Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Cautionary Statement
The Private Securities Litigation Reform Act of 1995
provides a "safe harbor" for forward-looking statements. Information in this Item 2, "Management's Discussion and Analysis
of Financial Condition and Results of Operations," and elsewhere in this 10-Q and its Exhibits that does not consist of historical
facts, are "forward-looking statements." Statements accompanied or qualified by, or containing, words such as "may,"
"will," "should," "believes," "expects," "intends," "plans," "projects,"
"estimates," "predicts," "potential," "outlook," "forecast," "anticipates,"
"presume," and "assume" constitute forward-looking statements and, as such, are not a guarantee of future performance.
The statements involve factors, risks and uncertainties, the impact or occurrence of which can cause actual results to differ materially
from the expected results described in such statements. Risks and uncertainties can include, among others, reductions in capital budgets
by our customers and potential customers; changing product demand and industry capacity; increased competition and pricing pressures;
advances in technology that can reduce the demand for the Company's products; the kind, frequency and intensity of natural disasters that
affect demand for the Company’s products; and other factors, many or all of which are beyond the Company's control. Consequently,
investors should not place undue reliance on forward-looking statements as predictive of future results. The Company disclaims any obligation
to release publicly any updates or revisions to the forward-looking statements herein to reflect any change in the Company's expectations
with regard thereto, or any changes in events, conditions or circumstances on which any such statement is based.
Results of Operations
A summary of the period-to-period changes in the principal
items included in the condensed consolidated statements of income is shown below:
| Summary comparison of the six months ended November 30, 2022 and 2021 |
| | |
Increase / |
| | |
(Decrease) |
| Sales, net | |
$ | 4,522,000 | |
| Cost of goods sold | |
$ | 1,506,000 | |
| Research and development costs | |
$ | 207,000 | |
| Selling, general and administrative expenses | |
$ | 772,000 | |
| Income before provision for income taxes | |
$ | 2,158,000 | |
| Provision for income taxes | |
$ | 438,000 | |
| Net income | |
$ | 1,720,000 | |
Sales under certain fixed-price contracts, in which
the product has no alternative use to the Company and the Company has enforceable rights to payment for progress completed to date, inclusive
of profit, are accounted for under the percentage-of-completion method of accounting whereby revenues are recognized based on estimates
of completion prepared on a ratio of cost to total estimated cost basis. Costs include all material and direct and indirect charges related
to specific contracts.
Adjustments to cost estimates are made periodically
and any losses expected to be incurred on contracts in progress are charged to operations in the period such losses are determined. However,
any profits expected on contracts in progress are recognized over the life of the contract.
For
financial statement presentation purposes, the Company nets progress billings against the total costs incurred and estimated earnings
recognized on uncompleted contracts. The asset, "costs and estimated earnings in excess of billings," represents revenues recognized
in excess of amounts billed. The liability, "billings in excess of costs and estimated earnings," represents billings in excess
of revenues recognized.
For
the six months ended November 30, 2022 (All figures discussed are for the six months ended November 30, 2022 as compared to
the six months ended November 30, 2021).
| | |
Six months ended November 30 | |
Change |
| | |
2022 | |
2021 | |
Amount | |
Percent |
| Net Revenue | |
$ | 19,588,000 | | |
$ | 15,066,000 | | |
$ | 4,522,000 | | |
| 30 | % |
| Cost of sales | |
| 12,109,000 | | |
| 10,603,000 | | |
| 1,506,000 | | |
| 14 | % |
| Gross profit | |
$ | 7,479,000 | | |
$ | 4,463,000 | | |
$ | 3,016,000 | | |
| 68 | % |
| … as a percentage of net revenues | |
| 38 | % | |
| 30 | % | |
| | | |
| | |
The
Company's consolidated results of operations showed a 30% increase in net revenues and an increase in net income of 204%. Revenue for
the first half of fiscal 2023 is higher than any half fiscal year period in the history of the Company. Revenues recorded in the current
period for long-term construction projects (“Project(s)”) were 18% more than the level recorded in the prior year.
