Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis should be read together with the Selected Financial Data and our Consolidated Financial Statements and the related notes included elsewhere in this Annual Report. The historical discussions and analysis herein relate to the continuing operations of the Company as of December 31, 2008 and do not include discussions of operations that have been discontinued.

Results of Operations

2008 Compared to 2007

Consolidated Revenues and Gross Margin from Continuing Operations

In the year ended December 31, 2008, consolidated revenues from continuing operations increased by $643,000, or 1.6%, to $40,179,000, from $39,536,000 in 2007. The increase is due primarily to an increase in foreign sales of $365,000 over the comparable period in 2007. This was in addition to an increase in domestic sales of $278,000 over the comparable period in 2007.

In the year ended December 31, 2008, consolidated gross margin from continuing operations as a percentage of revenues increased to 25.8% from 25.7% for 2007. The uniformity in gross margin reflects continuing efforts to improve upon our manufacturing and supply chain efficiency, offset by selling price reductions due to market pressures.

Operating Loss

The operating loss from continuing operations of $831,000 for 2008 is a reduction of $882,000 from $1,713,000 operating loss in 2007. This improvement was primarily due to an impairment on Lynch System's assets of $905,000 recognized in 2007. Engineering, selling and administrative expenses from continuing operations in 2008 increased by $228,000 from $10,981,000 in 2007 to $11,209,000 in 2008. This increase was due primarily to an increase in product development expenses and an increase in corporate costs. The product development expense was driven by an increase in engineering personnel and a decrease in billing for a government sponsored program. The corporate expense increase was the result of increased stock compensation costs of $34,000, and an increase in professional fees of approximately $400,000 primarily due to the Company's restatement during 2008 of its consolidated financial statements for the first two quarters of 2007, fiscal 2006 and prior years and the cost of continuing to comply with the Sarbanes-Oxley Act of 2002 , offset by other general cost reductions.

Other Income (Expense), Net

Investment income from continuing operations for the year ended December 31, 2008 was $0 compared to $1,526,000 for 2007. The decrease of $1,526,000 was due to the sale of substantially all of the marketable securities held for sale during the first quarter of 2007.

Interest expense from continuing operations declined by $14,000 to $292,000 for the year ended December 31, 2008, compared with $306,000 for 2007, primarily due to a reduction in the level of debt outstanding during the year, as well as a reduction in the variable interest rate on MtronPTI's revolving loan.

Gain on the sale of equipment for the year ended December 31, 2008 was $255,000 compared to a gain on the sale of land of $88,000 during 2007. The equipment sold was not related to MtronPTI's business.

Included in other expense is a realized loss on an other-than-temporary impairment charge for an equity security for the year ended December 31, 2008 was $54,000 compared to $0 for 2007. The impairment charge was due to the continuing decline in the fair value of an equity security through 2008. The carrying value of the equity security at December 31, 2008 is $14,000. The fair value of the equity security may continue to decline in 2009, but the Company does not anticipate future declines having a material impact on the Company's operations. Also included in other expense is $256,000 in expense related to foreign currency remeasurement losses in 2008 compared to $20,000 in expense related to foreign currency remeasurement losses in 2007. The increase in the expense is primarily related to the decrease in value of the U.S. dollar compared to the Indian Rupee (the operating currency of one of the Company's subsidiaries).

Income Taxes

The Company files consolidated federal income tax returns, which includes all subsidiaries.

The income tax expense for the year ended December 31, 2008 included provisions for foreign taxes totaling $127,000 compared to an income tax expense in 2007 comprising $135,000 for foreign taxes.

Net Loss

Net loss for the year ended December 31, 2008 was ($1,303,000) compared with net loss for the year ended December 31, 2007 of ($2,554,000). Basic and diluted income (loss) per share for the year ended December 31, 2008 was ($0.60) compared with ($1.18) for year ended December 31, 2007. Basic and diluted income (loss) per share from continuing operations for the year ended December 31, 2008 was ($0.61) compared with ($0.26) for year ended December 31, 2007.
Basic and diluted income (loss) per share from discontinued operations for the year ended December 31, 2008 was $0.01 compared with ($0.92) for year ended December 31, 2007.

