ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Summary
The Company has historically operated two business segments: 1) indicators and gauges that sell primarily to companies in the aircraft and locomotive industries and 2) automotive diagnostic tools and equipment that sell to OEMs and the aftermarket. In fiscal year 2016, there were two significant events that occurred:
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In July 2016, the Company expanded its markets with the acquisition of Federal Hose Manufacturing LLC (“Federal Hose”). Federal Hose manufactures flexible metal hose for use in heavy truck, drilling, and grain handling, as well as silicone hose sold to these same industries. The acquisition of this business resulted in a new segment for the Company.
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The Company was awarded a favorable legal settlement in the amount of $2,270,567 (after legal fees) for claims against BP Exploration & Product, Inc. for damages arising out of the BP Deepwater Horizon Oil Disaster.
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Introduction
The Company has been focused on tools for automotive servicers for about 30 years. In the automotive business, initially, tools developed for OEM dealership technicians were essentially all the Company’s offerings and in the late 1990s over 80% of the Company’s automotive business was concentrated in tools for two OEM dealerships. In the late 1990s, the Company perceived a change in OEM policies that was of concern relative to future business expectations. In 1998, the Company acquired Waekon Industries, an automotive aftermarket business, that expanded the Company's sales channels and product offering in the aftermarket markets, and the Company began to emphasize diversification into these markets. In addition, the Company began to offer several of the tools developed for OEMs to the aftermarket. One in particular, the NGS scan tool for Ford vehicles, became extremely successful and represented a substantial part of aftermarket sales until about 2008. In 2008, Ford began offering their replacement for NGS to the aftermarket and the Company's NGS sales began to decline. Although other aftermarket tools developed by the Company were a growing revenue source, the decline in NGS sales resulted in a net decline in aftermarket sales.
As an outgrowth of the Waekon acquisition, the Company also developed several unique devices for use in vehicle emissions testing programs mandated by the Environmental Protection Agency and applied for patent protection. In the intervening years, the Company continued to receive large orders for OEM tools and the emissions testing products that caused aftermarket sales to remain less than 50% of total automotive product sales. In fiscal 2016, approximately 30% of the Company’s automotive diagnostic tool revenue was from aftermarket customers and 70% was from OEM and emissions customers. Aftermarket revenue decreased to $1,082,000 in fiscal 2016 from approximately $1,287,000 in fiscal 2015.
During the past several years, the Company eliminated a number of unprofitable aftermarket products, re-developed and re-introduced a number of older products, and introduced a number of new aftermarket products. In addition, the Company renewed its emphasis on OEMs as a revenue source, but focused on working with the Tier 1 suppliers. In 2015 and 2014, this focus on the Tier 1 suppliers resulted in several large orders in addition to increases in the small order business for other tools used by the OEM dealerships aided results in those years. In 2016, there were several large orders from Tier 1 suppliers; however, general demand for the OEM business was down in 2016. The OEM business is a large order business and depending on OEM needs and timing, it can vary significantly from year to year.
Emissions products have largely become a replacement business sold through automotive aftermarket distribution channels, but there still may be occasional opportunities for larger orders as certain states expand emissions testing programs. Recently the State of Pennsylvania announced a new program that will be implemented in 2017 and early 2018. The Company believes that significant orders for emissions products may result from this program. The net result of these business developments over time is that the automotive business distinction between aftermarket, OEM, and emissions has become less clear, but the Company’s expertise applies to each of these automotive markets. In 2016, automotive products were 56% of the Company’s revenue and management believes there is a significant opportunity for growth in these products.
The Company has offered products for government sponsored emissions testing programs for a number of years. The Company also developed a product to test for leaks in vehicle evaporative systems (gas tanks). The Company has patents for both of these technologies and has been involved in a lawsuit with a company that infringed on our patents for these products. In December 2016, the Company settled the lawsuit.
Development efforts are divided between aftermarket and OEM projects. When OEM opportunities arise they require significant development resources and often slow development of aftermarket products for a period of time. During 2016, demands on the Company’s development resources resulted in essentially no new product introductions in the aftermarket. One of the products introduced in fiscal 2015 called AutoWave has been successful.
