IEC Electronics Corp.
Q2 2019 Earnings Call Transcript

Published: 12 May 2019

[Operator:]

Greetings and welcome to the IEC Electronics Second Quarter 2019 Earnings Call. [Operator Instructions] Please note that this conference is being recorded. I would now like to turn the conference over to your host, Audra Gavelis, Director of Marketing and Investor Relations. Thank you. You may begin.

[Audra Gavelis:]

Thank you for calling in. On the call this morning, we have Jeff Schlarbaum, President and CEO; and Tom Barbato, CFO. Before we get started, I would like to take a moment to read the Safe Harbor statements. 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 facts but 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 our 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, expect as required by law. I will now turn the call over to Jeff Schlarbaum. Please go ahead, Jeff.

[Jeff Schlarbaum:]

Great. Thank you, Audra. And good morning, everyone. We had a solid second quarter highlighted by revenue of $37.3 million, growth of 17.4% year-over-year and growth of 5.2% sequentially as compared to the first quarter of 2019. With the revenue growth achieved this quarter, we've now posted three consecutive quarters of increasing revenue, which we believe demonstrates the continued maturity of our business and the ability to deliver more consistent top line results. We are now squarely in growth mode, with all three of our market segments seeing improved revenues in the quarter. Our growth continues to be purely organic, driven by our customers who, based on our ability to meet and exceed their expectations, are awarding us new programs and projects. As a full-service electronic manufacturing provider, it's gratifying to see our customers expand their relationships with us and take advantage of the broad solutions we offer. We also continue to selectively onboard new customers who are aligned with our long-term strategy of supply chain partnership and growth. Scaling up new customer programs, especially in the regulated industries we support, can be a lengthy process due to the various quality systems qualification processes and validation requirement to transfer from one manufacturer to another. In addition, we saw continued sequential backlog growth in the second quarter, and our book-to-bill ratio during fiscal Q2 was 1.1

[Tom Barbato:]

Thanks, Jeff. And good morning, everyone. Revenue for the second quarter of fiscal 2019 was $37.3 million, an increase of 17.4% as compared to the second quarter of fiscal 2018 and a sequential increase of 5.2% compared to first quarter 2019. Looking at our market sectors, in the second quarter of fiscal 2019, we saw revenue distribution of aerospace and defense at 62%, medical at 19% and industrial at 19%. The aerospace and defense sector saw net increase of $3 million primarily driven by new programs from existing customers and increased demand on existing programs, offset by temporary demand decreases with other customers. We also saw an increase of $800,000 related to a production ramp from a new customer. Sales in the medical sector were essentially flat compared to the same period of the prior fiscal year. We saw increases from two new programs ramping with existing customers, offset by lower demand from various other customers. And then in the industrial sector, sales increased by $2.4 million primarily due to production ramp of new programs with three customers which amounted to $1.9 million of quarter-over-quarter growth. We also saw increased demand from several customers whose end markets have grown, by modest decreases in demand from other customers. Gross profit for the second quarter of fiscal 2019 was $4.6 million compared to gross profit of $4.8 million in the second quarter of fiscal 2018. Gross margin of 12.3% in the second quarter of 2019 decreased as compared to gross margins of 15.1% in second quarter of 2018. The impact from the previously mentioned tariff issue was approximately 0.5% in the quarter. Selling and administrative expenses increased $400,000 but reduced to 8.9% of revenue when compared to the second quarter of fiscal 2018 which was at 9.2%. The increase in expense was primarily due to higher wage and related expenses. The company recorded net income of $700,000 in the second quarter of fiscal 2019 or $0.06 per basic and diluted share compared to net income of $1.6 million or $0.15 per basic and diluted share in the second quarter of fiscal 2018. Now looking at the results the first six months of fiscal 2019. Revenue increased 37.4% to $72.7 million compared to $52.9 million in the prior fiscal period. Growth was primarily driven by increases in sales in the aerospace and defense sector of $8.7 million, an increase in the industrial sector of $5.6 million and an increase of $5.6 million in the medical sector. Gross profit increased $3.3 million from 11.9% of sales in the first six months of fiscal 2018 to 13.3% of sales for the first six months of fiscal 2019. Selling and administrative expenses increased $1 million but decreased as a percentage of sales to 9.2% in the first six months of fiscal 2019 compared to $5.7 million or 10.8% of sales in the prior fiscal period. The increase in selling and administrative expenses was primarily due to higher wage and related expenses. Net income for the first six months of fiscal 2019 was $1.7 million or $0.17 per basic share as compared to net income of $1.1 million or $0.11 per basic share in the same prior year period, which included a onetime tax benefit of $1 million and further highlights the overall improvement in our operational performance. Now looking at our balance sheet. Our balance sheet remained strong with $33.4 million in working capital and $28 million in stockholders' equity. You will see that inventory at March 29, 2019, was $38.8 million, up compared to $34.1 million at September 30, 2018. As we've discussed on prior calls, our inventory levels are directly associated with preparing our ability to convert our backlog. In the second quarter, we had increased inventory as we prepared to execute orders and attempted to mitigate the risks associated with the ongoing component shortage. We continue to see willingness of some of our customers to help mitigate the impact of the global component shortage, which is reflected in a $2.6 million increase in our customer deposits since September 2018. With that, I'll turn it back to Jeff.

