Nortech Systems Incorporated (NSYS) Q2 2022 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Nortech’s Second Quarter 2022 Earnings Call. [Operator Instructions] It is now my pleasure to turn the floor over to your hosts, Jay Miller, President and Chief Executive Officer and Chris Jones, Chief Financial Officer. Gentlemen the floor is yours.

Thanks, Paul. I’d also like to welcome everyone to Nortech Systems second quarter 2022 conference call. Jay will begin today’s call with a brief review of our second quarter operational performance, and then I will review Nortech’s Q2 financial results before turning it back over to Jay for his closing comments and some highlights from our recent strategic planning process. Then we’ll open up the call for some questions. Before we continue, though, please make note that statements made during this call and the Q&A session may be forward-looking regarding expected revenue, 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 Form 10-Q, maybe amended or supplemented. The statements made during this conference call are based upon information known by Nortech as of the date 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 will turn it over to Jay for his opening comments.

Thank you, Chris and good afternoon everyone. We are very pleased to be with you today and update you on what was a very strong quarter for Nortech and a great springboard for the second half of the year. But before I begin, I’d like to express my sincere appreciation to each and every Nortech team member in the U.S., Mexico and China for their commitment to serving our customers and for helping us drive the continued momentum we are seeing across our entire business. These are challenging times for us and for our customers, and we continue to experience component shortages, supply chain constraints, inflationary pressures and tightened labor markets. As we all know, the entire business ecosystem is still under severe stress. Especially in these times, our strongest resources are our most valuable assets, and our most valuable assets are Nortech’s people. Every day, they work very hard to deliver mission-critical quality solutions on time. These solutions help our industrial customers to build and maintain the essential infrastructure needed here in the U.S. and in other countries, our medical customers to diagnose, treat and cure illnesses by providing valuable aid to essential frontline health care workers, and our defense customers to support, protect and serve the United States Armed Forces and our global allies. Across Nortech Systems, we are proud to work with many leading Fortune 500 customers – companies. We value our customers’ loyalty and work very hard every day to earn it. Our suppliers are also vital connections. We consider these relationships as true win-win partnerships. We deal with nearly 3,000 different suppliers. Whether strategic customers or key suppliers, we have worked with many of them for decades. These long relationships do not happen by accident. They are mutually beneficial collaborations. In a few minutes, Chris will review our second quarter financial performance, which included some significant improvements. We are particularly proud of these accomplishments. These solid results consisted of both sequential and year-over-year improvements occurring in light of healthy 2021 comparisons. In the second quarter, we were encouraged by continued bookings growth across all our markets, evidenced by our record backlog of $106.2 million. This is almost a 50% increase from the second quarter of 2021 and up 9% from our total backlog at the end of the first quarter of this year. Our outlook for the remainder of the year is optimistic, and our healthy backlog is one reason driving that sentiment. We have orders booked well past December and into 2023. Despite the general business headlines, which tend to tilt negative, we have not yet seen any customers take their feet off the gas pedals. One of our large medical customers, for example, announced its own orders rose 8% in the most recent quarter, but sales were up only 2% due to supply chain constraints, coupled with the impact of COVID in select China regions where they operate. Overall growth trends in our industry are encouraging. A recent study by New Venture Research, which specializes in electronics manufacturing services industry, expects a compound annual growth rate of nearly 7% over the next 5 years. From our own sales growth and selective pricing actions, we expect to post modest margin expansion for the remainder of 2022. We also anticipate improved positive cash flow in the third and fourth quarters, reversing the seasonal trends of the first half of the year in which receivables are typically at a higher level. Chris will shed more light on our cash management strategies in a few minutes. Finally, as we move into 2023, we anticipate contributions from new Active Optical Xtreme, or AOX fiber optic cable technologies. We are investing in R&D innovation to ensure Nortech’s technical capabilities are keeping pace with trends toward more data and smaller components. AOX enables our customers to alter their engineering designs to improve performance, reduce cost and begin the process of reducing their carbon footprint, much more on that in future quarters. With our solid foundation, Nortech is better positioned than ever – than we have ever been to weather today’s storms and future ones. We are poised for growth, thanks to our employees, management team and Board of Directors. We also appreciate the support of our many loyal shareholders. Now I’ll ask Chris to review our financial results. Chris?

