Notes to Consolidated Financial Statements
(Unaudited)
(1)
Basis of Presentation and Description of Business
MGC Diagnostics Corporation (the “Company”), through its Medical Graphics Corporation and Medisoft SA subsidiaries, designs and markets non-invasive cardiorespiratory diagnostic systems that are sold under the MGC Diagnostics and Medisoft brand and trade names. These cardiorespiratory diagnostic systems have a wide range of applications within cardiorespiratory healthcare.
The consolidated balance sheet as of April 30, 2017, the consolidated statements of comprehensive(loss) income for the three- and six-month periods ended April 30, 2017 and 2016, the consolidated statements of cash flows for the six-month periods ended April
30, 2017 and 2016 and the related information presented in these notes have been prepared by management in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, without audit. Accordingly, they do not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of results have been included. The consolidated balance sheet at October 31, 2016 was derived from the audited consolidated financial statements as of that date. Operating results for the three- and six-month periods ended April
30, 2017 are not necessarily indicative of the results that may be expected for the year ending October 31, 2017. For further information, refer to the consolidated financial statements and notes thereto included in MGC Diagnostics Corporation’s Annual Report on Form 10-K for the year ended October 31, 2016.
Preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities made in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Estimates include accounts receivable reserves, product warranty and inventory reserves, realizability of deferred tax assets and depreciable lives of property, equipment and intangible assets (including internal software development costs).
(2) Summary of Significant Accounting Policies
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, transfer of title has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably ensured. The Company’s products are sold for cash or on unsecured credit terms requiring payment based on the shipment date. Credit terms can vary between customers due to many factors, but are generally, on average, 30 to 60 days. Revenue, net of discounts, is generally recognized upon shipment or delivery to customers in accordance with written sales terms. Standard sales terms do not include customer acceptance conditions, future credits, rebates, price protection or general rights of return. Although the terms of sales to both domestic customers and international distributors are identical, adherence to these terms is more pervasive with domestic customers than with international distributors. In instances when a customer order specifies final acceptance of the system, revenue recognition is deferred until all customer acceptance criteria have been met. Estimated warranty obligations are recorded upon shipment. In certain situations customer requested short-term bill-and-hold sale arrangements are accommodated and accounted for in accordance with authoritative literature. Sales and use taxes are reported on a net basis, excluding them from revenues and cost of revenues.
Service contract revenue is based on a stated contractual rate and is deferred and recognized ratably over the service period, which is typically from 1 to 5
years
beginning after the expiration of the standard warranty. Deferred income associated with servi
ce
contracts
was
$7,346,000 and $7,551,000 as of April 30, 2017 and October 31, 2016, respectively. Revenue from installation and training services provided to customers is deferred until the service has been performed or no further obligations to perform the service exist. The amount of deferred installation and training revenue was $452,000 and $533,000 as of April 30, 2017
and October 31, 2016, respectively.
When a sale involves multiple deliverables, such as equipment, installation services and training, the amount of the sale consideration is allocated to each respective element based on the relative selling price and revenue is recognized when revenue recognition criteria for each element are met. Consideration allocated to delivered equipment is equal to the total arrangement consideration less the selling price of installation and training. The selling price of installation and training services is based on specific objective evidence, including third-party invoices.
No customer accounted for more than
10
% of revenue in either of the three- or six-month periods ended April
30, 2017 or 2016.
Advance Payments from Customers
The Company typically does not receive advance payments from its customers in connection with the sale of its products. The Company occasionally enters into an arrangement under which a customer agrees to purchase a large quantity of product to be delivered over a period of time. Depending on the size of these arrangements, the Company may negotiate an advance payment from these customers. Advance payments from customers were $227,000 and $151,000 as of April
30, 2017
and October 31, 2016, respectively. Revenue recognition for customer orders that include advance payments is consistent with the Company’s revenue recognition policy described above.
Internal Software Development Costs
Internal software development costs consist primarily of internal salaries and consulting fees for developing software platforms for sale to or use by customers within equipment the Company sells. We capitalize costs related to the development of our software products because the Company will use these software products as an integral part of a product or process sold or leased. This software is primarily related to both our current Breeze Suite and our new next generation software platforms, including underlying support products. Capitalized software may also include other less significant projects supporting software for separate sale or for internal use.
