UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
NORTECH SYSTEMS INCORPORATED
Commission file number 0-13257
State of Incorporation: Minnesota
IRS Employer Identification No. 41-1681094
Executive Offices: 7550 Meridian Circle N., Suite # 150, Maple Grove, MN 55369
Telephone number: (952) 345-2244
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
Trading Symbol(s) |
Name of each exchange on which registered |
Common Stock, par value $.01 per share |
NSYS |
NASDAQ Capital Market |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ☐ |
|
Accelerated Filer ☐ |
Non-accelerated Filer ☒ |
|
Smaller Reporting Company ☒ |
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Number of shares of $.01 par value common stock outstanding at November 8, 2019 was 2,657,314.
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) |
(UNAUDITED) |
(IN THOUSANDS, EXCEPT SHARE DATA) |
THREE MONTHS ENDED |
NINE MONTHS ENDED |
|||||||||||||||
SEPTEMEBR 30, |
SEPTEMBER 30, |
|||||||||||||||
2019 |
2018 |
2019 |
2018 |
|||||||||||||
Net Sales |
$ | 30,058 | $ | 29,558 | $ | 85,515 | $ | 84,543 | ||||||||
Cost of Goods Sold |
26,423 | 26,171 | 76,594 | 74,311 | ||||||||||||
Gross Profit |
3,635 | 3,387 | 8,921 | 10,232 | ||||||||||||
Operating Expenses |
||||||||||||||||
Selling Expenses |
589 | 717 | 2,147 | 2,792 | ||||||||||||
General and Administrative Expenses |
2,333 | 2,021 | 7,374 | 6,177 | ||||||||||||
Total Operating Expenses |
2,922 | 2,738 | 9,521 | 8,969 | ||||||||||||
Income (Loss) From Operations |
713 | 649 | (600 | ) | 1,263 | |||||||||||
Other Expense |
||||||||||||||||
Interest Expense |
(256 | ) | (170 | ) | (780 | ) | (551 | ) | ||||||||
Income (Loss) Before Income Taxes |
457 | 479 | (1,380 | ) | 712 | |||||||||||
Income Tax Expense |
44 | 115 | 122 | 350 | ||||||||||||
Net Income (Loss) |
$ | 413 | $ | 364 | $ | (1,502 | ) | $ | 362 | |||||||
Net Income (Loss) Per Common Share: |
||||||||||||||||
Basic (in dollars per share) |
$ | 0.16 | $ | 0.14 | $ | (0.56 | ) | $ | 0.13 | |||||||
Weighted Average Number of Common Shares Outstanding - Basic (in shares) |
2,657,911 | 2,680,684 | 2,667,754 | 2,698,950 | ||||||||||||
Diluted (in dollars per share) |
$ | 0.16 | $ | 0.14 | $ | (0.56 | ) | $ | 0.13 | |||||||
Weighted Average Number of Common Shares Outstanding - Diluted (in shares) |
2,657,911 | 2,682,901 | 2,667,754 | 2,702,503 | ||||||||||||
Other comprehensive income (loss) |
||||||||||||||||
Foreign currency translation |
(56 | ) | (83 | ) | (56 | ) | (137 | ) | ||||||||
Comprehensive income (loss), net of tax |
$ | 357 | $ | 281 | $ | (1,558 | ) | $ | 225 |
See Accompanying Condensed Notes to Condensed Consolidated Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS |
(IN THOUSANDS, EXCEPT SHARE DATA) |
SEPTEMBER 30, |
DECEMBER 31, |
|||||||
2019 |
2018(1) | |||||||
|
(Unaudited) |
|||||||
ASSETS | ||||||||
Current Assets |
||||||||
Cash |
$ | 160 | $ | 480 | ||||
Restricted Cash |
1,794 | 467 | ||||||
Accounts Receivable, less allowances of $323 and $222 |
20,135 | 20,093 | ||||||
Inventories |
16,941 | 17,004 | ||||||
Contract Assets |
7,211 | 6,431 | ||||||
Prepaid Expenses and Other Current Assets |
2,019 | 1,381 | ||||||
Total Current Assets |
48,260 | 45,856 | ||||||
Property and Equipment, Net |
9,710 | 10,178 | ||||||
Operating Lease Assets |
5,018 | - | ||||||
Goodwill |
2,375 | 2,375 | ||||||
Other Intangible Assets, Net |
1,397 | 1,523 | ||||||
Other Non Current Assets |
19 | 28 | ||||||
Total Assets |
$ | 66,779 | $ | 59,960 | ||||
LIABILITIES AND SHAREHOLDERS' EQUITY |
||||||||
Current Liabilities |
||||||||
Current Maturities of Long-Term Debt |
$ | 444 | $ | 780 | ||||
Current Portion of Finance Lease Obligation |
476 | 337 | ||||||
Current Portion of Operating Lease Obligations |
841 | - | ||||||
Accounts Payable |
18,384 | 18,142 | ||||||
Accrued Payroll and Commissions |
2,626 | 2,747 | ||||||
Other Accrued Liabilities |
2,845 | 2,886 | ||||||
Total Current Liabilities |
25,616 | 24,892 | ||||||
Long-Term Liabilities |
||||||||
Long Term Line of Credit |
12,430 | 9,264 | ||||||
Long-Term Debt, Net |
3,295 | 3,624 | ||||||
Long Term Finance Lease Obligation, Net |
1,168 | 951 | ||||||
Long-Term Operating Lease Obligation, Net |
4,517 | - | ||||||
Other Long-Term Liabilities |
118 | 139 | ||||||
Total Long-Term Liabilities |
21,528 | 13,978 | ||||||
Total Liabilities |
47,144 | 38,870 | ||||||
Commitments and Contingencies |
||||||||
Shareholders' Equity |
||||||||
Preferred Stock, $1 par value; 1,000,000 Shares Authorized: 250,000 Shares Issued and Outstanding |
250 | 250 | ||||||
Common Stock - $0.01 par value; 9,000,000 Shares Authorized: 2,686,328 and 2,739,250 Shares Issued and Outstanding, respectively |
27 | 27 | ||||||
Additional Paid-In Capital |
15,713 | 15,610 | ||||||
Accumulated Other Comprehensive Loss |
(289 | ) | (233 | ) | ||||
Retained Earnings |
3,934 | 5,436 | ||||||
Total Shareholders' Equity |
19,635 | 21,090 | ||||||
Total Liabilities and Shareholders' Equity |
$ | 66,779 | $ | 59,960 |
See Accompanying Condensed Notes to Condensed Consolidated Financial Statements
(1) The balance sheet at December 31, 2018 has been derived from the audited financial statements at that date
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS |
(UNAUDITED) |
(IN THOUSANDS) |
NINE MONTHS ENDED |
||||||||
SEPTEMBER 30, |
||||||||
2019 |
2018 |
|||||||
Cash Flows From Operating Activities |
||||||||
Net (Loss) Income |
$ | (1,502 | ) | $ | 362 | |||
Adjustments to Reconcile Net (Loss) Income to Net Cash |
||||||||
Provided by (Used in) Operating Activities |
||||||||
Depreciation and Amortization |
1,648 | 1,655 | ||||||
Compensation on Stock-Based Awards |
226 | 80 | ||||||
Deffered Taxes |
1 | 1 | ||||||
Change in Accounts Receivable Allowance |
101 | (5 | ) | |||||
