TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

PART

ITEM 1. FINANCIAL STATEMENTS

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, 20202021 has been derived from the audited financial statements at that date

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-K for the year ended December 31, 2020.2021. 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-ownedwholly 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.

Stock-Based Awards

Following is the status of all stock options as of June 30, 2021:

Stock Options

In May 2017, the shareholders approved the 2017 Stock Incentive Plan which authorized the issuance of 400,000350,000 shares. ThereAn additional 50,000 and 175,000 shares were additional shares authorized by the shareholders in March 2020 totaling 50,000 and in May 20212022, totaling 75,000.respectively.

We granted 0 and 21,000 market condition options to our Chief Executive Officer during the three and six months ended June 30, 2022, respectively. The market condition options vest if certain stock prices are exceeded between February 27, 2024 and February 27, 2028. We granted 13,000 and 66,000 service-based options during the three and six months ended June 30, 2022, respectively. Total option grants for the three and six months ended June 30, 2022 were 13,000 and 108,000, respectively. There were 3,000 stock options granted during the six months ended June 30, 2021.

Total compensation expense related to stock options was $64 and $106 for the three months ended June 30, 2021 and2020 was $25 and $36, respectively and $46 and $75 for the six months ended June 30, 20212022, respectively. Total compensation expense related to stock options was $25 and $46 for the threeand 2020,six respectively. months ended June 30, 2021. As of June 30, 2021,2022, there was $283$851 of unrecognized compensation which will vest over the next 2.993.90 years.

Following is the status of all stock options as of June 30, 2022:

Restricted Stock Units

During the three and six months ended June 30, 2022, we granted 3,000 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 six months ended June 30, 2022. Total compensation expense related to the RSUs were $29 and $35 for the three and six months ended June 30, 2022, respectively. There was 0 compensation expense related to RSUs for the three and six months ended June 30, 2021. Total unrecognized compensation expense related to the RSUs was $218, which will vest over the next 1.74 years. The RSUs granted in the six months ended June 30, 2022 had an average grant price of $12.00 per share with a weighted average remaining contractual term of 9.73 years. NaN RSUs vested during the six months ended June 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. DuringThere were no units granted during the six months ended June 30, 2022 or June 30, 2021.

The 100,000 units outstanding at December 31, 2021 andwere paid on 2020,March 29, 2022. As of June 30, 2022, there were noare 0 units granted. We recognizedoutstanding. Total compensation expense related to the vested outstanding Units based on the estimated appreciation over their remaining terms was $100 and $114 of compensation expense infor the three and six months ended June 30, 2021, respectively. We had 0 amounts expensed in the comparable periods in 2020.

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. Dilutive 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 six months ended June 30, 2022, stock options of 203,625 and 197,285, respectively were included in the computation of diluted net income per common share as their impact were dilutive. For the three months ended June 30, 2021, stock options of 109,065 were included in the computation of diluted net income per common share amount as their impact were dilutive.share. For the six months ended June 30, 2021, all stock options are deemed to be antidilutive and therefore, were not included in the computation of incomernet income per common share amount. For

We had outstanding stock options totaling 45,878 and RSUs totaling 19,114 that are not considered in the computation of diluted net income per share as their effect would have been anti-dilutive for the three months ended June 30, 2020,2022. allWe had average outstanding stock options are deemed to be antidilutivetotaling 48,895 and therefore, wereRSUs totaling 20,057 that are not includedconsidered in the computation of diluted net income per common share amount. Foras their effect would have been anti-dilutive for the six months ended June 30, 2020,2022. Outstanding stock options of 9,002 were includedtotaling 622 are not considered in the computation of diluted net income per common share amount as their impact was dilutive. for the three months ended June 30, 2021.

Restricted Cash

Cash and cash equivalents classified as restricted cash on our condensed consolidated balance sheets are restricted as to withdrawal or use under the terms of certain contractual agreements. As of June 30, 2022 we had outstanding letters of credit for $400. Restricted cash as of June 30, 2022 was $231. The June 30, 20212022 restricted cash balance included 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. The amounts of tradeTrade accounts receivable have been reduced by an allowance for doubtful accounts of $459$297 at June 30, 20212022 and $343$328 at December 31, 2020.2021.

