IEC Electronics Corp.
Q3 2019 Earnings Call Transcript

Published: 11 Aug 2019

[Operator:]

Greetings and welcome to the IEC Electronics’ Third Quarter 2019 Conference Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.It is now my pleasure to introduce your host, Ms. Audra Gavelis, Director of Marketing and IR. Please go ahead, ma'am.

[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 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, 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, except as required by law.I will now turn the call over to Jeff Schlarbaum. Please go ahead, Jeff.

[Jeffrey Schlarbaum:]

Thank you, Audra, and good morning, everyone. Our third quarter results represent a breakthrough quarter for IEC. When I rejoined the Company in 2015, we immediately began restructuring our operations to reestablish customer confidence and reengineering our go-to-market strategy to broaden our sales funnel. We also established an internal quarterly revenue goal of $40 million.Now four years later, we are pleased to have surpassed that goal by delivering fiscal third quarter revenue of $40.3 million, which represents a 35% increase compared to last year's fiscal third quarter and an 8% sequential improvement compared to the second quarter of fiscal 2019. This quarter represents our fourth consecutive quarter of revenue growth, with all three market segments showing improved revenue.We also experienced improved profitability, achieving overall gross margins of 13.9%. So our fiscal 2019 third quarter was a very solid quarter for IEC. Our strong growth rate has been fueled by the addition of new programs and projects from existing customers, which is a direct reflection of and reward for our proven ability to meet and exceed customer expectations.In addition, we continue to onboard and ramp up brand new customers with revenue contribution from these new customers in the quarter totaling more than 10% of sales. We continue to enhance our reputation as reliable, full service electronic manufacturing provider for high complexity programs in highly regulated markets, and we're pleased that our customers recognize the value of our integrated offerings.Increasingly, we are seeing customers choose to expand their partnerships with IEC across the broad portfolio of vertical solutions we can provide to their supply chain. Not only are we growing our share of business with customers committing greater portions of their outsourcing to IEC, some of these commitments are now representing multiyear awards, demonstrating our customers' growing confidence in our strategic partnerships.An example of this is the recent $50 million award we announced in May 2019 from a top aerospace and defense customer. While we have supported all the circuit card assemblies for this particular program in the past, this award will utilize a broader array of our vertical services, representing a cradle-to-grave solution, including advanced order fulfillment and aftermarket services, including spares, repairs and upgrades.In addition, the award represents multi-year demand, which we estimate will start to fully ramp up beginning in the first quarter of calendar 2020, signifying this customer's continued commitment to fostering an ongoing partnership with IEC. On a related note, we had a very strong bookings quarter with a book-to-bill ratio of 2.5

[Thomas Barbato:]

Thanks, Jeff, and good morning, everyone. Revenue for the third quarter of fiscal 2019 was $40.3 million, an increase of 35.4% as compared to the [second] quarter of fiscal 2018 and a sequential increase of 8% compared to second quarter of fiscal 2019. Looking at our market sectors in the third quarter of fiscal 2019, we saw revenue distribution of aerospace and defense at 61%, medical at 22% and industrial at 17%.The aerospace and defense sector saw a net increase of $7.6 million, primarily driven by ramping of production for certain customers and increases in customer demand. The increases in the quarter were partially offset by decreases of $0.5 million related to certain contracts ending.Sales in the medical sector increased $1.9 million, primarily related to three new programs ramping with existing customers and $0.5 million revenue increase from a customer where material constraints removed in the quarter. The increases were partially offset by reductions in demand from certain customers that amounted to approximately $0.5 million. We expect the medical sector to begin to stabilize with the current forecast we are seeing from our customers.Industrial sector sales increased by $1 million, primarily due to production ramp of new programs with two customers. Gross profit for the third quarter of fiscal 2019 was $5.6 million compared to gross profit of $3.4 million in the third quarter of fiscal 2018. Gross margin of 13.9% in the third quarter of fiscal 2019 increased as compared to gross margins of 11.3% in the third quarter of fiscal 2018.Selling and administrative expenses increased $900,000, but came down as a percentage of revenue to 9.2% as compared to the third quarter of fiscal 2018, which was 10.3% of sales. The increase in expense was primarily due to higher wage and related expenses. The Company recorded net income of $1.2 million in the third quarter of fiscal 2019 or $0.12 per basic and $0.11 per diluted share compared to net income of $0.2 million or $0.02 per basic and diluted share in the third quarter of fiscal 2018.Now looking at the results for the nine months of fiscal 2019. Revenue increased 36.7% to $113.1 million compared to $82.7 million in the same fiscal period. Growth was primarily driven by an increase in sales in the aerospace and defense sector of $16.3 million, an increase in the medical sector of $7.8 million and an increase of $6.3 million in the industrial sector.Gross profit increased $5.6 million from 11.7% of sales in the first nine months of fiscal 2018 to 13.5% of sales for the first nine months of fiscal 2019. Selling and administrative expenses increased $1.9 million and decreased as a percentage of sales to 9.2% in the first nine months of fiscal 2019 compared to $8.5 million or 10.3% 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 nine months of fiscal 2019 was $3 million or $0.28 per basic and diluted share as compared to net income of $1.3 million or $0.12 per basic and diluted share. Excluding a $0.10 onetime tax benefit during the first nine months of fiscal 2018, net income was $0.02 per basic and diluted share.Now looking at our balance sheet. Our balance sheet remains strong with $36 million in working capital and $29.3 million in stockholders' equity. You'll see that inventory at June 28, 2019, was $44.9 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 our ability to convert our backlog.In the third quarter, we had increased inventory as we prepare to execute orders and attempted to mitigate the risks associated with the ongoing component shortages. In addition, we have seen ongoing commitments from our customers in the form of customer deposits. Hence, keeping approximately 20% of our inventory consistently covered. In addition, on July 8, 2019, the Company entered into the ninth amendment to our credit facility and increased the revolving credit commitment to $35 million.With that, I'll turn it back to Jeff.

