NORTECH SYSTEMS INC - Quarter Report: 2019 March (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2019

 

OR

 

o          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

 

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 x No o

 

Indicate by check mark whether the registrant has submitted electronically pursuant to Rule 405 of Regulation 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 x No o

 

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.

 

 

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. o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

 

Number of shares of $.01 par value common stock outstanding at May 2, 2019 was 2,684,672.

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

Table of Contents

 

TABLE OF CONTENTS

 

			PAGE
PART I - FINANCIAL INFORMATION
	Item 1 - Financial Statements
		Condensed Consolidated Statements of Operations and Comprehensive Income	3
		Condensed Consolidated Balance Sheets	4
		Condensed Consolidated Statements of Cash Flows	5
		Condensed Consolidated Statements of Shareholders’ Equity	6
		Condensed Notes to Consolidated Financial Statements	7-17
	Item 2 - Management’s Discussion and Analysis of Financial Condition And Results of Operations		18-22
	Item 3 - Quantitative and Qualitative Disclosures About Market Risk		22
	Item 4 - Controls and Procedures		22
PART II - OTHER INFORMATION
	Item 1 - Legal Proceedings		23
	Item 1A. - Risk Factors		23
	Item 2 - Unregistered Sales of Equity Securities, Use of Proceeds		23
	Item 3 - Defaults on Senior Securities		23
	Item 4 - Mine Safety Disclosures		23
	Item 5 - Other Information		23
	Item 6 - Exhibits		23
SIGNATURES			25

 

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PART 1

 

ITEM 1.  FINANCIAL STATEMENTS

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(UNAUDITED)

(IN THOUSANDS, EXCEPT SHARE DATA)

 

		THREE MONTHS ENDED
		MARCH 31,
		2019			2018
Net Sales		$	28,165		$	26,447
Cost of Goods Sold		25,204			23,419
Gross Profit		2,961			3,028
Operating Expenses
Selling Expenses		761			1,039
General and Administrative Expenses		2,304			2,109
Total Operating Expenses		3,065			3,148
Loss From Operations		(104		)	(120		)
Other Expense
Interest Expense		(245		)	(172		)
Loss Before Income Taxes		(349		)	(292		)
Income Tax Expense		14			99
Net Loss		$	(363	)	$	(391	)
Loss Per Common Share - Basic and Diluted		$	(0.14	)	$	(0.14	)
Weighted Average Number of Common Shares Outstanding - Basic and Diluted		2,659,859			2,720,609
Other comprehensive loss
Foreign currency translation		56			72
Comprehensive loss, net of tax		$	(307	)	$	(319	)

 

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

 

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE DATA)

 

		MARCH 31,			DECEMBER 31,
		2019			2018 (1)
		(Unaudited)
ASSETS
Current Assets
Cash		$	310		$	480
Restricted Cash		427			467
Accounts Receivable, less allowances of $246 and $222		23,092			20,093
Inventories		15,984			17,004
Contract Assets		8,584			6,431
Prepaid Expenses and Other Current Assets		2,133			1,381
Total Current Assets		50,530			45,856
Property and Equipment, Net		9,886			10,178
Operating Lease Assets		5,388			—
Goodwill		2,375			2,375
Other Intangible Assets, Net		1,469			1,523
Other Non Current Assets		28			28
Total Assets		$	69,676		$	59,960
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Current Maturities of Long-Term Debt		$	586		$	780
Current Portion of Finance Lease Obligations		359			337
Current Portion of Operating Lease Obligations		811			—
Accounts Payable		21,140			18,142
Accrued Payroll and Commissions		2,136			2,747
Other Accrued Liabilities		3,112			2,886
Total Current Liabilities		28,144			24,892
Long-Term Liabilities
Long Term Line of Credit		11,294			9,264
Long-Term Debt, Net		3,513			3,624
Long-Term Finance Lease Obligation, Net		864			951
Long-Term Operating Lease Liabilities, Net		4,813			—
Other Long-Term Liabilities		118			139
Total Long-Term Liabilities		20,602			13,978
Total Liabilities		48,746			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: 2,684,672 and 2,663,049 Shares Issued and Outstanding, respectively		27			27
Additional Paid-In Capital		15,757			15,610
Accumulated Other Comprehensive Loss		(177		)	(233		)
Retained Earnings		5,073			5,436
Total Shareholders’ Equity		20,930			21,090
Total Liabilities and Shareholders’ Equity		$	69,676		$	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.

