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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549



FORM 10-K

(Mark One)

 
/x/
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1999

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to                

Commission file number 0-13257



NORTECH SYSTEMS INCORPORATED
(Exact name of registrant as specified in its chapter)

Minnesota   41-16810894
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
 
641 East Lake St., Suite 244 Wayzata, MN
 
 
 
55391
(Address of principal executive offices)   (Zip code)

Registrant's telephone No., including area code: (612) 473-4102

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 per share par value.



   Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required of file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / /

   Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of regulation S-K is not contained herein and will not be contained to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / /

   Based upon the $4.75 per share average of the closing bid and asked prices, respectively, on March 14, 2000 for the shares of common stock of the Company, the aggregate market value of the Company's common stock held by non-affiliates as of such date was $5,377,565.

   As of March 19, 2000 there were 2,353,859 shares of the Company's $.01 per share par value common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

   The following documents are incorporated by reference to the parts indicated of the Annual Report on Form 10-K:

Parts of Annual Report on Form 10-K   Documents Incorporated by Reference
 
Part III
 
 
 
 
 
   Item 10
            11
            12
 
 
 
Reference is made to the Registrant's proxy statements to be used in connection with the 1999 Annual Shareholders' meeting and filed with the Securities and Exchange Commission no later than April 29, 2000.




NORTECH SYSTEMS INCORPORATED
Annual Report on Form 10-K
for the year ended December 31, 1999

INDEX

 
   
  Page
PART I    
Item 1.   Business   3-6
Item 2.   Properties   6
Item 3.   Legal Proceedings   6
Item 4.   Submission of Matters to a Vote of Security Holders   6
 
PART II
 
 
 
 
Item 5.   Market for Registrant's Common Equity and Related Stockholder Matters   7
Item 6.   Selected Financial Data   8
Item 7.   Management's Discussion and Analysis of Financial Condition and Results of Operations   8-9
Item 7a   Quantitative and Qualitative Disclosure about Market Risk   9
Item 8.   Consolidated Financial Statements and Supplemental Data   10-27
Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    
 
PART III
 
 
 
 
Item 10.   Directors and Executive Officers of the Registrant   28
Item 11.   Executive Compensation   28
Item 12.   Security Ownership of Certain Beneficial Owners and Management    
Item 13.   Certain Relationships and Related Transactions   28
 
PART IV
 
 
 
 
Item 14.   Exhibits, Financial Statement Schedule, and Reports on Form 8-K   29-32
Signatures   33

2



PART I

ITEM 1.  BUSINESS

Description of Business

    Nortech Systems Incorporated (the "Company") is a Minnesota corporation organized in December 1990. Prior to December 1990, the Company operated as DSC Nortech, Inc., which filed a petition for reorganization under Chapter 11 of the United States Bankruptcy Code during 1990. The business and assets of DSC Nortech, Inc. were transferred to Nortech Systems Incorporated during 1990. The Company's headquarters are in Wayzata, Minnesota, a suburb of Minneapolis, Minnesota. The Company's maintains various manufacturing facilities in Minnesota locations of Bemidji, Fairmont, Plymouth, Aitkin, and Merrifield as well as Augusta, Wisconsin. The Company manufactures wire harnesses, cables, electronic sub-assemblies and components, printed circuit board assemblies as well as large-screen high-resolution video monitors for radar, document and medical imaging. The Company provides a full "turnkey" contract manufacturing service to its customers. A majority of revenue is derived from products that are built to the customer's design specifications. Nortech Medical Services, Inc., it's wholly owned subsidiary, provides service bureau and office management services to physicians and clinics throughout Minnesota.

    The Company believes it provides a high degree of manufacturing sophistication. This includes the use of statistical process control to insure product quality, state-of-the-art materials management techniques, allowing just-in-time (JIT) delivery of products, and the systems necessary to effectively manage the business. This level of sophistication enables the Company to attract major original equipment manufacturers (OEM).

    The strategy of the Company in that regard has been to expand its customer base, and has added several new customers from various industries; including Companies engaged in the production of medical products, super computers, mid-size and micro computer business systems, automotive industry, defense industry and industrial products. The Company strategy is to develop a customer base spanning several industry segments to avoid the affects of fluctuations within a given industry. Some of the Company's major customers are G.E. Medical Systems, Raytheon, SPX Corporation, Imation, Thermo King, Polaris, Fisher-Rosemount, 3M, Allen-Bradley, Restaurant Technology Inc and United Defense.

    The Company believes that contract manufacturing will continue to grow and expand in the United States because contract manufacturing provides OEMs with the domestic equivalent of off-shore sourcing without the associated logistical problems. The contract manufacturer can provide an OEM with a quality product at a price well below that available in the OEM's own facility. This is due primarily to the specialization available through the contract manufacturer and the significantly lower overhead costs.

    In 1991, the Company acquired all of the common stock of SMR Computer Services, Inc. The Company, through its subsidiary (currently named Nortech Medical Services, Inc.), also provides service bureau and office management services to physicians. During 1999 this business was designated to be discontinued.

    In March 1995, the Company acquired all of the assets of Monitor Technology Corporation. The Company has continued the business of Monitor Technology Corporation, which is the manufacturing of large-screen, high-resolution video monitors for radar, document and medical imaging as well as repair services on internally and externally produced monitors, until June 1999 when these operations were discontinued.

    In August 1995, the Company acquired all the assets of the Aerospace Division of Communication Cable, Inc. The Company has continued the business formally conducted by Aerospace, which involves

3


the manufacturing of custom designed, high-technology electronic cable assemblies for various applications.

    In November 1996, the Company acquired the inventory and fixed assets of Zercom Corporation, a subsidiary of Communication Systems, Inc. The Company has been, and continues to be a contract manufacturer of electronic sub-assemblies and components.

    At December 31, 1998, the Company reported segment information of its three identifiable segments; Contract Manufacturing, Display Products and Medical Management. However, on June 30, 1999, the Company formally adopted a plan to dispose of two of the segments, including Display Products and Medical Management. Thus, the Company's remaining continuing operations fall within the Contract Manufacturing segment.

Marketing and Sales

Business Strategy

    The Company believes the electronic manufacturing sub-contracting business is emerging from a small job shop oriented business into a dynamic, high technology electronics industry. The Company operates mainly in the wire harness and cable assemblies market, and intends to expand from this market segment into complete electromechanical assemblies using the resources acquired from the recent addition of Zercom Corporation. Many companies no longer perform this type of work on a captive, in-house basis, as they are finding that independent subcontractors can more cost effectively perform this specialized work.

    As part of the Company's commitment to quality, the Bemidji location became ISO 9002 Certified in July 1995, the Merrifield Division became ISO 9002 Certified in October, 1998, the Intercon I operation became ISO 9002 certified in October, 1999, and continue to actively maintain their certification. The Company believes this certification benefits its current customer base as well as attracts new business opportunities.

    The Company will continue its commitment to quality, cost effectiveness and responsiveness to customer requirements. To achieve these objectives, the Company will provide complete manufacturing services to customers, from the procurement of materials to the manufacturing, testing and shipping of products. The Company will continue its efforts to diversify its customer base and expand into other segments of the electronic manufacturing subcontract business.

Marketing.

