Nortech Systems Incorporated — FY2011 Form 10-K Summary
Business context and reporting period
Nortech Systems is a single-segment electronic manufacturing services company providing design, testing, prototyping, supply-chain management, medical devices, printed circuit board assemblies, wire and cable assemblies, and electromechanical assemblies. Its customers primarily operate in Aerospace and Defense, Medical, and Industrial markets. Manufacturing facilities are located in Minnesota, Wisconsin, and Monterrey, Mexico. The filing covers the fiscal year ended December 31, 2011, with comparison to fiscal 2010. The consolidated financial statements were audited by McGladrey & Pullen, LLP, which issued an unqualified opinion.
Key financial metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Net sales | $114.2 million | $99.8 million | 14% increase |
| Gross profit | $13.3 million | $11.4 million | 17% increase |
| Gross margin | 11.7% | 11.4% | 30 basis-point increase |
| Income from operations | $1.5 million | $1.2 million | Increase |
| Net income | $1.19 million | $0.51 million | Increase |
| Diluted EPS | $0.43 | $0.18 | Increase |
| Operating cash flow | $(0.9) million | $2.9 million | Decrease |
| Capital expenditures | $1.27 million | $0.63 million | Increase |
| Working capital | $12.3 million | $13.1 million | Decrease |
Revenue growth was concentrated in Medical and Industrial markets. 2011 sales were $16.5 million in Aerospace and Defense, $33.4 million in Medical, and $64.4 million in Industrial. Selling expenses were $3.6 million and general and administrative expenses were $8.2 million. The effective tax rate was 32.0%, compared with 42.5% in 2010.
Cash declined to zero at December 31, 2011 from $0.23 million at December 31, 2010. Accounts receivable were $16.7 million and inventories were $19.0 million, compared with $15.6 million and $16.1 million, respectively, at the prior year-end.
Debt and liquidity
The Wells Fargo credit facility provides a $13.5 million line of credit, of which $9.35 million was outstanding at year-end. Net unused availability was approximately $3.9 million, subject to borrowing-base requirements and lender discretion. Long-term debt totaled $2.12 million, including $1.31 million of current maturities. The real estate term note, with a $1.01 million balance, matured May 31, 2012, and management was negotiating an extension. The line of credit expires May 31, 2013 unless renewed. Debt is secured by substantially all company assets.
Material changes versus the prior period
- Revenue increased 14%, primarily because of acquisitions, particularly the Mankato EMS operation acquired from Winland Electronics on January 1, 2011.
- The Mankato acquisition generated approximately $3.2 million of Medical sales and $15.7 million of Industrial sales during 2011, and produced a $791,615 bargain purchase gain.
- Net income excluding the bargain purchase gain, net of tax, was approximately $0.7 million, or $0.24 per diluted share.
- Gross margin improved because of favorable product mix and manufacturing cost and efficiency initiatives.
- Operating cash flow turned negative, primarily because of working-capital needs associated with the Mankato acquisition; inventory increased by approximately $2.9 million.
- Debt financing increased to fund acquisition-related needs and operations. Net borrowings under the line of credit increased by approximately $3.7 million.
- 90-day backlog was essentially unchanged at $18.5 million, although Medical backlog increased 34% while Aerospace and Defense and Industrial backlog declined 13% and 8%, respectively.
Guidance, outlook, risks, and unusual items
Management expects the EMS industry to benefit from continued outsourcing as macroeconomic conditions improve. Its strategy emphasizes organic growth, acquisitions, lean manufacturing, supply-chain services, Mexico-based lower-cost production, and expansion in Aerospace and Defense, Medical, and Industrial markets. The filing does not provide quantitative earnings or revenue guidance.
- The bargain purchase gain was a material nonrecurring benefit to 2011 earnings.
- The company expects financing arrangements and anticipated operating cash flows to satisfy foreseeable working-capital, capital-expenditure, investment, and debt-repayment needs.
- Key risks include economic weakness, customer concentration, intense EMS competition, component shortages, raw-material and energy-cost inflation, order cancellations and rescheduling, inventory obsolescence, labor availability, foreign operations in Mexico, acquisitions and integration, information-system interruptions, natural disasters, environmental compliance, and product-liability claims.
- G.E.'s Medical and Transportation divisions together represented 23% of 2011 net sales and 17% of year-end accounts receivable.
- The company was in compliance with debt covenants at December 31, 2011, but future noncompliance could restrict borrowing or accelerate repayment obligations.
- The company reported no material legal proceedings and no significant environmental compliance costs. It also reported effective disclosure controls and internal control over financial reporting; the auditor did not provide an internal-control attestation because the company qualified for the applicable smaller-reporting-company exemption.
- Operating lease commitments totaled approximately $2.94 million through 2017. The company paid no dividends in 2011 or 2010 and does not expect to pay dividends in the foreseeable future.
Most important facts to verify
- Whether the Mankato acquisition produces sustained revenue, margin, and cash-flow benefits after the 2011 acquisition-related effects.
- Availability and renewal or refinancing of the Wells Fargo real estate term note and the May 2013 revolving credit facility.
- Whether negative operating cash flow and higher inventory levels normalize as acquisition-related working-capital requirements subside.
- Customer concentration, particularly G.E. exposure, and the stability of the $18.5 million 90-day backlog.
- The sustainability of reported earnings excluding the $791,615 bargain purchase gain.
- Exposure to component shortages, inventory reserves, commodity costs, labor constraints, and Mexico operating risks.
- Future obligations related to debt maturities, leases, the Winland inventory commitment, and change-of-control arrangements.