Annual Statements Open main menu

NORTECH SYSTEMS INC - Quarter Report: 2014 September (Form 10-Q)

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2014

 

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) 345-2244

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  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 the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer o

 

Accelerated Filer o

 

 

 

Non-accelerated Filer o

 

Smaller Reporting Company x

 

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 November 1, 2014 - 2,742,992

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

 

 

 


 


Table of Contents

 

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION

 

 

 

 

 

PAGE

 

 

Item 1

-

Financial Statements

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets

3

 

 

 

 

 

 

 

 

Consolidated Statements of Income

4-5

 

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows

6

 

 

 

 

 

 

 

 

Condensed Notes to Consolidated Financial Statements

7-13

 

 

 

 

 

 

Item 2

-

Management’s Discussion and Analysis of Financial Condition And Results of Operations

13-19

 

 

 

 

 

 

Item 4

-

Controls and Procedures

19

 

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

 

 

Item 1

-

Legal Proceedings

20

 

 

 

 

 

 

Item 6

-

Exhibits

20

 

 

SIGNATURES

20

 

2



Table of Contents

 

PART 1

 

ITEM 1.  FINANCIAL STATEMENTS

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

 

 

 

SEPTEMBER 30

 

DECEMBER 31

 

 

 

2014

 

2013

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash

 

$

203,482

 

$

 

Accounts Receivable, Less Allowance for Uncollectible Accounts

 

15,606,066

 

16,030,848

 

Inventories

 

20,416,199

 

17,427,470

 

Prepaid Expenses

 

974,602

 

634,350

 

Income Taxes Receivable

 

400,051

 

140,174

 

Deferred Income Taxes

 

683,000

 

683,000

 

Total Current Assets

 

38,283,400

 

34,915,842

 

 

 

 

 

 

 

Property and Equipment, Net

 

11,033,721

 

11,037,160

 

Other Assets

 

118,450

 

122,419

 

Total Assets

 

$

49,435,571

 

$

46,075,421

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Line of Credit

 

$

 

$

7,234,983

 

Current Maturities of Long-Term Debt

 

737,961

 

632,176

 

Accounts Payable

 

9,346,406

 

8,185,012

 

Accrued Payroll and Commissions

 

3,282,766

 

2,595,393

 

Other Accrued Liabilities

 

938,842

 

718,974

 

Total Current Liabilities

 

14,305,975

 

19,366,538

 

 

 

 

 

 

 

Long-Term Liabilities

 

 

 

 

 

Line of Credit

 

7,831,089

 

 

Long-Term Debt, Net of Current Maturities

 

4,144,139

 

4,246,914

 

Deferred Income Taxes

 

333,680

 

282,000

 

Other Long-Term Liabilities

 

197,240

 

244,521

 

Total Long-Term Liabilities

 

12,506,148

 

4,773,435

 

Total Liabilities

 

26,812,123

 

24,139,973

 

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:

 

 

 

 

 

2,742,992 Shares Issued and Outstanding

 

27,430

 

27,430

 

Additional Paid-In Capital

 

15,760,678

 

15,738,233

 

Accumulated Other Comprehensive Loss

 

(62,936

)

(62,936

)

Retained Earnings

 

6,648,276

 

5,982,721

 

Total Shareholders’ Equity

 

22,623,448

 

21,935,448

 

Total Liabilities and Shareholders’ Equity

 

$

49,435,571

 

$

46,075,421

 

 

See Accompanying Condensed Notes to Consolidated Financial Statements

 

3



Table of Contents

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

 

 

THREE MONTHS ENDED

 

 

 

SEPTEMBER 30

 

 

 

2014

 

2013

 

 

 

 

 

 

 

Net Sales

 

$

28,037,865

 

$

27,389,275

 

 

 

 

 

 

 

Cost of Goods Sold

 

24,510,862

 

24,373,696

 

 

 

 

 

 

 

Gross Profit

 

3,527,003

 

3,015,579

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

Selling Expenses

 

1,303,920

 

1,228,583

 

General and Administrative Expenses

 

1,749,593

 

1,410,815

 

Total Operating Expenses

 

3,053,513

 

2,639,398

 

 

 

 

