UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
| ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2024
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
NORTECH SYSTEMS INCORPORATED
Commission file number 0-13257
State of Incorporation: Minnesota
IRS Employer Identification No. 41-1681094
Executive Offices: 7550 Meridian Circle N., Suite # 150, Maple Grove, MN 55369
Telephone number: (952) 345-2244
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
| Common Stock, par value $.01 per share | NSYS | NASDAQ Capital Market |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large Accelerated Filer ☐ | Accelerated Filer ☐ | |
| Non-accelerated Filer ☒ | Smaller Reporting Company ☒ | |
| Emerging growth company ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Number of shares of $ par value common stock outstanding as of August 1, 2024 was .
TABLE OF CONTENTS
| 2 |
PART I
ITEM 1. FINANCIAL STATEMENTS
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
| 2024 | 2023 | 2024 | 2023 | |||||||||||||
| THREE MONTHS ENDED | SIX MONTHS ENDED | |||||||||||||||
| JUNE 30, | JUNE 30, | |||||||||||||||
| 2024 | 2023 | 2024 | 2023 | |||||||||||||
| Net sales | $ | 33,891 | $ | 35,021 | $ | 68,106 | $ | 69,909 | ||||||||
| Cost of goods sold | 29,274 | 29,547 | 58,041 | 58,951 | ||||||||||||
| Gross profit | 4,617 | 5,474 | 10,065 | 10,958 | ||||||||||||
| Operating expenses: | ||||||||||||||||
| Selling | 909 | 953 | 1,714 | 1,843 | ||||||||||||
| General and administrative | 2,982 | 3,105 | 6,152 | 6,370 | ||||||||||||
| Research and development | 291 | 317 | 609 | 593 | ||||||||||||
| Restructuring charges | 91 | - | 91 | - | ||||||||||||
| Total operating expenses | 4,273 | 4,375 | 8,566 | 8,806 | ||||||||||||
| Income from operations | 344 | 1,099 | 1,499 | 2,152 | ||||||||||||
| Other expense: | ||||||||||||||||
| Interest expense | (165 | ) | (125 | ) | (332 | ) | (235 | ) | ||||||||
| Income before income taxes | 179 | 974 | 1,167 | 1,917 | ||||||||||||
| Income tax expense | 22 | 340 | 245 | 602 | ||||||||||||
| Net income | $ | 157 | $ | 634 | $ | 922 | $ | 1,315 | ||||||||
| Net income per common share: | ||||||||||||||||
| Basic (in dollars per share) | $ | 0.06 | $ | 0.23 | $ | 0.34 | $ | 0.49 | ||||||||
| Weighted average number of common shares outstanding - basic (in shares) | 2,760,052 | 2,718,066 | 2,751,330 | 2,705,121 | ||||||||||||
| Diluted (in dollars per share) | $ | 0.05 | $ | 0.22 | $ | 0.32 | $ | 0.46 | ||||||||
| Weighted average number of common shares outstanding - diluted (in shares) | 2,935,671 | 2,870,848 | 2,922,113 | 2,887,313 | ||||||||||||
| Other comprehensive income (loss) | ||||||||||||||||
| Foreign currency translation | (175 | ) | (281 | ) | (358 | ) | (241 | ) | ||||||||
| Comprehensive income (loss), net of tax | $ | (18 | ) | $ | 353 | $ | 564 | $ | 1,074 | |||||||
See Accompanying Condensed Notes to Condensed Consolidated Financial Statements.
| 3 |
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2024 AND DECMEBER 31, 2023
(IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, 2024 | DECEMBER 31, 2023(1) | |||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash | $ | 1,542 | $ | 960 | ||||
| Restricted cash | - | 715 | ||||||
| Accounts receivable, less allowances of $270 and $358, respectively | 17,577 | 19,279 | ||||||
| Inventories, net | 22,793 | 21,660 | ||||||
| Contract assets | 14,957 | 14,481 | ||||||
| Prepaid assets and other assets | 2,291 | 1,698 | ||||||
| Total current assets | 59,160 | 58,793 | ||||||
| Property and equipment, net | 6,001 | 6,513 | ||||||
| Operating lease assets, net | 8,274 | 6,917 | ||||||
| Deferred tax assets | 2,641 | 2,641 | ||||||
| Other intangible assets, net | 183 | 263 | ||||||
| Total assets | $ | 76,259 | $ | 75,127 | ||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
| Current liabilities: | ||||||||
| Current portion of finance lease obligations | $ | 214 | $ | 356 | ||||
| Current portion of operating lease obligations | 1,169 | 1,033 | ||||||
| Accounts payable | 12,728 | 15,924 | ||||||
| Accrued payroll and commissions | 2,612 | 4,138 | ||||||
| Customer deposits | 5,453 | 4,068 | ||||||
| Other accrued liabilities | 1,120 | 1,063 | ||||||
| Total current liabilities | 23,296 | 26,582 | ||||||
| Long-term liabilities: | ||||||||
| Long-term line of credit, net of issuance costs | 8,314 | 5,815 | ||||||
| Long-term finance lease obligations, net of current portion | 146 | 209 | ||||||
| Long-term operating lease obligations, net of current portion | 7,949 | 6,763 | ||||||
| Other long-term liabilities | 409 | 414 | ||||||
| Total long-term liabilities | 16,818 | 13,201 | ||||||
| Total liabilities | 40,114 | 39,783 | ||||||
| Shareholders’ equity: | ||||||||
| Preferred stock, $ par value; shares authorized; shares issued and outstanding | 250 | 250 | ||||||
| Common stock - $ par value; shares authorized; and shares issued and outstanding, respectively | 28 | 27 | ||||||
| Additional paid-in capital | 17,165 | 16,929 | ||||||
| Accumulated other comprehensive loss | (890 | ) | (532 | ) | ||||
| Retained earnings | 19,592 | 18,670 | ||||||
| Total shareholders’ equity | 36,145 | 35,344 | ||||||
| Total liabilities and shareholders’ equity | $ | 76,259 | $ | 75,127 | ||||
| (1) | The balance sheet as of December 31, 2023 has been derived from the consolidated audited financial statements at that date. |
See Accompanying Condensed Notes to Condensed Consolidated Financial Statements.
