Nortech Systems Incorporated (NSYS) Earnings Call Transcript

Good afternoon, ladies and gentlemen, and welcome to the Nortech Systems Inc. Second Quarter 2026 Earnings Conference Call. With me on the line today are Jay Miller, President and Chief Executive Officer; and Andrew La Frenz, 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 Andy Life.

Thank you, Jenny, and welcome, everyone. Jill will begin today's call with a review of our operations, recent developments and business outlook, I will then review Nortech's second quarter financial results before turning the call back to Jay for closing comments. After that, we will open the line for questions. . Before we continue, please note statements made during this call may be forward-looking statements regarding the 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 in this call. These risks, including those detailed in our most recent SEC filings may be amended or supplemented. The statements made during this conference call are 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 can 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? Thank you, Andy, and good afternoon, everyone. We appreciate you joining us. The second quarter reflected continued execution across the business, with net sales increasing 9.3% year-over-year to $33.5 million, gross margin improving to 17% and operating income of $623,000. Our results benefited from higher revenue levels improved manufacturing cost absorption from increased production activity and continued progress following the restructuring initiatives in late 2024 and early 2025. We -- these improvements were partially offset by higher incentive compensation expense in 2026. Backlog remains 1 of the clearest and best forward-looking indicators that our strategy is gaining traction. As of June 30, 2026, our 90-day shipment backlog was $33.4 million, up 6.3% from the beginning of the quarter and up 25.8% and from June 30, 2025. Our total order backlog as of June 30, 2026, was $93.8 million, up 3.4% from the beginning of the quarter and up 19.8% compared with the same period last year. Year-over-year growth in total backlog was primarily driven by an increase in aerospace and defense and medical imaging orders. This progress reflects stronger customer engagement, successful program transfers and the value of our manufacturing footprint across the U.S., Mexico and China. We continue to see strong quoting activity as customers evaluate nearshore manufacturing strategies for North America and Asia. We believe our North American footprint positions us well with our monitoring Mexico Maquiladora operations and Minnesota facilities operating within the framework of the U.S.-Mexico-Canada agreement. While the tariff environment remains somewhat uncertain, we are actively monitoring developments and the picture is getting clearer. We are pursuing reimbursement and recovery of previously paid EPA-related tariffs and while we are confident we are making important progress, the timing and amount of any recoveries remain uncertain and no amounts have been recognized as of June 30, 2026. The -- we remain proactive in monitoring trade policy, geopolitical uncertainty and supply chain risk. In June 2026, we've strengthened our supply chain leadership with the addition of a new Vice President of Supply Chain. This leadership addition comes at an important time as selected component constraints, longer lead times, allocation pressures and price volatility continue to affect many OEMs and EMS providers. We are working closely with customers and suppliers to plan ahead secure critical materials and protect production continuity. Next, I'll turn it over to Andy for a more in-depth look at our financial results. Andy? Thank you, Jay.

I will provide a brief overview of Nortech's financial performance for the second quarter ended June 30, 2026. Additional details are available in our Form 8-K earnings release in Form 10-Q filed with the Securities and Exchange Commission this afternoon. As we have discussed previously, quarterly results can be influenced by the timing of customer shipments, production schedules and working capital movements. One of those factors persist, our execution and longer-term strategies or gain traction as we move through 2026, consistent with Jay's comments earlier in the call. Net sales for the second quarter of 2026 were $33.5 million, an increase of $2.9 million or 9.3% and was compared with $30.7 million in the second quarter of 2025. Growth was led by the medical device market, where sales increased 36% year-over-year. primarily due to higher customer demand from existing customers and continued ramp-up in new programs. Medical Imaging sales increased 12.2%, driven by higher customer demand in part by increased revenues from a stocking program with a key customer that provides product availability to enable shorter lead times. Industrial sales decreased 4.7%, reflecting customer inventory adjustments and temporary production disruptions associated with the transfer of manufacturing activities to Monterey, Mexico partially offset by growth in China. Aerospace and defense sales decreased 12.8% in the quarter, primarily due to reduced demand from 1 customer who is reducing post-COVID inventory levels. However, year-to-date aerospace and defense sales increased 8.7% compared with the prior year period. benefiting from higher production volumes associated with completed transfers to our Bemidji location. Gross profit totaled $5.7 million compared with $4.8 million in the prior year period, and gross margin improved to 17% and up 120 basis points compared with 15.8% last year. The improvement was primarily attributable to higher revenue levels and improved manufacturing cost absorption resulting from increased production activity, partially offset by unfavorable sales mix. Total operating expenses were -- excuse me, $5.1 million in the second quarter of 2026 compared with $4.1 million in the prior year period. The increase in operating expenses was primarily attributable to higher incentive compensation accruals in 2026. For the 3 and 6 months ended June 30, 2026, incentive compensation expenses were 402,647,000, respectively, compared with a reversal of expense of $131,000 during the second quarter of 2025. And resulting in no management incentive compensation recorded in the first half of 2025. In summary, incentive compensation expense in the second quarter and year-to-date periods in 2026 were $533,000 and $647,000 higher than in the respective 2025 periods. As a result, we reported second quarter operating income of $623,000 compared with operating income of $742,000 in the prior year period. For the 6 months -- for the first 6 months of 2026, operating income was $670,000 compared with an operating loss of in the same prior year period, reflecting higher gross profit associated with increased revenue and improved operating leverage, offset by higher management incentive compensation together with the absence of a $266,000 restructuring charge recorded in the first quarter of 2025. Net interest expense was $197,000 compared with $257,000 last year during the quarter driven by lower average borrowings and reduced interest costs following the transition to our new financing arrangements, we reported second quarter net income of $316,000 or $0.11 per diluted shares compared with net income of $313,000 or $0.12 per diluted share in the second quarter of 2025. For the first 6 months of net income was $282,000 or $0.09 per share compared with a net loss of $1 million or $0.36 per share in the same prior period. Cash used in operating activities was $2.4 million in the first 6 months of 2026 compared with $2.8 million in the prior year period. Cash used by accounts receivable and contract assets was $4.5 million, largely due to the timing of customer shipments and related cash collections and an increase in our contract assets to support future customer shipments. Cash used by inventory was $3.5 million, reflecting purchases of materials need to support the growing backlog. These uses of cash were partially offset by $2.1 million of cash provided by changes in accounts payable primarily related to the timing of cash payments. And then at quarter end, cash and restricted cash totaled $1.7 million. Under our associated bank facility, the revolving credit facility balance was $7.6 million and we had $3.6 million of unused availability as of June 30, 2026. The -- for the remainder of the year, with support of our recently hired Vice President of Supply Chain, we are very focused on reducing investments in the inventory and generate cash from reductions in working capital. while year-over-year revenue growth, improved gross margins, positive year-to-date operating income and a more flexible capital structure -- we believe that Nortech is well positioned to continue building momentum throughout the year. With that, I will turn it back to Jay for his closing remarks. Jake?