The Company had 35 Projects in process during the current period as compared to 28 during the same period last year. Revenues recorded
in the current period for other-than long-term construction projects (non-projects) were 55% more than the level recorded in the prior
year. Total sales within the U.S. increased 43% from the same period last year. Total sales to Asia decreased 4% from the same period
of the prior year. Sales increases were recorded over the same period last year to customers involved in construction of buildings and
bridges (13%) as well as to customers in aerospace / defense (47%) and to industrial customers (93%). The increase in aerospace /defense
sales is due, in part, to a healthy combination of providing production hardware on several legacy programs and new development programs,
along with receiving substantial contracts for the refurbishment of hardware on existing naval platforms. The 108% increase in sales to
industrial customers is primarily due to some new domestic manufacturing facilities beginning operations which utilized the Company’s
products.
In prior years, the Company reported research and
development costs as part of cost of sales and therefore included in the gross profit. Management intends to continue to make significant
investments in research and development in order to promote profitable growth of the Company. In order to more clearly distinguish these
investments from the profitability of a period’s sales, effective with the first quarter of fiscal 2023, the Company is disclosing
research and development costs separately on the Condensed Consolidated Statements of Income below the gross profit line. Prior period
statements of income as well as disclosures in this document have been reclassified to conform with the presentation adopted for the current
period.
The gross profit as a percentage of net revenue of
38% in the current period is eight percentage points greater than the same period of the prior year (30%). The Company has been able to
increase sales prices to recover more of the increased costs for materials and labor that were incurred over the past year. Management
continues to work with suppliers to obtain more visibility of conditions affecting their respective markets. These actions combined with
the increase in volume have helped to improve the gross margin as a percentage of revenue over the prior year.
Sales of the Company’s products are made to
three general groups of customers: industrial, structural and aerospace / defense. A breakdown of sales to the three general groups of
customers is as follows:
| | |
Six months ended November 30 |
| | |
2022 | |
2021 |
| Industrial | |
| 11 | % | |
| 8 | % |
| Structural | |
| 54 | % | |
| 62 | % |
| Aerospace / Defense | |
| 35 | % | |
| 30 | % |
| | |
| | | |
| | |
At
November 30, 2021, the Company had 139 open sales orders in our backlog with a total sales value of $17.0 million. At November
30, 2022, the Company has 139 open sales orders in our backlog, and the total sales value is $18.1 million.
The Company's backlog, revenues, commission expense,
gross profits, and net income fluctuate from period to period. The changes in the current period, compared to the prior period, are not
necessarily representative of future results.
Net
revenue by geographic region, as a percentage of total net revenue for the six-month periods ended November 30, 2022 and November
30, 2021 is as follows:
| | |
Six months ended November 30 |
| | |
2022 | |
2021 |
| | USA | | |
| 80 | % | |
| 73 | % |
| | Asia | | |
| 13 | % | |
| 18 | % |
| | Other | | |
| 7 | % | |
| 9 | % |
Research and Development Costs
| | |
Six months ended November 30 | |
Change |
| | |
2022 | |
2021 | |
Amount | |
Percent |
| R & D | |
$ | 690,000 | | |
$ | 483,000 | | |
$ | 207,000 | | |
| 43 | % |
| … as a percentage of net revenues | |
| 3.5 | % | |
| 3.2 | % | |
| | | |
| | |
Research and development costs stayed consistent as a percent of net revenues
while increasing by 43% over the prior year.
Selling, General and Administrative Expenses
| | |
Six months ended November 30 | |
Change |
| | |
2022 | |
2021 | |
Amount | |
Percent |
| SG&A | |
$ | 3,853,000 | | |
$ | 3,081,000 | | |
$ | 772,000 | | |
| 25 | % |
| … as a percentage of net revenues | |
| 20 | % | |
| 20 | % | |
| | | |
| | |
Selling, general and administrative expenses increased
by 25% from the prior year. This increase is primarily due to increased employee compensation costs including incentive compensation.
The
above factors resulted in an operating income of $2,935,000 for the six months ended November 30, 2022, 227% more than the $899,000
in the same period of the prior year.
