SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

3 Months Ended

Mar. 31, 2012

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 March 31, 2012, including changes during the three-month period then ended:

	Shares		Weighted-Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value
Outstanding - January 1, 2012	623,600		$	7.33
Cancelled	(319,600	)	$	7.43
Outstanding - March 31, 2012	304,000		$	7.21	3.21	$	—
Exercisable - March 31, 2012	304,000		$	7.21	3.21	$	—

There were no options exercised during the three months ended March 31, 2012 and 2011.

Total compensation expense related to stock options for the three months ended March 31, 2012 and 2011 was $0 and $7,932, respectively.  As of March 31, 2012, there was no unrecognized compensation expense as all options were fully vested.

In January 2012, the Board of Directors terminated the 2007 FOCUS Incentive plan and as a result all 319,600 outstanding stock options under this plan were cancelled.

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 with a vesting date of December 31, 2012.  On March 7, 2012, we granted an additional 250,000 Units with vesting dates ranging from December 31, 2014 through December 31, 2016.

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.

Total compensation expense related to these Units based on the estimated appreciation over their remaining terms was $2,810 and $26,541 for the three months ended March 31, 2012 and 2011, respectively.  At March 31, 2012 and 2011, approximately $65,000 and $62,000 have been accrued under this plan.  As of March 31, 2012, approximately $60,000 of this balance is included in Other Accrued Liabilities as it is an estimate of the amount to be paid within 12 months.  The remaining $5,000 balance at March 31, 2012 and all of the balance at March 31, 2011 are included in Other Long-Term Liabilities.

Earnings per Common Share

For the three months ended March 31, 2012 and 2011, the effect of all stock options is antidilutive.  Therefore, no outstanding options were included in the computation of per-share amounts.

Segment Reporting Information

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, engineering, supply chain management, 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:

	March 31			December 31
	2012			2011
Raw Materials	$	14,305,411		$	13,056,955
Work in Process	2,924,446			3,202,002
Finish Goods	3,046,453			3,880,764
Reserve	(1,260,270		)	(1,110,128		)
Total	$	19,016,040		$	19,029,593

Finite Life Intangible Assets

Finite life intangible assets at March 31, 2012 and December 31, 2011 are as follows:

	March 31, 2012
	Remaining	Gross
	Lives	Carrying		Accumulated		Net Book
	(Years)	Amount		Amortization		Value
Bond Issue Costs	9	$	79,373	$	30,426	$	48,947
Customer Base	0	676,557		676,557		—
Totals		$	755,930	$	706,983	$	48,947

	December 31, 2011
	Remaining	Gross
	Lives	Carrying		Accumulated		Net Book
	(Years)	Amount		Amortization		Value
Bond Issue Costs	10	$	79,373	$	29,106	$	50,267
Customer Base	1	676,557		665,277		11,280
Totals		$	755,930	$	694,383	$	61,547

Amortization expense for the three months ended March 31, 2012 and 2011 was $12,600 and $35,151, respectively.  Estimated future amortization expense related to these assets is as follows:

Remainder of 2012	4,000
2013	5,000
2014	5,000
2015	5,000
2016	5,000
Thereafter	25,000
Total	$	49,000