Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Gencor
Industries, Inc. (the Company) is a leading manufacturer of heavy machinery used in the production of highway construction materials and environmental control equipment. The Companys core products include asphalt plants, combustion
systems, and fluid heat transfer systems. The Companys products are manufactured in two facilities in the United States.
Because the Companys
products are sold primarily to the highway construction industry, the business is typically seasonal. Traditionally, the Companys customers do not purchase new equipment for shipment during the summer and fall months to avoid disrupting their
peak season for highway construction and repair work. The majority of orders for the Companys products are thus received between October and February, with a significant volume of shipments occurring prior to June. The principal factors
driving demand for the Companys products are the overall economic conditions, the level of government funding for domestic highway construction and repair, the need for replacement parts, fluctuations in the price of crude oil (liquid asphalt,
as well as fuel costs), and a trend towards larger plants, resulting from economies of scale.
The manufacture of an asphalt plant typically has a lead
time from order to shipment of 90 to 150 days. The lead time can be impacted by the timing and scope of the order, as well as the customers delivery requirements. Therefore, the size of the Companys backlog should not be viewed as an
indicator of its revenues for the upcoming quarter or annual period. The Companys backlog was $31.6 million at March 31, 2016.
On July 6,
2012, President Obama signed a $118 billion transportation bill, Moving Ahead for Progress in the 21st Century Act
(MAP-21).
MAP-21
included a final
three-month extension of the previous SAFETEA-LU bill at then current spending levels combined with a new two-year, $105 billion authorization of the federal highway, transit, and safety programs effective October 1, 2012. The bill
provided states with two years of funding to build roads, bridges, and transit systems. On August 8, 2014, President Obama signed a $10.8 billion ten-month bill to fund federal highway and mass-transit programs through May 31, 2015.
On May 29, 2015,
MAP-21
was extended through July 31, 2015. On July 31, 2015, President Obama signed a three-month extension of
MAP-21,
which provided $8
billion in funding for the Highway Trust Fund from August 1, 2015 through October 29, 2015. Two additional short-term extensions were approved between October 29, 2015 and December 4, 2015.
On December 4, 2015, President Obama signed into law a five-year, $305 billion transportation bill, Fixing Americas Surface Transportation
(FAST) Act. The FAST Act reauthorizes the collection of the 18.4 cents per gallon gas tax that is typically used to pay for transportation projects. It also includes $70 billion from other areas of the federal budget to close a
$16 billion annual funding deficit. The bill includes spending of more than $205 billion on roads and highways over the next five years. The 2016 funding levels are approximately 5% above 2015 projected funding, with annual increases
between 2.0% and 2.5% from 2016 through 2020.
The Canadian government enacted major infrastructure stimulus programs, which benefitted the Company in
prior years. In 2007, the Building Canada Plan provided $33 billion in infrastructure funding through 2014. As part of the Building Canada Plan, the Gas Tax Fund was approved in 2009, providing $2 billion in annual infrastructure
spending.
In addition to government funding and overall economic conditions, fluctuations in the price of oil, which is a major component of asphalt mix,
may affect the Companys financial performance. An increase in the price of oil increases the cost of liquid asphalt and could, therefore, decrease demand for hot mix asphalt paving materials and certain of the Companys products.
Increases in oil prices also drive up the cost of gasoline and diesel, which results in increased freight costs. Where possible, the Company will pass increased freight costs on to its customers. However, the Company may not be able to recapture all
of the increased costs and thus could have a negative impact on the Companys financial performance.
Steel is a major component used in
manufacturing the Companys products. The Company is subject to fluctuations in market prices for raw materials such as steel. If the Company is unable to purchase materials it requires or is unable to pass on price increases to its customers
or otherwise reduce its cost of goods sold, its business results of operations and financial condition may be adversely affected.
