NORTECH SYSTEMS INC 10-Q

ITEM 1. FINANCIAL STATEMENTS   NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES    CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE DATA)       THREE MONTHS ENDED     SIX MONTHS ENDED       JUNE 30,     JUNE 30,       2022     2021     2022     2021                                     Net Sales   $ 32,518     $ 30,182     $ 63,229     $ 52,254                                     Cost of Goods Sold     27,514       26,597       54,181       47,108                                     Gross Profit     5,004       3,585       9,048       5,146                                     Operating Expenses                                 Selling Expenses     960       571       1,793       1,292   General and Administrative Expenses     2,668       2,418       5,397       5,214   Research and Development Expenses     351       207       679       207   Restructuring Charges     -       77       -       296   Gain on Sale of Assets     -       ( 94 )     ( 15 )     ( 94 )                                   Total Operating Expenses     3,979       3,179       7,854       6,915                                     Income (Loss) From Operations     1,025       406       1,194       ( 1,769 )                                   Other Expense                                 Interest Expense     ( 117 )     ( 116 )     ( 215 )     ( 202 )                                   Income (Loss) Before Income Taxes     908       290       979       ( 1,971 )                                   Income Tax Expense (Benefit)     189       111       122       ( 596 )                                   Net Income (Loss)   $ 719     $ 179     $ 857     $ ( 1,375 )                                   Net Income (Loss) Per Common Share:                                                                   Basic (in dollars per share)   $ 0.27     $ 0.07     $ 0.32     $ ( 0.52 ) Weighted Average Number of Common Shares Outstanding - Basic (in shares)     2,683,131       2,658,926       2,681,931       2,659,028                                     Diluted (in dollars per share)   $ 0.25     $ 0.06     $ 0.30     $ ( 0.52 ) Weighted Average Number of Common Shares Outstanding - Diluted (in shares)     2,886,755       2,767,991       2,879,216       2,659,028                                     Other comprehensive (loss) income                                 Foreign currency translation     ( 244 )     58       ( 239 )     24   Comprehensive income (loss), net of tax   $ 475     $ 237     $ 618     $ ( 1,351 )   See Accompanying Condensed Notes to Condensed Consolidated Financial Statements   3       NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS   (IN THOUSANDS, EXCEPT SHARE DATA)       JUNE 30     DECEMBER 31,       2022      2021 (1)       (Unaudited)           ASSETS                 Current Assets                 Cash   $ 944     $ 643   Restricted Cash     231       1,582   Accounts Receivable, less allowances of $ 297 and $ 328     16,468       14,548   Employee Retention Credit Receivable     5,209       5,209   Inventories, Net     22,970       19,434   Contract Assets     9,070       8,698   Prepaid Expenses and Other Current Assets     1,563       1,660   Total Current Assets     56,455       51,774                     Property and Equipment, Net     6,144       5,833   Operating Lease Assets     8,420       8,983   Other Intangible Assets, Net     471       501   Total Assets   $ 71,490     $ 67,091                     LIABILITIES AND SHAREHOLDERS' EQUITY                 Current Liabilities                 Current Portion of Finance Lease Obligations   $ 447     $ 601   Current Portion of Operating Lease Obligations     1,099       1,043   Accounts Payable     14,108       12,710   Accrued Payroll and Commissions     3,961       4,045   Other Accrued Liabilities     4,675       3,907   Total Current Liabilities     24,290       22,306                     Long-Term Liabilities                 Long Term Line of Credit     11,360       8,959   Long Term Finance Lease Obligations, Net     734       916   Long-Term Operating Lease Obligations, Net     8,103       8,695   Other Long-Term Liabilities     100       104   Total Long-Term Liabilities     20,297       18,674                     Total Liabilities     44,587       40,980                     Commitments and Contingencies                                       Shareholders' Equity                 Preferred Stock, $1 par value; 1,000,000 Shares Authorized: 250,000 Shares Issued and Outstanding     250       250   Common Stock - $0.01 par value; 9,000,000 Shares Authorized: 2,683,513 and 2,672,064 Shares Issued and Outstanding, respectively     27       27   Additional Paid-In Capital     16,136       15,962   Accumulated Other Comprehensive (Income) Loss     ( 183 )     56   Retained Earnings     10,673       9,816   Total Shareholders' Equity     26,903       26,111   Total Liabilities and Shareholders' Equity   $ 71,490     $ 67,091     See Accompanying Condensed Notes to Condensed Consolidated Financial Statements (1) The condensed consolidated balance sheet at December 31, 2021 has been derived from the audited financial statements at that date   4       NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)       SIX MONTHS ENDED       JUNE 30,       2022     2021   CASH FLOWS FROM OPERATING ACTIVITIES                 Net Income (Loss)   $ 857     $ ( 1,375 ) Adjustments to Reconcile Net Income (Loss) to Net Cash                 Provided By (Used In) Operating Activities:                 Depreciation and Amortization     967       967   Compensation on Stock-Based Awards     141       160   Change in Accounts Receivable Allowance     ( 31 )     116   Change in Inventory Reserves     ( 103 )     ( 655 ) Gain on Sale of Assets     ( 15 )     ( 94 ) Changes in Current Operating Items                 Accounts Receivable     ( 1,986 )     ( 1,153 ) Inventories     ( 3,540 )     ( 3,719 ) Contract Assets     ( 372 )     ( 1,019 ) Prepaid Expenses and other Curent Assets     89       ( 286 ) Income Taxes     ( 63 )     ( 757 ) Accounts Payable     1,346       1,576   Accrued Payroll and Commissions     ( 84 )     686   Other Accrued Liabilities     854       120   Net Cash Used In Operating Activities     ( 1,940 )     ( 5,433 )                   CASH FLOWS FROM INVESTING ACTIVITIES                 Proceeds from Sale of Property and Equipment     15       94   Purchase of Intangible Asset     ( 41 )     ( 77 ) Purchases of Property and Equipment     ( 1,182 )     ( 659 ) Net