During 2016, the Company modified several automotive products and introduced them to non-automotive service technicians in an effort to develop a new market. The initiative was unsuccessful in producing significant sales thus far. During 2014, the Company revamped its website to better support product sales. Since then, there have been major changes in how search engines determine the positioning of a website in their search results. The Company is in a continuing process of modifying its web pages to optimize positioning in search engine results. The Company continues to expand the use of social media and videos to explain the benefits of its products. Products are sold by several Internet distributors such as Amazon and EBay, and sales through this type of distributor have continued to grow. The Company plans to continue its emphasis on expansion of the use of internet distributors and electronic media in fiscal 2017.
The timing of order releases and large program implementations in the Company's automotive diagnostic equipment and emissions businesses can cause wide fluctuations in the Company's operating results, both on a quarter-to-quarter and a year-to-year basis. Orders for such equipment can be large, are subject to customer schedules, and may result in substantial variations in quarterly and yearly sales and earnings. The Company’s indicator product revenue decreased 8%, 13%, and 10% in fiscal 2016, 2015, and 2014, respectively. The continued year to year decrease was primarily a result of decreased customer orders of government funded programs for the military. The percentage decreases were due to lower indicator sales and increased automotive sales due to large OEM orders. The Company anticipates indicator sales will continue at current levels into the foreseeable future unless the military sales improve. Management feels that resources dedicated to this segment are adequate at the present time.
On July 1, 2016, Hickok Incorporated completed the acquisition of Federal Hose. In accordance with the Merger Agreement, the Company issued 911,250 validly issued, fully paid and non-assessable Class A Common Shares, without par value, and 303,750 validly issued, fully paid and non-assessable Class B Common Shares, without par value, to First Francis Company, Inc. as consideration at the closing of the merger. The Company also issued to First Francis Company Inc. a promissory note in the principal amount of $2,768,662 and a promissory note in the principal amount of $2,000,000, each of which is secured by all the assets of Hickok and certain of its subsidiaries, bears interest at a rate of 4.0% per annum, is amortized over a ten year period, and will be fully due six years after the issue date. These promissory notes contain customary provisions regarding acceleration of the Company’s obligations as a result of an event of default.
Expense Control
Management continues to monitor its expense reduction initiatives implemented and revised from time to time. The Company recently reduced employee count and expenses and replaced several internal functions with external service providers. The Company currently has no plans to add resources in fiscal 2017 unless revenue opportunities warrant such an increase. Management believes its strategy to improve revenue and profitability along with the acquisition of Federal Hose will aid results in fiscal 2017.
Reportable Segment Information
The Company is required to report segment information disclosures based on how management evaluates operating performance and resource allocations. The Company has determined that it has three reportable segments: 1) indicators and gauges, 2) automotive related diagnostic tools and equipment, and 3) flexible metal hose and silicone hose.
Indicators and Gauges
This segment consists of products manufactured and sold primarily to companies in the aircraft and locomotive industry. Within the aircraft market, the primary customers are those companies that manufacture or service business, military and pleasure aircraft. Within the locomotive market, indicators and gauges are sold to original equipment manufacturers, servicers of locomotives, and operators of railroad equipment.
Automotive Diagnostic Tools and Equipment
This segment consists primarily of products designed and manufactured to support the testing or servicing of automotive and truck systems using electronic means to measure vehicle parameters. These products are sold to OEMs and to the aftermarket using several brand names and a variety of distribution methods. Included in this segment are products used for state required testing of vehicle emissions.
Flexib
le Metal Hose and Silicone Hose
This segment, acquired July 1, 2016, consists primarily of flexible metal hose manufactured with a variety of metals and silicone rubber hoses that the Company purchases for resale to customers. These products are sold using a variety of distribution methods to heavy truck OEMs and aftermarket distributors for use primarily in the exhaust systems of trucks. The hoses are also sold to customers for use in petrochemical drilling operations and bulk material
handling in a variety of markets.
