Nortech Systems Incorporated: Q2 2021 Form 10-Q Summary
Business Context and Reporting Period
Nortech Systems Incorporated is an electronics manufacturing services provider producing wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds, with engineering and technical support services. Its primary markets are medical, aerospace and defense, and industrial equipment. The filing covers the three and six months ended June 30, 2021, compared with the comparable 2020 periods. The company filed the 10-Q on August 12, 2021.
Key Financial Metrics
| Metric | Q2 2021 | Q2 2020 | Six Months 2021 | Six Months 2020 |
|---|---|---|---|---|
| Net sales | $30.2 million | $26.5 million | $52.3 million | $53.9 million |
| Gross profit | $3.6 million | $2.7 million | $5.1 million | $6.0 million |
| Gross margin | 11.9% | 10.3% | 9.9% | 11.1% |
| Operating income (loss) | $0.4 million | $0.05 million | $(1.8) million | $0.4 million |
| Net income (loss) | $0.2 million | $(0.1) million | $(1.4) million | $0.01 million |
| Diluted EPS | $0.06 | $(0.05) | $(0.52) | $0.01 |
| Operating cash flow | Not separately provided | Not separately provided | $(5.4) million | $0.5 million |
- Q2 sales increased 14.0% year over year, while six-month sales declined 3.1%.
- Q2 operating margin was 1.3%, compared with 0.2% in the prior-year quarter. Six-month operating margin was negative 3.4%, compared with positive 0.8% in 2020.
- Q2 selling expense declined to $0.6 million from $0.7 million, while general and administrative expense increased to $2.4 million from $1.9 million. Six-month general and administrative expense increased to $5.2 million from $4.2 million.
- Interest expense was $0.1 million in Q2 and $0.2 million for the six months, compared with $0.2 million and $0.4 million, respectively, in 2020.
- At June 30, 2021, cash was $0.7 million and restricted cash was $0.6 million. Total cash and restricted cash used in the cash flow statement was $1.3 million.
- Total assets were $62.8 million and total shareholders’ equity was $17.4 million at June 30, 2021.
Revenue Mix and Operating Developments
- Q2 medical revenue increased 20.2% to $16.1 million, industrial revenue increased 24.3% to $10.2 million, and aerospace and defense revenue decreased 19.8% to $3.9 million.
- For the six months, medical revenue decreased 1.1% to $28.4 million, industrial revenue increased 5.9% to $16.4 million, and aerospace and defense revenue decreased 23.1% to $7.4 million.
- Approximately 82.2% of Q2 revenue and 79.3% of six-month revenue was recognized over time under contract manufacturing agreements.
- 90-day shipment backlog was $34.7 million at June 30, 2021, up 11.8% from March 31 and 49.1% from June 30, 2020. Total shipment backlog was $71.5 million, compared with $46.6 million a year earlier.
- The company consolidated production and closed its Merrifield, Minnesota facility, reducing its workforce by approximately 42 employees. It recorded $0.3 million of restructuring charges for the six months and a $0.1 million gain on asset sales in Q2.
Debt, Liquidity and Cash Flow
- Operating activities used $5.4 million of cash during the first six months, primarily because of increases in accounts receivable, inventory and contract assets. Inventory increased to $18.3 million from $13.9 million at year-end 2020.
- Investing activities used $0.6 million, including $0.7 million of property and equipment purchases, partly offset by proceeds from asset sales.
- Financing activities provided $3.8 million, including a $4.3 million net increase in borrowings under the line of credit.
- The Bank of America credit facility provides a $16.0 million line of credit and includes a $5.0 million real estate term note. The arrangement expires June 15, 2022; management expects to extend it beyond that date.
- Borrowings under the line of credit were $7.7 million, with $4.5 million of unused borrowing-base-supported availability at June 30, 2021. The line is secured by substantially all company assets.
- Long-term debt, including the $6.1 million PPP promissory note, totaled $6.8 million net of debt issuance costs, of which $3.0 million was classified as current.
- The company met its credit agreement covenants for the quarter. Advances remain subject to borrowing-base requirements and lender discretion.
- Total lease liabilities were $11.5 million, including $10.0 million of operating lease liabilities and $1.5 million of finance lease liabilities.
Outlook, Risks and Unusual Items
- Management stated that COVID-19 and related supply-chain shortages created indicators of an inability to continue as a going concern, although it believes cost reductions, working-capital management, cash on hand, operating cash flow and credit availability mitigate those concerns.
- The company cannot estimate the ultimate effect of COVID-19 on operations, liquidity or financial results. Key risks include supply-chain disruption, labor shortages, commodity and energy cost volatility, competition, loss of a major customer, currency fluctuations, FDA compliance, cybersecurity and broader economic conditions.
- The company applied in the third quarter for forgiveness of the $6.1 million PPP loan and will continue to account for it as debt until forgiveness is granted.
- The company also applied for Employee Retention Credits for the first and second quarters of 2021 and expects approximately $5 million in fiscal 2021 if approved. No ERC benefit had been recorded through June 30.
- The company expects substantially all contract assets of $6.9 million at June 30 to transfer to receivables within 90 days, with remaining amounts within 180 days.
- An IRS examination may result in an estimated $44,000 payable; a reserve has been recorded.
- A facility sale closed in July 2021 with a gain of less than $0.1 million.
- One customer’s divisions represented approximately 25% of Q2 sales and 27% of six-month sales, creating customer concentration risk.
- Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether the PPP loan receives forgiveness and the timing and amount of any resulting gain.
- Whether the approximately $5 million ERC claim is approved and collected.
- Whether the Bank of America credit facility and term note are extended before their June 2022 maturity dates.
- Whether operating cash flow improves as inventory, receivables and contract assets convert to cash.
- Whether the elevated backlog converts into revenue without further margin deterioration.
- The company’s ability to manage aerospace and defense weakness, customer concentration and COVID-related supply-chain and labor risks.