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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(Mark One)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
Commission file number 0-13257
-------
NORTECH SYSTEMS INCORPORATED
----------------------------
(Exact name of registrant as specified in its chapter)
Minnesota 41-16810894
- ------------------------------------ -----------
(State or other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification No.)
641 East Lake St., Suite 244 Wayzata, MN 55391
---------------------------------------- -----
(Address of principal executive offices) (Zip code)
Registrant's telephone No., including area code: (612) 473-4102
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
per share par value.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required of file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
---------------- ----------------
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of regulation S-K is not contained herein and will not be contained to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )
Based upon the $3.50 per share average of the closing bid and asked prices,
respectively, on February 26, 1999 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 $4,313,712.
As of February 26, 1999 there were 2,351,377 shares of the Company's $.01 per
share par value common stock outstanding.
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2
DOCUMENTS INCORPORATED BY REFERENCE
The following documents are incorporated by reference to the parts indicated of
the Annual Report on Form 10-K:
Parts of Annual Report Documents Incorporated by
on Form 10-K Reference
Part III
Item 10 Reference is made to the Registrant's
11 proxy statements to be used in
12 connection with the 1998 Annual
Shareholders' meeting and filed with
the Securities and Exchange
Commission no later than
April 30, 1999.
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3
NORTECH SYSTEMS INCORPORATED
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
INDEX
PART I PAGE
Item 1. Business 5- 9
Item 2. Properties 9-10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 10-11
Item 6. Selected Financial Data 12
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-14
Item 7a. Quantitative and Qualitative Disclosure about Market Risk 14
Item 8. Consolidated Financial Statements and Supplemental Data 15-34
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 35
PART III
Item 10. Directors and Executive Officers of the Registrant 35
Item 11. Executive Compensation 35
Item 12. Security Ownership of Certain Beneficial Owners and Management 35
Item 13. Certain Relationships and Related Transactions 35
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K 36-39
Signatures 40
4
PART I
ITEM 1. BUSINESS
DESCRIPTION OF BUSINESS
Nortech Systems Incorporated (the "Company") is a Minnesota corporation
organized in December 1990. Prior to December 1990, the Company operated as DSC
Nortech, Inc., which filed a petition for reorganization under Chapter 11 of the
United States Bankruptcy Code during 1990. The business and assets of DSC
Nortech, Inc., were transferred to Nortech Systems Incorporated during 1990. The
Company's headquarters are in Wayzata, Minnesota, a suburb of Minneapolis,
Minnesota. The Company's maintains various manufacturing facilities in Minnesota
locations of Bemidji, Fairmont, Plymouth, Aitkin, and Merrifield as well as
Augusta, Wisconsin. The Company manufactures wire harnesses, cables, electronic
sub-assemblies and components, printed circuit board assemblies as well as
large-screen high resolution video monitors for radar, document and medical
imaging. The Company provides a full "turnkey" contract manufacturing service to
its customers. A majority of revenue is derived from products which are built to
the customer's design specifications. Nortech Medical Services, Inc., its 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, defense industry product and industrial
products. The Company strategy is to develop a customer base spanning several
industry segments to avoid the affects of fluctuations within a given industry.
Some of the Company's major customers are G.E. Medical Systems, Raytheon, SPX
Corporation, Imation, Thermo King, Polaris, Fisher-Rosemount, 3M, Allen-Bradley
and United Defense.
The Company believes that contract manufacturing will continue to grow and
expand in the United States because contract manufacturing provides OEMs with
the domestic equivalent of off-shore sourcing without the associated logistical
problems. The contract manufacturer can provide an OEM with a quality product at
a price well below that available in the OEM's own facility. This is due
primarily to the specialization available through the contract manufacturer and
the significantly lower overhead costs.
5
In 1991, the Company acquired all of the common stock of SMR Computer Services,
Inc. The Company, through its subsidiary (currently named Nortech Medical
Services, Inc.), also provides service bureau and office management services to
physicians.
In March 1995, the Company acquired all of the assets of Monitor Technology
Corporation. The Company has continued the business of Monitor Technology
Corporation which is the manufacturing of large-screen, high resolution video
monitors for radar, document and medical imaging. In addition, this division
provides repair services on internally and externally produced monitors.
In August 1995, the Company acquired all the assets of the Aerospace Division of
Communication Cable, Inc. The Company has continued the business formally
conducted by Aerospace which involves the manufacturing of custom designed,
high-technology electronic cable assemblies for various applications.
In November 1996, the Company acquired the inventory and fixed assets of Zercom
Corporation, a subsidiary of Communication Systems, Inc. The Company has been,
and continues to be a contract manufacturer of electronic sub-assemblies and
components.
The Company has adopted SFAS No.131, disclosure about segments of an enterprise
and related information, the corresponding segmented financial data is shown in
Note 8 of the financial statements.
MARKETING AND SALES
BUSINESS STRATEGY
The Company believes the electronic manufacturing sub-contracting business is
emerging from a small job shop oriented business into a dynamic, high technology
electronics industry. The Company operates mainly in the wire harness and cable
assemblies market, and intends to expand from this market segment into complete
electromechanical assemblies using the resources acquired from the recent
addition of Zercom Corporation. Many companies no longer perform this type of
work on a captive, in-house basis, as they are finding that independent
subcontractors can more cost effectively perform this specialized work.
As part of the Company's commitment to quality, the Bemidji location became ISO
9002 Certified in July 1995, the Merrifield Division became ISO 9002 Certified
in October, 1998, and continue to actively maintain their certification. The
Company believes this certification benefits its current customer base as well
as attract new business opportunities.
6
The Company will continue it's 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 and military manufacturing industries. The emphasis
continues to be on mature companies which require a contract manufacturer with a
high degree of manufacturing and quality sophistication, including statistical
process control (SPC) and statistical quality control (SQC). The Company has
initiated efforts to expand its markets beyond the Upper Midwest area, which
presently extends east to the Ohio/Michigan area, south to Missouri, and west to
Colorado. New market opportunities are continuously being pursued. The Company
markets its products and services primarily through manufacturers'
representatives. The Company's marketing strategy emphasizes the sophistication
of its manufacturing services. The basic systems, procedures, and disciplines
normally associated with a mature corporate environment are in place. All the
Company's employees are well trained in SPC and SQC.
SOURCES AND AVAILABILITY OF MATERIALS
The Company is not dependent on any one supplier for materials for products sold
to customers. Components utilized in the assembly of wire harnesses, cable
assemblies and printed circuit assemblies 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.
7
COMPETITION
The contract manufacturing industry is characterized by competition among a
variety of sources, including small closely-held companies, larger full-service
manufacturers, company-owned facilities and foreign competitors. The Company
does not believe that the smaller operations are significant competitors as they
do not seem to have the capabilities required by target customers of the
Company. The Company also believes that foreign competitors do not provide a
substantial competitive threat because the cable and wire harness industry
involves a high weight-to-cost ratio. Consequently, shipping and transportation
costs decrease the ability of foreign manufacturers to compete in this market
segment. Further, off-shore production cannot effectively meet the requirements
of engineering change order activities, engineering support, delivery
flexibility and just-in-time inventory management techniques presently being
implemented by many major target customers. Therefore, the Company's principal
competitors are larger full-service manufacturers, many of which have
substantially far greater assets and capital resources than are available to the
Company and are better financed than the Company.
