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ORBT > SEC Filings for ORBT > Form 10-K on 31-Mar-2014All Recent SEC Filings

Show all filings for ORBIT INTERNATIONAL CORP

Form 10-K for ORBIT INTERNATIONAL CORP


31-Mar-2014

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, 2013 as compared to the prior year. Our sales decreased by 15.6% and we recorded a net loss of $2,570,000 as compared to a net loss of $135,000 in the prior year period. Our net loss during the current year was principally due to a non-cash charge of $2,252,000 of deferred tax expense related to a full valuation allowance taken on our net deferred tax asset. In addition, our net loss was also due to a decrease in sales and gross profit and a reduction in investment and other (income) as compared to the prior year. The net loss in the prior year period was principally due to the following: (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. The decrease in sales during the current year period was primarily attributable to a 23.0% and 5.4% decrease in sales at our Electronics and Power Groups, respectively.

Our backlog at December 31, 2013 was approximately $10,100,000 compared to $15,900,000 at December 31, 2012 due to lower backlog at both our Electronics and Power Groups. 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 4.7 to 1 current ratio at December 31, 2013. 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. We were in compliance with the financial covenants contained in our Credit Agreement at December 31, 2013. Despite being in compliance at December 31, 2013, we are uncertain whether we will be in compliance with one of the financial covenants contained in our lending agreement at March 31, 2014 due to our operating loss in 2013 and expected operating loss in the first quarter of 2014, principally due to the costs associated with consolidating our TDL, Quakertown, PA facility into our Hauppauge, NY operations. Accordingly, we have classified our line of credit as a current liability at December 31, 2013. We are currently negotiating with our primary lender to amend this covenant and based on preliminary discussions, we expect our lender to amend this covenant, although there can be no certainty that an agreement will be reached.


In November 2012, our Board of Directors authorized management, in its discretion, to purchase up to $400,000 of our common stock. On March 6, 2013, our Board of Directors approved a 10b5-1 Plan through which we conducted our authorized stock buy back program. We repurchased all of the remaining shares available under our stock buy back program (including the related 10b5-1 Plan) during the first and second quarters of 2013. From November 8, 2012 to June 20, 2013, we purchased a total of approximately 116,000 shares of our common stock for total cash consideration of approximately $400,000 for an average price of $3.45 per share. In June 2013, our Credit Agreement was amended whereby 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 the Credit Agreement. 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. 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 will most likely not make any further repurchases of our common stock until the second quarter of 2014, depending on the timing of receipt of certain material contracts.

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 could result 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, there are further reductions to defense spending planned for 2014. 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.


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 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

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

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 two most recent 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 that will be incurred in the first half of 2014 related to the TDL consolidation, which will affect 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 $7,000,000 and $6,000,000, 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 consolidated statements of operations.

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. At December 31, 2012, 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 during December 31, 2012, representing the remaining carrying value of TDL's goodwill.

Our analysis of Behlman's and 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, 2013, is $868,000 for Behlman.

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 $111,000 and $211,000 for the years ended December 31, 2013 and 2012, respectively. During 2013, 130,000 shares of restricted stock were awarded to senior management. During 2012, no shares of restricted stock or stock options were granted.


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 $243,000 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, 2013 vs. Year Ended December 31, 2012

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, cable and harness assemblies, 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, 2013 decreased by 15.6% to $24,838,000 from $29,438,000 for the year ended December 31, 2012 due to lower sales from both our Power and Electronics Groups. Sales from our Electronics Group decreased by 23.0% due to a decrease in sales from our Orbit Instrument Division and TDL and ICS subsidiaries. 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 during the current year period. The decrease in sales at our ICS subsidiary was primarily due to the absence of MK 437 sales and a decrease in revenue relating to our SDC order in the current year. The decrease in sales at our TDL subsidiary was principally due to (i) lower bookings in the current year as compared to the prior year and (ii) the absence of shipments in the current year for a certain display used in the ground mobile marketplace. Sales from our Power Group decreased by 5.4% due to a decrease in sales from our COTS division which was partially offset by an increase in sales at our commercial division. The increase in sales from our commercial division was principally due to an increase in shipments pursuant to customer delivery schedules. The decrease in sales at our COTS division was primarily related to a decrease in shipments pursuant to customer delivery schedules resulting from lower current year bookings.

Gross profit, as a percentage of sales decreased to 37.6% from 39.6% from the prior year. The decrease was primarily the result of lower gross margin from both our Electronics and Power Groups. The decrease in gross margin at our Electronics Group was principally due to lower gross margin at our ICS and TDL subsidiaries primarily due to lower 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 2.0% to $9,540,000 for the year ended December 31, 2013 from $9,732,000 for the year ended December 31, 2012. The decrease was primarily due to a 4.1% decrease in selling, general and administrative expenses at our Electronics Group. The decrease in selling, general and administrative expenses at our Electronics Group was principally due to the departure of a senior officer whose duties were assumed by other management and also to a reduction in personnel at our ICS subsidiary.

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.

During the fourth quarter of 2013, we recorded $29,000 of restructuring charges relating to our decision in October 2013 to consolidate the operations of our Quakertown, PA based TDL facility into our Hauppauge, NY facility.


During the fourth quarter of 2012, 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, 2013 decreased to $59,000 from $124,000 for the year ended December 31, 2012. In November 2012, we entered into a 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 all of our obligations (term debt and line of credit) to our former primary lender. The decrease in interest expense was principally due to the payoff of our term debt, a lower interest rate on our new line of credit and a decrease in amounts owed under our line of credit during the year.

Investment and other income for the year ended December 31, 2013 decreased to $22,000 from $144,000 from the prior year. The decrease was principally due to an $85,000 gain recognized during the prior year period relating to the remaining unamortized deferred gain on the sale of our building in 2001, a gain of $31,000 on insurance proceeds relating to a business interruption insurance claim in the prior year and to higher bond premium amortization expense in the current year.

Loss before income tax provision was $263,000 for the year ended December 31, 2013 compared to a loss before income tax provision of $65,000 for the year ended December 31, 2012. The decrease in profitability was principally due to a decrease in sales and investment and other (income) and an increase in restructuring costs during the current year period which was partially offset by the following: (i) a decrease in selling, general and administrative expenses and interest expense during the current year, (ii) a $1,194,000 charge taken in connection with the non-renewal of our former chief operating officer's contract during the prior year and (iii) an impairment charge of $820,000 relating to TDL's goodwill in the prior year.

Income taxes for the year ended December 31, 2013 and 2012 were $2,307,000 and $70,000, respectively. The increase was principally due to a $2,252,000 deferred tax expense relating to the full valuation allowance taken on our net deferred tax asset in the current year. The remaining income tax expense in both the current and prior year periods consists 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, 2013 was $2,570,000 compared to a net loss of $135,000 for the year ended December 31, 2012.

Earnings before interest, taxes, goodwill impairment, depreciation and amortization (Adjusted EBITDA) for the year ended December 31, 2013 decreased to $259,000 compared to $1,167,000 for the year ended December 31, 2012. Listed below is the Adjusted EBITDA reconciliation to net 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,
                                    2013            2012
Net loss                        $ (2,570,000 )   $  (135,000 )
Interest expense                      59,000         124,000
Income tax expense                 2,307,000          70,000
Goodwill impairment                        -         820,000
Depreciation and amortization        463,000         288,000
EBITDA, as adjusted             $    259,000     $ 1,167,000

Liquidity, Capital Resources and Inflation

Working capital decreased to $14,016,000 at December 31, 2013 as compared to $14,935,000 at December 31, 2012. The ratio of current assets to current liabilities was 4.7 to 1 at December 31, 2013 compared to 3.4 to 1 at December 31, 2012. The decrease in working capital was primarily attributable to the pre-tax loss for the period and the purchase of treasury stock and property and equipment.

Net cash provided by operating activities for the year ended December 31, 2013 was $3,985,000, primarily attributable to the non-cash deferred tax expense, depreciation and amortization, and stock based compensation, the decrease in accounts receivable, inventory and costs and estimated earnings in excess of billings on uncompleted contracts which was partially offset by the net loss for the current year, a decrease in the liability associated with non-renewal of a senior officer contract, accounts payable and accrued expenses. 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.

Cash flows used in investing activities for the year ended December 31, 2013 was $335,000, primarily attributable to the purchase of marketable securities and property and equipment that was partially offset by the sale of marketable securities. 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 financing activities for the year ended December 31, 2013 was $1,698,000, attributable to the repayments of note payable-bank, the purchase of treasury stock and the repayment of long-term debt. 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.

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 . . .

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