VIDEO DISPLAY CORP - Annual Report: 2017 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

(Mark One)

For the fiscal year ended February 28, 2017

OR

For the transition period from                      to                     

Commission file number 0-13394

VIDEO DISPLAY CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (770) 938-2080

Securities Registered Pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ☐    NO  ☒

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ☐    NO  ☒

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☒

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting 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 Securities Exchange Act of 1934).    YES  ☐    NO  ☒

As of August 31, 2016, the aggregate market value of the voting and non-voting common equity held by non-affiliates based upon the closing sales price for the Registrant’s common stock as reported in the Over the Counter Markets “OTCMKTS” was $396,323

The number of shares outstanding of the registrant’s Common Stock as of May 1, 2017 was 5,890,748.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement to be delivered to stockholders in connection with our 2017 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K. In addition, certain exhibits previously filed with the registrant’s prior Forms 10-K, Forms 8-K, Form S-18 and Schedule 14A are incorporated by reference in Part IV of this Form 10-K.

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VIDEO DISPLAY CORPORATION

TABLE OF CONTENTS

Table of Contents

PART I

Item 1. Business.

General

Video Display Corporation and subsidiaries (the “Company”, ”us” or “we”) is a provider and manufacturer of video products, components, and systems for visual display and presentation of electronic information media in a variety of requirements and environments. The Company designs, engineers, manufactures, markets, distributes and installs technologically advanced display products and systems, from basic components to turnkey systems, for government, military, aerospace, medical, industrial, and commercial organizations. The Company markets its products worldwide primarily from facilities located in the United States. Please read the comments under the caption “Forward looking statements and risk factors” in Item 1A Risk Factors of this Annual Report on Form 10-K.

Description of Principal Business

The Company generates revenues from the manufacturing and distribution of displays and display components. The Company operates primarily in four divisions: simulation and training products, cyber secure products, Data display CRTs, and broadcast and control center products.

Consolidated Net Sales by division for fiscal 2017 are comprised of the following:

Simulation and Training Products (35%)

Cyber Secure Products (9%)

Data Display CRTs (39%)

Broadcast and Control Center Products (17%)

A more detailed discussion of sales by category of product is included under the section entitled “Principal Products by Division.”

The Company’s manufacturing and distribution facilities are located in Kentucky, Georgia and Florida.

The Company continues to explore opportunities to expand its product offerings in the display industry. The Company anticipates that this expansion will be achieved by adding new products or by acquiring existing companies that would enhance the Company’s position in the display industry. Management continually evaluates product trends externally in the industry and internally in the divisions in which the Company operates. During the last two years, the Company expended research and development funds (approximately $0.1 million in fiscal 2017 and $0.2 million in fiscal 2016) in high-resolution projection displays and active matrix liquid crystal display (“AMLCD”) technologies, for commercial and military applications.

Segment Information

We operate and manage our business as one segment. The four divisions manufacture and distribute displays and display components and have similar production process, markets served and distribution methods. Therefore, we believe they meet the criteria for aggregation under the applicable authoritative guidance and, as such, are reported as one segment within the Consolidated Financial Statements.

Principal Products by Division

Simulation and Training Products

The Company’s simulation and training products operations are conducted in Cocoa, Florida’s VDC Display Systems (Display Systems).

This portion of the Company’s operations, which contributed approximately 35% of fiscal 2017 consolidated net sales, involves the design, engineering, and manufacture of digital projector display units. The Company customizes these units for specific applications, including ruggedization for military uses or size reduction due to space limitations in industrial and medical applications. Because of the Company’s flexible and cost efficient manufacturing, it is able to handle low volume orders that generate higher margins.

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This portion of the Company’s operations targets niche markets where competition from major multinational electronics companies tends to be lower. The prime customers for these products include defense, security, training, and simulation areas of the United States of America (U.S.) and foreign militaries as well as the major defense contractors such as the Boeing Company, L-3 Communications Corporation, Lockheed Martin Corporation, and others. Flight simulator displays are produced to provide a full range of flight training simulations for military and commercial applications.

Cyber Secure Products

The Company acquired the AYON Cyber Security (“ACS”) division in March 2012. ACS was formerly known as Hetra Products and most recently as StingRay56 before becoming part of Video Display Corporation. ACS specializes in advanced TEMPEST technology, also known as Emanation Security (EMSEC), products and custom engineering solutions to include extreme environmental performance and survivability technologies (MIL-STD-810 and DO-160) in support of military forces, intelligence agencies, prime contractors and niche commercial sectors worldwide. ACS has a long history of specializing in TEMPEST technology. In addition to its TEMPEST products and services, the business also provides various contract services to government agencies and prime contractors. Services performed include design and testing solutions for defense and niche commercial uses worldwide. ACS has office in the U.S., a representative in Canada, a Reseller Relationship/Partner in Europe and technology partners around the globe. This division represented approximately 9% of fiscal 2017 consolidated net sales.

Data Display CRTs

Since its organization in 1975, the Company has been engaged in the distribution and original equipment manufacturers (OEMs) of Cathode ray tubes (CRTs) using new and recycled CRT glass bulbs, primarily in the replacement market, for use in data display screens, including computer terminal monitors, medical monitoring equipment and various other data display applications and in television sets.

The Company’s CRT manufacturing operation of new and recycled CRTs is conducted at a facility located in Lexington, Kentucky (Lexel). The Company’s Tucker, Georgia location is the Company’s primary distribution point for data display CRTs purchased from outside sources.

The Company maintains the capability of manufacturing a full range of monochrome CRTs as well as remanufacturing color CRTs from recycled glass. In addition, our Lexel operations manufactures a wide range of radar, infrared, camera and direct-view storage tubes for military and security applications. All CRTs manufactured by the Company are tested for quality in accordance with standards approved by Underwriters Laboratories.

The Company also distributes new CRTs and other electronic tubes purchased from OEMs. The Company sells CRTs into the replacement market which sometimes takes five to seven years to develop; these purchased inventories sometimes do not sell as quickly as other inventories. Bulk CRT purchases have declined over the past few years as the Company is managing current inventory levels against the anticipated reduction in future CRT demand due to the growth of flat panel technology.

The Company maintains an internal sales organization to sell directly to OEMs and their service organizations.

In addition to factors affecting the overall market for such products, the Company’s sales volume in the CRT replacement markets is dependent upon the Company’s ability to provide prompt response to customers’ orders, while maintaining quality control and competitive pricing. The Data Display division represented approximately 39% of fiscal 2017 consolidated net sales.

Broadcast and Control Center Products

The Company began a start-up operation in July 2011, AYON Visual Solutions, as the North American distributor of a German company, eyevis GmbH. The division sells high-end visual display products for use in video walls and command and control centers.

The division has been built thus far by partnering with consultants and system integrators. These partners have first-hand knowledge of the needs of the market and have been educated about the division’s products. Management believes the division will continue to grow by expanding their network of partners and product offerings as eyevis GmbH introduces new products. This division represented approximately 17% of fiscal 2017 consolidated net sales.

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Patents and Trademarks

The Company holds patents with respect to certain products and services. The Company also sells products under various trademarks and trade names. The Company believes that success in its industry primarily will be dependent upon incorporating emerging technology into new product line introductions, frequent product enhancements, and customer support and service.

Seasonal Variations in Business

Historically, there has not been seasonal variability in the Company’s business.

Working Capital Practices

Currently, The Company has a $0.5 million line of credit with the Brand Banking Company with a current balance of $0.2 million at February 28, 2017. The only other outstanding debt of the Company is $0.1 million secured by a building owned by its subsidiary, Teltron Technologies, Inc. in Birdsboro, PA.

The Company is currently operating using cash from operations and investing activities. The Company has a $6.4 million working capital balance at February 28, 2017, including $0.5 million in liquid assets.

Management has implemented a plan to improve the liquidity of the Company. The Company has been implementing a plan to increase revenues at all the divisions, each structured to the particular division with an increase in the current backlog and growth in revenues subsequent to February 28, 2017. The Company implemented a plan to reduce expenses at the divisions, as well as at the corporate location in fiscal 2017 with the result that expenses were reduced by more than $1.4 million. Management continues to explore options to monetize certain assets of the business. If additional and more permanent capital is required to fund the operations of the Company, no assurance can be given that the Company will be able to obtain the capital on terms favorable to the Company, if at all.

