IEC Electronics Corp.
Q3 2016 Earnings Call Transcript

Published: 10 Aug 2016

[Operator:]

Greetings and welcome to the IEC Electronics Third Quarter 2016 Financial Results Conference Call. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce your host Mr. John Nesbett of IMS. Thank you sir, you may begin.

[John Nesbett:]

Good morning and thank you for calling in. And on the call this morning we have Jeff Schlarbaum, President and CEO, as well as Michael Williams, 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, anticipates will occur and other statements include but are not limited to, statements regarding future sales and operating results, future prospects, strategic initiatives, turnaround efforts, the capabilities and capabilities 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 correctness 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 differ than a 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 nearly before this call and in the Company's most recent annual report on Form 10-K and other reports filed with the SEC. The Company undertakes no obligation to publicly update or correct any of the forward-looking statements contained herein whether as a result of new information, future events or otherwise expect as required by law. I would now turn the call over to Jeff Schlarbaum. Please go ahead Jeff.

[Jeff Schlarbaum:]

Thanks John, good morning everyone. We delivered strong third quarter results characterized by improved profitability and consistent margin performance. Additionally, we continue to make progress strengthening our balance sheet, significantly reducing both our net debt and our inventory position by $4.7 million and $3.8 million respectively. Revenue was essentially flat for the quarter as we have communicated in previous calls during the fourth quarter of 2015, an industrial customer had shifted a portion of their outsourcing spend to a competitor resulting in a loss of approximately $10 million of annual revenue. So while the year-over-year away revenue comparisons are flat, I'm pleased we’ve been able to stabilize the business volume of this industrial customer as well as maintain revenue levels consistent with last year's third quarter. Clearly demonstrating we've made progress towards restoring the lost business. Now let me get into the details for the quarter. Revenue was $32.5 million, largely driven by our medical, and our aerospace and defense businesses. On a market sector basis, our revenue breakdown for the quarter was as follows. Aerospace and defense 43%, medical 39%, industrial 16%, communications and other 2%. We are encouraged by the opportunities we're seeing as we continue to regain the confidence of our customers in the marketplace. Gross margins were 16.8% reflecting our fourth consecutive quarter of solid gross margin performance. We anticipate margins will remain solid and as I stated on previous calls it’s reasonable to expect that we will generate gross margins at or above the gross margins we generated in our fiscal fourth quarter of 2015 as we continue to through the back half of fiscal 2016. Net income of $1.6 million or $0.16 per share demonstrates significantly enhanced profitability compared to the third quarter of fiscal 2015. Our balance sheet remains strong with $17.4 million in working capital and as I mentioned earlier we reduced inventory by $3.8 million in net debt was reduced by $4.7 million during the quarter. Moreover, since the election of the new board we reduced our overall net debt by nearly $15 million. For the past 18 months, our primary focus has been on driving operational improvement and on regaining the confidence of customers. We've made fundamental changes that is steadily improved the way IEC operates enabling us to deliver more consistent and predictable results. Our focus and delivered efforts have resulted in rebuilding a solid foundation for our company that will now enable us to place a greater emphasis on driving a long-term organic growth strategy. With our operational improvements well underway and the re-establishment of a solid balance sheet, we have secured the foundations that will enable us to leverage our expertise working within complex highly regulated markets to drive revenue growth. That said as many of you know, the sales [indiscernible] on our business is quite long, particularly the caliber of customers we are focused on. We recently announced two contract awards from existing customers but first a $10.2 million award from a tier-2 department of defense supplier is in support of digital, tactical, networking and voice communications equipment for our US military. We expect to begin production on this contract in the fourth quarter. The second contract was a $3.7 million award from an aerospace and defense customer with annual revenues of more than $700 million where we will be manufacturing guided missile firing system components to be used by a top US government prime contractor. These contracts demonstrates the marketplace’s recognition of our ability as a provider of specialized engineering and manufacturing solutions that enable the production of life saving and mission-critical products. We believe that our unique capabilities position us to broaden our customer base. Our entire team is focused on implementing continued operational improvement and executing on the strategic initiatives we've identified to grow revenue over the long term as well as to deliver consistent margins, sustained profitability and operational excellence. Achieving organic growth remains a key focus as we continue to strengthen our relationships with existing customers and expand the programs we participate in. Additionally, with a solid foundation we’ve built during the past few quarters, we can turn more of our attention towards winning new customers and projects within our core capabilities. Our proven expertise working with complex highly regulated markets providing specialized engineering and manufacturing solutions gives a competitive strength that will position us not just to win customers but to build long-term strategic relationships. We remain focused on making further progress towards the successful turnaround of our business while the work is far from over we are energized by the third quarter and our year-to-date results. I will now turn the call over to Mike Williams to review the Company's financial performance. Mike?

[Michael Williams:]

Thanks Jeff, as mentioned third quarter revenue was $32.5 million potentially flat as compared to $32.6 million in the third quarter of last year. Increases of $3.5 million in aerospace and defense sector and a $1.7 million in the medical sector were offset by a decrease of $5.2 million in industrial sector. Growth in aerospace and defense came from higher demand as well as new programs from existing customers. Our medical sector growth was driven by higher demand from our existing customers. This decline in industrial was primarily related to the fact of unfavorable sourcing blend that we initially spoke about back in the fourth quarter of last year from our largest industrial customer as well as lower demand from other customers. Third quarter gross profit increased to $5.5 million or 16.8% of sales from 14.4% of sales in the third quarter of prior fiscal year. Several factors contributed to margin increase including reduction in overhead driven by lower inventory reserve expense and depreciation and we continue to improve on our labor efficiencies. Selling and administrative expenses excluding restatement related expenses decreased $200,000 and represent 10.7% of sales in the third quarter of 2016 compared to 11.3% of sales in the same quarter of the prior fiscal year. The decrease in selling and administrative expenses was primarily due to lower labor costs related to some headcount reductions over the course of the year as well as lower professional fees. Net income for the quarter increased to $1.6 million or $0.16 per share compared to a net loss of $4 million or loss of $0.39 per share in the same prior year period. Prior year included income of $0.04 per share from continuing operations and a loss of $0.43 per share from discontinued operations. Now looking at the results for the first nine months of 2016. Revenue increased 5.9% to $98.6 million driven by a significant increase in our medical sector and growth in our aerospace and defense sector. This was partially offset by the decline in our industrial sector for the same reasons mentioned earlier. Gross profit margin was 17.3%, up from 11.9% largely due to improved leverage on fixed manufacturing costs plus by higher production volumes, reduction in various overhead costs and changes in customer mix and again improved labor efficiency. Selling and administrative expenses excluding restatement related expenses decreased to $11.2 million or 11.4% of sales compared to $13.3 million or 14.2% of sales in the first nine months of 2015. Prior year included roughly $3.3 million of costs related to a proxy contest and change in control, while this year included roughly $500,000 of severance and related costs, and additional professional fees associated with the bank refinancing and other matters in our fiscal Q1 of 2016. Net income for the nine months of 2016 was $4.6 million or $0.45 per share as compared to a net loss of $4.6 million or loss of $0.46 per share from continuing operations in the same prior year period. Prior year also includes a loss of $0.57 per share related to former SCB operation that were sold in July 2015 for a total loss of $10.3 million or $1.03 per share. Turning to the balance sheet, working capital at the end of the quarter was $17.4 million compared to $21.9 million at September 30, 2015. Inventory, as Jeff mentioned, declined by $3.8 million during the quarter driven mainly by lower raw materials and work in process. Improved manufacturing execution, lead time reduction has yielded improved inventory turns. Our operating performance coupled with our asset management enabled us to reduce our net debt by $4.7 million during the quarter. Our debt to EBITDA ratio declined from last quarter to this quarter as calculated per our credit agreement with M&T Bank. This reduction in our ratio will lead to a reduction in our interest rate margin for [indiscernible]. With that I will turn the call back over to Jeff.

