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TAYD > SEC Filings for TAYD > Form 10-K on 29-Aug-2013All Recent SEC Filings

Show all filings for TAYLOR DEVICES INC

Form 10-K for TAYLOR DEVICES INC


29-Aug-2013

Annual Report


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

Cautionary Statement

The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Information in this Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this 10-K that does not consist of historical facts are "forward-looking statements." Statements accompanied or qualified by, or containing, words such as "may," "will," "should," "believes," "expects," "intends," "plans," "projects," "estimates," "predicts," "potential," "outlook," "forecast," "anticipates," "presume," "assume" and "optimistic" constitute forward-looking statements and, as such, are not a guarantee of future performance. The statements involve factors, risks and uncertainties, the impact or occurrence of which can cause actual results to differ materially from the expected results described in such statements. Risks and uncertainties can include, among others, fluctuations in general business cycles and changing economic conditions; changing product demand and industry capacity; increased competition and pricing pressures; advances in technology that can reduce the demand for the Company's products, as well as other factors, many or all of which may be beyond the Company's control. Consequently, investors should not place undue reliance on forward-looking statements as predictive of future results. The Company disclaims any obligation to release publicly any updates or revisions to the forward-looking statements herein to reflect any change in the Company's expectations with regard thereto, or any changes in events, conditions or circumstances on which any such statement is based.

Application of Critical Accounting Policies and Estimates

The Company's consolidated financial statements and accompanying notes are prepared in accordance with U.S. generally accepted accounting principles. The preparation of the Company's financial statements requires management to make estimates, assumptions and judgments that affect the amounts reported. These estimates, assumptions and judgments are affected by management's application of accounting policies, which are discussed in Note 1. "Summary of Significant Accounting Policies" and elsewhere in the accompanying consolidated financial statements. As discussed below, our financial position or results of operations may be materially affected when reported under different conditions or when using different assumptions in the application of such policies. In the event estimates or assumptions prove to be different from actual amounts, adjustments are made in subsequent periods to reflect more current information. Management believes the following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company's financial statements.

Accounts Receivable

Our ability to collect outstanding receivables from our customers is critical to our operating performance and cash flows. Accounts receivable are stated at an amount management expects to collect from outstanding balances. Management provides for probable uncollectible accounts through a charge to earnings and a credit to a valuation allowance based on its assessment of the current status of individual accounts after considering the age of each receivable and communications with the customers involved. Balances that are collected, for which a credit to a valuation allowance had previously been recorded, result in a current-period reversal of the earlier transaction charging earnings and crediting a valuation allowance. Balances that are still outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable in the current period. The actual amount of accounts written off over the five year period ended May 31, 2013 equaled less than 0.1% of sales for that period. The balance of the valuation allowance remained constant since May 31, 2009 at the current level of $42,000. Management does not expect the valuation allowance to materially change in the next twelve months for the current accounts receivable balance.

Inventory

Inventory is stated at the lower of average cost or market. Average cost approximates first-in, first-out cost.

Maintenance and other inventory represent stock that is estimated to have a product life-cycle in excess of twelve-months. This stock represents certain items the Company is required to maintain for service of products sold, and items that are generally subject to spontaneous ordering.

This inventory is particularly sensitive to technical obsolescence in the near term due to its use in industries characterized by the continuous introduction of new product lines, rapid technological advances and product obsolescence. Therefore, management of the Company has recorded an allowance for potential inventory obsolescence. Based on certain assumptions and judgments made from the information available at that time, we determine the amount in the inventory allowance. If these estimates and related assumptions or the market changes, we may be required to record additional reserves. Historically, actual results have not varied materially from the Company's estimates.

The provision for potential inventory obsolescence was $180,000 for each of the years ended May 31, 2013 and 2012.

