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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 September 30, 2022

 

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 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 $.01 par value common stock outstanding at November 4, 2022 was 2,690,634.

 

1
 

 

 

TABLE OF CONTENTS

 

         

PART I - FINANCIAL INFORMATION  
      PAGE
  Item 1     -     Financial Statements  
     
    Condensed Consolidated Statements of Operations and Comprehensive Income   3
       
    Condensed Consolidated Balance Sheets 4
       
    Condensed Consolidated Statements of Cash Flows 5-6
       
    Condensed Consolidated Statements of Shareholders’ Equity 7
       
    Condensed Notes to Consolidated Financial Statements   8-19
     
  Item 2     -     Management's Discussion and Analysis of Financial Condition And Results of Operations 20-26
     
  Item 3     -     Quantitative and Qualitative Disclosures About Market Risk    27
     
  Item 4     -     Controls and Procedures 27
       
PART II - OTHER INFORMATION  
     
  Item 1     -     Legal Proceedings 28
     
  Item 1A. -     Risk Factors  28
     
  Item 2     -     Unregistered Sales of Equity Securities, Use of Proceeds 28
     
  Item 3     -     Defaults on Senior Securities 28
     
  Item 4     -     Mine Safety Disclosures 28
     
  Item 5     -     Other Information  28
     
  Item 6     -     Exhibits 29
       
SIGNATURES   30

 

2
 

 

 

PART I

 

ITEM 1. FINANCIAL STATEMENTS

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES  

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(UNAUDITED)

(IN THOUSANDS, EXCEPT SHARE DATA)

 

   

THREE MONTHS ENDED

    

NINE MONTHS ENDED

  
   

SEPTEMBER 30,

    

SEPTEMBER 30,

  
   

2022

    

2021

    

2022

    

2021

  
                                 

Net Sales

   $ 35,276     $ 29,452     $ 98,505     $ 81,706  
                                 

Cost of Goods Sold

     28,948       21,411       83,129       68,519  
                                 

Gross Profit

     6,328       8,041       15,376       13,187  
                                 
Operating Expenses                                

Selling Expenses

     959       449       2,752       1,741  

General and Administrative Expenses

     2,949       2,045       8,346       7,247  

Research and Development Expenses

     475       141       1,154       348  

Restructuring Charges

     -       23       -       319  

Loss on Abandonment of Intangible Assets

     -       560       -       560  

Gain on Sale of Assets

     -       (93 )     (15 )     (176 )
                                 

Total Operating Expenses

     4,383       3,125       12,237       10,039  
                                 

Income From Operations

     1,945       4,916       3,139       3,148  
                                 
Other Expense                                

Interest Expense

     (122 )     (112 )     (337 )     (314 )
                                 

Income Before Income Taxes

     1,823       4,804       2,802       2,834  
                                 

Income Tax Expense

     289       1,247       411       646  
                                 

Net Income

   $ 1,534     $ 3,557     $ 2,391     $ 2,188  
                                 
Net Income Per Common Share:                                
                                 

Basic (in dollars per share)

   $ 0.57     $ 1.33     $ 0.89     $ 0.82  

Weighted Average Number of Common Shares Outstanding - Basic (in shares)

     2,686,884       2,665,682       2,683,594       2,662,066  
                                 

Diluted (in dollars per share)

   $ 0.53     $ 1.24     $ 0.83     $ 0.78  

Weighted Average Number of Common Shares Outstanding - Diluted (in shares)

     2,899,526       2,880,073       2,886,073       2,806,958  
                                 
Other comprehensive income                                

Foreign currency translation

     (365 )     (5 )     (604 )     20  

Comprehensive income, net of tax

   $ 1,169     $ 3,552     $ 1,787     $ 2,208  

 

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

 

3
 

 

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS 

(IN THOUSANDS, EXCEPT SHARE DATA)

 

   

SEPTEMBER 30,

    

DECEMBER 31,

  
   

2022

       2021(1)  

 

  

(Unaudited)

          
ASSETS              
Current Assets                

Cash

   $ 1,300     $ 643  

Restricted Cash

     792       1,582  

Accounts Receivable, less allowances of $257 and $328

     15,497       14,548  

Employee Retention Credit Receivable

     5,209       5,209  

Inventories, Net

     23,610       19,434  

Contract Assets

     9,886       8,698  

Prepaid Expenses and Other Current Assets

     1,851       1,660  

Total Current Assets

     58,145       51,774  
                 

Property and Equipment, Net

     6,457       5,833  

Operating Lease Assets

     8,079       8,983  

Other Intangible Assets, Net

     433       501  

Total Assets

   $ 73,114     $ 67,091  
                 

LIABILITIES AND SHAREHOLDERS' EQUITY

                
Current Liabilities                

Current Portion of Finance Lease Obligations

   $ 390     $ 601  

Current Portion of Operating Lease Obligations

     1,113       1,043  

Accounts Payable

     14,701       12,710  

Accrued Payroll and Commissions

     5,116       4,045  

Customer Deposits

     3,870       2,936  

Other Accrued Liabilities

     1,380       971  

Total Current Liabilities

     26,570       22,306  
                 
Long-Term Liabilities                

Long Term Line of Credit

     9,826       8,959  

Long Term Finance Lease Obligations, Net

     639       916  

Long-Term Operating Lease Obligations, Net

     7,797       8,695  

Other Long-Term Liabilities

     99       104  

Total Long-Term Liabilities

     18,361       18,674  

Total Liabilities

     44,931       40,980  
                 
Commitments and Contingencies                
                 
Shareholders' Equity                

Preferred Stock, $1 par value; 1,000,000 Shares Authorized: 250,000 Shares Issued and Outstanding

