UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

 

FORM 10-Q

 

(Mark One)

 

ý        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2005

 

OR

 

o        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from            to           

 

NORTECH SYSTEMS INCORPORATED

 

Commission file number 0-13257

 

State of Incorporation: Minnesota

 

IRS Employer Identification No. 41-1681094

 

Executive Offices: 1120 Wayzata Blvd E., Suite 201, Wayzata, MN 55391

 

Telephone number: (952) 345-2277

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required of file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes o No ý.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o No ý.

 

Number of shares of $.01 par value common stock outstanding at October 31, 2005 - 2,582,318

 

(The remainder of this page was intentionally left blank.)

 

 

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
	Consolidated Balance Sheets
	Consolidated Statements of Income
	Consolidated Statements of Cash Flows
	Condensed Notes to Consolidated Financial Statements
Item 2 - Management’s Discussion and Analysis of Financial Condition And Results of Operations
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Item 4 - Controls and Procedures
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
Item 6 - Exhibits
SIGNATURES
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

 

2

 

PART 1

 

ITEM 1.  FINANCIAL STATEMENTS

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

 

		SEPTEMBER 30			DECEMBER 31
		2005			2004
		(Unaudited)
ASSETS
Current Assets
Cash and Cash Equivalents		$	612,793		$	555,783
Accounts Receivable, Less Allowance for Uncollectible Accounts of $247,000 and $280,000, respectively		13,999,603			13,355,730
Inventories:
Raw Materials		10,407,032			10,662,571
Work In Process		3,095,077			2,418,850
Finished Goods		2,198,219			2,373,495
Reserves		(1,167,269		)	(1,219,200		)
Total Inventories		14,533,059			14,235,716
Prepaid Expenses		303,036			399,210
Income Taxes Receivable		—			351,369
Deferred Income Tax Assets		895,000			818,000
Total Current Assets		30,343,491			29,715,808
Property and Equipment
Land		151,800			151,800
Building and Leasehold Improvements		4,775,476			4,720,518
Manufacturing Equipment		7,448,505			7,222,437
Office and Other Equipment		3,439,907			3,010,793
Total Property and Equipment		15,815,688			15,105,548
Accumulated Depreciation		(9,563,394		)	(8,681,033		)
Net Property and Equipment		6,252,294			6,424,515
Other Assets
Finite Life Intangibles		307,797			603,267
Goodwill		75,006			75,006
Deferred Income Tax Assets		146,000			52,000
Deposits		11,012			11,012
Total Other Assets		539,815			741,285
Total Assets		$	37,135,600		$	36,881,608

 

See Accompanying Condensed Notes to Consolidated Financial Statements

 

3

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

 

		SEPTEMBER 30			DECEMBER 31
		2005			2004
		(Unaudited)
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Bank Note Payable		$	7,144,396		$	7,523,058
Current Maturities of Notes Payable		1,281,642			997,815
Checks Written in Excess of Bank Balance		965,000			950,000
Accounts Payable		5,677,833			5,602,913
Accrued Payroll and Commissions		2,364,585			2,375,939
Accrued Health and Dental Claims		318,253			250,330
Income Taxes Payable		94,782			—
Other Accrued Liabilities		300,179			265,762
Total Current Liabilities		18,146,670			17,965,817
Long-Term Liabilities
Notes Payable (Net of Current Maturities)		2,964,120			3,399,210
Total Liabilities		21,110,790			21,365,027
Shareholders’ Equity
Preferred Stock, $1 par value; 1,000,000 Shares Authorized; 250,000 Shares Issued and Outstanding		250,000			250,000
Common Stock - $0.01 par value; 9,000,000 Shares Authorized: 2,582,318 Shares Issued and Outstanding at September 30, 2005; 2,582,147 Shares Issued and Outstanding at December 31, 2004		25,823			25,821
Additional Paid-In Capital		14,119,563			14,118,658
Accumulated Other Comprehensive Loss		(31,617		)	(40,729		)
Retained Earnings		1,661,041			1,162,831
Total Shareholders’ Equity		16,024,810			15,516,581
Total Liabilities and Shareholders’ Equity		$	37,135,600		$	36,881,608

