Techprecision Corp: Form 10-Q for the period ended Jun 30, 2012

Statement Regarding Forward Looking Disclosure

The following discussion of the results of our operations and financial condition should be read in conjunction with our consolidated financial statements and the related notes herein. This quarterly report on Form 10Q, including this section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” or MD&A, may contain predictive or “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, statements that express our intentions, beliefs, expectations, strategies, predictions or any other statements relating to our future activities or other future events or conditions. These statements are based on current expectations, estimates and projections about our business based in part on assumptions made by management. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may, and probably will, differ materially from what is expressed or forecasted in the forward-looking statements due to numerous factors. Those factors include those risks discussed in this Item 2 “Management’s Discussion and Analysis” in this Form 10-Q and those described in any other filings which we make with the SEC. In addition, such statements could be affected by risks and uncertainties related to our ability to generate business on an on-going basis, to obtain any required financing, to receive contract awards from the competitive bidding process, maintain standards to enable us to manufacture products to exacting specifications, enter new markets for our services, marketing and customer acceptance, our reliance on a small number of customers for a significant percentage of our business, competition, government regulations and requirements, pricing and development difficulties, our ability to make acquisitions and successfully integrate those acquisitions with our business, as well as general industry and market conditions and growth rates, and general economic conditions. We undertake no obligation to publicly update or revise any forward looking statements to reflect events or circumstances that may arise after the date of this report, except as required by applicable law. Any forward-looking statements speak only as of the date on which they are made, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this report. Investors should evaluate any statements made by the Company in light of these important factors.

Overview

We offer a full range of services required to transform raw materials into precise finished products. Our manufacturing capabilities include: fabrication operations (cutting, press and roll forming, assembly, welding, heat treating, blasting and painting) and machining operations including CNC (computer numerical controlled) horizontal and vertical milling centers. We also provide support services to our manufacturing capabilities: manufacturing engineering (planning, fixture and tooling development, manufacturing), quality control (inspection and testing), materials procurement, production control (scheduling, project management and expediting) and final assembly. All U.S. manufacturing is done in accordance with our written quality assurance program, which meets specific national and international codes, standards, and specifications. Ranor holds several certificates of authorization issued by the American Society of Mechanical Engineers and the National Board of Boiler and Pressure Vessel Inspectors. The standards used are specific to the customers’ needs, and our manufacturing operations are conducted in accordance with these standards.

During fiscal 2012, we brought our WCMC subsidiary online to meet shifting demands from key customers, and simultaneously had to weather slowdowns in our alternative energy business. The impact on our Ranor facility was significant, as manufacturing for their largest customer was transferred to China. We backfilled our Ranor facility with orders from existing and new customers that required domestic production capacity. Also during fiscal 2012, weaker market demand for our services in the Alternative energy industry impacted sales in that sector and were 28% lower than in fiscal 2011. However, we were successful in increasing sales to customers in the Commercial and Nuclear sectors, which more than offset the lower sales volume with Alternative energy customers. We concluded fiscal 2012, with an order backlog of $22.4 million.

Our backlog as of June 30, 2012 was $27.2 million. We expect to deliver a majority of this backlog during fiscal 2013. Our backlog was approximately $32.4 million on July 31, 2012.

We historically have experienced, and continue to experience, customer concentration. Our six largest customers collectively accounted for 77% of our revenue for fiscal 2012. For the first quarter of fiscal 2013 and 2012, our single largest customer accounted for approximately 28% and 48% of reported net sales, respectively. In any year, it is likely that five to six significant customers (albeit not always the same customers from year to year) will account for between 3% to 60% individually and up to 90% in aggregate of our total annual revenues.

Our contracts are generated both through negotiation with the customer and from bids made pursuant to a request for proposal. Our ability to receive contract awards is dependent upon the contracting party’s perception of such factors as our ability to perform on time, our history of performance, including quality, our financial condition and our ability to price our services competitively. Although some of our contracts contemplate the manufacture of one or a limited number of units, we are seeking more long-term projects with a more predictable cost structure.

