MESA LABORATORIES INC /CO/ - Quarter Report: 2014 December (Form 10-Q)

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ASSETS		December 31, 2014 (Unaudited)				March 31, 2014
Current assets:
Cash and cash equivalents		$	1,427			$	5,575
Accounts receivable, net			11,849				9,278
Inventories, net			12,596				7,771
Prepaid expenses and other			1,558				2,064
Deferred income taxes			1,878				1,878
Total current assets			29,308				26,566
Property, plant and equipment, net			9,241				7,680
Intangibles, net			33,532				25,417
Goodwill			44,097				37,866
Total assets		$	116,178			$	97,529
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	2,840			$	2,019
Accrued salaries and payroll taxes			3,968				3,567
Unearned revenues			1,421				1,886
Other accrued expenses			1,450				2,743
Current portion of long-term debt			3,000				--
Total current liabilities			12,679				10,215
Deferred income taxes			4,861				4,861
Long-term debt			25,000				16,500
Contingent consideration			1,920				1,620
Total liabilities			44,460				33,196
Commitments and Contingencies (Note 7)
Stockholders’ equity:
Common stock, no par value; authorized 25,000,000 shares; issued and outstanding, 3,535,349 and 3,490,628 shares, respectively			17,681				15,796
Employee loans to purchase stock			--				(24	)
Retained earnings			54,287				48,561
Accumulated other comprehensive loss			(250	)			--
Total stockholders’ equity			71,718				64,333
Total liabilities and stockholders’ equity		$	116,178			$	97,529

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		Three Months Ended December 31,								Nine Months Ended December 31,
		2014				2013				2014				2013
Revenues		$	17,830			$	13,116			$	52,770			$	37,010
Cost of revenues			6,778				5,410				20,890				14,907
Gross profit			11,052				7,706				31,880				22,103
Operating expenses
Selling			1,772				1,595				5,177				4,097
General and administrative			4,740				2,781				12,581				8,003
Research and development			832				524				2,459				1,639
Total operating expenses			7,344				4,900				20,217				13,739
Operating income			3,708				2,806				11,663				8,364
Other income (expense), net			5				(79	)			(314	)			316
Earnings before income taxes			3,713				2,727				11,349				8,680
Income taxes			1,310				981				4,005				3,142
Net income		$	2,403			$	1,746			$	7,344			$	5,538
Net income per share:
Basic		$	0.68			$	0.51			$	2.09			$	1.62
Diluted			0.66				0.48				2.01				1.54
Weighted average common shares outstanding:
Basic			3,532				3,434				3,513				3,414
Diluted			3,654				3,637				3,649				3,591

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		Three Months Ended December 31,								Nine Months Ended December 31,
		2014				2013				2014				2013
Net Income		$	2,403			$	1,746			$	7,344			$	5,538
Other comprehensive loss, net of tax:
Foreign currency translation			(250	)			--				(250	)			--
Total comprehensive income		$	2,153			$	1,746			$	7,094			$	5,538

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		Nine Months Ended December 31,
		2014				2013
Cash flows from operating activities:
Net income		$	7,344			$	5,538
Depreciation and amortization			4,162				2,682
Stock-based compensation			776				629
Loss (gain) on disposition of assets			16				(420	)
Foreign currency adjustments			(169	)			--
Change in assets and liabilities, net of effects of acquisitions
Accounts receivable, net			(1,994	)			1,202
Inventories, net			(3,340	)			(684	)
Prepaid expenses and other			538				(425	)
Accounts payable			747				105
Accrued liabilities and taxes payable			(1,439	)			714
Unearned revenues			(465	)			133
Net cash provided by operating activities			6,176				9,474
Cash flows from investing activities:
Acquisitions			(19,050	)			(22,758	)
Proceeds from dispositions			--				661
Purchases of property, plant and equipment			(2,212	)			(808	)
Net cash used in investing activities			(21,262	)			(22,905	)
Cash flows from financing activities:
Proceeds from the issuance of debt			23,000				18,000
Payments on debt			(11,500	)			(6,000	)
Dividends			(1,618	)			(1,467	)
Purchase and retirement of common stock			--				(15	)
Proceeds from the exercise of stock options			1,137				1,067
Net cash provided by financing activities			11,019				11,585
Effect of exchange rate changes on cash and cash equivalents			(81	)			--
Net decrease in cash and cash equivalents			(4,148	)			(1,846	)
Cash and cash equivalents at beginning of period			5,575				4,006
Cash and cash equivalents at end of period		$	1,427			$	2,160
Cash paid for:
Income taxes		$	2,789			$	3,248
Interest			354				52
Supplemental non-cash activity:
Repayment of employee loans for stock options		$	24			$	92
Contingent consideration as part of an acquisition			300				500

