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

FORM 10-K

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

For the fiscal year ended December 31, 2003

NORTECH SYSTEMS INCORPORATED

Commission file number    0-13257

State of Incorporation:    Minnesota
IRS Employer Identification No. 41-16810894
Executive Offices:    1120 Wayzata Blvd E., Suite 201, Wayzata, MN 55391
Telephone number:    (952) 345-2277

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

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $.01 Per Share

        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 ý    No o

        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. ý

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes o    No ý

        The aggregate market value of voting stock held by non-affiliates of the registrant, based on the closing price of $8.90 per share, was $11,101,255 on March 12, 2004.

        Shares of common stock outstanding at March 1, 2004: 2,512,687

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

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 10K
TABLE OF CONTENTS

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NORTECH SYSTEMS INCORPORATED
FORM 10-K
For the Year Ended December 31, 2003

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 files annual reports, quarterly reports, proxy statements, and other documents with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 (Exchange Act). The public may read and copy any materials that the Company files with the SEC at the SEC's Public Reference Room at 340 Fifth Street N.W., Washington, D.C. 20549. Also, the SEC maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The pubic can obtain any documents that the Company files with the SEC at http:\\www.sec.gov.

        The corporation makes available free of charge through its Internet website (http:\\nortechsys.com) the Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Press Releases, and Current Reports on Form 8-K.

GENERAL

        The Company's headquarters are in Wayzata, Minnesota, a suburb of Minneapolis, Minnesota. The Company maintains manufacturing facilities in Minnesota including Bemidji, Fairmont, Baxter, and Merrifield as well as Augusta, Wisconsin, and its most recently acquired operation in Monterrey, Mexico. 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.

        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 has been to expand and diversify its customer base. The Company has added several new customers from various industries, some of which produce medical products, computers for business systems, products in the automotive and defense industries and industrial products. The Company's strategy is to develop a customer base spanning several industry segments to avoid the effects 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, Comtech Mobile, Restaurant Technology Inc., Allen-Bradley, Semitool, Silicon Graphics, Graco, Nilfisk, Medical Reseach Labs and United Defense.

        The Company believes that contract manufacturing will continue to grow and expand in the United States and overseas 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

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through the contract manufacturer with significantly lower overhead costs and ability to solve logistical problems with offshore manufacturing.

ACQUISITIONS

        In June 2002, the Company acquired 100 percent of the outstanding common shares of Manufacturing Assembly Solutions of Monterrey, Inc. (MAS), a Mexican corporation, located in Monterrey, Mexico. The results of operations since this acquisition have been included in the consolidated financial statements. The primary reason for the acquisition was to enhance the Company's manufacturing capabilities in a low cost country. See the consolidated financial statements for more detail on this acquisition.

BUSINESS SEGMENTS

        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. During 2002, Display Products and Medical Management segments were sold. Thus, at December 31, 2003, the Company's 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. 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.

        In accordance with the Company's total commitment to quality, a quality system based on the ISO 9000 standards has been adopted and implemented company-wide. Certification to the ISO standard began in 1995 at the Bemidji, MN facility, and has continued to the point at which all five domestic facilities have now been certified to the latest version of the ISO 9001 standard. The newest facility, Manufacturing Assembly Solutions of Monterrey, Inc. in Mexico, passed certification in October 2003. 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 has adopted lean manufacturing supply chain management techniques at its facilities. The Company is committed to continuous improvement in order to provide world-class complete manufacturing services to its customers. The Company will also continue its efforts to diversify its customer base and expand into other segments of the electronic manufacturing subcontract business.

MARKETING

        The Company concentrates 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 increased participation in industry publications and selected trade shows. The

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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. 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 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 manufacturers. The Company does not believe that the small closely held operations pose significant competitive threat, as they generally do not appear to have the manufacturing capabilities required by target customers of the Company. The Company believes that foreign manufacturers do provide a substantial competitive threat as shown by the commoditization of PC/printer cable and "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 foreign 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 manufacturers to "stock" finished product at warehouse locations in the United States is another competitive advantage. To mitigate foreign competition, the Company maintains a contractual agreement that allows its products to be manufactured in China. The Company also acquired a Mexican manufacturing facility in 2002, thereby making itself competitive with other foreign low cost providers.

        The Company will pursue acquisitions, mergers, or joint ventures of manufacturing companies 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. 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 $11.2 million on December 31, 2003 compared to approximately $10.4 million on December 31, 2002. The Company expects a major portion of the backlog will be realized as revenue during first quarter 2004.

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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 23% and 31% of sales for the years ended December 31, 2003 and 2002, respectively. This reflects Nortech Systems, Inc. position as a key supplier to G.E. Medical.

