Techprecision Corp: Form 10-Q for the period ended Jun 30, 2018

Statement Regarding Forward Looking Disclosure

The following discussion of the results of our operations and financial condition should be read in conjunction with the condensed consolidated financial statements and the related notes, which appear elsewhere in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q, including this section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may contain predictive or “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of current or historical fact contained in this quarterly report, including statements that express our intentions, plans, objectives, beliefs, expectations, strategies, predictions or any other statements relating to our future activities or other future events or conditions are forward-looking statements. The words “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “should,” “would” and similar expressions are intended to identify forward-looking statements.

These statements are based on current expectations, estimates and projections made by management about our business, our industry and other conditions affecting our financial condition, results of operations or business prospects. 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 differ materially from what is expressed or implied in the forward-looking statements due to numerous risks and uncertainties. Factors that could cause such outcomes and results to differ include, but are not limited to:

• our reliance on individual purchase orders, rather than long-term contracts, to generate revenue;
• our ability to change the composition of our revenues and effectively reduce operating expenses;
• the availability of appropriate financing facilities impacting our operations, financial condition and/or liquidity;
• our ability to receive contract awards through competitive bidding processes;
• our ability to maintain standards to enable us to manufacture products to exacting specifications;
• our ability to enter new markets for our services;
• our reliance on a small number of customers for a significant percentage of our business;
• competitive pressures in the markets we serve;
• changes in the availability or cost of raw materials and energy for our production facilities;
• operating in a single geographic location;
• restrictions in our ability to our operate our business due to our outstanding indebtedness;
• government regulations and requirements;
• pricing and business development difficulties;
• changes in government spending on national defense;
• our ability to make acquisitions and successfully integrate those acquisitions with our business;
• general economic conditions, industry and market conditions, and growth rates;
• the risks discussed in “Item 1A. Risk Factors” and elsewhere in our 2018 Annual Report on Form 10-K, as well as those described in any other filings which we make with the SEC.

Any forward-looking statements speak only as of the date on which they are made, and 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 Quarterly Report on Form 10-Q, except as required by applicable law. Investors should evaluate any statements made by us in light of these important factors.

Overview

We offer a full range of services required to transform raw materials into precision 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.

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 the 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. Our business is dependent in part on the continuation of governmental programs which require our services and products.

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 predictable cost structures.

We historically have experienced, and continue to experience, customer concentration. For the three months ended June 30, 2018 and 2017, our largest customer accounted for approximately 39% and 50% of reported net sales, respectively. Our sales order backlog at June 30, 2018 was approximately $12.5 million compared with a backlog of $14.0 million at March 31, 2018.

For the three months ended June 30, 2018, our net sales and income before income taxes were $4.1 million and $0.2 million, respectively, compared with net sales and income before income taxes of $5.8 million and $0.7 million, respectively, for the three months ended June 30, 2017. Our gross margin for the three months ended June 30, 2018 was 25.7% compared with gross margin of 29.9% in the three months ended June 30, 2017.

Critical Accounting Policies

The preparation of the unaudited condensed consolidated financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We continually evaluate our estimates, including those related to revenue recognition, 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 results may differ under different assumptions or conditions.

Our significant accounting policies are set forth in detail in Note 2 to the consolidated financial statements included in the 2018 Form 10-K, and in Note 2 to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. We consider the policies relating to revenue recognition to be a critical accounting policy. There have been no significant changes to our critical accounting policies during the three months ended June 30, 2018, except for revenue recognition as noted below.

We recognize revenue when control over a good or service is transferred to the customer. Accounting Standards Codification Topic 606, or ASC 606, sets forth five steps for revenue recognition: identification of the contract, identification of any separate performance obligations in the contracts, determination of the transaction price, allocation of the transaction price to separate performance obligations, and revenue recognition when performance obligations are satisfied.

