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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

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) 345-2244

 

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 to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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

 

Number of shares of $.01 par value common stock outstanding at August 14, 2008 - 2,738,954

 

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

 

 

Table of Contents

 

TABLE OF CONTENTS

 

						PAGE
PART I - FINANCIAL INFORMATION
			Item 1 - Financial Statements
					Consolidated Balance Sheets	3 - 4
					Consolidated Statements of Income	5-6
					Consolidated Statements of Cash Flows	7
					Condensed Notes to the Consolidated Financial Statements	8-16
			Item 2 - Management’s Discussion and Analysis of Financial Condition And Results of Operations			17-21
			Item 3 - Controls and Procedures			21
PART II - OTHER INFORMATION
		Item 1 - Legal Proceedings				22
		Item 6 - Exhibits				22
SIGNATURES						23
	Exhibit 31.1
	Exhibit 31.2
	Exhibit 32.1

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PART 1

 

ITEM 1.  FINANCIAL STATEMENTS

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

 

		JUNE 30			DECEMBER 31
		2008			2007
		(Unaudited)
ASSETS
Current Assets
Cash and Cash Equivalents		$	286,032		$	888,036
Accounts Receivable, Less Allowance for Uncollectible Accounts of $258,000 and $198,000, respectively		18,467,568			15,366,965
Inventories, Less Reserves of $1,339,000 and $1,303,000 respectively		20,980,856			18,876,464
Prepaid Expenses		505,483			512,884
Deferred Income Taxes		1,066,000			974,000
Total Current Assets		41,305,939			36,618,349
Property and Equipment
Land		300,000			300,000
Building and Leasehold Improvements		6,470,748			6,435,732
Manufacturing Equipment		10,749,122			10,140,802
Office and Other Equipment		3,651,926			3,687,441
Construction in Progress		447,941			146,081
Total Property and Equipment		21,619,737			20,710,056
Accumulated Depreciation		(12,526,195		)	(11,785,374		)
Net Property and Equipment		9,093,542			8,924,682
Other Assets
Restricted Cash		427,500			427,500
Finite Life Intangibles		568,730			643,791
Goodwill		75,006			75,006
Deferred Income Taxes		286,000			303,400
Deposits		7,726			7,726
Total Other Assets		1,364,962			1,457,423
Total Assets		$	51,764,443		$	47,000,454

 

See Accompanying Condensed Notes to the Consolidated Financial Statements

 

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		JUNE 30			DECEMBER 31
		2008			2007
		(Unaudited)
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Bank Note Payable Under Line of Credit		$	8,114,004		$	5,635,076
Current Maturities of Long-Term Debt		1,018,261			1,176,209
Checks Written in Excess of Bank Balance		500,000			—
Accounts Payable		10,927,635			10,627,381
Accrued Payroll and Commissions		3,861,614			2,845,557
Accrued Health and Dental Claims		405,000			380,000
Other Accrued Liabilities		767,835			922,607
Income Taxes Payable		24,678			219,167
Total Current Liabilities		25,619,027			21,805,997
Long-Term Liabilities
Long-Term Debt (Net of Current Maturities)		4,313,873			4,840,689
Other Long-Term Liabilities		39,563			42,919
Total Long-Term Liabilities		4,353,436			4,883,608
Total Liabilities		29,972,463			26,689,605
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: 2,738,955 and 2,714,888 Shares Issued and Outstanding		27,390			27,149
Additional Paid-In Capital		15,382,299			15,111,179
Accumulated Other Comprehensive Gain (Loss)		4,271			(27,882		)
Retained Earnings		6,128,020			4,950,403
Total Shareholders’ Equity		21,791,980			20,310,849
Total Liabilities and Shareholders’ Equity		$	51,764,443		$	47,000,454

 

See Accompanying Condensed Notes to the Consolidated Financial Statements

 

