Nortech Systems Incorporated — Form 10-Q Summary
Business Context and Reporting Period
Nortech Systems Incorporated is an Electronics Manufacturing Services contract manufacturer serving aerospace and defense, medical, and industrial equipment markets. The filing covers the quarter and nine months ended September 30, 2012. Operations include facilities in Minnesota, Wisconsin, and Mexico. The statements are unaudited.
Financial Results and Key Metrics
| Metric | Three Months Ended September 30, 2012 | Three Months Ended September 30, 2011 | Nine Months Ended September 30, 2012 | Nine Months Ended September 30, 2011 |
|---|---|---|---|---|
| Net sales | $25.5 million | $28.3 million | $81.9 million | $85.1 million |
| Gross profit | $2.8 million | $3.3 million | $8.9 million | $9.7 million |
| Gross margin | 10.9% | 11.6% | 10.8% | 11.4% |
| Income from operations | $0.3 million | $0.4 million | $1.0 million | $1.0 million |
| Net income | $105,165 | $182,865 | $353,896 | $955,147 |
| Diluted EPS | $0.04 | $0.07 | $0.13 | $0.35 |
- Cash provided by operating activities was approximately $0.4 million in the third quarter and $1.7 million for the first nine months, compared with $2.2 million of operating cash used in the first nine months of 2011.
- Investing activities used $1.4 million in the first nine months, primarily for $1.5 million of property and equipment purchases.
- Financing activities used $0.3 million, including $1.5 million of line-of-credit repayments and $0.4 million of long-term debt principal payments, partially offset by $1.6 million of new long-term borrowings.
- Cash was zero at September 30, 2012 and December 31, 2011.
- At September 30, 2012, accounts receivable were $15.5 million, inventories were $17.7 million, and working capital was $14.6 million.
- Total debt consisted primarily of $7.9 million outstanding under the line of credit, $0.4 million of current long-term debt maturities, and $2.9 million of long-term debt.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales declined 10% year over year; nine-month sales declined 4%.
- Nine-month net income fell 63% year over year, primarily because the first nine months of 2011 included a $791,615 bargain purchase gain related to the Mankato acquisition. Management indicated that the after-tax effect of this gain increased 2011 nine-month earnings by approximately $0.5 million, or $0.20 per diluted share.
- Gross margin declined 70 basis points in the quarter and 60 basis points for the nine-month period. Management attributed the pressure primarily to underutilized plant capacity, partly offset by favorable product mix.
- Selling expense increased to 3.9% of sales from 3.2%, reflecting continued investment in business development and marketing. General and administrative expense declined to 5.7% of sales from 6.9% as personnel were redeployed and budget cuts were implemented.
- Industrial sales declined 15% in the quarter and 8% year to date. Aerospace and defense sales were flat in the quarter and increased 8% year to date; medical sales declined 4% in the quarter and 1% year to date.
- Inventory decreased from $19.0 million at December 31, 2011 to $17.7 million, while accounts payable declined from $11.3 million to $8.4 million.
Guidance, Outlook, Risks, and Unusual Items
- The 90-day backlog was $16.8 million at September 30, 2012, down from $17.3 million at June 30. Medical backlog increased, while industrial backlog declined and aerospace and defense backlog was approximately flat.
- Management reported economic uncertainty and weak industrial markets, medical customer inventory reductions, and limited large multi-year aerospace and defense opportunities. Cost-reduction and cost-containment actions were implemented during the third quarter.
- Management expected a 36% full-year 2012 effective tax rate, compared with 32% for 2011, principally because the federal research and development credit had not been extended for 2012.
- The Wells Fargo credit agreement provides a $13.5 million line of credit expiring May 31, 2015, a $1.8 million real estate term note maturing in 2027, and up to $2.0 million of capital expenditure financing. At quarter-end, $0.7 million of the capital expenditure facility had been used.
- The company had $4.5 million of unused borrowing-base-supported line availability and was in compliance with all debt covenants. The facilities are secured by substantially all assets and include financial, capital expenditure, reporting, and dividend-related restrictions.
- Key risks include market volatility, competition, facility and third-party operating reliability, labor availability, copper and other raw material costs, commodity and energy cost instability, general economic conditions, and integration of acquisitions.
- One customer group, GE Medical and Transportation, represented 23% of third-quarter sales and 24% of nine-month sales. It represented 17% of accounts receivable at September 30, 2012.
- The company stated that disclosure controls were effective and that no material change occurred in internal control over financial reporting. Legal proceedings were described as ordinary-course matters.
Important Facts for Investors to Verify
- Whether industrial demand and the $16.8 million backlog stabilize or decline further.
- Whether plant utilization improves sufficiently to recover the 2012 gross-margin contraction.
- Availability under the borrowing base, compliance with debt covenants, and refinancing or renewal requirements before the May 2015 credit expiration.
- The concentration of sales and receivables with GE Medical and Transportation and the related customer-credit exposure.
- The timing and amount of potential cash payments under the equity appreciation rights plan, including approximately $81,000 accrued at September 30, 2012.
- The effect of the 2011 bargain purchase gain and the absence of that unusual item on comparisons of future earnings.