CRAWFORD UNITED Corp - Quarter Report: 2014 March (Form 10-Q)

Item 1. Financial Statements.

See Notes to Consolidated Financial Statements

Note: Amounts derived from audited financial statements previously filed with the Securities and Exchange Commission

See Notes to Consolidated Financial Statements

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month and six month periods ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ended September 30, 2014. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended September 30, 2013.

2. Inventories

Inventories are valued at the lower of cost or market and consist of the following:

The above amounts are net of reserve for obsolete inventory in the amount of $828,376, $793,000 and $916,903 for the periods ended March 31, 2014, September 30, 2013 and March 31, 2013 respectively.

3. Notes receivable

The Company has a note receivable with a current employee at an interest rate of three percent per annum. The Company does not anticipate repayment within the next twelve months.

4. Convertible Notes Payable

5. Short-term Financing

The Company had a credit agreement of $250,000 with Robert L. Bauman, one of its major shareholders who is also an employee of the Company. The agreement was to expire in April 2013 but was modified on December 31, 2012 to extend the maturity date to December 2013. Effective October 30, 2012 for the remainder of the agreement, the lender may terminate the agreement with 45 days written notice, but it is at the discretion of the Company to deny the termination notice until December 2013 if it would have had a negative effect on the solvency of the Company.

The agreement provided for a revolving credit facility of $250,000 with interest at 0.24% per annum and was unsecured and included a three year warrant for 100,000 shares of Class A common stock at a price of $2.50 per share. In addition, the agreement generally allowed for borrowing based on an amount equal to eighty percent of eligible accounts receivables or $250,000. The Company had no outstanding borrowings under this loan facility at December 31, 2013. The revolving line of credit was not extended.

In partial consideration for the original extension of the revolving credit facility the Company and Bauman entered into a Warrant Agreement, dated December 30, 2012 whereby the Company issued a warrant to Bauman to purchase, at his option, up to 100,000 shares of Class A Common Stock of the Company at an exercise price of $2.50 per share, subject to certain anti-dilution and other adjustments. If not exercised, this warrant will expire on December 30, 2015.

The Company used the Black-Scholes option pricing model to determine the fair value estimate for recognizing the cost of services received in exchange for an award of equity instruments. The Black-Scholes option pricing model requires the use of subjective assumptions which can materially affect the fair value estimates. The warrants are immediately exercisable and expire in December 2015. The fair value of the warrants issued is amortized over the one year credit agreement period. During the three and six month periods ended March 31, 2013, $11,375 and $22,750 was expensed as non-cash interest expense. The following weighted-average assumptions were used in the option pricing model for the three and six month month periods ended March 31, 2013: a risk free interest rate of 0.42%; an expected life of 3 years; an expected dividend yield of 0.0%; and a volatility factor of .84.

6. Capital Stock, Treasury Stock, Contributed Capital and Stock Options

On October 11, 2012, the Company's Amended Articles of Incorporation and the Amended Code of Regulations were adopted by an affirmative vote of more than two-thirds of the Company's Class A and Class B Shareholders.

The Amended Articles amend and restate the Current Articles in a number of significant ways and are primarily as follows: increased the number of Class A Shares and Class B Shares from 3,750,000 and 1,000,000 to 10,000,000 and 2,500,000 respectively, and added a class of 1,000,000 Serial Preferred Shares; eliminated par value for for Class A Shares and Class B Shares; updated certain provisions relating to the payment of dividends; removed restrictions on the issuance of additional Class A Shares; clarified the method by which the Company may repurchase its shares; reduced the percentage of shareholder vote required to authorize corporate actions from two-thirds of the voting power to a majority of the voting power; and made other technical or conforming changes.

The Amended Regulations amend and restate the Current Regulations in a number of significant ways and are primarily as follows: updated certain provisions relating to the Company's meetings of shareholders in order to provide more consistency in the regulations regarding the Company's practices in this area; further clarifying the roles of the Company's officers and directors in conducting the Company's business; updated the Company's policy regarding the indemnification of its directors, officers, employees, and others; revised provisions allowing for the Board of Directors to adopt amendments to the Amended Regulations to the extent permitted by Ohio law; and made other technical or conforming changes.

Unissued shares of Class A common stock (956,233 shares) are reserved for the share-for-share conversion rights of the Class B common stock, stock options under the Directors Plans, conversion rights of the Convertible Promissory Note and available warrants.

On February 27, 2013, the Company's 2013 Omnibus Equity Plan was approved and adopted by an affirmative vote of a majority of the Company's Class A and Class B Shareholders.

