NORTECH SYSTEMS INC 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview We are a Minnesota, United States based full-service global EMS contract manufacturer in the Medical Device, Medical Imaging, Aerospace and Defense and Industrial markets offering a full range of value-added engineering, technical and manufacturing services and support including project management, design, testing, prototyping, manufacturing, supply chain management and post-market services. Our products are complex electromedical and electromechanical products including medical devices, wire and cable assemblies, printed circuit board assemblies, complex higher-level assemblies and other box builds for a wide range of industries. As of December 31, 2025, we have facilities in Minnesota: Bemidji, Mankato, Milaca and Maple Grove. We closed our facility in Blue Earth, Minnesota in December 2024 and sold this facility in July 2025. We also have facilities in Monterrey, Mexico and Suzhou, China. Our net sales are derived from complex designed products built to the customers’ specifications. The products we manufacture are engineered and designed products that require sophisticated manufacturing support. Quality, on-time delivery, and reliability are of utmost importance. Our goal is to expand and diversify our customer base by focusing on sales and marketing efforts that fit our value-added service, early engagement design, and development strategy. We continue to focus on lean manufacturing initiatives, quality and on-time delivery improvements to increase asset utilization, reduce lead times and provide competitive pricing. Our strategic investments have positioned us to capitalize on growth opportunities in the medical markets and improve our competitiveness by expanding our global footprint. Our industrial and defense markets are focused on improving our asset utilization and profitability while transforming to a value added, solution-sell business model that supports early engagement, design for manufacturability and rapid prototyping. All dollar amounts are stated in thousands of U.S. dollars. Results of Operations The Company’s results of operations in 2026 have benefited from higher gross margin from increased net sales as the result of improved backlog. This increase was offset in 2026 with increased incentive compensation expense. For the three and six months ended June 30, 2026, incentive compensation expense (reversal of expense) aggregated $402 and $647, respectively, as compared with ($131) and $0 in the three and six months ended June 30, 2025, respectively. Net Sales. Net sales for the three months ended June 30, 2026 and 2025 were $33,540 and $30,675, respectively, a comparative period increase of $2,865 or 9.3%. Net sales for the six months ended June 30, 2026 and 2025 were $63,856 and $57,570, respectively, a comparative period increase of $6,286 or 10.9%. The following is a summary of net sales by our major industry markets: Three Months Ended June 30, 2026 2025 Increase (Decrease) Medical Device $ 10,269 $ 7,550 $ 2,719 36.0 % Medical Imaging 10,841 9,664 1,177 12.2 % Industrial 8,120 8,516 (396 ) (4.7 )% Aerospace and Defense 4,310 4,945 (635 ) (12.8 )% Total net sales $ 33,540 $ 30,675 $ 2,865 9.3 % Six Months Ended June 30, 2026 2025 Increase (Decrease) Medical Device $ 19,180 $ 15,620 $ 3,560 22.8 % Medical Imaging 20,717 18,252 2,465 13.5 % Industrial 15,002 15,461 (459 ) (3.0 )% Aerospace and Defense 8,957 8,237 720 8.7 % Total net sales $ 63,856 $ 57,570 $ 6,286 10.9 % 18 ● Medical Device: Net sales to our Medical Device customers increased $2,719, or 36.0%, in the three months ended June 30, 2026 as compared with the same period in 2025 and increased $3,560, or 22.8%, in the six months ended June 30, 2026 as compared with the same period in 2025. The increase was primarily due to higher customer demand from existing customers and continued ramp up of new programs. ● Medical Imaging: Net sales to our Medical Imaging customers increased $1,177, or 12.2%, in the three months ended June 30, 2026 as compared with the same period in 2025 and increased $2,465, or 13.5%, in the six months ended June 30, 2026 as compared with the same period in 2025. The increase was driven by higher customer demand, supported in part by increased revenues from a stocking program with a key customer that improved product availability and enabled shorter lead times. ● Industrial: Net sales to our industrial customers decreased $396, or 4.7%, in the three months ended June 30, 2026 as compared with the same period in 2025 and decreased $459, or 3.0%, in the six months ended June 30, 2026 as compared with the same period in 2025. Industrial revenue reflects customer inventory adjustments and temporary production disruptions associated with the transfer of manufacturing activities to Monterrey, Mexico. The decline was largely offset by revenue growth in China. ● Aerospace and Defense: Net sales to our aerospace and defense customers decreased $635, or 12.8%, in the three months ended June 30, 2026 as compared with the same period in 2025 and increased $720, or 8.7%, in the