RESEARCH AND DEVELOPMENT

        The Company expended no dollars in 2003, 2002 or 2001 on Company-sponsored research and development. The Company has no proprietary research and development activities on an annual basis other than making improvements to its existing internal processes. However, the Company does perform research and development for customers on an as requested basis for development of conceptual engineering and design activities prior to manufacturing the products. This research and development is not always covered by customer contract. Some is done to improve the manufacturability of the product.

ENVIRONMENTAL LAW COMPLIANCE

        Management believes that its manufacturing facilities are currently operating under compliance with local, state, and federal environmental laws. The Company has made, and plans to continue making, necessary expenditures for compliance with applicable 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 444 full-time, 82 part-time and 91 temporary employees as of December 31, 2003. Manufacturing personnel, including direct, indirect support and sales functions, comprise 469 employees, while general administrative employees total 148.

ITEM 2.    PROPERTIES

ADMINISTRATION

        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 on July 31, 2005.

MANUFACTURING FACILITIES

        The Company owns its Bemidji, Minnesota facility consisting of eight acres of land and 60,000 square feet of office and manufacturing space.

        The Company owns its Augusta, Wisconsin facility consisting of five acres of land and 20,000 square feet of office and manufacturing space, which the Company exercised its option to purchase in December 2003.

        The Company owns three buildings, which together contain approximately 46,900 square feet, located in Fairmont, Minnesota. The buildings contain the manufacturing activities of Aerospace Systems operation, including custom designed, high technology electronic cable assemblies.

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        The Company owns another 45,800 square feet building in Merrifield, Minnesota. This facility is used for the building of surface-mount printed circuit board assemblies and electro-mechanical assemblies.

        The Company leases a building in Aitkin, Minnesota, which provides 10,750 square feet, that was used for video cable assembly and storage. The lease will expire March 31, 2004, and the Company does not intend to renew the lease.

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

        The Company leases a 15,000 square foot building in its Monterrey, Mexico location for office and manufacturing space. The lease expires in June of 2004, and the Company plans on exercising the additional three-year option at that time.

        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. The Company's facilities are highly suitable for the purposes for which they were designed.

ITEM 3.    LEGAL PROCEEDINGS

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

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

        None.

PART II

ITEM 5.    MARKET PRICE OF STOCK AND RELATED STOCKHOLDER MATTERS

        As of March 12, 2004, there were approximately 905 shareholders of record. The Company's stock is listed on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") Small Cap Market under the symbol "NSYS". The Company intends to invest its profits into the growth of the Company and, therefore, does not plan to pay out dividends to shareholders. Stock price comparisons follow.

        Stock price comparisons (NASDAQ):

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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, 2003 and 2002 and for each of the three years ended December 31, 2003, 2002 and 2001. The audited consolidated financial statements of Nortech Systems Incorporated and Subsidiary referred to above is included elsewhere herein. The selected historical financial data set forth below as of December 31, 2003, 2002 and 2001 and for each of the years ended December 31, 2000 and 1999 have been derived from the audited consolidated 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.

Year ended December 31:

        For additional financial data (2003 and 2002 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

FORWARD-LOOKING STATEMENTS

        This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements generally will be accompanied by words such as "anticipate," "believe," "estimate," "expect," "forecast," "intend," "possible," "potential," "predict," "project," or other similar words that convey the uncertainty of future events or outcomes. Although Nortech Systems, Incorporated believes these forward-looking statements are reasonable, they are based upon a number of assumptions concerning future conditions, any or all of which may ultimately prove to be inaccurate. Forward-looking statements involve a number of risks and uncertainties. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation:

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Volatility in the marketplace which may affect market supply and demand of the Company's products;



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Increased competition;



•

Changes in the reliability and efficiency of the Company's operating facilities or those of third parties;



•

Risks related to availability of labor;



•

General economic, financial and business conditions that could affect the Company's financial condition and results of operations.

        The factors identified above are believed to be important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement made by the Company. Unpredictable or unknown factors not discussed herein could also have material adverse effects on forward-looking statements. All forward-looking statements included in this Form 10-K are expressly qualified in their entirety by the forgoing cautionary statements. The Company undertakes no obligations to update publicly any forward-looking statement (or its associated cautionary language) whether as a result of new information or future events.

OVERVIEW

        Nortech Systems, Inc., based in Wayzata, Minn., is a full-service electronics manufacturing services (EMS) provider of wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds for a wide range of industries. Markets served include medical, automotive, defense, computer, peripheral, commercial, telecom, government and consumer. In Minnesota, Nortech Systems has additional facilities in Baxter, Bemidji, Fairmont and Merrifield. The company also has facilities in Augusta, Wis., and Monterrey, Mexico.

