PART I

ITEM 1. FINANCIAL STATEMENTS

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES  

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(UNAUDITED)

(IN THOUSANDS, EXCEPT SHARE DATA)

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

⁽¹⁾ The condensed consolidated balance sheet at December 31, 2021 has been derived from the audited financial statements at that date

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN THOUSANDS)

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited condensed 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 condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K10-K for the year ended December 31, 2021. 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 condensed consolidated financial statements, we have made our best estimates and judgments of certain amounts included in the condensed 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 condensed consolidated financial statements include the accounts of Nortech Systems Incorporated and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Revenue Recognition

Our revenue is comprised of product, engineering services and repair services. All revenue is recognized when the Company satisfies its performance obligation(s) under the contract by transferring the promised product or service to our customer either when (or as) our customer obtains control of the product or service, with the majority of our revenue being recognized over time including goods produced under contract manufacturing agreements and services revenue. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. A contract’s transaction price is allocated to each distinct performance obligation. The majority of our contracts have a single performance obligation. Revenue is recorded net of returns, allowances and customer discounts. Our net sales for services were less than 10% of our total sales for all periods presented, and accordingly, are included in net sales in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). Sales, value add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenues) basis. 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. Customer deposits represent cash received in advance of revenue earned.

Stock-Based Awards

Stock Options

In May 2017, the shareholders approved the 2017 Stock Incentive Plan which authorized the issuance of 350,000 shares. ThereAn additional 50,000 and 175,000 shares were additional shares authorized by the shareholders in March 2020 totaling 50,000. Since the last shareholders’ meeting, the Board of Directors has approved and is seeking shareholder approval of an additional 75,000 shares to be authorized under the plan.May 2022, respectively.

We granted 21,000 service-based options0 and 21,000 market condition options to Jay Miller per his employment agreement signed February 27, 2022. our Chief Executive Officer during the three and nine months ended September 30, 2022, respectively. The market condition options vest if certain stock prices are exceeded between February 27, 2024 and February 27, 2028. We granted 3,000 and 69,000 service-based options during the three and nine months ended September 30, 2022, respectively. Total option grants for the three and nine months ended September 30, 2022 were 3,000 and 90,000, respectively. There were an additional 32,000 employee grants during the three months ended March 31, 2022, for a total of 74,00027,000 stock options granted during the threenine months ended March 31, 2022. There were 0 options granted during the three months ended March 31,September 30, 2021.

Total compensation expense related to stock options was $43$62 and $21$168 for the three and nine months ended March 31,September 30, 2022, respectively. Total compensation expense related to stock options was $28 and $74 for the three and nine months ended September 30, 2021, respectively. As of March 31,September 30, 2022, there was $816$810 of unrecognized compensation which will vest over the next 3.963.86 years.

Following is the status of all stock options as of March 31,September 30, 2022:

Restricted Stock Units

During the three and nine months ended March 31,September 30, 2022, we granted 0 and 21,000 restricted stock units (“RSUs”), respectively, under our 2017 Stock Incentive Plan to non-employee directors which vest over two years. There were no RSUs outstanding prior to the threenine months ended March 31,September 30, 2022. Total compensation expense related to the RSUs were $5$31 and $0$66 for the three and nine months ended March 31,September 30, 2022, respectively. There was no compensation expense related to RSUs for the three and 2021, respectively.nine months ended September 30, 2021. Total unrecognized compensation expense related to the RSUs was $243,$186, which will vest over the next 1.961.49 years. The RSUs granted in the threenine months ended March 31,September 30, 2022 had aan average grant price of $11.80$12.00 per share with a weighted average remaining contractual term of 9.969.48 years. NaNNo RSUs vested during the threenine months ended March 31,September 30, 2022.

Equity Appreciation Rights Plan

In November 2010, the Board of Directors adopted the Nortech Systems Incorporated Equity Appreciation Rights Plan (“(“2010 Plan”). The total number of Equity Appreciation Right Units (“Units”) that can be issued under the 2010 Plan shall not exceed an aggregate of 1,000,000 Units as amended and restated on March 11, 2015. There were no units granted during the threenine months ended March 31,September 30, 2022 or March 31,September 30, 2021.