We begin to capitalize costs related to software developed for new products and significant enhancements of existing products once we reach technological feasibility and we have completed all research and development for the components of the product. We amortize these costs on a straight-line basis over the estimated useful life of the related product, generally five years, but not more than ten years, commencing with the date the product becomes available for general release to our customers. We amortize costs for internal use software over the expected use periods of the software (See Note 5). The achievement of technological feasibility and the estimate of a product’s economic life require management’s judgment. Any changes in key assumptions, market conditions or other circumstances could result in an impairment of the capitalized software asset and a charge to our operating results.
Income Taxes
The Company uses the asset and liability method of accounting for income taxes in accordance with FASB ASC 740,
Income Taxes
. The Company recognizes deferred tax assets or liabilities for the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities. Each quarter, the Company assesses the likelihood that its deferred tax assets will be recovered from future taxable income. The analysis to determine the amount of the valuation allowance is highly judgmental and requires weighing positive and negative evidence including historical and projected future taxable income and ongoing tax planning strategies. See Note 9 to the consolidated financial statements, “Income Taxes,” for further discussion.
Reclassification
Certain prior year Medisoft service revenues and costs of service revenues amounts have been reclassified to conform with current year classifications. There was no impact, as a result of these reclassifications, on the consolidated balance sheet, the consolidated comprehensive (loss) income or the consolidated statement of cash flows as previously reported.
New Accounting Pronouncements
Revenue from Contracts with Customers. In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance creating Accounting Standards Codification (“ASC”) Section 606,
Revenue from Contracts with Customers
. The new section will replace Section 605,
Revenue Recognition
, and creates modifications to various other revenue accounting standards for specialized transactions and industries. The section is intended to conform revenue accounting principles to a concurrently issued International Financial Reporting Standards to reconcile previously differing treatment between United States practices and those of the rest of the world and enhance disclosures related to disaggregated revenue information. In August 2015, the FASB deferred the effective date of the new guidance by
one
year, with the updated guidance now effective for annual reporting periods beginning after December 15, 2017, and interim periods within those fiscal years. The FASB has also issued ASU 2016-10 and ASU 2016-12, which are also related to ASC 606. The Company will adopt the new provisions of this accounting standard at the beginning of fiscal year 2019. The Company is currently evaluating the effect that this guidance will have on its consolidated financial statements.
In July 2015, FASB issued ASU 2015-11,
Inventory (Topic 330)
Related to Simplifying the Measurement of Inventory
, which will apply to all inventory, except inventory that is measured using either last-in, first-out (LIFO) or the retail inventory method. Inventory measured using either first-in, first-out (FIFO) or average cost is covered by the new amendments. Inventory within the scope of the new guidance should be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using LIFO or the retail inventory method. The amendments will take effect for public business entities for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The new guidance should be applied prospectively, and earlier application is permitted as of the beginning of an interim or annual reporting period. The Company is currently evaluating the effect that this guidance will have on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02,
Leases,
to increase transparency and comparability among organizations by recognizing all lease transactions with an initial term longer than
twelve
months on the balance sheet as a lease liability and a right-of-use asset (as defined). ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with earlier application permitted, and requires a modified retrospective transition method upon adoption. The Company is currently evaluating the effect that ASU 2016-02 will have on its consolidated financial statements.
(3) Shareholders' Equity
The MGC Diagnostics Corporation 2007 Stock Incentive Plan (the “2007 Plan”) provides that incentive stock options and nonqualified stock options to purchase shares of common stock may be granted at prices determined by the Human Capital Committee of the Company's Board of Directors, except that the purchase price of incentive stock options may not be less than the fair market value of the stock at the date of grant. Options under the 2007 Plan are subject to vesting schedules established on the date of grant. In addition, the 2007 Plan allows the granting of restricted stock awards, stock appreciation rights and performance stock.
