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Item 8. Financial Statements and Supplementary Data

2022-03-17 compared with 2021-03-23 · 475 added, 233 removed, 526 unchanged (57% of the section changed)

Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

Report of Independent Registered Public Accounting Firm (PCAOB Firm ID 23 )

Consolidated Financial Statements:

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders and the board of directors of Nortech Systems Incorporated:

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, 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.

To the shareholders and the board of directors of Nortech Systems, Inc.

and Subsidiaries:

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Nortech systems, Inc.

and Subsidiaries (the "Company") as of December 31, 2021 and 2020, 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, 2021 and 2020, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

12 unchanged sentences

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

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.

Critical Audit Matters

Critical audit matters are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that:

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

We determined that there are no critical audit matters.

/s/ Baker Tilly US, LLP

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31, 2021 AND 2020

(IN THOUSANDS, EXCEPT SHARE DATA)

$ 115,168  

$ 104,106  

Cost of Goods Sold

99,304  

94,441  

15,864  

Operating Expenses:

1 unchanged sentence

General and Administrative Expenses

10,002  

Restructuring Expenses

Impairment of Goodwill

Loss on Abandonment of Intangible Asset

Gain on Sale of Property and Equipment

( 141 )  

Total Operating Expenses

(Loss) Income From Operations

Other Expense

13,592  

10,281  

Income (Loss) from Operations

Other Income (Expense)

Interest Expense

Loss Before Income Taxes

( 430 )  

PPP Loan Forgiviness Gain

Total Other Income (Expense)

Income (Loss) Before Income Taxes

Income Tax Expense

Loss Per Common Share:

Weighted Average Number of Common Shares Outstanding - Basic

Weighted Average Number of Common Shares Outstanding - Dilutive

Net Income (Loss)

$ 7,154  

Income (Loss) Per Common Share:

$ 2.68  

Weighted Average Number of Common Shares

Outstanding - Basic

2,664,586  

2,657,738  

$ 2.54  

Weighted Average Number of Common Shares

Outstanding - Dilutive

2,821,523  

2,657,738  

Other comprehensive income (loss)

Foreign currency translation

Comprehensive loss, net of tax

Comprehensive income (loss), net of tax

$ 7,247  

See accompanying notes to consolidated financial statements

6 unchanged sentences

Accounts Receivable, less allowances of $ 328 and $ 343

14,548  

15,625  

Employee Retention Credit Receivable

Inventories, Net

19,434  

13,917  

Contract Assets

1 unchanged sentence

Total Current Assets

51,774  

41,037  

Property and Equipment, Net

1 unchanged sentence

Other Intangible Assets, Net

$ 67,091  

$ 57,634  

LIABILITIES AND SHAREHOLDERS' EQUITY

1 unchanged sentence

Current Portion of Long-Term Debt

$ 1,204  

Current Portion of Finance Lease Obligations

1 unchanged sentence

Accounts Payable

12,710  

11,239  

Accrued Payroll and Commissions

1 unchanged sentence

Total Current Liabilities

22,306  

19,536  

Long-Term Liabilities

5 unchanged sentences

Total Long-Term Liabilities

18,674  

19,380  

Total Liabilities

40,980  

38,916  

Shareholders' Equity

6 unchanged sentences

Additional Paid-In Capital

Accumulated Other Comprehensive Loss

15,962  

15,816  

Accumulated Other Comprehensive Income (Loss)

Retained Earnings

Total Shareholders' Equity

26,111  

18,718  

Total Liabilities and Shareholders' Equity

$ 67,091  

$ 57,634  

See accompanying notes to consolidated financial statements

4 unchanged sentences

CASH FLOWS FROM OPERATING ACTIVITIES

Net Income (Loss)

$ 7,154  

Adjustments to Reconcile Net Loss to Net Cash

2 unchanged sentences

Compensation on Equity Appreciation Rights

Loss on Abandonment of Intangible Asset

Loss on Goodwill Impairment

Deferred Taxes

Change in Accounts Receivable Allowance

( 15 )  

Change in Inventory Reserves

(Gain) loss on Disposal of Property and Equipment

( 860 )  

Gain on Disposal of Property and Equipment

( 141 )  

PPP Loan Forgiveness Gain

( 6,171 )  

Employee Retention Credit Receivable  

( 5,209 )  

