SERVOTRONICS INC /DE/ - Quarter Report: 2020 June (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

Form 10-Q 

(Mark One)

For the quarterly period ended June 30, 2020

or

Commission File No. 1-07109

SERVOTRONICS, INC.

(Exact name of registrant as specified in its charter)

1110 Maple Street

Elma, New York 14059

(Address of principal executive offices) (zip code)

(716) 655-5990

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Securities Exchange Act.

Large accelerated filer ¨   Accelerated filer ¨   Non-accelerated filer x   Smaller reporting company x   Emerging growth company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

INDEX

SERVOTRONICS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

($000’s omitted except share and per share data)

See notes to condensed consolidated financial statements

SERVOTRONICS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME 

($000’s omitted except per share data)

(Unaudited)

See notes to condensed consolidated financial statements

SERVOTRONICS, INC. AND SUBSIDIARIES

 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 ($000’s omitted)

 (Unaudited)

See notes to condensed consolidated financial statements

SERVOTRONICS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The accompanying unaudited condensed consolidated financial statements (“consolidated financial statements”) have been prepared in accordance with United States 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 United States generally accepted accounting principles for complete financial statements.

The accompanying consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. All such adjustments are of a normal recurring nature. Operating results for the three and six months ended June 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. The consolidated financial statements should be read in conjunction with the 2019 annual report and the notes thereto.

Business Description

Servotronics, Inc. and its subsidiaries design, manufacture and market advanced technology products consisting primarily of control components, and consumer products consisting of knives and various types of cutlery and other edged products.

Principles of Consolidation

The consolidated financial statements include the accounts of Servotronics, Inc. and its wholly-owned subsidiaries (the “Company”). All intercompany balances and transactions have been eliminated upon consolidation.

Cash

The Company considers cash to include all currency and coins owned by the Company as well as all deposits in the bank including checking accounts and savings accounts.

Accounts Receivable

The Company grants credit to substantially all of its customers and carries its accounts receivable at original invoice amount less an allowance for doubtful accounts. On a periodic basis, the Company evaluates its accounts receivable and establishes an allowance for doubtful accounts based on history of past write-offs, collections, and current credit conditions. The allowance for doubtful accounts amounted to approximately $156,000 at June 30, 2020 and $337,000 at December 31, 2019. The Company does not accrue interest on past due receivables.

Revenue Recognition

Revenues are recognized at the time of shipment of goods, transfer of title and customer acceptance, as required. Our revenue transactions generally consist of a single performance obligation to transfer contracted goods and are not accounted for under industry-specific guidance. Purchase orders generally include specific terms relative to quantity, item description, specifications, price, customer responsibility for in-process costs, delivery schedule, shipping point, payment and other standard terms and conditions of purchase. Service sales, principally representing repair, are recognized at the time of shipment of goods.

See notes to condensed consolidated financial statements

SERVOTRONICS, INC. AND SUBSIDIARIES

 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The costs incurred for nonrecurring engineering, development and repair activities of our products under agreements with commercial customers are expensed as incurred. Subsequently, the revenue is recognized as products are delivered to the customers with the approval by the customers.

Revenue is recognized at an amount that reflects the consideration to which the Company expects to be entitled in exchange for transferring goods and services to a customer. The Company determines revenue recognition using the following five steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when the company satisfies a performance obligation.

Revenue excludes taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by the Company from a customer (e.g., sales and use taxes). Revenue includes payments for shipping activities that are reimbursed by the customer to the Company.

Performance obligations are satisfied as of a point in time. Performance obligations are supported by contracts with customers, providing a framework for the nature of the distinct goods, services or bundle of goods and services. The timing of satisfying the performance obligation is typically indicated by the terms of the contract. As a significant portion of the Company’s revenue are recognized at the time of shipment, transfer of title and customer acceptance, there is no significant judgment applied to determine the timing of the satisfaction of performance obligations or transaction price.

The timing of satisfaction of our performance obligations does not significantly vary from the typical timing of payment. The Company generally receives payment for these contracts within the payment terms negotiated and agreed upon by each customer contract.

