Paula Graff - VP and CFO Richard Wasielewski - President and CEO.

Analysts:.

Good day everyone and welcome to today's program. At this time, all participants are in a listen only mode. Later you will have the opportunity to ask questions during the question and answer session. [Operator Instructions] It is now my pleasure to turn the conference over to Ms. Paula Graff. Please go ahead ma'am..

Thank you. Good morning and welcome to Nortech Systems' third quarter 2016 conference call. I'm Paula Graff, Vice President and CFO and with me is Rich Wasielewski, Nortech's President and CEO. Following my introduction, Rich will offer comments on our third quarter results, our industry and the markets we serve.

Then we’ll open up the call for all your questions. Before we begin, please be advised that the statements made during this call may be forward-looking and are subject to risk factors and uncertainties. Please see the complete Safe Harbor statements in our press release and our SEC filings. Now I will turn over the call to Rich Wasielewski. Rich..

Thank you, Paula, and good morning everyone. Yesterday we reported net sales of $29.7 million for the third quarter, up slightly from the prior year period. Sequentially sales were up 3% with continued mixed performance across customers and markets. For the nine months sales increased 5% to $87.6 million.

And our overall backlog grew by 5% sequentially and provides us with some momentum as we move into the fourth quarter.

Our third quarter results began to show signs of progress as we continue to focus on delivering on our business strategies of growing our medical market and improving our profitable and asset management with our defense and industrial customers.

The medical revenue grew 27% year-over-year in the quarter and that's the first overlapping period since we purchased Devicix in July of 2015. This is the first experienced growth we had.

The Devicix revenue in the quarter was $1.8 million compared to $1 million last year accounted for 25% of the medical increase, while our other core medical customers accounted for the other 75. The overall medical revenue is now up 34% for the nine months.

We continue to promote our full-service solutions including product development engineering, design transfer to manufacturing and production. The medical backlog continues to grow and increasing 7% sequentially and 35% year-over-year for all medical customers.

The defense markets were up 6% in the quarter compared to prior year and 16% for the nine months. Although backlog is down 25% in the third quarter we're seeing good quoting activity in larger and longer term opportunities. It's DoD funding season so we are focused on filing the money and growing the backlog in the next several months.

For industrial customers again it was mixed results. On a sequential basis sales were up 2% for the quarter. Year-over-year the quarter was down 25% and for the nine months it was down 17%. Our industrial markets continue to get hit the hardest in global economic factors and significantly lower demand coming from our transportation customers.

We expect the business to rebalance once the economy starts to grow. Our industrial backlog was off 14% in the third quarter, but increased 24% sequentially from the second quarter and we should see improvement from these customers as we end the year. EMF industry trends in how it compares to Nortech.

Looking at the EMF industry in North America, they are on pace to hit 5% revenue growth for 2016 as projected by new venture research. When you drill down further and examine North America EMF Company sorted by revenue or outpacing our peers, companies with the 100 million in annual sales.

North America is faring better than the worldwide EMF industry and September issue the publication of manufacturing market insider cited macroeconomic headwinds in the global economy when reporting the combined sales of the 11 largest EMF providers. They declined 8% in the first half of 2016. By contrast our sales rose 8% during the same period.

Looking at the U.S. economy news, the latest GDP reported - showed 2.9% growth in the third quarter, the highest rate in two years but again the messages were mixed for manufacturing. Last week it was reported the durable goods orders fell 0.1% in September and were off 0.4% for the nine months.

Nortech is not alone and wanting more help in growth from the macroeconomics of both the U.S. and global and it has a major effect on our industrial customer base. Moving onto profits and the financials. Gross margins improved substantially in the quarter by 320 basis points over last year to 12.7% of sales and 190 basis points for the nine months.

These improvements were driven by a strong medical product mix, increased engineering service revenue, material cost reductions, and selective pricing actions. Included should be noted and included in our gross margin was 200,000 of startup costs for the quarter and 560,000 for the nine months for our new China operations.

We expected $600,000 of startup costs for the year and without any additional delays and customer certifications in part validations we should be very close to this figure by the end the year. The shutdown of our Wisconsin facility announced in August is moving forward as planned.

Thanks to the quality and professionalism of our employees and leadership team there. As previously stated we expect to see savings from the consolidation in the early next year after all the transfers of startup costs are absorbed. SG&A expenses increased approximately 640,000 in the third quarter.

The unplanned 456,000 in bad debt reserve and expense and the planned increases in Devicix in China's SG&A accounted for the majority of the increase. In the quarter we had a customer filed bankruptcy protection on September 30 in the state California. It's our policy to write down the entire outstanding balance at the time of bankruptcy.

Some additional account details, 75% of the outstanding was current to the 30 day terms and another 25% was past due less than 20 days. Revenue for this account in the quarter was 536,000 and 1.2 million for the nine months year-to-date. They have been a customer with us since 2013 and we've shift just over $5 million since the initial shipments.

Operating profits are up sequentially and year-over-year in our quarterly and nine month basis. Our operating income for the third quarter rose 190,000 at $256,000 when compared to 66,000 operating loss for the third quarter in 2015. For the nine months improvement was over $1 million.

We reported operating income of 301,000 compared with an operating loss of 751 for the same period last year.

We reported net income in the third quarter of 63,000 or $0.02 per diluted common share compared with a loss of 124,000 or $0.05 for the same period last year and for the nine months we reported a net loss of 54,000 or $0.02 per diluted common share compared to 695,000 loss or $0.25 last year. Moving on to our liquidity.

We generated positive operating cash flow in the quarter of 825,000 and for the nine months 1.9 million. Cash was generated from income, noncash add backs of depreciation and amortization and positive working capital changes.

The main working capital changes were an increase in cash collections with increased inventory being offset by an increase in payables. Free cash flow generated in the quarter was 542,000 and for the nine months now is positive at 211,000.

We ended the quarter at availability of $6.1 million on our line of credit and is on par with the end of the second quarter. In closing the third quarter saw progress in our gross margin and profitability. The one-time bad debt expense presented an even stronger quarter.

It is also good to see us executing on a medical strategy that provides needed growth and profitability. A leading indicator of our progress in this area is the significant growth in backlog throughout the year.

Near-term we remain focused on cash flow and reducing debt by improving gross margins, reducing excess inventory, and in addition efforts continue on asset utilization and consolidation activities.

Longer-term there is more opportunity to grow with all our customers as we continue to invest in the earlier engagement engineering, value-added solutions, and expanded global footprint. Now I'd like to open up the call if there are any questions this morning. Operator, please open the call..

Operator:.

Well, I would like to thank everyone and we're going to finish out the year here and then probably see you some time - talk to you sometimes in the middle of March. Thank you for your interest and we look forward to updating you then. Have a great day..