six months ended June 30, 2026 as compared with the same period in 2025. The decrease in the second quarter of 2026 was primarily due to reduced demand from one customer who is rebalancing post-COVID inventory balances, which partially offset the benefits from the completion of the transfer of production programs to our Bemidji location. For the six-month period ended June 30, 2026, revenue increased compared to the prior-year period primarily due to higher production volumes associated with completed transfers to our Bemidji location, offset by impact of the above noted customer rebalancing activities. Backlog. Our 90-day shipment backlog as of June 30, 2026 was $33,445, an increase of 6.3% from $31,475 at the beginning of the quarter, and a 25.8% increase from June 30, 2025. Our 90-day backlog consists of firm purchase orders we expect to ship in the next 90 days, with any remaining amounts to be shipped within 180 days. Our total order backlog as of June 30, 2026, was $93,849, representing a 3.4% increase from $90,802 at the beginning of the quarter and a 19.8% increase compared to the same period in the prior year; this year over year growth was primarily driven by an increase in Aerospace and Defense orders. 90-day shipment and total backlog by our major industry markets are as follows: June 30, 2026 March 31, 2026 June 30, 2025 90 Day Total 90 Day Total 90 Day Total Medical Device $ 11,103 $ 22,060 $ 10,512 $ 27,332 $ 7,897 $ 32,222 Medical Imaging 6,971 11,041 6,509 9,476 5,101 7,584 Industrial 5,975 20,227 4,842 13,113 6,010 9,349 Aerospace and Defense 9,396 40,521 9,612 40,881 7,584 29,196 Total backlog $ 33,445 $ 93,849 $ 31,475 $ 90,802 $ 26,592 $ 78,351 The 90-day and total backlog as of June 30, 2026 includes orders already recognized in net sales and included in the contract asset value of $16,979. 19 Operating Costs and Expenses. Net sales, cost of goods sold, gross profit, and operating costs were as follows: Three Months Ended June 30, 2026 2025 Increase/(Decrease) Net sales $ 33,540 $ 30,675 $ 2,865 9.3 % Cost of goods sold 27,837 25,838 1,999 7.7 % Gross profit 5,703 4,837 866 17.9 % Gross margin percentage (1) 17.0 % 15.8 % 120 bpc (2) Selling 1,484 1,204 280 23.3 % % of Net sales 4.4 % 3.9 % General and administrative 3,250 2,589 661 25.5 % % of Net sales 9.7 % 8.4 % Research and development 346 302 44 14.6 % % of Net sales 1.0 % 1.0 % Operating income 623 742 (119 ) (16.0 )% % of Net sales 1.9 % 2.4 % (1) Gross margin percentage is defined as gross profit as a percentage of net sales. (2) Basis points change in gross margin percentage. Six Months Ended June 30, 2026 2025 Increase/(Decrease) Net sales $ 63,856 $ 57,570 $ 6,286 10.9 % Cost of goods sold 53,451 49,655 3,796 7.6 % Gross profit 10,405 7,915 2,490 31.5 % Gross margin percentage (1) 16.3 % 13.7 % 260 bpc (2) Selling 2,815 2,388 427 17.9 % % of Net sales 4.4 % 4.1 % General and administrative 6,264 5,504 760 13.8 % % of Net sales 9.8 % 9.6 % Research and development 656 628 28 4.5 % % of Net sales 1.0 % 1.1 % Restructuring charges - 266 (266 ) (100 )% % of Net sales - % 0.5 % Operating income (loss) 670 (871 ) 1,541 176.9 % % of Net sales 1.0 % (1.5 )% (1) Gross margin percentage is defined as gross profit as a percentage of net sales. (2) Basis points change in gross margin percentage. 20 Gross profit and gross margin percentage. Gross margin percentage was 17.0% and 15.8% for the three months ended June 30, 2026, and 2025, respectively. Gross margin percentage was 16.3% and 13.7% for the six months ended June 30, 2026, and 2025, respectively. The improvement was primarily attributable to higher revenue levels and improved manufacturing cost absorption resulting from increased production activity. The benefit of higher volumes was partially offset by unfavorable sales mix. Selling expenses . Selling expenses, as measured as a percentage of net sales , were 4.4% and 3.9% for the three months ended June 30, 2026, and 2025, respectively. Selling expenses, as measured as a percentage of net sales , were 4.4% and 4.1% for the six months ended June 30, 2026, and 2025, respectively. The increase as a percentage of sales was primarily attributable to higher incentive compensation accruals in 2026. General and administrative expenses. General and administrative expenses, as measured as a percentage of net sales, were 9.7% and 8.4% for the three months ended June 30, 2026 and 2025, respectively, and 9.8% and 9.6% for the six months ended June 30, 2026 and 2025, respectively. The increase as a percentage of net sales was primarily the result of higher incentive compensation accruals in 2026. Research and development. Research and development expenses increased slightly at $346 and $302 in the three months ended June 30, 2026 and 2025, respectively, and $656 and $628 in the six months ended June 30, 2026 and 2025, respectively. The increases are the result of higher incentive compensation accruals in 2026. Restructuring charges . Restructuring charges were $0 and $266 in the three and six months ended June 30, 2026 and 2025, respectively. During the first quarter of 2025, we