Nortech Systems Incorporated — Q2 2022 Form 10-Q Summary
Business Context and Reporting Period
Nortech Systems is a global electronics manufacturing services provider serving the medical, industrial, and aerospace and defense markets. It provides engineering, prototyping, manufacturing, testing, supply-chain, and post-market services from facilities in the United States, Mexico, and China. The filing covers the three and six months ended June 30, 2022, compared with the corresponding 2021 periods.
Key Financial Metrics
| Metric | Q2 2022 | Q2 2021 | Six Months 2022 | Six Months 2021 |
|---|---|---|---|---|
| Net sales | $32.5 million | $30.2 million | $63.2 million | $52.3 million |
| Gross profit | $5.0 million | $3.6 million | $9.0 million | $5.1 million |
| Gross margin | 15.4% | 11.9% | 14.3% | 9.9% |
| Operating income (loss) | $1.0 million | $0.4 million | $1.2 million | $(1.8) million |
| Net income (loss) | $0.7 million | $0.2 million | $0.9 million | $(1.4) million |
| Diluted EPS | $0.25 | $0.06 | $0.30 | $(0.52) |
| Net cash used in operating activities | Not separately provided | Not separately provided | $(1.9) million | $(5.4) million |
Q2 sales increased 7.6%, while six-month sales increased 20.8%. Medical sales rose 17.4% in Q2 and 19.0% year to date; aerospace and defense sales rose 7.7% and 50.7%, respectively. Industrial sales declined 7.8% in Q2 but increased 10.4% for the six-month period.
Management attributed margin improvement primarily to price increases responding to material and labor inflation and higher production volumes that improved plant utilization. Selling expenses increased to $1.0 million in Q2 from $0.6 million, while general and administrative expenses remained relatively stable. Research and development expense increased to $0.4 million in Q2 from $0.2 million.
At June 30, 2022, cash was $0.9 million and restricted cash was $0.2 million. Accounts receivable were $16.5 million, inventories were $23.0 million, and contract assets were $9.1 million. Total assets were $71.5 million and total shareholders’ equity was $26.9 million.
Borrowings under the Bank of America line of credit were $11.4 million, net of debt issuance costs, compared with $9.0 million at December 31, 2021. The facility has a $16.0 million commitment, expires June 15, 2026, bears a weighted-average rate of 3.9% at June 30, 2022, and had $4.2 million of unused availability. The facility is secured by substantially all company assets. Nortech reported compliance with its covenants.
Material Changes Versus the Prior Comparable Period
- Six-month revenue increased $11.0 million, or 20.8%, driven by increased demand and price increases.
- Gross margin expanded 440 basis points in Q2 and 440 basis points for the six-month period.
- The company moved from a six-month operating loss of $1.8 million in 2021 to operating income of $1.2 million in 2022.
- The company moved from a six-month net loss of $1.4 million to net income of $0.9 million.
- No restructuring charges were recorded in 2022; the prior-year six-month period included $0.3 million of restructuring charges related to the Merrifield, Minnesota facility closure.
- Operating cash use improved to $1.9 million from $5.4 million, but working-capital investment remained significant. Inventories increased $3.5 million and accounts receivable increased $2.0 million during the first six months.
- Line-of-credit borrowings increased approximately $2.4 million from year-end 2021, while cash and restricted cash declined by approximately $1.1 million from the beginning of the year.
Outlook, Commentary, Risks, and Unusual Items
Management stated that existing financing arrangements, anticipated operating cash flows, expected Employee Retention Credit proceeds, and cash on hand should be sufficient for working capital, capital expenditures, and debt repayments over the next twelve months. The filing does not provide formal revenue or earnings guidance.
COVID-19 continued to affect the business primarily through supply-chain disruptions and delays. Management is actively managing cash and working capital to preserve liquidity. Other identified risks include labor shortages, component and raw-material availability, commodity and energy cost volatility, currency movements, competition, loss of a major customer, FDA compliance, cybersecurity or information-system disruptions, and adverse economic conditions.
A single customer represented 28% of Q2 revenue and 26% of six-month revenue. Two customers represented approximately 37% of accounts receivable at June 30, 2022. The Employee Retention Credit receivable was $5.2 million and had not changed from December 31, 2021. The company had $35.9 million of 90-day shipment backlog, up 3.5% from June 30, 2021, and total shipment backlog of $106.2 million, including $9.1 million of recognized contract assets.
The company disclosed related-party activity involving entities associated with Chairman David Kunin, including $217 thousand of 2022 six-month revenue from Abilitech Medical and $113 thousand of revenue from Marpe Technologies. The company also contributed $182 thousand of services toward a conditional grant arrangement with Marpe.
Important Facts for Investors to Verify
- Whether the $5.2 million Employee Retention Credit receivable is collected on the expected timing and supports liquidity.
- Whether supply-chain constraints, labor availability, and inflation continue to affect production costs and gross margins.
- Customer concentration and the potential effect of losing or reducing business from major customers.
- Availability under the secured credit facility, covenant compliance, and the impact of rising benchmark interest rates.
- Conversion of the $9.1 million contract-asset balance and other working-capital investments into cash.
- Execution against the $35.9 million 90-day backlog and the sustainability of reported backlog levels.
- Commercial progress and funding risk related to the Marpe Technologies manufacturing opportunity and related-party transactions.
- The company’s statement that no material changes occurred in previously disclosed risk factors or internal control over financial reporting.