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NATIONAL TECHNICAL SYSTEMS INC /CA/ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
[December 11, 2012]

NATIONAL TECHNICAL SYSTEMS INC /CA/ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) Except for the historical information contained herein, the matters addressed in this Item 2 contain forward-looking statements. These forward-looking statements involve risks and uncertainties, including those described in the Company's Annual Report on Form 10-K. Actual results, events and performance may differ materially from those anticipated in the forward looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements. See the note at the beginning of this report.

Overview NTS is a leading provider of testing solutions and highly trained technical personnel for product design and evaluation, safety testing, certification and supply chain management to enable customers to sell their products in world markets. NTS is accredited by numerous national and international technical organizations which allow the Company to have its test data accepted in most countries. In addition, it performs management registration and certification services to ISO related standards.

NTS serves customers primarily in the aerospace, defense, telecommunications, automotive, energy, consumer products, commercial and industrial products and medical markets. The Company operates facilities throughout the United States and in Japan, Vietnam and Germany.


The following discussion should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Company's Annual Report on Form 10-K for the year ended January 31, 2012 and the consolidated quarterly financial statements and notes thereto contained in this report. All information in this report is based upon unaudited operating results of the Company for the three and nine-month periods ended October 31, 2012 and 2011.

Markets Aerospace.

NTS offers integrated life cycle product services to the aerospace market. These services include engineering, testing and supply chain management. From concept development and design, through detail design, certification, production and in-service life, NTS provides support throughout the full life cycle of the aerospace product. These integrated services fill the capability gaps that have developed in the aerospace supply chains after years of large scale integration, outsourcing and globalization.

NTS' engineering services consist of design and analysis of aerospace structures, systems, components and detailed parts as part of customers' design teams or as a fixed-price work package. Specific capabilities include engineering program management, managed engineering services (on-site management of customer engineering teams), design engineering, analysis, test engineering, test system engineering, failure forensics and expert witnessing.

Testing services include a wide range of test capabilities for structures and airborne equipment. For structures, NTS has extensive capability and expertise in large component static and fatigue testing, including full scale airframe static and fatigue, sonic fatigue, vibration, modal, ground vibration, high pressure/high flow air and fluid compatibility. Airborne equipment testing spans the full range of RTCA DO-160 requirements, including static and dynamic, electromagnetic effects (EME, EMI, EMC), electrostatic discharge (ESD), environmental, material and system compatibility, high intensity radiated field (HIRF), indirect lightning effects and highly accelerated life testing/stress screening (HALT/HASS).

Supply chain management services span a wide range of development, oversight, and certification/accreditation activities including product inspection, production monitoring and expediting, test witnessing and support, corrective action follow-up, supplier surveillance, sub-tier supplier management, new supplier surveys, systems evaluations and audits (including special processes), development of quality assurance protocols, supplier development and improvement, quality management system audit, certification and registration.

The Company's initial sector focus in the aerospace market has been in the large commercial transport, general aviation, and space exploration sectors. In all sectors NTS tests components and systems for the supply chain supporting the manufacturers. Also, NTS is increasingly providing engineering services that design, develop, test, and integrate pods and payloads for unmanned aerial systems (UAS). This group has expanded from airborne platforms into ground, sea (surface and subsurface), and robotic platforms. NTS has conducted test programs for UAS components, systems, payloads and completely integrated air vehicles.

NTS is actively engaged in a variety of unmanned system test programs, and has performed environmental, vibration and EMI testing on a number of UAS systems.

10 -------------------------------------------------------------------------------- Table of Contents Defense.

NTS plays an active role in numerous U.S. defense-related programs, performing a wide variety of defense technology research, development, test, and evaluation (RDT&E) services for the Department of Defense (DOD), military, government and commercial industry. These services evaluate the weapons, ordnance, munitions, avionics, electronics, hydraulic and pneumatic controls, engines and communication systems that make up the elements of today's modern battlefield.

The Company's testing platforms for the defense industry include fixed wing aircraft, helicopters, submarines, aircraft carriers and other naval ships, tanks and other tracked vehicles, trucks and road vehicles, command, control and communication systems and missiles and weapons systems. Testing includes associated system and component level tests of structures, hardware, electronics, personal protective equipment, armor, weapons and ammunition.