| 4 |
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
| 2024 | 2023 | |||||||
| SIX MONTHS ENDED | ||||||||
| JUNE 30, | ||||||||
| 2024 | 2023 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
| Net income | $ | 922 | $ | 1,315 | ||||
| Adjustments to reconcile net income to net cash (used in) provided by operating activities: | ||||||||
| Depreciation and amortization | 966 | 1,027 | ||||||
| Compensation on stock-based awards | 206 | 192 | ||||||
| Change in inventory reserves | 113 | (53 | ) | |||||
| Change in accounts receivable allowances | (88 | ) | (31 | ) | ||||
| Other, net | (59 | ) | (116 | ) | ||||
| Changes in current operating assets and liabilities: | ||||||||
| Accounts receivable | 1,690 | (1,580 | ) | |||||
| Employee Retention Credit Receivable | - | 2,650 | ||||||
| Inventories | (1,288 | ) | 1,350 | |||||
| Contract assets | (476 | ) | (1,620 | ) | ||||
| Prepaid expenses and other current assets | (531 | ) | (1,042 | ) | ||||
| Accounts payable | (2,546 | ) | 586 | |||||
| Accrued payroll and commissions | (1,516 | ) | (1,788 | ) | ||||
| Customer deposits | 1,385 | (195 | ) | |||||
| Other accrued liabilities | (236 | ) | (414 | ) | ||||
| Net cash (used in) provided by operating activities | (1,458 | ) | 281 | |||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
| Proceeds from sale of property and equipment | 9 | - | ||||||
| Purchases of property and equipment | (1,020 | ) | (956 | ) | ||||
| Net cash used in investing activities | (1,011 | ) | (956 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
| Proceeds from line of credit | 68,323 | 65,886 | ||||||
| Payments to line of credit | (65,809 | ) | (65,726 | ) | ||||
| Principal payments on financing leases | (202 | ) | (189 | ) | ||||
| Proceeds from stock option exercises | 31 | 173 | ||||||
| Net cash provided by financing activities | 2,343 | 144 | ||||||
| Effect of exchange rate changes on cash | (7 | ) | (35 | ) | ||||
| Net change in cash and cash equivalents | (133 | ) | (566 | ) | ||||
| Cash and cash equivalents - beginning of period | 1,675 | 2,481 | ||||||
| Cash and cash equivalents - end of period | $ | 1,542 | $ | 1,915 | ||||
| Reconciliation of cash and restricted cash reported within the condensed consolidated balance sheets: | ||||||||
| Cash | $ | 1,542 | $ | 781 | ||||
| Restricted cash | - | 1,134 | ||||||
| Total cash and restricted cash reported in the condensed consolidated statements of cash flows | $ | 1,542 | $ | 1,915 | ||||
| 5 |
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
| SIX MONTHS ENDED | ||||||||
| JUNE 30, | ||||||||
| 2024 | 2023 | |||||||
| Supplemental disclosure of cash flow information: | ||||||||
| Cash paid for interest | $ | 307 | $ | 248 | ||||
| Cash paid for income taxes | $ | 279 | $ | 1,036 | ||||
| Supplemental noncash investing and financing activities: | ||||||||
| Property and equipment purchases in accounts payable | $ | 75 | $ | 49 | ||||
| Operating lease assets acquired under operating leases | $ | 1,923 | $ | - | ||||
See Accompanying Condensed Notes to Condensed Consolidated Financial Statements.
| 6 |
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(UNAUDITED)
(IN THOUSANDS)
| Accumulated | ||||||||||||||||||||||||||||||||
| Additional | Other | Total | ||||||||||||||||||||||||||||||
| Preferred Stock | Common Stock | Paid-In | Comprehensive | Retained | Shareholders’ | |||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Loss | Earnings | Equity | |||||||||||||||||||||||||
| Balance as of March 31, 2023 | 250 | $ | 250 | 2,701 | $ | 27 | $ | 16,481 | $ | (330 | ) | $ | 12,477 | $ | 28,905 | |||||||||||||||||
| Net income | - | - | - | - | - | - | 634 | 634 | ||||||||||||||||||||||||
| Foreign currency translation adjustment | - | - | - | - | - | (281 | ) | - | (281 | ) | ||||||||||||||||||||||
| Stock option exercises | - | - | 36 | - | 138 | - | - | 138 | ||||||||||||||||||||||||
| Compensation on stock-based awards | - | - | - | - | 93 | - | - | 93 | ||||||||||||||||||||||||
| Balance as of June 30, 2023 | 250 | $ | 250 | 2,737 | $ | 27 | $ | 16,712 | $ | (611 | ) | $ | 13,111 | $ | 29,489 | |||||||||||||||||
| Balance as of March 31, 2024 | 250 | $ | 250 | 2,755 | $ | 27 | $ | 17,009 | $ | (715 | ) | $ | 19,435 | $ | 36,006 | |||||||||||||||||
| Net income | - | - | - | - | - | - | 157 | 157 | ||||||||||||||||||||||||
| Foreign currency translation adjustment | - | - | - | - | - | (175 | ) | - | (175 | ) | ||||||||||||||||||||||
| Issuance for stock-based awards | - | - | 7 | - | 126 | - | - | 126 | ||||||||||||||||||||||||
| Compensation on stock-based awards | - | - | - | 1 | 30 | - | - | 31 | ||||||||||||||||||||||||
| Balance as of June 30, 2024 | 250 | $ | 250 | 2,762 | $ | 28 | $ | 17,165 | $ | (890 | ) | $ | 19,592 | $ | 36,145 | |||||||||||||||||
| Balance as of December 31, 2022 | 250 | $ | 250 | 2,691 | $ | 27 | $ | 16,347 | $ | (370 | ) | $ | 11,826 | $ | 28,080 | |||||||||||||||||
| Net income | - | - | - | - | - | - | 1,315 | 1,315 | ||||||||||||||||||||||||
| Foreign currency translation adjustment | - | - | - | - | - | (241 | ) | - | (241 | ) | ||||||||||||||||||||||
| Compensation on stock-based awards | - | - | - | - | 192 | - | - | 192 | ||||||||||||||||||||||||
| Issuance for stock-based awards | - | - | 46 | - | 173 | - | - | 173 | ||||||||||||||||||||||||
| Cumulative adjustment related to adoption of ASC 326 (current expected credit loss) | - | - | - | - | - | - | (30 | ) | (30 | ) | ||||||||||||||||||||||
| Balance as of June 30, 2023 | 250 | $ | 250 | 2,737 | $ | 27 | $ | 16,712 | $ | (611 | ) | $ | 13,111 | $ | 29,489 | |||||||||||||||||
| Balance as of December 31, 2023 | 250 | $ | 250 | 2,740 | $ | 27 | $ | 16,929 | $ | (532 | ) | $ | 18,670 | $ | 35,344 | |||||||||||||||||
| Balance | 250 | $ | 250 | 2,740 | $ | 27 | $ | 16,929 | $ | (532 | ) | $ | 18,670 | $ | 35,344 | |||||||||||||||||
| Net income | - | - | - | - | - | - | 922 | 922 | ||||||||||||||||||||||||
| Foreign currency translation adjustment | - | - | - | - | - | (358 | ) | - | (358 | ) | ||||||||||||||||||||||
| Compensation on stock-based awards | - | - | - | - | 206 | - | - | 206 | ||||||||||||||||||||||||
| Issuance for stock-based awards | - | - | 22 | 1 | 30 | - | - | 31 | ||||||||||||||||||||||||
| Balance as of June 30, 2024 | 250 | $ | 250 | 2,762 | $ | 28 | $ | 17,165 | $ | (890 | ) | $ | 19,592 | $ | 36,145 | |||||||||||||||||
| Balance | 250 | $ | 250 | 2,762 | $ | 28 | $ | 17,165 | $ | (890 | ) | $ | 19,592 | $ | 36,145 | |||||||||||||||||
See Accompanying Condensed Notes to Condensed Consolidated Financial Statements.
| 7 |
CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation
The accompanying unaudited condensed consolidated financial statements for the interim periods have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, the Company has omitted footnote disclosures that would substantially duplicate the disclosures contained in the Company’s audited consolidated financial statements. These unaudited condensed consolidated financial statements should be read together with the audited consolidated financial statements for the year ended December 31, 2023, and notes thereto included in our Annual Report on Form 10-K as filed with the SEC.
