(1) Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of National Technical Systems, Inc. (NTS or the Company) and its subsidiaries that are wholly owned or controlled by the Company. All significant intercompany balances and transactions have been eliminated in consolidation.

The Company has consolidated NQA, Inc., a 50% owned subsidiary for which the distribution of profits and losses is 50.1% to the Company, and 49.9% to the other shareholder. NTS controls the management decisions and elects the president of NQA, Inc. and therefore has operating control of the subsidiary.

XXCAL Japan is a 50% owned subsidiary which started in fiscal 1999 and is accounted for under the equity method since NTS does not have operating control. XXCAL Japan's financial statements are prepared in accordance with generally accepted accounting principles in Japan. There are no material adjustments that need to be made to XXCAL Japan's financial statements for them to be in conformity with U.S. generally accepted accounting principles. The equity investment recorded in the accompanying balance sheets is $392,000 and $627,000 at January 31, 2013 and 2012, respectively. The Company's equity loss recorded in the accompanying income statements totaled $235,000 and $29,000 for the years ended January 31, 2013 and 2012, respectively.

In accordance with authoritative guidance released by the Financial Accounting Standards Board (FASB) clarifying that a noncontrolling interest held by others in a subsidiary is to be part of the equity of the controlling group and is to be reported on the balance sheet within the equity section as a distinct item separate from the Company's equity, noncontrolling interests are reported separately on the balance sheet. Net income attributable to noncontrolling interests was $976,000 and $866,000 for years ended January 31, 2013 and 2012, respectively. Noncontrolling interests balances were $245,000 as of January 31, 2013 and $1,381,000 as of January 31, 2012.

Risks, Uncertainties and Concentrations

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates made by the Company relate primarily to the recognition of revenue under long-term contracts, the valuation of goodwill and other intangible assets useful lives for depreciation and amortization, share-based compensation and accounting for income taxes. Actual results could differ from those estimates.

The Company did not have revenues from a single client in fiscal year 2013 which represented in excess of 10% of the Company's total revenues. Total revenues from clients in foreign countries were $9,406,000 in fiscal 2013 and $7,731,000 in fiscal 2012 adjusted for discontinued operations.

The Company performs ongoing credit evaluations of its clients' financial condition and generally requires no collateral.

Fair Value of Financial Instruments

The carrying values of financial instruments such as cash and cash equivalents, accounts receivable, and accounts payable approximate fair value at January 31, 2013 and 2012, due to their short-term maturities and the relatively stable interest rate environment.

The fair values of the Company's debt obligations are disclosed in Note 3.

The fair values of the Company's investment securities, contingent consideration obligations on past acquisitions and embedded derivative are disclosed in Note 6.

Revenue Recognition

The majority of the Company's revenues are derived from fixed price contracts. Revenues from fixed price testing contracts are generally recorded upon completion of the contracts, which are typically short-term, or upon completion of identifiable contractual tasks. At the time the Company enters into a contract that includes multiple tasks, the Company estimates the amount of actual labor and other costs that will be required to complete each task. Revenues from contracts which are time and materials based are recorded as effort is expanded.

Billings in excess of amounts earned are deferred. Any anticipated losses on contracts are charged to income when identified and can be reasonably estimated. To the extent management does not accurately forecast the level of effort required to complete a contract, or individual tasks within a contract, and the Company is unable to negotiate additional billings with a client for cost over-runs, the Company may incur losses on individual contracts.

Reimbursements made to the Company by clients under contract provisions, including those related to travel and other out-of-pocket expenses are recorded as revenues. An equivalent amount of reimbursable expenses is recorded as cost of sales.

Cash and Cash Equivalents

Cash and Cash Equivalents include currency and bank deposits. Cash equivalents include highly liquid investments with original maturities of three months or less. Cash and cash equivalents are held by large financial institutions. The balance in the accounts may, at times, exceed federally insured limits. The Company has not experienced any losses on its accounts and does not believe it is exposed to any significant credit risk on its cash balances.

Unbilled receivables

Unbilled receivables consist of accumulated revenues, including amounts earned related to costs incurred, in excess of amounts billed to customers. Unbilled receivables for each contract are reviewed on a monthly basis over the life of the contract and additional write-downs of unbilled receivables are made if there are insufficient revenues remaining on the contract such that unbilled receivables are not in excess of estimated net realizable value.

