SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Policies)

9 Months Ended

Sep. 30, 2015

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.

Basis of Presentation

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

Principles of Consolidation

The consolidated financial statements include the accounts of Nortech Systems Incorporated and its wholly owned subsidiaries, Manufacturing Assembly Solutions of Monterrey, Inc. and Nortech Systems Hong Kong Company, Limited.  All significant intercompany accounts and transactions have been eliminated.

Revenue Recognition

Revenue Recognition

We recognize manufacturing revenue when we ship goods or the goods are received by our customer, when title has passed, all contractual obligations have been satisfied, the price is fixed or determinable and collection of the resulting receivable is reasonably assured. Generally, there are no formal substantive customer acceptance requirements or further obligations related to manufacturing services.  If such requirements or obligations exist, then we recognize the related revenues at the time when such requirements are completed and the obligations are fulfilled.  We also provide engineering services separate from the manufacture of a product. Revenue for engineering services is generally recognized on a time and material basis or upon completion of the engineering process.  In addition, we have another separate source of revenue that comes from short-term repair services, which are recognized when the repairs are completed and the repaired products are shipped back to the customer.  Our net sales for services were less than 5% of our total sales for all periods presented, and accordingly, are included in net sales in the consolidated statement of operations.  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

Stock Options

Following is the status of all stock options outstanding as of September 30, 2015:

	Shares		Weighted- Average  Exercise  Price Per  Share		Weighted- Average  Remaining  Contractual  Term  (in years)	Aggregate  Intrinsic Value
Outstanding - January 1, 2015	181,000		$	6.36
Granted	—		—
Exercised	(3,333	)	3.20
Cancelled	(37,917	)	5.52
Outstanding - September 30, 2015	139,750		$	6.66	2.24	$	16,800
Exercisable - September 30, 2015	134,917		$	6.78	2.06	$	11,725

The total intrinsic value of options exercised during the three and nine months ended September 30, 2015 was $8,166.  Cash received from options exercised during the three and nine months ended September 30, 2015 was $10,666.  There were no options exercised during the three and nine months ended September 30, 2014.  There were no stock options granted during the three and nine months ended September 30, 2015 and 2014.

Total compensation expense related to stock options for the three months ended September 30, 2015 and 2014 was $1,989 and $7,482, respectively.  Total compensation expense related to stock options for the nine months ended September 30, 2015 and 2014 was $1,320 and $22,445, respectively.  As of September 30, 2015, there was approximately $3,000 of unrecognized compensation related to unvested option awards that we expect to recognize over a weighted-average period of 0.37 years.

Equity Appreciation Rights Plan

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 1,000,000 Units as amended and restated on March 11, 2015 and approved by the shareholders on May 6, 2015.  The 2010 Plan provides that Units issued shall fully vest three years from the base date as defined in the agreement 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 the 2010 Plan shall be paid in cash within 90 days after we determine the value as of the redemption date.

During the nine months ended September 30, 2015, we granted 57,500 Units with a base date of January 1, 2015 and vesting dates through January 1, 2018.

Total compensation expense (income) related to the vested outstanding Units based on the estimated appreciation over their remaining terms was approximately $(37,000) and $38,000 for the three months ended September 30, 2015 and 2014, respectively and $(95,000) and $119,000 for the nine months ended September 30, 2015 and 2014, respectively.  The income for the three and nine months ended September 30, 2015 was the result of a change in the assumption of the appreciation of book value per share of common stock.

As of September 30, 2015 and December 31, 2014, approximately $118,000 and $259,000 is accrued under this plan, respectively.  As of September 30, 2015, approximately $55,000 of this balance is included in Other Accrued Liabilities and the remaining $63,000 balance was included in Other Long-term Liabilities.  As of December 31, 2014, approximately $47,000 of this balance is included in Other Accrued Liabilites and the remaining $212,000 was included in Other Long-term Liabilities.

Earnings per Common Share

Earnings per Common Share

For the three and nine months ended September 30, 2015, the effect of all stock options is antidilutive due to the net loss incurred and, therefore, were not included in the computation of per-share amounts.  For the three and nine months ended September 30, 2015, stock options of 123,750 and 125,500, respectively, were excluded because their inclusion would be antidilutive.

For both the three and nine months ended September 30, 2014, 26,750 stock options were included in the computation of diluted per share amounts as their impact was dilutive.  For the three and nine months ended September 30, 2014, stock options of 169,250 and 178,139, respectively were excluded because their inclusion would be antidilutive.

Segment Reporting Information

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, information services, human resources, payroll, and all corporate accounting functions.  Consolidated financial information is available that is evaluated regularly by the chief operating decision maker in assessing performance and allocating resources.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts Receivable and Allowance for Doubtful Accounts

We grant credit to customers in the normal course of business.  Accounts receivable are unsecured and are presented net of an allowance for doubtful accounts.  The allowance for doubtful accounts was $130,000 and $137,000 at September 30, 2015 and December 31, 2014, respectively.  We determine our allowance by considering a number of factors, including the length of time accounts receivable are past due, our previous loss history, the customers’ current ability to pay their obligations to us, and the condition of the general economy and the industry as a whole.  We write-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for uncollectible accounts.

Inventories

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
	2015			2014
Raw Materials	$	14,238,633		$	12,745,623
Work in Process	3,840,602			3,653,670
Finished Goods	2,999,565			2,861,373
Reserve	(816,594		)	(732,248		)
Total	$	20,262,206		$	18,528,418

Finite Life Intangible Assets

Finite Life Intangible Assets

Finite life intangible assets at September 30, 2015 and December 31, 2014 are as follows:

	September 30, 2015
	Remaining	Gross
	Lives	Carrying		Accumulated		Net Book
	(Years)	Amount		Amortization		Value
Customer Relationships	9.0	$	1,302,000	$	36,167	$	1,265,833
Trade Names	20.0	$	814,000	$	10,174	$	803,826
Bond Issue Costs	6.0	$	79,373	$	48,948	$	30,425
Totals		$	2,195,373	$	95,289	$	2,100,084

	December 31, 2014
	Remaining	Gross
	Lives	Carrying		Accumulated		Net Book
	(Years)	Amount		Amortization		Value
Bond Issue Costs	7.0	$	79,373	$	44,978	$	34,395
Totals		$	79,373	$	44,978	$	34,395

Amortization expense for the three months ended September 30, 2015 and 2014 was $47,665 and $1,323, respectively.  Amortization expense for the nine months ended September 30, 2015 and 2014 was $50,312 and $3,969, respectively.

Estimated future amortization expense related to these assets is as follows:

Remainder of 2015	$	49,000
2016	160,000
2017	160,000
2018	160,000
2019	160,000
Thereafter	1,411,084
Total	$	2,100,084

Impairment Analysis

Impairment Analysis

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

Recent Accounting Pronouncements

Recent Accounting Pronouncements

In July 2015, the Financial Accounting Standards Board issued changes to the subsequent measurement of inventory. Currently, an entity is required to measure its inventory at the lower of cost or market, whereby market can be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin. The changes require that inventory be measured at the lower of cost and net realizable value, thereby eliminating the use of the other two market methodologies. Net realizable value is defined as the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation. These changes do not apply to inventories measured using LIFO (last-in, first-out) or the retail inventory method. Currently, Nortech applies the net realizable value market option to measure non-LIFO inventories at the lower of cost or market. These changes become effective for Nortech on January 1, 2017. Management has determined that the adoption of these changes will not have an impact on the Consolidated Financial Statements.

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). This standard outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service. Transfer of control is not the same as transfer of risks and rewards, as it is considered in current guidance.  In the first quarter of 2015, the FASB approved a deferral of the effective date to January 1, 2018.  Upon adoption in 2018, the company will record an adjustment to retained earnings as of the beginning of the year of initial application, which can be either the earliest comparative period presented, with all periods presented under the new rules, or January 1, 2018, without restating prior periods presented.  Management has not yet determined which transition reporting option it will apply.

In April 2014, the FASB issued ASU No. 2015-03, Interest — Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Cost. This ASU requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.  The recognition and measurement guidance for debt issuance costs is not affected by the new guidance.  The updated standard will be effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years.  All entities have the option of adopting the new requirements as of an earlier date for financial statements that have not been previously issued.  The guidance should be adopted on a retrospective basis, wherein the balance sheet of each individual period presented is adjusted to reflect the period-specific effects of applying the new guidance.  The Company has adopted ASU 2015-03 and presented its debt issuance costs as a component of long term debt.