Item 5. Market for Registrant’s Common Equity
Item 5. Market for Registrant ’ s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
As of March 12, 2024, there were 590 shareholders of record. Our stock is listed on the NASDAQ Capital Market under the symbol “NSYS”. We intend to invest our profits into the growth of our operations and, therefore, do not plan to pay out dividends to shareholders in the foreseeable future. We did not declare or pay a cash dividend in 2023 or 2022. Future dividend policy and payments, if any, will depend upon earnings and our financial condition, our need for funds, limitations on payments of dividends present in our current or future debt agreements, and other factors.
Stock price comparisons (NASDAQ):
During the Three Months Ended
Low
High
March 31, 2023
$
10.37
$
16.52
June 30, 2023
$
9.00
$
11.26
September 30, 2023
$
8.76
$
10.89
December 31, 2023
$
7.45
$
10.27
March 31, 2022
$
9.50
$
12.38
June 30, 2022
$
9.94
$
20.37
September 30, 2022
$
10.07
$
19.56
December 31, 2022
$
9.31
$
16.01
Equity Compensation Plan Information
Certain information with respect to our equity compensation plans are contained in Part III, Item 12 of this Annual Report on Form 10-K.
Item 6. Selected Financial Data [Reserved]
21
Item 7. 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, 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 December 31, 2023, we have facilities in Minnesota: Bemidji, Blue Earth, Mankato, Milaca and Maple Grove. We also have facilities in Monterrey, Mexico and Suzhou, China.
Our net ‘sales are derived from complex designed products built to the customers’ specifications. The products we manufacture are engineered and designed products that require sophisticated manufacturing support. Quality, on time delivery, and reliability are of upmost importance. Our goal is to expand and diversify our customer base by focusing on sales and marketing efforts that fit our value-added service, early engagement design, and development strategy. We continue to focus on lean manufacturing initiatives, quality and on-time delivery improvements to increase asset utilization, reduce lead times and provide competitive pricing.
Our strategic investments have positioned us to capitalize on growth opportunities in the medical markets and improve our competitiveness by expanding our global footprint. Our industrial and defense markets are focused on improving our asset utilization and profitability while transforming to a value added, solution-sell business model that supports early engagement, design for manufacturability and rapid prototyping.
22
Operating Results
The following table presents our statements of income data in dollars and as a percentage of total net sales for the years indicated (dollars in millions):
2023
2022
$
%
$
%
Net Sales
139.3
100.0
134.1
100.0
Cost of Goods Sold
116.2
83.4
113.6
84.7
Gross Profit
23.1
16.6
20.5
15.3
Selling Expenses
3.6
2.6
3.7
2.8
General and Administrative Expenses
12.3
8.9
11.4
8.5
Research and Development Expenses
1.2
0.9
1.5
1.1
Income from Operations
6.0
4.2
3.9
2.9
Interest Expense
(0.5
)
(0.3
)
(0.4
)
(0.3
)
Income Before Income Taxes
5.5
3.9
3.5
2.6
Income Tax (Benefit) Expense
(1.4
)
(1.0
)
1.5
1.1
Net Income
6.9
4.9
2.0
1.5
Net Sales
Our net sales in 2023 were $139.3 million, compared with $134.1 million in 2022, an increase of $5.2 million or 3.9%, that was driven by increases in all of our markets. The industrial market increased by $1.4 million or 3.6% in 2023 as compared with 2022. The medical market increased year-over-year by $2.8 million or 3.7% with medical devices accounting for the increase. Net sales from the aerospace and defense markets increased by $1.0 million or 5.1% in 2023 as compared with 2022. The increase in net sales is due to continued strong demand across our medical, industrial and defense markets, and the impact of pricing actions taken in the second half of 2022 to address increased manufacturing costs.