A summary of the period-to-period changes in the principal
items included in the condensed consolidated statements of income is shown below:
| Summary comparison of the three months ended November 30, 2022 and 2021 |
| | |
Increase / |
| | |
(Decrease) |
| Sales, net | |
$ | 2,739,000 | |
| Cost of goods sold | |
$ | 1,236,000 | |
| Research and development costs | |
$ | 114,000 | |
| Selling, general and administrative expenses | |
$ | 413,000 | |
| Income before provision for income taxes | |
$ | 1,122,000 | |
| Provision for income taxes | |
$ | 222,000 | |
| Net income | |
$ | 900,000 | |
Sales under certain fixed-price contracts, in which
the product has no alternative use to the Company and the Company has enforceable rights to payment for progress completed to date, inclusive
of profit, are accounted for under the percentage-of-completion method of accounting whereby revenues are recognized based on estimates
of completion prepared on a ratio of cost to total estimated cost basis. Costs include all material and direct and indirect charges related
to specific contracts.
Adjustments to cost estimates are made periodically
and any losses expected to be incurred on contracts in progress are charged to operations in the period such losses are determined. However,
any profits expected on contracts in progress are recognized over the life of the contract.
For
financial statement presentation purposes, the Company nets progress billings against the total costs incurred and estimated earnings
recognized on uncompleted contracts. The asset, "costs and estimated earnings in excess of billings," represents revenues recognized
in excess of amounts billed. The liability, "billings in excess of costs and estimated earnings," represents billings in excess
of revenues recognized.
For
the three months ended November 30, 2022 (All figures discussed are for the three months ended November 30, 2022 as compared
to the three months ended November 30, 2021).
| | |
Three months ended November 30 | |
Change |
| | |
2022 | |
2021 | |
Amount | |
Percent |
| Net Revenue | |
$ | 10,497,000 | | |
$ | 7,758,000 | | |
$ | 2,739,000 | | |
| 35 | % |
| Cost of sales | |
| 6,403,000 | | |
| 5,167,000 | | |
| 1,236,000 | | |
| 24 | % |
| Gross profit | |
$ | 4,094,000 | | |
$ | 2,591,000 | | |
$ | 1,503,000 | | |
| 58 | % |
| … as a percentage of net revenues | |
| 39 | % | |
| 33 | % | |
| | | |
| | |
The
Company's consolidated results of operations showed a 35% increase in net revenues and an increase in net income of 136%. Revenues recorded
in the current period for Projects were 22% more than the level recorded in the prior year. The Company had 28 Projects in process
during the current period as compared to 26 during the same period last year. Revenues recorded in the current period for other-than long-term
construction projects (non-projects) were 64% more than the level recorded in the prior year. Total sales within the U.S. increased 41%
from the same period last year. Total sales to Asia increased 36% from the same period of the prior year. Sales increases were recorded
over the same period last year to customers involved in construction of buildings and bridges (10%) as well as to customers in aerospace
/ defense (59%) and to industrial customers (152%). The increase in aerospace /defense sales is due, in part, to a healthy combination
of providing production hardware on several legacy programs and new development programs, along with receiving substantial contracts for
the refurbishment of hardware on existing naval platforms. The increase in sales to industrial customers is primarily due to some new
domestic manufacturing facilities beginning operations which utilized the Company’s products.
The gross profit as a percentage of net revenue of
39% in the current period is six percentage points higher than the same period of the prior year (33%). The Company has been able to increase
sales prices to recover more of the increased costs for materials and labor that were incurred over the past year. Management continues
to work with suppliers to obtain more visibility of conditions affecting their respective markets. These actions combined with the increase
in volume have helped to improve the gross margin as a percentage of revenue over the prior year.
