Nortech Systems Incorporated (NSYS) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Q3 2021 Nortech Systems Inc. Earnings Conference Call. [Operator Instructions] At this time, it is my pleasure to turn the floor over to your host, Chris Jones. Sir, the floor is yours.

Thank you, and good afternoon, and welcome to Nortech Systems Third Quarter 2021 Conference Call. I'm Chris Jones, Senior Vice President and CFO, and with me is our President and CEO, Jay Miller. Jay will begin today's call with a brief introduction, and then I'll review Nortech's Q3 financial results before turning it back over to Jay for his comments on the quarter. And at the end, we'll open it up for questions. Before we continue, please note that statements made during this call and 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 annual report on Form 10-K may be amended or supplemented. The statements made during this conference call are based upon information known to 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.

Thank you, Chris. I'd like to begin the call today by recognizing some people who are very important to Nortech's past and future success. First and foremost, it's critical to say thank you to our frontline workforce. They are the key people in the plant making mission-critical products and parts for our medical, military and industrial customers. They have been working over time for most of Q2 and Q3 '20 and '21 to scale up production, and I greatly appreciate their tireless efforts during these extremely challenging circumstances. I'm very proud of everyone in the Nortech facilities, in Bemidji, Blue Earth, Mankato, Maple Grove and Milaca, Minnesota as well as our people in Monterrey, Mexico and Suzhou, China. Thanks to our customers for their confidence in us. Our record $79 million backlog in September is a testament to their trust that we will continue to do everything possible to deliver them with quality products on time. We take this responsibility very seriously, and we work hard every day to take great care of our customers. Thanks to our suppliers for their resourcefulness and hard work in overcoming these unprecedented global supply chain challenges. It's a team effort, and we sincerely appreciate their partnership. I also want to thank our Board of Directors for their constant support during a very difficult 22 months since Nortech first encountered COVID-19 in China in January 2020. Our Board never wavered from the guiding principle that the health and safety of our frontline workers was our highest priority. Finally, I want to thank all of our shareholders for being patient with us as we worked hard to fix some of Nortech's fundamentals while battling COVID-19. Q3 and Q4 of 2020 and Q1 of 2021 were rough quarters, but we're very proud of our Q2 and our Q3 '21 results. Rest assured, Nortech is significantly stronger now than we were in 2020, and our future has never been brighter. Now I'll turn it over to Chris to review the Q3 financials.

Thanks, Jay. Also -- in the spirit of saying thank you, I want to recognize that today is Veterans Day, 11/11, and I'm a former member of the U.S. Navy. So today is very meaningful to me personally. And it's also really meaningful that I work here at Nortech Systems that manufactures parts that literally are mission-critical to people who are on the front lines of our core markets, so our medical customers, our industrial customers and our aerospace and defense customers. So I also want to say thank you to all of them on Veterans Day. Right. Turning to revenue. I think sequentially is the best way to look at Nortech's results in 2021. And in the first quarter, as Jay mentioned, that was a rough quarter at $22 million, and it was a low point of demand in this fiscal year for us. There is the COVID-19 downturn. We recovered in the second quarter to $30.2 million, and now we just finished our third quarter at $29.5 million, and that compares year-over-year to $26.4 million in the third quarter of 2020. So that's a 12 -- almost a 12% year-over-year increase in revenue. We do expect to continue that growth quarter-on-quarter growth in Q4 and throughout each quarter of 2022. Now I also want to highlight 3 nonrecurring items that occurred in Q3 2021. First, we applied for the employee retention credit, and that's for qualified wages paid in the first and second quarters of 2021. And we expect to receive approximately $5.2 million in Q4 or in 2022. ERC was recorded as a reduction of payroll and benefit costs of 4.7% of the reduction going to cost of goods and the remaining $500,000 of that $5.2 million to SG&A. The company has not received the ERC refund from the IRS yet. And we do have a $5.2 million receivable on the balance sheet. Second, in Q1 of 2021, Nortech completed the consolidation of our Merrifield, Minnesota production facility into our PCB Center of Excellence in Mankato, Minnesota. And in Q3 of 2021, we closed on the sale of that Merrifield plant in the equipment for approximately $600,000, and we use those cash proceeds to pay down long-term debt. And third, in Q3, we determined that the fair value of the Devicix, trade name was 0, and we recognized a $560,000 noncash loss on the abandonment of that intangible asset. So those were 3 relatively large nonrecurring items in the third quarter. So turning to net income, which includes those items. We reported net income of $3.6 million or $1.24 per diluted share in the third quarter, and this compares to $2 million or $0.73 per diluted share in the same period last year. So in addition to those 3 nonrecurring items in our third quarter this year, we also had 1 comparable -- 1 item in our comparable period from Q3 of last year when we completed a sale-leaseback transaction in our Bemidji and Mankato, Minnesota facilities. And net netted approximately $6 million in cash, that was also used to pay down debt last year in the third quarter, but we did record a $3.8 million gain on assets in the third quarter last year. Moving on to balance sheet and cash flow. So operating cash flow was a use of $2.9 million for the first 9 months of 2021 compared to a $0.1 million use in the 9 months -- in the first 9 months of 2020. The operating cash flow reflects Nortech's investment in higher inventory levels to meet increased customer demand and mitigate supply chain risk. Higher inventory levels were offset by lower accounts receivable as Nortech maximizes our participation in our customers' low cost of capital supply chain finance programs. We ended the third quarter with $6 million of borrowing on our line of credit, and we had $5.8 million availability on our ABO. As I mentioned earlier, the combination of the sale leaseback in Q3 of 2020, coupled with the proceeds from closing the Merrifield sale, has enabled Nortech to almost completely pay off our non-PPP long-term debt. So regarding the $6 million PPP loan in the third quarter of 2021, we applied for forgiveness with the SBA. We have not yet received notice that our forgiveness application has been approved, so we will continue to treat the PPP loan as debt on the balance sheet until forgiveness is granted, and we will issue a press release when we receive notice from the SBA. So I'll wrap up the financial section by highlighting our top priority in 2022. We're committed to building an operating model post COVID-19 that deliver sustainable free cash flow growth. And we're confident that onetime cash from programs like the PPP, the ERC and supply chain financing, coupled with disciplined operations execution and R&D innovation will enable Nortech to realize that goal. And with that, I'll turn it back over to Jay for his comments on the quarter.

Thanks, again, Chris. Overall, we're very pleased with the steady improvements we're making on many fronts. As with all global manufacturers, we are battling component shortages in many areas, chips, sensors, connectors, cables, power supplies, et cetera. Lead times are long, and delivery dates can be unreliable. Our operations team have been working aggressively to overcome these challenges. At the same time, our teams are building new supply chain capabilities to ensure we are getting stronger every day to scale our plans to meet future demand. We take great pride in the fact that we have such strong supplier relationships. We're a growth company, and every day, we're focused on finding innovative ways -- new ways to improve our ability to deliver high-quality products on time to meet growing demand, grow revenue and improve profitability. Speaking of growth and future demand, our backlog and bookings are -- both at record levels in Q3 and that's a trend we see continuing in Q4. At September 30, our backlog was $79 million, an increase of $33 million or 72% increase versus September of 2020. As I mentioned earlier, that rising backlog represents an encouraging vote of confidence from our customers that bodes well for growth throughout 2022. In addition to building stronger supply chain capabilities, I'm also very enthusiastic about the innovative new technologies Nortech has been developing. We are pivoting our engineering talent toward R&D investments and initiatives to develop customized solutions for our customers' most challenging wire and cable interconnect problems. Our engineers love challenging problems. And building powered smart cables that can leverage critical digital data represents a differentiating capability that Nortech is developing that will help our customers compete better and stay on the cutting edge of new digital data opportunities in 2023 and beyond. Our team is passionate about R&D, and they are inspired about developing these new technologies. We're confident this will enable Nortech to grow top line revenue, expand margins, improve free cash flow and create lasting shareholder value. With that, I'll conclude our prepared remarks this afternoon, and we'll open it up for questions.

[Operator Instructions] Okay. And it doesn't look like we have any questions coming in.

Thank you very much. Thanks, everybody. Thank you very much for taking the time to listen to us, and we look forward to our fourth quarter 2021 conference call. Thank you.

Thank you. This concludes today's conference call. We thank you for your participation. You may disconnect your lines at this time, and have a great day.