[Jeff Schlarbaum:]

Great. Thank you, Tom. As we entered the second half of fiscal 2019, we'll continue to build on our strong start by remaining focused on our three strategic initiatives

[Operator:]

[Operator Instructions] Our first question comes from the line of Christian Herbosa with NOBLE Capital Markets. Please state your question.

[Christian Herbosa:]

I just have a couple. So your long-term debt position saw a pretty sharp increase, so can you provide us with a little more color on what else is involved there and how you feel about your debt position overall?

[Jeff Schlarbaum:]

Yes. Let me have - I'll let Tom field that question, Christian.

[Tom Barbato:]

So Christian, the increase in our long-term debt is basically tied to our revolver balance and tied directly with the increased level of inventory we've seen over the past nine months. So we continue to be focused on finding the right balance between our inventory level and mitigating the supply chain risks that we're seeing and with a focus on consuming the inventory that we have to help drive down our inventory balance and therefore drive down our debt levels over the upcoming quarters.

[Jeff Schlarbaum:]

Can I just add to that also that we saw increasing inventory levels sequentially for three straight quarters, more or less? And then the last quarter started to - we saw some leveling off. So as I look forward out into the future, if we don't see any major increases in customer demand, we should start to be able to drive the inventory back down in the other direction. But clearly, we're in growth mode and our bookings are strong, and I believe that we'll continue to book even higher numbers of orders. So it's a balancing act.

[Christian Herbosa:]

Okay. Great. Thanks guys for the color. So I also wanted to ask about your labor force. So I guess you'd spoke a bunch about it in your comments, but in the past, you've mentioned that it takes a while to get new employees up to a full run rate. So I'm wondering how you feel about your workforce now and if you think that it could represent a bit of a constraint going forward at all.

[Jeff Schlarbaum:]

So it's an excellent question. As I said before, we're scaling the business not only to meet the needs today from our customers but to meet tomorrow's needs. And tomorrow is really I'm looking out into future quarters and into next year. And we see very strong demand, so it's not a static issue. We're onboarding employees and it's a continuum. They're coming up the learning curve at various levels of skill and predicated on the types of products that were awarded. Some require higher levels of skill, some lesser level of skill. Some are more complicated than others so I think it's going to be an interim process. And I think we're going to be in this position of continuing to scale our workforce for some time to come because we see strong demand signals from our customers. So today, I think we're in good position with the workforce additions we've had, but we'll really be focused over the next several quarters on developing the skill set of those new hires. But also, our forecasts indicate that we'll be hiring others right behind them because the demand signals continue to be strong. Hope that helps a little bit.

[Christian Herbosa:]

Okay. Yes. So that's all from me. Thanks for your time.

[Operator:]

Our next question comes from the line of Nehal Chokshi with Maxim Group. Please state your question.

[Nehal Chokshi:]

So congrats on maintaining that $40-plus million bookings quarterly run rate that's definitely great to see and gives me a lot of confidence that you will indeed build [ph] new growth 10% year-over-year as you've reiterated here. So [indiscernible] into that, though, you guys did lap your toughest year-over-year compare for this fiscal year, that being 49% year-over-year growth in the prior year ago quarter, with a 17% year-over-year growth for this March quarter. So between the continued strong bookings and lapping the toughest compare, it seems like you're share [ph] churning well better than 10% year-over-year growth, yet you're not increasing your top line guidance. So can you discuss that there?

