News Column

ORBIT INTERNATIONAL CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

August 14, 2014

Forward Looking Statements

Statements in this Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this document are certain statements which are not historical or current fact and constitute "forward-looking statements" within the meaning of such term in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that could cause our actual financial or operating results to be materially different from our historical results or from any future results expressed or implied by such forward-looking statements. Such forward looking statements are based on our best estimates of future results, performance or achievements, based on current conditions and our most recent results. In addition to statements which explicitly describe such risks and uncertainties, readers are urged to consider statements labeled with the terms "may," "will," "potential," "opportunity," "believes," "belief," "expects," "intends," "estimates," "anticipates" or "plans" to be uncertain and forward-looking. The forward-looking statements contained herein are also subject generally to other risks and uncertainties that are described from time to time in our reports and registration statements filed with the Securities and Exchange Commission.

Executive Overview

We recorded a decrease in our operating results for the three and six months ended June 30, 2014 as compared to the comparable prior year periods. Our net sales for the three and six months ended June 30, 2014 decreased by 16.7% and 19.5%, respectively, as compared to the prior year three and six month periods. We recorded a net loss of $171,000 and $1,233,000, respectively, for the three and six months ended June 30, 2014 as compared to net income of $109,000 and $29,000 for the respective prior year periods. The decrease in operating results for both the three and six month current periods was primarily attributable to lower revenue and profitability from both our Electronics and Power Groups. Our net loss for the three and six months ending June 30, 2014 included a $351,000 and $1,079,000 operating loss, respectively, from our TDL subsidiary which included costs associated with the consolidation of our Quakertown facility into our Hauppauge, NY facility. Beginning June 30, 2014, we do not expect to incur any additional costs associated with our Quakertown facility with the exception of some minor occupancy related costs.

Our backlog at June 30, 2014 was approximately $8,200,000 compared to $10,100,000 at December 31, 2013 due primarily to a lower backlog at our Electronics Group. There is no seasonality to our business. Our shipping schedules are generally determined by the shipping schedules outlined in the purchase orders received from our customers. Both of our operating segments are pursuing a significant amount of business opportunities and while we are confident that we will receive many of the orders we are pursuing, there can be no assurance as to the ultimate receipt and timing of these orders.

19



--------------------------------------------------------------------------------

Index

Our financial condition remains strong as evidenced by our 9.3 to 1 current ratio at June 30, 2014. During November 2012, we entered into a $6,000,000 line of credit facility with a new lender. This line of credit was used to pay off, in full, all of our obligations to our former primary lender and to provide for our general working capital needs. In June 2013, our Credit Agreement was amended whereby (i) the expiration date on our credit facility was extended to July 1, 2015 and (ii) we are permitted to purchase up to $400,000 of our common stock in each year beginning July 1 and ending June 30 during the term of our Credit Agreement. In April 2014, our Credit Agreement was further amended whereby (i) we are required, for a defined period of time, to have an aggregate of cash, marketable securities and excess availability under our borrowing base of no less than $3,000,000 (ii) the definition of our consolidated fixed charge coverage ratio was amended and compliance with such amended ratio was waived for the quarter ended March 31, 2014 and we are not required to comply with this amended ratio until the year ending December 31, 2014 and each fiscal quarter and year thereafter, and (iii) we are required to maintain consolidated tangible net worth of no less than $13,500,000 for the quarters ending June 30, 2014 and September 30, 2014. We were in compliance with the financial covenants contained in our Credit Agreement at June 30, 2014. On November 6, 2013, our Board of Directors authorized management to purchase up to $400,000 of our common stock pursuant to a buy back program. In conjunction with the buy back program, our Board of Directors authorized management to enter into a 10b5-1 Plan through which we were permitted to repurchase up to $200,000 of our common stock under the $400,000 buy back program. Our previously authorized 10b5-1 Plan was completed and is no longer in effect.

We are authorized to repurchase up to the remaining $200,000 of common stock under the $400,000 buyback program outside of the 10b5-1 Plan. From November 6, 2013 to February 27, 2014, we purchased a total of approximately 58,000 shares of our common stock for total cash consideration of approximately $200,000 for an average price of $3.46 per share. We do not expect to make any further repurchases of our common stock until certain expected material contracts for legacy hardware are received.

