Operating Expenses

The following table summarizes our operating expenses:

Selling, general and administrative expenses were lower in 2017 compared to 2016. This was primarily due to reduced trade show activity and agent commissions.     

Research and development expenses were higher in 2017 compared to 2016. This was due primarily to an increase in the use of engineering resources for product improvement projects as opposed to customer delivery activities.

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Pension expense declined slightly in 2017 compared to 2016 due to a decrease in the interest cost on the SERP.

Other Expense, net

The following table summarizes our other expense:

Other expense decreased in 2017 compared to 2016 mainly due to declining interest expense on the Pension Settlement Obligation and mortgage notes along with offsetting increase of interest income from a new capital lease receivable.  

LIQUIDITY AND CAPITAL RESOURCES

Outlook

As discussed above in the executive summary, we believe existing liquidity resources and funds generated from forecasted revenue will be sufficient to meet our current and long-term obligations. We continue to operate in a rapidly evolving and often unpredictable business environment that may change the timing or amount of expected future cash receipts and expenditures.

Cash Flows

In the first six months of 2017, $915 of cash used in operating activities was attributable to $192 of cash provided by the net income for the period, after the effect of $178 of non-cash items and an unfavorable change to working capital of $1,107. The change to working capital was driven by increases in receivables and costs and estimated earnings in excess of billings on uncompleted contracts and customer deposits.  These increases are attributable to the timing of billings and new customer orders.   The change in working capital was also affected by an increase in prepaid expenses and other assets and a decrease in restricted cash for a performance guarantee that was released upon completion of the project.

In the first six months of 2016, the $328 of cash used in operating activities was attributable to $385 of cash absorbed by the net loss for the period, after the effect of $348 of non-cash items and a slightly favorable change to working capital of $57.  The more significant working capital changes contributing to cash consisted of an increase in progress payments from customer contracts, the amortization of prepaid expenses and an increase in accrued expenses attributable to payroll schedules, which were mostly offset by an increase in inventory attributable to customer deliveries and the reduction of the deferred rent obligation related to a deferred gain from a prior year sale leaseback transaction.

Cash used in investing activities was $86 for the six months ended June 30, 2017 compared to $49 for the same period of 2016.  Investing activities for both periods presented consisted entirely of property and equipment purchases.  

For the six months ended June 30, 2017, financing activities used $105 of cash compared to $115 in 2016 for principal payments on mortgage notes.

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Line of Credit

The Company is a party to a line-of-credit agreement with a commercial bank which permits borrowings of up to $1,100 to fund the working capital requirements of Spitz. Under the line of credit agreement, interest is charged on amounts borrowed at the lender’s prime rate less 0.25%.  Any borrowings under the Credit Agreement are secured by Spitz real and personal property and all of the outstanding shares of Spitz common stock. The line-of-credit agreement and mortgage notes (with the same commercial bank) contain cross default provisions whereby a default on either agreement will result in a default on both agreements. There were no borrowings outstanding under the line-of-credit agreement as of June 30, 2017.

Letters of Credit

Under the terms of financing arrangements for letters of credit, the Company is required to maintain a balance in a specific cash account equal to or greater than the outstanding value of all letters of credit issued, plus other amounts necessary to adequately secure obligations with the financial institutions who issue the letters of credit.  As of June 30, 2017 there were outstanding letters of credit and bank guarantees of $221, which are scheduled to expire during the year ending December 31, 2017.  

Mortgage Notes

As of June 30, 2017, Spitz had obligations totaling $1,870 under its two mortgage notes payable.

Item 4. CONTROLS AND PROCEDURES  

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”) as of the end of the period covered by this report. Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is (1) accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding required disclosure and (2) recorded, processed, summarized and reported within the time periods specified in the United States Securities and Exchange Commission’s rules and forms.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, due to the material weakness in internal control over financial reporting as set forth below, our disclosure controls and procedures were not effective as of June 30, 2017.

Changes in Internal Control over Financial Reporting

In the course of the preparation of our financial statements for the interim period ended June 30, 2017, we discovered weaknesses in internal controls over financial reporting related to accounting for customer contracts. While the weaknesses identified did not result in material errors in the current or prior periods, we believe the weaknesses together result in a material weakness.  Management completed additional procedures and analyses to validate the accuracy and completeness of the financial reports impacted by the material weakness. Based on the additional procedures and analysis, management concluded that the condensed consolidated financial statements included in this report fairly present, in all material respects, our financial position, results of operations, equity and cash flows for the period presented, in conformity with U.S. GAAP. Management also concluded that the errors did not result in a material misstatement in our prior financial statements and therefore did not require our previously issued financial statements to be revised or the filed reports amended.  However, because of the potential significance of cumulative accounting errors resulting from the deficient controls, we are implementing changes to the internal controls over financial reporting as described below.

Management is committed to the planning and implementation of remediation efforts to address this material weakness.  These remediation efforts, summarized below, which are either implemented or in process, are intended to both address the identified material weakness and to enhance our overall financial control environment.  In this regard, our initiatives include:

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 Reassign primary responsibility for preparation of initial customer contract cost estimates from the accounting staff to the project manager who is more familiar with the scope of work and related costs under the contract.  

 Educate employees on the importance of including estimates for costs of contract deliverables when vendor quotes are not readily available.  

 Review project accounting transactions from the end of the reporting period until the published date of the financial statements to identify any material transactions that could affect contract accounting.    

 Conduct additional formal periodic reviews of all customer contracts with the Chief Financial Officer, Chief Operating Officer, project manager and the controller in attendance, including review of actual cost incurred, estimated cost to complete and status of contract obligations to enable accurate and timely update of accounting records.    

As we continue to evaluate and work to improve our internal control over financial reporting, management may execute additional measures to address potential control deficiencies or modify the remediation plan described above.  Management will continue to review and make necessary changes to the overall design of our internal controls.

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PART II - OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS  

In the normal course of business, we become involved in various legal proceedings.  Although the final outcome of such proceedings cannot be predicted with certainty, we believe the ultimate disposition of any such proceedings will not have a material adverse effect on our consolidated financial position, liquidity, or results of operations.

Item 6. EXHIBITS  

0.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended, filed herewith.  

0.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended, filed herewith.  

32.1 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.  

101 The following materials from this Quarterly Report on Form 10-Q for the period ended June 30, 2017, formatted in XBRL (Extensible Business Reporting Language) and filed electronically herewith: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements.  

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SIGNATURE

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

EVANS & SUTHERLAND COMPUTER CORPORATION  

Date: August 11, 2017 By:    /s/ Paul Dailey         

Paul Dailey, Chief Financial Officer  

and Corporate Secretary  

(Authorized Officer)  

             (Principal Financial and Accounting Officer)  

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