Mesa Laboratories, Inc. — Form 10-K Summary
Reporting period: Fiscal year ended March 31, 2018, filed June 5, 2018. The request metadata identifies “2016 Q4,” but the supplied filing is the fiscal 2018 Form 10-K.
Business context
Mesa operates four divisions serving regulated niche markets: Sterilization and Disinfection Control, Instruments, Cold Chain Monitoring, and Cold Chain Packaging. Revenue is generated from product sales and services, with 59% of fiscal 2018 revenue from the United States and 41% from foreign markets.
The company completed three acquisitions during fiscal 2018: Hucker in May 2017, Simicon in October 2017, and BAG Health Care’s Hygiene Monitoring business in November 2017. Mesa continued investing in its new Bozeman facility, relocating Omaha and Traverse City operations and expanding its European infrastructure and ERP implementation.
Financial performance and liquidity
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Revenue | $96.2 million | $93.7 million | +3% |
| Gross profit | $54.6 million | $53.2 million | +3% |
| Gross margin | 57% | 57% | Flat |
| Operating income | $2.2 million | $16.3 million | -87% |
| Net income (loss) | $(3.0) million | $11.2 million | Decline of $14.1 million |
| Diluted EPS | $(0.79) | $2.91 | Decline |
| Operating cash flow | $24.8 million | $7.8 million | +220% |
Adjusted operating income, excluding amortization, stock compensation, and goodwill impairment, was $24.6 million versus $24.2 million in the prior year. The company reported a 17% adjusted return on invested capital, while GAAP return on assets and stockholder investment were negative.
- Segment revenue: Sterilization and Disinfection Control increased 12% to $43.3 million; Instruments declined 1% to $34.1 million; Cold Chain Monitoring increased 3% to $13.0 million; and Cold Chain Packaging declined 27% to $5.8 million.
- Cash and working capital: Cash was $5.5 million at March 31, 2018, versus $5.8 million a year earlier. Working capital declined to $14.7 million from $19.2 million.
- Debt: Total debt was $46.6 million, comprising $28.0 million under the revolving line and $18.6 million under the term loan. The debt is variable-rate and secured by company assets. Mesa was in compliance with its debt covenants at year-end.
- Liquidity capacity: The credit facility provides an $80 million revolving line, a $20 million term loan, up to $2.5 million of letters of credit, and an accordion feature for up to an additional $100 million subject to conditions. As of May 31, 2018, outstanding debt was $43.6 million and unused capacity was $55.0 million.
- Capital allocation: The company paid $2.4 million in dividends, or $0.64 per share, and made no share repurchases during fiscal 2018. An additional $0.16 quarterly dividend was declared in April 2018.
Material changes versus the prior comparable period
- Revenue grew modestly due primarily to acquisitions and strong Sterilization and Disinfection Control performance, while organic revenue declined 1%.
- Cold Chain Packaging revenue fell 27% because of reduced orders from its largest customer and lengthy sales cycles. Its gross margin fell to 18% from 25%.
- Mesa recorded a $13.8 million goodwill impairment charge related to Cold Chain Packaging after lowering its revenue, margin, and profitability expectations.
- Inventory reserves increased by $2.1 million, including a $1.7 million Cold Chain Monitoring reserve related to discontinued or obsolete products. Without the additional inventory reserves, company-wide gross margin would have been approximately 59% rather than 57%.
- General and administrative expense increased 15%, primarily from personnel, amortization, employee relocation, and acquisition-related costs. Selling expense declined 11% and research and development expense declined 15%.
- Operating cash flow improved significantly, helped by lower inventory balances and the absence of the prior-year $9.6 million contingent consideration payment.
- Debt declined by approximately $9.0 million from March 31, 2017, despite $11.0 million of new borrowings during fiscal 2018.
Guidance, outlook, risks, and unusual items
Management expects continued growth through organic initiatives, improved commercial channels, new products, and acquisitions. Management stated that Sterilization and Disinfection Control markets remain strong and that demand for Instruments, Cold Chain Monitoring, and related services remains solid, although these businesses are more sensitive to economic conditions and customer capital spending.
Management expects the largest Cold Chain Packaging customer’s order rate to normalize during fiscal 2019, but emphasized that this expectation is not guaranteed. The company may consider a disposition of the division if performance does not trend toward revised targets. Remaining Cold Chain Packaging goodwill was $1.4 million and related intangible assets were $4.1 million at March 31, 2018, creating potential exposure to additional impairment charges.
- The company is exposed to variable interest rates; a one-percentage-point increase in rates would have increased annual interest expense by approximately $527,000 based on fiscal 2018 debt levels.
- Facility relocation costs totaled $842,000 in fiscal 2018, with total relocation costs expected to reach approximately $2.0 million. Completion was expected by June 30, 2018.
- The Tax Cuts and Jobs Act produced a provisional net tax benefit of $59,000. The company had not completed its accounting for all tax effects as of year-end.
- A putative class action filed in February 2018 alleges violations of the Telephone Consumer Protection Act involving unsolicited fax advertising. The company intends to defend the case but cannot estimate the potential liability.
- Key risks include acquisition integration and valuation, goodwill and intangible-asset impairment, regulatory compliance, product liability, competition, distributor dependence, foreign currency exposure, cybersecurity, supply interruptions, litigation, and changes in healthcare or tax policy.
- Management and the independent auditor concluded that internal control over financial reporting was effective as of March 31, 2018. The audit excluded fiscal 2018 acquired entities from management’s assessment due to acquisition timing; those entities represented 12% of total assets and 3% of revenue.
Investor verification checklist
- Verify the fiscal-period mismatch: the supplied document is a fiscal-year 2018 Form 10-K, not a 2016 Q4 filing.
- Assess whether Cold Chain Packaging revenue, margins, customer concentration, and profitability recover as management expected.
- Reconcile GAAP net loss and operating income with adjusted operating income and evaluate the recurring nature of excluded items.
- Review the $13.8 million goodwill impairment, remaining goodwill and intangible assets, and sensitivity to further underperformance.
- Monitor variable-rate debt, covenant compliance, refinancing requirements, and available credit capacity.
- Evaluate cash generation after acquisitions, facility relocation spending, dividends, debt service, and potential future acquisitions.
- Review the TCPA litigation, tax uncertainties, inventory reserves, and pending regulatory or product-related matters.