Changes in Current Operating Items

Accounts Receivable

( 4,613 )  

Contract Assets

( 2,799 )  

Prepaid Expenses and other Curent Assets

( 171 )  

Accounts Payable

1 unchanged sentence

Other Accrued Liabilities

Net Cash Provided by Operating Activities

Net Cash (Used In) Provided by Operating Activities

( 4,540 )  

CASH FLOWS FROM INVESTING ACTIVITIES

1 unchanged sentence

Purchase of Intangible Asset

( 64 )  

Purchases of Property and Equipment

Net Cash Provided by (Used in) Investing Activities

( 1,292 )  

Net Cash (Used In) Provided By Investing Activities

( 730 )  

CASH FLOWS FROM FINANCING ACTIVITIES

2 unchanged sentences

Principal Payments on Long-Term Debt

( 1,128 )  

Principal Payments on Financing Leases

( 664 )  

Stock Option Excercises

Share Repurchases

Net Cash Used in Financing Activities

Net Cash Provided By (Used In) Financing Activities

Effect of Exchange Rate Changes on Cash

Net Change in Cash

Cash - Beginning of Year

Cash - End of Year

Net Change in Cash and Cash Equivalents

( 1,339 )  

Cash and Cash Equivalents - Beginning of Year

Cash and Cash Equivalents - End of Year

$ 2,225  

$ 3,564  

Reconciliation of cash and restricted cash reported within the consolidated balance sheets

1 unchanged sentence

Total Cash and restricted cash reported in the consolidated statements of cash flows

$ 2,225  

$ 3,564  

Supplemental Disclosure of Cash Flow Information:

Cash Paid for Interest

Cash Paid for Income Taxes

Cash Paid (Refunded) for Income Taxes

( 114 )  

Supplemental Noncash Investing and Financing Activities:

2 unchanged sentences

Equipment Acquired under Finance Lease

PPP Loan Forgiveness

See accompanying notes to consolidated financial statements

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

CONSOLIDATED STATEMENTS OF SHAREHOLDERS ’

FOR THE YEARS ENDED DECEMBER 31, 2021 AND 2020

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Shareholders'

Income (Loss)

BALANCE DECEMBER 31, 2019

$ 15,748  

$ ( 257 )  

$ 4,208  

$ 19,976  

( 1,546 )  

Foreign Currency Translation Adjustment

Compensation on Stock-based awards

Share repurchases

BALANCE DECEMBER 31, 2020

15,816  

( 37 )  

18,718  

Foreign currency translation adjustment

Stock Option Exercises  

Compensation on stock-based awards

BALANCE DECEMBER 31, 2021

$ 15,962  

$ 9,816  

$ 26,111  

See accompanying notes to consolidated financial statements

5 unchanged sentences

Basis of Presentation

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”).

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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We also provide engineering services and repair services.

Our manufacturing facilities are located in Bemidji, Blue Earth, Merrifield, Milaca, and Mankato, Minnesota as well as, Monterrey, Mexico and Suzhou, China.

Our manufacturing facilities are located in Bemidji, Blue Earth, Milaca, and Mankato, Minnesota as well as, Monterrey, Mexico and Suzhou, China.

Products are sold to customers both domestically and internationally.

Principles of Consolidation

The consolidated financial statements include the accounts of Nortech Systems Incorporated and its wholly-owned subsidiaries, Manufacturing Assembly Solutions of Monterrey, Inc.

The consolidated financial statements include the accounts of Nortech Systems Incorporated and its wholly-owned subsidiaries, Manufacturing Assembly Solutions of Monterrey, Inc.

and Nortech Systems Hong Kong Company, Limited and its subsidiary, Nortech Systems Suzhou Company, Limited.

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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, 2021 we had outstanding letters of credit for $ 400 in total to Essjay Bemidji Holdings, LLC and Essjay Mankato Holdings, LLC.

Restricted cash as of December 31, 2021 and December 31, 2020 was $ 1,582 and $ 3,212 , respectively.

The December 31, 2021 and 2020 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.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Accounts Receivable and Allowance for Doubtful Accounts

1 unchanged sentence

Accounts receivable are unsecured and are presented net of an allowance for doubtful accounts.

The allowance for doubtful accounts was $343 and $335 at December 31, 2020 and 2019, respectively.

We determine our allowance by considering a number of factors, including the length of time accounts receivable are past due, our previous loss history, the customers’ current ability to pay their obligations to us, and the condition of the general economy and the industry as a whole.

The allowance for doubtful accounts was $ 328 and $ 343 at December 

31, 2021 and 2020, respectively.

We determine our allowance by considering a number of factors, including the length of time accounts receivable are past due, our previous loss history, the customers’

current ability to pay their obligations to us, and the condition of the general economy and the industry as a whole.

We write-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.

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)

Employee Retention Credit (ERC) and Payroll Tax Deferral

We qualified for Employee Retention Credits on qualified wages paid in the first and second quarters of 2021 and filed for both credits in the third quarter of 2021.

We recognize government grants for which there is a reasonable assurance of compliance with grant conditions and receipt of credits.

In 2021, there was $ 5,209 related to Employee Retention Credits recognized as a reduction of the associated costs within cost of goods sold of $ 4,670 , selling of $ 125 , and general and administrative expenses of $ 414 on the consolidated statements of operations and within Employee Retention Credits Receivable on the consolidated balance sheets.

The CARES Act allowed for the deferral of the employer portion of social security taxes incurred through the end of calendar 2020.

As of December 31, 2021, there was $ 1,158 of social security tax payments deferred, of which 50% was required to be remitted by December 2021 and the remaining 50% by December 2022.

IRS Notice 2020 - 22 and Notice 2021 - 24 provides that employers are not subject to the penalty for failing to timely deposit employment taxes under Code Section 6656 if (i) the amount of employment taxes that are not deposited (i.e., the deemed credit amount) is less than or equal to the employer’s anticipated credits (ERC) and (ii) the employer did not previously file for advance payment of these credits.

We did not remit the amount due on December 31, 2021 due to our awaiting receipt of the anticipated credits under the ERC, as allowed under the above IRS Notices.

The deferred amounts are recorded within accrued payroll and commissions on the condensed consolidated balance sheets.

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.

5 unchanged sentences

Raw materials

$ 18,492  

$ 14,865  

Work in process

Finished goods

( 1,298 )  

$ 19,434  

$ 13,917  

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Property and Equipment

4 unchanged sentences

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

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)

Buildings 

Leasehold improvements

Manufacturing equipment

Office and other equipment

Property and equipment at December 31, 2021 and 2020:

1 unchanged sentence

Manufacturing Equipment

18,892  

22,685  

Office and Other Equipment

Accumulated Depreciation and Amortization

( 24,224 )  

Total Property and Equipment, Net

Goodwill and Other Intangible Assets

In accordance with ASC 350, Goodwill and Other Intangible Assets, goodwill is not amortized but is required to be reviewed for impairment at least annually or when events or circumstances indicate that carrying value may exceed fair value.

We test impairment annually as of October 1st.

In testing goodwill for impairment, we perform a quantitative or qualitative impairment test, including computing the fair value of the reporting unit and comparing that value to its carrying value.

If the fair value is less than its carrying value, then the goodwill is determined to be impaired.

In the event that goodwill is impaired, an impairment charge to earnings would become necessary.

To the extent the carrying amount of goodwill exceeds the implied goodwill, the difference is the amount of the goodwill impairment.

Prior to completing the quantitative analysis described above, we have the option to perform a qualitative assessment of goodwill for impairment to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount, including goodwill and other intangible assets.

If we conclude the fair value is more likely than not less than the carrying value, we perform the quantitative analysis.

Otherwise, no further testing is needed.

$ 5,833  

$ 6,426  

Long-Lived Asset Impairment

3 unchanged sentences

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

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

3 unchanged sentences

No preferred stock dividends were declared or paid during the years ended December 31, 2021 and 2020.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Revenue Recognition

2 unchanged sentences

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.

22 unchanged sentences

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

5 unchanged sentences

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.

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

For the year ended December 31, 2021, stock options of 156,937 were included in the computation of diluted income per common share as their impact were dilutive.

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

Fair Value of Financial Instruments

9 unchanged sentences

Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

Unobservable inputs for the asset or liability, reflecting the reporting entity’s own assumptions about the assumptions that market participants would use in pricing

Our assessment of the significance of a particular input to the fair value measurements requires judgment and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy.