Change in Inventory Reserves |
285 | 118 | ||||||
Changes in Operating Assets and Liabilities: |
||||||||
Changes in Current Operating Items | ||||||||
Accounts Receivable |
(158 | ) | (1,619 | ) | ||||
Inventories |
(237 | ) | (1,959 | ) | ||||
Contract Assets |
(780 | ) | (617 | ) | ||||
Prepaid Expenses and Other Current Assets |
(641 | ) | (278 | ) | ||||
Accounts Payable |
663 | 4,913 | ||||||
Accrued Payroll and Commissions |
(120 | ) | (374 | ) | ||||
Other Accrued Liabilities |
281 | 287 | ||||||
Net Cash (Used in) Provided by Operating Activities |
(233 | ) | 2,564 | |||||
Cash Flows from Investing Activities |
||||||||
Proceeds from Sale of Property and Equipment |
- | 17 | ||||||
Purchase of Intangible Asset |
(37 | ) | (3 | ) | ||||
Purchases of Property and Equipment |
(785 | ) | (999 | ) | ||||
Net Cash Used in Investing Activities |
(822 | ) | (985 | ) | ||||
Cash Flows from Financing Activities |
||||||||
Net Change in Line of Credit |
3,165 | (445 | ) | |||||
Principal Payments on Long-Term Debt |
(728 | ) | (819 | ) | ||||
Principal Payments on Finance Leases |
(251 | ) | (231 | ) | ||||
Stock option exercises |
7 | - | ||||||
Share Repurchases |
(130 | ) | (229 | ) | ||||
Net Cash Provided By (Used In) Financing Activities |
2,063 | (1,724 | ) | |||||
Effect of Exchange Rate Changes on Cash |
(2 | ) | (1 | ) | ||||
Net Change in Cash |
1,006 | (146 | ) | |||||
Cash - Beginning of Period |
948 | 779 | ||||||
Cash - Ending of Period |
$ | 1,954 | $ | 633 | ||||
Reconciliation of cash and restricted cash reported within the condensed consolidated balance sheets |
||||||||
Cash |
$ | 160 | $ | 397 | ||||
Restricted Cash |
1,794 | 236 | ||||||
Total cash and restricted cash reported in the condensed consolidated statements of cash flows |
$ | 1,954 | $ | 633 | ||||
Supplemental Disclosure of Cash Flow Information: |
||||||||
Cash Paid During the Period for Interest |
$ | 739 | $ | 507 | ||||
Cash Paid (Refunded) During the Period for Income Taxes |
(83 | ) | 167 | |||||
Supplemental Noncash Investing and Financing Activities: |
||||||||
Property and Equipment Purchases in Accounts Payable |
30 | 304 | ||||||
Equipment Acquired under Finance Lease |
607 | 100 |
See Accompanying Condensed Notes to Condensed Consolidated Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY |
(UNAUDITED) |
(IN THOUSANDS) |
Preferred |
Common |
Additional Paid-In |
Accumulated Other Comprehensive |
Retained Income |
Total Shareholders' Equity |
|||||||||||||||||||
BALANCE JUNE 30, 2018 |
250 | 27 | 15,619 | (155 | ) | 5,268 | 21,009 | |||||||||||||||||
Net Income |
- | - | - | - | 364 | 364 | ||||||||||||||||||
Cumulative Adjustment |
- | - | - | - | - | - | ||||||||||||||||||
Foreign currency translation adjustment |
- | - | - | (83 | ) | - | (83 | ) | ||||||||||||||||
Compensation on stock-based awards |
- | - | 35 | - | - | 35 | ||||||||||||||||||
Share repurchases |
- | - | (42 | ) | - | - | (42 | ) | ||||||||||||||||
BALANCE SEPTEMBER 30, 2018 |
$ | 250 | $ | 27 | $ | 15,612 | $ | (238 | ) | $ | 5,632 | $ | 21,283 | |||||||||||
BALANCE DECEMBER 31, 2017 |
250 | 27 | 15,760 | (101 | ) | 3,889 | 19,825 | |||||||||||||||||
Net Income |
- | - | - | - | 362 | 362 | ||||||||||||||||||
Cumulative Adjustment |
- | - | - | - | 1,381 | 1,381 | ||||||||||||||||||
Foreign currency translation adjustment |
- | - | - | (137 | ) | - | (137 | ) | ||||||||||||||||
Compensation on stock-based awards |
- | - | 80 | - | - | 80 | ||||||||||||||||||
Share repurchases |
- | - | (228 | ) | - | - | (228 | ) | ||||||||||||||||
BALANCE SEPTEMBER 30, 2018 |
$ | 250 | $ | 27 | $ | 15,612 | $ | (238 | ) | $ | 5,632 | $ | 21,283 | |||||||||||
BALANCE JUNE 30, 2019 |
$ | 250 | $ | 27 | $ | 15,682 | $ | (233 | ) | $ | 3,521 | $ | 19,247 | |||||||||||
Net Income |
- | - | - | - | 413 | 413 | ||||||||||||||||||
Foreign currency translation adjustment |
- | - | - | (56 | ) | - | (56 | ) | ||||||||||||||||
Compensation on stock-based awards |
- | - | 35 | - | - | 35 | ||||||||||||||||||
Share repurchases |
- | - | (4 | ) | - | - | (4 | ) | ||||||||||||||||
BALANCE SEPTEMBER 30, 2019 |
$ | 250 | $ | 27 | $ | 15,713 | $ | (289 | ) | $ | 3,934 | $ | 19,635 | |||||||||||
BALANCE DECEMBER 31, 2018 |
$ | 250 | $ | 27 | $ | 15,610 | $ | (233 | ) | $ | 5,436 | $ | 21,090 | |||||||||||
Net Loss |
- | - | - | - | (1,502 | ) | (1,502 | ) | ||||||||||||||||
Foreign currency translation adjustment |
- | - | - | (56 | ) | - | (56 | ) | ||||||||||||||||
Stock option exercises |
- | - | 7 | - | - | 7 | ||||||||||||||||||
Compensation on stock-based awards |
- | - | 226 | - | - | 226 | ||||||||||||||||||
Share repurchases |
- | - | (130 | ) | - | - | (130 | ) | ||||||||||||||||
BALANCE SEPTEMBER 30, 2019 |
$ | 250 | $ | 27 | $ | 15,713 | $ | (289 | ) | $ | 3,934 | $ | 19,635 |
See Accompanying Condensed Notes to Condensed Consolidated Financial Statements
CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements for the interim periods have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the financial information and footnotes required by GAAP for complete financial statements, although we believe the disclosures are adequate to make the information presented not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2018. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year or for any other interim period. In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In preparing these condensed consolidated financial statements, we have made our best estimates and judgments of certain amounts included in the condensed consolidated financial statements, giving due consideration to materiality. Changes in the estimates and assumptions used by us could have a significant impact on our financial results, since actual results could differ from those estimates.
