NORTECH SYSTEMS INC - Annual Report: 2000 (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, 2000

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: (952) 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 $8.00 per share average of the closing bid and asked prices, respectively, on March 9, 2001 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 $9,131,232.

   As of March 1, 2001 there were 2,361,192 shares of the Company's $.01 per share par value common stock outstanding.

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DOCUMENTS INCORPORATED BY REFERENCE

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

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NORTECH SYSTEMS INCORPORATED
Annual Report on Form 10-K
for the year ended December 31, 2000

INDEX

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PART I

ITEM 1. BUSINESS

Description of Business

    Nortech Systems Incorporated and Subsidiary (the "Company") is a Minnesota corporation organized in December 1990. Prior to December 1990, the Company operated as DSC Nortech, Inc., which filed a petition for reorganization under Chapter 11 of the United States Bankruptcy Code during 1990. The business and assets of DSC Nortech, Inc. were transferred to Nortech Systems Incorporated during 1990. The Company's headquarters are in Wayzata, Minnesota, a suburb of Minneapolis, Minnesota. The Company maintains various manufacturing facilities in Minnesota locations of Bemidji, Fairmont, Aitkin, and Merrifield as well as Augusta, Wisconsin. The Company manufactures wire harnesses, cables, electronic sub-assemblies and components, and printed circuit board assemblies. The Company provides a full "turnkey" contract manufacturing service to its customers. A majority of revenue is derived from products that are built to the customer's design specifications. 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, Kodak, Thermo King, Polaris, Fisher-Rosemount, 3M, Allen-Bradley, Semitool, Restaurant Technology Inc and United Defense.

    The Company believes that contract manufacturing will continue to grow and expand in the United States and offshore because contract manufacturing provides OEMs with a quality product at a price well below that available in the OEM's own facility. This is due primarily to the specialization available through the contract manufacturer with significantly lower overhead costs and contract manufacturing is solving the logistical problems with offshore manufacturing.

    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. and known as the Company's Medical Management operating segment), also provides service bureau and office management services to physicians. During 1999 this subsidiary was designated a discontinued operation and continues to be classified as such in the consolidated financial statements.

    In March 1995, the Company acquired all of the assets of Monitor Technology Corporation. The Company had continued the business of Monitor Technology Corporation, (named Imaging Technologies and known as the Company's Display Products operating segment, which was 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. In June 1999, the Company adopted a formal plan to discontinue the Imaging Technologies Division and it was subsequently sold in February of 2000.

    In August 1995, the Company acquired all the assets of the Aerospace Division of Communication Cable, Inc. (CCI). The Company has continued the business formerly conducted by CCI, 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. (CSI). The Company has continued the business formerly conducted by CSI, which involves contract manufacturing of electronic sub-assemblies and components.

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

Business Strategy

    The Company believes the electronic manufacturing sub-contracting business is emerging from a small job shop oriented business into a dynamic, high technology electronics industry. The Company operates mainly in the wire harness and cable assemblies market, and intends to expand from this market segment into complete electromechanical assemblies using the resources acquired from the 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 location became ISO 9002 Certified in October, 1998, the Aerospace operation became ISO 9001 certified and AS 9000 recognized in April 1999, the Intercon I location became ISO 9002 certified in October 1999, and all operations continue to actively maintain their certifications. The Company believes these certifications benefit 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 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

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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 The JPM Company, some of which are located in Minnesota. Each of these companies specializes in molded cables or wire assemblies, printed circuit board assemblies and higher level build, 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 $9.7 million on December 31, 1999 and approximately $10.6 million on December 31, 2000. This backlog will be realized as revenue within the first quarter of 2001.

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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    One customer, G.E. Medical, accounted for 13.1% and 12.1% of sales for the years ended December 31, 2000 and 1999, respectively. This reflects Nortech Systems Inc. position as a key supplier to G.E. Medical and the increased growth rate for the medical industry.