[Jeffrey Schlarbaum:]

Great. Thank you, Tom. At the start of fiscal 2019, we reaffirmed our three strategic initiatives

[Operator:]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] The first question is from Aman Gulani, B. Riley FBR. Please go ahead, sir.

[Aman Gulani:]

Hey, guys. Thanks for taking my question and congratulations on a solid quarter. So my first question is any part of your business impacted by the grounding or rate cut of the Boeing 737 MAX?

[Jeffrey Schlarbaum:]

Zero. No, we don't have any commercial aerospace. It's all defense related.

[Aman Gulani:]

Got it. Okay. And then just looking at that DLA contract or that win, have you started testing for that opportunity already?

[Jeffrey Schlarbaum:]

So we have obviously achieved the certification. We have major aerospace and defense customer who has also approved the transition of the testing to our in-house lab versus using a third-party. And we expect that the ramp-up of that testing will begin most likely towards the latter half of the current quarter of Q4, but may slip into the first fiscal quarter next – of our upcoming year. So it's very, very close, Aman. So it's just a matter of getting it ramped up and transitioning some of the testing over.

[Aman Gulani:]

Okay. And I know you said you were sort of outsourcing your testing previously. I mean, just based on that, like how much do you think like the opportunity is on an annual basis?

[Jeffrey Schlarbaum:]

It's a great question. There's a whole host of different types of testing that's performed. So at the most basic level, you can start with passive components, the discrete components like resistors and capacitors, but then scale it all the way up to very active components like memory and CPUs. So we're starting at the passive level, capacitors and resistors.And over the course of time, as we expand the capability, we'll be able to climb the ladder. So it's hard for me to sense, with so new, to really get a handle on the revenue generation potential in the foreseeable future. But I guess, after like the first quarter or two as we get the testing underway, it will be much more visible to us, but it's millions of dollars. So it's not like it's a trivial amount. It's just a matter of how quickly we can come up the curve.

[Aman Gulani:]

Got it. Okay. That makes sense. Last question for me. Are you seeing any weakness in any particular end market you may serve?

[Jeffrey Schlarbaum:]

Currently, it's pretty steady across the spectrum. We are seeing the greatest amount of strength, obviously, in the aerospace and defense sector. I think in the broader macro market, if you look at the major A&D primes, they're doing quite well with very strong backlogs and earnings performance. So naturally, we're seeing very strong demand there. But it's holding steady in the other two sectors as well. We're not really seeing much softness.

[Aman Gulani:]

Got it. Thank you. I’ll pass it on.

[Jeffrey Schlarbaum:]

All right. Thanks, Aman.

[Operator:]

The next question is from Nehal Chokshi, Maxim Group. Please go ahead.