The condensed consolidated financial statements include the accounts of Nortech Systems Incorporated and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. All dollar amounts are stated in thousands of U.S. dollars.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of our consolidated financial statements. Estimates also affect the reported amounts of net sales and expenses during each reporting period. Significant items subject to estimates and assumptions include the valuation allowance for inventories, accounts receivable allowances, realizability of deferred tax assets and long-lived asset recovery. Actual results could differ from those estimates.
Recently Issued New Accounting Standards
In November 2023, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2023-07, Segment Reporting Topic (280): Improvements to Reportable Segment Disclosure. The ASU supplements reportable segment disclosure requirements, primarily through enhanced disclosures about significant segment expenses. The amendments in this ASU are effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024 on a retrospective basis. Early adoption is permitted. The Company is currently evaluating the impact of this ASU on its Consolidated Financial Statements and related disclosures.
In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures. The ASU enhances the transparency and decision usefulness of income tax disclosures and is effective for annual periods beginning after December 15, 2024 on a prospective basis. Early adoption is permitted. The Company is currently evaluating the impact of this ASU on its Consolidated Financial Statements and related disclosures.
Out-of-Period Correction
During the first quarter of 2024, we identified an error that understated our accrued liabilities by approximately $178 as of December 31, 2023. We corrected the error on a prospective basis during the first quarter of 2024 through an out of period adjustment lowering our net income by $178 in both the three and six months ended June 30, 2024. We assessed the materiality of the error and concluded that the error was not material to the results of operations or financial condition or for the prior annual and interim periods, and the correction is not expected to be material to the full year results for fiscal year 2024.
| 8 |
Inventories
Inventories are as follows:
SCHEDULE OF INVENTORIES
| June 30, | December 31, | |||||||
| 2024 | 2023 | |||||||
| Raw materials | $ | 22,463 | $ | 20,863 | ||||
| Work in process | 645 | 1,033 | ||||||
| Finished goods | 965 | 934 | ||||||
| Reserves | (1,280 | ) | (1,170 | ) | ||||
| Inventories, net | $ | 22,793 | $ | 21,660 | ||||
Other Intangible Assets
Other intangible assets as of June 30, 2024 and December 31, 2023 are as follows:
SCHEDULE OF OTHER INTANGIBLE ASSETS
Customer Relationships | Patents | Total | ||||||||||
| Balances as of January 1, 2023 | $ | 216 | $ | 206 | $ | 422 | ||||||
| Amortization | 144 | 15 | 159 | |||||||||
| Balances as of December 31, 2023 | $ | 72 | $ | 191 | $ | 263 | ||||||
| Balances | $ | 72 | $ | 191 | $ | 263 | ||||||
| Amortization | 72 | 8 | 80 | |||||||||
| Balances as of June 30, 2024 | $ | - | $ | 183 | $ | 183 | ||||||
| Balances | $ | - | $ | 183 | $ | 183 | ||||||
Intangible assets are amortized on a straight-line basis over their estimated useful lives. The weighted average remaining amortization period of our intangible assets is 5.5 years. Of the patents value as of June 30, 2024, $98 are being amortized and $85 are in process and a patent has not yet been issued.
Amortization expense of finite life intangible assets for both the three months ended June 30, 2024 and 2023 was $40. Amortization expense of finite life intangible assets for both the six months ended June 30, 2024 and 2023 was $80.
As of June 30, 2024, estimated future annual amortization expense (except projects in process) related to these assets is as follows:
SCHEDULE OF ESTIMATED FUTURE ANNUAL AMORTIZATION EXPENSE
| Year | Amount | ||||
2024 | $ | 9 | |||
| 2025 | 18 | ||||
| 2026 | 18 | ||||
| 2027 | 18 | ||||
| 2028 | 18 | ||||
| Thereafter | 17 | ||||
| Total | $ | 98 | |||
NOTE 2. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash, accounts receivable, and contract assets. With regard to cash, we maintain our excess cash balances in checking accounts at primarily two financial institutions, one in the United States and one in China. The account in the United States may at times exceed federally insured limits. The Company’s $1,542 cash balance as of June 30, 2024 included approximately $1,141 and $32 that was held at banks located in China and Mexico, respectively. We grant credit to customers in the normal course of business and generally do not require collateral on our accounts receivable.
We have certain customers whose revenue individually represented 10% or more of net sales, or whose accounts receivable balances individually represented 10% or more of gross accounts receivable. One customer accounted for 26% and 25% of net sales for the three and six months ended June 30, 2024, respectively. Two customers accounted for 39% of net sales for both the three and six months ended June 30, 2023.
| 9 |
As of June 30, 2024, three customers represented approximately 39% of our gross accounts receivable. As of December 31, 2023, two customers represented approximately 35% of our gross accounts receivable.
Contract assets for three customers accounted for 43% of gross contract assets as of June 30, 2024. Contract assets for two customers accounted for 34% of gross contract assets as of December 31, 2023.
Export sales from the U.S. represented approximately 3% and 2% of net sales for the three and six months ended June 30, 2024, respectively. Export sales represented approximately 3% of net sales for both three and six month ended June 30, 2023.
NOTE 3. REVENUE
Revenue Recognition
Revenue under contract manufacturing agreements that was recognized over time accounted for approximately 74% of net sales for both the three and six months ended June 30, 2024 and approximately 73% and 74% of net sales for the three and six months ended June 30, 2023, respectively.
