Nortech Systems Inc Q4 FY2023 Earnings Call

Good afternoon, ladies and gentlemen, and welcome to the Nortek 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. All lines have been placed on a listen-only mode, and the call will be open for questions and comments following the management presentation. 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 Nortek'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 Nortek 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 Nortek'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 Nortek, 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 non-profit boards. Andy also spent a number of years on the audit side as a partner at KPMG. Nortek is very fortunate to have Andy on the team. Along with overseeing Nortek'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 Nortek is an ongoing iterative process integrated into our DNA. Our strategic plan is not something we just dust off every three years before filing it away. We work on it diligently every year and take the process very seriously. Foundational to Nortek's strategic planning is an employee-first mindset. Our employees are our most valuable assets, and Nortek's strategic plan reflects that. We would not have delivered our strong 2023 financial results without our team members' outstanding contributions, and the whole Nortek team deserves our sincere appreciation. While financial and operational improvements are measured on income and cash flow statements, balance sheets and spreadsheets, it is much harder to quantify Nortek'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 Nortek'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 are not completely back to 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 Nortek as well. Our three-tiered global strategy of manufacturing in the U.S., Mexico, and China gives Nortek 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 mentioned on past calls, much of our production work there is built in country for the country, a near-shoring approach to better serve our customers in the global market, including reduced shipping costs. To support Nortek'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. 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 Nortek, most recently a Senior VP of Business Operations. During his tenure, Curt played a key role in Nortek's growth, both in the expansion of our full-service solutions offerings and a significant increase in our medical market sales. Stepping into 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.

Thank you, Jay. First, I'd like to acknowledge the tremendous team at Nortek. 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 that 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. Today, I'll 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. Our year-over-year increase in fourth quarter net sales helped us drive a 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 influenced Nortek'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 on strong results in respective prior periods. In 2023, net sales totaled $139.3 million, up nearly 4% from the prior year. Nortek's full-year 2023 net sales performance was driven by growth in all three 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 Nortek'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 a $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 a $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 a non-cash 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 non-cash 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 non-cash 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 metric 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 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 have recently replaced 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 one, three, or six months secured overnight finance rate or SOFR plus a defined margin. We believe that over time, this arrangement will be more beneficial to Nortek and provide greater flexibility in supporting our ongoing operations. Our evolution to our cash flow credit facility is a result of Nortek's focus on strengthening 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 the timing of cash receipts and 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 Nortek can deliver on our objectives. With that, I will turn it back over to Jay for his closing remarks.

Thanks, Andy. Before we open the call to your questions, I'm going to touch on three related areas that together serve our customers and help advance Nortek'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 three-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. Nortek'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 Nortek'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 Nortek comes in. Technologies like our EBX smart cables help to 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 copper, fiber optics offer 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 electromagnetic interference, improved security, and greater durability in harsh environments. Harsh environments, of course, are very common in aerospace and defense applications. Nortek has a 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. Our contributions to our national defense are a source of great pride for Nortek employees. The majority of our aerospace and defense cables are still traditional black round and molded type common in 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 recent quarters confirms that outlook. Now, we'll open up the call to your questions. John, please open the lines.

We have a question from Thor Mickelson, Private Investor. Thor, please go ahead. Your line is live.

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

Thank you for the question, Thor. The business has evolved significantly over the past five years, but the commitment and focus of our employees have remained constant. We have excellent staff, loyal customers, and strong supplier partnerships, which were key reasons I joined the company. We have also become more disciplined in managing our balance sheet, cleaning it up considerably in recent years, and now we're on a solid growth path. We expect to continue increasing our revenue and anticipate even faster growth in our profits. I'm confident in our team's ability to achieve this. Our strategic planning process is something we take seriously, and we focus on executing it effectively. While plans aren’t always perfect and sometimes require adjustments, our team has shown that it can adapt successfully to ensure strong revenue and profit growth. I’m excited about where we are today. When I reflect on what I envisioned five years ago, I realize I underestimated our progress. The pandemic and global supply chain challenges were unforeseen, yet our business has not only sustained itself through these obstacles but has emerged stronger. I couldn’t be prouder of the Nortek team for their incredible efforts. Thank you for the question.

This may be a question for Andrew or Jay jump in. But, looking at the gross margin, if I'm reading that correctly, I'm seeing there's a 300 basis point improvement over the last quarter. And I see 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. 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. 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 on a path here, but is that continuous?

Jay emphasized that since his arrival, there has been ongoing enhancement in the stability of the balance sheet and performance metrics. A significant focus for us is our capability to manage the business effectively. We will keep seeking opportunities to increase margins. As you might be aware, we are also observing limited instances of deflation in some of our costs, but we will proactively address these and ensure our customer relationships are managed effectively so that we can continue to boost volume through our facilities, which is essential for increasing those margins.

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 brewing off inventory. 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 that in the remarks. I mean, we've seen our backlog kind of normalize. Candidly, we expected our backlog would have, when I say normalized, gotten back to a more regular level. It obviously took off and went up quite a bit during COVID, and as we were experiencing a 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 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 from a number of new customers, which we 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 Cory Hancock that went even better than I could have imagined and that team is doing a great job right now. Of course, we expect more out of them moving forward.

Thank you so much. Congratulations.

Yes. Thank you, Thor.

It seems we have no more questions in the queue. I would like to hand it back to Jay Miller for any final remarks.

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

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