SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Policies)

9 Months Ended

Sep. 30, 2016

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 Annual Report on Form 10-K for the fiscal year ended December 31, 2015. 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., Nortech, Nortech Systems Hong Kong Company, Limited and Nortech Systems Suzhou 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. 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 as of September 30, 2016, 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, 2016	139,750		$	6.66
Exercised	(1,507	)	3.20
Cancelled	(59,493	)	7.18
Outstanding - September 30, 2016	78,750		$	6.33	2.19	$	8,000
Exercisable - September 30, 2016	78,750		$	6.33	2.19	$	8,000

The total intrinsic value of options exercised during the nine months ended September 30, 2016 and 2015 was approximately $1,000 and $8,000, respectively. Cash received from options exercised during the nine months ended September 30, 2016 and 2015 was approximately $5,000 and $11,000, respectively. There were no options exercised during the three months ended September 30, 2016 and 2015. There were no stock options granted during the three and nine months ended September 30, 2016 and 2015.

Total compensation expense related to stock options for the three months ended September 30, 2016 and 2015 was approximately $0 and $2,000, respectively. Total compensation expense related to stock options for the nine months ended September 30, 2016 and 2015 was $1,000. As of September 30, 2016 there was no remaining unrecognized compensation.

Equity Appreciation Rights Plan

Equity Appreciation Rights Plan

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. 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 book value of the Units as of the calendar year immediately preceding the redemption date.

On August 3, 2016, the Compensation Committee approved grants of equity appreciation rights to the non-employee members of the Board of Directors on that date. The grants were for 5,000 Units each, with the number of Units prorated to 3,333 for the two directors who were elected at the annual meeting. The Units vest in three years with a base period starting on January 1, 2016. No other grants of Units were made during the three and nine months ended September 30, 2016.

Total compensation expense (income) related to the vested outstanding Units based on the estimated appreciation over their remaining terms was approximately $12,000 and ($37,000) for the three months ended September 30, 2016 and 2015, respectively and $6,000 and ($95,000) for the nine months ended September 30, 2016 and 2015, respectively. The income for the three and nine months ended September 30, 2015 was the result of a change in the estimate of the appreciation of book value per share of common stock.

As of September 30, 2016 and December 31, 2015, approximately $87,000 and $143,000 is accrued under this plan, respectively. As of September 30, 2016, approximately $54,000 of this balance is included in other accrued liabilities and the remaining $33,000 balance was included in other long-term liabilities. As of December 31, 2015, approximately $61,000 of this balance is included in other accrued liabilities and the remaining $82,000 balance was included in other long-term liabilities.

Earnings per Common Share

Earnings per Common Share

For the three months ended September 30, 2016, 14,500 stock options were included in the computation of diluted per share amounts as their impact was dilutive. For the three months ended September 30, 2016, stock options of 64,250 were excluded because their inclusion would be antidilutive. For the nine months ended September 30, 2016, 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, 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.

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 approximately $633,000 and $320,000 at September 30, 2016 and December 31, 2015, 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.

For the three and nine month periods ended September 30, 2016, we increased our provision for doubtful accounts by $456,000 due to a customer bankruptcy.

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
	2016			2015
Raw Materials	$	14,868,590		$	13,782,411
Work in Process	4,684,076			4,674,223
Finished Goods	2,835,128			2,478,423
Reserve	(645,271		)	(749,612		)
Total	$	21,742,523		$	20,185,445

Other Intangible Assets

Other Intangible Assets

Other intangible assets at September 30, 2016 and December 31, 2015 are as follows:

	September 30, 2016
	Gross
	Carrying		Accumulated		Net Book
	Amount		Amortization		Value
Customer Relationships	$	1,302,000	$	180,830	$	1,121,170
Trade Names	$	814,000	$	50,875	$	763,125
Bond Issue Costs	$	79,373	$	54,240	$	25,133
Totals	$	2,195,373	$	285,945	$	1,909,428

	December 31, 2015
	Gross
	Carrying		Accumulated		Net Book
	Amount		Amortization		Value
Customer Relationships	$	1,302,000	$	72,333	$	1,229,667
Trade Names	$	814,000	$	20,350	$	793,650
Bond Issue Costs	$	79,373	$	50,270	$	29,103
Totals	$	2,195,373	$	142,953	$	2,052,420

Amortization expense for the three and nine months ended September 30, 2016 was $47,663 and $142,992, respectively. Amortization expense for the three and nine months ended September 30, 2015 was $47,665 and $50,312, respectively.

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

Remainder of 2016	$	31,000
2017	191,000
2018	191,000
2019	191,000
2020	191,000
Thereafter	1,114,428
Total	$	1,909,428

Impairment of Goodwill and Other Intangible Assets

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 1st. No events were identified during the three and nine months ended September 30, 2016 that would require us to test for impairment.

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. No impairment expense was recorded during the three and nine months ended September 30, 2016.