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NSYS > SEC Filings for NSYS > Form 10-Q on 14-Nov-2012All Recent SEC Filings

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Form 10-Q for NORTECH SYSTEMS INC


14-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview:

We are a Wayzata, Minnesota based full-service Electronics Manufacturing Services (EMS) contract manufacturer of wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds for a wide range of industries. We provide value added services and technical support including design, testing, prototyping and supply chain management to customers mainly in the Aerospace and Defense, Medical, and Industrial Equipment markets. We maintain manufacturing facilities in Baxter, Bemidji, Blue Earth, Mankato, Merrifield, and Milaca, Minnesota; Augusta, Wisconsin; and Monterrey, Mexico.

Summary of Results:

For the quarter ended September 30, 2012, we reported net sales of $25.5 million compared to $28.3 million reported in the same quarter of 2011, a 10% decrease. Our 90-day backlog at September 30, 2012 was $16.8 million, down from $17.3 at June 30, 2012. Our industrial customers continue to be impacted the hardest by economic uncertainty and a sluggish economy and account for the majority of the decrease in sales and backlog.

Our gross profit percentage for the three and nine months ended September 30, 2012 was 10.9% and 10.8%, respectively. The gross profit percentage for the three and nine months ended September 30, 2011 was 11.6% and 11.4%, respectively. Gross profit percentage is being negatively affected by the underutilization of plant capacity mostly offset by a favorable product mix.

Income from operations was approximately $329,000 and $976,000 for the three and nine months ended September 30, 2012, respectively and $420,000 and $1,046,000 for the three and nine months ended September 30, 2011, respectively. We implemented a number of cost reduction and cost containment actions in the third quarter to help soften the impact of the sales decrease.


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Net income for the third quarter of 2012 was $105,165 or $0.04 per diluted common share, compared to net income of $182,865 or $0.07 per diluted common share for the same period in 2011. Net income for the nine months ended September 30, 2012 was $353,896 or $0.13 per diluted common share, while net income for the same period in 2011 totaled $955,147 or $0.35 per diluted common share, with the net after tax impact of the non-operating gain increasing net income by $0.5 million or $0.20 per diluted common share.

Cash provided from operating activities was $0.4 million in the third quarter and $1.7 million in the first nine months of 2012. Cash used in operating activities for the first nine months of 2011 was $2.2 million. The cash used in 2011 was needed to fund the working capital needs of our Mankato acquisition.

(1.) Results of Operations:

The following table presents statements of income data as percentages of total net sales for the periods indicated:

                                        Three Months Ended      Nine Months Ended
                                           September 30            September 30
                                        2012         2011        2012        2011
Net Sales                                 100.0 %      100.0 %    100.0 %     100.0 %
Cost of Goods Sold                         89.1         88.4       89.2        88.6
Gross Profit                               10.9         11.6       10.8        11.4

Selling Expenses                            3.9          3.2        3.9         3.2
General and Administrative Expenses         5.7          6.9        5.7         7.0
Income from Operations                      1.3          1.5        1.2         1.2

Bargain Purchase Gain                       0.0          0.0        0.0         0.9
Other Expenses, Net                        (0.7 )       (0.5 )     (0.5 )      (0.5 )
Income Before Income Taxes                  0.6          1.0        0.7         1.6

Income Tax Expense                          0.2          0.3        0.2         0.5
Net Income                                  0.4 %        0.7 %      0.5 %       1.1 %

Net Sales:

We reported net sales of $25.5 million and $28.3 million for the three months ended September 30, 2012 and 2011, respectively. Net sales for the nine months ended September 30, 2012 and 2011 were $81.9 million and $85.1 million, respectively.

