Nortech Systems Q3 2023 Earnings Call Transcript

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November 8, 2023

There are 3 speakers on the call.

Operator

Greetings. Welcome to Nortek's Third Quarter 2023 Earnings Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded.

Operator

I will now turn the conference over to your host, Alan Nordstrom, Acting CFO at Nortek. Alan, you may begin.

Speaker 1

All right. Thank you, Paul. I'd like to welcome everyone to today's conference call. Jay will begin today's call with a review of our operations, Recent developments and business outlook. Then I'll review Nortek's Q3 2023 financial results before handing it back over to Jay for his closing comments.

Speaker 1

Then we'll open up the call for your questions. Please note that we're still working through the final steps with our independent auditors and we will file the Form 10 Q No steps have been completed. But before we continue, please note that statements made during this call and Q and A session may be forward looking regarding expected revenue, 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 Q, may be amended or supplemented.

Speaker 1

The statements made during this conference call Based upon information known by Nortek 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 Nortek's complete Safe Harbor statements in our SEC filings. And with that, I'll turn it over to you, Jay, for your opening comments.

Speaker 2

Thank you, Alan, and good afternoon, everyone. We're glad you could join us today. As usual, I'd like to start by thanking our more than 7 50 employees worldwide for their dedicated efforts. These people are truly Nortek's most important competitive advantage. Our team members work hard every day Deliver the mission critical electrical components, higher level assemblies, complete finished products and engineering services our customers rely on.

Speaker 2

Today, I'd like to especially recognize team members at our 2 international facilities. Alan and I are speaking to you from Nortek's in Monterrey, Mexico, about 1500 miles south of our Minneapolis headquarters. This week, we held our quarterly Board of Directors meetings Here, it's been a great opportunity for our Board to see our Monterey team in action. Our 77,000 square foot facility here opened in 2018, newly built and outfitted to our specifications for additional engineering resources and enhanced manufacturing workflow. Nortek has operated in Mexico since 2002.

Speaker 2

Our other international team members are in Suzhou, just west of Shanghai on the Eastern Coast of China, Well, it's already Thursday morning. They're about 6,800 miles away from Nortek's headquarters. This facility opened in 2016 It encompasses 60,000 square feet. By the way, Nortek first started in China in 1999 with an operating partnership. We're very proud we were very proud to announce last month that our Suzhou facility recently received Class II medical device certification From China's National Medical Products Administration for serving the Asian market, our Suzhou team members worked very hard to achieve this prestigious certification, which ensures the highest level of safety and effectiveness.

Speaker 2

This is a shining example of how Nortek's reputation for superior quality And customer service continues to grow around the world, thanks to our employees' efforts. This is a significant achievement for Nortek and our medical customers in the Asia Could more than double by 2,030 with 9% annual spending increases expected this decade under the government's Healthy China 2,030 plan. Healthcare spending as a percentage of GDP in China is on track to match that of some developed European countries. For Nortek, I should add the medical market is our largest and fastest growing. Over the past 5 years, our medical revenue Rose nearly 70 percent to $76,000,000 in 2022, accounting for 57% of our total revenue last year.

Speaker 2

This was up from $45,000,000 or 40 percent of total revenue in 2018. Meanwhile, we continue to see steady long term growth Turning next to our Q3 results. Our team's focused execution across China, Mexico And the U. S. Helped Nortek increase our gross margin sequentially and maintain EBITDA levels in the 3rd quarter.

Speaker 2

As previously discussed on these calls, we anticipate customer demand levels will sometimes fluctuate based on factors like inventory adjustments And other timing issues. We saw this influence in 3rd quarter revenue as a few customers requested that we delay shipments to them While they were working through inventory they built up during the COVID pandemic. From our ongoing dialogue with these customers, we expect to be the issue to be resolved in the near In the Q3, year over year comparisons were also challenging because the prior year period set all time quarterly margin records As we saw the benefits of implementing significant pricing actions ahead of material cost increases. However, that situation has since normalized a bit With gross margins consistently running in the mid teens. For this recent Q3, our backlog levels remained healthy.

Speaker 2

We continue to find promising opportunities with a diverse array of medical, industrial and defense customers, including many Fortune 500 Companies. One indicator of this positive momentum is the fact that our trailing 12 month revenue increased more than 5% from the prior trailing 12 month period. Given all these factors, we expect to finish 2023 strong. The U. S.