NTS has facilities that are specially constructed to store, handle, and test ordnance, munitions and hazardous materials. Routine testing includes live fire, function, environmental, dynamics, safety, MIL-STD-901 shipboard shock, insensitive munitions (IM), hazard classification, transportation and packaging safety. These tests are done for prototype, developmental, qualification and production/lot acceptance testing (LAT). Multiple NTS facilities around the country provide 200 v/m up to 40 GHz EMI/EMC testing of electronic and communications equipment. Custom designed NTS data acquisition systems are capable of collecting data at speeds of 2,000,000 data points per second and digital photography capability of over 160,000 color photos per second.

NTS' defense group is expanding to include energetic and prototype engineering services, including 2D and 3D CAD modeling; technical data package (TDP) development and modification; finite element analysis (FEA), projectile design and analysis; interior and exterior ballistics analysis, and design and development of custom test hardware and fixtures. Other services include support of, and procurement and delivery of precision metal parts and explosive loading of prototype hardware. Additional defense services include design, development, fabrication, and fielding of specialized high speed instrumentation and diagnostics for energetics and hazardous materials and ordnance testing. This includes custom sensor suite design, fabrication and deployment, often through specialized test facility design.

Telecommunications.

NTS provides engineering design, test evaluation and certification services for manufacturers of a broad array of telecommunications networking and storage equipment intended for commercial data centers, central/telecom office and customer premise environments. The Company's services are performed in accordance with domestic and international regulatory standards, the network equipment building systems (NEBS) specifications and fiber optics general requirements (GRs) as required by the telecommunications industry. Globally, NTS represents the largest network of independent test laboratories (ITL) certified and recognized by most regional bell operating companies' (RBOCs) carriers. The Company is also certified and accredited to support formal witness testing on behalf of the RBOC carriers at approved manufacturer's internal test facilities.

NTS has unique test capability in the Wireless telecom industry. As the wireless telecom industry continues to grow, globally, the need for engineering design, testing evaluation and certification services for faster and more robust backhaul networking equipment will continue to increase. The Company is well positioned to support this accelerated growth currently providing accredited ITL services at laboratories in California, Massachusetts, New Jersey, Texas, and Germany.

Automotive.

NTS supports the commercial and military vehicle industries with testing, including dynamometer operations on power train components, vibration and shock on mechanical and electrical assemblies, thermal and corrosion exposures on control and monitoring systems, pressure pulsing and burst on fluid handling items and fatigue and ultimate strength on mechanical components. NTS performs testing to support requirements in emerging markets of pure electric vehicles and electrical hybrid vehicles. This includes electric motors, integrated motor/transmissions, specialized high speed transmissions, batteries and control/distribution modules. It also performs highly accelerated life tests (HALT) and highly accelerated stress screen (HASS). These tests combine extremes of temperature, rapid temperature change, and multi-axis vibration to rapidly expose design weaknesses and process flaws. NTS is accredited to ISO 17025 through the American Accreditation of Laboratories Association (A2LA). This accreditation allows NTS automotive test reports to be accepted throughout the U.S. and internationally.

11 -------------------------------------------------------------------------------- Table of Contents Energy.

NTS offers multi-disciplinary expertise and capabilities to provide smart solutions to complex engineering, and scientific problems in the areas of nuclear energy, renewable energy, energy storage and smartgrid. The services provided are: · Technical functional knowledge of engineering fundamentals: mechanical, structural, electrical, reliability, and high technology communication and security software system test and monitoring solutions.

· Testing on a variety of smart energy/smart grid products with a focus on the communications functionality and network protocols of smart meters, smart outlets, thermostats/in-home displays and smart appliances.

· Supply chain management focusing on assuring product integrity through quality process and product auditing, supplier improvement plans, and management of quality systems.

· Multi-disciplinary expertise in global compliance and certification for components, devices, communication products, software/hardware interoperability, and system security vulnerability assessments and validation.

· Seismic, environmental, EMI/RFI, radiation, equipment qualification, commercial grade dedication, mechanical aging, thermal aging, vacuum testing, leak detection, and high expansion line breaks. Seismic and vibration simulation tests conducted on our single axis, dependent biaxial systems, or independent tri-axial and electro-mechanical shaker tables are used for a variety of customer products.

· Certification and evaluation services to nuclear utilities and suppliers worldwide.

· A full range of products, engineering and testing services under our NUPIC and NIAC audited 10CFR50, Appendix B Quality Program.

Consumer Products.

