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ORBT > SEC Filings for ORBT > Form 10-K on 29-Mar-2013All Recent SEC Filings

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Form 10-K for ORBIT INTERNATIONAL CORP


29-Mar-2013

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with our financial statements and related notes contained elsewhere in this Report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors discussed in this Report and those discussed in other documents we file with the SEC. In light of these risks, uncertainties and assumptions, readers are cautioned not to place undue reliance on such forward-looking statements. These forward-looking statements represent beliefs and assumptions only as of the date of this Report. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change.

Executive Overview

We recorded a decrease in our operating results for the year ended December 31, 2012 as compared to the prior year. Our sales decreased by 5.2% and we recorded a net loss of $135,000 as compared to net income of $3,147,000 in the prior year period. Our loss during the current year was principally due to a decrease in sales and gross profit and to the following one-time charges: (i) a $1,194,000 charge taken in connection with the non-renewal of our former chief operating officer's employment contract and (ii) an impairment charge of $820,000 relating to the goodwill associated with our TDL subsidiary which was partially offset by a decrease in selling, general and administrative expenses and interest expense. Exclusive of these two one-time charges, net income was $1,879,000. Our decrease in sales was attributable to decreases of 8.8% and 2.7% at our Electronics and Power Groups, respectively. All goodwill and intangible assets related to our TDL and ICS acquisitions have been written off at December 31, 2012.

Our backlog at December 31, 2012 was approximately $15,900,000 compared to $15,500,000 at December 31, 2011. 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 continue to pursue a significant number 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.

Our financial condition remains strong as evidenced by our 3.4 to 1 current ratio at December 31, 2012. 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. The new credit facility expires November 8, 2013. We were in compliance with the financial covenants contained in the New Credit Agreement at December 31, 2012. In March 2012, we engaged in a privately negotiated transaction whereby we purchased 95,000 shares of our common stock for total cash consideration of approximately $402,000, at an average price of $4.23. In August 2012, in a privately negotiated transaction, we purchased 100,000 shares of our common stock for total cash consideration of approximately $308,000 at an average price of $3.08. Under the terms of our New Credit Agreement, entered into November 8, 2012, we are permitted to purchase up to an additional $400,000 of our common stock during the term of our New Credit Agreement. In November 2012, our Board of Directors authorized management, in its discretion, to purchase up to this dollar amount of our common stock. From the commencement of the New Credit Agreement to March 22, 2013, we purchased a total of approximately 34,000 shares of our common stock for total cash consideration of approximately $115,000 for an average price of $3.34 per share.


Despite planned reductions in military spending in 2013, members of Congress were unable to agree on a plan to balance the budget to avoid sequestration cuts (that became effective March 1, 2013), which will reduce the budget for the Department of Defense. A reduction in defense spending as a result of full sequestration cuts could have a profound negative impact on the entire defense industry. At the present time, it appears the greatest immediate impact of sequestration will be civilian government employee furloughs. Program contract delays have always been a factor on our business and our industry and these expected government furloughs will more than likely exacerbate this problem for our industry. Consequently, significant delays in contract awards could adversely affect planned delivery schedules which could impact our operating performance for 2013.

Critical Accounting Policies

The discussion and analysis of our financial condition and the results of operations are based on our financial statements and the data used to prepare them. Our financial statements have been prepared based on accounting principles generally accepted in the United States of America ("GAAP"). On an on-going basis, we re-evaluate our judgments and estimates including those related to inventory valuation, the valuation allowance on our deferred tax asset, impairment of goodwill, valuation of share-based compensation, revenue and cost recognition on long-term contracts accounted for under the percentage-of-completion method and other than temporary impairment on marketable securities, among others. These estimates and judgments are based on historical experience and various other assumptions that are believed to be reasonable under current business conditions and circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect more significant judgments and estimates in the preparation of the consolidated financial statements.

