NOTE

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

-K for the year ended

December 31, 2018.

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.

Stoc

k-Based Awards

Following is the status of all stock options as of

June 30, 2019:

	Shares			Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in thousands)
Outstanding - January 1, 2019		224,750		$	3.44
Granted		169,500			4.44
Exercised		(2,250	)		3.20
Cancelled		(23,250	)		3.85
Outstanding - June 30, 2019		368,750		$	3.88		9.01	$	134
Exercisable - June 30, 2019		111,817		$	3.46		7.06	$	64

The

2005

Plan has

not

been renewed, and therefore

further grants

may

be made under the

2005

Plan. In

May 2017,

the shareholders approved the

2017

Stock Incentive Plan which authorized the issuance of

350,000

shares. There were

137,500

and

169,500

stock options granted during the

three

and

six

months ended

June 30, 2019,

respectively.

Total compensation expense related to stock options for the

three

months ended

June 30, 2019

and

2018

was

$32

and

$25,

respectively and

$75

and

$45

for the

six

months ended

June 30, 2019

and

2018,

respectively. As of

June 30, 2019,

there was

$444

of unrecognized compensation which will vest over the next

3.26

years.

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

days after we determine the book value of the Units as of the calendar year immediately preceding the redemption date. The Units are adjusted to market value for each reporting period.

During the

six

months ended

June 30, 2019,

100,000

Units were granted in the

first

quarter. During the

three

and

six

months ended

June 30, 2018,

additional Units were granted.

Total compensation expense (income) related to the vested outstanding Units based on the estimated appreciation over their remaining terms was

for the

three

and

six

months ended

June 30, 2019

and

2018.

During the

six

months ended

June 30, 2019,

there were

25,000

restricted shares awarded that vested immediately that had expense of

$116

during the

first

quarter.

Net Income (Loss) per Common Share

For both the

three

months and

six

months ended

June 30, 2019

and

2018,

all stock options are deemed to be antidilutive and, therefore, were

not

included in the computation of loss per common share amount.

Share Repurchase Program

As of

June 30, 2019,

we have a

$250

share repurchase program which was authorized by our Board of Directors in

August 2017.

Under this repurchase program, we repurchased

28,363

and

31,740

shares in the open market transactions totaling

$113

and

$126

for the

three

and

six

months ended

June 30, 2019,

respectively. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted from additional paid-in capital.

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

June 30, 2019

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

June 30, 2019,

we had

outstanding letters of credit.

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 at both the

three

months ended and

six

months ended

June 30, 2019

have been reduced by an allowance for doubtful accounts of

$262

June 30, 2019

and

$222

December 31, 2018.

Inventories

Inventories are stated at the lower of cost (

first

-in,

first

-out 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 (in thousands):

	June 30,			December 31,
	2019			2018
Raw Materials	$	16,447		$	16,769
Work in Process		780			1,015
Finished Goods		212			332
Reserves		(1,166	)		(1,112	)

Total	$	16,273		$	17,004

Other Intangible Assets

Other intangible assets at

June 30, 2019

and

December 31, 2018

are as follows (in thousands):

			June 30, 2019
			Gross
			Carrying		Accumulated		Net Book
	Years		Amount		Amortization		Value
Customer Relationships		9	$	1,302	$	578	$	724
Trade Names		3		100		78		22
Intellectual Property		20		814		163		651
Patents		7		42		-		42
Totals			$	2,258	$	819	$	1,439

			December 31, 2018
			Gross
			Carrying		Accumulated		Net Book
	Years		Amount		Amortization		Value
Customer Relationships		9	$	1,302	$	506	$	796
Intellectual Property		3		100		61		39
Trade Names		20		814		143		671
Patents		7		17		-		17
Totals			$	2,233	$	710	$	1,523

Amortization expense for the

three

and

six

months ended

June 30, 2019

was

$55

and

$109,

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 2019	$	109
2020		192
2021		185
2022		185
2023		185
Thereafter		541
Total	$	1,397

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

events were identified during the

six

months ended

June 30, 2018

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 it 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.

impairment expense was recorded during the

three

and

six

months ended

June 30, 2019

and

2018.

Recently Issued Accounting Standards

January 1, 2019,

we adopted ASU

No.

2016

02,

Leases (Topic

842

). This ASU requires lessees to recognize lease assets and lease liabilities on the balance sheet. Under the new guidance, lessor accounting is largely unchanged. We have elected to adopt the standard on the modified retrospective basis. We have also elected the package of practical expedients, which permits us

not

to reassess our prior conclusions about lease identification, lease classification and initial direct costs. In addition, we have elected the short-term lease recognition whereby we will

not

recognize operating lease related assets or liabilities for leases with a lease term less than

one

year. We did

not

elect the hindsight practical expedient to determine the reasonably certain term of existing leases.

The impact of adopting the new lease standard was the recognition of

$5,731

of lease assets and lease liabilities related to our operating leases. The adoption of the new lease standard had

impact to our Condensed Consolidated Statements of Operations, Condensed Consolidated Statements of Cash Flows or Condensed Consolidated Statements of Shareholders’ Equity.