Nortech Systems Incorporated (NSYS) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen, and welcome to the Q4 2021 Nortech Systems Inc. Earnings Conference Call. [Operator Instructions] And we will 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. Sir, the floor is yours.

Thanks, John, and I'd also like to welcome everyone to Nortech Systems' Fourth Quarter 2021 Conference Call. After my introduction, Jay will begin with a brief review of our fourth quarter and full year accomplishments, and then I'll review our financial results before turning it back over to Jay for his closing comments and our business outlook for 2022. And we'll open it up [Audio Gap] may be amended or supplemented. The statements made during this conference call are based upon 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 safe harbor statements in our SEC filings. And with that, I'll turn it over to Jay for his opening comments.

Thank you very much, 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 plants, building vital parts for our medical, defense and industrial customers. Our entire Nortech team deserves enormous credit for their commitment to delivering mission-critical solutions to our customers despite ongoing COVID concerns and significant supply chain disruptions. I greatly appreciate their tireless efforts under these extremely challenging circumstances. Thanks to our customers for their confidence in us. Our $95 million backlog at the end of 2021 is a testament to their trust that we will continue to do everything possible to deliver quality products to them on time despite unprecedented disruptions to the global supply chain. Thanks to our suppliers for partnering with Nortech to build more effective end-to-end fulfillment solutions to serve our customers. It's a team effort, and we sincerely appreciate their partnership and hard work. I also want to thank our Board of Directors for their constant support during a very difficult 2 years since Nortech first encountered COVID in China in late 2019. Our Board never wavered from the guiding principle that the safety of our frontline workers is our highest priority. Finally, I want to thank our shareholders for their commitment to Nortech. We survived the most difficult part of the COVID downturn, and our future has never been brighter. In a few minutes, Chris will review our financials, but first, I'll outline just a few of our many accomplishments in 2021. We augmented our strong Board of Directors with key additions. Phil Smith and Danny Sachs joined in December 2020, and we welcomed Stacy Kruse in May 2021. All 3 new Board members bring a wealth of experience. We're thrilled to have them join forces with our Chairman, David Kunin; as well as Steven Rosenstone, Ryan McManus and myself as we guide and oversee Nortech's next phase of growth. We truly have a world-class Board representing our shareholders. We utilized the CARES Act program, specifically the Paycheck Protection Program and Employee Retention Credit, to secure our workforce throughout 2020 and 2021. We added a number of new customers, including a strategic development partnership by signing a project funding agreement with Marpe Technologies of Israel for co-development of a tele-dermatology scanning system. We gained organizational efficiencies through the consolidation of our PCB operations in Mankato, Minnesota. Those transitions concluded in the third quarter. We also further established our centers of excellence in Bemidji, Milaca, Maple Grove and Blue Earth, Minnesota as well as in Monterrey, Mexico and Suzhou, China. Finally, we ended the year signing an extension of our $16 million Bank of America credit facility. Our BofA agreement was a key step in supporting our plans for future growth. In short, in 2021, we made progress on several important fronts. We strengthened our balance sheet, extended our Bank of America agreement until 2026, restored revenue growth and improved gross margins. We also tightened our focus on operational excellence and innovation for our customers. Creating shareholder value remains a top priority. We believe this is best accomplished by creating value for our diverse customer base. In today's problematic supply chain environment, our current and new customers increasingly recognize and appreciate Nortech as a key long-term partner offering complete fulfillment solutions. We believe that creating efficiencies for our customers and deepening these relationships will further improve Nortech's revenue, gross margin and operating cash flow. Our customers also increasingly appreciate Nortech as a key partner building fulfillment solutions tailored to their unique regional needs. That regionalization trend includes serving Asia with in-country manufacturing and serving Europe and the Americas with both the U.S. and Mexico operations. Now I'll ask Chris to review our financial results. Chris?

