NORTECH SYSTEMS INC 10-Q

ITEM 1. FINANCIAL STATEMENTS NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE DATA) 2024 2023 2024 2023 THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2024 2023 2024 2023 Net sales $ 33,891 $ 35,021 $ 68,106 $ 69,909 Cost of goods sold 29,274 29,547 58,041 58,951 Gross profit 4,617 5,474 10,065 10,958 Operating expenses: Selling 909 953 1,714 1,843 General and administrative 2,982 3,105 6,152 6,370 Research and development 291 317 609 593 Restructuring charges 91 - 91 - Total operating expenses 4,273 4,375 8,566 8,806 Income from operations 344 1,099 1,499 2,152 Other expense: Interest expense ( 165 ) ( 125 ) ( 332 ) ( 235 ) Income before income taxes 179 974 1,167 1,917 Income tax expense 22 340 245 602 Net income $ 157 $ 634 $ 922 $ 1,315 Net income per common share: Basic (in dollars per share) $ 0.06 $ 0.23 $ 0.34 $ 0.49 Weighted average number of common shares outstanding - basic (in shares) 2,760,052 2,718,066 2,751,330 2,705,121 Diluted (in dollars per share) $ 0.05 $ 0.22 $ 0.32 $ 0.46 Weighted average number of common shares outstanding - diluted (in shares) 2,935,671 2,870,848 2,922,113 2,887,313 Other comprehensive income (loss) Foreign currency translation ( 175 ) ( 281 ) ( 358 ) ( 241 ) Comprehensive income (loss), net of tax $ ( 18 ) $ 353 $ 564 $ 1,074 See Accompanying Condensed Notes to Condensed Consolidated Financial Statements. 3 NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2024 AND DECMEBER 31, 2023 (IN THOUSANDS, EXCEPT SHARE DATA) JUNE 30, 2024 DECEMBER 31, 2023 (1) ASSETS Current assets: Cash $ 1,542 $ 960 Restricted cash - 715 Accounts receivable, less allowances of $ 270 and $ 358 , respectively 17,577 19,279 Inventories, net 22,793 21,660 Contract assets 14,957 14,481 Prepaid assets and other assets 2,291 1,698 Total current assets 59,160 58,793 Property and equipment, net 6,001 6,513 Operating lease assets, net 8,274 6,917 Deferred tax assets 2,641 2,641 Other intangible assets, net 183 263 Total assets $ 76,259 $ 75,127 LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Current portion of finance lease obligations $ 214 $ 356 Current portion of operating lease obligations 1,169 1,033 Accounts payable 12,728 15,924 Accrued payroll and commissions 2,612 4,138 Customer deposits 5,453 4,068 Other accrued liabilities 1,120 1,063 Total current liabilities 23,296 26,582 Long-term liabilities: Long-term line of credit, net of issuance costs 8,314 5,815 Long-term finance lease obligations, net of current portion 146 209 Long-term operating lease obligations, net of current portion 7,949 6,763 Other long-term liabilities 409 414 Total long-term liabilities 16,818 13,201 Total liabilities 40,114 39,783 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; 2,762,177 and 2,740,178 shares issued and outstanding, respectively 28 27 Additional paid-in capital 17,165 16,929 Accumulated other comprehensive loss ( 890 ) ( 532 ) Retained earnings 19,592 18,670 Total shareholders’ equity 36,145 35,344 Total liabilities and shareholders’ equity $ 76,259 $ 75,127 (1) The balance sheet as of December 31, 2023 has been derived from the consolidated audited financial statements at that date. See Accompanying Condensed Notes to Condensed Consolidated Financial Statements. 4 NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS) 2024 2023 SIX MONTHS ENDED JUNE 30, 2024 2023 CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 922 $ 1,315 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation and amortization 966 1,027 Compensation on stock-based awards 206 192 Change in inventory reserves 113 ( 53 ) Change in accounts receivable allowances ( 88 ) ( 31 ) Other, net ( 59 ) ( 116 ) Changes in current operating assets and liabilities: Accounts receivable 1,690 ( 1,580 ) Employee Retention Credit Receivable - 2,650 Inventories ( 1,288 ) 1,350 Contract assets ( 476 ) ( 1,620 ) Prepaid expenses and other current assets ( 531 ) ( 1,042 ) Accounts payable ( 2,546 ) 586 Accrued payroll and commissions ( 1,516 ) ( 1,788 ) Customer deposits 1,385 ( 195 ) Other accrued liabilities ( 236 ) ( 414 ) Net cash (used