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, 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 December 31, 2012, we had 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 $5,000,000 and $6,000,000, respectively, which expire from 2018 through 2032. We record a valuation allowance to reduce our deferred tax asset when it is more likely than not that a portion of the amount may not be realized. We estimate our valuation allowance based on an estimated forecast of our future profitability. Any significant changes in future profitability resulting from variations in future revenues or expenses could affect the valuation allowance on our deferred tax asset and operating results could be affected, accordingly. We will evaluate the possibility of changing some or all of our valuation allowance relating to our deferred tax asset should we become profitable or incur further losses in the future. The increase or reduction of some or all of our valuation allowance would create a deferred tax expense or benefit, resulting in an increase or decrease to net income in our consolidated statements of operations.

Impairment of Goodwill

In connection with the annual impairment testing of TDL's goodwill pursuant to ASC 350, the analysis indicated that the fair value for the TDL reporting unit was less than the carrying value and therefore the goodwill was impaired. As a result, we recorded an impairment charge for $820,000, representing the remaining carrying value of TDL's goodwill.

Our analysis of TDL'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 December 31, 2012, is $868,000 for Behlman. After applying ASU 2011-08, the Company performed a qualitative assessment on Behlman's goodwill at December 31, 2012. The Company concluded as of December 31, 2012 that the fair value of Behlman was more likely than not greater than its carrying amount. This assessment was based on certain factors, such as: i) Behlman's bookings and revenue in 2012 (approximately $12.5 million and $12.4 million, respectively), ii) Behlman's net income (approximately $2.8 million) in 2012, iii) Behlman's backlog at December 31, 2012 of approximately $8.1 million and iv) the result of our 2010 quantitative goodwill impairment test under which Behlman's fair value at December 31, 2010 exceeded its carrying amount by approximately 27%.


Share-Based Compensation

We account for share-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 share-based compensation expense was $211,000 and $152,000 for the years ended December 31, 2012 and 2011, respectively. During 2012 and 2011, no shares of restricted stock or stock options were granted. In January 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 delivery of product. We recognize such revenue when title and risk of loss are transferred to our customer and when there is: i) 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.

Marketable Securities

We currently have approximately $251,000 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:

Year Ended December 31, 2012 vs. Year Ended December 31, 2011

We currently operate in two industry segments. Our Orbit Instrument Division and our TDL subsidiary are engaged in the design and manufacture of electronic components and subsystems and our ICS subsidiary performs system integration for Gun Weapons Systems and Fire Control Interface as well as logistics support and documentation (which collectively comprise our "Electronics Group"). Our Behlman subsidiary is engaged in the design and manufacture of commercial power units and COTS power solutions (which comprises our "Power Group").

Consolidated net sales for the year ended December 31, 2012 decreased by 5.2% to $29,438,000 from $31,041,000 for the year ended December 31, 2011 due to lower sales from both our Power and Electronics Groups. Sales from our Power Group decreased by 2.7% due to a decrease in sales from its commercial division which was partially offset by an increase in sales at its COTS division. The decrease in sales from its commercial division was principally due to a decrease in bookings during the current year and the increase in sales from its COTS division was principally due to increased shipments pursuant to customer delivery schedules, resulting from strong bookings in 2011 and 2012. Sales from our Electronics Group decreased by 8.8% due primarily to a decrease in sales at our Orbit Instrument Division and ICS subsidiary and despite an increase in sales at our TDL subsidiary. The decrease in sales at our Orbit Instrument Division was principally due to a decrease in shipments pursuant to customer delivery schedules resulting from lower bookings in the prior year period. The decrease in sales at our ICS subsidiary was principally due to the absence of MK 119 sales, as a follow-on order for the MK 119 was not received for shipping in 2012 and the decrease was also due to fewer MK 437 sales. Sales from our TDL subsidiary increased due primarily to an increase in sales for a vehicle display used by one of TDL's customers.

Gross profit, as a percentage of net sales, for the year ended December 31, 2012 decreased to 39.6% from 42.6% for the prior year. The decrease was primarily the result of lower gross margin from both our Electronics and Power Groups. The decrease at our Electronics Group was principally due to lower gross margin at our Orbit Instrument Division and TDL subsidiary and despite an increase in gross margin at our ICS subsidiary. The decrease in gross margin at our Orbit Instrument Division was primarily due to lower sales and a change in product mix which resulted in higher material and labor costs as a percentage of sales. The slight decrease in gross margin at our TDL subsidiary was primarily the result of higher material costs as a percentage of sales and despite an increase in sales. The increase in gross margin at our ICS subsidiary was primarily due to a reduction in personnel and rent expense (due to the consolidation of its two operating facilities into one) and also due to a change in product mix, particularly the inclusion of our SDC contract in the current year and despite a reduction in sales. The decrease in gross margin at our Power Group was primarily due to a decrease in sales and a change in product mix during the current year.


Selling, general and administrative expenses decreased by 2.2% to $9,732,000 for the year ended December 31, 2012 from $9,955,000 for the year ended December 31, 2011. The decrease was principally due to lower selling, general and administrative expenses at our ICS subsidiary primarily due to a reduction in personnel which was partially offset by an increase at our Orbit Instrument Division due to additional sales and engineering personnel. Selling, general and administrative expenses, as a percentage of sales, for the year ended December 31, 2012 increased to 33.1% from 32.1% for the year ended December 31, 2011 principally due to the decrease in sales and despite the decrease in expenses.

During the first quarter of 2012, we reached a decision that made it probable that the employment agreement of our former chief operating officer would not be renewed, which effectively terminated his employment as of July 31, 2012. Pursuant to the terms of his existing agreement, we recorded an expense of $1,194,000 for estimated costs associated with the contract non-renewal.

In connection with the annual impairment testing of TDL's goodwill pursuant to ASC 350, the analysis indicated that the fair value for the TDL reporting unit was less than the carrying value and therefore the goodwill was impaired. As a result, we recorded an impairment charge for $820,000, representing the remaining carrying value of TDL's goodwill.

Interest expense for the year ended December 31, 2012 decreased to $124,000 from $189,000 for the year ended December 31, 2011 due principally to a decrease in the amounts owed to lenders under our term debt and also due to a reduction in the interest rate on our term debt and line of credit and despite an increase in amounts owed under our line of credit.

Investment and other income for the year ended December 31, 2012 decreased to $144,000 from $149,000 for the prior year principally due to a gain of $45,000 in corporate bonds sold in the prior year and despite $31,000 of insurance proceeds relating to a business interruption insurance claim and a $5,000 gain on corporate bonds sold in the current year.

Net loss before income tax provision was $65,000 for the year ended December 31, 2012 compared to net income before income tax provision of $3,234,000 for the year ended December 31, 2011. The decrease in income was principally due to a $1,194,000 charge taken in connection with the non-renewal of our former chief operating officer's contract, the impairment charge of $820,000 relating TDL's goodwill, a decrease in sales and gross profit from both our Electronics and Power Groups and a decrease in investment and other (income) and despite a decrease in interest expense and selling, general and administrative expenses.


Income taxes for the year ended December 31, 2012 and 2011 were $70,000 and $87,000, respectively, consisting of 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, the net loss for the year ended December 31, 2012 was $135,000 compared to a net income of $3,147,000 for the year ended December 31, 2011.

Earnings before interest, taxes, goodwill impairment, depreciation and amortization (Adjusted EBITDA) for the year ended December 31, 2012 decreased to $1,167,000 compared to earnings of $3,693,000 for the year ended December 31, 2011. Listed below is the Adjusted EBITDA reconciliation to net income (loss):

Adjusted 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. Adjusted 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.

                                        Year ended
                                       December 31,
                                   2012            2011
Net (loss) income               $  (135,000 )   $ 3,147,000
Interest expense                    124,000         189,000
Income tax expense                   70,000          87,000
Goodwill impairment                 820,000               -
Depreciation and amortization       288,000         270,000
EBITDA, as adjusted             $ 1,167,000     $ 3,693,000

Liquidity, Capital Resources and Inflation

Working capital decreased to $14,935,000 at December 31, 2012 as compared to $17,038,000 at December 31, 2011. The ratio of current assets to current liabilities was 3.4 to 1 at December 31, 2012 compared to 5.4 to 1 at December 31, 2011. The decrease in working capital was primarily attributable to the net loss for the period, the refinancing of our long term debt with a new line of credit, the purchase of treasury stock and property and equipment and the repayment of debt.

Net cash used in operating activities for the year ended December 31, 2012 was $954,000, primarily attributable to the net loss for the year, an increase in costs and estimated earnings in excess of billings on uncompleted contracts, inventories and accounts receivable, a decrease in accrued expenses and accounts payable and despite an increase in the liability associated with non-renewal of senior officers' contracts and customer advances and the non-cash depreciation and amortization, goodwill impairment and stock based compensation. Net cash provided by operating activities for the year ended December 31, 2011 was $1,949,000, primarily attributable to the net income for the year, the non-cash depreciation and amortization, stock based compensation, a decrease in costs and estimated earnings in excess of billings, other current assets and accrued expenses and despite an increase in inventory, accounts receivable and a decrease in the liability associated with our former chief executive officer, deferred income and customer advances.


Cash flows used in investing activities for the year ended December 31, 2012 was $370,000 attributable to the purchase of property and equipment and marketable securities which was partially offset by the sale of marketable securities. Cash flows used in investing activities for the year ended December 31, 2011 was $216,000, primarily attributable to the purchase of marketable securities and property and equipment that was partially offset by the sale of marketable securities and property and equipment.

Cash flows provided by financing activities for the year ended December 31, 2012 was $225,000, attributable to the issuance of note payable-bank and long-term debt and a decrease in restricted cash that was partially offset by the repayment of long-term debt and purchase of treasury stock. Cash flows used in financing activities for the year ended December 31, 2011 was $1,988,000, attributable to the repayment of long term debt and note payable-bank and the increase in restricted cash which was slightly offset by the proceeds from stock option exercises.

On November 8, 2012, we entered into a new credit agreement (the "New Credit Agreement") with a new 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. The line of credit matures on November 8, 2013 and may be renewed on an annual basis. Payment of interest on the line of credit is due at a rate per annum as follows: (i) variable at the lender's prime lending rate; and/or (ii) 2% over LIBOR for 30, 60, or 90 day LIBOR maturities. The line of credit is secured by a first priority security interest in all of our tangible and intangible assets.

The New 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 New Credit Agreement. We were in compliance with the financial covenants contained in the New Credit Agreement at December 31, 2012.

Our existing capital resources, including our bank credit facility (which is expected to renew in 2013) and our cash flow from operations, are expected to be adequate to cover our cash requirements for the foreseeable future.

In March 2012, we purchased, in privately negotiated transactions, 95,000 shares of our common stock for total cash consideration of approximately $402,000. In August 2012, we purchased, in a privately negotiated transaction, 100,000 shares of our common stock for total cash consideration of approximately $308,000. Under the terms of our New Credit Agreement, we are permitted to purchase up to an additional $400,000 of our common stock during the term of the Agreement. In November 2012, our Board of Directors authorized management, in its discretion, to purchase up to this dollar amount of common stock. From the start of the New Credit Agreement on November 8, 2012 to March 22, 2013, we purchased a total of approximately 34,000 of our common shares for total cash consideration of approximately $115,000 for an average price of $3.34 per share.


On March 6, 2013, our Board of Directors approved a 10b5-1 Plan (the "Plan") through which we will conduct our currently authorized stock buy back program. We have authorized a total of approximately $300,000 which may be devoted to repurchases made pursuant to the Plan.

Inflation has not materially impacted the operations of our Company.

. . .

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