MOCON 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarter Ended March 31, 2011
o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission File Number 000-09273
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO x
5,281,824 Common Shares were outstanding as of April 30, 2011.
MOCON, INC. AND SUBSIDIARIES
For the Quarter Ended March 31, 2011
In this report, references to MOCON, the Company, we, our, or us, unless the context otherwise requires, refer to MOCON, Inc. and its subsidiaries.
All trademarks or trade names referred to in this report are the property of their respective owners.
MOCON, INC. AND SUBSIDIARIES
See accompanying notes to consolidated financial statements.
MOCON, INC. AND SUBSIDIARIES
See accompanying notes to consolidated financial statements.
MOCON, INC. AND SUBSIDIARIES
See accompanying notes to consolidated financial statements.
MOCON, INC. AND SUBSIDIARIES
Note 1 Condensed Consolidated Financial Statements
The condensed consolidated balance sheet as of March 31, 2011, the condensed consolidated statements of income for the three-month periods ended March 31, 2011 and 2010, and the condensed consolidated statements of cash flows for the three-month periods ended March 31, 2011 and 2010 have been prepared in accordance with accounting principles generally accepted in the United States of America. These interim unaudited condensed consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to fairly present the financial position, results of operations and cash flows at March 31, 2011, and for all periods presented. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted.
The results of operations for the three-month period ended March 31, 2011 are not necessarily indicative of operating results for the full year. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, previously filed with the Securities and Exchange Commission.
We are involved with the developing, manufacturing and marketing of measurement, analytical, monitoring and consulting products for customers in the barrier packaging, food, pharmaceutical, consumer products, industrial hygiene, air quality monitoring, oil and gas exploration and other industries throughout the world. We report our operating segments in accordance with accounting standards codified in ASC 280, Segment Reporting, with two operating segments (Lab Instruments and Field Instruments) that have been aggregated into one reporting segment for financial reporting purposes.
Principles of Consolidation
The consolidated financial statements include the accounts of MOCON, Inc. and its wholly-owned subsidiaries. All material inter-company balances and transactions have been eliminated in consolidation.
Foreign Currency Translation
The financial statements for operations outside the United States are maintained in their local currency. All assets and liabilities of our foreign subsidiaries are translated to United States dollars at period-end exchange rates, while revenue and expense accounts are translated at the average exchange rates during the period transactions occurred. Translation adjustments arising from the use of differing exchange rates are included in accumulated other comprehensive income or loss in stockholders equity. Gains and losses on foreign currency transactions are included in other income or loss.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Management adjusts such estimates and assumptions when facts and
circumstances change. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The carrying amount for cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximates fair value due to the immediate or short-term maturity of these financial instruments. The fair value of investments in marketable securities is based on quoted market prices and summarized in Note 5. See Note 7 for fair value disclosure of the investment in Luxcel.
Recently Adopted Accounting Pronouncements
In January 2010, the FASB updated the disclosure requirements for fair value measurements. The updated guidance requires companies to disclose separately the investments that transfer in and out of Levels 1 and 2 and the reasons for those transfers. Additionally, in the reconciliation for fair value measurement using significant unobservable inputs (Level 3), companies should present separately information about purchases, sales, issuances and settlements. We adopted the updated guidance on January 1, 2010, except for the disclosures about purchases, sales, issuances and settlements in the Level 3 reconciliation, which were effective for fiscal years beginning after December 15, 2010, and adopted on January 1, 2011. The adoption of the required guidance did not have an impact on our consolidated financial statements.
In December 2010, the FASB issued amended guidance to modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. We adopted the modified guidance on January 1, 2011. The adoption of the modified guidance did not have an impact on our consolidated financial statements.
Note 2 Inventories
Inventories consist of the following:
Note 3 Net Income Per Common Share
Basic net income per common share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted net income per common share is computed using the treasury stock method to compute the weighted average common stock outstanding assuming the conversion of potential dilutive common shares.
The following table presents a reconciliation of the denominators used in the computation of net income per common share basic, and net income per common share diluted, for the three-month periods ended March 31, 2011 and 2010:
Outstanding stock options totaling 123,200 and 222,763 at March 31, 2011 and 2010, respectively, have been excluded from the net income per common share calculations because the effect on net income per common share would not have been dilutive.
