Nortech Systems Incorporated (NSYS) Q1 2024 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and welcome to the Nortech Systems Incorporated First 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 Andrew LaFrence.

Thank you, Matthew. I'd 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 first quarter 2024 financial results before turning it back over 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 include those that are detailed in our most recent Form 10-Q may be amended or supplemented. The statements made during this conference call are based on information known by Nortech as of this 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 back over to Jay for his opening comments. Jay?

Thank you, Andy, and good afternoon, everyone. We're glad you can join us today. In the first quarter of 2024, we extended our reporting of solid operating results, notably by improving margins and managing expenses. During the first quarter, I have met with hundreds of Nortech employees to share our appreciation of their efforts and our results on behalf of the management, Board of Directors and shareholders. Everything starts and ends with how our employees live Nortech's values of teamwork, excellence, commitment, innovation and integrity every day. It is very clear to me that our employees are living these values, and we would not have delivered our first quarter 2024 financial results without our team members continued outstanding contributions. Once again, the whole Nortech team deserves our sincere appreciation. Touching briefly on our financial results now. We posted net sales of $34.2 million for the first quarter along with continued improvements in gross margin. We work carefully with our customers as strategic partners to adjust pricing as needed to reflect market conditions and supply chain realities. Our EBITDA levels were also solid at $1.6 million for the first quarter. In the 12-month period ended March 31, 2024, we have generated $8.1 million of EBITDA. Overall, we are seeing a shift in customer ordering activities wherein they are seeking to shorten their ordering times, which is requiring us to work on different strategies to stock inventories and work with vendors to have ready to pick parts on hand. We believe this is an expected evolution of supply chain management given the normalization of supply chains and focus on near-shoring strategies. We recently hired a new global leader in supply chain management to lead this initiative. We are also noting similar to many other contract manufacturers, recent reduced visibility to bookings in the next several quarters as compared with order patterns in the prior year quarters as customers are balancing their inventories and, therefore, deferring the placement of some orders. Earlier today, we announced our plan to consolidate our Minnesota facilities to optimize our operating expense structure and plant capacity utilization to increase the efficiency of our operations. Part of our strategy for continuing to improve the bottom line and direct our future capital expenditures. Specifically, we are closing our Blue Earth, Minnesota production facility by the end of 2024. We will be shifting wire and cable assembly and system-level assembly manufacturing to Nortech's Bemidji, Minnesota, location. All of the Blue Earth employees are being extended job offers at our other Minnesota facilities. We are very hopeful to keep all of the Blue Earth employees in the Nortech family. Further, we are reducing the square footage of our Maple Grove, Minnesota headquarters and engineering facility by almost 30%. This reduction reflects our current and future space needs, which we have been heavily -- which have been heavily influenced by the company's hybrid remote work arrangements. Andy will speak in more detail on the impact of these facility optimization activities. Our 3-tier global strategy of manufacturing in the U.S., Mexico and China gives Nortech's customers flexibility in improving their own competitiveness. We can move production around based on factors like cost, operational requirements, quality control 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 our product's lifetime. In terms of China, as I mentioned in past calls, much of our production work there is built in country for country, a near-shoring approach to better serve our customers in the global market, including reduced shipping and cost times. Next, I will turn it over to Andy for more in-depth look at our financial results. Andy?

Thank you, Jay. In the next few minutes, I'll provide certain details of our financial performance in the first quarter of 2024, but I would encourage you to review our press release issued earlier this morning and our latest filings this week with the U.S. Securities and Exchange Commission as they contain far more information about our business operations and financial results then we will cover on this call. 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 seasonal fluctuations, customer shipments and supply chain issues. Any of these could materially impact a particular quarter either positively or negatively. Consequently, we believe it is more appropriate to review our business on a 12-month basis rather than focusing 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 the first quarter results, I will provide some comparisons for the 12-month period ending March 31, 2024, and compared with the same period ended March 31, 2023. As of March 31, 2024, we did see sustained year-over-year 90-day backlogs. And for the quarter, we realized gross margin improvement as well as increased levels of net income, EBITDA as compared with the first quarter of 2023. Net sales for Q1 2024 totaled $34.2 million. This represents a 1.9% decrease from net sales of $34.9 million in the first quarter of 2023. Nortech's first quarter net sales performance was driven by year-over-year growth in the aerospace and defense category, offset by decreases in medical and industrial. For the quarter, the medical market was down by $1.1 million or 5.1% as compared with the same quarter in 2023, with the majority of the decrease coming from medical component products. For the quarter, net sales from the aerospace and defense category totaled $5.9 million, a 44.9% increase from the prior year quarter. And net sales from Nortech's industrial category were down $8.1 million or 14.8% from the prior year quarter. First quarter 2024 gross margin totaled $5.4 million or 15.9% of net sales compared with gross profit of $5.5 million or 15.7% of net sales in the same prior year quarter. First quarter operating expenses totaled $4.3 million, a 3.1% decrease from the first quarter 2023 operating expenses of $4.4 million. As a result of our performance in the first quarter of 2024, we realized net income of $765,000 or $0.26 per diluted share compared with $681,000 or $0.23 per diluted share in the same quarter of 2023. As Jay discussed in his comments, our Board of Directors just today approved 2 actions to facilitate our optimization of our North American facilities footprint. First, we announced the closure of our Blue Earth facility by the end of 2024. The decision to close our Blue Earth facility was not without much forethought and deliberation. While we're closing this facility, our commitment to all of our Blue Earth employees will continue through offering of employment at another Nortech facility in Minnesota. We hope that all of our Blue Earth employees will continue with Nortech. We estimate the Blue Earth closing will result in a restructuring charge of $1 million to $1.1 million in the last 3 quarters of 2024. These expenses include estimated noncash impairment charges of $400,000 with the remaining costs consisting of payments to move equipment, shut down the Blue Earth facility and employee retention. We expect to pay substantially all of the cash restructuring costs in 2024. Second, we have signed an amendment to our Maple Grove, Minnesota, lease to reduce our square footage by approximately 30%, while repositioning the remaining retained space to better serve our needs for the next several years. We expect to realize annual savings starting in 2025 of at least $1.6 million related to these 2 consolidation activities. Moving to the cash flow statement. First, for the quarter ended March 31, 2024, net cash provided by operating activities totaled $2.8 million as compared with $1.7 million for the same period in 2023. As noted in our press release distributed this morning, we used earnings before interest, tax, depreciation, 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 accounting principles and EBITDA. For the quarter ended March 31, 2024, EBITDA increased 5.1% to $1.637 million as compared to $1.558 million for the same period in 2023. This increase is largely due to improved gross margins and operating expense management. Turning to the balance sheet. As of March 31, 2024, cash and cash equivalents totaled $4 million, up from $1.7 million as of December 31, 2023. The fluctuation in cash balances reflects timing of cash receipts and expenditures as well as line of credit borrowings. We extended -- excuse me, we ended the first quarter of 2024 with [ $8.1 ] million of borrowing capacity under our line of credit. Accounts receivable as of March 31, 2024, were $16.1 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 $23 million as of March 31, 2024, as compared with $21.7 million as of December 31, 2023. Our contract asset, which represents revenue earned but not yet billed to customers decreased slightly to $14.2 million as of March 31, 2024, as compared with $14.5 million at the end of '23. This decrease reflects the timing of customer shipments. As a reminder, the majority of our net sales are generated from products manufactured specifically to a customer's unique application. And as such, we recognize revenue in accordance with U.S. generally accepted accounting principles as we produce those products. As we also disclosed in our press release issued earlier today, we have presented non-GAAP results including trailing 12 months financial data in EBITDA. For the trailing 12-month period ended March 31, 2024, net sales were $138.7 million as compared with $138.3 million for the same 12-month period ended March 31, 2023. In addition, EBITDA for the 12-month period ended March 31, 2024, was $8.1 million as compared with $6.7 million for the 12-month period ended March 31, 2023. As we stated in March, our top financial priorities for 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 the market demand that we are seeing to deliver sustainable EBITDA growth as well as driving improvements in free cash flow. Coupled with disciplined lean operation execution, expense management and R&D innovation, we believe Nortech can deliver on our objectives. With that, I will turn it back over to Jay for his closing comments. Jay?

Thanks, Andy. Before we open the call to your questions, I want to touch on 3 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 and reliability when compared to traditional copper. 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 such as 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 our sustainability goals we share with many of our 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 of the complex cables we manufacture. For example, aerospace and defense customers are adapting fiber optic technology due to these key advantages, reduced size, weight and power requirements, immunity to electromagnetic interference and greater durability 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 3 core markets by net sales but very important to our diversification. Our contributions to our national defense are also a source of great 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 fiber optics and evolving along with our customers. In closing, we are excited about technological developments across all of our markets and expect them to support our long-term sales momentum, aided by stabilization, supply chain and customer orders. Last month, ITC cited improving outlook among global electronics manufacturers with stronger demand and shipments reported in January. Our progress over recent quarters confirms that outlook. Now we will open the call for your questions. Matthew, go ahead and open the lines.