Our business is highly dependent on the level of military spending authorized by the U.S. Government. The current administration and Congress are under increasing pressure to reduce the federal budget deficit. This has resulted in a general decline in U.S. defense spending and could cause federal government agencies to reduce their purchases under contracts, exercise their rights to terminate contracts in whole or in part, issue temporary stop work orders or decline to exercise options to renew contracts, all of which could harm our operations and significantly reduce our future revenues. In particular, the Budget Control Act of 2011 commits the U.S. Government to significantly reduce the federal deficit over ten years through caps on discretionary spending and other measures. This had a dramatic effect on the defense budget, cutting $487 billion over a 10 year period. In addition, despite a bipartisan budget agreement in Washington reached in December 2013, defense spending continues to be well below historical levels. A reduction in defense spending as a result of present and future sequestration cuts could have a profound negative impact on the entire defense industry.

20



--------------------------------------------------------------------------------

Index

At the present time, it appears that consolidation resulting from budget pressure has created a resource issue with respect to the workloads on civilian government employees and the industry in general. Program contract delays have always been a factor on our business and our industry and these resource issues will more than likely exacerbate this problem for our industry. Consequently, significant delays in contract awards could adversely affect planned delivery schedules which could continue to impact our operating performance for 2014. As a result, our business, financial condition and results of operations could be materially adversely affected.

Critical Accounting Policies

There have been no changes to our critical accounting policies in the six months ended June 30, 2014. Those policies are discussed under "Critical Accounting Policies" in our "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7, as well as in our consolidated financial statements and footnotes thereto for the fiscal year ended December 31, 2013, as filed with the SEC with our 2013 Annual report on Form 10-K filed on March 31, 2014.

Inventories

Inventory is valued at the lower of cost (average cost method and specific identification) or market. Inventory items are reviewed regularly for excess and obsolete inventory based on an estimated forecast of product demand. Demand for our products can be forecasted based on current backlog, customer options to reorder under existing contracts, the need to retrofit older units and parts needed for general repairs. Although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have an impact on the level of obsolete material in our inventory and operating results could be affected, accordingly. However, world events which have forced our country into various conflicts have resulted in increased usage of hardware and equipment which are now in need of repair and refurbishment. This could lead to increased product demand as well as the use of some older inventory items that we had previously determined obsolete. In addition, recently announced reductions in defense spending may result in deferral or cancellation of purchases of new equipment, which may require refurbishment of existing equipment.

Deferred Tax Asset

At June 30, 2014, we continued to record a full valuation allowance on our net deferred tax asset. For the year ending December 31, 2013, we recorded a $2,252,000 deferred tax expense relating to a full valuation allowance taken on our net deferred tax asset. The full valuation allowance was recorded as a result of our conclusion that we will more likely than not be unable to generate sufficient future taxable income to utilize our net operating loss carryforwards and other temporary differences. This conclusion was based on the following: (i) pre-tax losses for the 2013 and 2012 calendar years, (ii) the challenging U.S. defense budget environment which has made it difficult to project revenue and profitability in future years with any degree of confidence, and (iii) the costs incurred in the first half of 2014 related to the TDL consolidation, which have affected our profitability. We have an alternative minimum tax credit of approximately $573,000 with no limitation on the carry-forward period and Federal and state net operating loss carry-forwards of approximately $8,000,000 and $7,000,000, respectively, which expire from 2018 through 2033. We will evaluate the possibility of changing some or all of our valuation allowance relating to our deferred tax asset should we return to profitability in the future. Any future reduction of some or all of our valuation allowance would create a deferred tax benefit, resulting in an increase to net income in our condensed consolidated statements of operations and comprehensive income (loss).

21



--------------------------------------------------------------------------------

Index

Impairment of Goodwill

At December 31, 2013, in connection with the annual impairment testing of Behlman's goodwill pursuant to ASC 350, the analysis indicated that the fair value for the Behlman reporting unit was 47% greater than the carrying value and therefore the goodwill was not impaired.

Our analysis of Behlman's goodwill employed the use of both a market and income approach. Significant assumptions used in the income approach include growth and discount rates, margins and our weighted average cost of capital. We used historical performance and management estimates of future performance to determine margins and growth rates. Our weighted average cost of capital included a review and assessment of market and capital structure assumptions. Considerable management judgment is necessary to evaluate the impact of operating changes and to estimate future cash flows. Changes in our actual results and/or estimates or any of our other assumptions used in our analysis could result in a different conclusion. The balance of our goodwill, as of June 30, 2014, is $868,000 for Behlman.

Stock-Based Compensation

We account for stock-based compensation awards by recording compensation based on the fair value of the awards on the date of grant and expensing such compensation over the vesting periods of the awards, which is generally one to ten years. Total stock-based compensation expense was $52,000 and $56,000 for the six months ended June 30, 2014 and 2013, respectively. During the six months ended June 30, 2014, no shares of restricted stock or stock options were granted. During the comparable period in 2013, 130,000 shares of restricted stock were awarded to senior management.