Inventories Net

Inventories are stated at the lower of average cost ((which approximates first-in, first-out method) 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 June 30, 20212022 and December 31, 20202021 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 asset is 2.0 years. Patents are not being amortized as they are in process and a patent has not yet been received.

and six months ended June 30, 2022 was $35 and $71, respectively. Amortization expense for the three and six months ended June 30, 2021 was $46 and $92, respectively.

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

Reclassification

Certain reclassifications have been made to the prior year’s financial statements to enhance comparability with the current year’s financial statements. As a result, certain line items have been amended in the statement of operations. Comparative figures have been adjusted to conform to the current year’s presentation.

The items were reclassified as follows:

Accounting Pronouncements Issued But Not Yet Adopted

In June 2016, the FASB issued ASU No.2016-13, “Financial Instruments - Credit Losses (ASC 326): Measurement of Credit Losses on Financial Instruments,” which amends theInstruments. This guidance on the impairment of financial instruments. The amendments in this update removes the thresholds that entities apply to measureintroduces a new model for recognizing credit losses on financial instruments measured at amortized cost, such as loans, trade receivables, reinsurance recoverables, off-balance-sheet credit exposures, and held-to-maturity securities. Under current U.S. GAAP, entities generally recognize credit losses when it is probable that the loss has been incurred. The guidance removes all current recognition thresholds and introduces the newbased on an estimate of current expected credit loss (“CECL”) model which will requirelosses. 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 to recognize an allowance for credit losses forthat meet the difference between the amortized cost basisdefinition of a financial instrumentSmaller Reporting Company as defined by the SEC for interim and the amount of amortized cost that an entity expects to collect over the instrument’s contractual life. The new CECL model is based upon expected losses rather than incurred losses. The amendments in this update are effective forannual periods beginning after December 15, 2022;2022. earlyEarly adoption is permitted. We are currently evaluating the impact of this guidance on our financial condition and results of operations.

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. We do not currently have any contracts that have been changed to a new reference rate, but we will continue to evaluate our contracts and the effects of this standard on our condensed consolidated financial statements prior to adoption.and related disclosures.

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 2two financial institutions, 1one in the United States and 1one in China. The account in the United States may at times exceed federally insured limits. Of the $1,253$1,175 in cash and restricted cash at June 30, 2021,2022, approximately $274$691 and $54 was held at banks located in China.China and Mexico, respectively. We grant credit to customers in the normal course of business and do not require collateral on our accounts receivable.

Our largest customer has 2 divisions that together accounted forWe have certain customers whose revenue individually represented 10% or more of our net sales, during theor whose accounts receivable balances individually represented three10% and six months ended June 30, 2021 and 2020.or more of total accounts receivable. One division customer accounted for approximately 23%28% and 24%26% of net sales for the three and six months ended June 30, 2021, respectively, and approximately 20% and 22% for the three and six months ended June 30, 2020,2022, respectively. The other divisionOne customer accounted for approximately 2% and 3% of net sales for the three months and six ended June 30, 2021, respectively, and approximately 3% and 2% of net sales for the three months and six ended June 30, 2020, respectively. Together they accounted for approximately 25% and 27% of net sales for the three and six months ended June 30, 2021, respectively,respectively.

At June 30, 2022, two customers represented approximately 37% of our total accounts receivable. At December 31, 2021, one customer represented approximately 19% of our total accounts receivable.

Export sales represented approximately 4% of net sales for both the three and six months ended June 30, 2022. Export sales represented approximately 23%2% and 24%3% of net sales for the three and six months ended June 30, 2020, respectively. Accounts receivable from the customer at June 30, 2021 and December 31, 2020 represented approximately 19% and 20% of our total accounts receivable, respectively.

Export sales represented approximately 2% and 3% of net sales for the three months ended June 30, 2021 and 2020, respectively. Export sales represented 3% of net sales for the six months ended June 30, 2021 and 2020.

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 82.2%74% of our revenue for both the three and 79.3%six months ended June 30, 2022 and 82% and 79% of our revenue for the three and six months ended June 30, 2021,respectively and for approximately 84.6% and 86.1% of our revenue for the three and six months ended June 30, 2020, respectively. Revenues under these agreements are generally recognized over time using an input measure based upon the proportion of actual costs incurred.

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.

