Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Gencor
Industries, Inc. (the Company) is a leading manufacturer of heavy machinery used in the production of highway construction materials, synthetic fuels, and environmental control equipment. The Companys core products include asphalt
plants, combustion systems and fluid heat transfer systems. The Companys products are manufactured in two facilities in the United States.
Because
the Companys products are sold primarily to the highway construction industry, the business is seasonal in nature. Traditionally, the Companys customers do not purchase new equipment for shipment during the summer and fall months to
avoid disrupting their peak season for highway construction and repair work. The majority of orders for the Companys products are thus received between October and February, with a significant volume of shipments occurring prior to June. The
principal factors driving demand for the Companys products are the overall economic conditions, the level of government funding for domestic highway construction and repair, Canadian infrastructure spending, the need for spare parts,
fluctuations in the price of crude oil (liquid asphalt as well as fuel costs), and a trend towards larger plants resulting from industry consolidation.
On December 4, 2015, President Obama signed into law a five-year, $305 billion transportation bill, Fixing Americas Surface Transportation Act
(the FAST Act). The FAST Act reauthorized the collection of the 18.4 cents per gallon gas tax that is typically used to pay for transportation projects. It also included $70 billion from other areas of the federal budget to close a
$16 billion annual funding deficit. The bill includes spending of more than $205 billion on roads and highways over five years. The 2016 funding levels are approximately 5% above 2015 projected funding, with annual increases between 2.0%
and 2.5% from 2016 through 2020.
Californias Senate Bill 1 (SB1), the Road Repair and Accountability Act of 2017, was signed into law
on April 28, 2017. The legislative package invests $54 billion over the next decade to fix roads, freeways and bridges in communities across California and puts more dollars towards transit and safety. These funds will be allocated to
state and local projects.
The Canadian government has also enacted major infrastructure stimulus programs. In 2007, the Building Canada Plan provided
$33 billion in infrastructure funding through 2014. The 2014 New Building Canada Fund is one component within the $53 billion 2014 New Building Canada Plan. The 2014 New Building Canada Fund provided funding for infrastructure projects at
the national, provincial and local levels.
In addition to government funding and overall economic conditions, fluctuations in the price of oil, which is
a major component of asphalt mix, may affect the Companys financial performance. An increase in the price of oil increases the cost of liquid asphalt and could, therefore, decrease demand for hot mix asphalt paving materials and certain of the
Companys products. Increases in oil prices also drive up the cost of gasoline and diesel, which results in increased freight costs. Where possible, the Company will pass increased freight costs on to its customers. However, the Company may not
be able to recapture all of the increased costs and thus could have a negative impact on the Companys financial performance.
Steel is a major
component used in manufacturing the Companys equipment. The Company is subject to fluctuations in market prices for raw materials such as steel. If the Company is unable to purchase materials it requires or is unable to pass on price increases
to its customers or otherwise reduce its cost of goods sold, its business results of operations and financial condition may be adversely affected.
The
Company believes its strategy of continuing to invest in product engineering and development and its focus on delivering the highest quality products and superior service will strengthen the Companys market position. The Company continues to
review its internal processes to identify inefficiencies and cost-reduction opportunities. The Company will continue to scrutinize its relationships with external suppliers to ensure it is achieving the highest quality materials and services at the
most competitive cost.
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Results of Operations
Quarter Ended December 31, 2017 versus December 31, 2016
Net revenues for the quarters ended December 31, 2017 and December 31, 2016 were $23,122,000 and $15,783,000, respectively, an increase of $7,339,000
or 46.5%. The FAST Act, along with plans to increase domestic infrastructure spending at the federal level, has resulted in an increase in asphalt plant and component orders. Domestic highway contractors continue to have a positive outlook supported
by favorable market conditions.
As a percent of sales, gross profit margins were 22.0% in the quarter ended December 31, 2017, compared to 26.3% in
the quarter ended December 31, 2016. Gross profit margins declined as the Company increased its manufacturing overhead to support the significantly higher production, as annual revenues have doubled over the past two years.
Product engineering and development expenses increased $284,000 for the quarter ended December 31, 2017 as compared to the quarter ended
December 31, 2016, due to increased staffing to meet the higher demands for our engineered products. Selling, general and administrative (SG&A) expenses increased $502,000 to $2,692,000 for the quarter ended December 31,
2017, compared to the quarter ended December 31, 2016. Headcount additions, higher sales commissions, and increased advertising and trade show expenses to capitalize on the renewed optimism within the highway construction industry contributed
to most of the increase in SG&A expenses.
