Techprecision Corp Q2 FY2020 Earnings Call

Good day, everyone. Welcome to today's call. All lines will be in listen-only mode, and we will have a session for questions and comments after the presentation. It is now my pleasure to hand the floor over to your host Brett Maas of Hayden IR. The floor is yours, Brett.

Thank you. On the call today is Alex Shen, Chief Executive Officer; and Tom Sammons, Chief Financial Officer. Before we begin, I'd like to remind our listeners that management's remarks may contain forward-looking statements, which are subject to risks and uncertainties and management may make additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the safe harbor for forward-looking statements as contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those discussed today and therefore we refer you to a more detailed discussion of risks and uncertainties in the company's financial filings with the SEC. In addition, projections as to the company's future performance represent management's estimates as of today, November 13, 2019. TechPrecision assumes no obligation to revise or update these forward-looking statements. With that out of the way, I'd like to turn the call over to Alex Shen, Chief Executive Officer, to provide opening remarks. Alex?

Brett, thank you. Good day to everyone, and thank you for joining us. Our second quarter of fiscal year 2020 was highlighted by the start-up of multiple new projects following the addition of $11 million in new sales orders since March 31, 2019. Our backlog at September 30, 2019 totaled $16.4 million, an increase of $3.8 million compared to $12.6 million at March 31, 2019. With the new projects coming online in the second quarter, we expect to operate above current revenue and operating income levels and return to profitability during the second half of fiscal 2020. I would now like to turn the call over to Tom Sammons, who will tell us more about our second quarter financial results. Tom?

Thank you, Alex. Net sales were $3.1 million for the second quarter of fiscal 2020 compared to $3.6 million in the second quarter of fiscal 2019. As Alex commented, our backlog remains strong as new orders for components continue to slow from prime defense contractors. Cost of sales for the second quarter was $2.7 million compared to $2.5 million for the same quarter the period a year ago. Our second quarter financial results were impacted by under-absorbed factory overhead and increased costs associated with the loss provision for certain projects already in progress. Selling, general and administrative expenses decreased by $10,000 in the second quarter. Interest expense and debt cost amortization was lower in the second quarter ended September 30, 2019 and will continue to decrease barring any indebtedness as we amortize debt principal to maturity. Net loss for the second quarter ended September 30, 2019 was $291,000. For the six months ended September 30, 2019, net sales decreased by $312,000 or 4% to $7.4 million when compared to $7.7 million for the six months ended September 30, 2018. Our cost of sales for the six months ended September 30, 2019 was $5.9 million compared to $5.6 million for the six months ended September 30, 2018. Gross margin was 20.6% for the six months ended September 30, 2019. Total SG&A expenses for the six months ended September 30, 2019 increased slightly by approximately $1,000 due primarily to an increase in outside advisory services almost entirely offset by a decrease in compensation expense. Interest expense decreased by 20% for the six months ended September 30, 2019 and should continue to decrease as we amortize debt principal. At September 30, 2019, we had $2.6 million in cash and working capital was $6.2 million. Cash provided by operating activities was $0.9 million for the six months ended September 30, 2019. Net debt at the end of the second quarter of fiscal 2020 was $1.3 million. With that, I will now turn the call back over to Alex.

Thank you, Tom. TechPrecision remains proud and honored to serve the United States defense industry, specifically naval submarine manufacturing through its Ranor subsidiary. We continue to see meaningful opportunities in our defense sector primarily in the nuclear submarine business for the next 12 months and beyond. I am excited with the start-up of multiple new projects. I would now like to open up the call for Q&A.

Thank you. The floor is now open for questions. Our first question comes from Howard Brous with Wellington Shields. Please go ahead.

Hi. Thank you. Alex, since I've been involved in the company for more than five years, this is the first time I've seen the backlog jump as much as it has. So, one congratulations. And two, it is exciting for me to hear you as excited as you are, because I've never heard that on any conference call that I've been on with you. So, I'm very happy to hear both. Could you comment as to what the backlog is as of today, is that possible?

Tom?