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 our engineering expertise, we have a dedicated engineering services team focused on optimizing 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 element of our long-term strategy is innovation. Nortech's engineering capabilities and research and development activities are focused on helping customers solve complex connectivity challenges with technologies that are ruggedized lighter, faster, more sustainable and more affordable. We see important customer priority shaping demand. First, these customers need ruggedized solutions that perform reliably in harsh environments, particularly in aerospace and defense applications. Nortech's fiber optic technologies have been tested to withstand twisting, vending and torque while maintaining data integrity and high-speed data transfer. While we continue to support legacy defense programs, we are also seeing growth -- growing interest in next-generation applications that utilize ruggedized fiber optics, MT and 38 connectors and wearable technology. Second, customers need better ways to capture, transmit and use system performance data. Nortech's digital Diagnostics Extreme and Sky IoT technology platforms integrate digital diagnostics with fiber optic cables to generate real-time cable and system performance data. helping customers improve visibility and transition from preventative to predictive maintenance strategies. Third, customers are seeking lighter, more sustainable technologies that reduce complexity while improving system performance. This is where we see significant opportunity for Nortech's power over fiber technology. by transmitting both power and data through fiber theraptical fiber, power over fiber can reduce overall cable weight, eliminate the need for certain local power sources and provide immunity to electromagnetic interference in demanding applications. These advantages are particularly valuable in medical devices, imaging systems, aerospace, defense, and satellite applications, where reliability, weight reduction and EMI immunity are critical. As copper costs continue to rise and system architecture will become more demanding we believe the power over fiber is well positioned to support the next generation of connected technologies. More and more often today, that data is being evaluated and analyzed using human intelligence as well as combined artificial and human intelligence for improved performance and data management for our customers and 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. To put a finer point on it, we are allocating resources and dedicating time to continue to build the AI skills of our employees in all functions to make better products, of course, but also to make us all more productive. With our intellectual property and fiber optics and digital technologies, Nortech is well positioned for projected future demand for fiber products. When compared with traditional copper, fiber optics offer dramatic 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. We're also taking a forward-looking stance on materials, shifting focus from copper to fiber optics to mitigate cost pressures and align with our long-term strategy to produce ruggedized, lighter, faster, more sustainable and more affordable technology. In closing, we are excited about technological developments across all of our markets and expect them to support our continued sales momentum in 2026 and beyond. -- aided by stabilization in the supply chain and customer orders. As we wrap up our prepared remarks, let me summarize the key takeaways from today's call. First, we are realizing operational and financial benefits from the restructuring activities completed in 2024 and early 2025. Second, we remain optimistic about our positioning in near-shoring landscape and continue to see strong customer interest in other North American and Asian manufacturing footprint. Third, Nortech's backlog remains strong with both 90-day shipment backlog and total order backlog up significantly year-over-year. Finally, we continue to invest in people, technology, innovation supply chain capabilities and regulatory expertise to better serve our customers and position Nortech for future growth. We believe the direction of the business is positive and has never been better. Our backlog is stronger Commercial activity remains healthy. Operating execution is improving, and our team is focused on converting these opportunities into sustainable growth and long-term value for our customers, employees and shareholders. Now we'll open the call for your questions. Jenny, please open the lines.

[Operator Instructions] Our first question is coming from Serge Mascaro from even discovery

. I think I've heard that most of the OpEx growth was one-off during the quarter. Is that correct? .

I'm sorry. We didn't quite hear that. It's -- so most of the OpEx growth for the quarter, it was really above and around incentive compensation. So there was 2 pieces there related to -- we had incentive compensation, and then we also had increased stock-based compensation -- so the combination of those 2 really drove the majority of the increase in terms of operating expenses during the quarter year-over-year.

All right. And then I'm wondering if you are seeing any opportunity related to the data center build-out, it sounds like your products should be very useful within the data center. Is that correct?

We're pursuing a number of opportunities. I would say we've closed a lot of business there, but we're pursuing a number of opportunities in that space where they are looking for custom, complex cable capabilities, especially fiber optics in pretty demanding environments, it fits us extremely well, and we feel like we're quite well positioned there. So we're looking at a number of things. I wouldn't say we've gained a lot of traction there yet, but we're certainly taking a hard look, and we've had a number of conversations. .