Earnings Call Transcript - NSYS Q2 2025

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the Nortech Systems, Inc. Second Quarter 2025 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. At this time, it is my pleasure to turn the call over to Andrew LaFrence.

Andrew D.C. LaFrence, CFO

Thank you, Jenny. I would 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 second quarter 2025 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 regarding expected net sales, operating results, 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 SEC filings, may be amended or supplemented. The statements made during this conference call are made 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 will 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. Jay?

Jay Dean Miller, CEO

Thank you, Andy, and good morning, everyone. We're glad you could join us today. Our second quarter results are testament to the dedication, resilience and execution of our entire team. Despite lower revenue compared with the second quarter of 2024, we delivered improved earnings and positive EBITDA this quarter, near-term clear evidence that our restructuring efforts and cost discipline are paying off. Increased plant utilization and improved manufacturing efficiencies across transfer programs are building the operational foundation we need for sustained performance improvement. Operationally, we have also made strategic inventory shifts, reducing raw materials while investing in finished goods to support key customer stocking programs. Further, we are starting to see improvements in our manufacturing efficiencies as our teams are gaining experience manufacturing transfer production between plants on a recurring basis. As previously noted, the first half of 2025 and the fourth quarter of 2024 revenues in our aerospace and defense market were negatively impacted by our closure of our Blue Earth facility and the transfer of customer programs to Bemidji due to unexpected delays as a result of slow customer approvals. We have made significant headway with our customers' approvals over the past quarter, and we fully expect our Aerospace and Defense business to get back to normal in the second half of 2025. The team at Bemidji has been working very hard, and we're very encouraged by the progress of the Bemidji team has made. Regarding our cost structure, we also continue to be very diligent in managing operating costs. Over the past 3 quarters, we have undertaken significant actions to reduce our cost structure with the Blue Earth facility closure, a reduction of our headquarters lease space, along with other actions during the first quarter of 2025, to further manage our headcount based on our current operating metrics. Meanwhile, the on-again, off-again imposition of tariffs may significantly impact manufacturers with facilities in China and Mexico, including Nortech. While the tariffs with Mexico are currently somewhat uncertain, it's important to note that Nortech is not the importer of record into the United States for goods produced in Mexico as we operate under a Maquiladora structure for our customers. This materially reduces our direct exposure to these tariffs. As we expected, many of our customers are evaluating their supply chain strategies. We believe we are currently well positioned with our North American footprint as our Monterey and Maquiladora operations and Minnesota facilities work under the framework of the USMCA. As for China, as I've mentioned on past calls, much of our production work there is built in country, for country and non-U.S. markets, a near-shoring approach to better serve our customers in the global market with reduced shipping costs and time. As a result, our China tariff exposure is primarily related to piece parts imported from China rather than larger finished goods imported from China. As tariffs on Chinese imports may change, we are closely monitoring these impacts on our business and adjusting customer pricing as well as our sourcing strategies as needed to mitigate any adverse effects. As with our North American footprint, we are seeing opportunities in China with companies seeking to consolidate their manufacturing within China to serve the Chinese and Asian markets. All in all, we're working hard to have all hands on deck to proactively monitor the shifting landscape, trade policies and uncertainties in the current geopolitical environment. As we are continuing to work to execute our strategy to partner closely with customers to drive shorter lead times, tailored on-time delivery strategies along with deeper customer partnerships that are fundamental to our long-term growth. As a result of the tariffs, we are also encouraged by the new flow of opportunities to quote onshore production in both North America under the USMCA as well as in China. A key takeaway from today's call, and I want to make this very clear, is we remain cautiously optimistic. Our position in the near-shoring landscape, both in Mexico and China is strong, and recent news articles in the New York Times and Wall Street Journal underscore the strategic advantage Mexico holds in today's tariff environment. Now I'll turn it over to Andy for a more in-depth look at our financial results. Andy?

