Overview

Elecsys Corporation provides innovative machine to machine (M2M) communication technology solutions, data acquisition and management systems, and custom electronic equipment for critical industrial applications worldwide. Our primary markets include energy production and distribution, agriculture, safety and security systems, water management, and transportation. Our Proprietary products and services encompass rugged remote monitoring, industrial data communication, mobile computing, and radio frequency identification (RFID) technologies that are deployed wherever high quality and reliability are essential. We develop, manufacture, and support proprietary technology and products for various markets under several premium brand names. In addition to our Proprietary products, we design and manufacture rugged and reliable custom electronic assemblies and integrated display modules to multiple original equipment manufacturers (OEMs) in a variety of industries worldwide.

Results of Operations

Three Months Ended July 31, 2012 Compared With Three Months Ended July 31, 2011.

The following table sets forth, for the periods presented, certain statements of
operations data of the Company:

                                                                    Three Months Ended
                                                          (In thousands, except per share data)
                                                          July 31, 2012               July 31, 2011
Sales                                                   4,257           100.0 %      5,673       100.0 %
Cost of products sold                                   2,868            67.4 %      3,669        64.7 %
Gross margin                                            1,389            32.6 %      2,004        35.3 %
Selling, general and administrative expenses            1,617            38.0 %      1,615        28.5 %
Operating (loss) income                                  (228 )          (5.4 )%       389         6.9 %
Interest expense                                          (21 )          (0.5 %)       (57 )      (1.0 %)
(Loss) income before income tax (benefit) expense        (249 )          (5.9 )%       332         5.9 %
Income tax (benefit) expense                              (88 )          (2.1 )%       119         2.3 %
Net (loss) income                                   $    (161 )          (3.8 )%   $   213         3.6 %
Net (loss) income per share - basic                 $   (0.04 )                    $  0.06
Net (loss) income per share - diluted               $   (0.04 )                    $  0.05

Sales for the three months ended July 31, 2012 were approximately $4,257,000, a decrease of $1,416,000, or 25.0%, from $5,673,000 for the comparable period of fiscal 2012.

                                        Three Months Ended
                                          (In thousands)
                               July 31, 2012           July 31, 2011
EMS sales                   $ 2,554        60.0 %   $ 3,310        58.3 %
Proprietary product sales     1,703        40.0 %     2,363        41.7 %
 Total Sales                  4,257       100.0 %     5,673       100.0 %

Proprietary products. Sales of our Proprietary products and services were $1,703,000 for the three-month period ended July 31, 2012, which was a $660,000, or 27.9%, decrease from sales of $2,363,000 in the prior year period.

Sales of our wireless remote monitoring solutions were approximately $954,000 for the three-month period ended July 31, 2012, which was a decrease of $661,000, or 40.9%, from $1,615,000 during the three-month period ended July 31, 2011. The overall decrease in sales of remote monitoring equipment and services was driven by a slowdown in customer orders received and shipped during the period. We continue to focus on sales, marketing, and new product development and have seen increases in our recurring data management services. Data management services revenue continues to grow as a function of the growing population of monitoring units deployed in the field. Overall, data management services revenue totaled approximately $236,000, an increase of $43,000, or 22.3%, from data management services revenue of $193,000 reported in the comparable period of the prior fiscal year. We anticipate, in the current economic environment and based on our new products in development, that over the next few quarters, revenues from our wireless remote monitoring solutions will grow steadily from the current period. Our targeted markets and potential new customers continue to remain cautious regarding their capital investments in infrastructure. However, we expect that our continued investment in sales and marketing will begin to produce meaningful additional revenues over the next few fiscal quarters and into the next fiscal year.

Sales of our industrial data communication solutions were approximately $216,000 for the three-month period ended July 31, 2012, which was a $99,000, or 84.6%, increase over the total sales of $117,000 for the three-month period ended July 31, 2011. The increase is the direct result of increased sales and marketing efforts to the existing customer base and an active pursuit of new customers for the Director series products. With this new effort, we expect revenues from our industrial communication products to grow over the next few quarters as we invest in new product development and continue our marketing efforts.

