Nortech Systems Incorporated — Form 10-Q Summary
Business context and reporting period
Nortech Systems is an electronics manufacturing services company producing wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds, with engineering and technical support services. Its principal markets are medical, aerospace and defense, and industrial equipment. This report covers the three and six months ended June 30, 2020, compared with the corresponding 2019 periods. The filing was signed August 11, 2020.
Financial performance and liquidity
| Metric | Three months ended June 30, 2020 | Three months ended June 30, 2019 | Six months ended June 30, 2020 | Six months ended June 30, 2019 |
|---|---|---|---|---|
| Net sales | $26.5 million | $27.3 million | $53.9 million | $55.5 million |
| Gross profit | $2.4 million | $2.3 million | $5.4 million | $5.3 million |
| Gross margin | 9.2% | 8.5% | 10.1% | 9.5% |
| Operating income (loss) | $0.05 million | $(1.2) million | $0.4 million | $(1.3) million |
| Net income (loss) | $(0.1) million | $(1.6) million | $0.01 million | $(1.9) million |
| Basic earnings (loss) per share | $(0.05) | $(0.58) | $0.01 | $(0.72) |
- Second-quarter sales declined 3.0%; six-month sales declined 2.8%.
- Medical sales were $13.4 million in the quarter, down 4.7%; aerospace and defense sales were $4.9 million, up 7.1%; industrial sales were $8.2 million, down 5.8%.
- For the first six months, medical sales declined 0.8%, aerospace and defense increased 9.8%, and industrial declined 12.4%.
- Six-month operating cash flow was $0.5 million, compared with cash used in operations of $2.2 million in 2019. Investing cash use was $0.2 million, and financing cash use was $0.1 million.
- Cash and restricted cash totaled $0.8 million at June 30, 2020, including $0.3 million of unrestricted cash and $0.4 million of restricted cash.
- Working capital was $21.8 million, compared with $21.1 million at December 31, 2019. Accounts receivable were $19.2 million and inventories were $15.5 million.
- Total liabilities were $41.1 million and shareholders’ equity was $20.0 million. Debt included $4.4 million drawn on the revolving line of credit, $9.5 million of gross long-term debt before debt issuance costs and $2.1 million of finance lease obligations.
- The company received a $6.1 million unsecured Paycheck Protection Program loan bearing interest at 1%. Management expected all or a significant portion to be forgiven, but forgiveness was not assured.
- The Bank of America credit facility provides a $16.0 million line expiring June 15, 2022 and a $5.0 million real estate term note. Unused borrowing-base availability was $8.3 million, and the company reported compliance with its fixed-charge coverage covenant.
Material changes versus the prior comparable period
- Profitability improved despite lower revenue, primarily because of a favorable product mix, higher gross margin and reduced selling and general and administrative expenses.
- General and administrative expense declined to $1.7 million in the second quarter from $2.7 million, and to $3.7 million for the six-month period from $5.0 million. Management attributed the decrease to prior-year one-time operational spending and cost-reduction measures.
- Backlog weakened materially. The 90-day shipment backlog was $23.3 million at June 30, 2020, down 15.3% from March 31, 2020 and 25.8% from June 30, 2019. Total shipment backlog was $46.6 million versus $58.7 million a year earlier.
- Industrial and medical backlog declined, while aerospace and defense backlog was comparatively stable and increased slightly year over year.
- Line-of-credit borrowings declined by $5.7 million from December 31, 2019, while the new $6.1 million PPP loan increased long-term debt.
Guidance, outlook, risks and unusual items
- The filing provides no formal revenue or earnings guidance. Management stated that operating cash flow, available credit, PPP proceeds and cash on hand were expected to meet working-capital, capital-expenditure and debt-payment needs, while noting that COVID-19 creates significant uncertainty.
- The company continued operating its manufacturing facilities during the COVID-19 pandemic, with work-from-home, social-distancing and other safety measures. Future effects on operations, customers, suppliers and markets could not be predicted.
- After quarter-end, the company entered into an agreement to sell and lease back its Bemidji and Mankato facilities. Closing was expected in the third quarter, subject to customary conditions, with anticipated net proceeds of approximately $5.0 million to be used primarily for debt reduction and liquidity.
- On August 7, 2020, the company approved closure of its Merrifield, Minnesota production facility by December 31, 2020. Approximately 60 employees were expected to be affected, with offers of positions at other Minnesota facilities.
- The PPP loan may be subject to Treasury or Small Business Administration review. An adverse finding could require repayment of up to the full $6.1 million loan and could result in fines, penalties, reputational costs and reduced liquidity.
- Key ongoing risks include customer concentration, COVID-19 effects, loss of a major customer, demand volatility, supply-chain and labor constraints, commodity costs, regulatory compliance, cybersecurity and facility disruptions. One customer represented approximately 23% of second-quarter sales and 40% of accounts receivable at June 30, 2020.
- No goodwill or long-lived-asset impairment expense was recorded. The company reported no off-balance-sheet arrangements and no material changes to internal controls.
Important facts for investors to verify
- Whether the PPP loan qualifies for forgiveness and the amount ultimately forgiven.
- Completion, proceeds and debt-reduction impact of the Bemidji and Mankato sale-leaseback transaction.
- The financial and operational effects of the Merrifield facility closure, including transition costs and employee retention.
- Whether the decline in 90-day backlog persists, particularly in the medical and industrial markets.
- Compliance with borrowing-base, fixed-charge coverage and other credit-agreement covenants.
- Exposure to the largest customer, whose sales and receivables concentration is material.
- Future COVID-19 effects on customer demand, production capacity, supply availability and cash flow.