SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20459
FORM 10-Q
(Mark One) | ||
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended June 30, 2008 | ||
or | ||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to |
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED December 31, 2007
COMMISSION FILE NUMBER 0-20970
VISION-SCIENCES, INC.
(Exact name of registrant as specified in its charter)
|
| |
Delaware | 13-3430173 | |
(State or other jurisdiction of
| (IRS Employer
| |
| 10962 | |
(Address of principal executive offices) | (Zip Code) |
(845) 365-0600
(Registrant’sRegistrant's telephone number, including area code)
NoneNone
(Former(Former name, former address, and
former fiscal year if changed since last report)
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 requirement for the past 90 days.
Yes ýx No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, or a non-accelerated filer.smaller reporting company. See definitiondefinitions of “accelerated filer"accelerated filer", "large accelerated filer", and large accelerated filer”"smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company x
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company ý |
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).
Yes o No ýx
Indicate the number of shares outstanding of each of the issuer’sissuer's classes of common stock, as of February 19,August 11, 2008
Common Stock, par value of $.01 |
| 36,666,274 |
(Title of Class) | (Number of Shares) |
VISION-SCIENCES, INC.
TABLE OF CONTENTS
Part I. | Information |
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Item 1. | Financial Statements | |||||
Consolidated Balance Sheets | 3 | |||||
4 | ||||||
5 | ||||||
6 | ||||||
7 | ||||||
Item 2. |
| 15 | ||||
Item 3. |
| 26 | ||||
Item 4. |
| 26 | ||||
Item 4T. |
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| 26 | |||
Part II. |
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Item | Legal Proceedings |
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Item 1A. | 28 | |||||
Item 2. |
| 40 | ||||
Item 3. |
| 40 | ||||
Item 4. |
| 49 | ||||
Item 5. | Other Information |
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Item 6. | Exhibits |
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| 41 |
2
Item 1: FINANCIAL STATEMENTSFinancial Statements
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
|
| December 31, |
| March 31, |
| ||
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| (Unaudited) |
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| ||
ASSETS |
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Current assets: |
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| ||
Cash and cash equivalents |
| $ | 406,172 |
| $ | 28,955,497 |
|
Short term investments |
| 20,197,372 |
| — |
| ||
Accrued interest receivable |
| 465,573 |
| — |
| ||
Accounts receivable, net of allowance for doubtful accounts of $150,650 and $129,600, respectively |
| 949,852 |
| 1,230,285 |
| ||
Inventories |
| 3,256,880 |
| 2,102,757 |
| ||
Prepaid expenses and deposits |
| 750,894 |
| 111,282 |
| ||
Total current assets |
| 26,026,743 |
| 32,399,821 |
| ||
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Property and equipment, at cost: |
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|
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| ||
Machinery and equipment |
| 4,590,953 |
| 3,713,074 |
| ||
Furniture and fixtures |
| 287,869 |
| 307,961 |
| ||
Leasehold improvements |
| 594,952 |
| 591,196 |
| ||
|
| 5,473,774 |
| 4,612,231 |
| ||
Less—accumulated depreciation and amortization |
| 4,234,843 |
| 4,071,537 |
| ||
|
| 1,238,931 |
| 540,694 |
| ||
Goodwill |
| 378,000 |
| — |
| ||
Equity investment |
| 667,994 |
| — |
| ||
Other assets, net of accumulated amortization of $70,655 and $66,200, respectively |
| 82,840 |
| 62,393 |
| ||
Total assets |
| $ | 28,394,508 |
| $ | 33,002,908 |
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| ||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
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Current liabilities: |
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|
|
| ||
Capital lease obligations and note payable |
| $ | 45,085 |
| $ | 3,785 |
|
Accounts payable |
| 472,002 |
| 591,166 |
| ||
Accrued expenses |
| 1,533,314 |
| 1,443,434 |
| ||
Income taxes payable |
| — |
| 549,000 |
| ||
Total current liabilities |
| 2,050,401 |
| 2,587,385 |
| ||
|
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|
|
| ||
Long term-debt: capital lease obligations |
| 84,504 |
| — |
| ||
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Commitments and contingencies |
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Stockholders’ equity: |
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|
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Preferred stock, $.01 par value— |
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Authorized—5,000,000 |
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| ||
Issued and outstanding—none |
| — |
| — |
| ||
Common stock, $.01 par value— |
|
|
|
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| ||
Authorized—50,000,000 shares |
|
|
|
|
| ||
Issued and outstanding—35,264,281 shares at December 31, 2007 and 35,243,931 shares at March 31, 2007 |
| 352,641 |
| 352,438 |
| ||
Additional paid-in capital |
| 77,095,036 |
| 76,483,273 |
| ||
Accumulated deficit |
| (51,188,074 | ) | (46,420,188 | ) | ||
Total stockholders’ equity |
| 26,259,603 |
| 30,415,523 |
| ||
Total liabilities and stockholders’ equity |
| $ | 28,394,508 |
| $ | 33,002,908 |
|
| June 30, 2008 | March 31, 2008 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|
ASSETS | ||||||||||
Current assets: | ||||||||||
Cash and cash equivalents | $ | 3,247,289 | $ | 10,655,033 | ||||||
Short term investments | 13,415,579 | 8,062,418 | ||||||||
Accounts receivable, net of allowance for doubtful accounts of $162,800 and $129,600 in 2008 and 2007, respectively | 2,022,260 | 1,092,460 | ||||||||
Inventories, net | 5,642,362 | 4,021,077 | ||||||||
Prepaid expenses and deposits | 281,989 | 446,682 | ||||||||
Total current assets | 24,609,479 | 24,277,670 | ||||||||
Property and equipment, at cost: | ||||||||||
Machinery and equipment | 5,379,965 | 5,073,701 | ||||||||
Furniture and fixtures | 497,473 | 390,586 | ||||||||
Leasehold improvements | 594,953 | 594,953 | ||||||||
6,472,391 | 6,059,240 | |||||||||
Less—Accumulated depreciation and amortization | 4,381,208 | 4,282,783 | ||||||||
Total property and equipment, net | 2,091,183 | 1,776,457 | ||||||||
Other assets, net of accumulated amortization of $72,200 and $81,700 in 2008 and 2007, respectively | 333,462 | 363,225 | ||||||||
Total assets | $ | 27,034,124 | $ | 26,417,352 | ||||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||
Current liabilities: | ||||||||||
Capital lease obligations | $ | 43,153 | $ | 56,810 | ||||||
Accounts payable | 988,888 | 1,768,859 | ||||||||
Accrued expenses | 2,345,591 | 2,439,159 | ||||||||
Total current liabilities | 3,377,632 | 4,264,828 | ||||||||
Capital lease obligations, net of current portion | 81,083 | 81,083 | ||||||||
Total liabilities | 3,458,715 | 4,345,911 | ||||||||
Commitments and contingencies | — | — | ||||||||
Stockholders' equity: | ||||||||||
Preferred stock, $.01 par value— | ||||||||||
Authorized—5,000,000 shares | ||||||||||
Issued and outstanding—none | — | — | ||||||||
Common stock, $.01 par value— | ||||||||||
Authorized—50,000,000 shares | ||||||||||
Issued and outstanding—36,661,899 shares and 35,647,512 shares at June 30, 2008 and 2007, respectively | 366,618 | 356,474 | ||||||||
Additional paid-in capital | 79,114,347 | 77,477,690 | ||||||||
Accumulated deficit | (55,905,556 | ) | (55,762,723 | ) | ||||||
Total stockholders' equity | 23,575,409 | 22,071,441 | ||||||||
Total liabilities and stockholders' equity | $ | 27,034,124 | $ | 26,417,352 | ||||||
See accompanying notes to consolidated financial statements.
3
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||||||||
Net sales |
| $ | 2,019,583 |
| $ | 2,215,615 |
| $ | 7,576,984 |
| $ | 6,513,993 |
| ||||||
Cost of sales |
| 1,504,381 |
| 1,922,092 |
| 5,241,727 |
| 5,335,946 |
| ||||||||||
Gross profit |
| 515,202 |
| 293,523 |
| 2,335,257 |
| 1,178,047 |
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Selling, general and administrative expense |
| 1,980,115 |
| 1,209,500 |
| 5,729,083 |
| 3,472,969 |
| ||||||||||
Research and development expense |
| 649,689 |
| 513,765 |
| 2,610,343 |
| 1,724,789 |
| ||||||||||
Loss from operations |
| (2,114,602 | ) | (1,429,742 | ) | (6,004,169 | ) | (4,019,711 | ) | ||||||||||
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Interest income |
| 288,837 |
| 27,831 |
| 857,949 |
| 117,669 |
| ||||||||||
Interest expense |
| (7,011 | ) | (270 | ) | (7,011 | ) | (1,126 | ) | ||||||||||
Other income (expense), net |
| 132,036 |
| (2,549 | ) | 717,351 |
| (9,429 | ) | ||||||||||
Loss in equity investment |
| (118,912 | ) | — |
| (332,006 | ) | — |
| ||||||||||
Loss before provision for income taxes |
| (1,819,652 | ) | (1,404,730 | ) | (4,767,886 | ) | (3,912,597 | ) | ||||||||||
Provision for income taxes |
| (180,000 | ) | — |
| — |
| — |
| ||||||||||
Net loss |
| $ | (1,999,652 | ) | $ | (1,404,730 | ) | $ | (4,767,886 | ) | $ | (3,912,597 | ) | ||||||
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Basic and diluted net loss per common share |
| $ | (0.06 | ) | $ | (0.04 | ) | $ | (0.14 | ) | $ | (0.11 | ) | ||||||
Shares used in computing basic and diluted net loss per common share |
| 35,266,781 |
| 35,166,330 |
| 35,266,781 |
| 35,161,713 |
| ||||||||||
| Three Months Ended June 30, | |||||||
---|---|---|---|---|---|---|---|---|
| 2008 | 2007 | ||||||
Net sales | $ | 2,928,934 | $ | 2,430,438 | ||||
Cost of sales | 2,239,802 | 1,487,046 | ||||||
Gross profit | 689,132 | 943,392 | ||||||
Selling, general and administrative expenses | 2,919,369 | 1,747,288 | ||||||
Research and development expense | 1,171,092 | 835,273 | ||||||
Restructuring charge | 27,744 | — | ||||||
Loss from operations | (3,429,073 | ) | (1,639,169 | ) | ||||
Interest income | 79,571 | 279,057 | ||||||
Interest expense | (13,904 | ) | — | |||||
Other income (expense), net | — | (1,560 | ) | |||||
Gain on sale of product line, net of direct costs | 3,229,885 | — | ||||||
Loss in equity investment | — | (82,255 | ) | |||||
Loss before provision for income taxes | (133,521 | ) | (1,443,927 | ) | ||||
Provision for income taxes | 9,312 | — | ||||||
Net loss | $ | (142,833 | ) | $ | (1,443,927 | ) | ||
Basic and diluted net loss per common share | $ | (0.00 | )* | $ | (0.04 | ) | ||
Shares used in computing basic and diluted net loss per common share | 36,661,899 | 35,249,431 | ||||||
See accompanying notes to consolidated financial statements.
4
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’STOCKHOLDERS' EQUITY
(Unaudited)
|
| Common Stock |
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| ||||||
|
| Number of |
| $ | .01 |
| Additional |
| Accumulated |
| Total |
| |||
Balance, March 31, 2007 |
| 35,243,931 |
| $ | 352,438 |
| $ | 76,483,273 |
| $ | (46,420,188 | ) | $ | 30,415,523 |
|
Exercise of stock options |
| 20,350 |
| 203 |
| 20,463 |
| — |
| 20,666 |
| ||||
Stock-based compensation |
| — |
| — |
| 591,300 |
| — |
| 591,300 |
| ||||
Net loss |
| — |
| — |
| — |
| (4,767,886 | ) | (4,767,886 | ) | ||||
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Balance, December 31, 2007 |
| 35,264,281 |
| $ | 352,641 |
| $ | 77,095,036 |
| $ | (51,188,074 | ) | $ | 26,259,603 |
|
| Preferred Stock | Common Stock | | | | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Number of Shares | $0.01 Par Value | Number of Shares | $0.01 Par Value | Additional Paid-in Capital | Accumulated Deficit | Total Stockholders' Equity | ||||||||||||||||
Balance, April 1, 2007 | 5,000,000 | $ | — | 35,243,931 | $ | 352,438 | $ | 76,483,273 | $ | (46,420,188 | ) | $ | 30,415,523 | ||||||||||
Exercise of stock options | — | — | 403,581 | 4,036 | 525,095 | — | 529,131 | ||||||||||||||||
Stock based compensation expense | — | — | — | — | 469,322 | — | 469,322 | ||||||||||||||||
Net loss | — | — | — | — | — | (9,342,535 | ) | (9,342,535 | ) | ||||||||||||||
Balance, March 31, 2008 | 5,000,000 | $ | — | 35,647,512 | $ | 356,474 | $ | 77,477,690 | $ | (55,762,723 | ) | $ | 22,071,441 | ||||||||||
Exercise of stock options and warrants | — | — | 1,014,387 | 10,144 | 1,467,657 | — | 1,477,801 | ||||||||||||||||
Stock based compensation expense | — | — | — | — | 169,000 | — | 169,000 | ||||||||||||||||
Net loss | — | — | — | — | — | (142,833 | ) | (142,833 | ) | ||||||||||||||
Balance, June 30, 2008 | 5,000,000 | $ | — | 36,661,899 | $ | 366,618 | $ | 79,114,347 | $ | (55,905,556 | ) | $ | 23,575,409 | ||||||||||
See accompanying notes to consolidated financial statements.
5
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
|
| Nine Months Ended |
| Nine Months Ended |
| ||
Cash flows from operating activities: |
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Net loss |
| $ | (4,767,886 | ) | $ | (3,912,597 | ) |
Adjustments to reconcile net loss to net cash used for operating activities: |
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Depreciation and amortization |
| 167,761 |
| 323,271 |
| ||
Stock-based compensation |
| 591,300 |
| 380,603 |
| ||
Loss in equity investment |
| 332,006 |
| — |
| ||
Changes in assets and liabilities: |
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|
|
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Accrued interest receivable |
| (465,573 | ) | — |
| ||
Accounts receivable |
| 280,433 |
| 335,313 |
| ||
Inventories |
| (1,154,123 | ) | 188,240 |
| ||
Prepaid expenses and deposits |
| (639,612 | ) | (187,988 | ) | ||
Other assets |
| (24,902 | ) | — |
| ||
Accounts payable |
| (119,164 | ) | (405,198 | ) | ||
Accrued expenses |
| 89,880 |
| 192,294 |
| ||
Income taxes payable |
| (549,000 | ) | — |
| ||
Net cash used for operating activities |
| (6,258,880 | ) | (3,086,062 | ) | ||
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Cash flows used for investing activities |
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Purchase of short term investments |
| (20,197,372 | ) | — |
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Acquisition of Best DMS assets: |
| (450,000 | ) |
|
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Purchase of property and equipment |
| (627,286 | ) | (450,344 | ) | ||
Purchase of equity investment |
| (1,000,000 | ) | — |
| ||
Net cash used for investing activities |
| (22,274,658 | ) | (450,344 | ) | ||
Cash flow used for financing activities: |
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Payments on capital leases |
| (36,453 | ) | (19,915 | ) | ||
Payments of acceptances payable to a bank |
| — |
| (51,584 | ) | ||
Exercise of stock options |
| 20,666 |
| 19,576 |
| ||
Net cash used for financing activities |
| 15,787 |
| (51,923 | ) | ||
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Net decrease in cash and cash equivalents |
| (28,549,325 | ) | (3,588,329 | ) | ||
Cash and cash equivalents, beginning of period |
| 28,955,497 |
| 6,138,148 |
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Cash and cash equivalents, end of period |
| $ | 406,172 |
| $ | 2,549,819 |
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Supplemental disclosure of cash flow information: |
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Cash paid during the period for interest |
| $ | — |
| $ | 1,126 |
|
Cash paid during the period for income taxes |
| $ | 549,000 |
| $ | — |
|
Supplemental noncash transactions |
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Capital lease - computer equipment |
| $ | 162,257 |
| $ | — |
|
| Three Months Ended June 30, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2008 | 2007 | ||||||||
Cash flows from operating activities: | ||||||||||
Net loss | $ | (142,833 | ) | $ | (1,443,927 | ) | ||||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||||
Depreciation and amortization | 99,895 | 40,200 | ||||||||
Cashless exercise of warrants | — | |||||||||
Gain on sale of product line | (3,229,885 | ) | — | |||||||
Loss in equity investment | — | 82,255 | ||||||||
Stock-based compensation | 169,000 | 132,164 | ||||||||
Changes in assets and liabilities: | ||||||||||
Accrued interest receivable | (21,300 | ) | (217,003 | ) | ||||||
Accounts receivable | (929,800 | ) | (12,769 | ) | ||||||
Inventories | (1,621,285 | ) | (715,453 | ) | ||||||
Prepaid expenses and deposits | 192,986 | (288,638 | ) | |||||||
Accounts payable | (779,971 | ) | 206,827 | |||||||
Accrued expenses | (93,568 | ) | (128,228 | ) | ||||||
Income taxes payable | — | (549,000 | ) | |||||||
Net cash used in operating activities | (6,356,761 | ) | (2,893,572 | ) | ||||||
Cash flows from investing activities: | ||||||||||
Purchase of short term investments | (11,167,052 | ) | (9,631,499 | ) | ||||||
Sale of short term investments | 5,835,191 | — | ||||||||
Purchase of property and equipment | (413,151 | ) | (380,863 | ) | ||||||
Net proceeds from sale of product line | 3,229,885 | — | ||||||||
Purchase of equity investment | — | (1,000,000 | ) | |||||||
Net cash used in investing activities | (2,515,127 | ) | (11,012,362 | ) | ||||||
Cash Flows from financing activities: | ||||||||||
Payments on capital leases | (13,657 | ) | (931 | ) | ||||||
Exercise of stock options | 1,477,801 | 8,790 | ||||||||
Net cash provided by financing activities | 1,464,144 | 7,859 | ||||||||
Net decrease in cash and cash equivalents | (7,407,744 | ) | (13,898,075 | ) | ||||||
Cash and cash equivalents, beginning of year | 10,655,033 | 28,322,316 | ||||||||
Cash and cash equivalents, end of year | $ | 3,247,289 | $ | 14,424,241 | ||||||
Supplemental disclosure of cash flow information: | ||||||||||
Cash paid during the period for interest | $ | 13,904 | $ | — |
See accompanying notes to consolidated financial statements.
6
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Unaudited)
1. Basis of Presentation
The consolidatedaccompanying financial statements included here havedata as of June 30, 2008 and for the three months ended June 30, 2008 ("Q1 09") and June 30, 2007 ("Q1 08") has been prepared by Vision-Sciences, Inc. and subsidiaries (the “Company”("we", "us" or “we” or “us”"the Company") in accordance with generally accepted accounting principles in the United States of America,, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission and include, in the opinion of management, all adjustments (consisting only of normal and recurring adjustments) that we consider necessary for a fair presentation of such information.(SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. WeThe March 30, 2008 Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. However, we believe however, that ourthe disclosures are adequate to make the information presented not misleading. These consolidated financial statementsConsolidated Financial Statements should be read in conjunction with the audited consolidated financial statementsConsolidated Financial Statements and the notes thereto, included in our latest annual report to stockholders. The resultsAnnual Report on Form 10-K for the interim periods presented are not necessarily indicative of results to be expected for the full fiscal year.year ended March 31, 2008.
Our fiscal year-end is on March 31 of each year, and is referred to hereherein as Fiscal 2009 ("FY 06, 09") ("our current Fiscal Year") and Fiscal 2008 ("FY 07 and FY 08 (our current fiscal year)08"), respectively.All amounts in the financial footnotes,notes except for share and per shareper-share data are reported in (000’s)($000's), unless otherwise indicated. Q3 07 refers to the period from October 1, 2006 to December 31, 2006; and Q3 08 refers to the period from October 1, 2007 to December 31, 2007.
