GENCOR INDUSTRIES INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Information This Quarterly Report contains certain “forward-looking statements” within the meaning of the Exchange Act, which represent the Company’s expectations and beliefs, including, but not limited to, statements concerning gross margins, sales of the Company’s products and future financing plans, income from investees and litigation. These statements by their nature involve substantial risks and uncertainties, certain of which are beyond the Company’s control. Actual results may differ materially depending on a variety of important factors, including the financial condition of the Company’s customers, changes in the economic and competitive environments, the performance of the investment portfolio and the demand for the Company’s products. For information concerning these factors and related matters, see the following sections of the Company’s Annual Report on Form 10-K for the year ended September 30, 2020: (a) Part I, Item 1A, “Risk Factors” and (b) Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. However, other factors besides those referenced could adversely affect the Company’s results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties. Any forward-looking statements made by the Company herein speak as of the date of this Quarterly Report. The Company does not undertake to update any forward-looking statements, except as required by law. Overview Gencor is a leading manufacturer of heavy machinery used in the production and application of highway construction materials and environmental control equipment. The Company’s core products include asphalt plants, combustion systems, fluid heat transfer systems and asphalt pavers. The Company’s products are manufactured at three facilities in the United States. Because the Company’s products are sold primarily to the highway construction industry, the business is seasonal in nature. Traditionally, the Company’s customers reduce their purchases of new equipment for shipment during the summer and fall months to avoid disrupting their peak season for highway construction and related repair work. The majority of orders for the Company’s products are thus received between October and February, with a significant volume of shipments occurring in the late winter and spring. The principal factors driving demand for the Company’s products are the overall economic conditions, the level of government funding for domestic highway construction and repair, Canadian infrastructure spending, the need for spare parts, fluctuations in the price of liquid asphalt, and a trend towards larger more efficient asphalt plants. On December 4, 2015, President Obama signed into law a five-year, $305 billion transportation bill, Fixing America’s Surface Transportation Act (the “FAST Act”). The FAST Act reauthorized the collection of the 18.4 cents per gallon gas tax that is typically used to pay for transportation projects. It also included $70 billion from other areas of the federal budget to close a $16 billion annual funding deficit. The bill included spending of more than $205 billion on roads and highways over five years. The 2016 funding levels were approximately 5% above 2015 projected funding, with annual increases between 2.0% and 2.5% from 2016 through September 2020. On the eve of its expiration, a one-year extension to the FAST Act was passed and signed into law. The one-year extension maintains current funding levels under the FAST Act through September 2021. California’s Senate Bill 1 (“SB1”), the Road Repair and Accountability Act of 2017, was signed into law on April 28, 2017. The legislative package invests $54 billion over the next decade to fix roads, freeways and bridges in communities across California and puts more dollars towards transit and safety. These funds will be allocated to state and local projects. Additionally, numerous other states have taken steps to increase their gas tax revenues in recent years. Fluctuations in the price of carbon steel, which is a significant cost and material used in the manufacturing of the Company’s equipment, may affect the Company’s financial performance. The Company is subject to fluctuations in market prices for raw materials, such as steel. If the Company is unable to purchase materials it requires or is unable to pass on price increases to its customers or otherwise reduce its cost of goods sold, its business results of operations and financial condition may be adversely affected. 15 Also, a significant increase in the price of liquid asphalt could decrease demand for hot mix asphalt paving materials and certain of the Company’s products. Increases in oil prices also drive up the cost of gasoline and diesel, which results in increased freight costs. Where possible, the Company will pass increased freight costs on to its customers. However, the Company may not be able to recapture all of the higher costs and thus could have a negative impact on the Company’s financial performance. The Company believes its strategy of continuing to invest in product engineering and development and its focus on delivering the highest quality products and superior service will strengthen the Company’s market position. The Company continues to review its internal processes to identify inefficiencies and cost-reduction opportunities. The Company will continue to scrutinize its relationships with suppliers to ensure it is achieving the highest quality materials and services at the most competitive cost. Results of Operations Quarter Ended December 31, 2020 versus December 31, 2019 Net revenues for the quarters ended December 31, 2020 and December 31, 2019 were $18,964,000 and $18,030,000, respectively, an increase of $934,000. The improved revenues reflect an increase in parts and component sales over the comparative quarter in the prior year. There were no revenues generated by Blaw-Knox during the quarter ended December 31, 2020, as the facility is being readied to begin production. As a percent of sales, gross profit margins were 15.7% in the quarter ended December 31, 2020, compared to 24.0% in the quarter ended December 31, 2019. The gross profit margins for the quarter ended December 31, 2020 were impacted by approximately $1.5 million of unabsorbed manufacturing labor and overhead expenses related to the Blaw-Knox paver product line. Excluding these expenses, the gross profit margin for the quarter ended December 31, 2020, would have been 23.5%, with increases in steel prices contributing to the lower overall gross margins. Product engineering and development expenses increased $79,000 