Cash Used In Investing Activities     ( 1,208 )     ( 642 )                   CASH FLOWS FROM FINANCING ACTIVITIES                 Net Change in Line of Credit     2,394       4,339   Principal Payments on Long-Term Debt     -       ( 249 ) Principal Payments on Financing Leases     ( 336 )     ( 326 ) Debt Issuance Costs     7       -   Stock Option Excercises     33       -   Net Cash Provided By Financing Activities     2,098       3,764                     Net Change in Cash and Cash Equivalents     ( 1,050 )     ( 2,311 ) Cash and Cash Equivalents - Beginning of Period     2,225       3,564   Cash and Cash Equivalents - End of Period   $ 1,175     $ 1,253                     Reconciliation of cash and restricted cash reported within the consolidated balance sheets                 Cash   $ 944     $ 661   Restricted Cash     231       592   Total Cash and restricted cash reported in the consolidated statements of cash flows   $ 1,175     $ 1,253   Supplemental Disclosure of Cash Flow Information:                 Cash Paid During the Period for Interest   $ 198     $ 81   Cash Paid During the Period for Income Taxes     20       156                     Supplemental Noncash Investing and Financing Activities:                 Property and Equipment Purchases in Accounts Payable     52       -   Property Acquired Under Operating Lease     -       858     See Accompanying Condensed Notes to Condensed Consolidated Financial Statements     5       NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED) (IN THOUSANDS)                               Accumulated                                       Additional     Other             Total       Preferred     Common     Paid-In     Comprehensive     Retained     Shareholders'       Stock     Stock     Capital     Loss     Earnings     Equity                                                     BALANCE MARCH 31, 2021   $ 250     $ 27     $ 15,837     $ ( 71 )   $ 1,108     $ 17,151   Net Income     -       -       -       -       179       179   Foreign currency translation adjustment     -       -       -       58       -       58   Compensation on stock-based awards     -       -       25       -       -       25                                                     BALANCE JUNE 30, 2021   $ 250     $ 27     $ 15,862     $ ( 13 )   $ 1,287     $ 17,413                                                     BALANCE DECEMBER 31, 2020   $ 250     $ 27     $ 15,816     $ ( 37 )   $ 2,662     $ 18,718   Net Loss     -       -       -       -       ( 1,375 )     ( 1,375 ) Foreign currency translation adjustment     -       -       -       24       -       24   Compensation on stock-based awards     -       -       46       -       -       46                                                     BALANCE JUNE 30, 2021   $ 250     $ 27     $ 15,862     $ ( 13 )   $ 1,287     $ 17,413                                                     BALANCE MARCH 31, 2022   $ 250     $ 27     $ 16,043     $ 61     $ 9,954     $ 26,335   Net Income     -       -       -       -       719       719   Foreign currency translation adjustment     -       -       -       ( 244 )     -       ( 244 ) Compensation on stock-based awards     -       -       93       -       -       93                                                     BALANCE JUNE 30, 2022   $ 250     $ 27     $ 16,136     $ ( 183 )   $ 10,673     $ 26,903                                                     BALANCE DECEMBER 31, 2021   $ 250     $ 27     $ 15,962     $ 56     $ 9,816     $ 26,111   Net Income     -       -       -       -       857       857   Foreign currency translation adjustment     -       -       -       ( 239 )     -       ( 239 ) Stock option exercises     -       -       33       -       -       33   Compensation on stock-based awards     -       -       141       -       -       141                                                     BALANCE JUNE 30, 2022   $ 250     $ 27     $ 16,136     $ ( 183 )   $ 10,673     $ 26,903     See Accompanying Condensed Notes to Condensed Consolidated Financial Statements   6     CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED)     NOTE 1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES   Basis of Presentation The accompanying unaudited condensed consolidated financial statements for the interim periods have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the financial information and footnotes required by GAAP for complete financial statements, although we believe the disclosures are adequate to make the information presented not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10 -K for the year ended December 31, 2021. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year or for any other interim period. In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.   The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In preparing these condensed consolidated financial statements, we have made our best estimates and judgments of certain amounts included in the condensed consolidated financial statements, giving due consideration to materiality. Changes in the estimates and assumptions used by us could have a significant impact on our financial results, since actual results could differ from those estimates.   Principles of Consolidation The condensed consolidated financial statements include the accounts of Nortech Systems Incorporated and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.   Revenue Recognition Our revenue is comprised of product, engineering services and repair services. All revenue is recognized when the Company satisfies its performance obligation(s) under the contract by transferring the promised product or service to our customer either when (or as) our customer obtains control of the product or service, with the majority of our revenue being recognized over time including goods produced under contract manufacturing agreements and services revenue. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. A contract’s transaction price is allocated to each distinct performance obligation. The majority of our contracts have a single performance obligation. Revenue is recorded net of returns, allowances and customer discounts. Our net sales for services were less than 10% of our total sales for all periods presented, and accordingly, are included in net sales in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). Sales, value add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenues) basis. Shipping and handling costs charged to our customers are included in net sales, while the corresponding shipping expenses are included in cost of goods sold.   7     Stock-Based Awards   Stock Options In May 2017, the shareholders approved the 2017 Stock Incentive Plan which authorized the issuance of 350,000 shares. An additional 50,000 and 175,000 shares were authorized by the shareholders in March 2020 and May 2022, respectively.   