We recognize revenue over time based on the transfer of control of the promised goods or services to the customer, or at a point in time. This transfer will occur over time when the Company’s performance does not create an asset that has an alternative use to the Company and we have an enforceable right to payment for performance completed to date. Otherwise, control to promised goods or services transfers to customers at a point in time.

The majority of the Company’s contracts have a single performance obligation and provide title to, or grant a security interest in, work-in-process to the customer. In addition, these contracts contain enforceable rights to payment, allowing the Company to recover both its cost and a reasonable margin on performance completed to date. The combination of these factors indicates that the customer controls the asset (and revenue is recognized) as the asset is created or enhanced. The Company measures progress for performance obligations satisfied 1) over time using input methods (e.g., costs incurred, resources consumed, labor hours expended, time elapsed), or 2) at a point in time when units produced are delivered.

Under arrangements where the customer does not have title to, or a security interest in, the work-in-process, our evaluation of whether revenue should be recognized over time requires significant judgment about whether the asset has an alternative use and whether the entity has an enforceable right to payment for performance completed to date. When one or both of these factors is not present, the Company will recognize revenue at the point in time where control over the promised good or service transfers to the customer, which is typically once the customer has taken physical possession of the product the Company has built for the customer.

The Company and its customers occasionally enter into contract modifications, including change orders. We will account for the modification as a separate contract, the termination of an old contract and creation of a new contract, or as part of the original contract, depending on the nature and pricing of the goods or services included in the modification. In general, contract modifications – as well as other changes in estimates of sales, costs, and profits on a performance obligation – are recognized using the cumulative catch-up method of accounting. This method recognizes in the current period the cumulative effect of the changes in current and prior periods. A significant change in an estimate on one or more contracts in a period could have a material effect on the consolidated balance sheet or results of operations for that period. For the three months ended June 30, 2018, net cumulative catch-up adjustments were not material. No individual adjustment was material to the Company's condensed consolidated statements of operations and comprehensive income for the three months ended June 30, 2018.

If incentives and other contingencies are provided as part of the contract, the Company will include in the initial transaction price the consideration to which it expects to be entitled under the terms and conditions of the contract, generally estimated using a most likely amount approach. In the context of variable consideration, the Company limits, or constrains, the transaction price to amounts for which the Company believes a significant reversal of revenue is not probable. Adjustments to constrain the transaction price, may be due to a portion of the transaction price in being in excess of approved funding, a lack of history with the customer, a lack of history with the goods or services being provided, or other items.

New Accounting Pronouncements

See Note 3 - New Accounting Standards to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for a discussion of recently adopted new accounting guidance and new accounting guidance not yet adopted.

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 in foreign markets. Generally, our product mix is made up of short-term contracts with a production timeline of less than twelve months. Units manufactured under the majority of our customer contracts are delivered on time and with a positive gross margin. Our results of operations are also affected by our success in booking new contracts, the timing of revenue recognition, delays in customer acceptances of our products, delays in deliveries of ordered products and our rate of progress fulfilling obligations under our contracts. A delay in deliveries or cancellations of orders could have an unfavorable impact on liquidity, cause us to have inventories in excess of our short-term needs, and delay our ability to recognize, or prevent us from recognizing, revenue on contracts in our order backlog.

Key Performance Indicators

While we prepare our financial statements in accordance with U.S. GAAP, we also utilize and present certain financial measures that are not based on or included in U.S. GAAP. We refer to these as Non-GAAP financial measures. Please see the section “EBITDA Non-GAAP financial measures” below for further discussion of these financial measures, including the reasons why we use such financial measures and reconciliations of such financial measures to the most directly comparable U.S. GAAP financial measures.

