Nortech Systems Incorporated (NSYS) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen, and welcome to the Nortech Systems Incorporated Fourth Quarter and Full Year 2023 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, John. 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 fourth quarter and full year 2023 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 including those that are detailed in our most recent Form 10-K filed today may be amended or supplemented. The statements made during this call are based upon information known by Nortech as of the date and time of this call, and we assume no responsibility or obligation to update the information in today's call. You can find Nortech's complete safe harbor statement in our recent SEC filings. And now with that, I'll turn the call over to Jay for his opening comments.

Thank you, Andy, and good afternoon, everyone. We're glad you could join us today. Since this is Andy's first conference call with Nortech, I'd like to take a minute and officially welcome him. Andy joined us in December as CFO and Senior VP of Finance, bringing a wealth of knowledge and experience. He's held C-suite positions with several public and private companies and has served on a number of corporate and nonprofit boards. Andy also spent a number of years on the audit side as a partner at KPMG. Nortech is very fortunate to have Andy on the team. Along with overseeing Nortech's financial operations, Andy will assist our leadership team and Board of Directors with strategic planning. As I've mentioned on past calls, strategic planning at Nortech is an ongoing iterative process integrated into our DNA. Our strategic plan is not something we just dust off every 3 years before filing it away. We work on that diligently every year and take the process very seriously. Foundational to Nortech strategic planning is an employee-first mindset. Our employees are our most valuable assets, and Nortech's strategic plan reflects that. We would not have delivered our strong 2023 financial results without our team members' outstanding contributions, and the whole Nortech team deserves our sincere appreciation. While financial and operational improvements are measured on income and cash flow statements, balance sheets and spreadsheets, it's much harder to quantify Nortech's culture and values. But the whole team creates the right environment where such quantitative improvements can be realized. Everything starts and ends with how our employees live out Nortech's values of teamwork, excellence, commitment, innovation and integrity every day. Touching briefly on our financial results now. We posted record net sales for the fourth quarter and the fiscal year 2023, 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 $3.2 million for the fourth quarter and $8 million for the year. Overall, we're seeing encouraging normalization trends in supply chain and customer ordering practices, factors that had influenced our unusually high backlog levels a year ago. While we're not completely back to what it was -- what was considered normal, we believe these situations have mostly stabilized. In supply chain dynamics, the concept of near-shoring is gaining attention recently. According to a January article by the global electronics trade association IPC, last year, Mexico surpassed China for the first time in 20 years by contributing the highest percentage of U.S. imports from any country. We have seen this trend at Nortech as well. Our 3-tiered global strategy of manufacturing in the U.S., Mexico and China gives Nortech customers flexibility in improving their own competitiveness. We can move production around based on factors like cost, operational requirements, quality control and intellectual property concerns. Our customer 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 life cycle. In terms of China, as I've mentioned on past calls, production 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 costs. To support Nortech's global operations, including our work with large multinational customers, we started a commercial banking relationship with Bank of America in 2017. We appreciate the flexibility this line of credit has provided as well as the endorsement of our strategic direction by a world banking leader. Recently, we made a change to the structure of that agreement in order to better support our operational needs. Andy will give you more details in a few minutes. On a final note, I'd like to recognize an important transition in our executive team. Congratulations, and thank you to Curt Steichen, who retired late last year after nearly 20 years at Nortech, most recently as Senior VP of Business Operations. During his tenure, Curt played a key role in Nortech's growth, both the expansion of our full-service solutions offerings and significant increase in our medical market sales. Stepping in to fill Curt's role is Corey Hancock, who joined us last spring as Vice President of Sales and Business Development. Previously, Corey was with Benchmark Electronics for nearly 24 years, most recently as Vice President of Strategic Accounts. Benchmark is a recognized world leader in our industry, operating multiple facilities across the Americas, Asia and Europe. They were the 13th largest EMS provider in 2022. Given that background and his ability to build and lead sales teams, we are very pleased to have Corey join our leadership team. Next, I'll turn it over to Andy for a more in-depth look at our financial results. Andy?