Results of Operations
Sales for the fiscal year ended September 30, 2016 increased to $6,645,780, an increase of approximately 14% from fiscal 2015 sales of $5,852,924. This increase in sales was primarily attributable to higher product sales of approximately $810,000. Service sales in fiscal 2016 decreased by approximately $17,000 to $228,020 compared to fiscal 2015 due to lower volume. Product sales were $6,417,760 in fiscal 2016 compared to $5,608,218 in fiscal 2015. This increase in sales was volume-driven and attributable primarily to a $1,761,000 increase of sales in flexible metal hose and silicone hose manufactured and distributed by Federal Hose Manufacturing LLC which was acquired on July 1, 2016, offset by decreases in product sales in both the indicator and gauge segment and the automotive diagnostic products segment. Within the automotive diagnostic products, OEM product sales decreased approximately $766,000 and aftermarket product sales decreased approximately $204,000 and was volume driven, offset in part by an increase in emission product sales of approximately $130,000. Sales of indicator products declined by approximately $111,000 and was volume related. Fiscal 2015 benefited from a large order from a Tier 1 Supplier to a large OEM with no similar order in 2016. The decrease in service sales in fiscal 2016 was volume related and attributable to lower chargeable repair sales.
Sales for the fiscal year ended September 30, 2015 decreased to $5,852,924, a decrease of approximately 7% from fiscal 2014 sales of $6,305,836. This decrease in sales was volume-driven and attributable primarily to lower product sales of approximately $470,000. Service sales in fiscal 2015 increased by approximately $17,000 to $244,706 compared to fiscal 2014 due to volume. Product sales were $5,608,218 in fiscal 2015 compared to $6,078,349 in fiscal 2014. The decrease in product sales occurred in both the indicator and gauge segment and the automotive diagnostic products segment. Within the automotive diagnostic products, OEM products sales decreased approximately $514,000 and emission products sales decreased approximately $31,000, offset by an increase in aftermarket products of approximately $236,000. Sales of indicator products decreased in fiscal 2015 by approximately $162,000 and was volume related due primarily to decreased military indicator movement orders. Both fiscal 2015 and 2014 benefited from a large order from a Tier 1 Supplier to a large OEM. The increase in service sales in fiscal 2015 was volume related and attributable to higher chargeable repair sales.
Cost of products sold in fiscal 2016 was $4,181,341 or 65% of net product sales compared to $3,017,837 or 54% of net product sales in fiscal 2015. Cost of products sold during fiscal 2014 was $3,462,092 or 57% of net product sales. The dollar and percentage increase in the cost of products sold to product sales between fiscal 2016 and 2015 was due primarily to product mix and cost specifics of the products sold as the acquisition of the flexible metal hose and silicone hose segment on July 1, 2016 represents 26% of the sales for the fiscal year 2016. The dollar and percentage decrease in the cost of products sold to product sales between fiscal 2015 and 2014 was due primarily to product mix and cost specifics of the products sold. In addition, the lower sales volume of product sales contributed to the lower dollar amount of cost of product sold between fiscal 2015 and 2014.
Cost of services sold in fiscal 2016 was $153,474 or 67% of net service sales compared to $150,466 or 61% respectively in fiscal 2015. Cost of services sold during fiscal 2014 was $149,068 or 66% of net service sales. The dollar and percentage increase between fiscal 2016 and 2015 was due primarily to product specific technical issues of the chargeable repairs in fiscal 2016. The percentage decrease between fiscal 2015 and 2014 was due primarily to product specific technical issues of the chargeable repairs in fiscal 2015.
Product development expenditures in fiscal 2016 were $1,050,157 or 16% of product sales compared to $1,015,414 or 18%, respectively, in fiscal 2015. Product development expenditures during fiscal 2014 were $965,975 or 16% of product sales. The percentage decrease between fiscal 2016 and 2015 was due primarily to the increase in sales volume during 2016. The dollar increase was primarily in labor costs professional fees and depreciation of approximately $34,000, $4,000 and $1,000 respectively, offset in part by a decrease in travel expense and research and experimental material of approximately $3,000 and $2,000 respectively. The percentage increase between fiscal 2015 and fiscal 2014 was due primarily to the decrease in sales volume during fiscal 2015. The dollar increase was primarily in labor costs and depreciation of approximately $55,000 and $4,000 respectively, offset in part by a decrease in research and experimental material of approximately $12,000. Management believes current resources will be sufficient to maintain current product development commitments and to continue to develop a reasonable flow of new diagnostic products for both the OEM and aftermarket customers.
