Nortech Systems Incorporated — Form 10-Q Summary
Business context and reporting period
Nortech Systems Incorporated is an electronics manufacturing services provider producing wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds, with value-added design, testing, prototyping and supply-chain services. Its principal markets are Aerospace and Defense, Medical and Industrial Equipment. The filing covers the unaudited three and six months ended June 30, 2013, compared with the corresponding 2012 periods.
Financial performance and key metrics
| Metric | Three months ended June 30, 2013 | Three months ended June 30, 2012 | Six months ended June 30, 2013 | Six months ended June 30, 2012 |
|---|---|---|---|---|
| Net sales | $28.5 million | $28.0 million | $54.4 million | $56.4 million |
| Gross profit | $3.4 million | $3.1 million | $6.6 million | $6.1 million |
| Gross margin | 11.8% | 11.0% | 12.1% | 10.8% |
| Income from operations | $0.4 million | $0.3 million | $0.6 million | $0.6 million |
| Net income | $187,219 | $125,925 | $328,308 | $248,730 |
| Basic and diluted EPS | $0.07 | $0.05 | $0.12 | $0.09 |
- Second-quarter sales increased approximately 1% year over year and 10% sequentially from the first quarter of 2013.
- Six-month sales decreased approximately 4% year over year, primarily because of weaker Industrial customer demand.
- Second-quarter operating income increased approximately 17%; six-month operating income declined approximately 8% because higher selling and general and administrative expenses more than offset gross-profit improvement.
- Gross-margin improvement was attributed to favorable product mix, increased automation and lean manufacturing initiatives.
- Operating expenses increased year over year, including general and administrative expenses of $1.8 million for the quarter and $3.5 million year to date. The company cited higher people and incentive expenses.
- The six-month effective tax rate was 19%, compared with 35% in 2012, primarily reflecting reinstated and extended federal research and development tax credits. Management expected a 27% full-year 2013 effective tax rate, compared with 32% for 2012.
Cash flow, liquidity and debt
- Cash used in operating activities was $1.4 million in the first six months of 2013, compared with $1.3 million of operating cash flow provided in the prior-year period. The use of cash was principally due to higher accounts receivable and inventory supporting anticipated production.
- Investing activities used $0.6 million, primarily for property and equipment purchases.
- Financing activities provided $2.1 million, including $1.7 million of long-term debt proceeds related to the Mankato facility and $0.8 million of increased line-of-credit borrowings, partly offset by $0.4 million of principal payments.
- The company reported no cash balance at June 30, 2013; the filing does not provide a clear cash reserve value beyond this reported amount.
- Working capital was $14.6 million at June 30, 2013, compared with $12.6 million at December 31, 2012.
- Accounts receivable were $15.5 million and inventories were $18.8 million at June 30, 2013, versus $13.6 million and $17.7 million, respectively, at year-end 2012.
- Line-of-credit borrowings were $8.7 million, with approximately $3.9 million of unused availability. The $13.5 million facility expires, if not renewed, on May 31, 2015, is subject to borrowing-base requirements and is secured by substantially all company assets.
- Total debt consisted of $8.7 million under the line of credit, $0.6 million of current long-term debt maturities and $4.1 million of long-term debt, excluding current maturities.
- Debt agreements contain financial-performance, reporting, dividend and capital-expenditure covenants. Borrowings have variable interest rates based on LIBOR.
Material changes, outlook and risks
- Aerospace and Defense sales increased 48% in the quarter and 20% year to date, driven by new programs and assemblies. Medical sales were broadly unchanged, while Industrial sales declined 8% in the quarter and 11% year to date.
- Reported 90-day backlog was $19.3 million at June 30, 2013, compared with $20.3 million at March 31, 2013 and $17.3 million at June 30, 2012. Management expected a major portion to convert to revenue in the following quarter; Medical and Defense demand remained strong while Industrial orders were soft.
- The company recorded a $74,000 impairment charge in the first six months of 2013 for an asset held for sale, which was sold during the second quarter.
- The company stated that its financing arrangements and expected operating cash flows should be sufficient for future working-capital needs, although operating cash flow was negative year to date and liquidity depends partly on borrowing availability.
- Key disclosed risks include market volatility, competition, facility or third-party operating reliability, labor availability, raw-material and copper costs, commodity and energy-price instability, general economic conditions and component availability.
- One customer’s divisions collectively represented 23% of net sales in both the quarter and six-month period. Export sales represented 12% of net sales in both 2013 periods, compared with 6% for the 2012 quarter and 7% for the 2012 six-month period.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. Legal proceedings were described as ordinary-course claims without further detail.
Investor verification points
- Verify the sustainability of the improved gross margins and whether the favorable mix and automation benefits offset higher operating expenses.
- Track accounts receivable, inventory and operating cash flow, particularly because working-capital growth produced negative year-to-date operating cash flow.
- Monitor line-of-credit availability, borrowing-base compliance, variable interest rates and covenant performance.
- Assess customer concentration and the durability of Aerospace and Defense growth against continued weakness in Industrial demand.
- Confirm conversion of the $19.3 million backlog into revenue and evaluate the timing and quality of future orders.
- Review the impact of the $74,000 impairment, the Mankato facility financing and any future capital-expenditure requirements.
- Validate the expected 27% full-year effective tax rate and the availability of research and development tax credits.