The following tables summarize our net sales by market for the three months ended June 30, 2024 and 2023, respectively:
SCHEDULE OF NET SALES BY MARKET
| Three Months Ended June 30, 2024 | ||||||||||||||||
| Product/ Service Transferred Over Time | Product Transferred at Point in Time | Noncash Consideration1 | Total Net Sales by Market | |||||||||||||
| Medical | $ | 12,725 | $ | 4,435 | $ | 711 | $ | 17,871 | ||||||||
| Aerospace and defense | 6,097 | 494 | 44 | 6,635 | ||||||||||||
| Industrial | 6,163 | 2,667 | 555 | 9,385 | ||||||||||||
| Total net sales | $ | 24,985 | $ | 7,596 | $ | 1,310 | $ | 33,891 | ||||||||
| Three Months Ended June 30, 2023 | ||||||||||||||||
| Product/ Service Transferred Over Time | Product Transferred at Point in Time | Noncash Consideration1 | Total Net Sales by Market | |||||||||||||
| Medical | $ | 14,570 | $ | 5,318 | $ | 719 | $ | 20,607 | ||||||||
| Aerospace and defense | 4,499 | 674 | 182 | 5,355 | ||||||||||||
| Industrial | 6,593 | 2,125 | 341 | 9,059 | ||||||||||||
| Total net sales | $ | 25,662 | $ | 8,117 | $ | 1,242 | $ | 35,021 | ||||||||
| 1 | Noncash consideration represents material provided by the customer used in the build of the product. |
| 10 |
The following tables summarize our net sales by market for the six months ended June 30, 2024 and 2023, respectively:
| Six Months Ended June 30, 2024 | ||||||||||||||||
| Product/ Service Transferred Over Time | Product Transferred at Point in Time | Noncash Consideration1 | Total Net Sales by Market | |||||||||||||
| Medical | $ | 25,789 | $ | 9,679 | $ | 1,508 | $ | 36,976 | ||||||||
| Aerospace and defense | 11,301 | 736 | 116 | 12,153 | ||||||||||||
| Industrial | 13,110 | 5,014 | 853 | 18,977 | ||||||||||||
| Total net sales | $ | 50,200 | $ | 15,429 | $ | 2,477 | $ | 68,106 | ||||||||
| Six Months Ended June 30, 2023 | ||||||||||||||||
| Product/ Service Transferred Over Time | Product Transferred at Point in Time | Noncash Consideration1 | Total Net Sales by Market | |||||||||||||
| Medical | $ | 30,295 | $ | 10,379 | $ | 1,305 | $ | 41,979 | ||||||||
| Aerospace and defense | 7,914 | 1,224 | 261 | 9,399 | ||||||||||||
| Industrial | 13,183 | 4,533 | 815 | 18,531 | ||||||||||||
| Total net sales | $ | 51,392 | $ | 16,136 | $ | 2,381 | $ | 69,909 | ||||||||
| 1 | Noncash consideration represents material provided by the customer used in the build of the product. |
Contract Assets
Contract assets, recorded as such in the Condensed Consolidated Balance Sheet, consist of unbilled amounts related to revenue recognized over time. Significant changes in the contract assets balance during the six months ended June 30, 2024 were as follows:
SCHEDULE OF CONTRACT ASSETS
| Balances as of January 1, 2024 | $ | 14,481 | ||
| Increase (decrease) attributed to: | ||||
| Amounts transferred over time to contract assets | 27,904 | |||
| Allowance for current expected credit losses | (14 | ) | ||
| Amounts invoiced during the period | (27,414 | ) | ||
| Balance outstanding as of June 30, 2024 | $ | 14,957 |
We expect substantially all of the remaining performance obligations for the contract assets recorded as of June 30, 2024 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.
NOTE 4. FINANCING ARRANGEMENTS
We had 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 was to expire on June 15, 2026.
On February 29, 2024, we replaced the asset backed line of credit agreement with a $15,000 Senior Secured Revolving Line of Credit with Bank of America (the “Revolver”). The Revolver allows for borrowings at a defined base rate, or at the one, three or six month Secured Overnight Finance Rate, also known as “SOFR”, plus a defined margin. If the Company prepays SOFR borrowings before their contractual maturity, the Company has agreed to compensate the bank for lost margin, as defined in the Revolver agreement. The Company is required to quarterly pay a 20-basis point fee on the unused portion of the Revolver.
The Revolver requires the Company to maintain no more than 2.5 times leverage ratio and at least a 1.25 times minimum fixed charges coverage ratio, both of which are defined in the Revolver agreement. The Company met the covenants for the period ended June 30, 2024. There are no subjective acceleration clauses under the Revolver that would accelerate the maturity of outstanding borrowings. The Revolver contains certain covenants which, among other things, require the Company to adhere to regular reporting requirements, abide by shareholder dividend limitations, maintain certain financial performance, and limit the amount of annual capital expenditures. The Revolver is secured by substantially all the Company’s assets and expires on February 28, 2027. We were in compliance with all the financial covenants related to this agreement as of and for the period ended June 30, 2024, except for the covenant related to operating expense contributions to our Mexican operations in excess of the amounts allowed under the Revolver. We have received a waiver of this event of default from the bank.
Under the amended Bank of America credit agreement signed February 29, 2024, the line of credit is subject to variations in the SOFR index rate. Under the prior credit agreement with Bank of America, the line of credit borrowing availability was restricted by a defined asset borrowing base, and interest was based on variations in the Bloomberg Short-Term Bank Yield (BSBY) index rate. Our line of credit bears interest at a weighted-average interest rate of 8.0% and 8.3% as of June 30, 2024 and December 31, 2023, respectively. We had borrowings on our line of credit of $8,360 and $5,846 outstanding as of June 30, 2024 and December 31, 2023, respectively. As of June 30, 2024 we had unused availability on the line of credit of $6,440.
The line of credit is shown net of debt issuance costs of $46 and $31 on the condensed consolidated balance sheet as of June 30, 2024 and December 31, 2023, respectively.
| 11 |
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. As of June 30, 2024, we do not have material lease commitments that have not commenced. We extended our operating leases for part of our manufacturing facility in China and our corporate office in Maple Grove, MN during the first six months of 2024 which extended the lease through August of 2033 with monthly lease payments of $14 to $18.
