OVERVIEW

We are a Wayzata, Minnesota based full-service Electronics Manufacturing Services (EMS) contract manufacturer of wire and cable assemblies, printed circuit board assemblies, higher-level assemblies and box builds for a wide range of industries. Markets served include industrial equipment, transportation, vision, medical, military/defense, agriculture, oil and gas. In Minnesota, we have facilities in Baxter, Bemidji, Blue Earth, Fairmont and Merrifield. We also have facilities in Augusta, Wisconsin, Garner, Iowa and Monterrey, Mexico.

The vast majority of our revenue is derived from products that are built to the customer's design specifications. We provide a high degree of manufacturing sophistication. During 2008, we continued our supply chain initiatives designed to reduce costs, improve asset utilization and increase responsiveness to customers. Our strategy has been to expand and diversify our customer base, and we are focusing our sales and marketing approach to target greater value-added service opportunities. Our market strength is low-volume, high-mix production, particularly with complex products. Our continued investment in our Mexico operation allows for expansion into medium volume, medium mix and lower cost production and our contractual arrangements with Chinese manufacturers allow us to meet higher volume, lower mix and lower cost customer requirements.

During 2008, we experienced growth in our Sales, Gross Profit, and Net Income. For the years ended December 31, 2008 we had sales of $121.9 million, compared to $118.1 million for 2007. The 2008 increase of $3.8 million was a 3.2% improvement over 2007. For the years ended December 31, 2008 and 2007, we had gross profit of $16.9 million and $16.2 million, respectively. Gross profits as a percentage of net sales were 13.8% and 13.7% for the years ended December 31, 2008 and 2007, respectively. Our net income in 2008 was $1,753,849 or $0.64 per diluted common share compared to $1,579,013 or $0.58 per diluted common share in 2007.

The global economy is currently experiencing a broad recession. Although we have not been significantly impacted through December 31, 2008, we are now experiencing increased customer order cancellations and delays.

CRITICAL ACCOUNTING ESTIMATES

Our significant accounting policies and estimates are summarized in the footnotes to our annual consolidated financial statements. Some of the accounting policies require us to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. Such judgments are subject to an inherent degree of uncertainty. These judgments are based on historical experience, known trends in the industry, terms of existing contracts and other information from outside sources, as appropriate. Actual results may differ from these estimates under different assumptions and conditions. Certain of the most critical estimates that require significant judgment are as follows.

Revenue Recognition:

We recognize revenue upon shipment of manufactured products to customers, when title has passed, all contractual obligations have been satisfied and collection of the resulting receivable is reasonably assured. We also provide engineering services separate from the manufacture of a product. Revenue for engineering services is recognized upon completion of the engineering process, providing standalone fair value to our customers. Our engineering services are short-term in nature. In addition, we have another separate source of revenue that comes from short-term repair services, which are recognized upon completion of the repairs, and the repaired products are shipped back to the customer. Shipping and handling costs charged to our customers are included in net sales, while the corresponding shipping expenses are included in cost of goods sold.

Allowance for Uncollectible Accounts:

When evaluating the adequacy of the allowance for doubtful accounts, we analyze accounts receivable, historical write-offs of bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment terms. We maintain an allowance for doubtful accounts at an amount estimated to be sufficient to provide adequate protection against losses resulting from collecting less than full payment on receivables. A considerable amount of judgment is required when assessing the realizability of receivables, including assessing the probability of

collection and the current credit-worthiness of each customer. If the financial condition of our customers was to deteriorate, resulting in an impairment of their ability to make payments, an additional provision for uncollectible accounts may be required. We have historically not experienced significant bad debts expense and believe the reserve is adequate for any exposure to loss in the December 31, 2008 accounts receivable.

Inventory Reserves:

Inventory reserves are maintained for the estimated value of the inventory that may have a lower value than stated or quantities in excess of future production needs. We have an evaluation process that is used to assess the value of the inventory that is slow moving, excess or obsolete on a quarterly basis. We evaluate our inventory based on current usage and the latest forecasts of product demand and production requirements from our customers. We believe the total reserve at December 31, 2008 is adequate.

Long-Lived and Intangible Asset Impairment:

We evaluate long-lived assets and intangible assets with finite 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 our 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 might be required to reduce the carrying amount to equal estimated fair value. To date, we have determined that no impairment of long-lived assets exists.

Stock-Based Compensation:

We follow the provisions of Statement of Financial Accounting Standards (SFAS) 123R, "Share-Based Payment" which requires us to measure and recognize in our consolidated financial statements the expense associated with all share-based payment awards made to employees and directors based on estimated fair values. We utilize the Black-Scholes option valuation model to measure the amount of compensation expense to be recognized for each option award. There are several assumptions that must be made when using the Black-Scholes model such as the expected term of each award, the expected volatility of the stock price during the expected term of the award, the expected dividends to be paid and the risk free interest rate expected during the award term. Of these assumptions, the expected term of the award and expected volatility of our common stock are the most difficult to estimate since they are based on the exercise behavior of employees and the expected future performance of our stock. An increase in the volatility of our stock price or an increase in the average period before exercise will increase the amount of compensation expense related to awards granted after December 31, 2008.

Based on a critical assessment of our accounting estimates and the underlying judgments and uncertainties of those estimates, we believe that our consolidated financial statements provide a meaningful and fair presentation of our financial position and results of operations. 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 our consolidated financial position, results of operations and cash flows in future periods.

No matters have come to our attention since December 31, 2008 that would cause the estimates included in the consolidated financial statements to change materially.

OPERATING RESULTS

    The following table presents statement of operations data as percentages of
net sales for the indicated year:

                                                      2008       2007
              Net Sales                               100.00 %   100.00 %
              Cost of Goods Sold                       86.20      86.30

              Gross Profit                             13.80      13.70
              Selling Expenses                          4.70       4.50
              General and Administrative Expenses       6.30       6.20

              Income from Operations                    2.80       3.00
              Other Expenses, Net                       0.50       0.90
              Income Tax Expense                        0.90       0.80

              Net Income                                1.40 %     1.30 %

Revenues:

For the years ended December 31, 2008 and 2007, we had sales of $121.9 million and $118.1 million,

respectively, an increase of $3.8 million or 3.2%. Our sales increase was mainly due to increases in Aerospace Systems sales of $4.7 million and Cable and Wire sales of $2.4 million, offset by a decrease of Electronic Circuit Board Assembly sales of $3.3 million. The increases are a result of continued growth in our defense and medical customers and the decrease was mainly the result of some softness in business from our industrial customer base being impacted by the economic downturn.

Gross Profit:

For the years ended December 31, 2008 and 2007, we had gross profit of $16.9 million and $16.2 million, respectively. Gross profits as a percentage of net sales were 13.8% and 13.7% for the years ended December 31, 2008 and 2007, respectively. The 2008 gross profit as a percentage of sales remained flat due primarily to the favorable impact of volume, product mix and leveraging on our operations, offset by energy and commodity (copper and petroleum based products) cost pressures early in the fiscal year.

Selling:

Selling expenses were $5.8 million or 4.7% of net sales for the year ended December 31, 2008 and $5.1 million or 4.5% of net sales for the year ended December 31, 2007. The 2008 increase in selling expense of $0.7 million from 2007 can be attributed to increased commission expenses of $0.2 million as a result of higher commissionable sales, as well as a $0.5 million increase in marketing and sales related spending, consisting primarily of personnel, travel and expense to support the sales efforts.

General and Administrative:

For the years ended December 31, 2008 and 2007, general and administrative expenses were $7.6 million and $7.4 million, respectively. General and administrative expenses as a percentage of net sales were 6.3% and 6.2% for the years ended December 31, 2008 and 2007, respectively. The $0.2 million increase in general and administrative expenses in 2008 from 2007 is mainly attributed to an increase in allowance for uncollectible accounts expense, offset by decreases in personnel and related expenses.

Other Income (Expense):

Other expense for the years ended December 31, 2008 and 2007 was approximately $0.6 million and $1.2 million, respectively. Interest income for the years ended December 31, 2008 and 2007 was approximately $10,000 and $24,000, respectively. For the year ended December 31, 2008 we had miscellaneous income of $78,000 compared to miscellaneous expense of $73,000 for the year ended December 31, 2007. The increasing value of the US Dollar against the Mexican Peso was the main reason for the year over year variance. Interest expense was approximately $0.7 million and $1.1 million for the years ended December 31, 2008 and 2007, respectively. Lower average debt levels and favorable interest rates in 2008 over 2007 accounted for the majority of the decreased interest expense.

Income Taxes:

Income tax expense amounted to $1,101,000 and $898,000 for the years ended December 31, 2008 and 2007, respectively. The effective tax rate for fiscal 2008 was 38.6% compared to 36.3% in fiscal 2007. The increase in the effective tax rate was mainly due to a $49,000 additional FIN 48 reserve and a $17,000 reduction of R & D tax credits.

Net Income:

Our net income in 2008 was $1,753,849 or $0.64 per diluted common share compared to $1,579,013 or $0.58 per diluted common share in 2007. The changes in net income are the result of the aforementioned factors.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 1 to our consolidated financial statements for a description of recent accounting pronouncements and their estimated impact on our consolidated financial statements.

FINANCIAL CONDITION AND LIQUIDITY

We believe that our existing financing arrangements and anticipated cash flows from operations will be sufficient to satisfy our working capital needs, capital expenditures, investments, and debt repayments for the foreseeable future.

We are currently in compliance with the covenants in our financing arrangements. However, we cannot be certain that, if we were to violate our credit agreement in the future, the lender would be agreeable to renegotiation. We currently do not have alternative financing arrangements, and if we were required to obtain

financing in a short period of time to avoid default, financing might not be available, or the terms of that financing might be disadvantageous.

Credit Lines:

On August 15, 2008, we entered into an 8th amendment to our credit agreement with WFB which expires, if not renewed, on June 30, 2010, and under which both the line of credit and real estate term note are subject to variations in the LIBOR rate. During 2008 our line of credit bore interest at LIBOR + 1.75% (3.625% at December 31, 2008). The weighted-average interest rate on our line of credit was 4.52% for the year ended December 31, 2008.

The line of credit and other installment debt with WFB contain certain covenants, which, among other things, require us to adhere to regular reporting requirements, abide by annual shareholder dividend limitations, maintain certain financial ratios, and limit the amount of annual capital expenditures. The availability under the line is subject to borrowing base requirements, and advances are at the discretion of the lender. The line is secured by substantially all of our assets. This commitment is summarized as described below:

                                    Total
                                    Amount        Outstanding at          Date of
   Other Commercial Commitment    Committed      December 31, 2008      Expiration
   Line of credit                $ 15,000,000    $        4,367,562     June 30, 2010

As of December 31, 2008 we have net unused availability under our line of credit agreement of approximately $8.2 million as supported by our borrowing base.

Cash Flow:

                                                       December 31,    December 31,
                                                           2008            2007
Cash flows provided by (used in):
Operating Activities                                    $  4,027,231    $  4,343,284
Investing Activities                                      (2,303,151 )    (6,316,568 )
Financing Activities                                      (1,809,730 )     2,135,833
Effect of exchange rate changes on cash                          655            (404 )

Net increase (decrease) in cash and cash equivalents    $    (84,995 )  $    162,145

On December 31, 2008, we had working capital of approximately $15.8 million as compared to $14.8 million at the end of 2007. During 2008, we generated approximately $4.0 million of cash flow from operating activities. The cash flow from operations is primarily due to net income of $1.8 million and noncash depreciation, amortization, and other noncash expenses, and the change in deferred taxes, which totaled $2.1 million in net positive adjustments. Cash flow from changes in operating assets and liabilities was $0.1 million. This was driven by a $2.2 million reduction in accounts receivable, offset by an increase in inventory of $1.8 million and other changes in current operating items of $0.3 million.

Our net cash used in investing activities of $2.3 million is primarily due to $2.3 million of capital equipment purchases. Net cash used in financing activities of $1.8 million consisted of paying down $1.2 million on our line of credit, a net decrease in long-term debt of $0.7 million, offset by proceeds of $0.1 million from the issuance of common stock due to the exercise of options.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

To the Board of Directors and Shareholders Nortech Systems Incorporated and Subsidiary

We have audited the accompanying consolidated balance sheets of Nortech Systems Incorporated and Subsidiary as of December 31, 2008 and 2007, and the related consolidated statements of income, shareholders' equity and cash flows for each of the years then ended. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall 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, 2008 and 2007, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

We were not engaged to examine management's assertion about the effectiveness of Nortech Systems Incorporated and Subsidiary's internal control over financial reporting as of December 31, 2008 included in the Company's Annual Report and titled Management's Report on Internal Control over Financial Reporting and, accordingly, we do not express an opinion thereon.

