NORTECH SYSTEMS INC 10-K

Item 8. Financial Statements and Supplementary Data       PAGE     Report of Independent Registered Public Accounting Firm (PCAOB Firm ID 23 ) 29     Consolidated Financial Statements:       Consolidated Statements of Income and Comprehensive Income for the years ended December 31, 2022 and 2021 31     Consolidated Balance Sheets as of December 31, 2022 and 2021 32     Consolidated Statements of Cash Flows for the years ended December 31, 2022 and 2021 33     Consolidated Statements of Shareholders' Equity for the years  ended December 31, 2022 and 2021 34     Notes to Consolidated Financial Statements 35-55     (The remainder of this page was intentionally left blank.)   28     REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   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, 2022 and 2021, the related consolidated statements of income and comprehensive income, 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, 2022 and 2021, and the results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.   Basis for Opinion   These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.   We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.   Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.   29     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   We have served as the Company's auditor since 2017.   Minneapolis, Minnesota   March 17, 2023   30       NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE DATA)       2022     2021                     Net Sales   $ 134,123     $ 115,168                     Cost of Goods Sold     113,643       99,304                     Gross Profit     20,480       15,864                     Operating Expenses:                 Selling Expenses     3,719       2,361   General and Administrative Expenses     11,425       10,002   Restructuring Expenses     -       327   R&D Expenses     1,463       483   Loss on Abandonment of Intangible Asset     -       560   Gain on Sale of Property and Equipment     ( 15 )     ( 141 ) Total Operating Expenses     16,592       13,592                     Income from Operations     3,888       2,272                     Other (Expense) Income                 Interest Expense     ( 411 )     ( 430 ) PPP Loan Forgiviness Gain     -       6,171   Total Other (Expense) Income     ( 411 )     5,741                     Income Before Income Taxes     3,477       8,013                     Income Tax Expense     1,467       859                     Net Income   $ 2,010     $ 7,154                     Income Per Common Share:                 Basic   $ 0.75     $ 2.68   Weighted Average Number of Common Shares Outstanding - Basic     2,685,378       2,664,586                     Diluted   $ 0.70     $ 2.54   Weighted Average Number of Common Shares Outstanding - Dilutive     2,891,285       2,821,523                     Other comprehensive income                 Foreign currency translation     ( 426 )     93   Comprehensive income, net of tax   $ 1,584     $ 7,247     See accompanying notes to consolidated financial statements   31       NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE DATA)       2022     2021   ASSETS                 Current Assets                 Cash   $ 1,027     $ 643   Restricted Cash     1,454       1,582   Accounts Receivable, less allowances of $ 334 and $ 328     15,975       14,548   Employee Retention Credit Receivable     2,650       5,209   Inventories, Net     22,438       19,434   Contract Assets     9,982       8,698   Prepaid Assets     1,334       1,660   Total Current Assets     54,860       51,774                     Property and Equipment, Net     6,408       5,833   Operating Lease Assets     7,850       8,983   Other Intangible Assets, Net     422       501   Total Assets   $ 69,540     $ 67,091                     LIABILITIES AND SHAREHOLDERS' EQUITY                 Current Liabilities                 Current Portion of Finance Lease Obligations   $ 390     $ 601   Current Portion of Operating Leases     1,155       1,043   Accounts Payable     14,792       12,710   Accrued Payroll and Commissions     4,803       4,045   Other Accrued Liabilities     5,258       3,907   Total Current Liabilities     26,398       22,306                     Long-Term Liabilities                 Long-term Line of Credit     6,853       8,959   Long-Term Finance Lease Obligations, Net of Current Portion     565       916   Long-Tem Operating Lease Obligations, Net of current Portion     7,549       8,695   Other Long-Term Liabilities     95       104   Total Long-Term Liabilities     15,062       18,674   Total Liabilities     41,460       40,980                     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; 2,690,633 and 2,672,064 Shares Issued and Outstanding, respectively     27       27   Additional Paid-In Capital     16,347       15,962   Accumulated Other Comprehensive (Loss) Income     ( 370 )     56   Retained Earnings     11,826       9,816   Total Shareholders' Equity     28,080       26,111   Total Liabilities and Shareholders' Equity   $ 69,540     $ 67,091     See accompanying notes to consolidated financial statements   32       NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS)       2022     2021   CASH FLOWS FROM OPERATING ACTIVITIES                 Net Income   $ 2,010     $ 7,154   Adjustments to Reconcile Net Income to Net Cash                 Provided by (Used In) Operating Activities:                 Depreciation     1,768       1,774   Amortization     150       176   Compensation on Stock-Based Awards     334       111   Compensation on Equity Appreciation Rights     -       143   Loss on Abandonment of Intangible Asset     -       560   Change in Accounts Receivable Allowance     6       ( 15 ) Change in Inventory