     250       250  

Common Stock - $0.01 par value; 9,000,000 Shares Authorized: 2,683,513 and 2,672,064 Shares Issued and Outstanding, respectively

     27       27  

Additional Paid-In Capital

     16,247       15,962  

Accumulated Other Comprehensive (Income) Loss

     (548 )     56  

Retained Earnings

     12,207       9,816  

Total Shareholders' Equity

     28,183       26,111  

Total Liabilities and Shareholders' Equity

   $ 73,114     $ 67,091  

 

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

(1) The condensed consolidated balance sheet at December 31, 2021 has been derived from the audited financial statements at that date

 

4
 

 

 

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN THOUSANDS)

 

   

NINE MONTHS ENDED

  
   

SEPTEMBER 30,

  
   

2022

    

2021

  
CASH FLOWS FROM OPERATING ACTIVITIES                

Net Income

   $ 2,391     $ 2,188  
Adjustments to Reconcile Net Income to Net Cash                

Provided By (Used In) Operating Activities:

                

Depreciation and Amortization

     1,440       1,506  

Compensation on Stock-Based Awards

     234       201  

Change in Accounts Receivable Allowance

     (71 )     18  

Change in Inventory Reserves

     (54 )     (959 )

Loss on Abandonment of Intangible Asset

     -       560  

Gain on Disposal of Property and Equipment

     (15 )     (176 )
Changes in Current Operating Items                

Accounts Receivable

     (1,115 )     1,686  

Employee Retention Credit Receivable

     -       (5,209 )

Inventories

     (4,402 )     (5,755 )

Contract Assets

     (1,188 )     (2,246 )

Prepaid Expenses and other Curent Assets

     (213 )     (276 )

Income Taxes

     (67 )     708  

Accounts Payable

     1,659       2,901  

Accrued Payroll and Commissions

     1,071       1,537  

Other Accrued Liabilities

     1,330       464  

Net Cash Provided By (Used In) Operating Activities

     1,000       (2,852 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES                

Proceeds from Sale of Property and Equipment

     15       626  

Purchase of Intangible Asset

     (43 )     (49 )

Purchases of Property and Equipment

     (1,687 )     (1,198 )

Net Cash Used In Investing Activities

     (1,715 )     (621 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES                

Net Change in Line of Credit

     857       2,681  

Principal Payments on Long-Term Debt

     -       (873 )

Principal Payments on Financing Leases

     (336 )     (492 )

Debt Issuance Costs

     10       -  

Stock Option Excercises

     51       36  

Net Cash Provided By Financing Activities

     582       1,352  
                 

Net Change in Cash and Cash Equivalents

     (133 )     (2,121 )

Cash and Cash Equivalents - Beginning of Period

     2,225       3,564  

Cash and Cash Equivalents - End of Period

   $ 2,092     $ 1,443  
                 
Reconciliation of cash and restricted cash reported within the consolidated balance sheets                

Cash

   $ 1,300     $ 444  

Restricted Cash

     792       999  

Total Cash and restricted cash reported in the consolidated statements of cash flows

   $ 2,092     $ 1,443  

 

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

 

5
 

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN THOUSANDS)

 

   

NINE MONTHS ENDED

  
   

SEPTEMBER 30,

  
   

2022

    

2021

  

Supplemental Disclosure of Cash Flow Information:

                

Cash Paid During the Period for Interest

   $ 328     $ 220  

Cash Paid (Refunded) During the Period for Income Taxes

     122       (114 )
                 

Supplemental Noncash Investing and Financing Activities:

                

Property and Equipment Purchases in Accounts Payable

     332       -  

Property Acquired Under Operating Lease

     -       858  

 

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              
    Preferred     Common     Paid-In     Comprehensive     Retained     Total Shareholders'  
    Stock     Stock     Capital     Loss     Earnings     Equity  
                                                 

BALANCE JUNE 30, 2021

   $ 250     $ 27     $ 15,862     $ (12 )   $ 1,293     $ 17,420  

Net Income

     -       -       -       -       3,557       3,557  

Foreign currency translation adjustment

     -       -       -       (5 )     -       (5 )

Stock option exercises

     -       -       36       -       -       36  

Compensation on stock-based awards

     -       -       28       -       -       28  
                                                 

BALANCE SEPTEMBER 30, 2021

   $ 250     $ 27     $ 15,926     $ (17 )   $ 4,850     $ 21,036  
                                                 

BALANCE DECEMBER 31, 2020

   $ 250     $ 27     $ 15,816     $ (37 )   $ 2,662     $ 18,718  

Net Income

     -       -       -       -       2,188       2,188  

Foreign currency translation adjustment

     -       -       -       20       -       20  

Stock option exercises

     -       -       36       -       -       36  

Compensation on stock-based awards

     -       -       74       -       -       74  
                                                 

BALANCE SEPTEMBER 30, 2021

   $ 250     $ 27     $ 15,926     $ (17 )   $ 4,850     $ 21,036  
                                                 

BALANCE JUNE 30, 2022

   $ 250     $ 27     $ 16,136     $ (183 )   $ 10,673     $ 26,903  

Net Income

     -       -       -       -       1,534       1,534  

Foreign currency translation adjustment

     -       -       -       (365 )     -       (365 )