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

		THREE MONTHS ENDED
		JUNE 30
		2008			2007
Net Sales		$	31,994,182		$	31,136,314
Cost of Goods Sold		27,502,515			26,883,177
Gross Profit		4,491,667			4,253,137
Operating Expenses:
Selling Expenses		1,424,765			1,375,314
General and Administrative Expenses		1,954,618			2,037,669
Total Operating Expenses		3,379,383			3,412,983
Income From Operations		1,112,284			840,154
Other Income (Expense)
Interest Income		2,293			6,162
Miscellaneous Expense, net		(38,226		)	(33,590		)
Interest Expense		(157,562		)	(260,226		)
Total Other Expense		(193,495		)	(287,654		)
Income Before Income Taxes		918,789			552,500
Income Tax Expense		367,000			185,000
Net Income		$	551,789		$	367,500
Earnings Per Common Share:
Basic		$	0.20		$	0.14
Weighted Average Number of Common Shares Outstanding Used for Basic Earnings Per Common Share		2,712,373			2,695,754
Diluted		$	0.20		$	0.13
Weighted Average Number of Common Shares Outstanding Plus Common Stock Equivalents		2,743,614			2,735,654

 

See Accompanying Condensed Notes to the Consolidated Financial Statements

 

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		SIX MONTHS ENDED
		JUNE 30
		2008			2007
Net Sales		$	63,223,545		$	59,130,776
Cost of Goods Sold		53,938,525			51,240,292
Gross Profit		9,285,020			7,890,484
Operating Expenses:
Selling Expenses		2,761,766			2,569,676
General and Administrative Expenses		4,173,171			3,829,275
Total Operating Expenses		6,934,937			6,398,951
Income From Operations		2,350,083			1,491,533
Other Income (Expense)
Interest Income		6,532			13,715
Miscellaneous Expense, net		(47,960		)	(39,167		)
Interest Expense		(371,038		)	(487,687		)
Total Other Expense		(412,466		)	(513,139		)
Income Before Income Taxes		1,937,617			978,394
Income Tax Expense		760,000			324,000
Net Income		$	1,177,617		$	654,394
Earnings Per Common Share:
Basic		$	0.43		$	0.24
Weighted Average Number of Common Shares Outstanding Used for Basic Earnings Per Common Share		2,708,881			2,685,469
Diluted		$	0.43		$	0.24
Weighted Average Number of Common Shares Outstanding Plus Common Stock Equivalents		2,736,659			2,724,808

 

See Accompanying Condensed Notes to the Consolidated Financial Statements

 

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

		SIX MONTHS ENDED
		JUNE 30
		2008			2007
Cash Flows From Operating Activities
Net Income		$	1,177,617		$	654,394
Adjustments to Reconcile Net Income to Net Cash
Provided by (Used in) Operating Activities:
Depreciation		855,083			772,007
Amortization		75,062			91,159
Stock-Based Compensation Awards		134,180			127,506
Other		(3,356		)	(11,284		)
Deferred Income Taxes		(74,600		)	(247,000		)
(Gain) Loss on Disposal of Property and Equipment		(6,751		)	10,492
Foreign Currency Transaction Loss		21,226			1,188
Changes in Current Operating Items, Net of Acquisition:
Accounts Receivable		(3,088,535		)	(327,902		)
Inventories		(2,104,392		)	(1,123,100		)
Prepaid Expenses and Other Assets		8,149			217,883
Income Taxes Payable		(176,690		)	293,017
Accounts Payable		294,712			700,741
Accrued Payroll and Commissions		1,004,196			(64,880		)
Accrued Health and Dental Claims		25,000			18,000
Other Accrued Liabilities		(173,937		)	12,632
Net Cash Provided by (Used in) Operating Activities		(2,033,036		)	1,124,853
Cash Flows from Investing Activities:
Proceeds from Sale of Property and Equipment		6,931			1,161
Business Acquisition		—			(4,807,699		)
Purchase of Property and Equipment		(1,011,159		)	(758,607		)
Net Cash Used in Investing Activities		(1,004,228		)	(5,565,145		)
Cash Flows from Financing Activities:
Net Change in Line of Credit		2,478,928			3,937,469
Proceeds from Long-Term Debt		—			1,668,195
Payments on Long-Term Debt		(684,764		)	(1,145,284		)
Issuance of Common Stock Upon Exercise of Stock Options		137,181			200,173
Checks in Excess of Bank Balance		500,000			—
Net Cash Provided by Financing Activities		2,431,345			4,660,553
Effect of Exchange Rate Changes on Cash		3,915			156
Net Increase (Decrease) in Cash and Cash Equivalents		(602,004		)	220,417
Cash and Cash Equivalents - Beginning		888,036			725,891
Cash and Cash Equivalents - Ending		$	286,032		$	946,308
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for interest		$	376,702		$	493,533
Cash paid during the period for income taxes		1,044,100			282,929
Supplemental Schedule of Noncash Operating Activity:
Cumulative effect of FIN 48 adoption		$	—		$	32,000
Supplemental Schedule of Noncash Financing Activity
Accrual for estimated earnout payment on business acquisition		$	—		$	200,000

 

See Accompanying Condensed Notes to the Consolidated Financial Statements

 

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CONDENSED NOTES TO THE 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, 2007.  The operating results for 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, since actual results could differ from those estimates.

 

Summary of Significant Accounting Policies

 

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 year ended December 31, 2007, some of which have been included herein as follows.

 

Revenue Recognition

 

We recognize revenue upon shipment of manufactured products to customers, when title has passed, all contractual obligations have been satisfied and collection of the resulting receivable is reasonably assured. We also provide engineering services separate from the manufacture of a product. Revenue for engineering services is recognized upon completion of the engineering process, providing standalone fair value to our customers. Our engineering services are short-term in nature. In addition, we have another separate source of revenue that comes from short-term repair services, which are recognized upon completion of the repairs, and the repaired products are shipped back to the customer. Shipping and handling costs charged to our customers are included in net sales, while the corresponding shipping expenses are included in cost of goods sold.

 

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Stock-Based Compensation

 

We have two types of stock-based compensation awards consisting of restricted stock and stock options.  Following is a summary of the key terms and methods of valuation for our stock-based compensation awards.

 

Restricted Stock

 

On March 7, 2006, 28,500 shares of restricted common stock were granted to our management and directors.  This benefit was valued at the market price of the stock on the date of grant.  These awards vest over a three-year term and are expensed ratably over the same period.  We recorded compensation expense of $17,475 and $34,950 for the three and six months ended, respectively, of both June 30, 2008 and 2007.  The following is the status of our restricted shares as of June 30, 2008:

 

		Restricted Shares		Weighted- Average  Grant Date Fair Value
Outstanding - January 1, 2008 through June 30, 2008		28,500		$	7.44
Vested - June 30, 2008		19,000		$	7.44

 

As of June 30, 2008 and 2007, there was approximately $35,000 and $105,000 of unrecognized compensation expense related to unvested restricted stock awards to be recognized over a weighted-average period of 0.5 and 1.5 years, respectively.

 

Stock Options

 

On May 3, 2005, the shareholders approved the 2005 Incentive Compensation Plan (the “2005 Plan”).  The total number of shares of common stock that may be granted under the 2005 Plan is 200,000, of which 39,500 remain available for grant at June 30, 2008.  The 2005 Plan provides that option shares granted come from our authorized but unissued common stock.  The price of the option shares granted under the plan will not be less than 100% of the fair market value of the common shares on the date of grant.  Options are generally exercisable after one or more years and expire no later than 10 years from the date of grant.

 

On July 11, 2007, the Board of Directors approved the adoption of the FOCUS Incentive Plan (the “2007 Plan”).  The total number of shares of common stock that may be granted under the 2007 Plan is 490,000 of which 29,300 remain available for grant at June 30, 2008.  The 2007 Plan also provides that option shares granted come from our authorized but unissued common stock.  The purpose of the 2007 Plan is to provide incentives to our employees to increase our return on sales (“ROS”) performance measurement.  The price of the option shares granted under the plan will not be less than 100% of the fair market value of the common shares on the date of grant.  Options expire no later than 10 years from the date of grant.  However, the FOCUS plan is unique from the preceding Plan in that vesting of options is conditional upon our achievement of established performance measurements as follows:

 

·                  If we achieve 1.95% ROS for any of the three years ending 2007, 2008, or 2009, one-third of the options will vest.