Reserves     ( 149 )     ( 860 ) Gain on Disposal of Property and Equipment     ( 15 )     ( 141 ) PPP Loan Forgiveness Gain     -       ( 6,171 ) Foreign Currency Transaction Gain     ( 72 )     -   Changes in Current Operating Items                 Accounts Receivable     ( 1,746 )     1,134   Employee Retention Credit Receivable     2,574       ( 5,209 ) Inventories     ( 2,985 )     ( 4,613 ) Contract Assets     ( 1,283 )     ( 2,799 ) Prepaid Expenses and other Curent Assets     317       ( 171 ) Income Taxes     643       634   Accounts Payable     2,216       1,471   Accrued Payroll and Commissions     783       1,176   Other Accrued Liabilities     851       1,106   Net Cash Provided by (Used In) Operating Activities     5,402       ( 4,540 )                   CASH FLOWS FROM INVESTING ACTIVITIES                 Proceeds from Sale of Property and Equipment     15       626   Purchase of Intangible Asset     ( 71 )     ( 64 ) Purchases of Property and Equipment     ( 2,370 )     ( 1,292 ) Net Cash Used In Investing Activities     ( 2,426 )     ( 730 )                   CASH FLOWS FROM FINANCING ACTIVITIES                 Proceeds from Line of Credit     119,349       109,544   Payments to Line of Credit     ( 121,468 )     ( 103,856 ) Principal Payments on Long-Term Debt     -       ( 1,128 ) Principal Payments on Financing Leases     ( 599 )     ( 664 ) Stock Option Excercises     51       35   Net Cash (Used In) Provided By Financing Activities     ( 2,667 )     3,931                     Effect of Exchange Rate Changes on Cash     ( 53 )     -                     Net Change in Cash and Cash Equivalents     256       ( 1,339 ) Cash and Cash Equivalents - Beginning of Year     2,225       3,564   Cash and Cash Equivalents - End of Year   $ 2,481     $ 2,225                     Reconciliation of cash and restricted cash reported within the consolidated balance sheets                 Cash   $ 1,027     $ 643   Restricted Cash     1,454       1,582   Total Cash and restricted cash reported in the consolidated statements of cash flows   $ 2,481     $ 2,225         2022     2021                     Supplemental Disclosure of Cash Flow Information:                 Cash Paid for Interest   $ 476     $ 316   Cash Paid (Refunded) for Income Taxes     237       ( 114 )                   Supplemental Noncash Investing and Financing Activities:                 Property and Equipment Purchases in Accounts Payable   $ 14     $ 35   Property Acquired under Operating Lease     44       1,188   Equipment Acquired under Finance Lease     41       368   PPP Loan Forgiveness     -       6,171     See accompanying notes to consolidated financial statements   33       NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS ’ EQUITY FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS)                               Accumulated                                       Additional     Other             Total       Preferred     Common     Paid-In     Comprehensive     Retained     Shareholders'       Stock     Stock     Capital     Income (Loss)     Earnings     Equity   BALANCE DECEMBER 31, 2020   $ 250     $ 27     $ 15,816     $ ( 37 )   $ 2,662     $ 18,718   Net Loss     -       -       -       -       7,154       7,154   Foreign Currency Translation Adjustment     -       -       -       93       -       93   Stock Option Exercises     -       -       35       -               35   Compensation on Stock-based awards     -       -       111       -       -       111                                                     BALANCE DECEMBER 31, 2021     250       27       15,962       56       9,816       26,111   Net Income     -       -       -       -       2,010       2,010   Foreign Currency Translation Adjustment     -       -       -       ( 426 )     -       ( 426 ) Stock Option Exercises     -       -       51       -       -       51   Compensation on stock-based awards     -       -       334       -       -       334                                                     BALANCE DECEMBER 31, 2022   $ 250     $ 27     $ 16,347     $ ( 370 )   $ 11,826     $ 28,080     See accompanying notes to consolidated financial statements   34     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)     NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES   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”).   Nature of Business Our manufacturing services include complete medical devices, printed circuit board assemblies, wire and cable assemblies, and complex higher-level electromechanical assemblies for a wide range of medical, industrial and defense and aerospace industries. We provide a full "turn-key" contract manufacturing service to our customers. All products are built to the customer's design specifications. We also provide engineering services and repair services.   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. and Nortech Systems Hong Kong Company, Limited and its subsidiary, Nortech Systems Suzhou Company, Limited. All significant intercompany accounts and transactions have been eliminated in consolidation.   Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of our consolidated financial statements. Estimates also affect the reported amounts of revenue and expense during the reporting period. Significant items subject to estimates and assumptions include the valuation allowance for inventories, allowance for doubtful accounts, realizability of deferred tax assets and long-lived asset impairment testing. Actual results could differ from those estimates.   