Research and Development

    The Company expended no dollars in 2000 and 1999, and $.3 million in 1998 on Company-sponsored research and development. The research amounts expended in 1998 related to the development of large-screen, high-resolution video monitors for the Display Products Segment.

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 604 full-time, 191 part-time and 109 temporary employees as of December 31, 2000, consisting of 845 employees in manufacturing, manufacturing product support and medical support services and 59 in general administration.

ITEM 2. PROPERTIES

    The Company's Corporate Headquarters consist of approximately 3,648 square feet located in Wayzata, Minnesota, a western suburb of Minneapolis, Minnesota. The Corporate Headquarters has a lease with a five-year term that expires in July 31, 2005. 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 20,000 square feet of manufacturing and office space in Augusta, Wisconsin.

    The Company's Medical Management operating segment operates from a facility shared with Corporate Headquarters located in Wayzata, Minnesota.

    The Company also owns three buildings, which contain approximately 46,900 square feet, and are located in Fairmont, Minnesota. The buildings contain the manufacturing activities of Aerospace Systems operation, including 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. The Company also assumed the lease of a separate building in Aitkin, Minnesota, which provides 10,750 square feet for video cable assembly. The lease is scheduled to expire December 1, 2005 at which time the Company has an option to purchase.

    The Company believes that each of these locations is adequate and that space is available if needed in the foreseeable future for their manufacturing needs.

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.

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PART II

ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

    The Company's Common Stock is traded on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") Small Cap Market under the symbol "NSYS".

    The high and low closing sales prices for the Company's Common Stock, as reported on the NASDAQ, for each quarterly period within the two most recent years were as follows:

    These quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission, and may not necessarily represent actual transactions.

    As of March 9, 2001, there were approximately 1,232 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.

ITEM 6. SELECTED FINANCIAL DATA

    The following selected historical financial data set forth below have been derived from, and are qualified by reference to the audited Consolidated Financial Statements of Nortech Systems Incorporated and Subsidiary as of December 31, 2000 and 1999 and for the three years ended December 31, 2000. The audited financial statements of Nortech Systems Incorporated and Subsidiary referred to above are included elsewhere herein. The selected historical financial data set forth below as of December 31, 1998, 1997 and 1996 and for the two years ended December 31, 1997 have been derived from the audited financial statements of Nortech Systems Incorporated and Subsidiary not included herein. The selected financial data set forth below should be read in conjunction with, and are qualified by reference to, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and accompanying notes thereto of Nortech Systems Incorporated and Subsidiary included elsewhere herein.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARIES

*

Company acquired the assets of Zercom Corporation in November 1996.

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    Certain amounts above have been restated to reflect the results of continuing operations.

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

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

Results of Continuing Operations, Years Ended December 31, 2000, 1999, and 1998

Revenues

    For the years ended December 31, 2000 and 1999, the Company had sales of $54.8 million and $38.5 million, respectively. The increase of $16.3 million or 42.4%, resulted primarily from internal growth of our current customer base. The major increases were in the medical and industrial industries. The Company's emphasis continues to be on mature companies that require a contract manufacturer with a high degree of manufacturing and quality sophistication. For the year ended December 31, 1998 the Company had sales of $35.4 million, the approximate 8.8% increase in sales in 1999 was attributable primarily to internal growth of our current customer base. The Company expects revenue growth to continue at a moderate rate for year 2001.

Gross Profit

    For the years ended December 31, 2000, 1999 and 1998, the Company had gross profit of $10.4 million, $6.5 million, and $5.8 million, respectively. Gross profits as a percentage of gross sales were 18.9%, 16.9%, and 16.4% for the years ended December 31, 2000, 1999, and 1998, respectively. The Company continues to strive to hold down cost levels by improved productivity and reduced material cost as revenue grows, to help offset the request for price reductions from customers. The price competitive nature of the business requires the use of service, quality and timely delivery to help attract customers.

