NORTECH SYSTEMS INC - Interim / Quarterly Report 2020

10-Q 1 nsys20200930_10q.htm FORM 10-Q nsys20200930_10q.htm Generated by ThunderDome Portal - 11/12/2020 5:39:18 PM

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

NORTECH SYSTEMS INCORPORATED

Commission file number 0-13257

State of Incorporation: Minnesota

IRS Employer Identification No. 41-1681094

Executive Offices: 7550 Meridian Circle N . , Suite # 150, Maple Grove, MN 55369

Telephone number: (952) 345-2244

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $.01 per share	NSYS	NASDAQ Capital Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ☐	Accelerated Filer ☐
Non-accelerated Filer ☒ Emerging growth company ☐	Smaller Reporting Company ☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Number of shares of $.01 par value common stock outstanding at November 4, 2020 was 2,657,530.

TABLE OF CONTENTS

		PAGE
PART I - FINANCIAL INFORMATION
Item 1 -	Financial Statements
	Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)	3
	Condensed Consolidated Balance Sheets	4
	Condensed Consolidated Statements of Cash Flows	5
	Condensed Consolidated Statements of Shareholders’ Equity	6
	Condensed Notes to Consolidated Financial Statements	7-17
Item 2 -	Management's Discussion and Analysis of Financial Condition And Results of Operations	18-25
Item 3 -	Quantitative and Qualitative Disclosures About Market Risk	25
Item 4 -	Controls and Procedures	25
PART II - OTHER INFORMATION
Item 1 -	Legal Proceedings	26
Item 1A. -	Risk Factors	26
Item 2 -	Unregistered Sales of Equity Securities, Use of Proceeds	27
Item 3 -	Defaults on Senior Securities	27
Item 4 -	Mine Safety Disclosures	27
Item 5 -	Other Information	27
Item 6 -	Exhibits	27
SIGNATURES		28

PART

ITEM 1. FINANCIAL STATEMENTS

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)

	THREE MONTHS ENDED
	SEPTEMBER 30,			SEPTEMBER 30,
	2020	2019		2020		2019
Net Sales	$ 26,362	$	30,058	$	80,263	$	85,515
Cost of Goods Sold	24,716		26,423		73,171		76,594
Gross Profit	1,646		3,635		7,092		8,921
Operating Expenses
Selling Expenses	594		589		1,945		2,147
General and Administrative Expenses	2,164		2,333		5,819		7,374
Gain on Sale of Property and Equipment	(3,821	)	-		(3,821	)	-
Total Operating Expenses	(1,063	)	2,922		3,943		9,521
Income (Loss) From Operations	2,709		713		3,149		(600	)
Other Expense
Interest Expense	(126	)	(256	)	(526	)	(780	)
Income (Loss) Before Income Taxes	2,583		457		2,623		(1,380	)
Income Tax Expense	612		44		638		122
Net Income (Loss)	$ 1,971	$	413	$	1,985	$	(1,502	)
Net Income (Loss) Per Common Share:
Basic (in dollars per share)	$ 0.74	$	0.16	$	0.75	$	(0.56	)
Weighted Average Number of Common Shares Outstanding - Basic (in shares)	2,657,530		2,657,911		2,657,530		2,667,754
Diluted (in dollars per share)	$ 0.73	$	0.16	$	0.74	$	(0.56	)
Weighted Average Number of Common Shares Outstanding - Diluted (in shares)	2,703,029		2,657,911		2,678,698		2,667,754
Other comprehensive income (loss)
Foreign currency translation	96		(56	)	54		(56	)
Comprehensive income (loss), net of tax	$ 2,067	$	357	$	2,039	$	(1,558	)

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

	SEPTEMBER 30, — 2020	2019 (1)
	(Unaudited)
ASSETS
Current Assets
Cash	$ 328	$	351
Restricted Cash	1,366		309
Accounts Receivable, less allowances of $493 and $335	16,019		18,558
Inventories	14,496		14,279
Contract Assets	7,334		7,659
Prepaid Expenses and Other Current Assets	1,274		2,128
Total Current Assets	40,817		43,284
Property and Equipment, Net	6,631		9,581
Operating Lease Assets	8,924		4,827
Goodwill	2,375		2,375
Other Intangible Assets, Net	1,210		1,343
Total Assets	$ 59,957	$	61,410
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current Maturities of Long-Term Debt	$ 444	$	444
Current Portion of Finance Lease Obligation	652		557
Current Portion of Operating Lease Obligations	614		858
Accounts Payable	11,213		14,014
Accrued Payroll and Commissions	2,912		3,493
Customer Deposits	631		618
Income Tax Payable	398		134
Other Accrued Liabilities	1,382		2,114
Total Current Liabilities	18,246		22,232
Long-Term Liabilities
Long Term Line of Credit	2,546		10,088
Long-Term Debt, Net	6,730		3,179
Long Term Finance Lease Obligation, Net	1,320		1,451
Long-Term Operating Lease Obligation, Net	8,832		4,366
Other Long-Term Liabilities	157		118
Total Long-Term Liabilities	19,585		19,202
Total Liabilities	37,831		41,434
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: 2,657,530 Shares Issued and Outstanding	27		27
Additional Paid-In Capital	15,859		15,748
Accumulated Other Comprehensive Loss	(203	)	(257	)
Retained Earnings	6,193		4,208
Total Shareholders' Equity	22,126		19,976
Total Liabilities and Shareholders' Equity	$ 59,957	$	61,410