in) provided by operating activities ( 1,458 ) 281 CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of property and equipment 9 - Purchases of property and equipment ( 1,020 ) ( 956 ) Net cash used in investing activities ( 1,011 ) ( 956 ) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from line of credit 68,323 65,886 Payments to line of credit ( 65,809 ) ( 65,726 ) Principal payments on financing leases ( 202 ) ( 189 ) Proceeds from stock option exercises 31 173 Net cash provided by financing activities 2,343 144 Effect of exchange rate changes on cash ( 7 ) ( 35 ) Net change in cash and cash equivalents ( 133 ) ( 566 ) Cash and cash equivalents - beginning of period 1,675 2,481 Cash and cash equivalents - end of period $ 1,542 $ 1,915 Reconciliation of cash and restricted cash reported within the condensed consolidated balance sheets: Cash $ 1,542 $ 781 Restricted cash - 1,134 Total cash and restricted cash reported in the condensed consolidated statements of cash flows $ 1,542 $ 1,915 5 NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS) SIX MONTHS ENDED JUNE 30, 2024 2023 Supplemental disclosure of cash flow information: Cash paid for interest $ 307 $ 248 Cash paid for income taxes $ 279 $ 1,036 Supplemental noncash investing and financing activities: Property and equipment purchases in accounts payable $ 75 $ 49 Operating lease assets acquired under operating leases $ 1,923 $ - See Accompanying Condensed Notes to Condensed Consolidated Financial Statements. 6 NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED) (IN THOUSANDS) Accumulated Additional Other Total Preferred Stock Common Stock Paid-In Comprehensive Retained Shareholders’ Shares Amount Shares Amount Capital Loss Earnings Equity Balance as of March 31, 2023 250 $ 250 2,701 $ 27 $ 16,481 $ ( 330 ) $ 12,477 $ 28,905 Net income - - - - - - 634 634 Foreign currency translation adjustment - - - - - ( 281 ) - ( 281 ) Stock option exercises - - 36 - 138 - - 138 Compensation on stock-based awards - - - - 93 - - 93 Balance as of June 30, 2023 250 $ 250 2,737 $ 27 $ 16,712 $ ( 611 ) $ 13,111 $ 29,489 Balance as of March 31, 2024 250 $ 250 2,755 $ 27 $ 17,009 $ ( 715 ) $ 19,435 $ 36,006 Net income - - - - - - 157 157 Foreign currency translation adjustment - - - - - ( 175 ) - ( 175 ) Issuance for stock-based awards - - 7 - 126 - - 126 Compensation on stock-based awards - - - 1 30 - - 31 Balance as of June 30, 2024 250 $ 250 2,762 $ 28 $ 17,165 $ ( 890 ) $ 19,592 $ 36,145 Balance as of December 31, 2022 250 $ 250 2,691 $ 27 $ 16,347 $ ( 370 ) $ 11,826 $ 28,080 Net income - - - - - - 1,315 1,315 Foreign currency translation adjustment - - - - - ( 241 ) - ( 241 ) Compensation on stock-based awards - - - - 192 - - 192 Issuance for stock-based awards - - 46 - 173 - - 173 Cumulative adjustment related to adoption of ASC 326 (current expected credit loss) - - - - - - ( 30 ) ( 30 ) Balance as of June 30, 2023 250 $ 250 2,737 $ 27 $ 16,712 $ ( 611 ) $ 13,111 $ 29,489 Balance as of December 31, 2023 250 $ 250 2,740 $ 27 $ 16,929 $ ( 532 ) $ 18,670 $ 35,344 Balance 250 $ 250 2,740 $ 27 $ 16,929 $ ( 532 ) $ 18,670 $ 35,344 Net income - - - - - - 922 922 Foreign currency translation adjustment - - - - - ( 358 ) - ( 358 ) Compensation on stock-based awards - - - - 206 - - 206 Issuance for stock-based awards - - 22 1 30 - - 31 Balance as of June 30, 2024 250 $ 250 2,762 $ 28 $ 17,165 $ ( 890 ) $ 19,592 $ 36,145 Balance 250 $ 250 2,762 $ 28 $ 17,165 $ ( 890 ) $ 19,592 $ 36,145 See Accompanying Condensed Notes to Condensed Consolidated Financial Statements. 7 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 and Principles of Consolidation 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, the Company has omitted footnote disclosures that would substantially duplicate the disclosures contained in the Company’s audited consolidated financial statements. These unaudited condensed consolidated financial statements should be read together with the audited consolidated financial statements for the year ended December 31, 2023, and notes thereto included in our Annual Report on Form 10-K as filed with the SEC. 