Business context and reporting period
The LGL Group, Inc. filed this Form 10-K for the fiscal year ended December 31, 2019, with comparative 2018 results. LGL designs and manufactures frequency and spectrum-control components through MtronPTI and time-and-frequency instruments through PTF. Electronic components generated $30.553 million, or about 95.8%, of 2019 revenue; electronic instruments generated $1.344 million. The report was signed March 30, 2020.
Financial performance, cash flow and liquidity
| Metric | 2019 | 2018 |
|---|---|---|
| Revenue | $31.897 million | $24.870 million |
| Gross profit and margin | $12.516 million; 39.2% | $9.659 million; 38.8% |
| Operating income | $3.439 million | $1.430 million |
| Income before taxes | $3.909 million | $1.570 million |
| Income tax benefit (provision) | $(3.107) million benefit | $0.165 million provision |
| Net income | $7.016 million | $1.405 million |
| Diluted EPS | $1.41 | $0.29 |
| Cash from operating activities | $2.666 million | $1.656 million |
| Cash and cash equivalents | $12.453 million | $15.508 million |
| Working capital | $24.586 million | $24.633 million |
- Revenue rose 28.3%, primarily due to a $4.230 million increase in filter sales. Gross margin improved modestly, while operating income more than doubled; engineering, selling and administrative expense declined as a share of revenue from 33.1% to 28.4%.
- The $7.016 million net income included a substantial tax benefit from releasing a valuation allowance. The company reported a $3.107 million income tax benefit, principally reflecting a $3.344 million valuation-allowance reversal in the third quarter. Accordingly, net income growth was not solely from operating performance.
- Investing activities used $6.163 million, including $3.350 million invested in the SPAC sponsor and net purchases of marketable securities. Capital expenditures were $1.163 million. Financing activities provided $0.442 million from stock-option exercises. Cash declined by $3.055 million for the year.
- Current assets were $28.910 million and current liabilities $4.324 million, for a 6.69:1 current ratio. The filing reports no off-balance-sheet arrangements and does not show borrowings on the balance sheet; operating subsidiaries have no available bank credit facilities.
- Backlog was $21.857 million at year-end, up 24.9% from $17.506 million. Management expected to fill the year-end backlog during 2020 but cautioned that cancellations, deferrals and scope changes occur.
Material changes, outlook and risks
- Domestic revenue increased to $23.397 million from $18.673 million; international revenue increased to $8.500 million from $6.197 million. International sales represented 26.6% of 2019 revenue, mainly from Asia, including Malaysia.
- The largest customer accounted for 17.3% of revenue, versus 17.8% in 2018; the second-largest accounted for 10.0%, versus 9.1%. Four customers represented approximately 40% of year-end receivables, compared with 30% in 2018.
- Management said existing cash and operating cash generation should cover working capital and capital expenditures for the 12 months following filing, while warning that COVID-19 impacts were uncertain. By the filing date, production at the Noida, India facility had ceased under a 21-day national lockdown; the Orlando facility was treated as an essential defense and aerospace manufacturer. The filing warned that prolonged disruption could pressure subsidiary liquidity and operations.
- In November 2019, LGL invested $3.35 million in the sponsor of LGL Systems Acquisition Corp. (DFNS), a SPAC. LGL accounted for the sponsor under the equity method and recognized a $16,000 investment loss. If the SPAC did not complete a business combination within 24 months of its IPO closing, the private warrants could expire worthless and LGL could lose its investment.
- After year-end, LGL established an at-the-market offering of up to $15 million. Through the report date, it had sold 263,725 shares at an average $13.65, generating approximately $3.491 million net proceeds. Further sales could dilute shareholders.
- Management identified a material weakness in internal control over financial reporting related to accounting for the SPAC-sponsor investment, including initial conclusions on consolidation and VIE status that were later corrected. The financial statements received an unqualified audit opinion, but the auditor did not audit internal control effectiveness. Management said remediation measures were expected during 2020.
- Other key risks include dependence on the electronic-components business, cyclical end markets, customer concentration, supply-chain and raw-material constraints, competition, U.S. government procurement compliance, and the effects of the COVID-19 pandemic. LGL has not paid cash dividends since 1989 and does not expect to do so in the foreseeable future.
Important facts for investors to verify
- How much of reported earnings and future tax benefits depends on realization of deferred tax assets; the year-end net deferred tax asset was $3.307 million and the remaining valuation allowance was $0.388 million.
- Whether the material weakness remediation was implemented effectively and whether subsequent filings report any further control deficiencies or restatements.
- How much of the $21.857 million backlog converted to revenue and cash, given order cancellation and deferral risks.
- The realized performance, liquidity implications and potential loss exposure of the $3.35 million SPAC-sponsor investment, including any business-combination outcome.
- The effects of COVID-19, especially the Noida production interruption, on output, suppliers, customers, subsidiary liquidity and consolidated results.
- Further ATM share sales, resulting dilution and the use of proceeds.