23
Net sales by our major EMS industry markets for the years ended December 31, 2023 and 2022 were as follows (in millions):
%
2023
2022
Change
Medical
$
78.7
$
75.9
3.7
Aerospace and Defense
20.5
19.5
5.1
Industrial
40.1
38.7
3.6
Total Net Sales
$
139.3
$
134.1
3.9
Net sales by timing of transfer of goods and services are as follows (in millions):
Year Ended December 31, 2023
Product/ Service
Transferred Over
Time
Product
Transferred
at
Point in
Time
Noncash
Consideration 1
Total Net
Sales
by Market
Medical
$
60.5
$
15.8
$
2.4
$
78.7
Aerospace and Defense
18.3
1.8
0.4
20.5
Industrial
31.4
7.4
1.3
40.1
Total net sales
$
110.2
$
25.0
$
4.1
$
139.3
Year Ended December 31, 2022
Product/ Service
Transferred Over
Time
Product
Transferred
at
Point in
Time
Noncash
Consideration 1
Total Net
Sales
by Market
Medical
$
51.5
$
22.3
$
2.1
$
75.9
Aerospace and Defense
16.7
1.9
0.9
19.5
Industrial
28.7
8.5
1.5
38.7
Total Net Sales
$
96.9
$
32.7
$
4.5
$
134.1
1 Noncash consideration represents material provided by the customer used in the build of the product.
24
Backlog
Our 90-day order backlog as of December 31, 2023 was $35.1 million as compared with $35.9 million at the end of 2022. 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 total order backlog as of December 31, 2023 was $91.7 million, a 11.9% decrease from $104.1 million as of December 31, 2022. Our total and 90-day order backlog by market has decreased when compared with the prior year. As the supply chain continues to normalize, customer order lead times are reducing and are starting to return to their pre-pandemic ordering practices. Our 90-day backlog varies each reporting period end due to order size, manufacturing delays, contract terms and conditions and timing from customer delivery schedules and releases.
90-day shipment backlog by our major industry markets are as follows (in millions):
90 Day Backlog as of
December 31,
%
2023
2022
Change
Medical
$
18.1
$
21.7
(16.6
)
Aerospace and Defense
8.4
5.1
64.7
Industrial
8.6
9.1
(5.5
)
Total Backlog
$
35.1
$
35.9
(2.2
)
Total order backlog by our major industry markets are as follows (in millions):
Total Backlog as of
December 31,
%
2023
2022
Change
Medical
$
47.6
$
57.1
(16.6
)
Aerospace and Defense
30.2
24.5
23.3
Industrial
13.9
22.5
(38.2
)
Total Backlog
$
91.7
$
104.1
(11.9
)
The 90-day and total backlog as of December 31, 2023 contain the contract asset value of $14.5 million, which has been recognized as net sales.
Gross Profit
Our gross profit was $23.1 million and $20.5 million, and as a percentage of net sales 16.6% and 15.3%, for the years ended December 31, 2023 and 2022, respectively. The gross profit improvement relates primarily to price increases in response to material and labor cost inflation.
25
Selling
Selling expenses were marginally lower at $3.6 million, or 2.6% of net sales, for the year ended December 31, 2023 compared with $3.7 million, or 2.8% of net sales, for the year ended December 31, 2022.
General and Administrative
General and administrative expenses were $12.3 million, or 8.9% of net sales, for the year ended December 31, 2023 and $11.4 million, or 8.5% of net sales, for the year ended 2022. General and administrative expenses for the year ended December 31, 2023 were up $0.9 million mainly due to higher wages of $0.7 due to merit increases and one-time higher professional fees related to a system implementation of $0.2 million.
Research and Development Expense
Research and development expenses were $1.2 million or 0.9% of net sales for the year ended December 31, 2023 and $1.5 million or 1.1% of net sales for the year ended 2022.
Income from Operations
Our income from operations for 2023 was $6.0 million, an increase of $2.1 million from the income of $3.9 million in 2022. The increase in income from operations was driven by the increase in gross profit.
Interest Expense
Interest expense for the year ended December 31, 2023 and December 31, 2022 was $0.5 and $0.4 million, respectively.