Sales of the Company’s products are made to
three general groups of customers: industrial, structural and aerospace / defense. A breakdown of sales to the three general groups of
customers is as follows:
| | |
Three months ended November 30 |
| | |
2022 | |
2021 |
| Industrial | |
| 15 | % | |
| 8 | % |
| Structural | |
| 52 | % | |
| 64 | % |
| Aerospace / Defense | |
| 33 | % | |
| 28 | % |
| | |
| | | |
| | |
Net
revenue by geographic region, as a percentage of total net revenue for the three-month periods ended November 30, 2022 and November
30, 2021, is as follows:
| | |
Three months ended November 30 |
| | |
2022 | |
2021 |
| | USA | | |
| 77 | % | |
| 75 | % |
| | Asia | | |
| 17 | % | |
| 16 | % |
| | Other | | |
| 6 | % | |
| 9 | % |
Research and Development Costs
| | |
Three months ended November 30 | |
Change |
| | |
2022 | |
2021 | |
Amount | |
Percent |
| R & D | |
$ | 315,000 | | |
$ | 201,000 | | |
$ | 114,000 | | |
| 57 | % |
| … as a percentage of net revenues | |
| 3.0 | % | |
| 2.6 | % | |
| | | |
| | |
Research and development costs stayed consistent as a percentage of net
revenues while increasing by 57% over the prior year.
Selling, General and Administrative Expenses
| | |
Three months ended November 30 | |
Change |
| | |
2022 | |
2021 | |
Amount | |
Percent |
| S G & A | |
$ | 2,022,000 | | |
$ | 1,609,000 | | |
$ | 413,000 | | |
| 26 | % |
| … as a percentage of net revenues | |
| 19 | % | |
| 21 | % | |
| | | |
| | |
Selling, general and administrative expenses increased
26% from the prior year. This increase is primarily due to increased employee compensation costs including incentive compensation.
The
above factors resulted in an operating income of $1,756,000 for the three months ended November 30, 2022, 125% more than the $780,000
in the same period of the prior year.
Stock Options
The Company has a stock option plan which provides
for the granting of nonqualified or incentive stock options to officers, key employees and non-employee directors. Options granted under
the plan are exercisable over a ten-year term. Options not exercised at the end of the term expire.
The
Company expenses stock options using the fair value recognition provisions of the FASB ASC. The Company recognized $128,000 and $126,000
of compensation cost for the six-month periods ended November 30, 2022 and 2021.
The fair value of each stock option grant has been
determined using the Black-Scholes model. The model considers assumptions related to exercise price, expected volatility, risk-free interest
rate, and the weighted average expected term of the stock option grants. Expected volatility assumptions used in the model were based
on volatility of the Company's stock price for the thirty-month period ending on the date of grant. The risk-free interest rate is derived
from the U.S. treasury yield. The Company used a weighted average expected term.
The following assumptions were used in the Black-Scholes
model to estimate the fair market value of the Company's stock option grants:
| | |
November
2022 | |
November
2021 |
| Risk-free interest rate: | |
| 1.625 | % | |
| 2.875 | % |
| Expected life of the options: | |
| 4.1 years | | |
| 4 years | |
| Expected share price volatility: | |
| 30 | % | |
| 32 | % |
| Expected dividends: | |
| zero | | |
| zero | |
| | |
| | | |
| | |
| These assumptions resulted in estimated fair-market value per stock option: | |
$ | 3.06 | | |
$ | 3.42 | |
The ultimate value of the options will depend on the
future price of the Company's common stock, which cannot be forecast with reasonable accuracy.
A summary of changes in the stock options outstanding
during the six-month period ended November 30, 2022 is presented below:
| | |
| |
Weighted- |
| | |
Number of | |
Average |
| | |
Options | |
Exercise Price |
| Options outstanding and exercisable at May 31, 2022: | |
| 283,000 | | |
$ | 11.43 | |
| Options granted: | |
| 42,000 | | |
$ | 11.45 | |
| Less: Options exercised: | |
| 4,000 | | |
$ | 8.06 | |
| Less: Options expired: | |
| 3,750 | | |
| — | |
| Options outstanding and exercisable at November 30, 2022: | |
| 317,250 | | |
$ | 11.49 | |
| Closing value per share on NASDAQ at November 30, 2022: | |
| | | |
$ | 13.40 | |
Capital Resources and Long-Term Debt
The Company's primary liquidity is dependent upon
the working capital needs. These are mainly inventory, accounts receivable, costs and estimated earnings in excess of billings, accounts
payable, other current liabilities, and billings in excess of costs and estimated earnings. The Company's primary source of liquidity
has been operations.