The Company will continue to pursue marketing opportunities in the Upper
Midwest. Although there presently are no dominant contract manufacturers in the
wire harness and cable or higher level build assembly business in the Upper
Midwest, there are several established competitors. The Company expects its
major competition to come from Americable, OEM Worldwide, MSL, Technical
Services, Inc. and Waters Instruments, Inc., all of which are located in
Minnesota. Each of these companies specializes in molded cables or wire
assemblies and has sufficient manufacturing capabilities to offer a significant
competitive challenge to the Company's operations. The principal competitive
factors in the contract manufacturing industry are price, quality and responsive
service. The Company believes that it can compete favorably in the market
segments to which it sells.
BACKLOG
Historically, the Company's backlog has been running 60 to 90 days, depending on
the customer. However, because of the increased emphasis on just-in-time
manufacturing (JIT), many of the Company's major customers are taking advantage
of the Company's ability to service them adequately under the JIT concept.
Additionally, because of the Company's quality history with customers, many
products now go directly from the Company's shipping dock to the customer's
production line.
The Company's 90 day order backlog was approximately $7,687,000 on December 31,
1997 and approximately $9,210,000 on December 31, 1998.
8
MAJOR CUSTOMERS
The Company sells its products to companies in the computer, medical,
governmental and various other industries. Historically, the Company has not
experienced significant losses related to the receivables from customers in any
particular industry or geographic area.
No customer accounted for more than 10% of revenue, for the year ended December
31, 1998.
RESEARCH AND DEVELOPMENT
The Company expended $337,093 in 1998, and $258,712 in 1997 and $273,697 in 1996
on Company-sponsored research and development. This research is related to the
development of large-screen, high resolution video monitors for the Imaging
Division.
COMPLIANCE WITH ENVIRONMENTAL PROVISIONS
Management believes that its manufacturing facilities are currently operating
under compliance with local, state, and federal environmental laws. Any
environmental-oriented equipment is capitalized and depreciated over a
seven-year period. The annualized depreciation expense for this type of
environmental equipment on a Company-wide basis is insignificant.
EMPLOYEES
The Company has 527 full-time and 73 part-time employees as of December 31,
1998, consisting of 555 employees in manufacturing, manufacturing product
support and medical support services and 45 in general administration.
ITEM 2. PROPERTIES
The Company's headquarters consist of approximately 1,500 square feet located in
Wayzata, Minnesota, a western suburb of Minneapolis, Minnesota. The Company has
a lease for a five year term that expires in June 30, 2002. The Company owns its
Bemidji, Minnesota facility consisting of eight acres of land and 60,000 square
feet of office and manufacturing space and owns another 8,000 square feet of
manufacturing and office space in Augusta, Wisconsin.
9
The Company's Imaging and Medical Services division operates from a facility
located in Plymouth, Minnesota. The building contains approximately 22,800
square feet and is leased for a term that terminates on May 31, 2000. The
Company has an option to extend the lease for an additional five-year term.
The Company also owns three buildings which contain approximately 46,900 square
feet and are located in Fairmont, Minnesota, which are used for the
manufacturing of the Company's custom designed, high-technology electronic cable
assemblies.
In connection with the Zercom acquisition, the Company acquired the building
with approximately 45,800 square feet in Merrifield, Minnesota. This facility is
used for the building of surface mount printed circuit board assemblies and
electro-mechanical assemblies. A leased building in Aitkin, Minnesota provides
10,750 square feet for video cable assembly and is leased for a term that
terminates December 1, 2005.
The Company believes that each of these locations is adequate and will be
adequate in the foreseeable future for their manufacturing needs.
ITEM 3. LEGAL PROCEEDINGS
The Company has litigation pending, both offensive and defensive arising from
the conduct of its business, none of which are expected to have any material
effect on the Company's financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters have been submitted to a vote of security holders which are required
to be reported under the instructions to this item.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the NASDAQ National Market under the
symbol NSYS. Prior to October 11, 1995, the stock was traded on the NASDAQ Small
Cap Market.
10
The high and low bid quotations for the Company's Common Stock for each
quarterly period within the two most recent years were as follows:
Quarter Ended Low High
------------- --- ----
March 31, 1997 $4.750 $6.000
June 30, 1997 $4.500 $5.750
September 30, 1997 $4.500 $5.750
December 31, 1997 $4.500 $5.875
March 31, 1998 $4.266 $5.125
June 30, 1998 $4.750 $6.625
September 30, 1998 $3.625 $5.500
December 31, 1998 $3.438 $4.438
The low and high quotations set forth above are as reported by NASDAQ. These
quotations reflect inter-dealer prices, without retail mark-up, mark-down, or
commission, and may not necessarily represent actual transactions.
As of March 1, 1999, there were approximately 1,301 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.
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11
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES
ITEM 6. SELECTED FINANCIAL DATA
FOR THE YEARS ENDED
---------------------------------------------------------------------------
Dec 31, 1998 Dec 31, 1997 Dec 31, 1996 Dec 31, 1995 Dec 31, 1994
------------ ------------ ------------ ------------ ------------
Sales $40,355,867 $36,433,918 $26,182,821 $18,305,928 $12,820,709
Net Income (Loss) 329,867 677,671 446,029 1,331,924 1,183,406
Basic Earnings
Per Share of
Common Stock 0.14 0.28 0.19 0.55 0.54
Total Assets 24,728,562 24,694,930 22,152,629 13,223,064 6,647,897
Total Long-Term
Debt 11,146,537 10,388,620 10,910,757 3,768,685 746,755
- - Company acquired the assets of Zercom Corporation in November, 1996.
- - Company acquired the assets of Monitor Technology in March, 1995, and
Aerospace Systems in August, 1995.
NOTE: For additional selected Financial Data (Past two years by
quarter information), see Note 11 of the Consolidated
Financial Statement.
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS, YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
REVENUES
For the years ended December 31, 1998, and 1997 the Company had sales of
$40,355,867 and $36,433,918 respectively. The increase of $3,921,949 or 10.8%
resulted primarily from internal growth of our current customer base. For the
year ended December 31, 1996 the Company had sales of $26,182,821. The
approximate 39% increase in sales in 1997 was attributable primarily to
increased sales from the newly acquired divisions in 1996.
GROSS PROFIT
The Company had gross profit of $6,597,719 in 1998, $6,795,052 in 1997, and
$4,627,362 in 1996. Gross profits as a percentage of gross sales were 16.3% in
1998, 18.7% in 1997, and 17.7% in 1996. The Company has experienced gross profit
pressure evolving from a change of product mix and material content offset by
some improvement in manufacturing productivity.
SELLING, GENERAL, AND ADMINISTRATIVE
Selling, general, and administrative expenses were $4,842,867 in 1998,
$4,542,498 in 1997, and $3,306,311 in 1996. The increases each year reflect
additional selling, general and administrative expenses associated with the
acquisitions and increased revenues.
MISCELLANEOUS INCOME
Miscellaneous income was $40,885 in 1998, $53,738 in 1997, and $65,732 in 1996.