26
Income Taxes
We realized an income tax benefit of $1.4 million resulting in an effective tax rate of 26% for the year ended December 31, 2023. This benefit was largely driven by the $2.6 million valuation allowance reversal as we concluded it was more likely than not that we will realize our net deferred tax assets. Income tax expense was $1.5 million for the year ended December 31, 2022 with an effective tax rate of 42%. Our 2022 tax rate was driven by the increase in deferred tax assets and corresponding valuation allowance from research and development expenses which were no longer tax deductible pursuant to the Tax Cuts and Jobs Act which requires the Company to capitalize and amortize research and experimental expenditures for tax return purposes starting in 2022.
The statutory rate reconciliation for the years ended December 31, 2023 and 2022 is as follows, (in thousands):
2023
2022
Statutory Rate
$
1,148
$
572
State Income Tax
79
41
Effect of Foreign Operations
(124
)
(82
)
Research and Development
(316
)
-
Change in State Deferred Rate
-
29
Valuation Allowance
(2,563
)
587
Maquiladora Tax
158
153
US Permanent Differences
(44
)
(28
)
Federal Tax Credits
-
(272
)
Global Intangible Low-Taxed Income Effect
7
301
Return to Provision - Credits, Perm Diffs
(189
)
9
Withholding Tax
318
122
IRS Payable
-
17
Other
118
18
$
(1,408
)
$
1,467
Net Income
Our net income in 2023 was $6.9 million or $2.38 per diluted common share and $2.53 per basic common share. Our net income in 2022 was $2.0 million or $0.70 per diluted and $0.75 per basic common share.
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, capital expenditures and debt repayments for the next twelve months.
27
Credit Facilities
We had a $16 million asset backed line of credit agreement with Bank of America which, as amended, was to expire on June 15, 2026. Under this credit agreement, 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. This line of credit weighted-average interest rate was 8.3% and 5.2% as of December 31, 2023 and 2022, respectively. We had borrowings on our line of credit of $5.8 million and $6.9 million as of December 31, 2023 and December 31, 2022, respectively. As of December 31, 2023 and 2022, we had unused availability under our line of credit of $9.4 million and $8.4 million, respectively, supported by our borrowing base. We were in compliance with all the financial covenants related to this agreement as of and for the year ended December 31, 2023.
On February 29, 2024, we replaced our asset back line of credit agreement with $15 million 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 we prepay SOFR borrowings before their contractual maturity, we have agreed to compensate the bank for lost margin, as defined in the Revolver agreement. We are required to quarterly pay a 20-basis point fee on the unused portion of the Revolver.
The Revolver requires us 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. There are no subjective acceleration clauses under the Revolver that would accelerate the maturity of our outstanding borrowings. The Revolver contains certain covenants which, among other things, require us 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.
Our China operation has a financing agreement with China Construction Bank which provides for a line of credit arrangement of 10,000,000 Renminbi (RMB) (approximately 1.4 million USD) that expires on August 18, 2024. No amounts were outstanding under this financing arrangement as of December 31, 2023 or 2022. The interest rate as of December 31, 2023 was approximately 4%.
28
Cash flows for the years ended December 31, 2023 and 2022 are summarized as follows:
(in millions)
2023
2022
Cash Flows Provided By (Used In):
Operating Activities
$
1.8
$
5.4
Investing Activities
(1.3
)
(2.4
)
Financing Activities
(1.3
)
(2.7
)
Effect of Exchange Rate Changes on Cash
0.0
0.0
Net Change in Cash
$
0.8
$
0.3
Cash provided by operating activities for the year ended December 31, 2023 was $1.8 million compared with cash provided by operations of $5.4 million for the year ended December 31, 2022. In 2023, the cash provided by operating activities was driven by $6.9 million in net income offset by a $2.2 million non-cash tax benefit from the reduction in our valuation allowance, and increased uses of working capital largely from accounts receivable and contract assets due to the increase in net sales and longer payment terms with several customers. In 2022, the cash provided by operating activities was driven by results from operations.