Selling, General, and Administrative

    Selling, general, and administrative expenses were $6.3 million, $4.1 million, and $3.8 million for the years ended December 31, 2000, 1999, and 1998, respectively. The majority of the increase from 1999 to 2000 reflected the additional costs related succession planning, incentive compensation and increased use of commissioned sales people contributing to revenue growth.

Miscellaneous Income

    Miscellaneous income was $.016 million, $.039 million and $.0185 million for the years ended December 31, 2000, 1999, and 1998, respectively. The miscellaneous income resulted primarily from charges for interest income and miscellaneous services which vary by year.

Interest Expense

    Interest expense was $.98 million, $.82 million, and $.92 million for the years ended December 31, 2000, 1999 and 1998, respectively. The Company has maintained a level debt by reinvesting the profits in the growth of the Company.

Income Taxes

    Income tax expense was $1.1 million, $.6 million, and $.3 million for the years ended December 31, 2000, 1999, and 1998, respectively.

    The Company utilized operating loss carryforwards of $1.5 million, $.9 million and $.5 million for the years ended December 31, 2000, 1999, and 1998, respectively, to offset federal taxable income. The

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Company also utilized some investment tax credit to offset federal tax and forfeited a small amount of credits due to expiration.

    At December 31, 2000, the Company has available for federal income tax purposes, some unused tax credits, which may provide future tax benefits. These credits begin expiring in 2017. The Company also has Alternative Minimum Tax credit carryforwards of approximately $.1 million. These credits do not expire.

Net Income

    The Company's net income in 2000 was $2.0 million or $.86 per common share. The Company's net income in 1999 was $1.1 million or $.46 per common share. The Company's net income in 1998 was $.8 million or $.35 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 $9.7 million as of December 31, 1999, to $9.6 million on December 31, 2000, due to one long-term note coming due in November 2001. Otherwise working capital would have increased by $2.5 million. Stockholders equity increased from $6.4 million on December 31, 1999, to $8.5 million on December 31, 2000 due to the Company's 2000 net profit from continued 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.

Provision for the Private Securities Litigation Reform Act of 1995

    While this release is based on management's best judgment and current expectations, actual results may differ based on many factors, including the Company's competitive performance and changes in market conditions.

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 2000 effective average interest rate on variable earnings should not have a material effect on the Company's earnings for 2001.

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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, 2000 and 1999, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. 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, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with generally accepted accounting principles.

LARSON, ALLEN, WEISHAIR & CO., LLP

St. Cloud, Minnesota
February 20, 2001

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2000 AND 1999

See accompanying Notes to Consolidated Financial Statements.

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NORTECH SYSTEMS INORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998

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, 2000, 1999, AND 1998

See accompanying Notes to Consolidated Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

See accompanying Notes to Consolidated Financial Statements.

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2000, 1999, AND 1998

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 located in Bemidji, Fairmont, Merrifield and Aitkin, Minnesota as well as 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. Products are sold to customers both domestically and internationally.

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 $187,294 and $102,030 at December 31, 2000 and 1999, 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). Costs include material, labor, and overhead required in the warehousing and production of the Company's products.

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, 2000, 1999, and 1998.

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 each of the three years in the period ended December 31, 2000 was $8,121. 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 each of the three years in the period ended December 31, 2000 was $8,151.

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 $415,937 and $250,700 at December 31, 2000 and 1999, respectively.

Advertising

    Advertising costs are charged to operations as incurred. Total amounts charged to expense for continuing operations were $94,860, $139,594, and $93,094 for the years ended December 31, 2000, 1999, and 1998, 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.

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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.

Stock Based Compensation

    The Company accounts for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Option ("APB") No. 25, "Accounting for Stock Issued to Employees," and complies with the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". Under APB No. 25, compensation costs is determined based on the difference, if any, on the grant date between the fair value of the Company's stock and the amount an employee must pay to acquire the stock. Compensation expense is recognized over the vesting period.