Alright. Thanks, Jay, and thanks to everyone for joining us today. So in a few minutes today, I’ll provide details about our financial performance in the 2022 second quarter, but I would encourage you again to review our latest Form 10-Q, which we filed earlier today because it contains far more information about our business operations and financial performance than we will cover on this call. So beginning with the P&L, in Q2 2022, revenue totaled $32.5 million, and this represents a 7.7% increase from revenue of $30.2 million in the second quarter of 2021, and up nearly 6% from our prior quarter this year. For the first 6 months of 2022, revenue totaled $63.2 million, a 21% increase from revenue of 52.3% in the first 6 months of 2021. Nortech’s second quarter revenue performance was driven by growth in sales for both medical and our defense market. The medical market was up by $2.5 million or 15.4% as compared to the prior year. And the Q2 revenue from the defense market was also up approximately 15%, totaling $4.5 million. The overall year-on-year revenue improvement was primarily due to a combination of production volume increases and price adjustments. Gross profit totaled $5 million or 15.4% compared to gross profit of $3.6 million or 11.9% in the prior year quarter. Year-over-year gross profit improvement and resulting 350-basis-point improvement in our gross margin was primarily due to pricing increases implemented to overcome inflationary cost pressures, coupled with higher plant volume and improved operating efficiencies. In the second quarter, operating expenses totaled $4 million, a 25% increase from the second quarter operating expenses of $3.2 million in the prior year. That $0.8 million increase in year-over-year operating expense was driven primarily by investments in research and development, sales and marketing and upgrading essential IT, HR and analytical capabilities. Finally, net income totaled $700,000 or $0.25 per diluted share in Q2 of 2022, up significantly from net income of $179,000 or $0.06 per diluted share in Q2 of 2021. Moving on to the balance sheet and cash flow statement. First, net cash used by operating activities for the quarter ended June 30, 2022, was $1.9 million compared with a net cash used by operations of $5.4 million for the quarter ended June 30, 2021. During the second quarter, increases in working capital due to higher sales backlog levels as well as actions taken to address the global supply chain shortages drove the use of cash from operating activities, primarily increasing inventories by $3.5 million. Receivables at June 30 were $16.5 million, an increase of $2 million from the beginning of the year. This is a seasonal pattern that we have seen evolve over the past couple of years. The first half of the year has been typically marked by higher receivables levels, while cash collections will improve in the second half of the year. As a result, we believe that we will generate modest levels of free cash flow in the second half of this year. We ended the second quarter of 2022 with $4.2 million of borrowing capacity on our $16 million line of credit with Bank of America. And we believe that our existing financing arrangements, our anticipated cash flows from operations, funds expected to be received from the ERC and cash on hand will be sufficient to satisfy our working capital needs for next year as well as any capital expenditures and debt repayments. We believe we have a solid financial base to take this company into the future. And before I turn it back over to Jay, I want to reiterate our top financial priority in the second half of this year and every year thereafter is that we are focused on building an enterprise that will deliver reliable, sustainable free cash flow growth. And over the last 2 years, we have battled through countless obstacles and it’s clear that Nortech is headed in the right direction, and we are very confident that our best days are in front of us. So with that, I’ll turn it back over to Jay for his closing comments.

