What changed in this filing

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Item 8. Financial Statements and Supplementary Data

2021-03-23 compared with 2020-03-19 · 240 added, 206 removed, 519 unchanged (46% of the section changed)

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Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Nortech Systems Incorporated and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity and cash flows, for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”).

We have audited the accompanying consolidated balance sheets of Nortech Systems Incorporated and subsidiaries (the "Company") as of December 31, 2020 and 2019, and the related consolidated statements of operations and comprehensive income (loss), shareholders' equity, and cash flows, for the years then ended, and the related notes (collectively referred to as the "consolidated financial statements").

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Adoption of New Accounting Standard

As discussed in Notes 1 and 5 to the consolidated financial statements, the Company has changed its method of accounting for operating leases as of January 1, 2019 due to the adoption of ASU 2016-02, Leases (Topic 842).

Basis for Opinion

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We conducted our audits in accordance with the standards of the PCAOB.

Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.

Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.

The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.

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Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.

Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements.

Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks.

Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements.

Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that our audits provide a reasonable basis for our opinion.

/s/ Baker Tilly Virchow Krause, LLP

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that:

(1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments.

The communication of this critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Critical Audit Matter Description

Goodwill Impairment Evaluation – Refer to Notes 1 and 4 to the consolidated financial statements

As discussed in Note 1 and Note 4 to the consolidated financial statements, goodwill is tested for impairment on the basis of the Company’s single reporting unit at least annually, or more frequently as events occur or circumstances change.

On October 1, 2020, the Company performed its annual quantitative impairment test and recorded an impairment charge of $2,375,000.

In connection with the quantitative impairment test, the Company reassessed its reporting units and concluded the Company, as a whole, is a single reporting unit.

The Company views its operations and manages its business as one operating segment since the restructuring of Devicix in 2020.

Prior to 2020, the Company had two reporting units, the Electronic Manufacturing Services and Devicix reporting units.

In performing the impairment test, management’s third-party valuation specialist calculated the fair value of the reporting unit using a market approach and a discounted cash flow approach to determine the estimated fair value of the Company.

The Company placed a 100% weighting on the discounted cash flow method, as they determined the results of the market approach were not representative of the Company, as there were no peer companies comparable to the Company in terms of size, profitability and product diversification.

Management concluded goodwill was fully impaired as the difference between the carrying value and fair value of the reporting unit was more than the amount of goodwill recorded.

Auditing management's goodwill impairment test was complex and highly judgmental due to the significant estimation required in the reassessment of the Company’s reporting unit and in the estimation of the fair value of the Company’s single reporting unit.

In particular, the fair value estimate was sensitive to significant assumptions, such as changes in the Company's financial forecast, the discount rate, risk-free rate, weighted-average cost of capital, equity risk premium and terminal growth rate, which are affected by expectations about future market or economic conditions, including uncertainty resulting from the COVID-19 pandemic.

How the Critical Audit Matter was Addressed in the Audit

The primary procedures we performed to address this critical audit matter included:

Obtained an understanding of the design and implementation of internal controls relating to the evaluation of the assumptions and inputs used to estimate the fair value of the Company's single reporting unit, including controls addressing:

Management’s review of the accuracy and reasonableness of the prospective financial information used in the discounted cash flow analysis.

Management’s evaluation and controls over identifying the single reporting unit.

Management's evaluation of the key assumptions and inputs used by a third-party valuation specialist, including discount rate, risk-free rate, weighted-average cost of capital, equity risk premium and terminal growth rate used to determine fair value.

Management’s controls over the completeness and accuracy of the data and assumptions used.

Substantively testing, with the assistance of firm personnel with experience in the application of fair value and valuation methodologies, the appropriateness of the judgments and assumptions used in management’s estimation process for determining the fair value of the Company's single reporting unit including:

Testing the mathematical accuracy of the calculations performed along with assessing the completeness of the information used in the calculation.

Evaluating the appropriateness of the valuation methodologies used, as well as the discount rate, risk-free rate, weighted-average cost of capital, equity risk premium, terminal growth rate, and overall reasonableness of the fair value calculation.

Comparing the significant assumptions used by management to current industry and economic trends, current and historical performance of the Company, and other relevant factors.

Compared the fair value of the reporting unit to the Company's enterprise value to coooborate a full impairment was appropriate.

/s/ Baker Tilly US, LLP

We have served as the Company's auditor since 2017.

