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[GRAPHICS PICTURES]
[LOGO] NORTECH SYSTEMS
1996 ANNUAL REPORT
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SYNERGY: THE INTERACTION OF TWO OR MORE FORCES SUCH THAT THEIR COMBINED EFFECT
IS GREATER THAN THE SUM OF THEIR INDIVIDUAL EFFECTS.
CORPORATE DESCRIPTION
Nortech Systems Incorporated manufactures wire harnesses, cable and
electromechanical assemblies, printed circuit board assemblies and higher-level
assemblies for a wide range of commercial and defense industries. It also
designs, manufactures and markets high-performance display monitors for medical
imaging, document imaging, radar and industrial applications.
Based in Wayzata, Minnesota, Nortech Systems' manufacturing operations are
located in Aitkin, Bemidji, Fairmont and Merrifield, Minnesota; and Augusta,
Wisconsin. Imaging operations are located in Plymouth, Minnesota.
Nortech Systems is traded on the Nasdaq Stock Market under the symbol NSYS
and appears in most stock listings under "NorSys."
CONTINUOUS QUALITY IMPROVEMENT
Nortech Systems practices quality management in every aspect of its
business. This philosophy demands continuous quality improvement, accurate
process measurement and intensive employee involvement at all levels. The
quality management effort at Nortech Systems is continuous, with increased
customer satisfaction as its constant goal.
SALES
(IN THOUSANDS)
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
$7,300 $11,706 $12,821 $18,306 $26,183
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TO OUR SHAREHOLDERS:
During 1996, Nortech Systems continued its successful evolution into a
full-service manufacturer by broadening its capabilities. We strengthened our
core contract manufacturing business by adding more sophisticated electronics,
such as printed circuit board assemblies and higher-level assemblies. We now
offer a complete package of manufacturing services to customers across diverse
industries.
GROWING WITH SYNERGY
The theme of this annual report is 'synergy' because cooperation among
Nortech Systems' different facilities is increasingly important to our success.
While similarities exist, our six facilities in Minnesota and Wisconsin each
offer distinctly different capabilities and expertise. Working together, they
create a whole that is greater than the sum of our parts. We continue to improve
cooperation among our facilities, analyzing the best fit for each business
opportunity and managing our resources accordingly. In addition, we evaluate
strategic acquisitions that will complement this synergy.
NEW MANUFACTURING CAPABILITIES
Our 1996 acquisition of Zercom Corporation, a division of Communications
Systems, Inc., enhanced our existing strengths and added manufacturing
capabilities in two key areas: printed circuit board assemblies and higher-level
assemblies. Our complete manufacturing services are attractive to customers who
are outsourcing some or all of their electronics manufacturing. Presently, we
are working with several large OEM customers who are interested in our enhanced
capabilities and we expect to finalize several contracts in the near future. The
addition of Zercom should add significantly to contract manufacturing revenues
in 1997.
CAPITALIZING ON OUTSOURCING TRENDS
Our broadened capabilities enable us to better capitalize on the recognized
growth in manufacturing outsourcing. Electronic Buyers' News reported in its
March 3, 1997, issue that original-equipment manufacturers from every segment of
the electronics industry are increasingly looking to outsiders like Nortech
Systems to perform complete system assembly. According to the Outsourcing
Institute, the primary reasons companies outsource are to improve company focus
and to access world-class capabilities. At Nortech Systems, we're justifiably
proud of our ability to help customers in these areas.
FINANCIAL RESULTS
We reported net sales for 1996 of $26,182,821 for the year ended Dec. 31,
1996, a 43 percent increase from net sales of $18,305,928 in 1995. Fourth
quarter sales were $7,841,475, an increase of 61 percent. Our net operating
income for 1996, before a one-time charge, was $1,292,029, or $.54 per share,
compared with $1,331,924, or $.55 per share, for 1995. For the fourth quarter,
net operating income before a one-time charge was $395,915, or $.17 per share,
compared with $424,899, or $.17 per share, for the same period in 1995. The
one-time charge consisted of a write-off of excess and obsolete inventory, and
costs associated with recent acquisitions. As a result, we reported net income
for the year of $446,029, or $.19 per share, and a net loss for the quarter of
$234,375, or $.10 per share. Addressing the one-time charge eliminates any long-
term detrimental effects, enabling us to focus on generating positive earnings.
IMAGING TECHNOLOGIES GROWTH
We have invested heavily in research and development for new medical
imaging products since we acquired Monitor Technology Corp. in 1995. We expect
to see a significant return on this investment from our Imaging Technologies
division as we move forward, and positive contributions to earnings in 1997. Our
medical imaging sales revenue increased more than 400 percent in 1996, compared
to 1995. Several large medical equipment manufacturers have selected our
monitors to be part of their diagnostic imaging systems. To create a
multinational presence for these products, we are adding well-established
distributors in Japan, South Korea, China and Hong Kong, as well as Australia
and Europe.
RANKED ON FORBES' "200 BEST SMALL COMPANIES" LIST
Nortech Systems was again named to Forbes magazine's annual listing of the
"200 Best Small Companies in America," ranking 67th. Ranking was based on five-
year average return on equity, and five-year average sales and earnings growth
per share.
Thank you for your interest in Nortech Systems. We look forward to a
profitable, exciting 1997.
/s/ Quent Finkelson
Quent Finkelson
CHAIRMAN, PRESIDENT & CEO
1
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[GRAPHICS]
CONNECTIONS
WIRES,CABLES AND PRINTED CIRCUIT BOARDS
PRODUCING "BUILDING BLOCKS"
Nortech Systems is a full-service electronics manufacturer with extensive
capabilities in many areas. On the most basic level, our products include
specialized wires, cables and printed circuit boards. These vary in size and
complexity, but all are important building blocks that provide the connections
necessary for electronics and electrical equipment to operate. Our customers
represent a range of high-technology industries, including computer,
communications, medical, automotive and defense. As a contract manufacturer, we
build products to meet exact customer specifications. Our facilities either have
received certification under ISO 9002 or are working towards it, and we also
operate in accordance with other quality standards. The Bemidji facility was
certified under ISO 9002 in July 1995 and has successfully completed two
recertification audits.
ADDING NEW CAPABILITIES
Our strategic acquisition of Zercom Corporation in 1996 added important
capabilities in manufacturing printed circuit board (PCB) assemblies. A PCB
consists of numerous electrical circuits mounted on an insulating base. They
vary in size and complexity -- we produce single- and double-sided PCBs
comprised of 35 to 800 components. One common PCB, a 486 processor board, is
used to operate many personal computers, robotic devices and other
2
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FULL-SERVICE MANUFACTURING CAPABILITIES ENABLE US TO SERVE A WIDE RANGE OF
CUSTOMERS, WITH EVERYTHING FROM BASIC WIRES AND CABLES TO HIGHER-LEVEL
ASSEMBLIES AND COMPLETE PRODUCTION.
other electronic equipment.
We use automated pick-and-place machines for component placement on both
types of PCBs: conventional through-hole and newer surface mount technology
(SMT). The main difference between the two types is size -- SMT boards and
components are smaller. Customers appreciate the capabilities we offer in both
types, particularly those customers who would otherwise be forced to redesign
their products to use SMT technology.