Principles of Consolidation
The condensed consolidated financial statements include the accounts of Nortech Systems Incorporated and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Revenue Recognition
Our revenue is comprised of product, engineering services and repair services. All revenue is recognized when the Company satisfies its performance obligation(s) under the contract by transferring the promised product or service to our customer either when (or as) our customer obtains control of the product or service, with the majority of our revenue being recognized over time including goods produced under contract manufacturing agreements and services revenue. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. A contract’s transaction price is allocated to each distinct performance obligation. The majority of our contracts have a single performance obligation. Revenue is recorded net of returns, allowances and customer discounts. Our net sales for services were less than 10% of our total sales for all periods presented, and accordingly, are included in net sales in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). Sales, value add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenues) basis. Shipping and handling costs charged to our customers are included in net sales, while the corresponding shipping expenses are included in cost of goods sold.
Stock-Based Awards
Following is the status of all stock options as of September 30, 2019:
Shares |
Weighted- Average Exercise Price Per Share |
Weighted- Average Remaining Contractual Term (in years) |
Aggregate Intrinsic Value (in thousands) |
|||||||||||||
Outstanding - January 1, 2019 |
224,750 | $ | 3.44 | |||||||||||||
Granted |
186,200 | 4.31 | ||||||||||||||
Exercised |
(2,250 | ) | 3.20 | |||||||||||||
Cancelled |
(109,700 | ) | 3.50 | |||||||||||||
Outstanding - September 30, 2019 |
299,000 | $ | 3.96 | 9.13 | $ | - | ||||||||||
Exercisable - September 30, 2019 |
26,867 | $ | 3.41 | 8.46 | $ | - |
The 2005 Plan has not been renewed, and therefore no further grants may be made under the 2005 Plan. In May 2017, the shareholders approved the 2017 Stock Incentive Plan which authorized the issuance of 350,000 shares. There were 16,700 and 186,200 stock options granted during the three and nine months ended September 30, 2019, respectively.
Total compensation expense was $35 for both the three ended September 30, 2019 and 2018, and $110 and $80 for the nine months ended September 30, 2019 and 2018, respectively. As of September 30, 2019, there was $403 of unrecognized compensation which will vest over the next 3.13 years.
In November 2010, the Board of Directors adopted the Nortech Systems Incorporated Equity Appreciation Rights Plan (“2010 Plan”). The total number of Equity Appreciation Right Units (“Units”) that can be issued under the 2010 Plan shall not exceed an aggregate of 1,000,000 Units as amended and restated on March 11, 2015. The 2010 Plan provides that Units issued shall fully vest three years from the base date as defined in the agreement unless terminated earlier. Units give the holder a right to receive a cash payment equal to the appreciation in book value per share of common stock from the base date, as defined, to the redemption date. Unit redemption payments under the 2010 Plan shall be paid in cash within 90 days after we determine the book value of the Units as of the calendar year immediately preceding the redemption date. The Units are adjusted to market value for each reporting period.
During the nine months ended September 30, 2019, 100,000 units were granted in the first quarter. During the three and nine months ended September 30, 2018, no units were granted.
Total compensation expense related to vested outstanding Units based on the estimated appreciation over their remaining terms was $0 for both the three and nine months ended September 30, 2019 and 2018.
During the nine months ended September 30, 2019, there were 25,000 shares awarded that vested immediately that had expense of $116 during the first quarter.
Net Income (Loss) per Common Share
For the three months ended September 30, 2019, all stock options are deemed to be antidilutive and, therefore, were not included in the computation of income per common share amount. For the nine months ended September 30, 2019, the Company reported a net loss and all stock options are deemed to be antidilutive and, therefore, were not included in the computation of loss per common share amount. For both the three months and nine months ended September 30, 2018, 2,217 and 3,553 stock options, respectively, were included in the computation of diluted income per common share amount as their impact were dilutive.
Share Repurchase Program
We had a $250 share repurchase program which was authorized by our Board of Directors in August 2017. Under this repurchase program, we repurchased 1,245 and 32,985 shares in the open market transactions totaling $4 and $130 for the three months and nine months ended September 30, 2019, respectively. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted from additional paid-in capital. As of September 30, 2019, our share repurchase program has expired, and no additional amounts are available for repurchase.
Restricted Cash
Cash and cash equivalents classified as restricted cash on our condensed consolidated balance sheets are restricted as to withdrawal or use under the terms of certain contractual agreements. The September 30, 2019 balance included lockbox deposits that are temporarily restricted due to timing at the period end. The lockbox deposits are applied against our line of credit the next business day. As of September 30, 2019, we had no outstanding letters of credit.
Accounts Receivable and Allowance for Doubtful Accounts
Credit is extended based upon an evaluation of the customer’s financial condition and, while collateral is not required, the Company periodically receives surety bonds that guarantee payment. Credit terms are consistent with industry standards and practices. The amounts of trade accounts receivable at both the three months ended and nine months ended September 30, 2019 have been reduced by an allowance for doubtful accounts of $323 at September 30, 2019 and $222 at December 31, 2018.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or net realizable value. Costs include material, labor, and overhead required in the warehousing and production of our products. Inventory reserves are maintained for the estimated value of the inventories that may have a lower value than stated or quantities in excess of future production needs.
Inventories are as follows:
September 30, |
December 31, |
|||||||
2019 |
2018 |
|||||||
Raw Materials |
$ | 17,036 | $ | 16,769 | ||||
Work in Process |
1,105 | 1,015 | ||||||
Finished Goods |
198 | 332 | ||||||
Reserves |
(1,398 | ) | (1,112 | ) | ||||
Total |
$ | 16,941 | $ | 17,004 |
Other Intangible Assets
Other intangible assets at September 30, 2019 and December 31, 2018 are as follows:
September 30, 2019 |
||||||||||||||||
Gross |
||||||||||||||||
Carrying |
Accumulated |
Net Book |
||||||||||||||
Years |
Amount |
Amortization |
Value |
|||||||||||||
Customer Relationships |
9 | $ | 1,302 | $ | 615 | $ | 687 | |||||||||
Intellectual Property |
3 | 100 | 86 | 14 | ||||||||||||
Trade Names |
20 | 814 | 173 | 641 | ||||||||||||
Patents |
7 | 55 | - | 55 | ||||||||||||
Totals |
$ | 2,271 | $ | 874 | $ | 1,397 |
December 31, 2018 |
||||||||||||||||
Gross |
||||||||||||||||
Carrying |
Accumulated |
Net Book |
||||||||||||||
Years |
Amount |
Amortization |
Value |
|||||||||||||
Customer Relationships |
9 | $ | 1,302 | $ | 506 | $ | 796 | |||||||||
Intellectual Property |
3 | 100 | 61 | 39 | ||||||||||||
Trade Names |
20 | 814 | 143 | 671 | ||||||||||||
Patents |
7 | 17 | - | 17 | ||||||||||||
Totals |
$ | 2,233 | $ | 710 | $ | 1,523 |
Amortization expense for the three and nine months ended September 30, 2019 was $55 and $164, respectively.