We granted 0 and 21,000 market condition options to our Chief Executive Officer during the three and six months ended June 30, 2022, respectively. The market condition options vest if certain stock prices are exceeded between February 27, 2024 and February 27, 2028. We granted 13,000 and 66,000 service-based options during the three and six months ended June 30, 2022, respectively. Total option grants for the three and six months ended June 30, 2022 were 13,000 and 108,000 , respectively. There were 3,000 stock options granted during the six months ended June 30, 2021.   Total compensation expense related to stock options was $ 64 and $ 106 for the three and six months ended June 30, 2022, respectively. Total compensation expense related to stock options was $ 25 and $ 46 for the three and six months ended June 30, 2021. As of June 30, 2022, there was $ 851 of unrecognized compensation which will vest over the next 3.90 years.   Following is the status of all stock options as of June 30, 2022:       Shares     Weighted- Average Exercise Price Per Share     Weighted- Average Remaining Contractual Term (in years)     Aggregate Intrinsic Value (in thousands)   Outstanding - January 1, 2022     387,500     $ 4.57                   Granted     87,000       11.10                   Exercised     ( 12,000 )     3.41                   Cancelled     ( 4,400 )     3.36                   Outstanding - June 30, 2022     458,100     $ 5.82       6.97     $ 3,326   Exercisable - June 30, 2022     222,700     $ 3.93       6.12     $ 2,038     Restricted Stock Units During the three and six months ended June 30, 2022, we granted 3,000 and 21,000 restricted stock units (“RSUs”), respectively, under our 2017 Stock Incentive Plan to non-employee directors which vest over two years. There were no RSUs outstanding prior to the six months ended June 30, 2022. Total compensation expense related to the RSUs were $ 29 and $ 35 for the three and six months ended June 30, 2022, respectively. There was no compensation expense related to RSUs for the three and six months ended June 30, 2021. Total unrecognized compensation expense related to the RSUs was $ 218 , which will vest over the next 1.74 years. The RSUs granted in the six months ended June 30, 2022 had an average grant price of $ 12.00 per share with a weighted average remaining contractual term of 9.73 years. No RSUs vested during the six months ended June 30, 2022.   8     Equity Appreciation Rights Plan In November 2010, the Board of Directors adopted the Nortech Systems Incorporated Equity Appreciation Rights Plan ( “2010 Plan”). The total number of Equity Appreciation Right Units (“Units”) that can be issued under the 2010 Plan shall not exceed an aggregate of 1,000,000 Units as amended and restated on March 11, 2015. There were no units granted during the six months ended June 30, 2022 or June 30, 2021.   The 100,000 units outstanding at December 31, 2021 were paid on March 29, 2022. As of June 30, 2022, there are no units outstanding. Total compensation expense related to the vested outstanding Units based on the estimated appreciation over their remaining terms was $ 100 and $ 114 for the three and six months ended June 30, 2021, respectively.   Net Income (Loss) per Common Share Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding. Dilutive net income (loss) per common share assumes the exercise and issuance of all potential common stock equivalents in computing the weighted-average number of common shares outstanding, unless their effect is antidilutive. All stock options and restricted stock units, while outstanding, are considered common stock equivalents.   For the three and six months ended June 30, 2022, stock options of 203,625 and 197,285 , respectively were included in the computation of diluted net income per common share as their impact were dilutive. For the three months ended June 30, 2021, stock options of 109,065 were included in the computation of diluted net income per common share. For the six months ended June 30, 2021, all stock options are deemed to be antidilutive and therefore, were not included in the computation of net income per common share amount.   We had outstanding stock options totaling 45,878 and RSUs totaling 19,114 that are not considered in the computation of diluted net income per share as their effect would have been anti-dilutive for the three months ended June 30, 2022. We had average outstanding stock options totaling 48,895 and RSUs totaling 20,057 that are not considered in the computation of diluted net income per share as their effect would have been anti-dilutive for the six months ended June 30, 2022. Outstanding stock options totaling 622 are not considered in the computation of diluted net income per share for the three months ended June 30, 2021.   Restricted Cash Cash and cash equivalents classified as restricted cash on our consolidated balance sheets are restricted as to withdrawal or use under the terms of certain contractual agreements. As of June 30, 2022 we had outstanding letters of credit for $ 400 . Restricted cash as of June 30, 2022 was $ 231 . The June 30, 2022 restricted cash balance included lockbox deposits that are temporarily restricted due to timing at the period end. The lockbox deposits are applied against our line of credit the next business day.   Accounts Receivable and Allowance for Doubtful Accounts Credit is extended based upon an evaluation of the customer’s financial condition and, while collateral is not required, the Company periodically receives surety bonds that guarantee payment. Credit terms are consistent with industry standards and practices. Trade accounts receivable have been reduced by an allowance for doubtful accounts of $ 297 at June 30, 2022 and $ 328 at December 31, 2021.   9     Inventories Inventories are stated at the lower of average cost (which approximates first -in, first out) or net realizable value. Costs include material, labor, and overhead required in the warehousing and production of our products. Inventory reserves are maintained for the estimated value of the inventories that may have a lower value than stated or quantities in excess of future production needs.   