Nortech Systems Incorporated (NSYS) Q2 2024 Earnings Call Transcript

Nortech Systems Incorporated (NASDAQ:NSYS) Q2 2024 Earnings Conference Call August 8, 2024 8:30 AM ET Company Participants Andrew LaFrence – CFO and SVP of FinanceJay Miller – President, CEO and Director Conference Call Participants Operator Good morning, ladies and gentlemen, and welcome to the Nortech Systems Incorporated Second Quarter 2024 Earnings Conference Call. With me on the line today are Jay Miller, President and Chief Executive Officer; and Andrew LaFrence, Chief Financial Officer and Senior Vice President of Finance. [Operator Instructions] At this time, it is my pleasure to turn the call over to Mr. Andy LaFrence. Sir, the floor is yours. Andrew LaFrence Thank you, Ali. I would also like to welcome everyone to today’s conference call. Jay will begin the call with a review of our operations, recent developments and business outlook. Then I will review Nortech’s second quarter 2024 financial results before turning it back to Jay for his closing comments. Then we will open up the call for your questions. Before we continue, please note that statements made during this call may be forward-looking statements regarding expected net sales, earnings, future plans, opportunities and other company expectations. These estimates, plans and other forward-looking statements involve unknown and known risks and uncertainties that may cause actual results to differ materially from those expressed or implied on this call. These risks, including those that are detailed in our most recent SEC filings, may be amended or supplemented. The statements made during this conference call are based upon information known by Nortech as of the date and time of this call and we assume no obligation to update the information in today’s call. You can find Nortech’s complete safe harbor statements in our SEC filings. And with that, I’ll turn it over to Jay for his opening comments. Jay? Jay Miller Thank you, Andy, and good morning, everyone. We’re glad you could join us today. In the second quarter of 2024, we continued to manage operating expenses as we faced near-term customer order headwinds and incremental training and other costs to transfer customer programs between various North American facilities. Regarding revenues, we are noting in the recent months reduced visibility to customer orders as compared with order patterns in the prior year quarters as medical and industrial customers in particular are balancing their inventories and, therefore, pushing or deferring the placement of some orders. In the case of certain medical customers, we’re also seeing the timing of product launches being delayed. We continue to see strong ordering patterns from our aerospace and defense customers. We’re also noting positive customer engagement as the normalization of supply chains focuses customers to further accelerate nearshoring. This combined with other shorter lead time and on-time delivery strategies and better overall customer service results in deeper customer partnerships, which are fundamental to our long-term growth strategy. In short, in the first half of 2024, we have made conscious decisions to face into some clear market dynamics and make a number of short-term sacrifices in exchange for improved long-term growth and profitability, including the facility consolidation and investment in business development I will touch on shortly. Regarding our cost structure, we continue to be very diligent managing our operating costs. With an eye for long-term optimization of our facilities, in the second quarter we announced the consolidation of our Blue Earth facility into our Bemidji factory by the end of the year and a 30% reduction in our Maple Grove leased space. These facility optimization activities will result in at least $1.6 million in annual savings in 2025 and beyond. Over the past several years, we have taken a number of steps to invest in core infrastructure and a world-class leadership team to drive our long-term growth strategy. We are very bullish on the future of Nortech and continue to make investments to accelerate long-term growth. For example, we have now completed staffing in industry-specific business development team. This team is performing at a very high level and driving impressive quote and new business opportunities. Further, we are taking advantage of the changes in supply chain dynamics to seamlessly restructure our operations to better serve our customers by delivering high quality products and services on time with shorter lead times. This will also facilitate and drive our long-term growth. This process is a natural evolution of our business and entails changes in the organizational structure to enhance customer intimacy and not a restructuring of our employee headcount. I continue to be impressed by how our employees live out Nortech’s values of teamwork, excellence, commitment, innovation and integrity every day. Once again the whole Nortech team deserves our sincere appreciation. Our 3-tier global strategy of manufacturing in the U.S., Mexico and China gives Nortech customers flexibility in improving our own competitiveness. We can move production around based on factors like cost, operational requirements including ever improving on-time delivery of high quality products and shorter lead times and intellectual property management. Our customer teams and engineers evaluate each customer’s needs to determine the most suitable location, which may also change over the course of a product’s life cycle. In terms of China, as I’ve mentioned on past calls, much of our production work there is built in country for country, a nearshoring approach to better serve our customers in the global market, including reduced shipping costs and time. Next I’ll turn it over to Andy for a more in-depth look at our financial results. Andy? Andrew LaFrence Thank you, Jay. In the next few minutes, I will provide certain details of our financial performance in the second quarter of 2024. I would encourage you to also review our Form 8-K containing our press