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General and Administrative Expenses

Impairment of Goodwill

Gain on Sale of Property and Equipment

Total Operating Expenses

Income From Operations

(Loss) Income From Operations

Other Expense

Interest Expense

(Loss) Income Before Income Taxes

Loss Before Income Taxes

Income Tax Expense

Net (Loss) Income

(Loss) Earnings Per Common Share:

Loss Per Common Share:

Weighted Average Number of Common Shares Outstanding - Basic

Weighted Average Number of Common Shares Outstanding - Dilutive

Other comprehensive (loss) income

Other comprehensive income (loss)

Foreign currency translation

Comprehensive (loss) income, net of tax

See accompanying n otes to Consolidated Statement of Operations and comprehensive Income (Loss)

Comprehensive loss, net of tax

See accompanying notes to consolidated financial statements

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018

CONSOLIDATED BALANCE SHEET

AS OF DECEMBER 31, 2020 AND 2019

(IN THOUSANDS, EXCEPT SHARE DATA)

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Accounts Receivable, less allowances of $343 and $335

Inventories, net

Contract Assets

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Other Intangible Assets, Net

Other Non Current Assets

LIABILITIES AND SHAREHOLDERS' EQUITY

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Total Liabilities and Shareholders' Equity

See accompanying notes to Consolidated Statement of Operations and comprehensive Income (Loss)

See accompanying notes to consolidated financial statements

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

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CASH FLOWS FROM OPERATING ACTIVITIES

Net Income (Loss)

Adjustments to Reconcile Net Income (Loss) to Net Cash

Adjustments to Reconcile Net Loss to Net Cash

Provided by Operating Activities:

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Compensation on Equity Appreciation Rights

Loss on Goodwill Impairment

Deferred Taxes

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Change in Inventory Reserves

Loss on Disposal of Property and Equipment

(Gain) loss on Disposal of Property and Equipment

Changes in Current Operating Items

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Purchases of Property and Equipment

Net Cash Used in Investing Activities

Net Cash Provided by (Used in) Investing Activities

CASH FLOWS FROM FINANCING ACTIVITIES

Net Change in Line of Credit

Proceeds from Long-Term Debt

Principal Payments on Long-Term Debt

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Property and Equipment Purchases in Accounts Payable

Equipment Acquired under Capital Lease

See accompanying notes to Consolidated Statement of Operations and comprehensive Income (Loss)

Property Acquired under Operating Lease

Equipment Acquired under Finance Lease

See accompanying notes to consolidated financial statements

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019

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BALANCE DECEMBER 31, 2018

Cumulative Adjustment

Foreign Currency Translation Adjustment

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Compensation on stock-based awards

Share repurchases

BALANCE DECEMBER 31, 2020

See accompanying notes to Consolidated Statement of Operations and comprehensive Income (Loss)

See accompanying notes to consolidated financial statements

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

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Basis of Presentation

The accompanying consolidated financial statements of Nortech Systems, Incorporated and Subsidiaries have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).

The accompanying consolidated financial statements of Nortech Systems, Incorporated and Subsidiaries (“the Company”, “we”, “our”) have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).

Nature of Business

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Estimates also affect the reported amounts of revenue and expense during the reporting period.

Significant items subject to estimates and assumptions include the valuation allowance for inventories, allowance for doubtful accounts, accrued warranties, realizability of deferred tax assets, goodwill impairment and long-lived asset impairment testing.

Significant items subject to estimates and assumptions include the valuation allowance for inventories, allowance for doubtful accounts, realizability of deferred tax assets, goodwill impairment and long-lived asset impairment testing.

Actual results could differ from those estimates.

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.

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.

The December 31, 2020 balance included cash collateral required to be held against our corporate employee purchasing card program and 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.

As of December 31, 2019, we had no outstanding letters of credit.

As of December 31, 2020 we had outstanding letters of credit for $500 in total to Essjay Bemidji Holdings, LLC and Essjay Mankato Holdings, LLC.

Restricted cash as of December 31, 2020 and December 31, 2019 was $3,212 and $309, respectively.

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(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Inventories are stated at the lower of cost (first-in, first-out method) or net realizable value.

Inventories consist of finished goods, raw materials and work-in-process and 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 production of our products.

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All other property and equipment are depreciated by the straight-line method over their estimated useful lives, as follows:

Leasehold improvements

Manufacturing equipment

Office and other equipment

Buildings (in years)

Leasehold improvements (in years)

Manufacturing equipment (in years)

Office and other equipment (in years)

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Property and equipment at December 31, 2020 and 2019:

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Office and Other Equipment

Accumulated Depreciation

Accumulated Depreciation and Amortization

Total Property and Equipment, Net

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Other Intangible Assets

Finite life intangible assets at December 31, 2019 and 2018 are as follows:

December 31, 2019

Customer Relationships

Intellectual Property

December 31, 2018

Customer Relationships

Intellectual Property

Amortization of finite life intangible assets was $219 for each of the years ended December 31, 2019 and 2018.

