mlab20160818_10q.htm

 

United States

Securities and Exchange Commission

Washington, D.C. 20549


FORM 10-Q

 

 (Mark one) 

 

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

For the quarterly period ended September 30, 2016  

 

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)

Colorado

 

84-0872291

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification number)

     

12100 West Sixth Avenue

   

Lakewood, Colorado

 

80228

(Address of principal executive offices)

 

(Zip Code)

 

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 ☒   No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (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 ☒     No ☐

 

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):

 

 

Large accelerated filer ☐

 

Accelerated filer☒

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

   

(Do not check if a smaller reporting company)

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐     No ☒

 

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

 

There were 3,679,481 shares of the Issuer’s common stock, no par value, outstanding as of October 28, 2016.

 



 
 

 

 

Table of Contents

 

 

Part I    

1.

Financial Statements 1
  Condensed Consolidated Balance Sheets 1
  Condensed Consolidated Statements of Income 2
  Condensed Consolidated Statements of Comprehensive Income 3
  Condensed Consolidated Statements of Cash Flows 4
  Notes to Condensed Consolidated Financial Statements 5

2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations 13

3.

Quantitative and Qualitative Disclosures About Market Risk 22

4.

Controls and Procedures 22
     
Part II    

1

Legal Proceedings 22

1A.

Risk Factors 22

2.

Unregistered Sales of Equity Securities and Use of Proceeds 23

6.

Exhibits 23
     
  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  
     

 

 
 

 

 

Part I. Financial Information

 

Item 1. Financial Statements

 

Mesa Laboratories, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except share amounts)

 

ASSETS

 

September 30, 2016

(Unaudited)

   

March 31, 2016

 

Current assets:

               

Cash and cash equivalents

  $ 5,070     $ 5,695  

Accounts receivable, less allowances of $219 and $375, respectively

    13,413       15,313  

Inventories, net

    14,400       14,017  

Prepaid expenses and other

    1,452       943  

Deferred income taxes

    --       1,218  

Total current assets

    34,335       37,186  
                 

Property, plant and equipment, net

    22,129       16,628  

Intangibles, net

    39,353       40,797  

Goodwill

    70,436       66,137  
                 

Total assets

  $ 166,253     $ 160,748  
                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

               

Current liabilities:

               

Accounts payable

  $ 3,484     $ 2,823  

Accrued salaries and payroll taxes

    3,547       5,040  

Unearned revenues

    3,384       3,026  

Current portion of contingent consideration

    6,280       4,757  

Other accrued expenses

    2,013       3,085  

Income taxes payable

    86       2,240  

Current portion of long-term debt

    3,000       3,000  

Total current liabilities

    21,794       23,971  
                 

Deferred income taxes

    4,322       5,419  

Long-term debt

    49,750       42,250  

Contingent consideration

    117       4,430  

Total liabilities

    75,983       76,070  
                 
Commitments and Contingencies (Note 7)                
                 

Stockholders’ equity:

               

Common stock, no par value; authorized 25,000,000 shares; issued and outstanding, 3,679,481 and 3,637,273 shares, respectively

    23,609       21,001  

Retained earnings

    67,947       64,828  

Accumulated other comprehensive loss

    (1,286 )     (1,151 )

Total stockholders’ equity

    90,270       84,678  
                 

Total liabilities and stockholders’ equity

  $ 166,253     $ 160,748  

 

See accompanying notes to condensed consolidated financial statements.

 

 
Page 1

 

 

Mesa Laboratories, Inc.

Condensed Consolidated Statements of Income

(Unaudited)

(In thousands except per share data)

 

   

Three Months Ended September 30,

   

Six Months Ended September 30,

 
   

2016

   

2015

   

2016

   

2015

 
                                 

Revenues

  $ 24,409     $ 21,776     $ 45,523     $ 39,934  

Cost of revenues

    10,685       8,709       19,785       15,726  

Gross profit

    13,724       13,067       25,738       24,208  
                                 

Operating expenses

                               

Selling

    2,694       2,288       5,118       4,087  

General and administrative

    5,973       6,782       11,953       11,519  

Research and development

    1,045       991       2,080       1,954  

Total operating expenses

    9,712       10,061       19,151       17,560  
                                 

Operating income

    4,012       3,006       6,587       6,648  

Other expense, net

    800       213       1,206       329  
                                 

Earnings before income taxes

    3,212       2,793       5,381       6,319  
                                 

Income taxes

    854       967       1,093       1,738  
                                 

Net income

  $ 2,358     $ 1,826     $ 4,288     $ 4,581  
                                 

Net income per share:

                               

Basic

  $ 0.64     $ 0.51     $ 1.17     $ 1.28  

Diluted

    0.62       0.48       1.12       1.22  
                                 

Weighted average common shares outstanding:

                         

Basic

    3,669       3,598       3,657       3,587  

Diluted

    3,831       3,774       3,816       3,743  

 

See accompanying notes to condensed consolidated financial statements.

 

 
Page 2

 

 

Mesa Laboratories, Inc.

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

(In thousands)

 

   

Three Months Ended September 30,

   

Six Months Ended September 30,

 
   

2016

   

2015

   

2016

   

2015

 
                                 

Net Income

  $ 2,358     $ 1,826     $ 4,288     $ 4,581  
                                 

Other comprehensive (loss) income, net of tax:

                               

Foreign currency translation

    (185 )     603       (135 )     631  
                                 

Total comprehensive income

  $ 2,173     $ 2,429     $ 4,153     $ 5,212  

 

See accompanying notes to condensed consolidated financial statements.