    The Company is continuing to concentrate its marketing activities in the medical, industrial, automotive and military manufacturing industries. The emphasis continues to be on mature companies, which require a contract manufacturer with a high degree of manufacturing and quality sophistication, including statistical process control (SPC) and statistical quality control (SQC). The Company has initiated efforts to expand its markets beyond the Upper Midwest area, which presently extends east to the Ohio/Michigan area, south to Missouri, and west to Colorado. New market opportunities are continuously being pursued. The Company markets its products and services primarily through manufacturers' representatives. The Company's marketing strategy emphasizes the sophistication of its manufacturing services. The basic systems, procedures, and disciplines normally associated with a mature corporate environment are in place. All the Company's employees are well trained in SPC and SQC.

Sources and Availability of Materials

    The Company is not dependent on any one supplier for materials for products sold to customers. Components utilized in the assembly of wire harnesses, cable assemblies and printed circuit assemblies

4


are purchased directly from the component manufacturers or from their distributors. On occasion some components may be placed on a stringent allocation basis; however, due to the excess manufacturing capacity currently available at most component manufacturers, the Company does not anticipate any major material purchasing or availability problems occurring in the foreseeable future.

Patents and Licenses

    The Company is not presently dependent on a proprietary product requiring licensing, patent, copyright or trademark protection. There are no revenues derived from a service-related business for which patents, licenses, copyrights and trademark protection are necessary for successful operations.

Competition

    The contract manufacturing industry is characterized by competition among a variety of sources, including small closely held companies, larger full-service manufacturers, company-owned facilities and foreign competitors. The Company does not believe that the smaller operations are significant competitors, as they do not seem to have the capabilities required by target customers of the Company. The Company also believes that foreign competitors do not provide a substantial competitive threat because the cable and wire harness industry involves a high weight-to-cost ratio. Consequently, shipping and transportation costs decrease the ability of foreign manufacturers to compete in this market segment. Further, off-shore production cannot effectively meet the requirements of engineering change order activities, engineering support, delivery flexibility and just-in-time inventory management techniques presently being implemented by many major target customers. Therefore, the Company's principal competitors are larger full-service manufacturers, many of which have substantially far greater assets and capital resources than are available to the Company and are better financed than the Company.

    The Company will continue to pursue marketing opportunities in the Upper Midwest. Although there presently are no dominant contract manufacturers in the wire harness and cable or higher level build assembly business in the Upper Midwest, there are several established competitors. The Company expects its major competition to come from Americable, OEM Worldwide, MSL, Technical Services, Inc. and Waters Instruments, Inc., all of which are located in Minnesota. Each of these companies specializes in molded cables or wire assemblies and has sufficient manufacturing capabilities to offer a significant competitive challenge to the Company's operations. The principal competitive factors in the contract manufacturing industry are price, quality and responsive service. The Company believes that it can compete favorably in the market segments to which it sells.

Backlog

    Historically, the Company's backlog has been running 60 to 90 days, depending on the customer. However, because of the increased emphasis on just-in-time manufacturing (JIT), many of the Company's major customers are taking advantage of the Company's ability to service them adequately under the JIT concept. Additionally, because of the Company's quality history with customers, many products now go directly from the Company's shipping dock to the customer's production line.

    The Company's 90 day order backlog was approximately $9,210,000 on December 31, 1998 and approximately $9,705,000 on December 31, 1999.

Major Customers

    The Company sells its products to companies in the computer, medical, governmental and various other industries. Historically, the Company has not experienced significant losses related to the receivables from customers in any particular industry or geographic area.

5


    Only one customer accounted for more than 10% of sales for the year ended December 31, 1999, G.E. Medical at 12.1% of sales.

Research and Development

    The Company expended no dollars in 1999, $337,093 in 1998, and $258,712 in 1997 on Company-sponsored research and development. This research was related to the development of large-screen, high-resolution video monitors for the Imaging Division.

Compliance with Environmental Provisions

    Management believes that its manufacturing facilities are currently operating under compliance with local, state, and federal environmental laws. Any environmental-oriented equipment is capitalized and depreciated over a seven-year period. The annualized depreciation expense for this type of environmental equipment on a Company-wide basis is insignificant.

Employees

    The Company has 473 full-time, 128 part-time and 94 temporary employees as of December 31, 1999, consisting of 648 employees in manufacturing, manufacturing product support and medical support services and 47 in general administration.


ITEM 2.  PROPERTIES

    The Company's headquarters consist of approximately 1,500 square feet located in Wayzata, Minnesota, a western suburb of Minneapolis, Minnesota. The Company has a lease for a five year term that expires in June 30, 2002. The Company owns its Bemidji, Minnesota facility consisting of eight acres of land and 60,000 square feet of office and manufacturing space and owns another 20,000 square feet of manufacturing and office space in Augusta, Wisconsin.

    The Company's Imaging and Medical Services division operates from a facility located in Plymouth, Minnesota. The building contains approximately 22,800 square feet and is leased for a term that terminates on May 31, 2000. The Company will not extend the lease.

    The Company also owns three buildings which contain approximately 46,900 square feet and are located in Fairmont, Minnesota, which are used for the manufacturing of the Company's custom designed, high-technology electronic cable assemblies.

    In connection with the Zercom acquisition, the Company acquired the building with approximately 45,800 square feet in Merrifield, Minnesota. This facility is used for the building of surface mount printed circuit board assemblies and electro-mechanical assemblies. A leased building in Aitkin, Minnesota provides 10,750 square feet for video cable assembly and is leased for a term that terminates December 1, 2005.

    The Company believes that each of these locations is adequate and will be adequate in the foreseeable future for their manufacturing needs.


ITEM 3.  LEGAL PROCEEDINGS

    The Company has litigation pending, both offensive and defensive arising from the conduct of its business, none of which are expected to have any material effect on the Company's financial position.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    No matters required to be reported under the instructions to this item have been submitted to a vote of security holders which.

6



PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

    The Company's Common Stock is traded on the NASDAQ Small Cap Market under the symbol NSYS.

    The high and low bid quotations for the Company's Common Stock for each quarterly period within the two most recent years were as follows:

Quarter Ended

  Low
  High
March 31, 1998   $ 4.266   $ 5.125
June 30, 1998   $ 4.750   $ 6.625
September 30, 1998   $ 3.625   $ 5.500
December 31, 1998   $ 3.438   $ 4.438
 
March 31, 1999
 
 
 
$
 
3.250
 
 
 
$
 
4.250
June 30, 1999   $ 2.875   $ 3.625
September 30, 1999   $ 2.281   $ 3.313
December 31, 1999   $ 1.313   $ 3.750

    The low and high quotations set forth above are as reported by NASDAQ. These quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission, and may not necessarily represent actual transactions.

    As of March 19, 2000, there were approximately 1,274 holders of shares of the Company's Common Stock. The Company has never paid a cash dividend on shares of its Common Stock and does not intend to pay cash dividends in the foreseeable future.

(The remainder of this page was intentionally left blank.)

7




NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

ITEM 6.  SELECTED FINANCIAL DATA

(Restated to show Continuing Operations Only)

 
  For The Years Ended
 
  Dec 31, 1999
  Dec 31, 1998
  Dec 31, 1997
  Dec 31, 1996
  Dec 31, 1995
Sales   $ 38,482,335   $ 35,356,813   $ 32,907,135   $ 23,607,807   $ 15,933,447
Net Income (Loss)     1,070,799     826,009     1,073,903     853,034     1,396,285
Basic Earnings Per Share of Common Stock     0.46     0.35     0.45     0.36     0.58
Total Assets     23,603,716     24,175,707     23,995,717     21,866,328     12,888,704
Total Long-Term Debt     10,246,911     11,146,537     10,388,620     10,910,757     3,768,685

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Continuing Operations, Years Ended December 31, 1999, 1998, and 1997

Revenues

    For the years ended December 31, 1999 and 1998 the Company had sales of $38,482,335 and $35,356,813 respectively. The increase of $3,125,522 or 8.8% resulted primarily from internal growth of our current customer base. For the year ended December 31, 1997 the Company had sales of $32,907,135. The approximate 7.4% increase in sales in 1998 was attributable primarily to internal growth of our current customer base.