/s/ McGladrey & Pullen, LLP

Minneapolis, Minnesota
March 11, 2009

                  NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

                          CONSOLIDATED BALANCE SHEETS

                           DECEMBER 31, 2008 AND 2007

ASSETS                                                           2008            2007
CURRENT ASSETS
  Cash and Cash Equivalents                                  $     803,041   $     888,036
  Accounts Receivable, Less Allowance for Uncollectible         13,161,578      15,366,965
  Accounts
  Inventories                                                   20,703,144      18,876,464
  Prepaid Expenses                                                 745,044         512,884
  Income Taxes Receivable                                          421,175               -
  Deferred Tax Assets                                            1,358,000         974,000

        Total Current Assets                                    37,191,982      36,618,349

PROPERTY AND EQUIPMENT
  Land                                                             300,000         300,000
  Building and Leasehold Improvements                            6,508,974       6,435,732
  Manufacturing Equipment                                       12,067,317      10,140,802
  Office and Other Equipment                                     4,105,009       3,687,441
  Construction in Progress                                         467,944         146,081

        Total Property and Equipment                            23,449,244      20,710,056
  Accumulated Depreciation                                     (13,204,036 )   (11,785,374 )

        Net Property and Equipment                              10,245,208       8,924,682

OTHER ASSETS
  Restricted Cash                                                  427,500         427,500
  Finite-Lived Intangible Assets, Net of Accumulated               493,670         643,791
  Amortization
  Goodwill                                                          75,006          75,006
  Deferred Tax Assets                                                    -         303,400
  Other Assets                                                       7,726           7,726

        Total Other Assets                                       1,003,902       1,457,423

              Total Assets                                   $  48,441,092   $  47,000,454

                  NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

                    CONSOLIDATED BALANCE SHEETS (Continued)

                           DECEMBER 31, 2008 AND 2007

 LIABILITIES AND SHAREHOLDERS' EQUITY                           2008           2007
 CURRENT LIABILITIES
     Bank Note Payable                                      $  4,367,562   $  5,635,076
     Current Maturities of Long-Term Debt                        951,437      1,176,209
     Accounts Payable                                         10,746,206     10,627,381
     Accrued Payroll and Commissions                           3,417,901      2,845,557
     Accrued Health and Dental Claims                            446,102        380,000
     Other Accrued Liabilities                                 1,484,990        922,607
     Income Taxes Payable                                              -        219,167

         Total Current Liabilities                            21,414,198     21,805,997

 LONG-TERM LIABILITIES
     Long-Term Debt (Net of Current Maturities)                4,386,064      4,840,689
     Deferred Tax Liabillities                                    69,000              -
     Other Long-Term Liabilities                                 153,805         42,919

         Total Long-Term Liabilities                           4,608,869      4,883,608

             Total Liabilities                                26,023,067     26,689,605

 SHAREHOLDERS' EQUITY
     Preferred Stock, $1 par value; 1,000,000 Shares
     Authorized; 250,000 Shares Issued and Outstanding           250,000        250,000
     Common Stock-$0.01 par value; 9,000,000 Shares
     Authorized; 2,738,955 and
     2,714,888 Shares Issued and Outstanding at
     December 31, 2008 and 2007,
     respectively                                                 27,390         27,149
     Additional Paid-In Capital                               15,525,981     15,111,179
     Accumulated Other Comprehensive Loss                        (89,598 )      (27,882 )
     Retained Earnings                                         6,704,252      4,950,403

         Total Shareholders' Equity                           22,418,025     20,310,849

             Total Liabilities and Shareholders' Equity     $ 48,441,092   $ 47,000,454

See accompanying Notes to Consolidated Financial Statements.

                  NORTECH SYSTEMS INCORPORATED AND SUBSIDIARY

                       CONSOLIDATED STATEMENTS OF INCOME

                 FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

                                                               2008            2007
Net sales                                                  $ 121,852,088   $ 118,099,031
Cost of goods sold                                           104,997,077     101,918,162

Gross profit                                                  16,855,011      16,180,869

Operating expenses:
    Selling expenses                                           5,772,762       5,146,354
    General and administrative expenses                        7,612,713       7,387,180

           Total operating expenses                           13,385,475      12,533,534

Income from operations                                         3,469,536       3,647,335

Other income (expense)
    Interest income                                                9,861          23,791
    Miscellaneous income (expense)                                77,910         (73,397 )
    Interest expense                                            (702,458 )    (1,120,716 )

           Total other expense                                  (614,687 )    (1,170,322 )

Income before income taxes                                     2,854,849       2,477,013
Income tax expense                                             1,101,000         898,000

Net income                                                 $   1,753,849   $   1,579,013

Net income per common share:
Basic                                                      $        0.64   $        0.59

Weighted average number of common shares outstanding
used for basic earnings per common share                       2,719,250       2,690,717
. . .