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, 20212022 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-K10-K for the year ended December 31, 2021. 2022. 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).Income. 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

Stock Options

In May 2017, the shareholders approved the 2017 Stock Incentive Plan which authorized the issuance of 350,000 shares. AnSubsequent to this approval, an additional 50,000 and 175,000325,000 shares werehave been authorized by the shareholders in March 2020 shareholders.

We granted 29,000 service-based stock options during the three and May 2022, respectively.six months ended June 30, 2023. The weighted-average grant-date fair value of options granted during the six months ended June 30, 2023 was $5.66. There were no market-based stock options granted during the three and six months ended June 30, 2023.

We granted 0 and 21,000 market conditionmarket-based stock 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

Total compensation expense related to stock options granted duringwas $55 and $123 for the three and six months ended June 30, 2021.

2023, respectively. Total compensation expense related to stock options was $64 and $106 for the three and six months ended June 30, 2022, respectively. Total compensation expense related to stock options was $25 and $46 for the three and six months ended As of June 30, 2021. As of June 30, 2022, 2023, there was $851$632 of unrecognized compensation which will vest over the next 3.90a weighted average period of 3.7 years.

Following is the status of all stock options as of June 30, 2022:2023:

Restricted Stock Units

During the three months and six months ended June 30, 2022, 2023, we granted 3,000 and 21,00018,000 restricted stock units (“RSUs”), respectively, under our 2017 Stock Incentive Plan to non-employee directors which vest over two years. There were noThe RSUs outstanding prior togranted in the three and six months ended June 30, 2022. 2023 had an average grant price of $9.37 per share. Total compensation expense related to the RSUs were $29was $38 and $35$69 for the three and six months ended June 30, 2022, 2023, 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,$195, 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 termperiod of 9.731.4 years. NaN RSUs vested during the six months ended June 30, 2022.

Equity Appreciation Rights Plan

In November 2010, During 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 amendedthree months and restated on March 11, 2015. There were no units granted during the six months ended June 30, 2022, or June 30, 2021.

The 100,000we granted 3,000 and 18,000 restricted stock units, outstanding at December 31, 2021 were paid on March 29, 2022. As of June 30, 2022, there are 0 units outstanding.respectively to non-employee directors which vest over two years. Total compensation expense related to the vested outstanding Units based on the estimated appreciation over their remaining termsRSUs was $100$29 and $114$35 for the three and six months ended June 30, 2021, 2022, respectively.

Following is a status of all RSUs as of June 30, 2023:

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, 2023, stock options of 203,625152,782 and 197,285,182,192, respectively were included in the computation of diluted net income per common share as their impact were dilutive. For the three and six months ended June 30, 2021, 2022, stock options of 109,065203,625 and 197,285, respectively were included in the computation of diluted net income per common share. For the six months ended June 30, 2021, all stock options are deemed to be antidilutive and therefore,share as their impact were not included in the computation of net income per common share amount.dilutive.

We had outstanding stock options totaling 45,87840,550 and RSUs totaling 19,11420,178 that are not included in the computation of diluted net income per share as their effect would have been anti-dilutive for the three months ended June 30, 2023. We had average outstanding stock options totaling 33,034 and RSUs totaling 14,148 that are not considered in the computation of diluted net income per share as their effect would have been anti-dilutive for the threesix months ended June 30, 2022. 2023. We had average outstanding stock options totaling 48,89545,878 and RSUs totaling 20,05719,114 that are not considered in the computation of diluted net income per share as their effect would have been anti-dilutive for the sixthree months ended June 30, 2022. OutstandingWe had average outstanding stock options totaling 62248,895 and RSUs totaling 20,057 that are not considered in the computation of diluted net income per share as their effect would have been anti-dilutive for the threesix months ended June 30, 2021.2022.

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 June 30, 2022 2023, we had outstanding letters of credit for $400.$300. Restricted cash as of June 30, 2022 2023 was $231.$1,134. The June 30, 2023 and December 31, 2022 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. Trade accounts receivable have been reduced by

Allowance for Credit Losses

When we record customer receivables and contract assets arising from revenue transactions, we record an allowance for doubtful accountscredit losses for the current expected credit losses (CECL) inherent in the asset over its expected life. The allowance for credit losses is a valuation account deducted from the cost basis of $297the assets to present their net carrying value at June 30, 2022 and $328 at December 31, 2021.the amount expected to be collected. Each period, the allowance for credit losses is adjusted through earnings to reflect expected credit losses over the remaining lives of the assets.

We estimate expected credit losses based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. When measuring expected credit losses, we pool assets with similar country risk and credit risk characteristics. Changes in the relevant information may significantly affect the estimates of expected credit losses.

Assets are written off when we determine them to be uncollectible. Write-offs are recognized as a deduction from the allowance for credit losses.

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 June 30, 2022 2023 and December 31, 2021 2022 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 assetassets is 2.01.4 years. PatentsOf the patents value at June 30, 2023, $88 arenot being amortized as theyand $110 are in process and a patent has not yet been received.

Amortization expense of finite life intangible assets for the three and six months ended June 30, 2023 was $40 and $80, respectively. Amortization expense of finite life intangible assets for the three 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(not including the patents in process)process of $110) related to these assets is approximately as follows:

Adoption of New Accounting Pronouncements Issued But Not Yet AdoptedStandards

In June 2016, the FASB issued ASU 2016-13, Measurement of2016-13, Financial Instruments – Credit Losses on Financial Instruments. This guidance(Topic 326). The ASU introduces a new model for recognizingcredit loss methodology, Current Expected Credit Losses (CECL), which requires earlier recognition of credit losses, onwhile also providing additional transparency about credit risk.

The CECL methodology utilizes a lifetime “expected credit loss” measurement objective for the recognition of credit losses for loans, held-to-maturity securities and other receivables at the time the financial instruments based on an estimate of currentasses is originated or acquired. The expected credit losses are adjusted each period for changes in expected lifetime credit losses. The ASU also provides updatedmethodology replaces the multiple existing impairment methods in current GAAP, which generally require that a loss be incurred before it is recognized.

On January 1, 2023, we adopted the guidance regardingprospectively with a cumulative adjustment to retained earnings. We have not restated comparative information for 2022 and, therefore, the impairmentcomparative information for 2022 is reported under the old model and is not comparable to the information presented for 2023.

At adoption, we recognized an allowance for credit losses related to accounts receivable and contract assets of available-for-sale debt securities$30, net of tax, and includes additional disclosure requirements. a decrease in retained earnings of $30 associated with the increased estimated credit losses.

Revision and Immaterial Correction of an Error in Previously Issued Financial Statements

The new guidance is effective for public business entities that meetCompany identified an error related to the definitionclassification 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 standardactivity on our line of credit facility with Bank of America at December 31, 2022 as reported on Form 10-K. In our June 30, 2022 condensed consolidated financial statements, we incorrectly classified borrowings and related disclosures.payments on our line of credit facility on a net basis within the financing section of the condensed consolidated cash flow statement; this activity should be shown on a gross basis. This change in presentation to the condensed consolidated cash flow statement does not impact total operating, investing, or financing cash flows. There was no change to the condensed consolidated statement of income or condensed consolidated balance sheet. In accordance with ASC 250, Accounting Changes and Error Corrections, we evaluated the materiality of the errors from quantitative and qualitative perspectives and concluded that the errors were immaterial to the Company’s 2022 audited financial statements. Since these revisions were not material to any prior period financial statements, no amendments to previously filed financial statements are required. Consequently, the Company has corrected these immaterial errors by revising the June 30, 2022 consolidated financial statements presented herein.

The tables below present the effect of the financial statement adjustments related to the revision discussed above of the Company’s previously reported financial statements as of and for the period ended June 30, 2022:

NOTE 2. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash, accounts receivable, and accounts receivable.contract assets. 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 $1,175$1,915 in cash and restricted cash at June 30, 2022, 2023, approximately $691$749 and $54$15 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 totalgross accounts receivable.Two customers accounted for 39% of net sales for both the three and six months ended June 30, 2023. One customer accounted for 28% and 26% of net sales for the three and six months ended June 30, 2022, respectively. One customer accounted for 25% and 27% of net sales for the three and six months ended June 30, 2021, respectively.

At June 30, 2022, 2023, two customers represented approximately 37%38% of our totalgross accounts receivable. At December 31, 2021, 2022, one customer represented approximately 19%21% of our totalgross accounts receivable.

Contract assets for one customer accounted for 18% and 22% of gross contract assets at June 30, 2023 and December 31, 2022, respectively.

Export sales represented approximately 3% for both the three and six months ended June 30, 2023. Export sales represented approximately 4% of net sales for both the three and six months ended June 30, 2022.Export sales represented approximately 2% and 3% of net sales for the three and six months ended June 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. 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. Revenue under contract manufacturing agreements that was recognized over time accounted for approximately 73% and 74% of our revenuenet sales for the three and six months ended June 30, 2023, respectively and 74% of net sales for both the three and six months ended June 30, 2022 and 82% and 79% of our revenue for the three and six months ended June 30, 2021, respectively. Revenues under these agreements are generally recognized over time using an input measure based upon the proportion of actual costs incurred.2022.

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.