 

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·                  If we achieve 3% ROS for either of the two calendar years 2008 or 2009, one-third of the options will vest.

 

·                  If we achieve 4% ROS for the calendar year 2009, the remaining one-third of the options will vest.

 

Following is the status of our stock option plan as of June 30, 2008, including changes during the three-month period then ended:

 

		Shares		Weighted- Average  Exercise  Price Per  Share			Weighted- Average  Remaining  Contractual  Term  (in years)		Aggregate  Intrinsic Value
Outstanding - January 1, 2008		809,500		$	7.30
Granted		10,700		$	6.35
Exercised		(24,000	)	$	5.70
Forfeited		(10,000	)	$	7.50
Outstanding - June 30, 2008		786,200		$	7.34		7.89		$	1,598,089
Exercisable - June 30, 2008		256,330		$	7.00		5.74		$	571,130

 

The total intrinsic value of options exercised during the three months ended June 30, 2008 was $56,960.  There were no options exercised during the three months ended March 31, 2008.

 

A summary of the status of our nonvested shares pursuant to all plans as of June 30, 2008 and changes during the six months ended June 30, 2008, is presented below:

 

Nonvested Shares		Shares		Weighted- Average  Grant-Date  Fair Value
Nonvested at January 1, 2008		551,500		$	4.38
Granted		10,700		3.26
Vested		(22,330	)	4.27
Forfeited		(10,000	)	4.40
Nonvested at June 30, 2008		529,870		$	4.36

 

To calculate the fair value of option-based awards under Statement of Financial Accounting Standard No. 123R (SFAS 123R), we used the Black-Scholes option-pricing model.  Our determination of fair value of option-based awards on the date of grant using the Black-Scholes model is affected by our stock price as well as assumptions regarding a number of subjective variables.  These variables include, but are not limited to, our expected stock price volatility over the term of the awards, risk-free interest rate, and the expected life of the options.  The risk-free interest rate is based on a treasury

 

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instrument whose term is consistent with the expected life of our stock options.  The expected volatility and holding period of options are based on our historical experience.  For all grants, the amount of compensation expense to be recognized is adjusted for an estimated forfeiture rate, which is also based on historical data.  The variables used for the grants for the three months ended June 30, 2008 are below.  There were no grants during the three months ended June 30, 2007.

 

·                  Expected volatility of 46%

·                  Risk-free interest rate of 3.5%

·                  Expected life of 7 years

·                  Expected dividend yield – 0%

 

Stock Options with Time-Based Vesting

 

Total compensation expense related to stock options with time-based vesting for the three months ended June 30, 2008 and 2007 was $49,615 and $46,278, respectively.  Total compensation expense related to stock options with time-based vesting for the six months ended June 30, 2008 and 2007 as $99,230 and $92,556, respectively.  At June 30, 2008 we had 325,500 time-based options outstanding.

 

As of June 30, 2008, there was approximately $193,000 of unrecognized compensation expense related to unvested option awards that we expect to recognize over a weighted-average period of .98 years.

 

Stock Options with Performance-Based Vesting

 

As mentioned previously, the vesting of options granted in July 2007, March 2008 and May 2008 are conditional upon our achievement of established performance measurements. At June 30, 2008, management has estimated the probability of achieving any of the performance goals is less than 50%, thus in accordance with provisions of SFAS 123R, no compensation expense has been recorded for the three months ended June 30, 2008 for these awards.

 

As of June 30, 2008 we have 460,700 performance-based options outstanding.  There was approximately $1,972,000 of unrecognized compensation expense available to be earned and expensed in future periods up through December 2009 on performance-based stock options.

 

 Segment Reporting Information

 

Our results of operations for the three and six months ended June 30, 2008 and 2007 represent a single segment referred to as Contract Manufacturing.  Export sales represented 4% of consolidated net sales for both the three-month and six-month periods ended June 30, 2008.  Export sales represented 1% and 2% of consolidated net sales for the three-month and six-month periods ended June 30, 2007.