incurred $235 of severance charges for a February 2025 reduction in force to align staffing to our forecasted net sales and $31 of expenses related to our closed Blue Earth facility. Operating income (loss). Operating income was $623 for the three months ended June 30, 2026 or 1.9% of net sales and operating income was $742 or 2.4% of net sales for the three months ended June 30, 2025. The decrease was primarily attributable to higher selling and general and administrative expenses, which more than offset the increase in gross profit resulting from higher sales volume. Operating income was $670 or 1.0% of net sales for the six months ended June 30, 2026 and operating loss was $(871) or (1.5)% of net sales for the six months ended June 30, 2025. The increase was primarily attributable to higher gross profit associated with increased revenue and improved operating leverage, together with the absence of restructuring charges recorded in the first quarter of 2025. Interest expense, net. Interest expense, net was $197 and $257 for the three months ended June 30, 2026 and 2025, respectively. Interest expense, net was $453 and $471 for the six months ended June 30, 2026 and 2025, respectively. This decrease in the quarterly comparison was driven by the lower average borrowings and reduced interest costs following the transition to the Company’s new financing arrangements. Refer to “Liquidity and Capital Resources” for further discussion of financing arrangements. Income taxes. Our effective tax rate for the three and six months ended June 30, 2026 was 26% and (30)%, respectively. Our effective tax rate for the three and six months ended June 30, 2025 was 35% and 25%, respectively. The primary drivers of the change in the effective tax rate were differences in pretax book income (loss) by jurisdiction and taxes on foreign entities. Cash Flow Operating Results The following is a summary of cash flow results: Six Months Ended June 30, 2026 2025 Cash provided by (used in): Operating activities $ (2,449 ) $ (2,773 ) Investing activities (323 ) (358 ) Financing activities 2,774 2,858 Effect of exchange rates on changes in cash and restricted cash 17 9 Net change in cash and restricted cash $ 19 $ (264 ) 21 Operating Activities. Cash used in operating activities was $2,449 in the first six months of 2026, compared with $2,773 in the same prior-year period. Significant changes in operating assets and liabilities affecting cash flows during these periods included: ● Cash used by accounts receivable and contract assets was $4,500 in the six months ended June 30, 2026 as compared with cash used of $4,034 in the same prior-year period. This use of cash is largely due to timing of customer shipments and cash collections in both periods and by an increase in contract assets in the current year period to support future customer shipments. ● Cash used by inventory was $3,530 in the six months ended June 30, 2026 as compared with cash provided of $2,714 in the prior-year period. The current-year increase in inventory primarily reflects purchases of materials needed to support the growing backlog and anticipated production requirements in the second half of 2026. In contrast, inventory levels declined in the prior-year period due to lower customer demand and corresponding reductions in material purchases. ● Cash provided by changes in accounts payable was $2,077 in the current-year period as compared with cash provided of $295 in the same prior-year period, primarily related to the timing of cash payments. Investing Activities. Cash used in investing activities was $323 in the first six months of 2026, compared with $358 in the same prior-year period, both due from the purchases of property and equipment. Financing Activities. Cash provided by financing activities was $2,774 in the first six months of 2026 and $2,858 in the same prior-year period. The cash provided by financing activities in both periods resulted from the line of credit advances for working capital and operations as well as the term loan borrowing in the first six months of 2026. Liquidity and Capital Resources We believe that our existing financing arrangements, anticipated cash flows from operations, and cash on hand will be sufficient to satisfy our working capital needs, capital expenditures and debt repayments for the next year from the date of this filing with the Securities and Exchange Commission. On March 20, 2026, the Company entered into a new Credit and Security Agreement with Associated Bank, National Association, which provides for a revolving credit facility of up to $15,000, subject to a borrowing base based on eligible accounts receivable and inventory in the United States of America (“U.S.”), and a $2,200 term loan (the “Associated Facility”). The Associated Facility includes a sublimit of $1,500 for letters of credit and is secured by substantially all of our assets in the U.S. The Associated Facility matures in March 2029. The Company is required to pay a 25-basis point fee per annum, paid monthly, on the unused portion of the revolving credit facility. The term loan requires monthly