Earnings Call Transcript - TPCS Q3 2020

Operator, Operator

Good day, everyone, and welcome to the TechPrecision Third Quarter 2020 Earnings Call. At this time, I am pleased to introduce Jeff Stanlis with Hayden IR. The floor is yours, Jeff.

Jeff Stanlis, Investor Relations

Our listeners should be aware that management's comments may include forward-looking statements, which carry risks and uncertainties. Management may also provide further forward-looking statements in response to your inquiries. Therefore, the company seeks protection under the safe harbor for forward-looking statements as outlined in the Private Securities Litigation Reform Act of 1995. Actual outcomes may vary from what is discussed today, and we encourage you to refer to a more detailed analysis of risks and uncertainties in the company’s financial filings with the SEC. Additionally, estimates regarding the company’s future performance reflect management's views as of February 13, 2020. TechPrecision does not commit to revising or updating these forward-looking statements. Now, I'll hand the call over to Alex Shen, Chief Executive Officer, for his opening remarks. Alex?

Alexander Shen, CEO

Thank you, Jeff. Good day to everyone, and thank you for joining us. Our third quarter results were negatively impacted by learning curve-related cost overruns that resulted in negative margins and loss provisions on a very limited number of new projects, which, for the most part, were not the same projects as in the prior quarter. These new projects are an opportunity to demonstrate technical excellence and the custom know-how of complex fabrication and complex machining. In addition, these new projects represent an entry point into new business prospects. We expect improved margins going forward as these projects approach completion, costs stabilize, and other new profitable projects come online. Our sales order backlog reached its highest level in over 3 years, increasing to $17 million at December 31, 2019, as approximately $15.3 million of new orders were booked over the first 9 months of fiscal 2020. We believe this strong backlog, along with increased order activity, should provide for a steady revenue stream and profitable margins in fiscal 2021. In December 2019, we signed an agreement to increase our available credit under our revolver loan by $2 million, and subsequently, in January 2020, used $1.1 million of available cash to pay in full our capital equipment loan, providing increased borrowing capacity and financial flexibility going forward as well as reducing our future interest expense. I'd now like to turn the call over to Tom Sammons, who will tell us more about our third quarter financial results. Tom?

Thomas Sammons, CFO

Thank you, Alex. Net sales were $3.7 million for the third quarter ended December 31, 2019, compared to $4.3 million in the third quarter ended December 31, 2018. Cost of sales for the third quarter was $3.4 million or $54,000 higher compared to the same quarterly period a year ago. The increase was due, in large part, to a $317,000 charge during the quarter for potential losses on certain customer projects, primarily the new projects referred to by Alex. Selling, general and administrative expenses increased by $31,000 in the third quarter, mainly due to increases in professional fees. Interest expense decreased by $16,000 in the third quarter as we continue to amortize debt principal to maturity. Net loss for the third quarter was $320,000. For the 9 months ended December 31, 2019, net sales decreased by 8% to $11.1 million from $12 million when compared to the 9 months ended December 31, 2018. Our cost of sales for the 9 months ended December 31, 2019 were $9.2 million compared to $8.9 million in the same period a year ago. Gross profit was 16.6% or $1.3 million lower due to primarily $850,000 of charges for potential losses on certain customer projects. Total SG&A expenses for the 9 months ended December 31, 2019 increased by approximately $32,000, due primarily to an increase in professional fees which were mostly offset by a decrease in compensation expense. Interest expense decreased by $43,000, again, as we continue to amortize our debt principal. For the 9 months ended December 31, 2019, our net loss was $390,000 compared with net income of $563,000 for the 9 months ended December 31, 2018. Moving to the balance sheet, we had $2 million in cash and $5.4 million in working capital at December 31, 2019. Cash provided by operating activities was $0.6 million for the 9 months ended December 31, 2019. Net debt at the end of the third quarter of fiscal 2020 was $1.7 million. As Alex mentioned, in December 2019, we signed an agreement to increase the amount available under our revolver loan from $1 million to $3 million and decreased our interest rate on the revolver by 50 basis points. In January 2020, we paid off, in full, our remaining debt obligation of $1.1 million on the higher interest rate capital loan equipment. This payment reduced our total debt obligations to $2.6 million at January 17, 2020, from $3.7 million at December 31, 2019. With that, I will now turn the call back over to Alex. Alex?