Net sales by industry markets for the three and nine month periods ended September 30, 2012 and 2011 are as follows:


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                           Three Months Ended         Nine Months Ended
                              September 30               September 30
                         2012     2011      %       2012     2011      %
(in thousands)            $        $      Change     $        $      Change
Aerospace and Defense    3,756    3,774       (0 ) 11,823   10,949        8
Medical                  8,192    8,503       -4   24,084   24,293       -1
Industrial              13,573   16,041      -15   46,008   49,871       -8
Total Sales             25,521   28,318      -10   81,915   85,113       -4

Our Aerospace and Defense sales were flat for the quarter and up for the nine months due to 2011 funding delays. We continue to see activity in smaller new projects but not large multi-year opportunities. Our Medical customers began adjusting their inventory levels down as a result of not experiencing the growth anticipated for the second half of 2012. And our Industrial customers are being negatively affected by the poor economic conditions in the markets they serve.

Backlog:

Our 90-day order backlog as of September 30, 2012 was approximately $16.8 million, compared to approximately $17.3 million at the beginning of the quarter. Again, as we end the quarter we are getting mixed results. Our Aerospace and Defense backlog is flat, our Medical backlog is experiencing increased activity with our medical device customers and our Industrial backlog is down due to the economy.

Backlog by industry market is shown below:

                            Backlog as of the Quarter Ended
                          September 30             June 30
(in thousands)                2012                  2012
Aerospace and Defense   $           3,196     $           3,275
Medical                             6,288                 5,858
Industrial                          7,308                 8,161
Total Backlog           $          16,792     $          17,294

Gross Profit:

Gross profit as a percent of net sales for the three months ended September 30, 2012 and 2011 was 10.9% and 11.6% of net sales, respectively. Gross profit percentage for the nine months ended September 30, 2012 and 2011 was 10.8% and 11.4%, respectively. Gross profit percentage is being negatively affected by the underutilization of plant capacity mostly offset by favorable mix of product.


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Selling Expense:

Our selling expenses were $1.0 million or 3.9% of net sales and $0.9 million or 3.2% of net sales for the three months ended September 30, 2012 and 2011, respectively. Selling expenses were $3.2 million or 3.9% of net sales and $2.7 million or 3.2% of net sales for the nine months ended September 30, 2012 and 2011, respectively. Our selling expenses are up slightly as we continue to invest in business development infrastructure and marketing initiatives in an effort to stimulate sales.

General and Administrative Expense:

Our general and administrative expenses were $1.5 million or 5.7% of net sales and $2.0 million or 6.9% of net sales for the three months ended September 30, 2012 and 2011, respectively. General and administrative expenses were $4.7 million or 5.7% of net sales and $6.0 million or 7.0% of net sales for the nine months ended September 30, 2012 and 2011, respectively. People and positions were redeployed into manufacturing and sales functions in 2012 and additional budget cuts were implemented as a result of the lower customer demand.

Other Income (Expense):

Other expense was $0.2 million and $0.1 million for the three months ended September 30, 2012 and 2011, respectively. Other expense was $0.4 million for the nine months ended September 30, 2012 compared to other income of $0.3 million for the nine months ended September 30, 2011. Other income in the first nine months of 2011 relates primarily to a bargain purchase gain of $0.8 million from the Mankato acquisition in the first quarter of 2011.

Income Taxes:

Our effective tax rate for the three and nine months ended September 30, 2012 was 35% compared with 35% and 31% for the three and nine months ended September 30, 2011, respectively. The nine month increase is due to the fact that the federal government has not yet extended the research and development credit for the 2012 tax year. The differences between federal income taxes computed at the federal statutory rate and reported income taxes for the three and nine months ended September 30, 2012 and 2011 are as follows:

                                      Three Months Ended       Nine Months Ended
                                         September 30            September 30
                                       2012         2011       2012        2011
Statutory federal tax provision     $    61,000   $ 96,000   $ 186,000   $ 473,000
State income taxes                        2,000      8,000      18,000      41,000
Income tax credits                       (4,000 )  (20,000 )   (10,000 )   (52,000 )
Tax authority closing agreement               -          -           -     (96,000 )
Change in uncertain tax positions        10,000      5,000      18,000      95,000
Other                                   (12,000 )    9,000     (20,000 )   (26,000 )
Income tax expense                  $    57,000   $ 98,000   $ 192,000   $ 435,000


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Liquidity and Capital Resources:

We have satisfied our liquidity needs over the past several years with cash flows generated from operations and an operating line of credit through WFB. We also have real estate and equipment term loans. Both the line of credit and real estate term note are subject to fluctuations in the LIBOR rates. The line of credit, real estate term note, and equipment loans with WFB contain certain covenants which, among other things, require us to adhere to regular reporting requirements, abide by annual shareholder dividend limitations, maintain certain financial performance, and limit the amount of annual capital expenditures. The availability under our line is subject to borrowing base requirements, and advances are at the discretion of the lender. The line of credit is secured by substantially all of our assets.

On September 30, 2012, we had outstanding advances of $7.9 million under the line of credit and unused availability of $4.5 million supported by our borrowing base. We believe our financing arrangements (see Note 3) and cash flows provided by operations will be sufficient to satisfy our future working capital needs. Our working capital was $14.6 million and $12.3 million as of September 30, 2012 and December 31, 2011, respectively. The increase in working capital relates primarily to the reclassification of the real estate term note from current liabilities to long term liabilities as a result of our new financing arrangement and a reduction in accounts payable and advances outstanding under the line of credit.

Net cash provided by operating activities for the nine months ended September 30, 2012 was $1.7 million. Income and non-cash addbacks for depreciation and amortization, and decreases in inventories and accounts receivable accounted for the majority of the operating cash provided, offset by decreased accounts payable. Net cash used in operating activities for the nine months ended September 30, 2011 was $2.2 million. The cash flow used in operations for the nine months ended September 30, 2011 was primarily the result of working capital requirements needed to support the newly acquired Mankato operation, which included the purchase of approximately $4.1 million of inventory.

Net cash used in investing activities of $1.4 million for the nine months ended September 30, 2012 is comprised primarily of property and equipment purchases to support the business.

Net cash used in financing activities for the nine months ended September 30, 2012 was $0.3 million, mainly due to repayments on the line of credit of $1.5 million and payments on long-term debt of $0.4 million, offset by loan proceeds of $1.6 million.

Critical Accounting Policies and Estimates

Our significant accounting policies and estimates are summarized in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011. There have been no significant changes in these critical accounting policies since December 31, 2011. Some of our accounting policies require us to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. Such judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, known trends in our industry, terms of existing


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contracts and other information from outside sources, as appropriate. Actual results could differ from these estimates.

Forward-Looking Statements:

Those statements in the foregoing report that are not historical facts are forward-looking statements made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements generally will be accompanied by words such as "anticipate," "believe," "estimate," "expect," "forecast," "intend," "possible," "potential," "predict," "project," or other similar words that convey the uncertainty of future events or outcomes. Although we believe these forward-looking statements are reasonable, they are based upon a number of assumptions concerning future conditions, any or all of which may ultimately prove to be inaccurate. Forward-looking statements involve a number of risks and uncertainties. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation:

Volatility in the marketplace which may affect market supply and demand for our products;

Increased competition;

Changes in the reliability and efficiency of operating facilities or those of third parties;

Risks related to availability of labor;

Increase in certain raw material costs such as copper;

Commodity and energy cost instability;

General economic, financial and business conditions that could affect our financial condition and results of operations;

Successful integration of recent acquisitions

The factors identified above are believed to be important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement made by us. Unpredictable or unknown factors not discussed herein could also have material adverse effects on forward-looking statements. All forward-looking statements included in this Form 10-Q are expressly qualified in their entirety by the forgoing cautionary statements. We undertake no obligations to update publicly any forward-looking statement (or its associated cautionary language) whether as a result of new information or future events.

Please refer to forward-looking statements and risks as previously disclosed in our report on Form 10-K for the fiscal year ended December 31, 2011.

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