Nortech Systems Inc (NSYS) 2018 Q2 法說會逐字稿

Greetings, and welcome to the Nortech Second Quarter 2018 Conference Call.

(Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Connie Beck, Vice President and Chief Financial Officer.

Thank you, Omer.

Good morning, and welcome to Nortech Systems’ Second Quarter 2018 Conference Call.

I'm Connie Beck, Vice President and CFO, and with me is our President and CEO, Rich Wasielewski.

I'm going to start today's call by going over our financial results, which were released yesterday morning.

Then I'll turn it over to Rich for additional comments on the second quarter, our markets and company developments, then we'll open it up for questions.

Before we 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 and 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.

Looking at our second quarter's results.

Our net sales of $28.5 million reflect additional revenue recognized due to our adoption of new FASB accounting standards this fiscal year.

We gave more details about this change during our Q1 call in May.

Our Form 10-Q also includes more information and disclosures.

The additional revenue recognized this quarter, due to the change in accounting standards, was $1.6 million.

On a pro forma basis, to adjust for this accounting change, second quarter sales were $26.9 million.

Sequentially, this is up $1.2 million or 5% from Q1 of 2018.

Our net sales in the second quarter of 2017 were $30.1 million.

Looking at our 3 core markets, I'll give revenue and backlog results for the quarterly year-over-year and sequential comparisons.

First on revenue.

Our industrial sales had a slight decrease of 1% from the prior year quarter.

Sequentially, industrial sales were up over 4%.

Medical sales decreased by $1.8 million or 13% from the prior year quarter.

The majority of the decline was attributed to medical devices, the rest was in medical component products.

Sequentially, medical sales were up 22% as medical customers began to work through the high level of on-hand inventory as well as program delays.

Our aerospace and defense sales increased over the prior year quarter by $400,000 or 10%.

Sequential sales were down 12%.

Our defense shipments were hit the hardest by the component part shortages.

Next on to our backlog.

At June 30, 2018, our 90-day shipment backlog was $24 million.

This is a 9% increase, both year-over-year and sequentially.

Breaking it down further, our industrial backlog increased 10% from the prior year quarter and 5% sequentially.

Our medical backlog was steady from the prior year quarter and up 13% sequentially.

Aerospace and defense backlog increased 31% from the prior year quarter and 7% sequentially.

Our gross margin percentage for Q2 of 2018 was 13.4%, up 220 basis points from 11.2% in the prior year's second quarter and up 190 basis points from 11.5% in the first quarter of 2018.

Due to the new revenue recognition policies I cited earlier, we've recognized $1.2 million of revenue related to the noncash consideration, which was recorded at 0 margin.

This negatively impacted our gross margin by 60 basis points.

The year-over-year gross margin improvement resulted from customer and product mix, operational efficiencies and cost reductions.

On to SG&A.

We continue to watch our spending and adjust where we can to our current demand levels.

Our selling expense for the second quarter was $1 million or 3.6% of sales versus $1.3 million or 4.4% of sales for the prior year period.

G&A expenses for the second quarter were $2 million or 7.2% of sales versus $1.9 million or 6.5% of sales for the second quarter of 2017.

Our operating income for the second quarter of 2018 was $700,000 compared to $100,000 for the second quarter of 2017.

The improvement was mainly due to the gross profit improvements.

We reported net income of $400,000 or $0.14 per share for the second quarter of 2018.

This compares with a net loss of $16,000 or $0.01 per share for the same period last year.

This was our best quarterly EPS in 7 years.

Moving on to the balance sheet.

Cash provided by operations was $2.7 million for the first 6 months of 2018 compared to $1.3 million for the first 6 months of 2017.

Cash flows were again positively impacted by the noncash add back of depreciation and amortization, along with increased accounts payable.

This was partially offset by an increase in accounts receivable.

Free cash flow was $2.2 million in the second quarter.

We ended the second quarter with $6.3 million available on our line of credit.

This compares to $3.9 million at the end of the first quarter.

Total debt was $12 million at the end of the second quarter, which excluded capital leases of $1.5 million.

This compares to debt of $12.6 million for the same period last year that did not have capital leases.

This concludes my financial overview.

Now I'll turn it over to Rich for his comments.

Thanks, Connie, and good morning, everyone.

Overall, we're pleased with our second quarter results and the progress being made, particularly our sequential improvements in quarterly sales and profits.