The components of lease expense were as follows:
SCHEDULE OF COMPONENTS OF LEASE EXPENSE
| Three Months Ended June 30, | ||||||||
| Lease Cost | 2024 | 2023 | ||||||
| Operating lease cost | $ | 581 | $ | 592 | ||||
| Finance lease interest cost | 6 | 11 | ||||||
| Finance lease amortization expense | 129 | 182 | ||||||
| Total lease cost | $ | 716 | $ | 785 | ||||
| Six Months Ended June 30, | ||||||||
| Lease Cost | 2024 | 2023 | ||||||
| Operating lease cost | $ | 1,177 | $ | 1,159 | ||||
| Finance lease interest cost | 12 | 23 | ||||||
| Finance lease amortization expense | 129 | 364 | ||||||
| Total lease cost | $ | 1,318 | $ | 1,546 | ||||
Supplemental condensed consolidated balance sheet information related to leases was as follows:
SCHEDULE OF SUPPLEMENTAL CONDENSED CONSOLIDATED BALANCE SHEET INFORMATION RELATED TO LEASES
| Balance Sheet Location | June 30, 2024 | December 31, 2023 | ||||||||
| Assets | ||||||||||
| Finance lease assets | Property and equipment, net | $ | 373 | $ | 636 | |||||
| Operating lease assets | Operating lease assets, net | 8,274 | 6,917 | |||||||
| Total leased assets | $ | 8,647 | $ | 7,553 | ||||||
| Liabilities | ||||||||||
| Current | ||||||||||
| Current finance lease liabilities | Current portion of finance lease obligations | $ | 214 | $ | 356 | |||||
| Current operating lease liabilities | Current portion of operating lease obligations | 1,169 | 1,033 | |||||||
| Noncurrent | ||||||||||
| Long-term finance lease liabilities | Long-term finance lease liabilities, net of current portion | 146 | 209 | |||||||
| Long-term operating lease liabilities | Long-term operating lease obligations, net of current portion | 7,949 | 6,763 | |||||||
| Total lease liabilities | $ | 9,478 | $ | 8,361 | ||||||
| 12 |
Supplemental condensed consolidated statement of cash flows information for the six months ended June 30, 2024 related to leases was as follows:
SCHEDULE OF SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS INFORMATION
| June 30, | June 30, | |||||||
| 2024 | 2023 | |||||||
| Operating Leases | ||||||||
| Cash paid for amounts included in the measurement of lease liabilities | $ | 933 | $ | 934 | ||||
| Property acquired under operating lease | $ | 1,923 | $ | - | ||||
Future payments of lease liabilities as of June 30, 2024 were as follows:
SCHEDULE OF FUTURE PAYMENTS OF LEASE LIABILITIES
Operating Leases | Finance Leases | Total | |||||||||||
| 2024 | $ | 928 | $ | 163 | $ | 1,091 | |||||||
| 2025 | 1,792 | 106 | 1,898 | ||||||||||
| 2026 | 1,758 | 105 | 1,863 | ||||||||||
| 2027 | 1,470 | - | 1,470 | ||||||||||
| 2028 | 1,469 | - | 1,469 | ||||||||||
| Thereafter | 5,510 | - | 5,510 | ||||||||||
| Total lease payments | $ | 12,927 | $ | 374 | $ | 13,301 | |||||||
| Less: imputed interest | (3,809 | ) | (14 | ) | (3,519 | ) | |||||||
| Present value of lease liabilities | $ | 9,118 | $ | 360 | $ | 9,478 | |||||||
The lease term and discount rate as of June 30, 2024 were as follows:
SCHEDULE OF LEASE TERM AND DISCOUNT RATE
| Weighted-average remaining lease term (years) | ||||
| Operating leases | 8.1 | |||
| Finance leases | 1.7 | |||
| Weighted-average discount rate | ||||
| Operating leases | 8.0 | % | ||
| Finance leases | 5.3 | % | ||
Stock-based compensation expense was reported as follows in the condensed consolidated statements of income within general and administrative expenses of $ and $ for the three months ended June 30, 2024 and 2023, respectively and $ and $ for the six months ended June 30, 2024 and 2023, respectively.
Stock Options
In May 2017, the shareholders approved the 2017 Stock Incentive Plan which authorized the issuance of shares. An additional , and shares were authorized in March 2020, May 2022, May 2023 and May 2024, respectively.
We granted service-based stock options during the three and six months ended June 30, 2024. The weighted-average grant-date fair value of options granted during the six months ended June 30, 2024 was $. We granted service-based stock options during the three and six months ended June 30, 2023. Weighted average stock option fair value assumptions and the weighted average grant date fair value of stock options granted were as follows:
| 2024 | 2023 | |||||||
| Stock option fair value assumptions: | ||||||||
| Risk-free interest rate | 4.40 | % | 3.45 | % | ||||
| Expected life (years) | ||||||||
| Dividend yield | 0 | % | 0 | % | ||||
| Expected volatility | % | % | ||||||
| Weighted average grant date fair value of stock options granted | $ | $ | ||||||
| 13 |
Total compensation expense related to stock options was $ and $ for the three and six months ended June 30, 2024, respectively. Total compensation expense related to stock options was $ and $ for the three and six months ended June 30, 2023, respectively. As of June 30, 2024, there was $ of unrecognized compensation related to stock options which will be recognized over a weighted average period of years.
SCHEDULE OF OPTION ACTIVITY
| Shares | Weighted- Average Exercise Price Per Share | Weighted- Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||||||||||
| Outstanding – December 31, 2023 | $ | $ | ||||||||||||||
| Granted | ||||||||||||||||
| Exercised | ) | |||||||||||||||
| Forfeited | ) | |||||||||||||||
| Outstanding – June 30, 2024 | $ | $ | ||||||||||||||
| Exercisable on June 30, 2024 | $ | $ | ||||||||||||||
Restricted Stock Units
During the three and six month periods ended June 30, 2024 and 2023, we granted and restricted stock units (“RSUs”), respectively, at an average grant price per share of $ and $, respectively, under our 2017 Stock Incentive Plan to non-employee directors which vest over . Total compensation expense related to the RSUs was $ and $ for the three and six months ended June 30, 2024 and 2023, respectively. Total compensation expense related to the RSUs was $ and $ for the three and six months ended June 30, 2023, respectively. As of June 30, 2024, total unrecognized compensation expense related to the RSUs was $, which will vest over a weighted average period of years.
SCHEDULE OF RESTRICTED STOCK ACTIVITY
| Shares | Weighted- Average Remaining Vesting Term | Aggregate Intrinsic Value | ||||||||||
| Outstanding – December 31, 2023 | $ | |||||||||||
| Granted | ||||||||||||
| Vested | ) | |||||||||||
| Forfeited | ) | |||||||||||
| Outstanding – June 30, 2024 | $ | |||||||||||
| 14 |
Basic net income per common share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares outstanding using the treasury stock method during the period. The Company’s potentially dilutive common shares are those that result from dilutive common stock options and non-vested stock relating to restricted stock units.
The calculation of diluted income per shared excluded and in weighted average shares for the three and six months ended June 30, 2024, respectively, and and in weighted average shares for the three and six months ended June 30, 2023, respectively, as their effect was anti-dilutive. Basic and diluted weighted average shares outstanding were as follows:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
| 2024 | 2023 | 2024 | 2023 | |||||||||||||
| Basic weighted average shares outstanding | 2,760,052 | 2,718,066 | 2,751,330 | 2,705,121 | ||||||||||||
| Dilutive effect of outstanding stock options and non-vested restricted stock units | 175,619 | 152,782 | 170,783 | 182,192 | ||||||||||||
| Diluted weighted average shares outstanding | 2,935,671 | 2,870,848 | 2,922,113 | 2,887,313 | ||||||||||||
NOTE 8. 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.
Our effective tax rate for the three and six months ended June 30, 2024 was 12% and 21%, respectively. Our effective tax rate for the three and six months ended June 30, 2023 was 35% and 31%. The decrease in the effective tax rate is attributable to the application of a valuation allowance during the three and six month periods ended June 30, 2023 and inclusion of estimated research and development tax credits in the three and six months ended June 30, 2024, partially offset by increased taxes on foreign entities.
