NORTECH SYSTEMS INC — Annual Report 1997

Mar 31, 1997

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, 1996 ( ) 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 -------- --------- 1 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 byreference in Part III of this Form 10-K or any amendment to this Form 10-K. ( ) Based upon the $4.875 per share average of the closing bid and asked prices, respectively, on February 28, 1997 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 $6,297,847. As of February 28, 1997 there were 2,362,262 shares of the Company's $.01 per share par value common stock outstanding. (The remainder of this page was intentionally left blank.) 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 on Form 10-K by Reference Part III Item 10 Reference is made to the 11 Registrant's proxy statements 12 to be used in connection with the 1996 Annual Shareholders' meeting and filed with the Securities and Exchange Commission no later than April 30,1997. Part IV Item 14 Reference is made to the Asset Purchase Agreement used in the acquisition of the Zercom Division. The agreement was filed with Form 8-K report date November 4, 1996 and filed November 12, 1996. (The remainder of this page was intentionally left blank) 3 NORTECH SYSTEMS INCORPORATED ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996 INDEX PAGE PART I 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 13-15 Item 8. Consolidated Financial Statements 16-38 Item 9. Changes in and Disagreements on Accounting and Financial Disclosure 39 PART III Item 10. Directors and Executive Officers of the Registrant 39 Item 11. Executive Compensation 39 Item 12. Security Ownership of Certain Beneficial Owners and Management 39 Item 13. Certain Relationships and Related Transactions 39 PART IV Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K 40-42 Signatures 43 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 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 Cray Research, G.E. Medical Systems, Hughes Defense, and SPX Corporation. 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. Zercom Corporation also manufactures a line of proprietary products for sport fishermen, including the Clearwater Classic and Clearwater Pro fish locators. Since the Company's inception, substantially all revenues generated have been directly related to the contract manufacturing industry. Therefore, segmented financial information is not included in this report. 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 first market segment the Company has entered is the wire harness and cable assemblies market. The Company 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 and has actively maintained this certification. The Company believes this certification will benefit 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. However, the Company does own the rights to manufacture certain patented products. For the year ending December 31, 1996, revenues related to this production were not material to the financial results. 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 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 assembly business in the Upper Midwest, there are several established competitors. The Company expects its major competition to come from Americable, Technical Services, Inc. and Waters Instruments, Inc., all of which are located on 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 $4,513,000 on December 31, 1995 and approximately $6,127,000 on December 31, 1996. 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 8 losses related to the receivables from customers in any particular industry or geographic area. Two customers, G.E. Medical Systems, and Cray Research, Inc. accounted for approximately 17.5%, and 11.3% of sales, respectively for the year ended December 31, 1996. RESEARCH AND DEVELOPMENT The Company expended $273,697 in 1996 and $124,919 in 1995 on Company-sponsored research and development. This research is related to the development of large- screen, high resolution video monitors for the imaging division. In 1994, no funds were expended on Company-sponsored research. 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 438 full-time and 99 part-time employees as of February 15, 1997, consisting of 502 employees in manufacturing, manufacturing product support and medical support services and 35 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 October 2001. The Company owns its Bemidji, Minnesota facility consisting of eight acres of land and 60,000 square feet of office and manufacturing space and leases another 8000 square feet of manufacturing and office space in Augusta, Wisconsin. The Company's imaging 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. 