NORTECH SYSTEMS INC - Annual Report: 1999 (Form 10-K)

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

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 1999

For the transition period from                to                

Commission file number 0-13257

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

Registrant's telephone No., including area code: (612) 473-4102

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

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 per share par value.

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

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

   Based upon the $4.75 per share average of the closing bid and asked prices, respectively, on March 14, 2000 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 $5,377,565.

   As of March 19, 2000 there were 2,353,859 shares of the Company's $.01 per share par value common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

   The following documents are incorporated by reference to the parts indicated of the Annual Report on Form 10-K:

NORTECH SYSTEMS INCORPORATED
Annual Report on Form 10-K
for the year ended December 31, 1999

INDEX

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PART I

ITEM 1.  BUSINESS

Description of Business

    Nortech Systems Incorporated (the "Company") is a Minnesota corporation organized in December 1990. Prior to December 1990, the Company operated as DSC Nortech, Inc., which filed a petition for reorganization under Chapter 11 of the United States Bankruptcy Code during 1990. The business and assets of DSC Nortech, Inc. were transferred to Nortech Systems Incorporated during 1990. The Company's headquarters are in Wayzata, Minnesota, a suburb of Minneapolis, Minnesota. The Company's maintains various manufacturing facilities in Minnesota locations of Bemidji, Fairmont, Plymouth, Aitkin, and Merrifield as well as Augusta, Wisconsin. The Company manufactures wire harnesses, cables, electronic sub-assemblies and components, printed circuit board assemblies as well as large-screen high-resolution video monitors for radar, document and medical imaging. The Company provides a full "turnkey" contract manufacturing service to its customers. A majority of revenue is derived from products that are built to the customer's design specifications. Nortech Medical Services, Inc., it's wholly owned subsidiary, provides service bureau and office management services to physicians and clinics throughout Minnesota.

    The Company believes it provides a high degree of manufacturing sophistication. This includes the use of statistical process control to insure product quality, state-of-the-art materials management techniques, allowing just-in-time (JIT) delivery of products, and the systems necessary to effectively manage the business. This level of sophistication enables the Company to attract major original equipment manufacturers (OEM).

    The strategy of the Company in that regard has been to expand its customer base, and has added several new customers from various industries; including Companies engaged in the production of medical products, super computers, mid-size and micro computer business systems, automotive industry, defense industry and industrial products. The Company strategy is to develop a customer base spanning several industry segments to avoid the affects of fluctuations within a given industry. Some of the Company's major customers are G.E. Medical Systems, Raytheon, SPX Corporation, Imation, Thermo King, Polaris, Fisher-Rosemount, 3M, Allen-Bradley, Restaurant Technology Inc and United Defense.

    The Company believes that contract manufacturing will continue to grow and expand in the United States because contract manufacturing provides OEMs with the domestic equivalent of off-shore sourcing without the associated logistical problems. The contract manufacturer can provide an OEM with a quality product at a price well below that available in the OEM's own facility. This is due primarily to the specialization available through the contract manufacturer and the significantly lower overhead costs.

    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. During 1999 this business was designated to be discontinued.

    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 as well as repair services on internally and externally produced monitors, until June 1999 when these operations were discontinued.

    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

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the manufacturing of custom designed, high-technology electronic cable assemblies for various applications.

    In November 1996, the Company acquired the inventory and fixed assets of Zercom Corporation, a subsidiary of Communication Systems, Inc. The Company has been, and continues to be a contract manufacturer of electronic sub-assemblies and components.

    At December 31, 1998, the Company reported segment information of its three identifiable segments; Contract Manufacturing, Display Products and Medical Management. However, on June 30, 1999, the Company formally adopted a plan to dispose of two of the segments, including Display Products and Medical Management. Thus, the Company's remaining continuing operations fall within the Contract Manufacturing segment.

