Nortech Systems Incorporated (NASDAQ:NSYS) Q3 2024 Earnings Call Transcript

Nortech Systems Incorporated (NASDAQ:NSYS) Q3 2024 Earnings Call Transcript November 9, 2024

Operator: Good morning, ladies and gentlemen, and welcome to the Nortech Systems Incorporated Third 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 Andy LaFrence.

Andrew LaFrence: Thank you, Jenny. I would 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 third quarter 2024 fiscal 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 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 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’ll now turn the call 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 our last earnings call, we noted customer order headwinds, which we expected to impact our near-term orders and revenue. Our third quarter net sales were impacted by a continuing pattern of customers delaying product purchases, customers’ desire to reduce their own on-hand inventories and to shorten order to fulfillment timelines. These impacts have been a theme at many contract manufacturers over the past couple of quarters. Industry headwinds and our investments in future operating leverage have negatively affected our near-term earnings and EBITDA generation. The backdrop of the quarter has provided us with incremental opportunities to work closely with customers to provide solutions for the new norm of supply chain nearshoring.

These discussions revolve around shorter lead time and on-time delivery strategies, along with deeper customer partnerships, which are fundamental to our long-term growth strategy. As noted last quarter, we have chosen to address these clear market dynamics by making a number of short-term sacrifices in exchange for improved long-term growth and profitability. This includes facility consolidations and investment in business development. We recognize that it was a difficult and disappointing quarter. We’re very pleased with the progress in the third quarter to consolidate our 2024 — to consolidate our North American footprint as well as moving customer programs to other manufacturing locations to better fit customers’ needs. We’re on track to complete the closure of our Blue Earth, Minnesota facility in December and move its production to our Bemidji, Minnesota facility.

Q&A Session

Regarding our cost structure, we continue to be very diligent managing operating costs with an eye for long-term optimization of our facilities. In addition to the Blue Earth closure, we are rapidly progressing with a 30% reduction in our Maple Grove lease 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 our core infrastructure and a world-class leadership team to drive our long-term growth strategy. We continued this investment and leadership in 2024 as we completed fully staffing our industry-specific business development team early in the year. This team is performing at a very high level and driving impressive business quotes and opportunities.

Further, to align our organization with the expected accelerated new business growth, we recently completed a seamless realignment of our back office and plant operations. This realignment will allow the company to serve our customers better by delivering high-quality products and services on time with shorter lead times. This process is a natural evolution of our business and entails changes in organizational structure to enhance customer intimacy. This is not a restructuring of employee headcount. A key takeaway for this quarter, and I want to make this very clear, is that we’re very bullish on the future of Nortech and continue to make investments to accelerate long-term growth. I continue to be impressed with 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 to improve their own competitiveness. We can move production among facilities based on factors like cost, intellectual property management and operational requirements, including ever-improving on-time delivery of high-quality products with shorter lead times. Our customer and business development 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 lifetime. In terms of China, as I’ve mentioned on past calls, much of our production work there is built in country for country, a near-shoring approach to better serve customers in the global market with reduced shipping costs, time and risk.

Fortunately, we had the foresight to start implementing this strategy faster than most of our competitors. 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’ll provide certain details of our financial performance in the third quarter of 2024. I would encourage you to review our Form 8-K containing our press release and non-GAAP measures as well as our quarterly report on 10-Q, both of which were filed 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 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 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 the third quarter and year-to-date 2024 results, I will provide some comparisons for the 12-month period ended September 30, 2024, compared with the same period ended September 30, 2023. Net sales for the third quarter of 2024 totaled $31.4 million. This represents a 5.9% decrease in net sales of $33.4 million in the third quarter of 2023. For the nine months ended September 30, 2024, net sales were $99.5 million as compared with $103.3 million in the same prior year period, a decrease of 3.6%. During 2024, we realized headwinds with our industrial customers as a result of softness in this market, which is similar to results published by other contract manufacturers, as well as delayed product launches.

In 2024, we’ve also experienced revenue headwinds from our medical customers as they are aggressively reducing their inventory investments. We have also noted several medical product introductions being pushed out. We continue to see strong revenue growth in our Aerospace and Defense category in the year-to-date period. Further, as Jay noted in his remarks, customers have changed their purchasing patterns and are requesting short lead times with new orders. These factors drove a reduction in customer backlog as of the end of the third quarter of 2024. Third quarter 2024 gross profit totaled $3.8 million or 12.2% of net sales compared with gross profit of $5.3 million or 15.9% of net sales in the same prior year quarter. For the first nine months of 2024, we realized a gross profit of $13.9 million or 14% of net sales as compared with $16.3 million or 15.8% of net sales in the first nine months of ’23.

The reduction in gross margin percentages in the 2024 period is largely due to lower net sales and resulting in reduced facility utilization, and to a lesser extent, incremental training and other transition costs related to the movement of Blue Earth’s production to Bemidji by the end of 2024. As these costs have ongoing benefit to the company, they are not included in our restructuring costs. Operating expenses for the third quarter and the first nine months of 2024 are lower than the prior year periods as a result of lower incentive compensation accruals and expense management, which offsets increased payroll-related costs. Year-to-date 2024, we have incurred $267,000 of restructuring costs related to retention bonuses and other costs associated with the upcoming Blue Earth closure.

We estimate that the Blue Earth closure will result in restructuring cash charges of between $650,000 and $750,000 in 2024. We currently do not anticipate any significant noncash asset impairment charges related to this closure. We expect to pay substantially all of these restructuring costs in 2024. Moving to the cash flow statement. For the nine months ended September 30, 2024, net cash used in operating activities totaled $3 million as compared with cash provided of $2.2 million in the same period in ’23. While the timing of customer and vendor payments impact operating cash flows for the period, we have purposely increased inventory levels in anticipation of the Blue Earth facility transitioning to Bemidji. As noted in our press release distributed this morning, we used earnings before interest, tax, depreciation and amortization or EBITDA as well as adjusted EBITDA, which does not reflect the restructuring charges we incurred through the third quarter related to our Blue Earth plant closure as key performance indicators to manage our business.

While EBITDA and adjusted EBITDA are non-GAAP measures, we believe these provide meaningful information regarding our underlying core business financial performance. In the press release, we have provided a reconciliation of our financial performance determined in accordance with U.S. generally accepted accounting principles and EBITDA as well as adjusted EBITDA. For the quarter ended September 30, 2024, adjusted EBITDA was $143,000 as compared with $1.6 million for the same period in ’23. Year-to-date, adjusted EBITDA was $2.7 million as compared with $4.8 million in the first nine months of 2023. The decrease in adjusted EBITDA is a result of lower net sales and related gross profit. Turning to the balance sheet. As of September 30, 2024, cash and equivalents totaled $1.2 million, down from $1.7 million as of December 31, 2023.

The fluctuation in cash balances reflects timing of cash receipts, expenditures and line of credit borrowings. We ended the third quarter of 2024 with $5.5 million of borrowing capacity under our line of credit. Accounts receivable as of September 30, 2024 were $16.6 million, down from $19.3 million as of December 31, 2023. This is in line with our strong fourth quarter sales in 2023 and the expected timing of customer payments. Inventories were $22.3 million as of September 30, 2024, as compared with $21.7 million as of December 31, 2023. The increase reflects the buildup of inventory balances in anticipation of completing the movement of Blue Earth production to our Bemidji facility. Our contract asset, which represents revenue earned, but not yet billed to customers increased to $15.1 million as of September 30, 2024, as compared with $14.5 million at the end of ’23.

This increase reflects the timing of customer shipments. 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 September 30, 2024, net sales were $135.6 million as compared with $138.9 million for the same 12-month period ended September 30, 2023. In addition, adjusted EBITDA for the 12 months period ended September 30, 2024 was $5.9 million as compared with $6 million for the 12-month period ended September 30, 2023. As we stated in August, 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, as noted in Jay’s comments today with market demand that are seen to deliver sustainable long-term 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 now turn the call back over to Jay for his closing comments. Jay?

Jay Miller: Thank you, 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 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. Our 3-tier cost structure across the U.S., Mexico and China allows us to quickly adopt our global engineering resources to fit our customers’ changing needs. A core goal of our long-term strategic plan focuses on unique innovation. This is somewhat unusual for most contract manufacturers.

Nortech’s engineering capabilities and innovation skills further our research and development activities with advancements like the Expanded Beam Xtreme fiber optic technology, or EBX, that was announced in January. EBX is designed for digital data transmission and offers improved speed, reliability and security when compared to traditional copper. We’re also excited about our Active Optical Xtreme technology 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 provide 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 electric 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 combine artificial and human intelligence for improved performance and data management for our customers as well as for their customers. For Nortech, we see AI capabilities as a clear opportunity to streamline and improve our processes, make our employees more productive and serve our customers better.

You will hear more about our innovations in AI in future conference calls. 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 here. 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 that 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 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 very 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 source of great pride for Nortech employees. The majority of our aerospace and defense cables are still the traditional type common in legacy defense systems, such as shipboard, missile launches for the Navy, but we are looking to the future with ruggedized fiber optics evolving along with our customers.

In closing, we are excited about technological developments across all of our markets and expect them to support our continued sales momentum in 2024, aided by stabilization of supply chain and customer orders. We’ll now open up the call for your questions. Jenny, please open the lines.

Operator:

Jay Miller: Very good. Thank you, Jenny, and thanks to everyone for joining us today. We look forward to talking with you in March when we report our fourth quarter 2024 results. Again, thank you very much, and goodbye.

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