Estimated future annual amortization expense (not including projects in process) related to these assets is approximately as follows (in thousands):
Year |
Amount |
|||
Remainder of 2019 |
$ | 55 | ||
2020 |
191 | |||
2021 |
185 | |||
2022 |
185 | |||
2023 |
185 | |||
Thereafter |
541 | |||
Total |
$ | 1,342 |
Impairment of Goodwill and Other Intangible Assets
In accordance with ASC 350, Goodwill and Other Intangible Assets, goodwill is not amortized but is required to be reviewed for impairment at least annually or when events or circumstances indicate that carrying value may exceed fair value. We test impairment annually as of October 1st. No events were identified during the nine months ended September 30, 2019 that would require us to test for impairment. In testing goodwill for impairment, we perform a quantitative impairment test, including computing the fair value of the reporting unit and comparing that value to its carrying value. If the fair value is less than it carrying value, then the goodwill is determined to be impaired. In the event that goodwill is impaired, an impairment charge to earnings would become necessary.
Impairment Analysis
We evaluate long-lived assets, primarily property and equipment and intangible assets, as well as the related depreciation periods, whenever current events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability for assets to be held and used is based on our projection of the undiscounted future operating cash flows of the underlying assets. To the extent such projections indicate that future undiscounted cash flows are not sufficient to recover the carrying amounts of related assets, a charge might be required to reduce the carrying amount to equal estimated fair value. No impairment expense was recorded during the three and nine months ended September 30, 2019 and 2018, respectively.
Recently Adopted Accounting Standards
On January 1, 2019, we adopted ASU No. 2016-02, Leases (Topic 842). This ASU requires lessees to recognize lease assets and lease liabilities on the balance sheet. Under the new guidance, lessor accounting is largely unchanged. We have elected to adopt the standard on the modified retrospective basis. We have also elected the package of practical expedients, which permits us not to reassess our prior conclusions about lease identification, lease classification and initial direct costs. In addition, we have elected the short-term lease recognition whereby we will not recognize operating lease related assets or liabilities for leases with a lease term less than one year. We did not elect the hindsight practical expedient to determine the reasonably certain term of existing leases.
The impact of adopting the new lease standard was the recognition of $5,731 of lease assets and lease liabilities related to our operating leases. The adoption of the new lease standard had no impact to our Condensed Consolidated Statements of Operations, Condensed Consolidated Statements of Cash Flows or Condensed Consolidated Statements of Shareholders’ Equity.
NOTE 2. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and accounts receivable. With regard to cash, we maintain our excess cash balances in checking accounts at primarily two financial institutions, one in the United States and one in China. The account in the United States may at times exceed federally insured limits. Of the $160 in cash at September 30, 2019, approximately $105 was held at banks located in China. We grant credit to customers in the normal course of business and do not require collateral on our accounts receivable.
Our largest customer has two divisions that together accounted for 10% or more of our net sales during the three and nine months ended September 30, 2019 and 2018. One division accounted for approximately 19% and 21% of net sales for the three and nine months ended September 30, 2019, respectively, and approximately 20% for both the three and nine months ended September 30, 2018. The other division accounted for approximately 3% of net sales for both the three months and nine months ended September 30, 2019, and approximately 1% net sales for the three and nine months ended September 30, 2018. Together they accounted for approximately 22% and 24% of net sales for the three and nine months ended September 30, 2019, respectively, and approximately 21% of net sales for both the three and nine months ended September 30, 2018. Accounts receivable from the customer at September 30, 2019 and December 31, 2018 represented approximately 28% and 16% of our total accounts receivable, respectively.
Export sales represented approximately 9% and 20% of net sales for the three months ended September 30, 2019 and 2018, respectively. Export sales represented 15% and 19% of net sales for the nine months ended September 30, 2019 and 2018, respectively.
NOTE 3. REVENUE
Revenue recognition
Our revenue is comprised of product, engineering services and repair services. All revenue is recognized when the Company satisfies its performance obligation(s) under the contract by transferring the promised product or service to our customer either when (or as) our customer obtains control of the product or service, with the majority of our revenue being recognized over time including goods produced under contract manufacturing agreements and services revenue. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. A contract’s transaction price is allocated to each distinct performance obligation. The majority of our contracts have a single performance obligation, as the promise to transfer products or services is not separately identifiable from other promises in the contract and, therefore, not distinct.
Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or providing services. As such, revenue is recorded net of returns, allowances and customer discounts. Sales, value add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenues) basis. Shipping and handling costs are included in cost of goods sold.
The majority of our revenue is derived from the transfer of goods produced under contract manufacturing agreements which have no alternative use and we have an enforceable right to payment for our performance completed to date. Our performance obligations within our contract manufacturing agreements are generally satisfied over time as the goods are produced based on customer specifications and we have an enforceable right to payment for the goods produced. If these requirements are not met, the revenue is recognized at a point in time, generally upon shipment. Revenue under contract manufacturing agreements that was recognized over time accounted for approximately 91% of our revenue for both the three and nine months ended September 30, 2019. Revenues under these agreements are generally recognized over time using an input measure based upon the proportion of actual costs incurred.
Accounting for contract manufacturing agreements involves the use of various techniques to estimate total revenue and costs. We estimate profit on these agreements as the difference between total estimated revenue and expected costs to complete the performance obligation within the terms of the agreement and recognize the respective profit as the goods are produced. The estimates to determine the profit earned on the performance obligation are based on anticipated selling prices and historical cost of goods sold and represent our best judgement at the time. Changes in judgements on these above estimates could impact the timing and amount of revenue recognized with a resulting impact on the timing and amount of associated profit.
On occasion our customers provide materials to be used in the manufacturing process and the fair value of the materials is included in revenue as noncash consideration at the point in time when the manufacturing process commences along with the same corresponding amount recorded as cost of goods sold. The inclusion of noncash consideration has no impact on overall profitability.
Contract Assets
Contract assets, recorded as such in the Condensed Consolidated Balance Sheets, consist of unbilled amounts related to revenue recognized over time. Significant changes in the contract assets balance during the three and nine months ended September 30, 2019 was as follows (in thousands):
Nine Months Ended September 30, 2019 |
||||
Outstanding at January 1, 2019 |
$ | 6,431 | ||
Increase (decrease) attributed to: |
||||
Transferred to receivables from contract assets recognized |
(4,923 | ) | ||
Product transferred over time |
5,703 | |||
Outstanding at September 30, 2019 |
$ | 7,211 |
We expect substantially all the remaining performance obligations for the contract assets recorded as of September 30, 2019, to be transferred to receivables within 90 days, with any remaining amounts to be transferred within 180 days. We bill our customers upon shipment with payment terms of up to 120 days.
The following tables summarize our net sales by market for the three and nine months ended September 30, 2019 (in thousands):
Three Months Ended September 30, 2019 |
||||||||||||||||
Product/ Service Transferred Over Time |
Product Transferred at Point in Time |
Noncash Consideration |
Total Net Sales by Market |
|||||||||||||
Medical |
$ | 14,399 | $ | 1,661 | $ | 983 | $ | 17,043 | ||||||||
Industrial |
7,279 | 822 | 522 | 8,623 | ||||||||||||
Aerospace and Defense |
3,978 | 133 | 281 | 4,392 | ||||||||||||
Total net sales |
$ | 25,656 | $ | 2,616 | $ | 1,786 | $ | 30,058 |
Nine Months Ended September 30, 2019 |
||||||||||||||||
Product/ Service Transferred Over Time |
Product Transferred at Point in Time |
Noncash Consideration |
Total Net Sales by Market |
|||||||||||||
Medical |
$ | 42,039 | $ | 1,914 | $ | 2,053 | $ | 46,006 | ||||||||
Industrial |
22,847 | 2,297 | 1,146 | 26,290 | ||||||||||||
Aerospace and Defense |
12,236 | 375 | 608 | 13,219 | ||||||||||||
Total net sales |
$ | 77,122 | $ | 4,586 | $ | 3,807 | $ | 85,515 |
NOTE 4. FINANCING ARRANGEMENTS
We have a credit agreement with Bank of America which was entered into on June 15, 2017 and amended effective December 29, 2017 and provides for a line of credit arrangement of $16,000 that expires on June 15, 2022. The credit arrangement also has a $5,000 real estate term note outstanding with a maturity date of June 15, 2022.
