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Management's Discussion of Results of Operations (Excerpts)

For purposes of readability, Zenith attempts to strip out all tables in excerpts from the Management Discussion. That information is contained elsewhere in our articles. The idea of this summary is simply to review how well we believe Management does its reporting. Also, this highlights what Management believes is important.

In our Decision Matrix at the end of each article, a company with 0 to 2 gets a "-1", and 3 to 5 gets a "+1."

On a scale of 0 to 5, 5 being best, Zenith rates this company's Management's Discussion as a 5.


We produce custom assemblies pursuant to 
long-term contracts and customer purchase orders. Backlog consists of aggregate 
values under such contracts and purchase orders, excluding the portion 
previously included in operating revenues on the basis of percentage of 
completion accounting, and including estimates of future contract price 
escalation. Substantially all of our backlog is subject to termination at will 
and rescheduling, without significant penalty. Funds are often appropriated for 
programs or contracts on a yearly or quarterly basis, even though the contract 
may call for performance that is expected to take a number of years. Therefore, 
our funded backlog does not include the full value of our contracts.

Approximately 80% of the total amount of our backlog at June 30, 2017 was 
attributable to government contracts.


Our unfunded backlog is primarily comprised of the long-term contracts for the 
G650, E-2D, F-16, T-38, F-35, HondaJet Light Business Jet, Bell AH-1Z, Cessna 
Citation X+, Sikorsky S-92 and Embraer Phenom 300. These long-term contracts 
are expected to have yearly orders, which will be funded in the future.



The low level of funded backlog on commercial programs is the result of 
customers placing funded orders based upon expected lead time. These programs 
are under long-term agreements with our customers, and as such, we are 
protected by termination liability provisions.



Critical Accounting Policies



Revenue Recognition



We recognize revenue from our contracts over the contractual period under the 
percentage-of-completion (“POC”) method of accounting. Under the POC method of 
accounting, sales and gross profit are recognized as work is performed based on 
the relationship between actual costs incurred and total estimated costs at the 
completion of the contract. Recognized revenues that will not be billed under 
the terms of the contract until a later date are recorded as an asset captioned 
“Costs and estimated earnings in excess of billings on uncompleted contracts.” 
Contracts where billings to date have exceeded recognized revenues are recorded 
as a liability captioned “Billings in excess of costs and estimated earnings on 
uncompleted contracts.” Changes to the original estimates may be required 
during the life of the contract. Estimates are reviewed monthly and the effect 
of any change in the estimated gross margin percentage for a contract is 
reflected in cost of sales in the period the change becomes known. The use of 
the POC method of accounting involves considerable use of estimates in 
determining revenues, costs and profits and in assigning the amounts to 
accounting periods. As a result, there can be a significant disparity between 
earnings (both for accounting and tax purposes) as reported and actual cash 
received by us during any reporting period. We continually evaluate all of the 
issues related to the assumptions, risks and uncertainties inherent with the 
application of the POC method of accounting; however, we cannot assure you that 
our estimates will be accurate. If our estimates are not accurate or a contract 
is terminated, we will be forced to adjust revenue in later periods. 
Furthermore, even if our estimates are accurate, we may have a shortfall in our 
cash flow and we may need to borrow money, or seek access to other forms of 
liquidity, to fund our work in process or to pay taxes until the reported 
earnings materialize as actual cash receipts.



When adjustments are required for the estimated total revenue on a contract, 
these changes are recognized with an inception-to-date effect in the current 
period. Also, when estimates of total costs to be incurred exceed estimates of 
total revenue to be earned, a provision for the entire loss on the contract is 
recorded in the period in which the loss is determined.



Results of Operations



Revenue



Revenue for the three months ended June 30, 2017 was $16,731,951 compared to 
$22,280,964 for the same period last year, a decrease of $5,549,013 or 24.9%. 
This decrease is predominantly the result of a normal cyclical decrease in 
revenue on the Company’s E-2D program.



Revenue for the six months ended June 30, 2017 was $36,764,652 compared to 
$34,950,997 for the same period last year, an increase of $1,813,655 or 5.2%.



During the three months ended March 31, 2016, the Company had information that 
the United States Air Force (“USAF”) was intending to increase the number of 
ship sets on order for the A-10. An increase in the number of ship sets on 
order would improve the Company’s estimated gross margin on the overall 
program.



In April 2016, the Company became aware that the USAF had reevaluated its 
position and, as such, had deferred any decision regarding increasing the 
orders on the A-10 program. These changes in position by the USAF were 
supported by communications from Boeing, the Company’s customer.



