Nortech Systems Incorporated — Q1 2023 Form 10-Q Summary
Business context and reporting period
Nortech is a global electronics manufacturing services provider serving medical, industrial, and aerospace and defense customers. Its offerings include engineering, prototyping, manufacturing, supply-chain management, testing, and post-market services. The filing covers the three months ended March 31, 2023, compared with the three months ended March 31, 2022. The interim financial statements are unaudited.
Financial performance and liquidity
| Metric | Q1 2023 | Q1 2022 |
|---|---|---|
| Net sales | $34.888 million | $30.711 million |
| Gross profit | $5.484 million | $4.044 million |
| Gross margin | 15.7% | 13.2% |
| Income from operations | $1.053 million | $0.169 million |
| Operating margin | 3.0% | 0.6% |
| Net income | $0.681 million | $0.138 million |
| Basic/diluted EPS | $0.25/$0.23 | $0.05/$0.05 |
| Cash flow from operations | $1.718 million | $1.491 million |
| Capital expenditures | $0.496 million | $0.529 million |
- Medical sales increased 40.8% to $21.4 million; industrial sales increased 9.2% to $9.5 million; aerospace and defense sales decreased 41.2% to $4.0 million.
- Management attributed sales growth to higher production volume and price increases intended to offset material and labor inflation.
- Cash and restricted cash totaled $2.633 million at March 31, 2023, including $1.267 million of unrestricted cash and $1.366 million of restricted cash.
- Accounts receivable were $16.219 million, inventories were $21.344 million, and contract assets were $10.790 million.
- Total liabilities were $41.150 million and shareholders’ equity was $28.905 million.
- The Bank of America line of credit had $5.886 million of borrowings outstanding, net of debt issuance costs, and $5.934 million of unused availability. The facility has a $16 million commitment and expires June 15, 2026.
- The weighted-average line-of-credit interest rate increased to 7.3% from 5.2% at December 31, 2022. The company met its debt covenants.
- Operating and finance lease liabilities totaled approximately $9.286 million on a present-value basis.
Material changes versus the prior comparable period
- Sales rose 13.7%, while gross profit increased 35.6%, reflecting improved pricing and plant utilization.
- Operating income increased substantially to $1.053 million from $0.169 million. General and administrative expense increased to $3.265 million from $2.729 million, primarily because of higher professional fees and labor costs.
- Net income increased to $0.681 million from $0.138 million. The effective tax rate was 28% versus a 94% tax benefit in the prior-year quarter, when the company reported a tax benefit related to U.S. losses and foreign-entity income.
- Operating cash flow increased by $0.227 million. Inventory reductions and increases in accrued payroll and customer deposits were partly offset by lower accounts payable and higher contract assets.
- Cash flow from financing was a use of $1.073 million, primarily reflecting net repayments on the line of credit.
- The company adopted the current expected credit loss standard on January 1, 2023, recording a $30 thousand after-tax reduction to retained earnings. Comparative 2022 information was not restated and is not fully comparable for credit-loss purposes.
- The 90-day shipment backlog declined to $33.8 million from $35.9 million at December 31, 2022 and $35.4 million at March 31, 2022. Total backlog declined to $98.8 million from $104.1 million at December 31, 2022 but remained above $97.6 million at March 31, 2022.
Outlook, commentary, risks, contingencies, and unusual items
- Management stated that existing financing arrangements, expected operating cash flow, cash on hand, and expected ERC proceeds should be sufficient for working capital, capital expenditures, and debt repayments for the next twelve months. The filing does not provide formal revenue or earnings guidance.
- The company held a $2.650 million Employee Retention Credit receivable at March 31, 2023 and reported receiving payment on May 1, 2023.
- One customer represented 29% of Q1 2023 net sales. One customer represented 24% of gross accounts receivable and another represented 20% of gross contract assets at March 31, 2023, creating customer-concentration and collection risk.
- Approximately 74% of revenue was recognized over time under contract manufacturing arrangements. Estimates of total contract revenue and costs can affect the timing and amount of reported revenue and profit.
- Key disclosed risks include supply-chain disruption, labor shortages, raw-material and energy cost volatility, competition, loss of a major customer, FDA compliance, cybersecurity or facility disruptions, foreign-currency changes, and general economic conditions.
- The company is subject to ordinary-course legal proceedings and claims; the filing does not identify a material legal matter. Management reported no material change in previously disclosed risk factors.
- Related-party revenue from Marpe Technologies was $67 thousand in Q1 2023. The chairman has an ownership and board relationship with Marpe. The company also carried fully reserved accounts receivable and inventory related to Abilitech Medical.
- Disclosure controls and procedures were assessed as effective, and no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether pricing actions and improved utilization can sustain the 15.7% gross margin amid higher interest, labor, commodity, and energy costs.
- The conversion and collectability of the $10.790 million contract-asset balance and $16.219 million accounts receivable.
- The timing and use of the $2.650 million ERC payment received after quarter-end.
- Customer concentration, particularly the customer representing 29% of quarterly sales and the customers representing significant receivable and contract-asset balances.
- Backlog trends by market, including the decline in medical and industrial backlog and the increase in aerospace and defense backlog.
- Interest-rate exposure and compliance with the secured credit facility’s financial and other covenants.
- The effect of the CECL adoption and related assumptions on future credit-loss provisions and retained earnings.