Concentration of Customers

The Company sells to a variety of domestic and international customers on an open-unsecured account basis. These customers principally operate in the medical, military, industrial and avionics industries. The Company had direct and indirect net sales to the U.S. government, primarily the Department of Defense for training and simulation programs that comprised approximately 32% and 40% of consolidated net sales for fiscal 2017 and 2016, respectively. Sales to foreign customers were approximately 21% and 24% of consolidated net sales for fiscal 2017 and 2016, respectively. The Company had three customers, Lockheed Martin that comprised 19.4%, TSAV, 13.0% and Flight Safety that comprised 10.6% of the Company’s consolidated net sales in fiscal 2017. The Company attempts to minimize credit risk by reviewing customers’ credit history before extending credit, and by monitoring customers’ credit exposure on a daily basis. The Company establishes an allowance for doubtful accounts receivable based upon factors surrounding the credit risk of specific customers, historical trends and other information.

Backlog

The Company’s backlog is comprised of undelivered, firm customer orders, which are scheduled to ship within eighteen months. The Company’s backlog was approximately $5.9 million at February 28, 2017 and $6.9 million at February 29, 2016. It is anticipated that more than 90% of the February 28, 2017 backlog will ship during fiscal 2018.

Environmental Matters

The Company’s operations are subject to federal, state, and local laws and regulations relating to the generation, storage, handling, emission, transportation, and discharge of materials into the environment. The costs of complying with environmental protection laws and regulations have not had a material adverse impact on the Company’s consolidated financial condition, results of operations, or cash flow in the past and are not expected to have a material adverse impact in the foreseeable future.

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Research and Development

The objectives of the Company’s research and development activities are to increase efficiency and quality in its manufacturing and assembly operations and to enhance its existing product line by developing alternative product applications to existing display systems and electron optic technology. The Company includes research and development expenditures in the consolidated financial statements as a part of general and administrative costs. Research and development costs were approximately $0.1 million and $0.2 million in fiscal 2017 and fiscal 2016 respectively.

Employees

As of February 28, 2017, the Company employed 106 persons on a full-time basis. Of these, 34 were employed in executive, administrative, and clerical positions, 5 were employed in sales and distribution, and 67 were employed in manufacturing operations. The Company believes its employee relations to be satisfactory.

Competition

The Company believes that it has a competitive advantage in the display industry due to its ability to engineer custom display solutions for a variety of industrial, military and commercial applications, its ability to provide internally produced component parts, and its manufacturing flexibility. As a result, the Company can offer more customization in the design and engineering of new products. With the operations of VDC Display Systems, AYON Visual Solutions and AYON Cyber Security, the Company believes it has become one of the leading suppliers within each of these specialty display markets.

The Company’s VDC Display Systems division specializes in projector design and video solutions, and the Company’s AYON Cyber Security division specializes in making electronic devices cyber secure. The Company became the North American distributor for the German company, Eyevis GmbH, focusing on configurable visual solutions for command and control and other large format visuals in the energy, utility, transportation, industrial and security markets.

The Company is a wholesale distributor and manufacturer of OEM CRTs. The Company believes it is the only company that offers complete service in replacement markets with its manufacturing and recycling capabilities. The Company’s ability to compete effectively in this market is dependent upon its continued ability to respond promptly to customer orders and to offer competitive pricing.

Item 1A. Risk Factors.

Forward looking statements and risk factors

All statements other than statements of historical facts included in this report, including, without limitation, those statements contained in Item 1, are statements that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934. The words “expect”, “estimate”, “anticipate”, “predict”, “believe” and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements appear in a number of places in this report and include statements regarding the intent, belief or current expectations of the Company, its directors or its officers with respect to, among other things: (i) trends affecting the Company’s consolidated financial condition, results of operations or cash flows; (ii) the Company’s financing plans; (iii) the Company’s business and growth strategies, including potential acquisitions; and (iv) other plans and objectives for future operations. Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and actual results may differ materially from those predicted in the forward-looking statements or which may be anticipated from historical results or trends.

Our Company operates in technology-based markets that involve a number of risks, some of which are beyond our control. The following discussion highlights some risks and uncertainties that investors should consider, in conjunction with all other information in this Annual Report on Form 10-K. Additional risks and uncertainties not presently known to the Company may impair the Company’s business and operations. If any of the following risks actually occur, the Company’s business, consolidated financial condition, cash flows, or results of operations could be materially affected.

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History of losses and declining liquidity

Declining liquidity and lack of credit availability could have important consequences, including:

Changes in government priorities may affect military spending, and our consolidated financial condition and results of operations or cash flows could suffer if their purchases decline.

We currently derive a portion of our net sales (32% in fiscal 2017) from direct and indirect sales to the U.S. government. If we are unable to replace expiring contracts, which are typically less than twelve months in duration, with contracts for new business, our sales could decline, which would have a material adverse effect on our business, consolidated financial condition, results of operations, or cash flows. We expect that direct and indirect sales to the U.S. government will continue to account for a substantial portion of our sales in the foreseeable future. We have no assurance that these government-related sales will continue to reach or exceed historical levels in future periods.

Our inability to secure financing could negatively affect the future of our business.

Our industry is highly competitive and competitive conditions may adversely affect our business.

Our success depends on our ability to compete in markets that are highly competitive, with rapid technological advances and products that require constant improvement in both price and performance. In most of our markets, we are experiencing increased competition, and we expect this trend to continue. This environment may result in changes in relationships with customers or vendors, the ability to develop new relationships, or the business failure of customers or vendors, which may negatively affect our business. If our competitors are more successful than we are in developing new technology and products, our business may be adversely affected.

Competitive pressures may increase or change through industry consolidation, entry of new competitors, marketing changes or otherwise. There can be no assurance that the Company will be able to continue to compete effectively with existing or potential competitors.

Competitors or third-parties may infringe on our intellectual property.

The Company holds patents with respect to certain products and services. The Company also sells products under various trademarks and trade names. Should competitors or third-parties infringe on these rights, costly legal processes may be required to defend our intellectual property rights, which could adversely affect our business.

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Migration to flat panel and other technology may negatively affect our CRT business.

The Company acquires CRT inventory when the replacement market appears to demonstrate adequate future demand and the purchase price allows a reasonable profit for the risk. Due to the extended time frame for the replacement market to develop (five to seven years), these purchased inventories may not sell as quickly as other inventories. If the Company is unable to manage CRT inventory levels in coordination with reduced future CRT demand due to the growth of flat panel technology, the marketability of inventory on hand may be affected and the Company may incur significant costs in the disposal of excess inventory.

The Company anticipates that flat panel and other technology products, due to their lower space and power requirements, has become the display of choice in many display applications. Given this shift, the Company has focused its efforts and its acquisition strategy toward flat panel technologies. If the Company is unable to replace any future declines in CRT sales with products based on other technologies, our business may be adversely affected.

Future acquisitions may not provide benefits to the Company.

The Company’s growth strategy includes expansion through acquisitions that enhance the profitability and shareholder value of the Company. The Company continues to seek new products through acquisitions and internal development that complement existing profitable product lines. There can be no assurance that the Company will be able to complete further acquisitions or that past or future acquisitions will not have a material adverse impact on the Company’s consolidated operations.

If we are unable to retain certain key personnel and hire new, highly-skilled personnel, we may not be able to execute our business plan.

Our future success depends on the skills, experience, and efforts of our senior managers. The loss of services of any of these individuals, or our inability to attract and retain qualified individuals for key management positions, could negatively affect our business.

If we are unable to meet our obligations under the settlement agreement reached in the Lexel Imaging Systems, Inc. Chapter 11 bankruptcy case, our business could be negatively impacted.

In the event management’s intentions are deemed to be a violation of the above settlement agreement, it is at least reasonably possible that, in addition to the $232 currently accrued, Lexel could incur: 1) losses of $100 thousand related to forfeiture if the escrow deposit, 2) costs of $200 thousand for the civil judgement, 3) additional legal fees incurred by Alidade related to enforcement of the settlement agreement (while foregoing remedies), and 4) subjection to eviction from the property causing significant interruption to business operations, which includes inventory of $2.3 million as of February 28, 2017. No assurance can be given that the Company will be able to secure a suitable lease agreement on favorable terms, if at all. While management believes its relocation plans are appropriate under the settlement agreement, they can provide no assurance that their actions will not trigger a default under the settlement agreement, as noted above.

Our business operations could be disrupted if our information technology systems fail to perform adequately.

We depend upon our information technology systems in the conduct of our operations and financial reporting. If our major information systems fail to perform as anticipated, we could experience difficulties in maintaining normal business operations. Such systems-related problems could adversely affect product development, sales, and profitability.

