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 and its Exhibits 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, 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; the kind, frequency and intensity of natural disasters that affect 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 three months ended August 31, 2016 and 2015
|
|
|
Increase /
|
|
|
|
|
(Decrease)
|
|
|
Sales, net
|
|
$ (3,717,000)
|
|
|
Cost of goods sold
|
|
$ (1,790,000)
|
|
|
Selling, general and administrative expenses
|
|
$ (645,000)
|
|
|
Income before provision for income taxes
|
|
$ (1,276,000)
|
|
|
Provision for income taxes
|
|
$ (476,000)
|
|
|
Net income
|
|
$ (800,000)
|
|
|
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 three months ended August 31, 2016
(All figures discussed are for the three months ended August 31, 2016 as compared
to the three months ended August 31, 2015.)
|
Three months ended August 31
|
Change
|
|
2016
|
2015
|
Amount
|
|
Percent
|
Net Revenue
|
$ 5,756,000
|
$ 9,473,000
|
$ ( 3,717,000)
|
|
-39%
|
Cost of sales
|
4,308,000
|
6,098,000
|
(1,790,000)
|
|
-29%
|
Gross profit
|
$ 1,448,000
|
$ 3,375,000
|
$ (1,927,000)
|
|
-57%
|
… as a percentage of net revenues
|
25%
|
36%
|
|
|
|
The
Company's consolidated results of operations showed a 39% decrease in net revenues and a decrease in net income of 79%. Revenues
recorded in the current
period for long-term construction projects (“Project(s)”) were 56% less than the level
recorded in the prior year. We had 33 Projects in process during the current period compared with 45 during the same period last
year. Revenues recorded in the current period for other-than long-term construction projects (non-projects) were 15% more than
the level recorded in the prior year. Total sales within the U.S. decreased 36% from the same period last year. Total sales to
Asia decreased 54% from the same period of the prior year. Sales decreases were recorded over the same period last year to customers
involved in construction of buildings and bridges (49%), aerospace / defense (24%), as well as industrial customers (21%). Please
refer to the charts, below, which show the breakdown of sales. The gross profit as a percentage of net revenue of 25% in the current
period is significantly less than during the same period of the prior year. This difference is primarily due to a combination of
a.) certain larger construction Projects in the prior year period for which the Company was able to negotiate higher than typical
selling prices; b.) several smaller, aerospace / defense Projects in the prior year period that have margins higher than the Company’s
average; c.) several export projects in the current period that were very competitively bid due to the unfavorable foreign exchange
rates; and d.) lower total volume of product sales in the current period to cover non-variable manufacturing costs.
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 August 31
|
|
|
2016
|
2015
|
|
Industrial
|
8%
|
6%
|
Construction
|
53%
|
63%
|
Aerospace / Defense
|
39%
|
31%
|
|
|
|
|
|
At
August 31, 2015, the Company had 150 open sales orders in our backlog with a total sales value of $26.4 million. At August
31, 2016, the Company has 31% fewer open sales orders in our backlog (103 orders), and the total sales value is $21.3 million or
19% less than the prior year value.
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 the three month periods ended August 31, 2016 and
August
31, 2015 is as follows:
|
Three months ended August 31
|
|
2016
|
2015
|
USA
|
70%
|
67%
|
Asia
|
24%
|
32%
|
Other
|
6 %
|
1%
|
Selling, General and Administrative Expenses
|
Three months ended August 31
|
Change
|
|
2016
|
2015
|
Amount
|
|
Percent
|
Outside Commissions
|
$ 293,000
|
$ 607,000
|
$ (314,000)
|
|
-52%
|
Other SG&A
|
889,000
|
1,220,000
|
(331,000)
|
|
-27%
|
Total SG&A
|
$ 1,182,000
|
$ 1,827,000
|
$ (645,000)
|
|
-35%
|
… as a percentage of net revenues
|
21%
|
19%
|
|
|
|
Selling, general and administrative expenses
decreased by 35% from the prior year. Outside commission expense decreased by 52% from last year's level. This fluctuation was
primarily due to the significant decrease in commissionable sales in the current year. Other selling, general and administrative
expenses decreased 27% from last year to this. This decrease is primarily due to a decrease in freight charges incurred in order
to meet contractual obligations to deliver products on schedule along with an decrease in estimated incentive compensation expense
in the current period related to the lower level of sales and operating results.
The
above factors resulted in operating income of $266,000 for the three months ended
August 31, 2016, 83% less than the $1,548,000
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 FASB ASC. The Company recognized $79,000 and
$61,000 of compensation cost for the three month periods ended August 31, 2016 and
August 31, 2015.
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 to
estimate the fair market value of the Company's stock option grants:
|
August
2016
|
|
August
2015
|
Risk-free interest rate:
|
1.625%
|
|
1.500%
|
Expected life of the options:
|
3.4 years
|
|
3.3 years
|
Expected share price volatility:
|
26%
|
|
31%
|
Expected dividends:
|
zero
|
|
zero
|
|
|
|
|
These assumptions resulted in estimated fair-market value per stock option:
|
$4.04
|
|
$3.11
|
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
three month period ended August 31, 2016 is presented below:
|
|
|
|
Weighted-
|
|
|
Number of
|
|
Average
|
|
|
Options
|
|
Exercise Price
|
Options outstanding and exercisable at May 31, 2016:
|
|
243,500
|
|
$ 9.530
|
Options granted:
|
|
19,500
|
|
$ 19.255
|
Options exercised:
|
|
19,500
|
|
$ 8.530
|
Options outstanding and exercisable at August 31, 2016:
|
|
243,500
|
|
$ 10.390
|
Closing value per share on NASDAQ at
August 31, 2016:
|
|
|
|
$ 18.740
|
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.
