MESA LABORATORIES INC /CO/ - Quarter Report: 2015 September (Form 10-Q)

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		September 30, 2015 (Unaudited)				March 31, 2015
ASSETS
Current assets:
Cash and cash equivalents		$	5,460			$	2,034
Accounts receivable, net			12,687				12,145
Inventories, net			13,363				12,420
Prepaid expenses and other			1,943				1,334
Deferred income taxes			1,541				1,689
Total current assets			34,994				29,622
Property, plant and equipment, net			14,713				9,598
Intangibles, net			40,794				33,231
Goodwill			65,392				44,869
Total assets		$	155,893			$	117,320
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	3,038			$	2,503
Accrued salaries and payroll taxes			4,021				4,105
Unearned revenues			3,041				1,314
Current portion of contingent consideration			4,892				1,220
Other accrued expenses			5,629				1,307
Income taxes payable			233				1,208
Current portion of long-term debt			3,000				3,000
Total current liabilities			23,854				14,657
Deferred income taxes			4,861				5,122
Long-term debt			43,750				23,250
Contingent consideration			4,480				812
Total liabilities			76,945				43,841
Commitments and Contingencies (Note 7)
Stockholders’ equity:
Common stock, no par value; authorized 25,000,000 shares; issued and outstanding, 3,602,331 and 3,561,540 shares, respectively			19,675				17,751
Retained earnings			58,876				55,962
Accumulated other comprehensive income (loss)			397				(234	)
Total stockholders’ equity			78,948				73,479
Total liabilities and stockholders’ equity		$	155,893			$	117,320

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		Three Months Ended September 30,								Six Months Ended September 30,
		2015				2014				2015				2014
Revenues		$	21,776			$	18,540			$	39,934			$	34,940
Cost of revenues			8,709				7,417				15,726				14,112
Gross profit			13,067				11,123				24,208				20,828
Operating expenses
Selling			2,288				1,342				4,087				3,405
General and administrative			6,782				4,005				11,519				7,841
Research and development			991				876				1,954				1,627
Total operating expenses			10,061				6,223				17,560				12,873
Operating income			3,006				4,900				6,648				7,955
Other expense, net			213				157				329				319
Earnings before income taxes			2,793				4,743				6,319				7,636
Income taxes			1,041				1,683				2,261				2,695
Net income		$	1,752			$	3,060			$	4,058			$	4,941
Net income per share:
Basic		$	0.49			$	0.87			$	1.13			$	1.41
Diluted			0.47				0.84				1.09				1.35
Weighted average common shares outstanding:
Basic			3,598				3,508				3,587				3,504
Diluted			3,742				3,640				3,715				3,648

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		Three Months Ended September 30,								Six Months Ended September 30,
		2015				2014				2015				2014
Net Income		$	1,752			$	3,060			$	4,058			$	4,941
Other comprehensive income, net of tax:
Foreign currency translation			603				--				631				--
Total comprehensive income		$	2,355			$	3,060			$	4,689			$	4,941

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		Six Months Ended September 30,
		2015				2014
Cash flows from operating activities:
Net income		$	4,058			$	4,941
Depreciation and amortization			3,439				2,721
Stock-based compensation			657				516
Loss on disposition of assets			--				16
Deferred income taxes			(113	)			--
Foreign currency adjustments			647				--
Change in assets and liabilities, net of effects of acquisitions
Accounts receivable, net			668				(1,952	)
Inventories, net			(548	)			(1,515	)
Prepaid expenses and other			(609	)			(682	)
Accounts payable			65				632
Accrued liabilities and taxes payable			2,785				(307	)
Unearned revenues			114				(626	)
Contingent consideration			(2,201	)			--
Net cash provided by operating activities			8,962				3,744
Cash flows from investing activities:
Acquisitions			(20,687	)			(13,817	)
Purchases of property, plant and equipment			(5,035	)			(908	)
Net cash used in investing activities			(25,722	)			(14,725	)
Cash flows from financing activities:
Proceeds from the issuance of debt			22,500				18,000
Payments on debt			(2,000	)			(8,750	)
Dividends			(1,144	)			(1,052	)
Proceeds from the exercise of stock options			846				865
Net cash provided by financing activities			20,202				9,063
Effect of exchange rate changes on cash and cash equivalents			(16	)			--
Net increase (decrease) in cash and cash equivalents			3,426				(1,918	)
Cash and cash equivalents at beginning of period			2,034				5,575
Cash and cash equivalents at end of period		$	5,460			$	3,657
Cash paid for:
Income taxes		$	2,862			$	1,492
Interest			315				210
Supplemental non-cash activity:
Repayment of employee loans for stock options		$	--			$	24
Contingent consideration as part of an acquisition			9,541				--

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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 and services, 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 four divisions across eight 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, 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. Our Cold Chain Division provides parameter monitoring of products in a cold chain, consulting services such as compliance monitoring, packaging development and validation or mapping of transport and storage containers, and thermal packaging products such as coolers, boxes, insulation materials and phase-change products to control temperature during transport.

 

Basis of Presentation

 

The accompanying condensed consolidated balance sheet as of March 31, 2015, 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, 2015.

 

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, 2015.

 

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, 2019. We are evaluating the impact of this standard on our condensed consolidated financial statements and disclosures.

 

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Note 2 – Acquisitions and Dispositions

 

Acquisitions

 

For the six months ended September 30, 2015, our acquisitions of businesses (net of cash acquired) totaled $30,228,000, which consisted of the following:

 

Infitrak

 

On July 6, 2015, we completed a business combination (the “Infitrak Acquisition”) whereby we acquired all of the common stock of 2396081 Ontario Inc. and its wholly owned operating subsidiary, Infitrak Inc. (collectively “Infitrak”), a company whose business provides consulting, packaging and measuring solutions for cold chain applications. The stock purchase agreement (the “Infitrak Agreement”) includes provisions for both contingent consideration based upon the two year growth in gross profit (as defined in the Earn-Out Agreement) of our cold chain 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 Infitrak Agreement, we are required to pay contingent consideration if the gross profit (as defined in the Earn-Out Agreement) for our cold chain business for the two years subsequent to the acquisition meets certain levels. The potential consideration payable ranges from $0 to $15,000,000 CDN (approximately $11,500,000) and is based upon a sliding scale of growth in gross profit (as defined in the Earn-Out Agreement) for year one and year two of 30 to 70 percent and 15 to 75 percent, respectively. Based upon both historical and projected growth rates, we recorded $9,541,000 of contingent consideration payable which represents our best estimate of the amount that will ultimately be paid. After the finalization of our purchase accounting, 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 cold chain business and we will adjust the contingent liability on a go forward basis, based on then current information. The contingent consideration is payable in two annual installments beginning in the second quarter of our year ending March 31, 2017.

 

We expect to achieve savings and generate growth as we integrate the Infitrak 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 not expected to be deductible for tax purposes and it was assigned to our Cold Chain segment.

 

The Infitrak 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 Infitrak Agreement (in thousands):

 

 

The accompanying condensed consolidated statements of income include the results of the Infitrak Acquisition from the acquisition date of July 6, 2015. The pro forma effects of the acquisition on the results of operations as if the acquisition had been completed on April 1, 2015 and 2014, are as follows (in thousands, except per share data):

 

  

 

North Bay

 

On August 6, 2015, we completed a business combination (the “North Bay Acquisition”) whereby we acquired substantially all of the assets (other than certain fixed assets) and certain liabilities of the dental sterilizer testing business of North Bay Bioscience, LLC (“North Bay”). The asset purchase agreement (the “North Bay Agreement”) includes a provision for a holdback payment (subject to a post-closing adjustment), payable at the one year anniversary of the closing date.

 

We expect to achieve savings and generate growth as we integrate the North Bay 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 North Bay 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 North Bay Agreement (in thousands):

 

 

The accompanying condensed consolidated statements of income include the results of the North Bay Acquisition from the acquisition date of August 6, 2015. The pro forma effects of the acquisition on the results of operations as if the acquisition had been completed on April 1, 2015 and 2014, are as follows (in thousands, except per share data):

 

 

Note 3 - Inventories

 

Inventories consist of the following (in thousands):

 

 

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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. Funds from the Credit Facility were used for general working capital and corporate needs, retiring existing debt, or to support acquisitions and capital expenditures.

 

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

 

On July 1, 2015, we further amended our Credit Facility to extend the maturity date to June 30, 2020, increase the Line of Credit to $50,000,000 and establish a new $20,000,000 term loan (the “Term Loan”). The majority of the proceeds from the Term Loan were used to pay down the remaining $12,000,000 balance of the Initial Term Loan. The remaining $8,000,000 was combined with a $1,000,000 draw under the Line of Credit to fund the Infitrak Acquisition (see Note 2).

 

Under the Line of Credit, indebtedness bears interest at either: (1) LIBOR, as defined, plus an applicable margin ranging from 1.5% to 2.25%; or (2) the bank’s commercial bank floating rate (“CBFR”), which is the bank’s prime rate adjusted down by 0.5%. We elect the interest rate with each borrowing under the line of credit. In addition, there is an unused line fee of 0.25%. Letter of credit fees are based on the applicable LIBOR rate.

 

The Term Loan bears interest at LIBOR, as defined, plus an applicable margin ranging from 1.5% to 2.25% and requires 20 quarterly principal payments (the first due date was July 15, 2015) in the amount of $750,000 with the remaining balance of principal and accrued interest due on June 30, 2020.

 

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 3.25 to 1.0 through March 31, 2016 and 3.0 to 1.0 thereafter, and a minimum fixed charge coverage ratio of 1.35 to 1.0. We were in compliance with the required covenants at September 30, 2015.

 

As of September 30, 2015, future contractual maturities of debt as are as follows (in thousands):

 

 

In October 2015, we made a $750,000 required principle payment on the Term Loan and we borrowed $2,000,000 under the Line of Credit to fund a litigation settlement payment (see Note 7).

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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 six months ended September 30, 2015:

 

 

The total intrinsic value of stock options exercised was $2,759,463 and $1,516,000 for the six months ended September 30, 2015 and 2014, respectively.

 

A summary of the status of our unvested stock option shares as of September 30, 2015 is as follows:

  

 

As of September 30, 2015, there was $5,214,386 of total unrecognized compensation expense related to unvested stock options. As of September 30, 2015, we have 917,610 shares available for future stock option grants.

 

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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 six months ended September 30, 2015, $136,000 and $135,000 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 six months ended September 30, 2014, 156,000 and zero 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 were 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 met certain levels. The potential consideration payable ranged from $0 to $10,000,000 and was 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 represented our best estimate of the amount that would ultimately be paid. Any changes to the contingent consideration ultimately paid would have resulted in additional income or expense in our condensed consolidated statements of income. The contingent consideration was payable in the third quarter of our year ending March 31, 2017.

 

In November 2014, Amega and its owner Anthony Amato (“Amato”) filed a complaint (Anthony Amato and Amega Scientific Corporation v. Mesa Laboratories, Inc., Civil Action No. 1:14-cv-03228) in the United States District Court for the district of Colorado asserting, 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. The plaintiff was seeking an immediate maximum payout of $10,000,000 under the Amega Earn-Out, the immediate acceleration of the 10,000 stock options granted Amato upon his initial employment along with other consequential damages in excess of $500,000, lost future earnings and punitive damages. In addition, Amato alleged that we improperly withheld $704,065.86 from the holdback consideration under the Amega Agreement. In January 2015 we filed a motion to dismiss the complaint with prejudice.

 

In October 2015, we entered into a settlement agreement (the “Amato Settlement”) whereby we paid Amato $3,165,000. In exchange, Amato agreed to dismiss the complaint, release Mesa of any and all claims by Amega and Amato, and relieve us of any future payment obligation under the Amega Earn-Out. Insurance covered $415,000 of the settlement payment while we had $1,041,000 accrued on our condensed consolidated balance sheet remaining from the original hold back and contingent consideration payable. The remaining $1,709,000 was recorded as general and administrative expense in the accompanying condensed consolidated statements of income for the three and six months ended September 30, 2015.

 

 

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 represented our best estimate of the amount that will ultimately be paid. The contingent consideration is payable in our quarter ending December 31, 2015 (based upon the current run rate projected over the entire three-year contingent consideration period) and is subject to modification at the end of the earn-out period based upon the actual revenues earned over the contingent consideration period. 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.

 

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. 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 year ended March 31, 2015 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 year ended March 31, 2015. During the six months ended September 30, 2015 we successfully completed and filed additional state sales tax returns which concluded our obligation for historical sales taxes in those remaining states.

 

Note 8 – Comprehensive Income

 

The following table summarizes the changes in each component of accumulated other comprehensive income (“AOCI”), net of tax (in thousands):

 

 

 

  

 

 

Note 9 - Segment Information

 

We have four reporting segments: Biological Indicators, Instruments, Continuous Monitoring and Cold Chain. 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 $4,359,000 and $18,690,000 which are associated with our French and Canadian subsidiaries, respectively.

 

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 other than Canada, which represents 10.6% of revenues for the three months ended September 30, 2015.

 

Note 10 – Income Taxes

 

For interim income tax reporting, we estimate our annual effective tax rate and apply this effective tax rate to our year to date pre-tax income. Each quarter, the estimate of the annual effective tax rate is updated, and if the estimated effective tax rate changes, a cumulative adjustment is made. There is a potential for volatility of the effective tax rate due to several factors, including changes in the mix of the pre-tax income and the jurisdictions to which it relates, changes in tax laws and foreign tax holidays, settlement with taxing authorities and foreign currency fluctuations.

 

Our effective income tax rate was 37.3 and 35.5 percent for the three months ended September 30, 2015 and 2014, respectively and 35.8 and 35.3 percent for the six months ended September 30, 2015 and 2014, respectively. The effective tax rate for the three and six months ended September 30, 2015 differed from the statutory federal rate of 35 percent primarily as a result of the impact of state income taxes and certain discrete period items. We anticipate that our effective tax rate for the year ending March 31, 2016 will approximate 35 to 37 percent.

 

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Note 11 - Subsequent Event

 

In October 2015, our Board of Directors declared a quarterly cash dividend of $0.16 per share of common stock, payable on December 15, 2015, to shareholders of record at the close of business on November 30, 2015.

 

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