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For the long term, the Company believes the strategy of continuing to invest in product engineering and
development and its focus on delivering high-quality products and superior service will strengthen the Companys market position. The Company continues to review its internal processes to identify inefficiencies and cost-reduction
opportunities. The Company will continue to scrutinize its relationships with external suppliers to ensure it is achieving the highest quality materials and services at the most competitive cost.
Results of Operations
Quarter Ended March 31,
2016 versus March 31, 2015
Net revenues for the quarter ended March 31, 2016 increased 60.5% to $22,078,000 from $13,754,000 for the quarter
ended March 31, 2015. During the latter part of the fourth quarter of 2015, the Companys quoting activity and order input picked up significantly. This trend has continued to be robust through the second quarter of fiscal 2016. Numerous
customers who had previously deferred equipment purchases have showed renewed optimism.
As a percent of sales, gross profit margin was 24.6% in the
quarter ended March 31, 2016, as compared to 26.4% in the quarter ended March 31, 2015. The difference in gross profit margins was the result of the mix between, plants, components and parts revenues.
Selling, general and administrative (SG&A) expenses increased $414,000 in the quarter ended March 31, 2016, compared to the quarter ended
March 31, 2015. As a percentage of net revenues, SG&A expenses decreased to 9.9%, compared to 12.9% in the prior year quarter. Sales commissions and other controllable operating expenses increased due to the higher revenues.
The Company had operating income of $2,872,000 for the quarter ended March 31, 2016 versus $1,500,000 for the quarter ended March 31, 2015.
Operating margins improved to 13.0%, compared to 10.9% in the prior year quarter. The increase in operating income was due to improved net revenues.
For
the quarter ended March 31, 2016, investment interest and dividend income, net of fees, from the investment portfolio was $204,000, as compared to $197,000 for the quarter ended March 31, 2015. Net realized and unrealized losses on
marketable securities were $(490,000) for the quarter ended March 31, 2016, as compared to net realized and unrealized gains of $195,000 for the quarter ended March 31, 2015.
The effective income tax rate for the quarter ended March 31, 2016 was 37.0% versus 37.4% for the quarter ended March 31, 2015. Net income for the
quarter ended March 31, 2016 was $1,630,000, or $.17 per diluted share, versus $1,184,000, or $.12 per diluted share, for the quarter ended March 31, 2015. The increase in net income was due to the improved sales and solid gross
and operating margins.
Six Months Ended March 31, 2016 versus March 31, 2015
Net sales for the six months ended March 31, 2016 and 2015 were $35,336,000 and $20,041,000, respectively, an increase of 76.3%.
Gross profit margin increased to 24.7% in the six months ended March 31, 2016 from 19.8% in the six months ended March 31, 2015. The improved gross
profit margin resulted from increased net revenues.
Product engineering and development expenses increased $75,000 in the six months ended March 31,
2016, compared to the six months ended March 31, 2015. SG&A expenses increased $549,000 in the six months ended March 31, 2016, compared to the six months ended March 31, 2015. As a percentage of net revenues, SG&A expenses
decreased to 11.2%, compared to 17.1% in the prior year six months. The higher expenses in 2016 were due to increased headcount and sales commissions from improved net revenues.
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The Company had operating income of $3,987,000 for the six months ended March 31, 2016 versus an operating
loss of $(134,000) for the six months ended March 31, 2015. The improved operating results were due to increased net revenues. Operating margins improved to 11.3%, compared to (0.7%) in the prior year six months.
For the six months ended March 31, 2016, investment interest and dividend income, net of fees, from the investment portfolio was $589,000, as compared to
$520,000 in 2015. Net realized and unrealized gains on marketable securities were $103,000 for the six months ended March 31, 2016 versus net realized and unrealized losses of $(232,000) for the six months ended March 31, 2015.
The effective income tax rate for the six months ended March 31, 2016 was 31.5% versus 42.2% for the six months ended March 31, 2015. The effective
income tax rate for the six months ended March 31, 2016 was positively impacted by a $256,000 increase in the prior year federal tax benefit estimate. Net income for the six months ended March 31, 2016 was $3,205,000, or $.33 per
diluted share, versus $89,000, or $.01 per diluted share, for the six months ended March 31, 2015. The increase in net income was due to the improved sales and solid gross and operating margins.