 

 

 

Income From Operations

 

473,490

 

376,181

 

 

 

 

 

 

 

Other Expense

 

 

 

 

 

Interest Expense

 

(89,598

)

(103,977

)

Miscellaneous Income (Expense), net

 

(13,195

)

32,713

 

Total Other Expense

 

(102,793

)

(71,264

)

 

 

 

 

 

 

Income Before Income Taxes

 

370,697

 

304,917

 

 

 

 

 

 

 

Income Tax Expense

 

38,000

 

87,000

 

 

 

 

 

 

 

Net Income

 

$

332,697

 

$

217,917

 

 

 

 

 

 

 

Earnings Per Common Share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.12

 

$

0.08

 

 

 

 

 

 

 

Weighted Average Number of Common Shares Outstanding - Basic

 

2,742,992

 

2,742,992

 

 

 

 

 

 

 

Diluted

 

$

0.12

 

$

0.08

 

 

 

 

 

 

 

Weighted Average Number of Common Shares Outstanding - Diluted

 

2,747,943

 

2,742,992

 

 

See Accompanying Condensed Notes to Consolidated Financial Statements

 

4



Table of Contents

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

 

 

NINE MONTHS ENDED

 

 

 

SEPTEMBER 30

 

 

 

2014

 

2013

 

 

 

 

 

 

 

Net Sales

 

$

81,595,474

 

$

81,765,375

 

 

 

 

 

 

 

Cost of Goods Sold

 

71,711,557

 

72,153,707

 

 

 

 

 

 

 

Gross Profit

 

9,883,917

 

9,611,668

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

Selling Expenses

 

3,570,066

 

3,618,354

 

General and Administrative Expenses

 

5,256,963

 

5,020,405

 

Total Operating Expenses

 

8,827,029

 

8,638,759

 

 

 

 

 

 

 

Income From Operations

 

1,056,888

 

972,909

 

 

 

 

 

 

 

Other Expense

 

 

 

 

 

Interest Expense

 

(271,661

)

(302,997

)

Miscellaneous Income (Expense), net

 

(46,672

)

40,314

 

Total Other Expense

 

(318,333

)

(262,683

)

 

 

 

 

 

 

Income Before Income Taxes

 

738,555

 

710,226

 

 

 

 

 

 

 

Income Tax Expense

 

73,000

 

164,000

 

 

 

 

 

 

 

Net Income

 

$

665,555

 

$

546,226

 

 

 

 

 

 

 

Earnings Per Common Share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.24

 

$

0.20

 

 

 

 

 

 

 

Weighted Average Number of Common Shares Outstanding - Basic

 

2,742,992

 

2,742,992

 

 

 

 

 

 

 

Diluted

 

$

0.24

 

$

0.20

 

 

 

 

 

 

 

Weighted Average Number of Common Shares Outstanding - Diluted

 

2,747,552

 

2,742,992

 

 

See Accompanying Condensed Notes to Consolidated Financial Statements

 

5



Table of Contents

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

 

NINE MONTHS ENDED

 

 

 

SEPTEMBER 30

 

 

 

2014

 

2013

 

Cash Flows From Operating Activities

 

 

 

 

 

Net Income

 

$

665,555

 

$

546,226

 

Adjustments to Reconcile Net Income to Net Cash

 

 

 

 

 

Provided by (Used in) Operating Activities

 

 

 

 

 

Depreciation

 

1,517,153

 

1,505,367

 

Amortization

 

3,969

 

3,969

 

Compensation on Stock-Based Awards

 

22,445

 

9,945

 

Impairment on Assets

 

1,150

 

74,003

 

Deferred Taxes

 

51,680

 

171,000

 

(Gain) Loss on Disposal of Property and Equipment

 

687

 

(1,007

)

Changes in Current Operating Items

 

 

 

 

 

Accounts Receivable

 

424,782

 

(1,474,677

)

Inventories

 

(2,988,729

)

(983,539

)

Prepaid Expenses

 

(340,252

)

(340,481

)

Income Taxes Receivable

 

(259,877

)

(200,126

)

Income Taxes Payable

 

 

(60,878

)

Accounts Payable

 

1,443,580

 

(650,810

)