It's been a while since we have, across the board, all our main revenue and profit-generating products and services exceed their projections in the same quarter.

We also saw good performance out of our manufacturing operations in the areas of quality, delivery and efficiency.

And our supply chain management did an excellent job of minimizing the impact of the industry's electronic part shortages.

From an earnings per share standpoint, this was our strongest quarter in 7 years.

The U.S. and global economies are having a positive impact on our business environment and customers, both domestically and internationally.

We continue to benefit from increased Department of Defense budget increases and winning new longer-term defense programs.

We are beginning to see the expected returns from our strategic investments in China and Mexico, and the engineering medical device project work is on a upward cycle.

In addition, as Connie mentioned earlier, we have done a decent job of adjusting our cost structure with current demand levels.

A closer look at our revenue by markets, our industrial segment was strong in Q2, with backlog up 5% over Q1.

This segment, again, tracks with the overall U.S. economy, so we've been riding the stronger GDP here in Q2.

Oil and gas construction equipment, capital equipment continue to see improving demands.

All these markets require our custom-rugged environmental electronic products.

Our global strategy for serving in-region, for-region, with our multinational customers continues to grow.

Moving on to medical.

With medical, we're seeing a robust pipeline of opportunities.

Our overall medical backlog is up 70% since the start of the year and 13% from the start of Q1.

Startup funding remains strong, and large multinational OEMs are also beginning to increase their investments.

And we are, finally, seeing several of our large medical customers work through their high on-hand inventory levels, that have impacted us for over the past 4 quarters.

The -- on to medical device services front.

We continued -- we conducted several studies and surveys in the first half of the year on the branding of Devicix by Nortech.

The findings indicate a strategic advantage in our ability to accelerate medical device commercialization under Devicix name and reputation.

To carry out this marketing message forward, we are assigning more dedicated resources, updating marketing collateral and increasing our targeted trade and market presence.

Another milestone is our recent medical capabilities expansion in China, where just last month, our Suzhou facility in BioBay medical industrial park passed its final medical 13485 audit.

We are now open for business for medical device manufacturing, building both Class 1 and Class 2 medical devices in the fast-growing Asia market, with our first devices scheduled to be produced in the fourth quarter.

On the defense side, overall defense budgets show an increase in spending, both in the U.S. and globally with the international tension surrounding Russia and North Korea.

For 2019, the Department of Defense budget will rise 5% over 2018 levels, and 10% from a continuing resolution level.

We're seeing increased quoting activity on both our legacy products and new programs.

We're also seeing our backlog rise 7 consecutive quarters and 7% from the start of the first quarter.

To better serve the defense market and our projected growth, we're adding government-required certification at our Nortech Mankato facility.

We now have 2 AS9100 ITAR facilities that complement each other very nicely with our Blue Earth operation specializing in custom cable assemblies and in mid -- in PCB boards in Mankato, with both sides doing higher-level assemblies, depending on the opportunity.

On the topic of component shortages and tariffs, with defense and other areas, we're seeing electronic component shortages that are causing some shipment delays and move outs.

We estimate that we're unable to ship $600,000 worth of product in Q2 due to these shortages.

From what we're being told by our supply chain partners and our field intelligence, such shortages could persist well into 2019.

Many OEMs and EMS manufacturers have been talking about this topic in the news for the past year.

We're watching the issue carefully and keeping in close contact with our supply chain and customers to determine the appropriate action.

With tariffs, the biggest current impact is uncertainty and questions.

We're not expecting any significant charges so far and like the shortages, we're keeping a close eye on this as well.

If you look at the economy and the industry outlook, we're encouraged by strong -- the U.S. economy, 4.1% [GDP] growth in the second quarter.

And we mentioned in our May call that the industry is expecting a 5% Americas growth in 2018, according to New Venture Research.

These external trends and projections, along with our internal indicators, all point up and provide plenty of optimism for us going into the second half of 2018.

Now to succession planning.

As we announced yesterday, I am planning on retiring.

A succession plan has been discussed with the board for some time.

The timing is right for me and for Nortech to make this transition.

The company has started a national-wide search with Russell Reynolds Associates.

I'll continue in my current role and will help in the search and transition for as long as it takes to find the right person.

Because of my faith in all Nortech employees, in all locations and in all countries and our long partnership with our customers, I believe and I know our company's future is bright and the strategic vision is on track.