[Nehal Chokshi:]

Yes. Thanks and congrats on that phenomenal $100 million booking this quarter. That's really awesome. And thank you for that additional color regarding if you backout product deliveries that are beyond 12 months, book-to-bills of 1.8

[Jeffrey Schlarbaum:]

Yes, it's a good clarification. So, nice talking to you, Nehal. The backing out of demand was really related to specifically that particular award. Since it's a significant magnitude, I want to give a little bit more color that had we just received that program award, but for a year's time horizon, we still would have delivered a 1.8

[Nehal Chokshi:]

Okay, understood. And then, so you're now talking about at least 25% year-over-year growth in fiscal year 2019, which is a nice bump up from at least 20% year-over-year growth previously that you were willing to commit to. But you now only have one quarter left.And so you're now effectively providing explicit September quarter guidance with that updated fiscal year guidance. And that equates to a worst case scenario of $33.5 million for the September quarter or down 17% Q-or-Q. So one, my presumption is that this represents the worst case scenario and doesn't much reflect the low probability outcome as far as this lower limit. Is that correct?

[Jeffrey Schlarbaum:]

I'm glad you bring it up Nehal. That's correct. And let me just provide some clarification there. We have publicly been talking about double-digit growth quarter-over-quarter as we have these earnings calls and as it is related to our year-over-year sales expectation. And to your point, our growing confidence inspired us to provide greater guidance, and we easily see in excess of 25%. We could have gone on the record as saying more.But look, we have this $40 million revenue target for some time, and because of the scaling of the workforce, the component challenges, we didn't want to be too optimistic, I guess, about eclipsing that level and levels beyond until we saw it ourselves and then now just having a few more quarters under our belt, but we're certainly bullish. We have the demand.Obviously, our backlog continues to grow. And we believe that we'll continue to see sequential growth. That's candidly where we see ourselves at. But at this new unprecedented level for us, it's one in a row, right. So we got to demonstrate that we can do this consistently for me to have greater confidence that I can go on the record to say when I think it's going to be in the future. So hopefully, that helps you.

[Nehal Chokshi:]

Yes, that does help. I guess, and you did describe what would need to happen for this lower probability outcome to transpire, which would be a) you might have some disruption with respect to the ramp in the workforce that you had? And then obviously, the component charges potentially picking up and the mitigation factors that you've put in place not being enough to mitigate that. That's the risk that you're trying to protect against basically?

[Jeffrey Schlarbaum:]

Exactly, yes. That's well said.

[Nehal Chokshi:]

Okay. All right. On the flip side, what would need to happen for the low probability outcome of a Q-o-Q growth to transpire?

[Jeffrey Schlarbaum:]

I think just more of what happened in Q3, which is we broke free of a number of the supply chain challenges that had confronted us in the prior quarters, and so continued success there, and then obviously, with some of these newer programs continuing to gain traction, climbing the skill level with our workforce to produce these newer programs at higher levels, which we were successful in doing in Q3. So it's not a mystery for us what it's going to take. And it's not a matter of if, but when. But again, it's our first quarter and I want to sort of take it one step at a time.

[Nehal Chokshi:]

Okay, great. I'll get back in the queue. Thank you.

[Jeffrey Schlarbaum:]

Thank you, Nehal.

[Operator:]

We have a question from Chris Sakai, Singular Research. Please go ahead, sir.

[Christopher Sakai:]

Hi. Good morning. My question, I guess is with regard to the backlog. I wanted to know, is there a – do you have a target level? And is there a point when the backlog could get too big?

[Jeffrey Schlarbaum:]

That's a great question. Obviously, the backlog represents order commitments from our customers. So as it relates to the backlog becoming too big, we introduced this particular earnings call, this notion that our customers are now booking out beyond 12 months of demand.So I think as that continues to evolve, growing backlog levels that go out multi-years presents a lot of security and confidence and visibility for us that we're not chasing our next new order. So I don't think that the backlog level growing – we don't envision there is a backlog level today that we could achieve that is unhealthy because I think as long as we continue to book out orders beyond a year and in multi-years, that's great for us and our ability to manage the business.

[Christopher Sakai:]

Okay. I just also had a question. You mentioned that you had a lot of new hires this year. How much of that – was there costs related to that for training? And will those costs be reduced in the future?

[Jeffrey Schlarbaum:]

Yes, that's a fair point. So clearly, there's a cost to recruit and onboard and train new employees. And to the extent that we continue to grow, we will continue to recruit, onboard and train future employees. But obviously, there will be efficiencies that we gain as the new employee skills continue to improve over time.So I think the magnitude of how many future hires, we might hire versus what we've done in the past, there could be some potential reduction in onboarding, training and recruiting expenses. But it's hard for me to say right now because the backlog continues to grow, and we're going to continue to scale to support the demand we have.

[Christopher Sakai:]

Okay. Thanks for that, and good quarter.

[Jeffrey Schlarbaum:]

Great. Thanks, Chris. Nice talking to you.

[Operator:]

The next question is from Shawn Boyd, Next Mark Capital. Please go ahead.

[Shawn Boyd:]

Congrats on the quarter. Can you guys hear me okay?