Inventories

Inventories consist of accumulated costs including direct labor, material and overhead applicable to uncompleted contracts and are stated at actual cost, which is not in excess of estimated net realizable value. Such inventories for each contract are reviewed on a monthly basis over the life of the contract and additional write-downs of inventories are made if there are insufficient revenues remaining on the contract.

Property, Plant and Equipment

Property, plant, and equipment is stated at actual cost and is depreciated or amortized using the straight-line method over the following estimated useful lives:

Buildings		30 to 35 years
Machinery and equipment		3 to 20 years
Leasehold improvements		Terms of lease, or estimated useful life (whichever is less)

Depreciation expense for the years ended January 31, 2013 and January 31, 2012 were $7,908,000 and $7,108,000 respectively.

Goodwill and Intangible Assets

Goodwill represents the excess of purchase price over fair value of assets of an acquired business. Goodwill and intangible assets acquired in a business combination and determined to have an indefinite useful life are not amortized. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives.

Goodwill and intangible assets not subject to amortization are tested at least annually for impairment. The goodwill test for impairment consists of a two-step process that begins with an estimation of the fair value of the reporting unit using the discounted cash flow approach. The first step of the test is a screen for potential impairment and the second step measures the amount of impairment, if any. The first step of the goodwill impairment test includes a comparison of the fair value of each reporting unit that has associated goodwill with the carrying value of the reporting unit. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors including future revenue forecasts and discount rates. As a result, there can be no assurance that the estimates and assumptions made for purposes of the annual goodwill impairment test will prove to be an accurate prediction of the future. Significant inputs include discount rates and estimated future cash flows for each of the three reporting units.

During the year ended January 31, 2013, the Company's operations were reorganized to change the manner in which the regional operating vice presidents manage the business and nature of those operations. Management further decided that it is more appropriate to aggregate the testing laboratories and engineering centers into one reporting unit based on economic similarities, sharing of assets and resources such as testing equipment and back office shared service centers. At January 31, 2013, the Company now has three reporting units.

The Company performed a goodwill impairment assessment on the new reporting units and determined on the basis of the step one impairment test that the fair value of its testing laboratory and engineering centers, certification, and supply chain reporting units exceeded its carrying value, and no impairment was indicated. For the year ended January 31, 2012, the Company recorded a goodwill impairment loss of $1,791,000 due to lower than expected results related to an acquisition made in December 2010 and a $400,000 write-down of other intangible assets.

Long-Lived Assets

The Company periodically evaluates the recoverability of the carrying amount of long-lived assets (including property, plant and equipment, and intangible assets with determinable lives) whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. The Company evaluates events or changes in circumstances based on a number of factors including operating results, business plans and forecasts, general and industry trends and economic projections and anticipated cash flows. An impairment loss is recorded when the undiscounted expected future cash flows derived from an asset are less than its carrying amount. Impairment losses are measured as the amount by which the carrying value of an asset exceeds its fair value and are recognized in earnings.

Share-Based Compensation

No stock options have been granted by the Company during fiscal years 2013 or 2012. Any stock options granted to existing and newly hired employees or directors will generally vest over a four-year period from the date of grant. Any share-based compensation expense relating to stock options incurred by the Company in fiscal years 2013 or 2012 was from stock options granted in prior years. The Company may use other types of equity incentive awards, such as restricted stock. The Company's equity incentive plan also allows for performance-based vesting for equity incentive awards.

Compensation expense for stock options is based on the Black-Scholes-Merton option pricing model for estimating fair value of stock options and non-vested shares granted under the Company's equity incentive plans and rights to acquire stock granted under the Company's stock participation plan.

Compensation expense related to non-vested shares represents the fair value of the shares at the date of the grant, net of assumptions regarding estimated future forfeitures, and is charged to earnings over the vesting period.

The Company adjusts share-based compensation on a quarterly basis for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience. The effect of adjusting the forfeiture rate is recognized in the period the forfeiture estimate is changed. The effect of forfeiture adjustments for fiscal years 2013 and 2012 was immaterial.

Restricted shares are granted to Directors as part of their compensation package. Restricted shares generally vest over a four-year period from the date of grant. Compensation expense, representing the fair market value of the shares at the date of grant, net of assumptions regarding estimated future forfeitures, is charged to earnings over the vesting period. No restricted shares were granted in fiscal 2013.

Accounting for Income Taxes

Deferred income taxes are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded, if necessary, to reduce deferred tax assets to an amount management believes is more likely than not to be realized. The Company's policy is to reflect penalties and interest as part of income tax expense when and if they become applicable.