Changes to accounting rules or regulations may adversely affect our results of operations.

New accounting rules or regulations and varying interpretations of existing accounting rules or regulations have occurred and may occur in the future. Future changes to accounting rules or regulations or the questioning of current accounting practices may adversely affect our consolidated financial condition or results of operations.

The Company’s stock price may be negatively affected by a variety of factors.

In addition to any impact the Company’s operating performance, potential future Company sales or repurchases of common stock, the Company’s dividend policies or possible anti-takeover measures available to the Company may have, changes in securities markets caused by general foreign or domestic economic, consumer or business trends, the impact of interest rate policies by the federal reserve board, and other factors outside the Company’s control may negatively affect our stock price.

Our stock may be traded infrequently and in low volumes, so you may be unable to sell your shares at or near the quoted bid price if you need to sell your shares.

Our stock is now quoted on the OTC Markets and the shares of our common stock may trade infrequently and in low volumes, meaning that the number of persons interested in purchasing our common shares at or near bid prices at any given time may be relatively small or non-existent. An investor may find it difficult to obtain accurate quotations as to the market value of our common stock or to sell his or her shares at or near bid prices, if at all.

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Changes to estimates, or operating results that are lower than our current estimates, may cause us to incur impairment charges.

If the Company determines it is more likely than not that the fair value of a reporting unit is less than the carrying value, then it applies the processes prescribed in FASB ASC Topic 360 “Property, Plant, and Equipment.” We make certain estimates and projections in connection with our impairment analyses for other long-term assets. If these estimates or projections change or prove incorrect, we may be required to record impairment charges. If these impairment charges were significant, our consolidated financial position or results of operations would be adversely affected.

International factors could negatively affect our business.

A significant portion of our consolidated net sales (21% in fiscal 2017) is made to foreign customers. We also receive a significant amount of our raw materials from foreign vendors. We are subject to the risks inherent in conducting our business across national boundaries, many of which are outside of our control. These risks include the following:

We cannot ensure that one or more of these factors will not negatively affect our international customers and, as a result, our business and consolidated financial performance.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

The Company leases its corporate headquarters at 1868 Tucker Industrial Road in Tucker, Georgia (within the Atlanta metropolitan area). Its headquarters occupy approximately 10,000 square feet of the total 59,000 square feet at this location. The remainder is utilized as warehouse and assembly facilities. This location, and one other, are leased from a related party at current market rates. See Part III, Item 13 Certain Relationships and Related Transactions in this Annual Report on Form 10-K. Management believes the facilities to be adequate for its needs.

The following table details manufacturing, warehouse, and administrative facilities:

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Item 3. Legal Proceedings.

The Company is involved in various legal proceedings relating to claims arising in the ordinary course of business.

On January 23, 2017, Lexel Imaging Systems, Inc. (“Lexel”), a wholly owned subsidiary of Video Display Corporation, was named as a Defendant in Forcible Detainer Complaint (the “Complaint”) filed against Lexel by Alidade Bull Lea, LLC (“Alidade”), the owner of real property located at 1500 Bull Lea Road, Suite 150, Lexington, Kentucky, 40511 (the “Property”). The Property is currently leased by Lexel. The complaint sought to evict Lexel from the Property and obtain a judgment against Lexel for $232 thousand for back rent and late fees. A hearing was held February 13, 2017.

After being unable to settle the Complaint, and with Lexel being unable to remove itself from the property in less than 10 days without significant interruption to business operations, Lexel filed for Chapter 11 bankruptcy protection in the Eastern District of Kentucky Case No.17-50240 on February 10, 2017 (the “Ch. 11 Bankruptcy”). Lexel and Alidade mediated the Ch. 11 Bankruptcy and reached a settlement on May 19, 2017 which requires Lexel to surrender possession of the Property on or before September 30, 2017 and remit to Alidade all past due rent of approximately $232 thousand. This amount is included in accounts payable as of February 28, 2017. Lexel is also required to make payments totaling $100 thousand into an escrow account between May 19, 2017 and July 28, 2017. These funds will be held by Alidade’s counsel until full and timely compliance with the settlement agreement are met, at which time the funds will be returned to Lexel. On May 19, 2017, upon approval of the settlement agreement, the Ch. 11 Bankruptcy case was dismissed.

The settlement agreement also stipulates certain events of default for non-compliance. Events of default include, but are not limited to the following; 1) failure to make timely payment of back-owed rent, escrow payments, and ongoing monthly rents through the exit date, 2) failure to enter into a new lease agreement or asset purchase agreement for all or substantially all of Lexel’s assets, with an unaffiliated third party on or before June 30, 2017, and 3) failure to vacate the property, as defined. In the event of non-compliance Lexel has agreed to the following; 1) escrow amounts will be forfeited, 2) a stipulated $200 thousand civil judgment will be awarded to Alidade, 3) eviction from the property within 10 days, and 4) Lexel will pay all legal fees incurred by Alidade related to enforcement of the settlement agreement and foregoing remedies.

Effective May 18, 2017, Ordway Properties, LLC entered into an Offer and Agreement to purchase property in Lexington, Kentucky. The Company’s management intends on entering into a lease of this property on or before June 30, 2017, in order to move Lexel’s operations on or before September 30, 2017. In the event management’s intentions are determined to be a violation of the above settlement agreement, it is at least reasonably possible that, in addition to the $232 thousand currently accrued, Lexel could incur: 1) losses of $100 thousand related to forfeiture of the escrow deposit, 2) costs of $200 thousand for the civil judgment, 3) additional legal fees incurred by Alidade related to enforcement of the settlement agreement (while foregoing remedies), and 4) subjection to eviction from the property causing significant interruption to business operations, which includes inventory of $2.3 million as of February 28, 2017. No assurance can be given that the Company will be able to secure a suitable lease agreement on favorable terms, if at all. While management believes its relocation plans are appropriate under the settlement agreement, they can provide no assurance that their actions will not trigger a default under the settlement agreement, as noted above.

Item 4. Submission of Matters to a Vote of Security Holders.

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this Annual Report.

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.

The Company’s common stock is traded on the Over the Counter Market (OTCMKTS) under the symbol VIDE. The Company had previously traded on National Association of Securities Dealers Automated Quotation System (“NASDAQ”) national market system under the symbol VIDE until April 30, 2015.

The following table shows the range of prices for the Company’s common stock as reported by NASDAQ and the OTCMKTS for each quarterly period beginning on March 1, 2015. The prices reflect inter-dealer prices, without mark-up, mark-down, or commission, and may not necessarily represent actual transactions.    

There were approximately 120 holders of record of the Company’s common stock as of May 15, 2017.

Payment of cash dividends in the future will be dependent upon the consolidated earnings and financial condition of the Company and other factors that the Board of Directors may deem appropriate.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information as of February 28, 2017 regarding compensation plans (including individual compensation arrangements) under which common stock of the Company is authorized for issuance.

Issuer Purchases of Equity Securities

The Company has a stock repurchase program, pursuant to which it had been authorized to repurchase up to 2,632,500 shares of the Company’s common stock in the open market. On January 20, 2014, the Board of Directors of the Company approved a continuation of the stock repurchase program, and authorized the Company to repurchase up to 1,500,000 additional shares of the Company’s common stock in the open market. There is no minimum number of shares required to be repurchased under the program. During the fiscal year ended February 28, 2017, the Company did not purchase any shares of Video Display Corporation stock. During the fiscal year ended February 29, 2016, the Company repurchased 71,406 shares at an average price of $1.61 per share, which were added to treasury shares on the consolidated balance sheet. Under this program, an additional 502,644 shares remain authorized to be repurchased by the Company at February 28, 2017.

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Item 6. Selected Financial Data

N/A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

The Company manufactures and distributes a wide range of display devices, encompassing, among others, industrial, military, medical, and simulation display solutions. The Company is comprised of one segment - the manufacturing and distribution of displays and display components. The Company is organized into four interrelated operations aggregated into one reportable segment:

During fiscal 2017, management of the Company focused key resources on strategic efforts to support the efforts of operations to increase market share. The Company also seeks to look for acquisition opportunities that enhance the profitability and shareholder value of the Company. The Company continues to seek new products and internal development that complement existing profitable product lines. Challenges facing the Company during these efforts include:

Inventory management - The Company monitors its inventory for obsolescence due to the rapid changes in display technology. The Company increased the inventory reserves $1.1 million in the fiscal year ending February 28, 2017 and disposed of $0.4 million in various raw material parts and demo equipment at its VDC Display division and AYON Cyber Security divisions.

