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

 

FORM 10-Q

 

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

 

For the Quarterly Period Ended September 30, 2003

 

NORTECH SYSTEMS INCORPORATED

 

Commission file number 0-13257

 

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

 

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

 

Number of shares of $.01 par value common stock outstanding at October 22, 2003: 2,505,487

 

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

 

 

TABLE OF CONTENTS

 

PART I  -  FINANCIAL INFORMATION
Item 1	-			Financial Statements (Unaudited)
				Consolidated Balance Sheets
				Consolidated Statements of Income
				Consolidated Statements of Cash Flows
				Notes to Consolidated Financial Statements
Item 2	-			Management’s Discussion and Analysis of Financial Condition And Results of Operations
Item 3	-			Quantitative and Qualitative Disclosures About Market Risk
Item 4	-			Controls and Procedures
PART II  -  OTHER INFORMATION
Item 4	-	Submission of Matters to a Vote of Security Holders
Item 6	-	Exhibits and Reports on Form 8-K
SIGNATURES
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

 

2

 

PART 1

 

ITEM 1.  FINANCIAL STATEMENTS

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2003 AND DECEMBER 31, 2002

 

		SEPTEMBER 30 2003			DECEMBER 31 2002
		(UNAUDITED)			(AUDITED)
ASSETS
Current Assets
Cash and Cash Equivalents		$	877,900		$	448,751
Accounts Receivable, Less Allowance for Uncollectible Accounts $292,149 and $488,451 Respectively		9,366,926			7,616,093
Inventories:
Finished Goods		2,295,537			2,172,379
Work In Process		1,407,547			1,859,000
Raw Materials		8,961,439			8,288,938
Total Inventories		12,664,523			12,320,317
Prepaid Expenses		501,071			369,252
Income Taxes Receivable		113,200			483,971
Deferred Tax Assets		1,025,000			959,000
Total Current Assets		24,548,620			22,197,384
Property and Equipment
Land		151,800			151,800
Building and Leasehold Improvements		4,808,163			4,671,905
Manufacturing Equipment		6,251,971			5,466,567
Office and Other Equipment		2,801,311			2,743,707
Total Property and Equipment		14,013,245			13,033,979
Accumulated Depreciation		(8,009,315		)	(7,084,565		)
Net Property and Equipment		6,003,930			5,949,414
Other Assets
Deposits		22,058			11,012
Non-Compete, Net of Accumulated Amortization		1,050,045			1,335,584
Goodwill		76,006			76,006
Deferred Tax Assets		119,000			33,000
Total Other Assets		1,267,109			1,455,602
Total Assets		$	31,819,659		$	29,602,400

 

See accompanying Notes to Consolidated Financial Statements

 

3

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2003 AND DECEMBER 31, 2002

 

		SEPTEMBER 30 2003			DECEMBER 31 2002
		(UNAUDITED)			(AUDITED)
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Current Maturities of Notes and Capital Lease Payable		$	1,324,157		$	1,642,179
Checks Written in Excess of Cash		950,000			300,000
Accounts Payable		3,599,966			3,298,474
Accrued Payroll and Commissions		1,529,760			2,119,566
Accrued Health and Dental Claims		268,623			277,864
Other Accrued Liabilities		549,496			243,243
Net Current Liabilities from Discontinued Operations		50,000			50,000
Total Current Liabilities		8,272,002			7,931,326
Long-Term Liabilities
Notes and Capital Lease Payable (Net of Current Maturities)		9,086,922			8,580,944
Total Liabilities		17,358,924			16,512,270
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: 2,505,487 and 2,441,946 Shares Issued and Outstanding at September 30, 2003 and December 31, 2002, Respectively		25,055			24,419
Additional Paid-In Capital		13,473,861			12,873,657
Accumulated Other Comprehensive Loss		(19,225		)	—
Retained Earnings (Accumulated Deficit)		731,044			(57,946		)
Total Shareholders’ Equity		14,460,735			13,090,130
Total Liabilities & Shareholders’ Equity		$	31,819,659		$	29,602,400

 

See accompanying Notes to Consolidated Financial Statements

 

4

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED

SEPTEMBER 30, 2003 AND SEPTEMBER 30, 2002

 