Net Income (Loss) Per Common Share

    The Company computes earnings per share pursuant to SFAS No. 128, "Earnings per Share". In accordance with SFAS No. 128, basic net income (loss) per share is computed using the weighted-average number of common shares outstanding. Diluted income per share is computed using the weight-average number of common shares outstanding and potential common shares from the assumed exercise of stock options outstanding during the period using the treasury stock method.

Cash Flow Information

    The Company received a net income tax refund of $6,461 for the year ended December 31, 1999 and paid income taxes of $80,880 and $189,843 for the years ended December 31, 2000 and 1998, respectively. Continuing operations of the Company paid interest expenses of $996,663, $840,746 and $949,279 for the years ended December 31, 2000, 1999 and 1998, respectively.

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 9 "Discontinued Operations", the Company 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 within the scope of the Contract Manufacturing operating segment.

Recent Pronouncements

    The FASB has issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities". SFAS No. 138 requires companies to record derivatives on the statement of

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financial position, measured at fair value. The statement also sets forth new accounting rules for gains and losses resulting from changes in the values of derivatives. The Company does not currently use derivative financial instruments, and its historical use of such instruments has not been material. The Company will adopt this statement in the first quarter of 2001 to the extent it may apply at that time.

    The FASB has issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." Statement No. 140 replaces the earlier SFAS No. 125 in its entirety. While the new statement revises certain accounting guidance for transfers of financial assets, most of the provisions of SFAS No. 125 have been carried over without reconsideration. SFAS No. 140 if effective for transfers and servicing of financial assets occurring after March 31, 2001, but requires certain disclosure relating to securitizations for fiscal years ending after December 15, 2000. The Company has adopted the disclosure provisions of SFAS No. 140 as of it fiscal year ending December 31, 2000. The accounting provisions of SFAS No. 140 will not impact the Company's financial statements.

NOTE 2  MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

    Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. With regard to cash, the Company maintains its excess cash balances in checking and money market accounts at three high-credit quality financial institutions. These balances exceed the federally insured limit by $288,435 and $405,000 at December 31, 2000 and 1999, respectively. The Company has not experienced any losses in any of the short-term investment instruments it has used for excess cash balances. As for trade accounts receivables, the Company does not require collateral on its receivables; however, credit risk is limited due to the large number of customers comprising the Company's customer base and their dispersion across different geographic areas and industries. Historically, the Company has not suffered significant losses with respect to trade accounts receivable.

    One customer accounted for approximately 13.1%, 12.1% and 12.7% of sales for the years ended December 31, 2000, 1999, and 1998, respectively.

NOTE 3  INVENTORIES

    Inventories consist of the following:

NOTE 4  PREPAID EXPENSES AND OTHER

    The Company had a $14,000 note receivable with its President at December 31, 1999. The unsecured note was non-interest bearing and was paid during 2000.

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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 $50,000 per individual per plan year and an estimated aggregate amount of $2,139,800 for the current plan year. The Company's dental plan pays claims based on actual amounts incurred. Estimated claims for incurred health and dental services of approximately $485,403 and $257,420 were included as other liabilities at December 31, 2000 and 1999, respectively.

    The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of any ultimate liability with respect to these actions will not materially affect the Company's consolidated financial statements or results of operations.

NOTE 6  LONG-TERM DEBT

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

    The weighted average interest rate on the Company's two lines of credit was 9.24% for the year ended December 31, 2000.

    The loan agreement pertaining to Wells Fargo Bank debt contains various covenants requiring maintenance of certain liquidity and debt service coverage ratios and maximum levels of property, plant and equipment acquisitions. At December 31, 2000, the Company is in violation of its current ratio covenant. The bank has waived this specific requirement of the loan agreement for a period of twelve months subsequent to December 31, 2000.

