M-tron Industries, Inc. (MPTI) FY 2023 MD&A

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis together with our audited consolidated financial statements and the accompanying notes. This discussion contains forward-looking statements, including statements regarding our expected financial position, business and financing plans. These statements involve risks and uncertainties. Our actual results could differ materially from the results described in or implied by these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Report, particularly under the headings "Caution Concerning Forward-Looking Statements" and "Risk Factors”.

Overview

MtronPTI is engaged in the designing, manufacturing and marketing of highly-engineered, high reliability frequency and spectrum control products used to control the frequency or timing of signals in electronic circuits in various applications. MtronPTI’s primary markets are aerospace and defense, space, and avionics.

The accompanying consolidated financial statements include the accounts of the Company and all of its majority-owned subsidiaries.

Results of Operations

Factors Which May Influence Results of Operations

We are not aware of any material trends or uncertainties, other than the global economic conditions affecting our industry generally, that may reasonably be expected to have a material impact, favorable or unfavorable, on our revenues or income other than those listed in Part I, Item 1A, Risk Factors, of this Annual Report on Form 10-K.

Inflation and Rising Interest Rates

During 2023, inflation in the United States moderated and, as of the date of this Report, is currently expected to fall slightly in the near-term. Inflation and the resulting higher interest rates may have an adverse impact on our Loan Agreement and general and administrative expenses, as these costs could increase at a rate higher than our revenue. The U.S. Federal Reserve raised the federal funds rate four times during 2023, with their last increase in July of 2023, resulting in a range from 5.25% to 5.50% as of December 31, 2023. It is expected that the Federal Reserve may ease the federal funds rate during 2024 to, among other things, control unemployment while balancing the risks of inflation. As a result, to the extent our exposure to increases in interest rates is not eliminated through interest rate swaps or other protection agreements, such increases may result in higher debt service costs, which will adversely affect our cash flows.

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2023 Compared to 2022

Consolidated Revenues, Gross Margin and Backlog

Total revenues for the year ended December 31, 2023 were $41,168,000, an increase of $9,323,000, or 29.3%, from $31,845,000 for the year ended December 31, 2022. The increase in revenue reflects strong aerospace and defense product shipments.

Consolidated gross margin, which is consolidated revenues less manufacturing cost of sales as a percentage of revenues, improved to 40.7% for the year ended December 31, 2023 compared to 35.6% for the prior year. Gross margins improved in 2023 as compared to 2022 due to increased business volume and the effects of product mix changes, offset by inflationary headwinds due to labor and materials cost increases on long term contracts.

As of December 31, 2023, our order backlog was $47,831,000, an increase of 3.6% compared to $46,180,000 as of December 31, 2022. Strong 2023 bookings of $42,818,000 following very strong 2022 bookings of $48,586,000 from the effect of increased aerospace and defense orders, drove the improvement. This booking trend in excess of our product shipments reflects strong aerospace and defense orders, most of which are expected to ship during 2024 and into 2025.

The backlog of unfilled orders includes amounts based on signed contracts and purchase orders, which are likely to be fulfilled substantially within the next 12 to 24 months. Order backlog is adjusted quarterly to reflect project cancellations, deferrals, revised project scope and cost. We expect to fill a substantial portion of our order backlog as of December 31, 2023 during 2024 and 2025, but cannot provide assurances as to what portion of the order backlog will be fulfilled in any given year.

Engineering, Selling and Administrative Expenses

Engineering, selling and administrative expenses for 2023 included a one-time stock option grant to employees for which the Company recognized a stock-based compensation expense of $2,013,000. The Board approved a one-time grant of 183,300 shares to all 185 full-time employees below the officer level with the quantity of shares for each determined based upon their length of time with the Company. This grant was made to align the interests of our employees with those of our stockholders, and to recognize and reward our valued employees for their past and continuing dedication and service to MtronPTI. It is our employees whose present and future contributions will help ensure the continued success of the organization. See Note G - Stock-Based Compensation to the Consolidated and Combined Financial Statements included in Item 8. Financial Statements and Supplementary Data of this Report for additional details on stock option grants.

Details for engineering, selling and administrative expenses are as follows:

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Engineering, selling and administrative costs increased $3,996,000 for the year ended December 31, 2023 compared to the year ended December 31, 2022, as a result of $210,000 of increased engineering costs supporting MtronPTI's research and development activities, $225,000 of increased sales costs due to the increase in revenues, and $3,561,000 of increased administrative costs for 2023. Administrative costs included the impact from the one-time employee stock option grant of $2,013,000, increased legal and SEC costs of $841,000, increased salaries and employee benefits of $579,000 along with increased audit and tax costs of $71,000 and general insurance and other cost increases of $56,000. The legal and SEC cost increase of $841,000 represents the incremental direct costs of being a public company, without comparable amounts from the prior year when results were presented on a standalone basis. Employee compensation and benefit costs were higher due primarily to increased bonuses of $505,000, higher salaries and benefits of $322,000, offset by reduced stock-based compensation expenses of $248,000, excluding the one-time stock option grant noted above. Audit and tax costs increased primarily due to the costs of being a standalone public company.