Accrued Payroll and Commissions

 

687,373

 

1,259,687

 

Other Accrued Liabilities

 

175,669

 

120,092

 

Net Cash Provided by (Used in) Operating Activities

 

1,405,185

 

(21,229

)

Cash Flows from Investing Activities

 

 

 

 

 

Proceeds from Sales of Assets

 

250

 

56,810

 

Purchases of Property and Equipment

 

(1,801,069

)

(1,006,874

)

Net Cash Used in Investing Activities

 

(1,800,819

)

(950,064

)

Cash Flows from Financing Activities

 

 

 

 

 

Borrowings on Line of Credit

 

83,477,209

 

 

Repayments on Line of Credit

 

(82,881,103

)

 

Net Borrowings on Line of Credit

 

 

59,653

 

Proceeds from Long-Term Debt

 

510,000

 

1,884,000

 

Principal Payments on Long-Term Debt

 

(506,990

)

(489,729

)

Net Cash Provided by Financing Activities

 

599,116

 

1,453,924

 

Net Increase in Cash

 

203,482

 

482,631

 

Cash - Beginning

 

 

 

Cash - Ending

 

$

203,482

 

$

482,631

 

Supplemental Disclosure of Cash Flow Information

 

 

 

 

 

Cash Paid During the Period for Interest

 

$

268,371

 

$

278,387

 

Cash Paid During the Period for Income Taxes

 

417,615

 

187,300

 

 

 

 

 

 

 

Supplemental Noncash Investing and Financing Activities

 

 

 

 

 

Capital Expenditures in Accounts Payable

 

35,720

 

105,468

 

 

See Accompanying Condensed Notes to Consolidated Financial Statements

 

6



Table of Contents

 

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 Generally Accepted Accounting Principles in the United States of America (GAAP) for interim financial information and pursuant to 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.  It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our latest shareholders’ annual report on Form 10-K.  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.

 

Principles of Consolidation

 

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

 

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 shipment of product 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.

 

7



Table of Contents

 

Stock Options

 

Following is the status of all stock options outstanding as of September 30, 2014:

 

 

 

Shares

 

Weighted-
Average
Exercise
Price Per
Share

 

Weighted-
Average
Remaining
Contractual
Term
(in years)

 

Aggregate
Intrinsic Value

 

Outstanding - January 1, 2014

 

216,000

 

$

6.46

 

 

 

 

 

Granted

 

 

 

 

 

 

 

Cancelled

 

(20,000

)

7.46

 

 

 

 

 

Outstanding - September 30, 2014

 

196,000

 

$

6.36

 

3.16

 

$

50,023

 

Exercisable - September 30, 2014

 

172,918

 

$

6.70

 

2.44

 

$

16,677

 

 

There were no options exercised during the three and nine months ended September 30, 2014 and 2013.  There were no stock options granted during the three and nine months ended September 30, 2014 and the three months ended September 30, 2013.  The weighted-average fair value of options granted during the nine months ended September 30, 2013 was $1.65 per share.

 

Total compensation expense related to stock options for the three months ended September 30, 2014 and 2013 was $7,482 and $4,444, respectively.  Total compensation expense related to stock options for the nine months ended September 30, 2014 and 2013 was $22,445 and $9,945, respectively.  As of September 30, 2014, there was approximately $24,000 of unrecognized compensation related to unvested option awards that we expect to recognize over a weighted-average period of 1.18 years.

 

Equity Appreciation Rights Plan

 

In November 2010, the Board of Directors approved the adoption of the Nortech Systems Incorporated Equity Appreciation Rights Plan (the “2010 Plan”). The total number of Equity Appreciation Right Units (Units) the Plan can issue shall not exceed an aggregate of 750,000 Units. The 2010 Plan provides that Units issued shall fully vest three years from the base date as defined in the agreement unless terminated earlier. Units give the holder a right to receive a cash payment equal to the appreciation in book value per share of common stock from the base date, as defined, to the redemption date. Unit redemption payments under this plan shall be paid in cash within 90 days after we determine the value as of the redemption date.

 

As of September 30, 2014, we had granted all 750,000 Units and 650,000 remain outstanding with vesting dates ranging from December 31, 2014 through December 31, 2019.

 

Total compensation expense related to these Units based on the estimated appreciation over their remaining terms was approximately $38,000 and $12,000 for the three months ended September 30, 2014 and 2013, respectively and approximately $119,000 and $49,000 for the nine months ended September 30, 2014 and 2013, respectively.

 

8



Table of Contents

 

As of September 30, 2014 and December 31, 2013, approximately $199,000 and $81,000 have been accrued under this plan, respectively.  As of September 30, 2014, approximately $43,000 of this balance was included in Other Accrued Liabilities and the remaining $156,000 balance was included in Other Long-term Liabilities.  As of December 31, 2013, approximately $29,000 of this balance is included in Other Accrued Liabilities and the remaining $52,000 was included in Other Long-term Liabilities.

 

Earnings per Common Share

 

For the three and nine months ended September 30, 2013, the effect of all stock options was antidilutive.  Therefore, no outstanding options were included in the computation of per-share amounts.  For both the three and nine months ended September 30, 2014, 26,750 stock options were included in the computation of diluted per share amounts as their impact was dilutive.  For the three and nine months ended September 30, 2014, stock options of 169,250 and 178,139, respectively were excluded because their inclusion would be antidilutive.

 

Segment Reporting Information

 

All of our operations fall under the Contract Manufacturing segment within the Electronic Manufacturing Services industry.  We strategically direct production between our various manufacturing facilities based on a number of considerations to best meet our customers’ requirements.  We share resources for sales, marketing, engineering, supply chain, information services, human resources, payroll, and all corporate accounting functions.  Consolidated financial information is available that is evaluated regularly by the chief operating decision maker in assessing performance and allocating resources.

 

Accounts Receivable and Allowance for Doubtful Accounts

 

We grant credit to customers in the normal course of business.  Accounts receivable are unsecured and are presented net of an allowance for doubtful accounts.  The allowance for doubtful accounts was $211,000 and $138,000 at September 30, 2014 and December 31, 2013, respectively.  We determine our allowance by considering a number of factors, including the length of time accounts receivable are past due, our previous loss history, the customers’ current ability to pay their obligations to us, and the condition of the general economy and the industry as a whole.  We write-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for uncollectible accounts.

 

Inventories

 

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 inventories that may have a lower value than stated or quantities in excess of future production needs.

 

9



Table of Contents

 

Inventories are as follows:

 

 

 

September 30

 

December 31

 

 

 

2014

 

2013

 

 

 

 

 

 

 

Raw Materials

 

$

13,748,286

 

$

12,282,902

 

Work in Process

 

4,612,452

 

3,317,573

 

Finished Goods

 

2,877,220

 

2,926,512

 

Reserve

 

(821,759

)

(1,099,517

)

 

 

 

 

 

 

Total

 

$

20,416,199

 

$

17,427,470

 

 

Impairment Analysis

 

We evaluate long-lived assets, primarily property and equipment, as well as the related depreciation periods, whenever current events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable.  Recoverability for assets to be held and used is based on our projection of the undiscounted future operating cash flows of the underlying assets.  To the extent such projections indicate that future undiscounted cash flows are not sufficient to recover the carrying amounts of related assets, a charge might be required to reduce the carrying amount to equal estimated fair value.

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). This standard outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service. Transfer of control is not the same as transfer of risks and rewards, as it is considered in current guidance.  We will also need to apply new guidance to determine whether revenue should be recognized over time or at a point in time.  This standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2016, with no early adoption permitted, using either of two methods: (a) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within ASU 2014-09; or (b) retrospective with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined in ASU 2014-09. We have not yet selected a transition method and are currently evaluating the impact of the pending adoption of ASU 2014-09 on the consolidated financial statements.

 

10



Table of Contents

 

NOTE 2. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS

 

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 two high-credit quality financial institutions.  These accounts may at times exceed federally insured limits.  We grant credit to customers in the normal course of business and do not require collateral on our accounts receivable.

 

Our largest customer has two divisions which accounted for 10% or more of our net sales for the three and nine months ended September 30, 2014 and 2013.  The first division accounted for 23% and 24% of net sales for the three and nine months ended September 30, 2014 and 22% and 20% of net sales for the three and nine months ended September 30, 2013.  The second division accounted for 7% and 5% of net sales for the three and nine months ended September 30, 2014, respectively and 6% of net sales for the three and nine months ended September 30, 2013.  Together the divisions accounted for 30% and 29% of net sales for the three and nine months ended September 30, 2014, respectively and 28% and 26% for the three and nine months ended September 30, 2013, respectively.

 

Combined accounts receivable from both divisions represented 20% of total accounts receivable at September 30, 2014 and December 31, 2013.

 

Export sales represented 13% of net sales for the three and nine months ended September 30, 2014 and 2013.

 

NOTE 3. FINANCING ARRANGEMENTS

 

We have a credit agreement with Wells Fargo Bank (WFB) which was most recently amended on May 16, 2014 and provides for a line of credit arrangement of $13.5 million that expires, if not renewed, on May 31, 2018.  The credit arrangement also has a $1.8 million real estate term note outstanding with a maturity date of March 31, 2027, an additional $1.7 million real estate term note outstanding that is due, if not renewed, on December 31, 2027, an equipment loan for $1.6 million and a new term loan facility of up to $1.0 million for capital expenditures, both with maturity dates of May 31, 2018.  As of September 30, 2014, we have borrowed $0.3 million against the $1.0 million capital term note.

 

11



Table of Contents

 

Long-term debt at September 30, 2014 and December 31, 2013 consisted of the following:

 

 

 

September 30

 

December 31

 

 

 

2014

 

2013

 

Real Estate Term Loan 1, interest at three month LIBOR + 3.0%, due in installments through March 31, 2027

 

$

1,445,078

 

$

1,533,928

 

Real Estate Term Loan 2, interest at three month LIBOR + 3.0%, due in installments through December 31, 2027

 

1,488,000

 

1,571,700

 

Equipment loan, interest at three month LIBOR + 3.0%, due January 31, 2016

 

126,666

 

197,916

 

Equipment loan, interest at three month LIBOR + 3.0%, due May 31, 2018

 

1,182,356

 

1,135,546

 

Equipment loan, interest at three month LIBOR + 3.0%, due May 31, 2018

 

280,000

 

 

Blue Earth Bond, which bears a variable interest rate, due in installments through June 30, 2021

 

360,000

 

440,000

 

Total debt

 

4,882,100

 

4,879,090

 

Less current maturities

 

737,961

 

632,176

 

Long-term debt

 

$

4,144,139

 

$

4,246,914

 

 

Under the credit agreement, both the line of credit and real estate term notes are subject to variations in the LIBOR rate.  Our line of credit bears interest at three-month LIBOR + 2.5% (approximately 2.75% at September 30, 2014) while our real estate term notes bear interest at three-month LIBOR + 3.0% (approximately 3.25% at September 30, 2014).  The weighted-average interest rate on our line of credit was 2.7% and 2.9% for the three and nine months ended September 30, 2014, respectively.  The weighted-average rate on our real estate term notes was 3.3% and 3.4% for the three and nine months ended September 30, 2014, respectively.  At December 31, 2013, we had borrowing on our line of credit of $7,234,983, included in current debt on the balance sheet.  At September 30, 2014, we had borrowings on our line of credit of $7,831,089.  In the second quarter, the line of credit was extended and reclassified to long-term on our balance sheet to reflect its long-term nature.  The line of credit requires a lock box arrangement; however there are no acceleration clauses that would accelerate the maturity of our outstanding borrowings.

 

The credit agreement contains 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 the line is subject to borrowing base requirements, and advances are at the discretion of the lender.  At September 30, 2014, we have net unused availability under our line of credit of approximately $4.3 million.  The line is secured by substantially all of our assets.

 

NOTE 4.  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, including discrete events, by each tax jurisdiction.  Our effective tax rate for the three months ended September 30, 2014 was 10%, compared with 29% for the three months ended September 30, 2013. The decrease in the

 

12



Table of Contents

 

effective tax rate in the third quarter of 2014 was the result of a favorable return to provision true-up discrete item primarily related to additional research and development credits that were determined when filing the return.  Our effective tax rate for the nine months ended September 30, 2014 was 10% compared with 23% for the nine months ended September 30, 2013.  The decrease in the effective tax rate is primarily due to the favorable return to provision true-up and the audit settlement with Minnesota Department of Revenue which included the acceptance of our research and development credits of $100,000 which were previously reserved for as an uncertain position.