For the three months ended June 30, 2012 and 2011, our net sales and net loss were $7.1 million and $0.7 million, as compared to net sales of $9.2 million and net income of $0.4 million, respectively. Our gross margins for the three months ended June 30, 2012 and 2011 were 15.5% and 26.5%, respectively. Fiscal 2013 gross margins continued to be dampened by contract losses incurred on first article projects and prototyping for customers of Ranor.

Because our revenues are derived from the sale of goods manufactured pursuant to a contract, and we do not sell from inventory, it is necessary for us to constantly seek new contracts. There may be a time lag between our completion of one contract and commencement of work on another contract. During such periods, we may continue to incur overhead expense but with lower revenue resulting in lower operating margins. Furthermore, changes in either the scope of an existing contract or related delivery schedules may impact the revenue we receive under the contract and the allocation of manpower. Although we provide manufacturing services for large governmental programs, we usually do not work directly for the government or its agencies. Rather, we perform our services for large governmental contractors and large utility companies. However, our business is dependent in part on the continuation of governmental programs which require our services and products.

Growth Strategy

Our strategy is to leverage our core competence as a manufacturer of high-precision, large-scale metal fabrications and machined components to expand our business into areas that have shown increasing demand and which we believe could generate higher margins. In November 2010, we announced the formation of WCMC. This subsidiary was formed to respond to an existing customer’s desire to migrate their supply chain nearer to their end market within China. Since the formation of WCMC, we have received numerous inquiries from current and potential customers for precision, large scale fabricated and machined metal components and systems in Asia. Based on the initial interest expressed, we believe there are attractive opportunities to expand our WCMC operations. During the quarters ended September 30, 2011, December 31, 2011 and March 31, 2012, WCMC provided initial production volumes on a single product line and completed first article production on four other product lines. After qualifying manufacturing capacity for five product lines on behalf of four customers in China, WCMC has received production volume orders for the production of multi-crystalline, mono-crystalline and sapphire chambers in fiscal 2013. At July 31, 2012, WCMC had a backlog of $2.2 million for the production of sapphire chambers.

We believe that rising energy demands along with increasing environmental concerns are likely to continue to drive demand in the Alternative energy industry, particularly the solar, wind and nuclear power industries. Because of our capabilities and the nature of the equipment required by companies in the alternative energy industries, we are uniquely qualified to deliver services in this sector. We also expect to market our services for medical device applications where customer requirements demand strict tolerances and an ability to manufacture complex heavy equipment.

Nuclear Energy

As a result of both the increased prices of oil and gas and the resulting greenhouse gas emissions, nuclear power may become an increasingly important source of energy. In January 2010, the Obama administration increased the level of government-backed debt guarantees as an incentive to support the construction of new nuclear plants in the U.S. The 2011 nuclear tragedy in Japan has bolstered demand for advanced nuclear reactor designs with passive safety systems. Over the next 10 years, 26 nuclear power plants are scheduled to be built in China, six in the United States and five in Europe (including three in the United Kingdom). Because Ranor is one of the few facilities in the United States that has the certifications required to produce the necessary components for these plants, this pipeline of new nuclear projects creates a significant opportunity. Because of our manufacturing capabilities, our certification from the American Society of Mechanical Engineers and our historic relationships with suppliers in the nuclear power industry, we believe that we are well positioned to benefit from any increased activity in the nuclear sector. However, we cannot assure you that we will be able to develop any significant business from the nuclear industry.

Medical Industry

We have been exploring potential business applications focused on the medical industry. These efforts include the development and fabrication of transportation/storage solutions for radioactive isotopes and the development and fabrication of critical components for proton beam therapy machines designed to be utilized in the treatment of cancer. In March 2012, our radioactive isotope customer received approval from the U.S. Nuclear Regulatory Commission, or NRC, to market its type B transportation containers. Now that our radioactive isotope customer has received regulatory approval we hope to receive production volume orders during the 2012 calendar year as they launch their type B transportation containers in the market.