Revenue and Cost Recognition

We recognize a substantial portion of our revenue upon the shipment of product. We recognize such revenue when title and risk of loss are transferred to our customer and when: i) there is persuasive evidence that an arrangement with the customer exists, which is generally a customer purchase order, ii) the selling price is fixed and determinable, iii) collection of the customer receivable is deemed probable, and iv) we do not have any continuing non-warranty obligations. However, for certain products, revenue and costs under larger, long-term contracts are reported on the percentage-of-completion method. For projects where materials have been purchased, but have not been placed in production, the costs of such materials are excluded from costs incurred for the purpose of measuring the extent of progress toward completion. The amount of earnings recognized at the financial statement date is based on an efforts-expended method, which measures the degree of completion on a contract based on the amount of labor dollars incurred compared to the total labor dollars expected to complete the contract. When an ultimate loss is indicated on a contract, the entire estimated loss is recorded in the period the loss is identified. Costs and estimated earnings in excess of billings on uncompleted contracts represent an asset that will be liquidated in the normal course of contract completion, which at times may require more than one year. The components of costs and estimated earnings in excess of billings on uncompleted contracts are the sum of the related contract's direct material, direct labor, and manufacturing overhead and estimated earnings less accounts receivable billings. We had no contracts outstanding at June 30, 2014 or December 31, 2013 that were accounted for under the percentage-of-completion method.

22



--------------------------------------------------------------------------------

Index

Marketable Securities

We currently have approximately $252,000 invested in corporate bonds. We treat our investments as available-for-sale which requires us to assess our portfolio each reporting period to determine whether declines in fair value below book value are considered to be other than temporary. We must first determine that we have both the intent and ability to hold a security for a period of time sufficient to allow for an anticipated recovery in its fair value to its amortized cost. In assessing whether the entire amortized cost basis of the security will be recovered, we compare the present value of future cash flows expected to be collected from the security (determination of fair value) with the amortized cost basis of the security. If the impairment is determined to be other than temporary, the investment is written down to its fair value and the write-down is included in earnings as a realized loss, and a new cost is established for the security. Any further impairment of the security related to all other factors is recognized in other comprehensive income. Any subsequent recovery in fair value is not recognized until the security either is sold or matures.

We use several factors in our determination of the cash flows expected to be collected including: i) the length of time and extent to which market value has been less than cost; ii) the financial condition and near term prospects of the issuer; iii) whether a decline in fair value is attributable to adverse conditions specifically related to the security or specific conditions in an industry; iv) whether interest payments continue to be made and v) any changes to the rating of the security by a rating agency.

Results of Operations

Three month period ended June 30, 2014 v. June 30, 2013

We currently operate in two industry segments, the "Electronics Group" and "Power Group". Our Electronics Group is comprised of our Orbit Instrument Division, our subsidiaries, TDL, ICS and beginning January 1, 2014, our TDL Division which conducts all operations of TDL that were moved to our Hauppauge, NY facility. The Orbit Instrument Division and TDL are engaged in the design and manufacture of electronic components and subsystems. Our ICS subsidiary performs system integration for Gun Weapons Systems and Fire Control Interface, cable and harness assemblies, as well as logistics support and documentation. Our Power Group, through our Behlman subsidiary, is engaged in the design and manufacture of commercial power units and commercial-off-the-shelf ("COTS") power solutions.

23



--------------------------------------------------------------------------------

Index

Consolidated net sales for the three month period ended June 30, 2014 decreased by 16.7% to $5,396,000 from $6,475,000 for the three month period ended June 30, 2013, due primarily to lower sales from both our Electronics and Power Groups. Sales from our Electronics Group decreased by 19.7% to $2,664,000 for the three months ended June 30, 2014 compared to $3,316,000 in the prior year period. The decrease in sales at our Electronics Group was primarily attributable to the absence of shipments in the current year period for a certain display used on a major helicopter program that was shipped by TDL in the prior year period. Sales from our Power Group decreased by 13.7% to $2,732,000 for the three months ended June 30, 2014 as compared to $3,166,000 in the prior year three month period. The decrease in sales at our Power Group was principally due to a decrease in sales at our commercial division which was partially offset by an increase in sales at our COTS division. The decrease in sales at our commercial division was primarily due to lower bookings in prior periods and the increase in sales at our COTS division was principally due to an increase in shipments pursuant to customer delivery schedules.

