Nortech Systems Incorporated — Q1 2019 Form 10-Q Summary
Reporting period: Three months ended March 31, 2019, compared with the three months ended March 31, 2018. The company is a contract electronics manufacturer serving aerospace and defense, medical, and industrial markets. The filing is unaudited and prepared under U.S. GAAP.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $28.165 million | $26.447 million | +6.5% |
| Gross profit | $2.961 million | $3.028 million | -2.2% |
| Gross margin | 10.5% | 11.5% | -1.0 percentage point |
| Loss from operations | $0.104 million | $0.120 million | Improved |
| Net loss | $0.363 million | $0.391 million | Improved |
| Loss per share | $0.14 | $0.14 | No change |
| Operating cash flow | $(1.438) million | $0.542 million | Declined |
Medical sales increased 44.7% to $14.939 million, while industrial sales declined 20.2% to $8.981 million and aerospace and defense sales declined 12.8% to $4.245 million. Approximately 91% of revenue was recognized over time under contract manufacturing arrangements.
Cost of goods sold increased to 89.5% of sales from 88.5%, primarily reflecting product and customer mix. Selling expense declined to $0.761 million from $1.039 million, while general and administrative expense increased to $2.304 million from $2.109 million. Interest expense increased to $0.245 million from $0.172 million.
At March 31, 2019, total assets were $69.676 million, including cash of $0.310 million and restricted cash of $0.427 million. Working capital was $22.4 million, compared with $20.7 million at December 31, 2018. Accounts receivable increased to $23.092 million and contract assets increased to $8.584 million, contributing to negative operating cash flow.
Total liabilities were $48.746 million. Line-of-credit borrowings were $11.294 million, with $4.706 million of unused availability supported by the borrowing base. Total long-term debt, net of current maturities, was approximately $3.512 million. Lease liabilities totaled $6.847 million following adoption of ASC 842.
Material changes versus the prior comparable period
- Sales increased 6.5%, driven by strong medical-market growth, but gross profit declined and gross margin compressed by 100 basis points.
- Net loss improved modestly, although the company remained unprofitable.
- Operating cash flow shifted from $0.542 million provided to $1.438 million used, primarily because of higher accounts receivable and contract assets.
- Interest expense increased substantially, consistent with higher borrowings and interest rates.
- 90-day shipment backlog increased to $31.413 million from $21.942 million one year earlier and $27.366 million at December 31, 2018. Medical backlog increased 80.6% year over year.
- The company adopted ASC 842 on January 1, 2019, recognizing approximately $5.731 million of operating lease assets and liabilities without an impact on earnings or cash flow statements.
- The company repurchased 3,377 common shares for $13 thousand during the quarter, leaving $153,148 available under the repurchase program.
Guidance, outlook, risks, and unusual items
Management stated that financing arrangements and expected operating cash flows should be sufficient to meet future working-capital needs. The company expects a 2019 effective tax rate of approximately 19%, compared with 64% for 2018, primarily due to projected pre-tax income levels and reduced GILTI effects. No formal revenue or earnings guidance was provided.
The credit agreement requires, among other conditions, a fixed-charge coverage ratio of at least 1.0 to 1.0 for the applicable four-quarter period. The line of credit is secured by substantially all company assets, and advances remain subject to borrowing-base requirements and lender discretion.
Key risks include customer concentration, loss or reduction of major customer orders, product and customer mix, competition, labor availability, raw-material and energy costs, foreign currency exposure, facility or supply-chain disruption, quality and regulatory requirements, cybersecurity incidents, and potential debt-covenant noncompliance. One customer’s divisions represented approximately 26% of Q1 2019 sales and 25% of accounts receivable at March 31, 2019. Export sales represented approximately 19% of quarterly sales.
The filing reports no material changes to previously disclosed risk factors, no defaults on senior securities, and no material off-balance-sheet arrangements. No goodwill or long-lived-asset impairment was recorded during the quarter. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether the significant medical-market growth and $31.4 million backlog convert into profitable revenue without further margin compression.
- The company’s ability to generate positive operating cash flow as accounts receivable and contract assets remain elevated.
- Compliance with the 1.0-to-1.0 fixed-charge coverage covenant and continued availability under the secured line of credit.
- Customer concentration and the effect of any changes in the largest customer’s orders.
- Exposure to LIBOR-linked borrowing costs, raw-material inflation, labor constraints, and foreign currency movements.
- The sustainability of the projected 19% effective tax rate and the effects of the ASC 842 lease obligations on leverage and liquidity.