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Nortech Systems Incorporated (NASDAQ:NSYS)

Q2 2014 Earnings Conference Call

August 7, 2014 11:00 AM ET

Executives

Paula M. Graff – Chief Financial Officer and Vice President

Richard G. Wasielewski – President and Chief Executive Officer

Analysts

Sheldon Grodsky – Grodsky Associates, Inc.

Operator

Greetings and welcome to the Nortech Systems’ Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the former presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I will now turn the conference over to you host Ms. Paula Graff, Vice President and Chief Financial Officer. Thank you. Miss you may begin.

Paula M. Graff

Thank you. Good morning and welcome to Nortech’s Systems second quarter fiscal 2014 conference call. I’m Paula Graff, Vice President and CFO. And with me today are Rich Wasielewski, Nortech’s President and CEO.

Following brief introduction, Rich will offer comments on our second quarter results and developments in the market we serve. Then we’ll open up the call for your audio 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 complete Safe Harbor Statements in our press-release and SEC filings. As I mentioned during our first quarter call, we are now coordinating the distribution of our quarterly SEC filing and related press release.

I know will turn over the call to Rich Wasielewski. Rich?

Richard G. Wasielewski

Thank you, Paula and good morning everyone. After a slow start to the year, the second quarter began to show signs of life across all our key financial performance indicators. Sequentially, revenue increased 5%, to $27.4 million. Our 90-day backlog increased 13%, gross profits increased and reached 12% of sales, operating income rose 47% to $347,000 and operating cash flow proved 54% as the quarter generated $805,000 in cash.

When compared with the prior year’s second quarter, sales and operating income were up 4% and 7%, respectively. While net income and EPS increased 35% due to a favorable state tax audit settlement of $100,000 associated with R&D activities. For the six months revenue, profits and EPS they are all about the same levels as prior year, $54 million of revenue, operating profits at $600,000, EPS at $0.12. However, we did generate $1.3 million in operating cash flow for the six months, compared to using $1.5 million for the first six months of 2013. A significant turnaround of $2.8 million. And we still feel there is opportunity to reduce inventory levels.

Before I close the financial performance, I’d like point out a major shift in reclassification of our line of credit balance of $7.2 million, from credit liabilities to long term as a result of a three year extension with Wells Fargo Bank. Our working capital is now up to $23 million, compared to $15.5 million at the start of the year.

Looking at major markets we serve, our medical customers led the way in revenue, up 13% sequentially and 33% over the prior year. Backlog also increased up 8% in the start of the quarter, and 17% to the prior year. Our growth and strength with our medical customers have offset the decrease in sales, to deep hands in industrial. We continue to offer medical customers advantages in accelerating product launches with design assistance and expertise navigating regulatory and FDA requirements. This expertise is especially valuable for development stage and start-up medical device companies. These companies are looking to us as manufacturing partners, so they can better focus on research and development and marketing of their products.

We’re also committed to expanding our research and our reach with large medical OEMs. Our mid-range size enables us to add value for both types of customers. We’re small enough to be [nimble] (ph) responses, but large enough to ramp up quickly when needed. Our sales to defense customers were only $3.6 million, down 28% for the quarter and 17% for the six months. Better news is in our 90-day backlog, which is up to $3.6 million and 20% higher than the start of the quarter. Mixed and uncertainty debt subscribe the current defense environment.

National headlines talk about ongoing budget negotiations and cutbacks. And defense contractors are seeing reduced orders program only to push outs, and funding delays or cancellations. Several of our long-term programs are no longer being funded or canceled. It’s challenging for our defense customers to plan effectively for the long-term in today’s budgetary environment and post award transition. We are also feeling a ripple effect.

However, there are opportunities for Nortech during these cycles. With some defense contractors looking to cut costs and overhead, we believe there is business for us to gain from outsourcing, particular in higher level assemblies. Also they are looking for better pricing, solutions to some other problems that they had no time to deal with and are consolidating the transaction cost, all of which increased RFQ activities.

We continue to see increased activities in these areas, but the opportunities remain low in dollar value and shorter in contract volume. And a tough environment also helped to weed out weaker competition and we’re seeing more evidence of that, as well.

For our industrial customers sales is coming around after a slow start to the year. We posted a 5% sequential increase with 90-day backlog up 14% in the start of the quarter. It appears the weather had a bigger impact on Q1 and slow to grow, especially for our industrial customers. These customers are also more closely tied to the general overall economic conditions than medical and defense.

I’d like to address briefly the general economic and EMF industry outlook. On a more macro setting, we’re beginning to see more positive trends. And to the supply management announced that manufacturing activities increased in July, for the fourteenth consecutive month with 95% of the industry showing growth. We’re seeing these positive signs across some of our sectors. In transportation, a major rail industry customer rated it’s order forecast by 25%. Driven by higher rail shipments of petroleum, gas and coal along with demand for more EPA compliant equipment.

We also serve OEM’s involvement in semi-conductor manufacturing business, where global equipment spending is projected to raise 15% in 2014. According to an analyst firm Gartner. Related to the semiconductor trends is print circuit board industry in North America, which also saw bookings increase 4.2% in June according to IPC. The first year-over-year increase in eight months.

