nsys20220930

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN THOUSANDS)

nsys20220930_10q.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

☒

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

For the quarterly period ended September 30, 2022

☐

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

For the transition period from to

NORTECH SYSTEMS INCORPORATED

Commission file number 0-13257

State of Incorporation: Minnesota

IRS Employer Identification No. 41-1681094

Executive Offices: 7550 Meridian Circle N., Suite # 150, Maple Grove, MN 55369

Telephone number: (952) 345-2244

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $.01 per share	NSYS	NASDAQ Capital Market

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 to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ☐		Accelerated Filer ☐
Non-accelerated Filer☐		Smaller Reporting Company ☒

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Number of shares of $.01 par value common stock outstanding at November 4, 2022 was 2,690,634.

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION
			PAGE
	Item 1 - Financial Statements

		Condensed Consolidated Statements of Operations and Comprehensive Income	3

		Condensed Consolidated Balance Sheets	4

		Condensed Consolidated Statements of Cash Flows	5-6

		Condensed Consolidated Statements of Shareholders’ Equity	7

		Condensed Notes to Consolidated Financial Statements	8-19

	Item 2 - Management's Discussion and Analysis of Financial Condition And Results of Operations		20-26

	Item 3 - Quantitative and Qualitative Disclosures About Market Risk		27

	Item 4 - Controls and Procedures		27

PART II - OTHER INFORMATION

	Item 1 - Legal Proceedings		28

	Item 1A. - Risk Factors		28

	Item 2 - Unregistered Sales of Equity Securities, Use of Proceeds		28

	Item 3 - Defaults on Senior Securities		28

	Item 4 - Mine Safety Disclosures		28

	Item 5 - Other Information		28

	Item 6 - Exhibits		29

SIGNATURES			30

PART I

ITEM 1. FINANCIAL STATEMENTS

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)

	THREE MONTHS ENDED						NINE MONTHS ENDED
	SEPTEMBER 30,						SEPTEMBER 30,
	2022			2021			2022			2021

Net Sales	$	35,276		$	29,452		$	98,505		$	81,706

Cost of Goods Sold		28,948			21,411			83,129			68,519

Gross Profit		6,328			8,041			15,376			13,187

Operating Expenses
Selling Expenses		959			449			2,752			1,741
General and Administrative Expenses		2,949			2,045			8,346			7,247
Research and Development Expenses		475			141			1,154			348
Restructuring Charges		-			23			-			319
Loss on Abandonment of Intangible Assets		-			560			-			560
Gain on Sale of Assets		-			(93	)		(15	)		(176	)

Total Operating Expenses		4,383			3,125			12,237			10,039

Income From Operations		1,945			4,916			3,139			3,148

Other Expense
Interest Expense		(122	)		(112	)		(337	)		(314	)

Income Before Income Taxes		1,823			4,804			2,802			2,834

Income Tax Expense		289			1,247			411			646

Net Income	$	1,534		$	3,557		$	2,391		$	2,188

Net Income Per Common Share:

Basic (in dollars per share)	$	0.57		$	1.33		$	0.89		$	0.82
Weighted Average Number of Common Shares Outstanding - Basic (in shares)		2,686,884			2,665,682			2,683,594			2,662,066

Diluted (in dollars per share)	$	0.53		$	1.24		$	0.83		$	0.78
Weighted Average Number of Common Shares Outstanding - Diluted (in shares)		2,899,526			2,880,073			2,886,073			2,806,958

Other comprehensive income
Foreign currency translation		(365	)		(5	)		(604	)		20
Comprehensive income, net of tax	$	1,169		$	3,552		$	1,787		$	2,208

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

	SEPTEMBER 30,			DECEMBER 31,
	2022				2021⁽¹⁾
	(Unaudited)
ASSETS
Current Assets
Cash	$	1,300		$	643
Restricted Cash		792			1,582
Accounts Receivable, less allowances of $257 and $328		15,497			14,548
Employee Retention Credit Receivable		5,209			5,209
Inventories, Net		23,610			19,434
Contract Assets		9,886			8,698
Prepaid Expenses and Other Current Assets		1,851			1,660
Total Current Assets		58,145			51,774

Property and Equipment, Net		6,457			5,833
Operating Lease Assets		8,079			8,983
Other Intangible Assets, Net		433			501
Total Assets	$	73,114		$	67,091

LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current Portion of Finance Lease Obligations	$	390		$	601
Current Portion of Operating Lease Obligations		1,113			1,043
Accounts Payable		14,701			12,710
Accrued Payroll and Commissions		5,116			4,045
Customer Deposits		3,870			2,936
Other Accrued Liabilities		1,380			971
Total Current Liabilities		26,570			22,306