2. Summary of Significant Accounting Policies
The accompanying consolidated financial statements reflect the application of certain accounting policies described below:
a. Principles of ConsolidationConsolidation:: The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.
b. Cash Equivalentsand Cash Equivalents:: The Company classifies We classify investments with original maturities of ninety days or less, consisting of commercial paper and a money market account at a bank, as cash equivalents. Cash equivalents are stated at amortized cost, which approximates market value.
c. Short Term InvestmentsInvestments:: The Company classifies We classify investments with original maturities of greater than 90 days in Government Securities and high grade Commercial Paper as Short Term Investments. The Company intendsWe intend to hold these investments to maturity. The following table summarizes these securities classified as held to maturity:
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| (Unaudited) |
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| December 31, 2007 |
| March 31, 2007 |
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|
| Fair Value |
| Cost |
| Fair Value |
| Cost |
| ||||
Held to maturity less than one year: |
|
|
|
|
|
|
|
|
| ||||
Government securities |
| $ | 17,850 |
| $ | 17,850 |
| $ | — |
| $ | — |
|
Commercial paper |
| 2,813 |
| 2,813 |
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total short term investments including accrued interest |
| 20,663 |
| 20,663 |
| — |
| — |
| ||||
| June 30, 2008 | March 31, 2008 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value | Cost | Fair Value | Cost | ||||||||||
Held to maturity less than one year: | ||||||||||||||
Government securities | $ | 11,697 | $ | 11,722 | $ | 6,563 | $ | 6,512 | ||||||
Commercial paper | 1,673 | 1,694 | 1,534 | 1,550 | ||||||||||
Total short term investments including accrued interest | $ | 13,370 | $ | 13,416 | $ | 8,097 | $ | 8,062 | ||||||
d. InventoriesInventories:: Inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) method and consist of the following:
|
| December 31, |
| March 31, 2007 |
| ||
Raw materials |
| $ | 1,717 |
| $ | 1,447 |
|
Work-in-process |
| 366 |
| 273 |
| ||
Finished goods |
| 1,174 |
| 383 |
| ||
|
|
|
|
|
| ||
Total |
| $ | 3,257 |
| $ | 2,103 |
|
7
| June 30, 2008 | March 31, 2008 | |||||
---|---|---|---|---|---|---|---|
Raw materials | $ | 4,203 | $ | 2,924 | |||
Work-in-process | 283 | 497 | |||||
Finished goods | 1,156 | 600 | |||||
$ | 5,642 | $ | 4,021 | ||||
Raw materials include components purchased from independent suppliers. Most purchased components are available from multiple sources, but we also rely on several single-source key suppliers. Work-in-process and finished goods inventories consist of material, labor, and manufacturing overhead.
e. Depreciation and AmortizationAmortization:: The Company provides for We calculate depreciation and amortization using the straight-line method in amounts that allocate the cost of the assets to operations over their estimated useful lives, as follows:
Asset Classification | Estimated | ||||
---|---|---|---|---|---|
Machinery and |
| 3 - 5 years | |||
Furniture and | 5 years | ||||
Intangible assets |
| 6 - 15 years |
Leasehold improvements are amortized over the shorter of their estimated useful lives or the lives of the leases.
lease lives.
f. Basic and Diluted Net Loss PerIncome (Loss) per Common ShareShare:: Basic and diluted net lossincome (loss) per common share is based oncalculated by dividing the net income (loss) by the weighted average number of common shares outstanding. For Q1 09 and Q1 08, the periods ended December 31, 2007 and 2006,diluted net loss per common share is the same as basic net loss per common share, as the inclusion of other shares of common stock issuable pursuant to outstanding stock options have not been considered, as their effectand warrants would be anti-dilutive.
g. Revenue RecognitionRecognition:: The Company recognizes We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 104,Revenue Recognition in Financial StatementsStatements. and EITF 00-21, Revenue Arrangements with Multiple Deliverables. These pronouncements require This pronouncement requires that certainfive basic criteria must be met before revenue can be recognized: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred or services were rendered; (3) the fee is fixed and determinable; (4) collectability is reasonably assured. The Company recognizesassured; and (5) the fair value of undelivered elements, if any, exists. Determination of criterion (4) is based on management's judgment regarding the collectability of invoices for products and services delivered to customers. Should changes in conditions cause management to determine this criterion is not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. We recognize revenue when title and risk of loss passes to the customer, generally upon shipment of products.our products F.O.B. shipping point.
h. Foreign Currency TransactionsTransactions:: The Company charges We charge to operations all foreign currency exchange gains or losses in connection with itsour purchases of products from foreign vendors to operations.vendors. For each of the two years in the period ended June 30, 2008, these amounts were immaterial.
i. Income TaxesTaxes:: The Company accounts We account for income taxes under the liability method, and deferred tax assets or liabilities are computed based on the differences between the financial statement and income tax basesbasis of assets and liabilities as measured by the enacted tax rates. The Company has recorded a valuation allowance equal to its net deferred tax asset due to the uncertainty of realizing the benefit of this asset.
j. Stock-based CompensationStock-based:: Effective April 1, 2006 the Company began accounting for compensation expense related to stock options in accordance with SFAS No. 123 (Revised 2004)Share-Based Payment (“ ("SFAS 123R”123R"). Prior to April 1, 2006, the Company accounted for stock options according to Accounting Principles Board (“APB”) Opinion 25, Accounting for Stock Issued to Employees.
The Company has adopted the modified prospective transition method and consequently has not retroactively adjusted results from prior periods. Under this transition method, compensation costCompensation costs associated with stock options now includes:include: (i) amortization related to the remaining unvested portion of all stock options outstanding at March 31, 2006, based on the fair value determined on the grant date in accordance with the original provisions of SFAS 123, and (ii) amortization related to all stock option awards granted subsequent to March 31, 2006, based upon the fair value estimated in accordance with SFAS 123R. The compensation expense for stock-based compensation awards under SFAS 123R is recognized over the vesting period of the options, and includes an estimate for forfeitures.
In accordance with SFAS 123R, the Company recorded stock-based compensation expense in the statement of operations for Q3Q1 09 and Q1 08, and Q3 07, respectively, and YTD FY 08 and YTD FY 07, respectively, in the following expense categories:
|
| (Unaudited) |
| |||||||||||||||||
|
| Three Months Ended |
| Nine Months Ended |
| Three Months Ended June 30, | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
| December 31, |
| December 31, |
| December 31, |
| December 31, |
| 2008 | 2007 | |||||||||
Cost of Goods Sold |
| $ | 18 |
| $ | 15 |
| $ | 48 |
| $ | 45 |
| $ | 13 | $ | 13 | |||
Selling, General & Administrative |
| 143 |
| 97 |
| 438 |
| 288 |
| |||||||||||
Research & Development |
| 39 |
| 25 |
| 105 |
| 48 |
| |||||||||||
Selling, General and Administrative | 117 | 102 | ||||||||||||||||||
Research and Development | 39 | 17 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total |
| $ | 200 |
| $ | 137 |
| $ | 591 |
| $ | 381 |
| $ | 169 | $ | 132 | |||
8
At December 31, 2007,June 30, 2008, total unamortized stock-based compensation iswas approximately $1,458.$1,902. The Company will expense that amount over periods ending through June 30, 2013. The Company does not expect to realize any tax benefits from future disqualifying dispositions, if any, since it currently has a full valuation allowance against its deferred tax asset.
In the ninethree months ended December 31, 2007,June 30, 2008, the Company granted options to purchase a total of 1,846,250294,000 shares of the Company’sCompany's Common Stock to employees, non-employee consultants and directors. The fair value of these options measured at the option grant date was approximately $1,458,$982, determined using the Black-Scholes option-pricing model. This amount is reduced by an estimated forfeiture rate and is being recorded as an expense over the vesting period. The assumptions used in the Black-Scholes option-pricing model in the period by the Company were as follows:
|
| December 31, 2007 |
| |
Risk-free interest rate |
| 3.45%-4.81 | % | |
Expected dividend yield |
| 0 | % | |
Expected life |
| 5.5-6.75 years |
| |
Expected volatility |
| 65%-70 | % | |
Weighted average value grant per share |
| $ | 0.83 |
|
| June 30, 2008 | |||
---|---|---|---|---|
Risk-free interest rate | 3.55% | |||
Expected dividend yield | — | |||
Expected life | 6.25 years | |||
Expected volatility | 74% | |||
Weighted average value grant per share | $ | 3.34 |
We grant options with vesting periods ranging from immediate to six years. We use the simplified method of calculating the expected option term, which averages an award’saward's weighted average vesting period and its contractual term. The contractual term of our options is ten years. The risk-free rate is based upon the daily Treasurytreasury yield curve for a period approximately equal to the expected option term. We used historical data to estimate the expected price volatility and forfeiture rate. The expected dividend yield is 0%, based on our history of not paying dividends.
k. NewRecently Issued Accounting StandardsStandards::
In July 2006,On April 1, 2008, we adopted the provisions of Financial Accounting Standards Board (“FASB’) issued FIN 48, Accounting for Uncertainty in Income Taxes-an Interpretation of FASB(FASB) Statement No. 109, which seeks to reduce the significant diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. Upon adoption, the cumulative effect of any changes in net assets resulting from the application of FIN 48 will be recorded as an adjustment to retained earnings. We adopted FIN 48 effective April 1, 2007, and the adoption of FIN 48 did not have a material impact on our results of operations, financial position or cash flow.159,
In February 2007, the FASB issued SFAS No. 159 (SFAS 159), The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASBLiabilities. This Statement No. 115. SFAS 159 permits entities to chooseallows companies the option to measure manyeligible financial instruments at fair value. Such election, which may be applied on an instrument by instrument basis, is typically irrevocable once elected. We have elected not to apply the fair value that are not currently requiredoption to be measured at fair value. It also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar typesany of assets and liabilities. SFAS 159 is effective for our fiscal year beginning after November 15, 2007. Adoption of this statement is not expected to have a material impact on our financial statements or results of operations.instruments except for those expressly required by U.S. GAAP.
In December 2007,March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment to FASB Statement No. 133" ("SFAS 161"), which requires additional disclosures about the objectives of using derivative instruments, the method by which the derivative instruments and related hedged items are accounted for under FASB Statement No. 133 and its related interpretations, and the effect of derivative instruments and related hedged items on financial position, financial performance, and cash flows. SFAS 161 also requires disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 (which for our company would be on April 1, 2009, our 2010 Fiscal Year), with early adoption encouraged. We are currently assessing the impact that the adoption of SFAS 161 will have on our financial statement disclosures.
In 2007 the FASB issued Statement No. 141(R),Business CombinationsCombinations—A Replacement of FASB Statement No. 141. This Statement significantly changes the principles and SFASrequirements for how an acquisition is recognized and measured in a company's financial statements including the identifiable assets acquired and the liabilities assumed. This Statement also provides guidance for recognizing and measuring goodwill acquired in a business combination and required disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This Statement is effective prospectively, except for certain retrospective adjustments to deferred income tax balances, for the Company beginning on January 1, 2009. The Company has not yet determined the impact, if any, the adoption of this Statement will have on its financial position.
In 2007 the FASB issued Statement No. 160,Accounting and Reporting of Noncontrolling InterestInterests in Consolidated Financial Statements,an amendment of ARB No. 5151. .. These new standards will This Statement significantly changechanges the financial accounting for and reporting of business combination transactions and noncontrolling (minority)(or minority) interests of a subsidiary in consolidated financial statements. SFAS Nos. 141(R) and 160 are required toFor our Company it would be adopted simultaneously and are effective for the first annual reporting periodprospectively beginning on or after December 15, 2008. Thus, we are required to adopt these Standards on AprilJanuary 1, 2009. Earlier adoption is prohibited. We are currently evaluatinghave not yet determined the impact, if any, the adoption of adopting SFAS Nos. 141(R) and SFAS 160this Statement will have on our consolidatedthe financial statements.position of the Company.
9
3. Stock Option Plans
Our first stock option plan (the “1990 Plan”"1990 Plan") allowed us to grant key employees and non-employee consultants incentive and non-statutory stock options at the fair value of the stock on the date of grant. Options became exercisable at varying dates ranging up to five years from the date of grant. Our Board of Directors (our “Board”"Board") had authorized the issuance of options for the purchase of up to 4,375,000 shares of common stock under the 1990 Plan. This plan expired in 2001 and was replaced with the 2000 Plan. The terms of the 2000 Plan are substantially the same as the 1990 Plan. Our Board and stockholders authorized the issuance of options for the purchase of up to 4,500,000 shares of common stock under the 2000 Plan, of which 5,40529,155 shares remain available for future grants.
At our annual stockholders meeting, held onIn August, 21, 2007, our stockholders approved our 2007 Stock Incentive Plan (the “2007 Plan”"2007 Plan"), which was previously approved by our Board.. Under the 2007 Plan, we are authorized to issue options for the purchase of up to 4,000,000 shares of common stock. The terms of the 2007 Plan are substantially the same as the 2000 Plan. As of December 31, 2007,June 30, 2008, there remain 2,646,5002,149,500 shares available for future grants under the 2007 Plan. WeIn the 2007 Plan, we grant options to both employees and non-employee consultants,non-employee-consultants, with vesting periods ranging from immediate to six years. For options granted in the current year,under this plan, we have chosen to employ the simplified method of calculating the option term, which averages an award’saward's weighted average vesting period and its contractual term. The contractual term of our options is ten years.
On June 30, 2008, the total unamortized stock-based compensation for the 1990, 2000 and 2007 plans is approximately $1,902, which will be expensed through the period ending June 30, 2013. The Company does not expect to realize any tax benefits from future disqualifying dispositions, if any,
because of its net operating loss carry-forwards and its policy of recording valuation allowances equal to all deferred tax assets.
A summary of the stock option activity for employees and non-employee consultants under the 1990, 2000 and 2007 plans for the ninethree months ended December 31, 2007June 30, 2008 is as follows:
| Number of Shares | Exercise Price Range | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Outstanding March 31, 2008 | 6,130,369 | $0.79–$4.30 | $ | 1.49 | 6.25 years | |||||||||
Granted | 290,000 | 4.88–5.10 | 4.89 | |||||||||||
Exercised | (799,785 | ) | 0.89–4.00 | 1.63 | ||||||||||
Canceled | (10,000 | ) | 2.05–3.20 | 2.91 | ||||||||||
Outstanding June 30, 2008 | 5,610,584 | $0.79–$5.10 | $ | 1.64 | 7.16 years | |||||||||
Exercisable June 30, 2008 | 3,037,146 | $0.79–$4.30 | $ | 1.41 | 5.61 years | |||||||||
|
| Number of Shares |
| Weighted Average |
| Weighted Average |
| |
Outstanding March, 31, 2007 |
| 4,703,550 |
| $ | 1.47 |
| 5.9 years |
|
Granted |
| 1,830,250 |
| 1.23 |
|
|
| |
Exercised |
| (20,350 | ) | 1.01 |
|
|
| |
Canceled |
| (157,500 | ) | 1.18 |
|
|
| |
|
|
|
|
|
|
|
| |
Outstanding December 31, 2007 |
| 6,355,950 |
| $ | 1.40 |
| 6.7 years |
|
|
|
|
|
|
|
|
| |
Exercisable December 31, 2007 |
| 3,708,950 |
| $ | 1.48 |
|
|
|
10
The following table summarizes information aboutIn August 1993, we adopted the 1993 Director Option Plan (the "1993 Plan") under which we may grant up to 200,000 non-statutory stock options outstanding andto non-employee directors of the Company at the fair value of the stock on the date of grant. Options become exercisable at December 31, 2007:
|
|
|
| Outstanding |
| Exercisable |
| |||||||
Range of Exercise Prices |
| Number |
| Weighted Average |
| Weighted Average |
| Number |
| Weighted Average |
| |||
$ | 0.79 - $1.05 |
| 1,075,000 |
| 5.5 |
| $ | 1.03 |
| 1,075,000 |
| $ | 1.03 |
|
1.06 - 1.31 |
| 2,626,950 |
| 8.0 |
| 1.15 |
| 699,200 |
| 1.13 |
| |||
1.32 - 1.88 |
| 2,250,500 |
| 5.7 |
| 1.54 |
| 1,613,000 |
| 1.58 |
| |||
2.05 - 2.28 |
| 150,000 |
| 7.3 |
| 2.13 |
| 100,000 |
| 2.17 |
| |||
2.70 - 3.69 |
| 128,500 |
| 6.7 |
| 3.51 |
| 115,500 |
| 3.59 |
| |||
4.00 - 4.30 |
| 125,000 |
| 6.7 |
| 4.18 |
| 106,250 |
| 4.17 |
| |||
|
|
| 6,355,950 |
| 6.7 |
| $ | 1.40 |
| 3,708,950 |
| $ | 1.48 |
|
over a four-year period from the date of grant. The Company had reserved 200,000 shares of common stock for the exercise of stock options under the 1993 Plan. We no longer grant options under this plan.
In July 2003, we adopted, and our stockholders approved, a 2003 Director Option Plan (the “2003 Plan”"2003 Plan"). The terms of the 2003 Plan are similar to the 1993 Directors Option Plan, and include automatic grants of 4,000 shares to each outside member of our Board on the date of the annual meeting of stockholders, so long as such outside director does not hold at that time any outstanding options to purchase Common Stock under the Company’sCompany's 1993 Plan, which options are not fully exercisable. Options granted under the 2003 Plan are 100% vested on the date of grant. In January 2008, our Board approvedupon the recommendation of the Executive Committee, our Board approved changes to change the compensation of our outside directors, and recommended toamong other things, by recommending an increase in the annual grant to 10,000 options per director, and increasing the maximum number of options available under the plan from 200,000 to 450,000, pending stockholder approval.approval at our Annual Stockholders Meeting scheduled to be held on August 28, 2008. If our annual meeting of stockholders is held in August of each year, and in the event that the number of outside directors wasremains unchanged (currently there are five outside directors), we would be required to grant options to purchase an aggregate of 50,000 shares in each of August of 2008 and August 2009. During our FY 08 Annual Shareholders meeting, held in August 2007, we granted 16,0004,000 options to each our then four outside directors.directors, and an additional 4,000 options to another outside director were granted in May, 2008. As of December 31, 2007,June 30, 2008, there remain 156,000152,000 shares available for future grants under the 2003 Plan.
Plan Assuming the amendments to the plan are approved by our stockholders.
A summary of the Director Option Plans activity is as follows:
| Number of Shares | Exercise Price Range | Weighted Average Exercise Price | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Outstanding March 31, 2008 | 104,000 | $1.00–$2.10 | $ | 1.39 | |||||||
Granted | 4,000 | $4.88–$4.88 | $ | 4.88 | |||||||
Exercised | — | — | — | ||||||||
Canceled | (20,000 | ) | $1.50–$1.50 | $ | 1.50 | ||||||
Outstanding June 30, 2008 | 88,000 | $1.00–$4.88 | $ | 1.55 | |||||||
Exercisable June 30, 2008 | 88,000 | $1.00–$4.88 | $ | 1.55 | |||||||
|
| Number of |
| Exercise |
| Weighted Average |
| ||
Outstanding March 31, 2007 |
| 88,000 |
| $ | 1.00 - $2.10 |
| $ | 1.41 |
|
Granted |
| 16,000 |
| 1.41 |
| 1.41 |
| ||
Exercised |
| — |
| — |
| — |
| ||
Canceled |
| (20,000 | ) | 1.50 |
| 1.50 |
| ||
|
|
|
|
|
|
|
| ||
Outstanding December 31, 2007 |
| 84,000 |
| $ | 1.00 - $2.10 |
| $ | 1.39 |
|
|
|
|
|
|
|
|
| ||
Exercisable December 31, 2007 |
| 84,000 |
| $ | 1.00 - $2.10 |
| $ | 1.39 |
|
The following table summarizes information about director stock options outstanding and exercisable at December 31, 2007:
|
|
|
| Outstanding |
| Exercisable |
| |||||||
Range of Exercise Prices |
| Number |
| Weighted Average |
| Weighted Average |
| Number |
| Weighted Average |
| |||
$ | 1.00 - $1.30 |
| 40,000 |
| 3.7 |
| $ | 1.15 |
| 40,000 |
| $ | 1.15 |
|
1.41 - 1.49 |
| 32,000 |
| 9.4 |
| 1.45 |
| 32,000 |
| 1.45 |
| |||
1.92 - 2.10 |
| 12,000 |
| 7.9 |
| 2.03 |
| 12,000 |
| 2.03 |
| |||
$ |
|
| 84,000 |
| 6.5 |
| $ | 1.39 |
| 84,000 |
| $ | 1.39 |
|
11
4. Segment Information
As of October 1, 2007, we operate in three reportable segments:medical, industrial, and health services.