1 unchanged sentence

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

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

We utilized a Level 3 valuation 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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Enterprise-Wide Disclosures

Our results of operations for the years ended December 31, 2021 and 2020 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.

Export sales from our domestic operations represent approximately 3.1 % and 2.8 % of consolidated net sales for the years ended December 31, 2021 and 2020, respectively.

Net sales by our major EMS industry markets for the years ended December 31, 2021 and 2020 are as follows:

$ 63,047  

$ 55,098  

Aerospace and Defense

16,639  

20,624  

35,482  

28,384  

Total Net Sales

$ 115,168  

$ 104,106  

Noncurrent assets, excluding deferred taxes, by country are as follows:

2 unchanged sentences

Property and equipment, net

$ 4,664  

$ 5,833  

Operating Lease Assets

$ 5,287  

$ 8,983  

December 31, 2020

Property and equipment, net

$ 5,057  

$ 6,426  

Operating Lease Assets

$ 5,574  

$ 8,998  

$ 1,173  

Foreign Currency Transactions

1 unchanged sentence

Foreign exchange transaction gains and losses attributable to exchange rate movements related to transactions made in the local currency and on intercompany receivables and payables not deemed to be of a long-term investment nature are recorded in other income (expense).

The functional currency for our China subsidiary is the Renminbi (“RMB”).

Assets and liabilities of the China operation are translated from RMB into U.S.

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 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.

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

The total foreign currency translation adjustment increased shareholders’

equity by $ 93 and $ 220 for the years ended December 31, 2021 and 2020, respectively.

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.

2 unchanged sentences

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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.

Reclassification

Certain reclassifications have been made to the prior year’s consolidated financial statements to enhance comparability with the current year’s financial statements.

As a result, certain line items have been restated in the statement of operations to properly reflect the classification of information technology related expenses.

Comparative figures have been adjusted to conform to the current year’s presentation.

The items were reclassified as follows:

December 31, 2020

Previously Reported

After Reclassification

Cost of Goods Sold

$ 95,651  

$ 94,441  

General and Administrative Expenses

Recently Issued Accounting Standards

5 unchanged sentences

We are currently evaluating the impact of this standard on our consolidated financial statements and related disclosures.

In March 2020, the FASB issued ASU 2020 - 04,  Reference Rate Reform.

ASU 2020 - 04 provides optional guidance for a limited period of time to ease potential accounting impact associated with transitioning away from reference rates that are expected to be discontinued, such as LIBOR.

The amendments in this ASU apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued.

The amendments in ASU 2020 - 04 can be adopted as of March 12, 2020 and are effective through December 31, 2022.

Our line of credit agreement with Bank of America was amended on December 31, 2021 to reference the Bloomberg Short-Term Bank Yield Index (BSBY) rather than LIBOR.

We do not anticipate a material impact on our consolidated financial statements related to the change in index.

We do not have additional material agreements that will be impacted by a change in reference rate.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2021 AND 2020

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS

3 unchanged sentences

We grant credit to customers in the normal course of business and do not require collateral on our accounts receivable.

Our largest customer has two divisions that together accounted for 20% or more of our net sales during the year ended December 31, 2020 and 2019.

One division accounted for approximately 21.2% and 19.9% of net division sales for the years ended December 31, 2020 and 2019, respectively.

The second division accounted for approximately 2.2% and 2.6% of net division sales for the years ended December 31, 2020 and 2019, respectively.

Together they accounted for approximately for 23.4% and 22.5% of net sales for the years ended December 31, 2020 and 2019, respectively.

Accounts receivable from the customer at December 31, 2020 and 2019 represented 19.6% and 35.6% of our total accounts receivable, respectively.

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 26.9 % and 23.4 % of net sales for the years ended December 31, 2021 and 2020, respectfully.

Accounts receivable for one customer was 19.3 % and 19.6 % at December 31, 2021 and 2020, respectfully.

Revenue recognition

2 unchanged sentences

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.

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)

Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or providing services.

7 unchanged sentences

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

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Accounting for contract manufacturing agreements involves the use of various techniques to estimate total revenue and costs.

4 unchanged sentences

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

2 unchanged sentences

Outstanding at January 1, 2020

$ 7,659  

Increase (decrease) attributed to:

6 unchanged sentences

Outstanding at December 31, 2021

$ 8,698  

We expect substantially all of the remaining performance obligations for the contract assets recorded as of December 31, 2021, 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, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The following tables summarize our net sales by market for the years ended December 31, 2021 and 2020:

5 unchanged sentences

Total Net Sales

$ 47,285  

$ 13,250  

$ 2,512  

$ 63,047  

Aerospace and Defense

14,879  

16,639  

27,213  

35,482  

Total net sales

$ 89,377  

$ 20,962  

$ 4,829  

$ 115,168  

Year Ending December 31, 2020

4 unchanged sentences

Total Net Sales

$ 45,694  

$ 6,398  

$ 3,006  

$ 55,098  

Aerospace and Defense

18,948  

20,624  

22,451  

28,384  

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)

$ 87,093  

$ 11,296  

$ 5,717  

$ 104,106  

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.

We test for impairment at the reporting unit level, which we had one reporting unit (Nortech) at December 31, 2020.

We tested goodwill for impairment as of October 1, 2020 and 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.

We recorded a $ 2,375 impairment loss, which fully impaired our remaining goodwill.

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

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

1 unchanged sentence

Finite life intangible assets at December 31, 2021 and 2020 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.

Relationships

Intellectual Property  

Balance at January 1, 2020

$ 1,343  

Additions  

Balance at December 31, 2020

$ 1,173  

Abandonment Loss

Balance at December 31, 2021

In 2021, we determined the fair value of the Devicix tradename was more likely than not at $ 0 based on management’s best estimate and recognized a $ 560 loss on abandonment of intangible assets.

Intangible assets are amortized on a straight-line basis over their estimated useful lives.

The weighted average remaining amortization period of our intangible assets is 3.0 years.

Patents are not being amortized as they are in process and a patent has not yet been received.

Amortization expense of finite life intangible assets was $ 176  and $ 191 for the years ended December 31, 2021 and 2020, respectively.

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

We completed our qualitative assessment of our long-lived assets as of December 31, 2021 and conclude it is more likely than not that our finite-lived intangible and other long-lived assets were not impaired.

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

4 unchanged sentences

We have a credit agreement with Bank of America which was entered into on June 15, 2017 and provides for a line of credit arrangement of $ 16,000 that expires on June 15, 2022.

The credit arrangement also has a $5,000 real estate term note outstanding with a maturity date of June 15, 2022.

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 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.

On December 31, 2021, we renewed the credit agreement through June 

Under the amended Bank of America credit agreement signed December 31, 2021, the line of credit is subject to variations in the Bloomberg Short-Term Bank Yield (BSBY) index rate.

Prior to the amendment, the line of credit was subject to variations in LIBOR.

Our line of credit bears interest at a weighted-average interest rate of 3.5 % and 4.0 % as of December 

31, 2021 and 2020, respectively.

We had borrowings on our line of credit of $ 9,016 and $ 3,328 outstanding as of December 

31, 2021 and December 

31, 2020, respectively.

There are no subjective acceleration clauses under the credit agreement that would accelerate the maturity of our outstanding borrowings.

The line of credit and real estate term notes with Bank of America contain certain covenants which, among other things, require us to adhere to regular reporting requirements, abide by annual shareholder dividend limitations, maintain certain financial performance, and limit the amount of annual capital expenditures.

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

The line of credit is secured by substantially all of our assets.

The Bank of America Credit Agreement provides for, among other things, a Fixed Charge Coverage Ratio of not less than 1.0 to 1.0, for the twelve months 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 line of credit is shown net of debt issuance costs of $ 58 on the consolidated balance sheet for the year ended December 31, 2021.

The line of credit with Bank of America contains certain covenants which, among other things, require us to adhere to regular reporting requirements, abide by annual shareholder dividend limitations, maintain certain financial performance, and limit the amount of annual capital expenditures. 

The 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, 2021 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.

The Company met the covenants for the period ended December 31, 2021.

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

At December 31, 2021 and 2020, we had unused availability under our line of credit of $ 3,539 and $ 8,131 , 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.

In the first quarter of 2022, we amended our credit agreement to include the Employee Retention Credit Receivable as security in our line of credit which improves our unused availability.

On April 15, 2020, we entered into a Promissory Note with Bank of America, N.A., which provides for an unsecured loan of $ 6,077 pursuant to the Paycheck Protection Program (“PPP”) under the Coronavirus, Aid, Relief, and Economic Security Act and applicable regulations (the “CARES Act”) of which funds were received on April 22, 2020.

