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

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2001

For the transition period from                                      to                                     

Commission file number 0-13257

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

Registrant's telephone No., including area code: (952) 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 $10.70 per share average of the closing bid and asked prices, respectively, on March 6, 2002 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 $11,714,456.

        As of March 1, 2002 there were 2,361,192 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:

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NORTECH SYSTEMS INCORPORATED
Annual Report on Form 10-K
for the year ended December 31, 2001

INDEX

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PART I

ITEM 1. BUSINESS

Description of Business

        Nortech Systems Incorporated and Subsidiary (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 maintains various manufacturing facilities in Minnesota locations of Bemidji, Fairmont, Baxter, and Merrifield as well as Augusta, Wisconsin. The Company manufactures wire harnesses, cables, electronic sub-assemblies and components, and printed circuit board assemblies. 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's 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, Kodak, Thermo King, Polaris, Cubic, Icon Systems, Allen-Bradley, Semitool, Silicon Graphics and United Defense.

        The Company believes that contract manufacturing will continue to grow and expand in the United States and offshore because contract manufacturing provides OEMs 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 with significantly lower overhead costs and ability to solve logistical problems with offshore manufacturing.

        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. and known as the Company's Medical Management operating segment), also provides service bureau and office management services to physicians. During 1999 this subsidiary was designated a discontinued operation and continues to be classified as such in the consolidated financial statements.

        In March 1995, the Company acquired all of the assets of Monitor Technology Corporation. The Company had continued the business of Monitor Technology Corporation, (named Imaging Technologies and known as the Company's Display Products operating segment), which was 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. In June 1999, the Company adopted a formal plan to discontinue the Imaging Technologies Division and it was ultimately sold in February of 2000.

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

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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. (CSI). The Company has continued the business formerly conducted by CSI, which involves contract manufacturing of electronic sub-assemblies and components.

        At December 31, 1998, the Company had 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.

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, and printed circuit board assemblies markets, and intends to expand from this market segment into complete electromechanical assemblies using the resources acquired from the 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 location became ISO 9002 Certified in October 1998, the Aerospace operation became ISO 9001 certified and AS 9000 recognized in April 1999, the Intercon I location became ISO 9002 certified in October 1999. All operations continue to actively maintain their certifications. The Company believes these certifications benefit its current customer base as well as attract 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), statistical quality control (SQC), International Standards Organization (ISO) and Aerospace Systems 9100 (AS). The Company has initiated efforts to expand its markets beyond the Upper Midwest area. New market opportunities are being pursued in Mexico, Asia and Europe, as well as industry publications and selected trade shows. The Company markets its products and services through internal sales people and 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 are purchased directly from the component manufacturers or from their distributors. On occasion some

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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 believes that foreign competitors do provide a substantial competitive threat as shown by the commoditization of PC/printer cable and the "bargain basement" prices. Many OEM's have moved their manufacturing to foreign soil, and in doing so have minimized freight costs to ship to their locations. Technical support from foreign competition has improved greatly along with their ability to be more responsive to engineering and schedule changes. The willingness of foreign competitors to "stock" finished product at warehouse locations in the United States is another competitive move.

        The Company has contractual agreements that allow its products to be manufactured in both China and Mexico, thereby making itself competitive with foreign low cost competitors.

        The Company will pursue acquisitions, mergers, or joint ventures of manufacturing companies/facilities in low cost countries to retain and grow its customer/revenue base and support its strategic vision to be a competitive world class Electronic Manufacturing Services provider.

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 $10.6 million on December 31, 2000 and approximately $10.8 million on December 31, 2001. This backlog will be realized as revenue within the first quarter of 2002.

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 on customer receivable collections in any particular industry or geographic area.

        One customer, G.E. Medical, accounted for 24% and 13% of sales for the years ended December 31, 2001 and 2000, respectively. This reflects Nortech Systems, Inc. position as a key supplier to G.E. Medical and the increased growth rate for the medical industry.