Total stock-based compensation expense included in the Company’s statements of comprehensive income was $133,000 and $204,000 for the three-month periods ended April 30, 2017 and 2016, respectively, and was $307,000 and $348,000
for the six-month periods ended
April 30, 2017 and
2016
, respectively.
Stock Options
A summary of the Company’s stock option activity for the six months ended April 30, 2017 and 2016 is presented in the following table:
|
|
For the Six Months ended
|
|
|
|
April 30, 2017
|
|
|
April 30, 2016
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Exercise
|
|
|
|
|
|
Exercise
|
|
|
|
Shares
|
|
|
Price
|
|
|
Shares
|
|
|
Price
|
|
Outstanding at beginning of period
|
|
|
371,733
|
|
|
$
|
6.64
|
|
|
|
177,900
|
|
|
$
|
6.48
|
|
Granted
|
|
|
34,000
|
|
|
|
8.20
|
|
|
|
68,638
|
|
|
|
6.55
|
|
Exercised
|
|
|
(
20,999
|
)
|
|
|
6.02
|
|
|
|
—
|
|
|
|
—
|
|
Expired or cancelled
|
|
|
(75,000
|
)
|
|
|
6.66
|
|
|
|
(13,305
|
)
|
|
|
6.62
|
|
Outs
tanding at end of
period
|
|
|
309,734
|
|
|
$
|
6.85
|
|
|
|
233,233
|
|
|
$
|
6.49
|
|
The
following table summarizes
informat
ion concerning stock options outstanding as of April
30, 2017
:
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
Remaining
|
|
Number
|
|
|
|
Number
|
|
Contractual
|
|
Subject to
|
|
Exercise Prices
|
|
Outstanding
|
|
Life
|
|
Exercise
|
|
$5.65
|
|
10,000
|
|
5.95
|
|
3,334
|
|
6.07
|
|
116,667
|
|
5.08
|
|
50,001
|
|
6.63
|
|
10,001
|
|
5.61
|
|
2,664
|
|
6.76
|
|
4,900
|
|
5.54
|
|
4,900
|
|
6.77
|
|
33,333
|
|
1.76
|
|
33,333
|
|
7.05
|
|
80,000
|
|
6.36
|
|
—
|
|
7.52
|
|
20,000
|
|
6.63
|
|
—
|
|
8.40
|
|
4,000
|
|
6.93
|
|
—
|
|
9.12
|
|
20,833
|
|
4.09
|
|
14,999
|
|
9.48
|
|
10,000
|
|
6.76
|
|
10,000
|
|
Total
|
|
309,734
|
|
5.22
|
|
119,231
|
|
The total intrinsic values for outstanding options and exercisable options as of April
30, 2017
were $
539,000
and $204,000, respectively, calculated using the closing stock price at the end of the second quarter less the option price of in-the-money options. The Company issues new shares when stock options are exercised. Unrecognized compensation expense related to outstanding stock options as of April
30, 2017
was $
438,000
and is expected to be recognized over a weighted average period of
1.66
years.