		SEPTEMBER 30 2003			SEPTEMBER 30 2002
		(Unaudited)			(Unaudited)
Net Sales		$	14,060,224		$	14,670,449
Cost of Goods Sold		12,235,996			12,317,278
Gross Profit		1,824,228			2,353,171
Operating Expenses
Selling Expenses		609,834			593,101
General and Administrative Expenses		775,360			723,498
Total Operating Expenses		1,385,194			1,316,599
Income From Operations		439,034			1,036,572
Other Income (Expense)
Interest Income		15,748			3,794
Miscellaneous Income (Expense)		7,265			(21,615		)
Interest Expense		(91,368		)	(96,717		)
Total Other Expense		(68,355		)	(114,538		)
Income From Operations Before
Income Taxes		370,679			922,034
Income Tax Expense (Benefit)		(70,000		)	363,000
Net Income		$	440,679		$	559,034
Earnings Per Share:
Basic		$	0.18		$	0.23
Average Number of Common Shares Outstanding Used for Basic Earnings Per Share		2,477,574			2,410,456
Diluted		$	0.17		$	0.22
Average Number of Common Shares Outstanding Plus Dilutive Common Stock Options		2,525,834			2,518,961

 

See accompanying Notes to Consolidated Financial Statements

 

5

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE NINE MONTHS ENDED

SEPTEMBER 30, 2003 AND SEPTEMBER 30, 2002

 

		SEPTEMBER 30 2003			SEPTEMBER 30 2002
		(Unaudited)			(Unaudited)
Net Sales		$	42,317,494		$	45,277,025
Cost of Goods Sold		37,109,031			37,558,573
Gross Profit		5,208,463			7,718,452
Operating Expenses
Selling Expenses		1,966,410			2,017,352
General and Administrative Expenses		2,242,818			2,494,157
Total Operating Expenses		4,209,228			4,511,509
Income From Operations		999,235			3,206,943
Other Income (Expense)
Interest Income		17,692			11,256
Miscellaneous Income (Expense)		80,049			(63,200		)
Interest Expense		(275,986		)	(328,776		)
Total Other Expense		(178,245		)	(380,720		)
Income From Operations Before
Income Taxes		820,990			2,826,223
Income Tax Expense		32,000			1,114,000
Net Income		$	788,990		$	1,712,223
Earnings Per Share:
Basic		$	0.32		$	0.72
Average Number of Common Shares Outstanding Used for Basic Earnings Per Share		2,469,318			2,390,713
Diluted		$	0.31		$	0.68
Average Number of Common Shares Outstanding Plus Dilutive Common Stock Options		2,516,600			2,514,829

 

See accompanying Notes to Consolidated Financial Statements

 

6

 

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED

SEPTEMBER 30, 2003 AND SEPTEMBER 30, 2002

 

		SEPTEMBER 30 2003			SEPTEMBER 30 2002
		(Unaudited)			(Unaudited)
Cash Flows From Operating Activities
Net Income		$	788,990		$	1,712,223
Adjustments to Reconcile Net Income to Net Cash Provided /(Uses) by Operating Activities:
Depreciation and Amortization		1,211,891			890,909
Deferred Taxes		(152,000		)	(150,000		)
Foreign Currency Transaction Gain		(4,569		)	—
Changes in Current Operating Items:
Accounts Receivable		(1,751,764		)	996,558
Accrued Income Taxes and Income Taxes Receivable		370,771			(594,862		)
Inventories		(344,231		)	(69,418		)
Prepaid Expenses and Deposits		(143,171		)	(106,745		)
Accounts Payable		301,957			(638,910		)
Accrued Payroll and Commissions		(589,678		)	603,516
Other Accrued Liabilities		298,935			758,919
Net Cash Provided (Used) by Operating Activities		(12,869		)	3,402,190
Cash Flows from Investing Activities:
Acquisition of Equipment		(989,616		)	(844,226		)
Purchase of Subsidiary		—			(650,000		)
Net Cash Used by Investing Activities		(989,616		)	(1,494,226		)
Cash Flows from Financing Activities:
Net Change in Line of Credit		1,104,356			(2,897,947		)
Proceeds From Notes Payable		—			4,879,017
Payments on Notes and Capital Lease Payable		(616,400		)	(3,970,432		)
Issuance of Stock		300,840			182,799
Repurchase of Treasury Stock		—			(68,131		)
Checks in Excess of Cash in Bank		650,000			—
Net Cash Provided (Used) by Financing Activities		1,438,796			(1,874,694		)
Effect of Exchange Rate Changes on Cash		(7,162		)	—
Net Increase in Cash and Cash Equivalents		429,149			33,270
Cash and Cash Equivalents - Beginning		448,751			181,730
Cash and Cash Equivalents - Ending		$	877,900		$	215,000

 

The Company has paid interest expense of $279,638 and income taxes of $32,000 for the nine month period ended September 30, 2003 compared to interest expense of $201,904 and income taxes of $1,469,236 for the same period in 2002.

