Nortech Systems 10K 2003 Annual report

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

FORM 10-K

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

For the fiscal year ended December 31, 2003

NORTECH SYSTEMS INCORPORATED

Commission file number 0-13257

State of Incorporation:    Minnesota
IRS Employer Identification No. 41-16810894
Executive Offices:    1120 Wayzata Blvd E., Suite 201, Wayzata, MN 55391
Telephone number:    (952) 345-2277

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

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $.01 Per Share

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

The aggregate market value of voting stock held by non-affiliates of the registrant, based on the closing price of $8.90 per share, was $11,101,255 on March 12, 2004.

Shares of common stock outstanding at March 1, 2004: 2,512,687

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

DOCUMENTS INCORPORATED BY REFERENCE

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

Parts of Annual Report on Form 10-K		Documents Incorporated by Reference
Part III
	Item 10	Reference is made to the Registrant's
	11	proxy statements to be used in connection
	12	with the 2003 Annual Shareholders'
	13	Meeting and filed with the Securities and Exchange Commission no later than April 30, 2004.

(The remainder of this page was intentionally left blank)

NORTECH SYSTEMS INCORPORATED
ANNUAL REPORT ON FORM 10K
TABLE OF CONTENTS

		PAGE
PART I
Item 1.	Business	4-7
Item 2.	Properties	7-8
Item 3.	Legal Proceedings	8
Item 4.	Submission of Matters to a Vote of Security Holders	8
PART II
Item 5.	Market Price of Stock and Related Matters	8
Item 6.	Selected Financial Data	9
Item 7.	Management's Discussion and Analysis	10-16
Item 7a	Quantitative and Qualitative Disclosure about Market Risk	16-17
Item 8.	Consolidated Financial Statements and Supplemental Data	18-44
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	45
PART III
Item 10.	Directors and Executive Officers of the Registrant	45
Item 11.	Executive Compensation	45
Item 12.	Security Ownership of Certain Beneficial Owners and Management	45
Item 13.	Certain Relationships and Related Transactions	45
Item 14.	Controls and Procedures	45
PART IV
Item 15.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K	46-47
	Signatures and Certifications	48-49
	Index to Exhibits	50

NORTECH SYSTEMS INCORPORATED
FORM 10-K
For the Year Ended December 31, 2003

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 files annual reports, quarterly reports, proxy statements, and other documents with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 (Exchange Act). The public may read and copy any materials that the Company files with the SEC at the SEC's Public Reference Room at 340 Fifth Street N.W., Washington, D.C. 20549. Also, the SEC maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The pubic can obtain any documents that the Company files with the SEC at http:\\www.sec.gov.

The corporation makes available free of charge through its Internet website (http:\\nortechsys.com) the Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Press Releases, and Current Reports on Form 8-K.

GENERAL

The Company's headquarters are in Wayzata, Minnesota, a suburb of Minneapolis, Minnesota. The Company maintains manufacturing facilities in Minnesota including Bemidji, Fairmont, Baxter, and Merrifield as well as Augusta, Wisconsin, and its most recently acquired operation in Monterrey, Mexico. 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.

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 has been to expand and diversify its customer base. The Company has added several new customers from various industries, some of which produce medical products, computers for business systems, products in the automotive and defense industries and industrial products. The Company's strategy is to develop a customer base spanning several industry segments to avoid the effects 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, Cubic, Comtech Mobile, Restaurant Technology Inc., Allen-Bradley, Semitool, Silicon Graphics, Graco, Nilfisk, Medical Reseach Labs and United Defense.

The Company believes that contract manufacturing will continue to grow and expand in the United States and overseas 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 ability to solve logistical problems with offshore manufacturing.

ACQUISITIONS

In June 2002, the Company acquired 100 percent of the outstanding common shares of Manufacturing Assembly Solutions of Monterrey, Inc. (MAS), a Mexican corporation, located in Monterrey, Mexico. The results of operations since this acquisition have been included in the consolidated financial statements. The primary reason for the acquisition was to enhance the Company's manufacturing capabilities in a low cost country. See the consolidated financial statements for more detail on this acquisition.

BUSINESS SEGMENTS

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. During 2002, Display Products and Medical Management segments were sold. Thus, at December 31, 2003, the Company's 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, and printed circuit board assemblies markets, and intends to expand from this market segment into complete electromechanical assemblies. 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.

In accordance with the Company's total commitment to quality, a quality system based on the ISO 9000 standards has been adopted and implemented company-wide. Certification to the ISO standard began in 1995 at the Bemidji, MN facility, and has continued to the point at which all five domestic facilities have now been certified to the latest version of the ISO 9001 standard. The newest facility, Manufacturing Assembly Solutions of Monterrey, Inc. in Mexico, passed certification in October 2003. The Company believes these certifications benefit its current customer base as well as attract new business opportunities.

The Company will continue its commitment to quality, cost effectiveness and responsiveness to customer requirements. To achieve these objectives, the Company has adopted lean manufacturing supply chain management techniques at its facilities. The Company is committed to continuous improvement in order to provide world-class complete manufacturing services to its customers. The Company will also continue its efforts to diversify its customer base and expand into other segments of the electronic manufacturing subcontract business.

MARKETING

The Company concentrates 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), statistical quality control (SQC), International Standards Organization (ISO) and Aerospace Systems 9100 (AS). The Company has initiated efforts to expand its markets beyond the Upper Midwest area. New market opportunities are being pursued in Mexico, Asia and Europe, as well as increased participation in industry publications and selected trade shows. The

Company markets its products and services through internal sales people and 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. The Company's employees are well trained in SPC and SQC.

SOURCES AND AVAILABILITY OF MATERIALS

The Company is not dependent on any one supplier for materials for products sold to customers. Components utilized in the assembly of wire harnesses, cable assemblies and printed circuit assemblies are purchased directly from the component manufacturers or from their distributors. On occasion some components may be placed on a stringent allocation basis; however, due to the excess manufacturing capacity currently available at most component manufacturers, the Company does not anticipate any major material purchasing or availability problems occurring in the foreseeable future.

PATENTS AND LICENSES

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

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 manufacturers. The Company does not believe that the small closely held operations pose significant competitive threat, as they generally do not appear to have the manufacturing capabilities required by target customers of the Company. The Company believes that foreign manufacturers do provide a substantial competitive threat as shown by the commoditization of PC/printer cable and "bargain basement" prices. Many OEM's have moved their manufacturing to foreign soil and in doing so have minimized freight costs to ship to their foreign locations. Technical support from foreign competition has improved greatly along with their ability to be more responsive to engineering and schedule changes. The willingness of foreign manufacturers to "stock" finished product at warehouse locations in the United States is another competitive advantage. To mitigate foreign competition, the Company maintains a contractual agreement that allows its products to be manufactured in China. The Company also acquired a Mexican manufacturing facility in 2002, thereby making itself competitive with other foreign low cost providers.

The Company will pursue acquisitions, mergers, or joint ventures of manufacturing companies in low cost countries to retain and grow its customer/revenue base and support its strategic vision to be a competitive world class Electronic Manufacturing Services provider.

BACKLOG

Historically, the Company's backlog has been running 60 to 90 days. 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 $11.2 million on December 31, 2003 compared to approximately $10.4 million on December 31, 2002. The Company expects a major portion of the backlog will be realized as revenue during first quarter 2004.

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 on customer receivable collections in any particular industry or geographic area.

One customer, G.E. Medical, accounted for 23% and 31% of sales for the years ended December 31, 2003 and 2002, respectively. This reflects Nortech Systems, Inc. position as a key supplier to G.E. Medical.

RESEARCH AND DEVELOPMENT

The Company expended no dollars in 2003, 2002 or 2001 on Company-sponsored research and development. The Company has no proprietary research and development activities on an annual basis other than making improvements to its existing internal processes. However, the Company does perform research and development for customers on an as requested basis for development of conceptual engineering and design activities prior to manufacturing the products. This research and development is not always covered by customer contract. Some is done to improve the manufacturability of the product.

ENVIRONMENTAL LAW COMPLIANCE

Management believes that its manufacturing facilities are currently operating under compliance with local, state, and federal environmental laws. The Company has made, and plans to continue making, necessary expenditures for compliance with applicable 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 444 full-time, 82 part-time and 91 temporary employees as of December 31, 2003. Manufacturing personnel, including direct, indirect support and sales functions, comprise 469 employees, while general administrative employees total 148.

ITEM 2. PROPERTIES

ADMINISTRATION

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 on July 31, 2005.

MANUFACTURING FACILITIES

The Company owns its Bemidji, Minnesota facility consisting of eight acres of land and 60,000 square feet of office and manufacturing space.

The Company owns its Augusta, Wisconsin facility consisting of five acres of land and 20,000 square feet of office and manufacturing space, which the Company exercised its option to purchase in December 2003.