Revenue Recognition

Sales are recognized when units are delivered or services are performed. Sales under fixed-price contracts are recorded as deliveries are made at the contract sales price of the units delivered. Sales under certain fixed-price contracts requiring substantial performance over several periods prior to commencement of deliveries, are accounted for under the percentage-of-completion method of accounting whereby revenues are recognized based on estimates of completion prepared on a ratio of cost to total estimated cost basis. Costs include all material and direct and indirect charges related to specific contracts. Other expenses are charged to operations, as incurred. Total estimated costs for each of the contracts are estimated based on a combination of historical costs of manufacturing similar products and estimates or quotes from vendors for supplying parts or services towards the completion of the manufacturing process. Adjustments to cost and profit estimates are made periodically due to changes in job performance, job conditions and estimated profitability, including those arising from final contract settlements. These changes may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Any losses expected to be incurred on contracts in progress are charged to operations in the period such losses are determined. If total costs calculated upon completion of the manufacturing process in the current period for a contract are more than the estimated total costs at completion used to calculate revenue in a prior period, then the revenue and profits in the current period will be lower than if the estimated costs used in the prior period calculation were equal to the actual total costs upon completion. Historically, actual results have not varied materially from the Company's estimates. In the fiscal year ended May 31, 2013, 58% of total revenue recognized was accounted for using the percentage-of-completion method of accounting while the remaining 42% of revenue was recorded as deliveries were made to our customers. In the fiscal year ended May 31, 2012, 77% of total revenue recognized was accounted for using the percentage-of-completion method of accounting while the remaining 23% of revenue was recorded as deliveries were made to our customers.

For financial statement presentation purposes, the Company nets progress billings against the total costs incurred on uncompleted contracts. The asset, "costs and estimated earnings in excess of billings," represents revenues recognized in excess of amounts billed. The liability, "billings in excess of costs and estimated earnings," represents billings in excess of revenues recognized.

Income Taxes

The provision for income taxes provides for the tax effects of transactions reported in the financial statements regardless of when such taxes are payable. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the tax and financial statement basis of assets and liabilities. The deferred tax assets relate principally to asset valuation allowances such as inventory obsolescence reserves and bad debt reserves and also to liabilities including warranty reserves, accrued vacation, accrued commissions and others. The deferred tax liabilities relate primarily to differences between financial statement and tax depreciation. Deferred taxes are based on tax laws currently enacted with tax rates expected to be in effect when the taxes are actually paid or recovered.

Realization of the deferred tax assets is dependent on generating sufficient taxable income at the time temporary differences become deductible. The Company provides a valuation allowance to the extent that deferred tax assets may not be realized. A valuation allowance has not been recorded against the deferred tax assets since management believes it is more likely than not that the deferred tax assets are recoverable. The Company considers future taxable income and potential tax planning strategies in assessing the need for a potential valuation allowance. In future years the Company will need to generate approximately $3.1 million of taxable income in order to realize our deferred tax assets recorded as of May 31, 2013 of $1,063,000. This deferred tax asset balance is 12% ($112,000) higher than at the end of the prior year. The amount of the deferred tax assets considered realizable however, could be reduced in the near term if estimates of future taxable income are reduced. If actual results differ from estimated results or if the Company adjusts these assumptions, the Company may need to adjust its deferred tax assets or liabilities, which could impact its effective tax rate. Historically, actual results have not varied materially from the Company's estimates.

The Company's practice is to recognize interest related to income tax matters in interest income / expense and to recognize penalties in selling, general and administrative expenses.

The Company and its subsidiary file consolidated Federal and State income tax returns. As of May 31, 2013, the Company had State investment tax credit carryforwards of approximately $142,000 expiring through May 2019.

Results of Operations

A summary of the period to period changes in the principal items included in the consolidated statements of income is shown below:

Summary comparison of the years ended May 31, 2013 and 2012

                                                 Increase /
                                                 (Decrease)
                                   Sales, net   $ (4,277,000)
                           Cost of goods sold   $ (4,175,000)
 Selling, general and administrative expenses   $   (682,000)
     Income before provision for income taxes    $    511,000
                   Provision for income taxes    $    162,000
                                   Net income    $    349,000

For the year ended May 31, 2013 (All figures being discussed are for the year ended May 31, 2013 as compared to the year ended May 31, 2012.)