 

Long-lived assets by country are as follows:

 

		United States			Mexico			Total
June 30, 2008
Net Property and Equipment		$	8,681,920		$	411,622		$	9,093,542
Other Noncurrent Assets		1,363,236			7,726			1,370,962
December 31, 2007
Net Property and Equipment		$	8,453,187		$	471,495		$	8,924,682
Other Noncurrent Assets		1,449,697			7,726			1,457,423

 

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Finite Life Intangible Assets

 

Finite life intangible assets at June 30, 2008 and December 31, 2007 are as follows:

 

		June 30, 2008
		Estimated		Gross
		Lives		Carrying			Accumulated			Net Book
		(Years)		Amount			Amortization			Value
Bond Issue Costs		15		$	79,373		$	10,584		$	68,789
Customer Base		5		676,557			191,690			484,867
Other Intangibles		3		28,560			13,486			15,074
Totals				$	784,490		$	215,760		$	568,730

 

		December 31, 2007
		Estimated		Gross
		Lives		Carrying			Accumulated			Net Book
		(Years)		Amount			Amortization			Value
Bond Issue Costs		15		$	79,373		$	7,938		$	71,435
Customer Base		5		676,557			124,035			552,522
Other Intangibles		3		94,347			74,513			19,834
Totals				$	850,277		$	206,486		$	643,791

 

Amortization expense related to these assets is as follows:

 

Three months ended June 30, 2008		$	38,176
Three months ended June 30, 2007		$	59,246
Six months ended June 30, 2008		$	75,062
Six months ended June 30, 2007		$	91,159

 

Estimated future amortization expense related to these assets is as follows:

 

Remainder of 2008		$	75,000
2009		150,000
2010		141,000
2011		141,000
2012		17,000
Thereafter		45,000
Total		$	569,000

 

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.

 

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NOTE 3. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

 

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and 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 accounts receivable.  Historically, we have not suffered significant losses with respect to accounts receivable.

 

Two customers accounted for 10% or more of our net sales for the three-month and six-month periods ended June 30, 2008 and 2007.  Northrop Grumman Corp. accounted for 25% and 23% of net sales for the three-month and six-month periods ended June 30, 2008, respectively.  Accounts receivable from Northrop Grumman Corp. represented 17% of total accounts receivable at June 30, 2008.  Additionally, G.E.’s Medical and Transportation Divisions together accounted for 18% and 17% of net sales for the three-month and six-month periods ended June 30, 2008, respectively.  Accounts receivable from G.E.’s Medical and Transportation Divisions represented 12% of total accounts receivable at June 30, 2008.

 

NOTE 4. FINANCING ARRANGEMENTS

 

We have a credit agreement with a bank, which provides for a line of credit arrangement of $15 million, which expires if not renewed, on April 30, 2009.  The credit arrangement also has a real estate term note with a maturity date of May 31, 2012.  Both the line of credit and real estate term note are subject to variations in LIBOR rates.  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.  As of June 30, 2008, we were in compliance with all covenants.  On June 30, 2008, we had an outstanding balance of $8.1 million under the line of credit and unused availability of $6.9 million supported by the borrowing base level.  The line of credit is secured by substantially all of our assets.

 

On June 28, 2006, we received $1.4 million in exchange for an industrial revenue bond with WFB, where the City of Blue Earth, Minnesota is the issuer of the bond.  The bond, which matures on June 1, 2021, bears a variable interest rate.  The bond is payable in annual installments per the agreement with WFB.  Our bond principal payment of $130,000 was made on June 1, 2008 and will be $130,000 on June 1, 2009.  The proceeds of the bond were used to purchase the facility in Blue Earth, Minnesota as well as facility upgrades and equipment to support the Blue Earth operations.

 

With WFB, we entered into an interest rate swap agreement with a notional amount of $1.4 million to effectively convert our industrial revenue bond debt from a variable rate to a fixed rate of 4.07% for five years, maturing on June 28, 2011.  The fair value of the swap at June 30, 2008 was recorded as a long-term liability of $39,563.