Marketing and administrative expenses amounted to $2,145,937 which was 32% of net sales in fiscal 2016, $1,798,960 or 31% of net sales in fiscal 2015 and $1,728,107 or 27% of net sales in fiscal 2014. Expenditures in fiscal 2016 were approximately 19% higher than the amount spent in fiscal 2015. Approximately 66% of the dollar increase, or $229,887 represents marketing and administrative expenses incurred by Federal Hose which was acquired on July 1, 2016. Product sales other than Federal Hose sales declined during fiscal 2016 contributing to the percentage increase. Marketing expenses were approximately $820,000 in fiscal 2016 compared to $729,000 a year ago. Marketing expenditures related to Federal Hose amounted to approximately $98,000 during fiscal 2016. Within marketing expenses, increases were primarily in labor costs of $71,000, freight expense of $19,000, commissions of $15,000, credit and collection expense of $12,000 and travel of $8,000. The increases were offset in part by decreases in royalty expense of $34,000 and advertising expense of $6,000. Administrative expenses were approximately $1,326,000 during the current fiscal year compared to $1,070,000 a year ago. Administrative expenditures related to Federal Hose amounted to approximately $131,000 during fiscal 2016. The dollar increase was due primarily to increases in labor costs of $72,000, professional fees of $71,000, depreciation expense of $69,000, data processing of $23,000, repairs and maintenance costs of $8,000, travel expense of $3,000 and rent machinery and equipment of $2,000.
The percentage increase in fiscal 2015 compared to fiscal 2014 was due to the decrease in total net sales between fiscal 2015 and 2014. Marketing expenses were approximately $729,000 in fiscal 2015 compared to $712,000 in fiscal 2014. Within marketing expenses, decreases were primarily in royalty expense of $51,000, outside consulting of $6,000 and promotion expense of $6,000. The decreases were offset by an increase in advertising expense of $28,000, labor costs of $22,000, collection expense of $22,000, commissions of $3,000 and travel expense of $3,000. Administrative expenses were approximately $1,070,000 during the2015 fiscal year compared to $1,017,000 in fiscal 2014. The dollar increase was due primarily to increases in professional fees of $23,000, labor costs of $21,000, data processing of $12,000, repairs and maintenance costs of $4,000 and depreciation expense of $3,000. The increases were offset in part by decreases in rent machinery and equipment of $8,000 and travel expense of $2,000.
Interest charges were $59,386 in fiscal 2016 compared with $657 in fiscal 2015 and $6,592 in fiscal 2014. The current year interest expense is primarily due to the recording of interest expense of $47,556 on notes payable related to the acquisition of Federal Hose Manufacturing LLC on July 1, 2016, lease payable related to the IT infrastructure replacement of approximately $8,250, revolving note payable - related party of approximately $2,889 and convertible note payable of approximately $691. Interest charges of $657 in fiscal 2015 were due to the recording of interest on the convertible note payable. Interest expense in fiscal 2014 was primarily due to the recording of interest expense on the short-term demand notes of approximately $6,364.
The legal settlement in fiscal 2016 was $2,270,567 and represents the proceeds received (after legal fees) for claims against BP Exploration & Product, Inc. for damages arising out of the BP Deepwater Horizon Oil Disaster. The settlement funds are for economic and property damages that were the result of the 2010 explosion on the Deepwater Horizon Oil Rig and subsequent oil spill in the Gulf of Mexico.
Other income was $7,196 in fiscal 2016 compared with $8,033 in fiscal 2015 and $14,374 in fiscal 2014. Other income consists primarily of interest income on cash and cash equivalents and proceeds from the sale of scrap metal shavings. The decrease in fiscal 2016 compared to fiscal 2015 was due primarily to a decrease in the sale of scrap metal shavings of approximately $650. The decrease in fiscal 2015 compared to fiscal 2014 was due primarily to a decrease in the sale of scrap metal shavings of approximately $6,000.
Income taxes in fiscal 2016 were a negative $3,299,600, representing a tax benefit resulting from a decrease in the valuation allowance on deferred income taxes of $3,330,600. Income taxes in fiscal 2015 were $0 which includes an increase in the valuation allowance on deferred income taxes of $82,200. Income taxes in fiscal 2014 were $0 which includes an increase in the valuation allowance on deferred income taxes of $44,400. It is anticipated that the effective tax rate in the near future will be similar to 2016 as the Company believes it will be able to utilize the majority of the net operating loss and research and development credit carryforwards before they expire. The deferred tax benefits begin to expire in fiscal 2018 and are available through 2036 (see footnote 10 to the consolidated financial statements).
