10-Q 1 form10-q.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
   
  For the quarterly period ended June 30, 2017

 

or

 

[  ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
   
  For the transition period from _____to _____

 

Commission file number 000-07441

 

SIERRA MONITOR CORPORATION

(Exact name of registrant as specified in its charter)

 

California   95-2481914

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1991 Tarob Court

Milpitas, California 95035

(Address and zip code of principal executive offices)

 

(408) 262-6611

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer [  ]   Accelerated filer [  ]
Non-accelerated filer [  ]     (Do not check if a smaller reporting company) Smaller reporting company [X]
Emerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [  ] No [X]

 

The number of shares outstanding of the issuer’s common stock, as of August 14, 2017 was 10,190,625.

 

 

 

 
 

 

PART I: FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

SIERRA MONITOR CORPORATION

Condensed Balance Sheets

 

  June 30, 2017    December 31, 2016 
   (unaudited)     
Assets        
Current assets:          
Cash  $4,639,458   $4,692,999 
Trade receivables, less allowance for doubtful accounts of approximately $75,000 at June 30, 2017 and December 31, 2016   2,639,429    2,502,601 
Inventories, net   2,524,298    2,443,774 
Prepaid expenses   285,885    575,177 
Income tax deposit   305,819    68,949 
Total current assets   10,394,889    10,283,500 
           
Property and equipment, net   130,740    167,831 
Deferred income taxes   249,967    249,967 
Other assets   149,423    202,875 
Total assets  $10,925,019   $10,904,173 
Liabilities and Shareholders’ Equity          
Current liabilities:          
Accounts payable  $853,709   $824,951 
Accrued compensation expenses   533,170    460,584 
Other current liabilities   668,834    168,584 
Total current liabilities   2,055,713    1,454,119 
           
Deferred tax liability   88,802    88,802 
Total liabilities   2,144,515    1,542,921 
           
Commitments and contingencies Shareholders’ equity:          
Common stock, $0.001 par value; 20,000,000 shares authorized; 10,190,625 and 10,171,551 shares issued and outstanding, at June 30, 2017 and December 31, 2016 respectively.   10,191    10,172 
Additional paid-in capital   4,321,598    4,139,527 
Retained earnings   4,448,715    5,211,553 
Total shareholders’ equity   8,780,504    9,361,252 
Total liabilities and shareholders’ equity  $10,925,019   $10,904,173 

 

See accompanying notes to the unaudited interim condensed financial statements.

 

  Page 2 of 17
 

 

SIERRA MONITOR CORPORATION

Condensed Statements of Operations

(Unaudited)

 

   Three months ended June 30,   Six months ended June 30, 
   2017   2016   2017   2016 
Net sales  $4,835,420   $4,818,592   $9,362,610   $9,359,589 
Cost of goods sold   2,048,474    2,022,418    3,841,280    3,935,198 
Gross profit   2,786,946    2,796,174    5,521,330    5,424,391 
Operating expenses                    
Research and development   768,212    680,441    1,528,508    1,380,362 
Selling and marketing   1,260,339    1,216,580    2,615,550    2,473,013 
General and administrative   824,726    828,098    1,612,538    1,597,237 
Non-recurring restructuring expense   580,425    -    580,425    - 
    3,433,702    2,725,119    6,337,021    5,450,612 
Income (loss) from operations   (646,756)   71,055    (815,691)   (26,221)
Interest income   -    150    -    203 
Income (loss) before income taxes   (646,756)   71,205    (815,691)   (26,018)
Income tax (benefit) provision   (221,292)   66,789    (256,385)   67,694 
Net income (loss)  $(425,464)  $4,416   $(559,306)  $(93,712)
Net income (loss) available to common shareholders per common share                    
Basic:  $(0.04)  $0.00   $(0.06)  $(0.01)
Diluted:  $(0.04)  $0.00   $(0.06)  $(0.01)
Weighted average number of common shares used in per share computations                    
Basic:   10,181,553    10,145,862    10,179,053    10,145,862 
Diluted:   10,181,553    10,147,539    10,179,053    10,145,862 

 

See accompanying notes to the unaudited interim condensed financial statements.

 

  Page 3 of 17
 

 

SIERRA MONITOR CORPORATION

Condensed Statements of Cash Flows

(Unaudited)

 

    Six months ended  
    June 30,  
    2017     2016  
Cash flows from operating activities:                
Net loss   $ (559,306 )   $ (93,712 )
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:                
Depreciation and amortization     140,507       179,505  
Provision for inventory losses     -       (21,411 )
Stock-based compensation expense     165,792       195,256  
Change in operating assets and liabilities:                
Trade receivables     (136,828 )     12,501  
Inventories     (80,524 )     (13,988 )
Prepaid expenses     289,292       (70,593 )
Income tax deposit     (236,870 )     (148,042 )
Other assets     -       600  
Accounts payable     28,758       (170,972 )
Accrued compensation expenses     72,586       (175,859 )
Other current liabilities     500,250       (2,668 )
Net cash provided by (used in) operating activities     183,657       (309,383 )
Cash flows from investing activities:                
Purchases of property and equipment     (49,964 )     (43,996 )
Net cash used in investing activities     (49,964 )     (43,996 )
Cash flows from financing activities:                
Dividend payout     (203,532 )     (202,918 )
Proceeds from exercise of stock options     16,298       -  
Net cash used in financing activities   $ (187,234 )   $ (202,918 )
Net decrease in cash and cash equivalents:     (53,541 )     (556,297 )
Cash and cash equivalents at beginning of period:   $ 4,692,999     $ 4,883,373  
Cash and cash equivalents at end of period:   $ 4,639,458     $ 4,327,076  

  

See accompanying notes to the unaudited interim condensed financial statements.

 

  Page 4 of 17
 

 

SIERRA MONITOR CORPORATION

Notes to the Interim Condensed Financial Statements

(Unaudited)

June 30, 2017

 

Basis of Presentation

 

The accompanying unaudited interim condensed financial statements have been prepared by Sierra Monitor Corporation (the “Company,” “we,” or “us”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been omitted pursuant to such SEC rules and regulations; nevertheless, the Company believes that the disclosures are adequate to make the information presented not misleading. Amounts related to disclosure of December 31, 2016 balances within these interim condensed financial statements were derived from the audited 2016 financial statements and notes thereto. These financial statements and the notes hereto should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, which was filed with the SEC on March 22, 2017. In the opinion of the Company, all adjustments, including normal recurring adjustments necessary to present fairly the financial position, results of operations, and cash flows of the Company for the interim period have been included. The results of operations for the interim period are not necessarily indicative of the results for any subsequent interim period or for the full year.

 

Summary of Business

 

Sierra Monitor Corporation addresses the industrial and commercial facilities management market with Industrial Internet of Things (“IIoT”) solutions that target facility automation and facility safety requirements, also referred to as “Connect” and “Protect”.

 

The Company’s FieldServer family of protocol gateways, routers, and network explorers targets facility automation requirements, and is used by original equipment manufacturers (“OEMs”) and system integrators to enable local and remote monitoring and control of assets and facilities. The FieldServer family of products works with the FieldPoP™ device cloud portal; a cloud-based service that registers and manages FieldServer products, provides secure remote access to the local web-based applications that run on FieldServer products, and integrates with third-party applications over REST APIs. With more than 200,000 installed gateways supporting over 140 protocols such as BACnet, LonWorks, MODBUS, and XML in commercial and industrial facilities, FieldServer is the industry’s leading multi-protocol gateway brand and is delivered in a variety of form factors appropriate to the asset being interfaced. The intellectual property in FieldServer products is embodied in the proprietary embedded software that runs on a variety of customized hardware platforms with different connectivity options such as Serial, Ethernet, Wi-Fi, or cellular. In addition to bridging data protocols between various assets or devices within a facility, the embedded software includes value-added “fog” or “local application” software for monitoring, logging, alarming, and trending local field data. Additionally, the embedded software enables the assets or devices in the facility to securely connect to third-party clouds and to the Company’s own FieldPoP device cloud portal. The FieldPoP device cloud portal is a proprietary, secure, and scalable Software-as-a-Service product and is developed and deployed using the same core technologies and providers that are used by many of the world’s leading web sites and Internet-based services.

 

  Page 5 of 17
 

 

The Company’s Sentry IT fire and gas detection solutions target facility safety requirements, and are used by industrial and commercial facilities managers to protect their personnel and assets. The motivation for installing gas detection systems is driven, in part, by industrial safety professionals guided by the United States Occupational Safety and Health Administration, state and local governing bodies, insurance companies and various industry rule-making bodies. The solution consists of proprietary system hardware that runs embedded controller and gateway software, detector modules that sense the presence of various toxic and combustible gases and flames, connectivity between the modules and the controller, and a user interface and applications that a facility manager can interact with, either locally on site or remotely over the Internet. The complex software embedded in the various products facilitates system-wide functions such as calibration, alarm detection, notification, and mitigation. The controller software also includes local web-based applications that simplify management of the complete solution and a gateway to integrate the fire and gas detection solution with the facility’s local supervisory system or to the Company’s FieldPoP device cloud portal. With more than 100,000 detector modules sold, our fire and gas detection solutions are deployed in a variety of facilities, such as oil, gas and chemical processing plants, wastewater treatment facilities, alternate fuel vehicle maintenance garages and other sites where hazardous gases are used or produced.

 

The Company’s solutions are also sold to telecommunication companies and their suppliers to manage environmental and security conditions such as temperature, gas, and smoke in remote structures such as local DSL distribution nodes and buildings at cell tower sites.

 

The Company was founded in 1978 and its common stock is quoted on the OTC Bulletin Board under the symbol “SRMC”.

 

Accounting Policies

 

a)Revenue Recognition

 

A detailed discussion of our revenue recognition policies is contained in Item 2 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) under Critical Accounting Policies below. The discussion is incorporated herein by reference.

 

b)Recent Accounting Pronouncements

 

Recent accounting pronouncements discussed in the notes to the December 31, 2016 audited financial statements, filed previously with the SEC in our Annual Report on Form 10-K on March 22, 2017, that are required to be adopted during the year ended December 31, 2017, did not have or are not expected to have a significant impact on the Company’s 2017 financial statements.

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, issued as a new Topic, ASC Topic 606 (ASU 2014-09). The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The premise of the guidance is that a Company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 can be adopted by the Company either retrospectively or as a cumulative-effect adjustment as of the date of adoption. On April 1, 2015, the FASB decided to defer the effective date of the new revenue standard by one year. For public entities, the update is effective for financial statements issued for fiscal years beginning after December 15, 2017. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its financial statements or decided upon the method of adoption.

 

On February 25, 2016, the FASB issued ASU 2016-2, “Leases” (Topic 842), which is intended to improve financial reporting for lease transactions. This ASU will require organizations that lease assets, such as real estate, airplanes and manufacturing equipment, to recognize on their balance sheet the assets and liabilities for the rights to use those assets for the lease term and obligations to make lease payments created by those leases that have terms of greater than 12 months. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as finance or operating lease. This ASU will also require disclosures to help investors and other financial statement users better understand the amount and timing of cash flows arising from leases. These disclosures will include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements. The ASU is effective for the Company for the year ending December 31, 2019 and interim reporting periods within that year, and early adoption is permitted. Management has not yet determined the effect of this ASU on the Company’s financial statements.

 

In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”), which simplifies the presentation of deferred income taxes. ASU 2015-17 requires that deferred tax assets and liabilities be classified as noncurrent in a classified statement of financial position. ASU 2015-17 is effective for financial statements issued for fiscal years beginning after December 15, 2016 (and interim periods within those fiscal years) with early adoption permitted. ASU 2015-17 may be either applied prospectively to all deferred tax assets and liabilities or retrospectively to all periods presented. We adopted ASU 2015-17 during our first quarter of fiscal year 2017 on a retrospective basis. Accordingly, we reclassified the current deferred taxes to noncurrent on our December 31, 2016 Condensed Balance Sheet, which increased noncurrent deferred tax assets to $249,967.

 

c)Employee Stock-Based Compensation

 

In March 2016, the Company’s 2006 Stock Plan expired. In April 2016, the Company’s board of directors approved the Company’s 2016 Equity Incentive Plan (the “2016 Stock Plan”) and reserved a total of (i) 279,680 Shares, plus (ii) 2,550,320 shares that remained available for issuance under the 2006 Stock Plan immediately prior to its expiration, plus (iii) any shares subject to stock options or restricted stock granted under the 2006 Stock Plan that, on or after the date the 2016 Stock Plan becomes effective, expire or otherwise terminate without having been exercised in full, or are forfeited to or repurchased by the Company, with the maximum number of shares to be added to the 2016 Stock Plan pursuant to clauses (ii) and (iii) equal to 2,668,320. Options granted under our 2006 Stock Plan and 2016 Stock Plan are granted with an exercise price equal to the fair market value of our common stock at the grant date, typically vest ratably over 4 years, and expire 10 years from the grant date.

 

  Page 6 of 17
 

 

All share-based payments to employees (incentive stock options) are recognized in the financial statements based on their fair values at the date of grant. The calculated fair value is recognized as expense (net of any capitalization) over the requisite service period, net of estimated forfeitures, using the straight-line method. The Company considers many factors when estimating expected forfeitures, including types of awards, employee class and historical experience. The modified prospective method of application requires compensation expense to be recognized in the financial statements for all unvested stock options beginning in the quarter of award. The cost is based on the grant date fair value of the stock option. Compensation expense recognized in future periods for share-based compensation will be adjusted for the effects of estimated forfeitures.

 

For the six-month periods ended June 30, 2017 and 2016, general and administrative expenses included stock based compensation expense of $165,792 and $195,256, respectively, increasing the Company’s loss before provision for income taxes and net income resulting from the recognition of compensation expense associated with employee stock options. There was no material impact on the Company’s basic and diluted net loss per share as a result of recognizing the employee stock-based compensation expense. The Company did not modify the terms of any previously granted stock options during the six-month periods ended June 30, 2017 and 2016.

 

d)Subsequent Events

 

Management has evaluated events subsequent to June 30, 2017 through the date that the accompanying condensed financial statements were filed with the Securities and Exchange Commission for transactions and other events which may require adjustment of and/or disclosure in such financial statements.

 

Inventories

 

A summary of inventories follows:

 

   June 30, 2017   December 31, 2016 
Raw materials  $1,251,557   $1,421,004 
Work-in-process   726,613    706,330 
Materials at vendor   393,990    247,680 
Finished goods   349,247    265,869 
Less: Allowance for obsolescence reserve   (197,109)   (197,109)
   $2,524,298   $2,443,774 

 

Net Loss Per Share

 

Basic loss per share (“EPS”) is computed using the weighted average number of common shares outstanding during the period. Diluted EPS is computed using the weighted average number of common and dilutive potential common shares outstanding during the period. Dilutive potential common shares consist of common stock issuable upon exercise of stock options using the treasury stock method. No adjustments to losses were made for purposes of per share calculations.

 

At June 30, 2017 and 2016, there were no options to acquire shares of common stock that were considered potentially dilutive due to the net loss for the year-to-date periods.

 

  Page 7 of 17
 

 

The following is a reconciliation of the shares used in the computation of basic and diluted EPS for the three and six-month periods ended June 30, 2017 and 2016, respectively:

 

   Three months ended   Six months ended 
   June 30, 2017   June 30, 2016   June 30, 2017   June 30, 2016 
Basic EPS – weighted-average number of common shares outstanding   10,181,553    10,145,862    10,179,053    10,145,862 
Effect of dilutive potential common shares – stock options outstanding   -    1,677    -    - 
Diluted EPS – weighted-average number of common shares and potential common shares outstanding   10,181,553    10,147,539    10,179,053    10,145,862 

 

Concentrations

 

No customer made up more than 10% of accounts receivable at June 30, 2017 or December 31, 2016. Additionally, no customers made up more than 10% of net sales for each of the three or six-month periods ended June 30, 2017 or June 30, 2016.

 

The Company currently maintains substantially all of its day to day operating cash with a major financial institution. At times, cash balances may be in excess of the amounts insured by the Federal Deposit Insurance Corporation. Cash balances of $4,139,000 and $4,331,000 were in excess of such insured amounts at June 30, 2017 and December 31, 2016, respectively.

 

Segment Information

 

The Company operates in a single business segment, industrial instrumentation. The Company’s chief operating decision maker, the Chief Executive Officer (“CEO”), evaluates the performance of the Company and makes operating decisions based on financial data consistent with the presentation in the accompanying unaudited condensed financial statements.

 

In addition, the CEO reviewed the following information on revenues by product category for the following periods:

 

    Three months ended June 30,   Six months ended June 30, 
    2017   2016   2017   2016 
 Instrumentation   $2,291,828   $2,199,892   $4,369,427   $4,267,476 
 FieldServers    2,543,592    2,618,700    4,993,183    5,092,113 
     $4,835,420   $4,818,592   $9,362,610   $9,359,589 

 

Line of Credit

 

The Company maintains a line of credit with its commercial bank in the maximum amount of $2,000,000. No borrowings have been made under the Company’s line of credit during the first six months of fiscal year 2017 and there were no outstanding balances at June 30, 2017 or December 31, 2016. As of June 30, 2017, the Company was not in compliance with one of the financial covenants for the line of credit related to the Company’s profitability and received a waiver of that covenant.

 

Stock Option Grants

 

A total of 238,000 options with a fair value of $162,554 were granted during the three month and six month periods ended June 30, 2017. No options were granted during the three-month and six-month periods ended June 30, 2016.

 

Stock Option Exercise and Expiration

 

A total of 135,000 stock options were exercised in the six-month period ended June 30, 2017 for total proceedes of 16,298. During the same period, 1,500 options expired.

 

No stock options were exercised in the six-month period ended June 30, 2016. During the same period, 27,500 options expired.

 

Commitments and Contingencies

 

From time to time, the Company is subject to legal proceedings and claims that arise in the normal course of business. While the outcome of these proceedings and claims cannot be predicted, we currently are not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, is expected to have a material adverse effect on the Company’s financial position or results of operations.

 

  Page 8 of 17
 

 

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Statements that are not statements of historical fact may be deemed to be forward-looking statements. The words “believe,” “anticipate,” “expect,” “intend,” “plan,” “project,” “will,” and similar words and phrases as they relate to us also identify forward-looking statements. Such forward-looking statements include, among others, any expectations of operating and non-operating expense, including research and development expense, potential litigation expense, sufficiency of resources, including cash and accounts receivable, estimates of allowances for doubtful accounts, credit lines or other financial items, our internal control environment and critical accounting policies; any statements concerning future sales levels and timing and demand for our products; any statements of the plans, strategies and objectives of management for future operations and identified opportunities; any statements concerning proposed new products, services, developments and related research and development activities; any statements related to our positioning to support current and near term levels of business; any statements of belief; and any statement of assumptions underlying any of the foregoing. Such statements reflect our current views and assumptions and are not guarantees of future performance. These statements are subject to various risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, without limitation, general economic conditions in both foreign and domestic markets, changes in the economy and the credit market, investment and research and development plans and success, market position and penetration, strategic plans and objectives, operating margins, government and regulatory approvals or certifications, cyclical factors affecting our industry, our ability to identify, attract, motivate and retain qualified personnel, lack of growth in our end-markets, our ability to develop and manufacture, seasonality in our products, availability of components and materials used in our products, and our ability to sell both new and existing products at a profitable yet competitive price and those issues described under the heading “Critical Accounting Policies,” below, and those risk factors identified in Item1A, Risk Factors, of our Annual Report on Form 10-K for our fiscal year ended December 31, 2016, which was filed with the SEC on March 22, 2017, as such section may be updated in our subsequent Forms 10-K, 10-Q and 8-K filed with, or furnished to, the SEC. We urge you to review and consider the various disclosures made by us from time to time in our filings with the SEC that attempt to advise you of the risks and factors that may affect our future results. All forward-looking statements in this document are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward-looking statement.

 

Results of Operations

 

For the three-month period ended June 30, 2017, Sierra Monitor Corporation (“we” or the “Company”) reported net sales of $4,835,420 compared to $4,818,592 for the three-month period ended June 30, 2016. For the six-month period ended June 30, 2017, net sales were $9,362,610 compared with $9,359,589 for the six-month period ended June 30, 2016.

 

Sales of gas detection products, including industrial accounts, military sales and environment controllers for telephone company applications, increased by approximately 4% in the second quarter of 2017 compared to the same period in 2016. In the first half of 2017, sales of gas detection products were 2% higher than the same period in 2016. Increased sales customers in the U.S. and Asia were partly offset by lower sales to customers in the Middle East.

 

  Page 9 of 17
 

 

Sales of our FieldServer product line decreased by 3% in the second quarter of 2017 compared to the second quarter of 2016. In the first half of 2017, sales of FieldServer products decreased by 2% compared with the same period in 2016. FieldServer units include box products and original equipment manufacturer (“OEM”) modules. Box products provide a platform for delivery and operation of our software for building automation projects and are generally sold to integrators. OEM modules are sold to companies that integrate our products into their commercial offerings. There were no significant changes in the sales levels for our box products and OEM products in either the first half or second quarter of 2017 compared to the same periods in 2016.

 

Gross profit for the three-month period ended June 30, 2017 was approximately $2,787,000, or 58% of net sales, compared to approximately $2,796,000, or 58% of net sales, in the same period in the previous year. Gross profit for the six-month period ended June 30, 2017 was approximately $5,521,000, or 59% of net sales, compared to approximately $5,424,000, or 58% of net sales, in the same period in the previous year. The margins in each of the first half and second quarter of 2017 are generally consistent with our historical results. Expenses for research and development, which include new product development and engineering to sustain existing products, were approximately $768,000, or 16% of net sales, for the three-month period ended June 30, 2017 compared to approximately $680,000, or 14% of net sales, in the comparable period in 2016. In the six-month periods ended June 30, 2017 and June 30, 2016, research and development expenses were approximately $1,529,000, or 16% of net sales, and approximately $1,380,000, or 15% of net sales, respectively. Our increased research and development spending is consistent with our strategy of developing products that we anticipate will have a positive impact on revenues in future periods. We introduced the FieldPoP service in the first quarter of 2017 and expect to conduct beta testing and enhancing the product throughout 2017. Additionally, we anticipate continuing approval testing of our Red Owl line of flame detectors with final release to market in the fourth quarter of 2017.

 

Selling and marketing expenses, which consist primarily of salaries, commissions and promotional expenses were approximately $1,260,000, or 26% of net sales, for the three-month period ended June 30, 2017, compared to approximately $1,217,000, or 25% of net sales, in the comparable period in the prior year. For the six-month periods ended June 30, 2017 and June 30, 2016, selling and marketing expenses were approximately $2,616,000, or 28% of net sales, and approximately $2,473,000, or 26% of net sales, respectively. Selling expenses have increased in the three and six month periods ending June 30, 2017 primarily as a result of higher commission payments undertaken to increase sales representive activity in developing early sales opportunities. A related sales campaign was discontinued at the end of second quarter of 2017.

 

General and administrative expenses, which consist primarily of salaries, building rent, insurance expenses, information technology expenses and fees for professional services, were approximately $825,000, or 17% of net sales, for the three-month period ended June 30, 2017 compared to approximately $828,000, or 17% of net sales, in the three-month period ended June 30, 2016. For the six-month periods ended June 30, 2017 and June 30, 2016, general and administrative expenses were approximately $1,613,000, or 17% of net sales, and approximately $1,597,000, or 17% of net sales, respectively. Our general and administrative expenses were essentially unchanged for the quarter and year-to-date periods.

 

In the second quarter of 2017, cost of $580,425 were incurred related to compensation expense incurred as a result of the departure of Varun Nagaraj as CEO and President and Anders Axelsson as Vice President of Sales and Marketing. Under the terms of his separation agreement, Mr. Nagaraj received: (i) a lump sum separation payment equal to six months of his annual base salary plus six months of his annual target bonus, for a total of $262,500; (ii) a payment of $21,000 in lieu of Company-subsidized COBRA; and (iii) vesting acceleration with respect to restricted stock awards and stock option awards previously granted to Mr. Nagaraj, in each case reflecting acceleration of 50% of the then unvested portion of each award as of the separation date.

 

  Page 10 of 17
 

 

Under the terms of his separation agreement, Mr. Axelsson received: (i) a lump sum separation payment equal to six months of his annual base salary plus six months of his annual target bonus, for a total of $250,000; (ii) a payment of $21,000 in lieu of Company-subsidized COBRA; and (iii) vesting acceleration with respect to the restricted stock awards and stock option awards previously granted to Mr. Axelsson, in each case reflecting acceleration of 50% of the then unvested portion of each award as of the separation date.

 

In the three-month period ended June 30, 2017, our loss from operations was approximately $647,000, representing a decrease of approximately $718,000 compared to our income from operations of approximately $71,000 in the three-month period ended June 30, 2016. In the six-month period ended June 30, 2017, our loss from operations was approximately $816,000 representing a decrease of approximately $789,000 compared to our loss from operations of $26,000 in the six-month period ended June 30, 2016. The decrease in income in both the second quarter and first half of 2017 compared to the same periods in 2016 is due primarily to the non-recurring expense for separation packages for our former two senior executives.

 

After interest and tax provisions, our net loss for the three-month period ended June 30, 2017 was approximately $425,000 compared to net income of approximately $4,000 in the same period of 2016. For the six-month period ended June 30, 2017, our net loss was approximately $559,000 compared to a net loss of approximately $94,000 in the same period of 2016.

 

Liquidity and Capital Resources

 

During the six months ended June 30, 2017, net cash provided by operating activities was approximately $184,000 compared to net cash used by operating activities of approximately $310,000 for the same period in 2016. As more fully described below, the change was due primarily to cash received by a potential strategic partner offset by changes in income. Working capital was approximately $8,339,000 at June 30, 2017, a decrease of approximately $490,000 from December 31, 2016. At June 30, 2017, our balance sheet reflected approximately $4,639,000 of cash and approximately $2,639,000 of net trade receivables. At December 31, 2016, our total cash on hand was approximately $4,693,000 and our net trade receivables were approximately $2,503,000.

 

As previously announced by the Company, in order to enhance value to the Company’s shareholders, the Company is currently in the process of identifying and evaluating a wide range of potential alternative strategic transactions, including strategic business model alternatives, disposition of one or more corporate assets, business combinations and the sale of the Company. There is no definitive timetable for completing the Company’s identification and evaluation of potential strategic alternatives. The Company has not made a decision to enter into or consummate any particular transaction, nor has the Company entered into any definitive agreement for any particular transaction. In connection with the Company’s discussions regarding potential alternative strategic transactions, on April 10, 2017, the Company received $1,000,000 in cash from a potential strategic partner. Of the total cash received, $500,000 is an expense reimbursement for some of the out-of-pocket costs the Company has incurred in connection with its consideration of strategic alternatives. The other $500,000 is a fully refundable amount which the Company expects to return to the payer in August 2017.

 

At June 30, 2017, we had no long term liabilities except for deferred tax liabilities.

 

We maintain a line of credit with our commercial bank in the maximum amount of $2,000,000. No borrowings have been made under our line of credit during the first six months of fiscal year 2017 and there were no outstanding balances at June 30, 2017 or December 31, 2016. As of June 30, 2017, we were not in compliance with one of the financial covenants of the line of credit and received a waiver of that covenant.

 

  Page 11 of 17
 

 

We believe that our present resources, including cash and accounts receivable, are sufficient to fund our anticipated level of operations through at least September 2018. There are no current plans for significant capital equipment expenditures and no other known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in our liquidity increasing or decreasing in any material way.

 

Critical Accounting Policies

 

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported in the Company’s condensed financial statements and the accompanying notes. The amounts of assets and liabilities reported on our balance sheets and the amounts of revenues and expenses reported for each of our fiscal periods are affected by estimates and assumptions, which are used for, but not limited to, the accounting for revenue recognition, accounts receivable, doubtful accounts and inventories. Actual results could differ from these estimates. The following critical accounting policies are significantly affected by judgments, assumptions and estimates used in the preparation of the condensed financial statements:

 

a)Revenue Recognition

 

The Company recognizes revenues when all of the following conditions exist: a) persuasive evidence of an arrangement exists in the form of an accepted purchase order; b) delivery has occurred, based on shipping terms, or services have been rendered; c) the Company’s price to the buyer is fixed or determinable, as documented on the accepted purchase order; and d) collectability is reasonably assured. By product and service type, revenues are recognized when the following specific conditions are met:

 

Gas Detection and Environment Control Products

 

Gas detection and environment control products are sold as off-the-shelf products with prices fixed at the time of order. Orders delivered to the Company by phone, fax, mail or email are considered valid purchase orders and once accepted by the Company are deemed to be the final understanding between us and our customer as to the specific nature and terms of the agreed-upon sale transaction. Products are shipped and are considered delivered when (a) for FOB factory orders they leave our shipping dock or (b) for FOB customer dock orders upon confirmation of delivery. The creditworthiness of customers is generally assessed prior to the Company accepting a customer’s first order. Additionally, international customers and customers who have developed a history of payment problems are generally required to prepay or pay through a letter-of-credit.

 

Gas Detection and Environment Control Services

 

Gas detection and environment control services consist of field service orders (technical support) and training, which are provided separate from product orders. Orders are accepted in the same forms as discussed for Gas Detection and Environment Control Products above with hourly prices fixed at the time of order. Revenue recognition occurs only when the service activity is completed. Such services are provided to current and prior customers, and, as noted above, creditworthiness has generally already been assessed. In cases where the probability of receiving payment is low, a credit card number is collected for immediate processing.

 

  Page 12 of 17
 

 

FieldServer Products

 

FieldServer products are sold in the same manner as Gas Detection and Environment Control Products (as discussed above) except that the products contain embedded software, which is integral to the operation of the device. The software embedded in FieldServer products includes two items: (a) a compiled program containing (i) the basic operating system for FieldServer products, which is common to every unit, and (ii) the correct set of protocol drivers based on the customer order (see FieldServer Services below for more information); and (b) a configuration file that identifies and links each data point as identified by the customer. The Company does not deem the hardware, operating systems with protocol drivers and configuration files to be separate units of accounting because the Company does not believe that they have value on a stand-alone basis. The hardware is useless without the software, and the software is only intended to be used in FieldServer hardware. Additionally, the software included in each sale is deemed not to require significant production, modification or customization, and therefore the Company recognizes revenues upon the shipment or delivery of products (depending on shipping terms), as described in Gas Detection and Environment Control Products above.

 

FieldServer Services

 

FieldServer services consist of orders for custom development of protocol drivers. Generally customers place orders for FieldServer products concurrently with their order for protocol drivers. However if custom development of the protocol driver is required, the product order is not processed until development of the protocol driver is complete. Orders are received in the same manner as described in FieldServer Products above, but due to the non-recurring engineering aspect of the customized driver development the Company is more likely to have a written evidence trail of a quotation and a hard copy order. The driver development involves further research after receipt of order, preparation of a scope document to be approved by the customer and then engineering time to write, test and release the driver program. When development of the driver is complete the customer is notified and can proceed with a FieldServer product (see FieldServer Products above). Revenues for driver development are billed and recognized upon shipment or delivery of the related product that includes the developed protocol drivers (as noted in FieldServer Products above). Collectability is reasonably assured as described in FieldServer Products above.