release and non-GAAP measures issued earlier this morning with the U.S. Securities and Exchange Commission. As a continued theme, we have historically noted that our individual quarterly performance can be affected by outside factors. These might include timing fluctuations, including seasonable fluctuations, customer shipments, supply chain issues. Any of these could materially impact a particular quarter either positively or negatively. Consequently, we believe it is more appropriate to view the business on a 12-month basis rather than focus on quarterly performance. This approach will help normalize these potential anomalies and offer a better gauge of our strategy’s long-term success. So today while I’ll focus most of my comments on our second quarter and year-to-date 2024 results, I will provide some comparisons for the 12-month period ended June 30, 2024 compared with the same period ended June 30, 2023. Net sales for the second quarter of 2024 totaled $33.9 million. This represents a 3.2% decrease to net sales of $35 million in the second quarter of 2023. For the six months ended June 30, 2024 net sales were $68.1 million as compared to $69.9 million in the same prior year period, a decrease of 2.6%. As Jay noted, we experienced reduced net sales from our medical customers as they are aggressively reducing their inventory investments. We have also noted several medical product introductions being pushed out to later in 2024 or into 2025. We continue to see strong revenue growth in our aerospace and defense category as well as moderate gains in our industrial customers. Further, as Jay noted in his remarks, we have realized a reduction in customer backlog in the second quarter of 2024 as customers have changed their purchasing patterns and are requesting shorter lead times with new orders. Second quarter of 2024 gross profit totaled $4.6 million or 13.6% of net sales compared with gross profit of $5.5 million or 15.6% of net sales in the same prior year quarter. For the first six months of 2024, we realized gross profit of $10.1 million or 14.8% of net sales as compared with $11 million or 15.7% of net sales in the first six months of 2023. Reduction in gross margin percentage in the 2024 periods is largely due to lower net sales and result in reduced facility utilization and, to a lesser extent, incremental training costs related to the movement of Blue Earth production to Bemidji by the end of 2024. Operating expenses for the second quarter and the first six months of 2024 are marginally lower than the prior year periods as a result of lower incentive compensation accruals and expense management, which offset increased payroll costs. Further, the 2024 periods reflect $91,000 of restructuring costs related to retention bonuses and other costs associated with the upcoming Blue Earth closure. The closure of our Blue Earth facility in the second half of 2024 is on schedule and going well. We now estimate the Blue Earth closing will result in a restructuring cash charge of between $750,000 and $850,000 in 2024. We currently do not anticipate any significant noncash impairment charges related to this closure. We expect to pay substantially all of the restructuring costs in 2024. As we previously disclosed, we expect to realize annual savings starting in 2025 of at least $1.6 million annually related to the optimization of our Minnesota facilities. Moving to the cash flow statement. For the first six months ended June 30, 2024 net cash used in operating activities totaled $1.5 million as compared with cash provided of $281,000 in the same period in 2023. While the timing of customer and vendor payments impacted operating cash flow for the period, we have purposely increased inventory levels in anticipation of the Blue Earth facility transition to Bemidji. As noted in our press release distributed this morning, we use earnings before interest, tax, depreciation and amortization or EBITDA as a key performance indicator to manage our business. In the press release, we have provided a reconciliation of our financial performance determined in accordance with the U.S. generally accepted account principles and EBITDA. For the quarter ended June 30, 2024 as adjusted for restructuring charges, EBITDA was $919,000 as compared with $1.6 million for the same period in 2023. Year-to-date 2024 adjusted EBITDA is $2.6 million as compared with $3.2 million in the first six months of 2023. The decreased adjusted EBITDA is a result of lower net sales and related gross profit. Turning to the balance sheet. As of June 30, 2024 cash and cash equivalents totaled $1.5 million, down from $1.7 million as of December 31, 2023. The fluctuation in cash balances reflects timing of cash receipts, expenditures in line of credit borrowings. We ended the second quarter of 2024 with $6.6 million of borrowing capacity under our line of credit. Accounts receivable as of June 30, 2024 were $17.6 million, down from $19.3 million as of December 31, 2023. This is in line with our strong fourth quarter sales and the expected timing of customer payments. Inventories were $22.8 million as of June 30, 2024 as compared with $21.7 million as of December 31, 2023. The increase in inventory reflects the buildup of inventory balances in anticipation of completing our movement of Blue Earth production to our Bemidji facility. Our contract asset, which represents revenue earned but not yet billed to customers, increased slightly to $15 million as of June 30, 2024 as compared with $14.5 million at the end of 2023. The increase reflects the timing of customer shipments. As we disclosed in our press release issued earlier today, we have presented non-GAAP results including trailing 12-month financial data and EBITDA. For the trailing 12-month period ended June 30, 2024 net sales were $137.5 million as compared with $140.8 million in the same 12-month period ended June 30, 2023. In addition, adjusted EBITDA for the 12-month period ended June 30, 2024 was $7.3 million as compared with $6.8 million for the 12-month period ended June 30, 2023. As we stated in May, our top priorities in 2024 remain unchanged. First, we are extremely focused on continuing to strengthen our balance sheet. Next we will take further advantage of opportunities to align our operations and infrastructure with market demand that we are seeing to deliver sustainable long-term EBITDA growth as well as driving improvements in free cash flow. Coupled with disciplined lean operations, execution, expense management and R&D innovation; we believe Nortech can deliver on our objectives. With that, I will turn it back to Jay for his closing comments. Jay? Jay Miller Thanks, Andy. Before we open the call to your questions, I want to touch on three related areas that together serve our customers and help advance Nortech’s… [Technical Difficulty] Operator Apologies, we appear to have lost, the speakers audio. One moment please. Jay Miller Hi, can you hear me. Operator Yes, indeed sir, your line is back. Jay Miller Okay, all right. Andrew LaFrence Well will likely start Jay with make anytime. Jay Miller Okay, I apologize this is redundant thing. Andy will open the call to your question — before we open the call to your question, I want to touch on three related areas that together serve our customers and help advance Nortech’s corporate stewardship, our engineering expertise, product innovation and sustainability plans. For engineering expertise, we have a dedicated engineering services team that is focused on enhancing manufacturability and serviceability, supply chain risk mitigation and cost efficiency for our customers. Earlier in this call, I mentioned the benefits of our 3-tier cost structure across the U.S., Mexico and China and how we can quickly adopt our global resources to fit our customers’ changing needs. Nortech’s engineering capabilities also further our research and development activities with advancements like the Expanded Beam Xtreme fiber optic technology or EBX that we announced in January. EBX is designed for digital data transmission and offers improved speed, reliability and security when compared to traditional copper. We are also excited about our Active Optical Xtreme technology that offers sophisticated — that works in sophisticated magnetic environments, a testament to our team’s dedication to innovation, hard work and excellence in the field of digital connectivity solutions. AOX represents a significant advancement in our product offerings and underscores our commitment to providing state-of-the-art solutions that meet the evolving needs of our clients to deliver products that offer lighter weight, lower cost and ruggedized solutions sustainably. At the simplest level, the vast majority of Nortech’s products provide digital connectivity solutions that transmit data and power in various applications. As you may know, the Internet of Things or IoT integrates a variety of electronic components like microcontrollers, sensors, actuators and connectivity modules. These components in turn enable IoT connected devices to collect, parse, transmit and receive data. More and more today that data is being evaluated and analyzed using human intelligence and combined artificial and human intelligence for improved performance and data management for our customers as well as for their customers. More data needs better data pipelines and that’s where Nortech comes in. Technology like our EBX smart cables helps collect and distribute this data faster, more cost effectively and more securely across these sophisticated networks. We see strong opportunities for growth. For example, industrial IoT applications are expected to experience impressive double-digit annual growth from 2023 to 2030 according to Fortune Business Insights. Our pivot to more fiber optic technology improves product performance for our customers by offering unparalleled speed and reliability. It also aligns with sustainability goals we share with many of those customers. When compared with traditional copper, fiber optics offers significant environmental benefits during both production and operation, including improved energy efficiency and less material usage while decreasing the carbon footprint in the complex cables we manufacture. For example, aerospace and defense customers are adopting fiber optic technology due to these key advantages; reduced size, weight and power requirements; immunity to electromagnetic interference; and greater ruggedization in harsh environments. Harsh environments of course are very common in aerospace and defense applications. Nortech has a proud history of serving these customers’ unique needs dating back roughly 30 years. It’s the smallest of our three core markets by net sales, but very important for our diversification and future growth. Our contributions to our national defense are also a great source of pride for Nortech employees. The majority of our aerospace and defense cables are still the traditional black rounded and molded type common and legacy defense systems such as shipboard missile launches for the Navy. But we are looking to the future with ruggedized fiber optics and evolving along with our customers. In closing, we are excited about technological developments across all our markets and expect them to support our continued sales momentum in 2024 aided by stabilization in supply chain and customer orders. Last month IPC cited improving outlook among global electronics manufacturers with stronger demand and shipments reported in January. Our progress over recent quarters confirms that outlook. We will now open up the call for your questions. Ali, please open the lines. Question-and-Answer Session Operator [Operator Instructions] We currently have no questions in queue at this time. So I’ll hand it back to Mr. Miller. Jay Miller Thank you, Ali, and thanks to everyone for joining us today. We look forward to talking with you in November when we report our third quarter 2024 results. Again thank you and goodbye. Operator Thank you. This concludes today’s call and you may disconnect your lines at this time. And we thank you for your participation.

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