Long-Term Liabilities
Long Term Line of Credit		9,826			8,959
Long Term Finance Lease Obligations, Net		639			916
Long-Term Operating Lease Obligations, Net		7,797			8,695
Other Long-Term Liabilities		99			104
Total Long-Term Liabilities		18,361			18,674
Total Liabilities		44,931			40,980

Commitments and Contingencies

Shareholders' Equity
Preferred Stock, $1 par value; 1,000,000 Shares Authorized: 250,000 Shares Issued and Outstanding		250			250
Common Stock - $0.01 par value; 9,000,000 Shares Authorized: 2,683,513 and 2,672,064 Shares Issued and Outstanding, respectively		27			27
Additional Paid-In Capital		16,247			15,962
Accumulated Other Comprehensive (Income) Loss		(548	)		56
Retained Earnings		12,207			9,816
Total Shareholders' Equity		28,183			26,111
Total Liabilities and Shareholders' Equity	$	73,114		$	67,091

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

	NINE MONTHS ENDED
	SEPTEMBER 30,
	2022			2021
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income	$	2,391		$	2,188
Adjustments to Reconcile Net Income to Net Cash
Provided By (Used In) Operating Activities:
Depreciation and Amortization		1,440			1,506
Compensation on Stock-Based Awards		234			201
Change in Accounts Receivable Allowance		(71	)		18
Change in Inventory Reserves		(54	)		(959	)
Loss on Abandonment of Intangible Asset		-			560
Gain on Disposal of Property and Equipment		(15	)		(176	)
Changes in Current Operating Items
Accounts Receivable		(1,115	)		1,686
Employee Retention Credit Receivable		-			(5,209	)
Inventories		(4,402	)		(5,755	)
Contract Assets		(1,188	)		(2,246	)
Prepaid Expenses and other Curent Assets		(213	)		(276	)
Income Taxes		(67	)		708
Accounts Payable		1,659			2,901
Accrued Payroll and Commissions		1,071			1,537
Other Accrued Liabilities		1,330			464
Net Cash Provided By (Used In) Operating Activities		1,000			(2,852	)

CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from Sale of Property and Equipment		15			626
Purchase of Intangible Asset		(43	)		(49	)
Purchases of Property and Equipment		(1,687	)		(1,198	)
Net Cash Used In Investing Activities		(1,715	)		(621	)

CASH FLOWS FROM FINANCING ACTIVITIES
Net Change in Line of Credit		857			2,681
Principal Payments on Long-Term Debt		-			(873	)
Principal Payments on Financing Leases		(336	)		(492	)
Debt Issuance Costs		10			-
Stock Option Excercises		51			36
Net Cash Provided By Financing Activities		582			1,352

Net Change in Cash and Cash Equivalents		(133	)		(2,121	)
Cash and Cash Equivalents - Beginning of Period		2,225			3,564
Cash and Cash Equivalents - End of Period	$	2,092		$	1,443

Reconciliation of cash and restricted cash reported within the consolidated balance sheets
Cash	$	1,300		$	444
Restricted Cash		792			999
Total Cash and restricted cash reported in the consolidated statements of cash flows	$	2,092		$	1,443

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

	NINE MONTHS ENDED
	SEPTEMBER 30,
	2022		2021
Supplemental Disclosure of Cash Flow Information:
Cash Paid During the Period for Interest	$	328	$	220
Cash Paid (Refunded) During the Period for Income Taxes		122		(114	)

Supplemental Noncash Investing and Financing Activities:
Property and Equipment Purchases in Accounts Payable		332		-
Property Acquired Under Operating Lease		-		858

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS)

							Accumulated
					Additional		Other
	Preferred		Common		Paid-In		Comprehensive			Retained		Total Shareholders'
	Stock		Stock		Capital		Loss			Earnings		Equity

BALANCE JUNE 30, 2021	$	250	$	27	$	15,862	$	(12	)	$	1,293	$	17,420
Net Income		-		-		-		-			3,557		3,557
Foreign currency translation adjustment		-		-		-		(5	)		-		(5	)
Stock option exercises		-		-		36		-			-		36
Compensation on stock-based awards		-		-		28		-			-		28

BALANCE SEPTEMBER 30, 2021	$	250	$	27	$	15,926	$	(17	)	$	4,850	$	21,036

BALANCE DECEMBER 31, 2020	$	250	$	27	$	15,816	$	(37	)	$	2,662	$	18,718
Net Income		-		-		-		-			2,188		2,188
Foreign currency translation adjustment		-		-		-		20			-		20
Stock option exercises		-		-		36		-			-		36
Compensation on stock-based awards		-		-		74		-			-		74

