BIO-TECHNE Corp - Quarter Report: 2019 March (Form 10-Q)

 

 

Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

---

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2019, or

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                    

 

Commission file number 0-17272 

 

---

BIO-TECHNE CORPORATION

(Exact name of registrant as specified in its charter)

 

---

 

Minnesota		41-1427402
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
614 McKinley Place N.E. Minneapolis, MN 55413		(612) 379-8854
(Address of principal executive offices) (Zip Code)		(Registrant's telephone number, including area code)

 

---

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

 

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

 

Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐

 

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

 

Indicate by check mark whether the Registrant is a shell company (as defined in Exchange Act Rule 12b- 2).    ☐  Yes    ☒  No

 

At May 1, 2019, 37,872,753 shares of the Company's Common Stock (par value $0.01) were outstanding.

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	TECH	NASDAQ

 

---

 

 

TABLE OF CONTENTS

 

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (Unaudited)		1
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations		19
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		25
Item 4.	Controls and Procedures		26
PART II: OTHER INFORMATION
Item 1.	Legal Proceedings		27
Item 1A.	Risk Factors		27
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		28
Item 5.	Other Information		28
Item 6.	Exhibits		28
	SIGNATURES		29

 

---

 

		Quarter Ended								Nine Months Ended
		March 31,								March 31,
		2019				2018				2019				2018
Net sales		$	184,861			$	163,973			$	522,341			$	462,739
Cost of sales			60,251				53,712				177,110				152,777
Gross margin			124,610				110,261				345,231				309,962
Operating expenses:
Selling, general and administrative			64,968				53,285				195,622				175,349
Research and development			15,552				13,892				46,154				41,350
Total operating expenses			80,520				67,177				241,776				216,699
Operating income			44,090				43,084				103,455				93,263
Other income (expense)			5,787				(18,102	)			(14,226	)			(23,581	)
Earnings before income taxes			49,877				24,982				89,229				69,682
Income tax expense (benefit)			5,223				5,244				9,617				(14,767	)
Net earnings		$	44,654			$	19,738			$	79,612			$	84,449
Other comprehensive income:
Foreign currency translation gain (loss)			5,232				2,297				(4,368	)			10,787
Unrealized gain (loss) on derivative instruments - cash flow hedges			(1,854	)			-				(5,769	)			-
Unrealized gain (loss) on available-for-sale investments			-				38,659				-				22,286
Other comprehensive income (loss)			3,378				40,956				(10,137	)			33,073
Comprehensive income		$	48,032			$	60,694				69,475			$	117,522
Earnings per share:
Basic		$	1.18			$	0.53			$	2.11			$	2.25
Diluted		$	1.15			$	0.52			$	2.05			$	2.22
Cash dividends per common share:		$	0.32			$	0.32			$	0.96				0.96
Weighted average common shares outstanding:
Basic			37,772				37,503				37,745				37,450
Diluted			38,861				38,142				38,813				37,933

---

 

		March 31, 2019				June 30, 2018
ASSETS
Current assets:
Cash and cash equivalents		$	95,561			$	121,990
Short-term available-for-sale investments			83,229				59,764
Accounts receivable, less allowance for doubtful accounts of $1,037 and $839, respectively			133,927				120,296
Inventories			93,839				85,648
Other current assets			16,877				10,668
Total current assets			423,433				398,366
Property and equipment, net			145,319				145,348
Goodwill			719,608				597,890
Intangible assets, net			579,142				446,332
Other assets			5,116				5,266
Total assets		$	1,872,618			$	1,593,202
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Trade accounts payable		$	14,898			$	18,452
Salaries, wages and related accruals			23,523				23,710
Accrued expenses			28,296				20,361
Contract liabilities			10,112				8,109
Income taxes payable			5,318				8,878
Current portion of contingent consideration payable			3,400				-
Current portion of long-term debt obligations			12,500				-
Total current liabilities			98,047				79,510
Deferred income taxes			96,844				86,293
Long-term debt obligations, net of deferred financing costs of $360 and $0 respectively			509,765				339,000
Long-term contingent consideration payable			2,200				-
Other long-term liabilities			19,496				9,338
Shareholders' equity:
Common stock, par value $.01 per share; authorized 100,000,000; issued and outstanding 37,813,367 and 37,607,500, respectively			378				376
Additional paid-in capital			297,748				246,568
Retained earnings			927,773				876,931
Accumulated other comprehensive loss			(79,633	)			(44,814	)
Total shareholders' equity			1,146,266				1,079,061
Total liabilities and shareholders’ equity		$	1,872,618			$	1,593,202

---

 

		Nine Months Ended
		March 31,
		2019				2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings		$	79,612			$	84,449
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization			58,252				47,311
Costs recognized on sale of acquired inventory			2,804				2,013
Deferred income taxes			(11,114	)			(48,030	)
Stock-based compensation expense			24,151				13,587
Fair value adjustment to contingent consideration payable			(1,100	)			20,100
Payments of contingent consideration			-				(26,200	)
Impairment of investment			-				16,226
Fair value adjustment on available for sale investments			(2,907	)			-
Other operating activity			2,255				1,664
Change in operating assets and operating liabilities, net of acquisition:
Accounts receivable			(13,136	)			9,399
Inventories			(11,550	)			(11,576	)
Prepaid expenses			(1,000	)			858
Trade accounts payable and accrued expenses			7,977				1,665
Salaries, wages and related accruals			(102	)			(4,159	)
Income taxes payable			(8,469	)			(1,779	)
Net cash provided by operating activities			125,673				105,528
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, net of cash acquired			(272,286	)			(65,066	)
Proceeds from maturities of available-for-sale investments			17,215				6,563
Purchases of available-for-sale investments			(37,693	)			(3,061	)
Purchases of property and equipment			(13,719	)			(15,116	)
Net cash used in investing activities			(306,483	)			(76,680	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash dividends			(36,237	)			(35,941	)
Proceeds from stock option exercises			27,029				13,724
Re-purchases of common stock			(15,405	)			-
Borrowings under credit agreement			580,000				55,000
Payments on credit agreement			(396,375	)			(6,000	)
Payments of contingent consideration			-				(58,800	)
Other financing			(4,731	)			(4,339	)
Net cash provided by (used in) financing activities			154,281				(36,356	)
Effect of exchange rate changes on cash and cash equivalents			99				2,504
Net increase (decrease) in cash and cash equivalents			(26,429	)			(5,004	)
Cash and cash equivalents at beginning of period			121,990				91,612
Cash and cash equivalents at end of period		$	95,561			$	86,608
Supplemental disclosure of cash flow information:
Cash paid for interest		$	16,110			$	6,877
Cash paid for income taxes		$	26,637			$	31,103

---

 

Note 1. Basis of Presentation and Summary of Significant Accounting Policies:

 

The interim consolidated financial statements of Bio-Techne Corporation and subsidiaries, (the Company) presented here have been prepared by the Company and are unaudited. They have been prepared in accordance with accounting principles generally accepted in the United States of America and with instructions to Form 10-Q and Article 10 of Regulation S-X. They reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. All such adjustments are of a normal recurring nature.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These interim unaudited condensed consolidated financial statements should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto for the fiscal year ended June 30, 2018, included in the Company's Annual Report on Form 10-K for fiscal year 2018. A summary of significant accounting policies followed by the Company is detailed in the Company's Annual Report on Form 10-K for fiscal year 2018. The Company follows these policies in preparation of the interim unaudited condensed consolidated financial statements.

 

Effective in the first quarter of fiscal year 2019, the Company changed its reportable segments due to changes in its underlying organizational model designed to better support the business following recent acquisitions and to facilitate global growth. The Company did not operate under the realigned reportable segment structure prior to fiscal year 2019. As a result, the Company’s new segment structure will focus on synergies between our existing businesses including sharing certain functions such as sales resources, with its five existing divisions aggregated into two reportable segments as follows:

 

●

“Diagnostics and Genomics” will consist of the ACD division, the Diagnostics division, as well as the ExosomeDx acquisition. As part of the realignment, ACD will now be referred to as the Genomics division.

 

●

“Protein Sciences” will consist of the Core Biotechnology division and the Protein Platforms division. As part of the realignment, Protein Platforms will now be referred to as the Analytical Solutions Division (ASD) and Core Biotechnology will now be referred to as the Reagent Solutions Division (RSD).

 

Recently Adopted Accounting Pronouncements

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (ASC 606). The standard provides revenue recognition guidance for any entity that enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets, unless those contracts are within the scope of other accounting standards. The core principle of ASC 606 is that revenue should be recognized 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.

 

On  July 1, 2018, the Company adopted ASC 606 using the modified retrospective method for all contracts. Results for reporting periods beginning  July 1, 2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historic accounting under Topic 605, Revenue Recognition.

 

The Company recorded a net increase to beginning retained earnings of $98,000 as of  July 1, 2018 due to the cumulative impact of adopting ASC 606. The impact to beginning retained earnings was primarily driven by the transition to over-time revenue recognition on custom development projects, partially offset by the deferral of revenue for unfulfilled performance obligations. The adoption of ASC 606 did not have a material impact on the Company’s consolidated financial statements as of and for the quarter and nine month period ended  March 31, 2019 and, as a result, comparisons of revenues and operating profit performance between periods are not affected by the adoption of this ASU. Refer to Note 2 for additional disclosures required by ASC 606.

 

In January 2016, the FASB issued ASU No. 2016-01 Recognition and Measurement of Financial Assets and Financial Liabilities. The standard is intended to improve the recognition, measurement, presentation and disclosure of financial instruments. Among other changes, there will no longer be an available-for-sale classification for which changes in fair value are currently reported in other comprehensive income for equity securities with readily determinable fair values. Equity investments with readily determinable fair values will be measured at fair value with changes in fair value recognized in net income. ASU 2016-01 was effective for us on July 1, 2018 which required a cumulative effect adjustment to opening retained earnings to be recorded for equity investments with readily determinable fair values. As of the adoption date, we held publicly traded equity investments with a fair value of $54.3 million in a net unrealized gain position of $35.4 million, and having an associated deferred tax liability of $8.3 million. We recorded a cumulative-effect adjustment of $27.1 million to decrease Accumulated Other Comprehensive Income (AOCI) with a corresponding increase to retained earnings for the amount of unrealized gains, net of tax as of the beginning of fiscal year 2019. As a result of the implementation of ASU 2016-01, effective on July 1, 2018 unrealized gains and losses in equity investments with readily determinable fair values are recorded on the Consolidated Statement of Income within other (expense) income. We recorded a gain in other (expense) income of $12.3 million and $2.9 million for the quarter and nine month period ended March 31, 2019 as a result of adopting this standard. The implementation of ASU 2016-01 is expected to increase volatility in our net income as the volatility previously recorded in Other Comprehensive Income (OCI) related to changes in the fair market value of available-for-sale equity investments will now be reflected in net income effective with the adoption date.

 

 

In February 2018, the FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The standard allows companies to make an election to reclassify from Accumulated Other Comprehensive Income (AOCI) to retained earnings the stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017. This ASU is effective for annual and interim periods beginning after December 15, 2018, which for us is July 1, 2019. Early adoption is permitted. We elected to early adopt ASU 2018-02 on July 1, 2018. We use a specific identification approach to release the income tax effects in AOCI. As a result of adopting this standard, we recorded a cumulative effect adjustment to increase AOCI by $2.4 million with a corresponding decrease to retained earnings. We recorded the impacts of adopting ASU 2018-02 prior to recording the impacts of adopting ASU 2016-01 and included state income tax related effects in the amounts reclassified to retained earnings.

 

The following table presents a summary of cumulative effect adjustments to retained earnings due to the adoption of new accounting standards on July 1, 2018 as noted above:

 

 

In January 2017, the FASB issued ASU No. 2017-01, Clarifying the Definition of a Business. The standard revises the definition of a business, which affects many areas of accounting such as business combinations and disposals and goodwill impairment. The revised definition of a business will likely result in more acquisitions being accounted for as asset acquisitions, as opposed to business combinations. We adopted this standard on July 1, 2018, applying the guidance to transactions occurring on or after this date.

 

In August 2017, the FASB issued ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities. The standard changes the designation and measurement guidance for qualifying hedging relationships to better align financial reporting to risk management activities.  As part of the guidance, the entire change in fair value of a qualifying hedging instrument will be recorded within other comprehensive income which is then reclassified into earnings in the same period or periods during which the hedged item impacts earnings. Additionally, the gain or loss resulting from the hedging activity will be presented in the same income statement line item as the hedged item. The standard is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2018, which for us is July 1, 2019. Early adoption is permitted. We elected to early adopt ASU 2017-12 on October 1, 2018, prior to the Company entering into cash flow hedges as described in Note 5. The adoption of this standard did not have a material impact on our consolidated financial statements.

 

Pronouncements Issued But Not Yet Adopted

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which amends the existing guidance to require lessees to recognize lease assets and lease liabilities from operating leases on the balance sheet. This ASU is effective using the modified retrospective approach for annual periods and interim periods within those annual periods beginning after December 15, 2018, which for us is July 1, 2019. Early adoption is permitted. The FASB has issued narrow codification improvements to Leases (Topic 842) through ASU No. 2018-10 and ASU 2019-01. Additionally, the FASB issued ASU 2018-11, allowing an entity to elect a transition method where they do not recast prior periods presented in the financial statements in the period of adoption. The Company plans to elect the transition method allowed for under ASU 2018-11 when adopting Leases (Topic 842). The Company is finalizing our assessment of the impact of the leasing standard, including performing reviews over lease agreements and finalizing the practical expedients to be elected. The Company is not able to quantify the impact of the standard at this time.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. The amendment in this update replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses on instruments within its scope, including trade and loan receivables and available-for-sale debt securities. This update is intended to provide financial statement users with more decision-useful information about the expected credit losses. This ASU is effective for annual periods and interim periods for those annual periods beginning after December 15, 2019, which for us is July 1, 2020. Entities may early adopt beginning after December 15, 2018. We are currently evaluating the impact of the adoption of ASU 2016-13 on our consolidated financial statements.

 

In August 2018, the FASB issued ASU No. 2018-15, Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The standard aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The accounting for the service element of a hosting arrangement that is a service contract is not affected by the new standard.  This ASU is effective for annual periods and interim periods for those annual periods beginning after December 15, 2019, which for us is July 1, 2020 and may be adopted retrospectively or prospectively to eligible costs incurred on or after the date the guidance is first applied. We are currently evaluating the impact of the adoption of ASU 2018-15 on our consolidated financial statements and anticipate that we will adopt the standard prospectively.

 

 

 

Note 2. Revenue Recognition:

 

Consumables revenues consist of single-use products and are recognized at a point in time following the transfer of control of such products to the customer, which generally occurs upon shipment. Instruments revenues typically consist of longer-lived assets that, for the substantial majority of sales, are recognized at a point in time in a manner similar to consumables. The vast majority of service revenues consist of extended warranty contracts, post contract support (“PCS”), and custom development projects that are recognized over time as either the customers receive and consume the benefits of such services simultaneously or the underlying asset being developed has no alternative use for the Company at contract inception and the Company has an enforceable right to payment for the portion of the performance completed. The remaining service revenues were not material to the period and consist of laboratory services recognized at point in time. Given the Company does not have significant historical experience collecting payments from Medicare or insurance providers, the Company considered the variable consideration for such services to be constrained as it would not be probable that a significant amount of revenue would not need to be reversed in future periods for the services provided. Accordingly, the Company did not record revenue upon completion of the performance obligation, but rather upon cash receipt, which was subsequent to the performance obligation being satisfied. Royalty revenues are based on net sales of the Company’s licensed products by a third party. We recognize royalty revenues in the period the sales occur using third party evidence. The Company has also elected the "right to invoice" practical expedient based on the Company's right to invoice a customer at an amount that approximates the value to the customer and the performance completed to date. 

 

The Company has elected the exemption to not disclose the unfulfilled performance obligations for contracts with an original length of one year or less and the exemption to exclude future performance obligations that are accounted under the sales-based or usage-based royalty guidance.  The Company's unfulfilled performance obligations were not material as of March 31, 2019. 

 

Contracts with customers that contain instruments may include multiple performance obligations. For these contracts, the Company allocates the contract’s transaction price to each performance obligation on a relative standalone selling price basis. Allocation of the transaction price is determined at the contracts’ inception.

 

Payment terms for shipments to end-users are generally net 30 days. Payment terms for distributor shipments may range from 30 to 90 days. Service arrangements commonly call for payments in advance of performing the work (e.g. extended warranty and service contracts), upon completion of the service (e.g. custom development manufacturing) or a mix of both.

 

Contract assets include revenues recognized in advance of billings. Contract assets are included within other current assets in the accompanying balance sheet as the amount of time expected to lapse until the company's right to consideration becomes unconditional is less than one year. We elected the practical expedient allowing us to expense costs of obtaining contracts less than one year that would otherwise be capitalized and amortized over the contract period. Contract assets as of March 31, 2019 are not material.

 

Contract liabilities include billings in excess of revenues recognized, such as those resulting from customer advances and deposits and unearned revenue on warranty contracts. Contract liabilities as of March 31, 2019 and June 30, 2018 were approximately $11.5 million and $9.3 million, respectively. Contract liabilities as of June 30, 2018 subsequently recognized as revenue during the quarter and nine month period ended March 31, 2019 were approximately $0.9 million and $6.5 million, respectively. Contract liabilities in excess of one year are included in Other long-term liabilities on the balance sheet. 

 

Any claims for credit or return of goods must be made within 10 days of receipt. Revenues are reduced to reflect estimated credits and returns. Although the amounts recorded for these revenue deductions are dependent on estimates and assumptions, historically our adjustments to actual results have not been material.

 

Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from revenue. Amounts billed to customers for shipping and handling are included in revenue, while the related shipping and handling costs are reflected in cost of products. We have elected the practical expedient that allows us to account for shipping and handling activities that occur after the customer has obtained control of a good as a fulfillment cost, and we accrue costs of shipping and handling when the related revenue is recognized.

 

The following tables present our disaggregated revenue for the periods presented.

 

Revenue by type is as follows:

 

 

Revenue by geography is as follows:

 

 

 

 

Note 3. Selected Balance Sheet Data:

 

Inventories:

 

Inventories consist of (in thousands):

 

 

 

Property and Equipment:

 

Property and equipment consist of (in thousands): 

 

 

Intangible Assets:

 

Intangible assets consist of (in thousands): 

 

 

 

Changes to the carrying amount of net intangible assets for the nine months ended March 31, 2019 consist of (in thousands):

 

 

The estimated future amortization expense for intangible assets as of March 31, 2019 is as follows (in thousands):

 

 

 

Goodwill:

 

Changes to the carrying amount of goodwill for the nine months ended March 31, 2019 consist of (in thousands):

 

 

We evaluate the carrying value of goodwill in the fourth quarter of each fiscal year and between annual evaluations if events occur or circumstances change that would indicate a possible impairment. The Company performed a quantitative assessment for all of its reporting units during the fourth quarter of fiscal 2018. The quantitative assessment indicated that all of the reporting units had substantial headroom as of June 30, 2018.

 

During the quarter ended March 31, 2019, the Company realigned the management of certain business processes between reporting units within the same reportable segment. A goodwill allocation was performed between the impacted reporting units based on the relative fair value of the processes realigned. In conjunction with the realignment, a quantitative goodwill impairment assessment was performed both prior to and subsequent to the realignment. The quantitative assessment indicated that all of the impacted reporting units had substantial headroom both prior to and subsequent to the realignment.  No triggering events or items beyond the realignment that would require a goodwill impairment assessment were identified during the nine months ended March 31, 2019. There has been no impairment of goodwill since the adoption of Financial Accounting Standards Board (“FASB”) ASC 350 guidance for goodwill and other intangibles on July 1, 2002.

 

 

 

Note 4. Acquisitions:

 

We periodically complete business combinations that align with our business strategy. Acquisitions are accounted for using the acquisition method of accounting, which requires, among other things, that assets acquired and liabilities assumed be recognized at fair value as of the acquisition date and the results of operations of each acquired business are included in our Condensed Consolidated Statement of Earnings and Comprehensive Income from their respective dates of acquisition. Acquisition costs are recorded in selling, general and administrative expenses as incurred.

 

 

Quad Technologies

 

On July 2, 2018, the Company acquired QT Holdings Corporation (Quad) for approximately $20.5 million, net of cash acquired, plus contingent consideration of up to $51.0 million, subject to certain product development milestones and revenue thresholds. The goodwill recorded as a result of the acquisition represents the strategic benefits of growing the Company’s product portfolio and the expected revenue growth from increased market penetration. The goodwill is not deductible for income tax purposes. The business became part of the Protein Sciences reportable segment in the first quarter of fiscal  year 2019.

 

Certain estimated fair values are not yet finalized and are subject to change, which could be significant. The Company expects to finalize by the end of the fourth quarter of fiscal year 2019 when we have completed our valuation models for acquired intangible assets, including the determination of related estimated useful lives, and finalized our income tax assessment of acquired net operating losses (NOLs). Amounts for intangible assets and related deferred tax liabilities, acquired NOLs, and goodwill also remain subject to change. The preliminary estimated fair values of the assets acquired and liabilities assumed are as follows (in thousands):

 

 

As summarized in the table, there were adjustments totaling $3.8 million to goodwill during the measurement period. These adjustments primarily relate to refinements made to acquired intangible asset cash flow models, an update in the discount rate used in the contingent consideration calculation based on refinements made in the acquired intangible asset cash flow models, and adjustments to preliminary deferred tax amounts based on updated assessments of the applicability of certain NOLs. 

 

Tangible assets and liabilities acquired were recorded at fair value on the date of close based on management's assessment. The purchase price allocated to developed technology was estimated based on management's forecasted cash inflows and outflows using a multi-period excess earnings method to calculate the fair value of assets purchased. The preliminary amount recorded for developed technology is being amortized with the expense reflected in cost of goods sold in the Condensed Consolidated Statement of Earnings and Comprehensive Income. The preliminary amortization periods for intangible assets acquired in fiscal 2019 are estimated to be 14 years for developed technology. The net deferred income tax liability represents the net amount of the estimated future impact of adjustments for costs to be recognized as intangible asset amortization, which is not deductible for income tax purposes offset by the deferred tax asset for the preliminary calculation of acquired NOLs.

 

Exosome Diagnostics

 

On August 1, 2018, the Company acquired Exosome Diagnostics, Inc. (ExosomeDx) for approximately $251.8 million, net of cash acquired, plus contingent consideration of up to $325.0 million as follows:

 

●	Up to $250 million if calendar year 2020 EBITA is between $45 million and $58 million or greater.
●	Up to $45 million if calendar year 2022 EBITA for a new instrument product is between $54 million and $70 million or greater.
●	Up to $30 million if calendar year 2022 EBITA for the remaining business is between $150 million and $190 million or greater.

 

The goodwill recorded as a result of the acquisition represents the strategic benefits of growing the Company’s product portfolio and the expected revenue growth from increased market penetration. The goodwill is not deductible for income tax purposes. The business became part of the Diagnostics and Genomics reportable segment in the first quarter of fiscal year 2019.

 

Certain estimated fair values are not yet finalized and are subject to change, which could be significant. The Company expects to finalize these by the end of fourth quarter of fiscal year 2019 when we have completed our assessment of the working capital adjustment, completed our valuation models for acquired intangible assets, and finalized our income tax assessment of acquired NOLs. Amounts for acquired current assets and liabilities, intangible assets, related deferred tax liabilities, and goodwill also remain subject to change. The preliminary estimated fair values of the assets acquired and liabilities assumed are as follows (in thousands):

 

 

As summarized in the table, there were adjustments totaling $13.5 million to goodwill during the measurement period. As previously disclosed, the intangible value associated with the ExosomeDx trade name and determination of the related estimated useful life was under assessment as part of purchase accounting review. During the period, the Company updated our intangible assessment to include a $58.0 million value for the ExosomeDx trade name. Due to our updated assessments and further refinements in our intangible asset cash flow models, the fair value of the developed technology intangible asset decreased by $75.0 million. Additionally, we recorded a Customer Relationships intangible asset of $2.3 million for the established physician network ordering ExosomeDx laboratory services that existed at the acquisition date. Adjustments to the opening balance sheet fair value also included updates to preliminary deferred tax amounts and working capital adjustments, primarily attributable to updates for the net realizable value of certain acquired receivables based on factors existing on the acquisition date. 

 

Tangible assets and liabilities acquired were recorded at fair value on the date of close based on management's assessment. The purchase price allocated to developed technology, trade names, and customer relationships was based on management's forecasted cash inflows and outflows and using either a relief-from-royalty or a multi-period excess earnings method to calculate the fair value of assets purchased. The preliminary amount recorded for developed technology is being amortized with the expense reflected in cost of goods sold in the Condensed Consolidated Statement of Earnings and Comprehensive Income. Preliminary amortization expense related to trade names, and customer relationships is reflected in selling, general and administrative expenses in the Consolidated Statement of Earnings and Comprehensive Income. The preliminary amortization periods for intangible assets acquired in fiscal 2019 are 15 years for developed technology and trade names, and 14 years for customer relationships. The net deferred income tax liability represents the net amount of the estimated future impact of adjustments for costs to be recognized as intangible asset amortization, which is not deductible for income tax purposes offset by the deferred tax asset for the preliminary calculation of acquired NOLs.

 

 

 

 

Note 5. Fair Value Measurements:

 

The Company’s financial instruments include cash and cash equivalents, available for sale investments, accounts receivable, accounts payable, contingent consideration obligations, derivative instruments, and long-term debt.

 

Fair value is defined as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. This standard also establishes a hierarchy for inputs used in measuring fair value. This standard maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability based on market data obtained from independent sources. Unobservable inputs are inputs that reflect our assumptions about the factors market participants would use in valuing the asset or liability based upon the best information available in the circumstances.

 

The categorization of financial assets and liabilities within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The hierarchy is broken down into three levels. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs (other than quoted prices) that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable for the asset or liability and their fair values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 may also include certain investment securities for which there is limited market activity or a decrease in the observability of market pricing for the investments, such that the determination of fair value requires significant judgment or estimation.

 

The following tables provide information by level for financial assets and liabilities that are measured at fair value on a recurring basis (in thousands):

 

 

 

	(1)	Included in available-for-sale investments on the balance sheet.   The cost basis in the Company's investment in CCXI at March 31, 2019 and June 30, 2018 was $18.8 million.
	(2)	Included in available-for-sale investments on the balance sheet.  The certificate of deposits have contractual maturity dates within one year.

 

 

Fair value measurements of available for sale securities

Our available for sale securities are measured at fair value using quoted market prices in active markets for identical assets and are therefore classified as Level 1 assets.

 

Fair value measurements of derivative instruments

In October 2018, the Company entered into forward starting swaps designated as cash flow hedges on outstanding debt. The forward starting swaps reduce the variability of cash flow payments for the Company by converting the variable interest rate on the Company’s long-term debt described in Note 6 to that of a fixed interest rate. Accordingly, as part of the forward starting swaps, the Company will exchange, at specified intervals, the difference between floating and fixed interest amounts based on $380 million of notional principal amount. The change in the fair value of the instrument is reported as a component of other comprehensive income and reclassified into interest expense over the corresponding term of the cash flow hedge. The Company did not reclassify any amounts out of other comprehensive income into interest expense during the quarter and nine month period ended March 31, 2019. The liability related to the derivative instrument was recorded within Other long-term liabilities on the Consolidated Balance Sheet. The instrument was valued using observable market inputs in active markets and therefore classified as a Level 2 liability.

 

Fair value measurements of contingent consideration

In connection with the ExosomeDx and Quad acquisitions the Company is required to make contingent consideration payments of up to $325.0 million and $51.0 million, respectively. The contingent consideration payments are subject to ExosomeDx achieving certain EBITA thresholds and Quad meeting certain product development milestones and revenue thresholds. The preliminary fair value of the liabilities for the contingent payments recognized upon the acquisition as part of the purchase accounting opening balance sheet totaled $6.7 million ($1.8 million for ExosomeDx and $4.9 million for Quad) as discussed in Note 4.  The preliminary fair value of the development milestone payments was estimated by discounting to present value the probability-weighted contingent payments expected to be made. Assumptions used in these calculations were probability of success, duration of the earn-out, and discount rate.   The preliminary fair value for the EBITA and revenue milestone payments was determined using a Monte Carlo simulation-based model discounted to present value.  Assumptions used in these calculations are units sold, expected revenue, expected expenses, discount rate and various probability factors. The ultimate settlement of contingent consideration could deviate from current estimates based on the actual results of these financial measures. This liability is considered to be a Level 3 financial liability that is re-measured each reporting period. The change in fair value of contingent consideration for these acquisitions is included in general and administrative expense.

 

The following table presents a reconciliation of the liability measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended March 31, 2019 (in thousands):

 

 

The use of different assumptions, applying different judgment to matters that inherently are subjective and changes in future market conditions could result in different estimates of fair value of our securities or contingent consideration, currently and in the future. If market conditions deteriorate, we may incur impairment charges for securities in our investment portfolio. 

 

Fair value measurements of other financial instruments – The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate fair value.

 

Cash and cash equivalents, certificates of deposit, accounts receivable, and accounts payable – The carrying amounts reported in the Condensed Consolidated Balance Sheet approximate fair value because of the short-term nature of these items.

 

Long-term debt – The carrying amounts reported in the Condensed Consolidated Balance Sheet for the amount drawn on our line-of-credit facility and borrowed under our term loan approximate fair value because our interest rate is variable and reflects current market rates.

 

 

Note 6. Debt and Other Financing Arrangements:

 

On August 1, 2018, the Company entered into a new revolving line-of-credit and term loan governed by a Credit Agreement (the Credit Agreement). The Credit Agreement provides for a revolving credit facility of $600.0 million, which can be increased by an additional $200.0 million subject to certain conditions, and a term loan of $250.0 million. Borrowings under the Credit Agreement may be used for working capital and expenditures of the Company and its subsidiaries, including financing permitted acquisitions. Borrowings under the Credit Agreement bear interest at a variable rate. The current outstanding debt is based on the Eurodollar Loans term for which the interest rate is calculated as the sum of LIBOR plus an applicable margin. The applicable margin is determined from the total leverage ratio of the Company and updated on a quarterly basis. The annualized fee for any unused portion of the credit facility is currently 20 basis points.

 

The Credit Agreement matures on August 1, 2023 and contains customary restrictive and financial covenants and customary events of default. At the closing on August 1, 2018, the Company borrowed $250.0 million under the term loan and $330.0 million under the revolving credit facility. As of March 31, 2019, the outstanding balance under the Credit Agreement was $522.6 million.

 

 

 

Note 7. Supplemental Equity and Accumulated Other Comprehensive Income (loss):

 

Consolidated Changes in Equity (amounts in thousands)

  

 

 

 

 

Accumulated Other Comprehensive Income

 

The components of other comprehensive income (loss) consist of changes in net unrealized gains (losses) on available for sale investments with readily determinable fair values in fiscal 2018, changes in foreign currency translation adjustments, and changes in net unrealized gains (losses) on derivative instruments designated as cash flow hedges entered into in fiscal 2019. There were no reclassifications of gains (losses) from accumulated other comprehensive income (loss) to earnings during the nine months ended March 31, 2019 and 2018.

 

The accumulated balances related to each component of other comprehensive income (loss), net of tax, are summarized as follows (in thousands):

 

 

⁽¹⁾See Note 1 for further information related to the adoption of ASU 2016-01 and 2018-02.

⁽²⁾ The gain (loss) on the forward starting interest rate swap will be reclassified into earnings beginning October 31, 2019. Approximately ($919) of the ($5,769) will be reclassified into earnings in the 12 months subsequent to March 31, 2019.

 

 

 

 

 

Note 8. Earnings Per Share:

 

The following table reflects the calculation of basic and diluted earnings per share (in thousands, except per share amounts):

 

 

The dilutive effect of stock options and restricted stock units in the above table excludes all options for which the aggregate exercise proceeds exceeded the average market price for the period. The number of potentially dilutive option shares excluded from the calculation was 1.3 million and 1.1 million for the quarter ended March 31, 2019 and 2018, respectively and 1.3 million and 1.6 million for the nine months ended March 31, 2019 and 2018, respectively.

 

 

Note 9. Share-based Compensation:

 

During the nine months ended March 31, 2019 and 2018, the Company granted 0.9 million and 1.1 million stock options at weighted average grant prices of $173.89 and $120.34 and weighted average fair values of $34.66 and $21.98, respectively. During the nine months ended March 31, 2019 and 2018, the Company granted 56,403 and 65,924 restricted stock units at a weighted average fair value of $170.96 and $128.30, respectively. During the nine months ended March 31, 2019 and 2018, the Company granted 14,877 and 20,106 shares of restricted common stock shares at a grant date fair value of $177.93 and $125.05, respectively.

 

Stock options for 263,995 and 139,602 shares of common stock with total intrinsic values of $22.3 million and $6.3 million were exercised during the nine months ended March 31, 2019 and 2018, respectively.

 

Stock-based compensation expense of $5.7 million and $4.7 million was included in selling, general and administrative expenses for the quarter ended March 31, 2019 and 2018, respectively. Stock-based compensation expense of $24.2 million and $13.6 million was included in selling, general, and administrative expenses for the nine months ended March 31, 2019 and 2018, respectively. As of March 31, 2019, there was $32.1 million of unrecognized compensation cost related to non-vested stock options, non-vested restricted stock units and non-vested restricted stock. The weighted average period over which the compensation cost is expected to be recognized is 2.1 years.

  

 

 

 

Note 10. Other Income / (Expense):

 

The components of other income (expense) in the accompanying Statement of Earnings and Comprehensive Income are as follows: 

 

 

 

Note 11. Income Taxes:

 

The Company’s effective income tax rate for the third quarter of fiscal 2019 and 2018 was 10.5% and 21.0% of consolidated earnings before income taxes, and 10.8% and (21.2)% for the first nine months of fiscal 2019 and 2018, respectively. The change in the Company’s tax rate for the third quarter and first nine months of fiscal 2019 compared to third quarter and first nine months of fiscal 2018 was driven by discrete tax items.

 

The Company recognized total net benefits related to discrete tax items of $6.2 million during the third quarter and $11.4 million during the first nine months of fiscal 2019.  U.S. tax reform (as described further below) resulted in $2.9 million and 3.5 million tax benefit for the third quarter and first nine months of fiscal 2019, respectively.  Share-based compensation excess tax benefit contributed $1.1 million and $4.8 million in the third quarter and first nine months of 2019, respectively. Additionally, the Company recognized a discrete benefit of $2.2 million for the quarter and nine month period ended March 31, 2019 for tax refunds relating to certain state apportionments.  

 

The Company recognized total net benefits related to discrete tax items of $0.7 million during the third quarter and $36.7 million during the first nine months of fiscal 2018.  U.S. tax reform (as described further below) resulted in a $31.7 million tax benefit for the first nine months of fiscal 2018.  This tax benefit was partially offset by a net discrete tax expense $3.2 million for the first nine months of fiscal 2018 related to the revaluation of contingent consideration, which is not tax deductible. There was no impact on the quarter ended March 31, 2018 related to U.S. tax reform or the revaluation of contingent consideration. 

 

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was enacted, which reduced the U.S. federal corporate tax rate from 35% to 21%, required companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and created new taxes on certain foreign sourced earnings. The Tax Act added many new provisions including changes the deduction for executive compensation, a tax on global intangible low taxed income (“GILTI”), the base erosion anti abuse tax (“BEAT”) and a deduction for foreign derived intangible income (“FDII”). The SEC staff issued Staff Accounting Bulletin (“SAB 118”) later codified as ASU 2018-05 Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (SAB) No. 118, which provides a measurement period of up to one year from the Tax Act’s enactment date to complete the accounting for the effects of the Tax Act.

 

During the quarter, the Company recorded a net discrete benefit of $2.9 million related to the mandatory deemed repatriation tax calculation which is inclusive of a benefit for a dividends received deduction for certain foreign tax credits upon completion of the tax return.  The additional dividends received deduction is based on our assessment of the treatment under the applicable provisions of the Tax Act as currently written and enacted. If, in the future, Congress or the Department of the Treasury provides legislative or regulatory updates, this could change our assessment of the benefit associated with the dividends received deduction, and we may be required to recognize additional tax expense up to the full amount of $5.5 million in the period such updates are issued.

 

The end of the measurement period allowed under ASU 2018-05 was December 31, 2018. However, the Company anticipates additional interpretations and clarifications to be issued by the U.S. Treasury Department, which may affect future period tax estimates. The Company made the accounting policy election to treat taxes due on U.S. inclusions in taxable income related to GILTI as a current period expense when incurred. 

 

 

 

 

Note 12. Segment Information:

 

The Company's management evaluates segment operating performance based on operating income before certain charges to cost of sales and selling, general and administrative expenses, principally associated with acquisition accounting related to inventory, stock based compensation, amortization of acquisition-related intangible assets and other acquisition-related expenses.  The Protein Sciences and Diagnostics and Genomics reportable segments both include consumables, instruments, services and royalty revenue.

 

The following is financial information relating to the Company's reportable segments (in thousands):