Inventories are as follows:       June 30,     December 31,       2022     2021   Raw Materials   $ 21,764     $ 18,492   Work in Process     1,793       1,678   Finished Goods     608       562   Reserves     ( 1,195 )     ( 1,298 )                   Total   $ 22,970     $ 19,434     Other Intangible Assets Other intangible assets at June 30, 2022 and December 31, 2021 are as follows:       Customer Relationships     Trade Names     Patents     Total   Balance at January 1, 2021   $ 507     $ 589     $ 77     $ 1,173   Additions     -       -       64       64   Amortization     147       29       -       176   Abandonment Loss     -       560       -       560   Balance at December 31, 2021     360       -       141       501   Additions     -       -       41       41   Amortization     71       -       -       71   Balance at June 30, 2022   $ 289     $ -     $ 182     $ 471     Intangible assets are amortized on a straight-line basis over their estimated useful lives. The weighted-average remaining amortization period of our in-use intangible asset is 2.0 years. Patents are not being amortized as they are in process and a patent has not yet been received.   Amortization expense of finite life intangible assets for the three and six months ended June 30, 2022 was $ 35 and $ 71 , respectively. Amortization expense for the three and six months ended June 30, 2021 was $ 46 and $ 92 , respectively.   10     Estimated future annual amortization expense ( not including the patents in process) related to these assets is approximately as follows:   Year   Amount   Remainder of 2022   $ 72   2023     145   2024     72   Total   $ 289       Accounting Pronouncements Issued But Not Yet Adopted In June 2016, the FASB issued ASU 2016 - 13, Measurement of Credit Losses on Financial Instruments. This guidance introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The ASU also provides updated guidance regarding the impairment of available-for-sale debt securities and includes additional disclosure requirements. The new guidance is effective for public business entities that meet the definition of a Smaller Reporting Company as defined by the SEC for interim and annual periods beginning after December 15, 2022. Early adoption is permitted. We are currently evaluating the impact of this standard on our consolidated financial statements and related disclosures.       NOTE 2.    CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS   Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and accounts receivable. With regard to cash, we maintain our excess cash balances in checking accounts at primarily two financial institutions, one in the United States and one in China. The account in the United States may at times exceed federally insured limits. Of the $ 1,175 in cash and restricted cash at June 30, 2022, approximately $ 691 and $ 54 was held at banks located in China and Mexico, respectively. We grant credit to customers in the normal course of business and do not require collateral on our accounts receivable.   We have certain customers whose revenue individually represented 10% or more of net sales, or whose accounts receivable balances individually represented 10% or more of total accounts receivable. One customer accounted for 28 % and 26 % of net sales for the three and six months ended June 30, 2022, respectively. One customer accounted for 25 % and 27 % of net sales for the three and six months ended June 30, 2021, respectively.   At June 30, 2022, two customers represented approximately 37 % of our total accounts receivable. At December 31, 2021, one customer represented approximately 19 % of our total accounts receivable.   Export sales represented approximately 4 % of net sales for both the three and six months ended June 30, 2022. Export sales represented approximately 2 % and 3 % of net sales for the three and six months ended June 30, 2021 respectively.   11       NOTE 3.    REVENUE   Revenue recognition Our revenue is comprised of product, engineering services and repair services. All revenue is recognized when the Company satisfies its performance obligation(s) under the contract by transferring the promised product or service to our customer either when (or as) our customer obtains control of the product or service, with the majority of our revenue being recognized over time including goods produced under contract manufacturing agreements and services revenue. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. A contract’s transaction price is allocated to each distinct performance obligation. The majority of our contracts have a single performance obligation, as the promise to transfer products or services is not separately identifiable from other promises in the contract and, therefore, not distinct.   Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or providing services. As such, revenue is recorded net of returns, allowances and customer discounts. Sales, value add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenues) basis. Shipping and handling costs are included in cost of goods sold.   The majority of our revenue is derived from the transfer of goods produced under contract manufacturing agreements which have no alternative use and we have an enforceable right to payment for our performance completed to date. Our performance obligations within our contract manufacturing agreements are generally satisfied over time as the goods are produced based on customer specifications and we have an enforceable right to payment for the goods produced. If these requirements are not met, the revenue is recognized at a point in time, generally upon shipment. Revenue under contract manufacturing agreements that was recognized over time accounted for approximately 74 % of our revenue for both the three and six months ended June 30, 2022 and 82 % and 79 % of our revenue for the three and six months ended June 30, 2021, respectively. Revenues under these agreements are generally recognized over time using an input measure based upon the proportion of actual costs incurred.   Accounting for contract manufacturing agreements involves the use of various techniques to estimate total revenue and costs. We estimate profit on these agreements as the difference between total estimated revenue and expected costs to complete the performance obligation within the terms of the agreement and recognize the respective profit as the goods are produced. The estimates to determine the profit earned on the performance obligation are based on anticipated selling prices and historical cost of goods sold and represent our best judgement at the time. Changes in judgements on these above estimates could impact the timing and amount of revenue recognized with a resulting impact on the timing and amount of associated profit.   