BALANCE SEPTEMBER 30, 2021	$	250	$	27	$	15,926	$	(17	)	$	4,850	$	21,036

BALANCE JUNE 30, 2022	$	250	$	27	$	16,136	$	(183	)	$	10,673	$	26,903
Net Income		-		-		-		-			1,534		1,534
Foreign currency translation adjustment		-		-		-		(365	)		-		(365	)
Stock option exercises		-		-		18		-			-		18
Compensation on stock-based awards		-		-		93		-			-		93

BALANCE SEPTEMBER 30, 2022	$	250	$	27	$	16,247	$	(548	)	$	12,207	$	28,183

BALANCE DECEMBER 31, 2021	$	250	$	27	$	15,962	$	56		$	9,816	$	26,111
Net Income		-		-		-		-			2,391		2,391
Foreign currency translation adjustment		-		-		-		(604	)		-		(604	)
Stock option exercises		-		-		51		-			-		51
Compensation on stock-based awards		-		-		234		-			-		234

BALANCE SEPTEMBER 30, 2022	$	250	$	27	$	16,247	$	(548	)	$	12,207	$	28,183

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, 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. An additional 50,000 and 175,000 shares were authorized by the shareholders in March 2020 and May 2022, respectively.

We granted 0 and 21,000 market condition options to 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 27,000 stock options granted during the nine months ended September 30, 2021.

Total compensation expense related to stock options was $62 and $168 for the three and nine months ended 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 September 30, 2022, there was $810 of unrecognized compensation which will vest over the next 3.86 years.

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

	Shares			Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in thousands)
Outstanding - January 1, 2022		387,500		$	4.57
Granted		90,000			11.13
Exercised		(19,800	)		3.40
Cancelled		(8,000	)		3.38
Outstanding - September 30, 2022		449,700		$	5.93		7.10	$	2,137
Exercisable - September 30, 2022		213,500		$	3.95		5.90	$	1,407

Restricted Stock Units

During the three and nine months ended 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 nine months ended September 30, 2022. Total compensation expense related to the RSUs were $31 and $66 for the three and nine months ended September 30, 2022, respectively. There was no compensation expense related to RSUs for the three and nine months ended September 30, 2021. Total unrecognized compensation expense related to the RSUs was $186, which will vest over the next 1.49 years. The RSUs granted in the nine months ended September 30, 2022 had an average grant price of $12.00 per share with a weighted average remaining contractual term of 9.48 years. No RSUs vested during the nine months ended 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 nine months ended September 30, 2022 or September 30, 2021.

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

Net Income per Common Share

Basic net income per common share is computed by dividing net income by the weighted-average number of common shares outstanding. Diluted net income 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 September 30, 2022, stock options of 212,643 and 202,479, respectively were included in the computation of diluted net income per common share 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 34,211 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 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 September 30, 2022, we had outstanding letters of credit for $400. Restricted cash as of September 30, 2022 was $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 $257 at September 30, 2022 and $328 at December 31, 2021.

Inventories

Inventories are stated at the lower of average cost (which approximates 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:

	September 30,			December 31,
	2022			2021
Raw Materials	$	22,520		$	18,492
Work in Process		1,719			1,678
Finished Goods		615			562
Reserves		(1,244	)		(1,298	)

Total	$	23,610		$	19,434

Other Intangible Assets

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

	Customer Relationships		Trade Names		Patents		Total
Balance at January 1, 2021	$	507	$	589	$	77	$	1,173
Additions		-		-		64		64
Amortization		147		29		-		176
Abandonment Loss		-		560		-		560
Balance at December 31, 2021		360		-		141		501
Additions		-		-		43		43
Amortization		108		-		3		111
Balance at September 30, 2022	$	252	$	-	$	181	$	433

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 2.1 years. In-process patents are not amortized until the patent is received. At September 30, 2022, patents totaling $96 had been received while $85 of patents were in-process.

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

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

Year	Amount
Remainder of 2022	$	40
2023		159
2024		86
2025		14
Thereafter		49
Total	$	348

Accounting Pronouncements Issued But Not Yet Adopted

In June 2016, the FASB issued ASU 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.

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 $2,092 in cash and restricted cash at September 30, 2022, approximately $561 and $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 28% and 26% of net sales for the three and nine months ended September 30, 2022, respectively. For the three months ended September 30, 2021, 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 September 30, 2022, two customers represented approximately 43% 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 nine months ended September 30, 2022. Export sales represented approximately 3% of net sales for the three and nine months ended September 30, 2021 respectively.

SEC Form 10-Q filed by Nortech Systems Incorporated