Contract Assets

Contract assets, recorded as such in the Condensed Consolidated Balance Sheets,Sheet, consist of unbilled amounts related to revenue recognized over time. Significant changes in the contract assets balance during the three months ended March 31, 2022 2023 was as follows (in thousands):

We expect substantially all of the remaining performance obligations for the contract assets recorded as of March 31, 2022, 2023, to be transferred to receivables within 90 days, with any remaining amounts to be transferred within 180 days. We bill our customers upon shipment with payment terms of up to 120 days.

The following tables summarize our net sales by market for the three ended March 31, 2022 2023 and 2021,2022, respectively:

NOTE 4. FINANCING ARRANGEMENTS

We have a credit agreement with Bank of America, which was entered into on June 15, 2017 and provides for a line of credit arrangement of $16,000 that expires on June 15, 2026.

Under the amended Bank of America credit agreement signed December 31, 2021, the line of credit is subject to variations in the Bloomberg Short-Term Bank Yield (BSBY) index rate. Our line of credit bears interest at a weighted-average interest rate of 3.6%7.3% and 3.5%5.2% as of March 31, 2022 2023 and December 31, 2021, 2022, respectively. We had borrowings on our line of credit of $7,579$5,886 and $9,016$6,897 outstanding as of March 31, 2022 2023 and December 31, 2021, 2022, respectively. There are no subjective acceleration clauses under the credit agreement that would accelerate the maturity of our outstanding borrowings. In addition, the credit agreement does not expire within one year, the Company is not in violation of the covenants and the Company expects Bank of America to be capable of honoring the financing arrangement. The line of credit is shown net of debt issuance costs of $53$41 and $58$44 on the condensed consolidated balance sheet for the periods ended March 31, 2022 2023 and December 31, 2021, 2022, respectively.

The line of credit and real estate term notes with Bank of America containcontains certain covenants which, among other things, require us to adhere to regular reporting requirements, abide by annual shareholder dividend limitations, maintain certain financial performance, and limit the amount of annual capital expenditures.

The Bank of America Credit Agreement provides for, among other things, a Fixed Charge Coverage Ratio of not less than 1.0 to 1.0, for the twelve months ending December 31, 2020 and each Fiscal Quarter end thereafter subject only during a trigger period commencing when our availability under our line is less than $2,000$2,000 until availability is above that amount for 30 days. The Company met the covenants for the period ended March 31, 2022.2023.

At March 31, 2022, 2023, we had unused availability under our line of credit of $8,021$5,934 supported by our borrowing base. The line is secured by substantially all of our assets. In the first quarter of 2022, we amended our credit agreement to include the Employee Retention Credit Receivable as security in our line of credit which improved our unused availability.

NOTE 5. LEASES

We have operating leases for certain manufacturing sites, office space, and equipment. Most leases include the option to renew, with renewal terms that can extend the lease term from one to five years or more. Right-of-use lease assets and lease liabilities are recognized at the commencement date based on the present value of the remaining lease payments over the lease term which includes renewal periods we are reasonably certain to exercise. Our leases do not contain any material residual value guarantees or material restrictive covenants. At March 31, 2022, 2023, we do not have material lease commitments that have not commenced.

The components of lease expense were as follows:

Supplemental balance sheet information related to leases was as follows:

Supplemental cash flow information related to leases was as follows:

Maturities of lease liabilities were as follows:

The lease term and discount rate at March 31, 2022 2023 were as follows:

NOTE 6. INCOME TAXES

On a quarterly basis, we estimate what our effective tax rate will be for the full fiscal year and record a quarterly income tax provision based on the anticipated rate. As the year progresses, we refine our estimate based on the facts and circumstances, including discrete events, by each tax jurisdiction. Our effective tax rate for the three months ended March 31, 2023 and 2022 was 28% and 2021 was (94)% and 31%, respectively. The primary drivers of the change in the effective tax rate isrelates to an increase in the valuation allowance on United States deferred tax assets and taxes on foreign entities.The prior year income tax benefit was attributable to the US loss compared to book income on foreign entities and expected US book income for the year. There are also discrete items related to a release of valuation allowance from use of state attributes and non-qualified options exercised over book value.

NOTE 7. RESTRUCTURING CHARGES

During the first quarter of 2021, we recorded restructuring charges of $219 related to the consolidation of our production facilities and closure of our Merrifield, Minnesota facility. Loss on held for sale assets, relating to write downs to fair value, was $28 during the three months ended March 31, 2021. There were no restructuring charges or amounts accrued in the three months ended March 31, 2022.

NOTE 8. EMPLOYEE RETENTION CREDIT

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law providing numerous tax provisions and other stimulus measures, including an employee retention credit (“ERC”), which is a refundable tax credit against certain employment taxes. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 and the American Rescue Plan Act of 2021 extended and expanded the availability of the ERC.

During the year ended December 31, 2022, we received payment on the Employee Retention Credit for the first quarter of 2021 of $2,559. At March 31, 2022 2023 and December 31, 2021, 2022, the Company has ERC benefits of $5,209$2,650 within Employee Retention Credits Receivable on the condensed consolidated balance sheet. The company received payment on this remaining receivable on May 1, 2023.

NOTE 9.8. RELATED PARTY TRANSACTIONS

David Kunin, our Chairman, is a minority owner of Abilitech Medical, Inc. Mr. Kunin also was a consultant to Abilitech which relationship ended on through March 1, 2021. In the three months ended March 31, 2022 2023 and 2021,2022, Abilitech paid the Company $54$0 and $268,$54, respectively, for delivery of medical products. We have assets recorded related to Abilitech including $226 of accounts receivable and inventory. We do not believe that Abilitech will pay the Company for outstanding accounts receivable or for inventory and we have recorded a full reserve against the gross amounts. The Company believes that transactions with Abilitech are on terms comparable to those that the Company could reasonably expect in an arm's length transaction with an unrelated third party.

David Kunin, our Chairman, is a minority owner (less than 10%10%) of Marpe Technologies, LTD an early-stage medical device company dedicated to the early detection of skin cancer through full body scanners. Mr. Kunin is also a member of the Board of Directors of Marpe Technologies. The Company worked with Marpe Technologies to apply for a grant from the Israel-United States Binational Industrial Research and Development Foundation, a legal entity created by Agreement between the Government of the State of Israel and the Government of the United States of America (“BIRD Foundation”). The parties were successful in receiving approval for a $1,000 conditional grant. The Company and Marpe Technologies will each receive $500$500 from the BIRD Foundation and, among other obligations under the grant, each is required to contribute $500$500 to match grant funds from the BIRD Foundation. The Company will meet its obligation by providing certain services at cost or with respect to administrative services at no cost to Marpe Technologies. The total value of the Company’s contribution will not exceed $$500.500. Marpe is engaged in raising funds for its operations, which funds are necessary to pay for the Company’s services beyond its contribution. The Company will receive a 10-year10-year exclusive right to manufacture the products of Marpe Technologies. There can be no assurances that Marpe Technologies’ medical device operations will be commercially successful, that Marpe Technologies will be successful in raising additional funds to finance its operations or, if commercially successful, the Company will recouprecover the value of services provided to Marpe for which is if not fully paid. paid when the services are provided. The transactions between the Company and Marpe Technologies have been approved by the Audit Committee pursuant to the Company Related-Party Transactions Policy. During the three months ended March 31, 2023 and 2022, we incurred expenses of $80 and recognized revenue of $89. There were 0 expenses incurred or revenue recognized for the three months ended March 31, 2021. providing services to Marpe Technologies of $67 and $169, respectively. The Company believes that transactions with Marpe are on terms comparable to those that the Company could reasonably expect in an arm’s length transaction with an unrelated third party.

ITEM 2. MANAGEMENT’SMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are a Minnesota, United States based full-service global EMS contract manufacturer in the Medical, Aerospace & Defense and Industrial markets offering a full range of value-added engineering, technical and manufacturing services and support including project management, design, testing, prototyping, manufacturing, supply chain management and post-market services. Our products are complex electromedical and electromechanical products including medical devices, wire and cable assemblies, printed circuit board assemblies, higher-level assemblies, and other box builds for a wide range of industries. We serve three major markets within the EMS industry: Aerospace and Defense, Medical, and the Industrial market, which includes industrial capital equipment, transportation, vision, agriculture, oil and gas. We maintain facilities in Bemidji, Blue Earth, Mankato, and Milaca, Minnesota; Monterrey, Mexico; and Suzhou, China. All of our facilities are certified to one or more of the ISO/AS standards, including 9001, AS9100 and 13485, with most having additional certifications based on the needs of the customers they serve.

Recent Developments

Global Pandemic

The COVID-19 pandemic continued to impact our business in the first quarter of 2022 primarily driven by the emergence of the Omicron variant with a resulting increase in COVID cases in early 2022. During the first quarter of 2022, our performance was also adversely affected by continued supply chain disruptions and delays. The full extent to which COVID-19 will directly or indirectly impact our business, financial condition, and results of operations will depend on future developments that are highly uncertain and cannot be accurately predicted, including new information that may emerge concerning COVID-19, the actions taken to contain it or treat its impact and the economic impact on local, regional, national and international markets.

We will continue to assess the current and potential impacts of the COVID-19 pandemic on our business, financial condition, and results of operations. We actively manage our cash and working capital to preserve adequate liquidity and ensure that our business can continue to operate during these uncertain times.

Results of Operations

The following table presents statements of operations data as percentages of total net sales for the periods indicated:

Net Sales

Net sales were $30.7$34.9 million in the first quarter of 2022,2023, as compared to $22.1$30.7 million in the first quarter of the prior year, an increase of $8.6$4.2 million or 38.9%13.7% that was driven primarily due to higher production volume as well as price increases to counteract higher material and labor cost. We have also taken actions to scale the direct labor workforce and strengthen the supply chain for parts.

Net sales by our major industry markets for the three months ended March 31, 20222023 and 20212022 were as follows (in millions):

Net sales by timing of transfer of goods and services for the three ended March 31, 2023 is as follows (in millions):

Net sales by timing of transfer of goods and services for the three ended March 31, 2022 is as follows (in millions):

Net sales by timing of transfer of goods and services for the three ended March 31, 2021 is as follows (in millions):

Backlog

Our 90-day shipment backlog as of March 31, 20222023 was $35.4$33.8 million, a 4.1%5.8% decrease from the beginning of the quarter and a 13.8% increase4.5% decrease from March 31, 2021. Backlog for our medical customers decreased 3.4% from the beginning of the quarter and increased 23.9% from the prior year. Our industrial customers’ backlog increased 9.0% from the beginning of the quarter and decreased 4.0% from the prior year. The aerospace and defense backlog decreased 21.1% from the beginning of the quarter and increased 17.6% from the prior year.2022. Our backlog consists of firm purchase orders we expect to ship in the next 90 days, with any remaining amounts to be transferredshipped within 180 days.

Our 90-day shipmentorder backlog by our major industry markets are as follows (in millions):

Ourmarket has remained relatively constant when compared to the same period of the prior year. 90-day backlog varies due to order size, manufacturing delays, contract terms and conditions and timing from customer delivery schedules and releases. These variables cause inconsistencies in comparing the backlog from one period to the next.

90-day shipment backlog by our major industry markets are as follows (in millions):

Our total shipmentorder backlog was $97.6 million and $62.8 million as of March 31, 20222023 was $98.8 million, a 5.1% decrease from $104.1 million at December 31, 2022. Our total backlog remains strong, however customers are returning to their pre-pandemic ordering practices as the global supply chain improves.

Total order backlog by our major industry markets are as follows (in millions):

The 90-day and total backlog at March 31, 2021, respectively. This backlog contains2023 contain the contract assetsasset value of $10.8 million which havehas been recognized as revenue.

Gross Profit

Gross profit as a percent of net sales 13.2%was 15.7% and 7.1%13.2% for the three months ended March 31, 20222023 and 2021,2022, respectively. The gross profit improvement wasrelates primarily driven by higher production volume which increased plant utilization. Additionally, we did implementto price increases in response to material and labor cost inflation.inflation and higher production volume which increased plant utilization.

Selling Expense

Selling expenses for the three months ended March 31, 2023 and 2022 was $0.9 million or 2.6% of sales and 2021 was $0.8 million or 2.7% of sales and $0.7 million or 3.3% of sales, respectively.

General and Administrative Expense

General and administrative expenses for the three months ended March 31, 2023 and 2022 and 2021 were held relatively flat,$3.3 million or 9.3% of sales and are generally fixed in nature, at $2.7 million or 8.9% of sales, respectively. The increase in general and $2.8 million or 12.7% of sales, respectively.

Restructuring Charges

Restructuring charges for the three months ended March 31, 2021administrative expense was $0.2 million or 1.0% of sales. The restructuring charges aremainly due to the closurehigher professional fees and higher cost of the Merrifield facility during 2021.labor.

Research and Development Expense

Research and development expenses were $0.3 million or 1.1% of net salesfor both the three months ended March 31, 2023 and 2022.

Income From Operations

Income from operations was $1.1 million and $0.2 million for the three months ended March 31, 2022. There were no research2023 and development expenses for the three months ended March 31, 2021.

Income (Loss) From Operations

First quarter 2022, respectively. The increase in income from operations was $169 thousand compared to a loss from operations of $2.3 million for the first quarter in 2021, driven by the increase in sales and gross margin as a percent of sales.sales, primarily due to price increases in response to material and labor cost inflation.

Interest Expense

Interest expense was $98$110 thousand and $86$98 thousand for the three months ended March 31, 20222023 and 2021,2022, respectively. The increase in interest expense relates to increased borrowingsinterest rates on the line of credit in the first quarter of 20222023 compared to the first quarter of 2021.2022.

Income Taxes

On a quarterly basis, we estimate what our effective tax rate will be for the full fiscal year and record a quarterly income tax provision based on the anticipated rate. As the year progresses, we refine our estimate based on the facts and circumstances, including discrete events, by each tax jurisdiction. Our effective tax rate for the three months ended March 31, 2023 and 2022 was 28% and 2021 was (94)% and 31%, respectively. The primary drivers of the change in the effective tax rate isrelates to an increase in the valuation allowance on US deferred tax assets and taxes on foreign entities.The prior year income tax benefit was attributable to the US loss compared to book income on foreign entities and expected US book income for the year. There are also discrete items related to a release of valuation allowance from use of state attributes and NQO options exercised over book value.

Net Income (Loss)

Net income for the three months ended March 31, 2023 was $681 thousand or $0.25 per basic common share and $0.23 per diluted common share. Net income for the three months ended March 31, 2022 was $138 thousand or $0.05 per basic and diluted common share. Net loss forThe increase in net income was driven by the three months ended March 31, 2021increase in sales and gross margin as a percent of $1.6 million or $0.58 per basicsales, primarily due to price increases in response to material and diluted common share.labor cost inflation.