 

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN THOUSANDS)

 

		THREE MONTHS ENDED
		MARCH 31,
		2019			2018
Cash Flows From Operating Activities
Net Loss		$	(363	)	$	(391	)
Adjustments to Reconcile Net Loss to Net Cash Provided by (Used in) Operating Activities
Depreciation and Amortization		570			561
Compensation on Stock-Based Awards		160			20
Deferred Taxes		—			(1		)
Change in Accounts Receivable Allowance		24			—
Change in Inventory Reserves		51			183
Changes in Current Operating Items
Accounts Receivable		(3,001		)	(762		)
Inventories		985			229
Contract Assets		(2,154		)	308
Prepaid Expenses and Other Current Assets		(819		)	81
Accounts Payable		3,209			317
Accrued Payroll and Commissions		(611		)	(579		)
Other Accrued Liabilities		511			576
Net Cash (Used in) Provided by Operating Activities		(1,438		)	542
Cash Flows from Investing Activities
Purchase of Intangible Asset		—			(4		)
Purchases of Property and Equipment		(396		)	(288		)
Net Cash Used in Investing Activities		(396		)	(292		)
Cash Flows from Financing Activities
Net Change in Line of Credit		2,030			146
Principal Payments on Long-Term Debt		(328		)	(222		)
Principal Payments on Finance Leases		(65		)	(82		)
Share Repurchases		(13		)	(126		)
Net Cash Provided by (Used in) Financing Activities		1,624			(284		)
Effect of Exchange Rate Changes on Cash		—			46
Net Change in Cash		(210		)	12
Cash - Beginning of Period		947			779
Cash - Ending of Period		$	737		$	791
Reconciliation of cash and restricted cash reported within the condensed consolidated balance sheets
Cash		$	310		$	466
Restricted Cash		427			325
Total restricted cash reported in the condensed consolidated statements of cash flows		$	737		$	791
Supplemental Disclosure of Cash Flow Information:
Cash Paid During the Period for Interest		$	224		$	139
Supplemental Noncash Investing and Financing Activities:
Property and Equipment Purchases in Accounts Payable		78			68

 

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

 

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

(IN THOUSANDS)

 

											Accumulated
								Additional			Other						Total
		Preferred			Common			Paid-In			Comprehensive			Retained Income			Shareholders’
BALANCE DECEMBER 31, 2017		250			27			15,760			(101		)	3,889			19,825
Net loss		—			—			—			—			(391		)	(391		)
Cumulative Adjustment		—			—			—			—			1,382			1,382
Foreign currency translation adjustment		—			—			—			72			—			72
Compensation on stock-based awards		—			—			20			—			—			20
Share repurchases		—			—			(126		)	—			—			(126		)
BALANCE MARCH 31, 2018		$	250		$	27		$	15,654		$	(29	)	$	4,880		$	20,782
BALANCE DECEMBER 31, 2018		$	250		$	27		$	15,610		$	(233	)	$	5,436		$	21,090
Net loss		—			—			—			—			(363		)	(363		)
Foreign currency translation adjustment		—			—			—			56			—			56
Compensation on stock-based awards		—			—			160			—			—			160
Share repurchases		—			—			(13		)	—			—			(13		)
BALANCE MARCH 31, 2019		$	250		$	27		$	15,757		$	(177	)	$	5,073		$	20,930

 

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

 

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CONDENSED NOTES TO 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 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.

 

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Stock-Based Awards

 

Following is the status of all stock options as of March 31, 2019:

 

		Shares		Weighted- Average Exercise Price Per Share			Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value
Outstanding - January 1, 2019		224,750		$	3.44
Granted		137,500		4.53
Exercised		—		—
Cancelled		(23,250	)	3.85
Outstanding - March 31, 2019		339,000		$	3.85		9.12		$	298
Exercisable - March 31, 2019		36,166		$	3.46		7.71		$	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 137,500 stock options granted during the three months ended March 31, 2019.

 

Total compensation expense related to stock options for the three months ended March 31, 2019 and 2018 was $43 and $20, respectively. As of March 31, 2019, there was $402 of unrecognized compensation which will vest over the next 3.29 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 three months ended March 31, 2019, there were 100,000 Units granted.  Total compensation expense (income) related to the vested outstanding Units based on the estimated appreciation over their remaining terms was $0 for the three months ended March 31, 2019 and 2018, respectively.

 

During the three months ended March 31, 2019, there were 25,000 restricted shares awarded that vested immediately that had expense of $116.

 

Net Loss per Common Share

 

For both the three months ended March 31, 2019 and 2018, 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.

 

Share Repurchase Program

 

As of March 31, 2019, we have a $250 share repurchase program which was authorized by our Board of Directors in August 2017. Under this repurchase program, we repurchased 3,377 shares in open market transactions totaling $13 for the three months ended March 31, 2019.  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.

 

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Segment Reporting Information

 

All of our operations fall under the contract manufacturing segment within the electronic manufacturing Services industry. We strategically direct production between our various manufacturing facilities based on a number of considerations to best meet our customers’ requirements. We share resources for sales, marketing, engineering, supply chain, information services, human resources, payroll, and all corporate accounting functions. Consolidated financial information is available that is evaluated regularly by the chief operating decision maker in assessing performance and allocating resources.