Note 4 Goodwill and Intangible Assets
As of March 31, 2011 and December 31, 2010, goodwill amounted to $3,276,521 and $3,160,858, respectively. The increase was primarily due to foreign currency translation relating to the acquisition of Paul Lippke Handels-GmbH. Other intangible assets (all of which are being amortized except projects in process) are as follows:
Total amortization expense for the three-month periods ended March 31, 2011 and 2010 was $20,535 and $23,842, respectively. Projects in process are not amortized until the patent or trademark is granted by the regulatory agency. Estimated amortization expense for the remainder of 2011 and each of the four succeeding fiscal years and thereafter based on the intangible assets as of March 31, 2011 is as follows:
Note 5 Marketable Securities
Marketable securities at March 31, 2011 consist of municipal bonds and certificates of deposits, and are classified as held-to-maturity. We classify our marketable securities as held-to-maturity due to our ability and intent to hold these securities until maturity or the call date as the case may be. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. A decline in the market value of any held-to-maturity security below the amortized cost basis that is deemed other than temporary is charged to income, resulting in the establishment of a new cost basis for the security. There was no impairment during the first three months of 2011, therefore, no adjustment to the amortized cost basis was made. Currently, all of our marketable securities mature in less than three years.
The amortized cost and fair value for held-to-maturity securities by major security type at March 31, 2011 and December 31, 2010 were as follows:
Note 6 Comprehensive Income
Other comprehensive income pertains to foreign currency translation adjustments that are not included in net income but rather are recorded directly in stockholders equity.
Note 7 Investment in Affiliated Company
In January 2010, we acquired a minority equity ownership interest in Luxcel Biosciences Limited (Luxcel) based in Cork, Ireland. The investment of approximately $3,625,000 (2,500,000) amounted to a 16.9% equity interest in Luxcel. We have evaluated the cost versus equity method of accounting for our investment in Luxcel and determined that we do not have the ability to exercise significant influence over the operating and financial policies of Luxcel and, therefore, account for our investment on a cost basis. In addition, we acquired warrants to purchase an additional 375,000 shares at 2.24 per share at any
time within three years from the date of the initial investment.
Luxcel has developed phosphorescence-based sensors that enable rapid, high-throughput screening and detection of bacterial contamination of food samples and non-invasive analysis of gas in food, beverage and pharmaceutical packaging, and one of the most specific measures of drug toxicity and metabolism within pharmaceutical research and development.
The investment in Luxcel is carried on our balance sheet at the original purchase price, adjusted for currency fluctuations. We believe that it is not feasible to readily determine the fair value of this investment. Information related to future cash flows of Luxcel is not readily available as the entity is a start-up research and development company and future cash flows are highly dependent on their ability to obtain additional funding, gain acceptance of their products in the marketplace, and obtain regulatory approvals. Luxcel has provided reimbursement for certain research and development costs incurred by us during the quarter ended March 31, 2011 in the amount of approximately $87,000, which has been reflected in the Condensed Consolidated Statements of Income as a reduction of research and development expenses.
As part of our relationship with Luxcel, we purchase sensors which accompany our instruments for sale to an end user and are required to pay a royalty to Luxcel on the sale of such instruments.
Note 8 Warranty
We provide a warranty for most of our products. Warranties are for periods ranging from ninety days to one year, and cover parts and labor for non-maintenance repairs, at our location. Operator abuse, improper use, alteration, damage resulting from accident, or failure to follow manufacturers directions are excluded from warranty coverage.
Warranty expense is accrued at the time of sale based on historical claims experience. Warranty reserves are also accrued for special rework campaigns for known major product modifications. We also offer extended warranty service contracts for select products when the factory warranty period expires.
Warranty provisions and claims for the three-month periods ended March 31, 2011 and 2010 were as follows:
Note 9 Income Taxes
As of March 31, 2011 and December 31, 2010, the liability for gross unrecognized tax benefits was $270,000 and $217,000, respectively. During the three months ended March 31, 2011, we increased the liability for gross unrecognized tax benefits by approximately $53,000 as a result of a $29,000 discrete item identified during the quarter, and $24,000 of other items consistent with past practice. It is expected that the amount of unrecognized tax benefits for positions which we have identified will not change significantly in the next twelve months. The year 2009 is currently under review by the Internal Revenue Service.
Note 10 Stock-Based Compensation
As of March 31, 2011, we have reserved 23,200 shares of common stock for options and other stock-based incentive awards that are still available for grant under our 2006 stock incentive plan, and 883,437 shares for options that have been granted under either the 2006 stock incentive plan or the 1998 stock option plan but have not yet been exercised. We issue new shares of common stock upon exercise of stock options. There were no options granted in the first three months of 2011.
Amounts recognized in the consolidated financial statements related to stock-based compensation are as follows:
The fair value of each 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, expected option life and expected forfeiture rate. We base our estimate of expected volatility for awards granted on daily historical trading data of our common stock for a period equivalent to the expected term of the award. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. We estimate the expected term consistent with historical exercise and cancellation activity of our previous share-based grants with a seven year contractual term. Forfeitures are based on historical experience. 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.
A summary of the option activity for the first three months of 2011 is as follows:
The total intrinsic value of options exercised was $133,688 and $115,775 during the three-month periods ended March 31, 2011 and 2010, respectively.
A summary of the status of our unvested option shares as of March 31, 2011 is as follows:
As of March 31, 2011, there was $499,932 of total unrecognized compensation cost related to unvested stock-based compensation granted under our plans. That cost is expected to be recognized over a weighted-average period of 1.4 years. The total fair value of option shares vested during the three-month periods ended March 31, 2011 and 2010 was $53,819 and $27,880, respectively.
Note 11 Derivatives
In May 2010, we entered into a foreign currency forward exchange contract, principally to hedge an intercompany loan denominated in euros. This contract did not qualify for hedge accounting under the Derivatives and Hedging Topic of the Codification. As a result, gains or losses related to mark-to-market adjustments on this foreign currency forward exchange contract were recognized as other income or expense in the income statement during the period in which the instrument was outstanding. This contract, with a notional amount totaling approximately $3,089,000, matured in January 2011 which coincided with the settlement of the intercompany loan. We do not utilize derivative instruments for trading or other speculative purposes.
This Managements Discussion and Analysis provides material historical and prospective disclosures intended to enable investors and other users to assess our financial condition and results of operations. Statements that are not historical are forward-looking and involve risks and uncertainties discussed below under the caption Forward-Looking Statements. The following discussion of the results of operations and financial condition of MOCON should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere in this report.
Description of Business
MOCON, Inc. designs, manufactures, markets and services products and provides consulting services primarily in the measurement and analytical instrument and services markets. Our products include instruments that detect, measure and monitor gases and chemical compounds. We continually seek growth opportunities through technological and product improvement, by acquiring and developing new products, and acquiring new companies.
We have three primary operating locations in the United States Minnesota, Colorado and Texas and foreign offices in Germany and China. We use a mix of direct sales force and independent sales representatives to market our products and services in the United States, Canada, Germany and China and use a network of independent sales representatives to market and service our products and services in other foreign countries.
Historically, a significant portion of our sales has come from international customers. In recognition of the importance of our international customers, we maintain a physical presence in Europe through our wholly-owned subsidiary located in Neuwied, Germany, and in Asia through a sales office in Shanghai, China.
Our ongoing plans for growth include substantial funding for research and development to foster new product development together with strategic acquisitions where appropriate.
Our permeation products consist of instruments and services that measure the rate at which various gases and vapors transmit through a variety of materials. This is our original business, and still contributes the largest portion of our consolidated revenues. These products perform measurements under precise temperature, pressure and relative humidity conditions. The principal market for these products consists of manufacturers of packaging materials and the users of such materials such as companies in the food, beverage, pharmaceutical and consumer product industries. We invest a portion of our R&D dollars each year on new product development in this area, which has resulted in continuous growth and market leadership. For example, our AQUATRAN® ultra-high sensitivity, trace moisture permeation analyzer has been increasingly accepted as the standard test instrument of choice in the flat panel, solar cell and electronics industries.
For permeation customers who do not desire to purchase our instrumentation, we offer a range of consulting and testing services. This part of our business is also growing and we are expanding the model beyond the borders of North America. Today, we have MOCON-owned laboratories in the United States, Germany and China, and collaborative laboratories in India, Canada and Ireland. We hope to have an additional collaborative laboratory in South America in the near future.
The instruments in our packaging products group are used to measure leaks and to analyze the gaseous headspace of sealed packages, as applied in the food, beverage, pharmaceutical, medical device and
other industries. We have recently developed and introduced our OpTech®-O2 Platinum oxygen analyzer which incorporates sensor technology developed by Luxcel Biosciences Limited (Luxcel). This instrument is able to measure the oxygen concentration in food, beverage, pharmaceutical or medical device packages without piercing the package. This new technology enables manufacturers in these industries to track and trace their products during the manufacturing and distribution phase, and follow changes in oxygen levels as they occur.
We also manufacture advanced gas analysis and monitoring instrumentation used in applications such as oil and gas exploration, process gas analysis, industrial hygiene and safety, environmental air monitoring and homeland security. The two principal instruments in this group are the gas chromatographs and total hydrocarbon analyzers. These instruments are typically installed in fixed locations at the monitoring sites and generally perform their functions of detecting and measuring various hydrocarbons continually or at regular intervals. Our new BevAlert® system tests the purity of carbon dioxide used to carbonate soft drinks, beer and mineral waters around the world. As manufacturers of these consumer beverages expand their businesses and operations, especially into developing countries, they are increasingly investing in better instrumentation to ensure the final product is free of contaminants. Our BevAlert system is well suited to addressing the concerns of manufacturers of beverages, and we believe this is a growth opportunity for us, as our sales of the BevAlert system have been ramping up over the past two years. We also manufacture and sell gas sensors and detectors which are sold to original equipment manufacturers (OEMs) of mobile monitoring equipment.
Our newest product offering is focused on the food safety market. With the sensor technologies and expertise we acquired with our recent investment in Luxcel, coupled with our instrumentation expertise, we developed our GreenLight food safety test apparatus. This breakthrough technology permits, for the first time, determination of the presence or absence of bacteria in food products or ingredients in as little as one to six hours. This is a dramatic improvement over the 48 to 72 hour tests currently being used by the food industry. There are two models of the GreenLight currently available, with another to follow in mid-2011.
Results of Operations
The following table sets forth the relationship between various components of our results of operations, stated as a percent of sales, for the three-month periods ended March 31, 2011 and 2010:
Comparison of Financial Results for the Three-Month Periods Ended March 31, 2011 and 2010
Sales for the three-month period ended March 31, 2011 were $9,075,000, up 28% compared to $7,093,000 for the same period in 2010. We experienced increases in all four of our major product groups as we continue to see signs of improvement in the global economy. Sales to domestic and foreign customers increased 20% and 34%, respectively, over the prior year. Domestic and foreign sales accounted for 43% and 57%, respectively, of our consolidated first quarter sales in 2011, and 45% and 55% of our consolidated sales, respectively, for the same period in 2010. Sales in Asia increased 51% in the current quarter compared to the first quarter in 2010 with South Korea, Turkey and the Philippines accounting for the majority of the increase.
The following table summarizes total sales by product line for the three-month periods ended March 31, 2011 and 2010:
The following table sets forth the relationship between various components of domestic and foreign sales for the three-month periods ended March 31, 2011 and 2010:
Permeation Products and Services Sales of our permeation products and services increased 37% for the first quarter ended March 31, 2011 compared to the same period in the prior year, and accounted for 62% and 58% of our consolidated first quarter sales in 2011 and 2010, respectively. We believe this increase is partially related to the need for packaging suppliers to develop environmentally friendly packaging materials. The increase in sales came from both our domestic and foreign markets, as domestic and foreign sales of permeation products and services increased 67% and 25%, respectively, for the first quarter 2011 compared to the same period in 2010.
Gas Analyzers, Sensors and Detectors Sales of our gas analyzers, sensors and detector products and services, which accounted for 17% and 19% of our consolidated first quarter sales in 2011
and 2010, respectively, increased 15% during the first quarter 2011 compared to the same period in 2010. Within this group, sales of total hydrocarbon analyzer instruments for use primarily in the environmental monitoring and well-logging areas, accounted for the majority of the increase.
Packaging Products and Services Sales of our packaging products and services, which accounted for 14% and 15% of our consolidated first quarter sales in 2011 and 2010, respectively, increased 16% during the first quarter 2011 compared to the same period in 2010. This group consists of headspace analyzers and leak detection instruments. The growth in the current quarter came from both our domestic and foreign markets due exclusively to increased sales of headspace analyzers.
Other Instruments and Services Sales in our other instruments and services category, which accounted for 7% and 8% our consolidated first quarter sales in 2011 and 2010, respectively, increased 14% in the first quarter 2011, compared to the same period in 2010. This increase was primarily the result of increased sales of specialty projects performed by our analytical testing and consulting groups and non-MOCON products sold by our German subsidiary.
The gross profit margin for our product sales was 65.2% for the three-month period ended March 31, 2011, compared to 62.4% for the three-month period ended March 31, 2010. This increase was due primarily to the favorable sales mix and higher production volume in the first quarter 2011. The gross profit margins for our consulting services were 53.3% and 46.7%, respectively, for the three-month periods ended March 31, 2011 and 2010. This increase was due primarily to the higher sales volume in the current quarter which more adequately covered our fixed costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $3,205,000 in the three-month period ended March 31, 2011, compared to $2,734,000 in the same period of 2010. The increase was primarily related to increased headcount, benefits and incentive compensation, and travel and marketing expense.
Research and Development Expenses
Research and development expenses were $557,000, or 6.1% of sales in the first quarter 2011, compared to $548,000, or 7.7% of sales, in the same period of 2010. The current period expense of $557,000 is net of approximately $87,000 received from Luxcel for certain collaborative research efforts. We are committed to spending 6% to 8% of our annual consolidated sales on research and development efforts.
Other income for the three-month periods ended March 31, 2011 and 2010 was as follows:
The foreign currency gain in the first quarter 2010 was primarily the result of adjusting a euro-based intercompany loan obligation to market value at March 31, 2010.
Income Tax Expense
Our provision for income taxes was 36.2% and 29.9% of income before income taxes for the first quarters ended March 31, 2011 and 2010, respectively. The higher rate in the first quarter 2011 was due to certain discrete adjustments which will not affect the core effective tax rate for the year. The lower rate in the first quarter 2010 was due primarily to foreign tax credits generated by the repatriation of funds from Germany.
Based on current projected annual operating results and current income tax rates, we expect the effective tax rate for the remainder of 2011 to be in the range of 31% to 34%. This rate fluctuates over time based on the income tax rates in the various jurisdictions in which we operate, and also the level of profits in those jurisdictions.
Net income was $1,317,000 in the first quarter 2011, compared to $922,000 in the first quarter 2010. Diluted net income per share was $0.24 and $0.17 in the first quarters of 2011 and 2010, respectively.
Liquidity and Capital Resources
We have historically financed our operations, capital equipment and other cash requirements through our cash flows generated from operations. Total cash, cash equivalents and marketable securities increased $1,838,000 during the first three months of 2011 to $14,239,000 as of March 31, 2011, compared to $12,401,000 at December 31, 2010. The increase was primarily due to the cash provided by operating activities in the amount of $2,355,000. Our working capital as of March 31, 2011 was consistent, decreasing $62,000 to $13,705,000 as compared to $13,767,000 at December 31, 2010.
We invest a large portion of our available cash in highly liquid marketable securities consisting primarily of certificates of deposits, municipal bonds, and money market funds. Our investment policy is to manage these assets to preserve principal, maintain adequate liquidity at all times, and maximize returns subject to investment guidelines we maintain.
We believe that a combination of our existing cash, cash equivalents and marketable securities, and an expected continuation of cash flow from operations, will continue to be adequate to fund our operations and working capital, capital expenditures, dividend payments and any authorized stock repurchases for at least the next twelve months. We currently do not have any committed lines of credit or other credit facilities.
One of our strategic objectives is, as market and business conditions warrant, to consider acquisitions of, or investments in, businesses, products and/or technologies. In this regard, in January 2010, we made the investment in Luxcel, to help us establish a stronger presence in the food safety market. If we consummate one or more additional acquisition or investment opportunities, the cost of which exceeds our existing cash resources, we may need to fund such activities with a portion of our cash balances and debt and/or equity financing. If we need to raise additional capital, an equity-based or equity-linked financing may be used which could be dilutive to existing shareholders. If we raise additional funds by issuing debt, we may be subject to restrictive covenants that could limit our operational flexibility and higher interest expense could dilute earnings per share.
Cash Flow from Operating Activities
Our primary source of funds is cash provided by operating activities which totaled $2,355,000 and
$1,487,000 in the first three months of 2011 and 2010, respectively. The key components of the cash provided by operating activities in 2011 were the income for the period, decreases in accounts receivable and prepaid income taxes and an increase in accounts payable, partially offset by a decrease in the accrual for compensation and related expenses, and an increase in inventories.
Cash Flow from Investing Activities
Cash used in investing activities totaled $2,214,000 and $1,810,000 in the first three months of 2011 and 2010, respectively. The primary reasons for cash used in investing activities in 2011 were the net purchases of marketable securities of $1,970,000 and capital expenditures of $216,000, the majority of which relates to laboratory and production equipment.
Cash Flow from Financing Activities
Cash used in financing activities totaled $398,000 and $361,000 in the first three months of 2011 and 2010, respectively. During the first three months of 2011 and 2010, we made dividend payments to our shareholders of $500,000 and $467,000, respectively. Partially offsetting the impact of the dividend payments were the proceeds from the exercise of stock options in the amounts of $78,000 and $104,000, respectively, in the first three months of 2011 and 2010.
We currently are not authorized by our Board of Directors to make repurchases of our common stock.
We refer you to our Annual Report on Form 10-K for the year ended December 31, 2010 for a summary of our contractual obligations. In May 2010, we entered into a foreign currency forward exchange contract to act as a hedge against fluctuations in a euro-denominated intercompany note. This contract had a notional amount totaling approximately $3,089,000, bearing an exchange rate of 1.2358 U.S. dollars per euro and matured in January 2011.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, as defined by the rules and regulations of the SEC, that have or are reasonably likely to have a material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. As a result, we are not materially exposed to financing, liquidity, market or credit risk that could arise if we had engaged in these arrangements.
Recently Issued Accounting Guidance
There was no new accounting guidance issued during the first three months of 2011 that was applicable to our company.
Critical Accounting Policies
Our significant accounting policies are described in Note 1 to our consolidated financial statements. This Managements Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Securities and Exchange Commission has defined a companys most critical accounting policies as those that are most important to the portrayal of its financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as
a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the following critical accounting policies. Although we believe that our estimates and assumptions are reasonable, they are based upon information available when they are made. Actual results may differ significantly from these estimates under different assumptions or conditions.
Revenue recognition We recognize revenue when it is realized or realizable and earned. We consider revenue realized or realizable when persuasive evidence of an arrangement exists, the product has been shipped or the services have been provided to the customer, title and risk of loss of products has passed to the customer, the sales price is fixed or determinable, and collectability is reasonably assured. Our terms are F.O.B. shipping point with no right of return, except in rare cases, and customer acceptance of our products is not required. The revenue recognition policy does not differ among the various product lines, the marketing venues, or various geographic destinations. We do not have distributors who stock our equipment. We do not offer rebates, price protection, or other similar incentives, and discounts when offered are recorded as a reduction in revenue. We record revenue net of sales tax charged to the customer.
Revenue for preventive maintenance agreements is recognized on a per visit basis and extended warranties on a straight-line basis over the life of the contracts.
Our accounting treatment for recognizing revenue from shipments with multiple element arrangements was changed in the first quarter 2010, as we adopted ASC Topic 605. This guidance provides that the overall arrangement fee will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, as demonstrated by vendor-specific objective evidence (VSOE) or third-party evidence (TPE). Where VSOE or TPE is not available, revenue will be allocated using an estimated selling price. This change did not have a material impact on our consolidated financial statements.
Allowance for doubtful accounts and sales returns Our allowance for doubtful accounts and sales returns is for accounts receivable balances that are estimated to be uncollectible as well as anticipated sales returns. The reserve is based on a number of factors, including: (1) an analysis of customer accounts and (2) our historical experience with accounts receivable write-offs and sales returns. The analysis includes the age of the receivable, the financial condition of a customer or industry and general economic conditions. We believe our financial results could be materially different if historical trends are not predictive of future results or if economic conditions worsened for our customers. In the event we determine that a smaller or larger allowance for doubtful accounts is appropriate, we would record a credit or charge to selling, general and administrative expense in the period that we made such a determination. As of March 31, 2011, we had $150,000 reserved against our accounts receivable for doubtful accounts and sales returns.
Accrual for excess and obsolete inventories We perform a quarterly analysis to identify excess and obsolete inventory. We record a charge to cost of sales for amounts identified. Our analysis includes inventory levels, the nature of the components and their inherent risk of obsolescence and the on-hand quantities relative to the sales history of that component. We believe that our financial results could be materially different if historical trends are not predictive of future results or if demand for our products decreased because of economic or competitive conditions or otherwise. As of March 31, 2011, we had $332,000 accrued for excess and obsolete inventories.
Recoverability of long-lived assets We assess the recoverability of goodwill and other long-lived assets annually or whenever events or changes in circumstances indicate that expected future undiscounted cash flows might not be sufficient to support the carrying amount of an asset. We deem an asset to be impaired if a forecast of undiscounted future operating cash flows is less than an assets carrying amount. If an asset is determined to be impaired, the loss is measured as the amount by which the carrying value of the asset exceeds its fair value. Changes in our business strategies, changes in the economic environment in which we operate, competitive conditions, and other factors could result in
future impairment charges.
Accrued product warranties Our products are generally covered by a warranty, with warranty periods ranging from ninety days to one year from the date of sale. Estimated warranty costs are accrued in the same period in which the related revenue is recognized, based on anticipated parts and labor costs, utilizing historical experience. Additional warranty reserves are also accrued for major rework campaigns. We periodically assess the adequacy of our warranty reserves based on changes in these factors and record any necessary adjustments if actual claim experience indicates that adjustments are necessary. Although we believe the likelihood to be relatively low, warranty claims experience could be materially different from actual results due to manufacturing changes that could impact product quality, a change in our warranty policy in response to industry trends, as yet unrecognized defects in products sold, or other factors. As of March 31, 2011, we had $220,000 accrued for future estimated warranty claims.
Income taxes In the preparation of our consolidated financial statements, management is required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax exposures together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our Consolidated Balance Sheets.
Management reviews the deferred tax assets for recoverability on a quarterly basis and assesses the need for valuation allowances. These deferred tax assets are evaluated by considering historical levels of income, estimates of future taxable income streams and the impact of tax planning strategies. A valuation allowance is recorded to reduce deferred tax assets when it is determined that it is more likely than not that we would not be able to realize all or part of our deferred tax assets. At March 31, 2011 and December 31, 2010, we provided a valuation allowance in the approximate amount of $318,000 against our net deferred tax assets, related primarily to the capital loss carryforward.
This quarterly report on Form 10-Q contains or incorporates by reference not only historical information, but also forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by those sections. In addition, we or others on our behalf may make forward-looking statements from time to time in oral presentations, including telephone conferences and/or web casts open to the public, in press releases or reports, on our website or otherwise. All statements other than statements of historical facts included in this report that address activities, events or developments that we expect, believe or anticipate will or may occur in the future are forward-looking statements including, in particular, the statements about our plans, objectives, strategies and prospects regarding, among other things, our financial condition, results of operations, addressable market size estimates and business. We have identified some of these forward-looking statements with words like believe, may, could, might, forecast, possible, potential, project, will, should, expect, intend, plan, predict, anticipate, estimate, approximate or continue and other words and terms of similar meaning. These forward-looking statements may be contained in the notes to our consolidated financial statements and elsewhere in this report, including under the heading Managements Discussion and Analysis of Financial Condition and Results of Operations.
Forward-looking statements involve risks and uncertainties. These uncertainties include factors that affect all businesses as well as matters specific to us. Some of the factors known to us that could cause our actual results to differ materially from what we have anticipated in our forward-looking statements are described below.
· Increases in prices for raw materials;
· Risks inherent in operating internationally and selling and shipping our products and purchasing our products and components internationally;
· The recent events in Japan could negatively impact our sales;
· Fluctuations in foreign currency exchange rates and interest rates;
· Failure to develop new products and technologies, delays in new product introduction and lack of market acceptance of new products;
· Failure to effect strategic acquisitions and integrate effectively newly acquired operations;
· Incurrence of additional debt, contingent liabilities and expenses in connection with future acquisitions;
· Exposure to assertions of intellectual property claims and failure to protect our intellectual property;
· Disruption in our ability to manufacture our products or the ability of our key suppliers to provide us products or components or raw materials for products resulting in our inability to supply market demand for our products;
· Reliance on independent sales distributors and sales associates to market and sell our products;
· Highly competitive nature of the markets in which we sell our products and the introduction of competing products;
· Loss of customers;
· Failure to retain senior management or replace lost senior management;
· Employee slowdowns, strikes or similar actions;
· Reliance on our management information systems for inventory management, distribution, accounting and other functions;
· Effects of any pending or threatened litigation;
· Failure to comply with applicable laws and regulations and adverse changes in applicable laws or regulations;
· Changes in generally accepted accounting principles; or
· Conditions and changes in general economic and business conditions.
For more information regarding these and other uncertainties and factors that could cause our actual results to differ materially from what we have anticipated in our forward-looking statements or could otherwise materially adversely affect our business, financial condition or operating results, see our annual report on Form 10-K for the fiscal year ended December 31, 2010 under the heading Part I Item 1A. Risk Factors on pages 9 through 14 of such report.
We wish to caution readers not to place undue reliance on any forward-looking statement that speaks only as of the date made and to recognize that forward-looking statements are predictions of future results, which may not occur as anticipated. Actual results could differ materially from those anticipated in the forward-looking statements and from historical results, due to the risks and uncertainties described above, as well as others that we may consider immaterial or do not anticipate at this time. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we do not know whether our expectations will prove correct. The expectations reflected in our forward-looking statements can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties, including those described above. The risks and uncertainties described above are not exclusive and further information concerning us and our business, including factors that potentially could materially affect our financial results or condition, may emerge from time to time. We assume no obligation to update forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements. We advise you, however, to consult any further disclosures we make on related subjects in our quarterly reports on Form 10-Q and current reports on Form 8-K we file with or furnish to the Securities and Exchange Commission.
Equity Price and Interest Rate Risk
All of our marketable securities, some of which are insured by the FDIC, are at fixed interest rates and mature within less than three years; therefore, we believe that the market risk arising from the holding of these financial instruments is minimal.
Foreign Currency Risk
Historically, in excess of 50% of our consolidated sales have been to international destinations. Since we invoice most of these customers in U.S. dollars, we do not have significant exposure to foreign currency transaction risk. We invoice a small amount to our international customers in their local currency which exposes us to some transaction gain or loss when converting their payments into U.S. dollars. We also pay a small number of our international suppliers in their local currency which exposes us to transaction gain or loss. However, these have not resulted in material amounts in the past.
Our foreign operations expose us to foreign currency exchange risk when the euro and yuan currency results of operations are translated to U.S. dollars. We historically have not experienced any material foreign currency translation gains or losses, however, we realized a foreign currency transaction gain in the first half of 2010 relating to the valuation of a euro-denominated intercompany loan which originated in the first quarter 2010. To mitigate the effect of any further currency fluctuations, we purchased a foreign currency forward contract which acted as a hedge against any additional gains or losses.
Our investments in foreign subsidiaries translated into U.S. dollars are not hedged. Any changes in foreign currency exchange rates would be reflected as a foreign currency translation adjustment, a component of accumulated other comprehensive income in stockholders equity, and would not impact our net income.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) that are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported, within the time periods specified in the Securities and Exchange Commissions rules and forms and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and we necessarily are required to apply our judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered in this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of such period, to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms, and that material information relating to our Company and our consolidated subsidiaries is made known to management, including our Chief Executive Officer and Chief Financial Officer, particularly during the period when our periodic reports are being prepared.
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting that occurred during our quarter ended March 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
We are affected by risks specific to us as well as factors that affect all businesses operating in a global market. The significant factors known to us that could materially adversely affect our business, financial condition or operating results or could cause our actual results to differ materially from our expectations are described in our annual report on Form 10-K for the fiscal year ended December 31, 2010 under the heading Part I Item 1A. Risk Factors. There has been no material change in those risk factors.
Unregistered Sales of Equity Securities
We did not sell any equity securities of MOCON, Inc. during the first quarter ended March 31, 2011 that were not registered under the Securities Act of 1933.
Issuer Repurchases of Equity Securities
Other than the withholding of 12,137 shares of our common stock in connection with the cashless net exercise of stock options to pay the exercise price of such options, we did not repurchase any equity securities of MOCON, Inc. during the first quarter ended March 31, 2011.
The following exhibits are being filed or furnished with this quarterly report on Form 10-Q:
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED MARCH 31, 2011