Estimated future annual amortization expense (except projects in process) related to these assets is approximately as follows:

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Goodwill and Other Intangible Assets

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Otherwise, no further testing is needed.

We recognize the assets acquired and liabilities assumed in business combinations on the basis of their fair values at the date of acquisition.

We assess the fair value of assets, including intangible assets, using a variety of methods and each asset is measured at fair value from the perspective of a market participant.

The method used to estimate the fair values of intangible assets incorporates significant assumptions regarding the estimates a market participant would make in order to evaluate an asset, including a market participant’s use of the asset and the appropriate discount rates for a market participant.

Any excess purchase price over the fair value of the net tangible and intangible assets acquired is allocated to goodwill.

Long-Lived Asset Impairment

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Assets held for sale are reported at the lower of the carrying amount or fair value less costs to dispose.

We determined there were no triggering events in 2019 or 2018.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Preferred Stock

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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 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.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Product Warranties

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These returns could be subject to material adjustments or differing interpretations of the tax laws.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Incentive Compensation

We use a Black-Scholes option-pricing model to determine the grant date fair value of our incentive awards and recognize the expense on a straight-line basis over the vesting period less awards expected to be forfeited using estimated forfeiture rates.

We use a Black-Scholes option-pricing model to determine the grant date fair value of our incentive awards and recognize the expense on a straight-line basis over the vesting period.

See Note 8 for additional information.

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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.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

A reconciliation of basic and diluted share amounts for the years ended December 31, 2019 and 2018 is as follows:

Basic weighted average common shares outstanding

Weighted average common stock equivalents from assumed exercise of stock options

Diluted weighted average common shares outstanding

There were no dilutive shares in the years ended 2020 or 2019 due to the net loss.

Fair Value of Financial Instruments

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Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Acquisition-Related Contingent Consideration

We acquired Devicix on July 1, 2015.

The aggregate consideration paid to Devicix shareholders includes up to $2,500 of contingent consideration to be paid based on the achievement of certain performance-based milestones.

The fair value of the contingent consideration was measured using an expected present value approach to estimate an expected value.

This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement within the fair value hierarchy.

The fair value of this Level 3 measured liability was $34 as of December 31, 2018 and was $0 as of December 31, 2019 as the liability was fully paid.

We utilized a Level 3 valuation of in our testing of goodwill as of October 1, 2020.

See Note 4, Goodwill and Intangible Assets, for more detail.

Enterprise-Wide Disclosures

Our results of operations for the years ended December 31, 2020 and 2019 represent a single operating and reporting segment referred to as Contract Manufacturing within the EMS industry.

Consolidated financial information is available that is evaluated regularly by the chief operating decision maker in assessing performance and allocating resources.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

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(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

In determining the nonrecurring fair value measurements of impairment of goodwill we utilized a blend of the market value and discounted cash flow approach.

We have $2,375 as of December 31, 2019 and 2018 and determined there was no impairment of goodwill during the years ended December 31, 2019 or 2018.

The cumulative goodwill impairment loss is $908 as of both December 31, 2019 and 2018.

Enterprise-Wide Disclosures

Our results of operations for the years ended December 31, 2019 and 2018 represent a single operating and reporting segment referred to as Contract Manufacturing within the EMS industry.

We strategically direct production between our various manufacturing facilities based on a number of considerations to best meet our customers’ requirements.

We share resources for sales, marketing, engineering, supply chain, information services, human resources, payroll and all corporate accounting functions.

Consolidated financial information is available that is evaluated regularly by the chief operating decision maker in assessing performance and allocating resources.

Export sales from our domestic operations represent approximately 2.1% and 3.1% of consolidated net sales for the years ended December 31, 2020 and 2019, respectively.

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Property and equipment, net

Operating Lease Assets

Foreign Currency Transactions

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dollars at period-end rates, while income and expense are translated at the weighted-average exchange rates for the period.

The related translation adjustments are reflected as a foreign currency translation adjustment in accumulated other comprehensive income (loss) within shareholders’ equity.

The total foreign currency translation adjustment decreased shareholders’ equity by $24, from an accumulated foreign currency translation loss of $233 as of December 31, 2018 to an accumulated foreign currency translation loss of $257 as of December 31, 2019.

The related translation adjustments are reflected as a foreign currency translation adjustment in accumulated other comprehensive loss within shareholders’ equity.

The total foreign currency translation adjustment increased shareholders’ equity by $220, from an accumulated foreign currency translation loss of $257 as of December 31, 2019 to an accumulated foreign currency translation loss of $37 as of December 31, 2020.

Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the Consolidated Statements of Operations.