[Operator Instructions] Your first question is coming from Aaron Sallen from Marion Road Capital Management.

As far as the Blue Earth closure goes, you guys own that facility, correct?

We do.

Are you going to put that up for sale?

Yes, we will. Once we move operations out of Blue Earth and up to Bemidji, we will put that on the market.

And can you say how that how that facility compares to the Bemidji and Mankato facilities that you sold a few years ago?

Yes. So it's an older facility. It happens to be larger. It's quite a bit less efficient, if you will. And as we've seen a shift in the global market, we've seen a shift of business out of Bemidji, for example, to Mexico. Bemidji, by the way, is a plant that is certified for aerospace and defense. And it just made sense with a newer, more efficient facility in Bemidji to move operations and hopefully as many are really good people as possible up to Bemidji.

Okay. Yes, it makes sense. And then as far as like the -- I guess, when I look out 12 months from now, just given the earnings of the company and any sort of cash coming in from a real estate sale. It looks like you should be net cash positive by the end of the year. What are your, I guess, anticipated priorities for using cash going forward?

Well, as you might imagine, there's a number of things, we -- it's nice to have the credit to pay down the line of credit, especially with interest rates a little bit higher, but we're also innovating -- we're also investing in taking good care of our employees, both in terms of benefits the environment we're going to invest in our plants, our existing plants. It's part of the reason we're moving to Bemidji as we have made some significant investments in that plant to make it a lot more sustainable and more employee friendly, if you will. And we expect we will continue to do that as well, along with continuing to fund our innovations. We talked about EBX. We expect to keep pushing on -- pushing the envelope in terms of fiber optic technologies for our customers in the future.

Okay. And then do you have any sense as far as where working capital or inventory levels stand at some of your customers? I know in the Q, there was mention of like destocking at the industrial and medical divisions. But do you have any insight into kind of like where we are in that cycle?

Aaron, I think as many contract manufactures we've seen that it's kind of across the board. And the way I would characterize it, you've got some customers in the medical device area, in particular, where they're level setting their inventories. I would also say we have some customers that are in a transition where they're at end of life of version going to their next version. And so it's really -- given our diversification we have in our portfolio of customers in those 2 segments, it's really kind of a mixed bag. We do think that what is happening is going back to more 2020, 2021 sort of buying habits where we see shorter lead time and less bookings. And we're just working our way through that with our customers right now to give better clarity to what the second half of 2024 is going to look like.

Got it. And as far as A&D goes, really, really strong growth there. Are there any kind of like projects or like subsectors that you can point to that has kind of driven that?

We don't really get into that sort of granularity. We keep our commentary at the segment level. So I don't know that we have done that traditionally.

As you might imagine, a lot of this stuff is pretty confidential too. So we typically don't share that level of information.

Yes. Okay. Fair enough. And then the last one, I know you don't necessarily manage the business like this. But just when I'm looking at the margin for the quarter and versus last quarter, obviously, a lot of variation between the two. Is there anything that you can point to as far as why Q4 was just so high relative to where it has been? And then why it's kind of coming back down to like more of a normal level this quarter?

Yes. We do have quarters where oftentimes, it's mix of product is a factor where we will just be shipping a range of products that are just higher margin as opposed to other quarters where we may ship a range of great products. They just happen to be a little bit lower margin. So that -- some of that is just mix. I think the general trend that you have seen, I mean, we expect to continue to improve our margins going forward. It was part of the reason we talk about these 12-month periods because that gives you a better sense of where the business is trending as opposed to quarter-to-quarter because clearly, on a gross margin basis, fourth quarter was quite a bit stronger than first quarter. We also tend to be a little -- we tend to -- if you look at our history, we tend to have stronger fourth quarters and the more revenue we have, typically, the higher our gross margins as well.

I would add to that, Aaron, two counts. [indiscernible] revenue kind of levels, you see changes in operating leverage related to the fixed cost is impactful. And the other thing that you would note in the Q is that we did record an adjustment for $178,000 for some Mexican retirement benefits that hit gross margin. So that had some impact on the quarter's margin as compared with Q4 as well.

[Operator Instructions] There are no further questions in the queue. I will now hand the conference back to our host for closing remarks. Please go ahead.

Thank you very much, Matthew, and thanks to everyone for joining us today. We look forward to talking with you in August when we report our second quarter 2024 results. Again, thank you, and goodbye.

Thank you, everyone. This concludes today's event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.