IEC Electronics Corp.
Q2 2020 Earnings Call Transcript

Published: 10 May 2020

[Operator:]

Greetings, and welcome to the IEC Electronics Second Quarter 2020 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.It is now my pleasure to introduce your host, John Nesbett of IMS. Thank you, Mr. Nesbett. You may begin.

[John Nesbett:]

Thank you for calling in, and good morning. On the call this morning, we have Jeff Schlarbaum, President and Chief Executive Officer; and Tom Barbato, Chief Financial Officer.Before we get started, I'd like to take a moment to read the safe harbor statement. This conference call contains certain statements that are or may be deemed to be forward-looking statements. These forward-looking statements, such as when the company describes what it believes, expects or anticipates will occur and other similar statements include, but are not limited to, statements regarding future sales, backlog and operating results, future prospects, strategic initiatives, turnaround efforts, the capabilities and capacities of business operations, any financial or other guidance and all statements that are not based on historical fact and rather reflect the company's current expectations concerning future results and events. The ultimate accuracy of these forward-looking statements is dependent upon a number of risks and uncertainties that may cause the company's actual results or performance to be different than as expressed or implied by these statements. Specific risks and uncertainties include, but are not limited to, those set forth in the company's earnings release issued immediately before this call and in the company's most recent annual report on Form 10-K, our quarterly reports on Form 10-Q and other reports filed with the Securities and Exchange Commission. The company undertakes no obligation to publicly update or correct any of the forward-looking statements made during this call, whether as a result of new information, future events or otherwise, except as required by law.I will now turn the call over to Jeff Schlarbaum. Please go ahead, Jeff.

[Jeffrey Schlarbaum:]

All right. Thank you, John. Good morning, everyone. Thank you all for joining us today. I hope everyone is staying safe and healthy. What a difference a few months make. When we last spoke during the first week of February, hard to believe any one of us could have imagined the devastating health crisis and ensuing economic crisis resulting from the COVID-19 pandemic we all have experienced. With this as our backdrop, I'm pleased to be here, though, this morning to review our fiscal second quarter and year-to-date results. And I will also provide some color about our experiences these last several weeks as it relates to our operations in light of the pandemic and provide some visibility around what we anticipate for the business moving forward.First off, I'm pleased to report we saw continued strength in the second quarter, with solid revenue increase of 18% to $44.2 million and significantly improved profitability with net income growth of a 127% to $1.5 million or $0.15 per basic and $0.14 per diluted share. Backlog remains strong, and I'm pleased to report we had a book-to-bill ratio of 1.5

[Thomas Barbato:]

Good morning, everyone. Revenue for the second quarter of fiscal 2020 was $44.2 million, an increase of 18.4% as compared to the second quarter of fiscal 2019. Gross profit for the second quarter of fiscal 2020 was $5.5 million compared to gross profit of $4.6 million in the second quarter of fiscal 2019. Gross margin was 12.5% in the second quarter of 2020, an increase from a gross margin of 12.3% in the second quarter of fiscal 2019.Selling and administrative expenses decreased to $3.2 million or 7.3% of sales as compared to $3.3 million or 8.9% of sales in the second quarter of fiscal 2019. The company recorded net income of $1.5 million in the second quarter of fiscal 2020 or $0.15 per basic and $0.14 per diluted share compared to net income of $700,000 or $0.06 per basic and diluted share in the second quarter of fiscal 2019.Looking at our market sectors for the second quarter of fiscal 2020, we saw revenue distribution of aerospace and defense at 60%, medical at 24% and industrial at 16%. The aerospace and defense sector saw an increase of $3.4 million in comparison to Q2 of fiscal year 2019, primarily driven by the ramping of production of certain customers, increases in demand with other customers, offset by reductions in revenue related to disengaging from certain customers.Sales in the medical sector increased $3.5 million, primarily related to new programs ramping with an existing customer, which resulted in a $4.2 million increase in revenue as well as increased demand in a variety of other customers. These increases were partially offset by a program being on hold with one customer and a discontinued program with another customer.Industrial sector sales decreased $100,000, primarily due to fluctuations in demand with certain customers and projects being temporarily on hold with 2 customers.Now looking at the results for the 6 months of 2020. Revenue increased 22.2% to $88.9 million compared to $72.7 million in the prior fiscal period. Growth was primarily driven by an increase in sales in the aerospace and defense sector of $12.3 million and an increase in sales in the medical sector of $5.3 million.Gross profit in the first six months of 2020 was $10.7 million or 12.1% of sales compared to gross profit of $9.6 million or 13.3% of sales in the first 6 months of fiscal 2019. First half 2020 gross margin was adversely impacted by a onetime inventory write-down of $1 million in the first fiscal quarter related to the reorganization activities at an end customer in our medical segment. Please refer to the reconciliation tables provided in the press release this morning for further information regarding this non-GAAP measure.Selling and administrative expenses decreased $200,000 and decreased as a percentage of sales to 7.3% in the first 6 months of fiscal 2020 compared to $6.7 million or 9.2% of sales in the comparable fiscal period. The decrease in selling and administrative expenses was primarily due to lower payroll and related expenses.Net income for the first six months of fiscal 2020 was $2.7 million or $0.26 per basic and $0.25 per diluted share as compared to net income of $1.7 million or $0.17 per basic and $0.16 per diluted share in the same prior fiscal year. Adjusted for the impact of the first quarter onetime inventory reserve, adjusted net income would have been $3.5 million or $0.34 per basic and $0.33 per diluted share. Again, please see the reconciliation tables included in the press release this morning for further information regarding these non-GAAP measures.Now looking at our balance sheet. Our balance sheet remains strong with $44.6 million in working capital and $33.4 million in stockholders' equity. You will see that inventory at the end of the second quarter was $45 million, up modestly compared to $44.3 million at the end of fiscal 2019. As we discussed on prior calls, our inventory levels are directly associated with our ability to convert our backlog. We continue to see a willingness on the part of our customers to help mitigate the risk associated with the ongoing component shortages, resulting in customer deposits growing to $15.8 million at the end of the second quarter in comparison to $13.2 million at September 30, 2019. One of the other items worth noting is we generated $1.8 million of operating cash flow in the first half of fiscal 2020. Positive cash generation continues to be a critical priority for us.With that, I'll turn it back to Jeff.

