IEC Electronics Corp.
Q4 2016 Earnings Call Transcript

Published: 14 Dec 2016

[Operator:]

Greetings, and welcome to the IEC Electronics' Fourth Quarter 2016 Financial Results. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, 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. Ms. Gavelis, you may begin.

[Audra Gavelis:]

Good morning, and thank you for calling in. 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 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 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 b 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 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 contained herein 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:]

Thank you, Audra, and good morning, everyone. IEC made substantial progress during our fiscal 2016 as we continue to drive the turnaround of our business. Since the change of control in 2015, our strategy has been to reinstate profitability in margins, improve asset management and reduce debt along with reestablishing organic growth. During the course of the fiscal year, we executed well against our operational goals and continued to deliver solid profitability as well as significant reductions in debt and inventory. While our overall revenue of 127 million is consistent with prior year performance, gross margins improved to 16% and we generated positive net income of 4.8 million or $0.47 per share versus the previous three years of net losses. With our positive cash flow in fiscal 2016, we are also able to reduce our total net debt by 11.8 million for the fiscal year. In terms of the distribution of our revenue breakdown for the year; medical was 42%, aerospace and defense was 40%, industrial 16%, communication and others 2%. As I’ve said previously, we are committed to a balanced portfolio of business trying to avoid too much concentration in any one end market sector, so we’re not overly exposed by the inevitable fluctuations that occur like the ones we’ve most recently seen in the energy sector. This past year, while our medical device and aerospace and defense markets were solid, we saw softness in the industrial sector, a softness I don't see picking back up in 2017. Looking ahead, we still view these three market segments as strategic and as a result, they will remain a key area of focus for our sales and marketing efforts. Fiscal 2016 was a full year for the new leadership team since the change of control, and during the year many of the one-time issues that plagued the company leading to three straight years of losses continued to fade. When we set out as a management team to commence the turnaround, we identified and put into place three strategic initiatives focused on one, improving margin and establishing profitability; two, strengthening our balance sheet by reducing debt and improving our inventory position; and three, positioning the company to reestablish organic growth. Our year-end results speak to the progress we've made in a relatively short timeframe and we're optimistic that the continued execution of our strategic initiatives will drive future growth. While our year-end results were much improved, during the fourth quarter we experienced volume reductions from certain key customers which negatively impacted our near-term revenue outlook and backlog, leading us to take proactive steps to align our cost structure with a workforce reduction at our Newark, New York facility. As an outsourced manufacturing services company, we adapt our structure to meet our customers’ needs as they expand or contract. In this recent case, we have reacted to near-term volume reductions by reducing our cost structure. However, since we did not lose a customer or any specific program, we made certain to retain the necessary skill set and structure to support our customers’ demand that we expect to see in the second half of fiscal 2017. Given the visibility we have today, we anticipate that near-term backlog softness will continue through the first half of fiscal 2017. It is important to note and worth reiterating this softness is not due to the loss of any customer programs but rather it's directly related to two customers who currently have excess inventory. These are longstanding IEC customers and committed manufacturing partners who are working through their respective end-market dynamics. We are optimistic that the backlog will strengthen in the second half of fiscal 2017 and are encouraged by the fact that we have already seen bookings of $23 million in the first eight weeks of the fiscal new year. To be more specific, we believe these volume reductions will result in approximately $20 million to $25 million in lower revenue in the first half of 2017. In addition, we don't expect to be profitable during the first half of this fiscal year although we have implemented numerous cost-saving measures to better align our cost structure with our current backlog. As I said before, we deliberately retained the necessary skilled labor and structure to support the lifesavings and mission-critical products we manufacture for our customers, so we’re able to respond to the anticipated volume ramp up in the second half of 2017 for both existing and new customers. I want to emphasize our belief in the fundamental strength of our core business and customer base. We work to proactively get ahead of the softness which we believe will be relatively short-lived based on our discussions with our customers. We expect to exit fiscal 2017 at levels similar to those we achieved during the first nine months of 2016, as anticipated volumes return with our existing customer programs and as we add new customers. We remain optimistic about the opportunities we’re seeing as we continue to strengthen the IEC brand and gain the confidence of the broader marketplace. Our balance sheet remains strong with $19.8 million in working capital. We’ve reduced inventory by 10.4 million. And as previously mentioned, net debt was reduced by 11.8 million. Moreover, since the change of control we’ve reduced our total net debt by 16.7 million. This strengthened balance sheet provides us the needed foundation to drive future growth and is key in our ability to compete for new customers and programs. As many of you know, turnaround such as this take time. During 2016, we continued to make progress regaining our reputation in the marketplace by meeting our customers’ expectations and by improving our operational execution to produce consistent and predictable results. With our operational improvements well underway and the reestablishment of a solid balance sheet, we are now shifting our focus on pursuing and winning contracts in the complex and highly regulated markets that are best suited to our capabilities and expertise. Our entire team remains committed to driving the strategic initiatives we identified to grow revenue over the long term, achieve consistent margins and promote operational excellence. I will now turn the call over to Mike Williams to review the company's financial performance. Mike?