Gross profit, as a percentage of sales, for the three months ended June 30, 2014 increased to 41.5% from 38.6% for the three month period ended June 30, 2013. The increase was the result of higher gross profit at our Electronics Group and slightly higher gross profit at our Power Group. The increase in gross profit from our Electronics Group was principally due to the following: (i) higher gross profit at our Orbit Instrument division due to a change in product mix, (ii) higher gross profit at our ICS subsidiary due to a change in product mix and also to lower overhead costs relating to ICS' move in April 2014 into a smaller facility, and (iii) reduced overhead costs due to the consolidation of our Quakertown facility into our Hauppauge facility. The slight increase in gross profit at our Power Group was principally due to a change in product mix which resulted in a lower material consumption in the current year period as compared to the prior year period.

Selling, general and administrative expenses increased by 1.2% to $2,384,000 for the three month period ended June 30, 2014 from $2,355,000 for the three month period ended June 30, 2013. The increase was due higher selling, general and administrative expenses from our Electronics Group which was partially offset by lower corporate costs and lower selling, general and administrative expenses from our Power Group. The higher selling, general and administrative expenses at our Electronics Group was principally due to higher selling costs. The decrease in corporate costs was primarily due to lower professional fees and other costs. The decrease in selling, general and administrative expenses from our Power Group was primarily due to lower selling costs associated with a decrease in personnel. Selling, general and administrative expenses, as a percentage of sales, for the three month period ended June 30, 2014 increased to 44.2% from 36.4% for the three month period ended June 30, 2013 principally due to a decrease in sales and a slight increase in costs.

24



--------------------------------------------------------------------------------

Index

Interest expense for the three months ended June 30, 2014 decreased to $10,000 from $15,000 for the three months ended June 30, 2013, principally due to a decrease in amounts owed under our line of credit.

Investment and other (income) expense, net for the three month period ended June 30, 2014, decreased to an expense of $3,000 from income of $2,000 for the three month period ended June 30, 2013 principally due to the loss on the disposal of property and equipment in the current year period which was partially offset by the gain on the sale of corporate bonds in the current year period and the loss on the sale of corporate bonds in the prior year period.

Loss before taxes was $160,000 for the three months ended June 30, 2014 compared to income before taxes of $129,000 for the three months ended June 30, 2013. The loss in the current year period was principally due to a decrease in sales from both our Electronics and Power Groups, a $351,000 operating loss from our TDL subsidiary which included costs associated with the consolidation of our Quakertown, PA facility into our Hauppauge, NY facility, and a slight increase in selling, general and administrative expenses which was partially offset by an increase in gross margin and a decrease in interest expense.

The provision for income taxes for the three months ended June 30, 2014 and June 30, 2013 consist of $11,000 and $20,000, respectively, in state income and Federal minimum taxes that cannot be offset by any state or Federal net operating loss carry-forwards.

As a result of the foregoing, net loss for the three months ended June 30, 2014 was $171,000 compared to net income of $109,000 for the three months ended June 30, 2013.

Earnings (loss) before interest, taxes and depreciation and amortization (EBITDA) for the three months ended June 30, 2014 decreased to a loss of $88,000 from earnings of $216,000 for the three months ended June 30, 2013. Listed below is the EBITDA reconciliation to net income:

EBITDA is a Non-GAAP financial measure and should not be construed as an alternative to net income. An element of our growth strategy has been through strategic acquisitions which have been substantially funded through the issuance of debt. This has resulted in significant interest expense and amortization expense. EBITDA is presented as additional information because we believe it is useful to our investors and management as a measure of cash generated by our business operations that will be used to service our debt and fund future acquisitions as well as provide an additional element of operating performance.

Three months ended June 30, 2014 2013 Net (loss) income $ (171,000 )$ 109,000 Interest expense 10,000 15,000 Income tax expense 11,000 20,000 Depreciation and amortization 62,000 72,000 EBITDA $ (88,000 )$ 216,000 25



--------------------------------------------------------------------------------

Index

Six month period ended June 30, 2014 v. June 30, 2013

Consolidated net sales for the six month period ended June 30, 2014 decreased by 19.5% to $10,403,000 from $12,922,000 for the six month period ended June 30, 2013 due to lower sales from both our Electronics and Power Groups. Sales from our Electronics Group decreased by 14.4%, due principally to a decrease in shipments resulting from lower bookings in prior periods. We recorded a 24.9% decrease in sales at our Power Group. The decrease was principally due to lower shipments at both our commercial and COTS divisions as a result of a lower backlog at December 31, 2013.