Net foreign currency transaction losses included in the determination of net earnings was $32 and $11 for the years ended December 31, 2020 and 2019, respectively.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

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(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Net foreign currency transaction losses included in the determination of net earnings was $11 and $170 for the years ended December 31, 2019 and 2018, respectively.

Recently Issued and Adopted Accounting Standards

On January 1, 2019, we adopted ASU No.

2016-02, Leases (Topic 842).

This ASU requires lessees to recognize lease assets and lease liabilities on the balance sheet.

Under the new guidance, lessor accounting is largely unchanged.

We have elected to adopt the standard on the modified retrospective basis.

We have also elected the package of practical expedients, which permits us not to reassess our prior conclusions about lease identification, lease classification and initial direct costs.

In addition, we have elected the short-term lease recognition whereby we will not recognize operating lease related assets or liabilities for leases with a lease term less than one year.

We did not elect the hindsight practical expedient to determine the reasonably certain term of existing leases.

The impact of adopting the new lease standard was the recognition of $5,731 of lease assets and lease liabilities related to our operating leases.

The adoption of the new lease standard had no impact to our Consolidated Statements of Operations, Consolidated Statements of Cash Flows or Consolidated Statements of Shareholders’ Equity.

Liquidity and Capital Resources

Our 2020 sales and shipment backlog were impacted by the ongoing COVID-19 pandemic.

Due to the inherent uncertainty of this evolving situation, we are unable at this time to predict the likely impact of the COVID-19 pandemic on our future operations which has led to indicators of an inability to continue as a going concern.

However, these indicators have been mitigated by our focus on reducing costs, minimizing capital expenditures, and managing working capital.

In addition, we believe that cash provided by operations, funds available under the credit agreement with Bank of America, N.A.

(BofA), funds available under a Promissory Note with BofA (“Promissory Note”) pursuant to the Paycheck Protection Program under the Coronavirus Aid, funds received from our sales leaseback transaction and cash on hand will be adequate to meet our liquidity needs, including working capital, capital expenditures, and debt payment obligations for at least the next 12 months from the financial statement release date.

Recently Issued Accounting Standards

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments.

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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 90% of our revenue for the year ended December 31, 2019.

Revenue under contract manufacturing agreements that was recognized over time accounted for approximately 84% and 90% of our revenue for the years ended December 31, 2020 and 2019, respectively.

Revenues under these agreements are generally recognized over time using an input measure based upon the proportion of actual costs incurred.

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The inclusion of noncash consideration has no impact on overall profitability.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Contract Assets

Contract assets, recorded as such in the Consolidated Balance Sheet, consist of unbilled amounts related to revenue recognized over time.

Significant changes in the contract assets balance during the year ended December 31, 2019 was as follows:

Year Ended December 31, 2019

Significant changes in the contract assets balance during the years ended December 31, 2020 and 2019 was as follows:

Outstanding at January 1, 2019

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Outstanding at December 31, 2019

Increase (decrease) attributed to:

Transferred to receivables from contract assets recognized

Product transferred over time

Outstanding at December 31, 2020

We expect substantially all of the remaining performance obligations for the contract assets recorded as of December 31, 2020, to be transferred to receivables within 90 days, with any remaining amounts to be transferred within 180 days.

We bill our customers upon shipment with payment terms of up to 120 days.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The following tables summarize our net sales by market for the year ended December 31, 2019:

The following tables summarize our net sales by market for the years ended December 31, 2020 and 2019:

Year Ending December 31, 2020

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Total net sales

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

GOODWILL AND OTHER INTANGIBLE ASSETS

We evaluate the value of our goodwill annually as of October 1 st or more frequently such as when events or changes in circumstances indicate there may be an impairment.

We test for impairment at the reporting unit level, which we had two reporting unit as of December 31, 2019 (Devicix and EMS) and one reporting unit (Nortech) at December 31, 2020.

All of our goodwill was derived from our acquisition of the Devicix business in 2015 which was fully consolidated and managed in our Nortech (EMS) reporting unit as of October 1, 2020.

We determined that we had a single reporting unit at October 1, 2020 as a result of fully integrating our former Devicix acquisition into our EMS operations which included consolidating the financial reporting and management decision making to the single reporting unit and operating as a single business.

As a result, we tested goodwill for impairment at the Nortech reporting unit as of October 1, 2020.

In determining the nonrecurring fair value measurements of goodwill, we utilized a discounted cash flow approach.

Our discounted cash flow model includes assumptions related to our product revenue, gross margins, operating margins and other assumptions along with a weighted average cost of capital that is a combination of the risk free rate coupled with our company specific risk premium.