Sales of our mobile data acquisition solutions, including our Radix handheld computer hardware, peripherals, maintenance contract revenues, and our eXtremeTAG RFID solutions, were approximately $434,000 for the three-month period ended July 31, 2012. Total sales decreased approximately $109,000, or 20.1%, as compared to the prior year period reported revenues of approximately $543,000. We made fewer shipments of Radix computer hardware and eXtremeTAG RFID tags during the fiscal year-to-date period. Overall poor international economic conditions adversely impacted sales to many of our largest international Radix customers during the past fiscal year; however, we have begun to see increased interest in the Radix FW950/960 and its related peripherals. We believe that improving international economic conditions in specific markets and increased domestic sales of Radix products will provide an overall increase in sales over the next few quarters. Recurring maintenance contract revenues posted a small decrease for the three-month period ended July 31, 2012 of approximately $18,000, or 7.7%, as a result of fewer Radix units covered under maintenance contracts that were largely the result of continuing budgetary constraints at many of our municipal customers that led them to discontinue their maintenance plans. Although we forecast an increase in sales of mobile data acquisition products during the next fiscal year, we expect maintenance contract revenues to decrease due to continued budgetary constraints in our current municipal government customer base.

EMS. Sales for the EMS business segment were approximately $2,483,000, a decrease of $776,000, or 23.8%, from $3,259,000 in the prior year period. The decrease was the result of reduced sales to our existing customers stemming from uncertain economic and business conditions combined with the elimination of certain lower margin customers as we focus on increasing EMS gross margins. We expect that our renewed investment in EMS sales and marketing, along with our focus on targeting additional customers likely to benefit from our proprietary technologies, will lead to moderate growth in EMS sales and margins in the second half of the current fiscal year. However, the prolonged uncertainty regarding future economic conditions will likely have an impact in the near term and could impact current scheduled orders as well as future bookings. These could adversely influence EMS sales over the next few quarters.

Other revenues. Additional miscellaneous revenues, which have been allocated between the EMS and Proprietary products business segments for segment disclosure purposes, totaled approximately $170,000 for the three-month period ended July 31, 2012. These revenues are related to service and repair, engineering services, and freight billings. These sales totaled approximately $139,000 in the three-month period ended July 31, 2011.

Total consolidated backlog at July 31, 2012 was approximately $8,175,000, an increase of $270,000, or 3.4%, from a total backlog of $7,905,000 on April 30, 2012 and an increase of approximately $2,396,000, or 41.5%, from a total backlog of $5,779,000 on July 31, 2011. EMS orders usually specify several deliveries scheduled over a defined and extended period of time. Typically, orders for our Proprietary products are completed and shipped to the customer soon after orders are received. Certain larger Proprietary product orders may have specific deliveries scheduled over a longer period of time. We anticipate that the amount of our total backlog relative to our revenues will fluctuate as our mix of Proprietary products and EMS sales varies.

The following table presents the backlog by business segment for the periods ended July 31, 2012, April 30, 2012, and July 31, 2011 (in thousands).

                        July 31, 2012       April 30, 2012       July 31, 2011
EMS                    $         7,647     $          7,750     $         5,586
Proprietary products               528                  155                 193
Total backlog          $         8,175     $          7,905     $         5,779

Gross margin for the three-month period ended July 31, 2012 was 32.6% of sales, or $1,389,000, compared to 35.3% of sales, or $2,004,000, for the three-month period ended July 31, 2011. The $615,000 reduction of gross margin dollars and the decrease in gross margin percentage was the direct result of lower overall sales volume during the period.