The 100,000 units outstanding at December 31, 2021 were paid on March 29, 2022. AsThere are no units outstanding as of March 31, 2022, there are 0 units outstanding.September 30, 2022. Total compensation expense related to the vested outstanding Units based on the estimated appreciation over their remaining terms was $0$13 and $143$127 for the three and nine months ended March 31, 2022 and September 30, 2021, respectively.

Net Income (Loss) per Common Share

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding. DilutiveDiluted net income (loss) per common share assumes the exercise and issuance of all potential common stock equivalents in computing the weighted-average number of common shares outstanding, unless their effect is antidilutive. All stock options and restricted stock units, while outstanding, are considered common stock equivalents.

For the three and nine months ended March 31,September 30, 2022,there were 191,170 diluted shares with $0.02 earnings per diluted share. For the three months ended March 31, 2021, all stock options were deemed to be antidilutive as there was a net lossof 212,643 and therefore,202,479, respectively werenot included in the computation of diluted net income per common share amount.as their impact were dilutive. For the three and nine months ended September 30, 2021, stock options of 214,391 and 144,892, respectively, were included in the computation of diluted income per common share amount as their impact were dilutive.

We had outstanding stock options totaling 51,911 and RSUs totaling 21,00034,211 that are not considered in the computation of diluted net income (loss) per share as their effect would have been anti-dilutive for the three months ended March 31,September 30, 2022. We had average outstanding stock options totaling 44,070 that are not considered in the computation of diluted net income per share as their effect would have been anti-dilutive for the nine months ended September 30, 2022. Outstanding stock options totaling 0 and 221 are not considered in the computation of diluted net income per share for the three and nine months ended September 30, 2021, respectively.

Restricted Cash

Cash and cash equivalents classified as restricted cash on our consolidated balance sheets are restricted as to withdrawal or use under the terms of certain contractual agreements. As of March 31,September 30, 2022, we had outstanding letters of credit for $400 in total to Essjay Bemidji Holdings, LLC and Essjay Mankato Holdings, LLC.$400. Restricted cash as of March 31,September 30, 2022 was $776. The March 31, 2022 restricted cash balance included$792, which includes lockbox deposits that are temporarily restricted due to timing at the period end. The lockbox deposits are applied against our line of credit the next business day.

Accounts Receivable and Allowance for Doubtful Accounts

Credit is extended based upon an evaluation of the customer’s financial condition and, while collateral is not required, the Company periodically receives surety bonds that guarantee payment. Credit terms are consistent with industry standards and practices. Trade accounts receivable have been reduced by an allowance for doubtful accounts of $366$257 at March 31,September 30, 2022 and $328 at December 31, 2021.

Inventories

Inventories are stated at the lower of average cost (which approximates first-in, first-in, first out) 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.

Inventories are as follows:

Other Intangible Assets

Other intangible assets at March 31,September 30, 2022 and December 31, 2021 are as follows:

Intangible assets are amortized on a straight-line basis over their estimated useful lives. The weighted-average remaining amortization period of our in-use intangible assetsasset is 2.52.1 years. PatentsIn-process patents are not being amortized as they are in process and auntil the patent has not yetis received. At September 30, 2022, patents totaling $96 had been received.received while $85 of patents were in-process.

Amortization expense of finite life intangible assets for the three and nine months ended March 31,September 30, 2022 was $40 and $111, respectively. Amortization expense for the three and nine months ended September 30, 2021 was $36$45 and $46,$139, respectively.

Estimated future annual amortization expense (not(not including the patents in process) related to these assets is approximately as follows:

Accounting Pronouncements Issued But Not Yet Adopted

In June 2016, the FASB issued ASU 2016-13,2016-13, Measurement of Credit Losses on Financial Instruments. This guidance introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The ASU also provides updated guidance regarding the impairment of available-for-sale debt securities and includes additional disclosure requirements. The new guidance is effective for public business entities that meet the definition of a Smaller Reporting Company as defined by the SEC for interim and annual periods beginning after December 15, 2022. Early adoption is permitted. We are currently evaluating the impact of this standard on our consolidated financial statements and related disclosures.

