Nortech Systems Incorporated — Q1 2021 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three months ended March 31, 2021, compared with the three months ended March 31, 2020. Nortech provides design and manufacturing solutions for complex electromechanical systems, assemblies and components, primarily serving medical, industrial, and aerospace and defense markets. The company operates facilities in the United States, Mexico, and China.
Financial performance and key metrics
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Net sales | $22.1 million | $27.4 million | Down 19.6% |
| Gross profit | $1.6 million | $3.0 million | Down $1.4 million |
| Gross margin | 7.1% | 11.0% | Down 3.9 percentage points |
| Operating income (loss) | $(2.2) million | $0.4 million | Declined $2.6 million |
| Net income (loss) | $(1.6) million | $0.1 million | Declined $1.7 million |
| Net cash from operations | $(0.9) million | $0.5 million | Declined $1.4 million |
Cost of goods sold was $20.5 million, or 92.9% of sales, versus $24.4 million, or 89.0%, in the prior-year quarter. Selling expense increased to $0.7 million from $0.6 million, while general and administrative expense increased to $2.8 million from $2.0 million, primarily due to higher bad-debt expense and training costs. Restructuring charges were $0.2 million, compared with none in Q1 2020.
The effective tax rate was 31% in Q1 2021 versus 18% in Q1 2020. The filing’s financial statements report basic and diluted loss per share of $0.85; the MD&A reports $0.58, so the correct per-share amount should be verified against the filed XBRL and financial statements.
Balance sheet, liquidity, debt, and cash flow
- Cash was $0.4 million and restricted cash was $0.6 million at March 31, 2021, for total cash and restricted cash of $1.0 million.
- Accounts receivable was $12.5 million, with a doubtful-account allowance of $0.7 million. Inventories increased to $17.1 million from $13.9 million at December 31, 2020.
- Total assets were $57.5 million and total liabilities were $40.3 million. Shareholders’ equity declined to $17.2 million from $18.7 million at year-end 2020.
- Line-of-credit borrowings were $2.2 million, down from $3.3 million at year-end, with $7.6 million of unused borrowing-base availability. The credit facility expires June 15, 2022 and is secured by substantially all company assets.
- Long-term debt, including the $6.1 million Paycheck Protection Program note, totaled $7.0 million before current-maturity classification and debt issuance costs. Current maturities of long-term debt were $2.0 million.
- Total lease liabilities were $11.9 million, including $10.2 million of operating lease liabilities and $1.7 million of finance lease liabilities.
- Cash used in investing activities was $0.3 million, primarily for property and equipment and intangible-asset purchases. Cash used in financing activities was $1.4 million, including a $1.1 million reduction in the line of credit.
- The company stated that it met its credit agreement covenants at March 31, 2021, including the applicable fixed-charge coverage requirement.
Material changes versus the prior comparable period
- Sales declined across all markets: medical sales fell 20.2% to $12.3 million, industrial sales fell 14.9% to $6.2 million, and aerospace and defense sales fell 24.8% to $3.5 million.
- Management attributed the sales decline and margin compression primarily to COVID-19 and related supply-chain shortages, with lower sales spread over a relatively fixed cost base.
- 90-day shipment backlog increased to $31.1 million from $27.5 million at March 31, 2020 and $24.2 million at December 31, 2020. Industrial backlog increased substantially, while aerospace and defense backlog declined.
- The Merrifield, Minnesota facility closure and consolidation was completed during Q1 2021. Approximately 42 employees were affected, and operations were shifted to other Minnesota facilities.
- Accounts receivable allowances increased, while inventory reserves decreased. The filing does not clearly quantify the total effect of supply-chain shortages on inventory valuation or future margins.
Guidance, outlook, risks, contingencies, and unusual items
The company provided no formal numerical revenue or earnings guidance. Management said cash from operations, available credit, proceeds from a sales-leaseback transaction, and cash on hand were expected to meet working-capital, capital-expenditure, and debt-payment needs. However, management disclosed that COVID-19 and related uncertainty had created indicators of an inability to continue as a going concern, although management believed mitigating actions and available liquidity addressed those indicators.
- The Merrifield facility and related assets were classified as held for sale. A liquidation auction was completed in April 2021, and management expected a second-quarter sale near carrying value, but stated that completion and proceeds were not guaranteed.
- The company recorded $0.2 million of restructuring charges and a $28,000 loss on held-for-sale assets in Q1.
- The company expected to apply for the Employee Retention Credit but had not recorded a benefit as of March 31, 2021. The amount and timing of any credit were not clear from the filing.
- The $6.1 million PPP loan remained outstanding; potential forgiveness and any remaining repayment obligation were not resolved in the filing.
- Customer concentration was significant: one customer’s two divisions represented approximately 29% of Q1 sales, and that customer represented approximately 23% of accounts receivable at March 31, 2021.
- Key risks include COVID-19 and supply-chain disruption, labor availability, customer concentration, raw-material and energy costs, competition, regulatory compliance, facility reliability, cybersecurity, and potential loss of major customers.
- The company reported no material changes to the risk factors disclosed in its 2020 Form 10-K, no defaults on senior securities, and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Resolve the discrepancy between the financial statements’ reported loss per share of $0.85 and the MD&A’s reported loss per share of $0.58.
- Confirm the status, forgiveness amount, and repayment terms of the $6.1 million PPP loan.
- Monitor liquidity, operating cash flow, borrowing-base availability, and compliance with the credit agreement through its June 2022 maturity.
- Verify completion and proceeds of the Merrifield facility sale and whether additional restructuring or impairment charges arise.
- Assess whether backlog converts to revenue despite supply-chain shortages and whether gross margins recover from 7.1%.
- Evaluate exposure to the largest customer and the concentration of accounts receivable.
- Confirm the amount and timing of any Employee Retention Credit and its effect on cash taxes and earnings.