NOTE 7  CAPITAL LEASE

    In January 2000, the former manufacturing facility in Augusta, Wisconsin was traded for a new facility with the same lessor. The Company entered into a capital lease for this location and will take ownership upon maturity. Depreciation on the building under capital lease is included in depreciation expense. The Company's land and building held under the capital lease on the balance sheet consist of the following:

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Minimum future lease obligations on the long-term capital lease in effect at December 31, 2000 are as follows:

    Recording the trade of the prior building and establishment of the capital lease payable resulted in a non-cash transaction of $204,879.

NOTE 8 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. No preferred stock dividends were paid during the years ended December 31, 2000, 1999, and 1998.

NOTE 9 DISCONTINUED OPERATIONS

    On June 30, 1999, the Company adopted a formal plan to sell two of their operating segments, Display Products and Medical Management. On February 22, 2000, the fixed assets and inventory of the Display Products segment were sold to Computron Display Systems. Under the terms of the purchase agreement, the Company sold these assets for $300,000, of which $50,000 will be held in escrow to cover future warranty expenses. The assets of Medical Management to be sold consist primarily of receivables and equipment, with an anticipated disposal date occurring prior to December 31, 2001. Results of these operations for the year ended December 31, 2000 have been recorded against the reserves established in 1999 to absorb future losses on these segments. Results of these operations for the year ending December 31, 1999 have been classified as discontinued and prior periods have been restated.

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    The net current liabilities and net non-current assets of discontinued operations consist of the following:

    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 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 2000, 1999 and 1998 were $619,472, $2,413,638 and $4,999,054, respectively. These amounts are not included in net sales in the accompanying income statements.

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NOTE 10 OPERATING LEASES

    The Company has entered into various operating leases for production and office equipment, office space and buildings. The Company has the option to purchase various equipment upon lease expiration at fair market value. The Company also has the option to purchase the Aitkin manufacturing plant, currently under an operating lease, upon expiration of 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 and expires in February 2001.

    Rent expense for the years ended December 31, 2000, 1999, and 1998, was $619,065, $459,739, and $412,714, respectively. The future minimum lease payments are as follows:

NOTE 11 INCOME TAXES

    The provision for income taxes for each of the three years in the period ended December 31, 2000, consists of the following:

    Net deferred tax assets at December 31, 2000 and 1999, consist of the following:

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    The statutory rate reconciliation for each of the three years in the period ended December 31, 2000 is as follows:

    At December 31, 2000, the Company has available for federal income tax purposes unused tax credits of approximately $60,000 which may provide future tax benefits. These credits begin expiring in 2017. The Company also has Alternative Minimum Tax credit carryforwards of approximately $106,000. These credits do not expire.

    The Company utilized operating loss carryforwards of $1,468,100, $902,000 and $506,000 for the years ended December 31, 2000, 1999, and 1998, respectively, to offset federal taxable income. The Company also utilized $1,400 of an expiring investment tax credit to offset federal tax and forfeited an additional $38,700 of credits due to expiration.

NOTE 12  STOCK OPTIONS AND GAINSHARING INCENTIVE PLANS

Stock Options

    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 options plans. Had compensation cost for the Company's stock option plan been determined based on the fair market value at the grant date consistent with the provisions of SFAS No. 123, the Company's net earnings (loss) and earnings (loss) per share would have been reduced to the pro forma amounts indicated below:

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    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, of which 45,500 shares remain available at December 31, 2000. The plan provides that shares granted come from the Company's authorized but unissued common stock. The price of the options granted under the plan will not be less than 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.

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

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    The following table summarizes information about fixed-price stock options outstanding at December 31, 2000:

Employee Gainsharing

    During 1993, the Company adopted an employee gainsharing 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. During 2000, 3,148 gainsharing shares were issued in connection with this plan resulting in a $11,263 non-cash equity transaction. Through December 31, 2000, 8,896 shares have been issued under this Plan.

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NOTE 13  SUPPLEMENTARY FINANCIAL INFORMATION