Andrew D.C. LaFrence, CFO

Thank you, Jay. In the next few minutes, I will provide certain details of our financial performance in the second quarter of 2025. I encourage you to review our Form 8-K containing our press release and non-GAAP measures, as well as our quarterly report on Form 10-Q filed earlier this morning with the U.S. Securities and Exchange Commission. As we have historically noted, our individual quarterly performance can be influenced by external factors such as timing fluctuations, seasonal variations, customer shipments, and supply chain issues. Any of these factors could significantly impact a given quarter, either positively or negatively. For this reason, we believe it is more relevant to assess our business on an annual basis rather than concentrating solely on quarterly performance. This perspective will help normalize potential irregularities and provide a clearer view of the long-term success of our strategy. Today, while I will mainly focus on our second quarter results, I will also spend some time discussing the trailing 12 months results for the business. Net sales for the second quarter of 2025 reached $30.7 million, reflecting a 9.5% decrease from the net sales of $33.9 million in the same quarter of 2024. The second quarter of 2025's net sales were negatively affected by delays in approvals from aerospace and defense customers for products being transferred from our Blue Earth facility to our Bemidji facility, as well as manufacturing and plant utilization inefficiencies related to the movement of production between plants. As Jay mentioned, we made significant progress in transferring these customer programs in the first half of 2025. Our customer backlog as of the end of the second quarter of 2025 increased by approximately $10 million from March 31, 2025, to $78.4 million. Gross profit for the second quarter of 2025 was $4.8 million, or 15.8% of net sales, compared to a gross profit of $4.6 million, or 13.6% of net sales in the same quarter last year. The increase in gross profit as a percentage of net sales this year was due to improved facility utilization and enhanced manufacturing productivity, which was more than offset by lower net sales. Operating expenses for the second quarter decreased by $178,000 compared to the same period last year due to higher selling expenses from realigning our customer-facing managers to a sales function reporting to business development, which were previously included in cost of sales. This rise is more than offset by reduced payroll costs and better expense management, along with lower restructuring costs. We sold our Blue Earth facility in July, further lowering our ongoing operating expenses. Regarding the cash flow statement, for the six months ending June 30, 2025, net cash used in operating activities was $2.8 million, compared to $1.5 million for the same period in 2024. The timing of revenue shipments and customer and vendor payments influenced operating cash flow during these periods. Additionally, we generated cash through our strategy to lower inventory levels in the second quarter, and we intend to further decrease our inventory investment for the remainder of 2025. As noted in our press release distributed this morning, we utilize earnings before interest, tax, depreciation, and amortization, or EBITDA, as well as adjusted EBITDA, which excludes restructuring charges incurred through the second quarter related to reductions in staff and the closure of our Blue Earth plant, as key performance indicators for managing our business. While EBITDA and adjusted EBITDA are non-GAAP measures, we believe they provide valuable insights into our core business financial performance. In our press release, we included a reconciliation of our financial performance in accordance with U.S. generally accepted accounting principles and EBITDA, along with adjusted EBITDA. For the quarter ended June 30, 2025, adjusted EBITDA was $1.1 million compared to $0.9 million for the same period in 2024. Turning to the balance sheet, as of June 30, 2025, cash amounted to $652,000, down from $916,000 as of December 31, 2024. The change in cash balances reflects the timing of cash receipts, expenses, distributions of earnings from our Chinese operations, and credit line borrowings totaling $11.6 million at the end of the quarter. Accounts receivable as of June 30 were $17.8 million, up from $14.9 million as of December 31, 2024. Inventories stood at $18.6 million as of June 30, 2025, compared to $21.6 million at the end of December 2024. Our contract asset, which represents revenue earned but not yet billed to customers, increased to $15 million as of June 30, 2025, up from $13.8 million at the end of December 2024. This increase is due to the timing of customer shipments and our focus on producing more to lower raw material inventory and optimize operations. In our press release issued earlier today, we presented non-GAAP results, including trailing 12-month financial data and EBITDA. For the 12 months ended June 30, 2025, net sales were $117.6 million, compared to $137.5 million for the 12-month period ended June 30, 2024. Furthermore, adjusted EBITDA for the 12-month period ended June 30, 2025, was negative $0.4 million, compared with $7.3 million for the 12-month period ended June 30, 2024. As mentioned, over the past year, we have faced revenue and earnings challenges due to changes in customer ordering patterns, adjustments in inventory levels by knuckle device customers post-COVID, and delays in aerospace and defense programs being shifted from Blue Earth to Bemidji. We believe that our second-quarter 2025 performance and the recent increase in customer backlog compared with the end of 2024 are encouraging indicators of future revenue growth. Our primary financial goals for 2025 remain the same. Firstly, we are committed to further strengthening our balance sheet, including our plan to reduce inventory investments in 2025. Secondly, we will concentrate on improving efficiencies in our manufacturing processes, particularly for programs transferred to new facilities over the past year, to achieve sustainable long-term EBITDA growth and enhance free cash flow. Along with disciplined execution of lean operations, expense management, and R&D innovation, we believe Nortech can meet our objectives.