[Jeffrey Schlarbaum:]

Yes, we hear you great. Thanks.

[Shawn Boyd:]

Great. Several of my questions have been asked, but I do want to get into just a couple. On the inventory, anything in there about customers trying to front run tariffs? Or is it more just as you guys try to manage through the component issues and as you scale up for new programs?

[Jeffrey Schlarbaum:]

It's really the latter. And it's absolutely the latter. When we look at the demands from our customers, it's become more of an art form versus a science on selecting the timing which we're going to bring in all of the material required to confer to a particular job. Some of these parts, as we go out and do the initial procurements, can have lead times that extend out 26 weeks or more. So you are talking over six months.And yet, we've collaborated with our customers in trying to select scheduling targets where we can achieve improved lead time, but it's – again, it's more of an art form than it is a science. So in this past quarter, we found ourselves bringing in significant number of parts that we weren't able to clear the last couple to convert them into finished products.So we have them here, and as we clear those remaining parts, we'll be able to convert them into product and deliver for our customers. But they really appreciate our willingness and flexibility to do that versus setting the lead time out six months and having delayed, which then puts them at risk of missing their end customer deliverables. So it's really just a collaboration between the two of us, which has resulted in some increased upward pressure on the inventory levels.

[Shawn Boyd:]

Right. And that coverage level of basically having 20% – the customer deposits covering 20% of the inventory. Are we getting any pushback on that? Is there – I'm guessing that's just kind of the way we roll right now, given the way the market is and what you're having to deal with. But do we expect that to change at all as we go forward? What's your view on that coverage there?

[Jeffrey Schlarbaum:]

Yes. I mean, first and foremost, it demonstrates that there's real strong positive collaboration between us and our customers. And in many cases, where they want to mitigate future risk and with the uncertainty of when all the parts can be cleared, they're willing to make a financial commitment to say, hey, IEC, we'll give you air cover financially to just go get all the parts now, even if it's only 95% of them, and the last 5% are going to be six months from now. At least, we mitigate the risk of the other 95% of the parts not being available when we need them.So I think it just shows that our customers are continuing to support the collaboration efforts and are willing to put economic commitments behind it. So I think that's sort of the current state of the business until the component shortages improve significantly. We won't have to entertain these types of arrangements, but until the marketplace improves, our customers want to mitigate the risk and they're willing to make the financial commitment to do so, which we appreciate.

[Shawn Boyd:]

Got it. Got it. And so just in terms of the gross margin, I think on the last call – on the last earnings call, you had indicated you expected to see that recover and churn up here we are recovering quite well.Do you still anticipate seeing that kind of something back to that Q1 level? Or maybe just frankly, it's not that far from the 13.9%. And maybe if you can give us any color on how that backlog looks in terms of your gross margin as we go into next year?

[Jeffrey Schlarbaum:]

Yes. So fair points and we believe that when you look at – you referenced Q1 margins, you look at where we were with the Q3 margins, they're not significantly different, but they're slightly better in Q1. I mean, those – that's a margin range we're comfortable with. The factors that are hard to predict are the mix issues, so some projects are more profitable than others based on the mix.Obviously, ongoing expenses associated with bringing up or scaling our workforce, but I think that's a margin range we're comfortable in. And as we get a few more of these quarters where we've consistently eclipsed the $40 million mark, I'll be more confident in giving you some longer-range gross margin projections.

[Shawn Boyd:]

Okay. And also on – in response to an earlier question regarding the strength in those orders and giving you the visibility to now talk about revenue growth in excess of 25%, but you also – and you had hit this $40 million quarter, you'd also hope to grow that sequentially.So – and that from a seasonality perspective, that all makes sense in September. I don't want to push too hard, but I do want to point out that given the Company's growth that you've really entered in the last couple of years, and especially this year, you were down in December after that, you were up again. So is your order really strong enough that we could see that again this year?

[Jeffrey Schlarbaum:]

Great question and I appreciate you pushing this a little bit further. And of course, I've always kind of held my ground and wanted to let things unfold as we really are building an entirely new business today versus what it was in the past. But no, I don't think that's an unreasonable expectation that we can't see continued sequential growth. So I guess I just would leave it at that for now.

[Shawn Boyd:]

Yes. Okay. And just last question for me is kind of longer-term. We're a year or two years into a great expansion here. Now that we're at this $40 million a quarter level, what you're building the business for? In other words, can you run this at a 10%, 15%, 20% growth rate going forward? What's your kind of target growth rate now?