[PICTURE]
SEEING A NICHE
Our Intercon 1 division in Aitkin, Minnesota, produces proprietary video
cables used for Closed Circuit Detection (CCD) applications, and is the largest
producer of CCD camera cables and accessories in the United States. CCD cables
are used in industrial diagnostics and robotic vision technology, where cameras
enable machine operators to quickly and safely monitor product quality. In the
medical field, CCD cameras are used for microscopic surgery. Other Intercon 1
products include coaxial and triaxial cable for high-speed modem communications.
WORKING TOGETHER -- PROFITABLY
Our expanding manufacturing capabilities enable Nortech Systems' facilities
to share resources and cooperate, each focusing on key areas of expertise. This
results in greater operating efficiency, lower production costs and increased
profitability. We expect cooperation to increase in the future. Wires, cables
and PCBs are produced at facilities in Bemidji, Merrifield and Aitkin,
Minnesota, and Augusta, Wisconsin. While these products provide the connections
needed for our customers' products to operate, we also utilize them within
Nortech Systems to manufacture more complex products, such as higher-level
assemblies.
3
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[PICTURE]
ASSEMBLIES
HIGHER-LEVEL ASSEMBLIES
PUTTING IT ALL TOGETHER
Zercom Corporation, acquired in 1996, has earned a strong reputation for
producing a wide array of higher-level assemblies. They consist of wires, cables
and PCBs configured together, and often enclosed in a box or housing made of
metal or plastic. A higher-level assembly may be a complete, finished product,
or a sub-component used by our customers in their manufacturing. Examples of
higher-level assemblies produced at our facility in Merrifield, Minnesota,
include control panels for refrigeration systems used in ocean freight carriers,
components for portable defibrillators, display panels for personal watercraft,
electronic assemblies for patient-lifting devices used in health care
facilities, and coin-operated control boxes for gas station air compressors.
[PICTURE]
CAPITALIZING ON OUTSOURCING TRENDS
Outsourcing is a growing trend across many industries, including
electronics. According to Technology Forecasters, the market for technology
outsourcing is expected to increase to $95 billion by 1999 -- an annual growth
rate of 22 percent. Customers outsource production steps to minimize their
investment in a manufacturing operation, allowing them to focus on product
design,
4
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MARKET DIVERSIFICATION REDUCES OUR DEPENDENCE ON ANY ONE MARKET. OUR CUSTOMER
BASE, BROADENED THROUGH STRATEGIC ACQUISITIONS, ENCOMPASSES MANY INDUSTRIES.
sales and order fulfillment. This representsopportunity for all of Nortech
Systems --opportunity we are better positioned to capitalize on than ever
before.
BUILDING PARTNERSHIPS WITH CUSTOMERS
Broadening our world-class manufacturing capabilities enables us to target
new opportunities, many from current customers. Indeed, much of our sales growth
comes from expanding existing relationships. We consider ourselves partners with
our customers, and we always strive for a better understanding of their
business. As we learn, we can better educate them about our complete
capabilities. Consolidating purchases with one vendor has many advantages for
our customers. It's easier to work with only one sales representative, and we
can provide one package bid at a competitive price.
[PICTURE]
PROVIDING FLEXIBLE MANUFACTURING
Today, our manufacturing capabilities range from basic wires and cables to
higher-level assemblies and completed final products -- and everything in
between. Some customers come to us first for basic wires and cables, and later
we earn the chance to bid on higher-level assembly or final production. In other
cases, higher-level assembly customers decide to have us also manufacture the
wires and cables, or the entire finished product. We can affix the customers'
logo, serial number or other information, and ship the completed product either
to their warehouses or directly to the final customer.
5
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[PICTURE]
AEROSPACE DIVISION
MILITARY WIRES AND CABLES
BUILDING FOR DEMANDING APPLICATIONS
The Aerospace Systems division, in Fairmont, Minnesota, produces complex,
custom-designed wires and cables for the defense industry and other demanding
applications. Products are engineered to withstand severe environmental
conditions, including extreme heat and cold variations, salt spray, water
immersion, chemical and abrasion resistance, and electromagnetic and radio
interference. Our defense-related products are used primarily in communication,
ground support, and training applications. Examples include cables for radio
systems, aircraft and missile test equipment, and combat-simulation equipment.
Other defense applications include shipboard radar, personnel detection, missile
avoidance, and helicopter engine harnessing. Approximately ten percent of
Aerospace Systems division revenues are generated by non-defense cables. These
are used on light- to medium-duty trailers that transport snowmobiles, personal
watercraft, construction equipment and livestock.
[PICTURE]
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ECONOMIES OF SCALE PRODUCE SAVINGS AND IMPROVE EFFICIENCY. MANY OPERATIONS CAN
BE CONSOLIDATED; FOR EXAMPLE, MORE THAN ONE-THIRD OF OUR FACILITIES' PURCHASES
ARE FROM COMMON SUPPLIERS.
STARTING WITH QUALITY
Like all Nortech Systems products, wires and cables built by Aerospace
Systems are designed to meet customer specifications. We adhere to stringent
quality requirements, including military specification MIL-I-43208 and other
international and industry standards. The defense industry is increasingly
shifting away from military-specific requirements and accepting quality
certifications such as ISO 9002. As this happens, it will open up additional
opportunities for other Nortech Systems facilities to serve the defense
industry. We incorporate statistical process control into our manufacturing
andmeasure quality in parts per million. Quality is built in first -- not
inspected in later.
[PICTURE]
RECOGNIZING NEW OPPORTUNITIES
Aerospace Systems' expertise in building custom wires and cables that meet
rigorous quality requirements enables us to also provide these unique
capabilities to commercial customers. We offer short-run production of custom
bulk cable and expertise in designing and building cables shielded for
electromagnetic or radio interference. Shielding helps ensure proper operation
of electronics in a wide range of machinery and equipment. This type of
protection is increasingly important today as electronic devices continue to
operate at lower and lower voltages, making them more susceptible to
interference.
7
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[PICTURE]
IMAGING TECHNOLOGIES
HIGH-RESOLUTION MONITORS
BUILDING TO PRECISE SPECIFICATIONS
We design, manufacture and market high-performance display monitors used in
medical imaging, shipboard radar and document imaging. All of our monitors are
sold to original equipment manufacturers (OEMs), who integrate them into their
own equipment. Nortech Systems' Imaging Technologies division monitors are
precisely engineered to meet demanding OEM customer specifications.
[PICTURE]
INCREASING SALES AND MARKET SHARE
Two years of significant investments in research and product development
are paying off -- we are now gaining market share and broadening our customer
base. During 1996, sales revenue from medical imaging - our primary target
market - increased more than 400 percent. We began shipping monitors to several
of the world's largest medical imaging equipment manufacturers.
FOCUSING ON MEDICAL IMAGING
Our monitors are used in the growing field of digital x-ray archiving,
where images are stored electronically instead of on film. Our two newest 21-
inch ultra-high resolution monitors feature 5 million pixels -- four times the
resolution of a standard 21-inch monitor.
8
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SUCCESSFUL CROSS-SELLING CAN RESULT WHEN A CUSTOMER IS INTRODUCED TO OUR
COMPLETE MANUFACTURING CAPABILITIES. CONSOLIDATING SUPPLIERS SIMPLIFIES BUSINESS
FOR THE CUSTOMER, AND PROVIDES OPPORTUNITY FOR US.
