# Nortech Systems Inc: Form 10-Q for the period ended Jun 30, 2019

- Company: [Nortech Systems Inc](/companies/nsys.md) (CIK 722313)
- Form: 10-Q
- Filed: 2019-08-14
- Accepted by EDGAR: Aug 14, 2019, 17:08 ET
- Period: 2019-06-30
- Accession: 0001437749-19-016855
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/722313/000143774919016855/nsys20190630_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/722313/000143774919016855/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2019-06-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2019-04-01 to 2019-06-30 | $27.3m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Revenue | 6 months, 2019-01-01 to 2019-06-30 | $55.5m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Cost of revenue | 3 months, 2019-04-01 to 2019-06-30 | $25.0m | us-gaap:CostOfGoodsAndServicesSold |
| Cost of revenue | 6 months, 2019-01-01 to 2019-06-30 | $50.2m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2019-04-01 to 2019-06-30 | $2.3m | us-gaap:GrossProfit |
| Gross profit | 6 months, 2019-01-01 to 2019-06-30 | $5.3m | us-gaap:GrossProfit |
| Operating income | 3 months, 2019-04-01 to 2019-06-30 | −$1.2m | us-gaap:OperatingIncomeLoss |
| Operating income | 6 months, 2019-01-01 to 2019-06-30 | −$1.3m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2019-04-01 to 2019-06-30 | $279.0k | us-gaap:InterestExpense |
| Interest expense | 6 months, 2019-01-01 to 2019-06-30 | $524.0k | us-gaap:InterestExpense |
| Income tax | 3 months, 2019-04-01 to 2019-06-30 | $64.0k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 6 months, 2019-01-01 to 2019-06-30 | $78.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2019-04-01 to 2019-06-30 | −$1.6m | us-gaap:NetIncomeLoss |
| Net income | 6 months, 2019-01-01 to 2019-06-30 | −$1.9m | us-gaap:NetIncomeLoss |
| Operating cash flow | 6 months, 2019-01-01 to 2019-06-30 | −$2.2m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 6 months, 2019-01-01 to 2019-06-30 | $545.0k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Share repurchases | 6 months, 2019-01-01 to 2019-06-30 | $126.0k | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2019-06-30 | $399.0k | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2019-06-30 | $46.8m | us-gaap:AssetsCurrent |
| Total assets | at 2019-06-30 | $65.3m | us-gaap:Assets |
| Current liabilities | at 2019-06-30 | $24.8m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2019-06-30 | $46.1m | us-gaap:Liabilities |
| Long-term debt | at 2019-06-30 | $3.4m | us-gaap:LongTermDebtNoncurrent |
| Current portion of debt | at 2019-06-30 | $878.0k | us-gaap:LongTermDebtCurrent |
| Shareholders' equity | at 2019-06-30 | $19.2m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 16,025 characters.

### Overview

We are a Maple Grove, Minnesota based full-service electronics manufacturing services (“EMS”) contract manufacturer of wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds for a wide range of industries. We provide value added engineering services and technical support including design, testing, prototyping and supply chain management to customers mainly in the aerospace and defense, medical, and industrial equipment markets. We maintain facilities in Bemidji, Blue Earth, Eden Prairie, Mankato, Merrifield, and Milaca, Minnesota; Monterrey, Mexico; and Suzhou, China. All of our facilities are certified to one or more of the ISO/AS standards, including 9001, AS9100 and 13485, with most having additional certifications based on the needs of the customers they serve.

### Results of Operations

The following table presents statements of operations data as percentages of total net sales for the periods indicated:

|  | Three Months Ended June 30, 2019 | 2018 | Six Months Ended June 30, 2019 | 2018 |
| --- | ---: | ---: | ---: | ---: |
| Net Sales | 100.0% | 100.0% | 100.0% | 100.0% |
| Cost of Goods Sold | 91.5 | 86.6 | 90.5 | 87.6 |
| Gross Profit | 8.5 | 13.4 | 9.5 | 12.4 |
| Selling Expenses | 2.9 | 3.6 | 2.8 | 3.8 |
| General and Administrative Expenses | 10.0 | 7.2 | 9.1 | 7.6 |
| Income from Operations | (4.4) | 2.6 | (2.4) | 1.0 |
| Other Expenses | (1.0) | (0.7) | (0.9) | (0.7) |
| Income (Loss) Before Income Taxes | (5.4) | 1.9 | (3.3) | 0.3 |
| Income Tax Expense (Benefit) | 0.2 | 0.5 | 0.1 | 0.4 |
| Net Income (Loss) | (5.6%) | 1.4% | (3.4%) | (0.1%) |

