Nortech Systems Inc (NSYS) 2009 Q1 法說會逐字稿

Good morning and welcome to Nortech's 2009 first-quarter conference call. I am Rich Wasielewski, Vice President and CFO. With me today is Nortech's President and CEO, Mike Degen.

Following my introduction, Mike will offer some comments on the first quarter, recent developments and EMS industries. I will then review our financial results before we open up the call for questions.

Before we begin, please be advised that statements made during the course of this call are not historical and are forward-looking in nature. These include statements regarding the Company's future growth and financial results and any statements containing words like believes, anticipates, expects, or similar words.

Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause results to differ materially from these statements. Demand for our products and service depends upon worldwide economic conditions, including but not limited to overall economic growth rates, construction, consumer spending, financing availability, employment rates, interest rates, inflation, consumer confidence, defense spending and profits, capital spending and liquidity of industrial companies.

A continued recession in our economy and in the markets that we serve could further cause our OEM customers to reduce spending levels resulting in rescheduling, program delays or canceled orders of our products and service having an adverse effect on our business and our financial results. For more of these details and discussions of these risk factors and uncertainties, please see our filings with the Securities and Exchange Commission. I will now turn the call over to Mike Degen. Mike?

Thanks, Rich. Good morning, everyone. Along with summarizing our first-quarter financial results, we will update you about our response to the macroeconomic forces impacting Nortech Systems.

In the first quarter, we continued to experience order delays and cancellations as many industrial customers worked off existing inventory and adjusted to the soft business conditions. Our revenue in the first quarter of 2009 was $21.6 million, which was 30% off the first quarter of 2008.

On the defense side, several large contracts for our aerospace systems operations are wrapping up. Our work for the mine-resistant ambush-protected vehicles, or MRAPs, has basically stopped and our production of communications systems for up-armored Humvees continues, but at a reduced rate. We are working diligently to rebuild this order pipeline. It will take some time, particularly when all defense spending is under scrutiny in Washington. And the normal leadtime for new business is in the area of 12 to 18 months. However, our quoting activity remains strong with many well-established first and second tier defense contractors.

With new customers, most of the opportunities are for long-term programs rather than quick turnkey ones. Across almost every market, our customers, like most consumers, are taking a wait-and-see attitude with the economy. The ensuing volume shortfall, along with our mix of product and some underutilized plant capacity, significantly affected our results in the first quarter.

On the net income line, we reported a loss of $1.3 million, the first quarterly loss since the fourth quarter of 2003, 21 quarters ago and coincidently in the midst of the last major macro economic downturn.

The speed and depth of this economic downturn and drop-off in demand made it very difficult to react on a timely basis. We have already implemented various cost reduction and cash management measures over the past several months, including employee layoffs, freezing all wages and new hires, reducing management salaries and cutting discretionary spending to offset the lower demand levels. Since October of 2008, we have reduced our workforce by approximately 30%. Everything is on the table. We will continue to do whatever is necessary to balance our expenses with the expected customer demand.

Our goal is to turn a quarterly profit by year-end. But we are also committed to not sacrificing our long-term objectives or weakening our competitive position so that Nortech is ready when the inevitable turnaround occurs and we return to more normal revenue and profit levels.

Throughout this economic downturn, we will continue supporting our sales and customer service infrastructure to maintain the high level of service to our customers. This difficult business climate has weakened some of our competition and also has motivated additional outsourcing by some OEM customers striving to reduce their costs. Our focused initiative for lean manufacturing remains a top priority, helping drive costs out of our Company.

On the financial side, we have maintained a strong balance sheet and working capital position. This will help us navigate successfully through these tough times. We are presently negotiating with Wells Fargo on a new financing agreement that meets our current and projected cash flow requirements. We expect this agreement to be in place by the end of the month. Nortech's long-term objectives remain unchanged, achieving profitable sales growth, advancing lean manufacturing and strengthening our customer relationships.

I am encouraged by some of the economic-related news I have been reading recently. A Creighton University study of nine Midwestern states ranked Minnesota's business conditions third in April and said overall indicators were improving in the Midwest from record lows seen earlier in 2009. The head Creighton economist expects the Midwestern economy to be out of recession by the end of 2009. This is consistent with many economists' forecasts across the country.