 

See Accompanying Condensed Notes to Consolidated Financial Statements

 

4

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED

SEPTEMBER 30, 2005 AND 2004

(UNAUDITED)

 

		SEPTEMBER 30			SEPTEMBER 30
		2005			2004
Net Sales		$	20,919,151		$	19,189,852
Cost of Goods Sold		18,364,908			16,621,178
Gross Profit		2,554,243			2,568,674
Operating Expenses:
Selling Expenses		794,094			1,038,061
General and Administrative Expenses		1,169,536			989,037
Total Operating Expenses		1,963,630			2,027,098
Income From Operations		590,613			541,576
Other Income (Expense)
Interest Income		676			221
Miscellaneous Expense, net		(29,229		)	(38,208		)
Interest Expense		(148,703		)	(128,150		)
Total Other Expense		(177,256		)	(166,137		)
Income Before Income Taxes		413,357			375,439
Income Tax Expense		153,000			139,000
Net Income		$	260,357		$	236,439
Earnings Per Common Share:
Basic		$	0.10		$	0.09
Weighted Average Number of Common Shares Outstanding Used for Basic Earnings Per Common Share		2,582,292			2,573,135
Diluted		$	0.10		$	0.09
Weighted Average Number of Common Shares Outstanding Plus Dilutive Common Stock Options		2,622,108			2,608,294

 

See Accompanying Condensed Notes to Consolidated Financial Statements

 

5

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED

SEPTEMBER 30, 2005 AND 2004

(UNAUDITED)

 

		SEPTEMBER 30			SEPTEMBER 30
		2005			2004
Net Sales		$	60,549,569		$	52,264,134
Cost of Goods Sold		53,042,347			46,081,267
Gross Profit		7,507,222			6,182,867
Operating Expenses:
Selling Expenses		2,596,031			2,344,431
General and Administrative Expenses		3,629,450			2,902,942
Total Operating Expenses		6,225,481			5,247,373
Income From Operations		1,281,741			935,494
Other Income (Expense)
Interest Income		1,455			1,903
Miscellaneous Income (Expense), net		(43,751		)	27,796
Interest Expense		(451,235		)	(350,721		)
Total Other Expense		(493,531		)	(321,022		)
Income Before Income Taxes		788,210			614,472
Income Tax Expense		290,000			230,000
Net Income		$	498,210		$	384,472
Earnings Per Common Share:
Basic		$	0.19		$	0.15
Weighted Average Number of Common Shares Outstanding Used for Basic Earnings Per Common Share		2,582,221			2,554,466
Diluted		$	0.19		$	0.15
Weighted Average Number of Common Shares Outstanding Plus Dilutive Common Stock Options		2,613,956			2,602,688

 

See Accompanying Condensed Notes to Consolidated Financial Statements

 

6

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED

SEPTEMBER 30, 2005 AND 2004

(Unaudited)

 

		SEPTEMBER 30			SEPTEMBER 30
		2005			2004
Cash Flows From Operating Activities
Net Income		$	498,210		$	384,472
Adjustments to Reconcile Net Income to Net Cash Provided by (Used in) Operating Activities:
Depreciation		885,278			538,742
Amortization		295,470			289,286
Deferred Taxes		(171,000		)	(33,000		)
Foreign Currency Transaction (Gain) Loss		45,650			(4,417		)
Changes in Current Operating Items:
Accounts Receivable		(643,873		)	(1,494,055		)
Inventories		(297,343		)	(2,865,170		)
Prepaid Expenses and Other Assets		96,174			158,848
Income Taxes Receivable		446,151			246,318
Accounts Payable		74,920			1,652,600
Accrued Payroll and Commissions		56,569			1,005,098
Other Accrued Liabilities		34,417			(5,581		)
Net Cash Provided by (Used in) Operating Activities		1,320,623			(126,859		)
Cash Flows from Investing Activities:
Acquisition of Equipment		(706,039		)	(889,445		)
Cash Flows from Financing Activities:
Net Change in Line of Credit		(378,662		)	549,512
Proceeds from Notes Payable		636,502			788,944
Payments on Notes and Capital Lease Payable		(787,765		)	(668,978		)
Issuance of Stock		907			21,750
Checks in Excess of Bank Balance		15,000			738,103
Net Cash Provided by (Used in) Financing Activities		(514,018		)	1,429,331
Effect of Exchange Rate Changes on Cash		(43,556		)	(558		)
Net Increase in Cash and Cash Equivalents		57,010			412,469
Cash and Cash Equivalents - Beginning		555,783			101,179
Cash and Cash Equivalents - Ending		$	612,793		$	513,648
Supplemental disclosure of cash flow information:
Cash paid during the period for interest		$	451,175		$	350,417
Cash paid (received) during the period for income taxes		—			186
Supplemental schedule of noncash financing activity:
Common Stock Issued in Payment of Notes Payable		$	—		$	600,000