Valuation Assumptions
The Company uses the Black-Scholes option-pricing model (“Black-Scholes model”) to determine the fair value of stock options as of the grant date. In determining the fair value of stock options under the Black-Scholes model, management must make assumptions regarding projected employee stock option exercise behaviors, risk-free interest rates, volatility of the Company’s stock price and expected dividends. The expense recognized for options granted under the
2007
Plan is equal to the fair value of stock options as of the grant date. The following table provides the weighted average fair value of options granted to empl
oyees and the related assumptions used in the Black-Scholes model for stock option grants made during the six months ended April
30, 2017
:
|
|
Options Granted
|
|
|
Options Granted
|
|
|
Options Granted
|
|
|
|
April 3, 2017
|
|
|
February 2, 2017
|
|
|
December 15, 2016
|
|
Weighted average fair value of options granted
|
|
$
|
3.91
|
|
|
$
|
4.37
|
|
|
$
|
3.48
|
|
Assumptions used:
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected life (years)
|
|
|
7.00
|
|
|
|
7.00
|
|
|
|
7.00
|
|
Risk-free interest rate
|
|
|
1.90
|
%
|
|
|
1.92
|
%
|
|
|
1.90
|
%
|
Volatility
|
|
|
42.65
|
%
|
|
|
42.06
|
%
|
|
|
42.45
|
%
|
Dividend Yield
|
|
|
—
|
%
|
|
|
—
|
%
|
|
|
—
|
%
|
Restricted Stock Awards
Restricted stock awards are awards of common stock that are subject to restrictions on transfer and to a risk of forfeiture if the holder leaves the Company before the restrictions lapse. The holder of a restricted stock award is generally entitled at all times on and after the date of issuance of the restricted shares to exercise the rights of a shareholder of the Company, including the right to vote the shares. The value of stock awards that vest over time is established by the market price on the date of its grant. A summary of the Company’s restricted stock activity for the six months ended April
30, 2017
and
2016
is presented in the following table:
|
|
For the Six Months ended
|
|
|
|
April 30, 2017
|
|
April 30, 2016
|
|
|
|
|
|
Weighted
|
|
|
|
Weighted
|
|
|
|
|
|
Average
|
|
|
|
Average
|
|
|
|
|
|
Grant Date
|
|
|
|
Grant Date
|
|
|
|
Shares
|
|
Fair Value
|
|
Shares
|
|
Fair Value
|
|
Unvested at beginning of period
|
|
|
41,497
|
|
$
|
6.59
|
|
|
49,993
|
|
$
|
7.61
|
|
Granted
|
|
|
27,546
|
|
|
8.74
|
|
|
31,998
|
|
|
6.00
|
|
Vested
|
|
|
(33,664
|
)
|
|
6.15
|
|
|
(31,594
|
)
|
|
6.98
|
|
Unvested at end of period
|
|
|
35,379
|
|
$
|
8.68
|
|
|
50,397
|
|
$
|
7.27
|
|
Unrecognized compensation expense related to outstanding restricted stock awards to employees and directors as of April
30, 2017
was $231,000 and is expected to be recognized over a weighted average period of 1.30 years.
Director Stock Awards in Lieu of Cash Retainer Fees
The Company has a program that allows non-employee Board members to elect and receive shares from the
2007
Plan in lieu of some or all of their quarterly cash retainer fees. During the three months ended April
30, 2017
and
2016
, the Company issued 1,282 and 1,639 shares, respectively, and during the six months ended April 30, 2017 and
2016
, the Company issued 2,771 and 3,342 shares, respectively, under this program. The expense was recognized at the time of share issuance and totaled $11,000 in each of the
three
-
month periods
ended April
30, 2017
and
2016
,
and $22,000 in each of the six-month periods ended April 30, 2017 and 2016.
Employee Stock Purchase Plan
The MGC Diagnostics Corporation
2003
Employee Stock Purchase Plan, as amended (“Purchase Plan”), allows participating employees to purchase up to 200,000 shares of the Company’s common stock at a discount through payroll deductions. The Purchase Plan is available to all employees subject to eligibility requirements. Under the Purchase Plan, participating employees may purchase the Company’s common stock on a voluntary after-tax basis at a price that is the lower of 85% of the fair market value of
one
share of common stock at the beginning or end of each stock purchase phase. The Purchase Plan is carried out in
six
-month phases, with phases beginning on January 1 and July 1 of each calendar year. For the phase that ended on December 31, 2016, emp
loyees purchas
ed 5,343 shares at a price of $5.54 per share. As of April
30, 2017
, the Company has withheld approximately $21,000 from employees participating in the phase that began on January
1, 2017
. As of April
30, 2017
, 44,010 shares of common stock were available for future purchase under the Purchase Plan.