        A majority of revenue is derived from products that are built to the customer's design specifications. The Company believes it provides a high degree of manufacturing sophistication. The strategy of the Company has been to expand and diversify its customer base. 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

        During 2003, Nortech Systems began implementing supply chain initiatives designed to reduce costs, improve asset utilization and increase responsiveness to customers. Moving forward, Nortech Systems has begun to expand its sales and marketing approach to target greater value-added opportunities that exploit broader, corporate-wide capabilities. Nortech's market strength is low-volume,

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high-mix production, particularly with complex products. We consider our supply chain and marketing initiatives to be key investments in our future growth and success. In both cases, the payoff will be realized over time, starting this year and continuing into the future. Nortech Systems also expects quarterly performance to show continued sequential revenue growth, with substantial earnings growth in the latter quarters of the year when more benefits are realized from the key initiatives outlined above.

CRITICAL ACCOUNTING ESTIMATES

        As stated in our significant accounting policies in Note 1 to the consolidated financial statements, the preparation of financial statements requires management to make estimates and assumptions. The Company believes its most critical accounting estimates relate to revenue recognition, inventory reserves, long-lived and intangible asset impairment, deferred tax balances, and self-insured health claim reserves.

Revenue Recognition:

        The Company recognizes revenue upon shipment of products to customers, when title has passed, all contractual obligations have been satisfied and collection of the resulting receivable is reasonably assured. In the normal course of business the Company enters into a number of contracts with customers under which we provide engineering services on a per project basis. Revenue for these services is recognized upon completion of the engineering process, usually upon initial shipment of the product. Revenues from repair services are recognized upon shipment of related equipment to customers.

Inventory Reserves:

        Inventory reserves are maintained for the estimated value of the inventory that may have a lower value than stated or in excess of production needs. These values are estimates and may differ from actual results. The Company has an evaluation process that is used to assess the value of the inventory that is slow moving, excess or obsolete. This process is reviewed on a quarterly basis.

Long-Lived and Intangible Asset Impairment:

        The Company evaluates long-lived assets and intangible assets with definite lives for impairment, as well as the related amortization periods, to determine whether adjustments to these amounts or useful lives are required based on current events and circumstances. The evaluation is based on the Company's projection of the undiscounted future operating cash flows of the underlying assets. To the extent such projections indicate that future undiscounted cash flows are not sufficient to recover the carrying amounts of related assets, a charge is recorded to reduce the carrying amount to equal estimated fair value.

        The test for impairment requires the Company to make several estimates about fair value, most of which are based on projected future cash flows. The estimates associated with the asset impairment tests are considered critical due to the judgments required in determining fair value amounts, including projected future cash flows. Changes in these estimates may result in the recognition of an impairment loss.

Income taxes:

        Management's estimate of the tax rates utilized in the calculation of the deferred tax balances is based on historical taxable income and expected future taxable income and corresponding rates. Further, management's consideration of a valuation allowance for deferred tax assets is based upon estimates of taxable income in future periods. These are estimates and may differ from actual results.

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Self-Insured Health Claim Reserves:

        Management estimates its reserve for employee health claims based on health claims incurred, historical lag times and an analysis of claims activity during the period, while taking into consideration insurance limits and coverage.

        Based on a critical assessment of its accounting policies and the underlying judgements and uncertainties affecting the application of those policies, management believes that the Company's consolidated financial statements provide a meaningful and fair perspective of the Company. This is not to suggest that other general risk factors, such as changes in worldwide economic conditions, fluctuations in foreign currency exchange rates, changes in materials costs, performance of acquired businesses and others, could not adversely impact the Company's consolidated financial position, results of operations and cash flows in future periods.

        No matters have come to Management's attention since December 31, 2003 that would cause the estimates included in the consolidated financial statements to be significantly misstated.

OPERATING RESULTS

        The following table presents statement of operations data as percentages of total revenues for the indicated year-end:

Revenues:

        For the years ended December 31, 2003 and 2002, the Company had sales of $58.0 million and $60.7 million, respectively. The decrease of $2.7 million or 4.4% resulted primarily from the general effects of the slow economy, customer base adjusting their inventory levels, the mix of revenue moved more to the lower margin product and customers demanded reduced pricing. Mexico revenue was also off by 60% from expectations, due to customer delays and slower economic conditions. For the year ended December 31, 2001 the Company had sales of $58.5 million. The approximate 3.8% increase in sales in 2002 was attributable primarily to internal growth of our current customer base. The Company expects revenue growth at a moderate rate for the year 2004. The Company's emphasis is to continually seek mature companies that require a contract manufacturer with a high degree of manufacturing and quality sophistication.