Under the Bank of America credit agreement, both the line of credit and real estate term notes are subject to variations in the LIBOR rate. Our line of credit bears interest at a weighted-average interest rate of 5.4% and 4.3% as of September 30, 2019 and 2018, respectively. We had borrowings on our line of credit of $12,430 and $9,264 outstanding as of September 30, 2019 and December 31, 2018, respectively. There are no subjective acceleration clauses under the credit agreement that would accelerate the maturity of our outstanding borrowings.
The line of credit and real estate term notes with Bank of America 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.
The Bank of America 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 September 30, 2019, we did not meet the fixed charge coverage ratio which was waived by BofA in the third amendment to the credit agreement received on November 8, 2019.
The availability under the line is subject to borrowing base requirements, and advances are at the discretion of the lender. At September 30, 2019, we had unused availability under our line of credit of $3,523, supported by our borrowing base. The line is secured by substantially all of our assets.
As part of the July 1, 2015 Devicix acquisition we entered into two unsecured subordinated promissory notes payable to the seller in the principal amounts of $1,000 and $1,300, which was fully paid off during the first half of 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 no amounts outstanding as of September 30, 2019.
Long-term debt at September 30, 2019 and December 30, 2018 consisted of following:
September 30, |
December 31, |
|||||||
2019 |
2018 |
|||||||
Real estate term notes bearing interest at one-month LIBOR + 2.25% (4.4% and 4.8% as of September 30, 2019 and December 31, 2018, respectively) maturing June 15, 2022 with monthly payments of approximately $41 plus interest secured by substantially all assets. |
$ | 3,880 | $ | 4,253 | ||||
Devicix Acquistion Note 1 payable to DeLange Holdings bears interest rate of 4.0% per annum, maturing July 1, 2019 |
- | 156 | ||||||
Devicix Acquistion Note 2 payable to DeLange Holdings bears interest rate of 4.0% per annum, maturing July 1, 2019 |
- | 203 | ||||||
3,880 | 4,612 | |||||||
Discount on Devicix Notes Payable |
- | (23 | ) | |||||
Debt issuance Costs |
(141 | ) | (185 | ) | ||||
Total long-term debt |
3,739 | 4,404 | ||||||
Current maturities of long-term debt |
(444 | ) | (780 | ) | ||||
Long-term debt - net of current maturities |
$ | 3,295 | $ | 3,624 |
NOTE 5. LEASES
We have operating leases for certain manufacturing sites, office space, and equipment. Most leases include the option to renew, with renewal terms that can extend the lease term from one to five years or more. Right-of-use lease assets and lease liabilities are recognized at the commencement date based on the present value of the remaining lease payments over the lease term which includes renewal periods we are reasonably certain to exercise. Our leases do not contain any material residual value guarantees or material restrictive covenants. At September 30, 2019, we do not have material lease commitments that have not commenced.
The components of lease expense were as follows:
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||
Lease Cost |
2019 |
2019 |
||||||
Operating lease cost |
$ | 253 | $ | 785 | ||||
Finance lease interest cost |
21 | 54 | ||||||
Finance lease amortization expense |
65 | 196 | ||||||
Total lease cost |
$ | 339 | $ | 1,035 |
Supplemental balance sheet information related to leases was as follows:
Balance Sheet Location |
September 30, 2019 |
||||
Assets |
|||||
Operating lease assets |
Operating lease assets |
$ | 5,018 | ||
Finance lease assets |
Property, Plant and Equipment |
1,834 | |||
Total leased assets |
6,852 | ||||
Liabilities |
|||||
Current |
|||||
Current operating lease liabilities |
Current Portion of Operating Lease Obligations |
841 | |||
Current finance lease liabilities |
Current Portion of Finance Lease Obligations |
476 | |||
Noncurrent |
|||||
Long-term operating lease liabilities |
Long Term Operating Lease Liabilities, Net |
4,517 | |||
Long term finance lease liabilities |
Long Term Finance Lease Obligations, Net |
1,168 | |||
Total lease liabilities |
$ | 7,002 |
Supplemental cash flow information related to leases was as follows:
Nine Months Ended September 30, |
||||
2019 |
||||
Operating leases |
||||
Cash paid for amounts included in the measurement of lease liabilities |
$ | 555 | ||
Right-of-use assets obtained in exchange for lease obligations |
$ | — |
Maturities of lease liabilities were as follows:
Operating Leases |
Finance Leases |
Total |
||||||||||
Remaining 2019 |
$ | 191 | $ | 133 | $ | 324 | ||||||
2020 |
858 | 534 | 1,392 | |||||||||
2021 |
722 | 534 | 1,256 | |||||||||
2022 |
726 | 359 | 1,085 | |||||||||
2023 |
738 | 138 | 876 | |||||||||
Thereafter |
3,381 | 102 | 3,483 | |||||||||
Total lease payments |
$ | 6,616 | $ | 1,800 | $ | 8,416 | ||||||
Less: Interest |
(1,258 |
) |
(156 | ) | (1,414 |
) |
||||||
Present value of lease liabilities |
$ | 5,358 | $ | 1,644 | $ | 7,002 |
The lease term and discount rate at June 30, 2019 were as follows:
Weighted-average remaining lease term (years) |
||||
Operating leases |
7.6 | |||
Finance leases |
3.4 | |||
Weighted-average discount rate |
||||
Operating leases |
4.8 |
% |
||
Finance leases |
5.4 |
% |
Rent expense for our operating leases the three and nine months ended September 30, 2018 as accounted under ASC 840, Leases, was $297 and $951, respectively.