Speaker 2

Economy seems to be gradually improving. Economists recently surveyed by the Wall Street Journal lowered their forecasted probability of a recession within the next year and raise GDP outlook. Consequently, we remain guardedly optimistic about the end of 2023, Our 2024 business outlook and long term prospects beyond 2024. We believe that Nortek's future is bright. This confidence comes from the combination of our diverse customer base, solid financial platform and hard working team members.

Speaker 2

Now I'll turn it over to Alan for a more in-depth look at our Q3 and 9 month financials. Alan? Thank you, Jay.

Speaker 1

In the next few minutes, I'll provide certain details of our financial performance in the 2023 Q3, but I also encourage you to review our latest Form 10 Q when filed as it contains far more information about our business operations And financial performance Ben will cover on this call. As we pointed out in the past, we believe that our individual quarters can be affected by outside factors. These might include timing fluctuations, customer shipment and supply chain issues. Any of these during a given reporting cycle could temporarily disrupt our momentum. Consequently, we believe it's more appropriate to review our business on a 12 month basis rather than a strict calendar fiscal year.

Speaker 1

This approach will help normalize these potential anomalies and offer a better gauge of our strategy's long term success. So switching to our Q3 financial performance, As Jay noted earlier, we had anticipated the demand levels to fluctuate as customers work through inventory. We saw this influence 3rd quarter revenue levels. However, we expect this issue to get resolved in the near term. Also, the year over year decline largely results from last year's record high 3rd quarter revenue levels That were boosted by significant pricing actions in the period ahead of material cost increases.

Speaker 1

Yet, we see sustained year over year backlog levels, Sequential 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 Q3 financial performance. They include: 1st, a review of certain factors impacting our income statement 2nd, selected items, which influence Nortek's cash flow 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 financial results, I'll be happy to address them during the Q and A portion of this afternoon's call. In Q3 2023, revenue totaled $33,400,000 This represents a 5.4% decline from revenue of $35,300,000 in the Q3 of 2022, yet is still up nearly 5% on a year to date basis.

Speaker 1

This performance is particularly noteworthy as it compares to strong results in the respective prior year periods. In fact, we've been able to achieve substantial revenue growth over the trailing 12 month period despite the stronger historical comparison. Nortek's year to date 2023 revenue performance is driven by growth in our medical categories, while our industrial and aerospace and defense The categories remained relatively consistent over the period. For the 1st 9 months of 2023, the medical market was up $5,500,000 or 10.1 percent As compared to the 1st 9 months of 2022, with the majority of the increase coming from medical component products. For the year to date period, revenue from the Industrial category was $29,000,000 unchanged from the prior year, while the Aerospace and Defense market totaled 14,500,000 down slightly from $15,200,000 in the prior year.

Speaker 1

Included in the financial performance for the year to date period of 2023, gross profit totaled $15,300,000 or 15.8 percent compared to gross profit of $15,400,000 or 15 point 6% in the prior year period. 3rd quarter 2023 operating expenses totaled $4,200,000 a 4.3 percent decrease from the Q3 of 'twenty two operating expense of $4,400,000 The $188,000 decrease in year over year operating This was driven primarily by a $161,000 reduction in 3rd quarter product research and development expenses. Despite the decline in year over year R and D expenses, we believe that this level of investment is sufficient to support new technologies. As a result of performance in the Q3, net income through the 1st 9 months of 2023 totaled $2,500,000 or $0.87 per diluted share compared to $2,400,000 or $0.83 per diluted share for the 1st 9 months of 2022. Moving to the balance sheet and cash flow statements.

Speaker 1

1st, through the 1st 9 months of 2023, net cash provided by operating activities totaled $2,200,000 more than double the level generated for the similar 2022 period. During the Q3, as a result of previously outlined Slow down in customer demand. Inventory levels of $21,500,000 was up from the prior quarter inventories, yet remained down from inventory of 22 point $1,000,000 at December 31, 2022. Receivables at September 30, 2023 were $16,000,000 down from $17,400,000 In the prior quarter and unchanged from $16,000,000 at December 31, 2022. This is in line with the seasonal pattern that we have seen evolve over the past couple of years.

Speaker 1

The first half of the year has been typically marked by higher receivable levels. While cash collections accelerate during the summer months and second half Receivable levels declined. Resulting me, we believe it will generate modest levels of free cash flow going forward. We ended the Q3 of 2023 with $7,500,000 of borrowing capacity on our $16,000,000 line of credit with Bank of America. This present agreement is important in giving Nortek the flexibility to manage through the headwinds we experienced in the last few years In the previously mentioned seasonal fluctuations we see in our receivables and collections.