The Company’s remaining business units utilize different inventory components than the divisions had in the past. The Company provides monthly for an obsolescence reserve at each of its divisions to offset any obsolescence although most purchases are for current orders, which should reduce the amount of obsolescence in the future. The Company still has CRT inventory in stock and, although it believes the inventory will be sold in the future, will continue to reserve for any additional obsolescence. Management believes its inventory reserves at February 28, 2017 to be adequate.

Operations

The following table sets forth, for the fiscal years indicated, the percentages that selected items in the Company’s consolidated statements of operations bear to total revenues (amounts in thousands):

(See Item 1. Business – Description of Principal Business and Principal Products for discussion about the Company’s Products and Divisions.)

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Lexel Imaging was presented as discontinued operations as Video Display Corporation through the third quarter of its fiscal year ending February 28, 2017 while it was still considering offers for the sale of the entity.

In February, 2017 the Company decided to accept an offer to sell certain assets of Lexel Imaging. Inc. and retain and operate the remainder of the company as part of its continuing operations. Accordingly, this year and last year’s results of operations, balance sheets and statements of cash flows include the results of Lexel Imaging, Inc. as continuing operations.

Fiscal 2017 Compared to Fiscal 2016

Net Sales

Consolidated net sales increased $1.3 million or 6.9% to $19.6 million for fiscal 2017, compared to $18.4 million for fiscal 2016 due to a $3.1 million increase at its AYON Visual Solutions division, primarily due to the largest project in the division’s brief history. AYON Visual Solution is expected to have another strong year as it continues to develop its relationships with its partners and customers. This increase was offset by smaller decreases at its four remaining divisions. AYON Cyber Security had some business delayed and pushed into the next year causing them to fall short of the previous year’s revenues. As the Company heads into its new fiscal year, AYON Cyber Security is sitting on its largest backlog since being acquired by Video Display Corporation in 2012.

The Company continues to service the existing CRT market, which accounts for approximately 39% of the Company’s revenues. The Company’s largest remaining division is VDC Display Systems, which services the simulation and training markets. VDC Display Systems sales decreased by 3.7% in fiscal 2017 compared to fiscal 2016, $6.8 million in fiscal 2017 to $7.1 million in fiscal 2016. The decrease was due to the completion of projects with no replacements. The division is expected to improve this next fiscal year due to new business in the government-related sector.

The Data Display CRTs decreased their net sales for fiscal 2017 compared to fiscal 2016 by 12.6% or $1.1 million. The sales decrease was primarily due to large infrequent purchases on CRTs in fiscal 2016 which were not available in fiscal 2017, the products are no longer available and backorders for product to their largest customer. Business is expected to be strong with their largest customer, but overall sales for this division are expected to decrease as more businesses switch to flat panel technology. The decrease is expected to be approximately 20%.

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AYON Cyber Security, which services the emanation security market, saw their sales decrease by $0.4 million or 20.4% to $1.7 million in fiscal 2017 from $2.2 million in fiscal 2016. The sales decrease was primarily due to delays in approval of samples by one their customers. The cyber security division is expected to increase its revenues in fiscal 2018 with further expansion in the government sector and additional penetration in the commercial market due to its marketing efforts in both sectors. Their current backlog at February 28, 2017 is $2.6 million.

AYON Visual Solutions had a record setting year with sales of $3.4 million compared to $0.4 million the prior fiscal year, an increase of 834.7%. The division is expected to continue to grow in the new fiscal year as it continues to grow its distribution network to create more opportunities with the new partners created this past year. Forecasted sales for this division are $4.0 million.

Gross Margins

Consolidated gross margins increased to 14.0% for fiscal 2017 from 11.1% for fiscal 2016. Overall gross margin dollars increased by $0.7 million versus the prior fiscal year.

The Company’s gross margins were affected by the Company’s focus on reducing costs and increasing sales and product mix. The Company expensed $1.1 million for inventory reserves in the current fiscal year, an increase of $0.2 million over last year. The increase in reserves occurred at the VDC Display division which limited their increase in gross margins. Despite the increased expense of inventory reserves, VDC Display Systems posted a 17.0% gross margin for fiscal 2017 compared to 15.3% for fiscal 2016. Every division saw an improvement in gross margins except for the Data Display division which saw a small decrease from 22.0% in fiscal 2016 to 20.0% in fiscal 2017. Management expects to see improvement in margins at all remaining divisions through better pricing and more cost reductions.

Operating Expenses

Operating expenses as a percentage of sales decreased from 30.8% for fiscal 2016 to 21.6% for fiscal 2017 primarily reflecting a decrease in employee salaries, health care costs, legal fees, audit fees, insurance and rent. In fiscal 2017, actual expenses decreased by $1.4 million.

The Company is working to reduce costs in all areas of the business to bring its cost structure in line with the current size of the business. The Company has made strategic cuts at the corporate level and is working towards merging its two Florida locations, VDC Display Systems and AYON Cyber Security; this consolidation is anticipated to save considerable operating expenses. The remaining business units are also making changes that are expected to improve profitability.

Interest Expense

Interest expense was $16 thousand for fiscal 2017 and $61 thousand for fiscal 2016. The Company also earned $9 thousand in interest income for fiscal 2017 and $103 thousand in fiscal 2016. The decrease is because the Company sold a note receivable it held with Z-Axis, Inc. (See Note 6) Interest expense includes (approximately $0.5 thousand per month) relating to debt owed on a building the Company owns in Pennsylvania and on the margin balance in the Company’s investment account, which is 2%.

Other Income (loss)

In fiscal 2017, the Company earned $0.5 million in other income, primarily due to investment gains of $0.2 million in gains in the investment account, $0.2 million in royalty income and $0.2 million in rental income, offset by $0.1 million in disposal of fixed assets. In fiscal 2016, the Company experienced a loss of $2.5 million due primarily to losses in the investment account of $2.8 million and $0.2 million recognized loss on a note receivable, offset by dividend income of $0.3 million royalty income of $0.1 million and rental income of $0.1 million.

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Income Taxes

The Company had net loss before taxes of approximately $1.0 million and an income tax benefit of $0.4 million before the valuation allowance of $0.6 million offset by rate variances of $0.2 million for a net realized tax expense of approximately $19 thousand for fiscal 2017, an effective rate of (1.8%), compared to a net loss of $6.1 million and an income tax benefit of $2.3 million before a valuation allowance of $3.8 million in fiscal 2016. The difference between the statutory rate and the effective rate is primarily due to the valuation allowances on the deferred tax assets.

Liquidity and Capital Resources

The accompanying consolidated financial statements were prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has sustained losses for each of the last three years and has seen a decline in both its working capital and liquid assets during this time. These losses were a combination of low revenues at all divisions without a commensurate reduction of expenses. During the year ended February 28, 2017, the Company operated using cash from operations of $1.2 million, which is primarily generated from a $1.2 million increase in accounts receivables. During the year ended February 29, 2016, operating cash flows provided $1.1 million. Related to these operational results the Company’s working capital and liquid asset position deteriorated during the year ended February 28, 2017 as presented below:

Management has implemented a plan to improve the liquidity of the Company. The Company has been implementing a plan to increase revenues at all the divisions, each structured to the particular division with an increase in the current backlog and growth in revenues subsequent to February 28, 2017. The Company implemented a plan to reduce expenses at the divisions, as well as at the corporate location in fiscal 2017 with the result that expenses were reduced by more than $1.4 million. Management continues to explore options to monetize certain assets of the business and is in the process of securing a new lease for Lexel as further described in Note 11. If additional and more permanent capital is required to fund the operations of the Company, no assurance can be given that the Company will be able to obtain the capital on terms favorable to the Company, if at all.

The ability of the Company to continue as a going concern is dependent upon the success of management’s plans to improve the operational effectiveness of continuing operations, to sell strategic assets noted above, the procurement of suitable financing, securing a lease for Lexel, or a combination of these. The uncertainty regarding the potential success of management’s plan create substantial doubt about the ability of the Company to continue as a going concern.

