(EDGAR Online via COMTEX) -- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of the Company's financial condition and results of operations should be read in conjunction with the accompanying unaudited condensed consolidated financial statements, the notes thereto and the other unaudited financial data included in this Quarterly Report on Form 10-Q. The following discussion should also be read in conjunction with the audited consolidated financial statements and the notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Company's Annual Report on Form 10-K for the year ended December 31, 2019. The terms "we," "us," "our," and the "Company" refer to The LGL Group, Inc. and unless otherwise defined herein, capitalized terms used herein shall have the same meanings as set forth in our condensed consolidated financial statements and the notes thereto.
Certain statements contained in this Quarterly Report on Form 10-Q of the Company and the Company's other communications and statements, other than historical facts, may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Company intends for all such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Exchange Act, as applicable by law. Such statements include, in particular, statements about the Company's beliefs, plans, objectives, goals, expectations, estimates, projections and intentions. These statements are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond the Company's control. The words "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," "target," "goal," and similar expressions are intended to identify forward-looking statements. All forward-looking statements, by their nature, are subject to risks and uncertainties. Therefore, such statements are not intended to be a guarantee of the Company's performance in future periods. The Company's actual future results may differ materially from those set forth in the Company's forward-looking statements. For information concerning these factors and related matters, see "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on March 30, 2020, this Quarterly Report on Form 10-Q and our other filings with the SEC. 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 on Form 10-Q. The Company does not undertake to update any forward-looking statement, except as required by law. As a result, you should not place undue reliance on these forward-looking statements.
The Company is a diversified holding company with subsidiaries engaged in the designing, manufacturing and marketing of highly-engineered, high reliability frequency and spectrum control products used to control the frequency or timing of signals in electronic circuits, and in the design of high performance Frequency and Time Reference Standards that form the basis for timing and synchronization in various applications. The Company's primary markets are aerospace and defense.
Results of Operations
Factors Which May Influence Results of Operations
We are not aware of any material trends or uncertainties, other than national economic conditions affecting our industry generally, that may reasonably be expected to have a material impact, favorable or unfavorable, on our revenues or income other than those set forth below and those listed in Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2019 and this Quarterly Report on Form 10-Q. However, due to the COVID-19 pandemic in the U.S. and globally, our business and operations have been impacted and may be further impacted.
The global outbreak of COVID-19 was declared a pandemic by the World Health Organization and a national emergency by the U.S. government in March 2020 and has negatively impacted the U.S. and global economy, disrupted global supply chains, resulted in significant travel and transport restrictions, including mandated closures and orders to "shelter-in-place," and created significant disruption of the financial markets.
As a result of the COVID-19 pandemic, the Company's operations in India were closed from March 23, 2020 and resumed limited operations on May 7, 2020 with a reduced level of staffing. By the end of June 2020, the Company's India facilities were fully staffed and operating at normal capacity. Despite the second quarter revenue decrease associated with the foregoing suspension of operations in India, the impact of the COVID-19 outbreak has not had a significant impact on the Company. Our updated 2020 annual projection shows some decline, although also not significant. However, the ultimate effect on our future results could be significant and will largely depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of COVID-19, the success of actions taken to contain or treat COVID-19, and reactions by consumers, companies, governmental entities and capital markets.
In accordance with the Department of Defense ("DoD") guidance issued in March 2020 designating the Defense Industrial Base as a critical infrastructure workforce, our U.S. production facilities have continued to operate in support of essential products and services required to meet national security commitments to the U.S. government and the U.S. military; however, facility closures or work slowdowns or temporary stoppages have occurred and could occur in the future. In addition, other countries have different practices and policies that can affect our international operations and the operations of our suppliers and customers. In some cases, our facilities are not operating under full staffing as a result of COVID-19, which could have a longer-term impact. Customer visits and representative training are being impacted by travel restrictions as a result of COVID-19, which could delay new design wins and future business with our customers.
The Company has taken measures to protect the health and safety of our employees, work with our customers to minimize potential disruptions and support our community in addressing the challenges posed by this global pandemic. The extent of the impact of the COVID-19 pandemic on our operational and financial performance, including our ability to execute our contracts in the expected timeframe, will depend on future developments, including the duration and spread of the pandemic and related actions taken by the U.S. government, state and local government officials, and international governments to prevent disease spread, all of which are uncertain and cannot be predicted.
An extended period of global supply chain disruption caused by the response to COVID-19 could impact our ability to perform on our contracts. To date, we have identified a number of suppliers that have potential delivery impacts due to COVID-19 and, if we are not able to implement alternatives or other mitigations, contract deliveries could be adversely impacted.
Delays in inspection, acceptance and payment by our customers, many of whom are teleworking, could also affect our sales and cash flows. This is particularly an issue with respect to classified work that is unable to be done remotely. Limitations on government operations can also impact regulatory approvals such as export licenses that are needed for international sales and deliveries. In addition, we could experience delays in new contract starts or awards of future work as well as the uncertain impact of contract modifications to respond to the national emergency. Government funding priorities may change as a result of the costs of COVID-19. If significant portions of our workforce are unable to work effectively, including because of illness, quarantines, absenteeism, government actions, facility closures, travel restrictions or other restrictions in connection with the COVID-19 pandemic, our operations will be impacted. We may be unable to perform fully on our contracts and our costs may increase as a result of the COVID-19 outbreak. These cost increases, including costs for employees whose jobs cannot be performed remotely, may not be fully recoverable under our contracts, or adequately covered by insurance. The impact of COVID-19 could worsen if there is an extended duration of any COVID-19 outbreak or a resurgence of COVID-19 infection in affected regions after they have begun to experience improvement.
The continued spread of COVID-19 has also led to disruption and volatility in the global capital markets, which depending on future developments could impact our capital resources and liquidity in the future. COVID-19 has also caused volatility in the equity capital markets. We are monitoring the impacts of COVID-19 on the fair value of our assets. While we do not currently anticipate any material impairments on our assets as a result of COVID-19, future changes in expectations for sales, earnings and cash flows related to intangible assets and goodwill below our current projections could cause these assets to be impaired. While these are our current assumptions, this is an emerging situation and these could change, which could affect our outlook.
As of September 30, 2020, our order backlog was $21,456,000, which is a decrease of 7.9% compared to the backlog of $23,285,000 as of September 30, 2019, and 1.8% below the backlog of $21,857,000 at December 31, 2019. The decrease reflects the Company's 2020 slower booking rate during the COVID-19 pandemic, particularly related to the avionics market, as well as higher year to date shipments despite the second quarter India operations shutdown. The backlog of unfilled orders includes amounts based on signed contracts as well as agreed letters of intent which we have determined are firm orders likely to be fulfilled in the next 12 months.
Order backlog is adjusted quarterly to reflect project cancellations, deferrals, revised project scope and cost, and sales of subsidiaries, if any. We expect to fill our entire order backlog within the next twelve months but cannot provide assurances as to what portion of the order backlog will be fulfilled in a given year.
Equity Investment in Unconsolidated Subsidiary
In November 2019, we invested $3.35 million into LGL Systems Acquisition Holdings Company, LLC, a subsidiary that serves as the Sponsor of LGL Systems Acquisition Corp /zigman2/quotes/217024998/composite DFNS -2.77% , a special purpose acquisition company, commonly referred to as a "SPAC" or a blank check company, formed for the purpose of effecting a business combination in the aerospace, defense and communications industries. Prior to a business combination, the Sponsor holds 100% of the shares of Class B convertible common stock outstanding of DFNS (the "B shares") along with 5,200,000 private warrants at a strike price of $11.50. The B shares equal 20% of the outstanding common stock of the SPAC. Upon the successful completion of an acquisition, the proforma ownership of the new company will vary depending on the business combination terms.
The Company is expected to own approximately a 43.57% interest in the Sponsor through its direct investment. Assuming the terms of the business combination are identical in capital structure as that of DFNS, the Company anticipates its economic interest will include approximately 8.7% of the SPAC's proforma equity immediately following a successful business combination. There can be no assurances that this scenario and the resulting ownership will occur, as changes may be made depending upon business combination terms.
There is no assurance that the SPAC will be successful in completing a business combination or that any business combination will be successful. The Company can lose its entire investment in the SPAC if a business combination is not completed within 24 months from the closing of the SPAC's initial public offering. If the SPAC does not complete a business combination within 24 months from the closing of the SPAC's initial public offering, the proceeds from the sale of the private warrants will be used to fund the redemption of the shares sold in the SPAC's initial public offering (subject to the requirements of applicable law), and the private warrants will expire worthless.