to $845,000 for the quarter ended December 31, 2020, as compared to $766,000 for the quarter ended December 31, 2019, due primarily to engineering wages related to the Blaw-Knox paver product line. Selling, general and administrative (“SG&A”) expenses increased by $812,000 to $3,194,000 for the quarter ended December 31, 2020, compared to the quarter ended December 31, 2019. The increase in SG&A expenses was primarily due to professional fees, salaries, travel and other general expenses of approximately $0.5 million related to the acquisition. In addition, increased advertising expenses contributed to the higher SG&A expenses during the first quarter of fiscal 2021. Operating income decreased from $1,172,000 for the quarter ended December 31, 2019 to an operating loss of $(1,058,000) for the quarter ended December 31, 2020, due primarily to the operational start-up costs related to the acquisition. For the quarter ended December 31, 2020, interest and dividend income, net of fees, was $804,000 as compared to $632,000 in the quarter ended December 31, 2019. Interest income for the quarter ended December 31, 2020, included $456,000 collected from a customer due to permitting delays. The net realized and unrealized gains on marketable securities were $2,193,000 for the quarter ended December 31, 2020 versus $1,317,000 for the quarter ended December 31, 2019, due to a strong domestic stock market during the quarter ended December 31, 2020. The effective income tax rate for the quarters ended December 31, 2020 and December 31, 2019, was 20.0% based on the expected annual effective income tax rate. Net income for the quarter ended December 31, 2020 was $1,551,000 or $0.11 basic and diluted earnings per share versus net income of $2,489,000 or $0.17 basic and diluted earnings per share for the quarter ended December 31, 2019. Liquidity and Capital Resources The Company generates capital resources through operations and returns on its investments. 16 The Company had no long-term or short-term debt outstanding at December 31, 2020 or September 30, 2020. As of December 31, 2020, the Company has funded $85,000 in cash deposits at insurance companies to cover related collateral needs. In April 2020, a financial institution issued an irrevocable standby letter of credit (“letter of credit”) on behalf of the Company for the benefit of one of the Company’s insurance carriers. The maximum amount that can be drawn by the beneficiary under the letter of credit is $150,000. The letter of credit expires in April 2021, unless terminated earlier, and can be extended, as provided by the agreement. The Company intends to renew the letter of credit for as long as the Company does business with the beneficiary insurance carrier. The letter is collateralized by restricted cash of the same amount on any outstanding drawings. To date, no amounts have been drawn under the letter of credit. As of December 31, 2020, the Company had $23,957,000 in cash and cash equivalents, and $92,049,000 in marketable securities, including $27,392,000 in corporate bonds, $15,129,000 in equities, $13,260,000 in mutual funds, $15,775,000 in exchange-traded funds, $16,056,000 in government securities, and $4,437,000 in cash and money funds. The marketable securities are invested through a professional investment management firm. These securities may be liquidated at any time into cash and cash equivalents. The Company’s backlog was $32.1 million at December 31, 2020 compared to $30.9 million at December 31, 2019. The Company’s working capital (defined as current assets less current liabilities) was $151.3 million at December 31, 2020 and $153.2 million at September 30, 2020. Cash provided by operations during the quarter ended December 31, 2020 was $3,705,000. The significant purchases, sales and maturities of marketable securities shown on the condensed consolidated statements of cash flows reflect the recurring purchases and sales of United States treasury bills. Costs and estimated earnings in excess of billings decreased by $1.7 million, inventories decreased by $2.6 million (excluding the $11.0 million of inventory acquired with the Blaw-Knox paver product line) and customer deposits decreased by $1.2 million reflecting the completion and shipment of several large contract jobs during the quarter ended December 31, 2020. Cash flows used in investing activities for the quarter ended December 31, 2020 of $15,332,000 were related to the acquisition of the Blaw-Know paver product line and subsequent capital expenditures, primarily for systems software and leasehold improvements for the Blaw-Knox manufacturing facility. Seasonality The Company’s primary business is the manufacture of asphalt plants and related components and asphalt pavers. These products typically experience a seasonal slowdown during the third and fourth quarters of the calendar year. This slowdown often results in lower reported sales and operating results during the first and fourth quarters of the fiscal year ended September 30. Critical Accounting Policies, Estimates and Assumptions The Company believes the following discussion addresses its most critical accounting policies, which are those that are most important to the portrayal of the financial condition and results of operations and require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Accounting policies, in addition to the critical accounting policies referenced below, are presented in Note 1 to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2020, “Nature of Operations and Summary of Significant Accounting Policies.” Estimates and Assumptions In preparing the condensed consolidated financial statements, the Company uses certain estimates and assumptions that may affect reported amounts and disclosures. Estimates and assumptions are used, among other places, when accounting for certain revenue (e.g., contract accounting), expense, and asset and liability valuations. The Company believes that the estimates and assumptions made in preparing the condensed consolidated financial statements are reasonable, but are inherently uncertain. Assumptions may be incomplete or inaccurate and unanticipated events may occur. The Company is subject to risks and uncertainties that may cause actual results to differ from estimated results. 17 Revenues & Expenses The Company recognizes revenue under ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). Revenues from contracts with customers for the design, manufacture and sale of custom equipment are recognized over time when the performance obligation is satisfied by transferring control of the equipment. Control of the equipment transfers over time, as the equipment is unique to the specific contract and thus does not create an asset with an alternative use to the Company. Revenues and costs are recognized in proportion to actual labor costs incurred, as compared with total estimated labor costs expected to be incurred, during the entire contract. All incremental costs related to obtaining a contract are expensed as incurred, as the amortization period is less than one year. Changes to total estimated contract costs or losses, if any, are recognized in the period in which they are determined. Contract assets (excluding accounts receivable) under contracts with customers represent revenue recognized in excess of amounts billed on equipment sales recognized over time. These contract assets were $4,709,000 and $6,405,000 at December 31, 2020 and September 30, 2020, respectively, and are included in current assets as costs and estimated earnings in excess of billings on the Company’s condensed consolidated balance sheets. The Company anticipates that all of the contract assets at December 31, 2020, will be billed and collected within one year. Revenues from all other contracts for the design and manufacture of equipment, for service and for parts sales, net of any discounts and return allowances, are recorded at a point in time when control of the goods or services has been transferred. Control of the goods or service typically transfers at time of shipment or upon completion of the service. Payment for equipment under contract with customers is typically due prior to shipment. Payment for services under contract with customers is due as services are completed. Accounts receivable related to contracts with customers for equipment sales were $346,000 at December 31, 2020 and $223,000 at September 30, 2020. Product warranty costs are estimated using historical experience and known issues and are charged to production costs as revenue is recognized. Under certain contracts with customers, recognition of a portion of the consideration received may be deferred and recorded as a contract liability if the Company has to satisfy a future obligation, such as to provide installation assistance. There were no contract liabilities other than customer deposits at December 31, 2020 and September 30, 2020. Customer deposits related to contracts with customers were $2,697,000 at December 31, 2020 and $3,853,000 at September 30, 2020 and are included in current liabilities on the Company’s condensed consolidated balance sheets. The Company records revenues earned for shipping and handling as freight revenue at the time of shipment, regardless of whether or not it is identified as a separate performance obligation. The cost of shipping and handling is classified as cost of goods sold concurrently with the revenue recognition. All product engineering and development costs, and selling, general and administrative expenses are charged to operations as incurred. Provision is made for any anticipated contract losses in the period that the loss becomes evident. The allowance for doubtful accounts is determined by performing a specific review of all account balances greater than 90 days past due and other higher risk amounts to determine collectability, and also adjusting for any known customer payment issues with account balances in the less-than-90-day past due aging category. Account balances are charged off against the allowance for doubtful accounts when they are determined to be uncollectible. Any recoveries of account balances previously considered in the allowance for doubtful accounts reduce future additions to the allowance for doubtful accounts. The allowance for doubtful accounts also includes an estimate for returns and allowances. Provisions for estimated returns and allowances and other adjustments, are provided for in the same period the related sales are recorded. Returns and allowances, which reduce product revenue, are estimated using known issues and historical experience. 18 Inventories Inventories are valued at the lower of cost or net realizable value. Net realizable value is defined as the estimated selling price of goods less reasonable costs of completion and delivery. Appropriate consideration is given to obsolescence, excessive levels, deterioration, possible alternative uses and other factors in determining net realizable value. The cost of work in process and finished goods includes materials, direct labor, variable costs and overhead. The Company evaluates the need to record inventory adjustments on all inventories, including raw material, work in process, finished goods, spare parts and used equipment. Used equipment acquired by the Company on trade-in from customers is carried at estimated net realizable value. Unless specific circumstances warrant different treatment regarding inventory obsolescence, an allowance is established to reduce the cost basis of inventories three to four years old by 50%, the cost basis of inventories four to five years old by 75%, and the cost basis of inventories greater than five years old to zero. Inventory is typically reviewed for obsolescence on an annual basis computed as of September 30, the Company’s fiscal year end. If significant known changes in trends, technology or other specific circumstances that warrant consideration occur during the year, then the impact on obsolescence is considered at that time. Marketable Securities and Fair Value Measurements Marketable debt and equity securities are categorized as trading securities and are thus marked to market and stated at fair value. Fair value is determined using the quoted closing or latest bid prices for Level 1 investments and market standard valuation methodologies for Level 2 investments. Realized gains and (losses) on investment transactions are determined by specific identification and are recognized as incurred in the condensed consolidated statements of income. Net unrealized gains and (losses) are reported in the condensed consolidated statements of income in the current period and represent the change in the fair value of investment holdings during the period. Long-Lived Asset Impairment Property and equipment and intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset (or asset group) may not be recoverable. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss to be recorded is calculated by the excess over its fair value of the asset’s carrying value. Fair value is generally determined using a discounted cash flow analysis. Off-Balance Sheet Arrangements None 19 Item 3. Quantitative and Qualitative Disclosures about Market Risk Not applicable.