Nortech Systems Incorporated — Q1 2015 Form 10-Q Summary
Business Context and Reporting Period
Nortech Systems Incorporated is a full-service electronics manufacturing services contractor producing wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds. It also provides engineering, testing, prototyping and supply-chain services. Its primary markets are aerospace and defense, medical, and industrial equipment. The filing covers the three months ended March 31, 2015, and was filed May 6, 2015.
Financial Performance and Position
- Net sales: $26.5 million, compared with $26.1 million in Q1 2014, an increase of 1.5%.
- Gross profit: $2.9 million; gross margin declined to 10.8% from 11.8%.
- Operating result: Operating loss of $202,000, compared with operating income of $236,000.
- Net result: Net loss of $193,000, or $0.07 diluted loss per share, compared with net income of $86,000, or $0.03 per share.
- Operating expenses: $3.1 million, up from $2.8 million. Selling expense increased to $1.4 million from $1.1 million, while general and administrative expense was approximately $1.7 million in both periods.
- Cash flow: Operating activities used $240,000, compared with $523,000 of operating cash generation in Q1 2014. Investing activities used $907,000, primarily for property and equipment purchases. Financing activities provided $1.1 million.
- Liquidity: Cash was $47,000 at March 31, 2015, compared with $66,000 at December 31, 2014. Working capital was approximately $24.7 million.
- Debt: Line-of-credit borrowings were $8.9 million, up from $8.0 million at year-end, with approximately $3.2 million of unused availability. Total debt, including current maturities, was approximately $13.9 million.
- Balance sheet: Total assets were $49.4 million and shareholders’ equity was $22.6 million at March 31, 2015. Inventories increased to $19.5 million from $18.5 million at year-end.
- Taxes: The company recorded a $104,000 income tax benefit. The effective tax rate was 35%, compared with 37% in Q1 2014.
Material Changes Versus the Prior Comparable Period
- Sales growth was modest, with industrial revenue increasing 17% to $14.5 million, offset by declines of 27% in aerospace and defense revenue to $3.1 million and 6% in medical revenue to $9.0 million.
- Gross margin contracted by 100 basis points because of product mix, lower demand from major global customers and underutilized operations.
- Selling expense rose by approximately $243,000 as the company increased business-development activity and expanded into Asian markets.
- The company moved from operating and net profitability to operating and net losses.
- Operating cash flow deteriorated because of the operating loss and higher inventories, partially offset by depreciation and accounts-receivable collections.
- The 90-day order backlog increased to $18.3 million from $17.3 million at December 31, 2014 and $17.0 million at March 31, 2014. Industrial and aerospace and defense backlogs improved, while medical backlog declined.
- GE Healthcare represented 17% of sales, down from 24% in Q1 2014; GE Transportation represented 9%, up from 5%. Combined GE receivables represented 18% of total accounts receivable.
Guidance, Outlook, Risks, Contingencies and Unusual Items
- Management stated that demand from larger global customers was affected by the strong U.S. dollar, oil and gas industry conditions, and challenging economies in China, Asia-Pacific and Europe.
- Management expects a major portion of the March 31 90-day backlog to convert to revenue in the following quarter, but notes that backlog can vary based on order size, manufacturing delays, contract terms and customer delivery schedules.
- Management believes financing arrangements and expected operating cash flows will be sufficient for future working-capital needs. The company’s credit facilities are secured by substantially all assets, subject to borrowing-base limits, lender discretion and financial covenants.
- Interest rates on the line of credit and real-estate term notes vary with LIBOR. The line of credit bears interest at approximately 2.75% at March 31, 2015.
- Identified risks include market demand volatility, competition, facility reliability, labor availability, raw-material and copper costs, commodity and energy-price instability, general economic conditions, and component availability.
- The company recorded approximately $11,700 of income from its equity appreciation rights plan because of a change in estimated book-value appreciation assumptions. Accrued obligations under the plan were approximately $201,000 at March 31, 2015.
- On April 1, 2015, the company entered into an 89-month lease for approximately 19,000 square feet of new headquarters space. Annual rent is expected to increase from approximately $139,000 to $165,000, excluding certain operating costs, taxes and insurance.
- The company is evaluating the future adoption and transition method for ASU 2014-09, Revenue from Contracts with Customers. Management had not determined the transition approach as of the filing date.
- The filing reports ordinary-course legal proceedings and claims, without identifying a material specific matter.
- Management reported that disclosure controls were effective and that no material change occurred in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether the lower gross margin and underutilization continued beyond Q1 2015.
- Conversion of the $18.3 million 90-day backlog into revenue and the related customer and market mix.
- Available borrowing capacity, compliance with debt covenants and sensitivity to LIBOR and borrowing-base changes.
- Inventory growth, working-capital requirements and the company’s ability to return to positive operating cash flow.
- Continuing customer concentration, particularly exposure to GE and weaker medical-market demand.
- Costs and operational implications of the new headquarters lease and Asian-market expansion.
- The eventual impact and transition method selected for the new revenue-recognition standard.