NTS provides engineering design, test evaluation and domestic and international certification services for a broad array of consumer products normally procured for use in a residence, school and recreation environments. This typically includes personal computing, PC peripheral, residential networking and personal wireless devices. These products are subjected to a wide range of electromagnetic compatibility, product safety, reliability, usability, interoperability tests and certifications to assure market compliance, reliability and effective use. The Company has been approved as an exclusive independent test laboratory (ITL) to offer Internet TV Set-top Box multimedia over coax (MoCA) certification. The Company is the exclusive certifications provider for Sirius/XM Radio Ready program and holds a number of domestic and international test accreditations throughout its network of commercial laboratories. NTS is an accredited Telecommunication Certification Body (TCB) in North America and an appointed Notified Body for wireless devices in the European Union. With the increased integration of wireless technology into traditional consumer products, the dramatic population growth, income gains, global macroeconomic shifts and the urbanization in regions throughout Asia, Central and South America and Africa, NTS is well positioned to support the growing market spaces to which manufacturers are seeking to sell. The Company's service offerings offer a 'one-stop-shop' to the consumer product market, ensuring a shorter time to market in the fierce 'to market' race manufacturers find themselves competing within.

Commercial & Industrial.

NTS provides engineering design, testing evaluation and domestic and international certification services to manufacturers of a broad array of commercial and industrial products normally procured for light and heavy industrial applications. This covers a wide range of industries from shipbuilding, semiconductor manufacturing equipment, automation, robotics, laboratory and materials handling devices. Various types of commercial grade electronic, hydraulic and pneumatic systems are subjected to electrical, environmental and safety testing to ensure regulatory compliance and safe and reliable use. Special combined mechanical and environmental testing processes such as highly accelerated life testing (HALT) are used to accelerate the effects of aging and wear to allow manufacturers to produce a more reliable product. Once this has been accomplished, similar highly accelerated stress screening (HASS) testing can be used to ensure consistent quality on the production line. Market trends are showing increased integration of Wireless Local Area Network (WLAN) and Wide Wireless Access Network (WWAN) communication technologies in such product lines. NTS offers a complete turnkey engineering design, testing evaluation and domestic and international certification services for industrial products, including customer driven requirements.

12 -------------------------------------------------------------------------------- Table of Contents Medical.

NTS provides engineering design, testing evaluation and domestic and international certification services to manufacturers of a broad array of medical products typically including non-invasive devices. Services include electromagnetic compatibility, electrical product safety and quality control/risk analysis consultation. Through various industry partnerships, the Company has affiliations with consultants and Notified Bodies to support medical approval in North America and throughout the European Union. With the increased integration of wireless communications into traditional medical device products, NTS is also well equipped to support domestic and international testing and approvals.

Growth Strategy Over the last few years, NTS restructured its executive leadership team and initiated a growth strategy to provide significant focus on corporate development activities within the mid-to longer-term time horizon, while continuing to drive efficiencies and market penetration within the shorter-term fiscal planning time horizon.

NTS' strategies for continued growth include: · increasing market share through superior service; · investing in human resources and physical assets to strengthen existing capabilities; · enhancing utilization of resources; · adding new, innovative service offerings; · identifying, qualifying and acquiring businesses with the potential to add significant value Recent Developments Consolidated revenues for the nine months ended October 31, 2012, were $140,703,000, an increase of $25,611,000 or 22.3% over the same period last year. The increased revenues combined with prudent cost controls resulted in net income for the period of $5,550,000.

During the fiscal quarter ended October 31, 2012, the Company continued the implementation of an integrated Enterprise Resource Planning or ERP solution across a number of its operating units. The ERP solution will provide a unified platform for financial and accounting information that allows aggregation of financial data, superseding a number of disparate legacy systems. The ERP solution will enable the Company to conduct more accounting operations on the system, and reduce the utilization of "off system" records such as accounting workpapers. Finally the system is designed to provide enhanced project management for open contracts, improving visibility into the status of completion and costs for longer term contracts. At October 31, 2012 the ERP system had been implemented at 26 facilities. The one remaining facility is expected to be integrated during fiscal 2013.

On April 17, 2012, the Company acquired all of the outstanding common stock of Garwood Laboratories, Inc. (Garwood), with testing facilities in Pico Rivera and San Clemente, CA. The acquisition expands NTS' customer relationships and market share in Southern California as well as the greater Western U.S. region. The aggregate purchase price was $5,092,000. Cash paid at closing was $3,165,000, and was funded by a draw down on the Company's acquisition line of credit under its senior credit facility. The Company also issued a promissory note for $1,175,000 which is due to the seller on April 17, 2013. The Company has withheld $750,000 of the purchase price for 18 months after closing to secure Garwood's indemnification obligations under the purchase agreement. In addition to the base purchase price, the Company agreed to pay an additional earn-out up to a maximum amount of $450,000 (earn-out) if Garwood meets certain targets related to customer retention and revenues for the 24 months following the purchase date. A liability of $200,000 has been recorded as an estimated fair value of the earn-out liability at October 31, 2012. A working capital adjustment receivable has been recorded at a preliminary amount of $198,000. The Company's consolidated statement of operations includes the operations of Garwood from April 17, 2012 to October 31, 2012.

On November 8, 2012, after the period covered by this report, the Company purchased the 49.9% minority interest of Unitek Technical Systems, Inc., consolidated subsidiary, for $2,245,000. Unitek is a leading provider of supply chain management services to primarily aerospace and defense clients.

13 -------------------------------------------------------------------------------- Table of Contents Unaudited Results of Operations for the Nine Months Ended October 31, 2012 REVENUES Nine months ended October 31, 2012 2011 Diff % Change (Dollars in thousands) Total revenues $ 140,703 $ 115,092 $ 25,611 22.3 % For the nine months ended October 31, 2012, consolidated revenues increased by $25,611,000 or 22.3% when compared to the same period in the prior year. Organic revenues (revenues from businesses owned throughout both reporting periods) increased by $16,826,000 or 14.6% which was primarily related to an increase in the aerospace, energy and defense markets. Revenues from acquisitions increased by $8,785,000 or 7.6% from the purchase of Ingenium Testing on July 20, 2011, Lightning Technologies on September 1, 2011, and Garwood Laboratories on April 17, 2012.

GROSS PROFIT Nine months ended October 31, 2012 2011 Diff % Change (Dollars in thousands) Total $ 38,108 $ 27,797 $ 10,311 37.1 % % to total revenues 27.1 % 24.2 % Gross profit for the nine months ended October 31, 2012 increased by $10,311,000 or 37.1% when compared to the same period in the prior year. Gross profit as a percentage of revenue, or gross margin, increased to 27.1% from 24.2% in the prior year. This increase in gross profit was primarily due to better leverage of fixed costs with the increased level in revenues, somewhat offset by pricing pressure in some markets.

SELLING, GENERAL & ADMINISTRATIVE Nine months ended October 31, 2012 2011 Diff % Change (Dollars in thousands) Total $ 26,373 $ 22,537 $ 3,836 17.0 % % to total revenues 18.7 % 19.6 % Total selling, general and administrative expenses increased by $3,836,000 or 17.0% for the nine months ended October 31, 2012 when compared to the same period in the prior year. The increase was primarily due to higher compensation and incentive related expense, especially in the sales and marketing areas to support the increasing sales levels, as well as increased amortization expense as a result of recent acquisitions, partially offset by a decrease in legal and other expenses.

OPERATING INCOME Nine months ended October 31, 2012 2011 Diff % Change (Dollars in thousands) Total $ 11,520 $ 5,250 $ 6,270 119.4 % % to total revenues 8.2 % 4.6 % Operating income for the nine months ended October 31, 2012 increased by $6,270,000 or 119.4% when compared to the same period in the prior year, primarily as a result of the increase in gross profit, partially offset by the increase in selling, general and administrative expense.

14 -------------------------------------------------------------------------------- Table of Contents Interest Expense Net interest expense was $2,645,000 in the nine months ended October 31, 2012, an increase of $1,084,000 when compared to the same period in the prior year.

The increase was due to interest on additional borrowings, higher overall interest rates, as well as $395,000 in debt issuance cost and debt discount amortization related to the Mill Road Capital financing and the Comerica senior credit facility.

Other Income Other income was $827,000 for the nine months ended October 31, 2012, consisting primarily of a gain from insurance recovery related to the fire at the Company's Fullerton facility in November of 2009.

Income Taxes The income tax provision rate for the nine months ended October 31, 2012 was 42.8% compared to 39.9% for the same period in the prior year. The higher income tax rate in the current year is primarily due to higher estimated permanent book to tax differences in the current year. Management has determined that it is more likely than not that the deferred tax assets will be realized on the basis of offsetting them against the reversal of deferred tax liabilities. The Company analyzes the value of the deferred income tax asset quarterly.

Net Income Net income from continuing operations for the nine months ended October 31, 2012 was $5,553,000 compared to $2,091,000 for the same period in the prior year.

This increase was primarily due to higher operating income and other income, partially offset by higher interest expense and income taxes.

On October 31, 2011, the Company closed its Calgary facility. Net loss from the discontinued Calgary operation for the nine months ended October 31, 2012 was $3,000 compared to $322,000 in the same period in the prior year.

Net income for the nine months ended October 31, 2012 was $5,550,000 compared to $1,769,000 for the same period in the prior year.

For the nine months ended October 31, 2012, net income attributable to noncontrolling interests was $808,000 compared to $660,000 for the same period in the prior year, an increase of $148,000 or 22.4%. This increase was due to higher net income for the Company's 50% owned NQA, Inc. subsidiary in the current year.

Net income attributable to NTS for the nine months ended October 31, 2012 was $4,742,000 compared to $1,109,000 for the same period in the prior year.

Adjusted EBITDA EBITDA (earnings before interest, taxes, depreciation and amortization) as adjusted to remove the effect of share based compensation expense or "adjusted EBITDA", was $20,617,000 for the first nine months of fiscal 2013 compared to $11,567,000 in the same period for the prior year.

Management uses adjusted EBITDA to evaluate the Company's core operations without reference to the impact of interest and tax payments resulting from its capital structure and tax jurisdictions, or depreciation and amortization which can fluctuate based on acquisition activity. The Company's senior credit facility also includes covenants related to adjusted EBITDA.

Adjusted EBITDA is a non-GAAP financial measure. The Company calculates adjusted EBITDA by taking net income, and adding back the expenses related to interest, taxes, depreciation, amortization, share based compensation expense and non-cash impairment loss, as each of those elements are calculated in accordance with GAAP. A reconciliation of the Company's adjusted EBITDA to net income for the nine months ended October 31, 2012 and 2011 is included in the table below.

15 -------------------------------------------------------------------------------- Table of Contents Nine months ended October 31, 2012 2011 Net Income $ 5,550,000 $ 1,769,000 Add Interest 2,645,000 1,561,000 Taxes 4,149,000 1,387,000 Depreciation 5,906,000 5,238,000 Amortization 1,508,000 1,100,000 EBITDA 19,758,000 11,055,000 Add Share based compensation 859,000 512,000 Adjusted EBITDA $ 20,617,000 $ 11,567,000 Unaudited Results of Operations for the Three Months Ended October 31, 2012 REVENUES Three months ended October 31, 2012 2011 Diff % Change (Dollars in thousands) Total revenues $ 49,921 $ 40,498 $ 9,423 23.3 % For the three months ended October 31, 2012, consolidated revenues increased by $9,423,000 or 23.3% when compared to the same period in the prior year. Organic revenues (revenues from businesses owned throughout both reporting periods) increased by $6,792,000 or 16.8% which was primarily related to an increase in the aerospace, energy and defense markets. Revenues from acquisitions increased by $2,631,000 or 6.5% from the purchase of Ingenium Testing on July 20, 2011, Lightning Technologies on September 1, 2011, and Garwood Laboratories on April 17, 2012.

GROSS PROFIT Three months ended October 31, 2012 2011 Diff % Change (Dollars in thousands) Total $ 13,977 $ 9,468 $ 4,509 47.6 % % to total revenues 28.0 % 23.4 % Gross profit for the three months ended October 31, 2012 increased by $4,509,000 or 47.6% when compared to the same period in the prior year. Gross profit as a percentage of revenue, or gross margin, increased to 28.0% from 23.4% in the prior year. This increase in gross profit was primarily due to better leverage of fixed costs with the increased level in revenues, somewhat offset by pricing pressure in some markets.

SELLING, GENERAL & ADMINISTRATIVE Three months ended October 31, 2012 2011 Diff % Change (Dollars in thousands) Total $ 9,294 $ 7,681 $ 1,613 21.0 % % to total revenues 18.6 % 19.0 % 16-------------------------------------------------------------------------------- Table of Contents Total selling, general and administrative expenses increased by $1,613,000 or 21.0% for the three months ended October 31, 2012 when compared to the same period in the prior year. The increase was primarily due to higher compensation and incentive related expense, especially in the sales and marketing areas to support the increasing sales levels, as well as increased amortization expense as a result of recent acquisitions, partially offset by a decrease in legal and other expenses.

OPERATING INCOME Three months ended October 31, 2012 2011 Diff % Change (Dollars in thousands) Total $ 4,604 $ 1,778 $ 2,826 158.9 % % to total revenues 9.2 % 4.4 % Operating income for the three months ended October 31, 2012 increased by $2,826,000 or 158.9% when compared to the same period in the prior year, primarily as a result of the increase in gross profit, partially offset by the increase in selling, general and administrative expense.

Interest Expense Net interest expense was $846,000 in the three months ended October 31, 2012, an increase of $124,000 when compared to the same period in the prior year. The increase was primarily due to interest on additional borrowings.

Other Income Other income was $734,000 for the three months ended October 31, 2012, consisting primarily of a gain from insurance recovery related to the fire at the Company's Fullerton facility in November of 2009.

Income Taxes The income tax provision rate for the three months ended October 31, 2012 was 44.6% compared to 26.3% for the same period in the prior year. The higher income tax rate in the current year is primarily due to higher estimated permanent book to tax differences in the current year. The prior year income tax rate was low due to the tax effect from discontinued operations. Management has determined that it is more likely than not that the deferred tax assets will be realized on the basis of offsetting them against the reversal of deferred tax liabilities.

The Company analyzes the value of the deferred income tax asset quarterly.

Net Income Net income from continuing operations for the three months ended October 31, 2012 was $2,489,000 compared to $642,000 for the same period in the prior year.

This increase was primarily due to higher operating income and other income, partially offset by higher interest expense and income taxes.

On October 31, 2011, the Company closed its Calgary facility. Net gain from the discontinued Calgary operation for the three months ended October 31, 2012 was $1,000 compared to a net loss of $547,000 in the same period in the prior year.

Net income for the three months ended October 31, 2012 was $2,490,000 compared to $95,000 for the same period in the prior year.

For the three months ended October 31, 2012, net income attributable to noncontrolling interests was $304,000 compared to net income of $282,000 for the same period in the prior year, an increase of $22,000 or 7.8%. This increase was due to higher net income for the Company's 50% owned NQA, Inc. subsidiary in the current year.

Net income attributable to NTS for the three months ended October 31, 2012 was $2,186,000 compared to a net loss of $187,000 for the same period in the prior year.

17 -------------------------------------------------------------------------------- Table of Contents Adjusted EBITDA EBITDA (earnings before interest, taxes, depreciation and amortization) as adjusted to remove the effect of share based compensation expense or "adjusted EBITDA", was $8,097,000 for the three months ended October 31, 2012 compared to $3,507,000 in the same period for the prior year.

Management uses adjusted EBITDA to evaluate the Company's core operations without reference to the impact of interest and tax payments resulting from its capital structure and tax jurisdictions, or depreciation and amortization which can fluctuate based on acquisition activity. The Company's senior credit facility also includes covenants related to adjusted EBITDA.

Adjusted EBITDA is a non-GAAP financial measure. The Company calculates adjusted EBITDA by taking net income, and adding back the expenses related to interest, taxes, depreciation, amortization, share based compensation expense and non-cash impairment loss, as each of those elements are calculated in accordance with GAAP. A reconciliation of the Company's adjusted EBITDA to net income for the three months ended October 31, 2012 and 2011 is included in the table below.

Three months ended October 31, 2012 2011 Net Income $ 2,490,000 $ 95,000 Add Interest 846,000 722,000 Taxes 2,003,000 229,000 Depreciation 1,972,000 1,835,000 Amortization 499,000 462,000 EBITDA 7,810,000 3,343,000 Add Share based compensation 287,000 164,000 Adjusted EBITDA $ 8,097,000 $ 3,507,000 Outlook The Company is increasing its revenue and Adjusted EBITDA guidance for fiscal year 2013, and maintaining its guidance for gross margin. Revenue is expected to be between $183 million and $186 million for fiscal year 2013, up from the previous guidance of between $164 million and $169 million; Adjusted EBITDA is expected to be between $24 million and $26 million, up from the prior guidance of between $20 million and $22 million; and gross margins are expected to be between 26.5% and 27.5% of revenue.

The foregoing outlook is based on management's expectations based on assumptions about market conditions and the Company's future operating performance, which the Company believes to be reasonable at this time. The Company's business involves procuring and performing on large contracts, and the timing of receipt of those contracts can have a significant impact on operating results for any quarter. Consequently the Company's results may vary significantly from quarter to quarter. In addition, changes in macroeconomic conditions, delays in government spending and other factors can cause actual results to vary from expectations. See the note on "Forward-Looking Statements" at the beginning of this report.

Off Balance Sheet Arrangements None.

Liquidity and Capital Resources Liquidity At October 31, 2012 cash and cash equivalents were $6,313,000 compared to $4,335,000 at January 31, 2012. In addition, at October 31, 2012, investments and accounts receivable were $3,244,000 and $45,918,000, respectively, compared to $3,318,000 and $34,775,000 at January 31, 2012. At October 31, 2012 the Company had working capital of $36,627,000, compared to working capital of $30,898,000 at January 31, 2012.

18 -------------------------------------------------------------------------------- Table of Contents Net cash provided by operating activities was $7,513,000 in the nine months ended October 31, 2012 and consisted of net income of $5,550,000 adjusted for depreciation and amortization of $7,414,000, share-based compensation of $859,000, amortization of debt issuance cost and debt discount of $501,000, allowance for doubtful accounts of $308,000, deferred income taxes of $218,000 and loss on retirement of assets of $3,000, partially offset by changes in working capital, net of acquired assets and liabilities of $7,318,000 and gain on investments of $22,000.

Net cash used in investing activities in the nine months ended October 31, 2012 was $8,320,000 and was partially attributable to capital spending of $5,273,000 and net cash used of $3,116,000 for the acquisition of Garwood. Additional cash used for investing activities included investment in retirement funds of $406,000 and investment in life insurance of $1,000, partially offset by cash surrender of insurance policy of $476,000.

Net cash provided by financing activities in the nine months ended October 31, 2012 was $2,760,000 and consisted of proceeds from borrowing of $11,376,000, proceeds from stock options exercised of $240,000 and tax benefit from restricted stock issuance and stock options exercised of $75,000, partially offset by repayment of debt of $8,732,000 and net cash dividends paid by NQA, Inc. of $199,000.

Capital Resources At October 31, 2012, the Company had cash and cash equivalents of $6,313,000 and working capital of $36,627,000. In addition to its cash and cash generated from operations, the Company has a $65 million senior credit facility that is comprised of a $20 million term loan, a $25 million revolving credit line, and a $20 million acquisition line. The senior credit facility is described in more detail under "Long-term Debt" below.

Under the revolving credit line the Company can borrow up to 85% of eligible accounts receivable. At October 31, 2012, 85% of eligible accounts receivable was $20,988,000.

Under the acquisition line, the Company can borrow for the purposes of financing eligible machinery or equipment. Advances under the acquisition line can be made at up to 100% of the invoice cost of new eligible equipment and 80% of the invoice cost of used eligible equipment.

As of October 31, 2012, the amount of available credit under the revolving credit line was $14,488,000 and there was no available credit under either the term or acquisition lines.

Based on our current operating projections, we believe that we will continue to generate positive cash from operations for at least the next twelve months, and that our existing capital resources will be sufficient to fund our operations during that time.

Long-term Debt On November 10, 2010, the Company obtained a senior credit facility from a banking group led by Comerica Bank that includes Bank of the West and U.S. Bank.

The credit facility originally included a $20 million term loan, a $25 million revolving credit line and a $20 million acquisition line. Interest rates under the credit agreement are at either LIBOR plus a range of 175 to 275 basis points, or at Comerica Bank's prime rate plus a range of 75 to 175 basis points. Commitment fees on the revolving credit line and acquisition line are 25 basis points and 35 basis points, respectively.

On June 27, 2011, the Company completed a $14 million private placement of debt and equity with Mill Road Capital. Of the $14 million, $7 million was in the form of an interest-bearing, five-year subordinated note.

19 -------------------------------------------------------------------------------- Table of Contents Debt as of October 31, 2012 and January 31, 2012 consisted of the following: October 31, 2012 January 31, 2012 Revolving credit line (a) $ 6,500,000 $ 5,000,000 Term loan (b) 14,800,000 17,150,000 Acquisition and equipment credit line: (c) Acquisition 16,890,000 14,000,000 Machinery and equipment 1,862,000 2,251,000 Mill Road debt (d) 6,826,000 6,337,000 Secured and other notes payable (e) 6,164,000 5,450,000 Subtotal 53,042,000 50,188,000 Less current installments 5,350,000 4,478,000 Total $ 47,692,000 $ 45,710,000 (a) The Company is required to repay the outstanding principal under the revolving credit line on November 10, 2015. Interest accrues at the Company's option at either (i) the Base Rate plus a specified margin ranging between 75 and 150 basis points depending on the Company's consolidated total debt to consolidated EBITDA ratio or (ii) the Eurodollar Rate plus a specified margin ranging between 175 and 250 basis points depending on the Company's consolidated total debt to consolidated EBITDA ratio. When interest is incurred at the Base Rate, interest is payable monthly in arrears on the first day of each month. When interest is incurred at the Eurodollar Rate, interest is payable at the end of each interest period, which is defined as one, two, three or six months after the applicable advance is disbursed to the Company (except that with respect to six month interest periods, interest is payable at three month intervals).