Greater resolution provides a clearer, more well-defined image for easier
diagnosis. Other medical imaging applications for our monitors include MRI, CT,
fluoroscopy and digital cardiology/angiography. We are an acknowledged leader in
the latter area, which includes monitors used in heart catheterization labs
performing procedures like balloon angioplasty. Our Imaging Technologies
division is well- positioned to benefit from this expanding market.
[PICTURE]
BENEFITING FROM EXTERNAL, INTERNAL COOPERATION
Our Imaging Technologies division provides another way to introduce
customers to the full range of Nortech Systems' manufacturing capabilities. In
addition to monitors, imaging equipment OEMs typically outsource wires, cables
and printed circuit boards. Because of our broad capabilities, we are positioned
to capture a larger share of this total business. And this is happening
already. For one of our customers, a large medical equipment manufacturer, we
supply monitors, as well as internal wires and cable harnesses.
Some components used in monitormanufacturing -- wires, cables and
sophisticated electronics -- can now be obtained from other Nortech Systems'
facilities, rather than purchased from outside suppliers. We are committed to
increasing this type of internal cooperation, including utilizing our
manufacturing capabilities most efficiently.
9
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATIONS, YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
REVENUES.
For the years ended December 31, 1996, and 1995 the Company had sales of
$26,182,821 and $18,305,928, respectively. The increase of $7,876,893, or 43%,
resulted primarily from additional revenues generated by the acquisitions which
were completed in 1995 and 1996. For the year ended December 31, 1994 the
Company had sales of $12,820,709. The approximate 42.8% increase in sales in
1995 was attributable primarily to increased sales in the medical and automotive
industries offset by the reduced sales to the mid-sized computer industries as
well as revenues from the newly acquired divisions.
GROSS PROFIT.
The Company had gross profit of $5,184,198 (before one-time write-offs) in
1996, $3,764,840 in 1995, and $2,598,569 in 1994. Gross profits as a percentage
of gross sales were 19.8% in 1996 (before one-time write-offs), 20.6% in 1995,
and 20.3% in 1994. In 1996, the Company experienced certain items which are
considered unusual events for their operations. Due to evolving customer
requirements, the Company wrote off certain inventories from two of the
divisions. A total of $544,000 in inventories was written off from the Bemidji
and Imaging balance sheets. The customer marketplace is complex and ever-
changing, but with the current inventory and production mix, the Company
believes they are well-poised to address the needs of their current customers as
they continue to pursue additional growth markets. After the one-time write-
offs, gross profit margin for 1996 was 17.7%.
The decrease in gross profit percent from 1995 to 1996 is due to an
increase in materials as a percent of total cost of goods sold.
SELLING, GENERAL, AND ADMINISTRATIVE.
Selling, general, and administrative expenses were $3,306,311 in 1996,
$2,280,105 in 1995, and $1,647,797 in 1994. The increases in each year reflect
additional selling, general and administrative expenses associated with the
acquisitions.
MISCELLANEOUS INCOME.
Miscellaneous income was $32,064 in 1996, $177,967 in 1995, and $86,307 in
1994. The miscellaneous income resulted primarily from charges formiscellaneous
services.
INTEREST EXPENSE.
Interest expense was $475,057 in 1996, $240,562 in 1995, and $117,835 in
1994. The increased expense for 1996 and 1995 is due to the increased debt from
acquired operations.
INCOME TAXES.
Income tax expense for 1996 was $192,000. Tax expense was not recorded in
1995 because of additional net operating loss carryforwards (NOL's) of
approximately $2,504,000 which were recognized because of final tax regulations.
The regulations clarified that tax carryforwards attributes in a Chapter 11
bankruptcy prior to December 31, 1993 where stock was issued for debt, need not
be reduced by cancellation income. The tax benefit of approximately $851,000
created by additional NOL's was partially offset by a $300,000 increase in the
deferred tax valuation allowance.
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.
Tax benefits of $245,794 were recorded in 1994 due to the reduction in the
deferred tax valuation allowance of $600,000 due to the realization of net
operating loss carryforwards.
NET INCOME.
The Company's net income in 1996 was $446,029 or $.19 per common share. The
Company's net income in 1995 was $1,331,924 or $.55 per common share. The
Company's net income in 1994 was $1,183,406 or $.54 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.
10
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LIQUIDITY AND CAPITAL RESOURCES.
The Company's working capital rose from $5,279,509 as of December 31, 1995
to $8,498,531 on December 31, 1996. Stockholders' equity increased from
$6,036,166 as of December 31, 1995 to $7,151,192 on December 31, 1996 due to the
Company's 1996 net income and the reclassification to equity of $668,400 of
redeemable stock. This reclassification occurred because the put option on
111,400 shares was not exercised. The Company's liquidity and capital resources
have improved substantially, 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.
In March 1995, the Company completed the net asset purchase of Monitor
Technology Corporation. This division of the Company designs and builds high
and ultra-high resolution CRT monitors for medical imaging, document imaging,
radar and industrial applications. In addition, they provide repair services on
internally and externally produced monitors.
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 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. Zercom Corporation also manufactures a line of proprietary
products for sport fishermen, including the Clearwater Classic and Clearwater
Pro fish locators.
These acquisitions are expected to positively impact future operations and
enhance the financial condition of the Company over time. However, there are no
guarantees of future performance.
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INDEPENDENT AUDITORS' 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, 1996 and 1995, and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 1996. 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 areasonable 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, 1996, 1995 and 1994, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1996, in conformity with generally accepted
accounting principles.