 

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, 2014 and 2013 are as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30

 

September 30

 

 

 

2014

 

2013

 

2014

 

2013

 

Statutory federal tax provision

 

$

129,000

 

$

105,000

 

$

259,000

 

$

245,000

 

State income taxes

 

14,000

 

16,000

 

33,000

 

39,000

 

Income tax credits

 

(19,000

)

(48,000

)

(33,000

)

(151,000

)

Change in uncertain tax positions

 

1,000

 

11,000

 

(99,000

)

33,000

 

Return to provision true-up

 

(84,000

)

 

(84,000

)

 

Other

 

(3,000

)

3,000

 

(3,000

)

(2,000

)

Income tax expense (benefit)

 

$

38,000

 

$

87,000

 

$

73,000

 

$

164,000

 

 

At September 30, 2014, we had $44,000 of net uncertain tax benefit positions remaining in other long-term liabilities related to research and development credits that would reduce our effective income tax rate if recognized.

 

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 engineering 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.  All of the our facilities are certified to one or more of the ISO standards, including 9001 and 13485, with most having additional certifications based on the needs of the customers they serve.

 

13



Table of Contents

 

Summary of Results:

 

Revenue and operating profit for the third quarter of 2014 continued to improve compared to the first two quarters of 2014.  Backlog and pipeline activities also continued to increase, with 90 day backlog ending the quarter 9% up from the beginning of the quarter and 11% over third quarter 2013.  Increased opportunities to our medical customers in Q3 played a large role in the higher revenue and backlog for third quarter.  Industrial customers are showing signs of recovery as the economy improves and the defense customers are adjusting to the decreased demand from budget and program cuts.

 

For the quarter ended September 30, 2014, we reported net sales of $28.0 million compared to $27.4 million reported in the same quarter of 2013.  Increased sales to our medical customers were offset by decreased sales to our aerospace and defense customers.  Industrial sales were flat compared to prior year but with an improving backlog.

 

Our gross profit percentage for the three months ended September 30, 2014 was 12.6% compared to 11.0% for the three months ended September 30, 2013.  Leveraging and plant utilization as well as continued process improvements in the third quarter of 2014 positively impacted gross margin.  Gross profit percentage for the nine months ended September 30, 2014 and 2013 was 12.1% and 11.8%, respectively.

 

Income from operations increased 26% to $473,000 for the three months ended September 30, 2014 versus $376,000 for the three months ended September 30, 2013.  Income from operations increased 9% to $1,057,000 for the nine months ended September 30, 2014 versus $973,000 for the nine months ended September 30, 2013.

 

Net income for the third quarter of 2014 was $332,697 or $0.12 per diluted common share, compared to net income of $217,917 or $0.08 per diluted common share for the same period in 2013.  Net income for the nine months ended September 30, 2014 was $665,555 or $0.24 per diluted common share, while net income from the same period in 2013 totaled $546,226 or $0.20 per diluted common share.

 

Cash provided by operating activities in the first nine months of 2014 was $1.4 million.  Cash provided in the first nine months of 2014 came primarily from profits, noncash addback of depreciation and the timing of payments on our accounts payable, offset by increased inventories to support our backlog increases.  Cash used by operating activities in the first nine months of 2013 was $21,000 due to increased inventories and slower than expected collections on our accounts receivable.