As a result of the improved revenues, the Company had higher operating income of $1,691,000 for the quarter
ended December 31, 2017 versus operating income of $1,544,000 for the quarter ended December 31, 2016.
For the quarter ended December 31,
2017, interest and dividend income, net of fees, from the investment portfolio was $293,000 as compared to $41,000 in the quarter ended December 31, 2016. The increase was due to additional interest income from investments in corporate bonds.
The net realized and unrealized gains on marketable securities were $161,000 for the quarter ended December 31, 2017 versus $407,000 for the quarter ended December 31, 2016.
The effective income tax rate for the quarter ended December 31, 2017 was a benefit of (9.2%) compared to expense of 30.0% for the quarter ended
December 31, 2016. The 2017 benefit resulted from a $0.7 million adjustment to the net deferred tax liability as a result of applying the lower corporate tax rates to comply with the recently enacted Tax Reform.
Net income for the quarter ended December 31, 2017 was $2,346,000 or $0.16 basic and diluted earnings per share versus net income of $1,394,000 or $0.10
basic and diluted earnings per share for the quarter ended December 31, 2016.
Liquidity and Capital Resources
The Company generates capital resources through operations and returns on its investments.
The Company had no long-term debt outstanding at December 31, 2017 or September 30, 2017. The Company does not currently require a credit facility.
As of December 31, 2017, the Company had funded $135,000 in cash deposits at insurance companies to cover collateral needs.
As of December 31,
2017, the Company had $24,863,000 in cash and cash equivalents, and $88,340,000 in marketable securities, including $42,499,000 in government securities, $16,387,000 in corporate bonds, $10,777,000 in equities, $8,730,000 in mutual funds, $4,508,000
in exchange-traded funds and $5,439,000 in cash and money funds. The marketable securities are invested through a global professional investment management firm. These securities may be liquidated at any time into cash and cash equivalents.
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The Companys backlog was $50.2 million at December 31, 2017, compared to $40.8 million at
December 31, 2016. The Companys working capital (defined as current assets less current liabilities) was equal to $125.0 million at December 31, 2017 and $124.7 million at September 30, 2017. The significant purchases,
sales and maturities of marketable securities shown on the condensed consolidated statements of cash flows reflect the recurring purchase and sale of United States treasury bills. Cash provided by operations during the quarter ended
December 31, 2017 was $3,617,000. Costs and estimated earnings in excess of billings decreased $1,041,000 and customer deposits decreased $1,315,000, reflecting the percentage of completion and timing of recognition of revenues on
jobs-in-progress
at December 31, 2017. Accounts payable increased from increased raw material purchases for production to meet the growth in customer orders.
Cash used in investing activities for the quarter ended December 31, 2017 of $1,954,000 related to capital expenditures, primarily new manufacturing
machinery for handling and processing raw materials. Cash provided by financing activities of $267,000 for the quarter ended December 31, 2017 related to proceeds from the exercise of stock options.
Seasonality
The Company is concentrated in the
manufacturing of asphalt plants and related components, which is typically subject to a seasonal slow-down during the third and fourth quarters of the calendar year.
Forward-Looking Information
This Report on Form
10-Q
contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended
(the Exchange Act), which represent the Companys expectations and beliefs, including, but not limited to, statements concerning gross margins, sales of the Companys products and future financing plans. These statements by
their nature involve substantial risks and uncertainties, certain of which are beyond the Companys control. Actual results may differ materially depending on a variety of important factors, including the financial condition of the
Companys customers, changes in the economic and competitive environments and demand for the Companys products.
For information concerning
these factors and related matters, see the following sections of the Companys Annual Report on Form
10-K
for the year ended September 30, 2017: (a) Risk Factors in Part I and (b)
Managements Discussion and Analysis of Financial Condition and Results of Operations in Part II. However, other factors besides those referenced could adversely affect the Companys results, and you should not consider any
such list of factors to be a complete set of all potential risks or uncertainties. Any forward-looking statements made by the Company herein speak as of the date of this Report. The Company does not undertake to update any forward-looking
statements, except as required by law.
Critical Accounting Policies, Estimates and Assumptions
The Company believes the following discussion addresses its most critical accounting policies, which are those that are most important to the portrayal of the
financial condition and results of operations and require managements most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Accounting
policies, in addition to the critical accounting policies referenced below, are presented in Note 1 to the Companys Consolidated Financial Statements included in the Companys Annual Report on Form
10-K
for the year ended September 30, 2017, Accounting Policies.
