National Technical Systems (NTSC) 10-Q 2013 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, 2012

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________ to ________________

Commission file number 000-16438

NATIONAL TECHNICAL SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

California	95-4134955
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
24007 Ventura Boulevard, Suite 200 Calabasas, California	91302
(Address of principal executive offices)	(Zip Code)

(818) 591-0776

(Issuer’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨	Accelerated filer   ¨	Non-accelerated filer  ¨	Smaller reporting company  x
		(do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:

Class	Outstanding at September 6, 2012
Common Stock, no par value	11,452,287 shares

NATIONAL TECHNICAL SYSTEMS, INC.  AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JULY 31, 2012

TABLE OF CONTENTS

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS			ii
PART I—FINANCIAL INFORMATION			1
	Item 1.	FINANCIAL STATEMENTS	1
		Consolidated Balance Sheets as of July 31, 2012 (unaudited) and January 31, 2012
		Unaudited Consolidated Statements of Operations For the Three and Six Months Ended July 31, 2012 and 2011
		Unaudited Consolidated Statements of Comprehensive Income For the Three and Six Months Ended July 31, 2012 and 2011
		Unaudited Consolidated Statements of Cash Flows For the Six Months Ended July 31, 2012 and 2011
		Notes to Unaudited Consolidated Financial Statements
	Item 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	10
	Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	21
	Item 4.	CONTROLS AND PROCEDURES	21
PART II—OTHER INFORMATION			23
	Item 1.	LEGAL PROCEEDINGS	23
	Item 1A.	RISK FACTORS	23
	Item 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	23
	Item 3.	DEFAULTS UPON SENIOR SECURITIES	23
	Item 4.	MINE SAFETY DISCLOSURES	23
	Item 5.	OTHER INFORMATION	23
	Item 6.	EXHIBITS	23
SIGNATURES			24
EXHIBIT INDEX			25

-i-

EXPLANATORY NOTE

In this report, unless the context otherwise requires, the terms “NTS,” “Company,” “we,” “us,” and “our” refer to National Technical Systems, Inc., a California corporation, and our consolidated subsidiaries.

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

Certain statements in this report, including information incorporated by reference, are “forward-looking statements.” Forward-looking statements reflect current views about future events and financial performance based on certain assumptions. They include opinions, forecasts, intentions, plans, goals, projections, guidance, expectations, beliefs or other statements that are not statements of historical fact. Words such as “may,” “should,” “could,” “would,” “expects,” “plans,” “believes,” “anticipates,” “intends,” “estimates,” “approximates,” “predicts,” or “projects,” or the negative or other variation of such words, and similar expressions may identify a statement as a forward-looking statement. Any statements that refer to projections of our future financial performance, anticipated trends in our business, our goals, strategies, focus and plans, and other characterizations of future events or circumstances, including statements expressing general optimism about future operating results and the development of our business, are forward-looking statements. Forward-looking statements in this report may include statements about:

• anticipated results of operations including expected trends in our revenues, gross margins, operating expenses, adjusted EBITDA and net income;

• the future actions of our competitors, including pricing decisions and new service offerings;

• our ability to obtain future financing or capital when needed;

• anticipated economic trends in the industries that we serve;

• our ability to complete or achieve the anticipated benefits from acquisitions, business combinations, strategic partnerships, divestitures and other significant transactions.

The forward-looking statements in this report speak only as of the date of this report and caution should be taken not to place undue reliance on any such forward-looking statements. Forward-looking statements are subject to risks and uncertainties that may be outside of our control. When considering forward-looking statements, you should carefully review the risks, uncertainties and other cautionary statements in this report as they identify certain important factors that could cause actual results to differ materially from those expressed in or implied by the forward-looking statements. These factors include, among others, the risks described under Item 1A and elsewhere in this report and in our 2012 Annual Report on Form 10-K, as well as in other reports and documents we file with the SEC.

-ii-

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

	At			At
	July 31,			January 31,
	2012			2012
ASSETS	(unaudited)
CURRENT ASSETS:
Cash and cash equivalents	$	4,236,000		$	4,335,000
Investments		3,142,000			3,318,000
Accounts receivable, less allowance for doubtful accounts of $800,000 at July 31, 2012 and $671,000 at January 31, 2012		42,316,000			34,775,000
Income taxes receivable, net		398,000			2,691,000
Inventories, net		3,451,000			4,247,000
Deferred income taxes		4,069,000			3,900,000
Prepaid expenses		2,948,000			2,964,000
Total current assets		60,560,000			56,230,000
Property, plant and equipment, at cost		143,878,000			137,131,000
Less: accumulated depreciation		(82,913,000	)		(78,979,000	)
Net property, plant and equipment		60,965,000			58,152,000
Goodwill		21,799,000			19,444,000
Intangible assets, net		17,177,000			16,986,000
Other assets		1,743,000			1,891,000
TOTAL ASSETS	$	162,244,000		$	152,703,000
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable	$	6,675,000		$	10,708,000
Accrued expenses		10,801,000			8,129,000
Deferred income		2,662,000			2,017,000
Current installments of long-term debt		5,100,000			4,478,000
Total current liabilities		25,238,000			25,332,000
Long-term debt, excluding current installments		49,850,000			45,710,000
Deferred income taxes		15,465,000			13,490,000
Deferred compensation		1,733,000			1,672,000
Other long-term liabilites		1,850,000			1,800,000
Commitments and contingencies
SHAREHOLDERS' EQUITY:
Preferred stock, no par value, 2,000,000 shares authorized; none issued		-			-
Common stock, no par value. Authorized, 20,000,000 shares; issued and outstanding, 11,375,000 as of July 31, 2012 and 11,306,000 as of January 31, 2012		28,912,000			28,654,000
Retained earnings		37,408,000			34,852,000
Accumulated other comprehensive loss		(97,000	)		(188,000	)
Total shareholders' equity		66,223,000			63,318,000
Noncontrolling interests		1,885,000			1,381,000
Total equity		68,108,000			64,699,000
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	162,244,000		$	152,703,000

See accompanying notes.

1

NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Unaudited Consolidated Statements of Operations

	Three Months Ended						Six Months Ended
	July 31,						July 31,
	2012			2011			2012			2011
Net revenues	$	47,329,000		$	37,516,000		$	90,782,000		$	74,594,000
Cost of sales		34,519,000			28,448,000			66,651,000			56,265,000
Gross profit		12,810,000			9,068,000			24,131,000			18,329,000
Selling, general and administrative expense		8,667,000			7,065,000			17,079,000			14,854,000
Equity loss from non-consolidated subsidiary		123,000			24,000			136,000			3,000
Operating income		4,020,000			1,979,000			6,916,000			3,472,000
Other income (expense):
Interest expense, net		(922,000	)		(548,000	)		(1,799,000	)		(839,000	)
Other income (expense), net		65,000			(84,000	)		93,000			(26,000	)
Total other income (expense), net		(857,000	)		(632,000	)		(1,706,000	)		(865,000	)
Income before income taxes and noncontrolling interests		3,163,000			1,347,000			5,210,000			2,607,000
Income taxes		1,313,000			632,000			2,146,000			1,158,000
Net income from continuing operations		1,850,000			715,000			3,064,000			1,449,000
(Loss) income from discontinued operations, net of tax		(12,000	)		234,000			(4,000	)		225,000
Net income		1,838,000			949,000			3,060,000			1,674,000
Net income attributable to noncontrolling interests		(236,000	)		(213,000	)		(504,000	)		(378,000	)
Net income attributable to NTS	$	1,602,000		$	736,000		$	2,556,000		$	1,296,000
Net income from continuing operations attributable to NTS	$	1,614,000		$	502,000		$	2,560,000		$	1,071,000
Net loss from discontinued operations attributable to NTS	$	(12,000	)	$	234,000		$	(4,000	)	$	225,000
Basic earnings attributable to NTS per common share:
Net income from continuing operations	$	0.14		$	0.05		$	0.23		$	0.10
Net income from discontinued operations		-			0.02			-			0.02
Net income attributable to NTS	$	0.14		$	0.07		$	0.23		$	0.12
Diluted earnings attributable to NTS per common share:
Net income from continuing operations	$	0.14		$	0.05		$	0.22		$	0.10
Net income from discontinued operations		-			0.02			-			0.02
Net income attributable to NTS	$	0.13		$	0.07		$	0.22		$	0.12
Weighted average common shares outstanding		11,340,000			10,616,000			11,330,000			10,429,000
Dilutive effect of stock options, nonvested shares and warrants		552,000			395,000			531,000			404,000
Weighted average common shares outstanding, assuming dilution		11,892,000			11,011,000			11,861,000			10,833,000

See accompanying notes.

2

NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Unaudited Consolidated Statements of Comprehensive Income

	Three Months Ended						Six Months Ended
	July 31,						July 31,
Net income	$	1,838,000		$	949,000		$	3,060,000		$	1,674,000
Other comprehensive (loss) income, net of tax:
Foreign currency translation adjustment		(30,000	)		(28,000	)		91,000			2,000
Comprehensive income	$	1,808,000		$	921,000		$	3,151,000		$	1,676,000
Comprehensive income attributable to non-controlling interest		(236,000	)		(213,000	)		(504,000	)		(378,000	)
Comprehensive income attributable to NTS	$	1,572,000		$	708,000		$	2,647,000		$	1,298,000

See accompanying notes.

3

NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Unaudited Consolidated Statements of Cash Flows

for the Six Months Ended July 31, 2012 and 2011

	2012			2011
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	3,060,000		$	1,674,000
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,943,000			4,041,000
Amortization of debt issuance cost and debt discount		344,000			40,000
Allowance for doubtful accounts		129,000			62,000
Gain on investments		(37,000	)		(42,000	)
Deferred income taxes		128,000			135,000
Share based compensation		572,000			348,000
Changes in operating assets and liabilities (net of acquisitions):
Accounts receivable		(6,879,000	)		(987,000	)
Inventories		796,000			144,000
Prepaid expenses		(182,000	)		(687,000	)
Other assets		190,000			38,000
Income taxes receivable, net		2,293,000			(307,000	)
Accounts payable		(4,190,000	)		(1,359,000	)
Accrued expenses		(268,000	)		(1,018,000	)
Deferred income		645,000			1,165,000
Deferred compensation		61,000			166,000
Net cash provided by operating activities		1,605,000			3,413,000
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(3,609,000	)		(2,390,000	)
Investment in life insurance		(1,000	)		-
Cash surrender of insurance policy		476,000			-
Acquisition of businesses, net of cash aquired		(3,116,000	)		(9,833,000	)
Investment in retirement funds		(281,000	)		(344,000	)
Net cash used in investing activities		(6,531,000	)		(12,567,000	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from current and long-term debt		10,579,000			4,655,000
Repayments of current and long-term debt		(5,963,000	)		(8,226,000	)
Proceeds from Mill Road financing, net		-			12,637,000
Proceeds from stock options exercised		65,000			90,000
Tax benefit from restricted stock issuance and stock options exercised		55,000			82,000
Net cash provided by financing activities		4,736,000			9,238,000
Effect of exchange rate changes on cash		91,000			2,000
Net (decrease) increase in cash and cash equivalents		(99,000	)		86,000
Beginning cash and cash equivalents balance		4,335,000	(c)		8,924,000	(a)
ENDING CASH AND CASH EQUIVALENTS BALANCE	$	4,236,000	(d)	$	9,010,000	(b)

(a) Cash and cash equivalents at January 31, 2011 includes cash from discontinued operations of $376,000.

(b) Cash and cash equivalents at July 31, 2011 includes cash from discontinued operations of $223,000.

(c) Cash and cash equivalents at January 31, 2012 includes cash from discontinued operations of $15,000.

(d) Cash and cash equivalents at July 31, 2012 includes cash from discontinued operations of $5,000.

See accompanying notes.

4

NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to the Unaudited Consolidated Financial Statements

1. Basis of Presentation

The consolidated financial statements include the accounts of National Technical Systems, Inc. (“NTS” or the “Company”) and its majority-owned or otherwise controlled subsidiaries. All significant intercompany accounts and transactions have been eliminated. Investments in entities in which the Company can exercise significant influence, but does not own a majority equity interest or otherwise control, are accounted for using the equity method and are included as investments in equity interests on the consolidated balance sheets.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission for Form 10-Q. Accordingly, certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. Certain prior period amounts have been reclassified to conform to the current period presentation.

The statements presented as of July 31, 2012 and for the three and six months ended July 31, 2012 and 2011 are unaudited. In the opinion of management, these financial statements reflect all normal recurring and other adjustments necessary for a fair presentation, and to make the financial statements not misleading. These financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended January 31, 2012.

Operating results for interim periods are not necessarily indicative of operating results for an entire fiscal year or any other future periods.

2.  Income Taxes

Income taxes for the interim periods are computed using the effective tax rates estimated to be applicable for the full fiscal year, as adjusted for any discrete taxable events that occur during the period.

The Company files income tax returns in the United States (“U.S.”) on a federal basis and in many U.S. state and foreign jurisdictions. Certain tax years remain open to examination by the major taxing jurisdictions to which the Company is subject. The Company does not anticipate that its total unrecognized tax benefits or obligations will significantly change due to the settlement of examinations or the expiration of statutes of limitation during the next twelve months.

3.  Comprehensive Income

In June 2011, the Financial Accounting Standards Board (“FASB”) amended its guidance on the presentation of comprehensive income. Under the amended guidance, an entity has the option to present comprehensive income in either one continuous statement or two consecutive financial statements. A single statement must present the components of net income and total net income, the components of other comprehensive income and total other comprehensive income, and a total for comprehensive income. In a two-statement approach, an entity must present the components of net income and total net income in the first statement. That statement must be immediately followed by a financial statement that presents the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The option under the prior guidance that permitted the presentation of components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. The amendment became effective for the Company on February 1, 2012. This guidance did not have an impact on the Company’s consolidated financial position, results of operations or cash flows as it is disclosure-only in nature.

4.  Inventories

Inventories consist of accumulated costs applicable to uncompleted contracts and are stated at actual cost which is not in excess of estimated net realizable value.

5

5. Noncontrolling Interests

Noncontrolling interest in the Company’s NQA, Inc. subsidiary is a result of 50% of the stock of NQA, Inc. owned by Ascertiva Group Limited formerly NICEIC Group Limited. Profits and losses are allocated 50.1% to NTS, and 49.9% to Ascertiva Group Limited.  The balance in noncontrolling interests as of January 31, 2012 was $1,381,000.  Net income attributable to noncontrolling interests for the six months ended July 31, 2012 was $504,000, resulting in a noncontrolling interest balance of $1,885,000 as of July 31, 2012.

6.  Earnings Per Share

Basic earnings per share have been computed using the weighted average number of shares of common stock outstanding during the year. Basic earnings per share exclude any dilutive effects of options, warrants, non-vested restricted shares and convertible securities.

7.  Intangible Assets

The following table summarizes the Company’s intangible assets as at July 31, 2012 and January 31, 2012:

	July 31, 2012							January 31, 2012
	Gross				Net		Estimated	Gross				Net		Estimated
	Carrying		Accum.		Carrying		Useful	Carrying		Accum.		Carrying		Useful
	Amount		Amort.		Amount		Life	Amount		Amort.		Amount		Life
Intangible assets subject to amortization:
Covenants not to compete	$	990,000	$	675,000	$	315,000	3-5 years	$	790,000	$	615,000	$	175,000	3 years
Customer relationships		20,547,000		4,645,000		15,902,000	3-15 years		19,547,000		3,757,000		15,790,000	3-15 years
Accreditations and certifications		20,000		18,000		2,000	5 years		20,000		17,000		3,000	5 years
Trademarks and tradenames		258,000		70,000		188,000	3-10 years		258,000		50,000		208,000	3-10 years
GSA Schedule		800,000		130,000		670,000	10 years		800,000		90,000		710,000	10 years
Total	$	22,615,000	$	5,538,000	$	17,077,000		$	21,415,000	$	4,529,000	$	16,886,000
Intangible assets not subject to amortization:
Goodwill					$	21,799,000						$	19,444,000
Trademarks and tradenames						100,000							100,000
Total					$	21,899,000						$	19,544,000

8.  Accrued Expenses

A summary of accrued expenses at July 31, 2012 and January 31, 2012:

	July 31, 2012		January 31, 2012
Compensation and employee benefits	$	6,031,000	$	5,608,000
Garwood note payable		1,175,000		-
LTI holdback		900,000		-
Other		2,695,000		2,521,000
Total accrued expenses	$	10,801,000	$	8,129,000

9.  Equity

Equity Incentive Plans

The Company has two employee incentive stock option plans: the “2002 stock option plan” and the “2006 equity incentive plan.” The 2006 equity incentive plan replaced the 2002 stock option plan, which was terminated and no further options will be granted under the 2002 stock option plan.

6

A summary of our stock option activity under the 2002 stock option plan and 2006 equity incentive plan as of July 31, 2012 is as follows:

	Shares			Weighted Avg. Exercise Price		Weighted Avg. Remaining Contract Life in years		Aggregate Intrinsic Value
Outstanding at January 31, 2012		484,050		$	4.39		2.18	$	438,000
Granted		-			-
Exercised		(23,000	)		1.95
Canceled, forfeited or expired		(2,500	)		2.19
Outstanding at July 31, 2012		458,550		$	4.52		1.78	$	1,068,000
Exercisable at July 31, 2012		458,550		$	4.52		1.78	$	1,068,000

There was no compensation expense related to stock options for the six months ended July 31, 2012 and 2011. As of July 31, 2012, there was no unamortized stock-based compensation expense related to unvested stock options, as all outstanding options are fully vested.

The Company has issued restricted shares under the 2006 equity incentive plan.  As of July 31, 2012, 76,000 non-vested restricted shares were outstanding at a weighted average grant date value of $5.28. The outstanding restricted shares vest at 25% per year commencing with the first anniversary of the grant date. Compensation expense, representing the fair market value of the shares at the date of grant, net of assumptions regarding estimated future forfeitures, is charged to earnings over the vesting period.  Compensation expense included in general and administrative expenses in the Company’s consolidated statement of operations, relating to these grants was $138,000 for the six months ended July 31, 2012.  As of July 31, 2012, there was $359,000 of unamortized stock-based compensation cost related to these non-vested shares which is expected to be recognized over a remaining period of 38 months.

Shareholders Rights Plan

On September 21, 2010 our Board of Directors adopted a shareholders rights plan.  Pursuant to the Shareholders Rights Agreement entered into in order to effect the rights plan, the Board of Directors declared a dividend distribution of one right for each outstanding share of common stock on the record date of October 1, 2010.  The rights also attach to subsequently issued shares of common stock. Each right, when it became exercisable, entitled the registered holder to purchase from the Company one one-hundredth (1/100th) of a share of the Company's Series A Junior Participating Preferred Stock, no par value ("Preferred Stock"), at a per-share exercise price of $30.00 in cash, subject to adjustment.

10.  Fair Value Measurement

The accounting standard for fair value establishes a framework for measuring fair value and requires disclosures about fair value measurements by establishing a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

Basis of Fair Value Measurement at Reporting Date Using

Level 1 Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the asset or the liability; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3 Unobservable inputs reflecting the Company’s own assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.

7

The following table summarizes the input levels that were used to determine the fair value of the Company’s investment securities, contingent consideration obligations and embedded derivative at July 31, 2012:

	Total			(Level 1)		(Level 2)		(Level 3)
SERP investment in mutual funds	$	3,142,000		$	3,142,000	$	-	$	-
Liability on earn-out for MSI acquisition		(100,000	)		-		-		(100,000	)
Liability on earn-out for Ingenium acquisition		(400,000	)		-		-		(400,000	)
Liability on earn-out for LTI acquisition		(500,000	)		-		-		(500,000	)
Liability on earn-out for Garwood acquisition		(200,000	)		-		-		(200,000	)
Embedded derivative in Mill Road debt		(61,000	)		-		-		(61,000	)

The following inputs were used to determine the fair value of the Company’s investment securities and contingent consideration obligation at January 31, 2012:

	Total			(Level 1)		(Level 2)		(Level 3)
SERP investment in mutual funds	$	3,318,000		$	3,318,000	$	-	$	-
Liability on earn-out for MSI acquisition		(100,000	)		-		-		(100,000	)
Liability on earn-out for Ingenium acquisition		(400,000	)		-		-		(400,000	)
Liability on earn-out for LTI acquisition		(500,000	)		-		-		(500,000	)
Embedded derivative in Mill Road debt		(61,000	)		-		-		(61,000	)

The fair value of the contingent earn-out consideration related to the MSI, Ingenium, LTI and Garwood acquisitions was estimated by applying the income approach.  That measure is based on significant inputs not observable in the market, which are considered to be Level 3 inputs.  Key assumptions in establishing the fair value of these liabilities include the discount rate and probability adjusted future revenues.

11. Acquisition of Garwood Laboratories

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 and is included in accrued expenses in the accompanying balance sheet. 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 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 July 31, 2012. A working capital adjustment receivable has been recorded at a preliminary amount of $198,000.

The intangible assets acquired consist of customer relations of $1,000,000 which will be amortized over 10 years and a covenant not to compete of $200,000 which will be amortized over the 5-year life of the agreement. The valuation techniques that were used by the Company to determine the fair value of the assets acquired and liabilities assumed are a combination of the market approach, the income approach and the cost approach and therefore the fair value is based on level 3 inputs. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value based on current market expectations about those future amounts, including present value techniques, option-pricing models and the excess earnings method. The cost approach is based on the amount that would be required to replace the service capacity of an asset (replacement cost). The Company used significant assumptions in the valuation techniques used including the discount rate and forecasted profitability.

8

The acquisition-related costs for the six months ended July 31, 2012 were $73,000 and were recorded to selling, general and administrative expense. As planned at the time of the acquisition, the Company also expects to incur a cost of approximately $300,000 to move equipment to other labs and such amount has been recorded as goodwill. Amortization of the goodwill and other intangibles on this transaction is not tax deductible. The Company’s consolidated statements of operations include Garwood’s results of operations for the period from April 17, 2012, the acquisition date, to July 31, 2012.

The fair values of the acquired assets have not been finalized pending further information that may impact the valuation of certain assets or liabilities. The Company has preliminarily estimated fair value at the date of acquisition of the acquired tangible and intangible assets and liabilities of Garwood as follows:

	Preliminary Estimated Purchase Price and Purchase Accounting			Subsequent Change in Valuation Estimates			Revised Purchase Price and Purchase Accounting
	April 30, 2012						July 31, 2012
Cash paid	$	3,165,000		$	-		$	3,165,000
Note payable		1,175,000			-			1,175,000
Purchase price held back		750,000			-			750,000
Working capital adjustment receivable		(198,000	)		-			(198,000	)
Estimated fair value of earn-out		200,000			-			200,000
Aggregate purchase price	$	5,092,000		$	-		$	5,092,000
Cash		49,000			-			49,000
Account Receivable, net		593,000			-			593,000
Property, plant and equipment		3,138,000			-			3,138,000
Other assets		23,000			-			23,000
Intangible assets (a)		1,300,000			(100,000	)		1,200,000
Accounts payable		(157,000	)		-			(157,000	)
Accrued expenses		(131,000	)		-			(131,000	)
Relocation expense (b)		-			(300,000	)		(300,000	)
Deferred taxes		(1,678,000	)		-			(1,678,000	)
Estimated fair value of assets and liabilities acquired		3,137,000			(400,000	)		2,737,000
Goodwill	$	1,955,000		$	400,000		$	2,355,000

(a) Change due to final valuation of customer relations intangible.

(b) Estimated relocation expense for excess assets. The Company is in the process of closing the Pico Rivera facility, and is redistributing excess assets to be utilized at other NTS facilities.

12. Subsequent Events

On August 24, 2012 the Company entered into an amendment to the Shareholder Rights Agreement dated as of September 21, 2010, between National Technical Systems, Inc., and Computershare Trust Company, N.A., as Rights Agent. The Amendment accelerates the final expiration date of the rights issued to the close of business on August 24, 2012. As a result of the Amendment, the Rights are no longer outstanding and are not exercisable.

Subsequent events have been evaluated up to and including the date these financial statements were issued.

9

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 six-month periods ended July 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 and general aviation sectors. 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

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. As the wireless telecom industry continues to see significant growth, 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

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

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 new 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 six months ended July 31, 2012, were $90,782,000, an increase of $16,188,000 or 21.7% over the same period last year.  Despite continuing weakness in western economies, the majority of this increase came from organic growth particularly in the aerospace and energy markets.  The increased revenues combined with prudent cost controls resulted in net income for the period of $3,060,000.

During the fiscal quarter ended July 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, 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 July 31, 2012 the ERP system had been implemented at 25 facilities.  The remaining two facilities are 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 July 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 July 31, 2012.

13

Unaudited Results of Operations for the Six Months Ended July 31, 2012

Revenues

REVENUES
Six months ended July 31,	2012		2011		Diff		% Change
(Dollars in thousands)
Total revenues	$	90,782	$	74,594	$	16,188		21.7	%

For the six months ended July 31, 2012, consolidated revenues increased by $16,188,000 or 21.7% when compared to the same period in the prior year.  Organic revenues (revenues from businesses owned throughout both reporting periods) increased by $10,035,000 or 13.5% which was primarily related to an increase in the aerospace and energy markets. Revenues from acquisitions were $6,154,000 or 8.2% 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

GROSS PROFIT
Six months ended July 31,	2012			2011			Diff		% Change
(Dollars in thousands)
Total	$	24,131		$	18,329		$	5,802		31.7	%
% to total revenues		26.6	%		24.6	%

Gross profit for the six months ended July 31, 2012 increased by $5,802,000 or 31.7% when compared to the same period in the prior year. Gross profit as a percentage of revenue, or gross margin, increased to 26.6% from 24.6% 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

SELLING, GENERAL & ADMINISTRATIVE
Six months ended July 31,	2012			2011			Diff		% Change
(Dollars in thousands)
Total	$	17,079		$	14,854		$	2,225		15.0	%
% to total revenues		18.8	%		19.9	%

Total selling, general and administrative expenses increased by $2,225,000 or 15.0% for the six months ended July 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 expenses.

Operating Income

OPERATING INCOME
Six months ended July 31,	2012			2011			Diff		% Change
(Dollars in thousands)
Total	$	6,916		$	3,472		$	3,444		99.2	%
% to total revenues		7.6	%		4.7	%

Operating income for the six months ended July 31, 2012 increased by $3,444,000 or 99.2% 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

Interest Expense

Net interest expense was $1,799,000 in the six months ended July 31, 2012, an increase of $960,000 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 $344,000 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 $93,000 for the six months ended July 31, 2012, consisting of various minor transactions.

Income Taxes

The income tax provision rate for the six months ended July 31, 2012 was 41.2% compared to 44.4% for the same period in the prior 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 six months ended July 31, 2012 was $3,064,000 compared to $1,449,000 for the same period in the prior year. This increase was primarily due to higher operating 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 six months ended July 31, 2012 was $4,000 compared to a net gain of $225,000 in the same period in the prior year.

Net income for the six months ended July 31, 2012 was $3,060,000 compared to $1,674,000 for the same period in the prior year.

For the six months ended July 31, 2012, net income attributable to noncontrolling interests was $504,000 compared to $378,000 for the same period in the prior year, an increase of $126,000 or 33.3%.  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 six months ended July 31, 2012 was $2,556,000 compared to $1,296,000 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 $12,520,000 for the first six months of fiscal 2013 compared to $8,060,000 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.  Our 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 six months ended July 31, 2012 and 2011 is included in the table below.

15

	Six months ended
	July 31,
	2012		2011
Net Income	$	3,060,000	$	1,674,000
Add
Interest		1,799,000		839,000
Taxes		2,146,000		1,158,000
Depreciation		3,934,000		3,403,000
Amortization		1,009,000		638,000
EBITDA		11,948,000		7,712,000
Add
Share based compensation		572,000		348,000
Adjusted EBITDA	$	12,520,000	$	8,060,000

Unaudited Results of Operations for the Three Months Ended July 31, 2012

Revenues

REVENUES
Three months ended July 31,	2012		2011		Diff		% Change
(Dollars in thousands)
Total revenues	$	47,329	$	37,516	$	9,813		26.2	%

For the three months ended July 31, 2012, consolidated revenues increased by $9,813,000 or 26.2% when compared to the same period in the prior year.  Organic revenues (revenues from businesses owned throughout both reporting periods) increased by $6,192,000 or 16.5% which was primarily related to an increase in the aerospace and energy markets. Revenues from acquisitions were $3,621,000 or 9.7%  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

GROSS PROFIT
Three months ended July 31,	2012			2011			Diff		% Change
(Dollars in thousands)
Total	$	12,810		$	9,068		$	3,742		41.3	%
% to total revenues		27.1	%		24.2	%

Gross profit for the three months ended July 31, 2012 increased by $3,742,000 or 41.3% 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.

16

Selling, General & Administrative

SELLING, GENERAL & ADMINISTRATIVE
Three months ended July 31,	2012			2011			Diff		% Change
(Dollars in thousands)
Total	$	8,667		$	7,065		$	1,602		22.7	%
% to total revenues		18.3	%		18.8	%

Total selling, general and administrative expenses increased by $1,602,000 or 22.7% for the three months ended July 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 expenses.

Operating Income

OPERATING INCOME
Three months ended July 31,	2012			2011			Diff		% Change
(Dollars in thousands)
Total	$	4,020		$	1,979		$	2,041		103.1	%
% to total revenues		8.5	%		5.3	%

Operating income for the three months ended July 31, 2012 increased by $2,041,000 or 103.1% 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 $922,000 in the three months ended July 31, 2012, an increase of $374,000 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 $171,000 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 $65,000 for the three months ended July 31, 2012, consisting of various minor transactions.

Income Taxes

The income tax provision rate for the three months ended July 31, 2012 was 41.5% compared to 46.9% for the same period in the prior 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 three months ended July 31, 2012 was $1,850,000 compared to $715,000 for the same period in the prior year. This increase was primarily due to higher operating 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 three months ended July 31, 2012 was $12,000 compared to a net gain of $234,000 in the same period in the prior year.

Net income for the three months ended July 31, 2012 was $1,838,000 compared to $949,000 for the same period in the prior year.

17

For the three months ended July 31, 2012, net income attributable to noncontrolling interests was $236,000 compared to $213,000 for the same period in the prior year, an increase of $23,000 or 10.8%.  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 July 31, 2012 was $1,602,000 compared to $736,000 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 $7,002,000 for the three months ended July 31, 2012 compared to $4,417,000 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.  Our 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 July 31, 2012 and 2011 is included in the table below.

	Three months ended
	July 31,
	2012		2011
Net Income	$	1,838,000	$	949,000
Add
Interest		922,000		548,000
Taxes		1,313,000		632,000
Depreciation		2,003,000		1,696,000
Amortization		506,000		317,000
EBITDA		6,582,000		4,142,000
Add
Share based compensation		420,000		275,000
Adjusted EBITDA	$	7,002,000	$	4,417,000

Outlook

For fiscal 2013, the Company provided annual guidance that it expected to generate (i) revenues of between $164 million and $169 million, (ii) gross margins between 26.5 percent and 27.5 percent of revenues, and (iii) Adjusted EBITDA between $20 million and $22 million.  Based on its results of operations through the second quarter, management continues to believe that the Company’s performance will meet the annual guidance and may exceed the targeted range in revenues and Adjusted EBITDA.

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.

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Off Balance Sheet Arrangements

None.

Liquidity and Capital Resources

Liquidity

At July 31, 2012 cash and cash equivalents were $4,236,000 compared to $4,335,000 at January 31, 2012. In addition, at July 31, 2012, investments and accounts receivable were $3,142,000 and $42,316,000, respectively, compared to $3,318,000 and $34,775,000 at January 31, 2012.  At July 31, 2012 the Company had working capital of $35,322,000, compared to working capital of $30,898,000 at January 31, 2012.

Net cash provided by operating activities was $1,605,000 in the six months ended July 31, 2012 and consisted of net income of $3,060,000 adjusted for depreciation and amortization of $4,943,000, share-based compensation of $572,000, amortization of debt issuance cost and debt discount of $344,000, allowance for doubtful accounts of $129,000 and deferred income taxes of $128,000, partially offset by changes in working capital, net of acquired assets and liabilities of $7,534,000 and gain on investments of $37,000.

Net cash used in investing activities in the six months ended July 31, 2012 was $6,531,000 and was primarily attributable to capital spending of $3,609,000, net cash used of $3,116,000  for the acquisition of Garwood, investment in retirement funds of $281,000 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 six months ended July 31, 2012 was $4,736,000 and consisted of proceeds from borrowing of $10,579,000, proceeds from stock options exercised of $65,000 and tax benefit from restricted stock issuance and stock options exercised of $55,000, partially offset by repayment of debt of $5,963,000.

Capital Resources

At July 31, 2012, the Company had cash and cash equivalents of $4,236,000 and working capital of $35,322,000.  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 July 31, 2012, 85% of eligible accounts receivable was $20,209,000 and the amount of available credit under the revolving credit line on that date was $12,709,000.

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.  At July 31, 2012, the Company had borrowed $19,759,000 under the acquisition line.

Long-term Debt

On November 10, 2010, the Company obtained a senior credit facility of up to $65 million from a banking group led by Comerica Bank that includes Bank of the West and U.S. Bank. The credit facility includes 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. The fair value of the $7 million in debt was estimated to be $5,960,000 as of June 27, 2011.

Debt as of July 31, 2012 and January 31, 2012 consisted of the following:

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	July 31, 2012		January 31, 2012
Revolving credit line (a)	$	7,500,000	$	5,000,000
Term loan (b)		15,300,000		17,150,000
Acquisition and equipment credit line:(c)
Acquistition		17,002,000		14,000,000
Machinery and equipment		1,992,000		2,251,000
Mill Road debt (d)		6,668,000		6,337,000
Secured and other notes payable (e)		6,488,000		5,450,000
Subtotal		54,950,000		50,188,000
Less current installments		5,100,000		4,478,000
Total	$	49,850,000	$	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 July 31, 2012 was $17,002,000.

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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 July 31, 2012 was $1,992,000.

(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 July 31, 2012 was $6,668,000 calculated based on the fair value of the debt.

(e) The Company has an additional $5,455,000 at July 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 $1,033,000 at July 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.

Substantially all of the Company’s assets are pledged as collateral to secure its outstanding long term debt.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in the Company’s quantitative and qualitative market risk since the disclosure in the Company’s Annual Report on Form 10-K for the year ended January 31, 2012, filed with the Securities and Exchange Commission on May 1, 2012.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

           We maintain disclosure controls and procedures that are designed to provide reasonable assurance that material information is: (1) gathered and communicated to our management, including our principal executive and principal financial officer, on a timely basis; and (2) recorded, processed, summarized, reported and filed with the SEC as required under the Securities Exchange Act of 1934, as amended.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of July 31, 2012. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective for their intended purpose described above.

Changes in Internal Controls Over Financial Reporting

During the six months ended July 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 is intended to provide a unified platform for financial and accounting information, 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 July 31, 2012 the ERP system had been implemented at 25 facilities.  The remaining two facilities are expected to be integrated during fiscal 2013.

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On July 25, 2012, we appointed Mr. Michael El-Hillow as our Chief Financial Officer.  Mr. El-Hillow, 60, is a certified public accountant, with nearly two decades of experience as a Chief Financial Officer of public companies including in high technology and engineering environments. He also has 16 years' experience working for Ernst & Young, LLP a global leader in assurance, tax, transaction and advisory services.  Mr. El-Hillow succeeded Raffy Lorentzian who entered into a separation agreement with the company on April 5, 2012. Mr. Lorentzian no longer serves as our Chief Financial Officer following Mr. El-Hillow’s appointment. This change in personnel resulted in no changes in the design or operation of internal control over financial reporting during the quarter ended July 31, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Limitations of the Effectiveness

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the internal control system are met.  Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations of any internal control system, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected.

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PART II.  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. As of the date of this report, we are not a party to any litigation which we believe would have a material adverse effect on our business operations or financial condition.

ITEM 1A. RISK FACTORS

Please see the risk factors set for in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended January 31, 2012 filed with the SEC on May 1, 2012 for a discussion of factors which could materially affect our business, financial position and results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

See the Exhibit Index immediately following the signature page of this report.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	National Technical Systems, Inc.
Date: September 14, 2012	/s/ Michael El-Hillow
	Michael El-Hillow, Chief Financial Officer
	(Principal Accounting Officer)

EXHIBIT INDEX
Exhibit Number	Description of Exhibit
4.1	Shareholder Rights Agreement dated September 21, 2010 between National Technical Systems, Inc. and Computershare Trust Company, N.A. as Rights Agent (incorporated by reference to Exhibit 4.1 of the registrant’s current report on Form 8-K filed on September 22, 2010).
4.2	Amendment No. 3 to Shareholder Rights Agreement dated August 24, 2012 between National Technical Systems, Inc. and Computershare Trust Company, N.A. as Rights Agent as Rights Agent (incorporated by reference to Exhibit 4.2 of the registrant’s current report on Form 8-K filed on August 28, 2012).
10.1	Letter Agreement dated April 5, 2012 between National Technical Systems, Inc. and Raffy Lorentzian (incorporated by reference to Exhibit 10.8 of the registrant’s Annual Report on Form 10-K filed with the Commission on May 1, 2012).
31.1*	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*	Certification of Chief Executive Officer pursuant to 18 U.S.C, Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*	Certification of Chief Financial Officer pursuant to 18 U.S.C, Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*	XBRL Instance.
101.SCH*	XBRL Taxonomy Extension Schema.
101.CAL*	XBRL Taxonomy Extension Calculation.
101.DEF*	XBRL Taxonomy Extension Definition.
101.LAB*	XBRL Taxonomy Extension Labels.
101.PRE*	XBRL Taxonomy Extension Presentation.

* Furnished herewith.

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