The 2013 Omnibus Plan will provide the Company with the flexibility to grant a variety of share-based awards for covered employees, consultants and Directors. The 2013 Omnibus Plan provides for the grant of the following types of incentive awards: stock options, stock appreciation rights, restricted shares, restricted share units, performance shares and Class A Common Shares. Those who will be eligible for awards under the 2013 Omnibus Plan include employees who provide services to the Company and its affiliates, executive officers, non-employee Directors and consultants designated by the Compensation Committee. The Plan has 150,000 Class A Common Shares reserved for issuance. The Class A Common Shares may be either authorized, but unissued, common shares or treasury shares. No share-based awards have been granted under the 2013 Omnibus Equity Plan as of March 31, 2014.

Under the Company's expired Key Employees Stock Option Plans (collectively the "Employee Plans"), incentive stock options, in general, were exercisable for up to ten years, at an exercise price of not less than the market price on the date the option is granted. Non-qualified stock options may be granted at such exercise price and such other terms and conditions as the Compensation Committee of the Board of Directors may determine. No options may be granted at a price less than $2.925. Under the expired Employee Plans there are no options currently available for grant and there are no options outstanding at March 31, 2014.

The Company's expired Outside Directors Stock Option Plans (collectively the "Directors Plans"), have provided for the automatic grant of options to purchase up to 29,000 shares of Class A Common Stock to members of the Board of Directors who are not employees of the Company, at the fair market value on the date of grant. Options for 29,000 Class A shares were outstanding at March 31, 2014 (31,000 shares at September 30, 2013 and 31,000 shares at March 31, 2013) at prices ranging from $2.925 to $11.00 per share. Options for 2,000 shares expired during the three month period ended March 31, 2014 at $7.25 per share. In addition, options for 2,000 shares expired during the three month period ended March 31, 2013 at $3.67 per share. All outstanding options under the expired Directors Plans become fully exercisable on March 8, 2015.

The following is a summary of the range of exercise prices for stock options outstanding and exercisable under the expired Directors Plans at March 31, 2014:

The Company accounts for Share-Based Payments under the modified prospective method for its stock options for both employees and non-employee Directors. Compensation cost for fixed based awards are measured at the grant date, and the Company uses the Black-Scholes option pricing model to determine the fair value estimates for recognizing the cost of employee and director services received in exchange for an award of equity instruments. The Black-Scholes option pricing model requires the use of subjective assumptions which can materially affect the fair value estimates. Employee stock options are immediately exercisable while Director's stock options are exercisable over a three year period. The fair value of stock option grants to Directors is amortized over the three year vesting period. During the three and the six month periods ended March 31, 2014 and 2013 respectively $543 and $1,208; $1,751 and $4,049 was expensed as share-based compensation. The following weighted-average assumptions were used in the option pricing model for the three and six month periods ended March 31, 2014 and 2013 respectively: a risk free interest rate of 5.0% and 5.0%; an expected life of 10 and 10 years; an expected dividend yield of 0.0% and 0.0%; and a volatility factor of .87 and .87.

7. Recently Issued Accounting Pronouncements

The Company did not incur any material impact to its financial condition or results of operations due to the adoption of any new accounting standards during the periods reported.

8. Earnings per Common Share

Earnings per common share information is computed on the weighted average number of shares outstanding during each period based on the provisions of FASB Codification ASC Topic 260, "Earnings per Share." The required reconciliations are as follows:

Options and warrants to purchase 29,000 and 200,000 shares of common stock respectively during the second quarter and the first six months of fiscal 2014 at prices ranging from $2.50 to $11.00 per share were outstanding but were not included in the computation of diluted earnings per share because the option's and warrant's effect was antidilutive or the exercise price was greater than the average market price of the common share.

In addition, conversion rights to purchase 252,367 shares of common stock during the second quarter and the first six months of fiscal 2014 at a price of $1.85 per share were not included in the computation of diluted earnings per share because the conversion rights of the Convertible Promissory Notes effect was antidilutive or the exercise price was greater than the average market price of the common share.

Options and warrants to purchase 31,000 and 200,000 shares of common stock respectively during the second quarter and the first six months of fiscal 2013 at prices ranging from $2.50 to $11.00 per share were outstanding but were not included in the computation of diluted earnings per share because the option's and warrant's effect was antidilutive or the exercise price was greater than the average market price of the common share.

9. Segment and Related Information

The Company's four business units have a common management team and infrastructure that offer different products and services. The business units have been aggregated into two reportable segments: 1.) indicators and gauges and 2.) automotive related diagnostic tools and equipment.

