Back to GetFilings.com

UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

or

Commission File Number 0-9273

MOCON, INC.
(Exact name of registrant as specified in its charter)

7500 Boone Avenue North, Minneapolis, Minnesota 55428
(Address of principal executive offices)             (Zip code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15 (d) of the SECURITIES EXCHANGE ACT OF 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES _X_ NO ___

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). YES ___ NO _X_

5,391,869 Common Shares were outstanding as of September 30, 2003

MOCON, INC.

INDEX TO FORM 10-Q
For the Quarter Ended September 30, 2003

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

MOCON, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

-1-

MOCON, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

-2-

MOCON, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

-3-

MOCON, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 – Condensed Consolidated Financial Statements

The condensed consolidated balance sheet as of September 30, 2003, the condensed consolidated statements of income for the three- and nine-month periods ended September 30, 2003 and 2002, and the condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2003 and 2002 have been prepared by us, without audit. However, all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows at September 30, 2003, and for all periods presented, have been made. The results of operations for the period ended September 30, 2003 are not necessarily indicative of operating results for the full year.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes included in our December 31, 2002 annual report to shareholders.

Stock–Based Compensation

We use the intrinsic-value method for employee stock-based compensation pursuant to Accounting Principles Board Opinion No. 25 (Opinion 25), Accounting for Stock Issued to Employees. Under the guidelines of Opinion 25, compensation cost for stock-based employee compensation plans is recognized based on the difference, if any, between the quoted market price of the stock on the date of grant and the amount an employee must pay to acquire the stock.

We have adopted the disclosure-only provisions for employee stock-based compensation and the fair-value method for non-employee stock-based compensation of Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation. These provisions require us to show, on a pro forma basis, our net income and income per common share if we had recorded an expense for our stock options at the time of grant. Other than disclosure in this footnote, we do not use these pro forma results for any purpose.

Had we recorded compensation cost based on the estimated fair value on the date of grant, as defined by SFAS 123, our net income and net income per common share would have been reduced to the pro forma amounts indicated below:

-4-

New Accounting Pronouncements

In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 (SFAS 150), Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards on the classification and measurement of financial instruments with characteristics of both liabilities and equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement did not have a material impact on our financial condition or results of operation.

In December 2002, the Emerging Issues Task Force issued EITF 00-21, “Revenue Arrangements with Multiple Deliverables.” This issue addresses certain aspects of the accounting for arrangements under which a company will perform multiple revenue-generating activities. In some arrangements, the different revenue-generating activities (deliverables) are sufficiently separable, and there exists sufficient evidence of their fair values to separately account for some or all of the deliverables (that is, there are separate units of accounting). In other arrangements, some or all of the deliverables are not independently functional, or there is not sufficient evidence of their fair values to account for them separately. This issue addresses when and, if so, how an arrangement involving multiple deliverables should be divided into separate units of accounting. This issue does not change otherwise applicable revenue recognition criteria. This issue was applicable for us for revenue arrangements entered into beginning in third quarter 2003. The adoption of EITF 00-21 did not have an impact on revenue recognition.

-5-

Note 2 – Inventories

Inventories consist of the following:

Note 3 – Net Income Per Common Share

Basic net income per common share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted net income per common share is computed using the treasury stock method to compute the weighted average common stock outstanding assuming the conversion of potential dilutive common shares.

The following table presents a reconciliation of the denominators used in the computation of net income per common share – basic and net income per common share – diluted for the three- and nine-month periods ended September 30, 2003, and 2002:

Note 4 – Goodwill and Intangible Assets

As of September 30, 2003, we have unamortized goodwill in the amount of $1,346,795. Other intangible assets (all of which are being amortized) are as follows:

-6-

Total amortization expense for the three and nine months ended September 30, 2003 was $44,949 and $135,498, respectively. Estimated amortization expense for each of the five succeeding fiscal years based on the intangible assets as of September 30, 2003 is as follows:

Note 5 – Marketable Securities

Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses on available-for-sale securities are excluded from income and are reported as a separate component of stockholders’ equity until realized. A decline in the market value of any available-for-sale security below cost that is deemed other than temporary is charged to income resulting in the establishment of a new cost basis for the security. At September 30, 2003, and September 30, 2002, this resulted in a net unrealized gain of $5,553 and $964, respectively, within stockholders’ equity.