The Company owns three buildings, which together contain approximately 46,900 square feet, located in Fairmont, Minnesota. The buildings contain the manufacturing activities of Aerospace Systems operation, including custom designed, high technology electronic cable assemblies.

The Company owns another 45,800 square feet building in Merrifield, Minnesota. This facility is used for the building of surface-mount printed circuit board assemblies and electro-mechanical assemblies.

The Company leases a building in Aitkin, Minnesota, which provides 10,750 square feet, that was used for video cable assembly and storage. The lease will expire March 31, 2004, and the Company does not intend to renew the lease.

The Company leases a 7,500 square foot building in Baxter, Minnesota for electronic board repair for medical equipment. The lease is scheduled to expire on June 30, 2006.

The Company leases a 15,000 square foot building in its Monterrey, Mexico location for office and manufacturing space. The lease expires in June of 2004, and the Company plans on exercising the additional three-year option at that time.

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. The Company's facilities are highly suitable for the purposes for which they were designed.

ITEM 3. LEGAL PROCEEDINGS

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

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

None.

PART II

ITEM 5. MARKET PRICE OF STOCK AND RELATED STOCKHOLDER MATTERS

As of March 12, 2004, there were approximately 905 shareholders of record. The Company's stock is listed on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") Small Cap Market under the symbol "NSYS". The Company intends to invest its profits into the growth of the Company and, therefore, does not plan to pay out dividends to shareholders. Stock price comparisons follow.

Stock price comparisons (NASDAQ):

During the Three Months Ended	Low		High
March 31, 2003	$	6.72	$	7.75
June 30, 2003	$	5.25	$	7.10
September 30, 2003	$	6.19	$	7.40
December 31, 2003	$	6.69	$	8.49
March 31, 2002	$	6.24	$	11.00
June 30, 2002	$	8.10	$	12.02
September 30, 2002	$	7.00	$	11.00
December 31, 2002	$	6.25	$	7.50

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, 2003 and 2002 and for each of the three years ended December 31, 2003, 2002 and 2001. The audited consolidated financial statements of Nortech Systems Incorporated and Subsidiary referred to above is included elsewhere herein. The selected historical financial data set forth below as of December 31, 2003, 2002 and 2001 and for each of the years ended December 31, 2000 and 1999 have been derived from the audited consolidated 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.

Year ended December 31:

	2003		2002		2001		2000		1999
Net Sales	$	57,958,698	$	60,655,579	$	58,460,589	$	54,775,279	$	38,498,459
Gross Profit		6,494,976		10,519,536		10,446,345		10,355,945		6,510,781
Net Income From Continuing Operations		633,448		2,403,112		2,102,863		2,043,573		1,070,799
Basic Earnings From Continuing Operations Per Share of Common Stock		..26		1.00		0.89		0.86		0.46
Diluted Earnings From Continuing Operations Per Share of Common Stock		..25		..95		..86		..83		..45
At December 31:
Total Assets		31,580,790		29,602,400		29,507,538		28,652,949		23,603,716
Working Capital		16,723,263		14,266,058		14,459,344		9,633,539		9,691,189
Total Long-Term Debt		9,643,336		8,580,944		9,791,722		7,665,536		10,246,911
Shareholders' Equity		14,321,280		13,090,130		10,571,793		8,447,566		6,378,480

For additional financial data (2003 and 2002 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

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements within the meaning 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, Incorporated 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 of the Company's products;
•: Increased competition;
•: Changes in the reliability and efficiency of the Company's 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-K 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.

OVERVIEW

Nortech Systems, Inc., based in Wayzata, Minn., is a full-service electronics manufacturing services (EMS) provider of wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds for a wide range of industries. Markets served include medical, automotive, defense, computer, peripheral, commercial, telecom, government and consumer. In Minnesota, Nortech Systems has additional facilities in Baxter, Bemidji, Fairmont and Merrifield. The company also has facilities in Augusta, Wis., and Monterrey, Mexico.

A majority of revenue is derived from products that are built to the customer's design specifications. The Company believes it provides a high degree of manufacturing sophistication. The strategy of the Company has been to expand and diversify its customer base. 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

During 2003, Nortech Systems began implementing supply chain initiatives designed to reduce costs, improve asset utilization and increase responsiveness to customers. Moving forward, Nortech Systems has begun to expand its sales and marketing approach to target greater value-added opportunities that exploit broader, corporate-wide capabilities. Nortech's market strength is low-volume,

high-mix production, particularly with complex products. We consider our supply chain and marketing initiatives to be key investments in our future growth and success. In both cases, the payoff will be realized over time, starting this year and continuing into the future. Nortech Systems also expects quarterly performance to show continued sequential revenue growth, with substantial earnings growth in the latter quarters of the year when more benefits are realized from the key initiatives outlined above.

CRITICAL ACCOUNTING ESTIMATES

As stated in our significant accounting policies in Note 1 to the consolidated financial statements, the preparation of financial statements requires management to make estimates and assumptions. The Company believes its most critical accounting estimates relate to revenue recognition, inventory reserves, long-lived and intangible asset impairment, deferred tax balances, and self-insured health claim reserves.

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.

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 on a quarterly basis.

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.

Income taxes:

Management's estimate of the tax rates utilized in the calculation of the deferred tax balances is based on historical taxable income and expected future taxable income and corresponding rates. Further, management's consideration of a valuation allowance for deferred tax assets is based upon estimates of taxable income in future periods. These are estimates and may differ from actual results.

Self-Insured Health Claim Reserves:

Management estimates its reserve for employee health claims based on health claims incurred, historical lag times and an analysis of claims activity during the period, while taking into consideration insurance limits and coverage.

Based on a critical assessment of its accounting policies and the underlying judgements 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.

No matters have come to Management's attention since December 31, 2003 that would cause the estimates included in the consolidated financial statements to be significantly misstated.

OPERATING RESULTS

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

	2003		2002		2001
Net Sales	100	%	100	%	100	%
Cost of Goods Sold	89	%	83	%	82	%

Gross Profit	11	%	17	%	18	%
Selling Expenses	4	%	4	%	5	%
General and Administrative Expenses	6	%	6	%	6	%

Income from Operations	1	%	7	%	7	%
Other Expenses, Net	0	%	1	%	1	%
Income Tax Expense	0	%	2	%	2	%

Net Income	1	%	4	%	4	%

Revenues:

For the years ended December 31, 2003 and 2002, the Company had sales of $58.0 million and $60.7 million, respectively. The decrease of $2.7 million or 4.4% resulted primarily from the general effects of the slow economy, customer base adjusting their inventory levels, the mix of revenue moved more to the lower margin product and customers demanded reduced pricing. Mexico revenue was also off by 60% from expectations, due to customer delays and slower economic conditions. For the year ended December 31, 2001 the Company had sales of $58.5 million. The approximate 3.8% increase in sales in 2002 was attributable primarily to internal growth of our current customer base. The Company expects revenue growth at a moderate rate for the year 2004. The Company's emphasis is to continually seek mature companies that require a contract manufacturer with a high degree of manufacturing and quality sophistication.

Gross Profit:

For the years ended December 31, 2003, 2002 and 2001, the Company had gross profit of $6.5 million, $10.5 million, and $10.4 million, respectively. Gross profits as a percentage of gross sales were 11.2%, 17.3%, and 17.9% for the years ended December 31, 2003, 2002 and 2001, respectively.

The reduced gross profit percentage in 2003 compared to 2002 is largely due to the unfavorable profit margins (5%) in our Mexico facility, that resulted from the shortfall in expected manufacturing volume, and higher than planned health care cost (1%) in our self insured plan. As revenues grow, the Company continues to strive to hold down cost levels by improving productivity and reducing material costs in order to help offset the request for price reductions from customers. . In 2002, margins were reduced from 2001 due to customer pricing pressures.

Selling:

Selling expenses were $2.4 million, $2.5 million, and $2.8 million for the years ended December 31, 2003, 2002 and 2001, respectively. The majority of the change from 2002 to 2003 reflected the change in the Company's method of selling by utilizing more internal and less outside representatives. The decrease in selling expenses from 2001 to 2002 reflects a larger portion of revenues being derived from non-commissioned sales.

General and Administrative:

For the years ended December 31, 2003, 2002 and 2001, general and administrative expenses were $3.3 million, $3.8 million and $3.4 million, respectively. The reduction in expenses from 2002 to 2003 reflected the use of cost cutting methods and reduced administrative incentive expenses. The increase in expenses from 2001 to 2002 reflects increased employee benefits and incentives for employees.

Interest Income:

Interest income for the years ended December 31, 2003, 2002 and 2001 was approximately $25,000, $5,000, and $18,000, respectively. The interest income was realized as a result of various highly liquid interest bearing accounts readily convertible to cash. The 2003 interest income reflects interest received from research and development tax refunds for 3 years.

