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NPK > SEC Filings for NPK > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Form 10-K for NATIONAL PRESTO INDUSTRIES INC


18-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

An overview of the Company's business and segments in which the Company operates and risk factors can be found in Items 1 and 1A of this Form 10-K. Forward-looking statements in this Management's Discussion and Analysis of Financial Condition and Results of Operations, elsewhere in this Form 10-K, in the Company's 2012 Annual Report to Shareholders, in the Proxy Statement for the annual meeting to be held May 21, 2013, and in the Company's press releases and oral statements made with the approval of an authorized executive officer are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. There are certain important factors that could cause results to differ materially from those anticipated by some of the statements made herein. Investors are cautioned that all forward-looking statements involve risks and uncertainty. In addition to the factors discussed herein and in the notes to Consolidated Financial Statements, among the other factors that could cause actual results to differ materially are the following: consumer spending and debt levels; interest rates; continuity of relationships with and purchases by major customers; product mix; the benefit and risk of business acquisitions; competitive pressure on sales and pricing; increases in material, freight/shipping, or production cost which cannot be recouped in product pricing; delays or interruptions in shipping or production from machine issues; work or labor disruptions stemming from a unionized work force; changes in government requirements and funding of government contracts; failure of subcontractors or vendors to perform as required by contract; the efficient start-up and utilization of capital equipment investments; and political actions of federal and state governments which could have an impact on everything from the value of the U.S. dollar vis--vis other currencies to the availability of affordable labor and energy. Additional information concerning these and other factors is contained in the Company's Securities and Exchange Commission filings.

2012 COMPARED TO 2011

Readers are directed to Note L, "Business Segments," to the Consolidated Financial Statements for data on the financial results of the Company's three business segments for the years ended December 31, 2012 and 2011.

On a consolidated basis, sales increased by $41,469,000 (10%), gross margins increased by $1,104,000 (1%), and selling and general expense increased by $15,122,000 (76%). Other income, principally interest, decreased by $583,000 (45%), while earnings before provision for income taxes decreased by $14,601,000 (20%), and net earnings decreased by $9,093,000 (19%). Details concerning these changes can be found in the comments by segment found below.

Housewares/Small Appliance net sales increased $14,171,000 from $130,852,000 to $145,023,000, or 11%, which was attributable to an increase in units shipped. Defense net sales increased by $42,626,000, from $202,372,000 to $244,998,000, or 21%, primarily reflecting an increase in unit shipments, a significant part of which was attributable to shipments from the segment's backlog of Department of Defense orders. Absorbent Products net sales decreased by $15,328,000 from $97,797,000 to $82,469,000, or 16%, primarily from a decrease in unit shipments due in large part to a decline in shipments to a significant customer which opened its own facility during the fourth quarter of 2011.

Housewares/Small Appliance gross profit increased $842,000 from $27,016,000 (21% of sales) in 2011 to $27,858,000 (19% of sales) in 2012, primarily reflecting the increase in sales mentioned above, largely offset by increases in product and ocean freight costs. Defense gross profit increased $2,089,000 from $62,006,000 (31% of sales) to $64,095,000 (26% of sales), reflecting the increase in sales mentioned above, approximately 84% of which was offset by a less favorable product mix primarily related to the five-year 40mm contract awarded in 2010. Absorbent products gross profit decreased $1,827,000, from $4,737,000 (5% of sales) to $2,910,000 (4% of sales), reflecting the decrease in sales mentioned above and lower production efficiencies due largely to the inability to absorb fixed costs incident to the sales decline, partially offset by lower costs on certain key raw materials.


Selling and general expenses for the Housewares/Small Appliance segment increased $1,844,000 from the prior year's levels. Significant items were increased litigation costs stemming from lawsuits of a spurious nature and increased employee health and accident costs of $1,400,000 and $696,000, respectively, partially offset by decreases in accruals for environmental costs and bad debts of $413,000 and $339,000, respectively. Defense segment selling and general expenses increased $2,067,000, primarily reflecting ongoing operational costs of $1,474,000 and intangible asset amortization of $1,049,000, both associated with the acquisition of a less than lethal manufacturing facility during the fourth quarter of 2011. The acquisition and intangible asset amortization are more fully described in Note P, "Business Acquisition," and Note A(9), "Goodwill and Intangible Assets," to the Company's Consolidated Financial Statements. Selling and general expenses for the Absorbent Products segment increased $11,211,000, stemming from the financial difficulties of a foreign independent manufacturing facility. During 2012, due to uncertainties attributed to the facility's government's legal system and the financial health of the facility, all Company-owned equipment located at the foreign facility was written off, as well as all note and accounts receivables related to the facility. Future recovery of some portion of that write-off is possible.

The above items were responsible for the change in operating profit.