 

 
Page 3

 

 

Mesa Laboratories, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

 

   

Six Months Ended September 30,

 
   

2016

   

2015

 

Cash flows from operating activities:

               

Net income

  $ 4,288     $ 4,581  

Depreciation and amortization

    4,411       3,439  

Stock-based compensation

    841       657  

Deferred income taxes

    138       (113 )

Foreign currency adjustments

    (28 )     647  

Change in assets and liabilities, net of effects of acquisitions

               

Accounts receivable, net

    1,900       668  

Inventories, net

    (348 )     (548 )

Prepaid expenses and other

    (509 )     (609 )

Accounts payable

    661       65  

Accrued liabilities and taxes payable

    (5,392 )     2,262  

Unearned revenues

    (39 )     114  

Contingent consideration

    (4,594 )     (2,201 )

Net cash provided by operating activities

    1,329       8,962  
                 
                 

Cash flows from investing activities:

               

Acquisitions

    (3,401 )     (20,687 )

Purchases of property, plant and equipment

    (6,669 )     (5,035 )

Net cash used in investing activities

    (10,070 )     (25,722 )
                 

Cash flows from financing activities:

               

Proceeds from the issuance of debt

    9,500       22,500  

Payments on debt

    (2,000 )     (2,000 )

Dividends

    (1,169 )     (1,144 )

Proceeds from the exercise of stock options

    1,767       846  

Net cash provided by financing activities

    8,098       20,202  
                 

Effect of exchange rate changes on cash and cash equivalents

    18       (16 )
                 

Net (decrease) increase in cash and cash equivalents

    (625 )     3,426  

Cash and cash equivalents at beginning of period

    5,695       2,034  
                 

Cash and cash equivalents at end of period

  $ 5,070     $ 5,460  
                 

Cash paid for:

               

Income taxes

  $ 3,140     $ 2,862  

Interest

    588       315  
                 

Supplemental non-cash activity:

               

Contingent consideration as part of an acquisition

    1,822       9,541  

 

 

See accompanying notes to condensed consolidated financial statements.

 

 
Page 4

 

 

Mesa Laboratories, Inc.

Notes to Condensed Consolidated Financial Statements

 

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

 

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 provides testing services, along with the manufacturing and marketing of biological indicators and distribution of 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 Cold Chain 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 Monitoring Division also provides parameter (primarily temperature) monitoring of products during transport in a cold chain and consulting services such as compliance monitoring and validation or mapping of transport and storage containers. Our Cold Chain Packaging Division provides packaging development consulting services 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, 2016, 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, 2016.

 

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, 2016.

 

Recently Issued Accounting Pronouncements

 

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-09, Compensation—Stock Compensation (Topic 718), as part of its simplification initiative, which affects all entities that issue share-based payment awards to their employees. The amendments in this update cover such areas as the recognition of excess tax benefits and deficiencies, the classification of those excess tax benefits on the statement of cash flows, an accounting policy election for forfeitures, the amount an employer can withhold to cover income taxes and still qualify for equity classification and the classification of those taxes paid on the statement of cash flows. The ASU was effective for our fiscal year ending March 31, 2018 using either the prospective, retrospective or modified retrospective transition method, depending on the area covered in this update. As permitted within the amendment, we elected to early adopt and prospectively apply the provisions of this amendment as of April 1, 2015.

 

As a result of the adoption of ASU No. 2016-09, the captions of income taxes, net income, and net income per share basic and diluted on the condensed consolidated statements of income for the three months ended September 30, 2015 have been restated to $967,000, $1,826,000, $0.51 and $0.48 as compared to amounts previously reported of $1,041,000, $1,752,000, $0.49 and $0.47, respectively. The captions of net income and total comprehensive income on the condensed consolidated statements of comprehensive income for the three months ended September 30, 2015 have been restated to $1,826,000 and $2,429,000 as compared to amounts previously reported of $1,752,000 and $2,355,000, respectively.

 

As a result of the adoption of ASU No. 2016-09, the captions of income taxes, net income, and net income per share basic and diluted on the condensed consolidated statements of income for the six months ended September 30, 2015 have been restated to $1,738,000, $4,581,000, $1.28 and $1.22 as compared to amounts previously reported of $2,261,000, $4,058,000, $1.13 and $1.09, respectively. The captions of net income and total comprehensive income on the condensed consolidated statements of comprehensive income for the six months ended September 30, 2015 have been restated to $4,581,000 and $5,212,000 as compared to amounts previously reported of $4,058,000 and $4,689,000, respectively. The captions of net income and accrued liabilities and taxes payable on the condensed consolidated statements of cash flows for the six months ended September 30, 2015 have been restated to $4,581,000 and $2,262,000 as compared to amounts previously reported of $4,058,000 and $2,785,000, respectively.

 

 
Page 5

 

 

In December 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”). ASU 2015-17 simplifies the presentation of deferred income taxes by requiring that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The standard was effective for our fiscal year (and interim periods within that year) ending March 31, 2018. As permitted within the amendment, we elected to early adopt and prospectively apply the provisions of this amendment as of April 1, 2016.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which impacts virtually all aspects of an entity’s revenue recognition. The core principle of the new standard is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. 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 currently evaluating when to adopt the new standard, the impacts of adoption and the implementation approach to be used.

 

Note 2 – Acquisitions

 

For the six months ended September 30, 2016, our acquisitions of businesses totaled $5,223,000, of which none were material in nature (see Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations).

 

Note 3 - Inventories

 

Inventories consist of the following (in thousands):

 

   

September 30, 2016

   

March 31, 2016

 

Raw materials

  $ 10,281     $ 9,433  

Work-in-process

    503       337  

Finished goods

    3,998       4,941  

Less: reserve

    (382 )     (694 )
    $ 14,400     $ 14,017  

 

Note 4 - Long-Term Debt

 

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

 

   

September 30, 2016

   

March 31, 2016

 

Line of credit (2.27% at September 30, 2016)

  $ 36,500     $ 27,500  

Term loan (2.27% at September 30, 2016)

    16,250       17,750  

Less: current portion

    (3,000 )     (3,000 )

Long-term portion

  $ 49,750     $ 42,250  

 

On July 1, 2015, we entered into a five year agreement (the “Credit Facility”) for a $50,000,000 revolving line of credit (“Line of Credit”), a $20,000,000 term loan (the “Term Loan”) and up to $1,000,000 of letters of credit.