The loan was accounted for as debt until November 3, 2021 when the $ 6,077 loan and $ 93 accrued interest was fully forgiven by the SBA.

As a result, we recorded a PPP loan forgiveness gain of $ 6,170 which is included in other income (expense) on the consolidated statements of operations and other comprehensive income (loss) for the year ended December 31, 2021.

Our China operation has a financing agreement with China Construction Bank which provides for a line of credit arrangement of 10,000,000 Renminbi (RMB) (approximately 1.6 million USD) that will expire on June 22, 2022.

This line of credit bears an interest rate of 4.5 % and we had no amounts outstanding as of December 31, 2021 and 2020.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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

There was no long-term debt at December 31, 2021.

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

Term note payable - Bank of America

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.

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

$ 1,071  

Promissory Note

3 unchanged sentences

Long-term debt - net of current maturities

Future maturity requirements for long-term debt outstanding as of December 31, 2020, are as follows:

Years Ending December 31,

$ 5,865  

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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

3 unchanged sentences

At December 31, 2021, we do not have material lease commitments that have not commenced.

We did extend and add operating leases for our manufacturing facilities in 2021.

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:

Operating lease cost

$ 2,291  

$ 1,643  

Finance lease interest cost

1 unchanged sentence

Total lease cost

$ 2,872  

$ 2,382  

Supplemental balance sheet information related to leases was as follows:

4 unchanged sentences

Operating lease assets

$ 8,983  

$ 8,998  

Finance lease assets

1 unchanged sentence

Total leased assets

$ 11,035  

$ 11,328  

Current operating lease liabilities

Current Portion of Operating Lease Obligations

$ 1,043  

Current finance lease liabilities

5 unchanged sentences

Total lease liabilities

$ 11,255  

$ 11,389  

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Supplemental cash flow information related to leases was as follows:

1 unchanged sentence

Cash paid for amounts included in the measurement of lease liabilities

$ 1,649  

$ 1,058  

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.

$ 1,188  

$ 4,999  

The right-of use-assets obtained in exchange in for lease obligations in the year ended December 31, 2021 was largely due to leasing of additional space in our Suzhou, China facility.

Maturities of lease liabilities were as follows:

1 unchanged sentence

Total lease payments

$ 14,610  

$ 1,648  

$ 16,258  

( 132 )  

Present value of lease liabilities

$ 9,739  

$ 1,516  

$ 11,255  

The lease term and discount rate at December 31, 2021 were as follows:

5 unchanged sentences

Finance leases

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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

RESTRUCTURING CHARGES

In 2021, we recorded restructuring charges of $ 327 related to the consolidation of our production facilities and closure of our Merrifield, Minnesota facility.

With the Merrifield closure, we shifted wire and cable assembly, system-level assembly and printed circuit board (PCB) manufacturing to Nortech’s other Minnesota locations.

No amounts were accrued as of December 31, 2021.

We reduced our workforce by approximately 42 employees as a result of this facility closure.

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.

We evaluated these items in its tax computation as of December 31, 2020 and determined that the items do not have a material impact on our financial statements as of December 

Additionally, as part of the Paycheck Protection Program (“PPP”) established by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), we received a PPP loan on April 15, 2020.

The full amount of the loan and accrued interest were forgiven on November 3, 2021.

This extinguishment of debt income is recorded in other income (expense) on the consolidated statements of operations and other comprehensive income for the year ended December 31, 2021.

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

The income tax expense for the years ended December 

31, 2021 and 2020 consists of the following:

Current taxes - Federal

1 unchanged sentence

Current taxes - Foreign

Deferred taxes - Foreign

Income tax expense

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

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The statutory rate reconciliation for the years ended December 

31, 2021 and 2020 is as follows:

Statutory Rate

$ 1,606  

State Income Tax

Effect of foreign operations

Uncertain tax benefits, including federal benefit for state reserves

Change in State Deferred Rate

( 39 )  

Valuation Allowance

PPP Loan Forgiveness

( 1,276 )  

US Permanent differences

Federal Tax Credits

( 37 )  

Global Intangible Low-Taxed Income Effect

Return to provision - credits, perm diffs

Deferred Adjustment

( 481 )  