Our proton beam therapy customer has received U.S Food and Drug Administration, or FDA, clearance on June 11, 2012 for their proton beam therapy system and we believe we are positioned to benefit from this development with new production orders as they begin marketing their regulated product.

LED Lighting/Enabled Products

Growing global demand for LED lighting and LED enabled products has increased the worldwide demand for Heat Exchanger Method (HEM) sapphire, a core component in high-end LED products. Accordingly, many polysilicon companies, including our customer GTAT, are expanding into the field of HEM sapphire and existing players in the HEM sapphire industry are expanding their production capacity. The production of HEM sapphire requires robust high temperature furnaces much like those we have been producing for the processing of polysilicon within the solar industry. Accordingly, we believe the HEM sapphire field is a growing sector where our manufacturing expertise and experience with similar products for the solar industry can be directly leveraged. We are in active dialogue with both existing customers and potential customers regarding our capability and capacity to manufacture furnaces for the HEM sapphire industry in both the U.S. and Asia. In February 2012, WCMC received a purchase agreement from an existing customer for up to $9.5 million in sapphire chamber orders over the term of the purchase agreement which contemplates orders being placed under the agreement from March 2012 through February 2013. As of July 31, 2012, we have received purchase orders for $2.2 million of sapphire chambers under this purchase agreement. We are also working on qualifying manufacturing capacity for other customers who also have developed engineering designs for sapphire growth chambers.

Solar Power

Historically we have participated in the multi-crystalline segment of the solar industry through the manufacturing support we have provided GTAT. Increasingly, GTAT and other companies are focusing on production innovations that will improve the production efficiency and cost competitiveness of mono-crystalline solar cells. To diversify our customer and sector concentration within the solar industry, we are in active discussions with various companies focused on enabling production equipment for mono-crystalline solar cells and believe these efforts will provide us with broader capacity and customer diversification in the future. During fiscal 2012, we completed manufacture of initial mono-crystalline furnaces for three separate customers with the goal of qualifying our production capacity in the U.S. and China for these customers and subsequent production volume orders.

During fiscal 2012, we expanded into the polysilicon field through receipt of a $4.8 million order to manufacture polysilicon reactor chambers for an existing customer. Polysilicon reactor chambers operate upstream of the solar equipment we have historically manufactured. Accordingly, this order presents an opportunity to further diversify our product portfolio within the solar sector. The initial production units covered by this order are expected to ship in fiscal 2013.

Expansion of Manufacturing Capabilities

In addition to the expansion of our existing manufacturing capabilities, we may, from time to time, pursue opportunistic acquisitions to increase and strengthen our manufacturing, marketing, product development and customer diversification. During fiscal 2012, we completed a 19,500 square foot expansion of our Westminster, Massachusetts facility at a cost of $1.7 million. The building expansion was completed and placed into service in September, 2011. We also completed the installation of a new $2.4 million gantry mill machine during the year and it was placed in service during January 2012. A portion of the proceeds from December 2010 municipal bond financing were utilized to finance the building expansion and final payments on the gantry machine.

Critical Accounting Policies

The preparation of our consolidated financial statements and related disclosures in conformity with generally accepted accounting principles in the United States requires management to make assumptions, estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Note 2 to the Consolidated Financial Statements describes the significant accounting policies used in preparation of the consolidated financial statements. We rely on historical experience and other assumptions we believe to be reasonable in making our estimates. We continually evaluate our estimates, including those related to contract accounting, inventories, recovery of long-lived assets, income taxes and the valuation of equity transactions. These estimates and assumptions require management’s most difficult, subjective or complex judgments. Actual financial results of the operations could differ materially from such estimates.

Percentage-of-completion is considered the revenue recognition model that best reflects the economics for our custom contracts. As a result of the transfer of solar production chambers for Ranor’s largest customer to WCMC during fiscal 2012, Ranor’s product mix changed and included a heavy volume of prototyping and first article production. These types of projects necessitated a different type of percentage-of-completion method of accounting for revenue recognition purposes. As a result, we are accounting for these types of projects based on an inputs based method utilizing labor hours incurred on the projects to determine progress toward completion.

