MESA LABORATORIES INC /CO/ - Quarter Report: 2013 September (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.20549

 

 

FORM 10-Q

 

(Mark one)

 

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

 

For the quarterly period ended September 30, 2013

 

o         TRANSITION REPORT PURSUANT TOSECTION 13 OR 15 (d) OF THE SECURITES EXCHANGE ACT OF 1934

 

For the transition period from        to       

 

Commission File No: 0-11740

 

 

MESA LABORATORIES, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (303) 987-8000

 

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

 

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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x  No  o

 

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

 

 

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

 

Indicate the number of shares outstanding of each of the Issuer’s classes of common stock, as of the latest practicable date:

 

There were 3,426,203 shares of the Issuer’s common stock, no par value, outstanding as of October 29, 2013.

 

 

Table of Contents

 

Table of Contents

 

Part I
1.	Financial Statements		1
		Condensed Balance Sheets	1
		Condensed Statements of Income	2
		Condensed Statements of Cash Flows	3
		Notes to Condensed Financial Statements	4
2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
3.	Quantitative and Qualitative Disclosures About Market Risk		16
4.	Controls and Procedures		17
Part II
1A.	Risk Factors		17
2.	Unregistered Sales of Equity Securities and Use of Proceeds		18
6.	Exhibits		19
	Signatures
	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)
	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)
	Certification of Chief Executive Officer Pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350
	Certification of Chief Financial Officer Pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350

 

Table of Contents

 

Part I. Financial Information

 

Item 1. Financial Statements

 

Mesa Laboratories, Inc.

Condensed Balance Sheets

(In thousands, except share amounts)

 

		September 30, 2013 (Unaudited)			March 31, 2013
ASSETS
Current assets:
Cash and cash equivalents		$	3,424		$	4,006
Accounts receivable, net		7,091			8,474
Inventories, net		6,089			5,576
Prepaid expenses and other		1,997			1,399
Total current assets		18,601			19,455
Property, plant and equipment, net		7,772			7,406
Intangibles, net		15,195			15,418
Goodwill		24,219			23,640
Total assets		$	65,787		$	65,919
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	1,344		$	1,010
Accrued salaries and payroll taxes		1,441			2,085
Other accrued expenses		1,604			422
Income taxes payable		298			1,145
Total current liabilities		4,687			4,662
Deferred income taxes		2,364			2,364
Long-term debt		—			4,000
Contingent consideration		2,164			2,140
Total liabilities		9,215			13,166
Commitments and Contingencies (Note 7)
Stockholders’ equity:
Preferred stock, no par value		—			—
Common stock, no par value; authorized 25,000,000 shares; issued and outstanding, 3,425,031 and 3,388,548 shares, respectively		11,610			10,723
Employee loans to purchase stock		(57		)	(149		)
Retained earnings		45,019			42,179
Total stockholders’ equity		56,572			52,753
Total liabilities and stockholders’ equity		$	65,787		$	65,919

 

See accompanying notes to condensed financial statements.

 

1

Table of Contents

 

Mesa Laboratories, Inc.

Condensed Statements of Income

(Unaudited)

(In thousands except per share data)

 

		Three months ended September 30,						Six months ended September 30,
		2013			2012			2013			2012
Revenues		$	12,676		$	11,706		$	23,894		$	22,266
Cost of revenues		5,076			4,458			9,497			8,562
Gross profit		7,600			7,248			14,397			13,704
Operating expenses
Selling		1,419			1,072			2,502			2,074
General and administrative		3,136			2,169			5,222			4,023
Research and development		530			519			1,115			899
Total operating expenses		5,085			3,760			8,839			6,996
Operating income		2,515			3,488			5,558			6,708
Other Income (expense), net		423			(36		)	395			(70		)
Earnings before income taxes		2,938			3,452			5,953			6,638
Income taxes		1,006			1,204			2,161			2,290
Net income		$	1,932		$	2,248		$	3,792		$	4,348
Net income per share:
Basic		$	0.57		$	0.67		$	1.11		$	1.30
Diluted		0.54			0.64			1.06			1.23
Weighted average common shares outstanding:
Basic		3,412			3,349			3,403			3,343
Diluted		3,592			3,538			3,568			3,531

 

See accompanying notes to condensed financial statements.

 

2

Table of Contents

 

Mesa Laboratories, Inc.

Condensed Statements of Cash Flows

(Unaudited)

(In thousands)

 

		Six months ended September 30,
		2013			2012
Cash flows from operating activities:
Net income		$	3,792		$	4,348
Depreciation and amortization		1,639			1,675
Gain on dispositions		(468		)	—
Deferred income taxes		—			—
Stock-based compensation		357			438
Change in assets and liabilities, net of effects of acquisitions and dispositions
Accounts receivable, net		1,383			(452		)
Inventories, net		(475		)	(282		)
Prepaid expenses and other		(598		)	134
Accounts payable		334			103
Accrued liabilities and taxes payable		(385		)	(1,038		)
Net cash flows provided by operating activities		5,579			4,926
Cash flows from investing activities:
Acquisitions		(1,721		)	(16,660		)
Proceeds from dispositions		661			—
Purchases of property, plant and equipment		(771		)	(370		)
Net cash used in investing activities		(1,831		)	(17,030		)
Cash flows from financing activities:
Proceeds from the issuance of debt		—			11,000
Payments on debt		(4,000		)	(3,000		)
Dividends		(952		)	(871		)
Purchase and retirement of common stock		(15		)	(57		)
Proceeds from the exercise of stock options		637			613
Net cash (used in) provided by financing activities		(4,330		)	7,685
Net decrease in cash and cash equivalents		(582		)	(4,419		)
Cash and cash equivalents at beginning of period		4,006			7,191
Cash and cash equivalents at end of period		$	3,424		$	2,772
Cash paid for:
Income taxes		$	3,190		$	2,814
Interest		—			75
Supplemental non-cash activity:
Employee loans issued for the exercise of stock options		$	—		$	166
Repayment of employee loans for stock options		92			347
Contingent consideration as part of an acquisition		—			2,140

 

See accompanying notes to condensed financial statements.

 

3

Table of Contents

 

Mesa Laboratories, Inc.

 

Notes to Condensed Financial Statements

 

Note 1 -Description of Business and Summary of Significant Accounting Policies

 

Description of Business

 

Mesa Laboratories, Inc. (we, us, our, the “Company” or “Mesa”) was incorporated under the laws of the State of Colorado on March 26, 1982.  We pursue a strategy of focusing primarily on quality control products, which are sold into niche markets that are driven by regulatory requirements.  We prefer markets that have limited competition where we can establish a commanding presence and achieve high gross margins.  We are organized into two divisions across four physical locations.  Our Instruments Division designs, manufactures and markets quality control instruments and disposable products utilized in connection with the healthcare, pharmaceutical, food and beverage, medical device, industrial hygiene, semiconductor and petrochemical industries. Our Biological Indicators Division manufactures and markets biological indicators and distributes chemical indicators used to assess the effectiveness of sterilization processes, including steam, gas, hydrogen peroxide and radiation, in the hospital, dental, medical device and pharmaceutical industries.

 

Basis of Presentation

 

The accompanying condensed balance sheet as of March 31, 2013, has been derived from audited financial statements. The accompanying unaudited interim condensed financial statements have been prepared on the same basis as our annual audited financial statements and in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial statements. In the opinion of management, such unaudited information includes all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of this interim information. Operating results and cash flows for interim periods are not necessarily indicative of results that can be expected for the entire year. The information included in this report should be read in conjunction with our audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended March 31, 2013.

 

The summary of our significant accounting policies is incorporated by reference to our Annual Report on Form 10-K for the year ended March 31, 2013.

