Q4 and Q1 by focusing on cost and cash management. This concludes my financial overview. I'll turn it over to Rich for his comments.

Thanks, Connie. Good morning, everyone. It's hard to believe that it's been six weeks since our March 20th year end conference call, and here now we're almost halfway through the 2018 year. Summarizing our first quarter results, our Q1 revenue was on-par with expectations. Industrial sales are up slightly aided by the improving economy. Our industrial sales historically tracked with the economy and EMS industry. Defense sales rose 45% in the quarter from strong defense spending and new programs. The 26% decline in medical revenue year-over-year related to customer on-hand inventory; inventory corrections started in the fourth quarter of last year and has slowly but steadily worked through the buildup, evidenced by our medical backlog rising over 50% since the start of the year. Gross profits, operating income, cash; are heading in the right direction as is our overall backlog, up 13% from the beginning of the year. With the cost adjustments and an increase in revenue, we expect return to profitability in the second half of this year. To initiate growth in 2018, there has been a renewed focus on sales and marketing. Internally, branding, lead-gen, sales coverage, account performance and product support all have been revitalized with goals and tracking metrics. The macro economy and EMS industries are both currently trending favorable for 2018. The medical EMS market offers the strongest growth outlook with 7% compounded annual growth expected. For the EMS industry overall, new venture research forecast is 5% growth in 2018 for Americas. In U.S. economy is improving it's 2018 outlook. Now closer to 3% GDP growth forecasted for the whole year along with increasing DoD budgets projected for the next several years. Our actions in the current trends have us optimistic, but 2018 isn't without these challenges. The two main concerns we faced today are electronic component shortages and all types of talent shortages, technical and manufacturing. We have action plans and initiatives underway for both; we are communicating with our supply chain and sources daily and working through the issues with our customers as well. And in the talent front; internships, apprenticeships and certification programs are all underway on the people side in addition to employees training and development. Longer term, increased investments and systems support and automation will complement these efforts. Connie mentioned last week we had our annual meeting here at our Maple Grow [ph] Minnesota Corporate Offices. We shared our 2020 vision for increasing shareholder value by continuing to transform Nortech through globalization, growing our medical market, evolving our traditional contract manufacturing business to provide increased value, and building an innovative and R&D culture. We highlighted our investments in operations, automations and facilities and discussed profitability coming off our 2017 results. Sustainable profit for us in our EMS industry requires consistent topline growth in operational execution. We've consistently executed at a high operating level but our quarter volatility has been a major factor in our profitability. Our sales and marketing efforts the focused on lead-gen and growing the pipeline. Topline growth is the key to smoothing out the quarterly volatility. We also recognized the service of two outstanding long tenure Directors that retired this year from our Board; Richard Perkins and Ken Larson. Perk has been a Director for 25 years and made a huge impact on Nortech's growth and development. In 2012, his Board service earned him recognition for Lifetime Achievement by Twin Cities business. Perk's Board services spanned 20 companies over three decades; Nortech was fortunate to have one of the longest tenure Board assignments. Ken Larson put in an impressive 16 years of Board of Directors service with Nortech. After leading a strong growth at Polaris as President and Chief Executive Officer, Ken received recognition from Twin Cities as an outstanding Board of Directors. Nortech will miss both of these fine gentlemen. Taking their place are two new Directors, who both bring strong credentials, Jay Miller brings us a broad background in medical technology companies, both as an executive and a board member. Dr. Steven Rosenstone, is the Former Chancellor of Minnesota State Colleges and Universities, bringing us strong academic awareness and HR experience, needed to attract the right talent in addition to his business support over the years. With their addition, our Board has evolved significantly, welcoming all new members over the past three years. Also, I should mention, today is Bill Murray's last day as a board member. His seat will be discussed in the August meeting. He has taken a position that will no longer allow him to be a board member for Nortech. In addition to the Board, there has been a considerable amount of change at Nortech with our personnel, operations, markets and growth opportunities these past several years. Collectively, it is providing momentum that gives us optimism and a bright future. We further emphasized our strategies are in place, including the global footprint, medical market presence and value-added engineering services. We need to build on these strategies, delivering a return on our investments in our other [ph] plans. We reinforced to our shareholders, that's our commitment and responsibility. That concludes our remarks this morning. We'll now open it up for questions. Operator, please open the lines.

[Operator Instructions] Our first question comes from the line of Sheldon Grodsky from Grodsky & Associates.

Can you make any comments on how your young Chinese operation is doing?

We did make a comment I believe at the last conference call and at the annual meeting. It's been a real winner for us, it's paid back on a cash flow basis in it's second year. The ability to move product and do it at per unit contribution as opposed to gross margin percentage has really paid off. Everybody wins that way but the customer wins for the lower costs that are associated with it and we win both dollar-wise and percentage-wise. But I would say that we did approximately 3% of our sales there last year and this year it could be in the 5% and 6% range.

Has there been any issues regarding the trade friction as far as the Chinese operation is concerned?

Well, that's yet to be played out. As far as our situation is that, everything we do in China is for the China market, it would have more impact on our OEMs sending back to the United States, which -- given the two OEMs that -- two or three OEMs that we currently are dealing with global OEMs, they are making things in North America for North America concept; so it will be more than not consumption. So it would be NAFTA that will be more of an issue in North America but in Asia, most of the stuff that we're making for the OEMs is going either to Europe or India or the Asian markets itself. So I don't believe that that will be a big issue in the near future; I think how it affects the local markets there dealing with United States will have a bigger impact.

[Operator Instructions] Our next question comes from the line of Sam Robotski [ph] from SCR Asset Management.

I'm new to Nortech, so excuse me if I ask questions that -- to educate me a little better. The first half, you talk about being profitable in the second half and I assume you expect to be profitable for the year. And as far as the coming quarter, is that looked like that might be the second quarter to be profitable too or…

Well, it is. The trends with the backlog bode well for the second quarter. The question is on the shortages and whether or not we can get everything that we have on the books out of the door. It's going to be close but again, we don't -- generally Sam gives out earnings, we give out our expectations and it probably be more like the third and fourth quarter before profitability comes to bear.

But for the whole year you expect to be profitable after the first half?

Yes, I believe that's what we're expecting but that's a long way right now, it's definitely the third and fourth quarter is looking promising. Is it going to offset the first and second quarter, it's too early to tell.

And as far as the shortage of product to complete, how much inventory -- your inventory is down from December to March but -- or you can -- is there a certain proportion of inventory you carried that you're concerned about being to complete and ship out? And in essence, if you had all the parts that you needed to ship the inventory and make the product you need to make, what would be normal inventory for you to carry?

You know, the shortages are not having that bigger impact on the inventory at this point. We got to -- we all have to careful and the industry don't start affording [ph] shortage parts, that's one thing I know the distributors and the manufacturers are concerned about. We just need to get good forecasts out there and hold steady and we're working closely again with our customers to make sure that we don't inflate those numbers across the Board. I think it's easier for me to say that in April, our sales were impacted between $250,000 and $500,000 by part shortages, and I think that's the first elbow we've been having about three quarters of problems with shortages, it hasn't impacted us as much as it did in April. So it did jump up and made me talk to you guys a little bit about it today to show that there is some risk. I think it's just a matter of upside for us at this point because we're -- our backlog is going up and again, the impact will be felt on the upside, and if we don't have any problems -- we're going to have problems in shortages, that is globalized right now. The manufacturers are refusing to increase capacity and it's going to be something give and take every month. So how soon we return to profitability, that's why I'm hedging a little bit to get out there past what we already think we can do.

And when I looked at the 10-Q that was filed, it indicated that you brought some stock; was these in the open market or any private transactions? And do you expect to increase your buying of the stock as the stock is well within at the time you bought the stock?

Yes, it's under a plan. Connie, is it the 13D plan that we've put out there?

Yes.

And it's all controlled by the plan and it's also been reported out there. So if you look up the reporting documents, you will see that that's all planned. We have no control over this, we have an upside on price that can be changed but we have not changed it since it's inception.

My understanding is that was $250,000 that would buy and you've completed not all of it but significant portion; do you expect to increase that size? Is that…

Yes. The expectation is to get approval and keep doing it at about $250,000 a year.

A year?

Yes.

So if you complete that before the end of the year, you will wait to the next year to buy stock?

It's not on a calendar basis, I think we just finished it in March -- June 30 was the end of the year, 12 months; so we start up again in July.

So there was no private transaction, it was all public?

That's correct; it was all public, all planned.

And you spoke of the questions that took place at the annual meeting on May 9; is there -- and how long did the meeting last? Do you have some kind of summary of what transpired to share?

I pretty much presented that today in summary. We have our -- we start off, Connie goes through the business -- official business plan and the voting recap, see if anybody else had anything else to say. We closed the business, I did a recap pretty much verbatim of what I gave you today; and then we recognized the Board as well. There was -- we have had special guests over the last five years, we've had -- in the last five years we've had our number one employee who is the Maggie [ph] and she is retiring this year that started 38-years ago working associated with Nortech, then there was a distributor that came in on a supply chain which would have been a good one for this year given the electronics components, probably Professor Hoy [ph] from Nextera [ph] presented at one of our programs, we had an international flavor to our annual meeting last year and this year being that we had a new service from Bank of America, we invited Bank of America just to discuss the current trends and global situation going out there and the economy. So that's pretty much what we did at the meeting and took some questions, and I pretty much answered the questions that were brought up at the meeting.

I'm trying to understand more about your company; where it's going and sort of get more familiar.

Feel free to give me a call.

Thank you very much. And good luck, hopefully you could ship and bill all your orders and be profitable.

We're working on it, Sam. Thanks for your questions.

There are no more questions at this time. I'd now like to turn the call back to management.

If there are no further questions, we'll conclude this call. Thanks for joining us today and your interest in Nortech. We look forward to updating you in the future. Have a great day, everyone.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.