Miscellaneous Income:

Miscellaneous income (loss) was $86,000, ($18,000) and $3,000 for the years ended December 31, 2003, 2002 and 2001, respectively. The miscellaneous income resulted primarily from charges for miscellaneous services that vary by year and in 2003 the Company had income from sales commissions for product sold in China by one of our vendors.

Interest Expense:

Interest expense was approximately $386,000, $432,000, and $776,000 for the years ended December 31, 2003, 2002 and 2001, respectively. The Company has maintained consistent levels of debt by reinvesting the profits in the growth of the Company. However, average annual prime lending rates have continually decreased from 2001 resulting in lower interest expense in 2003 and 2002.

Income Taxes:

Income tax expense (benefit) amounted to ($123,000), $1.4 million, and $1.4 million for the years ended December 31, 2003, 2002 and 2001, respectively. During 2003, the Company recorded $246,000 of net benefit for a refund claim relating to federal and state research and development tax credits for tax years 1999, 2000 and 2001. A reconciliation of income tax expense (benefit) for 2003 is included in Note 6 to the consolidated financial statements for the year ended December 31, 2003.

Net Income:

The Company's net income in 2003 was $.6 million or $0.26 per basic common share, or $0.25 per diluted common share. The Company's net income in 2002 was $2.4 million or $1.00 per basic common share, or $0.95 per diluted common share. The Company's net income in 2001 was $2.1 million or $0.89 per basic common share, or $0.86 per diluted 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. The Company believes it 2003 profits were impacted by several factors, all of which are being addressed. Margins were negatively impacted by increased material cost, higher than planned health care costs and a product mix that skewed toward lower margin products. Also, our Mexico facility continued to experience a shortfall in expected manufacturing volume.

Accounting Pronouncements:

In 2003, the Company adopted the following new Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards (SFAS) accounting pronouncements:

In December 2003, the Financial Accounting Standards Board (FASB) published a revision to FASB Interpretation 46 (FIN 46) to clarify some of the provisions of FASB Interpretation No. 46,Consolidation of Variable Interest Entities, and to exempt certain entities from its requirements. The Financial Accounting Standards Board issued, FIN 46, an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to improve financial reporting of special purpose and other entities. In accordance with FIN 46, business enterprises that represent the primary beneficiary of another entity by retaining a controlling financial interest in that entity's assets, liabilities and results of operating activities must consolidate the entity in its financial statements. Prior to the issuance of FIN 46, consolidation generally occurred when an enterprise controlled another entity through voting interests. The effective dates for these consolidation provisions, as revised apply to VIEs created or entered into after December 31, 2003. For VIEs created before December 31, 2003, the effective date of applying the provision of FIN 46 was deferred to annual periods beginning after December 15, 2004.

In December 2003, the Staff of the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 104 ("SAB 104"), "Revenue Recognition," which supersedes SAB 101, "Revenue Recognition in Financial Statements". SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element arrangements, superseded as a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." Additionally, SAB 104 rescinds the SEC's Revenue Recognition in Financial Statements Frequently Asked Questions and Answers (the "FAQ") issued with SAB 101 that had been codified in SAB Topic 13, "Revenue Recognition." Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 in December 2003 did not have an effect on the consolidated results of operations or financial position of the Company.

In May 2003, the FASB issued SFAS 150, "Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity" which establishes standards for how an issuer of financial instruments classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominately on a fixed monetary amount known at inception, variations in something other than the fair value of the issuer's equity shares or variations inversely related to changes in the fair value of the issuer's equity shares. SFAS No. 150 is effective for financial instruments entered into

or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 has not impacted the Company's financial position, results of operations or cash flows.

During November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on EITF Issue 00-21, Multiple-Deliverable Revenue Arrangements (EITF 00-21), which addresses how to account for arrangements that may involve the delivery or performance of multiple products, services, and/or rights to use assets. The final consensus was applicable to agreements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have an impact on the Company's financial position or results of operations.

FINANCIAL CONDITION AND LIQUIDITY

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 our readers.

	December 31, 2003		December 31, 2002		December 31, 2001
Current Ratio (Current Assets / Current Liabilities)		3.20		2.80		2.59
Working Capital (Current Assets - Current Liabilities)	$	16,723,263	$	14,266,058	$	14,459,344
Quick Ratio (Cash + Accounts Receivable / Current Liabilities)		1.44		1.02		1.02
Accounts Receivable to Working Capital (Average Accounts Receivable / Working Capital)		0.55		0.59		0.61
Inventory to Working Capital (Average Inventory / Working Capital)		0.72		0.87		0.83

		December 31, 2003			December 31, 2002			December 31, 2001
Cash flows provided (used) by:
	Operating Activities	$	(288,460	)	$	2,880,099		$	1,049,870
	Investing Activities		(1,412,069	)		(1,729,040	)		(711,968	)
	Financing Activities		1,355,538			(884,038	)		(684,170	)
Effect of exchange rate changes on cash			(2,581	)		—			—

Net (decrease)/increase in cash and cash equivalents		$	(347,572	)	$	267,021		$	(346,268	)

Overall, the improvement of the above liquidity ratios relate primarily to the Company's increase in accounts receivable balances due to a change in terms of payment for a major customer and the continued efforts of the Company to reduce inventory levels.

As of December 31, 2003, the Company's cash and cash equivalent balances totaled $101,179.

On December 31, 2003, the Company had working capital of approximately $16.7 million. During 2003, the Company used approximately $288,000 of cash flow for operating activities. This use of cash was primarily attributable to a change in accounts receivable terms with a main customer. The Company's net Investing and Financing activities decreased cash by $57,000. The Company continues to reinvest in equipment funded by the available line of credit.

The Company currently has a $7.0 million line of credit arrangement in place with Wells Fargo Bank for general working capital needs, of which $5.9 million was outstanding as of December 31, 2003. The Company had no material unused sources of liquidity other than the cash, accounts receivables, inventory and other current assets. The Company was compliant with all financial covenants at year-end, with the exception of the net earnings covenant for the year, for which Wells Fargo Bank has granted a waiver. The company expects to be in compliant with all financial covenants for the year ended December 31, 2004 including the quarterly minimum net earning convent of $100,000 through March 31, 2004, $300,000 though June 30, 2004, $450,000 though September 30, 2004 and $750,000 though December 31, 2004.

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 its operating line of credit.

Set forth below is information about the Company's long-term contractual obligations and other commercial commitments outstanding as of December 31, 2003. It brings together data for easy reference from the consolidated balance sheet and from individual notes to the consolidated financial statements. This information is important in understanding the financial position of the Company.

	Payments Due by Period
	Less than 1 Yr		1 - 3 Yrs		4 - 5 Yrs
Line of Credit	$	0	$	5,907,191	$	0
Long-Term Debt		1,360,935		1,515,790		2,220,355
Operating Leases		325,101		184,342		1,210

Total Contractual Obligations	$	1,686,036	$	7,607,323	$	2,221,565

ITEM 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

Market risk is the potential change in an instrument's value caused, for example, by fluctuations in interest and currency exchange rates. The Company's primary market risk exposures are interest rate and unfavorable movements in exchange rates between the U.S. dollar and the Mexican peso. Monitoring and managing these risks is a continual process carried out by senior management. Market risk is managed based on an ongoing assessment of trends in interest rates, foreign exchange rates, and economic developments, giving consideration to possible effects on both total return and reported earnings. The Company's financial advisors, both internal and external, provide ongoing advice regarding trends that affect management's assessment.

Exchange Rate Sensitivity:

The Company conducts operations in Mexico. Accordingly, exposure exists to potentially adverse movements in foreign currency rates. The Company does not use foreign exchange forward contracts to hedge the risk of change in foreign currency exchange rates. The Company's consolidated financial statements are denominated in U.S. dollars and accordingly, changes in the exchange rates between Company subsidiary's local currency and the U.S. dollar will affect the translation of such subsidiary's financial results into U.S. dollars for the purposes of reporting the consolidated financial results. The Company does not hedge these matters because cash flows from international operations are generally re-invested locally. It is estimated that a 10% change in foreign exchange rates would have an immaterial impact on reported net earnings.

Interest Rate Sensitivity:

The effective interest rate on the Company's credit facilities are influenced by the actions of the Federal Reserve in establishing from time to time the Federal Funds Interest Rate which is the rate banks borrow from the Federal Reserve Bank. During 2003, 2002 and 2001, the Federal Reserve implemented a number of reductions in the Federal Funds Interest Rate in an effort to stimulate the U.S. economy. As a result the effective interest rate that the Company paid on its borrowings under the facilities declined, leading to a corresponding reduction in interest expense. To the extent that the Federal Reserve increases the Federal Funds Interest Rate in the future, the effective interest rate on the Company's facilities will increase. The Company's interest expense will increase accordingly if borrowing levels remain constant. Based on the balance outstanding under our interest-bearing Facilities at year-end, a percentage point change in the effective interest rate would have changed interest expense by approximately $100,000.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

		PAGE
Reports of Independent Auditors'
	KPMG LLP	20
	Larson, Allen, Weishair & Co., LLP	21
Consolidated Financial Statements:
	Consolidated Balance Sheets as of December 31, 2003 and 2002	22
	Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001	23
	Consolidated Statements of Stockholders' Equity for the years ended December 31, 2003, 2002 and 2001	24
	Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001	25
	Notes to Consolidated Financial Statements	26-42

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NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
TABLE OF CONTENTS
DECEMBER 31, 2003, 2002, and 2001

INDEPENDENT AUDITORS' REPORTS		20-21
CONSOLIDATED BALANCE SHEETS		22
CONSOLIDATED STATEMENTS OF INCOME		23
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY		24
CONSOLIDATED STATEMENTS OF CASH FLOWS		25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS		26-42
INDEPENDENT AUDITORS' REPORTS ON SUPPLEMENTARY INFORMATION		43-44
SCHEDULE II		49

INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders
Nortech Systems Incorporated:

We have audited the accompanying consolidated balance sheets of Nortech Systems Incorporated and subsidiary (the Company) as of December 31, 2003 and 2002, and the related consolidated statements of income, shareholders' equity and cash flows for each of the years in the two-year period ended December 31, 2003. 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 auditing standards generally accepted in the United States of America. 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, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

/s/ KPMG LLP
Minneapolis, Minnesota
February 13, 2004, except as to note 4 which is as of March 9, 2004

INDEPENDENT AUDITORS' REPORT

Board of Directors
Nortech Systems Incorporated and Subsidiary
Bemidji, Minnesota

We have audited the accompanying consolidated statements of income, shareholders' equity and cash flows of Nortech Systems Incorporated and Subsidiary for the year ended December 31, 2001. 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 audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of Nortech Systems Incorporated and Subsidiary's operations and their cash flows for the year ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.

		LARSON, ALLEN, WEISHAIR & CO., LLP
St. Cloud, Minnesota February 13, 2002

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2003 AND 2002

					2003			2002
ASSETS
CURRENT ASSETS
	Cash and Cash Equivalents				$	101,179		$	448,751
	Accounts Receivable, Less Allowance for Uncollectible Accounts					10,835,696			7,616,093
	Inventories					11,594,557			12,320,317
	Prepaid Expenses					423,371			369,252
	Income Taxes Receivable					419,634			483,971
	Deferred Tax Assets					965,000			959,000

			Total Current Assets			24,339,437			22,197,384
PROPERTY AND EQUIPMENT
	Land					151,800			151,800
	Building and Leasehold Improvements					4,768,813			4,671,905
	Manufacturing Equipment					6,557,159			5,466,567
	Office and Other Equipment					2,803,819			2,743,707

		Total Property and Equipment				14,281,591			13,033,979
	Accumulated Depreciation					(8,191,274	)		(7,084,565	)

			Net Property and Equipment			6,090,317			5,949,414
OTHER ASSETS
	Non-Compete, Net of Accumulated Amortization					953,984			1,335,584
	Goodwill					75,006			75,006
	Deferred Tax Assets					71,000			33,000
	Other Assets					51,046			12,012

			Total Other Assets			1,151,036			1,455,602

				Total Assets	$	31,580,790		$	29,602,400

LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
	Current Maturities of Notes and Capital Lease Payable				$	1,360,935		$	1,642,179
	Checks Written in Excess of Cash					250,000			300,000
	Accounts Payable					4,068,148			3,298,474
	Accrued Payroll and Commissions					1,281,319			2,119,566
	Accrued Health and Dental Claims					217,514			277,864
	Other Accrued Liabilities					438,258			243,243
	Net Current Liabilities from Discontinued Operations					—			50,000

			Total Current Liabilities			7,616,174			7,931,326
LONG-TERM LIABILITIES
	Notes and Capital Lease Payable (Net of Current Maturities)					9,643,336			8,580,944

			Total Liabilities			17,259,510			16,512,270
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
	Preferred Stock, $1 Par Value; 1,000,000 Shares
		Authorized; 250,000 Shares Issued and Outstanding				250,000			250,000
	Common Stock $.01 Par Value; 9,000,000 Shares Authorized; 2,544,391 and 2,473,650 Shares Issued and 2,512,687 and 2,441,946 Shares Outstanding at December 31, 2003 and 2002, Respectively					25,127			24,419
	Additional Paid-In Capital					13,497,339			12,873,657
	Accumulated Other Comprehensive Loss					(26,688	)		—
	Retained Earnings (Accumulated Deficit)					575,502			(57,946	)

			Total Shareholders' Equity			14,321,280			13,090,130

				Total Liabilities and Shareholders' Equity	$	31,580,790		$	29,602,400

See accompanying Notes to Consolidated Financial Statements.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001

				2003			2002			2001
NET SALES				$	57,958,698		$	60,655,579		$	58,460,589
COST OF GOODS SOLD					(51,463,722	)		(50,136,043	)		(48,014,244	)

GROSS PROFIT					6,494,976			10,519,536			10,446,345
OPERATING EXPENSES
	Selling Expenses				2,377,311			2,466,460			2,847,727
	General and Administrative Expenses				3,332,474			3,835,885			3,367,062

		Total Operating Expenses			5,709,785			6,302,345			6,214,789

INCOME FROM OPERATIONS					785,191			4,217,191			4,231,556
OTHER INCOME (EXPENSE)
	Interest Income				24,624			5,231			17,921
	Miscellaneous Income (Expense)				86,386			(17,660	)		2,581
	Interest Expense				(385,753	)		(431,650	)		(776,195	)

			Total Other Expense, Net		(274,743	)		(444,079	)		(755,693	)

INCOME FROM OPERATIONS BEFORE INCOME TAXES					510,448			3,773,112			3,475,863
INCOME TAX BENEFIT (EXPENSE)					123,000			(1,370,000	)		(1,373,000	)

NET INCOME				$	633,448		$	2,403,112		$	2,102,863

EARNINGS PER SHARE:
	Basic			$	0.26		$	1.00		$	0.89
	Average Number of Common Shares Outstanding Used for Basic Earnings Per Share				2,478,921			2,410,890			2,361,192

	Diluted			$	0.25		$	0.95		$	0.86

	Average Number of Common Shares Outstanding Plus Dilutive Common Stock Options				2,528,810			2,517,482			2,457,088

See accompanying Notes to Consolidated Financial Statements.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001

		Preferred Stock		Common Stock			Additional Paid-In Capital		Accumulated Other Comprehensive Loss			(Accumulated Deficit) Retained Earnings			Total Shareholders' Equity
BALANCE
	DECEMBER 31, 2000		250,000		23,611			12,158,036		—			(3,984,081	)		8,447,566
	2001 Net Income		—		—			—		—			2,102,863			2,102,863
	Issuance of Stock		—		1			21,363		—			—			21,364

BALANCE
	DECEMBER 31, 2001		250,000		23,612			12,179,399		—			(1,881,218	)		10,571,793
	2002 Net Income		—		—			—		—			2,403,112			2,403,112
	Issuance of Stock		—		1,592			694,258		—			—			695,850
	Repurchase of Stock		—		(785	)		—		—			(579,840	)		(580,625	)

BALANCE
	DECEMBER 31, 2002		250,000		24,419			12,873,657		—			(57,946	)		13,090,130
	2003 Net Income		—		—			—		—			633,448			633,448
	Issuance of Stock		—		708			623,682		—			—			624,390
	Translation Loss		—		—			—		(26,688	)		—			(26,688	)

BALANCE
	DECEMBER 31, 2003	$	250,000	$	25,127		$	13,497,339	$	(26,688	)	$	575,502		$	14,321,280

See accompanying Notes to Consolidated Financial Statements.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

DECEMBER 31, 2003, 2002, AND 2001

				2003			2002			2001
CASH FLOWS FROM OPERATING ACTIVITIES
	Net Income			$	633,448		$	2,403,112		$	2,102,863
	Adjustments to Reconcile Net Income to Net Cash Provided (Used) By Operating Activities:
		Debt Refinance Charges			—			58,000			—
		Depreciation and Amortization			1,640,775			1,380,499			1,181,754
		Deferred Taxes			(44,000	)		439,000			22,000
		Gain on Disposal of Assets			(1,491	)		(942	)		—
		Foreign Currency Transaction Gain			(12,237	)		—			—
	Changes in Current Operating Items:
		Accounts Receivable			(3,221,380	)		1,573,155			(529,939	)
		Inventories			725,760			175,775			(856,344	)
		Prepaid Expenses and Other Assets			(93,642	)		(62,824	)		(258,966	)
		Income Tax Receivable			64,337			(1,022,677	)		356,376
		Accounts Payable			770,370			(1,567,968	)		(877,394	)
		Accrued Payroll and Commissions			(837,966	)		(77,863	)		502,376
		Accrued Health and Dental Claims			(60,350	)		(113,547	)		(31,230	)
		Other Accrued Liabilities			147,916			(303,621	)		(561,626	)

			Net Cash Provided (Used) by Operating Activities		(288,460	)		2,880,099			1,049,870
CASH FLOWS FROM INVESTING ACTIVITIES
	Proceeds from Sale of Discontinued Operations				—			2,000			—
	Proceeds from Sale of Assets				8,450			400			—
	Acquisition of Equipment & Leasehold Improvements				(1,420,519	)		(1,081,440	)		(711,968	)
	Acquisition of Subsidiary				—			(650,000	)		—

			Net Cash Used by Investing Activities		(1,412,069	)		(1,729,040	)		(711,968	)
CASH FLOWS FROM FINANCING ACTIVITIES
	Checks Written in Excess of Cash				(50,000	)		300,000			—
	Net Change in Line of Credit				1,484,336			(606,843	)		(395,302	)
	Debt Refinance Charges				—			(58,000	)		—
	Proceeds from Notes Payable				674,248			4,879,017			234,000
	Payments on Notes and Capital Lease Payable				(777,436	)		(5,513,437	)		(544,232	)
	Issuance of Stock				24,390			115,225			21,364

			Net Cash Provided (Used) by Financing Activities		1,355,538			(884,038	)		(684,170	)
Effect of Exchange Rate Changes on Cash					(2,581	)		—			—

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS					(347,572	)		267,021			(346,268	)
Cash and Cash Equivalents—Beginning of Year					448,751			181,730			527,998

CASH AND CASH EQUIVALENTS—END OF YEAR				$	101,179		$	448,751		$	181,730

See accompanying Notes to Consolidated Financial Statements.

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2003, 2002, AND 2001

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

Nortech Systems Incorporated (together with its wholly owned subsidiary, 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. The Company also provides repair service on circuit boards used in machines in the medical industry.

The Company's manufacturing facilities are located in Bemidji, Fairmont, Merrifield and Baxter, Minnesota as well as Augusta, Wisconsin. During 2002 the Company acquired a business and its related manufacturing operations in Monterrey, Mexico, as described in Note 10.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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, Manufacturing Assembly Solutions of Monterrey, Inc. All significant intercompany accounts and transactions have been eliminated.

Cash and Cash Equivalents

For purposes of reporting cash flows, the Company considers cash equivalents to be short-term, highly liquid interest-bearing accounts readily convertible to cash. The carrying amount approximates fair value.

Accounts Receivable

The Company grants credit to customers in the normal course of business. Accounts receivable are unsecured and are presented net of an allowance for doubtful accounts. The allowance for uncollectible accounts was $371,690 and $488,451 at December 31, 2003 and 2002, respectively. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company's previous loss history, the customer's current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes-off accounts receivable when they become uncollectible and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. The Company does not accrue interest on past due accounts receivable.

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. Inventory is shown net of reserve for excess and obsolete inventory as follows:

		2003			2002
Raw Materials		$	9,843,268		$	9,481,193
Work in Process			1,591,389			1,859,000
Finished Goods			1,479,150			2,172,379
Reserves			(1,319,250	)		(1,192,255	)

	Total	$	11,594,557		$	12,320,317

Property, Equipment and Depreciation

Property and equipment are stated at cost less accumulated depreciation. Additions, improvements and major renewals are capitalized, while maintenance, repairs and minor renewals are expensed as incurred. When assets are retired or disposed of, the assets and related accumulated depreciation is removed from the accounts and the resulting gain or loss is reflected in operations. Leasehold improvements are depreciated over the shorter of the estimated use life or the remaining lease term. All other property and equipment are depreciated by the straight-line method of depreciation over their estimated useful lives.

Buildings		39 Years
Leasehold Improvements		3-7 Years
Manufacturing Equipment		5-7 Years
Office and Other Equipment		3-7 Years

Depreciation expense was $1,260,175, $1,182,227 and $1,165,482, for the three years ended December 31, 2003, 2002 and 2001, respectively.

Goodwill and Other Intangible Assets

The Company accounts for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards Board No. ("SFAS") 142, "Goodwill and Other Intangible Assets," which requires that goodwill and certain indefinite-lived assets not be amortized but evaluated annually for impairment. Other intangible assets are amortized on a straight-line basis over their estimated useful lives, which range from four to seven years. See Note 10 for more detail on the Company's intangible assets.

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.

Goodwill is tested for impairment annually, or if an event occurs or circumstances change that may reduce the fair value of the reporting unit below its book value. The impairment test is conducted at the reporting unit level by comparing the fair value of the reporting unit with its carrying value. Fair value is primarily determined by computing the future discounted cash flows expected to be generated by the reporting unit. If the carrying value exceeds the fair value, goodwill may be impaired. If this occurs, the fair value of the reporting unit is then allocated to its assets and liabilities in a manner similar to a purchase price allocation in order to determine the implied fair value of the reporting unit goodwill. This implied fair value is then compared with the carrying amount of the reporting unit goodwill, and if it is less, the Company would then recognize an impairment loss.

Preferred Stock

Preferred stock issued is non-cumulative and nonconvertible. 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 declared or paid during the years ended December 31, 2003, 2002, and 2001.

Revenue Recognition

Shipping and Handling Costs

The Company's shipping and handling costs charged to its customers are included in net sales, while the corresponding shipping expenses are included in cost of goods sold.

Estimated Warranty Claims

The sales of the Company's products include warranties that provide for repairs or replacement of defective products. The warranty periods range from one to two years, depending on the product, in the period following the sale. A warranty reserve is estimated by management based on actual historical warranty claims coupled with an analysis of unfulfilled claims at the balance sheet date. Estimated warranty liabilities of approximately $2,900 and $40,000 are included in Other Accrued Liabilities at December 31, 2003 and 2002, respectively.

A tabular reconciliation of the changes in the Company's product warranty liability for the years ended December 31, 2003, 2002, and 2001 is as follows:

	Balance at Beginning of Year		Warranty Provisions	Change in Estimate		Warranty Claims	Balance at End of Year
2003	$	40,000	—	(34,100	)	3,000	$	2,900
2002	$	51,000	8,886	—		19,886	$	40,000
2001	$	41,450	22,000	—		12,450	$	51,000

The change in estimate for 2003 was the result of certain products no longer being sold.

Product Development Costs

Engineering costs associated with the development of new products and changes to existing products are charged to operations as incurred.

Advertising

Advertising costs are charged to operations as incurred. Total amount charged to expense was $106,873, $118,017 and $131,199, for the three years ended December 31, 2003, 2002 and 2001, respectively.

Income Taxes

The Company accounts for income taxes under the asset and liability method. Deferred income tax assets and liabilities are recognized 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.

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. Based on the borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the carrying value of long-term debt materially approximates fair value.

Stock Based Compensation

The Company accounts for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees," and complies with the disclosure provisions of SFAS No. 148 and 123, "Accounting for Stock-Based Compensation". Under APB No. 25, compensation cost 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.

The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation costs were charged to operations for the years ended December 31, 2003, 2002, and 2001. Had compensation cost for the Company's stock option plan been determined pursuant to SFAS No. 123, net earnings and earnings per share would have been as follows:

		2003			2002			2001
Net income, as reported		$	633,448		$	2,403,112		$	2,102,863
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects			(127,826	)		(68,529	)		(78,804	)

Pro forma net income		$	505,622		$	2,334,583		$	2,024,059

Earnings per share:
	Basic—as reported	$	0.26		$	1.00		$	0.89

	Basic—pro forma	$	0.20		$	0.97		$	0.86

	Diluted—as reported	$	0.25		$	0.95		$	0.86

	Diluted—pro forma	$	0.20		$	0.93		$	0.84

The weighted average fair values at grant date of the options granted in fiscal 2003, 2002 and 2001 were estimated as $5.20, $5.49 and $3.40, respectively, using the Black-Scholes option-pricing model with the following weighted average assumptions:

	2003		2002		2001
Expected Lives (Years)	10		10		2
Dividend Yield	0.00	%	0.00	%	0.00	%
Expected Volatility	71.6	%	68.0	%	57.0	%
Risk-Free Interest Rate	4.51	%	4.00	%	3.25	%

Net Income Per Common Share

Basic net income per share is computed using the weighted-average number of common shares outstanding. Diluted income per share is computed using the weighted-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 paid income taxes of $148,424, $1,998,677 and $994,624 for the years ended December 31, 2003, 2002 and 2001, respectively. The Company paid interest expenses of $389,941, $514,031 and $713,352 for the years ended December 31, 2003, 2002 and 2001, respectively.

During 2002, the Company incurred a note payable in the amount of $1,200,000 as part of the purchase price for certain assets of another corporation, as described in Note 10. The Company also received $580,625 of treasury stock in exchange for the exercise of incentive stock options.

During 2003, the Company exchanged 63,408 shares of its common stock for $600,000 payment of its note payable to SAE Assembly, LLC.

Segment Reporting Information

The Company's results from operations for the years ended December 31, 2003, 2002 and 2001, represent a single segment referred to as Contract Manufacturing. Foreign revenues represent 2%, 1% and 2% of consolidated revenues for the years ended December 31, 2003, 2002 and 2001, respectively.

Long-lived assets by country are as follows:

		United States		Mexico		Total
2003
	Net Property and Equipment	$	5,642,639	$	447,678	$	6,090,317
	Other Assets		185,040		965,996		1,151,036
2002
	Net Property and Equipment	$	5,645,086	$	304,328	$	5,949,414
	Other Assets		109,006		1,346,596		1,455,602

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).

Discontinued Operations

On June 30, 1999, the Company adopted a formal plan to sell one of their operating segments known as Medical Management. During 2002, certain assets of the Medical Management segment were sold for $2,000 to a private party. Through the sale in 2002, the results of operations for Medical Management have been recorded against the reserve established to absorb disposal losses. Reserve levels established for disposal losses were adequate in all material respects. Included in Other Income for the year ended December 31, 2003 is the reversal of a $50,000 reserve for discontinued operations.

New Accounting Standards

In December 2003, the Financial Accounting Standards Board (FASB) published a revision to FASB Interpretation 46 (FIN 46) to clarify some of the provisions of FASB Interpretation No. 46,

Consolidation of Variable Interest Entities, and to exempt certain entities from its requirements. The Financial Accounting Standards Board issued, FIN 46, an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to improve financial reporting of special purpose and other entities. In accordance with FIN 46, business enterprises that represent the primary beneficiary of another entity by retaining a controlling financial interest in that entity's assets, liabilities and results of operating activities must consolidate the entity in its financial statements. Prior to the issuance of FIN 46, consolidation generally occurred when an enterprise controlled another entity through voting interests. The effective dates for these consolidation provisions, as revised apply to VIEs created or entered into after December 31, 2003. For VIEs created before December 31, 2003, the effective date of applying the provisions of FIN 46 was deferred to annual periods beginning after December 15, 2004. The adoption of FIN 46 is not expected to impact the consolidated results of operations or financial position of the Company.

In May 2003, the FASB issued SFAS 150, "Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity" which establishes standards for how an issuer of financial instruments classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominately on a fixed monetary amount known at inception, variations in something other than the fair value of the issuer's equity shares or variations inversely related to changes in the fair value of the issuer's equity shares. SFAS No. 150 was effective for the Company in 2003 and the adoption of SFAS 150 has not impacted the Company's financial position, results of operations or cash flows.

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. The Company has not experienced any losses in any of the short-term investment instruments it has used for excess cash balances. The Company does not require collateral on its receivables. Historically, the Company has not suffered significant losses with respect to trade accounts receivable.

One customer accounted for 24% and 23% of accounts receivable at December 31, 2003 and 2002, respectively, and approximately 23%, 31% and 24% of sales for the years ended December 31, 2003, 2002, and 2001, respectively.

NOTE 3 ACCRUED HEALTH AND DENTAL CLAIMS

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 $80,000 per individual per plan year and an estimated aggregate amount of $2,393,216 for the plan year ending August 2004. The Company's dental plan pays claims based on actual amounts incurred. Estimated unpaid claims for incurred health and dental services of $217,514 and $277,684 are included in Accrued Health and Dental Claims at December 31, 2003 and 2002, respectively.

NOTE 4 NOTES AND CAPITAL LEASE PAYABLE

During 2002, the Company refinanced its lines of credit and $5,031,410 of various notes payable with Wells Fargo Bank, N.A. The refinanced debt was structured into a $1,750,000 equipment note, a $2,500,000 real estate note and a $6,000,000 revolving line of credit. The credit agreement includes a provision that commits the Company to pay a minimum of $150,000 of interest annually. During 2003, the Company increased the borrowing limit on its Wells Fargo revolving line of credit to $7,000,000.

A summary of all debt balances at December 31, 2003 and 2002 is as follows:

Description		2003			2002
Revolving Line of Credit—Wells Fargo Bank Minnesota, N.A., Borrowing Limit Increased to $7,000,000; Interest at Prime Rate of Wells Fargo; Due February 2007; Secured by Substantially All Assets		$	5,907,191		$	4,422,855
Notes Payable—Wells Fargo Bank Minnesota, N.A., Two Notes Bear Interest at Prime Rate of Wells Fargo, One Note Bears Interest at 4.21%; Combined Monthly Payments of $63,025, Including Principal and Interest; Maturities Range from October 2006 to February 2007; Secured by Substantially All Assets			3,941,769			3,819,444
Promissory Note—SAE Assembly, LLC, (See Discussion Below Describing Payment Terms); Secured by Shares of Nortech Common Stock			600,000			1,200,000
Notes Payable—Other, Interest at 6.5%; Monthly Installment Payments Through March 2007; Secured by Substantially All Assets			555,311			581,023
Capitalized Lease Payable—City of Augusta, Wisconsin, Company Exercised Option to Purchase During 2003			—			199,801

	Total Notes and Capital Lease Payable	$	11,004,271		$	10,223,123
	Current Maturities of Notes and Capital Lease Payable		(1,360,935	)		(1,642,179	)

	Notes and Capital Lease Payable—Net of Current Maturities	$	9,643,336		$	8,580,944

The weighted-average interest rate on the Company's line of credit was 4.12% and 4.67% for the years ended December 31, 2003 and 2002, respectively.

Repayment of SAE Assembly, LLC (SAE) debt will be made through semi-annual installments ending June 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 December 31, 2003, 63,408 shares comprising the first and second installments are considered issued and outstanding. The 31,704 shares required under the third installment were transferred to SAE on December 27, 2003, but were not considered outstanding at December 31, 2003 for purposes of calculating earnings per share as the four-week period of time had not expired. In January 2004, the market price of the Company's stock met the $7.00 four-week requirement, at which time the shares issued to SAE became outstanding.

All Wells Fargo Bank, N.A. debt agreements 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 expenditures. At December 31, 2003, the Company was in violation of one of its covenant requirements. On March 9, 2004, the bank has waived this specific requirement of the loan agreement for the December 31, 2003 measurement date.

Maturity requirements are as follows:

Years Ending December 31,	Amount
2004	$	1,360,935
2005		771,842
2006		743,948
2007		8,127,546

	$	11,004,271

NOTE 5 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 pieces of equipment upon lease expiration at fair market value. The Company also has the option to purchase the Aitkin, MN manufacturing plant, currently under an operating lease, upon expiration of lease. The Company has the option to renew the lease for the Baxter, MN facility for an additional five years upon expiration of the initial lease term in July 2006. The lease for the manufacturing facility in Mexico provides the Company the option of two three-year renewals extending the lease through 2010.

Rent expense, which includes amounts for other short term leases, for the years ended December 31, 2003, 2002, and 2001, amounted to 869,565, $799,571 and $661,475, respectively. Sublease income amounted to $3,000 and $750 for the years ended December 31, 2003 and 2002, respectively.

The future minimum lease payments are as follows:

Years Ending December 31,	Lease Commitment		Sublease Income		Net
2004	$	328,101	$	3,000	$	325,101
2005		151,772		1,750		150,022
2006		34,320		—		34,320
2007		1,210		—		1,210

Total	$	515,403	$	4,750	$	510,653

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2003, 2002, AND 2001

NOTE 6 INCOME TAXES

The expense (benefit) for income taxes for each of the three years ended December 31, 2003 consists of the following:

		2003			2002		2001
Current Taxes—Federal		$	(76,000	)	$	763,000	$	1,116,000
Current Taxes—State			(33,000	)		151,000		235,000
Current Taxes—Foreign			30,000			17,000		—
Deferred Taxes—Federal			(42,000	)		374,000		40,000
Deferred Taxes—State			(1,000	)		65,000		(18,000	)
Deferred Taxes—Foreign			(1,000	)		—		—

	Income Tax Expense (Benefit)	$	(123,000	)	$	1,370,000	$	1,373,000

The statutory rate reconciliation for each of the three years ended December 31, 2003 is as follows:

		2003			2002			2001
Statutory Tax Provision		$	174,000		$	1,283,000		$	1,182,000
State Income Taxes, Net of Federal Benefit			24,000			153,000			143,000
Effect of Foreign Operations			17,000			1,000			—
General Business Credits			(93,000	)		(82,000	)		(18,000	)
Research and Development Tax Credits, Net of Payments			(246,000	)		—			—
Other			1,000			15,000			66,000