[Michael Williams:]

Thanks, Jeff. Revenue for fiscal year 2016 was 127 million, consistent with revenue in fiscal 2015. Increases of 9.3 million in the medical sector and 3.5 million in aerospace and defense sector were offset by a decrease of 12.3 million in the industrial sector. Our medical sector growth was driven by higher demand from our existing customers and from some relatively new customers whose programs have now ramped. Growth in the aerospace and defense sector came from higher demand as well as new programs from existing customers. The decline in industrial was primarily related to the effects of unfavorable sourcing blend that we initially spoke about last year from our largest industrial customer, as well as some lower demand from other customers. As Jeff mentioned, we do anticipate that there will be a significant decline in overall sales during the first half of 2017, primarily related to two customers who have excess inventory and are working through their end-market dynamics. Gross profit for the year increased to 20.3 million or 16% of sales from 16.3 million or 12.8% of sales in fiscal 2015. Several factors contributed to the margin increase, including reduction in overhead driven by lower depreciation and better operational controls over costs. And we continue to improve our labor efficiencies. Also, fiscal 2015 included an additional 700,000 in stock-based compensation attributed to the change in control and resulting proxy contest. Selling and administrative expenses, excluding restatement and related expenses, decreased 2.6 million and represented 11% of sales in fiscal 2016 compared to 13.1% of sales in the prior fiscal year. The decrease in selling and administrative expenses was primarily due to total expenses of 3.5 million in 2015 related to the proxy contest and resulting change in control, partially offset by additional severance costs in fiscal 2016. Net income for the fiscal year 2016 increased 4.8 million or $0.47 per share compared to a net loss of 10.2 million or a loss of $1.01 per share in the prior year. Fiscal 2015 included a loss on discontinued operations of 6.4 million or $0.64 per share related to the company's divestiture of Southern California Braiding. Now looking at the results for fourth quarter 2016; revenue decreased 16.3% to 28.4 million, primarily driven by a decrease in demand in our medical sector. Gross profit margin for the fourth quarter was 11.5% as compared to 15.3% in the fourth quarter of 2015. Selling and administrative expenses, excluding restatement related expenses, remained flat year-over-year at 9.9% of sales for the fourth quarter. And net income for the fourth quarter of 2016 was 200,000 or $0.02 per share consistent with net income for the fourth quarter of 2015. During the fourth quarter of fiscal 2015, the company incurred a loss on discontinued operations of 700,000 or $0.07 per share related to its divestiture of Southern California Braiding. Now looking at the balance sheet; working capital as of September 30, 2016 was 19.8 million compared to 21.9 million at September 30, 2015. Inventory, as Jeff mentioned, declined by 10.4 million during the year 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 debt net of cash by 11.8 million for the fiscal year. Our debt to EBITDA ratio stayed flat at 2 this quarter as compared to last quarter and declined from 5.2 at September 30, 2015, as calculated per our credit agreement with M&T Bank. In addition, on November 18, we announced that IEC completed a sale and leaseback of our Albuquerque facility for an aggregate purchase price of 5.75 million with an initial term of 15 years. We presented these assets as held for sale as of September 30, 2016. The proceeds were used to pay off Albuquerque mortgage loan and pay down the term-loan A. Term-loan A now only has one more partial payment due January 1, 2017. On November 28, we entered into the second amendment to the fifth amended and restated credit facility agreement with M&T Bank. This amendment reduces the revolving credit commitment from 20 million to 16 million. We do not anticipate the need for this excess credit, which we pay for. The financial covenants were also modified to better align with our 2017 expectations. With that, I will turn the call back over to Jeff.

[Jeff Schlarbaum:]

Thanks, Mike. During 2016, we strengthened our operational performance and financial health, as we bolstered our existing customer relationships helping to lay the groundwork for the development and acquisition of new customers and programs. With the fundamental changes we made to the way IEC operates, we were able to deliver more consistent and predictable results and our proven ability to serve as a design and manufacturing partner for lifesaving and mission-critical products has broadened our recognition in the marketplace resulting in new opportunities. As we move into 2017, we’re focused on the elements of our business that we can control, exceed our customer expectations, continue to reduce our debt, continue to effectively manage our assets, drive operational excellence and leverage our capabilities with our rebuilt sales organization to identify and capture new customers. While the start of 2017 will be challenging, we’re optimistic that we’ll see a stronger second half as volumes return from our existing customers and we secure new customers. We’re focused on the continued execution of our strategic turnaround initiatives with the goal of demonstrating a return to revenue growth along with consistent margin and sustained profitability by the time we exit 2017. I also want to mention as a part of our ongoing outreach to the investment community, we will be presenting at the Noble Financial Conference which will be held January 30th and 31st in Boca Raton, Florida. With that, I will now turn the call over to questions.