LARSON, ALLEN, WEISHAIR & CO., LLP
ST. CLOUD, MINNESOTA
FEBRUARY 13, 1997
11
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CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1995
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
<TABLE>
<CAPTION>
ASSETS 1996 1995
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<S> <C> <C>
CURRENT ASSETS
Cash and Cash Equivalents (Including Interest Bearing
Cash of $1,069,369 and $906,111 at December 31, 1996 and 1995) $1,235,127 $924,590
Accounts Receivable, Less Allowance for Uncollectible
Accounts (1996 - $22,301; 1995 - $6,053) 3,695,763 1,856,219
Inventories 6,729,500 3,855,212
Prepaid Expenses and Other 88,821 131,701
Deferred Tax Asset 540,000 430,000
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Total Current Assets $12,289,211 $7,197,722
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PROPERTY AND EQUIPMENT (AT COST)
Land $136,300 $108,300
Building and Leasehold Improvements 3,559,155 1,897,559
Manufacturing Equipment 4,588,955 2,389,201
Office and Other Equipment 2,461,997 1,701,640
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Total $10,746,407 $6,096,700
Accumulated Depreciation (2,875,702) (2,256,862)
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Total Property and Equipment (at Depreciated Cost) $7,870,705 $3,839,838
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OTHER ASSETS
Goodwill and Other Intangible Assets $1,025,463 $998,254
Deferred Tax Asset 910,000 1,130,000
Other Assets 57,250 57,250
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Total Other Assets $1,992,713 $2,185,504
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Total Assets $22,152,629 $13,223,064
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Line of Credit $500,000 $0
Current Maturities of Long-Term Debt 731,080 283,100
Accounts Payable 1,596,326 1,054,880
Accrued Payroll 673,303 407,016
Other Liabilities 289,971 173,217
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Total Current Liabilities $3,790,680 $1,918,213
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LONG-TERM DEBT
Notes Payable (Net of Current Maturities Shown Above) $10,910,757 $3,768,685
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REDEEMABLE COMMON STOCK
$.01 Par Value; 50,000 and 250,000 Shares Issued and
Outstanding at December 31, 1996 and 1995, Respectively
Redeemable at $6 Per Share $300,000 $1,500,000
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STOCKHOLDERS' EQUITY
Preferred Stock, $1 Par Value; 1,000,000 Shares
Authorized; 250,000 Shares Issued and Outstanding $250,000 $250,000
12
LIABILITIES AND STOCKHOLDERS' EQUITY continued 1996 1995
Common Stock $.01 Par Value; 9,000,000 Shares
Authorized; 2,312,362 and 2,200,863 Shares Issued and
Outstanding, Net of Redeemable Shares Reported Above,
at December 31, 1996 and 1995, Respectively 23,124 22,009
Additional Paid-in Capital 11,910,554 11,242,672
Accumulated Deficit (5,032,486) (5,478,515)
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Total Stockholders' Equity $7,151,192 $6,036,166
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Total Liabilities and Stockholders' Equity $22,152,629 $13,223,064
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</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED
DECEMBER 31, 1996, 1995 AND 1994
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
<TABLE>
<CAPTION>
1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Sales $26,182,821 $18,305,928 $12,820,709
Cost of Sales (21,555,459) (14,541,088) (10,222,140)
- -------------------------------------------------------------------------------------------------------------------
Gross Profit $4,627,362 $3,764,840 $2,598,569
Selling, General and
Administrative Expenses (3,306,311) (2,280,105) (1,647,797)
Research and Development Costs (273,697) (124,919) 0
Interest Income 33,668 34,703 18,368
Miscellaneous Income 32,064 177,967 86,307
Interest Expense (475,057) (240,562) (117,835)
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Income Before Income Tax Provision $638,029 $1,331,924 $937,612
Income Tax Benefit (Expense) (192,000) 0 245,794
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Net Income $446,029 $1,331,924 $1,183,406
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Income Per Share of Common Stock
Net Income Per Share of Common Stock $0.19 $0.55 $0.54
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Weighted Average Number of
Shares Outstanding 2,384,512 2,407,804 2,194,021
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</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
13
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
<TABLE>
<CAPTION>
ADDITIONAL TOTAL
PREFERRED COMMON PAID-IN ACCUMULATED STOCKHOLDERS'
STOCK STOCK CAPITAL DEFICIT EQUITY
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE
DECEMBER 31, 1993 $250,000 $21,937 $11,226,761 $(7,948,965) $3,549,733
1994 Net Income 0 0 0 1,183,406 1,183,406
Issuance of Stock 0 6 2,304 0 2,310
Dividends Paid 0 0 0 (14,946) (14,946)
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BALANCE
DECEMBER 31, 1994 $250,000 $21,943 $11,229,065 $(6,780,505) $4,720,503
1995 Net Income 0 0 0 1,331,924 1,331,924
Issuance of Stock - Stock Options 0 50 8,700 0 8,750
Issuance of Stock - Other 0 16 4,907 0 4,923
Dividends Paid 0 0 0 (29,934) (29,934)
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BALANCE
DECEMBER 31, 1995 $250,000 $22,009 $11,242,672 $(5,478,515) $6,036,166
1996 Net Income 0 0 0 446,029 446,029
Issuance of Stock - Other 0 1,115 667,882 0 668,997
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BALANCE
DECEMBER 31, 1996 $250,000 $23,124 $11,910,554 $(5,032,486) $7,151,192
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
14
<PAGE>
----------------- [LOGO] -----------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
<TABLE>
<CAPTION>
1996 1995 1994
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Cash Received from Customers $24,375,341 $18,114,515 $13,307,176
Interest Income Received 33,668 34,703 18,368
Cash Paid to Suppliers and Employees (23,904,901) (17,379,766) (11,794,879)
Interest Expense Paid (403,003) (239,809) (117,927)
Income Taxes Paid (205,900) (19,016) (34,206)
- ---------------------------------------------------------------------------------------------------------
Net Cash Provided (Used) by
Operating Activities $(104,795) $510,627 $1,378,532
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of Businesses $(1,559,492) $(2,930,696) $0
Acquisition of Property and Equipment (718,835) (458,359) (224,096)
Acquisition of Intangible Assets 0 (82,059) 0
Purchase of Investments 0 (56,250) 0
- ---------------------------------------------------------------------------------------------------------
Net Cash Used by
Investing Activities $(2,278,327) $(3,527,364) $(224,096)
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net Proceeds (Payments) Under
Line of Credit $500,000 $0 $(266,533)
Payments on Long-Term Debt (431,453) (289,294) (963,178)
Proceeds from Long-Term Debt 3,156,115 3,405,180 531,000
Proceeds from Sale of Stock 597 13,673 2,310
Purchase of Redeemable Stock (531,600) 0 0
Payment of Dividends 0 (29,934) (14,946)
- ---------------------------------------------------------------------------------------------------------
Net Cash Provided (Used) by
Financing Activities $2,693,659 $3,099,625 $(711,347)
- ---------------------------------------------------------------------------------------------------------
NET INCREASE IN CASH
AND CASH EQUIVALENTS $310,537 $82,888 $443,089
Cash and Cash Equivalents - Beginning 924,590 841,702 398,613
- ---------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - ENDING $1,235,127 $924,590 $841,702
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
NON-CASH TRANSACTIONS
During 1995 the Company issued $1,500,000 of redeemable Common Stock as part of
the purchase of another corporation's net assets.
During 1996 the Company issued a long-term note payable in the amount of
$4,865,390 as part of the purchase price for certain assets of another
corporation.
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
15
<PAGE>
----------------- [LOGO] -----------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
<TABLE>
<CAPTION>
1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
RECONCILIATION OF NET INCOME TO NET
CASH PROVIDED BY OPERATING ACTIVITIES
Net Income $446,029 $1,331,924 $1,183,406
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Depreciation and Amortization 693,456 444,636 245,847
Deferred Taxes 110,000 (100,000) (280,000)
(Increase) Decrease in
Accounts Receivable (1,839,544) (369,380) 365,160
Decrease in Accounts
Receivable - Stockholder 0 0 35,000
(Increase) Decrease in Inventory (482,103) (407,932) 173,065
(Increase) Decrease in Prepaid Assets 42,880 (79,751) 33,507
Increase (Decrease) in
Accounts Payable 541,446 207,835 (391,788)
Increase (Decrease) in Accrued Payroll 266,287 (17,852) 6,077
Increase (Decrease) in
Accrued Liabilities 116,754 (498,853) 8,258
- -------------------------------------------------------------------------------------------------------------------
Net Cash Provided (Used) by
Operating Activities $(104,795) $510,627 $1,378,532
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
16
<PAGE>
----------------- [LOGO] -----------------
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS DESCRIPTION
Nortech Systems Incorporated (the Company) is a Minnesota corporation with
headquarters in Wayzata, Minnesota, a suburb of Minneapolis, Minnesota. The
Company's main manufacturing facility is located in Bemidji, Minnesota, with
additional manufacturing and engineering support locations in Fairmont,
Plymouth, Merrifield and Aitkin, Minnesota and Augusta, Wisconsin.