                                     Year ended May 31             Change
                                     2013        2012        Amount      Percent
                      Net Revenue $24,730,000 $29,007,000 $(4,277,000 )   -15%
                    Cost of sales  15,966,000  20,141,000  (4,175,000 )   -21%
                     Gross profit $ 8,764,000 $ 8,866,000 $  (102,000 )    -1%

as a percentage of net revenues 35% 31%

The Company's consolidated results of operations showed a 15% decrease in net revenues and an increase in net income of 16%. Gross profit decreased by 1%. Revenue in the prior year was bolstered by record high shipments of Taylor Devices' Seismic Dampers, largely to Asia. Last year's increase in demand for these products had been influenced by major earthquakes in Asia over the past several years. In the current period, revenues accounted for under the percentage-of-completion method of accountingdecreased by 35% from the level recorded in the prior year. This decrease is primarily due to less projects in process in the current year (59 in fiscal 2013; 75 in fiscal 2012). Of the 59 projects in process during this year, 16 were still in process at 5/31/13 compared with the prior year when 28 of the 75 projects worked on were still in process at 5/31/12. The average value of these projects in-process at the end of the current fiscal year ($415,000) decreased by 42% from the projects in-process at the end of the prior fiscal year ($715,000). The projects in the current year are 52% complete in the aggregate as compared with 61% for those in process at 5/31/12. Revenues recorded for all other product sales increased by 55% from last year. This fluctuation is attributable primarily to an increase in sales to customers in aerospace and defense from the prior year. The gross profit as a percentage of net revenues for the current and prior year periods was 35% and 31%, respectively.

The mix of customers buying our products changed from last year. Sales of the Company's products are made to three general groups of customers: industrial, construction and aerospace / defense. A 32% decrease in sales to construction customers who were seeking seismic / wind protection for either building new buildings and bridges or retrofitting existing buildings and bridges from last year's level was offset, somewhat, by a 24% increase in sales to aerospace / defense customers and a 33% increase in sales to customers using our products in industrial applications. A breakdown of sales to these three general groups of customers is as follows:

Year ended May 31

                      2013      2012
         Industrial    10%       6%
       Construction    57%       71%
Aerospace / Defense    33%       23%

At May 31, 2012, we had 151 open sales orders in our backlog with a total sales value of $17.5 million. At May 31, 2013, we had 108 open sales orders in our backlog and the total sales value is $13.1 million. $3.2 million of the current backlog is on projects already in progress. $8.0 million of the $17.5 million sales order backlog at May 31, 2012 was in progress at that date. 59% of the sales value in the backlog is for aerospace / defense customers compared to 38% at the end of fiscal 2012. As a percentage of the total sales order backlog, orders from customers in construction accounted for 38% at May 31, 2013 and 67% at May 31, 2012.

The Company's backlog, revenues, commission expense, gross margins, gross profits, and net income fluctuate from period to period. The changes in the current period, compared to the prior period, are not necessarily representative of future results.

Net revenue by geographic region, as a percentage of total net revenue for fiscal years ended May 31, 2013 and 2012 is as follows:

Year ended May 31

                2013      2012
North America    55%       40%
         Asia    41%       54%
        Other    4%        6%

Selling, General and Administrative Expenses



                                    Year ended May 31            Change
                                     2013       2012       Amount      Percent
              Outside Commissions $  858,000 $1,228,000 $  (370,000 )   -30%
                       Other SG&A  4,439,000  4,751,000    (312,000 )    -7%

Total SG&A $5,297,000 $5,979,000 $ (682,000 ) -11% as a percentage of net revenues 21% 21%

Selling, general and administrative expenses decreased by 11% from the prior year. Outside commission expense decreased 30% from last year's level. This fluctuation was primarily due to the decrease in the level of sales from last year to this. Other selling, general and administrative expenses decreased by 7% from last year. This decrease is primarily attributable to a decrease in estimated employee incentive compensation expense in the current period related to the lower level of sales.

The above factors resulted in operating income of $3,467,000 for the year ended May 31, 2013, up 20% from the $2,887,000 in the prior year.