It's not possible to provide that information at the moment because we net our POC revenue against the backlog. We need to understand how much we've realized against the backlog, and we don't have that number yet. Additionally, we have not received any new orders this month.

So additional orders beyond the $3.8 million backlog. Okay. Thank you. Secondly, I just want to confirm that Block 5 is effective and that the government has funded it. Is that a correct statement from your knowledge, Alex? It's TED Summaries.

Howard, I think I heard about three questions in there. So let me parse this.

Sorry.

It's okay. Ross does this to me all the time.

Don't worry. He is your next questioner.

So I believe the first question was about Block 5. Block 5 is a viable program and it is proceeding as planned. Your next question was about funding, and I can only direct you to publicly available information.

No. According to the public information, it has been funded for a total of nine submarines plus one additional?

I believe that you're quoting some hearsay that is not corroborated by any contracts.

No. There was a public announcement by the Department of Defense.

That's not a contract release announcement.

Okay. Appreciate that.

Right.

That's all I have. Again, I am very happy that you are as excited as you are. I’ll live the floor to Ross Taylor next. I'm sure.

Thank you for your support.

Oh, it's a pleasure, Alex, and thank you.

And our next question comes from Ross Taylor with ARS Investment Partners. Please go ahead.

So Howard is pressing. Okay. Let's deal with the one thing that really jumps that I haven't seen out of this company since you've been running it, Alex, which is the fact that you had some cost issues on a project loss. Can you talk to us about what that is? How much that loss was? And will that loss have an effect on the profitability long term of the Virginia Block 5 contracts?

Well, okay. So I think there were five questions in there. Let's deal with the first one. Can I talk to the losses? Yes.

Yes.

The losses were due to the start-up of multiple new projects exclusive to the new projects and not for repeating part numbers whatsoever.

Are the costs ongoing, or were they essentially one-time expenses that will be recovered and won't affect future profitability? It seems they were more about determining feasibility for projects rather than for ones that were already specified.

They are not things that we've built before. They're brand new part numbers. Generally speaking I would like to think that I'm going to go after business that repeats the part numbers over time rather than just onetime deals. So that's how I would characterize those as really start-up costs. And do I expect that the losses will repeat? Well, I don't think so. I would point out that our finance group has reserved for these losses already.

So all the damage that you expect to be done by these projects is included in the numbers that you released today?

As far as I know, yes. Absolutely.

Okay. Good. Because, as I said, I think and Howard was getting to it would appear that with the not official release of an order but the statement that the Navy and General Dynamics have reached an agreement to fund nine boats plus an option that you were set that this – the Virginia Block five within a few weeks will be set up to build what appears to me to be probably two years of three boats. And then as the Ohio, there is the Columbia class comes on board go – revert back to two boats built a year along with a Columbia class. And so we really have started that event when it is officially signed as a watershed is it not for this company?

I don't think I can comment intelligently on that, because you're talking about the build cycle. But we're not on this – it's a little difficult to answer the specificity of your questions.

What I'm actually getting at is – what I'm getting at, Alex, is it would appear that from what we have seen and what you have said you came out a few calls ago and talked about having a $40 million to $50 million annual run rate at $80 million to $100 million two-year projected revenue numbers. It's my assumption from everything I've read that that number is based – that $80 million to $100 million number is based on largely on, if not fully on the emergence of the Virginia Block five from the drawing board into production. And that it's the revenues that you would expect – TechPrecision would expect to be receiving as that project rolls forward in the next two years, is that not correct?

So the numbers that you're talking about are the opportunity numbers, not the annual revenue numbers just to be clear. The brunt of what we do in naval submarines is going to be Virginia class based as far as volume goes and Columbia class as well. But Columbia class has less volume, but it's a much bigger submarine.

Right. And it's also out? Is it not in time because the Columbia class is not on the ways nor is it projected to be on the ways in the next year I believe?

So there's the build cycle of the submarines and then there's the ordering cycle for components which is probably long-lead ordering cycle is way ahead of the build cycle.

At this point, everything seems to be aligning, and given the company's nearly neutral net debt position and the growing backlog, along with historic operating margins that are significantly better than those of the last quarter, I anticipate a considerable increase in free cash flow. Instead of asking for details on that, which I know you won't provide, I want to express that as a significant shareholder, we believe this situation justifies the company and its Board coming to us as investors to explain how capital will be returned to shareholders through this process. We view this as a pivotal moment. Securing this contract greatly reduces the risk outlook for TechPrecision. You've consistently been a strong operator, and I expect that to continue. Therefore, I believe the company should be able to generate a 20% to 30% free cash flow margin based on the current stock price over the next few years. In light of this, I hope there will be plans communicated to shareholders about a meaningful capital return in the coming years. The way the stock trades suggests that many shareholders do not fully grasp the business model, which is problematic. When there's a lack of communication, it leads to unnecessary volatility. This stock should be one of the least volatile on the market moving forward, especially with the visibility you have for the next four to five years, particularly with a contract that spans four fiscal years. Based on my experience in the defense sector, I find it hard to believe you don't have a clear understanding of the revenues expected from these submarines, as I imagine everyone has been briefed on what they can anticipate. Additionally, it seems you've been operating with inefficiencies due to carrying extra costs in preparation for these orders.

We have extra capacity? Yes. Are we operating inefficiently? I would say we're not operating inefficiently. I think we're pretty efficient.

I would say you're efficient in execution. However, you likely have more staff hired than necessary for the current demand, as we've seen with some of your competitors who are trying to fill positions. If you delay hiring until you secure the fiscal contracts, you may find it challenging to bring on the right people when needed. Considering your reputation and operational capability, I assume you want to avoid taking that risk.

Well, we balance that risk against the lumpiness. So when the demand sometimes spikes for a little while, I need to have the bodies to cover that demand. And then on the other hand when it dips into valleys where there's just the business is just naturally lumpy then I don't want to have too many bodies that I have to carry around for an extended period of time. So it's a balance that we just need to watch on a pretty very frequent basis.

But you're comfortable that you're adequately staffed to perform the contracts you have been receiving?

I'm comfortable that I have the capability to flex to meet demand. That's what I'm comfortable with. At any given point in time, it goes up and down. So I'm comfortable that we have the capability to flex to that adequately to meet customer requirements.

I believe it's important for the Board to develop a return of capital strategy for investors, especially considering the limited information we typically receive. Shareholders have previously expressed that they don't think this company, given its size, should remain public. To ensure we navigate this situation effectively, I think it's crucial to reward shareholders, and one of the best ways to do that is by returning a significant portion of the free cash flow through a buyback. There are precedents in the industry, such as Hexcel, which commits to returning 50% of its free cash flow to shareholders each year. Implementing a similar approach could help mitigate trading volatility caused by investors who may not grasp the long-term outlook for the business, making them more prone to sell shares aggressively. This, in turn, can discourage other potential investors worried about volatility.

Thank you for your support, Ross.

You're welcome.

Our next question comes from Aaron Warwick with ES Capital.

Hey, guys. Thanks for taking my call. Looking forward with these increased backlog numbers to future quarters and kind of referring to what Ross said about that $80 million to $100 million which if I remember correctly you changed later to just $100 million. I wanted to ask you about that. Alex, is that number that you're looking at the work that you're targeting is that $100 million still what you have in mind? Has that increased or decreased at all?

That has not decreased. That opportunity is there.

Okay. Has it increased at all?

I'm telling you it hasn't decreased.

Okay. Is any of the backlog that was reported as of September 30, does that include any of that $100 million?

The opportunity remains as far as the dollar value.

Okay.

I have to be very careful in answering these questions, because I've been pretty much point-blank told by our direct customers to be very careful.

Okay. Well, I respect that. Last thing, I want to do as a shareholder is get you in trouble that just gets me in trouble. You had also mentioned on previous calls about pursuing work with carriers and it looks like the Navy is moving forward with some of that as well. Is that something you're still pursuing or have you obtained any of that work?