These favorable developments near what we are beginning to see in our second quarter. Our backlog growth follow the increase coding and [noting] (ph) activities mentioned in our last call. As we look ahead to the second half of the 2014, we’re encouraged by the national economic news, which is also trending up.

Last week the gross growth net to product announcement showed 4% growth in the second quarter. That’s a nice bounce back from Q1 negative numbers, which was hovered by bad weather. From the economic side is in The Wall Street Journal are now projecting a sustained economic growth of at least 3% for the rest of the year. For our EMS industry peers in North America tracked by IPC, revenues are expected to raise 4.5% this year, after a 7% decline during the 2013.

In closing we believe our second quarter results and our momentum, positioned us well for the remainder of 2014. As we’ve said in our last call, this year had a feel of 2013, we started a little slow, but ended on an upswing with all our growth in the second half. Our growing backlog, increased in pipelines activities and the improving economy provide some optimism. We’ve been investing in business development efforts with our messaging and solution strong approach. And we’re beginning to see the traction. Our goal is to sustain the progress for the long-term.

Overall our diverse customer base medical, defense and industrial is a definite strength as we’re able to balance our ups and downs across different markets and take advantage of industrial trends. Nortech and its employees are committed to helping our customers succeed.

Now we look forward to answer any questions you might have this morning. Operator, please open the lines.

Question-and-Answer Session

Operator

Thank you, at this time we will be conducting a question-and-answer session (Operator Instructions) Our first question is coming from Sheldon Grodsky of Grodsky Associates. Please proceed with your question.

Sheldon Grodsky – Grodsky Associates, Inc.

Good morning everybody.

Richard G. Wasielewski

Good morning Sheldon.

Sheldon Grodsky – Grodsky Associates, Inc.

This, is as kind of tricky question for you to answer, but is there any prospect that we can get better margins out of the company, right now the net margins are kind of minuscule and would you be able to expand that if you’re able to get more business, going out to doo?

Richard G. Wasielewski

I think that’s the question I can answer Sheldon, this is Rich, good morning.

Sheldon Grodsky – Grodsky Associates, Inc.

Good morning.

Richard G. Wasielewski

We’ve been struggling as most folks in our industry with the ups and downs with the economy since 2009 in the recession. The capacity in our locations is very low, I mean we have plenty of capacity. So we can do more we can utilize our plants more. The customer service is, I believe they are all-time high in quality and delivery, for us. So that balanced between service and utilization of plants is always the key to success leveraging. If fields don’t change and its getting to that point where things don’t start changing more, we got to look at that, cost structure, at all our locations.

So, that we do constantly, but it’s a question of leveraging. If we do see some growth which we have seen from the first quarter to the second quarter but even from last year it’s kind of flat that is an issue for us. So Sheldon, your question is what we see, we’ve kept our margins and profitability is pretty steady, we’ve watched the things we can control, which is cash-flow and our asset based. But the gross margin profitability is either going to come out of the cost structure or the growth and that is a key to our industry and contract manufacturing.

Sheldon Grodsky – Grodsky Associates, Inc.

Okay let me add one more question. Your best growth gross seems to be coming from medical, medical industry, medical market right now. Is this is a result of one or two customer or it’s wide spread.

Richard G. Wasielewski

Right now it’s one or two customers, our top customer are being very active. We’re penetrating our larger customers we’re also seen some activity the growth from last year and the first quarter is concentrated on our current existing. The future growth should come from new opportunities and new customers. They are in the pipeline, some of them and FDA, some of them are looking at introducing new product. We all continue and we do have a heavy emphasis on penetrating our existing customers, because we have a kind of a rule of them here it takes ten times the efforts introducing a new customer, than it does to penetrate an existing one. So there’s still plenty of opportunity with our existing base, but our growth could come from both.

Sheldon Grodsky – Grodsky Associates, Inc.

One more question then I’ll let someone else take the line. I don’t recall here and you mentioned the printed board industry before, circuit board industry. What you sell to the circuit board industries?

Richard G. Wasielewski

Well, the semi-conductor industry we have several leading cleaning equipment manufacturers. AT any onetime it could be between 5% and 7% of our business. I would say over the past two years it’s become lower in the 2% range, because they have really taken a beat in, as far as the markets grow.

Sheldon Grodsky – Grodsky Associates, Inc.

What when you sell to them, what do you sell to them?

Richard G. Wasielewski

We sell them PC keyboards, PC boards, where their PC boards and higher level assemblies for their manufactured cleaning equipment. If we manufactured a full unit, we would sell cables, and PC boards and some subassemblies for that installation.

Sheldon Grodsky – Grodsky Associates, Inc.

Thank you.

Richard G. Wasielewski

You’re welcome. Thanks Sheldon for your questions.

Operator

Thank you. (Operator Instructions) One moment please while we poll for additional questions. We’re showing no further question in queue at this time.

Richard G. Wasielewski

If there are no further questions, we’ll conclude the call. Thank you for your interest in Nortech Systems, and we look forward to updating you in the future, have a great day.

Operator

Ladies and gentlemen, thank you for your participation. This concludes today’s teleconference. You may disconnect your lines at this time. And have a wonderful day.

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