Corporate Segment Elimination
Until the end of our fiscal year ended March 31, 2007, (FY 07), we had three reportable segments: medical, industrial and corporate. Our medical segment designs, manufactures and sells EndoSheath and endoscopes to users in the healthcare industry. Our industrial segment designs, manufactures and sells borescopes to a variety of users, primarily in the aircraft engine-manufacturing and aircraft engine-maintenance industries. Our corporate segment consisted of certain administrative expenses applicable to usthe company as a whole. As of April 1, 2007 (FY 08), we eliminated the corporate segment by consolidating it into the medical and industrial segments.
Our medical segment designs, manufactures, and sells our advanced line of endoscopy based products for a variety of specialties, including our state-of-the-art flexible endoscopes and our Slide-On EndoSheath technology.
Our industrial segment, through our wholly-owned subsidiary, Machida, Inc., designs, manufactures and sells borescopes to a variety of users, primarily in the aircraft engine-manufacturing and aircraft engine-maintenance industries. A borescope is an instrument that uses optical fibers for the visual inspection of narrow cavities, such as the bore of a gun.
Our health services segment is our newly formed wholly-owned subsidiary BEST-DMS, which was established in October 2007. BEST-DMS is a service-based segment, providing the Bedside Endoscopic Swallowing Test ("BEST") to nursing homes, rehabilitation centers, and assisted living facilities.
Between April 1, 2007 and September 30, 2007, we operated under two reportable segments, medical and industrial. In March 2007, we completed the license and sale of certain assets with respect to our ENT sheath business to Medtronic Xomed, Inc. (“Medtronic”, or “MENT”), a wholly-owned subsidiary of Medtronic, Inc. ThisMedtronic. That transaction resulted in a thorough review of our business, including how we evaluate and report our results of operations. In order to enable our Chief Executive Officer to make operating and financial decisions about allocating our resources and assessing performance, effective FY 08,April 1, 2007, we began operating under two reportable segments, medical and industrial. All expenses formerly reported under the corporate segment are allocated as follows: 95% to the medical segment and 5% to the industrial segment.
We also changed our method for inter-segment cost allocations between the medical and the industrial segments. As part of our business review, we examined the resources allocated between departments and changed the allocations accordingly. These changes affect certain expenses such as Cost of Goods Sold (“COGS”("COGS"), Research and Development (“("R&D”&D") and Sales, Marketing and Administration (“("SG&A”&A").
We reclassified our FY 07 segment information according to Statement of Financial Accounting Standard 131 (“FAS 131”("SFAS 131") to reflect the change in reportable segments. All expenses reported during FY 07 under the corporate segment, were allocated at a rate of 95% to the medical segment and 5% to the industrial segment. We determined, however, that it is impracticable to restate our FY 07 inter-segment allocations.
FASSFAS 131 providesstates that if an enterprise changed the structure of its internal organization in a manner that causes the composition of its reportable segments to change, and if segment information for earlier periods, including interim periods, is not restated to reflect the change, the enterprise must disclose in the year in which the change occurs segment information for the current period under both the old basis and the new basis of segmentation, unless it is impracticable to do so. We determined that it is impracticable for us to report our new allocation methodology under the old and new basis, and we are therefore reporting only under the new basis.
12
4. Segment Information (Continued)
The three segments follow the accounting policies described in the Summary Ofof Significant Accounting Policies, above. We evaluate segment performance based upon operating income. Identifiable assets are those used directly in the operations of each segment and general corporate assets, such as cash and marketable securities are allocated to each segment. Our segments are described in the following tables:
Three Months Ended June 30, | Medical | Industrial | Health | Adjustments | Total | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2008 (Q1 09) | ||||||||||||||||
Sales to external customers | $ | 2,000 | $ | 696 | $ | 233 | $ | — | $ | 2,929 | ||||||
Operating loss | (3,199 | ) | (42 | ) | (188 | ) | — | (3,429 | ) | |||||||
Interest income | 80 | — | — | — | 80 | |||||||||||
Depreciation and amortization | 82 | 9 | 9 | — | 100 | |||||||||||
Stock-based compensation | 169 | — | — | — | 169 | |||||||||||
Total assets | 27,625 | 2,473 | 587 | (3,651 | ) | 27,034 | ||||||||||
Expenditures for fixed assets | 393 | — | 20 | — | 413 | |||||||||||
2007 (Q1 08) | ||||||||||||||||
Sales to external customers | $ | 1,832 | $ | 598 | $ | — | $ | — | $ | 2,430 | ||||||
Operating loss | (1,654 | ) | 15 | — | — | (1,639 | ) | |||||||||
Interest income | 279 | — | — | — | 279 | |||||||||||
Depreciation and amortization | 31 | 9 | — | — | 40 | |||||||||||
Stock-based compensation | 129 | 3 | — | — | 132 | |||||||||||
Total assets | 31,172 | 1,277 | — | (1,220 | ) | 31,229 | ||||||||||
Expenditures for fixed assets | 381 | — | — | — | 381 |
Three months ended December 31, |
| Medical |
| Industrial |
| BEST |
| Total |
| ||||
2007 (Q3 08) |
|
|
|
|
|
|
|
|
| ||||
Sales to external customers |
| $ | 1,246 |
| $ | 598 |
| $ | 175 |
| $ | 2,019 |
|
(Loss) income from operations |
| (2,530 | ) | 470 |
| (54 | ) | (2,114 | ) | ||||
Interest income (expense), net |
| 289 |
| — |
| — |
| 289 |
| ||||
Depreciation and amortization |
| 78 |
| 3 |
| — |
| 81 |
| ||||
Other significant non-cash items: |
|
|
|
|
|
|
|
|
| ||||
Stock-based compensation |
| 197 |
| 3 |
| — |
| 200 |
| ||||
Loss in equity investment |
| (119 | ) | — |
| — |
| (119 | ) | ||||
Expenditures for fixed assets |
| 193 |
| — |
| 72 |
| 265 |
| ||||
Total assets |
| 25,511 |
| 2,753 |
| 130 |
| 28,394 |
| ||||
2006 (Q3 07) |
|
|
|
|
|
|
|
|
| ||||
Sales to external customers |
| $ | 1,535 |
| $ | 681 |
| $ | — |
| $ | 2,216 |
|
(Loss) income from operations |
| (1,116 | ) | (314 | ) | — |
| (1,430 | ) | ||||
Interest income (expense), net |
| 28 |
| — |
| — |
| 28 |
| ||||
Depreciation and amortization |
| 102 |
| 9 |
| — |
| 111 |
| ||||
Other significant non-cash items: |
|
|
|
|
|
|
|
|
| ||||
Stock-based compensation |
| 106 |
| 31 |
| — |
| 137 |
| ||||
Expenditures for fixed assets |
| 105 |
| 16 |
| — |
| 121 |
| ||||
Total assets |
| 5,937 |
| 1,777 |
| — |
| 7,714 |
| ||||
Nine months ended December 31, |
| Medical |
| Industrial |
| BEST |
| Total |
| ||||
2007 (YTD FY 08) |
|
|
|
|
|
|
|
|
| ||||
Sales to external customers |
| $ | 5,623 |
| $ | 1,779 |
| $ | 175 |
| $ | 7,577 |
|
(Loss) income from operations |
| (6,437 | ) | 487 |
| (54 | ) | (6,004 | ) | ||||
Interest income (expense), net |
| 858 |
| — |
| — |
| 858 |
| ||||
Depreciation and amortization |
| 148 |
| 20 |
| — |
| 168 |
| ||||
Other significant non-cash items: |
|
|
|
|
|
|
|
|
| ||||
Stock-based compensation |
| 582 |
| 9 |
| — |
| 591 |
| ||||
Loss in equity investment |
| (332 | ) | — |
| — |
| (332 | ) | ||||
Expenditures for fixed assets |
| 789 |
| 1 |
| 72 |
| 862 |
| ||||
Total assets |
| 25,511 |
| 2,753 |
| 130 |
| 28,394 |
| ||||
2006 (YTD FY 07) |
|
|
|
|
|
|
|
|
| ||||
Sales to external customers |
| $ | 4,474 |
| $ | 2,040 |
| $ | — |
| $ | 6,514 |
|
(Loss) income from operations |
| (3,449 | ) | (571 | ) | — |
| (4,020 | ) | ||||
Interest income (expense), net |
| 118 |
| — |
| — |
| 118 |
| ||||
Depreciation and amortization |
| 301 |
| 22 |
| — |
| 323 |
| ||||
Other significant non-cash items: |
|
|
|
|
|
|
|
|
| ||||
Stock-based compensation |
| 306 |
| 75 |
| — |
| 381 |
| ||||
Expenditures for fixed assets |
| 384 |
| 66 |
| — |
| 450 |
| ||||
Total assets |
| 5,937 |
| 1,777 |
| — |
| 7,714 |
| ||||
13
5. Acquisition
(i) BEST DMS Inc.
On October 1, 2007, weVision-Sciences purchased the assets of BESTBest Dysphagia Management, Services, Inc., a Florida-basedFlorida based speech pathology company which specializes in providing what is referred to as the Bedside Endoscopic Swallowing Test (“Best”("BEST") to nursing homes, rehabilitation centers and assisted living settings via our new wholly-owned subsidiary BEST DMS Inc. AtThe purchase price was $1,500, which was comprised of (a) $450 (the "Initial Purchase Price"), paid at the closing, we paidand (b) earn out payments payable over four years, in an aggregate amount not to exceed $1,050, based on certain milestones being met. The Initial Purchase Price of $450 for the assets andhas been allocated the purchase price as follows: $72$135 to fixed assets and $378$315 to Goodwill.intangible assets. This purchase price allocationacquisition will allow Vision-Sciences access to new markets, including the geriatric market, nursing homes and rehabilitation centers, and it is preliminaryexpected to provide a boost to our future growth. The operating results of BEST-DMS are included in the operating results as of the acquisition date, and subjectproforma numbers are not presented since this acquisition was immaterial.
(ii) Minos Medical, Inc.
In April 2007, we executed a definitive investment agreement under which we acquired a strategic interest in Minos Medical, Inc. ("Minos"). Minos is a privately held California-based development-stage medical device company concentrating in the emerging field of N.O.T.E.S. (Natural Orifice Trans-luminal Endoscopic Surgery). N.O.T.E.S. is a new frontier in surgery, focusing on using natural orifices to change (for more information, please referenter the body to Item 2 “Management’s Discussionfacilitate surgical procedures that require no incisions. We invested $1,000 in cash and Analysishave agreed to expend $165 in development costs in collaboration with Minos, in order to exploit
4. Segment Information (Continued)
certain surgical procedures. Our investment amounted to 30% of financial Conditionthe outstanding shares of Minos, and Resultswe accounted for this transaction on our balance sheet as an equity investment.
During FY 08, we recorded our share of Operations” below).
6. Subsequent Events
On January 7,equity losses totaling $350, and at March 31, 2008, we received 510(k) clearance (for a definitionwrote off our remaining investment balance of a 510(k) clearance, see below) from the U.S. Food and Drug Administration (“FDA”)$650 due to market our new advanced CCD-based digital, video flexible cystoscope, which incorporates an integrated “built–in” light source, eliminating the need for a separate, external light source and light guide cable. Our new cystoscopeliquidity issues at Minos. Minos is the world’s first advanced video-based cystoscope, which is used with our new generation EndoSheath technology, which together provide extraordinary vision and a superior endoscopic system that facilitates quality healthcare.
A 510(k) is a premarket notification submitted to the FDA to demonstrate that the device to be marketed is at least as safe and effective, that is, substantially equivalent (SE), to a legally marketed device that is not subjected to the more stringent premarket approval (PMA) process. Submitters must compare their device to one or more similar legally marketed devices and make and support their substantial equivalency claims. A legally marketed device is (i) a device that was legally marketed prior to May 28, 1976 (pre-amendments device), for which a PMA is not required, or (ii) a device which has been reclassified from Class III to Class II or I, or (iii) a device which has been found SE through the 510(k) process. The legally marketed device(s) to which equivalence is drawn is commonly known as the “predicate.” Although devices recently cleared under the 510(k) process are often selected as the predicate to which equivalence is claimed, any legally marketed device may be used as a predicate. Legally marketed also means that the predicate cannot be one that is in violation of the Federal Food, Drug, and Cosmetic Act.
Until the submitter receives an order declaring a device SE, the submitter may not proceed to market the device. Once the device is determined to be SE, it can then be marketed in the U.S. The SE determination is usually made within 90 days and is made based on the information submitted by the submitter.
On January 17, 2008, we filed with the Securities and Exchange a Registration Statement on Form S-8 relating to 4,000,000 shares of our common stock, $.01 par value for issuance under our 2007 Stock Incentive Plan.
On January 18, 2008, we entered into a $10.0 million revolving line of credit agreement with Merrill Lynch Bank USA (the “Bank”), pursuant to the terms of a Merrill Lynch Loan Management Account Agreement (the “Loan Agreement”). The Loan Agreement permits us to borrow funds from the Bank from time-to-time at fixed, variable or term rates. The current rate for our borrowing is set at LIBOR plus 1.75%. Any outstanding amounts for variable rate borrowings may be repaid at our option at any time without penalty or premium. If we repay a fixed advance or term advance prior to its scheduled repayment date, we may be required to pay a breakage fee to the Bank. The amount of advances available under the Loan Agreement varies from time-to-time and is based on the value of, and secured by, the securities we maintain with Merrill Lynch, Pierce Fenner, & Smith Incorporated. Under the Loan Agreement, the Bank has the right to demand repayment, in whole or in part, at any time, of any outstanding amounts. As of today, we have not requested any advances under the Loan Agreement.
Our lease for our Natick, MA operations located at 9 Strathmore Road in Natick, MA expires on April 30, 2008. We arepresently in the process of relocating our Natick operations to our Orangeburg, NY facilities. This will not be completed until December 31, 2008. Accordingly, we signedseeking additional sources of funding for development and for sales and marketing of their new products. In that regard, in early June, Minos received a short term lease to relocate our Natick facility to510K clearance for their initial product, the Megachannel™, from the Food and Drugs Administration ("FDA"). The Megachannel is a near-by location in Natick, MA.
During this quarter, our dispute22mm diameter flexible tube that rides along with Pentax resulted in a temporary shortage of parts for the manufacturing and repair of fiberscopes. Based on in-house orders at the end of Q3, we calculated that in this quarter, because of the Pentax dispute, we lost revenues for scopes and accessories totaling $756, and repair orders for a total of $26 thousand.
On February 12, 2008, we reached a satisfactory arrangement for the transition of our supply relationship with Pentax. Under the terms of the agreement entered into with Pentax, we resolved our pending dispute with Pentax and agreed to dismiss all related legal proceedings over pricing, volumes and delivery schedules for the components supplied by Pentax. The agreement modified the terms of our Supply Agreement with Pentax, dated March 16, 1992, as amended, by, among other things (i) moving forward the termination date of the supply relationship to February 28, 2009 from March 15, 2009, and (ii) providing an agreed upon purchase order and delivery schedule of components from Pentax through February 28, 2009.
We expect that the agreement reached with Pentax will enable us to meet our estimated production requirements for fiberscopes over the next twelve months, and will give us sufficient time to secure alternative manufacturing or supply arrangements with respectcolonoscope to the components supplied by Pentax, and to meet our expected future production requirements for fiberscopes. Pentax’s supply arrangement is limited to components usedtarget site. Once in our fiberscopes only. Pentax does not supply components used in any other of our products, including any of our products under development, or any of our video-based scopes.place it creates a 20mm working channel (or super highway) that allows rapid access beyond the sigmoid colon.
6. Subsequent Events
The dispute is partially affecting our Q4 08 Revenues. For more details, please refer to “Item 1. Legal Proceedings” in Part II–Other Information.
14None.
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSManagement's Discussion and Analysis of Financial Condition and Results of Operations
Executive Summary
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Examples1995, which are subject to various risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in such statements. Such factors include, but are not limited to, pricing pressures, including cost-containment measures which could adversely affect the price of, or demand for, our products; changes in economic conditions that may adversely affect the level of demand for our products; changes in foreign exchange markets; changes in financial markets and changes in the competitive environment. Other examples of forward-looking statements include statements about expectations about future financial results, future products and future sales of new and existing products, future expenditures, and capital resources to meet anticipated requirements. Generally, words such as “expect” “believe”"expect" "believe", “anticipate”"anticipate", “may”"may", “will”"will", “plan”"plan", “intend”"intend", “estimate”"estimate", “could”"could", and other similar expressions are intended to identify forward-looking statements. The forward-looking statements are based on our future plans, strategies, projections and predictions. These forward-looking statementspredictions and involve risks and uncertainties, and our actual results may differ significantly from those discussed in the forward-looking statements. Factors that might cause such a difference could include the availability of capital resources, the availability of third-party reimbursement, government regulation, the availability of raw material components, our dependence on certain distributors and customers, competition, technological difficulties, the completion of obligations under our contract with Medtronic Xomed, Inc. ("Medtronic", or "MENT"), general economic conditions and other risks detailed in our most recent Annual Report on Form 10-K and any subsequent periodic filings we mademake with the Securities and Exchange Commission. We do not undertake an obligation to update our forward-looking statements to reflect future events or circumstances.
Registered Trademarks, Trademarks and Service Marks
Vision-Sciences, Inc. and its subsidiaries own the registered trademarks Vision Sciences®, Slide-On®, EndoSheath® and BEST®.
Our fiscal year-end is on March 31 of each year, and is referred to hereherein as FY 06, FY 0708 and FY 0809 (our current fiscal year), respectively. Q3 07Q1 09 refers to the period from OctoberApril 1, 20062008 to December 31, 2006;June 30, 2008; and Q3Q1 08 refers to the period from OctoberApril 1, 2007 to December 31,June 30, 2007.
We ("Vision-Sciences" or the "Company") design, develop, manufacture and market products for endoscopy – endoscopy—the science of using an instrument, known as an endoscope – endoscope—to provide minimally invasive access to areas not readily visible to the human eye.
We were incorporated in Delaware in 1987 under the name Machida Incorporated ("Machida"). Since that time, we have acquired by merger Cyberex Corporation (October 1988), Vascu-Care, Inc. (March 1989), and we acquired Opielab, Inc. through a share exchange (September 1990). In December 1990, we changed our name to Vision-Sciences, Inc. ("VSI") and Machida became wholly owned subsidiary. Another VSI subsidiary, Vision Sciences Ltd., an Israeli corporation, has been inactive since the fiscal year ended March 31, 2002.
VSI primarily operates in the medical segment, while Machida primarily operates in the industrial segment. In October, 2007 we purchased the assets of BEST Dysphagia Management Services, Inc., a Florida based speech pathology company which specializes in providing what is referred to as the Bedside Endoscopic Swallowing Test ("BEST") to nursing homes, rehabilitation centers and assisted living facilities, via our new wholly-owned subsidiary BEST DMS Inc. ("BEST-DMS"). BEST-DMS is our health services segment.
