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NORTECH SYSTEMS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) 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 2013Statutory 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. |