Here's the complete report from insidertrader----
2/18/98
$12.13
Wake-Up Call.
With the constant threat of shareholder dissension looming over their heads, execs at publicly-traded companies constantly feel pressure to boost sales and profits. Private companies, on the other hand, can coast along, oblivious to any external compulsion to seek out growth. From the looks of things, Merrimac Industries appears to be a private company masquerading as a public one.
This maker of hardware for the military, wireless, and satellite industries has seen its sales drift lower for almost a decade. In the mid-1980s, annual sales in the $15-16 million range were the norm. More recently, sales have flatlined around $14 million. Don't blame it on cutbacks in military spending. "We were always just a job shop, lacking full-scale production capacity," says Charlie Huber, Merrimac's recently retired Chairman.
Adding insult, management took its eye away from the cost structure. Gross margins dropped from a company-record 52% in 1994, to 42% last year. Operating income predictably plunged from over $2 million in 1994 and 1995 to under $800,000 in 1996. By the end of 1996, Charlie Huber had seen enough. To jumpstart the company, he brought in Mason Carter, an industry veteran who had a knack for refocusing wayward enterprises.
Since his arrival in late 1996, Carter has aggressively moved to reduce costs and boost sales. Much of the cost reductions are now coming from the little things. "We are re-engineering our processes, de-bottlenecking and stressing design for manufacture," he says. And Merrimac's marketing approach is also paying off as the company places a new emphasis on the customer. "We're seeking out what the market wants rather than designing products and then looking for a customer," Carter adds.
Those efforts are already bearing fruit. In the first nine months of 1997, sales jumped 41% to $14.2 million. Gross margins are starting to climb back as well, into the mid-40's. Equally impressive: The company's backlog has also swelled to over $10 million, up 45% from the end of 1996.
Despite the sleepy previous management, Merrimac typically generated annual profits between $0.80 and $1.14 a share since 1993. The company also has a very clean balance sheet with no debt, no goodwill or other intangible assets, and $1.48 per share in cash. But the recent steps taken by Carter and his management team give credence to the view that earnings may soon soar for this solid little snoozer.
After earning $0.63 a share in the first nine months of this year, we expect full year-profits of $0.77-nothing to write home about. It's the prospects for 1998 and 1999 that spark our interest. Thanks to heavy marketing efforts that are focused on the company's top 20 customers, we expect sales to spurt 20% higher in 1998, to $22.6 million. And with tight SG&A control, per share profits should grow to $1.25 a share. For 1999, thing look even brighter. That's when the company's extensive satellite industry customer list should start its aggressive spending plans. Sales of $28.3 million, in conjunction with a return to 50% gross margins, should help Merrimac earn $1.75 a share.
Despite the company's brightening outlook, Merrimac insiders have not seen their actions rewarded by investors. Though the stock ran from $11 to $19 last summer on the heels of a particular buyer, the shares have drifted back down to $11. Part of the blame stems from investor misperception that a blowout second quarter (when the company earned $0.24 a share) was the beginning of a series of strong quarters. When profits dipped to $0.21 a share in the third quarter, investors were disappointed. And Mason Carter's intimations that the fourth quarter would be slightly lower than the third, sent investors fleeing in droves.
But Carter has been upfront with investors all along, stating that the steps that the company was taking would payoff over years, not quarters. Realizing that investors are being myopic, Merrimac insiders have bought over 20,000 MRM shares in the open market since last April at prices ranging from $10.38 to $17. As a group, insiders now own 27% of tiny Merrimac.
The challenge now for Carter is to unlock the value tied up in the company. As a first step, he suspended the company's dividend, figuring the money was better spent re-invested in the business. Another hurdle: the company's minuscule 900,000 share float, which keeps serious institutional investors from getting in and makes MRM's price fluctuate greatly on little trading volume. Realizing this, Carter hints at plans to expand the float, but has yet to tip his hand.
Whatever steps he takes, an expanded float, along with the brightening operating outlook, should help propel the stock northward. Merrimac's internal moves show up on the P&L by this Summer. We think investors will jump on the stock and bid it up to 15 times our 1998 earnings outlook, or $18.75.
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