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

(1) The balance sheet at December 31, 2019 has been derived from the audited financial statements at that date

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

	NINE MONTHS ENDED
	SEPTEMBER 30,
	2020	2019
Cash Flows From Operating Activities
Net Income (Loss)	$ 1,985	$	(1,502	)
Adjustments to Reconcile Net Income (Loss) to Net Cash
Used In Operating Activities
Depreciation and Amortization	1,703		1,648
Compensation on Stock-Based & Equity Awards	151		226
Deferred Taxes	-		1
Change in Accounts Receivable Allowance	158		101
Change in Inventory Reserves	398		285
Gain on Disposal of Property and Equipment	(3,821	)	-
Changes in Current Operating Items
Accounts Receivable	2,430		(158	)
Inventories	(567	)	(237	)
Contract Assets	325		(780	)
Prepaid Expenses and Other Current Assets	858		(641	)
Accounts Payable	(2,808	)	663
Accrued Payroll and Commissions	(621	)	(120	)
Other Accrued Liabilities	(290	)	281
Net Cash Used in Operating Activities	(99	)	(233	)
Cash Flows from Investing Activities
Proceeds from Sale of Property and Equipment	6,019		-
Purchase of Intangible Asset	(25	)	(37	)
Purchases of Property and Equipment	(397	)	(785	)
Net Cash Provided By (Used In) Investing Activities	5,597		(822	)
Cash Flows from Financing Activities
Net Change in Line of Credit	(7,542	)	3,165
Proceeds from Long-Term Debt	6,077		-
Principal Payments on Long-Term Debt	(2,567	)	(728	)
Principal Payments on Finance Leases	(432	)	(251	)
Stock option exercises	-		7
Share Repurchases	-		(130	)
Net Cash (Used In) Provided By Financing Activities	(4,464	)	2,063
Effect of Exchange Rate Changes on Cash	-		(2	)
Net Change in Cash	1,034		1,006
Cash - Beginning of Period	660		948
Cash - Ending of Period	$ 1,694	$	1,954
Reconciliation of cash and restricted cash reported within the condensed consolidated balance sheets
Cash	$ 328	$	160
Restricted Cash	1,366		1,794
Total cash and restricted cash reported in the condensed consolidated statements of cash flows	$ 1,694	$	1,954
Supplemental Disclosure of Cash Flow Information:
Cash Paid During the Period for Interest	$ 526	$	739
Cash Paid (Refunded) During the Period for Income Taxes	262		(83	)
Supplemental Noncash Investing and Financing Activities:
Property and Equipment Purchases in Accounts Payable	6		30
Equipment Acquired under Finance Lease	395		607

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS)


			Additional	Other			Retained	Total
	Preferred	Common	Paid-In	Comprehensive			Income	Shareholders'
	Stock	Stock	Capital	Loss			Earnings	Equity
BALANCE JUNE 30, 2019	$ 250	$ 27	$ 15,682	$	(233	)	$ 3,521	$	19,247
Net Income	-	-	-		-		413		413
Cumulative Adjustment	-	-	-		-		-		-
Foreign currency translation adjustment	-	-	-		(56	)	-		(56	)
Compensation on stock-based awards	-	-	35		-		-		35
Share repurchases	-	-	(4	)	-		-		(4	)
BALANCE SEPTEMBER 30, 2019	$ 250	$ 27	$ 15,713	$	(289	)	$ 3,934	$	19,635
BALANCE DECEMBER 31, 2018	$ 250	$ 27	$ 15,610	$	(233	)	$ 5,436	$	21,090
Net Income	-	-	-		-		(1,502	)	(1,502	)
Cumulative Adjustment	-	-	-		-		-		-
Foreign currency translation adjustment	-	-	-		(56	)	-		(56	)
Stock option exercises	-	-	7		-		-		7
Compensation on stock-based awards	-	-	226		-		-		226
Share repurchases	-	-	(130	)	-		-		(130	)
BALANCE SEPTEMBER 30, 2019	$ 250	$ 27	$ 15,713	$	(289	)	$ 3,934	$	19,635
BALANCE JUNE 30, 2020	$ 250	$ 27	$ 15,823	$	(299	)	$ 4,222	$	20,023
Net Income	-	-	-		-		1,971		1,971
Foreign currency translation adjustment	-	-	-		96		-		96
Compensation on stock-based awards	-	-	36		-		-		36
Share repurchases	-	-	-		-		-		-
BALANCE SEPTEMBER 30, 2020	$ 250	$ 27	$ 15,859	$	(203	)	$ 6,193	$	22,126
BALANCE DECEMBER 31, 2019	$ 250	$ 27	$ 15,748	$	(257	)	$ 4,208	$	19,976
Net Income	-	-	-		-		1,985		1,985
Foreign currency translation adjustment	-	-	-		54		-		54
Stock option exercises	-	-	-		-		-		-
Compensation on stock-based awards	-	-	111		-		-		111
Share repurchases	-	-	-		-		-		-
BALANCE SEPTEMBER 30, 2020	$ 250	$ 27	$ 15,859	$	(203	)	$ 6,193	$	22,126