I think two or three calls previous I had already alluded to the fact that carriers are not part of our business. Okay. And it still remains so.

Okay. On the international front, I'm just wondering I asked about it there was an article before the last call. And I know you couldn't talk about that much but it made me think about it more here. International opportunities especially here relates to submarine tube work. It sounds like some of the tube work could be available for competitors of a company that said they were no longer going to be working on that. Are you pursuing any international opportunities like in the U.K. or elsewhere?

I am absolutely restricted from any comment whatsoever on that topic.

Okay. Appreciate your time. Thank you guys.

Thank you for your support.

And our next question comes from Richard Greulich with REG Capital Advisors. Please go ahead.

Thank you. I wasn't able to hear clearly the answer to the question regarding what the backlog currently is. And I understand not being able to calculate that, but let me rephrase the question. Have you received continued new orders since the last quarter ended?

Have we received new orders since the last quarter ended?

Yes.

Yes. And have they run at the same rate as the prior quarter?

I can't tell you that right now.

Okay. Could you tell me what the capital spending program looks like over the next one to two years?

Due to competitive reasons, I'm going to not answer that question.

Okay. Could you tell me what you expect the employment level to look like in the year and then two years from now?

That again is going to be in the category of a competitive nature. Our competitors are all private companies and we're the only public one. So, we're all watching each other like hawks. So, I'm going to decline to answer that question. I would comment to let you know that I watch my employment levels carefully, so I can match them up with the up and down fluctuating lumpy demand, and I do not, as a rule, miss customer requirements.

Yes. That intrigued me. Like, could you describe the mechanics of how you're able to flex up and down your employment?

I'm not going to be able to do that due to the competitive nature of how we do it.

Separately, could you discuss any non-defense business during the quarter roughly how much of it was? And then what the outlook for that is?

Let me see here. I might not be able to grab how much of it is. But if you use the 80-20, it would be in the minority. So the outlook for that is opportunistically, we're going to pursue non-defense business. That is our stated objective, and we continue to execute that objective quite well.

And does it look like there are interesting opportunities to pursue in the non-defense area at this point?

Opportunistically, they land. I am pursuing primarily defense business. This company has been converted over to a defense-centric business. So, if the other opportunities in non-defense match well with our capabilities than defense, we'd be more than happy to take an order. If they don't match, then it doesn't work.

Okay. Thank you.

Thank you.

And our next question comes from Mark Gomes with Pipeline Data. Please go ahead.

Great progress, guys. Just, so I'm 100% clear. So we were discussing Block five and how it's not been contracted. So that's safe to assume that none of your orders or backlog include any of that, correct?

Correct.

And our next question comes from...

Mark, I need you to repeat that question, please.

And this is the operator. Mark is no longer in the Q&A queue.

Okay. Well, I think what I heard was, do your orders and your production include Block 5? And the answer is yes, that's correct.

And our next question comes from Howard Brous with Wellington Shields. Please go ahead.

Thank you. Just to clear up one issue. The comment from Commander Danny Hernandez, the Navy spokesman says, they have reached a multi-year agreement with General Dynamics and are working to announce a contract by December 31. So, just to clear that up. Secondly, to follow-up Richard's questions and comments. At one point in time, several years ago you were doing business for Mevion. Are you currently doing any business? Or can you not comment about that with Mevion?

I have been asked specifically by Mevion to not comment on their business.

Okay. That sort of answers the question. And secondly, there was a point in time several years ago that you were manufacturing nuclear casks. Can you comment about that?

That was before my time.

Okay. That's all I have. Thank you.

Thank you.

And our next question comes from Ross Taylor with ARS Investment Partners.

Okay. So, some follow-ups. With regard to the nuclear casks, are you doing or looking at the potential of doing business with the Department of Energy?

With regard to nuclear casks or DOE overall?

Overall.

Overall, opportunistically, we will take a look at DOE.

And what type of products might you supply them?

Ross, just to be very direct. It's not the type of product that we go for, it's really what fits and what they see fit to quote us on.

Okay.