Operating Income

The Company reported an operating income of $4,299,000 for the year ended December 31, 2023 compared to operating income of $2,875,000 for the year ended December 31, 2022. This increase reflects the higher revenues and effects from product mix changes, offset by increased engineering, selling and administrative expenses, which were 30.3% of revenue for the year ended December 31, 2023, compared to 26.6% of revenue for the year ended December 31, 2022.

Total Other Income (Expense), Net

Total other income (expense), net was income of $100,000 for the year ended December 31, 2023 compared to expense of $280,000 for the year ended December 31, 2022, primarily reflecting excess Separation costs of $219,000 in 2022 which represented 50% of the excess Separation costs which MtronPTI agreed to share with LGL Group (See Note B – Related Party Transactions to the Consolidated and Combined Financial Statements included in Item 8. Financial Statements and Supplementary Data of this Report), along with the impact from currency changes.

Income Tax Provision

We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, tax benefits and deductions and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. Significant changes to these estimates may result in an increase or decrease to the tax provision in a subsequent period.

We recorded a tax provision of $911,000 and $797,000 for the years ended December 31, 2023 and 2022, respectively. The income tax provision is based on an estimated annual effective tax rate across the jurisdictions in which we operate.

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Net Income

Net income was $3,489,000 for the year ended December 31, 2023 compared to $1,798,000 for the year ended December 31, 2022. Basic and diluted net income per share for the year ended December 31, 2023 was $1.29 and $1.28, respectively, and for the year ended December 31, 2022 basic and diluted net income per share was $0.67.

Adjusted EBITDA (a Non-GAAP Measure)

Adjusted EBITDA (as defined below) was $2,425,000 for the quarter ended December 31, 2023 versus $1,114,000 for the quarter ended December 31, 2022, a portion of which was reported on a standalone basis. Adjusted EBITDA was $7,692,000 for the year ended December 31, 2023 versus $4,008,000 for the year ended December 31, 2022, a portion of which was reported on a standalone basis. Adjusted EBITDA excluded excess Separation costs of $28,000 for 2023 and $219,000 for 2022. Included within the non-cash stock compensation is $2,013,000 for the impact from the one-time employee stock option grant. Note that adjusted EBITDA for the quarter and year ended December 31, 2022 does not include any adjustments for the potential impact from the additional costs of being a publicly traded company. Management calculated the incremental direct costs of being a public company which do not have any comparable amounts in the prior year when results were presented partially on a standalone basis at $106,000 and $841,000 for the quarter and year ended December 31, 2023, respectively.

Reconciliations of GAAP to Non-GAAP Measures

To supplement our consolidated financial statements presented on a GAAP basis, the Company uses certain non-GAAP measures, including Adjusted EBITDA, which we define as net income before income taxes adjusted to exclude depreciation and amortization expense, interest income and expense, stock-based compensation expense, and other items we believe are discrete events which have a significant impact on comparable GAAP measures and could distort an evaluation of our normal operating performance. These adjustments to our GAAP results are made with the intent of providing both management and investors with a more complete understanding of the underlying operational results and trends and our marketplace performance. The presentation of this additional information is not meant to be considered in isolation or as a substitute for net earnings or diluted earnings per share prepared in accordance with GAAP.

Reconciliation of GAAP Income Before Income Taxes to EBITDA and Non-GAAP Adjusted EBITDA:

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Liquidity and Capital Resources

As of December 31, 2023 and 2022, cash and cash equivalents were $3,913,000 and $926,000, respectively. The increase was due to our financial results following the Separation, as the cash balance at Separation exceeding $1,000,000 was retained by LGL Group.

Cash provided by operating activities was $4,405,000 and $2,042,000 for the years ended December 31, 2023 and 2022, respectively. The increase was largely due to our improved financial results, and a decrease in accounts payable and accrued expenses in 2023 as compared to 2022, partially offset by increases in inventory. Inventory increased due to supply chain constraints and as a result of an increase in our order backlog, while payables and accruals decreased due to the efficient use of available cash.

Cash used in investing activities for the years ended December 31, 2023 and 2022 was $1,281,000 and $936,000, respectively, and related entirely to capital expenditures, which were primarily used for new and upgraded production equipment to improve our costs and efficiency.

Cash used in financing activities for the years ended December 31, 2023 and 2022 was $137,000 and $2,815,000, respectively, with the 2023 amount related to the forfeiture of shares to pay taxes while the 2022 amount resulted almost exclusively from payments to LGL Group and its subsidiaries.

As of December 31, 2023, our consolidated working capital was $13,803,000, compared to $9,458,000 as of December 31, 2022. As of December 31, 2023, we had current assets of $18,187,000, current liabilities of $4,384,000 and a ratio of current assets to current liabilities of 4.15 to 1.00. As of December 31, 2022, we had current assets of $14,314,000, current liabilities of $4,856,000 and a ratio of current assets to current liabilities of 2.95 to 1.00. Management continues to focus on efficiently managing working capital requirements to match operating activity levels and will seek to deploy the Company’s working capital where it will generate the greatest returns.

