TECHPRECISION CORP - Quarter Report: 2017 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934      

For the quarterly period ended June 30, 2017

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________________ to __________________

Commission File Number: 000-51378

TechPrecision Corporation

(Exact name of registrant as specified in its charter)

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. 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    

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 Exchange Act.

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). 

The number of shares outstanding of the registrant’s common stock as of August 7, 2017 was 28,824,593.

TABLE OF CONTENTS

PART I.

ITEM 1. FINANCIAL STATEMENTS

TECHPRECISION CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

See accompanying notes to the condensed consolidated financial statements.

TECHPRECISION CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (Unaudited)

See accompanying notes to the condensed consolidated financial statements.

TECHPRECISION CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

See accompanying notes to the condensed consolidated financial statements.

SUPPLEMENTAL INFORMATION - NONCASH INVESTING AND FINANCING TRANSACTIONS:

Three Months Ended June 30, 2016

In accordance with our new Master Loan and Security Agreement, People's Capital and Leasing Corp. held back $182,763 of proceeds from the borrowing on the April 26, 2016 disbursement date. The holdback was released to the Company on July 6, 2016 upon the disclosure in our Annual Report on Form 10-K for the fiscal year ended March 31, 2016 of a debt service coverage ratio of 1.82 to 1.0 as of March 31, 2016. 

See accompanying notes to the consolidated financial statements.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - DESCRIPTION OF BUSINESS

TechPrecision Corporation, or TechPrecision, is the parent company of Ranor, Inc., or Ranor, a Delaware corporation and Wuxi Critical Mechanical Components Co., Ltd., or WCMC, a wholly foreign owned enterprise (WFOE) organized under the laws of the People’s Republic of China. TechPrecision, WCMC and Ranor are collectively referred to as the “Company”, “we”, “us” or “our”.

We manufacture large scale metal fabricated and machined precision components and equipment. These products are used in a variety of markets including defense and aerospace, nuclear, medical, and precision industrial.

NOTE 2 – BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Consolidation

The accompanying condensed consolidated financial statements include the accounts of TechPrecision, Ranor and WCMC. Intercompany transactions and balances have been eliminated in consolidation. The accompanying condensed consolidated balance sheet as of June 30, 2017, the condensed consolidated statements of operations and comprehensive income for the three months ended June 30, 2017 and 2016, and the condensed consolidated statements of cash flows for the three months ended June 30, 2017 and 2016 are unaudited, but, in the opinion of management, include all adjustments that are necessary for a fair presentation of our financial statements for interim periods in accordance with U.S. Generally Accepted Accounting Principles, or U.S. GAAP. All adjustments are of a normal, recurring nature, except as otherwise disclosed. The results of operations for an interim period are not necessarily indicative of the results of operations to be expected for the fiscal year.

The Notes to Condensed Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission, or the SEC, for Quarterly Reports on Form 10-Q. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited financial statements and related notes should be read in conjunction with our consolidated financial statements included with our Annual Report on Form 10-K for the fiscal year ended March 31, 2017, or the 2017 Form 10-K, filed with the SEC on June 29, 2017.

Significant Accounting Policies

Our significant accounting policies are set forth in detail in Note 2 to the 2017 Form 10-K.

NOTE 3 - NEW ACCOUNTING STANDARDS

New Accounting Standards Recently Adopted

In March 2016, the Financial Accounting Standards Board, or the FASB, issued Accounting Standards Update, or ASU, 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share Based Payment Accounting, or ASU 2016-09, which contains authoritative guidance intended to simplify various aspects to how share-based payment awards to employees are accounted for and presented in the financial statements. We adopted this guidance as of April 1, 2017, on a prospective basis. The guidance eliminates additional paid-in capital pools and allows entities to record tax benefits within income tax expense in the consolidated statement of operations, classify any excess tax benefits within net cash provided by operating activities in the consolidated statement of cash flows, and account for award forfeitures as they occur. The adoption of this new guidance did not have an impact on our Consolidated Balance Sheets, Consolidated Statements of Operations and Comprehensive Income, Consolidated Statements of Cash Flows and disclosures.

