Nortech Systems Incorporated — Q1 2022 Form 10-Q Summary
Business context and reporting period
Nortech Systems Incorporated is a global electronics manufacturing services provider serving the medical, industrial, and aerospace and defense markets. It provides engineering, prototyping, testing, manufacturing, supply-chain, and post-market services from facilities in the United States, Mexico, and China. The filing covers the three months ended March 31, 2022, with comparisons to the three months ended March 31, 2021. Financial statements are unaudited.
Financial performance and key metrics
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Net sales | $30.711 million | $22.072 million | +38.9% |
| Gross profit | $4.044 million | $1.561 million | +159.1% |
| Gross margin | 13.2% | 7.1% | +610 basis points |
| Income (loss) from operations | $169 thousand | $(2.175) million | Improved |
| Net income (loss) | $138 thousand | $(1.554) million | Improved |
| Basic and diluted EPS | $0.05 | $(0.58) | Improved |
| Operating cash flow | $1.491 million | $(896) thousand | Improved |
- Sales growth was driven primarily by higher production volume and price increases intended to offset higher material and labor costs. Medical sales increased 23.6% to $15.2 million, industrial sales increased 40.3% to $8.7 million, and aerospace and defense sales increased 88.9% to $6.8 million.
- Gross margin improved primarily because of higher production volume and plant utilization, together with pricing actions. Selling expense was $833 thousand, general and administrative expense was $2.729 million, and research and development expense was $328 thousand.
- Interest expense was $98 thousand versus $86 thousand in the prior-year quarter. The effective tax rate was negative 94%, compared with 31% in Q1 2021, reflecting jurisdictional income and loss differences and discrete tax items.
- Cash and restricted cash totaled $1.617 million at March 31, 2022, including $841 thousand of unrestricted cash and $776 thousand of restricted cash. Total assets were $67.911 million and shareholders’ equity was $26.335 million.
- Inventory increased to $21.187 million from $19.434 million at December 31, 2021. Contract assets were $8.114 million, with substantially all expected to transfer to receivables within 90 days and any remainder within 180 days.
Debt, liquidity, and cash flow
- The Bank of America revolving credit facility provides borrowing capacity of $16.0 million and expires June 15, 2026. Borrowings were $7.579 million at March 31, 2022, compared with $9.016 million at December 31, 2021.
- The weighted-average interest rate on the line of credit was 3.6%. The facility references the Bloomberg Short-Term Bank Yield Index following a December 2021 amendment.
- Unused availability was $8.021 million, supported by the borrowing base. The facility is secured by substantially all company assets, and the Employee Retention Credit receivable was added as collateral during Q1 2022.
- The company met its applicable credit agreement covenants at March 31, 2022. The filing states that existing financing arrangements, anticipated operating cash flows, expected Employee Retention Credit proceeds, and cash on hand should be sufficient for the next twelve months.
- Operating cash inflow of $1.491 million was more than offset by $514 thousand of investing outflows and $1.585 million of financing outflows, resulting in a $608 thousand decrease in cash and restricted cash during the quarter.
Material changes versus the prior comparable period
- Revenue increased 38.9%, while gross margin expanded from 7.1% to 13.2%.
- The company returned to operating profitability and net profitability after reporting operating and net losses in Q1 2021.
- Operating cash flow improved from an outflow of $896 thousand to an inflow of $1.491 million.
- Q1 2021 included $219 thousand of restructuring charges related to the closure of the Merrifield, Minnesota facility and $28 thousand of held-for-sale asset losses; no restructuring charges were recorded in Q1 2022.
- Research and development expense began in Q1 2022 at $328 thousand. The company also granted 74,000 stock options and 21,000 restricted stock units during the quarter.
- Debt borrowings declined by approximately $1.4 million from year-end 2021, while accounts payable, accrued payroll, and inventory increased.
Guidance, outlook, commentary, risks, and unusual items
- No quantitative full-year revenue or earnings guidance was provided.
- Management reported continued adverse effects from the COVID-19 pandemic, including the Omicron variant, supply-chain disruptions, delays, and labor constraints. The future impact remains uncertain.
- Management cited actions to scale the direct labor workforce, strengthen parts supply, increase pricing, and preserve liquidity and working capital.
- The 90-day shipment backlog was $35.4 million at March 31, 2022, down 4.1% from December 31, 2021 but up 13.8% from March 31, 2021. Total shipment backlog was $97.6 million, although it includes contract assets already recognized as revenue.
- Customer concentration remains material: one customer represented 23% of Q1 2022 sales, and two customers represented approximately 35% of accounts receivable at March 31, 2022.
- The company identified risks from supply-chain disruption, labor availability, raw-material and energy costs, competition, loss of a major customer, FDA compliance, cybersecurity, currency volatility, economic conditions, and future pandemics.
- The company has an Employee Retention Credit receivable of $5.209 million. Collection timing and realization of this receivable are important to liquidity.
- Related-party activity included $54 thousand of revenue from Abilitech Medical and $89 thousand of revenue and $80 thousand of expenses related to Marpe Technologies during Q1 2022.
- Management stated that there were no material changes to previously disclosed risk factors, no defaults on senior securities, and no material changes affecting internal control over financial reporting. Disclosure controls were deemed effective.
Important facts for investors to verify
- Whether improved gross margins and operating profitability are sustainable after pricing actions, production normalization, and resolution of supply-chain constraints.
- The timing and collectability of the $5.209 million Employee Retention Credit receivable.
- Inventory growth, contract-asset conversion, customer payment terms, and working-capital requirements.
- Compliance with credit facility covenants and the availability and terms of the $16.0 million revolving facility.
- Exposure to the company’s largest customers and the effect of any order reductions or delivery delays on backlog and revenue.
- The effect of COVID-19 developments, labor shortages, material inflation, and logistics disruptions on future margins and production capacity.
- Potential dilution from 450,900 outstanding stock options and 21,000 restricted stock units at March 31, 2022.