The net income in fiscal 2016 was $4,632,848, or $2.38 per share as compared to the net loss of $122,377, or $0.07 per share in fiscal 2015. Net income in fiscal 2014 was $8,376, or $0.01 per share. The increase in net income in fiscal 2016 versus fiscal 2015 was primarily due to the decrease of the valuation allowance on the deferred tax asset of $3,330,600 and the legal settlement for claims against BP Exploration & Product, Inc. for damages arising out of the BP Deepwater Horizon Oil Disaster of $2,270,567. The decrease in net income in fiscal 2015 versus fiscal 2014 was primarily due to a lower sales volume and higher operating expenses.
The Company has available a net operating loss carryforward of approximately $3,800,000 and research and development credit carryforwards of approximately $2,000,000 that begin to expire in fiscal 2018. The Company's deferred tax asset of $3,830,600 has been offset by a valuation allowance of $500,000. Because of the uncertainties involved with this significant estimate, it is reasonably possible that the Company's estimate may change.
Liquidity and Capital Resource
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Current assets of $7,766,817 at September 30, 2016 were 3.3 times current liabilities and the total of cash and cash equivalents and receivables was 1.9 times current liabilities. These ratios compare to 5.1 and 2.1 respectively at the end of fiscal 2015. Cash and cash equivalents were $3,060,734 at September 30, 2016 and $346,405 at September 30, 2015. Total current assets increased by approximately $4,280,000 from the previous year end due primarily to an increase in cash and cash equivalents, inventory and accounts receivable of approximately $2,714,000, $1,382,000 and $253,000, respectively. The increases were offset by a decrease in prepaid expenses of approximately $69,000. The increase in cash and cash equivalents was due primarily to the receipt of the legal settlement from BP Exploration & Product, Inc. for damages arising out of the BP Deepwater Horizon Oil Disaster. The increase in inventory and accounts receivable was due primarily to the acquisition of Federal Hose on July 1, 2016 which increased the sales volume in the last quarter of fiscal year 2016. The decrease in prepaid expenses was due primarily to timing.
Working capital at September 30, 2016 was $5,418,867 as compared to $2,796,806 a year ago. The increase of approximately $2,622,000 was due primarily to an increase in cash and cash equivalents, inventory and accounts receivable of approximately $2,714,000, $1,382,000 and $253,000, respectively offset in part by increases in leases and notes payable, notes payable related party, trade accounts payable, accrued payroll and related expenses, and accrued expenses of approximately $439,000, $250,000, $436,000, $133,000 and $369,000, respectively. In addition, accrued income taxes increased and prepaid expenses decreased by approximately $31,000 and $69,000, respectively. The increase in cash and cash equivalents was due primarily to the receipt of the legal settlement from BP Exploration & Product, Inc. for damages arising out of the BP Deepwater Horizon Oil Disaster. The increase in inventory and accounts receivable was due primarily to the acquisition of Federal Hose on July 1, 2016 which increased the sales volume in the last quarter of fiscal year 2016. The decrease in prepaid expenses was due primarily to timing. The decrease in accounts receivable was due primarily to a decrease in the sales volume in the last quarter of the fiscal year. Increase in notes payable related party, trade accounts payable, accrued payroll and related expenses, and accrued expenses was due primarily to the acquisition of Federal Hose. The increase in lease payable was due to the replacement and upgrade of the Company's infrastructure.
Cash provided by operating activities in fiscal 2016 was $2,513,886 and was adequate to fund the Company's investing activities consisting of capital expenditures of $36,209. Capital expenditures were needed for tooling, machinery and equipment for product manufacturing and IT infrastructure. The primary reason for the positive cash flow from operations was due to net proceeds of $2,270,567 for claims against BP Exploration & Product, Inc. for damages arising out of the BP Deepwater Horizon Oil Disaster.
Cash provided by operating activities in fiscal 2015 was $19,972 and was not adequate to fund the Company's primary non-operating cash requirements consisting of capital expenditures of $64,894. Capital expenditures were needed for tooling, machinery and equipment for product manufacturing and IT infrastructure. The primary reason for the positive cash flow from operations was a decrease in accounts receivable, an increase in accounts payable, accrued payroll and related expenses and other accrued expenses of $68,686, $70,714, $152,204, $35,051 and $101,497, respectively. Positive cash flow was offset by increases in inventory and prepaid expenses of $212,316 and $74,030, respectively.
Cash used by operating activities in fiscal 2014 was a $606,811 and was not adequate to fund the Company's primary non-operating cash requirements consisting of capital expenditures of $141,714 consisting of tooling, machinery and equipment for product manufacturing and IT infrastructure. The primary reason for the negative cash flow from operations was the increase in accounts receivable and inventory of $535,952 and $124,381, respectively.
The Company expects positive cash flow from operations to be sufficient to fund working capital needs and service principal and interest payments due related to the notes payable. In addition, the Company had cash and cash equivalents of $3,060,734 as of September 30, 2016, and continues to maintain liquidity to operate the business.
In June 2016, management entered into an unsecured revolving credit agreement with First Francis Company Inc. First Francis Company Inc, became a major shareholder of the Company on July 1, 2016 when the Company completed the acquisition of Federal Hose pursuant to an Agreement and Plan of Merger with First Francis Company Inc. as owner of Federal Hose, Federal Hose, and Mr. Edward Crawford and Mr. Matthew Crawford, each of whom are the shareholders of First Francis Company Inc. Edward Crawford and Matthew Crawford serve on the Board of directors of Hickok Incorporated. Matthew Crawford is the son of Edward Crawford. The Company had $250,000 outstanding borrowings on the credit facility at September 30, 2016. The outstanding balance of $250,000 plus accrued interest was paid in full in October 2016.
The revolving line of credit expires on May 31, 2017.
In connection with the acquisition of Federal Hose on July 1, 2016, the Company also issued to First Francis Company Inc. two promissory notes in the aggregate principal amount of $4,768,662, which are secured by all of the assets of Hickok and certain of its subsidiaries, bear interest at a rate of 4.0% per annum, are amortized over a ten year period, and will be full due six years after the issue date. At September 30, 2016, the outstanding balance on these notes was $4,768,662.
In December 2016, management entered into Amendment No. 5 of the Convertible Loan Agreement which provides up to $467,000 of liquidity to meet on going working capital requirements. The Convertible Loan Agreement, as amended, is between the Company and a major shareholder who is also affiliated with
two Directors, as discussed in Note 4 to the Company's financial statements. This amended agreement modified the terms of the previously amended agreement by extending the due date of the loan agreement from December 30, 2016 to December 30, 2017 and continues to allow $250,000 of borrowing on the agreement at the Company's discretion. At September 30, 2016, the outstanding balance on the loan was $200,000.
There may be a requirement to increase inventory in fiscal 2017, which will have a negative but temporary impact on working capital. Management continues to tightly control expenses and will take actions as deemed necessary to maintain the necessary liquidity. Management believes the Company has adequate liquidity for working capital, capital expenditures and other strategic initiatives.
Off-Balance Sheet Arrangements
Hickok has no off-balance sheet arrangements (as defined in Regulation S-K Item 303 paragraph (a)(4)(ii)) that have or are reasonably likely to have a material current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies
The Company describes its significant accounting policies in the notes to the consolidated financial statements included in the Company's Annual Report on Form 10-K. However, in response to the SEC's Release No. FR-60, "Cautionary Advice Regarding Disclosure About Critical Accounting Policies", issued December 12, 2001, the Company has identified the policies it believes are most critical to an understanding of the Company's financial statements. Since application of these accounting policies involves the exercise of judgment and use of estimates, actual results could differ from those estimates.
Revenue Recognition - Revenue is recognized as manufactured items are shipped to customers, legal title has passed, and all significant contractual obligations of the Company have been satisfied. Revenue from development contracts is recorded as agreed upon milestones are achieved.
Inventory Valuation and Reserves - Inventories are valued at the lower of cost or market using the first-in, first-out (FIFO) method. The Company's business may require an increase in inventory of component parts, work-in-process and finished goods in order to meet anticipated delivery schedules of customers. However, the Company is responsible for excess and obsolete inventory purchases in excess of inventory needed to meet customer demand forecasts, as well as inventory purchases generally not covered by supply agreements, or parts that become obsolete before use in production. If the Company's forecasts change or excess inventory becomes obsolete, the inventory reserves included in the Company's financial statements may be understated.
Deferred Taxes - Deferred income taxes are provided for temporary differences between financial and tax reporting. Significant factors considered by the Company in estimating the probability of the realization of deferred taxes include expectations of future earnings and taxable income, as well as application of tax laws in the jurisdictions in which the Company operates.
The Company does not have off-balance sheet arrangements, financing, or other relationships with unconsolidated entities or persons, also known as "special purpose entities" (SPEs).
Impact of Inflation
Over the past five years, inflation has had a minimal effect on the Company because of low rates of inflation and the Company's policy minimizing the acceptance of long-term fixed rate contracts without provisions permitting adjustment for inflation.
Forward-Looking Statements
The foregoing discussion includes forward-looking statements relating to the business of the Company. These forward-looking statements, or other statements made by the Company, are made based on management's expectations and beliefs concerning future events impacting the Company and are subject to uncertainties and factors (including, but not limited to, those specified below) which are difficult to predict and, in many instances, are beyond the control of the Company. As a result, actual results of the Company could differ materially from those expressed in or implied by any such forward-looking statements. These uncertainties and factors include (a) the Company's ability to effectively integrate Federal Hose and manage the larger operations of the combined business, (b) the Company's dependence upon a limited number of customers and the automotive industry, (c) the highly competitive industry in which the Company operates, which includes several competitors with greater financial resources and larger sales organizations, (d) the acceptance in the marketplace of new products and/or services developed or under development by the Company including automotive diagnostic products and indicating instrument products, (e) the ability of the Company to further establish distribution and a customer base in the automotive aftermarket, (f) the Company's ability to capitalize on market opportunities including state automotive emissions programs and OEM tool programs, (g) the Company's ability to obtain cost effective financing and (h) the Company's ability to satisfy its interest payments.
ITEM 9A. CONTROLS AND PROCEDURES.
As of September 30, 2016, an evaluation was performed, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer along with the Company's Vice President, Finance and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, the Company's management, including the Chief Executive Officer along with the Company's Vice President, Finance and Chief Financial Officer, concluded that the Company's disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended ("Exchange Act") were effective as of September 30, 2016 to ensure that information required to be disclosed by the Company in reports that it files and submits under the Exchange Act is (1) recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and (2) is accumulated and communicated to the Company's management, including its principal executive and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. There were no changes in the Company's internal controls over financial reporting during the fourth fiscal quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect the Company's internal control over financial reporting.
The Company's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles. The Company's internal control over financial reporting includes policies and procedures that (1) pertain to maintaining records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that the Company's receipts and expenditures are being made only in accordance with authorization of the Company's management and directors, and (3) provide reasonable assurance regarding prevention or the timely detection of unauthorized acquisition, use or disposal of the company's assets that could have a material effect on the financial statements.
Management, including the Company's Chief Executive Officer along with the Company's Vice President, Finance and Chief Financial Officer, does not expect that the Company's internal controls will prevent or detect all errors and all fraud. An internal control system no matter how well designed and operated can provide only reasonable, not absolute, assurance that the objectives of the system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, collusion of two or more people, or by management override of the control. Also, any evaluation of the effectiveness of controls in future periods are subject to the risk that those internal controls may become inadequate because of changes in business conditions, or that the degree of compliance with the policies or procedures may deteriorate.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Hickok Incorporated is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended. Under the supervision and with the participation of management, including the Company's Chief Executive Officer along with the Company's Vice President, Finance and Chief Financial Officer, we conducted an evaluation of the effectiveness of the Company's internal control over financial reporting as of September 30, 2016, as required by Rule 13a-15(c) of the Securities Exchange Act of 1934, as amended. In making this assessment, we used the criteria set forth in the framework in Internal Control-Integrated Framework (1992) for Small Public Companies issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control-Integrated Framework for Small Public Companies, our management concluded that our internal control over financial reporting was effective as of September 30, 2016.
This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report.
/s/ B. E. Powers
B. E. Powers
Chief Executive Officer
/s/
K. J. Marek
K. J. Marek
Chief Financial Officer
January 11, 2017