Restricted Cash Cash and cash equivalents classified as restricted cash on our consolidated balance sheets are restricted as to withdrawal or use under the terms of certain contractual agreements. As of December 31, 2022 we had outstanding letters of credit for $ 300 . Restricted cash as of December 31, 2022 and December 31, 2021 was $ 1,454 and $ 1,582 , respectively. The December 31, 2022 and 2021 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.   35     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   Accounts Receivable and Allowance for Doubtful Accounts We grant credit to customers in the normal course of business. Accounts receivable are unsecured and are presented net of an allowance for doubtful accounts. The allowance for doubtful accounts was $ 334 and $ 328 at December 31, 2022 and 2021, 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.   Employee Retention Credit (ERC) and Payroll Tax Deferral 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 Company qualified and applied for the ERC in 2021 for the first and second quarters of that year. The Company has elected to account for the credit as a government grant. U.S. GAAP does 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.   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, 2022, 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 or during 2022 due to our awaiting receipt of the anticipated credits under the ERC that exceeds the deferral amount as allowed under the above IRS Notices. The deferred amounts are recorded within accrued payroll and commissions on the condensed consolidated balance sheets.   Inventories Inventories consist of finished goods, raw materials and work-in-process and are stated at the lower of average cost (which approximates first-in, first-out) or net realizable value. Costs include material, labor, and overhead required in the production of our products. Inventory reserves are maintained for inventories that may have a lower value than stated or quantities in excess of future production needs.   We regularly review inventory quantities on-hand for excess and obsolete inventory and, when circumstances indicate, incur charges to write down inventories to their net realizable value. The determination of a reserve for excess and obsolete inventory involves management exercising judgment to determine the required reserve, considering future demand, product life cycles, introduction of new products and current market conditions.   36     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   Inventories are as follows:       2022     2021   Raw materials   $ 21,673     $ 18,492   Work in process     1,238       1,678   Finished goods     671       562   Reserves     ( 1,144 )     ( 1,298 ) Total   $ 22,438     $ 19,434     Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Additions, improvements and major renewals are capitalized, while maintenance and minor repairs are expensed as incurred. When assets are retired or disposed of, the assets and related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected in operations. Leasehold improvements are depreciated over the shorter of their estimated useful lives or their remaining lease terms. All other property and equipment are depreciated by the straight-line method over their estimated useful lives, as follows:       (in years)   Buildings       39     Leasehold improvements     3 - 15   Manufacturing equipment     3 - 7   Office and other equipment     3 - 7     Property and equipment at December 31, 2022 and 2021:       2022     2021   Land   $ 148     $ 148   Building and Leasehold Improvements     5,289       4,083   Manufacturing Equipment     19,128       18,892   Office and Other Equipment     6,822       6,934   Accumulated Depreciation and Amortization     ( 24,979 )     ( 24,224 ) Total Property and Equipment, Net   $ 6,408     $ 5,833     Long-Lived Asset Impairment We evaluate long-lived assets, primarily property and equipment, as well as the related depreciation periods, whenever current events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability for assets to be held and used is based on our projection of the undiscounted future operating cash flows of the underlying assets or asset group. To the extent such projections indicate that future undiscounted cash flows are not sufficient to recover the carrying amounts of related assets, a charge might be required to reduce the carrying amount to equal estimated fair value. Assets held for sale are reported at the lower of the carrying amount or fair value less costs to dispose. No impairments of long-lived assets were recorded during the years ended December 31, 2022 and 2021.   37     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   Preferred Stock Preferred stock issued is non-cumulative and nonconvertible. The holders of the preferred stock are entitled to a non-cumulative dividend of 12 % when and if declared. In liquidation, holders of preferred stock have preference to the extent of $ 1.00 per share plus dividends accrued but unpaid. No preferred stock dividends were declared or paid during the years ended December 31, 2022 and 2021.   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.   Goods created for customers with no alternative use and enforceable right to a payment of cost plus a reasonable margin, revenue is recognized over time instead of at a point in time. Revenue is recorded net of returns, allowances and customer discounts. Our net sales for services were less than 10% of our total sales for all periods presented, and accordingly, are included in net sales in the Consolidated Statements of Operations and Comprehensive 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.   