Gross Profit

    The Company had gross profit of $6,510,781 in 1999, $5,800,491 in 1998, and $6,325,710 in 1997. Gross profits as a percentage of gross sales were 16.9% in 1999, 16.4% in 1998, and 19.2% in 1997. The Company has experienced gross profit pressure, evolving from a change of product mix and material content offset by some improvement in manufacturing productivity.

Selling, General, and Administrative

    Selling, general, and administrative expenses were $4,046,524 in 1999, $3,784,331 in 1998, and , $3,797,668 in 1997. The increases each year reflect additional selling, general and administrative expenses associated with increased revenues.

Miscellaneous Income

    Miscellaneous income was $39,172 in 1999, $18,482 in 1998, and $17,520 in 1997. The miscellaneous income resulted primarily from charges for interest income and miscellaneous services.

8


Interest Expense

    Interest expense was $818,553 in 1999, $922,431 in 1998, and $939,049 in 1997.

Income Taxes

    Income tax expense was $641,000 in 1999, $311,000 in 1998, and $570,000 in 1997.

    The Company has recorded deferred tax assets of $2,261,000, the realization of the deferred tax asset is dependent upon the Company generating sufficient taxable earnings in future periods. In determining that realization of the deferred tax asset is more likely than not, the Company gave consideration to recent earnings history, its expectation for taxable earnings in the future and the expiration dates associated with tax carryforwards.

Net Income

    The Company's net income in 1999 was $1,070,799 or $.46 per common share. The Company's net income in 1998 was $826,009 or $.35 per common share. The Company's net income in 1997 was $1,073,903 or $.45 per common share. The Company believes that the effect of inflation on past operations has not been significant and anticipates that inflation will not have a significant impact on future operations.

Liquidity and Capital Resources

    The Company's working capital decreased from $10,984,033 as of December 31, 1998, to $9,691,189 on December 31, 1999. Stockholders equity decreased from $8,364,571 on December 31, 1998, to $6,378,480 on December 31, 1999 due to the Company's 1999 net loss from discontinued operations. The Company's liquidity and capital resources are strong, and the Company believes that its future financial requirements can be met with funds generated from the operating activities and from the Company's operating line of credit.

Update on Year 2000 Status

    Nortech Systems Inc incurred no major Y2K related problems in January, 2000 and does not anticipate any in the future. The Company will continue to evaluate its systems to ensure that any potential issues can be quickly addressed.


ITEM 7a.  QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

    Upward and downward changes in market interest rates and their impact on the reported interest expense of the Company's variable rate borrowings will effect the Company's future earnings. However, a ten-percent change in the 1999 effective average interest rate on variable earnings should not have a material effect on the Company's earnings for 2000.

9



ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

 
  Page
Independent Auditors' Report of :    
Larson, Allen, Weishair & Co., LLP   11
 
Consolidated Financial Statements:
 
 
 
 
Consolidated Balance Sheets at December 31, 1999 and 1998   12
 
Consolidated Statements of Income for the years ended December 31, 1999, 1998 and 1997
 
 
 
13
 
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999, 1998 and 1997
 
 
 
14
 
Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997
 
 
 
15
 
Notes to Consolidated Financial Statements
 
 
 
16-27

(The remainder of this page was intentionally left blank.)

10


INDEPENDENT AUDITOR'S REPORT

Board of Directors
Nortech Systems Incorporated and Subsidiary
Bemidji, Minnesota

    We have audited the accompanying consolidated balance sheets of Nortech Systems Incorporated and Subsidiary as of December 31, 1999 and 1998, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

    We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

    In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Nortech Systems Incorporated and Subsidiary as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles.

St. Cloud, Minnesota
February 11, 2000

11


NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 1999 AND 1998

 
  1999
  1998
 
ASSETS  
CURRENT ASSETS              
Cash and Cash Equivalents   $ 453,500   $ 375,528  
Accounts Receivable, Less Allowance for Uncollectible Accounts     5,427,441     4,647,378  
Inventories     8,725,417     7,805,369  
Prepaid Expenses and Other     102,156     246,728  
Deferred Tax Asset     1,961,000     695,000  
Net Current Assets from Discontinued Operations         1,878,629  
   
 
 
Total Current Assets   $ 16,669,514   $ 15,648,632  
   
 
 
 
PROPERTY AND EQUIPMENT
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Land   $ 141,300   $ 141,300  
Building and Leasehold Improvements     3,876,381     3,762,785  
Manufacturing Equipment     4,334,820     3,727,404  
Office and Other Equipment     2,094,049     2,628,238  
   
 
 
Total   $ 10,446,550   $ 10,259,727  
Accumulated Depreciation     (4,004,666 )   (3,955,922 )
   
 
 
Total Property and Equipment   $ 6,441,884   $ 6,303,805  
   
 
 
 
OTHER ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Goodwill and Other Intangible Assets   $ 116,022   $ 131,294  
Deferred Tax Asset     300,000     475,000  
Other Assets         57,250  
Other Assets from Discontinued Operations     76,296     1,559,726  
   
 
 
Total Other Assets   $ 492,318   $ 2,223,270  
   
 
 
Total Assets   $ 23,603,716   $ 24,175,707  
   
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
CURRENT LIABILITIES              
Current Maturities of Long-Term Debt   $ 860,079   $ 810,934  
Accounts Payable     4,101,981     2,749,688  
Accrued Payroll     870,775     610,850  
Other Liabilities     793,933     493,127  
Net Current Liabilities from Discontinued Operations     351,557      
   
 
 
Total Current Liabilities   $ 6,978,325   $ 4,664,599  
   
 
 
LONG-TERM DEBT              
Notes Payable (Net of Current Maturities)   $ 10,246,911   $ 11,146,537  
   
 
 
STOCKHOLDERS' EQUITY              
Preferred Stock, $1 Par Value; 1,000,000 Shares Authorized;
250,000 Shares Issued and Outstanding
  $ 250,000   $ 250,000  
Common Stock $.01 Par Value; 9,000,000 Shares Authorized;
2,351,907 and 2,351,377 Shares Issued and Outstanding at December 31, 1999 and 1998, Respectively
    23,519     23,514  
Additional Paid-In Capital     12,132,615     12,131,045  
Accumulated Deficit     (6,027,654 )   (4,039,988 )
   
 
 
Total Stockholders' Equity   $ 6,378,480   $ 8,364,571  
   
 
 
Total Liabilities and Stockholders' Equity   $ 23,603,716   $ 24,175,707  
   
 
 

See accompanying Notes to Financial Statements.