The future minimum lease commitments as of December 31, 2018, under ASC 840 are as follows:
Operating Leases |
||||
2019 |
$ | 1,024 | ||
2020 |
858 | |||
2021 |
722 | |||
2022 |
726 | |||
2023 |
738 | |||
Thereafter |
3,380 | |||
Total minimum obligations |
$ | 7,448 |
NOTE 6. 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 nine months ended September 30, 2019 was 10% and (9%), respectively and our effective tax rate for the three and nine months ended September 30, 2018 was 24% and 49%, respectively.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 |
Nine Months Ended |
|||||||||||||||
September 30, | September 30, | |||||||||||||||
2019 |
2018 |
2019 |
2018 |
|||||||||||||
Net Sales |
100.0 |
% |
100.0 |
% |
100.0 |
% |
100.0 |
% |
||||||||
Cost of Goods Sold |
87.9 | 88.5 | 89.6 | 87.9 | ||||||||||||
Gross Profit |
12.1 | 11.5 | 10.4 | 12.1 | ||||||||||||
Selling Expenses |
2.0 | 2.4 | 2.5 | 3.3 | ||||||||||||
General and Administrative Expenses |
7.7 | 6.8 | 8.6 | 7.3 | ||||||||||||
Income from Operations |
2.4 | 2.3 | (0.7 | ) | 1.5 | |||||||||||
Other Expenses |
(0.9 | ) | (0.7 | ) | (0.9 | ) | (0.7 | ) | ||||||||
Income (Loss) Before Income Taxes |
1.5 | 1.6 | (1.6 | ) | 0.8 | |||||||||||
Income Tax Expense |
0.1 | 0.4 | 0.2 | 0.4 | ||||||||||||
Net Income (Loss) |
1.4 |
% |
1.2 |
% |
(1.8 | %) | 0.4 |
% |
Net Sales
Net sales were $30.1 million in the third quarter of 2019, as compared to $29.6 million in the third quarter of the prior year, an increase of $0.5 million or 1.7%. Net sales results were varied by markets; the medical market increased by $2.7 million or 19.3% with medical devices accounting for the increase. The industrial market decreased by $2.5 million or 22.3% of sales in the third quarter of 2019 as compared to the same quarter of 2018. Net sales from the aerospace and defense markets increased by $0.2 million or 5.0% of sales in the third quarter of 2019 as compared to the third quarter of 2018.
Net sales were $85.5 million in the nine months ended 2019, as compared to $84.5 million in the prior year, an increase of $1.0 million or 1.1%. Net sales results were varied by markets; the medical market increased by 9.1 million, or 24.9% with medical device accounting for 84.5% of the increase and medical component products the remaining 15.5%. The industrial market decreased by $8.0 million of sales or 23.3% for the nine months ended September 30, 2019 as compared to the same period of 2018. Net sales from aerospace and defense markets remained flat in the nine months ended September 30, 2019 as compared to the same period of 2018.
Net sales by our major EMS industry markets for the three and nine months ended September 30, 2019 and 2018 were as follows (in thousands):
Three months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||||||||||
2019 $ |
2018 $ |
% Change |
2019 $ |
2018 $ |
% Change |
|||||||||||||||||||
Medical |
17,043 | 14,280 | 19.3 | 46,006 | 36,838 | 24.9 | ||||||||||||||||||
Industrial |
8,623 | 11,094 | (22.3 | ) | 26,290 | 34,261 | (23.3 | ) | ||||||||||||||||
Aerospace and Defense |
4,392 | 4,184 | 5.0 | 13,219 | 13,444 | (1.7 | ) | |||||||||||||||||
Total Net Sales |
30,058 | 29,558 | 1.7 | 85,515 | 84,543 | 1.1 |
Net sales by timing of transfer of goods and services for the three and nine months ended September 30, 2019 is as follows (in thousands):
Three Months Ended September 30, 2019 |
||||||||||||||||
Product/ Service Transferred Over Time |
Product Transferred at Point in Time |
Noncash Consideration |
Total Net Sales by Market |
|||||||||||||
Medical |
$ | 14,399 | $ | 1,661 | $ | 983 | $ | 17,043 | ||||||||
Industrial |
7,279 | 822 | 522 | 8,623 | ||||||||||||
Aerospace and Defense |
3,978 | 133 | 281 | 4,392 | ||||||||||||
Total net sales |
$ | 25,656 | $ | 2,616 | $ | 1,786 | $ | 30,058 |
Nine Months Ended September 30, 2019 |
||||||||||||||||
Product/ Service Transferred Over Time |
Product Transferred at Point in Time |
Noncash Consideration |
Total Net Sales by Market |
|||||||||||||
Medical |
$ | 42,039 | $ | 1,914 | $ | 2,053 | $ | 46,006 | ||||||||
Industrial |
22,847 | 2,297 | 1,146 | 26,290 | ||||||||||||
Aerospace and Defense |
12,236 | 375 | 608 | 13,219 | ||||||||||||
Total net sales |
$ | 77,122 | $ | 4,586 | $ | 3,807 | $ | 85,515 |
Net sales by timing of transfer of goods and services for the three and nine months ended September 30, 2018 is as follows (in thousands):
Three Months Ended September 30, 2018 | ||||||||||||||||
Product/ Service Transferred Over Time |
Product Transferred at Point in Time |
Noncash Consideration |
Total Net Sales by Market |
|||||||||||||
Medical |
$ | 13,461 | $ | 151 | $ | 668 | $ | 14,280 | ||||||||
Industrial |
9,486 | 1,116 | 492 | 11,094 | ||||||||||||
Aerospace and Defense |
3,931 | 50 | 203 | 4,184 | ||||||||||||
Total net sales |
$ | 26,878 | $ | 1,317 | $ | 1,363 | $ | 29,558 |
Nine Months Ended September 30, 2018 |
||||||||||||||||
Product/ Service Transferred Over Time |
Product Transferred at Point in Time |
Noncash Consideration |
Total Net Sales by Market |
|||||||||||||
Medical |
$ | 34,513 | $ | 720 | $ | 1,605 | $ | 36,838 | ||||||||
Industrial |
29,698 | 3,165 | 1,398 | 34,261 | ||||||||||||
Aerospace and Defense |
12,675 | 170 | 599 | 13,444 | ||||||||||||
Total net sales |
$ | 76,886 | $ | 4,055 | $ | 3,602 | $ | 84,543 |
Backlog
Our 90-day shipment backlog as of September 30, 2019 was $32 million, a 2.0% increase from the beginning of the quarter and a 15.6% increase from the prior year. Backlog for our medical customers has increased 6.4% from the beginning of the quarter and increased 37.8% from the prior year. Our industrial customers’ backlog increased 6.0% from the beginning of the quarter and decreased 10.2% from the prior year. The aerospace and defense backlog decreased 13.5% from the beginning of the quarter and increased 6.9% 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 |
||||||||||||
September 30, |
June 30, |
September 30, |
||||||||||
2019 |
2019 |
2018 |
||||||||||
Medical |
$ | 17,778 | $ | 16,701 | $ | 12,902 | ||||||
Industrial |
8,334 | 7,863 | 9,279 | |||||||||
Aerospace and Defense |
5,909 | 6,833 | 5,530 | |||||||||
Total 90-Day Backlog |
$ | 32,021 | $ | 31,397 | $ | 27,711 |
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 $58.1 million at September 30, 2019 compared to $43.1 million at the end of September 30, 2018.
Gross Profit
Gross profit as a percent of net sales for the three months ended September 30, 2019 and 2018 was 12.1% and 11.5%, respectively, driven by favorable product mix. Gross profit as a percentage of sales for the nine months ended September 30, 2019 and 2018 was 10.4% and 12.1%, respectively. The decline in gross profit in the year to date comparison was driven by product mix and operational inefficiencies due to component shortages.
Selling Expense
Selling expenses for the three months ended September 30, 2019 and 2018 was $0.6 million or 2.0% of sales and $0.7 million or 2.4% of sales, respectively. Selling expense for the nine months ended September 30, 2019 and 2018 was $2.1 million or 2.5% of sales and $2.8 million or 3.3% of sales, respectively. The decrease in both the three and nine 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 September 30, 2019 and 2018 were $2.3 million or 7.7% of sales and $2.0 million or 6.8% of sales, respectively. General and administrative expenses for the nine months ended September 30, 2019 and 2018 were $7.4 million or 8.6% of sales and $6.2 million or 7.3% 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.