[Jeff Schlarbaum:]

Great, thanks Mike. As we progressed through our turnaround initiatives I think it’s important to recap where we stand in relation to our strategic priorities. At the start of the turnaround, we identified our priorities as number one establishing strong operating margins for our industry and driving consistent margin performance. Second, strengthening the balance sheet through improved asset management and working capital and third, establishing a foundation to achieve long-term organic growth. As I mentioned earlier, we've made great progress on the margin front over the past four quarters with our margin levels among the best in our sector. Going forward, we expect to generate gross margins at or higher than the gross margins we generated exiting fiscal 2015. Second, we made significant inroads to improve our asset management resulting in reduced inventory levels. As we've established more linear and predictable production and profitability, we've achieved improved working capital and cash flow. Debt came down considerably during the quarter and reducing debt will remain a priority going forward since the election of the new board I'm pleased to reiterate we’ve reduced the Company's overall net debt by almost $50 million to its current level of $21 million exiting our fiscal Q3. With the ongoing execution of our operational initiatives, will be in a position to build a platform for driving a long-term organic growth strategy. Not only do we have a strong portfolio of existing customers, but as evidenced by our recently announced contract wins, our ability to deliver project and program success is resulting in new contract awards. We will continue to build up on our existing customer relationships, while also leveraging our capabilities and contact to capitalize on new opportunity. We’re pleased with our third quarter results and we’re energized to continue to execute on our strategic initiatives. Thank you all for your interest and for your continued support. And with that, I will now turn the call over to questions.

[Operator:]

Thank you. [Operator Instructions] Our first question is coming from Mark Jordan of Noble Financial. Please proceed with your question.

[Mark Jordan:]

Good morning, Jeff and Mike. I'd say it's been quite refreshing being on these calls for the first three quarters of this year. Congratulations on the improvements. Questions relative to your current assets, you've really blocked inventories down. Is this sort of a preview this is a normalized level or do you have the opportunity to further reduce inventory levels from where they are right now?

[Jeff Schlarbaum:]

Great question and good morning to you, Mark and thanks for the kind words. We will continue to focus on our asset management and our largest lever that we can control is material and so while we reduced material this quarter, we believe we will have additional opportunities to reduce inventory over the next several quarters. It might not likely be linear, but we still see opportunities to take our inventories lower.

[Mark Jordan:]

Okay. Question on gross margin, clearly over the near-term guidance, your statements have been at or above the fourth quarter run rate and you’ve outperformed those debt measure for the first three quarters of the year. Stepping out a little bit longer term going out into fiscal ‘17 or ‘18, at a time when you are able to - as we go from fiscal position to be showing positive organic growth, which should allow you to sort of approach what might be a sort of a theoretical maximum gross margin. Given the business mix that you have and looking out into that timeframe is not going to be ‘17 ‘18, but timeframe when you’re growing at a positive organic growth rate, what would you think should be the normalized gross margin that ICE should be able to produce again when you got everything kind of going on a normal basis?

[Michael Williams:]

It's a really clear question and I know you’re looking for a fairly precise projection and it is difficult, Mark. When I look at the new customer acquisition recipe, which was essentially lost, we will be formulating that and time will tell as we acquire these new customers what those margins might look like in the early phases of those engagements versus what the margins might look like over the longer term. So I look in the next 18 months as a period where we’ll start to see some traction from our new customer acquisition efforts. But I don't have any expectation that in the early phases of those programs during that period that we’re going to be at or better than the margin that we have from the core business which we’ve continued to gain efficiencies and streamline our processes. So while I think we’ll have continued operational opportunities to improve, I think we’ll also see a little bit of pressure from the new customer acquisition margins that will take us a bit of time to get efficient at producing. So I’m not going to give you a specific gross margin range today, but largely, where we exited the year of ‘15, you've seen how we've seen some strong margins in the early part of our year this year, and I would say that’s probably a reasonable range going forward for the foreseeable future and as we gain more traction on the organic customer acquisition front, then I’ll update you with how that - how I see that affecting the margins over the longer term.

[Mark Jordan:]

Okay. Final question for me is, looking out into the next year, right now, clearly you are focused on - absolutely on debt reduction, at what debt level do you get to a point where you will feel comfortable looking at a small tuck-in M&A acquisition if it were to be made available?

[Jeff Schlarbaum:]

Yes. So again, another good question. You are very familiar with our industry and the debt levels in our industry, healthy debt levels are typically in the 2 to 3 times debt-to-EBITDA. So we’ve been driving, as I've referenced in the past to get below two times EBITDA levels on our GAAP. And so we will continue to drive to that goal and once we surpass it, we’ll then start to put ourselves in a position where we consider what inorganic acquisition opportunity might look like and it's got to be a strategic fit. Really the most important thing for us is timing something that will continue to distinguish us in the marketplace. So as we pass through that 2x debt-to-EBITDA, it will give us opportunities to start looking at those more seriously in the marketplace and we’re not too far away candidly from where our debt levels are today.

