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TMCNet:  ELECTRONIC SYSTEMS TECHNOLOGY INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

[November 19, 2012]

ELECTRONIC SYSTEMS TECHNOLOGY INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

(Edgar Glimpses Via Acquire Media NewsEdge) Management's discussion and analysis is intended to be read in conjunction with the company's unaudited financial statements and the integral notes thereto for the quarter ending September 30, 2012. The following statements may be forward looking in nature and actual results may differ materially.



A.

RESULTS OF OPERATIONS REVENUES: Total revenues from the sale of the Company's ESTeem wireless modem systems, accessories, and services increased to $551,205 for the third quarter of 2012 as compared to $487,161 in the third quarter of 2011. As of September 30, 2012, year to date sales increased to $1,460,944 as compared to $1,332,765 as of September 30, 2011. Management believes the increase in quarterly and year to date sales revenues is due to increased orders received for all domestic market segments including industrial automation. Management believes the continued fragile economic recovery in the United States has resulted in delayed or canceled funding of projects involving the Company's products, however Q3 results show a modest improvement of the macro economic conditions that impact the core business. Management believes the fragile economic situation in the United States will continue to make sales revenues difficult to predict and prone to potential fluctuation.

The Company's revenues have historically fluctuated from quarter to quarter due to timing factors such as customer order placement and product shipments to customers, as well as customer buying trends, and changes in the general economic environment. The procurement process regarding plant and project automation, or project development, which usually surrounds the decision to purchase ESTeem products, can be lengthy. This procurement process may involve bid activities unrelated to the ESTeem products, such as additional systems and subcontract work, as well as capital budget considerations on the part of the customer. Because of the complexity of this procurement process, forecasts in regard to the Company's revenues become difficult to predict.

A percentage breakdown of EST's Domestic and Export Sales, for the third quarter of 2012 and 2011 are as follows: For the third quarter of 2012 2011 Domestic Sales 77% 73% Export Sales 23% 27% OPERATING SEGMENTS Segment information is prepared on the same basis that the Company's Management reviews financial information for operational decision-making purposes. The Company's operating segment information is contained in "Financial Statements, Notes to Financial Statements, Note 6 - Segment Reporting".

Domestic Revenues During the quarter ended September 30, 2012, the Company's domestic operations represented 77% of the Company's total net revenues. Domestic operations sell ESTeem modem products, accessories and service primarily through domestic resellers, as well as directly to end users of the Company's products. Domestic sales revenues increased to $423,307 for the quarter ended September 30, 2012, compared to $357,895 for the quarter ended September 30, 2011.

Industrial Networking Solutions a domestic customer comprised more than 10% of the Company's sales revenues for the quarter ended September 30, 2012.

Domestic segment operating income was $73,744 for the quarter ended September 30, 2012 as compared with a segment operating loss of $11,619 for the same quarter of 2011, due to increased sales revenues and flat expenses for the segment during the third quarter of 2012.

9 --------------------------------------------------------------------------------For the nine-month period ended September 30, 2012, the Company's domestic operations represented 77% of the Company's total net revenues. Year to date domestic sales revenues increased to $1,122,889 as of September 30, 2012, compared to $843,719 for the same period of 2011. Management believes the increase in quarterly sales revenues is due to improved macro economic conditions for its domestic customer base Management believes the continued fragile economic recovery in the United States will continue to make sales revenues difficult to predict and prone to potential fluctuation.

The domestic segment recorded operating income of $65,403 for the nine month period ended September 30, 2012 as compared with a segment an operating loss of $141,875 for the same period of 2011. The increase in profitability is due to increased sales revenues and managed expenses for the segment during the first nine months of 2012.

Foreign Revenues The Company's foreign operating segment represented 23% of the Company's total sales for the quarter ended September 30, 2012. The foreign operating segment is based wholly in the United States and maintains no assets outside of the United States. The foreign operating segment sells ESTeem modem products, accessories and service primarily through foreign resellers, as well as directly to end use customers of the Company's products located outside the United States.