Cash used by operations was $1.2 million in fiscal 2017 and cash provided by operations was $1.1 million in fiscal 2016. During fiscal 2017, the net loss from operations was $1.0 million and adjustments to reconcile net loss to net cash were $1.1 million to increase inventory reserves, $0.2 million in depreciation, offset by $0.2 in investment gains. Changes in working capital used $1.4 million, primarily due to an increase in accounts receivable of $1.2 million, an increase in prepaid expenses of $0.1 million, a decrease in customer deposits of $0.2 million, a decrease in deferred revenue of $0.1 million and a decrease in billings on uncompleted contracts of $ 0.2 million, offset by a decrease in inventories of $0.3 million, and an increase in accounts payable of $0.1 million. During fiscal 2016, adjustments to reconcile net loss to net cash for operating activities provided $4.8 million and net working capital items increased by $2.4 million. Of this the Company had adjustments to reconcile the net loss to net cash that included $6.1 million operating loss, $0.5 loss on impairment of intangible assets, and $0.2 loss for impairment of a note receivable, losses on investments of $2.8 million, $0.9 million in inventory reserves and $0.3 million in depreciation and amortization. The changes in the net cash for the working capital items included $1.0 million for inventory and $0.7 million for refundable income taxes, an increase in customer deposits of $0.6 million and a decrease in accounts receivable of $0.5 million, offset by a decrease in accounts payable of $0.3 million, a decrease in deferred revenue of $0.1 million and an increase in billings on uncompleted contracts of $0.2 million. Operating cash flows in fiscal year 2018 will utilize $.3 million to satisfy the terms of the settlement agreement as described in Note 11.

Investing activities used $0.0 million in fiscal 2017 and provided $3.0 million of cash in fiscal 2016. Investing activities in fiscal 2017 consisted of the sale of investment securities of $1.4 million, the purchase of investment securities of $1.1 million, and capital expenditures of $0.3 million. Investing activities in fiscal 2016 consisted of the sale of $10.6 million in investment securities, the purchase of $7.5 million of investment securities

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and capital expenditures of $0.2 million. The Company is expected to invest an additional $0.1 million to upgrade the Cocoa, Florida location to accommodate the merger of the two Florida businesses into one facility. The Company does not anticipate any additional significant investments in capital assets for fiscal 2018 beyond normal maintenance requirements, and $.50 thousand for leasehold improvements in the new facility for Lexel Imaging.

Financing activities provided $0.7 million in fiscal 2017, primarily from the sale of the note receivable of $0.9 million and net borrowings from the line of credit of $0.2 million offset by payment of $0.4 million of repayment of various debt. Financing activities used cash of $3.7 million in fiscal 2016. Payments from marginal float on the investment account were $3.6 million, and purchase of treasury stock was $0.1 million.

The Company has a stock repurchase program, pursuant to which it has been authorized to repurchase up to 2,632,500 shares of the Company’s common stock in the open market. On January 20, 2014, the Board of Directors of the Company approved a one-time continuation of the stock repurchase program, and authorized the Company to repurchase up to 1,500,000 additional shares of the Company’s common stock, depending on the market price of the shares. There is no minimum number of shares required to be repurchased under the program. During the fiscal year ended February 28, 2017, the Company did not repurchase any shares of Company stock and during the fiscal year ended February 29, 2016, the Company repurchased 71,406 shares at an average price of $1.61 per share, which were added to treasury shares on the consolidated balance sheet. Under this program, an additional 502,644 shares remain authorized to be repurchased by the Company at February 28, 2017.

Transactions with Related Parties, Contractual Obligations, and Commitments

The Company leases one building from the Company’s CEO in Tucker, Georgia and one building owned by Ordway Properties LLC in Cocoa, Florida. The building in Tucker, Georgia serves as the warehouse operations for the CRT division and the corporate headquarters. The building in Cocoa, Florida will be the new operational site for both VDC Display Systems (currently in Cape Canaveral) and AYON Cyber Security (currently in Palm Bay). See Note 11.

The Company also borrows money from the Chief Executive Officer on a short term basis when funds are needed. See Note 6. On March 30, 2016 Video Display Corporation entered into an assignment with recourse of their note receivable from Z-Axis, Inc. with Ronald D. Ordway and Jonathan R. Ordway for the sum of $912 thousand. The balance on the note at the time of the assignment was $1.14 million. The Company recognized an impairment of this note in the amount of $228 thousand to net realizable value at February 29, 2016. The Company also retains the right to repurchase the note at any time for 80% of the outstanding principle balance. In the event of default by Z-Axis, the Company is obligated to repurchase the note for 80% of the remaining balance plus any accrued interest.

Contractual Obligations

Future contractual maturities of long-term debt, future contractual obligations due under operating leases, and other obligations at February 28, 2017 are as follows (in thousands):

Critical Accounting Estimates

Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations are based upon the Company’s consolidated financial statements. These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.

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GAAP”). These principles require the use of estimates and assumptions that affect amounts reported and disclosed in the consolidated financial statements and related notes. The accounting policies that may involve a higher degree of judgments, estimates, and complexity include reserves on inventories, contract revenue recognition as well as profitability or loss recognition estimates, and the sufficiency of the valuation reserve relating to deferred tax assets. The Company uses the following methods and assumptions in determining its estimates:

Reserves on inventories

Reserves on inventories result in a charge to operations when the estimated net realizable value declines below cost. Management regularly reviews the Company’s investment in inventories for declines in value and establishes reserves when it is apparent that the expected net realizable value of the inventory falls below its carrying amount. In fiscal 2017, the Company increased the inventory reserves by $1.1 million, primarily at VDC Display Systems. The Company determined VDC Display Systems is the most vulnerable to inventory obsolescence due to the size and age of its inventory and the changes in the market.    In fiscal 2017, the Company disposed of an additional $0.4 million of inventory at the VDC Display Systems facility and increased the reserves by an additional $0.9 million in various raw materials and demo equipment as they reduced inventories they are holding for legacy repairs. The reserve for inventory obsolescence was approximately $1.9 million and $1.3 million at February 28, 2017 and February 29, 2016, respectively.

The Company provides monthly for an obsolescence reserve at each of its divisions to offset any obsolescence although most purchases are for current orders, which should reduce the amount of obsolescence in the future. The Company still has CRT inventory in stock and, although it believes the inventory will be sold in the future, will continue to reserve for any additional obsolescence. Management performs periodic assessments of the obsolescence and provide additional reserves when a change in current marketability is identified. The Company cannot guarantee the accuracy of future forecasts since these estimates are subject to change based on market conditions.

Revenue recognition

Revenues are recognized when there is persuasive evidence of an arrangement, delivery has occurred, the price has been fixed or is determinable and collectability can be reasonably assured. The Company’s delivery term typically is F.O.B. shipping point.

In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 605-45 “Revenue Recognition: Principal Agent Considerations”, shipping and handling fees billed to customers are classified in net sales in the consolidated statements of income. Shipping and handling costs incurred for the delivery of product to customers are classified in selling and delivery in the consolidated statements of income.

A portion of the Company’s revenue is derived from contracts to manufacture display systems to a buyer’s specification. These contracts are accounted for under the provisions of FASB ASC Topic 605-35 “Revenue Recognition: Construction-Type and Production-Type Contracts”. These contracts are fixed-price and cost-plus contracts and are recorded on the percentage of completion basis using the ratio of costs incurred to estimated total costs at completion as the measurement basis for progress toward completion and revenue recognition. Any losses identified on contracts are recognized immediately. Contract accounting requires significant judgment relative to assessing risks, estimating contract costs and making related assumptions for schedule and technical issues. With respect to contract change orders, claims, or similar items, judgment must be used in estimating related amounts and assessing the potential for realization. These amounts are only included in contract value when they can be reliably estimated and realization is probable.

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Other loss contingencies

Other loss contingencies are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss can reasonably be estimated. Disclosure is required when there is a reasonable possibility that the ultimate loss will exceed the recorded provision. Contingent liabilities are often resolved over long time periods. Estimating probable losses requires analysis of multiple factors that often depend on judgments about potential actions by third parties.

Income Taxes

Deferred income taxes are provided to reflect the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The Company has established a valuation allowance of $7.4 million on the Company’s current and non-current deferred tax assets.

The Company accounts for uncertain tax positions under the provisions of ASC Topic 740, which contains a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not, that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount, which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating the Company’s tax positions and tax benefits, which may require periodic adjustments. At February 28, 2017, the Company did not record any liabilities for uncertain tax positions.

Recent Accounting Pronouncements

In May, 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09 “Revenue with Contracts from Customers”. ASU 2014-09 clarifies the principles for recognizing revenue and develops a common revenue standard for U.S. GAAP and International Financial Reporting Standards (“IFRS”). The new guidance: (i) removes inconsistencies, and weaknesses in revenue requirements, (ii) provides a more robust framework for addressing revenue issues, (iii) improves comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets, (iv) provides more useful information to users of financial statements through improved disclosure requirements, and (v) simplifies the preparation of financial statements by reducing the number of requirements to which an entity must refer.

The guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period; however, a one year delay has been approved with the issuance of ASU 2015-14 “Revenue with Contracts from Customers”. The Company is still evaluating the effects that the adoption of this update will have on the Company’s consolidated financial statements.

In August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements. Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to continue as a Going Concern”. Prior to its effective date there was no guidance in U.S. GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern or to provide related footnote disclosures. This update requires that an entity’s management should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable.) This update is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The adoption of this standard did not have a material effect on our consolidated financial statements.

In July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory”. ASU 2015-11 requires an entity to measure inventory within the scope of this update at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. The guidance is effective for annual reporting periods beginning after December 15, 2016 and related interim periods. Early adoption is permitted. We do not believe this standard will have a material effect on its consolidated financial statements.

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In November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes”. ASU 2015-17 requires deferred tax assets and liabilities, along with related valuation allowances, to be classified as noncurrent on the balance sheet. Each tax jurisdiction will now only have one net noncurrent deferred tax asset or liability. The new guidance does not change the existing requirement that prohibits offsetting deferred tax liabilities from one jurisdiction against deferred tax assets of another jurisdiction. The guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is permitted. The Company does not expect the adoption of this update to have a significant effect on our consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, “Leases”. ASU 2016-02 increases transparency and comparability among organizations by requiring entities to recognize lease assets and lease liabilities on the balance sheet and disclose key information about the lease arrangements. The guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. Early adoption is permitted. The Company is in the process of evaluating the impact of this guidance on our consolidated financial statements.

Impact of Inflation

Inflation has not had a material effect on the Company’s results of operations to date.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

N/A

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Item 8. Financial Statements and Supplementary Data.

Video Display Corporation and Subsidiaries

Index to Consolidated Financial Statements

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Report of Independent Registered Public Accounting Firm

To the Board of Directors

Video Display Corporation

We have audited the accompanying consolidated balance sheets of Video Display Corporation and subsidiaries (the “Company”) as of February 28, 2017 and February 29, 2016, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the two-year period ended February 28, 2017. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Video Display Corporation and subsidiaries as of February 28, 2017 and February 29, 2016, and the results of their operations and their cash flows for each of the years in the two-year period ended February 28, 2017, in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has incurred recurring net losses and a decline in working capital and liquid assets. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans regarding those matters also are described in Note 1. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ Carr, Riggs & Ingram, LLC

Atlanta, Georgia

May 30, 2017

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Video Display Corporation and Subsidiaries

Consolidated Balance Sheets

(in thousands)

The accompanying notes are an integral part of these consolidated statements.

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Video Display Corporation and Subsidiaries

Consolidated Balance Sheets

(in thousands)

The accompanying notes are an integral part of these consolidated statements.

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Video Display Corporation and Subsidiaries

Consolidated Statements of Operations

(in thousands, except per share data)

The accompanying notes are an integral part of these consolidated statements.

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Video Display Corporation and Subsidiaries

Consolidated Statements of Shareholders’ Equity

(in thousands)

The accompanying notes are an integral part of these consolidated statements.

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Video Display Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(in thousands)

The accompanying notes are an integral part of these consolidated statements.

See Note 13 for supplemental cash flow information.

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Notes to Consolidated Financial Statements

Note 1. Summary of Significant Accounting Policies

Fiscal Year

All references herein to “2017” and “2016” mean the fiscal years ended February 28, 2017 and February 29, 2016, respectively. Unless otherwise noted, these policies and disclosures pertain to our continuing operations.

Nature of Business

Video Display Corporation and subsidiaries (the “Company”, ”our” or “we”) is a provider and manufacturer of video products, components, and systems for data display and presentation of electronic information media in various requirements and environments. The Company designs, engineers, manufactures, markets, distributes and installs technologically advanced display products and systems, from basic components to turnkey systems for government, military, aerospace, medical and commercial organizations.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after elimination of all intercompany accounts and transactions.

Basis of Accounting

“The FASB Accounting Standards Codification” (“FASB ASC”) establishes the source of authoritative accounting standards generally accepted in the United States of America (“U.S. GAAP”) recognized by the Financial Accounting Standards Board (“FASB”) to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. The FASB amends the FASB ASC through Accounting Standards Updates (“ASUs”). ASCs and ASUs are referred to throughout these consolidated financial statements.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Examples include, warranty reserves, bad debts, inventory reserves, valuations on deferred income tax assets, accounting for percentage of completion contracts and the length of product life cycles and fixed asset lives. Actual results could vary from these estimates.

Banking and Liquidity

The accompanying consolidated financial statements were prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has sustained losses for each of the last three years and has seen a decline in both its working capital and liquid assets during this time. These losses were a combination of low revenues at all divisions without a commensurate reduction of expenses. During the year ended February 28, 2017, the Company operated using cash from operations of $1.2 million, which is primarily generated from an increase in accounts receivable of $1.2 million. During the year ended February 29, 2016, operating cash flows provided $1.1 million. Related to these operational results the Company’s working capital and liquid asset position deteriorated during the year ended February 28, 2017 as presented below:

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Management has implemented a plan to improve the liquidity of the Company. The Company has been implementing a plan to increase revenues at all the divisions, each structured to the particular division with an increase in the current backlog and growth in revenues subsequent to February 28, 2017. The Company implemented a plan to reduce expenses at the divisions, as well as at the corporate location during the fiscal year ending February 28, 2017 with the expectation that expenses will be decreased by more than $1.7 million per year. The reduction in expenses was over $2.0 million for the year. Management continues to explore options to monetize certain assets of the business and is in the process of securing a new lease for Lexel as further described in Note 11. The Company secured a $500 thousand line of credit on September 14, 2016. If additional and more permanent capital is required to fund the operations of the Company, no assurance can be given that the Company will be able to obtain the capital on terms favorable to the Company, if at all.

The ability of the Company to continue as a going concern is dependent upon the success of management’s plans to improve the operational effectiveness of the operations, to sell strategic assets as noted above, the procurement of suitable financing, securing a lease for Lexel, or a combination of these. The uncertainty regarding the potential success of management’s plan create substantial doubt about the ability of the Company to continue as a going concern.

Revenue Recognition

Revenues are recognized when there is persuasive evidence of an arrangement, delivery has occurred, the price has been fixed or is determinable and collect-ability can be reasonably assured. The Company’s delivery term typically is F.O.B. shipping point.

In accordance with FASB ASC Topic 605-45 “Revenue Recognition: Principal Agent Considerations”, shipping, and handling fees billed to customers are classified in net sales in the consolidated statements of operations. Shipping costs of $0.1 million were included in the fiscal years ended 2017 and 2016, respectively.

A portion of the Company’s revenue is derived from contracts to manufacture display systems to a buyer’s specification. These contracts are accounted for under the provisions of FASB ASC Topic 605-35 “Revenue Recognition: Construction-Type and Production-Type Contracts”. These contracts are fixed-price and cost-plus contracts and are recorded on the percentage of completion basis using the ratio of costs incurred to estimated total costs at completion as the measurement basis for progress toward completion and revenue recognition. Losses identified on contracts are recognized immediately. Contract accounting requires significant judgment relative to assessing risks, estimating contract costs and making related assumptions for schedule and technical issues. With respect to contract change orders, claims, or similar items, judgment must be used in estimating related amounts and assessing the potential for realization. These amounts are only included in contract value when they can be reliably estimated and realization is probable.

Research and Development

The Company includes research and development expenditures in the consolidated financial statements as a part of general and administrative expenses. Research and development costs were approximately $0.1 million in the fiscal year ended 2017 and $0.2 in the fiscal year ended 2016.

Cash and Cash Equivalents and Investments

Highly liquid investments with an original maturity date of three months or less at the date of purchase are considered to be cash equivalents. Investment securities that are held by the Company, are bought and held principally for the purpose of selling them in the near term, are classified as “trading” and principally consist of equity securities and mutual funds. These trading investments are carried at fair value with realized gains or losses and changes in fair value included in operations. Gains/ (losses) on trading securities held were approximately $0.2 million and ($2.8) million on February 28, 2017 and February 29, 2016 respectively.