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

 

Description of Business

 

Mesa Laboratories, Inc. was incorporated under the laws of the State of Colorado on March 26, 1982. The terms “we,” “us,” “our,” the “Company” or “Mesa” are used in this report to refer collectively to the parent company and the subsidiaries through which our various businesses are actually conducted. 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 three divisions across six 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, environmental air sampling and semiconductor 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, ethylene oxide and radiation, in the hospital, dental, medical device and pharmaceutical industries. Our Continuous Monitoring Division designs, develops and markets systems which are used to monitor various environmental parameters such as temperature, humidity and differential pressure to ensure that critical storage and processing conditions are maintained in hospitals, pharmaceutical and medical device manufacturers, blood banks, pharmacies and a number of other laboratory and industrial environments

 

Basis of Presentation

 

The accompanying condensed consolidated balance sheet as of March 31, 2014, has been derived from audited consolidated financial statements. The accompanying unaudited interim condensed consolidated financial statements have been prepared on the same basis as our annual audited consolidated 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 consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended March 31, 2014.

 

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, 2014.

 

Recently Issued Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board (“IASB”) issued a jointly converged standard on the recognition of revenue from contracts with customers. The issued guidance converges the criteria for reporting revenues, as well as requiring disclosures sufficient to describe the nature, amount, timing and uncertainty of revenues and cash flows arising from these contracts. Companies can transition to the standard either retrospectively or as a cumulative effective adjustment as of the date of adoption. The new standard is effective for our fiscal year (and interim periods within that year) ending March 31, 2018. We are evaluating the impact of this standard on our condensed consolidated financial statements and disclosures.

 

Note 2 – Acquisitions and Dispositions

 

Acquisitions

 

For the nine months ended December 31, 2014, our acquisitions of businesses (net of cash acquired) totaled $19,050,000, which consisted primarily of the following material acquisitions:

 

PCD

 

On October 15, 2014, we completed a business combination (the “PCD Acquisition”) with PCD-Process Challenge Devices, LLC (“PCD”) whereby we acquired substantially all the assets (other than cash and accounts receivable) and certain liabilities of PCD’s process challenge device business. The asset acquisition agreement (the “PCD Agreement”) includes provisions for both contingent consideration based upon the cumulative three year revenues of our process challenge device business subsequent to the acquisition and for a holdback payment (subject to a post-closing adjustment), payable at the one year anniversary of the closing date.

 

 

Under the terms of the PCD Agreement, we are required to pay contingent consideration if the cumulative revenues for our process challenge device business for the three years subsequent to the acquisition meet certain levels. The potential consideration payable ranges from $0 to $1,500,000 and is based upon a sliding scale of three-year cumulative revenues between $9,900,000 and $12,600,000. Based upon both historical and projected growth rates, we recorded $300,000 of contingent consideration payable which represents our best estimate of the amount that will ultimately be paid. Any changes to the contingent consideration ultimately paid will result in additional income or expense in our condensed consolidated statements of income. We will continue to monitor the results of our process challenge device business and we will adjust the contingent liability on a go forward basis, based on then current information. The contingent consideration is payable in three annual installments beginning in the third quarter of our year ending March 31, 2016.

 

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

 

The PCD Acquisition constituted the acquisition of a business and was recognized at fair value. Due to the recent nature of the transaction, the purchase price allocation was based upon a preliminary estimated fair value of the assets and liabilities acquired as we are in the process of finalizing our valuation of the assets acquired and liabilities assumed. We determined the preliminary estimated fair values using discounted cash flow analyses and estimates made by management. The following reflects our preliminary allocation of the consideration, subject to customary purchase price adjustments in accordance with the PCD Agreement (in thousands):

 

 

The accompanying condensed consolidated statements of income include the results of the PCD Acquisition from the acquisition date of October 15, 2014. The pro forma effects of the acquisition on the results of operations as if the acquisition had been completed on April 1, 2014 and 2013, are as follows (in thousands, except per share data):

 

 

BGI

 

On April 15, 2014, we completed a business combination (the “BGI Acquisition”) whereby we acquired substantially all of the assets (other than cash and accounts receivable) and certain liabilities of BGI, Incorporated and BGI Instruments, Inc. (collectively “BGI”), a business focused on the sale of equipment primarily used for particulate air sampling. The purchase price for the acquired assets was $10,268,000.

 

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

 

 

The BGI 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, subject to customary purchase price adjustments in accordance with the BGI Agreement (in thousands):

 

 

The accompanying condensed consolidated statements of income include the results of the BGI Acquisition from the acquisition date of April 15, 2014. The pro forma effects of the acquisition on the results of operations as if the acquisition had been completed on April 1, 2014 and 2013, are as follows (in thousands, except per share data):

 

 

Dispositions

 

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

 

Note 3 - Inventories

 

Inventories consist of the following (in thousands):

 

 

Note 4 - Long-Term Debt

 

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

 

 

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 were used for general working capital and corporate needs, retiring existing debt, and supporting acquisitions.

 

In April 2014, the Credit Facility was amended to include a $15,000,000 term loan (the “Term Loan”) and to extend the maturity date of the Credit Facility to June 30, 2017.

 

 

Under the Line of Credit, indebtedness bears interest at either: (1) LIBOR, as defined, plus an applicable margin ranging from 1.25% to 2%; 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 (including amounts outstanding under the Term Loan) 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 Term Loan bears interest at LIBOR, as defined, plus 2% and requires 11 quarterly principal payments (the first due date was July 15, 2014) in the amount of $750,000 with the remaining balance of principal and accrued interest due on April 15, 2017. The proceeds from the Term Loan were used to support acquisition financing and to repay amounts outstanding under the Line of Credit.

 

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 1.35 to 1.0. We were in compliance with these covenants at December 31, 2014.

 

Future contractual maturities of debt are as follows (in thousands):

 

 

In October 2014, we borrowed $5,000,000 under the terms of the Line of Credit in order to fund the PCD Acquisition (see Note 2). During the three months ended December 31, 2014 we made a $750,000 required principal payment on the Term Loan and principal payments of $2,000,000 on the Line of Credit.

 

In January 2015 we made a $750,000 required principal payment on the Term Loan.

 

Note 5 - Stock-Based Compensation

 

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

 

 

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

 

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 nine months ended December 31, 2014:

 

 

The total intrinsic value of stock options exercised was $2,003,000 and $2,889,000 for the nine months ended December 31, 2014 and 2013, respectively.

 

A summary of the status of our unvested stock option shares as of December 31, 2014 is as follows:

  

 

As of December 31, 2014, there was $3,540,000 of total unrecognized compensation expense related to unvested stock options.

 

On August 8, 2014 we adopted The Mesa Laboratories, Inc. 2014 Equity Plan (the “2014 Plan”), which was subsequently approved by our shareholders on October 2, 2014 at our 2014 Annual Meeting of Shareholders. The purpose of the 2014 Plan is to promote the success and enhance the value of the Company by linking the personal interests of our employees, officers and directors to those of our shareholders by providing such persons with an incentive for outstanding performance. A total of 1,100,000 shares of common stock were reserved for issuance under the 2014 Plan and are subject to terms as set by the Compensation Committee of the Board of Directors at the time of grant. As a result of the approval of the 2014 Plan by our shareholders, no further awards will be made under the 2006 Plan and it will remain in effect only as long as awards previously made thereunder remain outstanding. As of December 31, 2014, we have 1,097,680 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.

 

 

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):

 

 

For both the three and nine months ended December 31, 2014, 155,000 and 173,000 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.

 

For both the three and nine months ended December 31, 2013, 27,000 and 60,000 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

 

Under the terms of the Amega Agreement, we are required to pay contingent consideration (the “Amega Earn Out”) if the cumulative revenues for our Continuous Monitoring Division for the three years subsequent to the acquisition meet certain levels. The potential consideration payable ranges from $0 to $10,000,000 and is based upon a sliding scale of three-year cumulative revenues between $31,625,000 and $43,500,000. Based upon both historical and projected growth rates, we recorded $500,000 of contingent consideration payable which represents our best estimate of the amount that will ultimately be paid. Any changes to the contingent consideration ultimately paid will result in additional income or expense in our condensed consolidated statements of income. We will continue to monitor the results of our Continuous Monitoring Division and we will adjust the contingent liability on a go forward basis, based on then current information. The contingent consideration is payable in the third quarter of our year ending March 31, 2017.

 

In November 2014, Amega Scientific Corporation (“Amega”) and its owner Anthony Amato (“Amato”) filed a complaint in the United States District Court for the district of Colorado alleging, among other items, that our termination of Amato as an employee impacted his ability to maximize the potential consideration payable under the Amega Earn Out and to exercise stock options that failed to vest. In addition, Amato has alleged that we improperly withheld certain amounts from the holdback consideration under the Amega Agreement. These amounts (which were recorded as liabilities in our original purchase accounting) remain recorded as other accrued expenses on the accompanying condensed consolidated balance sheets and will remain so until a final ruling by the court is made. In January 2015 we filed a motion to dismiss the complaint with prejudice. Given that the complaint is in the early stages of the process, we are unable to make a reasonable estimate of the potential loss or range of losses, if any, that might arise from this matter. We believe that we acted in a matter consistent with employment law and the provisions of the Amega Agreement and we intend to defend our position vigorously.

 

Under the terms of the Bios Agreement, we are required to pay contingent consideration if the cumulative revenues related to the acquisition for the three years subsequent to the acquisition exceed $22,127,000. The potential future payment that we could be required to make ranges from $0 to $6,710,000. Based upon historical growth rates, we initially recorded $2,140,000 of contingent consideration payable which represented our best estimate of the amount that would ultimately be paid. Based upon actual results and current run rates, during the year ended March 31, 2014, we revised our estimate of the ultimate contingent liability that would be paid, which resulted in reducing the contingent consideration payable to $1,120,000. Any further changes to the contingent consideration ultimately paid would result in additional income or expense in our condensed consolidated statements of income. We will continue to monitor the results associated with the Bios Acquisition and we will adjust the contingent liability on a go forward basis, based on then current information. The contingent consideration is payable in the first quarter of our year ending March 31, 2016.

 

 

Under the terms of the PCD Agreement, we are required to pay contingent consideration if the cumulative revenues for our process challenge device business for the three years subsequent to the acquisition meet certain levels. The potential consideration payable ranges from $0 to $1,500,000 and is based upon a sliding scale of three-year cumulative revenues between $9,900,000 and $12,600,000. Based upon both historical and projected growth rates, we recorded $300,000 of contingent consideration payable which represents our best estimate of the amount that will ultimately be paid. Any changes to the contingent consideration ultimately paid will result in additional income or expense in our condensed consolidated statements of income. We will continue to monitor the results of our process challenge device business and we will adjust the contingent liability on a go forward basis, based on then current information. The contingent consideration is payable in three annual installments beginning in the third 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 year ended March 31, 2014, we completed our analysis associated with the remaining states and we recorded an estimate of $1,408,000, which was included in other accrued expenses on the consolidated balance sheets and in general and administrative expense on the consolidated statements of income for the year ended March 31, 2014. That estimate was based upon facts and circumstances known at such time and our ultimate liability was subject to change as further analysis is completed and state sales tax returns are filed.

 

During the nine months ended December 31, 2014 we successfully completed and filed several state sales tax returns which concluded our obligation for historical sales taxes in those states. In addition we continued to work through the process in the remaining states. As a result of this work, we determined that our exposure had increased above and beyond our original accrual and as a result, we recorded an additional accrual of $460,000 during the three months ended December 31, 2014. We are hopeful that we are far enough in the process that we have accrued for the ultimate amount of liability that will be paid but our work was based upon facts and circumstances known at such time and our ultimately liability is subject to change as further analysis is completed and state sales tax returns are filed.

 

Note 8 – Comprehensive Income

 

Amounts recognized in the condensed consolidated financial statements related to comprehensive income are as follows (in thousands):

 

 

 

 

Accumulated other comprehensive loss balances, net of tax effects, consist of the following (in thousands):

 

 

Note 9 - Segment Information

 

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

 

 

 

 

 

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

 

 

 

All long-lived assets are located in the United States except for $3,269,000 which are associated with our subsidiary which is located in Chassieu, France.

 

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

 

 

No foreign country exceeds 10% of total revenues.

 

Note 10 - Subsequent Event

 

In January 2015, our Board of Directors declared a quarterly cash dividend of $0.16 per share of common stock, payable on March 16, 2015, to shareholders of record at the close of business on February 27, 2015.

 

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