Nortech Systems Incorporated — Form 10-Q Summary
Business Context and Reporting Period
Nortech Systems is an electronics manufacturing services provider producing wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds for aerospace and defense, medical and industrial customers. The filing covers the quarter and six months ended June 30, 2011. Operations are conducted across Minnesota, Wisconsin and Monterrey, Mexico. The company reports one operating segment: contract manufacturing.
Financial Highlights
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $27.8 million, versus $24.7 million | $56.8 million, versus $46.4 million |
| Gross profit | $3.2 million; 11.6% margin | $6.4 million; 11.3% margin |
| Income from operations | $0.3 million, versus $0.5 million | $0.6 million, versus $0.8 million |
| Net income | $0.1 million, or $0.05 per diluted share | $0.8 million, or $0.28 per diluted share |
| Operating cash flow | Not separately stated for the quarter in the financial statements | $(4.7) million, versus $0.4 million provided |
Six-month net income included a $791,615 bargain purchase gain from the Mankato acquisition. Management reported six-month net income of approximately $0.3 million, or $0.08 per diluted share, excluding the gain net of tax.
- Cash was $1.4 million at June 30, 2011, compared with $0.2 million at December 31, 2010.
- Accounts receivable were $17.5 million and inventories were $21.5 million, up from $15.6 million and $16.1 million, respectively, at year-end.
- Total liabilities were $31.6 million versus $22.3 million at December 31, 2010; shareholders’ equity was $20.1 million.
- The line of credit balance was $12.3 million, with $0.9 million of borrowing-base-supported availability. Current maturities of long-term debt were $2.7 million and long-term debt was $0.9 million.
- Working capital was $11.5 million at June 30, 2011, compared with $13.1 million at year-end.
- Financing activities provided $7.3 million, primarily from increased line-of-credit and term-loan borrowings. Investing activities used $1.4 million, including $1.0 million for the Mankato acquisition and $0.4 million for capital expenditures.
Material Changes Versus Prior Comparable Period
- Sales increased 13% in the second quarter and 22% for the first six months, primarily from the Milaca and Mankato acquisitions.
- Medical sales increased 18% for the quarter and 32% year to date; industrial sales increased 17% and 28%, respectively. Aerospace and defense sales declined 20% for the quarter and 11% year to date because of delays in federal defense-funding approvals.
- Gross margins declined from 12.6% to 11.6% in the quarter and from 12.4% to 11.3% year to date. Management attributed the decline to reinstated wages, incentives and benefits, acquisition-integration costs, and related operating pressures, partly offset by product mix and lean initiatives.
- Operating margins declined from 2.0% to 1.2% in the quarter and from 1.8% to 1.1% year to date.
- Operating cash flow deteriorated substantially because of working-capital needs, particularly approximately $4.2 million of inventory acquired for and used by the Mankato operation. Second-quarter cash usage improved to approximately $0.8 million from $3.9 million in the first quarter.
- The 90-day backlog increased 14% during the quarter to $22.8 million, compared with $21.3 million at June 30, 2010. Aerospace and defense backlog increased 44% from March 31, 2011, while medical and industrial backlog increased 19% and 5%, respectively.
Outlook, Risks, Contingencies and Unusual Items
- Management stated that financing arrangements and expected operating cash flows should be sufficient for future working-capital needs, but availability under the secured line of credit is subject to borrowing-base requirements and lender discretion.
- The Wells Fargo credit amendment reduced the line-of-credit rate to 3.0% plus three-month LIBOR and the real-estate term-note rate to 3.5% plus three-month LIBOR. The company was in compliance with its debt covenants at June 30, 2011.
- Management anticipated increased selling and business-development investment to support expected revenue growth and recent acquisitions. No formal revenue or earnings guidance was provided.
- The Mankato acquisition required additional deferred payments, including $212,233 paid July 1, 2011 and a final $250,000 payment due October 1, 2011, subject to the adjustment described in the filing. The company also committed to purchase at least $2.2 million of inventory over 24 months and had exceeded that minimum by June 30, 2011.
- Key risks include market volatility, competition, facility or third-party operating disruptions, labor availability, copper and other raw-material costs, commodity and energy-price instability, economic conditions, and successful integration of acquisitions.
- GE’s Medical and Transportation divisions represented 24% of second-quarter sales and 22% of six-month sales, creating customer concentration risk. Legal proceedings disclosed were limited to ordinary-course claims and proceedings.
- The company’s disclosure controls were assessed as effective, and no material change in internal control over financial reporting was reported.
Important Facts for Investors to Verify
- Whether acquisition-driven sales growth can offset lower gross margins and increased integration, labor and selling costs.
- The pace at which inventories and working capital normalize, and whether operating cash flow turns positive.
- Availability and covenant compliance under the secured Wells Fargo credit facility, particularly given the $12.3 million outstanding balance and only $0.9 million of supported availability.
- The sustainability of earnings excluding the one-time $791,615 bargain purchase gain.
- Exposure to GE customer concentration and the recovery timing of aerospace and defense demand.
- Completion of deferred Mankato acquisition payments and compliance with the related inventory-purchase commitment.