On occasion our customers provide materials to be used in the manufacturing process and the fair value of the materials is included in revenue as noncash consideration at the point in time when the manufacturing process commences along with the same corresponding amount recorded as cost of goods sold. The inclusion of noncash consideration has no impact on overall profitability.   12     Contract Assets Contract assets, recorded as such in the Condensed Consolidated Balance Sheets, consist of unbilled amounts related to revenue recognized over time. Significant changes in the contract assets balance during the six months ended June 30, 2022 was as follows (in thousands):   Balance outstanding at December 31, 2021   $ 8,698   Increase (decrease) attributed to:         Transferred to receivables from beginning contract assets     ( 8,360 ) Product transferred over time to ending contract assets     8,732   Balance outstanding at June 30, 2022   $ 9,070     We expect substantially all the remaining performance obligations for the contract assets recorded as of June 30, 2022 to be transferred to receivables within 90 days, with the majority of any remaining amounts to be transferred within 180 days. We bill our customers upon shipment with payment terms of up to 120 days.     The following tables summarize our net sales by market:       Three Months Ended June 30, 2022       Product/ Service Transferred Over Time     Product Transferred at Point in Time     Noncash Consideration     Total Net Sales by Market   Medical   $ 13,165     $ 4,763     $ 610     $ 18,538   Industrial     6,930       2,196       328       9,454   Aerospace and Defense     3,989       336       201       4,526   Total net sales   $ 24,084     $ 7,295     $ 1,139     $ 32,518           Three Months Ended June 30, 2021       Product/ Service Transferred Over Time     Product Transferred at Point in Time     Noncash Consideration     Total Net Sales by Market   Medical   $ 12,776     $ 3,050     $ 244     $ 16,070   Industrial     8,287       1,738       151       10,176   Aerospace and Defense     3,738       122       76       3,936   Total net sales   $ 24,801     $ 4,910     $ 471     $ 30,182     13         Six Months Ended June 30, 2022       Product/ Service Transferred Over Time     Product Transferred at Point in Time     Noncash Consideration     Total Net Sales by Market   Medical   $ 22,972     $ 9,678     $ 1,154     $ 33,804   Industrial     13,459       3,987       675       18,121   Aerospace and Defense     10,046       761       497       11,304   Total net sales   $ 46,477     $ 14,426     $ 2,326     $ 63,229           Six Months Ended June 30, 2021       Product/ Service Transferred Over Time     Product Transferred at Point in Time     Noncash Consideration     Total Net Sales by Market   Medical   $ 21,735     $ 5,942     $ 734     $ 28,411   Industrial     12,917       3,075       403       16,395   Aerospace and Defense     6,802       384       262       7,448   Total net sales   $ 41,454     $ 9,401     $ 1,399     $ 52,254         NOTE 4.    FINANCING ARRANGEMENTS   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, 2026.   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. Our line of credit bears interest at a weighted-average interest rate of 3.9 % and 3.5 % as of June 30, 2022 and December 31, 2021, respectively. We had borrowings on our line of credit of $ 11,410 and $ 9,016 outstanding as of June 30, 2022 and December 31, 2021, respectively. There are no subjective acceleration clauses under the credit agreement that would accelerate the maturity of our outstanding borrowings. The line of credit is shown net of debt issuance costs of $ 50 and $ 58 on the consolidated balance sheet for the periods ended June 30, 2022 and December 31, 2021, respectively.   The line of credit 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 ended at each Fiscal Quarter end 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. As of June 30, 2022 the Company was in compliance with its covenants.   At June 30, 2022, we had unused availability under our line of credit of $ 4,190 supported by our borrowing base. The line is secured by substantially all of our assets. 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 improved our unused availability.   14       NOTE 5.    LEASES   We have operating leases for certain manufacturing sites, office space, and equipment. Most leases include the option to renew, with renewal terms that can extend the lease term from one to five years or more. Right-of-use lease assets and lease liabilities are recognized at the commencement date based on the present value of the remaining lease payments over the lease term which includes renewal periods we are reasonably certain to exercise. Our leases do not contain any material residual value guarantees or material restrictive covenants. At June 30, 2022, we do not have material lease commitments that have not commenced.     The components of lease expense were as follows:       Three Months Ended June 30,     Three Months Ended June 30,   Lease Cost   2022     2021   Operating lease cost   $ 578     $ 589   Finance lease interest cost     17       21   Finance lease amortization expense     183       163   Total lease cost   $ 778     $ 773           Six Months Ended June 30,     Six Months ended June 30,   Lease Cost   2022     2021   Operating lease cost   $ 1,159     $ 1,120   Finance lease interest cost     36       43   Finance lease amortization expense     365       326   Total lease cost   $ 1,560     $ 1,489       Supplemental balance sheet information related to leases was as follows:     Balance Sheet Location   June 30, 2022     December 31, 2021   Assets                   Operating lease assets Operating lease assets   $ 8,420     $ 8,983   Finance lease assets Property, plant and equipment     1,867       2,052                     Total leased assets   $ 10,287     $ 11,035       Supplemental cash flow information related to leases was as follows:       June 30,     June 30,       2022     2021   Operating leases                 Cash paid for amounts included in the measurement of lease liabilities   $ 862     $ 821   Right-of-use assets obtained in exchange for lease obligations   $ -     $ 858     15     Maturities of lease liabilities were as follows:     Operating Leases     Finance Leases     Total   Remaining 2022   $ 871     $ 293     $ 1,164   2023     1,789       409       2,198   2024     1,507       357       1,864   2025     1,255       103       1,358   2026     1,217       115       1,332   Thereafter     7,066       -       7,066   Total lease payments   $ 13,705     $ 1,277     $ 14,982   Less: Interest     ( 4,504 )     ( 96 )     ( 4,600 ) Present value of lease liabilities   $ 9,201     $ 1,181     $ 10,382       The lease term and discount rate at June 30, 2022 were as follows:   Weighted-average remaining lease term (years)         Operating leases     9.2   Finance leases     2.6   Weighted-average discount rate         Operating leases     7.7 % Finance leases     5.2 %     NOTE 6.    