12


NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997

 
  1999
  1998
  1997
 
SALES   $ 38,482,335   $ 35,356,813   $ 32,907,135  
COST OF SALES     (31,971,554 )   (29,556,322 )   (26,581,425 )
   
 
 
 
GROSS PROFIT   $ 6,510,781   $ 5,800,491   $ 6,325,710  
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES     (4,046,524 )   (3,784,331 )   (3,797,668 )
INTEREST INCOME     26,923     24,798     37,390  
MISCELLANEOUS INCOME     39,172     18,482     17,520  
INTEREST EXPENSE     (818,553 )   (922,431 )   (939,049 )
   
 
 
 
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES   $ 1,711,799   $ 1,137,009   $ 1,643,903  
INCOME TAX EXPENSE     (641,000 )   (311,000 )   (570,000 )
   
 
 
 
INCOME FROM CONTINUING OPERATIONS   $ 1,070,799   $ 826,009   $ 1,073,903  
 
LOSS FROM DISCONTINUED OPERATIONS
 
 
 
 
 
(3,058,465
 
)
 
 
 
(496,142
 
)
 
 
 
(396,232
 
)
   
 
 
 
NET INCOME (LOSS)   $ (1,987,666 ) $ 329,867   $ 677,671  
   
 
 
 
EARNINGS (LOSS) PER SHARE:                    
BASIC                    
Income from Continuing Operations   $ 0.46   $ 0.35   $ 0.45  
Loss from Discontinued Operations     (1.30 )   (0.21 )   (0.17 )
   
 
 
 
Net Income (Loss)   $ (0.84 ) $ 0.14   $ 0.28  
   
 
 
 
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING USED FOR BASIC EARNINGS (LOSS) PER SHARE     2,351,775     2,347,391     2,362,362  
   
 
 
 
DILUTED                    
Income from Continuing Operations   $ 0.45   $ 0.35   $ 0.45  
Loss from Discontinued Operations     (1.29 )   (0.21 )   (0.17 )
   
 
 
 
Net Income (Loss)   $ (0.84 ) $ 0.14   $ 0.28  
   
 
 
 
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING PLUS DILUTIVE COMMON STOCK OPTIONS     2,365,844     2,372,448     2,387,829  
   
 
 
 

See accompanying Notes to Consolidated Financial Statements.

13


NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997

 
  Preferred Stock
  Common Stock
  Additional Paid-In Capital
  Accumulated Deficit
  Total Stockholders' Equity
 
BALANCE DECEMBER 31, 1996   $ 250,000   $ 23,124   $ 11,910,554   $ (5,032,486 ) $ 7,151,192  
1997 Net Income                 677,671     677,671  
Dividends Paid                 (15,040 )   (15,040 )
   
 
 
 
 
 
BALANCE DECEMBER 31, 1997   $ 250,000   $ 23,124   $ 11,910,554   $ (4,369,855 ) $ 7,813,823  
1998 Net Income                 329,867     329,867  
Issuance of Stock—Stock Options and Other         60     22,821         22,881  
Conversion of Redeemable Stock         330     197,670         198,000  
   
 
 
 
 
 
BALANCE DECEMBER 31, 1998   $ 250,000   $ 23,514   $ 12,131,045   $ (4,039,988 ) $ 8,364,571  
1999 Net Loss                 (1,987,666 )   (1,987,666 )
Issuance of Stock         5     1,570         1,575  
   
 
 
 
 
 
BALANCE DECEMBER 31, 1999   $ 250,000   $ 23,519   $ 12,132,615   $ (6,027,654 ) $ 6,378,480  
   
 
 
 
 
 

See accompanying Notes to Financial Statements.

14


NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997

 
  1999
  1998
  1997
 
CASH PROVIDED BY OPERATING ACTIVITIES                    
Net Income (Loss)   $ (1,987,666 ) $ 329,867   $ 677,671  
Plus Loss from Discontinued Operations     3,058,465     496,142     396,232  
   
 
 
 
Income from Continuing Operations   $ 1,070,799   $ 826,009   $ 1,073,903  
Adjustments to Reconcile Net Income from Continuing Operations to Net Cash Provided by Continuing Operations:                    
Depreciation and Amortization     940,101     874,360     914,264  
Deferred Taxes     556,000     71,000     209,000  
Compensation from Stock Grants         22,880      
Loss (Gain) on Disposal of Assets     695     (2,500 )   (299 )
Loss on Disposal of Stock Investment     56,250          
Changes in Current Operating Items:                    
Accounts Receivable     (780,063 )   (416,086 )   (822,623 )
Inventory     (920,048 )   (207,139 )   (1,826,700 )
Prepaid Assets     144,572     (152,722 )   (49,235 )
Accounts Payable     1,352,293     279,294     1,064,767  
Accrued Payroll     259,925     (383,110 )   379,246  
Accrued Liabilities     300,806     9,964     179,494  
   
 
 
 
Net Cash Provided by Continuing Operations   $ 2,981,330   $ 921,950   $ 1,121,817  
Net Cash Used by Discontinued Operations     (982,481 )   (677,848 )   (666,628 )
   
 
 
 
Net Cash Provided by Operating Activities   $ 1,998,849   $ 244,102   $ 455,189  
   
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES                    
Acquisition of Businesses   $   $ (24,839 ) $  
Proceeds from Sale of Assets         2,500     300,000  
Acquisition of Property and Equipment     (1,070,396 )   (458,551 )   (752,936 )
Costs to Acquire Product Technology         (332,000 )    
   
 
 
 
Net Cash Used by Investing Activities   $ (1,070,396 ) $ (812,890 ) $ (452,936 )
   
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES                    
Payments on Long-Term Debt   $ (1,375,481 ) $ (1,349,829 ) $ (2,720,271 )
Proceeds from Long-Term Debt     525,000     1,380,283     2,505,451  
Payment of Dividends             (15,040 )
   
 
 
 
Net Cash Provided (Used) by Financing Activities   $ (850,481 ) $ 30,454   $ (229,860 )
   
 
 
 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   $ 77,972   $ (538,334 ) $ (227,607 )
Cash and Cash Equivalents—Beginning     375,528     913,862     1,141,469  
   
 
 
 
CASH AND CASH EQUIVALENTS—ENDING   $ 453,500   $ 375,528   $ 913,862  
   
 
 
 

See accompanying Notes to Financial Statements.

15


NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

NOTES TO FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997

NOTE 1  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

    Nortech Systems Incorporated (the "Company") is a Minnesota corporation with headquarters in Wayzata, Minnesota, a suburb of Minneapolis, Minnesota. The Company has manufacturing facilities and engineering support located in Bemidji, Fairmont, Merrifield and Aitkin, Minnesota and Augusta, Wisconsin.

    The Company manufactures wire harnesses, cables and electromechanical assemblies, printed circuit boards and higher-level assemblies for a wide range of commercial and defense industries. The Company provides a full "turn-key" contract manufacturing service to its customers. All products are built to the customer's design specifications.

    The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates.

    The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All significant intercompany accounts and transactions have been eliminated.

    The Company provides an allowance for doubtful receivables which is offset against the gross amount of customer receivables. The allowance for doubtful receivables is an estimate of collection losses that may be incurred in the collection of all receivables. The allowance is based upon historical experience coupled with management's review of the current status of the existing receivables. The allowance for doubtful receivables for continuing operations was $102,030 and $111,627 at December 31, 1999 and 1998, respectively.

    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).

    The Company capitalizes the cost of purchased software, equipment, and leasehold improvements. Expenditures for maintenance and repairs and minor renewals and betterments which do not improve or extend the life of the respective assets are expensed. The assets and related depreciation accounts are adjusted for property retirements and disposals with the resulting gain or loss included in results of operations. Fully depreciated assets remain in the accounts until retired from service.