Jay Dean Miller, CEO

Thanks, Andy. Before we open the call to your questions, I want to highlight once again 3 related areas that together serve our customers and help advance Nortech's corporate stewardship, Nortech's engineering expertise, product innovation focus and sustainability plans. As for engineering expertise, we have a dedicated engineering services team focused on enhanced manufacturability, serviceability, supply chain risk mitigation and cost efficiency for our customers. Our 3-tier cost structure across the U.S., Mexico and China allows us to quickly adopt our global engineering resources to fit our customers' changing needs. A core goal of our long-term strategic plan focuses on unique innovation. This is somewhat unusual for most contract manufacturers. Nortech's engineering capabilities and innovation skills further our research and development activities with advancements like expanded Beam Extreme fiber optic technology, or EBX, that we announced in January. EBX is designed for digital data transmission through the very complex custom cable systems we manufacture and offers improved speed, reliability and security when compared to traditional copper. We're also excited about our Active Optical Extreme, or AOX, hybrid power plus data fiber optic technology that works in sophisticated magnetic environments, a testament to our team's dedication to innovation, hard work and excellence in the field of digital connectivity solutions. AOX represents a significant advancement in our product offerings and underscores our commitment to providing state-of-the-art solutions to meet the evolving needs of our clients to deliver products that offer lighter weight, lower cost and ruggedized solutions sustainably. At the simplest level, the vast majority of Nortech's products provide complex custom 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 combined artificial and human intelligence for improved performance and data management for our customers as well as for their customers. For Nortech, we see AI capabilities as a clear opportunity to streamline and improve our processes, make our employees more productive and serve our customers better. You will hear more about our innovations in AI in future conference calls. More data needs better and faster data pipelines, and that's where Nortech comes in. Technology like our EBX smart cables helps collect and distribute this data faster, more cost effectively and more securely across these sophisticated networks. We see strong opportunities for growth with EBX smart cables. Our pivot to more fiber optic technology improves product performance for our customers by offering unparalleled speed and reliability. It also aligns with the global sustainability goals we share with many of those customers. When compared with traditional copper, fiber optics offers significant environmental benefits during both production and operations, including improved energy efficiency and less material usage while significantly decreasing the carbon footprint of the complex cables we manufacture. One might think that our customers no longer care about their carbon footprint, but we're listening carefully to our customers. And for a range of important business reasons, we know they still do care. We also know our aerospace and defense customers are adopting fiber optic technology due to these key advantages, reduced size, weight and power requirements, immunity to electromagnetic interference and greater ruggedization in harsh environments. Harsh environments, of course, are very common for 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 4 core markets by net sales, but it's our fastest-growing segment and very important for our diversification and future growth. Our contributions to our national defense are also a source of great pride for the Nortech team. The majority of our aerospace and defense cables are still the traditional type common in legacy defense systems such as shipboard missile launchers for the Navy. But we're looking for the future with ruggedized fiber optics MT38999 connectors and evolving along with our customers. In closing, we are excited about these technological developments across all of our markets and expect them to support our continued sales momentum in 2025 and beyond, aided by stabilization of the supply chain and customer orders. We're seeing an increased interest in our fiber optics capabilities from our customers. Nortech is well positioned to capitalize on these trends with our advanced fiber optic capabilities. Our EBX and AOX technologies align perfectly with the industry's move toward more efficient and reliable fiber optic solutions. EBX offers nonphysical contact connectors for applications in harsh environments, while AOX combines fiber optics with copper to provide EMI immune, high-speed data transmission, low-speed signals and power delivery in one hybrid cable. By integrating digital diagnostics with fiber optic cables, we're able to generate real-time cable and system performance data. These digital diagnostic cables advance our customers' ability to monitor their systems and devices and evolve from preventative maintenance to predictive maintenance to minimize downtime and costs. With our intellectual property and fiber optic and digital technologies, we're well aligned with projected future demand for fiber products in the aerospace and defense market. We're also taking a forward-looking stance on materials, shifting focus from copper to fiber to mitigate cost pressures and align with our long-term strategic strategy to produce lighter, faster and more sustainable and potentially more affordable technology. Now we'll open up the call for questions. Jenny, please open the lines.

Operator, Operator

I'm not seeing any questions come into the queue at the moment, but we can wait a second just in case. Since there are no questions in the queue, I will hand it back over to Jay for any further comments.

Jay Dean Miller, CEO

Very good. Thank you, Jenny, and thanks, everyone, for joining us today. We look forward to talking with you in November when we report our third quarter 2025 results. Again, thank you, and goodbye.

Operator, Operator

Thank you very much. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a lovely day. We thank you for your participation.