 

14



Table of Contents

 

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

 

 

 

2014

 

2013

 

2014

 

2013

 

Net Sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of Goods Sold

 

87.4

 

89.0

 

87.9

 

88.2

 

Gross Profit

 

12.6

 

11.0

 

12.1

 

11.8

 

 

 

 

 

 

 

 

 

 

 

Selling Expenses

 

4.7

 

4.5

 

4.4

 

4.4

 

General and Administrative Expenses

 

6.2

 

5.1

 

6.4

 

6.2

 

Income from Operations

 

1.7

 

1.4

 

1.3

 

1.2

 

 

 

 

 

 

 

 

 

 

 

Other Expenses, Net

 

(0.4

)

(0.3

)

(0.4

)

(0.3

)

Income Before Income Taxes

 

1.3

 

1.1

 

0.9

 

0.9

 

 

 

 

 

 

 

 

 

 

 

Income Tax Expense

 

0.1

 

0.3

 

0.1

 

0.2

 

Net Income

 

1.2

%

0.8

%

0.8

%

0.7

%

 

Net Sales:

 

We reported net sales of $28.0 million and $27.4 million for the three months ended September 30, 2014 and 2013, respectively.  Net sales for the nine months ended September 30, 2014 and 2013 were $81.6 million and $81.8 million, respectively.  Revenue increases to our medical customers were offset by decreases to our aerospace and defense customers.  Decreases in aerospace and defense revenue resulted from reduced demand from several of our existing customers, some of which were due to delays in government funding.  Defense contract length and size continue to decrease in this post war environment with several large programs eliminated or substantially reduced.

 

Net sales by our major EMS industry markets for the three and nine month periods ended September 30, 2014 and 2013 are as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30

 

September 30

 

 

 

2014

 

2013

 

%

 

2014

 

2013

 

%

 

(in thousands)

 

$

 

$

 

Change

 

$

 

$

 

Change

 

Aerospace and Defense

 

3,656

 

4,693

 

(22

)

11,737

 

14,394

 

(18

)

Medical

 

10,792

 

9,045

 

19

 

30,837

 

24,959

 

24

 

Industrial

 

13,590

 

13,651

 

(0

)

39,021

 

42,412

 

(8

)

Total Sales

 

28,038

 

27,389

 

2

 

81,595

 

81,765

 

(0

)

 

15



Table of Contents

 

Backlog:

 

Our 90-day order backlog as of September 30, 2014 was approximately $20.9 million, a 9% increase compared to approximately $19.2 million at the beginning of the quarter.  Our medical customers backlog has continued to increase.  Aerospace and defense backlog decreased from the prior year due to lower Department of Defense funding and the post war transition. Our industrial customers are beginning to gain traction as the overall economy has been improving.  Our backlog consists of firm purchase orders and we expect a major portion of the current 90 day backlog to be realized as revenue during the following quarter.

 

90 Day backlog by our major EMS industry markets are as follows:

 

 

 

Backlog as of the Quarter Ended

 

 

 

September 30

 

June 30

 

September 30

 

(in thousands)

 

2014

 

2014

 

2013

 

 

 

 

 

 

 

 

 

Aerospace and Defense

 

$

3,690

 

$

3,647

 

$

5,222

 

Medical

 

10,112

 

8,638

 

5,576

 

Industrial

 

7,127

 

6,917

 

7,994

 

Total Backlog

 

$

20,929

 

$

19,202

 

$

18,792

 

 

Our 90 day backlog varies due to order size, manufacturing delays, contract terms and conditions and timing from customer delivery schedules and releases. These variables cause inconsistencies in comparing the backlog from one period to the next.

 

Gross Profit:

 

Gross profit as a percent of net sales for the three months ended September 30, 2014 and 2013 was 12.6% and 11.0%, respectively.  Leveraging and plant utilization and continued process improvements in the third quarter of 2014 positively impacted gross margin.  Gross profit percentage for the nine months ended September 30, 2014 and 2013 was 12.1% and 11.8%, respectively

 

Selling Expense:

 

Our selling expenses were $1.3 million or 4.7% of net sales and $1.2 million or 4.5% of net sales for the three months ended September 30, 2014 and 2013, respectively.  Selling expenses were $3.6 million or 4.4% of net sales for the nine months ended September 30, 2014 and 2013.

 

General and Administrative Expense:

 

Our general and administrative expenses were $1.7 million or 6.2% of net sales and $1.4 million or 5.1% of net sales for the three months ended September 30, 2014 and 2013, respectively.  General and administrative expenses were $5.3 million or 6.4% of net sales and $4.9 million or 6.1% of net sales for the nine months ended September 30, 2014 and 2013, respectively.  The increase is mainly due to infrastructure investments.