 

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.

 

 
Page 6

 

 

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

 

As of September 30, 2016, future contractual maturities of debt are as follows (in thousands):

 

Year ending March 31,

       

2017

  $ 1,500  

2018

    3,000  

2019

    3,000  

2020

    3,000  

2021

    42,250  
    $ 52,750  

 

In October 2016, we made a $750,000 required principle payment on the Term Loan and a $2,000,000 draw under our Line of Credit.

 

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):

 

   

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
   

2016

   

2015

   

2016

   

2015

 

Total cost of stock-based compensation charged against income before income taxes

  $ 412     $ 330     $ 841     $ 657  

Amount of income tax benefit recognized in earnings

    110       114       171       181  

Amount charged against net income

  $ 302     $ 216     $ 670     $ 476  

Impact on net income per common share:

                               

Basic

  $ 0.08     $ 0.06     $ 0.18     $ 0.13  

Diluted

    0.08       0.06     $ 0.18       0.13  

 

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, 2016:

 

   

Number of
Shares

   

Weighted-

Average Exercise

Price per Share

   

Weighted-

Average

Remaining

Contractual

Term

   

Aggregate

Intrinsic Value

(000s)

 

Outstanding at March 31, 2016

    515,720     $ 64.32       5.2     $ 16,561  

Stock options granted

    110,660       98.04       5.5          

Stock options forfeited

    (6,411 )     82.38       5.5          

Stock options expired

    (862 )     39.17       0.9          

Stock options exercised

    (50,150 )     54.20                  

Outstanding at September 30, 2016

    568,957       71.61       5.0       24,333  
                                 

Exercisable at September 30, 2016

    184,379       49.0       3.7       12,051  

 

The total intrinsic value of stock options exercised was $3,218,000 and $2,759,000 for the six months ended September 30, 2016 and 2015, respectively. 

 
Page 7

 

 

A summary of the status of our unvested stock option shares as of September 30, 2016 is as follows:

  

   

Number of
Shares

   

Weighted-

Average
Grant-Date
Fair Value

 

Unvested at March 31, 2016

    358,263     $ 19.46  

Stock options granted

    110,660       27.84  

Stock options forfeited

    (6,411 )     22.23  

Stock options vested

    (77,934 )     17.03  

Unvested at September 30, 2016

    384,578       22.32  

 

As of September 30, 2016, there was $6,216,000 of total unrecognized compensation expense related to unvested stock options. As of September 30, 2016, we have 819,744 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):

 

   

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
   

2016

   

2015

   

2016

   

2015

 

Net income available for shareholders

  $ 2,358     $ 1,826     $ 4,288     $ 4,581  

Weighted average outstanding shares of common stock

    3,669       3,598       3,657       3,587  

Dilutive effect of stock options

    162       176       159       156  

Common stock and equivalents

    3,831       3,774       3,816       3,743  
                                 

Net income per share:

                               

Basic

  $ 0.64     $ 0.51     $ 1.17     $ 1.28  

Diluted

    0.62       0.48       1.12       1.22  

 

For the three and six months ended September 30, 2016, 112,000 and 120,000 outstanding stock options, respectively, were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive.

 

For the three and six months ended September 30, 2015, 137,000 and 135,000 outstanding stock options, respectively, were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive.

 

Note 7- Commitments and Contingencies

 

Under the terms of the Infitrak Agreement, we are required to pay contingent consideration if the gross profit (as defined in the Infitrak Earn-Out Agreement) for our cold chain packaging business for the two years subsequent to the acquisition meets certain levels. The potential undiscounted consideration payable ranges from $0 to $15,000,000 CDN and is based upon a sliding scale of growth in gross profit (as defined in the Infitrak 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 $9,271,000 of contingent consideration payable which represented our best estimate of the then current fair value of the amount that would ultimately be paid. In July 2016 we made the first Earn-Out payment in the amount of $6,000,000 CDN ($4,594,000). As a result of this payment, the remaining potential undiscounted consideration payable ranges from $0 to $9,000,000 CDN (approximately $0 to $6,847,000 as of September 30, 2016). We have recorded $4,498,000 in our condensed consolidated balance sheet as of September 30, 2016, which represents our best estimate of the then current fair value 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 cold chain packaging business and we will adjust the contingent liability on a go forward basis, based on then current information. The remaining contingent consideration is payable in the second quarter of our year ending March 31, 2018.

 

 
Page 8

 

 

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 initially recorded $300,000 of contingent consideration payable which represented our best estimate of the amount that would ultimately be paid. We paid $150,000 of the contingent consideration during the year ended March 31, 2016 (based upon the then current run rate projected over the entire three-year contingent consideration period). Since the initial payment, the revenues have significantly increased and as a result, we recorded an additional $450,000 accrual as of September 30, 2016 (which is included in other expense, net in our condensed consolidated statements of income for the three and six months ended September 30, 2016). We expect that this second payment (estimated to be $600,000) will be paid in our third quarter ending December 31, 2016. This contingent consideration amount is also subject to modification at the end of the third year 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.

 

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.

 

Note 8 – Comprehensive Income

 

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

 

   

Foreign Currency Translation

   

AOCI

 

Balance at June 30, 2016

  $ (1,101 )   $ (1,101 )

Quarter ended September 30, 2016:

               

Unrealized loss arising during the period

    (185 )     (185 )

Balance at September 30, 2016

  $ (1,286 )   $ (1,286 )

 

   

Foreign Currency Translation

   

AOCI

 

Balance at June 30, 2015

  $ (206 )   $ (206 )

Quarter ended September 30, 2015:

               

Unrealized gain arising during the period

    603       603  

Balance at September 30, 2015

  $ 397     $ 397  

 

   

Foreign Currency Translation

   

AOCI

 

Balance at March 31, 2016

  $ (1,151 )   $ (1,151 )

Six months ended September 30, 2016:

               

Unrealized loss arising during the period

    (135 )     (135 )

Balance at September 30, 2016

  $ (1,286 )   $ (1,286 )

 

 
Page 9

 

 

   

Foreign Currency Translation

   

AOCI

 

Balance at March 31, 2015

  $ (234 )   $ (234 )

Six months ended September 30, 2015:

               

Unrealized gain arising during the period

    631       631  

Balance at September 30, 2015

  $ 397     $ 397  

 

Note 9 - Segment Information

 

As of March 31, 2016, our four operating segments were Biological Indicators, Instruments, Continuous Monitoring and Cold Chain. Effective April 1, 2016 we renamed our Continuous Monitoring and Cold Chain operating segments to Cold Chain Monitoring and Cold Chain Packaging, respectively. In addition, we transferred certain of the Cold Chain monitoring and other services to our Cold Chain Monitoring operating segment (historically included in our cold chain operating segment) to align with the information being used by the chief decision maker of the Company. Accordingly, all prior period segment information presented herein has been adjusted to reflect this change in our organization structure. The following tables set forth our segment information (in thousands):

 

   

Three Months Ended September 30, 2016

 
   

Biological

Indicators

   

Instruments

   

Cold Chain

Monitoring

   

Cold Chain

Packaging

   

Total

 

Revenues

  $ 8,897     $ 8,693     $ 3,545     $ 3,274     $ 24,409  
                                         

Gross profit

  $ 5,833     $ 5,326     $ 1,657     $ 908       13,724  

Reconciling items (1)

                                    (10,512 )

Earnings before income taxes

                                  $ 3,212  

 

   

Three Months Ended September 30, 2015

 
   

Biological

Indicators

   

Instruments

   

Cold Chain

Monitoring

   

Cold Chain

Packaging

   

Total

 

Revenues

  $ 8,482     $ 9,228     $ 2,510     $ 1,556     $ 21,776  
                                         

Gross profit

  $ 5,539     $ 5,705     $ 976     $ 847       13,067  

Reconciling items (1)

                                    (10,274 )

Earnings before income taxes

                                  $ 2,793  

 

   

Six Months Ended September 30, 2016

 
   

Biological

Indicators

   

Instruments

   

Cold Chain

Monitoring

   

Cold Chain

Packaging

   

Total

 

Revenues

  $ 18,364     $ 16,915     $ 5,862     $ 4,382     $ 45,523  
                                         

Gross profit

  $ 11,920     $ 10,175     $ 2,324     $ 1,319       25,738  

Reconciling items (1)

                                    (20,357 )

Earnings before income taxes

                                  $ 5,381  

 

   

Six Months Ended September 30, 2015

 
   

Biological

Indicators

   

Instruments

   

Cold Chain

Monitoring

   

Cold Chain

Packaging

   

Total

 

Revenues

  $ 15,718     $ 17,559     $ 5,101     $ 1,556     $ 39,934  
                                         

Gross profit

  $ 10,288     $ 11,060     $ 2,013     $ 847       24,208  

Reconciling items (1)

                                    (17,889 )

Earnings before income taxes

                                  $ 6,319  

 

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

 

 
Page 10

 

 

   

September 30, 2016

   

March 31, 2016

 

Total assets

               

Biological Indicators

  $ 64,888     $ 56,724  

Instruments

    43,755       49,077  

Cold Chain Monitoring

    28,436       27,613  

Cold Chain Packaging

    22,652       19,478  

Corporate and administrative

    6,522       7,856  
    $ 166,253     $ 160,748  

 

All long-lived assets are located in the United States except for $7,020,000 and $21,336,000 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):

 

   

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
   

2016

   

2015

   

2016

   

2015

 

Net revenues from unaffiliated customers:

                               

United States

  $ 15,403     $ 12,529     $ 30,914     $ 24,723  

Foreign

    9,006       9,247       14,609       15,211  
    $ 24,409     $ 21,776     $ 45,523     $ 39,934  

 

No foreign country exceeds 10 percent of total revenues.

 

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 26.6 and 34.6 percent for the three months ended September 30, 2016 and 2015, respectively, and 20.3 and 27.5 percent for the six months ended September 30, 2016 and 2015, respectively. The effective tax rate for the three months and six months ended September 30, 2016 differed from the statutory federal rate of 35 percent primarily as a result of the impact of state income taxes, domestic manufacturing deductions, research and development tax credits, foreign rate differential and share-based payment awards for employees. We anticipate that our effective tax rate for the year ending March 31, 2017 will approximate 33 to 36 percent, plus or minus the impact of excess tax benefits and deficiencies associated with share-based payment awards to employees (which may vary significantly from year to year).

 

During the six months ended September 30, 2016, the IRS examination of our tax year ended March 31, 2015 was completed with no change to the reported tax liability. We have reserved for any other potential adjustments for income taxes that may result from future examinations by tax authorities, and we believe the final outcome of these examinations or agreements will not have a material effect on our financial condition, results of operations or cash flows.

 

Since we are subject to audit by various taxing authorities, it is reasonably possible that the amount of unrecognized tax benefits will change during the next 12 months. However, we do not expect the change, if any, to have a material effect on our financial condition or results of operations within the next 12 months.

 

 
Page 11

 

 

Note 11 Fair Value Measurements

 

We follow authoritative guidance (GAAP) which requires that assets and liabilities carried at fair value be classified and disclosed in one of the established categories. A financial instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three categories are defined as follows:

 

• Level 1: Quoted prices in active markets for identical assets.

• Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

• Level 3: Significant inputs to the valuation model are unobservable inputs.

 

Assets and liabilities measured on a recurring basis:

 

Our financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities (including certain contingent consideration amounts that are short-term in nature) are carried at cost, which is considered to be representative of their fair value due to the short term maturity of these instruments. The recorded value of the Line of Credit and Term Loan (See Note 4), approximates fair value due to their variable rate structure.

 

The following table presents items required to be measured at fair value on a recurring basis by the level in which they are classified within the valuation hierarchy as follows:

 

   

September 30, 2016

 
       
   

Level 1

   

Level 2

   

Level 3

   

Total

 

Assets:

                               
    $ --     $ --     $ --     $ --  

Liabilities:

                               

Contingent Consideration

  $ --     $ --     $ 4,498     $ 4,498  

 

   

March 31, 2016

 
       
   

Level 1

   

Level 2

   

Level 3

   

Total

 

Assets:

                               
    $ --     $ --     $ --     $ --  

Liabilities:

                               

Contingent Consideration

  $ --     $ --     $ 9,037     $ 9,037  

 

Under the Infitrak Agreement (See Note 7), we were required to make two annual payments to the former owners based on future growth in gross profit (as defined in the Infitrak Earn-Out Agreement). In July 2016 we made the first Earn-Out payment in the amount of $6,000,000 CDN ($4,594,000). The remaining contingent consideration payable is a standalone liability that is measured at fair value on a recurring basis for which there is no available quoted market price, principal market or market participants. As such, the inputs for this instrument are unobservable and therefore classified as Level 3 inputs. This contingent consideration liability is valued using a discounted cash flow model based on internal forecasts and our current cost of borrowing. There were no changes to the valuation methodology during the period.

 

The contingent consideration arising from this agreement is our only Level 3 asset or liability. The following table presents a roll forward of the contingent consideration payable for the six months ended September 30, 2016 and 2015 (in thousands):

 

   

Six Months Ended

 
   

September 30,

 
   

2016

   

2015

 

Opening balance

  $ 9,037     $ --  

Payment

    (4,594 )     --  

Fair value adjustment – expense

    106       --  

Foreign exchange rate impact – included in other comprehensive gain

    (51 )     --  

Ending Balance

  $ 4,498     $ --  

 

Note 12 - Subsequent Event

 

In October 2016, our Board of Directors declared a quarterly cash dividend of $0.16 per share of common stock, payable on December 15, 2016, to shareholders of record at the close of business on November 30, 2016.

 

 
Page 12

 

 

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," "project," "anticipate," "intend," "estimate," "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 revenues 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, 2016, 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 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 provides testing services, along with the manufacturing and marketing of biological indicators and distribution of 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 Cold Chain 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 Monitoring Division also provides parameter (primarily temperature) monitoring of products during transport in a cold chain and consulting services such as compliance monitoring and validation or mapping of transport and storage containers. Our Cold Chain Packaging Division provides packaging development consulting services and thermal packaging products such as coolers, boxes, insulation materials and phase-change products to control temperature during transport.

 

Our revenues come from two main sources – product sales 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 indicators and many of the packaging products of our Cold Chain Packaging Division are disposable and are used on a routine basis, thus product sales are less sensitive to general economic conditions. Instrument products and cold chain monitoring systems and products have a longer life, and their purchase by our customers is somewhat discretionary, so sales are more sensitive to general economic conditions. Service demand is driven by our customers’ quality control and regulatory environments, which require periodic repair and recalibration or certification of our instrument products and cold chain monitoring systems. We typically evaluate costs and pricing annually. Our policy is to price our products competitively and, where possible, we 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 will 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 the substantial majority of general and administrative expense. Research and development expense is predominantly comprised of labor costs and third party consultants.

 

 
Page 13

 

 

Year Ending March 31, 2017 Acquisitions

 

During the year ending March 31, 2017, we completed the following four acquisitions (the “2017 Acquisitions”):

 

In August 2016, we completed a business combination (the “Rapid Aid Acquisition”) whereby we acquired certain assets (consisting primarily of fixed assets) and certain liabilities of Rapid Aid Corp’s (“Rapid Aid”) business segment associated with the manufacture and sale of cold chain packaging gel products;

 

In July 2016, we completed a business combination (the “HANSAmed Acquisition) whereby we acquired substantially all of the assets (other than cash and accounts receivable) and certain liabilities of HANSAmed Limited’s (“HANSAmed”) business segment associated with the distribution of our biological indicator products and mail-in testing services to the dental market in Canada;

 

In April 2016, we completed a business combination (the “ATS Acquisition”) whereby we acquired substantially all the assets (other than cash and certain inventories and fixed assets) and certain liabilities of Autoclave Testing Services, Inc. and Autoclave Testing Supplies, Inc., (collectively, “ATS”). ATS was in the business of supplying products and services for dental sterilizer testing in both the U.S. and Canada; and

 

In April 2016, we completed a business combination (the “Pulse Acquisition) whereby we acquired substantially all of the assets (other than cash and accounts receivable) and certain liabilities of Pulse Scientific, Inc.’s (“Pulse”) business segment associated with the distribution of our biological indicator products.

 

Year Ended March 31, 2016 Acquisitions

 

During the year ended March 31, 2016, we completed the following ten acquisitions (the “2016 Acquisitions”):

 

In January 2016, we completed two business combinations (the “January 2016 European BI Distributor Acquisitions”) whereby we acquired substantially all of the assets (other than cash and accounts receivable) and certain liabilities of the business segment associated with the distribution of our biological indicator products from CoaChrom Diagnostica GmbH of Austria and bioTRADING Benelux B.V of the Netherlands;

 

In October 2015, we completed six business combinations (the “October 2015 European BI Distributor Acquisitions”) whereby we acquired substantially all of the assets (other than cash and accounts receivable) and certain liabilities of the business segment associated with the distribution of our biological indicator products from BIOLOGIK S.R.L.(Italy), VWR International PBI S.R.L.(Italy), Cruinn Diagnostics Ltd.(Ireland), Mecolab AG (Switzerland), Miclev Medical Products AB (Sweden) and Tiselab S.L.(Spain);

 

In August 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”); and

 

In July 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.

 

General Trends and Outlook

 

Our strategic objectives include growth both organically and through further acquisitions. During the year ended March 31, 2016, we continued to build our infrastructure to prepare for future growth, including the addition of key personnel to our operations, sales and marketing, research and development, and finance teams. In addition, on October 1, 2015 we converted from our legacy enterprise resource planning (“ERP”) system to our new cloud based system. This represented a significant upgrade and we will continue to make smaller enhancements to the system in future periods.

 

The markets for our biological indicators and cold chain packaging products 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.

 

In general, our instruments products and cold chain services and monitoring systems are impacted more by general economic conditions than our biological indicator and cold chain packaging products. As a result, 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. However demand for our instruments products, and cold chain services and monitoring systems remains strong and we strive to continue to grow revenues going forward.

 

 
Page 14

 

 

We are working on several research and development projects that, if completed, may result in new products for both existing customers and new markets. We are hopeful that all of our 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 consolidated statements of income data. The table and the discussion below should be read in conjunction with the accompanying condensed consolidated financial statements and the notes thereto appearing elsewhere in this report (in thousands, except percent data):

 

   

Three Months Ended September 30,

           

Percent

 
   

2016

   

2015

   

Change

   

Change

 

Revenues

  $ 24,409     $ 21,776     $ 2,633       12 %

Cost of revenues

    10,685       8,709       1,976       23 %

Gross profit

  $ 13,724     $ 13,067     $ 657       5 %

Gross profit margin

    56 %     60 %     (4 )%        
                                 

Operating expenses

                               

Selling

  $ 2,694     $ 2,288     $ 406       18 %

General and administrative

    5,973       6,782       (809 )     (12 )%

Research and development

    1,045       991       54       5 %
    $ 9,712     $ 10,061     $ (349 )     (3 )%
                                 

Operating income

  $ 4,012     $ 3,006     $ 1,006       33 %

Net income

    2,358       1,826       532       29 %

Net profit margin

    10 %     8 %     2 %        

 

   

Six Months Ended September 30,

           

Percent

 
   

2016

   

2015

   

Change

   

Change

 

Revenues

  $ 45,523     $ 39,934     $ 5,589       14 %

Cost of revenues

    19,785       15,726       4,059       26 %

Gross profit

  $ 25,738     $ 24,208     $ 1,530       6 %

Gross profit margin

    57 %     61 %     (4 )%        
                                 

Operating expenses

                               

Selling

  $ 5,118     $ 4,087     $ 1,031       25 %

General and administrative

    11,953       11,519       434       4 %

Research and development

    2,080       1,954       126       6 %
    $ 19,151     $ 17,560     $ 1,591       9 %
                                 

Operating income

  $ 6,587     $ 6,648     $ (61 )     (1 )%

Net income

    4,288       4,581       (293 )     (6 )%

Net profit margin

    9 %     11 %     (2 )%        

 

Revenues

 

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

 

   

Three Months Ended September 30,

           

Percent

 
   

2016

   

2015

   

Change

   

Change

 

Biological Indicators

  $ 8,897     $ 8,482     $ 415       5 %

Instruments

    8,693       9,228       (535 )     (6 )%

Cold Chain Monitoring

    3,545       2,510       1,035       41 %

Cold Chain Packaging

    3,274       1,556       1,718       110 %

Total

  $ 24,409     $ 21,776     $ 2,633       12 %

 

 
Page 15

 

 

   

Six Months Ended September 30,

           

Percent

 
   

2016

   

2015

   

Change

   

Change

 

Biological Indicators

  $ 18,364     $ 15,718     $ 2,646       17 %

Instruments

    16,915       17,559       (644 )     (4 )%

Cold Chain Monitoring

    5,862       5,101       761       15 %

Cold Chain Packaging

    4,382       1,556       2,826       182 %

Total

  $ 45,523     $ 39,934     $ 5,589       14 %

 

Three and six months ended September 30, 2016 versus September 30, 2015

 

Biological Indicators revenues for the three months ended September 30, 2016 increased as a result of the North Bay, October 2015 European BI Distributor, January 2016 European BI Distributor, Pulse, ATS and HANSAmed Acquisitions, partially offset by an organic decrease in revenues of four percent. Biological Indicators revenues for the six months ended September 30, 2016 increased as a result of the North Bay, October 2015 European BI Distributor, January 2016 European BI Distributor, Pulse, ATS and HANSAmed Acquisitions, and organic growth of two percent. The decrease in organic growth for the three months ended September 30, 2016 was primarily due to the timing of orders between quarters.

 

Instruments revenues for the three and six months ended September 30, 2016 decreased as a result of organic decreases in revenues of six and four percent, respectively. The decrease was due primarily to a softening in demand for one of our instruments products. At this time we believe that this downturn will be short-term in nature but we will continue to monitor the situation closely.

 

Cold Chain Monitoring revenues for the three and six months ended September 30, 2016 increased due to organic growth of 41 and nine percent, respectively. The increases were primarily due to the timing of customer acceptance of certain installations and the nature and timing of orders within the quarter. Historically, Cold Chain Monitoring revenues fluctuate between quarters due to the complex nature and sometimes lengthy time periods associated with these types of installations and customer readiness for installation after placing an order. On a go forward basis, we anticipate the run rate for our Cold Chain Monitoring segment to approximate $2,500,000 - $3,000,000 per quarter over the next few quarters.

 

Cold Chain packaging revenues for the three months ended September 30, 2016 increased due to organic growth of 110 percent which was achieved through existing and new customers. We expect that revenues for this division will fluctuate due to seasonality but overall growth will be significant as compared to the same periods 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

 
   

2016

   

2015

   

Change

   

Change

 

Biological Indicators

  $ 5,833     $ 5,539     $ 294       5 %

Gross profit margin

    66 %     65 %     1 %        
                                 

Instruments

    5,326       5,705       (379 )     (7 )%

Gross profit margin

    61 %     62 %     (1 )%        
                                 

Cold Chain Monitoring

    1,657       976       681       70 %

Gross profit margin

    47 %     39 %     8 %        
                                 

Cold Chain Packaging

    908       847       61       7 %

Gross profit margin

    28 %     54 %     (26 )%        
                                 

Total gross profit

  $ 13,724     $ 13,067     $ 657       5 %

Gross profit margin

    56 %     60 %     (4 )%        

 

 
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Six Months Ended September 30,

           

Percent

 
   

2016

   

2015

   

Change

   

Change

 

Biological Indicators

  $ 11,920     $ 10,288     $ 1,632       16 %

Gross profit margin

    65 %     65 %     -- %        
                                 

Instruments

    10,175       11,060       (885 )     (8 )%

Gross profit margin

    60 %     63 %     (3 )%        
                                 

Cold Chain Monitoring

    2,324       2,013       311       15 %

Gross profit margin

    40 %     39 %     1 %        
                                 

Cold Chain Packaging

    1,319       847       472       56 %

Gross profit margin

    30 %     54 %     (24 )%        
                                 

Total gross profit

  $ 25,738     $ 24,208     $ 1,530       6 %

Gross profit margin

    57 %     61 %     (4 )%        

 

Three and six months ended September 30, 2016 versus September 30, 2015

 

Biological Indicators gross profit margin percentage for the three and six months ended September 30, 2016 was essentially flat. Gross profit margin percentage decreased as a result of the North Bay and ATS Acquisitions but was offset by the positive impact from the October 2015 and January 2016 European BI Distributor Acquisitions. We are currently contractually committed to purchase from a third party a significant portion of the BI’s that are used in the acquired North Bay and ATS dental sterilizer testing business which negatively impacts our gross profit margin percentage. This remaining contractual commitment winds down through approximately the end of the calendar year, at which time we will migrate to the use of internally produced BI’s which should increase the gross profit margin percentage in this division.

 

Instruments gross margin percentage decreased for the three and six months ended September 30, 2016 as a result of product and services mix and the loss of certain volume based efficiencies associated with the decrease in revenues.

 

Cold Chain Monitoring gross profit margin percentage increased for the three and six months ended September 30, 2016 primarily as a result of increases in revenues. A significant portion of our cost of revenues within this segment are fixed and as a result, increased or reduced revenues can significantly impact the related gross profit margin percentage. We have made substantial progress on our integration activities associated with this segment and we are now focused on cost reduction initiatives to streamline the operations and increase profitability. One of the critical components of our integration activities was to introduce a new monitoring system (consisting of both new software and hardware) which we believe will give us a competitive advantage in the marketplace. In addition to significant new features and functionality, we believe that the new system will reduce our costs (both from an installation and on-going maintenance perspective) which will lead to higher gross and operating margins. This system was originally planned to be rolled out during our year ended March 31, 2015. The software component of the system was completed in February 2016 but the remaining hardware component will not be ready until approximately midway through our third quarter ending December 31, 2016. We are hopeful to meet the newly stated release dates and that this new system will improve both our gross and operating income margins, however it is unclear as to how significant those improvements will be.

 

Cold Chain Packaging gross profit margin decreased for the three and six months ended September 30, 2016 primarily as a result of increased revenues due primarily to one significant contract that has a lower gross profit margin percentage. We expect that our Cold Chain Packaging gross profit margin percentage will continue to be lower than the historical results of our other segments due to the nature of these products.

 

 
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Operating Expenses

 

Operating expenses for the three and six months ended September 30, 2016 increased as compared to the prior year as follows (in thousands):

 

   

Increase (Decrease)

 
   

Three Months Ended

September 30, 2016

   

Six Months Ended

September 30, 2016

 

Selling

  $ 406     $ 1,031  
                 

General and administrative

               

ERP system implementation

    63       95  

Legal costs and litigation settlement

    (1,740 )     (1,721 )

Amortization

    71       460  

Personnel

    380       705  

Professional services

    19       119  

Banking fees

    31       90  

Depreciation

    133       245  

Other, net

    234       441  
      (809 )     434  
                 

Research and development

    54       126  
                 

Operating expenses

  $ (349 )   $ 1,591  

 

Selling

 

Three and six months ended September 30, 2016 versus September 30, 2015

 

Selling expense for the three months ended September 30, 2016 increased primarily due to additional personnel related to the 2017 and 2016 acquisitions. As a percentage of revenues, selling expense was 11 percent for both the three months ended September 30, 2016 and September 30, 2015, respectively.

 

Selling expense for the six months ended September 30, 2016 increased primarily due to additional personnel related to the 2017 and 2016 acquisitions. As a percentage of revenues, selling expense was 11 percent for the six months ended September 30, 2016 as compared to ten percent for the six months September 30, 2015.

 

Included in the increase of selling expenses are $173,000 and $346,000 for the three and six months ended September 30, 2016, respectively of recently hired Cold Chain Packaging sales personnel. We are currently making an investment to grow this segment and are hopeful that increases in related revenues will begin to be realized beginning in our third quarter ending December 31, 2016.

 

Historically selling expense approximates 10 to 12 percent of revenues.

 

General and Administrative

 

Three and six months ended September 30, 2016 versus September 30, 2015

 

General and administrative expenses for the three months ended September 30, 2016 decreased primarily due to the $1,709,000 charge during the three months ended September 30, 2015 related to the Amato settlement, partially offset by increases in personnel costs, amortization and depreciation.