I'm honored to have played a role in the company's growth and evolution, while maintaining our Nortech culture, which values its employees, where no one does it alone, and we strive to provide a quality place to work in the communities we're in.

We are customer focused, doing all we can to help them succeed, with full awareness of what we produce impacts the patients, the mission and the end users.

And never forgetting to build shareholders' value.

It's been the highlight of my professional career to serve this company, our shareholders and work alongside our outstanding and committed employees.

With that, I'll conclude our remarks this morning and we'll open it up for questions.

Operator, please open the line.

(Operator Instructions) Our first question comes from Sheldon Grodsky, Grodsky Associates.

First of all, let me wish you the best of luck in retirement, Rich, whenever that happens, I hope things go very well for you.

Thank you, Sheldon.

I think the 800-pound gorilla in the room isn't the operations of Nortech this week, but you had a rather unusual surge in activity, similar to one you had almost a year ago.

Does anyone in Nortech know where it came from and why?

Well, I guess, we don't track it very well and you possibly can't.

But it's -- it appears to be the same event that happened the year before, which is day traders.

There was a blog and an analyst for some day traders in a small article written that gave us pretty good grades, as far as consistency and longevity, and felt that Nortech was going to take off one of these days.

And I think that all of those things helped contribute to it.

But it wasn't any major player.

It was a number of day trades, is the best as we could tell.

Is there a particular brokerage firm associated with these day traders?

Not that we can tell.

And there was -- again, our intelligence doesn't show anything.

Okay, moving over to operations.

You kind of said that all -- the company is shooting on all cylinders for the first time in a long time.

Does it look like that's going to continue?

Or is anything showing signs of slowing down?

Right now there is not a lot of downturn that we can tell.

As I stated, our backlog is up, which, as you've tracked us over the years, that's always a good sign for the next quarter.

It's one of our leading indicators.

The economy -- the industrial follows the economy and that's got pent-up demand.

The medical has always been good to us.

We really took a lot of hits this past 4 quarters, because of robust -- maybe too much anticipation of growth and startups in 2017 that's worked its way through.

So being up 13% or so in that area is where we want to be.

If high single digits is medical growth then we're in there in the 10% to 14% range, we want to exceed the market.

In the defense, that's just a nice balance in our portfolio, and with the struggling for last -- a lot of that struggling that we said for the last 7 years has been in the defense arena, the defense market, as it's been depressed, has now become a good guy for us.

And I would say, the last 7 quarters, anytime you can keep increasing.

And there is no -- at least the next 2 years, the budgets are strong and I think they're talking about even a stronger 2020.

So really, Sheldon, I'm generally cost conservative in these, but all our indicators, all the environment, the global economy, the decisions we made are working.

The only negative being the tariff and the component shortages?

Yes.

But if we're growing double digits like that, it's going to have a minor impact, at least for the near future.

Our supply base is watching it close.

We also have triggers.

If it happens, anything, it will be inflation and some pricing pressures and that could get us into a downturn.

But it's not in the immediate future and I think -- there is enough demand here for 2018, and I think it may be beyond 2018.

(Operator Instructions) Our next question comes from Sam Rebotsky, SER Asset Management.

Good luck on your retirement.

Even though I'm new to Nortech, the change that's going on, hopefully is beneficial, and I guess, hopefully you'll do well in the future.

Thank you, Sam.

With -- there seems to be difficulty getting thoughts for various companies in your industry and some of them seem to be doing better than others.

Is there any consolidation that's going on?

Is there any benefit to you, to consolidate with anybody else or how would you look at that?

And I guess, with somebody new coming on, that's a difficult problem.

Of course, you want to sort of steer the ship before you make acquisitions or merge.

But is there any thoughts on that?

Well, it's a thought, but it's probably 2 or 3 down the road.

The first action that we take is always with our supply chain.

And so far so good with the supply chain.

There are shortages, don't get me wrong, there are shortages.

But we'll attack our supply chain, we'll attack anything we can get through the Internet of Things, and then we'll work with our customers.

Because of the custom nature of it and the quality and validation of components that come in and the certifications, makes it very difficult to see that anybody would have the same mix as us, other than our customers.

And they would know where to go.

The third that you're talking about here is, that card is, like I said, I think our third or fourth down before we get there.

But it is on the table.

We thought if we can partner with -- we can make kind of a group, co-op that for shortage parts, we could get together.

We generally do not have that type of relationship with our competition, so -- but it may be something for us CEOs to maybe have a discussion on.

