<PAGE>

================================================================================

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                               ----------------

                                   FORM 10-Q

                               [LOGO OF LITRONIC]

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999,

                                       OR

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

                         Commission File No. 000-26227

                                 LITRONIC INC.
             (Exact name of registrant as specified in its charter)

                  Delaware                                       33-0757190
        (State or other jurisdiction                          (I.R.S Employer
      of incorporation or organization)                     Identification No.)


2030 Main Street, Suite 1250 Irvine,California                     92614
  (Address of principal executive offices)                       (Zip Code)

                                 (949) 851-1085
              (Registrant'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 [_]

   As of November 8, 1999, the registrant had 9,741,986 shares of common stock
outstanding.

================================================================================
<PAGE>

                                 LITRONIC INC.

                                     INDEX

<TABLE>
<CAPTION>
                                                                          Page
                                                                          ----
 <C>      <S>                                                             <C>
 Part I.  FINANCIAL INFORMATION

 Item 1.  Financial Statements..........................................    3

          Condensed Consolidated Balance Sheets--September 30, 1999 and
           December 31, 1998............................................    3

          Condensed Consolidated Statements of Operations--Three and
           Nine months ended September 30, 1999 and 1998................    4

          Condensed Consolidated Statements of Cash Flows--Nine months
           ended September 30, 1999 and 1998............................    5

          Notes to Condensed Consolidated Financial Statements..........    6

 Item 2.  Management's Discussion and Analysis of Financial Condition
           and Results of Operations....................................   11

 Item 3.  Quantitative and Qualitative Disclosures About Market Risk....   24

 Part II. OTHER INFORMATION.............................................   25

 Item 1.  Legal Proceedings.............................................   25

 Item 2.  Changes in Securities and Use of Proceeds.....................   25

 Item 3.  Defaults upon Senior Securities...............................   25

 Item 4.  Submission of Matters to a Vote of Security Holders...........   25

 Item 5.  Other Information.............................................   25

 Item 6.  Exhibits and Reports on Form 8-K..............................   25
</TABLE>

                                       2
<PAGE>

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

                                 LITRONIC INC.

                     CONDENSED CONSOLIDATED BALANCE SHEETS

                       (in thousands, except share data)
                                  (unaudited)

<TABLE>
<CAPTION>
                                                     September 30, December 31,
                       ASSETS                            1999          1998
                       ------                        ------------- ------------
<S>                                                  <C>           <C>
Current assets:
  Cash and cash equivalents.........................   $  5,810      $   898
  Accounts receivable (net of allowance for bad
   debts of $66 and $14 as of September 30, 1999 and
   December 31, 1998 respectively)..................     10,814          740
  Inventories.......................................        721          533
  Other current assets..............................      1,867          385
                                                       --------      -------
    Total current assets............................     19,212        2,556
Property and equipment, net.........................        666          235
Goodwill and other intangibles, net.................     35,614          --
Other assets........................................        625          --
                                                       --------      -------
                                                        $56,117      $ 2,791
                                                       ========      =======

<CAPTION>
   LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
   ----------------------------------------------
<S>                                                  <C>           <C>
Current liabilities:
  Current installments of long-term debt............   $    334      $   580
  Accounts payable..................................      3,081          456
  Accrued liabilities...............................      1,586          762
                                                       --------      -------
    Total current liabilities.......................      5,001        1,798
  Long-term debt....................................        --         5,200
                                                       --------      -------
    Total liabilities...............................      5,001        6,998
                                                       --------      -------
Commitments and contingencies
Stockholders' equity (deficit):
  Preferred stock, $.01 par value; Authorized
   5,000,000 shares; no shares issued or
   outstanding......................................        --           --
  Common stock, $.01 par value; 25,000,000 shares
   authorized; 9,741,986 and 3,870,693 shares issued
   and outstanding at September 30, 1999 and
   December 31,1998, respectively...................         98           39
  Additional paid-in capital........................     52,771          --
  Accumulated deficit...............................     (1,753)      (4,246)
                                                       --------      -------
    Total stockholders' equity (deficit)............     51,116       (4,207)
                                                       --------      -------
                                                       $ 56,117      $ 2,791
                                                       ========      =======
</TABLE>

     See accompanying notes to condensed consolidated financial statements.

                                       3
<PAGE>

                                 LITRONIC INC.

                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

                     (in thousands, except per share data)
                                  (unaudited)

<TABLE>
<CAPTION>
                              Three Months Ended           Nine Months Ended
                          --------------------------- ---------------------------
                          September 30, September 30, September 30, September 30,
                              1999          1998          1999          1998
                          ------------- ------------- ------------- -------------
<S>                       <C>           <C>           <C>           <C>
Revenues:
  Product...............     $15,574       $1,526        $18,784       $3,886
  License and service...         451           98            703          925
  Research and
   development..........         103          140            798          140
                             -------       ------        -------       ------
    Total revenues......      16,128        1,764         20,285        4,951
                             -------       ------        -------       ------
Costs and expenses:
  Cost of sales--
   products.............      13,245          686         15,807        1,740
  Cost of sales--license
   and service..........         364          390            639          909
  Selling, general and
   administrative.......       2,249          778          4,531        1,990
  Research and
   development..........         973          285          2,476          919
  Amortization of
   goodwill and other
   intangibles..........         709          --             827          --
                             -------       ------        -------       ------
Operating loss..........      (1,412)        (375)        (3,995)        (607)
Interest expense........         (86)        (107)          (324)        (338)
Interest income.........         119           12            163           16
                             -------       ------        -------       ------
Loss before income
 taxes..................      (1,379)        (470)        (4,156)        (929)
Benefit from income
 taxes..................         --            (3)          (285)         (61)
                             -------       ------        -------       ------
Net loss................     $(1,379)      $ (467)       $(3,871)      $ (868)
                             =======       ======        =======       ======
Net loss per share--
 basic and diluted......     $ (0.14)      $(0.12)       $ (0.63)      $(0.22)
                             =======       ======        =======       ======
Shares used in per share
 computations--basic and
 diluted................       9,742        3,871          6,154        3,871
                             =======       ======        =======       ======
</TABLE>


     See accompanying notes to condensed consolidated financial statements.

                                       4
<PAGE>

                                 LITRONIC INC.

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 (in thousands)
                                  (unaudited)
<TABLE>
<CAPTION>
                                                          Nine Months Ended
                                                     ---------------------------
                                                     September 30, September 30,
                                                         1999          1998
                                                     ------------- -------------
<S>                                                  <C>           <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss.........................................    $ (3,871)      $  (868)
  Adjustments to reconcile net loss to net cash
   used in operating activities:
   Depreciation and amortization...................       1,062           153
   Deferred income tax benefit.....................        (285)          --
  Changes in assets and liabilities:
   Accounts receivable.............................      (5,184)         (175)
   Inventories.....................................          11          (104)
   Other current assets............................      (1,467)          (11)
   Accounts payable................................      (2,133)          193
   Accrued liabilities.............................        (493)         (599)
   Other assets....................................        (292)          --
                                                       --------       -------
     Net cash used in operating activities.........     (12,652)       (1,411)
                                                       --------       -------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property and equipment..............        (182)          (77)
                                                       --------       -------
     Net cash used in investing activities.........        (182)          (77)
                                                       --------       -------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from sale of common stock, net of
   issuance costs of $5,377........................      35,323           --
  Proceeds from revolving note payable to bank.....       9,142         4,205
  Proceeds from related party revolving line of
   credit..........................................         --            600
  Proceeds from long-term debt.....................       2,844         5,200
  Repayment of related party note payable..........                    (3,500)
  Principal payments on long-term debt.............     (29,563)       (4,330)
                                                       --------       -------
     Net cash provided by financing activities.....      17,746         2,175
                                                       --------       -------
     Net increase in cash..........................       4,912           687
                                                       --------       -------
Cash and cash equivalents at beginning of period...         898           490
                                                       --------       -------
Cash and cash equivalents at end of period.........    $  5,810       $ 1,177
                                                       ========       =======

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Cash paid during the period for:
   Interest........................................    $    607       $   323
   Income taxes....................................           2           --
                                                       ========       =======

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
 FINANCING ACTIVITIES:

The Company issued 2,169,938 shares of common stock in
connection with the acquisition of Pulsar. In connection with
the acquisition, net assets purchased were as follows:

  Merger costs.....................................    $   (121)      $   --
  Fair value of net assets acquired less
   liabilities assumed.............................     (12,450)          --
  Goodwill and other intangibles...................      36,441           --
                                                       --------       -------
  Market value of common stock issued..............    $ 23,870       $   --
                                                       ========       =======
</TABLE>

     See accompanying notes to condensed consolidated financial statements.