 

General and administrative expenses for the six months ended September 30, 2016 increased primarily due to increased personnel costs (of which approximately 50 percent is related to the North Bay and Infitrak acquisitions), amortization, and depreciation, partially offset by the $1,709,000 charge related to the Amato Settlement during the six months ended September 30, 2015.

 

Included in the increase of personnel expenses are $210,000 for the three and six months ended September 30, 2016, respectively of stay bonuses for employees currently working at our Omaha and Traverse City facilities. In August 2016 we announced that we will be relocating such facilities during calendar 2017 to our new facility in Bozeman (See Liquidity and Capital Resources for additional discussion).

 

 
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Research and Development

 

Three and six months ended September 30, 2016 versus September 30, 2015

 

Research and development expenses for the three and six months ended September 30, 2016 increased as a result of the addition of several new engineers to support existing and acquired businesses.

 

Other Expense

 

Other expense for the three and six months ended September 30, 2016 is comprised primarily of $450,000 related to an additional accrual for the PCD earn-out (see Note 7 – Commitments and Contingencies) and interest expense associated with our credit facility.

 

Net Income

 

Our income tax rate varies based upon many factors but in general, we anticipate that on a go forward basis, our effective tax rate will approximate 33 to 36 percent, plus or minus the impact of excess tax benefits and deficiencies associated with share-based payment awards to employees (which may vary significantly from period to period). Otherwise, net income for the six months ended September 30, 2016 varied with the changes in revenues, gross profit and operating expenses (which includes $3,222,000 of non-cash amortization of intangible assets).

 

Net income for the six months ended September 30, 2015 was significantly impacted by the $1,709,000 Amato Settlement. Otherwise, net income for the six months ended September 30, 2015 varied with the changes in revenues, gross profit and operating expenses (which includes $2,760,000 of non-cash amortization of intangible assets).

 

Liquidity and Capital Resources

 

Our sources of liquidity include cash generated from operations, working capital, capacity under our Credit Facility and potential equity and debt offerings. We believe that cash generated from these sources will be sufficient to meet our short-term and long-term needs. Our more significant uses of resources include quarterly dividends to shareholders, payment of debt obligations, long-term capital expenditures and potential acquisitions.

 

Due to continued organic and acquisition related growth, we have outgrown the capacity of our current building in Bozeman, Montana and as a result, we are building a new facility in the same general area. Construction began in July 2015 and we are hopeful that the building will be completed no later than January 31, 2017. We spent $6,711,000 on the development of the building and the related land prior to this year and have spent $5,678,000 during the six months ended September 30, 2016, which is included in property, plant and equipment, net on the accompanying condensed consolidated balance sheets. We anticipate that the total cost of the new facility will be approximately $17,000,000. Following the relocation from our current Bozeman building into the new facility, we expect to be able to sell the current facility for $2,000,000 - $2,500,000 to partially offset the cost of the new building.

 

In August 2016, we announced that we plan to shut down both our Omaha and Traverse City Biological Indicator facilities and relocate those operations to the new Bozeman building. The move of these two facilities, along with the current Bozeman operations will begin in early calendar 2017 and is estimated to be completed by the end of calendar 2017. We estimate that the total costs of the restructuring will be $2,100,000 (which is comprised primarily of facility moving expenses, retention bonuses for existing personnel and payroll costs for duplicate headcount during the transition period) of which $220,000 was incurred during the three and six months ended September 30, 2016 and is reflected in general and administrative expenses in the accompanying condensed consolidated statements of income. After the completion of the relocation of all three facilities, we estimate that the annual savings will be approximately $750,000. In addition, after completing the move of the Omaha facility, we expect to be able to sell that building for approximately $1,000,000-$1,500,000 to partially offset the cost of the new Bozeman building.

 

We implemented a new ERP system which required a significant amount of cash. We incurred approximately $2,100,000 of expense associated with this project of which approximately $1,400,000 was incurred during the year ended March 31, 2016. On a go forward basis, we expect our annual operating costs for our ERP system to approximate $450,000 plus any costs necessary for additional projects and enhancements.

 

Working capital is the amount by which current assets exceed current liabilities. We had working capital of $12,541,000 and $13,215,000 respectively, at September 30, 2016 and March 31, 2016.

 

 
Page 19

 

 

On July 1, 2015, we entered into a five year agreement (the “Credit Facility”) for a $50,000,000 revolving line of credit (“Line of Credit”), a $20,000,000 term loan (the “Term Loan”) and up to $1,000,000 of letters of credit.

 

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

 

As of October 31, 2016, we had $54,000,000 in outstanding indebtedness and unused capacity under our Credit Facility of $11,500,000.

 

In April 2015, the SEC declared effective our Universal Shelf Registration Statement which allows us to sell, in one or more public offerings, common stock or warrants, or any combination of such securities for proceeds in an aggregate amount of up to $130,000,000. The terms of any offering, including the type of securities involved, would be established at the time of sale.

 

We routinely evaluate opportunities for strategic acquisitions. Future material acquisitions may require that we obtain additional capital, assume third party debt or incur other long-term obligations. We believe that we have the option to utilize both equity and debt instruments as vehicles for the long-term financing of our investment activities and acquisitions.

 

On November 7, 2005, our Board of Directors authorized a program to repurchase up to 300,000 shares of our outstanding common stock. Under the plan, the shares may be purchased from time to time in the open market at prevailing prices or in negotiated transactions off the market. Shares purchased will be canceled and repurchases will be made with existing cash reserves. We do not maintain a set policy or schedule for our buyback program. We have purchased 162,486 shares of common stock under this program from inception through September 30, 2016.

 

We have been paying regular quarterly dividends since 2003. Dividends per share paid by quarter were as follows:

 

   

Year Ending March 31,

 
   

2017