See Accompanying Condensed Notes to Condensed Consolidated Financial Statements

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

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, 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:

Outstanding - January 1, 2020	372,200	$	3.85		Aggregate Intrinsic Value (in thousands)
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

In 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.

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, 2019, there were 137,500 Units granted. There were no 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 no expense in the three and nine months ended September 30, 2019. The total long-term liability recorded for the Units at September 30, 2020 is $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 at September 30, 2020 and $335 at 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, — 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 15-year term, with multiple 5-year renewal options. See disclosure of leases in Note 5, Leases.

Other Intangible Asse ts

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 st . No 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. No impairment expense was recorded during the three and nine months ended September 30, 2020 and 2019, respectively.

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.

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 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. Of the $1,694 in cash at September 30, 2020, approximately $244 was held at banks located in China. We grant credit to customers in the normal course of business and do not require collateral on our accounts receivable.

Our largest customer has two divisions that together accounted for 10% or more of our net sales during the three and nine months ended September 30, 2020 and 2019. One division accounted for approximately 20% and 21% of net sales for the three and nine months ended September 30, 2020, respectively, and approximately 19% and 21% for the three and nine months ended September 30, 2019, respectively. The other division accounted for approximately 3% of net sales for both the three months and nine months ended September 30, 2020, and approximately 3% net sales for the three and nine months ended September 30, 2019. Together they accounted for approximately 23% and 24% of net sales for the three and nine months ended September 30, 2020, respectively, and approximately 22% and 24% of net sales for both the three and nine months ended September 30, 2019, respectively. Accounts receivable from the customer at September 30, 2020 and December 31, 2019 represented approximately 37% and 36% of our total accounts receivable, respectively.

Export sales represented approximately 9% of net sales for both the three months ended September 30, 2020 and 2019. Export sales represented 10% and 15% of net sales for the nine months ended September 30, 2020 and 2019, respectively.

NOTE 3. REVENUE

Revenue recognition

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 80% and 84% of our revenue for the three and nine months ended September 30, 2020, 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.

Contract Assets

Contract assets, recorded as such in the Condensed Consolidated Balance Sheets, consist of unbilled amounts related to revenue recognized over time. Significant changes in the contract assets balance during the nine months ended September 30, 2020 was as follows:

Nine Months Ended September 30, 2020 — Outstanding at January 1, 2020	$ 7,659
Increase (decrease) attributed to:
Transferred to receivables from contract assets recognized	(6,104	)
Product transferred over time	5,779
Outstanding at September 30, 2020	$ 7,334

We expect substantially all the remaining performance obligations for the contract assets recorded as of September 30, 2020, 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 three and nine months ended September 30, 2020:

	Three Months Ended September 30, 2020 — Product/ Service Transferred Over Time	Product Transferred at Point in Time	Noncash Consideration	Total Net Sales by Market
Medical	$ 10,960	$ 1,853	$ 1,405	$ 14,218
Industrial	4,527	791	620	5,938
Aerospace and Defense	5,525	16	665	6,206
Total net sales	$ 21,012	$ 2,660	$ 2,690	$ 26,362

	Three Months Ended September 30, 2019 — Product/ Service Transferred Over Time	Product Transferred at Point in Time	Noncash Consideration	Total Net Sales by Market
Medical	$ 14,399	$ 1,661	$ 983	$ 17,043
Industrial	7,279	822	522	8,623
Aerospace and Defense	3,978	133	281	4,392
Total net sales	$ 25,656	$ 2,616	$ 1,786	$ 30,058

	Nine Months Ended September 30, 2020 — Product/ Service Transferred Over Time	Product Transferred at Point in Time	Noncash Consideration	Total Net Sales by Market
Medical	$ 35,835	$ 4,454	$ 2,464	$ 42,753
Industrial	17,434	3,354	1,213	22,001
Aerospace and Defense	14,160	396	953	15,509
Total net sales	$ 67,429	$ 8,204	$ 4,630	$ 80,263

	Nine Months Ended September 30, 2019 — Product/ Service Transferred Over Time	Product Transferred at Point in Time	Noncash Consideration	Total Net Sales by Market
Medical	$ 42,039	$ 1,914	$ 2,053	$ 46,006
Industrial	22,847	2,297	1,146	26,290
Aerospace and Defense	12,236	375	608	13,219
Total net sales	$ 77,122	$ 4,586	$ 3,807	$ 85,515

NOTE 4. FINANCING ARRANGEMENTS

We have a credit agreement with Bank of America which was entered into on June 15, 2017 and amended effective December 29, 2017 and provides for a line of credit arrangement of $16,000 that expires on June 15, 2022. The credit arrangement also has a $5,000 real estate term note outstanding with a maturity date of June 15, 2022.

Under the Bank of America credit agreement, both the line of credit and real estate term notes are subject to variations in the LIBOR rate. Our line of credit bears interest at a weighted-average interest rate of 3.7% and 5.4% as of September 30, 2020 and 2019, respectively. We had borrowings on our line of credit of $2,546 and $10,088 outstanding as of September 30, 2020 and December 31, 2019, respectively. There are no subjective acceleration clauses under the credit agreement that would accelerate the maturity of our outstanding borrowings.

The line of credit and real estate term notes with Bank of America contain 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 availability under our line is subject to borrowing base requirements, and advances are at the discretion of the lender. The line of credit is secured by substantially all of our assets. At September 30, 2020, we had unused availability under our line of credit of $8,640, supported by our borrowing base.

The Bank of America Credit Agreement provides for, among other things, a Fixed Charge Coverage Ratio of not less than (i) 1.0 to 1.0, for the three months ending December 31, 2019, six months ending March 31, 2020, nine months ending June 30, 2020 and twelve months ending September 30, 2020 and each Fiscal Quarter end thereafter. The Company met the covenants for the period ended September 30, 2020.

On April 15, 2020, we entered into a Promissory Note with Bank of America, N.A. (the “Promissory Note”), which provides for an unsecured loan of $6,077 pursuant to the Paycheck Protection Program 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 Promissory Note has a term of 2 years with a 1% per annum interest rate. Payments are deferred for 10 months after the end of the Promissory Note covered period (which is defined as 24 weeks after the date of the loan) and we can apply for forgiveness of the Promissory Note after 60 days. Forgiveness of the Promissory Note will be determined in accordance with the provisions of the Cares Act and applicable regulations. Any principal and interest amounts outstanding after the determination of amounts forgiven will be repaid on a monthly basis.

Long-term debt at September 30, 2020 and December 30, 2019 consisted of following:

	September 30, — 2020	2019
Real estate term notes bearing interest at one-month LIBOR + 2.25% (3.0% and 4.1% as of September 30, 2020 and December 31, 2019, respectively) maturing June 15, 2022 with monthly payments of approximately $41 plus interest secured by substantially all assets.	$ 1,188	$	3,755
Promissory Note	6,077		-
	7,265		3,755
Debt issuance Costs	(91	)	(132	)
Total long-term debt	7,174		3,623
Current maturities of long-term debt	(444	)	(444	)
Long-term debt - net of current maturities	$ 6,730	$	3,179

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. At September 30, 2020, we do not have material lease commitments that have not commenced.

Supplemental balance sheet information related to leases was as follows:

	Balance Sheet Location	September 30, 2020
Assets
Operating lease assets	Operating lease assets	$ 8,924
Finance lease assets	Property, Plant and Equipment	2,493
Total leased assets		$ 11,417
Liabilities
Current
Current operating lease liabilities	Current Portion of Operating Lease Obligations	$ 614
Current finance lease liabilities	Current Portion of Finance Lease Obligations	652
Noncurrent
Long-term operating lease liabilities	Long Term Operating Lease Liabilities, Net	8,832
Long term finance lease liabilities	Long Term Finance Lease Obligations, Net	1,320
Total lease liabilities		$ 11,418

Supplemental cash flow information related to leases was as follows:

	Nine Months Ended September 30,
	2020
Operating leases
Cash paid for amounts included in the measurement of lease liabilities	$ 686
Right-of-use assets obtained in exchange for lease obligations	$ 4,685

Maturities of lease liabilities were as follows:

Remaining 2020	Operating Leases — $ 351	$	207	$	558
2021	1,264		738		2,002
2022	1,279		575		1,854
2023	1,302		333		1,635
2024	1,374		277		1,651
Thereafter	9,489		20		9,509
Total lease payments	$ 15,059	$	2,150	$	17,209
Less: Interest	(5,613	)	(178	)	(5,791	)
Present value of lease liabilities	$ 9,446	$	1,972	$	11,418

The lease term and discount rate at September 30, 2020 were as follows:

Weighted-average remaining lease term (years)
Operating leases	11.1
Finance leases	3.3
Weighted-average discount rate
Operating leases	7.4 %
Finance leases	5.2 %

NOTE 6. 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, by each tax jurisdiction. Our effective tax rate for the three and nine months ended September 30, 2020 was 24% and our effective tax rate for the three and nine months ended September 30, 2019 was 10% and (9%), respectively.

NOTE 7. RELATED PARTY TRANSACTIONS

During three and nine months ended September 30, 2020, we did business with Printed Circuits, Inc. which is 90% owned by the Kunin family, of which, owns a majority of our stock. We had expenses incurred totaling $0 and $35 during the three months ended September 30, 2020 and 2019, and $28 and $87 for the nine months ended September 30, 2020 and 2019, respectively to Printed Circuits, Inc.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are a Maple Grove, Minnesota based full-service electronics manufacturing services (“EMS”) contract manufacturer of wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds for a wide range of industries. We provide value added engineering services and technical support including design, testing, prototyping and supply chain management to customers mainly in the aerospace and defense, medical, and industrial equipment markets. We maintain facilities in Bemidji, Blue Earth, Mankato, Maple Grove, Merrifield, and Milaca, Minnesota; Monterrey, Mexico; and Suzhou, China. All of our facilities are certified to one or more of the ISO/AS standards, including 9001, AS9100 and 13485, with most having additional certifications based on the needs of the customers they serve.

Recent Developments

Global Pandemic

In March 2020, the World Health Organization recognized the outbreak of a novel coronavirus (“COVID-19”) as a pandemic. While the COVID-19 pandemic has had an impact on our operations, we have been able to continue to operate our manufacturing facilities and provide essential services to our customers. Additionally, in an effort to protect the health and safety of our employees and in compliance with state regulations, we have instituted a work-from-home policy for employees who can perform their job functions offsite, implemented social distancing requirements and other measures to allow manufacturing and other personnel essential to production to continue work within our manufacturing facilities, and suspended all non-essential employee travel.

The full extent to which COVID-19 will directly or indirectly impact our business, financial condition, and results of operations will depend on future developments that are highly uncertain and cannot be accurately predicted, including new information that may emerge concerning COVID-19, the actions taken to contain it or treat its impact and the economic impact on local, regional, national and international markets. We will continue to assess the potential impact of the COVID-19 pandemic on our business, financial condition, and results of operations.

We continue to actively manage our cash and working capital to preserve adequate liquidity and ensure that our business can continue to operate during these uncertain times.

Facility Consolidation

To further improve operational efficiencies and lower overhead costs, the Company approved on August 7, 2020, the closure of our Merrifield, Minnesota, production facility, shifting wire and cable assembly, system-level assembly and printed circuit board (PCB) manufacturing to Nortech’s other Minnesota locations. The Merrifield production facility consolidation is expected to be complete on or before December 31, 2020, and will impact approximately 60 employees, who will be offered positions at other Nortech facilities in Minnesota. As of September 30, 2020, this closure did not qualify for held for sale nor discontinued operations accounting.

Results of Operations

The following table presents statements of operations data as percentages of total net sales for the periods indicated:


September 30,				September 30,
2020		2019		2020		2019
Net Sales	100.0	%	100.0	%	100.0	%	100.0	%
Cost of Goods Sold	93.8		87.9		91.2		89.6
Gross Profit	6.2		12.1		8.8		10.4
Selling Expenses	2.3		2.0		2.4		2.5
General and Administrative Expenses	8.2		7.7		7.2		8.6
Gain on Sale of Property and Equipment	(14.5	)	0.0		(4.8	)	0.0
Income (Loss) from Operations	10.2		2.4		4.0		(0.7	)
Other Expenses	(0.5	)	(0.9	)	(0.7	)	(0.9	)
Income (Loss) Before Income Taxes	9.7		1.5		3.3		(1.6	)
Income Tax Expense	2.3		0.1		0.8		0.2
Net Income (Loss)	7.4	%	1.4	%	2.5	%	(1.8	)%

Net Sales

Net sales were $26.4 million in the third quarter of 2020, as compared to $30.1 million in the third quarter of the prior year, a decrease of $3.7 million or 12.3% that was driven in part by the COVID-19 pandemic. Net sales results were varied by markets; the medical market decreased by $2.8 million or 16.6% with medical devices accounting for the largest portion of the decrease. The industrial market decreased by $2.7 million or 31.1% of sales in the third quarter of 2020 as compared to the same quarter of 2019. Net sales from the aerospace and defense markets increased by $1.8 million or 41.3% of sales in the third quarter of 2020 as compared to the third quarter of 2019.

Net sales were $80.3 million in the nine months ended 2020, as compared to $85.5 million in the prior year, a decrease of $5.3 million or 6.1% that was driven in part by the COVID-19 pandemic. Net sales results were varied by markets; the medical market decreased by $3.3 million, or 7.1% with medical device accounting for 45.6% of the decrease and medical component products the remaining 54.4%. The industrial market decreased by $4.3 million of sales or 16.3% for the nine months ended September 30, 2020 as compared to the same period of 2019. Net sales from aerospace and defense markets increased by $2.3 million of sales or 17.3% for the nine months ended September 30, 2020 as compared to the same period of 2019.

Net sales by our major EMS industry markets for the three and nine months ended September 30, 2020 and 2019 were as follows (in thousands):

2020	2019	%		2020	2019	%
$	$	Change		$	$	Change
Medical	14,218	17,043	(16.6	)	42,753	46,006	(7.1	)
Industrial	5,938	8,623	(31.1	)	22,001	26,290	(16.3	)
Aerospace and Defense	6,206	4,392	41.3		15,509	13,219	17.3
Total Net Sales	26,362	30,058	(12.3	)	80,263	85,515	(6.1	)

Net sales by timing of transfer of goods and services for the three and nine months ended September 30, 2020 is as follows (in thousands):

	Three Months Ended September 30, 2020 — Product/ Service Transferred Over Time	Product Transferred at Point in Time	Noncash Consideration	Total Net Sales by Market
Medical	$ 10,960	$ 1,853	$ 1,405	$ 14,218
Industrial	4,527	791	620	5,938
Aerospace and Defense	5,525	16	665	6,206
Total net sales	$ 21,012	$ 2,660	$ 2,690	$ 26,362

	Nine Months Ended September 30, 2020 — Product/ Service Transferred Over Time	Product Transferred at Point in Time	Noncash Consideration	Total Net Sales by Market
Medical	$ 35,835	$ 4,454	$ 2,464	$ 42,753
Industrial	17,434	3,354	1,213	22,001
Aerospace and Defense	14,160	396	953	15,509
Total net sales	$ 67,429	$ 8,204	$ 4,630	$ 80,263

Net sales by timing of transfer of goods and services for the three and nine months ended September 30, 2019 is as follows (in thousands):

	Three Months Ended September 30, 2019 — Product/ Service Transferred Over Time	Product Transferred at Point in Time	Noncash Consideration	Total Net Sales by Market
Medical	$ 14,399	$ 1,661	$ 983	$ 17,043
Industrial	7,279	822	522	8,623
Aerospace and Defense	3,978	133	281	4,392
Total net sales	$ 25,656	$ 2,616	$ 1,786	$ 30,058

	Nine Months Ended September 30, 2019 — Product/ Service Transferred Over Time	Product Transferred at Point in Time	Noncash Consideration	Total Net Sales by Market
Medical	$ 42,039	$ 1,914	$ 2,053	$ 46,006
Industrial	22,847	2,297	1,146	26,290
Aerospace and Defense	12,236	375	608	13,219
Total net sales	$ 77,122	$ 4,586	$ 3,807	$ 85,515

Backlog

Our 90-day shipment backlog as of September 30, 2020 was $23 million, a 0.8% decrease from the beginning of the quarter and a 27.8% decrease from the prior year. Backlog for our medical customers has decreased 4.2% from the beginning of the quarter and decreased 35.4% from the prior year. Our industrial customers’ backlog increased 10.4% from the beginning of the quarter and decreased 41.7% from the prior year. The aerospace and defense backlog decreased 2.0% from the beginning of the quarter and increased 14.5% from the prior year. Our backlog consists of firm purchase orders we expect to ship in the next 90 days, with any remaining amounts to be transferred within 180 days.

90-day shipment backlog by our major EMS industry markets are as follows (in thousands):

	Shipment Backlog as of the Period Ended — September 30,	June 30,	September 30,
	2020	2020	2019
Medical	$ 11,484	$ 11,987	$ 17,778
Industrial	4,860	4,401	8,334
Aerospace and Defense	6,764	6,900	5,909
Total 90-Day Backlog	$ 23,108	$ 23,288	$ 32,021

Our 90-day backlog varies due to order size, manufacturing delays, contract terms and conditions and timing from customer delivery schedules and releases. These variables cause inconsistencies in comparing the backlog from one period to the next. Our total shipment backlog was $45.7 million at September 30, 2020 compared to $58.1 million at the end of September 30, 2019. This decrease was driven in part to the impact of COVID-19.

Gross Profit

Gross profit as a percent of net sales for the three months ended September 30, 2020 and 2019 was 6.2% and 12.1%, respectively. Gross profit as a percentage of sales for the nine months ended September 30, 2020 and 2019 was 8.8% and 10.4%, respectively. The decrease in both comparisons was driven by lower sales on a fixed cost base in part due to the impact of COVID-19 and increased inventory reserves.