The Company has reviewed its positions in recording income and expenses and has no reason to record a liability for income tax uncertainties. The Company files income tax returns in the U.S. on a federal basis and in many U.S. states and foreign jurisdictions. Certain tax years remain open to examination by the major taxing jurisdictions to which the Company is subject. The Company does not anticipate that its total unrecognized tax benefits will significantly change due to the settlement of examinations or the expiration of statutes of limitations during the next twelve months.

Comprehensive Loss

Accumulated other comprehensive loss on the Company's consolidated balance sheets consists of cumulative equity adjustments from foreign currency translation.

Earnings Per Share

Basic and diluted net income per common share is computed using the weighted average number of shares of common stock outstanding during the year. Basic earnings per share exclude any dilutive effects of stock options and non-vested restricted shares. Diluted earnings per share exclude any non-vested restricted shares with an anti-dilutive effect.

Foreign Currency

The accounts of the foreign divisions are translated into U.S. dollars. All balance sheet accounts, except for certain fixed assets accounts, have been translated using the current rate of exchange at the balance sheet date. Certain fixed assets accounts are held at the exchange rate in place at the date of purchase. Results of operations have been translated using the average rates prevailing throughout the year. Translation gains or losses resulting from the changes in the exchange rates from year-to-year are recorded in accumulated other comprehensive loss. The translation of the balance sheet accounts resulted in $46,000 unrealized gain and $41,000 in unrealized loss in fiscal years 2013 and 2012, respectively.

Related Party Transactions

NTS provides management and consulting services to NQA, Inc. for an agreed-upon management fee. Such services include, but are not limited to, advice and assistance concerning any and all aspects of the operations of the Company. The Company earned management fees of $600,000 per year for fiscal years 2013 and 2012, which is eliminated in consolidation.

Ascertiva, the noncontrolling shareholder of NQA, Inc., provides certification oversight and advice and processes and issues ISO registration certificates. Ascertiva charges NQA, Inc. an agreed-upon fee for each certificate in place at the beginning of the year and issued during the year together with the appropriate United Kingdom Accreditation Service (UKAS) and Raad Voor Accreditatie (RVA) levy. Certification fees were $600,000 per year for fiscal years 2013 and 2012.

NQA, Inc. leases space from NTS and was assessed $83,000 for rent and utilities in fiscal years 2013 and 2012, which is eliminated in consolidation.

On November 8, 2012, the Company purchased the 49.9% minority interest of Unitek Technical Services, Inc., a consolidated subsidiary from NQA. See Note 2 below.

Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board ("FASB") amended its guidance on the presentation of comprehensive income. Under the amended guidance, an entity has the option to present comprehensive income in either one continuous statement or two consecutive financial statements. A single statement must present the components of net income and total net income, the components of other comprehensive income and total other comprehensive income, and a total for comprehensive income. In a two-statement approach, an entity must present the components of net income and total net income in the first statement. That statement must be immediately followed by a financial statement that presents the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The option under the prior guidance that permitted the presentation of components of other comprehensive income as part of the statement of changes in stockholders' equity has been eliminated. The amendment became effective for the Company on February 1, 2012. This guidance does not have an impact on the Company's consolidated financial position, results of operations or cash flows as it is presentation only in nature.

In September 2011, the FASB issued a revised standard on testing for goodwill impairment. The revised standard allows an entity to first assess qualitatively whether it is necessary to perform step one of the two-step annual goodwill impairment test. An entity is required to perform step one only if the entity concludes that it is more likely than not that a reporting unit's fair value is less than its carrying amount, a likelihood of more than 50 percent. An entity can choose to perform the qualitative assessment on none, some, or all of its reporting units. Moreover, an entity can bypass the qualitative assessment for any reporting unit in any period and proceed directly to step one of the impairment test, and then perform the qualitative assessment in any subsequent period. The revised standard became effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. This guidance did not have any impact on its consolidated financial position, results of operations, or cash flows.

In July 2012, the FASB issued ASU, Testing Indefinite - Lived Intangible Assets for Impairment, which allows an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset, other than goodwill is impaired. If an entity concludes, based on an evaluation of all relevant qualitative factors, that it is not more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, it will not be required to perform a quantitative impairment test for that asset. Entities are required to test indefinite-lived assets for impairment at least annually and more frequently if indicators of impairment exist. This ASU is effective for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company has not elected to early adopt this revised standard. The Company does not believe this guidance will have any impact on its consolidated financial position, results of operations, or cash flows.