 

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 March 31, 2019 balance included cash collateral required to be held against our corporate employee purchasing card program and 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 March 31, 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 March 31, 2019 and December 31, 2018 have been reduced by an allowance for doubtful accounts of $246 and $222, respectively.

 

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:

 

		March 31,			December 31,
		2019			2018
Raw Materials		$	16,197		$	16,769
Work in Process		698			1,015
Finished Goods		252			332
Reserves		(1,163		)	(1,112		)
Total		$	15,984		$	17,004

 

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Other Intangible Assets

 

Other intangible assets at March 31, 2019 and December 31, 2018 are as follows:

 

				March 31, 2019
				Gross
				Carrying			Accumulated			Net Book
		Years		Amount			Amortization			Value
Customer Relationships		9		$	1,302		$	542		$	760
Intellectual Property		3		100			69			31
Trade Names		20		814			153			661
Patents		7		17			—			17
Totals				$	2,233		$	764		$	1,469

 

				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 months ended March 31, 2019 and March 31, 2018 was $54 and $55, respectively.

 

Estimated future annual amortization expense (not including projects in process) related to these assets is approximately as follows:

 

Year		Amount
Remainder of 2019		$	165
2020		191
2021		185
2022		185
2023		185
Thereafter		541
Total		$	1,452

 

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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 three months ended March 31, 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 its 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 months ended March 31, 2019 or 2018.

 

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 Equity.

 

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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 $310 in cash at March 31, 2019, approximately $276 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 months ended March 31, 2019 and 2018. One division accounted for approximately 23% and 19% of net sales for the three months ended March 31, 2019 and 2018, respectively. The other division accounted for approximately 3% and 1% of net sales for the three months ended March 31, 2019 and 2018, respectively.  Together they accounted for approximately 26% and 20% of net sales for the three months ended March 31, 2019 and 2018, respectively.  Accounts receivable from the customer at March 31, 2019 and December 31, 2018 represented approximately 25% and 16% of our total accounts receivable, respectively.

 

Export sales represented approximately 19% of net sales for the three months ended March 31, 2019 and 2018.

 

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 the three months ended March 31, 2019 and 2018. 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 judgments 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.

 

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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 months ended March 31, 2019 was as follows (in thousands):

 

Outstanding at January 1, 2019		$	6,431
Increase (decrease) attributed to:
Transferred to receivables from contract assets recognized		(4,012		)
Product transferred over time		6,165
Outstanding at the end of period		$	8,584

 

We expect substantially all of the remaining performance obligations for the contract assets recorded as of March 31, 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 table summarizes our net sales by market for the three months ended March 31, 2019:

 

		Product/ Service Transferred Over Time			Product Transferred at Point in Time			Noncash Consideration			Total Net Sales by Market
Aerospace and Defense		$	4,103		$	20		$	122		$	4,245
Medical		14,495			35			409			$	14,939
Industrial		8,140			597			244			8,981
Total net sales		$	26,738		$	652		$	775		$	28,165

 

The following table summarizes our net sales by market for the three months ended March 31, 2018:

 

		Product/ Service Transferred Over Time			Product Transferred at Point in Time			Noncash Consideration			Total Net Sales by Market
Aerospace and Defense		$	4,623		$	48		$	195		$	4,866
Medical		9,434			482			405			10,321
Industrial		9,992			843			425			11,260
Total net sales		$	24,049		$	1,373		$	1,025		$	26,447

 

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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 5.6% and 3.0% as of March 31, 2019 and 2018, respectively. We had borrowings on our line of credit of $11,294 and $9,264 outstanding as of March 31, 2019 and December 31, 2018. 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.

 

The availability under the line is subject to borrowing base requirements, and advances are at the discretion of the lender. At March 31, 2019, we had unused availability under our line of credit of $4,706, 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. The $1,000 promissory note has a four-year term, bearing interest at 4% per annum, requiring monthly principal and interest payments of $23 and is subject to offsets if certain revenue levels are not met. The $1,300 promissory note has a four-year term and bears interest at 4% per annum, requiring monthly principal and interest payments of $29 and is not subject to offset.

 

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Long-term debt at March 31, 2019 and December 31, 2018 consisted of the following:

 

		March 31,			December 31,
		2019			2018
Real estate term notes bearing interest at one-month LIBOR + 2.25% (4.8% as of March 31, 2019 and December 31, 2018) maturing June 15, 2022 with monthly payments of approximately $41 plus interest secured by substantially all assets.		$	4,129		$	4,253
Devicix Acquistion Note 1 payable to DeLange Holdings bears interest rate of 4.0% per annum, maturing July 1, 2019		67			156
Devicix Acquistion Note 2 payable to DeLange Holdings bears interest rate of 4.0% per annum, maturing July 1, 2019		87			203
		4,283			4,612
Discount on Devicix Notes Payable		(13		)	(23		)
Debt issuance Costs		(172		)	(185		)
Total long-term debt		4,098			4,404
Current maturities of long-term debt		(586		)	(780		)
Long-term debt - net of current maturities		$	3,512		$	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 March 31, 2019, we do not have material lease commitments that have not commenced.