Revenue Recognition

We account for revenues and earnings in our business using the percentage-of-completion method of accounting. We recognize contract revenue under this method as the work progresses, either as the products are produced and delivered, or as services are rendered. We determine progress toward completion on production contracts based on either input measures, such as labor hours incurred, or output measures, such as units delivered.

Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability are recognized in the period in which the revisions are determined. Costs incurred on uncompleted contracts consist of labor, overhead, and materials. Work in process is stated at the lower of cost or market.

We may combine contracts for accounting purposes when they are negotiated as a package with an overall profit margin objective. These essentially represent an agreement to do a single project for a single customer, involve interrelated construction activities with substantial common costs, and are performed concurrently or sequentially. When a group of contracts is combined, revenue and profit are earned during the performance of the combined contracts. We may segment a single contract or group of contracts when a clear economic decision has been made during contract negotiations that would produce different rates of profitability for each element or phase of the contract.

Costs allocable to undelivered units are reported in the consolidated balance sheet as costs incurred on uncompleted contracts. Amounts in excess of agreed upon contract price for customer directed changes, construction changes, customer delays or other causes of additional contract costs are recognized in contract value if it is probable that a claim for such amounts will result in additional revenue and the amounts can be reliably estimated. Revenues from such claims are recorded only to the extent that contract costs have been incurred. Revisions in cost and profit estimates are reflected in the period in which the facts requiring the revision become known and are estimable. The unit of delivery method requires the existence of a contract to provide the persuasive evidence of an arrangement and determinable seller’s price, delivery of the product and reasonable collection prospects. We have written agreements with the customers that specify contract prices and delivery terms. We recognize revenues only when the collectability is reasonably assured.

When we can only estimate a range of revenues and costs, we use the most likely estimate within the range. If we cannot determine which estimate in the range is most likely, the amounts within the ranges that would result in the lowest profit margin (the lowest contract revenue estimate and the highest contract cost estimate) is used.

Income Taxes

We provide for federal and state income taxes currently payable, as well as those deferred because of temporary differences between reporting income and expenses for financial statement purposes versus tax purposes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recoverable. The effect of the change in the tax rates is recognized as income or expense in the period of the change. A valuation allowance is established, when necessary, to reduce deferred income taxes to the amount that is more likely than not to be realized.

As of June 30, 2012, our federal net operating loss carry-forward was approximately $1.5 million. If not utilized, the federal net operating loss carry-forward will begin to expire in 2025. Furthermore, because of the over fifty-percent change in ownership as a consequence of the reverse acquisition of Ranor in February 2006, the amount of net operating loss carry forward used in any one year in the future is substantially limited.

New Accounting Pronouncements

See Note 2, Significant Accounting Policies, in the Notes to our Consolidated Financial Statements.

Results of Operations

Our results of operations are affected by a number of external factors including the availability of raw materials, commodity prices (particularly steel), macroeconomic factors, including the availability of capital that may be needed by our customers, and political, regulatory and legal conditions in the United States and foreign markets.

Our results of operations are also affected by our success in booking new contracts and when we are able to recognize the related revenue, delays in customer acceptances of our products, delays in deliveries of ordered products and our rate of progress in the fulfillment of our obligations under our contracts. A delay in deliveries or cancellations of orders would cause us to have inventories in excess of our short-term needs, and may delay our ability to recognize, or prevent us from recognizing, revenue on contracts in our order backlog.

At the end of June 30, 2012, our purchase order backlog was $27.2 million compared with $22.4 million at March 31, 2011. Our backlog was approximately $32.4 million on July 31, 2012.

