Overview

Mesa Laboratories, Inc. has two segments - Our Instruments Division manufactures and markets quality control instruments and disposable products utilized in connection with the healthcare, pharmaceutical, food and beverage, medical device, and petrochemical industries. Our Biological Indicators Division manufactures and markets biological indicators and distributes chemical indicators used to assess the effectiveness of sterilization processes in the hospital, dental, medical device and pharmaceutical industries. We follow a philosophy of manufacturing a high quality product and providing a high level of on-going service for those products.

Our revenues come from two main sources - products sales, and parts and services. Product sales are dependent on several factors, including general economic conditions, both domestic and international, customer capital spending trends, competition, introduction of new products, and acquisitions. Biological indicator products are disposable and are used on a routine basis for quality control, thus product sales are less sensitive to general economic conditions. Instrument products have a longer life, and their purchase by our customers is somewhat discretionary, so sales are more sensitive to general economic conditions. Parts and service demand is driven by our customers' quality control and regulatory environments, which require periodic repair and recalibration or certification of our instrument products. We typically evaluate costs and pricing annually. Our policy is to price our products competitively and, where possible, we try to pass along cost increases in order to maintain our margins. As part of the integration of our biological indicator acquisitions we have been adjusting prices to achieve price parity for similar products.

Gross profit is affected by our product mix, manufacturing efficiencies and price competition. As we have integrated our acquisitions and taken advantage of manufacturing efficiencies, the Biological Indicator segment gross margins have improved and are now more comparable to the Instruments segment. The mix between segments, however, may continue to impact our overall gross margin.

Selling expense is driven primarily by labor costs, including salaries and commissions. Accordingly, they may vary with sales levels. Labor costs and amortization of intangible assets drive 70-80% of general and administrative expense. Research and development expense is predominantly comprised of labor costs.

Discussion of Key Indicators and Trends

In May 2012, we completed a business combination (the "Bios Acquisition") by acquiring specific assets and assuming certain liabilities of Bios International Corporation ("Bios"), a New Jersey corporation. Consideration consisted of a $15,660,000 closing payment and a future payment of $1,000,000 held in escrow. Contingent consideration involves a three year earn-out period. If cumulative revenues from the acquisition for the three year period subsequent to acquisition exceed certain growth targets, additional consideration of up to $6,710,000 will be required. We borrowed $11,000,000 under our Credit Facility to finance the acquisition, with the balance being paid from available cash. Due to the recency of the transaction, the purchase price allocation was based on preliminary estimated fair value of the assets and liabilities acquired, including the preliminary contingent purchase price liability. Upon completing our valuation analysis, the preliminary contingent purchase price liability, and the allocation between intangibles and goodwill may change.

Acquisitions in May 2012, December 2010, April 2010 and December 2009, impacted our current assets and working capital, as we used available cash and incurred debt to complete those transactions. It typically takes us from six to twelve months to fully integrate acquisitions, which impacts the key indicators during that time frame.

                                                                 Key Financial Indicators
(Dollars in thousands except earnings per             As of and for the three months ended June 30,
share)                                          2012           2011         2010         2009         2008
Cash and cash equivalents                    $     4,593    $    6,054    $   2,541    $  10,759    $   6,390

Trade Receivables Gross                      $     7,519    $    6,851    $   5,350    $   3,748    $   3,768
Days Revenues Outstanding (1)                         57            67           58           66           63

Inventory, Net                               $     5,575    $    5,377    $   5,936    $   4,749    $   4,498
Inventory Turns                                      3.0           2.6          2.1          1.7          1.7

Working Capital                              $    13,330    $    9,254    $   8,769    $  18,005    $  13,571
Current Ratio                                        4:1           2:1          3:1         13:1         11:1

Average Return On:
Stockholder Investments (2)                           19 %          18 %         17 %         15 %         17 %
Assets                                                13 %          13 %         14 %         14 %         16 %
Invested Capital (3)                                  17 %          18 %         19 %         22 %         22 %

Revenues (4)                                 $    10,559    $    9,297    $   7,781    $   5,245    $   5,329
Gross Profit (4)                             $     6,455    $    5,388    $   4,381    $   2,983    $   3,204
Gross Margin (4)                                      61 %          58 %         56 %         57 %         60 %

Operating Income                             $     3,219    $    2,693    $   2,214    $   1,608    $   1,536
Operating Margin (4)                                  30 %          29 %         28 %         31 %         29 %

Net Income                                   $     2,099    $    1,679    $   1,320    $   1,026    $   1,016
Net Profit Margin (4)                                 20 %          18 %         17 %         20 %         19 %
Earnings Per Diluted Share                   $      0.59    $     0.49    $    0.40    $    0.31    $     .31

Earnings Before Income Tax, Depreciation,
Amortization and Impairment of intangible
asset                                        $     3,969    $    3,184    $   2,619    $   1,800    $   1,756

Capital Expenditures, Net                    $       185    $      187    $   2,346    $      29    $      63

Employees (average for the period)                   200           178          170          114          118

Revenues Per Employee (annualized)           $       211    $      209    $     183    $     184    $     181

(2) Average return on stockholder investment is calculated by dividing total annualized net income by the average of end and beginning of period total stockholder's equity.

(3) Average return on invested capital (invested capital = total assets - current liabilities - cash and cash equivalents) is calculated by dividing total annualized net income by the average of end and beginning of period invested capital.

(4) Customer payments for shipping have been reclassified from cost of revenue to revenue for all five periods presented. This reclassification affects revenue, gross margin, gross margin percentage, operating margin percentage and net profit margin percentage, but has no impact on other figures in the income statement.

Reconciliation of Non-GAAP Measure

Earnings before income tax, depreciation and amortization is used by management as a supplemental performance and liquidity measure, primarily to assess financial performance without regard to historical cost basis, the ability of our assets to generate cash, and the evaluation of potential acquisitions.

Earnings before income tax, depreciation and amortization should not be considered an alternative to, or more meaningful than, net income, operating income, cash flow from operating activities or any other measure of financial performance presented in accordance with GAAP as measures of operating performance or liquidity.

The following table sets forth our reconciliation of Earnings before income tax, depreciation and amortization, a non-GAAP measure:

                                   Three months ended June 30,
(Dollars in thousands)    2012      2011      2010      2009      2008
Net income               $ 2,099   $ 1,679   $ 1,320   $ 1,026   $ 1,016
Income taxes               1,086       964       882       588       549
Depreciation                 203       165       167        82        65
Amortization                 581       376       250       104       126
                         $ 3,969   $ 3,184   $ 2,619   $ 1,800   $ 1,756

Results of Operations



                           Three months ended June 30,                Percent
(Dollars in thousands)        2012              2011        Change    Change
Revenues                 $        10,559    $       9,297   $ 1,262        14 %
Cost of revenues                   4,104            3,909       195         5 %
Gross profit                       6,455            5,388     1,067        20 %
Gross margin                          61 %             58 %       3 %

Operating expenses                 3,236            2,695       541        20 %

Net income                         2,099            1,679       420        25 %
Net profit margin                     20 %             18 %       2 %

Revenues



The following table summarizes our revenues by source:



                                    Three months ended June 30,                 Percent
(Dollars in thousands)                 2012              2011         Change    Change
Biological Indicators - Product   $         5,118    $       4,668   $    450        10 %
Instruments:
Product                                     3,607            2,998        609        20 %
Parts and disposables                         756              698         58         8 %
Service                                     1,078              933        145        16 %
Total Instruments                           5,441            4,629        812        18 %
                                  $        10,559    $       9,297      1,262        14 %

Biological indicator product sales increased due to continued organic growth, achieved through existing customers and expanding into new markets. Instruments revenues increased primarily due to the Bios Acquisition in May 2012, while our other Instruments revenues were relatively flat.

Cost of Revenues / Gross Profit

Biological indicator gross profit increased approximately $586,000 for the three month period ended June 30, 2012, compared to the prior year, due to improved manufacturing efficiencies and higher sales.

Gross profit for Instruments increased approximately $481,000 for the three month period ended June 30, 2012, compared to the prior year, primarily due to the Bios Acquisition. Gross profit for other Instruments product lines was relatively unchanged.

Operating Expenses

Selling expenses increased approximately $63,000 for the three month period ended June 30, 2012, compared to the prior year. The Bios Acquisition increased our costs, but we were able to offset these with cost savings elsewhere. As a percent of sales, selling expense remained relatively flat.

General and administrative expense increased approximately $506,000 for the three month period ended June 30, 2012, compared to the prior year. The increase relates primarily to a) additional amortization of approximately $200,000 from the Bios Acquisition and the amortization of trademarks, which we began in the fourth quarter of fiscal 2012; b) increased labor costs for additional personnel and salary adjustments; and c) professional fees of approximately $80,000 associated with the Bios Acquisition.