The miscellaneous income resulted primarily from charges for interest income and
miscellaneous services.
INTEREST EXPENSE
Interest expense was $1,004,777 in 1998, $1,010,909 in 1997, and $475,057 in
1996. The increased expense for 1997 is due to the increased debt from acquired
operations.
13
INCOME TAXES
Income tax expense for 1998 was $124,000, $359,000 in 1997, and $192,000 in
1996.
The Company has recorded deferred tax assets of $1,170,000, the realization of
the deferred tax asset is dependent upon the Company generating sufficient
taxable earnings in future periods. In determining that realization of the
deferred tax asset is more likely than not, the Company gave consideration to
recent earnings history, its expectation for taxable earnings in the future and
the expiration dates associated with tax carryforwards.
NET INCOME
The Company's net income in 1998 was $329,867 or $.14 per common share. The
Company's net income in 1997 was $677,671 or $.28 per common share. The
Company's net income in 1996 was $446,029 or $.19 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 rose from $9,670,225 as of December 31, 1997, to
$10,984,033 on December 31, 1998. Stockholders equity increased from $7,813,823
on December 31, 1997, to $8,364,571 on December 31, 1998 due to the Company's
1998 net income, and conversion of redeemable common stock to stockholders
equity. The Company's liquidity and capital resources have improved
substantially, and the Company believes that its' future financial requirements
can be met with funds generated from the operating activities and from the
Company's operating line of credit.
UPDATE ON YEAR 2000 STATUS
Nortech Systems, Inc recognizes the dangers of the "Year 2000 Problem". To
ensure a minimum negative impact on business operations Nortech has established
a Y2K Initiative. The Y2k Initiative addresses the effects on the company, our
vendors and our customers. We have completed the inventory and evaluation phase,
and are nearing completion of the implementation phase. Testing is nearly
completed on most systems. Monitoring and evaluation will continue throughout
1999 and into 2000 until we are sure all issues have been properly resolved.
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 1998
effective average interest rate on variable earnings should not have a material
effect on the Company's earnings for 1999.
14
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
PAGE
----
Independent Auditors' Report of :
Larson, Allen, Weishair & Co., LLP 16
Consolidated Financial Statements:
Consolidated Balance Sheets at December 31, 1998 and 1997 17
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996 18
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1998, 1997 and 1996 19
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 20-21
Notes to Consolidated Financial Statements 22-34
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15
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, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1998. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Nortech Systems
Incorporated and Subsidiary as of December 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
LARSON, ALLEN, WEISHAIR & CO., LLP
St. Cloud, Minnesota
February 12, 1999
16
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
1998 1997
------------ ------------
ASSETS
CURRENT ASSETS
Cash and Cash Equivalents (Including Interest Bearing Cash of
$203,886 and $463,248 at December 31, 1998 and 1997) $ 415,446 $ 714,169
Accounts Receivable, Less Allowance for Uncollectible
Accounts (1998 - $151,627; 1997 - $84,128) 5,381,344 5,008,689
Inventories 9,383,875 9,242,467
Prepaid Expenses and Other 325,822 226,387
Deferred Tax Asset 695,000 671,000
------------ ------------
Total Current Assets $ 16,201,487 $ 15,862,712
------------ ------------
PROPERTY AND EQUIPMENT (At Cost)
Land 141,300 141,300
Building and Leasehold Improvements 3,778,573 3,765,161
Manufacturing Equipment 4,577,838 4,439,401
Office and Other Equipment 3,052,834 2,805,557
------------ ------------
Total $ 11,550,545 $ 11,151,419
Accumulated Depreciation (4,785,474) (3,851,810)
------------ ------------
Total Property and Equipment (At Depreciated Cost) $ 6,765,071 $ 7,299,609
------------ ------------
OTHER ASSETS
Goodwill and Other Intangible Assets $ 1,229,754 $ 905,359
Deferred Tax Asset 475,000 570,000
Other Assets 57,250 57,250
------------ ------------
Total Other Assets $ 1,762,004 $ 1,532,609
------------ ------------
Total Assets $ 24,728,562 $ 24,694,930
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Line of Credit $ -- $ 500,000
Current Maturities of Long-Term Debt 810,934 1,038,397
Accounts Payable 3,232,593 3,013,131
Accrued Payroll 682,539 1,082,293
Other Liabilities 491,388 558,666
------------ ------------
Total Current Liabilities $ 5,217,454 $ 6,192,487
------------ ------------
LONG-TERM DEBT
Notes Payable (Net of Current Maturities Shown Above) $ 11,146,537 $ 10,388,620
------------ ------------
REDEEMABLE COMMON STOCK
$.01 Par Value; 0 and 50,000 Shares Issued and
Outstanding at December 31, 1998 and 1997
Redeemable at $6 Per Share $ -- $ 300,000
------------ ------------
STOCKHOLDERS' EQUITY
Preferred Stock, $1 Par Value; 1,000,000 Shares
Authorized; 250,000 Shares Issued and Outstanding $ 250,000 $ 250,000
Common Stock $.01 Par Value; 9,000,000 Shares
Authorized; 2,351,377 and 2,312,362 Shares Issued and
Outstanding, Net of Redeemable Shares Reported Above,
at December 31, 1998 and 1997, Respectively 23,514 23,124
Additional Paid-In Capital 12,131,045 11,910,554
Accumulated Deficit (4,039,988) (4,369,855)
------------ ------------
Total Stockholders' Equity $ 8,364,571 $ 7,813,823
------------ ------------
Total Liabilities and Stockholders' Equity $ 24,728,562 $ 24,694,930
------------ ------------
------------ ------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
17
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
------------ ------------ ------------
SALES $ 40,355,867 $ 36,433,918 $ 26,182,821
COST OF SALES (33,758,148) (29,638,866) (21,555,459)
------------ ------------ ------------
GROSS PROFIT $ 6,597,719 $ 6,795,052 $ 4,627,362
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES (4,842,867) (4,542,498) (3,306,311)
RESEARCH AND DEVELOPMENT COSTS (337,093) (258,712) (273,697)
INTEREST INCOME 24,832 37,423 33,668
MISCELLANEOUS INCOME 16,053 16,315 32,064
INTEREST EXPENSE (1,004,777) (1,010,909) (475,057)
------------ ------------ ------------
INCOME BEFORE INCOME TAX PROVISION $ 453,867 $ 1,036,671 $ 638,029
INCOME TAX EXPENSE (124,000) (359,000) (192,000)
------------ ------------ ------------
NET INCOME $ 329,867 $ 677,671 $ 446,029
------------ ------------ ------------
------------ ------------ ------------
BASIC EARNINGS PER SHARE
OF COMMON STOCK $ 0.14 $ 0.28 $ 0.19
------------ ------------ ------------
------------ ------------ ------------
AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING USED FOR BASIC
EARNINGS PER SHARE 2,347,391 2,362,362 2,384,512
------------ ------------ ------------
------------ ------------ ------------
DILUTED EARNINGS PER SHARE
OF COMMON STOCK $ 0.14 $ 0.28 $ 0.18
------------ ------------ ------------
------------ ------------ ------------
AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING PLUS DILUTIVE
COMMON STOCK OPTIONS 2,372,448 2,387,829 2,429,071
------------ ------------ ------------
------------ ------------ ------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
18
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Additional Total
