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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 4, 2015

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________________________ to ________________________________

Commission File Number 1-9789

SEVCON, INC.

(Exact name of registrant as specified in its charter)

155 Northboro Road, Southborough, Massachusetts 01772

(Address of principal executive offices and zip code)

(508) 281-5510

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐	Accelerated filer ☐	Non-accelerated filer ☐	Smaller reporting company ☒
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). Yes ☐  No ☒

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

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SEVCON, INC.

FORM 10-Q

FOR THE QUARTER ENDED JULY 4, 2015

INDEX

 

 

1

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PART I.

FINANCIAL INFORMATION

Item 1

Financial Statements

CONSOLIDATED BALANCE SHEETS

Sevcon, Inc. and Subsidiaries

The accompanying notes are an integral part of these consolidated financial statements.

 

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CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

Sevcon, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

Sevcon, Inc. and Subsidiaries

The accompanying notes are an integral part of these consolidated financial statements.

 

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CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

Sevcon, Inc. and Subsidiaries

The accompanying notes are an integral part of these consolidated financial statements.

 

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SEVCON, INC.

Notes to Consolidated Financial Statements – July 4, 2015

(Unaudited)

(1)	Basis of presentation

 

Sevcon, Inc. (“Sevcon” or “the Company”) is a Delaware corporation organized on December 22, 1987 to carry on the electronic controls business previously performed by Tech/Ops, Inc. Through wholly-owned subsidiaries located in the United States, the United Kingdom, France, South Korea and Japan, and a joint venture located in China, the Company designs and sells, under the Sevcon name, controls for zero emission and hybrid electric vehicles. The controls are used to vary the speed and movement of vehicles, to integrate specialized functions and to prolong the shift life of vehicles’ power source. The Company’s customers are manufacturers of on-road, off-road and industrial vehicles including automobiles, buses, trucks, fork lift trucks, aerial lifts, mining vehicles, agricultural tractors and implements and other electrically powered vehicles and systems. Through another subsidiary located in the United Kingdom, Sevcon, Inc. manufactures special metalized film capacitors that are used as components in the power electronics, signaling and audio equipment markets.

Accounting for wholly-owned subsidiaries

 

The accompanying consolidated financial statements include the accounts of the Company’s wholly-owned subsidiaries; Sevcon USA, Inc., Sevcon Ltd., Industrial Capacitors (Wrexham) Ltd., Sevcon SAS, Sevcon Asia Limited and Sevcon Japan KK, in accordance with the provisions required by the Consolidation Topic 810 of the Financial Accounting Standards Board (“FASB”)  Accounting Standards Codification (“ASC”).  All material intercompany transactions have been eliminated.

Accounting for joint-venture subsidiary

For the Company's less than wholly owned subsidiary, Sevcon New Energy Technology (Hubei) Company Limited, the Company first analyzes whether this joint venture subsidiary is a variable interest entity (a “VIE”) in accordance with ASC 810 and if so, whether the Company is the primary beneficiary requiring consolidation. A VIE is an entity that has (i) insufficient equity to permit it to finance its activities without additional subordinated financial support or (ii) equity holders that lack the characteristics of a controlling financial interest. VIEs are consolidated by the primary beneficiary, which is the entity that has both the power to direct the activities that most significantly impact the entity’s economic performance and the obligation to absorb losses or the right to receive benefits from the entity that potentially could be significant to the entity. Variable interests in a VIE are contractual, ownership, or other financial interests in a VIE that change with changes in the fair value of the VIE’s net assets. The Company continuously re-assesses (i) whether the entity is a VIE, and (ii) if the Company is the primary beneficiary of the VIE. If it is determined that the entity in which the Company holds its interest qualifies as a VIE and the Company is the primary beneficiary, it is consolidated.

Based on the Company's analysis for its 50% owned joint venture, the Company has determined that it is a VIE and that the Company is the primary beneficiary. While the Company owns 50% of the equity interest in this subsidiary, the other 50% is owned by a local unrelated third party, and the joint venture agreement with that third party provides the Company with greater voting rights. Accordingly, the Company consolidates its joint venture under the VIE rules and reflects the third party’s 50% interest in the consolidated financial statements as a non-controlling interest. The Company records this non-controlling interest at its initial fair value, adjusting the basis prospectively for their share of the respective consolidated investments’ net income or loss or equity contributions and distributions. This non-controlling interest is not redeemable by the equity holders and is presented as part of permanent equity. Income and losses are allocated to the non-controlling interest holder based on its economic ownership percentage.

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normally recurring accruals) necessary to present fairly the financial position of Sevcon, Inc. as of July 4, 2015 and the results of operations and cash flows for the three and nine month periods ended July 4, 2015. These unaudited interim financial statements should be read in conjunction with the 2014 annual consolidated financial statements and related notes included in the 2014 Sevcon, Inc. Annual Report filed on Form 10-K (the “2014 10-K”). Unless otherwise indicated, each reference to a year means the Company’s fiscal year, which ends on September 30.

 

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The results of operations for the three and nine month periods ended July 4, 2015 are not necessarily indicative of the results to be expected for the full year.

 

(2)	Summary of significant accounting policies

 

There have been no changes since the end of 2014 to the significant accounting policies followed by Sevcon, Inc.

(3)	New accounting pronouncements

 

In May 2014, the FASB amended its guidance regarding revenue recognition and created a new Topic 606, “Revenue from Contracts with Customers”. The objectives for creating Topic 606 were to remove inconsistencies and weaknesses in revenue recognition, provide a more robust framework for addressing revenue issues, provide more useful information to users of the financial statements through improved disclosure requirements, simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer, and improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve the core principle, an entity should apply the following steps: 1) identify the contract(s) with a customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the  transaction price to the performance obligations in the contract; and 5) recognize revenue when (or as) the entity satisfies a performance obligation. For public entities, the amendments are effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The amendments may be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the amendment recognized at the date of initial application. We are currently assessing the impact of adoption of this standard on our consolidated financial statements.

 

(4)	Stock-based compensation plans

Under the Company’s 1996 Equity Incentive Plan (the “Plan”) there were 139,578 shares reserved and available for grant at July 4, 2015. There were 183,400 shares reserved and available for grant at June 28, 2014.

Recipients of grants must execute a standard form of non-competition agreement. The plan provides for the grant of Restricted Stock, Restricted Stock Units, Options, and Stock Appreciation Rights (“SARs”). SARs may be awarded either separately, or in relation to options granted, and for the grant of bonus shares. Options granted are exercisable at a price not less than fair market value on the date of grant.

There were no options outstanding or exercisable at July 4, 2015 or June 28, 2014, and there were no options granted or exercised in the three and nine month periods ended July 4, 2015 and June 28, 2014.

 

In December 2014, the Company granted 42,000 shares of restricted stock to eight employees, which will vest in two equal annual installments so long as the employee is then employed by the Company or as determined by the Compensation Committee. The estimated fair value of the stock on the date of grant was $330,000 based on the fair market value of stock on the date of issue. This unvested compensation is being charged to income on a straight line basis over two years. The charge to income for this employee restricted stock in the first nine months of 2015 was $82,000 and the subsequent charge will be approximately $41,000 on a quarterly basis.

 

In December 2014, the Company granted 20,000 shares of restricted stock to three employees, which will vest in five equal annual installments so long as the employee is then employed by the Company or as determined by the Compensation Committee. The estimated fair value of the stock on the date of grant was $139,000 based on the fair market value of stock on the date of issue. This unvested compensation is being charged to income on a straight line basis over five years. The charge to income for this employee restricted stock in the first nine months of 2015 was $14,000 and the subsequent charge will be approximately $7,000 on a quarterly basis.

 

In February 2015, the Company granted 30,600 shares of restricted stock to nine non-employee directors, which will vest on the day before the 2016 annual meeting providing that the grantee remains a director of the Company, or as otherwise determined by the Compensation Committee. The aggregate fair value of the stock measured on the date of grant was $225,000, based on the closing sale price of the stock on the date of grant. Compensation expense is being charged to income on a straight line basis over the twelve month period during which the forfeiture conditions lapse. The charge to income for these restricted stock grants in the first nine months of fiscal 2015 was $75,000 and the subsequent charge will be approximately $56,000 on a quarterly basis.

 

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A summary of restricted stock activity for the nine months ended July 4, 2015 is as follows:

Stock-based compensation expense was $147,000 and $406,000 for the three and nine month periods ended July 4, 2015 and $98,000 and $225,000 for the three and nine month periods ended June 28, 2014, respectively. At July 4, 2015, there was $923,000 of unrecognized compensation expense related to restricted stock granted under the Plan. The Company expects to recognize that cost over a weighted average period of 2.3 years.

