Note 1 - Summary of Significant Accounting Policies

9 Months Ended

Sep. 30, 2021

Notes to Financial Statements

Basis of Presentation and Significant Accounting Policies [Text Block]

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements for the interim periods have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the financial information and footnotes required by GAAP for complete financial statements, although we believe the disclosures are adequate to make the information presented not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2020. 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, 2021:

	Shares			Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in thousands)
Outstanding - January 1, 2021		362,640		$	3.96
Granted		27,000			6.14
Exercised		(13,400	)		3.43
Cancelled		(10,340	)		3.42
Outstanding - September 30, 2021		365,900		$	4.15		7.25	$	2,688
Exercisable - September 30, 2021		180,500		$	3.75		6.56	$	1,398

In May 2017, the shareholders approved the 2017 Stock Incentive Plan which authorized the issuance of 400,000 shares. There were additional shares authorized in March 2020 totaling 50,000 and in May 2021 totaling 75,000. There were 27,000 and 11,300 stock options granted during the nine months ended September 30, 2021 and 2020, respectively.

Total compensation expense related to stock options for the three and nine months ended September 30, 2021 was $28 and $74, respectively. Total compensation expense related to stock options for the three and nine months ended September 30, 2020 was $36 and $111, respectively. As of September 30, 2021, there was $320 of unrecognized compensation which will vest over the next 3.12 years.

In November 2010, the Board of Directors adopted the Nortech Systems Incorporated Equity Appreciation Rights Plan (“2010 Plan”). The total number of Equity Appreciation Right Units (“Units”) that can be issued under the 2010 Plan shall not exceed an aggregate of 1,000,000 Units as amended and restated on March 11, 2015. During the nine months ended September 30, 2021 and 2020, there were no Units granted. We recognized $13 and $127 of compensation expense in the three and nine months ended September 30, 2021, respectively. Compensation expense was approximately $40 for both the three and nine months ended September 30, 2020. The current liability recorded for the Units at September 30, 2021 is $235.

Net Income per Common Share 

For the three and nine months ended September 30, 2021, stock options of 214,391 and 144,892, respectively, were included in the computation of diluted income per common share amount as their impact were dilutive. For the three and nine months ended September 30, 2020, stock options of 45,326 and 21,220, respectively, were included in the computation of diluted income per common share as their impact were dilutive.

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, 2021 balance included lockbox deposits that are temporarily restricted due to timing at the period end. The lockbox deposits are applied against our line of credit the next business day.

Accounts Receivable and Allowance for Doubtful Accounts

Credit is extended based upon an evaluation of the customer’s financial condition and, while collateral is not required, the Company periodically receives customer deposits. 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 $361 at September 30, 2021 and $343 at December 31, 2020.

Employee Retention Credit (ERC) and Payroll Tax Deferral

We qualified for Employee Retention Credits on qualified wages paid in the first and second quarters of 2021 and filed for both credits as of the date of this filing. We recognize government grants for which there is a reasonable assurance of compliance with grant conditions and receipt of credits. During the three and nine months ended September 30, 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 and within Employee Retention Credits Receivable on the condensed consolidated balance sheets.

The CARES Act allowed for the deferral of the employer portion of social security taxes incurred through the end of calendar 2020. As of September 30, 2021, there was $1,158 of social security tax payments deferred, of which 50% are required to be remitted by December 2021 and the remaining 50% by December 2022. The deferred amounts are recorded within accrued payroll and commissions on the condensed consolidated balance sheets.

Inventories, Net

Inventories are stated at the lower of cost (first-in, first-out 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,
	2021			2020
Raw Materials	$	19,673		$	14,865
Work in Process		1,683			969
Finished Goods		485			242
Reserves		(1,199	)		(2,159	)
Total	$	20,643		$	13,917

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.

Other Intangible Assets

Other intangible assets at September 30, 2021 and December 31, 2020 are as follows:

	Customer Relationships			Trade Names			Patents		Total
Balance at January 1, 2020	$	651		$	631		$	56	$	1,338
Additions		-			-			20		20
Amortization		(144	)		(41	)		-		(185	)
Balance at December 31, 2020	$	507		$	590		$	76	$	1,173
Additions		-			-			50		50
Amortization		(109	)		(30	)		-		(139	)
Abandonment Loss		-			(560	)		-		(560	)
Balance at September 31, 2021	$	398		$	-		$	126	$	524

In the three months ended September 30, 2021, we determined the fair value of the Devicix tradename was more likely than not be zero based on management’s best estimate and recognized a $560 loss on abandonment of intangible assets.

Intangible assets are amortized on a straight-line bases over their estimated useful lives. The weighted average remaining amortization period of our intangible assets is 3.0 years. Patents are not being amortized as they are in process and a patent has not yet been received.

Amortization expense for the three and nine months ended September 30, 2021 was $45 and $139, 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 2021	$	36
2022		145
2023		145
2024		72
Total	$	398

Reclassification

Certain reclassifications have been made to the prior year’s consolidated financial statements to enhance comparability with the current year’s financial statements. As a result, certain line items have been amended in the statement of operations. Comparative figures have been adjusted to conform to the current year’s presentation.

The items were reclassified as follows:

	Three Months Ended				Nine Months Ended
	September 30, 2020				September 30, 2020
	Previously Reported		After Reclassification		Previously Reported		After Reclassification
Cost of Goods Sold	$	24,717	$	24,400	$	73,171	$	72,336
General and Administrative Expenses		2,164		2,480		5,819		6,654

Accounting Pronouncements Issued But Not Yet Adopted

In 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.

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform. ASU 2020-04 provides optional guidance for a limited period of time to ease potential accounting impact associated with transitioning away from reference rates that are expected to be discontinued, such as LIBOR. The amendments in this ASU apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued. The amendments in ASU 2020-04 can be adopted as of March 12, 2020 and are effective through December 31, 2022. We do not currently have any contracts that have been changed to a new reference rate, we will continue to evaluate our contracts and the effects of this standard on our condensed consolidated financial statements prior to adoption.