During the quarter ended September 30, 2012, the Company had $127,898 in foreign export sales, amounting to 23% of total sales of the Company for the quarter, compared with foreign export sales of $129,266 for the same quarter of 2011.

Management believes the slight decrease in foreign sales revenues is due to reduced demand for industrial automation projects using the Company's products in Latin America. Revenues from foreign countries consisted primarily of revenues from Peru, Croatia, Colombia and Mexico. Products purchased by foreign customers were used primarily in industrial automation applications. No one foreign customer accounted for 10% of the Company's sales revenues for the quarter ended September 30, 2012.

Operating income for the foreign segment increased to $51,481 for the quarter ended September 30, 2012 as compared with an operating income of $45,737 for the same period of 2011 due to managed expenses for flat sales revenues for the segment.

For the nine-month period ended September 30, 2012, the Company had $338,055 in foreign export sales, amounting to 23% of total net revenues of the Company for the period, compared with foreign export sales of $489,046 for the same period of 2011. We believe the year to date decrease in foreign sales revenues is due to decreased orders for industrial automation and communication backbone applications in the Peru, Colombia, Morocco, Mexico and Canada, caused by continued stagnant economic conditions. Management believes the majority of foreign export sales are the result of the Company's Latin American sales staff, EST foreign reseller activity, and the Company's internet website presence.

Year to date foreign segment operating income decreased to $97,335 for the period ended September 30, 2012 as compared with a segment operating income of $188,192 for the same period of 2011, due to decreased year to date sales revenues.

Unallocated Corporate Unallocated corporate expenses relate to functions, such as accounting, corporate management and administration that support but are not attributable to the Company's domestic or foreign operating segments, including salaries, wages and other expenses related to the performance of these support functions.

Unallocated corporate expenses increased during the quarter ended September 30, 2012 to $66,419 as compared with $64,999 for the same quarter of 2011, and represented expense to total sales revenue percentages of 12% and 13% for the third quarters of 2012 and 2011, respectively.

Year to date unallocated corporate expenses increased for the period ended September 30, 2012 to $220,147 as compared with $220,663 for the same period of 2011 and represented expense to total sales revenue percentages of 15% and 17% for the first nine months of 2012 and 2011, respectively.

10 -------------------------------------------------------------------------------- BACKLOG: The Company had minimal backlog as of September 30, 2012. Customers generally place orders on an "as needed basis". Shipment for most of the Company's products is generally made within 1 to 15 working days after receipt of customer orders, with the exception of ongoing, scheduled projects, and custom designed equipment.

COST OF SALES: Cost of sales percentages of gross sales for the third quarters of 2012 and 2011 were 42% and 48%, respectively. The cost of sales decrease for the third quarter of 2012 is the result the product mix for items sold during the quarter having a mor favorable profit margin.

OPERATING EXPENSES: Operating expenses for the third quarter of 2012 decreased $25,549 when compared with the third quarter of 2011. The following is a delineation of operating expenses: For the quarter ended: September 30, September 30, 2012 2011 Increase(Decrease) General and Administrative $ 66,419 $ 64,999 $ 1,420 Research and Development 55,210 70,600 (15,390) Marketing 110,049 123,946 (13,897) Customer Service 28,756 26,438 2,318 Total Operating Expenses $ 260,434 $ 285,983 $ (25,549) GENERAL AND ADMINISTRATIVE: During the third quarter of 2012 General and Administrative expenses increased $1,420 when compared with the third quarter of 2011 due to increased department wages.

RESEARCH AND DEVELOPMENT: During the third quarter of 2012, Research and Development expenses decreased $15,390 when compared with the third quarter of 2011. The decrease is due to decreased subcontracted engineering expertise and research and development related wages when compared with the same period of 2011.

MARKETING: Marketing expenses decreased $13,897, during the third quarter of 2012 when compared with the third quarter of 2011 due to decreased marketing related wages, trade show and travel expenses.

CUSTOMER SERVICE: Customer service expenses for the third quarter of 2012 increased $2,318, when compared with the third quarter of 2011 due to a increased amount of engineering and customer support services being billed directly to customers.

INTEREST AND INVESTMENT INCOME: The Company earned $1,830 in investment and interest income for the quarter ended September 30, 2012. Sources of this income were money market accounts and certificates of deposit.

11 --------------------------------------------------------------------------------NET INCOME (LOSS): The Company recorded net income of $36,715 for the third quarter of 2012, compared to a net loss of $20,081 for the third quarter of 2011. The increased in profitability is the result of increased sales revenues and decreased expenses during the third quarter of 2012 when compared with the third quarter of 2011. Year to date, the Company has a net loss of $41,800 for the nine months ended September 30, 2012, compared with a net loss of $125,646 for the same period of 2011. The increase in the Company's year to date profitability is the result of increased sales revenues and decreased expenses during the first nine months of 2012 when compared with the same period of 2011.

B. Financial Condition, Liquidity and Capital Resources The Corporation's current asset to current liabilities ratio at September 30, 2012 was 20.0:1 compared to 29.1:1 at December 31, 2011. At September 30, 2012, the Company had cash and cash equivalent holdings of $728,446 as compared to cash and cash equivalent holdings of $1,227,490 at December 31, 2011. The Company had certificates of deposit investments in the amount of $1,407,000 as of September 30, 2012 as compared to $1,033,000 as of December 31, 2011, due to timing differences in certificate of deposit maturities and cash requirements of the Company.

Accounts receivable, net increased to $160,840 as of September 30, 2012, from December 31, 2011 levels of $104,166, due to sales revenues and collections timing differences. Inventory increased to $521,528 at September 30, 2012, from December 31, 2011 levels of $471,314, due to increased product sales during the first nine months of 2012. The Company's fixed assets, net of depreciation, decreased to $45,836 as of September 30, 2012, from December 31, 2011 levels of $54,358 due capital expenditures of $2,879 for research related test equipment and by depreciation of $11,401. Prepaid expenses increased to $59,035 as of September 30, 2012 from December 31, 2011 amounts of $29,694 due to recent renewal of annual insurance policies, Netsuite network services, and prepaid tradeshow and travel expenses. For the quarter ending September 30, 2012 the Company paid deposits to vendors providing long lead time, off-shore inventory in the amount of $35,980, which is included in vendor deposits on the Company's balance sheets.

Since January 1, 2005, the Company has contracted with Netsuite Inc. to provide the Company's customer relationship management and accounting software and related network infrastructure services. The prepaid Netsuite Inc. services as of September 30, 2012 are reflected in "prepaid expenses" on the Company's balance sheet in the amount of $26,807.

As of September 30, 2012, the Company's trade accounts payable balance was $58,921 as compared with $16,104 at December 31, 2011, and reflects amounts owed for purchases of inventory items and contracted services. Accrued liabilities as of September 30, 2012 were $37,558, compared with $34,707 at December 31, 2011, and reflect items such as accrued vacation benefits, and quarterly payroll and excise tax liabilities. Federal income tax receivable as of September 30, 2012 decreased to $11,909 compared with federal income tax receivable of $47,663 at December 31, 2011 due to increased profitability during the first nine months of 2012.

It is Management's opinion the Company's cash, cash equivalent reserves, and working capital at September 30, 2012 are sufficient to satisfy requirements for operations, capital expenditures, and other expenditures as may arise in the short term.

FORWARD LOOKING STATEMENTS: The above discussion may contain forward looking statements that involve a number of risks and uncertainties. In addition to the factors discussed above, among other factors that could cause actual results to differ materially are the following: competitive factors such as rival wireless architectures and price pressures; availability of third party component products at reasonable prices; inventory risks due to shifts in market demand and/or price erosion of purchased components; change in product mix, and risk factors that are listed in the Company's reports and registration statements filed with the Securities and Exchange Commission.

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