In our own industry, three large EMS firms recently announced their quarterly earnings and offered assessments of the market conditions. All three firms benchmarked -- Sanmina-SCI and Celestica -- gave indications of volatility decreasing and stabilization improving.

Taken alone, none of these developments are enough cause for celebration certainly, but when considered together, some glimmers of hope and stability are starting to emerge. Now I'll turn the call back over to Rich for an in-depth look at the first-quarter financial results. Rich?

Thanks, Mike. Now we will look more closely at our first-quarter financials. We reported net sales of $21.6 million for the first quarter, down from $31.2 million of net sales for the quarter last year. Our industrial medical customers are being affected the hardest from the continued economic downturn and uncertainties in the first quarter.

Our electronic board assembly operations were down 41% and our cable and wire operations were down 34% to last year's revenue levels. Our aerospace operations saw revenue decreases of 17%. Our 90-day backlog as of March 31, 2009 was approximately $15.2 million compared with approximately $18.2 million at the beginning of the quarter. We have been seeing less customer order cancellations recently and a trend towards more rescheduling as our customers adjust their inventory levels and change their buying practices to match current market conditions.

Our gross profit for the quarter had 3.9% of net sales compared to 15.3% of net sales for the first quarter of 2008. We were heavily impacted by our volume shortfall and underutilization of our manufacturing facilities. As Mike mentioned, we took steps at the end of January and again at the start of April to balance production resources and spending levels to current demand. These actions should improve our gross margin performance going forward.

Our selling expense for the quarter was $1.4 million, just slightly higher than the $1.3 million spent last year. It is our intent to maintain our sales infrastructure and marketing initiatives during this economic downturn in order to maintain our high level of customer service. We see the current EMS business environment as an opportunity to expand our customer base through OEMs looking to increase outsourcing and consolidate suppliers to reduce their costs.

Our general and admin expenses were $1.5 million for the quarter compared to $2.2 million reported in the first quarter of last year. The reduced spending and leveraging was a result of personnel and wage reductions in addition to lower discretionary spending as we adjust our organization and cost structure.

We reported an operating loss for the quarter of $2.1 million compared to a $1.2 million operating profit last year as a result of the sudden drop in magnitude of the revenue decline. Other expenses came in at $85,000 for the quarter ended March 31 compared to $219,000 for the first quarter of '08. The decrease in other expenses was due to decreases in interest expense and lower interest rates. We reported a net loss for the quarter of $1.3 million, or $0.47 per diluted common share versus a net income of $626,000, or $0.23 per diluted common share last year.

Moving on to the balance sheet and liquidity. We continue to satisfy our liquidity needs through revenues generated from operations and operating line of credit through Wells Fargo Bank. On March 31, we had an outstanding balance of $7.1 million on our line of credit and unused availability of $4.7 million supported by our borrowing base.

At the end of the first quarter, we were not in compliance with certain covenants, financial covenants of our current credit agreement with Wells Fargo. And as a result, we reclassified all outstanding debt to current on the balance sheet. Wells Fargo is not presently planning to exercise their rights and remedies per the agreement and in order to avoid this issue ongoing, we are in a process of negotiating a new financial agreement with Wells Fargo that we anticipate will be in place on or about May 31. We continue to strengthen our working capital position by focusing our efforts on lowering inventories and collecting our accounts receivable within terms.

Net cash used in operating activities for the three months ended March 31, 2009 was $3.1 million, which is up $800,000 from the $2.3 million used in the prior year. The cash used (inaudible) resulted in a net loss of $1.3 million, a positive non-cash adjustment of $0.5 million and a net change in assets and liabilities of cash used of $2.3 million.

We decreased inventory $3 million in the quarter and this was offset by a decrease in payables and accruals of 5.1. This accounts for the majority of the working capital change of $2.3 million. Net cash used in investing activities were $0.2 million, all for machinery and equipment purchases, compared to $0.4 million in 2008. Although we are watching our CapEx spending closely, we are still assuring the maintenance of the business.

Net cash provided by the financing activities was $2.5 million, consisting primarily of a line of credit -- consisting primarily of the line of credit advances of $2.8 million offset by principal payments and long-term debt.

As we close the first-quarter reporting cycle and approach the halfway point of the second quarter, our focus remains on taking the appropriate actions needed to maintain a strong balance sheet and working capital position. This concludes my financial review. Now we will open the call for questions. Operator?

(Operator Instructions). Richard Dearnly, Longport Partners.

Good morning. The comment about the Minnesota environment and then the three EMS companies, have you seen your inquiry levels pick up sort of in sync with those comments?

The answer is yes. We have -- I can't recall a time in recent history when we have been as busy with requests for quotes and requests for proposals both from existing customers and from new customers.

And are the new customers -- you mentioned folks are maybe outsourcing more. Is that what that is all about?

We believe that it is a little bit of both. There are new customers looking to outsource things -- new things to cut their costs and focus on the things they want to be focused on. And then also these difficult times give customers that have already outsourced given some of their business pause to look at the potential of changing for a whole host of reasons.

Right. Then on the fourth-quarter call, you referenced some defense spending peaking in '09 and then heading down -- of course, we are talking hundreds of billions, but the trend was south. How -- I take it the MRAP business stopping was not a surprise?

No, it was anticipated. Maybe the timing, Richard, might have been a little bit of a surprise, that it wound down as quickly as it did, but it was anticipated. I think we got some pretty clear signals in 2008 that that would be winding down because of a change of venue, if you will, in terms of where the focus was going to be brought.

And is the same thing happening with the Humvee?

That's correct.

And what were the sales rate of those two contracts roughly a quarter?

Well, I'm not sure I know that right off the top of my head, but if you give me a minute, I will see if I can't noodle that a little bit. We -- the Northrop Grumman business was about $18 million in 2008 and we anticipated that being about half of that in 2009. So that would be quite a bit of the up-armored Humvee business. And the MRAP business basically went from -- I think the number was about $4 million to less than $1 million.

Sorry, did you say the Northrop business was $18 million in '08?

Yes.

Yes, okay.

And it will be roughly half of that or maybe a little less in '09.

Right. And do you have a feeling for what the overhead burden was of the capacity, of excess capacity?

I am going to let Rich answer that one.

You are talking about the dollars or are you talking about percentages?

Either, both.

Well, it is about 10%. It will be the difference between our gross margin last year and the first quarter and this year. So it would be roughly about 10%.

And that 10% being 1000 basis points of gross margin?

Yes. Roughly $2 million.

And when I was going over the K, I was impressed that you owned on the order of 325,000 square feet of space. Now some of that might have been -- one of the pieces was both owned and leased and then you leased -- I didn't even write that down. But it struck me that that was an awful lot of square feet for $120 million of sales, even if it is less this year. Am I off here or my sales per foot kind of numbers out of date?

I think, Richard, the numbers are certainly approximately correct. Part of that was by intention. Let me take you back to 2006 I think was the date when we purchased a 140,000 square foot facility in the Fairmont -- in Blue Earth, Minnesota, which is in the Fairmont area. We knew that was way more space than what we needed at the time, but it was an exceptional buy and we made the decision full well knowing that there was going to be north of 100,000 square feet that we had no immediate need for. And we were betting on the future. It was a pretty safe bet, still is a good bet today because that is pretty cost-efficient, pretty low-cost space on a square foot basis.

As I remember, you didn't pay a lot for that.

That's correct.

Right. And were there any bad debt hits this quarter?

There were none.

Is it a safe guess you are watching those carefully?

You bet.

Okay, thank you.

(Operator Instructions). Richard Dearnly, Longport Partners.

Putting on the long-term top of the mountain view kind of hat, with your debt not in compliance, it doesn't make for lots of financial flexibility. But when you talk to the Board about how do we make this or is there any consideration about how do we make this a bigger company -- 2.7 million shares that are largely owned by one person makes you semipublic. Does the Board consider this and have a strategy?

Richard, Mike. I would answer that by saying that we, I think as a company, fully understand the dynamics of having our ownership weighted the way that it is. I think we understand clearly the positives and the negatives of such a structure. And it is a frequent item of discussion at the Board level in terms of how we can best serve our shareholders in total.

I see. Okey-doke. Thank you.

So the simple answer is the Board is very in tune and very aware.

I realize this isn't the forum to ask about the nature of the discussions.

No, I couldn't answer that.

I understand. Okay, thank you.

(Operator Instructions). Gentlemen, I am showing we have no further questions at this time. I would like to turn the floor back over to management for any closing comments.

If there are no further questions this morning, we will wrap up today's call. Thanks for joining in either by telephone or by Web and for your continued interest in Nortech Systems. Have a great day.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and we thank you for your participation.