16


    Property and equipment are depreciated by the straight-line and accelerated methods of depreciation over their estimated useful lives. Accelerated depreciation did not materially exceed straight-line depreciation for the years ended December 31, 1999, 1998, and 1997.

    Sales are recorded by the Company when products are shipped to the customer.

    Goodwill representing the excess of the purchase price over the fair value of the net assets of the acquired entities is being amortized on a straight-line basis over the period of expected benefit of fifteen years. Total amortization of goodwill recorded from continuing operations for fiscal years 1999, 1998 and 1997 was $8,121, $8,121, and $8,782, respectively. The carrying value of goodwill is reviewed periodically based on the undiscounted cash flows of the entity acquired over the remaining amortization period. Should this review indicate that goodwill will not be recoverable, the Company's carrying value of the goodwill will be reduced by the estimated shortfall of undiscounted cash flows.

    Intangible assets including purchased technology and certification costs are being amortized over a period of 3 to 7 years. The related amortization expense from continuing operations for fiscal years 1999, 1998 and 1997 was $8,151, $8,151, and $47,151 respectively.

    The Company considers its investments with an original maturity of three months or less to be cash equivalents. The Company had interest bearing cash amounting to $250,700 and $203,886 at December 31, 1999 and 1998, respectively.

    During 1998, the Company recorded a reduction of $300,000 in a long-term note pursuant to a 1996 asset purchase agreement. In addition, accounts payable includes $150,000 of costs to acquire product technology. Also goodwill was reduced by $102,000 as a result of an adjustment to the purchase price of an acquired business.

    Advertising costs are charged to operations as incurred. Total amounts charged to expense for continuing operations were $139,594, $93,094, and $97,785 for the years ended December 31, 1999, 1998, and 1997, respectively.

    The Company has adopted FASB Statement No. 109, Accounting for Income Taxes, which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax

17


bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.

    Preferred stock issued is noncumulative and nonconvertible.

    The carrying amounts for all financial instruments approximate fair values. The carrying amounts for cash, receivables, accounts payable and accrued liabilities approximate fair value because of the short maturity of these instruments. The carrying value of long-term debt materially approximates fair value based on current rates at which the Company could borrow funds with similar remaining maturities.

    The Company received a net income tax refund of $6,461 for the year ended December 31, 1999 and paid income taxes of $189,843 and $56,400 for the years ended December 31, 1998 and 1997, respectively. Continuing operations of the Company paid interest expenses of $840,746, $949,279 and $913,660 for the years ended December 31, 1999, 1998 and 1997.

    Certain reclassifications have been made to the 1998 financial statements to conform with the 1999 presentation. Such reclassifications had no impact on net income (loss) or equity.

    At December 31, 1998 the Company reported segment information of their three identifiable segments, Contract Manufacturing, Display Products and Medical Management. However, as disclosed in Note 8 "Discontinued Operations", the Company has formally adopted a plan during 1999 to dispose of two of the segments, including Display Products and Medical Management. The Company's remaining continuing operations fall with the scope of the Contract Manufacturing operating segment.

NOTE 2  MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

    The Company sells its products to companies in the computer, medical, governmental and various other industries. Historically, the Company has not experienced significant losses related to receivables from customers in any particular industry or geographic area.

    The Company maintains its excess cash balances in checking and money market accounts at three financial institutions. These balances exceed the federally insured limit by $405,000 and $166,225 at

18


December 31, 1999 and 1998, respectively. The Company has not experienced any losses in any of the short-term investment instruments it has used for excess cash balances.

    One customer accounted for approximately 12.1% and 12.7% of sales for the years ended December 31, 1999 and 1998.

NOTE 3  INVENTORIES

    Inventories consist of the following:

 
  1999
  1998
Raw Materials   $ 6,591,681   $ 5,208,748
Work in Process     1,404,018     1,153,878
Finished Goods     729,718     1,442,743
   
 
Total   $ 8,725,417   $ 7,805,369
   
 

NOTE 4  PREPAID EXPENSES AND OTHER

    The Company has a $14,000 note receivable with its President at December 31, 1999. The unsecured note is non-interest bearing and matures in 2000.

NOTE 5  CONTINGENT LIABILITIES

    The Company has self insured its employee health and dental plans. It has contracted with two separate administrative service companies to supervise and administer the programs and act as representatives. The Company's health plan insures for excessive or unexpected claims and is liable for claims not to exceed $40,000 per family per plan year and an estimated aggregate amount of $1,764,000 for the current plan year. The Company's dental plan does not contain the stop-loss insurance feature and pays claims based on actual amounts incurred. Estimated future claims for incurred health and dental services of approximately $257,420 and $164,695 were recorded as liabilities at December 31, 1999 and 1998, respectively.

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NOTE 6  LONG-TERM DEBT

Description

  1999
  1998
Notes Payable—Norwest Bank North Country, N.A., Revolving Lines of Credit, Borrowing Limit of $5,500,000; Promissory Note of $1,500,000; Interest at LIBOR Index Plus 21/2% and Highest Prime Rate in Money Rate Table in Wall Street Journal; Due January 2001; Secured by Accounts Receivable Equipment, Inventory, General Intangibles and Personal Guarantee and Stock Pledged By a Shareholder   $ 6,650,000   $ 6,675,000
Notes Payable—Norwest Bank North Country, N.A., Interest Ranging From 7.5% to 8.6%, Monthly Installment Payments Through January 2001; Secured by Accounts Receivable, Equipment, Inventory, General Intangibles and Real Estate     877,357     1,202,266
Note Payable—Communications Systems, Inc., Interest at Prime as Established by First Bank Minneapolis, Semi-Annual Principal Payments of $200,000; Due November 2001; Secured by Underlying Assets Purchased     3,365,390     3,765,390
Notes Payable—Other, Interest Ranging From 4.9% to 9%; Monthly Installment Payments Through March 2009; Secured by Land, Building, Leasehold Improvements, Equipment and Vehicle     214,243     314,815
   
 
Total Long-Term Debt   $ 11,106,990   $ 11,957,471
Current Maturities     860,079     810,934
   
 
Long-Term Debt—Net of Current Maturities   $ 10,246,911   $ 11,146,537
   
 

    Maturity requirements by year on long-term debt are as follows:

Years Ending December 31,

  Amounts
2000   $ 860,079
2001     10,160,532
2002     22,777
2003     15,285
2004     16,635

    The maximum and average amounts outstanding on the Company's long-term lines of credit were $6,850,000 and $6,569,041 during 1999 and $6,675,000 and $6,317,527 during 1998, respectively.

20



NOTE 7  PREFERRED STOCK TRANSACTIONS

    The holders of the preferred stock are entitled to a non-cumulative dividend of 12% when and as declared. In liquidation, holders of preferred stock have preference to the extent of $1.00 per share plus dividends accrued but unpaid. Preferred stock dividends of $0, $0 and $15,040 were paid during the years ended December 31, 1999, 1998, and 1997, respectively.

NOTE 8  DISCONTINUED OPERATIONS

    On June 30, 1999, the Company adopted a formal plan to sell two of their operating segments, Display Products and Medical Management. The anticipated disposal dates are expected to be no later than June 30, 2000. The assets of Display Products to be sold consist primarily of inventories and equipment. The assets of Medical Management to be sold consist primarily of receivables and equipment. Results of these operations for the year ending December 31, 1999 have been classified as discontinued and prior periods have been restated.

