Nortech Systems Incorporated — Form 10-Q Summary
Business Context and Reporting Period
Form 10-Q for the quarter and nine months ended September 30, 2017, filed November 8, 2017. Nortech is an electronics manufacturing services provider producing medical-device and systems wire and cable assemblies, printed circuit board assemblies, and higher-level box builds, with engineering and technical support services. Operations are located in Minnesota, Monterrey, Mexico, and Suzhou, China. The company reports one contract-manufacturing segment and is classified as a smaller reporting company.
Financial Performance and Position
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Net sales | $28.3 million, versus $29.7 million | $86.8 million, versus $87.6 million |
| Gross profit / margin | $3.5 million / 12.4%, versus 12.7% | $10.0 million / 11.5%, versus 11.7% |
| Income from operations | $0.3 million, versus $0.2 million | $0.5 million, versus $0.3 million |
| Net income (loss) | $43,000, versus $63,000 | $13,000, versus $(54,000) |
| Basic and diluted earnings per share | $0.02, versus $0.02 | $0.00, versus $(0.02) |
Operating performance benefited from cost containment and lower general and administrative expense, but gross profit and margins were pressured by lower volume, customer mix, and underutilized plant capacity. Nine-month operating income also benefited from a bad-debt recovery and a $355,000 gain on the sale of property and equipment.
- Cash and restricted cash totaled $1.1 million at September 30, 2017, including $0.5 million unrestricted cash and $0.6 million restricted cash.
- Net cash provided by operating activities was $0.6 million for the nine months, down from $1.9 million in the prior-year period.
- Net investing cash use was approximately $5,000, reflecting $669,000 of property-sale proceeds, $574,000 of capital expenditures, and a $100,000 intangible-asset purchase.
- Net financing cash provided was $0.2 million. Financing included a $1.2 million increase in the line of credit, $5.1 million of new long-term debt, $5.6 million of principal repayments, and $267,000 of debt-issuance costs.
- Total assets were $57.5 million, compared with $55.5 million at December 31, 2016. Total liabilities were $35.2 million, compared with $33.2 million.
- Working capital was $20.9 million, compared with $19.2 million at year-end. Accounts receivable were $18.3 million and inventory was $21.1 million.
Debt and Liquidity
In June 2017, Nortech entered into a Bank of America credit agreement providing a $16.0 million revolving line of credit and a $5.0 million real-estate term note, both maturing June 15, 2022 and bearing interest tied to LIBOR. Borrowings under the line were $8.5 million at September 30, 2017, with $4.5 million of unused borrowing-base availability. The line is secured by substantially all company assets.
Long-term debt, including current maturities and excluding capital leases, totaled $5.6 million gross of discounts and debt-issuance costs. A five-year capital lease for equipment added a $1.1 million principal obligation. The company was in compliance with its 1.00-to-1.00 fixed-charge coverage covenant at September 30, 2017. Management stated that financing arrangements and expected operating cash flows should satisfy future working-capital needs.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales declined 4.7%; nine-month sales declined 1.0%.
- Third-quarter medical revenue declined 7.4%, aerospace and defense declined 5.0%, and industrial declined 1.5%. For the nine-month period, medical revenue increased 7.8%, while industrial declined 7.1% and aerospace and defense declined 9.4%.
- Third-quarter operating income increased despite lower sales, primarily from expense reduction and cost-containment efforts.
- Nine-month net income improved from a $54,000 loss to $13,000 of income, although the improvement included a $355,000 property-sale gain and a bad-debt recovery.
- The company replaced its Wells Fargo credit agreement with Bank of America financing. The transition generated a $175,000 loss on extinguishment of debt.
- The Augusta, Wisconsin manufacturing facility was closed and consolidated into other facilities. The building was sold for $715,000, producing a net gain of approximately $354,000; net proceeds of approximately $668,000 were applied to debt.
- The 90-day backlog was $20.3 million at September 30, 2017, down 7.5% from June 30 and 15.2% from September 30, 2016. Medical backlog declined 35.7% year over year, while aerospace and defense backlog increased 26.9%.
- The cash conversion cycle was 78 days for the nine months, compared with 82 days in the prior-year period, although inventory days increased modestly and operating cash flow weakened.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide formal revenue or earnings guidance. Management expects a major portion of the September 30 backlog to convert to revenue in the following quarter but cautions that backlog varies with order size, manufacturing delays, contract terms, and customer delivery schedules.
- Medical customers reduced demand after accumulating excess inventory; project delays and customer funding constraints also affected third-quarter sales.
- The company depends materially on a major customer, whose divisions represented approximately 24.2% of third-quarter sales and 25.8% of nine-month sales. That customer represented approximately 19.2% of accounts receivable at September 30.
- Key risks include market volatility, competition, facility reliability, labor availability, copper and other raw-material costs, commodity and energy costs, customer cancellations or financial difficulties, economic conditions, and component availability.
- Interest expense is exposed to LIBOR fluctuations. The credit facility is subject to borrowing-base availability and lender discretion.
- The nine-month effective tax rate was 110.2%, affected by the low pretax income level and foreign tax-rate differentials. A $74,000 return-to-provision adjustment and other jurisdictional items affected the tax provision.
- Restricted cash is subject to contractual limitations and includes collateral for an employee purchasing-card program and timing-related lockbox deposits.
- The company reports ordinary-course legal proceedings and claims but does not identify a material specific legal contingency in the filing.
- The company adopted accounting guidance on restricted cash, stock-based compensation, and inventory measurement without a material cumulative effect. It planned to adopt the new revenue standard beginning January 1, 2018 and was still evaluating contract, process, control, and disclosure impacts.
Important Facts for Investors to Verify
- Whether the sharp decline in medical backlog and overall backlog persists into the fourth quarter.
- Availability under the borrowing-base formula, covenant compliance, and sensitivity to LIBOR and operating cash flow.
- Whether low sales volume and underutilized capacity cause further gross-margin deterioration.
- The sustainability of the nine-month return to profitability after excluding the Augusta property gain, bad-debt recovery, and other unusual items.
- Customer concentration, receivable collectibility, inventory reserves, and exposure to excess customer inventory.
- The final accounting and business-process impact of adopting the revenue-recognition standard in 2018.
- Execution of the Augusta consolidation and the operational status of equipment acquired under the new capital lease.