Our principal executive offices are currently located at 40 Ramland Road South, Orangeburg, New York 10962. Our telephone number is (845) 365-0600. Our corporate website iswww.visionsciences.com. Through a link on the Investor Relations section of our website, we make available all filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission ("SEC") including, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings are available free of charge.
We now operate in three reportingreportable segments:medical, industrial, and health services
Corporate Segment Elimination
Until the end of our fiscal year ended March 31, 2007, (FY 07), we had three reportable segments: medical, industrial and BEST DMS.corporate. Our corporate segment consisted of certain administrative expenses applicable to us as a whole. As of April 1, 2007 (FY 08), we eliminated the corporate segment by consolidating it into the medical and industrial segments.
Medical Segment
Our medical segment designs, manufactures and sells our Slide-On® EndoSheath® Systems (“EndoSheath” or “Slide-On EndoSheath” or “Sheath”), which consistsadvanced line of endoscopy products for a variety of specialties, including our state-of-the-art flexible endoscopes, and our Slide-On EndoSheath technology ("Sheath" or "EndoSheath disposable").
Our long standing primary lines of high-quality fiber-based flexible endoscopes is now augmented with our first generation CCD-based flexible video endoscope systems, which were announced and cleared for sale by the Food & Drugs Administration ("FDA") in Q3 and Q4 of FY 08. This new high-performance imaging technology platform is expected to redefine the Company's place in the minimally invasive device market. These flexible endoscopes are unlike conventional endoscopes, and when utilized with the EndoSheath technology, offer a multitude of benefits and advantages to the healthcare practice.
"EndoSheath Endoscopy", the differentiating term given to procedures performed with our unique technology, consists of a reusable flexible endoscope combined with a single-use, sterile, disposable covers and our proprietary endoscopes.protective sheath. The insertion tube which is protected by the Sheath, is the part of the endoscope that enters the patient’spatient's body. The use of a Sheaththe EndoSheath technology gives health-care providers severalclinical and economic advantages, as it allows them to avoid the burdensome cleaningelaborate high level disinfection and high-level disinfectionsterilization routines required of endoscopes, reduces repairconventional endoscopes. This design of "always ready" equipment which allows for a rapid and less caustic cleaning process provides a multitude of benefits, such as; less capital inventory investment, less service and maintenance costs to endoscopes caused byof capital equipment, less staff exposure to harshtoxic chemicals, used in the cleaningincreased patient scheduling flexibility, improved staff productivity, and disinfection process, and allows health-care providers to avoid investing in multiple endoscopes. Furthermore, the EndoSheath technology enables physicians to configure their EndoSheath system for specific procedures. For example, in fields like Urology, our EndoSheaths are offered in models with various size channels, which, unlike conventional flexible endoscopes, allow the healthcare provider the ability to customize the insertion tube to the procedure (e.g., diagnostic cystoscopy, which can utilize a small channel, or therapeutic cystoscopy, which requires a larger channel).more practical implementation of office-based endoscopy.
Our EndoSheath technology also providesallows for unprecedented practice efficiency in a wide array of healthcare settings; from the private practice to the busy academic hospital. In addition, each EndoSheath disposable is a sterile device, offeringproviding patients with a contaminant-free insertion tube for each procedure. The EndoSheathprocedure, which reduces the risk of cross-contamination from the reuse of conventional flexible endoscopes, which are difficult to clean and disinfect.
Industrial Segment
Our industrial segment, through our wholly-owned subsidiary, Machida, Inc., designs, manufactures and markets flexible endoscopes, called borescopes. sells borescopes to a variety of users, primarily in the aircraft engine-manufacturing and aircraft engine-maintenance industries. A borescope is an instrument using optical fibers for the visual inspection of narrow cavities, such as the bore of a gun. Machida's quality line of borescopes includes a number of advanced standard features normally found only in custom designed instruments. The borescopes are constructed in one of three standard body types, each specifically designed to cover a multitude of needs and applications; Slim Lever, Knob Type, and Battery Operated.
Our industrialhealth services segment, also manufactures all the flexible endoscopes marketed through the medical segment. The industrial segment markets are primarily aircraft maintenance, jet engine manufacturing, defense and other specialized industries.
BEST DMS Segment
Our BEST DMS segment,our newly formed wholly-owned subsidiary BEST-DMS, is a service-based segment, providing the Bedside Endoscopic Swallowing Test to nursing homes, rehabilitation centers and assisted living settings via our newly formed wholly-owned subsidiary BEST DMS, Inc.settings.
Sales Distribution—Medical Segment
The end users of our disposable EndoSheaths, flexible endoscopes and related products are otolaryngologists (ear, nose and throat, or ENT, doctors), urologists and gastroenterologists in hospitals, medical clinics and physicians’ offices.
15
Since September 2003 we have been distributing all of our products for the ENT markets in the United States and Canada through Medtronic ENT (“MENT”, or “Medtronic”), under the MENT Agreement. As part of the license and sale of the ENT sheath business to MENT during March 2007, MENT started the manufacturing of the ENT EndoSheaths and also continues to distribute, market and sell our ENT endoscope line worldwide, on a co-branded basis, through MENT’s global sales force.
From December 2004 to May 2006, we distributed all of our urology market products in the U.S.A. and Canada through Medtronic USA, Inc. (the Medtronic Gastroenterology/Urology business, or “MGU”). In May 2006, we terminated our distribution agreement with Medtronic Inc. (the “MGU Agreement”). We decided to explore other forms of distribution for our Slide-On EndoSheath flexible cystoscopy System (“CST”), including utilizing a network of independent sales representatives. This network has continued to expand during FY 08, and we intend to continue its expansion during the 4th quarter of FY 08 and beyond. We will continually assess our progress in this area, and could change our direction if a more efficient sales channel, or better arrangements are identified.
Sales Distribution—Industrial Segment
Our borescopes are sold directly by our Machida subsidiary and through a global network of independent sales representatives.
New Products and Markets
The BEST DMS Acquisition
On October 1, 2007, weVision-Sciences purchased the assets of BESTBest Dysphagia Management, Services, Inc., a Florida-basedFlorida based speech pathology company which specializes in providing what is referred to as the Bedside Endoscopic Swallowing Test (“Best”("BEST") to nursing homes, rehabilitation centers and assisted living settings via our new wholly-owned subsidiary BEST DMS Inc. AtThe purchase price was $1,500, which was comprised of (a) $450 (the "Initial Purchase Price"), paid at the closing, we paidand (b) earn out payments payable over four years, in an aggregate amount not to exceed $1,050, based on certain milestones being met. The Initial Purchase Price of $450 for the assets andhas been allocated the purchase price as follows: $72$135 to fixed assets and $378$315 to Goodwill.intangible assets. This purchase price allocationacquisition will allow Vision-Sciences access to new markets, including the geriatric market, nursing homes and rehabilitation centers, and it is preliminary and subjectexpected to change.
provide a boost to our future growth.
BEST is a comprehensive dysphagia (swallowing) evaluation, performed by a speech-language pathologist clinically privileged to perform endoscopy. Patients may be recommended for a BEST because of symptoms suggesting swallowing problems that may include: congestion; wet-gurgglywet-gurgly or weak voice; fever, pneumonia or chronic bronchitis; chronic weight loss and/or a decreasing desire to eat; coughing and/or choking on meals or medications; and pressure in a patient’spatient's chest during eating or drinking.
The procedure involves inserting an endoscopic tube through the nose and down to the patient’spatient's throat. The test is mildly uncomfortable at most, with patients feeling like they need to clean their nose of an obstruction. Most patientspatients' report that the uncomfortable feeling subsides in 60-90 seconds as the nasal passage adjusts to the endoscope sitting on the floor of the nose. Patients suffering from dementia and Alzheimer’s DiseaseAlzheimer's disease are approached with a special protocol to create a calm and non-threatening environment.
We believe that the benefits of BEST over other types of instrumentation and evaluations include: No limit on the length of time available during the BESTto diagnose dysphagia accurately; patients are tested with the food and liquid that they consume daily; no X-ray exposure or barium coated food substances are involved; patients can be tested in any position, regardless of contracture, posture or cooperation level; full color view of the swallowing structures; and immediate recommendations to enable quick intervention on behalf of the patients.
In a dysfunctional swallow, some aspects of a patient’s ability to coordinate a swallow is interrupted or slowed down because of a medical problem or a combination of conditions. Some common examples include:
·Patient has suffers a CVA (cerebral vascular accident or stroke) with hemiparesis (paralysis on one side of the body);
·A Parkinson’s disease patient suffers from reduced coordination and chronic fatigue;
·A patient with GERD (Gastro Esophageal Reflux Disease) or a Hiatal Hernia, (an abnormal condition in which part of the stomach protrudes upward through the esophagel cleft in the diaphragm, sometimes causing a backflow of acid stomach contents into the esophagus, with or without feeding tube) may be having reflux when the swallow is initiated (food or liquid in essence coming up into the throat while food or liquid is trying to go down to the stomach through the esophagus);
16
·Patients with copious secretions, tracheostomy placement, and/or generalized weakness may also be at added risk because of muscular weakness in swallowing, inability to handle their secretions, and lack of sensitivity in the pharynx; and
·Alzheimer’s or dementia patients may be holding food in the mouth because the swallow is not being stimulated.
BEST DMS is paid directly by the facility where the test is performed. The facilities are reimbursed for the BEST test in a number of different ways, depending on the patient’s type of insurance coverage:
i.For Medicare A customers, under PPS, the full cost of the BEST is paid by the nursing facility that contracts for BEST services. The PPS minutes are counted in the RUG level ( level of care for which the patient qualifies);
ii.For Medicare B customers, the cost of the BEST is reimbursed by Medicare to the facility. There may be a co-pay (usually 20%) for which the patient is responsible, just as in speech therapy services;
iii.For managed care customers, BEST is performed under agreement, and with the approval of the Managed Care Provider. Either the nursing facility contracting for the BEST or the BEST will be reimbursed for the cost of the test; and
iv.For private insurance customers, the BEST is performed with approval from the insurance company and the facility is reimbursed by the private insurer.
Research and Development
During our current fiscal year (FY 08),quarter we continued to develop and designreleased our new family of videoscopes, with a miniature digital camera mounted on the distal end of the insertion tube. This videoscope line includes the ENT-5000 (Ear, Nose and Throat) videoscope, the TNE-5000 (Transnasal Esophagoscopy) videoscopes and our Urology’sUrology's video-based flexible Cystoscope, the CST-5000.
We plan to launch this family of videoscopes duringare continuing the end of our current fiscal year (Q4 08). For the industrial market, we intend to release a new line of video borescopes during towards the enddevelopment of our next fiscal year.
Our videoscopes all include an integrated “built-in” light source, eliminating the need for an external light source and light guide cable. Our videoscopes are believed to be the first in the world that do not contain difficult-to-clean operating channels associated with scopes from other manufacturers. Instead, our scopes are used in combination with our patented, disposable, sterile Slide-On EndoSheath technology which covers the entire scope, and prevents any contact between the patient and the scope’s insertion tube. Our proprietary EndoSheath technology isolates the endoscope from the patient, and contains a disposable operative channel. This prevents instrumentation and patient tissue biopsies from coming in contact with the reusable scope, in contrast to the built-in channelgeneration of conventional scopes from other manufacturers. Our EndoSheath technology eliminates the need for elaborate high-level disinfection between procedures, leading to rapid equipment turnover; reducing capital investment for additional scope inventory; reducing staff exposure to toxic chemicals and dramatically lowering repair and maintenance costs.
The ENT-5000 flexible video laryngoscope is inserted through the nose down to the throat, providing precise, vivid images of the internal structures of the nasal cavity, vocal folds, larynx and other areas of the throat. The TNE-5000 flexible video transnasal esophagoscope allows for visualization and diagnosis further down to the esophagus and the stomach. The CST-5000 flexible video cystoscope provides vivid images of the internal structure of the bladder.
These lightweight videoscopes facilitate diagnostic and therapeutic procedures without general anesthesia or intravenous sedation. During the procedure, the patient’s comfort is enhanced by the scope’s use of the smallest diameter insertion tube known to date. The tip of the insertion tube contains a high resolution , tiny CCD (charge coupled device) based video camera, offering a sharp, high-resolution, vibrant full screen image.
Our new videoscope with the EndoSheath technology is poised to replace existing, pervasive fiber-optic technology. While gastroenterologists have been using costly conventional video endoscopes for years, other specialties were forced to use the old fiber technology due to high conversion costs. This is the first time physicians will have the opportunity to have a videoscope uniquely combined with the practice-efficiency of the EndoSheath Technology.
17
During Q3, as a result of our dispute with Pentax, we started developing our next generation, improved family of medical and industrial fiber scopes. Thisscopes, which will no longer have any Pentax parts. We anticipate that we will be able to have completed the development and the FDA approval process for our new line of fiberscopes scheduled to be released by the end of our nextthis fiscal year (FY ‘09), will no longer use any Pentax supplied parts.year.
We are also working on improving our manufacturing processes, which we believe will result in lower costs to produce our endoscopes and EndoSheaths.
In addition to the above research and development projects, we are at various stages of exploration of opportunities in, and development of products for use in the medical fields of gynecology, pulmonology and gastroenterology, among others.
The MINOS Medical Inc. Investment.
In April 2007, we executed a definitive investment agreement under which we acquired a strategic interest in Minos Medical, Inc. (“Minos”).Minos. Minos is a privately held California-based development-stage medical device company concentrating in the emerging field of N.O.T.E.S. (Natural Orifice Trans-luminal Endoscopic Surgery). N.O.T.E.S. is a new frontier in surgery, focusing on using natural orifices to enter the body to facilitate surgical procedures that require no incisions. We invested $1 million$1,000 in cash and have agreed to expend $165,000$165 in development costs in collaboration with Minos, in order to exploit certain surgical procedures. WeOur investment amounted to 30% of the outstanding shares of Minos, and we accounted for this transaction on our balance sheet as an equity investment.
During FY 08, we wrote off our entire investment balance of $1,000 due to liquidity issues at Minos. Minos is presently in the process of seeking additional sources of funding for development and for sales and marketing of their new products. In that regard, in early June, Minos received from the FDA a 510k clearance for their initial product, the Megachannel™. The Megachannel is a 22mm diameter flexible tube that rides along with a colonoscope to the target site. Once in place it creates a 20mm working channel (or super highway) that allows rapid access beyond the sigmoid colon.
Other Developments
On June 19, 2008 we entered into a Development and Supply Agreement (the "SpineView Agreement"), pursuant to which we are to develop and supply a CCD-based video endoscope to SpineView for use with SpineView's products. SpineView is engaged in the development and manufacture of miniature, minimally invasive, disposable spine surgery Devices that include reusable endoscopes for visualization and image guidance.
N.O.T.E.S. is oneSpineView agreed to pay us $225 for certain non-recurring engineering costs, and to reimburse us for up to $40 of our long term targeted fields,out-of-pocket costs. After the completion of certain milestones and we are actively lookingdelivery of a prototype, SpineView has agreed to place an initial firm order with us for acquiring related technologies and product lines. Our investment in Minos is our50 video endoscopes at a purchase price of $27 per unit (the "Initial Order"), for a total of $1,350. Following delivery of the Initial Order, SpineView shall submit a forecast for the following 12 months, of which the first publicly announced step towards positioning us in the forefront of this new field. N.O.T.E.S. represents the next generation of surgical procedures, going beyond minimally invasive laparoscopic surgery to achieve surgery without incisions. We are confident that Minossix months will be considered a valuable strategic partnerfirm order at a price of $23.5 per video endoscope. Payment for us as we pursue a leading position in the emerging N.O.T.E.S. field.
Other Developments
Earlier in FY 08, an expansion audit was successfully completed in our manufacturing facility in Orangeburg, New York, and we were awarded ISO certification. This certification allowed uscertain of these items is subject to start shipping scopes from our Orangeburg facility, in addition to shipments from our plant in Natick, Massachusetts. This development will improve our productivity and reduce our shipping costs.
In October 2007 we announced that we will consolidate all of our operations into our facility in Orangeburg, New York. As a result of this consolidation, we will be closing our facility in Natick, Massachusetts. We will transition this consolidation in a controlled fashion to prevent any disruption of activities. It is expected that the closing of certain of SpineView's fundraising activities. We are also to be the Natick facility will occur over the next 12 months.exclusive supplier to SpineView of visualization means for use with some future SpineView products.
The initial term of the SpineView Agreement is for four years from the date of delivery of the Initial Order, and will automatically renew for successive one year periods, unless either party gives the other notice of its intention not to renew.
ConsolidatingMr. Lewis C. Pell, the chairman of our facilities will allowboard of directors (our "Board"), is the chairman of the SpineView board of directors and an investor in SpineView. Mr. Ron Hadani, our president and chief executive officer and a member of our Board, and Mr. Katsumi Oneda, a member of our Board, are also investors in SpineView.
Our policy with respect to transactions in which any of our directors or officers may have an interest, requires that such transaction (a) be on terms no less favorable to us to achieve greater efficiencies between our endoscope designthan could be obtained from unaffiliated third parties and manufacturing activities, currently taking place in Orangeburg, NY, and(b) be approved by a majority of the EndoSheath design and manufacturing activities, currently taking place in Natick, MA. This is strategically necessary as we prepare for accelerated growth withuninterested, outside members of the introduction of new products and as we enter new markets. Our Research and Development groups will be also able to work more closely, allowing us to accelerate our ability to bring new products to market.Board.
At a Board meeting held on May 29, 2008, the Board reviewed the terms of the final draft of the SpineView Agreement, outside of the presence of Mr. Pell, Mr. Oneda and Mr. Hadani. The remaining (uninterested) members of our Board determined that the SpineView Agreement was fair, properly
negotiated, and would be at least as favorable to us as could have been obtained from unaffiliated third parties, and accordingly, after discussion, it was approved.
In DecemberMarch of 2007, we completed the sale to Medtronic alsoof certain assets with respect to our ENT EndoSheath business. As part of the transactions, we granted Medtronic an exclusive, royalty-free worldwide license to certain of our Vision-Sciences intellectual property, for use in making and selling EndoSheath products solely within the field of ENT (otorhinolaryngology). Under the terms of the agreement, Medtronic paid us $27,000 at the second installmentclosing, out of the first milestone payment achieved under the Transition Services Agreement with Medtronic. This agreement requires Medtronica total of up to make certain payments$34,000.
Up to us based onan additional $4,000 was scheduled to be paid upon the achievement of certain post-closing milestones related to the transition of manufacturing capability.capability to Medtronic, and an additional $3,000 was scheduled to be paid 15 months after closing, which was received by the end of June 2008.
We have thus far metcompleted the first milestone in December 2007, and were paid $1,000. The second milestone was amended into two separate parts: the first part was completed by March 2008, and we received a partial payment of $750; the second part was completed by this first quarter of FY 09, where we received the remaining balance of $250. As part of this transaction, we transferred our ENT production lines for a totalthe EndoSheath ENT products from our Natick facility to the Medtronic facility in Jacksonville, FL. The remaining milestone is expected to be completed by Q2 09, and the balance of $1,000,000 out of an anticipated total of $4,000,000.$2,000 is expected to be received upon completion.
18As of the end of Q1 09, total payments from Medtronic amounted to $32,000.
Critical Accounting Policies and Estimates
This discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with generally accepted accounting principles (“GAAP”("GAAP") in the United States of America, see the Notes to the Consolidated Financial Statements included elsewhere herein. Certain of our accounting policies require the application of judgment in selecting the appropriate assumptions for calculating financial estimates. By their nature these judgments are subject to an inherent degree of uncertainty. We periodically evaluate the judgments and estimates used for our critical accounting policies to ensure that such judgments and estimates are reasonable for our interim and year-end reporting requirements. These judgments and estimates are based upon our historical experience, current trends and information available from other sources, as appropriate. If different conditions result from those assumptions used in our judgment, the results could be materially different from our estimates. Our critical accounting policies include the following:
Revenue Recognition
We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 104,Revenue Recognition in Financial StatementsStatements. and EITF 00-21, Revenue Arrangements with Multiple Deliverables. These pronouncements require This pronouncement requires that certainfive basic criteria must be met before revenue can be recognized: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred or services were rendered; (3) the fee is fixed and determinable; (4) collectability is reasonably assured. The Company recognizesassured; and (5) the fair value of undelivered elements, if any, exists. Determination of criterion (4) is based on management's judgment regarding the collectability of invoices for products and services delivered to customers. Should changes in conditions cause management to determine this criteria is not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. We recognize revenue when title passes to the customer, generally upon shipment of products.our products F.O.B. shipping point.