    The net assets of the two discontinued segments in the December 31, 1999 balance sheet include:

 
  1999
  1998
 
Cash   $ 29,675   $ 39,918  
Accounts Receivable     224,649     733,966  
Prepaid Expenses     15,000     79,094  
Inventories     150,064     1,578,506  
Accounts Payable     (130,416 )   (482,905 )
Accrued Expenses     (640,529 )   (69,950 )
   
 
 
Net Current Assets (Liabilities) of Discontinued Operations   $ (351,557 ) $ 1,878,629  
   
 
 
Equipment, Net   $ 76,296   $ 461,266  
Intangibles and Other Assets         1,098,460  
   
 
 
Net Non-Current Assets of Discontinued Operations   $ 76,296   $ 1,559,726  
   
 
 

    The amount of "Loss from Discontinued Operations" for the year ended December 31, 1999 on the accompanying income statement is a combination of the operating results through the measurement

21


date as well as the estimated loss on disposal of the discontinued operations. The components of the "Loss from Discontinued Operations" includes the following:

 
  1999
  1998
  1997
 
Discontinued Operations:                    
Loss from operations of segments to be disposed of, net of income tax benefits of $83,000, $187,000 and $216,000 at December 31, 1999, 1998 and 1997, respectively   $ 153,278   $ 496,142   $ 396,232  
Estimated Loss on disposal of segments, net of income tax benefit of $1,564,000 at December 1, 1999     2,905,187          
   
 
 
 
Loss from Discontinued Operations   $ 3,058,465   $ 496,142   $ 396,232  
   
 
 
 
Earnings (Loss) per Share:                    
Basic                    
Loss from discontinued operations   $ (0.07 ) $ (0.21 ) $ (0.17 )
Estimated loss on disposal of segments     (1.24 )        
   
 
 
 
Total Loss from Discontinued Operations   $ (1.30 ) $ (0.21 ) $ (0.17 )
   
 
 
 
Diluted                    
Loss from discontinued operations   $ (0.06 ) $ (0.21 ) $ (0.17 )
Estimated loss on disposal of segments     (1.23 )        
   
 
 
 
Total Loss from Discontinued Operations   $ (1.29 ) $ (0.21 ) $ (0.17 )
   
 
 
 

    Net sales of the Display Products and Medical Management segments for 1999, 1998 and 1997 were $2,413,638, $4,999,054 and $3,526,783, respectively. These amounts are not included in net sales in the accompanying income statements.

    In February 2000, the fixed assets and inventory of the Display Products segment were sold to Computron Display Systems. Under the terms of the purchase agreement, dated February 22, 2000, the Company sold these assets for $300,000, of which $50,000 will be held in escrow to cover future warranty expenses. These terms are materially consistent with estimates recorded by the Company for 1999.

NOTE 9  LEASE OBLIGATION

    The Company has entered into various operating leases for production and office equipment, office space and buildings. The Company has the option to purchase equipment upon lease expiration at fair market value. The Company also has the option to purchase a building under an operating lease. The monthly rent expense on another building under an operating lease is subject to an annual adjustment for the increase in the Consumer Price Index.

22


    Rent expense for the years ended December 31, 1999, 1998, and 1997, was $459,739, $412,714, and $302,695, respectively. The future minimum lease payments are as follows:

2000   $ 211,212
2001     201,493
2002     134,317
2003     51,975
2004     51,975
   
Total   $ 650,972
   

NOTE 10  INCOME TAXES

    The provision for income taxes for each of the three years in the period ended December 31, 1999, consists of the following:

 
  1999
  1998
  1997
Current Taxes—Federal   $ 17,000   $ 8,000   $ 31,000
Current Taxes—State     68,000     45,000     119,000
Deferred Taxes     556,000     258,000     420,000
   
 
 
Total Expense   $ 641,000   $ 311,000   $ 570,000
   
 
 

    Net deferred tax assets at December 31, 1999 and 1998, consist of the following:

 
  1999
  1998
 
Net Operating Loss (NOL) Carryforwards   $ 543,000   $ 883,000  
Tax Credit Carryforwards     185,000     305,000  
Unrealized Loss on Discontinued Operations     1,157,000      
Allowance for Doubtful Accounts     89,000     60,000  
Inventory Reserves     345,000     210,000  
Accrued Vacation     156,000     140,000  
Accrued Warranty     16,000      
Health Insurance Reserve     94,000     65,000  
Property and Equipment     (159,000 )   (328,000 )
Valuation Allowance     (165,000 )   (165,000 )
   
 
 
Total   $ 2,261,000   $ 1,170,000  
   
 
 

23


The statutory rate reconciliation for each of the three years in the period ended December 31, 1999 is as follows:

 
  1999
  1998
  1997
 
Statutory Tax Provision   $ 582,000   $ 387,000   $ 559,000  
State Income Taxes     115,000     79,000     112,000  
Additional Credit Carryforwards     (33,000 )   (55,000 )    
Reduction in Deferred Tax Valuation Allowance (Net of Expired Tax Credit Carryforwards)         (25,000 )   (50,000 )
Allocation to Discontinued Operations         (89,000 )   (35,000 )
Other     (23,000 )   14,000     (16,000 )
   
 
 
 
Income Tax Expense   $ 641,000   $ 311,000   $ 570,000  
   
 
 
 

    The Company has available for Federal income tax purposes, operating loss carryforwards, unused investment and other tax credits which may provide future tax benefits, expiring as follows:

Year of Expiration
  Operating Loss
Carryforward

  Investment and
Other Tax Credit
Carryforwards

  Research and
Development Tax
Credit Carryforward

2000   $ 307,000   $ 62,900   $ 97,600
2001     767,300     40,000    
2002     253,200        
2003     140,600        
2004            
Later Years         38,400    
   
 
 
Totals   $ 1,468,100   $ 141,300   $ 97,600
   
 
 

    The Company utilized operating loss carryforwards of $902,000, $506,000 and $1,341,000 for the years ended December 31, 1999, 1998, and 1997, respectively, to offset federal taxable income.

    At December 31, 1998, the Company has Alternative Minimum Tax credit carryforwards of approximately $86,800. These credits do not expire.

NOTE 11  EMPLOYEE STOCK OPTIONS AND AWARD PLANS

    In 1992, the Company approved the adoption of a fixed stock based compensation plan. The purpose of the Plan is to promote the interests of the Company and its shareholders by providing officers, directors and other key employees with additional incentive and the opportunity, through stock ownership, to increase their proprietary interest in the Company and their personal interest in its continued success.

    The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized for the stock option plans. Had compensation cost for the Company's stock option plan been determined based on the fair market value at the grant date consistent with the provisions of

24


SFAS No. 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:

 
  1999
  1998
  1997
Net Earnings (Loss)—as Reported   $ (1,987,666 ) $ 329,867   $ 677,671
Net Earnings (Loss)—Pro Forma   $ (2,062,062 ) $ 259,366   $ 612,402
Basic Earnings (Loss) Per Share as Reported   $ (0.84 ) $ 0.14   $ 0.28
Basic Earnings (Loss) Per Share Pro-Forma   $ (0.88 ) $ 0.11   $ 0.25
Diluted Earnings Per Share—as Reported   $ (0.84 ) $ 0.14   $ 0.28
Diluted Earnings Per Share—Pro Forma   $ (0.87 ) $ 0.11   $ 0.25

    The assumption regarding stock options issued is that compensation cost is recognized over the graded vesting period of the options, which ranges from zero to five years. Options granted before 1995 were not considered in the calculation.