We believe that existing cash and cash equivalents, marketable securities and cash generated from operations will provide sufficient liquidity to meet our ongoing working capital and capital expenditure requirements for the next 12 months from the date of this filing. The Company’s management continues to strive for profitability both internally and through acquisition.

On June 15, 2022, we entered into a loan agreement (the “Loan Agreement”) for a revolving line of credit with Fifth Third Bank, National Association, for up to $5.0 million bearing interest at SOFR plus a margin of 2.25%, with a SOFR floor of 0.00%. The Loan Agreement has a maturity date of June 15, 2025 and contains certain financial covenants based on the following criteria: (a) Minimum Fixed Charge Coverage Ratio; (b) Minimum Current Ratio; and (c) Minimum Tangible Net Worth (each as defined in the Loan Agreement). All loans pursuant to the Loan Agreement will be secured by a continuing and unconditional first priority security interest in and to any and all property of the Company. See Note E – Revolving Credit Agreement to the Consolidated and Combined Financial Statements included in Item 8. Financial Statements and Supplementary Data of this Report for details of the Loan Agreement.

Our Board has adhered to a practice of not paying cash dividends. This policy takes into account our long-term growth objectives, including our anticipated investments for organic growth, potential acquisitions or other strategic ventures and stockholders' desire for capital appreciation of their holdings. No cash dividends are expected to be paid for the foreseeable future.

Critical Accounting Estimates

Our consolidated financial statements are prepared in accordance with GAAP. Our significant accounting policies are more fully described in Note A – Description of Business, Basis of Presentation and Summary of Significant Accounting Policies to the Consolidated and Combined Financial Statements included in Item 8. Financial Statements and Supplementary Data of this Report. Certain accounting policies require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. On an ongoing basis, we evaluate our estimates and assumptions, and the effects of revisions are reflected in the financial statements in the period in which they are determined to be necessary. The accounting policies described below are those that most frequently require us to make estimates and judgments and, therefore, are critical to understanding our results of operations.

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Income Taxes

We account for income taxes in accordance with Accounting Standards Codification Topic 740 “Income Taxes” (“ASC 740”), which requires an asset and liability approach for the financial accounting and reporting of income taxes. Under this method, deferred income taxes are recognized for the expected future tax consequences of differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. These balances are measured using the enacted tax rates expected to apply in the year(s) in which these temporary differences are expected to reverse. The effect of a change in tax rates on deferred income taxes is recognized in income in the period when the change is enacted.

Based on consideration of all available evidence regarding their utilization, we record net deferred tax assets to the extent that it is more likely than not that they will be realized. Where, based on the weight of all available evidence, it is more likely than not that some amount of a deferred tax asset will not be realized, we establish a valuation allowance for the amount that, in our judgment, is sufficient to reduce the deferred tax asset to an amount that is more likely than not to be realized. In reaching such conclusions, we consider available positive and negative evidence including past operating results, projections of future taxable income, the feasibility of ongoing tax planning strategies and the realizability of tax loss carryforwards. Our projections of future taxable income include estimates and assumptions regarding our income and costs, as well as the timing and amount of reversals of taxable temporary differences.

We account for unrecognized tax benefits in accordance with ASC 740, which prescribes a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. The minimum threshold is defined as a tax position that is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation, based solely on the technical merits of the position. The tax benefit recognized is the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.

During the periods prior to the Separation that are presented in the accompanying Consolidated and Combined Financial Statements, the Company's income tax expense was included in LGL Group’s income tax returns. Income tax expense contained in the accompanying Consolidated and Combined Financial Statements for periods prior to the Separation is presented on a separate return basis, as if the Company had filed its own income tax returns. As a result, actual tax transactions included in LGL Group’s consolidated financial statements may or may not be included in the accompanying Consolidated and Combined Financial Statements of the Company. Similarly, the tax treatment of certain items reflected in the accompanying Consolidated and Combined Financial Statements of the Company may or may not be reflected in LGL Group’s consolidated financial statements and income tax returns. The taxes recorded in the accompanying Consolidated and Combined Statements of Operations for periods prior to the Separation are not necessarily representative of the taxes that may arise in the future when the Company files its income tax returns independent from LGL Group's returns. Post-Separation, the Company filed a consolidated U.S. federal income tax return as well as separate and combined income tax returns in various state, local and international jurisdictions. Income tax expense contained in the accompanying Consolidated and Combined Financial Statements for the period after the Separation is based on the consolidated results of the Company on a standalone basis.

Inventories

We account for inventories at the lower of cost or net realizable value using the FIFO (first-in, first-out) method.

Inventory reserves are determined based on estimated losses that result from inventory that becomes obsolete or for which the Company has excess inventory levels. In determining these estimates, the Company performs an analysis on current demand and usage for each inventory item over historical time periods. Based on that analysis, the Company reserves a percentage of the inventory amount within each time period based on historical demand and usage patterns of specific items in inventory. Actual experience could differ from the amounts estimated requiring adjustments to inventory valuation in future periods.