Nortech Systems Incorporated — Form 10-Q Summary
Business context and reporting period
Report for the quarter and nine months ended September 30, 2011, filed November 4, 2011. Nortech is an Electronics Manufacturing Services provider producing wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds, with supporting design, testing, prototyping and supply-chain services. Its principal markets are aerospace and defense, medical and industrial equipment. The filing covers Nortech and its wholly owned subsidiary and presents unaudited interim GAAP financial statements.
Financial performance and condition
| Metric | Three months ended Sept. 30, 2011 | Three months ended Sept. 30, 2010 | Nine months ended Sept. 30, 2011 | Nine months ended Sept. 30, 2010 |
|---|---|---|---|---|
| Net sales | $28.3 million | $26.0 million | $85.1 million | $72.4 million |
| Gross profit | $3.3 million | $2.9 million | $9.7 million | $8.6 million |
| Gross margin | 11.6% | 11.1% | 11.4% | 11.9% |
| Operating income | $0.4 million | $0.2 million | $1.0 million | $1.0 million |
| Net income | $0.2 million | $0.1 million | $1.0 million | $0.4 million |
| Diluted EPS | $0.07 | $0.05 | $0.35 | $0.13 |
Operating margin was approximately 1.5% in the third quarter and 1.2% for the first nine months, compared with 0.6% and 1.3%, respectively, in the prior-year periods. The nine-month net income benefited from a $791,615 bargain purchase gain related to the Mankato acquisition; management reported approximately $0.4 million, or $0.15 per diluted share, of nine-month net income excluding the after-tax effect of that gain.
Cash was zero at September 30, 2011, compared with $230,582 at December 31, 2010. Nine-month operating cash flow was negative $2.2 million, versus positive $1.6 million in the prior-year period, primarily because of inventory and working-capital requirements supporting the Mankato operation. Management stated that third-quarter operating cash flow was positive $2.5 million, largely due to extended supplier payment terms.
At September 30, 2011, total assets were $50.0 million and shareholders’ equity was $20.3 million. Working capital was approximately $11.8 million, down from $13.1 million at December 31, 2010. Accounts receivable were $17.6 million and inventory was $21.4 million, up from $16.1 million at year-end.
Debt consisted of a $9.3 million line-of-credit balance, $2.1 million of current long-term debt maturities and $0.8 million of long-term debt, or approximately $12.2 million in total. The $13.5 million Wells Fargo credit facility expires May 31, 2013 if not renewed; $4.0 million of borrowing-base availability and the full $1.0 million capital-expenditure term-loan commitment remained available at September 30, 2011. The company was in compliance with its debt covenants. Variable-rate borrowings expose the company to LIBOR-related interest-rate risk.
Material changes versus the prior comparable period
- Third-quarter sales increased 9%; nine-month sales increased 18%, with recent acquisitions contributing $5.2 million and $15.9 million, respectively.
- Medical sales increased 21% in the quarter and 28% year to date; industrial sales increased 7% and 20%, respectively. Aerospace and defense sales declined 4% and 9% because of production delays and late federal defense-program funding.
- Third-quarter gross margin improved to 11.6% from 11.1%, reflecting favorable mix, pricing adjustments and cost-reduction initiatives. Nine-month gross margin declined to 11.4% from 11.9%.
- Operating income more than doubled in the quarter, while nine-month operating income was approximately unchanged.
- Interest expense increased to $130,152 in the quarter and $392,237 year to date, compared with $99,434 and $325,375, respectively.
- Management reported a 90-day backlog of $21.9 million at September 30, down 4% from $22.8 million at June 30 and below $23.5 million a year earlier. Industrial backlog fell 16% during the quarter, while aerospace and defense backlog rose 34%.
Outlook, commentary, risks and unusual items
Management attributed continued revenue growth primarily to acquisitions but noted cautious ordering and inventory management among existing industrial customers because of economic uncertainty. Management expected financing arrangements and operating cash flows to satisfy future working-capital needs, but the company had no cash balance and relied on its secured, borrowing-base-dependent line of credit.
The January 2011 Mankato acquisition expanded manufacturing capacity and required additional payments, including $250,000 due October 1, 2011, as well as a commitment to purchase at least $2.2 million of inventory over 24 months; the minimum inventory requirement had already been exceeded by September 30. The company also recognized the $791,615 bargain purchase gain.
Key risks identified include economic and demand volatility, competition, facility reliability, labor availability, copper and other raw-material costs, commodity and energy-price instability, and successful integration of recent acquisitions. Customer concentration is significant: GE’s Medical and Transportation divisions together represented 28% of third-quarter sales and 24% of nine-month sales. The company is also subject to ordinary-course legal proceedings and claims. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Investor verification checklist
- Verify the sustainability of revenue and margin gains after removing the Mankato bargain purchase gain and considering acquisition-related contributions.
- Monitor operating cash flow, inventory growth, supplier-payment extensions and the company’s reliance on its secured borrowing base.
- Review debt maturities, covenant compliance, LIBOR exposure and renewal terms for the credit facility.
- Assess backlog conversion, particularly the decline in industrial backlog and the recovery in aerospace and defense backlog.
- Evaluate customer concentration and the effect of GE-related demand on revenue and accounts receivable.
- Confirm integration results and contractual obligations associated with the Mankato acquisition, including remaining purchase payments and inventory commitments.