Nortech Systems Incorporated — Q2 2017 Form 10-Q Summary
Business Context and Reporting Period
Nortech is an electronics manufacturing services company serving medical, aerospace and defense, and industrial markets. It provides design, testing, prototyping, manufacturing, repair, and supply-chain services through facilities in the United States, Mexico, and China. This unaudited quarterly filing covers the three and six months ended June 30, 2017, with comparisons to the same periods of 2016.
Financial Performance and Key Metrics
| Metric | Q2 2017 | Q2 2016 | Six Months 2017 | Six Months 2016 |
|---|---|---|---|---|
| Net sales | $30.1 million | $28.9 million | $58.5 million | $57.9 million |
| Gross profit | $3.4 million | $3.1 million | $6.5 million | $6.5 million |
| Gross margin | 11.2% | 10.8% | 11.0% | 11.2% |
| Operating income | $0.1 million | $(0.1) million | $0.2 million | $0.1 million |
| Net loss | $(15,667) | $(180,183) | $(30,319) | $(117,257) |
| Loss per share | $(0.01) | $(0.07) | $(0.01) | $(0.04) |
- Medical revenue increased 14.1% in Q2 and 16.7% year to date. Aerospace and defense revenue declined 11.2% in Q2 and 13.8% year to date; industrial revenue declined 0.9% in Q2 and 9.2% year to date.
- Q2 gross margin improved 40 basis points, primarily from customer mix and the Suzhou operation reaching full production. Year-to-date gross margin declined 20 basis points.
- Operating cash flow was $1.3 million for the first six months, compared with $1.1 million in 2016.
- Investing activities provided $0.2 million, including $0.7 million of proceeds from the Augusta facility sale, partly offset by $0.4 million of capital expenditures and a $0.1 million intangible-asset purchase.
- Financing activities used $1.2 million, including net debt repayments, debt extinguishment costs, and debt issuance costs.
- Cash and restricted cash totaled $0.5 million at June 30, 2017, consisting of $0.2 million unrestricted cash and $0.3 million restricted cash.
- Working capital was $19.2 million, unchanged from December 31, 2016. The cash conversion cycle improved to 76 days for the first six months from 83 days in the comparable period.
Balance Sheet, Debt, and Liquidity
- Total assets were $55.9 million and total liabilities were $33.6 million at June 30, 2017.
- Accounts receivable were $17.1 million and inventories were $21.6 million. Inventory increased from $20.7 million at year-end 2016.
- Debt included $6.6 million outstanding under the Bank of America line of credit, $1.1 million of current long-term debt maturities, and $4.9 million of long-term debt net of current maturities.
- The new Bank of America agreement, effective June 15, 2017, provides a $16.0 million revolving credit facility and a $5.0 million real estate term note, both maturing June 15, 2022. The line was secured by substantially all company assets.
- Unused borrowing-base-supported availability was $7.4 million at June 30, 2017. The company was in compliance with the minimum 1.00-to-1.00 fixed-charge coverage covenant.
Material Changes, Outlook, and Unusual Items
- The company replaced its Wells Fargo financing arrangement with Bank of America. The refinancing produced a $174,834 loss on extinguishment of debt and approximately $0.3 million of debt issuance costs.
- Management stated that excluding debt extinguishment costs, the company would have reported approximately $0.2 million of Q2 net income and $0.1 million of year-to-date net income.
- A $0.3 million bad-debt bankruptcy settlement recovery supported Q2 operating results.
- The Augusta, Wisconsin manufacturing facility closed January 31, 2017, with operations consolidated into other facilities. The building was sold for $715,000, generating a net gain of approximately $354,000; net proceeds of approximately $668,000 were applied to debt.
- Backlog was $23.7 million at June 30, 2017, up 1.1% from March 31 and 4.2% from June 30, 2016. Management expects a major portion of the 90-day backlog to convert to revenue in the following quarter, but notes that backlog can vary with customer releases, delivery timing, contract terms, and manufacturing delays.
- No formal earnings or revenue guidance was provided. Management stated that existing financing arrangements and expected operating cash flows should be sufficient for future working-capital needs.
- The company appointed a Chief Operating Officer during the quarter to oversee global manufacturing, engineering, sourcing, and business development.
- Key risks identified include market volatility, competition, facility and labor constraints, raw-material and energy costs, customer concentration, order cancellations, customer financial difficulties, component availability, and general economic conditions. One customer’s divisions represented approximately 26.7% of Q2 and year-to-date sales.
- The company reported no material off-balance-sheet arrangements and stated that disclosure controls were effective. It was subject to ordinary-course legal proceedings and claims.
Important Facts for Investors to Verify
- Assess whether medical-market growth and improved China utilization can offset continued weakness in aerospace, defense, and industrial demand.
- Monitor the company’s low profitability, inventory level, customer concentration, and reliance on borrowing-base availability.
- Verify compliance with Bank of America financial covenants and the effect of LIBOR-linked interest rates on debt service.
- Separate recurring operating performance from the bad-debt recovery, Augusta facility gain, and debt-refinancing costs.
- Review the sustainability and conversion timing of the $23.7 million backlog.
- Evaluate the company’s unusually high reported effective tax rates for 2017 and the related foreign tax benefits and uncertain tax positions.
- Confirm the accounting and disclosure effects of the planned January 1, 2018 adoption of the new revenue-recognition standard.