INCOME TAXES   On a quarterly basis, we estimate what our effective tax rate will be for the full fiscal year and record a quarterly income tax provision based on the anticipated rate. As the year progresses, we refine our estimate based on the facts and circumstances, including discrete events, by each tax jurisdiction.   Our effective tax rate for the three and six months ended June 30, 2022 was 21 % and 12 %, respectively. The effective tax rate for the three and six months ended June 30, 2021 was 38 % and 30 %, respectively. The primary driver of the change in the effective tax rate is attributable to a US loss compared to income from the foreign entities.     NOTE 7.    RESTRUCTURING CHARGES   During the first six months of 2021, we recorded restructuring charges of $ 296  related to the consolidation of our production facilities and closure of our Merrifield, Minnesota facility. We had a gain on sale of assets of $ 15 and $ 94 in the six months ended June 30, 2022 and 2021, respectively, related to the sale of machinery and equipment. There were no restructuring charges or amounts accrued in the six months ended June 30, 2022.   16       NOTE 8.    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.   At June 30, 2022 and December 31, 2021, the Company has ERC benefits of $ 5,209 within Employee Retention Credits Receivable on the condensed consolidated balance sheet.     NOTE 9.    RELATED PARTY TRANSACTIONS   David Kunin, our Chairman, is a minority owner of Abilitech Medical, Inc. Mr. Kunin also was a consultant to Abilitech, which relationship ended on March 1, 2021. In the three and six months ended June 30, 2022, Abilitech paid the Company $ 163 and $ 217 , respectively, for delivery of medical products. In the three and six months ended June 30, 2021, Abilitech paid the Company $ 472 and $ 740 , respectively for the 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.   David Kunin, our Chairman, is a 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. Mr. 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. 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 no cost to Marpe Technologies. The total value of the contribution will not exceed $500; the Company has contributed $ 182 as of June 30, 2022. 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. During the six months ended June 30, 2022, we recognized revenue of $ 113 . There was no revenue recognized for the six months ended June 30, 2021. 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.   17     ITEM 2.       MANAGEMENT ’ S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   Overview   We are a Minnesota, United States based full-service global EMS contract manufacturer in the Medical, Aerospace & Defense and Industrial markets offering a full range of value-added engineering, technical and manufacturing services and support including project management, design, testing, prototyping, manufacturing, supply chain management and post-market services. Our products are complex electromedical and electromechanical products including medical devices, wire and cable assemblies, printed circuit board assemblies, higher-level assemblies, and other box builds for a wide range of industries. We serve three major markets within the EMS industry: Aerospace and Defense, Medical, and the Industrial market which includes industrial capital equipment, transportation, vision, agriculture, oil and gas. We maintain facilities in Bemidji, Blue Earth, Mankato, and Milaca, Minnesota; Monterrey, Mexico; and Suzhou, China. All of our facilities are certified to one or more of the ISO/AS standards, including 9001, AS9100 and 13485, with most having additional certifications based on the needs of the customers they serve.   Recent Developments   Global Pandemic The COVID-19 pandemic continued to impact our business in the first six months of 2022, primarily by continued supply chain disruptions and delays. The full extent to which COVID-19 will 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.   We will continue to assess the current and potential impacts 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.   18     Results of Operations   The following table presents statements of operations data as percentages of total net sales for the periods indicated:       Three Months Ended     Six Months Ended       June 30,     June 30,       2022     2021     2022     2021   Net Sales     100.0 %     100.0 %     100.0 %     100.0   Cost of Goods Sold     84.6       88.1       85.7       90.1   Gross Profit     15.4       11.9       14.3       9.9                                     Selling Expenses     2.9       1.9       2.8       2.5   General and Administrative Expenses     8.2       8.0       8.5       10.0   R&D Expenses     1.1       0.7       1.1       0.4   Restructuring Charges     -       0.3       -       0.6   Gain on Sale of Property and Equipment     0.0       (0.3 )     0.0       (0.2 ) Income (Loss) from Operations     3.2       1.3       1.9       (3.4 )                                   Interest Expense     (0.4 )     (0.3 )     (0.3 )     (0.4 ) Income (Loss) Before Income Taxes     2.8       1.0       1.6       (3.8 )                                   Income Tax Expense (Benefit)     0.6       0.4       0.2       (1.2 ) Net (Loss) Income     2.2 %     0.6 %     1.4 %     (2.6 )%   Net Sales   Net sales for the three months ended June 30, 2022 and 2021 were $32.5 and $30.2 million, respectively, an increase of $2.3 million or 8%. Net sales for the six months ended June 30, 2022 and 2021 were $63.2 million and $52.3 million, respectively, an increase of $11.0 million or 21.0%. The three and six month increases were driven by increased demand as well as price increases to counteract higher material and labor cost. We have also taken actions to scale the direct labor workforce and strengthen the supply chain for parts.   