	Income Tax (Benefit) Expense	$	(123,000	)	$	1,370,000		$	1,373,000

Income from operations before income taxes was derived from the following sources:

		2003	2002	2001
Domestic		471,000	3,726,000	3,476,000
Foreign		39,000	47,000	—

	Total	510,000	3,773,000	3,476,000

Deferred tax assets (liabilities) at December 31, 2003 and 2002, consist of the following:

		2003			2002
Unrealized Loss on Discontinued Operations		$	—		$	19,000
Allowance for Doubtful Accounts			140,000			187,000
Inventory Reserves			495,000			365,000
Accrued Vacation			228,000			243,000
Accrued Warranty			1,000			15,000
Health Insurance Reserve			82,000			106,000
Accrued Bonuses			—			7,000
Non-Compete Amortization			157,000			53,000
Property and Equipment			16,000			—
Other Reserves			19,000			17,000

	Deferred Tax Assets		1,138,000			1,012,000
Property and Equipment			(102,000	)		(20,000	)

	Deferred Tax Liabilities		(102,000	)		(20,000	)

	Net Deferred Tax Assets (Liabilities)	$	1,036,000		$	992,000

Net Short-Term Deferred Tax Assets		$	965,000		$	959,000
Net Long-Term Deferred Tax Assets			71,000			33,000

	Total Deferred Tax Assets	$	1,036,000		$	992,000

The Company has determined that it is more likely than not that its deferred tax assets will be realized, principally through carrybacks to prior tax years and taxable income in future tax years. As a result, management has determined that establishing a valuation allowance on the Company's deferred tax assets is not necessary.

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:

		Year Ended December 31, 2003			Year Ended December 31, 2002		Year Ended December 31, 2001
Net Income, As Reported		$	633,448		$	2,403,112	$	2,102,863
Other Comprehensive Loss:
	Translation Loss		(26,688	)		—		—

Comprehensive Income		$	606,760		$	2,403,112	$	2,102,863

NOTE 8 401(K) RETIREMENT PLAN

The Company has a 401(k) profit sharing plan (the "Plan") for its employees. The Plan is a defined contribution plan covering all employees of the Company except for employees covered by a collective bargaining agreement and non-resident aliens earning non-U.S. source income. Employees are eligible to participate in the Plan after completing six months of service and attaining the age of 21. Employees are allowed to contribute up to 15% of their wages to the Plan. The Company matches 25% of the employees' contribution up to 6% of covered compensation. The Company made contributions of $115,573, $117,509 and $100,448 during the years ended December 31, 2003, 2002, and 2001, respectively.

NOTE 9 GAINSHARING INCENTIVE AND STOCK OPTION PLANS

Employee Gainsharing

During 1993, the Company adopted an employee gainsharing plan (the "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 2003 and 2002, 133 and 12,355 shares, respectively, were issued in connection with this plan. Through December 31, 2003, 21,521 shares have been issued under this Plan.

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. In February 2003, the Company reached the maximum options allowed to be granted under the plan.

During 2003, the Company's shareholders approved the adoption of the Nortech Systems Incorporated 2003 Stock Option Plan (the "Plan"). The total number of shares of common stock that may be granted under the plan is 300,000, of which 212,500 shares remain available at December 31, 2003. 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.

The following table summarizes information about stock options outstanding at December 31, 2003:

Exercise Prices	Outstanding 12/31/2003	Exercisable 12/31/2003	Remaining Contractual Life
3.125	28,000	18,400	6.17 Years
3.625	6,000	6,000	0.07 Years
4.000	6,800	4,080	6.42 Years
5.000	60,000	60,000	3.14 Years
5.250	35,000	35,000	1.92 Years
5.500	4,000	4,000	5.01 Years
7.110	4,000	2,000	8.82 Years
7.220	50,000	—	9.12 Years
8.000	79,000	13,000	9.95 Years

	272,800	142,480

Following is a summary of the stock option plan activity during 2003, 2002 and 2001.

	2003				2002					2001
	Shares		Weighted- Average Exercise Price		Shares			Weighted- Average Exercise Price		Shares		Weighted- Average Exercise Price
Options Outstanding, Beginning of Year	151,000		$	4.60		297,500		$	4.39	297,500		$	4.39
Options Exercised	(7,200	)		3.27		(146,900	)		4.28	—			—
Options Forfeited	—			—		(3,600	)		3.13	(6,000	)		3.13
Options Granted	129,000			7.70		4,000			7.11	6,000			3.13

Options Outstanding, End of Year	272,800		$	6.10		151,000		$	4.60	297,500		$	4.39

Option Price Range of Exercised Shares	$3.125 - 4.00				$	1.625 - 5.25				—

NOTE 10 ACQUISITION OF SUBSIDIARY

On June 27, 2002, the Company acquired 100 percent of the outstanding common shares of Manufacturing Assembly Solutions of Monterrey, Inc. (MAS), a Mexican corporation, located in Monterrey, Mexico. The results of operations since June 27, 2002, have been included in the consolidated financial statements. The primary reason for this acquisition was to enhance the Company's manufacturing capabilities in a low cost country. The aggregate purchase price was $1,850,000, including $650,000 paid in cash in July 2002 and a $1,200,000 promissory note (see Note 4) to SAE Assembly, LLC.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition:

Current Assets		$	152,148
Net Property and Equipment			186,761
Other Assets			11,012
Intangible Assets			1,526,384

	Total Assets Acquired	$	1,876,305

Current Liabilities Assumed		$	26,305

	Net Assets Acquired	$	1,850,000

Intangible assets acquired consist principally of non-compete agreements, which are being amortized on a straight-line basis over the four year term of the agreements. The Company has recorded related amortization expense of $381,600 and $190,800 for the years ended December 31, 2003 and 2002, respectively. Accumulated amortization on the non-compete arrangements amounted to $572,400 and 190,800 at December 31, 2003 and 2002, respectively. The Company will record amortization expenses of $381,600, $381,600 and $190,784 for the years ended December 31, 2004, 2005 and 2006, respectively.

NOTE 11 COMMITMENTS AND CONTINGENCIES

Litigation

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.

Executive Life Insurance Plan

During 2002, the Company set up an Executive Bonus Life Insurance Plan (the "Plan") for its key employees ("participants"). Pursuant to the Plan, the Company will pay a bonus to participants equal to 10% of the participants' base annual salary, as well as an additional bonus to cover federal and state taxes incurred by the participants. The participants are required to purchase life insurance and retain ownership of the life insurance policy once it is purchased. The Plan provides a five-year graded vesting schedule in which the participants vest in their bonus at a rate of 20% each year. Should a participant terminate employment prior to the fifth year of vesting, that participant must reimburse the Company for any unvested amounts. Charges to income under the Plan were $156,091 and $135,759 for the years ended December 31, 2003 and 2002.

Change of Control Agreements

During 2002, the Company entered into Change of Control Agreements (the "Agreement(s)") with certain key executives ("the Executive(s)"). The Agreements provide an inducement for each Executive to remain as an employee of the Company in the event of any proposed or anticipated change of

control in the organization, including facilitating an orderly transition, and to provide economic security for the Executive after a change in control has occurred.

In the event of an involuntarily termination, each Executive would receive their base salary, annual bonus at time of termination, and continued participation in health, disability and life insurance plans for a period of three years. Each Executive would also receive professional outplacement services up to $10,000. Each Agreement remains in full force until the Executive terminates employment or the Company terminates the employment of the Executive.

NOTE 12 EARNINGS PER SHARE

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

	2003		2002		2001
Basic Earnings Per Common Share
Net Income	$	633,448	$	2,403,112	$	2,102,863

Weighted average common share outstanding		2,478,921		2,410,890		2,361,192

Basic earnings per common share*	$	0.26	$	1.00	$	0.89

Diluted Earnings Per Common Share
Net Income	$	633,448	$	2,403,112	$	2,102,863

Weighted average common shares outstanding		2,478,921		2,410,890		2,361,192
Stock options		49,889		106,592		95,896

Weighted average common shares for diluted earnings per common share		2,528,810		2,517,482		2,457,088

Diluted earnings per common share	$	0.25	$	0.95	$	0.86

*: For 2003, 2002 and 2001, there were approximately 17,350, 0 and 25 shares, respectively, excluded from the computation of diluted earnings per share because to include would be antidilutive.

