Nortech Systems Incorporated — Q2 2012 Form 10-Q Summary
Business Context and Reporting Period
Nortech Systems is an Electronics Manufacturing Services contract manufacturer 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 and operates facilities in Minnesota, Wisconsin and Mexico. The filing covers the unaudited quarter and six months ended June 30, 2012, compared with the corresponding 2011 periods.
The company reported 2,742,992 common shares outstanding at July 31, 2012 and was classified as a smaller reporting company.
Financial Performance and Position
| Metric | Three Months Ended June 30, 2012 | Three Months Ended June 30, 2011 | Six Months Ended June 30, 2012 | Six Months Ended June 30, 2011 |
|---|---|---|---|---|
| Net sales | $28.0 million | $27.8 million | $56.4 million | $56.8 million |
| Gross profit | $3.1 million | $3.2 million | $6.1 million | $6.4 million |
| Gross margin | 11.0% | 11.6% | 10.8% | 11.3% |
| Operating income | $0.3 million | $0.3 million | $0.6 million | $0.6 million |
| Net income | $0.1 million | $0.1 million | $0.2 million | $0.8 million |
| Diluted EPS | $0.05 | $0.05 | $0.09 | $0.28 |
Six-month 2012 operating cash flow was $1.3 million, compared with cash used in operations of $4.7 million in 2011. Investing cash outflow was $1.0 million, primarily for $1.0 million of property and equipment purchases. Financing cash outflow was $0.3 million, reflecting $1.1 million of line-of-credit repayments and $0.3 million of long-term debt payments, partially offset by $1.1 million of new long-term borrowings. Ending cash was zero at both June 30, 2012 and December 31, 2011.
At June 30, 2012, total assets were $45.8 million and shareholders’ equity was $20.8 million. Current assets were $36.2 million, including $15.6 million of receivables and $18.9 million of inventory. Working capital was approximately $14.0 million.
Total debt consisted principally of an $8.3 million line-of-credit balance, $0.4 million of current long-term debt maturities and $2.5 million of long-term debt. The company had $4.3 million of unused borrowing-base-supported availability under its $13.5 million line of credit and was in compliance with its debt covenants.
Material Changes Versus Prior Comparable Period
- Second-quarter sales increased 1%, while six-month sales declined 1% year over year.
- Gross margins declined by 0.6 percentage points in the quarter and 0.5 percentage points for the six months, primarily because of product and service mix and underutilized plant capacity.
- Selling expense increased to $1.2 million in the quarter and $2.2 million year to date as the company invested in business-development and marketing resources.
- General and administrative expense declined to $1.6 million in the quarter and $3.2 million year to date, attributed primarily to open positions and personnel redeployment.
- Six-month net income fell $0.5 million, primarily because the 2011 period included a $0.8 million bargain-purchase gain related to the Mankato acquisition. That gain increased 2011 after-tax earnings by approximately $0.5 million, or $0.20 per diluted share.
- Interest expense declined year over year, while the effective tax rate increased to 38% for the quarter and 35% for the six months, compared with 14% and 30%, respectively, in 2011.
- Industrial sales declined 4% in both the quarter and six-month period. Aerospace and Defense sales increased 23% in the quarter and 12% year to date; Medical sales increased 4% and 1%, respectively.
- The 90-day backlog declined to $17.3 million at June 30, 2012, from $18.4 million at March 31, 2012 and $22.8 million at June 30, 2011, driven primarily by Industrial customers.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal revenue or earnings guidance. Management described sales and backlog as mixed because of the sluggish economy and stated that Industrial customers continued to be affected by weak economic conditions. Management believed operating cash flow and existing financing arrangements would be sufficient for future working-capital needs.
The company entered into a May 2012 credit agreement amendment that extended the $13.5 million line of credit to May 31, 2015, replaced a prior real-estate term note with a $1.8 million note maturing in 2027, and added access to a capital-expenditure term loan of up to $2.0 million maturing in 2015. Borrowings are subject to borrowing-base requirements, lender discretion, interest-rate fluctuations tied to LIBOR and financial covenants.
Customer concentration is material: GE Medical and GE Transportation together represented 26% of second-quarter sales and 23% of six-month sales, and 20% of accounts receivable at June 30, 2012. Export sales represented 6% of second-quarter sales and 7% of six-month sales.
Principal disclosed risks include market volatility, competition, facility reliability, labor availability, increases in copper and other raw-material costs, commodity and energy-price instability, general economic conditions and successful integration of acquisitions. The company is subject to ordinary-course legal proceedings and claims; the filing does not identify a material specific proceeding.
At June 30, 2012, the company had approximately $126,000 of net uncertain tax-benefit positions recorded in other long-term liabilities. Management expected a 37% effective tax rate for full-year 2012, compared with 32% for 2011. Disclosure controls were assessed as effective, with no material changes to internal control over financial reporting.
Investor Verification Checklist
- Verify the company’s ability to maintain positive operating cash flow given zero cash and reliance on secured, borrowing-base-supported credit.
- Review debt covenant compliance, borrowing-base availability and the terms and maturity of the amended Wells Fargo facilities.
- Monitor gross-margin recovery, plant utilization and the effect of product and customer mix.
- Assess backlog conversion and the continuing decline in Industrial demand.
- Evaluate exposure to GE Medical and GE Transportation, which together represent a significant share of sales and receivables.
- Separate recurring operating performance from the nonrecurring 2011 bargain-purchase gain when comparing earnings.
- Review inventory reserves, raw-material costs, uncertain tax positions and the company’s disclosed ordinary-course legal matters.