In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory, or ASU 2015-11. The new guidance defines net realizable value as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. This definition is consistent with existing authoritative guidance. We adopted this guidance as of April 1, 2017, on a prospective basis. The adoption did not have an impact on our Consolidated Balance Sheets, Consolidated Statements of Operations and Comprehensive Income, Consolidated Statements of Cash Flows and disclosures.

Issued Standards Not Yet Adopted

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, the authoritative guidance that changes the criteria for recognizing revenue from a contract with a customer. The new revenue recognition standard replaces existing guidance on revenue recognition, including most industry specific guidance, with a five step model for recognizing and measuring revenue from contracts with customers. The objective of the new standard is to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability within industries, across industries and across capital markets.

The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. Current practice is primarily a risk and rewards based model, while the new standard introduces the concept of inventory control and satisfaction of performance obligations over time. We are currently assessing the impact that the new revenue recognition guidance may have on our Consolidated Financial Statements and disclosures by comparing our current revenue recognition policy with the requirements of the new standard. A review of contracts is underway, and it is possible that our current practices may no longer be viable under the new revenue recognition guidance.

The guidance also requires a number of disclosures regarding the nature, amount, timing and uncertainty of revenue and the related cash flows. The guidance can be applied retrospectively to each prior reporting period presented (full retrospective method) or retrospectively with a cumulative effect adjustment to retained earnings for initial application of the guidance at the date of initial adoption (modified retrospective method). The guidance is effective for annual reporting periods beginning on or after December 15, 2017. We do not plan to early adopt the standard.

In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers, or ASU 2016-20. The amendments in ASU 2016-20 update and affect narrow aspects of the guidance issued in ASU 2014-09. In May 2016, the FASB issued ASU 2016-12, Narrow Scope Improvements and Practical Expedients, which provided revised guidance on certain issues relating to revenue from contracts with customers, including clarification of the objective of the collectability criterion. In March 2016, the FASB issued an amendment to clarify the implementation guidance for principal versus agent considerations and in April 2016 issued a final amendment to clarify the guidance related to identifying performance obligations and the accounting for intellectual property licenses. We are currently evaluating the impact these updates may have on our Consolidated Financial Statements and disclosures.

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra Entity Transfers of Assets Other Than Inventory, or ASU 2016-16. The guidance in ASU 2016-16 requires companies to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted. We are currently evaluating the impact that this guidance will have on our Consolidated Financial Statements and disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases, or ASU 2016-02. Under this amendment, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: 1) a lease liability which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, and 2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early application permitted. Lessees must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. We have not determined the impact ASU 2016-02 will have on our Consolidated Financial Statements and disclosures.

In May 2017, the FASB issued ASU No. 2017-09, Compensation —Stock Compensation (Topic 718): Scope of Modification Accounting, or ASU 2017-09. ASU 2017-09 provides clarity and reduces both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation—Stock Compensation, to a change to the terms or conditions of a share-based payment award. The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-09 is effective for fiscal years beginning after December 15, 2017. We have not determined the impact ASU 2017-09 will have on our Consolidated Financial Statements and disclosures.

NOTE 4 - PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment, net consisted of the following as of: 

Depreciation expense, which includes amortization of equipment under capital leases, for the three months ended June 30, 2017 and 2016 was $171,613 and $176,050, respectively. On March 31, 2017 we classified certain machinery and equipment as assets held for sale. See Note 7 - Other Noncurrent Assets.

Capitalized leases were $54,376 at the end of June 30, 2016 and March 31, 2017. Accumulated depreciation on all property, plant and equipment accounted for as capitalized leases was $5,438 and $2,719 at June 30, 2017 and March 31, 2017, respectively.

We capitalize interest on borrowings during the active construction period of major capital projects. Capitalized interest is added to the cost of the underlying assets and is amortized over the useful lives of the assets. Capitalized interest for the three months ended June 30, 2017 was $4,667.