[Jeffrey Schlarbaum:]

So I think I'll just use your words in terms of can we grow at those rates that you just articulated, and we believe the answer is, yes. We believe the answer is absolutely yes. We're investing heavily in systems. We're heavily investing in workforce expansion. Infrastructure, we have a new building that's under construction.So that's all with an eye to grow at very solid growth rates that are ahead of our peer group and our competitors. So that's how we're designing the company and that's our focus. So that's we – we're going to continue to pledge our efforts to achieving. So I think what you articulated in the beginning of your question is where we're headed.

[Shawn Boyd:]

Very good. And just last question for me, Jack or – Jeff, at the – as you go into the Newark facility next summer, can you just remind us how we should think about the revenue – what's this whole revenue capacity of the company once you've made that move?

[Jeffrey Schlarbaum:]

So that would be giving you sort of guidance for next year's revenue, and I'm not prepared to do that today. But when you think about our strategy, we'd like to occupy this new building and capitalize on the process improvement and efficiencies with a new layout, so – by therefore transitioning much of the work that's in our current facility that we have today.So it's really an investment in continued capturing of efficiencies and then building the foundation to scale the business beyond it. I'm not prepared to tell you today what I think the revenue is going to be when we're there. But let things unfold, but we envision continued sequential growth. So better times ahead, we assume, but can't predict quite what the revenue levels are going to be at that time. So we'll continue to give you updates as we go.

[Shawn Boyd:]

Got it. Well, congratulations. It's great to see and good luck going forward.

[Jeffrey Schlarbaum:]

Great. Appreciate the questions. Thanks a lot.

[Operator:]

We have a follow-on question from Nehal Chokshi, Maxim Group. Please go ahead.

[Nehal Chokshi:]

Yes, thanks. How should we think about the working capital accounts for the September quarter?

[Jeffrey Schlarbaum:]

Tom, you want to try to take that and if any clarifications from Nehal or not?

[Thomas Barbato:]

Yes. I mean, I think the goal is we would see similar levels. We believe that we're kind of positioned with where we are with our current inventory levels to start consuming inventory versus building inventory in the quarter. But there are so many dependencies on that, right? So – but I think you should think about it in terms of similar levels with an opportunity to improve slightly on where we are at.

[Jeffrey Schlarbaum:]

Yes, I would just say, Nehal that it's kind of like that the revenue threshold that we just achieved first time and it was sort of overdue, but sort of long in the making. I think we've been building inventory because the demand keeps increasing. But at some point, we see our conversion rate improving and the supply chain cooperating, so we're able to draw it down. And whether that happens next quarter, we – certainly as we look into 2020, we see us being able to take advantage of that and improving the working capital.

[Nehal Chokshi:]

Okay. And when you say similar, you're talking about on a Q-o-Q basis, correct?

[Thomas Barbato:]

That's correct. Yes.

[Nehal Chokshi:]

Okay, which would then be up year-over-year, and I think if I look at past historical seasonality, it's typically been down Q-o-Q. And so the typical free cash flow generation that you get in the fiscal fourth quarter may not come to fruition because of the needs to support the growth in the tight component issues, especially on the sole-source items, correct?

[Jeffrey Schlarbaum:]

Yes. I think that's a fair way to look at it. And I think we have opportunity to do better, but we got to deliver on that first. So I think that's a fair expectation for now.

[Nehal Chokshi:]

Okay. And you probably did say this, but I didn't capture it. So I'm going to ask it, again. When do you expect the tightness on the sole-source components to start to loosen up?

[Jeffrey Schlarbaum:]

Well, that is a great question, Nehal, and one I wish I had an answer to, but I don't. The interesting thing, and you follow this closer than we do, but for a lot of the consumer goods, whether you're looking at the 5G rollout with smartphones or you're looking at the automobile electronics or you're looking at the cloud storage with server capacity, a lot of the mainstream components we've seen from the supply base improve lead times. Sadly, we don't procure many of those.Most of the packet sizes and component types are on these highly – high reliability applications. And so they're not the volume products that the manufacturers are producing. So we've seen continued improvements. So there's no doubt that we've seen continued improvement.When it improves for the package types and component styles that we're manufacturing completely, I still don't know, but we do see kind of quarter-over-quarter modest improvements. So I think we'll just continue to see modest improvements over the course of time. It's the best I got for now.

[Nehal Chokshi:]

Okay. That's great. Thank you very much.

[Jeffrey Schlarbaum:]

Hi, Nehal. Nice talking to you.

[Operator:]

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

[Jeffrey Schlarbaum:]

Great. Well, thank you, everyone, for calling in today. We appreciate it, and we also look forward to speaking with everyone again next quarter. Thank you.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.