Warranty and repair obligations are assessed on all returns. Revenue is not recorded on any warranty returns. The Company warrants its products against design, materials and workmanship based on an average of twenty-seven months. The Company determines warranty reserves needed based on actual average costs of warranty units shipped and current facts and circumstances. As of June 30, 2020 and December 31, 2019 under the guidance of ASC460 the Company has recorded a warranty reserve of approximately $287,000 and $420,000, respectively. This amount is reflected in other accrued expenses in the accompanying balance sheet. Revenue is recognized on repair returns, covered under a customer contract, at the contractual price upon shipment to the customer.

Inventories

Inventories are stated at the lower of cost or net realizable value. Cost includes all costs incurred to bring each product to its present location and condition. Market provisions in respect of lower of cost or market adjustments and inventory expected to be used in greater than two years are applied to the gross value of the inventory through a reserve of approximately $1,569,000 and $1,437,000 at June 30, 2020 and December 31, 2019, respectively. Pre-production and start-up costs are expensed as incurred.

The purchase of suppliers’ minimum economic quantities of material such as steel, etc. may result in a purchase of quantities exceeding one year of customer requirements. Also, in order to maintain a reasonable and/or agreed to lead time, certain larger quantities of other product support items may have to be purchased and may result in over one year’s supply. These amounts are not included in the inventory reserve discussed above.

SERVOTRONICS, INC. AND SUBSIDIARIES

 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Shipping and Handling Costs

Shipping and handling costs are classified as a component of cost of goods sold.

Property, Plant and Equipment

Property, plant and equipment is carried at cost; expenditures for new facilities and equipment and expenditures which substantially increase the useful lives of existing plant and equipment are capitalized; expenditures for maintenance and repairs are expensed as incurred. Upon disposal of properties, the related cost and accumulated depreciation are removed from the respective accounts and any profit or loss on disposition is included in income.

Depreciation is provided on the basis of estimated useful lives of depreciable properties, primarily by the straight-line method for financial statement purposes and by accelerated methods for income tax purposes. Depreciation expense includes the amortization of right-of-use (“ROU”) assets accounted for as finance leases. The estimated useful lives of depreciable properties are generally as follows:

Income Taxes

The higher effective tax rate during the six months ended June 30, 2020 was primarily due to a decrease in permanent deductible expenses.

In response to COVID-19, the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) was signed into law on March 27, 2020. The CARES Act provides numerous tax provisions and other stimulus measures, including temporary changes regarding the prior and future utilization of net operating losses, temporary suspension of certain payment requirements for the employer portion of Social Security taxes, technical corrections from prior tax legislation for tax depreciation of certain qualified improvement property, and the creation of certain refundable employee retention credits. The Company is currently evaluating the impact of these measures on its consolidated financial statements. If these measures are determined to be applicable to the Company, they may result in cash refunds and an income tax benefit recorded in the consolidated statement of income.

The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities, as well as operating loss and credit carryforwards. The Company and its subsidiaries file a consolidated federal income tax return, combined New York and Texas state income tax returns and various separate state income tax returns.

The Company’s practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company did not have any accrued interest or penalties included in its consolidated balance sheets at June 30, 2020 or December 31, 2019, and did not recognize any interest and/or penalties in its consolidated statements of income during the three months ended June 30, 2020 and 2019. The Company did not have any material uncertain tax positions or unrecognized tax benefits or obligations as of June 30, 2020 and December 31, 2019. On July 16, 2020, the Company was notified that the 2017 federal income tax return was randomly selected for examination. The 2016 through 2018 federal and state tax returns remain subject to examination.

SERVOTRONICS, INC. AND SUBSIDIARIES

 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Supplemental Cash Flow Information

Income taxes paid during the six months ended June 30, 2020 and 2019 amounted to approximately $42,000 and $0, respectively. Interest paid during the six months ended June 30, 2020 and 2019 amounted to approximately $84,000 and $57,000, respectively.

Employee Stock Ownership Plan

Contributions to the employee stock ownership plan are determined annually by the Company according to plan formula.

Impairment of Long-Lived Assets

The Company reviews long-lived assets for impairment annually or whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable based on undiscounted future operating cash flow analyses. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Due to the losses incurred by our Consumer Products Group (“CPG”), we performed a test for recoverability of the long-lived assets by comparing its carrying value to the future undiscounted cash flows that we expect will be generated by the asset group. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal. The Company has determined that no impairment of long-lived assets existed at June 30, 2020 and December 31, 2019.

Use of Estimates

The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Reclassifications

Certain balances, as previously reported, were reclassified to conform to classifications adopted in the current period.