[Jeff Schlarbaum:]

And again it's a great observation, and I think you're right on the mark. As I said before, Nehal, in the past, as we pivoted away from the transformation phase, now we're squarely in this growth mode, it's still a growing business. And we're developing a more mature base and we're not quite at the maturity levels yet, but I have clarity around not only the scaling of the workforce, the supply chain challenges that we've been confronted with and then just the nature of the new programs that we're building oftentimes in the early phases of the low-rate initial production, there's a lot of collaboration that's happening with our customers that are addressing engineering or design challenges. And so with all those factors together, I don't want set an unrealist [ph] expectations and I will, I think, tighten up outlook as we go forward. But today, I can tell you we still see very strong outlook obviously greater than 10%. I think it could be much stronger than that. And I'll just ask that you give me a quarter or two, as we established greater maturity, to give you more specific guidance. But I think you have implied in your question and I'm acknowledging that we see much greater growth prospects in the future.

[Nehal Chokshi:]

Okay. Very good. You did mention I guess, no, you didn't mention this. I'm wondering if you would be willing to discuss how did bookings perform relative to your internal expectations when you had your last call relative to your - well, what's your expectations were when you had your last conference call.

[Jeff Schlarbaum:]

Yes. I mean I think I'm really pleased that our bookings I expected our bookings to exceed our revenue. And our revenue, we believe, will continue to increase. We have the backlog to drive the increased revenue. And with the workforce-scaling investments and with some cooperation with the component marketplace, I see that continuing to scale forward. So I mean it met my expectations that we were going to exceed bookings to revenue and I'm bullish that we will continue that trend in the foreseeable future.

[Nehal Chokshi:]

Okay and it sounds like the main delta that you observed during the quarter in terms of customer relationships was a need to have this discussion that, “hey, the raw cost of materials is going up. Our quotes did not take that into consideration.” Did that impact in any way the follow-on orders or the amount of share that they're willing to allocate IEC?

[Jeff Schlarbaum:]

No, no. They really haven't because it's a broad industry issue. And just to clarify

[Nehal Chokshi:]

Okay. Very good. Moving down the income statement, so gross margin at 12.3%. Thomas, you mentioned that tariffs had about 50 basis points impact. Is that on a Q-o-Q basis or a year-over-year basis?

[Tom Barbato:]

That's on a year-over-year basis.

[Nehal Chokshi:]

Okay. And so the balance of the year-over-year decline, which was 276 basis points, was you would largely allocate that to proactively investing in the workforce then.

[Jeff Schlarbaum:]

Investing in the workforce and then there was a mix issue, as you know. So if you look at the mix of our product, some higher material content in this particular quarter that we hadn't anticipated, I think a part of that is due to some of the early phases of the new customers that we're onboarding would tend to see higher materials cost than when we get into higher volumes of production. And then additionally, we had investments in labor that weren't fully absorbed because we had anticipated shipping higher volumes.

[Nehal Chokshi:]

You did anticipate shipping higher volumes, you said.

[Jeff Schlarbaum:]

Yes, correct.

[Nehal Chokshi:]

Okay, all right. And then you also mentioned that gross margin was at the low end of expected range, but I don't believe you communicated a range for the March quarter call. So are you willing to give a range for the upcoming quarter?

[Jeff Schlarbaum:]

Let's see. Let me answer it this way. So sort of with the revenue outlook as well, Nehal, I think, as we get more mature in our business, that there'll come a time when we can say more confidently with all the moving pieces that we understand within a tighter band what our margins are likely to be. So for now and I won't give you specific guidance, but if I look at Q1, we had a solid quarter in Q1 margin-wise. I see us continuing to grow the sales and moving back towards that margin area that we experienced in Q1 and for now let me stick with that, and then we can revisit it as we get through other quarters.

[Nehal Chokshi:]

That's very helpful. A couple more questions. So DSOs were up about six days year-over-year. Is it fair to say that the shipments were more back-end loaded than a year ago? And if so, why?

[Jeff Schlarbaum:]

I just think it's we have more demand and we still have component challenges that are breaking late in the quarter and so that also contributes to some of the inefficiencies in the earlier part of the quarters, where we're not fully utilizing our staff and overhead. And then as late-breaking components happen in the quarter, it pushes production later in the quarter and we get a nonlinearity issue. So we just had greater level of demand this quarter and a high number of late-breaking shortages that caused a nonlinearity.

[Nehal Chokshi:]

Okay. Great. My final question, for Thomas. So you've been with IEC now, I think, for about eight months. I'd love to hear from you what you think you can improve, especially given your big company experiences - Xerox.