The following table presents the classification of pre-tax stock-based compensation expense recognized in the consolidated statements of
comprehensive (loss) income for the three months and six months ended April
30, 2017
and
2016
:
|
|
Three Months ended April 30,
|
|
|
Six Months ended April 30,
|
|
(In thousands)
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Cost of revenues
|
|
$
|
18
|
|
|
$
|
1
|
|
|
$
|
19
|
|
|
$
|
2
|
|
Selling and marketing
|
|
|
55
|
|
|
|
29
|
|
|
|
93
|
|
|
|
58
|
|
General and administrative
|
|
|
53
|
|
|
|
173
|
|
|
|
186
|
|
|
|
285
|
|
Research and development
|
|
|
7
|
|
|
|
1
|
|
|
|
9
|
|
|
|
3
|
|
Stock-based compensation expense
|
|
$
|
|
|
|
$
|
204
|
|
|
$
|
307
|
|
|
$
|
348
|
|
Tax Impact of Stock-Based Compensation
The Company reports the benefit of tax deductions in excess of recognized stock-based compensation expense on the consolidated statements of cash flows as operating cash flows. For the six months ended April
30, 2017
and
2016
, there
were
No
excess tax benefits recognized.
Dividend
On January 25, 2017, t
he Company declared a special cash dividend of $0.70 per share on its outstanding common stock to all shareholders of record as of February 10, 2017. The dividend was paid on February 24, 2017.
(4)
Inventories
Inventories consisted of the following as of April
30, 2017
and October 31, 2016:
(In thousands)
|
|
2017
|
|
2016
|
|
Current Assets:
|
|
|
|
|
|
|
|
Raw materials
|
|
$
|
2,142
|
|
$
|
2,072
|
|
Work-in-process
|
|
|
965
|
|
|
827
|
|
Finished goods
|
|
|
1,927
|
|
|
2,017
|
|
|
|
|
5,034
|
|
|
4,916
|
|
Non-current Assets:
|
|
|
|
|
|
|
|
Finished go
ods
|
|
|
46
|
|
|
115
|
|
|
|
$
|
5,080
|
|
$
|
5,031
|
|
(5)
Intangible Assets
Intangible assets consisted of the following as of April
30, 2017
and October 31, 2016:
(In thousands)
|
|
2017
|
|
|
2016
|
|
Intangible assets:
|
|
|
|
|
|
|
|
|
Developed technology
|
|
$
|
7,802
|
|
|
$
|
7,802
|
|
Customer and distributor relationships
|
|
|
371
|
|
|
|
373
|
|
Trademarks and trade names
|
|
|
252
|
|
|
|
254
|
|
Software
|
|
|
891
|
|
|
|
849
|
|
Capitalized software in progress
|
|
|
3,140
|
|
|
|
2,841
|
|
|
|
|
12,456
|
|
|
|
12,119
|
|
Less: accumulated amortization
|
|
|
(8,050
|
)
|
|
|
(7,908
|
)
|
|
|
$
|
4,406
|
|
|
$
|
4,211
|
|
The Company amortizes the intangible assets related to developed technology, patents and trademarks using the straight-line method over the estimated useful lives of the assets, which range from 5 to 10
years
.
T
otal amortization expense was
$35,000 and $92,000 for the three months ended April
30, 2017
and 2016, respectively and $76,000 and $162,000 for the six months ended April 30, 2017 and 2016, respectively. Of the total, amortization expenses
of $
32,000
and $
25,000
related to software costs are included in the cost of equipment, supplies and accessories revenues for the three-month periods ended April
30, 2017
and 2016
, respectively, and $66,000 and $37,000 for the six-month periods ended April 30, 2017 and 2016, respectively. The Company estimates it will incur the following amortization expense in the balance of fiscal 2017 and in future fiscal years based on the intangible assets the Company expects to have placed in service at the end of fiscal 2017:
(In thousands)
|
|
Amortization
|
|
Six months ending October 31, 2017
|
|
$
|
226
|
|
2018
|
|
|
575
|
|
2019
|
|
|
533
|
|
2020
|
|
|
510
|
|
2021
|
|
|
445
|
|
2022
|
|
|
374
|
|
Thereafter
|
|
|
1,411
|
|
|
|
$
|
4,074
|
|
This table does not include estimated amortization expense of $86,000 for patents included in “Developed technology,” or of $246,000 for capitalized software costs the Company expects to place into service after the current fiscal year. The Company capitalized software development costs of $181,000 and $196,000 during the three-month periods ended April
31, 2017
and 2016
, respectively, and $341,000 and $366,000 during the six-month periods ended April 30, 2017 and 2016, respectively. Upon completion of these development projects, the Company expects to amortize the capitalized software costs over a ten year period.
(6)
Warranty Reserve
Sales of the Company’s equipment are subject to a warranty obligation. Equipment warranties typically extend for a period of twelve months from the date of installation. Standard warranty terms are included in customer contracts. Under the terms of these warranties, the Company is obligated to repair or replace any components or assemblies that it deems defective in workmanship or materials. The Company reserves the right to reject warranty claims if it determines that failure is due to normal wear, customer modifications, improper maintenance or misuse. The Company maintains a warranty reserve that reflects the estimated expenses it will incur to honor the warranties on its products. The Company adjusts the warranty reserve based on the number and type of equipment subject to warranty and the remaining months of warranty coverage. The warranty reserve adjustment reflects the Company’s historical warranty experience based on the type of equipment.
Warranty provisions and claims for the six months ended April 30, 2017 and 2016 were as follows:
(In thousands)
|
|
2017
|
|
|
2016
|
|
Balance, beginning of period
|
|
$
|
151
|
|
|
$
|
147
|
|
Warranty provision based on units sold
|
|
|
104
|
|
|
|
137
|
|
Periodic reserve adjustments
|
|
|
5
|
|
|
|
(50
|
)
|
Warranty claims
|
|
|
(138
|
)
|
|
|
(123
|
)
|
Balance, end of period
|
|
$
|
122
|
|
|
$
|
111
|
|
(7)
Financing Arrangements
On July 24, 2014, the Company entered into a credit agreement with BMO Harris Bank NA. The Agreement, as amended, included
a $
4.0
million term loan and a $
250,000
revolving
credit facility. The term loan, which bore interest at a floating rate, was payable in equal monthly principal installments of $66,667 over a
five year
period commencing August 31, 2014 and was evidenced by a term note. The Company borrowed the $4.0 million under the term loan on July 24, 2014 and used these proceeds in connection with its August 1, 2014 acquisition of Medisoft SA. On June 14, 2016, the Company paid off the remaining balance of the term loan and terminated the revolving credit facility.
(8)
Net Income (Loss) per Share
Basic income (loss) per share is computed by dividing net income (loss) by the weighted average shares outstanding during the reporting period. Diluted income per share is computed similarly to basic income (loss) per share except that the weighted average shares outstanding are increased to include additional shares issuable from the assumed exercise of warrants and stock options, if dilutive, as well as the dilutive effects of any unvested restricted share awards. Diluted loss per share does not include any of these dilutive effects in its calculation. The number of additional shares is calculated by assuming that outstanding warrants and stock options are exercised, outstanding restricted share grants vest and that the cash proceeds from the exercise together with the assumed employment value represented by the unamortized stock-based compensation were used to reacquire shares of common stock at the average market price during the reporting period.
The Company had unexpired options and warrants for the purchase of its common stock and unvested restricted awards as of April 30, 2017 and
2016
of 513,455 and 451,972 shares, respectively.
Shares used i
n the net income (loss) per share computations are as follows:
|
|
Three Months ended April 30,
|
|
|
Six Months ended April 30,
|
|
(In thousands)
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Weighted average common shares outstanding - basic
|
|
|
4,381
|
|
|
|
4,306
|
|
|
|
4,361
|
|
|
|
4,293
|
|
Dilutive effect of stock options, warrants and unvested restricted shares
|
|
|
—
|
|
|
|
13
|
|
|
|
—
|
|
|
|
17
|
|
Weighted average common shares outstanding - diluted
|
|
|
4,381
|
|
|
|
4,319
|
|
|
|
4,361
|
|
|
|
4,310
|
|
Anti-dilutive shares excluded from the calculation for each of the three- and six-month periods ended April 30, 2016 totaled 432,576 and 432,576, respectively. As a result of the net loss for the three- and six-month periods ended April 30, 2017, all outstanding warrants, stock options and unvested restricted stock shares were considered anti-dilutive and, therefore, were excluded from diluted loss per share for each period.
(9)
Income Taxe
s
The Company has recorded
a provision
for
income taxes of $
187,000
and $
125,000
for the three months ended April 30, 2017 and 2016, re
spectively and $
188,000 and $187,000 for the six months ended April 30, 2017 and 2016, respectively. The Company records its interim provision for income taxes based on its estimated worldwide annual effective rate for the year, excluding MGC Diagnostics Belgium S.P.R.L.
net losse
s of
$
140,000
and $
234,000
for
the three- and six-month periods ended April 30
, 2017 and $104,000 and $192,000) for the three- and six-month periods ended April 30, 2016
, respectively, for which no tax benefit can be recognized due to expected future losses and the resulting valuation allowance related to these losses. As such, the $188,000 fiscal 2017 year to date tax expense
compared to the world wide consolidated pre-tax income of $
157,000 (which excludes the Medisot Belgium S.P.R.L. loss) results in an effective rate of approximately 119.8%.
For the six months ended April 30, 2017, the Company recorded
a domestic income tax expense
of $
135,000
based on an estimated U.S. annual effective tax rate of
45.2
%. The differences fro
m the federal statutory rate re
sult from the effects of anticipated federal alternative minimum tax (AMT) whose credit cannot be offset due to the partial valuation allowance, state taxes expected to be paid and permanent differences whose effects are to increase the effective rate, including non-deductible meals and entertainment expenses, stock-based compensation expenses related to incentive stock options and restricted stock awards and expense related to reserves for uncertain tax positions. For the six months ended April 30, 2017, the foreign tax expense of $53,000 is primarily from the increase in the valuation allowance against the deferred tax assets for Medisoft Belgium.
As of April 30, 2017, the Company had a reserve for uncertain tax positions of $95,000 compared to the October 31, 2016 balance of $92,000. If recognized, approximately $61,000 of these benefits would lower the effective tax rate. The remaining $34,000, if recognized, would result in a deferred tax asset subject to a valuation allowance and therefore would not affect the effective rate.
Estimated interest and penalties related to potential underpayment of income taxes are classified as a component of tax expense in the consolidated statements of comprehensive (loss) income. The Company does not expect the amount of reserves for uncertain tax positions to change significantly in the next twelve months. Similarly, the Company does not anticipate that the total reserve for uncertain tax positions will significantly change due to the settlement of audits and the expiration of statutes of limitations within the next twelve months.
The Company files a consolidated federal income tax return in the United States federal jurisdiction and files various combined and separate tax returns in several state and local jurisdictions. For United States federal tax, the Company is no longer subject to examinations by the authorities for fiscal years ending prior to November 1, 1998. The expiration dates of the statute of limitations related to the various state income tax returns vary by state. There is no statute of limitations for assessments related to jurisdictions where the Company may have a nexus but has chosen not to file an income tax return.
The Company has federal net operating loss (“NOL”) and general business tax credit carry forwards; however, the utilization of some of these tax loss and tax credit carry forwards is limited under Internal Revenue Code (“IRC”) §
382
and §
383
, respectively, as a result of an IRS-deemed change in ownership that occurred in the fourth quarter of fiscal 2006.
The Company’s estimated domestic NOL carry forwards of $
6.5
million that are not limited as of October 31, 2016 include $
2.8
million of income tax deductions in excess of previously recorded tax benefits. The tax benefit of these excess deductions was added to deferred tax assets as of October 31, 2016 as a result of the adoption of ASU 2016-09 retroactively to November 1, 2015; however the additional benefit was offset by an equivalent increase to the valuation allowance for domestic net deferred tax assets.
These loss carry forwards will expire in years 2018 through 2032. Additionally, the Company has general business credit carry forwards of $461,000 that will expire in 2033. Use of this general business credit carry forward is not limited because it was generated after the change in ownership. The Company also has $266,000 of alternative minimum tax credit carry forwards that do not have expiration dates. The
alternative
minimum tax credit carry forwards are limited by IRC §383, but their ultimate use is not affected since these do not expire.
In addition, as of October 31, 2016, the Company has foreign NOL carry forwards of approximately $
4.8
million. Foreign NOL expiration varies by country; however, a substantial portion of the foreign NOLs are in Belgium, and do not expire
.
As of
October 31, 2016, the Company had a remaining valuation allowances for domestic and international entities of approximately $
1,951,000
and $772,000, respectively.
(10)
Segment Reporting
The Company operates in a single industry segment, the manufacture and sale of cardiorespiratory diagnostic products. The Company sells its products into many countries throughout the world. Net sales and long-lived assets by geographic area are shown in the following tables.
|
|
Three Months ended April 30,
|
|
Six Months ended April 30,
|
|
(In thousands)
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
Revenues from unaffiliated customers:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
7,134
|
|
$
|
7,119
|
|
$
|
13,415
|
|
$
|
14,119
|
|
Americas
|
|
|
490
|
|
|
222
|
|
|
936
|
|
|
403
|
|
Europe, Middle East, Africa
|
|
|
1,785
|
|
|
1,574
|
|
|
3,342
|
|
|
3,146
|
|
Asia Pacific
|
|
|
410
|
|
|
516
|
|
|
866
|
|
|
1,014
|
|
|
|
$
|
9,819
|
|
$
|
9,431
|
|
$
|
18,559
|
|
$
|
18,682
|
|
|
|
April 30, 2017
|
|
October 31, 2016
|
|
Long-lived assets:
|
|
|
|
|
|
|
|
United States
|
|
$
|
6,918
|
|
$
|
6,829
|
|
Europe
|
|
|
2,588
|
|
|
2,796
|
|
|
|
$
|
9,506
|
|
$
|
9,625
|
|
(11)
Litigation
The Company is also subject to certain claims and lawsuits that have been filed in the ordinary course of business. From time to time, the Company initiates lawsuits against others to enforce patents or to seek collection of debts in the ordinary course of business. T
he Company is not subject to any significant litigation, except as set forth below.
MGC Diagnostics Corporation v. Mr. Guy Martinot and Dr. Jean-Benoît Martinot
In November 2015, the Company commenced litigation in the French-speaking courts of Brussels, Belgium against the selling shareholders of Medisoft for violations of representations and warranties in the stock purchase agreement dated as of July 10, 2014 under which the Company purchased Medisoft. The Company alleged
that these violations resulted in Company damages of approximately €985,400 ($1,084,000). In May 2015, the Company received payment of €406,700 ($447,000) with respect to these alleged violations pursuant to a bank guaranteed contractual escrow fund and has reflected that payment on its books and records. On May 30, 2016, the defendant selling shareholders filed an answer and asserted a counterclaim against the Company seeking to recover the €406,700 that was paid to the Company in May 2015 and legal costs. The Company continues to believe the Medisoft selling shareholders are liable to it for violations of representations and warranties in the stock purchase agreement and intends to continue to pursue this matter. The Company has not accrued any losses re
lated to the litigation or accrued any related legal costs it has not yet incurred. The Company currently expects that this litigation process may continue until the fall of 2018.
Neurovirtual USA, Inc. v. MGC Diagnostics Corporation
The Company was also involved in litigation with Neurovirtual USA that it settled in June 2016. In that settlement the Company made a
one
-time cash payment of $650,000 to Neurovirtual and each party agreed to dismiss with prejudice the lawsuit and all claims against the other party. As part of the settlement, the Company has retained Neurovirtual sleep diagnostics inventory that it purchased and Neurovirtual agreed to support this inventory pursuant to the distribution agreement. The Company has no continuing obligation to purchase additional Neurovirtual diagnostics products.
The Company recorded a loss of $
650,000
, which was included in general and administrative expense for the quarter ended April 30, 2016. For the quarter ended October 31, 2016, the Company recorded an impairment loss of $
354,000
with respect to a por
tion of its sleep diagnostic inventory, which resulted from its ongoing analysis of projected unit sales in future periods. The Company continues to carry inventory and other noncurrent assets valued at $68,000 and $46,000, respectively, as of April 30, 2017.
(
12
)
Subsequent Even
t
In May 2016, the Company entered into the Fifth Addendum to its lease for its Saint Paul manufacturing and office facility, extending its lease commitment by one year to December 31, 2018. Monthly rental payments total to an annual commitment of $338,000 in the extension period. The agreement includes a Company right to extend the lease through December 31, 2019.