Gross Profit:

        For the years ended December 31, 2003, 2002 and 2001, the Company had gross profit of $6.5 million, $10.5 million, and $10.4 million, respectively. Gross profits as a percentage of gross sales were 11.2%, 17.3%, and 17.9% for the years ended December 31, 2003, 2002 and 2001, respectively.

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The reduced gross profit percentage in 2003 compared to 2002 is largely due to the unfavorable profit margins (5%) in our Mexico facility, that resulted from the shortfall in expected manufacturing volume, and higher than planned health care cost (1%) in our self insured plan. 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. . In 2002, margins were reduced from 2001 due to customer pricing pressures.

Selling:

        Selling expenses were $2.4 million, $2.5 million, and $2.8 million for the years ended December 31, 2003, 2002 and 2001, respectively. The majority of the change from 2002 to 2003 reflected the change in the Company's method of selling by utilizing more internal and less outside representatives. The decrease in selling expenses from 2001 to 2002 reflects a larger portion of revenues being derived from non-commissioned sales.

General and Administrative:

        For the years ended December 31, 2003, 2002 and 2001, general and administrative expenses were $3.3 million, $3.8 million and $3.4 million, respectively. The reduction in expenses from 2002 to 2003 reflected the use of cost cutting methods and reduced administrative incentive expenses. The increase in expenses from 2001 to 2002 reflects increased employee benefits and incentives for employees.

Interest Income:

        Interest income for the years ended December 31, 2003, 2002 and 2001 was approximately $25,000, $5,000, and $18,000, respectively. The interest income was realized as a result of various highly liquid interest bearing accounts readily convertible to cash. The 2003 interest income reflects interest received from research and development tax refunds for 3 years.

Miscellaneous Income:

        Miscellaneous income (loss) was $86,000, ($18,000) and $3,000 for the years ended December 31, 2003, 2002 and 2001, respectively. The miscellaneous income resulted primarily from charges for miscellaneous services that vary by year and in 2003 the Company had income from sales commissions for product sold in China by one of our vendors.

Interest Expense:

        Interest expense was approximately $386,000, $432,000, and $776,000 for the years ended December 31, 2003, 2002 and 2001, respectively. The Company has maintained consistent levels of debt by reinvesting the profits in the growth of the Company. However, average annual prime lending rates have continually decreased from 2001 resulting in lower interest expense in 2003 and 2002.

Income Taxes:

        Income tax expense (benefit) amounted to ($123,000), $1.4 million, and $1.4 million for the years ended December 31, 2003, 2002 and 2001, respectively. During 2003, the Company recorded $246,000 of net benefit for a refund claim relating to federal and state research and development tax credits for tax years 1999, 2000 and 2001. A reconciliation of income tax expense (benefit) for 2003 is included in Note 6 to the consolidated financial statements for the year ended December 31, 2003.

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Net Income:

        The Company's net income in 2003 was $.6 million or $0.26 per basic common share, or $0.25 per diluted common share. The Company's net income in 2002 was $2.4 million or $1.00 per basic common share, or $0.95 per diluted common share. The Company's net income in 2001 was $2.1 million or $0.89 per basic common share, or $0.86 per diluted 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. The Company believes it 2003 profits were impacted by several factors, all of which are being addressed. Margins were negatively impacted by increased material cost, higher than planned health care costs and a product mix that skewed toward lower margin products. Also, our Mexico facility continued to experience a shortfall in expected manufacturing volume.

Accounting Pronouncements:

        In 2003, the Company adopted the following new Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards (SFAS) accounting pronouncements:

        In December 2003, the Financial Accounting Standards Board (FASB) published a revision to FASB Interpretation 46 (FIN 46) to clarify some of the provisions of FASB Interpretation No. 46, Consolidation of Variable Interest Entities, and to exempt certain entities from its requirements. The Financial Accounting Standards Board issued, FIN 46, an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to improve financial reporting of special purpose and other entities. In accordance with FIN 46, business enterprises that represent the primary beneficiary of another entity by retaining a controlling financial interest in that entity's assets, liabilities and results of operating activities must consolidate the entity in its financial statements. Prior to the issuance of FIN 46, consolidation generally occurred when an enterprise controlled another entity through voting interests. The effective dates for these consolidation provisions, as revised apply to VIEs created or entered into after December 31, 2003. For VIEs created before December 31, 2003, the effective date of applying the provision of FIN 46 was deferred to annual periods beginning after December 15, 2004.