Capital expenditures for the six months ended November
30, 2022 were $1,391,000 compared to $560,000 in the same period of the prior year. As of November 30, 2022, the Company has commitments
for capital expenditures totaling $1,800,000 during the next twelve months.
The Company believes it is carrying adequate insurance
coverage on its facilities and their contents.
|
Inventory and Maintenance Inventory
|
| | |
November 30, 2022 | |
May 31, 2022 | |
Increase /(Decrease) |
| Raw materials | |
$ | 575,000 | | |
| | | |
$ | 489,000 | | |
| | | |
$ | 86,000 | | |
| 18 | % |
| Work-in-process | |
| 4,901,000 | | |
| | | |
| 5,166,000 | | |
| | | |
| (265,000 | ) | |
| -5 | % |
| Finished goods | |
| 120,000 | | |
| | | |
| 200,000 | | |
| | | |
| (80,000 | ) | |
| -40 | % |
| Inventory | |
| 5,596,000 | | |
| 85 | % | |
| 5,855,000 | | |
| 84 | % | |
| (259,000 | ) | |
| -4 | % |
| Maintenance and other inventory | |
| 972,000 | | |
| 15 | % | |
| 1,107,000 | | |
| 16 | % | |
| (135,000 | ) | |
| -12 | % |
| Total | |
$ | 6,568,000 | | |
| 100 | % | |
$ | 6,962,000 | | |
| 100 | % | |
$ | (394,000 | ) | |
| -6 | % |
| | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
| Inventory turnover | |
| 3.6 | | |
| | | |
| 3.1 | | |
| | | |
| | | |
| | |
NOTE: Inventory turnover is annualized for the six-month
period ended November 30, 2022.
Inventory, at $5,596,000 as of November 30, 2022,
is $259,000 less than the prior year-end level of $5,855,000. Approximately 88% of the current inventory is work in process, 2% is finished
goods, and 10% is raw materials.
Maintenance and other inventory represent stock that
is estimated to have a product life cycle in excess of twelve months. This stock represents certain items the Company is required to maintain
for service of products sold and items that are generally subject to spontaneous ordering. This inventory is particularly sensitive to
technological obsolescence in the near term due to its use in industries characterized by the continuous introduction of new product lines,
rapid technological advances and product obsolescence. Management of the Company has recorded an allowance for potential inventory obsolescence.
The provision for potential inventory obsolescence was zero and $90,000 for the six-month periods ended November 30, 2022 and 2021. The
Company continues to rework slow-moving inventory, where applicable, to convert it to product to be used on customer orders.
Accounts Receivable, Costs and Estimated Earnings
in Excess of Billings (“CIEB"), and Billings in Excess of Costs and Estimated Earnings ("BIEC")
| | |
November 30, 2022 | |
May 31, 2022 | |
Increase /(Decrease) |
| Accounts receivable | |
$ | 5,941,000 | | |
$ | 4,467,000 | | |
$ | 1,474,000 | | |
| 33 | % |
| CIEB | |
| 5,295,000 | | |
| 3,336,000 | | |
| 1,959,000 | | |
| 59 | % |
| Less: BIEC | |
| 1,090,000 | | |
| 1,123,000 | | |
| (33,000 | ) | |
| -3 | % |
| Net | |
$ | 10,146,000 | | |
$ | 6,680,000 | | |
$ | 3,466,000 | | |
| 52 | % |
| | |
| | | |
| | | |
| | | |
| | |
| Number of an average day’s sales outstanding in accounts receivable | |
| 51 | | |
| 42 | | |
| | | |
| | |
| | |
| | | |
| | | |
| | | |
| | |
The Company combines the totals of accounts receivable,
the current asset, CIEB, and the current liability, BIEC, to determine how much cash the Company will eventually realize from revenue
recorded to date. As the accounts receivable figure rises in relation to the other two figures, the Company can anticipate increased cash
receipts within the ensuing 30-60 days.