Other income decreased $583,000, which was attributable to lower interest income resulting from decreased yields on lower dollars of marketable securities invested.

Earnings before provision for income taxes decreased $14,601,000 from $75,025,000 to $60,424,000. The provision for income taxes decreased from $27,057,000 to $21,549,000, which resulted in an effective income tax rate of 36% in both years. Net earnings decreased $9,093,000 from $47,968,000 to $38,875,000.

2011 COMPARED TO 2010

Readers are directed to Note L, "Business Segments," to the Consolidated Financial Statements for data on the financial results of the Company's three business segments for the years ended December 31, 2011 and 2010.

On a consolidated basis, sales decreased by $47,979,000 (10%), gross margins decreased by $19,815,000 (17%), and selling and general expense increased by $3,699,000 (23%). Other income, principally interest, decreased by $816,000 (39%), while earnings before provision for income taxes decreased by $24,330,000 (25%), and net earnings decreased by $15,563,000 (25%). Details concerning these changes can be found in the comments by segment found below.

Housewares/Small Appliance net sales decreased $26,622,000 from $157,474,000 to $130,852,000, or 17%, which was primarily attributable to a decrease in units shipped, largely attributed to the growing retail trend of purchasing private label products, coupled with a phenomenon known as the just in time consumer, resulting in the retailers' failure to maintain adequate stock when the consumers were ready to make a purchase. Defense net sales decreased by $38,390,000, from $240,762,000 to $202,372,000, or 16%, primarily reflecting a decrease in unit shipments, which has had the effect of deferring sales to a later date. Absorbent Products net sales increased by $17,033,000 from $80,764,000 to $97,797,000, or 21%, primarily from an increase in unit shipments due in large part to its successful implementation of its customer diversification program.

Housewares/Small Appliance gross profit decreased $10,016,000 from $37,032,000 (24% of sales) in 2010 to $27,016,000 (21% of sales) in 2011, primarily reflecting the decrease in sales mentioned above, augmented by increased commodity costs. Defense gross profit decreased $6,065,000 from $68,071,000 (28% of sales) to $62,006,000 (31% of sales), reflecting the decrease in sales mentioned above, approximately half of which was offset by realized efficiencies and a more favorable product mix. Absorbent products gross profit decreased $3,734,000, from $8,471,000 (11% of sales) to $4,737,000 (5% of sales), primarily reflecting increased commodity costs, inefficiencies stemming from the installation and startup of new production equipment, and a fire on one of the segment's machines. The decrease was further augmented by differences in year to year supplier rebate timing, which favorably affected prior year margins by $401,000.

Selling and general expenses for the Housewares/Small Appliance segment increased $826,000 from the prior year's levels. Significant items were increases in employee benefit cost and bad debt accruals of $1,076,000 and $350,000, respectively, and legal and professional costs of $260,000, partially offset by decreases in self-insurance and environmental reserves of $771,000 and $159,000, respectively. Defense segment selling and general expenses increased $329,000, primarily reflecting increases in legal and professional costs of $127,000, employee benefit costs of $51,000, and other individually insignificant items. Selling and general expenses for the Absorbent Products segment increased $2,544,000. The most significant items were the absence of the prior year's gain on the sale of obsolete equipment of $1,293,000 and an increase in the reserve for bad debts of $638,000.


The above items were responsible for the change in operating profit.

Other income decreased $816,000, which was attributable to lower interest income resulting from decreased yields on lower dollars of marketable securities invested.

Earnings before provision for income taxes decreased $24,330,000 from $99,355,000 to $75,025,000. The provision for income taxes decreased from $35,824,000 to $27,057,000, which resulted in an effective income tax rate of 36% in both years. Net earnings decreased $15,563,000 from $63,531,000 to $47,968,000.

LIQUIDITY AND CAPITAL RESOURCES

2012 COMPARED TO 2011

Cash provided by operating activities was $62,342,000 during 2012 as compared to $58,686,000 during 2011. The principal factors behind the increase in cash provided can be found in the changes in the components of working capital within the Consolidated Statements of Cash Flows. Of particular note during 2012 were net earnings of $38,875,000 and decreases in inventory levels and deposits with vendors included in other current assets. These were partially offset by a decrease in net payables and an increase in accounts receivable levels. Of particular note during 2011 were net earnings of $47,968,000, reflecting a decrease in late fourth quarter sales and a reduction in accounts receivable levels. These items were offset by increases in inventory levels and deposits with vendors included in other current assets, and a decrease in payable levels.

Net cash used in investing activities was $13,578,000 during 2012 as compared to $21,816,000 provided by investing activities during 2011. Of note during 2012 were the acquisition of plant and equipment of $13,584,000, primarily to support the expansion of the Absorbent Products segment, and a note receivable of $3,500,000. The note receivable is described further in Note Q, "Other," to the Consolidated Financial Statements. These were partially offset by net maturities/sales of marketable securities of $3,744,000. Of note during 2011 were net maturities/sales of marketable securities of $41,559,000, partially offset by the acquisition of plant and equipment of $15,003,000, primarily to support the expansion of the Absorbent Products segment, and the acquisition of assets comprising a small business in the Defense segment, described in Note P to the Consolidated Financial Statements, of $4,526,000.

Based on the accounting profession's 2005 interpretation of cash equivalents under Financial Accounting Standards Board ("FASB") Accounting Standard Codification ("ASC") 230, the Company's variable rate demand notes have been classified as marketable securities. This interpretation, which is contrary to the interpretation that the Company's representative received directly from the FASB (which indicated it would not object to the Company's classification of variable rate demand notes as cash equivalents), has resulted in a presentation of the Company's Consolidated Balance Sheets that the Company believes understates the true liquidity of the Company's income portfolio. As of December 31, 2012 and 2011, $31,092,000 and $33,034,000, respectively, of variable rate demand notes are classified as marketable securities. These notes have structural features that allow the Company to tender them at par plus interest within any 7-day period for cash to the notes' trustees or remarketers, and thus provide the liquidity of cash equivalents.

Cash used in financing activities for 2012 and 2011 differed primarily as a result of the payment of two dividends in 2012. The first was the 2012 dividend paid in March, while the second was an accelerated payment made in late December of the annual 2013 dividend. The acceleration was occasioned by the uncertainty over the federal income tax rates that would be in effect in 2013. In contrast, a single payment was made in 2011 per the Company's normal practice.

As a result of the foregoing factors, cash and cash equivalents decreased in 2012 by $36,558,000 to $37,437,000.

Working capital decreased by $48,178,000 to $214,781,000 at December 31, 2012 for the reasons stated above. The Company's current ratio was 4.8 to 1.0 at December 31, 2012, compared to 5.0 to 1.0 at December 31, 2011.

The Company expects to continue to evaluate acquisition opportunities that align with its business segments and will make further acquisitions, as well as continue to make capital investments in these segments per existing authorized projects and for additional projects if the appropriate return on investment is projected. See Items 1-A-2 and 1-A-3.


The Company has substantial liquidity in the form of cash and cash equivalents and marketable securities to meet all of its anticipated capital requirements, to make dividend payments, and to fund future growth through acquisitions and other means. The bulk of its marketable securities are invested in the tax-exempt variable rate demand notes described above and in municipal bonds that are pre-refunded with escrowed U.S. Treasuries. The Company intends to continue its investment strategy of safety and short-term liquidity throughout its investment holdings. Comparative yields during 2012 were lower than those in the preceding year. The lower yields, combined with a decrease in the Company's investment holdings, served to decrease interest income. There can be no assurance that interest rates will not continue to decline. The interest rate environment is a function of national and international monetary policies as well as the growth and inflation rates of the U.S. and foreign economies, and is not controllable by the Company.

2011 COMPARED TO 2010

Cash provided by operating activities was $58,686,000 during 2011 as compared to $57,768,000 during 2010. The principal factors behind the increase in cash provided can be found in the changes in the components of working capital within the Consolidated Statements of Cash Flows. Of particular note during 2011 were net earnings of $47,968,000, reflecting a decrease in late fourth quarter sales and a reduction in accounts receivable levels. These items were offset by increases in inventory levels and deposits with vendors included in other current assets, and a decrease in payable levels. Of particular note during 2010 were net earnings of $63,531,000 and an increase in payable levels, largely reflecting deposits received from one customer during the year. Also of note were an increase in inventory levels and a change in other current assets attributable to additional deposits made to vendors.

Net cash provided by investing activities was $21,816,000 during 2011 compared to $1,542,000 used during 2010. Of note during 2011 were net maturities/sales of marketable securities of $41,559,000, partially offset by the acquisition of plant and equipment of $15,003,000, primarily to support the expansion of the Absorbent Products segment, and the acquisition of assets comprising a small business in the Defense segment, described in Note P to the Consolidated Financial Statements, of $4,526,000. Of note during 2010 was the $17,972,000 of cash used in the acquisition of plant and equipment primarily to support the expansion of the Absorbent Products segment. The purchase of plant and equipment was essentially funded through the sale of marketable securities.

Based on the accounting profession's 2005 interpretation of cash equivalents under Financial Accounting Standards Board ("FASB") Accounting Standard Codification ("ASC") 230, the Company's variable rate demand notes have been classified as marketable securities. This interpretation, which is contrary to the interpretation that the Company's representative received directly from the FASB (which indicated it would not object to the Company's classification of variable rate demand notes as cash equivalents), has resulted in a presentation of the Company's Consolidated Balance sheets that the Company believes understates the true liquidity of the Company's income portfolio. As of December 31, 2011 and 2010, $33,034,000 and $37,779,000, respectively, of variable rate demand notes are classified as marketable securities. These notes have structural features that allow the Company to tender them at par plus interest within any 7-day period for cash to the notes' trustees or remarketers, and thus provide the liquidity of cash equivalents.

The Company increased its dividends paid in 2011 by $0.10, which accounted for the increase in cash used in financing activities.

As a result of the foregoing factors, cash and cash equivalents increased in 2011 by $24,276,000 to $73,995,000.

Working capital decreased by $15,852,000 to $262,959,000 at December 31, 2011 for the reasons stated above. The Company's current ratio was 5.0 to 1.0 at December 31, 2011, compared to 5.2 to 1.0 at December 31, 2010.

DEFENSE SEGMENT BACKLOG

The Company's Defense segment contract backlog was approximately $310,000,000 at December 31, 2012, and $342,000,000 at December 31, 2011. Backlog is defined as the value of orders from the customer less the amount of sales recognized against the orders. It is anticipated that the backlog will be produced and shipped during an 18 to 24-month period.


       CONTRACTUAL OBLIGATIONS

       The below table discloses a summary of the Company's specified
       contractual obligations at December 31, 2012:




                                           Payments Due By Period (In thousands)

    Contractual                                                                          More Than
    Obligations            Total         Under 1 Year      1-3 Years      3-5 Years       5 Years

Operating lease
obligations             $        401    $          300    $        44    $        44    $        13
Purchase
obligations(1)               201,073           201,073              0              0              0
Earn-out payments(2)           3,000                 0          3,000              0              0

Total                   $    204,474    $      201,373    $     3,044    $        44    $        13

(1) Purchase obligations includes outstanding purchase orders at December 31, 2012. Included are purchase orders issued to the Company's housewares manufacturers in the Orient, to equipment manufacturers of absorbent products machinery, and to material suppliers and building contractors in the Defense and Absorbent Products segments. The Company can cancel or change many of these purchase orders, but may incur costs if its supplier cannot use the material to manufacture the Company's or other customers' products in other applications or return the material to their supplier. As a result, the actual amount the Company is obligated to pay cannot be estimated.
(2) The Company has agreed to make certain payments dependent upon the future performance of a Defense segment subsidiary based upon its anticipated future level of earnings.

CRITICAL ACCOUNTING POLICIES

The preparation of the Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the amount of reported assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and revenues and expenses during the periods reported. Actual results may differ from those estimates. The Company reviewed the development and selection of the critical accounting policies and believes the following are the most critical accounting policies that could have an effect on the Company's reported results. These critical accounting policies and estimates have been reviewed with the Audit Committee of the Board of Directors.

Inventories
New Housewares/Small Appliance product introductions are an important part of the Company's sales to offset the morbidity rate of other Housewares/Small Appliance products and/or the effect of lowered acceptance of seasonal products due to weather conditions. New products entail unusual risks and have occasionally in the past resulted in losses related to obsolete or excess inventory as a result of low or diminishing demand for a product. There were no such obsolescence issues that had a material effect during the current year and, accordingly, the Company did not record a reserve for obsolete product. In the future should product demand issues arise, the Company may incur losses related to the obsolescence of the related inventory. Inventory risk for the Company's other segments is not deemed to be significant, as products are largely built pursuant to customers' specific orders.

Self Insured Product Liability & Health Insurance The Company is subject to product liability claims in the normal course of business and is self-insured for health care costs, although it does carry stop loss and other insurance to cover claims once a health care claim reaches a specified threshold. The Company's insurance coverage varies from policy year to policy year, and there are typically limits on all types of insurance coverage, which also vary from policy year to policy year. Accordingly, the Company records an accrual for known claims and incurred but not reported claims, including an estimate for related legal fees in the Company's Consolidated Financial Statements. The Company utilizes historical trends and other analysis to assist in determining the appropriate accrual. There are no known claims that would have a material adverse impact on the Company beyond the reserve levels that have been accrued and recorded on the Company's books and records. An increase in the number or magnitude of claims could have a material impact on the Company's financial condition and results of operations.


Sales and Returns
Sales are recorded net of discounts and returns. The latter pertain primarily to warranty returns, returns of seasonal items, and returns of those newly introduced products sold with a return privilege. The calculation of warranty returns is based in large part on historical data, while seasonal and new product returns are primarily developed using customer provided information.

NEW ACCOUNTING PRONOUNCEMENTS

Please refer to Note A(17) to the Consolidated Financial Statements for information related to the effect of adopting new accounting pronouncements on the Company's Consolidated Financial Statements.

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