                                       5
<PAGE>

                                 LITRONIC INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                          September 30, 1999 and 1998
                                  (unaudited)
                     (in thousands, except per share data)

(1) General Information:

 Condensed Consolidated Financial Statements

   In the opinion of the Company, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (which are normal
recurring accruals) necessary to present fairly the financial position as of
September 30, 1999; the results of operations for the three and nine months
ended September 30, 1999 and 1998; and the statements of cash flows for the
nine months ended September 30, 1999 and 1998. Interim results for the three
and nine months ended September 30, 1999 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1999. The interim
financial statements should be read in conjunction with the Company's
consolidated financial statements for the year ended December 31, 1998 included
in the Company's Form S-1 filed in June 1999.

 Public Offering and Reorganization

   In June 1999, Litronic completed an initial public offering of common stock
of Litronic Inc., a newly formed corporation with no operations (the
"Offering"). Litronic Industries, Inc. also initiated certain events (the
"Reorganization") in connection with the Offering which resulted in it becoming
a wholly-owned subsidiary of Litronic Inc. on June 8, 1999. The Reorganization
was accomplished through a stock-for-stock exchange between Litronic Inc. and
Litronic Industries, Inc. and was accounted for as an "as if pooling of
interests" for entities under common control. Concurrent with the
Reorganization, Litronic Industries, Inc. terminated its Subchapter S
corporation status and is subject to federal and state income taxes.

   All of the outstanding shares of Litronic Industries, Inc. were exchanged
for 3,870,693 shares of the Company's common stock. Consequently, as of June 8,
1999, the consolidated group includes the operations of Litronic Inc. and its
wholly owned subsidiary Litronic Industries, Inc. The prior period financial
statements have been restated to reflect the exchange of these shares.

   The Company also entered into a stock acquisition agreement with Pulsar Data
Systems, Inc. (Pulsar) which was effected simultaneously with the Offering. All
of the outstanding shares of Pulsar were exchanged for 2,169,938 shares of the
Company's common stock.

 Segment Reporting

   As of January 1, 1998, the Company adopted Statement No. 131, Disclosures
about Segments of an Enterprise and Related Information", which requires
entities to report financial and descriptive information about its reportable
operating segments. We provide professional Internet data security services and
develop and market software and microprocessor-based products to secure
electronic commerce business transactions and communications over the Internet
and other communications networks based on Internet protocols. To increase our
sales capacity and to capitalize on opportunities in the rapidly growing
Internet information technology security market, we acquired Pulsar Data
Systems, Inc. in June 1999. The Company's combined operations pertain to only
one segment.

(2) Pro Forma Financial Information Reflecting Pulsar Acquisition

   The Company entered into a stock acquisition agreement with Pulsar which was
effected simultaneously with the Offering. This acquisition was contingent upon
the successful completion of the Offering and was completed on June 14, 1999.
Litronic acquired all of the outstanding shares of Pulsar in exchange for

                                       6
<PAGE>

                                 LITRONIC INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          September 30, 1999 and 1998

2,169,938 shares of the Company's common stock. The acquisition was accounted
for by the purchase method and, accordingly, the results of operations of
Pulsar have been included in the Company's consolidated financial statements
from June 14, 1999. The excess of the purchase price over the fair value of the
net assets acquired less the liabilities assumed, resulted in a total of $36.4
million recorded as goodwill and intangible assets which is being amortized on
a straight-line basis over 10-15 years. The purchase price of the Pulsar
acquisition was based on the fair market value of the common stock issued at
June 14, 1999.

   The goodwill and intangibles include the following subcomponents:

<TABLE>
<CAPTION>
                                                                     Useful life
   Description                                              Amount     (years)
   -----------                                              -------  -----------
   <S>                                                      <C>      <C>
   Distribution Channel.................................... $12,147       15
   Customer Base...........................................  12,147       10
   Goodwill................................................  12,147       15
                                                            -------
                                                             36,441
   Less accumulated amortization...........................    (827)
                                                            -------
                                                            $35,614
                                                            =======
</TABLE>

   The following unaudited pro forma financial information presents the
combined results of operations of Litronic and Pulsar for the nine month
periods as if the acquisition had occurred as of the beginning of 1999 and
1998, after giving effect to certain adjustments including amortization of
goodwill and other intangibles, increased interest expense on debt assumed and
related income tax effects. The pro forma financial information does not
necessarily reflect the results of operations that would have occurred had
Litronic and Pulsar constituted a single entity during such periods.

<TABLE>
<CAPTION>
                                                                   Nine Months
                                                Nine Months Ended     Ended
                                                  September 30,   September 30,
                                                      1999            1998
                                                ----------------- -------------
   <S>                                          <C>               <C>
   Total revenues..............................      $37,860         $66,329
                                                     =======         =======
   Net loss....................................      $(7,102)        $(6,707)
                                                     =======         =======
   Net loss per share, basic and diluted.......      $( 1.15)        $ (0.74)
                                                     =======         =======
</TABLE>

(3) Inventories

   A summary of inventories follows:
<TABLE>
<CAPTION>
                                                      September 30, December 31,
                                                          1999          1998
                                                      ------------- ------------
   <S>                                                <C>           <C>
   Raw materials.....................................     $294          $239
   Work-in-process...................................      218            25
   Finished goods....................................      209           269
                                                          ----          ----
                                                          $721          $533
                                                          ====          ====
</TABLE>

                                       7
<PAGE>

                                 LITRONIC INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          September 30, 1999 and 1998


(4) Long-term Debt

   A summary of long-term debt follows:
<TABLE>
<CAPTION>
                                                     September 30, December 31,
                                                         1999          1998
                                                     ------------- ------------
<S>                                                  <C>           <C>
Notes payable to bank secured by substantially all
assets of the Company and personal assets of, and a
guarantee by, the Company's chairman and majority
shareholder, bearing interest at 6.6% payable
monthly, paid on June 14, 1999.....................      $ --         $5,200

Revolving note payable to bank with maximum
availability of $20 million, bearing interest at
prime plus 1.5% (9.75% at December 31, 1998)
payable in monthly interest-only payments through
maturity on May 10, 2002; secured by substantially
all assets of the Company and by personal assets
of, and a guarantee by, the Company's chairman and
majority shareholder, renewable at the bank's
option for additional one-year periods paid in
September, 1999....................................        --            580

Other..............................................         33           --
                                                         -----        ------
                                                           334         5,780
Less current installments..........................        334           580
                                                         -----        ------
                                                         $ --         $5,200
                                                         =====        ======
</TABLE>
   Principal maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
                                                                   September 30,
                                                                       1999
                                                                   -------------
     <S>                                                           <C>
       2000.......................................................     $334
       2001 and thereafter........................................      --
                                                                       ----
                                                                       $334
                                                                       ====
</TABLE>

                                       8
<PAGE>

                                 LITRONIC INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          September 30, 1999 and 1998


   The Company has a $20 million revolving credit agreement that matures on May
10, 2002. This agreement contains certain covenants and restrictions, including
maintenance of certain financial ratios and a restriction on future borrowings.
As of September 30, 1999, the Company was in compliance with the covenants. As
of September 30, 1999, the Company had available borrowings of $20 million
under the revolving credit agreement.

(5) Concentration of Risk and Significant Customers

   Financial instruments that potentially subject the Company to concentration
of credit risk are trade receivables. Credit risk on trade receivables is
limited as a result of the Company's customer base and their dispersion across
different industries and geographic regions. As of December 31, 1998 and
September 30, 1999, accounts receivable included $308,000 and $9.7 million,
respectively, due from the U.S. Government and related agencies. Sales to
federal government agencies represented 87% and 75% of the Company's sales for
the nine months ended September 30, 1998 and 1999, respectively.