Liquidity and Capital Resources
The Company does not
currently require a credit facility but continues to review and evaluate its needs and options for such a facility.
The Company had no long-term or
short-term debt outstanding at March 31, 2016 or September 30, 2015. As of March 31, 2016, the Company had funded $135,000 in cash deposits at insurance companies to cover related collateral needs.
As of March 31, 2016, the Company had $17,143,000 in cash and cash equivalents, and $85,048,000 in marketable securities, including $41,268,000 in cash
and money funds, $29,998,000 in government securities, $6,170,000 in equities, $6,572,000 in mutual funds, and $1,040,000 in exchange-traded funds. These marketable securities are invested through a global professional investment management firm.
These securities may be liquidated at any time into cash and cash equivalents.
The Companys backlog was $31.6 million at March 31, 2016. The
Companys working capital (defined as current assets less current liabilities) was equal to $109.5 million at March 31, 2016 and $105.0 million at September 30, 2015. Cash provided by operations during the six months ended
March 31, 2016 was $5,975,000. The significant purchases, sales and maturities of marketable securities shown on the Condensed Consolidated Statements of Cash Flows reflect the recurring purchase and sale of United States treasury bills.
Inventories increased $1,075,000 reflecting an increase in jobs-in-progress at March 31, 2016, compared to September 30, 2015. Customer deposits increased $2,356,000 with the increase in the number of open percentage-of-completion jobs,
compared to September 30, 2015.
Cash flows used in investing activities for the six months ended March 31, 2016 of $85,000 were related to
capital expenditures. Cash flows from financing activities of $101,000 during the six months ended March 31, 2015 reflect the proceeds received from stock option exercises.
Seasonality
The Company primarily manufactures and sells
asphalt plants and related components and is subject to a seasonal slow-down during the third and fourth quarters of the calendar year. This slow-down often results in lower reported sales and operating results during the first and fourth quarters
of each fiscal year ended September 30.
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Forward-Looking Information
This Report on
Form 10-Q
contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), which represent the Companys expectations and beliefs, including, but not
limited to, statements concerning gross margins, sales of the Companys products and future financing plans. These statements by their nature involve substantial risks and uncertainties, certain of which are beyond the Companys control.
Actual results may differ materially depending on a variety of important factors, including the financial condition of the Companys customers, changes in the economic and competitive environments and demand for the Companys products.
For information concerning these factors and related matters, see the following sections of the Companys Annual Report on
Form 10-K
for the year ended September 30, 2015: (a) Risk Factors in Part I and (b) Managements Discussion and Analysis of Financial Condition and Results of
Operations in Part II. However, other factors besides those referenced could adversely affect the Companys results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties.
Any forward-looking statements made by the Company herein speak as of the date of this Report. The Company does not undertake to update any forward-looking statements, except as required by law.
Critical Accounting Policies, Estimates and Assumptions
The Company believes the following discussion addresses its most critical accounting policies, which are those that are most important to the portrayal of the
financial condition and results of operations and require managements most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Accounting
policies, in addition to the critical accounting policies referenced below, are presented in Note 1 to the Companys Consolidated Financial Statements included in the Companys Annual Report on
Form 10-K
for the year ended September 30, 2015, Accounting Policies.
Estimates and
Assumptions
In preparing the Consolidated Financial Statements, the Company uses certain estimates and assumptions that may affect reported amounts
and disclosures. Estimates and assumptions are used, among other places, when accounting for certain revenue (e.g., contract accounting), expense, and asset and liability valuations. The Company believes that the estimates and assumptions made in
preparing the Consolidated Financial Statements are reasonable, but are inherently uncertain. Assumptions may be incomplete or inaccurate and unanticipated events may occur. The Company is subject to risks and uncertainties that may cause actual
results to differ from estimated results.