Thanks, Jay, and thanks to everybody for joining us today. So in the next few minutes, I'll provide financial details of our 2021 fourth quarter and full year. But I'd again like to encourage everyone to review our 2021 Form 10-K, which we filed on March 17. It contains far more information about our business operations and financial performance than we will cover on this call. If you have specific questions about these items or any of our quarterly or annual financial results, I'll be happy to address those during the Q&A portion of the call. So turning to the fourth quarter 2021, our revenue totaled $33.5 million. That was a 40% increase year-over-year from revenue of $23.8 million in the fourth quarter of 2020. And though we're very pleased with that year-over-year revenue growth, it's also useful to look at Nortech's revenue performance on a sequential quarter-on-quarter basis. So in our fourth quarter, revenue was up $4 million or nearly 14% from $29.5 million in the third quarter of 2021. Both 2020 and '21 were greatly impacted by the negative impacts of COVID and supply chain disruptions. And over time, these -- our quarters will normalize as we anniversary nonrecurring events impacting quarterly results. But until then, our sequential comparisons are an important indicator of our performance. Nortech's revenue for the full year 2021 was $115 million compared to $104 million in 2020, an increase of $11 million or nearly 11%. Revenue growth was driven by customer demand rebounding in the second quarter of 2021, and that higher demand persisted throughout the last 3 quarters of 2021. So turning to gross profit. In Q4, our gross profit totaled $2.7 million or 8% compared to a gross profit of $1.7 million or 7.3% on the prior year quarter. For the full year 2021, gross profit totaled $15.9 million or 13.8% compared to a gross profit of $9.7 million or 9.3% in the prior year. Note that 2021 gross profit included $4.7 million in CARES Act Employee Retention Credits that were recognized in the third quarter of 2021. Net of the ERC adjusted full year 2021 gross profit would have totaled $11.2 million or 9.7%, which is a 40 basis point increase on 9.3% in the prior year. Improving that gross margin is a strategic imperative for Nortech in 2022 as the rising cost of raw materials, coupled with higher inventory levels, exerts a pressure on our operating cash flow. Now I want to highlight several nonrecurring items that impacted the P&L below gross profit. So I mentioned earlier that $4.7 million of ERC credits were recognized in the third quarter. We also recognized another $500,000 of ERC credits in SG&A in Q3 for a total ERC credit of $5.2 million. Now the IRS has not processed our ERC filing, and you will see a $5.2 million receivable on our balance sheet until we receive those funds. A second large nonrecurring item in 2021 was forgiveness of our PPP loan. You'll see a gain in the fourth quarter P&L of $6.2 million. Combining the 2 CARES Act programs, Nortech recognized $11.4 million of nonrecurring income in 2021. Both of those programs were essential to Nortech continuing full operations all the way through 2020 and 2021 in service of our customers, our suppliers, our employees and all Nortech stakeholders. For a full discussion of these nonrecurring events, please see again our recently filed 10-K. So moving to the balance sheet and cash flow. First, our cash used in operating activities for the year ended December 31, 2021, was $4.6 million compared to cash provided by operations of $1.4 million in the year ended December 31, 2020. In 2021, Nortech had to react quickly to customer POs by securing critical inventory and ramping up production to address global supply chain shortages. So our inventory rose from $13.9 million in December 2020 to a peak of $20.6 million in June of 2021, and we ended the year with inventory of $19.4 million. For 2022, optimizing that investment in inventory and building a more robust end-to-end supply chain fulfillment solution is our top strategic priority. Again, turning to our relationship with Bank of America, we financed that higher working capital with our ABL. As of 12/31/21, we were borrowing $9 million on the ABL with $3.5 million of unused availability. Throughout 2022, we believe that cash provided by operations, funds available under our credit agreement with BofA, receipt of the $5.2 million of ERC money from the IRS, will be adequate to meet our liquidity needs, including working capital, capital expenditures, R&D investments and debt payment obligations. Let me take a moment to reinforce why we believe that Bank of America line of credit is so important for Nortech. BofA has been a great partner with us since 2017. Their team has worked with us to extend our credit agreement for 4 more years until 2026. And as the IRS was delayed in processing ERC's claims, BofA amended our credit agreement to allow us an additional $2.5 million of availability against the $5.2 million receivable. So those actions demonstrate BofA's confidence in our improved results throughout 2021 and our outlook through 2022 and beyond. So as I wrap up, let me clearly state our top financial priority through 2022. We are building a company that will deliver reliable and sustainable free cash flow growth over the long term. In the same way, our customers rely on us for ruggedized, high-quality, reliable solutions, our financial stakeholders also rely on Nortech for ruggedized, reliable free cash flow growth. Our entire organization is focused on that financial mission. So we've taken many steps in 2020 and 2021 to ensure our core business becomes a cash-generating engine. An essential step with securing those onetime contributions from CARES Act programs, but also $6 million of sale-leaseback transactions in August 2020 and $5 million from maximizing participation in our customers' supply chain finance programs. Those onetime events, coupled with disciplined operational execution, R&D innovation and supply chain optimization, give us great confidence that Nortech is well positioned to achieve our goals for our customers and employees and our shareholders. With that, I'll turn it back over to Jay for his closing comments.