Accounts
receivable of $5,941,000 as of November 30, 2022 includes $6,000 of an allowance for doubtful accounts (“Allowance”). The
accounts receivable balance as of May 31, 2022 of $4,467,000 included an Allowance of $16,000. The number of an average day's sales outstanding
in accounts receivable (“DSO”) increased from 42 days at May 31, 2022 to 51 at November 30, 2022. The DSO is a function
of 1.) the level of sales for an average day (for example, total sales for the past three months divided by 90 days) and 2.) the level
of accounts receivable at the balance sheet date. The level of sales for an average day in the second quarter of the current fiscal year
is 9% more than in the fourth quarter of the prior year. The level of accounts receivable at the end of the current fiscal quarter is
33% more than the level at the end of the prior year. The increase in the level of accounts receivable off-set by the increase in the
level of an average day’s sales caused the DSO to increase from last year end to this quarter-end. The Company expects to collect
the net accounts receivable balance during the next twelve months. The level of accounts receivable is greater than at the end of the
prior year primarily because of the $1.2 million increase in the level of sales for the month of November 2022 over the month of May 2022.
As noted above, CIEB represents revenues recognized
in excess of amounts billed. Whenever possible, the Company negotiates a provision in sales contracts to allow the Company to bill, and
collect from the customer, payments in advance of shipments. Unfortunately, such provisions are often not possible. The $5,295,000 balance
in this account at November 30, 2022 is 59% more than the prior year-end balance. This increase is the result of normal flow of the Projects
through production with billings to the customers as permitted in the related contracts. The Company expects to bill the entire amount
during the next twelve months. 17% of the CIEB balance as of the end of the last fiscal quarter, August 31, 2022, was billed to those
customers in the current fiscal quarter ended November 30, 2022. The remainder will be billed as the Projects progress, in accordance
with the terms specified in the various contracts.
The balances in this account are comprised of the
following components:
| | |
November 30, 2022 | |
May 31, 2022 |
| Costs | |
$ | 3,380,000 | | |
$ | 3,250,000 | |
| Estimated Earnings | |
| 3,221,000 | | |
| 2,642,000 | |
| Less: Billings to customers | |
| 1,306,000 | | |
| 2,556,000 | |
| CIEB | |
$ | 5,295,000 | | |
$ | 3,336,000 | |
| Number of Projects in progress | |
| 16 | | |
| 11 | |
As noted above, BIEC represents billings to customers
in excess of revenues recognized. The $1,090,000 balance in this account at November 30, 2022 is down 3% from the $1,123,000 balance at
the end of the prior year. The balance in this account fluctuates in the same manner and for the same reasons as the CIEB, discussed above.
Final delivery of product under these contracts is expected to occur during the next twelve months.
The balances in this account are comprised of the
following components:
| | |
November 30, 2022 | |
May 31, 2022 |
| Billings to customers | |
$ | 2,037,000 | | |
$ | 2,711,000 | |
| Less: Costs | |
| 676,000 | | |
| 1,019,000 | |
| Less: Estimated Earnings | |
| 271,000 | | |
| 569,000 | |
| BIEC | |
$ | 1,090,000 | | |
$ | 1,123,000 | |
| Number of Projects in progress | |
| 4 | | |
| 8 | |
Summary of factors affecting the balances in CIEB and BIEC:
| | |
November 30, 2022 | |
May 31, 2022 |
| Number of Projects in progress | |
| 20 | | |
| 19 | |
| Aggregate percent complete | |
| 54 | % | |
| 47 | % |
| Average total sales value of Projects in progress | |
$ | 657,000 | | |
$ | 795,000 | |
| Percentage of total value invoiced to customer | |
| 25 | % | |
| 35 | % |
The Company's backlog of sales orders at November
30, 2022 is $18.1 million, down from the $23.7 million at the end of the prior year. $5.6 million of the current backlog is on Projects
already in progress. While too late to be included in the backlog as of November 30, 2022, the Company recorded an additional $8.2 million
of sales order bookings in the first half of December.
Other Balance Sheet Items
Accounts payable, at $1,537,000 as of November 30,
2022, is 8% more than the prior year-end. Other current liabilities decreased 10% from the prior year-end, to $3,088,000. The Company
expects the current accrued amounts to be paid or applied during the next twelve months.
Management believes the Company's cash flows from
operations are sufficient to fund ongoing operations and capital improvements for the next twelve months.