Marketing and Sales

Business Strategy

    The Company believes the electronic manufacturing sub-contracting business is emerging from a small job shop oriented business into a dynamic, high technology electronics industry. The Company operates mainly in the wire harness and cable assemblies market, and intends to expand from this market segment into complete electromechanical assemblies using the resources acquired from the recent addition of Zercom Corporation. Many companies no longer perform this type of work on a captive, in-house basis, as they are finding that independent subcontractors can more cost effectively perform this specialized work.

    As part of the Company's commitment to quality, the Bemidji location became ISO 9002 Certified in July 1995, the Merrifield Division became ISO 9002 Certified in October, 1998, the Intercon I operation became ISO 9002 certified in October, 1999, and continue to actively maintain their certification. The Company believes this certification benefits its current customer base as well as attracts new business opportunities.

    The Company will continue its commitment to quality, cost effectiveness and responsiveness to customer requirements. To achieve these objectives, the Company will provide complete manufacturing services to customers, from the procurement of materials to the manufacturing, testing and shipping of products. The Company will continue its efforts to diversify its customer base and expand into other segments of the electronic manufacturing subcontract business.

Marketing.

    The Company is continuing to concentrate its marketing activities in the medical, industrial, automotive and military manufacturing industries. The emphasis continues to be on mature companies, which require a contract manufacturer with a high degree of manufacturing and quality sophistication, including statistical process control (SPC) 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

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are purchased directly from the component manufacturers or from their distributors. On occasion some components may be placed on a stringent allocation basis; however, due to the excess manufacturing capacity currently available at most component manufacturers, the Company does not anticipate any major material purchasing or availability problems occurring in the foreseeable future.

Patents and Licenses

    The Company is not presently dependent on a proprietary product requiring licensing, patent, copyright or trademark protection. There are no revenues derived from a service-related business for which patents, licenses, copyrights and trademark protection are necessary for successful operations.

Competition

    The contract manufacturing industry is characterized by competition among a variety of sources, including small closely held companies, larger full-service manufacturers, company-owned facilities and foreign competitors. The Company does not believe that the smaller operations are significant competitors, as they do not seem to have the capabilities required by target customers of the Company. The Company also believes that foreign competitors do not provide a substantial competitive threat because the cable and wire harness industry involves a high weight-to-cost ratio. Consequently, shipping and transportation costs decrease the ability of foreign manufacturers to compete in this market segment. Further, off-shore production cannot effectively meet the requirements of engineering change order activities, engineering support, delivery flexibility and just-in-time inventory management techniques presently being implemented by many major target customers. Therefore, the Company's principal competitors are larger full-service manufacturers, many of which have substantially far greater assets and capital resources than are available to the Company and are better financed than the Company.

    The Company will continue to pursue marketing opportunities in the Upper Midwest. Although there presently are no dominant contract manufacturers in the wire harness and cable or higher level build assembly business in the Upper Midwest, there are several established competitors. The Company expects its major competition to come from Americable, OEM Worldwide, MSL, Technical Services, Inc. and Waters Instruments, Inc., all of which are located in Minnesota. Each of these companies specializes in molded cables or wire assemblies and has sufficient manufacturing capabilities to offer a significant competitive challenge to the Company's operations. The principal competitive factors in the contract manufacturing industry are price, quality and responsive service. The Company believes that it can compete favorably in the market segments to which it sells.

Backlog

    Historically, the Company's backlog has been running 60 to 90 days, depending on the customer. However, because of the increased emphasis on just-in-time manufacturing (JIT), many of the Company's major customers are taking advantage of the Company's ability to service them adequately under the JIT concept. Additionally, because of the Company's quality history with customers, many products now go directly from the Company's shipping dock to the customer's production line.

    The Company's 90 day order backlog was approximately $9,210,000 on December 31, 1998 and approximately $9,705,000 on December 31, 1999.

Major Customers

    The Company sells its products to companies in the computer, medical, governmental and various other industries. Historically, the Company has not experienced significant losses related to the receivables from customers in any particular industry or geographic area.

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    Only one customer accounted for more than 10% of sales for the year ended December 31, 1999, G.E. Medical at 12.1% of sales.