### Net Sales

Net sales were $27.3 million in the second quarter of 2019, as compared to $28.5 million in the second quarter of the prior year, a decrease of $1.2 million or 4.2%. Net sales results were varied by markets, the medical market increased by $1.5 million or 11.6% with medical devices accounting for most of that increase. The industrial market decreased by $3.1 million or 25.8% of sales in the second quarter of 2019 as compared to the same quarter of 2018. Net sales from the aerospace and defense markets increased by $0.4 million or 7.3% in the second quarter of 2019 as compared to the second quarter of 2018.

Net sales were $55.5 million in the six months ended 2019, as compared to $55.0 million in the prior year, an increase of $0.5 million or 0.9%. Net sales results were varied by markets, the medical market increased by 6.2 million, or 27.5% with medical component products accounting for 42% of the increase and medical devices 58%. The industrial market decreased by $5.4 million of sales or 23.3%. Net sales from the aerospace and defense markets decreased $0.4 million or 4.4%.

Net sales by our major EMS industry markets for the three and six months ended June 30, 2019 and 2018 were as follows (in thousands):

|  | Three Months Ended June 30, | Six Months Ended June 30, |
| --- | ---: | ---: |
|  | 2019 2018% | 2019 2018% |
|  | $$ Change | $$ Change |
| Aerospace and Defense | 4,582 4,269 7.3 | 8,827 9,230 (4.4) |
| Medical | 14,024 12,565 11.6 | 28,963 22,715 27.5 |
| Industrial | 8,686 11,704 (25.8) | 17,667 23,040 (23.3) |
| Total Net Sales | 27,292 28,538 (4.4) | 55,457 54,985 0.9 |

Net sales by timing of transfer of goods and services for the three and six months ended June 30, 2019 is as follows (in thousands):

|  | Three Months Ended June 30, 2019 Product/ Service Transferred Over Time | Product Transferred at Point in Time | Noncash Consideration | Total Net Sales by Market |
| --- | ---: | ---: | ---: | ---: |
| Aerospace and Defense | $4,155 | $222 | $205 | $4,582 |
| Medical | 13,145 | 218 | 661 | 14,024 |
| Industrial | 7,428 | 878 | 380 | 8,686 |
| Total net sales | $24,728 | $1,318 | $1,246 | $27,292 |

|  | Six Months Ended June 30, 2019 Product/ Service Transferred Over Time | Product Transferred at Point in Time | Noncash Consideration | Total Net Sales by Market |
| --- | ---: | ---: | ---: | ---: |
| Aerospace and Defense | $8,258 | $242 | $327 | $8,827 |
| Medical | 27,640 | 253 | 1,070 | 28,963 |
| Industrial | 15,568 | 1,475 | 624 | 17,667 |
| Total net sales | $51,466 | $1,970 | $2,021 | $55,457 |

20

Net sales by timing of transfer of goods and services for the three and six months ended June 30, 2018 is as follows (in thousands):

|  | Three Months Ended June 30, 2018 Product/ Service Transferred Over Time | Product Transferred at Point in Time | Noncash Consideration | Total Net Sales by Market |
| --- | ---: | ---: | ---: | ---: |
| Aerospace and Defense | $4,001 | $72 | $196 | $4,269 |
| Medical | 11,934 | 87 | 544 | 12,565 |
| Industrial | 10,023 | 1,206 | 475 | 11,704 |
| Total net sales | $25,958 | $1,365 | $1,215 | $28,538 |

|  | Six Months Ended June 30, 2018 Product/ Service Transferred Over Time | Product Transferred at Point in Time | Noncash Consideration | Total Net Sales by Market |
| --- | ---: | ---: | ---: | ---: |
| Aerospace and Defense | $8,717 | $120 | $393 | $9,230 |
| Medical | 21,201 | 569 | 945 | 22,715 |
| Industrial | 20,089 | 2,049 | 902 | 23,040 |
| Total net sales | $50,007 | $2,738 | $2,240 | $54,985 |

### Backlog

Our 90-day shipment backlog as of June 30, 2019 was $31 million, flat from the beginning of the quarter and a 31.4% increase as compared to the prior year. Backlog for our medical customers has decreased 3.2% from the beginning of the quarter and increased 55.0% from the prior year. The aerospace and defense backlog increased 13.4% from the beginning of the quarter and increased 22.7% from the prior year. Our industrial customers’ backlog decreased 3.3% from the beginning of the quarter and increased 4.1% from the prior year. Our backlog consists of firm purchase orders we expect to ship in the next 90 days, with any remaining amounts to be transferred within 180 days.