NOTE 13 SUPPLEMENTARY FINANCIAL INFORMATION (UNAUDITED)

	Quarter Ending 3/31/2003		Quarter Ending 6/30/2003		Quarter Ending 9/30/2003		Quarter Ending 12/31/2003
Net Sales	$	13,770,288	$	14,486,982	$	14,060,224	$	15,641,204
Gross Profit		1,649,500		1,734,735		1,824,228		1,286,513
Net Income (Loss)		121,524		226,786		440,679		(155,541	)
Basic Earnings (Loss) per Share of Common Stock		0.05		0.09		0.18		(0.06	)
Diluted Earnings (Loss) per Share of Common Stock		0.05		0.09		0.17		(0.06	)

	Quarter Ending 3/31/2002		Quarter Ending 6/30/2002		Quarter Ending 9/30/2002		Quarter Ending 12/31/2002
Net Sales	$	15,362,896	$	15,243,680	$	14,670,449	$	15,378,553
Gross Profit		2,779,465		2,837,651		2,353,171		2,307,737
Net Income		618,919		534,269		559,034		690,890
Basic Earnings per Share of Common Stock		0.26		0.22		0.23		0.29
Diluted Earnings per Share of Common Stock		0.25		0.21		0.22		0.27

INDEPENDENT AUDITORS' REPORT
ON FINANCIAL STATEMENT SCHEDULE

Board of Directors and Shareholders
Nortech Systems Incorporated:

Under date of February 13, 2004, except as to note 4 which is as of March 9, 2004, we reported on the consolidated balance sheets of Nortech Systems Incorporated and subsidiary as of December 31, 2003 and 2002, and related consolidated statements of income, shareholders' equity and cash flows for each of the years in the two-year period ended December 31, 2003, which are included in the Annual Report on Form 10-K for the year 2003. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule as listed in the accompanying index for each of the years in the two-year period ended December 31, 2003. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.

In our opinion, such financial statement schedule, when considered in relation to the 2003 and 2002 basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ KPMG LLP

Minneapolis, Minnesota
February 13, 2004

INDEPENDENT AUDITORS' REPORT ON
SUPPLEMENTARY INFORMATION

Board of Directors
Nortech Systems Incorporated and Subsidiary
Bemidji, Minnesota

Our report on the basic consolidated financial statements of Nortech Systems Incorporated and Subsidiary for 2001 precedes the consolidated financial statements. The audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule on the following page is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.

LARSON, ALLEN, WEISHAIR & CO., LLP

St. Cloud, Minnesota
February 13, 2002

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding the directors and executive officers of the Registrant will be included in the Registrant's 2003 proxy statement to be filed with the Securities and Exchange Commission not later than April 30, 2004 and said portions of the proxy statement are incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

Information regarding executive compensation of the Registrant will be included in the Registrant's 2003 proxy statements to be filed with the Securities and Exchange Commission not later than April 30, 2004 and said portions of the proxy statement are incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information regarding security ownership of certain beneficial owners and management of the Registrant will be included in the Registrant's 2003 proxy statements to be filed with the Securities and Exchange Commission no later than April 30, 2004 and said portions of the proxy statements are incorporated herein by reference.

Information regarding executive compensation plans as of the end of the last fiscal year, on two categories of equity compensation plans (including individual compensation arrangements): that is, plans that have been approved by security holders and plans that have not been approved by security holders, will be included in the Registrant's 2003 proxy statements to be filed with the Securities and Exchange Commission no later than April 30, 2004 and said portions of the proxy statements are incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.

ITEM 14. CONTROLS AND PROCEDURES

A.: The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the specified time periods. As of the end of the period covered by this report, the Company's management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures. Based on the evaluation, which disclosed no significant deficiencies or material weaknesses, the Chief Executive Officer and Chief Financial Officer each concluded that the Company's disclosure controls and procedures are effective.
B.: There were no changes in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that may have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

PART IV

ITEM 15. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K

(a) 1.		Consolidated Financial Statements—consolidated financial statements and related Notes are included in Part II, Item 8, and are identified in the Index on Page 19.
(a) 2.		Consolidated Financial Schedule—The following consolidated financial statement schedule supporting the consolidated financial statements and the Accountants' report thereon is included in this Annual Report on Form 10-K:

		Page
Independent Auditors' Reports on Supplementary Information
	KPMG LLP	54
	Larson, Allen Weishair & Co., LLP	55
Consolidated Financial Statement Schedule for the years ended December 31, 2003, 2002 and 2001
	II Valuation and Qualifying Accounts	56

All other schedules are omitted since they are not applicable, not required, or the required information is included in the financial statements or notes thereto.

(b): Reports on Form 8-K

The Company filed the following Current Reports on Form 8-K during the quarter ended December 31, 2003:

•: On October 22, 2003, under Item 12, Results of Operations and Financial Condition, summarizing financial results for the quarter ended September 30, 2003.

No other reports on Form 8-K were filed during the quarter ended December 31, 2003; however,

•: On March 17, 2004, under Item 12, Results of Operations and Financial Condition, the Company filed a Current Report on Form 8-K summarizing financial results for the year and quarter ended December 31, 2003.

The following exhibits are incorporated by reference to exhibits accompanying the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

10.1		Third Amendment to amended and restated Credit and Security Agreement, Amended and Restated Revolving Note between the Company and Wells Fargo Bank Minnesota National Association.
23.1		Letter of Consent from KPMG LLP in reference to the S-8 Forms filed June 21, 1994 and June 30, 1993.
23.2		Letter of Consent from Larson, Allen Weishair & Co., LLP in reference to the S-8 Forms filed June 21, 1994 and June 30, 1993.
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.

The following exhibits are incorporated by reference to exhibits accompanying the Company's Annual Report on Form 10-K for the year ended December 31, 2002.

10.1		Stock purchase agreement for all outstanding shares of capital stock of Manufacturing Assembly Solutions of Monterrey Inc. dated June 27, 2002.
10.2		Change of Control Agreement entered into on October 1, 2002 by and between the Company and the Officers and Vice Presidents referred to collectively as the Corporation and the Executive.
10.3		Resolution Authorizing Executive Bonus Life Insurance Plan for certain key Employees of the Company effective on October 23, 2002.

The following exhibit is incorporated by reference to exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001.

10.4

Letter of Undertaking, Promissory Notes for Real Estate, Equipment and Revolving Line of Credit between Wells Fargo Bank Minnesota National Association (formerly Norwest Bank Minnesota South, N.A), and the Company.

The following exhibit is incorporated by reference to exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000.

10.5

Lease Agreement for Augusta building at 750 Industrial Park Drive, and Sales Agreement for Augusta building at 350 Industrial Park Drive, both in Augusta, Wisconsin.

The following exhibit is incorporated by reference to exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1999.

10.1

Master lease agreement for equipment between Amplicon Financial and the Company.

The following exhibit is incorporated by reference to exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998.

10.1

Master lease agreement for equipment between Amplicon Financial and the Company.

The following exhibit is incorporated by reference to exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.

10.6

Asset Purchase Agreement for the purchase of Aerospace Division of Communication Cable, Inc. dated August 23, 1995.

The following exhibit is incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.

3.1

Articles of Incorporation dated October 30, 1990.

The following exhibit is incorporated by reference to Exhibit 3.2 to the Annual Report on Form 10-K for the year ended December 31, 1984:

3.2

Bylaws

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

NORTECH SYSTEMS INCORPORATED
March 30, 2004	By:	/s/ GARRY M. ANDERLY
		Garry M. Anderly Chief Financial Officer and Principal Accounting Officer
March 30, 2004	By:	/s/ MICHAEL J. DEGEN
		Michael J. Degen President, Chief Executive Officer and Director

Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report.

March 30, 2004		/s/ MICHAEL J. DEGEN
		Michael J. Degen President, Chief Executive Officer and Director
March 30, 2004		/s/ MYRON KUNIN
		Myron Kunin, Chairman and Director
March 30, 2004		/s/ RICHARD W. PERKINS
		Richard W. Perkins, Director
March 30, 2004		/s/ C. TRENT RILEY
		C. Trent Riley, Director
March 30, 2004		/s/ KEN LARSON
		Ken Larson, Director

NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY
SCHEDULE II
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001

Column A		Column B		Column C		Column D		Column E
Classification		Balance at Beginning of Period		Additions Charged to Costs And Expenses		Add (Deduct)		Balance at End of Period
Year Ended December 31, 2003:
	Allowance for Doubtful Accounts	$	488,451	(19,694	)	(97,067	)	$	371,690
Year Ended December 31, 2002:
	Allowance for Doubtful Accounts	$	318,557	231,500		(61,606	)	$	488,451
Year Ended December 31, 2001:
	Allowance for Doubtful Accounts	$	187,294	131,263		—		$	318,557

INDEX TO EXHIBITS

DESCRIPTIONS OF EXHIBITS

	10.1		Third Amendment to amended and restated Credit and Security Agreement, Amended and Restated Revolving Note between the Company and Wells Fargo Bank Minnesota National Association.
	23.1		Letter of Consent from KPMG LLP in reference to the S-8 Forms filed June 21, 1994 and June 30, 1993.
	23.2		Letter of Consent from Larson, Allen Weishair & Co., LLP in reference to the S-8 Forms filed June 21, 1994 and June 30, 1993.
	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.