Selling Expense

Selling expenses for the three months ended September 30, 2020 and 2019 was $0.6 million or 2.3% of sales and $0.6 million or 2.0% of sales, respectively. Selling expense for the nine months ended September 30, 2020 and 2019 was $1.9 million or 2.4% of sales and $2.1 million or 2.5% of sales, respectively.

General and Administrative Expense

General and administrative expenses for the three months ended September 30, 2020 and 2019 were $2.2 million or 8.2% of sales and $2.3 million or 7.7% of sales, respectively. General and administrative expenses for the nine months ended September 30, 2020 and 2019 were $5.8 million or 7.2% of sales and $7.4 million or 8.6% of sales, respectively. The decrease in the year to date comparison was due to higher spend in the prior year related one-time expenditures to improve operations in 2019 and the benefits of those cost reduction measures in 2020.

Gain on Sale of Property and Equipment

The gain on sale of property and equipment was $3.8 million in the three and nine months ended September 30, 2020. This gain was due to the sale leaseback transaction we completed in the period relating to the manufacturing facilities in Bemidji and Mankato, Minnesota.

Income (Loss) from Operations

Third quarter 2020 income from operations was $2.7 million compared to $0.7 million for the third quarter in 2019. Income from operations for the first nine months in 2020 was $3.1 million as compared to a loss of $0.6 million for the same comparable period in 2019. The increase in the income from operations in both comparisons was due to the gain on sale of property and equipment of $3.8 million partially offset by lower gross profit.

Income Taxes

Net Income (Loss)

Net income for the three months ended September 30, 2020 and September 30, 2019 was $2.0 and $0.4 million, respectively. Net income for the nine months ended September 30, 2020 was $2.0 million and net loss for the nine months ended September 30, 2019 was $1.5 million.

Liquidity and Capital Resources

Our third quarter sales and shipment backlog were impacted by the COVID-19 pandemic. However, our focus on reducing costs, minimizing capital expenditures, and managing working capital mitigated the impact on liquidity. Due to the inherent uncertainty of this evolving situation, we are unable at this time to predict the likely impact of the COVID-19 pandemic on our future operations. However, we believe that cash provided by operations, funds available under the credit agreement with Bank of America, N.A. (BofA), funds available under a Promissory Note with BofA (“Promissory Note”) pursuant to the Paycheck Protection Program under the Coronavirus Aid, funds received from our sales leaseback transaction and cash on hand will be adequate to meet our liquidity needs, including working capital, capital expenditures, and debt payment obligations.

Net cash used in operating activities for the nine months ended September 30, 2020 and September 30, 2019 was $0.1 million and $0.2 million, respectively.

We have satisfied our liquidity needs over the past several years with cash flows generated from operations and a bank operating line of credit. We have a credit agreement with Bank of America (BofA) which was entered into on June 15, 2017 and amended on December 29, 2017 and provides for a line of credit arrangement of $16.0 million that expires on June 15, 2022. The credit arrangement also has a $5.0 million real estate term note outstanding with a maturity date of June 15, 2022.

Both the line of credit and real estate term notes are subject to fluctuations in the LIBOR rates. The line of credit and real estate term notes with BofA contain 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 availability under our line is subject to borrowing base requirements, and advances are at the discretion of the lender. The line of credit is secured by substantially all of our assets.

On September 30, 2020, we had outstanding advances of $2.5 million under the line of credit and unused availability of $8.6 million supported by our borrowing base. We believe our financing arrangements and cash flows to be provided by operations will be sufficient to satisfy our future working capital needs. Our working capital was $22.6 million and $21.1 million as of September 30, 2020 and December 31, 2019, respectively.

The Bank of America Credit Agreement provides for, among other things, a Fixed Charge Coverage Ratio of not less than (i) 1.0 to 1.0 for the three months ending December 31, 2019, six months ending March 31, 2020, nine months ending June 30, 2020 and twelve months ending September 30, 2020 and each fiscal quarter end thereafter. The Company met the covenants for the nine months ended September 30, 2020.

On April 15, 2020, we entered into a Promissory Note, which provides for an unsecured loan of $6.1 million pursuant to the Paycheck Protection Program 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 Promissory Note has a term of 2 years with a 1% per annum interest rate. Payments are deferred for 10 months after the end of the Promissory Note covered period (which is defined as 24 weeks after the date of the loan) and we can apply for forgiveness of the Promissory Note after 60 days. Forgiveness of the Promissory Note will be determined in accordance with the provisions of the Cares Act and applicable regulations. Any principal and interest amount outstanding after the determination of amounts forgiven will be repaid on a monthly basis. We expect that all or a significant portion of the Promissory Note will be forgiven.

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.

Critical Accounting Policies and Estimates

Our significant accounting policies and estimates are summarized in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2019. Some of our accounting policies require us to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. Such judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, known trends in our industry, terms of existing contracts and other information from outside sources, as appropriate. Actual results could differ from these estimates.