 

See Accompanying Condensed Notes to Consolidated Financial Statements

 

7

 

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

The accompanying unaudited consolidated financial statements for the interim periods have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and in accordance with the rules and regulations of the Securities and Exchange Commission.  Accordingly, they do not include all of the financial information and footnotes required by GAAP for complete financial statements, although we believe the disclosures are adequate to make the information presented not misleading.  These statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2004.  The operating results of the interim periods presented are not necessarily indicative of the results expected for the full year or for any other interim period.  In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  In preparing these consolidated financial statements, we have made our best estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality.  Changes in the estimates and assumptions used by us could have a significant impact on our financial results.  Actual results could differ from those estimates.

 

Reclassification

Certain expenses on the consolidated statements of income for the three and nine-month periods ended September 30, 2004 have been reclassified, with no effect on net income or earnings per common share amounts, to be consistent with the classifications adopted for the three and nine-month periods ended September 30, 2005.

 

Stock Based Compensation

As allowed by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” and by SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” we elected to continue to apply the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.”  Accordingly, no compensation cost is recognized in our consolidated statements of income for options granted with exercise prices that are equal to the market values of the underlying common stock on the dates of grant.  Had compensation cost for the stock options been based on the estimated fair values at grant dates, our pro forma net income and net income per common share would have been as follows:

 

8

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2005			2004			2005			2004
Net income, as reported		$	260,357		$	236,439		$	498,210		$	384,472
Deduct: Total stock-based compensation expense, determined under fair value-based method for all awards, net of related tax effects		(32,807		)	(25,934		)	(98,420		)	(77,803		)
Pro forma net income		$	227,550		$	210,505		$	399,790		$	306,669
Earnings per share:
Basic – as reported		$	0.10		$	0.09		$	0.19		$	0.15
Basic – pro forma		$	0.09		$	0.08		$	0.15		$	0.12
Diluted – as reported		$	0.10		$	0.09		$	0.19		$	0.15
Diluted – pro forma		$	0.09		$	0.08		$	0.15		$	0.12

 

For the three-month period ended September 30, 2005, we granted no stock options. For the nine-month period ended September 30, 2005, we granted 20,000 stock options.  We will be required to apply SFAS 123R as of the beginning of fiscal year 2006 (see Note 9).

 

Segment Reporting Information

Our results of operations for the three months and nine months ending September 30, 2005 and 2004 represent a single segment referred to as Contract Manufacturing.  Export sales represent 6% and 7% of consolidated net sales for the three-month periods ended September 30, 2005 and 2004, respectively.  For both the nine-month periods ended September 30, 2005 and 2004, export sales represent 5% of consolidated net sales.

 

Long-lived assets by country are as follows:

 

		United States			Mexico			Total
September 30, 2005
Net Property and Equipment		$	5,570,868		$	681,426		$	6,252,294
Other Assets		241,619			298,196			539,815
December 31, 2004
Net Property and Equipment		$	5,755,401		$	669,114		$	6,424,515
Other Assets		156,889			584,396			741,285

 

9

 

Finite Life Intangible Assets

Finite life intangible assets at September 30, 2005 and December 31, 2004 are as follows:

 