Three Months Ended June 30, 2012 and 2011

The following table sets forth information from our statements of operations for the three months ended June 30, 2012 and 2011, in dollars and as a percentage of revenue:

(dollars in thousands)

Net Sales

Net sales decreased by $2.0 million, or 22%, to $7.1 million for the three months ended June 30, 2012 when compared to the same period last year. This decrease in net sales was impacted by our customers in Alternative Energy, Nuclear and Commercial sectors by $3.5, $0.4 and $0.3 million, respectively, when compared with the three months ended June 30, 2011. Net sales to our largest customer in Alternative Energy decreased by $4.0 million during the quarter ended June 30, 2012 when compared with the same quarterly period one year ago because of weaker demand for alternative energy products. The decrease in net sales was partially offset by sales to our customers in the Defense and Aerospace, and Medical markets which increased by $1.4 and $0.8 million, respectively.

Cost of Sales and Gross Margin

Our cost of sales for the three months ended June 30, 2012 decreased by $0.7 million to $6.0 million, or 11%, from $6.7 million for the same period in fiscal 2012. The decrease in the cost of sales was principally due to a decrease in the volume of shipments to our customers. Gross profit was $1.1 million compared with $2.4 million for the three month periods ended June 30, 2012 and June 30, 2011, respectively. Gross margins were 16% and 26% for the same comparable periods, respectively.

Gross margin in any reporting period is impacted by the mix of services we provide on projects completed within that period. Gross margins during fiscal 2013 decreased because of lower gross profit and additional contract losses ($0.4 million) on contracts for first article production and prototyping at Ranor. Ranor’s production mix shifted to a greater volume of prototyping and first article production during fiscal 2012 as we redeployed open U.S. production capacity because of the transfer of solar production chambers to China for our largest customer.

Selling, General and Administrative Expenses

Selling, general and administrative, or SG&A, expenses for the three months ended June 30, 2012 were $2.0 million compared to $1.7 million for three months ended June 30, 2011, representing an increase of $0.3 million or 15%. SG&A was 28% as a percentage of sales during the first quarter of fiscal 2013, compared with 19% of net sales for the same period in fiscal 2012. Primary drivers of this increase in expense were higher fringe benefit costs of $0.1 million and outside accounting and auditing services of $0.1 million. Additionally, we incurred an increase of $0.1 million in local operating costs for WCMC’s local SG&A costs versus the prior year same quarter.

Interest Expense

The following table reflects other income and interest expense for the three months ended June 30:

Interest expense increased by 37% or $21,400 for the three months ended June 30, 2012 when compared with the same period in fiscal 2011. This increase in interest expense is due to higher average levels of long-term debt for the current year three month period when compared to the same prior year quarter.

Income Taxes

For the three months ended June 30, 2012, we recorded a tax benefit of $0.3 million compared to income tax expense for federal and state of $0.3 million when compared to the three months ended June 30, 2011. The tax benefit for the three months ended June 30, 2012 was primarily the result of pretax losses from operations recorded at the U.S. federal and state statutory tax rates. The Company expects its effective tax rate for fiscal 2013 to be 33%.

Our future effective tax rate would be affected if earnings were lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates, by changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws, regulations, accounting principles, or interpretations thereof. We regularly assess the effects resulting from these factors to determine the adequacy of our provision for income taxes.

Net (Loss) Income

As a result of the factors described above, our net loss was $0.7 million, or $0.04 per share basic and fully diluted respectively, for the three months ended June 30, 2012, compared to net income of $0.4 million, or $0.02 per share basic and $0.01 per share fully diluted, for the three months ended June 30, 2011.

Liquidity and Capital Resources

At June 30, 2012, we had working capital of $9.6 million as compared with working capital of $10.2 million at March 31, 2012, representing a decrease of $0.6 million or 6%. The following table sets forth information as to the principal changes in the components of our working capital:

(dollars in thousands)

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The following table summarizes our primary cash flows for the periods presented:

(dollars in thousands)

Operating activities

For the three months ended June 30, 2012, cash provided by operations was $1.9 million as compared with cash provided by operations of $1.4 million for the comparable fiscal 2012 period, a change of $0.5 million. Cash provided by operations in fiscal 2013 were impacted by receipt of approximately $3.0 million in customer deposits reflecting an increase in customer orders and manufacturing activity. This amount was partially offset by a swing from net income to a net loss of $1.1 million and increased spending on completed projects and uncompleted projects in progress because of the remaining volume mix of manufacturing activity related to new production projects which began in fiscal 2012. We also received $0.6 million for estimated federal and state income taxes refunded in fiscal 2013. We expect another $0.2 million will be refunded when state tax returns are filed in fiscal 2013.