Fair Value Measurements and Financial Instruments

The FASB’s fair value measurement guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:

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Assets measured at fair value on a recurring basis by the Company consist of investment securities held for trading using Level 1 inputs. The following table sets forth our financial assets and liabilities that were accounted for at fair value on a recurring basis as of February 28, 2017 and February 29, 2016 (in thousands):

Other financial instruments on the Company’s consolidated balance sheets include cash, accounts receivable, short-term liabilities, and debt. The estimated fair value of these financial instruments approximate cost due to the short period of time to maturity. Recorded amounts of long-term debt are considered to approximate fair value due to either rates that fluctuate with the market or are otherwise commensurate with the current market.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are customer obligations due under normal trade terms. The Company sells its products primarily to general contractors, government agencies, manufacturers, and consumers of video displays and CRTs. Management performs continuing credit evaluations of its customers’ financial condition and although the Company generally does not require collateral, letters of credit may be required from its customers in certain circumstances, such as foreign sales. The allowance for doubtful accounts is determined by reviewing all accounts receivable and applying credit loss experience to the current receivable portfolio with consideration given to the current condition of the economy, assessment of the financial position of the creditors as well as payment history and overall trends in past due accounts compared to established thresholds.

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The following is a roll-forward of the allowance for doubtful accounts (in thousands):

Warranty Reserves

The Company records, under the provisions of FASB ASC Topic 460-10-25 “Guarantees: Recognition”, a liability for estimated warranty obligations at the date products are sold. Adjustments are made as new information becomes available.

The warranty reserve is determined by recording a specific reserve for known warranty issues and a general reserve based on claims experience. The Company considers actual warranty claims compared to net sales, then adjusts its reserve liability accordingly. Actual claims incurred could differ from the original estimates, requiring adjustments to the reserve.

Inventories

Inventories consist primarily of CRTs, electron guns, monitors, digital projectors, video components and electronic parts. Inventories are stated at the lower of cost (primarily first-in, first-out) or market.

Reserves on inventories result in a charge to operations when the estimated net realizable value declines below cost. Management regularly reviews the Company’s investment in inventories for declines in value and establishes reserves when it is apparent that the expected net realizable value of the inventory falls below its carrying amount. The reserve for inventory obsolescence was approximately $1.9 million and $1.3 million at February 28, 2017 and February 29, 2016, respectively.

Property, Plant and Equipment

Property, plant, and equipment are stated at cost. Depreciation is computed principally by the straight-line method for financial reporting purposes over the following estimated useful lives: Buildings – ten to twenty-five years; Machinery and Equipment – five to ten years. Depreciation expense totaled approximately $237 thousand and $220 thousand for the fiscal years ended 2017 and 2016, respectively. Substantial betterments and costs to install to property, plant, and equipment are capitalized, while routine repairs and maintenance are expensed as incurred.

Management reviews and assesses long-lived assets, which includes property, plant, and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, management estimates the future cash flows expected to result from the use of the asset. If the sum of the undiscounted expected cash flows is less than the carrying amount of the asset, an impairment loss is recognized based upon the estimated fair value of the asset.

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Intangibles    

The Company had no intangible assets for the fiscal year ended February 28, 2017; therefore, there was no amortization expense. During the fiscal year ended February 29, 2016, the Company had intangible assets consisting of customer lists for legacy products for the airline industry. The Company evaluated the asset for impairment and determined it was appropriate to record an impairment charge equal to the remaining value of the intangible asset due to declining sales. The amount of the impairment was $471 thousand. Amortization expense related to the intangible assets before the impairment charge to operations was approximately $88 thousand.

Stock-Based Compensation Plans

The Company accounts for employee share-based compensation under the fair value method and uses an option pricing model for estimating the fair value of stock options at the date of grant as required by FASB ASC Topic 718-10-30, “Compensation – Stock Compensation: Initial Measurement”. For the fiscal years ended February 28, 2017 and February 29, 2016, the Company recognized immaterial amounts of share-based compensation in general and administrative expense; the liability for the share-based compensation recognized is presented in the consolidated balance sheet as part of additional paid in capital. As of February 28, 2017, total unrecognized compensation costs related to stock options and shares of restricted stock granted was $0.1 thousand. The amount of unrecognized share based compensation cost is expected to be recognized ratably over a period of approximately one year.

Stock Repurchase Program

The Company has a stock repurchase program, pursuant to which it had been authorized to repurchase up to 2,632,500 shares of the Company’s common stock in the open market. On January 20, 2014, the Board of Directors of the Company approved a one-time continuation of the stock repurchase program, and authorized the Company to repurchase up to 1,500,000 additional shares of the Company’s common stock in the open market. There is no minimum number of shares required to be repurchased under the program. During the fiscal year ended February 28, 2017, the Company did not repurchase any shares of Company stock. During the fiscal year ended February 29, 2016, the Company repurchased 71,406 shares at an average price of $1.61 per share, which were added to treasury shares on the consolidated balance sheet. Under this program, an additional 502,644 shares remain authorized to be repurchased by the Company at February 28, 2017.

Income Taxes

The Company accounts for income taxes under the asset and liability method prescribed in FASB ASC Topic 740, “Income Taxes”, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s consolidated financial statements or tax returns. In estimating future tax consequences, the Company generally considers all expected future events other than possible enactments of changes in the tax laws or rates.

Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company has determined that a valuation allowance is needed due to recent taxable net operating losses, the sale of profitable divisions and the limited taxable income in the carry back periods. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.

Deferred income taxes as of February 28, 2017 and February 29, 2016, reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and certain tax loss carryforwards, less any valuation allowance.

The Company accounts for uncertain tax positions as required in that a position taken or expected to be taken in a tax return is recognized in the consolidated financial statements when it is more likely than not (i.e., a likelihood of more than fifty percent) that the position would be sustained upon examination by tax authorities. A recognized tax position is then measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. As of February 28, 2017 and February 29, 2016 the Company did not have any material unrecognized tax benefits.

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The Company recognizes accrued interest and penalties related to unrecognized tax benefits as components of interest expense and other expense, respectively, in arriving at pretax income. The Company did not have any interest and penalties accrued as of February 28, 2017 and February 29, 2016.

The Company’s 2015, 2014 and 2013 tax years remain open to examination by the Internal Revenue Service (“IRS”).

Earnings (Loss) per Share

Basic earnings (loss) per share is computed by dividing income (loss) available to common shareholders by the weighted average number of common shares outstanding during each year. Shares issued or repurchased during the year are weighted for the portion of the year that they were outstanding. Diluted earnings per share is calculated in a manner consistent with that of basic earnings per share while giving effect to all potentially dilutive common shares that were outstanding during the period.

The following is a reconciliation of basic earnings (loss) per share to diluted earnings (loss) per share for 2017 and 2016, (in thousands, except for per share data):

Stock options, debentures, and other liabilities convertible into 69,000 and 83,000 shares, respectively, of the Company’s common stock were anti-dilutive and, therefore, were excluded from the fiscal 2017 and 2016 diluted earnings (loss) per share calculation.

Segment Reporting

The Company applies FASB ASC Topic 280, “Segment Reporting” to report information about operating segments in its annual and interim financial reports. An operating segment is defined as a component that engages in business activities, whose operating results are reviewed by the chief operating decision maker in order to make decisions about allocating resources, and for which discrete financial information is available. We operate and manage our business as one reportable segment. All of our divisions have similar products, production process, markets served and distribution methods; therefore, we believe they meet the criteria for aggregation under the applicable authoritative guidance and, as such, these operations are reported as one segment within the Consolidated Financial Statements.

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Recent Accounting Pronouncements

In May, 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09 “Revenue with Contracts from Customers”. ASU 2014-09 clarifies the principles for recognizing revenue and develops a common revenue standard for U.S. GAAP and International Financial Reporting Standards (“IFRS”). The new guidance (i) removes inconsistencies, and weaknesses in revenue requirements, (ii) provides a more robust framework for addressing revenue issues, (iii) improves comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets, (iv) provides more useful information to users of financial statements through improved disclosure requirements, and (v) simplifies the preparation of financial statements by reducing the number of requirements to which an entity must refer.

The guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period; however, a one year delay has been approved with the issuance of ASU 2015-14, “Revenue with Contracts from customers”. The Company is still evaluating the effects that the adoption of this update will have on the Company’s consolidated financial statements.

In August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements. Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to continue as a Going Concern”. Prior to its effective date there was no guidance in U.S. GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern or to provide related footnote disclosures. This update requires that an entity’s management should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable.) This update is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The adoption of this standard did not have a material effect on our consolidated financial statements.

In July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory”. ASU 2015-11 requires an entity to measure inventory within the scope of this update at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. The guidance is effective for annual reporting periods beginning after December 15, 2016 and related interim periods. Early adoption is permitted. We do not believe this standard will have a material effect on our consolidated financial statements.

In November 2015, the FASB issued Accounting Standards Update No. (ASU 2015-17), “Balance Sheet Classification of Deferred Taxes”. ASU 2015-17 requires deferred tax assets and liabilities, along with related valuation allowances, to be classified as noncurrent on the balance sheet. Each tax jurisdiction will now only have one net noncurrent deferred tax asset or liability. The new guidance does not change the existing requirement that prohibits offsetting deferred tax liabilities from one jurisdiction against deferred tax assets of another jurisdiction. The guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is permitted. We do not expect the adoption of this update to have a significant effect on our consolidated financial statements.

In February 2016, the FASB issued Accounting Standards Update No. (ASU 2016-02), “Leases”. ASU 2016-02 increases transparency and comparability among organizations by requiring entities to recognize lease assets and lease liabilities on the balance sheet and disclose key information about the lease arrangements. The guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. Early adoption is permitted. The Company is in the process of evaluating the impact of this guidance on the Company’s consolidated financial statements.

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Note 2. Costs and Estimated Earnings Related to Billings on Uncompleted Contracts

Information relative to contracts in progress consisted of the following (in thousands):

Billings in excess of costs and estimated earnings are the results of contracts in progress (jobs) in completing orders to customers’ specifications on contracts accounted for under FASB ASC Topic 605-35, “Revenue Recognition: Construction-Type and Production-Type Contracts.” Costs included are material, labor, and overhead. These jobs require design and engineering effort for a specific customer purchasing a unique product. The Company records revenue on these fixed-price and cost-plus contracts on the percentage of completion basis using the ratio of costs incurred to estimated total costs at completion as the measurement basis for progress toward completion and revenue recognition. Any losses identified on contracts are recognized immediately. Contract accounting requires significant judgment relative to assessing risks, estimating contract costs and making related assumptions for schedule and technical issues. With respect to contract change orders, claims, or similar items, judgment must be used in estimating related amounts and assessing the potential for realization. These amounts are only included in contract value when they can be reliably estimated and realization is probable. Billings are generated based on specific contract terms, which might be a progress payment schedule, specific shipments, etc. None of the above contracts in progress contains post-shipment obligations. Changes in job performance, manufacturing efficiency, final contract settlements, and other factors affecting estimated profitability may result in revisions to costs and income and are recognized in the period in which the revisions are determined.

As of February 28, 2017 and February 29, 2016, there were no production costs that exceeded the aggregate estimated cost of all in process and delivered units relating to long-term contracts. Additionally, there were no claims outstanding that would affect the ultimate realization of full contract values. As of February 28, 2017 and February 29, 2016, there were no progress payments that had been netted against inventory.

Note 3. Intangible Assets

Intangible assets consist of customer lists for airlines using legacy products. In the fiscal year ended February 29, 2016, the Company evaluated the asset for impairment and determined it appropriate to record an impairment charge equal to the remaining value of this intangible asset in the third quarter of it’s fiscal year due to declining sales associated with this asset. The amount of the impairment is $471 thousand. Amortization expense related to intangible assets was $88 thousand for fiscal 2016 (excluding the impairment charge). As of February 28, 2017 and February 29, 2016, the cost and accumulated amortization of intangible assets was as follows (in thousands):

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Note 4. Inventories

Inventories consisted of the following (in thousands):

The following is a roll forward of the Inventory Reserves (in thousands):

Note 5. Line of Credit and Long-Term Debt

The Company has a $0.5 million line of credit with the Brand Banking Company with a current balance of $0.2 million at February 28, 2017. The only other commercial debt of the Company is $0.1 million it owes on a building owned by its subsidiary, Teltron Technologies, Inc. in Birdsboro, PA.

Long-term debt consisted of the following (in thousands):

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Future maturities of lines of long-term debt are as follows (in thousands):

Note 6. Notes Payable to Officers and Directors

The Company owed the Chief Executive officer $85 thousand dollars at the beginning of the Company’s fiscal year ended February 28, 2017. The Company repaid the $85 thousand during the first quarter of the fiscal year ended February 28, 2017. The interest rate was eight percent. The Company paid $1 thousand interest on this loan for fiscal 2017.

On March 30, 2016, the Company entered into an assignment with recourse of the note receivable from Z-Axis Inc. (Z-Axis) with Ronald D. Ordway, CEO, and Jonathan R. Ordway, related parties, for the sum of $912 thousand. The note receivable is collateralized by a security interest in the shares of Z-Axis as well as a personal guaranty of its majority shareholder. Z-Axis is current on all scheduled payments regarding this note. The Company retains the right to repurchase the note at any time for 80% of the outstanding principle balance. Also, in the event of default by Z-Axis, the Company is obligated to repurchase the note for 80% of the remaining principle balance plus any accrued interest. Accordingly, the Company has recognized this transaction as a secured borrowing in accordance with the provisions of ASC 860-10. The $ 0.9 million, 9% interest rate, note originated on March 30, 2016, with payments beginning on April 16, 2016 and continuing for 56 months thereafter. The balance of the note at February 28, 2017 was $765 thousand.

Note 7. Accrued Expenses and Warranty Obligations

The following provides a reconciliation of changes in the Company’s warranty reserve for fiscal years 2017 and 2016. The Company provides no other guarantees.

Accrued liabilities consisted of the following (in thousands):

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Note 8. Stock Options

Upon recommendation of the Board of Directors of the Company, on August 25, 2006, the shareholders of the Company approved the Video Display Corporation 2006 Stock Incentive Plan (“Plan”), whereby options to purchase up to 500,000 shares of the Company’s common stock may be granted and up to 100,000 restricted common stock shares may be awarded. Options may not be granted at a price less than the fair market value, determined on the day the options are granted. Options granted to a participant who is the owner of ten percent or more of the common stock of the Company may not be granted at a price less than 110% of the fair market value, determined on the day the options are granted. The exercise price of each option granted is fixed and may not be re-priced. The life of each option granted is determined by the plan administrator, but may not exceed the lesser of seven years from the date the participant has the vested right to exercise the option, or nine years from the date of the grant. The life of an option granted to a participant who is the owner of ten percent or more of the common stock of the Company may not exceed five years from the date of grant. All full-time or part-time employees, and Directors of the Company, are eligible for participation in the Plan. In addition, any consultant or advisor who renders bona fide services to the Company, other than in connection with the offer or sale of securities in a capital-raising transaction, is eligible for participation in the Plan. The plan administrator is appointed by the Board of Directors of the Company. The Plan may be terminated by action of the Board of Directors, but in any event will terminate on the tenth anniversary of its effective date.

Prior to expiration on May 1, 2006, the Company maintained an incentive stock option plan whereby options to purchase up to 1.2 million shares could be granted to directors and key employees at a price not less than fair market value at the time the options were granted. Upon vesting, options granted are exercisable for a period not to exceed ten years. No further options may be granted pursuant to the plan after the expiration date; however, those options outstanding at that date will remain exercisable in accordance with their respective terms.

Information regarding the stock option plans is as follows:

The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing model, which requires the Company to estimate the expected term of the stock option grants and expected future stock price volatility over the term. The term represents the expected period of time the Company believes the options will be outstanding based on historical information. Estimates of expected future stock price volatility are based on the historic volatility of the Company’s common stock. The Company calculates the historic volatility based on the weekly stock closing price, adjusted for dividends and stock splits. The fair value of the stock options is based on the stock price at the time the option is granted, the annualized volatility of the stock and the discount rate at the grant date.

The assumptions used and the weighted average calculated value of the units is as follows for the years ended February 28, 2017 and 2016.

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Note 9. Taxes on Income

Provision (benefit) for income taxes in the consolidated statements of income consisted of the following components (in thousands):

The provision for income taxes differs from the amount computed by applying the federal statutory rate of 34% to income before income taxes as follows (in thousands):

The income tax expense effective tax rate for fiscal 2017 was (1.8%) % compared to 0% for fiscal 2016. The higher effective rate in 2017 compared to the effective rate in 2016 was primarily due to state income taxes, the valuation allowance the Company recognized on deferred tax benefits not expected to be realized, research and experimentation credits, the non-deductible losses and various other permanent items.

The deferred tax assets were reduced by a valuation allowance because, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company has determined that a 100% valuation allowance is needed due to recent taxable net operating losses, the sale of profitable divisions and the limited taxable income in the carry back periods.