(b) The Company is required to repay the $20 million five-year term loan in equal quarterly principal installments of $500,000 commencing on February 1, 2011 until November 10, 2015, the maturity date, when all remaining outstanding principal plus accrued interest thereon is due and payable in full. Interest accrues at a specified margin plus either: (i) the greatest of (a) the prime rate announced by Comerica Bank, (b) the federal funds effective rate as published by the Federal Reserve Bank of New York plus 1.0%, and (c) a daily adjusting LIBOR rate plus 1.0%; or (ii) a rate based on LIBOR. The Company refers to the rates described in clauses (i) and (ii) in the preceding sentence, respectively, as the "Base Rate" and as the "Eurodollar Rate." The specific per annum interest rate will be, at the Company's option, either the Base Rate plus a specified margin ranging between 100 and 175 basis points depending on the Company's consolidated total debt to consolidated EBITDA ratio or the Eurodollar Rate plus a specified margin ranging between 200 and 275 basis points depending on the Company's consolidated total debt to consolidated EBITDA ratio. When interest is based on the Base Rate, interest is payable monthly in arrears on the first day of each month. When interest is based on the Eurodollar Rate, interest is payable at the end of each interest period, which is defined as one, two, three or six months after the applicable loan is disbursed to the Company (except that with respect to six month interest periods, interest is payable at three month intervals). Excess cash flow payments as required under the credit agreement are applied to the term loan.

(c) With respect to any credit advance under this line that is used to finance eligible acquisitions, the Company is required to make quarterly principal payments commencing one year after the date such credit advance is made, until November 10, 2015, the maturity date, when all remaining outstanding principal plus accrued interest thereon is due and payable in full. No principal payments are due during the first year. The amount of such quarterly principal payments is 1.25% of the aggregate original principal amount of such credit advance during the second year, increasing to 2.50% during the third year and increasing to 3.75% during the fourth and fifth years.

Interest on the acquisition credit line accrues at the Company's option at either (i) the Base Rate plus a specified margin ranging between 100 and 175 basis points depending on the Company's consolidated total debt to consolidated EBITDA ratio or (ii) the Eurodollar Rate plus a specified margin ranging between 200 and 275 basis points depending on the Company's consolidated total debt to consolidated EBITDA ratio. When interest is based on the Base Rate, interest is payable monthly in arrears on the first day of each month following the disbursement of an advance. When interest is based on the Eurodollar Rate, interest is payable at the end of each interest period, which is defined as one, two, three or six months after the applicable advance is disbursed to us (except that with respect to six month interest periods, interest is payable at three month intervals). The outstanding balance from acquisitions at October 31, 2012 was $16,890,000.

20 -------------------------------------------------------------------------------- Table of Contents With respect to any credit advance under this line that is used to finance the purchase of eligible machinery and equipment, the Company is required to make quarterly principal payments in an amount equal to 5% of the aggregate original principal amount of such credit advance. Such principal payments are due quarterly after the date such credit advance is made, until November 10, 2015, the maturity date, when all remaining outstanding principal plus accrued interest thereon is due and payable in full. The outstanding balance from equipment credit advances at October 31, 2012 was $1,862,000.

(d) The outstanding principal and accrued and unpaid interest on the Mill Road subordinated note is due and payable on June 27, 2016. Cash based interest accrues at a rate of 10.0% per annum and is payable quarterly. Additional interest accrues at a rate of 5.0% per annum and is added automatically to the unpaid principal amount of the subordinated note on each date that cash interest is payable. The outstanding balance at October 31, 2012 was $6,826,000 calculated based on the fair value of the debt.

(e) The Company has an additional $5,230,000 at October 31, 2012 in equipment line balances which were used to finance various test equipment with terms of 60 months for each equipment schedule at interest rates ranging from 4.39% to 7.42%.

The Company's 50% owned subsidiary, NQA, Inc., has total borrowings of $935,000 at October 31, 2012, stemming from the acquisitions of Unitek Technical Services, Inc., TRA Certification, Inc. and International Management Systems, Inc. Advances under the business acquisitions line of credit bear interest, at the option of NQA, at a fluctuating rate equal to the lender's corporate base rate plus 0.5% or at a fixed rate based on the Federal Home Loan Bank Advance Rate plus 3.0%. Advances under the business acquisitions line of credit are due and payable, at the option of NQA, 3 or 5 years from the advance date and are subject to additional interest charges in the event of prepayment.

As of October 31, 2012 the Company was in compliance with all its bank covenants. Substantially all of the Company's assets are pledged as collateral to secure its outstanding long term debt.

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