Three Months Ended June 30, 2018 and 2017

The following table sets forth information from the Condensed Consolidated Statements of Operations and Comprehensive Income, in dollars and as a percentage of revenue:

(dollars in thousands)

Net Sales

Changes in net sales reflect a different product mix when comparing reporting periods as our customers gauge their demand for new components. For the three months ended June 30, 2018, net sales decreased by $1.7 million, or 30%, to $4.1 million, which includes an increase in recognized revenue of $2.5 million associated with the impact of the implementation of ASC Topic 606, when compared to $5.8 million for the three months ended June 30, 2017. Net sales in our defense market decreased by $1.1 million in the three months ended June 30, 2018 when compared to the three months ended June 30, 2017. The June 30, 2017 net sales were higher because revenue from a greater number of orders was recognized and because of favorable timing with customer delivery schedules in that prior year period. Net sales in our energy market decreased by $0.6 million when compared to the three months ended June 30, 2017, primarily on lower shipment volume of nuclear plant components.

Cost of Sales and Gross Margin

Cost of sales consists primarily of raw materials, parts, labor, overhead and subcontracting costs. Our cost of sales for the three months ended June 30, 2018 decreased by $1.0 million, which is net of an increase of $1.6 million associated with the impact of implementation of ASC Topic 606, compared to the three months ended June 30, 2017, primarily due to lower volume and a change in product mix. Gross profit decreased by $0.7 million for the three months ended June 30, 2018 when compared to the three months ended June 30, 2017. Gross margin was 25.7% for the three months ended June 30, 2018, on a higher volume of low margin sales mix, compared with 29.9% for the three months ended June 30, 2017.

Selling, General and Administrative Expenses

Total SG&A expenses for the three months ended June 30, 2018 decreased by approximately $0.2 million due primarily to a decrease in accrued bonus, share-based compensation expense and outside advisory fees when compared to the three months ended June 30, 2017.

Other Expense, net

Interest expense and amortization of debt issue costs for the three months ended June 30, 2018 were lower when compared to the three months ended June 30, 2017, as we pay down our long-term debt on time. We reduced our overall interest rates on debt when we completed our debt refinancing transactions in fiscal 2017. The following table reflects other income, interest expense and amortization of debt issue costs for the three months ended June 30:

(dollars in thousands)

nm- not meaningful

Income Taxes

For the three months ended June 30, 2018 we recorded tax expense of $65,029, compared to tax expense of $287,635 for the three months ended June 30, 2017. The lower tax expense for the three months ended June 30, 2018 was primarily the result of the lower U.S. federal statutory tax rate of 21% enacted under the Tax Cuts and Jobs Act, or 2017 Tax Act.

Net Income

As a result of the foregoing, for the three months ended June 30, 2018, our net income was $164,385, or $0.01 per share basic and fully diluted, compared with net income of $424,502, or $0.01 per share basic and fully diluted, for the three months ended June 30, 2017.

Liquidity and Capital Resources

At June 30, 2018, we had working capital of $5.1 million as compared with working capital of $4.9 million at March 31, 2018. At June 30, 2018, we had cash and cash equivalents of $2.1 million. We used cash in operating activities of $0.3 million for the three months ended June 30, 2018 as project and production levels began returning to normal levels. In the first quarter of fiscal 2019, the Company successfully secured new contracts for select submarine components. This is compared to net cash provided by operating activities for the three months ended June 30, 2017 of $0.6 million, a quarter where net sales and net income were significantly higher. The table below presents selected liquidity and capital measures as of:

(dollars in thousands)

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

(dollars in thousands)

At June 30, 2018 we were in compliance with all financial covenants contained in all of our debt agreements. We believe our available cash will be sufficient to fund our operations, capital expenditures and principal and interest payments under our debt obligations through the 12 months from the issuance date of our financial statements.

Operating activities

Our primary sources of cash are from accounts receivable collections, customer advance payments and project progress payments. Our customers make advance payments and progress payments under the terms of each manufacturing contract. Our cash flows can fluctuate significantly from period to period as the composition of our receivables collections mix changes between advance payments and customer payments made after shipment of finished goods. Cash used in operations for the three months ended June 30, 2018 was $0.3 million compared with cash provided by operations of $0.6 million for the three months ended June 30, 2017. The three month period ended June 30, 2018 was marked by an increase in customer project activity which resulted in more cash expended to ramp up production offset in part by cash collected from customer advances and progress payments. Favorable timing with customer delivery schedules in the prior year period resulted in higher amounts of cash generated for the three months ended June 30, 2017.