Gross profit, as a percentage of sales, for the six months ended June 30, 2014 decreased to 35.9% from 38.6% for the six month period ended June 30, 2013. This decrease was primarily the result of lower gross profit from our Power Group which was partially offset by higher gross profit from our Electronics Group. The decrease in gross profit at our Power Group was principally due to lower sales during the current year period. The increase in gross profit from our Electronics Group was primarily attributable to higher gross profit at our Orbit Instrument division due to a change in product mix and to higher gross profit at our ICS subsidiary due to higher sales and lower overhead costs relating to ICS' move in April 2014 into a smaller facility.

Selling, general and administrative expenses increased slightly by 0.8% to $4,927,000 for the six month period ended June 30, 2014 from $4,886,000 for the six month period ended June 30, 2013. The increase was primarily due to higher selling, general and administrative expenses from our Electronics Group which was partially offset by lower expenses at our Power Group and lower corporate costs. The increase in selling, general and administrative expenses at our Electronics Group was primarily due to $161,000 of accelerated non-cash depreciation and amortization expense relating to the consolidation of our Quakertown, PA facility and higher selling expenses during the current six month period as compared to the prior year period. The decrease in selling, general and administrative expenses at our Power Group was primarily due to lower selling costs associated with a decrease in personnel. Selling, general and administrative expenses, as a percentage of sales, for the six month period ended June 30, 2014 increased to 47.4% from 37.8% for the six month period ended June 30, 2013 principally due to a decrease in sales and a slight increase in costs.

Interest expense for the six months ended June 30, 2014 decreased to $21,000 from $32,000 for the six months ended June 30, 2013, principally due to a decrease in amounts owed under our line of credit.

Investment and other (income) expense, net for the six month period ended June 30, 2014 increased to income of $7,000 from income of $5,000 for the six month period ended June 30, 2013.

Loss before taxes was $1,204,000 for the six months ended June 30, 2014 compared to income before income taxes of $75,000 for the six months ended June 30, 2013. The loss in the current year period was principally due to a decrease in sales from both our Electronics and Power Groups, a $1,079,000 operating loss from our TDL subsidiary, which included costs associated with the consolidation of our Quakertown, PA facility into our Hauppauge, NY facility, and a slight increase in selling, general and administrative expenses which was partially offset by a decrease in interest expense.

26



--------------------------------------------------------------------------------

Index

The provision for income taxes for the six months ended June 30, 2014 and June 30, 2013 consist of $29,000 and $46,000, respectively, in state income and Federal minimum taxes that cannot be offset by any state or Federal net operating loss carry-forwards.

As a result of the foregoing, net loss for the six months ended June 30, 2014 was $1,233,000 compared to net income of $29,000 for the six months ended June 30, 2013.

Earnings (loss) before interest, taxes and depreciation and amortization (EBITDA) for the six months ended June 30, 2014 decreased to a loss of $875,000 from earnings of $247,000 for the six months ended June 30, 2013. Listed below is the EBITDA reconciliation to net income:

Six months ended June 30, 2014 2013 Net (loss) income $ (1,233,000 )$ 29,000 Interest expense 21,000 32,000 Income tax expense 29,000 46,000 Depreciation and amortization 308,000 140,000 EBITDA $ (875,000 )$ 247,000



Material Change in Financial Condition

Working capital increased to $14,924,000 at June 30, 2014 compared to $14,016,000 at December 31, 2013. The ratio of current assets to current liabilities increased to 9.3 to 1 at June 30, 2014 compared to 4.7 to 1 at December 31, 2013. The increase in working capital was primarily attributable to the reclassification of our line of credit as a non-current liability at June 30, 2014 as a result of an amendment to our credit agreement which was partially offset by the net loss for the current period and by the purchase of treasury stock and property and equipment.

Net cash provided by operating activities for the six month period ended June 30, 2014 was $483,000, which was primarily attributable to the decrease in inventories and accounts receivable, the increase in customer advances and the non-cash depreciation and amortization and stock-based compensation which was partially offset by the net loss for the period. Net cash provided by operating activities for the six month period ended June 30, 2013 was $1,459,000, primarily attributable to a decrease in accounts receivable and inventories and the non-cash depreciation and amortization and stock based compensation which was partially offset by a decrease in accounts payable and the liability associated with the non-renewal of a senior officer contract and an increase in costs and estimated earnings in excess of billings on uncompleted contracts.

Cash flows used in investing activities for the six month period ended June 30, 2014 was $66,000, attributable to the purchase of fixed assets and marketable securities which was partially offset by the sale of marketable securities. Cash flows used in investing activities for the six month period ended June 30, 2013 was $157,000, attributable to the purchase of fixed assets and marketable securities that was partially offset by the sale of marketable securities.