 

7

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1.  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.  However, as disclosed herein, there have been no material changes in the information disclosed in the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.  In the opinion of management, 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 management 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 financial statements, management has made its best estimates and judgements of certain amounts included in the financial statements, giving due consideration to materiality.  Changes in the estimates and assumptions used by management could have a significant impact on the Company’s financial results.  Actual results could differ from those estimates.

 

The operating results of the interim periods presented are not necessarily indicative of the results expected for the full year or for any other interim period.  The accompanying condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2002 included in the Company’s Annual Report Form 10-K for the year ended December 31, 2002 as filed with the Securities and Exchange Commission.

 

Certain reclassifications have been made to the financial statements for the periods presented from amounts previously reported to conform to classifications currently adopted. Such reclassifications had no effect on previously reported shareholders equity or net income.

 

NOTE 2.  PRINCIPLES OF CONSOLIDATION

 

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

 

8

 

NOTE 3.  NEW ACCOUNTING STANDARDS

 

In November 2002, the FASB issued Interpretation No. 45 (FIN 45) “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57 and 107 and a Rescission of FASB Interpretation No. 34”.  FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued.  The Company adopted the disclosure provisions of FIN 45 as of December 31, 2002.  FIN 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligations undertaken.  The initial recognition and measurement provisions of the Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002.  In 2003, the Company adopted the initial recognition and initial measurement provisions of FIN 45.  The Company does not provide guarantees.  As a result, this interpretation has not impacted our financial statements.

 

In May 2003, the FASB issued SFAS 150, “Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity” which establishes standards for how an issuer of financial instruments classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominantly on a fixed monetary amount known at inception, variations in something other than the fair value of the issuer’s equity shares or variations inversely related to changes in the fair value of the issuer’s equity shares. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 has not impacted the Company’s financial position, results of operations or cash flows.

 

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” which addresses consolidation by business enterprises of variable interest entities that either: (1) do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) the equity investors lack an essential characteristic of a controlling financial interest. We do not anticipate that the adoption of FIN 46 will have a material impact on the Company’s financial position, results of operations or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure - An amendment of FASB Statement No. 123.”  The company is choosing to continue with its current practice of applying the recognition and measurement principles of APB No. 25, “Accounting for Stock Issued to Employees.” The company has adopted the disclosure requirements of SFAS No. 148. Pro forma amounts based on the options’ estimated fair value, net of tax, at the grant dates for awards under the Incentive Stock Option Plan for the three and nine month periods ended September 30, 2003 and 2002, are included in Note 5 to the financial statements.

 

In November 2002, the FASB reached a consensus on EITF Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.”  This EITF sets out criteria for whether revenue can be recognized separately from other deliverables in a multiple deliverable arrangement.  The criteria considers whether the delivered item has stand-alone value to the customer, whether the fair value of the delivered item can be reliably determined and the rights of returns for the delivered item.  This EITF is required to be adopted by the Company beginning

 

9

 

July 1,2003.  The adoption of this EITF did not have a material effect on the Company’s consolidated financial statements.

 

 

NOTE 4. LONG TERM DEBT

 

As described in the December 31, 2002 financial statements, repayment of SAE Assembly, LLC (“SAE”) debt will be made through semi-annual installments ending June 2004.  Each installment on the note will be satisfied with the issuance of 31,704 shares of Nortech stock.  Should the average market price of the stock fail to reach or exceed $7.00 during a four-week period of time during each semi-annual period, the Company shall at the buyer’s discretion repurchase the shares in that installment within 30 days at a price of $7.00.  The 31,704 shares required under the second installment were transferred to SAE on June 27, 2003, but were not considered outstanding at June 30, 2003 for purposes of calculating earnings per share, as the four-week period of time had not expired.  On September 19, 2003, the market price of the Company’s stock met the $7.00 four-week requirement, at which time the shares issued to SAE became outstanding.   The impact on earnings per share calculations is not material.  The balance of SAE debt as of September 30, 2003 is $600,000.