Product Warranties We provide limited warranty for the replacement or repair of defective product within a specified time period after the sale at no cost to our customers. We make no other guarantees or warranties, expressed or implied, of any nature whatsoever as to the goods including, without limitation, warranties to merchantability, fit for a particular purpose or non-infringement of patent or the like unless agreed upon in writing. We estimate the costs that may be incurred under our limited warranty and provide a reserve based on actual historical warranty claims coupled with an analysis of unfulfilled claims at the balance sheet date. Our warranty claim costs are not material given the nature of our products and services.   Advertising Advertising costs are charged to operations as incurred. The total amount charged to expense was $ 63 and $ 57 for the years ended December 31, 2022 and 2021, respectively.   Income Taxes We account for income taxes under the asset and liability method. Deferred income tax assets and liabilities are recognized annually for differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. We recognize interest and penalties accrued on any unrecognized tax benefits as a component on income tax expense.   38     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. Management must also assess whether uncertain tax positions as filed could result in the recognition of a liability for possible interest and penalties if any. Our estimates are based on the information available to us at the time we prepare the income tax provisions. Our income tax returns are subject to audit by federal, state, and local governments, generally three years after the returns are filed. These returns could be subject to material adjustments or differing interpretations of the tax laws.   Incentive Compensation We use a Black-Scholes option-pricing model to determine the grant date fair value of our service-based incentive awards and recognize the expense on a straight-line basis over the vesting period. We determine the grant date fair value of our market-based incentive awards using a lattice simulation model and recognize the expense on a straight-line basis over the vesting period. The grant date fair value of restricted stock units is determined based on the closing market price of the Company's common stock on the date of grant, with compensation expense recognized ratably over the applicable vesting period. See Note 8 for additional information.   Net Income Per Common Share Basic net income 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. For the year ended December 31, 2022, stock options of 205,907 were included in the computation of diluted income per common share as their impact were dilutive. 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.   Fair Value of Financial Instruments The carrying amounts of all financial instruments approximate their fair values. The carrying amounts for cash, accounts receivable, ERC receivable, accounts payable, and other assets and liabilities approximate fair value because of the short maturity of these instruments. Based on the borrowing rates currently available to us for bank loans with similar terms and average maturities, the carrying value of our long-term debt and line of credit approximates its fair value.   Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs.   The fair value framework requires the categorization of assets and liabilities into one of three levels based on the assumptions (inputs) used in valuing the asset or liability. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. The three levels are defined as follows:   Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities.   Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.   39     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   Level 3: 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. We endeavor to use the best available information in measuring fair value. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. See Note 4, Other Intangible Assets, for more detail.   Enterprise-Wide Disclosures Our results of operations for the years ended December 31, 2022 and 2021 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 4.0 % and 3.1 % of consolidated net sales for the years ended December 31, 2022 and 2021, respectively.   Net sales by our major EMS industry markets for the years ended December 31, 2022 and 2021 are as follows:       2022     2021   Medical   $ 75,907     $ 63,047   Aerospace and Defense     19,479       16,639   Industrial     38,737       35,482   Total Net Sales   $ 134,123     $ 115,168     Noncurrent assets, excluding deferred taxes, by country are as follows:       United States     Mexico     China     Total   December 31, 2022                                 Property and Equipment, Net   $ 5,109     $ 494     $ 805     $ 6,408   Operating Lease Assets   $ 5,381       2,469       -     $ 7,850   Other Assets   $ 422       -       -     $ 422                                     December 31, 2021                                 Property and Equipment, Net   $ 4,664     $ 454     $ 715     $ 5,833   Operating Lease Assets   $ 5,287       2,800       896     $ 8,983   Other Assets   $ 501       -       -     $ 501     40     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   Foreign Currency Transactions The functional currency for our Mexico subsidiary is the US dollar. 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 decreased shareholders’ equity by $ 426 and increased shareholder’s equity by $ 93 for the years ended December 31, 2022 and 2021, 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. Net foreign currency transaction losses included in the determination of net earnings was $ 42 and $ 131 for the years ended December 31, 2022 and 2021, respectively.   Recently Issued Accounting Standards 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. We have evaluated the impact of this standard on our consolidated financial statements and related disclosures and conclude it will not be material.   