Nortech Systems Incorporated — Q1 2017 Form 10-Q Summary
Business Context and Reporting Period
Nortech Systems is an electronics manufacturing services provider producing wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds, with engineering and supply-chain services. Its primary markets are medical, industrial, and aerospace and defense. The filing covers the three months ended March 31, 2017, and was filed May 11, 2017. The company is a smaller reporting company.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net sales | $28.318 million | $28.950 million |
| Gross profit | $3.092 million; 10.9% margin | $3.379 million; 11.7% margin |
| Income from operations | $120,000 | $221,000 |
| Income before taxes | $(19,000) | $89,000 |
| Net income (loss) | $(15,000); $(0.01) per share | $63,000; $0.02 per share |
| Cash flow from operating activities | $(255,000) | $1.316 million |
| Cash at period end | $205,000 | $741,000 |
At March 31, 2017, total assets were $55.812 million and shareholders’ equity was $22.297 million. Current assets were $40.338 million versus current liabilities of $20.827 million, producing working capital of approximately $19.5 million.
Total debt consisted of $8.050 million outstanding under the bank line of credit and $5.569 million of net long-term debt, including current maturities. The $15.0 million revolving credit facility had approximately $4.9 million of net unused availability, subject to borrowing-base requirements. The line of credit bears interest at approximately 3.4% at quarter-end and is secured by substantially all company assets.
Cash flow from investing activities was $370,000, primarily reflecting $668,000 of proceeds from the sale of the Augusta facility, partly offset by capital expenditures and a $100,000 intangible-asset purchase. Financing activities used $168,000, as $735,000 of line borrowings and $123,000 of new long-term debt were more than offset by $1.026 million of principal repayments.
Material Changes Versus the Prior Comparable Period
- Revenue declined 2.2% year over year, reflecting a $2.3 million, or 17.1%, decline in industrial sales and a $461,000, or 12.1%, decline in aerospace and defense sales. Medical sales increased $2.1 million, or 18.0%.
- Gross margin declined 80 basis points to 10.9%, primarily because of lower plant utilization, Augusta closure costs, and product-transfer costs.
- Operating income declined $101,000 despite a $354,000 gain on the sale of the Augusta building, as gross-margin pressure and higher general and administrative expenses more than offset lower selling expenses.
- The company moved from $63,000 of net income to a $15,000 net loss. Interest expense increased to $140,000 from $132,000.
- Operating cash flow declined from $1.316 million provided to $255,000 used, primarily reflecting higher inventory and timing-related working-capital changes.
- General and administrative expense increased to $2.120 million from $1.854 million, driven by professional fees, information-systems investments, and the company’s China operations.
- The cash conversion cycle improved to 78 days from 83 days, although days in inventory increased to 78 from 76 and days in receivables increased to 54 from 53.
Guidance, Outlook, Risks, and Unusual Items
Management stated that first-quarter revenue softness was expected because customers began the year with lower demand and backlog. The 90-day backlog was $23.457 million at March 31, 2017, up 14.5% from December 31, 2016 and 15.9% from March 31, 2016. Management expected a major portion of this backlog to convert to revenue in the following quarter. The filing does not provide formal full-year revenue or earnings guidance.
Medical backlog increased 33.6% year over year, industrial backlog increased 24.0%, and aerospace and defense backlog decreased 22.7%. Management expects increased funding for business development and marketing activities.
The Augusta manufacturing operation was closed January 31, 2017 and consolidated into other facilities. The Augusta building was sold March 31, 2017 for $715,000, generating a $354,000 gain after related expenses. Net proceeds of approximately $668,000 were applied to the related real estate debt.
The company was in compliance with its debt covenants at March 31, 2017. Its fixed-charge coverage ratio was 1.43 to 1.00 versus a required minimum of 1.05 to 1.00. The credit agreement was amended in January 2017, and the revolving facility expires, if not renewed, on May 31, 2018. Debt is exposed to LIBOR fluctuations.
Principal risks include customer concentration, order cancellations, demand volatility, competition, labor availability, raw-material and energy costs, component availability, facility execution, customer financial difficulty, and general economic conditions. One customer accounted for approximately 26.7% of first-quarter sales and 19.1% of accounts receivable at March 31, 2017. The company also had approximately $2.839 million of future minimum operating-lease payments and $49,500 of uncertain tax positions.
The company adopted applicable inventory and stock-compensation accounting updates in the quarter without a material financial-statement impact. No goodwill or long-lived-asset impairment was recorded, and no material changes in internal control were reported.
Investor Verification Points
- Verify whether the improved backlog converted into second-quarter revenue and whether medical-market growth continued.
- Assess whether plant utilization, Augusta transition costs, and product-transfer expenses improve gross margin.
- Monitor operating cash flow, inventory levels, accounts payable timing, and the cash conversion cycle.
- Review borrowing-base availability, LIBOR sensitivity, covenant compliance, and the May 2018 credit-facility expiration.
- Evaluate customer concentration and the year-over-year decline in aerospace and defense backlog.
- Confirm the effect of the Augusta closure and facility consolidation on recurring operating costs versus the nonrecurring $354,000 gain.