So it isn't -- your question is right on.

It may just be a little bit too soon to answer that for us.

Well, that's good.

And hopefully the day traders have something right in that you're at the beginning of future growth as we may be.

And then -- and instead of day trading, maybe they should become investors, okay?

So let's hope that we keep growing the earnings and improving.

(Operator Instructions) Our next question comes from [Robert Paglee,] private investor.

I'm curious -- first of all, I want to congratulate you on your successes and I wanted to get a little more feel for what's going on in China.

Are you being affected by these shortages?

Is that something to do with the issues with the trade in -- with China?

Or is it something totally different?

What is the nature of the shortage issue?

And what is it that you actually do in China?

By the way, I'm an electrical engineer, and I have a PE license, (inaudible), so I'm curious about this and I appreciate you giving me a little update on it.

Well, first of all, thanks for your question.

China was -- we went to China primarily to work with our multinational customers in the cable and wire complex assembly arena.

And we also had this vision with the aging population that our strength in medical devices is a nice expansion and we're seeing that today.

We have a great start -- we started greenfield so we have a great organization being done there, their quality and their delivery performance has been outstanding so far in the last 3 years.

So that's what's taking place there.

To follow our multinationals that are doing in-region production for the region.

The second benefit of Asia is that 55% of the electronic supply chain comes out of Asia and we really weren't playing until we got there 3 years ago.

We were only purchasing about 2% of our electronics here in the United States from Asia.

That particular initiative hasn't taken full hold yet, we're still in single digits.

And the particular parts that we have, have not been impacted by the tariffs, coming over here, on this first phase.

And hopefully, they don't go to Phase 2 and Phase 3 on the tariffs.

But right now, the type of components have not been impacted by Phase 1 of the government's tariff program.

The other, I guess, benefit that we get out of China today is by making the product in -- by manufacturing the product in China for China, we don't have to deal with this tariff a lot.

Most of the parts are sourced there.

There are still some coming from United States, and those parts -- we'll work with the customers to get those possibly transferred to a China source if needed.

Hopefully, that answers most of what you asked, [Robert].

If not, you can expand on it, if you want.

Okay.

One other thing I wanted to tell you.

I'm 94 years old and I just, last week, got a pacemaker put into my breast.

And I am suffering from the swollen effect of that, but it works.

And I'm curious about what is the electronic devices you make that -- I'm curious, it's not anything like my pacemaker, but what is it that you do in terms of your product?

Well, first of all, 94, that's just -- you're just a young man right now, buddy, as far as I'm concerned.

So you keep it up, good luck with that pacemaker.

We do more Class 2s, which are more mechanical devices outside the body.

We have done Class 3s that are more evasive.

We are planning to do more along the lines of the pacemaker product.

We do have a device that does affect the heart, that's on the table today, a project that we're working.

We'll see how it goes.

So -- but right now the St.

Judes, Boston Scis, Medtronics, they have a very good supply chain or they're producing for themselves.

And we're making headway in that arena, but not at this time.

So mostly outside mechanical-type Class 1 and 2s.

Okay.

It would be a packaging issue then.

I don't think you would do any of the, kind of, esoteric deposition of stuff on a straight up?

That's correct.

That's correct.

Well, I thank you very much, you telling me about this.

And I guess, from what you say the issues of trade with China have -- that are now in the headlines, that's not affecting you as far as these part shortages is concerned to any extent, is that true?

That is true today.

It could change.

And even here in the third quarter, we're not seeing any kind of great changes to it.

But there is a lot of uncertainty and a lot of talk.

So the caveat would be not today, there's an expectation and we're watching it very closely.

Okay.

That's good because I think they're starting to -- I guess, there's some Chinese people coming to visit Washington next month or next week, I don't know.

They are on their way supposedly to try to resolve some of these issues and that will be good news for all of us, not just for your company, but for all of us who buy stuff and it's made in China and most of it is pretty good.

So I wish you well and congratulations on all your successes.

I -- and I wish you a very productive and happy retirement, if that's where you're headed.

Thank you, [Robert].

Good luck with that pacemaker.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to Rich Wasielewski for closing remarks.

Well, that concludes our call.

Thanks for joining us today and your interest in Nortech and we'll look forward to updating you in the future.

Have a great day.

This concludes today's conference.

You may disconnect your lines at this time.

Thank you for your participation.