[Tom Barbato:]

Yes. That's a good question, Nehal. I think the biggest area we could approve is obviously around operational efficiency. And some of that will come with the component shortages kind of resolving themselves and allowing us to become much more linear. And I think I get excited about the step we've taken in the past couple weeks with ERP and the benefits that we're going to get from the ERP system as we continue our implementations. And we get better data. We have much tighter handoffs within the system versus a lot of the manual processes that we have taking place today outside of the system. So I would hone in on those two areas.

[Operator:]

Our next question comes from the line of Mike Morales with Walthausen. Please state your question.

[Mike Morales:]

Can you guys remind me of the time that it takes to - and I know this is going to depend on the program, but the time that it takes to train an employee from hiring to productivity essentially?

[Jeff Schlarbaum:]

Yes. It's a great question, Mike. I hate to say it really depends, but it does. It depends. We have some employees that have been with us for more than a decade and are proficient at many different skills and in many different job functions. And some of the newer people that come in may be proficient in one area but may not be proficient in other job functions. And so it's the diversity of skills that allows to be more efficient in moving our workforce to where the demand spikes are. And so we can bring somebody in and in six months' time have them fairly proficient in an area, but the workers that give us the most flexibility are the ones that are adept at the skills in multiple job functions so they can pretty much handle any type of production demand that comes their way. And in that case, it can take a year or years to develop that kind of skill.

[Mike Morales:]

Sure. Is there a specific function that you can point to that you think is seeing the most training being done in that area?

[Jeff Schlarbaum:]

I think for us its electronic circuit card assembly is the core of our manufacturing services. It's the non-automated areas of assembly that are the areas that, when we're hiring, we're pointing our training efforts at. So those are a lot of hand soldering, really intricate hand soldering operations; as well as a lot of backend what we call higher end assembly, so transforming the product into a finished product. So those are really the two areas we're spending the majority of our time focused on skill development.

[Mike Morales:]

Sure. As you think about the balance of 2019, do you see a point where some of the new employees that you've been onboarding over the past few months will offset any of the margin dilutive impact of onboarding new employees? Or is a lot of the gross margin improvement that I think you answered in a previous question going to come from mix? Help me understand that.

[Jeff Schlarbaum:]

I don't think we're expecting a huge change in mix. I think there'll be some quarter-to-quarter variation, but overall I think the mix will stay fairly, in a fairly static range or band. I think the efficiency improvements are going to become from better utilizing the workforce as it's coming up the learning curve and becomes more efficient in how they're deployed. I think we're also going to see some benefits of maturity of the supply chain as we get through builds one and two and into the higher volume builds. We're not stopping and starting. Stopping and starting is hugely inefficient. And I think, once we get in a rhythm with a supply chain and with a particular product, we'll get efficiencies as well there, too. So those are probably the two areas I think of the most that will help improve efficiencies and then, hopefully, margin contribution in the future.

[Mike Morales:]

Sure. Would you be willing to disclose turnover metrics for both new employees that you bring on as well as existing employees?

[Jeff Schlarbaum:]

I'm not prepared to talk to them today, but it's a fair question. And I'll take that under consideration and maybe we can factor that into some future outlook.

[Mike Morales:]

Sure. And then I guess, just more broadly speaking, the last one for me is, how do you think about labor availability around the Rochester area. I mean it sounds like, to support this growth, you're going to continue to need bringing new people into IEC. How do you resolve the need to do that with the state of the economy, especially if it keeps growing?

[Jeff Schlarbaum:]

Yes. It's a great question. I mean I think, if you look at the broader indices, I mean, unemployment rates are low, whether in Rochester or whether you're in some major metropolitan city. So for us, we believe that the market itself in Rochester is more than sufficient to supply the workforce needs that we see being required for future demand fulfillment. So I think we're well positioned in this area. It's just, as I said before, the skill development phase where we have a very unique set of products and technologies our customers have developed. And so those workers aren't readily available with those specific skills, but I think the talent pool in the greater Rochester area is sufficient enough to meet our needs.

[Mike Morales:]

Sure. So the employees are out there. The difficulty is just getting those employees up to speed quick enough in order to support the growth. Is that a fair way of characterizing it all?

[Jeff Schlarbaum:]

Yes, it's a very fair to characterize it that way.

[Mike Morales:]

All right. Thank you Jeff for the color I appreciate it. That's all from me.

[Operator:]

As there are no further questions up in the queue, I would like to turn the call back over to management for closing remarks.

[Jeff Schlarbaum:]

Well, great. That's concludes our formal presentation. Appreciate everybody calling in, and we look forward to speaking with everyone again next quarter.

[Operator:]

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