    The fair value of each option grant issued is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

 
  1999
  1997
 
Expected Lives (Years)   10   10  
Dividend Yield   0.0 % 0.0 %
Expected Volatility   61 % 45 %
Risk-Free Interest Rate   5.75 % 6.25 %

    The total number of shares of common stock that may be granted under the plan is 350,000. The plan provides that shares granted come from the Company's authorized but unissued common stock. The price of the options granted to the plan will not be less that 100% of the fair market value of the shares on the date of grant. Options are generally exercisable after one or more years and expire no later than 10 years from the date of grant.

25


Information regarding the Company's common stock options is as follows:

 
  1999
  1998
  1997
 
  Shares
  Weighted-
Average
Exercise
Price

  Shares
  Weighted-
Average
Exercise
Price

  Shares
  Weighted-
Average
Exercise
Price

Options Outstanding, Beginning of Year     247,500   $ 4.60     252,500   $ 4.61     137,500   $ 4.29
Options Exercised             1,000     5.25        
Options Forfeited             4,000     5.25        
Options Granted     5,000     5.50             115,000     5.00
   
       
       
     
Options Outstanding, End of Year     252,500   $ 4.62     247,500   $ 4.60     252,500   $ 4.61
   
       
       
     
 
Option Price Range of Exercised Shares
 
 
 
$
 
 
 
 
 
 
 
 
 
 
$
 
5.25
 
 
 
 
 
 
 
 
 
$
 
 
 
 
 
 
 
 
Weighted Average Fair Value of Options Granted During the Year
 
 
 
$
 
2.40
 
 
 
 
 
 
 
 
 
$
 
 
 
 
 
 
 
 
 
 
$
 
3.31
 
 
 
 
 
 

    The following table summarizes information about fixed-price stock options outstanding at December 31, 1999:

Exercise Prices
  Outstanding
12/31/99

  Exercisable
12/31/99

  Remaining
Contractual Life

1.625   15,000   15,000   3 Years
1.75   17,500   17,500   2 Years
3.625   10,000   10,000   4 Years
5.00   115,000   69,000   7 Years
5.25   95,000   76,000   6 Years
5.50   5,000   2,500   9 Years

    During 1993, the Company adopted a gain-sharing plan. The purpose of the Plan is to provide a bonus for increased output, improved quality and productivity and reduced costs. The Company has authorized 50,000 shares to be available under this Plan.

    In accordance with the terms of the Plan, employees can acquire newly issued shares of common stock for 90% of the current market value. 5,748 shares have been issued under this Plan through 6,278 December 31, 1999.

26


NOTE 12  SUPPLEMENTARY FINANCIAL INFORMATION

 
  Quarter Ending
3/31/99

  Quarter Ending
6/30/99

  Quarter Ending
9/30/99

  Quarter Ending
12/31/99

  Total
1999

 
NET SALES   $ 9,467,339   $ 9,421,813   $ 9,333,901   $ 10,259,282   $ 38,482,335  
GROSS PROFIT     1,700,139     1,634,042     1,547,247     1,629,353     6,510,781  
NET INCOME CONTINUING OPERATIONS     248,704     288,496     226,380     307,219     1,070,799  
NET LOSS DISCONTINUED OPERATIONS         (1,447,957 )   (1,678,516 )   68,008     (3,058,465 )
BASIC EARNINGS PER SHARE OF COMMON STOCK:                                
CONTINUING OPERATIONS     0.11     0.12     0.10     0.13     0.46  
DISCONTINUED OPERATIONS         (0.62 )   (0.71 )   0.03     (1.30 )
   
 
 
 
 
 
TOTAL     0.11     (0.50 )   (0.61 )   0.16     (0.84 )


 
  Quarter Ending
3/31/98

  Quarter Ending
6/30/98

  Quarter Ending
9/30/98

  Quarter Ending
12/31/98

  Total
1998

 
NET SALES   $ 9,229,348   $ 8,374,281   $ 8,322,743   $ 9,430,441   $ 35,356,813  
GROSS PROFIT     1,513,613     1,448,751     1,473,125     1,365,002     5,800,491  
NET INCOME CONTINUING OPERATIONS     217,689     158,452     164,714     285,154     826,009  
NET LOSS DISCONTINUED OPERATIONS     28,743     29,386     (37,996 )   (516,275 )   (496,142 )
BASIC EARNINGS PER SHARE OF COMMON STOCK:                                
CONTINUING OPERATIONS     0.09     0.07     0.07     0.12     0.35  
DISCONTINUED OPERATIONS     0.02     0.01     (0.02 )   (0.22 )   (0.21 )
   
 
 
 
 
 
TOTAL     0.11     0.08     0.05     (0.10 )   0.14  

    In the 4th quarter of 1999, the Company recorded an increase to income tax expense to reflect a higher than anticipated effective tax rate.

    In the 4th quarter of 1998, the Company had an inventory write down of approximately $240,000 of pretax income. This reduced discontinued operations basic and diluted earnings per share by .07.

27



ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

    None.


PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

    Information regarding the directors and executive officers of the Registrant will be included in the Registrant's 1999 proxy statement to be filed with the Securities and Exchange Commission not later than April 30, 2000 and said portions of the proxy statement are incorporated herein by reference.


ITEM 11.  EXECUTIVE COMPENSATION

    Information regarding executive compensation of the Registrant will be included in the Registrant's 1999 proxy statements to be filed with the Securities and Exchange Commission not later than April 30, 2000 and said portions of the proxy statement are incorporated herein by reference.


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

    Information regarding security ownership of certain beneficial owners and management of the Registrant will be included in the Registrant's 1999 proxy statements to be filed with the Securities and Exchange Commission not later than April 30, 2000 and said portions of the proxy statements are incorporated herein by reference.


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

    None.

(The remainder of this page was intentionally left blank.)

28



PART IV

ITEM 14.  EXHIBITS, CONSOLIDATED FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K

(a)1.   Consolidated Financial Statements—Consolidated Financial Statements and related Notes are included in Part II, Item 8, and are identified in the Index on Page 15.
 
(a)2.
 
 
 
Consolidated Financial Schedule—The following Consolidated Financial Statement Schedule supporting the Consolidated Financial Statements and the accountant's report thereon are included in this Annual Report on Form 10-K:
 
  PAGE
Independent Auditors' Report on Supplementary Information    
 
Larson, Allen, Weishair & Co., LLP
 
 
 
34
 
Consolidated Financial Statement Schedule for the years ended December 31, 1999, 1998 and 1997
 
 
 
 
 
II Valuation and Qualifying Accounts
 
 
 
35

    All other schedules are omitted since they are not applicable, not required, or the required information is included in the financial statements or notes thereto.

(a)3.   THE FOLLOWING EXHIBITS ARE FILED AS A PART OF THIS REPORT:

    The following exhibits are incorporated by reference to exhibits 10.1 and 23.1 respectively, to the Company's Annual Report on Form 10-K for the year ended December 31, 1999.

10.1   Amendments to Promissory Notes, Loan Agreement Mortgage and Guaranty between Norwest Bank Minnesota South, N.A. (formerly Northern National Bank), and the Company.
 
23.1
 
 
 
Letter of Consent from Larson, Allen, Weishair & Company in reference to the S-8 Forms filed June 21, 1994 and June 30, 1993.