[Operator:]

Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Ben Klieve with Noble Financial. Please proceed with your question.

[Ben Klieve:]

All right. Good morning, Jeff and Mike. A few questions here. Mike, first, at the end of your commentary you touched on changes with the credit agreement, so can we assume that that given the first half challenges that you’re looking at that there’s minimal risk to debt to EBITDA covenant that you had outstanding?

[Michael Williams:]

Correct. So the new amendment aligns with our 2017 expectations.

[Ben Klieve:]

Okay, perfect. And then so given the workforce reduction that took place a couple months ago, can we expect any meaningful one-time charges looking into the first quarter or even the first half of next fiscal year? And then following any severance charges, what do you see as kind of the long-term SG&A run rate?

[Michael Williams:]

So as far as severance charges, it’s all going to be in Q1 and it’s less than 200,000. At least for fiscal '17 regarding selling and administrative expenses, it’s going to be a lower percent than what we had in '15 but slightly higher than what we had in '16, so probably around 12%. Long term, we certainly want to get it down below 11 but we don’t see that in 2017.

[Ben Klieve:]

Okay, perfect. Thank you. So I guess the other question I have right now is regarding cash flow expectations for next year. You discussed net loss for the first half of the year return to profit in the second half. What about from a cash flow perspective and do you anticipate pulling any more cash off of the balance sheet from what you have only first half?

[Michael Williams:]

In the first half we’ll be using a revolver a little bit more but by the time we get to the end of '17, we’ll have continued to pay down our debt net of cash. So that’s a goal for '17 is continued to pay that down, obviously not to the extent that happened in 2016 but to a modest extent in '17. But again, it’s still going to be a little bit more in the first half than the back half paying it down more.

[Ben Klieve:]

Okay. Thank you. And my final question here is regarding your business development initiatives as you’ve taken and specifically with regard to the really positive bookings, it sounds like 23 million for the first eight weeks of the year. I’m wondering if those bookings were a result of the initiative that you’ve taken on or if you’re still working on developing those initiatives with further progress hopeful down the road?

[Jeff Schlarbaum:]

Ben, it’s Jeff, good question. It’s a combination of a couple of things. The bookings are directly related to the improved financial condition of the company, so our existing customers are not only committing to longer-term demand of existing programs but they’re also awarding us newer programs. So where we’ve seen new programs that we were not on before emerge and see order commitments for those new programs with existing customers. We’re also starting to see the new customer activities start to materialize and so that really wasn’t a part of the bookings but we expect to see that be a contributor to future bookings. And certainly, Mike’s comments around SG&A as a percent of sales, obviously with the lower sales volume, our SG&A as a percent is a little higher. But to your point about business development, we are investing very deliberately in a go-to-market strategy that now will take advantage of our improved financial condition, our strong balance sheet, our improved operational execution and put us in a position to compete very effectively for new programs with our existing customers as well as attracting new customers to the company.

[Ben Klieve:]

Perfect. All right, very good. Thank you much to you both and best of luck navigating the next couple of quarters here.

[Jeff Schlarbaum:]

Great. Thanks, Ben.

[Michael Williams:]

Thank you.

[Operator:]

[Operator Instructions]. Our next question comes from the line of Bryce Thomas with North Grove Asset Management [ph]. Please proceed with your question.

[Unidentified Analyst:]

Hi. Could you help us get a sense as to how the $20 million to $25 million reduction in revenue in the first half of the year breaks down between the first and second quarters?

[Jeff Schlarbaum:]

Absolutely, yes. So we talked about a $20 million to $25 million sales reduction directly related to two specific customers whose demand and production volume has been reduced, however, we remain a strategic supplier for those programs. Those programs are active and we expect that the volume will increase in the second half of the year. But the revenue distribution, while I can’t be precise with an exact dollar amount, it’s probably evenly split between Q1 and Q2. And then we start to see the revenue pick up in the second half of the year to really look like the aggregate revenue that we drove in second half of 2016.

[Unidentified Analyst:]

Okay, great. Thank you.

[Operator:]

[Operator Instructions]. Our next question comes from the line of Herve Francois from B. Riley & Company. Please proceed with your question.

[Herve Francois:]

Thank you very much. Good morning, gentlemen.

[Jeff Schlarbaum:]

Good morning.

[Herve Francois:]

You talk about in regards to the revenue shortfall, just a clarification. Can you tell us which end markets those customers belong to if it’s not the same end markets, it’s two different end markets? Because you had mentioned something about – during your opening remarks some softness on the energy side, which obviously a lot of people have been experiencing this year, but also I think a hit by some medical customers. So the revenue shortfall that you’re talking about for the fiscal first half, what end markets are those customers in? And is it those customers that are coming back to you with backlog strength that gives you confidence for revenues that picked back up in the fiscal second half of your year?

