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

Sheldon Grodsky - Grodsky Associates Inc..

Good day, ladies and gentlemen, and welcome to the Nortech Systems' Second Quarter 2017 Earnings Conference Call. All lines have been placed on a listen-only mode. And the floor will be open for questions and comments, following the presentation.

[Operator Instructions] At this time, it is my pleasure to turn the floor over to your host, Paula Graff, CFO of Nortech Systems. Ma'am, the floor is yours..

Thank you. Good morning and welcome to Nortech Systems second quarter 2017 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 some comments on our second quarter results, our markets and our strategic initiatives, then we will open up the call to 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 Safe Harbor statements in our press release and our SEC filings. Now, I will turn the call over to Rich Wasielewski.

Rich?.

Thanks Paula, and good morning, everyone. We're pleased to report continued progress on our two main strategic initiatives of growing our medical market and strengthening our global capabilities. In the quarter, we also added two critical pieces in helping us meet our long-term objectives.

We signed a new banking agreement with Bank of America and appointed a COO to oversee our growing global operations. I'll expand on both later in the call. But first, I look at the second quarter results.

Yesterday, we reported net sales of $30.1 million for the second quarter ended June 30th, up 4% over the prior year, and up 6% sequentially from the first quarter. Our 90-day backlog end of the second quarter up 4% year-over-year.

Our revenue growth is in line with industrial global trends, and we continue to see mixed results by markets and segments within markets. Looking at our core markets, our medical sales grew in the quarter. They were up 14% over the prior year period and comprised almost half of our total revenue at 48%. Last year, it was 44%.

Our 30-day medical backlog increased 7% from the prior year period and 3% from the first quarter. Our sales of defense and aerospace customers were $3.9 million in the quarter, up 16% sequentially, but down 11% to prior year. Our 90-day defense backlog showed similar trends with the second quarter, up 3% sequentially, but down 11% year-over-year.

Our defense customers continue to show mixed results. Although we're seeing increased activity in quoting and booking, the size of contracts and the timing remain contingent on budget constraints. Finally, our industrial sales were flat year-over-year for the second quarter, although up 7% sequentially from Q1.

We saw some seasonality in the results across the segment, but our diverse customer base remains a strength. Power generation and process control customers are strong in the quarter on increased global activity and new project wins. Our semiconductor customers also showed an increase in the quarter as did the overall semiconductor industry.

We are executing on existing business and with demand picking up, we're seeing a rise in the number of unexpected drop in orders, we requested looking to accelerate lead-times. Looking at our transportation, this segment decreased 7% as compared to last year, mainly due to reduced locomotive production.

Our industrial customers are heavily impacted by the economy, so some positive U.S. economic news is encouraging. This includes a 2.6% growth in GDP in the second quarter and the recent records in the stock markets. This news could provide a little momentum for the second half of the year.

Looking at the current EMS industry trends, both short and long-term from new venture research. They estimate the EMS industry in the Americas to decline 4% in 2017, but rebound to a plus 5% in 2018. Meanwhile, the worldwide industry is expected to rise 5% in both 2017 and 2018. This is in line what we are seeing and experiencing.

And looking further out, new venture research estimates compound annual growth rates between now and 2021 to be 6.6% for medical, 6% for industrial, and 4.8% for defense. Diving into the profitability, our second quarter gross margin was 11.2% of sales compared to 10.8% last year and 10.9% in the first quarter of this year.

Gross margins were impacted mainly by the increased revenue gains in our China facility, now being fully operational. Overall, SG&A spending was up slightly from 2016 levels, primarily due to increased professional service fees, information systems, and a full year of the China G&A spending.

Operating income was a positive $95,000 for the second quarter of 2016 compared to an operating loss of $110,000 last year, up $205,000 improvement. We reported net loss of $16,000 or $0.01 per share for the second quarter compared to $180,000 loss or $0.07 per share for the same period last year.

The EPS was favorably impacted by a tax benefit in the quarter. There were several significant financial events in the quarter that I'll mention. Our net debt bad debt reserve, good guy of $180,000, offset by the loan pay off penalty of $175,000 for our move to Bank of America.

The new credit facility of up to $21 million with the Bank of America Merrill Lynch, with an additional $20 million accordion feature was signed in June.

This important agreement is an endorsement of our corporate strategies and the progress we have made in transforming our business from a commodity transaction amount to a global value-based engineering solution. Bank of America is well-qualified to serve our financial needs through their U.S. and international treasury services.