Options Issued
Effective April 1, 2006 we began accounting for compensation expense related to stock options in accordance with SFAS No. 123 (Revised 2004)Share-Based Payment (“ ("SFAS 123R”123R"). Prior to April 1, 2006, wethe Company accounted for stock options according to Accounting Principles Board (“APB”("APB") Opinion 25,Accounting for Stock Issued to Employees.
We adopted the modified prospective transition method and consequently have not retroactively adjusted results from prior periods. Under this transition method, compensation cost associated with stock options now includes: (i) amortization related to the remaining unvested portion of all stock options outstanding at March 31, 2006, based on the fair value determined on the grant date in accordance with the original provisions of SFAS 123, and (ii) amortization related to all stock option awards granted subsequent to March 31, 2006, based upon the fair value estimated in accordance with SFAS 123R. The compensation expense for stock-based compensation awards under SFAS 123R is recognized over the vesting period of the options, and includes an estimate for forfeitures.
In accordance with SFAS 123R, the Companywe recorded $200$169 and $137$132 of stock-based compensation expense in the statement of operations for Q3 08Q1 09 and for Q3 07,Q1 08, respectively, in the following expense categories:
|
| Q3 08 |
| Q3 07 |
| ||
Cost of Goods Sold |
| $ | 18 |
| $ | 15 |
|
Selling, General & Administrative |
| 143 |
| 97 |
| ||
Research & Development |
| 39 |
| 25 |
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Total |
| $ | 200 |
| $ | 137 |
|
In accordance with SFAS 123R, we recorded $591 and $381 of stock-based compensation expense in the statement of operations for the nine month period ended December 31, 2007 (“Fiscal Year to Date 08”or “YTD 08”) and for the nine month period ended December 31, 2006 (“Fiscal Year to Date 07”or “YTD 07”), in the following expense categories:
|
| YTD 08 |
| YTD 07 |
| ||
Cost of Goods Sold |
| $ | 48 |
| $ | 45 |
|
Selling, General & Administrative |
| 438 |
| 288 |
| ||
Research & Development |
| 105 |
| 48 |
| ||
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| ||
Total |
| $ | 591 |
| $ | 381 |
|
| Three Months Ended June 30, | ||||||
---|---|---|---|---|---|---|---|
| 2008 | 2007 | |||||
Cost of Goods Sold | $ | 13 | $ | 13 | |||
Selling, General and Administrative | 117 | 102 | |||||
Research and Development | 39 | 17 | |||||
Total | $ | 169 | $ | 132 | |||
At December 31, 2007,June 30, 2008, the total unamortized stock-based compensation is approximately $1,458.$1,902. We will expense that amount over periods ending through June 30, 2013. We do not expect to realize any tax benefits from future disqualifying dispositions, if any, due to its policy of recording valuation allowances equal to its deferred tax asset.
19
In the ninethree months ended December 31, 2007,June 30, 2008, we granted options to purchase a total of 1,846,250294,000 shares of our Common Stock. A total of 426,750290,000 of these options were granted from our 2000 Stock Incentive Plan (the “2000 Plan”), 1,403,500 of these options were granted from the our 2007 Stock Incentive Plan (the “2007 Plan”"2007 Plan") and 16,0004,000 of these options were granted from our 2003 Directors Stock Option Plan (the “2003"2003 Directors Plan”Plan"). The fair value of these options measured at the option grant date was approximately $1,458,$982, determined using the Black-Scholes option-pricing model. This amount is reduced by an estimated forfeiture rate and is being recorded as an expense over the vesting period. The assumptions used in the Black-Scholes option-pricing model in the period by the Company were as follows:
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| June 30, 2008 | |||
---|---|---|---|---|
Risk-free interest rate | 3.55 | % | ||
Expected dividend yield | — | |||
Expected life | 6.25 years | |||
Expected volatility | 74 | % | ||
Weighted average value grant per share | $ | 3.34 |
We account for options issued to directors, non-employees and employees in accordance with the provisions of SFAS 123R. We grant options with vesting periods ranging from immediate to six years. We use the simplified method of calculating the expected option term, which averages an award’saward's weighted average vesting period and its contractual term. The contractual term of our options is ten years. The risk-free rate is based upon the daily Treasurytreasury yield curve for a period approximately equal to the expected option term. We used historical data to estimate the expected price volatility and forfeiture rate. The expected dividend yield is 0%, based on our history of not paying dividends.
Income Taxes
Under ourThe Company accounts for income taxes under the liability method, and deferred tax policy, we recordassets or liabilities are computed based on the estimated future tax effects of temporary differences between the financial statement and income tax basesbasis of assets and liabilities and amountsas measured by the enacted tax rates. We have recorded in the accompanying consolidated balance sheets, as well as operating losses and tax credit carry-forwards. The evaluation of the recoverability of any tax assets recorded on the balance sheet is subjecta valuation allowance equal to significant judgment. We provided valuation allowances for all ourits net deferred tax assetsasset due to date. During Q2 08, we recorded a recoverythe uncertainty of income taxes inrealizing the amountbenefit of $180, in anticipation of filing a certain state annual return during the last quarter of our FY 08. We have now filed our tax returns for all jurisdictions, and we have recorded the following adjustments: (i) We reversed the above mentioned tax recovery and booked a total of $188 in tax liability; (ii) we booked an additional $31 tax liability for other state jurisdictions; (iii) for federal taxes, we recorded a recovery of income tax of $39. Total net change to our valuation allowance is $180. These tax liabilities stem from our FY 07 net income of $20 million, resulting from our sale of certain assets to Medtronic.this asset.
20
Results of Operations
Net Sales
Three-month periodThree-months ended December 31, 2007June 30, 2008 (Q1 09) compared to the Three-month periodThree-months ended December 31, 2006June 30, 2007 (Q1 08) in (000’s)(000's)
Net sales for the three months ended December 31, 2007, (“Q3 08”),Q1 09 were $2,019, a decrease$2,929, an increase of $197,$499, or (9)%21%, compared to the three-month period ended December 31, 2006 (“Q3 07”).sales of $2,430 for Q1 08. During Q3 08,Q1 09 net sales of the medical segment decreasedincreased by $289,$168, or 19%9%, from $1,832 to $1,246,$2,000, and net sales of the industrial segment decreasedincreased by $83,$98, or 12%16%, from $598 to $598.$696. Sales of our new health services segment BEST, contributed $175.$233 to our Q1 09 sales.
Sales by segment and category in Q3Q1 09 and Q1 08 and Q3 07 were as follows:
Segment: | Q1 09 | Q1 08 | Increase/ (Decrease) | Percentage | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Medical | ||||||||||||||
Scopes | $ | 1,177 | $ | 656 | $ | 521 | 79 | % | ||||||
EndoSheaths | 216 | 681 | (465 | ) | (68 | )% | ||||||||
Repairs | 499 | 406 | 93 | 23 | % | |||||||||
Peripherals and Accessories | 108 | 89 | 19 | 21 | % | |||||||||
Total Medical | $ | 2,000 | $ | 1,832 | $ | 168 | 9 | % | ||||||
Industrial | ||||||||||||||
Borescopes and Accessories | $ | 459 | $ | 395 | $ | 64 | 16 | % | ||||||
Repairs | 237 | 203 | 34 | 17 | % | |||||||||
Total Industrial | $ | 696 | $ | 598 | $ | 98 | 16 | % | ||||||
Helth Services | ||||||||||||||
Total Health Services | $ | 233 | $ | — | $ | 233 | 100 | % | ||||||
Total Sales | $ | 2,929 | $ | 2,430 | $ | 499 | 21 | % | ||||||
Category |
| Q3 08 |
| Q3 07 |
| Increase |
| Percent |
| |||
Scopes |
| $ | 456 |
| $ | 417 |
| $ | 39 |
| 9 | % |
Sheaths |
| 488 |
| 930 |
| (442 | ) | (48 | )% | |||
Repairs, Peripherals and Accessories |
| 302 |
| 188 |
| 114 |
| 61 | % | |||
Total Medical |
| 1,246 |
| 1,535 |
| (289 | ) | (19 | )% | |||
|
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| |||
Scopes |
| 423 |
| 467 |
| (44 | ) | (9 | )% | |||
Repairs, Peripherals and Accessories |
| 175 |
| 214 |
| (39 | ) | (18 | )% | |||
Total Industrial |
| 598 |
| 681 |
| (83 | ) | (12 | )% | |||
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BEST Services |
| 175 |
| — |
| 175 |
| — |
| |||
Total Best |
| 175 |
| — |
| 175 |
| — |
| |||
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| |||
Total Sales |
| $ | 2,019 |
| $ | 2,216 |
| $ | (197 | ) | (9 | )% |
Medical Sales—Scope Products
Net Sales to the medical scope market include products used for the ENT (including TNE), Urology and Urologyother customers, were as follows:
Medical Scope Market | Q1 09 | Q1 08 | Increase | Percentage | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
ENT and TNE | $ | 690 | $ | 432 | $ | 258 | 60 | % | ||||||
Urology and Other | 487 | 224 | 263 | 117 | % | |||||||||
Total Scopes | $ | 1,177 | $ | 656 | $ | 521 | 79 | % | ||||||
Scope Market |
| Q3 08 |
| Q3 07 |
| Increase |
| Percent |
| |||
ENT and TNE |
| $ | 311 |
| $ | 371 |
| $ | (60 | ) | (16 | )% |
Urology and Other |
| 145 |
| 46 |
| 99 |
| 215 | % | |||
|
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Total Scope |
| $ | 456 |
| $ | 417 |
| $ | 39 |
| 9 | % |
Overall scopeendoscope sales increased by $521, or 79%, from $417$656 to $456$1,177, mainly due to more than doubling our sales to the Urology market. The increase was offsetSales in our Urology and Other customers increased by a reduction of 16%$263, or 117%, from $224 in Q1 08 to $487 in Q1 09. In Q1 09, our ENT scope sales resultingincreased by $258, or 60%, from a shortage of parts from Pentax. During$432 to $690, compared to Q1 08. The increase in our scope sale this quarter has partially benefited from the introduction of our dispute with Pentax, (which was settled on February 12, 2008 – please refer to “Item 1. Legal Proceedings” in Part II-Other Information), resulted in a temporary shortagevideoscope family of parts for the manufacturing and repair of fiberscopes. Based on in-house orders atproducts towards the end of Q3 08, we calculated that in this quarter, because of the Pentax Dispute we lost revenues for scopes and accessories totaling $756, and repair orders for a total of $26.quarter.
Our ENT scopes are marketed and distributed globally by MENT. As a result of our exclusive ENT distribution agreement with MENT, the success of our ENT endoscope lines depends substantially upon the success of the marketing and sales activities of MENT, over which we have limited control.
21
Medical Sales—EndoSheath Products
Net Sales of EndoSheaths include products used for theour ENT (including TNE) and Urology customers as follows:
Products |
| Q3 08 |
| Q3 07 |
| Increase |
| Percent |
| |||
ENT and TNE |
| $ | 343 |
| $ | 884 |
| $ | (541 | ) | (61 | )% |
Urology and Other |
| 145 |
| 46 |
| 99 |
| 215 | % | |||
|
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|
|
|
|
|
| |||
Total Sheaths |
| $ | 488 |
| $ | 930 |
| $ | (442 | ) | (48 | )% |
Products | Q1 09 | Q1 08 | (Decrease)/ Increase | Percentage | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
ENT and TNE | $ | 5 | $ | 600 | $ | (595 | ) | (99 | )% | |||||
Urology and Other | 211 | 81 | 130 | 160 | % | |||||||||
Total EndoSheaths | $ | 216 | $ | 681 | $ | (465 | ) | (68 | )% | |||||
Sales of our ENT sheaths& TNE EndoSheaths decreased by $595, or 99% in Q3 08,Q1 09, compared to Q3 07,Q1 08, as MENT decreasedMedtronic ceased its purchases from us, as of December 2007. This is a result of commencing its own manufacturing of certain ENT sheaths as part of and in accordance with the Medtronic Transition Agreement of March 26, 2007. As of December 2007, MENT ceased its orders of ENT Sheaths from us.
The increase in sales of Urology and Other sheaths reflects our continued focus on this part of the medical segment. In May 2006, we terminated the MGU Agreement. We decided$130, or 160%, from $81 in Q1 08 to explore other forms of distribution for our Slide-On EndoSheath flexible cystoscopy System, including utilizing a network of independent sales representatives. This network has continued to expand during FY 08, and we will continue to expand it during the fourth quarter of FY 08 and beyond. Although current performance reflects an increase$211 in sales asQ1 09 is a result of these efforts, we will continually assess our progress in this area,additional scopes sales and could abandon our efforts if they do not prove to be successful.
re-orders from existing users.
We believe the CSTCystoscopy EndoSheath System can significantly enhance the practice efficiency of urologists by allowing them to avoid the tedious and time-consuming reprocessing of conventional cystoscopes, and presents the significant benefit of a sterile insertion tube for each patient.
Medical Sales—Repairs, Peripherals and Accessories
SalesRevenue from repairs together with sales of peripheralperipherals and accessory productsaccessories increased in Q3 08,Q1 09 by $112, or 23%, from $495 to $607, as compared to Q3 07, dueQ1 08. This increase is primarily related to the higher demand for our medical scopes.
Industrial Segment
The decrease in netNet sales of the industrial segment was dueincreased $98, or 16%, from $598 in Q1 08 to lower demand$696 in the market for new fiberscopes and repairs to fiberscopes.
Nine-month period ended December 31, 2007Q1 09. Although sales grew this quarter as compared to the Nine-month periodsame quarter last year, future sales in this segment may be negatively impacted by the slowdown in purchases from the airline industry.
Gross Profit
Three-months ended December 31, 2006 in (000’s)
Net sales for the nine months ended December 31, 2007 (“YTD 08”), were $7,577, an increase of $1,063, or 16%,June 30, 2008 (Q1 09) compared to the nine month periodThree-months ended December 31, 2006 (“YTD 07”). During YTD 08, net sales of medical segment increased by $1,149, or 26%, to $5,623; net sales of the industrial segment decreased by $261, or 13%, to $1,779. Net sales of the new BEST segment contributed $175. Sales by segment and category during YTD 08 and YTD 07 were as follows:
Category |
| YTD 08 |
| YTD 07 |
| Increase |
| Percent |
| |||
Scopes |
| $ | 2,454 |
| $ | 1,070 |
| $ | 1,384 |
| 129 | % |
Sheaths |
| 2,007 |
| 2,788 |
| (781 | ) | (28 | )% | |||
|
|
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|
|
|
|
|
|
| |||
Repairs, Peripherals and Accessories |
| 1,162 |
| 616 |
| 546 |
| 89 | % | |||
Total Medical |
| 5,623 |
| 4,474 |
| 1,149 |
| 26 | % | |||
|
|
|
|
|
|
|
|
|
| |||
Scopes |
| 1,151 |
| 1,152 |
| (1 | ) | (0 | )% | |||
Repairs, Peripherals and Accessories |
| 628 |
| 888 |
| (260 | ) | (29 | )% | |||
Total Industrial |
| 1,779 |
| 2,040 |
| (261 | ) | (13 | )% | |||
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| |||
BEST Services |
| 175 |
| — |
| 175 |
| — |
| |||
Total Best |
| 175 |
| — |
| 175 |
| — |
| |||
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|
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| |||
Total Sales |
| $ | 7,577 |
| $ | 6,514 |
| $ | 1,063 |
| 16 | % |
22
Medical Sales—Scope Products
Net sales to the medical scope market include products for ENT/ TNE and Urology customers as follows:
Scope Market |
| YTD 08 |
| YTD 07 |
| Increase |
| Percent |
| |||
ENT and TNE |
| $ | 2,071 |
| $ | 916 |
| $ | 1,155 |
| 126 | % |
Urology and Other |
| 383 |
| 154 |
| 229 |
| 149 | % | |||
|
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|
|
|
|
|
| |||
Total Scope |
| $ | 2,454 |
| $ | 1,070 |
| $ | 1,384 |
| 129 | % |
The primary reasons for the riseJune 30, 2007 (Q1 08) in sales of products to the medical scope market were (i) an increase in orders (earlier in this fiscal year) from our exclusive distributor for ENT products, MENT, and (ii) the increase of sales of Cystoscopes as a result of the growth of our sales force. We previously sold our ENT products to the international markets through our own network of independent foreign distributors. As of Q1 08, we sell all our ENT products for the domestic and international markets through MENT, our global ENT scope distributor.
As a result of our exclusive ENT distribution agreement with MENT, the success of our ENT endoscope lines is substantially dependent upon the success of the marketing and sales activities of MENT, over which we have limited control.
During this quarter, our dispute with Pentax, (which was settled on February 12, 2008 - please refer to “Item 1. Legal Proceedings” in Part II- Other Information, resulted in a temporary shortage of parts for the manufacturing and repair of fiberscopes. Based on in-house orders at the end of Q3 08, we calculated that in this quarter, because of the Pentax dispute we lost revenues for scopes and accessories totaling $756, and repair orders for a total of $26.
Medical Sales—EndoSheath Product
Net Sales of EndoSheaths include products used for the ENT (including TNE) and Urology customers as follows:
Products |
| YTD 08 |
| YTD 07 |
| Increase |
| Percent |
| |||
ENT and TNE |
| $ | 1,624 |
| $ | 2,634 |
| $ | (1,010 | ) | (38 | )% |
Urology and Other |
| 383 |
| 154 |
| 229 |
| 149 | % | |||
|
|
|
|
|
|
|
|
|
| |||
Total Sheaths |
| $ | 2,007 |
| $ | 2,788 |
| $ | (781 | ) | (28 | )% |
Sales of our ENT Sheath decreased in the first 9 months of FY 08 vs. FY 07, by $1,010, or 38%, as MENT decreased its purchases from us, as a result of commencing its own manufacturing of certain ENT sheaths as part of the Medtronic Transition Agreement of March 26, 2007. As of December 2007, MENT ceased its orders of ENT Sheaths from us.
The increase in sales of Urology EndoSheath products, by $229, or 149% reflects our focus on this medical segment. In May 2006, we terminated the MGU Agreement with Medtronic, Inc. We decided to explore other forms of distribution for our Slide-On EndoSheath flexible cystoscopy System, the CST-2000 and the CST-2000A, including utilizing a network of independent sales representatives. Although this network has continued to expand during FY 08 we believe it will take an additional 9 to 12 months to complete the build up of an effective independent sales representative network. Although current performance reflects an increase in sales as a result of these efforts, we will continually assess our progress in this area, and could abandon our efforts if they do not prove to be successful during that time frame.
We believe the CST EndoSheath System can significantly enhance the practice efficiency of urologists by allowing them to avoid the tedious and time-consuming reprocessing of conventional cystoscopes, and presents the significant benefit of a sterile insertion tube for each patient. Use of our CST cystoscope with the Slide-On EndoSheath sterile, single-use cover, also avoids the need to reprocess endoscopes with harsh chemicals, one of which has been contraindicated for use on patients with bladder cancer.
Medical Sales—Repairs, Peripherals and Accessories
Sales of peripheral and accessory products increased in Q3 08, compared to Q3 07, is directly correlated to the higher demand for our medical scopes
23
Industrial Segment
The decrease in net sales of the industrial segment was due to lower demand in the market for new borescopes and repair services.
Gross Profit(000's)
Three-month period ended December 31, 2007 compared to the Three-month period ended December 31, 2006
Gross profit was $515of $703 in Q3 08, an increase of $222,Q1 09 decreased by $240 compared to gross profit of $943 in Q3 07.Q1 08. For thisthe current quarter, gross profit was $492, $171 and $40 for the medical, segment was a loss of $150, Industrial segment contributed $597industrial and BEST contributed $68. Grosshealth services segments, respectively. Our gross profit as percenta percentage of net sales was 25%24% in Q1 09, vs. 39% in Q1 08. The decrease in gross profit is mainly attributable to startup costs of our videoscope line of products, offset by the addition of the health services segment which started in Q3 08 vs. 13% in Q3 07. 08.
Operating Expenses
Nine-month periodThree-months ended December 31, 2007June 30, 2008 (Q1 09) compared to the Nine-month periodThree-months ended December 31, 2006June 30, 2007 (Q1 08) in (000's)
Gross profit was $2,335 in YTD 08, an increase of $1,157 compared to gross profit in YTD 07. Gross profit increased by approximately $1,149 in the medical segment primarily as a result of production efficiencies that were accomplished with increased production, and decreased by approximately $60 in the industrial segment due to lower sales. BEST contributed $68. Gross profit as a percent of net sales was 31% in YTD 08 vs. 18% in YTD 07.
Operating Expenses
Three-month period ended December 31, 2007 compared to the Three-month period ended December 31, 2006
Selling, General and Administrative Expenses
Selling, general and administrative (“("SG&A”&A") expenses in Q3 08Q1 09 were $1,980,$2,919, an increase of $771,$1,172, or 64%67%, compared to Q3 07.SG&A expense of $1,747 in Q1 08. This increase resultedin SG&A expense is primarily from higher spendingincreases of $658 in sales and marketing expenses due to more trade shows attended
and videoscope demo equipment for personnel, including salaries and stock-based compensation, of approximately $143, $85outside sales reps, as well as $228 in legalSG&A expenses related to the Pentax dispute and $122in Q1 09 from the BEST segment.Health Services segment which we did not have in Q1 08. The increased level of expense reflects our commitment to establish the company’sCompany's infrastructure to support our projected future accelerated growth.
Research and Development Expenses
Research and development (“("R&D”&D") expenses in Q3 08Q1 09 were $650,$1,171, an increase of $136,$336, or 26%40%, as compared to Q3 07.expenses of $835 in Q1 08. This increase resulted primarily from additional spending for materials, a feasibility study on a potential new product, and on additional personnel developing our new lines of videoscope and EndoSheath products. We expect R&D expenses will continue to increase in FY 08,09 compared to FY 07,08, as we are developing a new family of fiberscopes to replace our current fiberscopes, and continue working on the videoscopes as well as other new products.
Loss from Operations
Nine-month periodThree-months ended December 31, 2007June 30, 2008 (Q1 09) compared to the Nine-month periodThree-months ended DecemberJune 30, 20062007 (Q1 08) in (000's)
Selling, General and Administrative Expenses
SG&A expenses for YTD 08 were $5,729, as compared to $3,473 YTD 07, an increase of $2,256, or 65%. The increase resulted primarily from higher spending for personnel, including salaries and stock-based compensation, of approximately $438. Personnel expenses growth were mainly for the addition of new sales and marketing personnel to support and grow our network of independent sales representatives, and the introduction process of our new family of videoscopes. In addition, we had higher spending on product promotion and travel related to our medical products of approximately $225, and higher expenses for professional fees of approximately $150. The increased level of expense reflects our commitment to build —up the Company’s infrastructure to support our future growth. BEST SG&A were $122.
Research and Development Expenses
R&D expenses for YTD 08 were $2,610, as compared to $1,725 in YTD 07, an increase of $885, or 51%. This increase resulted primarily from additional spending for materials and personnel developing our new lines of videoscope and EndoSheath products. We expect R&D expenses will continue to increase in FY 08, compared to FY 07, as we increase
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our efforts to develop this new family of videoscopes, a new family of fiberscopes to replace our current line of products, as well as other new products.
Loss from Operations
Three-month period ended December 31, 2007 compared to the Three-month period ended December 31, 2006
(Loss) income from operations by segment was as follows ($000’s):follows:
Segment |
| Q3 08 |
| Q3 07 |
| Change |
| |||
Medical |
| $ | (2,530 | ) | $ | (1,116 | ) | $ | (1,414 | ) |
Industrial |
| 470 |
| (314 | ) | 784 |
| |||
BEST |
| (54 | ) | — |
| (54 | ) | |||
|
|
|
|
|
|
|
| |||
Total |
| $ | (2,114 | ) | $ | (1,430 | ) | $ | (684 | ) |
Segment | Q1 09 | Q1 08 | Change | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Medical | $ | (3,199 | ) | $ | (1,654 | ) | $ | (1,545 | ) | |
Industrial | (42 | ) | 15 | (57 | ) | |||||
Health Services | (188 | ) | — | (188 | ) | |||||
Total | $ | (3,429 | ) | $ | (1,639 | ) | $ | (1,790 | ) | |
In the medical segment, the improved gross profit was offset by the higher spendingincreased loss from operations is primarily due to (i) an increase in our COGS, mainly due to startup costs of production for our new videoscope line of products; (ii) increases in our SG&A and R&D expenses, as discussed above; and (iii) and an additional $28 in restructuring charges resulting in increasedfrom severance and other termination expenses due to the closing of our Natick, MA facility and relocation to Orangeburg, NY. Our total loss from operations for Q3 08. In the industrial segment, the higher gross profit was the primary cause for the increase in profit in Q3 08. The BEST segment increasedhad an additional expense of $188 from our loss by $54.newly added health services segment.
Nine-month period ended December 31, 2007 compared to the Nine-month period ended December 31, 2006
(Loss) income from operations by segment was as follows ($000’s):
Segment |
| YTD 08 |
| YTD 07 |
| Change |
| |||
Medical |
| $ | (6,437 | ) | $ | (3,449 | ) | $ | (2,988 | ) |
Industrial |
| 487 |
| (571 | ) | 1,058 |
| |||
BEST |
| (54 | ) | — |
| (54 | ) | |||
|
|
|
|
|
|
|
| |||
Total |
| $ | (6,004 | ) | $ | (4,020 | ) | $ | (1,984 | ) |
In the medical segment, the reduction in gross margin and higher spending for SG&A and R&D, resulted in the increased loss from operations for YTD 08. In the industrial segment, the higher gross profit was the primary cause for the increases in profit in YTD 08. The BEST segment increased our loss by $54.
Liquidity and Capital Resources
At December 31, 2007,June 30, 2008 our principal source of liquidity was working capital of approximately $24.0 million,$21,232, including $20.2 million$16,663 in cash and short term investments.
During Q1 09 we purchased $11,167 and sold $5,835 of short term investments for a net investment of $5,332. Net cash used in operating activities of $5,486 included (i) an increase of $1,621 in inventory, mainly for parts related to the new videoscope production; (ii) an increase of $930 in accounts receivable, mainly due to higher sales volume during the end of the quarter; (iii) the cashless exercise of warrants in the amount $870,370 which we did not have last year and (iv) a decrease in accounts payable and accrued expenses of $874. In addition, we recorded $3,230 in net proceeds from the sale of a certain product line to Medtronic.
Our cash and cash equivalents decreased by approximately $28.5 million$7,408 in the nine months ended December 31, 2007,Q1 09 as compared to a decrease of $13,898 in Q1 08. The Q1 09 decrease is due primarily to cash used for investing activities of approximately $22.3 million (including a $20.2 millionthe purchase of short term investments and $1 million investment in MINOS); cash used for operations of approximately $6.3 million (including $0.45 million for the BEST DMS acquisition).investments.
We expect that our current balance of cash and short term investments will be sufficient to fund our operations for at least the next twelve months.
In April 2007, we executed a definitive investment agreement under which we acquired a strategic interest in Minos Medical, Inc. (“Minos”). Minos is a privately held California based development stage medical device company concentrating in the emerging field of N.O.T.E.S. (Natural Orifice Trans-luminal Endoscopy Surgery). N.O.T.E.S. is a new frontier in surgery, focusing on using natural orifices to enter the body to facilitate surgical procedures that require no incisions. We invested $1 million in cash and have agreed to expend $165,000 in development costs in collaboration with Minos, in order to exploit certain surgical procedures. We accounted for this transaction on our Balance Sheet as an Equity Investment.
On January, 18, 2008, we entered into a $10.0 million$10,000 revolving line of credit agreement with Merrill Lynch Bank USA (the “Bank”"Bank"), pursuant to the terms of a Merrill Lynch Loan Management Account Agreement (the “Loan Agreement”"Loan Agreement"). The Loan Agreement permits us to borrow funds from the Bank from time-to-time at fixed, variable or term rates. The current rate for our borrowing is set at LIBOR plus 1.75%. Any outstanding amounts for variable rate borrowings may be repaid at our option at any time without penalty or premium. If we repay a fixed advance or term advance prior to its
25
scheduled repayment date, we may be required to pay a breakage fee to the Bank. The amount of advances available under the Loan Agreement varies from time to time and is based on the value of, and secured by, the securities we maintain with Merrill Lynch, Pierce, Fenner & Smith Incorporated. Under the Loan Agreement, the Bank has the right to demand repayment, in whole or in part, at any time, of any outstanding amounts. As of today,June 30, 2008, we have not requested any advances under the Loan Agreement.
We have incurred losses since our inception, and losses are expected to continue at least during FY 08.09. We have funded the losses principally with theproceeds from operations, proceeds from public and private equity financings, and the sale of certain assets topayments from Medtronic.
WeDuring FY 09, we expect total spending for property and equipment to be approximately $1.5 million$2,500, including approximately $1,600 for FY 08.
renovation of our new facility in Orangeburg, NY.
We conduct our operations in certain leased facilities. These leases expire on various dates through August 31, 2010.2013. In addition, we have operating leases for certain office equipment. At December 31, 2007,June 30, 2008, the minimum lease and rent commitments are as follows:
Fiscal Year | | |||
---|---|---|---|---|
2009 | $ | 550 | ||
2010 | 786 | |||
2011 | 593 | |||
2012 | 476 | |||
2013 | 269 | |||
$ | 2,674 | |||
Notes to the lease commitments table:
Fiscal Year |
| Commitments |
| |
2008 |
| $ | 154 |
|
2009 |
| 749 |
| |
2010 |
| 346 |
| |
2011 |
| 120 |
| |
|
|
|
| |
Total |
| $ | 1,369 |
|
We have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Recently Issued Accounting Standards
In July 2006,On April 1, 2008, we adopted the provisions of Financial Accounting Standards Board (“FASB”) issued FIN 48, Accounting for Uncertainty in Income Taxes-an Interpretation of FASB(FASB) Statement No. 109, which seeks to reduce the significant diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. It also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. Upon adoption, the cumulative effect of any changes in net assets resulting from the application of FIN 48 will be recorded as an adjustment to retained earnings. We adopted FIN 48 effective April 1, 2007, and the adoption of FIN 48 did not have a material impact on our results of operations, financial position or cash flow.159,
In February 2007, the FASB issued SFAS No. 159 (SFAS 159), The Fair Value Option for Financial Assets and Financial Liabilities, includingLiabilities. This Statement
allows companies the option to measure eligible financial instruments at fair value. Such election, which may be applied on an instrument by instrument basis, is typically irrevocable once elected. We have elected not to apply the fair value option to any of our financial instruments except for those expressly required by U.S. GAAP.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 115. 133" ("SFAS 159 permits entities to choose to measure many161"), which requires additional disclosures about the objectives of using derivative instruments, the method by which the derivative instruments and related hedged items are accounted for under FASB Statement No. 133 and its related interpretations, and the effect of derivative instruments and related hedged items on financial position, financial performance, and cash flows. SFAS 161 also requires disclosure of the fair values of derivative instruments at fair value that are not currently required to be measured at fair value. It also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assetstheir gains and liabilities.losses in a tabular format. SFAS 159161 is effective for ourfinancial statements issued for fiscal yearyears and interim periods beginning after November 15, 2007. Adoption2008 (which for our company it would be on April 1, 2009, our Fiscal 2010), with early adoption encouraged. We are currently assessing the impact that the adoption of thisSFAS 161 will have on its financial statement is not expected to have a material impact on our financial statements or results of operations.
disclosures.
In December 2007 the FASB issued SFASStatement No. 141(R),Business Combinations Combinations—a replacement of FASB Statement No. 141. This Statement significantly changes the principles and SFASrequirements for how an acquisition is recognized and measured in a company's financial statements including the identifiable assets acquired and the liabilities assumed. This Statement also provides guidance for recognizing and measuring goodwill acquired in a business combination and required disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This Statement is effective prospectively, except for certain retrospective adjustments to deferred income tax balances, for the Company beginning on January 1, 2009. The Company has not yet determined the impact, if any, the adoption of this Statement will have on the financial position of the Company.
In 2007 the FASB issued Statement No. 160,, Accounting and Reporting of Noncontrolling InterestInterests in Consolidated Financial Statements,an amendment of ARB No. 5151.. These new standards will This Statement significantly changechanges the financial accounting for and reporting of business combination transactions and noncontrolling (minority)(or minority) interests of a subsidiary in consolidated financial statements. SFAS Nos. 141(R) and 160 are required toFor our Company it would be adopted simultaneously and are effective for the first annual reporting periodprospectively beginning on or after December 15, 2008. Thus, we are required to adopt these Standards on AprilJanuary 1, 2009. Earlier adoption is prohibited. We are currently evaluatinghave not yet determined the impact, if any, the adoption of adopting SFAS Nos. 141(R) and SFAS 160this Statement will have on our consolidatedthe financial statements.position of the Company.
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, we are subject to the risks associated with fluctuations in interest ratesQuantitative and changes in foreign currency exchange rates.
Interest andQualitative Disclosures About Market Risk
We currently invest our excess cashare a smaller reporting company, as defined in a money market account at our bank. We haveRule 12b-2 of the Exchange Act and are not used derivative financial instruments in our investment portfolio. We attemptrequired to limit our exposure to interest rate and credit riskprovide the information required by placing our investments with high-quality financial institutions and have established investment guidelines relative to diversification and maturities designed to maintain safety and liquidity.
Investments in both fixed-rate and floating-rate interest earning instruments carry a degree of interest rate risk. Fixed-rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating-rate securities may produce less income than expected if interest rates decline. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates, or we may suffer losses in principal if forced to sell securities which have seen a decline in market value due to changes in interest rates.
Our Loan Agreement with Merrill Lynch Bank USA described above permits us to borrow funds from the Bank from time-to-time at fixed, variable or term rates. The current rate for our borrowing is set at LIBOR plus 1.75%. If interest rates rise unexpectedly, interest we owe on amounts outstanding under the Loan Agreement will increase. As of today, we have not requested any advances under the Loan Agreement.
Foreign Currency Exchange
We face exposure, due to purchases of raw materials from foreign suppliers, to adverse movements in the value of certain foreign currencies. This exposure may change over time, and could have an adverse effect on our financial results. We may attempt to limit this exposure by purchasing forward contracts, as required. Currently we do not have forward contracts. Most of our foreign exchange liabilities are settled within 90 days of receipt of materials. As of December 31, 2007, our liabilities related to foreign currency were not material.item.
Item 4. CONTROLS AND PROCEDURESControls and Procedures
Evaluation of Disclosure Controls and Procedures.
We are a smaller reporting company, as defined in Rule 12b-2 of the Exchange Act and are not required to provide the information required by this item.
Item 4T. Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports are recorded, processed, summarized and reported within the time periods specified in the SEC’sSEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the
definition of “disclosure"disclosure controls and procedures”procedures" in Rule 13a-15(e). In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
We carried out an evaluation,have evaluated, under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2007.June 30, 2008. Based upon the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at that dateas of June 30, 2008 due to a material weakness relating to a lack of adequate resources within the accounting and finance department, resulting primarily from our newly-hired controller resigned on very short notice to pursue an opportunity closer to his home.department. The effect of the lack of resources has resulted in certain reviews of financial information not being performed on a timely basis or at all, leading to adjustments being made after the books and records are closed. The term “material weakness” meanswere closed and reduced resources to complete the Company's review and preparation of this Quarterly Report on Form 10-Q to permit its filing within the prescribed time frame. In March 2008 we retained a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. To correct this material weakness wenew controller, and since then have added two additional senior accountants, and retained an outside certified public accountant on a consulting basis, and we initiated an employment search processhave one more position to fill several new staff positions.in order to be adequately staffed.
Changes in Internal Controls Over Financial Reporting
Except as provided in the prior paragraphs, thereThere have been no changes in our internal controls over financial reporting during the quarter ended December 31, 2007June 30, 2008 that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.
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Item 1. LEGAL PROCEEDINGSLegal Proceedings
On November 15, 2007, Pentax Corporation (“Pentax”), our sole supplier of certain critical components for our line of fiberscopes informed us that it intended to significantly increase the price and limit the quantities of certain components it supplied to us. We require these components to produce our three models of ENT fiberscopes, our two models of TNE fiberscope, our fiber Cystoscope for the medical segment and some of our borescopes for the industrial segment. Pentax, a competitor of ours and a beneficial owner of approximately 5.0% of our Common Stock, unilaterally took these actions. We concluded that as a result of Pentax’s actions, we would not receive sufficient quantities of components required for the production of these products through at least the third quarter of this fiscal year, which ended on December 31, 2007.
None
Pentax has been supplying us with these components pursuant to a Supply Agreement dated March 16, 1992, as amended on October 1, 2002. This agreement has been automatically and continuously renewed since it was executed, and was due to expire on March 2009. Pentax does not supply, nor does this have any effect on our ability to produce our other products, including our recently introduced family of advanced videoscopes.
On December 3, 2007, we filed an Arbitration Demand with the International Center for Dispute Resolution of the American Arbitration Association in New York City. As a result of this demand for arbitration, negotiations commenced with Pentax to resolve this dispute. Our goal is to have Pentax supply us with components in the quantities and prices that are necessary to meet our needs based on our forecast for new orders and for repairs. During this period we will seek to develop our next generation line of fiberscopes, and obtain FDA clearance. Since we are still negotiating with Pentax, we are unable at this point to quantify the impact on our revenues and results of operations.
On February 12, 2008, we reached a satisfactory arrangement for the transition of our supply relationship with Pentax. Under the terms of the agreement entered into with Pentax, we resolved our pending disputes and agreed to dismiss all related legal proceedings, over pricing, volumes and delivery schedules for the components supplied by Pentax. The agreement modified the terms of our Supply Agreement with Pentax, dated March 16, 1992, as amended, by, among other things (i) moving forward the termination date of the supply relationship to February 28, 2009 from March 15, 2009, and (ii) providing an agreed upon purchase order and delivery schedule of components from Pentax through February 28, 2009.
We expect that the agreement reached with Pentax will enable us to meet our estimated production requirements for fiberscopes over the next twelve months, and will give us sufficient time to secure alternative manufacturing, or supply arrangements with respect to the components supplied by Pentax, to meet our expected future production requirements for fiberscopes. Our Q4 08 revenues will be partially impacted by the shortage of Pentax components until we ramp up production to full capacity. Pentax’s supply arrangement is limited to components used in our fiberscopes only. Pentax does not supply components used in any other of our products, including any of our products under development, or any of our video-based scopes.
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Item 1A. RISK FACTORSRisk Factors
Set forth below and elsewhere in this report and in other documents we file with the SEC are descriptions ofYou should carefully consider the risks and uncertainties that could cause our actual results to differ materially fromwe describe below and the results contemplated by the forward-looking statements containedother information in this report. The description below includes any material changesQuarterly Report or incorporated by reference before deciding to invest in, or retain, shares of our common stock. These are not the only risks and amendsuncertainties that we face. Additional risks and supersedes, the description of the risk factors affectinguncertainties that we do not currently know about or that we currently believe are immaterial, or that we have not predicted, may also harm our business previously disclosed in “Part I, Item 1A. Risk Factors”operations or adversely affect us. If any of these risks or uncertainties actually occurs, our Annual Report on Form 10-K for the fiscal year ended March 31, 2007.
business, financial condition, operating results or liquidity could be materially harmed.
Our controller position is vacant, We have a history of operating losses and we may have difficulty fillingnot achieve or maintain profitability in the position. Failure to fill this position may reduce our ability to accurately report our financial results.future
Senior membersWe have incurred substantial operating losses since our inception (our net income in FY 07 resulted from the sale of our accounting staff, including our controller, have historically coordinated the managementa product line) and application of our accounting systems and directed our financial activities, including preparing reports which summarize and forecast our business activities, including our financial position in the areas of income, expenses, and earnings, based on past, present, and expected operations. As a result, our ability to accurately measure our financial activities and manage our growth is largely dependent on the efforts and abilities of our senior accountants. Our controller, who had been with us for only a short period, recently resigned on brief notice to take a position closer to his home. We are aware, and our auditors have confirmed, that without additional employees to fill our financial and administrative functions, our limited accounting staff represents a risk to the Company's internal controls. We are in the process of recruiting qualified additional employees and/or consultants in a financial and accounting capacity. If we are unable to recruit, hire in the near term and retain qualified employees and/or consultants with financial and accounting functions, it is reasonably likely to materially affect our internal controls over financial reporting. Even if we are able to retain qualified staff in this capacity, any system of controls and procedures, no matter how well designed and operated,there can provide only reasonable assurance that the desired objectives are met. The market for qualified management-level accounting personnel is very competitive and we can makebe no assurance that we will be able to quickly hireachieve a controller with appropriate qualifications. Although we have retained outside staff on a consulting basis for the interim, a failure to hire a controller with appropriate qualifications in the near future may have a material adverse effect on our ability to manage our accounting activities, report our results and complete our required filings in a timely manner.
We currently purchase certain critical components from several single source manufacturers under various supply agreements, and if these manufacturers are unable or unwilling to produce components, meeting our specifications in quantities that meet our production needs, our business will be harmed.
We currently purchase certain critical components from several single source manufacturers under various supply agreements, and if these manufacturers are unable or unwilling to produce components, meeting our specifications in quantities that meet our production needs, our business will be harmed.
In our the medical and the industrial segments, we purchase certain critical components for the majority of fiberscopes, such as image bundles, solely from a key supplier, Pentax, which is a competitor of ours. These components are being purchased pursuant to a supply agreement now due to expire in February 2009. Although we recently settled our dispute with Pentax, our agreement with them ends in one year and will not to be renewed.
We believe that while substitute components, which are currently produced by sources other than Pentax, will be available, and we are starting the design a new line of fiberscopes, a process which requires additional regulatory clearances. Moreover, these substitute components may not be immediately available in quantities and the quality needed by us. Our inability to obtain a sufficient quantity of such critical components on favorable terms and to obtain the required regulatory clearances for our new line of fiberscopes soon enough to permit us to produce them in sufficient quantities to meet customer demand could materially adversely affect our business.
With respect to our new, digital, video-based flexible scopes, we also depend on several single source manufacturers for certain critical components. The success of our new videoscopes will depend in part, on our ability to manufacture these videoscopes in sufficient quantities to meet customer demand. The failure or inability of one of these key suppliers to meet our production and quality needs could have a material adverse effect on the sales of our new videoscopes, their acceptance into the marketplace and our long term prospects.
29
We expect gross margin to vary over time, and ourprofitable level of product gross margin may not be sustainable
Our level of product gross margins may not be sustainable and may continue to be adversely affected by numerous factors, including:
· Changes in customer, geographic, or product mix
· Introduction of new products, including the introduction of the new family of videoscopes
· Our ability to reduce production costs
· Our entry into new markets, including markets with different pricing and cost structures, through acquisitions, such as our acquisition of the assets of BEST Dysphasia, Inc., or internal development
· Increases in material or labor costs
· Changes in shipment volume
· Loss of cost savings due to changes in component pricing including the affect of foreign exchange rates for components purchased overseas
· Increased price competition, especially due to the anticipated introduction of our family of videoscopes
· Changes in distribution channels
· Increased warranty costs
We depend on a small group of independent distributors for all of our revenues, and this dependence is likely to continueoperations in the future. Although we intend to expand this group, there is no assurance that we will be able to manage them.
InWe anticipate a negative cash flow during FY 09, because of additional spending for research and development, increasing our medical and industrial segments, we depend on distributors of medical devices and supplies and industrial equipment, respectively, for all of our product sales. Other than our ENT distributor, Medtronic, we do not have long-term contracts with our distributors, but rather typically sell to them on a unit-by-unit basis. We expect this relatively small group of distributors, which may change from year to year, to generate all of our product-sales revenue. We cannot assure you that any distributor will continue to purchase our products at the same levels as in prior years or that such relationships will continue. We expect that in any given period a relatively small, and changing, number of distributors will continue to account for all of our product-sales revenues.
Further, although we intend to significantly expand our currentglobal network of distributors, there is no assurance thatindependent sales representatives for the urology market, general business operations and capital expenditures. As of June 30, 2008, we will succeed in doing so in thehad cash and cash equivalents including short term. As we expand our distribution network, our inability to effectively manage this larger group may adversely impact our reputation among end users of our products, interfere with our ability to service existing customers and reduce our revenues from product sales, as further described below.
30
We need to expand our urology outside sales force to maintain and grow our business and product-sale revenues. Our failure to expand and maintain an effective sales force or successfully develop our relationship with other distributors, may materially and adversely affect our business, prospects and brand.
We currently market and sell our existing fiber-scopes for our ENT business through a single distributor, Medtronic, and our other scopes through other outside distributors and sales representatives. As part of our growth plan, we intend to increase the number of distributors we utilize to distribute our fiberscopes and videoscopes. We have limited experience in managing a large sales force and distributor network. We cannot assure you that we will be able to maintain an effective sales force or successfully develop our relationships with third-party, outside distributors. If we fail to do any one of those, our sales could fail to grow or could even decline, and our ability to grow our business could be adversely affected. The expansion of our sales force and distribution network is also likely to require a significant investment of financial resources and management efforts, and the benefits, if any, which we gain from such expansion, may not be sufficient to generate an adequate return on our investment.
If we fail to effectively manage our distribution network, our business, prospects and brand may be materially and affected by actions taken by our distributors.
We have a limited ability to manage the activities of our third-party, outside distributors, who are independent from us. Our distributors could take one or more of the following actions, any of which could have a material adverse effect on our business, prospects and brand:
·sell products that compete with our products in breach of their non-competition agreements with us;
·fail to adequately promote our products; or
·fail to provide proper service to our end-users.
Failure to adequately manage our distribution network, or the non-compliance of our distributors with their obligations under distribution agreements with us, could harm our corporate image among end users of our products and disrupt our sales, resulting in a failure to meet our sales goals.term investments totaling $16.7 million. Although we do not have significantly large overseas sales, foreign governments have increased their anti-bribery effortsanticipate the need for additional financing in the healthcare sectorFY 09, management may seek new financing, if terms are favorable. However, there can be no assurance that such financing will be available on terms acceptable to reduce improper payments received by hospital administratorsus, if at all.
Our stock price is volatile, and doctors in connection with the purchase of pharmaceutical products and medical devices. To our knowledge, none of our distributors engages in corrupt practices. However, our distributorsyou may violate these laws or otherwise engage in illegal practices with respect to their sales or marketing of our products which would adversely affect our corporate image and business.
If we fail to increase awareness and acceptance of our new videoscope system in the medical community, we will not be able to grow or even sustain our business.
Our new, digital, video-based flexible scopes, which come with an integrated “built-in’’ light source, eliminating the needsell your shares for a separate camera head, light cable and optical coupler, use new CCD technology, as opposed to older fiber-optic technology. To penetrate the potential market for this family of videoscopes, we must increase market awareness and useprofit
The trading price of our new technology, which depends on, among other things, the following:
·the general levelscommon stock is volatile. Our common stock price could be subject to fluctuations in response to a number of awareness and acceptancefactors, including:
·the effectiveness of our videoscope system, which we intend to further refine through research and development activities;
·the relative costs and benefits of treatment using our videoscope system as compared to other treatments;
·the financial or other benefits gained by doctors that use our videoscope with our EndoSheath system;
·the amount of resources we have available to increase product awareness and to educate potential purchasers and users of our videoscope system;
·our ability to continue to develop and enhance our family of videoscopes;
·our ability to provide good technical support and customer service; and
·our ability to keep up with technological changes and remain competitive.
We may not have the financial and operational resources required to promote awareness and acceptance of our new videoscopes systems as widely or rapidly as is necessary to grow or sustain our business. Even if we were
31
to devote a substantial portion of our resources to promoting our product, we may not succeed in raising the levels of awareness and acceptance of our videoscopes as quickly as is necessary to grow or sustain our business, if at all. If we fail to increase awareness and acceptance of our videoscopes in the medical community, we will not be able to grow, or even sustain, our business as planned, harming our financial condition and results of operations.
We may not succeed in sustaining a market for our new videoscopes.
Certain of our new line of videoscopes only recently received 510k clearance from the FDA. Going forward, the long-term success of our videoscope system depends on several factors, including our ability to:
·successfully promote product awareness of our videoscopes;
·competitively price our videoscopes and add-on components;
·develop new applications to expand our family of videoscopes;
·select effective distributors; and
·obtain additional regulatory approvals or clearances for new components or systems in a timely manner.
Existing videoscope technology is a well-established method for obtaining clinical diagnoses. As a result, our videoscopes are competing in a market in which there are already several established industry players. We cannot assure you that we will be able to successfully market or sell our videoscopes in the future. We also cannot assure you that our videoscopes, or any future enhancements to our videoscopes, will generate adequate revenue to offset our investments and costs in acquiring, developing or marketing our videoscopes. If there is insufficient demand for our videoscopes, our business, financial condition and results of operations may be harmed. In addition, any announcement of new products, services or enhancements
In the past, companies that have experienced volatility in the market price of their stock have been the target of securities class action litigation. We may become the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert management attention, which could seriously harm our business.
Rapid growth and a rapidly changing operating environment may strain our limited resources.resources
Our growth strategy includes our efforts to build our brand, develop new products, increase market penetration of our new videoscopes and develop a new line of fiber-based scopes to replace those manufactured with components supplied by Pentax. This growth strategy requires significant capital resources, and we may not generate an adequate return on our investment. Our growth may involve the acquisition of new technologies, businesses, products or services or the creation of strategic alliances in areas in which we do not currently operate. This could require our management to develop expertise in new areas, manage new business relationships and attract new types of customers. We may also experience difficulties integrating these acquired businesses, products or services into our existing business and operations. The success of our growth strategy also depends in part on our ability to utilize our financial, operational and management resources and to attract, train, motivate and manage an increasing number of employees. The success of our growth strategy depends on a number of internal and external factors, such as:
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We may not be able to implement our growth strategy successfully or manage our expansion effectively.
Further, as we ramp up our manufacturing operations to accommodate our planned growth, we may encounter difficulties associated with increasing production scale, including shortages of qualified personnel to operate our equipment, assemble our products or manage manufacturing operations, as well as shortages of key raw materials or components for our products. In addition, we may also experience difficulties in producing sufficient quantities of products or in achieving desired product quality. If we are unable to successfully operate and manage our manufacturing operations to meet our needs, we may not be able to provide our customers with the quantity or quality of products they require in a timely manner. This could cause us to lose customers and result in reduced product-sale revenues.
Our inability to continue to hire and retain key employees could have a negative impact on our future operating results
32 Our success depends on the services of our senior management team and other key employees in our research and development, manufacturing, operations, accounting, and sales and marketing departments. If we are unable to recruit, hire, develop and retain a talented, competitive work force, we may not be able to meet our strategic business objectives.
Our products and manufacturing practices are subject to regulation by the FDA and by other state and foreign regulatory agencies
Our products are medical devices and therefore subject to extensive regulation in the United States and in the foreign countries where we do business.
In the U.S., we are subject to regulation by the FDA and other regulatory agencies. The process of obtaining required regulatory clearances can be lengthy and expensive, and compliance with the FDA's Quality Systems Regulation can be burdensome. FDA regulations govern, among other things, the following activities that we perform, and will continue to perform, in connection with our products: design and development; product testing; manufacturing; labeling and packaging; storage; shipping and receiving; pre-market clearance or approval; advertising and promotion; and sales, distribution, and servicing.
There can be no assurance that the required regulatory clearances will be obtained, and those obtained may include significant limitations on the uses of the product in question. In addition, changes in existing regulations or the adoption of new regulations could make regulatory compliance by us more difficult in the future. The failure to obtain the required regulatory clearances or to comply with applicable regulations may result in fines, delays, suspensions of clearances, seizures, recalls of products, operating restrictions or criminal prosecutions, and could have a material adverse effect on our operations.
Foreign government regulations vary substantially from country to country. The time required to obtain approval by a foreign country may be longer or shorter than that required for FDA approval, and the requirements may differ significantly.
The European Union has adopted legislation, in the form of directives to be implemented in each member state, concerning the regulation of medical devices within the European Union. The directives include, among others, the Medical Devices Directive that establishes standards for regulating the design, manufacture, clinical trials, labeling, and vigilance reporting for medical devices. We have received CE (Conformité Européne) certification from Underwriters Laboratories UK for conformity with the European Union Medical Devices Directive allowing us to use the CE mark on our product lines. This quality system has been developed by the International Organization for Standardization to ensure that companies are aware of the standards of quality to which their products will be held worldwide. While no additional pre-market approvals in individual European Union countries are required prior to marketing of a device bearing the CE mark, practical complications with respect to marketing introduction may occur. For example, differences among countries have arisen with regard to labeling requirements. Failure to maintain the CE mark will preclude us from selling our products in the European Union. We may not be successful in maintaining certification requirements necessary for distribution of our products in the European Union.
Under the Canadian Medical Devices Regulations, all medical devices are classified into four classes, Class I being the lowest risk class and Class IV being the highest risk. Class I devices include among others, devices that make only non-invasive contact with the patient. Classes II, III and IV include devices of increasingly higher risk as determined by such factors as degree of invasiveness and the potential consequences to the patient if the device fails or malfunctions. Our current products sold in Canada generally fall into Classes II and III. All Class II, III and IV medical devices must have a valid Medical Device License issued by the Therapeutic Products Directorate of Health Canada before they may be sold in Canada (Class I devices do not require such a license). We have obtained applicable Medical Device Licenses for many of our products. Failure to maintain required Medical Device Licenses in Canada or to meet other requirements of the Canadian Medical Devices Regulations (such as quality system standards and labeling requirements) for our products will preclude us from selling our products in Canada. We may not be successful in continuing to meet the medical device licensing requirements necessary for distribution of our products in Canada.
The process of obtaining required regulatory clearances can be lengthy and expensive, and compliance with ISO 13485, CMDR, MDD and the FDA's QSR and regulatory requirements can be burdensome. Moreover, there can be no assurance that the required regulatory clearances will be obtained, and those obtained may include significant limitations on the uses of the product in question.
In addition, changes in existing regulations or the adoption of new regulations could make regulatory compliance by us more difficult in the future. The failure to obtain the required regulatory clearances or to comply with applicable regulations may result in fines, delays or suspensions of clearances, seizures, recalls of products, operating restrictions or criminal prosecutions, and could have a material adverse effect on our operations.
Reimbursements from third-party healthcare payers is uncertain because of factors beyond our control, and changes in third-party healthcare payers' policies could adversely affect our sales growth
In the U.S. and other foreign countries, government-funded or private insurance programs, or third-party payers, pay a significant portion of the cost of a patient's medical expenses. There is no uniform policy of reimbursement among all these payers. We believe that reimbursement is an important factor to the success of our product sales.
All U.S. and foreign third-party reimbursement programs, whether government funded or commercially insured, are developing increasingly sophisticated methods of controlling healthcare costs through prospective reimbursement and capitation programs, group purchasing, redesign of benefits, careful review of bills, and exploring more cost-effective methods of delivering healthcare. These types of programs can potentially limit the amount which healthcare providers may be willing to pay for our products.
There can be no assurance that third-party reimbursement will continue to be available for procedures performed with our products. In addition, reimbursement standards and rates may change. We believe that the failure of users of our products to obtain adequate reimbursement from third-party payers has had a materially adverse effect on our sales.
We currently purchase certain critical components from several single source manufacturers under various supply agreements, and if these manufacturers are unable or unwilling to produce components, meeting our specifications in quantities that meet our production needs, our business will be harmed
In our medical and industrial segments, we purchase certain critical components for the majority of our fiberscopes, and our newly developed videoscopes, from several single source manufacturers. For example, some critical parts for our existing line of fiberscopes are purchased solely from a key supplier, Pentax, which is a competitor of ours. These components are being purchased pursuant to a supply agreement now due to expire in February 2009. Although we recently settled our dispute with Pentax, our agreement with them ends in less than one year and will not be renewed.
As a result of the expiration of our supply agreement with Pentax, we are designing a new line of fiberscopes that do not use any parts manufactured by Pentax. We anticipate that we will be able to have completed the redesign and FDA approval process for our new line of fiberscopes by February '09. However, there are no assurances that we will be able to complete this process within such timeframe. Furthermore, as with the fiberscopes produced with Pentax parts, certain critical components of our redesigned fiberscopes and our newly designed videoscopes are available only from one or two suppliers. An interruption of supply from one of these suppliers or our inability to obtain a sufficient quantity of such critical components on favorable terms could materially adversely affect our business.
In addition, the success of our new videoscopes will depend in part on our ability to manufacture these videoscopes in sufficient quantities to meet customer demand. The failure or inability of one of these key suppliers to meet our production and quality needs could have a material adverse effect on the sales of our new videoscopes, their acceptance into the marketplace and our long term prospects.
In the industrial segment, borescopes are assembled using components and subassemblies purchased from independent vendors. While most components and subassemblies are currently available from more than one supplier, certain critical components are currently purchased only from two key suppliers Including Pentax. Our failure to obtain a sufficient quantity of such components on favorable terms could materially adversely affect our business.
We depend on a small group of independent distributors for all of our revenues, and a loss of one of these distributors may have a material adverse effect on our business. Although we intend to expand this group, there is no assurance that we will be able to obtain or manage them
In our medical and industrial segments, we depend on distributors of medical devices, supplies, and industrial equipment, respectively, for all of our product sales. In particular, in FY08 Medtronic accounted for 53% of our sales and 76% of our medical segment sales. We expect that in any given period a relatively small, and changing, number of distributors will continue to account for all of our product-sales revenues. We do not have long-term contracts with our distributors, but rather typically sell to them on a unit-by-unit basis. We expect this relatively small group of distributors, which may change from year to year, to generate all of our product-sales revenue. We cannot assure you that any distributor will continue to purchase our products at the same levels as in prior years, will purchase our new products (such as our videoscopes) or that such relationship will continue on favorable terms, if at all.
Further, although we intend to expand our current network of distributors, there is no assurance that we will succeed in doing so in the short term. As we expand our distribution network, our inability to effectively manage this larger group may adversely impact our reputation among end users of our products, interfere with our ability to service existing customers and reduce our revenues from product sales, as further described below.
If we fail to effectively manage our distribution network, our business, prospects and brand may be materially and adversely affected by actions taken by our distributors
We have a limited ability to manage the activities of our third-party, outside distributors, who are independent from us. Our distributors could take one or more of the following actions, any of which could have a material adverse effect on our business, prospects and brand:
Failure to adequately manage our distribution network, or the non-compliance of our distributors with their obligations under distribution agreements with us could harm our corporate image among end users of our products and disrupt our sales, resulting in a failure to meet our sales goals. Although we do not have significantly large overseas sales, foreign governments have increased their anti-bribery efforts in the healthcare sector to reduce improper payments received by hospital administrators and doctors in connection with the purchase of pharmaceutical products and medical devices. To our knowledge, none of our distributors engages in corrupt practices. However, our distributors may violate these laws or otherwise engage in illegal practices with respect to their sales or marketing of our products which would adversely affect our corporate image and business.