90-day shipment backlog by our major EMS industry markets are as follows (in thousands):

|  | Shipment Backlog as of the Period Ended June 30, 2019 | March 31, 2019 | June 30, 2018 |
| --- | ---: | ---: | ---: |
| Aerospace and Defense | $6,833 | $6,027 | $5,568 |
| Medical | 16,701 | 17,256 | 10,776 |
| Industrial | 7,863 | 8,130 | 7,552 |
| Total Backlog | $31,397 | $31,413 | $23,896 |

Our 90-day backlog varies due to order size, manufacturing delays, contract terms and conditions and timing from customer delivery schedules and releases. These variables cause inconsistencies in comparing the backlog from one period to the next. Our total shipment backlog was $58.7 million at June 30, 2019 compared to $40.1 million at June 30, 2018.

### Gross Profit

Gross profit as a percent of net sales for the three months ended June 30, 2019 and 2018 was 8.5% and 13.4%, respectively. Gross profit as a percentage of sales for the six months ended June 30, 2019 and 2018 was 9.5% and 12.4%, respectively. The decline in gross profit both comparisons was driven by product mix and operational inefficiencies due to component shortages.

### Selling Expense

Selling expenses for the three months ended June 30, 2019 and 2018 was $0.8 million or 2.9% of sales and $1.0 million or 3.6% of sales, respectively. Selling expense for the six months ended June 30, 2019 and 2018 was $1.6 million or 2.8% of sales and $2.1 million or 3.8% of sales, respectively. The decrease in both the three and six month periods is due to lower sales incentives and timing of events.

### General and Administrative Expense

General and administrative expenses for the three months ended June 30, 2019 and 2018 were $2.7 million or 10.0% of sales and $2.0 million or 7.2% of sales, respectively. General and administrative expenses for the six months ended June 30, 2019 and 2018 were $5.0 million or 9.1% of sales and $4.2 million or 7.6% of sales, respectively. The increase in both comparisons was due to additional spend related to our recently implemented ERP system and one-time expenditures to improve operations.

### Loss from Operations

Second quarter 2019 loss from operations was $1.2 million compared to income of $0.7 million for the second quarter in 2018. The increase in loss from operations for the period was due to the gross profit decline and higher general and administrative expenses.

Loss from operations for the first six months in 2018 was $1.3 million as compared to income of $0.6 million for the same comparable period in 2018. The decrease to a loss from operations for the period was due to the gross profit decline and higher general and administrative expenses.

### Income Taxes

On a quarterly basis, we estimate what our effective tax rate will be for the full fiscal year and record a quarterly income tax provision based on the anticipated rate. As the year progresses, we refine our estimate based on the facts and circumstances, including discrete events, by each tax jurisdiction. Our effective tax rate for the three and six months ended June 30, 2019 was (4%) and the rate for the three and six months ended June 30, 2018 was 26% and 101%, respectively.

### Net Income (Loss)

Net loss for the three and six months ended June 30, 2019 was $1.6 million and $1.9 million, respectively. Net income for the three months ended June 30, 2018 was $0.4 million and net loss for six month ended June 30, 2018 was $0.2 million.

### Liquidity and Capital Resources

Net cash used in operating activities for the six months ended June 30, 2019 was $2.2 million. The increase in accounts receivable and unbilled revenue and decrease in accounts payable drove this cash outflow, partially offset by a decrease inventory.

Net cash provided by operating activities for the six months ended June 30, 2018 was $2.7 million. The noncash addback of depreciation and amortization, along with an increase in accounts payable, has positively impacted cash flows, offset by an increase in accounts receivable.

We have satisfied our liquidity needs over the past several years with cash flows generated from operations and a bank operating line of credit. We have a credit agreement with Bank of America (BofA) which was entered into on June 15, 2017 and amended on December 29, 2017 and provides for a line of credit arrangement of $16.0 million that expires on June 15, 2022. The credit arrangement also has a $5.0 million real estate term note outstanding with a maturity date of June 15, 2022.

Both the line of credit and real estate term notes are subject to fluctuations in the LIBOR rates. The line of credit and real estate term notes with BofA contain certain covenants which, among other things, require us to adhere to regular reporting requirements, abide by annual shareholder dividend limitations, maintain certain financial performance, and limit the amount of annual capital expenditures. The availability under our line is subject to borrowing base requirements, and advances are at the discretion of the lender. The line of credit is secured by substantially all of our assets.