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;

● 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;

● Risks related to availability of labor;

● 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;

● Outbreaks of epidemic, pandemic, or contagious diseases, such as the recent novel coronavirus 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. Discussion of these factors is also incorporated in Part I, Item 1A, “Risk Factors,” and should be considered an integral part of Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” 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 obligations 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, 2019, and the risks set forth in PART II, ITEM 1A below.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q, our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act). These controls and procedures are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon their evaluation of these disclosure controls and procedures as of the date of the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

Except for the implementation of certain internal controls related to the adoption of the new lease standard (ASC 842), there was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II

ITEM 1. LEGAL PROCEEDINGS

We are subject to various legal proceedings and claims that arise in the ordinary course of business.

ITEM 1A. RISK FACTORS

We are affected by the risks specific to us as well as factors that affect all businesses operating in a global market. The significant factors known to us that could materially adversely affect our business, financial condition or operating results or could cause our actual results to differ materially from our expectations are described in our annual report on Form 10-K for the fiscal year ended under the heading “Part I – Item 1A.Risk Factors.” Other than as noted below, there have been no material changes in the risk factors from those disclosed in the Annual Report on Form 10-K for the year ended December 31, 2019.

Pandemics or disease outbreaks such as the current novel coronavirus (COVID-19 virus) pandemic have affected and is expected to continue to affect adversely our operations, supply chains, financial condition and results of operations.

The coronavirus (COVID-19) pandemic is adversely affecting, and is expected to continue to affect adversely, our operations, supply chains, financial condition and results of operations, and we have experienced and expect to continue to experience unpredictable reductions in demand for certain of our services. During the current COVID-19 pandemic, the Company has experienced reduced sales, supply chain disruption, reduced customer demand and reduced availability of workforce.

Outbreaks of epidemic, pandemic, or contagious diseases, such as, historically, the Ebola virus, Middle East Respiratory Syndrome, Severe Acute Respiratory Syndrome, or the H1N1 virus, could cause a disruption to our business. Business disruptions could include temporary closures of our facilities or the facilities of our suppliers, reduced demand from customers, unavailability or restricted availability of our material portions of our workforce, raw materials or components necessary to manufacture our products, or disruptions or restrictions on our ability to travel or to distribute our products. Any disruption of our operations, our suppliers or our customers would likely impact our sales and operating results. In addition, a significant outbreak of epidemic, pandemic, or contagious diseases in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could affect demand for our products and services. Any of these events could negatively impact our sales and have a material adverse effect on our business, financial condition, results of operations, or cash flows.

We may be subject to additional regulatory scrutiny in the form of an audit or review as a result of our Paycheck Protection Program Promissory Note which would have an adverse effect on our liquidity.

On April 15, 2020, we entered into a Promissory Note with Bank of America, N.A. (the “Promissory Note”), which provides for an unsecured loan of $6.1 million 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. On April 23, 2020, the Small Business Administration (“SBA”) issued new guidance that questioned whether a public company with substantial market value and access to capital markets would qualify to participate in the PPP under the CARES Act. Subsequently, on April 28, 2020, the secretary of the Treasury and SBA announced that the government will review all PPP loans of more than $2 million for which a borrower applies for forgiveness. Should we be audited or reviewed by the U.S. Department of Treasury as a result of filing an application for forgiveness or otherwise, such audit or review could result in legal and reputational costs as well as significant use of management time. While the Company believes that it acted in good faith and has complied with all requirements of the PPP, if we are audited and receive an adverse or negative finding in such audit, we could be required to return up to the full amount of the Promissory Note, which would reduce our liquidity by such amount and potentially subject us to fines and penalties.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

As of September 30, 2020, our share repurchase program has expired, and no additional amounts are available for repurchase.

ITEM 3. DEFAULTS ON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

Exhibits

10.1* Third Quarter 2020 Earnings Release

31.1* Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.

31.2* Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.

32* Certification of the Chief Executive Officer and Chief Financial Officer, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101* Financial statements from the quarterly report on Form 10-Q for the quarter ended September 30, 2020, formatted in XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations and Comprehensive Loss, (iii) Condensed Consolidated Statements of Cash Flows, and (iv) the Condensed Notes to Condensed Consolidated Financial Statements.

*Filed herewith

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Nortech Systems Incorporated and Subsidiaries

Date: November 12, 2020	by /s/ Jay D. Miller
	Jay D. Miller Chief Executive Officer and President Nortech Systems Incorporated
Date: November 12, 2020	by /s/ Chris topher D. Jones
	Christopher D. Jones Sr. Vice President and Chief Financial Officer Nortech Systems Incorporated

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NORTECH SYSTEMS INC Interim / Quarterly Report 2020

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NORTECH SYSTEMS INC — Interim / Quarterly Report 2020

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