Nortech Systems Incorporated — Q3 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. It also provides engineering, testing, prototyping and supply-chain services. Its principal markets are medical, aerospace and defense, and industrial equipment. The filing covers the unaudited three and nine months ended September 30, 2021, compared with the corresponding 2020 periods.
Financial performance and key metrics
| Metric | Q3 2021 | Q3 2020 | 9M 2021 | 9M 2020 |
|---|---|---|---|---|
| Net sales | $29.5 million | $26.4 million | $81.7 million | $80.3 million |
| Gross profit | $8.0 million | $2.0 million | $13.2 million | $7.9 million |
| Gross margin | 27.3% | 7.4% | 16.1% | 9.9% |
| Operating income | $4.9 million | $2.7 million | $3.1 million | $3.1 million |
| Net income | $3.6 million | $2.0 million | $2.2 million | $2.0 million |
| Diluted earnings per share | $1.24 | $0.73 | $0.78 | $0.74 |
- Q3 sales increased 11.7%, driven primarily by industrial sales growth of 58.0% and medical sales growth of 19.4%. Aerospace and defense sales declined 50.2%.
- For the first nine months, sales increased 1.8%; medical sales rose 6.2% and industrial sales rose 17.2%, while aerospace and defense sales declined 32.0%.
- Gross profit benefited substantially from $4.7 million of Employee Retention Credit-related reductions in payroll and medical expenses, as well as higher manufacturing utilization.
- Nine-month operating cash flow was negative $2.9 million, primarily because inventory increased $5.8 million, contract assets increased $2.2 million and the company recorded a $5.2 million ERC receivable.
- Cash and restricted cash totaled $1.4 million at September 30, 2021, including $0.4 million of unrestricted cash and $1.0 million of restricted cash.
- Total assets were $66.5 million and shareholders’ equity was $21.0 million, compared with $57.6 million and $18.7 million, respectively, at December 31, 2020.
Debt, liquidity and working capital
- The Bank of America facility provides a $16.0 million line of credit and includes a $5.0 million real estate term note; both mature June 15, 2022. Management expects to extend the agreement beyond that date.
- Line-of-credit borrowings were $6.0 million at September 30, 2021, with $5.8 million of unused availability supported by the borrowing base. The line bears interest at a weighted-average rate of 3.4% and is secured by substantially all company assets.
- The company had $3.2 million of current long-term debt maturities, $3.2 million of current line-of-credit maturities, and $11.1 million of lease liabilities.
- The company met its required fixed-charge coverage covenant at September 30, 2021. Availability and borrowing remain subject to borrowing-base requirements and lender discretion.
- The company continues to classify the $6.1 million PPP loan as debt while its forgiveness application, submitted in the third quarter, remains pending.
Material changes versus the prior comparable period
- Q3 gross margin increased 19.9 percentage points, and operating margin increased from 10.3% to 16.6% based on reported figures.
- The company recognized $5.2 million of ERC benefits in 2021, recorded as a reduction of operating costs and as a receivable. Management expects receipt in fiscal 2021 or 2022.
- The company recorded a $560,000 loss on abandonment of the Devicix tradename, compared with no such charge in 2020.
- The company recorded $319,000 of restructuring charges during the first nine months related to the closure and consolidation of the Merrifield, Minnesota facility. Approximately 42 employees were affected.
- The Merrifield facility sale closed in Q3 2021 and generated a $176,000 year-to-date gain, compared with a $3.8 million gain on asset sales in the first nine months of 2020.
- Inventory increased from $13.9 million at December 31, 2020 to $20.6 million at September 30, 2021, while accounts receivable decreased from $15.6 million to $13.9 million.
- 90-day shipment backlog reached $38.9 million, up 68.3% from September 30, 2020; total backlog was $78.6 million versus $45.7 million a year earlier.
Outlook, commentary, risks and unusual items
- Management states that COVID-19, supply-chain disruption and workforce shortages affected 2021 sales and liquidity. The filing states that these conditions created indicators of an inability to continue as a going concern, although management believes such indicators are mitigated by cost reductions, limited capital spending, expected ERC receipts, available borrowing capacity and operating cash flows.
- No quantitative full-year revenue or earnings guidance was provided. Management expects liquidity to be sufficient for working capital, capital expenditures and debt obligations, but this depends in part on operating cash flow, ERC collections and continued credit availability.
- Key risks include COVID-19 impacts, supply-chain and labor shortages, raw-material and energy-cost inflation, loss of major customers, customer outsourcing decisions, facility or information-system disruptions, cybersecurity incidents, FDA compliance risks and general economic conditions.
- Customer concentration is significant: two customers represented 36% of Q3 sales and two customers represented approximately 36% of accounts receivable at September 30, 2021.
- Contract assets were $8.1 million at September 30, 2021. Management expects substantially all related performance obligations to transfer to receivables within 90 days, with remaining amounts within 180 days.
- The company disclosed ordinary-course legal proceedings but no material change in risk factors from its 2020 Form 10-K. Management concluded that disclosure controls and procedures were effective.
Important facts for investors to verify
- Whether and when the $6.1 million PPP loan is forgiven, and the amount of any remaining repayment obligation.
- The timing and collectability of the $5.2 million ERC receivable and its effect on future cash flow and operating margins.
- Whether the Bank of America credit facility and term note are extended beyond June 15, 2022, and whether borrowing-base availability remains adequate.
- Whether the elevated backlog converts into revenue and cash flow without material delays, cancellations or margin pressure.
- Inventory growth, contract-asset conversion and the company’s ability to return to positive operating cash flow.
- The sustainability of reported margins after removing ERC benefits and other unusual items.
- Customer concentration and the sharp year-to-date decline in aerospace and defense sales.