        In December 2003, the Staff of the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 104 ("SAB 104"), "Revenue Recognition," which supersedes SAB 101, "Revenue Recognition in Financial Statements". SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element arrangements, superseded as a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." Additionally, SAB 104 rescinds the SEC's Revenue Recognition in Financial Statements Frequently Asked Questions and Answers (the "FAQ") issued with SAB 101 that had been codified in SAB Topic 13, "Revenue Recognition." Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 in December 2003 did not have an effect on the consolidated results of operations or financial position of the Company.

        In May 2003, the FASB issued SFAS 150, "Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity" which establishes standards for how an issuer of financial instruments classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominately on a fixed monetary amount known at inception, variations in something other than the fair value of the issuer's equity shares or variations inversely related to changes in the fair value of the issuer's equity shares. SFAS No. 150 is effective for financial instruments entered into

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or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 has not impacted the Company's financial position, results of operations or cash flows.

        During November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on EITF Issue 00-21, Multiple-Deliverable Revenue Arrangements (EITF 00-21), which addresses how to account for arrangements that may involve the delivery or performance of multiple products, services, and/or rights to use assets. The final consensus was applicable to agreements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have an impact on the Company's financial position or results of operations.

FINANCIAL CONDITION AND LIQUIDITY

        The following unaudited ratios are not required under the SEC guidelines or accounting principles generally accepted in the United States of America, however, we believe they are meaningful measures and are useful to our readers.

        Overall, the improvement of the above liquidity ratios relate primarily to the Company's increase in accounts receivable balances due to a change in terms of payment for a major customer and the continued efforts of the Company to reduce inventory levels.

        As of December 31, 2003, the Company's cash and cash equivalent balances totaled $101,179.

        On December 31, 2003, the Company had working capital of approximately $16.7 million. During 2003, the Company used approximately $288,000 of cash flow for operating activities. This use of cash was primarily attributable to a change in accounts receivable terms with a main customer. The Company's net Investing and Financing activities decreased cash by $57,000. The Company continues to reinvest in equipment funded by the available line of credit.

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        The Company currently has a $7.0 million line of credit arrangement in place with Wells Fargo Bank for general working capital needs, of which $5.9 million was outstanding as of December 31, 2003. The Company had no material unused sources of liquidity other than the cash, accounts receivables, inventory and other current assets. The Company was compliant with all financial covenants at year-end, with the exception of the net earnings covenant for the year, for which Wells Fargo Bank has granted a waiver. The company expects to be in compliant with all financial covenants for the year ended December 31, 2004 including the quarterly minimum net earning convent of $100,000 through March 31, 2004, $300,000 though June 30, 2004, $450,000 though September 30, 2004 and $750,000 though December 31, 2004.

        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 its operating line of credit.

        Set forth below is information about the Company's long-term contractual obligations and other commercial commitments outstanding as of December 31, 2003. It brings together data for easy reference from the consolidated balance sheet and from individual notes to the consolidated financial statements. This information is important in understanding the financial position of the Company.

ITEM 7a.    QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

        Market risk is the potential change in an instrument's value caused, for example, by fluctuations in interest and currency exchange rates. The Company's primary market risk exposures are interest rate and unfavorable movements in exchange rates between the U.S. dollar and the Mexican peso. Monitoring and managing these risks is a continual process carried out by senior management. Market risk is managed based on an ongoing assessment of trends in interest rates, foreign exchange rates, and economic developments, giving consideration to possible effects on both total return and reported earnings. The Company's financial advisors, both internal and external, provide ongoing advice regarding trends that affect management's assessment.

Exchange Rate Sensitivity:

        The Company conducts operations in Mexico. Accordingly, exposure exists to potentially adverse movements in foreign currency rates. The Company does not use foreign exchange forward contracts to hedge the risk of change in foreign currency exchange rates. The Company's consolidated financial statements are denominated in U.S. dollars and accordingly, changes in the exchange rates between Company subsidiary's local currency and the U.S. dollar will affect the translation of such subsidiary's financial results into U.S. dollars for the purposes of reporting the consolidated financial results. The Company does not hedge these matters because cash flows from international operations are generally re-invested locally. It is estimated that a 10% change in foreign exchange rates would have an immaterial impact on reported net earnings.

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Interest Rate Sensitivity:

        The effective interest rate on the Company's credit facilities are influenced by the actions of the Federal Reserve in establishing from time to time the Federal Funds Interest Rate which is the rate banks borrow from the Federal Reserve Bank. During 2003, 2002 and 2001, the Federal Reserve implemented a number of reductions in the Federal Funds Interest Rate in an effort to stimulate the U.S. economy. As a result the effective interest rate that the Company paid on its borrowings under the facilities declined, leading to a corresponding reduction in interest expense. To the extent that the Federal Reserve increases the Federal Funds Interest Rate in the future, the effective interest rate on the Company's facilities will increase. The Company's interest expense will increase accordingly if borrowing levels remain constant. Based on the balance outstanding under our interest-bearing Facilities at year-end, a percentage point change in the effective interest rate would have changed interest expense by approximately $100,000.

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
TABLE OF CONTENTS
DECEMBER 31, 2003, 2002, and 2001

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INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders
Nortech Systems Incorporated:

        We have audited the accompanying consolidated balance sheets of Nortech Systems Incorporated and subsidiary (the Company) as of December 31, 2003 and 2002, and the related consolidated statements of income, shareholders' equity and cash flows for each of the years in the two-year period ended December 31, 2003. 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, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

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INDEPENDENT AUDITORS' REPORT

Board of Directors
Nortech Systems Incorporated and Subsidiary
Bemidji, Minnesota

        We have audited the accompanying consolidated statements of income, shareholders' equity and cash flows of Nortech Systems Incorporated and Subsidiary for the year 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 audit 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 audit provides a reasonable basis for our opinion.

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of Nortech Systems Incorporated and Subsidiary's operations and their cash flows for the year ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2003 AND 2002

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, 2003, 2002, AND 2001

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, 2003, 2002, AND 2001

See accompanying Notes to Consolidated Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

DECEMBER 31, 2003, 2002, AND 2001

See accompanying Notes to Consolidated Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2003, 2002, AND 2001

NOTE 1    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

        Nortech Systems Incorporated (together with its wholly owned subsidiary, 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.

        The Company's manufacturing facilities are located in Bemidji, Fairmont, Merrifield and Baxter, Minnesota as well as Augusta, Wisconsin. During 2002 the Company acquired a business and its related manufacturing operations in Monterrey, Mexico, as described in Note 10.

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, Manufacturing Assembly Solutions of Monterrey, Inc. All significant intercompany accounts and transactions have been eliminated.

Cash and Cash Equivalents

        For purposes of reporting cash flows, the Company considers cash equivalents to be short-term, highly liquid interest-bearing accounts readily convertible to cash. The carrying amount approximates fair value.

Accounts Receivable

        The Company grants credit to customers in the normal course of business. Accounts receivable are unsecured and are presented net of an allowance for doubtful accounts. The allowance for uncollectible accounts was $371,690 and $488,451 at December 31, 2003 and 2002, respectively. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company's previous loss history, the customer's current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes-off accounts receivable when they become uncollectible and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. The Company does not accrue interest on past due accounts receivable.

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

Property, Equipment and Depreciation

        Property and equipment are stated at cost less accumulated depreciation. Additions, improvements and major renewals are capitalized, while 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. Leasehold improvements are depreciated over the shorter of the estimated use life or the remaining lease term. All other property and equipment are depreciated by the straight-line method of depreciation over their estimated useful lives.

        Depreciation expense was $1,260,175, $1,182,227 and $1,165,482, for the three years ended December 31, 2003, 2002 and 2001, respectively.

Goodwill and Other Intangible Assets

        The Company accounts for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards Board No. ("SFAS") 142, "Goodwill and Other Intangible Assets," which requires that goodwill and certain indefinite-lived assets not be amortized but evaluated annually for impairment. Other intangible assets are amortized on a straight-line basis over their estimated useful lives, which range from four to seven years. See Note 10 for more detail on the Company's intangible assets.

        The Company evaluates long-lived assets and intangible assets with definite lives for impairment, as well as the related amortization periods, to determine whether adjustments to these amounts or useful lives are required based on current events and circumstances. The evaluation is based on the Company's projection of the undiscounted future operating cash flows of the underlying assets. To the

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extent such projections indicate that future undiscounted cash flows are not sufficient to recover the carrying amounts of related assets, a charge is recorded to reduce the carrying amount to equal estimated fair value.

        Goodwill is tested for impairment annually, or if an event occurs or circumstances change that may reduce the fair value of the reporting unit below its book value. The impairment test is conducted at the reporting unit level by comparing the fair value of the reporting unit with its carrying value. Fair value is primarily determined by computing the future discounted cash flows expected to be generated by the reporting unit. If the carrying value exceeds the fair value, goodwill may be impaired. If this occurs, the fair value of the reporting unit is then allocated to its assets and liabilities in a manner similar to a purchase price allocation in order to determine the implied fair value of the reporting unit goodwill. This implied fair value is then compared with the carrying amount of the reporting unit goodwill, and if it is less, the Company would then recognize an impairment loss.

Preferred Stock

        Preferred stock issued is non-cumulative and nonconvertible. 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, 2003, 2002, and 2001.

Revenue Recognition

        The Company recognizes revenue upon shipment of products to customers, when title has passed, all contractual obligations have been satisfied and collection of the resulting receivable is reasonably assured. In the normal course of business the Company enters into a number of contracts with customers under which we provide engineering services on a per project basis. Revenue for these services is recognized upon completion of the engineering process, usually upon initial shipment of the product. Revenues from repair services are recognized upon shipment of related equipment to customers.

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.

Estimated Warranty Claims

        The sales of the Company's products include warranties that provide for repairs or replacement of defective products. The warranty periods range from one to two years, depending on the product, in the period following the sale. A warranty reserve is estimated by management based on actual historical warranty claims coupled with an analysis of unfulfilled claims at the balance sheet date. Estimated warranty liabilities of approximately $2,900 and $40,000 are included in Other Accrued Liabilities at December 31, 2003 and 2002, respectively.

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        A tabular reconciliation of the changes in the Company's product warranty liability for the years ended December 31, 2003, 2002, and 2001 is as follows:

        The change in estimate for 2003 was the result of certain products no longer being sold.

Product Development Costs

        Engineering costs associated with the development of new products and changes to existing products are charged to operations as incurred.

Advertising

        Advertising costs are charged to operations as incurred. Total amount charged to expense was $106,873, $118,017 and $131,199, for the three years ended December 31, 2003, 2002 and 2001, respectively.

Income Taxes

        The Company accounts for income taxes under the asset and liability method. 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. Based on the borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the carrying value of long-term debt materially approximates fair value.

Stock Based Compensation

        The Company accounts for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees," and complies with the disclosure provisions of SFAS No. 148 and 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.

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        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 ended December 31, 2003, 2002, and 2001. Had compensation cost for the Company's stock option plan been determined pursuant to SFAS No. 123, net earnings and earnings per share would have been as follows:

        The weighted average fair values at grant date of the options granted in fiscal 2003, 2002 and 2001 were estimated as $5.20, $5.49 and $3.40, respectively, using the Black-Scholes option-pricing model with the following weighted average assumptions:

Net Income Per Common Share

        Basic net income per share is computed using the weighted-average number of common shares outstanding. Diluted income per share is computed using the weighted-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.

Cash Flow Information

        The Company paid income taxes of $148,424, $1,998,677 and $994,624 for the years ended December 31, 2003, 2002 and 2001, respectively. The Company paid interest expenses of $389,941, $514,031 and $713,352 for the years ended December 31, 2003, 2002 and 2001, respectively.

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        During 2002, the Company incurred a note payable in the amount of $1,200,000 as part of the purchase price for certain assets of another corporation, as described in Note 10. The Company also received $580,625 of treasury stock in exchange for the exercise of incentive stock options.

        During 2003, the Company exchanged 63,408 shares of its common stock for $600,000 payment of its note payable to SAE Assembly, LLC.

Segment Reporting Information

        The Company's results from operations for the years ended December 31, 2003, 2002 and 2001, represent a single segment referred to as Contract Manufacturing. Foreign revenues represent 2%, 1% and 2% of consolidated revenues for the years ended December 31, 2003, 2002 and 2001, respectively.

        Long-lived assets by country are as follows:

Foreign Currency Translation

        Local currency is considered the functional currency for the operation outside the United States. Assets and liabilities are translated at year-end exchange rates. Income and expense items are translated at average rates of exchange prevailing during the year. Translation adjustments are recorded as a component of accumulated other comprehensive loss in stockholders' equity. Foreign exchange transaction gains and losses attributable to exchange rate movements on intercompany receivables and payables not deemed to be of a long-term investment nature are recorded in Miscellaneous Income (Expense).

Discontinued Operations

        On June 30, 1999, the Company adopted a formal plan to sell one of their operating segments known as Medical Management. During 2002, certain assets of the Medical Management segment were sold for $2,000 to a private party. Through the sale in 2002, the results of operations for Medical Management have been recorded against the reserve established to absorb disposal losses. Reserve levels established for disposal losses were adequate in all material respects. Included in Other Income for the year ended December 31, 2003 is the reversal of a $50,000 reserve for discontinued operations.