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. All dollar amounts are stated in thousands of U.S. dollars. 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 net sales and expenses during each reporting period. Significant items subject to estimates and assumptions include the valuation allowance for inventories, accounts receivable allowances, realizability of deferred tax assets and long-lived asset recovery. Actual results could differ from those estimates. Recently Issued New Accounting Standards In November 2023, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2023-07, Segment Reporting Topic (280): Improvements to Reportable Segment Disclosure . The ASU supplements reportable segment disclosure requirements, primarily through enhanced disclosures about significant segment expenses. The amendments in this ASU are effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024 on a retrospective basis. Early adoption is permitted. The Company is currently evaluating the impact of this ASU on its Consolidated Financial Statements and related disclosures. In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures . The ASU enhances the transparency and decision usefulness of income tax disclosures and is effective for annual periods beginning after December 15, 2024 on a prospective basis. Early adoption is permitted. The Company is currently evaluating the impact of this ASU on its Consolidated Financial Statements and related disclosures. Out-of-Period Correction During the first quarter of 2024, we identified an error that understated our accrued liabilities by approximately $ 178 as of December 31, 2023. We corrected the error on a prospective basis during the first quarter of 2024 through an out of period adjustment lowering our net income by $ 178 in both the three and six months ended June 30, 2024. We assessed the materiality of the error and concluded that the error was not material to the results of operations or financial condition or for the prior annual and interim periods, and the correction is not expected to be material to the full year results for fiscal year 2024. 8 Inventories Inventories are as follows: SCHEDULE OF INVENTORIES June 30, December 31, 2024 2023 Raw materials $ 22,463 $ 20,863 Work in process 645 1,033 Finished goods 965 934 Reserves ( 1,280 ) ( 1,170 ) Inventories, net $ 22,793 $ 21,660 Other Intangible Assets Other intangible assets as of June 30, 2024 and December 31, 2023 are as follows: SCHEDULE OF OTHER INTANGIBLE ASSETS Customer Relationships Patents Total Balances as of January 1, 2023 $ 216 $ 206 $ 422 Amortization 144 15 159 Balances as of December 31, 2023 $ 72 $ 191 $ 263 Balances $ 72 $ 191 $ 263 Amortization 72 8 80 Balances as of June 30, 2024 $ - $ 183 $ 183 Balances $ - $ 183 $ 183 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 5.5 years. Of the patents value as of June 30, 2024, $ 98 are being amortized and $ 85 are in process and a patent has not yet been issued. Amortization expense of finite life intangible assets for both the three months ended June 30, 2024 and 2023 was $ 40 . Amortization expense of finite life intangible assets for both the six months ended June 30, 2024 and 2023 was $ 80 . As of June 30, 2024, estimated future annual amortization expense (except projects in process) related to these assets is as follows: SCHEDULE OF ESTIMATED FUTURE ANNUAL AMORTIZATION EXPENSE Year Amount 2024 $ 9 2025 18 2026 18 2027 18 2028 18 Thereafter 17 Total $ 98 NOTE 2. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash, accounts receivable, and contract assets. 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. The Company’s $ 1,542 cash balance as of June 30, 2024 included approximately $ 1,141 and $ 32 that was held at banks located in China and Mexico, respectively. We grant credit to customers in the normal course of business and generally 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 gross accounts receivable. One customer accounted for 26 % and 25 % of net sales for the three and six months ended June 30, 2024, respectively. Two customers accounted for 39 % of net sales for both the three and six months ended June 30, 2023. 