Nortech Systems Incorporated — Q1 2013 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. It serves aerospace and defense, medical and industrial equipment customers, with facilities in the United States and Mexico. The filing covers the unaudited three months ended March 31, 2013, compared primarily with the three months ended March 31, 2012.
Financial Performance and Position
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net sales | $25.9 million | $28.4 million | Down 9% |
| Gross profit | $3.2 million | $3.0 million | Up 8% |
| Gross margin | 12.5% | 10.6% | Up 1.9 percentage points |
| Income from operations | $224 thousand | $328 thousand | Down 32% |
| Net income | $141 thousand | $123 thousand | Up 15% |
| Basic and diluted EPS | $0.05 | $0.04 | Up $0.01 |
| Cash flow from operations | $(419) thousand | $2.7 million | Declined |
Industrial sales fell 16% to $13.4 million, aerospace and defense sales declined 2% to $4.6 million, and medical sales increased 2% to $8.0 million. Selling expenses were $1.2 million, or 4.6% of sales, and general and administrative expenses were $1.8 million, or 7.0% of sales.
At March 31, 2013, total assets were $46.1 million and shareholders’ equity was $21.3 million. Working capital was $14.5 million, compared with $12.6 million at December 31, 2012. Inventory increased to $19.1 million from $17.7 million, primarily to support future production schedules. Accounts receivable totaled $14.0 million.
Cash was $18 thousand at March 31, 2013, compared with no reported cash at December 31, 2012. Operating activities used $419 thousand, investing activities used $202 thousand for property and equipment, and financing activities provided $639 thousand. Capital expenditures were $202 thousand.
Total debt included $7.0 million outstanding under the line of credit, $565 thousand of current long-term debt maturities and $4.3 million of long-term debt, net of current maturities. The company had approximately $4.8 million of unused line availability at March 31, 2013. The line of credit bears interest at three-month LIBOR plus 2.75%, was secured by substantially all assets, and is subject to borrowing-base limitations and financial covenants.
Material Changes Versus the Prior Comparable Period
- Sales declined 9%, principally because of weaker industrial demand. Management stated that customers had built inventory in early 2012 in anticipation of growth that did not materialize in the second half of that year.
- Gross margin improved to 12.5% from 10.6%, reflecting cost-reduction efforts, automation and lean productivity improvements.
- Operating income declined despite higher gross profit, largely because of increased selling and administrative costs and a $74 thousand impairment charge on an asset held for sale.
- Net income increased because the company recorded a $21 thousand income tax benefit in Q1 2013 versus $59 thousand of tax expense in Q1 2012. The reported effective tax rates were negative 17% and 32%, respectively.
- Operating cash flow shifted from $2.7 million of cash provided to $419 thousand used, primarily because of a $1.5 million inventory build and timing of accounts receivable collections.
- The 90-day order backlog increased to $20.3 million from $18.3 million at December 31, 2012. Aerospace and defense and medical backlogs increased, while industrial backlog declined modestly.
Guidance, Outlook, Risks and Unusual Items
Management did not provide formal revenue or earnings guidance. The company expected a 24% effective tax rate for full-year 2013, compared with 32% for 2012, principally because of reinstated and extended research and development tax credits.
Management stated that financing arrangements and expected operating cash flows should be sufficient to meet future working capital needs. However, liquidity remains dependent on operating cash generation, borrowing-base availability and compliance with debt covenants. Debt is exposed to changes in LIBOR.
Key risks include industrial market weakness, demand and supply volatility, competition, labor availability, raw-material and copper costs, commodity and energy price instability, facility or third-party operating issues, and availability of component materials. One customer’s two divisions represented 24% of Q1 2013 sales and 15% of accounts receivable at March 31, 2013. Export sales represented 11% of Q1 sales.
Unusual items included the $74 thousand asset impairment charge, a $21 thousand income tax benefit, an $86,817 cash payment related to equity appreciation rights, and a $1.7 million real estate term loan funded in January 2013. The company reported no material legal proceedings beyond ordinary-course claims. Management concluded that disclosure controls were effective and that no material change occurred in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether industrial demand and customer inventory levels recover, and whether the higher backlog converts into revenue as expected.
- Whether the inventory build and accounts receivable timing normalize without creating additional working-capital pressure.
- Available borrowing capacity, borrowing-base calculations, covenant compliance and the effect of LIBOR changes on interest expense.
- The sustainability of the improved gross margin after cost reductions and automation investments.
- The concentration of sales and receivables with the largest customer and the potential impact of customer-specific changes.
- The assumptions supporting the projected 24% full-year tax rate and the availability of research and development credits.
- Potential further impairment or disposal costs related to assets held for sale.