New Accounting Standards

        In December 2003, the Financial Accounting Standards Board (FASB) published a revision to FASB Interpretation 46 (FIN 46) to clarify some of the provisions of FASB Interpretation No. 46,

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Consolidation of Variable Interest Entities, and to exempt certain entities from its requirements. The Financial Accounting Standards Board issued, FIN 46, an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to improve financial reporting of special purpose and other entities. In accordance with FIN 46, business enterprises that represent the primary beneficiary of another entity by retaining a controlling financial interest in that entity's assets, liabilities and results of operating activities must consolidate the entity in its financial statements. Prior to the issuance of FIN 46, consolidation generally occurred when an enterprise controlled another entity through voting interests. The effective dates for these consolidation provisions, as revised apply to VIEs created or entered into after December 31, 2003. For VIEs created before December 31, 2003, the effective date of applying the provisions of FIN 46 was deferred to annual periods beginning after December 15, 2004. The adoption of FIN 46 is not expected to impact the consolidated results of operations or financial position of the Company.

        In December 2003, the Staff of the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 104 ("SAB 104"), "Revenue Recognition," which supersedes SAB 101, "Revenue Recognition in Financial Statements". SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element arrangements, superseded as a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." Additionally, SAB 104 rescinds the SEC's Revenue Recognition in Financial Statements Frequently Asked Questions and Answers (the "FAQ") issued with SAB 101 that had been codified in SAB Topic 13, "Revenue Recognition." Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 in December 2003 did not have an effect on the consolidated results of operations or financial position of the Company.

        In May 2003, the FASB issued SFAS 150, "Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity" which establishes standards for how an issuer of financial instruments classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominately on a fixed monetary amount known at inception, variations in something other than the fair value of the issuer's equity shares or variations inversely related to changes in the fair value of the issuer's equity shares. SFAS No. 150 was effective for the Company in 2003 and the adoption of SFAS 150 has not impacted the Company's financial position, results of operations or cash flows.

        During November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on EITF Issue 00-21, Multiple-Deliverable Revenue Arrangements (EITF 00-21), which addresses how to account for arrangements that may involve the delivery or performance of multiple products, services, and/or rights to use assets. The final consensus was applicable to agreements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have an impact on the Company's financial position or results of operations.

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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. 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. Historically, the Company has not suffered significant losses with respect to trade accounts receivable.

        One customer accounted for 24% and 23% of accounts receivable at December 31, 2003 and 2002, respectively, and approximately 23%, 31% and 24% of sales for the years ended December 31, 2003, 2002, and 2001, respectively.

NOTE 3    ACCRUED HEALTH AND DENTAL CLAIMS

        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 $80,000 per individual per plan year and an estimated aggregate amount of $2,393,216 for the plan year ending August 2004. The Company's dental plan pays claims based on actual amounts incurred. Estimated unpaid claims for incurred health and dental services of $217,514 and $277,684 are included in Accrued Health and Dental Claims at December 31, 2003 and 2002, respectively.

NOTE 4    NOTES AND CAPITAL LEASE PAYABLE

        During 2002, the Company refinanced its lines of credit and $5,031,410 of various notes payable with Wells Fargo Bank, N.A. The refinanced debt was structured into a $1,750,000 equipment note, a $2,500,000 real estate note and a $6,000,000 revolving line of credit. The credit agreement includes a provision that commits the Company to pay a minimum of $150,000 of interest annually. During 2003, the Company increased the borrowing limit on its Wells Fargo revolving line of credit to $7,000,000.

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        A summary of all debt balances at December 31, 2003 and 2002 is as follows:

        The weighted-average interest rate on the Company's line of credit was 4.12% and 4.67% for the years ended December 31, 2003 and 2002, respectively.

        Repayment of SAE Assembly, LLC (SAE) debt will be made through semi-annual installments ending June 2004. Each installment on the note will be satisfied with the issue of 31,704 shares of Nortech stock. Should the average market price of the stock fail to reach or exceed $7.00 during a four-week period of time during each semi-annual period, the Company shall at SAE's discretion repurchase such shares within 30 days at a price of $7.00. At December 31, 2003, 63,408 shares comprising the first and second installments are considered issued and outstanding. The 31,704 shares required under the third installment were transferred to SAE on December 27, 2003, but were not considered outstanding at December 31, 2003 for purposes of calculating earnings per share as the four-week period of time had not expired. In January 2004, the market price of the Company's stock met the $7.00 four-week requirement, at which time the shares issued to SAE became outstanding.

        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, abide by annual shareholder dividend limitations, maintain certain financial ratios, and limit the amount of annual capital expenditures. At December 31, 2003, the Company was in violation of one of its covenant requirements. On March 9, 2004, the bank has waived this specific requirement of the loan agreement for the December 31, 2003 measurement date.

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        Maturity requirements are as follows: