ITEM 1. Business.
General
Micronetics was incorporated in New Jersey in 1975 and re-incorporated in Delaware in 1987.
Business of Issuer
Headquartered in Hudson, New Hampshire, Micronetics manufactures microwave and radio frequency (RF) components and integrated multifunction subassemblies used in a variety of commercial wireless, defense and aerospace products, including satellite communications, electronic warfare and electronic counter-measures. We also manufacture and design test equipment, subassemblies and components that are used to test the strength, durability and integrity of signals in communications equipment. Our products are embedded in a variety of radars, electronic warfare systems, guidance systems, wireless telecommunications and satellite equipment. Our microwave devices are used on subassemblies and integrated systems in addition to being sold on a component basis.
Micronetics operates through its four wholly-owned subsidiaries, Microwave Concepts, Inc. (“Micro-Con”), Microwave & Video Systems, Inc. (“MVS”), Stealth Microwave, Inc. (“Stealth”) and MICA Microwave Corporation (“MICA”). These subsidiaries, along with Micronetics’ NH based facility, manufacture products in three major product categories: RF Microwave Components, Microwave Integrated Multifunction Subassemblies and Test Solutions.
Management has determined that we operate as a single integrated business and as such have one operating segment as a provider of RF and microwave components and sub-assemblies for defense and commercial customers worldwide. Our product groups have similar characteristics such as cost to design and manufacture, applications, types of customers, and sales channels.
The following are descriptions of Micronetics’ three major product categories:
RF Microwave Components:
Micronetics’ RF Microwave Component product family consists of high performance receiver components, noise components, voltage controlled oscillator components, linearized and non-linearized power amplifier
components and ferrite components. These components are designed and manufactured at our wholly-owned subsidiaries MVS, Micro-Con, Stealth, MICA and the Micronetics’ NH facility.
Our receiver components (switches, attenuators, phase shifters, detectors and mixers) are used widely in military ground-based, shipboard and airborne radar for tracking and simulation, phased array radar, electronic warfare systems, electronic intelligence and tactical/satellite communication systems. In addition, receiver components have commercial applications such as wireless communications, radar surveillance and test equipment to support systems. This category of products offers several competitive technical advantages, including a dedicated high power design and development facility, which manufactures receiver components in power levels up to 1200W CW (carrier wave). These designs are successfully embedded into applications such as radar measurement, airborne synthetic aperture radar polarization and receiver protection in radar and communications. In addition, Micronetics also offers high power testing services.
Micronetics’ noise components are employed in testing and measuring sophisticated communication systems to determine the quality of the reception and transmission of information. The widest application for our noise components is as a reference standard in test instruments that measures unwanted noise in devices and components. Our noise components are used in wireless communication systems as part of built-in test equipment to continuously monitor the quality of the receiver. The major application of the noise source components involves some function of detection, calibration, simulation, security and statistical analysis. The components apply impulses of noise to the receiver to measure the radar sensitivity, signal gain, and frequency bandwidth. Our components used in conjunction with other electronic components are an effective means of jamming, blocking and disturbing hostile radar and other communications, as well as insulating and protecting friendly communications. Micronetics’ noise source components are also used to test satellite communications and automated test equipment.
Micronetics’ voltage controlled oscillators (VCOs) provide a precise signal source within a given frequency range. These products generate sinusoidal signals in frequency ranges from 100MHz to over 7.5GHz, utilizing packaged silicon bipolar transistors that are controlled by an input voltage signal. Our VCOs are used in wireless applications including some military communications and satellite voice/messaging. We offer products in a series of narrow-band, wide-band and selective octave tuning bandwidths. Depending on the series, packaging configurations for MIL and commercial applications include PIN types, SMT, hermetic and miniature packages.
Micronetics designs and manufactures a broad selection of linearized and non-linearized power amplifiers including analog and digital pre-distortion products. Our specialized amplifiers are designed with a proprietary linearization capability that allows for smaller size amplifier solutions with a fraction of the power consumption. Our amplifier products are used in various commercial and military applications, and are currently in operation in applications such as base stations for commercial telecommunications standards to 3G and 4G standards, portable mobile video transmitters, MMDS transmitters, digital electronic news gathering equipment, RF test and measurement, multi-band military radio systems for man-pack, vehicular, and flight applications military countermeasures, jamming systems, and RF medical devices.
Micronetics designs and manufactures broadband mixers and ferrites. Our products offer exceptional performance for systems where spectral purity is important, including IED Jamming, TD-CDMA, WiMAX, COFDM, Radar, Electronic Warfare and Space applications.
Microwave Integrated Multifunction Subassemblies:
Micronetics designs and manufactures complex microwave integrated multifunction subassemblies, also known as microwave multifunction modules, which consist of sophisticated assemblies that perform many functions related to the switching of microwave signals. Micronetics’ integrated subassemblies are employed in several defense, commercial or aerospace electronics systems and programs. These subassemblies combine
microwave functions such as amplification, attenuation, switching of multiple signals, and phase and amplitude control. We also facilitate the assembly and testing services of high-end, customer-designed RF microwave assemblies, including all assembly, testing and environmental screening of customer-designed complex subassemblies.
The primary design and development of these subassemblies is performed at our Micro-Con facility, where the manufacturing capability extends across the 0.1GHz to 40GHz frequency range for both broadband multi-octave and narrowband applications. We have design proficiencies in over 125 unique designs that include such highly integrated multi-function modules as, low noise receivers, both up and down conversion modules, RF microwave distribution networks, transmit drivers, broadband frequency synthesizers and phase/amplitude control networks.
Test Solutions
Micronetics designs and manufactures several broadband test solution platforms specifically designed to serve the wireless telecommunications and satellite communication markets employing such application standards as TDMA, CDMA, GSM, PCS, HDTV and other markets employing cable modem transmission and other internet infrastructure applications. The test equipment is centered around the following four platforms: Carrier-to-Noise, Automated Noise Generators, bench-top Noise Generators and hand-held Power Meter instruments. These platforms perform a variety of tests, which are used in performance verification, and the emulation of impairments in cellular/PCN/PCS, satellite, television and cable modem communication systems.
Overview of Markets Served
Defense/Aerospace Marketplace
The defense/aerospace marketplace is in a period of transition, attempting to keep pace with a U.S. military strategy that has been evolving to respond to the decentralized, asymmetric threats that have emerged since the mid-1980s. Current U.S. defense strategy and force structure is moving towards lighter, smarter and more flexible weapons systems with an emphasis on intelligence, surveillance and reconnaissance.
The defense industry is currently dominated by a small number of large domestic prime contractors and a few large European defense companies with an increasing presence in U.S. markets. The large defense prime contractors have shifted their business strategies to focus on platforms and systems integration and consequently have subcontracted the development of many systems and subsystems.
The current business, political and global security environments continue to provide opportunities for mid-tier defense/aerospace manufacturers, like us, to develop strategic relationships with prime contractors. Retro-fits and upgrades of existing platforms continue to be funded even as major new programs are being deferred.
Commercial Marketplace
Wireless communication is the transmission of voice and data signals through the air, without a physical connection, such as metal wire or fiber-optic cable. Information transmitted through wireless communications equipment is transmitted by electromagnetic waves, also known as signals. Electromagnetic waves vary in length, or frequency, and intensity. The range of electromagnetic waves is called the spectrum, which encompasses sound near the low end and light toward the higher end. In between is the radio spectrum that is used in all wireless communications. RF indicates lower frequencies, while “microwave” refers to relatively higher frequencies in the spectrum.
Different types of wireless communications systems utilize different frequencies in the spectrum. Frequency is measured in cycles per second, or Hertz. The spectrum currently in use by all types of wireless communications equipment ranges from 1 kilohertz (1 thousand cycles per second) to 20 gigahertz (20 billion
cycles per second). The Federal Communications Commission (“FCC”) allocates portions of the spectrum for the various types of wireless communication systems. Wireless communications systems currently in use include cellular and PCS telephones and base stations, wireless cable, satellite communications, global positioning systems, direct broadcast satellites, local area networks, as well as radar systems. Non-wireless communications systems are also concerned whether there is unwanted noise in the line that could disrupt the integrity of the communicating signals. Our products are designed for use in wireless and non-wireless applications.
A key driver of demand for Micronetics’ products is the pervasive transformation of information from the analog domain to the digital domain. Because digital technologies require greater degrees of precision and rely more on miniature circuits than analog technologies, testing is critical for the rapid commercialization of reliable products necessitated by broadband and wireless communication technologies. In addition as speed to market requirements increase, larger companies are increasingly outsourcing the manufacture and testing of components and integrated subassemblies to meet their customer requirements. Micronetics has been seeking to capitalize on this trend by increasing its capability for manufacturing and testing integrated subassemblies and leveraging our designs of high power, noise and mixer component technologies to continue to be a vital microwave subsystem supplier.
Micronetics’ overall strategy in these markets is to:
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INCREASE VALUE THROUGH HIGHER LEVELS OF INTEGRATION AND BUILT-IN SELF TEST. Combining our microwave components and microwave subsystem designs, we are able to achieve significant cost reduction and improved reliability over subsystems based on components alone. This is an attractive solution for long-term high reliability programs.
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REMAIN A LEADING SUPPLIER OF KEY TECHNOLOGIES. We are a leading supplier of certain key technologies in all our business segments. Our core competencies are our broadband noise sources, low noise amplifiers, low IMD switches and mixers, high power components and linearized power amplifiers. These areas provide a real lead into many microwave system applications.
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STRENGTHEN OUR EXISTING RELATIONSHIPS WITH PRIME CONTRACTORS. Our history as a supplier of quality high reliability microwave components for airborne platforms has established us as a key supplier to many prime contractors. We continue to leverage off that legacy to support higher integration subsystems with those prime contractors.