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform. ASU 2020-04 provides optional guidance for a limited period of time to ease potential accounting impact associated with transitioning away from reference rates that are expected to be discontinued, such as LIBOR. The amendments in this ASU apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued. The amendments in ASU 2020-04 can be adopted as of March 12, 2020 and are effective through December 31, 2022. Our line of credit agreement with Bank of America was amended on December 31, 2021 to reference the Bloomberg Short-Term Bank Yield Index (BSBY) rather than LIBOR. We do not anticipate a material impact on our consolidated financial statements related to the change in index. We do not have additional material agreements that will be impacted by a change in reference rate.

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 primarily two financial institutions, one in the United States and one in China. The account in the United States may at times exceed federally insured limits. Of the $1,617$2,092 in cash and restricted cash at March 31,September 30, 2022, approximately $769$561 and $63$11 was held at banks located in China and Mexico, respectively. We grant credit to customers in the normal course of business and do not require collateral on our accounts receivable.

We have certain customers whose revenue individually represented 10% or more of net sales, or whose accounts receivable balances individually represented 10% or more of total accounts receivable. One customer accounted for 23%28% and 29%26% of net sales for the three and nine months ended March 31,September 30, 2022, and respectively. For the three months ended September 30, 2021, respectively.two customers accounted for 36% of net sales. For the nine months ended September 30, 2021, one customer accounted for 26% of net sales.

At March 31,September 30, 2022, two customers represented approximately 35%43% of our total accounts receivable. At December 31, 2021, one customer represented approximately 19% of our total accounts receivable.

Export sales represented approximately 5% and 4% of net sales for both the three and nine months ended March 31, 2022 September 30, 2022. Export sales represented approximately 3% of net sales for the three and nine months ended September 30, 2021 respectively.

NOTE 3. REVENUE

Revenue recognition

Our revenue is comprised of product, engineering services and repair services. All revenue is recognized when the Company satisfies its performance obligation(s) under the contract by transferring the promised product or service to our customer either when (or as) our customer obtains control of the product or service, with the majority of our revenue being recognized over time including goods produced under contract manufacturing agreements and services revenue. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. A contract’s transaction price is allocated to each distinct performance obligation. The majority of our contracts have a single performance obligation, as the promise to transfer products or services is not separately identifiable from other promises in the contract and, therefore, not distinct.

Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or providing services. As such, revenue is recorded net of returns, allowances and customer discounts. Sales, value add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenues) basis. Shipping and handling costs are included in cost of goods sold.

The majority of our revenue is derived from the transfer of goods produced under contract manufacturing agreements which have no alternative use and we have an enforceable right to payment for our performance completed to date. Our performance obligations within our contract manufacturing agreements are generally satisfied over time as the goods are produced based on customer specifications and we have an enforceable right to payment for the goods produced. If these requirements are not met, the revenue is recognized at a point in time, generally upon shipment. Revenue under contract manufacturing agreements that was recognized over time accounted for approximately 73%74% of our revenue for both the three and 75%nine months ended September 30, 2022 and 82% and 80% of our revenue for the three and nine months ended March 31, 2022 and September 30, 2021, respectively. Revenues under these agreements are generally recognized over time using an input measure based upon the proportion of actual costs incurred. If these requirements are not met, the revenue is recognized at a point in time, generally upon shipment.

Accounting for contract manufacturing agreements involves the use of various techniques to estimate total revenue and costs. We estimate profit on these agreements as the difference between total estimated revenue and expected costs to complete the performance obligation within the terms of the agreement and recognize the respective profit as the goods are produced. The estimates to determine the profit earned on the performance obligation are based on anticipated selling prices and historical cost of goods sold and represent our best judgement at the time. Changes in judgements on these above estimates could impact the timing and amount of revenue recognized with a resulting impact on the timing and amount of associated profit.

On occasion our customers provide materials to be used in the manufacturing process and the fair value of the materials is included in revenue as noncash consideration at the point in time when the manufacturing process commences along with the same corresponding amount recorded as cost of goods sold. The inclusion of noncash consideration has no impact on overall profitability.