9 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 None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 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. The high and low bid quotations for the Company's Common Stock for each quarterly period within the two most recent years were as follows: Quarter Ended: Low High ------------- --- ---- March 31, 1995 $3.000 $4.000 June 30, 1995 $3.000 $4.250 September 30, 1995 $3.250 $6.000 December 31, 1995 $4.750 $8.500 March 31, 1996 $6.000 $9.000 June 30, 1996 $6.000 $8.000 September 30, 1996 $5.000 $7.250 December 31, 1996 $5.250 $6.750 10 The low and high quotations set forth above are as reported by NASDAQ. These quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission, and may not necessarily represent actual transactions. As of March 1, 1997, there were approximately 1,419 holders of shares of the Company's Common Stock. The Company has never paid a cash dividend on shares of its Common Stock and does not intend to pay cash dividends in the foreseeable future. (The remainder of this page was intentionally left blank.) 11 NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY ITEM 6. SELECTED FINANCIAL DATA

• Company acquired the assets of Zercom Corporation in November, 1996. ** Company acquired the assets of Monitor Technology in March, 1995, and of Aerospace Systems in August, 1995. NOTE: For additional selected Financial Data (Past two years by quarter information) See note 12 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, 1996, 1995, AND 1994 REVENUES. For the years ended December 31, 1996, and 1995 the Company had sales of $26,182,821 and $18,305,928, respectively. The increase of $7,876,893, or 43% resulted primarily from additional revenues generated by the acquisitions which were completed in 1995 and 1996. For the year ended December 31, 1994 the Company had sales of $12,820,709. The approximate 42.8% increase in sales in 1995 was attributable primarily to increased sales in the medical and automotive industries offset by the reduced sales to the mid-sized computer industries as well as revenues from the newly acquired divisions. GROSS PROFIT. The Company had gross profit of $5,184,198 (before one time write offs) in 1996, $3,764,840 in 1995, and $2,598,569 in 1994. Gross profits as a percentage of gross sales were 19.8% in 1996 (before one time write-offs), 20.6% in 1995, and 20.3% in 1994. In 1996, the Company experienced certain items which are considered unusual events for their operations. Due to evolving customer requirements, the Company wrote off certain inventories from two of the divisions. A total of $544,000 in inventories was written off from the Bemidji and Imaging balance sheets. The customer marketplace is complex and ever changing, but with the current inventory and production mix, the Company believes they are well poised to address the needs of their current customers as they continue to pursue additional growth markets. After the one time write- offs, gross profit margin for 1996 was 17.7%. The decrease in gross profit percent from 1995 to 1996 is due to an increase in materials as a percent of total cost of goods sold. SELLING, GENERAL, AND ADMINISTRATIVE. Selling, general, and administrative expenses were $3,306,311 in 1996, $2,280,105 in 1995, and $1,647,797 in 1994. The increases in each year reflects additional selling, general and administrative expenses associated with the acquisitions. MISCELLANEOUS INCOME. Miscellaneous income was $32,064 in 1996, $177,967 in 1995, and $86,307 in 1994. The miscellaneous income resulted primarily from charges for miscellaneous services. INTEREST EXPENSE. Interest expense was $475,057 in 1996, $240,562 in 1995, and $117,835 in 1994. The increased expense for 1996 and 1995 is due to the increased debt from acquired operations. 13 INCOME TAXES. Income tax expense for 1996 was $192,000. Tax expense was not recorded in 1995 because of additional net operating loss carryforwards (NOL's) of approximately $2,504,000 which were recognized because of final tax regulations. The regulations clarified that tax carryforwards attributes in a Chapter 11 bankruptcy prior to December 31, 1993 where stock was issued for debt, need not be reduced by cancellation income. The tax benefit of approximately $851,000 created by additional NOL's was partially offset by a $300,000 increase in the deferred tax valuation allowance. Realization of the deferred tax asset is dependent upon the Company generating sufficient taxable earnings in future periods. In determining that realization of the deferred tax asset is more likely than not, the Company gave consideration to recent earnings history, its expectation for taxable earnings in the future and the expiration dates associated with tax carryforwards. Tax benefits of $245,794 were recorded in 1994 due to the reduction in the deferred tax valuation allowance of $600,000 due to the realization of net operating loss carryforwards. NET INCOME. The Company's net income in 1996 was $446,029 or $.19 per common share. The Company's net income in 1995 was $1,331,924 or $.55 per common share. The Company's net income in 1994 was $1,183,406 or $.54 per common share. The Company believes that the effect of inflation on past operations has not been significant and anticipates that inflation will not have a significant impact on future operations. LIQUIDITY AND CAPITAL RESOURCES The Company's working capital rose from $5,279,509 as of December 31, 1995 to $8,498,531 on December 31, 1996. Stockholders equity increased from $6,036,166 as of December 31, 1995 to $7,151,192 on December 31, 1996 due to the Company's 1996 net income and the reclassification to equity of $668,400 of redeemable stock. This reclassification occurred because the put option on 111,400 shares was not exercised. The Company's liquidity and capital resources have improved substantially, and the Company believes that its' future financial requirements can be met with funds generated from the operating activities and from the Company's operating line of credit. In March 1995, the Company completed the net asset purchase of Monitor Technology Corporation. This division of the Company designs and builds high and ultra-high resolution CRT monitors for radar, document and medical imaging. In addition, they provide repair services on internally and externally produced monitors. 14 In August 1995, the Company acquired all the assets of the Aerospace Division of Communication Cable, Inc. The Company has continued the business formally conducted by Aerospace which involves the manufacturing of custom-designed, high-technology electronic cable assemblies for various applications. In November 1996, the Company acquired the inventory and fixed assets of Zercom Corporation, a subsidiary of Communication Systems, Inc. The Company has been, and continues to be a contract manufacturer of electronic sub-assemblies and components. Zercom Corporation also manufactures a line of proprietary products for sport fishermen, including the Clearwater Classic and Clearwater Pro fish locators. These acquisitions are expected to positively impact future operations and enhance the financial condition of the Company over time. However, there are no guarantees of future performance. (The remainder of this page was intentionally left blank.) 15 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA PAGE ---- Independent Auditors' Report of : Larson, Allen, Weishair & Co., LLP 17 Consolidated Financial Statements: Consolidated Balance Sheets at December 31, 1996 and 1995. 18 Consolidated Statements of Income for the years ended December 31, 1996, 1995 and 1994. 19 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1995 and1994. 20 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994. 21-22 Notes to Consolidated Financial Statements 23-38 (The remainder of this page was intentionally left blank.) 16 INDEPENDENT AUDITORS' REPORT Board of Directors Nortech Systems Incorporated and Subsidiary Bemidji, Minnesota We have audited the accompanying consolidated balance sheets of Nortech Systems Incorporated and Subsidiary as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide 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, 1996, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. LARSON, ALLEN, WEISHAIR & CO., LLP St. Cloud, Minnesota February 13, 1997 17

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 18

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 19

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 20

NON-CASH TRANSACTIONS During 1995 the Company issued $1,500,000 of redeemable Common Stock as part of the purchase of another corporation's net assets. During 1996 the Company issued a long-term note payable in the amount of $4,865,390 as part of the purchase price for certain assets of another corporation. SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 21