		September 30, 2005
		Estimated		Gross			Accumulated			Net Book
		Lives		Carrying			Amortization			Value
		(Years)		Amount			Amount			Amount
Non-Compete		4		$	1,526,384		$	1,240,200		$	286,184
Other Intangibles		3		37,059			15,446			21,613
Totals				$	1,563,443		$	1,255,646		$	307,797
		December 31, 2004
		Estimated		Gross			Accumulated			Net Book
		Lives		Carrying			Amortization			Value
		(Years)		Amount			Amount			Amount
Non-Compete		4		$	1,526,384		$	954,000		$	572,384
Other Intangibles		3		37,059			6,176			30,883
Totals				$	1,563,443		$	960,176		$	603,267

 

Amortization expense related to these assets is as follows:

 

Quarter ended September 30, 2005		$	98,490
Quarter ended September 30, 2004		98,486
Nine months ended September 30, 2005		295,470
Nine months ended September 30, 2004		289,286

 

Estimated amortization expense related to these assets is as follows:

 

2005		$	394,000
2006		203,000
2007		6,000

 

NOTE 2.  PRINCIPLES OF CONSOLIDATION

 

The consolidated financial statements include the accounts of Nortech Systems Incorporated (“Nortech”) and its wholly owned subsidiary, Manufacturing Assembly Solutions of Monterrey, Inc.  All significant intercompany accounts and transactions have been eliminated.

 

NOTE 3.  ACCOUNTING PRINCIPLES

 

In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States, we must make decisions, which impact the reported amounts and related disclosures. Such decisions include the selection of the appropriate principles to be applied and the assumptions on which to base accounting estimates. In reaching such decisions, we apply judgment based on our understanding and analysis of the relevant circumstances.

 

The accounting principles followed in the preparation of the consolidated financial information contained on Form 10-Q are the same as those described in our Annual Report on Form 10-K for the

 

10

 

year ended December 31, 2004. Refer to our Annual Report on Form 10-K for detailed information on accounting policies.

 

NOTE 4. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

 

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and trade accounts receivable.  With regard to cash, we maintain our excess cash balances in checking accounts at three financial institutions.  We do not require collateral on our receivables.  Historically, we have not suffered significant losses with respect to trade accounts receivable.

 

On May 13, 2005, we negotiated new terms for a customer account, which is supported by a promissory note.  The balance on this account as of September 30, 2005 was $309,627 with full payment required by December 31, 2005.

 

Two customers accounted for more than 10% of net sales for the nine-month period ended September 30, 2005, and one customer accounted for more than 10% of net sales for the same period in 2004.  For the nine-month periods ended September 30, 2005 and 2004, G.E. Medical and Transportation Divisions accounted for 16% and 15% of net sales, respectively.  Accounts receivable from G.E. Medical and Transportation Divisions at September 30, 2005 and 2004, represented 21% and 22% of total accounts receivable, respectively.  For the nine-month period ended September 30, 2005, Northrop Grumman Corp. accounted for 10% of net sales.  Accounts receivable from Northrop Grumman Corp. at September 30, 2005 represented 9% of total accounts receivable.

 

NOTE 5. LONG TERM DEBT

 

We currently have an $8 million line of credit arrangement with a maturity date of January 31, 2007 at Wells Fargo Bank, N.A. (WFB). The line of credit and other installment debt 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 ratios, and limit the amount of annual capital expenditures.  On September 30, 2005, we had an outstanding balance of $7.1 million under the line of credit and unused availability of $0.9 million.

 

On August 2, 2005, we received $636,502 in exchange for a promissory note payable to WFB bearing an annual interest rate of 6.3%, payable over 36 monthly installments, maturing on July 15, 2008.  The collateral for the promissory note is comprised of equipment purchases.

 

11

 

NOTE 6. NET INCOME PER COMMON SHARE

 

The following is a reconciliation of the numerators and the denominators of the basic and diluted per common share computations.