Net sales to medical and defense customers increased compared to prior year for both the three and six month periods ended June 30, 2022. Sales to industrial customers decreased in the three months ended June 30, 2022 versus the same period in the prior year primarily due to supply chain challenges for electronic components.   19     Net sales by our major EMS industry markets for the three and six months ended June 30, 2022 and 2021 were as follows (in millions):       Three Months Ended June 30,     Six Months Ended June 30,       2022     2021     % Change     2022     2021     % Change   Medical   $ 18.9     $ 16.1       17.4     $ 33.8     $ 28.4       19.0   Industrial     9.4       10.2       (7.8 )     18.1       16.4       10.4   Aerospace and Defense     4.2       3.9       7.7       11.3       7.5       50.7   Total Net Sales   $ 32.5     $ 30.2       7.6     $ 63.2     $ 52.3       20.8       Net sales by timing of transfer of goods and services for the three and six months ended June 30, 2022 is as follows (in millions):       Three Months Ended June 30, 2022       Product/ Service Transferred Over Time     Product Transferred at Point in Time     Noncash Consideration     Total Net Sales by Market   Medical   $ 13.2     $ 4.8     $ 0.6     $ 18.6   Industrial     6.9       2.2       0.3       9.4   Aerospace and Defense     3.9       0.4       0.2       4.5   Total net sales     24.0       7.4       1.1       32.5           Six Months Ended June 30, 2022       Product/ Service Transferred Over Time     Product Transferred at Point in Time     Noncash Consideration     Total Net Sales by Market   Medical   $ 23.0     $ 9.7     $ 1.1     $ 33.8   Industrial     13.4       4.0       0.7       18.1   Aerospace and Defense     10.0       0.8       0.5       11.3   Total net sales   $ 46.4     $ 14.5     $ 2.3     $ 63.2     20     Net sales by timing of transfer of goods and services for the three and six months ended June 30, 2021 is as follows (in millions):       Three Months Ended June 30, 2021       Product/ Service Transferred Over Time     Product Transferred at Point in Time     Noncash Consideration     Total Net Sales by Market   Medical   $ 12.8     $ 3.1     $ 0.2     $ 16.1   Industrial     8.3       1.7       0.2       10.2   Aerospace and Defense     3.7       0.1       0.1       3.9   Total net sales   $ 24.8     $ 4.9     $ 0.5     $ 30.2           Six Months Ended June 30, 2021       Product/ Service Transferred Over Time     Product Transferred at Point in Time     Noncash Consideration     Total Net Sales by Market   Medical   $ 21.7     $ 6.0     $ 0.7     $ 28.4   Industrial     12.9       3.1       0.4       16.4   Aerospace and Defense     6.8       0.4       0.3       7.5   Total net sales   $ 41.4     $ 9.5     $ 1.4     $ 52.3     21     Backlog   Our 90-day shipment backlog as of June 30, 2022 was $35.9 million, a 1.2% increase from the beginning of the quarter and a 3.5% increase from June 30, 2021. Our backlog consists of firm purchase orders we expect to ship in the next 90 days, with any remaining amounts to be transferred within 180 days.   Our 90-day shipment backlog by market has remained relatively constant when compared to the prior quarter end and the same period of the prior year. 90-day shipment backlog by our major industry markets are as follows (in millions):       Shipment Backlog as of the Period Ended       June 30     March 31     June 30       2022     2022     2021   Medical   $ 20.9     $ 19.7     $ 18.9   Industrial     9.8       9.7       9.8   Aerospace and Defense     5.2       6.0       6.0   Total 90-Day Backlog   $ 35.9     $ 35.4     $ 34.7     Our 90-day backlog varies due to order size, manufacturing delays, contract terms and conditions and timing from customer delivery schedules and releases. These variables cause inconsistencies in comparing the backlog from one period to the next. Our total shipment backlog was $106.2 million and $71.5 million as of June 30, 2022 and 2021, respectively. This backlog contains the contract asset value of $9.1 million which have been recognized as revenue.   Gross Profit   Gross profit as a percent of net sales was 15.4% and 11.9% for the three months ended June 30, 2022 and 2021, respectively. Gross profit as a percent of net sales was 14.3% and 9.9% for the six months ended June 30, 2022 and 2021, respectively. The gross profit improvement was primarily driven by price increases in response to material and labor cost inflation as well as higher production volume which increased plant utilization.   Selling Expense   Selling expenses for the three months ended June 30, 2022 and 2021 were $1.0 million or 2.9% of sales and $0.6 million or 1.9% of sales, respectively. Selling expenses for the six months ended June 30, 2022 and 2021 were $1.8 million or 2.8% of sales and $1.3 million or 2.5% of sales, respectively. The increase in selling expense for the three and six months ended June 30, 2022 compared to the same periods of the prior year relates to an increase in headcount to support the increased sales.   General and Administrative Expense   General and administrative expenses for the three months ended June 30, 2022 and 2021 were $2.7 million or 8.2% of sales and $2.4 million or 8.0% of sales, respectively. General and administrative expenses for the six months ended June 30, 2022 and 2021 were $5.4 million or 8.5% of sales and $5.2 million or 10.0% of sales, respectively. General and administrative expenses for the three and six months ended June 30, 2022 were held relatively flat compared to the same periods of the prior year, and are generally fixed in nature.   22     Restructuring Charges   Restructuring charges for the three and six months ended June 30, 2021 were $0.1 million and $0.3 million, respectively. There were no restructuring charges for the three and six months ended June 30, 2022. The restructuring charges relate to the closure of the Merrifield facility during 2021.   Research and Development Expense   Research and development expenses were $0.4 million or 1.1% of net sales for the three months ended June 30, 2022 and $0.7 million or 1.1% of net sales for the six months ended June 30, 2022. Research and development expenses for both the three and six months ended June 30, 2021 was $0.2 million.   