Research and development expense decreased approximately $28,000 for the three month period ended June 30, 2012, compared to the prior year. Our internal costs increased, but our external consulting expense decreased. The cost of intangible assets that are purchased from others for use in research and development activities and have future use are capitalized and amortized over their expected useful lives. In fiscal 2012, we partially funded Biological Indicator research, which was capitalized as an intangible asset because it has alternative future uses. That project continues in fiscal 2013.

Net Income

Net income varied consistently with the growth in revenues and gross profit, as we managed our other expenses. Our effective income tax rate decreased period over period because the goodwill from the Bios acquisition is deductible for tax purposes.

Liquidity and Capital Resources

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

We invest surplus cash in various interest bearing instruments, including money market funds. All investments are fixed dollar investments with variable rates in order to minimize the risk of principal loss.

Working capital is the amount by which current assets exceed current liabilities. We had working capital of approximately $13,330,000 and $14,899,000, respectively, at June 30 and March 31, 2012. The decrease in working capital is due to the use of cash for the Bios Acquisition, offset by higher sales and net income.

In February 2012, we entered into a three year agreement for a $20,000,000 revolving line of credit and up to $1,000,000 of letters of credit (the "Credit Facility"). Funds from the Credit Facility may be used for general working capital and corporate needs, retiring existing debt, or to support acquisitions and capital expenditures. In February 2012 we also extinguished our obligations under our previous debt agreement. In May 2012, we borrowed $11,000,000 against the Credit Facility to partially finance the Bios Acquisition. At June 30, 2012, we had unused capacity under our Credit Facility of $9,000,000.

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

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

On November 12, 2003, our Board of Directors instituted a policy of paying regular quarterly dividends. Dividends per share paid by quarter were as follows:

Fiscal Year

                  2013     2012
First quarter    $ 0.13   $ 0.12
Second quarter        -     0.12
Third quarter         -     0.13
Fourth quarter        -     0.13

On August 8, 2012, our Board of Directors declared a quarterly cash dividend of $0.13 per share of common stock, payable on September 17, 2012, to shareholders of record at the close of business on August 29, 2012.

Cash Flow - Operating, investing and financing activities were as follows:

                                                   Three months ended June 30,
(Dollars in thousands)                              2012                2011
Net cash provided by operating activities      $         3,412     $         2,888
Net cash used in investing activities                  (16,845 )              (187 )
Net cash provided by (used in) financing
activities                                              10,835                (193 )

Net cash provided by operating activities changed primarily due to increased sales and improved net income, as well as management of working capital.

Net cash used in investing activities was driven by a $16,660,000 acquisition in May 2012. Capital expenditures were $185,000 and $187,000, respectively, during the quarters ended June 30, 2012 and 2011.

Financing activity in the quarter ended June 30, 2012, included borrowing under our Credit Facility of $11,000,000 and the payment of dividends of $434,000, offset by proceeds from exercised stock options of $312,000. Activity in the quarter ended June 30, 2011, included repayment of debt of $250,000, payment of dividends of $394,000, offset by proceeds from exercised stock options of $478,000.

At June 30, 2012, we had contractual obligations for open purchase orders for routine purchases of supplies and inventory, which would be payable in less than one year. In September 2011, we entered into a license agreement for certain biological indicator technology and up to $225,000 of additional payments may be made in the future, depending on meeting certain development and performance milestones. As part of our Bios Acquisition, the Bios Agreement includes a provision for contingent consideration based on revenue growth over a three year earn-out period. The contingent consideration arrangement requires us to pay the former owners of Bios if cumulative revenues from the acquisition for the three years subsequent to the acquisition exceed approximately $22,127,000. The potential undiscounted future payments that we could be required to make is between $0 and $6,710,000.

Forward Looking Statements

All statements other than statements of historical fact included in this quarterly report regarding our Company's financial position and operating and strategic initiatives and addressing industry developments are forward-looking statements. Where, in any forward-looking statement, the Company, or its management, expresses an expectation or belief as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will result or be achieved or accomplished. Factors which could cause actual results to differ materially from those anticipated, include but are not limited to general economic, financial and business conditions; competition in the data logging market; competition in the kidney dialysis market; competition in the fluid measurement market; competition in the biological indicator market; competition in the bottlecap torque testing market; the business abilities and judgment of personnel; the impacts of unusual items resulting from ongoing evaluations of business strategies; and changes in business strategy. We do not intend to update these forward looking statements except to the extent required by federal securities laws. You are advised to review Item 1A. "Risk Factors" provided in our most recent Form 10-K filing with the SEC for more information about risks that could affect the financial results of Mesa Laboratories, Inc.