NOTE 1 – NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Gencor Industries, Inc. and its subsidiaries (collectively, the “Company”) is a diversified, heavy machinery manufacturer for the production of highway construction materials and environmental control machinery and equipment.

These consolidated financial statements include the accounts of Gencor Industries, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

Accounting Pronouncements and Policies

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers: (Topic 606) (“ASU 2014-09”), amending its accounting guidance related to revenue recognition. Under this ASU and subsequently issued amendments, revenue is recognized to depict the transfer of 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. Additional disclosures are required to provide the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The standard is effective for annual periods beginning after December 15, 2017, including interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients or (ii) a retrospective approach with the cumulative effect upon initial adoption recognized at the date of adoption, which includes additional footnote disclosures. The Company plans to adopt the new standard in fiscal 2019. The Company does not expect the adoption of this standard to have a material impact on its results of operations.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). With adoption of this standard, lessees will have to recognize most leases as a right-of-use asset and a lease liability on their balance sheet. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Classification will be based on criteria that are similar to those applied in current lease accounting. ASU 2016-02 must be applied on a modified retrospective basis and is effective for fiscal years beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. The Company does not expect the new accounting standard to have a significant impact on its financial results when adopted.

In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718). The new standard identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. The Company adopted the provisions of ASU No. 2016-09 during the quarter ended March 31, 2017 with no material impact on the Company’s financial position, results of operations or cash flows.

No other accounting pronouncements issued or effective during the fiscal 2017 have had or are expected to have a material impact on the Company’s consolidated financial statements.

Use of Estimates

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Earnings per Share (“EPS”)

The consolidated financial statements include basic and diluted earnings (loss) per share (“EPS”) information. Basic EPS is based on the weighted-average number of shares outstanding. Diluted EPS is based on the sum of the weighted-average number of shares outstanding plus common stock equivalents.

On July 11, 2016, the Company’s Board of Directors approved a three-for-two split of the Company’s common and Class B stock to be effected in the form of a 50% stock dividend. As a result, shareholders received one additional share of common or Class B stock for every two shares they held of the respective class of stock as of the record date. These shares were distributed on August 1, 2016, to shareholders of record as of the end of business on July 22, 2016. All share and per share data (except par value) has been adjusted to reflect the effect of the stock split for all periods presented. The number of shares of common and Class B stock issuable upon exercise of outstanding stock options were proportionately increased in accordance with terms of the respective plans (see Note 11). The number of authorized shares, as reflected on the consolidated balance sheets, was not affected by the stock split and, accordingly, has not been adjusted.

Weighted-average shares issuable upon the exercise of stock options included in the diluted EPS calculation as of September 30, 2017 were 463,000, which equates to 284,000 dilutive common stock equivalents on a post stock split basis. For the year ended September 30, 2016, weighted-average shares issuable upon the exercise of stock options included in the diluted EPS calculation were 480,000, which equates to 190,000 dilutive common stock equivalents. For the year ended September 30, 2015, there were no common stock equivalents included in the diluted EPS calculations, as to do so would have been anti-dilutive. Weighted-average shares issuable upon the exercise of stock options, which were not included in the diluted EPS calculation because they were anti-dilutive, were zero in 2017 and 2016, and 512,000 in 2015 on a post stock split basis.

The following presents the calculation of the basic and diluted EPS for the years ended September 30, 2017, 2016 and 2015:


	2017						2016						2015
	Net Income		Shares		EPS		Net Income		Shares		EPS		Net Loss			Shares		EPS
Basic EPS	$	8,418,000		14,396,000	$	0.58	$	7,043,000		14,334,000	$	0.49	$	(1,819,000	)		14,283,000	$	(0.13	)
Common stock equivalents				284,000						190,000							—

Diluted EPS	$	8,418,000		14,680,000	$	0.57	$	7,043,000		14,524,000	$	0.48	$	(1,819,000	)		14,283,000	$	(0.13	)

Cash Equivalents

Cash equivalents consist of short-term certificates of deposit and deposits in money market accounts with original maturities of three months or less.

Marketable Securities

Marketable debt and equity securities are categorized as trading securities and are thus marked to market and stated at fair value. Fair value is determined using the quoted closing or latest bid prices for Level 1 investments and market standard valuation methodologies for Level 2 investments. Realized gains and losses on investment transactions are determined by specific identification and are recognized as incurred in the consolidated statements of operations. Net changes in unrealized gains and losses are reported in the consolidated statements of operations in the current period.

Fair Value Measurements

The fair value of financial instruments is presented based upon a hierarchy of levels that prioritizes the inputs of valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

The fair value of marketable equity securities, mutual funds, exchange-traded funds, corporate bonds, government securities, and cash and money funds are substantially based on quoted market prices (Level 1). Corporate and municipal bonds are valued using market standard valuation methodologies, including: discounted cash flow methodologies, and matrix pricing or other similar techniques. The inputs to these market standard valuation methodologies include, but are not limited to: interest rates, credit standing of the issuer or counterparty, industry sector of the issuer, coupon rate, call provisions, maturity, estimated duration and assumptions regarding liquidity and estimated future cash flows. In addition to bond characteristics, the valuation methodologies incorporate market data, such as actual trades completed, bids and actual dealer quotes, where such information is available. Accordingly, the estimated fair values are based on available market information and judgments about financial instruments (Level 2). Fair values of the Level 2 investments are provided by the Company’s professional investment management firm.

The following table sets forth by level, within the fair value hierarchy, the Company’s assets measured at fair value as of September 30, 2017:


	Fair Value Measurements
	Level 1		Level 2		Level 3		Total
Equities	$	11,338,000	$	—	$	—	$	11,338,000
Mutual Funds		7,155,000		—		—		7,155,000
Exchange-Traded Funds		3,417,000		—		—		3,417,000
Corporate Bonds		—		7,196,000		—		7,196,000
Government Securities		54,542,000		—		—		54,542,000
Cash and Money Funds		4,238,000		—		—		4,238,000

Total	$	80,690,000	$	7,196,000	$	—	$	87,886,000

Net unrealized gains reported during fiscal 2017 on trading securities still held as of September 30, 2017, were $1,183,000. There were no transfers of investments between Level 1 and Level 2 during the year ended September 30, 2017.

The following table sets forth by level, within the fair value hierarchy, the Company’s assets measured at fair value as of September 30, 2016:


	Fair Value Measurements
	Level 1		Level 2		Level 3		Total
Equities	$	2,408,000	$	—	$	—	$	2,408,000
Mutual Funds		5,212,000		—		—		5,212,000
Exchange-Traded Funds		510,000		—		—		510,000
Government Securities		69,583,000		—		—		69,583,000
Cash and Money Funds		8,225,000		—		—		8,225,000

Total	$	85,938,000	$	—	$	—	$	85,938,000

Net unrealized gains reported during fiscal 2016 on trading securities still held as of September 30, 2016, were $2,502,000. There were no transfers of investments between Level 1 and Level 2 during the year ended September 30, 2016.

Net unrealized losses reported during fiscal 2015 on trading securities still held as of September 30, 2015, were $(4,882,000).

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, customer deposits and accrued expenses approximate fair value because of the short-term nature of these items.

Foreign Currency Transactions

Gains and losses resulting from foreign currency transactions are included in income and were not significant during the years ended September 30, 2017, 2016 and 2015.

Risk Management

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, marketable securities, and accounts receivable. The Company maintains its cash accounts in various domestic financial institutions which may from time to time exceed federally insured limits. Operating cash is retained overnight in non-interest-bearing accounts which allow for offsets to treasury service charges. The marketable securities are invested in cash and money funds, mutual funds, exchange-traded funds (ETF’s), corporate bonds, government securities and stocks through a professional investment advisor. Investment securities are exposed to various risks, such as interest rate, market and credit risks.

The Company’s customers are not concentrated in any specific geographic region, but are concentrated in the road and highway construction industry. The Company extends limited credit to its customers based upon their credit- worthiness and generally requires a significant up-front deposit before beginning construction and full payment subject to hold-back provisions prior to shipment on complete asphalt plant and component orders. The Company establishes an allowance for doubtful accounts based upon the credit risk of specific customers, historical trends and other pertinent information.

Inventories

Inventories are valued at the lower of cost or market, with cost being determined principally by using the last-in, first-out (“LIFO”) method and market defined as replacement cost for raw materials and net realizable value for work in process and finished goods (see Note 2). Appropriate consideration is given to obsolescence, excessive levels, deterioration, possible alternative uses and other factors in determining net realizable value. The cost of work in process and finished goods includes materials, direct labor, variable costs and overhead. The Company evaluates the need to record inventory adjustments on all inventories, including raw material, work in process, finished goods, spare parts and used equipment. Used equipment acquired by the Company on trade-in from customers is carried at estimated net realizable value. Unless specific circumstances warrant different treatment regarding inventory obsolescence, the cost basis of inventories three to four years old are reduced by 50%, while the cost basis of inventories four to five years old are reduced by 75%, and the cost basis of inventories greater than five years old are reduced to zero. Inventory is typically reviewed for obsolescence on an annual basis computed as of September 30, the Company’s fiscal year end. If significant known changes in trends, technology or other specific circumstances that warrant consideration occur during the year, then the impact on obsolescence is considered at that time.

Changes in the allowance for slow move and obsolete inventories are as follows:


	2017			2016			2015
Balance, beginning of year	$	3,869,000		$	3,310,000		$	3,139,000
Charged to cost of sales		77,000			621,000			144,000
Disposal of inventory, net of recoveries		(120,000	)		(62,000	)		27,000

Balance, end of year	$	3,826,000		$	3,869,000		$	3,310,000

Property and Equipment

Property and equipment are stated at cost (see Note 4). Depreciation of property and equipment is computed using the straight-line method over the estimated useful lives of the related assets, as follows:


	Years
Land improvements		15
Buildings and improvements		6-40
Equipment		2-10

Impairments

Property and equipment and intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset (or asset group) may not be recoverable. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss to be recorded is calculated by the excess of the asset’s carrying value over its fair value. Fair value is generally determined using a discounted cash flow analysis. No such impairment loss was recorded during the years ended September 30, 2017, 2016 and 2015.

Revenues and Expenses

Revenues from contracts for the design, manufacture and sale of asphalt plants are recognized under the percentage-of-completion method. The percentage-of-completion method of accounting for these contracts recognizes revenue, net of any promotional discounts, and costs in proportion to actual labor costs incurred, as compared with total estimated labor costs expected to be incurred during the entire contract. Pre-contract costs are expensed as incurred. Changes to total estimated contract costs or losses, if any, are recognized in the period in which they are determined. Revenue recognized in excess of amounts billed is classified as current assets under “costs and estimated earnings in excess of billings.” The Company anticipates that all incurred costs associated with these contracts at September 30, 2017, will be billed and collected within one year.

Revenues from all other contracts for the design and manufacture of custom equipment, for service and for parts sales, net of any discounts and return allowances, are recorded when the following four revenue recognition criteria are met: product is delivered/ownership is transferred or service is performed, persuasive evidence of an arrangement exists, the selling price is fixed or determinable, and collectability is reasonably assured.

Product warranty costs are estimated using historical experience and known issues and are charged to production costs as revenue is recognized.

Changes in the accrual for warranty and related costs are composed of the following:


	2017			2016			2015
Balance, beginning of year	$	401,000		$	205,000		$	367,000
Warranties issued		400,000			475,000			20,000
Warranties settled		(389,000	)		(279,000	)		(182,000	)

Balance, end of year	$	412,000		$	401,000		$	205,000

All product engineering and development costs, and selling, general and administrative expenses are charged to operations as incurred. Provision is made for any anticipated contract losses in the period that the loss becomes evident.

The allowance for doubtful accounts is determined by performing a specific review of all account balances greater than 90 days past due and other higher risk amounts to determine collectability and also adjusting for any known customer payment issues with account balances in the less-than-90-day past due aging category. Account balances are charged off against the allowance for doubtful accounts when they are determined to be uncollectable. Any recoveries of account balances previously considered in the allowance for doubtful accounts reduce future additions to the allowance for doubtful accounts. The allowance for doubtful accounts also includes an estimate for returns and allowances. Provisions for estimated returns and allowances and other adjustments, are provided for in the same period the related sales are recorded. Returns and allowances, which reduce product revenue, are estimated using known issues and historical experience.

Changes in the allowance for doubtful accounts are composed of the following:


	2017			2016			2015
Balance, beginning of year	$	195,000		$	357,000		$	244,000
Provision for doubtful accounts		115,000			105,000			60,000
Provision for estimated returns and allowances		385,000			175,000			170,000
Uncollectible accounts written-off		(16,000	)		(89,000	)		(46,000	)
Returns and allowances issued		(472,000	)		(353,000	)		(71,000	)

Balance, end of year	$	207,000		$	195,000		$	357,000

Shipping and Handling Costs

Shipping and handling costs are included in production costs in the consolidated statements of operations.

Income Taxes

Income taxes are provided for the tax effects of transactions reported in the consolidated financial statements and consist primarily of taxes currently due, plus deferred taxes (see Note 6).

The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns using current tax rates. The Company and its domestic subsidiaries file a consolidated federal income tax return.

Deferred tax assets and liabilities are measured using the rates expected to apply to taxable income in the years in which the temporary differences are expected to reverse and the credits are expected to be used. The effect on deferred tax assets and liabilities of the change in tax rates is recognized in income in the period that includes the enactment date. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, the Company is more likely than not to realize the benefit of a deferred tax asset and whether a valuation allowance is needed for some portion or all of a deferred tax asset. No such valuation allowances were recorded as of September 30, 2017 and 2016.

Comprehensive Income

For the years ended September 30, 2017, 2016 and 2015, other comprehensive income (loss) is equal to net income (loss).

Reporting Segments and Geographic Areas

The Company only has one reportable segment. Information concerning principal geographic areas is as follows:


	2017				2016				2015
	Revenues		Long-Term Assets		Revenues		Long-Term Assets		Revenues		Long-Term Assets
United States	$	80,608,000	$	5,775,000	$	69,991,000	$	5,292,000	$	39,230,000	$	7,778,000
Other		—		—		—		—		—		—

Total	$	80,608,000	$	5,775,000	$	69,991,000	$	5,292,000	$	39,230,000	$	7,778,000

Revenues are attributed to geographic areas based on the location of the assets producing the revenues.

Customers with 10% (or greater) of Net Revenues

Approximately 13% of total net revenue in the year ended September 30, 2017, 14% of total net revenue for the year ended September 30, 2016 and 15% of total net revenue for the year ended September 30, 2015, was from one or more separate U.S. entities owned by a foreign-based global company.

One other customer accounted for approximately 10% of net revenue for the year ended September 30, 2017. Net revenue for this customer was less than 1% during the two prior year comparative periods.

Subsequent Events

Management has evaluated events occurring from September 30, 2017 through the date these financial statements were filed with the SEC for proper recording and disclosures therein (see Note 12).

Reclassifications and Adjustments

Certain prior year amounts in the consolidated financial statements have been reclassified to conform to the fiscal 2017 presentation. All historical share and per share data in the consolidated financial statements and notes thereto have been restated to give retroactive recognition of the Company’s three-for-two stock split. In the Consolidated Statements of Shareholders’ Equity, for all periods presented, the par value of the additional shares was reclassified from capital in excess of par value to common stock. Refer to Note 10 and Note 11 for additional information regarding the stock split.