Income (Loss) From Operations   Income from operations for the three months ended June 30, 2022 was $1.0 million compared to $0.4 million for the three months ended June 30, 2021. Income from operations for the six months ended June 30, 2022 was $1.2 million compared to a loss from operations of $1.8 million for the six months ended June 30, 2021. The three and six month improvements compared to the same periods of the prior year were driven by the increase in sales and gross margin as a percent of sales.   Interest Expense   Interest expense was $0.1 million for both the three months ended June 30, 2022 and 2021. Interest expense was $0.2 million for both the six months ended June 30, 2022 and 2021.   Income Taxes   On a quarterly basis, we estimate what our effective tax rate will be for the full fiscal year and record a quarterly income tax provision based on the anticipated rate. As the year progresses, we refine our estimate based on the facts and circumstances, including discrete events, by each tax jurisdiction.   Our effective tax rate for the three and six months ended June 30, 2022 was 21% and 12%, respectively. The effective tax rate for the three and six months ended June 30, 2021 was 38% and 30%, respectively. The primary driver of the change in the effective tax rate is attributable to a US loss compared to income from the foreign entities.   Net Income (Loss)   Net income for the three months ended June 30, 2022 was $719 thousand or $0.27 per basic common share and $0.25 per diluted common share. Net income for the three months ended June 30, 2021 was $179 thousand or $0.07 per basic common share and $0.06 per diluted common share. Net income for the six months ended June 30, 2022 was $857 thousand or $0.32 per basic common share and $0.30 per diluted common share. Net loss for the six months ended June 30, 2021 was ($1,375) thousand or ($0.52) per basic and diluted common share.   Liquidity and Capital Resources   We believe that our existing financing arrangements, anticipated cash flows from operations, funds expected to be received for the ERC and cash on hand will be sufficient to satisfy our working capital needs for the next twelve months, capital expenditures and debt repayments.   23     Credit Facility   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 $16.0 million that expires on June 15, 2026.   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. Our line of credit bears interest at a weighted-average interest rate of 3.9% and 3.5% as of June 30, 2022 and December 31, 2021, respectively. We had borrowings on our line of credit of $11.4 million and $9.0 million outstanding as of June 30, 2022 and December 31, 2021, respectively. There are no subjective acceleration clauses under the credit agreement that would accelerate the maturity of our outstanding borrowings. The line of credit is shown net of debt issuance costs of $50 thousand and $58 thousand on the consolidated balance sheet for the periods ended June 30, 2022 and December 31, 2021, respectively.   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 ended at each Fiscal Quarter end 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. As of June 30, 2022 the Company was in compliance with its covenants.   At June 30, 2022, we had unused availability under our line of credit of $4.2 million supported by our borrowing base. The line is secured by substantially all of our assets. 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 improved our unused availability.   Off-Balance Sheet Arrangements   We have not engaged in any off-balance sheet activities as defined in Item 303(a)(4) of Regulation S-K.   Critical Accounting Policies and Estimates   Our significant accounting policies and estimates are summarized in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2021. Some of our accounting policies require us to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. Such judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, known trends in our industry, terms of existing contracts and other information from outside sources, as appropriate. Actual results could differ from these estimates.   24     Forward-Looking Statements   Those statements in the foregoing report that are not historical facts are forward-looking statements made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995.     ♦ Volatility in the marketplace which may affect market supply, demand of our products, labor rates or currency exchange rates;   ♦ Supply chain disruption and unreliability;   ♦ Lack of supply of sufficient human resources to produce our products;   ♦ Increased competition from within the EMS industry or the decision of OEMs to cease or limit outsourcing;   ♦ Changes in the reliability and efficiency of our operating facilities or those of third parties;   ♦ Increases in certain raw material costs such as copper and oil;   ♦ Commodity and energy cost instability;   ♦ Risks related to FDA noncompliance;   ♦ The loss of a major customer;   ♦ General economic, financial and business conditions that could affect our financial condition and results of operations;   ♦ Increased or unanticipated costs related to compliance with securities and environmental regulation;   ♦ Disruption of global or local information management systems due to natural disaster or cyber-security incident;   ♦ Outbreaks of epidemic, pandemic, or contagious diseases, such as the recent novel coronavirus that affect our operations, our customers' operations or our suppliers' operations.   The factors identified above are believed to be important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement made by us. Discussion of these factors is also incorporated in Part I, Item 1A, “Risk Factors,” and should be considered an integral part of Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Unpredictable or unknown factors not discussed herein could also have material adverse effects on forward-looking statements. All forward-looking statements included in this Form 10-K are expressly qualified in their entirety by the forgoing cautionary statements. We undertake no obligations to update publicly any forward-looking statement (or its associated cautionary language) whether as a result of new information or future events.   Please refer to forward-looking statements and risks as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.   25     ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK   Not applicable.