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CAPITALIZE ON OUTSOURCING DYNAMICS IN THE AEROSPACE AND DEFENSE INDUSTRY. As new platforms are becoming increasingly expensive and world threats are becoming less defined, key industries are facing an urgent need to upgrade existing platforms with new electronics. Government agencies are working with smaller companies as opposed to the large OEMs for these upgrades. Our ability to provide a timely, cost effective, and reliable design upgrade allows us to become a key provider in this area.
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PURSUE STRATEGIC ACQUISITIONS. We will continue to look for small profitable, entrepreneurial organizations with compatible technologies for potential acquisitions. We believe our philosophy of adding some corporate structure, sharing sales and marketing intelligence and combining forces to win large microwave subsystems positions us for growth.
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CONTROL COSTS THROUGH OUTSOURCING. We have controlled costs of goods sold through the use of manufacturing partners. These partnership arrangements allow us to focus on the quality, integrity and intelligence of our engineering designs, while maintaining tight control over costs, scheduling, quality, manufacturing and final test.
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MAINTAIN DIVERSITY IN THE DEFENSE AND COMMERCIAL MARKETPLACE. We balance business in defense with commercial marketplaces in order to diversify our customers. The defense marketplace provides stable growth opportunities with long-range visibility, while the commercial marketplace offers more aggressive growth opportunities and is more variable. We believe this dual focus maximizes our growth potential.
Manufacturing
Our components that require automated assembly equipment are generally manufactured by third parties and tested by Micronetics for quality assurance. The production process for these products is usually completed within two to three weeks. Manufacturing of our other products, which involve less automated assembly equipment, takes place at our Hudson, NH, Monroe, CT, West Caldwell, NJ, Trenton, NJ, or Manteca, CA facilities. The production process for these products ranges from one to twenty-four weeks.
Micronetics, Micro-Con, and Stealth are ISO 9001: 2000 certified facilities. Independent ISO 9001 quality system registrars certified these facilities as compliant, following rigorous audits to assess our quality assurance systems against ISO certification requirements. To be in compliance with ISO standards, we had to demonstrate our use of well-documented and highly disciplined controls and processes to ensure consistency and reliability of product quality, interaction with our customers and a continuous effort to improve.
MICA is an AS9100C certified facility. AS9100 is the quality management system for the aviation, space and defense industries. AS9100 fully incorporates ISO 9001 while adding additional requirements specific to quality and safety for aerospace.
Suppliers
We have approximately 500 suppliers, a few of which are the sole source for some raw materials. During the past ten years, we have experienced limited supply problems and do not anticipate any material increase in these problems in the foreseeable future. We do not believe there would be any significant business disruption if we were to lose one of our sole suppliers because we generally have sufficient inventory to give us time to develop an alternative supplier.
Sales and Marketing
Our sales are made primarily through direct sales personnel or through independent sales representatives who promote and solicit orders for our products on a commission basis in exclusive marketing territories. We select our sales representatives on the basis of technical and marketing expertise, reputation within the industry and financial stability. These sales representatives represent other manufacturers with products complementary to, rather than competitive with Micronetics’ products.
We also promote our products through field visits to customers, telephone solicitation, direct mailing campaigns, advertising in trade journals, participation in trade shows and maintenance of a website.
The mix of sales for Fiscal 2012 was 78% for defense applications and 22% for commercial applications as compared to 77% defense and 23% commercial for Fiscal 2011.
Customers
We sell primarily to original equipment manufacturers of communications equipment in either the commercial or the defense electronic marketplace. Many of those customers are prime contractors for defense work or larger Fortune 500 companies with world-wide operations. Our three largest customers, ITT Exelis, BAE Systems and Tecom Industries, Inc., accounted for 36%, 13% and 5% of the consolidated sales in Fiscal 2012, respectively.
Other customers of Micronetics include Lockheed Martin Corporation, Raytheon Company, Richardson RFPD, Inc., Rockwell Collins, Cobham, Northrop Grumman Corporation, L3 Communications Corporation, EADS Deutschland GMBH, Thales and the Department of Defense.
Competition
We are subject to active competition in the sale of virtually all of our products. Many of our competitors, including divisions of major corporations, have significantly greater resources than those currently available to us. Additionally, some of our customers compete directly by manufacturing certain components themselves, rather than purchasing them from Micronetics.
Our primary competitors are AeroFlex, Crane, Cobham PLC, Comtech Telecommunications, Kratos, Smiths Interconnect, API Technologies Corp., Teledyne Technologies and Mercury Computer.
Micronetics’ competitive position is supported by:
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A HISTORY OF RELIABILITY ON AIRBORNE PROGRAMS. We have an excellent performance track record in airborne programs. Our experience has allowed us to deliver complex integrated subsystems to meet the exacting requirements of airborne in-flight satellite broadcasting.
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DIVERSE PRODUCTS AND MARKET BASE. With a balanced combination of defense and commercial markets, we are able to leverage technology development for defense programs to commercial products and the volume on commercial applications reduces manufacturing cost for our defense products.
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SUCCESSFUL ACQUISITION TRACK RECORD. Our goal is to selectively expand our company through acquisitions which increase manufacturing capacity or design capabilities for complex integrated subassemblies.
Research and Development
Research and development consist of development of new products and modifications to existing products usually in response to customers’ specific design requirements. Occasionally we will invest in new technology development without a customer specification if we believe the technology has significant potential to result in future business opportunities. Research and development expenditures consist primarily of internal engineering time and materials. Occasionally we will outsource technology development. These expenses were $1,454,460 for Fiscal 2012 and $1,790,803 for Fiscal 2011, respectively. Micronetics research and development expense varies to a certain degree based upon emerging technologies, shifts in product requirements and our assessment of future business opportunities.
Micronetics intends to continue our research and development activities and considers these efforts to be vital to its future growth and success.
Backlog
Micronetics’ backlog of firm orders was approximately $26 million and $31 million on March 31, 2012 and 2011, respectively.
Government Regulatory Matters
In many instances, we have been required to obtain export licenses before filling foreign orders. United States Export Administration regulations control high tech exports like our products for reasons of national security and compliance with foreign policy, to guarantee domestic reserves of products in short supply and, under certain circumstances, for the security of a destination country. Thus, any foreign sales of our products requiring export licenses must comply with these general policies. Although we have not experienced any significant export licensing problems to date, such problems may arise in the future, since many of our
products have military and other governmental applications. These regulations are subject to change, and any such change may require us to improve our technologies, incur expenses or both in order to comply with such regulations.
Employees
As of March 31, 2012, we had 208 full-time employees including 50 engaged in management and administration, 37 in product development, 115 in production and testing and 6 in sales. Management believes that relations with our employees are good.
Intellectual Property
Due to the rapid rate of technological change in our market, we believe the ability to innovate is of greater importance to our business than availability of patents and proprietary rights. We believe barriers to competitor entry into our markets include the time and expense necessary to design and manufacture components and the difficulty of selling to an established customer who has already designed our products into its equipment.
We have registered “Micronetics” as a trademark with the U.S. Patent and Trademark Office.
Warranty and Service
We generally provide one-year warranties on all of our products covering both parts and labor. Micronetics, at its option, repairs or replaces products that are defective during the warranty period if the proper preventative maintenance procedures have been followed by the customer. Repairs that are necessitated by misuse of such products or are required outside the warranty period are not covered by warranty.
In the case of defective products, the customer typically returns them to our facility. Micronetics’ service personnel replace or repair the defective items and ship them back to the customer. Generally, all servicing is done at our plants, and we charge our customers a fee for those service items that are not covered by warranty. We do not offer our customers any formal written service contracts.
Product Liability Coverage
The testing of electronic communications equipment and the accurate transmission of information entail a risk of product liability by customers and others. Claims may be asserted against Micronetics by end-users of any of our products. We maintain product liability insurance coverage with an aggregate annual liability coverage limit, regardless of the number of occurrences, of $2.0 million. There is no assurance that such insurance will continue to be available at a reasonable cost or sufficient to cover all possible liabilities.
Environmental Laws
The costs and effects of compliance with federal, state and local environmental laws were not material to our business.
Item 1A.
Item 1A. Risk Factors.
An investment in our common stock involves a high degree of risk. You should carefully consider the following risk factors in evaluating our business. If any of these risks, or other risks not presently known to us or that we currently believe are not significant, develops into an actual event, then our business, financial condition and results of operations could be adversely affected. If that happens, the market price of our common stock could decline.
We may be materially and adversely affected by reductions in spending by certain of our customers including the U.S. and foreign governments.
Our results of operations may be materially adversely affected by the conditions in the global economy and the impact of those conditions on U.S. and foreign government spending. Among the factors that could impact U.S. and foreign government spending are:
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a significant decline in, or reapportioning of, defense budgets;
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changes, delays or cancellations of U.S. or foreign government programs or requirements;
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the adoption of new laws or regulations that affect companies that provide services to the U.S. or foreign government; and
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government shutdowns or other delays in the government appropriations process.
In recent years, demand for our products has been favorably impacted by an upward trend in U.S. defense spending. Although the ultimate size of future defense budgets remains uncertain, current indications are that the total U.S. defense budget may decline over the next few years. Future defense budgets, however, may be impacted by numerous economic and political factors. In addition, the specific programs in which we participate, or in which we may seek to participate in the future, must compete with other programs for consideration during the budget formulation and appropriation processes. While we believe many of our products are used in high priority military/defense programs, one or more of the programs that we currently serve could be phased-out or terminated. Reductions in these existing programs, unless offset by other programs and opportunities, would adversely affect our future revenues and profitability.
Our operating results have historically been subject to yearly and quarterly fluctuations and are expected to continue to fluctuate.