It's more of a passive approach maybe, but it's not a very laser targeted on this type of product. It's not a product-oriented approach.

Is your strategy that they approach you for your expertise to understand what you can offer, or are you presenting them with ideas regarding what you can supply that they might need?

I do not go to them with ideas on what products. I go to them with capabilities.

Okay.

It's up to them to match the capabilities with the products that they know about what they would outsource. They're not the core customer. So I don't know that much about them internally. And frankly the opportunity with defense and nuclear submarines is just overwhelmingly large. And that's the space that we primarily live in.

Looking at the press release referenced by Howard Brous, it discusses a four-year deal. In your earlier comments about the $100 million revenue base, which you noted remains unchanged, you mentioned a two-year revenue base. If the Navy enters a four-year agreement with Electric Boat, would that imply that all products you're supplying would be included throughout the entire four-year cycle? Based on my experience, the types of things you're doing, as long as you execute well, are not likely to be reassigned to someone else during a four-year procurement process. So, with your projections spanning four years instead of two, would they total $200 million?

I don't know.

Am I on the low side?

Well I think we're both on the I don't know side, because I don't have the visibility into three and four years. So I don't know how to answer the question is the honest answer.

Okay. Lastly, being a public company has its drawbacks, particularly for those we work with. I want to assure you that if being public is a significant issue, as your largest holder, we are open to discussing ways to address that situation.

Understood.

It's incredibly frustrating as a shareholder to be unable to share what I believe is a truly compelling story with the public. My concern is that the company's valuation may be persistently undervalued because people may not put in the effort to understand the underlying narrative. We see evidence of this consistently, including in the recent fluctuations in the stock price. That's all I have for now.

Thank you, Ross.

Our next question comes from Aaron Warwick with ES Capital. Please go ahead.

Hey guys. Thanks. I just want to follow-up with one thing. I think it especially relates to what Ross said about people not understanding the company. And so one thing I want to do, I don't know if this could help provide some clarity, but just using as an example as you know that this Block 5 thing could close with the nine boats by December 31. So let's just say that it does close by December 31. And I honestly don't know. I mean I'm a novice in this industry myself. But how long does it take then for the majority of that work that you're confident in getting? How long that takes to show up in your backlog? When would people see that?

That's an area I've been told to really be cautious on revealing insider information from the Navy and the two prime shipyards. So I'm going to respectfully decline to answer the question because of the cautions that have been put on me by the prime shipyards.

Okay. That's all I have. Thank you.

Thank you.

And our next question comes from Richard Greulich with REG Capital Advisors.

Alex, to date you've only mentioned backlog and orders at the end of the quarters. If you were to receive a meaningfully large order in the middle of a quarter, would you feel that would be an event that should be announced to shareholders in the market?

I would need to get permission from clients. And I would also need to balance that against things of a competitive nature, so that I don't diminish our ability to secure more orders.

Would you be able to make an announcement to the extent of what the numerical numbers are without directly tying that into a specific contract? In other words, if your backlog...

I think these pauses that I have are both trying to think through the process as well as how to let you know once again that these pieces of information that are put out there need to be carefully managed. So we don't lose anything, therefore damaging shareholder value versus the value of the information. It's a careful line that needs to be walked. Much of the time the customers are pretty negative on us bragging about things because they tend to punish us with less. So that's the direct responses that I would end up getting from our clients. And they are very, very large clients, very powerful, and very capable of really squeezing down the number of orders and the value of the orders that we get. And then there's the competition. Once they know that certain things are happening well, then they're going to compete more fiercely against us.

Okay. Thank you.

And our next question comes from Ross Taylor with ARS Investment Partners.

It's not a question, but more of a comment. I believe the last point made was very valid, and I would recommend observing how some of your peers manage communications with investors, especially those with ties to three-letter agencies in Washington D.C. They've found ways to inform the market promptly when significant developments occur as a public company. While you discuss your commitments to the Navy, the Submarine Corps, and Electric Boat, you also bear a responsibility to your shareholders. If the conclusion is that remaining public isn’t in the best interest of the company, then that should be acknowledged, but it needs to be examined thoroughly so investors can make informed decisions. I understand this is a challenging situation for you, but it's equally difficult for your investors who are trying to make sense of the information as if it’s unintelligible.