[Mark Jordan:]

Okay, thank you very much.

[Operator:]

Thank you. Our next question is coming from Herve Francois of B. Riley & Company. Please proceed with your question.

[Zach Cummins:]

Hi, good morning. This is actually Zach Cummins on for Herve today, but congratulations on strong results this quarter. I was just wondering, it seems that now that you've kind of strengthened your balance sheet and you've established more of a stronger foundation for your long-term organic growth, would you say there is any possibility that we could see any sort of sequential growth over the next few quarters?

[Jeff Schlarbaum:]

Yes. So good to me Zach. Great question. If you think back when we were in the midst of the change of control back in 2015 and subsequent quarters there towards the end of the year, we had talked about a large industrial customer that shifted some of their volumes to a competitor, and we characterize that about a magnitude of - that’s about $10 million revenue shift. So some of the successes we've had this year have been a little overshadowed because it's really been just closing that gap that existed from the $10 million that we were - we experienced a shortfall from the 2015 shift. In addition, if you look at the market sector shift in our business, just from one quarter to the next, our medical business was 50% of our overall revenue in Q2 and it came down to 39% in Q3 and that roughly represents about a $3.5 million shift just quarter-over-quarter. So there is still a fair bit of variation that we’re experiencing in customer volumes quarter-to-quarter and we’re making that ground from the lost revenues. So I want to be cautious over the next couple of quarters about sequential revenue growth and really look at it on an annualized basis and we will start to see hopefully in the next couple of quarters some evidence of our new customer acquisition activity, but again, given the sales cycle and the time to revenue on some of these new programs, it's not going to happen overnight. So I wouldn't guide over the next couple of quarters sequential revenue increases until some of these initiatives take hold.

[Zach Cummins:]

Great, that's really helpful. And then I guess just talking about some of your new contract award wins on the aerospace and defense sector, I think you mentioned you’d started some production for one of those contracts in Q4, I was just wondering what's kind of the timeline where we can expect to see some revenues from these contracts?

[Jeff Schlarbaum:]

Yes. So if you think specifically about the two that we announced, the first contract that we announced for the tactical networking gear, we’ll start to see some early stage production in our Q4 and in those early stages of production, typically we are building and delivering to our customers for them to do testing and approve us to turn on higher volumes of production. So in those first couple of quarters, in Q4 and Q1, we'll really see modest revenue from that particular contract and it will really start to take effect more in the second half of our upcoming fiscal year in terms of volume revenue. The second contract was actually an award from an existing customer at our Albuquerque facility and those volumes will actually, it's a smaller contract, but those volumes will actually start in Q4 and fairly increase as we go through Q1 and now through the balance of next fiscal year.

[Zach Cummins:]

All right, great. Thank you for taking my questions.

[Operator:]

[Operator Instructions] Our next question is coming from Alan Lyons, a private investor. Please proceed with your question.

[Unidentified Analyst:]

Congratulations, Jeff on the job you’ve done since you’ve taken over this company. It's been great. My question is more for Mike, it’s just a cosmetic question. What is the criteria for full-year partially reversed in the allowance for deferred taxes that you had set up previously?

[Michael Williams:]

So, there is one of the test you do on a cumulative, pre-year basis to look at your operating income and whether it’s in a loss position or income and then you do some qualitative analysis. So right now, our expectation is, we wouldn't be looking at reversing that until sometime mid to late 2017, when one we’re much closer to a three-year cumulative profit as well as we've established some of the qualitative metrics, which as Jeff kind of talked about, the three things that we focused on which was gross profit improvement, improve our balance sheet and then organic growth. We are looking at those on the qualitative standpoint. So it wouldn't be until at the earliest mid ‘17 or late ‘17.

[Unidentified Analyst:]

Okay, thank you.

[Operator:]

Thank you. At this time, I’d like to turn the floor back over to management for any additional or closing comments.

[Jeff Schlarbaum:]

Well, thank you everyone for calling in today. We look forward to speaking with you all once again next quarter.

[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.