Income (Loss) from Operations
Third quarter 2019 income from operations was $0.7 million compared to $0.6 million for the third quarter in 2018. Loss from operations for the first nine months in 2019 was $0.6 million as compared to income of $1.3 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 nine months ended September 30, 2019 was 10% and (9%) and the rate for the three and nine months ended September 30, 2018 was 24% and 49%, respectively.
Net Income (Loss)
Net income for the three months ended September 30, 2019 and September 30, 2018 was $0.4 million. Net loss for the nine months ended September 30, 2019 was $1.5 million and net income for the nine months ended September 30, 2018 was $0.4 million.
Liquidity and Capital Resources
Net cash used in operating activities for the nine months ended September 30, 2019 was $0.2 million. Net cash provided by operating activities for the nine months ended September 30, 2018 was $2.6 million driven by the net income net of the noncash adjustment of depreciation and amortization, along with an increase in accounts payable, partially offset by an increase in accounts receivable and inventories.
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 September 30, 2019, we had outstanding advances of $12.4 million under the line of credit and unused availability of $3.5 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 $22.7 million and $20.7 million as of September 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 September 30, 2019, we did not meet the fixed charge coverage ratio which was waived by BofA in the third amendment to the credit agreement received on November 8, 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; |
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Volatility in the marketplace which may affect market supply and demand for our products or currency exchange rates; |
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Increased competition from within the EMS industry or the decision of OEMs to cease or limit outsourcing; |
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Changes in the reliability and efficiency of operating facilities or those of third parties; |
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Risks related to availability of labor; |
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Increase in certain raw material costs such as copper and oil; |
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Commodity and energy cost instability; |
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Risks related to quality, regulatory, securities laws and debt covenant noncompliance; |
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Loss of a major customer or changes to customer orders; |
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Increased or unanticipated costs related to compliance with securities and environmental regulation; and |
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♦ |
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 4. CONTROLS AND PROCEDURES
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.
We are subject to various legal proceedings and claims that arise in the ordinary course of business.
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, 2018.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The table below sets forth information regarding the repurchases we made of our common stock during the periods indicated.
Period |
Total Number of Shares Purchased |
Average Price Paid Per Share |
Total Number of Shares Purchased as Part of Publicly Announced Plan |
Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plan |
||||||||||||
July 1 - July 31, 2019 |
1,029 | $ | 3.94 | 1,029 | $ | 33,508 | ||||||||||
August 1 - August 30, 2019 |
216 | $ | 3.90 | 216 | $ | 32,644 | ||||||||||
September 1 - September 30, 2019 |
- | $ | - | - | $ | - | ||||||||||
Total |
1,245 | $ | 3.93 | 1,245 | $ | - |
As of September 30, 2019, our share repurchase program has expired, and no additional amounts are available for repurchase.
ITEM 3. DEFAULTS ON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
None.
Exhibits
10.2* | Third Amendment to Loan and Security Agreement and Waiver. | |
31.1* |
31.2* |
32* |
101* |
Financial statements from the quarterly report on Form 10-Q for the quarter ended September 30, 2019, formatted in XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations and Comprehensive Loss, (iii) Condensed Consolidated Statements of Cash Flows, and (iv) the Condensed Notes to Condensed Consolidated Financial Statements. |
*Filed herewith
---------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Nortech Systems Incorporated and Subsidiaries
------------------------------------------------------------
Date: November 12, 2019 |
by /s/ Jay D. Miller
Jay D. Miller Chief Executive Officer and President Nortech Systems Incorporated |
Date: November 12, 2019 |
by /s/ Constance M. Beck
Constance M. Beck Vice President and Chief Financial Officer Nortech Systems Incorporated |
27
Exhibit 10.2
Execution Version
THIRD AMENDMENT TO LOAN AND SECURITY AGREEMENT AND WAIVER
THIS THIRD AMENDMENT TO LOAN AND SECURITY AGREEMENT AND WAIVER (this “Amendment”) is made and entered into effective as of November __, 2019, by and between NORTECH SYSTEMS INCORPORATED, a Minnesota corporation (“Borrower”), and BANK OF AMERICA, N.A., a national banking association (the “Lender”).
RECITALS:
A. Borrower and Lender are parties to a certain Loan and Security Agreement dated as of June 15, 2017 (as amended, restated, supplemented or otherwise modified from time to time, the “Loan Agreement”). Capitalized terms not otherwise defined in this Amendment shall have the meanings assigned to them in the Loan Agreement.
B. The Borrower has requested that the Lender (i) amend and modify certain terms and provisions of the Loan Agreement and (ii) waive the Borrower’s non-compliance with certain provisions set forth in the Loan Agreement.
C. The Lender has agreed to grant such waiver and to so amend the Loan Agreement upon the terms and subject to the conditions set forth in this Amendment.
AGREEMENTS:
NOW, THEREFORE, in consideration of the premises herein set forth and for other good and valuable consideration, the nature, receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows:
1. Recitals. The Borrower and the Lender agree that the Recitals set forth above are true and correct.
2. Waiver.
a. Pursuant to Section 9.3.1 of the Loan Agreement (prior to giving effect to this Amendment), the Borrower is required maintain a Fixed Charge Coverage Ratio of at least 1.0 to 1.0 for each period of four Fiscal Quarters. The Borrower has informed the Lender that the Fixed Charge Coverage Ratio for the four Fiscal Quarter period ending September 30, 2019, was less than 1.0 to 1.0. Such non-compliance with Section 9.3.1 of the Loan Agreement constitutes an Event of Default pursuant to Section 10.1(c) of the Loan Agreement (the “Existing Default”).
b. Borrower has requested that the Lender waive the Existing Default. Subject to the Borrower’s full satisfaction of all conditions precedent set forth in Section 4 below, the Lender hereby so waives the Existing Default. The foregoing waiver shall not apply to any other provision of the Loan Agreement or the other Loan Documents, and shall not give rise to any course of dealing or course of performance with respect to future requests.
3. Amendment. Section 9.3.1 of the Loan Agreement is hereby amended and restated in its entirety as follows:
9.3.1 Fixed Charge Coverage Ratio. Maintain a Fixed Charge Coverage Ratio, determined as of the last day of each Fiscal Quarter for the measurement period then ended, of not less than the applicable ratio set forth below for such measurement period:
4. Conditions Precedent. This Amendment shall become effective upon delivery to the Lender of the following, each in form and substance acceptable to the Lender:
a. This Amendment, duly executed by the Borrower and the Lender.
b. Such other documents, instruments and agreements as the Lender may reasonably require.