 

Recently Issued Accounting Pronouncements

 

In October 2012, the FASB issued ASU 2012-04, Technical Corrections and Improvements.  This standard includes: 1) source literature amendments to conform the language between current accounting literature and legacy source literature; 2) clarification of guidance and reference corrections; and 3) relocation of guidance to a more appropriate location.  The adoption of this standard did not have an impact on our financial statements or disclosures.

 

Note 2 — Acquisitions and Dispositions

 

Acquisitions

 

On July 1, 2013, we completed a business combination (the “Suretorque Acquisition”) whereby we acquired essentially all of the assets of ST Acquisitions, LLC’s (“ST Acquisitions”) business involving the design, manufacturing, sale and service of its SureTorque line of bottle cap torque testing instrumentation.  The asset acquisition agreement (the “Suretorque Agreement”) includes a provision for a holdback payment, payable to the seller one year from the effective date less any losses incurred by the buyer, as defined.

 

We expect to achieve savings and income growth as we integrate the Suretorque operations and marketing functions.  These factors, among others, contributed to a purchase price in excess of the estimated fair value of the net identifiable acquired assets and, as a result, we recorded goodwill in connection with this transaction.  The goodwill is expected to be deductible for tax purposes.  All of the goodwill was assigned to our Instruments segment.

 

The Suretorque Acquisition constituted the acquisition of a business and was recognized at fair value.  We determined the estimated fair values using discounted cash flow analyses and estimates made by management.  The following reflects our allocation of the consideration in accordance with the Suretorque Agreement (in thousands):

 

Cash consideration		$	1,721
Holdback payment liability		100
Aggregate consideration		$	1,821

 

4

Table of Contents

 

The purchase price was allocated as follows:
Inventories, net		$	230
Property, plant and equipment		7
Intangible assets		1,005
Goodwill		579
Total purchase price allocation		$	1,821

 

Our condensed statements of income includes the results of the Suretorque Acquisition from the acquisition date of July 1, 2013.  The pro forma effects of the acquisition on the results of operations as if the acquisition had been completed on April 1, 2013 and 2012 are as follows:

 

		Three months ended September 30,						Six months ended  September 30,
		2013			2012			2013			2012
Total net revenues		$	12,676		$	11,993		$	24,311		$	22,840
Net income		1,932			2,370			3,969			4,591
Net Income per common share:
Basic		$	0.57		$	0.71		$	1.17		$	1.37
Diluted		0.54			0.67			1.11			1.30

 

On May 15, 2012, we completed a business combination (the “Bios Acquisition”) by acquiring specific assets and assuming certain liabilities of Bios International Corporation (“Bios”), a New Jersey corporation.  The asset acquisition agreement (the “Bios Agreement”) includes a provision for contingent consideration based on revenue growth over a three year earn-out period.  The Bios Acquisition further diversified and grew our Instruments segment.

 

The contingent consideration arrangement requires us to pay Bios if cumulative revenues related to the acquisition for the three years subsequent to the acquisition exceed $22,127,000.  The potential undiscounted future payment that we could be required to make ranges from $0 to $6,710,000.  The fair value of the contingent consideration arrangement included in the purchase price below was estimated based on the historic revenue growth rates of Bios.  Over the remaining term of the agreement, we are accreting through interest expense the difference between the estimated fair value of the contingent consideration, $2,140,000, and the amount we estimate we will pay, $2,240,000.

 

The Bios Acquisition constituted the acquisition of a business and was recognized at fair value.  We determined the estimated fair values using discounted cash flow analyses and estimates made by management.  The financial statements for the three months ended June 30, 2012, reflected our preliminary purchase price allocation, which was finalized in the second quarter of the year ended March 31, 2013.  The following reflects our allocation of the consideration in accordance with the Bios Agreement (in thousands):

 

Cash consideration		$	16,660
Contingent purchase price liability		2,140
Aggregate consideration		$	18,800
The purchase price was allocated as follows:
Accounts receivable, net		$	478
Inventories, net		910
Other current assets		28
Property, plant and equipment		63
Intangible assets		8,200
Goodwill		9,190
Current liabilities		(69		)
Total purchase price allocation		$	18,800

 

Dispositions

 

On August 12, 2013, we entered into an agreement whereby we sold our NuSonics product line (the “Nusonics Disposal”) for $661,000. The carrying value of this product line was $193,000 which resulted in a pre-tax gain of $468,000.

 

5

Table of Contents

 

Note 3 - Inventories

 

Inventories consist of the following (in thousands):

 

		September 30, 2013			March 31, 2013
Raw materials		$	4,298		$	4,052
Work-in-process		349			271
Finished goods		1,813			1,514
Less: reserve		(371		)	(261		)
		$	6,089		$	5,576

 

Note 4 - Long-term Debt

 

Long-term debt consists of the following (in thousands):

 

		September 30, 2013		March 31, 2013
Line of credit (1.5% at September 30, 2013)		—		$	4,000
Less: current portion		—		—
Long-term portion		—		$	4,000

 

In February 2012, we entered into a three year agreement (the “Credit Facility”) for a $20,000,000 revolving line of credit (“Line of Credit”) and up to $1,000,000 of letters of credit, maturing in February 2015.  Funds from the Credit Facility may be used for general working capital and corporate needs, retiring existing debt, or to support acquisitions and capital expenditures.

 

Under the Credit Facility, indebtedness bears interest at either: (1) LIBOR, as defined, plus an applicable margin ranging from 1.25% to 2.00%; or (2) the bank’s commercial bank floating rate (“CBFR”), which is the greater of the bank’s prime rate or one month LIBOR + 2.50%, adjusted down, from 1.25% to 0.50%.  We elect the interest rate with each borrowing under the line of credit.  In addition, there is an unused capacity fee of 0.15% to 0.30%.  The adjustments and unused capacity fee depend on the ratio of funded debt to our trailing four quarters of EBITDA, as defined, with four tiers ranging from a ratio of less than one to greater than two.  Letter of credit fees are based on the applicable LIBOR rate.

 

The Credit Facility is secured by all of our assets and requires us to maintain a ratio of funded debt to our trailing four quarters of EBIDTA, as defined, of 2.5 to 1.0, and a minimum fixed charge coverage ratio of 1.5 to 1.0.  We were in compliance with these covenants at September 30, 2013.

 

In order to facilitate the Bios Acquisition, in May 2012 we borrowed $11,000,000 under the terms of the Line of Credit.  During the three months ended September 30, 2013 we made principal repayments of $1,500,000. As a result, there are no amounts outstanding as of September 30, 2013.

 

Note 5 - Stock-based Compensation

 

Amounts recognized in the condensed financial statements related to stock-based compensation are as follows (in thousands, except per share data):

 

		Three months ended September 30,						Six months ended September 30,
		2013			2012			2013			2012
Total cost of stock-based compensation charged against income before income taxes		$	208		$	289		$	357		$	438
Amount of income tax benefit recognized in earnings		71			101			130			151
Amount charged against net income		$	137		$	188		227			287
Impact on net income per common share:
Basic		$	0.04		$	0.06		$	0.07		$	0.09
Diluted		0.04			0.05			0.06			0.08

 

Stock-based compensation expense is included in cost of revenues, selling, and general and administrative expense in the accompanying condensed statements of income.

 

6

Table of Contents

 

The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model (“Black-Scholes”). We use historical data to estimate the expected price volatility, the expected stock option life and expected forfeiture rate. The risk-free interest rate is based on the United States Treasury yield curve in effect at the time of grant for the estimated life of the stock option. The dividend yield is calculated based upon the dividend payments made during the prior four quarters as a percent of the average stock price for that period.

 

The following is a summary of stock option activity for the six months ended September 30, 2013:

 

		Number of Shares		Weighted- average Exercise Price per Share			Weighted- average Remaining Contractual Term		Aggregate Intrinsic Value (000s)
Outstanding at March 31, 2013		416,125		$	29.87		3.7		$	9,529
Stock options granted		103,124		52.09			6.0
Stock options forfeited		(12,670	)	45.19
Stock options expired		—		—
Stock options exercised		(42,155	)	19.98
Outstanding at September 30, 2013		464,424		35.29			4.3		15,009
Exercisable at September 30, 2013		210,730		25.16			3.3		8,946

 

The total intrinsic value of stock options exercised was $1,710,000 and $1,300,000 for the six months ended September 30, 2013 and 2012, respectively.

 

A summary of the status of our unvested stock option shares as of September 30, 2013 is as follows:

 

		Number of Shares		Weighted- average Grant-Date Fair Value
Unvested at March 31, 2013		257,805		$	9.55
Stock options granted		103,124		12.27
Stock options forfeited		(12,260	)	10.84
Stock options vested		(94,975	)	8.45
Unvested at September 30, 2013		253,694		11.11

 

As of September 30, 2013, there was $1,908,000 of total unrecognized compensation expense related to unvested stock options.  As of September 30, 2013, we have 220,366 shares available for future stock option grants.

 

Note 6 - Net Income Per Share

 

Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during the reporting period.  Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised.

 

7

Table of Contents

 

The following table presents a reconciliation of the denominators used in the computation of net income per share - basic and diluted (in thousands, except per share data):

 

		Three months ended September 30,						Six months ended September 30,
		2013			2012			2013			2012
Net income available for stockholders		$	1,932		$	2,248		$	3,792		$	4,348
Weighted average outstanding shares of common stock		3,412			3,349			3,403			3,343
Dilutive effect of stock options		180			189			165			188
Common stock and equivalents		3,592			3,538			3,568			3,531
Net income per share:
Basic		$	0.57		$	0.67		$	1.11		1.30
Diluted		0.54			0.64			1.06			1.23

 

For both the three and six months ended September 30, 2013 and 2012, zero and 84,000 outstanding stock options, respectively, were excluded from the calculation of diluted net income per share because the exercise prices of the stock options were greater than or equal to the average price of the common shares and, therefore, their inclusion would have been anti-dilutive.

 

Note 7- Commitments and Contingencies

 

As part of the Bios Acquisition, the Bios Agreement includes a provision for contingent consideration based on revenue growth over a three year earn-out period.  The contingent consideration arrangement requires us to pay Bios if the cumulative revenues from the acquisition for the three years subsequent to the acquisition exceed $22,127,000.  The potential undiscounted future payment that we could be required to make ranges from $0 to $6,710,000.  The fair value of the contingent consideration arrangement included in the purchase price was estimated based on the historic revenue growth of Bios.  We recorded a contingent consideration liability of $2,140,000 on the accompanying condensed balance sheets.  Any changes to the contingent consideration ultimately paid would result in additional income or expense on the condensed statements of income.  There has been no material change to the contingent consideration liability as of September 30, 2013.  The contingent consideration is payable in the first quarter of our year ending March 31, 2016.

 

A company is required to collect and remit state sales tax from certain of its customers if that company is determined to have “nexus” in a particular state.  The determination of nexus varies state by state and often requires knowledge of each jurisdiction’s tax case law.  During the year ended March 31, 2013, we determined that there are states in which we most likely had established nexus during prior periods without properly collecting and remitting sales tax.  We recorded an estimate of $100,000 associated with one specific state but we were unable to estimate our remaining exposure at that time.  The ultimate amount due in remaining states will depend upon a number of factors, including the amount of sales that were made to customers who are either exempt or have already paid the tax, the number of years of exposure, and any penalties or interest that might be due.  During the three months ended September 30, 2013 we completed our analysis associated with the remaining states and we recorded an estimate of $1,106,000, which is included in other accrued expenses on the accompanying condensed balance sheets and in general and administrative expense on the accompanying condensed statements of income for the three and six months ended September 30, 2013.  This estimate was based upon facts and circumstances known at such time and our ultimate liability may change as further analysis is completed and state sales tax returns are filed.

 

8

Table of Contents

 

Note 8 - Segment Information

 

We have two reporting segments:  Biological Indicators and Instruments.  The following tables set forth our segment information (in thousands):

 

		Three months ended September 30, 2013									Three months ended September 30, 2012
		Biological Indicators			Instruments			Total			Biological Indicators			Instruments			Total
Revenues		$	6,010		$	6,666		$	12,676		$	5,320		$	6,386		$	11,706
Gross profit		$	3,482		$	4,118		$	7,600		$	3,063		$	4,185		$	7,248
Selling expenses		556			863			1,419			414			658			1,072
		$	2,926		$	3,255		6,181			$	2,649		$	3,527		6,176
Reconciling items (1)								(3,243		)							(2,724		)
Earnings before income taxes								$	2,938								$	3,452

 

		Six months ended September 30, 2013									Six months ended September 30, 2012
		Biological Indicators			Instruments			Total			Biological Indicators			Instruments			Total
Revenues		$	10,864		$	13,030		$	23,894		$	10,438		$	11,828		$	22,266
Gross profit		$	6,043		$	8,354		$	14,397		$	5,956		$	7,748		$	13,704
Selling expenses		946			1,556			2,502			780			1,294			2,074
		$	5,097		$	6,798		11,895			$	5,176		$	6,454		11,630
Reconciling items (1)								(5,942		)							(4,992		)
Earnings before income taxes								$	5,953								$	6,638

 

(1) Reconciling items include general and administrative, research and development, and other expenses.

 

		September 30, 2013			March 31, 2013
Total assets
Biological Indicators		$	24,479		$	27,558
Instruments		35,887			31,782
Corporate and administrative		5,421			6,579
		$	65,787		$	65,919

 

All long-lived assets are located in the United States.

 

Revenues from external customers are attributed to individual countries based upon locations to which the product is shipped or exported, as follows (in thousands):

 

		Three months ended September 30,						Six months ended September 30,
		2013			2012			2013			2012
Net revenues from unaffiliated customers:
United States		$	7,794		$	7,121		$	13,824		$	13,491
Foreign		4,882			4,585			10,070			8,775
		$	12,676		$	11,706		$	23,894		$	22,266

 

No foreign country exceeds 10% of total revenues.

 

9

Table of Contents

 

Note 9 - Subsequent Event

 

In October 2013, our Board of Directors declared a quarterly cash dividend of $0.15 per share of common stock, payable on December 16, 2013, to stockholders of record at the close of business on November 29, 2013.

 

10

Table of Contents

 

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

 

Forward Looking Statements

 

This report contains information that may constitute “forward-looking statements.”  Generally, the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “will” and similar expressions identify forward-looking statements, which generally are not historical in nature.  However, the absence of these words or similar expressions does not mean that a statement is not forward-looking.  All statements that address operating performance, events or developments that we expect or anticipate will occur in the future — including statements relating to revenue growth and statements expressing general views about future operating results — are forward-looking statements.  Management believes that these forward-looking statements are reasonable as and when made.  However, caution should be taken not to place undue reliance on any such forward-looking statements because such statements speak only as of the date when made.  We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.  In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections.  These risks and uncertainties include, but are not limited to those described in Part II, “Item 1A. Risk Factors” and elsewhere in this report and in our Annual Report on Form 10-K for the year ended March 31, 2013, and those described from time to time in our subsequent reports filed with the Securities and Exchange Commission.

 

General Discussion

 

We pursue a strategy of focusing primarily on quality control products, which are sold into niche markets that are driven by regulatory requirements.  We prefer markets that have limited competition where we can establish a commanding presence and achieve high gross margins.  We are organized into two divisions across four physical locations.  Our Instruments Division designs, manufactures and markets quality control instruments and disposable products utilized in connection with the healthcare, pharmaceutical, food and beverage, medical device, industrial hygiene, semiconductor and petrochemical industries.  Our Biological Indicators Division manufactures and markets biological indicators and distributes chemical indicators used to assess the effectiveness of sterilization processes, including steam, gas, hydrogen peroxide and radiation, in the hospital, dental, medical device and pharmaceutical industries.  We follow a philosophy of manufacturing a high quality product and providing a high level of on-going service for those products.

 

Our revenues come from two main sources — products sales, and parts and services.  Product sales are dependent on several factors, including general economic conditions, both domestic and international, customer capital spending trends, competition, introduction of new products, and acquisitions.  Biological indicator products are disposable and are used on a routine basis for quality control, thus product sales are less sensitive to general economic conditions.  Instrument products have a longer life, and their purchase by our customers is somewhat discretionary, so sales are more sensitive to general economic conditions.  Parts and service demand is driven by our customers’ quality control and regulatory environments, which require periodic repair and recalibration or certification of our instrument products.  We typically evaluate costs and pricing annually.  Our policy is to price our products competitively and, where possible, we try to pass along cost increases in order to maintain our margins.

 

Gross profit is affected by our product mix, manufacturing efficiencies and price competition.  Historically, as we have integrated our acquisitions and taken advantage of manufacturing efficiencies, our gross margins for some of the products have improved.  There are, however, differences in gross margins between different product lines, and ultimately the mix of sales may continue to impact our overall gross margin.

 

Selling expense is driven primarily by labor costs, including salaries and commissions.  Accordingly, it may vary with sales levels.  Labor costs and amortization of intangible assets drive 70-80% of general and administrative expense.  Research and development expense is predominantly comprised of labor costs and third party consultants.

 

In May 2012, we completed the Bios Acquisition by acquiring specific assets and assuming certain liabilities of Bios, a New Jersey corporation, for $16,660,000 and potential contingent consideration based on revenue growth over a three year earn-out period.

 

In July 2013, we completed a business combination by entering into an asset purchase agreement with ST Acquisitions pursuant to which we acquired essentially all of the assets of ST Acquisitions’ business involving the design, manufacturing, sale and service of its SureTorque line of bottle cap torque testing instrumentation.  The purchase price for the acquired assets was $1,821,000, consisting of a cash payment of $1,721,000 at closing and a $100,000 holdback amount that is expected to be settled on July 1, 2014.

 

In August 2013, we entered into an agreement whereby we sold our NuSonics product line for $661,000, which resulted in a pre-tax gain of $468,000.

 

11

Table of Contents

 

General Trends and Outlook

 

Our strategic objectives include growth both organically and through further acquisitions.  During the year ended March 31, 2013, we continued to build our infrastructure to prepare for future growth, including the addition of key personnel to our operations, research and development, and finance teams.  As needed, we intend to continue to strengthen our infrastructure during the year ending March 31, 2014, including our information systems.  We expect Sarbanes-Oxley (“SOX”) compliance costs to remain relatively flat during the year ending March 31, 2014, as we maintain our internal control structure while simultaneously making efficient and effective improvements.

 

The markets for our biological indicators remain strong, as the disposable nature of these products makes them less sensitive to general economic conditions.  The worldwide market for biological indicators is growing, as more countries focus on verifying the effectiveness of sterilization processes.  Recent general economic conditions however have slowed the organic growth of our instruments business, due to the discretionary nature of these products.  Additionally, uncertainty about global economic conditions may cause businesses to postpone spending in response to tighter credit, unemployment, negative financial news and/or declines in income or asset values. Worldwide and regional economic conditions could also reduce the demand for our products and services, as our customers reduce or delay capital equipment and other types of purchases.  Demand for our instruments products, however, is still strong and we strive to maintain or grow revenue going forward.

 

We are working on several research and development projects that, if completed, may result in new products for both existing customers and in new markets.  We are hopeful that both our Biological Indicators and Instruments Divisions will have new products available for sale in the coming year.

 

Results of Operations

 

The following table sets forth, for the periods indicated, condensed statements of income data.  The table and the discussion below should be read in conjunction with the accompanying condensed financial statements and the notes thereto appearing elsewhere in this report (in thousands, except percent data):

 

		Three months ended September 30,									Percent
		2013			2012			Change			Change
Revenues		$	12,676		$	11,706		$	970		8	%
Cost of revenues		5,076			4,458			618			14	%
Gross profit		$	7,600		$	7,248		$	352		5	%
Gross margin		60		%	62		%	(2		)%
Operating expenses
Selling		$	1,419		$	1,072		$	347		32	%
General and administrative		3,136			2,169			967			45	%
Research and development		530			519			11			2	%
		$	5,085		$	3,760		$	1,325		35	%
Net income		$	1,932		$	2,248		$	(316	)	(14	)%
Net profit margin		15		%	19		%	(4		)%

 

		Six months ended September 30,									Percent
		2013			2012			Change			Change
Revenues		$	23,894		$	22,266		$	1,628		7	%
Cost of revenues		9,497			8,562			935			11	%
Gross profit		$	14,397		$	13,704		$	693		5	%
Gross margin		60		%	62		%	(2		)%
Operating expenses
Selling		$	2,502		$	2,074		$	428		21	%
General and administrative		5,222			4,023			1,199			30	%
Research and development		1,115			899			216			24	%
		$	8,839		$	6,996		$	1,843		26	%
Net income		$	3,792		$	4,348		$	(556	)	(13	)%
Net profit margin		16		%	20		%	(4		)%

 

12

Table of Contents

 

Revenues

 

The following table summarizes our revenues by source (in thousands, except percent data):

 

		Three months ended September 30,									Percent
		2013			2012			Change			Change
Biological Indicators		$	6,010		$	5,320		$	690		13	%
Instruments		6,666			6,386			280			4	%
Total		$	12,676		$	11,706		$	970		8	%

 

		Six months ended September 30,									Percent
		2013			2012			Change			Change
Biological Indicators		$	10,864		$	10,438		$	426		4	%
Instruments		13,030			11,828			1,202			10	%
Total		$	23,894		$	22,266		$	1,628		7	%

 

Three and six months ended September 30, 2013 versus September 30, 2012

 

Biological Indicators revenues for the three and six months ended September 30, 2013 increased as compared to the prior year as a result of continued organic growth, achieved through existing customers and expansion into new markets.  In addition, Biological Indicators revenues for the three months ended September 30, 2013 also increased as compared to the prior year due to the fulfillment of backlog from the previous quarter end which resulted from the requirement to replace three product batches that had longer than expected incubation times. Our efforts to quickly manufacture and replace these product batches during the three months ended June 30, 2013 decreased product available to fulfill new orders, which resulted in an increase from our typical backlog at the end of the prior quarter.  We were successful in our efforts to fulfill substantially all of this backlog during the three months ended September 30, 2013.

 

Instruments revenues for the three and six months ended September 30, 2013 increased as compared to the prior year primarily from organic growth in our Bios product line and the acquisition of the SureTorque product line, while other Instruments product lines remained relatively unchanged.  The increase in Instruments revenues for the six months ended September 30, 2013 as compared to the prior year was also impacted by the timing of the Bios Acquisition in the prior year.

 

Gross Profit

 

The following summarizes our gross profit by segment (in thousands, except percent data):

 

		Three months ended September 30,									Percent
		2013			2012			Change			Change
Biological Indicators		$	3,482		$	3,063		$	419		14	%
Gross profit margin		58		%	58		%	0		%
Instruments		4,118			4,185			(67		)	(2	)%
Gross profit margin		62		%	66		%	(4		)%
Total		$	7,600		$	7,248		$	352		5	%
Gross profit margin		60		%	62		%	(2		)%

 

13