 

Discounts and Allowances

 

Discounts are applied at time of order entry and sales are processed at net pricing. No allowances are offered to customers.

 

b)Accounts Receivable and Related Allowances

 

Our domestic sales are generally made on an open account basis unless specific experience or knowledge of the customer’s potential inability or unwillingness to meet the payment terms dictates secured payments. Our international sales are generally made based on secure payments, including cash wire advance payments and letters of credit. International sales are made on open account terms where sufficient historical experience justifies the credit risks involved. In many of our larger sales, the customers are construction contractors who are in need of our field services to complete their work and obtain payment. Management’s ability to manage the credit terms and utilize the leverage provided by the clients’ need for our services is critical to the effective application of credit terms and minimization of accounts receivable losses.

 

We maintain an allowance for doubtful accounts which is analyzed on a periodic basis to determine whether it is adequate. We believe that we have demonstrated the ability to make reasonable and reliable estimates of allowances for doubtful accounts based on significant historical experience.

 

c)Inventories

 

Inventories are stated at the lower of cost or estimated market, cost being determined on the first-in, first-out method. The Company uses an Enterprise Requirements Planning (“ERP”) software system which provides data upon which management relies to determine inventory trends and identify excesses. The carrying value of inventory is reduced to market for slow moving and obsolete items based on historical experience and current product demand. We evaluate the carrying value of inventory quarterly. The adequacy of carrying amounts is dependent upon management’s ability to forecast demands accurately, manage product changes efficiently, and interpret the data provided by the ERP system.

 

  Page 13 of 17
 

 

Off-Balance Sheet Arrangements.

 

None.

 

Contractual Obligations

 

Not applicable.

 

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable.

 

ITEM 4: CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

As of the end of the period covered by this Quarterly Report on Form 10-Q, our management, with the participation of Gordon R. Arnold, our current interim principle executive officer, and Tamara S. Allen, our principal financial officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e), which includes inquiries made to certain other employees. Based upon that evaluation, Mr. Arnold and Ms. Allen concluded that, as of June 30, 2017, our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) were effective.

 

Changes in Internal Control over Financial Reporting

 

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

  Page 14 of 17
 

 

PART II: OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

From time to time, the Company is subject to legal proceedings and claims that arise in the normal course of business. While the outcome of these proceedings and claims cannot be predicted, we currently are not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, is expected to have a material adverse effect on the Company’s financial position or results of operations.

 

ITEM 1A. RISK FACTORS

 

Please see those risk factors identified in Item1A, Risk Factors, of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016. The Company’s risk factors have not changed materially since December 31, 2016.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS

 

A list of exhibits to this Quarterly Report on Form 10-Q is set forth on the Index to Exhibits immediately preceding such exhibits and is incorporated herein by reference.

 

  Page 15 of 17
 

 

SIGNATURES

 

Pursuant to the requirements 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.

 

    SIERRA MONITOR CORPORATION
    Registrant
     
Date:  August 14, 2017 By:  /s/ Gordon R. Arnold
    Gordon R. Arnold
    Interim Chief Executive Officer
    (Principal Executive Officer)
     
Date:  August 14, 2017 By:  /s/ Tamara S. Allen
    Tamara S. Allen
    Chief Financial Officer
    (Principal Financial Officer)

 

  Page 16 of 17
 

 

Index to Exhibits

 

        Incorporated by Reference

Exhibit

Number

 

Exhibit

Description

  Form   Exhibit
Number
 

Date

Filed

3.1   Articles of Incorporation of the Registrant.   10-K   3.1   March 23, 1990
                 
3.2   Bylaws of the Registrant.   8-K   3.2   June 2, 2017
                 
10.1   Separation Agreement with Anders B. Axelsson, dated May 5, 2017   Filed herewith        
                 
10.2   Separation Agreement with Varun Nagaraj, dated May 10, 2017   Filed herewith        
                 
31.1   Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.   Filed herewith        
                 
31.2   Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.   Filed herewith        
                 
32.1   Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.   Furnished herewith        
                 
32.2   Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.   Furnished herewith        

 

101.INS XBRL Instance Document.
101.SCH XBRL Taxonomy Extension Schema.
101.CAL XBRL Taxonomy Extension Calculation Linkbase.
101.DEF XBRL Taxonomy Extension Definition Linkbase.
101.LAB XBRL Taxonomy Extension Label Linkbase.
101.PRE XBRL Taxonomy Extension Presentation Linkbase.

 

  Page 17 of 17