5. Representations; No Default. Borrower represents and warrants that: (a) Borrower has the power and legal right and authority to enter into this Amendment and has duly authorized the execution and delivery of this Amendment and other agreements and documents executed and delivered by Borrower in connection herewith, (b) neither this Amendment nor the agreements contained herein contravene or constitute a Default or Event of Default under the Loan Agreement or a default under any other agreement, instrument or indenture to which Borrower is a party or a signatory, or any provision of Borrower’s Articles of Incorporation or By-Laws or, to the best of Borrower’s knowledge, any other agreement or requirement of law, or result in the imposition of any lien or other encumbrance on any of its property under any agreement binding on or applicable to Borrower or any of its property except, if any, in favor of the Lender, (c) no consent, approval or authorization of or registration or declaration with any party, including but not limited to any governmental authority, is required in connection with the execution and delivery by Borrower of this Amendment or other agreements and documents executed and delivered by Borrower in connection herewith or the performance of obligations of Borrower herein described, except for those which Borrower has obtained or provided and as to which Borrower has delivered certified copies of documents evidencing each such action to the Lender, (d) no events have taken place and no circumstances exist at the date hereof which would give Borrower grounds to assert a defense, offset or counterclaim to the obligations of Borrower under the Loan Agreement or any of the other Loan Documents, (e) there are no known claims, causes of action, suits, debts, liens, obligations, liabilities, demands, losses, costs and expenses (including attorneys’ fees) of any kind, character or nature whatsoever, fixed or contingent, which Borrower may have or claim to have against the Lender, which might arise out of or be connected with any act of commission or omission of the Lender existing or occurring on or prior to the date of this Amendment, including, without limitation, any claims, liabilities or obligations arising with respect to the indebtedness evidenced by any promissory note executed by Borrower in favor of the Lender, (f) the representations and warranties of Borrower contained in the Loan Agreement are true and correct on and as of the date hereof, except to the extent that such representations and warranties specifically refer to an earlier date, in which case they shall be true and correct as of such earlier date and (g) except as expressly set forth in Section 2 above, no Default or Event of Default has occurred and is continuing under the Loan Agreement.
6. Affirmation, Further References. The Lender and the Borrower each acknowledge and affirm that the Loan Agreement, as hereby amended, is hereby ratified and confirmed in all respects and all terms, conditions and provisions of the Loan Agreement (except as amended by this Amendment) and of each of the other Loan Documents shall remain unmodified and in full force and effect. All references in any document or instrument to the Loan Agreement are hereby amended and shall refer to the Loan Agreement as amended by this Amendment.
7. Severability. Whenever possible, each provision of this Amendment and any other statement, instrument or transaction contemplated hereby or thereby or relating hereto or thereto shall be interpreted in such manner as to be effective, valid and enforceable under the applicable law of any jurisdiction, but, if any provision of this Amendment or any other statement, instrument or transaction contemplated hereby or thereby or relating hereto or thereto shall be held to be prohibited, invalid or unenforceable under the applicable law, such provision shall be ineffective in such jurisdiction only to the extent of such prohibition, invalidity or unenforceability, without invalidating or rendering unenforceable the remainder of such provision or the remaining provisions of this Amendment or any other statement, instrument or transaction contemplated hereby or thereby or relating hereto or thereto in such jurisdiction, or affecting the effectiveness, validity or enforceability of such provision in any other jurisdiction.
8. Successors. This Amendment shall be binding upon the Borrower and the Lender and their respective successors and assigns, and shall inure to the benefit of the Borrower and the Lender and to the respective successors and assigns of the Lender.
9. Costs and Expenses. The Borrower agrees to reimburse the Lender, upon execution of this Amendment, for all reasonable out-of-pocket expenses (including attorneys’ fees and legal expenses of counsel for the Lender) incurred in connection with the Loan Agreement, including in connection with the negotiation, preparation and execution of this Amendment and all other documents negotiated, prepared and executed in connection with this Amendment, and in enforcing the obligations of the Borrower under this Amendment, and to pay and save the Lender harmless from all liability for, any stamp or other taxes which may be payable with respect to the execution or delivery of this Amendment.
10. Headings. The headings of various sections of this Amendment have been inserted for reference only and shall not be deemed to be a part of this Amendment.
11. Counterparts; Digital Copies. This Amendment may be executed in several counterparts as deemed necessary or convenient, each of which, when so executed, shall be deemed an original, provided that all such counterparts shall be regarded as one and the same document, and any party to this Amendment may execute any such agreement by executing a counterpart of such agreement. A facsimile or digital copy (pdf) of this signed Amendment shall be deemed to be an original thereof.
12. Governing Law. This Amendment shall be governed by the internal laws of the State of Minnesota, without giving effect to conflict of law principles thereof.
13. Release of Rights and Claims. Borrower, for itself and its successors and assigns, hereby releases, acquits, and forever discharges the Lender and its successors and assigns for any and all manner of actions, suits, claims, charges, judgments, levies and executions occurring or arising from the transactions entered into with the Lender prior to entering into this Amendment whether known or unknown, liquidated or unliquidated, fixed or contingent, direct or indirect which Borrower may have against the Lender.
14. No Waiver. Except as expressly provided in Section 2 above, nothing contained in this Amendment (or in any other agreement or understanding between the parties) shall constitute a waiver of, or shall otherwise diminish or impair, the Lender’s rights or remedies under the Loan Agreement or any of the other Loan Documents, or under applicable law.
[Remainder of Page Intentionally Blank]
IN WITNESS WHEREOF, the parties hereto have entered into this Amendment as of the date first above written.
BORROWER:
|
NORTECH SYSTEMS INCORPORATED
By:/s/ Constance M. Beck Name: Constance M. Beck Title: CFO
|
LENDER: |
BANK OF AMERICA, N.A. |
5
Exhibit 31.1
Certification of Chief Executive Officer
Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934
I, Jay D. Miller, certify that:
1. |
I have reviewed this quarterly report on Form 10-Q of Nortech Systems, Inc. and Subsidiary; |
2. |
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. |
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. |
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
a) |
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
b) |
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c) |
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in the report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report on such evaluation; and |
d) |
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
5. |
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
a) |
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
b) |
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
Date: November 12, 2019 |
By: |
/s/ Jay D. Miller |
Jay D. Miller |
||
Chief Executive Officer and President |
||
Nortech Systems Incorporated |
Exhibit 31.2
Certification of Chief Financial Officer
Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934
I, Constance M. Beck, certify that:
1. |
I have reviewed this quarterly report on Form 10-Q of Nortech Systems, Inc. and Subsidiary; |
2. |
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. |
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. |
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
a) |
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
b) |
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c) |
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in the report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report on such evaluation; and |
d) |
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
5. |
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
a) |
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
b) |
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
Date: November 12, 2019 |
By: |
/s/ Constance M. Beck |
Constance M. Beck |
||
Vice President and Chief Financial Officer |
||
Nortech Systems Incorporated |
Exhibit 32
Written Statement of the Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350
Solely for the purposes of complying with 18 U.S.C. Section 1350, I, the undersigned Jay D. Miller, hereby certify, based on my knowledge, that the Quarterly Report on Form 10-Q of the Company for the quarter ended September 30, 2019 (the “Report”) fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: November 12, 2019
By: |
/s/ Jay D. Miller |
|
Jay D. Miller |
||
Chief Executive Officer and President |
||
Nortech Systems Incorporated |
Written Statement of the Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350
Solely for the purposes of complying with 18 U.S.C. Section 1350, I, the undersigned Constance M. Beck, hereby certify, based on my knowledge, that the Quarterly Report on Form 10-Q of the Company for the quarter ended September 30, 2019 (the “Report”) fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: November 12, 2019
By: |
/s/ Constance M. Beck |
|
Constance M. Beck |
||
Vice President and Chief Financial Officer |
||
Nortech Systems Incorporated |