Eltek Ltd Q2 FY2024 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to the Eltek Limited 2024 Second Quarter Financial Results Conference Call. All participants are present in listen-only mode. Following management's formal presentation, instructions will be given for the question-and-answer session. As a reminder, this conference is being recorded. Before I turn the call over to Mr. Eli Yaffe, Chief Executive Officer; and Ron Freund, Chief Financial Officer, I would like to remind you that they will be referring to forward-looking information in today's presentation and in the Q&A. By its nature, this information contains forecasts, assumptions and expectations about future outcomes, which are subject to risks and uncertainties outlined here and discussed more fully in Eltek's public disclosure filings. These forward-looking statements are projections and reflect the current beliefs and expectations of the company. Actual events or results may differ materially. We'll also be referring to non-GAAP measures. Eltek undertakes no obligation to publicly release revisions to such forward-looking statements to reflect events or circumstances occurring subsequent to this date. I will now turn the call over to Mr. Eli Yaffe, Mr. Yaffe, please go ahead.

Thank you for joining us for our second quarter earnings call for 2024. With me is Ron Freund, our Chief Financial Officer. We will start with an overview of our business and a summary of the main factors that influenced our results during this quarter. After our prepared remarks, we will be available for your questions. You should all have access to our press release, which was issued earlier today and is also available on our website. I would like to focus on two key areas: revenues and operations. To begin with revenues, since early 2023, we have seen consistent growth driven by strong demand for our products, timely workforce expansion, and ongoing investments in machinery and infrastructure. We predicted increased demand and began an accelerated investment plan in early 2022, which has already improved our capacity and will continue to do so through the end of 2025. However, this quarter, we saw a decline in revenue and profit compared to the prior period. This drop is mainly due to the significant timing shift of some key customers who prioritized medium-technology PCB orders, resulting in lower prices and margins. We couldn't maintain our profitable mix from the previous period as orders for more complex, higher-margin PCBs were postponed to the end of Q2 2024 and Q3 2024. Additionally, as mentioned in the previous call, our current bottleneck is manpower. We faced production delays in Q2 due to capacity constraints related to manpower. During the quarter, we had 59 working days compared to 60 to 90 days in Q2 2023, reflecting a decrease of 5%. The manpower shortage and reduced workdays hindered our ability to produce and deliver some high-margin PCB orders scheduled for Q2. This unfavorable mix negatively impacted our short-term financial performance, ending Q2 with $10.5 million in revenue, a gross profit of $1.6 million, and a gross margin of 16%. As previously mentioned, the lower gross margin for the quarter is attributed to the product mix. Manufacturing costs remained stable compared to last quarter, but the lower average sales price led to a decline in gross margin. We remain confident in our long-term strategy and market position, anticipating a return to profitability in Q3 and Q4 2024 as we realign our product mix strategies. As of today, our backlog has increased by 30% since the beginning of 2024, indicating an immediate need to expand capacity, primarily by growing our workforce. This backlog increase is driven by strong demand from the defense sector amidst the current regional situation and the shift of manufacturing back from the East. We believe that we have not yet fully realized the impact of the regional conflict and expect further growth in defense sector demand for our products in the coming quarters. Our focus continues to be on securing long-term orders while ensuring enough capacity for our high-end industrial and medical sectors, aiming to maintain our service segment mix. Now, regarding our accelerated investment plan and strategies to address manpower issues, we are actively progressing with our accelerated investment plan with significant emphasis on three new coating lines. The first line, known as the VFV line, is already installed and operational. During the quarter, we assessed our suppliers and confirmed that installation of the remaining two coating lines will be completed by the end of 2025. These new lines will enhance our capacity, allow for the production of advanced technological products, and improve yields. We are currently restructuring office space within our facility to support the necessary construction for the two additional coating lines. By the end of Q2, we had issued purchase orders for all components of this plan, with a projected remaining payment of around $8 million through the end of 2025. It is crucial to mention that this investment is beyond our usual capital expenditure, which typically ranges from $2 million to $3 million annually. Concerning manpower, we are navigating a competitive market with strong demand for workers. In response to this and our forecast for increased order flow, we have revised our recruitment policy, primarily by raising direct labor salaries. This adjustment has already yielded positive results, and we are now expanding our workforce daily. We plan to hire around 50 new employees in the upcoming months and extend our manufacturing capacity, including adding an additional sales shift. We expect these actions will enable us to meet delivery schedules, accelerate delivery times, and boost revenue. I will now pass the call to Ron Freund, our CFO, to discuss our financial results.

Thank you, Eli. I would like to draw your attention to the financial statements for the second quarter of 2024. During this call, I will also discuss certain non-GAAP financial measures. Eltek uses EBITDA as a non-GAAP financial performance measurement. Please see our earnings release for its definition and the reasons for its use. I will now go over the highlights of the second quarter of 2024. All numbers mentioned are in U.S. dollars. Revenues for the second quarter of 2024 were $10.5 million, compared to $11 million in the second quarter of 2023. Gross profit reached $1.6 million, compared to a gross profit of $3 million in the second quarter of 2023. The decrease is due to the decline in revenue and the unfavorable mix of products sold. Operating profit amounted to $0.4 million in Q2 2024, compared to $1.4 million in Q2 2023. We recorded financial income of $0.5 million during Q2 2024, including income from the devaluation of the NIS against the U.S. dollar and interest on our interest-bearing bank deposits. Net profit was $0.8 million or $0.11 per share in Q2 2024, compared to net profit of $1.3 million or $0.22 per share in Q2 2023. EBITDA was $0.10 million, compared to $1.7 million in Q2 2023. During the second quarter of 2024, we enjoyed positive cash flow from operating activities of $1.8 million. As of June 30, 2024, we had cash and cash equivalents and short-term bank deposits of $18.3 million, with no debt outstanding. We are now ready to answer your questions.

Thank you. Ladies and gentlemen, at this time, we will begin the question-and-answer session. The first question is from Tom Kerr of Zacks. Please, go ahead.

Good morning. Can you explain in more detail the timing shift by these customers that shifted to medium technology? What specific reason would they shift to medium technology PCBs instead of traditional complex PCBs?

The reason for this unfavorable mix was the timing of production that was required by our customers for lower technology than the regular mix. As mentioned, we produced more than 40% of region instead of the average of 30%. It was a requirement by our customers. We usually try to support our customers and change the manufacturing plan according to their requirements.

Okay. And you indicated it will return to more complex PCBs in the third and fourth quarter. Will that mean the traditional gross margin of 27% will be returning?

Yes. Hi, Tom, it's Eli. Yes, we will return to the 27% for the long term. As I mentioned before, some of the high-end PCBs were pushed to the end of Q2 and toward Q3 2024.

Got it. And I noticed that capital expenditures were $5.9 million for the quarter. Is that all related to the accelerated investment program?

Most of it.

Most of it? And what can we expect that in the next half of the year?

Just one correction, the $5.9 million is for the six months, not the quarter. In the quarter, we invested $3 million.

Okay. Sorry, I thought that was the other one. Where do you expect that in the second half of the year in terms of capital expenditures?

So as we said, it depends mainly on the timing of the installation of machines and delivery. We have a balance of about $8 million regarding the accelerated investment plan to be paid during the rest of 2024 and 2025. I estimate that during the next half year, we'll spend somewhere around $2 million.

Okay. So much of that will be in 2025, then?

Yes.

And one more, are you guys still looking for a presence in North America? Any progress on that?

Yes, we are still looking for a suitable target company. We cannot share details at this moment as it hasn't reached a stage where we will report on it, but we are actively working on this issue as well.

Okay. Thank you. I'll jump back in the line. Thank you.

The next question is from Michael Wu. Please go ahead.

Hi. First of all, would you mind disclosing the percentage of the revenue mix for the defense sector?

The defense sector is approximately 60% — it was 60% in Q2 2024.

So it's the same, right, around?

Yes. Yes. It does not change. What changed is the mix of the product within the defense sector.

Okay. So, do you expect Q3 and Q4 will be similar in terms of revenue mix?

No, the mix is going to change back to 30%-70% as we mentioned, not 40%-60% as it was in Q2, sorry.

Okay. So it will go up a little bit, right?

Yes, it will go up.

It will go up. High-margin PCBs will go up.

About the CapEx, for the next 1.5 years until the end of 2025, would you expect the total CapEx to be around $10 million, $12 million?

Yes. We expect it to be around $10 million.

Okay, great. Thank you. That's all my questions. Thanks.

The next question is from Tom Kerr of Zacks. Please go ahead.

Hi, just one follow-up on the manpower issue. I couldn't quite hear; the phone line was a little blurry, but did you say you will be hiring 50 people? Can you explain the manpower issue one more time?

Right now, the current situation in the manpower labor market in Israel is very tough. So we increased salaries for direct employees at Eltek on July 1. By doing this, we started to absorb more people to work with us. I'm speaking about direct employees. The plan is to increase manpower by 50 people.

And we are hoping to do this by the year-end. It's a very tough market, but our steps show positive performance. That means that once we raise the salaries of direct labor, we could recruit more employees, and we are recruiting on a daily basis.

And are those primarily manufacturing employees? Or are there other areas?

Manufacturing employees.

Direct employees and manufacturing employees, yes.

Great. Okay, thanks.

Thank you, Tom.

That's all I had.

The next question is from Ron Su. Please go ahead.

Hi, everyone. First question is regarding this potential future deal in North America. How are you going to finance these kinds of deals? Do you consider future offerings as you did in the $16 per share offering? Or do you consider financing with a bank loan or change of shares? This is the first question. Second question is, do you think that the changes in the mixture of PCB complex products will allow you to compensate both revenue and profit? So that in the total year, you will reach your target, because you don't publish a target to compensate even more for the 27% gross margin and for even higher revenue than previous quarters?

Hi, Ron. In regard to your first question, any financing plans for the purchase will depend, of course, on the scope of the acquisition and the form of financing that will be discussed and agreed upon by the parties. But at this point, our plans are to try and finance the purchase with the cash we have on hand. And by raising debt, we do not intend, at this stage, to raise additional capital for this purchase.

Regarding your second question, Ron, about the mix of products in Q2, as I stated in our press release, the mix of the quarter contained requirements that resulted in lower prices and margins. The normal average is 30% rigid PCB and 70% rigid flex with high margins. But this quarter, the mix contained approximately 42% rigid PCB, which is low margin, and 58% high-end PCB, with high margin. We agreed to produce this order since we have long-term relationships with our key customers. When there is a demand for changed priorities, we support our customers and change our manufacturing plan accordingly. This was a unique event due to the situation in the defense sector in Israel, and we support them. But in the long term, we are still focused on achieving that 27% gross margin.

As for the balance of the year, we don't give guidelines, as you probably know. We believe we will perform better than this quarter. At this point, I will stop.

Okay, thank you.

Thank you.

There are no further questions at this time. Before I ask Mr. Yaffe to go ahead with his closing statement, I would like to remind the participants that a replay of this call will be available tomorrow on the website. Would you like to make a concluding statement?

Before we conclude, I want to express my gratitude to our employees for their unwavering dedication in executing our strategy. I also extend my thanks to our customers, partners, and investors for their ongoing support. Thank you all for joining today's call. Have a great day.

Thank you. This concludes the Eltek Limited 2024 second quarter financial results conference call. Thank you for your participation. You may now go ahead and disconnect.