Note 6 – Comprehensive Income

Note 7 – Warranty Guarantees

We provide a warranty for most of our products. Warranties are for periods ranging from ninety days to one year, and cover parts and labor for non-maintenance repairs, at our location. Operator abuse, improper use, alteration, damage resulting from accident, or failure to follow manufacturer’s directions, are excluded from warranty coverage.

Warranty expense is accrued at the time of sales based on historical claims experience. Special warranty reserves are also accrued for special rework campaigns for known major product modifications. We also offer service contracts for select products when the factory warranty period expires.

-7-

Warranty provisions and claims for the nine-month periods ended September 30, 2003 and 2002 were as follows:

Note 8 – Stock Repurchase

In May of 2003, our Board of Directors authorized a $1,200,000 increase in our common stock repurchase program, bringing the total repurchase authorization up to $3,200,000 of our common stock. Pursuant to this authorization, we have acquired $627,606 of our common stock.

-8-

MOCON, INC.

Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition

This Form 10-Q includes certain statements that are deemed to be “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. All statements, other than statements of historical facts, included in this Form 10-Q that address activities, events, or developments that we expect, believe, or anticipate will or may occur in the future, are forward-looking statements. The forward-looking statements in this filing are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that any such statements are not guarantees of future performance and that actual results or developments may differ materially from those projected in the forward-looking statements because these statements are subject to a number of risks and uncertainties including the risk factors described in our annual report on Form 10-K for the year ended December 31, 2002, including, but not limited to, the factors included in the section entitled “Certain Important Factors.”Persons reading this Form 10-Q should carefully review the discussion of all of the risk factors described in such Form 10-K and in our other filings made from time to time with the Securities and Exchange Commission.

Summary

Sales decreased 2 percent and net income decreased 1 percent for the three-month period ended September 30, 2003, compared to the three-month period ended September 30, 2002. Sales increased 2 percent and net income increased 1 percent for the nine-month period ended September 30, 2003, compared to the same period in 2002. Basic and diluted net income per share was 10 cents for both three-month periods ended September 30, 2003 and 2002. Basic net income per share was 32 cents for the nine-month periods ended September 30, 2003 and 2002 and diluted net income per share was 32 cents for the nine-month period ending September 30, 2003, and 31 cents for same period in 2002. International sales were 40 percent of sales for the three and nine months ended September 30, 2003. We use a network of independent representatives to market and service our products in foreign countries, and expect that international sales will continue to account for a significant portion of our revenues for the foreseeable future. We have four operating locations, all of which are located in the United States.

Results of Operations

Sales for the three-month period ended September 30, 2003, were $4,778,161, down 2 percent from third quarter 2002 sales of $4,853,612. The decrease in 2003 sales was primarily the result of decreases in the sales volume of our sample preparation and gas analyzer products, offset somewhat by increases in the foreign sales volume of our permeation products and domestic sales volume of our weighing products. The decrease in the sales volume of our sample preparation products was primarily due to decreased sales in the life sciences and drug discovery markets. The impact of price increases was not significant.

Sales for the nine-month period ended September 30, 2003, were $14,939,584, up 2 percent from sales for the first nine months of 2002 of $14,637,325. The 2 percent increase was due primarily to increases in the sales volume of our permeation and weighing products, offset somewhat by decreases in the sales volume of our gas analyzer and sample preparation

-9-

products. The decrease in the sales volume of our sample preparation products was primarily due to decreased sales in the life sciences and drug discovery markets. The impact of price increases was not significant.

Total domestic sales for the quarter ended September 30, 2003 decreased 13 percent from the third quarter of 2002 to $2,856,792, and total foreign sales increased 23 percent to $1,921,369. Domestic sales were 60 percent of total third quarter 2003 sales, compared to $3,287,711, or 68 percent, of third quarter 2002 sales. Foreign sales were 40 percent of total third quarter 2003 sales, compared to $1,565,901, or 32 percent, of third quarter 2002 sales. The increase in foreign sales in the third quarter of 2003 is primarily due to an increase in sales to customers in Canada.

Total domestic sales for the nine months ended September 30, 2003, decreased 8 percent over the nine months ended September 30, 2002, to $8,928,636, and total foreign sales increased 22 percent to $6,010,948. Domestic sales were 60 percent of total sales for the nine months ended September 30, 2003, compared to $9,724,449, or 66 percent for the same period in 2002. Foreign sales were 40 percent for the first nine months of 2003, compared to $4,912,876, or 34 percent, for the same period in 2002. The increase in foreign sales in the first nine months of 2003 is primarily due to an increase in sales to customers in Japan.

Our sales to customers located in foreign countries are subject to a number of risks. These include, but are not limited to, the following: agreements may be difficult to enforce; receivables may be difficult to collect; foreign customers may have longer payment cycles; the countries into which we sell may impose tariffs or adopt other restrictions on foreign trade; fluctuations in exchange rates may affect product demand; export licenses, if required, may be difficult to obtain; and the protection of intellectual property in foreign countries may be more difficult to enforce. If any of the above risks were to materialize, our sales into foreign countries could decline or our operating costs could increase, which would adversely affect our financial results.

We derive our revenue from product sales and consulting services, consisting of standard laboratory testing services and consulting and analytical services performed for various customers. In the third quarter of 2003, product sales were $4,318,284 and consulting services were $459,877, or 90 and 10 percent, respectively, of our total third quarter 2003 sales. This compares to product sales of $4,364,453 and consulting services of $489,159 in the third quarter of 2002, also 90 and 10 percent of total sales, respectively. For the first nine months of 2003, product sales were $13,548,271 and consulting services were $1,391,313, or 91 and 9 percent, respectively, of our total sales for the first nine months of 2003. This compares to product sales of $13,205,189 and consulting services of $1,432,136, or 90 and 10 percent of total sales, respectively, for the same period in 2002.

The cost of sales for product sales was 45 percent and 49 percent, respectively, for the third quarters of 2003 and 2002. The cost of sales for consulting services sales was 47 percent and 44 percent for the third quarters of 2003 and 2002, respectively. The cost of sales for the product sales in the nine-month periods ended September 30, 2003 and 2002 was 44 percent and 46 percent, respectively. The cost of sales for consulting services sales was 48 percent for the nine months ended September 30, 2003 and 54 percent for the same period in 2002. The percentage decrease in the cost of sales for product sales was primarily due to the product mix in the third quarter and first nine months of 2003 including more permeation and weighing product sales, which on average carry a higher gross margin. The slight increase in the cost of sales for consulting services for the third quarter of 2003 as compared to the same period in 2002 was mostly due to fixed costs on reduced revenue. The decrease in the cost of consulting services

-10-

sales for the nine months ended September 30, 2003 as compared to the same period in 2002, both in total dollars and as a percent of sales, was primarily the result of tighter cost controls, including lower headcount, particularly in the consulting and analytical services area.

Selling, general and administrative expenses were 31 percent of total sales for the three- and nine-month periods ended September 30, 2003. This compares to 30 percent of total sales for the same periods in 2002. The $52,705 and $227,872 total dollar increases for the three- and nine-month periods ended September 30, 2003, respectively, are due primarily to increased selling expenses, including increases in travel and marketing expenses, and to increases in general and administrative expenses, including increases in insurance costs and professional expenses which are expected to continue to increase.

Research and development (R&D) expenses increased $8,116 and $94,804 for the quarter and nine-month period ended September 30, 2003, respectively, compared to the same periods in 2002. As a percent of sales, R&D expenditures were 7 percent of sales for the quarter and nine-month period ended September 30, 2003, and 6 percent of sales for the quarter and nine-month period ended September 30, 2002. The increase is primarily due to R&D expenses associated with the development of new permeation products. Continued R&D expenditures are necessary as we develop new products to expand in our niche markets and into new markets. For the foreseeable future, we expect to spend on an annual basis approximately 6 to 8 percent of sales on R&D.

Investment income decreased $16,155 in the third quarter of 2003 as compared to the third quarter of 2002, and decreased $66,595 in the first nine months of 2003 as compared to the same period in 2002. The decrease is the result of lower average investment yields, offset somewhat by higher average investment balances in 2003 versus 2002.

Our provision for income taxes was 35 percent of income before income taxes for the three- and nine-month periods ended September 30, 2003 compared to 33.5 and 33 percent of income before income taxes for the three- and nine-month periods ended September 30, 2002, respectively. The increase in the rate is due in part to lower benefits from export tax incentives and lower tax-exempt interest income. We review the tax rate quarterly and may make adjustments to reflect changing estimates. Based on current operating conditions and income tax laws, we expect the effective tax rate for all of 2003 to be in the range of 34 to 36 percent.

Net income was $534,316 for the third quarter of 2003, compared to $537,350 for the third quarter of 2002. Diluted net income per share was $.10 for both the third quarters of 2003 and 2002. For the nine months ended September 30, 2003, net income was $1,750,253 compared to $1,740,034 for the nine months ended September 30, 2002. Diluted net income per share was $.32 and $.31, respectively, for the nine-month periods ended September 30, 2003, and 2002.

Liquidity and Capital Resources

We continue to maintain a strong financial position. Cash flow provided by operating activities totaled $2,231,733 in the first nine months of 2003. Total cash, temporary cash investments and marketable securities increased $238,630 during the same period, primarily as a result of the net income for the period and decreases in accounts receivable, offset somewhat by dividend payments totaling $1,027,080, repurchases of shares of our common stock totaling $627,606, and decreases in accrued income taxes. The $136,091 year-to-date decrease in accounts receivable is primarily due to lower shipments in the third quarter of 2003 compared to the fourth

-11-

quarter of 2002. The $329,998 year-to-date decrease in current liabilities is primarily due to the decrease in accrued income taxes resulting from the timing of payments.

We have no long-term debt or material commitments for capital expenditures as of September 30, 2003. Our plant and equipment would not require any major expenditures to accommodate a significant increase in operating demands. We anticipate that a combination of our existing cash, temporary cash investments and marketable securities, plus an expected continuation of cash flow from operations, will continue to be adequate to fund operations, capital expenditures and dividend payments for the foreseeable future.

Critical Accounting Policies

Our estimates related to certain significant assets and liabilities are an integral part of these consolidated financial statements. These estimates are considered critical to the consolidated financial statements because they require subjective and complex judgements. We consider our critical accounting policies to be the policies applicable to allowance for doubtful accounts, inventory reserves, and the recoverability of long-lived assets. These policies are discussed in the section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations entitled Critical Accounting Policies contained in our Annual Report on Form 10-K for the year ended December 31, 2002. No material change occurred in these policies in the periods covered by this report.

-12-

MOCON, INC.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market Risk Management

Substantially all of our marketable securities are at fixed interest rates. However, virtually all of our marketable securities mature within two years, therefore, we believe that the market risk arising from the holding of these financial instruments is minimal.

We currently sell our products and services in United States dollars; accordingly, the exposure to foreign currency exchange risk is minimal.

There have been no significant changes since December 31, 2002.

Item 4. Controls and Procedures

As of September 30, 2003, the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in alerting them in a timely manner to material information required to be included in our periodic SEC filings. There were no changes identified by our Chief Executive Officer and Chief Financial Officer in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

-13-

MOCON, INC.

PART II. OTHER INFORMATION

-14-

SIGNATURES

Pursuant to the requirements of the SECURITIES EXCHANGE ACT of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

-15-