Net cash used in investing activities was $1.3 million for the year ended December 31, 2023 and net cash used in investing activities was $2.4 million for the year ended December 31, 2022. Cash used in investing activities in both years primarily relates to the purchase of property and equipment.
Net cash used in financing activities in 2023 of $1.3 million consisted primarily of net payments on the line of credit of $1.0 million and capital lease payments of $0.4 million, partially offset by cash receipts of $0.1 million from stock option exercises. The cash used by financing activities in 2022 of $2.7 million consisted primarily of net payments on the line of credit of $2.1 million and capital lease payments of $0.6 million.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our audited consolidated financial statements, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”). The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of our consolidated financial statements, the reported amounts of net sales and expenses during the reporting periods presented, as well as our disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and assumptions, including, but not limited to, valuation allowance for inventories, allowance for doubtful accounts, realizability of deferred tax assets and long-lived asset impairment testing.
We base our estimates and assumptions on our historical experience and on various other information available to us at the time that these estimates and assumptions are made. We believe that these estimates and assumptions are reasonable under the circumstances and form the basis for our making judgments about the carrying values of our assets and liabilities that are not readily apparent from other sources. Actual results and outcomes could differ from our estimates primarily due to incorrect sales forecasting. We utilize a pipeline generated by our sales team and speak directly with all departments regarding estimates and assumptions. If, for any reason, those estimates, and assumptions vary substantially it would also impact our financial results.
29
Our accounting policies are described in “Note 1 – Summary of Significant Accounting Policies,” in Notes to Consolidated Financial Statements of this Annual Report on Form 10-K. We believe that the following discussion addresses our critical accounting policies and reflects those areas that require more significant judgments and use of estimates and assumptions in the preparation of our consolidated financial statements.
Revenue Recognition
Our net sales are comprised of product, engineering services and repair services. All net sales are 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 net sales being recognized over time including goods produced under contract manufacturing agreements and services net sales. 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. Most of our contracts have a single performance obligation and require that we provide services and products that are unique to each customer’s designed products and have no alternative usage. As of December 31, 2023, the Company has recorded a contract asset of $14.5 million for unbilled customer net sales included in net sales. Net sales are 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 Income and Comprehensive Income. Sales, value added, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from net sales) 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.
Long-Lived Assets Impairment
We evaluate long-lived assets, primarily property and equipment, whenever current events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability for assets to be held and used is based on our projection of the undiscounted future operating cash flows of the underlying assets. To the extent such projections indicate that future undiscounted cash flows are not sufficient to recover the carrying amounts of related assets, a charge might be required to reduce the carrying amount to equal estimated fair value. As of December 31, 2023, the Company’s common stock was trading at a value less than the Company’s net equity value. As such, the Company evaluated future undiscounted cash flows and determined that no long-lived asset impairment was required as of December 31, 2023.
Allowance for Credit Losses
When we record customer receivables and contract assets arising from net sales transactions, we record an allowance for credit losses for the current expected credit losses (“CECL”) inherent in the asset over its expected life. The allowance for credit losses is a valuation account deducted from the cost basis of the assets to present their net carrying value at the amount expected to be collected. Each period, the allowance for credit losses is adjusted through earnings to reflect expected credit losses over the remaining lives of the assets. We adopted CECL as of January 1, 2023 with a $30 thousand adjustment to retained earnings. As of December 31, 2023, we held an allowance for credit losses of $0.4 million.
We estimate expected credit losses based on relevant information about past events, including historical write-offs of bad debts, customer concentrations, customer creditworthiness, current economic trends and changes in customer payment terms that affect the collectability of the reported amount. When measuring expected credit losses, we pool assets with similar country risk and credit risk characteristics. Changes in the relevant information may significantly affect the estimates of expected credit losses.
Assets are written off when we determine them to be uncollectible. Write-offs are recognized as a deduction from the allowance for credit losses.