 

Effective January 1, 2008, we adopted SFAS No. 157 (SFAS 157), “Fair Value Measurements” for its financial instruments.  The estimated fair values of our short-term financial instruments, including receivables and payables arising in the ordinary course of business, approximate their individual carrying amounts due to the relatively short period of time between their origination and expected realization.  The fair value of our interest rate swap (used for purposes other than trading) is the estimated amount we would pay to terminate the agreement at June 30, 2008, taking into account current interest rates and our creditworthiness.  The adoption of SFAS 157 for financial instruments did not have a material impact on our financial statements.  SFAS 157 is effective for non-financial instruments for fiscal years beginning after November 15, 2008.

 

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NOTE 5. EARNINGS PER COMMON SHARE

 

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

 

		Three Months Ended						Six Months Ended
		June 30						June 30
		2008			2007			2008			2007
Basic Earnings Per Common Share
Net income, as reported		$	551,789		$	367,500		$	1,177,617		$	654,394
Weighted average common shares oustanding		2,712,373			2,695,754			2,708,881			2,685,469
Basic earnings per common share		$	0.20		$	0.14		$	0.43		$	0.24
Diluted Earnings Per Common Share
Net income, as reported		$	551,789		$	367,500		$	1,177,617		$	654,394
Weighted average common shares outsanding		2,712,373			2,695,754			2,708,881			2,685,469
Effect of Stock Options		21,881			34,209			18,768			33,769
Effect of Restricted Stock		9,360			5,691			9,010			5,570
Weighted average common shares for diluted earnings per common share		2,743,614			2,735,654			2,736,659			2,724,808
Diluted earnings per common share		$	0.20		$	0.13		$	0.43		$	0.24

 

For the six-month periods ended June 30, 2008 and 2007, 39,779 and 51,373 shares, respectively were excluded from the computation of diluted earnings per share because to include them would be antidilutive.

 

NOTE 6.  INCOME TAXES

 

On a quarterly basis, we estimate what our effective tax rate will be for the full fiscal year and record a quarterly income tax provision based on the anticipated rate.  As the year progresses, we refine our estimate based on the facts and circumstances by each tax jurisdiction.  The effective tax rates for the quarters ended June 30, 2008 and 2007 were 40% and 33%, respectively.  The increase in the effective tax rate from 2007 is primarily due to federal research and experimentation credits which have not yet been enacted beyond 2007.

 

Effective January 1, 2007, we adopted FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes.”  On adoption, we recognized a $32,000 income tax liability for unrecognized tax benefits, which was accounted for as a cumulative change to opening retained earnings.  At June 30, 2008 we had $61,000 of net uncertain tax benefit positions that would reduce our effective income tax rate if recognized.  Due to statute expiration, a decrease could occur with

 

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respect to this FIN 48 reserve of less than $20,000 during fiscal year 2008.  This reserve, including associated interest, relates primarily to federal research tax credits taken in prior years.

 

NOTE 7. COMPREHENSIVE INCOME

 

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

 

		Three Months Ended						Six Months Ended
		June 30						June 30
		2008			2007			2008			2007
Net Income, as reported		$	551,789		$	367,500		$	1,177,617		$	654,394
Other Comprehensive Income:
Currency Translation Adjustment		18,007			11,083			32,153			984
Comprehensive Income		$	569,796		$	378,583		$	1,209,770		$	655,378

 

NOTE 8.  RECENTLY ISSUED ACCOUNTING STANDARDS

 

In February 2007, the FASB issued SFAS No. 159 (SFAS 159), “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115”.  SFAS 159 allows organizations to measure and report the fair market value of many financial instruments and certain other items. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS 159 did not have a material impact on our financial statements.

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS 141R), which replaces FASB Statement No. 141, and SFAS No 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51 (SFAS 160).  SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired.  SFAS 160 will change the accounting and reporting for minority interests, reporting them as equity separate from the parent entity’s equity, as well as requiring expanded disclosures.  SFAS 141R and SFAS 160 are effective as of the beginning of an entity’s fiscal year beginning after December 15, 2008.

 

In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities” (SFAS 161).  The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, results of operations and cash flows.  SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with earlier application encouraged.  We are currently investigating the impact, if any, of adopting SFAS 161 on our financial statements.