Thank you, Jay. First, I'd like to acknowledge the tremendous team at Nortech. When I started in early December, I had very high expectations based upon my interview process. I can report that our leadership team, employees and culture are top-notch. In the next few minutes, I will provide certain details of our financial performance in 2023, but I would encourage you to review our press release and recently filed Form 10-K as it contains more information about our business operations and financial performance than we will cover on this call today. As we have pointed out in the past, we believe that our individual quarters can be affected by outside factors. These might include timing, fluctuations, customer shipments and supply chain issues. Any of these could materially impact a particular quarter, either positively or negatively. Consequently, we believe it's 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, I will focus most of my comments on our full year results. As Jay noted earlier, in 2023, we anticipated demand levels to fluctuate as customers continue to work through their respective inventories. We saw this influence in the third quarter net sales levels. However, we were pleased to see this issue begin to resolve in the fourth quarter. A year-over-year increase in fourth quarter net sales helped us to drive nearly 4% increase in net sales for all of 2023 from the prior year. Additionally, we did see sustained year-over-year 90-day backlog levels, gross margin expansion and solid levels of net income and EBITDA. In the balance of my comments, I will review key areas which drove our 2023 financial performance. They include, first, our view of certain factors impacting our income statement; second, selected items which influence Nortech's cash statement; and lastly, a brief review of the balance sheet. As usual, if you have specific questions about these items or any of our quarterly or annual financial results, I will be happy to address them during our Q&A portion of this afternoon's call. In Q4, 2023 net sales totaled $36.1 million. This represents a 1.2% increase from the net sales of $35.6 million in the fourth quarter of 2022 and is up approximately 8% on a sequential quarterly basis. This performance is particularly noteworthy as it comes to strong results in the respective prior periods. In 2023, net sales totaled $139.3 million, up nearly 4% from the prior year. Nortech's full year 2023 net sales performance was driven by growth in all 3 of our major industry categories, medical, aerospace and defense as well as industrial. For the year, the medical market was up by $2.8 million or 3.7% as compared with 2022 with the majority of the increase coming from medical component products. For the year, net sales from the aerospace and defense category totaled $20.5 million, a 5.1% increase from the prior year. And net sales from Nortech's industrial category were $40.1 million, up $3.6 million from the prior year. Included in the financial performance for the full year 2023, gross profit was $23.1 million or 16.6% compared with gross profit of $20.5 million or 15.3% in the prior year. Operating expenses totaled $17.2 million, a 3.4% increase from 2022 operating expense of $16.6 million. The $559,000 increase in year-over-year operating expense was driven primarily by $929,000 increase in general and administrative expenses as we incurred merit wage increases plus investments in our back-office infrastructure to create efficiencies. This was offset by $121,000 reduction in 2023 selling expenses and a $264,000 decrease in product research and development costs. Despite the decline in year-over-year R&D expenses, we believe that this level of investment is sufficient to support new [ RDX ] technologies. Based on our historical continued and consistent profitability over the past several years and our forecast of future performance, fourth quarter 2023 GAAP net income, including noncash income tax -- included a noncash income tax benefit of $2.6 million related to the reversal of a previously established deferred income tax valuation allowance. As a result of our performance in the fourth quarter and the noncash income tax benefit, net income in 2023 totaled $6.9 million or $2.38 per diluted share compared with $2 million or $0.70 per diluted share in 2022. Adjusted for the noncash income tax benefit, net income would have totaled $4.3 million or $1.48 per share, more than double the level of net income in 2022. As noted in our press release distributed this afternoon, we are using earnings before interest, tax, depreciation and 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 GAAP and EBITDA. For the year ended December 31, 2023, EBITDA increased 38.2% to $8 million compared with $5.8 million for 2022. This increase is largely due to increased sales. Moving to the balance sheet and cash flow statement. First, for the year ended December 31, 2023, net cash provided by operating activities totaled $1.8 million. During the fourth quarter, as a result of the previously outlined normalization in the slowdown in customer demand, inventory levels of $21.7 million were materially unchanged from the prior quarter and down from $22.4 million as of December 31, 2022. Receivables as of December 31, 2023, were $19.7 million up from receivables of $16 million as of December 31, 2022. This is in line with our strong fourth quarter sales and the timing of customer payments. Our contract asset, which represents revenue earned but not yet billed to customers increased to $14.5 million as of December 31, 2023, as compared with $10 million at the end of 2022. This increase reflects the timing of customer shipments and the strong fourth quarter net sales. As a reminder, the majority of our net sales are generated from products contractually manufactured specifically to a customer's unique application. And as such, we recognize revenue in accordance with the U.S. GAAP as we produce these products. We ended the fourth quarter with $9.4 million of borrowing capacity on our line of credit. We recently placed our asset-backed line of credit with a cash flow backed $15 million senior secured revolving line of credit, which will expire at the end of February 2027. The new revolver allows for borrowings at a defined rate or at 1, 3 or 6 months secured overnight finance rate, or SOFR, plus a defined margin. We believe that over time, this arrangement will be more beneficial to Nortech and provide greater flexibility in supporting our ongoing operations. Our evolution to our cash flow credit facility is a result of Nortech's focus on strengthening of its balance sheet and delivering sustained EBITDA growth. For a more detailed explanation of this new agreement, please see our explanation in the 2023 10-K. As of December 31, 2023, cash and cash equivalents totaled $1.7 million, up from $1.1 million at the end of the prior quarter and down from $2.5 million at the end of the prior year. The fluctuation in cash balances reflects timing of cash receipts, expenditures, combined with the timing of line of credit borrowings and repayments. On a final note, 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 market demand that we are seeing to deliver sustainable EBITDA growth as well as driving improvements in free cash flow. Our confidence results from growing momentum as we saw in 2023. Coupled with disciplined lean operations, 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 remarks. Jay?

Thanks, Andy. Before we open the call to your questions, I'm going 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 adapt 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, reliability and security 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 artificial intelligence for improved performance and data management for our customers as well as for their customers. More data means -- needs better data pipelines, and that's where Nortech comes in. Technologies like our EBX smart cables help collect and distribute this data faster, more cost effectively and more securely across these sophisticated networks. We see strong opportunities for growth here. 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 the sustainability goals we share with many of those customers. When compared with traditional fiber -- 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 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 electronic -- electromagnetic interference, improved security 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 for our diversification. Our contributions to our national defense are a source of great pride for Nortech employees. The majority of our space and defense cables are still traditional black, round and molded type common and legacy defense systems such as shipboard missile launchers, 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 continued sales momentum in 2024, aided by stabilization in supply chain and customer orders. Last month, IPC cited improving sentiment among global electronics manufacturers with stronger demand and shipments reported in January. Our progress over these quarters -- over recent quarters confirms that outlook. Now we'll open up the call to your questions. John, please open the lines.

[Operator Instructions] And we do have a question coming from [ Thor Michelson ], private investor.

Jay and Andrew, congratulations on a great quarter. We really appreciate that. This is a question for Jay. Congratulations, Jay, on your 5-year anniversary with Nortech. As a shareholder, I'm delighted for your tenure at Nortech. Could you please briefly comment on what you've seen Nortech accomplish in these last 5 years, your perspectives on that and where you see Nortech going now?

Yes. Thank you, [ Thor ]. That's a really good question, and I appreciate it. Look, the businesses the business has changed quite a bit in the past 5 years. But what has not changed is the dedication and the focus of the employees here. We have great employees. We have great customers. We have great supplier partners. And candidly, it was for those reasons why I took the job to begin with. Now we've gotten a lot more disciplined about managing our balance sheet. We've done a lot, as you've seen. We've done a lot of cleanup of our balance sheet over the past 5 years. And now we're much more on a growth trajectory. Our expectation is that we will take it from here. Our expectation is we'll continue to grow the top line. And candidly, we'll grow the bottom line faster. And I am very confident this team can do that. I mentioned in my remarks our strategic planning process, which we take very, very seriously. And we execute very, very -- we're very focused on the execution of that plan. We very seldom, if ever, deviate from our strategic plan. Now plans are never perfect, and we have to make adjustments along the way, but this team has proven that it can make great adjustments along the way to deliver good top line growth and really good bottom line growth. So look, I'm thrilled with how things have gone. If I look back at where I thought we would be 5 years from the time I took this business, candidly, I don't think we -- I would have thought we would have made this much progress. And I didn't know anything about COVID, and I didn't -- we didn't predict a global supply chain crisis. So the fact that this business has done so well through COVID, in fact, gotten stronger through COVID in a lot of ways and managed the global supply chain crisis as gracefully as it has, I can't tell you, I couldn't be any more proud of the people at Nortech for what they've done. So thanks for the question.

This may be a question for Andrew, or Jay, jump in. But looking at the margin for this last -- gross margin, if I'm reading that correctly, I'm seeing there's a 300 basis point improvement over the last quarter. And I'd say generally, your operating expenses have been well controlled. Could you comment on what drove -- if that's correct, what drove and what's been driving -- you mentioned last quarter you were expecting improved gross margins. Is there something happening there?

Yes. It's a really good question, [ Thor ]. A combination of things that really drove it. One is just an increase of revenue covering our fixed cost structure was helpful. As we did note in earlier calls, we have been really hyper-focused on costs and also customer relationships and making sure that we are sending those costs back to customers when we've had supply costs. So I think it's a combination of us getting in front of some historical cost curves, but as importantly, understanding the leverage of the business, especially a couple of years out here from some consolidation of our plants. So it really just was everybody was operating well. We had a minor mix improvement as well in the fourth quarter. But the team -- John Lindeen's team just operated very, very well and executed.

And do you think that's sustainable? I mean you've been doing a path here, but is that continuous?

Yes. Jay made a very important concept here, is that since he's been here, there's been continuous improvement in terms of the stability of the balance sheet and the performance metrics. And one of the things that's really become important for us is our ability to manage this business. And we will continue to look for opportunities to expand the margin. We are, as you well know, the -- also the other side of the curve here, where we're starting to see some limited cases of deflation in some of our costs, but we'll keep in front of those, make sure we manage our customer relationships so that we can eventually continue to drive more volume through the facilities, which is really the key to drive those margins up.

Maybe just one last question. I was surprised, Jay, you talked about improved sales. I've not heard you talking a lot about sales as much, but you're seeing some improved sales, and it looks like your backlog is improving. A lot of other operators are seeing challenges bringing off inventory. So you're seeing perhaps an inflection point here?

Yes. I mean we've seen that, too, by the way. And Andy touched on that. I think we both touched on it in the remarks. I mean we've seen our backlog kind of normalize. Candidly, we expected our backlog would have -- when I say normalized, we've gotten back to a more regular level. It obviously took off and went up quite a bit during COVID and as we were experiencing global supply chain crisis. But actually, we've seen a little less of that, I'll use quotes, normalization than we expected. Look, I think we're -- we have proven that we can execute better than most of our competitors. We have challenges. We face challenges every day, but we manage those challenges pretty darn well. And it is our expectation that we're going to close more business not only from existing customers but also for a number of new customers, which we are -- have been reasonably successful at doing. I'm very proud of the business development team. I'm very proud, as I mentioned in the comments, that we transitioned so gracefully from Curt Steichen to Corey Hancock. That went even better than I could have imagined. And that team is doing a great job right now. And of course, we expect more out of them moving forward.

Congratulations.

Yes. Thank you, [ Thor ].

[Operator Instructions] Okay. It looks like we have no further questions in queue. I'd like to turn the floor back to Jay Miller for any closing remarks.

Thank you, John, and thanks to everyone for joining us today. We look forward to talking to you in May when we report our first quarter 2024 results. Again, thank you and goodbye.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.