In our goodwill impairment test as of October 1, 2020, we concluded that goodwill was impaired due to a significant reduction of results from operations during the fourth quarter of 2020 that was more than expected suggesting a greater impact of the COVID-19 pandemic and took a $2,375 impairment loss, which fully impaired our remaining goodwill.

We determined there was no impairment of goodwill during the year ended December 31, 2019.

The cumulative goodwill impairment loss is $3,283 and $908 as of December 31, 2020 and 2019, respectively.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Other Intangible Assets

Finite life intangible assets at December 31, 2020 and 2019 are as follows:

December 31, 2020

Customer Relationships

Intellectual Property

December 31, 2019

Customer Relationships

Intellectual Property

Amortization of finite life intangible assets was $191 and $219 for the years ended December 31, 2020 and 2019, respectively.

Estimated future annual amortization expense (except projects in process) related to these assets is approximately as follows:

In the fourth quarter of 2020, we evaluated that there was a trigger event, largely driven by the ongoing impact of COVID-19, that indicated that the carrying amount of our long-lived assets may not be recoverable.

We performed the recoverability test of our undiscounted cash flow forecast over the life of our primary asset and determined there was no impairment.

We completed our qualitative assessment of our long lived assets as of December 31, 2019 and concluded it is more likely than not that our finite-lived intangible and other long lived assets were not impaired.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

FINANCING ARRANGEMENTS

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Under the Bank of America credit agreement, both the line of credit and real estate term notes are subject to variations in the LIBOR rate.

Our line of credit bears interest at a weighted-average interest rate of 5.5% and 4.8% as of December 31, 2019 ad 2018, respectively.

Our line of credit bears interest at a weighted-average interest rate of 4.0% and 5.5% as of December 31, 2020 and 2019, respectively.

We had borrowings on our line of credit of $3,328 and $10,088 outstanding as of December 31, 2020 and December 31, 2019, respectively.

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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 (i) 1.0 to 1.0, for the three months ending December 31, 2019, six months ending March 31, 2020, nine months ending June 30, 2020 and twelve months ending September 30, 2020 and each Fiscal Quarter end thereafter.

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 ending December 31, 2020 and 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 of 2020.

The Company met the covenants for the period ended December 31, 2020.

The availability under the line is subject to borrowing base requirements, and advances are at the discretion of the lender.

At December 31, 2020 and 2019, we had unused availability under our line of credit of $8,131 and $4,148, respectively, supported by our borrowing base.

The line is secured by substantially all of our assets.

On April 15, 2020, we entered into the Promissory Note, which provides for an unsecured loan of $6,077 pursuant to the Paycheck Protection Program 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 of 2 years with a 1% per annum interest rate.

Payments are deferred for 10 months after the end 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.

In the second quarter of 2019, our China operations entered into a line of credit arrangement with China Construction Bank which provides for a line of credit arrangement of 6,000,000 Renminbi (RMB), approximately $860, that will expire on April 3, 2021.

This line of credit bears an interest rate of 6% and we had no amounts outstanding as of both December 31, 2020 and 2019.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

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(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The availability under the line is subject to borrowing base requirements, and advances are at the discretion of the lender.

At December 31, 2019 and 2018, we had unused availability under our line of credit of $4,148 and $6,137, respectively, supported by our borrowing base.

The line is secured by substantially all of our assets.

This line of credit bears an interest rate of 6% and we had no amounts outstanding as of December 31, 2019.

Long-term debt balances at December 31, 2020 and 2019 consisted of the following (in thousands):

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Real estate term note bearing interest at one-month LIBOR + 2.25% (4.3% and 4.1% as of December 31, 2020 and 2019, respectively) maturing June 15, 2022 with monthly payments of approximately $41,000 plus interest secured by substantially all assets.

Devicix Acquistion Note 1 payable to DeLange Holdings, matured on July 1, 2019.

Devicix Acquistion Note 2 payable to DeLange Holdings, matured on July 1, 2019.

Discount on Devicix Notes Payable

Promissory Note

Debt issuance Costs

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Years Ending December 31,

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

We have operating leases for certain manufacturing sites, office space, and equipment.

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We have financing leases for certain property and equipment used in the normal course of business.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The components of lease expense were as follows:

December 31 ,

Operating lease cost

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December 31, 2020

December 31, 2019

Operating lease assets

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Total lease liabilities

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Supplemental cash flow information related to leases was as follows:

December 31 ,

Operating leases

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Right-of-use assets obtained in exchange for lease obligations

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The right-of use-assets obtained in exchange in for lease obligations in the year ended December 31, 2020 was largely due to the sale leaseback transaction we completed relating to the manufacturing facilities in Bemidji and Mankato, Minnesota.

