Business

Micropac Industries, Inc. (the "Company"), a Delaware corporation, designs, manufactures and distributes various types of microelectronic circuits including solid state relays and power controllers, optoelectronic components, and sensor and display components and assemblies. The Company's products are used as components and assemblies in a broad range of military, space and industrial systems, including aircraft instrumentation and navigation systems, satellite systems, power supplies, electronic controls, computers, medical devices, and high-temperature (200o C) products.

The Company's facilities are certified and qualified by the Defense Logistics Agency (DLA) to MIL-PRF-38534 (class K-space level) and MIL-PRF-19500 JANS (space level) and are certified to ISO 9001:2008 and AS 9100D. Micropac is a National Aeronautics and Space Administration (NASA) core supplier, and is registered to AS9100-Aerospace Industry standard for supplier certification. The Company has Underwriters Laboratories (UL) approval on our industrial power controllers.

The Company's core technology are microelectronic and optoelectronic designs to include the packaging and interconnecting of multi-chip microelectronics modules. Other technologies include light emitting and light sensitive materials and products, including light emitting diodes and silicon phototransistors, and electronic integration used in the Company's optoelectronic components and assemblies.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions and factors that are believed to be reasonable under the circumstances. Note 2 to the Financial Statements in the Quarterly Report Form 10-Q for the quarter ended May 28, 2022, describes the significant accounting policies and methods used in the preparation of the Financial Statements. liabilities. Actual results could differ from these estimates.

The core principle of revenue recognition under accounting principles generally accepted in the Unites States of America (GAAP) is that the Company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company's revenue on the majority of its customer contracts are recognized at a point in time, generally upon shipment of products. The application of GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, the determination of whether revenues related to our revenue contracts should be recognized over time or at a point in time, as these determinations impact the timing and amount of our reported revenues and net income. Other significant judgments include the estimation of the point in the manufacturing process at which we are entitled to receive payment, as well as the progress of the job order to completion in order to determine the amount of consideration earned for contractual revenue recognized over time.

The allowance for doubtful accounts is based on our assessment of the collectability of specific customer accounts and the aging of the accounts receivable. If there is a deterioration of a major customer's credit worthiness or actual defaults are higher than our historical experience, our estimates of the recoverability of amounts due us could be adversely affected.

Inventory purchases and commitments are based upon future demand. If there is a sudden and significant decrease in demand for our products or there is a higher risk of inventory obsolescence because of changing customer requirements, we may be required to increase our inventory allowances and our gross margin could be adversely affected.

The Company recognizes deferred tax assets and liabilities based on differences between the financial reporting and tax basis of assets and liabilities using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered. If we were to determine we would not be able to realize all or part of the deferred tax asset in the future, an adjustment to the deferred tax asset would be necessary which would reduce our net income for that period.

Depreciable and useful lives estimated for property and equipment are based on initial expectations of the period of time these assets will provide benefit. Changes in circumstances related to a change in our business



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or other factors could result in these assets becoming impaired, which could adversely affect the value of these assets.





Results of Operations

                                           Three months ended                Six months ended
                                      5/28/2022        5/29/2021        5/28/2022        5/29/2021
NET SALES                                 100.0 %          100.0 %          100.0 %          100.0 %

COST AND EXPENSES:
  Cost of Goods Sold                       59.1 %           54.3 %           56.7 %           58.4 %
  Research and development                  7.0 %            5.2 %            7.3 %            6.4 %
  Selling, general and
administrative expenses                    25.7 %           20.8 %           27.3 %           25.5 %
                  Total cost and
expenses                                   91.8 %           80.3 %           91.3 %           90.3 %

OPERATING INCOME BEFORE INTEREST            8.2 %           19.7 %            8.7 %            9.7 %

AND INCOME TAXES



  Interest and other income, net             -                -                -               0.2 %

INCOME BEFORE TAXES                         8.2 %           19.7 %            8.7 %            9.9 %

  Provision for taxes                       1.4 %            2.8 %            1.5 %            1.4 %

NET INCOME                                  6.8 %           16.9 %            7.2 %            8.5 %

Sales for the three and six month periods ended May 28, 2022 totaled $7,188,000 and $13,254,000, respectively. Sales for the second quarter decreased $447,000 from the same period of 2021 while sales for the first six months of 2022 increased $1,569,000 from the first six months of 2021. The majority of the increase is related to timing of shipments of customer orders of standard microelectronic products. Sales were 8% in the commercial market, 10% in the medical market, 69% in the military market, and 13% in the space market for the six months ended May 28, 2022 compared to 6% in the commercial market, 14% in the medical market, 64% in the military market, and 16% in the space market for the six months ended May 29, 2021.

Two customers accounted for 15% and 11% of the Company's sales for the three months ended May 28, 2022, and one customer accounted for 17% for the six months ended May 28, 2022, while one customer accounted for 20% and 19% of the Company's sales for the three months and six months ended May 29, 2021.

Cost of goods sold for the second quarters of 2022 and 2021 totaled 59.1% and 54.3% of net sales, respectively, while cost of goods sold for the six months ended May 28, 2022 and May 29, 2021 totaled 56.7% and 58.4% of net sales, respectively. In actual dollars, cost of goods sold increased $104,000 in the second quarter of 2022 compared to the same period of 2021. Year to date cost of goods sold increased $690,000 for the first six months of 2022 as compared to the same period in 2021. The majority of the increase in the second quarter is associated with the increase in cost of goods sold with the decrease in sales compared to second quarter of 2021.

Research and development expense increased $104,000 for the second quarter of 2022 versus 2021 and increased $223,000 for the first six months of 2022 compared to the same period of 2021. The research and development expenditures were associated with continued development of several power management products, fiber optic transceivers and high voltage optocouplers. The Company will continue to invest in research and development of these products and other new opportunities.

Selling, general and administrative expenses for the second quarter and first six months of 2022 totaled 25.7% and 27.3% respectively of net sales compared to 20.8% and 25.5% for the same periods in 2021. In actual dollars, selling, general and administrative expenses increased $260,000 for the second quarter and increased $639,000 for the first six months of 2022 compared to the same periods in 2021. The majority of the increase for the first six months resulted from an increase in commission expense in 2022, property tax on the new building and consultant fees.





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Provisions for taxes decreased $109,000 for the second quarter of 2022 and increased $35,000 for the first six months of 2022 compared to the same period in 2021. The estimated effective tax rate was 17% for 2022 and 14% for 2021.

Net income decreased $802,000 for the second quarter of 2022 versus 2021 and decreased $36,000 for the first six months of 2022 compared to the same period of 2021.

Liquidity and Capital Resources

The Company will use a combination of cash and a commercial real estate construction loan for the construction of a new 76,000 square foot manufacturing center on the 9.2 acres of land in Garland, Texas the Company purchased. On March 26, 2021, the Company (acting as borrower) entered into a Construction Loan Agreement with Frost Bank ("Frost"), (acting as lender). The Construction Loan Agreement provides for a construction loan as discussed in Note 5 to the condensed financial statements.

As of May 28, 2022, the Company has $16,116,000 in construction in process on the new facility and has $11,792,000 in notes payable on the construction loan, outstanding draw request of $879,000 in accounts payable and has used $2,515,000 of the Company's cash. In addition, the Company has unamortized loan fees on the construction loan in the amount of $179,000.

In addition, the Company continues on-going investigations for the use of cumulative cash for business expansion and improvements, such as operational improvements and new product expansion.

Cash and cash equivalents totaled $16,019,000 as of May 28, 2022 compared to $15,252,000 on November 30, 2021, an increase of $767,000. The increase in cash and cash equivalents is attributable to $1,626,000 cash provided by operations, $8,244,000 proceeds from the construction loan, offset by the payment of a cash dividend of $258,000, $356,000 in cash for additional manufacturing equipment and $8,489,000 for construction in process on the new facility.

In addition to cash on hand, the Company also has the ability to borrow under a loan agreement as discussed in Note 5 to the condensed financial statements.

The Company has no significant off-balance sheet arrangements.





Outlook

New orders for year-to-date 2022 totaled $15,395,000 compared to $13,105,000 for 2021. The increase resulted from timing of new orders for several custom products.

Backlog totaled $35,055,000 on May 28, 2022 compared to $31,517,000 as of May 29, 2021 and $32,635,000 on November 30, 2021 and represents a good mix of the company's products and technologies.





                         2022 Current Backlog by Major Market
                          Military       Space     Medical      Commercial        Total

Domestic Direct $ 17,937 $ 1,359 $ 4,263 $ 2,312 $ 25,871 Domestic Distribution 7,594 710 -

              430        8,734
International                116          65          -              269          450
                        $ 25,647     $ 2,134     $ 4,263     $     3,011     $ 35,055




  2022 Current Backlog by Product Line
Microelectronics             $  12,507
Optoelectronics                  5,639
Sensors and Displays            16,909
                             $  35,055

The Company cannot assure that the results of operations for the interim period presented are indicative of total results for the entire year due to fluctuations in customer delivery schedules, or other factors over which the Company has no control.

Impact of COVID-19 on our Business

In March 2020 the World Health Organization declared the spread of the COVID-19 virus a pandemic.



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The Company continues to monitor our supply chain and orders from customers for COVID-19 pandemic related changes. We are continuing to serve our customers while taking precautions to provide a safe work environment for our employees and customers. We have been staggering some shifts and otherwise adjusting work schedules to maximize our capacity while adhering to recommended precautions. We have established and implemented a work from home provision where possible.

To date, we have not experienced significant raw material shortages; however, supply-chain disruptions could potentially delay or prevent us from fulfilling customer orders.





Cautionary Statement

This Form 10-Q contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially. Investors are warned that forward-looking statements involve risks and unknown factors including, but not limited to: our expectations regarding the potential impacts on our operations of the COVID-19 pandemic; our expectations regarding the potential impacts on our supply chain and on our customers of the COVID-19 pandemic; overall changes in governmental spending for military and space programs; customer cancellation or rescheduling of orders, problems affecting delivery of vendor-supplied raw materials and components, unanticipated manufacturing problems and availability of direct labor resources.

The Company does not intend to update the forward-looking statements contained herein, except as may be required by law.

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