Nortech Systems Incorporated — Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2014, with comparison to fiscal 2013. The filing covers a single Contract Manufacturing segment within the electronic manufacturing services industry. Nortech provides engineering, prototyping, testing, manufacturing, and supply-chain services for medical, aerospace and defense, and industrial customers, with operations in the United States and Mexico.
Financial Performance and Position
| Metric | 2014 | 2013 | Change |
|---|
| Net sales | $112.0 million | $111.1 million | +0.9% |
| Gross profit | $13.3 million | $13.1 million | +1.7% |
| Gross margin | 11.9% | 11.8% | +0.1 percentage point |
| Income from operations | $1.33 million | $1.46 million | Down |
| Net income | $880,000 | $787,000 | +11.8% |
| Diluted EPS | $0.32 | $0.29 | +10.3% |
| Operating cash flow | $1.58 million | $276,000 | Improved |
| Capital expenditures | $2.19 million | $1.20 million | Increased |
| Cash at year-end | $66,000 | None reported | Increased |
- Operating margin declined to approximately 1.2% from 1.3%, primarily because selling expenses increased to $5.1 million from $4.8 million while general and administrative expense remained approximately $6.9 million.
- Income tax expense fell to $81,000 from $300,000, reducing the effective tax rate to 8.4% from 27.6%. Management attributed the reduction primarily to a favorable Minnesota Department of Revenue audit settlement.
- Total assets were $48.7 million at December 31, 2014, versus $46.1 million at December 31, 2013. Shareholders’ equity increased to $22.8 million from $21.9 million.
- Accounts receivable increased to $17.4 million from $16.0 million, and inventories increased to $18.5 million from $17.4 million.
- Working capital increased to approximately $24.3 million from $15.5 million, principally because the line of credit was extended and reclassified as long-term debt.
- The cash conversion cycle increased slightly to 84 days from 83 days.
Revenue Mix and Material Changes
| Market | 2014 sales | 2013 sales | Change |
|---|
| Aerospace and Defense | $14.9 million | $19.9 million | -25% |
| Medical/Life Sciences | $41.4 million | $35.4 million | +17% |
| Industrial | $55.8 million | $55.8 million | Flat |
- Medical revenue growth and stable industrial revenue offset a significant decline in aerospace and defense revenue, which management attributed to Department of Defense budget cuts and the elimination or reduction of several programs.
- 90-day backlog increased 7% to $17.3 million from $16.1 million. Industrial backlog rose 30% to $7.7 million, medical backlog rose 4% to $6.3 million, and aerospace and defense backlog declined 20% to $3.2 million.
- GE divisions collectively represented 29% of 2014 net sales, including GE Healthcare at 23% and GE Transportation at 6%. GE represented 26% of 2013 sales. GE accounts receivable represented 19% of total accounts receivable at year-end 2014.
- Export sales increased to 13% of net sales from 12%. Employee headcount also increased, reflecting adjustments to customer demand.
Cash Flow, Debt, Liquidity, and Capital Resources
- Operating cash flow of $1.58 million was generated from profits, depreciation, and higher accounts payable, partly offset by increases in accounts receivable and inventory.
- Investing cash use increased to $2.19 million, primarily for purchases of property and equipment.
- Financing cash inflow was $672,000, including $763,000 of additional line-of-credit borrowings and $593,000 of long-term debt proceeds, partly offset by $667,000 of principal repayments.
- The Wells Fargo credit facility provides a $13.5 million revolving line expiring May 31, 2018. Borrowings were $8.0 million at year-end, with approximately $5.1 million of net unused availability subject to borrowing-base requirements.
- Long-term debt totaled $4.8 million, including $733,000 of current maturities. The credit facility and term notes are secured by substantially all company assets and bear variable interest rates tied to LIBOR.
- Nortech stated that it was in compliance with all debt covenants at December 31, 2014 and expected existing financing arrangements and operating cash flows to meet foreseeable working capital, capital expenditure, and debt repayment needs.
- No cash dividends were declared or paid in 2014 or 2013, and management does not expect to pay dividends in the foreseeable future.
Outlook, Commentary, Risks, and Unusual Items
- Management is continuing lean manufacturing, automation, quality, supply-chain, and asset-utilization initiatives, while expanding customer support in Asia and using Mexico as a lower-cost production alternative.
- The company intends to pursue acquisitions, mergers, joint ventures, and other growth opportunities in the EMS industry, creating integration and financing risks.
- Key risks include customer concentration, defense-program reductions, intense EMS competition, component shortages and higher material costs, customer cancellations and rescheduled orders, inventory obsolescence, labor availability, foreign operations in Mexico, regulatory and FDA compliance, product liability, environmental obligations, information-system interruptions, and natural disasters.
- GE concentration is material: its two divisions accounted for 29% of 2014 net sales. The loss or reduction of a major customer could materially affect revenue and profitability.
- Equity appreciation rights compensation expense increased to approximately $179,000 from $67,000, and the related liability increased to $259,000 from $81,000.
- The company recorded no impairment charge in 2014; a $74,000 impairment charge was recorded in 2013. The 2014 arbitration settlement and warranty obligations were not material.
- The filing provides no formal quantitative revenue or earnings guidance. Forward-looking statements are subject to economic, competitive, operational, labor, commodity, and financing uncertainties.
- Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2014. The independent auditor issued an unqualified opinion on the consolidated financial statements but did not audit internal control effectiveness.
Important Facts for Investors to Verify
- Whether the increase in medical and industrial demand can offset continued aerospace and defense program declines.
- The sustainability of the 11.9% gross margin and the effect of launch costs, automation, and operating expense investment on future operating margins.
- GE customer concentration, backlog conversion, and the quality and timing of the $17.3 million 90-day backlog.
- Borrowing-base availability, variable interest-rate exposure, debt maturities, and continued compliance with Wells Fargo covenants.
- Working-capital requirements, particularly the growth in accounts receivable and inventory and the 84-day cash conversion cycle.
- The impact of the pending revenue-recognition standard, ASU 2014-09, which the company was still evaluating and had not yet selected a transition method for.
- Potential obligations under change-of-control agreements, equity appreciation rights, operating leases, product warranties, environmental requirements, and ordinary-course litigation.