Alexander Shen, CEO

Tom, thank you. TechPrecision is proud and honored to serve the United States defense industry, specifically, naval submarine and aircraft carrier manufacturing through its Ranor subsidiary. We continue to replenish our backlog and will seek out other new opportunities in the defense and industrial markets in the next 12 months and beyond. I would now like to open up the call for Q&A.

Operator, Operator

And we'll take Aaron Warwick from ES Capital as our first questioner.

Unknown Analyst, Analyst

You mentioned some struggles in the quarter due to some of these new things. Wondering, do you believe that, at the end of it, that you did demonstrate the technical excellence and the custom know-how to win this business going forward?

Alexander Shen, CEO

I think your question was can you repeat your question?

Unknown Analyst, Analyst

Yes. So you mentioned that you had some struggles during the quarter related to some new types of parts and the learning curve. And you said it provided you more opportunity to demonstrate technical excellence for complex fabrication and complex machining. And I'm wondering if, as you sit here today, do you think that you did demonstrate that despite the losses and that going forward, this new type of business would be something that you'll earn?

Alexander Shen, CEO

So I was saying there’s a negative part of this very limited number of new projects, the learning curve-related cost overruns. That's the first point. The second point, these new projects represent an entry point into new business projects because they are an opportunity to demonstrate technical excellence and custom know-how.

Unknown Analyst, Analyst

And my question is, do you think you demonstrated that to the customer that they would award future business?

Alexander Shen, CEO

Yes. They’re an opportunity to demonstrate, and we continue to demonstrate, and that's why I was telling you. I think you’re just reaffirming that is it an opportunity to demonstrate? Yes. Yes, it is. Absolutely, yes.

Unknown Analyst, Analyst

Good, good. Speaking of opportunities, you've mentioned before the $100 million over 2 years. And I just wondered where you sit with that now.

Alexander Shen, CEO

That has not decreased.

Unknown Analyst, Analyst

I have another question related to the recent performance. You achieved approximately $3 million this quarter. Securing $100 million over the next two years will necessitate significantly more personnel. There is a widespread concern in the industry regarding the recruitment of enough individuals. Unlike larger contractors such as Electric Boat, you aren't in need of thousands of workers. Based on past filings, it seems you might need around 100 additional employees at most when this opportunity comes to fruition. Could you provide some insight into your plans for attracting the necessary talent? This is specialized work, and it's not just a matter of hiring anyone.

Alexander Shen, CEO

I will tell you that on this very public call that talking about our strategy and revealing these things to our competitors on an open line would probably not be the best idea.

Unknown Analyst, Analyst

Okay. But is it safe to say that you can go ahead?

Alexander Shen, CEO

I would like to reassure all our listeners and our shareholders that I am fully capable of executing properly. Whether the revenue goes down or goes up, we will be able to flex ourselves to appropriately manage resources against demand. I will also point out the $100 million opportunity that has not decreased looking forward. That is not equal to revenue, that's opportunity, just so we're all clear.

Unknown Analyst, Analyst

I wanted to mention one other thing before I get back in the queue for any additional questions. There has been a significant amount of M&A activity in the defense industry recently. On their Q3 call in late January, Graham Corporation described the current environment as nearly an auction scenario, stating it's nearly impossible to pay 10 times forward EBITDA unless a business is struggling, which was their exact phrasing. They also mentioned that they've observed other companies paying around 15 times forward EBITDA, which is roughly where your stock is currently valued. It's worth noting that 15 times refers to trailing EBITDA, not forward. I'm curious if you're noticing similar interest from potential acquirers who are exploring opportunities with your company.

Alexander Shen, CEO

Tom?

Thomas Sammons, CFO

I don't think that's a question we can really answer at this point.

Operator, Operator

We'll move next to Ross Taylor with ARS Investment Partners.

P. Taylor, Analyst

Alex, has backlog grown since 12/31?

Alexander Shen, CEO

I want to say yes.

P. Taylor, Analyst

Okay. You can say yes, Alex. So we'll take that as a yes. Now let's move to the next question. I'm not really familiar with the term cost overruns in any organization you've been part of. Could you provide some background on the technological challenges faced? You mentioned that these are new projects different from the previous ones. Considering the total over the last two quarters, do you anticipate that in the end, you will recover business and more than compensate for the impact on the profit and loss statement due to the learning curve and these various efforts?