Research and Development Costs

Research and development costs are expensed as incurred.

Concentration of Credit Risks

Financial instruments that potentially subject the Company to concentration of credit risks principally consist of cash accounts in financial institutions. Although the accounts exceed the federally insured deposit amount, management does not anticipate nonperformance by the financial institutions.

SERVOTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Fair Value of Financial Instruments

The carrying amount of cash, accounts receivable, accounts payable and accrued expenses are reasonable estimates of their fair value due to their short maturity. Based on variable interest rates and the borrowing rates currently available to the Company for loans similar to its long-term debt, the fair value approximates its carrying amount.

Depreciation and amortization expense amounted to approximately $363,000 and $289,000 for the three months ended June 30, 2020 and 2019, respectively. Amortization expense primarily related to ROU assets amounted to approximately $17,000 and $21,000 for the three months ended June 30, 2020 and 2019, respectively. Depreciation and amortization expense amounted to approximately $718,000 and $563,000 for the six months ended June 30, 2020 and 2019, respectively. Amortization expense, primarily related to ROU assets, amounted to approximately $35,000 and $41,000 for the six months ended June 30, 2020 and 2019, respectively. The Company maintains property and casualty insurance in amounts adequate for the risk and nature of its assets and operations and which are generally customary in its industry.

As of June 30, 2020, there is approximately $442,000 ($331,000 – December 31, 2019) of construction in progress (CIP) included in property, plant and equipment all of which is related to capital projects. There is approximately $298,000 in CIP for machinery & equipment and self-constructed assets ($280,000 – December 2019), $27,000 for computer equipment ($32,000 – December 2019) and $117,000 for building improvements ($19,000 – December 2019) primarily related to the Advanced Technology Group (“ATG”).

SERVOTRONICS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SERVOTRONICS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Remaining principal maturities of long-term debt are as follows: 2020 - $430,000, 2021 - $4,635,000, 2022 - $5,037,000, 2023 - $154,000 and 2024 - $93,000. Remaining principal payments and interest payments for the capital note and capital equipment financing lease obligations for each of the next five years:

SERVOTRONICS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

6.            Shareholders’ Equity

SERVOTRONICS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company’s Board of Directors authorized the purchase of up to 450,000 shares of its common stock in the open market or in privately negotiated transactions. As of June 30, 2020, the Company has purchased 360,615 shares and there remains 89,385 shares available to purchase under this program. There were 360 and 4,502 shares purchased by the Company during the six month period ended June 30, 2020 and 2019, respectively.

The Company’s 2012 Long-Term Incentive Plan provides for the granting of stock awards, including restricted stock, stock options and stock appreciation rights, to employees and non-employees, including directors of the Company. Compensation expense is amortized over the related service period, which is normally three years. Shares of unvested restricted stock are generally forfeited if a recipient leaves the Company before the vesting date. Shares that are forfeited become available for future awards.

The following is a summary of restricted stock activity for the six months ended June 30, 2020. Of the shares that vested, the Company withheld 9,543 shares to satisfy the tax obligations for those participants who elected this option as permitted under the applicable equity plan.

SERVOTRONICS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Earnings Per Share

Basic earnings per share is computed by dividing net earnings by the weighted average number of common shares outstanding during the period. The weighted average number of common shares outstanding does not include any potentially dilutive securities or any unvested restricted shares of common stock. These unvested restricted shares, although classified as issued and outstanding, are considered forfeitable until the restrictions lapse and will not be included in the basic EPS calculation until the shares are vested. Diluted earnings per share is computed by dividing net earnings by the weighted average number of common shares outstanding during the period plus the number of shares of common stock that would be issued assuming all contingently issuable shares having a dilutive effect on the earnings per share that were outstanding for the period. Incremental shares from assumed conversions are calculated as the number of shares that would be issued, net of the number of shares that could be purchased in the marketplace with the cash received upon stock option exercise. The dilutive effect of unvested restrictive stock is determined using the treasury stock method.

Post retirement obligation. As previously disclosed in filings with the Securities and Exchange Commission (“SEC”), the Company, under an employment agreement, is expected to pay post-employment health related benefits to a former Executive Officer of the Company (the “Former Employee”), of which approximately $1,663,000 and $1,543,000 has been accrued as of June 30, 2020 and December 31, 2019, and is reflected as Post Retirement Obligation in the accompanying consolidated balance sheet.

Employment Agreements. The Company provides certain post-employment health and life insurance benefits for its Chief Executive Officer and President Kenneth Trbovich. Upon retirement and after attaining at least the age of 65, the Company will pay for the retired Executive’s and dependent’s health benefits and will continue the Company-provided life insurance offered at the time of retirement. The retiree’s health insurance benefits ceases upon the death of the retired executive. Approximately $661,000 and $583,000 has been accrued as of June 30, 2020 and December 31, 2019, respectively, and is reflected as Post Retirement Obligation in the accompanying consolidated balance sheet.

SERVOTRONICS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Litigation. The Company has pending litigation relative to leases of certain equipment and real property with a former related party. Aero, Inc. is suing Servotronics, Inc. and its wholly owned subsidiary and has alleged damages in the amount of $3,000,000. The Company has filed a response to the Aero, Inc. lawsuit and has also filed a counter-claim in the amount of $3,191,000. The Company considers the risk of loss remote, and is unable to reasonably or accurately estimate the likelihood and amount of any liability or benefit that may be realized as a result of this litigation. Accordingly, no gain or loss has been recognized in the accompanying consolidated financials statements related to this litigation.

There are no other legal proceedings currently pending by or against the Company other than ordinary routine litigation incidental to the business which is not expected to have a material adverse effect on the business or earnings of the Company.

The Company paid legal fees and disbursements of approximately $132,000 and $48,000 in the six month period ended June 30, 2020 and 2019, respectively, for services provided by a law firm that is owned by a member of the Company’s Board of Directors. Legal fees paid for the three month period ended June 30, 2020 and 2019 amounted to approximately $37,000 and $29,000, respectively. Additionally, the Company had accrued unbilled legal fees at June 30, 2020 and 2019 of approximately $25,000 and $22,000, respectively, with this firm.

The Company operates in two business segments, ATG and CPG. The Company’s reportable segments are strategic business units that offer different products and services. The segments are composed of separate corporations and are managed separately. Operations in ATG primarily involve the design, manufacture, and marketing of servo-control components (i.e., torque motors, control valves, actuators, etc.) for government, commercial and industrial applications. CPG’s operations involve the design, manufacture and marketing of a variety of cutlery products for use by consumers and government agencies. The Company derives its primary sales revenue from domestic customers, although a portion of finished products are for foreign end use.

As of June 30, 2020, the Company had identifiable assets of approximately $56,180,000 ($49,470,000 – December 31, 2019) of which approximately $46,208,000 ($39,980,000 – December 31, 2019) was for ATG and approximately $9,972,000 ($9,490,000 – December 31, 2019) was for CPG.

SERVOTRONICS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Information regarding the Company’s operations in these segments is summarized as follows:

During the six months ended June 30, 2020 and 2019, approximately 87% and 87%, respectively, of the Company’s consolidated revenues were derived from the ATG sale of product to a small base of customers. During the six months ended June 30, 2020 and 2019, approximately 13% and 13%, respectively, of the Company’s consolidated revenues were derived from the CPG sale of product to a large base of retail customers. There was an increase in consolidated revenue in the six months ended June 30, 2020 from 2019 of approximately $2,882,000. This is due to an increase in shipments and price/mix at both the ATG and CPG of approximately $2,298,000 and $584,000, respectively.

The Company’s commercial business is affected by such factors as uncertainties in today’s global economy, global competition, the vitality and ability of the commercial aviation industry to purchase new aircraft, the effects and threats of terrorism, market demand and acceptance both for the Company’s products and its customers’ products which incorporate Company made components.

The ATG engages its business development efforts in its primary markets and is broadening its activities to include new domestic and foreign markets that are consistent with its core competencies. We believe our business remains particularly well positioned in the strong commercial aircraft market driven by the replacement of older aircraft with more fuel efficient alternatives and the increasing demand for air travel in emerging markets. Although the ATG backlog continues to be strong, actual scheduled shipments may be delayed/changed as a function of the Company’s customers’ final delivery determinations based on changes in the global economy and other factors.

The ATG and CPG continue to respond to U.S. government procurement requests for quotes. New product development activities are ongoing along with the acquisition and development of new product lines.

See also Note 10, Business Segments, of the accompanying consolidated financial statements for information concerning business segment operating results.

Business Environment

As an essential business, we have continued to conduct our operations to the fullest extent possible, while responding to the novel coronavirus (COVID-19) outbreak with actions that include implementing measures to protect the health and safety of our employees, including implementing social distancing protocols, requiring working from home for those employees that do not need to be physically present on the manufacturing floor to perform their work and extensively and frequently disinfecting our workspaces.

We have experienced, and expect to continue to experience, reductions in customer demand and we expect that the social distancing measures and any preventive or protective actions taken by governmental authorities will more meaningfully impact our operations, supply chain, and customers in the third quarter and possibly beyond. The extent to which COVID-19 may adversely impact our business depends on future developments, which are highly uncertain and unpredictable, depends upon the severity and duration of the outbreak and the effectiveness of actions taken globally to contain or mitigate its effect. Any resulting financial impact cannot be estimated reasonably at this time, but may materially adversely affect our business, results of operations, financial condition, and cash flows. Even after the COVID-19 pandemic has subsided, we may experience materially adverse impacts to our business due to any resulting economic recession or depression.

We took actions in the first quarter to strengthen our liquidity and financial condition. On March 20, 2020 we increased our line of credit to $6,000,000 as part of our pre-COVID-19 planning. Additionally, in the beginning of the second quarter we applied for and received a $4,000,000 loan as part of the Paycheck Protection Program authorized under the CARES Act. We believe the combination of the PPP loan and our increased capacity under our line of credit, together with internal cost reductions will preserve our financial flexibility during the pandemic.

Results of Operations

The following table compares the Company’s consolidated statements of income data for the six months and three months ended June 30, 2020 and 2019 ($000’s omitted):

Revenue

The Company’s consolidated revenues from operations increased approximately $2,882,000 or 11.1% for the six month period ended June 30, 2020 when compared to the same period in 2019. This is due to an increase in shipments and price/mix at the ATG of approximately $2,298,000 or 10.1% and an increase in shipments and price/mix at the CPG of approximately $584,000 or 17.6%.

The increase in revenue is attributable to an increase in shipments at the ATG of approximately $381,000 and an increase in price/mix of units shipped of approximately $1,917,000. Additionally, there was an increase in shipments at the CPG of approximately $470,000 and an increase in price/mix of units shipped of approximately $114,000 for the six month period ended June 30, 2020 when compared to the same period in 2019.

The Company’s consolidated revenues from operations decreased approximately $563,000 or (4.0)% for the three month period ended June 30, 2020 when compared to the same period in 2019. This is due to a decrease in shipments offset by an increase in price/mix at the ATG of approximately $921,000 or (7.6)% offset by an increase in shipments and price/mix at the CPG of approximately $358,000 or 18.7%.

The decrease in revenue is attributable to a decrease in shipments at the ATG of approximately $2,019,000 partially offset by an increase in price/mix of units shipped of approximately $1,098,000. Additionally, there was an increase in shipments at the CPG of approximately $243,000 and an increase in price/mix of units shipped of approximately $115,000 for the three month period ended June 30, 2020 when compared to the same period in 2019.

Gross Margin

The Company’s consolidated gross margins from operations increased approximately $2,389,000 or 44.7% for the six month period ended June 30, 2020 when compared to the same period in 2019.

Gross margin increased in the six month period due to an increase in shipments at the ATG of approximately $231,000 and an increase in price/mix of units shipped of approximately $1,229,000. Additionally, gross margin increased due to an increase in price/mix at the CPG of approximately $1,092,000 partially offset by a decrease in price/mix of units shipped of approximately $163,000 for the six month period ended June 30, 2020 when compared to the same period in 2019.

The Company’s consolidated gross margins from operations decreased approximately $250,000 or (7.6)% for the three month period ended June 30, 2020 when compared to the same period in 2019.

Gross margin decreased in the three month period due to a decrease in shipments at the ATG of approximately $1,768,000 partially offset by an increase in price/mix of units shipped of approximately $908,000. Additionally, gross margin increased due to an increase in price/mix of units shipped at the CPG of approximately $1,087,000 partially offset by a decrease in price/mix of approximately $477,000 for the three month period ended June 30, 2020 when compared to the same period in 2019.

Selling, General and Administrative Expenses

Selling, general and administrative (SG&A) expenses decreased approximately $286,000 or (6.6)% for the six month period ended June 30, 2020 compared to the same period in 2019. This net decrease is driven by an increase of approximately $126,000 at the ATG offset by a decrease of approximately $412,000 at the CPG. The ATG increase is driven by wages and employee related benefits, including postretirement benefits of approximately $491,000 offset by a reversal of bad debt expense of approximately $187,000 versus a bad debt expense charge of approximately $191,000 that was recognized in the six month period ending June 30, 2019. There was a net increase of approximately $13,000 in all other SG&A expenditures for the ATG for the six month period ended June 30, 2020 compared to the same period in 2019. The CPG decrease is driven by lower expenditures of approximately $142,000 related to sales promotion and support, approximately $134,000 for media and advertising, approximately $86,000 for trade shows and travel, and approximately $50,000 for the reversal of bad debt expense for the six month period ended June 30, 2020 compared to the same period in 2019.

Selling, general and administrative (SG&A) expenses decreased approximately $627,000 or (26.4)% for the three month period ended June 30, 2020 compared to the same period in 2019. This net decrease is driven by a decrease of approximately $337,000 at the ATG and a decrease of approximately $290,000 at the CPG. The net decrease at the ATG is driven by an increase in wages and employee related benefits of approximately $256,000 and professional fees of approximately $46,000 offset by a reversal of bad debt expense of approximately $256,000 versus a bad debt expense charge of approximately $191,000 that was recognized in the three month period ending June 30, 2019. Additional decreases in the ATG SG&A expenses include timing of legal expenses of approximately $132,000, travel, meals and lodging expenses of approximately $41,000 and a net decrease in all other SG&A expenses of approximately $19,000 for the three month period ended June 30, 2020 compared to the same period in 2019. The CPG decrease is driven by lower expenditures of approximately $102,000 for sales promotion and support, approximately $64,000 for trade shows and travel, approximately $61,000 for media and advertising, less bad debt expense of approximately $45,000 and a net decrease of approximately $18,000 in all other SG&A expenditures for the CPG for the three month period ended June 30, 2020 compared to the same period in 2019.

Interest Expense

Interest expense increased by 59.6% and 63.3% in the six and three month periods ended June 30, 2020, respectively, when compared to the same period in 2019. This is primarily due to the equipment lease/note and usage of the line of credit for the ATG for the six and three month periods ended June 30, 2020 compared to the same period in 2019. See also Note 5, Long-Term Debt, of the accompanying consolidated financial statements for information on long-term debt.

Income Taxes

The Company’s effective tax rate was approximately 21.0% and 17.4% for the three and six month periods ended June 30, 2020 and 2019, respectively. The effective tax rate in both years reflects federal and state income taxes, permanent non-deductible expenditures and the federal tax credit for research and development expenditures.

Net Income

Net income for the six month period ended June 30, 2020 increased approximately $2,051,000. This increase is primarily the result of increases in revenue at both the ATG and CPG business segments and a net decrease in selling, general and administrative expenses. Net income for the three month period ended June 30, 2020 increased approximately $251,000, when compared to the same periods in 2019. This increase is primarily the result of a decrease in revenue at the ATG business partially offset by an increase at the CPG business and decreases in selling, general and administrative expenses in both business segments.

Liquidity and Capital Resources

The Company’s primary liquidity and capital expenditure requirements relate to working capital needs; primarily inventory, accounts receivable, accounts payable, capital expenditures for property, plant and equipment and principal payments on debt. At June 30, 2020, the Company had working capital of approximately $35,247,000 ($27,659,000 – 2019) of which approximately $7,140,000 ($2,029,000 – 2019) was comprised of cash.

The Company generated approximately $1,476,000 in cash from operations during the six month period ended June 30, 2020 as compared to generating cash of approximately $638,000 during the same period in 2019. Cash was generated primarily through net income of approximately $2,863,000, adjustments to reconcile net income to net cash of approximately $708,000 offset by the net use of cash by all other operating changes of approximately $(2,095,000), primarily attributable to the increases of inventory.

The Company’s primary use of cash in its investing activities in the six month period ended June 30, 2020 are for building improvements and capital expenditures of approximately $593,000 for production requirements at the ATG.

The Company’s primary providing of cash in its financing activities in the six month period ended June 30, 2020 include proceeds from the line of credit and PPP Loan of approximately $4,750,000 partially offset by approximately $274,000 of principal payments on long-term debt, approximately $148,000 of principal payments on equipment financing obligations and approximately $100,000 for the purchase of treasury shares.

As of March 20, 2020, the Company increased its line of credit from $4,000,000 to $6,000,000.  As of July 31, 2020, the Company extended the line of credit to expire December 31, 2022. As of July 31, 2020, the interest rate is a rate per year equal to the bank’s prime rate or Libor plus 1.65%.  In addition, the Company is required to pay a commitment fee of 0.25% on the unused portion of the line of credit.  There was $3,750,000 balance outstanding at June 30, 2020 and $3,000,000 balance at December 31, 2019.

The Company has an equipment loan facility in the amount of $1,000,000 available until July 9, 2021. This line is non-revolving and non-renewable. The loan term for the equipment covered by the agreement is 60 months. Monthly payments are fixed for the term of each funding based upon the Lender’s lease pricing in effect at the time of such funding. There is nothing outstanding as of June 30, 2020 and at December 31, 2019.

On April 21, 2020, the Company executed a promissory note (the “Note”) in the amount of $4,000,000 as part of the Paycheck Protection Program (the “PPP Loan”) administered by the Small Business Administration (the “SBA”) and authorized under the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act”). The PPP Loan is being made through the Bank of America, NA (the “Lender”). The term of the PPP Loan is two years with an annual interest rate of 1.00%. Payments of principal and interest on the PPP Loan will be deferred for the first six months of the loan term. Payments on any unforgiven amounts will begin on the date on which loan forgiveness is determined or 10 months after the end of the borrower’s covered period if forgiveness is not requested. Commencing one month after the expiration of the deferral period, the Company is required to pay the Lender the principal amount outstanding on the PPP Loan in equal monthly payments of principal and interest. 

The Company believes its cash generating capability and financial condition, together with available credit facilities will be adequate to meet our future operating, investing and financing needs.

The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information required under this item.

Disclosure Controls and Procedures

The Company carried out an evaluation under the supervision and with the participation of its management, including the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of June 30, 2020. Based upon that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in SEC reports under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Controls

During the six month period ended June 30, 2020, there were no changes in internal controls over financial reporting that have materially affected, or are reasonably likely to affect, the Company’s internal controls over financial reporting.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

Except as set forth in Note 8, Litigation, there are no other legal proceedings which are material to the Company currently pending by or against the Company other than ordinary routine litigation incidental to the business which is not expected to materially adversely affect the business or earnings of the Company.

Item 1A. Risk Factors

Not applicable.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(c)  Company Purchases of Company’s Equity Securities

(1)          The Company’s Board of Directors authorized the purchase of up to 450,000 shares of its common stock in the open market or in privately negotiated transactions. As of June 30, 2020, the Company has purchased 360,615 shares and there remains 89,385 shares available to purchase under this program. There were 360 shares purchased by the Company during the six month period ended June 30, 2020.

(2)            Includes 9,543 shares withheld by the Company in January 1, 2020 to satisfy statutory minimum withholding tax requirements for those participants who elected this option as permitted under the Company’s 2012 Long-Term Incentive Plan.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable

Item 6. Exhibits

FORWARD-LOOKING STATEMENTS

In addition to historical information, certain sections of this Form 10-Q contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, such as those pertaining to the Company’s capital resources and profitability, the timing and amount of payment obligation relating to the arbitration award and the Company’s ability to pay these obligations. Forward-looking statements involve numerous risks and uncertainties. The Company derives a material portion of its revenues from contracts with agencies of the U.S. Government or their prime contractors. The Company’s business is performed under fixed price contracts and the following factors, among others discussed herein, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements: uncertainties in today’s global economy and global competition, and difficulty in predicting defense appropriations, the vitality of the commercial aviation industry and its ability to purchase new aircraft, the willingness and ability of the Company’s customers to fund long-term purchase programs, and market demand and acceptance both for the Company’s products and its customers’ products which incorporate Company-made components. The success of the Company also depends upon the trends of the economy, including interest rates, income tax laws, governmental regulation, legislation, population changes and those risk factors discussed elsewhere in this Form 10-Q. Readers are cautioned not to place undue reliance on forward-looking statements, which reflect management’s analysis only as of the date hereof. The Company assumes no obligation to update forward-looking statements.

SIGNATURES

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.

Date: August 13, 2020