The Company manufactures wire harnesses, cables, and electromechanical
assemblies, printed circuit board assemblies and higher-level assemblies for a
wide range of commercial and defense industries. The Company also manufactures
and markets high performance display monitors for medical imaging, document
imaging, radar and industrial applications. The Company provides a full turnkey
contract manufacturing service to its customers. All products are built to the
customer's design specifications.
In addition, the Company also manufactures a line of proprietary products
for sport fishermen. Nortech Medical Services, Inc., its wholly owned
subsidiary, provides service bureau and office management services to physicians
and clinics throughout Minnesota.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary. All significant intercompany accounts and
transactions have been eliminated.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or
market (based on the lower of replacement cost or net realizable value).
PROPERTY AND EQUIPMENT
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.
DEPRECIATION
Property and equipment are depreciated by the straight-line and accelerated
methods of depreciation. Accelerated depreciation did not materially exceed
straight-line depreciation for the years ended December 31, 1996, 1995 and 1994.
Depreciation was calculated over estimated useful lives as follows:
Building and Improvements: 31 Years
Manufacturing Equipment: 5-7 Years
Office and Other Equipment: 5-7 Years
REVENUE RECOGNITION
Sales are recorded by the Company when products are shipped to the
customer.
GOODWILL
Goodwill representing the excess of the purchase price over the fair value
of the net assets of the acquired entities (see Note 2), is being amortized on a
straight-line basis over the period of expected benefit of fifteen years. Total
amortization of goodwill recorded for fiscal years 1996, 1995 and 1994 was
$54,614, $30,724 and $-0-, respectively. The carrying value of goodwill will be
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
The Company acquired other intangible assets including purchased technology
and certification costs in the amount of $42,333 and $82,059 during 1996 and
1995, respectively. These assets are being amortized over a period of 3 to 7
years. The related amortization expense for 1996 and 1995 was $13,152 and
$1,096, respectively.
CASH AND CASH EQUIVALENTS
The Company considers its investments with an original maturity of three
months or less to be cash equivalents. At December 31, 1996 and 1995, the
Company had invested excess funds of $266,000 and $285,000, respectively, in
repurchase agreements collateralized by government-backed securities. Due to the
short-term nature of the agreements, the Company does not take possession of the
securities, which are instead held at the Company's principal bank from which it
purchases the securities.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts for cash, short-terminvestments, receivables, accounts
payable and accrued liabilities approximate fair value because of the short
maturity of these instruments. The fair value of long-term debt approximates its
carrying value and is based
17
<PAGE>
on current rates at which the Company could borrow funds with similar remaining
maturities.
USE OF ESTIMATES
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.
ADVERTISING
Advertising costs are charged to operations as incurred. Total amounts
charged to expense were $65,234, $17,994 and $16,694 for the years ended
December 31, 1996, 1995 and 1994, respectively.
INCOME TAXES
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 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.
Investment credits are accounted for by using the flow-through method
whereby the benefit is reflected as a reduction of income taxes in the year
utilized.
EARNINGS PER SHARE
Primary earnings per share of common stock is computed by dividing net
income by the weighted average number of common shares outstanding during the
period.
The impact of outstanding options was not material and was not included in
the calculation of primary earnings per share.
Preferred stock issued is noncumulative and nonconvertible.
ACCOUNTING FOR STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation, establishes a new fair value based accounting method
for stock-based compensation plans. As permitted by the statement, the Company
continues to apply the accounting provisions of Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees, in determining
net income.
----------------- [LOGO] -----------------
NOTE 2: ACQUISITIONS
In 1996 and 1995 the Company acquired the three businesses described below,
which have been accounted for by the purchase method of accounting. The results
of the operations of the acquired Companies are included in the Company's
consolidated statement of income from the dates of the acquisitions.
ZERCOM CORPORATION
On November 4, 1996, the Company acquired substantially all of the assets
of Zercom Corporation (Zercom). Zercom is a contract manufacturer of electronic
sub-assemblies and components. Zercom also manufactures a line of proprietary
products for sport fishermen.
The purchase price was $6,424,882, consisting of a cash payment of
$1,500,000, issuance of promissory notes totalling $4,865,390, and acquisition
costs of $59,492.
The excess of the purchase price over the estimated fair value of the net
assets acquired is being amortized on a straight line basis over 15 years.
A summary of the purchase price allocation for the 1996 acquisition of
Zercom is as follows:
Net Working Capital Items $2,392,185
Property, Plant and Equipment 3,930,872
Other Assets 42,333
Excess of Cost Over Fair
Value of Net Assets of Net Assets
of Purchased Business 59,492
- ---------------------------------------------------------
Total $6,424,882
- ---------------------------------------------------------
- ---------------------------------------------------------
MONITOR TECHNOLOGY CORPORATION
On March 28, 1995, the Company acquired substantially all of the assets and
assumed certain liabilities of Monitor Technology Corporation (MTC). MTC designs
and builds high and ultra-high resolution CRT monitors for computer applications
throughout the United States. In addition, they provide repair services on
internally and externally produced monitors.
18
<PAGE>
The purchase price of $2,232,667, which includes the assumption of
liabilities of $707,887 and acquisition costs of $24,780, was paid with cash and
by issuing 250,000 shares of the Company's common stock. The common stock was
valued at $6, which is the redeemable price based on a repurchase agreement
issued to the seller at closing. The excess of the purchase price over the
estimated fair value of assets acquired is being amortized on a straight-line
basis over 15 years.
In 1996, 88,600 shares were put back to the Company at $6 per share and the
put option was not exercised on 111,400 shares. The Company remains contingently
liable to repurchase the remaining 50,000 shares, which are in dispute. The
Company's obligation under the repurchase agreement is guaranteed by a director
of the Company.
AEROSPACE
On August 23, 1995, the Company acquired the Aerospace Division of
Communication Cable, Inc. The Aerospace Division manufactures and sells multi-
conductor electrical cable assemblies to customer specifications for the
aerospace industry throughout the United States.
The purchase price was $2,950,517 consisting of a cash payment of
$2,845,506, the assumption of liabilities of $44,601, and acquisition costs of
$60,410.
A summary of the purchase price allocation for the 1995 acquisitions of MTC
and Aerospace is as follows:
Net Working Capital Items $1,984,359
Property, Plant and Equipment 2,250,810
Excess of Cost over Fair Value
of Net Assets of Purchased Businesses 948,015
- ---------------------------------------------------------
Total $5,183,184
- ---------------------------------------------------------
- ---------------------------------------------------------
The following proforma unaudited consolidated statements of income for the
Company are presented as though the acquisition of Zercom Corporation had
occurred on January 1, 1996 and 1995 and the acquisitions of Monitor Technology
Corporation and the Aerospace Division of Communication Cable, Inc. had occurred
on January 1, 1995.