NOTE 9. RESTRUCTURING CHARGES
During the first six months of 2024, we accrued restructuring charges of $91 related to the closure and consolidation of our Blue Earth, Minnesota production facility, which is planned to be completed in the fourth quarter of 2024. There were no restructuring charges or amounts accrued in the six months ended June 30, 2023.
NOTE 10. PAYROLL TAX DEFERRAL
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law which allowed for the deferral of the employer portion of social security taxes incurred through the end of calendar 2020. During the year ended December 31, 2023, the Company remitted $1,158 to the Internal Revenue Service (“IRS”) related to the deferral of payroll taxes, of which $785 was recorded as a refund receivable as of December 31, 2023, with a corresponding liability due. These amounts were settled during the first quarter of 2024.
NOTE 11. RELATED PARTY TRANSACTIONS
David Kunin, our Chairman, is a minority owner of Abilitech Medical, Inc. We have accounts receivable related to Abilitech of $85. Abilitech has ceased operations and therefore we do not believe that Abilitech will pay the Company for outstanding accounts receivable, and we have recorded a full allowance against the gross amount. The Company believes that transactions with Abilitech were 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%) 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 has an agreement 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 from the BIRD Foundation and, among other obligations under the grant, each is required to contribute $500 to match grant funds from the BIRD Foundation. The Company has met 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. 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-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 recover the value of services provided to Marpe if not 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 and six months ended June 30, 2024 and 2023, we recognized net sales to Marpe Technologies of $0 and $67, respectively. As of June 30, 2024 and December 31, 2023, we have recorded an unbilled receivable of $21 and $39, respectively, related to expected reimbursement from the BIRD Foundation and have outstanding accounts receivable of $0 and $20, 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.
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ITEM 2. Management’s Discussion and Analysis of Financial Conditions 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, complex higher-level assemblies and other box builds for a wide range of industries. We serve three major markets within the EMS industry: Medical, Aerospace and Defense, and the Industrial market which includes industrial capital equipment, transportation, vision, agriculture, oil and gas. As of June 30, 2024, we have facilities in Minnesota: Bemidji, Blue Earth, Mankato, Milaca and Maple Grove (corporate office). We also have facilities in Monterrey, Mexico and Suzhou, China. In May, 2024, we announced the closure of our Blue Earth facility by the end of 2024 and moving its operations to our Bemidji facility.
All dollar amounts are stated in thousands of U.S. dollars.
Results of Operations
Net Sales. Net sales for the three months ended June 30, 2024 and 2023 were $33,891 and $35,021, respectively, a decrease of $1,130 or 3.2%. Net sales for the six months ended June 30, 2024 and 2023 were $68,106 and $69,909, respectively, a decrease of $1,803 or 2.6%. The following is a summary of net sales by our major industry markets:
| Three Months Ended June 30, | ||||||||||||||||
| 2024 | 2023 | Increase (Decrease) | ||||||||||||||
| Medical | $ | 17,871 | $ | 20,607 | $ | (2,736 | ) | (13.3 | )% | |||||||
| Industrial | 9,385 | 9,059 | 326 | 3.6 | % | |||||||||||
| Aerospace and defense | 6,635 | 5,355 | 1,280 | 23.9 | % | |||||||||||
| Total net sales | $ | 33,891 | $ | 35,021 | $ | (1,130 | ) | (3.2 | )% | |||||||
| Six Months Ended June 30, | ||||||||||||||||
| 2024 | 2023 | Increase (Decrease) | ||||||||||||||
| Medical | $ | 36,976 | $ | 41,979 | $ | (5,003 | ) | (11.9 | )% | |||||||
| Industrial | 18,977 | 18,531 | 446 | 2.4 | % | |||||||||||
| Aerospace and defense | 12,153 | 9,399 | 2,754 | 29.3 | % | |||||||||||
| Total net sales | $ | 68,106 | $ | 69,909 | $ | (1,803 | ) | (2.6 | )% | |||||||
| ● | Medical: Net sales to our medical customers decreased $2,736, or 13.3%, in the three months ended June 30, 2024 as compared with the same period in 2023, and $5,002, or 11.9%, in the six months ended June 30, 2024 as compared with the same period in 2023. The decrease was primarily due to inventory re-balancing with existing customers, timing of customer product launches and lower average sales prices in anticipation of moving several programs for one customer to our Monterrey, Mexico facility. | |
| ● | Industrial: Net sales to our industrial customers increased $326, or 3.6%, in the three months ended June 30, 2024 as compared with the same period in 2023, and $446, or 2.4%, in the six months ended June 30, 2024 as compared with the same period in 2023. The increase in net sales was primarily due to stronger demand with existing customers. | |
| ● | Defense: Net sales to our aerospace and defense customers were up $1,280, or 23.9%, in the three months ended June 30, 2024 as compared with the same period in 2023, and $2,754, or 29.3% in the six months ended June 30, 2024 as compared with the same period in 2023. The increase in net sales relates to increasing demand in the aerospace and defense market, and improved supply chain availability of component materials. |
Backlog. Our 90-day shipment backlog as of June 30, 2024 was $30,095, down 14.5% from March 31, 2024, and 12.2% from the prior-year comparable quarter end. Our 90-day backlog consists of firm purchase orders we expect to ship in the next 90 days, with any remaining amounts to be shipped within 180 days.
Our total order backlog as of June 30, 2024 was $73,296, a 14.8% decrease from the prior quarter end and a 27.4% decrease from the prior-year comparable quarter end. As the supply chain lead times have normalized, customers are returning to their pre-pandemic ordering practices, which has resulted in a decrease in our backlog. More recently we are also noting reduced visibility to revenues in the next several quarters as customers are rebalancing their inventories and, therefore, deferring the placement of some orders.
90-day shipment and total backlog by our major industry markets are as follows:
| June 30, 2024 | March 31, 2024 | June 30, 2023 | ||||||||||||||||||||||
| 90 Day | Total | 90 Day | Total | 90 Day | Total | |||||||||||||||||||
| Medical | $ | 15,906 | $ | 34,450 | $ | 16,995 | $ | 40,201 | $ | 18,283 | $ | 51,925 | ||||||||||||
| Industrial | 6,398 | 11,423 | 8,200 | 15,184 | 9,702 | 21,037 | ||||||||||||||||||
| Aerospace and defense | 7,791 | 27,423 | 10,018 | 30,616 | 6,283 | 28,056 | ||||||||||||||||||
| Total backlog | $ | 30,095 | $ | 73,296 | $ | 35,213 | $ | 86,001 | $ | 34,268 | $ | 101,018 | ||||||||||||
| 16 |
The 90-day and total backlog as of June 30, 2024 includes orders already recognized in net sales and included in the contract asset value of $14,957.
Operating Costs and Expenses.
