TECHPRECISION CORP - Quarter Report: 2019 September (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 September 30, 2019

¨ 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)

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. 

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 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit 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 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 November 7, 2019 was 29,254,594.

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 (LOSS) INCOME (unaudited)

See accompanying notes to the condensed consolidated financial statements.

TECHPRECISION CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (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.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - DESCRIPTION OF BUSINESS

TechPrecision Corporation, or TechPrecision, is a Delaware corporation organized in February 2005 under the name Lounsberry Holdings II, Inc. The name was changed to TechPrecision Corporation on March 6, 2006. 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. 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. We consider our business to consist of one segment - metal fabrication and precision machining. All of our operations and customers are located in the United States.

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 sheets as of September 30, 2019 and March 31, 2019, the condensed consolidated statements of operations and comprehensive (loss) income and stockholders’ equity for the three and six months ended September 30, 2019 and 2018, and the condensed consolidated statements of cash flows for the six months ended September 30, 2019 and 2018 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.

These notes to the 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 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 the consolidated financial statements included with our Annual Report on Form 10-K for the fiscal year ended March 31, 2019, or the 2019 Form 10-K, filed with the SEC on June 27, 2019.

Use of Estimates in the Preparation of Financial Statements - In preparing the condensed consolidated financial statements in conformity with U.S. GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and revenues and expenses during the reported period. We continually evaluate our estimates, including those related to contract accounting, accounts receivable, inventories, recovery of long-lived assets, income taxes and the valuation of equity transactions. We base our estimates on historical and current experiences and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates.

NOTE 3 - ACCOUNTING STANDARDS UPDATE

New Accounting Standards Recently Adopted

On April 1, 2019, we adopted Accounting Standards Update (ASU) 2016-02, Leases, or Accounting Standards Codification 842 (ASC 842) and all the related amendments using the modified retrospective method. The comparative information has not been restated and continues to be reported under the lease accounting standard in effect for those periods.

The most significant effects of the standard on our condensed consolidated financial statements are (1) the recognition of new right-of-use asset and lease liability on our condensed consolidated balance sheet for our operating lease, and (2) new disclosures about our leasing activities (see Note 12). The adoption did not result in a cumulative-effect adjustment to retained earnings. The new standard did not have a material impact on our results of operations, balance sheet or cash flows.

We elected the practical expedients permitted under the transition guidance of the new standard that retained the lease classification and initial direct costs for any leases that existed prior to adoption of the standard. The new lease standard requires all leases to be reported on the balance sheet as right-of-use assets and lease obligations.

We also adopted the following ASUs effective April 1, 2019, none of which had a material impact to our financial statements or financial statement disclosures: ASU 2018-13 Fair Value Measurement - Changes to the Disclosure Requirements for Fair Value Measurement, ASU 2018-07, Compensation - Stock Compensation (Topic 718) Improvements to Nonemployee Share-Based Payment Accounting, and ASU 2018-02 Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.

NOTE 4 - REVENUE

The Company generates its revenues from performance obligations completed under contracts with customers in three main market sectors: defense, energy and precision industrial. The period over which the Company performs is generally less than one year. The Company invoices and receives related payments based on performance progress not less frequently than monthly.

Revenue is recognized over-time or at a point-in-time given the terms and conditions of the related contracts. The Company utilizes an inputs methodology based on estimated labor hours to measure performance progress. This model best depicts the transfer of control to the customer.

The Company’s contract portfolio is comprised of fixed-price contracts and provide for product type sales only. The following table presents net sales on a disaggregated basis by market and contract type:

As of September 30, 2019, the Company had $16.4 million of remaining performance obligations, of which $8.5 million were less than 50% complete. We expect to recognize all of the remaining performance obligations as revenue within the next 24 months.

We are dependent each year on a small number of customers who generate a significant portion of our business. These customers change from year to year. The following table lists customers who accounted for more than 10% of our net sales:  

*Less than 10% of total 

On our condensed consolidated balance sheet, contract assets and contract liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period. In fiscal 2020, we recognized revenue of $0.5 million related to our contract liabilities at March 31, 2019. At September 30, 2019 contract assets consisted of the following:

NOTE 5 - 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. We recorded an income tax benefit of $17,358 for the six months ended September 30, 2019. Income tax expense was $142,403 for the six months ended September 30, 2018. The Company's effective tax rates for the six months ended September 30, 2019 and 2018 were 19.8% and 29.2%, respectively.

The valuation allowance on deferred tax assets was approximately $1.7 million at September 30, 2019. 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 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.

NOTE 6 - EARNINGS PER SHARE

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.

All potential common stock 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. For the three and six months ended September 30, 2019, there were 2,968,000 of potentially anti-dilutive stock options, none of which were included in the EPS calculations above. For the three and six months ended September 30, 2018, there were 642,668, and 596,668, respectively, of potential common stock equivalents that were out-of-the-money and were not included in the EPS calculations above.

NOTE 7 - STOCK-BASED COMPENSATION

The TechPrecision Corporation 2016 Equity Incentive Plan, or the 2016 Plan, authorizes the award of incentive and non-qualified stock options, restricted stock awards, restricted stock units, and performance awards to employees, directors, consultants, and other individuals who provide services to TechPrecision or its affiliates. The purpose of the 2016 Plan is to: (a) enable TechPrecision and its affiliated companies to recruit and retain highly qualified employees, directors and consultants; (b) provide those employees, directors and consultants with an incentive for productivity; and (c) provide those employees, directors and consultants with an opportunity to share in the growth and value of the Company. Subject to adjustment as provided in the 2016 Plan, the maximum number of shares of common stock that may be issued with respect to awards under the 2016 Plan is 5,000,000 shares (inclusive of awards issued under the 2006 Long-Term Incentive Plan, or the 2006 Plan, that remained outstanding as of the effective date of the 2016 Plan). Shares of our common stock subject to awards that expire unexercised or are otherwise forfeited shall again be available for awards under the 2016 Plan.

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 is computed is zero. The risk-free interest rate is selected based upon yields of 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. We account for award forfeitures as they occur. As such, the assumed period for each vesting tranche is computed separately and then averaged together to determine the expected term for the award. At September 30, 2019, there were 1,572,000 shares available for grant under the 2016 Plan.

The following table summarizes information about options for the most recently completed periods:  

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 2020 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 September 30, 2019. This amount changes based on the fair market value of the Company’s common stock. All of the options are vested and exercisable and the maximum contractual term is ten years for option grants.

On April 5, 2019, the Company issued 20,000 shares of the Company’s common stock, par value $0.0001 per share, pursuant to an option award exercised on March 20, 2019, granted previously under the Company’s 2016 Long-Term Incentive Plan. At September 30, 2019, there was no remaining unrecognized compensation cost related to stock options. Other information relating to stock options outstanding at September 30, 2019 is as follows: 

Restricted Stock Awards

On December 7, 2018 we granted a total of 100,000 shares of restricted stock under the 2016 Plan to the board of directors and a total of 25,000 shares of restricted stock to our executive officers. The stock-based compensation expense of $122,500 for service-based restricted stock was measured at fair value on the date of grant based on the number of shares expected to vest and the quoted market price of the Company’s common stock. The shares of restricted stock fully vest and cease to be subject to forfeiture on December 7, 2019, one year following the grant date. Each grantee must be serving as a director or executive officer on the vesting date and must have been continuously serving in such capacity from the grant date through the vesting date for the shares of restricted stock to vest. Prior to the vesting date, the grantee is not permitted to sell, transfer, pledge, assign or otherwise encumber the shares of restricted stock and if the grantee’s service with the Company terminates prior to the vesting date, the grantee’s restricted stock will be forfeited automatically. The aggregate fair value of the restricted stock expensed during the six months ended September 30, 2019 was $61,250. At September 30, 2019 there was $20,417 of total unrecognized compensation cost related to the restricted stock awards.

NOTE 8 - CONCENTRATION OF CREDIT RISK

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 September 30, 2019, there were trade accounts receivable balances outstanding from five customers comprising 99% of the total trade receivables balance. The following table sets forth information as to trade accounts receivable from customers who accounted for more than 10% of our accounts receivable balance as of: 

*less than 10% of total

NOTE 9 - OTHER CURRENT ASSETS

NOTE 10 - ACCRUED EXPENSES 

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. Accrued project costs are estimates for certain project expenses during the reporting period.

NOTE 11 - DEBT 

Berkshire Term Loan Facility

On December 21, 2016, TechPrecision, through Ranor, closed on a Loan Agreement, or the Berkshire Loan Agreement, with Berkshire Bank. Pursuant to the Berkshire Loan Agreement, Berkshire Bank 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, collectively, the Berkshire Loans.  The Berkshire Loans are secured by a first lien on all personal and real property of Ranor.  Payments on the Term Loan began on January 20, 2017 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. Ranor’s obligations under the Berkshire Loan Agreement are guaranteed by TechPrecision. The Company pays, as consideration for the bank’s commitment to make advances under the Revolver Loan, a nonrefundable commitment fee equal to 0.25% per annum on the average daily difference between the amount of $1,000,000 and the aggregate amount of all advances made under the Revolver Loan as of each quarterly period.

Pursuant to the Berkshire Loan Agreement, the Company covenants to cause its balance sheet leverage to be less than or equal to 2.50 to 1.00 for the fiscal year ending March 31, 2019 and each fiscal year end thereafter. The Berkshire Loan Agreement also 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 Berkshire Loans.  The DSCR is measured at the end of each fiscal quarter of the Company.  The Company was in compliance with all of the financial covenants at September 30, 2019 and March 31, 2019. 

Also, Ranor’s annual capital expenditures cannot exceed $1,500,000 for the fiscal year ending March 31, 2020 and each fiscal year thereafter.  The Berkshire 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.

The Berkshire Loans may be accelerated upon the occurrence of an “Event of Default” (as defined in the Berkshire Loan Agreement).  Events of Default include (i) the failure to pay any monthly installment payment before the tenth day following the due date of such payment; (ii) the failure of Ranor or TechPrecision to observe, perform or pay any obligations under the Berkshire Loan Agreement or any other obligation to Berkshire; (iii) the failure of Ranor or TechPrecision to pay any indebtedness in excess of $100,000 (other than the Berkshire Loans) when due; (iv) any representation or warranty of Ranor or TechPrecision in the Berkshire Loan Agreement and related documents, or the Loan Documents, being proven to have been incorrect, in any material respect, when made; (v) the failure of Ranor to discharge any attachment, levy or distraint on its property; (vi) any default by Ranor or TechPrecision under any of the collateral security documents executed in connection with the Berkshire Loan Agreement past any applicable grace period; (vii) the failure of Ranor or TechPrecision to file or pay taxes when due, unless such taxes are being contested in a manner permitted under the Loan Documents; (viii) a change in ownership or control of Ranor or change in management of Ranor where either the chief executive officer or chief financial officer as of December 21, 2016 is replaced without Berkshire Bank’s prior consent; (ix) Ranor or TechPrecision ceasing to do business as a going concern, making an assignment for the benefit of creditors, or commencing a bankruptcy or other similar insolvency proceeding; and (x) the entry of a judgment against Ranor or TechPrecision in excess of $150,000. Some of the Events of Default are subject to certain cure periods. Subject to the lapse of any applicable cure period, a default under the Berkshire Loans could cause the acceleration of all outstanding obligations under the Berkshire Loans.

On December 19, 2018, the Company entered into a Second Modification to Loan Agreement and First Modification and Allonge to Promissory Note with Berkshire Bank, or the Modification. The Modification amended and modified the Berkshire Loan Agreement, and the related Promissory Note dated December 20, 2016 made by Ranor in favor of Berkshire in the stated principal amount of $1,000,000. Under the terms of the Berkshire Loan Agreement and the related promissory note, Ranor was entitled to borrow up to $1,000,000 on a revolving basis. As of the date of the Modification, there were no amounts outstanding under the Revolver Loan. The maturity date of the Revolver Loan was originally December 20, 2018. Under the Modification, the maturity date of the Revolver Loan was extended until December 20, 2020. There were no amounts outstanding under the Revolver Loan at September 30, 2019 and March 31, 2019.The Company paid $7,245 of expenses related to the execution of the Modification, which are classified as other noncurrent assets.

Other unamortized debt issue costs at September 30, 2019 and March 31, 2019 were $26,688 and $32,982, respectively.

People’s Equipment Loan Facility

On April 26, 2016, TechPrecision, through Ranor, executed and closed a Master Loan and Security Agreement No. 4180, as supplemented with Schedule No. 001, or, together, the MLSA, with People’s Capital and Leasing Corp., or People’s.  The MLSA is dated and effective as of March 31, 2016.  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 is measured at the end of each fiscal year of the Company. The Company was in compliance with the DSCR at March 31, 2019. 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. The Company was in compliance with all of the financial covenants at March 31, 2019.

On October 4, 2016, TechPrecision and Ranor became committed to Schedule No. 002 to the MLSA, or Schedule 2. Pursuant to Schedule 2, People’s made an additional loan in the amount of $365,852, or the Additional People’s Loan, to Ranor upon the terms and conditions set forth in the MLSA and Schedule 2. Ranor will repay the Additional People’s Loan in monthly installments of principal and interest of $7,399 over 60 months.  The Additional People’s Loan is guaranteed by TechPrecision pursuant to the original Corporate Guaranty from TechPrecision in favor of People’s dated March 31, 2016.  The Additional People’s Loan is secured by a security interest in certain machinery and equipment of Ranor as provided in Schedule 2.

On December 21, 2016, TechPrecision and Ranor closed on an Amendment to the MLSA, or the MLSA Amendment, with People’s. The MLSA Amendment, dated as of December 20, 2016, amends the definition of “Permitted Liens” under the MLSA to include the liens held by Berkshire Bank pursuant to the terms of the Berkshire Loan Agreement and to delete the reference to the liens held by a former creditor of the Company.

Unamortized debt issue costs at September 30, 2019 and March 31, 2019, were $19,049 and 31,720, respectively.

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.

Finance Lease

See Note 12 for information regarding our obligations under the finance lease.

NOTE 12 - LEASES

Leases that are economically similar to the purchase of an asset are classified as finance leases. The leased, or right-of-use assets in finance lease arrangements are reported in net property, plant and equipment on our condensed consolidated balance sheet. Our operating lease has expired under the contract terms in October 2019. The following table lists our right-of-use assets and liabilities on our condensed consolidated balance at:

Future payments for our finance lease follows by fiscal year: 2020: $6,600, 2021: $13,200 and 2022: $11,000. The amount representing finance lease interest is $2,757. Other supplemental information regarding our leases are contained in the following tables: 

NOTE 13 - COMMITMENTS

Retirement Benefits

Ranor has a defined contribution and savings plan that covers substantially all Ranor employees who have completed 90 days of service. Ranor retains the option to match employee contributions. The Company contributed $39,663 and $40,825 in the six months ended September 30, 2019 and 2018, respectively.

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 titled “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 quarterly 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, or implied by, 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, risks and uncertainties arising from:

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 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 continue to seek more long-term projects with predictable cost structures.

All of our sales recorded for the six months ended September 30, 2019 were generated in the U.S. We have experienced, and continue to experience, customer concentration. For the six months ended September 30, 2019 and 2018, our largest customer accounted for approximately 19% and 40% of reported net sales, respectively. For the six months ended September 30, 2019, we had five customers which accounted for approximately 76% of our revenue, in the aggregate. Our sales order backlog at September 30, 2019 and March 31, 2019 was approximately $16.4 million and $12.6 million, respectively.

For the six months ended September 30, 2019, our net sales were $7.4 million compared with net sales of $7.7 million for the six months ended September 30, 2018.  Our gross margin for the six months ended September 30, 2019 and 2018 was 20.6% and 27.8%, respectively. Our gross margin for the six months ended September 30, 2019 was impacted by higher cost of sales due to under- absorbed factory overhead, project startup activity, and a loss provision for certain customer projects. We generated $0.9 million of cash from operating activities in the six months ended September 30, 2019 and had a cash balance of $2.6 million at September 30, 2019.

Critical Accounting Policies

The preparation of the 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 revenue recognition, 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 2019 Annual Report on Form 10-K. We consider the policies relating to revenue recognition to be a critical accounting policy. There have been no significant changes to our critical accounting policies during the six months ended September 30, 2019.

Accounting Pronouncements

New Accounting Standards

See Note 3, Accounting Standards Update, in the Notes to the condensed consolidated financial statements in “Item 1. Financial Statements” for a discussion of recently adopted new accounting guidance and new accounting guidance not yet adopted.

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 measure” 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 September 30, 2019 and 2018

The following table sets forth information from our condensed consolidated statements of operations and comprehensive (loss) income, in dollars and as a percentage of revenue:

Net Sales

Net sales were $3.1 million for the three months ended September 30, 2019, or 15% lower when compared to net sales for the three months ended September 30, 2018 of $3.6 million. Changes in net sales generally reflect a different product mix and project volume when comparing the current and prior periods. Our second quarter was marked by more project startup activity, which can dampen revenue recognition because of a higher number of projects in early production.

Net sales to defense customers decreased by $0.5 million when compared to the three months ended September 30, 2018. Defense market revenue was lower during the quarterly period due to the timing of closed projects and new project startup activity. Our defense backlog remains strong as new orders for components continue to flow from prime defense contractors.

Cost of Sales and Gross Margin

Cost of sales consists primarily of raw materials, parts, labor, overhead and subcontracting costs. Our cost of sales were $2.7 million for the three months ended September 30, 2019, compared to $2.5 million for the three months ended September 30, 2018. Gross profit was $0.4 million, a $0.7 million decrease when compared to the three months ended September 30, 2018. An increase in the loss provision for certain customer projects and under-absorbed factory overhead impacted our gross profit and gross margin for the three months ended September 30, 2019. As a result, gross margin was 13.5% for the three months ended September 30, 2019, compared to 30.2% for the three months ended September 30, 2018.

Selling, General and Administrative Expenses

Total selling, general and administrative expenses for the three months ended September 30, 2019 decreased by $10,000 when compared to the three months ended September 30, 2018, due primarily to a decrease in salary expense and share-based compensation, offset in part by an increase in professional fees.

Other Expense, net

Interest expense and debt cost amortization was lower for the three months ended September 30, 2019 when compared to the three months ended September 30, 2018, and, absent any changes to outstanding indebtedness, will continue to decrease as we amortize debt principal to maturity. The following table reflects other income, interest expense and amortization of debt issue costs for the three months ended:

Income Taxes

As a result of the foregoing, the Company reported a pretax loss and recorded a tax benefit of $107,576 for the three months ended September 30, 2019. For the three months ended September 30, 2018 we recorded tax expense of $77,374.

Net (Loss) Income

As a result of the foregoing, for the three months ended September 30, 2019, we recorded net loss of $0.3 million compared with net income of $0.2 million for the three months ended September 30, 2018.

Six Months Ended September 30, 2019 and 2018

The following table sets forth information from our condensed consolidated statements of operations and comprehensive (loss) income, in dollars and as a percentage of revenue:

Net Sales

Net sales were $7.4 million for the six months ended September 30, 2019, or 4% lower when compared to net sales for the six months ended September 30, 2018 of $7.7 million. Changes in net sales generally reflect a different product mix and project volume when comparing the current and prior periods.

For the six months ended September 30, 2019, net sales in defense markets decreased by $0.8 million when compared to the six months ended September 30, 2018. Defense market revenue was lower during the six month period due to the timing of related project closing and startup activities. Our defense backlog remains strong as new orders for components continue to flow from prime defense contractors. Revenue from precision industrial markets increased by $0.6 million and revenue from the energy market decreased by $0.1 million.

The Company records a significant amount of its revenue over time as it completes performance obligations. Remaining performance obligations reflect future revenue which will be recorded in subsequent periods as projects in progress are completed. At September 30, 2019, the Company had $16.4 of remaining performance obligations, an increase of $3.8 million when compared with March 31, 2019. This increase should lead to sequential revenue improvement in the second half of fiscal 2020.  

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 the six months ended September 30, 2019 were $5.9 million compared to $5.6 million for the six months ended September 30, 2018. Gross profit decreased by $0.6 million to $1.5 million. Gross margin was lower at 20.6% for the six months ended September 30, 2019 compared to 27.8% for the six months ended September 30, 2018.

The fiscal 2020 six month period was marked by a higher number of new project startup activities. There was an increase in costs of sales due primarily to an increase in the loss provision for certain customer projects and under absorbed factory overhead. The same six month period in fiscal 2019 included a higher number of closed projects.

Selling, General and Administrative Expenses

Total selling, general and administrative expenses for the six months ended September 30, 2019 were unchanged at $1.5 million, due primarily to an increase in professional fees almost entirely offset by a decrease in salary expense when compared to the six months ended September 30, 2018.

Other Expense, net

Interest expense and debt cost amortization was lower for the six months ended September 30, 2019 when compared to the six months ended September 30, 2018, and, absent any changes to our outstanding indebtedness, will continue to decrease as we amortize debt principal to maturity. Other income, net for the six months ended September 30, 2019 includes proceeds from the sale of machinery and equipment for $16,000. The following table reflects other income, interest expense and amortization of debt issue costs for the six months ended:

Income Taxes

For the six months ended September 30, 2019 we recorded a tax benefit of $17,358 compared to tax expense of $142,403 for the six months ended September 30, 2018. The tax benefit for the six months ended September 30, 2019 was primarily the result of a pretax loss recorded for the period in all tax jurisdictions. Our effective tax rate for the first six months of fiscal 2020 was 19.8%.

Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. 

The valuation allowance on deferred tax assets at September 30, 2019 was approximately $1.7 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.

Net (Loss) Income

As a result of the foregoing, for the six months ended September 30, 2019, we recorded net loss of $70,245 compared with net income of $345,100 for the six months ended September 30, 2018.

Liquidity and Capital Resources

At September 30, 2019, we had cash and cash equivalents of $2.6 million and working capital of $6.2 million. We believe our available cash plus cash provided from operations 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.  We also have a revolving line of credit with Berkshire Bank available as a resource, if necessary. The table below presents selected liquidity and capital measures for the periods ended:

The following table summarizes the primary components of cash flows for the six months ended:

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. We use cash to pay suppliers, employee wages and benefits, and interest and taxes.

Cash provided by operations for the six months ended September 30, 2019 was $0.9 million compared with cash used in operations of $0.7 million for fiscal 2018, reflecting a change of $1.6 million. Favorable timing with customer advance payments and progress payments resulted in higher amounts of cash generated for the six months ended September 30, 2019. The six months ended September 30, 2019 was marked by an increase in project startup activity which resulted in more cash collected from customer advances and progress payments. At September 30, 2018, the Company had fewer sales orders in production, which led to a slow cash build at the beginning of fiscal 2019.

Investing activities

We anticipate that we will continue to make small investments in new factory machinery and equipment over the next six months. Net cash used in investing activities totaled $11,544 for the six months ended September 30, 2019. We expended $228,148 for new factory machinery and equipment for the six months ended September 30, 2018.

Financing activities

We used $0.4 million of cash in financing activities for the six months ended September 30, 2019 and 2018 for monthly principal payments in connection with our debt obligations.

All of the above activity resulted in a net increase in cash of $0.5 million for the six months ended September 30, 2019 compared with a decrease in cash of $1.3 million for the six months ended September 30, 2018.

Off-Balance Sheet Arrangements

We do not currently have, and have not had any off-balance sheet assets, liabilities or arrangements at September 30, 2019.

EBITDA Non-GAAP Financial Measure

To complement our condensed consolidated statements of operations and comprehensive (loss) 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 GAAP.

We define EBITDA as net (loss) income plus interest, income taxes, depreciation and amortization. The following table provides a reconciliation of EBITDA to net income, the most directly comparable GAAP measure reported in our condensed consolidated financial statements for the three and six months ended: 

(1) Includes amortization of debt issue costs.

As a smaller reporting company, we have elected not to provide the information required by this Item.

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 September 30, 2019, 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. 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 September 30, 2019, 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.

Exhibit Index

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.