[Jeffrey Schlarbaum:]

Great. Thank you, Tom. Our performance in the first half of fiscal 2020 reflects our deliberate focus on strategically executing our initiatives to ensure sustained organic growth and profitability. As we move through the balance of the year, we're focused on continuing to strengthen and diversify our customer base by expanding our existing customer relationships and leveraging our solid industry reputation to attract new partners. The current global world situation is an extraordinary one, and we are focused on controlling what we can to solidify our leadership position as a provider of a 100% U.S.-based manufactured product for life-saving and mission-critical products.With that, I will now hand it back over to the operator for any questions.

[Operator:]

[Operator Instructions]Our first question comes from the line of Chris Sakai with Singular Research. Please proceed with your question.

[JoichiSakai:]

Hi. Good morning. I just had a question on the - I wanted to know if, has the coronavirus pandemic actually helped your medical segment? And if it has, to what extent and is this a long-term - is this - will this help long term?

[JeffreySchlarbaum:]

Yes. Great question. So if you think about our medical sector, there's a variety of different products that we manufacture. Some directly are in higher demand for treating many coronavirus patients. In contrast, however, there are other medical devices we manufacture that are deemed nonessential for, say, pain management or other applications that are used in dentistry and whatnot. So I'd like to say that all of the medical sector would be benefiting from increased demand. But really, some are up. It's kind of like the balance of our business. Some of those customers are up for sure. And then other customers that are serving some of these other applications, demand is actually down. So I'd say, overall, our medical sector is staying pretty steady with the fluctuations based on the end product, some up, some down.

[JoichiSakai:]

Okay. Great. And then the other parts, the other segments have they been - how have they been affected with the coronavirus? Are they - is it about the same?

[JeffreySchlarbaum:]

Yes. So as you know, we - the largest sector we serve is the defense and aerospace sector, and those products continue to be in very strong demand. So we haven't seen any drop-off in that particular sector, so it's staying steady. On the industrial space, there are some customers who have seen some modest decreases in demand. But again, because of the diversity of our customer base, demand for the most part, is steady and solid. So yes, that's how I see it today.

[Operator:]

Our next question comes from the line of Shawn Boyd with Next Mark Capital. Please proceed with your question.

[ShawnBoyd:]

Good morning. Can you hear me okay, guys?

[JeffreySchlarbaum:]

Yes, I can hear you well.

[ShawnBoyd:]

Right. Congrats on the quarter. I just wanted to get into a couple of things. The book-to-bill at 1.5

[JeffreySchlarbaum:]

Yes, absolutely. So what I had indicated on my previous comments was that we saw a pretty healthy diversity of bookings coming across what I said was just under 10 customers that individually had booked multimillion-dollar orders during the quarter. So the value of those orders vary somewhat, but what I was most pleased with is that we saw around 10 customers or so with multimillion-dollar bookings. So once again, it wasn't from a single win or for one large customer. It was across the board across a number of different customers. So that's a sign to me that they're optimistic, they still have strong demand in their end markets. And so we would need to compare - need to continue to prepare to support the growing demand.