Based on the above facts, the Company believed that it was not probable that 
there would be any future orders on the A-10 beyond the 173 currently on order. 
As a result of the information that management became aware of in April 2016, 
for the quarter ended March 31, 2016, the Company estimated that the A-10 
program would run through the conclusion of its current purchase order with 
Boeing at ship set number 173. The change in estimate resulted in a reduction 
of revenue of approximately $8.9 million in the quarter ended March 31, 2016.



In addition to the change in estimate adjustment to revenue in the quarter 
ended March 31, 2016, which caused military revenue to be unusually low in that 
year, military revenue in 2017 increased by approximately $8.0 million.



Revenue from commercial subcontracts was $14,106,590 for the six months ended 
June 30, 2017 compared to $20,524,578 for the six months ended June 30, 2016, a 
decrease of $6,417,988 or 31.3%. The decrease in revenue is the result of an 
approximate $3.3 million decrease in revenue on our Embraer Phenom 300 program, 
as production rates have declined and a $1.8 million decrease in revenue on our 
G650 program.



Inflation historically has not had a material effect on our operations.



Cost of sales



Cost of sales for the three months ended June 30, 2017 and 2016 was $13,048,203 
and $17,246,963, respectively, a decrease of $4,198,760 or 24.3%, This decrease 
is the result of the comparable decline in revenue.



Cost of sales for the six months ended June 30, 2017 and 2016 was $28,543,390 
and $41,556,100, respectively, a decrease of $13,012,710 or 31.3%. The 
provision for contract losses, as well as lower rate production on our E-2D, 
Phenom 300 and Embraer programs, all described above have resulted in lower 
cost of sales.



Other contract costs (credit) for the six months ended June 30, 2017 was 
($734,997) compared to $3,004,444, a decrease of $3,739,441. Other contract 
costs (credit) for the three months ended June 30, 2017 was ($262,492) compared 
to ($1,526,323), an decrease of $1,263,831 or 82.8%. Other contract costs 
relate to expenses recognized for changes in estimates and expenses 
predominately associated with loss contracts. Other contract costs are 
comprised predominantly of charges related to the change in estimate on the 
A-10 program in 2016. In the six months ended June 30, 2017, other contract 
costs are a credit, as we have incurred actual expenses on our A-10 program 
that had been previously recognized as part of the change in estimate charge.



Procurement for the six months ended June 30, 2017 was $17,904,113 compared to 
$26,232,905, a decrease of $8,328,792 or 31.7%. Procurement for the three 
months ended June 30, 2017 was $8,064,051 compared to $12,930,373, a decrease 
of $4,866,322 or 37.6%. This decrease is a result of a $3.4 million decrease in 
procurement on our E-2D program, as we are shipping parts from stock and 
lowering inventory on this program, as well as an approximately $4.9 million 
decrease in procurement on the commercial programs described above.



Labor costs for the six months ended June 30, 2017 was $3,586,568 compared to 
$4,330,410, a decrease of $743,842 or 17.2%. The decrease is the result of 
approximately $224,000 decrease in the commercial programs described above, as 
well as $519,000 decrease in military programs. Labor costs for the three 
months ended June 30, 2017 was $1,712,025 compared to $2,035,949, a decrease of 
$323,924 or 15.9%.



Factory overhead for the six months ended June 30, 2017 was $7,787,706 compared 
to $7,988,341, a decrease of $200,635 or 2.5%. Factory overhead for the three 
months ended June 30, 2017 was $3,534,619 compared to $3,806,964, a decrease of 
$272,345 or 7.2%.



Gross Profit (Loss)



Gross profit (loss) for the six months ended June 30, 2017 was a profit of 
$8,221,262 compared to a loss of $6,605,103 for the six months ended June 30, 
2016, an increase of $14,826,365, predominately the result of the change in 
estimate on the A-10 program.



Gross profit for the three months ended June 30, 2017 was $3,683,748 compared 
to $5,034,001 for the three months ended June 30, 2016, a decrease of 
$1,350,253 predominately the result of lower volume, as described above.



Favorable/Unfavorable Adjustments to Gross Profit (Loss)



During the six months ended June 30, 2017 and 2016, circumstances required that 
we make changes in estimates to various contracts.


During the six months ended June 30, 2017, we had two contracts which had an 
approximately $659,000 and $436,000 of unfavorable adjustments caused by 
changing estimates on a long-term program, that we are working with the 
customer to agree to contract extensions and expect to have to decrease our 
selling price. Additionally, we had one contract that had a gap in production, 
as well as a smaller than expected order quantity. The gap in production and 
low quantity has resulted in an unfavorable adjustment of approximately 
$475,000. There were no other material changes favorable or unfavorable during 
the six months ended June 30, 2017.



During the six months ended June 30, 2016 we had one contract which had an 
approximately $270,000 unfavorable adjustment caused by excess labor and 
procurement costs due to difficulty in the manufacturing process. In addition, 
we had an approximate $159,000 unfavorable adjustment on one contract that was 
canceled by the government. Also, we had four contracts that each had between 
$139,000 and $188,000 (cumulatively $654,000) of unfavorable adjustments caused 
by excess labor costs incurred.



In addition to the above mentioned unfavorable adjustments, in 2016 we had the 
unfavorable adjustment of approximately, $12.2 million related to the A-10 
program described previously.



Selling, General and Administrative Expenses



Selling, general and administrative expenses for the three months ended June 
30, 2017 were $2,002,198 compared to $1,868,787 for the three months ended June 
30, 2016, an increase of $133,411, or 7.1%. This change was predominately the 
result of a decrease of approximately $86,000 in bank fees offset by an 
increase of $76,000 in marketing, an increase of $75,000 in accrued bonuses and 
an increase of $73,000 in salaries.



Selling, general and administrative expenses for the six months ended June 30, 
2017 were $4,166,076 compared to $4,589,170 for the six months ended June 30, 
2016, a decrease of $423,094 or 9.2%. This decrease was predominately the 
result of an approximately $395,000 decrease in loss on unrealized receivables, 
an approximately $300,000 decrease in professional fees because of the extended 
audit CPI had in 2016, offset by an increase in salaries of $173,000 and an 
increase in accrued bonuses of $150,000.



Income (Loss) Before Provision for (Benefit from) Income Taxes



Income before provision for income taxes for the three months ended June 30, 
2017 was $1,215,647 compared to $2,841,580 for the same period last year, a 
decrease of $1,625,933. Income before provision for income taxes for the six 
months ended June 30, 2017 was $3,198,948 compared to loss before benefit from 
income taxes of $11,793,640 for the same period last year, an increase of 
$14,992,588, predominately the result of the change in estimate on the A-10 
program.



Provision for (Benefit from) Income Taxes



Provision for income taxes was $450,000 and $1,184,000 for the three and six 
months ended June 30, 2017, compared to provision for income taxes of 
$1,051,000 for the three months ended June 30, 2016 and benefit from income 
taxes of $4,364,000 for the six months ended June 30, 2016. The effective tax 
rate at June 30, 2017 was 37%. The benefit from income taxes recognized in the 
six months ending March 31, 2016, resulted in the booking of a deferred tax 
asset. At December 31, 2016, the Company had net operating loss carryforwards 
of approximately $14.6 million which will expire in 2031. Our historical tax 
rates have been below the federal statutory rate because of the effect of 
permanent differences between book and tax deductions, predominately the R&D 
tax credit and the domestic production activity deduction.



Net Income (Loss)



Net income for the three months ended June 30, 2017 was $765,647 or $0.09 per 
basic share, compared to $1,790,580 or $0.21 per basic share, for the same 
period last year. Net income for the six months ended June 30, 2017 was 
$2,014,948 or $0.23 per basic share, compared to a loss of $7,429,640 or $0.86 
per basic share for the same period last year. Diluted income per share was 
$0.09 for the three months ended June 30, 2017 calculated utilizing 8,865,055 
weighted average shares outstanding. Diluted income per share for the six 
months ended June 30, 2017 was $0.23, calculated utilizing 8,840,309 average 
shares outstanding as adjusted for the dilutive effect of outstanding stock 
options and RSUs. Diluted income per share for the three months ended June 30, 
2016 was $0.21, calculated utilizing 8,637,393 average shares outstanding as 
adjusted for the dilutive effect of outstanding stock options and RSUs. Basic 
and diluted income per share for the six months ended June 30, 2016 were the 
same as effects of outstanding options would be anti-dilutive.



Liquidity and Capital Resources



General



At June 30, 2017, we had working capital of $73,799,885 compared to $70,595,485 
at December 31, 2016, an increase of $3,204,400 or 4.5%.



Cash Flow



A large portion of our cash flow is used to pay for materials and processing 
costs associated with contracts that are in process and which do not provide 
for progress payments. Costs for which we are not able to bill on a progress 
basis are components of “Costs and estimated earnings in excess of billings on 
uncompleted contracts” on our condensed balance sheets and represent the 
aggregate costs and related earnings for uncompleted contracts for which the 
customer has not yet been billed. These costs and earnings are recovered upon 
shipment of products and presentation of billings in accordance with contract 
terms.



Because the POC method of accounting requires us to use estimates in 
determining revenue, costs and profits and in assigning the amounts to 
accounting periods, there can be a significant disparity between earnings (both 
for accounting and tax purposes) as reported and actual cash that we receive 
during any reporting period. Accordingly, it is possible that we may have a 
shortfall in our cash flow and may need to borrow money, or to raise additional 
capital, until the reported earnings materialize into actual cash receipts.



At June 30, 2017, we had a cash balance of $1,115,297 compared to $1,039,586 at 
December 31, 2016.



Our costs and estimated earnings in excess of billings increased by $2,113,884 
million during the six months ended June 30, 2017.



Several of our programs require us to expend up-front costs that may have to be 
amortized over a portion of production units. In the case of significant 
program delays and/or program cancellations, we could be required to bear 
impairment charges which may be material, for costs that are not recoverable. 
Such charges and the loss of up-front costs could have a material impact on our 
liquidity.



We continue to work to obtain better payment terms with our customers, 
including accelerated progress payment arrangements, as well as exploring 
alternative funding sources.



We believe that our existing resources, together with the availability under 
our credit facility, will be sufficient to meet our current working capital 
needs for at least 12 months from the date of the filing of this Quarterly 
report on Form 10-Q.



Credit Facilities



Credit Agreement and Term Loan



On March 24, 2016, the Company entered into a Credit Agreement with Bank 
United, N.A. as the sole arranger, administrative agent and collateral agent 
and Citzens Bank, N.A. (the “BankUnited Facility”). The BankUnited Facility 
provides for a revolving credit loan commitment of $30 million (the “Revolving 
Loan”) and a $10 million term loan (“Term Loan”). The proceeds of the 
BankUnited Facility were used to pay off all amounts outstanding under the 
Santander Term Loan and the Revolving Facility. The Revolving Loan bears 
interest at a rate based upon a pricing grid, as defined in the agreement.



As of March 31, 2016, the Company was not in compliance with the net profit, 
Debt Service Coverage, and Leverage Coverage Ratio financial covenants 
contained in the BankUnited Facility, which non-compliance was waived (the 
“Wavier”) by the banks. On May 9, 2016 the Company entered into an amendment 
(the “Amendment”) to the BankUnited Facility which, among other things, 
provided for the Waiver. In addition, the Amendment changes the definition of 
EBITDA for the Leverage Coverage Ratio Covenant for the remainder of 2016 and 
changes the maximum leverage ratio from 3 to 1 to 3.5 to 1 for the quarters 
ending June 30, 2016 and September 30, 2016. Also, the Amendment increased the 
interest rate on the BankUnited Facility by 50 basis points and requires the 
repayment of a portion of the Term Loan if and to the extent that the Company 
receives any contract reimbursement payments from its current REA with Boeing 
on the A-10 program. The Company was in compliance with all of the financial 
covenants contained in the bank agreement as of June 30, 2017.



As of June 30, 2017, the Company had $24.2 million outstanding under the 
Revolving Loan bearing interest at 4.75%.



The BankUnited Revolving Facility is secured by all of our assets.



The Term Loan had an initial amount of $10 million, payable in monthly 
installments, as defined in the agreement, which matures on March 31, 2019. The 
maturities of the Term Loan are included in the maturities of long-term debt.



On March 9, 2012, the Company obtained a $4.5 million term loan from Santander 
to be amortized over five years (the “Santander Term Facility”). Santander Term 
Facility was used to purchase tooling and equipment for new programs.



Additionally, the Company and Santander Bank entered into a five-year interest 
rate swap agreement, in the notional amount of $4.5 million. Under the interest 
rate swap, the Company paid an amount to Santander Bank representing interest 
on the notional amount at a fixed rate of 4.11% and received an amount from 
Santander Bank representing interest on the notional amount of a rate equal to 
the one-month LIBOR plus 3%. The effect of this interest rate swap was the 
Company paying a fixed interest rate of 4.11% over the term of the Santander 
Term Facility.



The Santander interest swap agreement was terminated and the Santander Term 
Facility paid off on March 24, 2016 using the proceeds of the BankUnited 
Facility.



In May 2016, the Company entered into a new interest rate swap with the 
objective of reducing its exposure to cash flow volatility arising from 
interest rate fluctuations associated with certain debt. The notional amount, 
maturity date, and currency of this contract match those of the underlying 
debt. The Company has designated this interest rate swap contract as a cash 
flow hedge.