Investing activities

Net cash used in investing activities totaled $101,695 for the three months ended June 30, 2018. The Company will fund any further investments with cash or debt. For the three months ended June 30, 2017, net cash used in investing activities totaled $132,946, primarily made up of a $212,946 deposit for new factory machinery and equipment, offset in part by $80,000 in proceeds from the sale of certain machinery and equipment.

Financing activities

For the three months ended June 30, 2018 and 2017, net cash used in financing activities were $186,896 and $174,591, respectively. Each period consisted of monthly principal payments in connection with our debt obligations.

All of the above activity resulted in a net decrease in cash of $577,857 for the three months ended June 30, 2018 compared with an increase in cash of $266,058 for the three months ended June 31, 2017.

Off-Balance Sheet Arrangements

We do not currently have, and have not had during the three months ended June 30, 2018, any off-balance sheet assets, liabilities or arrangements.

EBITDA Non-GAAP Financial Measure

To complement our condensed consolidated statements of operations and comprehensive income and condensed consolidated statements of cash flows, we use EBITDA, a non-GAAP financial measure. Net income is the financial measure calculated and presented in accordance with U.S. GAAP that is most directly comparable to EBITDA. We believe EBITDA provides our board of directors, management and investors with a helpful measure for comparing our operating performance with the performance of other companies that have different financing and capital structures or tax rates. We also believe that EBITDA is a measure frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry, and is a measure contained in our debt covenants. However, while we consider EBITDA to be an important measure of operating performance, EBITDA and other non-GAAP financial measures have limitations, and investors should not consider them in isolation or as a substitute for analysis of our results as reported under U.S. GAAP.

We define EBITDA as net income plus interest, income taxes, depreciation and amortization. Net income was $164,385 for the three months ended June 30, 2018 as compared to $424,502 for the three months ended June 30, 2017. EBITDA, a non-GAAP financial measure, was $0.5 million for the three months ended June 30, 2018, as compared to $1.0 million for the three months ended June 30, 2017, a decrease of $0.5 million over the prior period.

The following table provides a reconciliation of EBITDA to net income, the most directly comparable U.S. GAAP measure reported in the condensed consolidated financial statements:

(dollars in thousands)

(1) Includes amortization of debt issue costs.

Evaluation of Disclosure Controls and Procedures.

Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are controls and procedures that are designed to ensure that the information required to be disclosed in our 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 includes controls and procedures designed to ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

As of the end of the period covered by this report, an evaluation was carried out, 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. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2018, our disclosure controls and procedures were effective at a reasonable assurance level.

Changes in Internal Control over Financial Reporting

Our evaluation did not identify any change in the Company’s internal control over financial reporting during the quarter ended June 30, 2018 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. We implemented internal controls to ensure we adequately evaluated our contracts and properly assessed the impact of the new accounting standards related to revenue recognition on our financial statements in preparation for the adoption on April 1, 2018. There were no significant changes to the Company’s internal control over financial reporting due to the adoption of the new standard.

Inherent Limitations Over Internal Controls

The Company’s internal control over financial reporting is designed under the supervision of our Chief Executive Officer and Chief Financial Officer, and effected by our board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that the Company’s receipts and expenditures are being made only in accordance with authorizations of the Company’s management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Management, including the Chief Executive Officer and Chief Financial Officer, does not expect that the Company’s internal controls will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of internal controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, any evaluation of the effectiveness of controls in future periods is subject to the risk that those internal controls may become inadequate because of changes in business conditions, or that the degree of compliance with the policies or procedures may deteriorate.