Backlog/New Orders

Total backlog of manufactured products at December 31, 2008 was $7,486,000, a $3,379,000 decrease from the $10,865,000 backlog at December 31, 2007. Backlog orders do not necessarily represent future guaranteed orders from customers. Customers may cancel or change their orders with little or no penalties.

Sale of Select Assets and Liabilities of Subsidiary and Discontinued Operations

In June 2007, the Company finalized its sale of certain assets and liabilities of Lynch Systems to a third party. The assets sold included certain accounts receivable, inventories, machinery and equipment. The Buyer also assumed certain liabilities of Lynch Systems, including accounts payable, customer deposits and accrued warranties. The result of the sale transaction was a loss of $982,000. Lynch Systems retained certain assets including the land, buildings and some equipment used in its operations and certain accounts receivable balances. The Company intends to sell the land, buildings and remaining equipment, which are classified as held and used in accordance with SFAS 144, "Accounting for the Impairment of Disposal of Long Lived Assets" ("SFAS 144").

Revenue generated by the operations of Lynch Systems, now classified as Discontinued Operations, was $0 for 2008 and $2,534,000 for 2007, and the income
(loss) was $24,000 for 2008 and ($1,999,000) for 2007.

Assets Being Marketed for Sale

During 2007, the Company decided to sell selected assets of its subsidiary, Lynch Systems. These assets are included within the respective balances in property, plant and equipment in the consolidated balance sheet and they are considered held and used in accordance with SFAS 144.

Inflationary Risk for Raw Materials

In the two most recent years, the Company has had some exposure to the impact of inflationary risk with respect to the prices of raw materials. Most raw materials used in the production of MtronPTI products are available in adequate supply from a number of sources. The prices of these raw materials are relatively stable. However, some raw materials including printed circuit boards, quartz, and certain metals including steel, aluminum, silver, gold, tantalum and palladium, are subject to greater supply fluctuations and price volatility, as experienced over the past year in conjunction with the current economic slowdown. The Company generally has been able to include some cost increases in its pricing, but revenues and margins have been adversely impacted.

Liquidity and Capital Resources

The Company's cash and cash equivalents and investments in marketable securities at December 31, 2008 totaled $5,339,000, an increase of $58,000 over the prior year. At December 31, 2007, the Company had $5,281,000 in cash and cash equivalents and investments. The cash and cash equivalents component increased by $92,000, from $5,233,000 at December 31, 2007 to $5,325,000 at December 31, 2008.

Cash used in operating activities from continuing operations was $861,000 in 2008, compared to $993,000 of cash used in operating activities in 2007. The year to year change in operating cash flow from continuing operations of $132,000 was primarily due to a increase in accounts receivable of $101,000 and a decrease in accounts payable and accrued liabilities of $575,000 in 2008 compared to a decrease in accounts payable and accrued liabilities of $758,000 offset by an decrease in inventories of $924,000 in 2007.

Investing activities from continuing operations used $282,000 in cash during 2008 compared to providing $2,085,000 during 2007 primarily the results of $2,292,000 of proceeds from the sales of marketable securities in 2007.

Cash of $1,317,000 was provided by financing activities from continuing operations during 2008, mainly as a result of $1,714,000 of borrowings against MtronPTI's short-term credit facility offset by $397,000 of note repayments made on its three outstanding long-term debt agreements. Cash of $994,000 was used in financing activities from continuing operations during 2007 mainly as a result of $1,116,000 of long-term debt repayments and $321,000 of note repayments, offset by $443,000 in new borrowings.

At December 31, 2008, the Company's consolidated working capital was $9,683,000, compared to $10,758,000 at December 31, 2007. At December 31, 2008, the Company had consolidated current assets from continuing operations of $17,343,000 and consolidated current liabilities from continuing operations of $7,660,000. The ratio of consolidated current assets to consolidated current liabilities was 2.26 to 1.00. At December 31, 2007, the Company had consolidated current assets from continuing operations of $17,225,000 and consolidated current liabilities from continuing operations of $6,241,000, and a current ratio of 2.76 to 1.00.
The decrease in consolidated working capital is primarily due to an increase in borrowings against MtronPTI's short-term credit facility.

On October 14, 2004, MtronPTI, entered into a loan agreement with First National Bank of Omaha ("FNBO") (the "FNBO Loan"). The FNBO Loan provides for a revolving credit facility of up to $5,500,000 (the "FNBO Revolver"). The provisions of the FNBO Revolver were subsequently amended, most recently on June 30, 2008. The principal balance of the FNBO Revolver currently bears interest at 30-day LIBOR plus 2.1%, with interest only payments due monthly and the final payment of principal and interest due on June 30, 2009. As of March 27, 2009, the principal balance outstanding under the FNBO Revolver was $1,529,000. The Company believes that if it does not renew or replace this loan, it will have sufficient cash available to pay its outstanding balance upon maturity.

At December 31, 2008, the amount outstanding under the revolving credit loan was $2,749,000, compared to $1,035,000 at December 31, 2007. The change was due to normal operating cash flow variances, and the amount outstanding returned to historical levels by March, 27, 2009. The Company had $2,751,000 of unused borrowing capacity under its revolving line of credit at December 31, 2008, compared to $4,465,000 at December 31, 2007.

The FNBO Loan also provides for a term loan in the original principal amount of $2,000,000 (the "FNBO Term Loan"). The provisions of the FNBO Term Loan were subsequently amended, most recently on June 30, 2008. Under such amendment, the original principal amount of the FNBO Term Loan was approximately $1,410,000, and the principal balance bears interest at 30-day LIBOR plus 2.1%, with principal and interest payments due monthly and the final payment of principal and interest due January 24, 2013.

The FNBO Loan contains a variety of affirmative and negative covenants, including, but not limited to, financial covenants that MtronPTI maintain: (i) tangible net worth of not less than $7,000,000, (ii) a ratio of current assets to current liabilities of not less than 1.5 to 1.0; (iii) a ratio of total liabilities to tangible net worth of not greater than 2.75 to 1.0; and (iv) a fixed charge ratio of 1.2 to 1.0. At December 31, 2008, the Company was in compliance with these covenants.

All outstanding obligations under the FNBO Loan are guaranteed by the Company.

In connection with the FNBO Term Loan, MtronPTI entered into a separate interest rate swap agreement with FNBO from which it receives periodic payments at the LIBOR Base Rate and makes periodic payments at a fixed rate of 5.60% through the life of the FNBO Term Loan. The Company has designated this swap as a cash flow hedge in accordance with Financial Accounting Standards Board's ("FASB") 133 "Accounting for Derivative Instruments and Hedging Activities" ("FASB 133").
The interest rate swap's notional amount is for the entire outstanding balance. The fair value of the interest rate swap at December 31, 2008 is ($53,000) net of any tax effect, and is included in "other accrued expenses" on the consolidated balance sheet. The value is reflected in other comprehensive loss, net of any tax effect.

On September 30, 2005, MtronPTI entered into a loan agreement with RBC Centura Bank (the "RBC Loan Agreement"), which provides for a loan in the original principal amount of $3,040,000 (the "RBC Term Loan"). The RBC Term Loan bears interest at LIBOR Base Rate plus 2.75% and is being repaid in monthly installments based on a 20 year amortization, with the then remaining principal balance and interest due on the fifth anniversary of the RBC Loan Agreement, October 1, 2010. The RBC Loan Agreement contains a variety of affirmative and negative covenants, including, but not limited to, financial covenants that MtronPTI maintain: (i) a ratio of total liabilities to tangible net worth of at least 4.0 to 1.0; (ii) tangible net worth of at least $4.2 million; and (iii) a fixed charge coverage ratio of not less than 1.2 to 1.0. At December 31, 2008, the Company was in compliance with these covenants.

All outstanding obligations under the RBC Loan Agreement are collateralized by security interests in the assets of MtronPTI and are guaranteed by the Company.

In connection with the RBC Term Loan, MtronPTI entered into a five-year interest rate swap from which it receives periodic payments at the LIBOR Base Rate and makes periodic payments at a fixed rate of 7.51% with monthly settlement and rate reset dates. The Company has designated this swap as a cash flow hedge in accordance with FASB 133. The interest rate swap's notional amount is for the entire outstanding balance. The fair value of the interest rate swap at December 31, 2008 is ($182,000) net of any tax effect, and ($80,000) net of any tax effect at December 31, 2007 and both are included in "other accrued expenses" on the consolidated balance sheets, respectively. The value is reflected in other comprehensive loss, net of any tax effect.

Debt outstanding at December 31, 2008 included $4,057,000 of fixed rate debt at year-end weighted average interest rate of 6.9% (after considering the effect of the interest rate swap) and variable rate debt of $2,749,000 at a year end average rate of 4.1%.

Aggregate principal maturities of long-term debt for each of the next five years based upon payment terms and interest rates in effect at December 31, 2008 are as follows (in thousands):

2009 $ 397 2010 3,016 2011 301 2012 322 2013 21 Total $ 4,057

The Board of Directors has adopted a policy of not paying cash dividends. This policy takes into account the long-term growth objectives of the Company, especially its acquisition program, stockholders' desire for capital appreciation of their holdings and the current tax law disincentives for corporate dividend distributions. In addition, substantially all of the subsidiaries' assets are restricted under the Company's current credit agreements, which limit the subsidiaries' ability to pay dividends.
Accordingly, no cash dividends have been paid since January 30, 1989, and none are expected to be paid for the foreseeable future.

Critical Accounting Policies

The Company's significant accounting policies are described in Note 1 to the Consolidated Financial Statements. The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to the carrying value of inventories, realizability of outstanding accounts receivable, value of stock based compensation, and the provision for income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. In the past, actual results have not been materially different from the Company's estimates. However, results may differ from these estimates under different assumptions or conditions.

The Company has identified the following as critical accounting policies, based on the significant judgments and estimates used in determining the amounts reported in its consolidated financial statements:

Accounts Receivable

Accounts receivable on a consolidated basis consist principally of amounts due from both domestic and foreign customers. Credit is extended based on an evaluation of the customer's financial condition and collateral is not generally required. Certain subsidiaries and business segments have credit sales to industries that are subject to cyclical economic changes. The Company maintains an allowance for doubtful accounts at a level that management believes is sufficient to cover potential credit losses.

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. We base our estimates on our historical collection experience, current trends, credit policy and relationship of our accounts receivable and revenues. In determining these estimates, we examine historical write-offs of our receivables and review each customer's account to identify any specific customer collection issues. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payment, additional allowances may be required. Our failure to estimate accurately the losses for doubtful accounts and ensure that payments are received on a timely basis could have a material adverse effect on our business, financial condition, and results of operations.

Inventory Valuation

Inventories are stated at the lower of cost or market value. At MtronPTI, inventories are valued using the first-in-first-out (FIFO) method for 66% of the inventories, and 34% is valued using last-in-first-out (LIFO). The Company reduces the value of its inventories to market value when the value is believed to be less than the cost of the item.

Revenue Recognition

Revenues are recognized upon shipment when title passes. Shipping costs are included in manufacturing cost of sales. The Company believes that recognizing revenue at time of shipment is appropriate because the Company's sales policies meet the four criteria of SEC's Staff Accounting Bulletin No. 104, which are:
(i) persuasive evidence that an arrangement exists, (ii) delivery has occurred,
(iii) the seller's price to the buyer is fixed and determinable, and
(iv) collectability is reasonably assured.

Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes" ("SFAS No. 109"), which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. A valuation allowance is recorded for deferred tax assets whose realization is not considered more likely than not. As of December 31, 2008 a valuation allowance of $4,447,000 was recorded compared with a valuation allowance of $3,504,000 recorded at December 31, 2007. The increase of $943,000 is due to the continuing losses recognized by the Company.

The carrying value of the Company's net deferred tax assets at December 31, 2008 and 2007 is $111,000. This is equal to the amount of the Company's carry-forward alternative minimum tax ("AMT") at such dates.

The calculation of tax assets and liabilities involves dealing with uncertainties in the application of complex tax regulations in several different tax jurisdictions. The Company evaluates the exposure associated with the various filing positions and records estimated reserves for probable exposures.
Based on the Company's evaluation of current tax positions, it believes that it has appropriately accrued for probable exposures.

Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation ("FIN") No. 48, "Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS 109. The Interpretation prescribes a recognition and measurement method for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation also provides guidance on recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately forecast actual outcomes. Based on a review of our tax positions, the Company was not required to record a liability for unrecognized tax benefits as a result of adopting FIN 48 on January 1, 2007. Further, there has been no change during the years ended December 31, 2008 and 2007, respectively. Accordingly, we have not accrued any interest and penalties through December 31, 2008.

Stock-Based Compensation

The Company adopted the provisions of SFAS No. 123-R, "Share-Based Payments" ("SFAS 123-R") beginning January 1, 2006, using the modified prospective transition method. SFAS 123-R requires the Company to measure the cost of employee services in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize cost over the requisite service period. Under the modified prospective transition method, financial statements for periods prior to the date of adoption are not adjusted for the change in accounting. However, the compensation expense is recognized for (a) all share-based payment granted after the effective date under SFAS 123-R, and
(b) all awards granted under SFAS 123 to employees prior to the effective date that remain unvested on the effective date. The Company recognizes compensation expense on fixed awards with pro rata vesting on a straight-line basis over the service period.

The Company estimates the fair value of stock-based compensation on the grant date using the Black-Scholes-Merton option-pricing model. The Black-Scholes-Merton option-pricing model requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. There is no expected dividend rate.
Historical Company information was the primary basis for the expected volatility assumption. Prior years grants were calculated using historical volatility as the Company believes that the historical volatility over the life of the option is more indicative of the options expected volatility in the future. The risk-free interest rate is based on the U.S. Treasury zero-coupon rates with a remaining term equal to the expected term of the option. SFAS 123-R also requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Based on past history of actual performance, a zero forfeiture rate has been assumed.

Recently Issued Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations" ("SFAS 141(R)"). SFAS 141(R) expands the definition of transactions and events that qualify as business combinations; requires that the acquired assets and liabilities, including contingencies, be recorded at the fair value determined on the acquisition date and changes thereafter reflected in earnings, not goodwill; changes the recognition and timing for restructuring costs; and requires acquisition costs to be expensed as incurred. Adoption of SFAS 141(R) is required for combinations occurring in fiscal years beginning after December 15, 2008. Early adoption and retroactive application of SFAS 141(R) to fiscal years preceding the effective date are not permitted.

In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interest in Consolidated Financial Statements" ("SFAS 160"). SFAS 160 re-characterizes minority interests in consolidated subsidiaries as non-controlling interests and requires the classification of minority interests as a component of equity. Under SFAS 160, a change in control will be measured at fair value, with any gain or loss recognized in earnings. The effective date for SFAS 160 is for annual periods beginning on or after December 15, 2008. Early adoption and retroactive application of SFAS 160 to fiscal years preceding the effective date are not permitted. We currently do not have significant minority interests in our consolidated subsidiaries.

In March 2008, the Financial Accounting Standards Board ("FASB") issued SFAS No. 161 "Disclosures about Derivative Instruments and Hedging Activities" ("SFAS 161"). This new standard enhances disclosure requirements for derivative instruments in order to provide users of financial statements with an enhanced understanding of (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" and its related interpretations and (iii) how derivative instruments and related hedged items affect an entity's financial position, financial performance and cash flows. SFAS 161 is to be applied prospectively for the first annual reporting period beginning on or after November 15, 2008. The Company is currently assessing the impact of the adoption of SFAS 161 on its consolidated financial statements.

In April 2008, the FASB issued FASB Staff Position ("FSP") 142-3, "Determination of the Useful Life of Intangible Assets", ("FSP 142-3"). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, "Goodwill and Other Intangible Assets". FSP 142-3 is effective for fiscal years beginning after December 15, 2008. The Company is currently assessing the potential impact of FSP 142-3 on its consolidated financial position and results of operations.

In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"). SFAS 162 identifies the sources of accounting principles (see below) and provides entities with a framework for selecting the principles used in preparation of financial statements that are presented in conformity with Generally Accepted Accounting Principles ("GAAP"). The current GAAP hierarchy has been criticized because it is directed to the auditor rather than the entity, it is complex, and it ranks FASB Statements of Financial Accounting Concepts, which are subject to the same level of due process as FASB Statements of Financial Accounting Standards, below industry . . .