Research and Development

    The Company expended no dollars in 1999, $337,093 in 1998, and $258,712 in 1997 on Company-sponsored research and development. This research was related to the development of large-screen, high-resolution video monitors for the Imaging Division.

Compliance with Environmental Provisions

    Management believes that its manufacturing facilities are currently operating under compliance with local, state, and federal environmental laws. Any environmental-oriented equipment is capitalized and depreciated over a seven-year period. The annualized depreciation expense for this type of environmental equipment on a Company-wide basis is insignificant.

Employees

    The Company has 473 full-time, 128 part-time and 94 temporary employees as of December 31, 1999, consisting of 648 employees in manufacturing, manufacturing product support and medical support services and 47 in general administration.

ITEM 2.  PROPERTIES

    The Company's headquarters consist of approximately 1,500 square feet located in Wayzata, Minnesota, a western suburb of Minneapolis, Minnesota. The Company has a lease for a five year term that expires in June 30, 2002. The Company owns its Bemidji, Minnesota facility consisting of eight acres of land and 60,000 square feet of office and manufacturing space and owns another 20,000 square feet of manufacturing and office space in Augusta, Wisconsin.

    The Company's Imaging and Medical Services division operates from a facility located in Plymouth, Minnesota. The building contains approximately 22,800 square feet and is leased for a term that terminates on May 31, 2000. The Company will not extend the lease.

    The Company also owns three buildings which contain approximately 46,900 square feet and are located in Fairmont, Minnesota, which are used for the manufacturing of the Company's custom designed, high-technology electronic cable assemblies.

    In connection with the Zercom acquisition, the Company acquired the building with approximately 45,800 square feet in Merrifield, Minnesota. This facility is used for the building of surface mount printed circuit board assemblies and electro-mechanical assemblies. A leased building in Aitkin, Minnesota provides 10,750 square feet for video cable assembly and is leased for a term that terminates December 1, 2005.

    The Company believes that each of these locations is adequate and will be adequate in the foreseeable future for their manufacturing needs.

ITEM 3.  LEGAL PROCEEDINGS

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

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

    No matters required to be reported under the instructions to this item have been submitted to a vote of security holders which.

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PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

    The Company's Common Stock is traded on the NASDAQ Small Cap Market under the symbol NSYS.

    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:

    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 19, 2000, there were approximately 1,274 holders of shares of the Company's Common Stock. The Company has never paid a cash dividend on shares of its Common Stock and does not intend to pay cash dividends in the foreseeable future.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

ITEM 6.  SELECTED FINANCIAL DATA

(Restated to show Continuing Operations Only)

•

Company acquired the assets of Zercom Corporation in November, 1996.



•

Company acquired the assets of Monitor Technology in March, 1995, and Aerospace Systems in August, 1995.




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

•

Results are restated to reflect the affect of Discontinued Operations.

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

Results of Continuing Operations, Years Ended December 31, 1999, 1998, and 1997

Revenues

    For the years ended December 31, 1999 and 1998 the Company had sales of $38,482,335 and $35,356,813 respectively. The increase of $3,125,522 or 8.8% resulted primarily from internal growth of our current customer base. For the year ended December 31, 1997 the Company had sales of $32,907,135. The approximate 7.4% increase in sales in 1998 was attributable primarily to internal growth of our current customer base.

Gross Profit

    The Company had gross profit of $6,510,781 in 1999, $5,800,491 in 1998, and $6,325,710 in 1997. Gross profits as a percentage of gross sales were 16.9% in 1999, 16.4% in 1998, and 19.2% in 1997. The Company has experienced gross profit pressure, evolving from a change of product mix and material content offset by some improvement in manufacturing productivity.

Selling, General, and Administrative

    Selling, general, and administrative expenses were $4,046,524 in 1999, $3,784,331 in 1998, and , $3,797,668 in 1997. The increases each year reflect additional selling, general and administrative expenses associated with increased revenues.

Miscellaneous Income

    Miscellaneous income was $39,172 in 1999, $18,482 in 1998, and $17,520 in 1997. The miscellaneous income resulted primarily from charges for interest income and miscellaneous services.