Thanks, Chris. Before we open the call to your questions, I’d like to briefly touch on our recent strategic planning process and ongoing supply chain optimization activities. First, our strategic planning process is dynamic and involves all facets of our business across three countries. This annual activity focuses on maximizing our major – maximizing our major strategic customer relationships, which are defined by three characteristics: proactive communication with customer leadership, early engagement between our engineering teams, and frequent dialogue between our supply chain teams. These relationships also leverage Nortech’s highest value-add strengths, which help differentiate us in the marketplace, and position us well for the future. Second, the relationships I just outlined in our strategic planning process are vital to our end-to-end supply chain optimization efforts. We are continuing to make measurable process in numerous areas that are critical to improving customer on-time delivery, including hiring great people, providing them with effective training and retaining them for the long-term, improving plant capacity and throughput, reducing waste and process inefficiencies, reducing risk via customer stocking programs, conducting customer engineering summits to planned future capacity expansion, relocating production to the optimal plant, whether it’s in the U.S., Mexico or China, and proactive communication up and down the supply chain to address bottlenecks and prevent lead time issues. Supply chain success starts and ends with our team members, and I must thank them again for their tireless efforts in all these areas and more. As always, we look forward to updating you on our progress in the future – in future quarterly calls and shareholder communications. With that, I will conclude our prepared remarks this afternoon, and we will open the call up for questions.

[Operator Instructions] And we did have a question come from Paul Cooper. Paul is a shareholder. Paul, your line is live. You may go ahead. Hello, Paul, please check your mute button. You are in the talk box [ph], you may go ahead with your question.

Sorry, I was muted. First off, congrats on the strong quarter and great backlog, that’s great to see. I have been a long-standing shareholder. And just to kind of follow on some comments made, it sounds like you anticipate sequential quarterly revenue growth and margin improvement through the balance of this year, is that correct?

Yes. Yes, it is, Paul.

And that’s great to hear. And do you – is there any thought on when you will receive the ERC funds?

Yes. This is Chris. I will take that one. And I think the challenges within the IRS, I think are well known to all of you with respect to the administrative processing times. Like it’s uncertain when we will receive those funds, we are – we have been in contact with the IRS. We are absolutely qualified for the ERC credit. And we have dotted every I and crossed every T, and we are merely in administrative review process with the IRS. And we are coordinating with them and trying to reach out to them and contact them via their ERC communication line. And we will continue to do that. I think we expect those funds at any time. We are also coordinating with Bank of America, too. And I think we are – right now, we do have a $5 million receivable, which you have seen on our balance sheet from recognizing income in the third quarter of last year. And that $5 million receivable is part of our borrowing base right now. And so we are working with both the IRS and with Bank of America to make sure that those funds are available for what they are intended for, which was the employee retention credit. And that’s what we are using those funds for. We are retaining and building our workforce. And those funds, at this point, have come from our asset-based lending facility, but then when they come from the IRS, we will pay down that debt on the ABL.

Got it. Thank you. And kind of related, do you anticipate any major or significant capital expenditure spends in projects for the balance of 2022?

Not out of the ordinary. So, for the first half of this year, we have invested $1.2 million in CapEx. And I think that’s a little beyond trend for Nortech Systems, but it’s about on our plan. And I think about $500,000 or so per quarter has been our trajectory.

Got it. Great. Well, thank you and gentlemen, congratulations again on the stellar performance this last quarter.

Thank you very much Paul.

Thank you.

Thank you. And there were no other questions in queue at this time. I would now like to hand the call back to Chris Jones for closing remarks.

Okay. Thanks operator and thanks to everybody for joining us today. And we certainly look forward to talking to you in our November call to talk about our third quarter results. And at the end of the call, I am going to go back through our forward-looking statement. So, again, in closing, I just want to remind everybody that the comments during this call and the Q&A session will have forward-looking statements regarding revenue and earnings, future plans and opportunities and other company expectations. And again, these estimates, plans and other forward-looking statements involve unknown and known risks and uncertainties, and they may cause actual results to differ materially from those expressed or implied in this call. And these risks, including those that are detailed in our most recent 10-Q, may be amended or supplemented. And the statements made during this call are based on information known by Nortech as of the date and time of this call, and we assume no obligation to update information on today’s call. So, with that, we will end the call. And thank you, and goodbye.

Thank you, ladies and gentlemen. This does conclude today’s conference. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.