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SRMC > SEC Filings for SRMC > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for SIERRA MONITOR CORP /CA/

Form 10-Q for SIERRA MONITOR CORP /CA/


14-Nov-2012

Quarterly Report


ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Statements that are not statements of historical fact may be deemed to be forward-looking statements. The words "believe," "expect," "intend," "plan," "project," "will," and similar words and phrases as they relate to us also identify forward-looking statements. Such forward-looking statements include any expectations of operating and non-operating expense, including research and development expense, sufficiency of resources, including cash and accounts receivable, estimates of allowances for doubtful accounts, credit lines or other financial items; any statements of the plans, strategies and objectives of management for future operations and identified opportunities; any statements concerning proposed new products, services, developments and related research and development activities; any statements related to the Company's positioning to support current and near term levels of business; any statements of belief; and any statement of assumptions underlying any of the foregoing. Such statements reflect our current views and assumptions and are not guarantees of future performance. These statements are subject to various risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, without limitation, those issues described under the heading "Critical Accounting Policies," and those risk factors indentified in Item1A, Risk Factors, of our Annual Report on Form 10-K for our fiscal year ended December 31, 2011, as such section may be updated in our subsequent Forms 10-K, 10-Q and 8-K filed with, or furnished to, the SEC. We urge you to review and consider the various disclosures made by us from time to time in our filings with the SEC that attempt to advise you of the risks and factors that may affect our future results. We expressly disclaim any obligation to release publicly any updates or revisions to any forward-looking statement to reflect any changes in expectations, or any change in events or circumstances on which those statements are based, unless otherwise required by law.

Results of Operations

For the three-month periods ended September 30, 2012, Sierra Monitor Corporation ("we" or the "Company") reported net sales of $4,040,406 compared to $3,803,336 for the three-month period ended September 30, 2011. For the nine-month period ended September 30, 2012, net sales were $14,907,621 compared with $11,956,114 in the prior year nine-month period. The sales results for the three and nine-month periods ended September 30, 2012 represent increases of 6% and 25%, respectively, compared to the same periods in 2011.

For the three-month period ended September 30, 2012, sales of our gas detection products were approximately $1,787,000 compared to $1,612,000 in the three-month period ended September 30, 2011. For the nine-month period ended September 30, 2012, our gas detection product sales were approximately $7,766,000 compared to $5,258,000 in the same period in 2011. These results represent an 11% year-over-year increase in the third quarter and a 48% year-over-year increase in the year-to-date period. In the third quarter of 2012 our industrial gas detection sales were robust compared to the same period in 2011, but in the same comparative periods our Navy sales were substantially lower. Industrial sales included new international fire and gas detection projects and larger than normal domestic spare parts sales. Navy sales that are dependent upon unpredictable military buying cycles slowed in the third quarter after relatively higher sales in the first half of the year. The increase in year-to-date gas detection product sales is primarily the result of the first quarter, 2012 shipment of a single order with a value exceeding $2,000,000. The order was sold to an architectural and engineering firm (A&E) undertaking construction of a petroleum pipeline booster station in the Middle East.

Sales of Environment Controllers to the telecommunications industry in the three-month period ended September 30, 2012 were approximately $201,000 compared to $238,000 in the three-month period ended September 30, 2011. In the nine-month period ended September 30, 2012, sales of Environment Controllers were approximately $654,000 compared to $800,000 in the same period in 2011. Our sales to the telecommunications industry are dependent upon expansion of field infrastructure by wire phone and cable companies. In the current year there have been no significant infrastructure projects and our sales are reliant upon field upgrades and retrofits.

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In the three-month period ended September 30, 2012, sales of FieldServer products were approximately $2,052,000 compared to $1,953,000 in the same period in 2011. In the nine-month period ended September 30, 2012, sales of our FieldServer products were approximately $6,488,000, compared to $5,898,000 in sales reported in the same period in 2011. These results represent a 5% year-over-year increase in the third quarter and a 10% year-over-year increase in the year-to-date period.

FieldServer sales include both box products and original equipment manufacturer ("OEM") modules. Box products provide a platform for delivery and operation of our software for integration with building automation systems and are generally sold to building automation integrators.

Box product sales increased approximately 21% in the three-month period and 3% in the nine-month period ended September 30, 2012 on a year-over-year basis. The increase in sales in the third quarter of 2012 is due, in part, to shipment of a one-time single order for a military application. In early 2011 we completed the introduction of a more competitive FieldServer box product with a lower selling price. The impact of that introduction was lower revenue, even as the unit volume increased. In the second and third quarters of 2012 the unit volume has increased sufficiently to overcome the lower selling price, resulting in a year-over-year revenue improvement.

OEM module sales decreased approximately 10% in the three-month period ended September 30, 2012 as compared to the same period in 2011, and increased 17% on a year-to-date basis in 2012 compared to the prior year period. While order bookings for the OEM module have continued to increase, shipment releases by key customers slowed in the third quarter. We believe that the lower shipment releases were a temporary timing issue.

Gross profit of $2,340,399 for the three-month period ended September 30, 2012 was 58% of net sales compared to $2,239,917, or 59% of net sales, in the same period in the previous year. Gross profit for the nine-month period ended September 30, 2012 was $8,204,334, or 55% of net sales, compared to $7,104,568, or 59% of net sales, in the same period in the previous year. The gross profit for the third quarter was consistent with our current margin expectations based on continued competitive pressure on selling prices. The gross profit for the nine month year-to-date period was lower than our historical levels as a result of discounted pricing for a single large order to the Middle East in the first quarter of 2012.

Expenses for research and development, which include new product development and engineering to sustain existing products, were $523,310, or 13% of net sales, for the three-month period ended September 30, 2012 compared to $552,950, or 15% of net sales, in the comparable period in 2011. In the nine-month periods ended September 30, 2012 and September 30, 2011, research and development expenses were $1,641,118, or 11% of net sales, and $1,648,016, or 14% of net sales, respectively. We maintain product development programs to continually increase the number and types of products for sale in each of the product lines. In addition, our engineering team supports third party approval programs. The expenses for each of the reported periods in 2012 are consistent with the corresponding prior year periods and reflect our ongoing commitment to continue investment in each of the product lines.

Selling and marketing expenses, which consist primarily of salaries, commissions and promotional expenses were $1,012,646, or 25% of net sales for the three-month period ended September 30, 2012, compared to $857,828 or 23% of net sales, in the comparable period in the prior year. For the nine-month periods ended September 30, 2012 and 2011, selling and marketing expenses were $3,101,386, or 21% of net sales, and $2,659,782, or 22% of net sales, respectively. Third quarter and year-to-date 2012 selling expenses are generally higher than the comparative periods due, primarily, to higher selling costs and our expansion of the sales team, including the early 2012 opening of new offices in Singapore and Berlin. Variable selling costs include commission payments within the sales channels that increase in correlation with the sales level.

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General and administrative expenses, which consist primarily of salaries, building rent, insurance expenses and fees for professional services, were $550,572, or 14% of net sales, for the three-month period ended September 30, 2012 compared to $526,508, or 14% of net sales, in the three-month period ended September 30, 2011. For the nine-month periods ended September 30, 2012 and 2011, general and administrative expenses were $1,694,828, or 11% of net sales, and $1,588,368, or 13% of net sales, respectively. There were no overall significant changes in general and administrative expenses except for generally higher employee compensation expenses.

In the three-month period ended September 30, 2012, our income from operations was $253,871 compared to $302,631 for the three-month period ended September 30, 2011. In the nine-month period ended September 30, 2012, our income from operations was $1,767,002 representing an increase of $558,600 compared to the nine-month period ended September 30, 2011. In the third quarter of 2012 our higher gross profit compared to the same period of 2011 was offset by increases in each category of our fixed expenses resulting in lower income from operations. Our higher income in the first nine months of 2012 compared with the same period in 2011 was primarily the result of a single large order shipped in the first quarter of 2012.

In the three and nine-month periods ended September 30, 2012 tax deposits of $110,000 and $883,000, respectively, were paid to federal and state agencies for current obligations. After interest income and tax expenses, our net income for the three-month period ended September 30, 2012 was $152,395 compared to $181,736 in the same period of 2011. For the nine-month period ended September30, 2012 our net income was $1,060,326 compared to $725,560 in the same period of 2011.

Liquidity and Capital Resources

During the nine months ended September 30, 2012, net cash provided by operating activities was approximately $1,328,000 compared to net cash of approximately $389,000 provided by operating activities for the same period in 2011. Working capital was approximately $6,850,000 at September 30, 2012, an increase of approximately $1,221,000 from December 31, 2011.

At September 30, 2012, our balance sheet reflected approximately $2,408,000 of cash, $2,943,000 of inventory and $2,089,000 of net trade receivables. At December 31, 2011, our total cash on hand was approximately $1,212,000, our inventory was $3,918,000 and our net trade receivables were $1,648,000. Our inventory was higher at December 31, 2011 in preparation for shipment of a large order to the Middle East in the first quarter of 2012.

At September 30, 2012, we had no long term liabilities. We maintain a $1,000,000 line of credit, secured by certain assets of the Company, with a commercial bank. The line of credit requires annual renewal and compliance with certain financial covenants, including the requirement to maintain a quick ratio of 1.3:1.0 and a profitability test. At September 30, 2012, the Company was in compliance with all financial covenants contained in the line of credit. There were no borrowings on this line of credit during the nine-month period ended September 30, 2012.

We believe that our present resources, including cash and accounts receivable, are sufficient to fund the Company's anticipated level of operations through at least January 1, 2013. There are no current plans for significant capital equipment expenditures and no other known demands, commitments, events or uncertainties, except as previously disclosed in this Liquidity and Capital Resources section, that will result in or that are reasonably likely to result in the Company's liquidity increasing or decreasing in any material way.

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Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported in the Company's condensed financial statements and the accompanying notes. The amounts of assets and liabilities reported on our balance sheets and the amounts of revenues and expenses reported for each of our fiscal periods are affected by estimates and assumptions, which are used for, but not limited to, the accounting for revenue recognition, accounts receivable, doubtful accounts and inventories. Actual results could differ from these estimates. The following critical accounting policies are significantly affected by judgments, assumptions and estimates used in the preparation of the financial statements:

a) Revenue Recognition

The Company recognizes revenues when all of the following conditions exist: a) persuasive evidence of an arrangement exists in the form of an accepted purchase order; b) delivery has occurred, based on shipping terms, or services have been rendered; c) the Company's price to the buyer is fixed or determinable, as documented on the accepted purchase order; and d) collectability is reasonably assured. By product and service type, revenues are recognized when the following specific conditions are met:

Gas Detection and Environment Control Products

Gas detection and environment control products are sold as off-the-shelf products with prices fixed at the time of order. Orders delivered to the Company by phone, fax, mail or email are considered valid purchase orders and once accepted by the Company are deemed to be the final understanding between us and our customer as to the specific nature and terms of the agreed-upon sale transaction. Products are shipped and are considered delivered when (a) for FOB factory orders they leave our shipping dock or (b) for FOB customer dock orders upon confirmation of delivery. The creditworthiness of customers is generally assessed prior to the Company's acceptance of a customer's first order. Additionally, international customers and customers who have developed a history of payment problems are generally required to prepay or pay through a letter-of-credit.

Gas Detection and Environment Control Services

Gas detection and environment control services consist of field service orders (technical support) and training, which are provided separate from product orders. Orders for gas detection and environment control services are accepted in the same forms as discussed for Gas Detection and Environment Control Products above with hourly prices fixed at the time of order. Revenue recognition occurs only when the service activity is completed. Such services are provided to current and prior customers, and, as noted above, creditworthiness has generally already been assessed. In cases where the probability of receiving payment is low, a credit card number is collected in advance of the provision of services for immediate processing.

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FieldServer Products

FieldServer products are sold in the same manner as Gas Detection and Environment Control Products (as discussed above) except that the products contain embedded software, which is integral to the operation of the device. The software embedded in FieldServer products includes two items: (a) a compiled program containing (i) the basic operating system for FieldServer products, which is common to every unit, and (ii) customized protocol drivers based on the customer order (see FieldServer Services below for more information); and (b) a configuration file that identifies and links each data point as identified by the customer. The Company does not deem the hardware, operating systems with protocol drivers and configuration files to be separate units of accounting because the Company does not believe that they have value on a stand-alone basis. The hardware is useless without the software, and the software is only intended to be used in FieldServer hardware. Additionally, the software included in each sale is deemed to not require significant production, modification or customization, and therefore the Company recognizes revenues upon the shipment or delivery of products (depending on shipping terms), as described in Gas Detection and Environment Control Products above.

FieldServer Services

FieldServer services consist of orders for custom development of protocol drivers. Generally customers place orders for FieldServer products concurrently with their order for protocol drivers. However if custom development of the protocol driver is required, the product order is not processed until development of the protocol driver is complete. Orders are received in the same manner as described in FieldServer Products above, but due to the non-recurring engineering aspect of the customized driver development, the Company is more likely to have a written evidence trail of a quotation and a hard copy order. The driver development involves further research after receipt of order, preparation of a scope document to be approved by the customer and then engineering time to write, test and release the driver program. When development of the driver is complete the customer participates in testing and provides written confirmation that the driver program meets their expectations. The customer is then able to place or release orders for FieldServer product with the new driver loaded into it (see FieldServer Products above). Revenues for driver development are billed and recognized only after the customer's written confirmation is received. Collectability is reasonably assured as described in FieldServer Products above.

Discounts and Allowances

Discounts are applied at time of order entry and sales are processed at net pricing. No allowances are offered to customers.

b) Accounts Receivable and Related Allowances

Our domestic sales are generally made on an open account basis unless specific experience or knowledge of the customer's potential inability or unwillingness to meet the payment terms dictate secured payments. Our international sales are generally made based on secure payment terms including cash wire advance payments and letters of credit. International sales are made on open account terms where sufficient historical experience justifies the assumption of customer credit risk. In many of our larger sales, our customers are frequently construction contractors who are in need of our field services to complete their work and obtain payment. Management's ability to manage the credit terms and utilize of the leverage provided by the clients' need for our services is critical to the effective application of credit terms and minimization of accounts receivable losses.

We maintain an allowance for doubtful accounts which is analyzed on a periodic basis to determine adequacy. We believe that we have demonstrated the ability to make reasonable and reliable estimates of allowances for doubtful accounts based on significant historical experience.

c) Inventories

Inventories are stated at the lower of cost or estimated market, with cost being determined on the first-in, first-out method. The Company uses an Enterprise Requirements Planning ("ERP") software system which provides data upon which management relies to determine inventory trends and identify excesses. The carrying value of inventory is reduced to market for slow moving and obsolete items based on historical experience and current product demand. We evaluate the carrying value of inventory quarterly. The adequacy of carrying amounts is dependent upon management's ability to forecast demands accurately, manage product changes efficiently, and interpret the data provided by the ERP system.

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