27



--------------------------------------------------------------------------------

Index

Cash flows used in financing activities for the six month period ended June 30, 2014 was $307,000, attributable to the repayment of note payable-bank and the purchase of treasury stock. Cash flows used in financing activities for the six month period ended June 30, 2013 was $1,065,000, attributable to the repayment of note payable-bank and long term debt and the purchase of treasury stock.

On November 8, 2012, we entered into a credit agreement ("Credit Agreement") with a commercial lender pursuant to which we established a committed line of credit of up to $6,000,000. This line of credit was used to pay off, in full, all of our obligations to our former primary lender and to provide for our general working capital needs. In June 2013, our Credit Agreement was amended whereby (i) the expiration date on our credit facility was extended to July 1, 2015 and (ii) we are permitted to purchase up to $400,000 of our common stock in each year beginning July 1 and ending June 30 during the term of our Credit Agreement. In April 2014, our Credit Agreement was further amended whereby (i) we are required, for a defined period of time, to have an aggregate of cash, marketable securities and excess availability under our borrowing base of no less than $3,000,000 (ii) the definition of our consolidated fixed charge coverage ratio was amended and compliance with such amended ratio was waived for the quarter ended March 31, 2014 and we are not required to comply with this amended ratio until the year ending December 31, 2014 and each fiscal quarter and year thereafter, and (iii) we are required to maintain consolidated tangible net worth of no less than $13,500,000 for the quarters ending June 30, 2014 and September 30, 2014.

Outstanding borrowings under our line of credit bear interest at a rate per annum as follows: either (i) variable at the lender's prime lending rate (3.25% at June 30, 2014) and/or (ii) 2% over LIBOR for 30, 60, or 90 day LIBOR maturities, at our sole discretion. The line of credit is collateralized by a first priority security interest in all of our tangible and intangible assets. Outstanding borrowings under the line of credit were $1,885,000 at June 30, 2014 at an interest rate of 2.15% representing 2% plus the 30 day LIBOR rate.

The Credit Agreement contains customary affirmative and negative covenants and certain financial covenants. Additionally, available borrowings under the line of credit are subject to a borrowing base of eligible accounts receivable and inventory. All outstanding borrowings under the line of credit are accelerated and become immediately due and payable (and the Line of Credit terminates) in the event of a default, as defined, under the Credit Agreement. We were in compliance with the financial covenants contained in our Credit Agreement at June 30, 2014. On November 6, 2013, our Board of Directors authorized management to purchase up to $400,000 of our common stock pursuant to a buy back program. In conjunction with the buy back program, our Board of Directors authorized management to enter into a 10b5-1 Plan through which we were permitted to repurchase up to $200,000 of our common stock under the $400,000 buy back program. Our previously authorized 10b5-1 Plan was completed and is no longer in effect. We are authorized to repurchase up to the remaining $200,000 of common stock under the $400,000 buyback program outside of the 10b5-1 Plan. Through June 30, 2014, we purchased a total of approximately 58,000 shares of our common stock for total cash consideration of approximately $200,000 for an average price of $3.46 per share. We do not expect to make any further repurchases of our common stock until certain expected material contracts for legacy hardware are received.

28



--------------------------------------------------------------------------------

Index

Our existing capital resources, including our bank credit facility and our expected cash flow from operations for the remainder of 2014, are expected to be adequate to cover our cash requirements for the foreseeable future.

Inflation has not materially impacted the operations of our Company.

Certain Material Trends

Backlog at June 30, 2014 was $8.2 million compared to $9.6 million at March 31, 2014 and $13.6 million at June 30, 2013. The decrease in backlog at June 30, 2014 from June 30, 2013 was attributable to lower backlogs at both our Electronics and Power Groups. The decrease in the backlog at the Electronics Group was primarily attributable to lower backlogs at both of our Orbit Instrument and TDL divisions. The decrease in backlog at June 30, 2014 from March 31, 2014 was due principally to a lower backlog at our Orbit Instrument Division due to the delay in the receipt of expected legacy contract awards and despite a slight increase in our backlog at our ICS subsidiary. Backlogs at our Power Group only slightly decreased from March 31, 2014 to June 30, 2014. The general decrease in backlog for the respective periods is primarily attributable to a difficult business environment resulting from general budget uncertainty and defense budget reductions related to the Budget Control Act of 2011 and sequestration.

