Nortech Systems Incorporated — Form 10-Q Summary
Business Context and Reporting Period
Quarterly report for the three and six months ended June 30, 2016, filed August 3, 2016. Nortech is an electronics manufacturing services provider serving aerospace and defense, medical, and industrial equipment markets, with operations in the United States, Mexico, and China. The company reports one Contract Manufacturing segment.
Financial Results and Key Metrics
| Metric | Q2 2016 | Q2 2015 | Six Months 2016 | Six Months 2015 |
|---|---|---|---|---|
| Net sales | $28.9 million | $26.8 million | $57.9 million | $53.3 million |
| Gross profit | $3.1 million | $2.4 million | $6.5 million | $5.3 million |
| Gross margin | 10.8% | 9.1% | 11.2% | 9.9% |
| Operating income (loss) | $(0.1) million | $(0.5) million | $0.1 million | $(0.7) million |
| Net loss | $(0.2) million | $(0.4) million | $(0.1) million | $(0.6) million |
| Loss per share | $(0.07) | $(0.14) | $(0.04) | $(0.21) |
| Operating cash flow | Not separately provided | Not separately provided | $1.1 million | $(0.1) million |
Medical revenue increased 40% in the quarter and 33% year to date, including $2.0 million and $3.6 million, respectively, from Devicix engineering services. Aerospace and defense revenue increased 20% in the quarter and 25% year to date. Industrial revenue declined 15% in the quarter and 11% year to date.
At June 30, 2016, cash was $13,536, accounts receivable were $18.1 million, inventories were $21.5 million, and total assets were $57.7 million. Working capital was approximately $20.6 million. The cash conversion cycle improved to 83 days from 96 days in the prior-year period, primarily because of extended vendor payment terms.
Capital expenditures were $1.4 million during the first six months. Cash flow from investing activities was $(1.4) million, while financing activities provided $0.3 million. Ending cash was $13,536, compared with $68,783 at June 30, 2015.
Total liabilities were $35.5 million, including $8.5 million outstanding under the revolving line of credit, $1.5 million of current debt maturities, and $5.5 million of long-term debt net of current maturities. The $15.0 million line of credit had approximately $6.1 million of unused borrowing-base availability and expires, if not renewed, on May 31, 2018. The fixed-charge coverage ratio was 1.21 to 1.00 versus a required minimum of 1.15 to 1.00.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 8%; six-month sales increased 9%.
- Gross margin expanded 170 basis points in the quarter and 130 basis points year to date, driven by volume and product/service mix, including Devicix engineering services.
- Second-quarter operating loss narrowed to $110,000 from $483,000; six-month results improved to $111,000 of operating income from a $685,000 loss.
- Net loss declined to $180,000 in the quarter and $117,000 year to date, compared with $378,000 and $571,000, respectively, in the prior-year periods.
- General and administrative expense increased due primarily to Devicix-related expenses and amortization. More than $200,000 of startup costs for the new Asia manufacturing facility reduced second-quarter operating profit.
- The 90-day backlog increased to $22.7 million, up 17% from the prior year and 12% from the beginning of the quarter. Medical backlog increased materially, while industrial backlog remained below the prior year.
- The Devicix acquisition-related contingent consideration liability was reduced by $45,000 to an estimated $806,000 because the first revenue target was only partially met.
Guidance, Outlook, Risks, and Unusual Items
Management reported favorable prospects for continued medical-market growth, stabilization and recovery in defense, and increased emphasis on engineering design, prototyping, and box-build services. Industrial demand remained weak, particularly in transportation, semiconductor equipment, and oil and gas-related markets. Management expected a 33% effective tax rate for 2016, compared with 36% in 2015, primarily due to the federal research and development credit.
On August 1, 2016, after quarter-end, Nortech announced plans to close its Augusta, Wisconsin manufacturing operation by the end of 2016 and consolidate production at other facilities. Approximately 50 employees are expected to be affected. Management stated that customer service would continue without interruption and that the consolidation should improve asset utilization and cost leverage. The filing does not provide an estimated closure or restructuring cost.
Principal risks include customer concentration, dependence on firm orders and market demand, competition, labor availability, raw-material and energy-cost volatility, availability of components, facility reliability, economic conditions, variable-rate debt exposure, and compliance with debt covenants. One customer’s divisions represented approximately 24% of second-quarter sales and 18% of accounts receivable at June 30, 2016.
The company had approximately $3.3 million of future minimum operating lease payments after June 30, 2016. No impairment expense or material legal proceeding was reported. Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the Augusta facility closure is completed on schedule and the actual restructuring, severance, relocation, and impairment costs.
- Whether medical and defense growth, backlog conversion, and Devicix engineering revenue offset continued industrial-market weakness.
- Compliance with the 1.15-to-1.00 fixed-charge coverage covenant and continued availability under the asset-secured revolving credit facility.
- Working-capital requirements, particularly the elevated inventory balance and reliance on extended accounts-payable terms.
- The impact of Asia facility startup costs and future operating performance of that facility.
- The amount and timing of Devicix earnout payments, with contingent consideration capped at $2.5 million and estimated at $806,000 at June 30, 2016.
- The effect of pending accounting standards for stock compensation, leases, and revenue recognition.