Indicators and Gauges
This segment consists of products manufactured and sold primarily to companies in the aircraft and locomotive industry. Within the aircraft market, the primary customers are those companies that manufacture or service business, military and pleasure aircraft. Within the locomotive market, indicators and gauges are sold to both original equipment manufacturers and to operators of railroad equipment.

Automotive Diagnostic Tools and Equipment
This segment consists primarily of products designed and manufactured to support the testing or servicing of automotive systems using electronic means to measure vehicle parameters. These products are sold to OEM's and to the aftermarket using several brand names and a variety of distribution methods. Included in this segment are products used for state required testing of vehicle emissions.

Information by industry segment is set forth below:

All export sales to Australia, Canada, Mexico, Taiwan and other foreign countries are made in United States of America Dollars.

11. Subsequent Events

The Company has analyzed its operations subsequent to March 31, 2014 through the date the financial statements were submitted to the Securities and Exchange Commission and has determined that no subsequent events have occurred that would require recognition in the consolidated financial statements or disclosure in the notes to the consolidated financial statements.

12. Business Condition and Management Plan

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has suffered recurring losses from operations during the past several years due primarily to decreasing sales of existing product lines and a general economic downturn in all markets the Company serves.

The ability of the Company to continue as a going concern is dependent on improving the Company's profitability and cash flow and securing additional financing if needed. Management continues to review and revise its strategic plan and believes in the viability of its strategy to increase revenues and profitability through increased sales of existing products and the introduction of new products to the market place. Management believes that the actions presently being taken by the Company will provide the stimulus for it to continue as a going concern, however, because of the inherent uncertainties there can be no assurances to that effect. These consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

On December 30, 2012 management entered into an amended unsecured convertible loan agreement and an additional revolving line of credit which may provide approximately $717,000 of liquidity to meet on going working capital requirements. One agreement was an unsecured revolving line of credit with a major shareholder who is also an employee and the other was an unsecured convertible loan agreement with a major shareholder who is also a Director as discussed in Notes 4 and 5. These facilities were available through December 2013. The revolving line of credit was not extended.

In addition, on December 30, 2013 management entered into Amendment No. 2 of the unsecured convertible loan agreement which may provide approximately $467,000 of liquidity to meet on going working capital requirements. The agreement is with a major shareholder who is also a Director as discussed in Note 4. This facility is available through December 2014.

The above available financing resource together with management’s revised strategic plan to increase revenues and profitability through increased sales of existing products and the introduction of new products to the market place should provide the Company with the needed working capital for the next twelve months. In addition, in January of 2014 the Company received an order for approximately $1,800,000. The order is expected to cause a short-term cash drain and subsequently provide additional cash reserves as the Company is paid.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The Company has determined that it has two reportable segments: 1) indicators and gauges and 2) automotive related diagnostic tools and equipment. The indicators and gauges segment consists of products manufactured and sold primarily to companies in the aircraft and locomotive industry. Within the aircraft market, the primary customers are those companies that manufacture or service business, military and pleasure aircraft. Within the locomotive market, indicators and gauges are sold to original equipment manufacturers, servicers of locomotives and operators of railroad equipment. Revenue in this segment was $346,196 and $417,607 for the second quarter of fiscal 2014 and fiscal 2013, respectively and $750,601 and $827,833 for the first six months of fiscal 2014 and fiscal 2013, respectively.

The automotive diagnostic tools and equipment segment consists primarily of products designed and manufactured to support the testing or servicing of automotive systems using electronic means to measure vehicle parameters. These products are sold to OEM's and to the aftermarket using several brand names and a variety of distribution methods. Included in this segment are products used for state required testing of vehicle emissions. Revenue in this segment was $770,271 and $1,546,731 for the second quarter of fiscal 2014 and fiscal 2013, respectively, and $1,416,108 and $2,875,408 for the first six months of fiscal 2014 and fiscal 2013, respectively. The higher sales volume in the prior year was primarily due to the large order from a Tier 1 OEM supplier.

Product sales for the six months ended March 31, 2014 were $2,038,079 versus $3,538,687 for the same period in fiscal 2013. The decrease in product sales during the first six months of the current fiscal year of approximately $1,501,000 was volume related due primarily to decreased sales of automotive diagnostic testing products, primarily, automotive diagnostic testing products to OEM's of approximately $1,350,000. Sales of emission products and aftermarket products decreased by approximately $53,000 and $35,000 respectively. In addition, sales of indicator products decreased by approximately $63,000. The decrease in product sales to OEM's is due to the prior year benefiting from the large order for a Tier 1 OEM supplier with no similar order during the current period. Management anticipates product sales for the third and fourth quarter will increase significantly due to the large order received in January.

