SMTC Corporation: Poised To Climb Higher In 2014 And Beyond (Update)

Jan.17.14 | About: SMTC Corporation (SMTX)

(Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.)

When my first article on SMTC Corporation (NASDAQ:SMTX) was published on November 12, 2013 the stock was trading right under $2. The pps has trended upwards since then and has attempted unsuccessfully to break the $2.5 resistance. I believe that this resistance will be broken and the stock will rally to the mid $3's before the company reports its 4Q 2013 financial results. In the company's 2Q 2013 earnings release the then company's interim CEO, Larry Silber, hinted that he expected improved results in 3Q and 4Q compared to the first two quarters of 2013. Mr. Silber was right, on November 13, 2013, the company reported significantly better results for 3Q 2013 compared to the previous two quarters. Based on the comments made in the 3Q 2013 CC, it's likely that 4Q 2013 to be reported in a few weeks will also be a good one - and more importantly, a profitable one.

SMTC Corporation is a global Electronics Manufacturing Services (EMS) delivering contract manufacturing services to original equipment manufacturers (OEMs) and specialized turn-key engineering and manufacturing services to global emerging technology companies. The company's services include product design and engineering services, printed circuit board assembly, production, enclosure fabrication, systems integration, testing, and configuration services. It also provides enclosure and precision metal fabrication, cable assembly, interconnect, and engineering design services. The company provides its services to technology companies primarily in the industrial, networking and computing, communications, consumer, and medical market segments. SMTC services extend over the entire electronic product life cycle, from the development and introduction of new products through to the growth, maturity and end-of-life phases. In 2013 Frost & Sullivan presented the 2013 Growth Leadership Award in the EMS market to the SMTC Corporation.

SMTC Corporation has several manufacturing / technology centers in the United States, Canada, Mexico, and China. The company has more than 40 manufacturing and assembly lines and employs approximately 2,300 employees worldwide.

Below is a summary of the various improvements achieved in 3Q 2013 over the prior quarter(s) results:

  1. Revenues of $72.9 million up by 12.3% from the prior quarter.
  2. Achieved positive adjusted EBITDA of $2.1 million versus $(1.3) million in the prior quarter.
  3. Net income was $0.6 million (4c/share) and was negatively affected by two non-recurring legacy items totaling $0.51 million. This compares favorably to losses in the two prior quarters
  4. The company achieved compliance with bank covenants.

Interim President and Chief Executive Officer Larry Silber commented: "We are pleased with the improvement in revenue over the prior quarter and our order book remains strong. Significant gains have been made across our business resulting in improved customer satisfaction. We will now put additional emphasis on our operational effectiveness leading to margin improvement through increasing productivity, third party supplier actions and lean initiatives,"

Mr. Silber continued, "Our short-term goals includes, successfully completing the CEO search and implementing a smooth transition plan, substantially reducing inventories, improving the efficiency and profitability of our sites, continuing to expand our business with existing customers and the pipeline for new customers, and continue with our strong order book to make sure that our work is efficient and timely delivery of the order book in hand."

The interim management team lead by Mr. Larry Silber did an exceptional job preparing the company for the arrival of the new CEO. On December 23, 2013, after an extensive search that lasted several months and with the assistance of an internationally known recruiting firm, SMTX announced the appointment of Sushil Dhiman as its President and Chief Executive Officer effective January 6, 2014.

Commenting on Mr. Dhiman's appointment, Executive Chairman Clarke Bailey stated: "we are pleased that our search resulted in Sushil joining SMTC as President and CEO. He brings a wealth of experience in operations, customer service and business development. I believe he is a great fit for our company and expect him to have a significant impact on the success of SMTC."

Mr. Dhiman is a respected and accomplished executive with over 25 years of experience in the EMS industry. Prior to joining SMTX, Mr. Dhiman was a competitor's Sanmina-SCI (NASDAQ:SANM) Senior Vice President of Operations. During his career, he has been responsible for managing multiple facilities generating over $500 million in revenue. Mr. Dhiman has successfully grown and lead complex operations by developing new business and effectively managing costs and working capital. Prior to joining SANM in 2009, Mr. Dhiman was Vice President -West Coast Operations for PNY technologies where he managed all aspects of the West Coast operations including Mfg. operations, Engineering, Business Development and Human Resources with complete P&L responsibilities. It is interesting to note that SANM's stock price went from $2 in 2009 when Mr. Dhiman joined the company to $16 recently.