Investing activities

During the three months ended June 30, 2012, we purchased approximately $20,000 in new equipment at our manufacturing facility in Westminster, MA.

Financing activities

Net cash used in financing activities was $0.3 million during the three months ended June 30, 2012 as compared with net cash used in financing activities of $0.1 million for the same period in fiscal 2012. The primary use of cash under financing activities in fiscal 2013 and 2012 related to repayment of long-term debt.

Debt Facilities

On December 30, 2010, the Company completed a $6,200,000 tax exempt bond financing with the MDFA pursuant to which the MDFA sold to the Bank the Series A Bonds and the Series B Bonds. The Bank then loaned the proceeds of such sale to the Company under the terms of the MLSA.

The proceeds from the sale of the Series A Bonds were used to finance the Ranor facility acquisition and used to finance the 19,500 sq. ft. expansion of Ranor’s manufacturing facility located in Westminster, MA. The proceeds of the sale of the Series B Bonds used to finance acquisitions of qualifying manufacturing equipment installed at the Westminster facility. Under the MLSA and related documents, the Westminster facility secures, and the Company further guarantees the Company’s obligations to the Bank and subsequent holders of the Bonds.

In connection with the December 30, 2010 financing, we executed an Eighth Amendment to the Loan Agreement. The Eighth Amendment incorporated borrowing of the Bond proceeds into the borrowings covered by the Loan Agreement. Under the MLSA and the Eighth Amendment, we must meet certain financial covenants applicable while the Bonds remain outstanding. As of December 31, 2011, we were in compliance with the leverage ratio. However we did not meet the ratio of earnings available to cover fixed charges or the interest coverage covenants.

In February 2012, we executed a Tenth Amendment and obtained a waiver of the breach of such covenants from the Bank, which waiver covered the breach that otherwise would have occurred in connection with the covenant testing for the third quarter ended December 31, 2011 and waived the fixed charge covenant at March 31, 2012.

On July 6, 2012, we executed an Eleventh Amendment and obtained a waiver for failure to comply with the Fixed Charge Coverage Ratio and the Interest Coverage Ratio covenants at March 31, 2012. The Eleventh Amendment also waived the covenant testing related to the ratio of earnings available to cover fixed charges and the interest coverage ratio for the fiscal quarters ended June 30, 2012 and September 30, 2012. The leverage covenant remained in effect. Without the execution of the Eleventh Amendment for the applicable periods the Company would have been required to reclassify all of its long-term debt as a current liability at June 30, 2012. In addition, if the lender had demanded repayment and caused the debt to be considered as short-term obligation, the Company would have been unable to pay the obligation because the Company does not have existing facilities or sufficient cash on hand to satisfy these obligations. Although there will be no testing of the ratio of earnings available to cover fixed charges and the interest coverage covenant testing for the fiscal quarters ended at June 30 and September 30, 2012, the Bank requires that the Company have EBIT (earnings before interest and taxes) greater than $1 for the fiscal quarter ended September 30, 2012. The waiver does not apply to any future covenant testing dates beyond the fiscal quarter ended December 31, 2012.

In addition as part of the Eleventh Amendment, the Bank required the Company to transfer $840,000 into an interest-bearing restricted cash account as additional collateral. This collateral will be released to the Company upon successful compliance with all debt covenant tests. The earliest date this could occur is December 31, 2012, the first date the Company will again be subject to all of the financial covenants. The ratio of earnings available to cover fixed charges and the interest coverage covenant testing will resume at December 31, 2012 on a trailing six month basis, and continue at March 31, 2013 on a trailing nine month basis and quarterly thereafter on a trailing twelve month basis beginning on June 30, 2013. Under the amendment the Company shall not permit earnings available for fixed charges to be less than 125%, interest coverage to be less than 2:1, and the leverage ratio to be greater than 2:1 at any time, tested quarterly. The Company believes that it will remain in compliance with all of the revised covenants through at least September 30, 2013.