Thanks, Chris. We believe our results for 2021 provide a great springboard for 2022. For the remainder of the year, we will continue to focus on managing supply chain disruptions and the related cost challenges that our customers are experiencing. To give a better color on this, here are some of the industry data we are seeing. Rising material and labor costs continue to be the largest issues facing the electronics supply chain. A January 2022 ITC study found that 90% of electronics manufacturers reporting rising material costs. Over 75% cite rising labor costs, and material costs in North America are rising faster than the Asia Pacific region. Semiconductor shortages persist and most of our assemblies require them. Global semiconductor sales were up 26% in 2021, with chip lead times from 28 weeks to 52 weeks. Companies are over-rowing to shore up inventories, which raises prices and further squeezes capacity. In this current environment, our customer partnerships run much deeper than purchase orders. Innovation is also increasingly important for Nortech. Along with key customers, we are leveraging our strong technical expertise in digital connectivity solutions, including cables, connectors, sensors, machine vision technology, et cetera. We are fluid in the numerous aspects of technical infrastructure needed to organize, digitize and transmit data, including for the Industrial Internet of Things or IIoT. A recent article in [indiscernible] Europe said the global IIoT market was worth over $77 billion in 2020 and is expected to grow to over $110 billion in 2025, a compound annual growth rate of roughly 7.5%. In tandem with our customers, we are leveraging our decades of technical expertise to develop innovative proprietary technologies for manufacturing methods and products. With that, I will conclude our prepared remarks this afternoon, and we will open it up for questions. John?

[Operator Instructions] The first question is coming from Paul Luber, Private Investor.

Chris and Jay, thanks for the report out and I've been a long-standing shareholder of Nortech and really appreciate how you guys navigated the last 2 years. And on top of that, I think the restructuring and consolidation taking place at the company is also a positive step. And kind of with that said, I'm just curious what you guys anticipate kind of a go-forward margins at the gross profit level and the net profit level. And on top of that, if you're willing to put out a general sales and earnings forecast for 2022?

Yes, Paul, thank you for the question. First of all, we are not going any guidance, so I'm going to not be very specific with my answer, other than to say that our expectations are that we will continue to grow top line revenue. We expect to grow our gross profit. Candidly, we expect to grow our gross margins faster than revenue growth, of course. And we expect EBITDA to grow even faster. So we expect this business to grow on the top line and grow faster on the bottom line and consistently generate positive cash flows. And we'll leave it at that for now.

Got it. Appreciate it. Maybe a little bit of a related question is can you provide a sense of your ability to pass on labor and material increases to the customer base? And is that in the respective timing of your ability to do that?

Yes, it's a very good question, a very timely question right now. And we are and have been engaged in conversations with our customers around passing on cost increases, specifically due to material cost increases and labor cost increases. And of course, like nearly everyone else, we have had to come face-to-face with those things and deal with those things. But we're also having conversations with our customers about moving production to plants that are, in some ways -- in many ways, less expensive for them. Some of those are we're starting to facilitate now. And candidly, we should have done them years ago. But now, given what's going on with inflation, we're getting a lot more attention, I would say, with our customers to moving those things to plants that are more productive for them and for us. We also expect to work with our customers hand-in-hand, longer term to work on innovative new solutions that will help them drive cost productivity. We also expect that will help us grow our margins as well. But if we can help our customers drive cost productivity through better engineering solutions and candidly make their products more competitive, that's a win-win for everybody.

[Operator Instructions] Okay. We have a few questions in queue. The first is coming from [ Mark Raca ], private investor.

Good job, gentlemen. Glad to see what's going on here. My question is -- there's two questions here. I just want to make sure that I'm understanding something on, your year-end backlog of $95 million come up over 50% from 2020 is in this press release. And I'm sure this is just maybe semantics, but I just want to play it safe. Your -- in the 10-K, you state that you are $95 million up from $48 million, which would be damn close to 100% increase. Maybe you're just being conservative. Maybe I'm just being picky, I don't know, last [indiscernible].

Well yes, those are the right numbers. It's $49 million, up to $95 million. Yes, so it's double.

Okay, very good. very good. Okay. All right. And let me think here. Okay. And then the last question, correct me if I'm wrong, so now, with the good growth you've had and the good numbers that your book value per share is approximately $9 a share.