                                                 Three Months Ended
                                                   (In thousands)
                                        July 31, 2012          July 31, 2011
Gross margin - EMS                    $   610       23.9 %   $   781       23.6 %
Gross margin - Proprietary products       779       45.7 %     1,223       51.8 %
 Total gross margin                   $ 1,389       32.6 %   $ 2,004       35.3 %

Gross margin for the Proprietary products business segment was approximately 45.7% of sales, or $779,000, for the three-month period ended July 31, 2012 as compared to 51.8% of sales, or $1,223,000, for the three-month period ended July 31, 2011. The decrease in gross margin for the Proprietary products was mainly due to the overall decrease in Proprietary product sales and the specific product mix.

The gross margin for the EMS business segment was $610,000, or 23.9% of sales, compared to $781,000, or 23.6% of sales, for the prior year period. The decrease of EMS gross margin dollars stemmed from a decrease in sales volumes during the period while the slight increase in gross margin percentage resulted from our continued focus on improving EMS gross margins and the elimination of less profitable accounts.

We expect that consolidated gross margins over the next few quarters will continue in the current range of 32% to 37%. This expectation is based on our forecasted sales mix of Proprietary products and EMS products and services which impacts our manufacturing efficiency and gross margins. We continue to work to increase our EMS margins through productivity improvements and new OEM production opportunities and also anticipate increases in Proprietary product revenues as a percentage of our overall total sales volume.

Selling, general and administrative ("SG&A") expenses totaled approximately $1,617,000 for the three-month period ended July 31, 2012. This was similar to the total SG&A expenses of $1,615,000 for the three-month period ended July 31, 2011. SG&A expenses were 38.0% of sales for the current fiscal quarter of 2013 as compared to 28.5% of sales for the comparable period for fiscal 2012.

                                                                  Three Months Ended
                                                                    (In thousands)
                                                         July 31, 2012           July 31, 2011
Research & development expenses                       $   406         9.5 %   $   342         6.0 %
Selling & marketing expenses                              524        12.3 %       538         9.5 %
General & administrative expenses                         687        16.1 %       735        13.0 %
 Total selling, general and administrative expenses   $ 1,617        38.0 %   $ 1,615        28.5 %

Research and development expenses increased $64,000, to $406,000, during the fiscal quarter as compared to the prior year period. This increase was primarily driven by higher engineering personnel expenses of approximately $46,000 resulting from our increased investment in additional product design and an increase of $56,000 in product development costs. These increases were slightly offset by lower contract labor costs of $23,000 and a $15,000 decrease in recruiting expenses.

Selling and marketing expenses were $524,000 for the three-month period ended July 31, 2012 and $538,000 for the three-month period ended July 31, 2011. The decrease of $14,000 was the result of changes in sales personnel from the previous year period. During the third quarter of last fiscal year, we eliminated a sales management position and reallocated those resources to add additional sales people. The result of this reallocation was a slight reduction in overall personnel expenses of approximately $13,000 and we believe these additional resources will help increase both EMS and Proprietary product revenues over the long term.

General and administrative expenses decreased approximately $48,000 from the comparable period of the prior year. The decrease was primarily the result of the reduction in professional fees and a slight reduction in personnel expenses as compared to the comparable period of the prior year.

Total SG&A expenses over the next few quarters are expected to increase slightly over the previous periods as a result of our continued investments in personnel, new product development, systems and capabilities.

Operating loss for the three-month period ended July 31, 2012 was approximately $228,000, a decrease of $617,000 from operating income of $389,000 reported for the three-month period ended July 31, 2011.

Financial expense, including interest, was $21,000 and $57,000 for the three-month periods ended July 31, 2012 and 2011, respectively. The decrease of $36,000 resulted from lower total outstanding borrowings compared to the previous fiscal year period in addition to the reduction of the interest rate on the Industrial Revenue Bonds in fiscal 2012. During the three-month period ended July 31, 2012, there were no additional net borrowings on the operating line of credit and the Company made payments of $750,000 that eliminated the outstanding balance. As of January 31, 2012, there was also $2,941,000 outstanding in current and long-term borrowings (Industrial Revenue Bonds) compared to $3,166,000 at July 31, 2011. We may utilize the operating line of credit in the near term to fund increases in production activity when necessary but seek to minimize our interest expense when possible.

The income tax benefit for the three-month period ended July 31, 2012 was approximately $88,000 which was the result of the loss for the period. For the three-month period ended July 31, 2011, income tax expense was approximately $119,000. The effective income tax rate was 35.3% and 35.8% for the three-month periods ended July 31, 2012 and 2011, respectively. The change in the effective tax rate was due to the recognition of certain income tax adjustments and the benefit derived from the domestic manufacturing deduction in the previous period of the prior fiscal year.

As a combined result of the above factors, our net loss was $161,000, or $0.04 per diluted share, for the three-month period ended July 31, 2012 as compared to net income of $213,000, or $0.05 per diluted share, reported for the three-month period ended July 31, 2011.

Liquidity and Capital Resources

Cash and cash equivalents decreased $59,000 to $77,000 as of July 31, 2012 compared to $136,000 at April 30, 2012. This decrease was primarily the result of the debt reduction and purchases of equipment slightly offset by cash provided by collections of accounts receivable and a relatively small decrease in inventory.

Operating activities. Our consolidated working capital decreased approximately $841,000 during the three-month period ended July 31, 2012. The decrease was primarily due to a reduction in current assets, primarily accounts receivable and inventory, along with a significantly smaller decrease in current liabilities. Cash generated from operating activities as a result of a reduction in working capital was used in the reduction of debt during the period as well as some purchases of equipment. Operating cash receipts totaled approximately $5,188,000 and $6,102,000 during the three-month periods ended July 31, 2012 and 2011, respectively. The decrease is primarily the result of the decrease in sales and the net loss for the current period in combination with a reduction in receivables as compared to the prior year. Total cash disbursements for operations, which include purchases of inventory and operating expenses, were approximately $4,407,000 for the three-month period ended July 31, 2012 and $5,459,000 for the three-month period ended July 31, 2011.

Investing activities. Cash used in investing activities totaled $46,000 and $197,000 during the three-month periods ended July 31, 2012 and 2011, respectively, as we purchased additional equipment in 2011.

Financing activities. As of July 31, 2012, we had a $6,000,000 operating line of credit that provided us and our wholly-owned subsidiary with short-term financing for our working capital requirements. The line of credit's borrowing capacity is calculated as a specified percentage of accounts receivable and inventory on a monthly basis and expires on October 30, 2013. As of July 31, 2012, there were no borrowings outstanding on the operating line of credit. The total amount of borrowing base for the line of credit as of July 31, 2012 was approximately $3,971,000. It is secured by accounts receivable and inventory and accrues interest at a performance-based rate that is based on the prime rate (3.25% at July 31, 2012) plus/minus 0.5% and has an interest rate floor of 3.50%. The interest rate actually assessed is determined by our debt-to-tangible net worth ratio and the rate of 3.50% for the period was the lowest rate allowed under the terms of the operating line of credit. The loan agreement has various covenants, including a financial covenant pertaining to the maintenance of total tangible net worth and a required debt service coverage ratio. As of July 31, 2012 we were in compliance will all covenants. For the three-month period ended July 31, 2012 there were no additional net borrowings on the operating line of credit. Total payments on the line of credit were $750,000 for the three-month period while payments on long-term debt totaled approximately $44,000. Effective September 1, 2011, the 5-year adjustable interest rate on our Industrial Revenue Bonds was reset to 1.89% through September 1, 2016. For the three-month period ended July 31, 2011, financing activities included $500,000 of cash used in payment on the line of credit and $33,000 in payments on long-term debt.

Although there can be no assurances, we believe that existing cash, the cash expected to be generated from our operations, amounts available under our line of credit, and amounts available from trade credit, will be sufficient to finance our anticipated working capital needs, our capital expenditures, and our scheduled debt repayment for the foreseeable future.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We cannot ensure that actual results will not differ from those estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition. We derive revenue from the manufacture of production units of electronic assemblies, liquid crystal displays, and our Proprietary products including our remote monitoring equipment, RFID technology and solutions and our mobile computing products. We also derive revenue from repairs and non-warranty services, engineering design services, remote monitoring services and maintenance contracts. Production and repaired units are billed to the customer after they are shipped. Remote monitoring services and maintenance contracts are billed and the revenue recognized at the end of the month the services or maintenance periods are completed. For customers that utilize our engineering design services, we bill the customer and recognize revenue after the design services or tooling have been completed. We require our customers to provide a binding purchase order to verify the manufacturing services to be provided and to ensure payment. Typically, we do not have any post-shipment obligations that would include customer acceptance requirements. We do provide training and installation services to our customers and those services are billed and the revenue recognized at the end of the month the services are completed. Revenue recognized is net of sales taxes, tariffs, or duties remitted to any governmental authority.

Inventory Valuation. Our inventories are stated at the lower of cost, using the first-in, first-out (FIFO) method, or fair value. Our industry is characterized by rapid technological change, short-term customer commitments and rapid changes in demand, as well as other market considerations. We make provisions for estimated excess and obsolete inventory based on our quarterly reviews of inventory quantities on hand and the latest forecasts of product demand and production requirements from our customers. We review our inventory in detail on a quarterly basis utilizing multiple annual time horizons ranging from 24-months to 60-months. Individual part numbers that have not been used within each of the time horizons are examined by manufacturing personnel for obsolescence, excess and fair value. Parts that are not identified for common use or are unique to a former customer or application are categorized as obsolete and are discarded as part of our quarterly inventory write-down. If actual market conditions or our customers' product demands are less favorable than those projected, additional inventory write-downs may be required.

Allowance for Doubtful Accounts. Accounts receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. We determine the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer's financial condition and credit history, and current economic conditions. Receivables are written off when deemed uncollectible. Recoveries of receivables previously written off are recorded when received. The majority of the customer accounts are considered past due after the invoice becomes older than the customer's credit terms (30 days for the majority of customers). Interest is not charged on past due accounts for the majority of our customers.

Warranty Reserve. We have established a warranty reserve for rework, product warranties and customer refunds. We provide a limited warranty for a period of one year from the date of receipt of our products by our customers. Our customers may also elect to purchase an extended warranty. Our standard warranties require us to repair or replace defective products at no cost to the customer or refund the customer's purchase price. The warranty reserve is based on historical experience and analysis of specific known and potential warranty issues. The product warranty liability reflects management's best estimate of probable liability under our product warranties.

Goodwill. Goodwill is initially measured as the excess of the cost of an acquired business over the fair value of the identifiable net assets acquired. We do not amortize goodwill, but rather review our carrying value for impairment annually (January 31), and whenever an impairment indicator is identified. The goodwill impairment test involves a two-step approach. The first step is to identify if potential impairment of goodwill exists. If impairment of goodwill is determined to exist, the second step of the goodwill impairment test measures the amount of the impairment using a fair value-based approach.

Intangible Assets. Intangible assets consist of patents, trademarks, copyrights, customer relationships, and capitalized software. Intangible assets are amortized over their estimated useful lives using the straight-line method. The useful lives of the intangible assets range from 5 - 15 years.

Impairment of Long-Lived Intangible Assets. Long-lived assets, including amortizable intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be fully recoverable. These events or changes in circumstances may include a significant deterioration of operating results, changes in business plans, or changes in anticipated future cash flows. If an impairment indicator is present, we evaluate recoverability by a comparison of the carrying amount of the assets to future undiscounted cash flows expected to be generated by the assets. If the sum of the expected future undiscounted cash flows is less than the carrying amount, we would recognize an impairment loss. An impairment loss would be measured by comparing the amount by which the carrying value exceeds the fair value of the long-lived assets and intangibles.

Forward Looking Statements

This report contains 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, as amended, including, but not limited to, statements on strategy, operating forecasts, and our working capital requirements and availability. In addition, from time to time, the Company or its representatives have made or may make forward-looking statements, orally or in writing. Such . . .