 

NOTE 5.  STOCK OPTIONS

 

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

 

		Three Months Ended Sept. 30, 2003			Three Months Ended Sept. 30, 2002			Nine Months Ended Sept 30, 2003			Nine Months Ended Sept. 30, 2002
Net income, as reported		$	440,679		$	559,034		$	788,990		$	1,712,223
Deduct:   Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects		(9,851		)	(13,324		)	(29,554		)	(47,588		)
Proforma net income		$	430,828		$	545,710		$	759,436		$	1,664,635
Earnings per share:
Basic – as reported		$	0.18		$	0.23		$	0.32		$	0.72
Basic – pro forma		$	0.17		$	0.23		$	0.31		$	0.70
Diluted – as reported		$	0.17		$	0.22		$	0.31		$	0.68
Diluted – pro forma		$	0.17		$	0.22		$	0.30		$	0.66

 

10

 

During the nine-month period ended September 30, 2003, the Company granted options to purchase 50,000 shares of common stock, at fair market value, to executives. There were no stock options granted during the nine-month period ended September 30, 2002.

 

NOTE 6. NET INCOME PER COMMON SHARE

 

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

 

		Three Months Ended Sept. 30, 2003			Three Months Ended Sept. 30, 2002			Nine Months Ended Sept 30, 2003			Nine Months Ended Sept 30, 2002
Basic Earnings Per Common Share
Net Income		$	440,679		$	559,034		$	788,990		$	1,712,223
Weighted average common shares outstanding		2,477,574			2,410,456			2,469,318			2,390,713
Basic earnings per common share		$	0.18		$	0.23		$	0.32		$	0.72
Diluted Earnings Per Share
Net Income		$	440,679		$	559,034		$	788,990		$	1,712,223
Weighted average common shares outstanding		2,477,574			2,410,456			2,469,318			2,390,713
Stock options		48,260			108,505			47,282			124,116
Weighted average common shares for diluted earnings per common share		2,525,834			2,518,961			2,516,600			2,514,829
Diluted earnings per common share		$	0.17		$	0.22		$	0.31		$	0.68

 

For the three and nine month periods ended September 30, 2003, 3,759 and 12,954 shares, respectively, were excluded from the computation of diluted earnings per share as these shares were antidilutive.  For the three and nine month periods ended September 30, 2002, there were no antidilutive shares.

 

11

 

NOTE 7. FOREIGN CURRENCY TRANSLATION

 

Local currency is considered the functional currency for the operation outside the United States.  Assets and liabilities are translated at period-end exchange rates.  Income and expense items are translated at average rates of exchange prevailing during the period.  Cumulative translation adjustments, are recorded as a component of accumulated other comprehensive income in stockholders’ equity.

 

 

NOTE 8. COMPREHENSIVE INCOME

 

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

 

		Three Months Ended September 30 2003			Three Months Ended September 30, 2002			Nine Months Ended September 30 2003			Nine Month Ended September 30, 2002
Net Income		$	440,679		$	559,034		$	788,990		$	1,712,223
Other Comprehensive Loss:
Currency Translation Adjustment		—			—			(19,225		)	—
Comprehensive Income		$	440,679		$	559,034		$	769,765		$	1,712,223

 

12

 

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

 

(1.)         Results of Operations:

 

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

 

		Three Months Ended				Nine Months Ended
		Sept. 30, 2003		Sept. 30, 2002		Sept. 30, 2003		Sept. 30, 2002
Net Sales		100	%	100	%	100	%	100	%
Cost of Goods Sold		87	%	84	%	88	%	83	%
Gross Profit		13	%	16	%	12	%	17	%
Selling Expenses		4	%	4	%	5	%	4	%
General and Administrative Expenses		6	%	5	%	5	%	6	%
Income from Operations		3	%	7	%	2	%	7	%
Other Expenses, Net		0	%	1	%	0	%	1	%
Income Tax Expense		0	%	2	%	0	%	2	%
Net Income		3	%	4	%	2	%	4	%

 

 

Net Sales:

The Company had net sales of $14,060,224 compared to net sales of $14,670,449 for the three months ended September 30, 2003 and 2002, respectively.  For the nine months ended September 30, 2003 and 2002, the Company had net sales of $42,317,494 compared to net sales of $45,277,025, respectively.  The decreases in net sales are due to three main factors, order delays from a major customer,  general economic softness and pressure from offshore competitors.  These conditions mainly affected the Company’s commercial wire harness and cable products, which is particularly vulnerable in the short run to customer push-outs and order delays. As the economy improves the company expects these conditions to improve during the balance of the year.