Besides being an effective executive, Mr. Dhiman appears to be a well-rounded individual. For instance, he was the coauthor of a SANM patent issued in 2012 and was awarded a medal by Binghamton University for assisting numerous graduate students as they conducted research for Sanmina-SCI, and has continued to mentor them after their graduation.

Besides returning the company to profitability, improving working capital and receivables management, and to achieving bank-covenant compliance, the interim management lead by Mr. Larry Silber made significant progress in several key performance areas prior to Mr. Dhiman's arrival:

Gross Margin Improvements

According to the 3Q 2013 earnings transcript, an important company focus has been to ensure a more efficient operation of the Mexico facilities. SMTX brought on board Chris Christiani as Senior Vice President of Operations to optimize the Mexico operations. According to Executive Chairman Clarke Bailey, Mr. Christiani has done a great job establishing and implementing processes aimed at enhancing quality, and improving efficiency and gross margins in the Mexico manufacturing complex. Mr. Bailey commented, "So there's some good things that we're doing in Mexico. We think that as their margins come up you'll see the gross margin come up."

Other initiatives to increase gross margins relate to: 1) supply-chain optimization to improve procurement terms, 2) throughput and productivity optimization and implementation of lean initiatives in the company's manufacturing plants, 3) inventory management improvements, 4) software system upgrades to improve efficiency and the ability to manage materials flow through the factory, 5) better management of bill of materials to make sure that they process through the plants in a more effective way, 6) working with a host of third-party suppliers, like logistics companies, insurance companies to optimize insurance costs, HR consultants to optimize manpower requirements, etc.. Mr. Bailey added, "I think these things will certainly contribute to improved margins as we go forward into 2014."

Improvements in the pipeline and customer quality

During the 3Q 2013 CC, Mr. Silber responded to an analyst's question regarding the pipeline of opportunities, "Well, we have a pipeline today, whereas last quarter I would tell you we didn't really have a pipeline of new viable customers that we can consider would become reality in the future.

So, we believe we have what we call - we've created a three-tiered pipeline, in terms of readiness so we have some in early stages of development, some mid-way along and some - we're actually at the quoting stage, so we have a pipeline and we're optimistic."

Mr. Silber and the interim management team have spent a lot of time in developing the profile of customers to go after that are best fitted for SMTX's capabilities. Mr. Silber added, "As an example, we put out a press release a few weeks ago relative to a new customer called SpiderCloud Wireless and we've actually done a fair amount of business with them already this year and that's been a new ramp-up and a nice development for us. And going into 2014, it's going to be a significant customer for us. Indeed, since Mr. Silber made those comments during the 3Q 2013 CC, SpiderCloud Wireless claimed that 2013 was a breakthrough year for enterprise small cells and 2014 and beyond will see explosive growth in this technological area.

Mr. Silber further added: "We are actively engaged in seeking innovative customers like SpiderCloud Wireless because they are a great fit with our expertise and our capability primarily in doing process engineering and throughput technology and capability in our factories, and the fact that particularly when it comes to ramping up a new product we are fairly flexible, in terms of our manufacturing process and we can manage that type of activity very well in our various plants. And then as they reach full production capability or volumes, we could move them to some of our larger higher volume plants and move their material through"……"we've gone through a great deal of effort over the last six months in identifying what is the appropriate profile of the customer that we can handle, most effectively within our manufacturing facilities and within our capability in our engineering group."

SMTX meets my criteria as an undervalued stock with potentially significant long-term upside and moderate downside. SMTX is currently trading at 0.1 time sales, or a fraction of sector leaders Flextronics (NASDAQ:FLEX), Sanmina-SCI , Celestica Inc. (NYSE:CLS), and Jabil Circuit Inc. (NYSE:JBL). There are several positives at play including the improvements made by the interim management led by Mr. Silber, a new well-qualified CEO with extensive industry experience, new innovative high-growth clients like SpiderCloud Wireless, significant and persistent insider buying, and a relatively small public float of less than 10 million shares. But since no investment is risk free, those considering in investing in SMTX are encouraged to carefully read and understand the risks associated with investing in this (or any other company) as stated in 10-K and 10-Q filings with the SEC.

Note. My next update will include a Q&A with the new CEO. I encourage existing shareholders and those considering investing in SMTX to suggest questions for CEO Dhiman.

Disclosure: I am long SMTX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.