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2005			2004			2005			2004
Basic Earnings Per Common Share
Net income, as reported		$	260,357		$	236,439		$	498,210		$	384,472
Weighted average common shares outstanding		2,582,292			2,573,135			2,582,221			2,554,466
Basis earnings per common share		$	0.10		$	0.09		$	0.19		$	0.15
Diluted Earnings Per Common Share
Net income, as reported		$	260,357		$	236,439		$	498,210		$	384,472
Weighted average common shares outstanding		2,582,292			2,573,135			2,582,221			2,554,466
Effect of Stock options		39,816			35,159			31,735			48,222
Weighted average common shares for diluted earnings per common share		2,622,108			2,608,294			2,613,956			2,602,688
Diluted earnings per common share		$	0.10		$	0.09		$	0.19		$	0.15

 

For the three-month and nine-month periods ended September 30, 2005, 33,556 shares and 131,796 shares, respectively, were excluded from the computation of diluted earnings per common share as these shares were antidilutive.  For the three-month and nine-month periods ended September 30, 2004, 33,111 and 42,037 shares, respectively, were excluded from the computation of diluted earnings per common share as these shares were antidilutive.

 

NOTE 7. FOREIGN CURRENCY TRANSLATION

 

Local currency is considered the functional currency for operations outside the United States.  Assets and liabilities are translated at period-end exchange rates.  Income and expense items are translated at average rates of exchange prevailing during the period.  Translation adjustments are recorded as a component of accumulated other comprehensive loss in shareholders’ equity.  Foreign currency exchange transaction gains and losses attributable to exchange rate movements on intercompany receivables and payables not deemed to be of a long-term investment nature are recorded in Miscellaneous Income (Expense).  For the nine-month period ended September 30, 2005, we experienced a foreign currency transaction loss of $45,650.  For the nine-month period ended September 30, 2004, we experienced a foreign currency transaction gain of $4,417.  The Mexican peso is the only foreign currency being translated.

 

12

 

NOTE 8. COMPREHENSIVE INCOME

 

Comprehensive income is comprised of net income and other comprehensive income (loss).  Other comprehensive income (loss) includes gains and losses resulting from foreign currency translations.  The details of comprehensive income are as follows:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2005			2004			2005			2004
Net Income, as reported		$	260,357		$	236,439		$	498,210		$	384,472
Other Comprehensive Income (Loss):
Currency Translation Adjustment		(10,626		)	(10,704		)	9,112			(17,823		)
Comprehensive Income		$	249,731		$	225,735		$	507,322		$	366,649

 

NOTE 9.  RECENTLY ISSUED ACCOUNTING STANDARDS

 

In December 2004, the FASB issued Statement No. 123R, “Share-Based Payment”.  This statement revises Statement No. 123, “Accounting for Stock-Based Compensation”, and requires companies to expense the value of employee stock options and similar awards using the fair value method.  The effective date of this standard is the first interim period of fiscal year 2006.  Although we have not fully analyzed the effect this new statement will have on our consolidated financial statements in the future, the pro forma net income effect of using the fair value method for the past three fiscal years is presented in Note 1 to our consolidated financial statements on Form 10-K.

 

In November 2004, the FASB issued Statement No. 151, “Inventory Costs”, an amendment to ARB No. 43, Chapter 4.  The amendments made by SFAS No. 151 require that abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) be recognized as current-period charges.  This statement requires the allocation of fixed production overhead to inventory based on the normal capacity of production facilities.  Statement No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005.  We do not believe the adoption of Statement No. 151 will have a material effect on our financial position or results of operations.

 

In March 2005, the FASB issued Interpretation No.47, or “FIN 47,” which clarifies terminology in FASB Statement No. 143, Accounting for Asset Retirement Obligations.  FIN 47 clarifies when an entity has sufficient information to reasonably estimate the fair value of an asset retirement obligation.  FIN 47 is effective for us in fiscal 2006.  We do not expect adoption of FIN 47 to have a material impact on our consolidated financial statements.

 

13

 

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

 

Overview:

 

We are a Wayzata, Minnesota based full-service Electronic Manufacturing service (EMS) provider of wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds for a wide range of industries. Markets we serve include medical, automotive, defense, computer, peripheral, commercial, telecom, government, and consumer.  In Minnesota, we have facilities in Baxter, Bemidji, Fairmont and Merrifield. We also have facilities in Augusta, Wisconsin, and Monterrey, Mexico.