 

In May 2008, the FASB issued SFAS 162, “The Hierarchy of Generally Accepted Accounting Principles” (SFAS 162).  The new standard identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of

 

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nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy).  This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.  We do not anticipate any significant changes as a result of adopting SFAS 162.

 

NOTE 9.  ACQUISITION

 

On February 4, 2007, we purchased substantially all of the assets and assumed certain liabilities of Suntron’s Midwest Operations located in Garner, Iowa. This operation is an Electronics Manufacturer Service (EMS) provider of printed circuit board assemblies, box build assemblies and repair services. This acquisition strengthened our capabilities in printed circuit board assemblies and high level complete box build assemblies while opening new market segments in the agriculture and oil and gas industries.

 

The purchase agreement called for a contingent earn-out if certain revenue levels were achieved in 2007.  Based on actual revenue levels, an earn-out payment of $200,000 was made in February 2008.

 

The table below reflects our unaudited pro forma combined results of operations for the six months ended June 30, 2007 as if the acquisition had taken place as of January 1, 2007:

 

		Pro Forma
		Six Months Ended
		June 30, 2007
		(unaudited)
Net Sales		$	60,289,000
Net Income		$	631,000
Basic earnings per common share		$	0.23
Diluted earnings per common share		$	0.23

 

The pro forma unaudited results do not purport to be indicative of the results which would have been obtained had the acquisition been completed as of January 1, 2007.

 

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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.  Major markets served include industrial equipment and transportation, medical and military/defense. We have operating facilities in Baxter, Bemidji, Blue Earth, Fairmont and Merrifield, Minnesota, Garner, Iowa, Augusta, Wisconsin, and Monterrey, Mexico.

 

Summary:

 

For the quarter ended June 30, 2008, we reported net sales of $32.0 million, up 3% over the $31.1 million we reported in the same quarter of 2007.  For the six months ended June 30, 2008, we reported net sales of $63.2 million, up 7% over the $59.1 million we reported for the first six months of 2007.  The gross profit percentage was 14% for the second quarters of 2008 and 2007.  For the first six months of 2008 and 2007, the gross profit percentage was 15% and 13%, respectively.  Income from operations for the second quarter of 2008 totaled $1,112,284, an increase of 32% over the $840,154 reported in the second quarter of 2007.  Income from operations for the first six months of 2008 totaled $2,350,083, an increase of 58% above the $1,491,533 reported in the first six months of 2007.  Net income for the second quarter of 2008 totaled $551,789, or $0.20 per diluted common share which is up 50% compared to $367,500, or $0.13 per diluted common share, reported in the second quarter of 2007.  Net income for the first six months of 2008 totaled $1,177,617, or $0.43 per diluted common share, and was 80% higher than the $654,394, or $0.24 per diluted common share, reported in the first six months of 2007.

 

(1.) Results of Operations:

 

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

 

		Three Months Ended				Six Months Ended
		June 30				June 30
		2008		2007		2008		2007
Net Sales		100.0	%	100.0	%	100.0	%	100.0	%
Cost of Goods Sold		86.0	%	86.3	%	85.3	%	86.7	%
Gross Profit		14.0	%	13.7	%	14.7	%	13.3	%
Selling Expenses		4.5	%	4.4	%	4.4	%	4.3	%
General and Administrative Expenses		6.0	%	6.6	%	6.6	%	6.5	%
Income from Operations		3.5	%	2.7	%	3.7	%	2.5	%
Other Expenses, Net		0.6	%	0.9	%	0.7	%	0.9	%
Income Tax Expense		1.2	%	0.6	%	1.2	%	0.5	%
Net Income		1.7	%	1.2	%	1.8	%	1.1	%

 

Net Sales:

 

We reported net sales of $32.0 million and $31.1 million for the second quarters ended June 30, 2008 and 2007, respectively, a 3% increase year over year.  The sales increase is a result of our Aerospace Systems operations being up 19% and our Commercial Cable and Wire operation up 9% as compared to the second quarter of 2007.  These increases were offset by a 14% sales decline in our Commercial

 

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