 

Gross Profit:

The Company had gross profit of $1,824,228 or 13% compared to gross profit of $2,353,171 or 16% for the three months ended September 30, 2003 and 2002, respectively. The Company had gross profit of $5,208,463 or 12% compared to $7,718,452 or 17% for the nine months ended September 30, 2003 and 2002, respectively. These decreases reflect the reduced volume of business as stated above.  Since the Company has elected to keep its overhead infrastructure intact, the Company’s margins are affected in the short term accordingly.  While the Company believes in long-term benefits of having a low-cost manufacturing site in Mexico, start up costs and lower than anticipated volume have negatively impacted gross profit margins.

 

13

 

Selling Expense:

The Company’s selling expenses are $609,834 and $593,101 for the three months ended September 30, 2003 and 2002, respectively.  The Company’s selling expenses are $1,966,410 and $2,017,352 for the nine months ended September 30, 2003 and 2002, respectively.  Selling expense decreases are mainly the result of a smaller revenue base under which sales commissions are incurred.

 

General and Administrative Expense:

The Company’s general and administrative expenses are $775,360 and $723,498 for the three months ended September 30, 2003 and 2002, respectively.  The Company’s general and administrative expenses are $2,242,818 and $2,494,157 for the nine-month periods ended September 30, 2003 and 2002, respectively.  The overall reduction of general and administrative expenses through the first nine months of 2003 is due to lower head-count and related compensation as well as recovery approximately $100,000 of an account receivable account that had previously been written off.

 

Other Income and Expense:

Other Income and expenses are $68,355 for three months ended September 30, 2003 compared to $114,538 for the three months ended September 30, 2002. Other expense was $178,245 and $380,720 for the nine months ended September 30, 2003 and 2002, respectively.  The reductions in other expenses are primarily twofold.  First, the Company is benefiting from more favorable lending rates on its variable interest rate borrowings.  Second, the Company had improved other income from tooling sales and commission income.

 

Income Tax:

The Company recorded an income tax benefit for the three months ended September 30, 2003 of $70,000 compared to income tax expense of $363,000 for the three months ended September 30, 2002.  The Company recorded income tax expense for the nine months ended September 30, 2002 of $32,000 compared to $1,114,000 for the nine months ended September 30, 2002.

 

During the three and nine-months ended September 30, 2003, the Company recorded $213,000 and $278,000, respectively, of benefit for refunds received on  claims relating to federal and state research and development tax credits for tax years 1999, 2000 and 2001.  A reconciliation of income tax expense (benefit) for 2003 is as follows:

 

		Three Months Ended September 30, 2003			Nine Months Ended September 30, 2003
Income Before Tax		$	370,679		$	820,990
Normal Effective Tax Rate		38.5		%	37.8		%
Expected Tax Expense		143,000			310,000
R & D Credits and Other		(213,000		)	(278,000		)
Income Tax Expense (Benefit)		$	(70,000	)	$	32,000

 

Backlog:

The Company’s 90-day order backlog was approximately $11,800,000 as of September 30, 2003, compared with approximately $10,800,000 at the beginning of the quarter.  Based on the current conditions, the Company anticipates revenue levels in the fourth quarter of 2003 to be slightly higher than third quarter of 2003.

 

14

 

(2.) Liquidity and Capital Resources

 

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

 

		September 30, 2003			December 31, 2002			December 31, 2001			December 31, 2000
Current Ratio		2.97			2.80			2.59			1.77
(Current Assets / Current Liabilities)
Working Capital		$	16,276,618		$	14,266,058		$	14,459,344		$	9,633,539
(Current Assets – Current Liabilities)
Quick Ratio		1.24			1.02			1.02			0.73
(Cash + Accounts Receivable / Current Liabilities)
Accounts Receivable to Working Capital		0.52			0.59			0.61			0.73
(Average Accounts Receivable/ Working Capital)
Inventory to Working Capital		0.77			0.87			0.83			1.05
(Average Inventory/ Working Capital)

 

 

Cash flows provided by / (used for):
Operating Activities		$	(12,869	)	$	2,880,099		$	1,049,870		$	855,040
Investing Activities		(989,616		)	(1,729,040		)	(711,968		)	(493,123		)
Financing Activities		1,438,796			(884,038		)	(684,170		)	(287,419		)
Effect of exchange rate changes on cash		(7,162		)	—			—			—
Net (decrease) / increase in cash and cash equivalents		$	429,149		$	267,021		$	346,268		$	74,498

 

Overall, the improvement of the above liquidity ratios and the decrease in operating cash flow in 2003 relate primarily to extension of payment terms for one major customer, the effect of which has increased current accounts receivables and any resulting cash borrowing needs are made on a long-term basis, which has improved the liquidity of the Company.