30
Inventory Reserves
Inventory reserves are maintained for the estimated value of the inventory that may have a lower value than stated or quantities in excess of future production needs. Certain raw material inventories are purchased solely to meet a customer’s unique manufacturing requirements. We seek to require our customers to prepay for end of life or certain inventory in excess of current customer order quantities. We have an evaluation process to assess the value of the inventory that is slow moving, excess or obsolete on a quarterly basis. This process includes an evaluation of our inventory based on current usage and the latest forecasts of product demand and production requirements from our customers. On at least an annual basis we review the underlying inventory reserve assumptions based on recent trends. As of December 31, 2023, we had an inventory reserve of $1.2 million.
Income Taxes
Significant judgment is required in evaluating our tax positions and in determining income tax expense, deferred tax assets and liabilities, and any valuation allowance recorded against our deferred tax assets. We evaluate the recoverability of deferred tax assets based on available evidence. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between future projected operating performance and actual results. We establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not (defined as a likelihood of more than 50%) that all or a portion of the deferred tax assets will not be realized. In making this determination, we evaluate all positive and negative evidence as of the end of each reporting period. Future adjustments (either increases or decreases) to the deferred tax asset valuation allowance are determined based upon changes in the expected realization of the net deferred tax assets. As of December 31, 2022, we had recorded a valuation allowance of $2.6 million that resulted from the establishment of a full valuation allowance against U.S. net deferred tax assets as of that date. In 2023, we recorded a $2.6 million tax benefit as we reversed our valuation allowance against our net U.S. deferred tax assets. During the fourth quarter of 2023 concluded that it was more likely than not it would realize it net deferred tax assets given its recent three-year cumulative losses were insignificant as well as the Company’s forecasted pre-tax income in 2024 and beyond. The realization of the deferred tax assets ultimately depends on the existence of sufficient taxable income or tax liability in either the carryback or carry-forward periods under the tax law. Due to significant estimates used to establish the valuation allowance and the potential for changes in facts and circumstances, it is reasonably possible that we will be required to record additional adjustments to the valuation allowance in future reporting periods that could have a material effect on our results of operations.
We establish reserves for uncertain tax positions when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are likely to be challenged and that we may or may not prevail. If we determine that a tax position is more likely than not of being sustained upon audit, based solely on the technical merits of the position, we recognize the benefit. We measure the benefit by determining the amount that is greater than 50% likely of being realized upon settlement. We presume that all tax positions will be examined by a taxing authority with full knowledge of all relevant information. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We regularly monitor our tax positions and tax liabilities. We reevaluate the technical merits of our tax positions and recognize an uncertain tax benefit, or derecognize a previously recorded tax benefit, when there is (i) a completion of a tax audit, (ii) effective settlement of an issue, (iii) a change in applicable tax law including a tax case or legislative guidance, or (iv) the expiration of the applicable statute of limitations. Significant judgment is required in accounting for tax reserves. Although we believe that we have adequately provided for liabilities resulting from tax assessments by taxing authorities, positions taken by these tax authorities could have a material impact on our results of operations. Our reserve for uncertain tax positions aggregated $131 thousand as of December 31, 2023.
31
New Accounting Pronouncements
Information regarding new accounting pronouncements is included in Note 1 to the consolidated financial statements in “Financial Statements and Supplementary Data” in Part II, Item 8 of this Annual Report on Form 10-K.
Forward-Looking Statements
This Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We may also make forward-looking statements in other reports filed with the SEC, in materials delivered to stockholders and in press releases. Such statements generally will be accompanied by words such as “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “intend,” “possible,” “potential,” “predict,” “project,” or other similar words that convey the uncertainty of future events or outcomes. Although we believe these forward-looking statements are reasonable, they are based upon a number of assumptions concerning future conditions, any or all of which may ultimately prove to be inaccurate. Forward-looking statements involve a number of risks and uncertainties. Discussion of these factors is 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 obligations to update publicly any forward-looking statement (or its associated cautionary language) whether as a result of new information or future events.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
32
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
TABLE OF CONTENTS
FOR THE YEARS ENDED DECEMBER 31, 2023 AND 2022
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.