Nortech Systems Incorporated — Form 10-Q Summary
Business Context and Reporting Period
Nortech Systems Incorporated is an Electronics Manufacturing Services contract manufacturer serving aerospace and defense, medical, and industrial equipment customers. The company manufactures wire and cable assemblies, printed circuit board assemblies, higher-level assemblies, and box builds, with facilities in Minnesota, Wisconsin, and Mexico. This report covers the three months ended March 31, 2012; financial statements are unaudited.
Financial Results and Key Metrics
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Net sales | $28.36 million | $29.00 million |
| Gross profit | $3.01 million | $3.20 million |
| Gross margin | 10.6% | 11.0% |
| Income from operations | $328,430 | $286,662 |
| Income before taxes | $181,805 | $939,188 |
| Net income | $122,805 | $626,188 |
| Basic and diluted EPS | $0.04 | $0.23 |
| Cash provided by operating activities | $2.65 million | Cash used of $3.91 million |
Operating expenses declined to $2.68 million from $2.91 million. Selling expense increased to $1.09 million from $0.93 million, while general and administrative expense declined to $1.59 million from $1.98 million. Interest expense was $136,779, compared with $119,992 in the prior-year quarter. The effective tax rate was 32%, compared with 33%.
At March 31, 2012, total assets were $46.03 million, including $15.96 million of accounts receivable and $19.02 million of inventory. The company reported no cash balance. Total liabilities were $25.40 million and shareholders’ equity was $20.63 million.
Debt included $7.28 million outstanding under the line of credit, $477,586 of current long-term debt maturities, and $1.52 million of long-term debt. Working capital was approximately $13.0 million. The company had $5.9 million of unused line-of-credit availability supported by its borrowing base and was in compliance with its debt covenants.
Investing activities used $462,576, primarily for property and equipment. Financing activities used $2.19 million, principally from $2.06 million of line-of-credit repayments and $126,386 of long-term debt repayments. The company had no cash at period end.
Material Changes Versus the Prior Comparable Period
- Sales decreased 2% to $28.36 million. Aerospace and defense sales increased 6%, while medical sales declined 2% and industrial sales declined 4%.
- Gross margin declined to 10.6% from 11.0%, primarily because of product and service mix and underutilized capacity.
- Operating income increased 15% despite lower sales, reflecting lower general and administrative costs that more than offset higher selling expenses.
- Net income declined 80% because Q1 2011 included a $791,615 bargain purchase gain related to the Winland Electronics acquisition. Management stated that the after-tax effect of that gain increased Q1 2011 earnings by approximately $0.5 million, or $0.19 per diluted share.
- Operating cash flow improved substantially to $2.65 million from a $3.91 million use of cash, primarily due to stronger receivable collections and the absence of the prior-year acquisition-related inventory build.
- Order backlog was $18.44 million at March 31, 2012, compared with $18.53 million at December 31, 2011 and $20.02 million at March 31, 2011.
- On March 7, 2012, the company granted 250,000 equity appreciation right units. In January 2012, it cancelled 319,600 stock options following termination of the 2007 FOCUS Incentive Plan.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management described sales and backlog trends as mixed because of a sluggish economy. It reported improving traction with medical-device customers and increased orders from several large industrial customers, while aerospace and defense backlog declined from December 31, 2011. Management believed financing arrangements and operating cash flows would be sufficient to meet future working-capital needs.
The May 2, 2012 credit agreement amendment provides for a $13.5 million line of credit expiring May 31, 2015, a $1.8 million real estate term note maturing March 31, 2027, and a capital-expenditure term loan of up to $2.0 million maturing May 31, 2015. The financial statements reflect the refinancing as if it occurred on March 31, 2012. Borrowings are subject to LIBOR variability, borrowing-base requirements, lender discretion, and financial and capital-expenditure covenants.
Management expected a 2012 effective tax rate of approximately 35%, compared with 34% for 2011. The filing identifies risks from market volatility, competition, facility reliability, labor availability, copper and other raw-material costs, commodity and energy prices, general economic conditions, and integration of acquisitions. One customer group, GE’s medical and transportation divisions, represented 22% of Q1 2012 sales; GE’s medical division alone represented 17%.
The company is subject to ordinary-course legal proceedings and claims. It reported no material changes in critical accounting policies, no material changes in internal control over financial reporting, and effective disclosure controls and procedures.
Important Facts for Investors to Verify
- Confirm the borrowing-base calculation, availability, LIBOR exposure, maturity terms, and covenant compliance under the amended Wells Fargo credit agreement.
- Assess the sustainability of the 10.6% gross margin given product mix and underutilized capacity.
- Monitor customer concentration, particularly GE-related revenue and receivables.
- Evaluate backlog conversion and changes in industrial and aerospace and defense demand.
- Review inventory reserves, inventory levels, and working-capital requirements.
- Reconcile reported zero cash with operating cash generation and reliance on the secured line of credit.
- Consider the comparability impact of the $791,615 bargain purchase gain recorded in Q1 2011.
- Review the approximately $121,000 of uncertain tax benefit positions and the expected 2012 tax rate.