Alexander Shen, CEO

The cost overruns were due to the learning curve. In the past two quarters, they originated from a different set of part numbers than in the previous quarter. I wanted to clarify that these are not ongoing cost overruns from the same part number. Instead, it is a different set of part numbers that is leading to these learning curve-related cost overruns. There's always the factor of not having built it before, so we make our best estimates to try to understand the costs and anticipate any unexpected difficulties. This situation represents two different sets of part numbers in the different quarters. Will I be able to recover from this in the future? I fully expect to do so.

P. Taylor, Analyst

Okay. And then you also then just addressed my next question, which was, these are new parts that you haven't made before. So this would be new business on either Virginia Block 5 that you did not have on Block 4 or on carriers?

Alexander Shen, CEO

I didn't have Virginia Block 5 or Columbia class before, or carriers.

P. Taylor, Analyst

Carriers?

Alexander Shen, CEO

Yes, the 3 classes of boats. Yes.

P. Taylor, Analyst

Okay. With debt in cash...

Alexander Shen, CEO

So that's really exciting because it provides a chance to show that we can handle this challenging work. Unfortunately, we encountered some difficulties since it was something we hadn't built before, which led to cost overruns.

P. Taylor, Analyst

But the key, in the end is you did build it. When all was said and done, you were able to successfully build it and you now have an understanding of how to build it going forward, correct?

Thomas Sammons, CFO

Yes, correct. It was done well.

Alexander Shen, CEO

And for our CFO to actually say something like that is probably a key. It only pretty critical of me, so...

P. Taylor, Analyst

Well, I appreciate his help. So looking forward, the way you're setting this out, we're still seeing the $100-plus million, seeing these projects we're beginning to see, as you talked about Columbia class, we're seeing Virginia Block 5 starting to come to fruition. It's been a long time waiting. I think people have gotten very frustrated, the Virginia Block 5, in particular, is running well behind previous expectations of when the boats would be on the ways and under construction. Looking at all of that, it would seem that we're about to kind of roll into a cusp where we're going to start generating some pretty significant free cash flow going forward. Have you and the Board discussed how you anticipate using or returning that free cash flow, as you generate it, to shareholders?

Thomas Sammons, CFO

No, we have not. You can see we used some of the cash to pay down our debt.

P. Taylor, Analyst

Right. But you're now having debt. With debt where it is, quite honestly, given previous comments made by a Board representative on a call about the place for companies of TPCS' size in the public marketplace, it would strike me as, there's a level of debt you don't want to go below because it becomes a suboptimal utilization of resources, particularly when debt is a 1 multiple or a minus 1 multiple to valuation for a company and the number of shares as a multiple of that. So it would make sense, at some point in here, we begin to return cash either through dividend or aggressive share buybacks as cash is generated because the value here, on these programs, and I think the Graham call, which was referenced earlier, they talked about this being a decade-long opportunity, which is why valuations are so high in the space and why there's a bit of a feeding frenzy potentially occurring in the space. We would suggest that, as you develop that free cash flow, it would be returned to shareholders through buybacks.

Alexander Shen, CEO

Away from that, I want to get the idea and a feel, there was a lot of talk. Recently, the Commander of the 2nd Fleet in a speech said that the Atlantic fleet needed to understand that it would be in contested waters the minute it left port because of the significant increase in Soviet submarine activity and the vastly improved quality of their boats. It was recently highlighted in several defense publications that the U.S. spent 10 days trying to find the most modern Soviet submarine in the North Atlantic and did not find it in those 10 days. That would strike me as really compelling argument for significantly increasing the capabilities of our submarines, and the Block 5 does just that. Have you seen anything out there to indicate that there would be any slowing to the increase into the build-out for the Virginia Block 5 boats? I can only direct you to what's available in the public sector, and there's all kinds of stuff out there, I guess.

P. Taylor, Analyst

Yes. I was actually saying, I was shocked when I heard the comments by the Commander of the 2nd Fleet, because I think it's been since the '40s, early days of the second World War, that a U.S. naval commander has indicated that ships needed to be prepared to be engaged the minute they left harbor. Looking at all of this, it seems to me that you haven't expressed much excitement. Are you more enthusiastic today than you were three months ago, Alex, when we last spoke?

Alexander Shen, CEO

Am I more excited? I think my excitement was pretty high last time we spoke. I don't know how it can get higher. It's at the same high level. And seriously, the opportunity to demonstrate our excellence is going well. So I'm able to maintain the high level of excitement.

P. Taylor, Analyst

So what you're seeing is that I would assume that Ranor is...