 

The Company’s working capital increased to $16,276,618 at the close of third quarter 2003, compared to $14,266,058 as of December 31, 2003.  The Company believes that its financial liquidity will improve during the balance of 2003 and expects that its operating cash flow and available credit facilities will be sufficient to fund the expected growth in the next twelve months.

 

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3.) Critical Accounting Policies

 

Revenue Recognition:

Revenue from sales of products is recognized at the time product is shipped to the customer, at which time title and risk of ownership transfer to the purchaser.

 

Allowance for Uncollectible Accounts:

We evaluate our allowance for doubtful accounts on a quarterly basis and review any significant customers with delinquent balances to determine future collectibility.  We base our determinations on legal issues (such as bankruptcy status), past history, current financial and credit agency reports, and experience.  We reserve accounts deemed to be uncollectible in the quarter in which we make the determination.  We maintain additional reserves based on our historical based debt experience.  Changes in these factors could result in significant adjustments to all allowances.

 

Inventory Reserves:

Inventory reserves are maintained for the estimated value of the inventory that may have a lower value than stated or in excess of production needs.  These values are estimates and may differ from actual results.  The Company has an evaluation process that is used to assess the value of the inventory that is slow moving, excess or obsolete.  This process is reviewed quarterly.

 

Deferred Tax Valuation:

At December 31, 2002 and September 30, 2003, the Company has recorded U.S. deferred tax assets pertaining to the recognition of future deductible temporary differences.  The Company has not provided any valuation allowance with respect to these assets, as it believes its realization is “more likely than not.”  This determination is primarily based upon our expectation that future U.S. operations will be sufficiently profitable, as well as various tax, business and other planning strategies available to the Company.  We cannot assure you that we will be able to realize this asset or that future valuation allowances will not be required.  The failure to utilize this asset would adversely affect our results of operations and financial position.

 

Long-Lived and Intangible Asset Impairment:

The Company evaluates long-lived assets and intangible assets with definite lives for impairment, as well as the related amortization periods, to determine whether adjustments to these amounts or useful lives are required based on current events and circumstances.  The evaluation is based on the Company’s 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 is recorded to reduce the carrying amount to equal estimated fair value.

 

The test for impairment requires the Company to make several estimates about fair value, most of which are based on projected future cash flows.  The estimates associated with the asset impairment tests are considered critical due to the judgments required in determining fair value amounts, including projected future cash flows. Changes in these estimates may result in the recognition of an impairment loss.

 

Based on a critical assessment of its accounting policies and the underlying judgments and uncertainties affecting the application of those policies, management believes that the Company’s consolidated financial statements provide a meaningful and fair perspective of the Company.  This is not to suggest that other general risk factors, such as changes in worldwide economic conditions, fluctuations in foreign currency exchange rates, changes in materials costs,

 

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performance of acquired businesses and others, could not adversely impact the Company’s consolidated financial position, results of operations and cash flows in future periods.

 

 

(4.) 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 Nortech Systems, Inc. believes these forward-looking statements are reasonable, they are based upon a number of assumptions concerning future conditions, any or all of which may ultimately prove to be inaccurate.  Forward-looking statements involve a number of risks and uncertainties.  Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation:

 

•                  Volatility in the marketplace which may affect market supply and demand the Company’s products;

•                  Increased competition;

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

•                  Risks related to availability of labor;

•                  General economic, financial and business conditions that could affect the Company’s financial condition and results of operations.

 

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 the Company.  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.  The Company undertakes no obligations to update publicly any forward-looking statement (or its associated cautionary language) whether as a result of new information or future events.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

There have been no material changes in market risk from what was reported on Form 10-K for the year ended December 31, 2002.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of September 30, 2003. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the

 

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Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations and are operating in an effective manner.

 

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during the fiscal quarter ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8K

 

(a)            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.

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

 

(b)           Reports on Form 8-K

 

On July 29, 2003, we furnished a Current Report on Form 8-K dated July 29, 2003 under Item 9 containing a copy of our earnings release for the period ended June 30, 2003 pursuant to Item 12 (Results of Operations and Financial Condition).

 

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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 13, 2003			By		/s/ Michael J. Degen
			Michael J. Degen
			President and Chief
			Executive Officer
Date: November 13, 2003			By		/s/ Garry M. Anderly
			Garry M. Anderly
			Principal Financial
			Officer and Principal
			Accounting Officer

 

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