 

Summary:

 

For the third quarter ended September 30, 2005, we reported net sales of $20.9 million, up 9 percent over the $19.2 million we reported in the third quarter of 2004.  The third quarter gross profit percentage for 2005 was 12% compared to 13% for the third quarter of 2004.  Income from operations for the third quarter of 2005 totaled $590,613, an increase of 9% above the $541,576 reported in the third quarter of 2004.  Net income for the third quarter of 2005 totaled $260,357, or $0.10 per diluted common share and was above the $236,439, or $0.09 per diluted common share, reported in the third quarter of 2004.  The increased volume and profit in the third quarter of 2005 comes primarily from our Aerospace and Printed Circuit Board Assemblies Divisions, whose results offset the shortfalls experienced in our Cable and Wire Divisions.

 

For the nine-month period ended September 30, 2005, we had net sales of $60.5 million, up 16 percent over the $52.3 million we reported for the nine months ended September 30, 2004.  The gross profit for the nine-month period ended September 30, 2005 of $7.5 million or 12% of net sales showed an increase of $1.3 million or a 21% improvement over the nine-month period ended September 30, 2004, as a result of a more favorable product and customer mix.  Income from operations of $1.3 million for the nine-months of 2005 increased 37% from the $0.9 million reported in the first nine months of 2004.  Net income for the nine-month period ended September 30, 2005, totaled $498,210, or $0.19 per diluted common share and was above the $384,472, or $0.15 per diluted common share, reported in the nine-month period ended September 30, 2004.

 

14

 

(1.)  Results of Operations:

 

The following table presents statement of operations data as percentages of total revenues for the periods indicated:

 

		Three Months Ended				Nine Months Ended
		September 30,				September 30,
		2005		2004		2005		2004
Net Sales		100	%	100	%	100	%	100	%
Cost of Good Sold		88	%	87	%	88	%	88	%
Gross Profit		12	%	13	%	12	%	12	%
Selling Expenses		4	%	5	%	4	%	4	%
General and Administrative Expenses		5	%	5	%	6	%	6	%
Income from Operations		3	%	3	%	2	%	2	%
Other Expenses, Net		1	%	1	%	1	%	1	%
Income Tax Expense		1	%	1	%	0	%	0	%
Net Income		1	%	1	%	1	%	1	%

 

Net Sales:

We reported net sales of $20.9 million and $19.2 million for the third quarter ended September 30, 2005 and 2004, respectively, a 9% increase year over year. For the nine months ended September 30, 2005 and 2004, we reported net sales of $60.5 million and $52.3 million for an increase of 16%.  The increase in net sales of $1.7 million and $8.2 million for both the current quarter and year-to-date, respectively, is primarily due to increased sales volume in our Aerospace Systems Division of $0.8 million and $6.3 million, respectively, and our Industrial Electronic Printed Circuit Board Assemblies Division of $2.2 million and $3.7 million, respectively.  We saw decreases in sales of our Commercial Wire and Cable Divisions of $1.3 million and $1.7 million for the current quarter and year-to-date, respectively.  Our Commercial Wire and Cable Divisions’ sales continue to be negatively impacted by competitive pricing pressures from overseas competition and domestic excess capacity levels.  Our 90-day order backlog was approximately $22.5 million as of September 30, 2005, compared to approximately $17.6 million at the beginning of the quarter.  Based on current trends we expect the fourth quarter of 2005 to have similar to slightly higher sales levels than the third quarter of 2005.

 

Gross Profit:

Our gross profit for the third quarter of 2005 was $2.6 million or 12% of net sales compared to gross profit of $2.6 million or 13% of net sales for the third quarter of 2004.  For the nine months ended September 30, 2005, we had gross profit of $7.5 million or 12% of net sales compared to gross profit of $6.2 million or 12% of net sales for the same period in 2004.  The third quarter gross profit was negatively affected by volume shortfalls and underutilized plant capacity in both domestic and international Cable and Wire Divisions.  Also, higher energy and commodity costs are unfavorably impacting our gross profit.

 

Selling Expense:

We had selling expenses of $794,094 or 4% of net sales for the third quarter of 2005 compared to $1,038,061 or 5% of net sales for the third quarter of 2004.  Comparing the third quarter of 2005 to the third quarter of 2004, the decrease in selling expenses of $244,000 resulted from a decrease in commissions of $137,000 from a one time settlement in commission fees to a manufacturing sales representative and a reduction of $107,000 in marketing materials and other selling expenses.  For the

 

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nine months ended September 30, 2005, we had selling expenses of $2.6 million or 4% of net sales compared to $2.3 million or 4% of net sales for the same period in 2004.  Comparing the first nine months of 2005 to the first nine months of 2004, the increase in selling expenses of $252,000 resulted from an increase in commissions of $163,000 and an increase in other selling expenses of $89,000. We continue to invest in our sales force and brand in order to maintain a high level of customer service and support the revenue growth.

 

General and Administrative Expense:

Our general and administrative expenses were $1.2 million or 5% of net sales for the third quarter of 2005 and $1.0 million or 5% of net sales for the third quarter ended September 30, 2004.  The increase in general and administrative expenses is attributable in part to the increased investment in infrastructure, primarily additional personnel, of $0.2 million to support the growth and consolidation of corporate shared services (i.e. accounting, information services, and human resources).  For the nine months ended September 30, 2005, we had general and administrative expenses of $3.6 million or 6% of net sales compared to $2.9 million or 6% of net sales for the same period in 2004.  As previously described above, the increase in general and administrative expenses resulted from the investment in infrastructure of $0.5 million, corporate shared services and outside service costs related to process improvements and increased compliance requirements of $0.2 million.

 

Other Expense:

Other expenses, net were $177,256 for the quarter ended September 30, 2005 compared to $166,137 for the third quarter of 2004.  For the nine months ended September 30, 2005, net other expenses were $493,531 compared to $321,022 for the same period in 2004.  The majority of the variance is accounted for in the increase in interest expense which was $20,553 higher for the three months ended September 30, 2005, and an increase of $100,514 for the nine months, attributed to higher interest rates.

 

Income Tax:

Income tax expense for the three months ended September 30, 2005 is $153,000 compared to an income tax expense of $139,000 for the three months ended September 30, 2004.  For the nine months ended September 30, 2005, income tax expense was $290,000 compared to $230,000 for the same period in 2004.  The effective tax rate for 2005 is expected to approximate 36.8%, comprised of an effective rate of 33.3% for domestic federal and state taxes and 3.5% for foreign taxes.  The effective tax rate for 2004 was 31%, comprised of an effective rate of 28.5% for domestic federal and state taxes and 2.5% for foreign taxes.  While additional Research and Development Tax Credits are anticipated in 2005, we continue to see an overall decrease in the benefit derived from these credits, resulting in a higher effective domestic tax rate. In addition, the effective rate for foreign taxes decreased from 6.5% to 2.5% in the first quarter of 2005 due to a federal decree in Mexico, which reduced the revenue portion of the Mexico subsidiary that is subject to Mexico taxes.

 

(2.) Liquidity and Capital Resources:

We have satisfied our liquidity needs over the past several years through revenue generated from operations and an operating line of credit through Wells Fargo Bank, N.A. (WFB).  We currently have an $8 million line of credit arrangement with a maturity date of January 31, 2007. The line of credit and other installment debt 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 ratios, and limit the amount of annual capital expenditures.  On September 30, 2005, we had an outstanding balance of $7.1 million under the line of credit and unused availability of $0.9 million.

 

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The following unaudited ratios are not required under the SEC guidelines or accounting principles generally accepted in the United States of America, however, we believe they are meaningful measures and are useful to readers of our financial statements.

 

Our line of credit is classified as a current liability as of September 30, 2005 and December 31, 2004.  At December 31, 2003 and 2002, the line of credit was classified as a long-term liability.  Therefore, in order to present the following ratios as comparable to the prior periods, the line of credit at December 31, 2003 and 2002 has been included in the current liabilities to compute the ratios below to make the comparisons below more meaningful.