(Unaudited) 1996 1995
- --------------------------------------------------------------
Revenues $39,702,215 $42,283,397
- --------------------------------------------------------------
- --------------------------------------------------------------
Net Income $230,045 $1,887,304
- --------------------------------------------------------------
- --------------------------------------------------------------
Net Income Per Share
of Common Stock $ 0.10 $ 0.78
The proforma financial information is presented for information purposes
only and is not necessarily indicative of the operating results that would have
occurred had the acquisitions been consummated as of the above dates, nor are
they necessarily indicative of future operating results.
----------------- [LOGO] -----------------
NOTE 3: INVENTORIES
Inventories consist of the following:
1996 1995
- --------------------------------------------------------------
Raw Materials $3,626,665 $1,972,384
Work in Process 1,837,247 1,676,949
Finished Goods 1,265,588 205,879
- --------------------------------------------------------------
Total $6,729,500 $3,855,212
- --------------------------------------------------------------
- --------------------------------------------------------------
----------------- [LOGO] -----------------
NOTE 4: SHORT-TERM LINE OF CREDIT
The Company has a revolving line of credit available at December 31, 1996, for
$500,000. The line of credit is with Northern National Bank, accrues interest at
the prime rate, matures February 10, 1997, and is secured by accounts
receivable, equipment, inventory, general intangibles and a personal guarantee
by a shareholder. The interest rate was 8.25% at December 31, 1996. The maximum
and average amounts outstanding on short-term lines of credit during 1996, were
$500,000 and $266,066, respectively. There was no balanceoutstanding as of
December 31, 1995.
19
<PAGE>
----------------- [LOGO] -----------------
NOTE 5: LONG-TERM DEBT
DESCRIPTION 1996 1995
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Note Payable - Northern National
Bank, Revolving Line of Credit,
Borrowing Limit of $3,000,000,
Interest at LIBOR Index Plus 2.5%,
Due June 1998; Secured by
Accounts Receivable, Equipment,
Inventory and General
Intangibles $2,736,179 $2,161,179
- --------------------------------------------------------------------------------
Note Payable - Northern National
Bank, Revolving Line of Credit,
Borrowing Limit of $1,500,000,
Interest at LIBOR Index Plus 2.5%,
Due June 1998; Secured by
Accounts Receivable, Equipment,
Inventory, General Intangibles
and Personal Guarantee and Stock
Pledged by a Shareholder 680,760 0
- --------------------------------------------------------------------------------
Note Payable - Northern National
Bank, Line of Credit, Borrowing
Limit of $400,000, Interest at
Bank's Prime, Monthly Payments
of $7,500 Including Interest, Due
December 1998; Secured by
Accounts Receivable, Equipment,
Inventory and General Intangibles 200,000 0
- --------------------------------------------------------------------------------
Note Payable - Northern National
Bank, Interest at LIBOR Index Plus
2.5%, Interest Only Payments
Beginning February 1997, Due
June 1998; Secured by Accounts
Receivable, Equipment, Inventory,
General Intangibles and Personal
Guarantee and Stock Pledged by
a Shareholder 1,500,000 0
- --------------------------------------------------------------------------------
DESCRIPTION 1996 1995
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Notes Payable - Communications
Systems, Inc., Interest at Prime as
Established by First Bank
Minneapolis, Semi-Annual Principal
Payments of $200,000 Beginning
May 1997, Due November 2001 4,865,390 0
- --------------------------------------------------------------------------------
Note Payable - City of Augusta,
Interest at Prime, Five Annual
Payments Beginning August 1996,
Due August 2000; Secured by
Leasehold Improvements 20,802 40,000
- --------------------------------------------------------------------------------
Note Payable - Northern States
Power Company, Interest at 6%,
Monthly Payments of $483 Including
Interest, Due December 1998;
Secured by Equipment 10,476 15,483
- --------------------------------------------------------------------------------
Note Payable - Northern National
Bank, Interest at Bank's Prime Plus
2%, Monthly Payments of $1,200
Including Interest, Due April 2000;
Secured by Real Estate 116,447 120,754
- --------------------------------------------------------------------------------
Note Payable - Midwest Minnesota
Community, Development Corporation,
Interest at 9%, Monthly Payments
of $2,802 Including Interest, Due
March 2000; Secured by Real Estate
and Equipment 91,288 115,297
- --------------------------------------------------------------------------------
20
<PAGE>
NOTE 5: LONG-TERM DEBT CONTINUED
DESCRIPTION 1996 1995
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Note Payable - Midwest Minnesota
Community, Development Corporation,
Interest at 8%, Monthly Payments of
$1,654 Including Interest, Due March
2009; Secured by Real Estate and
Equipment 133,858 142,185
- --------------------------------------------------------------------------------
Note Payable - Northern National
Bank, Interest at 7.5%, Monthly
Payments of $5,270 Including Interest,
Due May 1999; Secured by Inventory,
Equipment, Accounts Receivable and
General Intangibles 187,577 230,608
- --------------------------------------------------------------------------------
Note Payable - Northern National
Bank, Interest at LIBOR Index Plus
2.5%, Monthly Payments of $13,060
Including Interest, Due January 2001;
Secured by Equipment, Accounts
Receivable and Inventory and General
Intangibles 542,017 640,000
- --------------------------------------------------------------------------------
Note Payable - Northern National
Bank, Interest at LIBOR Index Plus
2.5%, Monthly Payments of $5,000
Including Interest, Due January
2001; Secured by Equipment,
Accounts Receivable, Inventory,
General Intangibles and Real
Estate 493,533 510,000
- --------------------------------------------------------------------------------
Note Payable - Joint Economic
Development Commission, Inc.,
Interest at 8.25%, Monthly Payments
of $1,652 Including Interest, Due
August 2000; Secured by Building
and Land 63,510 76,279
- --------------------------------------------------------------------------------
DESCRIPTION 1996 1995
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Total Long-Term Debt $11,641,837 $4,051,785
Current Maturities 731,080 283,100
Long-Term Debt - Net of
Current Maturities $10,910,757 $3,768,685
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Maturity requirements by year on long-term debt are as follows:
YEARS ENDING DECEMBER 31, AMOUNT
- --------------------------------------------------------------------------------
1997 $731,080
1998 5,714,488
1999 715,625
2000 1,122,880
2001 3,278,477
Later Years 79,287
- --------------------------------------------------------------------------------
Total $11,641,837
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The maximum and average amounts outstanding on the Company's long-term lines of
credit were $3,716,939 and $2,596,711 during 1996, respectively, and $2,161,179
and $400,000 during 1995, respectively.
21
<PAGE>
----------------- [LOGO] -----------------
NOTE 6: LEASE OBLIGATION
The Company has entered into various operating leases for equipment and office
space. Rent expense for the years ended December 31, 1996, 1995 and 1994, was
$451,659, $290,799 and $118,672, respectively. The future minimum lease payments
are as follows:
YEARS ENDING DECEMBER 31, AMOUNT
- --------------------------------------------------------------------------------
1997 $337,214
1998 327,675
1999 327,675
2000 190,650
2001 82,575
- --------------------------------------------------------------------------------
Total $1,265,789
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
----------------- [LOGO] -----------------
NOTE 7: RELATED PARTY TRANSACTIONS
Ceridian Corporation is one of the Company's stockholders at December 31,
1996, 1995 and 1994. Transactions and balances with Ceridian Corporation are as
follows:
CONTRACT FOR DEED - CERIDIAN CORPORATION
During 1991 the Company entered into a contract for deed with Ceridian
Corporation for the purchase of the building and land. The original purchase
price was $840,000. The contract was paid off in 1994.
SALES
In 1996, 1995 and 1994, sales to Ceridian Corporation represented
approximately 1% of total sales in each year.
22
<PAGE>
----------------- [LOGO] -----------------
NOTE 8: INCOME TAXES
The provision for income taxes for each of the three years in the period ended
December 31, 1996, consists of the following:
1996 1995 1993
- --------------------------------------------------------------------------------
Current Taxes
- Federal $10,000 $37,000 $17,183
Current Taxes
- State 72,000 63,000 17,023
Deferred Taxes 110,000 (100,000) (280,000)
- --------------------------------------------------------------------------------
Total Expense
(Benefit) $192,000 $0 $(245,794)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Deferred tax assets at December 31, 1996 and 1995, consist of the following:
1996 1995
- --------------------------------------------------------------------------------
Net Operating Loss (NOL)
Carryforwards $1,415,000 $1,635,000
Tax Credit Carryforwards 235,000 295,000
Other 40,000 30,000
Valuation Allowance (240,000) (400,000)
- --------------------------------------------------------------------------------
Total $1,450,000 $1,560,000
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The statutory rate reconciliation for each of the three years in the period
ended December 31, is as follows:
1996 1995 1994
- --------------------------------------------------------------------------------
Statutory Tax
Provision $217,000 $453,000 $319,000
State Income
Taxes 78,000 80,000 50,000
Additional NOL
Carryforwards 0 (851,000) 0
Increase (Reduction)
in Deferred Tax
Valuation Allowance
(Net of Expired
Tax Credit
Carryforwards) (100,000) 300,000 (600,000)
Other (3,000) 18,000 (14,794)
- --------------------------------------------------------------------------------
Income Tax
Provision(Benefit)
Expense $192,000 $0 $(245,794)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The Company has available for Federal income tax purposes, operating loss
carryforwards, unused investment credits, and unused research and development
credits which may provide future tax benefits, expiring as follows:
Research and
Year Operating Investment Tax Development
of Loss Credit Tax Credit
Expiration Carryforward Carryforward Carryforward
- --------------------------------------------------------------------------------
1997 $0 $4,064 $43,051
1998 0 50,888 97,643
1999 3,035,800 39,965 0
2001 767,300 0 0
2002 253,200 0 0
2003 109,700 0 0
- --------------------------------------------------------------------------------
Totals $4,166,000 $94,917 $140,694
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
During 1995 the Company identified an additional $2,503,778 of net
operating loss carryforwards related to final tax regulations. The regulations
clarified that tax carryforward attributes in a Title 11 bankruptcy prior to
December 31, 1993, where stock was issued for debt, need not be reduced by debt
cancellation income. As a result of the increase in net operating loss
carryforwards, which must be utilized prior to taking the benefit in tax credit
carryovers, the Company has increased its valuation allowance accordingly.
In 1996 the Company utilized operating loss carryforwards of $642,000 to
offset federal taxable income.
In 1995 the Company utilized operating loss carryforwards of $1,450,000 to
offset federal taxable income and $46,000 of research and development credits to
offset state tax.
In 1994 the Company utilized operating loss carryforwards of $932,000 to
offset federal taxable income and $126,100 to offset state taxable income. The
Company also utilized $33,900 of research and development tax credits to offset
state tax.
23
<PAGE>
----------------- [LOGO] -----------------
NOTE 9: PREFERRED STOCK TRANSACTIONS
The holders of the preferred stock are entitled to a noncumulative 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-, $29,934 and $14,946 were paid during the year
ended December 31, 1996, 1995 and 1994, respectively.
----------------- [LOGO] -----------------
NOTE 10: 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 balancesin checking and money market
accounts at three financial institutions. These balances exceed the federally
insured limit by $775,000 and $520,000 at December 31, 1996 and 1995,
respectively. The Company has not experienced any losses in any of the short-
term investment instruments it has used for excess cash balances.
Two customers accounted for approximately 11.3% and 17.5% of sales,
respectively, for the year ended December 31, 1996.
Three customers accounted for approximately 24.1%, 16.6% and 11.8% of
sales, respectively, for the year ended December 31, 1995. One customer
accounted for approximately 10.4% of accounts receivable at December 31, 1995.
Three customers accounted for approximately 26.8%, 24.5% and 20.2% of
sales, respectively, for the year ended December 31, 1994. Three customers
accounted for approximately 29.8%, 20.5% and 11.3% of accounts receivable,
respectively, at December 31, 1994.
24
<PAGE>
----------------- [LOGO] -----------------
NOTE 11: EMPLOYEE STOCK OPTION 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 authorized 200,000
shares for issuance under this Plan.
Stock options may be granted for the purchase of common stock at a price
not less than the fair market value on the date of the grant. Options are
generally exercisable after one or more years and expire no later than 10 years
from the date of grant.
The Company applies APB Opinion No. 25, Accounting for Stock Issued to
Employees, in accounting for its fixed stock based compensation plan.
Accordingly, no compensation cost has been recognized for this Plan in 1996,
1995 or 1994. Had compensation cost been determined on the basis of fair value
pursuant to SFAS No. 123, Accounting for Stock-Based Compensation, net income
and earnings per share would not differ materially from amounts reported under
APB Opinion No. 25.
Since the proforma disclosures of results under SFAS No. 123 are only
required to consider grants awarded in 1995 and 1996, the proforma effects of
applying SFAS No. 123 during this initial phase-in period may not be
representative of the effects on reported results for future years.
Following is a summary of the Plan's transactions:
Option Price
Shares (Per Share)
- ----------------------------------------------------------------------
Balance as of
December 31, 1992 22,500 $1.75
Granted
January 21, 1993 15,000 $1.625
- ----------------------------------------------------------------------
Balance as of
December 31, 1993 37,500 $1.625 - $1.75
Granted
January 24, 1994 10,000 $3.625
- ----------------------------------------------------------------------
Option Price
Shares (Per Share)
- ----------------------------------------------------------------------
Balance as of
December 31, 1994 47,500 $1.625 - $3.625
Granted
December 1, 1995 95,000 $5.25
Exercised (5,000) $1.75
- ----------------------------------------------------------------------
Balance as of
December 31, 1995 137,500 $1.625 - $5.25
Granted
December 1, 1996 0 -
Exercised 0 -
- ----------------------------------------------------------------------
Balance as of
December 31, 1996 137,500 $1.625 - $5.25
- ----------------------------------------------------------------------
- ----------------------------------------------------------------------
A summary of the status of fixed options outstanding at December 31, 1996,
is as follows:
Average
Remaining
Exercise Outstanding Exercisable Contractural
Price Options Options Life
- -------------------------------------------------------------------------
$1.625 15,000 15,000 6 Years
$1.75 17,500 17,500 5 Years
$3.625 10,000 10,000 7 Years
$5.25 95,000 19,000 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. 5,168 shares
have been issued under this Plan through December 31, 1996.
25
<PAGE>
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NOTE 12: SUPPLEMENTARY FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Quarter Ending Quarter Ending Quarter Ending Quarter Ending Total
3/31/96 6/30/96 9/30/96 12/31/96 1996
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET SALES $5,574,986 $6,622,903 $6,143,457 $7,841,475 $26,182,821
GROSS PROFIT $1,006,356 $1,214,275 $1,096,171 $1,310,560 $4,627,362
NET INCOME (LOSS) $189,894 $288,552 $201,958 $(234,375) $446,029
INCOME (LOSS) PER SHARE
OF COMMON STOCK $0.08 $0.12 $0.09 $(0.10) $0.19
Quarter Ending Quarter Ending Quarter Ending Quarter Ending Total
3/31/95 6/30/95 9/30/95 12/31/95 1995
- ---------------------------------------------------------------------------------------------------------------------------------
NET SALES $3,625,264 $4,374,899 $5,449,175 $4,856,590 $18,305,928
GROSS PROFIT $673,905 $964,800 $966,969 $1,159,166 $3,764,840
NET INCOME $244,003 $244,049 $212,588 $631,284 $1,331,924
INCOME PER SHARE
OF COMMON STOCK $0.11 $0.10 $0.10 $0.25 $0.55
</TABLE>
In the 4th quarter of 1995, the Company reduced previous quarter's tax
expense of $206,388, which increased 4th quarter net income by $.08 per share
due to recognition of additional net operating loss carryforwards. In the 4th
quarter of 1996, the Company wrote off $544,000 of inventories due to evolving
customer requirements. This reduced 4th quarter net income by $.15 per share.
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INDEPENDENT AUDITORS' 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 1996, 1995 and 1994 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 below 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.
LARSON, ALLEN, WEISHAIR & CO., LLP
ST. CLOUD, MINNESOTA
FEBRUARY 13, 1997
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SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
<TABLE>
<CAPTION>
Column A Column B Column C Column E Column F
- ---------------------------------------------------------------------------------------------------------------
Additions
Balance at Charged Balance at
Beginning to Costs End of
Classification Of Period And Expenses Add (Deduct) Period
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Year Ended December 31, 1996:
Allowance for Doubtful Accounts $6,053 $16,248 $0 $22,301
Deferred Tax Valuation Allowance $400,000 $0 $(160,000) $240,000
- ---------------------------------------------------------------------------------------------------------------
$406,053 $16,248 $(160,000) $262,301
- ---------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1995:
Allowance for Doubtful Accounts $4,343 $1,710 $0 $6,053
Deferred Tax Valuation Allowance $100,000 $0 $300,000 $400,000
- ---------------------------------------------------------------------------------------------------------------
$104,343 $1,710 $300,000 $406,053
- ---------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1994:
Allowance for Doubtful Accounts $0 $4,343 $0 $4,343
Deferred Tax Valuation Allowance $700,000 $0 $(600,000) $100,000
- ---------------------------------------------------------------------------------------------------------------
$700,000 $4,343 $(600,000) $104,343
- ---------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
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REGISTRAR AND TRANSFER AGENT
American Securities Transfer, 1825 Lawrence Street, #444, Denver, Colorado 80202
LEGAL COUNSEL
Phillips & Gross, P.A., 5420 Norwest Center, 90 South 7th Street, Minneapolis,
Minnesota 55402
AUDITORS
Larson, Allen, Weishair & Co., 500 Zapp Bank Plaza, 1015 St. Germain, St. Cloud,
Minnesota 56301
ANNUAL REPORT ON FORM 10-K
A copy of the Company's Annual Report on Form 10-K for the year ended December
31, 1996 (including financial statements and a list of exhibits thereto) may be
obtained by shareholders without charge upon written request addressed to
Quentin E. Finkelson, Nortech Systems Incorporated, 641 East Lake Street,
Wayzata, Minnesota 55391. The exhibits to the Form 10-K may be obtained in the
same manner, but a reasonable fee will be charged to such shareholders for
copying and related expenses.
DIVIDEND POLICY
The Company has never paid cash dividends on its Common Stock. The Board of
Directors currently intends to retain any and all earnings for use in the
Company's business and does not anticipate paying cash dividends in the
foreseeable future. Any future determination as to payment of dividends will
depend upon the financial condition and results of operations of the Company and
such other factors as are deemed relevant by the Board of Directors.
ANNUAL MEETING
The annual meeting of shareholders will be held June 12, 1997, at 4:00 p.m. at
the Wayzata Country Club, 200 West Wayzata Boulevard, Wayzata, Minnesota. All
shareholders are invited to attend.
MARKET INFORMATION
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol NSYS. It appears in most stock listings under "NorSys." Prior to October
11, 1995, the stock was traded on the Nasdaq Small Cap Market.
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, 1995 $3.000 $4.000
June 30, 1995 $3.000 $4.250
September 30, 1995 $3.250 $6.000
December 31, 1995 $4.750 $8.500
March 31, 1996 $6.000 $9.000
June 30, 1996 $6.000 $8.000
September 30, 1996 $5.000 $7.250
December 31, 1996 $5.250 $6.750
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 1, 1997, there were approximately 1,419 holders of shares of the
Company's Common Stock.
28
<PAGE>
DIRECTORS
Quentin E. Finkelson
Chairman, President & Chief Executive Officer
Nortech Systems Incorporated
Wayzata, Minnesota
Myron Kunin
Chairman
Regis Corporation
Edina, Minnesota
Richard W. Perkins
President & Chief Executive Officer
Perkins Capital Management
Wayzata, Minnesota
OFFICERS
Quentin E. Finkelson
Chairman, President & Chief Executive Officer
Gregory D. Tweed
Executive Vice President & Chief Operating Officer
Garry Anderly
Senior Vice President, Corporate Finance; Treasurer
Peter L. Kucera
Vice President, Corporate Quality
ADDITIONAL INFORMATION
FOR ADDITIONAL COMPANY
INFORMATION, YOU MAY CONTACT:
Quentin E. Finkelson
Chairman, President & Chief Executive Officer
Nortech Systems Incorporated
641 East Lake Street
Wayzata, Minnesota 55391
(612) 473-4102
CORPORATE HEADQUARTERS
Nortech Systems Incorporated
641 East Lake Street
Wayzata, Minnesota 55391
MANUFACTURING FACILITIES
Nortech Systems
350 Industrial Drive
Augusta, Wisconsin 54722
Nortech Systems
4050 Norris Court N.W.
Bemidji, Minnesota 56601
Nortech Systems
P.O. Box 84 Zercom Drive
Merrifield, Minnesota 56465
Nortech Systems
Aerospace Systems Division
1007 East 10th Street
P.O. Box 998
Fairmont, Minnesota 56031
Nortech Systems
Imaging Technologies Division
2500 Niagara Lane North
Plymouth, Minnesota 55447
Nortech Systems
Intercon 1 Division
HC7 Airport Road
Aitkin, Minnesota 56431
<PAGE>
NASDAQ STOCK MARKET: NSYS
STOCK LISTINGS:NORSYS
[LOGO] NORTECH SYSTEMS
641 EAST LAKE STREET, WAYZATA, MINNESOTA 55391 612-473-4102