Speaker 1

At September 30, 2023, Cash and equivalents totaled $1,100,000 down from $1,900,000 at the end of the prior quarter. We believe that our existing financing arrangement, as well as any capital expenditures and debt repayments. On a final note, let me reiterate that our top financial priorities for 2023 remain unchanged. First, we are extremely focused on continuing to strengthen our balance sheet and mitigate impacts we may see from changes in the economic environment or seasonality. Next, we will take further advantage of opportunities to align our operations and infrastructure with the market demand that we are seeing to deliver Sustainable free cash flow growth.

Speaker 1

Our confidence results from growth momentum we saw in 2022 that has sustained thus far in 2023, Coupled with disciplined lean operations execution, expense management and R and D innovation, we believe Nortek can deliver on our objective. With that, I'll turn it back over to Jay for

Speaker 2

his closing comments. Thanks again, Alan. Before we open the call up to your questions, there are 3 topics I'd like to touch on: Inflation, ESG and Nortek's peer comparisons. First, over the past couple of years, unfortunately, inflation is nothing new. We've been carefully managing through its impact on both wages and raw materials.

Speaker 2

For wages, our team members received across the board pay increases this past April. We feel strongly about taking care of the financial well-being of our team members and their families. By the way, I should add that Staffing levels are good across all Nortek locations. As a company, we addressed inflation somewhat early, including the price increases we made during the Q3 of 2022. In calculating these price adjustments, we consider both inflation trends And the fact that our pricing for certain technologies and surfaces was not in line with the market.

Speaker 2

Because of timing issues for price increases relative to expense recognition, Quarterly margin comparisons will fluctuate. However, if you look at the trailing 12 month chart we include in our press release, It shows a tremendous expansion in gross margin levels over the past 2 years. Going forward, we expect gross margins will continue to increase through a combination of strategic pricing actions and operational improvements. 2nd, our ESG efforts, environmental, social and governance continue to follow methodical measured approach. Guided by our long term vision, we are in the early stages of activities, specifically baseline measurements for Nortek's emissions, both direct and indirect Through our supplier partners, we expect to post ESG updates to the Nortek website in early 2024.

Speaker 2

Being proactive with ESG positions Nortek well with our own customers, many of which are already actively engaged in ESG efforts. Early on this call, I mentioned the growing importance in the medical market for Nortek. This market, including the larger life science healthcare Sector is the most engaged in preparing for future ESG disclosure requirements according to a Deloitte survey published late last year. Over 70% of such customers are actively involved. And finally, for our industry and comparisons with Nortek peers, We've described on past calls how we operate under a low volume, high mix business model.

Speaker 2

We make a wide array of complex, highly technical assemblies, sometimes in relatively low quantities. Most of the large publicly traded electronic manufacturing systems firms like Foxconn and Jabil and Benchmark are the reverse, High volume and low mix. Think cell phones, smartwatches and personal computers. These are very different products from the ones we manufacture that include things like Complete medical devices as well as very complex cable systems with printed circuit boards for the defense and industrial markets. However, all EMS companies operate in a similar macroeconomic environment and face related challenges and industry trends.

Speaker 2

According to data from new research new venture research published by the trade organization IPC, the global EMS market in 2022 Grew by 3.2%. By contrast, Nortek substantially outpaced the industry. Our goal remains to outperform our peer group both And finally today, I want to express my sincere gratitude to our dedicated shareholders for their support and loyalty. Many have been with Nortek for decades. I hope all our shareholders share the team's enthusiasm for Nortek's direction and our vision, Aspiring to be the global market leader in digital connectivity and data management engineering and manufacturing.

Speaker 2

Along with delivering on this vision, I can speak for more Nortek management team, team members and Board of Directors in saying that Nortek also remains firmly committed to delivering positive financial value for our shareholders. That concludes our presentation. And now we'll open the call up for your questions. Paul, please open the line.

Operator

Thank you. At this time, we will be conducting a question and answer session. One moment please while we poll for questions. And there were no questions from the lines. I'd now like to hand the call back to Jay Miller for closing remarks.

Speaker 2

Thank you, Paul, and thanks to everyone for joining us today. We look forward to talking to you next March when we present our Q4 2023 results. Thank you again and goodbye.

Operator

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

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Nortech Systems Q3 2023
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