Maturities of lease liabilities were as follows:

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Finance leases

Rent expense for our operating leases the year ended December 31, 2018 as accounted under ASC 840, Leases , was $1,376.

In December 2020, the Consolidated Appropriations Act, 2021 (“CAA”) was signed into law.

The CAA included additional funding through tax credits as part of its economic package for 2021.

The Company evaluated these items in its tax computation as of December 31, 2020 and determined that the items do not have a material impact on the Company’s financial statements as of December 31, 2020.

Additionally, as part of the Paycheck Protection Program (“PPP”) established by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), enacted on March 27, 2020, the Company received a PPP loan that is anticipated to be forgiven.

The PPP loan does not have an impact on the Company’s financial statements as of December 31, 2020 since forgiveness has not occurred.

The PPP loan forgiveness will be treated as tax-exempt income when forgiven due to the provisions in the CAA.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

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(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The future minimum lease commitments as of December 31, 2018, under ASC 840 are as follows:

Operating Leases

Total minimum obligations

On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA” or the Act) was enacted.

The legislation significantly changed U.S.

tax law by lowering the federal corporate tax rate from 34.0% to 21.0%, effective January 1, 2018, modifying the foreign earnings deferral provisions, and imposing a one-time toll charge on deemed repatriated earnings of foreign subsidiaries as of December 31, 2017.

Effective for 2018 and forward, there is a tax on global intangible low-taxed income provisions (“GILTI”) which has been considered in the provision for income taxes..

The income tax expense for the years ended December 31, 2020 and 2019 consists of the following:

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Income tax expense

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The statutory rate reconciliation for the years ended December 31, 2020 and 2019 is as follows:

Statutory federal tax provision (benefit)

State income tax benefit

Statutory Rate

State Income Tax

Effect of foreign operations

FIN 48 adjustment, including federal benefit for state reserves

Income tax credits

Uncertain tax benefits, including federal benefit for state reserves

Change in State Deferred Rate

Valuation allowance

Permanent differences

Global Intangile Low-Taxed Income Effect

Return to Provision - Credits and NOL

Deferred adjustments

Income tax expense

(Loss) Income from operations before income taxes was derived from the following sources:

US Permanent differences

Federal Tax Credits

Global Intangible Low-Taxed Income Effect

Return to provision - credits, perm diffs

Deferred Adjustment

Goodwill Impairment

Loss from operations before income taxes was derived from the following sources:

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

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Tax credit carryforwards

Unrealized Foreign Currency Gain

Valuation allowance

Deferred tax (liabilities) assets

Prepaid expenses

Deferred tax assets

Accumulated Other Comprehensive Income

Lease Accounting ASC 842 Lease Asset

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GAAP income, research and development tax credit carry forwards and state net operating loss carry forwards.

A deferred tax asset generally represents future tax benefits to be received when temporary differences previously reported in our consolidated financial statements become deductible for income tax purposes, or when net operating loss carry forwards are applied against future taxable income, or when tax credit carry forwards are utilized on our tax returns.

A deferred tax asset generally represents future tax benefits to be received when temporary differences previously reported in our financial statements become deductible for income tax purposes, or when net operating loss carry forwards are applied against future taxable income, or when tax credit carry forwards are utilized on our tax returns.

We assess the realizability of our deferred tax assets and the need for a valuation allowance based on the guidance provided in current financial accounting standards.

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The assessment of whether valuation allowances are required considers, among other matters, the nature, frequency and severity of any current and cumulative losses, forecasts of future profitability, the duration of statutory carry forward periods, our experience with loss carry forwards not expiring unused and tax planning alternatives.

We have concluded that a valuation allowance is needed for all our United States based deferred tax assets due to the cumulative net losses we have sustained in the past three years.

In analyzing the need for a valuation allowance, we considered our history of operating results for income tax purposes over the past three years in each of the tax jurisdictions where we operate, statutory carry forward periods and tax planning alternatives.

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After considering all available evidence both positive and negative, we concluded that the valuation allowance is needed for all our U.S.

based deferred tax assets.

based deferred tax assets, no valuation allowance was placed on the foreign assets.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

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(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

At December 31, 2019, we had federal general business tax credit carryforwards of $284 that will begin to expire in 2028, if unused.

state tax purposes, we have Minnesota R&D credit carryforwards of $190 and various state net operating loss carryforwards of $1, The state credits and NOLs expire at various years starting in 2024.

At December 31, 2020, for U.S.

state tax purposes, we have Minnesota R&D credit carryforwards of $190 and various state net operating loss carryforwards of $212 for Iowa, $326 for Minnesota, $586 for Wisconsin.

The state credits and NOLs expire at various years starting in 2024;

we have a valuation allowance related to these state credits and NOLs of $302.