Bookings at our Orbit Instrument Division exceeded $8,500,000 in 2013 which was lower than the prior year due to certain orders for legacy hardware that have been delayed. This delay has carried over into the first half of 2014 although we believe we will begin receiving contracts for our legacy hardware in the third quarter of 2014. There has been a significant amount of bid and proposal activity for our Orbit Instrument Division on both legacy products and new opportunities. Three of these new opportunities are now in the qualification stage and an award for a new design effort was received during the third quarter. In addition, information from our customers related to all legacy opportunities is that the timing of the receipt of these awards and their expected value is uncertain but the business remains intact. In addition to an increase in sales during the current quarter, gross margins at our Orbit Instrument Division significantly increased from the prior year principally due to product mix and cost containment.

In April 2012, ICS received a follow-on base contract award for its SDC for approximately $5,758,000. ICS received initial orders of $1,597,000 against this contract and in September 2013, received its first production order valued at approximately $626,000 that was shipped in the first quarter of 2014. The remainder of this contract is expected to be awarded over a four year period that could total approximately $3,000,000. A new contract award for the SDC is expected in the third quarter of 2014. ICS is currently working on other business opportunities and took certain cost cutting initiatives starting in 2012 including a reduction in personnel beginning in November 2012 and the consolidation of its two operating facilities into one during 2013. ICS's lease expired on March 31, 2014 and moved its operation from an underutilized 23,000 square foot facility to a 4,500 square foot facility, which will create additional savings.

29



--------------------------------------------------------------------------------

TDL's operating lease is due to expire in October 2014. Due to the uneven revenue stream at TDL, its expiring lease, the uncertainty surrounding defense spending related to budget discussions in Washington, DC and our focus on cost containment and increasing operating efficiencies, we decided to consolidate our operations in Quakertown, PA with our operation in Hauppauge, NY. We incurred a considerable amount of costs during the first quarter of 2014 as a result of this consolidation with the remaining closing costs incurred in the current second quarter. We kept a majority of our workforce in Quakertown through the end of March 2014 to complete the manufacturing of certain WIP inventory and to assist in the transfer of assets to our Hauppauge facility. Certain other employees were guaranteed employment through April 30, 2014 in order to satisfy outstanding engineering tasks and to complete the consolidation. Although most of the costs incurred at TDL were associated with the consolidation of its operation into our Hauppauge facility, these costs were not considered incremental in nature and therefore were included in regular operating costs during the six month period ended June 30, 2014. Beginning in June 2014, we did not incur any additional costs associated with our Quakertown facility with the exception of some minor occupancy related costs.

All new orders received by TDL after December 31, 2013 are being manufactured in our Hauppauge facility. We expect to realize annual savings of approximately $2,000,000 due to the consolidation but will not begin to fully realize these savings until the second half of 2014. Following the consolidation, we believe our Hauppauge facility will have sufficient capacity to support future growth without any significant facility investment.

For the year ended December 31, 2013, bookings and year-end backlog for our Power Group, particularly from our COTS division which relies on military spending, decreased from the prior year. However, bookings for the Power Group for the first half of 2014 have increased from the prior comparable year. Strong bookings have also continued into the third quarter. Due to the decrease in bookings in 2013, revenue and profitability for the first half of 2014 decreased compared to the prior comparable year period. Although there has been an increase in bookings in 2014, many of the awards have 2015 scheduled deliveries; therefore, we expect our Power Group's 2014 revenue and profitability to be down from 2013 levels.

In order to address difficult industry conditions, we have taken several measures to restructure our business to significantly reduce our costs. These include the consolidation of our Quakertown operation into our Hauppauge facility, a reduction in personnel at our ICS subsidiary, the consolidation of two operating facilities into one smaller facility for ICS's operation in Louisville, KY and a small reduction in personnel in our Hauppauge facility. We are continuing to look to further reduce costs to improve our operating margins and not compromise our ability to seek new opportunities in the marketplace. Our second quarter benefitted from higher gross margins despite a reduction in sales due to these cost cutting initiatives.

Our Company has historically been dependent on a strong defense budget as a source of its revenues. Over 90% of our revenues are related to programs procured by the Department of Defense. The challenges now facing defense contractors are two-fold. The Budget Control Act of 2011, requiring the Pentagon to reduce spending by $487 billion over a ten year period and the adverse consequences of the budget impasse from earlier in 2013 that led to sequestration cuts. These cuts have had a profound effect on the budget for the Department of Defense and their implementation has created great uncertainty for our Company and the defense industry as a whole. In December 2013, a new budget plan was agreed to in Washington which did provide some relief from sequestration; however, this still has left the defense budget well below historical levels.