Stock option exercises

     -       -       18       -       -       18  

Compensation on stock-based awards

     -       -       93       -       -       93  
                                                 

BALANCE SEPTEMBER 30, 2022

   $ 250     $ 27     $ 16,247     $ (548 )   $ 12,207     $ 28,183  
                                                 

BALANCE DECEMBER 31, 2021

   $ 250     $ 27     $ 15,962     $ 56     $ 9,816     $ 26,111  

Net Income

     -       -       -       -       2,391       2,391  

Foreign currency translation adjustment

     -       -       -       (604 )     -       (604 )

Stock option exercises

     -       -       51       -       -       51  

Compensation on stock-based awards

     -       -       234       -       -       234  
                                                 

BALANCE SEPTEMBER 30, 2022

   $ 250     $ 27     $ 16,247     $ (548 )   $ 12,207     $ 28,183  

 

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

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, they do not include all of the financial information and footnotes required by GAAP for complete financial statements, although we believe the disclosures are adequate to make the information presented not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2021. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year or for any other interim period. In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In preparing these condensed consolidated financial statements, we have made our best estimates and judgments of certain amounts included in the condensed consolidated financial statements, giving due consideration to materiality. Changes in the estimates and assumptions used by us could have a significant impact on our financial results, since actual results could differ from those estimates.

 

Principles of Consolidation

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.

 

Revenue Recognition

Our revenue is comprised of product, engineering services and repair services. All revenue is recognized when the Company satisfies its performance obligation(s) under the contract by transferring the promised product or service to our customer either when (or as) our customer obtains control of the product or service, with the majority of our revenue being recognized over time including goods produced under contract manufacturing agreements and services revenue. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. A contract’s transaction price is allocated to each distinct performance obligation. The majority of our contracts have a single performance obligation. Revenue is recorded net of returns, allowances and customer discounts. Our net sales for services were less than 10% of our total sales for all periods presented, and accordingly, are included in net sales in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). Sales, value add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenues) basis. Shipping and handling costs charged to our customers are included in net sales, while the corresponding shipping expenses are included in cost of goods sold. Customer deposits represent cash received in advance of revenue earned.

 

8
 

 

Stock-Based Awards

 

Stock Options

In May 2017, the shareholders approved the 2017 Stock Incentive Plan which authorized the issuance of 350,000 shares. An additional 50,000 and 175,000 shares were authorized by the shareholders in March 2020 and May 2022, respectively.

 

We granted 0 and 21,000 market condition options to our Chief Executive Officer during the three and nine months ended September 30, 2022, respectively. The market condition options vest if certain stock prices are exceeded between February 27, 2024 and February 27, 2028. We granted 3,000 and 69,000 service-based options during the three and nine months ended September 30, 2022, respectively. Total option grants for the three and nine months ended September 30, 2022 were 3,000 and 90,000, respectively. There were 27,000 stock options granted during the nine months ended September 30, 2021.

 

Total compensation expense related to stock options was $62 and $168 for the three and nine months ended September 30, 2022, respectively. Total compensation expense related to stock options was $28 and $74 for the three and nine months ended September 30, 2021, respectively. As of September 30, 2022, there was $810 of unrecognized compensation which will vest over the next 3.86 years.

 

Following is the status of all stock options as of September 30, 2022:

 

   

Shares

    

Weighted-

Average

Exercise Price

Per Share

    

Weighted-

Average

Remaining

Contractual

Term

(in years)

    

Aggregate

Intrinsic Value

(in thousands)

  

Outstanding - January 1, 2022

     387,500     $ 4.57                  

Granted

     90,000       11.13                  

Exercised

     (19,800 )     3.40                  

Cancelled

     (8,000 )     3.38                  

Outstanding - September 30, 2022

     449,700     $ 5.93       7.10     $ 2,137  

Exercisable - September 30, 2022

     213,500     $ 3.95       5.90     $ 1,407  

 

Restricted Stock Units

During the three and nine months ended September 30, 2022, we granted 0 and 21,000 restricted stock units (“RSUs”), respectively, under our 2017 Stock Incentive Plan to non-employee directors which vest over two years. There were no RSUs outstanding prior to the nine months ended September 30, 2022. Total compensation expense related to the RSUs were $31 and $66 for the three and nine months ended September 30, 2022, respectively. There was no compensation expense related to RSUs for the three and nine months ended September 30, 2021. Total unrecognized compensation expense related to the RSUs was $186, which will vest over the next 1.49 years. The RSUs granted in the nine months ended September 30, 2022 had an average grant price of $12.00 per share with a weighted average remaining contractual term of 9.48 years. No RSUs vested during the nine months ended September 30, 2022.

 

9
 

 

Equity Appreciation Rights Plan

In November 2010, the Board of Directors adopted the Nortech Systems Incorporated Equity Appreciation Rights Plan (“2010 Plan”). The total number of Equity Appreciation Right Units (“Units”) that can be issued under the 2010 Plan shall not exceed an aggregate of 1,000,000 Units as amended and restated on March 11, 2015. There were no units granted during the nine months ended September 30, 2022 or September 30, 2021.

