NOTE

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements for the interim periods have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do

not

include all of the financial information and footnotes required by GAAP for complete financial statements, although we believe the disclosures are adequate to make the information presented

not

misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form

-K for the year ended

December 31, 2019.

The operating results for the interim periods presented are

not

necessarily indicative of the results expected for the full year or for any other interim period. In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In preparing these condensed consolidated financial statements, we have made our best estimates and judgments of certain amounts included in the condensed consolidated financial statements, giving due consideration to materiality. Changes in the estimates and assumptions used by us could have a significant impact on our financial results, since actual results could differ from those estimates.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of Nortech Systems Incorporated and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Revenue Recognition

Our revenue is comprised of product, engineering services and repair services. All revenue is recognized when the Company satisfies its performance obligation(s) under the contract by transferring the promised product or service to our customer either when (or as) our customer obtains control of the product or service, with the majority of our revenue being recognized over time including goods produced under contract manufacturing agreements and services revenue. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. A contract's transaction price is allocated to each distinct performance obligation. The majority of our contracts have a single performance obligation. Revenue is recorded net of returns, allowances and customer discounts. Our net sales for services were less than

10%

of our total sales for all periods presented, and accordingly, are included in net sales in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). Sales, value add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenues) basis. Shipping and handling costs charged to our customers are included in net sales, while the corresponding shipping expenses are included in cost of goods sold.

Stock-Based Awards

Following is the status of all stock options as of

September 30, 2020:

	Shares			Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in thousands)
Outstanding - January 1, 2020		372,200		$	3.85
Granted		11,300			2.95
Exercised		-
Cancelled		(16,667	)		3.65
Outstanding - September 30, 2020		366,833		$	3.83		7.88	$	317
Exercisable - September 30, 2020		181,640		$	3.72		7.44	$	176

May 2017,

the shareholders approved the

2017

Stock Incentive Plan which has authorized the issuance of

400,000

shares including an additional

50,000

shares authorized in

March 2020.

There were

11,300

stock options granted during the

nine

months ended

September 30, 2020.

Total compensation expense was

$36

and

$35

for the

three

months ended

September 30, 2020

and

2019,

respectively, and

$111

and

$226

for the

nine

months ended

September 30, 2020

and

2019,

respectively. As of

September 30, 2020,

there was

$260

of unrecognized compensation which will vest over the next

2.39

years.

November 2010,

the Board of Directors adopted the Nortech Systems Incorporated Equity Appreciation Rights Plan (

“2010

Plan”). The total number of Equity Appreciation Right Units (“Units”) that can be issued under the

2010

Plan shall

not

exceed an aggregate of

1,000,000

Units as amended and restated on

March 11, 2015.

During the

nine

months ended

September 30, 2019,

there were

137,500

Units granted. There were

Units granted during the

nine

months ended

September 30, 2020.

Total compensation expense related to the vested outstanding Units based on the estimated appreciation over their remaining terms was approximately

$40

for both the

three

and

nine

months ended

September 30, 2020

and

expense in the

three

and

nine

months ended

September 30, 2019.

The total long-term liability recorded for the Units at

September 30, 2020

$40.

Net Income (Loss) per Common Share

For the

three

and

nine

months ended

September 30 ,2020,

stock options of

45,326

and

21,110,

respectively, were included in the computation of diluted income per common share amount as their impact were dilutive. For both the

three

months and

nine

months ended

September 30, 2019,

all stock options were deemed to be antidilutive and, therefore, were

not

included in the computation of income per common share amount.

Restricted Cash

Cash and cash equivalents classified as restricted cash on our condensed consolidated balance sheets are restricted as to withdrawal or use under the terms of certain contractual agreements. The

September 30, 2020

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. As of

September 30, 2020,

we had outstanding letters of credit for

$500

in total to Essjay Bemidji Holdings, LLC and Essjay Mankato Holdings, LLC.

Accounts Receivable and Allowance for Doubtful Accounts

Credit is extended based upon an evaluation of the customer's financial condition and, while collateral is

not

required, the Company periodically receives surety bonds that guarantee payment. Credit terms are consistent with industry standards and practices. The amounts of trade accounts receivable have been reduced by an allowance for doubtful accounts of

$493

September 30, 2020

and

$335

December 31, 2019.