 

The components of lease expense were as follows:

 

		Three Months Ended March 31,
Lease Cost		2019
Operating lease cost		$	274
Finance lease interest cost		17
Finance lease amortization expense		65
Total lease cost		$	356

 

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Supplemental balance sheet information related to leases was as follows:

 

		Balance Sheet Location		March 31, 2019
Assets
Operating lease assets		Operating lease assets		$	5,387
Finance lease assets		Property, Plant and Equipment		1,358
Total leased assets				6,745
Liabilities
Current
Current operating lease liabilities		Current Portion of Operating Lease Obligations		811
Current finance lease liabilities		Current Portion of Finance Lease Obligations		359
Noncurrent
Long-term operating lease liabilities		L-T Operating Lease Liabilities, Net		4,813
Long term finance lease liabilities		L-T Finance Lease Obligations, Net		864
Total lease liabilities				$	6,847

 

Supplemental cash flow information related to leases was as follows:

 

		Three Months Ended March 31,
		2019
Operating leases
Cash paid for amounts included in the measurement of lease liabilities		$	107
Right-of-use assets obtained in exchange for lease obligations		$	—

 

Maturities of lease liabilities were as follows:

 

		Operating Leases			Finance Leases			Total
Remaining 2019		$	671		$	320		$	991
2020		858			398			1,256
2021		722			398			1,120
2022		726			223			949
2023		738			2			740
Thereafter		3,380			—			3,380
Total lease payments		$	7,095		$	1,341		$	8,436
Less: Interest		(1,471		)	(118		)	(1,589		)
Present value of lease liabilities		$	5,624		$	1,223		$	6,847

 

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The lease term and discount rate at March 31, 2019 were as follows:

 

		March 31,
		2019
Weighted-average remaining lease term (years)
Operating leases		8.3
Finance leases		3.7
Weighted-average discount rate
Operating leases		4.8	%
Finance leases		5.4	%

 

Rent expense for our operating leases the three months ended March 31, 2018 as accounted under ASC 840, Leases, was $335.

 

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 months ended March 31, 2019 and 2018 was (4%) and (34%), respectively. Our effective tax rate for the year ended December 31, 2019 is expected to be 19% compared to 64% for the year ended December 31, 2018.  The decrease in rate mainly relates to: (1) a higher ratio of projected annual pre-tax book income compared to permanent differences; (2) the Company’s ability to reduce the impact of global intangible low-taxed income (“GILTI”).

 

NOTE 7.  RELATED PARTY TRANSACTIONS

 

During 2016, the Company entered into a consulting arrangement with a company co-owned by Matt Mahmood, who became the Chief Operating Officer of the Company on May 20, 2017 and who resigned from the Company on October 5, 2018. For the three months ended March 31, 2019 and 2018, expenses were incurred in the amounts of $0, and $12 respectively.

 

On February 22, 2018, the Company entered into a Consulting Agreement with Crosscourt Group, LLC, a limited liability company owned and managed by William Murray, formerly an independent director of the Company.  Mr. Murray resigned from this position in May 2018. The term of the Consulting Agreement was three months and ended in the second quarter of 2018. The Company is paying severance benefits per his employment and separation agreements of $235 over 12 months, to be paid in full during 2019, which was fully expensed in the fourth quarter of 2018.

 

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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
		March 31,
		2019		2018
Net Sales		100.0	%	100.0	%
Cost of Goods Sold		89.5		88.5
Gross Profit		10.5		11.5
Selling Expenses		2.7		3.9
General and Administrative Expenses		8.1		8.0
Loss from Operations		(0.3	)	(0.4	)
Other Expenses		(0.9	)	(0.7	)
Loss Before Income Taxes		(1.2	)	(1.1	)
Income Tax Expense (Benefit)		0.1		0.4
Net Loss		(1.3	)%	(1.5	)%

 

Net Sales

 

Net sales were $28.2 million in the first quarter of 2019, as compared to $26.4 million in the first quarter of the prior year, an increase of $1.8 million or 6.5%. Net sales results were varied by markets, the medical market increased by $4.6 million or 44.7% with medical component products accounting for 60% of the increase and medical devices the remaining 40%. The industrial market sector was down $2.3 million or 20.2% in the first quarter of 2019 as compared to the same quarter of 2018. Net sales from the aerospace and defense markets decreased by $0.6 million or 12.8% in the first quarter of 2019 as compared to the first quarter of 2018.

 

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