Nortech Systems Incorporated — FY2013 Form 10-K Summary
Business context and reporting period
Nortech Systems Incorporated is a Minnesota-based electronic manufacturing services company serving Aerospace and Defense, Medical, and Industrial customers. It provides design support, prototyping, testing, printed circuit board assemblies, wire and cable assemblies, medical devices, and complex electromechanical assemblies. Operations include facilities in Minnesota, Wisconsin, and Monterrey, Mexico. The filing covers the fiscal year ended December 31, 2013, with comparison to fiscal 2012. The company reports one operating segment: Contract Manufacturing.
Financial performance and condition
| Metric | 2013 | 2012 |
|---|---|---|
| Net sales | $111.1 million | $106.9 million |
| Gross profit | $13.1 million | $12.4 million |
| Gross margin | 11.8% | 11.6% |
| Income from operations | $1.5 million | $1.5 million |
| Operating margin | 1.3% | 1.4% |
| Income before taxes | $1.1 million | $0.9 million |
| Net income | $787,376 | $629,438 |
| Diluted EPS | $0.29 | $0.23 |
| Cash from operating activities | $275,939 | $4.6 million |
| Capital expenditures, net of asset-sale proceeds | $1.1 million | $4.4 million |
| Working capital | $15.5 million | $12.6 million |
Cash on the balance sheet was reported as zero at both year-end dates. Accounts receivable increased to $16.0 million from $13.6 million, while inventories declined modestly to $17.4 million from $17.7 million. Total assets were $46.1 million and shareholders’ equity was $21.9 million at December 31, 2013.
At year-end, the company had $7.2 million outstanding under its $13.5 million revolving credit facility and approximately $5.8 million of net unused availability subject to borrowing-base requirements. Current maturities of long-term debt were $632,176 and long-term debt, net of current maturities, was $4.25 million. Debt is secured by substantially all company assets and bears variable interest rates linked to LIBOR.
Material changes versus the prior comparable period
- Sales increased 3.9%, driven primarily by new Aerospace and Defense contracts and programs with existing customers.
- Aerospace and Defense sales increased 27% to $19.9 million; Medical sales increased 9% to $35.4 million; Industrial sales declined 5% to $55.8 million.
- Gross margin improved by 20 basis points, reflecting higher volume, automation investment, and cost-control initiatives, partly offset by product mix and launch costs.
- Operating income was essentially unchanged because higher gross profit was offset by increased selling and general and administrative expenses.
- Net income increased 25% and diluted EPS increased from $0.23 to $0.29, aided in part by lower interest and other expense and a lower effective tax rate.
- Operating cash flow fell substantially to $0.3 million from $4.6 million, primarily because accounts receivable increased and accounts payable decreased.
- Year-end 90-day backlog declined 12% to $16.1 million from $18.3 million. Medical backlog declined 13% and Industrial backlog declined 21%, while Aerospace and Defense backlog increased 7%.
- Export sales increased to 12% of net sales from 7%. The company’s largest customer’s two divisions represented 26% of 2013 sales, compared with 24% in 2012.
Outlook, commentary, risks, and unusual items
Management stated that existing financing arrangements and anticipated operating cash flows should be sufficient for foreseeable working capital, capital expenditures, and debt repayments. The company continues to pursue organic growth, acquisitions, mergers, joint ventures, supply-chain initiatives, lean manufacturing, automation, and lower-cost production opportunities through Mexico. No specific revenue or earnings guidance was provided.
- Industrial demand remains affected by a slow economic recovery and weaker capital-equipment markets.
- Medical orders were affected by timing, customer inventory levels, and program delays.
- Backlog is subject to order timing, manufacturing delays, inventory programs, contract terms, and customer releases and may not be a reliable indicator of future revenue.
- Material risks include customer concentration, competitive pricing pressure, component shortages, raw-material and energy-cost volatility, labor availability, execution risk, foreign operations, economic conditions, product liability, environmental compliance, information-system disruptions, natural disasters, and acquisition integration.
- Failure to comply with credit-agreement covenants could restrict borrowing or accelerate repayment obligations. The company reported compliance with its covenants at December 31, 2013.
- The company recorded $74,000 of impairment charges related to assets held for sale, compared with $127,000 in 2012.
- An arbitration matter settled on February 12, 2014 and did not materially affect operations. Management also stated that ordinary-course legal proceedings are not expected to have a material effect.
- Unrecognized tax benefits totaled $193,000 at year-end. Management concluded that deferred tax assets were realizable and recorded no valuation allowance.
- The independent auditor issued an unqualified opinion on the consolidated financial statements. Management concluded that disclosure controls and internal control over financial reporting were effective; the auditor was not engaged to audit internal control effectiveness.
Important facts for investors to verify
- Confirm the company’s ability to convert reported earnings into cash, given the sharp decline in operating cash flow and zero reported cash balance.
- Review revolving-credit borrowing-base availability, covenant requirements, variable interest rates, and maturities through and after the May 31, 2015 facility expiration.
- Assess customer concentration and the effect of any changes in the largest customer’s programs or purchasing levels.
- Monitor backlog conversion and trends in the Industrial and Medical markets, where year-end backlog declined materially.
- Evaluate inventory reserves, accounts-receivable concentration, and potential exposure to customer cancellations, rescheduled orders, or component shortages.
- Verify the terms and financial effects of executive compensation, equity appreciation rights, leases, product warranties, and unrecognized tax benefits.