NSYS

Nortech Systems Inc. 10-K Summary (Fiscal Year Ended Dec 31, 2006)

Business Context and Reporting Period

Company: Nortech Systems Inc.
Reporting Period: Fiscal year ended December 31, 2006.
Industry: Electronic Manufacturing Services (EMS) / Contract Manufacturing.
Operations: Manufactures wire harnesses, cable assemblies, printed circuit board assemblies, and box builds. Facilities are located in Minnesota, Wisconsin, Iowa (acquired Feb 2007), and Mexico.
Markets Served: Industrial Equipment, Medical, Military/Defense, Transportation, Agriculture, and Oil & Gas.

Key Financial Metrics

Note: Total Debt for 2006 includes $4,694,027 in current bank notes, $1,524,743 in current maturities of long-term debt, and $3,509,039 in long-term debt.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 24.9% ($20.9 million) from 2005 to 2006. Growth was driven by Aerospace Systems (51% of increase), Electronic Circuit Board Assemblies (27%), and Cable & Wire sales (22%).
• Profitability: Net income increased 41.2% to $1.31 million. Gross margin improved to 12.2% due to volume leveraging and favorable product mix, which offset rising commodity (copper) and energy costs.
• Expenses: Selling expenses rose to $4.7 million (4.4% of sales) due to increased commissions and marketing spend. General and Administrative expenses increased to $5.4 million, partly due to the adoption of SFAS 123R (stock-based compensation) adding ~$0.2 million in expense.
• Cash Flow: Operating cash flow decreased to $2.8 million from $5.1 million in 2005, primarily due to higher income tax payments and changes in working capital components.
• Backlog: 90-day backlog decreased to approximately $19.5 million at year-end 2006 from $24.9 million in 2005.

Guidance, Outlook, Risks, and Unusual Items

• Acquisitions: On February 4, 2007 (post-year-end), the company acquired Suntron Corporation's Mid-West Operation in Garner, Iowa, for $5.61 million. This expands capabilities in PCB assemblies and enters agriculture/oil & gas markets. Pro forma 2006 results would show Net Sales of $117.7 million and Net Income of $1.4 million.
• Debt Facilities: In February 2007, the revolving credit line was increased from $10 million to $15 million, and the real estate term note was increased to $3.35 million to fund the Iowa acquisition.
• Risks:
  • Customer Concentration: General Electric (Medical and Transportation divisions) accounted for 17% of 2006 sales. Northrop Grumman accounted for 10%.
  • Competition: High competition from global EMS providers and foreign manufacturers with lower cost structures.
  • Supply Chain: Dependence on suppliers for electronic components; potential for shortages or cost increases.
  • Foreign Operations: Risks associated with the Monterrey, Mexico facility, including currency fluctuation and political instability.
• Accounting Changes: Adopted SFAS 123R (Share-Based Payment) in 2006, resulting in $188,259 of stock-based compensation expense.

Investor Verification Checklist

• Customer Concentration: Verify the stability of contracts with General Electric and Northrop Grumman, which collectively represent 27% of revenue.
• Acquisition Integration: Monitor the integration and financial performance of the Suntron (Iowa) acquisition and the Blue Earth facility expansion.
• Debt Covenants: Review compliance with Wells Fargo Bank covenants, specifically financial ratios and capital expenditure limits, given the increased debt load post-acquisition.
• Margin Sustainability: Assess whether the 12.2% gross margin can be maintained amidst rising raw material (copper) and energy costs.
• Backlog Realization: Confirm the conversion of the $19.5 million backlog into revenue in Q1 2007, noting the impact of Just-In-Time (JIT) manufacturing on backlog reliability.