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SRMC > SEC Filings for SRMC > Form 10-K on 27-Mar-2014All Recent SEC Filings

Show all filings for SIERRA MONITOR CORP /CA/

Form 10-K for SIERRA MONITOR CORP /CA/


27-Mar-2014

Annual Report


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

Results of Operations - Fiscal 2013 vs. Fiscal 2012

For the fiscal year ended December 31, 2013, our net sales were $18,345,179, compared to net sales of $18,759,030 in the prior fiscal year ended December 31, 2012. Net sales decreased approximately 2.2% in 2013 compared to the prior year. Our income from operations before interest income and income taxes was $2,218,399 in 2013, compared to operating income before interest income and income taxes of $1,954,903 in 2012. Net income in 2013 was $1,352,589, or $0.13 per share, compared to net income of $1,195,829, or $0.12 per share, in 2012.

Sales of our FieldServer communications bridge products increased approximately 4% in 2013 compared to 2012. FieldServer products are generally sold to integrators, generally related to building automation for energy efficiency, and to Original Equipment Manufacturers (OEM's) for a broad range of products from lighting controls to roof-top air conditioners, window and drape controls and others. In 2013 OEM customers began purchasing production quantities of approximately twenty new ProtoCessor products while most existing customers increased their purchasing quantities.

Our sales of gas detection products, including industrial accounts and military sales, decreased by approximately 7% in 2013 compared to 2012. In 2012, a single large international order accounted for approximately 26% of gas detection sales. Excluding that single order, our 2013 gas detection sales were increased 26% compared to the prior year aided by strong sales of gas detection systems to the U.S. Navy.

We also sell environment control products for high-value remote telecommunications buildings including cell towers and underground vaults. Due to the low level of demand for new remote buildings our sales of environment control products for telecommunications buildings decreased by approximately 8% in 2013.

Gross profit as a percent of sales was approximately 58% in 2013 and 56% in 2012. 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 margins in 2013 were consistent with our historical levels but higher than 2012 primarily as the result of the higher percentage of domestic sales in 2013. We did not experience any significant increases in costs for materials including electronic components, fabricated materials and contract assembly. 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 $2,156,322, or 12% of net sales, in the fiscal year ended December 31, 2013, compared to $2,167,548, or 12% of net sales, in the fiscal year ended December 31, 2012. 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 the introduction of new gas detection modules and continued migration of our FieldServer user tools from a textual interface to a web-browser supported graphical user interface. Additionally, we completed a project to replace a critical single-sourced component with a manufactured equivalent.

Selling and marketing expenses were $4,094,819, or 22% of net sales, in 2013, compared to $4,081,745, 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.

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General and administrative expenses, which include salaries and benefits, professional fees, and product and general liability insurance, were $2,246,301, or 12% of net sales, in 2013, compared to $2,236,415, or 12% of net sales, in 2012. Higher compensation, professional fees and IT support services were partially offset by lower depreciation and maintenance fees.

Our financial results reflect a revenue decrease of $413,851 and an increase in income from operations of $263,496 over the prior year. All of our current deferred income tax benefits have been utilized. We are currently accruing income taxes at the maximum corporate rate.

Liquidity and Capital Resources

Our working capital at December 31, 2013 was $7,780,766, compared to working capital of $6,887,628 at December 31, 2012. We undertook no significant equity or long-term debt transactions in 2013.

Inventories on hand at December 31, 2013 were $2,740,835, a decrease of $253,969 compared to the end of the prior year. Current inventory levels are consistent with our historical experience.

At December 31, 2013, our balance sheet reflected $3,421,679 of cash on hand compared to $2,306,258 at December 31, 2012. 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, 2013 were $1,943,643 compared to $1,913,185 at December 31, 2012. Trade receivables measured by days of sales outstanding decreased to 36 days at December 31, 2013 compared to 42 days at December 31, 2012.

Income taxes paid totaled $806,262 during 2013 compared with $898,893 during 2012.

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, 2013, we were in compliance with the financial covenants, and there were no borrowings on the line of credit.

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, 2015. 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 2014 include, but are not limited to, currency fluctuations as we buy materials and sell products internationally and also fluctuations in materials prices. 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:

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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 leverage 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.

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.

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At December 31, 2013 and 2012, 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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