Revenues & Expenses
Revenues from contracts for the design, manufacture and sale of asphalt plants are recognized under the percentage-of-completion method. The
percentage-of-completion method of accounting for these contracts recognizes revenue, net of any promotional discounts, and costs in proportion to actual labor costs incurred as compared with total estimated labor costs expected to be incurred
during the entire contract. Pre-contract costs are expensed as incurred. Changes to total estimated contract costs or losses, if any, are recognized in the period in which they are determined. Revenue recognized in excess of amounts billed is
classified as current assets under costs and estimated earnings in excess of billings. The Company anticipates that all incurred costs associated with these contracts at March 31, 2016 will be billed and collected within one year.
Revenues from all other contracts for the design and manufacture of custom equipment, for service and for parts sales, net of any discounts and return
allowances, are recorded when the following four revenue recognition criteria are met: product is delivered or service is performed, persuasive evidence of an arrangement exists, the selling price is fixed or determinable, and collectability is
reasonably assured.
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Return allowances, which reduce product revenue, are estimated using historical experience. The Companys
customers may qualify for certain cash rebates generally based on the level of sales attained during a twelve-month period. Provisions for these rebates, as well as estimated returns and allowances and other adjustments are provided for in the same
period the related sales are recorded.
Product warranty costs are estimated using historical experience and known issues and are charged to production
costs as revenue is recognized.
All product engineering and development costs, and selling, general and administrative expenses are charged to operations
as incurred. Provision is made for any anticipated contract losses in the period that the loss becomes evident.
The allowance for doubtful accounts is
determined by performing a specific review of all account balances greater than 90 days past due and other higher risk amounts to determine collectability and also adjusting for any known customer payment issues with account balances in the
less-than-90-day past due aging buckets. Account balances are charged off against the allowance for doubtful accounts when they are determined to be uncollectable. Any recoveries of account balances previously considered in the allowance for
doubtful accounts reduce future additions to the allowance for doubtful accounts.
Inventories
Inventories are valued at the lower of cost or market, with cost being determined principally by using the last-in, first-out (LIFO) method and
market defined as replacement cost for raw materials and net realizable value for work in process and finished goods. Appropriate consideration is given to obsolescence, excessive levels, deterioration, possible alternative uses and other factors in
determining net realizable value. The cost of work in process and finished goods includes materials, direct labor, variable costs and overhead. The Company evaluates the need to record inventory adjustments on all inventories, including raw
material, work in process, finished goods, spare parts and used equipment. Used equipment acquired by the Company on trade-in from customers is carried at estimated net realizable value. Unless specific circumstances warrant different treatment
regarding inventory obsolescence, the cost basis of inventories three to four years old are reduced by 50%, while the cost basis of inventories four to five years old are reduced by 75%, and the cost basis of inventories greater than five years old
are reduced to zero. Inventory is typically reviewed for obsolescence on an annual basis computed as of September 30, the Companys fiscal year end. If significant known changes in trends, technology or other specific circumstances that
warrant consideration occur during the year, then the impact on obsolescence is considered at that time.
Investments
Marketable debt and equity securities are categorized as trading securities and are thus marked to market and stated at fair value. Fair value is determined
using the quoted closing or latest bid prices for Level 1 investments and market standard valuation methodologies for Level 2 investments. Realized gains and losses on investment transactions are determined by specific identification and
are recognized as incurred in the Consolidated Statements of Operations. Net unrealized gains and losses are reported in the Consolidated Statements of Operations in the current period and represent the change in the fair value of investment
holdings during the period.
Long-Lived Asset Impairment
Property and equipment and intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset (or asset group) may not be recoverable. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated undiscounted cash flows expected to result from the use of the asset and its
eventual disposition. The amount of the impairment loss to be recorded is calculated by the excess over its fair value of the assets carrying value. Fair value is generally determined using a discounted cash flow analysis.
Off-Balance Sheet Arrangements
None
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