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Interest Expense

    Interest expense was $818,553 in 1999, $922,431 in 1998, and $939,049 in 1997.

Income Taxes

    Income tax expense was $641,000 in 1999, $311,000 in 1998, and $570,000 in 1997.

    The Company has recorded deferred tax assets of $2,261,000, the realization of the deferred tax asset is dependent upon the Company generating sufficient taxable earnings in future periods. In determining that realization of the deferred tax asset is more likely than not, the Company gave consideration to recent earnings history, its expectation for taxable earnings in the future and the expiration dates associated with tax carryforwards.

Net Income

    The Company's net income in 1999 was $1,070,799 or $.46 per common share. The Company's net income in 1998 was $826,009 or $.35 per common share. The Company's net income in 1997 was $1,073,903 or $.45 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 decreased from $10,984,033 as of December 31, 1998, to $9,691,189 on December 31, 1999. Stockholders equity decreased from $8,364,571 on December 31, 1998, to $6,378,480 on December 31, 1999 due to the Company's 1999 net loss from discontinued operations. The Company's liquidity and capital resources are strong, and the Company believes that its future financial requirements can be met with funds generated from the operating activities and from the Company's operating line of credit.

Update on Year 2000 Status

    Nortech Systems Inc incurred no major Y2K related problems in January, 2000 and does not anticipate any in the future. The Company will continue to evaluate its systems to ensure that any potential issues can be quickly addressed.

ITEM 7a.  QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

    Upward and downward changes in market interest rates and their impact on the reported interest expense of the Company's variable rate borrowings will effect the Company's future earnings. However, a ten-percent change in the 1999 effective average interest rate on variable earnings should not have a material effect on the Company's earnings for 2000.

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ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

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INDEPENDENT AUDITOR'S REPORT

Board of Directors
Nortech Systems Incorporated and Subsidiary
Bemidji, Minnesota

    We have audited the accompanying consolidated balance sheets of Nortech Systems Incorporated and Subsidiary as of December 31, 1999 and 1998, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. 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, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles.

LARSON, ALLEN, WEISHAIR & CO., LLP

St. Cloud, Minnesota
February 11, 2000

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 1999 AND 1998

See accompanying Notes to Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997

See accompanying Notes to Consolidated Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997

See accompanying Notes to Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997

See accompanying Notes to Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

NOTES TO FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997

NOTE 1  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business Description

    Nortech Systems Incorporated (the "Company") is a Minnesota corporation with headquarters in Wayzata, Minnesota, a suburb of Minneapolis, Minnesota. The Company has manufacturing facilities and engineering support located in Bemidji, Fairmont, 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 provides a full "turn-key" contract manufacturing service to its customers. All products are built to the customer's design specifications.

Use of Estimates

    The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates.

Principles of Consolidation

    The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All significant intercompany accounts and transactions have been eliminated.

Receivables

    The Company provides an allowance for doubtful receivables which is offset against the gross amount of customer receivables. The allowance for doubtful receivables is an estimate of collection losses that may be incurred in the collection of all receivables. The allowance is based upon historical experience coupled with management's review of the current status of the existing receivables. The allowance for doubtful receivables for continuing operations was $102,030 and $111,627 at December 31, 1999 and 1998, respectively.

Inventories

    Inventories are stated at the lower of cost (first-in, first-out method) or market (based on the lower of replacement cost or net realizable value).

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.

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Depreciation

    Property and equipment are depreciated by the straight-line and accelerated methods of depreciation over their estimated useful lives. Accelerated depreciation did not materially exceed straight-line depreciation for the years ended December 31, 1999, 1998, and 1997.

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 is being amortized on a straight-line basis over the period of expected benefit of fifteen years. Total amortization of goodwill recorded from continuing operations for fiscal years 1999, 1998 and 1997 was $8,121, $8,121, and $8,782, respectively. The carrying value of goodwill is reviewed periodically based on the undiscounted cash flows of the entity acquired over the remaining amortization period. Should this review indicate that goodwill will not be recoverable, the Company's carrying value of the goodwill will be reduced by the estimated shortfall of undiscounted cash flows.

Intangible Assets

    Intangible assets including purchased technology and certification costs are being amortized over a period of 3 to 7 years. The related amortization expense from continuing operations for fiscal years 1999, 1998 and 1997 was $8,151, $8,151, and $47,151 respectively.

Cash and Cash Equivalents

    The Company considers its investments with an original maturity of three months or less to be cash equivalents. The Company had interest bearing cash amounting to $250,700 and $203,886 at December 31, 1999 and 1998, respectively.

    During 1998, the Company recorded a reduction of $300,000 in a long-term note pursuant to a 1996 asset purchase agreement. In addition, accounts payable includes $150,000 of costs to acquire product technology. Also goodwill was reduced by $102,000 as a result of an adjustment to the purchase price of an acquired business.

Advertising

    Advertising costs are charged to operations as incurred. Total amounts charged to expense for continuing operations were $139,594, $93,094, and $97,785 for the years ended December 31, 1999, 1998, and 1997, 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

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bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.

Preferred Stock

    Preferred stock issued is noncumulative and nonconvertible.

Fair Value of Financial Instruments

    The carrying amounts for all financial instruments approximate fair values. The carrying amounts for cash, receivables, accounts payable and accrued liabilities approximate fair value because of the short maturity of these instruments. The carrying value of long-term debt materially approximates fair value based on current rates at which the Company could borrow funds with similar remaining maturities.

Cash Flow Information

    The Company received a net income tax refund of $6,461 for the year ended December 31, 1999 and paid income taxes of $189,843 and $56,400 for the years ended December 31, 1998 and 1997, respectively. Continuing operations of the Company paid interest expenses of $840,746, $949,279 and $913,660 for the years ended December 31, 1999, 1998 and 1997.

Reclassifications

    Certain reclassifications have been made to the 1998 financial statements to conform with the 1999 presentation. Such reclassifications had no impact on net income (loss) or equity.

Segment Reporting Information

    At December 31, 1998 the Company reported segment information of their three identifiable segments, Contract Manufacturing, Display Products and Medical Management. However, as disclosed in Note 8 "Discontinued Operations", the Company has formally adopted a plan during 1999 to dispose of two of the segments, including Display Products and Medical Management. The Company's remaining continuing operations fall with the scope of the Contract Manufacturing operating segment.

NOTE 2  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 $405,000 and $166,225 at

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December 31, 1999 and 1998, respectively. The Company has not experienced any losses in any of the short-term investment instruments it has used for excess cash balances.

    One customer accounted for approximately 12.1% and 12.7% of sales for the years ended December 31, 1999 and 1998.

NOTE 3  INVENTORIES

    Inventories consist of the following:

NOTE 4  PREPAID EXPENSES AND OTHER

    The Company has a $14,000 note receivable with its President at December 31, 1999. The unsecured note is non-interest bearing and matures in 2000.

NOTE 5  CONTINGENT LIABILITIES

    The Company has self insured its employee health and dental plans. It has contracted with two separate administrative service companies to supervise and administer the programs and act as representatives. The Company's health plan insures for excessive or unexpected claims and is liable for claims not to exceed $40,000 per family per plan year and an estimated aggregate amount of $1,764,000 for the current plan year. The Company's dental plan does not contain the stop-loss insurance feature and pays claims based on actual amounts incurred. Estimated future claims for incurred health and dental services of approximately $257,420 and $164,695 were recorded as liabilities at December 31, 1999 and 1998, respectively.

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NOTE 6  LONG-TERM DEBT

    Maturity requirements by year on long-term debt are as follows:

    The maximum and average amounts outstanding on the Company's long-term lines of credit were $6,850,000 and $6,569,041 during 1999 and $6,675,000 and $6,317,527 during 1998, respectively.

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NOTE 7  PREFERRED STOCK TRANSACTIONS

    The holders of the preferred stock are entitled to a non-cumulative dividend of 12% when and as declared. In liquidation, holders of preferred stock have preference to the extent of $1.00 per share plus dividends accrued but unpaid. Preferred stock dividends of $0, $0 and $15,040 were paid during the years ended December 31, 1999, 1998, and 1997, respectively.

NOTE 8  DISCONTINUED OPERATIONS

    On June 30, 1999, the Company adopted a formal plan to sell two of their operating segments, Display Products and Medical Management. The anticipated disposal dates are expected to be no later than June 30, 2000. The assets of Display Products to be sold consist primarily of inventories and equipment. The assets of Medical Management to be sold consist primarily of receivables and equipment. Results of these operations for the year ending December 31, 1999 have been classified as discontinued and prior periods have been restated.

    The net assets of the two discontinued segments in the December 31, 1999 balance sheet include:

    The amount of "Loss from Discontinued Operations" for the year ended December 31, 1999 on the accompanying income statement is a combination of the operating results through the measurement

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

    Net sales of the Display Products and Medical Management segments for 1999, 1998 and 1997 were $2,413,638, $4,999,054 and $3,526,783, respectively. These amounts are not included in net sales in the accompanying income statements.

    In February 2000, the fixed assets and inventory of the Display Products segment were sold to Computron Display Systems. Under the terms of the purchase agreement, dated February 22, 2000, the Company sold these assets for $300,000, of which $50,000 will be held in escrow to cover future warranty expenses. These terms are materially consistent with estimates recorded by the Company for 1999.

NOTE 9  LEASE OBLIGATION

    The Company has entered into various operating leases for production and office equipment, office space and buildings. The Company has the option to purchase equipment upon lease expiration at fair market value. The Company also has the option to purchase a building under an operating lease. The monthly rent expense on another building under an operating lease is subject to an annual adjustment for the increase in the Consumer Price Index.

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    Rent expense for the years ended December 31, 1999, 1998, and 1997, was $459,739, $412,714, and $302,695, respectively. The future minimum lease payments are as follows:

NOTE 10  INCOME TAXES

    The provision for income taxes for each of the three years in the period ended December 31, 1999, consists of the following:

    Net deferred tax assets at December 31, 1999 and 1998, consist of the following:

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The statutory rate reconciliation for each of the three years in the period ended December 31, 1999 is as follows:

    The Company has available for Federal income tax purposes, operating loss carryforwards, unused investment and other tax credits which may provide future tax benefits, expiring as follows:

    The Company utilized operating loss carryforwards of $902,000, $506,000 and $1,341,000 for the years ended December 31, 1999, 1998, and 1997, respectively, to offset federal taxable income.

    At December 31, 1998, the Company has Alternative Minimum Tax credit carryforwards of approximately $86,800. These credits do not expire.

NOTE 11  EMPLOYEE STOCK OPTIONS AND AWARD PLANS

    In 1992, the Company approved the adoption of a fixed stock based compensation plan. The purpose of the Plan is to promote the interests of the Company and its shareholders by providing officers, directors and other key employees with additional incentive and the opportunity, through stock ownership, to increase their proprietary interest in the Company and their personal interest in its continued success.

    The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized for the stock option plans. Had compensation cost for the Company's stock option plan been determined based on the fair market value at the grant date consistent with the provisions of

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SFAS No. 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:

    The assumption regarding stock options issued is that compensation cost is recognized over the graded vesting period of the options, which ranges from zero to five years. Options granted before 1995 were not considered in the calculation.

    The fair value of each option grant issued is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

    The total number of shares of common stock that may be granted under the plan is 350,000. The plan provides that shares granted come from the Company's authorized but unissued common stock. The price of the options granted to the plan will not be less that 100% of the fair market value of the shares on the date of grant. Options are generally exercisable after one or more years and expire no later than 10 years from the date of grant.

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Information regarding the Company's common stock options is as follows:

    The following table summarizes information about fixed-price stock options outstanding at December 31, 1999:

    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. 5,748 shares have been issued under this Plan through 6,278 December 31, 1999.

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NOTE 12  SUPPLEMENTARY FINANCIAL INFORMATION