Our operating results have historically been and are expected to continue to be subject to quarterly and yearly fluctuations as a result of a number of factors including:
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our reliance on a limited number of customers for a large portion of our revenues;
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our ability to successfully implement programs to stimulate sales by anticipating and offering the kinds of products and services customers will require in the future to increase the efficiency and profitability of their products;
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our ability to successfully complete programs on a timely basis, to reduce our cost structure, including fixed costs, to streamline our operations and to reduce product costs;
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our ability to focus our business on what we believe to be potentially higher growth, higher margin businesses and to dispose of or exit non-core businesses;
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increased price and product competition in our markets;
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the inherent uncertainties of using forecasts, estimates and assumptions for asset valuations and in determining the amounts of accrued liabilities and other items in our consolidated financial statements;
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our ability to implement our work plan without negatively impacting our relationships with our customers, the delivery of products based on new and developing technologies, the delivery of high
quality products at competitive prices, the maintenance of technological leadership, the effectiveness of our internal processes and organizations and the retention of qualified personnel;
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fluctuations in our gross margins;
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the development, introduction and market acceptance of new technologies;
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variations in sales channels, product costs and the mix of products sold;
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the size and timing of customer orders and shipments;
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our ability to maintain appropriate inventory levels;
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the impact of acquired businesses and technologies;
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the impact of our product development schedules, product quality variances, manufacturing capacity and lead times required to produce our products;
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changes in legislation, regulation and/or accounting rules; the impact of higher insurance premiums and deductibles and greater limitations on insurance coverage; and
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acts of terrorism or the outbreak of hostilities or armed conflict between countries.
There are a number of trends and factors which affect our markets, including economic conditions in the United States, Europe and globally, and are beyond our control. These trends and factors may result in reduced demand and pricing pressure on our products.
There are trends and factors affecting our markets that are beyond our control and may affect our operations. Such trends and factors include:
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adverse changes in the public and private equity and debt markets and our ability, as well as the ability of our customers and suppliers, to obtain financing or to fund working capital and capital expenditures;
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reduced capital spending and/or negative economic conditions in the United States, Europe as well as other areas of the world;
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adverse changes in our current credit condition or the credit quality of our customers and suppliers;
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adverse changes in the market conditions in our markets;
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the trend towards the sale of integrated products;
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visibility to, and the actual size and timing of, capital expenditures by our customers;
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inventory practices, including the timing of product and service deployment, of our customers;
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policies of our customers regarding utilization of single or multiple vendors for the products they purchase;
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the overall trend toward industry consolidation and rationalization among our customers, competitors and suppliers;
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conditions in the broader market for military and communications products;
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governmental regulation or intervention affecting our products; and
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the effects of war and acts of terrorism, such as disruptions in general global economic activity, changes in logistics and security arrangements and reduced customer demand for our products and services.
Our reliance on a limited number of customers for a large portion of our revenues could materially and adversely affect our results of operations and financial condition.
Relatively few customers have accounted for a substantial portion of our net sales. During Fiscal 2012 our top three customers collectively accounted for 54% of our total net sales. We may not continue to receive significant revenues from any of these or from other large customers. Because of our significant customer concentration, our net sales and operating income could fluctuate significantly due to the loss of, reduction of
business with, or less favorable terms for any of our significant customers. A reduction or delay in orders from any of our significant customers, or a delay or default in payment by any significant customer could materially harm our results of operation and liquidity.
Federal government contracts may be terminated by the federal government at any time prior to their completion which could lead to unexpected loss of sales and reduction in backlog.
Under the terms of federal government contracts, the federal government may unilaterally:
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terminate or modify existing contracts;
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reduce the value of existing contracts through partial termination; and
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delay the payment of our invoices by government payment offices.
The federal government can terminate or modify any of its contracts with us or its prime contractors either for its convenience, or if we or its prime contractors default, by failing to perform under the terms of the applicable contract. A termination arising out of our default could expose us to liability and have a material adverse effect on our ability to compete for future contracts and subcontracts. If the federal government or its prime contractors terminate and/or materially modify any of our contracts or if any applicable options are not exercised, our failure to replace sales generated from such contracts would result in lower sales and could adversely affect our earnings, which could have a material adverse effect on our business, results of operations and financial condition.
Our backlog as of March 31, 2012 was approximately $26 million. Our backlog could be adversely affected if contracts are modified or terminated.
We depend on single manufacturing lines for certain of our products, and any significant disruption in production could impair our ability to deliver our products.
We currently manufacture and assemble our products at our various facilities using individual production lines for certain product categories. Any significant disruption to one of these production lines will require time either to reconfigure and equip an alternative production line or to restore the original line to full capacity. Some of our production processes are complex, and we may be unable to respond rapidly to the loss of the use of any production line. This could result in delayed shipments, which could result in customer dissatisfaction, loss of sales and damage to our reputation.
We depend on sole or limited source suppliers, and any disruption in supply could impair our ability to deliver our products on time or at expected cost.
We obtain many key components for our products from third-party suppliers, and in some cases we obtain raw materials from a single or a limited number of suppliers. Interruptions in supply of components or other products from third-party suppliers could impair our ability to deliver our products until we identify a new source of supply, which could take several weeks, months or longer and could increase our costs significantly. In general, we do not have written long-term supply agreements with our suppliers but instead purchase components through purchase orders, which expose us to potential price increases and termination of supply without notice or recourse. If we are required to use a new source of materials or components, it could also result in unexpected manufacturing difficulties and could affect product performance and reliability.
Our gross margins may be negatively affected, which in turn would negatively affect our operating results.
Our gross margins may be negatively affected by a result of a number of factors, including:
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increased price competition;
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excess capacity or excess fixed assets;
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customer and contract settlements;
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higher product, material or labor costs;
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increased inventory provisions or contract and customer settlement costs;
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warranty costs;
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obsolescence charges;
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loss of cost savings on future inventory purchases as a result of high inventory levels;
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introductions of new products and costs of entering new markets;
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increased levels of customer services;
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changes in distribution channels; and
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changes in product and geographic mix.
Lower than expected gross margins would negatively affect our operating results.
We may not be able to attract or retain the specialized technical and managerial personnel necessary to achieve our business objectives.
Competition for certain key positions and specialized technical personnel in the high-technology industry is strong. We believe that our future success depends in part on our continued ability to hire, assimilate, and retain qualified personnel in a timely manner, particularly our Chief Executive Officer, other senior-executives and other key positions in our areas of potential growth. In addition, the loss of David Robbins, our Chief Executive Officer, or certain other senior executives, could harm our relations with our customers, our ability to respond to technological change and our business.
We may also find it difficult to attract or retain qualified employees because of our size. In addition, if we have not properly sized our workforce and retained those employees with the appropriate skills, our ability to compete effectively may be adversely affected. If we are not successful in attracting and retaining qualified employees, in the future, we may not have the necessary personnel to effectively compete in the highly dynamic, specialized and volatile industry in which we operate or to achieve our business objectives.
Future cash flow fluctuations may affect our ability to fund our working capital requirements or achieve our business objectives in a timely manner.
Our working capital requirements and cash flows historically have been, and are expected to continue to be, subject to quarterly and yearly fluctuations, depending on such factors as timing and size of capital expenditures, levels of sales, timing of deliveries and collection of receivables, inventory levels, customer payment terms and supplier terms and conditions. We believe our cash on hand and availability under our line of credit will be sufficient to fund our current business model, and meet our customer commitments for at least the next 12 months. However, a greater than expected slow down in capital spending by our customers may require us to adjust our current business model. As a result, our revenues and cash flows may be materially lower than we expect and we may be required to reduce our capital expenditures and investments or take other measures in order to meet our cash requirements. We may seek additional funds from liquidity-generating transactions and other conventional sources of external financing (which may include a variety of debt, convertible debt and/or equity financings). We cannot provide any assurance that our net cash requirements will be as we currently expect. Our inability to manage cash flow fluctuations resulting from the above factors could have a material adverse effect on our ability to fund our working capital requirements from operating cash flows and other sources of liquidity or to achieve our business objectives in a timely manner.
Our business may be materially and adversely affected by increased levels of debt.
In order to finance our business or to finance possible acquisitions we may incur significant levels of debt compared to historical levels, and we may need to secure additional sources of funding, which may include debt
or convertible debt financing, in the future. A high level of debt, arduous or restrictive terms and conditions relating to accessing certain sources of funding, failure to meet the financial and/or other covenants in our credit and/or support facilities and any significant reduction in, or access to, such facilities, poor business performance or lower than expected cash inflows could have adverse consequences on our ability to fund our business and the operation of our business.
Other effects of a high level of debt include the following:
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we may have difficulty borrowing money in the future or accessing sources of funding;
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we may need to use a large portion of our cash flow from operations to pay principal and interest on our indebtedness, which would reduce the amount of cash available to finance our operations and other business activities;
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a high debt level, arduous or restrictive terms and conditions, or lower than expected cash flows would make us more vulnerable to economic downturns and adverse developments in our business; and
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if operating cash flows are not sufficient to meet our operating expenses, capital expenditures and debt service requirements as they become due, we may be required, in order to meet our debt service obligations, to delay or reduce capital expenditures or the introduction of new products, sell assets and/or forego business opportunities including acquisitions, research and development projects or product design enhancements.
We operate in highly dynamic and volatile industries characterized by changing technologies, evolving industry standards, frequent new product introductions and relatively short product life cycles.
The markets for our products are characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions and short product life cycles. We expect our success to depend, in substantial part, on the timely and successful introduction of high quality, new products and upgrades, as well as cost reductions on current products to address the operational speed, bandwidth, efficiency and cost requirements of our customers. Our success will also depend on our ability to comply with emerging industry standards, to operate with products of other suppliers, to address emerging market trends, to provide our customers with new revenue-generating opportunities and to compete with technological and product developments carried out by others. The development of new, technologically advanced products, is a complex and uncertain process requiring high levels of innovation, as well as the accurate anticipation of technological and market trends. Investments in such development may result in expenses growing at a faster rate than revenues, particularly since the initial investment to bring a product to market may be high. We may not be successful in targeting new market opportunities, in developing and commercializing new products in a timely manner or in achieving market acceptance for our new products.
The success of new or enhanced products depends on a number of other factors, including the timely introduction of such products, market acceptance of new technologies and industry standards, the quality and robustness of new or enhanced products, competing product offerings, the pricing and marketing of such products and the availability of funding for such networks. Products and technologies developed by our competitors may render our products obsolete. If we fail to respond in a timely and effective manner to unanticipated changes in one or more of the technologies affecting telecommunications or our new products or product enhancements fail to achieve market acceptance, our ability to compete effectively in our industry, and our sales, market share and customer relationships could be materially and adversely affected.
We face significant competition and may not be able to increase or maintain our market share and may suffer from competitive pricing practices.
We operate in an industry that is characterized by industry rationalization and consolidation, vigorous competition for market share and rapid technological development. Competition is heightened in periods of slow
overall market growth. These factors could result in aggressive pricing practices and growing competition from niche companies, established competitors, as well as well-capitalized companies, which, in turn, could have a material adverse effect on our gross margins.
We expect that we will face additional competition from existing competitors and from a number of companies that have entered or may enter our existing and future markets. Some of our current and potential competitors have greater marketing, technical and financial resources, including access to capital markets and/or the ability to provide customer financing in connection with the sale of products. Many of our current and potential competitors have also established, or may in the future establish, relationships with our current and potential customers. Other competitive factors include the ability to provide new technologies and products, end-to-end solutions, and new product features, as well as conformance to industry standards. Increased competition could result in price reductions, negatively affecting our operating results, reducing profit margins and potentially leading to a loss of market share.
The testing of electronic communications equipment and the accurate transmission of information entail a risk of product liability claims by customers and others.
Product liability claims may be asserted against us by end-users of any of our products. We maintain product liability insurance coverage with an aggregate annual liability coverage limit, regardless of the number of occurrences, of $2.0 million. There is no assurance that such insurance will continue to be available at a reasonable cost or will be sufficient to cover all possible liabilities. In the event of a successful suit against us, lack or insufficiency of insurance coverage could result in substantial cost and could have a material adverse effect on our business.
Our products with military applications are subject to export regulations, which may be costly.
We are required to obtain export licenses before filling foreign orders for many of our products with military or other governmental applications. United States Export Administration regulations control high tech exports like our products for reasons of national security and compliance with foreign policy, to guarantee domestic reserves of products in short supply and, under certain circumstances, for the security of a destination country. Thus, any foreign sales of our products requiring export licenses must comply with these general policies. In addition, these regulations are subject to change, and any such change may require us to improve our technologies, incur expenses or both in order to comply with such regulations.
We design custom products to meet specific requirements of our customers. The uncertain nature of the development cycle for custom products can result in variability in the timing of our receipt of revenue from such products.
The design and sales cycle for our custom products, from initial contact by our sales force to the commencement of shipments of those products may be lengthy. In this process, our sales and application engineers work closely with the customer to analyze the customer’s system requirements and establish a technical specification for the custom product. We then select a process, evaluate components, and establish assembly and test procedures before manufacturing can begin. The length of this cycle is influenced by many factors, including the difficulty of the technical specification, the novelty and complexity of the design and the customer’s procurement processes. Our customers typically do not commit to purchase significant quantities of the custom product until they are ready to commence volume shipments of their own system or equipment. Our receipt of substantial revenue from sales of a custom product often depends on that customer’s commercial success in manufacturing and selling its system or equipment that incorporates our custom product. As a result, a significant period may elapse between our investment of time and resources in designing and developing a custom product and our receipt of substantial revenue from sales of that custom product.
The length of this process may increase the risk that a customer will decide to cancel or change its plans related to its system or equipment. Such a cancellation or change in plans by a customer could cause us to lose anticipated sales. In addition, our business, results of operations and financial condition could be materially
adversely affected if a significant customer curtails, reduces or delays orders during our sales cycle, chooses not to release its system or equipment that contains our custom products, or is not successful in the sale and marketing of its system or equipment that contains our custom products.
We have made, and may continue to make, strategic acquisitions in order to enhance our business. If we are not successful in operating or integrating these acquisitions, our business, results of operations and financial condition may be materially and adversely affected.
In the past, we acquired companies to enhance the expansion of our business and products. We may consider additional acquisitions which could involve significant risks and uncertainties.
These risks and uncertainties include:
•
the risk that the industry may develop in a different direction than anticipated and that the technologies we acquire do not prove to be those we need to be successful in the industry;
•
the risk that future valuations of acquired businesses may decrease from the market price we paid for these acquisitions;
•
the generation of insufficient revenues by acquired businesses to offset increased operating expenses associated with these acquisitions;
•
the potential difficulties in completing in-process research and development projects and delivering high quality products to our customers;
•
the potential difficulties in integrating new products, businesses and operations in an efficient and effective manner;
•
the risk that our customers or customers of the acquired businesses may defer purchase decisions as they evaluate the impact of the acquisitions on our future product strategy;
•
the potential loss of key employees of the acquired businesses;
•
the risk that acquired businesses will divert the attention of our senior management from the operation of our business; and
•
the risks of entering new markets in which we have limited experience and where competitors may have a stronger market presence.
Our inability to successfully operate and integrate newly-acquired businesses appropriately, effectively and in a timely manner could have a material adverse effect on our ability to take advantage of further growth in demand for products in our marketplace, as well as on our revenues, gross margins and expenses.
If we cannot effectively manage our growth, our business may suffer.
We have previously expanded our operations through acquisitions in order to pursue existing and potential market opportunities. If we fail to manage our growth properly, we may incur unnecessary expenses and the efficiency of our operations may decline. To manage our growth effectively, we must, among other things:
•
successfully attract, train, motivate and manage a larger number of employees for production and testing, engineering and administration activities;
•
control higher inventory and working capital requirements; and
•
improve the efficiencies within our operating, administrative, financial and accounting systems, and our procedures and controls.
Claims by others that we infringe their intellectual property rights could harm our business and financial condition.
We cannot be certain that our products do not and will not infringe issued patents, patents that may be issued in the future, or other intellectual property rights of others. We do not conduct exhaustive patent searches to determine whether the technology used in our products infringes patents held by third parties.
Any claim of infringement could cause us to incur substantial costs defending against the claim, even if the claim is invalid, and could distract the attention of our management. If any of our products are found to violate third-party proprietary rights, we may be required to pay substantial damages. In addition, we may be required to re-engineer our products or obtain licenses from third parties to continue to offer our products. Any efforts to re-engineer our products or obtain licenses on commercially reasonable terms may not be successful, which would prevent us from selling our products, and, in any case, could substantially increase our costs and have a material adverse effect on our business, financial condition and results of operations.
The market price of our common stock may be volatile.
Our stock price has historically been volatile. From April 1, 2010 to March 31, 2012, the trading price of our common stock ranged from $3.75 to $9.19. Many factors may cause the market price of our common stock to fluctuate, including:
•
variations in our quarterly results of operations;
•
the introduction of new products by us or our competitors;
•
the hiring or departure of key personnel;
•
acquisitions or strategic alliances involving us or our competitors;
•
changes in, or adoptions of, accounting principles; and
•
market conditions in our industries.
In addition, the stock market can experience extreme price and volume fluctuations. These fluctuations, which are often unrelated to the operating performance of particular companies, may adversely affect the market price of our common stock.
Our common stock is thinly traded; therefore, our stock price may fluctuate more than the stock market as a whole.
Although our shares are traded on the Nasdaq Stock Market, our stock is thinly traded. As a result, its market price may fluctuate significantly more than the stock market as a whole or the stock prices of similar companies. Without a larger float, our common stock will be less liquid than the stock of companies with broader public ownership, and as a result, the trading prices for our common stock may be more volatile. Among other things, trading of a relatively small volume of common stock may have a greater impact on the trading price than would be the case if the public float were larger.
Declines in the market price of our common stock may negatively impact our ability to make future strategic acquisitions, raise capital, issue debt or retain employees.
The stock markets have experienced extreme price fluctuations that have affected the market price and trading volumes of many technology and telecommunications companies in particular, with potential consequential negative effects on the trading of securities of such companies. A major decline in the capital markets generally, or an adjustment in the market price or trading volumes of our common stock may negatively impact our ability to raise capital, issue debt, retain employees or make future strategic acquisitions. These factors, as well as general economic and political conditions, and continued negative events within the technology sector, may in turn have a material adverse effect on the market price of our common stock.
We are subject to environmental regulation and compliance which may be costly.
Certain of our products may be rendered obsolete due to environmental directives and could require that we redesign or change how we manufacture our products. This could result in additional costs and expense, shipment delays and possible inventory obsolescence.
ITEM 1B.
ITEM 1B. Unresolved Staff Comments.
None.
ITEM 2.
ITEM 2. Properties.
Our principal manufacturing facility and corporate office is located in a 32,000 square foot building in Hudson, NH which we own. In addition, a small facility of 800 square feet is leased from an unaffiliated entity in Westminster, CO for product development.
MVS operates out of a 3,700 square foot facility located in Monroe, CT, which is leased from an unaffiliated entity.
Micro-Con operates out of a 23,000 square foot facility located in West Caldwell, NJ, which is leased from an unaffiliated entity.
Stealth operates out of a 21,000 square foot facility located in Trenton, NJ, which is leased from an entity whose owners include one executive of Micronetics.
MICA operates out of a 20,750 square foot facility located in Manteca, CA, and a 1,500 square foot facility in San Jose, CA. Both facilities are leased from unaffiliated entities.
We believe our facilities are adequate for our current and presently anticipated future needs.
ITEM 3.
ITEM 3. Legal Proceedings.
Micronetics is not a party to any pending legal proceedings.
ITEM 4.
ITEM 4. Mine Safety Disclosures
Not applicable.
Part II
ITEM 5.
ITEM 5. Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities.
The common stock is traded on the NASDAQ Capital Market under the symbol NOIZ.
The closing high and low sale prices for the Common Stock for each fiscal quarter from April 1, 2010 until March 31, 2012 as reported by NASDAQ were as follows:
Sales Prices
The number of holders of record of the common stock as of May 25, 2012 was 178. Micronetics believes that there are a substantially greater number of beneficial owners of shares of its common stock who maintain their shares in “street” name. On May 25, 2012, the last sale price of the common stock as reported by NASDAQ was $7.84 per share.
Micronetics has not paid any cash dividends during its two most recent fiscal years, nor during any subsequent interim period. Under its loan agreements, it is restricted from paying dividends without the consent of the lender.
Equity Compensation Plan Information
ITEM 6.
ITEM 6. Selected Financial Data (unaudited)
ITEM 7.
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This section should be read in combination with the accompanying audited consolidated financial statements and related notes prepared in accordance with accounting principles generally accepted in the United States of America. This section contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of a variety of factors, including those discussed under the heading “Risk Factors” and elsewhere in this annual report.
Recent Accounting Pronouncements
For information with respect to recent accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note 1 of Notes to Consolidated Financial Statements.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and the results of operations are based on the Company’s consolidated financial statements and the data used to prepare them. Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). On an on-going basis, we evaluate our judgments and estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. Estimates and judgments include revenue recognition, assumptions used in stock option and goodwill valuations, reserves for accounts receivable and inventories, useful lives of long lived assets, accrued liabilities, and deferred income taxes and various other assumptions that we believe are reasonable under the circumstances. These estimates and judgments are based on historical experience and various other assumptions that are believed to be reasonable under current business conditions and circumstances. Actual results may differ from these estimates under different assumptions or conditions.
Revenue Recognition And Product Warranties
We generate revenue from the sale of products, technology development, and licensing. Revenue is recognized when persuasive evidence of an arrangement exists, delivery of product has occurred or services have been rendered, the price to the customer is fixed or determinable, collection is reasonably assured, and no future services are required. Our products are primarily hardware components and to a lesser extent integrated
assemblies which includes microwave hardware and embedded software that are delivered to original equipment manufacturers (OEMs) of telecommunication and networking products who are considered to be end users.
We occasionally enter into contracts for production of customized microwave and radio frequency components and integrated sub-assemblies which we record revenue based on the percentage of completion method (assuming all other requirements for revenue recognition have been satisfied) typically using labor hours to measure progress toward completion of the contract as we have determined this methodology best reflects the fundamentals of the contract. If estimates to complete the contract change materially from one period to the next, profit levels could significantly vary. We currently have no such contracts in process that require the percentage of completion method for revenue recognition.
Deferred revenue represents billings in excess of revenue recognized.
We record amounts for shipping and handling fees billed to customers as revenue. The cost of shipping and handling fees are recorded as a component of cost of sales.
We sell our products using a direct sales force and sales representatives. Our standard terms of sale do not include product return rights or price protection. The estimated costs of product warranties are accrued based on historical experience at the time the revenue is recognized. Unless customers purchase an extended warranty, Micronetics typically offers a one-year warranty.
Accounts Receivable, Net of Allowance For Doubtful Accounts
Accounts receivable are customer obligations due under normal trade terms, carried at face value less an allowance for doubtful accounts. We regularly monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon the review of the aging of outstanding accounts, loss experiences, factors related to specific customers’ ability to pay, current economic trends and any specific customer collection issues that have been identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that have been experienced in the past. We write off accounts receivable against the allowance in the period that a receivable is determined to be uncollectible.
Inventories
Inventories are valued at the lower of cost or market, based on the first in, first out method. Inventory items are reviewed regularly for excess and obsolescence based on an estimated forecast of product demand. Inventories that are in excess of future requirements are written down to their estimated value based upon projected demand. Demand for our products can be forecasted based on current backlog, customer options to reorder under existing contracts, and the need to retrofit older units and parts needed for general repairs. Although management makes every effort to ensure the accuracy of its forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have an impact on the level of obsolete material in our inventories and operating results could be affected accordingly.
Valuation Of Long-Lived Assets, Goodwill And Intangible Assets And Their Impairment
We assess the need to record impairment losses on definite long-lived assets, including fixed assets and other intangible assets, to be held and used in operations, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, we estimate the undiscounted future cash flows to result from the use of the asset and its ultimate disposition. If the sum of the undiscounted cash flows is less than the carrying value, we would recognize an impairment loss, measured as the amount by which the carrying value exceeds the fair value of the asset. Assets to be disposed of are carried at their lower of the carrying value or fair value less costs to sell.
Goodwill and other indefinite lived intangible assets are tested annually for impairment or whenever a triggering event occurs. We assess goodwill, by reporting unit, for impairment at least once each year by applying a direct value-based fair value test. Goodwill could be impaired due to market declines, reduced expected future cash flows, or other factors or events. Should the fair value of goodwill at the measurement date fall below its carrying value, a charge for impairment of goodwill would occur in that period.
In September 2011, the FASB issued ASU 2011-08, Intangibles, Goodwill and Other (Topic 350): Testing Goodwill for Impairment. The amendment is effective for annual impairment tests done for fiscal years that start after December 15, 2011 though early adoption is permitted. The changes to FASB ASC 350-20 permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If an entity concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it would not be required to perform the two-step impairment test for that reporting unit. During the fourth quarter of Fiscal 2012, we adopted ASU 2011-08 and prepared a qualitative assessment of our goodwill. As part of our qualitative assessment, we evaluated a number of factors including industry conditions, economic conditions, competition, business strategy and positioning, cost factors, market capitalization and discounted cash flows. Based upon this analysis, we determined that there was no goodwill impairment.
On an on-going basis, management reviews the value and period of amortization or depreciation of long-lived assets. During this review, we evaluate the significant assumptions used in determining the original cost of long-lived assets. Although the assumptions may vary from transaction to transaction, they generally include revenue growth, operating results, cash flows and other indicators of value. Management then determines whether there has been an impairment of the value of long-lived assets based upon events or circumstances that have occurred since the acquisition. The impairment policy is consistently applied in evaluating impairment for each of our wholly-owned subsidiaries and investments. At March 31, 2012 and 2011, we determined that no new triggering events had occurred warranting a further impairment assessment of our long-lived assets.
Stock Compensation Expense
We measure compensation cost for stock-based compensation at fair value. We use the Black-Scholes option-pricing model, which requires the input of subjective assumptions. These assumptions include estimates of the expected term, the volatility of our common stock price over the expected term, risk free interest rate and the number of options that will not vest. Changes in these assumptions could materially affect the estimate of fair value stock-based compensation and consequently, the related amount recognized on the consolidated statements of operations.
Income Taxes and Valuation Allowances
We recognize income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are established for temporary differences. Temporary differences occur when income and expenses are recognized in different periods for financial reporting purposes and for purposes for computing income taxes currently payable. A valuation allowance is provided when it is more likely than not that some portion, or all, of the deferred tax asset will not be realized. We had a valuation allowance of $103,230 at March 31, 2011 for the deferred tax asset relating to state net operating loss carryforwards due to the uncertainty of future utilization. At March 31, 2012, a valuation allowance of $88,472 remains.
Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. We evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on its technical merit in the event of a tax audit.
We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions as well as related interest and penalties.
Results of Operations
Fiscal 2012 versus Fiscal 2011
Net sales
Net sales for Fiscal 2012 were $45,970,284, an increase of $10,673,579 or 30% as compared to net sales of $35,296,705 for Fiscal 2011. Component sales increased by approximately $6.6 million for defense applications and integrated sub-systems sales increased by approximately $4.1 million for both defense and commercial applications.
Foreign sales accounted for approximately $3,457,000 and $5,360,000 in Fiscal 2012 and Fiscal 2011, respectively.
Gross margin
Gross margins were 32.2% for Fiscal 2012 as compared to 32.7% for Fiscal 2011. Gross margin decreased due to start-up costs associated with integrated sub-systems.
Research and development
Research and development (“R&D”) expense for Fiscal 2012 was $1,454,460, a decrease of $336,343 or 19% as compared to $1,790,803 for Fiscal 2011. The decrease is due to lower spending on a defense sub-system program and lower spending on commercial components. Our research and development expense varies to a certain degree based upon emerging technologies, shifts in product requirements and our assessment of future business opportunities.
Selling, general and administrative
Selling, general and administrative expense for Fiscal 2012 was $7,442,404, an increase of $543,354 or 8% as compared to $6,899,050 for Fiscal 2011. $285,000 of the increase was payroll related primarily related to the addition of sales personnel. Approximately $130,000 was due to increased sales commission expense. Bad debt increased by approximately $83,000 in Fiscal 2012 as bad debt in Fiscal 2011 was reduced due to the partial recovery of a previously reserved receivable. All other selling, general and administrative costs increased by a net of approximately $45,000.
Amortization of intangible assets
Amortization expense attributable to our intangible assets related to previous acquisitions decreased to $314,047 for Fiscal 2012 as compared to $320,700 for Fiscal 2011. The decrease of $6,653 is due to completing amortization of certain intangibles.
Interest expense
Interest expense for Fiscal 2012 was $236,593, a decrease of $128,670 or 35% as compared to $365,263 for Fiscal 2011. The decrease is due primarily to lower average interest rates and to lower average debt in Fiscal 2012 as compared to Fiscal 2011.
Interest rate swap
A realized gain of $58,965 was recorded in Fiscal 2012 as compared to a unrealized gain of $106,085 for Fiscal 2011 to reflect the change in fair value of the mark to market valuation for the interest rate swap agreement entered into in April 2007 to mitigate the interest rate fluctuations on our term loan. The interest rate swap expired on March 30, 2012 and therefore has no value as of March 31, 2012 and no remaining unrealized gains.
Provision for income taxes
Our effective tax rate was 37.3% for Fiscal 2012 as compared to 34.0% for Fiscal 2011. The increase in the effective tax rate relates primarily to a lower R&D credit, a higher average state tax rate offset to some degree by reduced tax expense in a number of areas including the domestic production activity deduction and lower non-deductible employee stock compensation expense.
Financial Condition, Liquidity and Capital Resources
We finance our operating and investment requirements primarily through operating cash flows and borrowings. Cash and cash equivalents were $856,931 at March 31, 2012 as compared to $745,116, at March 31, 2011. Working capital, defined as accounts receivable, inventory, prepaid expenses, other current assets net of accounts payable, accrued expenses and deferred revenue was $15,043,885 at March 31, 2012 as compared to $15,086,387 at March 31, 2011. Borrowings under our revolving line of credit were $4,220,045 at March 31, 2012 as compared to $6,714,319 at March 31, 2011 representing a 37% decrease.
Our current ratio was approximately 2.37 at March 31, 2012 as compared to 1.74 at March 31, 2011.
Net cash provided by operating activities was $5,362,940 in Fiscal 2012 as compared to $192,476 in Fiscal 2011. In Fiscal 2012, approximately $5.6 million was provided by net income after adjusting for non-cash items including depreciation, amortization, stock-based compensation, changes in working capital reserves and a realized gain on interest rate swap. Cash used for working capital needs was approximately $0.3 million. Net income in Fiscal 2012 increased by approximately 125%.
In Fiscal 2011, net cash provided by net income after adjusting for non-cash items including depreciation, amortization, stock-based compensation, changes in working capital reserves and a realized gain on interest rate swap was approximately $3.3 million. Approximately $3.2 million was used to fund working capital needs. Of this amount, approximately $0.1 million was provided by receivables and unbilled/deferred revenue and approximately $3.3 million was used to fund inventory requirements. A portion of this increase is related to the delay in shipments while we upgraded procedures in response to a customer’s request. Approximately $0.1 million was used for a charge to a deferred tax asset related to the cancellation of non-qualified stock options.
In Fiscal 2012 net cash used in investing activities was $1,346,218 as compared to $957,542 in Fiscal 2011. In Fiscal 2012 and Fiscal 2011, investing activities was primarily comprised of capital expenditures.
In Fiscal 2012 net cash used in financing activities was $3,904,907 as compared to net cash provided by financing activities in Fiscal 2011 of $1,027,740. In Fiscal 2012 we repaid approximately $2.5 million to our line of credit, repaid term debt of approximately $1.3 million and paid approximately $0.2 million for capital lease obligations offset by approximately $0.1 million of proceeds from stock option exercises.
In Fiscal 2011 we borrowed approximately $2.5 million from our line of credit, repaid term debt of approximately $1.3 million and paid approximately $.3 million for capital lease obligations. In addition, approximately $0.1 million of a deferred tax asset related to the cancellation of non-qualified stock options was charged to additional paid in capital.
We believe that cash and cash equivalents on hand, anticipated future cash receipts, and borrowings available under our line of credit will be sufficient to meet our obligations as they become due for the next twelve months. However, a decrease in our sales or demand for our products would likely adversely affect our working
capital amounts. As part of our business strategy, we occasionally evaluate potential acquisitions of businesses, products and technologies. Accordingly, a portion of our available cash may be used at any time for the acquisition of complementary products or businesses. These potential transactions may require substantial capital resources, which, in turn, may require us to seek additional debt or equity financing. There are no assurances that we will be able to consummate any such transaction. There are no current plans to raise additional debt or equity capital, nor is there a projected need to raise any such capital.
Term Loan and Revolver
In March 2007, we entered into a credit facility which consisted of a $6.5 million five year secured term loan and a $5.0 million three year revolving line of credit. In Fiscal 2009, the revolving line of credit was extended by two years. On August 13, 2010, the revolving line of credit was increased to $7.5 million and was extended until March 31, 2013.
On September 19, 2011, we entered into an amendment to the term loan and revolving line of credit agreement under which the revolving line of credit was increased to $10 million and extended until September 30, 2015. The term loan and revolving line of credit are guaranteed by our subsidiaries and are secured by substantially all of our assets. The term loan is payable in quarterly principal installments of $325,000 plus accrued interest at the rate of 5.2% plus the applicable margin. At March 31, 2012, the interest rate was 7.45%. The final payment for the term loan was made in April 2012. The revolving line of credit bears interest at LIBOR plus the applicable margin. At March 31, 2012, the interest rate was 2.49%. We had approximately $5.8 million available under the line of credit at March 31, 2012.
In April 2007, the Company entered into an interest rate swap agreement with an initial notional amount of $6.5 million to mitigate the effect of interest rate fluctuations on the term loan. The interest rate swap was not designated as a hedging instrument at the initiation of the swap, and therefore the Company has not applied hedge accounting. As a result, at the end of each reporting period, the change in fair value of the interest rate swap is recorded on the consolidated balance sheet, with any related gains or losses included in earnings. The interest rate swap agreement expired March 30, 2012 and therefore has no value at March 31, 2012.
Under the terms of the amended term loan and the revolving line of credit agreement, the Company is required to maintain certain financial covenants on a quarterly and annual basis, including total funded debt to EBITDA not exceeding 2.5:1, minimum debt service coverage of 1.25:1 and a minimum current ratio of 1.25:1. At March 31, 2012, we are in compliance with our bank covenants.
Capital leases
Commercial capital leases payable are reflected at their present value based upon interest rates of approximately 6.8% per annum, and are secured by the underlying assets. The assets are depreciated over their estimated useful lives. There are no outstanding capital leases at March 31, 2012.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements, other than operating leases, that have or are, in the opinion of management, likely to have a current or future material effect on our financial statements.
Contractual Obligations
The following table sets forth the Company’s future contractual obligations at March 31, 2012:
(1) Bears interest at LIBOR plus applicable margin (2.49% as of March 31, 2012)
(2) Bears interest at 5.2% plus the applicable margin (7.45% as of March 31, 2012). The final payment was made in April 2012.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data.
This information is contained on pages through hereof.
ITEM 9.
ITEM 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
ITEM 9A.
ITEM 9A. Controls and Procedures.
Evaluation of disclosure controls and procedures-As of March 31, 2012, the Company carried out an evaluation, under the supervision and with the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2012, to provide reasonable assurance that material information relating to the Company was made known to our Chief Executive Officer and Chief Financial Officer by others within the Company.
Evaluation of internal control over financial reporting-Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Act of 1934. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting. In making its assessment of internal control over financial reporting, management used criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our evaluation under such framework, our management concluded that our internal control over financial reporting was effective as of March 31, 2012.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to a permanent exemption from the internal control audit requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002.
Changes in internal control-There were no significant changes in the Company’s internal control over financial reporting that occurred during the quarterly period ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Important Considerations-The effectiveness of our disclosure controls and procedures is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Because of these limitations, there can be no assurance that any system of disclosure controls and procedures will be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.
Item 9B:
Item 9B: Other Information.
None.
PART III
The information to be contained in Items 10-14 herein is incorporated by reference to the Company’s proxy statement to be filed with the Securities and Exchange Commission on or before July 29, 2012.
PART IV
ITEM 15.
ITEM 15. Exhibits and Financial Statement Schedules.
(a) Financial Statements, Schedules and Exhibits:
(1),(2) The consolidated financial statements and required schedules begin on page.
(3) Exhibits.
* Management contract or compensatory plan or arrangement
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Micronetics, Inc.
We have audited the accompanying consolidated balance sheets of Micronetics, Inc. (a Delaware Corporation) and subsidiaries (the “Company”) as of March 31, 2012 and 2011 and the related statements of operations, shareholders’ equity and cash flows for the years in the period ended March 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Micronetics, Inc. and subsidiaries as of March 31, 2012 and 2011 and the results of their operations and their cash flows for the years in the period ended March 31, 2012 in conformity with accounting principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
Boston, Massachusetts
May 31, 2012
MICRONETICS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
MICRONETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these consolidated financial statements.
MICRONETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
MICRONETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2012 AND 2011
1. PRINCIPAL BUSINESS ACTIVITY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Summary of operations and basis of consolidation-Micronetics, Inc. and subsidiaries (collectively the “Company” or “Micronetics”) are engaged in the design, development, manufacturing and marketing of a broad range of high performance wireless components, test equipment and integrated multifunction subassemblies used in cellular, microwave, satellite, radar and communication systems around the world.
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Microwave & Video Systems, Inc. (“MVS”), Microwave Concepts, Inc. (“MicroCon”) Stealth Microwave, Inc. (“Stealth”) and MICA Microwave Corporation (“MICA”). All intercompany activity has been eliminated in consolidation.
Use of estimates-The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Estimates and judgments include revenue recognition, assumptions used in stock option and goodwill valuations, reserves for accounts receivable and inventories, useful lives of property, plant and equipment, intangibles, accrued liabilities, and deferred income taxes. Actual results could differ from those estimates.
Revenue recognition-The Company generates revenue from the sale of products, technology development, and licensing. Revenue is recognized when persuasive evidence of an arrangement exists, delivery of product has occurred or services have been rendered, the price to the customer is fixed or determinable, collection is reasonably assured, and no future services are required. The Company’s products are primarily hardware components, and to a lesser extent integrated assembly which includes microwave hardware and embedded software, that are delivered to original equipment manufacturers (OEMs) of telecommunication and networking products who are considered to be end users.
The Company occasionally enters into contracts for production of customized microwave and radio frequency components and integrated sub-assemblies for which it records revenue based on the percentage of completion method (assuming all other requirements for revenue recognition have been satisfied) typically using labor hours to measure progress toward completion of the contract as the Company has determined this methodology best reflects the fundamentals of the contract. If estimates to complete the contract change materially from one period to the next, profit levels could significantly vary. We currently have no contracts that require the percentage of completion method for revenue recognition.
Deferred revenue represents billings in excess of revenue recognized and unbilled revenue represents revenue recognized in excess of billings.
The Company sells its products using a direct sales force and sales representatives. Contracts with customers do not include product return rights or price protection. The estimated cost of product warranties are accrued based on historical experience at the time the revenue is recognized. Unless customers purchase an extended warranty, Micronetics typically offers a one-year warranty.
Shipping and handling fees-The Company records shipping and handling fees billed to customers as revenue. Shipping and handling costs are reported as a component of cost of sales.
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
Cash and cash equivalents-The Company considers certificates of deposit, money market funds, and highly liquid debt instruments with an original maturity of three months or less to be cash equivalents. As of March 31, 2012, substantially all the Company’s cash and cash equivalents consisted of money market investments which the Company believes are subject to minimal credit and market risks.
Concentration of credit risk-Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, an interest rate swap and accounts receivable. The Company may invest in high-quality money market funds that invest in securities of the U.S. government and other high-quality corporate issuers. Accounts receivable are generally unsecured and are derived from the Company’s customers located around the world. The Company performs ongoing credit evaluations of its customers and maintains an allowance for doubtful accounts. The Company has two customers that account for 32% and 13% of its gross trade receivables, respectively, at March 31, 2012. The Company believes there is minimal risk associated with these receivables and their terms are comparable to other customers.
Fair value of financial instruments-The carrying amounts reported in the consolidated balance sheet for cash, trade receivables, accounts payable, and accrued expenses approximate fair value because of the relatively short maturity of these instruments. The interest rate swap is at fair value and is arrived at by discounting the present value of the difference between the contractual swap rate and the current market swap rates on March 31, 2012, utilizing the notional amounts and the remaining terms of the swap agreement. At March 31, 2011, the fair value of the swap was recorded as a liability in the amount of $58,965. The interest rate swap expired March 30, 2012 and therefore has no value at March 31, 2012. The book value of the Company’s long term debt approximates fair value as it bears interest at variable market rates.
Accounts receivable, net of allowance for doubtful accounts-Accounts receivable are customer obligations due under normal trade terms, carried at face value less an allowance for doubtful accounts. The Company regularly monitors collections and payments from their customers and maintains a provision for estimated credit losses based upon the review of the aging of outstanding accounts, loss experiences, factors related to specific customers’ ability to pay, current economic trends and any specific customer collection issues that have been identified. While such credit losses have historically been within our expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same credit loss rates that have been experienced in the past. The Company writes off accounts receivable against the allowance in the period that a receivable is determined to be uncollectible. Recovery of amounts previously written off are recorded when received.
Inventories -Inventories are valued at the lower of cost or market (net realizable value), determined using the first-in, first-out method. Inventory items are reviewed regularly for excess and obsolete inventory based on an estimated forecast of product demand. Demand for the Company’s products can be forecasted based on current backlog, customer options to reorder under existing contracts, the need to retrofit older units and parts needed for general repairs. Inventories that are in excess of future requirements are written down to their estimated value based upon projected demand. Although management makes every effort to insure the accuracy of its forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have an impact on the level of obsolete material in our inventories and operating results could be affected accordingly.
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
Property, plant and equipment-Property, plant and equipment are stated at historical cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets as follows:
Buildings and improvements
Up to 40 years
Machinery and equipment
3-10 years
Furniture and fixtures
7 years
Leasehold improvements
lesser of the lease term or useful life
Goodwill and intangible assets-Goodwill is recorded when the consideration paid for an acquisition exceeds the fair value of net tangible and identifiable intangible assets acquired.
In September 2011, the FASB issued ASU 2011-08, Intangibles, Goodwill and Other (Topic 350): Testing Goodwill for Impairment. The amendment is effective for annual impairment tests done for fiscal years that start after December 15, 2011 though early adoption is permitted. The changes to FASB ASC 350-20 permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If an entity concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it would not be required to perform the two-step impairment test for that reporting unit. During the fourth quarter of Fiscal 2012, we adopted ASU 2011-08 and prepared a qualitative assessment of our goodwill. As part of our qualitative assessment, we evaluated a number of factors including industry conditions, economic conditions, competition, business strategy and positioning, cost factors, market capitalization and discounted cash flows. Based upon this analysis, we determined that there was no goodwill impairment at March 31, 2012.
Intangible assets consist of certain identifiable assets resulting from business combinations, including intellectual property, customer relationships and tradename. These assets are being amortized over their estimated useful lives.
At March 31, 2012 and 2011 we determined that no new triggering events had occurred warranting an impairment assessment of our intangible assets.
Research and development-Research and development costs are charged to expense when incurred. Amounts expended for the years ended March 31, 2012 and 2011 were $1,454,460 and $1,790,803, respectively. R&D expenses consist of salaries, materials and third party costs.
Advertising costs-Advertising costs are expensed as incurred and are reported as a component of selling, general and administrative expenses in the consolidated statements of operation. Advertising expense was $6,094 in Fiscal 2012 and $46,818 in Fiscal 2011.
Income taxes-The Company calculates its provision for federal and state income taxes based on current tax law and recognizes income taxes under the asset and liability method. Under this method deferred tax assets and liabilities are established for temporary differences. Temporary differences occur when income and expenses are recognized in different periods for financial reporting purposes and for purposes for computing income taxes currently payable. A valuation allowance is provided when it is more likely than not that some portion, or all, of the deferred tax asset will not be realized.
Earnings per share-Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is determined by
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Potential dilutive common shares represent the dilutive effect of the assumed exercise of certain outstanding stock options.
Restricted shares of common stock that vest based on the satisfaction of certain conditions are treated as contingently issuable shares until the conditions are satisfied. These shares are excluded from the basic earnings per share calculation and included in the diluted earnings per share calculation.
Stock-based compensation-The Company measures compensation cost for stock-based compensation at fair value. The Company uses the Black-Scholes option-pricing model, which requires the input of subjective assumptions. These assumptions include estimates of the length of time employees will retain their vested stock options before exercising them, expected term, the volatility of our common stock price over the expected term and the risk free interest rate. Changes in these assumptions could materially affect the estimate of fair value stock-based compensation and consequently, the related amount recognized on the consolidated statements of operations. For all awards the Company has recognized compensation expense using the straight-line amortization method over the vesting period of the awards and this estimated expense for Fiscal 2012 and 2011 has been reduced for forfeitures.
Subsequent events-The Company evaluated its March 31, 2012 financial statements for subsequent events through the date the financial statements were issued. The Company is not aware of any subsequent events which would require recognition or disclosure in the financial statements.
Recently adopted accounting pronouncements-In May 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-04, “Fair Value Measurement (ASC Topic 820)-Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU No. 2011-04 amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. The changes to the ASC as a result of this update are effective prospectively for interim and annual periods beginning after December 15, 2011. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
2. INTANGIBLE ASSETS AND GOODWILL
The following table presents details of the Company’s finite-lived intangible assets as of March 31, 2012 and March 31, 2011 (in thousands):
The Company amortizes intangible assets with finite lives over the estimated useful lives of the respective assets. The following is a summary of estimated aggregate amortization expense for each of the five succeeding fiscal years:
The Company performs an assessment of goodwill for impairment annually to determine whether is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. As part of the qualitative assessment, a number of factors were analyzed including industry conditions, economic conditions, competition, business strategy and positioning, cost factors, market capitalization and discounted cash flows. Based upon this analysis, the Company determined that there was no goodwill impairment at March 31, 2012.
Goodwill is deductible for income tax purposes.
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
3. ACCOUNTS RECEIVABLE, NET
At March 31, 2012 and 2011 accounts receivable, net of allowances consisted of the following:
The activity related to the Company’s allowance for doubtful accounts on accounts receivable for Fiscal 2012 and Fiscal 2011 is as follows:
4. INVENTORIES, NET
At March 31, 2012 and 2011 inventories consisted of the following:
5. PROPERTY, PLANT AND EQUIPMENT
At March 31, 2012 and 2011, property, plant and equipment consisted of the following:
Assets held under capital leases are classified as property, plant and equipment and amortized over their useful lives. Lease amortization is included in depreciation expense.
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
At March 31, 2012 and 2011 accrued expenses and other current liabilities consisted of the following:
Included in accrued payroll are bonuses of $771,387 and $500,000 for Fiscal 2012 and Fiscal 2011, respectively.
7. ACCRUED WARRANTY
The Company provides one-year warranties on all of its products covering both parts and labor. Micronetics, at its option, repairs or replaces products that are defective during the warranty period if the proper preventative maintenance procedures have been followed by the customer.
Product warranty activity in Fiscal 2012 and Fiscal 2011 is as follows:
8. LONG-TERM DEBT AND LINE OF CREDIT
At March 31, 2012 and 2011 long-term debt consisted of the following:
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
Term Loan and Revolver
In March 2007, the Company entered into a credit facility which consisted of a $6.5 million five year secured term loan and a $5.0 million three year revolving line of credit. In fiscal 2009, the revolving line of credit was extended by two years. On August 13, 2010, the revolving line of credit was increased to $7.5 million and was extended until March 31, 2013.
On September 19, 2011, the Company entered into an amendment to the term loan and revolving line of credit agreement under which the revolving line of credit was increased to $10 million and extended until September 30, 2015. The term loan and revolving line of credit are guaranteed by the Company and its subsidiaries and are secured by substantially all of the Company’s assets. The term loan is payable in quarterly principal installments of $325,000 plus accrued interest at the rate of 5.2% plus the applicable margin. At March 31, 2012, the interest rate was 7.45%. The final payment for the term loan was made in April 2012. The revolving line of credit bears interest at LIBOR plus the applicable margin. At March 31, 2012, the interest rate was 2.49%. The Company had approximately $5.8 million available under the line of credit at March 31, 2012.
In April 2007, the Company entered into an interest rate swap agreement with an initial notional amount of $6.5 million to mitigate the effect of interest rate fluctuations on the term loan. The interest rate swap was not designated as a hedging instrument at the initiation of the swap, and therefore the Company has not applied hedge accounting. As a result, at the end of each reporting period, the change in fair value of the interest rate swap is recorded on the consolidated balance sheet, with any related gains or losses included in earnings. The interest rate swap agreement expired March 30, 2012 therefore there was no value at March 31, 2012.
Under the terms of the amended term loan and the revolving line of credit agreement, the Company is required to maintain certain financial covenants on a quarterly and annual basis, including total funded debt to EBITDA not exceeding 2.5:1, minimum debt service coverage of 1.25:1 and a minimum current ratio of 1.25:1. The Company was in compliance with its bank covenants at March 31, 2012.
9. STOCK OPTION PLANS AND STOCK-BASED COMPENSATION
During Fiscal 2007, the Company adopted a stock option plan entitled “The 2006 Equity Incentive Plan” (the “2006 Plan”) under which the Company may grant shares of restricted stock or stock options to purchase up to 1,000,000 shares of common stock. As of March 31, 2012 there were 511,000 options available for grant under the 2006 Plan.
The 2006 Plan is administered by the Board of Directors or a Committee of the Board of Directors which has the authority to determine the persons to whom the options may be granted, the number of shares of common stock to be covered by each option grant, and the terms and provisions of each option grant. Options granted under the 2006 Plan may be incentive stock options or non-qualified options, and may be issued to employees, consultants, advisors and directors of the Company. The exercise price of options granted under the 2006 Plan may not be less than the fair market value of the Company’s common stock on the date of grant, and may not be granted more than ten years from the date of adoption of the plan or exercised more than ten years from the date of grant.
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
The following table sets forth the Company’s stock option activity during the year ended March 31, 2012:
The following table sets forth the status of the Company’s non-vested stock options as of March 31, 2012:
The following table summarizes information about stock options outstanding at March 31, 2012:
Total stock-based compensation reported in the consolidated statements of operations for Fiscal 2012 and Fiscal 2011 was classified as follows:
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
Unrecognized stock-based compensation expense, net of estimated forfeitures, related to the unvested options is approximately $0.9 million, and will be recorded over the remaining service period of 3.12 years. This estimate is based on the number of unvested options currently outstanding and could change based on the number of options granted or forfeited in the future.
The Company based its expected volatility on the historical volatility of the Company’s stock price with consideration given to the expected life of the award. The Company intends to continue to consistently use its historical stock price to determine volatility in the future.
The risk-free interest rate used for each grant is equal to the U.S. Treasury yield in effect at the time of grant for instruments with a similar expected life.
For Fiscal 2012 and 2011 the expected term was calculated based upon the simplified method.
The Company has not declared or paid a cash dividend, and has no current plans to pay a cash dividend in the future.
The Company recognizes compensation expense for only those options that are expected to vest. Therefore, the Company has estimated expected forfeitures of stock options. In developing a forfeiture rate estimate, the Company considered its historical experience. If the actual number of forfeitures differs from those estimated by management, additional adjustments to compensation expense may be required in future periods.
The fair value of options issued during Fiscal 2012 and 2011 were estimated at the date of grant with the following weighted-average assumptions:
The per share weighted average fair value of stock options granted in Fiscal 2012 and 2011 was $4.26 and $2.61, respectively.
The total fair value of options that vested in Fiscal 2012 and 2011 was $173,334 and $228,098, respectively.
The total intrinsic value of options exercised during Fiscal 2012 and 2011 was $71,925 and $6,500, respectively.
10. PREFERRED STOCK
Pursuant to the Company’s Certificate of Incorporation, the Board of Directors has the authority, without further action by the stockholders, to issue up to 100,000 shares of preferred stock, par value $.10 per share, in one or more series and to fix the designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions thereof, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights of the common stock.
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
11. INCOME TAXES
The following sets forth the provision for income taxes for Fiscal 2012 and 2011:
The Company and its subsidiaries file a consolidated federal income tax return. Tax benefits from the early disposition of stock by optionees under incentive stock options and from exercises of non-qualified options are credited to additional paid-in capital, to the extent that the tax deduction exceeds stock compensation recorded for book purposes. The Company recorded $13,519 in tax benefits from early stock dispositions in Fiscal 2012. There were no tax benefits recorded in Fiscal 2011. Tax deficiencies related to the cancellation of non-qualified stock options is charged to additional paid in capital to the extent there are amounts available to absorb such tax deficiencies.
For Fiscal 2012 and 2011 the difference between the income tax provision computed at the Federal statutory rate of 34% and the actual tax provision is accounted for as follows:
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
At March 31, 2012 and 2011 deferred tax assets (liabilities) are comprised of:
As of March 31, 2012, the Company has state net operating loss carryforwards of approximately $1,297,000 of which $731,000 will expire in 2016, $121,000 in 2029 and $445,000 in 2030. A valuation allowance of $88,000 has been provided for the deferred tax asset relating to state net operating losses due to the uncertainty of future utilization. The Company’s effective tax rate was 37.3% and 34.0% for the years ended March 31, 2012 and 2011, respectively.
The amount of uncertain tax benefits in Fiscal 2011 of $1,740 was recognized due to statute of limitations expiring. The Company’s policy is to recognize interest and penalties accrued on any uncertain tax positions as a component of income tax expense, if any. There were no interest and penalties accrued for the years ended March 31, 2012 and 2011 due to the uncertain tax benefit being recognized during the year.
As of March 31, 2012, the Company is subject to tax in the U.S. and various state jurisdictions. The Company is open to examination for tax years March 31, 2009 through 2012.
The Company finalized an IRS audit for its Fiscal 2008 tax returns in Fiscal 2011 with no findings.
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
12. EARNINGS PER SHARE
Basic earnings per share, or EPS, is computed based on the net income or loss for each period divided by the weighted average actual shares outstanding during the period. Diluted earnings per share is computed based on the net income or loss per period divided by the weighted average number of common shares and common equivalent shares outstanding during each period unless the effect would be anti-dilutive. Common stock equivalents represent the dilutive effect of the assumed exercise of certain outstanding stock options using the treasury stock method. The computations of basic and diluted earnings per share for the years ended March 31, 2012 and 2011 are as follows:
At March 31, 2012 and 2011, 10,000 and 126,000 stock options, respectively, were excluded from the diluted earnings per share calculation because they would have been anti-dilutive.
13. COMMITMENTS AND CONTINGENCIES
The Company is obligated under various non-cancelable operating leases for manufacturing facilities and equipment, which expire in December 2013. The Company has options to extend leases in its leased facilities. The Company pays building operating costs in its leased facilities.
The aggregate future minimum lease payments, are as follows:
Rental expense for the years ended March 31, 2012 and 2011 was $741,998 and $766,134, respectively.
14. FAIR VALUE MEASUREMENTS
The Company assesses fair value as an exit price representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, this standard establishes a three-tier value hierarchy, which prioritizes, in descending order, the inputs used in measuring fair value as follows:
Level 1-Inputs used to measure fair value are unadjusted quoted prices that are available in active markets for the identical assets or liabilities as of the reporting date.
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
Level 2-Inputs used to measure fair value, other than quoted prices included in Level 1, are either directly or indirectly observable as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data from actively quoted markets for substantially the full term of the financial instrument.
Level 3-Inputs used to measure fair value are unobservable inputs that are supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.
This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. Assets and liabilities measured at fair value on a recurring basis, include the following as of March 31, 2012 and 2011.
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
The fair value of the money market fund was determined based on pricing provided by a large investment bank. Since the valuation was not observable, the Company has classified it as level 2 securities. There has been no change in the per share fair value of the money market fund since March 31, 2011. The interest rate swap agreement expired March 30, 2012 therefore there was no value at March 31, 2012.
15. RELATED PARTY TRANSACTION
On December 4, 2008, Micronetics, Inc. entered into a lease with SBJ Development, LLC (the “Landlord”) for a new headquarters for Stealth Microwave, Inc, its subsidiary. The property is located in the Township of Ewing, New Jersey. The lease has an initial term of five years and contains three options to extend the lease, each for a term of five years. The annual rent for the initial term of the lease is $225,600.
Kevin Beals, President of Micronetics, is a member of the Landlord. Mr. Beals owns sixteen percent of the outstanding units of membership interest of the Landlord.
The Audit Committee of the Board of Directors of Micronetics reviewed and approved the terms of the lease prior to its execution.
16. MAJOR CUSTOMERS
The Company sells primarily to original equipment manufacturers of communications equipment in either the commercial or the defense electronic marketplace. Many of those customers are prime contractors for defense work or Fortune 500 companies with world-wide operations. The top three customers accounted for 36%, 13% and 5% of the Company’s consolidated sales in Fiscal 2012. For Fiscal 2011, the top three customers accounted for 22%, 11% and 5% of the Company’s consolidated sales. The top customer also accounts for 32% of the Company’s accounts receivable at March 31, 2012 and 25% of the account receivable at March 31, 2011.
17. INDUSTRY SEGMENT INFORMATION
The Company’s product groups have similar characteristics such as cost to design and manufacture, applications, types of customers, and sales channels. Accordingly, management has determined that the Company operates as a single integrated business and as such has one operating segment as a provider of RF and microwave components and subassemblies for defense and commercial customers worldwide.
Exports accounted for 8% and 15% of the Company’s net sales in the years ended March 31, 2012 and 2011, respectively. Net sales representing shipments by geographical area of customers are shown below (in thousands):
MICRONETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
MARCH 31, 2012 AND 2011
18. EMPLOYEE BENEFIT PLANS
The Company sponsors a defined contribution plan under Section 401(k) of the Internal Revenue Code under which it provides matching contributions of 50% on up to 6% of the participant’s annual salary.
Company contributions to the plan for Fiscal 2012 and 2011 were $231,606 and $199,756, respectively.
19. UNAUDITED QUARTERLY FINANCIAL INFORMATION (amounts in thousands, except per share amounts)