Goodwill Impairment

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

( 25 )  

Income and loss from operations before income taxes was derived from the following sources:

$ 6,072  

$ 8,013  

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

5 unchanged sentences

Stock-based compensation and equity appreciation rights

Other Accruals

Lease Accounting ASC 842 Lease Liability

3 unchanged sentences

Unrealized Foreign Currency Gain

COGS Rev Rec Adjustment

COGS Offset Adjustment

( 1,807 )  

Valuation allowance

( 1,976 )  

Deferred tax assets

Accumulated Other Comprehensive Income

( 297 )  

Lease Accounting ASC 842 Lease Asset

( 1,518 )  

Property and equipment

( 71 )  

Deferred tax liabilities

( 1,886 )  

Net deferred tax assets

We currently have significant deferred tax assets as a result of temporary differences between taxable income on our tax returns and U.S.

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 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.

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 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.

1 unchanged sentence

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.

Finally, we considered both our near and long-term financial outlook and timing regarding when we might return to profitability.

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, no valuation allowance was placed on the foreign assets.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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. Finally, we considered both our near and long-term financial outlook and timing regarding when we might return to profitability.  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, no valuation allowance was placed on the foreign assets.

At December 31, 2021, for U.S.

1 unchanged sentence

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.

The tax effects from 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):

The following table sets forth changes in our total gross unrecognized tax benefit liabilities, excluding accrued interest, for the years ended December 

31, 2021 and 2020 (in thousands):

Balance at December 31, 2020

3 unchanged sentences

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

The liability for accrued interest as of December 31, 2020 and 2019 was not significant.

The liability for accrued interest as of December 

31, 2021 and 2020 was not significant.

Interest is computed on the difference between our uncertain tax benefit positions and the amount deducted or expected to be deducted in our tax returns.

2 unchanged sentences

The Company files income tax returns in the U.S.

federal jurisdiction and various state and foreign jurisdictions.

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

federal jurisdiction and various state and foreign jurisdictions. 

As of December 

31, 2021, 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.

4 unchanged sentences

Employees are allowed to contribute up to 60 % of their wages to the 401 (k) Plan.

Historically we have matched 25% of the employees’ contributions up to 6% of covered compensation.

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.

Historically we have matched 25 % of the employees’

contributions up to 6 % of covered compensation.

We made contributions, net of forfeitures, of approximately $ 276 and $ 267 during the years ended December 

31, 2021 and 2020, respectively.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

2 unchanged sentences

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

INCENTIVE PLANS

Stock Options

In May 2017, the shareholders approved the 2017 Stock Incentive Plan which authorized the issuance of 350,000 shares.

There were additional shares authorized by the shareholders in March 2020 totaling 50,000 .

Since the last shareholders’

meeting, the Board of Directors has approved and is seeking shareholder approval of an additional 175,000 to be authorized under the plan.

There were 49,000 and 42,300 options granted during the years ended December 31, 2021 and 2020, respectively.

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

10 unchanged sentences

Exercise Price

Term (in years)

Intrinsic Value

Outstanding – January 1, 2019

Outstanding – December 31, 2019

Outstanding – December 31, 2020

Outstanding –

January 1, 2020

Outstanding –

December 31, 2020

Outstanding –

December 31, 2021

Exercisable on December 31, 2021

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

There were 13,400 options exercised during the year ended December 31, 2021 and 14,133 options exercised during the year ended December 31, 2020.

8 unchanged sentences

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

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)

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.

During the years ended December 31, 2021 and 2020, no Units were granted.

Total compensation expense related to the vested outstanding Units based on the estimated appreciation over their remaining terms was approximately $ 143 and $ 108 for the years ended December 31, 2021 and 2020, respectively.

6 unchanged sentences

In the event of an involuntarily termination in connection with a change of control as defined in the agreements, each Executive would receive their base salary, annual bonus at time of termination, and continued participation in health, disability and life insurance plans for a period of three years for officers and two years for all other participants.

Stock Repurchase Plan

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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.

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.

The full extent to which COVID- 19 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.

2 unchanged sentences

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.

EMPLOYEE RETENTION CREDIT

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law providing numerous tax provisions and other stimulus measures, including an employee retention credit (“ERC”), which is a refundable tax credit against certain employment taxes.