Service sales for the six months ended March 31, 2014 were $128,630 compared with $164,554 for the same period in fiscal 2013. The decrease was volume related and due primarily to a lower sales volume for chargeable repairs. The current level of service sales related to product repair sales is expected to continue for the balance of the fiscal year.

Cost of product sold was $1,295,284 or (63.6% of product sales) compared to $1,956,903 (55.3% of product sales) for the six months ended March 31, 2013. The percentage increase in the cost of product sold was due primarily to a lower sales volume, lower plant utilization and a change in product mix. The change in mix was largely decreased sales of automotive diagnostic testing products to OEM's. The dollar decrease is due to the volume decrease of product sales during the current period. The current cost of product sold percentage is expected to decrease significantly for the balance of the fiscal year due to both increased plant utilization, improved product mix, and delivery of the large OEM order.

Cost of service sold was $82,556 (64.2% of service sales) compared with $77,660 (47.2% of service sales) for the six months ended March 31, 2013. The dollar and percentage increase was due primarily to lower plant utilization and product specifics of chargeable repairs. The cost of services sold percentage is expected to decrease moderately for the balance of the fiscal year.

Product development expenses were $484,210 (23.8% of product sales) compared to $477,245 (13.5% of product sales) for the six months ended March 31, 2013. The percentage increase was due primarily to lower product sales during the current six months of fiscal 2014. The current level of product development expenditures is expected to continue for the balance of the fiscal year. Management believes the existing and planned resources will be sufficient to continue to develop identified new products for both OEM and Aftermarket customers.

Marketing and administrative expenses were $928,542 for the six months ended March 31, 2014 (42.9% of total sales) versus $885,998 (23.9% of total sales) for the six months ended March 31, 2013. The percentage increase was due primarily to the lower level of total sales for the current six months of fiscal 2014. Marketing expenses were approximately $317,000 during the first six months of the current fiscal year as compared to $362,000 for the same period a year ago. Within marketing expenses, decreases were primarily in royalties and commissions of approximately $51,000 and $12,000 respectively. These decreases were offset in part by increases in labor costs, credit and collection expense, travel expenses and advertising of approximately $9,000, $4,000, $2,000 and $3,000 respectively. Administrative expenses were approximately $612,000 during the first six months of the current fiscal year as compared to $524,000 for the same period a year ago. The dollar increase was due primarily to increases in professional fees and labor costs of approximately $99,000 and $11,000 respectively, offset in part by a decrease in rent machinery and equipment, data processing costs, depreciation and travel expenses of approximately $9,000, $5,000, $5,000 and $3,000 respectively. The current level of marketing and administrative expenses are expected to continue for the remainder of the fiscal year.

Interest expense was $0 for the six months ended March 31, 2014, and $45,678 for the same period in 2013. The interest charges in the prior six month period were primarily due to recording as non-cash interest expense a portion of the present value of the warrants issued in December 2012. The current level of interest expense is expected to continue for the continue for the year due to the remainder of the fiscal year.

Other income of $5,941 for the six months ended March 31, 2014 compares with other income of $3,478 in the same period last year. Other income consists primarily of interest income on cash and cash equivalents invested and the proceeds from the sale of scrap metal shavings. The increase is due primarily to a higher level of scrap metal sales of approximately $3,300 during the current year six month period. The current level of other income is expected to decrease for the remainder of fiscal 2014.

Income taxes during the first six months of fiscal 2014 were $0 which compares with income taxes of $0 in the first six months of fiscal 2013. In the first six months of fiscal 2014 recovery of income taxes was calculated at an effective tax rate of 37% offset by a increase in the valuation allowance netting to $0. In the first six months of fiscal 2013 income taxes were recorded at an effective tax rate of 37% offset by deferred taxes, specifically net operating loss carryforwards.

The net loss for the six months ended March 31, 2014 was $617,942 compared with net income of $263,235 for the six months ended March 31, 2013. The net loss for the first half of fiscal 2014 was primarily the result of a lower sales volume.