Revision and Immaterial Correction of an Error in Previously Issued Financial Statements The Company identified an error related to the classification of the activity on our line of credit facility with Bank of America at December 31, 2021 as reported on Form 10-K.  In our December 31, 2021 consolidated financial statements, we incorrectly classified borrowings and payments on our line of credit facility on a net basis within the financing section of the consolidated cash flow statement; this activity should be shown on a gross basis.  This change in presentation to the consolidated cash flow statement does not impact total operating, investing, or financing cash flows.  There was no change to the consolidated statement of income or consolidated balance sheet.  In accordance with ASC 250, Accounting Changes and Error Corrections, we evaluated the materiality of the errors from quantitative and qualitative perspectives and concluded that the errors were immaterial to the Company’s 2022 audited financial statements. Since these revisions were not material to any prior period financial statements, no amendments to previously filed financial statements are required. Consequently, the Company has corrected  these immaterial errors by revising the December 31, 2021 consolidated financial statements presented herein.   The tables below present the effect of the financial statement adjustments related to the revision discussed above of the Company’s previously reported financial statements as of and for the periods ended December 31, 2021.   The effect of the immaterial correction of an error on our previously filed audited consolidated financial statements as of December 31, 2021 and for the year then ended is as follows:   Consolidated Statements of Cash Flows                             December 31, 2021   CASH FLOWS FROM FINANCING ACTIVITIES   As reported     Adjustment     As revised   Net Proceeds from Line of Credit     5,688       ( 5,688 )     -   Proceeds from Line of Credit     -       109,544       109,544   Payments to Line of Credit     -       ( 103,856 )     ( 103,856 ) Principal Payments on Long-Term Debt     ( 1,128 )             ( 1,128 ) Principal Payments on Financing Leases     ( 664 )             ( 664 ) Stock Option Excercises     35               35   Net Cash Provided By Financing Activities     3,931       -       3,931         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 two high-credit quality financial institutions. These accounts may at times exceed federally insured limits. 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 26.9 % of net sales for both of the years ended December 31, 2022 and 2021. Accounts receivable for one customer was 21.1 % and 19.3 % at December 31, 2022 and 2021, respectfully.   41     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)     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 72 % and 78 % of our revenue for the years ended December 31, 2022 and 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.   42     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   Contract Assets Contract assets, recorded as such in the Consolidated Balance Sheet, consist of unbilled amounts related to revenue recognized over time. Significant changes in the contract assets balance during the years ended December 31, 2022 and 2021 was as follows:   Balance outstanding at December 31, 2021   $ 8,698   Increase (decrease) attributed to:         Amounts transferred over time to contract assets     96,924   Amounts invoiced during the period     ( 95,640 ) Balance outstanding at December 31, 2022   $ 9,982     We expect substantially all of the remaining performance obligations for the contract assets recorded as of December 31, 2022, 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.   The following tables summarize our net sales by market for the years ended December 31, 2022 and 2021:       Year Ending December 31, 2022       Product/ Service Transferred Over Time     Product Transferred at Point in Time     Noncash Consideration     Total Net Sales by Market   Medical   $ 51,473     $ 22,288     $ 2,146     $ 75,907   Aerospace and Defense     16,745       1,859       875       19,479   Industrial     28,706       8,541       1,490       38,737   Total net sales   $ 96,924     $ 32,688     $ 4,511     $ 134,123         Year Ending December 31, 2021       Product/ Service Transferred Over Time     Product Transferred at Point in Time     Noncash Consideration     Total Net Sales by Market   Medical   $ 47,285     $ 13,250     $ 2,512     $ 63,047   Aerospace and Defense     14,879       861       899       16,639   Industrial     27,213       6,851       1,418       35,482   Total net sales   $ 89,377     $ 20,962     $ 4,829     $ 115,168     43     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)     NOTE 4. OTHER INTANGIBLE ASSETS   Finite life intangible assets at December 31, 2022 and 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     -       -       71       71   Amortization     144       -       6       150   Balance at December 31, 2022   $ 216     $ -     $ 206     $ 422     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 1.9 years. Of the patents value at December 31, 2022, $ 95 are being amortized and $ 111 are in process and a patent has not yet been received.   Amortization expense of finite life intangible assets was $ 150 and $ 176 for the years ended December 31, 2022 and 2021, respectively.   