[ShawnBoyd:]

That's fantastic. And would you say those were spread across our 3 major - your 3 major end markets in the same way as your current revenue spread? Or were they more toward medical or more towards airspace and defense? Or anything you can give us there?

[JeffreySchlarbaum:]

Yes. No, that's actually a good point. It was equally spread. So all 3 industries were represented and you're right, it's probably in the ratios of the revenue distribution. That's a pretty fair way to look at it.

[ShawnBoyd:]

Okay, okay. Fantastic. So - and I know that those will come on at all different rates, right? And we can't expect to flip a switch and have those immediately contributing to the third quarter here. But relative to maybe if we just think about the first half, can we talk a little bit about what we should think about with the growth for the second half?

[JeffreySchlarbaum:]

Yes. It's a fair question. So a couple of ways I look at this. One is we've shipped just under $90 million in the first 2 quarters of our fiscal 2020. And our backlog, we ended last year with a backlog of $212 million. And so we've shipped 90, more or less, just a little under 90. Our backlog is up over what we reported at fiscal year-end. And so these orders are spread over the course of time. And so that's the one takeaway is that we're not consuming backlog. We're actually building it at much higher revenue levels, number one. Number two, in the back half of the year, I had talked about the sort of $40 million revenue threshold, and we've been bumping up against that and having a tough time eclipsing it. And we finally got in a rhythm where we were consecutively over that $40 million threshold. We got to now kind of climb the ladder and get to that next revenue tollgate for us is $45 million and be able to do it consistently. And we haven't been able to do that the last couple of quarters. So until we can demonstrate that we can take this next step up and consistently scaling to that demand level. I just want to be cautious about how bullish I guide for future revenue expectations. But again, as I said in my prepared remarks, I'm thankful we don't have a demand issue. It's really a fulfillment issue and scaling the business.

[ShawnBoyd:]

Got it, got it. Okay. And if I could, just to go to gross margin for a second. The issues in the quarter, I mean, the gross margin was pretty strong, but I understand that you were looking for something a little bit higher. What were the issues in the electronic assembly operations? What was the required investment?

[JeffreySchlarbaum:]

Yes. So as I've talked about in the past, we have strong demand from our customers as represented by not only the bookings, but the backlog. And we're onboarding new employees. We're expanding our workforce. Training is a nontrivial piece of scaling the business, and the skill sets required to build these highly engineered products is pretty significant. So the investment that we have to make upfront is pretty significant and timing it with climbing the revenue generation ladder is the delicate balance. And so in Q2, we had made some deliberate investments early on believing that we could convert slightly higher revenue levels, which would have added another 50 basis points to the margin. And then I talked about new program, that it's been very challenging for one of our other sites to introduce. And we had a lot of start and stops and a few missteps along the way, and we're working with that customer. And that probably accounted for another 50 basis points more or less. So those are the 2 issues, specifically, that I think those notwithstanding could have been an extraordinary quarter, but we had a solid one nonetheless.

[Operator:]

Our next question comes from the line of [Jen Wolfertz] with Comstock Partners. Please proceed with your question.

[UnidentifiedAnalyst:]

Hi. Good morning. Changing gears a little bit. I know you've spoken in the past about the importance and the high level of your counterfeit detection business, particularly as a differentiator. Could you give us a little more color around where you stand with that? And does it still continue to be such a key differentiator?

[JeffreySchlarbaum:]

Yes. Good question. Thank you very much. So the counterfeit detection business has evolved, and I talked about, probably last quarter at least and maybe some prior quarters, about an expansion of the business into component up-screening, and that is really where we see future revenue expansion and margin expansion opportunities as the defense customers that we support mandate that the components we procure conform to military grade standards. The only way you can ensure that a component is a military grade standard is to test it. And so in the past, we've had to outsource the testing of the military grade certification to third-party suppliers. And this past year, we were certified by the government now to perform that testing service, not only for the customers that we support, the defends customers we support, but we can also support other companies that we don't do the manufacturing for. And so that business is starting to ramp. We're transitioning the work from outsourced to in-sourced. And that's kind of where we're at, the current stage. So we haven't seen a significant increase in revenue yet. But I think over the next 3 or 4 quarters as we start to bring on additional outside customers that direct their testing demand to us it will not only have an impact on the top line, but we believe it could be an increase in our margins on the bottom line, too. So more to come on that front. But it's an initiative that we've invested in for a couple of years. And now we're just starting to see the very early stages of return on it. And I think we'll be able to give better color on the coming quarters as it comes up to speed.

[Operator:]

Our next question comes from the line of Mike Morales with Walthausen & Co. Please proceed with your question.