On June 30, 2019, we had outstanding advances of $12.3 million under the line of credit and unused availability of $3.7 million supported by our borrowing base. We believe our financing arrangements and cash flows to be provided by operations will be sufficient to satisfy our future working capital needs. Our working capital was $21.9 million and $21.0 million as of June 30, 2019 and December 31, 2018, respectively.

The BofA credit agreement as amended provides for, among other things, a fixed charge coverage ratio of not less than (i) 1.0 to 1.0 for each period of four fiscal quarters, commencing with the period of four fiscal quarters ending December 31, 2018. As of June 30, 2019 we did not meet the fixed charge cover ratio which was waived by BofA in the second amendment to the credit agreement received on August 13, 2019.

In the second quarter of 2019, our China operations entered into a line of credit arrangement with China Construction Bank which provides for a line of credit arrangement of 6,000,000 Renminbi (RMB) that expires on April 3, 2021. This line of credit bears an interest rate of 6% and we had borrowings of 3,006,204 RMB ($437) at June 30, 2019.

### Off-Balance Sheet Arrangements

We have not engaged in any off-balance sheet activities as defined in Item 303(a)(4) of Regulation S-K.

### Critical Accounting Policies and Estimates

Our significant accounting policies and estimates are summarized in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2018. Some of our accounting policies require us to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. Such judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, known trends in our industry, terms of existing contracts and other information from outside sources, as appropriate. Actual results could differ from these estimates.

### Forward-Looking Statements

Those statements in the foregoing report that are not historical facts are forward-looking statements made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements generally will be accompanied by words such as “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “intend,” “possible,” “potential,” “predict,” “project,” or other similar words that convey the uncertainty of future events or outcomes. Although we believe these forward-looking statements are reasonable, they are based upon a number of assumptions concerning future conditions, any or all of which may ultimately prove to be inaccurate. Forward-looking statements involve a number of risks and uncertainties. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation:

|  |  |
| --- | --- |
| ♦ | General economic, financial and business conditions that could affect our financial condition and results of operations; |
| ♦ | Volatility in the marketplace which may affect market supply and demand for our products or currency exchange rates; |
| ♦ | Increased competition from within the EMS industry or the decision of OEMs to cease or limit outsourcing; |
| ♦ | Changes in the reliability and efficiency of operating facilities or those of third parties; |
| ♦ | Risks related to availability of labor; |
| ♦ | Increase in certain raw material costs such as copper and oil; |
| ♦ | Commodity and energy cost instability; |
| ♦ | Risks related to quality, regulatory, securities laws and debt covenant noncompliance; |
| ♦ | Loss of a major customer or changes to customer orders; |
| ♦ | Increased or unanticipated costs related to compliance with securities and environmental regulation; and |
| ♦ | Disruption of global or local information management systems due to natural disaster or cyber-security incident. |

The factors identified above are believed to be important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement made by us. Discussion of these factors is also incorporated in Part I, Item 1A, “Risk Factors,” and should be considered an integral part of Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Unpredictable or unknown factors not discussed herein could also have material adverse effects on forward-looking statements. All forward-looking statements included in this Form 10-Q are expressly qualified in their entirety by the forgoing cautionary statements. We undertake no obligations to update publicly any forward-looking statement (or its associated cautionary language) whether as a result of new information or future events.

Please refer to forward-looking statements and risks as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

## Controls and procedures

As filed, 1,550 characters.

### Evaluation of Disclosure Controls and Procedures

In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q, our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act). These controls and procedures are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon their evaluation of these disclosure controls and procedures as of the date of the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective.

### Changes in Internal Control Over Financial Reporting

Except for the implementation of certain internal controls related to the adoption of the new lease standard (ASC 842), there was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 627 characters.

We are affected by the risks specific to us as well as factors that affect all businesses operating in a global market. The significant factors known to us that could materially adversely affect our business, financial condition or operating results or could cause our actual results to differ materially from our expectations are described in our annual report on Form 10-K for the fiscal year ended under the heading “Part I – Item 1A.Risk Factors.” Other than as noted below, there have been no material changes in the risk factors from those disclosed in the Annual Report on Form 10-K for the year ended December 31, 2017.

Filed Aug 14, 2019.
Source: SEC EDGAR, the filing index for accession 0001437749-19-016855. Last ingested by Listed: Oct 24, 2026, 14:55 ET. No prices; not investment advice.