Three months ended September 30, 2020 compared to three months ended September 30, 2019
Consolidated Revenues and Gross Margin
Total revenues for the three months ended September 30, 2020 were $8,071,000, a decrease of $517,000, or 6.0%, from revenues of $8,588,000 for the three months ended September 30, 2019. The revenue decline resulted from a $409,000 reduction in sales of purchased products, decreased crystal and oscillator sales of $397,000 and decreased sales of time and frequency instruments of $159,000. These declines were partly offset by an increase in filter sales of $448,000. The lower sales levels reflect the production interruption from the second quarter 2020 COVID-19 related shutdown of the Company's India operations and the lag in shipments as we resumed full operations.
Consolidated gross margin, which is consolidated revenues less manufacturing cost of sales as a percentage of revenues, decreased to 35.5% for the three months ended September 30, 2020 from 41.2% for the three months ended September 30, 2019. The decrease reflects product mix changes and costs related to the avionics production work slowdown.
Operating income of $709,000 for the three months ended September 30, 2020 declined $413,000 from operating income of $1,122,000 for the three months ended September 30, 2019. This decline was primarily due to the decline in revenues and the reduction in gross margin noted above.
Other Income, Net
For the three months ended September 30, 2020, other income (expense), net was $155,000 compared to $82,000 for the three months ended September 30, 2019. These balances are primarily comprised of income from our investment portfolio.
Income Tax Expense (Benefit)
We recorded a tax expense (benefit) of $171,000 and ($3,326,000) for the three months ended September 30, 2020 and 2019, respectively. The expense is based on an estimated annual effective rate across the jurisdictions in which we operate. The benefit in the quarter ended September 30, 2019 is primarily due to release of substantially all of the valuation allowance of the Company's U.S. deferred tax assets.
Net income for the three months ended September 30, 2020 was $629,000, compared to $4,530,000 for the three months ended September 30, 2019. The decrease was largely due to the 2019 tax benefit ($3.3 million). The remaining net income decline ($0.6) reflected the lower revenue, unfavorable product mix and costs related to the avionics production slowdown. Diluted net income per share for the three months ended September 30, 2020 and 2019 was $0.12 and $0.91, respectively.
Nine months ended September 30, 2020 compared to nine months ended September 30, 2019
Consolidated Revenues and Gross Margin
Total revenues for the nine months ended September 30, 2020 were $23,748,000, an increase of $690,000, or 3.0%, from revenues of $23,058,000 for the nine months ended September 30, 2019. The revenue increase resulted from higher filter sales of $1,831,000 partly offset by decreased crystal and oscillator sales of $530,000, a $406,000 reduction in sales of purchased products and decreased sales of time and frequency instruments of $205,000. Sales growth was slowed by the production interruption from the second quarter 2020 COVID-19 related shutdown of the Company's India operations and the lag in shipments as we resumed full operations.
Consolidated gross margin, which is consolidated revenues less manufacturing cost of sales as a percentage of revenues, decreased to 34.0% for the nine months ended September 30, 2020 from 39.4% for the nine months ended September 30, 2019. The decrease reflects product mix changes and costs related to the avionics production work slowdown and the India operation shutdown during the second quarter of 2020.
For the nine months ended September 30, 2020 and 2019, stock-based compensation expense was $104,000 and $17,000, respectively. Compensation expense related to stock-based compensation is recognized over the applicable vesting periods.
Operating income of $1,553,000 for the nine months ended September 30, 2020 declined $859,000 from operating income of $2,412,000 for the nine months ended September 30, 2019. This decline was primarily due to the reduction in gross margin noted above.
Other Income, Net
For the nine months ended September 30, 2020, other income (expense), net was $3,000, compared to $352,000 for the nine months ended September 30, 2019. These balances are comprised of income from our investment portfolio partly offset by 2020 currency losses related to our India operations.
Income Tax Expense (Benefit)
We recorded a tax expense (benefit) of $282,000 and ($3,286,000) for the nine months ended September 30, 2020 and 2019, respectively. The tax expense is based on an estimated effective annual rate across the jurisdictions in which we operate. The benefit in the nine months ended September 30, 2019 is primarily due to our release of substantially all of the valuation allowance of the Company's U.S. deferred tax assets.
Net income for the nine months ended September 30, 2020 was $1,067,000 compared to $6,051,000 for the nine months ended September 30, 2019. The decrease was largely due to the tax benefit in 2019 ($3.3 million). The remaining net income decline ($1.7 million) reflected the lower margin from unfavorable product mix and cost impacts of the avionics production slowdown and second quarter India operations shutdown. Diluted net income per share for the nine months ended September 30, 2020 and 2019 was $0.21 and $1.22, respectively.
Liquidity and Capital Resources
As of September 30, 2020 and December 31, 2019, cash and cash equivalents were $17,276,000 and $12,453,000, respectively. In the first quarter of 2020, we raised approximately $3,254,000 as a result of sales of securities under our ATM Offering.
Cash provided by operating activities for the nine months ended September 30, 2020 and 2019 was $1,830,000 and $1,089,000, respectively. The $741,000 increase was primarily due to favorable changes in working capital accounts of $1,680,000 (including the impact of recent discontinuance of certain consignment inventory offerings to our customers) and deferred taxes of $3,567,000 partly offset by the Company's year-over-year decrease in net income of $4,984,000.
Cash used in investing activities for the nine months ended September 30, 2020 and 2019 was $329,000 and $5,826,000, respectively. The use of cash for the nine months ended September 30, 2020 was due to $329,000 in capital expenditures. The use of cash for the nine months ended September 30, 2019 included a $5,000,000 investment in marketable securities and capital expenditures of $826,000.
For the nine months ended September 30, 2020, the $3,322,000 of cash provided by financing activities represented $3,254,000 received by the Company from the first quarter 2020 sale of securities under our ATM Offering and $68,000 of proceeds from the exercise of stock options. For the nine months ended September 30, 2019, financing activities represented $390,000 received by the Company for the exercise of stock options.
As of September 30, 2020, our consolidated working capital was $29,564,000, compared to $24,586,000 as of December 31, 2019. As of September 30, 2020, we had current assets of $33,264,000, current liabilities of $3,700,000 and a ratio of current assets to current liabilities of 8.99 to 1.00. As of December 31, 2019, we had current assets of $28,910,000, current liabilities of $4,324,000 and a ratio of current assets to current liabilities of 6.69 to 1.00. Management continues to focus on efficiently managing working capital requirements to match operating activity levels and will seek to deploy the Company's working capital where it will generate the greatest returns.
As more fully described in Note N, Revolving Credit Agreement, to the accompanying unaudited condensed consolidated financial statements in this Quarterly Report on Form 10-Q, on May 12, 2020, MtronPTI and PTF, both operating subsidiaries of the Company, entered into a loan agreement for a revolving line of credit with Synovus Bank for up to $3.5 million bearing interest at the London Inter-bank Offered Rate (LIBOR) 30-day rate plus 2.50%, with a floor of 0.50%. The loan agreement has a maturity date of May 12, 2022 and contains certain financial covenants. Borrowings under the loan agreement are secured by all of the property of MtronPTI and PTI. At September 30, 2020, the Company had no borrowings outstanding under its revolving line of credit with Synovus Bank.
We believe that existing cash and cash equivalents, marketable securities, cash generated from operations and availability under our revolving credit agreement will provide sufficient liquidity to meet our ongoing working capital and capital expenditure requirements for the next 12 months from the date of this filing. However, we are continuing to monitor the outbreak of COVID-19 and its impact on our customers and suppliers, as well as our industry as a whole. The magnitude and duration of the pandemic and its impact on our operations and liquidity is uncertain as of the filing date of this Quarterly Report on Form 10-Q as this continues to evolve globally.
However, if the outbreak continues, such impacts could grow and become material. To the extent that our customers and suppliers continue to be impacted by the COVID-19 outbreak, such impacts could materially disrupt our business operations.
Our board of directors has adhered to a practice of not paying cash dividends. This policy takes into account our long-term growth objectives, including our anticipated investments for organic growth, potential technology acquisitions or other strategic ventures, and stockholders' desire for capital appreciation of their holdings. No cash dividends have been paid to the Company's stockholders since January 30, 1989, and none are expected to be paid for the foreseeable future.
Critical Accounting Policies
For a discussion of the Company's critical accounting policies, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2019.
Nov 12, 2020
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