Nortech Systems Incorporated: Q2 2023 Form 10-Q Summary
Business context and reporting period
Nortech Systems is a global electronics manufacturing services company serving the medical, industrial, and aerospace and defense markets. It provides engineering, prototyping, manufacturing, supply-chain, testing, and post-market services from facilities in the United States, Mexico, and China. The filing covers the three and six months ended June 30, 2023, compared with the same periods in 2022. The financial statements are unaudited.
Key financial metrics
| Metric | Three months ended June 30, 2023 | Three months ended June 30, 2022 | Six months ended June 30, 2023 | Six months ended June 30, 2022 |
|---|---|---|---|---|
| Net sales | $35.0 million | $32.5 million | $69.9 million | $63.2 million |
| Gross profit | $5.5 million | $5.0 million | $11.0 million | $9.0 million |
| Gross margin | 15.6% | 15.4% | 15.7% | 14.3% |
| Operating income | $1.1 million | $1.0 million | $2.2 million | $1.2 million |
| Net income | $0.6 million | $0.7 million | $1.3 million | $0.9 million |
| Diluted earnings per share | $0.22 | $0.25 | $0.46 | $0.30 |
| Operating cash flow | Not separately provided | Not separately provided | $0.3 million | $(1.9) million |
At June 30, 2023, cash was $0.8 million and restricted cash was $1.1 million. Accounts receivable were $17.4 million, inventory was $21.1 million, and contract assets were $11.6 million. Total assets were $68.4 million and total liabilities were $38.9 million.
The company had $7.1 million of borrowings under its $16.0 million Bank of America line of credit, with a weighted-average interest rate of 7.9%. Unused availability was $5.3 million. The facility expires June 15, 2026, is secured by substantially all company assets, and the company was in compliance with its covenants. Lease liabilities totaled $8.9 million on a present-value basis.
Six-month investing cash use was $1.0 million, primarily for property and equipment. Financing activities provided $0.1 million on a net basis. Cash and restricted cash declined by $0.6 million to $1.9 million at June 30, 2023.
Material changes versus the prior comparable period
- Three-month sales increased 8% and six-month sales increased 11%, driven primarily by higher production volume and price increases intended to offset higher material and labor costs.
- Medical sales rose 11% in the second quarter and 24% year to date. Aerospace and defense sales rose 20% in the quarter but declined 17% year to date. Industrial sales declined 4% in the quarter and increased 2% year to date.
- Gross margin improved year to date from 14.3% to 15.7%, reflecting pricing actions and improved plant utilization.
- Six-month operating income increased approximately 80% to $2.2 million, while six-month net income increased approximately 53% to $1.3 million.
- Second-quarter net income declined despite higher sales and operating income, primarily because the effective tax rate increased to 35% from 21%. The six-month effective tax rate increased to 31% from 12%, partly because of higher projected pretax income and a valuation allowance related to Section 174.
- General and administrative expense increased to $6.4 million year to date from $5.4 million, primarily because of higher professional fees and labor costs.
- The employee retention credit receivable of $2.7 million at December 31, 2022 was collected during the first half of 2023.
- The company adopted the current expected credit loss model on January 1, 2023, recording a $30 thousand after-tax reduction to retained earnings. The filing states that 2022 comparative credit-loss information is not comparable because it was reported under the prior model.
Guidance, outlook, commentary, risks, and unusual items
Management stated that existing financing arrangements, anticipated operating cash flows, cash on hand, and expected collections are expected to fund working capital, capital expenditures, and debt repayments for the next twelve months. The filing does not provide formal revenue or earnings guidance.
Backlog was $34.3 million for the next 90 days at June 30, 2023, up 1% from March 31 but down 4% from June 30, 2022. Total backlog was $101.0 million, up 2% sequentially but down 5% year over year. Management noted that medical customers were returning to pre-pandemic ordering practices as supply-chain conditions improved. Backlog includes $11.6 million of contract assets already recognized as revenue.
Two customers represented 39% of net sales in both the three- and six-month periods, and two customers represented approximately 38% of gross accounts receivable at June 30, 2023. This concentration creates exposure to customer demand, credit, and contract risks.
Key disclosed risks include supply-chain disruption, labor shortages, raw-material and energy-cost volatility, foreign-currency movements, competition, loss of a major customer, FDA or regulatory noncompliance, cybersecurity or information-system disruptions, facility disruptions, and general economic conditions. The company stated that there were no material changes to the risk factors disclosed in its 2022 Form 10-K.
The company disclosed ordinary-course legal proceedings and claims but did not identify a material legal contingency. It reported no off-balance-sheet arrangements, no defaults on senior securities, and no material changes in internal control over financial reporting. Disclosure controls and procedures were assessed as effective.
Important facts for investors to verify
- Whether pricing actions and improved utilization can sustain the year-to-date gross-margin improvement.
- The impact of the higher interest rate on the secured credit facility and the company’s compliance with borrowing-base and fixed-charge coverage requirements.
- Customer concentration, particularly the two customers contributing 39% of sales and approximately 38% of gross receivables.
- Conversion and collectability of the $11.6 million contract-asset balance and the timing of related receivables.
- Whether total backlog converts to revenue as expected, given the year-over-year decline and normalization of medical-customer ordering patterns.
- The effect of higher effective tax rates, including the Section 174-related valuation allowance, on future earnings.
- Exposure to foreign operations, currency fluctuations, supply-chain constraints, labor availability, and raw-material costs.
- The company’s ability to maintain liquidity given only $0.8 million of unrestricted cash at period end and approximately $7.1 million of line-of-credit borrowings.