NORTECH SYSTEMS INC — Interim / Quarterly Report 2004

Aug 16, 2004

10-Q 1 a04-9279_110q.htm 10-Q

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

*FORM 10-Q*

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

For the Quarterly Period Ended June 30, 2004

*NORTECH SYSTEMS INCORPORATED*

*Commission file number 0-13257*

State of Incorporation: *Minnesota*

IRS Employer Identification No. *41-1681094*

Executive Offices: *1120 Wayzata Blvd E., Suite 201, Wayzata, MN 55391*

Telephone number: *(952) 345-2277*

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required of file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

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

Number of shares of $.01 par value common stock outstanding at July 15, 2004 - 2,550,391

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

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*TABLE OF CONTENTS*

	PAGE
PART I - FINANCIAL INFORMATION
Item 1 -
Financial Statements (Unaudited)
Consolidated Balance Sheets	3 - 4
Consolidated Statements of Income	5 - 6
Consolidated
Statements of Cash Flows	7
Notes
to Consolidated Financial Statements	8
- 11
Item
2 -
Management’s Discussion and Analysis of Financial Condition And
Results of Operations	12
- 17
Item 3 -
Quantitative and Qualitative Disclosures About Market Risk	17
Item
4 -
Controls and Procedures	17 - 18
PART II - OTHER INFORMATION
Item
1 -
Legal Proceedings	18
Item 4 -
Submission of Matters to a Vote of Security Holders	18
Item 6 -
Exhibits and Reports on Form 8-K	18-19
SIGNATURES	20
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

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*PART 1*

*ITEM 1. FINANCIAL STATEMENTS*

Consolidated Balance Sheet - ASSETS

*NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY*

*CONSOLIDATED BALANCE SHEETS*

*JUNE 30, 2004 AND DECEMBER 31, 2003*

	JUNE 30 2004 — (UNAUDITED)		DECEMBER 31 2003 — (AUDITED)
ASSETS
Current Assets
Cash and Cash
Equivalents	$ 818,367		$ 101,179
Accounts
Receivable, Less Allowance for Uncollectible Accounts of $280,368 and
$371,690, respectively	11,180,313		10,835,696
Inventories:
Finished Goods	2,266,417		1,479,150
Work In Process	2,619,284		1,591,389
Raw Materials	9,662,094		8,524,018
Total
Inventories	14,547,795		11,594,557
Prepaid Expenses	364,263		423,371
Income Taxes
Receivable	281,843		419,634
Deferred Tax
Assets	1,054,000		965,000
Total Current
Assets	28,246,581		24,339,437
Property and
Equipment
Land	151,800		151,800
Building and
Leasehold Improvements	4,692,148		4,768,813
Manufacturing
Equipment	7,043,024		6,557,159
Office and Other
Equipment	2,906,457		2,803,819
Total Property
and Equipment	14,793,429		14,281,591
Accumulated
Depreciation	(8,635,311	)	(8,191,274	)
Net Property and
Equipment	6,158,118		6,090,317
Other Assets
Deposits	16,017		51,046
Non-Compete, Net
of Accumulated Amortization	897,259		953,984
Goodwill	75,006		75,006
Deferred Tax
Assets	49,000		71,000
Total Other
Assets	1,037,282		1,151,036
Total Assets	$ 35,441,981		$ 31,580,790

See accompanying Notes to Consolidated Financial Statements

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Consolidated Balance Sheet - LIABILITIES

*NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY*

*CONSOLIDATED BALANCE SHEETS*

*JUNE 30, 2004 AND DECEMBER 31, 2003*

	JUNE 30 2004 — (UNAUDITED)		DECEMBER 31 2003 — (AUDITED)
LIABILITIES
AND SHAREHOLDERS’ EQUITY
Current
Liabilities
Current
Maturities of Notes and Capital Lease Payable	$ 8,141,612		$ 1,360,935
Checks Written
in Excess of Cash	1,568,448		250,000
Accounts Payable	5,198,806		4,068,148
Accrued Payroll
and Commissions	1,520,041		1,281,319
Accrued Health
and Dental Claims	192,553		217,514
Other Accrued
Liabilities	542,656		438,258
Total Current
Liabilities	17,164,116		7,616,174
Long-Term
Liabilities
Notes and
Capital Lease Payable (Net of Current Maturities)	3,493,921		9,643,336
Total
Liabilities	20,658,037		17,259,510
Shareholders’
Equity
Preferred Stock, $1 par value; 1,000,000 Shares Authorized; 250,000
Shares Issued and Outstanding	250,000		250,000
Common Stock -
$0.01 par value; 9,000,000 Shares Authorized: 2,550,391 Shares Issued and
Outstanding at June 30, 2004; 2,544,391 Shares Issued and 2,512,687 Shares
Outstanding at December 31, 2003	25,504		25,127
Additional
Paid-In Capital	13,818,712		13,497,339
Accumulated
Other Comprehensive Loss	(33,807	)	(26,688	)
Retained
Earnings	723,535		575,502
Total
Shareholders’ Equity	14,783,944		14,321,280
Total
Liabilities and Shareholders’ Equity	$ 35,441,981		$ 31,580,790

See accompanying Notes to Consolidated Financial Statements

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Consolidated Statements of Income – 3-MO P&L

*NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY*

*CONSOLIDATED STATEMENTS OF INCOME*

*FOR THE THREE MONTHS ENDED*

*JUNE 30, 2004 AND JUNE 30, 2003*

	JUNE 30 2004 — (Unaudited)		JUNE 30 2003 — (Unaudited)
Net Sales	$ 18,028,197		$ 14,486,982
Cost of Goods
Sold	16,109,674		12,752,247
Gross Profit	1,918,523		1,734,735
Operating
Expenses:
Selling Expenses	892,747		682,743
General and
Administrative Expenses	847,031		760,906
Total Operating
Expenses	1,739,778		1,443,649
Income From
Operations	178,745		291,086
Other Expense
Interest Income	25,387		1,231
Miscellaneous
Income	54,920		55,059
Interest Expense	(89,068	)	(95,590	)
Total Other
Expense	(8,761	)	(39,300	)
Income From
Operations Before
Income Taxes	169,984		251,786
Income Tax
Expense	65,000		25,000
Net Income	$ 104,984		$ 226,786
Earnings Per
Share:
Basic	$ 0.04		$ 0.09
Average Number
of Common Shares Outstanding Used for Basic Earnings Per Share	2,550,391		2,473,760
Diluted	$ 0.04		$ 0.09
Average Number
of Common Share Outstanding Plus Dilutive Common Stock Options	2,600,086		2,512,727

See accompanying Notes to Consolidated Financial Statements

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*NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY*

*CONSOLIDATED STATEMENTS OF INCOME*

*FOR THE SIX MONTHS ENDED*

*JUNE 30, 2004 AND JUNE 30, 2003*

	JUNE 30 2004 — (Unaudited)		JUNE 30 2003 — (Unaudited)
Net Sales	$ 33,074,282		$ 28,257,270
Cost of Goods
Sold	29,650,888		24,873,035
Gross Profit	3,423,394		3,384,235
Operating
Expenses:
Selling Expenses	1,482,170		1,356,576
General and
Administrative Expenses	1,547,305		1,467,458
Total Operating
Expenses	3,029,475		2,824,034
Income From
Operations	393,919		560,201
Other Expense
Interest Income	26,682		1,944
Miscellaneous
Income	41,003		72,784
Interest Expense	(222,571	)	(184,618	)
Total Other
Expense	(154,886	)	(109,890	)
Income From
Operations Before
Income Taxes	239,033		450,311
Income Tax
Expense	91,000		102,000
Net Income	$ 148,033		$ 348,311
Earnings Per
Share:
Basic	$ 0.06		$ 0.14
Average Number
of Common Shares Outstanding Used for Basic Earnings Per Share	2,545,028		2,465,122
Diluted	$ 0.06		$ 0.14
Average Number
of Common Share Outstanding Plus Dilutive Common Stock Options	2,599,782		2,511,915

See accompanying Notes to Consolidated Financial Statements

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CASHFLOW

*NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY*

*CONSOLIDATED STATEMENTS OF CASH FLOWS*

*FOR THE SIX MONTHS ENDED*

*JUNE 30, 2004 AND JUNE 30, 2003*

	JUNE 30 2004 — (Unaudited)		JUNE 30 2003 — (Unaudited)
Cash Flows From
Operating Activities	—		—
Net Income	$ 148,033		$ 348,311
Adjustments to
Reconcile Net Income to Net Cash Provided by Operating Activities:
Depreciation and
Amortization	504,299		790,356
Deferred Taxes	(67,000	)	(120,000	)
Foreign Currency
Transaction Gain	14,441		(4,031	)
Changes in
Current Operating Items:
Accounts
Receivable	(351,307	)	743,077
Income Taxes
Receivable	137,822		232,425
Inventories	(2,953,793	)	(343,714	)
Prepaid Expenses
and Deposits	92,813		(176,640	)
Accounts Payable	2,449,893		181,739
Accrued Payroll
and Commissions	238,934		(878,697	)
Other Accrued
Liabilities	79,415		171,811
Net Cash
Provided by Operating Activities	293,550		944,637
Cash Flows from
Investing Activities:
Acquisition of
Equipment	(525,691	)	(489,037	)
Net Cash Used by
Investing Activities	(525,691	)	(489,037	)
Cash Flows from
Financing Activities:
Net Change in
Line of Credit	1,060,445		47,677
Payments on
Notes and Capital Lease Payable	(129,183	)	(221,885	)
Issuance of
Stock	21,750		840
Net Cash
Provided (Used) by Financing Activities	953,012		(173,368	)
Effect of
Exchange Rate Changes on Cash	(3,683	)	(7,808	)
Net Increase in
Cash and Cash Equivalents	717,188		274,424
Cash and Cash
Equivalents - Beginning	101,179		448,751
Cash and Cash
Equivalents - Ending	$ 818,367		$ 723,175

The Company has paid interest expense of $222,375 and income taxes of $186 for the six month period ended June 30, 2004 compared to interest expense of $185,537 and income taxes of $37,361 for the same period in 2003.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

**Basis of Presentation****

The accompanying unaudited consolidated financial statements for the interim periods have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and in accordance with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the financial information and footnotes required by GAAP for complete financial statements. However, as disclosed herein, there have been no material changes in the information disclosed in the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. Changes in the estimates and assumptions used by management could have a significant impact on the Company’s financial results. Actual results could differ from those estimates.

The operating results of the interim periods presented are not necessarily indicative of the results expected for the full year or for any other interim period. The accompanying condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2003 included in the Company’s Annual Report Form 10-K for the year ended December 31, 2003 as filed with the Securities and Exchange Commission.

**Stock Options****

As allowed by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” and by SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” the Company has elected to continue to apply the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation cost is recognized in the Company’s net income for options granted with exercise prices that are equal to the market values of the underlying common stock on the dates of grant. Had compensation cost for the stock options been based on the estimated fair values at grant dates, the Company’s pro forma net income and net income per share would have been as follows:

	Three Months Ended June 30, — 2004		2003		Six Months Ended June 30, — 2004		2003
Net
income, as reported	$ 104,984		$ 226,786		$ 148,033		$ 348,311
Deduct:
Total stock-based compensation expense, determined under fair value-based
method for all awards, net of related tax effects	(25,935	)	(9,851	)	(51,869	)	(19,703	)
Pro
forma net income	$ 79,049		$ 216,935		$ 96,164		$ 328,608
Earnings
per share:
Basic
– as reported	$ 0.04		$ 0.09		$ 0.06		$ 0.14
Basic
– pro forma	$ 0.03		$ 0.09		$ 0.04		$ 0.13
Diluted
– as reported	$ 0.04		$ 0.09		$ 0.06		$ 0.14
Diluted
– pro forma	$ 0.03		$ 0.09		$ 0.04		$ 0.13

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There were no stock options granted during the three or sixth month periods ended June 30, 2004.

NOTE 2. PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of Nortech Systems Incorporated (the “Company” or “Nortech”) and its wholly owned subsidiary, Manufacturing Assembly Solutions of Monterrey, Inc. All significant intercompany accounts and transactions have been eliminated.

NOTE 3. NEW ACCOUNTING STANDARDS

In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States, management must make decisions which impact the reported amounts and related disclosures. Such decisions include the selection of the appropriate principles to be applied and the assumptions on which to base accounting estimates. In reaching such decisions, management applies judgment based on its understanding and analysis of the relevant circumstances.

The accounting principles followed in the preparation of the financial information contained on Form 10-Q are the same as those described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. Refer to the Annual Report on Form 10-K for detailed information on accounting policies.

NOTE 4. LONG TERM DEBT

As described in the December 31, 2003 financial statements, repayment of SAE Assembly, LLC (“SAE”) debt will be made through semi-annual installments ending June 27, 2004. Each installment on the note will be satisfied with the issue of 31,704 shares of Nortech stock. Should the average market price of the stock fail to reach or exceed $7.00 during a four-week period of time during each semi-annual period, the Company shall at SAE’s discretion repurchase such shares within 30 days at a price of $7.00.

At June 30, 2004, 95,112 shares comprising three installments were considered issued and outstanding. The 31,704 shares required under the fourth and last installment were transferred to SAE on June 27, 2004, but were not considered outstanding at June 30, 2004 for purposes of calculating earnings per share, as the four-week period of time had not expired. The impact on earnings per share calculations is not material and the remaining balance of SAE debt as of June 30, 2004 is $300,000. As of July 23, 2004 the stock did average above the $7.00 per share required level and will be re-classed from debt to equity in the next accounting period.

All Wells Fargo Bank, N. A. (WFB) debt agreements contain certain requirements and covenants, regular reporting, dividend limitations, financial ratios and limits on the amount of annual capital expenditures. At June 30, 2004, the Company was in violation of one of its covenant requirements.

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On July 20, 2004, WFB waived this specific requirement of the loan agreement for the June 30, 2004 measurement date. On July 23, 2004, WFB amended the lending agreement regarding net income requirements for the third and fourth quarter of 2004 and increased the line of credit from $7 million to $8 million. Due to the maturity date on the line of credit being June 30, 2005 the line of credit debt was classified as a current liability at June 30, 2004 (balance as of June 30, 2004 was $6,967,656).

NOTE 5. NET INCOME PER COMMON SHARE

The following is a reconciliation of the numerators and the denominators of the basic and diluted per common share computations.

	Three Months Ended June 30, — 2004	2003	Six Months Ended June 30, — 2004	2003
Basic
Earnings Per Common Share
Net
income, as reported	$ 104,984	$ 226,786	$ 148,033	$ 348,311
Weighted
average common shares outstanding	2,550,391	2,473,760	2,545,028	2,465,122
Basis
earnings per common share	$ 0.04	$ 0.09	$ 0.06	$ 0.14
Diluted
Earnings Per Common Share
Net
income, as reported	$ 104,984	$ 226,786	$ 148,033	$ 348,311
Weighted
average common shares outstanding	2,550,391	2,473,760	2,545,028	2,465,122
Stock
options	49,695	38,968	54,754	46,793
Weighted
average common shares for diluted earnings per common share	2,600,086	2,512,728	2,599,782	2,511,915
Diluted
earnings per common share	$ 0.04	$ 0.09	$ 0.06	$ 0.14

For the three and six month periods ended June 30, 2004, 7,427 and 8,523 shares, respectively, were excluded from the computation of diluted earnings per share as shares were antidilutive. For the three and six month periods ended June 30, 2003, 0 and 9,195 shares were excluded from the computation of diluted earnings per share, as these shares were antidilutive.

NOTE 6. FOREIGN CURRENCY TRANSLATION

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

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NOTE 7. COMPREHENSIVE INCOME

Comprehensive income is comprised of net income and other comprehensive income (loss). Other comprehensive income (loss) includes gains and losses resulting from foreign currency translations. The details of comprehensive income are as follows:

	Three Months Ended June 30, — 2004		2003	Six Months Ended June 30, — 2004		2003
Net Income, as
reported	$ 104,984		$ 226,786	$ 148,033		$ 348,311
Other
Comprehensive Income (Loss):
Currency
Translation Adjustment	(7,119	)	7,461	(7,119	)	(19,225	)
Comprehensive
Income	$ 97,865		$ 234,247	$ 140,914		$ 329,086

NOTE 8. CONTINGENCIES

The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. Subsequent to June 30, 2004 the company reached a settlement on August 3rd, 2004, on a litigation filed against it in the amount of $187,500. The company is pursuing insurance reimbursement and received advise from external counsel that recovery is deemed probable, and accordingly accrued the $187,500 settlement and $137,500 as a receivable in the June 30th, 2004 Financial Statements.

NOTE 9. LIQUIDITY

The Company has financed its liquidity needs over the past several years through revenue generated from operations and an operating line of credit through Wells Fargo Bank. The company currently has $8 million line of credit arrangement that on June 30, 2004 had outstanding $6.97 million. Due to the maturity date on the line of credit being June 30, 2005 the line of credit debt was classified as a current liability at June 30, 2004. The Company expects to renew its line of credit in March of 2005. The Company believes that its future financial requirements can be met with funds generated from the operating activities and its operating line of credit.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIA L CONDITION AND RESULTS OF OPERATIONS

Overview

Nortech Systems, Inc. is a full-service Electronic Manufacturing service (EMS) provider of wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds for a wide range of industries. The Company reported record net sales of $18.0 million for the second quarter ended June 30, 2004, up 20 percent over the $15.0 million the company reported in the first quarter. Net income totaled $104,984, or $0.04 per share, up 144 percent over the first quarter. Operating income totaled $169,984, a sequential increase of 146 percent. Compared to the second quarter of 2003, revenue for the period was up 24 percent; net income was down 54 percent versus the same period last year.

We had solid revenue growth across our company and setting a new quarterly sales record Our Aerospace Systems division, for example, revenue surged more than 50 percent over the first quarter and our Electronics division saw a 25 percent revenue increase. We continue to be very encouraged by a strong backlog in our commercial wire products operations – up 60 percent over the same point in 2003. Nortech Systems also made progress at its facility in Mexico during the second quarter, both in revenue and income, including an operating profit in June. The company believes that this facility will break even in the second half of the year and become profitable with anticipated new business and increased plant utilization.

(1.) Results of Operations:

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

	Three Months Ended June 30, — 2004	2003	Six Months Ended June 30, — 2004	2003
Net Sales	100 %	100 %	100 %	100	%
Cost of Good
Sold	89 %	88 %	90 %	88	%
Gross Profit	11 %	12 %	10 %	12	%
Selling Expenses	5 %	5 %	4 %	5	%
General and
Administrative Expenses	5 %	5 %	5 %	5	%
Income from
Operations	1 %	2 %	1 %	2	%
Other Expenses,
Net	0 %	0 %	0 %	(1	)%
Income Tax
Expense	0 %	0 %	0 %	0	%
Net Income	1 %	2 %	1 %	1	%

Net Sales:

The Company reported net sales of $18,028,197 and $14,486,982 for the three months ended June 30, 2004 and 2003, respectively. The growth of 24% is primarily due to increased sales in our Industrial Electronic Assemblies and Aerospace/Defense sectors resulting from the continued economic recovery

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as well as new business being awarded to our Mexico operation. This increase was partially offset by a reduction in Medical products that went overseas. The Company reported net sales of $33,074,282 and $28,257,270 for the six months ended June 30, 2004 and 2003, respectively. Sales for these six months increased 17%, most noticeably in the Industrial Electronic Sector and Mexico operation as stated above.

Gross Profit:

The Company had gross profit of $1,918,522 or 11% compared to gross profit of $1,734,735 or 12% for the three months ended June 30, 2004 and 2003, respectively. For the six months ended June 30, 2004 the Company had gross profit of $3,423,394 or 10% compared to gross profit of $3,384,235 or 12% for June 30, 2003. The decrease in gross profit margins, for both the current quarter and year to date, is the result of market pressure from offshore competition, material price increases, component availability and the additional start-up costs with the Mexico operation. There was improvement in the gross profit percentage over the first quarter performance due to a favorable product mix.

Selling Expense:

The Company had selling expenses of $892,747 or 5% of net sales compared to $682,743 or 5% of net sales for the three months ended June 30, 2004 and 2003, respectively. For the six months ended June 30, 2004 the Company had selling expense of $1,482,170 or 4% compared to selling expense of $1,356,576 or 5% for June 30, 2003. The Company has continued to invest in sales support and resources in order to improve the quality, focus and footprint of our customers.

General and Administrative Expense:

The Company’s general and administrative expenses were $847,031 or 5% of net sales and $760,906 or 5% of net sales for the three months ended June 30, 2004 and 2003, respectively. For the six months ended June 30, 2004 the Company had general and administrative expense of $1,547,305 or 5% compared to general and administrative expense of $1,467,458 or 5% for June 30, 2003. The overall dollar increase of general and administrative expenses through the first six months of 2004 is due to increases in the use of consulting services, higher medical expenses and continued investment in infrastructure to support growth.

Other Expense:

Other Expenses, Net were $8,761 for three months ended June 30, 2004 compared to $39,300 for the three months ended June 30, 2003. For the six months ended June 30, 2004, Other Expenses, Net were $154,886 compared to Other Expenses of $109,890 for June 30, 2003. The increase is due to higher carrying amounts of debt over the past six months in comparison to past periods. This increase was partially offset by increased income for commissions from China-based revenue and other interest income.

Income Tax:

Income tax expense for the three months ended June 30, 2004 is $65,000, or 38% of income from operations compared to $25,000, or 10%, for the three months ended June 30, 2003. Income tax expense for the six months ended June 30, 2004 is $91,000, or 38%, compared to $102,000, or 23%, for the six months ended June 30, 2003. The tax rate for 2004 is expected to approximate 38%.

During the second quarter of 2003, the Company recorded $65,000 of benefit for a refund claim relating to Minnesota research and development tax credits for years 1999, 2000 and 2001. The resulting rate for the quarter of 10% is comprised of 36% from core operations and (26%) from the aforementioned benefit. The resulting rate for the six month period of 23% is comprised of 36% from core operations and (13%) from the aforementioned benefit.

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Backlog:

The Company’s 90-day order backlog was approximately $12,200,000 as of June 30, 2004, compared with approximately $11,800,000 at the beginning of the quarter. Based on the current conditions, the Company anticipates revenue levels in the third quarter of 2004 to be about the same as second quarter of 2004.

(2.) Liquidity and Capital Resources

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

At June 30, 2004, the Company classified its line of credit as a current liability based on the maturity date of June 30, 2005. At December 31, 2003, 2002 and 2001, the line of credit was classified as a long term liability since maturity dates extended beyond one year. Therefore, in order to present the following ratios as comparable to the prior periods, the line of credit at December 31, 2003, 2002 and 2001 has been included in the current liabilities to compute the ratios below. This classification differs from that reported in the Company’s annual filings with the SEC in order to present meaningful comparisons below.

	June 30, 2004	December 31, 2003*	December 31, 2002*	December 31, 2001*
Current Ratio (Current Assets /
Current Liabilities)	1.65	1.80	1.80	1.67
Working Capital (Current Assets –
Current Liabilities)	$ 11,082,465	$ 10,816,072	$ 9,843,203	$ 9,429,646
Quick Ratio (Cash + Accounts
Receivable / Current Liabilities)	0.70	0.81	0.65	0.66
Accounts Receivable to Working Capital (Average Accounts
Receivable/ Working Capital)	0.89	0.85	0.85	0.94
Inventory to Working Capital (Average Inventory/
Working Capital)	1.16	1.11	1.26	1.28

• Re-classed as noted in above comments.

The Company’s working capital increased to $11,082,465 at the close of second quarter 2004 from $10,816,072 at December 31, 2003. The ratios above have remained relatively consistent with that of prior periods. The Company expects to renew its line of credit in March of 2005. The Company believes that its future financial requirements can be met with funds generated from the operating activities and its operating line of credit.

The Wells Fargo Bank line of credit arrangement, which increased $1,000,000 to $8,000,000 on July 23, 2004, is for general working capital needs, and no material unused sources of liquidity other than the cash, accounts receivables, inventory and other current assets. The line of credit and other installment debt with Wells Fargo Bank, N.A., contain certain covenants, which, among other things, will require the Company to adhere to regular reporting requirements, abide by annual shareholder dividend limitations, maintain certain financial ratios, and limit the amount of annual capital

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expenditures. At June 30, 2004, the Company was in violation of the net income covenant which it has received a waiver from its lender on July 23, 2004.

	June 30, 2004		June 30, 2003
Cash flows provided by / (used for):
Operating Activities	$ 293,550		$ 944,637
Investing Activities	(525,691	)	(489,037	)
Financing Activities	953,012		(173,368	)
Effect of exchange rate changes on cash	(3,683	)	(7,808	)
Net increase in cash and cash equivalents	$ 717,188		$ 274,424

The increase in cash and cash equivalents was funded by the increase in operating activities; majors changes were in accounts payable and inventory due to sales growth of 24% in June and 17% year to date. The Company’s net Investing and Financing activities increased cash by approximately $427,000, which was largely comprised of the increased line of credit. The $250,000 acquisition of inventory and assets from Zachariah and Lundbergh, Inc. (Z&L), a manufacturer of camera power supplies and cable assemblies will be funded primarily by operating activities. The products acquired from Z&L fit the growth strategy of the Company and provides valuable expansion and diversification opportunities for the Intercon I product line. The Company continues to reinvest in equipment funded by the available line of credit.

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3.) Critical Accounting Policies

Revenue Recognition:

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

Allowance for Uncollectible Accounts:

We evaluate our allowance for doubtful accounts on a quarterly basis and review any significant customers with delinquent balances to determine future collectibility. We base our determinations on legal issues (such as bankruptcy status), past history, current financial and credit agency reports, and experience. We reserve accounts deemed to be uncollectible in the quarter in which we make the determination. We maintain additional reserves based on our historical based debt experience. We believe these values are estimates and may differ from actual results. We believe that, based on past history and credit policies, the net accounts receivable are of good quality.

Inventory Reserves:

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

Deferred Tax Valuation:

At June 30, 2004 and December 31, 2003, the Company has recorded U.S. deferred tax assets pertaining to the recognition of future deductible temporary differences. The Company has not provided any valuation allowance with respect to these assets, as it believes its realization is “more likely than not.” This determination is primarily based upon our expectation that future U.S. operations will be sufficiently profitable, as well as various tax, business and other planning strategies available to the Company. We cannot assure you that we will be able to realize this asset or that future valuation allowances will not be required. The failure to utilize this asset would adversely affect our results of operations and financial position.

Long-Lived and Intangible Asset Impairment:

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

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

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

(4.) Forward-Looking Statements

Those statements in the foregoing report that are not historical facts are forward-looking statements made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements generally will be accompanied by words such as “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “intend,” “possible,” “potential,” “predict,” “project,” or other similar words that convey the uncertainty of future events or outcomes. Although Nortech Systems, Inc. believes these forward-looking statements are reasonable, they are based upon a number of assumptions concerning future conditions, any or all of which may ultimately prove to be inaccurate. Forward-looking statements involve a number of risks and uncertainties. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation:

• Volatility in the marketplace which may affect market supply and demand the Company’s products;

• Increased competition;

• Changes in the reliability and efficiency of operating facilities or those of third parties;

• Risks related to availability of labor;

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

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in market risk from what was reported on Form 10-K for the year ended December 31, 2003.

*ITEM 4. CONTROLS AND PROCEDURES*

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of June 30, 2004 . Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized

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and reported within the time periods specified in the SEC’s rules and regulations and are operating in an effective manner.

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during the fiscal quarter ended June 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II

*ITEM 1. LEGAL PROCEEDINGS:*

See Part I - Note 8 of the Financial Statements regarding litigation.

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

The Annual Meeting of Shareholders of Nortech Systems Incorporated (the “Company”) was at the Wayzata Country Club, 200 West Wayzata Boulevard, Wayzata, Minnesota, on May 13, 2004, at 4:00 p.m., for the following purposes:

1. To consider and act upon the Board of Directors’ recommendation to fix the number of directors of the Company at five;

2. To elect a Board of Directors to serve for a one-year term and until their successors are elected and qualify;

3. To transact such other business as may properly come before the meeting or any adjournment thereof.

Results of the Voting:

Item #	Total Votes	For	Against	Abstentions
1	2,230,362	2,220,868	4,304	5,190
2	2,225,642	2,171,698	53,944	0
3	1,698,622	1,555,508	138,344	4,770

ITEM 6. EXHIBITS AND REPORT S ON FORM 8K

(a)
31.1	Certification of
the Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a),
promulgated under the Securities Exchange Act of 1934, as amended.
31.2	Certification of
the Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a),
promulgated under the Securities Exchange Act of 1934, as amended.
32.1	Certification of
the Chief Executive Officer and Chief Financial Officer, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.

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(b) Reports on Form 8-K

None

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Signatures

Pursuant to the requirements 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.

| Date: August 12,
2004 | by | /s/ Michael J. Degen |
| --- | --- | --- |
| | Michael J. Degen | |
| | President and Chief | |
| | Executive Officer | |
| Date: August 12, 2004 | by | /s/ Richard G.
Wasielewski |
| | Richard G. Wasielewski | |
| | Chief Financial Officer | |

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