 

The 100,000 units outstanding at December 31, 2021 were paid on March 29, 2022. There are no units outstanding as of September 30, 2022. Total compensation expense related to the vested outstanding Units based on the estimated appreciation over their remaining terms was $13 and $127 for the three and nine months ended September 30, 2021, respectively.

 

Net Income per Common Share

Basic net income per common share is computed by dividing net income by the weighted-average number of common shares outstanding. Diluted net income per common share assumes the exercise and issuance of all potential common stock equivalents in computing the weighted-average number of common shares outstanding, unless their effect is antidilutive. All stock options and restricted stock units, while outstanding, are considered common stock equivalents.

 

For the three and nine months ended September 30, 2022, stock options of 212,643 and 202,479, respectively were included in the computation of diluted net income per common share as their impact were dilutive. For the three and nine months ended September 30, 2021, stock options of 214,391 and 144,892, respectively, were included in the computation of diluted income per common share amount as their impact were dilutive.

 

We had outstanding stock options totaling 34,211 that are not considered in the computation of diluted net income per share as their effect would have been anti-dilutive for the three months ended September 30, 2022. We had average outstanding stock options totaling 44,070 that are not considered in the computation of diluted net income per share as their effect would have been anti-dilutive for the nine months ended September 30, 2022. Outstanding stock options totaling 0 and 221 are not considered in the computation of diluted net income per share for the three and nine months ended September 30, 2021, respectively.

 

Restricted Cash

Cash and cash equivalents classified as restricted cash on our consolidated balance sheets are restricted as to withdrawal or use under the terms of certain contractual agreements. As of September 30, 2022, we had outstanding letters of credit for $400. Restricted cash as of September 30, 2022 was $792, which includes lockbox deposits that are temporarily restricted due to timing at the period end. The lockbox deposits are applied against our line of credit the next business day.

 

Accounts Receivable and Allowance for Doubtful Accounts

Credit is extended based upon an evaluation of the customer’s financial condition and, while collateral is not required, the Company periodically receives surety bonds that guarantee payment. Credit terms are consistent with industry standards and practices. Trade accounts receivable have been reduced by an allowance for doubtful accounts of $257 at September 30, 2022 and $328 at December 31, 2021.

 

10
 

 

Inventories

Inventories are stated at the lower of average cost (which approximates first-in, first out) or net realizable value. Costs include material, labor, and overhead required in the warehousing and production of our products. Inventory reserves are maintained for the estimated value of the inventories that may have a lower value than stated or quantities in excess of future production needs.

 

Inventories are as follows:

 

   

September 30,

    

December 31,

  
   

2022

    

2021

  

Raw Materials

   $ 22,520     $ 18,492  

Work in Process

     1,719       1,678  

Finished Goods

     615       562  

Reserves

     (1,244 )     (1,298 )
                 

Total

   $ 23,610     $ 19,434  

 

Other Intangible Assets

Other intangible assets at September 30, 2022 and December 31, 2021 are as follows:

 

   

Customer

Relationships

    

Trade

Names

    

Patents

    

Total

  

Balance at January 1, 2021

   $ 507     $ 589     $ 77     $ 1,173  

Additions

     -       -       64       64  

Amortization

     147       29       -       176  

Abandonment Loss

     -       560       -       560  

Balance at December 31, 2021

     360       -       141       501  

Additions

     -       -       43       43  

Amortization

     108       -       3       111  

Balance at September 30, 2022

   $ 252     $ -     $ 181     $ 433  

 

Intangible assets are amortized on a straight-line basis over their estimated useful lives. The weighted-average remaining amortization period of our in-use intangible asset is 2.1 years. In-process patents are not amortized until the patent is received. At September 30, 2022, patents totaling $96 had been received while $85 of patents were in-process.

 

Amortization expense of finite life intangible assets for the three and nine months ended September 30, 2022 was $40 and $111, respectively. Amortization expense for the three and nine months ended September 30, 2021 was $45 and $139, respectively.

 

11
 

 

Estimated future annual amortization expense (not including patents in process) related to these assets is approximately as follows:

 

Year

  

Amount

  

Remainder of 2022

   $ 40  

2023

     159  

2024

     86  

2025

     14  

Thereafter

     49  

Total

   $ 348  

 

Accounting Pronouncements Issued But Not Yet Adopted

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. This guidance introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The ASU also provides updated guidance regarding the impairment of available-for-sale debt securities and includes additional disclosure requirements. The new guidance is effective for public business entities that meet the definition of a Smaller Reporting Company as defined by the SEC for interim and annual periods beginning after December 15, 2022. Early adoption is permitted. We are currently evaluating the impact of this standard on our consolidated financial statements and related disclosures.

 

 

 

NOTE 2. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS

 

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and accounts receivable. 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. Of the $2,092 in cash and restricted cash at September 30, 2022, approximately $561 and $11 was held at banks located in China and Mexico, respectively. We grant credit to customers in the normal course of business and 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 total accounts receivable. One customer accounted for 28% and 26% of net sales for the three and nine months ended September 30, 2022, respectively. For the three months ended September 30, 2021, two customers accounted for 36% of net sales. For the nine months ended September 30, 2021, one customer accounted for 26% of net sales.

 

At September 30, 2022, two customers represented approximately 43% of our total accounts receivable. At December 31, 2021, one customer represented approximately 19% of our total accounts receivable.

 

Export sales represented approximately 4% of net sales for both the three and nine months ended September 30, 2022. Export sales represented approximately 3% of net sales for the three and nine months ended September 30, 2021 respectively.

 

12
 

 

 

NOTE 3. REVENUE

 

Revenue recognition

Our revenue is comprised of product, engineering services and repair services. All revenue is recognized when the Company satisfies its performance obligation(s) under the contract by transferring the promised product or service to our customer either when (or as) our customer obtains control of the product or service, with the majority of our revenue being recognized over time including goods produced under contract manufacturing agreements and services revenue. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. A contract’s transaction price is allocated to each distinct performance obligation. The majority of our contracts have a single performance obligation, as the promise to transfer products or services is not separately identifiable from other promises in the contract and, therefore, not distinct.

 

Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or providing services. As such, revenue is recorded net of returns, allowances and customer discounts. Sales, value add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenues) basis. Shipping and handling costs are included in cost of goods sold.

 

The majority of our revenue is derived from the transfer of goods produced under contract manufacturing agreements which have no alternative use and we have an enforceable right to payment for our performance completed to date. Our performance obligations within our contract manufacturing agreements are generally satisfied over time as the goods are produced based on customer specifications and we have an enforceable right to payment for the goods produced. If these requirements are not met, the revenue is recognized at a point in time, generally upon shipment. Revenue under contract manufacturing agreements that was recognized over time accounted for approximately 74% of our revenue for both the three and nine months ended September 30, 2022 and 82% and 80% of our revenue for the three and nine months ended September 30, 2021, respectively. Revenues under these agreements are generally recognized over time using an input measure based upon the proportion of actual costs incurred.

 

Accounting for contract manufacturing agreements involves the use of various techniques to estimate total revenue and costs. We estimate profit on these agreements as the difference between total estimated revenue and expected costs to complete the performance obligation within the terms of the agreement and recognize the respective profit as the goods are produced. The estimates to determine the profit earned on the performance obligation are based on anticipated selling prices and historical cost of goods sold and represent our best judgement at the time. Changes in judgements on these above estimates could impact the timing and amount of revenue recognized with a resulting impact on the timing and amount of associated profit.

 

On occasion our customers provide materials to be used in the manufacturing process and the fair value of the materials is included in revenue as noncash consideration at the point in time when the manufacturing process commences along with the same corresponding amount recorded as cost of goods sold. The inclusion of noncash consideration has no impact on overall profitability.

 

13
 

 

Contract Assets

Contract assets, recorded as such in the Condensed Consolidated Balance Sheets, consist of unbilled amounts related to revenue recognized over time. Significant changes in the contract assets balance during the nine months ended September 30, 2022 was as follows (in thousands):

 

Balance outstanding at December 31, 2021

   $ 8,698  

Increase (decrease) attributed to:

        

Amounts transferred over time to contract assets

     72,536  

Amounts invoiced during the period

     (71,348 )

Balance outstanding at September 30, 2022

   $ 9,886  

 

We expect substantially all the remaining performance obligations for the contract assets recorded as of September 30, 2022 to be transferred to receivables within 90 days, with the majority of 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 timing of transfer of goods and services by market:

 

   

Three Months Ended September 30, 2022

  
   

Product/ Service

Transferred Over

Time

    

Product

Transferred at

Point in Time

    

Noncash

Consideration

    

Total Net Sales by

Market

  

Medical

   $ 14,753     $ 5,366     $ 420     $ 20,539  

Industrial

     8,104       2,314       420       10,838  

Aerospace and Defense

     3,202       493       204       3,899  

Total net sales

   $ 26,059     $ 8,173     $ 1,044     $ 35,276  

 

 

   

Nine Months Ended September 30, 2022

  
   

Product/ Service

Transferred Over

Time

    

Product

Transferred at

Point in Time

    

Noncash

Consideration

    

Total Net Sales by

Market

  

Medical

   $ 37,725     $ 15,044     $ 1,574     $ 54,343  

Industrial

     21,563       6,301       1,095       28,959  

Aerospace and Defense

     13,248       1,254       701       15,203  

Total net sales

   $ 72,536     $ 22,599     $ 3,370     $ 98,505  

 

14
 

 

   

Three Months Ended September 30, 2021

  
   

Product/ Service

Transferred Over

Time

    

Product

Transferred at

Point in Time

    

Noncash

Consideration

    

Total Net Sales by

Market

  

Medical

   $ 13,762     $ 2,933     $ 282     $ 16,977  

Industrial

     7,468       1,757       158       9,383  

Aerospace and Defense

     2,883       144       65       3,092  

Total net sales

   $ 24,113     $ 4,834     $ 505     $ 29,452  

 

 

   

Nine Months Ended September 30, 2021

  
   

Product/ Service

Transferred Over

Time

    

Product

Transferred at

Point in Time

    

Noncash

Consideration

    

Total Net Sales by

Market

    

Medical

   $ 35,497     $ 8,876     $ 1,017     $ 45,390  

Industrial

     20,385       4,832       560       25,777  

Aerospace and Defense

     9,685       527       327       10,539  

Total net sales

   $ 65,567     $ 14,235     $ 1,904     $ 81,706  

 

 

 

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 4.1% and 3.5% as of September 30, 2022 and December 31, 2021, respectively. We had borrowings on our line of credit of $9,873 and $9,016 as of September 30, 2022 and December 31, 2021, respectively. There are no subjective acceleration clauses under the credit agreement that would accelerate the maturity of our outstanding borrowings. The line of credit is shown net of debt issuance costs of $48 and $58 on the consolidated balance sheet for the periods ended September 30, 2022 and December 31, 2021, respectively.

 

The line of credit with Bank of America contains 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 ended at each Fiscal Quarter end subject only during a trigger period commencing when our availability under our line is less than $2,000 until availability is above that amount for 30 days. As of September 30, 2022 the Company was in compliance with its covenants.

 

At September 30, 2022, we had unused availability under our line of credit of $5,827 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. In the third quarter of 2022, we amended our credit agreement to extend the inclusion of the Employee Retention Credit Receivable through December 31, 2022.

 

15
 

 

 

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 September 30, 2022, we do not have material lease commitments that have not commenced.

 

The components of lease expense were as follows:

 

 

   

Three Months Ended

September 30,

    

Three Months Ended

September 30,

  

Lease Cost

  

2022

    

2021

  

Operating lease cost

   $ 572     $ 576  
                 

Finance lease interest cost

     14       18  
                 

Finance lease amortization expense

     182       163  
                 

Total lease cost

   $ 768     $ 757  

 

 

   

Nine Months Ended

September 30,

    

Nine Months ended

September 30,

  

Lease Cost

  

2022

    

2021

  

Operating lease cost

   $ 1,731     $ 1,696  
                 

Finance lease interest cost

     50       61  
                 

Finance lease amortization expense

     547       489  
                 

Total lease cost

   $ 2,328     $ 2,246  

 

 

Supplemental balance sheet information related to leases was as follows:

 

Balance Sheet Location

  

September 30, 2022

    

December 31, 2021

  

Assets

                  

Operating lease assets

Operating lease assets

   $ 8,079     $ 8,983  

Finance lease assets

Property, plant and equipment

     1,505       2,052  
                 

Total leased assets

   $ 9,584     $ 11,035  

 

16
 

 

Supplemental cash flow information related to leases was as follows:

 

   

September 30,

    

September 30,

  
   

2022

    

2021

  

Operating leases

                

Cash paid for amounts included in the measurement of lease liabilities

   $ 1,279     $ 861  

Right-of-use assets obtained in exchange for lease obligations

   $ -     $ 858  

 

Maturities of lease liabilities were as follows:

 

   

Operating

Leases

    

Finance Leases

    

Total

  

Remaining 2022

   $ 430     $ 126     $ 556  

2023

     1,765       409       2,175  

2024

     1,505       357       1,861  

2025

     1,255       103       1,358  

2026

     1,217       108       1,332  

Thereafter

     7,066       -       7,066  

Total lease payments

   $ 13,238     $ 1,103     $ 14,341  

Less: Interest

     (4,328

)

     (74 )     (4,402

)

Present value of lease liabilities

   $ 8,910     $ 1,029     $ 9,939  

 

The lease term and discount rate at September 30, 2022 were as follows:

 

Weighted-average remaining lease term (years)

        

Operating leases

     9.1  

Finance leases

     2.8  

Weighted-average discount rate

        

Operating leases

     7.7

%

Finance leases

     5.2

%

 

17
 

 

 

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 and nine months ended September 30, 2022 was 16% and 15%, respectively. The effective tax rate for the three and nine months ended September 30, 2021 was 26% and 23%, respectively. The primary drivers of the change in effective tax rate are due to a change in the federal valuation allowance, a discrete item of non-qualified options exercised over book value, and the amount due from the IRS exam conclusion.

 

 

NOTE 7. RESTRUCTURING CHARGES

 

During the first nine months of 2021, we recorded restructuring charges of $319 related to the consolidation of our production facilities and closure of our Merrifield, Minnesota facility. We recognized a gain on the sale of assets related to the restructure of $93 and $176 for the three and nine months ended September 30, 2021, respectively. There were no restructuring charges or amounts accrued in the nine months ended September 30, 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.

 

At September 30, 2022 and December 31, 2021, the Company has ERC benefits of $5,209 within Employee Retention Credits Receivable on the condensed consolidated balance sheet.

 

18
 

 

 

NOTE 9. 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 March 1, 2021. In the three and nine months ended September 30, 2022, Abilitech paid the Company $0 and $217, respectively, for delivery of medical products. In the three and nine months ended September 30, 2021, Abilitech paid the Company $316 and $1,056, respectively for the delivery of medical products. 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%) 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. Under the terms of the BIRD Foundation grant, the Company and Marpe Technologies are to 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 will meet its obligation by providing certain services at cost or no cost to Marpe Technologies. The total value of the contribution will not exceed $500; the Company has contributed $226 as of September 30, 2022. 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 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 recoup the value of services provided to Marpe for which is not fully paid. 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 nine months ended September 30, 2022, we recognized revenue of $66 and $182. During both the three and nine months ended September 30, 2021, we recognized revenue of $78. 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.

 

19
 

 

 

ITEM 2. MANAGEMENT’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 nine months of 2022, primarily 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.

 

20
 

 

Results of Operations

 

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

 

   

Three Months Ended

    

Nine Months Ended

  
   

September 30,

    

September 30,

  
   

2022

    

2021

    

2022

    

2021

  

Net Sales

     100.0

%

     100.0

%

     100.0

%

     100.0  

Cost of Goods Sold

     82.1       72.7       84.4       83.9  

Gross Profit

     17.9       27.3       15.6       16.1  
                                 

Selling Expenses

     2.7       1.5       2.8       2.1  

General and Administrative Expenses

     8.4       6.9       8.5       8.9  

R&D Expenses

     1.3       0.5       1.2       0.4  

Restructuring Charges

     -       0.1       -       0.4  

Gain on Sale of Property and Equipment

     -       (0.3 )     -       (0.2 )

Income from Operations

     5.5       18.6       3.1       4.5  
                                 

Interest Expense

     (0.3 )     (0.4 )     (0.3 )     (0.4 )

Income Before Income Taxes

     5.2       18.2       2.8       4.2  
                                 

Income Tax Expense

     0.8       4.2       0.4       0.8  

Net Income

     4.4

%

     14.0

%

     2.4

%

     3.4

%

 

 

Net Sales

 

Net sales for the three months ended September 30, 2022 and 2021 were $35.3 and $29.5 million, respectively, an increase of $5.8 million or 19.7%. Net sales for the nine months ended September 30, 2022 and 2021 were $98.5 million and $81.7 million, respectively, an increase of $16.8 million or 20.6%. The three and nine month increases were driven by increased demand 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 EMS industry markets for the three and nine months ended September 30, 2022 and 2021 were as follows (in millions):

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2022

    

2021

    

% Change

    

2022

    

2021

    

% Change

  

Medical

   $ 20.5     $ 17.0       20.6     $ 54.3     $ 45.4       19.6  

Industrial

     10.9       9.4       16.0       29.0       25.8       12.4  

Aerospace and Defense

     3.9       3.1       25.8       15.2       10.5       44.8  

Total Net Sales

   $ 35.3     $ 29.5       19.7     $ 98.5     $ 81.7       20.6  

 

21
 

 

Backlog

 

Our 90-day order backlog as of September 30, 2022 was $36.9 million, a 2.8% increase from the beginning of the quarter and a 5.1% decrease from September 30, 2021. Our 90-day backlog consists of firm purchase orders we expect to ship in the next 90 days, with any remaining amounts to be transferred within 180 days.

 

Our 90-day order backlog by market has remained relatively constant when compared to the prior quarter end and 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):

 

   

90 Day Backlog as of the Period Ended

  
   

September 30

    

June 30

    

September 30

  
   

2022

    

2022

    

2021

  

Medical

   $ 22.8     $ 20.9     $ 19.7  

Industrial

     8.3       9.8       10.6  

Aerospace and Defense

     5.8       5.2       8.6  

Total 90-Day Backlog

   $ 36.9     $ 35.9     $ 38.9  

 

 

Our total order backlog as of September 30, 2022 was $103.3 million, a 2.7% decrease from the beginning of the quarter and a 31.4% increase from September 30, 2021. Our total backlog remains strong as our biggest customers are placing orders into the future to secure supply of critical components, in particular for those with long lead times.

 

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

 

   

Total Backlog as of the Period Ended

  
   

September 30

    

June 30

    

September 30

  
   

2022

    

2022

    

2021

  

Medical

   $ 58.4     $ 63.7     $ 37.3  

Industrial

     22.8       22.6       17.8  

Aerospace and Defense

     22.1       19.9       23.5  

Total Backlog

   $ 103.3     $ 106.2     $ 78.6  

 

 

The 90-day and total backlog at September 30, 2022 contain the contract asset value of $9.9 million which has been recognized as revenue.

 

22
 

 

Gross Profit

 

Gross profit as a percent of net sales was 17.9% and 27.3% for the three months ended September 30, 2022 and 2021, respectively. Gross profit as a percent of net sales was 15.6% and 16.1% for the nine months ended September 30, 2022 and 2021, respectively. The decrease in gross profit as a percent of net sales for the three and nine months ended September 30, 2022 compared to the same periods in 2021 is primarily due to the $4.7 million reduction in payroll and medical expenses related to the ERC in 2021, partially offset by price increases in response to material and labor cost inflation and higher production volume which increased plant utilization.

 

Selling Expense

 

Selling expenses for the three months ended September 30, 2022 and 2021 were $1.0 million or 2.7% of sales and $0.4 million or 1.5% of sales, respectively. Selling expenses for the nine months ended September 30, 2022 and 2021 were $2.8 million or 2.8% of sales and $1.7 million or 2.1% of sales, respectively. Selling expense for the three and nine months ended September 30, 2021 includes a $0.1 million reduction in payroll and medical expenses related to the ERC. The increase in selling expense for the three and nine months ended September 30, 2022 compared to the same periods of the prior year relates to an increase in sales engineering expenses to support the increased sales.

 

General and Administrative Expense

 

General and administrative expenses for the three months ended September 30, 2022 and 2021 were $2.9 million or 8.4% of sales and $2.0 million or 6.9% of sales, respectively. General and administrative expenses for the nine months ended September 30, 2022 and 2021 were $8.3 million or 8.5% of sales and $7.2 million or 8.9% of sales, respectively. General and administrative expenses for the three and nine months ended September 30, 2021 includes a $0.4 million reduction in payroll and medical expenses related to the ERC. General and administrative expenses for the three and nine months ended September 30, 2022 were otherwise held relatively flat compared to the same periods of the prior year, and are generally fixed in nature.

 

Restructuring Charges

 

Restructuring charges for the three and nine months ended September 30, 2021 were $23 thousand and $0.3 million, respectively. There were no restructuring charges for the three and nine months ended September 30, 2022. The restructuring charges relate to the closure of the Merrifield facility during 2021.

 

Research and Development Expense

 

Research and development expenses were $0.5 million or 1.3% of net sales for the three months ended September 30, 2022 and $1.2 million or 1.2% of net sales for the nine months ended September 30, 2022. Research and development expenses for the three and nine months ended September 30, 2021 were $0.1 and $0.3 million, respectively.

 

23
 

 

Income From Operations

 

Income from operations for the three months ended September 30, 2022 was $1.9 million compared to $4.9 million for the three months ended September 30, 2021. Income from operations for both the nine months ended September 30, 2022 and 2021 was $3.1 million. The decrease in income from operations for the three months ended September 30, 2022 compared to the same period in 2021 is primarily due to the $5.2 million reduction in payroll and medical expenses related to the ERC in 2021, partially offset by the increased gross profit in 2022.

 

Interest Expense

 

Interest expense was $0.1 million for both the three months ended September 30, 2022 and 2021. Interest expense was $0.3 million for both the nine months ended September 30, 2022 and 2021.

 

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 and nine months ended September 30, 2022 was 16% and 15%, respectively. The effective tax rate for the three and nine months ended September 30, 2021 was 26% and 23%, respectively. The primary drivers of the change in effective tax rate are a release in valuation allowance, a discrete item of non-qualified options exercised over book value, and the amount due from the IRS exam conclusion.

 

Net Income

 

Net income for the three months ended September 30, 2022 was $1.5 million or $0.57 per basic common share and $0.53 per diluted common share. Net income for the three months ended September 30, 2021 was $3.6 million or $1.33 per basic common share and $1.24 per diluted common share. The decrease in net income for the three months ended September 30, 2022 compared to the same period in 2021 is primarily due to the $5.2 million reduction in payroll and medical expenses related to the ERC in 2021, partially offset by the increased gross profit in 2022. Net income for the nine months ended September 30, 2022 was $2.4 million or $0.89 per basic common share and $0.83 per diluted common share. Net income for the nine months ended September 30, 2021 was $2.2 million or $0.82 per basic common share and $0.78 per diluted common share.

 

Liquidity and Capital Resources

 

We believe that our existing financing arrangements, anticipated cash flows from operations, funds expected to be received for the ERC and cash on hand will be sufficient to satisfy our working capital needs for the next twelve months, capital expenditures and debt repayments.

 

24
 

 

Credit Facility

 

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 $16.0 million 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 4.1% and 3.5% as of September 30, 2022 and December 31, 2021, respectively. We had borrowings on our line of credit of $9.9 million and $9.0 million outstanding as of September 30, 2022 and December 31, 2021, respectively. There are no subjective acceleration clauses under the credit agreement that would accelerate the maturity of our outstanding borrowings. The line of credit is shown net of debt issuance costs of $48 thousand and $58 thousand on the consolidated balance sheet for the periods ended September 30, 2022 and December 31, 2021, respectively.

 

The line of credit with Bank of America contains 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 ended at each Fiscal Quarter end subject only during a trigger period commencing when our availability under our line is less than $2.0 million until availability is above that amount for 30 days. As of September 30, 2022 the Company was in compliance with its covenants.

 

At September 30, 2022, we had unused availability under our line of credit of $5.8 million 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. In the third quarter of 2022, we amended our credit agreement to extend the inclusion of the Employee Retention Credit Receivable through December 31, 2022.

 

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.

 

Critical Accounting Policies and Estimates

 

Our significant accounting policies and estimates are summarized in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2021. Some of our accounting policies require us to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. Such judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, known trends in our industry, terms of existing contracts and other information from outside sources, as appropriate. Actual results could differ from these estimates.

 

25
 

 

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, labor rates 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” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. Unpredictable or unknown factors not discussed herein could also have material adverse effects on forward-looking statements. All forward-looking statements included or incorporated into this Form 10-Q are expressly qualified in their entirety by the forgoing cautionary statements. We undertake no obligations 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, 2021.

 

26
 

 

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.

 

27
 

 

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, 2021.

 

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

As of September 30, 2022, our share repurchase program has expired, and no additional amounts are available for repurchase.

 

 

ITEM 3. DEFAULTS ON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

28
 

 

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 September 30, 2022, formatted in Inline 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).

 

 

105*

Eighth Amendment dated September 1, 2022 to Loan and Security Agreement between the Company and Bank of America N.A.

 

 

*Filed herewith

 

29
 

 

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: November 9, 2022     

by:

/s/ Jay D. Miller
     

 

 

Jay D. Miller

 

 

Chief Executive Officer and President
    Nortech Systems Incorporated

 

 Date: November 9, 2022     

by:

/s/ Christopher D. Jones
     

 

 

Christopher D. Jones

 

 

Vice President and Chief Financial Officer
    Nortech Systems Incorporated

 

30
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