MICROPAC INDUSTRIES INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) Twelve Months Ended 11/30/12 11/30/11 Net Sales 100.0 % 100.0 % Cost of sales 71.1 % 65.8 % Research and Development 3.2 % 3.0 % Selling , General, and Administrative 21.7 % 19.2 % Total Cost & Expenses 96.0 % 88.0 % Operating Income 4.0 % 12.0 % Other and Interest Income .4 % .5 % Income before Income Taxes 4.4 % 12.4 % Provision for taxes 1.8 % 4.3 % Net Income 2.6 % 8.1 % The Company manufactures and distributes various types of hybrid microelectronic circuits, solid state relays, power operational amplifiers, and optoelectronic components and assemblies. The Company's products are used as components in a broad range of military, space and industrial systems, including aircraft instrumentation and navigation systems, power supplies, electronic controls, computers, medical devices, and high-temperature (200o C) products.

The Company's products are either custom (being application-specific circuits designed and manufactured to meet the particular requirements of a single customer) or standard proprietary components. Custom-designed components accounted for approximately 36% of the Company's sales for the fiscal year ended November 30, 2012, and were 34% for fiscal 2011.Standard components accounted for approximately 64% of the Company's sales for the fiscal year ended November 30, 2012, and were 66% for fiscal 2011.

The Company provides microelectronic and optoelectronic components and assemblies along with contract electronic manufacturing services and offers a wide range of products sold to the industrial, medical, military, aerospace and space markets.

9 --------------------------------------------------------------------------------The microcircuits product line, including custom microcircuits, solid state relays, power operational amplifiers, and regulators accounted for 30% of the Company's business in 2012, and the optoelectronics product line accounted for 70% of the Company's business in 2012, compared to 38% and 62% in 2011, respectively.

Sales in 2012 were approximately $17,699,000, a decrease of 12.4% or $2,506,000 compared to 2011 sales. The major decrease in sales was in microcircuits products with a delay or decrease in new orders in the space industry.

Sales through the Company's distribution channels were $5,127,000 in 2012 compared to $3,790,000 in 2011 or 29% and 19% of sales, respectively.

Approximately 18% of the sales for fiscal year 2012 (21% in 2011) were to international customers.

The Company's major customers include contractors to the United States government. Sales to these customers for the Department of Defense (DOD) and NASA contracts accounted for approximately 65% of the Company's revenues in 2012 compared to 62% in 2011.

The Company's major customers are Lockheed Martin, Northrop Grumman, Boeing, Rockwell, Goodrich, Raytheon, Rockwell Int'l, and NASA. Two of the Company's distributors accounted for 13% and 10% of the Company's sales during 2012 and no customer accounted for 10% or more of the Company's sales during 2011.

New orders for fiscal year 2012 totaled $21,240,000 compared to $15,538,000 for fiscal 2011. Approximately $11,797,000 of the new orders received in 2012 were delivered to customers in 2012, along with approximately $5,801,000 of the Company's $6,231,000 backlog of orders at November 30, 2011 resulting in a total billing of $17,598,000. In addition, the Company recognized $99,000 in deferred revenue from advance billings and $2,000 in other revenue for total revenue of $17,699,000 in 2012. The Company, with agreement from the customer, closed several orders prior to completion totaling approximately $23,000.

At November 30, 2012, the Company had a backlog of unfilled orders totaling approximately $9,850,000 compared to approximately $6,231,000 at November 30, 2011. The Company expects to complete and ship most of its November 30, 2012 backlog during fiscal 2013.

Cost of sales, as a percentage of net sales, was 71.1% in 2012 compared to 65.8% in 2011. The increase of 5.3% as a percent of sales is attributable to a decrease of $2,500,000 in sales of several microcircuit space level products in 2012 which generate overall higher margins. In actual dollars, cost of sales decreased $715,000 for 2012 versus 2011.

In 2012, the Company's investment in technology through research and development, which was expensed, totaled approximately $574,000 ($610,000 in 2011). The Company's research and development expenditures were directed primarily toward long-term specific customer requirements, some of which have future potential as Micropac proprietary products, and product development and improvement associated with the Company's space level and other high reliability programs.

Selling, general, and administrative expenses totaled 21.7% of net sales in 2012, compared to 19.2% in 2011, based on lower sales in 2012. In dollars expensed, selling, general and administrative expenses totaled $3,836,000 in 2012 as compared to $3,878,000 in 2011, a decrease of $42,000. The majority of the decrease was associated with lower commission expense associated with the lower sales in 2012.

Interest and other income for fiscal 2012 totaled $79,000 compared to $95,000 for fiscal 2011. The other income is related to the reclamation of precious metals, such as gold and silver (from scrap and obsolete material).

Income before taxes for fiscal 2012 was approximately $782,000, or 4.4% of net sales, compared to $2,511,000, or 12.4% of net sales in fiscal 2011. The decrease in income was associated with the lower product sales.

Provisions for income tax for fiscal 2012 totaled $326,000 compared to $868,000 for fiscal 2011. The Company's effective income tax rate was 42% for the year ended November 30, 2012 and was 35% for the year ended November 30, 2011. The increase in the effective rate was an increase in the Texas Franchise Tax that is based on margins as opposed to net income before taxes. As a percent of income before taxes, the Texas franchise tax was 7.7% in 2012 compared to 2.5% in 2011.

Net income totaled approximately $456,000 or $0.18 per share in 2012 versus 2011 net income of $1,643,000 or $0.64 per share.

10 --------------------------------------------------------------------------------Liquidity and Capital Resources On June 1, 2011, the Company renewed a $6,000,000 revolving line of credit agreement with a Texas banking institution for a term of two years. The interest rate is equal to the prime rate. The line of credit requires that the Company maintain a quick ratio of at least 1:1, maintain a tangible net worth of $10,000,000 and maintain a total liabilities to tangible net worth of less than 1.25:1. The Company has not, to date, used any of the available line of credit.

The Company used $403,000 of cash from operations in 2012, primarily from a decrease in net income which totaled $470,000 offset by a net change in working capital. The Company used $408,000 in cash for investment in additional manufacturing equipment and improvements to buildings in 2012 compared to $807,000 in 2011.

The Company issued a dividend payment of $.10 per share to all shareholders of record for each of the last two years. The total dividend payment was $258,000 per year.

As of November 30, 2012, the Company had $7,415,000 in cash and cash equivalents compared to $8,488,000 in cash and cash equivalents on November 30, 2011. The Company held $2,004,000 in short term investments at November 30, 2012 and $2,000,000 at November 30, 2011.

The Company continues on-going investigations for the use of cumulative cash for business expansion and improvements, such as operational improvements, new product expansion, facility upgrades, and acquisition opportunities.

Company management believes it will meet its 2013 capital requirements through the use of cash derived from operations for the year and/or usage of the Company's cash and cash equivalents. There were no significant outstanding commitments for equipment purchases or improvements at November 30, 2012.

Off-Balance Sheet Arrangements The Company has no significant off-balance sheet arrangements.

Critical Accounting Policies Revenue Recognition Revenues are recorded as shipments are made based upon contract prices. Any losses anticipated on fixed price contracts are provided for currently. Sales are recorded net of sales returns, allowances and discounts.

The Company recognizes revenue in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Subtopic 605-10-S99, Revenue Recognition (ASC 605-10-S99). ASC 605-10-S99 requires that four basic criteria must be met before revenues can be recognized: (1) persuasive evidence of an arrangement exists; (2) shipment has occurred or services have been rendered; (3) the fee is fixed and determinable; and (4) collectability is reasonably assured.

Inventories Inventories are stated at lower of cost or market value and include material, labor and manufacturing overhead. All inventories are valued using the FIFO (first-in, first-out) method of inventory valuation. The Company determines the need to write inventory down below its cost via an analysis based on the usage of inventory over a three year period and projected usage based on current backlog.

Income Taxes The Company accounts for income taxes using the asset and liability method.

Under this method the Company records deferred income taxes for the temporary differences between the financial reporting basis and the tax basis of assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. The resulting deferred tax liabilities and assets are adjusted to reflect changes in tax law or rates in the period that includes the enactment date.

11 --------------------------------------------------------------------------------In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax-planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences.

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