Alexander Shen, CEO

I'm not trying to downplay the fact that we had cost overruns, negative margins, loss provisions, and incurred losses. I acknowledge these issues, but I am very excited to maintain my level of enthusiasm because these opportunities are real and becoming a reality.

P. Taylor, Analyst

Yes, Alex, as your largest shareholder, I don't mind if you lose $300,000 if it allows you to make millions in the future. To me, that's the cost of entering the market. You're developing complex systems with extremely fine tolerances, and it's not a simple business like mass-producing widgets or making cornflakes. You're creating components for vessels that operate in some of the most challenging environments on Earth. The fact that you can handle these challenges, learn from them, and turn those losses into future revenue is a trade-off that I find acceptable as an investor.

Alexander Shen, CEO

Thank you.

P. Taylor, Analyst

I see that you are excited about the opportunities ahead. It seems that we should begin to see the results of all the efforts you have been putting in over the past couple of years. Can I safely assume that?

Alexander Shen, CEO

Yes. It's just this clunky timing is so hard to predict. Yes, it should be getting closer and closer, absolutely. That's what...

P. Taylor, Analyst

I'm going to ask one final question before I pass it on to others. It's really difficult to assess your capacity in this area. A question was raised earlier regarding human resources. From everything I've gathered, I believe, though I don't expect a definitive answer, I would like to know what your current capacity level is compared to these potential businesses. Considering the goal of $100 million over two years, I assume you can fulfill a portion of that potential business with the resources and facilities you have available. Is that correct? Would it be half of that amount, two-thirds, or the entire sum?

Alexander Shen, CEO

I can produce some of it. Yes, that's correct. How to categorize it any further really depends on what it is because different part numbers require different resources. So, this aspect is highly dependent on the situation, the part number, and its characteristics. But yes, we can manage some of the increase as it stands and...

P. Taylor, Analyst

Would it be safe to say you see yourself being able to handle your expected uptake over the next 12 months? Do you need to do anything? If you get the business you think you're going to get, can you handle that business without significant additional capital expenditure or the need to bring in significant additional people?

Alexander Shen, CEO

I believe the answer involves a combination of factors. The most straightforward response is that some of what I'm considering requires investment while other aspects do not. It really depends on how the releases turn out. We will need to increase capital expenditures, manpower, and headcount; that is a certainty. The timing of these changes will depend heavily on the part numbers and their specifications. I hope I am addressing your question.

P. Taylor, Analyst

Yes, it's a complex question because you aren't just producing widgets; you're dealing with various factors that require different resources, which in turn occupy varying amounts of space and human resources. I understand this question is intricate, but my assumption is that you are currently operating with excess capacity, which may be affecting the company's profitability. Moving forward, I believe you will first fully utilize the capacity you have in-house, which should enhance margins. After achieving that, you'll need to acquire additional resources. I would assume that much of what you anticipate involves the capital equipment necessary for this, as you have invested significantly in capital equipment in recent years.

Alexander Shen, CEO

We've invested in capital equipment in recent years? Yes. Will we be investing some more? It's highly probable. Yes.

P. Taylor, Analyst

But you invest more as you win business?

Alexander Shen, CEO

More or less, yes. It's difficult to get it approved by the CFO otherwise. He will be cautious in his decisions.

Operator, Operator

And next, we'll move to John Hardison, a private investor.

Unknown Shareholder, Shareholder

From public information that we know, in the past, the prime Navy contractor had welding problems on missile tubes about 1.5 years ago, and I know you guys have not had welding issues. So I would think that the Navy and Electric Boat probably put a lengthy hold on all missile tube welding work until they could add appropriate quality control procedures. So I'd also think this work is now getting cleared to go ahead and that it will dramatically increase your workflow going forward. So Alex, can you give us any additional color on that?

Alexander Shen, CEO

That's a specific question, John. Thank you. The issues encountered outside of Ranor do not affect our subsidiary, as Ranor has not faced those problems. Therefore, we are problem-free in those areas. To answer your question, as demand is released again, we are positioned to secure some of those orders. There are more opportunities than before.

Unknown Shareholder, Shareholder

Did it slow it down though?

Alexander Shen, CEO

More or less, yes.

Operator, Operator

And that does conclude our question-and-answer session for today. I'll turn it back over to management for any closing remarks.

Alexander Shen, CEO

Thank you, everyone, for your attendance. Have a great day.

Operator, Operator

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