The tax effects from an uncertain tax positions can be recognized in our consolidated financial statements, only if the position is more likely than not to be sustained on audit, based on the technical merits of the position.

We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit.

For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.

The following table sets forth changes in our total gross unrecognized tax benefit liabilities, excluding accrued interest, for the years ended December 31, 2020 and 2019 (in thousands):

Balance as of December 31, 2018

Tax positions related to current year:

Additions based on tax positions related to the current year

Statute of limitations

Balance as of December 31, 2019

The $44 of unrecognized tax benefits as of December 31, 2019 includes $25 which, if ultimately recognized, will reduce our annual effective tax rate.

The remainder would be a reduction in the deferred tax asset and valuation allowance.

Balance at December 31, 2019

Tax Positions - Additions

Tax Positions - Reductions

Balance at December 31, 2020

Our policy is to accrue interest related to potential underpayment of income taxes within the provision for income taxes.

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As of December 31, 2020, with few exceptions, the Company or its subsidiaries are no longer subject to examination prior to tax year 2017.

Our tax year 2018 income tax return is currently under IRS audit.

401(K) RETIREMENT PLAN

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We made contributions, net of forfeitures, of approximately $267 and $152 during the years ended December 31, 2020 and 2019, respectively.

INCENTIVE PLANS

Stock Options

In May 2017, the shareholders approved the 2017 Stock Incentive Plan which authorized the issuance of 400,000 shares.

There were 42,300 and 186,200 options granted during the years ended December 31, 2020 and 2019, respectively.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

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(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

INCENTIVE PLANS

Stock Options

On May 3, 2005, the shareholders approved the 2005 Incentive Compensation Plan (the 2005 Plan) and eliminated the remaining 172,500 option shares available for grant under the prior 2003 Plan effective February 23, 2005.

The total number of shares of common stock that may be granted under the 2005 Plan is 200,000.

The 2005 Plan has not been renewed, and therefore no further grants may be made under the 2005 Plan.

The 2005 Plan provides that option shares granted come from our authorized but unissued common stock.

The price of the option shares granted under the plan will not be less than 100% of the fair market value of the common shares on the date of grant.

Options are generally exercisable after one or more years and expire no later than 10 years from the date of grant.

In May 2017, the shareholders approved the 2017 Stock Incentive Plan which authorized the issuance of 400,000 shares.

There were 186,200 and 134,000 options granted during the year ended December 31, 2019 and 2018, respectively

We estimate the fair value of share-based awards on the date of grant using an option-pricing model.

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For all grants, the amount of compensation expense recognized has been adjusted for an estimated forfeiture rate, which is based on historical data.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

A summary of option activity as of and for the years ended December 31, 2020 and 2019 as follows:

Exercise Price

Term (in years)

Intrinsic Value

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Exercisable on December 31, 2020

There were 2,250 options exercised during the year ended December 31, 2019 and no options exercised during the year ended December 31, 2018.

There were 14,133 options exercised during the year ended December 31, 2020 and 2,250 options exercised during the year ended December 31, 2019.

Total compensation expense related to stock options for the years ended December 31, 2020 and 2019 was $68 and $268, respectively.

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The Units are adjusted to each reporting period based on the expected appreciation of the Units as defined in the Plan.

During the year-ended December 31, 2019, we granted a total of 100,000 Units with a vesting date of December 31, 2021.

There were no units granted in fiscal 2018.

Total compensation expense related to the vested outstanding Units based on the estimated appreciation over their remaining terms was approximately $0 for the years ended December 31, 2019 and 2018.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

2 unchanged sentences

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

During the year-ended December 31, 2020, no Units were granted.

During the year-ended December 31, 2019, we granted a total of 100,000 Units with a vesting date of December 31, 2021.

Total compensation expense related to the vested outstanding Units based on the estimated appreciation over their remaining terms was approximately $108 and $0 for the years ended December 31, 2020 and 2019, respectively.

COMMITMENTS AND CONTINGENCIES

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Stock Repurchase Plan

The $250 share repurchase program, authorized by our Board of Directors in August 2017, expired in July 2018 with no authorized repurchases remaining under this program.

Under this repurchase program, we repurchased 55,199 shares totaling $201 with commissions and fees during the year ended December 31, 2018.

In August 2018, the Board of Directors approved an additional $250 share repurchase program.

Under this repurchase program, we repurchased 32,769 and 21,002 shares totaling $133 and $83 commissions and fees during the years ended December 31, 2019 and 2018, respectively.

As of December 31, 2019, this share repurchase plan has expired.

Executive Separation Agreement

We entered into a Separation Agreement with Matt Mahmood, our former Chief Operating Officer, effective October 5, 2018.