We believe that the $2.0 million revolving credit facility that expires on January 31, 2013, all of which is available and unused as of June 30, 2012, our capacity to access equipment-specific financing, plus our current cash balance of $4.3 million and ability to generate cash from operations, will be sufficient to enable us to satisfy our cash requirements for the foreseeable future. Nevertheless, it is possible that we may require additional funds to the extent that we upgrade or expand our manufacturing facilities.

Obligations under the Term Note, Revolving Note, Capital Expenditure Note and Staged Advance Note are guaranteed by us. Collateral securing such notes comprises all personal property of ours, including cash, accounts receivable, inventories, equipment, financial and intangible assets.

The term note issued on February 24, 2006 has a term of seven years with an initial fixed interest rate of 9%. The interest rate on the term note converted from a fixed rate of 9% to a variable rate on February 28, 2011. From February 28, 2011 until maturity the term note will bear interest at the prime rate plus 1.5%, payable on a quarterly basis. Principal is payable in quarterly installments of $142,857 plus interest, with a final payment due on March 1, 2013. The balance outstanding on the term note as of June 30, 2012 was $428,572.

We also had a $3.0 million capital expenditure facility which was available until November 30, 2009. The capital expenditure facility was not renewed upon its expiration on November 30, 2009. Borrowings available under this facility were converted to a note when the facility terminated. Principal and interest payments are due monthly based on a five year amortization schedule. The current rate of interest is based on LIBOR, plus 3%. Any unpaid balance on the capital expenditures facility is to be paid on November 30, 2014. As of June 30, 2012, there was $416,506 outstanding under this facility.

Under a Staged Advance Facility, the Bank made certain loans to the Company limited to a cap of $1,900,000 for the purpose of acquiring a gantry mill machine. The machine serves as collateral for the loan. The total aggregate amount of advances under this agreement could not exceed 80% of the actual purchase price of the gantry mill machine. All advances provided for payment of interest only monthly through February 28, 2011, and thereafter no further borrowings are permitted under this facility. The interest rate is LIBOR plus 4%. Beginning on April 1, 2011, the Company is obligated to pay principal and interest sufficient to amortize the outstanding balance on a five year schedule. As of June 30, 2012, there was $445,133 outstanding under this facility.

The securities purchase agreement pursuant to which we sold Series A Convertible Preferred Stock to Barron Partners provides Barron Partners with a right of first refusal on future equity financings, which may affect our ability to raise funds from other sources if the need arises. In the event that we make an acquisition, we may require additional financing for the acquisition. We have no commitment from any party for additional funds, however, the terms of our agreement with Barron Partners, particularly the right of first refusal, may impair our ability to raise capital in the equity markets to the extent that potential investors would be reluctant to negotiate a financing when another party has a right to match the terms of the financing. We have no off-balance sheet assets or liabilities.

Evaluation of Disclosure Controls and Procedures

As of June 30, 2012, we carried out an evaluation, under the supervision and with the participation of management, including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, or Exchange Act.

Disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits to the SEC is recorded, processed, summarized and reported, within the time periods specified in SEC rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were designed and operating effectively as of June 30, 2012, to provide reasonable assurance that information required to be disclosed by the Company in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Controls

During the three months ended June 30, 2012, there were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes to the risk factors discussed in Part I, "Item 1A. Risk Factors," in the 2012 Form 10-K. You should carefully consider the risks described in our 2012 Form 10-K which could materially affect our business, financial condition or future results. The risks described in our 2012 Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. If any of the risks actually occur, our business, financial condition and/or results of operations could be negatively affected.