NOTE 5 - COSTS INCURRED ON UNCOMPLETED CONTRACTS

The following table sets forth information as to costs incurred on uncompleted contracts as of:

Contract costs consist primarily of labor and materials and related overhead, to the extent that such costs are recoverable. Revenues associated with these contracts are recorded only when the amount of recovery can be estimated reliably and realization is probable. As of June 30, 2017 and March 31, 2017, we had billings in excess of costs totaling $574,309 and $642,831, respectively. Billings on uncompleted contracts represent customer prepayments on their contracts and completed contracts for which all revenue recognition criteria were not met.   We also receive advance billings and deposits representing down payments for acquisition of materials and progress payments on contracts. The agreements with our customers allow us to offset the progress payments against the costs incurred.

NOTE 6 - OTHER CURRENT ASSETS

Other current assets included the following as of:

NOTE 7 - OTHER NONCURRENT ASSETS

Other noncurrent assets included the following as of:

At June 30, 2017 and March 31, 2017, we classified certain machinery and equipment of $20,000 and $100,000, respectively, to assets held for sale. This amount approximates fair value net of selling costs. We expect to sell this remaining fixed asset before the end of fiscal 2018. In fiscal 2017, we wrote down certain machinery held for sale and subsequently sold the machinery in May 2017.

NOTE 8 - ACCRUED EXPENSES

Accrued expenses included the following as of:  

Accrued compensation includes amounts for executive bonuses, payroll and vacation and holiday pay. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in the provision are recorded in cost of sales. 

NOTE 9 - DEBT

Long-term debt included the following as of: 

Commerce Bank & Trust Company Loan Facility

On December 21, 2016, TechPrecision, through Ranor, closed on a Loan Agreement, or the Commerce Loan Agreement, with Commerce Bank & Trust Company, or Commerce.  Pursuant to the Commerce Loan Agreement, Commerce made a term loan to Ranor in the amount of $2,850,000, or the Term Loan, and made available to Ranor a revolving line of credit in the amount of $1,000,000, or the Revolver Loan, and together with  the Term Loan, the Commerce Loans.  The Commerce Loans are secured by a first lien on all personal and real property of Ranor.  Starting on January 20, 2017, payments on the Term Loan began and will be made in 60 monthly installments of $19,260 each, inclusive of interest at a fixed rate of 5.21% per annum, with all outstanding principal and accrued interest due and payable on December 20, 2021.  A prepayment penalty will apply during the loan term but will not apply if a prepayment is made from either casualty loss insurance proceeds or a condemnation award applicable to any collateral or if a full prepayment is made during the 45-day period immediately preceding the maturity date.  Advances under the Revolver Loan will be subject to a borrowing base equal to the lesser of (A) $1,000,000 and (B) the sum of (i) 80% of eligible accounts receivable, and (ii) the lesser of (a) 25% of eligible raw material inventory and (b) $250,000.  Advances made under the Revolver Loan bear interest at a variable rate equal to the one-month LIBOR plus 275 basis points.  Interest-only payments on advances made under the Revolver Loan will be payable monthly in arrears.  The Revolver Loan will mature on December 21, 2018.  Ranor’s obligations under the Commerce Loan Agreement are guaranteed by TechPrecision. There were no amounts outstanding under the Revolver Loan at June 30, 2017 and March 31, 2017. Unamortized debt issue costs at June 30, 2017 were $55,948.

The Commerce Loan Agreement contains a covenant whereby the Company is required to maintain a debt service coverage ratio, or DSCR, of at least 1.2 to 1.0 during the term of the Commerce Loans.  The DSCR will be measured at the end of each fiscal quarter of the Company.  Pursuant to the Commerce Loan Agreement, Ranor covenants (a) to cause its balance sheet leverage to be less than or equal to 3.00 to 1.00 for the fiscal year ending March 31, 2018, and less than or equal to 2.50 to 1.00 for the fiscal year ending March 31, 2019 and each fiscal year end thereafter, and (b) that its annual capital expenditures shall not exceed $2,500,000 for the fiscal year ending March 31, 2018, $2,500,000 for the fiscal year ended March 31, 2019, and $1,500,000 for the fiscal year ending March 31, 2020 and each fiscal year end thereafter.  The Commerce Loan Agreement contains an additional covenant whereby Ranor is required to maintain a loan-to-value ratio of not greater than 0.75 to 1.00, to be measured by appraisal not more frequently than one time during each 365-day period. At June 30, 2017 and March 31, 2017, the DSCR was 3.41 to 1.00 and 3.40 to 1.00, respectively. At March 31, 2017, the leverage ratio was 1.01 to 1.00.

People’s Capital and Leasing Corp. Equipment Loan Facility

On April 26, 2016, TechPrecision, through Ranor, executed and closed a Master Loan and Security Agreement, or the MLSA, with People’s Capital and Leasing Corp., or People’s.  Loan proceeds were disbursed to Ranor on April 26, 2016.  Pursuant to the MLSA, People’s loaned $3,011,648 to Ranor, or the People’s Loan. The People’s Loan is secured by a first lien on certain machinery and equipment of Ranor, or the Equipment Collateral.  Payments on the People’s Loan will be made in 60 monthly installments of $60,921 each, inclusive of interest at a fixed rate of 7.90% per annum.  The first monthly installment payment was paid on May 26, 2016.  A prepayment penalty will apply during the first four years of the loan term.  Ranor’s obligations under the MLSA are guaranteed by TechPrecision.  The Company covenants to maintain a DSCR of at least 1.5 to 1.0 during the term of the People’s Loan.  The DSCR will be measured at the end of each fiscal year of the Company. At March 31, 2017, the DSCR was 2.86 to 1.00. The People’s Loan may be accelerated upon the occurrence of an “Event of Default” (as defined in the MLSA). Some of the Events of Default are subject to certain cure periods. Unamortized debt issue costs at June 30, 2017 were $99,466.

Capital Lease

We entered into a new capital lease in January 2017 for certain office equipment. The lease term is for 60 months, bears interest at 7.9% per annum and requires monthly payments of principal and interest of $1,169.

Concurrently, in January 2017 we retired certain office equipment under an existing capital lease which was amended in 2014. The revised lease term will expire in March 2018 and the required monthly payments of principal and interest will be $1,187 through October 2017, and then $720 until the lease payment expires in September 2018.

Collateral securing the above obligations comprises all personal and real property of TechPrecision and Ranor, including cash, accounts receivable, inventories, equipment, financial and intangible assets.

NOTE 10 - INCOME TAXES

We account for income taxes under the provisions of FASB ASC 740, Income Taxes.   The tax provision for interim periods is determined using the estimated annual effective consolidated tax rate, based on the current estimate of full-year earnings before taxes, adjusted for the impact of discrete quarterly items. The provision for income taxes was $287,635 and $9,453 and the effective tax rate was 40.4% and 2.1%, for the three months ended June 30, 2017 and 2016, respectively. For the three months ended June 30, 2016, the effective tax rate was 2.1% as a result of the utilization of net operating losses and the associated reduction in the valuation allowance which had been provided for this deferred tax asset. The 2016 tax provision was an accrual for the alternative minimum tax.

The valuation allowance on deferred tax assets at June 30, 2017 and March 31, 2017 was approximately $1.5 million. We believe that it is more likely than not that the benefit from certain state and foreign NOL carryforwards and other deferred tax assets will not be realized. In recognition of this risk, we continue to provide a valuation allowance on these items. In the event future taxable income is below management’s estimates or is generated in tax jurisdictions different than projected, the Company could be required to increase the valuation allowance for deferred tax assets. This would result in an increase in the Company’s effective tax rate.

We regularly assess the effects of various factors to determine the adequacy of our provision for income taxes. For example, our future effective tax rate would be affected if earnings were lower than anticipated in tax jurisdictions where we have lower statutory rates and higher than anticipated in tax jurisdictions where we have higher statutory rates, by changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws, regulations, accounting principles, or interpretations thereof. 

NOTE 11 - PROFIT SHARING PLAN

Ranor has a 401(k) profit sharing plan that covers substantially all Ranor employees who have completed 90 days of service. Ranor retains the option to match employee contributions. The Company’s contributions were $22,319 and $18,750 for the three months ended June 30, 2017 and 2016, respectively.

NOTE 12 - STOCK BASED COMPENSATION

Our board of directors, upon the recommendation of the compensation committee of our board of directors, approved the 2016 TechPrecision Equity Incentive Plan, or the 2016 Plan, on November 10, 2016. Our stockholders approved the 2016 Plan at the Company’s Annual Meeting of Stockholders on December 8, 2016, and it applies to awards granted after that date. The 2016 Plan provides for a share reserve of 5,000,000 shares of common stock.

On April 4, 2017, we granted stock options to members of our board of directors to collectively purchase 200,000 shares of common stock at an exercise price of $0.74 per share, the closing stock market price on the date of grant. Forty percent of the options granted vested immediately. The remaining options will vest equally at the end of each quarter during fiscal 2018, beginning with the second quarter of fiscal 2018. The fair value of the stock options expensed during the three months ended June 30, 2017 was $66,109.

The fair value of the options we grant is estimated using the Black-Scholes option-pricing model based on the closing stock prices at the grant date and the weighted average assumptions specific to the underlying options. Expected volatility assumptions are based on the historical volatility of our common stock. The average dividend yield over the historical period for which volatility was computed is zero. The risk-free interest rate was selected based upon yields of five-year U.S. Treasury issues. We used the simplified method for all grants to estimate the expected life of the option. We assume that stock options will be exercised evenly over the period from vesting until the awards expire. As such, the assumed period for each vesting tranche is computed separately and then averaged together to determine the expected term for the award. The assumptions utilized for options granted during the period were 110.1% for volatility, 1.88% for the risk free interest rate, and approximately six years for the expected life. At June 30, 2017, there were 1,797,332 shares available for grant under the 2016 Plan.

The following table summarizes information about options for the most recent annual income statements presented: 

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the closing stock price on the last trading day of the first quarter of fiscal 2018 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on June 30, 2017. This amount changes based on the fair market value of the Company’s common stock.

The following table summarizes the status of our stock options outstanding but not vested for the year ended June 30, 2017:

The total fair value of shares vested during the year was $48,079. Other information relating to stock options outstanding at June 30, 2017 is as follows:

NOTE 13 - CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS

We maintain bank account balances, which, at times, may exceed insured limits. We have not experienced any losses with these accounts and believe that we are not exposed to any significant credit risk on cash.

At June 30, 2017, there were accounts receivable balances outstanding from four customers comprising 95% of the total receivables balance. The following table sets forth information as to accounts receivable from customers who accounted for more than 10% of our accounts receivable balance as of: 

*less than 10% of total

We have been dependent in each year on a small number of customers who generate a significant portion of our business, and these customers change from year to year. The following table sets forth information as to net sales from customers who accounted for more than 10% of our net sales for the fiscal year ended:

*less than 10% of total

NOTE 14 - COMMITMENTS

Employment Agreements

We have employment agreements with each of our executive officers. Such agreements provide for minimum salary levels, adjusted annually, and incentive bonuses that are payable if specified company goals are attained. The aggregate commitment at June 30, 2017 for future executive salaries during the next fiscal year ending March 31, 2018 was approximately $0.5 million. For the remainder of our employees, the aggregate commitment at June 30, 2017 was approximately $0.3 million for accrued payroll, vacation and holiday pay.

NOTE 15 - EARNINGS PER SHARE (EPS)

Basic EPS is computed by dividing reported earnings available to stockholders by the weighted average shares outstanding. Diluted EPS also includes the effect of stock options that would be dilutive. The following table provides a reconciliation of the numerators and denominators reflected in the basic and diluted earnings per share computations, as required under FASB ASC 260, for the three months ended:

All potential common share equivalents that have an anti-dilutive effect (i.e. those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS. There were 502,668 of potential common stock equivalents that were out-of-the-money and were not included in the EPS calculations above for the three months ended June 30, 2017. For the three months ended June 30, 2016 there were 428,500 of potentially anti-dilutive stock options, none of which were included in the EPS calculations above.

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

Statement Regarding Forward Looking Disclosure

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

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

Any forward-looking statements speak only as of the date on which they are made, and we undertake no obligation to publicly update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this Quarterly Report on Form 10-Q, except as required by applicable law. Investors should evaluate any statements made by us in light of these important factors.

Overview

We offer a full range of services required to transform raw materials into precision finished products. Our manufacturing capabilities include: fabrication operations (cutting, press and roll forming, assembly, welding, heat treating, blasting and painting) and machining operations including CNC (computer numerical controlled) horizontal and vertical milling centers. We also provide support services to our manufacturing capabilities: manufacturing engineering (planning, fixture and tooling development, manufacturing), quality control (inspection and testing), materials procurement, production control (scheduling, project management and expediting) and final assembly.

All U.S. manufacturing is done in accordance with our written quality assurance program, which meets specific national and international codes, standards and specifications. Ranor holds several certificates of authorization issued by the American Society of Mechanical Engineers and the National Board of Boiler and Pressure Vessel Inspectors. The standards used are specific to the customers’ needs, and our manufacturing operations are conducted in accordance with these standards.

Because our revenues are derived from the sale of goods manufactured pursuant to a contract, and we do not sell from inventory, it is necessary for us to constantly seek new contracts. There may be a time lag between our completion of one contract and commencement of work on another contract. During such periods, we may continue to incur overhead expense but with lower revenue resulting in lower operating margins. Furthermore, changes in either the scope of an existing contract or related delivery schedules may impact the revenue we receive under the contract and the allocation of manpower. Although we provide manufacturing services for large governmental programs, we usually do not work directly for the government or its agencies. Rather, we perform our services for large governmental contractors. Our business is dependent in part on the continuation of governmental programs which require our services and products.

Our contracts are generated both through negotiation with the customer and from bids made pursuant to a request for proposal. Our ability to receive contract awards is dependent upon the contracting party’s perception of such factors as our ability to perform on time, our history of performance, including quality, our financial condition and our ability to price our services competitively.  Although some of our contracts contemplate the manufacture of one or a limited number of units, we are seeking more long-term projects with predictable cost structures.

We historically have experienced, and continue to experience, customer concentration. For the three months ended June 30, 2017 and June 30, 2016, our largest customer accounted for approximately 50% and 32% of reported net sales, respectively. Our sales order backlog at June 30, 2017 was approximately $11.6 million compared with a backlog of $15.8 million at March 31, 2017.

For the three months ended June 30, 2017, our net sales and net income were $5.8 million and $0.4 million, respectively, compared with net sales of $4.6 million and net income of $0.4 million, for the three months ended June 30, 2016.  Our gross margins for the three months ended June 30, 2017 were 30% compared with gross margins of 33% in the three months ended June 30, 2016. We generated $0.6 million of cash from operating activities for the three months ended June 30, 2017 and had a cash balance of $3.3 million at June 30, 2017.

Critical Accounting Policies

The preparation of the unaudited condensed consolidated financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We continually evaluate our estimates, including those related to contract accounting, inventories, recovery of long-lived assets, income taxes and the valuation of equity transactions. These estimates and assumptions require management's most difficult, subjective or complex judgments. Actual results may differ under different assumptions or conditions.

Our significant accounting policies are set forth in detail in Note 2 to the consolidated financial statements included in the 2017 Form 10-K. There were no significant changes in the critical accounting policies during the three months ended June 30, 2017, nor did we make any changes to our accounting policies that would have changed these critical accounting policies.

New Accounting Pronouncements

See Note 3 – New Accounting Standards to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for a discussion of recently adopted accounting guidance and other new accounting guidance.

Results of Operations

Our results of operations are affected by a number of external factors including the availability of raw materials, commodity prices (particularly steel), macroeconomic factors, including the availability of capital that may be needed by our customers, and political, regulatory and legal conditions in the United States and in foreign markets. Generally, our product mix is made up of short-term contracts with a production timeline of less than twelve months. Units manufactured under the majority of our customer contracts are delivered on time and with a positive gross margin.  Our results of operations are also affected by our success in booking new contracts, the timing of revenue recognition, delays in customer acceptances of our products, delays in deliveries of ordered products and our rate of progress fulfilling obligations under our contracts. A delay in deliveries or cancellations of orders could have an unfavorable impact on liquidity, cause us to have inventories in excess of our short-term needs, and delay our ability to recognize, or prevent us from recognizing, revenue on contracts in our order backlog.

Key Performance Indicators

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

Three Months Ended June 30, 2017 and 2016

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

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Net Sales

Our shipments in the three months ended June 30, 2017 included orders for new and repeat business from existing key customers. Generally, increases and decreases in net sales reflect changes in product mix as our customers gauge their demand for new components. Customer acceptance and the timing of delivery dates play a significant role as to when we can recognize revenue in any given period. For the three months ended June 30, 2017, net sales increased by $1.2 million, or 26%, to $5.8 million when compared to $4.6 million for the three months ended June 30, 2017.  Net sales in our defense market, increased by $2.0 million in the three months ended June 30, 2017 when compared to the three months ended June 30, 2016, primarily on higher shipments of new product components to one of our largest defense customers.  Net sales in our energy market increased by $0.7 million when compared to the three months ended June 30, 2016, primarily on a higher shipment volume of nuclear plant components. Net sales in our precision industrial market decreased by $1.5 million when compared to the three months ended June 30, 2016 on lower shipments of large scale medical device components.

Cost of Sales and Gross Margin

Cost of sales consists primarily of raw materials, parts, labor, overhead and subcontracting costs. Our cost of sales for fiscal 2018 increased by $1.0 million compared to fiscal 2017 primarily on higher sales volume, higher estimates for contract losses and higher amounts of unabsorbed overhead. Contract losses increased by $0.1 million for the three months ended June 30, 2017, and are included in cost of sales. Gross profit increased by $0.2 million for the three months ended June 30, 2017 when compared to the three months ended June 30, 2016.  Gross margin in any reporting period is impacted by the mix of products and services we provide on projects completed within that period. Gross margins were 30% and 33% for the three months ended June 30, 2017 and 2016, respectively. Lower gross margin for the three months ended June 30, 2017 was caused by an increase in loss reserves and higher rework activity on certain contracts.

Selling, General and Administrative Expenses

Total SG&A expenses increased by $31,582 for the three months ended June 30, 2017 compared to the three months ended June 30, 2016, primarily the result of remuneration for the board of directors and share-based compensation, offset in part by lower outside advisory services and other office expenses.

Other Income (Expense)

The following table reflects other income, interest expense and amortization of debt issue costs for the three months ended June 30:

Interest expense and amortization of debt issue costs for the three months ended June 30, 2017 were lower when compared to the three months ended June 30, 2016. The decrease in interest expense is primarily due to lower interest rates in connection with our debt refinancing transactions completed in fiscal 2017. Debt issue costs amortization for the three months ended June 30, 2017 decreased when compared to the three months ended June 30, 2016 because of lower debt issue costs in connection with our new debt.

Income Taxes

For the three months ended June 30, 2017 we recorded tax expense of $287,635, compared to tax expense of $9,453 for the three months ended June 30, 2016. The effective tax rate was 40.4% and 2.1%, for the three months ended June 30, 2017 and 2016, respectively. For the three months ended June 30, 2016 the effective tax rate of 2.1% was a result of the utilization of net operating losses and the associated reduction in the valuation allowance which had been provided for this deferred tax asset. The 2016 tax provision was an accrual for the alternative minimum tax.

The valuation allowance on deferred tax assets at June 30, 2017 and March 31, 2017 was approximately $1.5 million. We believe that it is more likely than not that the benefit from certain state and foreign NOL carryforwards and other deferred tax assets will not be realized. In recognition of this risk, we continue to provide a valuation allowance on these items. In the event future taxable income is below management’s estimates or is generated in tax jurisdictions different than projected, the Company could be required to increase the valuation allowance for deferred tax assets. This would result in an increase in the Company’s effective tax rate.

Our future effective tax rate may be affected if earnings are lower than anticipated in tax jurisdictions with lower statutory rates and higher than anticipated in tax jurisdictions with higher statutory rates, by changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws, regulations, accounting principles, or interpretations thereof.

Net Income

As a result of the foregoing, for the three months ended June 30, 2017, our net income was $424,502, or $0.01 per share basic and fully diluted, compared with net income of $445,303, or $0.02 per share basic and fully diluted, for the three months ended June 30, 2016.

Liquidity and Capital Resources

At June 30, 2017, we had cash and cash equivalents of $3.3 million. Net cash provided by operating activities was $0.6 million for the three months ended June 30, 2017. Net cash provided by operating activities for the three months ended June 30, 2016 was $1.4 million. At June 30, 2017, we had working capital of $5.6 million as compared with working capital of $5.0 million at March 31, 2017. The table below presents selected liquidity and capital measures as of:

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

At June 30, 2017 the Company was in compliance with all financial covenants contained in all of its debt agreements. We believe our available cash will be sufficient to fund our operations, capital expenditures and principal and interest payments under our debt obligations through the 12 months from the issuance date of our financial statements.

Operating activities

Our primary sources of cash are from accounts receivable collections, customer advance payments, and project progress payments. Our customers make advance payments and progress payments under the terms of each manufacturing contract. Our cash flows can fluctuate significantly from period to period as the composition of our receivables collections mix changes between advance payments and customer payments made after shipment of finished goods. Cash provided by operations for the three months ended June 30, 2017 was $0.6 million compared with cash provided by operations of $1.4 million for the three months ended June 30, 2016. The three month period ended June 30, 2016 was marked by higher collections of cash from customer advances and progress payments.

Investing activities

For the three months ended June 30, 2017, net cash used in investing activities totaled $132,946, primarily made up of a $212,946 deposit for new factory machinery and equipment, offset in part by $80,000 in proceeds from the sale of certain machinery and equipment.

Financing activities

For the three months ended June 30, 2017, net cash used in financing activities was $174,591 consisting of monthly principal payments in connection with our debt obligations. For the three months ended June 30, 2016, cash provided by financing activities was $139,862. For the three months ended June 30, 2016 we received proceeds of $2.8 million from our MLSA with People's and used $2.5 million of the proceeds from the People's Loan as payment in full for the principal obligations under the Utica LSA. We also paid $144,338 in loan closing costs.

All of the above activity resulted in a net increase in cash of $0.3 million for the three months ended June 30, 2017 compared with an increase in cash of $1.5 million for the three months ended June 30, 2016.

Off-Balance Sheet Arrangements

We do not currently have, and have not had during the three months ended June 31, 2017, any off-balance sheet assets, liabilities or arrangements.

EBITDA Non-GAAP Financial Measure

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

We define EBITDA as net income plus interest, income taxes, depreciation and amortization. Net income was $424,502 for the three months ended June 30, 2017, as compared to $445,303 for the three months ended June 30, 2016. EBITDA, a non-GAAP financial measure, was $1.0 million for the three months ended June 30, 2017, as compared to $0.8 million for the three months ended June 30, 2016, an increase of $0.2 million over the prior period.

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

(1) Includes amortization of debt issue costs.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures.

Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are controls and procedures that are designed to ensure that the information required to be disclosed in our reports filed or submitted under the Exchange Act, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and includes controls and procedures designed to ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

As of the end of the period covered by this report, an evaluation was carried out, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2017, our disclosure controls and procedures were effective at a reasonable assurance level.

Inherent Limitations Over Internal Controls

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

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

Changes in Internal Control over Financial Reporting

For the quarter ended June 30, 2017, there have been no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION.

Item 1. Legal Proceedings.

Class Action Lawsuit

There have been no material changes to the legal proceedings discussed in Item 3. "Legal Proceedings," in the 2016 Form 10-K.

Item 6. Exhibits.

 †     Management contract or compensatory arrangement or plan.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

EXHIBIT INDEX

 †     Management contract or compensatory arrangement or plan.