Net sales, cost of goods sold, gross profit, and operating costs were as follows:
| Three Months Ended June 30, | ||||||||||||||||
| 2024 | 2023 | Increase/(Decrease) | ||||||||||||||
| Net sales | $ | 33,891 | $ | 35,021 | $ | (1,130 | ) | (3.2 | )% | |||||||
| Cost of goods sold | 29,274 | 29,547 | (273 | ) | (0.9 | )% | ||||||||||
| Gross profit | 4,617 | 5,474 | (857 | ) | (15.7 | )% | ||||||||||
| Gross margin percentage (1) | 13.6 | % | 15.6 | % | (200 | ) bpc(2) | ||||||||||
| Selling | 909 | 953 | (44 | ) | (4.7 | )% | ||||||||||
| % of Net sales | 2.7 | % | 2.7 | % | ||||||||||||
| General and administrative | 2,982 | 3,105 | (123 | ) | (4.0 | )% | ||||||||||
| % of Net sales | 8.8 | % | 8.9 | % | ||||||||||||
| Restructuring charges | 91 | - | 91 | - | % | |||||||||||
| % of Net sales | 0.2 | % | - | % | ||||||||||||
| Research and development | 291 | 317 | (26 | ) | (8.2 | )% | ||||||||||
| % of Net sales | 0.9 | % | 0.9 | % | ||||||||||||
| Operating income | 344 | 1,099 | (755 | ) | (68.7 | )% | ||||||||||
| % of Net sales | 1.0 | % | 3.1 | % | ||||||||||||
| (1) | Gross margin percentage is defined as gross profit as a percentage of net sales. | |
| (2) | Basis points change in gross margin percentage. |
| Six Months Ended June 30, | ||||||||||||||||
| 2024 | 2023 | Increase/(Decrease) | ||||||||||||||
| Net sales | $ | 68,106 | $ | 69,909 | $ | (1,803 | ) | (2.6 | )% | |||||||
| Cost of goods sold | 58,041 | 58,951 | (910 | ) | (1.5 | )% | ||||||||||
| Gross profit | 10,065 | 10,958 | (893 | ) | (8.1 | )% | ||||||||||
| Gross margin percentage (1) | 14.8 | % | 15.7 | % | (90 | ) bpc(2) | ||||||||||
| Selling | 1,714 | 1,843 | (129 | ) | (7.0 | )% | ||||||||||
| % of Net sales | 2.5 | % | 2.6 | % | ||||||||||||
| General and administrative | 6,152 | 6,370 | (218 | ) | (3.4 | )% | ||||||||||
| % of Net sales | 9.0 | % | 9.1 | % | ||||||||||||
| Restructuring charges | 91 | - | 91 | - | % | |||||||||||
| % of Net sales | 0.2 | % | - | % | ||||||||||||
| Research and development | 609 | 593 | 16 | 2.7 | % | |||||||||||
| % of Net sales | 0.9 | % | 0.8 | % | ||||||||||||
| Operating income | 1,499 | 2,152 | (653 | ) | (30.3 | )% | ||||||||||
| % of Net sales | 2.3 | % | 3.1 | % | ||||||||||||
| (1) | Gross margin percentage is defined as gross profit as a percentage of net sales. | |
| (2) | Basis points change in gross margin percentage. |
Gross profit and gross margins. Gross profit as a percent of net sales was 13.6% and 15.6% for the three months ended June 30, 2024 and 2023, respectively. Gross profit as a percent of net sales was 14.8% and 15.7% for the six months ended June 30, 2024 and 2023, respectively. The decrease in gross profit as a percentage of net sales in the 2024 periods as compared with the same prior-year periods was the result of lower net sales, as discussed above, and reduced facility utilization.
| 17 |
Selling expenses. Selling expenses as measured as a percent of net sales, were relatively flat in the three and six months ended June 30, 2024 and 2023.
General and administrative expenses. General and administrative expenses decreased in the 2024 periods as compared with the 2023 periods as the result of lower incentive compensation accruals in the current-year periods, and ,as a percent of net sales, remained relatively flat.
Restructuring charges. Restructuring charges were $91 in the three and six months ended June 30, 2024 for accrued employee retention bonuses for our facility consolidation and closure of our Blue Earth facility. We expect to incur approximately $800 of cash restructuring costs, including employee retention and facility moving cost in 2024, of which substantially all are expected to be incurred and paid by December 2024.
Operating income. Operating income for the three months ended June 30, 2024 and 2023 were $344 or 1.0% of net sales, and $1,099 or 3.1% of net sales, respectively. Operating income for the six months ended June 30, 2024 and 2023 were $1,499 or 2.3% of net sales and $2,152 or 3.1% of net sales, respectively. Decreases in both periods were driven by the decrease in net sales and resulting gross margin.
Other expense
Interest expense. Interest expense was $165 and $125 for the three months ended June 30, 2024 and 2023, respectively. Interest expense was $332 and $235 for the six months ended June 30, 2024 and 2023, respectively. This increase was driven by higher borrowings under our line of credit arrangement. Refer to “Liquidity and Capital Resources” for further discussion of financing arrangements.
Income taxes. Our effective tax rate for the three and six months ended June 30, 2024 was 12% and 21%. Our effective tax rate for the three and six months ended June 30, 2023 was 35% and 31%. The decrease in the effective tax rate is attributable to the application of a valuation allowance during the three and six month periods ended June 30, 2023 and inclusion of estimated research and development tax credits in the three and six months ended June 30, 2024, partially offset by increased taxes on foreign entities.
Cash Flow Operating Results
The following is a summary of cash flow results:
| Six Months Ended June 30, | ||||||||
| 2024 | 2023 | |||||||
| Cash provided by (used in): | ||||||||
| Operating activities | $ | (1,458 | ) | $ | 281 | |||
| Investing activities | (1,011 | ) | (956 | ) | ||||
| Financing activities | 2,343 | 144 | ||||||
| Effect of exchange rates on changes in cash and cash equivalents | (7 | ) | (35 | ) | ||||
| Net change in cash and cash equivalents | $ | (133 | ) | $ | (566 | ) | ||
Operating Activities. Cash used in operating activities was $1,458 in the first six months of 2024, compared with cash provided of $281 in the same prior-year period. Significant changes in operating assets and liabilities affecting cash flows during these periods included:
| ● | Cash provided by accounts receivable and contract assets was $1,214 in the six months ended June 30, 2024 as compared with cash usage of $3,200 in the same prior-year period. The improved cash flow in the current year was due an expected increase in cash collections due to higher sales and the timing of customer payments in the fourth quarter of 2023 as compared with the fourth quarter of 2022. | |
| ● | Cash used in inventory was $1,288 in the six months ended June 30, 2024 as compared with cash provided of $1,350 in the prior-year period. The increase in the current-year period cash usage was the result of normal timing variances of inventory purchases and timing of product shipments and increased inventory levels to support the transition of manufacturing from our Blue Earth facility to our Bemidji plant. |
| 18 |
| ● | Cash used by changes in accounts payable was $2,546 in the current-year period as compared with cash provided of $586 in the same prior-year period, primarily related to the timing of cash payments. | |
| ● | Cash provided by customer deposits was $1,385 in the six months ended June 30, 2024 as compared with cash used of $195 in the same prior-year period which is driven by timing of customer deposits received before the quarter end. |
Investing Activities. Cash used in investing activities was $408 in the first six months of 2024, compared with cash used of $956 in the same prior-year period, both primarily for capital expenditures.