Estimated future annual amortization expense (except projects in process) related to these assets is approximately as follows:   Year   Amount   2023   $ 159   2024     87   2025     14   2026     14   2027     14   Thereafter     23   Total   $ 311     44     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)     NOTE 5. FINANCING ARRANGEMENTS   We have a credit agreement with Bank of America which was entered into on June 15, 2017, and subsequently extended, which 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. 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 5.2 % and 3.5 % as of December 31, 2022 and 2021, respectively. We had borrowings on our line of credit of $ 6,897 and $ 9,016 outstanding as of December 31, 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. In addition, the credit agreement does not expire within one year, the Company is not in violation of the covenants and the Company expects Bank of America to be capable of honoring the financing arrangement. The line of credit is shown net of debt issuance costs of $ 44 thousand on the consolidated balance sheet for the year ended December 31, 2022.   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, 2022 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, 2022.   At December 31, 2022 and 2021, we had unused availability under our line of credit of $ 8,380 and $ 3,539 , respectively, supported by our borrowing base. The line is secured by substantially all of our assets. During 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 which expired on January 15, 2023.   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 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 1.5 million USD) that will expire on August 18, 2023. We had no amounts outstanding as of December 31, 2022 and 2021.   45     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)     NOTE 6. 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 December 31, 2022, 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.   The components of lease expense were as follows:       December 31,     December 31,   Lease Cost   2022     2021   Operating lease cost   $ 2,309     $ 2,291   Finance lease interest cost     63       79   Finance lease amortization expense     730       502   Total lease cost   $ 3,102     $ 2,872     Supplemental balance sheet information related to leases was as follows:   Balance Sheet Location   December 31, 2022     December 31, 2021   Assets                   Operating lease assets Operating lease assets   $ 7,850     $ 8,983   Finance lease assets Property, Plant and Equipment     1,363       2,052   Total leased assets   $ 9,213     $ 11,035                       Liabilities                   Current                   Current operating lease liabilities Current Portion of Operating Lease Obligations   $ 1,155     $ 1,043   Current finance lease liabilities Current Portion of Finance Lease Obligations     390       601   Noncurrent                   Long-term operating lease liabilities Long Term Operating Lease Liabilities, Net     7,549       8,695   Long term finance lease liabilities Long Term Finance Lease Obligations, Net     565       916   Total lease liabilities   $ 9,659     $ 11,255     46     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   Supplemental cash flow information related to leases was as follows:       December 31,     December 31,       2022     2021   Operating leases                 Cash paid for amounts included in the measurement of lease liabilities   $ 1,721     $ 1,649   Right-of-use assets obtained in exchange for lease obligations   $ 44     $ 1,188     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:       Operating Leases     Finance Leases     Total   2023     1,786       433       2,219   2024     1,515       379       1,894   2025     1,265       103       1,368   2026     1,227       109       1,336   2027     1,256       -       1,256   Thereafter     5,818       -       5,818   Total lease payments   $ 12,867     $ 1,024     $ 13,891   Less: Interest     ( 4,163 )     ( 69 )     ( 4,232 ) Present value of lease liabilities   $ 8,704     $ 955     $ 9,659     The lease term and discount rate at December 31, 2022 were as follows:   Weighted-average remaining lease term (years)         Operating leases     8.9   Finance leases     2.6   Weighted-average discount rate         Operating leases     7.7 % Finance leases     5.2 %   47     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)     NOTE 7. 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.     NOTE 8. INCOME TAXES   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 31, 2020. 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, 2022 and 2021 consists of the following:       2022     2021                     Current taxes - Federal   $ 855     $ 401   Current taxes - State     55       17   Current taxes - Foreign     557       441   Income tax expense   $ 1,467     $ 859     48     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   The statutory rate reconciliation for the years ended December 31, 2022 and 2021 is as follows:       2022     2021   Statutory Rate   $ 572     $ 1,606   State Income Tax     41       14   Effect of foreign operations     71       110   Change in State Deferred Rate     29       ( 39 ) Valuation Allowance     587       472   PPP Loan Forgiveness     -       ( 1,276 ) US Permanent differences     ( 28 )     3   Federal Tax Credits     ( 272 )     ( 37 ) Global Intangible Low-Taxed Income Effect     301       391   Return to provision - credits, perm diffs     9       ( 481 ) Withholding Tax     122       -   IRS Payable     17       121   Other     18       ( 25 )     $ 1,467     $ 859     Income and loss from operations before income taxes was derived from the following sources:       2022     2021   Domestic   $ 990     $ 6,072                     Foreign     2,487       1,941       $ 3,477     $ 8,013     49     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   Deferred tax (liabilities) assets at December 31, 2022 and 2021, consist of the following:       2022     2021   Deferred Tax                 Allowance for uncollectable accounts   $ 81     $ 80   Inventories reserve     263       303   Accrued vacation     127       135   Accrued bonus     462       274   Stock-based compensation and equity appreciation rights     159       135   Other Accruals     548       547   Lease Accounting ASC 842 Lease Liability     1,351       1,555   Capitalized Research Expenses     318       -   Net operating loss carryforwards     -       101   Tax credit carryforwards     156       162   Unrealized Foreign Currency Gain     20       22   Intangibles     515       569   COGS Rev Rec Adjustment     1,864       1,776   COGS Offset Adjustment     ( 1,875 )     ( 1,807 ) Other     235       10   Total     4,224       3,862   Valuation allowance     ( 2,563 )     ( 1,976 ) Deferred tax assets     1,661       1,886                     Accumulated Other Comprehensive Income     ( 56 )     ( 297 ) Lease Accounting ASC 842 Lease Asset     ( 1,301 )     ( 1,518 ) Prepaid Expenses     ( 143 )     -   Property and equipment     ( 161 )     ( 71 ) Deferred tax liabilities     ( 1,661 )     ( 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. A deferred tax asset generally represents future tax benefits to be received when temporary differences previously reported in our financial statements become deductible for tax purposes. We assess the realizability of our deferred tax assets and the need for a valuation allowance based on guidance provided in current financial accounting standards.   Significant judgment is required in determining the realizability of our deferred tax assets. 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.   After considering all available evidence, both positive and negative, we have concluded that a valuation allowance is needed for all our United States based deferred tax assets due to the history of operating losses sustained in the past three years.   At December 31, 2022, for U.S. state purposes, we have Minnesota R&D credit carry forwards of $ 172 , which begin to expire in 2027.   50     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   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 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 tables set forth changes in our total gross unrecognized tax benefit liabilities, excluding accrued interest, for the years ended December 31, 2022 and 2021 (in thousands):   Balance at December 31, 2021   $ 50   Tax Positions - Additions     -   Tax Positions - Reductions     -   Balance at December 31, 2022   $ 50     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, 2022 and 2021 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.   We are subject to income taxes in the U.S. federal jurisdiction and various state jurisdictions. The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. As of December 31, 2022, our 2018 IRS audit was finalized.     NOTE 9. 401(K) RETIREMENT PLAN   We have a 401(k) profit sharing plan (the 401(k) Plan) for our employees. The 401(k) Plan is a defined contribution plan covering substantially all of our U.S. employees. Employees are eligible to participate in the Plan after completing three months of service and attaining the age of 18 . 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 $ 301 and $ 276 during the years ended December 31, 2022 and 2021, respectively.   51     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)     NOTE 10. INCENTIVE PLANS   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. There were 115,000 options and restricted stock units and 49,000 options granted during the years ended December 31, 2022 and 2021, respectively.   Stock Options We estimate the fair value of share-based awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense in the consolidated statements of operations over the requisite service periods. Because share-based compensation expense is based on awards that are ultimately expected to vest, share-based compensation expense will be reduced to account for estimated forfeitures. We estimate forfeitures at the time of grant and revise the estimate, if necessary, in subsequent periods if actual forfeitures differ from those estimates.   We used the Black-Scholes option-pricing model to calculate the fair value of option-based awards. Our determination of fair value of option-based awards on the date of grant using the Black-Scholes model is affected by our stock price as well as assumptions regarding a number of subjective variables. These variables include, but are not limited to, our expected stock price, volatility over the term of the awards, risk-free interest rate, and the expected life of the options. The risk-free interest rate is based on a treasury instrument whose term is consistent with the expected life of our stock options. The expected volatility and holding period are based on our historical experience. For all grants, the amount of compensation expense recognized has been adjusted for an estimated forfeiture rate, which is based on historical data.   We granted 21,000 market condition options to our Chief Executive Officer during the twelve months ended December 31, 2022. The market condition options vest if certain stock prices are exceeded between February 27, 2024 and February 27, 2028. We granted 73,000 service-based options during the twelve months ended December 31, 2022. There were 49,000 stock options granted during the twelve months ended December 31, 2021.   Total compensation expense related to stock options was $ 237 for the twelve months ended December 31, 2022. Total compensation expense related to stock options was $ 116 for the twelve months ended December 31, 2021. As of December 31, 2022, there was $ 762 of unrecognized compensation which will vest and expense over the next 3.61 years.   52     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   A summary of option activity as of and for the years ended December 31, 2022 and 2021 as follows:       Shares     Weighted- Average Exercise Price Per Share     Weighted- Average Remaining Contractual Term (in years)     Aggregate Intrinsic Value   Outstanding – January 1, 2021     362,640     $ 3.96                   Granted     49,000       8.50                   Exercised     ( 13,400 )     3.43                   Cancelled     ( 10,740 )     3.42                   Outstanding – December 31, 2021     387,500     $ 4.57       7.17     $ 1,225   Granted     94,000       11.18                   Exercised     ( 19,800 )     3.40                   Cancelled     ( 9,000 )     4.19                   Outstanding – December 31, 2022     452,700     $ 5.97       6.87     $ 2,855   Exercisable on December 31, 2022     223,300     $ 4.11       5.76     $ 1,817     Restricted Stock Units During the twelve months ended December 31, 2022, we granted 21,000 restricted stock units (“RSUs”) under our 2017 Stock Incentive Plan to non-employee directors which vest over two years. Total compensation expense related to the RSUs were $ 97 for the twelve months ended December 31, 2022. There was no compensation expense related to RSUs for the twelve months ended December 30, 2021. Total unrecognized compensation expense related to the RSUs was $ 155 , which will vest over the next 1.24 years. The RSUs granted in the twelve months ended December 31, 2022 had an average grant price of $ 12.00 per share with a weighted average remaining contractual term of 9.24 years. No RSUs vested during the twelve months ended December 31, 2022.   Equity Appreciation Rights Plan In November 2010, the Board of Directors approved the adoption of the Nortech Systems Incorporated Equity Appreciation Rights Plan (the 2010 Plan). The total number of Equity Appreciation Right Units (Units) the Plan can issue shall not exceed an aggregate of 1,000,000 Units as amended and restated on March 11, 2015 and approved by the shareholders on May 6, 2015. The 2010 Plan provides that Units issued shall fully vest three years from the base date as defined in the agreement unless terminated earlier. Units give the holder a right to receive a cash payment equal to the appreciation in book value per share of common stock from the base date, as defined, to the redemption date. Unit redemption payments under this plan shall be paid in cash within 90 days after we determine the book value of the Units as of the calendar year immediately preceding the redemption date. The Units are adjusted to each reporting period based on the expected appreciation of the Units as defined in the Plan.   During the years ended December 31, 2022 and 2021, no Units were granted. Total compensation expense related to the vested outstanding Units based on the estimated appreciation over their remaining terms was approximately $ 0 and $ 143 for the year ended December 31, 2022 and 2021, respectively.   53     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)     NOTE 11. COMMITMENTS AND CONTINGENCIES   Litigation We are subject to various legal proceedings and claims that arise in the ordinary course of business. In our opinion, the amount of any ultimate liability with respect to these actions will not materially affect our consolidated financial statements or results of operations.   Change of Control Agreements Since 2002, we entered into Change of Control Agreements (the Agreement(s)) with certain key executives (the Executive(s)). The Agreements provide an inducement for each Executive to remain as an employee in the event of any proposed or anticipated change of control in the organization, including facilitating an orderly transition, and to provide economic security for the Executive after a change in control has occurred.   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.     NOTE 12. EMPLOYEE RETENTION CREDIT   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. We received payment on the Employee Retention Credit for the first quarter of 2021 of $ 2,559 in the fourth quarter of 2022. The remaining Employee Retention Credits Receivable of $ 2,650 is recorded on the Consolidated Balance Sheets.   During the year ended December 31, 2022, the Company received the ERC related to the first quarter of 2021 of $ 2,559 . The remaining Employee Retention Credits Receivable of $ 2,650 is recorded on the consolidated balance sheets as of December 31, 2022.   54     NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)     NOTE 13. 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. Abilitech paid the Company $ 247 and $ 1,079 in the years ended December 31, 2022 and 2021, respectively, for delivery of medical products. We have exposure to Abilitech which includes $ 141 of accounts receivable and $ 113 of inventory. We do not believe that Abilitech will pay the Company on accounts receivable or for inventory and we have fully reserved for such exposure. 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 with respect to administrative services at no cost to Marpe Technologies. The total value of the contribution will not exceed $ 500 . Marpe is engaged in raising funds for its operations, which funds are necessary to pay for the Company's services beyond its contribution. 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 twelve months ended December 31, 2022 and 2021, we recognized revenue of $ 440 and $ 148 , respectively. 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.   55       Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   None.