30



--------------------------------------------------------------------------------

Program contract delays, such as what we are experiencing now, particularly at our Orbit Instrument Division, TDL subsidiary and the COTS division of our Power Group, have always been a factor in our business. However, we are experiencing greater time delays between contract proposal and actual award. Continued delays in contract awards have adversely impacted our delivery schedules and compromised our operating leverage, which adversely impacted our results for 2013 and the first six months of 2014. Nevertheless, it appears that aside from the timing of the receipt of certain pending orders and the value of such orders, all of our legacy business with our customers remains intact.

Aside from our legacy business, both our Electronics Group and Power Group have made great advancement in providing a number of new VME and VPX-related products to the marketplace. Our Power Group has three 6U VPX power supplies in the marketplace and a new smaller 3U version of the VPX power supply has been developed and is nearing completion. Our 6U VPX units have been installed and tested on numerous platforms at several prime contractors. These potential new business opportunities are all subject to program funding. Our Electronics Group has introduced its own new VPX technology including backplanes, system health monitors and other related products which can be found on its newly launched web portal.

As previously mentioned, reduced military spending, as a result of the Budget Control Act of 2011 and sequestration, has had a profound effect on our annual bookings, revenues and backlog. However, we continue to believe that the need for refurbishment and modernization, as opposed to the building of new equipment, could become a defense spending priority. As a result and because our legacy business appears to be intact, we believe there could be opportunities for us as military efforts are curtailed and defense spending priorities are refocused. However, there is no guarantee that the quantity of units that will be ordered for these legacy products will be comparable to historical levels. Furthermore, future business for our Company resulting from these opportunities will also be dependent upon the make/buy decisions made by our prime contractors who have also been significantly affected by cutbacks in defense spending. Like many other companies in the defense sector, we are attempting to reduce the impact of reduced revenues by reducing costs.

Although our Electronics Group and the COTS Division of our Power Group are pursuing several opportunities for reorders as well as new contract awards, we have normally found it difficult to predict the timing of these awards. In addition, we have several new opportunities that are in the prototype, pre-production or qualification stage. These opportunities generally move to a production stage at a later date, although the timing is also uncertain. However, once initial production orders are received, we are generally well positioned to receive follow-on orders depending on government needs and funding requirements.

31



--------------------------------------------------------------------------------

There is no seasonality to our business. Our revenues are generally determined by the shipping schedules outlined in the purchase orders received from our customers. We stratify all the opportunities we are pursuing by various confidence levels. We generally realize a very high success rate with those opportunities to which we apply a high confidence level. We currently have a significant number of potential contract awards to which we have applied a high confidence level. However, because it is difficult to predict the timing of awards for most of the opportunities we are pursuing, it is also difficult to predict when we will commence shipping under these contracts. A delay in the receipt of any contract from our customer ultimately causes a corresponding delay in shipments.

In March 2011, we hired a new investment banker to help us expand our operations and achieve better utilization of our existing facilities through strategic, accretive acquisitions. Again, due to sequestration, the merger and acquisition ("M&A") process has become more difficult. Because of the uncertainty surrounding the DoD budget, there is elevated risk to revenue and profitability projections from potential targets. Currently, we are engaged in discussions, although preliminary, related to certain acquisition targets. However, there is no assurance that any future acquisition will be accomplished. However, we believe our strong balance sheet will allow us to take advantage of opportunities in the marketplace as other weaker companies struggle with current industry conditions.

Although we have had several positive discussions with investment bankers looking to support our M&A initiatives, there can be no assurance that we will obtain the necessary financing to complete additional acquisitions. Moreover, even if we are able to obtain financing, there can be no assurance that we will have sufficient income from operations from any acquired companies to satisfy scheduled debt payments, in which case, we will be required to make the payments out of our existing operations.

We are in compliance with the financial covenants contained in our Credit Agreement at June 30, 2014.

We continue to pay down our debt and, when appropriate, repurchase our shares in the marketplace. Since January 1, 2012, we have repurchased in excess of 368,000 shares at an average price of $3.55. On November 6, 2013, our Board of Directors authorized management to purchase up to $400,000 of our common stock pursuant to a buy back program. In conjunction with the buy back program, our Board of Directors authorized management to enter into a 10b5-1 Plan through which we were permitted to repurchase up to $200,000 of our common stock. Purchases under this 10b5-1 Plan were completed in the first quarter of 2014 and the 10b5-1 plan is no longer in effect. Management is authorized to repurchase up to the remaining $200,000 of common stock under the $400,000 buy back program outside of the 10b5-1 Plan. However, we will most likely not make any further purchases under our current program until certain expected material contracts for legacy hardware are received.

Off-balance sheet arrangements

We presently do not have any off-balance sheet arrangements.

32



--------------------------------------------------------------------------------

Index


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters