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Micronetics 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2007

OR

 

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

Commission file number 0-17966

 

 

MICRONETICS, INC.

(Exact name of small business issuer as specified in its charter)

 

 

 

Delaware   22-2063614

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

26 Hampshire Drive, Hudson NH   03051
(Address of principal executive offices)   (Zip Code)

(603) 883-2900

(Issuer’s telephone number)

 

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of February 5, 2008, the issuer had 5,391,217 shares of common stock, par value $.01 per share, outstanding.

 

 

 


Table of Contents

MICRONETICS, INC.

INDEX

 

               Page No.

Part I. Financial Information:

  
   Item 1.    Financial Statements.   
      Consolidated Balance Sheets – December 31, 2007 (unaudited) and March 31, 2007 (audited)    3
      Consolidated Statements of Income – Three and Nine Months Ended December 31, 2007 and December 31, 2006 (unaudited)    4-5
      Consolidated Statement of Shareholders’ Equity – Nine Months Ended December 31, 2007 (unaudited)    6
      Consolidated Statements of Cash Flows – Nine Months Ended December 31, 2007 and December 31, 2006 (unaudited)    7
      Notes to Interim Consolidated Financial Statements (unaudited)    8-17
   Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    18-24
   Item 3.    Quantitative and Qualitative Disclosures About Market Risk    25
   Item 4.    Controls and Procedures    25

Part II. Other Information:

  
   Item 1.    Legal Proceedings    26
   Item 1A.    Risk Factors    26-32
   Item 2.    Unregistered Sales of Equity Securities And Use of Proceeds    32
   Item 3.    Defaults Upon Senior Securities    32
   Item 4.    Submission of Matters to Vote of Security Holders    32
   Item 5.    Other Information    32
   Item 6.    Exhibits    32

 

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Table of Contents

MICRONETICS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

     December 31, 2007     March 31, 2007  
   (Unaudited)     Audited  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 3,008,459     $ 7,058,524  

Marketable securities

     650,000       —    

Accounts receivable, net of allowance for doubtful accounts of $415,274 and $297,886 in December 31, 2007 and March 31, 2007, respectively

     4,892,399       3,932,029  

Inventories, net

     6,658,946       5,548,691  

Deferred tax asset

     153,316       —    

Prepaid expenses and other current assets

     705,293       784,649  
                

Total current assets

     16,068,413       17,323,893  
                

Property, plant and equipment, net

     4,135,424       4,017,465  

Other assets:

    

Security deposits

     24,909       12,302  

Other long term assets

     41,216       138,493  

Intangible assets, net of accumulated amortization

     3,544,557       2,344,364  

Goodwill

     8,932,444       5,982,709  
                

Total other assets

     12,543,126       8,477,868  
                

TOTAL ASSETS

   $ 32,746,963     $ 29,819,226  
                
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Current liabilities:

    

Current portion of long-term debt

   $ 1,442,869     $ 1,449,443  

Accounts payable

     662,481       695,142  

Accrued expenses

     2,645,369       3,342,365  

Current portion of deferred tax liability

     52,502       —    
                

Total current liabilities

     4,803,221       5,486,950  

Long-term debt, net of current portion

     4,577,581       5,633,386  

Non-current income taxes payable

     114,731       —    

Deferred tax liability

     1,421,917       721,917  
                

Total liabilities

     10,917,450       11,842,253  
                

Shareholders’ equity:

    

Preferred stock, $0.10 par value; 100,000 shares authorized; no shares issued or outstanding

     —         —    

Common stock, $0.01 par value; 10,000,000 shares authorized; 5,391,217 and 5,025,457 shares issued and outstanding at December 31, 2007 and March 31, 2007, respectively

     53,912       50,255  

Additional paid-in capital

     11,332,499       8,541,274  

Retained earnings

     12,175,301       10,912,458  
                
     23,561,712       19,503,987  

Treasury stock at cost, 383,475 and 358,541 shares at December 31, 2007 and March 31, 2007, respectively

     (1,732,199 )     (1,527,014 )
                

Total shareholders’ equity

     21,829,513       17,976,973  
                

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 32,746,963     $ 29,819,226  
                

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

MICRONETICS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

     Three months ended December 31,  
   2007     2006  

Net sales

   $ 8,828,302     $ 5,510,155  

Cost of sales

     5,202,993       3,373,503  
                

Gross profit

     3,625,309       2,136,652  
                

Operating expenses:

    

Research and development

     288,880       179,920  

Selling, general and administrative

     1,986,427       1,444,882  

Amortization of intangible assets

     183,357       178,296  
                

Total operating expenses

     2,458,664       1,803,098  
                

Income from operations

     1,166,645       333,554  
                

Other (expense) income:

    

Interest income

     23,570       53,551  

Interest expense

     (107,846 )     (108,022 )

Other (expense) income

     (84,973 )     15,861  
                

Total other expense

     (169,249 )     (38,610 )
                

Income before provision for income taxes

     997,396       294,944  

Provision for income taxes

     441,363       183,840  
                

Net income

   $ 556,033     $ 111,104  
                

Earnings per common share

    

Basic

   $ 0.11     $ 0.02  
                

Diluted

   $ 0.11     $ 0.02  
                

Weighted average common shares outstanding

    

Basic

     4,987,525       4,642,041  

Diluted

     4,993,559       4,715,315  

The accompanying notes are an integral part of these consolidated financial statements.

 

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MICRONETICS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

     Nine months ended December 31,  
   2007     2006  

Net sales

   $ 24,901,931     $ 17,377,919  

Cost of sales

     15,231,272       10,457,375  
                

Gross profit

     9,670,659       6,920,544  
                

Operating expenses:

    

Research and development

     601,344       591,853  

Selling, general and administrative

     5,616,755       4,281,243  

Amortization of intangible assets

     549,807       534,887  
                

Total operating expenses

     6,767,906       5,407,983  
                

Income from operations

     2,902,753       1,512,561  
                

Other (expense) income

    

Interest income

     83,344       139,939  

Interest expense

     (384,692 )     (335,869 )

Gain on sale of assets

     44,364       —    

Other (expense) income

     (152,253 )     48,690  
                

Total other expense

     (409,237 )     (147,240 )
                

Income before provision for income taxes

     2,493,516       1,365,321  

Provision for income taxes

     1,134,230       664,665  
                

Net income

   $ 1,359,286     $ 700,656  
                

Earnings per common share:

    

Basic

   $ 0.28     $ 0.15  
                

Diluted

   $ 0.28     $ 0.15  
                

Weighted average common shares outstanding

    

Basic

     4,911,995       4,631,854  

Diluted

     4,936,774       4,827,284  

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited)

 

     Common Stock    Additional
Paid-In
Capital
   Retained
Earnings
     Treasury
Stock
     Total  
   Shares    Par
Value
           

Balance at March 31, 2007

   5,025,457    $ 50,255    $ 8,541,274    $ 10,912,458      $ (1,527,014 )    $ 17,976,973  

Exercise of stock options

   84,625      846      268,019      —          —          268,865  

Issuance of common stock for MICA acquisition

   248,135      2,481      1,997,487      —          —          1,999,968  

Stock based compensation

   —        —        148,972      —          —          148,972  

Cumulative effect of the recognition of uncertain income tax positions

   —        —        —        (96,443 )      —          (96,443 )

Purchase of treasury stock

   —        —        —        —          (205,185 )      (205,185 )

Net income

   —        —        —        185,094        —          185,094  
                                             

Balance at June 30, 2007

   5,358,217    $ 53,582    $ 10,955,752    $ 11,001,109      $ (1,732,199 )    $ 20,278,244  

Stock based compensation

   —        —        127,541      —          —          127,541  

Net income

   —        —        —        618,159        —          618,159  
                                             

Balance at September 30, 2007

   5,358,217    $ 53,582    $ 11,083,293    $ 11,619,268      $ (1,732,199 )    $ 21,023,944  

Exercise of stock options

   8,000      80      61,034      —          —          61,114  

Issuance of restricted stock

   25,000      250      —        —          —          250  

Stock based compensation

   —        —        188,172      —          —          188,172  

Net income

   —        —        —        556,033        —          556,033  
                                             

Balance at December 31, 2007

   5,391,217    $ 53,912    $ 11,332,499    $ 12,175,301      $ (1,732,199 )    $ 21,829,513  
                                             

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

MICRONETICS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     Nine Months Ended December 31,  
   2007     2006  

Cash flow from operating activities:

    

Net income

   $ 1,359,286     $ 700,656  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     1,286,641       1,216,555  

Stock-based compensation

     464,685       514,676  

Unrealized gain from marketable securities

     —         (32,745 )

Net gain on sale of assets

     (44,364 )     —    

Provision for allowances on accounts receivable

     117,388       27,017  

Provision for inventory obsolescence and losses

     401,698       273,539  

Non-cash charges for options issued for services

     —         7,480  

Changes in operating assets and liabilities, net of acquisition:

    

Accounts receivable

     (401,851 )     997,589  

Inventories

     (203,375 )     (357,997 )

Other long term assets

     97,276       —    

Income taxes payable

     —         (1,008,901 )

Prepaid expenses, other current assets, and other assets

     (11,276 )     (568,960 )

Accounts payable

     (410,118 )     (243,939 )

Accrued expenses and deferred revenue

     476,806       (874,662 )
                

Net cash provided by operating activities

     3,132,796       650,308  
                

Cash flows (used in) provided by investing activities

    

Proceeds from sale of building

     461,898       —    

Purchase of marketable securities

     (650,000 )     (500,000 )

Purchase of equipment

     (789,671 )     (574,171 )

Additional cash paid for Stealth acquisition

     (1,500,000 )     (92,455 )

Cash paid for MICA acquisition, net of cash acquired

     (3,120,933 )     —    
                

Net cash used in investing activities

     (5,598,706 )     (1,166,626 )
                

Cash flows (used in) provided by financing activities:

    

Repayment of the line of credit

     (728,528 )     (475,972 )

Proceeds from line of credit

     728,528       —    

Repayments on mortgages and term loan

     (1,059,736 )     (648,164 )

Repayments of MICA debt

     (646,820 )     —    

Repayments of capital leases

     (2,643 )     (11,933 )

Purchase of treasury stock

     (205,185 )     —    

Proceeds from the exercise of stock options and issuance of restricted common stock

     330,229       212,559  
                

Net cash used in financing activities

     (1,584,155 )     (923,510 )
                

Net decrease in cash and cash equivalents

     (4,050,065 )     (1,439,828 )

Cash and cash equivalents at beginning of period

     7,058,524       5,266,580  
                

Cash and cash equivalents at end of period

   $ 3,008,459     $ 3,826,752  
                

Supplemental disclosure of cash flow information:

    

Cash paid during the period for:

    

Interest

   $ 247,656     $ 334,356  
                

Income taxes

   $ 1,134,000     $ 2,086,899  
                

Supplemental disclosure of non-cash financing activities:

    

Shares issued to MICA stockholders

   $ 1,999,968     $ —    
                

The accompanying notes are an integral part of these consolidated financial statements.

 

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MICRONETICS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information and the rules of the Securities and Exchange Commission for quarterly reports on Form 10-Q. It is suggested that these consolidated condensed financial statements be read in conjunction with the Company’s Annual Report on Form 10-KSB for its fiscal year ended March 31, 2007. In the opinion of management, the statements contain all adjustments, including normal recurring adjustments necessary in order to present fairly the financial position as of December 31, 2007, the results of operations for the three and nine months ended December 31, 2007 and 2006, and the cash flows for the nine months ended December 31, 2007 and 2006.

The results of operations for the three and nine months ended December 31, 2007 are not necessarily indicative of the results to be expected for the full year ended March 31, 2008.

2. 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 and test equipment used in cellular, microwave, satellite, radar and communication systems around the world.

The consolidated financial statements include the accounts of Micronetics, Inc. (“Micronetics”) and its wholly-owned subsidiaries, Microwave & Video Systems, Inc. (“MVS”), Enon Microwave, Inc. (“Enon”), Microwave Concepts, Inc. (“MicroCon”) Stealth Microwave, Inc. (“Stealth”) and MICA Microwave Corporation (“MICA”). The operating results of MICA have been included in the Company’s consolidated financial statements since June 5, 2007, the date of acquisition (See Note 3). In September 2007, the Enon subsidiary was dissolved and its operations were merged with and into the Micronetics’ operations. All material intercompany balances and transactions have been eliminated in consolidation.

Use of estimates—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, purchase price allocation, intangibles, accrued liabilities, and deferred income taxes and various other assumptions that it believes are reasonable under the circumstances. Actual results could differ from those estimates.

Marketable securities—The Company’s investments in marketable securities are classified as “available for sale” and are reported at fair value in the Company’s consolidated balance sheets, with net unrealized holding gains or losses recorded as a separate component of other comprehensive income, net of tax.

Financial instruments—The Company entered into an interest rate swap agreement with a notional amount of $6.5 million in April 2007, as required under its credit facility, to mitigate the effect of interest rate fluctuations on the term loan. This interest rate swap was not designated as a hedging instrument at the initiation of the swap, and the Company has not applied hedge accounting. As a result, at the end of each period, the interest rate swap is recorded on the consolidated balance sheet, with any related gains or loses charged to earnings. During the three and nine months ending December 31, 2007, the Company recorded a loss of $83,973 and $154,041, respectively, to reflect the fair value for the interest rate swaps.

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 bundled hardware components and software, that are delivered to original equipment manufacturers (OEMs) of telecommunication and networking products who are considered to be end users.

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 costs of product warranties are accrued based on historical experience at the time the revenue is recognized. Unless customers purchase an extended warranty, Micronetics offers a one-year warranty.

 

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Recent accounting pronouncements—In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109 (“FIN No. 48”).” FIN No. 48 provides guidance with respect to the recognition and measurement in the financial statements of uncertain tax positions taken or expected to be taken in a tax return, and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company adopted the provisions of FIN No. 48 in the first quarter of Fiscal 2008. The Company’s adoption of FIN No. 48 on April 1, 2007 resulted in the recognition of $96,443 of previously uncertain tax benefits which, in accordance with FIN No. 48, the cumulative amount was accounted for as an adjustment to the April 1, 2007 retained earnings balance in the first quarter of fiscal 2008.

In December 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective in the first quarter of Fiscal 2009. The Company is currently evaluating the effect of this statement on its consolidated financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted, provided the Company also elects to apply the provisions of SFAS 157. The Company is currently evaluating the effect that the adoption of SFAS 159 will have on its consolidated results of operations and financial condition.

In June 2007, the FASB ratified Emerging Issues Task Force (EITF) 07-03, “Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities” (“EITF 07-03”). EITF 07-03 requires companies to defer and capitalize prepaid nonrefundable advance payments for goods or services that will be used for future research and development activities over the period that the research and development activities are performed or the services are provided, subject to an assessment of recoverability. The provisions of EITF 07-3 are effective beginning April 1, 2008. The Company is currently evaluating the effect that the adoption of EITF 07-03 will have on its consolidated results of operations and financial condition.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (“SFAS 141(R)”), which replaces Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS 141”). SFAS 141(R) requires the assets acquired, liabilities assumed, and any non-controlling interest to be measured at their fair values as of the acquisition date. SFAS 141(R) also requires expensing of acquisition related costs and restructuring costs, and re-measurement of earn out provisions at fair value. SFAS 141(R) is effective for any of the Company’s business combinations on or after April 1, 2009. The Company is currently evaluating the effect that the adoption of SFAS 141(R) will have on its consolidated results of operations and financial condition.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 clarifies the accounting and reporting standards for the noncontrolling interest in a subsidiary, including classification as a component of equity. SFAS 160 is effective for the Company on April 1, 2009. The Company is currently evaluating the effect that the adoption of SFAS 160 will have on its consolidated results of operations and financial condition.

3. ACQUISITION

On June 5, 2007, the Company entered into an Agreement of Merger and Plan of Reorganization (the “Merger Agreement”) with MICA, a California corporation whereby MICA became a wholly-owned subsidiary of Micronetics. Pursuant to the terms and conditions of the Merger Agreement, the Company acquired all of the common stock of MICA for $3.0 million in cash and $2.0 million in shares of Micronetics’ common stock (248,135 shares), subject to a post-closing adjustment based upon MICA’s net worth on the closing date.

The acquisition of MICA provides a broader range of RF/Microwave products, including high performance mixers and ferrites to the Company, and will provide the Company with further integrated microwave sub-systems and systems solutions.

 

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The following table summarizes the preliminary fair value assigned to the assets acquired and liabilities assumed at the date of acquisition:

 

     (Unaudited)
(in thousands)
 

Cash and accounts receivable

   $ 773  

Inventory

     1,308  

Property, plant and equipment

     483  

Other assets

     41  

Development technology drawings

     220  

Customer relationships

     1,180  

Order backlog

     90  

Trade name

     260  

Goodwill

     2,950  

Debt

     (647 )

Deferred taxes

     101  

Deferred taxes on acquired intangible assets

     (700 )

Income taxes payable

     (137 )

Accounts payable and accrued expenses

     (704 )
        

Subtotal

     5,218  

Less: cash assumed

     (97 )
        

Net purchase price

   $ 5,121  
        

The acquisition of MICA was accounted for as a purchase under SFAS No. 141, “Business Combinations”. Accordingly, the operating results of MICA have been included in the Company’s consolidated financial statements since the June 5, 2007 acquisition date. The Company estimated the useful lives of the acquired other intangible assets to be one to ten years and has included them in intangible assets, net, in the accompanying consolidated balance sheet as of December 31, 2007. The values assigned to intangible assets were based on an independent appraisal. The allocation of the purchase price is preliminary and may be subject to adjustments.

The following table sets forth certain pro forma results for the nine months ended December 31, 2007 and 2006 if the acquisition of MICA had taken place on April 1, 2006:

 

     Nine Months Ended
(Unaudited)
   December 31, 2007    December 31, 2006
  

(in thousands, except

earnings per share)

  

(in thousands, except

earnings per share)

Pro forma revenue

   $ 25,697    $ 21,554

Pro forma net income (1)

   $ 1,404    $ 767

Pro forma earnings per share:

     

Basic

   $ 0.29    $ 0.16

Diluted

   $ 0.28    $ 0.16

 

(1) Amortization costs of approximately $161,000 related to the purchase price in 2007 were assessed to the 2006 income. Management believes that including these adjustments in the above periods allow investors to better compare results in the future periods.

 

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4. INVENTORIES, NET

At December 31, 2007 and March 31, 2007, inventories consisted of the following:

 

     December 31, 2007     March 31, 2007  
   (Unaudited)     (Audited)  

Raw materials

   $ 5,235,587     $ 4,072,116  

Work in process

     1,765,598       1,339,160  

Finished goods

     639,579       717,534  
                
     7,640,764       6,128,810  

Less allowance for obsolescence

     (981,818 )     (580,119 )
                
   $ 6,658,946     $ 5,548,691  
                

5. PROPERTY, PLANT AND EQUIPMENT, NET

At December 31, 2007 and March 31, 2007, property, plant and equipment, net consisted of the following:

 

     December 31, 2007     March 31, 2007  
   (Unaudited)     (Audited)  

Land

   $ 162,000     $ 162,000  

Buildings and leasehold improvements

     1,105,746       1,555,106  

Machinery and equipment

     8,839,593       7,877,654  

Furniture, fixtures and other

     242,563       286,516  
                
     10,349,902       9,881,276  

Less accumulated depreciation

     (6,214,478 )     (5,863,811 )
                
   $ 4,135,424     $ 4,017,465  
                

In May 2007, the commercial condominium housing Micronetics’ Enon division was sold. The proceeds from the sale were $461,898. The Company recorded a gain on the sale of the building of $69,609 in the quarter ended June 30, 2007.

6. INTANGIBLE ASSETS AND GOODWILL

The Company’s finite-lived intangible assets include certain identifiable intangible assets acquired as a result of business combinations, including customer relationships, covenants not to compete, order backlog, trade name and developed technology.

The following table presents details of the Company’s finite-lived intangible assets as of December 31, 2007 and March 31, 2007 (in thousands):

 

Intangible Assets

   December 31, 2007
(Unaudited)
   March 31, 2007
(Audited)
   Useful
Life
(years)
   Gross
Value
   Accumulated
Amortization
   Net
Value
   Gross
Value
   Accumulated
Amortization
   Net
Value

Customer relationships (non-contractual)

   7-10    $ 4,130    $ 1,148    $ 2,982    $ 2,950    $ 761    $ 2,189

Covenants not to compete

   2      480      480      —        480      433      47

Order backlog

   1      380      341      39      290      290      —  

Trade Name

   10      260      15      245      —        —        —  

Developed technology- drawings

   5      390      112      278      170      62      108
                                            

Total intangibles

      $ 5,640    $ 2,096    $ 3,544    $ 3,890    $ 1,546    $ 2,344

 

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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:

 

     (in thousands)

Remainder of 2008

   $ 184

2009

     660

2010

     643

2011

     616

2012

     618

Thereafter

     823
      

Total

   $ 3,544
      

Changes in the carrying amount of goodwill at December 31, 2007 and March 31, 2007 are as follows:

 

     December 31, 2007    March 31, 2007
   (Unaudited)    (Audited)

Balance at the beginning of the period

   $ 5,982,709    $ 4,390,254

Acquisitions

     2,949,735      —  

Earnout payment

     —        1,500,000

Purchase accounting adjustments

     —        92,455
             

Balance at the end of the period

   $ 8,932,444    $ 5,982,709
             

7. ACCRUED EXPENSES

At December 31, 2007 and March 31, 2007 accrued expenses consisted of the following:

 

     December 31, 2007    March 31, 2007
   (Unaudited)    (Audited)

Unbilled payables

   $ 643,517    $ 169,755

Professional fees

     297,776      261,372

Payroll, benefits and related taxes

     1,088,883      1,195,273

Warranty

     98,443      100,178

Miscellaneous

     516,750      1,615,787
             
   $ 2,645,369    $ 3,342,365
             

Included in accrued payroll are bonuses of $534,951 and $572,951 at December 31, 2007 and March 31, 2007. Miscellaneous accrued expenses at March 31, 2007 included $1.5 million in earnout payments due to the former stockholders of Stealth that was paid in April 2007.

8. LONG-TERM DEBT

At December 31, 2007 and March 31, 2007 long-term debt consisted of the following:

 

     December 31, 2007     March 31, 2007  
   (Unaudited)     (Audited)  

Term loan

     5,850,000       6,500,000  

Mortgage payable, MA

     —         310,531  

Mortgage payable, NH

     164,871       264,076  

Capital leases

     5,579       8,222  
                

Total

     6,020,450       7,082,829  

Less current portion

     (1,442,869 )     (1,449,443 )
                

Long-term debt net of current portion

   $ 4,577,581     $ 5,633,386  
                

 

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Term Loan and Revolver

In March 2007, the Company entered into a credit facility which consists of a $6.5 million five year secured term loan and a $5.0 million three year revolving line of credit, which replaced the then existing $6.0 million term loan entered into in June 2005.

The Company entered into an interest rate swap agreement in April 2007 to mitigate interest rate fluctuations on the term loan. At the end of each reporting period the Company records the current fair value of the interest rate swap on the balance sheet. Any unrealized gain or loss is charged to earnings.

The term loan is guaranteed by the Company’s subsidiaries and 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 3 Month LIBOR rate plus 1.8%, which at December 31, 2007 was 7.03%. The term loan expires in June 2012.

The revolving line of credit bears interest at the current 30 day LIBOR rate plus 1.8%, which at December 31, 2007 was 6.62%. The company had $5.0 million available under the line at December 31, 2007.

Under the terms of the term loan and the revolver, the Company is required to maintain certain financial covenants on a quarterly and annual basis, including total funded debt to EBITDA not exceeding 2.25:1, minimum debt service coverage of 1.25:1, and minimum tangible net worth of $7.5 million. At December 31, 2007, the Company was in compliance with all financial debt covenants.

Mortgage payable, NH

In February 2004, Micronetics refinanced the mortgage on its headquarters by entering into a new five-year mortgage payable for $630,000. The note bears interest at 5.75% per annum and is payable in monthly installments, including interest, of $12,107. This loan is secured by the land and building of Micronetics’ headquarters.

Mortgage payable, MA

In March 2003, in connection with the purchase of a portion of a commercial condominium housing Micronetics’ Enon division, Micronetics entered into a mortgage payable for $352,750. In May 2007, the commercial condominium was sold and the remaining mortgage was settled.

Capital leases

Commercial capital leases payable are reflected at their present value based upon interest rates that range from 8.67% to 8.88% per annum, and are secured by the underlying assets. The assets are depreciated over their estimated useful lives.

9. STOCK- BASED COMPENSATION

On April 1, 2006, the Company adopted the provisions of SFAS 123R, “Share-Based Payment,” a revision of SFAS 123, “Accounting for Stock-Based Compensation” and superseding Accounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires the Company to recognize the cost of employee services received in exchange for grants issued under stock option and employee stock purchase plans, based on the fair value of the awards, and recognized over the vesting period of the plans, using the modified-prospective transition method. Prior to April 1, 2006 the Company measured employee stock-based compensation cost under the provisions of APB Opinion 25 as permitted by SFAS 123, “Accounting for Stock-Based Compensation”. APB Opinion 25 provided for compensation cost to be recognized over the vesting period of the options based on the difference, if any, between the fair market value of the Company’s stock and the option price on the grant date. As the Company only issued fixed term stock option grants at or above the quoted market price on the date of grant, no compensation expense was recognized in the consolidated statements of income prior to April 1, 2006.

Under the modified-prospective method, the Company recognized compensation expense in the financial statements issued subsequent to April 1, 2006 for all stock-based payments granted, modified or settled subsequent to April 1, 2006 as well as for any awards that were granted prior to April 1, 2006 which were not fully vested as of that date. Compensation expense for those awards issued prior to April 1, 2006 was recognized using the fair values determined for the pro forma disclosures on stock-based compensation. The amount of stock based compensation expense recognized on awards that have not fully vested excludes the compensation expense for vested options recognized in the pro forma disclosures for stock-based compensation.

 

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The following table summarizes the effects of stock-based compensation resulting from the application of SFAS No. 123(R) for the three months ended December 31, 2007 and December 31, 2006:

 

     Three Months Ended  
   December 31, 2007
(Unaudited)
    December 31, 2006
(Unaudited)
 

Cost of sales

   $ 13,096     $ 22,718  

Selling, general and administrative

     175,076       125,597  

Research and development

     —         28,125  
                

Stock-based compensation effect in income before taxes

     188,172       176,440  

Income taxes

     (46,956 )     (24,767 )
                

Net stock-based compensation effect on basic earnings per common share

   $ 141,216     $ 151,673  
                

Stock-based compensation effect on basic earnings per common share

   $ 0.03     $ 0.03  

Stock-based compensation effect on diluted earnings per common share

   $ 0.03     $ 0.03  

The following table summarizes the effects of stock-based compensation resulting from the application of SFAS No. 123(R) for the nine months ended December 31, 2007 and December 31, 2006:

 

     Nine Months Ended  
   December 31, 2007
(Unaudited)
    December 31, 2006
(Unaudited)
 

Cost of sales

   $ 46,470     $ 81,153  

Selling, general and administrative

     390,995       353,992  

Research and development

     27,220       79,531  
                

Stock-based compensation effect in income before taxes

     464,685       514,676  

Income taxes

     (88,913 )     (71,746 )
                

Net stock-based compensation effect on basic earnings per common share

   $ 375,772     $ 442,930  
                

Stock-based compensation effect on basic earnings per common share

   $ 0.08     $ 0.07  

Stock-based compensation effect on diluted earnings per common share

   $ 0.08     $ 0.09  

Unrecognized stock-based compensation expense related to the unvested options is approximately $1.5 million, and will be recorded over the remaining vesting periods of one to ten 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 granted 25,000 shares of restricted stock to an employee under the 2006 Equity Incentive Plan on November 14, 2007. The shares were issued at a purchase price of $.01 per share. The fair value of the restricted stock was determined based on the fair value of the Company’s common stock on the grant date. Upon issuance of the restricted stock 10,000 shares were vested, with the remaining 15,000 shares to vest twenty percent upon the completion of each quarterly period thereafter. The stock will be fully vested on August 14, 2008. As a result of the issuance of the restricted stock, the Company recognized $184,750 of stock compensation costs, $73,900 of which was expensed in Q3 FY 08 and $110,850 remaining in unearned compensation cost as of December 31, 2007, to be recognized during the next three quarters.

In accordance with SFAS No. 123(R), the Company adjusts share-based compensation on an annual basis for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience. The effect of adjusting the forfeiture rate for all expense amortization after April 1, 2006 will be recognized in the period the forfeiture estimate is changed.

There were 55,000 options granted in the third quarter of Fiscal 2008 and 178,000 in the first quarter of Fiscal 2008. No options were granted in the second quarter of Fiscal 2008. The fair value of options issued in the first and third quarters of Fiscal 2008 were estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions (unaudited):

 

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     December 31, 2007     June 30, 2007  

Risk Free Interest Rate

   3.89 %   4.98 %

Expected Life

   7.57 years     3.97 years  

Expected Volatility

   55 %   60 %

Expected Dividend Yield

   0 %   0 %

The per share weighted average fair value of stock options granted for the nine months ended December 31, 2007 was $4.19.

At December 31, 2007, the Company had three stock option plans under which grants were outstanding. The stock options outstanding are for grants issued under the Company’s 1996 Stock Option Plan, the 2003 Stock Option Plan and the 2006 Equity Incentive Plan.

The 1996 Stock Option Plan

During the fiscal year ended March 31, 1997, the Company adopted a stock option plan, entitled the “1996 Stock Option Plan” (the “1996 Plan”), under which the Company may grant options to purchase up to 300,000 shares of common stock. During the fiscal year ended March 31, 2002, the Board of Directors amended the 1996 Plan to increase the number of shares of common stock that may be granted under the Plan to 900,000. As of December 31, 2007, there were 2,500 options outstanding under the 1996 Plan. In 2003, the Board of Directors determined that it would not issue any new option awards under the 1996 Plan.

The 2003 Stock Incentive Plan

During the fiscal year ended March 31, 2004, the Company adopted a stock option plan entitled “The 2003 Stock Incentive Plan” (the “2003 Plan”) under which the Company may grant options to purchase up to 900,000 shares of common stock plus any shares of common stock remaining available for issuance as of July 22, 2003 under the 1996 Plan. In July 2006 the Board of Directors determined that it would not issue any new option awards under the 2003 Plan. As of December 31, 2007, there were 501,325 options outstanding under the 2003 Plan.

The 2006 Equity Incentive Plan

During the fiscal year ending March 31, 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 options to purchase up to 1,000,000 shares of common stock. As of December 31, 2007 there were 236,000 options and 25,000 shares of restricted stock outstanding under the 2006 Plan.

The 1996 Plan, the 2003 Plan and the 2006 Plan are 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 1996 Plan, the 2003 Plan and 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 and its subsidiaries. The exercise price of options granted under the 1996 Plan, the 2003 Plan and the 2006 Plan may not be less than the fair market value of the shares of common stock on the date of grant, and may not be granted more than ten years from the date of adoption of each respective plan or exercised more than ten years from the date of grant.

The following table sets forth the Company’s stock option activity during the nine months ended December 31, 2007 (unaudited):

 

     Shares
Underlying
options
    Weighted
Average
Exercise
price
   Weighted
Average
Remaining
Contractual
life
   Aggregate
Intrinsic
value

Outstanding at March 31, 2007

   796,825     $ 7.29      

Granted

   233,000       7.90      

Exercised

   (92,625 )     3.51      

Canceled

   (142,375 )     7.86      
                        

Outstanding at December 31, 2007

   794,825     $ 7.81    4.75    $ 526,692
                        

Exercisable at December 31, 2007

   332,850     $ 7.58    2.22    $ 297,319
                        

 

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The following table sets forth the status of the Company’s non-vested stock options as of December 31, 2007 (unaudited):

 

     Number of
Options
    Weighted-Average
Grant-Date

Fair Value

Non-vested as of March 31, 2007

   481,025     $ 3.48

Granted

   233,000       4.19

Forfeited

   (74,750 )     3.26

Vested

   (177,300 )     3.38
            

Non-vested as of December 31, 2007

   461,975     $ 3.91
            

During the year ended March 31, 2004, the Company granted options to purchase an aggregate of 8,000 shares of common stock to consultants for services to be provided. These options are exercisable at $7.12 per share, and vest 25% per year on each anniversary date, with an expiration of five years from the date of grant for all options. The Company has valued these at their fair value on the date of grant using the Black-Scholes option-pricing model. The consultants have since ceased performance of services. During the fiscal year ended March 31, 2007, the Company expensed the remaining unamortized amount of $5,940.

10. INCOME TAXES

The Company’s effective tax rate was 44% and 62% for the three months ended December 31, 2007 and 2006 as compared to 45% and 49% for the nine months ended December 31, 2007 and 2006.

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109 (“FIN No. 48”), which clarifies the accounting for uncertainty in income taxes by prescribing the minimum recognition threshold and measurement requirements a tax position must meet before recognized a benefit in the financial statements. FIN No. 48 also provides guidance on de-recognition, measurement, classification, interest and penalties, accounting for interim periods and disclosures for uncertain tax positions. FIN No. 48 is effective for fiscal years beginning after December 15, 2006.

The Company’s adoption of FIN No. 48 on April 1, 2007 resulted in the recognition of $96,443 of previously uncertain tax benefits which, in accordance with FIN No. 48, the cumulative amount was accounted for as an adjustment to the April 1, 2007 retained earnings balance in the first quarter of Fiscal 2008. The FIN No. 48 analysis for the nine months ended December 31, 2007 resulted in an additional $18,288 in uncertain tax benefits. The Company’s policy is to recognize interest and penalties accrued on any uncertain tax positions as a component of income tax expense. The Company incurred $4,650 in interest and penalty expense for the nine months ended December 31, 2007.

As a result of the adoption of FIN No. 48, the Company has $114,731 of uncertain tax benefits, substantially all of which, if recognized, would be recorded as a component of the provision for income taxes.

As of April 1, 2007, the Company is subject to tax in the U.S. Federal and various state jurisdictions. The Company is generally open to examination for tax years 2004 through 2006.

11. EARNINGS PER SHARE

Basic earnings per share is computed based on the net income 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 per period divided by the weighted average number of common shares and common equivalent shares outstanding during each period. Common stock equivalents represent the dilutive effect of the assumed exercise of certain outstanding stock options. The computations of basic and diluted EPS for the three months ended December 31, 2007 and 2006 (unaudited) are:

 

     Three Months Ended
   December 31, 2007    December 31, 2006

Net income

   $ 556,033    $ 111,104

Weighted average shares outstanding

     4,987,525      4,642,041

Basic earnings per share

   $ 0.11    $ 0.02

Common stock equivalents

     6,034      73,274

Weighted average common and common equivalent shares outstanding

     4,993,559      4,715,315

 

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     Three Months Ended
   December 31, 2007    December 31, 2006

Diluted earnings per share

   $  0.11    $  0.02

The computations of basic and diluted EPS for the nine months ended December 31, 2007 and 2006 (unaudited) are:

 

     Nine Months Ended
   December 31, 2007    December 31, 2006

Net income

   $ 1,359,286    $ 700,656

Weighted average shares outstanding

     4,911,995      4,631,854

Basic earnings per share

   $ 0.28    $ 0.15

Common stock equivalents

     24,779      195,430

Weighted average common and common equivalent shares outstanding

     4,936,774      4,827,284

Diluted earnings per share

   $ 0.28    $ 0.15

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward Looking Statements

Certain statements in this report contain words such as “could,” “expects,” “may,” “anticipates,” “believes,” “intends,” “estimates,” “plans,” “envisions,” and other similar language and are considered forward-looking statements. These statements are based on our expectations, estimates, forecasts and projections about the operating environment, economies and markets in which we operate and are merely our current predictions of future events. In addition, other written or oral statements which are considered forward-looking may be made by us or others on our behalf. These statements are subject to important risks, uncertainties and assumptions, which are difficult to predict and the actual outcome may be materially different. Some of the factors which could cause results or events to differ from current expectations include, but are not limited to, the factors described below. We assume no obligation to update our forward-looking statements to reflect new information or developments.

An investment in our common stock involves a high degree of risk. We urge readers to review carefully the risk factors described below and in the other documents that we file with the Securities and Exchange Commission. You can read these documents at www.sec.gov. 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.

Critical Accounting Policies

The discussion and analysis of our financial condition and the results of operations are based on our consolidated financial statements and the data used to prepare them. Our consolidated financial statements have been prepared based on accounting principles generally accepted in the United States of America. On an on-going basis, we evaluate our judgments and estimates including those related to allowances for doubtful accounts and sales returns, inventory valuation and obsolescence, long-lived assets, business combination purchase price allocation and goodwill impairment, stock-based compensation, warranty obligations, and the valuation allowance on our deferred tax asset. 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 a sales 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 bundled hardware components and software, that are delivered to original equipment manufacturers (OEMs) of telecommunication and networking products who are considered to be end users.

Advance payments received from customers prior to product shipment are recorded as deferred revenue.

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. 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 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.

 

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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 obsolete inventory 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 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.

Business Combinations

We are required to allocate the purchase price of an acquired company based on the estimated fair values of assets acquired and liabilities assumed, determined as of the date of acquisition. Micronetics employs independent valuation specialists to determine the fair values of identifiable intangible assets in order to determine the portion of the purchase price allocable to these assets. The excess of the purchase price over the estimated fair value of the net assets acquired is recorded as goodwill.

Valuation Of Long-Lived Assets, Goodwill And Intangible Assets And Their Impairment

We assess the need to record impairment losses on long-lived assets, including fixed assets, goodwill 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. Additionally, goodwill is assessed for impairment on an annual basis in accordance with the provisions of SFAS 142. We completed the annual impairment test for FY 2007 in the fiscal fourth quarter and determined that no impairment exists.

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.

Stock Compensation Expense

Effective April 1, 2006, we account for stock-based compensation in accordance with the fair value recognition provision of FAS 123R. We use 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, the volatility of our common stock price over the expected term 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 income.

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. No valuation allowance was required at December 31, 2007 and 2006.

 

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Recent Accounting Pronouncements

In June 2006, the Financial Accounting Standard Board (“FASB”) issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109” (“FIN No. 48”). FIN No. 48 provides guidance with respect to the recognition and measurement in the financial statements of uncertain tax positions taken or expected to be taken in a tax return, and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We adopted the provisions of FIN No. 48 in the first quarter of Fiscal 2008. The adoption of FIN No. 48 resulted in an adjustment for uncertain tax benefits of $96,443 to the April 1, 2007 retained earnings balance.

In December 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective in the first quarter of Fiscal 2009. We are currently evaluating the effect of this statement on our consolidated financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted, provided the Company also elects to apply the provisions of SFAS 157. We are currently evaluating the effect that the adoption of SFAS 159 will have on our consolidated results of operations and financial condition.

In June 2007, the FASB ratified Emerging Issues Task Force (EITF) 07-03, “Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities” (“EITF 07-03”). EITF 07-03 requires companies to defer and capitalize prepaid nonrefundable advance payments for goods or services that will be used for future research and development activities over the period that the research and development activities are performed or the services are provided, subject to an assessment of recoverability. The provisions of EITF 07-3 are effective beginning April 1, 2008. We are currently evaluating the effect that the adoption of EITF 07-03 will have on our consolidated results of operations and financial condition.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (“SFAS 141(R)”), which replaces Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS 141”). SFAS 141(R) requires the assets acquired, liabilities assumed, and any non-controlling interest to be measured at their fair values as of the acquisition date. SFAS 141(R) also requires expensing of acquisition related costs and restructuring costs, and re-measurement of earn out provisions at fair value. SFAS 141(R) is effective for any of the Company’s business combinations on or after April 1, 2009. We are currently evaluating the effect that the adoption of SFAS 141(R) will have on its consolidated results of operations and financial condition.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 clarifies the accounting and reporting standards for the noncontrolling interest in a subsidiary, including classification as a component of equity. SFAS 160 is effective for the Company on April 1, 2009. We are currently evaluating the effect that the adoption of SFAS 160 will have on its consolidated results of operations and financial condition.

Acquisition

On June 5, 2007, we entered into an Agreement of Merger and Plan of Reorganization (the “Merger Agreement” with MICA Microwave Corporation (“MICA”), a California corporation, whereby MICA became a wholly-owned subsidiary of Micronetics. Pursuant to the terms and conditions of the Merger Agreement, the holders of MICA common stock were paid $3.0 million in cash and $2.0 million in shares of Micronetics’ common stock, subject to a post-closing adjustment based upon MICA’s net worth on the closing date.

The acquisition of MICA provides us with a broader range of RF/Microwave products, including high performance mixers and ferrites, and will provide us with further integrated microwave sub-systems and systems solutions.

Overview

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

 

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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, Micro-Con, MVS, Stealth and MICA. During Q3 FY 08, the Enon subsidiary was dissolved and its operations were merged within the Micronetics’ operations in NH. 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.

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.

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. As the speed to market challenges increase, larger companies are relying increasingly on other companies to manufacture a module or an integrated subassembly to perform such testing. This module or subassembly is then assembled by the larger company into an integrated piece of equipment and sold to a customer. Micronetics has been seeking to capitalize on this trend by increasing its capability of manufacturing integrated subassemblies. Our goal is to leverage our high power and noise technology to continue to be the most reliable microwave subsystem supplier in the merchant marketplace.

Results of Operations

The Consolidated Statements of Income for the three and nine months ended December 31, 2007 include the operations of MICA from the acquisition date of June 5, 2007.

Three Months Ended December 31, 2007 compared to December 31, 2006

Net sales

Net sales for the three months ended December 31, 2007 (“Q3 FY 08”) were $8,828,302, an increase of $3,318,147, or 60% as compared to $5,510,155 for the three months ended December 31, 2006 (“Q3 FY 07”). The increase in net sales for Q3 FY 08 is primarily attributable to an increase in net sales of high performance power amplifiers to the commercial market of $1.4 million, $1.3 million in sales of high performance mixers and ferrites from MICA, as well as an increase in net sales of voltage controlled oscillators used in electronic jamming systems of $.4 million and an increase in net sales of noise sources of $.4 million. As a result, commercial and defense revenues were 71% and 29%, respectively, of the total revenues for Q3 FY 08, as compared to 65% and 35%, respectively, for Q3 FY 07.

Gross profit margin

Gross profit as a percent of sales increased to 41% for Q3 FY 08 from 39% for Q3 FY 07. The increase is primarily attributable to the volume increase in net sales of high performance power amplifiers, offset in part by lower average selling prices of amplifiers to a major customer and lower margins on our ferrite products.

Research and development

Research and development (R&D) expense increased $108,960 for Q3 FY 08 as compared to Q3 FY 07. The increase is primarily due to the increase in R&D salaries related to new development programs. R&D expenses as a percentage of sales remained at 3.3% for Q3 FY 08 as compared to Q3 FY 07.

Selling, general and administrative

Selling, general and administrative (SG&A) expense increased $541,545 for Q3 FY 08 as compared to Q3 FY 07. The increase was primarily attributable to increases in salaries and benefits of $133,000, professional fees of $52,000, commissions of $48,000, and the inclusion of MICA’s SG&A expenses of $243,000. SG&A expenses as a percentage of sales decreased to 22.5% on Q3 FY 08 as compared to 26.2% for Q3 FY 07, primarily due to the increase in net sales for Q3 FY 08 as compared to Q3 FY 07.

Amortization of intangible assets

Amortization expense was $183,357 for Q3 FY 08 as compared to $178,296 for Q3 FY 07.

 

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Interest expense

Interest expense was $107,847 for Q3 FY 08 as compared to $108,022 for Q3 FY 07.

Provision for income taxes

Our effective tax rate was 44% for Q3 FY 08 as compared to 62% for Q3 FY 07. The decrease in the effective tax rate for the quarter ended December 31, 2007 is primarily due to a decrease in incentive stock-based compensation expense, which is not deductible for tax purposes, as well as an increase in tax benefits associated with the domestic production activity deduction as compared to the quarter ended December 31, 2006.

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109 (“FIN No. 48”), which clarifies the accounting for uncertainty in income taxes by prescribing the minimum recognition threshold and measurement requirements a tax position must meet before recognized a benefit in the financial statements. FIN No. 48 also provides guidance on de-recognition, measurement, classification, interest and penalties, accounting for interim periods and disclosures for uncertain tax positions. FIN No. 48 is effective for fiscal years beginning after December 15, 2006.

Our adoption FIN No. 48 on April 1, 2007 resulted in the recognition of $96,443 of uncertain tax benefits, which in accordance with FIN No. 48, the cumulative amount was accounted for as an adjustment to the April 1, 2007 balance of retained earnings. In the third quarter of Fiscal 2008 the liability for uncertain tax benefits increased by $15,000. Our policy is to recognize interest and penalties accrued on any uncertain tax positions as a component of income tax expense, if any.

As a result of the adoption of FIN No. 48, the Company has $114,731 of uncertain tax benefits, substantially all of which, if recognized, would be recorded as a component of the provision for income taxes.

As of April 1, 2007, the Company is subject to tax in the U.S. Federal and various state jurisdictions. The Company is generally open to examination for tax years 2004 through 2006.

Nine Months Ended December 31, 2007 compared to December 31, 2006

Net sales

Net sales for the nine months ended December 31, 2007 were $24,901,931, an increase of $7,524,012, or 43% as compared to $17,377,919 for the nine months ended December 31, 2006. The increase in net sales for the nine months ended December 31, 2007 is primarily attributable to a increase in net sales of high performance power amplifiers to the commercial market of $3.5 million, $3.2 million in sales of high performance mixers and ferrites from MICA, as well as an increase in net sales of voltage controlled oscillators used in electronic jamming systems of $.9 million. As a result, commercial and defense revenues were 71% and 29%, respectively, as a percent of the total revenues for the nine months ended December 31, 2007, as compared to 65% and 35%, respectively, for the nine months ended December 31, 2006.

Gross profit margin

Gross profit as a percent of sales decreased for the nine months ended December 31, 2007 to 39% from 40% for the nine months ended December 31, 2006. The decrease is primarily attributable to the lower average selling prices of power amplifiers to a major customer, and lower margins on our ferrite products.

Research and development

Research and development (R&D) expense increased $9,491 for the nine months ended December 31, 2007 as compared to the nine months ended December 31, 2006. R&D expenses decreased to 2% of net sales for the nine months ended December 31, 2007 from 3% of net sales for the nine months ended December 31, 2006.

Selling, general and administrative

Selling, general and administrative (SG&A) expense increased $1,335,512 for the nine months ended December 31, 2007 as compared to the nine months ended December 31, 2006. SG&A expenses decreased to 23% of net sales for the nine months ended December 31, 2007 from 25% for the nine months ended December 31, 2006. The increase in spending was primarily attributable to increases in salaries and benefits of $315,000, commissions of $87,000, professional expenses of $76,000, travel and entertainment expenses of $47,000 and the inclusion of $619,000 in MICA selling expenses.

 

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Amortization of intangible assets

Amortization expense was $549,807 for the nine months ended December 31, 2007 as compared to $534,887 for the nine months ended December 31, 2006.

Interest expense

Interest expense increased $48,824 or 15% to $384,693 for the nine months ended December 31, 2007 as compared to $335,869 for the nine months ended December 31, 2006.

Provision for income taxes

Our effective tax rate was 45% for the nine months ended December 31, 2007 as compared to 49% for the nine months ended December 31, 2006.

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109 (“FIN No. 48”), which clarifies the accounting for uncertainty in income taxes by prescribing the minimum recognition threshold and measurement requirements a tax position must meet before recognized a benefit in the financial statements. FIN No. 48 also provides guidance on de-recognition, measurement, classification, interest and penalties, accounting for interim periods and disclosures for uncertain tax positions. FIN No. 48 is effective for fiscal years beginning after December 15, 2006.

We adopted FIN No. 48 on April 1, 2007 resulting in the recognition of $96,443 of uncertain tax benefits which, in accordance with FIN No. 48, the cumulative amount was accounted for as an adjustment to the April 1, 2007 balance of retained earnings. The FIN No. 48 analysis for the nine months ended December 31, 2007 resulted in an additional $18,288 in uncertain tax benefits.

Following the adoption of FIN No. 48, we had $114,731 of uncertain tax benefits, substantially all of which, if recognized, would be recorded as a component of the provision for income taxes. There have been no significant changes to these amounts during the nine months ended December 31, 2007.

Our policy is to recognize interest and penalties accrued on any uncertain tax positions as a component of income tax expense, if any. No material amount of such expense was recognized during the nine months ended December 31, 2007.

Liquidity and Capital Resources

We finance our operating and investment requirements primarily through operating cash flow and borrowings. We had cash and working capital at December 31, 2007 of $3,008,459 and $11,274,063, respectively, as compared with cash and working capital of $7,058,524 and $11,836,943, respectively at March 31, 2007. Our current ratio was approximately 3.3 to 1 at December 31, 2007, as compared to 3.2 to 1 at March 31, 2007. The reduction in cash was primarily related to the cash used in connection with the acquisition of MICA, and the increase in working capital other than cash.

Net cash provided by operating activities was $3,132,796 during the nine months ended December 31, 2007 as compared to net cash provided by operating activities of $650,308 during the nine months ended December 31, 2006. Cash provided by operating activities resulted from net income of $1,359,286, adjusted by non-cash charges for depreciation and amortization of $1,286,641, stock-based compensation of $464,685, increases in accounts receivable and inventory reserves of $519,086, and a decrease in working capital changes of $461,408. Working capital changes primarily resulted from an increase in accounts receivable of $401,851 and a decrease in accounts payable of $410,118, offset by an increase in accrued expenses of $476,806. Accounts receivable increased primarily due to strong sales in the nine months ended December 31, 2007.

Net cash used in investing activities was $5,598,706 during the nine months ended December 31, 2007 as compared to $1,166,626 during the nine months ended December 31, 2006, primarily as a result of the acquisition of MICA of $3,120,933 and the final earnout payment of $1.5 million to the former stockholders of Stealth in Q1 FY 08. Investing activities incurred by the Company during the nine months ended December 31, 2007 also included $789,671 of capital expenditures and $650,000 of marketable securities offset by $461,898 related to the sale of the Enon condominium in Q1 FY 08.

Net cash used in financing activities was $1,584,155 during the nine months ended December 31, 2007 as compared to $923,510 during the nine months ended December 31, 2006 primarily due to repayments on the mortgages, line of credit and term loans in the nine months ended December 31, 2007.

Term Loan and Revolver

In March 2007, we entered into a credit facility consisting of a $6.5 million five year secured term loan and a $5.0 million three year revolving line of credit, which replaced our existing $6.0 million term loan entered into in June 2005.

 

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The Company entered into an interest rate swap agreement in April 2007 to mitigate interest rate fluctuations on the term loan. At the end of each reporting period the Company records the current fair value of the interest rate swap on the balance sheet. Any unrealized gain or loss is charged to earnings.

The term loan is guaranteed by the Company’s subsidiaries and secured by substantially all of our assets. The term loan is payable in quarterly principal installments of $325,000 plus accrued interest at the 3 month LIBOR rate plus 1.8%, which at December 31, 2007 was 7.03%. The term loan expires in June 2012.

The revolving line of credit bears interest at the current 30 day LIBOR rate plus 1.8%, which at December 31, 2007 was 6.62%. We had $5.0 million available under the line at December 31, 2007.

Under the terms of the term loan and the revolver, we are required to maintain certain financial covenants on a quarterly and annual basis, including total funded debt to EBITDA not exceeding 2.25:1, minimum debt service coverage of 1.25:1, and minimum tangible net worth of $7.5 million. At December 31, 2007, we were in compliance with all financial debt covenants.

Mortgage payable, NH

In February 2004, Micronetics refinanced the mortgage on its headquarters, entering into a new five-year mortgage payable for $630,000. The note bears interest at 5.75% per annum and is payable in monthly installments, including interest, of $12,107. This loan is secured by the land and building of Micronetics’ headquarters.

Mortgage payable, MA

In March 2003, in connection with the purchase of a portion of a commercial condominium housing Micronetics’ Enon division, Micronetics entered into a mortgage payable for $352,750. In May 2007, the commercial condominium was sold and the remaining mortgage was settled.

Capital leases

Commercial capital leases payable are reflected at their present value based upon interest rates that range from 8.67% to 8.88% per annum, and are secured by the underlying assets. The assets are depreciated over their estimated useful lives.

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.

Off-Balance Sheet Arrangements

Micronetics has no off-balance sheet arrangements.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to a variety of market risks, including changes in interest rates primarily as a result of our borrowing and investing activities. Our investment portfolio consists entirely of money market and bond funds, which are subject to interest rate risk. Due to the short duration and conservative nature of these instruments, we do not believe we have a material exposure to interest rate risk on investments.

We are subject to interest rate exposure on our long-term debt. Our long-term borrowings are in variable rate instruments, with interest rates tied to either the Prime Rate or the LIBOR. We have entered into an interest rate swap agreement to minimize our exposure to interest rate fluctuations on these borrowings. Our interest rate swap has not been designated as a hedging instrument, therefore changes in fair value are recognized in earnings.

We conduct our transactions with foreign customers in U.S. dollars. Although we are not subject to the risks of foreign currency fluctuations directly, demand from foreign customers may be affected by the relative change in value of the customer’s currency to the value of the U.S. dollar. Changes in the relative value of the U.S. dollar may also change our prices relative to the prices of our foreign competitors.

 

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures – As of December 31, 2007, the Company carried out an evaluation, under the supervision and with the Company’s management, including the Company’s Chief Executive Officer and the Company’s 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 December 31, 2007 to provide reasonable assurance that material information relating to the Company was made known to them by others within the Company.

Changes in internal control – There were no significant changes in the Company’s internal controls over financial reporting that occurred during the quarter ended December 31, 2007 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 certain 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.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

The Company is not a party to any material pending legal proceedings.

 

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.

The significant slowdown in capital spending by certain of our customers, coupled with existing economic and geopolitical uncertainties and the potential impact on customer demand, has created uncertainty as to market demand. As a result, revenues and operating results for a particular period can be difficult to predict. In addition, there can be no certainty as to the severity or duration of the current industry adjustment. As a result of changes in industry and market conditions, many of our customers have significantly reduced their capital spending. Our revenues and operating results have been and may continue to be materially and adversely affected by reductions in capital spending by our customers.

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:

 

   

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;

 

   

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;

 

   

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;

 

   

increased price and product competition in our markets;

 

   

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;

 

   

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;

 

   

fluctuations in our gross margins;

 

   

the development, introduction and market acceptance of new technologies;

 

   

variations in sales channels, product costs and the mix of products sold;

 

   

the size and timing of customer orders and shipments;

 

   

our ability to maintain appropriate inventory levels;

 

   

the impact of acquired businesses and technologies;

 

   

the impact of our product development schedules, product quality variances, manufacturing capacity and lead times required to produce our products;

 

   

changes in legislation, regulation and/or accounting rules; the impact of higher insurance premiums and deductibles and greater limitations on insurance coverage; and

 

   

acts of terrorism or the outbreak of hostilities or armed conflict between countries.

 

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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:

 

   

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;

 

   

adverse changes in our current credit condition or the credit quality of our customers and suppliers;

 

   

adverse changes in the market conditions in our markets;

 

   

the trend towards the sale of integrated products;

 

   

visibility to, and the actual size and timing of, capital expenditures by our customers;

 

   

inventory practices, including the timing of product and service deployment, of our customers;

 

   

policies of our customers regarding utilization of single or multiple vendors for the products they purchase;

 

   

the overall trend toward industry consolidation and rationalization among our customers, competitors and suppliers;

 

   

conditions in the broader market for military and communications products;

 

   

governmental regulation or intervention affecting our products; and

 

   

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.

Economic conditions affecting the industry, which affect market conditions in the military and communication infrastructure industry in the United States, Europe and globally, affect our business.

Reduced capital spending and/or negative economic conditions in the United States, Europe as well as other areas of the world have resulted in, and could continue to result in, reduced demand for or increased pricing pressures on our 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

 

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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.

We depend on single manufacturing lines for 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. We have experienced manufacturing difficulties in the past, and 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 use a single or a limited number of suppliers. Any interruption in supply 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 as a result of a number of factors, including:

 

   

increased price competition;

 

   

excess capacity or excess fixed assets;

 

   

customer and contract settlements;

 

   

higher product, material or labor costs;

 

   

increased inventory provisions or contract and customer settlement costs;

 

   

warranty costs;

 

   

obsolescence charges;

 

   

loss of cost savings on future inventory purchases as a result of high inventory levels;

 

   

introductions of new products and costs of entering new markets;

 

   

increased levels of customer services;

 

   

changes in distribution channels; and

 

   

changes in product and geographic mix.

Lower than expected gross margins would negatively affect our operating results.

 

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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 in key senior management positions and in our key areas of potential growth. An important factor in attracting and retaining qualified employees is our ability to provide employees with the opportunity to participate in the potential growth of our business through programs such as stock option plans. We may also find it more 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, retaining or recruiting qualified employees, including members of senior management, 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 will be sufficient to fund our current business model, manage our investments 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:

 

   

we may have difficulty borrowing money in the future or accessing sources of funding;

 

   

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;

 

   

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

 

   

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.

 

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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.

Our business may suffer if we cannot protect our proprietary technology.

Our ability to compete depends significantly upon our patents and our other proprietary technology. The steps we have taken to protect our technology may be inadequate to prevent others from using what we regard as our technology to compete with us. Our patents could be challenged, invalidated or circumvented, and the rights we have under our patents could provide no competitive advantages. Existing trade secrets, copyright and trademark laws offer only limited protection. In addition, other companies could independently develop similar or superior technology without violating our intellectual property rights. Any misappropriation of our technology or the development of competing technology could seriously harm our competitive position, which could lead to a substantial reduction in net sales.

If we resort to legal proceedings to enforce our intellectual property rights, the proceedings could be burdensome, disruptive and expensive, distract the attention of management, and there can be no assurance that we would prevail.

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.

 

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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, 2005 to December 31, 2007, the trading price of our common stock ranged from $23.31 to $6.52. 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.

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.

The testing of electronic communications equipment and the accurate transmission of information entail a risk of product liability claims 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 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. Although we have not experienced any significant export licensing problems to date, such problems may arise in the future. 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.

 

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We are subject to recently enacted environmental regulation, compliance with which may be costly.

In 2006 the European Union (“EU”) implemented two new directives known as the Restriction on Certain Hazardous Substances Directive (RoHS) and the Waste Electrical and Electronic Equipment Directive (WEEE). These directives place restrictions on the distribution within the EU of certain substances, and require a manufacturer to recycle products containing the restricted substances. We believe that the majority of our products are exempt from the directives because they are used for military purposes rather than by consumers. However, we may not be able to rely on such an exemption until regulators review documentation and issue a ruling on each product. We are redesigning our products that we believe may not be exempt from the directives in order to be able to continue to offer such products for sale in the EU. We may encounter unanticipated delays in the completion of the redesign or in the delivery of any products that are not exempt from the directives. In addition certain products that we maintain in inventory may be rendered obsolete if not in compliance with the directives and may have to be written off. Although we cannot predict the ultimate impact of the directives, they will likely result in additional costs or decreased revenue and could require that we redesign or change how we manufacture our products.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

 

Item 3. Defaults upon Senior Securities.

None.

 

Item 4. Submission of Matters to a Vote of Security Holders.

 

(a) On October 17, 2007, the Company held its Annual Meeting of Shareholders.

 

(b) Not Applicable

 

(c) At such meeting, the shareholders of the Company voted:

 

  (1) To elect five (5) Directors to serve for the ensuing year. The votes cast were as follows:

 

Nominees

   Votes For    Votes
Withheld

David Siegel

   4,163,423    56,715

David Robbins

   4,164,937    55,210

Gerald Hattori

   4,164,012    56,135

Stephen Bathelmes, Jr.

   4,151,144    69,003

D’Anne Hurd

   4,163,982    56,165

 

  (2) To ratify the selection of Grant Thornton, LLP as the Company’s independent auditors for the fiscal year ending March 31, 2008. The votes cast were as follows:

 

Votes For   Votes Against   Abstained   Broker Non-
Votes
4,206,967   5,066   0   0

 

(d) Not Applicable

 

Item 5. Other Information.

None.

 

Item 6. Exhibits.

 

31.1

   Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

   Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

32.2

   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

 

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SIGNATURE

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  MICRONETICS, INC.
Dated: February 13, 2008   By:  

/s/ DAVID ROBBINS

    David Robbins,
    President and Chief Executive Officer
    (Principal Executive Officer)
Dated: February 13, 2008   By:  

/s/ DIANE BOURQUE

    Diane Bourque,
    Vice President and Chief Financial Officer
    (Principal Financial and Accounting Officer)

 

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