principal payments of $37 plus interest. Borrowings under the Associated Facility bear interest, at the Company’s option, at a defined base rate derived from the Bank’s prime rate, or at one-month or three-month Term Secured Overnight Financing Rate, referred to as SOFR, plus 2.00% in the case of revolving credit borrowings, and plus 2.25% in the case of the term loan. The revolving credit facility and term loan bear interest at a weighted-average interest rate of 7.9% and 7.7%, respectively, for the three months ended June 30, 2026. At June 30, 2026, there was $7,573 outstanding under the revolving credit facility and $3,552 of unused availability. Borrowings under the Associated Facility may be prepaid at any time without penalty. The Associated Facility does not contain prepayment premiums, make-whole provisions, or other features that would require separate accounting as embedded derivatives. The Associated Facility contains customary affirmative and negative covenants that restrict or limit our ability to incur additional indebtedness, create liens, make investments, sell assets, pay dividends or engage in certain transactions without lender consent. This agreement also requires us to comply with financial covenants, including maintaining a Fixed Charge Coverage Ratio of 1.10 to 1.00, which measures the ratio of EBITDA, as defined to exclude certain other non-cash items, and less unfunded capital expenditures, to fixed charges such as interest as well as debt and finance lease principal payments. The Company was in compliance with all covenants under the Associated Facility as of June 30, 2026. The Associated Facility agreement includes broad and customary events of default such as non-payment of obligations, breaches of representations or covenants, unauthorized liens, insolvency events, material adverse changes, cross-defaults to other significant indebtedness, and change-of-control triggers. Additional events include unsatisfied judgments, loss of lender lien priority, defaults under material business agreements, impairment of key intellectual property, destruction of collateral, and certain ERISA, hedging, or legal compliance violations. Upon an event of default, including the lender’s determination that a material adverse event has occurred, as defined by the Associated Facility agreement, the lender may accelerate all obligations, terminate the commitments, and exercise its full rights and remedies against the collateral. Our ability to comply with these covenants depends in part on our ability to generate sufficient EBITDA and operating cash flow. If our EBITDA or cash flows declines due to any factor, we may not remain in compliance with our financial covenants under the Associated Facility. 22 Off-Balance Sheet Arrangements We have not engaged in any off-balance sheet activities as defined in Item 303(a)(4) of Regulation S-K. Forward-Looking Statements Those statements in the foregoing report that are not historical facts are forward-looking statements made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. ♦ Volatility in the marketplace which may affect market supply, demand of our products or currency exchange rates; ♦ Whether our existing financing arrangements, anticipated cash flows from operations and cash on hand will be sufficient to satisfy our working capital needs, capital expenditures and debt repayments for the next twelve months; ♦ Supply chain disruption and unreliability; ♦ Lack of supply of sufficient human resources to produce our products; ♦ Increased competition from within the EMS industry or the decision of OEMs to cease or limit outsourcing; ♦ Changes in the reliability and efficiency of our operating facilities or those of third parties; ♦ Increases in certain raw material costs such as copper and oil; ♦ Commodity and energy cost instability; ♦ Risks related to FDA noncompliance; ♦ The loss of a major customer; ♦ General economic, financial and business conditions that could affect our financial condition and results of operations; ♦ Increased or unanticipated costs related to compliance with securities and environmental regulation; ♦ Disruption of global or local information management systems due to natural disaster or cyber-security incident; and ♦ Outbreaks of epidemic, pandemic, or contagious diseases that affect our operations, our customers’ operations or our suppliers’ operations. The factors identified above are believed to be important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement made by us. Unpredictable or unknown factors not discussed herein could also have material adverse effects on forward-looking statements. All forward-looking statements included in this Form 10-Q are expressly qualified in their entirety by the forgoing cautionary statements. We undertake no obligation to update publicly any forward-looking statement (or its associated cautionary language) whether as a result of new information or future events. Please refer to forward-looking statements and risks as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2025. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.