 

		September 30, 2005			December 31, 2004			December 31, 2003*			December 31, 2002*
Current Ratio		1.67			1.65			1.80			1.80
(Current Assets / Current Liabilities)
Working Capital		$	12,196,821		$	11,749,991		$	10,816,072		$	9,843,203
(Current Assets – Current Liabilities)
Quick Ratio		0.81			0.77			0.81			0.65
(Cash + Accounts Receivable / Current Liabilities)
Accounts Receivable to Working Capital		1.12			1.03			0.85			0.85
(Average Accounts Receivable/ Working Capital)
Inventory to Working Capital		1.18			1.10			1.11			1.26
(Average Inventory/ Working Capital)

 

* Proforma ratios since the line of credit debt has been reclassified to current liabilities as noted in above comments.

 

Our working capital as of September 30, 2005 was $12.2 million compared to $11.7 million at December 31, 2004. Our increases in both accounts receivable and inventories are the result of our growth in sales. We continue to take the necessary actions needed and implement initiatives to improve our working capital position by focusing on lowering inventory levels and collecting accounts receivable within terms.

 

Net cash provided by operating activities for the nine months ended September 30, 2005 was $1.3 million; an improvement over the net cash used in operating activities of $0.1 million for the nine months ended September 30, 2004.  The cash flow from operations for the nine months ended September 30, 2005 is the result of net income of $0.5 million adjusted for noncash depreciation, amortization, foreign currency transaction loss, and the change in deferred taxes, which totaled $1.1 million in positive adjustments, less the net change in operating assets and liabilities of $0.3 million.

 

Net cash used in investing activities of $706,039 for the first nine months of 2005 is down from $889,445 spent on capital equipment purchases in the first nine months of 2004.  The 2005 major investments are related to software for corporate shared services, which enables us to meet additional compliance requirements, and equipment to support our growth activities.

 

Net cash used in financing activities for the nine months ended September 30, 2005 was $513,449, consisting primarily of paying down the line of credit by $378,662 and principal on notes payable of

 

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$787,765. A new promissory note payable of $636,502 was issued on August 2, 2005 to finance capital equipment purchases (See Note 5 for additional details).

 

We believe that our future financing requirements can be met with funds generated from the operating activities and our operating line of credit.  Set forth below is information about our long-term contractual obligations outstanding as of September 30, 2005. Refer to the Annual Report on Form 10-K for detailed information on our long-term contractual obligations and commitments.

 

		Remainder
		of 2005			2 - 3 Yrs			4 - 5 Yrs
Notes Payable		$	310,080		$	3,843,787		$	91,895
Operating Leases		80,729			653,496			183,759
Equipment Purchase Commitments		200,000			—			—
Total Contractual Obligations and Commitments		$	590,809		$	4,497,283		$	275,654

 

(3.) Critical Accounting Policies:

Our significant accounting policies and estimates are summarized in the footnotes to the annual consolidated financial statements.  Some of the most critical accounting policies and estimates that require us to exercise significant judgment are listed below.

 

Revenue Recognition:

We recognize revenue upon shipment of products to customers, when title has passed, all contractual obligations have been satisfied and collection of the resulting receivables are reasonably assured.  In the normal course of business, we enter into a number of contracts with customers under which we provide engineering services on a per project basis.  Revenue for these services is recognized upon completion of the engineering process, usually upon initial shipment of the product.  Revenues from repair services are recognized upon shipment of related equipment to customers.

 

Allowance for Uncollectible Accounts:

We evaluate our allowance for uncollectible accounts on a quarterly basis and review any significant customers with delinquent balances to determine future collectibility.  We base our determinations on legal issues (such as bankruptcy status), past history, current financial and credit agency reports, and experience.  We reserve accounts deemed to be uncollectible in the quarter in which we make the determination.  We maintain additional reserves based on our historical bad debt experience. We believe these estimates may differ from actual results. We believe that, based on past history and credit policies, the net accounts receivable are of good quality.

 

Inventory Valuation and Reserves:

Inventories are stated at the lower of cost (first-in, first out method) or market (based on the lower of replacement cost or net realizable value).  Costs include material, labor, and overhead required in the warehousing and production of our products.  Inventory reserves are maintained for the estimated value of the inventory that may have a lower value than stated or in excess of production needs.  These estimates may differ from actual results.  We have an evaluation process that is used to assess the value of the inventory by part and customer that is slow moving, excess or obsolete.  This process is reviewed and evaluated quarterly.

 

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