Paula Graff - Vice President and Chief Financial Officer Richard Wasielewski - President and Chief Executive Officer.

Sheldon Grodsky - Grodsky Associates, Inc..

Good day ladies and gentlemen, and welcome to Nortech Systems’ Fourth Quarter 2016 Earnings Conference Call. All lines have been placed in a listen only mode. And the floor will be open for questions following the presentation. [Operator Instructions] At this time, it is my pleasure to turn the floor over to Paula Graff. Ma’am the floor is yours..

Thank you. Good morning and welcome to Nortech Systems' fourth quarter and year-end 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 fiscal year and fourth quarter results, and markets we serve and our industry.

Then we’ll open up the call for any of your questions. Before we begin, please be advised that 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 SEC filings. Now I will turn over the call to Rich Wasielewski.

Rich?.

Thank you, Paula, and good morning, everyone. To start, I’d like reiterate our strategic goal is to be the proffered EMS supplier partner to our customers in the medical, aerospace, defense and the industrial commercial industries.

We are continuing to transform our business from a commodity transaction model focused on price and service manufactured to customer specifications to a model more global, offering value added and cost effective services that will deliver solutions and technology opportunities.

In 2016, there were several initiatives that contributed to that value added solution business model across all our markets. The successful opening of our operations in Suzhou in China now servicing our largest global customers.

In addition to providing our customers with global regional support, we’re starting take advantage of the Asia electronic component supply chain that has developed over the last 20 years. Also in 2016, we began to resource and budget for an intellectual property for our products platforms and services.

Our efforts have resulted in a number of potential trade secrets and pattern opportunities that will enhance our value added solution selling process. During the year, we took further action on profiling our customer base into transactional key and strategic partners.

There were targeted pricing actions and accounts that were more transactional which we describe as PO-to-PO customers they aided in our gross margin improvement. And on the key and strategic partners, we stepped up our penetration increasing our cross sell and own engagement activities.

And also we consolidated resources and reduced excess capacity in our aerospace and defense and industrial cable and wire products build by closing down the Wisconsin facility. The last production in the Augusta, Wisconsin was January 31st, although closing the plant was not easy.

Our employees there did a professional job and we owe them a great deal of gratitude. And I thanks for all their effort and sticking with us during the tough process. We sincerely wish them all the best. We’re pleased with the overall progress made in 2016 towards these strategic initiatives.

Yesterday, we reported fiscal 2016 results that showed improvement over the prior year. Net sales of $116.6 million was up 1% despite major declines in our transportation sector of over $8 million. Year-end 90 backlog of 20.5 million is on par with the prior year-end.

Gross margins increased 140 basis points to 12% after absorbing the startup costs for our new Asian operations. Operation income came in at 629,000, an improvement of 1.1 million over 2015. EPS improved 23% per share from a loss last year of $0.21 to a profit this year of $0.02. Cash provided by operations came in at $3.5 million.

Free cash flow was positive $1.6 million for the year and we paid down debt by $1.4 million. All of our positive results year-over-year was led by the gross margin increase, driven by the mix in medical products and engineering services, cost improvements and selective pricing actions.

As described in our 10-K, year-end results included G&A expenses increasing by $1.1 million.

This was due to an increase in our provision for doubtful accounts of $400,000 from a customer’s bankruptcy in Q3 and also a write-off in Q4 for our customer mediation settlement in February of 2017 that resulted in Nortech waving the past due balance of 211,000 on the balance sheet in 2016 and acquiring some certain intellectual properties.

Because the settlement occurred in 2017, the asset will be recorded in Q1 of 2017. 2016 also saw - 2016 G&A also saw a full year of operating cost for $500,000 of medical device engineering service operation that we acquired in 2015 and $200,000 for our new Asian facility.

The fourth quarter results were more of the same with transportation customers being down approximately 2 million but offset by a favorable medical mix, selective pricing actions and cost reduction efforts helping offset this volume impact. In the fourth quarter, sales were $29 million compared to $31.4 million for the fourth quarter of 2015.

Q4 ending 90 day backlog was $20.5 million, down from the start of the quarter of $23.9. Operating income was steady at 328,000. Net income was 98,000 and the EPS was $0.04 per share.

A comment on liquidity, we amended our credit agreement with Wells Fargo Bank on January 12, 2017 and it provides for a line of credit arrangement of 15 million that expires if not renewed on May 31st, 2018. At December 31st, we have net unused availability under our line of credit approximately $5.7 million.

And look at our three core markets more closely. For medical, our revenue increased 30% to $53.8 million, now becoming the largest of our three markets at over 46% of revenue compared to 36% in 2015. Our medical sales were up 18% without the impact of the Devicix Engineering acquisition.

Our medical device production saw a second half surgeon manufacturing that included launching six new medical devices into the market place for our customers. This resulted in the medical device manufacturing rise of 56% in Q4 over the prior period and then increasing 36% year-over-year.

We continued to leverage our engineering service investment; we are integrating our processes to streamline total customer experiences from product development through design transfers and into manufacturing. This strategy is also gaining traction in our other two markets industrial and defense.

For the medical customers, we’re providing expertise for complete medical devices along with component solutions for wire and cable assemblies and PCB boards. This includes hardware both wired and wireless through the cloud using Wi-Fi, Bluetooth and cell phone applications.

They lead that into the Internet-of-Things and patient monitoring and electro mechanical medical devices for many applications such as neuro and cardiac treatments. We are also expanding diagnostic imaging solutions with global manufacturing capabilities in the U.S., Mexico and our new facility in Asia.

We believe we are well positioned for increasing our customer values for the medical growth strategy. A recent report by transparency market research shows that our strategies in medical are timely. They are forecasting a 14.3% compounded growth rate for the global medtech sector through 2019.