   The Company had sales to 3 and 2 customers which represented 86% and 34%,
respectively, of total revenue for the nine months ended September 30, 1998 and
1999. No other customers accounted for more than 10% of net revenues during the
nine months ended September 30, 1998 and 1999. Trade accounts receivable
aggregated $493,000 and $3.2 million from the aforementioned major customers as
of December 31, 1998 and September 30, 1999, respectively.

   At September 30, 1999, the Company's investment portfolio consisted of $3.7
million in cash equivalents. The Company does not believe that it has a
concentration of investment risk due to the diversification of the investment
portfolio.

(6) 1999 Stock Option Plan

   Under the Company's 1999 Stock Option Plan (the "1999 Plan"), which was
established in April 1999, the Company granted options to purchase 98,000
shares at an exercise price of $8.75 per share in June 1999, the fair market
value on the date of grant.

(7) Loss Per Share

   In December 1997, the FASB issued Statement 128, Earnings per Share ("EPS").
Statement 128 replaced the calculation of primary and fully diluted EPS with
basic and diluted EPS. Unlike primary EPS, basic EPS excludes any dilutive
effects of common stock equivalents, such as options and warrants. Diluted EPS
is very similar to the previously reported fully diluted EPS. All EPS amounts
for all periods have been restated to conform to the Statement 128
requirements.

   The computation of diluted net loss per share for the three months ended
September 30, 1999 and 1998 and the nine months ended September 30, 1999 and
1998 excluded the effect of 300,758, 161,678, 360,647 and 249,679,
respectively, of incremental common shares attributable to the exercise of
outstanding common stock options because their effect was antidilutive.

(8) Contingent Liabilities

   The Company had cost reimbursable type contracts with the Federal
Government. Consequently, the Company is reimbursed based upon their direct
expenses attributable to the contract, plus a percentage based upon overhead,
material handling, and general and administrative expenses. The overhead,
material handling, and general and administrative rates are estimates.
Accordingly, if the actual rates as determined by the Defense

                                       9
<PAGE>

                                 LITRONIC INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          September 30, 1999 and 1998

Contract Audit Agency are below the Company's estimates, a refund for the
difference would be due to the Federal Government. It is management's opinion
that no material liability will result from any contract audits.

   On January 16, 1998, G2 Resources Inc. filed a complaint against Pulsar in
the Circuit Court, Fifteenth Judicial Circuit, Palm Beach County, Florida. G2
claims that Pulsar breached a contract under which G2 agreed to provide
services related to the monitoring of government contracts available for bid
and the preparation and submission of bids on behalf of Pulsar. The contract
provides that Pulsar pay G2 $500,000 in 30 monthly installments of $16,666 and
an additional fee of 2% of the gross dollar amount generated by awards. In its
complaint, G2 alleged that Pulsar failed to make payments under the contract
and claimed damages in excess of $525,000 plus interest, costs and attorneys
fees. In the course of discovery G2 asserted that its losses/costs arising out
of its claim amount to approximately $10.3 million. Pulsar has asserted that G2
failed to perform the services required under the contract and Pulsar filed a
claim for compensatory damages, interest and attorneys fees against G2.
Classical Financial Services, LLC intervened in the case. Classical claims that
G2 assigned its accounts receivable to Classical under a financing program and
that Pulsar breached its obligations to Classical by failing to make payments
under the contract with G2. Pulsar has asserted defenses to Classical's claim.
Pulsar believes that the claims of G2 and Classical against Pulsar are without
merit and intends to continue to vigorously defend against the claims. If G2 or
Classical were to prevail in this lawsuit, our business and financial condition
could be materially adversely affected. Management does not believe that the
outcome will have a material impact on its financial statements.

   On July 11, 1997, Rudolph Menna filed a complaint against Pulsar and William
W. Davis, Sr. in the U.S. District Court for Northern District of Georgia,
Atlanta Division. Mr. Menna alleges that he was wrongfully terminated as a
Pulsar employee and that Pulsar and Mr. Davis unlawfully discriminated against
him on the basis of race and age. Mr. Menna's complaint seeks an unspecified
amount of damages including back pay, front pay, benefits, compensatory and
punitive damages, interest and attorneys fees. A settlement of $140,000 has
been tentative agreed to and has been accrued in its financial statements. The
Company intends to seek indemnification or reimbursement from William Davis,
Sr. and Lillian Davis, the former owners of Pulsar. Management does not believe
that the outcome will have a material impact on its financial statements.

   On April 19, 1999, A&T Marketing Inc. filed a complaint against Pulsar in
the Circuit Court for Prince George's County, Maryland. A&T claims that Pulsar
owes A&T $262,000 plus interest and costs, for software that A&T sold Pulsar in
1998. Pulsar believes it has defenses to A&T's claim and that A&T's claim is
without merit. Pulsar intends to vigorously defend against the claim.
Management does not believe that the outcome will have a material impact on its
financial statements.

   The Company is also involved in various routine legal actions arising in the
normal course of business. After taking into consideration legal counsel's
evaluation of such actions, management is of the opinion that any potential
liability arising from these claims against the Company would be minimal.

   As of September 30, 1999, Pulsar had not yet filed the Form 5500 Annual
Return/Report for 1997 and 1998 for its Employee Retirement Plan. The Form
5500, along with an audit report, was due October 15, 1998 and 1999,
respectively. The Company may be assessed penalties by both the Department of
Labor and the Internal Revenue Service for its late filing. The Company has
accrued $50,000, which represents the Company's estimate of the maximum amount
of penalties that could be assessed.

                                       10
<PAGE>

Item 2. Management's Discussion and Analysis of Financial Condition and Results
        of Operations

Forward-Looking Statements

   This report contains forward-looking statements based on our current
expectations, estimates and projections about our industry, management's
beliefs and certain assumptions we have made. Words such as "anticipates,"
"expects," "intend," "plans," "believes," "may," "will," or similar expressions
are intended to identify forward-looking statements. In addition, any
statements that refer to expectations, projections, forecasts or other
predictions regarding future events or circumstances, including any underlying
assumptions, are forward-looking statements. These statements may include, but
are not limited to, statements concerning projected revenues, expenses and
income or loss, the need for additional capital, Year 2000 compliance,
acceptance of our products, growth of the Internet, our ability to identify and
consummate acquisitions and integrate these operations successfully, our
ability to integrate previously acquired businesses successfully, the status of
evolving technologies and their growth potential, our production capacity, and
the outcome of pending and threatened litigation. These statements are not
guarantees or assurances of future performance and are subject to various
risks, uncertainties, and assumptions that are difficult to predict. Therefore,
our actual results could differ materially and adversely from those expressed
in any forward-looking statements. The section labeled "Risk Factors" set forth
in this Form 10-Q and similar sections in our other Securities and Exchange
Commission ("SEC") filings, including our prospectus filed in June 1999,
discuss some of the important risk factors that may affect our business,
results of operations and financial condition. You should carefully consider
those risks, in addition to the other information in this report and in our
other SEC filings, before deciding to buy or sell our Common Stock. We
undertake no obligation to revise or update publicly any forward-looking
statements for any reason.

   The information contained in this report is not a complete description of
our business or the risks associated with an investment in our Common Stock.
You should carefully review and consider the various disclosures made by us in
this report and in our materials filed with the SEC, including our prospectus
filed in June 1999, that discuss our business in greater detail and that also
disclose various risks, uncertainties and other factors that may affect our
business, results of operations or financial condition.

Company Overview

   We provide professional Internet data security services and develop and
market software and microprocessor-based products to secure electronic commerce
business transactions and communications over the Internet and other
communications networks based on Internet protocols. To increase our sales
capacity and to capitalize on opportunities in the rapidly growing Internet
information technology security market, we acquired Pulsar Data Systems, Inc.
in June 1999.

                                       11
<PAGE>

RESULTS OF OPERATIONS

   The following table sets forth the percentage of net revenues represented by
selected items from the unaudited Condensed Consolidated Statements of
Operations. This table should be read in conjunction with the Condensed
Consolidated Financial Statements included elsewhere herein.

<TABLE>
<CAPTION>
                                      Percentage of Total Revenues
                         -------------------------------------------------------
                             Three Months Ended           Nine Months Ended
                         --------------------------- ---------------------------
                         September 30, September 30, September 30, September 30,
                             1999          1998          1999          1998
                         ------------- ------------- ------------- -------------
<S>                      <C>           <C>           <C>           <C>
Revenues:
  Product...............      96.6%         86.5%         92.6%         78.5%
  License and service...       2.8           5.6           3.5          18.7
  Research and
   development..........       0.6           7.9           3.9           2.8
                             -----         -----         -----         -----
  Total revenues........     100.0         100.0         100.0         100.0
                             -----         -----         -----         -----
Costs and expenses:
  Cost of sales--
   products.............      82.1          38.8          77.9          35.1
  Cost of sales--license
   and service..........       2.3          22.1           3.2          18.3
  Selling, general and
   administrative.......      13.9          44.1          22.3          40.2
  Research and
   development..........       6.0          16.2          12.2          18.5
  Amortization of
   goodwill and other
   intangibles..........       4.4           --            4.1           --
                             -----         -----         -----         -----
Operating loss..........      (8.8)        (21.2)        (19.7)        (12.1)
Interest expense........      (0.5)         (6.0)         (1.6)         (6.8)
Interest income.........       0.7           0.6           0.8           0.1
                             -----         -----         -----         -----
Loss before income
 taxes..................      (8.6)        (26.6)        (20.5)        (18.8)
Benefit from income
 taxes..................       --           (0.1)         (1.4)         (1.3)
                             -----         -----         -----         -----
Net loss................      (8.6)%       (26.5)%       (19.1)%       (17.5)%
                             =====         =====         =====         =====
</TABLE>

Results of operations--comparison of the three months ended September 30, 1999
and 1998

   Total revenues. Total revenues increased 814% from $1.8 million during the
three months ended September 30, 1998 to $16.1 million during the three months
ended September 30, 1999. The increase was primarily attributable to sales of
products by Pulsar of $14.8 million.

   During the three months ended September 30, 1998, we derived 56%, 22% and
11% of our revenue from sales to Lockheed Martin Corporation, the National
Security Agency and U.S. Army Corps of Engineers. During the three months ended
September 30, 1999, we derived 31%, and 12% of our revenue from sales to the
U.S. Immigration and Naturalization Service and the U.S. Department of State.

   Sales to Federal government agencies accounted for approximately 89% and 84%
of our sales during the three months ended September 30, 1998 and 1999,
respectively.

   Product revenue. Product revenue increased 921% from $1.5 million during the
three months ended September 30, 1998 to $15.6 million during the three months
ended September 30, 1999. The increase was primarily attributable to sales of
products by Pulsar of $14.8 million.

   License and service revenue. License and service revenue increased from
$98,000 during the three months ended September 30, 1998 to $451,000 during the
three months ended September 30, 1999, primarily due to an increase in revenue
from the National Security Agency Defense Messaging System support services.

   Research and development revenue. Research and development revenue decreased
from $140,000 during the three months ended September 30, 1998 to $103,000 for
the three months ended September 30, 1999 due to completion of government
fiscal year 1999 funding. This represents amounts earned under a contract with
the

                                       12
<PAGE>

National Security Agency under which we are designing a microprocessor meeting
minimum specifications established by the National Security Agency. We have
contracted with others to perform aspects of this project. All related project
costs are expensed as research and development as incurred. The related
research and development costs are not separately identifiable. Therefore, the
corresponding costs of the entire development effort are included in research
and development expenses.

   Product gross margin. Product gross margins decreased as a percentage of net
product revenue from 55% during the three months ended September 30, 1998 to
15% during the three months ended September 30, 1999. The decrease resulted
primarily from sales of lower margin products of Pulsar.

   License and service gross margin. License and service gross margin increased
as a percentage of its revenue from (298)% during the three months ended
September 30, 1998 to 19% during the three months ended September 30, 1999.
This increase resulted primarily from an increase in license and service
revenue partially offset by higher compensation costs associated with the
increased emphasis on building our infrastructure related to professional
services capabilities.

   Selling, general and administrative expenses. Selling, general and
administrative expenses increased 189% from $778,000 during the three months
ended September 30, 1998 to $2.2 million during the three months ended
September 30, 1999 primarily due to the acquisition of Pulsar and the resulting
inclusion of Pulsar's selling, general and administrative expenses as well as
increased staffing to support business expansion, and increased professional
fees. As a percentage of revenue, however, selling, general and administrative
expenses decreased from 44% during the three months ended September 30, 1998 to
14% during the three months ended September 30, 1999 reflecting the increase in
revenues.

   Research and development expenses. Research and development expenses
increased 241% from $285,000 during the three months ended September 30, 1998
to $973,000 during the three months ended September 30, 1999. The increase was
primarily attributable to increased costs associated with increased new product
development, including the development of the Forte microprocessor, which we
are designing with Atmel Corporation, and increased staffing to support
research and development efforts including the Forte project. As a percentage
of revenue, however, research and development expenses decreased from 16%
during the three months ended September 30, 1998 to 6% during the three months
ended September 30, 1999 reflecting the increase in revenues.

   Interest expense (income), net. Interest expense (income), net, went from
$95,000 interest expense during the three months ended September 30, 1998 to
$(33,000) interest income during the three months ended September 30, 1999. The
average borrowings required for operations were comparable during the three
months ended September 30, 1998 and 1999. The change is due primarily to
interest income on cash equivalents and short-term investments subsequent to
the initial public offering.

   Income taxes. Before our initial public offering, Litronic Industries Inc.
had elected to be treated as an S corporation under the provisions of Section
1362 of the Internal Revenue Code of 1986. Accordingly, we did not provide for
Federal income taxes at the corporate level. We were subject to state taxes on
earnings before taxes. The provision for state income taxes was a credit of
$3,000 for the three months ended September 30, 1998. Subsequent to the initial
public offering, we are taxed as a C corporation. In assessing the
realizability of net deferred tax assets classified as non-current assets, we
consider whether it is more likely than not that some or all of the deferred
tax assets will not be realized. Based on our projected results of operations,
we believe it is more likely than not that we will realize the benefit of the
already existing net deferred tax assets at September 30, 1999. However, since
the ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income and there can be no assurance that we will
generate any earnings or any specific level of continuing earnings in future
years we have not recognized any tax benefit from operating losses in the three
months ended September 30, 1999.

                                       13
<PAGE>

Results of operations--comparison of the nine months ended September 30, 1999
and 1998

   Total revenues. Total revenues increased 310% from $5.0 million during the
nine months ended September 30, 1998 to $20.3 million during the nine months
ended September 30, 1999. The increase was primarily attributable to sales of
products by Pulsar subsequent to the acquisition of $16.5 million and an
increase in research and development revenue of $658,000.

   During the nine months ended September 30, 1998, we derived 44%, 23% and 19%
of our revenue from sales to Lockheed Martin Corporation, the National Security
Agency and the U.S. Army Corps of Engineers. During the nine months ended
September 30, 1999, we derived 24% and 10% of our revenue from sales to the
U.S. Immigration and Naturalization Service and the U.S. Department of State.

   Sales to Federal government agencies accounted for approximately 87% and 75%
of our sales during the nine months ended September 30, 1998 and 1999.

   Product revenue. Product revenue increased 383% from $3.9 million in the
nine months ended September 30, 1998 to $18.8 million in the nine months ended
September 30, 1999. The increase was primarily attributable to sales of
products by Pulsar subsequent to the acquisition of $16.5 million offset by
reduced sales of ARGUS reader/writers, primarily to Lockheed Martin
Corporation, and related products of $1.2 million.

   License and service revenue. License and service revenue decreased from
$925,000 during the nine months ended September 30, 1998 to $703,000 during the
nine months ended September 30, 1999. The decrease was primarily due to
decreased revenues from the National Security Agency Defense Messaging System
support services agreement due to reduced requests for support services during
the first half of 1999.

   Research and development revenue. Research and development revenue of
$140,000 for the nine months ended September 30, 1998 and $798,000 for the nine
months ended September 30, 1999 represents amounts earned under a contract with
the National Security Agency under which we are designing a microprocessor
meeting minimum specifications established by the National Security Agency. The
increase is due to the fact that the project began in July 1998 and therefore,
the nine months ended September 30, 1998 only includes revenues for two months.
We have contracted with others to perform aspects of this project. All related
project costs are expensed as research and development as incurred. The related
research and development costs are not separately identifiable. Therefore, the
corresponding costs of the entire development effort are included in research
and development expenses.

   Product gross margin. Product gross margins decreased as a percentage of net
product revenue from 55% during the nine months ended September 30, 1998 to 16%
during the nine months ended September 30, 1999. The decrease resulted
primarily from sales of low margin products of Pulsar subsequent to the
acquisition of Pulsar and decreased sales of ARGUS data encryption products to
the U.S. Army Corps of Engineers.

   License and service gross margin. License and service gross margin increased
as a percentage of its revenue from 2% during the nine months ended September
30, 1998 to 9% during the nine months ended September 30, 1999. This increase
resulted primarily from an increase in license and service revenues and lower
cost of sales associated with the revenues.

   Selling, general and administrative expenses. Selling, general and
administrative expenses increased 128% from $2.0 million during the nine months
ended September 30, 1998 to $4.5 million during the nine months ended September
30, 1999 primarily due to the acquisition of Pulsar and the resulting inclusion
of Pulsar's selling, general and administrative expenses as well as increased
staffing to support business expansion and increased professional fees. As a
percentage of revenue, however, selling, general and administrative expenses
decreased from 40% during the nine months ended September 30, 1998 to 22%
during the nine months ended September 30, 1999 reflecting the increase in
revenues.

   Research and development expenses. Research and development expenses
increased 169% from $919,000 during the nine months ended September 30, 1998 to
$2.5 million during the nine months ended September 30, 1999. The increase was
primarily attributable to increased costs associated with new product

                                       14
<PAGE>

development, including the development of the Forte microprocessor, which we
are designing with Atmel Corporation, and increased staffing to support
research and development efforts including the Forte project. As a percentage
of revenue, however, research and development expenses decreased from 19%
during the nine months ended September 30, 1998 to 12% during the nine months
ended September 30, 1999, reflecting the increase in revenues.

   Interest expense (income), net. Interest expense, net, changed from $322,000
interest expense during the nine months ended September 30, 1998 to $161,000
interest expense during the nine months ended September 30, 1999. The average
borrowings required for operations were comparable during the nine months ended
September 30, 1998 and 1999. The change is due primarily to interest income on
cash equivalents and short-term investments subsequent to the initial public
offering.

   Income taxes. Before the initial public offering, Litronic Industries, Inc.
had elected to be treated as an S corporation under the provisions of Section
1362 of the Internal Revenue Code of 1986. Accordingly, we did not provide for
federal income taxes at the corporate level. We were subject to state taxes on
earnings before taxes. The provision for state income taxes was a credit of
$61,000 for the nine months ended September 30, 1998. Subsequent to the initial
public offering, we are taxed as a C corporation and therefore have recognized
a tax benefit of $285,000 for the nine months ended September 30, 1999. In
assessing the realizability of the net deferred tax assets classified as non-
current assets, we consider whether it is more likely than not that some or all
of the deferred tax assets will not be realized. Based on the Company's
projected results of operations, we believe it is more likely than not that the
Company will realize the benefit of the already existing net deferred tax
assets at September 30, 1999. However, since the ultimate realization of
deferred tax assets is dependent upon the generation of future taxable income
and there can be no assurance that we will generate any earnings or any
specific level of continuing earnings in future years we have not recognized
any benefit subsequent to June 30, 1999.

LIQUIDITY AND CAPITAL RESOURCES

   In June 1999, we completed our initial public offering of common stock. The
net proceeds of the offering were $35.3 million.

   In June 1999 we entered into a three-year agreement with Fidelity Funding
permitting borrowings under a new $20.0 million secured revolving line of
credit facility commencing on June 14, 1999. The agreement provides for an
annual interest rate of prime plus .625%; a pledge of substantially all of our
personal and real property as collateral; and maximum borrowings equal to 85%
of our eligible accounts receivable plus the lesser of (a) 50% of the value of
our eligible on-hand inventory or (b) $1.0 million.

   Our debt facilities contain covenants and restrictions, including
maintenance of minimum tangible net worth and working capital, and prohibit the
payment of dividends. We were in compliance with these covenants as of
September 30, 1999.

   During the nine months ended September 30, 1999 cash used in operations was
$12.7 million primarily due to a net loss of $3.9 million, increases in
accounts receivable of $5.2 million and other current assets of $1.5 million
and a decrease in accounts payable of $2.1 million. The larger amount of cash
used in operations, as compared to $1.4 million in 1998, reflects increased
expenditures related to the acquisition of Pulsar in June 1999.

   During the nine months ended September 30, 1999, cash provided by financing
activities was $17.7 million, consisting primarily of net proceeds from the
initial public offering of $35.3 million, and borrowings of $46.4 million under
bank borrowing agreements. These were partially offset by repayments of $29.6
million under bank borrowing agreements.

                                       15
<PAGE>

   We believe that the current availability under our $20.0 million revolving
line of credit and existing cash and cash equivalents will be sufficient to
satisfy our contemplated cash requirements for at least the next 12 months,
including planned capital expenditures of approximately $1,200,000 and an
anticipated increase in rent expense of $400,000 per year following the
anticipated relocation of our California headquarters.

   Although we believe that we have sufficient capital to fund our operations
for at least the next 12 months, our future capital requirements may vary
materially from those now planned. The amount of capital that we will need in
the future will depend on many factors including, but not limited, to:

  . the market acceptance of our products and services

  . the levels of promotion and advertising that will be required to launch
    new products and services and attain a competitive position in the market
    place

  . research and development plans

  . levels of inventory and accounts receivable

  . technological advances

  . competitors' responses to our products and services

  . relationships with partners, suppliers and customers

  . our projected capital expenditures

   In addition, we may require additional capital to accommodate planned
growth, hiring, infrastructure and facility needs or to consummate acquisitions
of other businesses, products or technologies.

YEAR 2000 ISSUES

   An issue affecting us and others is the inability of many computer systems
and applications to process the year 2000 date change, and the leap year 2000.
Many currently installed computer systems and software applications are coded
to accept only two digit entries in the date code field. These date code fields
will need to accept entries to distinguish 21st century dates from 20th century
dates. The inability to recognize or properly treat the year 2000 issue may
cause our systems and applications to process critical financial and
operational information incorrectly.

   We have established a committee to determine the extent to which we may be
vulnerable to the year 2000 issue. The committee is responsible for the ongoing
assessment, renovation of, testing, and certification of all business-critical
infrastructure systems and applications software. In the process of its
evaluation of the year 2000 issue, the committee has developed potential
business disruption scenarios and contingency plans, and tested critical
systems. The costs incurred to date related to the year 2000 issue have related
primarily to time spent by employees in year 2000 compliance matters and
testing, and have not been significant. We do not believe future costs will be
significant. The following is a description of how we have categorized and are
addressing the year 2000 issue.

 Internal systems

   We evaluated our internal computer systems in an effort to determine the
actions, if any, necessary to make them year 2000 compliant. Our evaluation
involved testing our systems to ensure that they are year 2000 compliant. Based
on our review of our systems, the committee has determined that we have no
foreseen problems related to year 2000 internal computer system issues.

 Embedded systems

   We recognize that there are risks with respect to embedded systems that are
not necessarily part of our information technology systems but contain
microprocessor chips which may not function properly with the change of date to
the year 2000. The majority of the embedded systems on which we rely in our
day-to-day

                                       16
<PAGE>

operations are owned and managed by the lessors of the buildings in which our
offices are located, or by agents of these lessors. We have received letters
from our lessors and, as applicable, their agents indicating the year 2000
compliance of the embedded systems. Based upon these responses we do not
believe there are any year 2000 compliance issues with our embedded systems.

 Outside vendors and customers

   Disruptions with respect to the computer systems of vendors or customers,
which are outside our control, could impair our ability to obtain services or
conduct business with our customers. Disruptions of our utilities or
telecommunications systems could have a material adverse effect upon our
financial condition and results of operations. We believe that no other
providers are material to our business. Disruptions of customers' computer
systems could interfere with customers' ability to make timely payments on
accounts, could disrupt our customers' ability to manage the installation
process of our products, which could adversely affect our ability to reach our
milestones, and thus to recognize revenue, and could disrupt other
administrative activities.

   The committee sent year 2000 issue questionnaires to our significant
vendors, suppliers and customers. Although the responses we have received do
not indicate any significant year 2000 issues, we do not have any assurances
that all of our significant vendors, suppliers and customers will take the
necessary steps to ensure that their respective systems will be protected
against the year 2000 issue or that even if such steps are taken, they will be
successful. We continually assess the risk of our significant vendors',
customers' and suppliers' systems, and we will develop and implement, if
necessary, curative plans and contingency plans to address any year 2000
compliance issues that may arise before year-end.

 Our products

   We have determined that our products, to the extent that underlying hardware
platforms, operating systems and databases will accommodate the year 2000 date
change, are year 2000 compliant and will accommodate the year 2000 date change.

   We anticipate that virtually all of our customers and potential customers
will be required to evaluate their information technology systems with respect
to the year 2000 date change and that some of our customers and potential
customers may incur material costs in connection with this evaluation and any
necessary repairs and replacements. Customers and potential customers may be
required to devote material portions of their information technology budgets to
these evaluations, repairs and replacements, which could materially reduce
their other information technology purchases in 1999, including their purchases
of Litronic's products, particularly as the year 2000 date change draws closer.
We do not have any information as to the degree to which this issue will affect
our customers or potential customers.

 Summary

   There can be no assurance that any year 2000 issue-related precautions with
respect to our internal information technology systems, embedded systems or our
products will eliminate the numerous and varied risks associated with the year
2000 date change. Further, there is a risk that we will be adversely affected
by the year 2000 issue or related difficulties encountered by vendors or
customers or by any downturn in information technology purchases or in the
economy in general as the year 2000 date change draws nearer. Any of these
risks could adversely affect our business.

   Management believes that the most likely worst case scenario related to the
year 2000 issues that we may experience would be either an inability to obtain
inventory components from suppliers or delays in receiving orders or payments
from customers due to year 2000 problems experienced by these third parties.
These events, if experienced, could have a material adverse effect on our
business, results of operations, financial condition and liquidity.

                                       17
<PAGE>

BUSINESS ENVIRONMENT AND RISK FACTORS

QUARTERLY EARNINGS FLUCTUATIONS

 Fluctuations in quarterly operating results

   Our quarterly operating results may fluctuate significantly as a result of a
variety of factors, many of which are outside our control. These factors
include:

  . the length of our customer commitments;

  . patterns of information technology spending by customers;

  . the timing, size, mix and customer acceptance of our product and service
    product offerings and those of our competitors;

  .  the timing and magnitude of required capital expenditures; and

  .  the need to use outside contractors to complete some assignments.

RISK FACTORS

 We have a history of losses and may incur future losses.

   We may not become profitable or significantly increase our revenue. Litronic
incurred net losses of $1.4 million for the year ended December 31, 1998 and
$3.9 million for the nine months ended September 30, 1999. Pulsar incurred net
losses of $8.1 million for the year ended December 31, 1998. Our pro forma
combined statements of operations, included in the prospectus filed in June
1999, reflected net losses of $11.6 million for the year ended December 31,
1998. Our pro forma net loss for the nine months ended September 30, 1999 was
$7.1 million.

 Our inability to integrate, or implement our plans for, the operations of
 Pulsar may adversely affect our business.

   Our failure to successfully integrate, or implement our plans for, the
operations of Pulsar would significantly diminish the value of the Pulsar
acquisition and adversely affect our future operations. Moreover, integration
of the Pulsar acquisition may place strain on our managerial and financial
resources, which could, in turn, adversely affect our business. To achieve the
full benefits of the Pulsar acquisition, we need to continue to:

  . integrate our administrative, financial and engineering resources and
    coordinate our marketing and sales efforts;

  . roll out our data security products to Pulsar's existing client base;

  . successfully complete the implementation of Pulsar's recent shift in
    product reselling focus;

  . expand Pulsar's professional service offerings; and

  . increase sales of Pulsar's products and professional services.

 We will continue to incur amortization expenses related to the Pulsar
 acquisition.

   The goodwill and other intangibles acquired in the Pulsar acquisition may
have an adverse impact on our operating results and the market price of our
common stock.

   A total of $35.6 million, or 63%, of our assets as of September 30, 1999,
consisted of intangible assets, including goodwill, arising from the
acquisition of Pulsar. This amount, the components of which are amortized over
10 to 15 years, constitutes a non-cash, non-tax deductible expense in each
amortization period that will

                                       18
<PAGE>

reduce net income or increase net loss for that period. The reduction in our
net earnings or an increase in our net loss resulting from the amortization of
goodwill and other intangibles may have an adverse impact on our operating
results and the market price of our common stock. There is also a risk that we
may never realize the value of our intangible assets.

 The terms of our loan agreement could limit our ability to implement our
 business strategy.

   The terms of our loan agreement with our credit provider could limit our
ability to implement our strategy. In addition to substantially prohibiting us
from incurring additional indebtedness, our loan agreement with our creditor
limits or prohibits us from:

  . declaring or paying cash dividends;

  . making capital distributions or other payments to stockholders;

  . merging or consolidating with another corporation; or

  . selling all or substantially all of our assets.

 We derive a substantial portion of our revenue from a small number of
 customers and, therefore, the loss of even one of these customers could
 significantly and negatively impact our operating results.

   We depend on a limited number of customers for a substantial portion of our
revenue and many of our contracts with our significant customers are short-
term contracts. The non-renewal of any significant contract upon expiration,
or a substantial reduction in sales to any of our significant customers, would
adversely affect our business unless we were able to replace the revenue we
received from these customers. For the year ended December 31, 1998, we
derived 81% of our revenue from three customers. For the nine months ended
September 30, 1999, we derived 34% of our revenue from 2 customers.

 Doing business with the U.S. government entails many risks which could
 adversely affect us.

   Sales to U.S. government agencies accounted for 81% of our revenue for the
year ended December 31, 1998 and 75% of our revenue for the nine months ended
September 30, 1999. Our sales to these agencies are subject to risks,
including:

  . early termination of our contracts;

  . disallowance of costs upon audit; and

  . the necessity to participate in competitive bidding and proposal
    processes, which is costly, time consuming and may result in unprofitable
    contracts.

   In addition, the government may be in a position to obtain greater rights
with respect to our intellectual property than we would grant to other
entities. Government agencies also have the power, based on financial
difficulties or investigations of its contractors, to deem contractors
unsuitable for new contract awards. Because we engage in the government
contracting business, we have been and will be subject to audits and may be
subject to investigation by governmental entities. Failure to comply with the
terms of any of our governmental contracts could result in substantial civil
and criminal fines and penalties, as well as our suspension from future
government contracts for a significant period of time, any of which could
adversely affect our business.

 If use of the Internet and other communications networks based on Internet
 protocols does not continue to grow, demand for our products may not
 increase.

   Increased demand for our products depends in large part on the continued
growth of the Internet and Internet protocol-based networks and the widespread
acceptance and use of these mediums for electronic

                                      19
<PAGE>

commerce and communications. Because electronic commerce and communications
over these networks are evolving, we cannot predict the size of the market and
its sustainable growth rate. A number of factors may affect market size and
growth rate, including:

  . the use of electronic commerce and communications may not increase, or
    may increase more slowly than we expect;

  . the Internet infrastructure and communications services to support
    electronic commerce may not be able to continue to support the demands
    placed on it by continued growth; and

  . the growth and reliability of electronic commerce and communications
    could be harmed by delays in development or adoption of new standards and
    protocols to handle increased levels of activity or by increased
    governmental regulation.

 If PKI technology is compromised, our business would be adversely affected.

   Many of our products are based on PKI technology. The security afforded by
this technology depends on the integrity of a user's private key, which
depends in part on the application of algorithms, or advanced mathematical
factoring equations. The occurrence of any of the following could result in a
decline in demand for our data security products:

  . any significant advance in techniques for attacking PKI systems,
    including the development of an easy factoring method or faster, more
    powerful computers;

  . publicity of the successful decoding of cryptographic messages or the
    misappropriation of private keys; and

  . government regulation limiting the use, scope or strength of PKI.

 If we do not respond to rapid technological changes, our products and service
 offerings could become obsolete.

   If we are unable to modify existing products and develop new products that
are responsive to changing technology and standards and meet customer needs in
a timely and cost effective manner, our business could be adversely affected.
The markets we serve are characterized by rapidly changing technology,
emerging industry standards and frequent introduction of new products. The
introduction of products embodying new technologies and the emergence of new
industry may render our products obsolete or less marketable. The process of
developing our products and services is extremely complex and requires
significant continuing development efforts.

 If we fail to establish and maintain strategic relationships, our ability to
 develop and market our products would be adversely affected.

   The loss of any of our existing strategic relationships, or the inability
to create new strategic relationships in the future, could adversely affect
our ability to develop and market our products. We depend upon our partners to
develop and market products and to fund and perform their obligations as
contemplated by our agreements with them. We do not control the time and
resources devoted by our partners to these activities. These relationships may
not continue or may require us to spend significant financial, personnel and
administrative resources from time to time. We may not have the resources
available to satisfy our commitments, which may adversely affect our strategic
relationships. Further, our products and services may compete with the
products and services of our strategic partners. This competition may
adversely affect our relationships with our strategic partners, which could
adversely affect our business.

 We depend on key management personnel.

   Our success will depend largely on the continuing efforts of our executive
officers and senior management, especially those of Kris Shah, our chairman of
the board and chief executive officer, and William W. Davis, Sr.,

                                      20
<PAGE>

our president and chief operating officer. Our business may be adversely
affected if the services of any of our key personnel become unavailable to us.
We have not entered into employment agreements with any employees other than
Messrs. Shah and Davis. Even with these agreements, there is a risk that these
individuals will not continue to serve for any particular period of time.
While we have obtained key person life insurance policies on the lives of
Messrs. Shah and Davis, each in the amount of $3.0 million, these amounts may
not be sufficient to offset the loss of their services.

 There is significant competition in our industry for highly skilled employees
 and our failure to attract and retain technical personnel would adversely
 affect our business.

   We may not be able to successfully attract or retain highly skilled
employees. Our inability to hire or retain highly qualified individuals may
impede our ability to develop, install, implement and service our software and
hardware systems, customers and potential customers or efficiently conduct our
operations, all of which may adversely affect our business. The information
security and networking solution industry is characterized by a high level of
employee mobility, and the market for highly qualified individuals in the
computer-related fields is intense. This competition means there are fewer
highly qualified employees available to hire and the costs of hiring and
retaining these individuals are high. Even if we are able to hire these
individuals, we may be unable to retain them. Furthermore, there is increasing
pressure to provide technical employees with stock options and other equity
interests, which may dilute earnings per share.

 Potential product defects could subject us to claims from customers.

   Products as complex as those we offer may contain undetected errors or
result in failures when first introduced or when new versions are released.
Despite our product testing efforts and testing by current and potential
customers, it is possible that errors will be found in new products or
enhancements after commencement of commercial shipments. The occurrence of
product defects or errors could result in adverse publicity, delay in product
introduction, diversion of resources to remedy defects, loss of or a delay in
market acceptance or claims by customers against us, or could cause us to
incur additional costs, any of which could adversely affect our business.

 We may be exposed to potential liability for actual or perceived failure to
 provide required products or services.

   Because our customers rely on our products for critical security
applications, we may be exposed to potential liability claims for damage
caused to an enterprise as a result of an actual or perceived failure of our
products. An actual or perceived breach of enterprise network or data security
systems of one of our customers, regardless of whether the breach is
attributable to our products or solutions, could adversely affect our business
reputation. Furthermore, our failure or inability to meet a customer's
expectations in the performance of our services, or to do so in the time frame
required by the customer, regardless of our responsibility for the failure,
could:

  . result in a claim for substantial damages against us by the customer;

  . discourage customers from engaging us for these services; and

  . damage our business reputation.

   In addition, as a professional services provider, a portion of our business
involves employing people and placing them in the workplace of other
businesses. Therefore, we are also exposed to liability for actions taken by
our employees while on assignment.

 Problems relating to the year 2000 issue could adversely affect our business.

   The failure of our significant vendors and customers to make their products
and systems year 2000 compliant may adversely affect the performance of our
products, which may in turn adversely affect our

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business. Customers or third parties might seek indemnification or damages from
us as a result of year 2000 issue-related errors caused by or not prevented by
our products or services. We cannot predict the extent to which we might be
liable for these costs, but it is conceivable in general that year 2000 errors
could result in substantial judgments against us or other providers of
information technology. If we were to suffer an adverse judgment as a result of
prior year 2000 noncompliance of our products, it may have an adverse impact on
our business.

   Customers' purchasing decisions could be affected by the year 2000 issue as
they may need to expend significant resources to correct their existing
systems. This situation may result in reduced funds available to implement the
infrastructure needed to conduct trusted and secure electronic commerce and
communications over the Internet, intranets and extranets. These factors could
lead to a decline in sales of our products and services, which could, in turn,
adversely affect our business.

   The extent of the potential impact of the year 2000 issue generally is not
known, and we cannot predict the likelihood that the year 2000 issue will cause
a significant disruption in the economy as a whole.

 We face intense competition from a number of sources.

   The markets for our products and services are intensely competitive and, as
a result, we face significant competition from a number of different sources.
We may be unable to compete successfully as many of our competitors are more
established, benefit from greater name recognition and have substantially
greater financial, technical and marketing resources than we have. In addition,
there are several smaller and start-up companies with which we compete from
time to time. We also expect that competition will increase as a result of
consolidation in the information security technology and product reseller
industries.

 Third parties could obtain access to our proprietary information or
 independently develop similar technologies because of the limited protection
 for our intellectual property.

   Our business, financial condition and operating results could be adversely
affected if we are unable to protect our intellectual property rights.
Notwithstanding the precautions we take, third parties may copy or obtain and
use our proprietary technologies, ideas, know-how and other proprietary
information without authorization or independently develop technologies similar
or superior to our technologies. In addition, the confidentiality and non-
competition agreements between us and our employees, distributors, and clients
may not provide meaningful protection of our proprietary technologies or other
intellectual property in the event of unauthorized use or disclosure. Policing
unauthorized use of our technologies and other intellectual property is
difficult, particularly because the global nature of the Internet makes it
difficult to control the ultimate destination or security of software or other
data transmitted. Furthermore, the laws of other jurisdictions may afford
little or no effective protection of our intellectual property rights.

 We may face claims of infringement of proprietary rights.

   There is a risk that our products infringe the proprietary rights of third
parties. In addition, whether or not our products infringe on proprietary
rights of third parties, infringement or invalidity claims may be asserted or
prosecuted against us and we could incur significant expense in defending them.
If any claims or actions are asserted against us, we may be required to modify
our products or seek licenses for these intellectual property rights. We may
not be able to modify our products or obtain licenses on commercially
reasonable terms, in a timely manner or at all. Our failure to do so could
adversely affect our business.

 Our efforts to expand international operations are subject to a number of
 risks.

   We are currently seeking to increase our international sales. Our inability
to maintain or to obtain federal or foreign regulatory approvals relating to
the import or export of our products on a timely basis could

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<PAGE>

adversely affect our ability to expand our international business.
Additionally, our international operations could be subject to a number of
risks, any of which could adversely affect our future international sales,
including:

  . increased collection risks;

  . trade restrictions;

  . export duties and tariffs; and

  . uncertain political, regulatory and economic developments.

 Our ability to produce the Forte PKI smart card on a timely and cost-effective
 basis depends on the availability of a computer chip from a third-party
 supplier, with whom we do not expect to maintain a supply agreement.

   Any inability to receive adequate supplies of Atmel Corporation's specially
designed Forte microprocessor would adversely affect our ability to complete
and sell the Forte PKIcard. We do not anticipate maintaining a supply agreement
with Atmel Corporation for the Forte microprocessor. If Atmel were unable to
deliver the Forte microprocessor for a lengthy period of time or terminated its
relationship with us, we would be unable to produce the Forte PKI smart card
until we could design a replacement computer chip for the Forte microprocessor.
We anticipate this would take substantial time and resources to complete.

 A small number of stockholders, including our officers and directors, have the
 ability to control stockholder votes.

   Kris Shah and members of his family, William W. Davis, Sr. and Lillian A.
Davis beneficially own, in the aggregate, approximately 62.0% of our
outstanding common stock. These stockholders, if acting together, have the
ability to elect our directors and to determine the outcome of corporate
actions requiring stockholder approval, irrespective of how other stockholders
may vote. This concentration of ownership may also have the effect of delaying
or preventing a change in control.

 There are lawsuits pending and threatened against the Company which could
 adversely affect our business if they are resolved against Pulsar.

   Lawsuits are pending and threatened against Pulsar which, if resolved
against Pulsar, could materially and adversely affect our business and
financial condition. These lawsuits and threats claim: (a) damages of
approximately $10.3 million resulting from Pulsar's alleged breach of a
contract for government contract bid preparation services, (b) damages
resulting from alleged race and age discrimination in connection with the
termination of a Pulsar employee, (c) damages by a former employee relating to
amounts due under an employment contract including approximately $200,000 of
incentive compensation and an equity stake in Pulsar, and (d) alleged amount of
approximately $262,000 due from Pulsar for software acquired from
A&T Marketing.

 Our stock price could be extremely volatile.

   The trading price of our common stock has been and may continue to be highly
volatile as a result of factors specific to us or applicable to our market and
industry in general. These factors include:

  . variations in our annual or quarterly financial results or those of our
    competitors;

  . changes by financial research analysts in their recommendations or
    estimates of our earnings;

  . conditions in the economy in general or in the information technology
    service sector in particular;

  . announcements of technological innovations or new products or services by
    us or our competitors; and

  . unfavorable publicity or changes in applicable laws and regulations, or
    their judicial or administrative interpretations, affecting us or the
    information technology service sectors.

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<PAGE>

   In addition, the stock market has recently been subject to extreme price and
volume fluctuations. This volatility has significantly affected the market
prices of securities issued by many companies for reasons unrelated to the
operating performance of these companies. In the past, following periods of
volatility in the market price of a company's securities, some companies have
been sued by their stockholders. If we were sued, it could result in
substantial costs and a diversion of management's attention and resources,
which could adversely affect our business.

 We have anti-takeover defenses that could delay or prevent an acquisition and
 could adversely affect the price of our common stock.

   Our certificate of incorporation and bylaws contain provisions that may
deter a takeover or a change in control or prevent an acquisition not approved
by our board of directors, or that may adversely affect the price of our common
stock.

 The number of shares eligible for future sale and the existence of
 registration rights could depress the market for our common stock.

   A substantial number of our shares of common stock are tradeable in the
public market. This may adversely affect prevailing market prices for our
common stock and could impair our ability to raise capital through the sale of
additional equity securities. An aggregate of 3,870,693 of the 6,040,631 shares
previously restricted from trading in the public market became eligible for
sale on September 12, 1999, subject to agreements with the lead underwriters of
our initial public offering restricting their sale for periods of at least six
months. We cannot predict the effect, if any, that sales of these additional
securities or the availability of these additional securities for sale will
have on the market prices prevailing from time to time. In addition, the
representatives of the underwriters of the initial public offering have also
been granted registration rights commencing one year from the date of the
initial public offering providing for the registration under the Securities Act
of the securities issuable upon exercise of the representatives' warrants. The
exercise of these rights could result in substantial expense to us.
Furthermore, if the representatives exercise their registration rights, they
will be unable to make a market in our securities for up to nine days before
the initial sales of the warrants until the discontinuation of sales. If the
representatives cease making a market, the market and market prices for the
securities may be adversely affected and the holders of these securities may be
unable to sell them.

Item 3. Quantitative and Qualitative Disclosures about Market Risks

Investment Portfolio

   We do not use derivative financial instruments in our held to maturity
investment portfolio. We place our investments in instruments that meet high
credit quality standards, as specified in our investment policy guidelines. The
policy also limits the amount of credit exposure to any one issue, issuer or
type of investment. We do not expect any material loss with respect to our
investment portfolio, and market value approximates cost at September 30, 1999.

   At September 30, 1999, our investment portfolio consists of cash
equivalents. Currently the carrying value of these investments approximates
market value. However, the fair market value of these investments is subject to
interest rate risk. If market interest rates were to change 10% from levels
existing at September 30, 1999, the change in the fair market value of our
investment portfolio would not be material to the Company's financial position.

Interest Rate Sensitivity

   The Company has no indebtedness at September 30, 1999, which bears interest
at rates that fluctuate based on changes in the interest rates.

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Part II. OTHER INFORMATION

Item 1. Legal Proceedings

   We are involved from time to time in routine litigation that arises in the
ordinary course of business. We are not currently involved in any litigation
which we believe will have a material impact on our results of operations,
financial condition or liquidity, other than the following:

   On January 16, 1998, G2 Resources Inc. filed a complaint against Pulsar in
the Circuit Court, Fifteenth Judicial Circuit, Palm Beach County, Florida. G2
claims that Pulsar breached a contract under which G2 agreed to provide
services related to the monitoring of government contracts available for bid
and the preparation and submission of bids on behalf of Pulsar. The contract
provides that Pulsar pay G2 $500,000 in 30 monthly installments of $16,666 and
an additional fee of 2% of the gross dollar amount generated by awards. In its
complaint, G2 alleged that Pulsar failed to make payments under the contract
and claimed damages in excess of $525,000 plus interest, costs and attorneys
fees. In the course of discovery G2 asserted that its losses/costs arising out
of its claim amount to approximately $10.3 million. Pulsar has asserted that G2
failed to perform the services required under the contract and Pulsar filed a
claim for compensatory damages, interest and attorneys fees against G2.
Classical Financial Services, LLC intervened in the case. Classical claims that
G2 assigned its accounts receivable to Classical under a financing program and
that Pulsar breached its obligations to Classical by failing to make payments
under the contract with G2. Pulsar has asserted defenses to Classical's claim.
Pulsar believes that the claims of G2 and Classical against Pulsar are without
merit and intends to continue to vigorously defend against the claims. If G2 or
Classical were to prevail in this lawsuit, our business and financial condition
could be materially adversely affected.

   On July 11, 1997, Rudolph Menna filed a complaint against Pulsar and William
W. Davis, Sr. in the U.S. District Court for Northern District of Georgia,
Atlanta Division. Mr. Menna alleges that he was wrongfully terminated as a
Pulsar employee and that Pulsar and Mr. Davis unlawfully discriminated against
him on the basis of race and age. Mr. Menna's complaint seeks an unspecified
amount of damages including back pay, front pay, benefits, compensatory and
punitive damages, interest and attorneys fees. A settlement of $140,000 has
been tentatively agreed to. We intend to seek indemnification or reimbursement
from William Davis, Sr. and Lillian R. Davis, the former owners of Pulsar.

   On April 19, 1999, A&T Marketing Inc. filed a complaint against Pulsar in
the Circuit Court for Prince George's County, Maryland. A&T claims that Pulsar
owes A&T $262,000 plus interest and costs, for software that A&T sold Pulsar in
1998. Pulsar believes it has defenses to A&T's claim and that A&T's claim is
without merit. Pulsar intends to vigorously defend against the claim.

Item 2. Changes in Securities and Use of Proceeds--None.

Item 3. Defaults Upon Senior Securities--None.

Item 4. Submission of Matters to a Vote of Security Holders--None.

Item 5. Other Information--None.

Item 6. Exhibits and Reports on Form 8-K--27.1 Financial Data Schedule.

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                                   SIGNATURES

   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.

Date: November 12, 1999
                                          LITRONIC INC.

                                                      /s/ Kris Shah
                                          By___________________________________
                                                         Kris Shah
                                              Director, Chairman of the Board
                                                         and Chief
                                                     Executive Officer

                                                  /s/ Thomas W. Seykora
                                          By___________________________________
                                                Chief Financial Officer and
                                               principal accounting officer


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