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 22 NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995 AND 1994 NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS DESCRIPTION Nortech Systems Incorporated (the "Company") is a Minnesota corporation with headquarters in Wayzata, Minnesota, a suburb of Minneapolis, Minnesota. The Company's main manufacturing facility is located in Bemidji, Minnesota, with additional manufacturing and engineering support locations in Fairmont, Plymouth, Merrifield and Aitkin, Minnesota and Augusta, Wisconsin. The Company manufactures wire harnesses, cables, and electromechanical assemblies, printed circuit 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 "turnkey" contract manufacturing service to its customers. All products are built to the customer's design specifications. In addition, the Company also manufactures a line of proprietory products for sport fishermen. Nortech Medical Services, Inc., its wholly owned subsidiary, provides service bureau and office management services to physicians and clinics throughout Minnesota. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All significant intercompany accounts and transactions have been eliminated. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out method) or market (based on the lower of replacement cost or net realizable value). PROPERTY AND EQUIPMENT The Company capitalizes the cost of purchased software, equipment, and leasehold improvements. Expenditures for maintenance and repairs and minor renewals and betterments which do not improve or extend the life of the respective assets are expensed. The assets and related depreciation accounts are adjusted for property retirements and disposals with the resulting gain or loss included in results of operations. Fully depreciated assets remain in the accounts until retired from service. 23 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, 1996, 1995 and 1994. Depreciation was calculated over estimated useful lives as follows: Building and Improvements 31 Years Manufacturing Equipment 5 - 7 Years Office and Other Equipment 5 - 7 Years REVENUE RECOGNITION Sales are recorded by the Company when products are shipped to the customer. GOODWILL Goodwill representing the excess of the purchase price over the fair value of the net assets of the acquired entities (see Note 2), is being amortized on a straight-line basis over the period of expected benefit of fifteen years. Total amortization of goodwill recorded for fiscal years 1996, 1995 and 1994 was $54,614, $30,724 and $-0-, respectively. The carrying value of goodwill will be reviewed periodically based on the undiscounted cash flows of the entity acquired over the remaining amortization period. Should this review indicate that goodwill will not be recoverable, the Company's carrying value of the goodwill will be reduced by the estimated shortfall of undiscounted cash flows. INTANGIBLE ASSETS The Company acquired other intangible assets including purchased technology and certification costs in the amount of $42,333 and $82,059 during 1996 and 1995, respectively. These assets are being amortized over a period of 3 to 7 years. The related amortization expense for 1996 and 1995 was $13,152 and $1,096, respectively. CASH AND CASH EQUIVALENTS The Company considers its investments with an original maturity of three months or less to be cash equivalents. At December 31, 1996 and 1995, the Company had invested excess funds of $266,000 and $285,000, respectively, in repurchase agreements collateralized by government backed securities. Due to the short-term nature of the agreements, the Company does not take possession of the securities, which are instead held at the Company's principal bank from which it purchases the securities. 24 NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts for cash, short-term investments, receivables, accounts payable and accrued liabilities approximate fair value because of the short maturity of these instruments. The fair value of long- term debt approximates its carrying value and is based on current rates at which the Company could borrow funds with similar remaining maturities. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates. ADVERTISING Advertising costs are charged to operations as incurred. Total amounts charged to expense were $65,234, $17,994 and $16,694 for the years ended December 31, 1996, 1995 and 1994, respectively. INCOME TAXES The Company has adopted FASB Statement No. 109, ACCOUNTING FOR INCOME TAXES, which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. Investment credits are accounted for by using the "flow-through" method whereby the benefit is reflected as a reduction of income taxes in the year utilized. 25 NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) EARNINGS PER SHARE Primary earnings per share of common stock is computed by dividing net income by the weighted average number of common shares outstanding during the period. The impact of outstanding options was not material and was not included in the calculation of primary earnings per share. Preferred stock issued is noncumulative and nonconvertible. ACCOUNTING FOR STOCK-BASED COMPENSATION Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock Based Compensation," establishes a new fair value based accounting method for stock-based compensation plans. As permitted by the statement, the Company continues to apply the accounting provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," in determining net income. NOTE 2 ACQUISITIONS In 1996 and 1995 the Company acquired the three businesses described below, which have been accounted for by the purchase method of accounting. The results of the operations of the acquired Companies are included in the Company's consolidated statement of income from the dates of the acquisitions. ZERCOM CORPORATION On November 4, 1996, the Company acquired substantially all of the assets of Zercom Corporation (Zercom). Zercom is a contract manufacturer of electronic sub-assemblies and components. Zercom also manufactures a line of proprietary products for sport fishermen. The purchase price was $6,424,882, consisting of a cash payment of $1,500,000, issuance of promissory notes totalling $4,865,390, and acquisition costs of $59,492. The excess of the purchase price over the estimated fair value of the net assets acquired is being amortized on a straight line basis over 15 years. 26 NOTE 2 ACQUISITIONS (CONTINUED) ZERCOM CORPORATION (CONTINUED) 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 ------------ ------------ MONITOR TECHNOLOGY CORPORATION On March 28, 1995, the Company acquired substantially all of the assets and assumed certain liabilities of Monitor Technology Corporation (MTC). Monitor Technology Corporation designs and builds high and ultra-high resolution CRT monitors for computer applications throughout the United States. In addition, they provide repair services on internally and externally produced monitors. The purchase price of $2,232,667, which includes the assumption of liabilities of $707,887 and acquisition costs of $24,780, was paid with cash and by issuing 250,000 shares of the Company's common stock. The common stock was valued at $6, which is the redeemable price based on a repurchase agreement issued to the seller at closing. The excess of the purchase price over the estimated fair value of assets acquired is being amortized on a straight-line basis over 15 years. In 1996, 88,600 shares were put back to the Company at $6 per share and the put option was not exercised on 111,400 shares. The Company remains contingently liable to repurchase the remaining 50,000 shares, which are in dispute. The Company's obligation under the repurchase agreement is guaranteed by a director of the Company. 27 NOTE 2 ACQUISITIONS (CONTINUED) AEROSPACE On August 23, 1995, the Company acquired the Aerospace Division of Communication Cable, Inc. The Aerospace Division manufactures and sells multi-conductor electrical cable assemblies to customer specifications for the aerospace industry throughout the United States. The purchase price was $2,950,517 consisting of a cash payment of $2,845,506, the assumption of liabilities of $44,601, and acquisition costs of $60,410. A summary of the purchase price allocation for the 1995 acquisitions of MTC and Aerospace is as follows: Net Working Capital Items $ 1,984,359 Property, Plant and Equipment 2,250,810 Excess of Cost over Fair Value of Net Assets of Purchased Businesses 948,015 ------------ Total $ 5,183,184 ------------ ------------ The following proforma unaudited consolidated statements of income for the Company are presented as though the acquisition of Zercom Corporation had occurred on January 1, 1996 and 1995 and the acquisitions of Monitor Technology Corporation and the Aerospace Division of Communication Cable, Inc. had occurred on January 1, 1995. (Unaudited) 1996 1995 ----------------------------------------- ------------- ------------- Revenues $ 39,702,215 $ 42,283,397 ------------- ------------- ------------- ------------- Net Income $ 230,045 $ 1,887,304 ------------- ------------- ------------- ------------- Net Income Per Share of Common Stock $ 0.10 $ 0.78 ------------- ------------- ------------- ------------- The proforma financial information is presented for information purposes only and is not necessarily indicative of the operating results that would have occurred had the acquisitions been consummated as of the above dates, nor are they necessarily indicative of future operating results. 28 NOTE 3 INVENTORIES Inventories consist of the following: 1996 1995 ------------- ------------- Raw Materials $ 3,626,665 $ 1,972,384 Work in Process 1,837,247 1,676,949 Finished Goods 1,265,588 205,879 ------------- ------------- Total $ 6,729,500 $ 3,855,212 ------------- ------------- ------------- ------------- NOTE 4 SHORT-TERM LINE OF CREDIT The Company has a revolving line of credit available at December 31, 1996, for $500,000. The line of credit is with Northern National Bank, accrues interest at the prime rate, matures February 10, 1997, and is secured by accounts receivable, equipment, inventory, general intangibles and a personal guarantee by a shareholder. The interest rate was 8.25% at December 31, 1996. The maximum and average amounts outstanding on short-term lines of credit during 1996, were $500,000 and $266,066, respectively. There was no balance outstanding as of December 31, 1995. NOTE 5 LONG-TERM DEBT

31 NOTE 5 LONG-TERM DEBT (CONTINUED) Maturity requirements by year on long-term debt are as follows: Years Ending December 31, Amount ------------------------- ------ 1997 $ 731,080 1998 5,714,488 1999 715,625 2000 1,122,880 2001 3,278,477 Later Years 79,287 ------------- Total $ 11,641,837 ------------- ------------- The maximum and average amounts outstanding on the Company's long-term lines of credit were $3,716,939 and $2,596,711 during 1996, respectively, and $2,161,179 and $400,000 during 1995, respectively. NOTE 6 LEASE OBLIGATION The Company has entered into various operating leases for equipment and office space. Rent expense for the years ended December 31, 1996, 1995 and 1994, was $451,659, $290,799 and $118,672, respectively. The future minimum lease payments are as follows: Years Ending December 31, Amount --------------------------- -------- 1997 $ 337,214 1998 327,675 1999 327,675 2000 190,650 2001 82,575 ------------- Total $ 1,265,789 ------------- ------------- 32 NOTE 7 RELATED PARTY TRANSACTIONS Ceridian Corporation is one of the Company's stockholders at December 31, 1996, 1995 and 1994. Transactions and balances with Ceridian Corporation are as follows: CONTRACT FOR DEED - CERIDIAN CORPORATION During 1991 the Company entered into a contract for deed with Ceridian Corporation for the purchase of the building and land. The original purchase price was $840,000. The contract was paid off in 1994. SALES In 1996, 1995 and 1994, sales to Ceridian Corporation represented approximately 1% of total sales in each year. NOTE 8 INCOME TAXES The provision for income taxes for each of the three years in the period ended December 31, 1996, consists of the following: 1996 1995 1993 ---------- --------- ------------ Current Taxes - Federal $ 10,000 $ 37,000 $ 17,183 Current Taxes - State 72,000 63,000 17,023 Deferred Taxes 110,000 (100,000) (280,000) ---------- --------- ------------ Total Expense (Benefit) $ 192,000 $ 0 $ (245,794) ---------- --------- ------------ ---------- --------- ------------ Deferred tax assets at December 31, 1996 and 1995, consist of the following: 1996 1995 ------------ ------------ Net Operating Loss (NOL) Carryforwards $ 1,415,000 $ 1,635,000 Tax Credit Carryforwards 235,000 295,000 Other 40,000 30,000 Valuation Allowance (240,000) (400,000) ------------ ------------ Total $ 1,450,000 $ 1,560,000 ------------ ------------ ------------ ------------ 33 NOTE 8 INCOME TAXES (CONTINUED) The statutory rate reconciliation for each of the three years in the period ended December 31, is as follows: 1996 1995 1994 ----------- ------------ ----------- Statutory Tax Provision $ 217,000 $ 453,000 $ 319,000 State Income Taxes 78,000 80,000 50,000 Additional NOL Carryforwards 0 (851,000) 0 Increase (Reduction) in Deferred Tax Valuation Allowance (Net of Expired Tax Credit Carryforwards) (100,000) 300,000 (600,000) Other (3,000) 18,000 (14,794) ----------- ----------- ----------- Income Tax Provision (Benefit) Expense $ 192,000 $ 0 $ (245,794) ----------- ----------- ----------- ----------- ----------- ----------- The Company has available for Federal income tax purposes, operating loss carryforwards, unused investment credits, and unused research and development credits which may provide future tax benefits, expiring as follows: Investment Research and Operating Loss Tax Credit Development Tax Year of Expiration Carryforward Carryforward Credit Carryforward ------------------ -------------- ------------ ------------------- 1997 $ 0 $ 4,064 $ 43,051 1998 0 50,888 97,643 1999 3,035,800 39,965 0 2001 767,300 0 0 2002 253,200 0 0 2003 109,700 0 0 -------------- ------------- ------------- Totals $ 4,166,000 $ 94,917 $ 140,694 -------------- ------------- ------------- -------------- ------------- ------------- During 1995 the Company identified an additional $2,503,778 of net operating loss carryforwards related to final tax regulations. The regulations clarified that tax carryforward attributes in a Title 11 bankruptcy prior to December 31, 1993, where stock was issued for debt, need not be reduced by debt cancellation income. As a result of the increase in net operating loss carryforwards, which must be utilized prior to taking the benefit in tax credit carryovers, the Company has increased its valuation allowance accordingly. In 1996 the Company utilized operating loss carryforwards of $642,000 to offset federal taxable income. 34 NOTE 8 INCOME TAXES (CONTINUED) In 1995 the Company utilized operating loss carryforwards of $1,450,000 to offset federal taxable income and $46,000 of research and development credits to offset state tax. In 1994 the Company utilized operating loss carryforwards of $932,000 to offset federal taxable income and $126,100 to offset state taxable income. The Company also utilized $33,900 of research and development tax credits to offset state tax. NOTE 9 PREFERRED STOCK TRANSACTIONS The holders of the preferred stock are entitled to a noncumulative dividend of 12% when and as declared. In liquidation, holders of preferred stock have preference to the extent of $1.00 per share plus dividends accrued but unpaid. Preferred stock dividends of $-0-, $29,934 and $14,946 were paid during the year-ended December 31, 1996, 1995 and 1994, respectively. NOTE 10 MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK The Company sells its products to companies in the computer, medical, governmental and various other industries. Historically, the Company has not experienced significant losses related to receivables from customers in any particular industry or geographic area. The Company maintains its excess cash balances in checking and money market accounts at three financial institutions. These balances exceed the federally insured limit by $775,000 and $520,000 at December 31, 1996 and 1995, respectively. The Company has not experienced any losses in any of the short-term investment instruments it has used for excess cash balances. Two customers accounted for approximately 11.3% and 17.5% of sales, respectively, for the year ended December 31, 1996. Three customers accounted for approximately 24.1%, 16.6% and 11.8% of sales, respectively, for the year ended December 31, 1995. One customer accounts for approximately 10.4% of accounts receivable at December 31, 1995. Three customers accounted for approximately 26.8%, 24.5% and 20.2% of sales, respectively, for the year ended December 31, 1994. Three customers accounted for approximately 29.8%, 20.5% and 11.3% of accounts receivable, respectively, at December 31, 1994. 35 NOTE 11 EMPLOYEE STOCK OPTION AND AWARD PLANS In 1992, the Company approved the adoption of a fixed stock based compensation plan. The purpose of the Plan is to promote the interests of the Company and its shareholders by providing officers, directors and other key employees with additional incentive and the opportunity, through stock ownership, to increase their proprietary interest in the Company and their personal interest in its continued success. The Company has authorized 200,000 shares for issuance under this Plan. Stock options may be granted for the purchase of common stock at a price not less than the fair market value on the date of the grant. Options are generally exercisable after one or more years and expire no later than 10 years from the date of grant. The Company applies APB Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for its fixed stock based compensation plan. Accordingly, no compensation cost has been recognized for this Plan in 1996, 1995 or 1994. Had compensation cost been determined on the basis of fair value pursuant to SFAS No. 123, "Accounting for Stock Based Compensation," net income and earnings per share would not differ materially from amounts reported under APB Opinion No. 25. Since the proforma disclosures of results under SFAS No. 123 are only required to consider grants awarded in 1995 and 1996, the proforma effects of applying SFAS No. 123 during this initial phase-in period may not be representative of the effects on reported results for future years. Following is a summary of the Plan's transactions: Option Price Shares (Per Share) --------- ------------ Balance as of December 31, 1992 22,500 $1.75 Granted January 21, 1993 15,000 $1.625 --------- Balance as of December 31, 1993 37,500 $1.625 - $1.75 Granted January 24, 1994 10,000 $3.625 --------- Balance as of December 31, 1994 47,500 $1.625 - $3.625 Granted December 1, 1995 95,000 $5.25 Exercised (5,000) $1.75 --------- Balance as of December 31, 1995 137,500 $1.625 - $5.25 Granted December 1, 1996 - - Exercised - - --------- Balance as of December 31, 1996 137,500 $1.625 - $5.25 --------- --------- 36 NOTE 11 EMPLOYEE STOCK OPTION AND AWARD PLANS (CONTINUED) A summary of the status of fixed options outstanding at December 31, 1996, is as follows: Outstanding Exercisable Average Remaining Exercise Price Options Options Contractural Life -------------- ----------- ----------- ----------------- 1.625 15,000 15,000 6 Years 1.75 17,500 17,500 5 Years 3.625 10,000 10,000 7 Years 5.25 95,000 19,000 9 Years During 1993, the Company adopted a gain sharing plan. The purpose of the Plan is to provide a bonus for increased output, improved quality and productivity and reduced costs. The Company has authorized 50,000 shares to be available under this Plan. In accordance with the terms of the Plan, employees can acquire newly issued shares of common stock for 90% of the current market value. 5,168 shares have been issued under this Plan through December 31, 1996. 37 NOTE 12 SUPPLEMENTARY FINANCIAL INFORMATION

In the 4th quarter of 1995, the Company reduced previous quarter's tax expense of $206,388, which increased 4th quarter net income by .08 per share due to recognition of additional net operating loss carryforwards. In the 4th quarter of 1996, the Company wrote off $544,000 of inventories due to evolving customer requirements. This reduced 4th quarter net income by .15 per share. 38 ITEM 9. CHANGES IN AND DISAGREEMENTS 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 1996 proxy statement to be filed with the Securities and Exchange Commission not later than April 30, 1997 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 1996 proxy statements to be filed with the Securities and Exchange Commission not later than April 30, 1997 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 1996 proxy statements to be filed with the Securities and Exchange Commission not later than April 30, 1997 and said portions of the proxy statements are incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. (See note 7 of Consolidated Financial Statements) (The remainder of this page was intentionally left blank.) 39 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 16. (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 44 Consolidated Financial Statement Schedule for the years ended December 31, 1996, 1995 and 1994 VIII Valuation and Qualifying Accounts 45 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: 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. 40 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. 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 10.2, 10.3, 10.4, 10.5, 10.6 and 23.1, respectfully, to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. 10.2 Promissory Note for purchase of facility in Fairmont, Minnesota between Company and Northern National Bank dated December 29, 1995. 10.3 Promissory Note for purchase of capital equipment located at Fairmont, Minnesota facility between Company and Northern National Bank dated December 29, 1995. 10.4 Security Agreement covering Promissory Notes in Exhibits 10.1, 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, respectfully, 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. 41 The following exhibits are incorporated by reference to Exhibits 10.3 and 10.4, respectfully, 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. 10.4 Promissory Notes and Loan Agreement for capital equipment between the Company and Northern States Power Company dated November 15, 1993. The following exhibits are incorporated by reference to Exhibits 3.1, 3.2, 10.1 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. 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. Form 8-K report date November 4, 1996 and filed November 12, 1996 for purchase of assets of Zercom Corporation. Form 8-K/A 1 filed on March 3, 1997. This Form 8-K/A was an amendment to Form 8-K report date November 4, 1996 and filed November 12, 1996. 42 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 27, 1997 By:/s/ ---------------------------------- Quentin E. Finkelson Its President and Chief Executive Officer March 27, 1997 By:/s/ ---------------------------- Garry M. Anderly Principal Financial Officer and Principal Accounting 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 27, 1997 /s/ ---------------------------------- Quentin E. Finkelson, President, Chief Executive Officer and Director March 27, 1997 /s/ ---------------------------------- Myron Kunin, Director March 27, 1997 /s/ ---------------------------------- Richard W. Perkins, Director 43 INDEPENDENT AUDITORS' REPORT ON SUPPLEMENTARY INFORMATION Board of Directors Nortech Systems Incorporated And Subsidiary Bemidji, Minnesota Our report on the basic consolidated financial statements of Nortech Systems Incorporated and Subsidiary for 1996, 1995 and 1994 precedes the consolidated financial statements. The audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule 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 state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. LARSON, ALLEN, WEISHAIR & CO., LLP St. Cloud, Minnesota February 13, 1997 44

45 INDEX TO EXHIBITS DESCRIPTIONS OF EXHIBITS - ------------------------ 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. 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. 46