Book value... yes. Is that a question or just...

Well, I'm checking myself is what I'm doing here. I'm making sure I'm thinking correctly. The reason I'm asking -- I'm sorry, go ahead. You finish, please.

Yes. Go ahead and...

Go ahead and finish your question. I think we can also follow up with you.

Okay. Well, okay. So I'm just thinking about the valuation of the stock. Your -- the price of the stock are well below, your revenues per share probably around $40 a share. And I think I've got that one down pat. And I was just trying to determine to make sure I'm not miscalculating that the book value -- your book value per share, is approximately $9 per share?

Right. Yes, so our total shareholder equity, this is what you're saying is our $26 million shareholder equity booked shareholder equity?

Correct.

Yes, at about 2.7 million shares, yes, and that's about $9 per share book value of equity, yes.

Okay. Very good. And did I understand correctly, this would be my last question, that you're optimistic for growing revenues this year? I realize costs can be out of your control, but do you think you got the top line pretty much ahead of you for this year?

Yes. We -- as I mentioned earlier, we expect to grow revenue, and we expect to grow the bottom line faster.

The next question is coming from [ Thor Nicholson ], private investor.

Congratulations to your whole team, Chris and Jay, for your remarkable achievement since last year. It's really breathtaking. Congratulations. I have just a couple of quick questions on revenue and margins. On revenue, you've been really building on your earlier achievements at Nortech. I think that this might be the highest revenue in recent years, if not ever from, is what I'm seeing from your quarterly results. Your total shipment backlog has increased significantly as well. And it looks like it's up $16.4 million from the September quarter. Your 90-day backlog suggests that the bulk of the total shipment backlog will be fulfilled after the March quarter. Could you comment on that? And what is causing your backlog to build? Is this due to some combination of new programs, extension programs, deferred orders due to supply chain disruptions?

Yes. I would say most of it is due to customers giving us orders earlier and a little farther out. They're concerned about the supply chain disruptions. They asked us how they could help. We have conversations with them. Part of those conversations is giving us more visibility into their business and placing orders sooner so that we can get orders to our suppliers sooner as well. This is all very helpful for our supply chain, especially given the circumstances we have right now. So our customers have really done a good job of partnering with us and helping us, candidly, so we can help our suppliers. And at the end of the day, this all helps us and our ability to deliver quality products to our customers on time or as close to on time as we possibly can.

Okay. On the margin front, you were just mentioning this, the issue of supply chain disruptions class challenges the whole industry is facing. Could you provide some more color on what you're experiencing with supply chain and class challenges? And could you also comment on how these increases and revenues might be affecting your margins? For example, as you're ramping up programs, is this also affecting margins on these initial programs?

Yes. Well, as you might imagine, our suppliers are faced with a lot of the same challenges we have. So they're faced with rising labor costs of course. Certainly, here in the States, as we all know, we read about this often, we know we're facing inflation, not only domestically but globally at this point. We know the supply chain disruptions have resulted in increase in materials. That's also driving inflation. So -- and so our suppliers are seeing that, which means we're seeing that. And then we're having our conversations with our customers as well. And for better or for worse, this is what's part of the reason that we're seeing inflation in this country. We do expect it to abate at some point and we are -- we feel like we obviously recognize this pretty quickly, and we started programs with our customers to increase prices so that we can maintain or candidly improve our margins going forward. I have to say our customers have been pretty darn patient with us as we've gone through this, as we've tried to be patient with our suppliers. So anyway, we expect that -- and as I mentioned earlier, we are having different conversations with our customers now, really productive conversations with our customers about ways to mitigate some of these increases in the cost. For example, if we can manufacture in another lower-cost location, we are looking to do those things. If we can decrease shipping costs by manufacturing in certain locations, we are working on those things. We can help our customers with their engineering. And oftentimes, we know the products that we're building for our customers better than our customers do. And we have good ideas as to how to drive cost productivity through engineering with those customers. They're engaged actively in those discussions as well. We're all working to try to mitigate this.

The next question is coming from [ Daniel Everingham ], private investor. Okay, it looks like Daniel has disconnected. [Operator Instructions] Okay. Looks like there's no remaining questions in queue. I'd like to turn the floor back to Mr. Miller for closing remarks.

Thank you, and thank you all for those questions. Very good set of questions. And thanks to everybody for taking the time to listen to our call today. We look forward to updating you on our first quarter 2022 conference call in May. Thank you all very much, and goodbye.

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.