The Taxpayer Certainty and Disaster Tax Relief Act of 2020 and the American Rescue Plan Act of 2021 extended and expanded the availability of the ERC.

The ERC is calculated as a percentage of qualified wages (as defined in the CARES Act, as amended) paid by an eligible employer.

The Company qualified for the ERC as it experienced a significant decline in gross receipts (for 2020, defined as a 50% decline in gross receipts when compared to the same calendar quarter in 2019, and for 2021, defined as a 20% decline in gross receipts when compared to the same quarter in 2019 ).

As a small employer, all of the Company’s otherwise qualified wages were eligible for the ERC.

For 2020, the ERC equaled 50 percent of an employee’s qualified wages up to $10,000 per employee per calendar quarter with a maximum annual credit for each employee of $5,000.

For 2021, the ERC equaled 70 percent of an employee’s qualified wages up to $10,000 per employee per calendar quarter with a maximum annual credit of $21,000 for each employee.

The Company determined that it was eligible for the ERC as revenues in the first quarter of 2021 declined more than 20% compared to the same quarter of 2019.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED

DECEMBER 31, 2021 AND

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

As it relates to the 2020 and 2021 amounts, the Company has elected to account for the credit as a government grant.

GAAP do not include grant accounting guidance for for-profit entities, therefore, the Company has elected to follow the grant accounting model in International Accounting Standard (IAS) 20, Accounting for Government Grants and Disclosure of Government Assistance.

In accordance with IAS 20, the Company cannot recognize any income from the grant until there is reasonable assurance (similar to the “probable”

threshold in U.S.

GAAP) that any conditions attached to the grant will be met and that the grant will be received.

Once it is reasonably assured that the grant conditions will be met and that the grant will be received, grant income is recorded on a systematic basis over the periods in which the Company recognizes the payroll expenses for which the grant is intended to compensate.

Income from the grant can be presented as either other income or as a reduction in the expenses for which the grant was intended to compensate.

During the year ended December 31, 2021 and 2020, the Company recorded ERC benefits of $ 5,209 as a reduction of the associated costs within cost of goods sold of $ 4,670 , selling of $ 125 , and general and administrative expenses of $ 414 on the consolidated statements of operations and within Employee Retention Credits Receivable on the consolidated balance sheet.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2021 AND 2020

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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 to Printed Circuits, Inc.

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

During the years ended December 31, 2021 and 2020, we did business with Printed Circuits, Inc.

which was 90% owned by the Kunin family until late 2020.

The Kunin family owns a majority of our stock.

We had payments totaling $ 91 and $ 28 in the years ended December 31, 2021 and 2020, respectively, to Printed Circuits, Inc.

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.

3 unchanged sentences

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.

Abilitech paid the Company $ 1,079 and $ 1,095 in the years ended December 31, 2021 and 2020, respectively, 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.

David Kunin, our Chairman, is a small minority owner (less than 10 %) of Marpe Technologies, LTD an early-stage medical device company dedicated to the early detection of skin cancer through full body scanners.

Kunin is also a member of the Board of Directors of Marpe Technologies.

The Company worked with Marpe Technologies to apply for a grant from the Israel-United States Binational Industrial Research and Development Foundation, a legal entity created by Agreement between the Government of the State of Israel and the Government of the United States of America (“BIRD Foundation”).

The parties were successful in receiving approval for a $ 1,000 conditional grant from the BIRD Foundation.

The Company and Marpe Technologies will each receive $500 from the BIRD Foundation and, among other obligations under the grant, each is required to contribute $500 to match grant funds from the BIRD Foundation.

The Company will meet its obligation by providing certain services at cost or with respect to administrative services at no cost to Marpe Technologies.

The total value of the contribution will not exceed $500.

The Company will receive a 10 -year exclusive right to manufacture the products of Marpe Technologies.

There can be no assurances that Marpe Technologies’

medical device will be commercially successful, that Marpe Technologies will be successful in raising additional funds to finance its operations or, if commercially successful, the Company will recoup the value of services provided to Marpe for which is not fully paid.

The transactions between the Company and Marpe Technologies have been approved by the Audit Committee pursuant to the Company Related-Party Transactions Policy.

As of December 31, 2021, we have received a $ 100 deposit, incurred expenses of $ 169 and recognized revenue of $ 148 from Marpe.

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

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