Preferred Common Paid-In Accumulated Stockholders'
Stock Stock Capital Deficit Equity
---------------------------------------------------------------------------------------------
BALANCE
DECEMBER 31, 1995 $ 250,000 $ 22,009 $11,242,672 $(5,478,515) $ 6,036,166
1996 Net Income -- -- -- 446,029 446,029
Issuance of Stock -
Other -- 1,115 667,882 -- 668,997
---------------------------------------------------------------------------------------------
BALANCE
DECEMBER 31, 1996 $ 250,000 $ 23,124 $11,910,554 $(5,032,486) $ 7,151,192
1997 Net Income
-- -- -- 677,671 677,671
Dividends Paid -- -- -- (15,040) (15,040)
---------------------------------------------------------------------------------------------
BALANCE
DECEMBER 31, 1997 $ 250,000 $ 23,124 $11,910,554 $(4,369,855) $ 7,813,823
1998 Net Income -- -- -- 329,867 329,867
Issuance of Stock -
Stock Options and Other -- 60 22,821 -- 22,881
Conversion of
Redeemable Stock -- 330 197,670 -- 198,000
---------------------------------------------------------------------------------------------
BALANCE
DECEMBER 31, 1998 $ 250,000 $ 23,514 $12,131,045 $(4,039,988) $ 8,364,571
---------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
19
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Cash Received from Customers $ 39,999,265 $ 35,137,009 $ 24,375,341
Cash Paid to Suppliers and Employees (38,318,916) (33,970,078) (23,904,901)
Interest Expense Paid (1,031,625) (985,519) (403,003)
Interest Income Received 24,832 37,423 33,668
Income Taxes Paid (189,843) (56,400) (205,900)
------------ ------------ ------------
Net Cash Provided (Used) by
Operating Activities $ 483,713 $ 162,435 $ (104,795)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of Businesses $ (24,839) $ -- $ (1,559,492)
Proceeds from Sale of Assets 2,500 300,000 --
Acquisition of Property and Equipment (458,551) (753,533) (718,835)
Costs to Acquire Product Technology (332,000) -- --
------------ ------------ ------------
Net Cash Used by
Investing Activities $ (812,890) $ (453,533) $ (2,278,327)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net Proceeds Under Line of Credit $ -- $ -- $ 500,000
Payments on Long-Term Debt (1,349,829) (2,720,271) (431,453)
Proceeds from Long-Term Debt 1,380,283 2,505,451 3,156,115
Proceeds from Sale of Stock -- -- 597
Purchase of Redeemable Stock -- -- (531,600)
Payment of Dividends -- (15,040) --
------------ ------------ ------------
Net Cash Provided (Used) by
Financing Activities $ 30,454 $ (229,860) $ 2,693,659
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS $ (298,723) $ (520,958) $ 310,537
Cash and Cash Equivalents - Beginning 714,169 1,235,127 924,590
------------ ------------ ------------
CASH AND CASH EQUIVALENTS - ENDING $ 415,446 $ 714,169 $ 1,235,127
------------ ------------ ------------
------------ ------------ ------------
NON-CASH TRANSACTIONS
During 1996 the Company issued a long-term note payable in the amount of
$4,865,390 as part of the purchase price for certain assets of another
corporation.
During 1998 the Company recorded a reduction of $300,000 in a long-term note
pursuant to a 1996 asset purchase agreement. In addition, accounts payable
includes $150,000 of costs to acquire product technology. Also goodwill was
reduced by $102,000 as a result of an adjustment to the purchase price of an
acquired business.
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
20
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
----------- ----------- -----------
RECONCILIATION OF NET INCOME TO NET
CASH PROVIDED (USED) BY OPERATING ACTIVITIES
Net Income $ 329,867 $ 677,671 $ 446,029
Adjustments to Reconcile Net Income to
Net Cash Provided (Used) by Operating Activities:
Depreciation and Amortization 1,073,534 1,145,032 693,456
Deferred Taxes 71,000 209,000 110,000
Compensation from Stock Grants 22,880 -- --
Gain on Sale of Assets (2,500) (299) --
Changes in Current Operating Items:
Accounts Receivable (372,655) (1,312,926) (1,839,544)
Inventory (141,408) (2,512,967) (482,103)
Prepaid Assets (99,435) (137,566) 42,880
Accounts Payable 69,462 1,416,805 541,446
Accrued Payroll (399,754) 408,990 266,287
Accrued Liabilities (67,278) 268,695 116,754
----------- ----------- -----------
Net Cash Provided (Used) by
Operating Activities $ 483,713 $ 162,435 $ (104,795)
----------- ----------- -----------
----------- ----------- -----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
21
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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
and engineering support located in Bemidji, Fairmont, Plymouth,
Merrifield and Aitkin, Minnesota and Augusta, Wisconsin.
The Company manufactures wire harnesses, cables and electromechanical
assemblies, printed circuit boards and higher-level assemblies for a
wide range of commercial and defense industries. The Company also
manufactures and markets high performance display monitors for
medical imaging, radar document imaging and industrial applications.
The Company provides a full "turn-key" contract manufacturing service
to its customers. All products are built to the customer's design
specifications.
Nortech Medical Services, Inc., its wholly owned subsidiary, provides
service bureau and office management services to physicians and
clinics throughout Minnesota.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements. Estimates also affect the
reported amounts of revenue and expense during the reporting period.
Actual results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiary. All significant intercompany
accounts and transactions have been eliminated.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out
method) or market (based on the lower of replacement cost or net
realizable value).
PROPERTY AND EQUIPMENT
The Company capitalizes the cost of purchased software, equipment,
and leasehold improvements. Expenditures for maintenance and repairs
and minor renewals and betterments which do not improve or extend the
life of the respective assets are expensed. The assets and related
depreciation accounts are adjusted for property retirements and
disposals with the resulting gain or loss included in results of
operations. Fully depreciated assets remain in the accounts until
retired from service.
22
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DEPRECIATION
Property and equipment are depreciated by the straight-line and
accelerated methods of depreciation. Accelerated depreciation did not
materially exceed straight-line depreciation for the years ended
December 31, 1998, 1997, and 1996. Depreciation was calculated over
estimated useful lives as follows:
Leasehold Improvements 7 Years
Buildings and Improvements 31 Years
Manufacturing Equipment 5 - 7 Years
Office Equipment and Purchased Software 5 - 7 Years
REVENUE RECOGNITION
Sales are recorded by the Company when products are shipped to the
customer.
GOODWILL
Goodwill representing the excess of the purchase price over the fair
value of the net assets of the acquired entities (see Note 3), is
being amortized on a straight-line basis over the period of expected
benefit of fifteen years. Total amortization of goodwill recorded for
fiscal years 1998, 1997 and 1996 was $67,293, $67,954, and $54,614,
respectively. The carrying value of goodwill is reviewed periodically
based on the undiscounted cash flows of the entity acquired over the
remaining amortization period. Should this review indicate that
goodwill will not be recoverable, the Company's carrying value of the
goodwill will be reduced by the estimated shortfall of undiscounted
cash flows.
INTANGIBLE ASSETS
Costs related to the conceptual formulation and design of products
and processes are expensed as research and development. Costs
incurred to acquire product and process technology are capitalized.
Capitalized costs are amortized on a straight-line basis over the
estimated useful life.
The Company acquired intangible assets including patent rights,
licenses, design rights and purchased product technology in the
amount of $482,000 during 1998. No related amortization expense was
recognized at December 31, 1998, as the acquired technology was not
yet in production. The remaining intangible assets, including
purchased technology and certification costs, are being amortized
over a period of 3 to 7 years. The related amortization expense for
fiscal years 1998, 1997 and 1996 was $13,152, $52,151, and $13,152
respectively.
CASH AND CASH EQUIVALENTS
The Company considers its investments with an original maturity of
three months or less to be cash equivalents. At December 31, 1998 and
1997, the Company had invested excess funds of $0 and $116,219,
respectively, in repurchase agreements collateralized by government
backed securities. Due to the short-term nature of the agreements,
the Company does not take possession of the securities, which are
instead held at the Company's principal bank from which it purchases
the securities.
ADVERTISING
Advertising costs are charged to operations as incurred. Total
amounts charged to expense were $119,889, $124,997, and $65,234 for
the years ended December 31, 1998, 1997, and 1996, respectively.
23
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company has adopted FASB Statement No. 109, Accounting for Income
Taxes, which requires an asset and liability approach to financial
accounting and reporting for income taxes. Deferred income tax assets
and liabilities are computed annually for differences between the
financial statement and tax bases of assets and liabilities that will
result in taxable or deductible amounts in the future based on
enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation
allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized. The provision for
income taxes is the tax payable or refundable for the period plus or
minus the change during the period in deferred tax assets and
liabilities.
PREFERRED STOCK
Preferred stock issued is noncumulative and nonconvertible.
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.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1997 financial
statements to conform with the 1998 presentation. Such
reclassifications had no impact on net income or equity.
DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
The Company has adopted SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information, effective January 1, 1998.
SFAS No. 131 establishes disclosure requirements for reportable
segments based on how a company is managed rather than on the
industry, geographic and major customer approach of SFAS No. 14.
NOTE 2 INVENTORIES
Inventories consist of the following:
1998 1997
---------- ----------
Raw Materials $6,259,890 $5,961,221
Work in Process 1,386,502 1,659,244
Finished Goods 1,737,483 1,622,002
---------- ----------
Total $9,383,875 $9,242,467
---------- ----------
---------- ----------
24
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 1 ACQUISITIONS
In 1996 the Company acquired the business described below, which has
been accounted for by the purchase method of accounting. The results
of the operations of the acquired Company is included in the
Company's consolidated statement of income from the dates of the
acquisition.
ZERCOM CORPORATION
On November 4, 1996, the Company acquired substantially all of the
assets of Zercom Corporation (Zercom). Zercom is a contract
manufacturer of electronic sub-assemblies and components. Zercom also
manufactures a line of proprietary products for sport fishermen.
The purchase price was $6,424,882, consisting of a cash payment of
$1,500,000, issuance of promissory notes totaling $4,865,390, and
acquisition costs of $59,492.
The excess of the purchase price over the estimated fair value of the
net assets acquired is being amortized on a straight-line basis over
15 years.
A summary of the purchase price allocation for the 1996 acquisition
of Zercom is as follows:
Net Working Capital Items $2,392,185
Property, Plant and Equipment 3,930,872
Other Assets 42,333
Excess of Cost Over Fair Value of Net
Assets of Purchased Business 59,492
----------
Total $6,424,882
----------
----------
The following proforma unaudited consolidated statements of income
for the Company is presented as though the acquisition of Zercom
Corporation had occurred on January 1, 1996.
(Unaudited) 1996
------------ ----
Revenues $39,702,215
Net Income $ 230,045
Net Income Per Share of Common Stock $ 0.10
The proforma financial information is presented for information
purposes only and is not necessarily indicative of the operating
results that would have occurred had the acquisitions been
consummated as of the above dates, nor are they necessarily
indicative of future operating results.
25
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 2 LONG-TERM DEBT
Description 1998 1997
-------------------------------------------------------- ------------ ------------
Notes Payable - Norwest Bank North Country, N.A.,
Revolving Lines of Credit, Borrowing Limit of
$5,500,000; Promissory Note of $1,500,000;
Interest at LIBOR Index Plus 2% and Highest
Prime Rate in "Money Rate" Table in Wall Street
Journal; Due January 2000; Secured by Accounts
Receivable, Equipment, Inventory, General
Intangibles and Personal Guarantee and Stock
Pledged By a Shareholder $ 6,675,000 $ 5,069,717
Notes Payable - Norwest Bank North Country, N.A.,
Interest Ranging From 7.5% to 8.2%, Monthly
Installment Payments Through January 2001;
Secured by Accounts Receivable, Equipment,
Inventory, General Intangibles and Real Estate 1,202,266 1,480,579
Note Payable - Communications Systems, Inc,
Interest at Prime as Established by First Bank
Minneapolis, Semi-Annual Principal Payments
of $200,000; Due November 2001; Secured by
Underlying Assets Purchased 3,765,390 4,465,390
Notes Payable - Other, Interest Ranging From
4.9% to 9%; Monthly Installment Payments
Through March 2009; Secured by Land, Building,
Leasehold Improvements, Equipment and Vehicle
314,815 411,331
------------ ------------
Total Long-Term Debt $ 11,957,471 $ 11,427,017
Current Maturities 810,934 1,038,397
------------ ------------
Long-Term Debt - Net of
Current Maturities $ 11,146,537 $ 10,388,620
------------ ------------
------------ ------------
26
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 4 LONG-TERM DEBT (CONTINUED)
Maturity requirements by year on long-term debt are as follows:
Years Ending December 31, Amounts
------------------------ ----------
1999 $ 810,934
2000 7,700,705
2001 3,407,399
2002 23,175
2003 15,258
The maximum and average amounts outstanding on the Company's
long-term lines of credit were $6,675,000 and $6,317,527 during 1998,
and $4,389,281 and $3,804,534 during 1997, respectively.
NOTE 5 LEASE OBLIGATION
The Company has entered into various operating leases for production
and office equipment, office space and buildings. The Company has the
option to purchase equipment upon lease expiration at fair market
value. The Company also has the option to purchase a building under
an operating lease which, however, is subject to cancellation fees
until December 1999. The monthly rent expense on another building
under operating lease is subject to an annual adjustment for the
increase in the Consumer Price Index.
Rent expense for the years ended December 31, 1998, 1997, and 1996,
was $675,200, $548,943, and $451,659, respectively. The future
minimum lease payments are as follows:
Years Ending December 31, Amounts
------------------------ ----------
1999 $ 467,905
2000 325,283
2001 201,483
2002 134,317
2003 51,975
----------
Total $1,180,963
----------
----------
27
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 6 INCOME TAXES
The provision for income taxes for each of the three years in the
period ended December 31, 1998, consists of the following:
1998 1997 1996
-------- -------- --------
Current Taxes - Federal $ 8,000 $ 31,000 $ 10,000
Current Taxes - State 45,000 119,000 72,000
Deferred Taxes 71,000 209,000 110,000
-------- -------- --------
Total Expense $124,000 $359,000 $192,000
-------- -------- --------
-------- -------- --------
Net deferred tax assets at December 31, 1998 and 1997, consist of the
following:
1998 1997
---------- ----------
Net Operating Loss (NOL) Carryforwards $ 883,000 $1,100,000
Tax Credit Carryforwards 305,000 240,000
Allowance for Doubtful Accounts 60,000 35,000
Inventory Obsolescence Reserve 210,000 125,000
Accrued Vacation 140,000 135,000
Health Insurance Reserve 65,000 55,000
Property and Equipment (328,000) 259,000
Valuation Allowance (165,000) (190,000)
---------- ----------
Total $1,170,000 $1,241,000
---------- ----------
---------- ----------
The statutory rate reconciliation for each of the three years in the
period ended December 31, 1998 is as follows:
1998 1997 1996
--------- --------- ---------
Statutory Tax Provision $ 154,000 $ 353,000 $ 217,000
State Income Taxes 36,000 72,000 78,000
Additional Credit Carryforwards (55,000) -- --
Reduction in Deferred Tax Valuation
Allowance (Net of Expired Tax
Credit Carryforwards) (25,000) (50,000) (100,000)
Other 14,000 (16,000) (3,000)
---------- --------- ---------
Income Tax Expense $ 124,000 $ 359,000 $ 192,000
---------- --------- ---------
---------- --------- ---------
28
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 6 INCOME TAXES (CONTINUED)
The Company has available for Federal income tax purposes, operating
loss carryforwards, unused investment and other tax credits, and
unused research and development credits which may provide future tax
benefits, expiring as follows:
Investment and Research and
Operating Loss Other Tax Credit Development Tax
Year of Expiration Carryforward Carryforwards Credit Carryforward
------------------ -------------- ---------------- -------------------
1999 $ -- $ 4,000 $ --
2000 1,221,800 50,900 97,600
2001 767,300 40,000 --
2002 253,200 -- --
2003 109,700 -- --
Later Years -- 18,500 --
---------- ---------- ----------
Totals $2,352,000 $ 113,400 $ 97,600
---------- ---------- ----------
---------- ---------- ----------
The Company utilized operating loss carryforwards of $506,000
$1,341,000 and $642,000 for the years ended December 31, 1998, 1997,
and 1996, respectively, to offset federal taxable income.
At December 31, 1998, the Company has Alternative Minimum Tax credit
carryforwards of approximately $94,000. These credits do not expire.
NOTE 7 EMPLOYEE STOCK OPTIONS AND AWARD PLANS
In 1992, the Company approved the adoption of a fixed stock based
compensation plan. The purpose of the Plan is to promote the
interests of the Company and its shareholders by providing officers,
directors and other key employees with additional incentive and the
opportunity, through stock ownership, to increase their proprietary
interest in the Company and their personal interest in its continued
success.
29
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 7 EMPLOYEE STOCK OPTION AND AWARD PLANS (CONTINUED)
The Company has adopted the disclosure-only provisions of Statement
of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation." Accordingly, no compensation cost has been
recognized for the stock option plans. Had compensation cost for the
Company's stock option plan been determined based on the fair market
value at the grant date consistent with the provisions of SFAS No.
123, the Company's net earnings and earnings per share would have
been reduced to the pro forma amounts indicated below:
1998 1997 1996
-------- -------- --------
Net Earnings - as Reported $329,867 $677,671 $446,029
Net Earnings - Pro Forma $259,366 $612,402 $413,236
Basic Earnings Per Share - as Reported $ 0.14 $ 0.28 $ 0.19
Basic Earnings Per Share - Pro Forma $ 0.11 $ 0.25 $ 0.17
Diluted Earnings Per Share - as Reported $0.14 $0.28 $0.18
Diluted Earnings Per Share - Pro Forma $0.11 $0.25 $0.17
The assumption regarding stock options issued is that compensation
cost is recognized over the graded vesting period of the options,
which ranges from zero to five years. Options granted before 1995
were not considered in the calculation. No options were granted
during the year ended December 31, 1998 or 1996.
The fair value of each option grant issued is estimated on the date
of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions:
1997
----
Expected Lives (Years) 10
Dividend Yield 0.0%
Expected Volatility 45%
Risk-Free Interest Rate 6.25%
The total number of shares of common stock that may be granted under
the plan is 200,000. The plan provides that shares granted come from
the Company's authorized but unissued common stock. The price of the
options granted to the plan will not be less that 100% of the fair
market value of the shares on the date of grant. Options are
generally exercisable after one or more years and expire no later
than 10 years from the date of grant.
30
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 7 EMPLOYEE STOCK OPTION AND AWARD PLANS (CONTINUED)
Information regarding the Company's common stock options is as
follows:
1998 1997 1996
---------------------- ------------------------- -----------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- ------- ------- ----------- ------- ---------
Options Outstanding,
Beginning of Year 252,500 $ 4.61 137,500 $ 4.29 137,500 $ 4.29
Options Exercised 1,000 5.25 -- -- -- --
Options Forfeited 4,000 5.25 -- -- -- --
Options Granted -- -- 115,000 5.00 -- --
Options Outstanding,
End of Year 247,500 $ 4.60 252,500 $ 4.61 137,500 $ 4.29
------- -------- ------- --------- ------- -------
------- -------- ------- --------- ------- -------
Option Price Range
of Exercised Shares $ 5.25 $ -- $ --
Weighted Average
Fair Value of Options
Granted During the
Year $ -- $ 3.31 $ --
The following table summarizes information about fixed-price stock
options outstanding at December 31, 1998:
Outstanding Exercisable Remaining
Exercise Prices 12/31/98 12/31/98 Contractual Life
--------------- ----------- ----------- ----------------
1.625 15,000 15,000 4 Years
1.75 17,500 17,500 3 Years
3.625 10,000 10,000 5 Years
5.00 115,000 46,000 8 Years
5.25 95,000 57,000 7 Years
During 1993, the Company adopted a gain-sharing plan. The purpose of
the Plan is to provide a bonus for increased output, improved quality
and productivity and reduced costs. The Company has authorized 50,000
shares to be available under this Plan.
In accordance with the terms of the Plan, employees can acquire newly
issued shares of common stock for 90% of the current market value.
5,218 shares have been issued under this Plan through December 31,
1998.
31
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 8 SEGMENT REPORTING INFORMATION
Nortech Systems, Inc. manufactures and sells a variety of products
used in the computer, medical, government and defense industries,
primarily for the commercial industrial market. The Company's
principal businesses are based upon the nature of the manufacturing
operations of the respective location.
The Company has three principal businesses:
1. CONTRACT MANUFACTURING - Includes the manufacture
of wire harnesses, cable and electromechanical assemblies,
printed circuit board assemblies, and higher-level assemblies,
all of which are manufactured under contract specifications.
These products are sold primarily to the commercial and
defense industries.
2. DISPLAY PRODUCTS - Includes the design,
manufacture, and marketing of high-performance display
monitors. The products are sold primarily to the medical,
industrial, and service industries.
3. MEDICAL MANAGEMENT - Provides service bureau and
office management services to physicians and clinics.
Each of these is a business segment, with its respective financial
performance detailed in this report.
BUSINESS SEGMENT NET REVENUES 1998 1997 1996
----------------------------- ----------- ----------- ------------
Contract Manufacturing $35,356,813 $32,907,137 $ 23,600,741
Display Products 4,577,625 3,085,129 2,094,395
Medical Management 421,429 441,652 487,685
Total $40,355,867 $36,433,918 $26,182,821
----------- ----------- ------------
----------- ----------- ------------
BUSINESS SEGMENT PROFIT (LOSS) 1998 1997 1996
----------- ----------- ------------
Contract Manufacturing $1,009,898 $ 1,221,901 $ 964,346
Display Products (540,339) (433,380) (441,962)
Medical Management (139,692) (110,850) (76,355)
Total $329,867 $ 677,671 446,029
----------- ----------- ------------
----------- ----------- ------------
BUSINESS SEGMENT ASSETS 1998 1997 1996
----------- ----------- ------------
Contract Manufacturing $20,737,352 $21,016,701 $ 19,238,772
Display Products 3,846,402 3,408,630 2,680,254
Medical Management 144,808 269,599 233,603
Total $24,728,562 $24,694,930 $ 22,152,629
----------- ----------- ------------
----------- ----------- ------------
32
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 8 BUSINESS SEGMENT INFORMATION (CONTINUED)
BUSINESS SEGMENT PROPERTY, PLANT AND
EQUIPMENT AND INTANGIBLE ASSETS 1998 1997 1996
----------- ----------- ------------
Depreciation and Amortization:
Contract Manufacturing $ 874,360 $ 914,264 $ 466,668
Display Products 186,613 182,929 150,454
Medical Management 12,561 47,839 76,334
Total $ 1,073,534 $1,145,032 $ 693,456
----------- ----------- ------------
----------- ----------- ------------
Additions:
Contract Manufacturing $ 428,396 $ 725,777 $ 670,383
Display Products 512,155 13,707 87,472
Medical Management -- 14,049 20,472
Total $ 940,551 $ 753,533 $ 778,327
----------- ----------- ------------
----------- ----------- ------------
GEOGRAPHIC AREA NET TRADE REVENUES 1998
-----------
United States $38,403,780
Foreign 1,952,087
Total $40,355,867
----------- ----------- ------------
----------- ----------- ------------
NOTE 9 MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK
The Company sells its products to companies in the computer, medical,
governmental and various other industries. Historically, the Company
has not experienced significant losses related to receivables from
customers in any particular industry or geographic area.
The Company maintains its excess cash balances in checking and money
market accounts at three financial institutions. These balances
exceed the federally insured limit by $166,225 and $540,000 at
December 31, 1998 and 1997, respectively. The Company has not
experienced any losses in any of the short-term investment
instruments it has used for excess cash balances.
One customer accounted for approximately 12.7% of sales for the year
ended December 31, 1997.
Two customers accounted for approximately 11.3% and 17.5% of sales,
respectively, for the year ended December 31, 1996.
NOTE 10 PREFERRED STOCK TRANSACTIONS
The holders of the preferred stock are entitled to a non-cumulative
dividend of 12% when and as declared. In liquidation, holders of
preferred stock have preference to the extent of $1.00 per share plus
dividends accrued but unpaid. Preferred stock dividends of $0,
$15,040, and $0 were paid during the years ended December 31, 1998,
1997, and 1996, respectively.
33
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
NOTE 12 SUPPLEMENTARY FINANCIAL INFORMATION
Quarter Ending Quarter Ending Quarter Ending Quarter Ending Total
3/31/98 6/30/98 9/30/98 12/31/98 1998
-------------- -------------- -------------- -------------- -------------
NET SALES $ 10,491,792 $ 9,582,777 $ 9,625,049 $ 10,656,249 $ 40,355,867
GROSS PROFIT 1,750,416 1,778,825 1,735,116 1,333,362 6,597,719
NET INCOME 246,430 187,840 126,719 (231,122) 329,867
BASIC EARNINGS PER SHARE
OF COMMON STOCK 0.11 0.08 0.05 (0.10) 0.14
Quarter Ending Quarter Ending Quarter Ending Quarter Ending Total
3/31/97 6/30/97 9/30/97 12/31/97 1997
-------------- -------------- -------------- -------------- -------------
NET SALES $ 8,564,846 $ 9,039,176 $ 8,693,449 $10,136,447 $36,433,918
GROSS PROFIT 1,520,489 1,655,316 1,564,735 2,054,512 6,795,052
NET INCOME 132,755 167,255 140,555 237,106 677,671
BASIC EARNINGS PER SHARE
OF COMMON STOCK 0.06 0.07 0.06 0.09 0.28
In the 4th quarter of 1998, the Company had an inventory write down
of approximately $240,000 of pretax income. This reduced basic and
diluted earnings per share by .07.
34
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the directors and executive officers of the Registrant
will be included in the Registrant's 1998 proxy statement to be filed with the
Securities and Exchange Commission not later than April 30, 1999 and said
portions of the proxy statement are incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation of the Registrant will be included
in the Registrant's 1998 proxy statements to be filed with the Securities and
Exchange Commission not later than April 30, 1999 and said portions of the proxy
statement are incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and
management of the Registrant will be included in the Registrant's 1998 proxy
statements to be filed with the Securities and Exchange Commission not later
than April 30, 1999 and said portions of the proxy statements are incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
(The remainder of this page was intentionally left blank.)
35
PART IV
ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
(a) 1. Consolidated Financial Statements - Consolidated Financial Statements and
related Notes are included in Part II, Item 8, and are identified in the
Index on Page 15.
(a) 2. Consolidated Financial Schedule - The following Consolidated Financial
Statement Schedule supporting the Consolidated Financial Statements and
the accountant's report thereon are included in this Annual Report on
Form 10-K:
PAGE
Independent Auditors' Report on Supplementary Information
Larson, Allen, Weishair & Co. , LLP 41
Consolidated Financial Statement Schedule for the years ended
December 31, 1998, 1997 and 1996
II Valuation and Qualifying Accounts 42
All other schedules are omitted since they are not applicable, not required,
or the required information is included in the financial statements or notes
thereto.
(a) 3. THE FOLLOWING EXHIBITS ARE FILED AS A PART OF THIS REPORT:
The following exhibits are incorporated by reference to exhibits 10.1, 10.2 and
23.1 respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998.
10.1 Master lease agreement for equipment Amplicon Financial and the
Company.
10.2 Amendments to Promissory Notes, Loan Agreement Mortgage and
Guaranty between Norwest Bank Minnesota South, N.A. (formerly
Northern National Bank), and the Company.
23.1 Letter of Consent from Larson, Allen, Weishair & Company in
reference to the S-8 Forms filed June 21, 1994 and June 30, 1993.
The following exhibits are incorporated by reference to exhibits 10.1, 10.2 and
23.1 respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997.
36
10.1 Master lease agreement for equipment between Norwest Leasing
Company and the Company.
10.2 Land contract between the city of Augusta and the Company for the
purchase of building and land in Augusta, Wisconsin.
The following exhibits are incorporated by reference to exhibits 10.1, 10.2,
10.3, 10.4, 10.5, 10.6, 10.7 and 10.8 respectively, to the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.
10.1 Promissory Note for acquisition of division between Company and
Northern National Bank dated December 31, 1996.
10.2 Revolving Note for working capital line of credit between
Company and Northern National Bank dated December 31, 1996.
10.3 Promissory Note for equipment purchases between Company and
Northern National Bank dated December 31, 1996.
10.4 Revolving Note for the working capital line of credit between
Company and Northern National Bank dated December 31, 1996.
10.5 Revolving Note for repurchase of stock between Company and
Northern National Bank dated May 10, 1996.
10.6 Security Agreement covering Notes in Exhibits 10.1, 10.2, 10.3,
10.4 and 10.5.
10.7 Promissory Note for acquisition of division between Company and
Communications Systems, Inc. dated November 4, 1996.
10.8 Promissory Note for the acquisition of division between Company
and Communications Systems, Inc. dated November 4, 1996.
The following exhibits are incorporated by reference to exhibits 10.2, 10.3,
10.4, 10.5, and 10.6, respectively, to the Company's Annual Report on Form 10-K
for the year ended December 31, 1995.
10.2 Promissory Note for purchase of facility in Fairmont,
Minnesota between Company and Northern National Bank dated
December 29, 1995.
10.3 Promissory Note for purchase of capital equipment located at
Fairmont, Minnesota facility between Company and Northern
National Bank dated December 29, 1995.
37
10.4 Security Agreement covering Promissory Notes in Exhibits 10.2 and
10.3.
10.5 Asset Purchase Agreement for the purchase of assets of Monitor
Technology Corporation dated February 24, 1995.
10.6 Asset Purchase Agreement for the purchase of Aerospace Division of
Communication Cable, Inc. dated August 23, 1995.
The following exhibits are incorporated by reference to exhibits 10.2, 10.3, and
10.5, respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1994.
10.2 Promissory Note and Loan Agreement for capital equipment line
of credit between the Company and Northern National Bank dated
April 29, 1994.
10.3 Loan Agreement for Real Estate between the Company and Northern
National Bank dated March 18, 1994.
10.5 Promissory Notes and Loan Agreement for Real Estate between the
Company and MMCDC and MMCDC/NNC dated March 18, 1994.
The following exhibits are incorporated by reference to Exhibits 10.3 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1993.
10.3 Promissory Notes for capital equipment between the Company and
City of Augusta, Wisconsin dated August 17, 1993.
The following exhibits are incorporated by reference to Exhibits 3.1, 3.2 and
10.3 respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1991.
3.1 Articles of Incorporation (SMR) dated August 9,1991
3.2 Bylaws (SMR)
10.3 Promissory Note and Mortgage between the Company and Joint
Economic Development Commission, Inc. dated June 28, 1991.
The following exhibit is incorporated by reference to Exhibit 3.1 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1990.
3.1 Articles of Incorporation dated October 30, 1990.
38
The following exhibit is incorporated by reference to Exhibit 3.2 to the Annual
Report on Form 10-K for the year ended December 31, 1984:
3.2 Bylaws
(b) Reports on Form 8-K.
None.
(The remainder of this page was intentionally left blank.)
39
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
NORTECH SYSTEMS INCORPORATED
March 31, 1999 By: /s/ GARRY M. ANDERLY
--------------------------------
Garry M. Anderly
Principal Financial Officer
and
Principal Accounting Officer
March 31, 1999 By: /s/ QUENTIN E FINKELSON
--------------------------------
Quentin E. Finkelson
President
and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
is signed by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
March 31, 1999 By: /s/ QUENTIN E FINKELSON
--------------------------------
Quentin E. Finkelson
President, Chief Executive
Officer and Director
March 31, 1999 /s/ MYRON KUNIN
--------------------------------
Myron Kunin, Director
March 31, 1999 /s/ RICHARD W. PERKINS
--------------------------------
Richard W. Perkins, Director
March 31, 1999 /s/ MICHAEL J. DEGEN
--------------------------------
Michael J. Degen, Director
40
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
INDEPENDENT AUDITORS' REPORT ON
SUPPLEMENTARY INFORMATION
Board of Directors
Nortech Systems Incorporated and Subsidiary
Bemidji, Minnesota
Our report on the basic consolidated financial statements of Nortech Systems
Incorporated and Subsidiary for 1998, 1997 and 1996, precedes the
consolidated financial statements. The audits were made for the purpose of
forming an opinion on the basic consolidated financial statements taken as a
whole. The schedule on the following page is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part
of the basic consolidated financial statements. This schedule has been
subjected to the auditing procedures applied in the audits of the basic
consolidated financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic consolidated financial statements taken as a whole.
LARSON, ALLEN, WEISHAIR & CO., LLP
St. Cloud, Minnesota
February 12, 1999
41
NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Column A Column B Column C Column E Column F
- -------------------------------------- --------- ---------- ----------- ---------
Additions
Balance at Charged Balance at
Beginning to Costs End of
Classification Of Period And Expenses Add (Deduct) Period
-------------- --------- ------------ ------------ ----------
Year Ended December 31, 1998:
Allowance for Doubtful Accounts $ 84,128 $ 67,499 $ $151,627
-
Inventory Obsolescence Reserve 320,000 200,000 520,000
-
Deferred Tax Valuation Allowance 190,000 (25,000) 165,000
-
--------- ---------- ----------- ---------
$594,128 $ 267,499 $ (25,000) $836,627
--------- ---------- ----------- ---------
--------- ---------- ----------- ---------
Year Ended December 31, 1997:
Allowance for Doubtful Accounts $ 22,301 $ 61,827 $ $ 84,128
-
Inventory Obsolescence Reserve 120,000 200,000 320,000
-
Deferred Tax Valuation Allowance 240,000 (50,000) 190,000
-
--------- ---------- ----------- ---------
$382,301 $ 261,827 $ (50,000) $594,128
--------- ---------- ----------- ---------
--------- ---------- ----------- ---------
Year Ended December 31, 1996:
Allowance for Doubtful Accounts $ 6,053 $ 16,248 $ $ 22,301
-
Inventory Obsolescence Reserve 120,000 120,000
- -
Deferred Tax Valuation Allowance 400,000 (160,000) 240,000
-
--------- ---------- ----------- ---------
$526,053 $ 16,248 $(160,000) $382,301
--------- ---------- ----------- ---------
--------- ---------- ----------- ---------
42
INDEX TO EXHIBITS
DESCRIPTIONS OF EXHIBITS
10.1 Master lease agreement for equipment Amplicon Financial and the
Company.
10.2 Amendments to Promissory Notes, Loan Agreement Mortgage and Guaranty
between Norwest Bank Minnesota South, N.A. (formerly Northern
National Bank), and the Company.
23.1 Letter of Consent from Larson, Allen, Weishair & Company in reference
to the S-8 Forms filed June 21, 1994 and June 30, 1993.
43