9 As of June 30, 2024, three customers represented approximately 39 % of our gross accounts receivable. As of December 31, 2023, two customers represented approximately 35 % of our gross accounts receivable. Contract assets for three customers accounted for 43 % of gross contract assets as of June 30, 2024. Contract assets for two customers accounted for 34 % of gross contract assets as of December 31, 2023. Export sales from the U.S. represented approximately 3 % and 2 % of net sales for the three and six months ended June 30, 2024, respectively. Export sales represented approximately 3 % of net sales for both three and six month ended June 30, 2023. NOTE 3. REVENUE Revenue Recognition Revenue under contract manufacturing agreements that was recognized over time accounted for approximately 74 % of net sales for both the three and six months ended June 30, 2024 and approximately 73 % and 74 % of net sales for the three and six months ended June 30, 2023, respectively. The following tables summarize our net sales by market for the three months ended June 30, 2024 and 2023, respectively: SCHEDULE OF NET SALES BY MARKET Three Months Ended June 30, 2024 Product/ Service Transferred Over Time Product Transferred at Point in Time Noncash Consideration 1 Total Net Sales by Market Medical $ 12,725 $ 4,435 $ 711 $ 17,871 Aerospace and defense 6,097 494 44 6,635 Industrial 6,163 2,667 555 9,385 Total net sales $ 24,985 $ 7,596 $ 1,310 $ 33,891 Three Months Ended June 30, 2023 Product/ Service Transferred Over Time Product Transferred at Point in Time Noncash Consideration 1 Total Net Sales by Market Medical $ 14,570 $ 5,318 $ 719 $ 20,607 Aerospace and defense 4,499 674 182 5,355 Industrial 6,593 2,125 341 9,059 Total net sales $ 25,662 $ 8,117 $ 1,242 $ 35,021 1 Noncash consideration represents material provided by the customer used in the build of the product. 10 The following tables summarize our net sales by market for the six months ended June 30, 2024 and 2023, respectively: Six Months Ended June 30, 2024 Product/ Service Transferred Over Time Product Transferred at Point in Time Noncash Consideration 1 Total Net Sales by Market Medical $ 25,789 $ 9,679 $ 1,508 $ 36,976 Aerospace and defense 11,301 736 116 12,153 Industrial 13,110 5,014 853 18,977 Total net sales $ 50,200 $ 15,429 $ 2,477 $ 68,106 Six Months Ended June 30, 2023 Product/ Service Transferred Over Time Product Transferred at Point in Time Noncash Consideration 1 Total Net Sales by Market Medical $ 30,295 $ 10,379 $ 1,305 $ 41,979 Aerospace and defense 7,914 1,224 261 9,399 Industrial 13,183 4,533 815 18,531 Total net sales $ 51,392 $ 16,136 $ 2,381 $ 69,909 1 Noncash consideration represents material provided by the customer used in the build of the product. Contract Assets Contract assets, recorded as such in the Condensed Consolidated Balance Sheet, consist of unbilled amounts related to revenue recognized over time. Significant changes in the contract assets balance during the six months ended June 30, 2024 were as follows: SCHEDULE OF CONTRACT ASSETS Balances as of January 1, 2024 $ 14,481 Increase (decrease) attributed to: Amounts transferred over time to contract assets 27,904 Allowance for current expected credit losses ( 14 ) Amounts invoiced during the period ( 27,414 ) Balance outstanding as of June 30, 2024 $ 14,957 We expect substantially all of the remaining performance obligations for the contract assets recorded as of June 30, 2024 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. NOTE 4. FINANCING ARRANGEMENTS We had 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 was to expire on June 15, 2026. On February 29, 2024, we replaced the asset backed line of credit agreement with a $ 15,000 Senior Secured Revolving Line of Credit with Bank of America (the “Revolver”). The Revolver allows for borrowings at a defined base rate, or at the one, three or six month Secured Overnight Finance Rate, also known as “SOFR”, plus a defined margin. If the Company prepays SOFR borrowings before their contractual maturity, the Company has agreed to compensate the bank for lost margin, as defined in the Revolver agreement. The Company is required to quarterly pay a 20-basis point fee on the unused portion of the Revolver. The Revolver requires the Company to maintain no more than 2.5 times leverage ratio and at least a 1.25 times minimum fixed charges coverage ratio, both of which are defined in the Revolver agreement. The Company met the covenants for the period ended June 30, 2024. There are no subjective acceleration clauses under the Revolver that would accelerate the maturity of outstanding borrowings. The Revolver contains certain covenants which, among other things, require the Company to adhere to regular reporting requirements, abide by shareholder dividend limitations, maintain certain financial performance, and limit the amount of annual capital expenditures. The Revolver is secured by substantially all the Company’s assets and expires on February 28, 2027. We were in compliance with all the financial covenants related to this agreement as of and for the period ended June 30, 2024, except for the covenant related to operating expense contributions to our Mexican operations in excess of the amounts allowed under the Revolver. We have received a waiver of this event of default from the bank. Under the amended Bank of America credit agreement signed February 29, 2024, the line of credit is subject to variations in the SOFR index rate. Under the prior credit agreement with Bank of America, the line of credit borrowing availability was restricted by a defined asset borrowing base, and interest was based on variations in the Bloomberg Short-Term Bank Yield (BSBY) index rate. Our line of credit bears interest at a weighted-average interest rate of 8.0 % and 8.3 % as of June 30, 2024 and December 31, 2023, respectively. We had borrowings on our line of credit of $ 8,360 and $ 5,846 outstanding as of June 30, 2024 and December 31, 2023, respectively. As of June 30, 2024 we had unused availability on the line of credit of $ 6,440 . The line of credit is shown net of debt issuance costs of $ 46 and $ 31 on the condensed consolidated balance sheet as of June 30, 2024 and December 31, 2023, respectively. 11 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. As of June 30, 2024, we do not have material lease commitments that have not commenced. We extended our operating leases for part of our manufacturing facility in China and our corporate office in Maple Grove, MN during the first six months of 2024 which extended the lease through August of 2033 with monthly lease payments of $ 14 to $ 18 . The components of lease expense were as follows: SCHEDULE OF COMPONENTS OF LEASE EXPENSE Three Months Ended June 30, Lease Cost 2024 2023 Operating lease cost $ 581 $ 592 Finance lease interest cost 6 11 Finance lease amortization expense 129 182 Total lease cost $ 716 $ 785 Six Months Ended June 30, Lease Cost 2024 2023 Operating lease cost $ 1,177 $ 1,159 Finance lease interest cost 12 23 Finance lease amortization expense 129 364 Total lease cost $ 1,318 $ 1,546 Supplemental condensed consolidated balance sheet information related to leases was as follows: SCHEDULE OF SUPPLEMENTAL CONDENSED CONSOLIDATED BALANCE SHEET INFORMATION RELATED TO LEASES Balance Sheet Location June 30, 2024 December 31, 2023 Assets Finance lease assets Property and equipment, net $ 373 $ 636 Operating lease assets Operating lease assets, net 8,274 6,917 Total leased assets $ 8,647 $ 7,553 Liabilities Current Current finance lease liabilities Current portion of finance lease obligations $ 214 $ 356 Current operating lease liabilities Current portion of operating lease obligations 1,169 1,033 Noncurrent Long-term finance lease liabilities Long-term finance lease liabilities, net of current portion 146 209 Long-term operating lease liabilities Long-term operating lease obligations, net of current portion 7,949 6,763 Total lease liabilities $ 9,478 $ 8,361 12 Supplemental condensed consolidated statement of cash flows information for the six months ended June 30, 2024 related to leases was as follows: SCHEDULE OF SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS INFORMATION June 30, June 30, 2024 2023 Operating Leases Cash paid for amounts included in the measurement of lease liabilities $ 933 $ 934 Property acquired under operating lease $ 1,923 $ - Future payments of lease liabilities as of June 30, 2024 were as follows: SCHEDULE OF FUTURE PAYMENTS OF LEASE LIABILITIES Operating Leases Finance Leases Total 2024 $ 928 $ 163 $ 1,091 2025 1,792 106 1,898 2026 1,758 105 1,863 2027 1,470 - 1,470 2028 1,469 - 1,469 Thereafter 5,510 - 5,510 Total lease payments $ 12,927 $ 374 $ 13,301 Less: imputed interest ( 3,809 ) ( 14 ) ( 3,519 ) Present value of lease liabilities $ 9,118 $ 360 $ 9,478 The lease term and discount rate as of June 30, 2024 were as follows: SCHEDULE OF LEASE TERM AND DISCOUNT RATE Weighted-average remaining lease term (years) Operating leases 8.1 Finance leases 1.7 Weighted-average discount rate Operating leases 8.0 % Finance leases 5.3 % NOTE 6. STOCK BASED AWARDS Stock-based compensation expense was reported as follows in the condensed consolidated statements of income within general and administrative expenses of $ 126 and $ 93 for the three months ended June 30, 2024 and 2023, respectively and $ 206 and $ 192 for the six months ended June 30, 2024 and 2023, respectively. 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 , 175,000 100,000 and 100,000 shares were authorized in March 2020, May 2022, May 2023 and May 2024, respectively. We granted 22,000 service-based stock options during the three and six months ended June 30, 2024. The weighted-average grant-date fair value of options granted during the six months ended June 30, 2024 was $ 8.22 . We granted 29,000 service-based stock options during the three and six months ended June 30, 2023. Weighted average stock option fair value assumptions and the weighted average grant date fair value of stock options granted were as follows: SCHEDULE OF WEIGHTED AVERAGE GRANT DATE FAIR VALUE OF STOCK OPTIONS GRANTED 2024 2023 Stock option fair value assumptions: Risk-free interest rate 4.40 % 3.45 % Expected life (years) 6.0 6.5 Dividend yield 0 % 0 % Expected volatility 58 % 60 % Weighted average grant date fair value of stock options granted $ 6.47 $ 5.67 13 Total compensation expense related to stock options was $ 65 and $ 121 for the three and six months ended June 30, 2024, respectively. Total compensation expense related to stock options was $ 55 and $ 123 for the three and six months ended June 30, 2023, respectively. As of June 30, 2024, there was $ 844 of unrecognized compensation related to stock options which will be recognized over a weighted average period of 3.8 years. Following is the status of option activity for the six months ended and as of June 30, 2024: SCHEDULE OF OPTION ACTIVITY Shares Weighted- Average Exercise Price Per Share Weighted- Average Remaining Contractual Term (in years) Aggregate Intrinsic Value Outstanding – December 31, 2023 458,700 $ 6.63 6.53 $ 1,432 Granted 22,000 11.06 Exercised ( 5,500 ) 5.42 Forfeited ( 9,600 ) 10.26 Outstanding – June 30, 2024 465,600 $ 6.78 6.20 $ 3,150 Exercisable on June 30, 2024 279,300 $ 4.67 4.60 $ 2,479 Restricted Stock Units During the three and six month periods ended June 30, 2024 and 2023, we granted 15,141 and 18,000 restricted stock units (“RSUs”), respectively, at an average grant price per share of $ 11.06 and $ 9.37 , respectively, under our 2017 Stock Incentive Plan to non-employee directors which vest over two years . Total compensation expense related to the RSUs was $ 61 and $ 85 for the three and six months ended June 30, 2024 and 2023, respectively. Total compensation expense related to the RSUs was $ 38 and $ 69 for the three and six months ended June 30, 2023, respectively. As of June 30, 2024, total unrecognized compensation expense related to the RSUs was $ 220 , which will vest over a weighted average period of 0.9 years. Following is the status of restricted stock activity for the six months ended and as of June 30, 2024: SCHEDULE OF RESTRICTED STOCK ACTIVITY Shares Weighted- Average Remaining Vesting Term (in years) Aggregate Intrinsic Value Outstanding – December 31, 2023 27,000 1.0 $ 254 Granted 15,141 Vested ( 16,500 ) Forfeited ( 1,500 ) Outstanding – June 30, 2024 24,141 0.9 $ 330 14 NOTE 7. NET INCOME PER SHARE DATA Basic net income per common share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares outstanding using the treasury stock method during the period. The Company’s potentially dilutive common shares are those that result from dilutive common stock options and non-vested stock relating to restricted stock units. The calculation of diluted income per shared excluded 31,611 and 45,453 in weighted average shares for the three and six months ended June 30, 2024, respectively, and 60,728 and 47,182 in weighted average shares for the three and six months ended June 30, 2023, respectively, as their effect was anti-dilutive. Basic and diluted weighted average shares outstanding were as follows: SCHEDULE OF BASIC AND DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING Three Months Ended June 30, Six Months Ended June 30, 2024 2023 2024 2023 Basic weighted average shares outstanding 2,760,052 2,718,066 2,751,330 2,705,121 Dilutive effect of outstanding stock options and non-vested restricted stock units 175,619 152,782 170,783 182,192 Diluted weighted average shares outstanding 2,935,671 2,870,848 2,922,113 2,887,313 NOTE 8. 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. Our effective tax rate for the three and six months ended June 30, 2024 was 12 % and 21 %, respectively. Our effective tax rate for the three and six months ended June 30, 2023 was 35 % and 31 %. The decrease in the effective tax rate is attributable to the application of a valuation allowance during the three and six month periods ended June 30, 2023 and inclusion of estimated research and development tax credits in the three and six months ended June 30, 2024, partially offset by increased taxes on foreign entities. NOTE 9. RESTRUCTURING CHARGES During the first six months of 2024, we accrued restructuring charges of $ 91 related to the closure and consolidation of our Blue Earth, Minnesota production facility, which is planned to be completed in the fourth quarter of 2024. There were no restructuring charges or amounts accrued in the six months ended June 30, 2023. NOTE 10. PAYROLL TAX DEFERRAL On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law which allowed for the deferral of the employer portion of social security taxes incurred through the end of calendar 2020. During the year ended December 31, 2023, the Company remitted $ 1,158 to the Internal Revenue Service (“IRS”) related to the deferral of payroll taxes, of which $ 785 was recorded as a refund receivable as of December 31, 2023, with a corresponding liability due. These amounts were settled during the first quarter of 2024. NOTE 11. RELATED PARTY TRANSACTIONS David Kunin, our Chairman, is a minority owner of Abilitech Medical, Inc. We have accounts receivable related to Abilitech of $ 85 . Abilitech has ceased operations and therefore we do not believe that Abilitech will pay the Company for outstanding accounts receivable, and we have recorded a full allowance against the gross amount. The Company believes that transactions with Abilitech were 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 has an agreement 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 has met 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 Company’s 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 operations 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 recover the value of services provided to Marpe if not paid when the services are provided. 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 three and six months ended June 30, 2024 and 2023, we recognized net sales to Marpe Technologies of $ 0 and $ 67 , respectively. As of June 30, 2024 and December 31, 2023, we have recorded an unbilled receivable of $ 21 and $ 39 , respectively, related to expected reimbursement from the BIRD Foundation and have outstanding accounts receivable of $ 0 and $ 20 , 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. 15