SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

9 Months Ended

Sep. 30, 2011

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited 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 consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our latest shareholders’ annual report on Form 10-K.  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 consolidated financial statements, we have made our best estimates and judgments of certain amounts included in the 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 consolidated financial statements include the accounts of Nortech Systems Incorporated and its wholly owned subsidiary, Manufacturing Assembly Solutions of Monterrey, Inc.  All significant intercompany accounts and transactions have been eliminated.

Revenue Recognition

We recognize revenue upon shipment of manufactured products to customers, when title has passed, all contractual obligations have been satisfied and collection of the resulting receivable is reasonably assured. We also provide engineering services separate from the manufacture of a product. Revenue for engineering services is recognized upon completion of the engineering process, providing standalone fair value to our customers. Our engineering services are short-term in nature. In addition, we have another separate source of revenue that comes from short-term repair services, which are recognized upon completion of the repairs and shipment of product back to the customer.

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 Options

Following is the status of all stock options as of September 30, 2011, including changes during the nine-month period then ended:

	Shares		Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value
Outstanding - January 1, 2011	663,150		$	7.32
Forfeited	(39,550	)	$	7.28
Outstanding - September 30, 2011	623,600		$	7.33	4.77	$	91
Exercisable - September 30, 2011	292,000		$	7.28	3.57	$	—

There were no options exercised during the three and nine months ended September 30, 2011.  The total intrinsic value of options exercised during the three and nine months ended September 30, 2010 was $0 and $20, respectively.  Cash received from option exercises during the three and nine months ended September 30, 2010 was $0 and $12,500, respectively.

Total compensation expense related to stock options with time-based vesting for the three months ended September 30, 2011 and 2010 was $7,930 and $7,932, respectively.  Total compensation expense related to stock options with time-based vesting for the nine months ended September 30, 2011 and 2010 was $23,792 and $23,796, respectively.  As of September 30, 2011, there was approximately $3,000 of unrecognized compensation expense related to unvested option awards that we expect to recognize by November 30, 2011.

Equity Appreciation Rights Plan

In November 2010, the Board of Directors approved the adoption of the Nortech Systems Incorporated Equity Appreciation Rights Plan (the “2010 Plan”).  The total number of Equity Appreciation Right Units (Units) the Plan can issue shall not exceed an aggregate of 750,000 Units, of which 100,000 Units were granted during the year ended December 31, 2010.  There were no additional Units granted during the three and nine months ended September 30, 2011.

The 2010 Plan provides that Units granted shall fully vest three years from the grant date unless terminated earlier.  Units give the holder a right to receive a cash payment equal to the appreciation in book value per share of common stock from the base date, as defined, to the redemption date.  Unit redemption payments under this plan shall be paid in cash within 90 days after we determine the book value of the Units as of the calendar year immediately preceding the redemption date.  The Units granted during the year ended December 31, 2010 have a book value per Unit of $6.84 and have a weighted average life remaining of 1.25 years at September 30, 2011.  Total compensation expense related to these Units based on the estimated appreciation over their remaining term was $10,193 and $42,655 for the three and nine months ended September 30, 2011, respectively.  No compensation expense related to these Units was recognized in the three and nine months ended September 30, 2010.

Earnings per Common Share

For the three and nine months ended September 30, 2011 and 2010, the effect of all outstanding stock options was antidilutive.  Therefore, no outstanding options were included in the computation of per-share amounts.

Segment Reporting Information

For the three and nine months ended September 30, 2011 and 2010 all of our operations fall under the Contract Manufacturing segment within the Electronic Manufacturing Services industry.  We strategically direct production between our various manufacturing facilities based on a number of considerations to best meet our customers’ requirements.  We share resources for sales, marketing, cash and risk management, banking, credit and collections, human resources, payroll, internal control, audit, taxes, SEC reporting and corporate accounting.  Consolidated financial information is available that is evaluated regularly by the chief operating decision maker in assessing performance and allocating resources.

Inventories

Inventories are stated at the lower of cost (first-in, first-out method) or market (based on the lower of replacement cost 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
	2011			2010
Raw Materials	$	14,643,580		$	11,277,741
Work in Process	4,268,633			3,477,236
Finish Goods	3,501,299			2,395,843
Reserve	(1,017,054		)	(1,042,047		)
Total	$	21,396,458		$	16,108,773

Finite Life Intangible Assets

Finite life intangible assets at September 30, 2011 and December 31, 2010 are as follows:

	September 30, 2011
	Remaining	Gross
	Lives	Carrying		Accumulated		Net Book
	(Years)	Amount		Amortization		Value
Bond Issue Costs	10	$	79,373	$	27,782	$	51,591
Customer Base	1	676,557		631,450		45,107
Totals		$	755,930	$	659,232	$	96,698

	December 31, 2010
	Remaining	Gross
	Lives	Carrying		Accumulated		Net Book
	(Years)	Amount		Amortization		Value
Bond Issue Costs	11	$	79,373	$	23,814	$	55,559
Customer Base	2	676,557		529,966		146,591
Totals		$	755,930	$	553,780	$	202,150

Amortization expense for the three months ended September 30, 2011 and 2010 was $35,150 and $35,151, respectively.  Amortization expense for the nine months ended September 30, 2011 and 2010 was $105,452 and $106,248, respectively.  Estimated future amortization expense related to these assets is as follows:

Remainder of 2011	$	35,000
2012	17,000
2013	5,000
2014	5,000
2015	5,000
Thereafter	30,000
Total	$	97,000