 

16



Table of Contents

 

Income Taxes:

 

Our effective tax rate for the nine months ended September 30, 2014 was 10% compared with 23% for the nine months ended September 30, 2013.  The decrease in the effective tax rate is primarily due to the favorable return to provision true-up and the audit settlement with Minnesota Department of Revenue which included the acceptance of our research and development credits of $100,000 which were previously reserved for as an uncertain position.

 

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, 2014 and 2013 are as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30

 

September 30

 

 

 

2014

 

2013

 

2014

 

2013

 

Statutory federal tax provision

 

$

129,000

 

$

105,000

 

$

259,000

 

$

245,000

 

State income taxes

 

14,000

 

16,000

 

33,000

 

39,000

 

Income tax credits

 

(19,000

)

(48,000

)

(33,000

)

(151,000

)

Change in uncertain tax positions

 

1,000

 

11,000

 

(99,000

)

33,000

 

Return to provision true-up

 

(84,000

)

 

(84,000

)

 

Other

 

(3,000

)

3,000

 

(3,000

)

(2,000

)

Income tax expense

 

$

38,000

 

$

87,000

 

$

73,000

 

$

164,000

 

 

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 notes are subject to fluctuations in the LIBOR rates.  The line of credit, real estate term notes, 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, 2014, we had outstanding advances of $7.8 million under the line of credit and unused availability of $4.3 million supported by our borrowing base.  We believe our financing arrangements and cash flows to be provided by operations will be sufficient to satisfy our future working capital needs.  Our working capital was $24.0 million and $15.5 million as of September 30, 2014 and December 31, 2013, respectively.  The increase in working capital relates primarily to the line of credit which was extended in second quarter and reclassified to long term on our balance sheet at September 30, 2014 to reflect its long-term nature.

 

Net cash provided by operating activities for the nine months ended September 30, 2014 was $1.4 million.  Cash provided in the  first nine months of 2014 came primarily from profits,

 

17



Table of Contents

 

noncash addback of depreciation and the timing of payments on our accounts payable, offset by increased inventories to support the increase in our 90 day backlog.

 

Net cash used in investing activities of $1.8 million for the nine months ended September 30, 2014 is comprised of property and equipment purchases to support the business.

 

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, 2013.  There have been no significant changes in these critical accounting policies since December 31, 2013.  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 contracts and other information from outside sources, as appropriate.  Actual results could differ from these estimates.

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). This standard outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service. Transfer of control is not the same as transfer of risks and rewards, as it is considered in current guidance. The Company will also need to apply new guidance to determine whether revenue should be recognized over time or at a point in time.  This standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2016, with no early adoption permitted, using either of two methods: (a) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within ASU 2014-09; or (b) retrospective with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined in ASU 2014-09. The Company has not yet selected a transition method and is currently evaluating the impact of the pending adoption of ASU 2014-09 on the consolidated financial statements.

 

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. 

 

18



Table of Contents

 

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; and

·            Availability of raw material components.

 

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, 2013.

 

ITEM 4.   CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures:

 

In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q, our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act).  Based upon their evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective as of the date of such evaluation in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

19



Table of Contents

 

Changes in Internal Control Over Financial Reporting:

 

There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II

 

ITEM 1.    LEGAL PROCEEDINGS

 

We are subject to various legal proceedings and claims that arise in the ordinary course of business.

 

ITEM 6. EXHIBITS

 

Exhibits

 

31.1

Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.

 

 

31.2

Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.

 

 

32

Certification of the Chief Executive Officer and Chief Financial Officer, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

101

Financial statements from the quarterly report on Form 10-Q for the quarter ended September 30, 2014, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Cash Flows, and (iv) the Condensed Notes to Consolidated Financial Statements.

 

Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Nortech Systems Incorporated and Subsidiary

 

 

 

 

Date: November 5, 2014

by

 /s/ Richard G. Wasielewski

 

 

 

Richard G. Wasielewski

 

Chief Executive Officer and President

 

Nortech Systems Inc.

 

 

 

 

Date: November 5, 2014

by

 /s/ Paula M. Graff

 

 

 

Paula M. Graff

 

Vice President and Chief Financial Officer

 

Nortech Systems Inc.

 

20