(5)	Cash dividends

Common stock dividends

The Board of Directors suspended common stock dividends to conserve cash during the global recession that began in 2009 and will consider whether to resume paying common stock dividends as conditions and the Company’s operating results improve.

Preferred Stock dividends

At July 4, 2015 there were 452,374 shares of Series A Convertible Preferred Stock issued and outstanding. The preferred stock, which has a stated value of $24 per share, pays a 4% cumulative annual dividend semi-annually on October 15 and April 15 each year. Semi-annual dividends of $42,000 and $221,000 were paid on October 15, 2014 and April 15, 2015, respectively.  The next semi-annual dividend will be paid on October 15, 2015.

 

(6)	Calculation of earnings per share and weighted average shares outstanding

Basic earnings per share is computed by dividing the net income or loss for the period attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. The computation of diluted earnings per share is similar to the computation of basic earnings per share, except that the numerator of net income attributable to common stockholders is adjusted by the effect of dilutive securities, including convertible preferred stock using the treasury stock method.  The denominator is increased for the assumed exercise of dilutive options and other potentially dilutive securities, including convertible preferred stock and unvested restricted stock, using the treasury stock method, unless the effect is anti-dilutive.

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Basic and diluted net income per common share for the three and nine month periods ended July 4, 2015 and June 28, 2014 were calculated as follows:

(7)	Segment information

The Company has two reportable segments: electronic controls and capacitors. The electronic controls segment produces control systems for zero emission and hybrid electric vehicles. The capacitors segment produces metalized film capacitors for sale to electronic equipment manufacturers. Each segment has its own management team and sales force and the capacitors segment has its own manufacturing facility.

The significant accounting policies of the segments are those described in Note 1 to the Notes to Consolidated Financial Statements in the 2014 10-K. Inter-segment revenues are accounted for at current market prices. The Company evaluates the performance of each segment principally based on operating income. The Company does not allocate income taxes, interest income and expense or foreign currency translation gains and losses to segments. Information concerning operations of these businesses is as follows:

 

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In the electronic controls segment, revenues derived from the following products and services:

(8)	Research and development

In recent years the Company has received several awards of research and development grants by public bodies established by the U.K. government to stimulate technology-enabled innovation.

In 2011, the Company was awarded a research and development grant by the UK Technology Strategy Board to lead a collaborative project with Cummins Generator Technologies and Newcastle University in the U.K. to develop an innovative electric drive system for electric vehicles using advanced switched reluctance motor technology. The Company recorded grant income from this Technology Strategy Board project of $69,000 in the nine month period ended July 4, 2015, associated with research and development expense of $245,000, in the same period. The Company recorded grant income of $61,000 in the nine month period ended June 28, 2014, associated with research and development expense of $180,000, in the same period.

 

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In July 2013, the Company was awarded a grant of approximately $480,000 by the Low Emission Transport Collaborative Projects Fund, a U.K. government body. The grant is to develop next-generation controls for high-voltage, low-power applications. This grant defrayed part of the research and development expense associated with this project over the period from July 2013 to March 31, 2015 and included a commitment to increase employment by twenty five heads at the Company’s U.K. facility. The Company recorded grant income from this project of $53,000 in the nine month period ended July 4 2015, associated with research and development expense of $450,000, in the same period.  The Company recorded grant income of $339,000 in the nine month period ended June 28, 2014, associated with research and development expense of $1,392,000, in the same period. The Company has received payment for the full amount of the awarded grant although there is an on-going obligation under the terms of the grant award to complete the job creation target by adding a further ten permanent positions at the Company’s U.K. facility by the end of the second quarter of 2017.

 

In the third quarter of 2015 the Company was awarded a grant of approximately $625,000 by the U.K. Regional Growth Fund, a U.K. government body.  The grant is to develop an innovative range of low voltage motor controls which are designed to serve the emerging needs for on-road, automotive electrification.  The grant will defray part of the research and development expense associated with this project over the period to March 31, 2017 and includes a commitment to create or safeguard a total of twenty jobs at the Company’s U.K. facility over the period of the project.  The Company recorded grant income from this project of $37,000 in the three and nine month period ended July 4, 2015 associated with research and development expense of $149,000.

(9)	Employee benefit plans

Sevcon has defined contribution plans covering the majority of its U.S. and U.K. employees in the controls business. There is also a small defined contribution plan covering senior managers in the capacitor business. The Company has frozen the U.K. and U.S. defined benefit plans for which no future benefits are being earned by employees.  The following table sets forth the components of the net pension cost for the three and nine month periods ended July 4, 2015 and June 28, 2014, respectively:

 

 

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The following table sets forth the movement in the liability for pension benefits in the nine month periods ended July 4, 2015 and June 28, 2014, respectively:

 

		(in thousands of dollars)
		Nine Months ended
		July 4, 2015				June 28, 2014
Liability for pension benefits at beginning of period			9,529				8,354
Interest cost			928				973
Expected return on plan assets			(937	)			(978	)
Plan contributions			(497	)			(429	)
Effect of exchange rate changes			(349	)			400
Balance at end of period			8,674				8,320

 

Amounts recognized in the balance sheet consist of:

Amounts recognized in accumulated other comprehensive loss consist of:

Sevcon, Inc. contributed $150,000 to its frozen U.S. defined benefit plan in the nine months ended July 4, 2015; it presently anticipates contributing a further $50,000 to fund its U.S. plan in the remainder of fiscal 2015. In addition, employer contributions to the frozen U.K. defined benefit plan were $347,000 in the first nine months and are estimated to total $464,000 in 2015.

In the second quarter of 2015, the assets of the frozen U.K. defined benefit plan (the Sevcon Limited Pension Plan, “the Plan”) were reorganized by the trustees of the Plan. The trustees appointed Legal & General Investment Management to sell the Plan investments held in pooled funds previously managed by Standard Life Investments and a holding in the Absolute Return Fund managed by Ruffer LLP. The cash proceeds were subsequently invested as to 80% in an investment in Adept Strategy 9 Fund, a sub-fund of Adept Investment Management plc, a Qualifying Investor Alternative Investment Fund authorized and supervised by the Central Bank of Ireland. The other 20% of the cash proceeds were invested in a range of Schroder Matching Plus Nominal and Index Linked Liability Driven Investment Swap Funds to match the profile of the Plan’s liability cash flows.

The table below presents information about the Company’s pension plan assets measured and recorded at fair value as of July 4, 2015 and indicates the fair value hierarchy of the inputs utilized by the Company to determine the fair values.

 

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		(in thousands of dollars)
		Level 1* (Quoted prices in active markets)				Level 2** (Significant observable inputs)				Level 3*** (Unobservable inputs)
Mutual Funds
Standard Life Pension Global Absolute Returns Strategies Fund			7,187				-				-
Standard Life UK Indexed Linked Fund			1,856				-				-
Standard Life Long Corporate Bond Fund			1,785				-				-
CF Ruffer Absolute Return Fund			7,177				-				-
U.S. Mutual Funds			2,431				-				-
U.S. Exchange Traded Funds			348				-				-
Other Types of Investments
Cash			333				-				-
Total			21,117				-				-

 

The following estimated benefit payments have been, or are expected, to be paid:

(10)	Inventories

Inventories, net of reserve, were comprised of:

 

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(11)	Fair value of financial instruments

The Company's financial instruments consist mainly of cash and cash equivalents, short-term investments, accounts receivable and accounts payable. The carrying amount of these financial instruments as of July 4, 2015 approximates fair value due to the short-term nature of these instruments.

(12)	Derivative financial instruments

The Company uses derivative financial instruments to partially offset its market exposure to fluctuations in certain foreign currencies, principally the British Pound and the Euro, and does not enter into derivative contracts for speculative or trading purposes.

Derivative financial instruments designated as cash flow hedges

The Company documents at the inception of the transaction the relationship between the hedging instruments and the hedged items, as well as its risk management objectives and strategy for undertaking various hedging transactions.  The Company also documents its assessment, both at hedge inception and on an on-going basis, whether the derivative financial instruments that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items.

The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognized in equity in other comprehensive income.  The gain or loss relating to the ineffective portion is recognized immediately in the consolidated statement of income within “Other income and expense”.

Amounts accumulated in equity are reclassified to profit or loss in the periods when the hedged item affects profit or loss (for example, when foreign currency denominated financial liabilities are translated into their functional currencies).  The gain or loss relating to the effective portion of cross currency swaps which hedge the effects of changes in foreign exchange rates are recognized in the consolidated statement of income within “foreign exchange differences”.  When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognized when the forecast transaction is ultimately recognized in the consolidated statement of income.

The company did not have any financial instruments designated as cash flow hedges at July 4, 2015 or June 28, 2014.

Derivative financial instruments not designated for hedging

The fair value of derivative financial instruments that do not meet the FASB authoritative guidance for hedge accounting are immediately recognized in the consolidated statement of income under “Other income and expense”.  The fair value of these derivatives are recorded under “Prepaid expenses and other current assets” for asset derivatives or “Accrued expenses and other current liabilities” for liability derivatives, in the consolidated balance sheet.

In the quarter ended April 4, 2015 the company entered into foreign currency forward contracts to hedge its exposure to future fluctuations in the exchange rate between the U.S. Dollar and the Euro.  These contracts were intended to partially hedge the U.S. Dollar equivalent cost of the company’s planned purchases of inventory denominated in Euros.  The total gross amount of the outstanding forward contracts was $2,009,000 at July 4, 2015 ($0 at September 30, 2014).  These agreements were recorded at fair value in the consolidated balance sheet, resulting in a net gain of $132,000 and a net loss of $68,000 in the consolidated statement of income for the three and nine month periods, respectively, ended July 4, 2015 ($0 net  gain or loss for the three and nine month periods ended June 28, 2014).

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The following table presents the fair values of the Company’s derivative financial instruments for the following periods:

The above liability derivative foreign currency contracts represent a Level 2 liability at July 4, 2015 in accordance with the fair value hierarchy described in Note 9.

(13)	Accrued expenses

Set out below is an analysis of other accrued expenses at July 4, 2015 and September 30, 2014, which shows separately any items in excess of 5% of total current liabilities:

(14)	Warranty reserves

Warranty reserves are included on the balance sheet within accrued expenses; the movement in warranty reserves was as follows:

(15)

Debt

The Company’s wholly owned subsidiary, Sevcon USA, Inc., has a $3,500,000 secured revolving credit facility with Citizens Bank, for working capital and general corporate purposes. The loan and security agreement will expire on June 14, 2017 when any outstanding principal and unpaid interest at that time will be due and payable in full.  The facility may be paid before maturity in whole or in part at the option of Sevcon USA, Inc., without penalty or premium. Under the facility, Sevcon USA, Inc. must maintain, on a quarterly basis, a debt to tangible net worth ratio of no more than 2.40:1 and a debt service coverage ratio of no less than 1.25:1 for each rolling twelve-month period. Interest on the loan is payable monthly, and is calculated at a margin of 3.125% over LIBOR.  The total amount outstanding under this secured revolving credit facility at July 4, 2015 was $500,000 and at September 30, 2014 was $1,700,000. The fair value of the debt at July 4, 2015 was $500,000.

 

In July 2015, the Company’s U.K. bank renewed the overdraft facilities of the Company’s U.K. controls and capacitor subsidiaries. The Company’s U.K. controls and capacitor subsidiaries each have multi-currency overdraft facilities which together total $1,400,000 and which are secured by real estate owned by those companies. The renewal of the facilities is for a twelve month period although they can be withdrawn on demand by the bank. The facilities were unused at July 4, 2015 and at September 30, 2014.

 

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Annual principal payments on secured revolving credit facility at July 4, 2015 are as follows:

 

(16)	Commitments and Contingencies

Sevcon, Inc. is involved in various legal proceedings in the ordinary course of business but believes that it is remote that the outcome will be material to operations.

The Company maintains a directors' retirement plan which provides for certain retirement benefits to non-employee directors. Effective January 1997 the plan was frozen and no further benefits are being accrued. While the cost of the plan has been fully charged to expense, the plan is not separately funded. The estimated maximum liability which has been recorded based on the cost of buying deferred annuities at July 4, 2015 and September 30, 2014 was $156,000 and $162,000, respectively.

Minimum rental commitments under all non-cancelable leases are as follows for the years ended September 30,  2015 - $213,000; 2016 - $205,000; 2017 - $205,000; 2018 - $208,000; 2019 - $194,000 and $3,405,000 thereafter.

 

The U.K. subsidiaries of the Company have given to RBS Nat West Bank a security interest in certain leasehold and freehold property assets as security for overdraft facilities of $1,400,000. There were no amounts outstanding on the overdraft facilities at July 4, 2015 and at September 30, 2014. The obligations under a secured revolving credit facility entered into in 2011 by the U.S. subsidiary of the Company, are guaranteed by the Company and are secured by all of the assets and a pledge of all of the capital stock, of Sevcon USA, Inc. The total amount outstanding under this revolving credit facility was $500,000 at July 4, 2015 and $1,700,000 at September 30, 2014.

(17)	Subsequent events

In preparing these interim consolidated financial statements, the Company has evaluated, for potential recognition or disclosure, events or transactions subsequent to the end of the most recent quarterly period, the issuance date of these financial statements.

No material subsequent events were identified that require recognition or disclosure in these financial statements.

 

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Item 2

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

FORWARD LOOKING STATEMENTS

Statements in this discussion and analysis about the Company’s anticipated financial results and growth, as well as those about the development of its products and markets, are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected. Important factors that could cause these statements not to be realized include the risks discussed under “Risk Factors” below and others discussed in this report.

CRITICAL ACCOUNTING ESTIMATES

As of July 4, 2015, there have been no material changes to the critical accounting estimates described in the Company’s 2014 10-K. However, if the business and economic realities vary from those assumed in these judgments and estimates, actual operating results may differ materially from the amounts derived from these judgments and estimates. In addition, if the continuing worldwide economic troubles continue to have a negative effect on our business, estimates used in future periods may vary materially from those included in the Company’s previous disclosures.

For example:

 

(i)	if the financial condition of any of the Company's customers deteriorates as a result of further business declines, the Company may be required to increase its estimated allowance for bad debts;

 

(ii)	if actual future demand is less than previously projected, inventory write-downs may be required; or

 

(iii)

significant negative industry or economic trends that adversely affect our future revenues and profits, or a reduction of our market capitalization relative to net book value, among other factors, may change the estimated future cash flows or other factors that we use to determine whether or not goodwill has been impaired and lead us to conclude that an impairment charge is required.

 

All of these factors, and others resulting from the current economic situation, may have a material adverse  impact on the Company’s results.

 

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OVERVIEW OF THIRD QUARTER AND FIRST NINE MONTHS

Results of Operations

Three months ended July 4, 2015 and June 28, 2014

The following table compares the results by segment for the three months ended July 4, 2015 with the same period in the prior year. The table shows the effect of currency and volume changes in percentage terms:

 

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Nine months ended July 4, 2015 and June 28, 2014

The following table compares the results by segment for the nine months ended July 4, 2015 with the same period in the prior year.  The table shows the effect of currency and volume changes in percentage terms.

 

 

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Financial Condition

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Item 3

Quantitative and Qualitative Disclosures about Market Risk.

As a smaller reporting company, the Company is not required to respond to this item. However, we are providing the following information about our foreign currency and interest rate risks to supplement the disclosures in Item 2.

Foreign currency risk

The Company sells to customers throughout the industrialized world and the majority of the Company’s products are sourced in Europe. In the first nine months of 2015, approximately 52% of the Company’s sales were made in U.S. Dollars, 24% were made in British Pounds and 24% were made in Euros. Approximately 85% of the Company’s cost of sales was incurred in British Pounds and Euros. This resulted in the Company’s sales and margins being exposed to fluctuations due to the change in the exchange rates of the U.S. Dollar, the British Pound and the Euro. The Company has trade accounts receivable and accounts payable denominated in both British Pounds and Euros that are exposed to exchange fluctuations.

 

In addition, the translation of the sales and income of foreign subsidiaries into U.S. Dollars is also subject to fluctuations in foreign currency exchange rates.

The following table provides information about the Company’s foreign currency accounts receivable, accounts payable, firmly committed sales contracts and derivative financial instruments outstanding as of July 4, 2015. The information is provided in U.S. Dollar amounts, as presented in the Company’s consolidated financial statements. The table presents the amounts at which the Company’s foreign currency accounts receivable, accounts payable, firmly committed sales contracts and forward exchange agreements as of July 4, 2015 are expected to mature based on the exchange rate of the relevant foreign currency to U.S. Dollars at July 4, 2015, and the notional amount (at contract exchange rates) and the weighted average contractual foreign currency exchange rates:

 

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Interest Rate Risk

The Company’s policy is to invest surplus funds in instruments with maturities of less than 12 months at both fixed and floating interest rates. This investment portfolio is generally subject to general credit, liquidity, counterparty, market and interest rate risks. If the banking system or the fixed income or credit markets deteriorate or become volatile, the values and liquidity of these investments could be adversely affected. The Company did not have any surplus funds invested as of July 4, 2015.

Item 4

Controls and Procedures.

PART II.

OTHER INFORMATION

Item 1

Legal Proceedings

None.

 

Item 1A

Risk Factors

In addition to the market risk factors set forth in Part I, Item 1A of our 2014 10-K and the considerations set out in Part I, Items 2 and 3 above, the Company believes that the following represent the most significant risk factors for the Company:

Capital markets are cyclical and weakness in the United States and international economies may harm our business.

The Company’s traditional customers are mainly manufacturers of capital goods such as fork lift trucks, aerial lifts and railway signaling equipment. These markets are cyclical and depend heavily on worldwide transportation, shipping and other economic activity. They experienced a significant decline in demand during the recent global recession. Further, as our business has expanded globally, we have become increasingly subject to the risks arising from adverse changes in global economic conditions. While market conditions have appeared to improve since 2010, economic instability remains, particularly in the Eurozone. As a result, current or potential customers may be unable to fund purchases or manufacturing of products, which could cause them to delay, decrease or cancel purchases of our products or not to pay the Company or to delay paying for previously purchased products. In addition, continuing instability in the European credit markets may cause the Company to lose its current overdraft facilities and be unable otherwise to obtain financing for operations as needed.

Demand for on-road electric vehicles incorporating our products may not materialize.

The Company is increasingly involved in developing products for the on-road electric vehicle market. We have relationships with several customers that incorporate our products into their EV products. Our competitors and others are also developing products for other entrants in the EV market, with similar and competing technologies. If our customers’ products or technology are not successful commercially, or if worldwide demand for EVs fails to grow as much as we hope, we may not realize the anticipated demand for our products in the EV market, which may have a material adverse effect on our results of operations.

The Company relies on a small number of key customers for a substantial portion of its revenues.

Ten customers accounted for 43% of the Company’s revenues in the first nine months of 2015 and the largest customer accounted for 10% of revenues. Although we have had business relationships with some of these customers for many years, our relationships with on-road EV customers are newer and, in any event, there are no long-term contractual supply agreements in place with any customer. Accordingly our performance could be adversely affected by the loss of one or more of these key customers.

 

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The Company has substantial sales and operations outside the United States that could be adversely affected by changes in international markets.

A significant portion of our operations is located, and a significant portion of our business comes from, outside the United States. Accordingly, our performance could be adversely affected by economic downturns in Europe or the Far East as well as in the United States. A consequence of significant international business is that a large percentage of our revenues and expenses are denominated in foreign currencies that fluctuate in value versus the U.S. Dollar. Significant fluctuations in foreign exchange rates can and do have a material impact on our financial results, which are reported in U.S. Dollars. Other risks associated with international business include: changing regulatory practices and tariffs; staffing and managing international operations, including complying with local employment laws; longer collection cycles in certain areas; and changes in tax and other laws.

The continuing debt crisis in the Eurozone may have a material adverse effect on our business and operating results, which could adversely affect our stock price.

There continues to be significant uncertainty about the stability of global credit and financial markets in light of the continuing debt crisis in certain European countries.  A default or a withdrawal from the Eurozone by any of the countries involved, or the uncertainty alone, could cause the value of the Euro to deteriorate.  This, or a change to a local currency, would reduce the purchasing power of affected European customers. We are unable to predict the likelihood of any of these events but, if any occurs, our business, financial position and results of operations could be materially and adversely affected.

Program development timescales are long and can be cancelled

In certain markets in which the Company operates, and in particular in the Company’s new market sectors, non-recurring engineering development programs may take several years to complete and as result programs periodically reviewed by the customer can be cancelled at short notice. Cancellation of an engineering development program would potentially result in the Company not being nominated for the production phase of a project.

Production readiness is outside our control

In some new markets the Company’s customer is responsible for ensuring that all of the components of their vehicle, working in unison, comply with local governmental regulations in order to achieve the necessary certification to proceed to volume production. Even though the Company’s product performs to specification in all respects, the customer’s vehicle may fail to satisfy overall the local governmental regulations due to the failure of one or more components supplied by other suppliers resulting in a project not proceeding to volume production.

The Company’s commitment to make defined benefit pension contributions could adversely impact its financial position.

It is estimated that the Company will make contributions to its frozen U.K. and U.S. defined benefit pension plans of approximately $664,000 in 2015 and at a similar level in subsequent years. Should the Company suffer a material reduction in revenues this commitment could adversely impact the Company’s financial position.

Single source materials and sub-contractors may not meet the Company’s needs.

The Company relies on single, or a small number of, suppliers and sub-contractors for its requirements for most components, sub-assemblies and finished products. In the event that such suppliers and sub-contractors are unable or unwilling to continue supplying the Company, or to meet the Company’s cost and quality targets or needs for timely delivery, there is no certainty that the Company would be able to establish alternative sources of supply in time to meet customer demand.

Damage to the Company’s or sub-contractors’ buildings would hurt results.

In the electronic controls segment, the majority of the Company’s finished product is produced in four separate plants in Poland, Mexico, Malaysia and China; these plants are owned by sub-contractors. The capacitor business is located in a single plant in Wales. In the event that any of these plants was to be damaged or destroyed, there is no certainty that the Company would be able to establish alternative facilities in time to meet customer demand. The Company does carry property damage and business interruption insurance but this may not cover certain lost business due to the long-term nature of the relationships with many customers.

 

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Management judgment in assessing inventory and warranty reserves may be less than required

Management uses its judgment and market information to assess levels of reserve required in certain areas including inventory and warranty. If actual future demand or market conditions are less favorable than those projected by management, or if product designs change more quickly than forecast, additional inventory reserves may be required. Should actual product failure rates and repair or replacement costs differ from management estimates, revisions to the estimated warranty reserve may be required and the Company’s results may be materially adversely affected.

Failure to comply with financial covenants in our loan agreement could adversely affect us.

As of July 4, 2015, the Company’s subsidiary in the United States, Sevcon USA, Inc. had a $3,500,000 revolving credit facility with Citizens Bank; the total amount outstanding under this facility at July 4, 2015 was $500,000.  Any indebtedness under this facility is secured by all of Sevcon USA, Inc.’s assets and a pledge of all the capital stock of Sevcon USA, Inc.  The loan agreement includes financial covenants which require us to maintain compliance with certain financial ratios during the term of the agreement.  See “Management's Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition”.  Failure to comply with the financial covenants would be an event of default under the loan agreement that would give the lender the right to cease making additional advances, accelerate repayment of all sums due and take action to collect any monies owed to it, including foreclosing on its security interest, which could have a material adverse effect on the Company’s financial condition.

Product defect may result in product recall

In the event that the Company discovers a product defect that impacts the safety or operation of its products, then a product recall may be necessary which could involve the Company in a substantial unanticipated expense significantly in excess of any reserve that had been made.

Product liability claims may have a material adverse effect.

The Company’s products are technically complex and are installed and used by third parties. Defects in their design, installation, use or manufacturing may result in product liability claims against the Company. Such claims may result in significant damage awards, and the cost of any such litigation could be material.

Businesses we acquire may not generate the revenue and earnings we anticipate and may otherwise adversely affect our operations and financial condition.

We are considering supplementing our growth by acquiring new businesses. If we do that, but we fail to successfully integrate and manage the businesses we acquire, or if an acquisition does not further our business strategy as we expected, our operating results and financial condition may be materially adversely affected. Business combinations also involve a number of risks and uncertainties that can have an adverse impact, including that:

·

the costs of acquiring and integrating another business may be materially greater than we anticipate;

·

managing an acquired company’s technologies or lines of business or entering new markets where we have limited or no prior experience or where competitors may have stronger market positions may be more difficult than we anticipate;

·

we may fail to achieve the expected return on our investments, which could adversely affect our business or operating results and potentially cause impairment to assets that we recorded as a part of an acquisition, including intangible assets and goodwill;

·

the attention of our management and employees may be diverted;

·

we may not be able to retain key personnel of an acquired business;

·

we may assume unanticipated legal or financial liabilities;

·

we may suffer significant increases in our interest expense, leverage and debt service requirements if we incur additional debt to pay for an acquisition; and

·

our existing stockholders may be diluted and earnings per share may decrease if we were to issue a significant amount of equity securities in connection with an acquisition.

 

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Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

 

Shares of common stock re-acquired in order to pay the withholding taxes due upon vesting of restricted stock awards during the three months ended July 4, 2015, were as follows:

 

Period		Total number of shares purchased				Average price  paid per share				Total number of shares purchased as part of publicly  announced plans or  programs				Maximum number of shares that may yet be  purchased under the plans  or programs
April 5, 2015 to May 2, 2015			12,621			$	7.74				-				-
May 3, 2015 to May 30, 2015			-				-				-				-
May 31, 2015 to July 4, 2015			-				-				-				-
Total			12,621			$	7.74				-				-

Item 3

Defaults upon Senior Securities

None.

Item 4

Mine Safety Disclosures

Not Applicable.

Item 5

Other Information

None.

Item 6

Exhibits

See Exhibit Index immediately preceding the exhibits.

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	SEVCON, INC.
Date: August 10, 2015	By: /s/ Paul N. Farquhar
	Paul N. Farquhar
	Chief Financial Officer (Principal Financial Officer)

 

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