Estimates and Assumptions
In preparing the Condensed Consolidated Financial Statements, the Company uses certain estimates and assumptions that may affect reported amounts and
disclosures. Estimates and assumptions are used, among other places, when accounting for certain revenue (e.g., contract accounting), expense, and asset and liability valuations. The Company believes that the estimates and assumptions made in
preparing the Condensed Consolidated Financial Statements are reasonable, but are inherently uncertain. Assumptions may be incomplete or inaccurate and unanticipated events may occur. The Company is subject to risks and uncertainties that may cause
actual results to differ from estimated results.
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Revenues & Expenses
Revenues from contracts for the design, manufacture and sale of asphalt plants are recognized under the
percentage-of-completion
method. The
percentage-of-completion
method of accounting for these contracts recognizes revenue, net
of any promotional discounts, and costs in proportion to actual labor costs incurred as compared with total estimated labor costs expected to be incurred during the entire contract.
Pre-contract
costs are
expensed as incurred. Changes to total estimated contract costs or losses, if any, are recognized in the period in which they are determined. Revenue recognized in excess of amounts billed is classified as current assets under costs and
estimated earnings in excess of billings. The Company anticipates that all incurred costs associated with these contracts at December 31, 2017, will be billed and collected within one year.
Revenues from all other contracts for the design and manufacture of custom equipment, for service and for parts sales, net of any discounts and return
allowances, are recorded when the following four revenue recognition criteria are met: product is delivered/ownership is transferred or service is performed, persuasive evidence of an arrangement exists, the selling price is fixed or determinable,
and collectability is reasonably assured.
In May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers
: (Topic 606)
(ASU 2014-09), amending its accounting guidance related to revenue recognition. Under this ASU and subsequently issued amendments, revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects
the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is effective for annual periods beginning after December 15, 2017. The Company plans to adopt the new standard in fiscal 2019. The
Company does not expect the adoption of this standard to have a material impact on its results of operations and is currently evaluating which one of the two retrospective methods will be used for implementation.
Provisions for estimated returns and allowances and other adjustments are provided for in the same period the related sales are recorded. Returns and
allowances, which reduce product revenue, are estimated using historical experience.
Product warranty costs are estimated using historical experience and
known issues and are charged to production costs as revenue is recognized.
All product engineering and development costs, and selling, general and
administrative expenses are charged to operations as incurred. Provision is made for any anticipated contract losses in the period that the loss becomes evident.
The allowance for doubtful accounts is determined by performing a specific review of all account balances greater than 90 days past due and other higher risk
amounts to determine collectability and also adjusting for any known customer payment issues with account balances in the
less-than-90-day
past due aging buckets.
Account balances are charged off against the allowance for doubtful accounts when they are determined to be uncollectable. Any recoveries of account balances previously considered in the allowance for doubtful accounts reduce future additions to the
allowance for doubtful accounts.
Inventories
Inventories are valued at the lower of cost or market, with cost being determined principally by using the
last-in,
first-out
(LIFO) method and market defined as replacement cost for raw materials and net realizable value for work in process and finished goods. Appropriate consideration is given to obsolescence,
excessive levels, deterioration, possible alternative uses and other factors in determining net realizable value. The cost of work in process and finished goods includes materials, direct labor, variable costs and overhead. The Company evaluates the
need to record inventory adjustments on all inventories, including raw material, work in process, finished goods, spare parts and used equipment. Used equipment acquired by the Company on
trade-in
from
customers is carried at estimated net realizable value. Unless specific circumstances warrant different treatment regarding inventory obsolescence, the cost basis of inventories three to four years old are reduced by 50%, while the cost basis of
inventories four to five years old are reduced by 75%, and the cost basis of inventories greater than five years old are reduced to zero. Inventory is typically reviewed for obsolescence on an annual basis computed as of September 30, the
Companys fiscal year end. If significant known changes in trends, technology or other specific circumstances that warrant consideration occur during the year, then the impact on obsolescence is considered at that time.
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Investments
Marketable debt and equity securities are categorized as trading securities and are thus marked to market and stated at fair value. Fair value is determined
using the quoted closing or latest bid prices for Level 1 investments and market standard valuation methodologies for Level 2 investments. Realized gains and losses on investment transactions are determined by specific identification and
are recognized as incurred in the condensed consolidated statements of income. Net unrealized gains and losses are reported in the condensed consolidated statements of income and represent the change in the fair value of investment holdings during
the period.
Long Lived Asset Impairment
Property
and equipment, and intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset (or asset group) may not be recoverable. An impairment loss would be
recognized when the carrying amount of an asset exceeds the estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss to be recorded is calculated by the excess
over its fair value of the assets carrying value. Fair value is generally determined using a discounted cash flow analysis.
Off-Balance
Sheet Arrangements
None
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