This is driven by increasing demand for healthcare worldwide and technologies like biopsy devices, wearable patient monitors and implantable devices. Moving on to our industrial customers they accounted for 40% of our overall 2016 revenue compared with 2015 these sales were down 21%. Our year-end industrial backlog was down 15%.

This market was mostly impacted by the macroeconomic softness, the global instability and the slowdown into transportation in oil and gas. For example our largest transportation customer orders fall almost 60% during 2016 with equipment orders of 98%.

Our Q4 sales were down 16% sequentially from Q3 the second half of 2016 was down 41% from the first half of the year.

Fortunately we are diversified which helps cushion these impacts again in 2016 the industrial customer performance was mixed and our 20 largest industrial customers half of the customers were up 10% and the other half excluding the transportation customer was flat.

We've been having success moving up the food chain by selling to a higher level assemblies that combined PCB boards and cables and boxes and providing that extra value and supply chain consolidation to our customers.

This strategic approach of engaging customers early in the design cycle and discussing their production transition plans is helping us build deeper relationships with new and existing customers. The economic performance will help us gauge the year ahead for our industrial capital equipment customers, after U.S.

economic - economy grew by 1.9% in 2016, economic forecasters are predicting slightly stronger growth in the next few years. Other encouraging signs the U.S.

manufacturing industry expanded at its fastest pace since 2014, According to the Institute of Supply Management with 17 of 18 industries reporting growth, across the Midwest a recent Creighton University manufacturing survey showed improvements for the fourth straight month.

In oil and gas many experts believe the industry have stabilized although the gasoline glut is still weighing down oil prices. Power generation was a real bright spot for Nortech last year.

Sales in Q4 were up 300% over Q3 and the second half of 2016 was 180% up from the first half, big swing that we watch closely to see if the growth can be sustained. For semiconductor OEMs our business in the second half of 2016 was equivalent to the first half so we're seeing some stabilization here as well.

For the industry overall capital equipment spending for semiconductors is expected to grow 3% of 2017 off slightly from 2016. For our process control customers 2016 results were very positive, Q4 four sales were up 8% sequentially, second half grow 6% from the first half.

Looking at our defense market now, our fiscal 2016 sales rose 12% over fiscal 2015 and in comprise 14% of our overall sales. We saw year-over-year sales growth there in the first three quarters of 2016. These results were driven by our sustained growth in molded wire and cable reflecting our unique technology capabilities.

We've made black, brown and molded cables for ruggedized military applications for over 50 years our company’s longest legacy is with the defense business. We’ve seen success here through two means, first our years of experience working in the industry, and second our early engagement with engineering.

We're increasingly combining our legacy cable capabilities with higher level assemblies to sell. This effort is aided by our expansion of PCBA capabilities in Mankato and AS9100 industry certification. Adding this level of engineering and value takes some time, but we're making progress.

We're working to reestablish relationships with core aerospace and defense OEMs to collaboration and frightening solutions on new systems and projects. The new administration certainly improved the defense industry outlook the S&P 500 aerospace and defense index increased 9% during the fourth quarter.

And hopefully the funding and timing that has been the biggest issue on contracts over the past several years along with the sequestration is behind us. Looking forward there are a number of positive signs and trends in the industry and economy that give us confidence and optimism going into 2017.

In North America the EMS industry is estimated to grow at 4.8% in 2017 according to a new venture research in IPC and outsourcing the contract manufacturers like Nortech is still the trend and will contribute to the growth into the future. Leading economists are predicting stronger growth in the U.S.

economy in the next few years, aided by government policies and regulatory reductions favoring businesses along with increased spending on infrastructure and defense. For Nortech, we're still seeing the ongoing cyclical effects as in the past.

Our increased amount of product business and engineering plays a factor along with normal customer and market adjustments.

In 2016 our Q2 was the down quarter and given the low backlog and timing of projects to start this year and that we are already two thirds through the first quarter it's looking like the first quarter of 2016 will be our softest quarter. Looking out further beyond Q1 2017 is setting up to be a profitable growth year for Nortech.

We're encouraged by recent increased activities in new projects and bookings the strongest levels we've seen since 2009, combining our trends with the renewed U.S. government confidence we’re cautiously optimistic for a positive outlook for 2017. We'll continue to focus on the things we can control and that's executing on our business fundamentals.

That concludes my presentation. Now we’ll open up the call for any of your questions this morning. Operator if you please open the line..

Thank you. [Operator Instructions] And our first question comes from Sheldon Grodsky please state your question..

Good morning everybody..

Good morning Sheldon. I missed you last quarter..

I don't recall, but it’s possible I missed it.

Let me - I just want to give a quick summary of the unusual items you hand in the third quarter bad debt expense of about 300,000?.

It was 400,000, but we got it was 450,000, but I believe we got a credit by the end of the year for about 50,000, so about 400,000 for that impact..

So you went quickly over something that was new to me today, was that an arbitration you said?.

It was mediation, if we didn't mediate it, it was going to go through binding arbitration..

Okay.

Mediation and how much you - I’ll say whatever you have to adjust for that one?.

The net of it was 211,000..

And did that hit the fourth quarter or?.

It hit the fourth quarter. The intangible IP that we got out of the settlement will get in the first quarter of this year, and that’s about $100,000..

So the intangible - what was that?.

The IP, the intellectual property we got out of the settlement. We'll hit the books in Q1 about $100,000..

As a plus item?.

As a plus, as an asset..

Okay. I think I'll let that be it for the moment. Thanks..

Okay. Well thank you, Sheldon..

Thank you. [Operator Instructions] And there appears to be no more questions at this time..

If there are no further questions we conclude this call. Thank you for your interest in Nortech and we look forward to updating you in a future. Have a great day..

Thank you. This does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time. And have a great day..