Total current assets were $2,714,048, $3,199,326 and $3,178,786 at March 31, 2014, September 30, 2013 and March 31, 2013, respectively. The decrease of approximately $465,000 from March to March was due primarily to the decrease in cash and cash equivalents and accounts receivable of approximately $730,000 and $274,000 respectively, offset by an increase in inventory of approximately $540,000. The decrease in cash and cash equivalents and accounts receivable was due primarily to the decrease in the sales volume during the period. The increase in inventory was due to the purchase of inventory for the large OEM order to be shipped in the third and fourth quarter. The decrease from September to March of approximately $485,000 was due primarily to the decrease in cash and cash equivalents and accounts receivable of approximately $786,000 and $185,000 respectively, offset in part by an increase in inventory and prepaid expenses of approximately $431,000 and $55,000 respectively. The decrease in cash and cash equivalents and accounts receivable was due primarily to the lower level of sales during the period and the purchase of inventory for the large order. The increase in inventory was due to the purchase of inventory for the large OEM order to be shipped in the third and fourth quarter.

Working capital as of March 31, 2014 amounted to $1,781,469 as compared with $2,491,294 a year earlier. Current assets were 2.9 times current liabilities compared to 4.6 a year ago. The quick ratio was .7 compared to 2.3 a year ago.

Internally generated funds during the six months ended March 31, 2014 were a negative $708,250 and were not adequate to fund the Company's primary non-operating cash requirements consisting of capital expenditures of $77,554. The primary reason for the negative cash flow from operations was the net loss during the period of $617,942 and the increase in inventory. The Company does anticipate additional capital expenditures during fiscal 2014 of approximately $70,000. The Company believes that cash and cash equivalents, together with funds anticipated to be generated by operations in addition to available short-term financing will provide adequate funding of the Company's working capital needs.

Shareholders' equity during the six months ended March 31, 2014 decreased by $616,191 which was the net loss during the period of $617,942 and share-based compensation expense of $1,751.

During fiscal 2014 the Company received an order for approximately $1,800,000. The order has required a temporary increase in inventory and has caused a short-term cash drain and will subsequently provide additional cash reserves as the Company is paid. The Company believes that internally generated funds and available short-term financing will provide sufficient liquidity to meet ongoing working capital requirements.

Our critical accounting policies are as presented in Notes to Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K for the year ended September 30, 2013.

The foregoing discussion includes forward-looking statements relating to the business of the Company. These forward-looking statements, or other statements made by the Company, are made based on management's expectations and beliefs concerning future events impacting the Company and are subject to uncertainties and factors (including, but not limited to, those specified below) which are difficult to predict and, in many instances, are beyond the control of the Company. As a result, actual results of the Company could differ materially from those expressed in or implied by any such forward-looking statements. These uncertainties and factors include (a) the Company's dependence upon a limited number of customers, (b) the highly competitive industry in which the company operates, which includes several competitors with greater financial resources and larger sales organizations, (c) the acceptance in the marketplace of new products and/or services developed or under development by the Company including automotive diagnostic products, fastening systems products and indicating instrument products, (d) the ability of the Company to further establish distribution and a customer base in the automotive aftermarket, (e) the Company's ability to capitalize on market opportunities including state automotive emissions programs and OEM tool programs and (f) the Company's ability to obtain cost effective financing.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Market Risk

The Company is exposed to certain market risks from transactions that are entered into during the normal course of business. The Company has not entered into derivative financial instruments for trading purposes. The Company's primary market risks are exposure related to interest rate risk and equity market fluctuations. The Company's only debt subject to interest rate risk during the current quarter was the funds available from the convertible note agreement. The Company currently has available under the convertible note agreement a credit facility subject to a nominal fixed rate of interest. As a result, the Company believes that the market risk related to interest rate movements is minimal. The Company had no outstanding borrowings under this credit facility at March 31, 2014.

Item 4. Controls and Procedures.

As of March 31, 2014, an evaluation was performed, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer along with the Company's Vice President, Finance and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, the Company's management, including the Chief Executive Officer along with the Company's Vice President, Finance and Chief Financial Officer, concluded that the Company's disclosure controls and procedures were effective as of March 31, 2014 in ensuring that information required to be disclosed by the Company in the reports it files and submits under the Exchange Act is (1) recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and (2) is accumulated and communicated to the Company's management, including its principal executive and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. There were no changes in the Company's internal controls over financial reporting during the second fiscal quarter ended March 31, 2014 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

The Company is the plaintiff in a suit pursuing patent infringement against a competitor in the emissions market. There have been several legal developments in this legal proceeding since the filing of Form 10-K for fiscal 2013 however it is still difficult to access the status of the proceedings or probable outcomes. Management believes that it is not currently possible to estimate the impact, if any, that the ultimate resolution of the patent infringement matter will have on the Company's results of operations, financial position or cash flows.

Item 6. Exhibits.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.