The Company's effective tax rate (ETR) is calculated based upon current assumptions relating to the year's operating results and various tax related items. The ETR for the fiscal year ended May 31, 2013 is 26.4%, slightly more than the ETR for the prior year of 25.4%. A reconciliation of provision for income taxes at the statutory rate to income tax provision at the Company's effective rate is as follows:

                                                             2013                2012
Computed tax provision at the expected statutory rate    $1,176,000           $1,003,000
State income tax - net of Federal tax benefit                (3,000 )              2,000
Tax effect of permanent differences:
Research tax credits                                       (213,000 )           (207,000 )
Other permanent differences                                 (30,000 )            (27,000 )
Other                                                       (18,000 )            (21,000 )
                                                         $  912,000           $  750,000

Stock Options

The Company has stock option plans which provides for the granting of nonqualified or incentive stock options to officers, key employees and non-employee directors. Options granted under the plans are exercisable over a ten year term. Options not exercised by the end of the term expire.

The Company measures compensation cost arising from the grant of share-based payments to employees at fair value and recognizes such cost in income over the period during which the employee is required to provide service in exchange for the award. The Company recognized $110,000 and $117,000 of compensation cost for the years ended May 31, 2013 and 2012.

The fair value of each stock option grant has been determined using the Black-Scholes model. The model considers assumptions related to exercise price, expected volatility, risk-free interest rate, and the weighted average expected term of the stock option grants. The Company used a weighted average expected term. Expected volatility assumptions utilized in the model were based on volatility of the Company's stock price for the thirty month period immediately preceding the granting of the options. The Company issued stock options in August 2012 and April 2013. The risk-free interest rate is derived from the U.S. treasury yield.

The following assumptions were used in the Black-Scholes model in estimating the fair market value of the Company's stock option grants:

                                                                              August 2012   April 2013
                                                   Risk-free interest rate:     1.875%        2.375%
                                              Expected life of the options:    2.9 years    2.9 years
                                           Expected share price volatility:       43%          44%
                                                        Expected dividends:      zero          zero
These assumptions resulted in estimated fair-market value per stock option:      $2.46        $2.47


The ultimate value of the options will depend on the future price of the
Company's common stock, which cannot be forecast with reasonable accuracy. A
summary of changes in the stock options outstanding during the year ended May
31, 2013 is presented below.

                                                                     Weighted-
                                                       Number of      Average
                                                        Options    Exercise Price
Options outstanding and exercisable at May 31, 2012:     163,750       $6.30
                                    Options granted:      44,500       $7.84
                              Less: Options expired:       1,500       $6.17
Options outstanding and exercisable at May 31, 2013:     206,750       $6.63
  Closing value per share on NASDAQ at May 31, 2013:                   $8.07

Capital Resources, Line of Credit and Long-Term Debt

The Company's primary liquidity is dependent upon its working capital needs. These are primarily inventory, accounts receivable, costs and estimated earnings in excess of billings, accounts payable, accrued commissions, billings in excess of costs and estimated earnings, and debt service. The Company's primary sources of liquidity have been operations and bank financing.

Capital expenditures for the year ended May 31, 2013 were $3,293,000 compared to $1,550,000 in the prior year. The Company has commitments to make capital expenditures of $496,000 as of May 31, 2013. These purchases are related to the substantial renovation of the new buildings acquired in the fiscal year ended May 31, 2012, as discussed in item 2, above.

The Company has a $6,000,000 demand line of credit from a bank, with interest payable at the Company's option of 30, 60, 90 or 180 day LIBOR rate plus 2.5% or the bank's prime rate less .25%. There is no outstanding balance at May 31, 2013. There was a $258,000 principal balance outstanding as of May 31, 2012. The outstanding balance on the line of credit fluctuates as the Company's various long-term projects progress. The line is secured by accounts receivable, equipment, inventory, and general intangibles, and a negative pledge of the Company's real property. This line of credit is subject to the usual terms and conditions applied by the bank and is subject to renewal annually. In conjunction with this line of credit, the Company agreed to the following covenants:

             Covenant                 Minimum per Covenant   Current Actual    When Measured
Minimum level of working capital           $3 million        $13.8 million       Quarterly
Minimum debt service coverage ratio          1.5:1                64:1        Fiscal Year-end

The bank is not committed to make loans under this line of credit and no commitment fee is charged.

The level of cash and cash equivalents has increased significantly from May 31, 2012 ($74,000) to May 31, 2013 ($1,998,000). This increase was due to a record high net income along with the changes in the assets and liabilities as itemized in the consolidated statements of cash flow. The assets that decreased the most from last year to this were accounts receivable and costs and estimated earnings in excess of billings. These changes are discussed below. The Company believes that cash on hand combined with the line of credit should be sufficient to fund its expansion plans described in Item 2 of this Report.

Inventory and Maintenance Inventory

                                  May 31, 2013     May 31, 2012   Increase /(Decrease)
                  Raw materials  $  583,000      $  622,000          ($   39,000 )  -6%
                Work in process   7,876,000       7,112,000              764,000    11%
                 Finished goods     665,000         638,000               27,000    4%
                      Inventory   9,124,000 91%   8,372,000 91%          752,000    9%
Maintenance and other inventory     904,000 9%      845,000 9%            59,000    7%

Total $10,028,000 100% $9,217,000 100% $ 811,000 9%

Inventory turnover 1.7 2.7

Inventory, at $9,124,000 as of May 31, 2013, is 9% higher than the prior year-end. Of this, approximately 86% is work in process, 7% is finished goods, and 7% is raw materials. All of the current inventory is expected to be consumed or sold within twelve months. The level of inventory will fluctuate from time to time due to the stage of completion of the non-project sales orders in progress at the time.

The Company continues to rework slow-moving inventory, where applicable, to convert it to product to be used on customer orders. There was approximately $149,000 of slow-moving inventory used during the year ended May 31, 2013. The Company disposed of approximately $268,000 and $26,000 of obsolete inventory during the years ended May 31, 2013 and 2012, respectively.

Accounts Receivable, Costs and Estimated Earnings in Excess of Billings ("CIEB) and Billings in Excess of Costs and Estimated Earnings (BIEC")

                                     May 31, 2013    May 31, 2012      Increase /(Decrease)
               Accounts receivable    $ 2,245,000     $5,610,000       $(3,365,000 )    -60%
                              CIEB      2,458,000      5,492,000        (3,034,000 )    -55%
                        Less: BIEC        172,000        669,000          (497,000 )    -74%
                               Net    $ 4,531,000    $10,433,000       $(5,902,000 )    -57%

  Number of an average day's sales
outstanding in accounts receivable
                             (DSO)       39              52

The Company combines the totals of accounts receivable, the asset CIEB, and the liability BIEC, to determine how much cash the Company will eventually realize from revenue recorded to date. As the accounts receivable figure rises in relation to the other two figures, the Company can anticipate increased cash receipts within the ensuing 30-60 days.

Accounts receivable of $2,245,000 as of May 31, 2013 includes approximately $355,000 of amounts retained by customers on long-term construction projects. This retained amount is almost 25% of the amount retained as May 31, 2012. The decrease is simply due to contractual requirements of certain open projects at the year ends. The Company expects to collect all of these amounts, including the retained amounts, during the next twelve months. The number of an average day's sales outstanding in accounts receivable (DSO) decreased from 52 days at May 31, 2012 to 39 days at May 31, 2013. The DSO is a function of 1.) the level of sales for an average day (for example, total sales for the past three months divided by 90 days) and 2.) the level of accounts receivable at the balance sheet date. The level of sales for an average day in the fourth quarter of the current year is just over half of the level in the fourth quarter of the prior year. This is consistent with the overall decrease in revenue for the quarter from the historic high of $9,643,000 last year to $5,152,000 this year. The level of accounts receivable at the end of the current year is 60% less than at the end of the prior year. The combination of these two factors caused the DSO to decrease from last year end to this. The decrease in the level of accounts receivable was due to: a.) the decrease in retained amounts on projects, as discussed above and b.) a significant decrease (92%) in the amount of billings to customers on projects in May 2013 over May 2012.

The status of the projects in-progress at the end of the current and prior fiscal years have changed in the factors affecting the year-end balances in the asset CIEB, and the liability BIEC:

                                                          2013     2012
             Number of projects in progress at year-end    16       28
                 Aggregate percent complete at year-end   52%      61%

Average total value of projects in progress at year-end $415,000 $715,000 . . .
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