In connection with the Separation Agreement, the Company recognized approximately $235 in expense during the year ended December 31, 2018 related to separation payments.

We paid approximately $60 in 2018 and the remainder in 2019.

COVID-19 has not had a significant impact on our business.

Although we currently expect that any future disruptive impact of COVID-19 on our business to be temporary, this situation continues to evolve rapidly and therefore we cannot predict the extent of which COVID-19 ‘s impact on us.

We expect and are seeing that COVID-19 (and reactions to it) are having and will have negative global financial consequences and heightened uncertainty, which may directly or indirectly negatively impact the operation of our supply chain, our liquidity and capital resources, and our workforce availability, any of which could have a material adverse effect on our business, financial condition, results of operations or cash flows.

RELATED PARTY TRANSACTIONS

During 2016, the we entered into a consulting arrangement with a company co-owned by Matt Mahmood, who became our Chief Operating Officer, on May 20, 2018 and who resigned from the Company on October 5, 2018.

For the years ended December 31, 2019 and 2018, expenses were incurred in the amounts of $0, and $50, respectively.

On February 22, 2018, we entered into a Consulting Agreement with Crosscourt Group, LLC, a limited liability company owned and managed by William Murray, formerly an independent director of the Company.

Murray resigned from this position in May 2018.

The term of the Consulting Agreement was three months and ended in the second quarter of 2018.

For the year ended December 31, 2018, expenses were incurred in the amounts of $68.

In August 2018, the Board of Directors approved a $250 share repurchase program.

Under this repurchase program, we repurchased 32,769 shares totaling $133 commissions and fees during the year ended December 31, 2019.

As of December 31, 2019, this share repurchase plan expired.

We did not repurchase any shares in the year ended December 31, 2020 and no additional share repurchase programs were approved.

Global Pandemic

In March 2020, the World Health Organization recognized the outbreak of a novel coronavirus (“COVID-19”) as a pandemic.

While the COVID-19 pandemic has had an impact on our operations, we have been able to continue to operate our manufacturing facilities and provide essential services to our customers.

Additionally, in an effort to protect the health and safety of our employees and in compliance with state regulations, we have instituted a work-from-home policy for employees who can perform their job functions offsite, implemented social distancing requirements and other measures to allow manufacturing and other personnel essential to production to continue work within our manufacturing facilities, and suspended all non-essential employee travel.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

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(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

During fiscal year ended December 31, 2019 we did business with Printed Circuits, Inc.

The full extent to which COVID-19 has and will continue to directly or indirectly impact our business, financial condition and results of operations will depend on future developments that are highly uncertain and cannot be accurately predicted, including new information that may emerge concerning COVID-19, the actions taken to contain it or treat its impact and the economic impact on local, regional, national and international markets.

The ultimate impact of COVID-19 depends on factors beyond our knowledge or control, including the duration and severity of the outbreak, as well as third-party actions taken to contain its spread and mitigate its public health effects.

As a result, we are unable to estimate the extent to which COVID-19 will negatively impact our financial results or liquidity.

We will continue to assess the potential impact of the COVID-19 pandemic on our business, financial condition, and results of operations.

We actively manage our cash and working capital to preserve adequate liquidity and ensure that our business can continue to operate during these uncertain times.

RELATED PARTY TRANSACTIONS

During fiscal years ended December 31, 2020 and 2019 we did business with Printed Circuits, Inc.

which is 90% owned by the Kunin family, of which, owns a majority of our stock.

We made payments totaling $131 during 2019 to Printed Circuits, Inc.

We made payments to Printed Circuits, Inc.

totaling $28 and $131 in the years ended December 31, 2020 and 2019, respectively.

The Company believes that these transactions are on terms comparable to those that the Company could reasonably expect in an arm's length transaction with an unrelated third party.

David Kunin, our Chairman is a minority owner of Abilitech Medical, Inc.

Kunin also was a consultant to Abilitech, which relationship ended on March 1, 2021.

During 2020, Mr.

Kunin earned $16 as a consultant to Abilitech.

In 2020, Abilitech paid the Company $1,095 and in 2019, Abilitech paid the Company $537 for delivery of medical products.

The Company believes that transactions with Abilitech are on terms comparable to those that the Company could reasonably expect in an arm's length transaction with an unrelated third party.

SUBSEQUENT EVENT

We entered into an agreement on February 23, 2021 with a third-party agent to sell our facility in Merrifield, MN and some related assets.

We expect the sale to close in the second quarter of 2021 near the carrying value of the assets, however a sale transaction and the expected sale value is not guaranteed.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 8. Financial Statements and Supplementary Data