Contract Assets

Contract assets, recorded as such in the Condensed Consolidated Balance Sheet,Sheets, consist of unbilled amounts related to revenue recognized over time. Significant changes in the contract assets balance during the six months ended June 30, 20212022 was as follows (in thousands):

We expect substantially all the remaining performance obligations for the contract assets recorded as of June 30, 2021,2022 to be transferred to receivables within 90 days, with the majority of any remaining amounts to be transferred within 180 days. We bill our customers upon shipment with payment terms of up to 120 days.

The following tables summarize our net sales by market for the three and six months ended June 30 (in thousands):market:

NOTE 4.   FINANCING ARRANGEMENTS

We have a credit agreement with Bank of America which was entered into on June 15, 2017 which was amended five separate occasions on December 29, 2017, August 13, 2019, November 12, 2019, August 27, 2020, and December 1, 2020 and provides for a line of credit arrangement of $16,000 that expires on June 15,2022. The credit arrangement also has a $5,000 real estate term note outstanding with a maturity date of June 15, 2022. The line of credit is classified as current on the balance sheet as of June 30, 2021, however we expect to extend the agreement past June 15, 2022.2026.

Under the amended Bank of America credit agreement both signed December 31, 2021, the line of credit and real estate term notes areis subject to variations in the LIBORBloomberg Short-Term Bank Yield (BSBY) index rate. Our line of credit bears interest at a weighted-average interest rate of 3.4%3.9% and 4.0%3.5% as of June 30, 20212022 and December 31, 2020,2021, respectively. We had borrowings on our line of credit of $7,667$11,410 and $3,328$9,016 outstanding as of June 30, 20212022 and December 31, 2020,2021, respectively. There are no subjective acceleration clauses under the credit agreement that would accelerate the maturity of our outstanding borrowings. The line of credit is shown net of debt issuance costs of $50 and $58 on the consolidated balance sheet for the periods ended June 30, 2022 and December 31, 2021, respectively.

The line of credit and real estate term notes with Bank of America containcontains 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.

The Bank of America Credit Agreement provides for, among other things, a Fixed Charge Coverage Ratio of not less than 1.0 to 1.0 for the twelve months ended December 31, 2020 andat each Fiscal Quarter end thereafter subject only during a trigger period commencing when our availability under our line is less than $2,000 until availability is above that amount for 30 days due to amendment to our agreement dated in December days. As of2020. The Company met the covenants for the period ended June 30, 2021.2022 the Company was in compliance with its covenants.

The availability under the line is subject to borrowing base requirements, and advances are at the discretion of the lender. At June 30, 2021,2022, we had unused availability under our line of credit of $4,523,$4,190 supported by our borrowing base. The line is secured by substantially all of our assets.

On In the April 15, 2020, firstwe entered into the Promissory Note, which provides for an unsecured loan of $6,077 pursuant to the Paycheck Protection Program (“PPP”) under the Coronavirus Aid, Relief, and Economic Security Act and applicable regulations (the “CARES Act”) of which funds were received on April 22, 2020. The Promissory Note has a term quarter of 22022, years with a 1% per annum interest rate. Payments are deferred for 10 months afterwe amended our credit agreement to include the endEmployee Retention Credit Receivable as security in our line of the Promissory Note covered period (which is defined as 24 weeks after the date of the loan) and we can apply for forgiveness of the Promissory Note after 60 days. Forgiveness of the Promissory Note will be determined in accordance with the provisions of the Cares Act and applicable regulations. Any principal and interest amounts outstanding after the determination of amounts forgiven will be repaid on a monthly basis. credit which improved our unused availability.

Long-term debt at June 30, 2021 and December 30, 2020 consisted of following:

NOTE 5.   LEASES

We have operating leases for certain manufacturing sites, office space, and equipment. Most leases include the option to renew, with renewal terms that can extend the lease term from one to five years or more. Right-of-use lease assets and lease liabilities are recognized at the commencement date based on the present value of the remaining lease payments over the lease term which includes renewal periods we are reasonably certain to exercise. Our leases do not contain any material residual value guarantees or material restrictive covenants. At June 30, 2021,2022, we do not have material lease commitments that have not commenced.

The components of lease expense were as follows:

Supplemental balance sheet information related to leases was as follows: