Executive Summary

Our financial and operating results for 2012 improved significantly from the prior year. Total sales, sales of P-25 digital products and sales of new KNG products all increased compared with the previous year. At the same time, costs of products and selling, general and administrative expenses declined. These factors combined to yield operating income for 2012, compared with an operating loss for 2011. Additionally, our working capital improved during the year, including an increased cash position.

Total sales for 2012 increased 14.4%, to approximately $27.6 million, compared with approximately $24.1 million for the prior year, reflecting increased sales of both legacy and KNG P-25 digital products as well as sales to new customers, including some internationally.

Gross margins as a percentage of sales in 2012 were 47.4%, compared with 42.0% for the prior year. The improved gross margins reflect increased sales, particularly of P-25 digital products. Also, unit product costs declined as we improved manufacturing efficiencies for KNG products and more fully utilized and absorbed our manufacturing overhead as a result of higher manufacturing volumes.

Selling, general and administrative expenses for 2012 decreased approximately $0.6 million, or 5.7%, to approximately $10.2 million compared with $10.8 million last year. This decrease was primarily from reductions in engineering expenses as we completed product development initiatives.

We reported pretax income for 2012 of approximately $2.9 million, compared with a pretax loss of $766,000 last year. For 2012, we recognized income tax expense of $0.8 million, compared with an income tax benefit of $273,000 last year. Our income tax expense and benefit are largely non-cash, relating to deferred items including net operating loss carryforwards.

Net income for 2012 was $2.1 million ($0.15 per basic and diluted share), compared with a net loss of approximately $493,000 ($0.04 per basic and diluted share) for the prior year.

As of December 31, 2012, working capital totaled approximately $23.6 million, of which $8.6 million was comprised of cash and trade receivables. This compares with working capital totaling approximately $19.5 million at year end 2011, which included $6.8 million of cash and trade receivables. Also, as of December 31, 2012 there were no borrowings outstanding under our revolving credit facility.

We experience seasonality in our quarterly results in part due to governmental customer spending patterns that are influenced by government fiscal year-end budgets and appropriations. We also experience seasonality in our quarterly results in part due to our concentration of sales to federal and state agencies that participate in fire-suppression efforts, which are typically the greatest during the summer season when forest fire activity is heightened. In some years, these factors may cause an increase in sales for the second and third quarters compared with the first and fourth quarters of the same fiscal year. Such increases in sales may cause quarterly variances in our cash flow from operations and overall financial condition.

Results of Operations

As an aid to understanding our operating results, the following table shows items from our consolidated statements of operations expressed as a percentage of sales:

                                                                 Percent of Sales
                                                            for Years Ended December 31
                                                        2012           2011            2010

Sales                                                     100.0 %        100.0 %         100.0 %
Cost of products                                          (52.6 )        (58.0 )         (56.4 )
Gross margin                                               47.4           42.0            43.6
Selling, general and administrative expenses              (36.9 )        (44.8 )         (46.0 )
Net interest expense                                       (0.1 )         (0.4 )          (0.1 )
Income (loss) before income tax (expense) benefit          10.4           (3.2 )          (2.5 )
Income tax (expense) benefit                               (2.9 )          1.1            (0.0 )
Net income (loss)                                           7.5 %         (2.1 ) %        (2.5 ) %

Fiscal Year 2012 Compared With Fiscal Year 2011

Sales, net

Sales in 2012 increased $3.5 million (14.4%) to approximately $27.6 million compared with approximately $24.1 million for the prior year. Sales of P-25 digital products in 2012 reached a record level, totaling approximately $17.9 million (65.0% of total sales), compared with approximately $15.4 million for 2011, an increase of $2.5 million (16.5%).

The increase in total sales and P-25 digital sales compared with the prior year was attributed primarily to our P-25 digital products, including both legacy and new KNG models. The broad line of KNG products increased our addressable market by offering products in frequencies where we were previously unable to compete. Consequently, we were successful in realizing sales to new customers. These customers included agencies in state and local governments, as well as international organizations. They supplement our traditional strongholds in federal agencies, such as the U.S. Department of the Interior and the U.S. Forest Service. For 2012 the profile of our total sales was much broader with less reliance on any particular market segment or customer.