Inventories

Inventories are stated at the lower of cost (average cost method) or net realizable value. Costs include material, labor, and overhead required in the warehousing and production of our products. Inventory reserves are maintained for the estimated value of the inventories that

may

have a lower value than stated or quantities in excess of future production needs.

Inventories are as follows:

	September 30,			December 31,
	2020			2019
Raw Materials	$	15,314		$	15,245
Work in Process		607			479
Finished Goods		459			41
Reserves		(1,884	)		(1,486	)

Total	$	14,496		$	14,279

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.

In the

three

months ended

September 30, 2020,

we closed on a sale and leaseback agreement with Essjay Investment Company, LLC (“Essjay”) relating to the Company's manufacturing facilities in Bemidji and Mankato, Minnesota. The Company received net proceeds from the sale, excluding closing costs, of approximately

$6,019

and recorded a gain on sale of property of equipment of

$3,821.

The Company entered into lease agreements for the Bemidji, Minnesota facility and the Mankato, Minnesota facility for an initial

-year term, with multiple

-year renewal options. See disclosure of leases in Note

Leases.

Other Intangible Asse

Other intangible assets at

September 30, 2020

and

December 31, 2019

are as follows:

			September 30, 2020
			Gross
			Carrying		Accumulated		Net Book
	Years		Amount		Amortization		Value
Customer Relationships		9	$	1,302	$	759	$	543
Intellectual Property		3		100		100		-
Trade Names		20		814		214		600
Patents		7		67		-		67
Totals			$	2,283	$	1,073	$	1,210

			December 31, 2019
			Gross
			Carrying		Accumulated		Net Book
	Years		Amount		Amortization		Value
Customer Relationships		9	$	1,302	$	651	$	651
Intellectual Property		3		100		95		5
Trade Names		20		814		183		631
Patents		7		56		-		56
Totals			$	2,272	$	929	$	1,343

Amortization expense for the

three

and

nine

months ended

September 30, 2020

was

$47

and

$145

respectively.

Estimated future annual amortization expense (

not

including projects in process) related to these assets is approximately as follows (in thousands):

Year	Amount
Remainder of 2020	$	46
2021		186
2022		185
2023		185
2024		113
Thereafter		428
Total	$	1,143

Impairment of Goodwill and Other Intangible Assets

In accordance with ASC

350,

Goodwill and Other Intangible Assets

, goodwill is

not

amortized but is required to be reviewed for impairment at least annually or when events or circumstances indicate that carrying value

may

exceed fair value. We test impairment annually as of

October 1

events were identified during the

nine

months ended

September 30, 2020

that would require us to test for impairment. In testing goodwill for impairment, we perform a quantitative impairment test, including computing the fair value of the reporting unit and comparing that value to its carrying value. If the fair value is less than its carrying value, then the goodwill is determined to be impaired. In the event that goodwill is impaired, an impairment charge to earnings would become necessary.

Impairment Analysis

We evaluate long-lived assets, primarily property and equipment and intangible assets, 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. 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.

impairment expense was recorded during the

three

and

nine

months ended

September 30, 2020

and

2019,

respectively.

Accounting Pronouncements Issued But

Not

Yet Adopted

June 2016,

the FASB issued ASU

No.

2016

13,

“Financial Instruments - Credit Losses (ASC

326

): Measurement of Credit Losses on Financial Instruments,” which amends the guidance on the impairment of financial instruments. The amendments in this update removes the thresholds that entities apply to measure credit losses on financial instruments measured at amortized cost, such as loans, trade receivables, reinsurance recoverables, off-balance-sheet credit exposures, and held-to-maturity securities. Under current U.S. GAAP, entities generally recognize credit losses when it is probable that the loss has been incurred. The guidance removes all current recognition thresholds and introduces the new current expected credit loss (“CECL”) model which will require entities to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that an entity expects to collect over the instrument's contractual life. The new CECL model is based upon expected losses rather than incurred losses. The amendments in this update are effective for periods beginning after

December 15, 2022;

early adoption is permitted. We are currently evaluating the impact of this guidance on our financial condition and results of operations.