Understood Ross. Thank you.

Finding a solution to this situation is certainly challenging. I've experienced instances where issues remained unresolved for a long time, and it's tough to navigate. In a diversified company, it's easier to conceal issues, and I don't foresee any steps toward diversification that might help mask these problems. Consequently, this remains a puzzle we need to solve. It's important for the business to thrive, and for shareholders to have clarity so that we can achieve a more accurate valuation of the company. This situation is quite unique, and as an investor, I've rarely encountered such a long road ahead. It’s frustrating for my clients and me when the stock is negatively impacted by individuals who often haven't done their homework, leading them to sell off aggressively, which benefits no one. We would prefer to have the stock in the hands of investors who are willing to stay invested for the long term while we generate free cash flow and distribute it through share buybacks or dividends over the years.

Yes, sir. Thank you.

And our next question comes from Maj Soueidan with GeoInvesting. Please go ahead.

Hello. I'm relatively new to the story and would appreciate some clarification. For everyone who is new, how does revenue actually get realized in this process? Are we talking about the awards and then unlocking old budgets, or are there awards contracts involved? Can you explain the process of how orders eventually flow to you and how revenue is generated?

Tom do you want to take this one? I don't understand the question completely maybe because I'm too simple.

Well, we have two revenue streams. One is items when they ship. So, we fulfill an order and ship a product. And the other is on some projects we are able to do percent complete revenue. So, we recognize revenue as we build a unit.

Can you explain the process of how you receive your orders?

I'm not going to be able to tell you all the steps that occur because that would be really telling you some inside information that I need to keep inside, right?

Not necessarily, no.

Okay. They confidently provide us with orders. Our focus is primarily on defense, specifically U.S. Navy nuclear submarines. The customers include the two shipyards and the primary contractors that work with them.

In terms of when a prime receives an order or wins a contract, I can't provide all the steps involved because that would share sensitive information. However, I can say that they confidently place orders with us, and our focus is primarily on defense, particularly related to U.S. Navy nuclear submarines. The shipyards and primes working with them are our customers.

It depends. It really depends. Each item is certainly different and sometimes the same part number, it's different. It's a very lumpy business.

All right. You have expectations what that range could be, right, from your experience running the company.

I have expectations what I want it to be and then the cost do whatever they like.

I understand that. Based on your experience, what is the typical range? I know you have experience with them.

Whatever range I try to tie myself down to, I'm bound to be wrong.

I have been in this industry for 30 years, and it's unusual for a company to say they cannot announce contracts when they win them because it might affect future contracts. It doesn't make sense to withhold that information when it happens. I understand your desire to limit what you share, but there are certain key details you can provide to shareholders, and winning significant contracts is important information that should be communicated.

I understand your comment.

And our next question comes from John Hardison, a Private Investor. Please go ahead.

Hey, good afternoon, Tom. How are you doing?

Good.

I have one question that relates to the new orders that you have the onetime charges with I assume that they're DoD orders, is that correct?

While most of our orders are DoD, so that would be a great assumption.

Okay. And then the part 2, are they new parts for Virginia, for Colombia or for carriers or all of the above?

Yes.

All of the above?

Yes.

Okay. That makes me excited because that confirms that you are doing a very good job and they're giving you additional parts that you've never done before. So, congratulations on that. And then last, I completely agree with everything Ross said and it'd be nice if we could get Ross to be your IR person.

I'm writing that one down.

Okay. All right. Thanks. I'm happy to see the backlog up and Virginia finally coming to fruition.

John, thank you for your support.

And that does conclude our Q&A session for today. I'll turn the call back over to management for any closing remarks.

Thank you, very much everyone. I appreciate your support. Have a good day.

And that does conclude today's teleconference. We appreciate your participation. You may disconnect your lines and have a great day.