[Jeff Schlarbaum:]

All right, thank you, Herve, excellent question; so let me try to clarify a bit. So the comments regarding the industrial sector were how we sort of see long term the industrial sector as being sort of on a macro level softer for us just given some of the macroeconomic conditions. The short-term revenue shortfall is really tied to the medical sector and just to reiterate, those are programs that are active. Those are programs that have a long lifecycle ahead of them, and we remain a strategic partner to those customers and have reiterated their commitment to IEC. So we see those volumes returning and we see in the second half we believe that the volume increases will start to occur. And it’s really the first half of the year that’s isolated to that industry and those couple of programs.

[Herve Francois:]

Got it. Do you know if, or can you tell us if these programs or these customers, do they do any manufacturing internally or has pretty much all what they do have been outsourced to you guys?

[Jeff Schlarbaum:]

Yes, so like with most of our customers, all of them possess some internal manufacturing capabilities. But typically what they’re outsourcing to us at IEC is a portion of their manufacturing that they don’t produce internally. So we don’t see any competition with our customers with their internal manufacturing. They’re more focused on the end product manufacturing versus the subcomponents and the subassemblies that we produce.

[Herve Francois:]

Got it. So in your press release you talk about how you have to retain some key skill labor and expertise to support some lifesaving and mission-critical products that you manufacture. Are you largely talking about the assembly workers that are tied to your programs in the military, aerospace and defense end markets?

[Jeff Schlarbaum:]

It’s across the board, Herve, when you look. If we had visibility that the volume reductions we’re experiencing now were going to be a long-term issue and if we were able to tie them to either a program going end of life or a customer resourcing, then we probably would have looked at the restructuring or would have looked at the restructuring a bit differently. However, given the fact that these programs are active, they’ve got long lifecycles ahead of them and it’s a near-term volume reduction as they sell off inventory that they’ve accumulated, it’s really not only the manufacturing personnel but it’s all the technical horsepower and the engineering infrastructure that we have to build these highly complicated, highly engineered products. So as I said in the press release and on the call, yes, it’s absolutely paramount that we retain that, because our customers not only in the aerospace and defense sector but across the board are increasingly looking to IEC to support their future production needs. And so we’re going to put ourselves in a position to make sure we make our customers successful.

[Herve Francois:]

Got it. And then just a couple of more. With the medical customers that are causing the softness to revenues in your fiscal first half, what kind of impact do you see that having on your inventories in the fiscal first half? Typically they’re known to have the EMS companies hold on to the inventory. And as you say, those are long lifecycle programs. So is that going to be a little drain on your cash flow in the fiscal first half, because you’re going to have to hold on to their inventory until you ramp up with them again in the fiscal second half of next year?

[Jeff Schlarbaum:]

No. As you’ve seen from the financials, we’ve put in place a very robust inventory management program with our supply chain team. And so we’ve created a fairly precise and high-velocity inventory management program. We will utilize more of our finished goods to deliver to the customers even at a slower pace and just not replace them at the same pace until their volumes start to pick up. So we really don’t see an impact to increasing pressure on inventory. Likewise, I don’t see our inventory going down in the first half of the year like we did in fiscal '16. Those inventory reduction opportunities are really sort of shift to the second half of fiscal 2017.

[Herve Francois:]

Got it. And then just one last one from me and I’ll get back into the queue. Can you give us an update on the program win that you announced back in late June, that 10 million contract on the aerospace and defense? I think you had said back then that you were going to commence production for that contract in your fiscal fourth quarter. So did you commence production and can you give us some update on how that ramp is going?

[Jeff Schlarbaum:]

Absolutely, yes. In the aerospace and defense sector, as you know, there’s a fair bit of runway to volume production. We’re in the low rate initial production phase right now. And as our customers receive product from us and test and qualify it, we’ll be – to be expect to be turned on to higher volumes as we progress through the latter part of the first half of 2017, so they’re right on schedule. And in fact that same customer we are engaged with conversations on considerations for new programs. So I’m very optimistic that with that particular customer and others in the aerospace and defense sector that given our improved financial health and frankly the execution that we’ve demonstrated, we’ll have increasingly more opportunities.

[Herve Francois:]

All right, good stuff. Thank you very much.

[Jeff Schlarbaum:]

Great. Thanks, Herve.

[Operator:]

[Operator Instructions]. It appears there are no further questions in the queue. I’d like to hand the call back over to management for closing comments.

[Jeff Schlarbaum:]

Thank you very much and thanks for everyone for calling in. Again, we appreciate it and we certainly look forward to speaking with everyone once again next quarter.

[Operator:]

Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.