The new line of credit includes lower costs that will offset the penalty in less than one year and increase our borrowing flexibility. The accordion option expands our credit facilities, subject to further conditions and is in place to fund potential unplanned growth or expansion, new R&D technology activities, and strategic acquisitions.

Also in the quarter, as I mentioned, we received a favorable overall income tax benefit of $206,000 generated out of the mix of lower foreign tax rates being compared to the higher U.S. tax rates. On our liquidity, we generated $1.5 million in operating cash flow in the second quarter and $1.3 million of positive cash flow for the six months of 2017.

Cash flow was positively impacted by the timing of working capital items, accounts payable payments, accounts receivable collections, and were offset by an increase in inventory. Free cash flow was a positive $1.4 million in the quarter.

Total debt of $12.6 million at the end of the second quarter has been reduced from $15.5 million for the same period last year, a $2.9 million improvement year-over-year. We ended the quarter with $7.4 million available on our new line of credit compared to $5.7 million available at the end of the year of 2016.

In case some of you might have missed in the second quarter, we were pleased to announce the appointment of Matt Mahmood, as Chief Operating Officer for Nortech. In his role, Matt is responsible for overseeing all aspects of our operations, including engineering, global sourcing and business development.

He brings over 20 years of management experience in manufacturing, technology and information services, with proven experience in creating and growing profitable companies. We are pleased to welcome Matt to our management team, excited about his approach to influence by automation, specialized analytics and the metric-based decision-making process.

We'll give Matt a couple of quarters to on board and then bring him into the conference call to update us on his thoughts and initiatives and taking our operation to the next level. In closing, it's hard to believe we're more than half way into 2017. Our global operations and medical customers have carried the load through the first half results.

We'll need them to continue their strong performance and increase our efforts on the industrial and defense bookings and pipelines. Now, we'll open up the call for any questions, this morning. Operator, please open up the lines..

Thank you. The floor is now open for questions. [Operator Instructions] Okay we have a question that came in from Sheldon Grodsky. Please state your question..

Hi. Actually, I have two. I apologize, I got a little -- I was having some distractions here. So, I didn't catch everything.

Did you say that you had a bad debt recovery in the second quarter?.

Yes, we had a bad debt loss in the third quarter of last year with a medical startup company. And we made that -- they came out of bankruptcy with a plan and paid us off less the -- about a third of the cost -- about 25% of the cost for legal fees to get through it.

So, yes, we had that bad debt that was in the third quarter of last year, now became a good guy here in the second quarter..

Well, congratulations on that.

And did you indicate something about strength in the second half of this year?.

Well, again, the comment was our medical and global operations have been strong compared to last year. They continue -- they'll continue in the second half from what we can tell. The industrial business is mixed.

Some of our -- the transportation segment is really getting hurt, and that carried a lot of weight in our industrial accounts about 20% to 25%. The defense accounts, although are steady, they're not growing and we're still seeing small orders.

It seems like the defense budget is still up in the air, for us, at least on the defense side and the vehicle side, which is where we participate a lot. We're trying to make a pivot to more aerospace and more communications cable -- custom cables..

Thank you..

Thanks Sheldon. I forgot to say good morning to you..

Good morning..

[Operator Instructions] Okay, our next question comes from Michael Hughes [ph]. Please state your question..

Hi Rich.

Just was wondering what type of acquisitions you'd be looking at with your new line of credit?.

Good morning Mike. It's a little changed. It's a little changed than in the past where we bought distressed and stressed companies and it takes a lot of effort to get those going. That's what we're excited about with this expanded line and Bank of America's willingness to grow with us with maybe not the typical borrowing base.

It's important for us to prove to them that that we're strong on our equity side, but to get on that side. So, that requires a much different funding than in the past. There might be some goodwill involved because you're buying a little bit of technology. You're buying more, what I call, going Jennie business as opposed to the distress business.

So, those are going to come out with higher multiples. And possibly some goodwill with it. So, it's going to take a lot of analytics and it's going to take a lot of confidence on the return and the analysis to get Bank of America to play with us.

So, there isn't -- if I said specifically anything that complements the medical markets, we're playing very well with engineering. We're playing very well with the contract, the PC board and also the cable bills. But we are still purchasing plastics and the boxes and that would be one area that in the medical area that we'd be looking for.

So, I would think that -- and any time you can get talent in our business nowadays. It's all about the people and the talents. So, we'd be looking at more engineering support, more technical support wherever we can..

Okay, great. Thanks..

You bet. Thank you for the question..

[Operator Instructions].

Well, if there are no further questions, we'll conclude this call. Thank you for your interest in Nortech and we look forward to updating you in the future. Have a great day everyone..

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