Competition in the medical device industry is intense, and many of our competitors have greater resources than we do
The flexible endoscopes and related products currently sold and under development by us face competition primarily from medical products companies such as Olympus Group, Pentax Imaging Company, Karl Storz GmbH & Co., Stryker Corp, and Gyrus Group PLC. In addition, any company that is able to significantly redesign conventional flexible endoscopes to simplify the cleaning process, or significantly improve the current methods of cleaning flexible endoscopes, would provide competition for our products.
The principal competitors for our industrial products are Olympus, General Electric—Inspection Technology and Karl Storz GmbH & Co. Many of our competitors and potential competitors have far greater financial resources, research and development personnel, and manufacturing and marketing capabilities than we have. Our competitors could utilize their greater financial resources to acquire other companies to gain enhanced name recognition and market share, as well as to acquire new technologies or products that could effectively compete with our product lines. In addition, it is possible that other large health care companies may enter the flexible endoscope market in the future.
Our ability to compete effectively depends upon our ability to distinguish our company and our products from our competitors and their products. Factors affecting our competitive position include:
We need to expand our outside sales force to maintain and grow our business and product-sale revenues. Our failure to expand and maintain an effective sales force or successfully develop our relationship with other distributors, may materially and adversely affect our business, prospects and brand
We currently market and sell our existing fiberscopes for our ENT business through a single distributor, Medtronic, and our other scopes through other outside distributors and sales representatives. As part of our growth plan, we intend to increase the number of distributors we utilize to distribute our fiberscopes and videoscopes. We have limited experience in managing a large sales force and distributor network. We cannot assure you that we will be able to maintain an effective sales force or successfully develop our relationships with third-party, outside distributors. If we fail to do any one of those, our sales could fail to grow or could even decline, and our ability to grow our business could be adversely affected. The expansion of our sales force and distribution network is also likely to require a significant investment of financial resources and management efforts, and the benefits, if any, which we gain from such expansion, may not be sufficient to generate an adequate return on our investment.
If we fail to increase awareness and acceptance of our new videoscope system in the medical community, we will not be able to grow or even sustain our business
Our new, digital, video-based flexible scopes, which comes with an integrated "built-in light" source, eliminating the need for a separate camera head, light cable and optical coupler, use new CCD technology, as opposed to older fiber-optic technology. To penetrate the potential market for this family of videoscopes, we must increase market awareness and use of our new technology, which depends on, among other things, the following:
We may not have the financial and operational resources required to promote awareness and acceptance of our new videoscope systems as widely or rapidly as is necessary to grow or sustain our business. Even if we were to devote a substantial portion of our resources to promoting our product, we may not succeed in raising the levels of awareness and acceptance of our videoscopes as quickly as is necessary to grow or sustain our business, if at all. If we fail to increase awareness and acceptance of
our videoscopes in the medical community, we will not be able to grow, or even sustain, our business as planned, harming our financial condition and results of operations.
We may not succeed in sustaining a market for our new videoscopes
Certain of our new line of videoscopes only recently received 510k clearance from the FDA. Going forward, the long-term success of our videoscope system depends on several factors, including our ability to:
Existing videoscope technology is a well-established method for obtaining clinical diagnoses. As a result, our videoscopes are competing in a market in which there are already several established industry players. We cannot assure you that we will be able to successfully market or sell our videoscopes in the future. We also cannot assure you that our videoscopes, or any future enhancements to our videoscopes, will generate adequate revenue to offset our investments and costs in acquiring, developing or marketing our videoscopes. If there is insufficient demand for our videoscopes, our business, financial condition and results of operations may be harmed. In addition, any announcement of new products, services or enhancements by us or our competitors may cause our customers to cancel or postpone purchasing decisions for our existing products in anticipation of these new products, services or enhancements.
New product development in the medical device and supply industry is both costly and labor-intensive and has a very low rate of successful commercialization
Our success will depend in part on our ability to enhance our existing products and technologies, through the development of alternate manufacturing lines for our fiberscopes, and to develop and acquire new products, such our videoscopes. The development process for medical technology is complex and uncertain, as well as time-consuming and costly. Product development requires the accurate assessment of technological and market trends as well as precise technological execution. We cannot assure you that:
We may also be unable to locate suitable products or technologies to acquire or acquire such products or technologies on commercially reasonable terms. Failure to develop or acquire, obtain necessary regulatory clearances or approvals for, or successfully commercialize or market potential new products or technologies could have a material adverse effect on our financial condition and results of operations.
If we do not continue to develop and commercialize new products and identify new markets for our products and technology, we may not remain competitive, and our revenues and operating results could suffer
The endoscopy industry is subject to continuous technological development and product innovation. If we do not continue to innovate in developing new products and applications, our competitive position will likely deteriorate as other companies successfully design and commercialize new products and applications. Accordingly, our success depends in part on developing new and innovative applications of our endoscopy technology and identifying new markets for and applications of existing products and technology. If we are unable to develop and commercialize new products and identify new markets for our products and technology, our products and technology could become obsolete and our revenues and operating results could be adversely affected.
Our operating results could be negatively impacted if we are unable to capitalize on research and development spending
We have spent, and continue to spend, a significant amount of time and resources on research and development projects, in order to develop and validate new and innovative products. We believe that these projects will result in the manufacturing of new products and will create additional future sales. However, factors including regulatory delays, safety concerns, or patent disputes could slow down the introduction or marketing of new products. Additionally, unanticipated issues may arise in connection with current and future clinical studies, which could delay or terminate a product's development prior to regulatory approval. We may also experience an unfavorable impact on our operating results if we are unable to capitalize on those efforts by attaining the proper FDA approval, or other foreign regulatory approvals, or to successfully market new products, including the new family of videoscope products, or other flexible endoscope products.
We expect gross margins to vary over time, and our level of product gross margins may not be sustainable
Our level of product gross margins may not be sustainable and may continue to be adversely affected by numerous factors, including:
Product quality problems could lead to reduced revenue, gross margins and net income
We produce highly complex videoscope products that incorporate leading-edge technology, including both hardware and software. Software typically contains bugs that can unexpectedly interfere with expected operations. There can be no assurance that our Quality Assurance testing programs will be adequate to detect all defects, either ones in individual products or ones that could affect numerous shipments, which might interfere with customer satisfaction, reduce sales opportunities, or affect gross margins. In the past, we have had to replace certain components and provide remediation in response to the discovery of defects or bugs in products that we had shipped. Although the cost of such remediation has not been material in the past, there can be no assurance that such a remediation, depending on the product involved, would not have a material impact. An inability to cure a product defect could result in the failure of a product line, temporary or permanent withdrawal from a product or market, damage to our reputation, inventory costs, or product reengineering expenses, any of which could have a material impact on our revenue, margins, and net income.
Our costs could substantially increase if we experience a significant number of warranty claims.claims
We provide 12-month product warranties against technical defects of our fiberscopes, and intend to offer a similar warranty for our new line of videoscopes. Our product warranty requires us to repair defects arising from product design and production process, and if necessary, replace defective components. Historically, we have received a limited number of warranty claims for our fiberscopes, but we are introducing a new line of videoscopes. The costs associated with our warranty claims have historically been relatively low. Thus, we generally do not accrue a significant liability contingency for potential warranty claims. As we only recently developed our videoscope line, we do not currently have historical data on potential warranty claims.
Our videoscope product is technologically superior to our fiberscope product, and was designed, built and tested against substantially higher benchmarks than our current fiberscope product line. Although we have insufficient historical warranty data to estimate the expected warranty claims from our videoscope product line, we expect that these warranty claims will be less than our historical warranty claims for the fiberscope product line. As of June 30, 2008, our warranty reserve was at 2.7% of our medical scopes revenues, reflecting our expected future liability from fiberscopes and videoscopes warranty claims, based on our historical fiberscope warranty claims.
We do believe that by using the historical data of our fiberscope product line, and the superior technological nature of our videoscope product, our current warranty reserve is reasonable, and we believe that the fiberscope historical data represents a reasonable basis for the videoscopes' warranty reserve. We will monitor the warranty data of our videoscope product line on a quarterly basis, and will update our warranty reserve accordingly.
If we experience an increase in warranty claims, or if our repair and replacement costs associated with warranty claims increase significantly, we will begin to incur liabilities for potential warranty claims after the sale of our products. Anproducts at levels that we have not previously incurred or anticipated. In addition, an increase in the frequency of warranty claims or amount of warranty costs may harm our reputation and could have a material adverse effect on our financial condition and results of operations.
Product liability suits against us may result in expensive and time consuming litigation, payment of substantial damages, and an increase in our insurance rates
New The development, manufacture, and sale of our products involve a significant risk of product developmentliability claims. We maintain product liability insurance with coverage limits of $22 million. We believe that this level of coverage is adequate, given our past sales levels, our anticipated sales levels for FY 09, and our claims experience. We will re-evaluate the adequacy of this coverage when and if our sales substantially increase, or another need arises. No product liability claims have been brought against us
to date. However, there can be no assurance that product liability insurance will continue to be available to us on acceptable terms, or that product liability claims in excess of our insurance coverage, if any, will not be successfully asserted against us in the medical device and supply industry is both costly and labor-intensive and has a very low rate of successful commercializationfuture.
We sell our products in numerous international markets.
Our success will dependoperating results may suffer if we are unable to manage our international sales and marketing activities effectively. We sell some of our products in part on our abilityforeign countries, and we therefore are subject to enhance our existing productsrisks associated with having international sales, such as:
·our product or technology development will Our operating results could be successfully completed;
·necessary regulatory clearances or approvals will be grantednegatively impacted by the FDAeconomic, political or other regulatory bodies as required on a timely basis, or at all; or
·any product or technologydevelopments in countries in which we develop can be commercialized or will achieve market acceptance.do business
We may also be unableOur business requires us to locate suitable productsmove some goods across international borders. Any events that interfere with, or technologies to acquire or acquire such products or technologies on commercially reasonable terms. Failure to develop or acquire, obtain necessary regulatory clearances or approvals for, or successfully commercialize or market potential new products or technologiesincrease the costs of, the transfer of goods across international borders could have a material adverse effect on our business.
We transport some of our goods across international borders, primarily those of the United States, Canada, Europe, Japan and Israel. Since September 11, 2001, there has been more intense scrutiny of goods that are transported across international borders. As a result, we may face delays, and increase in costs due to such delays in delivering goods to our customers. Any events that interfere with, or increase the costs of the transfer of goods across international borders could have a material adverse effect on our business.
Conditions in Israel affect our operations and may limit our ability to produce and sell our products
Currently we use several subcontractors in Israel to develop and produce some of our products. Political, economic and military conditions in Israel may directly affect our operations, and we could be adversely affected by hostilities involving Israel, the interruption or curtailment of trade between Israel and its trading partners or a significant downturn in the economic or financial condition of Israel. Israel frequently has been subject to terrorist activity, with varying levels of severity, and resultsthe United States Department of operations.State has issued an advisory regarding travel to Israel. According to the U.S. Department of State's website, the violence in Iraq and the clashes between Palestinians and Israelis have the potential to produce demonstrations and unrest throughout the region. Also, although it has not yet occurred, the political and security situation in Israel may result in certain parties with whom we have contracts claiming that they are not obligated to perform their commitments pursuant to force majeure provisions of those contracts.
In addition, since some of the components of our manufacturing and research and development sub-contractors are located in Israel, we could experience disruption of our manufacturing, and research and development activities due to terrorist attacks. If terrorist acts were to result in substantial damage to our sub-contractors facilities, our business activities would be disrupted, and our revenues may be severely impacted. Our business interruption insurance may not adequately compensate us for losses that may occur, and any losses or damages sustained by us could have a material adverse effect on our business.
Currency exchange rate fluctuations could adversely affect our operating results
33 Because some of our business includes international business transactions, costs and prices of our products or components in overseas countries are affected by foreign exchange rate changes. As a result, foreign exchange rate fluctuations may adversely affect our business, operating results and financial condition. Given the current weakness of the dollar, it is likely that we will have to pay more for certain components or subassemblies, which may harm our results, particularly as most of our sales take place in the United States.
Currently, we do not enter into foreign exchange forward contracts and we do not hedge anticipated foreign currency cash flows.
We are exposed to credit risk of some of our customers
Most of our sales are on an open credit basis, with typical payment terms of 30 days in the United States and, because of local customs or conditions, longer in some markets outside the United States. We monitor individual customer payment capability in granting such open credit arrangements, seek to limit such open credit to amounts we believe the customers can pay, and maintain reserves we believe are adequate to cover exposure for doubtful accounts. Beyond our open credit arrangements, we have also experienced demands for customer financing and facilitation of leasing arrangements, which we refer to leasing companies unrelated to us.
Our exposure to the credit risks may increase if there is an economic slowdown. Although we have programs in place that are designed to monitor and mitigate the associated risk, there can be no assurance that such programs will be effective in reducing our credit risks. Future credit losses, if incurred, could harm our business and have a material adverse effect on our operating results and financial condition. A portion of our sales is derived through our distributors and retail partners. These distributors and retail partners are generally given business terms that allow them to return a portion of inventory, receive credits for changes in selling prices, and participate in various cooperative marketing programs. We maintain estimated accruals and allowances for such business terms. However, distributors tend to have more limited financial resources than other resellers and end-user customers and therefore represent potential sources of increased credit risk because they may be more likely to lack the reserve resources to meet payment obligations.
We may not be able to protect our intellectual property rights or technology effectively
Our success depends in part on our ability to maintain patent protection for our products, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. There can be no assurance that our pending patent applications will result in patents being issued, or that our competitors will not circumvent, or challenge the validity of, any patents issued to us. There can be no assurance that measures taken by us to protect our proprietary information will prevent the unauthorized disclosure or use of this information or that others will not be able to independently develop such information. In addition, in the event that another party infringes our patent rights or other proprietary rights, the enforcement of such rights is at our option and can be a lengthy and costly process, with no guarantee of success. Moreover, there can be no assurance that claims alleging infringement by us of other's proprietary rights will not be brought against us in the future or that any such claims will not be successful. If we are unable to maintain the proprietary nature of our technologies, our ability to market or be competitive with respect to some or all of our products may be affected, which could reduce our sales and affect our ability to become profitable.
There can be no assurance that our pending patent applications will result in patents being issued or that our competitors will not circumvent, or challenge the validity of, any patents issued to us. In addition, in the event that another party infringes our patent rights, the enforcement of such rights is at our option and can be a lengthy and costly process, with no guarantee of success.
Some of the technology used in, and that may be important to, our products is not covered by any patent or patent application. We seek to maintain the confidentiality of our proprietary technology by requiring all our employees to sign confidentiality agreements, and by limiting access by outside parties to such confidential information. However, there can be no assurance that these measures will prevent the unauthorized disclosure or use of this information, or that others will not be able to independently develop such information. Moreover, as is the case with our patent rights, the enforcement of our trade secret rights can be lengthy and costly, with no guarantee of success.
We may not be able to complete our consolidation on time
On May 1, 2008, we entered into a definitive lease agreement (the "Lease"), with Ramland Realty Associates, L.L.C. (the "Landlord"), for our new premises, consisting of approximately 34,795 square feet at One Ramland Road, Orangeburg, New York. The new premises will permit us to complete our previously announced consolidation of our Natick manufacturing facilities with our Orangeburg research and development, manufacturing and office facilities into one site. However, if we are unable to do so by the time our short term lease in Natick expires in December 2008, and we are unable to extend it for an additional period of time, it could disrupt our production of the EndoSheath, which could adversely affect the Company.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.Proceeds
N/A.A
Item 3. DEFAULTS UPON SENIOR SECURITIESDefaults Upon Senior Securities
N/A.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERSSubmission of Matters to a Vote of Stockholders
N/A.
Item 5. OTHER INFORMATIONOther Information
N/A.
Exhibits | ||||
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31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-15(e)/15d-15(e), promulgated under the Securities Exchange Act of 1934, as amended. | |||
31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-15(e)/15d-15(e), promulgated under the Securities Exchange Act of 1934, as amended. | |||
32 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
34
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.
| ||
VISION-SCIENCES, INC. | ||
| /s/ RON HADANI | |
Ron Hadani President, CEO (Duly Authorized Officer) | ||
Date: August 14, 2008 | ||
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| |
Yoav M. Cohen Vice President Finance, Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |
35 VISION-SCIENCES, INC.
EXHIBIT INDEX
Exhibit No. | Description | ||
---|---|---|---|
3.1(1) | Amended and Restated Certificate of Incorporation of the Company, as amended to date | ||
3.2(2) | By-laws, as amended to date | ||
*10.1(3) | 1990 Stock Option Plan, as amended | ||
*10.2(3) | 2003 Director Option Plan | ||
*10.3(4) | 2000 Stock Incentive Plan | ||
10.3.1(14) | 2007 Stock Incentive Plan | ||
*10.4(2) | Vision-Sciences, Inc. 401(k) Plan, as amended | ||
*10.5(2) | Form of Vision-Sciences, Inc. Invention, Non-Disclosure and Non-Competition Agreement for employees | ||
*10.6(17) | Letter Agreement between the Company and Ron Hadani dated January 24, 2003 | ||
10.9(2) | Registration Rights Agreement dated as of February 28, 1992 among the Registrant and the persons listed therein | ||
10.10(1) | Piggyback Registration Rights Agreement, dated January 2, 2001, between the Company and the individuals and entities listed therein | ||
10.11(9) | Supply Agreement dated March 16, 1992 between the Registrant and Pentax Corporation (formerly known as Asahi Optical Co., Ltd.) and amendment dated October 1, 2002 | ||
10.12(15) | Termination Agreement between Pentax Corporation and Vision-Sciences, Inc. dated February 12, 2008 | ||
10.14(6) | License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated June 10, 1993 | ||
10.15(7) | Amendment to License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated April 5, 1994 | ||
10.16(8) | Amendment to License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated April 5, 1995 | ||
10.17(8) | Amendment to License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated April 5, 1996 | ||
**10.19(5) | License Agreement dated as of August 6, 1998 between Vision-Sciences, Inc. and Pentax Corporation (formerly Asahi Optical Co., Ltd.) | ||
10.21(4) | Agreement of Lease between 30 Ramland Road LLC and Vision-Sciences, Inc. dated as of March 23, 2000 | ||
10.26(10) | Exclusive Distribution Agreement between the Company and Medtronic Xomed, Inc. dated August 6, 2003 |
VISION-SCIENCES, INC.
EXHIBIT INDEX
Exhibit No. | Description | ||
---|---|---|---|
10.31(11) | Asset Purchase Agreement dated as of January 16, 2007 by and between Medtronic Xomed, Inc. and the Company | ||
10.32(11) | Amended and Restated Exclusive Distribution Agreement dated as of March 26, 2007 by and between the Company and Medtronic Xomed, Inc. | ||
10.33(11) | License Agreement dated as of March 26, 2007 by and between the Company and Medtronic Xomed, Inc. | ||
*10.34(17) | Amendment dated April 4, 2007 to Employment Letter Agreement of Yoav Cohen | ||
*10.35(17) | Amendment dated April 4, 2007 to Employment Letter Agreement of Ron Hadani | ||
10.36(12) | Merrill Lynch Loan Management Account Agreement (the "Agreement") between Vision-Sciences, Inc. and Merrill Lynch Bank USA ("Bank") and accompanying Commitment Letter from the Bank | ||
10.37(13) | Lease Agreement dated as of May 1, 2008 between Ramland Realty Associates LLC and Vision Sciences, Inc. | ||
10.38(17) | Third Amendment to Lease between 30 Ramland Road, LLC dated as December 26, 2006 LLC and Vision Sciences, Inc. | ||
10.39(16) | Development and Supply Agreement between Vision-Sciences, Inc. and SpineView, Inc. dated June 19, 2008 | ||
21.1(17) | Subsidiaries of the Company | ||
31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended. | ||
31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended. | ||
32 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
VISION-SCIENCES, INC.
EXHIBIT INDEX