Nortech Systems Incorporated (NASDAQ:NSYS) Q3 2022 Earnings Call Transcript

Nortech Systems Incorporated (NASDAQ:NSYS) Q3 2022 Earnings Call Transcript November 11, 2022

Operator: Good afternoon, ladies and gentlemen, and welcome to Nortech’s Third Quarter 2022 Earnings Call. At this time, all participants have been placed on a listen-only mode and we’ll open the floor for your questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Chris Jones, CFO. Sir, the floor is yours.

Chris Jones: Thanks, John. I’d also like to welcome everybody to Nortech’s third quarter 2022 conference call. So Jay will begin today’s call with a brief review of our third quarter operational performance, and then I will review Nortech’s Q3 financial results, before turning it back over to Jay for his closing comments and then we’ll open up the call at the end for your questions. Before we continue, please note that statements made during this call and Q&A session may be forward-looking regarding expected revenue, earnings, EBITDA, free cash flow, 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 may be amended or supplemented. The statements made during this conference call are based on 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 will turn it over to Jay for his opening comments.

Jay Miller: Thanks, Chris, and good afternoon, everyone. We appreciate you taking the time with us today. On the subject of appreciation, I want to start by thanking our roughly 700 dedicated Nortech team members across our seven locations in Minnesota, Mexico and China. Whenever I visit our facilities, I’m always impressed with the high-level of commitment, care and quality that our people exhibit on a daily basis. In my travels, I also met with Nortech customers, and I know they certainly share my appreciation. I should thank our customers as well. They’ve been very patient with us as we’ve been working hard to manage through the current global supply chain crisis. Speaking of which, I want to thank our supplier partners, who’ve been working very hard with us to get quality parts ship to us as close to on time as possible.

We really appreciate all of their hard work. Turning now to our third quarter results. We continued the trend of sequential and year-over-year improvements that we have seen over the past four quarters, both on the top and bottom lines. On the revenue side, we’re pleased that demand from our diverse customer base remains solid. We posted strong double-digit sales growth for the third quarter and nine-month periods both overall and in each of our three core markets: Medical, Industrial and Defense. Our third quarter and year-to-date results also benefited from selective pricing actions that we are taking to offset inflationary pressure on labor rates and material costs. We’re seeing continued positive trends in our chosen markets. For example, our largest customer in the Medical segment recently reported quarterly revenue up in the mid-single-digits.

They also cited solid spending trends on healthcare equipment, especially in Europe and Asia. Much of their current equipment innovation is aimed at productivity improvements, in large part driven by labor shortages, including highly skilled jobs like nurses and imaging techs. We collaborate closely with this customer every facet of their growing business, including end-to-end supply chain optimization, advanced research and development and cost improvement initiatives to move production to the lowest cost plant location. Nortech offers our customers a unique skillset of capabilities and strategic fulfillment solutions, truly a collaborative partnership. As such, our services deserve to be valued differently and more highly than if we operate merely as a transaction-based commodity business.

I believe this partnership mindset shared by Nortech and our customers is a key reason why we have not experienced any significant order cancellations or pushouts from customers in any of our core markets thus far. We work hard to act as an extension of our customers’ own operations as a trusted resource. In the third quarter, we were able to increase shipments due to continued supply chain improvements, fewer component shortages and shorter component lead times. The lead time improvements are in sync with the latest industry outlook from the Electronic Components Industry Association announced last month. For the remainder of 2022, we are cautiously optimistic about finishing strong with momentum also carrying over into 2023. Our backlog remains healthy.

As Nortech has done constantly in recent quarters, we expect to outpace the overall economy by focusing on the things we can control, executing with excellence, taking great care of our employees, listening carefully to our customers, innovating quickly with our new core technologies and remaining disciplined with our cash. To explain our financials in more depth, I’ll now turn it back over to Chris.

Chris Jones: All right. Thanks, Jay. So I’ll provide more details of our financial performance in the third quarter, but I would also encourage all of you to review our latest Form 10-Q, which we filed yesterday as it contains far more information about our business operations and financial performance than we will cover on this call. So as Jay pointed out, we’re carefully monitoring macroeconomic headwinds, and we are encouraged as our customers are reporting fewer supply chain disruptions. So while our backlog was up more than 30% from prior year levels to $103 million, we did see a slight sequential decline from $106 million at the end of second quarter of 2022. And we view that slight decline in our backlog as a positive sign because increased component availability resulted in orders moving through our production process, so we could build and ship more product this quarter.

Turning to the P&L details. In Q3 2022, our revenue totaled $35.3 million. This represents a 19.8% increase from revenue of $29.5 million in the third quarter of 2021, and it was up more than 8% from our prior quarter with increases coming from both higher volume and pricing actions. For the first nine months of 2022, our revenue totaled $98.5 million, a nearly 21% increase from revenue of $81.7 million for the first nine months in 2021. Nortech’s third quarter 2022 revenue performance was driven by growth in net sales across all the markets that we serve. The Medical market was up by $3.5 million or 21% compared to the prior year; the Industrial market was up by $1.5 million or 16% from the prior year; and finally, the Aerospace and Defense markets were also up from prior year levels by 26%, totaling $3.9 million.

In Q3, gross profit totaled $6.3 million or 17.9% compared to gross profit of $8 million or 27.3% in the prior year quarter. However, gross profit in Q3 last year included a one-time cost of goods credit of $4.7 million related to the employee retention credit or ERC. If we exclude that ERC credit, adjusted Q3 gross profit totaled $3.4 million or 11.4%. So year-over-year, our gross margin was up from 11.4% to 17.9%. That resulting 650 basis point improvement relates primarily to price increases coupled with increased plant utilization resulting from sales volume increases. Third quarter 2022 operating expenses totaled $4.4 million, a 38% increase from the third quarter of 2022, adjusted operating expenses of $3.2 million. We also had adjustments in SG&A last year.

We had three of those non-recurring items. So the first one is $540,000 for the SG&A portion of the ERC credit, a $560,000 non-cash expense from the Devicix trade name abandonment, and a $93,000 gain from our final settlement of our Merrifield facility sale. So the resulting $1.2 million year-over-year increase in operating expenses was driven in three areas: first, $385,000 in selling expenses related to technology innovation, marketing initiatives and sales engineering resources; second, a $490,000 increase in SG&A for essential investments in IT and other back-office capabilities; and third, a $334,000 increase in research and development costs to support continued investment in new technologies such as the AOX cable platform announced earlier this year and a recent patent announcement for the new Flex Faraday Xtreme technology.

Finally, on the P&L, we have grown EBITDA each quarter in 2022. Adjusted EBITDA in Q3 was $2.4 million compared to $735,000 of adjusted EBITDA in Q3 of 2021. For the year-to-date, adjusted EBITDA is now $4.7 million compared to only $149,000 for the same timeframe last year. The year-over-year improvement is due to higher volume, improved plant efficiency and pricing actions. Moving on to the balance sheet and cash flow statement. Operating cash flow for the year-to-date 9/30/2022 was a $1 million source of cash as compared to an operating use of cash last year at this time of $2.9 million. During the third quarter, decreases in working capital due to increased shipments as well as less pressure to build higher inventory safety stocks kept inventory levels at $23.6 million, relatively flat quarter-on-quarter.

We ended the third quarter in 2022 with $5.8 million of borrowing capacity on our $16 million line of credit. And in the third quarter of 2022, we also amended our credit agreement through 12/31/22 to extend the inclusion of the employee retention credit receivable as collateral on our borrowing base. We have been in contact with the IRS and based on their confirmation of progress they are making on our ERC application, we are cautiously optimistic that we will receive the $5.2 million ERC relatively soon, and we will use those funds to reduce our line of credit balance. In addition, we anticipate that over coming quarters, we will continue to make steady progress, generating free cash flow that we will use in combination with that one-time ERC payment to reduce the outstanding balance on our line of credit and improve our liquidity position.

So with that, I will turn it back over to Jay for his closing comments.

Jay Miller: Thanks, Chris. Before we open the call to your questions, I’d like to briefly comment on our strategic planning process and ongoing supply chain optimization activities. First, our strategic planning process is dynamic and quite detailed and involves all facets of our business across three countries. This annual activity focuses on delivering value for all of our stakeholders. This includes taking great care of our people as well as our supplier partners and maximizing our major strategic customer relationships, which are defined by four key characteristics: proactive communication with customer leadership; R&D investments in development in new core intellectual property that delivers higher quality, environmentally sustainable and more competitive product capabilities; early engagement between our engineering teams; and frequent, open, candid and honest dialogue between our supply chain teams.

These relationships leverage Nortech’s highest value-added strengths, which help differentiate us in the marketplace and position us well for the future. We are continuing to make measurable progress in numerous areas that are critical to improving customer on-time delivery of quality products, including hiring great people, providing them with effective training, paying them fairly, offering great benefits and retaining them for the long-term, improving plant capacity and throughput, reducing waste and process inefficiencies, conducting customer engineering discussions to planned future product capabilities, relocating production to the optimal plant whether it’s in 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 operations and supply chain team. We are always seeing — and we’re always seeing steady improvement. I must thank them again for their tireless efforts in these areas. As always, we look forward to updating you on our progress in future quarterly calls and shareholder communications. With that, I’ll conclude our prepared remarks, and we’ll open the call up for questions. John?

Q&A Session

Operator: Thank you. Ladies and gentlemen, the floor is now open for questions. . Okay. The first question is coming from Paul Uber, Private Investor. Paul, your line is live.

Paul Uber: Hey, thank you. First and foremost, congrats on another wonderful quarter and great progress. And with that, I guess, my ask would be, do you see continued sequential revenue and margin growth into Q4 of this year?

Jay Miller: Yes. We expect — without giving any formal guidance or quantitative guidance, we expect a good solid Q4, and we expect that to carry over — that momentum to carry over into 2023. We’re optimistic about 2023. We’re — as Chris mentioned, we are carefully monitoring macroeconomic conditions, of course, but we’re feeling pretty good about the fourth quarter and 2023.

Paul Uber: Hey, that’s wonderful. So with that, my question would go to more shareholder value. Now you’re in $0.50 plus in Q3 and hypothetically, if you annualize that, you’re in that $2 EPS line and where the stock is, that seems like a very modest valuation. I mean you take a Plexus albeit a larger quasi-equivalent to you guys, they’re trading at a 20 PE plus. And even if you apply a small cap discount or such you think the value would be higher. So I mean is there initiatives at your end to try to take on analyst coverage, attend shareholder events, have them at your place or just really create awareness for the wonderful job you guys are doing in the performance because I feel it’s unrecognized?

Jay Miller: Yes, Paul, it’s a very good question that is not lost on Chris or myself or our Board of Directors. We — first of all, we will communicate more as we generate good results, as we come up with new intellectual property and make some announcements there. We will — you’ll see, I’d say, generally, you’ll see a more steady and more frequent set of press releases around how the business is doing. In terms of comparison with a company like Plexus, obviously, they’re much, much larger. They’ve got many, many, many more shares out there. Candidly, I might argue they’ve got a more efficient share price because of that. And again, that’s not lost on either Chris or I or the Board of Directors. We’re not necessarily ready to announce any actions around those things, but we do recognize that. And of course, for you, our shareholder — stakeholders, it’s important that we recognize how important it is to realize the value of the company in the financial markets.

Paul Uber: That’s wonderful because you got a good story to tell and would love to see more known about it. One last question. How are you guys situated with labor? I mean, are you staffed where you want to be for the current business run rate? Are you tight and running a lot of overtime and — or temp labor or kind of a sense of that?

Jay Miller: We’re actually doing reasonably well on the labor side. We typically — we’ll work a little bit of over time but not so much over time that we’re burning people out. And we’re in the plants where we need to hire; we’re able to steady — to hire relatively steadily. That said, the thing that really is the bottleneck for us more than labor is just parts, of course. I mentioned in the comments that — we are — we do a better job every day of managing the supply chain — global supply chain crisis. But in fact, there is still a global supply chain crisis. And we’re not getting quality parts in as fast as we’d like to, which means we can’t get quality parts built and shipped to our customers as fast as we’d like to. So the bottleneck — the point there, the bottleneck is not right now, for the most part, people, it’s really parts. We’re — I’d say, right now, we’re relatively happy with where we’re staffed.

Chris Jones: Yes. And this is Chris. I will add to that. As you heard in our prepared comments, our — but our backlog did level out. And so it is improving. I think Jay had that as part of his prepared comments and I did, too, is that supply chain component parts, while it’s worse in direct labor, it’s still better than it has been, and we see trends going in the right direction.

Jay Miller: We are seeing things get a little bit better almost on a daily basis. It’s still a challenge, of course. But we are start to see things loosen up a little bit.

Paul Uber: Understood. So perhaps you’re closing kind of past due work as material becomes available and you’re closing the gap?

Jay Miller: Yes. Yes, that’s a good way to look at it.

Paul Uber: Great. Well, thank you and keep up the good work.

Jay Miller: Thank you, Paul.

Operator: . We have a question coming from Dennis Wilson , Private Investor. Dennis, your line is live.

Unidentified Analyst: You’re talking about supply chain disruptions for you. I was kind of wondering about your customers now. Does — how many of them are basically reshoring? You hear a lot about China and the problems they’re having with COVID lockdowns and getting parts out of there. How many of your customers, how much extra revenue are you getting from customers that are going to you and reshoring?

Jay Miller: It’s a very good question. And I can’t give you a quantitative answer. I will tell you that through this whole supply chain crisis, we have a lot more strategic discussions with our customers about making sure that we are manufacturing in the right plants for them, whether it’s a full reshoring or it’s just moving production — maybe a little closer to where they’re going to sell the product, and we have a lot of those discussions. Before COVID and before this global supply chain crisis, we — there were these issues, but they weren’t as big a deal with our customers as they are now, of course. So as we have brought these things up and some issues we’ve known about with them for four, five or more years, now it really gets their attention because they are shifting more and more resources to help mitigate their supply chain risks, which candidly helps us build in the right place and ship to the right place more efficiently.

So there is quite a bit of that activity going on. Now those things are not things you necessarily fix overnight. They take work and oftentimes they take engineering work. But we’re spending quite a bit of time helping our customers, making sure — to make sure that we’re building the right places as efficiently as possible.

Operator: . There are no further questions in queue. I’d like to turn the floor back to Jay Miller for closing remarks.

Jay Miller: Thank you very much, John, and thank you, everyone, for joining us today. We look forward to talking to you next in March with our fourth quarter results. Goodbye for now. I’ll turn things back over to Chris.

Chris Jones: Yes. And at the request of our attorney, I’m going to close with our Safe Harbor statement. So I want to reiterate that statements made during this call and the Q&A session may be forward-looking regarding expected revenue, earnings, EBITDA, free cash flow, liquidity, future plans, opportunities, other company expectations, including our expectation of receiving the ERC funds timely. 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 in this call. These risks, including those that are detailed in our most recent Form 10-Q may be amended or supplemented. And statements made during this conference call are based on information as Nortech knows it as of the date and time of this call, and we assume no obligation to update the information on today’s call.

You’ll find Nortech’s full Safe Harbor statements in our SEC filings and we thank you for the call.

Operator: Thank you. Ladies and gentlemen, this does conclude today’s conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.