Financing Activities. Cash provided by financing activities was $2,343 in the first six months of 2024, compared with cash provided of $144 in the same prior-year period. The increase in cash provided by financing activities resulted from the cash used for working capital in the six months ended June 30, 2024.
Liquidity and Capital Resources
We believe that our existing financing arrangements, anticipated cash flows from operations and cash on hand will be sufficient to satisfy our working capital needs for the next twelve months, capital expenditures and debt repayments.
Credit Facility. We had a credit agreement with Bank of America, which was entered into on June 15, 2017 and provided for a line of credit arrangement of $16,000 that was to expire on June 15, 2026.
On February 29, 2024, we replaced the asset backed line of credit agreement with a $15,000 Senior Secured Revolving Line of Credit with Bank of America (the “Revolver”). The Revolver allows for borrowings at a defined base rate, or at the one, three or six month Secured Overnight Finance Rate, also known as “SOFR”, plus a defined margin. If the Company prepays SOFR borrowings before their contractual maturity, the Company has agreed to compensate the bank for lost margin, as defined in the Revolver agreement. The Company is required to quarterly pay a 20-basis point fee on the unused portion of the Revolver.
The Revolver requires the Company to maintain no more than 2.5 times leverage ratio and at least a 1.25 times minimum fixed charges coverage ratio, both of which are defined in the Revolver agreement. The Company met the covenants for the period ended June 30, 2024. There are no subjective acceleration clauses under the Revolver that would accelerate the maturity of outstanding borrowings. The Revolver contains certain covenants which, among other things, require the Company to adhere to regular reporting requirements, abide by shareholder dividend limitations, maintain certain financial performance, and limit the amount of annual capital expenditures. The Revolver is secured by substantially all the Company’s assets and expires on February 28, 2027. We were in compliance with all the financial covenants related to this agreement as of and for the period ended June 30, 2024, except for the covenant related to operating expense contributions to our Mexican operations in excess of the amounts allowed under the Revolver. We have received a waiver of this event of default from the bank.
Under the amended Bank of America credit agreement signed February 29, 2024, the line of credit is subject to variations in the SOFR index rate. Under the prior credit agreement with Bank of America, the line of credit borrowing availability was restricted by a defined asset borrowing base, and interest was based on variations in the Bloomberg Short-Term Bank Yield (BSBY) index rate. Our line of credit bears interest at a weighted-average interest rate of 8.0% and 8.3% as of June 30, 2024 and December 31, 2023, respectively. We had borrowings on our line of credit of $8,360 and $5,846 outstanding as of June 30, 2024 and December 31, 2023, respectively. As of June 30, 2024 we had unused availability on the line of credit of $6,440.
Off-Balance Sheet Arrangements
We have not engaged in any off-balance sheet activities as defined in Item 303(a)(4) of Regulation S-K.
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Forward-Looking Statements
Those statements in the foregoing report that are not historical facts are forward-looking statements made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995.
| ♦ | Volatility in the marketplace which may affect market supply, demand of our products or currency exchange rates; | |
| ♦ | Supply chain disruption and unreliability; | |
| ♦ | Lack of supply of sufficient human resources to produce our products; | |
| ♦ | Increased competition from within the EMS industry or the decision of OEMs to cease or limit outsourcing; | |
| ♦ | Changes in the reliability and efficiency of our operating facilities or those of third parties; | |
| ♦ | Increases in certain raw material costs such as copper and oil; | |
| ♦ | Commodity and energy cost instability; | |
| ♦ | Risks related to FDA noncompliance; | |
| ♦ | The loss of a major customer; | |
| ♦ | General economic, financial and business conditions that could affect our financial condition and results of operations; | |
| ♦ | Increased or unanticipated costs related to compliance with securities and environmental regulation; | |
| ♦ | Disruption of global or local information management systems due to natural disaster or cyber-security incident; | |
| ♦ | Outbreaks of epidemic, pandemic, or contagious diseases, such as the recent novel coronavirus that affect our operations, our customers’ operations or our suppliers’ operations. |
The factors identified above are believed to be important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement made by us. Discussion of these factors is also incorporated in Part I, Item 1A, “Risk Factors,” and should be considered an integral part of Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Unpredictable or unknown factors not discussed herein could also have material adverse effects on forward-looking statements. All forward-looking statements included in this Form 10-K are expressly qualified in their entirety by the forgoing cautionary statements. We undertake no obligation to update publicly any forward-looking statement (or its associated cautionary language) whether as a result of new information or future events.
Please refer to forward-looking statements and risks as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q, our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act). These controls and procedures are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon their evaluation of these disclosure controls and procedures as of the date of the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II
ITEM 1. LEGAL PROCEEDINGS
We are subject to various legal proceedings and claims that arise in the ordinary course of business.
ITEM 1A. RISK FACTORS
We are affected by the risks specific to us as well as factors that affect all businesses operating in a global market. The significant factors known to us that could materially adversely affect our business, financial condition or operating results or could cause our actual results to differ materially from our expectations are described in our annual report on Form 10-K for the fiscal year ended under the heading “Part I – Item 1A.Risk Factors.” There have been no material changes in the risk factors from those disclosed in the Annual Report on Form 10-K for the year ended December 31, 2023.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In June 2024, the Company authorized the repurchase of $100,000 of its Common Stock. As of June 30, 2024, no Common Stock has been repurchased under this program.
ITEM 3. DEFAULTS ON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
| Exhibits | ||
| 31.1* | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended. | |
| 31.2* | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended. | |
| 32* | Certification of the Chief Executive Officer and Chief Financial Officer, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 101* | Financial statements from the quarterly report on Form 10-Q for the quarter ended June 30, 2024, formatted in XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations and Comprehensive Loss, (iii) Condensed Consolidated Statements of Cash Flows, and (iv) the Condensed Notes to Condensed Consolidated Financial Statements. | |
| 104 | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). |
*Filed herewith
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Nortech Systems Incorporated and Subsidiaries | ||
| Date: August 8, 2024 | by | /s/ Jay D. Miller |
| Jay D. Miller | ||
| Chief Executive Officer and President | ||
| Nortech Systems Incorporated | ||
| Date: August 8, 2024 | by | /s/ Andrew D. C. LaFrence |
| Andrew D. C. LaFrence | ||
| Chief Financial Officer and Senior Vice President of Finance | ||
| Nortech Systems Incorporated | ||
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