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SRMC > SEC Filings for SRMC > Form 10-K on 28-Mar-2013All Recent SEC Filings

Show all filings for SIERRA MONITOR CORP /CA/ | Request a Trial to NEW EDGAR Online Pro

Form 10-K for SIERRA MONITOR CORP /CA/


28-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Results of Operations - Fiscal 2012 vs. Fiscal 2011

For the fiscal year ended December 31, 2012, our net sales were $18,759,030, compared to net sales of $15,529,041 in the prior fiscal year ended December 31, 2011. Net sales increased approximately 21% in 2012 compared to the prior year. Our income from operations before interest income and income taxes was $1,954,903 in 2012, compared to operating income before interest income and income taxes of $1,436,598 in 2011. Net income in 2012 was $1,195,829, or $0.12 per share, compared to net income of $868,947, or $0.09 per share, in 2011.

Sales of our FieldServer communications bridge products increased approximately 10% in 2012 compared to 2011. FieldServer offerings include box products and Original Equipment Manufacturer (OEM) modules. Box products provide a platform for delivery and operation of our software for building automation integration and are generally sold to integrators. In early 2011 we completed the introduction of a more competitive FieldServer box product with a lower selling price resulting in generally lower revenue in 2011 than in 2010. In 2012 the volume of unit sales increased sufficiently to offset the lower selling price, contributing to an 8% increase in sales of box products as compared to 2011. OEM modules sold under the trade name ProtoCessors are small electronic assemblies that deliver our software functionality to equipment manufacturers. ProtoCessor shipments increased approximately 11% in 2012 compared to 2011. ProtoCessor sales depend upon the adoption into equipment manufacturers' designs for a range of products from lighting controls to roof top air conditioners, variable frequency drives and others. In 2012 approximately eleven new customers began purchasing production quantities of ProtoCessor products, while most existing customers increased their purchasing quantities.

Our sales of gas detection products, including industrial accounts and military sales, increased by approximately 39% in 2012 compared to 2011. Increased international sales, including shipment during the first and second quarters of 2012 of a single order with a value exceeding $2,500,000, and stronger sales to Latin America and Asia, offset lower domestic sales. We believe that the lower domestic sales, which reflect a 24% decrease in Military shipments, are due to the generally weak domestic economy.

Sales of environment controller products, which are used by telecommunications companies, decreased by approximately 18% in 2012 compared to 2011. We supply controllers to OEM accounts for installation in new remote telephone company buildings used primarily by Comcast, AT&T and T-Mobile. In 2012, we observed a low level of infrastructure spending by major telecommunications companies, which we believe to have been the result of general economic conditions. We also sell spare parts to the telephone companies for support of the installed base of our controllers. The demand for spare parts is generally consistent on a year to year basis.

Gross profit as a percent of sales was approximately 56% in 2012 and 59% in 2011. Our gross margins vary by product mix and channel of distribution. In particular, domestic sales generate higher margins but also higher selling expenses, while international shipments are sold at a discount and have lower selling expenses. Our lower margins in 2012 were primarily the result of the higher percentage of international sales. We did not experience any significant increases in material costs due to the weak economy and the resulting general lack of normal demand levels for fabricated materials and electronic components. Increases in our labor costs were generally offset by product pricing increases.

Research and development expenses, which include new product development and support for existing products, were $2,167,548, or 12% of net sales, in the fiscal year ended December 31, 2012, compared to $2,204,610, or 14% of net sales, in the fiscal year ended December 31, 2011. We maintained our historical level of spending for engineering projects in an effort to continue to produce new products and product enhancements. While we continue to produce new products, generally in the form of new software programs known as protocol drivers, we also completed a project to introduce a new gas detection controller and continued migration of our FieldServer user tools from a textual interface to web-browser supported graphical user interface. We also initiated a project to replace a critical single sourced component with a manufactured equivalent.

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Selling and marketing expenses were $4,081,745, or 22% of net sales, in 2012, compared to $3,459,110, or 22% of net sales, in the prior year. Increases in sales salaries, commission expenses and advertising contributed to the increase in selling and marketing expenses. We are continuing a program to increase our sales coverage in both domestic and international markets.

General and administrative expenses, which include salaries and benefits, professional fees, and product and general liability insurance, were $2,236,415, or 12% of net sales, in 2012, compared to $2,087,382, or 13% of net sales, in 2011. Higher compensation, depreciation and travel expenses contributed to the higher general and administrative expenses for 2012 compared to 2011.

Our financial results reflect a revenue increase of $3,229,989 and an increase in income from operations of $518,305 over the prior year. All of our current deferred income tax benefits have been utilized. We are currently expensing income taxes at the maximum corporate rate.

Liquidity and Capital Resources

Our working capital at December 31, 2012 was $6,887,628, compared to working capital of $5,628,791 at December 31, 2011. There were no significant equity or long-term debt transactions in 2012.

Inventories on hand at December 31, 2012 were $2,994,804, a decrease of $923,357 compared to the end of the prior year. Current inventory levels are consistent with our historical experience. The higher inventories on hand at the end of 2011 were required to support a single large order that shipped in the first quarter of 2012.

At December 31, 2012, our balance sheet reflected $2,306,258 of cash on hand compared to $1,212,426 at December 31, 2011. The increase in cash is due, in part, to the increase in net profit and the reduction of inventory on hand.

Our net trade receivables at December 31, 2012 were $1,913,185 compared to $1,647,948 at December 31, 2011. Trade receivables measured by days of sales outstanding increased to 42 days at December 31, 2012 compared to 39 days at December 31, 2011.

Income taxes paid totaled $898,893 during 2012 compared with $602,814 during 2011.

At December 31, 2012 and 2011, we had no long term liabilities. The company has $20,000 of Deferred Revenue at December 31, 2012 which is included in other current liabilities on the balance sheet and is expected to be recognized in the first quarter of 2013. We had $254,000 of Deferred Revenue at December 31, 2011.

We maintain a $1,000,000 line of credit with our commercial bank, secured by certain assets of ours. The line of credit requires annual renewal and compliance with certain restrictive covenants, including the requirement to maintain a quick ratio of 1.3:1.0 and a profitability test. At December 31, 2012, we were in compliance with the financial covenants and there were no borrowings on the line of credit.

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We believe that our present resources, including cash and accounts receivable, are sufficient to fund our anticipated level of operations through at least January 1, 2014. There are no current plans for significant capital equipment expenditures.

Inflation

We believe that inflation will not have a direct material effect on our results of operations.

The economic factors that could adversely impact our business in 2013 include, but are not limited to, currency fluctuations as we buy materials and sell products internationally and also fluctuations in materials prices. Recent fluctuations in stainless steel and aluminum prices and electronic component supply problems due to Thailand floods are examples of the factors that can impact our margins. We consider it necessary to maintain an elevated inventory level of critical components to mitigate potential supply disruptions.

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 our consolidated financial statements and the accompanying notes. The amounts of assets and liabilities reported on our balance sheet 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:

Revenue Recognition

A detailed discussion of our revenue recognition policies is contained in Note 1 (Summary of the Company and Significant Accounting Policies) of the notes to financial statements below. The discussion is incorporated herein by reference.

Accounts Receivable

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 payments, including cash wire advance payments and letters of credit. International sales are made on open account terms only where sufficient historical experience justifies the credit risks involved. In many of our larger sales, the customers are frequently construction contractors who are in need of our start-up services to complete their work and obtain payment. Management's ability to manage the credit terms and take advantage of the leverage of the 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 insure that it is adequate to the best of management's knowledge. We believe that we have demonstrated the ability to make reasonable and reliable estimates of product returns and of allowances for doubtful accounts based on significant historical experience. Trends of sales returns, exchanges and warranty repairs are tracked as a management review item in our International Organization for Standardization ("ISO") quality program, and data generated from that program forms a basis for the reserve management.

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Inventories

Inventories are stated at the lower of cost or market, cost being determined on the first-in, first-out method. We use an Enterprise Requirements Planning ("ERP") software system which provides data upon which management can rely to determine inventory trends and identify excesses. Write-downs of slow moving and obsolete inventories are determined based on historical experience and current product demand. We evaluate the inventory for excess or obsolescence on a quarterly basis. The ultimate write-down is dependent upon management's ability to forecast demands accurately, manage product changes efficiently, and interpret the data provided by the ERP system.

The market cost of our inventory is equal to the realizable value which is based on management's forecast for sales of our products in the ensuing years. The industry in which we operate is characterized by technological advancements and change. Should demand for our products prove to be significantly less than anticipated, the ultimate realizable value of our inventory could be substantially less than the amount shown on the accompanying balance sheet.

Determination of Applicability of Valuation Allowance for Deferred Tax Assets

We determine the applicability of a valuation allowance against the accrued tax benefit by evaluating recent trends including sales levels, changes in backlog and fixed expenses. We also consider our plans for the current twelve month period regarding activities that would change the level of expenses relative to historical trends.

At December 31, 2012 and 2011, we determined that, based on the profitable results and full utilization of the available deferred tax benefits, no valuation allowance against the remaining deferred tax asset is required.

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