Looking forward, government and public safety agencies continue to face budget and funding challenges. However, although fiscal and economic conditions remain uncertain, we are encouraged by the progress we realized in 2012 and a growing pipeline of sales opportunities. We believe we are well positioned with products and technology to build upon the momentum initiated in 2012.

Cost of Products and Gross Margins

Cost of products as a percentage of sales for 2012 was 52.6% compared with 58.0% in 2011.

Our cost of products and gross margins are primarily related to material and labor costs, product mix, manufacturing volumes and pricing. The improvement in cost of products and corresponding gross margins for 2012 reflected a favorable mix of product sales weighted toward new KNG and legacy P-25 digital products. Additionally, we have continued to better refine the production processes for new KNG products, which have yielded lower unit costs. As a result of the increase in total sales relative to last year, manufacturing volumes increased. Accordingly, we more fully utilized and absorbed our base of manufacturing and support expenses.

We continue to utilize contract manufacturing relationships to maximize production efficiencies and minimize material and labor costs. We also regularly consider manufacturing alternatives to improve quality, speed and costs. We anticipate that the current contract manufacturing relationships or comparable alternatives will be available to us in the future. As demonstrated during 2012, we believe leveraging increased sales volumes and P-25 product sales, combined with the aforementioned manufacturing improvements, should yield gross margin improvements. We are likely to encounter product cost and competitive pricing pressures in the future; however, the extent of their impact on gross margins is uncertain.

Selling, General and Administrative Expenses

Selling, general and administrative ("SG&A") expenses consist of marketing, sales, commissions, engineering, product development, management information systems, accounting, headquarters expenses and non-cash share-based employee compensation expense.

For 2012, SG&A expenses decreased approximately $0.6 million (5.7%) to approximately $10.2 million or 36.9% of sales, compared with approximately $10.8 million or 44.7% of sales for the prior year.

Engineering and product development expenses for 2012 declined approximately $728,000 (16.6%) compared with last year. The decrease was the result of expense reductions initially implemented during the second quarter last year, and maintained thereafter, as some product development initiatives were completed.

Marketing and selling expenses for 2012 increased by approximately $29,000 (0.8%) compared with last year. The increase in marketing and selling expenses related primarily to commissions and incentives, which directly correlate with the growth in sales. Those increases were partially offset by expense reductions initially implemented during the second quarter last year and maintained thereafter.

General and administrative expenses for 2012 increased by approximately $86,000 (3.1%) from last year. This increase was primarily related to additional headquarters and public company expenses.

Operating Income (Loss)

Operating income for 2012 totaled approximately $2.9 million (10.5% of sales), compared with an operating loss of approximately $653,000 (2.7% of sales) for 2011. Improvement in operating income for the year was primarily due to higher product sales combined with lower product and operating costs.

Interest Expense, net

For 2012, net interest expense totaled $3,000, compared with $106,000 for the prior year. We incur interest expense on outstanding borrowings under our revolving credit facility and earn interest income on our cash balances. Our revolving credit facility was largely unutilized during the year. Accordingly, very little interest expense was incurred. The interest rate on our revolving credit facility as of December 31, 2012 was 4.50% per annum.

Income Tax Expense

We recorded income tax expense for 2012 of approximately $0.8 million, compared with an income tax benefit of $273,000 last year. Our income tax expense and benefit are primarily non-cash.

As of December 31, 2012, our net deferred tax assets totaled approximately $7.4 million, and are primarily composed of net operating loss carry forwards ("NOLs"). These NOLs total $8.3 million for federal and $17.8 million for state purposes, with expirations starting in 2017 through 2030.

In order to fully utilize the net deferred tax assets, we will need to generate sufficient taxable income in future years to utilize our NOLs prior to their expiration. ASC Topic 740, "Income Taxes", requires us to analyze all positive and negative evidence to determine if, based on the weight of available evidence, we are more likely than not to realize the benefit of the net deferred tax assets. The recognition of the net deferred tax assets and related tax benefits is based upon our conclusions regarding, among other considerations, estimates of future earnings based on information currently available and current and anticipated customers, contracts and product introductions, as well as historical operating results and certain tax planning strategies.

We have evaluated the available evidence and the likelihood of realizing the benefit of our net deferred tax assets. From our evaluation we have concluded that based on the weight of available evidence, it is more likely than not that we will not realize a portion of the benefit of our net deferred tax assets recorded at December 31, 2012. Accordingly, as of December 31, 2012, we maintained a valuation allowance totaling approximately $14,000 for the portion of benefit of our federal and state deferred tax assets that more likely than not will not be realized. We cannot presently estimate what, if any, changes to the valuation of our deferred tax assets may be deemed appropriate in the future. If we incur future losses, it may be necessary to record additional valuation allowance related to the deferred tax assets recognized as of December 31, 2012.

Accounting for Income Taxes

We account for income taxes using the asset and liability method specified by ASC Topic 740, " Income Taxes", as modified by ASC Topic 740-10-05. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply in the period in which the deferred tax asset or liability is expected to be realized. The effect of changes in net deferred tax assets and liabilities is recognized on our consolidated balance sheets and consolidated statements of income in the period in which the change is recognized. Valuation allowances are provided to the extent that it is more likely than not that some portion, or all, of deferred tax assets will not be realized. In determining whether a tax asset is realizable, we consider among other things, estimates of future earnings based on information currently available, current and anticipated customers, contracts and new product introductions, as well as recent operating results during 2012, 2011 and 2010, and certain tax planning strategies. If we fail to achieve the future results anticipated in the calculation and valuation of net deferred tax assets, we may be required to adjust our valuation allowance related to our deferred tax assets in the future.

Fiscal Year 2011 Compared With Fiscal Year 2010

Sales, net

Sales in 2011 decreased $1.9 million (7.1%) to approximately $24.1 million compared with approximately $26.0 million for the prior year. Sales of P-25 digital products in 2011 decreased approximately $1.2 million (7.3%) to approximately $15.4 million, compared with approximately $16.6 million for 2010.

The decrease in total sales and P-25 digital sales compared with the prior year was attributed primarily to federal government agencies. These agencies, including our longstanding legacy customers, faced budget and funding constraints during the year. The enactment of a federal budget was delayed until April 2011. Once enacted, the budget did not provide adequate funding for many land mobile radio requirements. Consequently, agencies had to scale-down or defer fulfilling their requirements.

Cost of Products and Gross Margins

Cost of products as a percentage of sales for 2011 was 58.0% compared with 56.4% in 2010. Product mix, manufacturing volume and pricing are the primary factors that impact product costs and the resulting gross margins. For 2011, our cost of products and gross margins reflected reduced sales and higher material and labor costs for the early production of new products. These factors abated during the second half of the year. Production runs later in the year benefited from refinements in our manufacturing processes, yielding lower material costs and improved labor efficiencies. Also, sales increased in the second half of the year compared with the first half resulting in increased manufacturing volumes, and better utilization and absorption of our base of manufacturing support expenses.

Selling, General and Administrative Expenses

For 2011, SG&A expenses decreased approximately $1.2 million (9.8%) to approximately $10.8 million or 44.8% of sales compared with approximately $12.0 million or 46.0% of sales for the prior year.

Engineering and product development expenses for 2011 decreased approximately $464,000 (9.5%) compared with the prior year. The decrease was the result of expense reductions that commenced in the second quarter and continued for the remainder of the year, as some product development initiatives were completed. The expense reductions were partially offset by amortization of additional capitalized software that commenced during the fourth quarter 2010 when we released our new trunking digital radio and continued in 2011.

Marketing and selling expenses for 2011 decreased by approximately $616,000 (14.5%) compared with the prior year. These decreases related primarily to expense and commission reductions implemented during the second quarter 2011 and maintained for the remainder of the year.

General and administrative expenses for 2011 decreased by approximately $90,000 (3.2%) compared with the prior year. These expense reductions were primarily the result of reductions in headquarters and public company expenses, including non-cash share-based employee compensation expenses.

Operating (Loss)

We reported an operating loss of $653,000 for 2011, compared with an operating loss of $628,000 in 2010. The operating loss for 2011 was primarily due to sluggish sales and increases in cost of products during the first half of the year. These factors were partially offset by operating expense reductions implemented during the second quarter 2011 and maintained for the remainder of the year.

Interest Expense, net

For 2011, net interest expense totaled $106,000, compared with $29,000 for the prior year. The expense increase was due to borrowings under our revolving credit facility. We incur interest expense on outstanding borrowings under our revolving credit facility and earn interest income on our cash balances. We had no borrowings outstanding under the credit facility as of December 31, 2011, compared with $2.0 million outstanding as of year end 2010. The interest rate on our revolving credit facility as of December 31, 2011 was 3.75% per annum.

Income Tax (Benefit) Expense

We recorded an income tax benefit of $273,000 for 2011 compared with income tax expense of $7,000 for 2010. Our income tax expense is largely non-cash as a result of the deferred tax asset related primarily to federal and state net operating loss carryforwards.

As of December 31, 2011, we had deferred tax assets of approximately $8.2 million, which was materially unchanged from the previous year. These assets are primarily composed of NOLs. These NOLs totaled approximately $10.7 million for federal and approximately $18.8 million for state purposes as of December 31, 2011, with expirations starting in 2017 through 2030. During 2011, we utilized approximately $4.2 million of our NOLs.

In order to fully utilize the net deferred tax assets, we need to generate sufficient taxable income in future years to utilize our NOLs prior to their expiration. Consistent with ASC Topic 740, "Income Taxes", we evaluated the available evidence and the likelihood of realizing the benefit of our net deferred tax assets December 31, 2011, and from our evaluation we concluded that based on the weight of available evidence, we were more likely than not to not realize a portion of the benefit of our state deferred tax assets recorded at December 31, 2011. Accordingly, we established a valuation allowance totaling approximately $250,000 for the portion of benefit of state deferred tax assets that more likely than not will not be realized.

Changing Prices

Changing prices for the years ended December 31, 2012, 2011 and 2010 did not have a material impact on our operations. The extent of competitive pricing pressure in the future and its impact is uncertain.

Liquidity and Capital Resources

For the year ended December 31, 2012, net cash provided by operating activities totaled approximately $4.6 million compared with net cash used in operating activities totaling approximately $142,000 last year. The increase in cash provided by operating activities was primarily related to net income, depreciation and amortization, deferred tax assets and accounts receivable. These items were partially offset by increases in inventories. For the year ended December 31, 2012, we realized net income of approximately $2.1 million compared with a net loss totaling approximately $493,000 last year. Depreciation and amortization totaled approximately $1.4 million for 2012, which was materially unchanged from last year. Deferred tax assets for 2012 decreased by approximately $763,000 due to non-cash tax expense on our pretax income. During the same period last year deferred tax assets increased approximately $368,000. Accounts receivable as of December 31, 2012 decreased by approximately $2.1 million as a result of collections. For the prior year accounts receivable increased by approximately $255,000. Accounts payable for the year decreased approximately $624,000 due to payments to suppliers. Last year accounts payable decreased by approximately $1.0 million primarily due to payments to suppliers. Accrued compensation as of December 31, 2012 increased by approximately $678,000 reflecting incentive compensation related to improved sales and operating results. For the same period last year, accrued compensation increased approximately $12,000. Net inventories increased during the year ended December 31, 2012 by approximately $1.3 million in anticipation of sales growth.

Cash used in investing activities for 2012 totaled approximately $739,000 compared with approximately $215,000 last year. Cash used in investing activities for 2012 was primarily to fund the purchase of engineering and manufacturing equipment and the development of software. We anticipate that future capital expenditures will be funded through our existing cash balance and operating cash flow.

Cash provided by financing activities for the 2012 totaled approximately $23,000, representing proceeds from the issuance of common stock. For the same period last year cash used in financing activities totaled approximately $2.0 million, which represented the repayment of borrowings under our revolving credit facility.

We have a secured revolving credit facility with Silicon Valley Bank ("SVB"), which was most recently amended in December 2012, with a maximum borrowing availability of $5.0 million (subject to the borrowing base) and a maturity date of December 31, 2014. The loan and security agreement, as amended, governing this revolving credit facility contains customary borrowing terms and conditions, including the accuracy of representations and warranties, compliance with financial maintenance and restrictive covenants and the absence of events of default. The terms of the loan and security agreement include the following:

? Financial maintenance covenants, required to be maintained at all times and tested on the last day of each month, of: (1) a ratio of "quick assets to current liabilities" minus "deferred revenue" (all as defined in the loan and security agreement) of at least 1.00:1.00 and (2) "tangible net worth" (as defined in the loan and security agreement) of at least $25.77 million, increasing by (a) 50% of quarterly net profits and (b) 75% of net proceeds derived from issuances of equity and issuances of subordinated debt.

? Borrowings under the revolving credit facility bear interest at the prime rate, as in effect from time to time, plus 50 basis points, provided if our "Adjusted Quick Ratio" is greater than or equal to 1.25 to 1.00, then the interest rate is the prime rate.

? The maximum that we may borrow at any given time is based on among other things, eligible accounts receivable, inventory, and cash.

? Our obligations are secured by substantially all of our assets, principally accounts receivable and inventory.

? We are prohibited from paying cash dividends on our common stock and making any distribution or payment or redeeming, retiring or purchasing any of our capital stock, provided that we are permitted to make "Permitted Stock Repurchases" consisting of repurchases of our common stock when (1) no default or event of default exists, (ii) our representations and warranties remain true in all material respects, (3) the repurchase occurs not later than December 31, 2013, (4) the aggregate purchase price for all Permitted Stock Repurchases does not exceed $2,500,000 and (5) at the time of the repurchase the "Adjusted Quick Ratio" is at least 1.25 to 1.00.

For a more detailed description of such borrowing terms and conditions, reference is made to Note 6 (Debt) of our Consolidated Financial Statements included elsewhere in this report.

We were in compliance with all covenants under the loan and security agreement, as amended, as of December 31, 2012 and as of the date of this report on Form 10-K. As of December 31, 2012 and the date of filing this report, we had no borrowings outstanding under the secured credit facility, and approximately $2.5 million and $3.0 million, respectively, was available for borrowing under the revolving credit facility.

Our cash balance at December 31, 2012 was approximately $6.6 million. We believe these funds combined with anticipated cash generated from operations and borrowing availability under our revolving credit facility are sufficient to meet our working capital requirements for the foreseeable future. However, although we do not anticipate needing additional capital in the near term, the current financial and economic conditions could limit our access to credit and impair our ability to raise capital, if needed, on acceptable terms or at all. We also face other risks that could impact our business, liquidity and financial condition. For a description of these risks, see "Item 1A. Risk Factors" set forth elsewhere in this report.

The following table sets forth the Company's future contractual obligations for the next five years and in the aggregate as of December 31, 2012:

                                            Payments Due by Period
                                       Less than      1-3        3-5       More than
Contractual Obligations      Total       1 Year       Years      Years      5 Years
                                                (In thousands)
Operating leases            $ 1,348      $    540      $ 808      $   -       $     -
Purchase Obligations          4,204         4,204          -          -             -
Revolving credit facility         -             -          -          -             -
Total                       $ 5,552      $  4,744      $ 808      $   -       $     -

For a description of our revolving credit facility and our operating leases, reference is made to Notes 6 and 7 to our Consolidated Financial Statements included elsewhere in this report.

Off Balance Sheet Arrangements

We do not have any off balance sheet arrangements.

Recent Accounting Pronouncements

There have been no recent accounting pronouncements or changes in accounting pronouncements that impacted the years ended December 31, 2012, 2011 and 2010, or which are expected to impact future periods, which were not previously disclosed in prior periods.

Critical Accounting Policies and Estimates

In response to the SEC's financial reporting release, FR-60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies, we have selected for discussion our revenue recognition process and our more subjective accounting estimation processes. These processes affect our reported revenues and current assets and are therefore critical in assessing our financial and operating status. The processes for determining the allowance for collection of trade receivables, reserves for excess or obsolete inventory, software development and income taxes, involve certain assumptions that if incorrect could create an adverse impact on our operations and financial position.

Revenue

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