Capital expenditures for the three months ended
August 31, 2016 were $673,000 compared to $299,000 in the same period of the prior year. As of August 31, 2016, the Company has
commitments for capital expenditures totaling $520,000 during the next twelve months. These costs are primarily related to a building
expansion to allow the Company to assemble and test larger units used to provide seismic protection in buildings and bridges.
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 August 31, 2016 or as of May 31, 2016. 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
|
|
$20,952,000
|
|
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
|
|
August 31, 2016
|
May 31, 2016
|
Increase /(Decrease)
|
Raw materials
|
$ 482,000
|
|
$ 512,000
|
|
$ (30,000
|
)
|
-6%
|
Work-in-process
|
9,164,000
|
|
8,639,000
|
|
525,000
|
|
6%
|
Finished goods
|
558,000
|
|
454,000
|
|
104,000
|
|
23%
|
Inventory
|
10,204,000
|
94%
|
9,605,000
|
93%
|
599,000
|
|
6%
|
Maintenance and other inventory
|
697,000
|
6%
|
697,000
|
7%
|
-
|
|
0%
|
Total
|
$ 10,901,000
|
100%
|
$ 10,302,000
|
100%
|
$ 599,000
|
|
6%
|
|
|
|
|
|
|
|
|
Inventory turnover
|
1.6
|
|
2.3
|
|
|
|
|
NOTE: Inventory turnover is annualized for
the three month period ended August 31, 2016.
Inventory, at $10,204,000 as of August 31,
2016, is $599,000, or 6%, more than the prior year-end level of $9,605,000. Approximately 90% of the current inventory is work
in process, 5% is finished goods, and 5% 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. Management of the Company has recorded an allowance
for potential inventory obsolescence. The provision for potential inventory obsolescence was $45,000 for each of the three month
periods ended August 31, 2016 and August 31, 2015. 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")
|
August 31, 2016
|
May 31, 2016
|
Increase /(Decrease)
|
Accounts receivable
|
$ 3,576,000
|
|
$ 3,992,000
|
|
$ (416,000
|
)
|
-10%
|
|
CIEB
|
4,883,000
|
|
5,501,000
|
|
(618,000
|
)
|
-11%
|
|
Less: BIEC
|
941,000
|
|
1,464,000
|
|
(523,000
|
)
|
-36%
|
|
Net
|
$ 7,518,000
|
|
$ 8,029,000
|
|
$ (511,000
|
)
|
-6%
|
|
|
|
|
|
|
|
|
|
|
Number of an average day’s sales outstanding in accounts receivable
|
56
|
|
40
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 $3,576,000 as of August 31, 2016 includes
approximately $831,000 of amounts retained by customers on Projects. It also includes $10,000 of an allowance for doubtful accounts
(“Allowance”). The accounts receivable balance as of May 31, 2016 of $3,992,000 included an Allowance of $20,000. It
is expected that amounts retained by customers under contracts 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.
The number of an average day's sales outstanding
in accounts receivable (“DSO”) increased from 40 days at May 31, 2016 to 56 at August 31, 2016. 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 first quarter of the current
year is 36% less than the level in the fourth quarter of the prior year. The level of accounts receivable at the end of the current
period is only 10% less than at the end of the prior year. The combination of these two factors caused the DSO to increase from
last year end to this quarter end.
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, such provisions are often not possible. The $4,883,000
balance in this account at August 31, 2016 is 11% less than the prior year-end balance. 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 Company expects to
bill the entire amount during the next twelve months. 31% of the CIEB balance as of the end of the last fiscal quarter, May 31,
2016, was billed to those customers in the current fiscal quarter ended August 31, 2016. 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:
|
August 31, 2016
|
May 31, 2016
|
Costs
|
$ 6,132,000
|
|
$ 8,080,000
|
Estimated Earnings
|
2,308,000
|
|
3,191,000
|
Less: Billings to customers
|
3,557,000
|
|
5,770,000
|
CIEB
|
$ 4,883,000
|
|
$ 5,501,000
|
Number of Projects in progress
|
17
|
|
19
|
As noted above, BIEC represents billings to
customers in excess of revenues recognized. The $941,000 balance in this account at August 31, 2016 is down 36% from the $1,464,000
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:
|
August 31, 2016
|
May 31, 2016
|
Billings to customers
|
$ 5,021,000
|
|
$ 5,886,000
|
Less: Costs
|
2,949,000
|
|
3,362,000
|
Less: Estimated Earnings
|
1,131,000
|
|
1,060,000
|
BIEC
|
$ 941,000
|
|
$ 1,464,000
|
Number of Projects in progress
|
3
|
|
6
|
Summary of factors affecting the balances in CIEB and BIEC:
|
August 31, 2016
|
May 31, 2016
|
Number of Projects in progress
|
20
|
|
25
|
Aggregate percent complete
|
54%
|
|
59%
|
Average total sales value of Projects in progress
|
$1,171,000
|
|
$1,062,000
|
Percentage of total value invoiced to customer
|
37%
|
|
43%
|
The Company's backlog of sales orders at August
31, 2016 is $21.3 million, down slightly from the $21.5 million at the end of the prior year. $10.9 million of the current backlog
is on Projects already in progress.
Other Balance Sheet Items
Accounts payable, at $1,611,000 as of August
31, 2016, is 9% less than the prior year-end. 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 August 31, 2016 are
$684,000, equal to the accrual at the prior year-end. Other current liabilities decreased 31% from the prior year-end, to $1,894,000.
This decrease is primarily due to a decrease in accrued incentive compensation. The Company expects the current accrued amounts
to be paid during the next twelve months.
Management believes the Company's cash flows
from operations and borrowing capacity under the bank line of credit are sufficient to fund ongoing operations and capital improvements
for the next twelve months.