    The following exhibits are incorporated by reference to exhibits 10.1 and 10.2 respectively, to the Company's Annual Report on Form 10-K for the year ended December 31, 1998.

10.1   Master lease agreement for equipment Amplicon Financial and the Company.
 
10.2
 
 
 
Amendments to Promissory Notes, Loan Agreement Mortgage and Guaranty between Norwest Bank Minnesota South, N.A. (formerly Northern National Bank), and the Company.

    The following exhibits are incorporated by reference to exhibits 10.1, 10.2 and 23.1 respectively, to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.

10.1   Master lease agreement for equipment between Norwest Leasing Company and the Company.
 
10.2
 
 
 
Land contract between the city of Augusta and the Company for the purchase of building and land in Augusta, Wisconsin.

29


    The following exhibits are incorporated by reference to exhibits 10.1, 10.2, 10.3, 10.4, 10.5, 10.6, 10.7 and 10.8 respectively, to the Company's Annual Report on Form 10-K for the year ended December 31, 1996.

10.1   Promissory Note for acquisition of division between Company and Northern National Bank dated December 31, 1996.
 
10.2
 
 
 
Revolving Note for working capital line of credit between Company and Northern National Bank dated December 31, 1996.
 
10.3
 
 
 
Promissory Note for equipment purchases between Company and Northern National Bank dated December 31, 1996.
 
10.4
 
 
 
Revolving Note for the working capital line of credit between Company and Northern National Bank dated December 31, 1996.
 
10.5
 
 
 
Revolving Note for repurchase of stock between Company and Northern National Bank dated May 10, 1996.
 
10.6
 
 
 
Security Agreement covering Notes in Exhibits 10.1, 10.2, 10,3 10.4 and 10.5.
 
10.7
 
 
 
Promissory Note for acquisition of division between Company and Communications Systems, Inc. dated November 4, 1996.
10.8   Promissory Note for the acquisition of division between Company and Communications Systems, Inc. dated November 4, 1996.

    The following exhibits are incorporated by reference to exhibits 10.2, 10.3, 10.4, 10.5, and 10.6, respectively, to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.

10.2   Promissory Note for purchase of facility in Fairmont, Minnesota between Company and Northern National Bank dated December 29, 1995.
 
10.3
 
 
 
Promissory Note for purchase of capital equipment located at Fairmont, Minnesota facility between Company and Northern National Bank dated December 29, 1995.
 
10.4
 
 
 
Security Agreement covering Promissory Notes in Exhibits 10.2 and 10.3.
 
10.5
 
 
 
Asset Purchase Agreement for the purchase of assets of Monitor Technology Corporation dated February 24, 1995.
10.6   Asset Purchase Agreement for the purchase of Aerospace Division of Communication Cable, Inc. dated August 23, 1995.

30


    The following exhibits are incorporated by reference to exhibits 10.2, 10.3, and 10.5, respectively, to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.

10.2   Promissory Note and Loan Agreement for capital equipment line of credit between the Company and Northern National Bank dated April 29, 1994.
 
10.3
 
 
 
Loan Agreement for Real Estate between the Company and Northern National Bank dated March 18, 1994.
10.5   Promissory Notes and Loan Agreement for Real Estate between the Company and MMCDC and MMCDC/NNC dated March 18, 1994.

    The following exhibits are incorporated by reference to Exhibits 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.

10.3   Promissory Notes for capital equipment between the Company and City of Augusta, Wisconsin dated August 17, 1993.

    The following exhibits are incorporated by reference to Exhibits 3.1, 3.2 and 10.3 respectively, to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.

3.1   Articles of Incorporation (SMR) dated August 9, 1991
 
3.2
 
 
 
Bylaws (SMR)
10.3   Promissory Note and Mortgage between the Company and Joint Economic Development Commission, Inc. dated June 28, 1991.

31



    The following exhibit is incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.


    The following exhibit is incorporated by reference to Exhibit 3.2 to the Annual Report on Form 10-K for the year ended December 31, 1984:

(b)
Reports on Form 8-K.

    None.

(The remainder of this page was intentionally left blank.)

32



SIGNATURES

    Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

    NORTECH SYSTEMS INCORPORATED
 
March 30, 2000
 
 
 
By:
 
 
 
/s/ 
GARRY M. ANDERLY   
Garry M. Anderly
Principal Financial Officer and
Principal Accounting Officer
 
March 30, 2000
 
 
 
By:
 
 
 
/s/ 
QUENTIN E FINKELSON   
Quentin E. Finkelson
President and
Chief Executive Officer

    Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

March 30, 2000       /s/ QUENTIN E FINKELSON   
Quentin E. Finkelson
President, Chief Executive
Officer and Director
 
March 30, 2000
 
 
 
 
 
 
 
/s/ 
MYRON KUNIN   
Myron Kunin,
Director
 
March 30, 2000
 
 
 
 
 
 
 
/s/ 
RICHARD W. PERKINS   
Richard W. Perkins,
Director
 
March 30, 2000
 
 
 
 
 
 
 
/s/ 
MICHAEL J. DEGEN   
Michael J. Degen,
Director

33


INDEPENDENT AUDITOR'S REPORT ON
SUPPLEMENTARY INFORMATION

Board of Directors
Nortech Systems Incorporated and Subsidiary
Bemidji, Minnesota

    Our report on the basic consolidated financial statements of Nortech Systems Incorporated and Subsidiary for 1999, 1998 and 1997, precedes the consolidated financial statements. The audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule on the following page is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.

St. Cloud, Minnesota
February 11, 2000

34


NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

SCHEDULE II

FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997

Column A
  Column B
  Column C
  Column E
  Column F
Classification
  Balance at Beginning Of Period
  Additions Charged to Costs And Expenses
  Add (Deduct)
  Balance at End of Period
Year Ended December 31, 1999:*                        
Allowance for Doubtful Accounts   $ 111,627   $ (9,597 ) $   $ 102,030
Inventory Obsolescence Reserve     419,295     345,713         765,008
Deferred Tax Valuation Allowance     165,000             165,000
   
 
 
 
    $ 695,922   $ 336,116   $   $ 1,032,038
   
 
 
 
 
Year Ended December 31, 1998:*
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for Doubtful Accounts   $ 58,585   $ 53,042   $   $ 111,627
Inventory Obsolescence Reserve     270,000     149,295         419,295
Deferred Tax Valuation Allowance     190,000         (25,000 )   165,000
   
 
 
 
    $ 518,585   $ 202,337   $ (25,000 ) $ 695,922
   
 
 
 
 
Year Ended December 31, 1997:*
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for Doubtful Accounts   $ 16,248   $ 42,337   $   $ 58,585
Inventory Obsolescence Reserve     70,000     200,000         270,000
Deferred Tax Valuation Allowance     240,000         (50,000 )   190,000
   
 
 
 
    $ 326,248   $ 242,337   $ (50,000 ) $ 518,585
   
 
 
 

*
Amounts have been restated each year to reflect activities of continuing operations.

35



INDEX TO EXHIBITS

DESCRIPTIONS OF EXHIBITS

10.1   Amendments to Promissory Notes, Loan Agreement Mortgage and Guaranty between Norwest Bank Minnesota South, N.A. (formerly Northern National Bank), and the Company.
 
23.1
 
 
 
Letter of Consent from Larson, Allen, Weishair & Company in reference to the S-8 Forms filed June 21, 1994 and June 30, 1993.

36



QuickLinks

PART I
PART II
PART III
PART IV
SIGNATURES