Research and Development

        The Company expended no dollars in 2001, 2000 and 1999, on Company-sponsored research and development.

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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 484 full-time, 119 part-time and 112 temporary employees as of December 31, 2001. Manufacturing, manufacturing product support and medical support services comprise 664 employees while general administration comprises 51 employees.

ITEM 2. PROPERTIES

        The Company's Corporate Headquarters consist of approximately 3,648 square feet located in Wayzata, Minnesota, a western suburb of Minneapolis, Minnesota. The Corporate Headquarters has a lease with a five-year term that expires in July 31, 2005. The Company owns its Bemidji, Minnesota facility consisting of eight acres of land and 60,000 square feet of office and manufacturing space and leases another 20,000 square feet of manufacturing and office space in Augusta, Wisconsin.

        The Company's Medical Management operating segment operates from a facility shared with Corporate Headquarters located in Wayzata, Minnesota.

        The Company also owns three buildings, which contain approximately 46,900 square feet, and are located in Fairmont, Minnesota. The buildings contain the manufacturing activities of Aerospace Systems operation, including 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. The Company also assumed the lease of a building in Aitkin, Minnesota, which provides 10,750 square feet, which, was used for video cable assembly and storage. The lease is scheduled to expire December 1, 2005 at which time the Company has an option to purchase.

        The Company also leases a 7,500 square foot building in Baxter, Minnesota for electronic board repair for medical equipment. The lease is scheduled to expire June 30, 2006.

        The Company believes that each of these locations is adequate and that space is available if needed 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.

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PART II

ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

        The Company's Common Stock is traded on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") Small Cap Market under the symbol "NSYS".

        The high and low closing sales prices for the Company's Common Stock, as reported on the NASDAQ, for each quarterly period within the two most recent years were as follows:

        These quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission, and may not necessarily represent actual transactions.

        As of March 9, 2002, there were approximately 1,161 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.

ITEM 6. SELECTED FINANCIAL DATA

        The following selected historical financial data set forth below have been derived from, and are qualified by reference to the audited Consolidated Financial Statements of Nortech Systems Incorporated and Subsidiary as of December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001. The audited financial statements of Nortech Systems Incorporated and Subsidiary referred to above are included elsewhere herein. The selected historical financial data set forth below as of December 31, 1999, 1998 and 1997 and for each of the two years in the period ended December 31, 1998 have been derived from the audited financial statements of Nortech Systems Incorporated and Subsidiary not included herein. The selected financial data set forth below should be read in conjunction with, and are qualified by reference to, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and accompanying notes thereto of Nortech Systems Incorporated and Subsidiary included elsewhere herein.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

        Certain amounts above have been restated to reflect the results of continuing operations.

        For additional selected Financial Data (Past two years by quarter information), see Note 13 of the Consolidated Financial Statements.

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

Results of Continuing Operations For Years Ended December 31, 2001, 2000, and 1999

Revenues

        For the years ended December 31, 2001 and 2000, the Company had sales of $58.5 million and $54.8 million, respectively. The increase of $3.7 million or 6.8%, resulted primarily from internal growth of our current customer base. The major increases were in the medical and defense industries. The Company's emphasis is to continually seek mature companies that require a contract manufacturer with a high degree of manufacturing and quality sophistication. For the year ended December 31, 1999 the Company had sales of $38.5 million. The approximate 42.4% increase in sales in 2000 was attributable primarily to internal growth of our current customer base. The Company expects revenue growth to continue at a moderate rate for the year 2002.

Gross Profit

        For the years ended December 31, 2001, 2000 and 1999, the Company had gross profit of $10.4 million, $10.3 million, and $6.5 million, respectively. Gross profits as a percentage of gross sales were 17.9%, 18.7%, and 16.7% for the years ended December 31, 2001, 2000 and 1999, respectively. As revenues grow, the Company continues to strive to hold down cost levels by improving productivity and reducing material costs in order to help offset the request for price reductions from customers. The price competitive nature of the business requires the use of service, quality and timely delivery to help attract customers.

Selling

        Selling expenses were $2.8 million, $2.2 million, and $1.6 million for the years ended December 31, 2001, 2000 and 1999, respectively. The majority of the increase from 1999 to 2000 and from 2000 to 2001 reflected the costs related to additional internal sales force and commissioned sales on revenue growth.

General and Administrative

        For the years ended December 31, 2001, 2000 and 1999, general and administrative expenses were $3.4 million, $4.0 million and $2.4 million, respectively. The reduction in expenses from 2000 to 2001 reflected the use of cost cutting methods and a reduction in administrative staff. The increase in expenses from 1999 to 2000 reflected the costs related to succession planning and incentive compensation.

Interest Income

        Interest income for the years ended December 31, 2001, 2000 and 1999 were $.018 million, $.028 million and $.027 million, respectively. The interest income was realized as a result of various investments of cash.

Miscellaneous Income

        Miscellaneous income was $.003 million, $.016 million and $.039 million for the years ended December 31, 2001, 2000 and 1999, respectively. The miscellaneous income resulted primarily from charges for miscellaneous services that vary by year.

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Interest Expense

        Interest expense was $.78 million, $1.0 million, and $.82 million for the years ended December 31, 2001, 2000 and 1999, respectively. The Company has maintained level debt by reinvesting the profits in the growth of the Company. However, prime lending rates decreased in 2001 resulting in lower interest expense.

Income Taxes

        Income tax expense was $1.4 million, $1.1 million, and $.6 million for the years ended December 31, 2001, 2000 and 1999, respectively.

        All of the Alternative Minimum and other tax credits available at the end of December 31, 2000 were used to offset federal income taxes due in 2001.

        The Company utilized operating loss carryforwards of $1.5 million and $.9 million for the years ended December 31, 2000, and 1999, respectively, to offset federal taxable income. The Company also utilized $.001million of an expiring investment tax credit to offset federal tax and forfeited an additional $.039 million of credits due to expiration in 2000.

Net Income

        The Company's net income from continuing operations in 2001 was $2.1 million or $.89 per common share. The Company's net income from continuing operations in 2000 was $2.0 million or $.86 per common share. The Company's net income from continuing operations in 1999 was $1.1 million or $.46 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 increased from $9.6 million as of December 31, 2000, to $14.5 million on December 31, 2001. Increase in working capital is due to refinancing majority of its debt with Wells Fargo Bank, N.A on January 31, 2002 (refer to Note 4 in the notes to Consolidated Financial Statements for further disclosures). Stockholders equity increased from $8.5 million on December 31, 2000, to $10.6 million on December 31, 2001 as a result of the Company's 2001 net profit from continuing 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.

Provision for the Private Securities Litigation Reform Act of 1995

        While this release is based on management's best judgment and current expectations, actual results may differ based on many factors, including the Company's competitive performance and changes in market conditions.

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 2001 effective average interest rate on variable earnings should not have a material effect on the Company's earnings for 2002.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

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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, 2001 and 2000, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. 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 auditing standards generally accepted in the United States of America. 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, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.

LARSON, ALLEN, WEISHAIR & CO., LLP

St. Cloud, Minnesota
February 13, 2002

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2001 AND 2000

See accompanying Notes to Consolidated Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

See accompanying Notes to Consolidated Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999

See accompanying Notes to Consolidated Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999

See accompanying Notes to Consolidated Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2001, 2000, AND 1999

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 has manufacturing facilities located in Bemidji, Fairmont, Merrifield and Baxter, Minnesota as well as 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. Products are sold to customers both domestically and internationally. The Company also provides repair service on circuit boards used in machines in the medical industry.

Use of Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.

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.

Cash and Cash Equivalents

        The Company considers its investments with an original maturity of three months or less to be cash equivalents. Cash equivalents consist of short term repurchase agreements.

Receivables

        Accounts receivable are reported net of an allowance for uncollectible accounts. The allowance for losses arising from uncollectible accounts is based on historical bad debt experience and an evaluation of periodic aging of the accounts. The allowance for uncollectible accounts for continuing operations was $318,557 and $187,294 at December 31, 2001 and 2000, respectively.

Inventories

        Inventories are stated at the lower of cost (first-in, first-out method) or market (based on the lower of replacement cost or net realizable value). Costs include material, labor, and overhead required

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in the warehousing and production of the Company's products. Inventory is shown net of reserve for excess and obsolete inventory as follows:

Property and Equipment and Depreciation

        Property and equipment are stated at cost less accumulated depreciation. Additions, improvements and major renewals are capitalized; maintenance, repairs and minor renewals are expensed as incurred. When assets are retired or disposed of, the assets and related accumulated depreciation is removed from the accounts and the resulting gain or loss is reflected in operations. 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, 2001, 2000, and 1999.

Goodwill

        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 each of the three years in the period ended December 31, 2001 was $8,121. 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

        Intangible assets represent certification costs which are being amortized over a period of seven years. The related amortization expense from continuing operations for each of the three years in the period ended December 31, 2001 was $8,151.

Preferred Stock

        Preferred stock issued is noncumulative and nonconvertible.

Revenue Recognition

        Revenue from product sales is recognized upon shipment to customer, title passing and all obligations of the Company have been satisfied. Provisions for discounts and rebates to customers, and returns and other adjustments are provided for in the same period the related sales are recorded.

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Shipping and Handling Costs

        The Company's shipping and handling costs charged to its customers are included in net sales, while the corresponding shipping expenses are included in cost of goods sold for all periods presented.

Advertising

        Advertising costs are charged to operations as incurred. Total amounts charged to expense for continuing operations for each of the three years in the period ended December 31, 2001 were $131,199, $94,860, and $139,594, respectively.

Income Taxes

        The Company accounts for income taxes under FASB Statement No. 109, which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are recognized 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.

Fair Value of Financial Instruments

        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.

Stock Based Compensation

        The Company accounts for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Option ("APB") No. 25, "Accounting for Stock Issued to Employees," and complies with the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". Under APB No. 25, compensation cost is determined based on the difference, if any, on the grant date between the fair value of the Company's stock and the amount an employee must pay to acquire the stock. Compensation expense is recognized over the vesting period.

Net Income (Loss) Per Common Share

        The Company computes earnings per share pursuant to SFAS No. 128, "Earnings per Share". In accordance with SFAS No. 128, basic net income (loss) per share is computed using the weighted-average number of common shares outstanding. Diluted income per share is computed using the weight-average number of common shares outstanding and potential common shares from the assumed exercise of stock options outstanding during the period using the treasury stock method.

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Cash Flow Information

        The Company paid income taxes of $994,624 and $80,880 for the years ended December 31, 2001 and 2000, respectively, and received a net income tax refund of $6,461 for the year ended December 31, 1999. Continuing operations of the Company paid interest expenses of $713,352, $996,663 and $840,746 for the years ended December 31, 2001, 2000 and 1999, respectively.

        During the year ended December 31, 2000, the trade of the prior leased building, forgiveness of debt, and establishment of the capital lease payable resulted in a non-cash transaction of $204,879.

        During the year ended December 31, 1999, the Company had a $2,418,245 non-cash transaction resulting from the reduction of discontinued assets to their net realizable values.

Segment Reporting Information

        During 1999, the Company formally adopted a plan to dispose of two of its operating segments, including Display Products and Medical Management. See additional disclosures regarding these discontinued operations in Note 9. The Company's results from continuing operations for the years ending December 31, 2001, 2000 and 1999, consist entirely of the Contract Manufacturing segment.

        Foreign revenues for the Contract Manufacturing operating segment represent 2% of consolidated revenues for the years ended December 31, 2001, 2000 and 1999. Long-lived assets related to the Contract Manufacturing operating segment are located entirely within the United States.

Recent Pronouncements Not Yet Adopted

        In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141 (SFAS No. 141), Business Combinations and No. 142 (SFAS No. 142), Goodwill and Other Intangible Assets. SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. SFAS No. 142 replaces the requirement to amortize intangible assets with indefinite lives and goodwill with a requirement for an impairment test. SFAS No. 142 also requires an evaluation of intangible assets and their useful lives and a transitional impairment test for goodwill and certain intangible assets upon adoption. After transition, the impairment tests will be performed annually. SFAS No. 142 becomes effective for the first quarter of 2002. Management believes that SFAS No. 141 and SFAS No. 142 will have no significant effect on the balance sheet, results of operations and cash flows of the Company.

        In August 2001, the FASB issued SFAS No. 144 (SFAS No. 144), Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of that Statement. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. As of December 31, 2001, management believes that SFAS No. 144 will have no significant effect on the balance sheet, results of operations, and cash flows of the Company.

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Reclassifications

        Certain reclassifications were made to the 1999 and 2000 financial statements to conform to the 2001 presentation. Such reclassifications had no impact on net income or equity.

NOTE 2    MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

        Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. With regard to cash, the Company maintains its excess cash balances in checking and money market accounts at three high-credit quality financial institutions. These balances exceed the federally insured limit by $132,419 and $288,435 at December 31, 2001 and 2000, respectively. The Company has not experienced any losses in any of the short-term investment instruments it has used for excess cash balances. The Company does not require collateral on its receivables; however, credit risk is limited due to the large number of customers comprising the Company's customer base and their dispersion across different geographic areas and industries. Historically, the Company has not suffered significant losses with respect to trade accounts receivable.

        One customer accounted for 17% of accounts receivable at December 31, 2001 and approximately 24%, 13% and 12% of sales for the years ended December 31, 2001, 2000, and 1999, respectively.

NOTE 3    OTHER 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 $60,000 per individual per plan year and an estimated aggregate amount of $3,483,000 for the current plan year. The Company's dental plan pays claims based on actual amounts incurred. Estimated claims for incurred health and dental services of approximately $391,413 and $485,403 were included in other liabilities at December 31, 2001 and 2000, respectively.

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NOTE 4    LONG-TERM DEBT

        The weighted average interest rate on the Company's two lines of credit was 6.92% and 9.24% for the years ended December 31, 2001 and 2000, respectively.

        The Company refinanced its lines of credit and $5,031,410 of notes payable with Wells Fargo Bank, N.A on January 31, 2002. The refinanced debt was structured using three instruments including a $1,750,000 equipment note, a $2,500,000 real estate note and an $8,000,000 revolving line of credit.

        The $1,750,000 equipment note and the $2,500,000 real estate notes are payable in monthly principal installments of $29,167 and $13,889, respectively, plus accrued interest, and mature February 2007. The $8,000,000 revolving line of credit requires monthly interest payments and is scheduled to mature January 31, 2005. The term notes and revolving line of credit bear interest equal to the prime rate published by Well's Fargo Bank, N.A and are secured by substantially all the Company's assets.

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        The refinanced line of credit agreement includes a provision that commits the Company to pay a minimum of $150,000 of interest annually.

        All Wells Fargo Bank, N.A. debt agreements contain certain covenants, which, among other things, will require the Company to adhere to regular reporting requirements, maintain certain financial ratios, and limit the amount of annual capital expenditures. There were no covenant violations at or for the year ended December 31, 2001.

        Maturity requirements, which reflect the terms of the refinanced debt, are as follows:

NOTE 5    CAPITAL LEASE

        In January 2000, the former manufacturing facility in Augusta, Wisconsin was traded for a new facility with the same lessor. The Company entered into a capital lease for this location and will take ownership upon maturity of lease in 2003. Depreciation on the building under capital lease is included in depreciation expense. The Company's land and building held under the capital lease on the balance sheet consist of the following:

        Minimum future lease obligations on the long-term capital lease in effect at December 31, 2001 are as follows:

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NOTE 6    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. No preferred stock dividends were declared or paid during the years ended December 31, 2001, 2000, and 1999.

NOTE 7    OPERATING LEASES

        The Company has entered into various operating leases for production and office equipment, office space and buildings. The Company has the option to purchase various equipment upon lease expiration at fair market value. The Company also has the option to purchase the Aitkin, MN manufacturing plant, currently under an operating lease, upon expiration of lease. The Company has the option to renew the lease for the Baxter, MN facility for an additional five years upon expiration of the initial lease term.

        Rent expense from continuing operations, which includes amounts for short term leases, for the years ended December 31, 2001, 2000, and 1999, was $661,475, $619,065, and $459,739, respectively.

        The future minimum lease payments are as follows:

NOTE 8    INCOME TAXES

        The provision for income taxes for each of the three years in the period ended December 31, 2001, consists of the following:

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        Net deferred tax assets at December 31, 2001 and 2000, consist of the following:

        The statutory rate reconciliation for each of the three years in the period ended December 31, 2001 is as follows:

        All of the Alternative Minimum and other tax credits available at the end of December 31, 2000 were used to offset federal income taxes due in 2001.

        The Company utilized operating loss carryforwards of $1,468,100 and $902,000 for the years ended December 31, 2000, and 1999, respectively, to offset federal taxable income. The Company also utilized $1,400 of an expiring investment tax credit to offset federal tax and forfeited an additional $38,700 of credits due to expiration in 2000.

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NOTE 9    DISCONTINUED OPERATIONS

        On June 30, 1999, the Company adopted a formal plan to sell two of their operating segments, Display Products and Medical Management. On February 22, 2000, the fixed assets and inventory of the Display Products segment were sold to Computron Display Systems. Under the terms of the purchase agreement, the Company sold these assets for $300,000, of which $50,000 was held in escrow to cover future warranty expenses. The assets of Medical Management to be sold consist primarily of receivables and equipment, with an anticipated disposal date occurring prior to December 31, 2002. Results of operations for these segments for the years ended December 31, 2001 and 2000 have been recorded against the reserve established in 1999 to absorb future losses. Results of these operations for the year ending December 31, 1999 have been classified as discontinued.

        The net current liabilities and net non-current assets of discontinued operations consist of the following:

        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

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

        Net sales of the Display Products and Medical Management segments for the years ending December 31, 2000 and 1999 were $619,472 and $2,413,638, respectively. Net sales Medical Management segment were $430,365 for the year ending December 31, 2001. These amounts are not included in net sales in the accompanying statements of income.

NOTE 10    401(k) RETIREMENT PLAN

        The Company has a 401(k) profit sharing plan for its employees. The Plan is a defined contribution plan covering all employees of the Company except for employees covered by a collective bargaining agreement and non-resident aliens earning non-U.S. source income. Employees are eligible to participate in the Plan after completing six months of service and attaining the age of 21. Employees are allowed to contribute up to 15% of their wages to the Plan. The Company matches 25% of the employees' contribution, however, employer contributions are limited to 4% of covered compensation. This limit was increased to 6% effective January 1, 2001. The Company made contributions of $100,448, $63,105, and $51,171 during the three years ended December 31, 2001, 2000, and 1999, respectively.

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NOTE 11    STOCK OPTIONS AND GAINSHARING INCENTIVE PLANS

Stock Options

        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 total number of shares of common stock that may be granted under the plan is 350,000, of which 45,500 shares remain available at December 31, 2001. The plan provides that shares granted come from the Company's authorized but unissued common stock. The price of the options granted under the plan will not be less than 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.

        The fair value of each option grant issued is estimated on the date of grant using the Black-Scholes option-pricing model. The following assumptions were made in estimating fair value:

        The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation costs were charged to operations for the years ending December 31, 2001, 2000, and 1999. Had compensation cost for the Company's stock option plan been determined pursuant to SFAS No. 123, net earnings (loss) and earnings (loss) per share would have been as follows:

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        Following is a summary of the fixed stock option plan transactions during 2001, 2000 and 1999.

        The following table summarizes information about fixed-price stock options outstanding at December 31, 2001: