Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Cautionary Statement
The Private Securities Litigation Reform Act
of 1995 provides a "safe harbor" for forward-looking statements. Information in this Item 2, "Management's Discussion
and Analysis of Financial Condition and Results of Operations," and elsewhere in this 10-Q that does not consist of historical
facts, are "forward-looking statements." Statements accompanied or qualified by, or containing, words such as "may,"
"will," "should," "believes," "expects," "intends," "plans," "projects,"
"estimates," "predicts," "potential," "outlook," "forecast," "anticipates,"
"presume," and "assume" constitute forward-looking statements and, as such, are not a guarantee of future performance.
The statements involve factors, risks and uncertainties, the impact or occurrence of which can cause actual results to differ materially
from the expected results described in such statements. Risks and uncertainties can include, among others, uncertainty regarding
how long the worldwide economic recession will continue and whether the recession will deepen; reductions in capital budgets by
our customers and potential customers; changing product demand and industry capacity; increased competition and pricing pressures;
advances in technology that can reduce the demand for the Company's products; and other factors, many or all of which are beyond
the Company's control. Consequently, investors should not place undue reliance on forward-looking statements as predictive of future
results. The Company disclaims any obligation to release publicly any updates or revisions to the forward-looking statements herein
to reflect any change in the Company's expectations with regard thereto, or any changes in events, conditions or circumstances
on which any such statement is based.
Results of Operations
A summary of the period to period changes in
the principal items included in the condensed consolidated statements of income is shown below:
Summary comparison of the nine months ended February 28, 2013 and February 29, 2012
|
|
|
Increase /
|
|
|
|
|
(Decrease)
|
|
|
Sales, net
|
|
$ 214,000
|
|
|
Cost of goods sold
|
|
$ (1,151,000
|
)
|
|
Selling, general and administrative expenses
|
|
$ 287,000
|
|
|
Income before provision for income taxes
|
|
$ 1 015,000
|
|
|
Provision for income taxes
|
|
$ 351,000
|
|
|
Net income
|
|
$ 664,000
|
|
|
Sales under certain fixed-price contracts,
requiring substantial performance over several periods prior to commencement of deliveries, are accounted for under the percentage-of-completion
method of accounting whereby revenues are recognized based on estimates of completion prepared on a ratio of cost to total estimated
cost basis. Costs include all material and direct and indirect charges related to specific contracts.
Adjustments to cost estimates are made periodically
and any losses expected to be incurred on contracts in progress are charged to operations in the period such losses are determined.
However, any profits expected on contracts in progress are recognized over the life of the contract.
For financial statement presentation purposes,
the Company nets progress billings against the total costs incurred on uncompleted contracts. The asset, "costs and estimated
earnings in excess of billings," represents revenues recognized in excess of amounts billed. The liability, "billings
in excess of costs and estimated earnings," represents billings in excess of revenues recognized.
For
the nine months ended February 28, 2013
(All figures discussed are for the nine months ended February 28, 2013 as compared
to the nine months ended February 29, 2012.)
|
Nine months ended
|
Change
|
|
February 28, 2013
|
February 29, 2012
|
Amount
|
|
Percent
|
Net Revenue
|
$ 19,578,000
|
$ 19,363,000
|
$ 215,000
|
|
1%
|
Cost of sales
|
12,414,000
|
13,565,000
|
(1,151,000
|
)
|
-8%
|
Gross profit
|
$ 7,164,000
|
$ 5,798,000
|
$ 1,366,000
|
|
24%
|
… as a percentage of net revenues
|
37%
|
30%
|
|
|
|
The Company's consolidated results of operations
showed a 1% increase in net revenues and an increase in net income of 50%. Revenues recorded in the current period for long-term
construction projects (“Project(s)”) were 15% lower than the level recorded in the prior year. We had 52 Projects in
process during the current period compared with 66 during the same period last year. Revenues recorded in the current period for
other-than long-term construction projects (non-projects) were 50% higher than the level recorded in the prior year. Total sales
within the U.S. increased 40% from the same period last year. Total sales to Asia are down 18% from the record high level recorded
in the same period of the prior year. Sales increases over the same period last year to customers in aerospace / defense (21%)
and industrial (29%) were off-set by a decline in sales to customers involved in construction of buildings and bridges (9%) The
gross profit as a percentage of net revenues for the current and prior year periods was 37% and 30%. The gross profit in the current
year was positively affected by the increase in the percentage of sales to customers in aerospace / defense because the level of
competition is more favorable to the Company than in sales to customers involved in construction of buildings and bridges. Please
refer to the charts, below, which show the breakdown of sales.
Sales of the Company’s products are made
to three general groups of customers: industrial, construction and aerospace / defense. A breakdown of sales to the three general
groups of customers is as follows:
|
Nine months ended
|
|
|
February 28, 2013
|
February 29, 2012
|
|
Industrial
|
9%
|
7%
|
Construction
|
62%
|
69%
|
Aerospace / Defense
|
29%
|
24%
|
|
|
|
|
|
At February 29, 2012, the Company had 140 open
sales orders in our backlog with a total sales value of $23 million. At February 28, 2013, the Company has 5% fewer open sales
orders in our backlog (133 orders) and the total sales value is $11.7 million or 49% less than the prior year value. Last year’s
backlog included a small number of orders for a single customer with a high aggregate sales value, to provide seismic protection
to buildings in Asia.
The Company's backlog, revenues, commission
expense, gross margins, gross profits, and net income fluctuate from period to period. The changes in the current period, compared
to the prior period, are not necessarily representative of future results.
Net revenue by geographic region, as a percentage
of total net revenue for nine month periods ended February 28, 2013 and February 29, 2012 is as follows:
|
Nine months ended
|
|
February 28, 2013
|
February 29, 2012
|
USA
|
53%
|
38%
|
Asia
|
43%
|
53%
|
Other
|
4%
|
9%
|
Selling, General and Administrative Expenses
|
Nine months ended
|
Change
|
|
February 28, 2013
|
February 29, 2012
|
Amount
|
|
Percent
|
Outside Commissions
|
$ 724,000
|
$ 811,000
|
$ (87,000
|
)
|
- 11%
|
Other SG&A
|
3,440,000
|
3,066,000
|
374,000
|
|
12%
|
Total SG&A
|
$ 4,164,000
|
$ 3,877,000
|
$ 287,000
|
|
7%
|
… as a percentage of net revenues
|
21%
|
20%
|
|
|
|
Selling, general and administrative expenses
increased by 7% from the prior year. Outside commission expense decreased by 11% from last year's level. Other selling, general
and administrative expenses increased 12% from last year to this. This increase is primarily due to an increase in air-freight
charges incurred in order to meet contractual obligations to deliver products on schedule.
The above factors resulted in operating income
of $3,000,000 for the nine months ended February 28, 2013, up 56% from the $1,921,000 in the same period of the prior year.
Summary comparison of the three months ended February 28, 2013 and February 29, 2012
|
|
|
Increase /
|
|
|
|
|
(Decrease)
|
|
|
Sales, net
|
|
$ (2,256,000
|
)
|
|
Cost of goods sold
|
|
$ (2,011,000
|
)
|
|
Selling, general and administrative expenses
|
|
$ (424,000
|
)
|
|
Income before provision for income taxes
|
|
$ 161,000
|
|
|
Provision for income taxes
|
|
$ 53,000
|
|
|
Net income
|
|
$ 108,000
|
|
|
For
the
three
months ended February 28, 2013
(All figures
discussed are for the three months ended February 28, 2013 as compared to the three months ended February 29, 2012.)
|
Three months ended
|
Change
|
|
February 28, 2013
|
February 29, 2012
|
Amount
|
|
Percent
|
Net Revenue
|
$ 5,753,000
|
$ 8,009,000
|
$(2,256,000
|
)
|
-28%
|
Cost of sales
|
3,690,000
|
5,701,000
|
(2,011,000
|
)
|
-35%
|
Gross profit
|
$ 2,063,000
|
$ 2,308,000
|
$ (245,000
|
)
|
-11%
|
… as a percentage of net revenues
|
36%
|
29%
|
|
|
|
The Company's consolidated results of operations
showed a 28% decrease in net revenues and an increase in net income of 21%. Revenues recorded in the current period for Project
were 50% lower than the level recorded in the prior year. We had 27 Projects in process during the current period compared with
44 during the same period last year. Revenues recorded in the current period for non-projects were 61% higher than the level recorded
in the prior year. Total sales within the U.S. were down only slightly from the same period last year. Total sales to Asia are
down 29% from the record high level recorded in the same period of the prior year. Sales increases over the same period last year
to customers in aerospace / defense (34%) and industrial (20%) were over-shadowed by a decline in sales to customers involved in
construction of buildings and bridges (46%) The gross profit as a percentage of net revenues for the current and prior year periods
was 36% and 29%. The gross profit in the current year was positively affected by the increase in the percentage of sales to customers
in aerospace / defense because the level of competition is more favorable to the Company than in sales to customers involved in
construction of buildings and bridges. Please refer to the charts, below, which show the breakdown of sales.
Sales of the Company’s products are made
to three general groups of customers: industrial, construction and aerospace / defense. A breakdown of sales to the three general
groups of customers is as follows:
|
Three
months ended
|
|
|
February 28, 2013
|
February 29, 2012
|
|
Industrial
|
9%
|
4%
|
Construction
|
57%
|
77%
|
Aerospace / Defense
|
34%
|
19%
|
|
|
|
|
|
|
Net revenue by geographic region, as a percentage
of total net revenue for three month periods ended February 28, 2013 and February 29, 2012 is as follows:
|
Three
months ended
|
|
February 28, 2013
|
February 29, 2012
|
USA
|
43%
|
34%
|
Asia
|
56%
|
57%
|
Other
|
1%
|
9%
|
Selling, General and Administrative Expenses
|
Three months ended
|
Change
|
|
February 28, 2013
|
February 29, 2012
|
Amount
|
|
Percent
|
Outside Commissions
|
$ 163,000
|
$ 355,000
|
$ (192,000
|
)
|
-54%
|
Other SG&A
|
967,000
|
1,199,000
|
(232,000
|
)
|
-19%
|
Total SG&A
|
$ 1,130,000
|
$ 1,554,000
|
$ (424,000
|
)
|
-27%
|
… as a percentage of net revenues
|
20%
|
17%
|
|
|
|
Selling, general and administrative expenses
decreased by 27% from the prior year. Outside commission expense decreased by 54% from last year's level. This fluctuation was
due to the decrease in commissionable sales in the current year. Other selling, general and administrative expenses decreased 19%
from last year to this. This decrease is primarily due to an decrease in air-freight charges incurred in the prior period in order
to meet contractual obligations to deliver products on schedule, which was not necessary in the current quarter.
The above factors resulted in operating income
of $933,000 for the three months ended February 28, 2013, up 24% from the $754,000 in the same period of the prior year.
Stock Options
The Company has a stock option plan which provides
for the granting of nonqualified or incentive stock options to officers, key employees and non-employee directors. Options granted
under the plan are exercisable over a ten year term. Options not exercised at the end of the term expire.
The Company expenses stock options using the
fair value recognition provisions of the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). The
Company recognized $36,000 and $27,000 of compensation cost for the nine month periods ended February 28, 2013 and February 29,
2012.
The fair value of each stock option grant has
been determined using the Black-Scholes model. The model considers assumptions related to exercise price, expected volatility,
risk-free interest rate, and the weighted average expected term of the stock option grants. Expected volatility assumptions used
in the model were based on volatility of the Company's stock price for the thirty month period ending on the date of grant. The
risk-free interest rate is derived from the U.S. treasury yield. The Company used a weighted average expected term.
The following assumptions were used in the
Black-Scholes model in estimating the fair market value of the Company's stock option grants:
|
February 2013
|
|
February 2012
|
Risk-free interest rate:
|
1.875%
|
|
1.875%
|
Expected life of the options:
|
2.9 years
|
|
2.7 years
|
Expected share price volatility:
|
43%
|
|
49%
|
Expected dividends:
|
Zero
|
|
Zero
|
|
|
|
|
These assumptions resulted in estimated fair-market value per stock option:
|
$2.46
|
|
$1.74
|
The ultimate value of the options will depend
on the future price of the Company's common stock, which cannot be forecast with reasonable accuracy.
A summary of changes in the stock options outstanding
during the nine month period ended February 28, 2013 is presented below:
|
|
|
|
Weighted-
|
|
|
Number of
|
|
Average
|
|
|
Options
|
|
Exercise Price
|
Options outstanding and exercisable at May 31, 2012:
|
|
163,750
|
|
$6.30
|
Options granted:
|
|
14,500
|
|
$8.06
|
Options expired:
|
|
1,500
|
|
$6.17
|
Options outstanding and exercisable at February 28, 2013:
|
|
176,750
|
|
$6.44
|
Closing value per share on NASDAQ at February 28, 2013:
|
|
|
|
$8.82
|
Capital Resources, Line of Credit and Long-Term Debt
The Company's primary liquidity is dependent
upon the working capital needs. These are mainly inventory, accounts receivable, costs and estimated earnings in excess of billings,
accounts payable, accrued commissions, and billings in excess of costs and estimated earnings. The Company's primary source of
liquidity has been operations and bank financing.
Capital expenditures for the nine months ended
February 28, 2013 were $2,164,000 compared to $940,000 in the same period of the prior year. As of February 28, 2013, the Company
has commitments for capital expenditures of $1,225,000 during the next twelve months. These expenditures are construction costs
contracted to renovate recently acquired buildings which will house the Company’s machining operations, as discussed below.
In December 2011, the Company closed on its
purchase of three industrial buildings in the City of North Tonawanda, NY. The location of the site is 1.4 miles from the Company’s
existing facilities on Tonawanda Island. In February 2012, the Company closed on its purchase of vacant lots adjacent to the new
facilities. The combined real estate of the new parcel totals 9+ acres.
The additional manufacturing space is needed
to address overcrowding of the Company’s large parts machining and assembly areas due to increased sales. Total area of the
three buildings is 46,000 square feet, which more than doubles the Company’s current manufacturing space.
Two of the three buildings are now occupied
and the Company’s painting operations have been relocated to the facility. Work continues on the third building, which is
expected to be completed in the summer of 2013. When the remaining building is fully renovated, the Company’s production
machinery will be relocated from the Company’s Tonawanda Island site, and large overhead cranes will be installed to move
large parts from machine to machine. The Company plans to move all machining and metalworking operations to the new site in the
autumn of 2013. This will allow the former machining areas at the existing Tonawanda Island site to house greatly expanded assembly
and product testing areas. All corporate and engineering offices will be unaffected by the change and will remain on Tonawanda
Island.
The renovations and modifications to the buildings
are extensive, with a total construction cost of $2.9 million. The Company anticipates that its current cash and bank line of credit
resources will be sufficient for that purpose.
The Company believes it is carrying adequate
insurance coverage on its facilities and their contents.
The Company has available a $6,000,000 bank
demand line of credit, with interest payable at the Company's option of 30, 60, 90 or 180 day LIBOR rate plus 2.5%, or the bank's
prime rate less .25%. There is no balance outstanding as of February 28, 2013. There was a $258,000 principal balance outstanding
at May 31, 2012. The line is secured by accounts receivable, equipment, inventory, and general intangibles, and a negative pledge
of the Company’s real property. This line of credit is subject to the usual terms and conditions applied by the bank, is
subject to renewal annually, and is not subject to an express requirement on the bank’s part to lend. The outstanding balance
on the line of credit fluctuates as the Company's various long-term projects progress.
The Company is in compliance with restrictive covenants under the
line of credit. In these covenants, the Company agrees to maintain the following minimum levels of the stated item:
Covenant
|
|
Minimum per Covenant
|
|
Current Actual
|
|
When Measured
|
Minimum level of working capital
|
|
$3,000,000
|
|
$13,857,000
|
|
Quarterly
|
Minimum debt service coverage ratio
|
|
1.5:1
|
|
n/a
|
|
Fiscal Year-end
|
All of the $6,000,000 unused portion of our
line of credit is available without violating any of our debt covenants.
Inventory and Maintenance Inventory
|
|
February 28, 2013
|
May 31, 2012
|
Increase /(Decrease)
|
Raw materials
|
$ 607,000
|
|
$ 622,000
|
|
$ (15,000
|
)
|
-2%
|
Work in process
|
7,835,000
|
|
7,112,000
|
|
723,000
|
|
10%
|
Finished goods
|
565,000
|
|
638,000
|
|
(73,000
|
)
|
-11%
|
Inventory
|
9,007,000
|
89%
|
8,372,000
|
91%
|
635,000
|
|
8%
|
Maintenance and other inventory
|
1,080,000
|
11%
|
845,000
|
9%
|
235,000
|
|
28%
|
Total
|
$10,087,000
|
100%
|
$ 9,217,000
|
100%
|
$ 870,000
|
|
9%
|
|
|
|
|
|
|
|
|
Inventory turnover
|
1.7
|
|
2.7
|
|
|
|
|
NOTE: Inventory turnover is annualized for
the nine month period ended February 28, 2013.
Inventory, at $9,007,000 as of February 28,
2013, is $635,000 or 8% higher than the prior year-end level of $8,372,000. Approximately 87% of the current inventory is work
in process, 6% is finished goods, and 7% is raw materials.
Maintenance and other inventory represent stock
that is estimated to have a product life cycle in excess of twelve months. This stock represents certain items the Company is required
to maintain for service of products sold and items that are generally subject to spontaneous ordering. This inventory is particularly
sensitive to technological obsolescence in the near term due to its use in industries characterized by the continuous introduction
of new product lines, rapid technological advances and product obsolescence. The maintenance inventory increased 28% since May
31, 2012. This increase is primarily due to a concerted effort to reduce the lead-time and increase sales of our products used
in seismic protection by maintaining stock of certain materials used in production of standard seismic units. Management of the
Company has recorded an allowance for potential inventory obsolescence. The provision for potential inventory obsolescence was
$135,000 for each of the nine month periods ended February 28, 2013 and February 29, 2012. The Company continues to rework slow-moving
inventory, where applicable, to convert it to product to be used on customer orders.
Accounts Receivable, Costs and Estimated
Earnings in Excess of Billings (CIEB"), and Billings in Excess of Costs and Estimated Earnings ("BIEC")
|
February 28, 2013
|
May 31, 2012
|
Increase /(Decrease)
|
Accounts receivable
|
$ 4,606,000
|
|
$ 5,610,000
|
|
$ (1,004,000
|
)
|
18%
|
|
CIEB
|
1,879,000
|
|
5,492,000
|
|
(3,613,000
|
)
|
-66%
|
|
Less: BIEC
|
72,000
|
|
669,000
|
|
(597,000
|
)
|
-89%
|
|
Net
|
$ 6,413,000
|
|
$10,433,000
|
|
$(4,020,000
|
)
|
-39%
|
|
|
|
|
|
|
|
|
|
|
Number of an average day’s sales outstanding in accounts receivable
|
72
|
|
52
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company combines the totals of accounts
receivable, the current asset CIEB, and the current liability, BIEC, to determine how much cash the Company will eventually realize
from revenue recorded to date. As the accounts receivable figure rises in relation to the other two figures, the Company can anticipate
increased cash receipts within the ensuing 30-60 days.
Accounts receivable of $4,606,000 as of February
28, 2013 includes approximately $415,000 of amounts retained by customers on Projects. It also includes $42,000 of an allowance
for doubtful accounts (“Allowance”). The accounts receivable balance as of May 31, 2012 of $5,610,000 included an Allowance
of $42,000. The number of an average day's sales outstanding in accounts receivable (“DSO”) increased from 52 days
at May 31, 2012 to 72 at February 28, 2013. The DSO is a function of 1.) the level of sales for an average day (for example, total
sales for the past three months divided by 90 days) and 2.) the level of accounts receivable at the balance sheet date. The level
of sales for an average day in the third quarter of the current fiscal year is approximately 40% less than in the fourth quarter
of the prior year when the Company recorded record high level of sales. The level of accounts receivable at the end of the current
fiscal quarter is 18% less than at the end of the prior year. The net effect of these two factors caused the DSO to increase from
last year end to this quarter-end. The $1,004,000 decrease in accounts receivable is primarily due to an 83% decrease in the retained
amounts by customers on construction Projects along with a 40% decrease in the level of sales from the fourth quarter of the prior
year compared with the third quarter of the current year. The retained amounts are lower at this time due to the recent collection
of retained amounts following completion of several Projects. It is expected that the retained amounts will be released in the
normal course of the business in accordance with the related contracts. The Company expects to collect the net accounts receivable
balance, including the retainage, during the next twelve months.
As noted above, CIEB represents revenues recognized
in excess of amounts billed. Whenever possible, the Company negotiates a provision in sales contracts to allow the Company to bill,
and collect from the customer, payments in advance of shipments. Unfortunately, provisions such as this are often not possible.
The $1,879,000 balance in this account at February 28, 2013 is 66% less than the prior year-end. The Company expects to bill the
entire amount during the next twelve months. 69% of the CIEB balance as of the end of the last fiscal quarter, August 31, 2012,
was billed to those customers in the current fiscal quarter ended February 28, 2013. The remainder will be billed as the Projects
progress, in accordance with the terms specified in the various contracts.
The balances in this account are comprised
of the following components:
|
February 28, 2013
|
May 31, 2012
|
Costs
|
$ 2,112,000
|
|
$ 9,342,000
|
Estimated Earnings
|
697,000
|
|
2,251,000
|
Less: Billings to customers
|
930,000
|
|
6,101,000
|
CIEB
|
$ 1,879,000
|
|
$ 5,492,000
|
Number of Projects in progress
|
13
|
|
20
|
As noted above, BIEC represents billings to
customers in excess of revenues recognized. The $72,000 balance in this account at February 28, 2013 is down from the $669,000
balance at the end of the prior year. This decrease is the result of normal flow of the projects through production with billings
to the customers as permitted in the related contracts.
The balance in this account
fluctuates in the same manner and for the same reasons as the account “costs and estimated earnings in excess of billings”,
discussed above. Final delivery of product under these contracts is expected to occur during the next twelve months.
The balances in this account are comprised
of the following components:
|
February 28, 2013
|
May 31, 2012
|
Billings to customers
|
$ 270,000
|
|
$ 1,107,000
|
Less: Costs
|
164,000
|
|
328,000
|
Less: Estimated Earnings
|
34,000
|
|
110,000
|
BIEC
|
$ 72,000
|
|
$ 669,000
|
Number of Projects in progress
|
2
|
|
8
|
Summary of factors affecting the balances in CIEB and BIEC:
|
February 28, 2013
|
May 31, 2012
|
Number of Projects in progress
|
15
|
|
28
|
Aggregate percent complete
|
44%
|
|
61%
|
Average total sales value of Projects in progress
|
$434,000
|
|
$715,000
|
Percentage of total value invoiced to customer
|
18%
|
|
36%
|
The Company's backlog of sales orders at February
28, 2013 is $11.7 million, down 33% from $17.5 million at the end of the prior year. $3.5 million of the current backlog is on
Projects already in progress.
Other Balance Sheet Items
Accounts payable, at $1,248,000 as of February
28, 2013, is 63% less than the prior year-end. The volume of purchases is lower because sales volume decreased from the final quarter
of fiscal 2012. Commission expense on applicable sales orders is recognized at the time revenue is recognized. The commission is
paid following receipt of payment from the customers. Accrued commissions as of February 28, 2013 are $491,000, down 22% from the
$631,000 accrued at the prior year-end. The Company expects the current accrued amount to be paid during the next twelve months.
Other current liabilities decreased 35% from the prior year-end, to $1,473,000. This is primarily due to a lower level of customer
advance payments, lower level of accrued incentive compensation expense and a lower level of customer charge-backs on open Projects.
Payments on these liabilities will take place as scheduled within the next twelve months.
Management believes the Company's cash flows
from operations and borrowing capacity under the bank line of credit is sufficient to fund ongoing operations, capital improvements
and share repurchases (if any) for the next twelve months.