10-K 1 moco20161231_10k.htm FORM 10-K moco20161231_10k.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________________________

FORM 10-K

(Mark one)

ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2016

 

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ________________ to __________________.

 

Commission File No.: 000-09273

____________________

 

Mocon, inc.

(Exact name of registrant as specified in its charter)

 

Minnesota

41-0903312

(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
   

7500 Mendelssohn Avenue North

 

Minneapolis, Minnesota

55428
(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code: (763) 493-6370

 

Securities registered under Section 12(b) of the Act:

 

Title of each class

Name of each exchange on which registered

Common Stock, par value $0.10 per share

The NASDAQ Stock Market LLC

  (NASDAQ Global Market)

Securities registered under Section 12(g) of the Act: None

 


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   YES ☐ NO ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  YES ☐ NO ☒

 

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 (§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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒

 

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.  Large accelerated filer ☐ Accelerated filer ☒ Non-accelerated filer (do not check if a smaller reporting company) ☐ Smaller reporting company ☐

 

Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Act). YES ☐ NO ☒

 

The aggregate market value of the registrant’s common stock, excluding outstanding shares beneficially owned by directors and executive officers, computed by reference to the price at which the common stock was last sold as of June 30, 2016 (the last business day of the registrant’s second quarter) as reported by the Nasdaq Global Market System, was $76,782,697.

 

As of March 3, 2017, 5,854,761 shares of common stock of the registrant were deemed outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III of this annual report on Form 10-K incorporates by reference information (to the extent specific sections are referred to herein) from the registrant’s Proxy Statement for its 2017 Annual Meeting of Shareholders to be held May 25, 2017.

 



 
 

 

 

part i

 

This annual report on Form 10-K 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. We refer you to the information under the heading “Part I. Item 1. Business – Forward-Looking Statements.”

 

As used in this annual report on Form 10-K, references to “MOCON, the “Company,” “we,” “our” or “us,” unless the context otherwise requires, refer to MOCON, Inc. and our subsidiaries.

 

All trademarks or trade names referred to in this report are the property of their respective owners.

 

Item 1.

BUSINESS

 

MOCON, Inc. designs, manufactures, markets and services products, and provides consulting services, primarily in the test and measurement, analytical instrument and services markets. Our products include instruments that detect, measure and monitor gases and other chemical compounds which help our customers improve the quality of their products, as well as develop new products.

 

Our gas and vapor permeation instruments were first used in the food packaging industry, starting in the 1970s, to measure small amounts of moisture which can adversely affect dry cereals and other food packaging. Today our core business is involved in the detection, measurement and analysis of vapors and gases, serving industries far beyond food packaging. Our products serve markets such as foods, beverages, pharmaceuticals and consumer products, oil and gas exploration and industrial and environmental safety.

 

Our principal business strategy is to employ our product development and technological capabilities, manufacturing processes and revenue and marketing skills where we can successfully penetrate the market and become a leader in the segment. Our management team continually emphasizes product innovation, product performance, quality improvements, cost reductions and other value-adding activities. We seek growth opportunities through technological and product improvement, by acquiring and developing new products, by acquiring companies or new product lines, or by purchasing the rights to existing technologies.

 

MOCON, Inc. was incorporated as a Minnesota corporation in February 1966 as Modern Controls, Inc., and was initially involved in the commercialization of technology developed for the measurement of water vapor permeating through food packaging materials. Today, the key drivers in the industries we serve are food and beverage product safety and quality, improving workplace safety, supplying testing equipment for oil and gas exploration, and analyzing the quality of air both indoors and outdoors as well as water.

 

Our current plans for growth include continued substantial funding for research and development to foster new product development and to pursue strategic acquisitions and investments where appropriate. 

 

Our principal executive offices and worldwide headquarters are located at 7500 Mendelssohn Avenue North, Minneapolis, Minnesota 55428, USA, and our telephone number is (763) 493-6370. Our website address is www.mocon.com. The information contained on our website or connected to our website is not incorporated by reference into this annual report on Form 10-K and should not be considered part of this report.

 

 
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We make available, free of charge on our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. We also make available, free of charge and through our website, to any shareholder who requests, the charters of our Board committees and our Code of Ethics. Requests for copies can be directed to our Chief Financial Officer at the address and phone number above.

 

Products and Services

 

We develop, manufacture, market and service test and measurement, analytical and monitoring instruments and systems used to detect, measure and analyze gases and other chemical compounds, as well as provide related consulting services. Please see our consolidated financial statements beginning on page F-1 for financial information concerning our business, including our revenue, net income and net assets.

 

Package Testing Products and Services

 

We manufacture and sell three primary products in this group: headspace analyzers, leak detection equipment and gas mixers. Our headspace analyzer products are used to analyze the amount and type of gas present in the headspace of flexible and rigid packages, as applied to gas flushing in modified or controlled atmosphere packaging. The principal market for these products consists of packagers of foods, beverages and pharmaceuticals. Our headspace analyzer products include the PAC CHECK®, CheckMateTM and CheckPointTM series of off-line headspace analyzers and the MAP Check 3TM series of on-line analyzers for continuous and intermittent monitoring of Modified Atmosphere Packaging (MAP) and other gas flushing operations.

 

Our leak detection products detect leaks in sterile medical trays, food pouches, blister packs and a wide range of other sealed packages. We currently manufacture three types of leak detection instruments. The first type is a non-destructive leak detector that senses small amounts of carbon dioxide escaping from a package or tray. The second type of instrument detects leaks and checks for seal integrity by applying and measuring pressure within a package. The third type pulls a vacuum on a package and looks for vacuum or gas flow changes. The principal markets for these products are packagers of sterile medical items, pharmaceuticals and food products. Our leak detection products include the LeakMatic IITM and LeakPointer IITM series of instruments. During 2016, we introduced a modular leak testing product named LeakProtego that is designed to detect micro leaks in packages.

 

Our gas mixers are used in the food production environment to assure that the package has been properly flushed with the correct mixture of gases. Our gas mixer products include the MAP Mix Provectus and MAP Mix 9001 on-line instruments.

 

Our package testing products and services group accounted for 48 percent, 44 percent and 44 percent of our consolidated revenue in 2016, 2015 and 2014, respectively.

 

 
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Permeation Products and Services

 

Our permeation products consist of systems and services that measure the rate at which various gases and vapors transmit through a variety of materials. These products perform measurements under precise temperature, pressure and relative humidity conditions. The principal market for these products consists of manufacturers of packaging materials, including manufacturers of papers, plastic films, coatings and containers and the users of such packaging materials, such as companies in the food, beverage, pharmaceutical and consumer product industries. Other customers include manufacturers of flat panel displays, solar panels, electronics, and many other sophisticated materials.

 

We also provide certain laboratory testing services to companies that have a need for permeation data. These services consist primarily of testing film and package permeation for companies that:

 

 

wish to outsource their testing needs to us;

 

are interested in evaluating our instrumentation prior to purchase; or

 

have purchased our products but have a need for additional capacity.

 

Our permeation products and services accounted for approximately 36 percent, 40 percent and 36 percent of our consolidated revenue in 2016, 2015 and 2014, respectively. Permeation instruments that we currently manufacture include OX-TRAN® systems for oxygen transmission rates, PERMATRAN-W® systems for water vapor transmission rates, and PERMATRAN-C® systems for carbon dioxide transmission rates. 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. Our systems are available in a wide range of options for our customers, including high or low throughput, price, sensitivity and ease of use. They are primarily marketed to research and development departments, as well as production and quality assurance groups.

 

Industrial Analyzer Products and Services

 

We manufacture and distribute advanced gas analysis and monitoring instrumentation used in applications such as oil and gas exploration, process and beverage gas analysis, industrial hygiene, safety, environmental air monitoring and indoor air quality.

 

In this group, we manufacture and sell two types of gas analyzer instruments: gas chromatographs (GCs) and total hydrocarbon analyzers (THAs). These instruments are typically installed in fixed locations at the monitoring sites and perform their functions of detecting and measuring various gases continually or at regular intervals. We also make miniaturized gas sensors and detectors which are sold to original equipment manufacturers (OEMs) of mobile gas safety equipment.

 

Our industrial analyzer products, sensors and detectors are for use in industrial hygiene (detection of hazardous gases in the workplace), hydrocarbon gas analysis for oil and gas exploration, contaminant detection in the manufacture of specialty gases, and environmental monitoring (tracking the release, or the presence, of toxic substances). Our newest GC offering measures trace levels of contaminants in beverage grade carbon dioxide which is used to carbonate soft drinks, beer and water.

 

 
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Revenue for our Industrial Analyzer business’ products accounted for approximately 16 percent, 16 percent and 20 percent of our consolidated revenue in each of the years 2016, 2015 and 2014. We market some of these products under the names PetroAlert®, piD-TECH®, and BevAlert®.

 

Microbial Detection Products

 

Our microbial detection products are designed to rapidly detect microbial growth in food and beverage samples. Using the total viable count (TVC) method, our GreenLight instrument performs rapid and precise measurements to determine the presence or absence of aerobic bacteria in food products or ingredients. In addition to instruments, we sell vials and swab kits which provide a recurring revenue opportunity. Revenue from these products do not contribute to our total revenue at a meaningful level.

 

Competition

 

We have several competitors for all of our products and services in both foreign and domestic markets. The principal competitive factors for our products and services are:

 

 

product quality and performance;

 

product reliability;

 

product support; and

 

price.

 

We compete with a variety of companies in each market in which we sell our products. Some of our competitors have greater assets and resources than we do, and some are smaller than we are. To remain competitive, we must continue to invest in research and development, marketing, customer service and support, and manage our operating expenses. We believe that we have strategies in place to develop technological and other advantages that will give us a competitive advantage over our competitors. However, there can be no assurance that we will have sufficient resources to execute these strategies, or that our competitors will not develop new technologies or other advantages which would require us to reduce our prices, result in lost orders or otherwise adversely affect our financial results.

 

Manufacturing and Supplies

 

Our manufacturing capabilities include electro-mechanical assembly, testing, integration of components and systems, calibration and validation of systems. Certain components that we use in our products are currently purchased from single source suppliers. Although we maintain an inventory of these components, an interruption or delay in supply from one of these sources could result in delays in our production while we locate an alternative supplier, which in turn could result in a loss of sales and income.

 

 
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Patents, Trademarks and Other Intellectual Property Rights

 

We believe that the protection afforded us by our patent rights is important to our business, and we will continue to seek patent protection for our technology and products. We require all of our employees and consultants to assign to us all inventions that are conceived and developed during their employment, except to the extent prohibited by applicable law. To protect our proprietary information, we have entered into confidentiality and non-compete agreements with those of our employees and consultants who have access to sensitive information. We hold both U.S. and international patents and have U.S. and international patents pending. We currently hold 49 active U.S. patents and 91 foreign patents which will expire during the period from 2017 through 2034, and have another 34 patents pending. We do not believe that the expiration of our patents on their scheduled expiration dates will have a material adverse effect on our business.

 

We own, have the right to use, or have applied for certain trademarks which protect and identify our products. Our trademarks and service marks include the following: MOCON®, APCHECK®, AQUATRACE®, AQUATRAN, BASELINE®, BEVALERT, CALCARD®, CAL-SMART®, CheckMate, CheckPoint, CMV-2, COULOX®, DANSENSOR®, FLO SMART®, GREENLIGHT, HERSCH®, IMPULSE®, ISM-3, LeakMatic, LeakPointer, LIPPKE®, LUXCEL, MAP Check 3, MAP Mix, MICROANALYTICS®, MULTICHECK®, OPTECH®, OX-TRAN, PAC CHECK®, PAC GUARD®, PERMATRAN-C®, PERMATRAN-W®, PETROALERT®, piD-TECH®, QUICK START®, SKYE®, TRU SEAL® , VOC-TRAQ® and VACUCORE. Our trademarks and service marks have a life of 5 to 20 years, and are subject to periodic maintenance which may be extended in accordance with applicable law.

 

Marketing and Customers; Distribution Methods

 

We market our products and services throughout the United States and in over 60 foreign markets. We use a direct sales force of approximately 25 employees and 100 independent sales representatives and distributors to market and sell our products and services to end users throughout the world. To our knowledge, none of our independent sales representatives sell a material amount of product manufactured by any of our competitors.

 

For information concerning our export sales by geographic area, see Note 15 of the notes to consolidated financial statements. We market products and services to research laboratories, production departments and quality control groups in the life science, medical, food, pharmaceutical, plastics, paper, electronics, oil and gas and other industries. We do not believe that the loss of any single customer would have a material adverse effect on our business or financial performance.

 

Backlog 

 

As of December 31, 2016, our total backlog was $5.6 million for all of our products as compared to $5.3 million as of December 31, 2015. We anticipate shipping substantially all of the December 31, 2016 backlog in 2017. 

 

 
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Research and Development

 

We are committed to an ongoing engineering program dedicated to innovating new products and improving the quality and performance of our existing products. Our engineering expenses are primarily incurred in connection with the improvement of existing products, cost reduction efforts, and the development of new products that may have additional applications or represent extensions of existing product lines. None of these costs are borne directly by our customers. 

 

We incurred expenses of approximately $4.8 million, $4.3 million and $4.2 million during the fiscal years ended December 31, 2016, 2015 and 2014, respectively, for research and development (R&D) of our products. These amounts were 7 percent to 8 percent of our consolidated revenue for each of those three fiscal years. On an annual basis, we currently intend to spend 6 percent to 8 percent of our consolidated revenue on R&D in the future.  

 

Working Capital Practices

 

We strive to maintain a level of inventory that is appropriate given our projected revenue. Our domestic and international payment terms vary, however, generally ranging between 30 and 90 days. International revenue is, in some cases, transacted pursuant to letters of credit.

 

Seasonality

 

Our business is not seasonal in nature.

 

Employees

 

As of December 31, 2016, we had approximately 258 full-time employees. Included in this total are 24 scientists and engineers who research and develop potential new products. None of our employees are represented by a labor union, and we consider our employee relations to be satisfactory.

 

Executive Officers of the Registrant

 

Our executive officers, their ages and their offices held, as of March 9, 2017 are as follows:

 

Name

Age

Title

     

Robert L. Demorest

71

Chairman of the Board, President and

    Chief Executive Officer, MOCON, Inc.

Elissa Lindsoe

50

Chief Financial Officer, MOCON, Inc.

Michael Barto

42

Senior Vice President of Manufacturing and Engineering

Maurice Janssen

48

Senior Vice President of Global Sales & Marketing

 

There are no family relationships among any of our directors and executive officers. Information regarding the business experience of our executive officers is set forth below.

 

Mr. Robert L. Demorest has been our President, Chief Executive Officer, and Chairman of the Board since April 2000. Mr. Demorest is also a director of Marten Transport, Ltd., a publicly traded company located in Mondovi, Wisconsin, and is a member of its audit committee.

 

Ms. Elissa Lindsoe has been our Chief Financial Officer since October 2014. Ms. Lindsoe was previously the CFO of Galil Medical Ltd., a private equity owned medical device manufacturing firm.

 

 
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Mr. Michael Barto has been a Vice President for us since August 2015. Mr. Barto was promoted to Senior Vice President of Manufacturing and Engineering in December of 2016. Prior to joining MOCON in 2015, Mr. Barto was the Director of Sensor Technology for the Rosemount Flow division of Emerson since March 2012.

 

Mr. Maurice Janssen joined us in January 2017. Prior to joining MOCON, Maurice was Vice President of Sales & Marketing, Latin America, for FOSS ANA, a Danish-based supplier of analytical instruments for the food, beverage and agriculture sectors.

 

Forward-Looking Statements

 

This Annual Report on Form 10-K 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 Annual Report on Form 10-K 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 Annual Report on Form 10-K, including under the heading “Management’s 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. The following are some of the uncertainties and factors known to us that could cause our actual results to differ materially from what we have anticipated in our forward-looking statements: realizing the expected financial benefits from the acquisition of Dansensor and the Realignment Plan; general economic conditions; failing to comply with the terms of our credit agreement; restrictions in our credit agreement, growth in the markets we serve, successfully competing against competitors; the decline in the value of the Euro and the price of oil; factors impacting the stock market and share price; ability of the Company’s manufacturing facilities to meet customer demand; regulatory matters; timing and success of new product introductions; adequate protection of intellectual property rights; and currency and other economic risks inherent in selling products internationally.

 

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 otherwise could materially adversely affect our business, financial condition or operating results, refer to this Annual Report on Form 10-K under Part I, Item 1A, “Risk Factors.”

 

 
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All forward-looking statements included in this Annual Report on Form 10-K are expressly qualified in their entirety by the foregoing cautionary statements. 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 in this Annual Report on Form 10-K under the heading “Item 1A. Risk Factors” below, 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 below under the heading “Item 1A. Risk Factors.” The risks and uncertainties described under the heading “Item 1A. Risk Factors” below 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.

 

ITEM 1A.

RISK FACTORS

 

The following are significant factors known to us that could have material adverse effects on our business, financial condition or operating results and should be considered carefully in connection with any evaluation of an investment in our common stock. Additionally, the following risk factors could cause our actual results to materially differ from those reflected in any forward-looking statements.

 

If economic conditions decline, this could adversely affect our business, operating results and financial condition.

 

Our operations and performance depend significantly on worldwide economic conditions. Uncertainty about global economic conditions poses a risk as consumers and businesses postpone spending in response to tighter credit, unemployment, negative financial news and/or declines in income or asset values, which could have a material negative effect on demand for our products and services. Our customers include pharmaceutical, food, medical and chemical companies; laboratories; government agencies; and public and private research institutions. The capital spending of these entities can have a significant effect on the demand for our products. Decreases in capital spending by any of these customer groups could have a material adverse effect on our revenue, business and results of operations.

 

 

Further, our customers’ and independent representatives’ ability to borrow money from their existing lenders or to obtain credit from other sources to purchase our products may be impacted. Although we maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments and such losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same loss rates that we have in the past, especially given the current turmoil in certain parts of the worldwide economy. A significant change in the liquidity or financial condition of our customers could cause unfavorable trends in our receivable collections and additional allowances may be required, which could adversely affect our operating results. If investors have concerns that our business, operating results and financial condition will be negatively impacted by a worldwide economic downturn, our share price could decrease.

 

 
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If we violate the terms of our credit agreement and financial covenants, it could cause our lender to demand immediate repayment of our credit facilities.

 

We have a credit agreement with Wells Fargo Bank, our primary lender, with which we entered into a line of credit through August 26, 2018. Our credit agreement with Wells Fargo Bank includes various financial and restrictive covenants. Our current internal projections indicate that we will be in compliance with our financial and restrictive covenants for the next 12 months. However, unforeseen circumstances may develop which could result in us violating our loan covenants. If we violate the terms of our credit agreement, including our financial and restrictive covenants, Wells Fargo Bank could deem us to be in default and require us to immediately repay the entire outstanding balance of our credit facilities, if any. If we do not have the funds available to repay the credit facilities or we cannot find another source of financing, we may fail to meet the terms of our agreement which could decrease the value of our common stock or have other material adverse consequences for us.  

 

Some of the markets in which we operate have experienced minimal growth in recent years, and in the case of the oil and gas market has experienced declines, and our ability to increase our revenue will depend in part on our ability to develop new products, develop new applications for our existing products or acquire complementary businesses and product lines.

 

We have identified a number of strategies that we believe will allow us to grow our business and increase our revenue in markets experiencing minimal growth. This includes developing new products and technologies, entering new markets such as food safety, developing new applications for our technologies, acquiring complementary businesses and product lines, and strengthening our sales force. However, we can make no assurance that we will be able to successfully implement these strategies, or that these strategies will result in the growth of our business or an increase in our revenue. Acquisitions that we may find attractive may be subject to the consent of Wells Fargo Bank under the credit agreement we have executed with them.

 

If we fail to attract and retain qualified managerial and technical personnel, we may fail to remain competitive.

 

Our future success depends, in significant part, upon the continued service and performance of our senior management and other key personnel. We rely on knowledgeable, experienced and skilled technical personnel, particularly engineers, scientists and service personnel, to design, assemble, sell and service our products. The loss of the services of our management team, some of whom have significant experience in our industry, and other key personnel could impair our ability to effectively manage our company and to carry out our business plan. Our inability to attract or retain qualified personnel could have a significant negative effect and thereby materially harm our business.

 

We face risks of technological changes that may render our products obsolete.

 

The markets for our products and services are characterized by technological change and evolving industry standards. As a result of such changes and evolving standards, our products may become noncompetitive or obsolete and we may have to develop new products in order to maintain or increase our revenue. New product introductions that are responsive to these factors require significant planning, design, development and testing at the technological, product and manufacturing process levels, and we may not be able to timely develop new products. In addition, industry acceptance of new technologies that we may develop may be slow due to, among other things, existing regulations or standards written specifically for older technologies and general unfamiliarity of users with new technologies. As a result, any new products that we may develop may not generate any meaningful revenue or profits for us for a number of years, if at all.

 

 
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A significant portion of our revenue is generated from foreign countries and selling in foreign countries entails a number of risks which could result in a decrease in our revenue or an increase in our operating expenses.

 

Revenue outside the United States accounted for approximately 66 percent of our revenue in 2016, 66 percent in 2015 and 69 percent in 2014, and we expect that foreign revenue will continue to account for a significant portion of our revenues in the future. Revenue to customers in foreign countries are subject to a number of risks including, among others:

 

 

agreements may be difficult to enforce;

 

 

receivables may be difficult to collect;

 

 

certain regions may experience political unrest and conflict and economic instability;

 

 

foreign customers may have longer payment cycles;

 

 

the countries into which we sell may impose tariffs or adopt other restrictions on foreign trade;

 

 

currency fluctuations could reduce reported revenue and profitability in future periods;

 

 

fluctuations in exchange rates may affect product demand;

 

 

legal and regulatory requirements may be difficult to monitor and comply with, especially if inconsistent with U.S. laws and regulations;

 

 

customizing products for foreign countries and managing and staffing international operations may lead to increased costs; and

 

 

protection of intellectual property in foreign countries may be more difficult to enforce.

 

If any of these risks were to materialize, our revenue into foreign countries could decline, or our operating costs could increase, which would adversely affect our financial results.

 

A portion of our revenue is derived from third party distributors and a disruption to our relationship with them could adversely impact our business. In addition, a portion of our international revenue is derived through third party distributors. As a result, we are dependent upon the financial health of our distributors. We also are dependent upon the compliance of our distributors with foreign laws and the U.S. Foreign Corrupt Practices Act, or the FCPA. If a distributor were to go out of business, it would take substantial time, cost and resources to find a suitable replacement.

 

 

 
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Further, changes to tax and trade policies, international trade agreements and other governmental regulations affecting trade between the United States and other countries could adversely affect our ability to sell our products in countries outside the United States, increases the costs of selling outside the United States or decrease the profitability of selling outside the United States. Recent elections in the United States could increase the likelihood of any such change being pursued by the United States government.

 

Fluctuations in foreign currency exchange rates could result in declines in our cash, revenue and earnings.

 

Because the functional currency of our foreign operations is the applicable local currency, we are exposed to foreign currency transaction risk arising from transactions in the normal course of business, such as revenue to third party customers and purchases from suppliers denominated in foreign currencies. At December 31, 2016, there were no forward contract hedge instruments in place in our foreign operations.

 

Some of our competitors have greater resources than we do, which may provide our competitors with an advantage in the development and marketing of new products.

 

We currently encounter, and expect to continue to encounter, competition in the sale of our products. We believe that the principal competitive factors affecting the market for our products include product quality and performance, price, reliability and customer service. Our competitors include large multinational corporations. Some of our competitors have substantially greater financial, marketing and other resources than we do. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the promotion and sale of their products than we can. In addition, competition could increase if new companies enter the market or if existing competitors expand their product lines or intensify efforts within existing product lines. Our current products, products under development and our ability to discover new technologies may be insufficient to enable us to compete effectively with our competitors.

 

Our reliance upon patents, domestic trademark laws, trade secrets and contractual provisions to protect our proprietary rights may not be sufficient to protect our intellectual property from others who may sell similar products.

 

We hold patents relating to various aspects of our products and believe that proprietary technical know-how is critical to many of our products. Proprietary rights relating to our products are protected from unauthorized use by third parties only to the extent that they are covered by valid and enforceable patents or are maintained in confidence as trade secrets. We cannot be certain that we will be issued any patents from any pending or future patent applications owned by or licensed to us or that the claims allowed under any issued patents will be sufficiently broad enough to protect our technology. In the absence of patent protection, we may be vulnerable to competitors who attempt to copy our products or gain access to our trade secrets and proprietary know-how. Our competitors may initiate litigation to challenge the validity of our patents, or they may use their resources to design comparable products that do not infringe our patents. We may incur substantial costs if our competitors initiate litigation to challenge the validity of our patents or if we initiate any proceedings to protect our proprietary rights. If the outcome of any such litigation is unfavorable to us, it could have a material adverse effect on our business and results of operations. There may also be pending or issued patents held by parties not affiliated with us that relate to our products or technologies and we may need to acquire licenses to any such patents to continue selling some or all of our products. If we are required to obtain any such license in order to be able to continue to sell some or all of our products, we may not be able to do so on terms that are favorable to us, if at all.

 

 
12

 

 

In addition, we rely on trade secrets and proprietary know-how that we seek to protect, in part, by confidentiality agreements with our collaborators, employees and consultants. These agreements may be breached and we may not have adequate remedies for any such breach. Even if these confidentiality agreements are not breached, our trade secrets may otherwise become known or be independently developed by competitors.

 

The market price of our common stock has fluctuated significantly in the past, and will likely continue to do so in the future, and any broad market fluctuations may materially adversely affect the market price of our common stock.

 

The market price of our common stock has been volatile in the past, with closing prices ranging from a high of $19.65 and a low of $13.01 during 2016. Several factors could cause the price to fluctuate substantially in the future. Some of these factors include:

 

 

announcements of new products by us or our competitors;

 

 

quarterly fluctuations in our financial results;

 

 

merger and acquisition activity in our industry segment;

 

 

customer contract awards;

 

 

a change to the rates at which we have historically paid dividends, which could be impacted by our credit agreement with Wells Fargo Bank;

 

 

changes in regulation; and

 

 

general economic and political conditions in the various markets where our products are sold.

 

In addition, the share prices of instrumentation companies have experienced significant fluctuations that often have been unrelated to the operating performance of such companies. This market volatility may adversely affect the market price of our common stock.

 

Complying with securities laws and regulations is costly for us.

 

Changing laws, regulations and standards relating to corporate governance and public disclosure, including regulations promulgated by the SEC and Nasdaq, are creating particular challenges for smaller publicly-held companies like us. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.

 

 
13

 

 

We are exposed to risks relating to our evaluation of our internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act.

 

Our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our assessment of its internal control over financial reporting have required and will continue to require the expenditure of significant financial and managerial resources. Although our management has concluded that our internal control over financial reporting was effective as of December 31, 2016 and our independent registered public accounting firm agreed, no assurance can be provided that our management or independent registered public accounting firm will reach a similar conclusion as of any later date. Our failure to maintain effective internal control over financial reporting may have an adverse effect on our stock price.

 

If we experience any increase in the cost of raw materials or supplies, we may experience a decrease in profit margins.

 

In the past, the overall cost of the materials that we purchase has not risen much more than the rate of inflation. We believe that the price of our products and the prices of our competitors’ products is a significant factor affecting our customers’ buying decisions and consequently, we may not be able to pass along any cost increases in raw materials and supplies in the form of price increases or sustain profit margins that we have achieved in prior years. 

 

We have spent significant resources to develop new products, and the realized revenue from these products may be minimal for a time frame after each new product is being introduced to the marketplace.

 

In recent years we began to market new products including next generation of existing products such as the OX-TRAN 2/22, PERMATRAN-W 3/34 and LeakProtego. We believe that there are significant markets for our new products and while we believe these products are superior in many respects to similar products being sold by our competitors, each one is new to the marketplace and may not gain the market acceptance necessary to allow us to capitalize on what we believe will be an increasing demand in the industries for which products are utilized. While we have realized increasing revenue of products introduced in the marketplace historically, there can be no assurance that revenue of these products will continue. While we believe our recent new product offerings represent a dramatic improvement over existing technology being used in the respective applications, for some of them, we have not realized significant revenue to date.

 

If we are not able to successfully market new products, we will not recover the significant research and development and other expenses we have incurred to bring these products to market.

 

Our information systems are critical to our business. If our information systems fail to adequately perform, or any our systems were accessed by unauthorized parties, our business, reputation, financial condition, and operating results could be adversely affected.

 

We have many information systems that are critical to our business. These information systems are used to record, process, summarize, transmit, and store electronic information, including, among other things, sensitive data related to our research and development efforts and third party information. Although we take steps to secure our information systems and protect data stored on these systems, the security measures we have implemented may not be effective and our systems may be vulnerable to theft, loss, damage, and interruption from a number of potential sources and events, including unauthorized access or security breaches, cyber attacks, computer or other disruptive events. Any unauthorized access of our information systems or loss of information stored on our information systems could result in legal claims or proceedings and could disrupt our business and harm our reputation, which cause our business, reputation, financial condition, and operating results to suffer.

 

 

Beginning in 2015, we implemented a realignment plan (“Realignment Plan”), which may result in additional or unanticipated non-recurring charges, and we may not be able to achieve the cost savings and other benefits expected from these realignment efforts.

 

 Throughout 2015, we completed an initiative to reduce the number of legal entities by merging those entities into other legal entities we have. This initiative is intended to reduce the complexity and administrative burden and cost of maintaining those legal entities. Further, to improve our profitability, during the fourth quarter of 2015, we brought the Package Testing and Permeation segment sales and marketing functions under common leadership and decreased our U.S. headcount by 5 percent. We continued these efforts during 2016, with the elimination of the chief operating officer position and the hiring of a Sr. VP of Global Sales and Marketing, and other personnel changes. These changes were also designed to strengthen our market presence and provide a cost-effective approach to achieving our objectives.

 

 
14

 

 

 However, we may not be able to achieve the level of benefits that we expect to realize from these or any future realignment activities, within expected timeframes, or at all. Changes in the amount, timing and character of charges related to our current or future realignment activities and the failure to complete, or a substantial delay in completing, our current and any future realignment plan could have a material adverse effect on our financial results.  

 

ITEM 1B.

UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

Item 2.

PROPERTIES

 

We lease an aggregate of 110,460 square feet of office, engineering, laboratory and production space in Minnesota, Germany, Denmark, Spain, Italy, France and China. We believe that all of our facilities are generally adequate for their present operations and that suitable space is readily available if any of our leases are not extended. 

 

We signed a 15-year lease for our Minneapolis headquarters and operations center. The lease commenced July 1, 2011 and is for a location consisting of approximately 60,000 square feet of space. This space is leased until October 2025. This location is our corporate headquarters from which a portion of all reporting segments conduct operations.

 

Dansensor A/S, based in Denmark, and operating subsidiaries located in Germany, France, Spain, and Italy lease an aggregate of approximately 37,000 square feet. These buildings are leased through various dates until December 2021. These properties are utilized for the operations of the Package Testing segment.  

 

Dansensor A/S also has a location in Neuwied, Germany that occupies approximately 8,075 square feet. This space is leased until July 2018. This property is utilized for the operations of the Permeation segment. During 2016, this lease was negotiated to expand the existing building with an additional 3,000 square feet, which is expected to be completed in the second quarter of 2017 at which time will be utilized for the operations of Permeation and Package Testing segments. The renegotiated lease will expire in June 2028. 

 

The MOCON (Shanghai) Trading Co., Ltd. operations are located in Shanghai, China, and occupy approximately 1,700 square feet. This space is leased until December 2017. This property is utilized in the operations of the Permeation segment.

 

In addition to our leased facilities described above, we own approximately two acres of land and a building located near Boulder, Colorado that consists of approximately 9,300 square feet of office and production space for our Industrial Analyzers and Other segment.

 

Item 3.

LEGAL PROCEEDINGS

 

There are no material pending legal, governmental, administrative or other proceedings to which we are a party or of which any of our property is the subject.

 

 
15

 

 

ITEM 4. 

MINE SAFETY DISCLOSURES

     

Not applicable.

 

 
16

 

 

PART II

 

Item 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED ShareHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information and Dividends

 

Our common stock is quoted on the Nasdaq Global Market System under the symbol MOCO. The following table sets forth, for the fiscal periods indicated, the high and low closing sales prices for our common stock as reported by the Nasdaq Global Market System. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. The following table also sets forth, for the fiscal periods indicated, the amount of cash dividends declared on our common stock: 

 

    2016     2015  

Fiscal Period

 

High

   

Low

   

Dividend

   

High

   

Low

   

Dividend

 
                                                 

1st Quarter

  $ 14.66     $ 13.01     $ 0.11     $ 17.29     $ 15.86     $ 0.11  

2nd Quarter

  $ 14.85     $ 13.16     $ 0.11     $ 17.99     $ 15.90     $ 0.11  

3rd Quarter

  $ 16.87     $ 14.05     $ 0.11     $ 16.25     $ 13.03     $ 0.11  

4th Quarter

  $ 19.65     $ 15.05     $ 0.11     $ 15.20     $ 13.54     $ 0.11  
                                                 

 

We have been consistently paying dividends since 1984. Cash dividends paid in 2016, 2015 and 2014 were approximately $2.6 million, $2.5 million and $2.5 million, respectively. Our Board of Directors monitors and evaluates our dividend practice quarterly, and the Board may elect at any time to increase, decrease or not pay a dividend on our common stock based upon our financial condition, results of operations, cash requirements and future prospects and other factors deemed relevant by the Board. Under the loan agreement we have with Wells Fargo Bank, we are required to maintain certain financial ratios. One of these ratios will be impacted by the amount of dividends we pay. If paying dividends at our historical rate were to cause us to be out of compliance with this ratio, or otherwise cause us to be in breach of our covenants under our loan agreement with Wells Fargo Bank, we may be required to reduce or eliminate dividends until such time as we are able to repay our loan, regain compliance with the financial ratios and other covenants in the loan agreement, or negotiate a waiver or amendment with Wells Fargo Bank.

 

For information concerning securities authorized for issuance under equity compensation plans, please see Part III – Item 12.

 

Holders 

 

As of March 3, 2017, there were approximately 309 holders of record and 3,400 beneficial holders of our common stock. 

 

 
17

 

 

Issuer Repurchases of Equity Securities

 

Other than the withholding of 65,728 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 shares of our common stock or other equity securities of MOCON registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended, during the fourth quarter ended December 31, 2016. We currently are not authorized by our Board of Directors to make repurchases of our common stock.

 

Recent Sales of Unregistered Securities

 

During the fourth quarter and year ended December 31, 2016, we did not issue or sell any shares of our common stock or other equity securities of MOCON without registration under the Securities Act of 1933, as amended.

 

 
18

 

 

Stock Performance Graph

 

The following graph compares the cumulative shareholder return on MOCON’s common stock to the S&P 500 Index and a peer group consisting of five companies with a market capitalization similar to MOCON. The peer companies were selected from the scientific and technical instruments industry within the technology sector. The graph compares the performance for the last five fiscal years, assuming an investment of $100 on December 31, 2011, including the reinvestment of all dividends. The peer group consists of the following companies: CyberOptics Corporation, eMagin Corporation, Perceptron, Inc., Sypris Solutions, Inc. and Transcat, Inc. We chose these five companies because they operate in similar technology sectors that we do and have a market capitalization similar to ours. 

 

   

12/11

   

12/12

   

12/13

   

12/14

   

12/15

   

12/16

 
                                                 

MOCON, Inc.

    100.00       92.43       104.57       121.75       102.45       140.71  

S&P 500

    100.00       116.00       153.58       174.60       177.01       198.18  

Peer Group

    100.00       91.12       104.10       99.10       72.69       111.45  

 

Source: Research Data Group, Inc.

 

 
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ITEM 6. 

SELECTED FINANCIAL DATA

           

    Years Ended December 31,  
   

2016

   

2015

   

2014

   

2013

   

2012

 
   

(in thousands, except per share data)

 

CONSOLIDATED STATEMENTS OF INCOME DATA:

                                       
                                         

Revenue

  $ 63,311   (1)  $ 60,754     $ 64,475     $ 57,108     $ 49,941  

Net income

    5,000       2,972       1,536       3,461       2,002  

Net income per common share:

                                       

Basic

    0.86       0.52       0.27       0.62       0.37  

Diluted

    0.86       0.51       0.27       0.61       0.35  

Cash dividends declared per share

    0.44       0.44       0.44       0.44       0.42  

 

(1) See Note 1, page F-9.

 

    As of December 31,    
   

2016

   

2015

   

2014

   

2013

   

2012

 
   

(in thousands)

 

CONSOLIDATED BALANCE SHEET DATA:

                                       
                                         

Current assets

  $ 27,162     $ 24,702     $ 27,501     $ 27,570     $ 26,913  

Total assets

    48,448       47,419       52,509       58,704       57,220  

Current liabilities

    10,715       9,600       15,449       16,935       16,494  

Noncurrent liabilities

    1,282       4,348       2,587       4,300       6,845  

Shareholders' equity

    36,451       33,471       34,473       37,469       33,881  

 

 
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Item 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAl CONDITION AND RESULTS OF OPERATIONS

 

This Management’s 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 including those discussed under the heading “Item 1A. Risk Factors” and elsewhere in this Annual Report on Form 10-K. For more information, see “Part I Item 1 Business — Forward-Looking Statements” of this Annual Report on Form 10-K. The following discussion of the results of the 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 Annual Report on Form 10-K.

 

Overview

 

MOCON, Inc. designs, manufactures, markets and services products and provides consulting and testing 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 developing new products, and by acquiring new companies, new product lines, or rights to technologies. 

 

We are headquartered in Minnesota and have operating locations in Minnesota, Denmark, and Colorado. We have offices and laboratories in Germany, France, Italy, Spain and China. We use a mix of a direct sales force and independent sales representatives to market our products and services in the United States, Canada, Europe and China, and we use a network of independent sales representatives and distributors to market and service our products and services in most other foreign countries.

 

Our ongoing plans for growth include continued substantial funding for research and development to drive new product introductions, together with strategic acquisitions and investments where appropriate.

 

Significant Transactions and Financial Trends

 

Throughout these financial sections, you will read about significant transactions or events that materially contribute to, or reduce our earnings, and materially affect our financial results and financial position.

 

Our research and development costs were approximately 7 percent to 8 percent of our consolidated revenue in 2016, 2015 and 2014. On an annual basis, we intend to spend 6 percent to 8 percent of our revenue on research and development in the future.

 

Beginning 2015, we implemented a series of initiatives, including a reduction in workforce and simplification of business structures (“Realignment Plan”). In conjunction with our One MOCON initiative, the integrations of our European based businesses are near completion which has changed the leadership needs in our business as a whole from one that is individual segment-based toward another that is designed to fuel growth through our sales strategy. As a result, during 2016, we continued to evaluate our business needs and therefore have incurred additional realignment expenses from the elimination of two senior executive positions in our company which included our chief operating officer. These actions are intended to increase operating efficiencies and provide additional resources to execute our long-term growth strategy.

 

 
21

 

 

On January 14, 2016, we entered into an Asset Purchase Agreement, as amended on May 18, 2016 (the “Agreement”) with Volatile Analysis Corporation (“VAC”) pursuant to which we agreed to sell to VAC the assets exclusively used in our business of providing equipment and analytical chemistry services and related formulation, product development, and consulting services, primarily focused on identification of odors and aromas. This business was included in our Permeation segment and was conducted from a facility in Round Rock, Texas. The purchase and sale of the assets was finalized and closed on May 18, 2016. We received proceeds of $701,000 resulting in a realized gain of $553,000, which is included in other income (expense), net on the Consolidated Statement of Income. The remaining $599,000 owed by VAC as of December 31, 2016 in accordance with the Agreement will be recognized on the cost recovery method upon receipt. This business does not qualify for discontinued operations since it does not represent a strategic shift that had or will have a major effect on our operations and financial results. The revenue related to this business was $54,000, $0.6 million and $0.9 million for the years ended December 31, 2016, 2015 and 2014, respectively. The gross profit/(loss) contribution related to the Microanalytics business was ($0.1) million, $0.2 million and $0.4 million for the years ended December 31, 2016, 2015 and 2014, respectively. 

 

While these items are important in understanding and evaluating our financial results, certain trends, such as our international revenue accounting for a significant portion of our revenue, and other transactions or events such as those discussed later in this Management’s Discussion and Analysis, may also have a material impact on our financial results.

 

Critical Accounting Policies

 

Our significant accounting policies are described in Note 1 to our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. This Management’s 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 company’s most critical accounting policies as those that are most important to the portrayal of its financial condition and results of operations, and which require us 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 product 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. We recognize service and consulting revenue upon delivery of the services. 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.

 

 
22

 

 

Revenue for service arrangements such as maintenance, repair, technical support are recognized either as the service is provided or ratably over the defined contractual period for service maintenance. 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. Unearned revenue related to these contracts is recorded in current liabilities in the consolidated balance sheets.

 

Periodically, we have shipments of products to customers where we are required to recognize revenue under the accounting guidance related to multiple element arrangements. This guidance provides that the overall arrangement fee will be allocated to each element (both delivered and undelivered items) based on their relative selling price, as demonstrated by vendor-specific objective evidence (VSOE) or third-party evidence (TPE). Where VSOE or TPE is not available, revenue will be assigned to each element using an estimated selling price.

 

Reserve for Doubtful Accounts and Returns

 

Our allowance for doubtful accounts and returns is for accounts receivable balances that are estimated to be uncollectible as well as anticipated 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 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 determined 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 December 31, 2016 and 2015, we had approximately $180,000 and $141,000, respectively, reserved against our accounts receivable for doubtful accounts and returns.

 

Accrual for Excess and Obsolete Inventories

 

We perform an analysis to identify excess and obsolete inventory. We record a charge to cost of revenue 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 December 31, 2016 and 2015, we had approximately $552,000 and $511,000, respectively, accrued for excess and obsolete inventories.

 

Recoverability of Long-Lived Assets 

 

We assess the recoverability of definite-lived intangibles and other long-lived assets periodically 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, or asset group. We deem an asset to be impaired if a forecast of undiscounted future operating cash flows is less than an asset’s 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.  

 

 
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During 2014 we identified an impairment indicator and concluded that the carrying value of our investment in an affiliated company, Luxcel Biosciences Limited (Luxcel) exceeded its fair value. The impairment was determined to be other-than-temporary. As a result, a non-cash, non-tax deductible impairment charge of $3.2 million, representing 100 percent of the carrying value, has been recognized within operating expenses of the consolidated statements of income in 2014.

 

Goodwill

 

We assess the recoverability of goodwill on our annual measurement date or whenever events or changes in circumstances indicate that a potential impairment may exist. Goodwill is considered to be impaired if it is determined that the carrying amount of the reporting unit exceeds its fair value. Assessing the impairment of goodwill requires us to make judgments regarding the fair value of the net assets of our reporting units and the allocation of the carrying amount of shared assets to the reporting units. Our annual assessment included comparison of the carrying amount of the net assets of a reporting unit, including goodwill, to the fair value of the reporting unit. A significant change in our market capitalization or in the carrying amount of net assets of a reporting unit could result in an impairment charge in future periods. We performed our annual 2016 assessment during the fourth quarter, and determined there was no impairment of goodwill for any of our reporting units as their related fair values were in excess of their carrying values.

 

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. We provided a valuation allowance in the amount of $1.4 million and $1.3 million at December 31, 2016 and 2015, respectively, against our net deferred tax assets.

 

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 740 requires application of a more-likely-than-not threshold to the recognition and de-recognition of uncertain tax positions. Under ASC 740, once the more-likely-than-not threshold is met, the amount of benefit to be recognized is the largest amount of tax benefit that is greater than 50 percent likely of being ultimately realized upon settlement. It further requires that a change in judgment related to the expected ultimate resolution of uncertain tax positions be recognized in earnings in the period of such a change. We have unrecognized tax benefits in the amount of $134,000 and $201,000 in 2016 and 2015, respectively, for estimated exposures associated with uncertain tax positions. However, due to the complexity of some of these uncertainties, the ultimate settlement may result in payments that are different from our current estimate of tax liabilities, resulting in the recognition of additional charges or benefits to income tax expense. 

 

 
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Results of Operations

 

The following table sets forth the relationship between various components of our results of operations, stated as a percent of revenue, for fiscal years ended December 31, 2016, 2015 and 2014. Our historical financial data were derived from our consolidated financial statements and related notes included in Item 8 of this Annual Report on Form 10-K. 

 

   

Percent of Revenue

 
   

2016

   

2015

   

2014

 
                         

Revenue

    100.0       100.0       100.0  

Cost of revenue

    43.7       45.3       44.0  

Gross profit

    56.3       54.7       56.0  

Selling, general and administrative expenses

    37.3       38.6       38.8  

Research and development expenses

    7.7       7.1       6.5  

Realignment Expense

    1.4       1.7       -  

Impairment of investment in affiliated company

    -       -       4.9  

Operating income

    9.9       7.3       5.8  

Other income (expense), net

    0.6       0.1       (0.5 )

Income before income taxes

    10.5       7.4       5.3  

Income taxes

    2.6       2.5       3.0  

Net income

    7.9       4.9       2.3  

 

The following table summarizes total revenue by segment for 2016, 2015 and 2014 (expressed in thousands): 

 

      Years Ended December 31,  
   

2016

      2015 (1)       2014  
                         

Package Testing

  $ 30,257     $ 26,583     $ 28,071  

Permeation

    23,039       24,599       23,380  

Industrial Analyzers and Other

    10,015       9,572       13,024  
                         

Total revenue

  $ 63,311     $ 60,754 (1)    $ 64,475  

 

(1) See revision note on Note 1, page F-9.

 

 
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The following table sets forth the relationship between various components of domestic and foreign revenue for 2016, 2015 and 2014 (expressed in thousands): 

 

    Years Ended December 31,  
   

2016

   

2015

   

2014

 
                         

Domestic revenue

  $ 21,660     $ 20,872     $ 19,836  

Foreign revenue:

                       

Europe

    26,190       23,203       26,324  

Asia

    12,790       12,762       14,166  

Other

    2,671       3,917       4,149  

Total foreign revenue

    41,651       39,882       44,639  

Total revenue

  $ 63,311     $ 60,754     $ 64,475  

  

Revenue

 

Fiscal 2016 vs. Fiscal 2015 

 

Revenue in 2016 was $63.3 million, an increase of 4 percent compared to $60.8 million for 2015. The growth in our Package Testing and Industrial Analyzers and Other segments was offset by the decline in revenue for our Permeation segment. We believe future revenue results depend primarily upon our ability to continue to introduce new products, retain and attract market demand and grow in the markets we serve, including oil and gas markets.

 

Package Testing Products and Services

 

Revenue in our Package Testing segment accounted for 48 percent and 44 percent of our consolidated revenue in each of 2016 and 2015, respectively. Revenue grew 14 percent in the year ended December 31, 2016 to $30.3 million compared to $26.6 million in 2015. This growth is a result of a continued demand for our headspace analyzers, leak detection equipment and related services There are increasingly more two income households in Europe which is driving consumer trends toward convenience and sustainable food packaging. In the U.S., growth in modified atmosphere packaging technologies is being driven through overall market expansion as food production lines are upgraded. Revenue to foreign destinations comprised 73 percent and 74 percent of total revenue in this segment for the years ended December 31, 2016 and 2015, respectively.


Permeation Testing Products and Services
 

 

Revenue in our Permeation segment accounted for 36 percent and 40 percent of our consolidated revenue for the years ended December 31, 2016 and 2015, respectively. Revenue decreased six percent in the year ended December 31, 2016 to $23.0 million compared to $24.6 million in 2015. The decrease is attributable to decreased revenue in the domestic markets. Approximately $640,000 of this decrease is driven by the sale of the business formerly known as Microanalytics. Foreign revenue comprised 68 percent of the revenue in this segment in 2016, compared to 63 percent from the prior year.

 

 
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Industrial Analyzer Products and Services and Other

 

Revenue in our Industrial Analyzers and Other segment accounted for 16 percent of our consolidated revenue for both the years ended December 31, 2016 and 2015. Revenue increased slightly from prior year to $10.0 million during the year ended December 31, 2016 compared to $9.6 million for 2015. The increase in revenue compared to the prior year is primarily due to growth experienced in the sensor and detector products during 2016 of approximately $1.3 million, partially offset by a decrease of instrument sales from the beverage safety and oil and gas exploration markets. Revenue to foreign destinations comprised 38 percent and 49 percent of total revenue in this segment for the years ended December 31, 2016 and 2015, respectively.

 

Fiscal 2015 vs. Fiscal 2014 

 

Revenue in 2015 was $60.8 million, a decrease of 4 percent compared to $64.5 million for 2014. Foreign currency translation had an unfavorable impact of $5.3 million compared to the prior year. When excluding the effect of the currency rate impact, revenue grew 3 percent. The growth in our Package Testing and Permeation segments on a constant currency basis was offset by the decline in revenue for our Industrial Analyzers and Other segment. We believe future revenue results depend primarily upon our ability to continue to introduce new products, retain and attract market demand and grow in the markets we serve, including oil and gas markets.

 

Package Testing Products and Services

 

Revenue in our Package Testing segment accounted for 44 percent and 44 percent of our consolidated revenue in each of 2015 and 2014, respectively. Revenue decreased 5 percent in the year ended December 31, 2015 to $26.6 million compared to same period in 2014. Revenue in our Package Testing segment was negatively impacted by $4.4 million during 2015 due to currency rate fluctuations as compared to the prior year. Excluding the impact of the currency rate fluctuations, revenue for our Package Testing segment grew 11 percent compared to the prior year. This growth on a constant currency basis is a result of a continued revenue increase in our headspace and mixer products as we increase our market share. Revenue to foreign destinations comprised 74 percent and 77 percent of total revenue in this segment for the years ended December 31, 2015 and 2014, respectively.


Permeation Testing Products and Services
 

 

Revenue in our Permeation segment increased 5 percent for the current year as compared to the prior year, and accounted for 40 percent and 36 percent of our consolidated revenue for the years ended December 31, 2015 and 2014, respectively. Permeation segment revenue was negatively impacted by $897,000 due to currency rate fluctuations compared to the prior year. Excluding the impact of the currency rate fluctuations, revenue for our Permeation segment grew 9 percent compared to the prior year. This increase is due to strong demand for our new generation of oxygen permeation instrumentation. Foreign revenue comprised 63 percent of the revenue in this segment in 2015, compared to 70 percent from the prior year.

 

 
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Industrial Analyzer Products and Services and Other
 

 

Revenue in our Industrial Analyzers and Other segment accounted for 16 percent and 20 percent of our consolidated revenue for the years ended December 31, 2015 and 2014, respectively. Revenue decreased 27 percent to $9.6 million during the year ended December 31, 2015 compared to $13.0 million for the same period in 2014. The decline in revenue compared to the prior year was primarily due to a 77 percent, or $3.9 million, decline in instrument revenue from the oil and gas exploration markets partially offset by an increase in demand from the environmental monitoring, in which instrument sales were up 5 percent, and beverage safety markets. Revenue to foreign destinations comprised 49 percent and 50 percent of total revenue in this segment for the years ended December 31, 2015 and 2014, respectively.

 

Gross Profit

 

Fiscal 2016 vs. Fiscal 2015

 

Our overall gross profit was 56 percent and 55 percent of revenue during 2016 and 2015, respectively. Gross profit as a percentage of revenue in our Package Testing segment increased three percentage points to 57 percent in 2016 from 54 percent in 2015 driven by revenue growth and process improvement initiatives. The gross profit as a percentage of revenue in our Permeation segment increased by one percentage points to 60 percent in the current year from 59 percent in 2015 driven by the mix of product services and consulting. The gross profit as a percentage of revenue in our Industrial Analyzers and Other segment declined by one percentage points to 45 percent in 2016 compared to 46 percent in 2015 driven by growth in the sensor related revenue which generates lower margins.

 

Fiscal 2015 vs. Fiscal 2014

 

Our overall gross profit was 55 percent and 56 percent of revenue during 2015 and 2014, respectively. Gross profit as a percentage of revenue in our Package Testing segment increased five percentage points to 54 percent in 2015 from 49 percent in 2014 due to an increase in the revenue volume from headspace and accessory products which have a higher level of gross profit. The gross profit as a percentage of revenue in our Permeation segment decreased by five percentage points to 59 percent in the current year from 64 percent in 2014 due to foreign exchange pricing impacts on instruments made in the U.S.A. and sold in foreign currencies and additional production costs related to the new generation of instruments. The gross profit as a percentage of revenue in our Industrial Analyzers and Other segment declined by ten percentage points to 46 percent in 2015 compared to 56 percent in 2014. The decline in gross profit as a percent of revenue is due to decrease in volume to absorb semi-variable and fixed production related costs and an increase in warranty costs for a quality issue with sensor components in the latest release of gas chromatograph instruments.

 

Selling, General and Administrative Expenses

 

Fiscal 2016 vs. Fiscal 2015

 

Selling, general and administrative expenses were approximately $23.6 million and $23.5 million, or 37 and 39 percent of revenue for, 2016 and 2015, respectively. During 2016, cost reductions realized from our realignment plans were partially offset by increased personnel costs due to new hires to support growth and inflation.

 

 
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Fiscal 2015 vs. Fiscal 2014

 

Selling, general and administrative expenses were approximately $23.5 million and $25.0 million, or 39 percent of revenue for 2015 and 2014, respectively. During 2015, selling, general and administrative expenses included an increase in domestic commissions due to an increase in domestic revenue and additional personnel costs due to increased headcount, offset by a decline in the foreign currency rates when compared to the prior year.

 

Research and Development Expenses

 

Fiscal 2016 vs. Fiscal 2015

 

Research and development (R&D) expenses were approximately $4.8 million and $4.3 million in 2016 and 2015, or 8 percent and 7 percent of revenue in each year, respectively. For the foreseeable future, we intend to continue spending 6 percent to 8 percent of revenue to R&D. We believe continued R&D expenditures are necessary as we develop new products to expand revenue opportunities in our niche markets to remain competitive.

 

Fiscal 2015 vs. Fiscal 2014

 

Research and development (R&D) expenses were approximately $4.3 million and $4.2 million in 2015 and 2014, or 7 percent of revenue in each year.

 

Realignment expenses

 

Realignment expense was approximately $903,000 and $1.0 million for year ended December 31, 2016 and 2015, respectively. 

 

During 2016, management concluded to eliminate the chief operating officer position and a divisional executive position in addition to other personnel changes. As a result, $903,000 of realignment expense was recognized during 2016.

 

During 2015, we implemented a series of activities including the Realignment Plan in order to simplify our business structure by reducing the number of legal entities and by combining the sales and marketing teams of our Permeation and Package Testing segments under common leadership. The realignment expenses incurred in 2015 were $1.0 million. There were no realignment expenses in 2014. The Realignment Plan activities completed during 2015 included:

 

 

The elimination of approximately 10 positions across all areas

 

Costs associated with legal and professional fees of $414,000

 

Separation costs of $635,000

 

 
29

 

 

Impairment of 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 €2.5 million amounted to a 16.9 percent equity interest in Luxcel. During 2014 we became aware of a triggering event that indicated possible impairment. After further analysis, we determined that the investment was other than temporarily impaired, and as a result, recorded a non-cash, non-tax deductible charge of $3.2 million in 2014 to fully impair the asset.

 

Other Income (Expense), Net

 

Other income (expense), net for 2016, 2015 and 2014 was as follows (expressed in thousands):

 

    Years Ended December 31,  
   

2016

   

2015

   

2014

 
                         

Interest income

  $ -     $ 2     $ 3  

Interest expense

    (56 )     (119 )     (186 )

Foreign currency exchange gain (loss)

    (116 )     209       (136 )

Other

    (10 )     1       13  

Gain on sale of business

    553       -       -  

Total other income (expense), net

  $ 371     $ 93     $ (306 )

 

Fiscal 2016 vs. Fiscal 2015  

 

The interest expense in 2016 is primarily related to the debt incurred in connection with the line of credit, and the foreign currency exchange loss was primarily due to transaction settlement in the normal course of business. Interest expense decrease in 2016 compared to 2015 due to the net pay-down on total debt by $2.8 million year over year. The gain on sale of business is related to the sale of our odor and aroma business formerly known as Microanalytics. 

 

Fiscal 2015 vs. Fiscal 2014

 

Interest income stayed consistent in 2015, as compared to 2014, due to similar levels of cash. The interest expense in 2015 is primarily related to the debt incurred in connection with the line of credit, and the foreign currency exchange gain was primarily due to revaluing the foreign currency contract and related note payable to fair value. Interest expense decrease in 2015 compared to 2014 due to the net pay-down on total debt by $1.6 million year over year.

 

Income Tax Expense

 

Fiscal 2016 vs. Fiscal 2015 

 

Our provision for income taxes in 2016 was $1.7 million, or 25 percent of income before income taxes, compared to $1.5 million, or 33 percent of income before income taxes for 2015. The current year effective tax rate is lower than the expected statutory rate due to the effect of foreign operations where we generally experience lower tax rates, tax benefits associated with the change in our assertion over unremitted earnings, and the research credit and domestic manufacturing deduction for 2016, which is partially offset by discrete items recognized in 2016 associated with foreign income inclusions required for U.S. income tax purposes. 

 

 
30

 

 

Fiscal 2015 vs. Fiscal 2014

 

Our provision for income taxes in 2015 was $1.5 million, or 33 percent of income before income taxes, compared to $1.9 million, or 56 percent of income before income taxes for 2014. The prior year effective tax rate is lower than the expected statutory rate due to the effect of foreign operations where we generally experience lower tax rates, and the research credit and domestic manufacturing deduction for 2015 partially offset by discrete items recognized in 2015.

 

Inflation

 

We do not believe that inflation has had a material effect on our results of operations in recent years; however, there can be no assurance that our business will not be adversely affected by inflation in the future.

 

Liquidity and Capital Resources

 

Total cash and cash equivalents was $8.3 million and $6.3 million at December 31, 2016 and 2015. Of the $8.3 million in cash and cash equivalents as of December 31, 2016, $4.8 million was held at banks located primarily in Germany and Denmark. Cash provided by operating activities was approximately $7.3 million in 2016 compared to $6.4 million in 2015. Cash flows provided by operating activities were offset by cash used to pay down our debt, net of proceeds in the amount of $2.8 million; dividends paid totaling $2.6 million, and $1.0 million was used to purchase property, plant and equipment.

 

At December 31, 2016, we had $163,000 in total debt compared to $3.0 million on December 31, 2015. Total debt on December 31, 2016 is comprised of capital leases for equipment.

 

Our working capital as of December 31, 2016 increased approximately $1.3 million to $16.4 million, compared to $15.1 million at December 31, 2015. This increase was primarily due to an increase in cash and trade accounts receivable, partially offset by a decrease in inventory and an increase in accrued income taxes.

 

During 2016, management eliminated the chief operating officer position and a divisional executive position in addition to other personnel changes. This resulted in a non-recurring charge of $903,000 during 2016. The total cash paid during 2016 for these activities was $400,000, with an additional $500,000 expected to be paid in 2017. 

 

During 2015, we implemented a Realignment Plan which decreased our U.S.A. headcount by 5 percent, including elimination of vacant positions. In addition, during 2015 we undertook an initiative to reduce the number of legal entities that we have and resulted in a non-recurring charge of $1.0 million during 2015. The total cash paid during 2015 for these activities was $400,000 and an additional $600,000 was paid during 2016.

 

One of our strategic objectives is, as market and business conditions warrant, to consider acquisitions of, or investments in, businesses, products and/or technologies. If we wish to pursue one or more additional acquisition opportunities, this may require the consent of the Bank under the credit agreement we have executed, and we may need to fund such activities with a portion of our cash balances and debt 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 additional restrictive covenants that could limit our operational flexibility and higher interest expense could dilute earnings per share.

 

 
31

 

 

We may invest a 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.  

 

A significant amount of our earnings are generated outside the U.S.A. and have historically been indefinitely reinvested in non-U.S.A. subsidiaries, resulting in the majority of our cash being held outside the U.S.A. If these funds were repatriated to the U.S.A. or used for U.S.A. operations, the amount would be subject to U.S.A. taxes with the related foreign tax credit, such that a net benefit is available from unremitted non-U.S.A earnings. Therefore, we intend to remit and use the cash generated from non-U.S.A. operations as well as borrowings, if needed, to meet our U.S.A. cash needs. As the remittance is expected to occur within the foreseeable future, we have recorded an income tax benefit associated with this remittance. Further, we intend to accrue income taxes on unremitted earnings going forward to reflect the expectation of future remittances to the U.S.A., which may increase our effective tax rate upon utilization of existing foreign tax credits. We could also seek additional borrowing capacity or seek to raise additional capital in the U.S.A. These alternatives could result in additional interest expense or other dilution of our earnings.

 

We believe that a combination of our existing cash and cash equivalents, funds available under the revolving credit facility, and an expected continuation of cash flow from operations, will continue to be adequate to fund our operations and working capital, capital expenditures, required payments on indebtedness, costs of realignment expenses and declared dividend payments.

 

Cash Flow

 

Cash Flows from Operating Activities

 

Our primary source of funds has historically been cash provided by operating activities. Cash flow from operating activities totaled $7.3 million, $6.4 million and $9.7 million in 2016, 2015 and 2014, respectively. The increase in 2016 was driven by an increase in overall net income of $2.0 million, a decrease in inventory along with an increase in accrued income taxes, and offset by an increase in accounts receivable. The decrease in 2015 was driven by an increase in accounts receivable, which is at a lesser rate than 2014, with a decrease of $3.3 million in 2015 revenue compared to 2014 along with a decrease in accounts payable and overall operating income. The increase in 2014 was primarily due to the decrease in accounts receivable from 2013, partially offset by increases in inventories. Working capital requirements typically will increase or decrease with changes in the level of revenue. In addition, the timing of certain accrued payments will affect cash flow from reporting period to reporting period. Income tax payments and any employee incentive payments affect the timing of our operating cash flow as they are accrued throughout the year but paid on a quarterly, semi-annual or annual basis.

 

 
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Cash Flows from Investing Activities 

 

Cash flows used in investing activities totaled $275,000 in 2016 as compared to $1.7 million in 2015 and $1.5 million in 2014, respectively. The primary uses of cash for investing activities in 2016 were for purchase of property, plant and equipment of $907,000 and cash paid for intangible assets of $179,000. These uses were partially offset by proceeds from the sale of property, plant and equipment, sale of business, and cash surrender value of line insurance in the amount of $701,000, $52,000 and $58,000 respectively. The primary uses of cash for investing activities in 2015 were for purchase of property, plant and equipment of $1.6 million and cash paid for intangible assets of $218,000. These uses were partially offset by proceeds from the sale of property, plant and equipment and cash surrender value of line insurance in the amount of $56,000 and $96,000 respectively. The primary uses of cash for investing activities in 2014 were for purchase of property, plant and equipment of $1.3 million and cash paid for intangible assets of $540,000. These uses were partially offset by proceeds from the sale of marketable securities and property, plant and equipment in the amount of $205,000 and $154,000 respectively. We do not believe that any major property, plant and equipment expenditures are required to accommodate our current level of operations.

 

Cash Flows from Financing Activities

 

Cash used in financing activities totaled approximately $5.0 million in 2016, due primarily to the net reduction of the line of credit totaling $2.8 million and dividends paid in the amount of $2.6 million. These uses were partially offset by the proceeds from the exercise of share based options in the amount of $406,000. Cash used in financing activities totaled approximately $4.0 million in 2015, due primarily to the pay-down of term loans in the amount of $704,000, the net reduction of the line of credit totaling $1.1 million and dividends paid in the amount of $2.5 million. These uses were partially offset by the proceeds from the exercise of stock options in the amount of $315,000.Cash used in financing activities in 2014 was $5.4 million, due primarily to the pay-down of term loans in the amount of $2.7 million, the net reduction of the line of credit totaling $1.0 million, and dividend payments in the amount of $2.5 million. These uses were partially offset by the proceeds from the exercise of stock options in the amount of $702,000.  

 

Contractual Obligations

 

The following table summarizes our future contractual cash obligations as of December 31, 2016 (expressed in thousands): 

 

   

Payments Due By Period

 
   

Total

   

Less than

1 year

   

1-3 years

   

4-5 years

   

After 5 years

 
                                         

Operating and capital leases

  $ 7,541     $ 1,143     $ 2,529     $ 1,404     $ 2,465  

Purchase obligations

    5,565       5,565       -       -       -  

Realignment Accrual

    547       547       -       -       -  

Total contractual cash obligations

  $ 13,653     $ 7,255     $ 2,529     $ 1,404     $ 2,465  

 

We lease space in Minneapolis, Minnesota which services as our headquarters and operations center. The lease commenced on June 1, 2011 and is for a 15 year term. The required future minimum lease payments, starting at $367,000 per year and subject to annual increases, have been included in the above table.

 

 
33

 

 

In Europe, we have operating lease agreements for company automobiles as well as the buildings occupied by each subsidiary location in Germany, Spain, Italy, France, and Denmark. The required minimum lease payments range from the low thousands of dollars up to $400,000 per year and are included in the table above. The leases have various maturity dates through June 2028.

 

We entered into a capital lease agreement on August 27, 2015 for a new phone system. The lease term is 3 years with an imputed interest rate of 1.70 percent per annum. The present value of the minimum lease payments was $162,000 at inception. We entered into a capital lease agreement on November 1, 2016 for new server equipment. The lease term is 3 years with an imputed interest rate of 2.28 percent per annum. The present value of the minimum lease payments was $68,000 at inception.

 

In the U.S., we have a secured line of credit with availability up to a maximum of $10.0 million which was amended on August 28, 2015 with a maturity date of August 26, 2018. As of December 31, 2016 the outstanding balance is zero. In addition, Dansensor has a DKK 5 million (approximately $0.7 million) available line of credit of which no amount was outstanding as of December 31, 2016.

 

We are subject to various financial and restrictive covenants in the bank Credit Agreement, including maintaining certain financial ratios and limits on incurring additional indebtedness, acquisitions, making capital and lease expenditures and making share repurchases. We are in compliance with our debt covenants at December 31, 2016 and expect to remain in compliance through 2017.    

 

In relation to our accrual for uncertain tax positions, we have approximately $134,000 and $201,000 accrued at December 31, 2016 and 2015, respectively. The timing of any payments which could result from these unrecognized tax benefits will depend on a number of factors. Accordingly, we cannot make reasonably reliable estimates of the period of potential cash settlement, if any, with taxing authorities. Due to the uncertainty regarding the timing of these liabilities, we have excluded these amounts from the contractual obligations table.

 

We have severance agreements with four of our executive officers and two of our vice presidents, which provides for the payment of a lump sum amount upon the occurrence of certain termination events. The payment could range from an amount of half to two times their current annual salary depending on the reason for termination. In connection with our Realignment Plan, we expensed $903,000 during 2016 for separation agreements with officers and executives. As of December 31, 2016, $547,000 of this expense is included in accrued compensation, and per the agreements will be paid during 2017.

 

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 any financing, liquidity, market or credit risk that could arise if we had engaged in these arrangements.

 

Recently Issued Accounting Guidance

 

New Accounting Standards Not Yet Adopted

 

 
34

 

 

Revenue from Contracts with Customers 

 

In May 2014, the FASB issued new accounting requirements for the recognition of revenue from contracts with customers. The requirements of the new standard are effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual periods. The Company intends to adopt the new standard in the first quarterly period of fiscal 2018. We do not believe adoption of the new standard will have a material impact on our Consolidated Statements of Income, but expect expanded financial statement footnote disclosure. We are continuing to evaluate the impacts of the pending adoption, and have engaged a third party to assist management in assessing the impact. As such, our preliminary assessments are subject to change.

 

Inventory – Simplifying the Measurement of Inventory

 

In July 2015, the FASB issued new accounting guidance in an effort to simplify the measurement of inventory. The requirements of the new standard are effective for annual reporting periods beginning after December 15, 2016, and interim periods within those annual periods. We do not believe adoption of the new standard will have a material impact on our results of operations and financial position.

 

Leases

 

In February 2016, the FASB issued new accounting guidance, which requires that lease arrangements longer than 12 months result in an entity recognizing an asset and liability. The new guidance is effective for interim and annual periods beginning after December 15, 2018. Early adoption of the update is permitted. We are currently evaluating the impact of this guidance on our results of operations and financial position.

 

Stock Compensation

 

In March 2016, the FASB issued a new standard that changes the accounting for share-based payments. The standard is effective for the Company in fiscal 2017. It simplifies several aspects of accounting for share-based payments, including the accounting for income taxes, forfeitures, and classification in the statement of cash flows. Under the new standard, excess tax benefits on the exercise of stock options currently credited to equity will reduce the current tax provision, potentially creating volatility in the Company’s effective tax rate. We do not believe adoption of the new standard will have a material impact on our results of operations and financial position.

 

ITEM 7.A

Quantitative and Qualitative disclosures about market risk

 
Interest Rate Risk
 

 

Our principal financial market risks are sensitive to interest rates and foreign currency exchange rates. Our market risk on interest rates relates primarily to LIBOR-based short-term debt from commercial banks and interest-bearing cash equivalents and short-term investments which are generally instruments with maturities of three months or less. Based on our average debt balances during 2016, a 100 basis point change in interest rates would potentially increase or decrease interest expense, net of offsetting impacts in interest income, by approximately $17,000. 

 

 
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Foreign Currency Exchange Risk

 

Today, nearly 66 percent of our consolidated revenue is generated from international customers. In our U.S. operations, we invoice most of these customers in U.S. dollars, so we do not have significant exposure to foreign currency transaction risk for revenue transacted by the U.S. operation. In our European based operations, we have some exposure to foreign currency fluctuations as we invoice our customers primarily in euros and Danish krone. The revenue impact due to foreign currency fluctuations has been immaterial during 2016. In addition, we have some exposure due to foreign exchange pricing impacts on instruments made in the U.S.A. and sold in foreign currencies by non-U.S. operations. However, because we also pay a number of our employees, international suppliers and service providers in their local foreign currency, the negative impact to revenue due to the strong U.S. dollar is naturally hedged resulting in minimal impact to our operating income. However, the net transactional gains or losses resulting from the revenue and expense transactions denominated in foreign currencies have not been material in the past.

 

We experienced a net of approximately $116,000 foreign currency transactional loss during the year ended December 31, 2016 primarily due to the weakening of European currencies. Our balance sheet related translation income (loss) is recorded in accumulated other comprehensive income (loss) on the consolidated balance sheets.

 

Our investments in foreign subsidiaries translated into U.S. dollars are not hedged. Any changes in foreign currency exchange rates are reflected as a foreign currency translation adjustment, a component of accumulated other comprehensive income (loss) in shareholders’ equity, and would not impact our net income.

 

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

      

Our consolidated financial statements and Report of Independent Registered Public Accounting Firms are included beginning on page F-1 of this Annual Report on Form 10-K and are incorporated herein by reference.

 

SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) 

(in thousands, except per share data) 

 

    Quarter ended  
                         
   

March 31,

   

June 30,

    September 30,     December 31,  

2016:

                               

Revenue

  $ 14,730     $ 15,631     $ 16,060     $ 16,890  

Gross profit

    8,104       8,771       9,198       9,584  

Net income

    488       789       1,964       1,759  

Net income per common share:

                               

Basic

  $ 0.08     $ 0.14     $ 0.34     $ 0.30  

Diluted

    0.08       0.14       0.34       0.30  
                                 

2015:

                               

Revenue

  $ 15,360     $ 15,049  (1)   $ 15,022     $ 15,323  

Gross profit

    8,479       8,025       8,318       8,402  

Net income

    908       646       1,152       266  

Net income per common share:

                               

Basic

  $ 0.16     $ 0.11     $ 0.20     $ 0.05  

Diluted

    0.16       0.11       0.20       0.05  

 

 

(1)

See Note 1, Page F-9

   

 

Note:

The sum of the quarterly amounts above may not agree with annual amounts due to rounding.

  

 
36 

 

 

ITEM 9.

CONTROLS AND PROCEDURES

  

(a)

Evaluation of Disclosure Controls and Procedures

 

Based on an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act were effective as of the end of the period covered by this Annual Report on Form 10-K to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

(b)

Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control system is designed to provide reasonable assurance to our management, Board of Directors and shareholders regarding the reliability of financial reporting and the preparation and fair presentation of our consolidated financial statements for external reporting purposes.

 

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met. In designing and operating a control system, one must consider the potential benefits of controls relative to their costs and the reality of limited resources available to allocate to control activities, particularly in smaller companies. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any control will meet its objectives under all potential future conditions. Because of such inherent limitations in any control system, there can be no absolute assurance that control issues, misstatements, and/or fraud will be prevented or detected.

 

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2016 based on the framework in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2016.

 

RSM US LLP, an independent registered public accounting firm, has issued an auditors’ report on management’s assessment of our internal control over financial reporting as of December 31, 2016, which is included elsewhere in this Form 10-K.

 

 
37

 

 

(c)

Inherent Limitations of Disclosure Controls and Procedures and Internal Control over Financial Reporting

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies may deteriorate.

 

(d)

Changes in Internal Control over Financial Reporting

 

There were no changes in internal control over financial reporting that occurred during the quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 

 

ITEM 9B.

OTHER INFORMATION

      

None.

 

 
38

 

 

PART III

 

Item 10.

DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

The information required under Item 10 of this Annual Report on Form 10-K is to be contained under the headings “Proposal One – Election of Directors — Information About Board Nominees,” “Proposal One – Election of Directors — Additional Information About Board Nominees,” “Corporate Governance — Information About our Board and its Committees” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement to be filed with the SEC with respect to our next annual meeting of shareholders, which involves the election of directors and is incorporated herein by reference, or, if such proxy statement is not filed with the SEC within 120 days after the end of the fiscal year covered by this report, such information will be filed as part of an amendment to this report not later than the end of the 120-day period.

 

The information concerning our executive officers is included in this Annual Report under Item 1, “Executive Officers” and is incorporated herein by reference.

 

During the fourth quarter 2016, we made no material changes to the procedures by which shareholders may recommend nominees to the board of directors, as described in our most recent proxy statement.

 

Our Code of Ethics applies to all of our officers, directors and employees, including our principal executive officer and principal financial officer, and meets the requirements of the rules and regulations of the Securities and Exchange Commission. We will disclose any amendments to, and any waivers from a provision of, our Code of Ethics on a Form 8-K filed with the Securities and Exchange Commission. We make available, free of charge and through our website, to any shareholder who requests, the charters of our board committees and our Code of Ethics. Our website is www.mocon.com.

 

To request a copy of the charters of our board committees or our Code of Ethics, write to us at:

 

MOCON, Inc.

7500 Mendelssohn Avenue North

Minneapolis, Minnesota 55428

Attention: Chief Financial Officer

 

Item 11.

EXECUTIVE COMPENSATION

 

The information required under Item 11 of this Annual Report on Form 10-K is to be contained under the headings “Director Compensation,” “Executive Compensation,” “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in our definitive proxy statement to be filed with the SEC with respect to our next annual meeting of shareholders, which involves the election of directors and is incorporated herein by reference, or, if such proxy statement is not filed with the SEC within 120 days after the end of the fiscal year covered by this report, such information will be filed as part of an amendment to this report not later than the end of the 120-day period.

 

 
39

 

 

ITem 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED shareHOLDER MATTERS

 

The information required under Item 12 of this Annual Report on Form 10-K is to be contained under the headings “Principal Shareholders and Beneficial Ownership of Management” in our definitive proxy statement to be filed with the SEC with respect to our next annual meeting of shareholders, which involves the election of directors and is incorporated herein by reference, or, if such proxy statement is not filed with the SEC within 120 days after the end of the fiscal year covered by this report, such information will be filed as part of an amendment to this report not later than the end of the 120-day period.

 

The following table summarizes outstanding options under our equity compensation plans as of December 31, 2016. Our only equity compensation plans as of December 31, 2016 were the MOCON, Inc. 2015 Equity Incentive Plan, MOCON, Inc. 2006 Stock Incentive Plan, as amended, the MOCON, Inc. 1998 Stock Option Plan and the 2015 Employee Stock Purchase Plan. The MOCON, Inc. 2006 Stock Incentive Plan and MOCON, Inc. 1998 Stock Option Plan have terminated with respect to future grants. Options and other stock incentive awards to be granted in the future under the MOCON, Inc. 2015 Equity Incentive Plan are within the discretion of our Board of Directors and the Compensation Committee of our Board of Directors and therefore cannot be ascertained at this time. 

 

Plan Category

 

Number of Securities

to be Issued upon

Exercise of Outstanding

Options, Warrants

and Rights (1)

   

Weighted Average

Exercise Price of Outstanding Options, Warrants and Rights

   

Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in First Column)

 
                         

Equity compensation plans approved by security holders

    814,544     $ 16.04       226,915  
                         

Equity compensation plans not approved by security holders

                 

 

 

(1)

Excludes employee stock purchase rights under the MOCON Inc. 2015 Employee Stock Purchase Plan, as amended. Under such plan, each eligible employee may purchase up to $25,000 of common stock of the Company at semi-annual intervals on June 30th and December 31st each calendar year at a purchase price per share equal to 85% of the closing sales price per share of shares of common stock on the first or last day of the offering period, whichever is lowest.

 

Item 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

 

The information required under Item 13 of this Annual Report on Form 10-K is to be contained under the heading “Related Party Relationships and Transactions” and “Corporate Governance – Director Independence” in our definitive proxy statement to be filed with the SEC with respect to our next annual meeting of shareholders, which involves the election of directors and is incorporated herein by reference, or, if such proxy statement is not filed with the SEC within 120 days after the end of the fiscal year covered by this report, such information will be filed as part of an amendment to this report not later than the end of the 120-day period.

 

 

 
40

 

 

Item 14.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The information required under Item 14 of this Annual Report on Form 10-K is to be contained under the headings “Proposal Five – Ratification of Selection of Independent Registered Public Accounting Firm” in our definitive proxy statement to be filed with the SEC with respect to our next annual meeting of shareholders, which involves the election of directors and is incorporated herein by reference, or, if such proxy statement is not filed with the SEC within 120 days after the end of the fiscal year covered by this report, such information will be filed as part of an amendment to this report not later than the end of the 120-day period.

 

PART IV

 

Item 15.

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a)            1.     Financial Statements

 

The following consolidated financial statements of MOCON, Inc. and its subsidiaries are included herein:

 

  Page

Reports of Independent Registered Public Accounting Firms

F-1

   

Consolidated Balance Sheets as of December 31, 2016 and 2015 

F-4

   

Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014

F-5

   

Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2016, 2015 and 2014

F-6

   

Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2016, 2015 and 2014

F-7

   

Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014

F-8

   

Notes to Consolidated Financial Statements 

F-9

 

2.     Financial Statement Schedule

 

The following financial statement schedule is included herein and should be read in conjunction with the consolidated financial statements referred to above:

 

Schedule II: Valuation and Qualifying Accounts 

S-1

 

 

 

 
41

 

 

3.     Exhibits

 

The exhibits to this Annual Report on Form 10-K are listed in the Exhibit Index.

 

 

A.

MOCON, Inc. 2006 Stock Incentive Plan, as amended and restated (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed on June 1, 2011 (File No. 000-09273)).

 

 

B.

Form of Incentive Stock Option Agreement between MOCON, Inc. and its Executive Officers under the MOCON, Inc. 2006 Stock Incentive Plan (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed on May 23, 2006 (File No. 000-09273)).

 

 

C.

Form of Non-Statutory Stock Option Agreement between MOCON, Inc. and its Non-Employee Directors and Executive Officers under the MOCON, Inc. 2006 Stock Incentive Plan (incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K filed on May 23, 2006 (File No. 000-09273)).

 

 

D.

MOCON, Inc. 2015 Equity Incentive Plan, as amended and restated (filed herewith).

 

 

E.

MOCON, Inc. 2015 Stock Purchase Plan (filed herewith).

 

 

F.

First Amendment to MOCON, Inc. 2015 Employee Stock Purchase Plan (filed herewith).

 

 

G.

Form of Executive Severance Agreement (incorporated by reference to Exhibit 10.11 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 (File No. 000-09273)).

 

 

I.

MOCON, Inc. Annual Incentive Plan (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed on March 3, 2017 (File No. 000-09273)).

 

 

J.

MOCON, Inc. Special Performance Bonus Plan (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed on March 3, 2017 (File No. 000-09273)).

 

 

K.

Description of Non-Employee Director Retirement Plan (incorporated by reference to Exhibit 10.20 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2004 (File No. 000-09273)).

 

 

L.

Description of Non-Employee Director Compensation Arrangements (filed herewith).

 

 

M.

Description of Executive Officer Compensation Arrangements (filed herewith).

 

 

N.

Amendment to Executive Severance Agreement (incorporated by reference to Exhibit 10.21 to our Annual Report on FOrm 10-K for the fiscal year ended December 31, 2015 (File No. 000-09273).

  

 
42

 

 

 

(b)

Exhibits

 

The exhibits to this Annual Report on Form 10-K are listed in the Exhibit Index.

 

 

(c)

Financial Statement Schedule

 

See Item 15(a)(2) above for the financial statement schedule filed herewith.

 

 
43

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Date: March 9, 2017

MOCON, Inc.

   
 

By:/s/ Robert L. Demorest                                                                 

  Robert L. Demorest, Chairman of the Board,
  President and Chief Executive Officer
  (principal executive officer)
   
 

By:/s/ Elissa Lindsoe                                                                         

  Elissa Lindsoe, Chief Financial Officer,
  (principal financial and accounting officer) 

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated and on March 9, 2017.

 

 

Signature and Title

   
 

/s/ Robert L. Demorest

 

Robert L. Demorest, Chairman of the Board, President and Chief Executive Officer

   
 

/s/ Robert F. Gallagher

 

Robert F. Gallagher, Director

   
 

/s/ Bradley D. Goskowicz

 

Bradley D. Goskowicz, Director

   
 

/s/ Kathleen Iverson

 

Kathleen Iverson, Director

   
 

/s/ Tom C. Thomas

 

Tom C. Thomas, Director

   
 

/s/ David J. Ward

 

David J. Ward, Director

 

 

/s/ Paul R. Zeller

 

Paul R. Zeller, Director

   

 

 
44

 

 

MOCON, INC. AND SUBSIDIARIES

 

Consolidated Financial Statements

 

December 31, 2016, 2015 and 2014

 

 

 

Table of Contents

 

 

 

  Page

Reports of Independent Registered Public Accounting Firms

F-1

   

Consolidated Balance Sheets

F-4

   

Consolidated Statements of Income

F-5

   
Consolidated Statements of Comprehensive Income (Loss) F-6
   

Consolidated Statements of Shareholders’ Equity

F-7

   

Consolidated Statements of Cash Flows

F-8

   

Notes to Consolidated Financial Statements

F-9

 

 
45

 

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders
MOCON, Inc.

 

We have audited MOCON, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. MOCON, Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, MOCON, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of MOCON, Inc. and subsidiaries as of and for the year ended December 31, 2016, and our report dated March 9, 2017 expressed an unqualified opinion.

 

/s/ RSM US LLP

 

Minneapolis, Minnesota

March 9, 2017 

 

 
F-1

 

 

Report of Independent Registered Public Accounting Firm


To the Board of Directors and Shareholders
MOCON, Inc.


We have audited the accompanying consolidated balance sheet of MOCON, Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for the years then ended. Our audit also included the financial statement schedule listed in Item 15(a). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MOCON, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), MOCON, Inc.’s and subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 9, 2017 expressed an unqualified opinion on the effectiveness of MOCON, Inc. and subsidiaries’ internal control over financial reporting.

 

/s/ RSM US LLP

 

Minneapolis, Minnesota

March 9, 2017

 

 
F-2

 

 

The Board of Directors and shareholders

 

 

MOCON, Inc.:

 

We have audited the accompanying consolidated statements of income of MOCON, Inc. and subsidiaries for the year ended December 31, 2014, and the related consolidated statements of comprehensive income (loss), shareholders’ equity, and cash flows for the year then ended. In connection with our audit of the consolidated financial statements, we also have audited financial statement schedule II. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations of MOCON, Inc. and subsidiaries for the year ended December 31, 2014, and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

 

/s/ KPMG LLP

 

Minneapolis, Minnesota

March 12, 2015

 

 
F-3

 

 

MOCON, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2016 and 2015

(expressed in thousands, except share amounts)

 

 

 

2016

   

2015

 
Assets                

Current assets:

               

Cash and cash equivalents

  $ 8,313     $ 6,344  

Trade accounts receivable, less allowance for doubtful accounts of $180 in 2016 and $141 in 2015

    10,726       8,786  

Other receivables

    21       326  

Inventories

    6,728       7,790  

Prepaid income taxes

    498       559  

Prepaid expenses, other

    876       897  

Total current assets

    27,162       24,702  
                 

Property, plant, and equipment, net of accumulated depreciation of $8,537 in 2016 and $8,154 in 2015

    5,457       5,995  

Goodwill

    7,180       7,437  

Intangible assets, net

    7,831       8,986  

Other assets

    118       88  

Deferred income taxes

    700       211  

Total assets

  $ 48,448     $ 47,419  

Liabilities and Shareholders’ Equity

               

Current liabilities:

               

Current maturities of long-term notes payable

  $ 83     $ 65  

Accounts payable

    2,905       3,033  

Accrued compensation and related expenses

    3,948       3,969  

Other accrued expenses

    947       811  

Accrued product warranties

    209       223  

Accrued income taxes

    999       -  

Dividends payable

    644       637  

Deferred revenue

    980       862  

Total current liabilities

    10,715       9,600  
                 

Line of credit

    -       2,793  

Notes payable

    80       93  

Obligations to former employees

    -       34  

Deferred income taxes

    1,068       1,227  

Accrued income taxes

    134       201  

Total noncurrent liabilities

    1,282       4,348  

Total liabilities

    11,997       13,948  

Commitments and contingencies (Note 7)

               

Shareholders’ equity:

               

Capital stock – undesignated. Authorized 3,000,000 shares; none issued and outstanding in 2016 and 2015

    -       -  

Common stock – $0.10 par value. Authorized 22,000,000 shares; issued and outstanding 5,854,413 shares in 2016 and 5,792,126 shares in 2015

    585       579  

Additional paid-in capital

    8,617       7,412  

Retained earnings

    33,144       30,700  

Accumulated other comprehensive loss

    (5,895 )     (5,220 )

Total shareholders’ equity

    36,451       33,471  

Total liabilities and shareholders' equity

  $ 48,448     $ 47,419  

 

See accompanying notes to consolidated financial statements.

 

 

 
F-4

 

 

MOCON, INC. AND SUBSIDIARIES

Consolidated Statements of Income

Years ended December 31, 2016, 2015 and 2014

(expressed in thousands, except per share amounts)

 

   

2016

   

2015

   

2014

 

Revenue:

                       

Products

  $ 49,506     $ 47,832     $ 50,694  

Services

    11,674       9,956       10,658  

Consulting

    2,131       2,966       3,123  

Total revenue

    63,311       60,754       64,475  

Cost of revenue:

                       

Products

    21,198       21,308       22,174  

Services

    4,793       4,205       4,188  

Consulting

    1,663       2,017       1,999  

Total cost of revenue

    27,654       27,530       28,361  

Gross profit

    35,657       33,224       36,114  

Selling, general and administrative expenses

    23,615       23,468       24,988  

Research and development expenses

    4,844       4,341       4,191  

Realignment expenses

    903       1,049       -  

Impairment of investment in affiliated company

    -       -       3,171  

Operating income

    6,295       4,366       3,764  

Other income (expense), net

    371       93       (306 )

Income before income taxes

    6,666       4,459       3,458  

Income taxes

    1,666       1,487       1,922  

Net income

  $ 5,000     $ 2,972     $ 1,536  
                         

Net income per common share:

                       

Basic

  $ 0.86     $ 0.52     $ 0.27  

Diluted

  $ 0.86     $ 0.51     $ 0.27  
                         

Weighted average common shares outstanding:

                       

Basic

    5,802       5,753       5,665  

Diluted

    5,835       5,818       5,754  
                         

Dividends declared per common share

  $ 0.44     $ 0.44     $ 0.44  

 

See accompanying notes to consolidated financial statements.

 

 
F-5

 

 

MOCON, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)

Years ended December 31, 2016, 2015 and 2014

(expressed in thousands)

 

   

2016

   

2015

   

2014

 
                         

Net income

  $ 5,000     $ 2,972     $ 1,536  
                         

Other comprehensive income (loss):

                       

Cumulative translation adjustment

    (674 )     (2,429 )     (3,405 )
                         

Comprehensive income (loss)

  $ 4,326     $ 543     $ (1,869 )

 

See accompanying notes to consolidated financial statements.

 

 
F-6

 

 

MOCON, INC. AND SUBSIDIARIES 

Consolidated Statements of Shareholders’ Equity

Years ended December 31, 2016, 2015 and 2014

(expressed in thousands, except share amounts)

 

                                   

 

         
   

Common stock

   

Additional

           

Accumulated other

         
   

Number of

shares

   

Amount

   

paid-in

capital

   

Retained

earnings

   

comprehensive income (loss)

   

Total

 
                                                 

Balance, January 1, 2014

    5,630,197     $ 563     $ 5,064     $ 31,229     $ 613     $ 37,469  
                                                 

Stock options exercised, net of surrendered shares

    102,308       10       692       -       -       702  

Dividends declared ($0.44 per share)

    -       -       -       (2,500 )     -       (2,500 )

Share-based compensation expense

    -       -       591       -       -       591  

Tax benefit on stock plans

    -       -       80       -       -       80  

Net income

    -       -       -       1,536       -       1,536  

Cumulative translation adjustment

    -       -       -       -       (3,405 )     (3,405 )
                                                 

Balance, December 31, 2014

    5,732,505       573       6,427       30,265       (2,792 )     34,473  
                                                 

Stock options exercised, net of surrendered shares

    59,621       6       309       -       -       315  

Dividends declared ($0.44 per share)

    -       -       -       (2,536 )     -       (2,536 )

Share-based compensation expense

    -       -       668       -       -       668  

Tax benefit on stock plans

    -       -       8       -       -       8  

Net income

    -       -       -       2,972       -       2,972  

Cumulative translation adjustment

    -       -       -       -       (2,429 )     (2,429 )
                                                 

Balance, December 31, 2015

    5,792,126       579       7,412       30,701       (5,221 )     33,471  
                                                 

Stock issued under share-based equity plans

    62,287       6       444       -       -       450  

Dividends declared ($0.44 per share)

    -       -       -       (2,557 )     -       (2,557 )

Share-based compensation expense

    -       -       750       -       -       750  

Tax benefit on stock plans

    -       -       11       -       -       11  

Net income

    -       -       -       5,000       -       5,000  

Cumulative translation adjustment

    -       -       -       -       (674 )     (674 )

Balance, December 31, 2016

    5,854,413     $ 585     $ 8,617     $ 33,144     $ (5,895 )   $ 36,451  

 

See accompanying notes to consolidated financial statements.

 

 

 
F-7

 

  

MOCON, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended December 31, 2016, 2015 and 2014

(expressed in thousands)

 

   

2016

   

2015

   

2014

 

Cash flows from operating activities:

                       

Net income

  $ 5,000     $ 2,972     $ 1,536  

Adjustments to reconcile net income to net cash provided by operating activities:

                       

Share-based compensation expense

    750       668       591  

Change in other receivable

    -       (3 )     186  

Loss on disposition of long-term assets

    67       16       34  

Gain on sale of business

    (553 )     -       -  

Depreciation and amortization

    2,551       2,460       2,555  

Impairment of investment in affiliated company

    -       -       3,171  

Deferred income taxes

    (801 )     457       (147 )

Excess tax benefit from employee stock plans

    11       (8 )     (80 )

Changes in operating assets and liabilities:

                       

Trade accounts receivable

    (1,589 )     615       1,727  

Other receivables

    309       (194 )     (68 )

Inventories

    1,264       725       (1,557 )

Prepaid income taxes

    (21 )     162       (279 )

Prepaid expenses

    64       61       296  

Accounts payable

    (811 )     (1,349 )     519  

Accrued compensation and related expenses

    (359 )     71       625  

Other accrued expenses

    163       84       (18 )

Accrued product warranties

    (13 )     (49 )     (32 )

Accrued income taxes