[MichaelMorales:]

Hi. Good morning. And thanks for taking my question. I hope everybody is well and safe. Jeff, you commented on supply chain. Can you just expand on that a little bit? And maybe over the past month to the last 1.5 months, comment on any changes that you've seen in the supply chain from a component availability standpoint? And maybe any particular areas of tightness that you're seeing right now that is new or otherwise worsening?

[JeffreySchlarbaum:]

Yes. No, it's a good question. And it's a fluid situation, clearly, the - so I'll kind of give you an array of impacts we've seen. So they're obviously - the first one started when manufacturing operations in China were pausing manufacturing. And so there - because we don't produce directly from China much of our material spends, we do buy electronic components. And we buy most of them through distribution. So distribution was well-stocked and met a lot of our needs. So it's really for a few one-off custom fabricated parts that we bought. So we saw a little bit of supply interruption there in the neighborhood of 3-4 week kind of delays. It wasn't significant, but still a nuisance. Then there are other companies that, not related to China, but related to COVID-19 where they just shut down their operations.And there are suppliers of ours in California that shut down, one specifically I can think of that will be just starting up right now. And so again, we've had sufficient stock. And we carry Kanban quantities of some of these parts that Tom alluded to earlier that our customers are willing to front the deposits to secure the demand. But we've seen some interruptions from companies in the U.S. that have either shut down operations or paused operations. And my biggest fear is the uncertainty around replenishment in the future. The distribution channels have been stocked, I think, well this past quarter. But as those stock piles get consumed, are they going to be replenished? And I think in many cases, the answer is yes. But the uncertainty around which manufacturers may not replenish at the rates at which they were consumed, I think poses some risk. And I just - I'm not able to get clear visibility and on how much risk that impose, but that's probably the one uncertainty that we'll be grappling with.

[MichaelMorales:]

Yes, that absolutely makes sense. And maybe to some extent, you're working with some pretty big name customers, even though IEC itself might be smaller than that. So do you think there's some chance that your customers might be able to use some of their weight in order to maybe help you secure supply in an environment that might be somewhat tight as this does go back to the upswing?

[JeffreySchlarbaum:]

Yes, a little bit. I don't think that's going to be the total answer. I think the bigger answer is us collaborating with our customers on opening up the approved vendor list and allowing us to source from multiple manufacturers. And that's really been the challenge all along in our business is that when our customers specify a single-sourced manufacturer it doesn't give you a lot of wiggle room to procure through alternate means. So it's really working with these customers of ours to identify equivalent manufacturers so we have multiple sourcing options. And that's really the thing that we're working on is opening up that approved vendor list, which will give us greater flexibility for procurement in the future.

[MichaelMorales:]

Great. And I know the company that you talked about in the past, have those conversations been more active with everything that's been going on recently? Or have you seen more flexibility from some of your customers? Or is it still too soon?

[JeffreySchlarbaum:]

No. I mean we've continued - it's an issue we've been working all along. They're obviously highly motivated to maintain continuity of supply. In some cases, they've got a manufacturer they specified, and that's all that works in their design. In other cases, they've listened to our recommendations, and they're going through qualification processes, some quicker than others. And it's helping relieve some of those constraints. So it's kind of a mixed bag.

[MichaelMorales:]

Great. And then just one more, if I could, switching gears onto thinking about with everything that's going on, new business development. Over the past month, 1.5 months, 2 months, have you guys been approached by anybody that maybe you haven't been in the past, whether it's on the medical side, looking to take advantage of your capabilities now that I think you've kind of proven out what IEC can do from an execution standpoint? Or has new business development kind of taken a back burner with everybody just kind of assessing the day-to-day?

[JeffreySchlarbaum:]

That's actually a really good question. Obviously, with this new norm we're experiencing, it's not business as usual, interacting with customers and facilitating new business discussions. Having said that, we have seen a fair bit of new business activity, and we're winning business, like we announced that large defense program, but that's not the only win. We've won other programs. And we have customers that are proceeding to qualify us as a new supplier without performing traditional on-site audits. They're doing things virtually. It's a little more cumbersome, but they're not stopping. And so that's been very encouraging to me that I'm seeing some very positive signs on the business development front that despite the human interaction limitations, we're seeing good progress, and we're seeing customers that have committed to bring us on as a new supplier. They're just having to do it through unconventional means, and it's a little bit slower, but still positive sign nonetheless.

[Operator:]

There are no further questions at this time. I'd like to turn the floor back over to management for closing comments.

[Jeffrey Schlarbaum:]

Great. Well, thank you, again, everyone, for calling in. We wish everyone continued health and safety as we work through the challenges associated with this pandemic. And of course, we look forward to speaking with everyone again next quarter.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.